<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 22, 1995
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(A) OF THE SECURITIES EXCHANGE ACT OF
1934
Filed by the Registrant [X]
Filed by a Party other than the Registrant [_]
Check the appropriate box:
[_] Preliminary Proxy Statement [_] Confidential, for Use of
[X] Definitive Proxy Statement the Commission Only (as
[_] Definitive Additional Materials permitted by Rule 14a-
6(e)(2))
[_] Soliciting Material Pursuant to Rule 14a-11(c) or Rule 14a-12
SIERRA HEALTH SERVICES, INC.
(NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Payment of Filing Fee (Check the appropriate box):
[_] $125 per Exchange Act Rule 0-11(c)(1)(ii), 14a-6(i)(1), or 14a-6(i)(2) or
Item 22(a)(2) of Schedule 14A.
[_] $500 per each party to the controversy pursuant to Exchange Act Rule 14a-
6(i)(3).
[_] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.
[_] Fee paid previously with preliminary materials.
[X] Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.
(1) Amount Previously Paid: $33,996
(2) Form, Schedule of Registration Statement No.: Registration No. 33-60591
(3) Filing Party: Sierra Health Services, Inc.
(4) Date Filed: June 27, 1995
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<PAGE>
[LETTERHEAD OF SIERRA HEALTH SERVICES, INC.]
September 19, 1995
Dear Shareholder:
You are cordially invited to attend a Special Meeting of Shareholders of
Sierra Health Services, Inc. that will be held on October 24, 1995 at 11:00
A.M., local time, at the Omni Los Angeles Hotel & Centre, 930 Wilshire Blvd.,
Los Angeles, California.
At the Special Meeting, shareholders will be asked to approve an Agreement
and Plan of Merger providing for the merger of Health Acquisition Corp., a
wholly-owned subsidiary of Sierra, with and into CII Financial, Inc. and the
issuance of shares of Sierra Common Stock pursuant to such Agreement.
Pursuant to the merger, each share of Common Stock of CII will be converted
into 0.37 of a share of Common Stock of Sierra. The proposed merger is
described in the accompanying Joint Proxy Statement/Prospectus, the forepart
of which includes a summary of the terms of the merger and certain other
information relating to the proposed transaction.
Sierra's Board of Directors has determined that the merger is in the best
interests of Sierra and its shareholders. Accordingly, the Board of Directors
has unanimously approved the merger and recommends that you vote in favor of
the merger at the meeting.
Because of the significance of the proposed merger to Sierra, your
participation in this meeting, in person or by proxy, is especially important.
Please sign and return the enclosed proxy card as soon as possible in the
envelope provided so that your shares can be voted at the Special Meeting in
accordance with your instructions. Even if you plan to attend the Special
Meeting, we urge you to sign and promptly return the enclosed proxy. You can
revoke the proxy at any time prior to voting, or vote your shares personally
if you attend the Special Meeting.
Thank you and I look forward to seeing you at the Special Meeting.
Sincerely,
Anthony M. Marlon, M.D.
Chairman of the Board and Chief
Executive Officer
[ADDRESS OF SIERRA HEALTH SERVICES, INC.]
<PAGE>
SIERRA HEALTH SERVICES, INC.
P.O. BOX 15645
LAS VEGAS, NEVADA 89114-5645
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD ON OCTOBER 24, 1995
A Special Meeting of Shareholders of SIERRA HEALTH SERVICES, INC. will be
held on Tuesday, October 24, 1995 at the Omni Los Angeles Hotel & Centre, 930
Wilshire Blvd., Los Angeles, California at 11:00 A.M., local time, to consider
the following matters:
(1) The approval of the Agreement and Plan of Merger, dated as of June
12, 1995, attached as Annex A to the accompanying Joint Proxy
Statement/Prospectus, providing for the merger of Health Acquisition Corp.,
a wholly-owned subsidiary of Sierra, with and into CII Financial, Inc.,
pursuant to which each share of Common Stock of CII will be converted into
0.37 of a share of Common Stock, par value $.005 per share, of Sierra (the
"Sierra Common Stock"), and the approval of the issuance of shares of
Sierra Common Stock pursuant to such Agreement in the Merger and upon
exercise of CII's outstanding options and conversion of its outstanding
debentures; and
(2) Such other business as may properly be brought before the Special
Meeting.
Only holders of record of the Sierra Common Stock at the close of business
on September 11, 1995, will be entitled to notice of and to vote at the
Special Meeting and at any adjournments or postponements thereof.
You are cordially invited to attend the Special Meeting. Whether or not you
expect to attend the Special Meeting in person, please fill out, sign, date
and return at your earliest convenience, in the envelope provided, the
enclosed proxy card which is being solicited on behalf of Sierra's Board of
Directors. The proxy card shows the form in which your shares of Sierra Common
Stock are registered. Your signature must be in the same form. The return of
the proxy card does not affect your right to vote in person should you decide
to attend the Special Meeting. We look forward to seeing you.
By Order of the Board of Directors,
Frank E. Collins
Secretary
Las Vegas, Nevada
September 19, 1995
ALL SHAREHOLDERS ARE CORDIALLY INVITED TO ATTEND THE SPECIAL MEETING.
YOUR VOTE IS IMPORTANT. TO ASSURE THAT YOUR SHARES WILL BE VOTED AT THE
SPECIAL MEETING, HOWEVER, YOU ARE REQUESTED TO MARK, SIGN AND RETURN THE
ENCLOSED PROXY CARD PROMPTLY IN THE ENCLOSED POSTAGE-PAID, ADDRESSED
ENVELOPE WHETHER OR NOT YOU EXPECT TO ATTEND THE SPECIAL MEETING. NO
ADDITIONAL POSTAGE IS REQUIRED IF MAILED IN THE UNITED STATES. IF YOU
ATTEND THE SPECIAL MEETING, YOU MAY VOTE IN PERSON EVEN THOUGH YOU HAVE
SENT IN YOUR PROXY.
<PAGE>
SIERRA HEALTH SERVICES, INC.
AND
CII FINANCIAL, INC.
JOINT PROXY STATEMENT
----------------
SIERRA HEALTH SERVICES, INC.
PROSPECTUS
This Joint Proxy Statement/Prospectus ("Joint Proxy Statement/Prospectus")
is being furnished to shareholders of Sierra Health Services, Inc. ("Sierra")
and CII Financial, Inc. ("CII") in connection with the solicitation of proxies
by the Board of Directors of Sierra from holders of Sierra's outstanding
shares of Common Stock, par value $0.005 per share (the "Sierra Common
Stock"), for use at a special meeting of shareholders of Sierra (together with
any adjournments or postponements thereof, the "Sierra Special Meeting") and
in connection with the solicitation of proxies by the Board of Directors of
CII from holders of CII's outstanding shares of Common Stock (the "CII Common
Stock"), for use at a special meeting of shareholders of CII (together with
any adjournments or postponements thereof, the "CII Special Meeting" and,
together with the Sierra Special Meeting, the "Special Meetings"). This Joint
Proxy Statement/Prospectus relates to the proposed merger of Health
Acquisition Corp. ("Sierra Sub"), a wholly-owned subsidiary of Sierra, with
and into CII, pursuant to the Agreement and Plan of Merger, dated as of June
12, 1995, among Sierra, Sierra Sub and CII (the "Merger Agreement").
This Joint Proxy Statement/Prospectus also constitutes a prospectus of
Sierra with respect to shares of the Sierra Common Stock issuable to CII
shareholders in the Merger, shares of Sierra Common Stock to be issuable after
the Merger upon conversion of CII's 7 1/2% Convertible Subordinated Debentures
due 2001 (the "CII Debentures") and shares of Sierra Common Stock to be
issuable after the Merger upon exercise of stock options granted pursuant to
various stock option plans maintained by CII.
This Joint Proxy Statement/Prospectus and the accompanying forms of proxy
are first being mailed to shareholders of Sierra and CII on or about September
22, 1995.
SEE "RISK FACTORS" FOR A DISCUSSION OF CERTAIN FACTORS WHICH SHAREHOLDERS OF
SIERRA AND CII SHOULD CONSIDER IN CONNECTION WITH THEIR VOTE.
----------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
----------------
THE DATE OF THIS JOINT PROXY STATEMENT/PROSPECTUS IS SEPTEMBER 19, 1995.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C>
AVAILABLE INFORMATION...................................................... 2
INCORPORATION OF CERTAIN INFORMATION BY REFERENCE.......................... 2
SUMMARY.................................................................... 3
The Companies............................................................ 3
Special Meetings......................................................... 3
The Merger............................................................... 4
Risk Factors............................................................. 6
Selected Consolidated Financial Data--Sierra Health Services, Inc. ...... 7
Selected Consolidated Financial Data--CII Financial, Inc. ............... 8
Comparative Market Price Data............................................ 9
Selected Comparative Per Share Data...................................... 10
RISK FACTORS............................................................... 11
Risk Factors Applicable to Sierra........................................ 11
Risk Factors Applicable to CII........................................... 14
Risk Factors Applicable to the Merger.................................... 17
COMPARATIVE MARKET PRICE DATA.............................................. 18
SPECIAL MEETINGS........................................................... 19
VOTING AND PROXY INFORMATION............................................... 19
Sierra................................................................... 19
CII...................................................................... 20
THE MERGER................................................................. 21
Background............................................................... 21
Retention of Financial Advisors; Projections............................. 22
Sierra Reasons for the Merger; Recommendation of Sierra's Board of
Directors............................................................... 24
Opinion of Sierra's Financial Advisor.................................... 26
CII Reasons for the Merger; Recommendation of CII's Board of Directors... 29
Opinion of CII's Financial Advisor....................................... 30
The Merger Agreement..................................................... 35
Litigation Challenging the Merger........................................ 40
Certain Federal Income Tax Consequences.................................. 40
Rights of CII Dissenting Shareholders.................................... 42
Restrictions on Resales of Securities.................................... 44
Accounting Treatment..................................................... 44
Board of Directors and Management Following the Merger................... 45
Interests of Certain Persons in the Merger............................... 45
Regulatory Approvals..................................................... 48
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............. 49
Sierra................................................................... 49
CII...................................................................... 50
</TABLE>
<TABLE>
<S> <C>
COMPARISON OF RIGHTS OF HOLDERS OF SIERRA AND CII COMMON STOCK............. 52
Authorized Capital Stock................................................. 52
Board of Directors....................................................... 52
Cumulative Voting........................................................ 52
Preemptive Rights........................................................ 53
Director's Liability..................................................... 53
Indemnification.......................................................... 53
Special Meetings of Shareholders; Action Without a Meeting............... 54
Mergers, Share Exchanges and Sales of Assets............................. 54
Amendment of Articles of Incorporation and By-laws....................... 55
Rights of Dissenting Shareholders........................................ 55
Dividends................................................................ 56
Shareholder Rights Plan.................................................. 56
CERTAIN INFORMATION CONCERNING SIERRA...................................... 56
CERTAIN INFORMATION CONCERNING CII......................................... 58
General.................................................................. 58
Recent Developments...................................................... 59
Additional Information................................................... 59
UNAUDITED CONSOLIDATED CONDENSED PRO FORMA FINANCIAL DATA.................. 60
PROXY SOLICITATION......................................................... 68
LEGAL MATTERS.............................................................. 68
EXPERTS.................................................................... 68
SHAREHOLDER PROPOSALS...................................................... 68
RESTATED CONSOLIDATED FINANCIAL STATEMENTS OF CII.......................... F-1
ANNEX A: Agreement and Plan of Merger....................................
ANNEX B: CII Annual Report on Form 10-K/A for the
year ended December 31, 1994...................................
ANNEX C: CII Quarterly Report on Form 10-Q/A for
the quarter ended June 30, 1995................................
ANNEX D: Selected Sections of the California General Corporation Law.....
ANNEX E: Opinion of Bear, Stearns & Co. Inc. ............................
ANNEX F: Opinion of Vector Securities International Inc. ................
ANNEX G: Information Concerning Proposed Directors
and Management of CII. ........................................
</TABLE>
i
<PAGE>
AVAILABLE INFORMATION
Sierra and CII are subject to the informational requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act") and in
accordance therewith such companies file periodic reports, proxy statements
and other information with the Securities and Exchange Commission (the
"Commission"). Such reports, proxy statements and other information concerning
Sierra and CII may be inspected and copied at the Commission's Public
Reference Section, Room 1024, 450 Fifth Street, N.W., Judiciary Plaza,
Washington, D.C. 20549, where copies may be obtained at prescribed rates, as
well as at the following regional offices: Northeast Regional Office, 7 World
Trade Center, Suite 1300, New York, New York 10048; and Midwest Regional
Office, Northwestern Atrium Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661-2511. Sierra Common Stock is listed on the New York
Stock Exchange. Copies of reports, proxy statements and other information
concerning Sierra may also be inspected at the office of such Exchange, 20
Broad Street, New York, New York 10005. The CII Common Stock is listed on the
American Stock Exchange. Copies of reports, proxy statements and other
information concerning CII may also be inspected at the office of such
Exchange, 86 Trinity Place, New York, New York 10006.
Sierra has filed a Registration Statement on Form S-4 (the "Registration
Statement") under the Securities Act of 1933, as amended (the "Securities
Act"), with the Commission with respect to the shares of Sierra Common Stock
to be issued by it in the Merger. This Joint Proxy Statement/Prospectus
constitutes the Prospectus of Sierra that is filed as part of such
Registration Statement. As permitted by the rules and regulations of the
Commission, this Joint Proxy Statement/Prospectus omits certain information
contained in the Registration Statement and reference is hereby made to the
Registration Statement for further information with respect to Sierra and the
Sierra Common Stock.
INCORPORATION OF CERTAIN INFORMATION BY REFERENCE
The following documents filed with the Commission by Sierra are incorporated
in this Joint Proxy Statement/Prospectus by reference:
1. Annual Report on Form 10-K for the fiscal year ended December 31, 1994
filed pursuant to Section 13(a) or 15(d) of the Exchange Act, as amended on
Form 10-K/A filed with the Commission on September 1, 1995 (the "Sierra 10-
K").
2. Quarterly Report on Form 10-Q for the fiscal quarter ended March 31,
1995 filed with the Commission on May 12, 1995.
3. Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 1995
filed with the Commission on August 14, 1995.
4. Current Report on Form 8-K filed with the Commission on March 2, 1995.
5. Current Report on Form 8-K filed with the Commission on June 21, 1995,
as amended on June 22 and July 11, 1995.
6. All other reports filed by Sierra pursuant to Section 13(a) or 15(d) of
the Exchange Act since the end of the fiscal year ended December 31, 1994.
7. The description of the Sierra Common Stock contained in the Registration
Statement of Sierra on Form 8-A filed pursuant to the Exchange Act on March
31, 1994, and effective on April 14, 1994.
8. The description of certain rights attaching to the Sierra Common Stock
to purchase Series A Junior Participating Preferred Stock contained in the
Registration Statement of Sierra on Form 8-A filed pursuant to the Exchange
Act on July 1, 1994.
All reports and other documents filed by Sierra after the date of this Joint
Proxy Statement/Prospectus pursuant to Sections 13(a), 13(c), 14 or 15(d) of
the Exchange Act and prior to October 24, 1995 shall be deemed to be
incorporated by reference herein and to be a part hereof.
The following documents filed with the Commission by CII are incorporated in
this Joint Proxy Statement/Prospectus by reference:
1. Annual Report on Form 10-K for the fiscal year ended December 31, 1994
filed pursuant to Section 13(a) or 15(d) of the Exchange Act, as amended on
Form 10-K/A filed with the Commission on August 16, 1995 (the "CII 10-K").
2. Quarterly Report on Form 10-Q for the fiscal quarter ended March 31,
1995 filed pursuant to Section 13(a) or 15(d) of the Exchange Act.
3. Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 1995
filed with the Commission on August 14, 1995, as amended on Form 10-Q/A filed
with the Commission on September 1, 1995 (the "CII 10-Q").
4. All other reports filed by CII pursuant to Section 13(a) or 15(d) of the
Exchange Act since the end of the fiscal year ended December 31, 1994.
Statements contained in this Joint Proxy Statement/Prospectus as to the
contents of any contract or document are not necessarily complete and in each
instance such statements are qualified in their entirety by reference to the
copy of such contract or other document filed as an exhibit to the
Registration Statement or incorporated by reference therein. Any statement
contained in a document incorporated or deemed to be incorporated in this
Joint Proxy Statement/Prospectus by reference shall be deemed to be modified
or superseded for the purpose of this Joint Proxy Statement/Prospectus to the
extent that a statement contained in this Joint Proxy Statement/Prospectus or
in any other subsequently filed document which also is or is deemed to be
incorporated in this Joint Proxy Statement/Prospectus by reference modifies or
supersedes such statement. Any such statement so modified or superseded shall
not be deemed, except as so modified or superseded, to constitute a part of
this Joint Proxy Statement/Prospectus.
THIS JOINT PROXY STATEMENT/PROSPECTUS INCORPORATES DOCUMENTS BY REFERENCE
WHICH ARE NOT PRESENTED HEREIN OR DELIVERED HEREWITH. THESE DOCUMENTS ARE
AVAILABLE UPON REQUEST FROM SIERRA, P.O. BOX 15645, LAS VEGAS, NEVADA 89114-
5645, ATTENTION: SECRETARY, TELEPHONE: (702) 242-7189 OR FROM CII, P.O. BOX
9025, PLEASANTON, CALIFORNIA 94566-9025, ATTENTION: SECRETARY, TELEPHONE:
(510) 416-8700. IN ORDER TO ENSURE TIMELY DELIVERY OF THE DOCUMENTS, ANY
REQUEST SHOULD BE MADE BY OCTOBER 17, 1995 IN THE CASE OF ANY REQUEST FOR
DOCUMENTS FROM SIERRA, AND BY OCTOBER 17, 1995 IN THE CASE OF ANY REQUEST FOR
DOCUMENTS FROM CII.
2
<PAGE>
SUMMARY
The following summary is intended only to highlight certain information
contained elsewhere in this Joint Proxy Statement/Prospectus. The summary is
not intended to be a complete statement of all material features of the Merger
and is qualified in its entirety by reference to the more detailed information
contained elsewhere in this Joint Proxy Statement/Prospectus and the annexes
attached hereto.
THE COMPANIES
SIERRA. Sierra is a managed health care company that provides and administers
the delivery of comprehensive health care programs with an emphasis on quality
care and cost management. Sierra's strategy has been to develop and offer a
portfolio of managed health care products to employer groups and individuals.
Sierra's broad range of managed health care services is provided through its
federally qualified health maintenance organization ("HMO") in Nevada, an HMO
in Texas, in which Sierra has a 50% ownership interest, managed indemnity
plans, third-party administrative services programs for employer-funded health
benefit plans and workers' compensation medical management programs. Ancillary
products and services that complement Sierra's managed health care product
lines are also offered.
The address of Sierra's principal executive offices is 2724 North Tenaya Way,
Las Vegas, Nevada 89128 and its telephone number is (702) 242-7000.
CII. CII is a holding company primarily engaged in writing workers'
compensation insurance through its wholly-owned subsidiaries. CII is also
engaged in the insurance premium finance business through a wholly-owned
subsidiary. In addition, CII has two operating insurance agencies, neither of
which is significant to the Consolidated Financial Statements of CII. For the
year ended December 31, 1994, CII operated in two reportable segments: (i)
workers' compensation and (ii) door lock manufacturing. In June 1995, CII
recorded the sale of its interest in its electronic door lock manufacturing
subsidiary.
The address of CII's principal executive offices is 5627 Gibraltar Drive,
Pleasanton, California 94588 and its telephone number is (510) 416-8700.
SPECIAL MEETINGS
GENERAL. The Sierra Special Meeting will be held on October 24, 1995, at
11:00 A.M., local time, at the Omni Los Angeles Hotel & Centre, 930 Wilshire
Blvd., Los Angeles, California. The purpose of the Sierra Special Meeting is to
consider and vote upon a proposal to approve the Merger Agreement and to
approve the issuance of Sierra Common Stock pursuant thereto and upon exercise
of outstanding CII stock options and conversion of the outstanding CII
Debentures. The CII Special Meeting will be held on October 24, 1995, at 10:00
A.M., local time, at the Omni Los Angeles Hotel & Centre, 930 Wilshire Blvd.,
Los Angeles, California. The purpose of the CII Special Meeting is to consider
and vote upon a proposal to approve and adopt the Merger Agreement. CII
shareholders should not send in their stock certificates until they receive a
transmittal form. See "Special Meetings."
RECORD DATES; SHARES ENTITLED TO VOTE. Holders of record of shares of Sierra
Common Stock at the close of business on September 11, 1995 (the "Sierra Record
Date") and holders of record of shares of CII Common Stock at the close of
business on September 11, 1995 (the "CII Record Date") will be entitled to
notice of and to vote at the respective Special Meetings. At the Sierra Record
Date, there were outstanding 14,812,613 shares of Sierra Common Stock. At the
CII Record Date, there were outstanding 7,206,221 shares of CII Common Stock.
See "Voting and Proxy Information."
3
<PAGE>
REQUIRED VOTES. The proposal to approve the Merger Agreement and the issuance
of Sierra Common Stock pursuant thereto must be approved by the holders of at
least a majority of the voting power of the shares of Sierra Common Stock
present at the Sierra Special Meeting in person or by proxy and entitled to
vote thereon and the proposal to approve the Merger Agreement must be approved
by the holders of at least a majority of the shares of CII Common Stock
outstanding at the CII Record Date. At the respective Record Dates, directors
and executive officers of Sierra and CII and their affiliates had the right to
vote, in the aggregate, 2,558,059 and 2,039,654 shares, respectively, of Sierra
Common Stock and CII Common Stock, representing approximately 17.3% and 28.3%,
respectively, of the Sierra Common Stock and CII Common Stock outstanding as of
the respective Record Dates. All of the directors and executive officers of
Sierra have indicated that they intend to vote all shares of Sierra Common
Stock held by them in favor of the Merger. All of the directors and each of the
officers of CII with employment agreements have indicated that they intend to
vote all shares of CII Common Stock which such persons have the right to vote
in favor of the Merger. Joseph G. Havlick, the Chairman of the Board, Chief
Executive Officer and President of CII, and Lee W. Spitler, Jr., the Senior
Vice President and Treasurer of CII, have entered into voting agreements with
Sierra to vote the shares which such persons have the right to vote in favor of
the Merger. See "Voting and Proxy Information."
THE MERGER
GENERAL. Under the terms of the Merger Agreement, Sierra Sub, a wholly-owned
subsidiary of Sierra, will be merged with and into CII and Sierra Sub will
cease to exist as a separate legal entity. In connection with the Merger, each
outstanding share of CII Common Stock will be converted into 0.37 of a share of
Sierra Common Stock as more fully described herein (the "Exchange Ratio").
Holders of CII Common Stock who would otherwise receive a fractional share will
be entitled to receive cash in lieu of a fractional share. The amount of such
cash (without interest) will be determined by multiplying the closing price for
the Sierra Common Stock as reported on the New York Stock Exchange Composite
Transactions on the business day two days prior to the effective time of the
Merger by the fractional share interest to which such holder would otherwise be
entitled. Additionally, at the effective time of the Merger, each outstanding
option to purchase shares of CII Common Stock issued pursuant to CII's stock
option plans will be assumed by Sierra and will constitute an option to acquire
the same number of shares of Sierra Common Stock into which such shares would
have been converted pursuant to the Merger had such options been exercised
immediately prior to the effective time. At the effective time of the Merger,
the CII Debentures will no longer be convertible into CII Common Stock and will
be convertible into Sierra Common Stock based on a conversion price adjusted
according to the Exchange Ratio. Based upon the capitalization of CII and
Sierra as of June 12, 1995 and the Exchange Ratio of 0.37, the holders of the
then outstanding shares of CII Common Stock would own securities representing
approximately 15% of the outstanding shares of Sierra Common Stock as a result
of the Merger. See "The Merger."
RECOMMENDATION OF SIERRA BOARD OF DIRECTORS. The Board of Directors of Sierra
has unanimously approved the Merger Agreement and recommends that holders of
Sierra Common Stock vote for the proposal to approve the Merger Agreement and
the issuance of Sierra Common Stock pursuant thereto. The Sierra Board's
recommendation is based upon a number of factors discussed in this Joint Proxy
Statement/Prospectus. See "The Merger--Sierra Reasons for the Merger;
Recommendation of Sierra's Board of Directors."
OPINION OF SIERRA'S FINANCIAL ADVISOR. Bear, Stearns & Co. Inc. ("Bear
Stearns") delivered to the Sierra Board of Directors on June 12, 1995 its oral
opinion to the effect that, as of such date, the Merger was fair from a
financial point of view to the shareholders of Sierra. Bear Stearns has
confirmed its opinion by delivery to the Sierra Board of a written opinion to
the same effect dated as of the date of this Joint Proxy Statement/Prospectus.
The full text of the written opinion of Bear Stearns, which sets forth the
assumptions made, matters considered and limitations on the review undertaken,
is attached as Annex E to this Joint Proxy Statement/Prospectus and should be
read carefully in its entirety. See "The Merger--Opinion of Sierra's Financial
Advisor."
RECOMMENDATION OF CII BOARD OF DIRECTORS. The Board of Directors of CII has
unanimously approved the Merger Agreement and recommends that the holders of
the CII Common Stock vote for the proposal to
4
<PAGE>
approve and adopt the Merger Agreement. The CII Board's recommendation is based
upon a number of factors discussed in this Joint Proxy Statement/Prospectus.
See "The Merger--CII Reasons for the Merger; Recommendation of CII's Board of
Directors."
OPINION OF CII'S FINANCIAL ADVISOR. On June 12, 1995, Vector Securities
International, Inc. ("Vector Securities") delivered its oral opinion (which
opinion was confirmed in writing) to CII's Board of Directors to the effect
that the consideration to be received in the Merger by the holders of CII
Common Stock was fair to such holders from a financial point of view as of such
date. The full text of the Vector Securities opinion, which sets forth the
procedures followed, the factors considered and the assumptions made by Vector
Securities, is included as Annex F to this Joint Proxy Statement/Prospectus and
should be read carefully in its entirety. See "The Merger--Opinion of CII's
Financial Advisor."
CONDITIONS TO THE MERGER. The respective obligations of Sierra and CII to
effect the Merger are subject to various conditions, including, among others,
(i) the Merger Agreement shall have been approved and adopted by the
shareholders of Sierra and CII, (ii) the shares of Sierra Common Stock issuable
and reserved for issuance in connection with the Merger shall have been
authorized for listing on the New York Stock Exchange, upon official notice of
issuance, (iii) the receipt of all material governmental authorizations,
consents, orders or approvals, (iv) the Registration Statement shall have
become effective and shall not be the subject of a stop order or proceedings
seeking a stop order, (v) no temporary restraining order, preliminary or
permanent injunction or other order shall be in effect that prevents the
consummation of the Merger, (vi) material nongovernmental consents or approvals
required in connection with the Merger shall have been received and (vii) the
Board of Directors of either party not having amended, modified, rescinded or
repealed the resolutions adopted by it in connection with the Merger and not
having adopted any other resolutions inconsistent therewith. See "The Merger--
The Merger Agreement--Conditions to the Merger."
REGULATORY APPROVALS. The Merger may not be consummated until notifications
have been given and certain information has been furnished to the Federal Trade
Commission and the Antitrust Division of the Department of Justice, and
specified waiting period requirements have been satisfied. Sierra's request for
early termination of the required waiting period has been granted and become
effective. The Merger is also subject to approval by the California Department
of Corporations and the California Department of Insurance. Under California
law, the Insurance Commissioner has 60 days from the date of the filing of a
Form A Information Statement with respect of the Merger to approve or
disapprove of the Merger. Sierra has been notified that the California
Department of Insurance approved the contemplated transactions. Filings with
and approvals from certain other state insurance regulatory authorities may
also be made or obtained in connection with the Merger. See "The Merger--
Regulatory Approvals."
CERTAIN FEDERAL INCOME TAX CONSEQUENCES. The Merger is expected to qualify as
a tax free reorganization under Section 368 of the Internal Revenue Code of
1986, as amended. The consummation of the Merger is conditioned on the receipt
of an opinion of counsel as to the federal income tax consequences, but no
ruling will be requested from the Internal Revenue Service. Holders of CII
Common Stock should consult with their own tax advisors regarding the federal,
state, local and foreign tax consequences of the Merger. See "The Merger--
Certain Federal Income Tax Consequences."
TERMINATION. The Merger Agreement may be terminated at any time prior to the
effective time of the Merger, (i) by mutual consent of Sierra and CII, (ii) by
either Sierra or CII if the other party has materially breached any
representation, warranty or covenant of the Merger Agreement, (iii) by CII if
its Board of Directors shall have adopted and recommended a competing offer to
its shareholders, (iv) by either Sierra or CII if the Merger shall not have
been consummated by December 31, 1995, (v) by either Sierra or CII if their
respective shareholders do not approve the Merger Agreement and the Merger or
(vi) by Sierra, in certain circumstances, if the Board of Directors of CII
withdraws, modifies or changes its recommendation of the Merger Agreement or
the Merger in a manner adverse to Sierra or Sierra Sub or if the Board of
Directors of CII recommends to the shareholders of CII certain types of
competing transactions or if a tender offer or exchange offer for the CII
5
<PAGE>
Common Stock is commenced and the Board of Directors of CII fails to recommend
against acceptance of such offer by its shareholders or takes no position with
respect to the acceptance of such offer by its shareholders. See "The Merger--
The Merger Agreement--Termination."
TERMINATION FEE. CII is required to pay Sierra a termination fee of
$5,000,000 in certain circumstances. See "The Merger--The Merger Agreement--
Termination Fee."
LITIGATION CHALLENGING THE MERGER. A holder of CII Common Stock has filed a
lawsuit as a purported class action against CII and the directors of CII
alleging breach of fiduciary duty in entering into the Merger Agreement and
against Sierra alleging that Sierra aided and abetted the alleged breach of
fiduciary duty by the CII directors. See "The Merger--Litigation Challenging
the Merger."
NO SOLICITATION OF TRANSACTIONS. Pursuant to the Merger Agreement, CII has
agreed not to solicit, encourage, facilitate, agree to or endorse any takeover
proposal of a third party. However, CII and its Board of Directors are not
prohibited from taking any action which is necessary in the exercise of its
fiduciary duties. See "The Merger--The Merger Agreement--No Solicitation of
Transactions."
EMPLOYMENT AGREEMENTS. In connection with the Merger, Messrs. Havlick and
Spitler, have agreed to enter into new employment agreements with CII effective
upon consummation of the Merger. See "The Merger--Interests of Certain Persons
in the Merger."
RIGHTS OF CII DISSENTING SHAREHOLDERS. Holders of CII Common Stock are
generally entitled to dissenters' rights with respect to the Merger under the
California General Corporation Law (the "CGCL") if, and only if, the holders of
5% or more of the outstanding shares of CII Common Stock elect to exercise
dissenters' rights. If the Merger is approved by the required vote of CII's
shareholders and is not terminated, CII's shareholders who vote against the
Merger and who have fully complied with all applicable provisions of the CGCL
and whose shares constitute CII Dissenting Shares (as defined below) will,
provided generally that the CII Dissenting Shares aggregate 5% or more of the
outstanding shares of CII Common Stock, have the right to require CII to
purchase the shares of CII Common Stock held by them for cash at the fair
market value of those shares as of the day before the terms of the Merger were
first announced, excluding any appreciation or depreciation resulting from the
Merger but adjusted for any stock split, reverse stock split or share dividend
which becomes effective thereafter. Under the CGCL, no shareholder of CII who
is entitled to exercise dissenters' rights has any right at law or in equity to
attack the validity of the Merger or to have the Merger set aside or rescinded,
except in an action to test whether the number of shares required to authorize
or approve the Merger had been legally voted in favor of the Merger. As used
herein, "CII Dissenting Shares" means those shares of CII Common Stock with
respect to which the holders have voted against the Merger and have perfected
their purchase demand in accordance with the CGCL, except that no such shares
shall constitute CII Dissenting Shares unless either (i) holders of 5% or more
of the outstanding shares of CII Common Stock file demands for payment as
dissenting shares under the CGCL or (ii) the shares in question are subject to
a restriction on transfer imposed by CII or by any law or regulation. Holders
of CII Dissenting Shares will be notified of the date on which the CII
Dissenting Shares will cease to be eligible for treatment as dissenting shares
under the CGCL. Procedures applicable to the exercise of dissenters' rights are
set forth under the caption "The Merger--Rights of CII Dissenting
Shareholders."
RISK FACTORS
The Merger involves certain risk factors that should be carefully considered
by the shareholders of Sierra and CII. See "Risk Factors."
6
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA--SIERRA HEALTH SERVICES, INC.
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following selected consolidated financial data of Sierra at December 31,
1990, 1991, 1992, 1993 and 1994 and for each of the years in the five-year
period ended December 31, 1994 have been derived from the audited Consolidated
Financial Statements of Sierra. The following selected consolidated financial
data of Sierra at June 30, 1995 and for the six-month periods ended June 30,
1994 and 1995 have been derived from Sierra's unaudited consolidated financial
statements which, in the opinion of management, include normal recurring
adjustments necessary for a fair presentation of the results of operations and
financial condition. The results of operations for the six-month period ended
June 30, 1995 are not necessarily indicative of the results to be expected for
the full year. See "Incorporation of Certain Information by Reference."
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------------------ ------------------
1990 1991 1992 1993 1994 1994 1995
-------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT
DATA: (1)
Operating Revenues:
Premiums............... $158,643 $192,904 $217,624 $240,691 $269,382 $129,679 $153,425
Professional Fees...... 8,375 10,306 10,206 11,254 12,331 5,900 7,670
Specialty Product
Revenues.............. 2,117 3,296 4,063 4,100 10,487 5,197 5,720
Investment and Other
Revenues.............. 2,725 2,515 2,060 2,032 3,601 1,310 3,455
-------- -------- -------- -------- -------- -------- --------
Total................ 171,860 209,021 233,953 258,077 295,801 142,086 170,270
-------- -------- -------- -------- -------- -------- --------
Operating Expenses:
Medical Expenses....... 121,811 147,169 166,495 178,526 200,229 96,519 116,490
General,
Administrative and
Other................. 38,362 43,363 44,176 50,715 53,671 26,444 30,803
Specialty Product
Expenses.............. 879 1,502 2,451 2,977 5,823 2,690 3,326
-------- -------- -------- -------- -------- -------- --------
Total................ 161,052 192,034 213,122 232,218 259,723 125,653 150,619
-------- -------- -------- -------- -------- -------- --------
Operating Income....... 10,808 16,987 20,831 25,859 36,078 16,433 19,651
-------- -------- -------- -------- -------- -------- --------
Other Income (Expense):
Minority Interests in
Subsidiary (Income)
Loss.................. 7 134 (249) (179) (113) (60) 1,096
Interest Expense and
Other, Net............ (573) (429) (505) 2 (1,830) (1,005) (761)
Litigation Settlement.. (5,500) (1,500) (784) -- -- -- --
-------- -------- -------- -------- -------- -------- --------
Total................ (6,066) (1,795) (1,538) (177) (1,943) (1,065) 335
-------- -------- -------- -------- -------- -------- --------
Income Before Income
Taxes................. 4,742 15,192 19,293 25,682 34,135 15,368 19,986
Provision for Income
Taxes................. 1,495 4,422 5,690 8,239 11,931 5,392 6,695
-------- -------- -------- -------- -------- -------- --------
Net Income............. $ 3,247 $ 10,770 $ 13,603 $ 17,443 $ 22,204 $ 9,976 $ 13,291
======== ======== ======== ======== ======== ======== ========
Earnings Per Common
Share (2)............. $ 0.28 $ 0.92 $ 1.14 $ 1.42 $ 1.71 $ 0.80 $ 0.91
======== ======== ======== ======== ======== ======== ========
Weighted Average Common
Shares Outstanding (2) 11,607 11,739 11,949 12,296 13,021 12,492 14,680
======== ======== ======== ======== ======== ======== ========
<CAPTION>
DECEMBER 31,
------------------------------------------------ JUNE 30,
1990 1991 1992 1993 1994 1995
-------- -------- -------- -------- -------- -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working Capital
(Deficit)............. $ (5,770) $ (2,138) $ 9,243 $ 5,727 $ 59,690 $ 75,859
Total Assets........... 82,421 85,487 108,113 144,424 223,250 245,986
Long-term Debt (Net of
Current Maturities)... 6,114 6,318 7,661 16,002 18,409 18,083
Cash Dividends Per
Common Share.......... -- -- -- -- -- --
Shareholders' Equity... 11,886 24,079 42,327 62,132 134,372 153,078
</TABLE>
--------
(1) Sierra reclassified amounts in its Consolidated Statements of Operations to
conform to the current presentation.
(2) Adjusted to account for a two-for-one stock split of the Sierra Common
Stock distributed on or about January 11, 1993 to shareholders of record as
of November 13, 1992.
7
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA--CII FINANCIAL, INC.
(IN THOUSANDS, EXCEPT RATIOS AND PER SHARE DATA)
The following selected consolidated financial data of CII at December 31,
1990, 1991, 1992, 1993 and 1994 and for each of the years in the five-year
period ended December 31, 1994 have been derived from the audited Consolidated
Financial Statements of CII. The following selected consolidated financial data
of CII at June 30, 1995 and for the six-month periods ended June 30, 1994 and
1995 have been derived from CII's unaudited consolidated financial statements
which, in the opinion of management, include normal recurring adjustments
necessary for a fair presentation of the results of operations and financial
condition. The results of operations for the six-month period ended June 30,
1995 are not necessarily indicative of the results to be expected for the full
year. See "Incorporation of Certain Information by Reference."
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------------------ ----------------
1990 1991 1992 1993 1994 1994 1995
-------- -------- -------- -------- -------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT
DATA:(3)
Net Earned Premiums.... $ 81,172 $101,701 $103,166 $109,614 $ 90,800 $45,919 $41,037
Net Investment Income.. 6,087 9,455 11,746 13,831 12,792 6,179 7,022
Other Revenues......... -- 1,083 1,591 1,908 2,688 1,110 1,686
-------- -------- -------- -------- -------- ------- -------
Total Revenues......... 87,259 112,239 116,503 125,353 106,280 53,208 49,745
Total Costs and
Expenses.............. 79,163 131,001 157,727 120,151 95,235 50,271 46,251
-------- -------- -------- -------- -------- ------- -------
Income (Loss) From
Continuing Operations
Before Federal Income
Tax................... 8,096 (18,762) (41,224) 5,202 11,045 2,937 3,494
Income Tax Expense
(Benefit)............. 1,662 (2,542) 1,355 196 (3,695) -- (750)
-------- -------- -------- -------- -------- ------- -------
Income (Loss) From
Continuing Operations. 6,434 (16,220) (42,579) 5,006 14,740 2,937 4,244
Loss From Discontinued
Operations............ -- -- -- (404) (2,501) (679) (6,600)
Extraordinary Gain..... -- -- 457 -- -- -- --
-------- -------- -------- -------- -------- ------- -------
Net Income (Loss)...... $ 6,434 $(16,220) $(42,122) $ 4,602 $ 12,239 $ 2,258 $(2,356)
======== ======== ======== ======== ======== ======= =======
Income (Loss) Per Share
From Continuing
Operations............ $ 1.22 $ (2.25) $ (5.94) $ 0.70 $ 2.05 $ 0.41 $ 0.57
Loss Per Share From
Discontinued
Operations............ -- -- -- (.06) (.35) (.10) (.90)
Extraordinary Gain Per
Share................. -- -- 0.06 -- -- -- --
-------- -------- -------- -------- -------- ------- -------
Net Income (Loss) Per
Share................. $ 1.22 $ (2.25) $ (5.88) $ 0.64 $ 1.70 $ 0.31 $ (.33)
======== ======== ======== ======== ======== ======= =======
Weighted Average Common
Shares Outstanding.... 5,275 7,210 7,168 7,142 7,181 7,173 7,406
======== ======== ======== ======== ======== ======= =======
Ratio of Earnings to
Fixed Charges(1)(2)... 47x -- -- 2x 3x 2x 2x
UNDERWRITING RATIOS:
Loss Ratio............. 70.2% 100.7% 115.8% 75.5% 59.1% 68.9% 59.0%
Underwriting Expense
Ratio................. 27.0 25.4 31.0 29.0 37.8 35.0 46.7
-------- -------- -------- -------- -------- ------- -------
Combined Ratio......... 97.2% 126.1% 146.8% 104.5% 96.9% 103.9% 105.7%
======== ======== ======== ======== ======== ======= =======
<CAPTION>
DECEMBER 31,
------------------------------------------------ JUNE 30,
1990 1991 1992 1993 1994 1995
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:(3)
Total Investments...... $125,331 $192,799 $183,987 $207,487 $221,717 $221,695
Total Assets........... 160,378 248,187 265,735 295,836 306,987 304,280
Total Long-term Debt... -- 58,250 56,800 56,800 56,800 56,800
Total Liabilities...... 89,123 193,825 253,682 278,510 278,452 275,918
Total Shareholders'
Equity................ 71,255 54,362 12,053 17,326 28,535 28,362
</TABLE>
--------
(1) For the purpose of calculating the ratio of earnings to fixed charges,
earnings consist of pretax income from continuing operations and fixed
charges. Fixed charges consist of interest expense and a representative
portion of rental expense.
(2) Earnings were inadequate to cover fixed charges by $20,337 and $45,686 for
the years ended December 31, 1991 and 1992, respectively.
(3) The historical financial information for 1994 and prior periods have been
adjusted to reflect the disposition of InteLock Technologies ("InteLock").
Revenues, expenses, and income taxes related to InteLock have been
eliminated from continuing operations and are shown as a net operating loss
from discontinued operations. InteLock's liabilities have been netted
against its related assets and the net amount is included in total assets
as net assets of discontinued operations.
8
<PAGE>
COMPARATIVE MARKET PRICE DATA
The Sierra Common Stock has been traded under the symbol "SIE" on the New
York Stock Exchange since 1994 and, prior to that, on the American Stock
Exchange since 1985. The CII Common Stock has been traded on the American Stock
Exchange under the symbol "CII" since 1990. The table below sets forth, for the
calendar quarters indicated, the high and low sales prices for the Sierra
Common Stock and the CII Common Stock as reported by the New York Stock
Exchange or the American Stock Exchange. During the periods presented below,
neither Sierra nor CII has declared or paid any dividends.
<TABLE>
<CAPTION>
PRICE PER SHARE OF COMMON STOCK
--------------------------------
SIERRA CII
----------------- --------------
HIGH LOW HIGH LOW
FISCAL 1993 --------- ------- ------ -------
<S> <C> <C> <C> <C>
First Quarter................................. $21 11/16 $12 3/4 $6 7/8 $4 5/8
Second Quarter................................ 21 1/4 11 1/2 7 5 1/8
Third Quarter................................. 22 15 1/8 6 1/4 5
Fourth Quarter................................ 22 5/8 15 1/2 7 1/2 5 1/4
FISCAL 1994
First Quarter................................. 30 3/4 22 7 3/8 4 3/4
Second Quarter................................ 29 21 1/4 6 1/4 4 5/8
Third Quarter................................. 28 23 1/8 6 3/8 5
Fourth Quarter................................ 33 1/2 25 5/8 6 1/4 4 3/4
FISCAL 1995
First Quarter................................. 32 7/8 27 3/8 7 4 5/8
Second Quarter ............................... 33 5/8 22 1/8 9 3/8 5 1/2
Third Quarter (through September 18, 1995).... 29 23 10 3/8 7 7/8
</TABLE>
On June 12, 1995, the last full trading day prior to the announcement of the
Merger Agreement, the reported New York Stock Exchange Composite Transactions
closing price of the Sierra Common Stock was $29.375 per share and the reported
American Stock Exchange Composite Transactions closing price of the CII Common
Stock was $8.125 per share. On September 18, 1995, the most recent available
date prior to the date of this Joint Proxy Statement/Prospectus, the reported
New York Stock Exchange Composite Transactions closing price of the Sierra
Common Stock was $26.875 per share and the reported American Stock Exchange
Composite Transactions closing price of the CII Common Stock was $9.625 per
share.
9
<PAGE>
SELECTED COMPARATIVE PER SHARE DATA
The following table sets forth certain information concerning the Sierra
Common Stock and the CII Common Stock. The tables also include certain pro
forma per share consolidated information which is based on the historical data
of Sierra and CII adjusted to give effect to the Merger. See "Incorporation of
Certain Information by Reference."
<TABLE>
<CAPTION>
SIERRA CII
-------------------- ------------------------
PRO FORMA EQUIVALENT
PER SHARE PRO FORMA PER
HISTORICAL DATA HISTORICAL SHARE DATA(1)
---------- --------- ---------- -------------
<S> <C> <C> <C> <C>
Book Value Per Share(2):
June 30, 1995................. $10.38 $ 9.94 $ 3.94 $ 3.68
December 31, 1994............. 9.22 9.64 3.97 3.57
Net Income (Loss) Per Share from
Continuing Operations(3):
June 30, 1995................. $ 0.91 $ 1.01 $ 0.57 $ 0.37
June 30, 1994................. 0.80 0.85 0.41 0.32
December 31, 1994............. 1.71 2.36 2.05 0.87
December 31, 1993............. 1.42 1.50 0.70 0.56
December 31, 1992............. 1.14 (1.98) (5.94) (0.73)
</TABLE>
--------
(1) The equivalent pro forma per share data represents the value of the pro
forma per share data multiplied by the Exchange Ratio.
(2) The pro forma book value per share of Sierra Common Stock is based upon the
pro forma consolidated total shareholders' equity for the consolidated
companies divided by the pro forma shares of Sierra Common Stock assuming
conversion of the CII Common Stock at the Exchange Ratio.
(3) The pro forma net income (loss) per share from continuing operations of
Sierra is based on the pro forma net income from continuing operations for
the consolidated companies divided by the pro forma weighted average shares
outstanding of the consolidated companies. See "Unaudited Consolidated
Condensed Pro Forma Financial Data." The historical and equivalent pro
forma per share data of CII for 1994 and prior periods has been adjusted to
reflect the operations of InteLock Technologies as a discontinued
operation.
10
<PAGE>
RISK FACTORS
In evaluating the Merger, shareholders of Sierra and CII should consider,
among other factors, the following.
RISK FACTORS APPLICABLE TO SIERRA
LACK OF CONTROL OVER PREMIUM STRUCTURE; LACK OF CONTROL OVER AND
UNPREDICTABILITY OF MEDICAL COSTS. Substantially all of Sierra's revenues are
generated by premiums, including capitation payments, which represent fixed
monthly payments for each person enrolled in Sierra's plans. These premiums
are generally fixed in advance by annual contracts and Sierra is obligated to
provide extensive health care services as established by a member's benefit
plan during the contract period whether or not the premiums cover the costs of
providing benefits. Although Sierra has purchased insurance contracts to
mitigate this risk and historically has been able to increase its premiums,
there can be no assurance that Sierra will be able to continue to do so in the
future in light of competitive and regulatory considerations. If Sierra is
unable to obtain adequate premiums because of competitive or regulatory
considerations, Sierra could incur significant losses. Because a significant
portion of Sierra's premium revenues are paid by the federal government in
connection with the Medicare program, to the extent Medicare premium rates do
not keep pace with rising medical costs, Sierra's profitability could be
materially adversely affected. Historically, these rates have been subject to
wide variations from year to year and have decreased in two of the past six
years. Although Sierra received an approximate 7.5% rate increase for 1995,
any significant decrease in such rates in subsequent years could have a
material adverse effect on Sierra's business.
Sierra's profitability is dependent, in large part, upon its ability to
accurately project and manage health care costs. Health care costs are
affected by a variety of factors that are difficult to predict and not
entirely within Sierra's control, including the severity and frequency of
claims. Medical cost inflation, new technologies, natural disasters, epidemics
and other external factors relating to the delivery of health care services
may adversely affect Sierra's ability to manage the costs of providing health
care services. Hospital utilization and associated costs constitute the most
variable components of Sierra's medical expenses. Although Sierra attempts to
manage its health care costs effectively, there can be no assurance that
Sierra will be able to continue to do so in the future.
DEPENDENCE ON KEY ENROLLMENT CONTRACTS. For the year ended December 31, 1994
and the six months ended June 30, 1995, Sierra received approximately 28.0%
and 30.7%, respectively, of its total revenues pursuant to its contract with
the United States Health Care Finance Administration ("HCFA") to provide
health care services to Medicare enrollees. Sierra's contract with HCFA is
subject to annual renewal at the election of HCFA and requires Sierra to
comply with federal HMO and Medicare laws and regulations and may be
terminated if Sierra fails to so comply. The termination of Sierra's contract
with HCFA would have a material adverse effect on Sierra's business. In
addition, there have been, and Sierra expects that there will continue to be,
a number of legislative proposals to limit Medicare reimbursements. Future
levels of funding of the Medicare program by the federal government cannot be
predicted with certainty.
Sierra's ability to obtain and maintain favorable group benefit agreements
with employer groups affects Sierra's profitability. The agreements are
generally renewable on an annual basis but are subject to termination on 60
days' prior notice. For the fiscal year ended December 31, 1994, Sierra's ten
largest HMO employer groups were, in the aggregate, responsible for
approximately 20% of its total revenues. Although none of such employer groups
accounted for more than 5% of total revenues during that period, the loss of
one or more of the larger employer groups would have a material adverse effect
upon Sierra's business. Sierra has generally been successful in retaining
these employer groups. However, there can be no assurance that Sierra will be
able to renew its agreements with such employer groups in the future or that
it will not experience a decline in enrollment within its employer groups.
HEALTH CARE REFORM. As a result of the continued escalation of health care
costs and the inability of many individuals to obtain health care insurance,
numerous proposals relating to health care reform have been or may
11
<PAGE>
be introduced in the United States Congress and in state legislatures. In
November 1993, President Clinton introduced comprehensive legislation to
reform the nation's health care system in an effort to control public and
private health care spending and provide universal access to health care. A
number of other major health care reform proposals have since been introduced
in Congress. Certain states, including several states in which Sierra
operates, have enacted or are considering independent health care reform
initiatives. It is uncertain what reforms will ultimately be enacted by the
federal government or any state government. Sierra cannot predict the effect
of health care reform on its business or give assurance that any reform will
not have a material adverse effect on it. Although Sierra believes that it may
benefit from some proposals favoring the growth of managed health care, any
proposals affecting underwriting practices, limiting rate increases or
affecting contracting arrangements (including proposals to require HMOs and
Preferred Provider Organizations ("PPOs") to accept any health care providers
willing to abide by an HMO's or PPO's contract terms) may have a material
adverse effect on Sierra's business.
COMPETITION. Managed care companies and HMOs operate in a highly competitive
environment. Sierra has numerous types of competitors, including, among
others, HMOs, PPOs, self-insured employer plans and traditional indemnity
carriers, many of which have substantially larger total enrollments, have
greater financial resources and offer a broader range of products than Sierra.
Additional competitors with greater financial resources than Sierra may enter
Sierra's market in the future. Moreover, competitive pressures are expected to
limit Sierra's ability to increase premiums and may, to a lesser extent,
result in declining premiums. Accordingly, the continued profitability of
Sierra will, to a large extent, depend on Sierra's ability to manage the costs
of providing health care benefits to its members. The inability of Sierra to
manage these costs effectively may have an adverse impact on Sierra's future
results of operations by reducing profitability margins. In addition,
competitive pressures may also result in reduced membership levels. Any such
reductions would materially affect Sierra's results of operations.
GEOGRAPHIC CONCENTRATION; CURRENT EXPANSION PROGRAM; LIMITED SUCCESS OF
PREVIOUS EXPANSION PROGRAM. Sierra's operations are currently concentrated in
southern Nevada. Sierra is the principal provider of managed health care
services in Nevada and has the largest HMO enrollment in the state. This
concentration creates operational efficiencies and makes Sierra's products
more attractive to potential customers in southern Nevada. Any adverse
economic, regulatory or other developments that may occur in southern Nevada
may negatively impact Sierra's operations and financial condition. In
addition, health care patterns among the population of southern Nevada may
result in increased health care costs for Sierra. In order to diversify
geographically, Sierra has recently commenced HMO operations in Texas and
northern Nevada and is exploring opportunities to expand its HMO operations
into other areas of the country. Membership in the Texas HMO was approximately
1,000 at August 1, 1995. Sierra began to actively market for enrollment in
northern Nevada in August 1995. In the past, Sierra also attempted to expand
its operations into northern Nevada and other regions outside of the state.
These activities met with limited success and, in some cases, resulted in
Sierra incurring significant losses. Although Sierra believes that it is now
more experienced, there can be no assurance that Sierra will be able to
recover its initial investments or expand into other regions successfully and
without incurring losses. See "Certain Information Concerning Sierra."
ESTIMATION OF INCURRED BUT NOT REPORTED LIABILITIES. Sierra's calculation of
its medical costs includes an estimate of incurred but not reported ("IBNR")
liabilities in its claim reserves. Accordingly, the accuracy of Sierra's
medical costs reported in its Consolidated Financial Statements depends, in
part, on Sierra's ability to estimate IBNR liabilities accurately. Sierra
estimates IBNR liabilities on a monthly basis using actuarial methods, which
are based upon the historical average interval between the date services are
rendered and the date claims are paid. Other items that are considered include
hospital utilization rates, claims backlog, membership changes, provider fee
schedules and benefit changes and inflation rates. Although Sierra believes
that its estimates for IBNR liabilities are adequate to satisfy its ultimate
related claims liability, there can be no assurance as to the ultimate
accuracy or completeness of such IBNR liability estimates or that adjustments
to such IBNR liabilities would not have a material adverse effect on Sierra's
results of operations.
12
<PAGE>
NEVADA HOME OFFICE TAX CREDIT. Under existing Nevada law, a 50% premium tax
credit is generally available to HMOs and insurers that own and substantially
occupy home offices or regional home offices within Nevada. In connection with
the settlement of a prior dispute concerning the premium tax credit, the
Nevada Department of Insurance acknowledged in November 1993 that Sierra's HMO
and insurance subsidiaries meet the statutory requirements to qualify for this
tax credit. Sierra intends to take all necessary steps to continue to comply
with these requirements. The elimination or reduction of the premium tax
credit, or any failure by Sierra to qualify for the premium tax credit, would
have a material adverse effect on Sierra's results of operations.
GOVERNMENT REGULATION; POTENTIAL DECLINE IN ENROLLMENT. Sierra's business is
subject to extensive federal and state laws and regulations, including, but
not limited to, financial requirements, licensing requirements, enrollment
requirements and periodic examinations by governmental agencies. In
particular, Sierra's HMO and insurance subsidiaries are subject to regulations
relating to cash reserves, minimum net worth, premium rates and approval of
policy language and benefits. Although such regulations have not significantly
impeded the growth of Sierra's business to date, there can be no assurance
that Sierra will be able to continue to obtain or maintain required
governmental approvals or licenses or that regulatory changes will not have a
material adverse effect on Sierra's business. In addition, Sierra has in the
past enrolled HMO members from various employer groups by utilizing provisions
of the Health Maintenance Organization Act of 1973, as amended (the "HMO Act")
which require employers to offer their employees HMO coverage under certain
circumstances. This requirement of the HMO Act expires in October 1995. Upon
expiration, federally qualified HMOs will no longer be able to require
employers to include the HMOs as a coverage option for their employees.
Although Sierra anticipates that the expiration of this requirement may result
in a minor decline in its HMO enrollment, there can be no assurance that such
expiration will not result in a more significant membership decline than
Sierra currently anticipates.
DEPENDENCE UPON HEALTH CARE PROVIDERS. Sierra's profitability is dependent,
in large part, upon its ability to contract favorably with hospitals,
physicians and other health care providers. Sierra's contracts with its
primary providers are generally renewable annually, but certain contracts may
be terminated on 90 days' prior written notice by either party. There can be
no assurance that Sierra will be able to continue to renew such contracts or
enter into new contracts enabling it to service its members profitably. Sierra
expects that it will be required to expand its health care provider network in
order to service membership growth adequately. Although Sierra believes that
it will be able to enter into agreements with such providers, there can be no
assurance that it will be able to do so on a timely basis or under favorable
terms. See "Certain Information Concerning Sierra."
ABSENCE OF ACCREDITATION FROM THE NATIONAL COMMITTEE ON QUALITY ASSURANCE.
Sierra has not received accreditation from the National Committee on Quality
Assurance (the "NCQA"). Earlier this year, Health Plan of Nevada, Inc.,
Sierra's largest subsidiary, voluntarily applied for accreditation from the
NCQA with respect to its operations in southern Nevada. The initial response
from the NCQA was to deny such accreditation; that response is being appealed
and no final determination is expected until October. Although no final
determination has been made, there can be no assurance that Sierra will
receive accreditation. See "Certain Information Concerning Sierra."
LITIGATION AND INSURANCE. Sierra is, and is likely in the future to be,
subject to certain types of litigation, including medical malpractice claims
and claim disputes pertaining to its contracts and other arrangements with
providers, employer groups and their employees and individual members. Sierra
maintains general and professional liability, property and fidelity insurance
coverage and its multi-specialty medical group maintains excess malpractice
insurance for the providers presently employed by the group. Additionally,
Sierra requires all of its independently contracted provider physician groups,
individual practice physicians, specialists, dentists, podiatrists and other
health care providers (with the exception of certain hospitals) to maintain
professional liability coverage. Certain of the hospitals with which Sierra
contracts are self-insured. Sierra may incur losses not covered by insurance,
beyond the limits of its insurance coverage for its employed physicians and
staff, for acts or omissions by independent providers who do not carry
sufficient malpractice coverage, or for other acts or omissions. Sierra may in
the future be unable to obtain adequate insurance. Generally, punitive damage
awards
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are not covered by insurance. Although Sierra believes that it currently
carries adequate insurance, no assurance can be given that Sierra's insurance
coverage will be adequate in amount or type, or as to the future availability
or cost of such insurance.
MANAGEMENT INFORMATION SYSTEM. Sierra's management information system is
critical to its current and future operations. The information gathered and
processed by Sierra's management information system assists Sierra in, among
other things, pricing its services, monitoring utilization and other cost
factors, processing provider claims, providing bills on a timely basis and
identifying accounts for collection. Sierra regularly modifies its management
information system. Any difficulty associated with or failure of such system,
or any inability to expand processing capability or to develop and maintain
networking capability, could have a material adverse effect on Sierra's
business.
DEPENDENCE ON MANAGEMENT. The success of Sierra has been dependent to a
large extent upon the efforts of Sierra's founder, Anthony M. Marlon, M.D.,
the Chairman of the Board and Chief Executive Officer of Sierra, who has an
employment agreement with Sierra. Erin E. MacDonald has recently assumed the
duties of President from Dr. Marlon. Although Sierra believes that this change
and the development of the management staff have made Sierra less dependent on
Dr. Marlon, the loss of Dr. Marlon could still have a material adverse effect
on Sierra.
CONTROL BY PRINCIPAL SHAREHOLDER; ANTI-TAKEOVER PROVISIONS. Upon completion
of the Merger, Dr. Marlon, who currently beneficially owns approximately 16.7%
of the outstanding Sierra Common Stock, will continue to beneficially own
approximately 14.2% of the outstanding Sierra Common Stock and consequently
will continue to have significant influence over the election of directors and
matters submitted to a vote of Sierra's shareholders. In addition, Sierra's
Shareholder Rights Plan, certain provisions of the Nevada Revised Statutes, as
amended (the "NRS"), and Sierra's Articles of Incorporation and By-laws could
have the effect of discouraging unsolicited takeover bids by third parties.
See "Security Ownership of Certain Beneficial Owners and Management--Sierra"
and "Comparison of Rights of Holders of Sierra and CII Common Stock."
RISK FACTORS APPLICABLE TO CII
OPERATING HISTORY. During the seven year period ended December 31, 1994, CII
had net operating losses in 1988, 1991 and 1992. The net operating losses in
1991 and 1992, however, were more than twice the net operating incomes for all
other years combined. The continued profitability of CII will depend largely
on its success in obtaining adequate premium rates, maintaining appropriate
reserves and controlling administrative and other expenses. See Annex B: the
CII 10-K--"Management's Discussion and Analysis of Financial Condition and
Results of Operations" and Annex C: the CII 10-Q --"Management's Discussion
and Analysis of Financial Condition and Results of Operations."
CALIFORNIA WORKERS' COMPENSATION INDUSTRY; PROFIT UNCERTAINTIES RELATED TO
NEW OPEN RATING ENVIRONMENT. CII writes workers' compensation insurance
principally in California. The workers' compensation industry in California
has undergone major changes in the past several years. In 1991 and 1992, the
California recession and abuses of the workers' compensation system, including
a significant increase in "stress and strain" claims, adversely affected the
workers' compensation insurance industry, including CII. Although fraudulent
cases still occur, management of CII believes that subsequent legislation has
decreased the level of abuse by requiring, among other changes, that a
preponderance of an injury must be caused by work-related activities while
prior law only required 10%, and additionally, by restricting post-termination
claims by requiring that the injured employee notify the employer of the
injury prior to the employee's termination. Also, subsequent to such
legislation, the frequency and severity of "stress and strain" claims have
been reduced. See Annex B: the CII 10-K--"Business--Workers' Compensation
Insurance."
Premium rates, which are regulated by the Department of Insurance in
California, have been under significant pressure for the last three years. In
July 1993, workers' compensation legislation reduced minimum rates by 7%.
Further decreases in the minimum rates of 12.7% and 16% were mandated by the
California
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Insurance Commissioner effective January 1994 and October 1994, respectively.
Pursuant to workers' compensation legislative reforms enacted in 1993, "open
rating" rules replaced "minimum rate" laws effective January 1, 1995. Under
minimum rate laws, insurers could not charge a premium which was less than the
published minimum rate and, therefore, competed primarily on the basis of
service to policyholders, the level of agent commissions and policyholders'
dividends. In the open rating environment, each California workers'
compensation insurer must determine and file with the Department of Insurance
the premiums and rating plans that it will use. The Department of Insurance
can only disapprove a filed rate if it determines that the rate will threaten
the insurer's solvency or will lead to a monopoly which is defined to be 20%
or more of the total California workers' compensation market. The new open
rating environment brings uncertainties to premium revenues and continued
operating profits due to increased price competition and the risk of
incurringadverse loss experience over a smaller premium base. See "Certain
Information Concerning CII," Annex B: the CII 10-K--"Business--Workers'
Compensation Insurance" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and Annex C: the CII 10-Q--"Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Although CII intends to underwrite each account taking into consideration
the insured's risk profile, prior loss experience, loss prevention plans and
other underwriting considerations, there can be no assurance that CII will be
able to operate profitably in the California workers' compensation industry or
that future workers' compensation legislation will not be adopted in
California or other states which might adversely affect CII's results of
operations. See Annex B: the CII 10-K--"Business--Underwriting."
GEOGRAPHIC CONCENTRATION. For the year ended December 31, 1994 and the six
months ended June 30, 1995, approximately 86% and 83%, respectively, of CII's
direct written premiums were in California. As discussed above, the California
open rating environment has increased the risk that CII will not be able to
write workers' compensation insurance at adequate rates. CII currently also
writes workers' compensation insurance in Colorado, Nebraska, New Mexico and
Utah and has plans to commence writing workers' compensation insurance in
Kansas, South Dakota and Texas. There can be no assurance, however, that CII
will expand into these or other regions without incurring losses.
Consequently, CII's operating results are expected to be largely dependent
upon its ability to write profitable workers' compensation insurance in
California. See "Certain Information Concerning CII," Annex B: the CII 10-K--
"Business--Workers' Compensation Insurance" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations," and Annex C: the
CII 10-Q--"Management's Discussion and Analysis of Financial Condition and
Results of Operations."
LOSS RESERVES. CII's loss reserves are estimates of future costs based on
various assumptions. The accuracy of these estimates may be affected by
external forces such as changes in the rate of inflation, the regulatory
environment, the judicial administration of claims, medical costs and other
factors. Because certain workers' compensation claims may not be fully paid
for several years or more, estimating reserves for such claims can be more
difficult and uncertain than estimating reserves in other lines of insurance
in which the period between the occurrence of the claim and final
determination of the loss is shorter. Included in the loss reserves are
estimates for IBNR claims which are established for unreported claims and
adverse loss developments relating to current and prior years. On a quarterly
basis, CII and its independent actuary review the adequacy of its loss
reserves using generally accepted actuarial methods, and annually, an opinion
is issued by the actuary as to the adequacy of the reserves. If the
assumptions on which the estimates are based prove to be incorrect and
reserves are inadequate to cover CII's actual experience, CII's profitability
would be adversely affected. See "Certain Information Concerning CII," Annex
B: the CII 10-K--"Business--Losses and Loss Adjustment Expenses" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and Annex C: the CII 10-Q--"Management's Discussion and Analysis
of Financial Condition and Results of Operations."
REGULATORY ENVIRONMENT. CII's insurance subsidiaries are subject to
extensive governmental regulation and supervision in each state in which they
do business. The primary purpose of such regulation and supervision is to
provide safeguards for policyholders and injured workers rather than to
protect the interests of shareholders. Typically, state regulations extend to
such matters as licensing agents and insurance companies; restricting the
types or quality of investments; requiring triennial financial examinations
and market conduct surveys of
15
<PAGE>
insurance companies; regulating premium rates, forms and advertising;
determining minimum reserve and deposit requirements; regulating aspects of a
company's relationship with its agents; restricting use of some underwriting
criteria; limiting the grounds for cancellation or nonrenewal of policies,
solicitation and replacement practices; policyholders' dividends; and
specifying what might constitute unfair practices.
Typically, states mandate participation in insurance guaranty associations,
which assess solvent insurance companies in order to fund claims of
policyholders of insolvent insurance companies. Insurers can be assessed a
percentage of premiums written for workers' compensation insurance each year
to pay losses on covered claims of insolvent insurers. In California and
certain other states, insurers are allowed to recoup such assessments from
policyholders while certain other states allow an offset against premium
taxes. Potential assessment expenses, net of recoupment, if any, for
insolvencies are not accrued until after an insolvency has occurred since the
likelihood and the amount of the assessment expense cannot be reasonably
determined or estimated. In California, there have been no new assessments for
insolvent workers' compensation insurance companies since 1990.
California's Insurance Holding Company Act regulates the payment of
shareholder dividends by insurance companies as well as changes in control of
insurance holding companies. Currently, CII's insurance subsidiaries cannot
pay any shareholder's dividend to CII without prior approval by the California
Insurance Commissioner. See Annex B: the CII 10-K--"Business--Regulation" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and Annex C: the CII 10-Q--"Management's Discussion and Analysis
of Financial Condition and Results of Operations."
COMPETITION. Many of CII's competitors have been in business longer, have
larger volumes of business, offer a more diversified line of insurance
coverage, have greater financial resources, have greater distribution
capability and better financial risk ratings than CII. Under the new open
rating environment in California, CII believes that the price of workers'
compensation insurance will become an increasingly important factor. This is
also true for the other states in which CII does business. The future
profitability of CII is dependent upon its ability to effectively compete in
these markets at premium rates that will be adequate to fund claims and
expenses and provide a profit. The inability of CII to obtain adequate premium
rates would have an adverse effect on CII's results of operations. In
addition, CII's largest insurance subsidiary has not been able to pay
policyholders' dividends since 1992 because of regulatory restrictions and its
other insurance subsidiary has not paid any policyholders' dividends since
1992. The absence of policyholders' dividends contributed to the decrease in
premiums written in 1994 and could continue to be a competitive disadvantage
in the open rating environment. CII believes, however, that payment of
policyholders' dividends will be less important in this environment. See Annex
B: the CII 10-K--"Business--Competition," "--Workers' Compensation Insurance"
and "Management's Discussion and Analysis of Financial Condition and Results
of Operations," and Annex C: the CII 10-Q--"Management's Discussion and
Analysis of Financial Condition and Results of Operations."
DEPENDENCE ON KEY PERSONNEL. The success of CII is largely dependent on the
services of Mr. Havlick and the experienced management team he has assembled.
CII has employment agreements with Mr. Havlick and other key employees. The
loss of Mr. Havlick could have a materially adverse effect on CII. See "The
Merger--Interests of Certain Persons in the Merger."
CONVERTIBLE SUBORDINATED DEBENTURES. CII has outstanding $56,800,000
principal amount of the CII Debentures. While the indenture relating to the
CII Debentures includes a provision which allows holders to require CII to
repurchase the CII Debentures in the event of a change in control of CII, such
provision will not be triggered by the Merger and, accordingly, the CII
Debentures will remain outstanding after the Merger. Sierra will enter into a
supplemental indenture providing that the CII Debentures will be convertible
into shares of Sierra Common Stock at a current conversion price $59.097 per
share. Although CII currently does not have sufficient liquid assets to meet
the $2,130,000 semi-annual interest payment on the CII Debentures due March
15, 1996, it believes it can make the payments due during at least the next
twelve months by, among other things, receiving payments on intercompany
receivables from its premium finance subsidiary which, at June 30, 1995,
totaled $9.9 million. Subsequent to June 30, 1995, CII received a $1.8 million
payment from its premium finance
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<PAGE>
subsidiary that will enable CII to make its semi-annual interest payment due
September 15, 1995. CII is exploring alternative funding sources for its
premium finance subsidiary which include, but are not limited to, expanding
the existing bank line of credit facility, selling a portion of the premium
finance receivables to either a third party or a related party, using a CII
insurance subsidiary to grant an interest bearing loan in place of CII's
advances and further reducing the amount of premium finance loans issued.
Other potential sources of liqudity for CII to make interest payments on the
CII Debentures include selling the premium finance operation and seeking
approval from the California Insurance Commissioner for the payment of a
shareholder dividend to CII by its insurance subsidiary. Upon consummation of
the Merger, Sierra will assess available alternatives relating to the CII
Debentures. Although Sierra currently anticipates that it will not assume
CII's obligations under the CII Debentures or guarantee their repayment, it
expects to take such steps as may be necessary to prevent default and
acceleration of the CII Debentures, and has sufficient liquid assets to do so
for at least the next twelve months. However, there can be no assurance that
Sierra will take such steps or have sufficient liquid assets to prevent such a
default in the future. See Annex B: the CII 10-K--"Management's Discussion and
Analysis of Financial Condition and Results of Operations" and Annex C: the
CII 10-Q--"Management's Discussion and Analysis of Financial Condition and
Results of Operations."
RISK FACTORS APPLICABLE TO THE MERGER
BENEFITS ACCRUING TO MANAGEMENT OF CII. As a result of the Merger, certain
officers and directors of CII will receive shares of Sierra Common Stock in
exchange for shares of CII Common Stock on the same terms as are applicable to
the other shareholders of CII. In addition, all stock options currently held
by each officer and director of CII will, in connection with the Merger, be
converted into a right to receive shares of Sierra Common Stock based on the
Exchange Ratio. Certain stock option and benefit plans of CII or the
agreements thereunder provide for the acceleration of certain benefits upon a
change of control. The benefits of a number of officers and directors of CII
and its subsidiaries under such plans will be subject to such acceleration as
a result of the Merger. In addition, certain officers of CII, in order to
fulfill a condition to Sierra's obligation to consummate the Merger, have
agreed to enter into new employment agreements with CII upon consummation of
the Merger, which agreements will supersede existing agreements. The new
agreements constitute a significant reduction in term length and certain
benefits provided to such employees. As a result of these transactions,
certain officers and directors of CII may have conflicts of interest in
connection with the Merger. See "The Merger--Interests of Certain Persons in
the Merger."
INTEGRATION OF CERTAIN OPERATIONS. Sierra and CII have entered into the
Merger Agreement with the expectation that the Merger will result in certain
benefits for the combined companies. Achieving the anticipated benefits of the
Merger will depend in part upon whether the two companies' businesses can be
integrated in an efficient and effective manner. There can be no assurance
that this will occur or that cost savings in operations will be achieved. The
successful combination of the two companies will require, among other things,
integration of the companies' respective product offerings, medical management
of health care claims and management information systems enhancements. The
difficulties of such integration may be increased by the necessity of
coordinating geographically separated organizations. The integration of
certain operations following the Merger will require the dedication of
management resources which may temporarily distract attention from the day-to-
day business of the combined companies. There can be no assurance that
integration will be accomplished smoothly or successfully. Failure to
effectively accomplish the integration of the two companies' operations could
have an adverse effect on Sierra's results of operations and financial
condition following the Merger.
POSSIBLE VOLATILITY OF COMMON STOCK PRICE. Recently, there has been
significant volatility in the market prices of securities of companies in the
health care industry, including the price of the Sierra Common Stock. Many
factors, including medical cost increases, analysts' comments, announcements
of new legislative proposals or laws relating to health care reform, the
performance of, and investor expectations for, Sierra, the trading volume of
the Sierra Common Stock and general economic and market conditions, may
influence the trading price of the Sierra Common Stock. Accordingly, there can
be no assurance as to the price at which the Sierra Common Stock will trade in
the future. See "Summary--Comparative Market Price Data."
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<PAGE>
COMPARATIVE MARKET PRICE DATA
The Sierra Common Stock has been traded under the symbol "SIE" on the New
York Stock Exchange since 1994 and, prior to that, was traded on the American
Stock Exchange since 1985. The CII Common Stock has been traded on the
American Stock Exchange under the symbol "CII" since 1990. The table below
sets forth, for the calendar quarters indicated, the high and low sales prices
for the Sierra Common Stock and the CII Common Stock as reported by the New
York Stock Exchange or the American Stock Exchange. During the periods
presented below, neither Sierra nor CII has declared or paid any dividends.
<TABLE>
<CAPTION>
PRICE PER SHARE OF
COMMON STOCK
----------------------------------------------------
SIERRA CII
------------------------ ------------------------
HIGH LOW HIGH LOW
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
FISCAL 1993
First Quarter............................... $21 11/16 $12 3/4 $ 6 7/8 $ 4 5/8
Second Quarter.............................. 21 1/4 11 1/2 7 5 1/8
Third Quarter............................... 22 15 1/8 6 1/4 5
Fourth Quarter.............................. 22 5/8 15 1/2 7 1/2 5 1/4
FISCAL 1994
First Quarter............................... 30 3/4 22 7 3/8 4 3/4
Second Quarter.............................. 29 21 1/4 6 1/4 4 5/8
Third Quarter............................... 28 23 1/8 6 3/8 5
Fourth Quarter.............................. 33 1/2 25 5/8 6 1/4 4 3/4
FISCAL 1995
First Quarter............................... 32 7/8 27 3/8 7 4 5/8
Second Quarter ............................. 33 5/8 22 1/8 9 3/8 5 1/2
Third Quarter (through September 18, 1995).. 29 23 10 3/8 7 7/8
</TABLE>
On June 12, 1995, the last full trading day prior to the announcement of the
Merger Agreement, the reported New York Stock Exchange Composite Transactions
closing price of the Sierra Common Stock was $29.375 per share and the
reported American Stock Exchange Composite Transactions closing price of the
CII Common Stock was $8.125 per share. On September 18, 1995, the most recent
available date prior to the date of this Joint Proxy Statement/Prospectus, the
reported New York Stock Exchange Composite Transactions closing price of the
Sierra Common Stock was $26.875 per share and the reported American Stock
Exchange Composite Transactions closing price of the CII Common Stock was
$9.625 per share.
Following the Merger, the Sierra Common Stock will continue to trade on the
New York Stock Exchange. Following the Merger, the CII Common Stock will cease
to trade on the American Stock Exchange, and there will be no further market
for the CII Common Stock.
Because the Exchange Ratio is fixed and because the market price of the
Sierra Common Stock is subject to fluctuation, the market value of the shares
of the Sierra Common Stock that holders of the CII Common Stock will receive
in the Merger may increase or decrease prior to and following the Merger.
Shareholders are urged to obtain current market quotations for the Sierra
Common Stock and the CII Common Stock.
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<PAGE>
SPECIAL MEETINGS
This Joint Proxy Statement/Prospectus is being furnished to the shareholders
of Sierra and CII in connection with the solicitation of proxies by the Board
of Directors of Sierra for use at the Sierra Special Meeting to be held on
October 24, 1995, at 11:00 A.M., local time, at the Omni Los Angeles Hotel &
Centre, 930 Wilshire Blvd., Los Angeles, California, and at all adjournments
and postponements thereof and by the Board of Directors of CII for use at the
CII Special Meeting to be held on October 24, 1995, at 10:00 A.M., local time,
at the Omni Los Angeles Hotel & Centre, 930 Wilshire Blvd., Los Angeles,
California, and at all adjournments and postponements thereof.
At the respective Special Meetings, the holders of Sierra Common Stock and
CII Common Stock will be separately asked to consider and vote upon proposals
to approve and adopt the Merger Agreement. A copy of the Merger Agreement
(without the schedules thereto) is attached as Annex A to this Joint Proxy
Statement/Prospectus. Pursuant to the Merger Agreement, upon satisfaction of
certain conditions described in the Merger Agreement, (i) Sierra Sub, a
wholly-owned subsidiary of Sierra, will be merged with and into CII, (ii) each
outstanding share of CII Common Stock will be converted into 0.37 of a share
of Sierra Common Stock and (iii) Sierra Sub will cease to exist as a separate
legal entity. As a result of the Merger, CII will become a wholly-owned
subsidiary of Sierra.
A representative of Deloitte & Touche LLP, Sierra's independent auditors,
will be present at the Sierra Special Meeting and will have an opportunity to
make a statement, if such representative so desires, and to respond to
appropriate questions raised at the Sierra Special Meeting.
A representative of BDO Seidman, CII's Independent Certified Public
Accountants, will be present at the CII Special Meeting and will have an
opportunity to make a statement, if such representative so desires, and to
respond to appropriate questions raised at the CII Special Meeting.
VOTING AND PROXY INFORMATION
SIERRA
The Board of Directors of Sierra has fixed the close of business on
September 11, 1995 as the Sierra Record Date for determining the holders of
Sierra Common Stock entitled to receive notice of and to vote at the Sierra
Special Meeting or any adjournments or postponements thereof. At the close of
business on the Sierra Record Date, there were outstanding 14,812,613 shares
of Sierra Common Stock. As of such date, such shares of Sierra Common Stock
were held by approximately 215 shareholders of record. The presence in person
or by proxy of holders of record of shares representing a majority of the
total issued and outstanding shares of the Sierra Common Stock will constitute
a quorum at the Sierra Special Meeting.
Under Nevada law and Sierra's Articles of Incorporation, as amended (the
"Sierra Articles"), and By-laws, as amended (the "Sierra By-laws") the
affirmative vote of the holders of at least a majority of the voting power of
the Sierra Common Stock represented at the Sierra Special Meeting in person or
by proxy and entitled to vote thereon is required in order to adopt and
approve the Merger Agreement. The holders of Sierra Common Stock are entitled
to one vote on all matters properly brought before the Sierra Special Meeting
for each share of Sierra Common Stock held by such persons. Votes may be cast
in person at the Sierra Special Meeting or by proxy.
As of the Sierra Record Date, directors and executive officers of Sierra and
their affiliates had the right to vote 2,558,059 shares of Sierra Common Stock
in the aggregate (representing approximately 17.3% of the outstanding shares
of Sierra Common Stock as of the Sierra Record Date). The directors and
executive officers of Sierra who hold such shares have informed Sierra that
they intend to vote all such shares in favor of the approval and adoption of
the Merger Agreement.
Any shareholder who signs and returns a proxy may revoke it at any time
before it has been voted by (i) delivering written notice to the Secretary of
Sierra of its revocation, (ii) executing and delivering to the Secretary
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<PAGE>
of Sierra a proxy bearing a later date or (iii) attending the Sierra Special
Meeting and voting in person. Attendance at the Sierra Special Meeting will
not in and of itself constitute a revocation of any proxy given to Sierra.
Written notice of revocation should be sent to Sierra, P.O. Box 15645, Las
Vegas, Nevada 89114, Attention: Secretary. All properly executed proxies, if
received in time for voting and not revoked, will be voted in accordance with
the instructions specified, or, if no instructions are specified, will be
voted for the approval of the adoption of the Merger Agreement.
CII
The Board of Directors of CII has fixed the close of business on September
11, 1995 as the CII Record Date for determining the holders of CII Common
Stock entitled to receive notice of and to vote at the CII Special Meeting. At
the close of business on the CII Record Date, there were outstanding 7,206,221
shares of CII Common Stock. As of such date, the shares of CII Common Stock
were held by approximately 173 shareholders of record.
Under California law and CII's Articles of Incorporation and By-laws, the
affirmative vote of the holders of not less than a majority of the shares of
CII Common Stock outstanding as of the CII Record Date is required in order to
adopt and approve the Merger Agreement. The holders of CII Common Stock are
entitled to one vote on all matters properly brought before the CII Special
Meeting for each share of CII Common Stock held by such persons. Votes may be
cast in person at the CII Special Meeting or by proxy.
As of the CII Record Date, directors and executive officers of CII and their
affiliates had the right to vote 2,039,654 shares of CII Common Stock in the
aggregate (representing approximately 28.3% of the outstanding shares of CII
Common Stock as of the CII Record Date). All of the directors and each of the
officers of CII with an employment agreement have indicated that they intend
to vote all shares of CII Common Stock held by them in favor of the approval
and adoption of the Merger. In addition, Messrs. Havlick and Spitler have
entered into letter agreements with Sierra to vote the shares which such
persons have the right to vote in favor of the Merger.
All shares of CII Common Stock represented at the CII Special Meeting by
properly executed proxies received by CII prior to or at the CII Special
Meeting and not revoked will be voted at the CII Special Meeting in accordance
with the instructions contained in such proxies. Unless instructions to the
contrary are specified in the proxy, each such proxy will be voted for the
proposal to approve and adopt the Merger Agreement.
Any proxy given to CII may be revoked by the person giving such proxy at any
time before the shares represented by such proxy are voted. Proxies may be
revoked by (i) filing with the Secretary of CII, before the vote is taken at
the CII Special Meeting, a written notice of revocation bearing a date later
than the date of the proxy, (ii) duly executing and delivering a subsequent
proxy relating to the same shares of CII Common Stock or (iii) attending the
CII Special Meeting and voting in person. Attendance at the CII Special
Meeting will not in and of itself constitute a revocation of any proxy given
to CII. Written notice of revocation should be sent to CII, P.O. Box 9025,
Pleasanton, California 94566-9025, Attention: Secretary.
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<PAGE>
THE MERGER
BACKGROUND
In January 1995, CII retained Vector Securities for the purpose of assessing
the strategic alternatives available to CII. After discussing various
strategic alternatives with Vector Securities, CII decided to solicit,
principally through Vector Securities, indications of interest in a possible
acquisition of, or other similar business combination involving, more than a
majority of the business, assets, or Common Stock of CII. After preparing a
summary of publicly available information concerning CII, Vector Securities,
in mid-March, began the solicitation process.
On April 4, 1995, Anthony M. Marlon, M.D., the Chairman of the Board and
Chief Executive Officer of Sierra, received correspondence from Vector
Securities concerning the possibility of Sierra engaging in a strategic
transaction with CII. On April 13, James L. Starr, the Vice President of
Finance, Chief Financial Officer and Treasurer of Sierra, responding on behalf
of Sierra, indicated a willingness to consider a possible transaction
involving Sierra and CII, requested additional information concerning CII and
returned a signed confidentiality letter. Shortly thereafter, Sierra asked
Bear Stearns to serve as financial advisor to Sierra in connection with the
discussions. Sierra also retained Morgan, Lewis & Bockius, its regular
counsel, to provide legal counsel in connection with any possible transaction
with CII.
After receiving further information from Vector Securities concerning CII
and its business and operations, Sierra and Bear Stearns began analyzing CII,
its financial position, businesses and operations and the perceived benefits
and risks of a strategic transaction involving the two companies. On April 20,
representatives of Bear Stearns and Sierra met in New York to discuss the
possible combination.
On April 26, a meeting was held at CII's headquarters in Pleasanton,
California among representatives of Sierra, CII and their respective financial
advisors. Dr. Marlon, Mr. Starr and Frank E. Collins, Esq., the Secretary and
General Counsel of Sierra, attended on behalf of Sierra. In attendance on
behalf of CII were Joseph G. Havlick, the Chairman of the Board, Chief
Executive Officer and President of CII, and Lee W. Spitler, Jr., the Senior
Vice President and Treasurer of CII. At the meeting the parties discussed
Sierra's and CII's operations and the potential benefits of a transaction
involving the two companies.
On May 10, a meeting was held at Sierra's offices in Las Vegas, attended by
Dr. Marlon, Messrs. Starr and Collins, Erin E. MacDonald, the President and
Chief Operating Officer of Sierra, Messrs. Havlick and Spitler and
representatives of Vector Securities. At such meeting, further discussions
were held regarding CII's and Sierra's operations and the possible form of a
proposed transaction involving the two companies. During the next two weeks,
the parties, with the assistance of their respective financial advisors,
continued to assess the desirability and potential terms of a transaction.
On May 11, at a meeting of CII's Board of Directors, management of CII
reported on its two previous meetings and the status of discussions with
Sierra. The CII Board authorized continuing discussions and the retention of
BDO Seidman and Gibson, Dunn & Crutcher to assist in the due diligence
concerning Sierra and the negotiation of a transaction.
On May 16, at a regular meeting of the Board of Directors of Sierra, Dr.
Marlon advised the Board of Directors of the recent discussions between the
two companies. Dr. Marlon also explained to the Board of Directors the
potential benefits of a transaction and outlined, in general terms, the
possible structure of a transaction. After consideration, the Board of
Directors authorized Dr. Marlon to proceed with discussions.
On May 19, representatives of the parties and their financial advisors met
at the offices of CII in Pleasanton to hold further discussions. At the
meeting the parties exchanged financial information and discussed, among other
things, underwriting practices and CII's methods utilized for developing loss
reserves.
On May 25 and May 26, representatives of Sierra and Bear Stearns engaged in
discussions in preparation for a meeting to be held on May 29 between Sierra
and CII executives. On May 29, Dr. Marlon, Ms. MacDonald and Messrs. Havlick
and Spitler met in Pleasanton to discuss in greater detail the possible terms
of a merger.
On May 31, Sierra held a telephonic special meeting of its Board of
Directors to advise the Board on the results of the May 29 meeting. The Board
of Directors authorized management of Sierra to continue negotiations
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and begin preparation of a definitive agreement, as well as a due diligence
investigation of CII. Also on May 31, CII held a telephonic meeting of its
Board of Directors at which Messrs. Havlick and Spitler reported on the status
of the discussions with Sierra and the Board of Directors authorized them to
commence negotiations of a definitive agreement and to continue its due
diligence investigation of Sierra.
From June 1 through June 3, Sierra continued its due diligence investigation
of CII at CII's offices. On June 4, Sierra held a meeting of its Board of
Directors to present to the Board of Directors the results of the due
diligence investigation of CII as of such date and to discuss further the
proposed transaction.
From June 5 through June 7, representatives of CII, Vector Securities, BDO
Seidman, Gibson, Dunn & Crutcher and CII's independent actuary met at Sierra's
offices in Las Vegas to conduct a more extensive due diligence investigation
of Sierra. Additionally, on June 8, all of the independent directors of CII
met with certain members of Sierra's management in Las Vegas, at which meeting
Sierra presented an overview of its business and responded to questions and
the Board conducted an onsite inspection of Sierra's operational and medical
facilities including its management information system.
On June 7, CII announced, in response to marketplace rumors and unusual
trading activity in its stock, that it was having preliminary discussions with
another party concerning a possible stock for stock reorganization.
On June 12, CII held a special meeting of its Board of Directors in
Pleasanton to consider the proposed Merger Agreement. At this meeting, Vector
Securities discussed the financial aspects of the proposed business
combination and the procedures it had undertaken to evaluate the proposal from
a financial point of view and addressed questions from members of the Board.
BDO Siedman reported on its due diligence procedures concerning Sierra and
responded to questions from members of the Board. Gibson, Dunn & Crutcher made
a presentation regarding the structure of the proposed transaction and the
negotiations surrounding the Merger Agreement and then discussed the Merger
Agreement and the disclosure schedules thereto with the Board. Vector
Securities delivered its oral opinion that the consideration to be received by
the CII shareholders was fair to such shareholders from a financial point of
view as of such date. Following considerable further discussion of the terms
of the proposed transaction, the Board of Directors of CII unanimously
approved the Merger Agreement, subject to certain changes and the resolution
of certain remaining issues.
On June 12, a telephonic meeting of the Board of Directors of Sierra was
held to discuss and consider the terms of the transaction as embodied in the
Merger Agreement. Representatives of Deloitte & Touche LLP, Bear Stearns,
Morgan, Lewis & Bockius and Sierra's independent actuary also participated.
Bear Stearns discussed the financial terms of the Merger and the impact of the
Merger on Sierra and presented the methods it employed to evaluate the
financial aspects and valuation of the Merger. Bear Stearns responded to
questions posed by the Board of Directors and then delivered its oral opinion
to the effect that, as of such date, the Merger was fair from a financial
point of view to the shareholders of Sierra. Sierra's independent actuary
presented the results of its diligence investigation as well as its analysis
of CII's reserves. Sierra's independent actuary responded to questions posed
by the Board of Directors with respect to the calculation of the reserves by
CII. Morgan, Lewis & Bockius discussed the negotiation and terms of the Merger
Agreement and the results of its diligence investigation. After discussion of
the terms of the Merger and consideration of the perceived benefits of the
transaction, the Board of Directors of Sierra voted unanimously to approve the
terms of and authorize the execution of a Merger Agreement in substantially
the form presented to the Board and to proceed with the Merger.
RETENTION OF FINANCIAL ADVISORS; PROJECTIONS
Sierra and CII retained Bear Stearns and Vector Securities, respectively, as
their financial advisors and to render opinions to their respective Boards of
Directors as to the fairness, from a financial point of view, of the Merger to
their respective shareholders. In connection with the Merger, Sierra and CII
provided to Bear Stearns
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and Vector Securities financial projections for their respective companies.
These projections were prepared by management of Sierra and CII to assist in
financial planning and analysis and not with a view to publication. Such
projections were prepared based on historical information available at such
time and estimates as to the future financial performance of the respective
companies. The projections encompassed estimates of revenues, expenses, taxes
and income for the fiscal years of 1995, 1996 and 1997 and, with respect to
CII, for 1998 and 1999 as well. Neither the Sierra projections nor the CII
projections have been prepared in accordance with the guidelines established
by the American Institute of Certified Public Accountants for preparation and
presentation of financial forecasts, nor have they been audited, compiled or
otherwise examined by Deloitte & Touche LLP or BDO Seidman, respectively, or
any other independent accountants or auditors.
The projections were among several factors taken into consideration by the
respective financial advisors and Boards of Directors of Sierra and CII. Since
projections are based upon forecasts of future financial performance, they and
the assumptions on which they are based are inherently subject to substantial
uncertainties and are not necessarily indicative of actual future results,
which may be significantly more or less favorable than suggested by the
projections. The projections and underlying assumptions for Sierra and CII are
subject to additional uncertainties created by federal and state regulation of
the healthcare industry and state regulation of the insurance industry,
particularly regulation of premium rate increases, and recent proposed
healthcare reform legislation on a federal and state level. (See "Risk Factors
Applicable to Sierra--Lack of Control Over Premium Structure; Lack of Control
Over and Unpredictability of Medical Costs;--Dependence on Key Enrollment
Contracts; and--Health Care Reform" and "Risk Factors Applicable to CII--
California Workers' Compensation Industry; Profit Uncertainties Related to New
Open Rating Environment"). Accordingly, none of the projections or their
underlying assumptions should be viewed as indications of expected results or
indicative of future performance of either company or of the two companies on
a combined basis.
Sierra's Projections
Sierra prepared its projections for the remainder of 1995 and for 1996 and
1997 based on historical information available in May, 1995 and upon Sierra's
estimates of its expected future performance. The projections for the
remainder of 1995 used the first quarter actual results and increased revenues
on the basis of membership growth estimates which were similar to growth rates
Sierra had experienced from 1993 to 1994, but used a slightly higher weighted
average premium rate increase than Sierra experienced between 1993 and 1994
due principally to the 7.5% increase in Medicare rates that became effective
in January 1995. The resulting revenue increases were estimated to be offset
in part by accompanying increases in the cost of providing medical care. This
cost was projected to increase at a rate slightly higher than the estimated
weighted average premium rate increase for the year. Other operating expenses
were also projected to increase to support expanding operations. Certain non-
operating expenses (primarily interest expense), Sierra's minority interest in
HMO Texas and an effective tax rate of 33.5% were also factored in to produce
the 1995 projections.
The Sierra projections for 1996 assumed further modest core membership
growth which was slightly less than projected growth for 1995, as well as
membership growth for HMO Texas and Medicaid, and a weighted average premium
increase which was slightly higher on a percentage basis than the 1995
increase, due to an anticipated 7% overall increase in Medicare rates and
slight increases in commercial rates for 1996. Since Medicare and Medicaid
membership was assumed to constitute a larger percentage of total membership,
Sierra incorporated into the 1996 assumptions an increased medical loss ratio
which was slightly higher on a percentage basis than the 1995 ratio. Sierra
also assumed an effective tax rate of 33.5% for 1996.
The Sierra projections for 1997 assumed further revenue and expense
increases which, on a percentage basis, were slightly lower than the 1996
assumptions. The remaining assumptions were generally consistent with those
used for the 1996 projections. The projected increases in revenues for each of
1995 through 1997 resulted in material estimated increases in projected net
income for each of the three years that were generally consistent with
increases in prior years.
CII Projections
In the case of CII, the projections covered the period from 1995 through
1999 and were prepared starting with actual results for 1994. Net earned
premiums were assumed to increase moderately in 1995, significantly in 1996
and moderately over the rest of the five-year period with the majority of the
growth anticipated to come from non-California states. The projected growth
for 1995 anticipated that CII would begin writing workers' compensation
insurance in Texas in the second half of 1995 and the growth in 1996 assumes
Texas premiums
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will increase significantly over 1995. The nominal projected growth in
California written premiums for 1995 took into account the new open rating
environment which took effect January 1, 1995 and the various steps that CII
would take in light of this new environment. The projections assumed that
premium rates under open rating would begin to stabilize and increase in the
fourth quarter of 1995. Losses and loss adjustment expenses were projected to
increase moderately in 1995 and remain relatively consistent as a percentage
of net earned premiums over the remainder of the five-year period.
Underwriting expenses were projected to decrease slightly as a percentage of
net earned premiums in 1995 and thereafter remain relatively consistent as a
percentage of net earned premiums. Net investment income was projected to
increase moderately each year due primarily to an increase in the size of the
investment portfolio. As a result of the foregoing, net income was projected
to decrease slightly for 1995, with a significant percentage increase in 1996
and moderate percentage increases thereafter.
Sierra, with the assistance of Bear Stearns, modified the CII projections
and their underlying assumptions based upon other information derived from
Sierra's due diligence investigation of CII including, among others, the paid
loss pattern assumptions, the current conditions in the California workers'
compensation market and the projected cost savings which may be achieved by
applying Sierra's managed care techniques to CII's workers' compensation
business. The modifications resulted in various changes to CII's projections
including, among others, net premium income growth rates varying from 12.4% to
11% between 1995 and 1997 which were less than CII's growth projections, and
additional adjustments relating to an increase in the combined ratio and a
reduction in expenses related to anticipated cost savings. The cumulative
effect of these adjustments to CII's projections resulted in estimates of its
net income for each of 1995 through 1997 that were significantly lower than
CII's net income in 1994.
SIERRA REASONS FOR THE MERGER; RECOMMENDATION OF SIERRA'S BOARD OF DIRECTORS
The Sierra Board of Directors has unanimously approved the Merger and, for
the reasons set forth below, believes that the Merger is in the best interests
of Sierra and the shareholders of Sierra.
The Board of Directors has determined that the Merger provides an
opportunity for Sierra to acquire a company that has significant expertise in
workers' compensation rate development, underwriting and claims administration
that are important to Sierra's continued growth of its workers' compensation
medical management services. The importance to Sierra of developing its
workers' compensation capabilities results largely from (i) Sierra's
expansion, and plans to expand its managed care activities, in other parts of
the country and (ii) recent legislative initiatives in Nevada which would
allow private insurers to issue workers' compensation insurance policies
covering employees in Nevada. The Board of Directors believes that CII's added
expertise in workers' compensation insurance and related matters will position
Sierra to compete effectively in the evolving workers' compensation
environment in Nevada and to expand into other parts of the country,
particularly Texas.
Workers' compensation is a statutory system that requires employers to
provide employees with medical care and other specified benefits for work-
related injuries, even though the injuries may have resulted from the
negligence or wrongs of the employees or other persons. Historically, Nevada
has maintained a state-funded workers' compensation program, whereby the state
charges premiums to employers doing business in the state and pays the costs
associated with providing medical benefits to injured workers. Largely as a
result of the substantial deficits incurred by Nevada's state-funded plan, in
June 1993 the Nevada legislature passed a comprehensive workers' compensation
bill that implemented, as of January 1, 1994, a mandatory system of managed
care for workers' compensation claims.
The application of managed care techniques in Nevada is consistent with
trends elsewhere in the country toward providing workers' compensation
benefits within the framework of managed care programs. Sierra believes that
providing benefits within a managed care framework allows for greater cost
controls and permits employers and employees to benefit from the "24 hour
care" concept that managed care companies are able to offer to their
enrollees. Unlike traditional workers' compensation insurers, managed care
companies seek to reduce costs through various means, including utilization
review, case management, provider contracting, rehabilitation services,
earlier identification of injuries and other programs. Sierra believes that
the application of these programs should reduce the frequency and severity of
workers' compensation claims and will result in an earlier identification of
injuries. The earlier identification of injuries is important because it
should result in more appropriate courses of medical treatment, which in turn,
should lead to reductions in both medical and compensation costs. Sierra
further believes that, as this trend continues throughout the country, it will
become increasingly important to offer 24 hour managed care products to its
customers.
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The Nevada legislature also currently has under consideration a bill that
would allow private insurers to issue workers' compensation insurance policies
covering employees in Nevada beginning in 1999. Accordingly, Sierra expects to
issue workers' compensation insurance policies in Nevada when permitted under
the pending legislation.
In February 1995, HMO Texas L.C. ("HMO Texas") received a certificate of
authority to operate as a health maintenance organization in Texas. Sierra
holds a 50% ownership interest in HMO Texas. Sierra, which began actively
marketing its HMO product in late March 1995, believes that Texas presents an
attractive market for a 24 hour care program. A 24 hour program was recently
approved in Texas and Sierra anticipates that HMO Texas will seek approval of
such a program.
In acquiring ownership of CII, Sierra will acquire an established insurance
company with significant expertise in underwriting workers' compensation
insurance and providing ancillary services. CII has obtained licenses to
underwrite insurance in 18 states, including California, Colorado, Texas and
New Mexico. Sierra has operations in certain of these states. As a result of
the Merger, Sierra will be licensed in various other states and will avoid the
time-consuming and often costly process of obtaining the licenses needed to
provide workers' compensation insurance services. In addition, as a result of
the Merger, Sierra will benefit from the significant expertise of CII's
management and personnel. Sierra will seek to retain the management of CII
following the Merger. In this regard, Messrs. Havlick and Spitler and other
key employees have agreed to enter into employment agreements with CII
effective upon consummation of the Merger. See "The Merger--Interests of
Certain Persons in the Merger." The management and personnel of CII have
significant expertise in matters such as workers' compensation insurance
underwriting, claims administration and the development of loss control
programs. Accordingly, the management and personnel of CII are expected to
provide immediate assistance to Sierra in developing and implementing workers'
compensation programs in Texas, Colorado and elsewhere.
The Board of Directors believes that CII is a well-managed company, that it
is adequately reserved and that it has historically taken a disciplined
approach to workers' compensation insurance underwriting. Therefore, the Board
of Directors believes that the acquisition of CII by Sierra will afford Sierra
an immediate and cost-effective means of expanding its existing workers'
compensation capabilities. In the absence of the Merger, obtaining the
regulatory approvals held by CII and acquiring the accumulated workers'
compensation expertise of CII's management and personnel would require
substantial effort, time and expense. In addition, the independent development
of a workers' compensation insurance company would also divert the attention
of Sierra's management from current operations and other development
activities.
In reaching its decision, the Sierra Board of Directors considered a number
of factors, including, among other things, (i) the financial performance,
condition and business operations of CII, (ii) the results of the due
diligence investigations performed by its management and advisors, including
the review of CII's reserves and the legal due diligence, (iii) the structure
and terms of the Merger, including the Exchange Ratio, (iv) the perceived
benefits to Sierra from the Merger, (v) Sierra's operational desire to expand
its workers' compensation product line, (vi) certain beneficial synergies and
cost savings available to the combined companies and (vii) the opinion of Bear
Stearns concerning the fairness of the transaction, from a financial point of
view, to the shareholders of Sierra (see "The Merger--Opinion of Sierra's
Financial Advisor").
The Sierra Board of Directors also considered several potentially negative
factors in its deliberations, including, among other things, (i) the recent
downward trends in California workers' compensation insurance pricing, (ii)
the limited availability of Sierra managed care networks in California, (iii)
the possibility that CII's claims may exceed established reserves and (iv) the
possibility that CII may not have sufficient liquid assets to meet semi-annual
interest payments on the CII Debentures during the next 12 months. After
consideration of these factors, the Sierra Board of Directors concluded that
the potential negative factors, individually and in the aggregate, did not
outweigh the perceived advantages of the Merger.
AFTER CONSIDERING ALL OF THE FACTORS DISCUSSED ABOVE, THE SIERRA BOARD OF
DIRECTORS HAS DETERMINED TO APPROVE THE MERGER AND UNANIMOUSLY RECOMMENDS THAT
THE SIERRA SHAREHOLDERS VOTE FOR THE APPROVAL OF THE MERGER AGREEMENT AND THE
ISSUANCE OF SHARES OF SIERRA COMMON STOCK PURSUANT THERETO.
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OPINION OF SIERRA'S FINANCIAL ADVISOR
Sierra retained Bear Stearns to act as its financial advisor and to render
its opinion to the Sierra Board of Directors as to the fairness of the Merger,
from a financial point of view, to the shareholders of Sierra. Sierra selected
Bear Stearns based on its qualifications, expertise and familiarity with
Sierra.
Bear Stearns delivered its oral opinion to the Sierra Board of Directors to
the effect that, as of June 12, 1995, the Merger was fair, from a financial
point of view, to the shareholders of Sierra. Bear Stearns confirmed its
opinion as of the date of this Joint Proxy Statement/Prospectus.
The full text of Bear Stearns' fairness opinion, which sets forth certain
assumptions made, certain procedures followed and certain matters considered
by Bear Stearns, is attached as Annex E to this Joint Proxy
Statement/Prospectus. As set forth therein, Bear Stearns relied upon and
assumed the accuracy and completeness of the financial and other information
provided to it by Sierra, CII and their respective independent actuaries.
Sierra and CII provided financial projections for their respective companies.
In addition, Sierra, with the assistance of Bear Stearns, modified projections
for CII based on assumptions provided by Sierra (the "Modified CII
Projections"). With respect to these projected financial results, Bear Stearns
assumed that the projections had been reasonably prepared on bases reflecting
the best currently available estimates and judgments of the managements of
Sierra and CII as to the expected future performance of Sierra and CII. Bear
Stearns did not perform any independent verification of the information or
projections provided to it and Bear Stearns relied upon the assurances of the
managements of Sierra and CII that they are unaware of any facts that would
make the information and projections provided to Bear Stearns incomplete or
misleading. In arriving at its opinion, Bear Stearns did not perform or obtain
any independent appraisal of the assets of Sierra or CII. Bear Stearns'
opinion is necessarily based on economic, market and other conditions, and the
information made available to it as of the date of its opinion. Bear Stearns
further assumed that the Merger would be accounted for in accordance with the
pooling-of-interests method of accounting.
The summary of the opinion of Bear Stearns set forth in this Joint Proxy
Statement/Prospectus is qualified in its entirety by reference to the full
text of such opinion. SIERRA SHAREHOLDERS ARE URGED TO, AND SHOULD, READ THIS
OPINION CAREFULLY IN ITS ENTIRETY IN CONJUNCTION WITH THIS JOINT PROXY
STATEMENT/PROSPECTUS FOR ASSUMPTIONS MADE, MATTERS CONSIDERED AND LIMITS OF
THE REVIEW BY BEAR STEARNS.
In rendering the fairness opinion, Bear Stearns, among other things: (i)
reviewed the Joint Proxy Statement/Prospectus in substantially final form;
(ii) reviewed Sierra's and CII's Annual Reports to Shareholders and their
Annual Reports on Form 10-K for the fiscal years ended December 31, 1990
through 1994, and their Quarterly Reports on Form 10-Q for the periods ended
March 31, and June 30, 1995; (iii) reviewed CII's statutory financial
statements for the years ended December 31, 1990 through 1994, and its
statutory financial statements for the quarters ended March 31, and June 30,
1995; (iv) reviewed CII's Initial Public Offering Prospectus dated March 7,
1990, its Common Stock Offering Prospectus dated December 14, 1990 and its
Prospectus dated September 15, 1991 relating to the CII Debentures; (v)
reviewed certain operating and financial information, including projections,
provided by the managements of Sierra and CII relating to their respective
business prospects; (vi) met with certain members of Sierra's and CII's senior
managements to discuss their respective operations, historical financial
statements and future prospects; (vii) met with certain members of Sierra's
senior management to discuss CII's operations, historical financial statements
and results and future prospects and Sierra's plans for CII post-acquisition,
including projections and expected medical management cost savings and their
views of the benefits and other implications of the Merger; (viii) discussed
CII's loss and loss adjustment expense reserve philosophy and adequacy with
CII's management and CII's independent actuary, and with Sierra's management
and Sierra's independent actuary; (ix) reviewed the report of Sierra's
independent actuary dated August 24, 1995 on the adequacy of CII's loss and
loss adjustment expense reserves as of March 31, 1995; (x) visited certain of
Sierra's and CII's facilities; (xi) reviewed the historical stock prices and
trading volumes of the Sierra Common Stock and the CII Common Stock and the
trading prices and volumes of the CII Debentures; (xii) reviewed publicly
available financial data and stock market performance data of companies which
were deemed generally comparable to Sierra and CII; (xiii) reviewed the terms
of recent acquisitions of
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companies which were deemed generally comparable to CII; and (xiv) conducted
such other studies, analyses, inquiries and investigations as were deemed
appropriate.
In arriving at its valuation of CII, Bear Stearns valued CII's insurance
subsidiaries and then adjusted the resulting valuation for the remaining
assets and liabilities of CII. Bear Stearns performed three primary valuation
analyses of CII's insurance subsidiaries: (i) a discounted cash flow analysis,
which consisted of adding (A) the discounted present value of the projected
future cash flows from CII's insurance subsidiaries and (B) the discounted
present value of the terminal value of the insurance subsidiaries at the end
of the reference period, (ii) a comparison with publicly traded comparable
companies, which consisted of reviewing and considering certain financial and
market data for certain other publicly traded companies determined to be
similar to CII's insurance subsidiaries and (iii) a precedent acquisition
analysis, which consisted of reviewing purchase prices and financial terms of
selected acquisitions involving workers' compensation insurance companies
having characteristics determined to be similar to CII's insurance
subsidiaries.
Discounted Cash Flow Analysis. Bear Stearns performed a discounted cash flow
analysis pursuant to which a stand-alone value of CII's insurance subsidiaries
was determined by adding (A) the estimated present value of CII's insurance
subsidiaries' future cash flows which will be available through dividends from
the insurance subsidiaries plus (B) the present value of the insurance
subsidiaries' terminal value, based on statutory and GAAP operating earnings
projections provided by CII and Sierra. Key assumptions in the discounted cash
flow analysis included (a) Merger-related cost savings, (b) maintenance of
sufficient policyholders' surplus for future business needs, (c) discount
rates of 11%, 13%, and 15%, (d) the federal income tax rate of 35% and (e)
terminal values based on multiples of projected GAAP net earnings in the year
2005 of 8.0x, 9.0x and 10.0x.
Comparable Company Analysis. Bear Stearns compared CII's insurance
subsidiaries to six comparable workers' compensation companies. In this
regard, Bear Stearns noted that although such companies were considered
similar to CII's insurance subsidiaries insofar as they participate in certain
business segments in which they engage, none of the companies exhibits the
same makeup, size and combination of businesses as CII's insurance
subsidiaries. In performing the comparable public company analysis for CII,
Bear Stearns selected the following publicly traded companies (the "Comparable
Companies"): Argonaut Group Inc., Citation Insurance Group, Fremont General
Corp., Orion Capital Corp., Pac Rim Holding Corp., and Zenith National
Insurance. Using publicly available information, Bear Stearns analyzed, among
other things, the market values and certain historical and financial criteria
of the Comparable Companies including (i) net operating income per share,
including 1994 actual and 1995 and 1996 estimated results, (ii) book value per
share both stated and tangible, (iii) price to earnings ratios, (iv) price to
book value ratios, (v) dividends per share and dividend yield, (vi) debt and
preferred equity to total capitalization, (vii) return on average common
equity of the Comparable Companies, (viii) historical combined loss and
expense ratios and (ix) development of loss and loss adjustment expense
reserves. Bear Stearns derived multiples from the foregoing analysis of
Comparable Companies and applied them to certain financial data of the
company's insurance subsidiaries, including 1994 net operating income, 1995
and 1996 estimated net operating income, and book value as of March 31, 1995.
The ranges of these multiples for the Comparable Companies were as follows:
(i) fiscal 1994 net operating income: 9.1x to 21.1x, (ii) estimated 1995 net
operating income: 3.8x to 12.1x, (iii) estimated 1996 net operating income:
6.4x to 11.5x, and (iv) book value as of March 31, 1995: 0.5x to 1.4x.
Analysis of Precedent Acquisition Transactions. Bear Stearns reviewed the
consideration paid in certain acquisition or business combination transactions
in the workers' compensations insurance industry involving companies having
characteristics determined to be similar to the Company's insurance
subsidiaries. The acquisitions or business combinations reviewed included the
following: Fremont General Corp./Casualty Insurance (The Continental Corp.);
Blue Cross Blue Shield of Michigan/Accident Fund of Michigan; CareAmerica
Health Plans Inc. (UniHealth America)/CE Health Compensation & Liability
Insurance Co.; WellPoint Health Networks/UniCare Financial Corp.; Foundation
Health Corp./California Compensation Insurance Co. (Hilb Rogal & Hamilton's
Business Insurance Corp.); Penn Central Corp./Republic American Corp.;
Transamerica Corp./Fairmont Financial Corp. Using publicly available
information, Bear Stearns compared the valuation multiples in these
transactions to, among other things, the acquired companies' (i) GAAP
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net operating income, (ii) GAAP book value, (iii) statutory net income from
operations and (iv) policyholders' surplus. Bear Stearns derived the following
multiples from the foregoing analysis and applied them to the following
results of CII's insurance subsidiaries' for the period ended December 31,
1994: (i) GAAP net operating income : 9.6x to 15.3x, (ii) GAAP book value:
1.0x to 2.5x, (iii) statutory net income from operations: 10.7x to 42.8x and
(iv) policyholders' surplus: 1.2x to 3.0x.
Based on the foregoing three valuation analyses, Bear Stearns arrived at a
valuation range for the CII's insurance subsidiaries of $120 to $130 million.
These values were adjusted to reflect the book value of certain other CII
subsidiaries and assets and liabilities, the present value of CII's net
operating loss carryforward, the market value of the CII Debentures and the
after-tax costs associated with the sale of InteLock. After such adjustments,
CII's combined equity value was estimated to be $81 million to $91 million, or
$10.22 to $11.49 per share. These adjusted values were compared to the $86
million equity value, or $10.87 per share of CII Common Stock, implied by the
Exchange Ratio of 0.37 and the market value of Sierra Common Stock of $29.38
on June 12, 1995.
No company, transaction or business used in the Comparable Company Analysis
or Analysis of Precedent Acquisition Transactions is identical to Sierra, CII
or the new combined entity. Accordingly, an analysis of the results of the
foregoing is not entirely mathematical; rather, it involves complex
considerations and judgments concerning differences in financial and operating
characteristics and other factors that could affect the acquisition or public
trading value of the comparable companies or the business segment or company
to which they are being compared.
Contribution Analysis. Bear Stearns analyzed the pro forma contribution of
each of Sierra and CII to the combined company, if the Merger were to be
consummated, and reviewed certain historical and estimated future operating
and financial information including, among other things, the revenues,
operating income and net income of Sierra and CII, and the pro forma revenues,
operating income and net income of the combined company resulting from the
Merger based on internal financial analyses and projections for Sierra and CII
prepared by their respective managements and the Modified CII Projections. The
contribution analysis took into account potential synergies and cost savings
that might be realized after the Merger. Such analysis indicated that, based
on management projections for 1995 and 1996, Sierra's relative contribution to
the financial results of the combined company would be (i) approximately 76%
and 80% respectively, of revenues, (ii) approximately 82% and 82%,
respectively, of operating income and (iii) approximately 82% and 81%
respectively, of adjusted net income. Bear Stearns noted that the
approximately 85% of the outstanding shares for the combined company to be
owned by former Sierra stockholders after the Merger is greater than Sierra's
projected relative contributions of revenue, operating income and net income
in 1995 and 1996. Bear Stearns further noted that the contribution analysis
did not consider the different valuation multiples, such as the price/earnings
multiples, that the market ascribed to Sierra and CII both on a current basis
and on an historical basis.
Other Factors and Analyses. In rendering its opinion, Bear Stearns
considered certain other factors and certain other analyses, including, among
other things: (i) the history of trading prices for CII Common Stock, Sierra
Common Stock and the Comparable Companies and the relationship between the
movements of the trading prices of such common stock and (ii) issues regarding
the pro forma earnings and capitalization of the combined entity.
The preparation of a fairness opinion is a complex process and is not
necessarily susceptible to partial analysis or summary description. Selecting
portions of the analyses in the summary set forth above, without considering
the analysis as a whole, could create an incomplete view of the processes
underlying Bear Stearns' opinion. In arriving at its opinion, Bear Stearns
considered the results of all such analyses. The analyses were prepared solely
for purposes of providing its opinion as to the fairness of the Merger, from a
financial point of view, to the shareholders of Sierra. Analyses based upon
forecasts of future results are not necessarily indicative of actual future
results, which may be significantly more or less favorable than suggested by
such analyses. As described above, Bear Stearns' opinion and presentation to
the Sierra Board of Directors was one of many factors
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taken into consideration by the Sierra Board in making its determination to
approve the Merger Agreement. The foregoing summary does not purport to be a
complete description of the analyses performed by Bear Stearns.
Bear Stearns is an internationally recognized investment banking firm and is
continually engaged in the valuation of businesses and their securities in
connection with mergers and acquisitions and other purposes.
In the ordinary course of its business, Bear Stearns may actively trade the
equity securities of Sierra and CII for its own account and for the accounts
of customers and, accordingly, may, at any time, hold a long or short position
in such securities.
Sierra has agreed to pay Bear Stearns $300,000 for rendering its opinion in
connection with the Merger. These fees are fully creditable against a merger
fee of $1,100,000 which Sierra has agreed to pay to Bear Stearns upon
consummation of the Merger. Sierra has also agreed to reimburse Bear Stearns
for its reasonable out-of-pocket expenses and to indemnify Bear Stearns and
certain related persons against certain potential liabilities in connection
with the engagement of Bear Stearns, including certain potential liabilities
under the federal securities laws.
CII REASONS FOR THE MERGER; RECOMMENDATION OF CII'S BOARD OF DIRECTORS
The Board of Directors of CII believes that the Merger is fair to and in the
best interests of CII and its shareholders. In reaching its conclusion to
enter into the Merger Agreement and to recommend approval of the Merger
Agreement by the CII shareholders, at or prior to the June 12, 1995 special
meeting at which the CII Board approved the Merger Agreement, the CII Board
considered a number of factors of which CII shareholders should be aware in
determining whether to vote for approval of the Merger Agreement, including,
without limitation, the following:
1. The CII Board considered the recent trends in the California workers'
compensation insurance industry including the open rating environment which
became effective January 1, 1995. The CII Board determined that under open
rating, the price of a workers' compensation policy has become an
increasingly important factor. Secondary factors include service and how an
insured can either reduce its loss experience or prevent future work place
accidents from occurring. Loss control prevention services that an insurer
can provide to an insured and managed care techniques and cost reduction
plans, such as medical cost savings, pre-employment physicals and ongoing
substance abuse screenings have become increasingly important. To compete
effectively in this environment, the CII Board concluded that it would be
necessary either to obtain significant additional capital to engage in
increased price competition or to reduce costs, increase loss control
prevention services and enhance its managed care capabilities. While the
CII Board considered these competitive challenges in the context of
remaining independent, the Board believed that CII would benefit from the
synergies and greater resources that a merger with a partner such as Sierra
could provide.
2. The CII Board considered the strategic and operating synergies as well
as other benefits that could result from the Merger. The CII Board
considered Sierra's expansion into Texas and other markets which
complements CII's plans for expansion. The CII Board also determined that
as a result of the Merger, the combined entity would be in a position to
compete more effectively with those providers of insurance and health care
who are striving to offer a 24 hour care package for health care both on
and off the job. The CII Board also believed that the medical management
expertise of Sierra would be extremely valuable to CII in developing and
accelerating medical cost containment programs which are becoming
increasingly necessary in order for CII to remain competitive in the
California market.
3. The CII Board considered the results of the due diligence review of
the operations of Sierra, including the reputation and capabilities of
Sierra and its management and Sierra's financial strength, prospects,
market position and strategic objectives.
4. The amount of consideration to be received by the shareholders of CII
in the Merger was considered in conjunction with the CII Board's review of
the analysis presented by Vector Securities, which is discussed in greater
detail below, regarding the fairness, from a financial point of view, to
the shareholders
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of CII of the consideration to be received in connection with the Merger.
See "The Merger--Opinion of CII's Financial Advisor."
5. The CII Board also considered the enhancement to CII's claims
processing that could be provided through the application of Sierra's
management information system.
6. In addition to the analyses and fairness opinion of Vector Securities,
the CII Board considered the historical market trends and prices of CII
Common Stock and Sierra Common Stock in its analysis of the Exchange Ratio
proposed in the Merger Agreement. The CII Board considered the fact that
the consideration to be received by holders of CII Common Stock in the
Merger represented a significant premium over the market price of CII
Common Stock prevailing prior to the announcement of the Merger and also
the fact that the Exchange Ratio would not be adjusted regardless of
whether the price of Sierra's Common Stock rises or falls.
7. The CII Board considered the fact that holders of CII Common Stock
will receive Sierra Common Stock in the Merger, which will represent a
continuing equity interest in an integrated health care delivery and
insurance entity which is a larger and more diversified company that is
expected to benefit strategically and competitively from the Merger.
8. The CII Board also considered the tax structure of the transaction
which allows shareholders of CII to participate in the synergies of the
combined enterprise on a tax free basis. Business combination transactions
in which there is a material cash component as part of the consideration to
be received by shareholders, as opposed to an exchange of shares as in the
Merger, may result in a taxable event to shareholders upon the consummation
of the transaction. See "The Merger--Certain Federal Income Tax
Consequences."
9. The CII Board also considered the structure of the Merger. While the
Merger Agreement contains a provision which prevents the Board from
soliciting further interest in CII and provides for a five million dollar
termination fee, the Merger Agreement specifically contemplates that the
CII Board may withdraw its recommendation that the shareholders approve the
Merger Agreement and negotiate with and enter into an agreement with a
different party if it deems such action to be necessary in the exercise of
its fiduciary duties. See "The Merger--The Merger Agreement--No
Solicitation of Transactions."
10. The CII Board also considered many of the matters described in this
Joint Proxy Statement/Prospectus under the captions Risk Factors Applicable
to Sierra and Risk Factors Applicable to the Merger with particular
emphasis on the competition and governmental regulation and reform in the
health care industry and the geographic concentration of Sierra's business.
In its evaluation of the Merger, the CII Board was advised by Vector
Securities. On June 12, 1995, Vector Securities made a presentation to the CII
Board and rendered its opinion regarding the fairness, from a financial point
of view, to the shareholders of CII of the consideration to be received in the
Merger. A copy of Vector Securities' opinion is attached hereto as Annex F.
AFTER CONSIDERING ALL OF THE FACTORS DISCUSSED ABOVE, THE CII BOARD OF
DIRECTORS HAS DETERMINED TO APPROVE THE MERGER AND UNANIMOUSLY RECOMMENDS THAT
SHAREHOLDERS VOTE FOR THE PROPOSAL TO APPROVE AND ADOPT THE MERGER AGREEMENT.
OPINION OF CII'S FINANCIAL ADVISOR
On June 12, 1995, Vector Securities delivered its oral opinion (which
opinion was confirmed in writing) to CII's Board of Directors, that the
consideration to be received in the Merger by the holders of CII Common Stock
was fair to such holders from a financial point of view as of such date (the
"Vector Securities Opinion").
THE FULL TEXT OF THE VECTOR SECURITIES OPINION, WHICH SETS FORTH THE
PROCEDURES FOLLOWED, THE FACTORS CONSIDERED AND THE ASSUMPTIONS MADE BY VECTOR
SECURITIES, IS ATTACHED TO THIS JOINT PROXY
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STATEMENT/PROSPECTUS AS ANNEX F AND IS INCORPORATED HEREIN BY REFERENCE. CII
SHAREHOLDERS ARE URGED TO READ THE VECTOR SECURITIES OPINION CAREFULLY AND IN
ITS ENTIRETY. The summary of the Vector Securities Opinion set forth in this
Joint Proxy Statement/Prospectus is qualified in its entirety by reference to
the full text of such opinion.
The Vector Securities Opinion was directed to the CII Board of Directors and
did not address the underlying business decision to recommend the Merger. The
Vector Securities Opinion is directed only to the fairness of the
consideration to be received by holders of CII Common Stock from a financial
point of view and does not constitute a recommendation to any shareholder of
CII or the CII Board of Directors with respect to approval of the Merger.
CII retained Vector Securities, pursuant to an engagement letter dated
January 23, 1995, to provide financial advisory services in connection with
possible corporate development transactions in which CII might become involved
and, if requested, to render its opinion regarding the fairness to CII
shareholders, from a financial point of view, of the consideration involved in
certain such transactions. The consideration to be received by the
shareholders of CII in the Merger was determined as a result of negotiations
between CII and Sierra and was not determined or recommended by Vector
Securities. No limitations were imposed by CII's Board of Directors upon
Vector Securities with respect to the investigations made or the procedures
followed by it in rendering its opinion.
In arriving at its opinion, Vector Securities, among other things: (i)
reviewed the Merger Agreement; (ii) held discussions with the management of
CII and Sierra concerning the business, operations and prospects of each
company; (iii) reviewed certain business and financial information relating to
CII and Sierra, including financial forecasts, prepared and provided by the
respective managements of CII and Sierra; (iv) reviewed certain documents
filed by CII and Sierra since 1990 with the Commission pursuant to the
Exchange Act; (v) compared certain financial data of CII and Sierra with other
publicly traded companies which Vector Securities deemed comparable; (vi)
reviewed the price and trading history of the CII Common Stock and Sierra
Common Stock; (vii) compared the financial terms of the Merger with those of
other transactions which Vector Securities deemed comparable; (viii) reviewed
the pro forma impact of the Merger on Sierra's financial results and
condition; and (ix) performed such other financial studies and analyses as
Vector Securities deemed appropriate. Vector Securities also generally took
into account its experience in other acquisition transactions and securities
valuations, as well as its knowledge of the industries in which CII and Sierra
operate.
In connection with its opinion, Vector Securities did not assume any
responsibility for independent verification of any information supplied or
otherwise made available to Vector Securities regarding CII and Sierra, and
assumed that such information was, and relied on such information being,
accurate and complete. Vector Securities did not undertake an independent
evaluation or appraisal of the assets of CII or Sierra, nor was it furnished
with any such evaluations or appraisals. With respect to the financial
forecasts referred to above, Vector Securities assumed that they were
reasonably prepared on bases reflecting the best available estimates and
judgments of the respective managements of CII and Sierra as to the future
financial performance of CII and Sierra, respectively. Vector Securities also
assumed that the receipt of Sierra Common Stock by CII shareholders in the
Merger will be tax-free to such holders pursuant to Section 368 of the
Internal Revenue Code of 1986, as amended, and that the Merger will qualify as
a pooling-of-interests under United States Generally Accepted Accounting
Principles. Vector Securities' conclusions were based solely on information
available to it on or before the date of the Vector Securities Opinion, and
reflect economic, market and other conditions as of such date. The Vector
Securities Opinion does not represent an opinion as to what the market value
of the Sierra Common Stock will be when such Common Stock is delivered to the
shareholders of CII upon consummation of the Merger or the prices at which
such stock will trade subsequent to the Merger. In rendering its opinion,
Vector Securities assumed that the transaction contemplated by the Merger will
be consummated on the terms described in the Merger Agreement, without any
material waiver of or modification by CII, and that obtaining any necessary
regulatory approvals for the transaction will not have an adverse effect on
CII or Sierra.
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At the special meeting of the CII Board of Directors held on June 12, 1995
(the "Special Board Meeting"), Vector Securities discussed certain financial
and comparative analyses in connection with the delivery of its opinion. In
connection with its presentation, Vector Securities provided CII's Board of
Directors with a summary of valuation results using several different
valuation methodologies as well as certain other materials concerning the
Common Stock of CII and Sierra, the material portions of which are summarized
below.
Stock Premium Analysis. Vector Securities reviewed five selected business
combinations (the "Comparable Acquisitions") involving the acquisition of
companies in the insurance industry announced since February 1992, for which
information was publicly available, and which Vector Securities considered to
be comparable to the Merger. Vector Securities noted for each Comparable
Acquisition the "acquisition premium" (defined as the premium of the offer
price per share over the acquired company's closing stock price thirty days
prior to the announcement of the business combination). The Comparable
Acquisitions and the date each transaction was announced were as follows: the
acquisition of Niagara Exchange Corporation by Selective Insurance Group, Inc.
(February 1992); the acquisition of PHLCORP, Inc. by Leucadia National
Corporation (August 1992); the acquisition of Southern Educators Life
Insurance Co. by United Insurance Companies, Inc. (January 1993); the
acquisition of North American National Corporation by Liberty Corporation
(April 1993); and the acquisition of UniCARE Financial Corp. by WellPoint
Health Networks Inc. (October 1993). The mean and median of the acquisition
premiums were 33.6% and 37.2%, respectively. Vector Securities then compared
the mean and median acquisition premiums to the premium of (i) Sierra's Common
Stock closing price on June 9, 1995 times the Exchange Ratio over (ii) CII's
Common Stock price on May 12, 1995, thirty days prior to the Special Board
Meeting. This premium equaled 78.2%.
Discounted Cash Flow Analyses. Vector Securities analyzed the value of each
of CII and Sierra utilizing an unlevered discounted cash flow analysis. Each
of these analyses was based solely upon information, including certain
projected financial information, prepared or provided by the managements of
CII or Sierra, as the case may be. The projections were based on assumptions
that were made at the time of the preparation of the projections by the
respective managements of CII and Sierra and have not been updated to the date
of this Joint Proxy Statement/Prospectus to reflect any current assumptions or
financial expectations of CII or Sierra management. As part of its analyses,
Vector Securities also considered certain sensitivity tests to evaluate the
impact of changes in certain variables on overall valuation, including, among
other things, changes in loss ratios and expense experience.
Vector Securities calculated ranges of equity value for CII based upon the
discount to present value of CII's projected five-year stream of unlevered
after-tax cash flows and its fiscal 1999 terminal values based upon a range of
multiples of CII's projected earnings before taxes ("EBT"). Vector Securities
utilized discount rates ranging from 12.5% to 17.5% and terminal value
multiplies of 1999 EBT ranging from 5.0x to 9.0x. Based on the foregoing,
Vector Securities indicated a discounted cash flow implied value reference
range for CII of between $6.94 and $8.33 per share of CII Common Stock.
Vector Securities calculated ranges of equity value for Sierra based upon
the discount to present value of Sierra's projected three-year stream of
unlevered after-tax cash flows and its fiscal 1997 terminal values based upon
a range of multiples of Sierra's projected earnings before interest and taxes
("EBIT"). Vector Securities utilized discount rates ranging from 17.5% to
22.5% and terminal value multiples of 1997 EBIT ranging from 5.0x to 9.0x.
Based on the foregoing, Vector Securities indicated a discounted cash flow
implied value reference range for Sierra of between $27.79 and $36.06 per
share of Sierra Common Stock.
In determining the range of discount rates used in the discounted cash flow
analyses of CII and Sierra, Vector Securities noted, among other things,
factors such as inflation, prevailing market interest rates, the business risk
inherent to each of CII and Sierra, the historical weighted average cost of
capital for each of CII and Sierra, and the historical weighted average cost
of capital for public companies Vector Securities deemed comparable to each of
CII and Sierra. In determining the range of terminal value multiples used in
the discounted cash flow analyses of CII and Sierra, Vector Securities noted,
among other things, the multiples at which each of the CII Common Stock and
Sierra Common Stock historically traded, the multiples at which public
companies
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Vector Securities deemed comparable to each of CII and Sierra historically
traded, and the multiples observed in historical business combination
transactions which Vector Securities deemed relevant.
Selected Comparable Public Company Analyses. Using publicly available
information, Vector Securities compared selected financial data of CII and
Sierra with similar data of selected publicly traded companies engaged in
businesses considered by Vector Securities to be comparable to those of CII
and Sierra. In this regard, Vector Securities noted that although such
companies were considered similar to CII or Sierra, none of the companies has
the same management, makeup, size or combination of business as CII or Sierra,
as the case may be. Vector Securities considered the following companies to be
comparable to CII (the "CII Comparable Companies"): Argonaut Group, Inc.;
Fremont General Corporation; UniCARE Financial Corp., prior to its acquisition
by WellPoint Health Networks, Inc.; and Zenith National Insurance Corporation.
Vector Securities considered the following companies to be comparable to
Sierra (the "Sierra Comparable Companies"): Coventry Corporation; FHP
International Corporation; Foundation Health Corporation; Healthsource, Inc.;
Oxford Health Plans, Inc.; Pacificare Health Systems, Inc.; and U.S.
Healthcare, Inc.
Vector Securities analyzed the following financial data for each of the CII
Comparable Companies: (i) the "market value" (defined as the number of shares
outstanding times the closing stock price on June 9, 1995, except in the case
of UniCARE Financial Corp. for which the closing stock price immediately prior
to the announcement of its acquisition by WellPoint Health Networks Inc. was
used) as a multiple of (a) publicly reported latest twelve months ("LTM") net
income, (b) 1995 and 1996 estimated earnings per share ("EPS") (which
estimates reflected a composite of research analysts' estimates as reported by
Zacks Investment Research, Inc. for each of the CII Comparable Companies, and
management projections for CII), and (c) latest publicly reported "tangible
book value" (defined as total stockholders' equity less intangible assets);
(ii) the market value plus total debt less cash and cash equivalents as a
multiple of LTM revenues; and (iii) LTM "loss ratio" (defined as loss and loss
adjustment expenses divided by the net earned premiums), LTM "combined ratio"
(defined as the sum of loss and loss adjustment expenses plus underwriting
expenses, divided by net earned premiums) and LTM "EBT margin" (defined as LTM
EBT divided by LTM revenues). In the case of UniCARE Financial Corp., LTM and
latest publicly reported data referred to data available prior to the
acquisition of UniCARE Financial Corp. by WellPoint Health Networks Inc.
Vector Securities derived mean and median multiples or percentages, as the
case may be, from the foregoing analyses and applied them to certain financial
data of CII. Based on the foregoing mean and median values for the CII
Comparable Companies, Vector Securities indicated an implied value reference
range for CII of between $10.75 and $12.94 per share of CII Common Stock.
Vector Securities analyzed the following financial data for each of the
Sierra Comparable Companies: (i) the market value as a multiple of LTM net
income, 1995 and 1996 estimated earnings per share (which estimates reflected
a composite of research analysts' estimates as reported by Zacks Investment
Research, Inc. for each of the Sierra Comparable Companies, and management
projections for Sierra), and LTM "free cash flow" (defined as earnings before
interest and after taxes plus depreciation and amortization expenses less
capital expenditures less changes in net working capital); (ii) the market
value plus total debt less cash and cash equivalents as a multiple of LTM
revenues, LTM EBIT and LTM EBIT plus depreciation and amortization expenses
("EBITDA"); and (iii) LTM "EBIT margin" (defined as LTM EBIT divided by LTM
revenues), LTM "net margin" (defined as LTM net income divided by LTM
revenues), the compound annual growth rate in revenues observed over the most
recent publicly reported three fiscal years, and the compound annual growth
rate in net income observed over the most recent publicly reported three
fiscal years. Vector Securities derived mean and median multiples or
percentages, as the case may be, from the foregoing analyses and applied them
to certain financial data of Sierra. Based on the foregoing mean and median
values for the Sierra Comparable Companies, Vector Securities indicated an
implied value reference range for Sierra of between $27.49 and $33.21 per
share of Sierra Common Stock.
Selected Comparable Transactions Analyses. Vector Securities reviewed
certain publicly available information regarding selected merger and
acquisition transactions involving companies engaged in similar businesses to
CII and Sierra occurring since February 1992. The transactions deemed
comparable in the case of CII were the Comparable Acquisitions as described
above. The transactions deemed comparable in the case of
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Sierra (the "Sierra Comparable Transactions") and the date each Sierra
Comparable Transaction was announced were as follows: the acquisition of
Century MediCorp, Inc. by Foundation Health Corporation (July 1992); the
acquisition of HMO America, Inc. by United HealthCare Corporation (May 1993);
the acquisition of Mediplex Group, Inc. by Sun Healthcare Group, Inc. (January
1994); the acquisition of TakeCare, Inc. by FHP International Corporation
(January 1994); the acquisition of Ramsay-HMO by United Healthcare, Inc.
(February 1994); the acquisition of Intergroup Healthcare Corporation by
Foundation Health Corporation (July 1994); and the acquisition of Southern
Health Management Corporation by Coventry Corporation (September 1994).
Vector Securities compared selected financial data of CII and Sierra
(including in the case of CII public market multiples of LTM net income,
latest publicly reported tangible book value and LTM revenues, and in the case
of Sierra public market multiples of LTM net income, LTM revenues, LTM EBIT
and LTM EBITDA) with similar data for the Comparable Acquisitions and the
Sierra Comparable Transactions, respectively. Vector Securities then applied
the multiples derived from this analysis to CII's and Sierra's respective
results of operations, which indicated a range of value for CII between $8.56
and $10.17 per share of CII Common Stock and for Sierra between $41.15 and
$49.83 per share of Sierra Common Stock.
Pro Forma Analyses. Vector Securities utilized several analyses to calculate
a range of equity value on a pro forma basis for the combined entity after the
Merger, including the following: (i) a discounted cash flow analysis based
upon the discount to present value of the projected pro forma three-year
stream of unlevered after-tax cash flows using discount rates ranging from
15.0% to 20.0% and fiscal 1997 terminal values based upon a range of multiples
of projected pro forma EBT from 5.0x to 9.0x; (ii) an analysis applying the
mean and median values for the Sierra Comparable Companies described above to
the pro forma operating results; and (iii) an analysis applying the mean and
median values for the Sierra Comparable Transactions described above to the
pro forma operating results. Vector Securities based these analyses on
management projections and on sensitivity projections which gave effect to
projected costs savings of the Merger, as given by management. No assurances
can be given that such projected cost savings in the amount estimated will be
realized as a result of the Merger. Vector Securities concluded that, in its
judgment, the imputed value reference range for the combined entity on a pro
forma basis was between $30.35 and $40.85 per share.
Stock Trading History Analysis. Vector Securities examined the daily history
of the trading prices and volume for the CII Common Stock and the Sierra
Common Stock, both separately and in relation to each other. The analysis
showed, among other things, that over the twelve-month period ended June 9,
1995, CII Common Stock rose by approximately 40.9%, compared with an
approximate 9.8% rise in Sierra Common Stock. Vector Securities also examined
the ratios of the prices of CII Common Stock and Sierra Common Stock to their
respective earnings per share (the "P/E" ratios) over the period December 31,
1993 to June 9, 1995. This analysis showed, among other things, that the P/E
ratio for CII decreased from 9.6x to 4.4x, while the P/E ratio for Sierra
increased from 15.6x to 16.6x.
In response to a request posed by the CII Board of Directors, Vector
Securities indicated that the composite value reference range for the shares
of CII Common Stock and Sierra Common Stock, based upon all of its analyses,
was approximately $7.87 to $10.75 per share and $29.04 to $35.25 per share,
respectively.
The summary set forth in this section does not purport to be a complete
description of the analyses performed by Vector Securities in arriving at its
opinion. The preparation of a fairness opinion is a complex process that
involves various determinations as to the most appropriate and relevant
methods of financial analysis and the application of those methods to the
particular circumstances and, therefore, such an opinion is not readily
susceptible to partial analysis or summary description. Furthermore, in
arriving at its opinion, Vector Securities did not attribute any particular
weight to any analysis or factor considered by it, but rather made qualitative
judgments as to the significance and relevance of each analysis and factor.
Accordingly, Vector Securities believes that its analyses must be considered
as a whole and that considering any portions of such analyses and the factors
considered, without considering all analyses and factors, could create a
misleading or incomplete view of the process underlying the Vector Securities
Opinion. With respect to the stock premium analysis, comparable public company
analysis, comparable acquisition analysis and comparable transaction analysis
summarized
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above, no public company, acquisition or transaction utilized as a comparison
is identical to CII, Sierra or the Merger and such analyses necessarily
involve complex considerations and judgments concerning the differences in
financial and operating characteristics of the companies and other factors
that could affect the acquisition or public trading values of the companies
concerned. In its analyses, Vector Securities made numerous assumptions with
respect to industry performance, general business, economic, market and
financial conditions and other matters, many of which are beyond the control
of CII and Sierra. Any estimates and financial projections used in these
analyses are inherently uncertain and are therefore not necessarily indicative
of actual value or predictive of future results or values, which may be
significantly more or less favorable than suggested by such analyses. In
addition, analyses relating to the value of businesses and securities are
inherently subject to substantial uncertainty and do not purport to be
appraisals or to reflect the prices at which the businesses or securities
actually may be sold. Accordingly, because such estimates are inherently
subject to uncertainty, Vector Securities assumes no responsibility for their
accuracy.
Vector Securities is an internationally recognized investment banking firm
and is continually engaged in the valuation of businesses and their securities
in connection with mergers and acquisitions, negotiated underwritings, private
placements and corporate and other purposes. CII selected Vector Securities to
act as its financial advisor on the basis of Vector Securities' experience and
its reputation in investment banking and mergers and acquisitions.
Pursuant to an engagement letter dated January 23, 1995, between CII and
Vector Securities, CII has agreed to pay Vector Securities upon consummation
of the Merger a fee equal to 2.75% of the market value of the Sierra Common
Stock received by CII shareholders in the Merger. The fee payable to Vector
Securities is not contingent upon the content of the Vector Securities
Opinion. Also, upon entering into the engagement letter, CII paid Vector
Securities a retainer fee of $150,000, and agreed to reimburse Vector
Securities for its reasonable out-of-pocket expenses incurred in acting as
financial advisor to CII up to $18,000, and in excess of $18,000 if consented
to by CII. In addition, CII has agreed to indemnify Vector Securities and its
affiliates and their respective directors, officers, stockholders, agents and
employees against certain liabilities arising out of or in conjunction with
its rendering of services under its engagement. Vector Securities is a full
service securities firm, and in the course of its normal trading activities
may from time to time effect transactions and hold positions in securities of
CII and Sierra.
THE MERGER AGREEMENT
The following is a brief summary of certain provisions of the Merger
Agreement, which is attached as Annex A to this Joint Proxy
Statement/Prospectus and is incorporated herein by reference. Such summary is
qualified in its entirety by reference to the Merger Agreement.
THE MERGER. The Merger Agreement provides that, following the approval and
adoption of the Merger Agreement by the shareholders of Sierra and CII and the
satisfaction or waiver of the other conditions to the Merger, Sierra Sub will
be merged with and into CII, with CII continuing as the surviving corporation
(the "Surviving Corporation").
If the Merger Agreement is approved and adopted by the shareholders of CII
and Sierra, and the other conditions to the Merger are satisfied or waived,
the Merger will become effective upon the filing by the Surviving Corporation
with the Secretary of State of the State of California of a duly executed
Merger Agreement with the duly executed respective officer's certificate of
each of Sierra Sub and CII attached thereto.
Upon consummation of the Merger, pursuant to the Merger Agreement (other
than any shares of CII Common Stock held by Sierra, Sierra Sub or any wholly-
owned subsidiary of Sierra, all of which will be cancelled) each issued and
outstanding share of CII Common Stock will be converted into the right to
receive 0.37 of a share of Sierra Common Stock, including the right to
purchase shares of Series A Junior Participating Preferred Stock of Sierra
pursuant to the Rights Agreement, dated as of June 14, 1994, between Sierra
and Continental Stock Transfer & Trust Company, as Rights Agent. Based upon
the capitalization of CII and Sierra
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as of June 12, 1995 and the Exchange Ratio, the holders of the then
outstanding shares of CII Common Stock would own securities representing
approximately 15% of the outstanding shares of Sierra Common Stock as a result
of the Merger. If any holder of CII Common Stock would be entitled to receive
a number of shares of Sierra Common Stock that includes a fraction, then in
lieu of a fractional share, such holder will be entitled to receive cash. The
amount of such cash (without interest) will be determined by multiplying the
closing price of the Sierra Common Stock as reported on the New York Stock
Exchange Composite Transactions on the business day two days prior to the
effective time of the Merger by the fractional share interest to which such
holder would otherwise be entitled. Pursuant to the Merger Agreement, with
respect to the CII Debentures issued pursuant to the Indenture (the
"Indenture") dated as of September 15, 1991 between CII and Chemical Trust
Company of California, as Trustee (the "Trustee"), and pursuant to an
indenture supplemental thereto to be executed by CII, Sierra and the Trustee
as of the date of the closing of the Merger, the CII Debentures will no longer
be convertible into CII Common Stock and will be convertible into Sierra
Common Stock. The current conversion price for conversion of the CII
Debentures into CII Common Stock is $21.866. The conversion price for the
conversion of the CII Debentures into Sierra Common Stock after the Merger
will be $59.097. Additionally, at the effective time of the Merger, each
outstanding option to purchase shares of CII Common Stock issued pursuant to
CII's stock option plans will be assumed by Sierra and will constitute an
option to acquire the same number of shares of Sierra Common Stock into which
such shares would have been converted pursuant to the Merger had such options
been exercised immediately prior to the effective time.
Promptly after the effective time of the Merger, transmittal forms will be
mailed to each holder of record of CII Common Stock to be used in forwarding
his or her certificates evidencing such shares for surrender and exchange for
certificates evidencing the shares of Sierra Common Stock to which he or she
has become entitled and, if applicable, cash in lieu of a fractional share of
Sierra Common Stock. After receipt of such transmittal form, each holder of
certificates formerly representing CII Common Stock should surrender such
certificates to the Exchange Agent, and each such holder will receive in
exchange therefor certificates evidencing the whole number of shares of Sierra
Common Stock to which such holder is entitled and any cash which may be
payable in lieu of a fractional share of Sierra Common Stock. Such transmittal
forms will be accompanied by instructions specifying other details of the
exchange. CII SHAREHOLDERS SHOULD NOT SEND IN THEIR CERTIFICATES UNTIL THEY
RECEIVE A TRANSMITTAL FORM.
After the effective time of the Merger, each certificate evidencing CII
Common Stock (other than those evidencing CII Dissenting Shares), until so
surrendered and exchanged, will be deemed, for all purposes, to evidence only
the right to receive the number of shares of Sierra Common Stock which the
holder of such certificate is entitled to receive and the right to receive any
cash payment in lieu of a fractional share of Sierra Common Stock. The holder
of such unexchanged certificate will not be entitled to receive any dividends
or other distributions payable by Sierra until the certificate is surrendered.
Subject to applicable laws, such dividends and distributions, if any, will be
accumulated and, at the time of such surrender, all such unpaid dividends and
distributions, together with any cash payment in lieu of a fractional share of
Sierra Common Stock, will be paid, without interest.
REPRESENTATIONS AND WARRANTIES. The Merger Agreement contains various
representations and warranties relating to, among other things, (i) each of
Sierra's and CII's and certain of their respective subsidiaries' organization
and similar corporate matters, (ii) each of Sierra's and CII's capital
structure and the ownership of Sierra Sub by Sierra, (iii) the authorization,
execution, delivery, performance and enforceability of the Merger Agreement
and related matters, (iv) documents filed by each of Sierra and CII with the
Commission and the accuracy of information contained therein, (v) the accuracy
of information supplied by each of Sierra and CII in connection with the
Registration Statement and this Joint Proxy Statement/Prospectus, (vi)
compliance with law, (vii) litigation, (viii) taxes, (ix) certain contracts
relating to certain employment, consulting and benefits matters, (x)
retirement and other employee plans and matters relating to the Employee
Retirement Income Security Act of 1974, as amended ("ERISA"), (xi) patents,
trademarks and related matters, (xii) the absence of certain material changes
or events, (xiii) the shareholder votes required to approve the Merger and
related matters and (xiv) certain accounting matters.
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CERTAIN COVENANTS. Pursuant to the Merger Agreement, CII has agreed as to
itself and its subsidiaries that, during the period from the date of the
Merger Agreement until the effective time of the Merger, except (A) as
expressly contemplated or permitted by the Merger Agreement, (B) as otherwise
consented to in writing by Sierra and (C) with respect to employment and
compensation arrangements entered into by CII, CII will, and will cause its
subsidiaries to, among other things, (i) carry on their respective businesses
in the usual, regular and ordinary course in substantially the same manner as
heretofore conducted, (ii) not declare or pay any dividends on or make other
distributions in respect of any of its capital stock, except for dividends by
a wholly-owned subsidiary of CII, and will not effect certain other changes in
its capitalization, (iii) not issue, deliver or sell, or authorize or propose
the issuance, delivery or sale of, any shares of its capital stock, or any
securities convertible into, or any rights, warrants, or options to acquire,
any such shares or convertible securities, subject to certain exceptions, (iv)
not amend its Articles of Incorporation or By-laws, subject to one exception,
(v) not acquire or agree to acquire by any manner, any business or any
corporation, partnership, association or other business organization or
division thereof or otherwise acquire or agree to acquire any assets in each
case which are material, individually or in the aggregate, to CII or any such
subsidiary, (vi) subject to certain exceptions, not sell, lease, encumber or
otherwise dispose of or agree to sell, lease, encumber or otherwise dispose
of, any of its assets, which are material, individually or in the aggregate,
to CII or any of its subsidiaries taken as a whole, without the prior consent
of Sierra, (vii) subject to certain exceptions, not incur indebtedness for
borrowed money (or guarantees thereof) or issue or sell any debt securities or
warrants or rights to acquire any debt securities of such party or any of its
subsidiaries or guarantee any debt securities of others, (viii) not take any
action that would or is reasonably likely to result in any of its
representations and warranties set forth in the Merger Agreement becoming
untrue as of the date made (to the extent so limited) or in any of the
conditions to the Merger not being satisfied and (ix) confer with Sierra on a
regular and frequent basis and report on operational matters and promptly
advise Sierra of material adverse changes or events.
NO SOLICITATION OF TRANSACTIONS. The Merger Agreement provides that CII will
not, nor will CII permit any of its subsidiaries to, nor will it authorize or
permit any of its or their officers, directors or employees or any investment
banker, financial advisor, attorney, accountant or other representative
retained by it or any of its subsidiaries to solicit or encourage (including
by way of furnishing information), or take any other action to facilitate, any
inquiries or the making of any proposal which constitutes, or may reasonably
be expected to lead to, any takeover proposal, or agree to or endorse any
takeover proposal, or participate in any discussions or negotiations, or
provide third parties with any nonpublic information, relating to any such
inquiry or proposal. The Merger Agreement provides that CII shall promptly
advise Sierra, orally and in writing of any such inquiries or proposals. As
used in the Merger Agreement, "takeover proposal" means any tender or exchange
offer, proposal for a merger, consolidation or other business combination
involving CII or any subsidiary of CII or any proposal or offer to acquire in
any manner a substantial equity interest in, or a substantial portion of the
assets of, CII or any of its insurance subsidiaries other than the
transactions contemplated by the Merger Agreement. However, the Merger
Agreement does not prohibit CII or its Board of Directors from (i) taking and
disclosing to CII's shareholders a position with respect to a takeover
proposal pursuant to Rules 14d-9 and 14e-2 promulgated under the Exchange Act,
(ii) making such disclosures to CII's shareholders as are required under
applicable law or (iii) subject to compliance with the provisions of the
Merger Agreement relating to the termination of the Merger Agreement
furnishing information to, or entering into discussions or negotiations with,
any person or entity that makes a bona fide unsolicited offer to acquire CII
pursuant to a merger, consolidation, tender offer, share exchange, business
combination, stock or asset purchase or other similar transaction (a
"Competing Offer") if: (A) the Board of Directors of CII, after consultation
with and receiving the advice of its legal counsel and financial advisors,
determines in good faith that such action is necessary or required for the
Board of Directors of CII to comply with its fiduciary duties to CII's
shareholders under applicable law, (B) before furnishing such information to,
or entering into discussions or negotiations with, such person or entity, CII
discloses to Sierra that it is furnishing information to, or entering into
discussions or negotiations with, such person or entity, which notice shall
describe the terms thereof (but need not identify the person or entity making
the offer), (C) prior to furnishing such information to such person or entity,
CII receives from such person or entity an executed confidentiality agreement,
and (D) CII keeps Sierra informed promptly of the status, including the terms
of any such discussions or negotiations (provided that, CII shall not be
required to disclose to Sierra confidential information concerning the
business or operations of the person making the expression of interest).
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INDEMNIFICATION. The Merger Agreement provides that from and after the
effective time of the Merger, Sierra and the Surviving Corporation shall,
indemnify, defend and hold harmless each person who was as of the date of the
Merger Agreement or has been at any time prior to the date thereof, or who
becomes prior to the effective time of the Merger, an officer, director or
employee of CII or any of its subsidiaries (the "Indemnified Parties") against
all losses, claims, damages, costs, expenses (including attorney's fees),
liabilities or judgments or amounts that are paid in settlement (which
settlement shall require the prior written consent of Sierra, which consent
shall not be unreasonably withheld) of or in connection with any claim,
action, suit, proceeding or investigation (a "Claim") in which an Indemnified
Party is or is threatened to be made, a party or witness based in whole or in
part on or arising in whole or in part out of the fact that such person is or
was a director, officer or employee of CII or any of its subsidiaries, whether
such Claim pertains to any matter existing or occurring at or prior to the
effective time of the Merger (including, without limitation, the Merger and
other transactions contemplated by the Merger Agreement) regardless of whether
such Claim is asserted or claimed prior to, at or after the effective time of
the Merger (the "Indemnified Liabilities"), and all Indemnified Liabilities
based in whole or in part on, or arising in whole or in part out of, or
pertaining to the Merger Agreement or the transactions contemplated thereby,
in each case to the full extent CII would have been permitted under California
law and its Articles of Incorporation and By-laws to indemnify such person.
The Merger Agreement further provides that for a period of six years after the
effective time of the Merger, Sierra and the Surviving Corporation shall cause
to be maintained in effect the current policies of directors' and officers'
liability insurance maintained by CII and its subsidiaries (provided that
Sierra and the Surviving Corporation may substitute therefor policies of at
least the same coverage containing terms and conditions which are no less
advantageous to the Indemnified Parties in all material respects so long as no
lapse in coverage occurs as a result of such substitution) with respect to all
matters, including the transactions contemplated hereby, occurring prior to,
and including, the effective time, provided that, in the event that any Claim
is asserted or made within such six-year period, such insurance shall be
continued in respect of any such Claim until final disposition of any and all
such Claims, provided further that, Sierra shall not be obligated to make
annual premium payments for such insurance to the extent such premiums exceed
200% of the premiums paid as of the date hereof by Sierra for such insurance.
Notwithstanding anything to the contrary contained elsewhere herein, Sierra's
agreement set forth above shall be limited to cover claims only to the extent
that those claims are not covered under CII's directors' and officers'
insurance policies (or any substitute policies permitted by the Merger
Agreement).
CONDITIONS TO MERGER. The respective obligations of Sierra and CII to effect
the Merger are subject to the following conditions, among others, (i) the
Merger Agreement shall have been approved and adopted by the shareholders of
CII and Sierra, (ii) the shares of Sierra Common Stock issuable and reserved
for issuance in connection with the Merger shall have been authorized for
listing on the New York Stock Exchange, upon official notice of issuance,
(iii) the receipt of all material governmental authorizations, consents,
orders or approvals, (iv) the Registration Statement shall have become
effective and shall not be the subject of a stop order or proceedings seeking
a stop order, (v) no temporary restraining order, preliminary or permanent
injunction or other order shall be in effect that prevents the consummation of
the Merger (see "The Merger--Regulatory Approvals"), (vi) the accuracy in all
material respects of the representations and warranties set forth in the
Merger Agreement, (vii) the performance in all material respects of all
obligations required to be performed under the Merger Agreement, (viii) the
receipt by Sierra of letters from CII affiliates relating to restrictions on
the transferability of the shares of Sierra Common Stock to be received in the
Merger as a result of restrictions under the Securities Act and pooling-of-
interest accounting rules (see "The Merger--Restrictions on Resales of
Securities"), (ix) the receipt of certain legal opinions with respect to tax
matters, (x) the receipt of material nongovernmental consents or approvals
required in connection with the Merger and (xi) the Board of Directors of
either party not having amended, modified, rescinded or repealed the
resolutions adopted by it in connection with the Merger and not having adopted
any other resolutions inconsistent therewith.
STOCK OPTION AND BENEFIT PLANS. The treatment under the Merger Agreement of
stock options to acquire shares of CII Common Stock is described under "The
Merger--Interests of Certain Persons in the Merger."
CII has agreed to take all necessary steps at or prior to the closing of the
Merger to terminate, effective as of such closing, the following designated
benefit plans which it now maintains: (i) the Profit Sharing Plan, (ii)
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the Supplemental Benefit Plan, (iii) the Supplemental Executive Retirement
Plan, (iv) the Supplemental Senior Executive Retirement Plan, (v) the Employee
Incentive Plan, (vi) the Stock Purchase Match Plan and (vii) the InteLock 1993
Stock Option Plan, the Supplemental Executive Retirement Plan, the Founders'
Bonus Plan and the Phantom Stock Bonus Plan. CII has agreed that, on or after
the date of this Agreement, it will not issue any stock option or any other
award pursuant to the 1988 Stock Option Plan, the 1989 Stock Option Plan, the
1991 Employee Stock Incentive Plan, the 1993 Employee Stock Incentive Plan, or
the Non-Employee Directors Stock Option Plans. Sierra and CII have agreed that
the remaining designated plans will continue subsequent to the closing of the
Merger, but may be terminated at any time thereafter provided that at such
time the employees of CII are either covered under a plan, if any, providing
benefits of the same nature that is maintained by either Sierra or a
subsidiary of Sierra for its employees or by a plan comparable to any such
plan.
TERMINATION. The Merger Agreement may be terminated at any time prior to the
effective time of the Merger, whether before or after approval by the
shareholders of CII or by the shareholders of Sierra, (i) by mutual consent of
Sierra and CII, (ii) by either Sierra or CII if there has been a material
breach of any representation, warranty, covenant or agreement on the part of
the other party set forth in the Merger Agreement which breach has not been
cured within five business days following receipt by the breaching party of
notice of such breach, or if any permanent injunction or other order of a
court or other competent authority preventing the consummation of the Merger
shall have become final and non-appealable, (iii) by CII, if the Board of
Directors of CII shall have adopted and recommended a Competing Offer, (iv) by
either Sierra or CII if the Merger shall not have been consummated before
December 31, 1995, (v) by either Sierra or CII if any required approval of the
respective shareholders of CII or Sierra shall not have been obtained by
reason of the failure to obtain the required affirmative vote at a duly held
meeting of shareholders or at any adjournment thereof or (vi) by Sierra, if
(A) the Board of Directors of CII withdraws, modifies or changes its
recommendation of the Merger Agreement or the Merger in a manner adverse to
Sierra or Sierra Sub or shall have resolved to do so, or (B) the Board of
Directors of CII shall have recommended to the shareholders of CII any
Competing Transaction or resolved to do so, or (C) a tender offer or exchange
offer for ten percent or more of the outstanding shares of capital stock of
CII is commenced, and the Board of Directors of CII, within 10 business days
after such tender offer or exchange offer is so commenced, either fails to
recommend against acceptance of such tender offer or exchange offer by its
shareholders or takes no position with respect to the acceptance of such
tender offer or exchange offer by its shareholders. As used in the Merger
Agreement, "Competing Transaction" means any of the following involving CII or
any of its subsidiaries (other than the transactions contemplated by the
Merger Agreement): (A) any merger, consolidation, share exchange, business
combination, or other similar transaction; (B) any sale, lease, exchange,
mortgage, pledge, transfer or other disposition of twenty percent or more of
the assets of CII and its subsidiaries, taken as a whole, in a single
transaction; (C) any tender offer or exchange offer for ten percent or more of
the outstanding shares of capital stock of CII or the filing of a registration
statement under the Securities Act in connection therewith; (D) any
solicitation of proxies in opposition to approval by CII's shareholders of the
Merger; (E) any person shall have acquired beneficial ownership or the right
to acquire beneficial ownership of, or any "group" (as such term is defined
under Section 13(d) of the Exchange Act) shall have been formed which
beneficially owns or has the right to acquire beneficial ownership of, ten
percent or more of the then outstanding shares of capital stock of CII; or (F)
any agreement to, or public announcement by CII of a proposal, plan or
intention to, do, facilitate (including by way of providing information) or
recommend any of the foregoing.
In the event of any termination of the Merger Agreement by either CII or
Sierra as provided above, the Merger Agreement will become void and there will
be no liability or obligation on the part of Sierra, CII, Sierra Sub or their
respective officers or directors (other than under certain specified
provisions of the Merger Agreement), except to the extent that such
termination results from the willful breach by a party thereto of any of its
representations, warranties, covenants or agreements set forth in the Merger
Agreement. The Merger Agreement further provides that each party agrees that
should any court or other competent authority hold any provision of the Merger
Agreement to be null, void or unenforceable, or order any party to take any
action inconsistent with the Merger Agreement or not to take any action
required therein, the other party shall not be entitled to specific
performance of such provision of the Merger Agreement or to any other remedy,
including
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but not limited to money damages, for breach of the Merger Agreement or of any
other provision of such agreement as a result of such holding or order.
TERMINATION FEE. Pursuant to the Merger Agreement, CII has agreed that (x)
if CII shall terminate the Merger Agreement pursuant to Section 7.1(e) of the
Merger Agreement or (y) if Sierra or CII shall terminate the Merger Agreement
pursuant to Section 7.1(d) of the Merger Agreement due to the failure of CII's
shareholders to approve and adopt this Agreement, and (A) at the time of such
failure so to approve and adopt the Merger Agreement there shall exist a
Competing Transaction and (B) prior to such failure so to approve and adopt
the Merger Agreement the Board of Directors of CII shall have withdrawn,
modified or changed its recommendation of the Merger Agreement or the Merger
in a manner adverse to Sierra and Sierra Sub, or shall have resolved to do any
of the foregoing, or shall have recommended to the shareholders of CII any
Competing Transaction or shall have resolved to do so, or (z) if Sierra
terminates the Merger Agreement pursuant to Section 7.1(f) of the Merger
Agreement, then on the Payment Date (as defined below), CII shall pay to
Sierra an amount equal to $5,000,000 plus all of Sierra's expenses, including
Sierra's share of the expenses described in Section 7.5(a) of the Merger
Agreement, which sum CII and Sierra have agreed is reasonable under the
circumstances since it would be impracticable and extremely difficult to fix
the actual damage to Sierra in the case of such a termination. Payment Date is
defined as the date 10 days following the earliest of the following to occur:
(1) the closing of any transaction resulting from a Competing Transaction, (2)
the date as of which CII publicly announces that the Competing Transaction
will not proceed, and (3) the date twelve months following a termination of
the Merger Agreement by Sierra or CII giving rise to payment under the Merger
Agreement.
AMENDMENT AND WAIVER. Subject to applicable law, the Merger Agreement may be
amended at any time by action taken or authorized by the respective Boards of
Directors of Sierra and CII and the parties, by action taken or authorized by
their respective Boards of Directors, may extend the time for performance of
the obligations of the other parties to the Merger Agreement and may waive
compliance with any agreements or conditions for their respective benefit
contained in the Merger Agreement.
LITIGATION CHALLENGING THE MERGER
On or about June 13, 1995, Crandon Capital Partners filed a purported class
action complaint in the Superior Court, Alameda County, California against
CII, certain of CII's directors and Sierra. The complaint alleges, among other
claims, that, by entering into the Merger Agreement, CII and its directors
breached their fiduciary duties to CII's shareholders and further alleges that
Sierra aided and abetted such breach. The plaintiff seeks damages, injunctive
relief against the consummation of the transaction, the appointment of a
shareholders' committee to participate in the sale of CII and other relief.
Sierra and the other defendants have filed motions to dismiss the plaintiff's
complaint on the grounds that the plaintiff's sole remedy is to seek to
enforce its dissenter's rights. See "The Merger--Rights of CII Dissenting
Shareholders." The motions are scheduled to be heard by the court in September
1995.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
In the opinion of Gibson, Dunn & Crutcher, tax counsel to CII, the following
are the material United States federal income tax consequences of the Merger
to the holders of CII Common Stock. The discussion is general in nature, is
based on the current provisions of the Internal Revenue Code of 1986, as
amended (the "Code"), applicable Treasury Regulations, judicial authority and
administrative rulings and practice, is for general informational purposes
only and is not tax advice. Counsel's opinion is subject to assumptions and
qualifications concerning the accuracy of the representations contained in the
Merger Agreement and the intentions of CII's shareholders at the time of the
Merger and, unlike a ruling from the Internal Revenue Service (the "IRS"), is
not binding on the IRS. Accordingly, there can be no assurance that the IRS
will not take a position contrary to one or more of the positions described
below, or that such positions would be upheld by the courts if challenged by
the IRS. No ruling from the IRS has been or will be sought with respect to any
aspect of the Merger. Furthermore, such counsel's opinion is based on current
law and legislative, judicial or administrative changes or interpretations
might occur in the future that would alter or modify the discussion herein.
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The following does not consider the tax consequences of the Merger under
state, local or foreign law. Moreover, it does not describe any special
considerations that may apply to certain taxpayers, such as financial
institutions, broker-dealers, insurance companies, tax-exempt organizations,
investment companies and persons who are neither citizens nor residents of the
United States, or who are foreign corporations, foreign partnerships or
foreign estate or trusts as to the United States.
EACH CII SHAREHOLDER IS URGED TO CONSULT HIS OR HER OWN TAX ADVISOR
REGARDING THE FEDERAL, STATE, LOCAL AND FOREIGN TAX CONSEQUENCES OF THE
MERGER.
Subject to the qualifications set forth above, the Merger is expected to
qualify as a tax-free reorganization under Section 368 of the Code, with the
following results:
(i) No gain or loss will be recognized by the shareholders of CII for tax
purposes upon the conversion of their shares of CII Common Stock into
shares of Sierra Common Stock pursuant to the Merger (except as
discussed below with respect to cash received in lieu of a fractional
share of Sierra Common Stock).
(ii) The tax basis of the shares of Sierra Common Stock received by each
shareholder of CII will be the same as the tax basis of the shares of
CII Common Stock surrendered in exchange therefor (reduced by any
amount of basis allocable to a fractional share interest for which
cash is received).
(iii) The holding period of the shares of Sierra Common Stock received by
each shareholder of CII will include the holding period of the shares of
CII Common Stock surrendered in exchange therefor, provided that such
shareholder held such shares of CII Common Stock as a capital asset on
the date of the Merger.
(iv) No gain or loss will be recognized by CII as a result of the Merger.
(v) A shareholder of CII who is entitled to receive cash in lieu of a
fractional share of Sierra Common Stock in connection with the Merger
will recognize, as of the date of the Merger, gain or loss equal to the
difference between the amount of such cash and the shareholder's tax
basis in the fractional share interest. Any gain or loss recognized
will be capital gain or loss if the CII Common Stock is held by such
shareholder as a capital asset. Any capital gain or loss will be long-
term capital gain or loss if the holding period for the shares of CII
Common Stock is more than one year.
(vi) Sierra's ability, following the Merger, to utilize any existing net
operating loss carryforwards and certain other tax attributes of
Sierra and CII to reduce its tax liability may be limited.
Information Reporting. Treasury Regulations require that every taxpayer who
receives stock in connection with a corporate reorganization must file with
his or her income tax return a complete statement of all facts pertinent to
the nonrecognition of gain or loss upon the transaction including: (i) a
statement of the basis of the stock transferred in the transaction and (ii) a
statement of the fair market value of the stock and other property or money
received in the transaction, including any liabilities to which property
received is subject. In addition, taxpayers are required to maintain permanent
records in substantial form with respect to the foregoing information. CII
shareholders will be required to comply with these requirements.
Backup Withholding. Under the backup withholding rules of the Code, a CII
shareholder may be subject to backup withholding with respect to payments of
cash in lieu of fractional shares. To prevent such backup withholding, a CII
shareholder must, unless an exception applies under the applicable law and
regulations, provide the payor of such cash with such shareholder's correct
taxpayer identification number ("TIN") on a Substitute Form W-9 and certify
under penalties of perjury that such number is correct and that such
shareholder is not subject to backup withholding. A Substitute Form W-9 will
be provided to each CII shareholder in the letter of transmittal to be mailed
to each shareholder. If the correct TIN and certifications are not provided, a
$50 penalty may be imposed on the shareholder by the IRS and payments of cash
to such shareholder may be subject to backup withholding at a rate of 31%.
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RIGHTS OF CII DISSENTING SHAREHOLDERS
Holders of CII Common Stock are generally entitled to dissenters' rights
with respect to the Merger under Chapter 13 of the CGCL if, and only if, the
holders of 5% or more of the outstanding shares of CII Common Stock elect to
exercise dissenters' rights. A person having a beneficial interest in shares
of CII Common Stock held of record in the name of another person, such as a
broker or nominee, must act promptly to cause the record holder to follow the
steps summarized below properly and in a timely manner to perfect whatever
appraisal rights the beneficial owner may have.
The following discussion is not a complete statement of the law pertaining
to appraisal rights under the CGCL and is qualified in its entirety by
reference to the full text of Chapter 13 of the CGCL, selected sections of
which are reprinted in their entireties as Annex D to this Joint Proxy
Statement/Prospectus.
If the Merger is approved by the required vote of CII's shareholders and is
not terminated, CII's shareholders who vote against the Merger and who have
fully complied with all applicable provisions of Chapter 13 of the CGCL and
whose shares constitute CII Dissenting Shares will, provided generally that
the CII Dissenting Shares aggregate 5% or more of the outstanding shares of
CII Common Stock, have the right to require CII to purchase the shares of CII
Common Stock held by them for cash at the fair market value of those shares as
of the day before the terms of the Merger were first announced, excluding any
appreciation or depreciation because of the Merger but adjusted for any stock
split, reverse stock split or share dividend which becomes effective
thereafter. Under the CGCL, no shareholder of CII who is entitled to exercise
dissenters' rights has any right at law or in equity to attack the validity of
the Merger or to have the Merger set aside or rescinded, except in an action
to test whether the number of shares required to authorize or approve the
Merger had been legally voted in favor of the Merger.
CII Dissenting Shares means those shares of CII Common Stock with respect to
which the holders have voted against the Merger and have perfected their
purchase demand in accordance with Chapter 13 of CGCL, except that no shares
shall constitute CII Dissenting Shares unless either (i) holders of 5% or more
of the outstanding shares of CII Common Stock file demands for payment as
dissenting shares under the CGCL or (ii) the shares in question are subject to
a restriction on transfer imposed by CII or by any law or regulation.
CII is not aware of any restriction on transfer of any shares of the CII
Common Stock except restrictions that may be imposed upon shareholders who are
"affiliates" of CII for purposes of Rule 145 under the Securities Act,
shareholders who received shares in private transactions exempt from the
registration requirements of the Securities Act and restrictions on transfer
imposed on certain affiliates of CII in connection with the Merger. Those
shareholders who believe there is some such restriction affecting their shares
should consult with their own legal counsel as to the nature and extent of any
dissenters' rights they may have.
For a holder of CII Common Stock to exercise dissenters' rights, the
procedures to be followed under Chapter 13 of the CGCL include the following
requirements:
(1) The shareholder of record must have voted the shares against the
Merger. It is not sufficient to abstain from voting. However, the
shareholder may abstain as to part of his or her shares or vote part of
those shares for the Merger without losing the right to exercise
dissenters' rights as to other shares which were voted against the Merger.
(2) Any such shareholder who votes against the Merger, and who wishes to
have the shares that are being voted against the Merger purchased, must
make a written demand to have CII purchase those shares for cash at their
fair market value. The demand must include the information specified below
and must be received by CII not later than the date of the CII Special
Meeting. Merely voting or delivering a proxy directing a vote against the
approval of the Merger does not constitute a demand for purchase. A written
demand is essential.
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The written demand that the dissenting shareholder must deliver to CII must:
(1) Be made by the person who was the shareholder of record on the CII
Record Date (or such shareholder's duly authorized representative) and not
by someone who is merely a beneficial owner of the shares and not by a
shareholder who acquired the shares subsequent to the CII Record Date:
(2) State the number and class of dissenting shares held of record by the
dissenting shareholders; and
(3) Include a demand that CII purchase the shares at the dollar amount
that the shareholder claims to be the fair market value of such shares on
the day before the terms of the Merger were first announced, excluding any
appreciation or depreciation because of the proposed Merger but adjusted
for any stock split, reverse stock split or share dividend which becomes
effective thereafter. CII believes that this day is June 12, 1995. A
shareholder may take the position in the written demand that a different
date is applicable. The shareholder's statement of fair market value
constitutes an offer by such dissenting shareholder to sell the shares to
CII at such price.
The written demand should be delivered to CII at its principal executive
offices, P.O. Box 9025, Pleasanton, California 94566-9025, Attention
Secretary.
A shareholder may not withdraw a demand for payment without the consent of
CII. Under the terms of the CGCL, a demand by a shareholder is not effective
for any purpose unless it is received by CII (or any transfer agent thereof).
Within 10 days after the approval of the Merger by CII's shareholders, CII
must notify all holders of CII Dissenting Shares of the approval and must
offer all of such shareholders a cash price for their shares which CII
considers to be the fair market value of the shares. The notice also must
contain a brief description of the procedures to be followed under Chapter 13
of the CGCL to dispute the price offered and attach a copy of the relevant
provisions of the CGCL in order for a shareholder to exercise the right to
have CII purchase his or her shares.
Within 30 days after the date on which the notice of the approval of the
Merger is mailed by CII to holders of CII Dissenting Shares, the shareholder's
certificates, representing any shares which the shareholder demands be
purchased, must be submitted to CII, at its principal office, or at the office
of any transfer agent, to be stamped or endorsed with a statement that the
shares are dissenting shares or to be exchanged for certificates of
appropriate denomination so stamped or endorsed. Upon subsequent transfer of
those shares, the new certificates will be similarly stamped, together with
the name of the original dissenting shareholder.
If CII and a holder of CII Dissenting Shares agree that the shares held by
such shareholder are eligible for dissenters' rights and agree upon the price
of such shares, such holder of CII Dissenting Shares is entitled to receive
from CII the agreed price with interest thereon at the legal rate on judgments
from the date of such agreement. Any agreement fixing the fair market value of
dissenting shares as between CII and the holders thereof must be filed with
the Secretary of CII at the address set forth below. Subject to certain
provisions of Section 1306 and Chapter 5 of the CGCL, payment of the fair
market value of the CII Dissenting Shares shall be made within 30 days after
the amount has been agreed upon or within 30 days after any statutory or
contractual conditions to the Merger are satisfied, whichever is later,
subject to the surrender of the certificate therefor, unless provided
otherwise by agreement.
If CII and a holder of CII Dissenting Shares fail to agree on either the
fair market value of the shares or on the eligibility of the shares to be
purchased, then either such holder of CII Dissenting Shares or CII may file a
complaint for judicial resolution of the dispute in the superior court of the
proper county. The complaint must be filed within six months after the date on
which the respective notice of approval is mailed to the shareholders. If a
complaint is not filed within six months, the shares will lose their status as
CII Dissenting Shares. Two or more holders of CII Dissenting Shares may join
as plaintiffs or be joined as defendants in such an action. If the
43
<PAGE>
eligibility of the shares is at issue, the court must first decide that issue.
If the fair market value of the shares is in dispute, the court must
determine, or shall appoint one or more impartial appraisers to assist in its
determination of, the fair market value. The cost of the action will be
assessed or apportioned as the court considers equitable. If, however, the
appraised value of the dissenting shares exceeds the price offered by CII, CII
must pay the costs.
Any demands, notices, certificates or other documents required to be
delivered to CII may be sent to P.O. Box 9025, Pleasanton, California 94566-
9025, Attention Secretary.
RESTRICTIONS ON RESALES OF SECURITIES
The shares of Sierra Common Stock to be issued pursuant to the Merger
Agreement have been registered under the Securities Act. Persons who are not
affiliates of CII and who will not be affiliates of Sierra at the effective
time of the Merger may resell their shares of CII Common Stock without
restriction. Under present law, any public reoffering or sale of such shares
by any person who is an "affiliate" of CII at the time the Merger Agreement is
submitted to a vote of CII's shareholders will require either (i) the further
registration of such shares under the Securities Act, (ii) compliance with
Rule 145 promulgated under the Securities Act (which permits sales under
certain conditions, more fully described below) or (iii) the availability of
some other exemption for the registration requirements of the Securities Act.
In general, under Rule 145, assuming that a person proposing to resell his or
her shares of Sierra Common Stock is not at any time an affiliate of Sierra,
such person may resell such stock if (a) a period of at least two years has
elapsed since the time the shares were acquired from Sierra or an affiliate of
Sierra and such person sells at a time when there is adequate public
information concerning Sierra, (b) a period of at least three years has
elapsed since the time the shares were acquired from Sierra or an affiliate of
Sierra or (c) such person (i) sells during any three-month period no more than
the number of shares permitted under Rule 144(e) (the greater of 1% of the
outstanding shares of Sierra Common Stock and the average weekly trading
volume of Sierra Common Stock for the four calendar weeks prior to the
proposed resale), (ii) sells in a "broker's transaction" where the broker can
do no more than execute the order as agent for the seller, can receive no more
than the usual broker's commission, cannot solicit orders to buy in connection
with the transaction and does not believe that the seller is an underwriter of
the securities being sold, (iii) does not solicit orders to buy in connection
with the transaction and does not make any payment in connection with such
sale to anyone other than the selling broker and (iv) such person sells at
time when there is adequate current public information concerning Sierra.
In connection with the Merger, each affiliate of CII who will receive Sierra
Common Stock pursuant to the Merger, will execute a letter agreement whereby
each such person agrees that he or she will not sell, assign or transfer any
shares of Sierra Common Stock except pursuant to an effective registration
statement or in a transaction not requiring registration under the Securities
Act. Each such person will further agree that he or she will not sell,
transfer, dispose of or hedge such person's risk relative to shares of Sierra
Common Stock received pursuant to the Merger until such time as financial
results covering at least 30 days of combined operations of Sierra and CII on
a consolidated basis have been published by Sierra.
ACCOUNTING TREATMENT
It is contemplated that the Merger will be accounted for as a pooling-of-
interests. It is a condition to the obligation of Sierra to consummate the
Merger that Sierra receive an opinion from its independent accountants,
Deloitte & Touche LLP, that under generally accepted accounting principles,
the Merger can be treated as a pooling-of-interests transaction. As a result
of pooling-of-interests accounting, the consolidated financial statements of
Sierra after the Merger will combine the accounts of CII with those of Sierra
at their historically recorded amounts. Operating results of both Sierra and
CII will be combined for all periods prior to the consummation of the Merger
using the historically recorded amounts as though Sierra and CII had always
been combined.
44
<PAGE>
BOARD OF DIRECTORS AND MANAGEMENT FOLLOWING THE MERGER
Following the consummation of the Merger, the composition of the Board of
Directors of Sierra and the persons appointed as executive officers of Sierra
will remain unchanged as a result of the Merger. Information concerning such
persons is incorporated by reference to the Sierra 10-K. See "Incorporation of
Certain Documents by Reference."
Following the consummation of the Merger, Sierra anticipates that the
composition of the Board of Directors of CII will be reconstituted and will
consist of: Joseph Havlick, currently Chairman of the Board, Chief Executive
Officer and President of CII; Lee Spitler, currently Senior Vice President and
Treasurer of CII; Erin MacDonald, President and Chief Operating Officer of
Sierra; James Starr, Vice President of Finance, Chief Financial Officer and
Treasurer; and Frank Collins, Secretary and General Counsel of Sierra. Joseph
Havlick will continue to serve as Chairman of the Board of CII following the
Merger. Additional information about these proposed directors and the
management of CII after the Merger is contained in Annex G: Information
Concerning Proposed Directors and Management of CII.
INTERESTS OF CERTAIN PERSONS IN THE MERGER
No officers, directors or persons holding more than 5% of the voting power
of either Sierra or CII or their associates will have a material interest in
the Merger except as described below and the interest arising from the
ownership of securities of Sierra or CII, respectively, which interests are
shared pro rata by all holders of the same class of security.
Each of Joseph Havlick, Lee Spitler, Richard Dobson, Wing Kwong, Tanna
Handley, John Okita, Lawrence Havlick and Michael Havlick are parties to
existing employment agreements with CII. Joseph Havlick and Lee Spitler have
agreed, in order to fulfill a condition to Sierra's obligation to consummate
the Merger, to enter into new employment agreements with CII upon consummation
of the Merger which agreements will supersede the existing agreements, with
significant reductions in the length of the term and in certain benefits and
which will be comparable to arrangements with Sierra officers.
Currently, Joseph Havlick is employed as Chairman of the Board, Chief
Executive Officer and President of CII under an agreement with CII that
expires December 31, 2000. The agreement provides for an annually adjustable
minimum base salary of $375,000, minimum annual cash bonus under the Employee
Incentive Plan (capped at 175% of base salary) equal to a percentage of the
greater of (i) growth in revenues or (ii) the greater of pretax or net income,
a year-end "Christmas" bonus payment equal to at least one-eighth (1/8) of his
highest base salary during that year, and a maximum annual reimbursement of
$20,000 for medical expenses not covered by group medical insurance provided
by CII. Pursuant to the formula for computation of the cash bonus under the
Employee Incentive Plan, Mr. Havlick was entitled to and received the minimum
bonus of $611,950 for services rendered to CII in all capacities during 1994.
If Mr. Havlick's employment is terminated prior to the agreement's termination
for reasons other than a breach by CII, he is entitled to a lump-sum severance
payment equal to 5% of his total annual remuneration (including cash bonuses,
but excluding medical and car allowances), multiplied by the number of years
that he had been employed by CII. If Mr. Havlick's employment is terminated
due to death or total disability for a period of six months, Mr. Havlick or
his legal representative is entitled to receive his then current base salary
for a period of twelve months, all previously accruing bonuses or other
rights, and in the case of disability, Mr. Havlick or his legal representative
is entitled to all medical, disability and term life insurance benefits for a
period of two years following the date of disability and an annual payment
equal to 80% of his base salary in effect immediately preceding such
termination. In the event that Mr. Havlick terminates his employment agreement
as a result of a breach by CII, or by Mr. Havlick for good reason, as defined
in the agreement, after a change in control, as defined in the agreement, he
is generally entitled to continue receiving the cash compensation and other
benefits provided for in his agreement until December 31, 2000. In addition to
the above payments made pursuant to the employment agreement, CII currently
pays premiums on Mr. Havlick's behalf for additional life insurance coverage
at an approximate cost of $36,000 per year.
45
<PAGE>
Currently, Lee Spitler, Richard Dobson, Wing Kwong, Tanna Handley, John
Okita, Lawrence Havlick, and Michael Havlick are employed under agreements
with CII that expire on March l, 2001, which provide for annually adjustable
minimum base salaries of $210,000, $175,000, $117,200, $110,000, $105,200,
$104,400, and $95,260, respectively, monthly automobile allowances of $450
each and a maximum annual reimbursement of $5,000 for medical expenses not
covered by group medical insurance provided by CII. The agreements of Lee
Spitler, Richard Dobson, Tanna Handley and John Okita further provide for
annual bonuses equal to at least one-eighth (1/8) of each executive's highest
base salary in effect during such year. The agreements of Wing Kwong, Lawrence
Havlick, and Michael Havlick provide for annual bonuses equal to at least one-
twelfth (1/12) of each executive's highest base salary in effect during such
year. Under the agreements, if employment is terminated for reasons other than
a breach by CII, the executive is entitled to a lump-sum payment equal to 5%
of his or her respective total remuneration (including cash bonuses, but
excluding medical and car allowances), multiplied by the number of years that
such terminated executive had been employed by CII. If employment is
terminated due to death or total disability for a period of six months, the
executives or their respective legal representatives are entitled to receive
such executives' then current base salary for a period of twelve months, all
previously accruing bonuses and other rights and, in the case of disability,
all medical, disability and term life insurance benefits for a period of two
years following the date of disability. If employment is terminated due to a
breach by CII, the terminated executive is generally entitled to continue
receiving the cash compensation and other benefits for the remaining unexpired
term.
Joseph Havlick and Lee Spitler have agreed, in order to fulfill a condition
to Sierra's obligation to consummate the Merger, to enter into new employment
agreements which are the result of negotiations with Sierra at annual salaries
of $375,000 and $210,000, respectively. The new agreements constitute a
significant reduction in the term length of their contracts and the benefits
provided for Mr. Havlick and Mr. Spitler to make their CII arrangements
comparable to those with Sierra's officers. Each of the new agreements has a
three-year term. Under the terms of the new agreements Mr. Havlick and Mr.
Spitler will receive options to purchase 50,000 and 25,000 shares of Sierra
Common Stock, respectively. The granting of these options is based on Mr.
Havlick's and Mr. Spitler's continuing active participation in management and
the importance of such involvement to the success of Sierra and CII as
combined companies. Such options are consistent with Sierra's compensation
policy which relies on the incentive aspects of stock options more than CII's
does and are comparable to Sierra's employment arrangements with its officers.
Additionally, Mr. Havlick and Mr. Spitler will be eligible for bonuses of 100%
and 50% of their respective annual salaries. In addition, both are entitled to
twelve months of extended sick leave; a cash payment in the event of their
death in an amount equal to their respective prior year's salary and bonus;
continuation of their group health and life benefits for twenty-four months
under certain circumstances; and four weeks vacation. Mr. Havlick will also
continue to have paid on his behalf premiums for additional life insurance
coverage at an approximate cost of $36,000 per year. These agreements are both
terminable by the executive officers upon sixty days notice. In the event of
termination without cause, Mr. Havlick and Mr. Spitler are generally entitled
to receive payment for the remaining term of their employment agreement. In
addition, in the event of a change of control of Sierra not approved by the
Board of Directors and a subsequent termination without cause or a diminution
of duties or compensation, Mr. Havlick and Mr. Spitler are entitled to
scheduled payments of two year's and one year's base salary, respectively. In
the event the employment agreements of Joseph Havlick or Lee Spitler are not
renewed, they are entitled to severance payments of $750,000 and $210,000,
respectively.
Sierra is negotiating with the other six employees who currently have
employment agreements with CII concerning new employment agreements which
will, if entered into, supersede their existing agreements.
There are outstanding under CII's 1988 Stock Option Plan (the "1988 Plan"),
1989 Employee Incentive Stock Option Plan (the "1989 Plan"), 1991 Employee
Stock Incentive Plan (the "1991 Plan"), 1993 Employee Stock Incentive Plan
(the "1993 Plan") and the Non-Employee Director Stock Option Plans (together
with the 1988 Plan, 1989 Plan, the 1991 Plan and the 1993 Plan, the "Option
Plans") options to purchase shares of CII Common Stock ("Options"). The Merger
Agreement provides that at the effective time of the Merger the outstanding
Options under the Option Plans will be assumed by Sierra. Thereafter, such
Options will be
46
<PAGE>
exercisable on the same terms and conditions that were applicable under the
Option Plans for the same number of shares of Sierra Common Stock into which
such shares of CII Common Stock would have been converted pursuant to the
Merger had such Options been exercised in full immediately prior to the
effective time of the Merger.
Options under the 1989 Plan accelerate upon the occurrence of a change of
control. The stock option agreements under the 1991 Plan provide that vesting
of the Options will accelerate upon the occurrence of the first public
announcement that a change in control has occurred unless the committee of the
Board of Directors responsible for the administration of the plan shall
determine otherwise within 10 days of such announcement. The stock option
agreements under the 1991 Plan also provide for the acceleration of vesting of
such Options following a change in control if the optionee's employment is
terminated for "good reason" within 18 months following the change in control.
A termination for "good reason" includes demotion or substantial reduction in
salary or benefits. The stock option agreements under the 1993 Plan generally
provide that if the Options under the plan are assumed by an acquiring entity,
acceleration following a change in control occurs if the optionee's employment
is terminated. If the Options under the 1993 Plan are not assumed by the
acquiring entity, vesting will accelerate with respect to such employees'
Options. Certain agreements of key employees under the 1993 Plan provide for
automatic acceleration of vesting upon change in control.
Pursuant to the Merger Agreement, CII has agreed to terminate, as of the
effective time of the Merger, the executive nonqualified benefit plans,
including the Supplemental Benefit Plan, the Supplemental Executive Retirement
Plan and the Supplemental Senior Executive Retirement Plan. The Supplemental
Benefit Plan is an excess benefit plan under which vesting of the deferred
portion of the benefit attributable to CII matching and profit sharing
contributions made on such participants' behalf accelerates both on plan
termination and in the event of a change in control. Payment of benefits from
participants' accounts under the Supplemental Benefit Plan, however, is not
accelerated upon either a termination of the plan or a change in control.
Under the terms of this plan, distribution of supplemental retirement benefits
to any participant is made in accordance with the terms of a participants'
deferral agreements entered into at the time the participant elected to defer
a portion of his or her compensation. Generally, payments are deferred until
the participant reaches age 65, terminates employment or terminates service as
a member of the Board, as applicable. Payment of participants' after-tax
deferrals and directors' compensation deferrals may be made after one year
following the deferral.
The Supplemental Executive Retirement Plan provides supplemental retirement
benefits to selected employees. In the event of the termination of the
Supplemental Executive Retirement Plan or a change in control, there is no
provision for the acceleration of the vesting of participants' benefits. Upon
termination of such plan, a participant's benefit is determined based on his
vesting and accrual percentage as of the date of plan termination. In the
event of a change in control, payment of a participant's supplemental benefit
under this plan is accelerated only if the participant incurs a termination of
employment for "good reason" following such change in control. Good reason
includes, among other things, a reduction in the participant's base salary, a
demotion or a reduction in benefits. The Supplemental Senior Executive
Retirement Plan contains the same provisions in the event of both termination
of the plan and change in control as discussed with respect to the
Supplemental Executive Retirement Plan. The Supplemental Senior Executive
Retirement Plan covers only Joseph Havlick who is fully vested.
The Profit Sharing Plan is a retirement plan intended to be qualified under
Section 401(a) of the Code. Under the Merger Agreement, the Profit Sharing
Plan will be terminated on or before the effective time of the Merger. Upon
termination of the Profit Sharing Plan, the portion of participants' accounts
that is not vested will become fully vested.
47
<PAGE>
The accelerated benefits (in dollars) accruing to the following officers of
CII and its subsidiaries for the plans listed below are:
<TABLE>
<CAPTION>
1989 1991 1993
EMPLOYEE EMPLOYEE EMPLOYEE
PROFIT SUPPLEMENTAL INCENTIVE STOCK STOCK
SHARING BENEFIT STOCK OPTION INCENTIVE INCENTIVE
NAME PLAN(1) PLAN(2) PLAN(3) PLAN(3) PLAN(3)
---- ------- ------------ ------------ --------- ----------
<S> <C> <C> <C> <C> <C>
Joseph Havlick........... $ 0 $ 0 $ 0 $ 0 $ 412,500
Lee Spitler.............. 0 0 0 34,500 177,000
Richard Dobson........... 24,413 13,221 35,438 15,188 222,063
Farley Iman.............. 8,271 0 0 0 0
Wing Kwong............... 0 0 0 17,250 99,875
Tanna Handley............ 0 0 0 0 10,125
John Okita............... 8,621 2,786 23,000 11,500 65,313
Lawrence Havlick......... 0 0 0 17,250 62,375
Jerry Katz............... 9,459 1,389 27,600 6,900 0
Howard Heller............ 6,126 0 0 34,500 0
Michael Havlick.......... 0 0 0 13,800 62,375
------- ------- ------- -------- ----------
TOTAL.................... $56,890 $17,396 $86,038 $150,888 $1,111,626
======= ======= ======= ======== ==========
</TABLE>
--------
(1) The accelerated benefits under the Profit Sharing Plan have been
calculated as of August 15, 1995.
(2) The accelerated benefits under the Supplemental Benefit Plan have been
calculated as of August 15, 1995.
(3) The calculated benefit under the stock option plans have been calculated
using the closing price of CII Common Stock as reported on the American
Stock Exchange Composite Transactions as of August 15, 1995.
REGULATORY APPROVALS
Under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended,
and the rules promulgated thereunder by the Federal Trade Commission, the
Merger may not be consummated until filings have been made and notifications
have been given and certain information has been furnished to the Federal
Trade Commission and the Antitrust Division of the Department of Justice, and
specified waiting period requirements have been satisfied. Sierra's request
for early termination of the required waiting period has been granted and
became effective on August 16, 1995.
The Merger and related transactions are subject to approval by the
California Department of Corporations and the California Department of
Insurance. Under California law, a Form A Information Statement describing the
contemplated transactions and the business character and financial condition
of Sierra, the entity acquiring control of the two California-domiciled
insurers, was filed with the California Insurance Commissioner. The Insurance
Commissioner has 60 days from the date of the Form A Information Statement
filing to approve or disapprove the transactions. On September 5, 1995, Sierra
was notified that the California Department of Insurance approved the
contemplated transactions. Filings with and approvals from certain other state
insurance regulatory authorities may also be made or obtained in connection
with the Merger and related transactions.
48
<PAGE>
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
SIERRA
The following table sets forth certain information regarding the beneficial
ownership of the Sierra Common Stock as of August 15, 1995 (except as
otherwise noted in the footnotes below) by (1) each of the "named executives"
of Sierra, (2) each director of Sierra, (3) all directors and executive
officers as a group and (4) each person known by Sierra to be the beneficial
owner of more than 5% of the Sierra Common Stock. Subject to applicable
community property and similar statutes and except as otherwise noted in the
footnotes below, each of the following persons has sole voting and dispositive
power with respect to the shares that he or she beneficially owns. Except as
noted below, the address of all shareholders, directors, executive officers
and nominees identified in the table and accompanying footnotes below is in
care of Sierra's principal executive offices.
<TABLE>
<CAPTION>
AMOUNT AND
NATURE OF PERCENTAGE OF
BENEFICIAL OUTSTANDING
NAME OF BENEFICIAL OWNER OWNERSHIP(1) COMMON STOCK
------------------------ -------------- -------------
<S> <C> <C>
Anthony M. Marlon, M.D..................... 2,509,490(2) 16.8%
Erin E. MacDonald.......................... 44,001(3) *
Jerry D. Reeves, M.D....................... 16,376(4) *
Michael Montalvo........................... 4,515(5) *
Frank E. Collins........................... 17,180(6) *
Thomas Y. Hartley.......................... 4,400(7) *
Charles L. Ruthe........................... 6,100(8) *
William J. Raggio.......................... 21,200(9) *
All directors and executive officers as a
group (12 persons) ....................... 2,701,199(10) 18.0%
Putnam Investment, Inc..................... 1,870,875(11) 12.5%
</TABLE>
--------
*Less than 1%
(1) All share amounts on this table have been adjusted to reflect a two-for-
one split of the Sierra Common Stock distributed on or about January 11,
1993 to shareholders of record as of November 13, 1992.
(2) Includes 30,000 shares that can be acquired within 60 days of August 15,
1995 upon the exercise of stock options, 694,638 shares held indirectly
through the Marlon Family Trust (the "Family Trust"), 1,783,852 shares
held indirectly through a total of ten other trusts (the "Ten Trusts"),
and 1,000 shares held indirectly through a limited partnership (the
"Partnership") in which Dr. Marlon and his wife are the only limited
partners and general partners. Dr. Marlon, as managing general partner of
the Partnership, has sole voting and dispositive power over the shares
held by the Partnership. Dr. Marlon and his wife are co-trustees of the
Family Trust, and Dr. Marlon may be deemed to have voting and dispositive
power over the shares held by the Family Trust and, therefore, to have
beneficial ownership with respect to such shares. Erin E. MacDonald,
President, Chief Operating Officer and a director of the Company is the
trustee or, together with Dr. Marlon, a co-trustee of each of the Ten
Trusts. Although the trustee/co-trustees of each of the Ten Trusts have
express power to vote and dispose of the shares held in the respective
trusts, either of Dr. Marlon or Ms. MacDonald may be deemed to have or
share voting power and/or dispositive power over the shares held by the
Ten Trusts and, therefore, to have beneficial ownership with respect to
such shares. Dr. Marlon disclaims beneficial ownership as to the shares
held by the Ten Trusts and 500 of the shares held by the Partnership.
(3) Includes 33,800 shares that can be acquired within 60 days of August 15,
1995 upon the exercise of stock options.
(4) Includes 5,400 shares that can be acquired within 60 days of August 15,
1995 upon the exercise of stock options.
(5) Includes 4,000 shares that can be acquired within 60 days of August 15,
1995 upon the exercise of stock options.
(6) Includes 7,400 shares that can be acquired within 60 days of August 15,
1995 upon the exercise of stock options.
(7) Includes 2,400 shares that can be acquired within 60 days of August 15,
1995 upon the exercise of stock options.
(8) Includes 4,200 shares that can be acquired within 60 days of August 15,
1995 upon the exercise of stock options.
(9) Includes 12,000 shares that can be acquired within 60 days of August 15,
1995 upon the exercise of stock options.
(10) Includes 143,140 shares that can be acquired within 60 days of August 15,
1995 upon the exercise of stock options.
(11) The business address of this shareholder is One Post Office Square,
Boston, Massachusetts 02109. Putnam Investments, Inc. ("PI"), a wholly-
owned subsidiary of Marsh & McLennan Companies, Inc., beneficially owns
shares through wholly-owned subsidiaries. Such subsidiaries are
registered investment advisors whose securities include securities
beneficially owned by their clients, which may include investment
companies registered under the Investment Company Act and/or employee
benefit plans, pension funds, endowment funds or other institutional
clients. PI has certain voting rights and shared dispositive powers
related to the above stock. All of the foregoing information is based on
information available to Sierra as of the date of this filing. The
information presented is as of June 30, 1995.
49
<PAGE>
CII
The following table sets forth information, as of August 15, 1995, with
respect to the beneficial ownership of the CII Common Stock and CII Debentures
by each of its directors and "named executives," all directors and named
executive officers as a group, and by each person (or group of affiliated
persons) known by CII to be the beneficial owner of more than 5% of CII's
securities.
<TABLE>
<CAPTION>
AMOUNT AND
NATURE
NAME AND ADDRESS OF BENEFICIAL PERCENTAGE OF
TITLE OF CLASS OF BENEFICIAL OWNER(17) OWNERSHIP(1) CLASS(16)
-------------- --------------------------- -------------- -------------
<C> <S> <C> <C>
Common Stock Joseph G. Havlick........ 717,040(2) (2)
Walter E. Girardin....... 47,500(3) *
Tanna P. Handley......... 717,040(2) (2)
John F. Petrick, Jr...... 64,050(4) *
David L. Rice............ 28,806(5) *
Mahesh U. Buxani......... 1,454,400(6) 18.6
Lee W. Spitler, Jr....... 245,063(7) 3.1
Richard E. Dobson........ 35,523(8) *
Thomas E. Corder......... -0-(9) *
John F. Okita............ 25,215(10) *
All directors and named
executive officers as a
group (11 persons)...... 2,639,040 33.8
Jethira Limited ......... 1,454,400(11) 18.6
P.O. Box 659
Road Town
Tortola, British Virgin
Islands
Robert Fleming Inc....... 453,000(12) 5.8
1285 Avenue of the
Americas
Sixteenth Floor
New York, New York 10019
7 1/2% Convertible
Subordinated
Debentures Due 2001
John F. Petrick, Jr...... 1,828(13) *
David L. Rice............ 50(14) *
All directors and
executive officers as a
group (11 persons)...... 1,878 *
Elliott Associates, L.P.. 505,350(15) 6.5
110 E. 59th Street
Thirty-first Floor
New York, NY 10022
</TABLE>
--------
*Less than 1%
(1) The amounts are expressed as shares of CII's Common Stock, and sole
voting and dispositive power are possessed with respect to all of CII's
Common Stock shown.
(2) Mr. Havlick individually owns 15,000 shares and holds options, that are
or will become exercisable before October 14, 1995, to purchase 310,000
shares and Ms. Handley individually owns 2,500 shares and holds options,
that are or will become exercisable before October 14, 1995, to purchase
30,000 shares. The amount of beneficial ownership also reflects 359,540
duplicate shares indirectly beneficially owned by Mr. Havlick and Ms.
Handley, through a family trust under which they are co-trustees and
share voting and dispositive power. Collectively, Mr. Havlick and Ms.
Handley own 717,040 shares (including 340,000 shares subject to options
that are or will become exercisable before October 14, 1995) or 9.19% of
CII's Common Stock.
(3) Includes 22,500 shares held in a family trust of which Mr. Girardin and
his wife are co-trustees and share voting and dispositive power and
options, that are or will become exercisable before October 14, 1995, to
purchase 25,000 shares.
(4) Includes 19,000 shares held in a family trust of which Mr. Petrick and
his wife are co-trustees and share voting and dispositive power, 2,800
shares indirectly beneficially owned through a dependent daughter, 1,900
shares indirectly beneficially owned through a dependent son and options,
that are or will become exercisable before October 14, 1995, to purchase
20,500 shares.
(5) Includes options, that are or will become exercisable before October 14,
1995, to purchase 25,000 shares.
(6) These shares are held by Jethira Limited. Mr. Buxani's parents are the
sole shareholders of Jethira Limited and have the power to vote and
control the disposition of such shares. See Note 11 below.
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(7) Includes 5,593 shares owned through CII's Profit Sharing Plan, 350 shares
indirectly beneficially owned through a dependent daughter, 350 shares
indirectly beneficially owned through a dependent son, options, that are
or will become exercisable before October 14, 1995, to purchase 83,000
shares and options, that are or will become exercisable before October
14, 1995, to purchase 72,000 shares held by Mr. Spitler as trustee of The
Havlick Family Grandchildren's Trust. Mr. Spitler disclaims beneficial
ownership of the options held in The Havlick Family Grandchildren's
Trust.
(8) Includes 4,785 shares owned through CII's 401(k) Plan, 4,868 shares owned
through CII's Profit Sharing Plan and options, that are or will become
exercisable before October 14, 1995, to purchase 13,250 shares.
(9) Mr. Corder was President of InteLock and does not hold any of CII's
Common Stock. In July 1995, CII sold its entire interest in Intelock and
Mr. Corder is no longer affiliated with CII.
(10) Includes 1,276 shares owned through CII's 401(k) Plan, 1,429 shares owned
through CII's Profit Sharing Plan and options, that are or will become
exercisable before October 14, 1995, to purchase 8,250 shares.
(11) Based on Schedule 13D filed with the Commission through February 15,
1995, which also indicates that all of the shares attributed to Jethira
Limited are subject to shared voting and dispositive power by Poonam
Udhav Buxani and Udhav Hiranand Buxani.
(12) Based on Schedule 13G filed with the Commission through February 15,
1995, which also indicates that all of the shares attributed to Robert
Fleming Inc. are subject to shared voting and dispositive power.
(13) Includes indirectly beneficially owned CII Debentures with a face value
of $6,000 and $7,000 which when converted at $21.866 per debenture equals
274 and 320 shares through a dependent son and dependent daughter,
respectively. All CII Debentures directly and indirectly beneficially
owned by Mr. Petrick are currently convertible.
(14) All CII Debentures are currently convertible at $21.866 per debenture.
(15) Based on Schedule 13D filed with the Commission through February 15,
1995, which also indicates that all of the CII Debentures attributed to
Elliott Associates, L.P. are subject to sole dispositive power.
(16) Based on 7,802,971 shares of Common Stock outstanding on August 15, 1995,
which amount includes shares covered by options exercisable by all
directors and executive officers as a group within 60 days from such
date.
(17) Except as noted above, the address of all shareholders, directors,
executive officers and nominees identified in the table and accompanying
footnotes above is the address of CII set forth earlier in this Joint
Proxy Statement/Prospectus.
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COMPARISON OF RIGHTS OF HOLDERS OF SIERRA AND CII COMMON STOCK
Sierra is a corporation organized under the NRS. CII is a corporation
organized under the CGCL. As a result of the Merger, the rights of the holders
of CII Common Stock, which will be converted into shares of Sierra Common
Stock, will be governed by the Sierra Articles and Sierra By-laws and by the
relevant provisions of the NRS.
The following is a summary of the material differences in the rights of
shareholders of Sierra and CII.
AUTHORIZED CAPITAL STOCK
Sierra. The Sierra Articles authorize the issuance of up to 40,000,000
shares of Sierra Common Stock, par value $0.005, of which, as of May 31, 1995,
14,821,184 shares were issued and outstanding, 2,891,376 shares were reserved
for issuance pursuant to the Sierra stock option plans and Sierra restricted
stock plans, 100,200 shares were held by Sierra as treasury shares and 177,126
shares of Sierra Series A Junior Participating Preferred Stock, $.01 par value
per share (the "Series A Preferred Stock"), were reserved for issuance upon
exercise of certain rights described in the Sierra Certificate of Voting
Powers, Designations, Preferences and Rights of Preferred Stock filed with the
Nevada Secretary of State on June 24, 1994. A full description of the Common
Stock and Series A Junior Participating Preferred Stock is incorporated by
reference herein. See "Incorporation of Certain Documents by Reference."
CII. The Articles of Incorporation of CII (the "CII Articles") authorize the
issuance of up to 100,000,000 shares of CII Common Stock, of which, as of June
9, 1995, 7,187,721 shares were outstanding, 1,481,760 shares were reserved for
issuance upon the exercise of outstanding stock options or pursuant to CII's
other benefit plans and 2,597,641 shares were reserved for issuance upon
conversion of the outstanding $56,800,000 principal amount of the CII
Debentures. The CII Articles do not authorize shares of preferred stock.
BOARD OF DIRECTORS
Sierra. The Sierra By-laws provide that Sierra's Board of Directors will
consist of no fewer than 3 and no more than 7 members. Sierra's Board of
Directors presently has 5 directors. As allowed by the NRS, any director may
be removed from office with or without cause by the affirmative vote of the
holders of at least two-thirds of the outstanding voting shares of Sierra's
Common Stock then entitled to vote for the election of directors.
CII. The CII By-laws provide that CII's Board of Directors will consist of
no fewer than 4 and no more than 6 members. CII's Board of Directors presently
has 6 directors. As allowed by Section 303 of the CGCL, a director may be
removed from office with or without cause by the affirmative vote of the
holders of a sufficient number of the outstanding voting shares of CII's
Common Stock then entitled to vote for election of directors.
CUMULATIVE VOTING
Sierra. Pursuant to the Sierra Articles, each shareholder is entitled to one
vote for each share of Sierra Common Stock held, except that such holders are
entitled to cumulative voting rights in the election of directors. Each one
one-hundredth of a share of Series A Preferred Stock is entitled to one vote.
CII. Pursuant to the CII By-laws and in accordance with the CGCL, each
shareholder is entitled to one vote for each share of CII's Common Stock held,
except that such holders may be entitled to cumulative voting rights in the
election of directors. Under the CGCL, cumulative voting is not required
unless, at the annual meeting and prior to the voting, at least one
shareholder gives notice of his intention to cumulate his votes and the
candidates' names for whom votes are to be cumulated have been placed in
nomination prior to voting. If one shareholder gives notice of an intention to
cumulate votes, then all shareholders have cumulative voting rights in the
election of directors. If no such notice is given, voting for directors is
noncumulative, which means that a simple majority of the shares voting may
elect all of the directors. Under cumulative voting, each
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shareholder entitled to vote has the right to give one candidate a number of
votes equal to the number of authorized directors multiplied by the number of
votes to which his shares are entitled, or to distribute his votes on the same
principle among as many candidates as he desires. The California cumulative
voting law applies only to the election of directors and not to any other
matters as to which shareholders may vote.
PREEMPTIVE RIGHTS
Sierra. Except for the Shareholder Rights Plan, the holders of Sierra Common
Stock have no preemptive rights to acquire any additional shares of Sierra
Common Stock or any other shares of Sierra capital stock.
CII. The holders of CII's Common Stock have no preemptive rights to acquire
any additional shares of CII Common Stock or any other shares of CII capital
stock.
DIRECTOR'S LIABILITY
Sierra. The NRS and the Sierra Articles provide that a director or officer
of the corporation will not be liable to the corporation or its shareholders
for damages for breach of fiduciary duty as a director or officer, except that
such provision does not eliminate or limit the liability of a director or an
officer for (i) acts or omissions which involve intentional misconduct, fraud
or knowing violation of law or (ii) the payment of distributions in violation
of NRS 78.300.
CII. The CII Articles eliminate the liability of directors of CII for
monetary damages to the fullest extent permitted by California law. The CGCL
does not permit the elimination of monetary liability if such liability is
based on: (i) acts or omissions that involve intentional misconduct or a
knowing and culpable violation of law, (ii) acts or omissions that a director
believes to be contrary to the best interests of CII or its shareholders or
that involve the absence of good faith on the part of the director, (iii) any
transaction from which a director derived an improper personal benefit, (iv)
acts or omissions that show a reckless disregard for the director's duty to
CII or its shareholders in circumstances in which the director was aware, or
should have been aware, in the ordinary course of performing a director's
duties, of a risk of serious injury to CII or its shareholders, (v) acts or
omissions that constitute an unexcused pattern of inattention that amounts to
an abdication of the director's duty to CII or its shareholders, (vi)
transactions between CII and a director in which a director has a material
financial interest, or (vii) an unlawful dividend, distribution, loan,
guarantee, stock repurchase or redemption. This provision would generally
absolve directors of CII of personal liability for negligence in the
performance of duties, including gross negligence.
INDEMNIFICATION
Sierra. The Sierra By-laws provide that directors, officers and certain
other persons may be indemnified to the fullest extent authorized by Nevada
law. The NRS provides that a corporation has the power to indemnify a
director. Such indemnification would apply if it was determined that the
proposed indemnitee acted in good faith and in a manner he or she reasonably
believed to be in or not opposed to the best interests of Sierra and, with
respect to any criminal proceeding, if he or she had no reasonable cause to
believe that the conduct was unlawful. Such indemnification is, however,
limited in actions brought by Sierra or derivatively on behalf of Sierra. In
actions brought by or in the right of Sierra, such indemnification is limited
to reasonable expenses (including attorneys' fees) and amounts paid in
settlement, and applies if it is determined that the proposed indemnitee acted
in good faith and in a manner such person reasonably believed to be in or not
opposed to the best interests of Sierra, except that no indemnification may be
made with respect to any matter as to which such person is adjudged liable to
Sierra, unless, and only to the extent that, the court determines upon
application that, in view of all the circumstances of the case, the proposed
indemnitee is fairly and reasonably entitled to indemnity for such expenses as
the court deems proper. To the extent that any director, officer, employee, or
agent of Sierra has been successful on the merits or otherwise in defense of
any of the foregoing actions, suits, or proceedings, such person must be
indemnified against reasonable expenses incurred by him in connection with the
defense of such action.
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CII. The CII By-laws and Sections 204 and 317 of the CGCL contain
comprehensive provisions for the indemnification of directors, officers and
agents of California corporations against expenses, judgments, fines and
settlements in connection with litigation. Under the CGCL, other than an
action brought by or in the right of CII, such indemnification is available if
it is determined that the proposed indemnitee acted in good faith and in a
manner he or she reasonably believed to be in the best interests of CII and
its shareholders, and, with respect to any criminal action or proceeding, has
no reasonable cause to believe his conduct was unlawful. In actions brought by
or in the right of CII, such indemnification is limited to expenses (including
attorneys' fees) actually and reasonably incurred if the indemnitee acted in
good faith and in a manner he reasonably believed to be in the best interests
of CII, except that no indemnification may be made in respect of any claim,
issue or matter as to which such person is adjudged to be liable to CII,
unless and only to the extent that the court in which the action was brought
determines that in view of all the circumstances of the case, the person is
fairly and reasonably entitled to indemnity for such expenses as the court
deems proper. To the extent that the proposed indemnitee has been successful
in defense of any action, suit or proceeding, he must be indemnified against
expenses (including attorneys' fees) actually and reasonably incurred by him
in connection with the action. The CII Articles provide for indemnification of
the directors and officers of CII against liabilities to the maximum extent
provided by California law, which includes indemnification for breach of the
directors' fiduciary duties to CII, except as provided in "Comparison of
Rights of Holders of Sierra and CII Common Stock--Director's Liability--CII"
above.
SPECIAL MEETINGS OF SHAREHOLDERS; ACTION WITHOUT A MEETING
Sierra. The Sierra By-laws authorize the President of Sierra, a majority of
the Sierra Board of Directors or holders of at least 10% of the shares
entitled to vote to call a special meeting of shareholders at any time.
Pursuant to the NRS and the Sierra By-laws, any action required to be taken at
any special or annual meeting may be taken without such meeting and without
action by the Sierra Board of Directors or shareholders, as the case may be,
if all directors or a majority of the shareholders entitled to vote
affirmatively consent in writing to taking such action without a meeting.
CII. Under the CII By-laws, a special meeting of CII's shareholders may be
called by the CII Board of Directors, any two directors, the Chairman of the
Board, if any, the President or the holder(s) of at least 10% of the
outstanding CII Common Stock entitled to be voted for directors. Under the
CGCL and the CII By-laws, no action required to be taken or which may be taken
at any annual or special meeting of the CII Board of Directors or shareholders
may be taken without such a meeting, unless adopted by the unanimous written
consent of the directors, in the case of action by the Board of Directors, or
by the written consent of holders of outstanding shares having not less than
the minimum number of votes that would be necessary to authorize or take such
action at a meeting at which all shares entitled to vote thereon were present
and voting, in the case of action by the shareholders.
MERGERS, SHARE EXCHANGES AND SALES OF ASSETS
Sierra. The NRS requires that mergers and share exchanges must be adopted by
the board of directors of each corporation and (except in certain limited
circumstances) approved by a majority of all the votes entitled to be cast by
each voting group of each corporation entitled to vote on the plan of merger
or share exchange, unless the corporation's board of directors requires, or
the articles of incorporation provide for, a greater vote. The Sierra Articles
and By-laws do not require a greater vote. In addition, the NRS provides that
a corporation may sell or otherwise dispose of all or substantially all of its
property, other than in the usual course of business, when approved by the
board of directors and the holders of the majority of all votes entitled to be
cast on the transaction approve such transaction.
The NRS also provides, however, that the shareholders of the corporation
surviving a merger need not approve the transaction if (i) the corporation's
articles of incorporation will not differ significantly after the merger, (ii)
the corporation's shareholders will hold the same number of shares with
identical designations, preferences, limitations and relative rights
immediately after the merger as they held before the merger and
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(iii) the number of voting shares outstanding immediately after the merger
plus the number of voting shares issuable as a result of the merger (including
shares issuable upon conversion of securities or the exercise of rights or
warrants issued in the merger) will not exceed by more than 20% the total
number of voting shares and participating shares of the surviving corporation
outstanding before the merger.
CII. The CGCL generally requires that a majority of the shareholders of both
the acquiring and acquired corporations approve statutory mergers. The CGCL
contains an exception to its voting requirements for reorganizations in which
the acquiring corporation or its shareholders immediately prior to the
reorganization, or both, will own (immediately after the reorganization)
equity securities constituting more than five-sixths of the voting power
(assuming the conversion of convertible equity securities) of the surviving or
acquiring corporation or its parent entity. The CGCL also generally requires
that a sale of all or substantially all of the assets of a corporation be
approved by a majority of the voting shares of the corporation transferring
such assets. With certain exceptions, the CGCL also requires that mergers,
reorganizations and similar transactions be approved by a majority vote of
each class of shares outstanding.
AMENDMENT OF ARTICLES OF INCORPORATION AND BY-LAWS
Sierra. Pursuant to the NRS, amendments to the Sierra Articles must be
recommended by the Sierra Board and approved by a majority of the
shareholders' votes entitled to be cast by each voting group entitled to vote
on the amendment. Under the Sierra Articles and the Sierra By-laws, either
Sierra's shareholders or the Sierra Board of Directors may adopt, amend or
repeal the Sierra By-laws by a majority vote.
CII. Under the CGCL, the CII Articles can be amended by the affirmative vote
of the Board of Directors of CII and of the holders of a majority of the
outstanding shares entitled to vote, and a majority of the outstanding stock
of each class entitled to vote as a class, unless the CII Articles require the
vote of a larger portion of the stock. The CII Articles do not require a
larger or smaller percentage affirmative vote. As is permitted by the CGCL,
the CII By-laws give its Board of Directors the power, with certain
exceptions, to adopt, amend or repeal the CII By-laws. CII's shareholders
entitled to vote have concurrent power to adopt, amend or repeal the CII By-
laws.
RIGHTS OF DISSENTING SHAREHOLDERS
Sierra. Under the NRS, a shareholder is entitled to dissent and obtain
payment in cash for the fair value of his shares in the event of, among other
things, (i) consummation of a plan of merger to which the corporation is a
party, if either (a) shareholder approval is required and the shareholder is
entitled to vote on the plan, or (b) the corporation is a subsidiary that is
owned by and is merged into its parent, (ii) consummation of a plan of
exchange to which a corporation is a party as the corporation whose shares
will be acquired if the shareholder is entitled to vote on the plan or (iii)
any corporate action pursuant to a shareholder vote to the extent that the
articles, by-laws or board resolutions provide that dissenters' rights shall
apply. If the shareholder does not agree with the corporation's estimate of
the shares' fair value, he is entitled to a legal proceeding to determine fair
value. No holder of any shares of any class or series is entitled to
dissenter's rights, however, if such shares are listed on a national
securities exchange, designated as a national market system security on an
interdealer quotation system by the National Association of Securities
Dealers, Inc., or held of record by at least 2,000 shareholders, unless (a)
the articles of incorporation of the corporation issuing the shares provide
otherwise or (b) the holders of the shares are required under the plan to
accept for their shares (or fractional shares) anything except cash or shares
of the surviving or acquiring corporation, or of any other corporation listed
on a national securities exchange, designated a national market system
security on an interdealer quotation system by the National Association of
Securities Dealers, Inc., or held of record by more than 2,000 shareholders.
Sierra's shares are listed on the New York Stock Exchange.
CII. Under the CGCL, a shareholder has the right, in certain circumstances,
to dissent from certain corporate transactions and receive the fair market
value (excluding any appreciation or depreciation in expectation of the
transaction) of his shares in cash in lieu of the consideration he otherwise
would have received
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in the transaction. If the shareholder does not agree with the corporation's
determination of the shares' fair market value, he is under certain
circumstances entitled to appraisal rights. For a complete description of
dissenters' rights under the CGCL, see "The Merger--Rights of CII Dissenting
Shareholders."
DIVIDENDS
Sierra. The NRS provides that, subject to restrictions in a corporation's
articles of incorporation, the board may authorize and the corporation may
make a distribution to its shareholders unless the corporation would not be
able to pay its debts as they become due in the usual course of business, or
the corporation's total assets would be less than the sum of its total
liabilities plus the amount that would be needed, in the case of the
dissolution, to satisfy the preferential rights of shareholders whose
preferential rights are superior to those receiving the dividend.
CII. The CGCL provides that, subject to any restrictions in the
corporation's articles of incorporation, dividends may be declared (i) if the
amount of retained earnings of the corporation immediately prior to the
dividend equals or exceeds the amount of the dividend or (ii) if immediately
after giving effect to the dividend (A) the sum of the assets of the
corporation (exclusive of goodwill, capitalized research and development
expenses and deferred charges) would be at least equal to 1 1/4 times its
liabilities (not including deferred taxes, deferred income and other deferred
credits); and (B) the current assets of the corporation would be at least
equal to its current liabilities or, in the event the average of the earnings
of the corporation before taxes on income and before interest expense for the
two preceding fiscal years was less than the average of the interest expense
of the corporation for those fiscal years, at least equal to 1 1/4 times its
current liabilities. Dividends may not be declared, however, if the
corporation's capital has been diminished to an amount less than the aggregate
amount of all capital represented by the issued and outstanding stock of all
classes having a preference upon the distribution of assets.
SHAREHOLDER RIGHTS PLAN
Sierra. In June 1994 the Sierra Board of Directors authorized and declared a
dividend distribution of one right (a "Right") for each share of Sierra Common
Stock. The Rights were distributed to the holders of record of Sierra Common
Stock as of the close of business on June 30, 1994. Each Right entitles the
registered holder to purchase from Sierra a unit consisting of one one-
hundredth of a share of Series A Junior Participating Preferred Stock, par
value $.01 per share, of Sierra, or a combination of securities and assets of
equivalent value, at a purchase price of $100.00 per Unit, subject to
adjustment. The Rights have certain anti-takeover effects. The Rights will
cause substantial dilution to a person or group that attempts to acquire
Sierra on terms not approved by the Sierra Board of Directors, except pursuant
to an offer conditioned on a substantial number of Rights being acquired. The
Rights should not interfere with any merger or other business combination
approved by the Board of Directors since Sierra may redeem the Rights at the
price of $.02 per Right prior to the time that a person or group has acquired
beneficial ownership of 20% or more of the Sierra Common Stock.
CII. CII has not adopted a Shareholder Rights Plan.
CERTAIN INFORMATION CONCERNING SIERRA
Sierra is a managed health care company that provides and administers the
delivery of comprehensive health care programs with an emphasis on quality
care and cost management. Sierra's strategy has been to develop and offer a
portfolio of managed health care products to employer groups and individuals.
Sierra's broad range of managed health care services is provided through its
federally qualified health maintenance organization in Nevada, an HMO in
Houston, Texas in which Sierra has a 50% ownership interest, managed indemnity
plans, a third-party administrative services program for employer-funded
health benefit plans and workers' compensation medical management programs.
Ancillary products and services that complement Sierra's managed health care
product lines are also offered.
Sierra's primary types of insurance coverage are two HMO plans and a managed
indemnity plan, which includes a PPO option. In 1994, Sierra enhanced its
product line by introducing the first HMO Point of Service plan in Nevada.
This new product allows members to choose one of the above coverage options
when medical
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services are required instead of one plan for the entire year. As of August 1,
1995 the POS membership was approximately 32,000 in Southern Nevada or
approximately 24% of Sierra's total HMO membership. This POS plan is also
available in its Texas HMO.
Sierra operates a mixed group/network model HMO as well as a PPO. Most of
its managed health care services in southern Nevada are provided through its
network of approximately 1,500 providers and 12 hospitals. This network
includes Sierra's multi-specialty medical group, which provides medical
services to approximately 80% of Sierra's HMO members and employs more than
110 primary care and other providers in over 20 medical specialties. Sierra
directly provides home health care, hospice care and behavioral health care
services. In addition, Sierra operates a 24-hour urgent care center, a
radiology department, a vision department, an occupational medicine department
and a free-standing, state licensed and Medicare approved ambulatory surgery
center. Most medical facilities offer full laboratory services.
In Texas, Sierra operates an IPA model HMO that began enrolling members in
March 1995. This HMO is 50% owned by Sierra with an insurance brokerage firm
owning the remaining 50% interest.
Sierra currently provides managed indemnity and Medicare supplement services
to individuals in five other western states. Sierra is also exploring further
expansion into these and other states.
Sierra has not received accreditation from the national committee on quality
assurance (the "NCQA"). In January, 1994, Health Plan of Nevada, Inc. ("HPN"),
the Company's largest subsidiary, voluntarily applied for accreditation from
the NCQA. The initial response from the NCQA was to deny such accreditation;
that response is being appealed and no final determination is expected until
October. The response from the NCQA raised no questions regarding the quality
of medical care delivered to HPN's patients. The initial denial of
accreditation was generally based on the assessment that HPN did not meet
certain administrative and procedural technical criteria established by the
NCQA. While HPN conducted quality improvement initiatives, NCQA has initially
determined that such initiatives did not always meet the technical criteria as
they relate to structure, measurement and evaluation. Additionally, the NCQA
initially determined that certain aspects of HPN's Integrated Delivery System
were not consistent with the NCQA's technical criteria related to
organizational structure. NCQA also raised certain other administrative issues
related to HPN's documentation processes.
Since the NCQA site review visit, HPN has already voluntarily implemented
several of NCQA's recommendations to enhance its quality improvement program.
These changes include the establishment of a single point of accountability
for HPN's quality improvement program, increased dedicated resources and an
improved organizational structure for its quality improvement program.
No other HMO doing business in Nevada has such accreditation with respect to
its Nevada operations and, in light of Sierra's market share in the southern
Nevada health care coverage market and considering the recognition for quality
that HPN has received from other national organizations, the absence of
accreditation has not affected Sierra's operations. Accordingly, there is no
basis to predict what long range effect, if any, a lack of accreditation would
have on HPN's competitive position in southern Nevada. Accreditation is a
voluntary process and is applied for on a regional basis and, consequently,
even if NCQA accreditation is not received for southern Nevada, it would not
inhibit HMO Texas L.C. or any other Sierra affiliate from making a similar
application with respect to another region.
Although no final NCQA determination has been made, there can be no
assurance that HPN will receive accreditation.
After review of a request for proposal received on August 18, 1995, Sierra
has determined not to submit a bid for an HMO program covering certain
Medicaid recipients in the State of Nevada for 1996 and 1997. Additionally,
Sierra is an 11% owner of a consortium of bidders for a CHAMPUS contract to
provide healthcare coverage to military personnel and their dependents in a
number of western and midwestern states, including the State of Nevada. The
contract is scheduled to be awarded in February 1996 and, if obtained, would
begin to affect Sierra's revenues in the latter part of 1996.
Additional information concerning Sierra is included in various documents
incorporated by reference in this Joint Proxy Statement/Prospectus. See
"Available Information" and "Incorporation of Certain Information by
Reference."
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CERTAIN INFORMATION CONCERNING CII
GENERAL
CII is a holding company primarily engaged in writing workers' compensation
insurance through its wholly owned subsidiaries. CII also has two operating
insurance agencies and an insurance premium finance business. CII writes
workers' compensation insurance in the states of California, Colorado,
Nebraska, New Mexico and Utah primarily through independent insurance agents
and brokers and has plans to commence writing workers' compensation insurance
in Kansas, South Dakota and Texas. CII also has licenses or applications
pending for licenses in certain other states. In 1994, California represented
approximately 86% of CII's direct written premiums. See "Summary--Selected
Consolidated Financial Data--CII Financial, Inc." for certain financial and
other information relating to CII.
CII's insurance policies are sold primarily through independent insurance
agents and brokers, who may also represent other insurance companies. CII also
employs full-time employees as marketing representatives to make personal
contacts with agents and brokers, to maintain regular communication with them,
to advise them of CII's services and products, and to recruit additional
agents and brokers.
In 1994, the first year it was eligible to receive an A.M. Best Company
("A.M. Best") rating, CII's insurance subsidiaries received a rating of B+.
This rating was confirmed in 1995. The B+ rating is assigned to those
companies, which in the opinion of A.M. Best, "have achieved very good overall
performance when compared to the norms of the property/casualty insurance
industry."
A.M. Best is a widely recognized insurance rating organization. To be
eligible for an initial letter rating from A.M. Best, an insurance company
must have a minimum statutory policyholders' surplus of $1,500,000 and have
had a minimum of five consecutive years of representative operating
experience. A.M. Best assigns a total of 15 letter ratings ranging from a low
of F (in liquidation) to A++ (superior). The letter ratings are further
grouped into "secure ratings" (consisting of B+ or better) and "vulnerable
ratings" (consisting of B or less). The B+ rating is the sixth highest rating
in the A.M. Best letter rating system. While meeting the minimum surplus
requirements, CII's insurance subsidiaries did not meet the minimum operating
experience requirement until they had completed the 1993 fiscal year.
Workers' compensation is a statutory system that requires an employer to
provide its employees with medical care and other specified benefits for work-
related injuries, even though the injuries may have resulted from the
negligence or wrongs of any person, including the employee. Employers
typically purchase workers' compensation insurance to provide these benefits.
The benefits payable are generally established by statute. In California,
prior to 1995, minimum or "manual" premium rates for approximately 650
separate employment classifications were recommended by the Workers'
Compensation Insurance Rating Bureau ("WCIRB") and were subject to approval by
the California Department of Insurance. The minimum rate law was repealed by
the California legislature effective with policies issued or renewed on or
after January 1, 1995. Without the minimum rate structure, every insurer must
establish its own rate structure. Each insurer is able to charge whatever rate
that insurer wishes to use, subject only to the requirements that the rate
used (i) may not impair or threaten the solvency of the insurer, (ii) may not
create a monopoly, (iii) may not be unfairly discriminatory and (iv) be filed
with the California Department of Insurance.
In establishing its rate structure, CII is permitted to base its rates on
pure loss cost factors developed by the WCIRB. Pure loss cost factors
represent the estimated dollar costs needed to pay losses and loss adjustment
expenses ("LAE"). CII's operating expenses and a profit factor are added to
the pure loss cost factors to derive base premium rates. The base premium rate
is then subject to modification and adjustments. CII is then permitted to
develop its own rating plans to modify or adopt its base premium rates. As
with the prior rate law, insurers are required to apply an insured's
experience modification factor to derive the final premium.
Often, several years may elapse between the occurrence of a loss, the
reporting of a loss to CII and the final settlement of the loss. To recognize
liabilities for unpaid losses, CII establishes reserves, which are balance
sheet
58
<PAGE>
liabilities representing estimates of future amounts needed to pay claims and
related expenses for insured events, including reserves for events that are
incurred but have not yet been reported to CII. CII reviews the adequacy of
its reserves with its independent actuary at the end of each quarter and
annually, an opinion is issued by the actuary as to the adequacy of the
reserves. CII also considers external forces such as changes in the rate of
inflation, the regulatory environment, the judicial administration of claims,
medical costs and other factors that could cause actual losses and LAE to
change. Management evaluates the reserves in the aggregate, based upon the
actuarial indications and makes adjustments where appropriate. The
consolidated financial statements of CII provide for reserves based on the
anticipated ultimate cost of losses.
RECENT DEVELOPMENTS
In June 1993, CII acquired an 80% interest in InteLock, a manufacturer of
electronic door locks. The cost of the acquisition and the operating loss for
the year ended December 31, 1993 for this subsidiary were not material to the
consolidated financial statements of CII. During 1994, CII began to evaluate
its investment in InteLock due to costs associated with the development of new
lock prototypes and continued operating losses.
As a result of the increasing losses, during the second quarter of 1994 CII
management began to consider and discuss the possible disposition of InteLock
and the CII Board considered whether it should be sold, continued as an
ongoing entity, or liquidated. In the fourth quarter of 1994, CII management
formulated preliminary plans to discontinue InteLock pending further study and
evaluation of alternatives by management and its outside advisors. Such
studies, including a search for outside buyers were completed in the second
quarter of 1995. In May, 1995, the CII Board reviewed the various reports and
evaluations and concluded that InteLock should be disposed of either by sale
or liquidation. The deteriorating financial performance of InteLock was a
problem from both an operational and cash flow perspective that existed
independent of any thought or contemplation of a merger with any other entity.
The disposition of InteLock was never a subject of negotiation with Sierra nor
is it a condition to the merger with Sierra.
In June 1995, CII recorded the sale of its common stock investment in
InteLock to Vista 2000, Inc. ("Vista"), a publicly traded company, in exchange
for Vista common stock, warrants and cash. The total loss that was recognized
in 1995 from the disposition of InteLock, including operating losses prior to
its status as a discontinued operation, was $6,600,000.
In August 1995, CII reached an agreement to extend its bank line of credit
agreement to August 1, 1996 and the $7,000,000 currently outstanding
thereunder to become due on February 15, 1996. The bank is in the process of
preparing documentation in connection with this extension. See Annex C: the
CII 10-Q--"Note 3 to Notes to Condensed Consolidated Financial Statements."
ADDITIONAL INFORMATION
Additional information concerning CII is included in the CII 10-K and the
CII 10-Q, which are included as Annex B and Annex C, respectively, to this
Joint Proxy Statement/Prospectus. Such documents and certain other documents
are also incorporated by reference herein. See "Available Information" and
"Incorporation of Certain Information by Reference."
59
<PAGE>
UNAUDITED CONSOLIDATED CONDENSED PRO FORMA FINANCIAL DATA
The accompanying unaudited consolidated condensed pro forma balance sheet
presents the consolidated financial position of Sierra and CII at June 30,
1995, assuming that the proposed Merger had occurred as of June 30, 1995. Such
pro forma information is based upon the historical balance sheet data of the
respective companies, at that date, giving effect to the proposed Merger using
the pooling-of-interests method of accounting and the discontinued operations
adjustments described in the accompanying notes to unaudited consolidated
condensed pro forma financial data.
The accompanying unaudited consolidated condensed pro forma statements of
operations give effect to the proposed Merger by consolidating the results of
operations of Sierra and CII for the six months ended June 30, 1995 and for
each of the years in the three-year period ended December 31, 1994 using the
pooling-of-interests method of accounting and by giving effect to the
discontinued operations adjustments described in the accompanying notes to
unaudited consolidated condensed pro forma financial data.
In the second quarter of 1995, CII reached a definitive agreement to dispose
of InteLock. The accompanying unaudited consolidated condensed pro forma
financial data contain adjustments to eliminate the operations of InteLock
from continuing operations.
Certain reclassifications have been made to the historical financial data of
Sierra for certain periods to conform to its current presentation. Certain
reclassifications have been made to the historical financial data of CII to
conform to Sierra's current presentation. CII's historical balance sheets were
previously unclassified. For purposes of the pro forma presentation, judgments
were made as to expected maturities of assets and liabilities.
The accompanying unaudited consolidated condensed pro forma financial data
should be read in conjunction with the separate historical financial
statements and notes thereto of Sierra and CII. The following unaudited
consolidated condensed pro forma financial data is presented for information
purposes only and is not necessarily indicative of the results of future
operations of the consolidated entity or the actual results that would have
been achieved had the Merger been consummated on the dates presented.
60
<PAGE>
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Unaudited Consolidated Condensed Pro Forma Balance Sheet at June 30,
1995.................................................................... 62
Unaudited Consolidated Condensed Pro Forma Statements of Operations for
the:
Six months ended June 30, 1995......................................... 63
Year ended December 31, 1994........................................... 64
Year ended December 31, 1993........................................... 65
Year ended December 31, 1992........................................... 66
Notes to Unaudited Consolidated Condensed Pro Forma Financial Data....... 67
</TABLE>
61
<PAGE>
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED CONDENSED PRO FORMA BALANCE SHEET
JUNE 30, 1995
<TABLE>
<CAPTION>
HISTORICAL POOLING-OF-
-------------------------- INTERESTS PRO FORMA
SIERRA CII ADJUSTMENTS CONSOLIDATED
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
ASSETS
Current Assets:
Cash and Cash
Equivalents........... $ 46,644,000 $ 6,054,000 $ 52,698,000
Short-term Securities.. 77,156,000 12,748,000 89,904,000
Accounts Receivable.... 5,984,000 14,206,000 20,190,000
Reinsurance
Recoverable........... 1,167,000 1,167,000
Financed Premiums
Receivable............ 12,773,000 12,773,000
Prepaid Expenses and
Other Assets.......... 10,968,000 9,231,000 $ 2,250,000 (c) 22,449,000
------------ ------------ ------------ ------------
Total Current Assets. 140,752,000 56,179,000 2,250,000 199,181,000
------------ ------------ ------------ ------------
Land, Building and
Equipment.............. 95,960,000 6,271,000 102,231,000
Accumulated Deprecia-
tion.................. (26,116,000) (2,650,000) (28,766,000)
------------ ------------ ------------ ------------
Land, Building and
Equipment-Net....... 69,844,000 3,621,000 73,465,000
------------ ------------ ------------ ------------
Other Assets:
Funds Withheld by
Ceding Insurance
Company............... 9,577,000 9,577,000
Long-term Securities... 15,304,000 196,856,000 212,160,000
Restricted Cash and
Securities............ 3,819,000 6,534,000 10,353,000
Reinsurance
Recoverable .......... 28,407,000 28,407,000
Other.................. 6,690,000 12,683,000 19,373,000
------------ ------------ ------------ ------------
Total Other Assets... 35,390,000 244,480,000 279,870,000
------------ ------------ ------------ ------------
TOTAL ASSETS....... $245,986,000 $304,280,000 $ 2,250,000 $552,516,000
============ ============ ============ ============
LIABILITIES AND
SHAREHOLDERS' EQUITY
Current Liabilities:
Accrued Liabilities.... $ 9,649,000 $ 13,082,000 $ 10,500,000 (b) $ 33,231,000
Accrued Payroll and
Taxes................. 9,982,000 1,811,000 11,793,000
Medical Claims
Payable............... 32,255,000 32,255,000
Current Portion of
Loss and Loss
Adjustment Expense.... 46,995,000 46,995,000
Unearned Premiums
Revenue............... 10,590,000 9,995,000 20,585,000
Current Portion of
Long-term Debt........ 2,417,000 7,000,000 9,417,000
------------ ------------ ------------ ------------
Total Current Liabil-
ities............... 64,893,000 78,883,000 10,500,000 154,276,000
Future Policy Benefits.. 9,577,000 9,577,000
Loss and Loss Adjustment
Expense................ 137,608,000 137,608,000
Long-term Debt.......... 18,083,000 56,800,000 74,883,000
Other Liabilities....... 2,627,000 2,627,000
Minority Interests...... 355,000 355,000
------------ ------------ ------------ ------------
Total Liabilities.... 92,908,000 275,918,000 10,500,000 379,326,000
------------ ------------ ------------ ------------
Shareholders' Equity:
Common Stock........... 74,000 3,602,000 (3,589,000)(a) 87,000
Additional Paid-in
Capital............... 83,362,000 58,613,000 3,589,000 (a) 145,564,000
Treasury Stock......... (130,000) (130,000)
Unrealized (Loss) Gain
on Available-for-Sale
Securities............ (257,000) 937,000 680,000
Retained Earnings (Ac-
cumulated Deficit).... 70,029,000 (34,790,000) (10,500,000)(b) 26,989,000
2,250,000 (c)
------------ ------------ ------------ ------------
Total Shareholders'
Equity.............. 153,078,000 28,362,000 (8,250,000) 173,190,000
------------ ------------ ------------ ------------
TOTAL LIABILITIES &
SHAREHOLDERS'
EQUITY............ $245,986,000 $304,280,000 $ 2,250,000 $552,516,000
============ ============ ============ ============
</TABLE>
See the accompanying notes to unaudited consolidated condensed pro forma
financial data
62
<PAGE>
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED CONDENSED PRO FORMA
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 1995
<TABLE>
<CAPTION>
HISTORICAL
------------------------- PRO FORMA
SIERRA CII CONSOLIDATED
------------ ----------- ------------
<S> <C> <C> <C>
OPERATING REVENUES:
Premiums........................... $153,425,000 $153,425,000
Specialty Product Revenues......... 5,720,000 $41,037,000 46,757,000
Professional Fees.................. 7,670,000 7,670,000
Investment and Other Revenues...... 3,455,000 8,708,000 12,163,000
------------ ----------- ------------
Total.......................... 170,270,000 49,745,000 220,015,000
------------ ----------- ------------
OPERATING EXPENSES:
Medical Expenses................... 116,490,000 116,490,000
Specialty Product Expenses......... 3,326,000 24,225,000 27,551,000
General, Administrative and Other.. 30,803,000 19,572,000 50,375,000
------------ ----------- ------------
Total.......................... 150,619,000 43,797,000 194,416,000
------------ ----------- ------------
OTHER INCOME (EXPENSE):
Minority Interests................. 1,096,000 1,096,000
Interest Expense and Other, Net.... (761,000) (2,454,000) (3,215,000)
------------ ----------- ------------
Total.......................... 335,000 (2,454,000) (2,119,000)
------------ ----------- ------------
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES............... 19,986,000 3,494,000 23,480,000
PROVISION (BENEFIT) FOR INCOME
TAXES............................. 6,695,000 (750,000) 5,945,000
------------ ----------- ------------
INCOME FROM CONTINUING OPERATIONS.. $ 13,291,000 $ 4,244,000 $ 17,535,000
============ =========== ============
INCOME PER SHARE FROM CONTINUING
OPERATIONS........................ $ .91 $ .57 $ 1.01 (d)
============ =========== ============
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING....................... 14,680,000 7,406,000 17,420,000
</TABLE>
See the accompanying notes to unaudited consolidated condensed pro forma
financial data
63
<PAGE>
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED CONDENSED PRO FORMA
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1994
<TABLE>
<CAPTION>
HISTORICAL
-------------------------- PRO FORMA
SIERRA CII CONSOLIDATED
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING REVENUES:
Premiums.......................... $269,382,000 $269,382,000
Specialty Product Revenues........ 10,487,000 $ 90,800,000 101,287,000
Professional Fees................. 12,331,000 12,331,000
Investment and Other Revenues..... 3,601,000 15,480,000 19,081,000
------------ ------------ ------------
Total......................... 295,801,000 106,280,000 402,081,000
------------ ------------ ------------
OPERATING EXPENSES:
Medical Expenses.................. 200,229,000 200,229,000
Specialty Product Expenses........ 5,823,000 53,689,000 59,512,000
General, Administrative and Other. 53,671,000 37,088,000 90,759,000
------------ ------------ ------------
Total......................... 259,723,000 90,777,000 350,500,000
------------ ------------ ------------
OTHER INCOME (EXPENSE):
Minority Interests................ (113,000) (113,000)
Interest Expense and Other, Net... (1,830,000) (4,458,000) (6,288,000)
------------ ------------ ------------
Total......................... (1,943,000) (4,458,000) (6,401,000)
------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES.............. 34,135,000 11,045,000 45,180,000
PROVISION (BENEFIT) FOR INCOME
TAXES............................ 11,931,000 (3,695,000) 8,236,000
------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS. $ 22,204,000 $ 14,740,000 $ 36,944,000
============ ============ ============
INCOME PER SHARE FROM CONTINUING
OPERATIONS....................... $ 1.71 $ 2.05 $ 2.36 (d)
============ ============ ============
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING...................... 13,021,000 7,181,000 15,678,000
</TABLE>
See the accompanying notes to unaudited consolidated condensed pro forma
financial data
64
<PAGE>
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED CONDENSED PRO FORMA
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1993
<TABLE>
<CAPTION>
HISTORICAL
-------------------------- PRO FORMA
SIERRA CII CONSOLIDATED
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING REVENUES:
Premiums.......................... $240,691,000 $240,691,000
Specialty Product Revenues........ 4,100,000 $109,614,000 113,714,000
Professional Fees................. 11,254,000 11,254,000
Investment and Other Revenues..... 2,032,000 15,739,000 17,771,000
------------ ------------ ------------
Total......................... 258,077,000 125,353,000 383,430,000
------------ ------------ ------------
OPERATING EXPENSES:
Medical Expenses.................. 178,526,000 178,526,000
Specialty Product Expenses........ 2,977,000 82,752,000 85,729,000
General, Administrative and Other. 50,715,000 33,139,000 83,854,000
------------ ------------ ------------
Total......................... 232,218,000 115,891,000 348,109,000
------------ ------------ ------------
OTHER INCOME (EXPENSE):
Minority Interests................ (179,000) (179,000)
Interest Expense and Other, Net... 2,000 (4,260,000) (4,258,000)
------------ ------------ ------------
Total......................... (177,000) (4,260,000) (4,437,000)
------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES.............. 25,682,000 5,202,000 30,884,000
PROVISION FOR INCOME TAXES........ 8,239,000 196,000 8,435,000
------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS. $ 17,443,000 $ 5,006,000 $ 22,449,000
============ ============ ============
INCOME PER SHARE FROM CONTINUING
OPERATIONS....................... $ 1.42 $ .70 $ 1.50 (d)
============ ============ ============
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING...................... 12,296,000 7,142,000 14,939,000
</TABLE>
See the accompanying notes to unaudited consolidated condensed pro forma
financial data
65
<PAGE>
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED CONDENSED PRO FORMA
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1992
<TABLE>
<CAPTION>
HISTORICAL
-------------------------- PRO FORMA
SIERRA CII CONSOLIDATED
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING REVENUES:
Premiums.......................... $217,624,000 $217,624,000
Specialty Product Revenues........ 4,063,000 $103,166,000 107,229,000
Professional Fees................. 10,206,000 10,206,000
Investment and Other Revenues..... 2,060,000 13,337,000 15,397,000
------------ ------------ ------------
Total......................... 233,953,000 116,503,000 350,456,000
------------ ------------ ------------
OPERATING EXPENSES:
Medical Expenses.................. 166,495,000 166,495,000
Specialty Product Expenses........ 2,451,000 119,496,000 121,947,000
General, Administrative and Other. 44,176,000 34,095,000 78,271,000
------------ ------------ ------------
Total......................... 213,122,000 153,591,000 366,713,000
------------ ------------ ------------
OTHER INCOME (EXPENSE):
Minority Interests................ (249,000) (249,000)
Interest Expense and Other, Net... (505,000) (4,136,000) (4,641,000)
Litigation Settlement............. (784,000) (784,000)
------------ ------------ ------------
Total......................... (1,538,000) (4,136,000) (5,674,000)
------------ ------------ ------------
INCOME (LOSS) FROM CONTINUING
OPERATIONS BEFORE INCOME TAXES... 19,293,000 (41,224,000) (21,931,000)
PROVISION FOR INCOME TAXES........ 5,690,000 1,355,000 7,045,000
------------ ------------ ------------
INCOME (LOSS) FROM CONTINUING
OPERATIONS....................... $ 13,603,000 $(42,579,000) $(28,976,000)
============ ============ ============
INCOME (LOSS) PER SHARE FROM
CONTINUING
OPERATIONS....................... $ 1.14 $ (5.94) $ (1.98)(d)
============ ============ ============
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING...................... 11,949,000 7,168,000 14,601,000
</TABLE>
See the accompanying notes to unaudited consolidated condensed pro forma
financial data
66
<PAGE>
NOTES TO UNAUDITED CONSOLIDATED CONDENSED PRO FORMA FINANCIAL DATA
NOTE 1--BASIS OF PRESENTATION
The accompanying unaudited consolidated condensed pro forma balance sheet
presents the consolidated financial position of Sierra and CII as of June 30,
1995, assuming that the proposed Merger had occurred as of June 30, 1995, and
records the effects of the decision to dispose of InteLock. The accompanying
unaudited consolidated condensed pro forma statements of operations give
effect to the proposed Merger by consolidating the results of operations of
the respective companies for the six months ended June 30, 1995 and for each
of the years in the three-year period ended December 31, 1994 assuming that
the proposed Merger had occurred as of January 1, of each period presented.
NOTE 2--PRO FORMA ADJUSTMENTS
(a) To reflect the issuance of approximately 2,665,000 shares of Sierra Common
Stock in exchange for 100% of the shares of outstanding CII Common Stock
based upon applying the Exchange Ratio fixed at 0.37 to the number of
shares of CII Common Stock outstanding at June 30, 1995.
(b) Nonrecurring costs estimated to be $10,500,000 will be recorded in
connection with the Merger. These costs consist primarily of professional
fees. Because such costs are nonrecurring, they have not been recorded in
the accompanying unaudited consolidated condensed pro forma statements of
operation. However, such costs will be charged to income in the first
period following the consummation of the Merger.
(c) Subsequent to the Merger, CII will be included in Sierra's consolidated
tax return. CII has loss reserves that were expensed for financial
reporting purposes but not deducted for income tax purposes resulting in a
deferred tax asset. Because of the unlikelihood that CII would be able to
utilize the benefit of the deferred tax asset, a valuation reserve was
recorded to reduce the deferred tax asset. As a result of including CII in
the consolidated tax return with Sierra, it is more likely than not that
$2,250,000 of the benefit of the deferred tax asset will be utilized.
Consequently, in accordance with Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" ("FAS 109"), $2,250,000
of the valuation allowance related to the net deferred tax asset will be
reduced and will be recorded as an increase in the amount of the
adjustment to the cumulative effect of adopting FAS 109, effective January
1, 1993, and will be reported in the statement of operations below income
from continuing operations.
(d) Pro forma consolidated earnings per share calculations are based upon the
weighted average common shares outstanding for Sierra for each period plus
CII's weighted average common shares outstanding multiplied by the
Exchange Ratio fixed at 0.37.
NOTE 3--DISCONTINUED OPERATIONS
In June 1995, CII signed a definitive agreement to sell InteLock
Technologies, its majority owned electronic door lock manufacturing
subsidiary, to a publicly traded entity for a combination of 219,200 shares of
common stock and 138,400 shares of warrants of the purchaser, and cash of
$5,000. The common stock and warrants were valued at fair market value which
approximated $1,000,000. Losses on discontinued operations were $2,010,000,
$2,501,000 and $404,000 for the six-month period ended June 30, 1995 and the
years ended December 31, 1994 and 1993, respectively. In the three-month
period ended June 30, 1995, CII reported a charge to income and a reduction of
shareholders' equity of $5,636,000 for a total loss of $6,600,000 in 1995. The
loss for the three months ended June 30, 1995 of $5,636,000 consists of
operating losses of $1,046,000 and a loss on disposal of $4,590,000. The loss
on disposal includes the write off of the remaining investment in InteLock of
approximately $2,000,000, operating losses subsequent to the discontinued
operation measurement date of approximately $350,000, and accrued estimated
run-off and other disposal costs in accordance with the terms of the sales
agreement of approximately $2,240,000.
67
<PAGE>
PROXY SOLICITATION
Proxies are being solicited from Sierra's and CII's shareholders by and on
behalf of the respective Boards of Directors of each of Sierra and CII. Each
of Sierra and CII will bear their own expenses for the solicitations,
including the costs of preparing and mailing this Joint Proxy
Statement/Prospectus to their respective shareholders. In addition to
solicitation by mail, proxies may be solicited from the shareholders of Sierra
or CII by directors, officers and regular employees of Sierra and CII,
respectively, in person, by telecopy or by telephone. Such directors, officers
and employees will not receive any additional compensation for such services
but may be reimbursed for reasonable expenses incurred by them in forwarding
the proxy soliciting materials to the beneficial owners of Sierra Common Stock
and CII Common Stock. Although there is no formal agreement to do so, Sierra
and CII, respectively, will reimburse banks, brokerage firms and other
custodians, nominees and fiduciaries for the forwarding of proxy solicitation
materials to beneficial owners of Sierra Common Stock and CII Common Stock
held of record by such persons.
LEGAL MATTERS
The validity of the Sierra Common Stock issuable in the Merger has been
passed upon by Morgan, Lewis & Bockius, Los Angeles, California. The opinion
of counsel as described under "The Merger--Certain Federal Income Tax
Consequences," has been rendered by Gibson, Dunn & Crutcher, which opinion is
subject to various assumptions and is based on current law.
EXPERTS
The Consolidated Financial Statements of CII Financial, Inc. as of December
31, 1994 and 1993 and for each of the three years in the period ended December
31, 1994 incorporated in this Joint Proxy Statement/Prospectus by reference
from the CII 10-K and the Restated Consolidated Financial Statements of CII
Financial, Inc. as of December 31, 1994 and 1993 and for each of the three
years in the period ended December 31, 1994 as presented herein as restated to
conform to the presentation of the unaudited interim financial information of
CII Financial, Inc. as of June 30, 1995 have been audited by BDO Seidman, LLP,
Independent Certified Public Accountants as stated in their reports. These
reports are either incorporated herein by reference or presented herein and
have been so incorporated by reference or presented herein in reliance upon
the reports of such firm given upon their authority as experts in accounting
and auditing.
The Consolidated Financial Statements of Sierra Health Services, Inc. as of
December 31, 1994 and 1993 and for each of the three years in the period ended
December 31, 1994 incorporated in this Joint Proxy Statement/Prospectus by
reference from the Sierra 10-K/A have been audited by Deloitte & Touche LLP,
independent auditors, as stated in their report, which is incorporated herein
by reference and has been so incorporated in reliance upon the report of such
firm given upon their authority as experts in accounting and auditing.
SHAREHOLDER PROPOSALS
Proposals which Sierra shareholders intend to present at the next Annual
Meeting of Shareholders in May 1996 must be received by the Secretary of
Sierra at its principal executive offices (P.O. Box 15645, Las Vegas, Nevada
89114-5645) no later than December 2, 1995 for inclusion in Sierra's Proxy
Statement and proxy for that meeting and must be otherwise in compliance with
applicable Securities and Exchange Commission regulations. Use of certified
mail is suggested.
68
<PAGE>
INDEX TO RESTATED CONSOLIDATED FINANCIAL STATEMENTS
OF CII FINANCIAL, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Certified Public Accountants........................ F-2
Consolidated Balance Sheets at December 31, 1994 and 1993................. F-3
Consolidated Financial Statements for Years Ended December 31, 1994, 1993
and 1992:
Statements of Operations................................................ F-4
Statements of Shareholders' Equity...................................... F-5
Statements of Cash Flows................................................ F-6
Summary of Accounting Policies............................................ F-8
Notes to Consolidated Financial Statements................................ F-11
Report of Independent Certified Public Accountants on Financial Statement
Schedules................................................................ F-26
Schedule I--Summary of Investments--Other Than Investments in Related
Parties.................................................................. F-27
Schedule II--Condensed Financial Information of Registrant:
Condensed Balance Sheet Information..................................... F-28
Condensed Statement of Operations Information........................... F-29
Condensed Statements of Cash Flows...................................... F-30
Note to Condensed Financial Information................................. F-31
</TABLE>
All other schedules have been omitted because they are not required, not
applicable or the information has otherwise been supplied.
F-1
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors
CII Financial, Inc.
Pleasanton, California
We have audited the accompanying consolidated balance sheets of CII
Financial, Inc. and Subsidiaries as of December 31, 1994 and 1993 and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the three years in the period ended December 31, 1994. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of CII Financial, Inc. and Subsidiaries at December 31, 1994 and 1993, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1994 in conformity with generally
accepted accounting principles.
/s/ BDO SEIDMAN, LLP
BDO SEIDMAN, LLP
Los Angeles, California
February 17, 1995, except for Note 16
which is as of June 13, 1995
F-2
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1994 1993
------------ ------------
<S> <C> <C>
ASSETS
Investments (Note 2):
Held to maturity, at amortized cost (fair value
$107,535,000)................................... $107,751,000 $ --
Available for sale, at fair value (amortized cost
$109,311,000)................................... 108,125,000 --
Trading portfolio, at fair value which approxi-
mates cost...................................... -- 10,921,000
Bonds, at amortized cost (fair value
$178,133,000)................................... -- 168,991,000
Equity securities, at fair value (cost
$1,768,000)..................................... -- 1,659,000
Short-term investments, at amortized cost which
approximates fair value......................... -- 19,935,000
Relocation mortgage loans from employees (Note
11)............................................. 5,841,000 5,981,000
------------ ------------
Total investments.............................. 221,717,000 207,487,000
Cash (Note 6)...................................... 6,845,000 10,110,000
Reinsurance recoverable (Note 3)................... 29,407,000 26,012,000
Premiums receivable, less allowances of $2,192,000
and $2,222,000 for possible losses................ 12,789,000 18,918,000
Financed premiums receivable, less allowance of
$100,000 and $0 for possible losses............... 15,576,000 12,873,000
Investment income receivable....................... 3,170,000 2,813,000
Deferred policy acquisition costs.................. 2,285,000 2,022,000
Earned but unbilled receivable..................... 2,244,000 2,095,000
Federal income taxes receivable.................... -- 5,272,000
Deferred income taxes (Note 7)..................... 4,000,000 --
Property and equipment, less accumulated
depreciation of $2,253,000 and $1,587,000......... 4,035,000 3,464,000
Net assets of discontinued operations (Note 16).... 2,595,000 2,221,000
Other assets....................................... 2,324,000 2,549,000
------------ ------------
TOTAL ASSETS................................... $306,987,000 $295,836,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Losses and loss adjustment expenses (Note 4)..... $190,962,000 $200,356,000
Unearned premiums................................ 8,940,000 10,641,000
Ceded reinsurance premiums payable............... 543,000 842,000
Convertible subordinated debentures (Note 5)..... 56,800,000 56,800,000
Note payable to bank (Note 6).................... 8,000,000 --
Federal income taxes payable (Note 7)............ 291,000 --
Other liabilities (Note 5)....................... 12,916,000 9,871,000
------------ ------------
TOTAL LIABILITIES.............................. 278,452,000 278,510,000
------------ ------------
COMMITMENTS AND CONTINGENCIES (Notes 3, 9, 13 & 14)
SHAREHOLDERS' EQUITY (Notes 1 and 8):
Common stock: Stated value $.50 per share; shares
authorized-- 100,000,000; issued and
outstanding--7,187,000 and 7,170,000............ 3,593,000 3,585,000
Additional paid-in capital....................... 58,563,000 58,523,000
Unrealized losses on marketable securities....... (1,187,000) (109,000)
Accumulated deficit................................ (32,434,000) (44,673,000)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY..................... 28,535,000 17,326,000
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY..... $306,987,000 $295,836,000
============ ============
</TABLE>
See accompanying summary of accounting policies and notes to consolidated
financial statements.
F-3
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1994 1993 1992
------------ ------------ -------------
<S> <C> <C> <C>
REVENUES:
Direct written premiums........... $ 92,983,000 $113,954,000 $ 103,226,000
Changes in direct unearned premi-
ums.............................. 1,701,000 71,000 4,088,000
------------ ------------ -------------
Direct earned premiums............ 94,684,000 114,025,000 107,314,000
Less: reinsurance (Note 3)........ 3,884,000 4,411,000 4,148,000
------------ ------------ -------------
Net earned premiums............... 90,800,000 109,614,000 103,166,000
Net investment income (Note 2).... 12,506,000 11,635,000 11,815,000
Net realized gains (losses) (Note
2)............................... 286,000 2,196,000 (69,000)
Other income...................... 2,688,000 1,908,000 1,591,000
------------ ------------ -------------
Total revenues.................. 106,280,000 125,353,000 116,503,000
------------ ------------ -------------
COSTS AND EXPENSES:
Losses and loss adjustment ex-
penses (Note 4).................. 58,307,000 88,841,000 124,382,000
Reinsurance recoveries (Note 3)... (4,618,000) (6,089,000) (4,886,000)
------------ ------------ -------------
Net loss and loss adjustment ex-
penses........................... 53,689,000 82,752,000 119,496,000
Policy acquisition costs.......... 23,238,000 21,582,000 20,671,000
General and administrative........ 13,850,000 11,557,000 13,424,000
Interest expense.................. 4,458,000 4,260,000 4,136,000
------------ ------------ -------------
Total costs and expenses........ 95,235,000 120,151,000 157,727,000
------------ ------------ -------------
INCOME (LOSS) FROM CONTINUING
OPERATIONS BEFORE FEDERAL INCOME
TAX ............................... 11,045,000 5,202,000 (41,224,000)
Federal income tax expense (benefit)
(Note 7)........................... (3,695,000) 196,000 1,355,000
------------ ------------ -------------
INCOME (LOSS) FROM CONTINUING
OPERATIONS......................... 14,740,000 5,006,000 (42,579,000)
Loss from discontinued operations
(Note 16).......................... (2,501,000) (404,000) --
------------ ------------ -------------
INCOME (LOSS) BEFORE EXTRAORDINARY
GAIN............................... 12,239,000 4,602,000 (42,579,000)
Extraordinary gain (Note 5)......... -- -- 457,000
------------ ------------ -------------
NET INCOME (LOSS)................... $ 12,239,000 $ 4,602,000 $ (42,122,000)
============ ============ =============
NET INCOME (LOSS) PER SHARE (Note
12):
Income (loss) from continuing
operations......................... $ 2.05 $ 0.70 $ (5.94)
Loss from discontinued operations... (0.35) (0.06) --
Extraordinary gain.................. -- -- 0.06
------------ ------------ -------------
NET INCOME (LOSS) PER SHARE......... $ 1.70 $ 0.64 $ (5.88)
============ ============ =============
</TABLE>
See accompanying summary of accounting policies and notes to consolidated
financial statements.
F-4
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
UNREALIZED
GAINS
(LOSSES)
ADDITIONAL ON
NUMBER COMMON PAID-IN ACCUMULATED MARKETABLE
OF SHARES STOCK CAPITAL DEFICIT SECURITIES TOTAL
--------- ---------- ----------- ------------ ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1,
1992................... 7,216,000 $3,608,000 $58,754,000 $ (7,153,000) $ (847,000) $54,362,000
Stock option activity... 12,000 6,000 (44,000) -- -- (38,000)
Shares repurchased and
retired................ (115,000) (57,000) (348,000) -- -- (405,000)
Unrealized gains on
marketable equity
securities............. -- -- -- -- 256,000 256,000
Net loss for the year
ended December 31,
1992................... -- -- -- (42,122,000) -- (42,122,000)
--------- ---------- ----------- ------------ ----------- -----------
Balance, December 31,
1992................... 7,113,000 3,557,000 58,362,000 (49,275,000) (591,000) 12,053,000
Stock option activity... 58,000 28,000 164,000 -- -- 192,000
Shares repurchased and
retired................ (1,000) -- (3,000) -- -- (3,000)
Unrealized gains on
marketable equity
securities............. -- -- -- -- 482,000 482,000
Net income for the year
ended December 31,
1992................... -- -- -- 4,602,000 -- 4,602,000
--------- ---------- ----------- ------------ ----------- -----------
Balance, December 31,
1993................... 7,170,000 3,585,000 58,523,000 (44,673,000) (109,000) 17,326,000
Stock option activity... 17,000 8,000 40,000 -- -- 48,000
Unrealized losses on
available for sale
securities............. -- -- -- -- (1,078,000) (1,078,000)
Net income for the year
ended December 31,
1994................... -- -- -- 12,239,000 -- 12,239,000
--------- ---------- ----------- ------------ ----------- -----------
Balance, December 31,
1994................... 7,187,000 $3,593,000 $58,563,000 $(32,434,000) $(1,187,000) $28,535,000
========= ========== =========== ============ =========== ===========
</TABLE>
See accompanying summary of accounting policies and notes to consolidated
financial statements.
F-5
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------
1994 1993 1992
-------------- -------------- -------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIV-
ITIES:
Income (loss) from continuing
operations................... $ 14,740,000 $ 5,006,000 $ (42,579,000)
-------------- -------------- -------------
Adjustments to reconcile
income (loss) from continuing
operations to net cash
provided by operating
activities:
Depreciation and amortiza-
tion....................... 809,000 916,000 602,000
Provision for losses on pre-
miums receivable........... 76,000 (327,000) 331,000
Loss (gain) on the sale of
investments................ (286,000) (2,196,000) 69,000
Loss on the sale of fixed
assets..................... 14,000 -- 64,000
Compensatory stock options.. -- -- (78,000)
Purchase of trading invest-
ments...................... (130,172,000) (222,914,000) (20,385,000)
Disposal of trading invest-
ments...................... 141,279,000 223,563,000 9,772,000
Increase (decrease) in cash
from changes in:
Premiums receivable....... 6,159,000 (2,233,000) 2,262,000
Investment income receiv-
able..................... (357,000) (101,000) (41,000)
Deferred policy acquisi-
tion costs............... (263,000) 46,000 605,000
Earned but unbilled re-
ceivable................. (149,000) (426,000) 2,969,000
Reinsurance recoverable on
unpaid losses............ (3,501,000) (5,634,000) --
Reinsurance recoverable on
paid losses.............. 106,000 (37,000) (94,000)
Federal income taxes, net. 5,563,000 (108,000) 3,790,000
Deferred income taxes..... (4,000,000) -- 4,458,000
Other assets.............. (11,000) (423,000) 121,000
Loss and loss adjustment
expense reserves......... (9,394,000) 21,896,000 45,503,000
Unearned premiums......... (1,701,000) (73,000) (4,088,000)
Accrued policyholders'
dividends................ (656,000) -- (560,000)
Ceded reinsurance payable. (299,000) (91,000) (190,000)
Other liabilities......... 3,701,000 3,248,000 607,000
-------------- -------------- -------------
Total adjustments......... 6,918,000 15,106,000 45,717,000
-------------- -------------- -------------
Net cash provided by continu-
ing operating activities..... 21,658,000 20,112,000 3,138,000
-------------- -------------- -------------
Loss from discontinued
operations................... (2,501,000) (404,000) --
Adjustments to reconcile loss
from discontinued operations
to net cash used by
discontinued operations:
Decrease in cash from change
in net assets of
discontinued operations.... (374,000) (2,221,000) --
-------------- -------------- -------------
Net cash used by discontinued
operations................... (2,875,000) (2,625,000) --
-------------- -------------- -------------
Net cash provided by operating
activities................... 18,783,000 17,487,000 3,138,000
-------------- -------------- -------------
CASH FLOWS FROM INVESTING ACTIV-
ITIES:
Purchase of available for sale
investments.................. (1,517,923,000) -- --
Purchase of held to maturity
investments.................. (17,605,000) -- --
Disposal of available for sale
investments.................. 1,502,298,000 -- --
Disposal of held to maturity
investments upon call or
maturity..................... 7,027,000 -- --
Purchase of short-term invest-
ments........................ -- (2,454,649,000) (969,548,000)
Disposal of short-term invest-
ments........................ -- 2,452,900,000 1,026,004,000
Purchase of other investments. -- (54,559,000) (41,639,000)
Disposal of other investments
upon call or maturity........ -- 9,063,000 9,364,000
Disposal of other investments
prior to call or maturity.... -- 25,061,000 2,152,000
Financed premiums receivable.. (2,809,000) (1,095,000) (4,907,000)
Mortgage loans funded......... -- (200,000) (7,050,000)
Mortgage loan payments re-
ceived....................... 140,000 545,000 225,000
Purchase of property and
equipment.................... (1,232,000) (553,000) (1,680,000)
Proceeds on disposal of prop-
erty and equipment........... 8,000 38,000 64,000
-------------- -------------- -------------
Net cash provided by (used in)
investing activities......... (30,096,000) (23,449,000) 12,985,000
-------------- -------------- -------------
</TABLE>
(Continued next page)
F-6
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONCLUDED)
INCREASE (DECREASE) IN CASH
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------
1994 1993 1992
-------------- -------------- --------------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING AC-
TIVITIES:
Net proceeds from the exer-
cise of stock options....... $ 48,000 $ 193,000 $ 40,000
Repurchase and retire common
stock....................... -- (3,000) (405,000)
Repurchase of subordinated
debentures.................. -- -- (993,000)
Borrowing/(payment) of notes
payable..................... 8,000,000 -- (34,000)
Other obligations............ -- -- (139,000)
-------------- -------------- --------------
Net cash (used in) provided
by financing activities..... 8,048,000 190,000 (1,531,000)
-------------- -------------- --------------
Net increase (decrease) in
cash.......................... (3,265,000) (5,772,000) 14,592,000
CASH, beginning of period...... 10,110,000 15,882,000 1,290,000
-------------- -------------- --------------
CASH, end of period............ $ 6,845,000 $ 10,110,000 $ 15,882,000
============== ============== ==============
</TABLE>
See accompanying summary of accounting policies and notes to consolidated
financial statements
F-7
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
SUMMARY OF ACCOUNTING POLICIES
BASIS OF PRESENTATION AND BUSINESS
CII Financial, Inc. ("CII Financial") was incorporated in the State of
California on September 15, 1988. CII Financial is a holding company primarily
engaged in writing workers' compensation insurance in California through its
wholly-owned subsidiaries, California Indemnity Insurance Company ("California
Indemnity") and Commercial Casualty Insurance Company ("Commercial Casualty").
CII Financial is also engaged in the business of issuing insurance premium
finance loans for commercial insurance policies through its wholly-owned
subsidiary, CII Premium Finance Company ("CIIPF") which commenced operations
in February 1991. In addition, CII Financial has two operating insurance
agencies, neither of which are significant to the consolidated financial
statement. An 80% interest in InteLock Technologies was acquired in June 1993
and was subsequently sold. Accordingly, the operations of InteLock
Technologies are included in these financial statements as discontinued
operations. See Note 16.
CII Financial acquired California Indemnity through an exchange of common
stock during November 1989, and then acquired Commercial Casualty during
November 1990 in consideration for 211,201 shares of CII Financial's Common
Stock. Following the later acquisition, CII Financial contributed the shares
of Commercial Casualty to California Indemnity as a surplus contribution.
These transactions were accounted for as a "pooling of interests" and
therefore the financial statements have been prepared as if the transactions
were completed at January 1, 1988.
The consolidated financial statements of CII Financial for 1994, 1993 and
1992 include the accounts of all of its wholly-owned subsidiaries, including
California Indemnity, Commercial Casualty and CIIPF. All material intercompany
transactions and balances are eliminated.
As used herein, the term the "Company" means CII Financial, Inc. and its
subsidiaries, and the term "CII Financial" means CII Financial, Inc.,
exclusive of such subsidiaries.
INVESTMENTS
Total fixed maturities, consisting entirely of bonds, have been segregated
between held to maturity, which is carried at amortized cost because the
Company has the ability and intends to hold these securities until maturity,
available for sale which are carried at fair value with the unrealized gains
or losses shown as a separate component of shareholders' equity, and trading
which are carried at fair value, with the unrealized gains or losses reflected
in the operating statement.
Equity security investments are reported at fair value and for 1994 are part
of the available for sale portfolio. The net unrealized gains and losses on
equity securities are credited or charged directly to shareholders' equity.
The fair values for fixed maturities and equity securities are based on
quoted market prices.
In 1994, short-term investments are reported as part of the available for
sale portfolio. Prior to 1994, short-term investments were reported at cost
which approximated fair value. Relocation mortgage loan receivables are
carried at the unpaid principal balance which approximates fair value. Net
realized investment gains and losses, based on specific identification of
securities sold, are reported separately on the Statements of Operation.
INCOME TAXES
Deferred federal income taxes are provided for temporary differences between
the financial reporting and tax return bases of the Company's assets and
liabilities.
F-8
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
SUMMARY OF ACCOUNTING POLICIES--(CONTINUED)
REVENUE AND EXPENSE RECOGNITION
Earned premiums
Earned premiums and the liability for unearned premiums are calculated by
formula such that the premium written is earned pro rata over the term of the
policy. The insurance policies currently written by California Indemnity and
Commercial Casualty are for one year or less. Premiums earned include an
estimate for earned but unbilled audit premiums.
Premium finance income
Finance charges on loans are initially charged to unearned finance charges
and are recognized over the life of the loan using the effective interest
method. A loan is typically repaid in nine (9) monthly installments. The loans
earn interest at rates between 7% and 24%. Late charges are assessed for
delinquent payments and are generally collected within one month.
Policy acquisition costs
Policy acquisition costs consist of commissions, premium taxes and other
underwriting costs, which are directly related to the production and retention
of new and renewal business and are deferred and amortized as the related
premiums are earned. When it is determined that future policy revenues on
existing insurance contracts are not adequate to cover related costs and
expenses, deferred policy acquisition costs are written off. Earnings on
invested funds between the time of premium receipts and related claim payments
are considered in determining whether this condition exists.
Property and equipment
Property and equipment are stated at cost. Depreciation is computed on a
straight-line method over the estimated useful lives of the assets which
generally range from five to ten years.
Reinsurance
In the normal course of business, the Company seeks to reduce the loss that
may arise from events that cause unfavorable underwriting results by
reinsuring certain levels of risk with other insurance enterprises or
reinsurers. Amounts recoverable from reinsurers are estimated in a manner
consistent with the claim liability associated with the reinsured policy and
reported separately on the balance sheets.
Reinsurance premiums, commissions, expense reimbursements and reserves
related to reinsured business are accounted for on bases consistent with those
used in accounting for the original policies issued and the terms of the
reinsurance contracts. Premiums ceded to other companies, which are calculated
based on direct earned premiums, are reported as a reduction of direct earned
premiums. Amounts applicable to reinsurance ceded for loss and loss adjustment
expenses are reported as a reduction of this item on the statements of
operations.
Liability for loss and loss adjustment expenses
The liability for loss and loss adjustment expenses is based upon the
accumulation of cost estimates for each unpaid loss and claim reported prior
to the close of the accounting period. In addition, the liability contains a
provision for the current estimate of the probable cost of losses that have
occurred but have not yet been reported. This estimate includes loss
adjustment expenses. The methods for making such estimates and for
establishing the resulting liabilities, which include actuarial method
evaluations, are continually reviewed and updated, and any adjustments
resulting therefrom are reflected in current operations.
F-9
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
SUMMARY OF ACCOUNTING POLICIES--(CONCLUDED)
STATEMENTS OF CASH FLOWS
For purposes of the statements of cash flows, the Company considers cash to
be only cash on hand and in banks.
RECENT ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards No. 119, Disclosure about
Derivative Financial Instruments and Fair Value of Financial Instruments,
increases the disclosures about derivative financial instruments which include
futures, forward, swap, or option contracts or other financial instruments
with similar characteristics. The Statement is effective for financial
statements issued for fiscal years ending after December 15, 1994.
The Company does not have any significant investments in derivative
financial instruments. The Company does not invest in futures, forward, swap,
or option contracts nor does the Company invest in hedging or risk adjustment
financial instruments. In addition, there are no off-balance sheet
instruments.
Statement of Financial Accounting Standards No. 114, Accounting by Creditors
for Impairment of a Loan, requires that impaired loans be measured at the
present value of anticipated future cash flows, discounted at the loan's
effective interest rate. Statement of Financial Accounting Standards No. 118,
Accounting by Creditors for Impairment of a Loan--Income Recognition and
Disclosure, amends the disclosure requirements in Statement No. 114 to require
information on certain impaired loans and how a creditor recognizes income on
these impaired loans. Both Statements are effective for fiscal years beginning
after December 15, 1994. The financial impact to the Company from implementing
these pronouncements will be immaterial.
F-10
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--SHAREHOLDERS' EQUITY
During 1992, CII Financial repurchased 115,000 shares of its Common Stock on
the open market at prices averaging $3.52 per share. These shares were
cancelled pursuant to the California Corporations Code.
NOTE 2--INVESTMENTS
Net investment income is summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1994 1993 1992
----------- ----------- -----------
<S> <C> <C> <C>
Interest income:
Bonds.............................. $11,693,000 $10,907,000 $10,258,000
Short-term investments............. 1,037,000 971,000 1,881,000
Relocation mortgage loans from em-
ployees........................... 216,000 254,000 91,000
----------- ----------- -----------
12,946,000 12,132,000 12,230,000
Investment expenses................ (440,000) (497,000) (415,000)
----------- ----------- -----------
Net investment income............ $12,506,000 $11,635,000 $11,815,000
=========== =========== ===========
</TABLE>
The amortized cost and estimated fair values of investments in financial
instruments held by the Company as of December 31, 1994 are as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
------------ ---------- ---------- ------------
<S> <C> <C> <C> <C>
FIXED MATURITIES HELD TO MATU-
RITY
U.S. Treasury securities and
obligations of U.S. govern-
ment corporations and agen-
cies........................ $ 21,988,000 $ 74,000 $ 813,000 $ 21,249,000
Obligations of states and
political subdivisions...... 80,538,000 2,514,000 1,457,000 81,595,000
Corporate securities......... 5,225,000 -- 534,000 4,691,000
------------ ---------- ---------- ------------
Total Fixed Maturities Held
to Maturity................. 107,751,000 2,588,000 2,804,000 107,535,000
------------ ---------- ---------- ------------
SECURITIES AVAILABLE FOR SALE
Fixed Maturities
U.S. Treasury securities and
obligations of U.S.
government corporations and
agencies.................... 49,522,000 535,000 533,000 49,524,000
Obligations of states and
political subdivisions...... 33,919,000 774,000 197,000 34,496,000
Corporate securities......... 24,105,000 18,000 497,000 23,626,000
------------ ---------- ---------- ------------
Total Fixed Maturities
Available for Sale.......... 107,546,000 1,327,000 1,227,000 107,646,000
------------ ---------- ---------- ------------
Equity Securities.............. 1,765,000 -- 1,286,000 479,000
------------ ---------- ---------- ------------
Total Securities Available for
Sale.......................... 109,311,000 1,327,000 2,513,000 108,125,000
------------ ---------- ---------- ------------
Total.......................... $217,062,000 $3,915,000 $5,317,000 $215,660,000
============ ========== ========== ============
</TABLE>
F-11
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 2--INVESTMENTS (CONTINUED)
The amortized cost and estimated fair values of investments in financial
instruments held by the Company as of December 31, 1993 are as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
------------ ----------- ---------- ------------
<S> <C> <C> <C> <C>
FIXED MATURITIES INCLUDING
SHORT-TERM:
U.S. Treasury securities and
obligations of U.S.
government corporations and
agencies..................... $ 64,928,000 $ 1,511,000 $ 7,000 $ 66,432,000
Obligations of states and
political subdivisions....... 111,548,000 8,459,000 1,211,000 118,796,000
Corporate securities.......... 12,450,000 409,000 19,000 12,840,000
------------ ----------- ---------- ------------
Total bonds............... 188,926,000 10,379,000 1,237,000 198,068,000
Trading portfolio............. 10,921,000 -- -- 10,921,000
------------ ----------- ---------- ------------
Total fixed maturities.... 199,847,000 10,379,000 1,237,000 208,989,000
------------ ----------- ---------- ------------
EQUITY SECURITIES:
Common stock.................. 1,768,000 -- 109,000 1,659,000
------------ ----------- ---------- ------------
Total......................... $201,615,000 $10,379,000 $1,346,000 $210,648,000
============ =========== ========== ============
</TABLE>
Realized gains and losses are summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1994 1993 1992
--------- ---------- ---------
<S> <C> <C> <C>
Realized gain (loss):
Fixed maturities.......................... $ -- $2,135,000 $ 179,000
Equity securities......................... -- 61,000 (248,000)
Trading portfolio......................... 186,000 -- --
Investments available for sale............ 30,000 -- --
Investments held to maturity.............. 70,000 -- --
--------- ---------- ---------
Net gain (loss)......................... $ 286,000 $2,196,000 $ (69,000)
========= ========== =========
</TABLE>
The change in unrealized gains and losses on fixed maturity and equity
security investments is summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1994 1993 1992
------------ ---------- ----------
<S> <C> <C> <C>
Fixed maturities........................ $ -- $2,886,000 $1,539,000
Equity securities....................... -- 482,000 256,000
Trading portfolio....................... -- -- --
Investments available for sale.......... (3,470,000) -- --
Investments held to maturity............ (6,965,000) -- --
------------ ---------- ----------
Net gain (loss)..................... $(10,435,000) $3,368,000 $1,795,000
============ ========== ==========
</TABLE>
F-12
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 2--INVESTMENTS (CONTINUED)
Individual financial investments, excluding investments in bonds and notes
of the United States government and United States government agencies, which
exceed ten percent of total shareholders' equity at December 31, 1994 are as
follows:
<TABLE>
<CAPTION>
Fixed maturities:
<S> <C>
Oklahoma City, OK General Obligation......................... $3,073,000
Cargill Financial Services Corp.............................. 3,194,000
----------
$6,267,000
==========
</TABLE>
Individual financial investments, excluding investments in bonds and notes
of the United States government and United States government agencies, which
exceed ten percent of total shareholders' equity at December 31, 1993 are as
follows:
<TABLE>
<CAPTION>
<S> <C>
Fixed maturities:
Michigan State ESG Dev Auth ............................... $ 7,904,000
Illinois State Toll Hwy Auth Rev........................... 1,834,000
Salt Lake City UT Rdv Agy Rev.............................. 1,800,000
Oklahoma City OK G/O Ref................................... 1,745,000
-----------
$13,283,000
===========
</TABLE>
The amortized cost and estimated fair value of debt securities at December
31, 1994, by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
ESTIMATED
AMORTIZED FAIR
COST VALUE
------------ ------------
<S> <C> <C>
DEBT SECURITIES HELD TO MATURITY
Due in one year or less.............................. $ -- $ --
Due after one year through five years................ 24,270,000 24,107,000
Due after five years through ten years............... 55,746,000 55,335,000
Due after ten years through fifteen years............ 26,462,000 26,791,000
Due after fifteen years.............................. 1,273,000 1,302,000
------------ ------------
Total Held to Maturity............................... 107,751,000 107,535,000
------------ ------------
DEBT SECURITIES AVAILABLE FOR SALE
Due in one year or less.............................. 48,469,000 48,268,000
Due after one year through five years................ 16,278,000 16,564,000
Due after five years through ten years............... 22,550,000 22,307,000
Due after ten years through fifteen years............ 13,085,000 13,155,000
Due after fifteen years.............................. 7,164,000 7,352,000
------------ ------------
Total Available for Sale............................. 107,546,000 107,646,000
------------ ------------
Total Debt Securities................................ $215,297,000 $215,181,000
============ ============
</TABLE>
F-13
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 3--REINSURANCE
The Company has reinsurance treaties in effect with unrelated entities. The
reinsurers assume the liability on that portion of workers' compensation
claims between $250,000 and $60,000,000 per occurrence for 1994, 1993 and
1992.
Reinsurance contracts do not relieve the Company from its obligations to
policyholders. Failure of reinsurers to honor their obligations could result
in losses to the Company. Consequently, allowances are established for amounts
deemed uncollectible which at December 31, 1994 and 1993 were none. The
Company evaluates the financial condition of its reinsurers to minimize its
exposure to significant losses from reinsurer insolvencies. At December 31,
1994 and 1993, the amount of reinsurance recoverable for unpaid losses and
loss adjustment expenses was $29,342,000 and $25,841,000, respectively. The
amount of reinsurance receivable for paid losses and loss adjustment expenses
was $65,000 and $171,000, respectively. All reinsurance recoverable and
receivable amounts are due from General Reinsurance Corporation which is rated
A++ by the A.M. Best Company.
The following table provides reinsurance information by reinsurer for the
three years ended December 31, 1994:
<TABLE>
<CAPTION>
RECOVERIES RECOVERABLE
ON PAID ON UNPAID PREMIUMS
LOSSES/LAE LOSSES/LAE CEDED
---------- ----------- ----------
<S> <C> <C> <C>
1994:
General Reinsurance Corporation......... $1,117,000 $3,501,000 $3,679,000
Others.................................. -- -- 205,000
---------- ---------- ----------
Total................................. $1,117,000 $3,501,000 $3,884,000
========== ========== ==========
1993:
General Reinsurance Corporation......... $ 594,000 $5,495,000 $4,156,000
Others.................................. -- -- 255,000
---------- ---------- ----------
Total................................. $ 594,000 $5,495,000 $4,411,000
========== ========== ==========
1992:
General Reinsurance Corporation......... $ 920,000 $3,966,000 $3,885,000
Others.................................. -- -- 263,000
---------- ---------- ----------
Total................................. $ 920,000 $3,966,000 $4,148,000
========== ========== ==========
</TABLE>
F-14
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 4--LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table provides a reconciliation of the beginning and ending
reserve balances for unpaid losses and loss adjustment expenses ("LAE").
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1994 1993 1992
------------ ------------ ------------
<S> <C> <C> <C>
Net beginning loss and LAE reserve. $174,515,000 $158,253,000 $112,749,000
Net provision for:
Insured events incurred in cur-
rent period..................... 67,642,000 86,617,000 91,430,000
Insured events incurred in prior
periods......................... (13,953,000) (3,865,000) 28,066,000
------------ ------------ ------------
Total net provision............ 53,689,000 82,752,000 119,496,000
------------ ------------ ------------
Net payments for losses and LAE:
Attributable to insured events
incurred in current year........ 16,374,000 16,130,000 16,381,000
Attributable to insured events
incurred in prior years......... 50,210,000 50,360,000 57,611,000
------------ ------------ ------------
Total net payments............. 66,584,000 66,490,000 73,992,000
------------ ------------ ------------
Net ending loss and LAE reserve.... 161,620,000 174,515,000 158,253,000
Reinsurance recoverable............ 29,342,000 25,841,000 20,207,000
------------ ------------ ------------
Gross ending loss and LAE reserve.. $190,962,000 $200,356,000 $178,460,000
============ ============ ============
</TABLE>
In 1994, the Company experienced a favorable loss development trend on prior
accident years 1992 and 1993 which resulted in a net reduction in the prior
accident years' reserves of $13,953,000. The favorable development on the 1992
accident year was primarily due to the Company's aggressive actions to settle
claims. The favorable development on the 1993 accident year appears to be
aided in part by the legislative reforms that were enacted in July 1993. In
1993, a favorable development on the prior accident years resulted in a net
reduction to the incurred losses of $3,865,000. There can be no assurances
that such favorable development, nor the magnitude of any favorable
development, will continue in the future.
During the first and second quarters of 1992 and the fourth quarter of 1991,
the Company significantly increased its loss reserves for 1991 and prior
accident years. This was primarily due to the increased frequency and severity
of stress and strain claims and the increased use of forensic medical
examinations associated with litigation of claims.
The increase in reinsurance recoverables are all due to increases in claims
exceeding the Company's retention levels.
NOTE 5--7 1/2% CONVERTIBLE SUBORDINATED DEBENTURES
In September 1991, CII Financial sold $58,250,000 of its 7 1/2% Convertible
Subordinated Debentures due September 15, 2001, currently traded on the
American Stock Exchange. Each $1,000 in principal amount of Debentures is
convertible into 45.733 shares of Common Stock, at a conversion price of
$21.866 per share. The unamortized issuance costs of $1,427,000 are included
in the other assets caption on the balance sheet and are being amortized over
the life of the Debentures. Accrued interest on the 7 1/2% Convertible
Subordinated Debentures as of December 31, 1994, 1993 and 1992 is $1,243,000,
$1,243,000 and $1,259,000, respectively, and is included in the other
liabilities caption on the balance sheet.
The debentureholders may require CII Financial to repurchase the Debentures,
in whole or in part, in certain circumstances involving a change in control of
CII Financial prior to September 15, 2001.
F-15
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 5--7 1/2% CONVERTIBLE SUBORDINATED DEBENTURES (CONTINUED)
The Debentures are redeemable at the option of CII Financial in whole or in
part, commencing any time after September 15, 1994. The Debentures are
redeemable at the following redemption prices equal to the percentage of the
principal amount plus accrued interest for the 12 month period beginning
September 15 of the years indicated:
<TABLE>
<CAPTION>
REDEMPTION
YEAR PRICE
---- ----------
<S> <C>
1994........................................................... 105.25%
1995........................................................... 104.50%
1996........................................................... 103.75%
1997........................................................... 103.00%
1998........................................................... 102.25%
1999........................................................... 101.50%
Thereafter..................................................... 100.75%
</TABLE>
The net proceeds from the offering of approximately $56,147,000 were used
principally to make contributions to the capital and surplus of CII
Financial's insurance and premium finance subsidiaries and for general
corporate purposes.
In December 1991, CII Financial approved the implementation of a program to
purchase up to $10,000,000 of its Convertible Subordinated Debentures and/or
Common Stock, at fair value, pursuant to applicable law. During 1992, CII
Financial repurchased $1,450,000 of its Convertible Subordinated Debentures at
a $457,000 gain.
The fair value of the 7 1/2% Convertible Subordinated Debentures at December
31, 1994 was $38,624,000, which was determined based on the quoted market
price at December 31, 1994. The fair value reflects the market risks of the
stated interest rate and the non-payment of the annual interest and/or the
principal upon maturity.
CII Financial has limited sources of cash in which to pay the annual
interest expense of $4,260,000. As disclosed in Note 8 of Notes to
Consolidated Financial Statements, CII's insurance subsidiaries cannot pay
shareholder's dividends to CII Financial without prior approval by the
California Insurance Commissioner. CII Financial's other subsidiaries do not
have the financial resources to pay shareholder's dividends to give CII
Financial sufficient funds to pay the annual interest expense. As of December
31, 1994, CII Financial had a loan and advances to CII Premium Finance
totalling $8,533,000 to fund the premium finance loans. To meet the interest
payment requirement on the Convertible Subordinated Debentures for the next
twelve months, CII Financial is exploring alternative funding sources for its
premium finance operation which will then allow CII Financial to reduce its
advances to the premium finance operation. The alternatives that are being
explored include expansion of the existing line of credit facility (see Note 6
to Notes to Consolidated Financial Statements), a partial sale of the premium
finance receivables to either a third party or a related party, an interest
bearing loan from CII's insurance subsidiaries, further reductions in the
amount of outstanding premium finance loans, and a sale of the premium finance
operation.
NOTE 6--NOTE PAYABLE TO BANK
The Company has a $12,000,000 revolving line of credit agreement with a bank
which expires on August 1, 1995. During the term of the agreement, the Company
can borrow at the bank's prime rate plus one-half percent or a fixed LIBOR
rate plus two and a half percent, payable monthly. Advances are available up
to 80% of eligible loans receivable, and are collateralized by installment
loans receivable. A commitment fee of one-tenth percent per annum is payable
on the $12,000,000. The Company is required to maintain a compensating balance
of fifteen percent of the revolving line of credit. Under this agreement, the
Company borrowed $8,000,000, at the LIBOR rate plus two and one-half percent
(8.5% at December 31, 1994), maturing on June 12, 1995.
F-16
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 6--NOTE PAYABLE TO BANK (CONTINUED)
The revolving line of credit agreement requires compliance with certain loan
covenants including, but not limited to, minimum tangible net worth, debt
leverage ratio, and current ratio. The revolving line of credit of $12,000,000
is guaranteed by CII Financial, Inc. (the "Parent Company"). In addition, the
Parent Company subordinated $2,000,000 of its debt. As of December 31, 1994,
the Company was in compliance with all financial and non-financial covenants,
however at September 30, 1994, the Company obtained a waiver for noncompliance
with the debt leverage ratio covenant.
NOTE 7--FEDERAL INCOME TAXES
As required by Statement of Financial Accounting Standards No. 109,
Accounting for Income Taxes, effective January 1, 1993, the Company changed
its method of accounting for income taxes from the deferred to the liability
method. Deferred income tax balances are determined based on the difference
between financial statement and tax return bases using current tax rates.
Accordingly, the impact of a change in tax rates on deferred tax balances is
recognized in income in the period that the change is enacted. As permitted,
prior years' financial statements have not been restated. The cumulative
effect of this change in accounting for income taxes was immaterial.
Provision for taxes on income consists of:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1994 1993 1992
----------- -------- -----------
<S> <C> <C> <C>
Current provision (benefit).............. $ 305,000 $196,000 $(3,103,000)
Deferred provision....................... (4,000,000) -- 4,458,000
----------- -------- -----------
Total federal income tax (benefit)....... $(3,695,000) $196,000 $ 1,355,000
=========== ======== ===========
</TABLE>
The current provision for the year ended December 31, 1994 is net of a
$799,000 tax benefit of alternative minimum tax net operating loss
carryforwards.
At December 31, 1994 and 1993, temporary differences between the financial
statement carrying amounts and tax bases of assets and liabilities that cause
deferred tax assets (liabilities) consist of the following:
<TABLE>
<CAPTION>
1994 1993
------------ ------------
<S> <C> <C>
Discount on loss reserves........................ $ 13,790,000 $ 15,062,000
Net operating loss carryforward.................. 6,814,000 6,163,000
Provisions for doubtful accounts................. 796,000 755,000
Alternative minimum tax credits.................. 780,000 --
Unearned premiums................................ 608,000 724,000
Supplemental benefit plans....................... 723,000 348,000
Policyholders' dividends......................... -- 223,000
Other............................................ 427,000 401,000
------------ ------------
Gross deferred asset........................... 23,938,000 23,676,000
------------ ------------
Deferred policy acquisition costs................ (777,000) (687,000)
Unamortized original issue discount.............. (490,000) --
Excess tax depreciation over book................ (478,000) (400,000)
Other............................................ (154,000) (255,000)
------------ ------------
Gross deferred liability....................... (1,899,000) (1,342,000)
------------ ------------
Net deferred asset before valuation allowance.... 22,039,000 22,334,000
Valuation allowance.............................. (18,039,000) (22,334,000)
------------ ------------
$ 4,000,000 $ --
============ ============
</TABLE>
F-17
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 7--FEDERAL INCOME TAXES (CONTINUED)
For the year ended December 31, 1993, the Company established a valuation
allowance equal to the net deferred asset as the Company could not conclude
that it was more likely than not that the entire net deferred asset could be
realized. For the year ended December 31, 1994, the Company re-evaluated the
valuation allowance taking into consideration, for the next three years,
projected operating results and the establishment and reversal of permanent
and temporary tax differences. As a result, the Company reduced its valuation
allowance by $4,000,000.
At December 31, 1994, the Company has a net operating loss carryforward of
$20,041,000 available to offset future taxable income until December 31, 2008.
The Company has no alternative minimum tax net operating loss carryforwards.
For the years ended December 31, 1994, 1993 and 1992, deferred taxes
resulted from temporary differences in recognition of certain revenue and
expense for tax and financial reporting purposes. The sources of these
temporary differences and the related tax effects are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1994 1993 1992
----------- ----------- ----------
<S> <C> <C> <C>
Discount on loss reserves.............. $(1,272,000) $ 1,525,000 $3,957,000
Net operating loss..................... 651,000 -- --
Provisions for doubtful accounts....... 41,000 (111,000) 339,000
Alternative minimum tax credits........ 780,000 -- --
Unearned premiums...................... (116,000) (5,000) 442,000
Supplemental benefit plans............. 375,000 348,000 --
Policyholders' dividends............... (223,000) -- 181,000
Deferred policy acquisition costs...... (90,000) 16,000 (399,000)
Unamortized original issue discount.... (490,000) -- --
Valuation allowance.................... 4,295,000 (1,424,000) --
Other.................................. 49,000 (349,000) (62,000)
----------- ----------- ----------
$ 4,000,000 $ -- $4,458,000
=========== =========== ==========
</TABLE>
A reconciliation of the federal statutory income tax rates to the effective
tax rates in the Consolidated Statements of Operations is as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
---------------------
1994 1993 1992
----- ----- -----
<S> <C> <C> <C>
Income tax provision
(benefit) at statutory
rate.................... 34.0 % 34.0 % (34.0)%
Tax exempt income........ (29.4) (53.4) (6.7)
Proration adjustment on
tax exempt income....... 4.4 7.9 1.0
Discount on loss re-
serves.................. (10.5) 33.9 10.4
Tax loss producing no
current tax benefit..... 3.8 -- 31.6
Utilization of net oper-
ating loss carryforward. -- (9.0) --
Alternative minimum tax.. 3.6 4.1 0.7
Compensation related to
below market loans...... (5.7) -- --
Decrease in valuation al-
lowance................. (46.8) -- --
Other.................... 3.4 (13.4) 0.3
----- ----- -----
Effective income tax
provision (benefit)
rate.................. (43.2)% 4.1 % 3.3 %
===== ===== =====
</TABLE>
F-18
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 7--FEDERAL INCOME TAXES (CONTINUED)
In lieu of state franchise and corporate income taxes, California Indemnity
and Commercial Casualty pay premium taxes based upon direct written premiums
to the states in which they write business. Premium tax expense is included in
policy acquisition costs in the consolidated statements of operations.
NOTE 8--DIVIDEND RESTRICTIONS--INSURANCE SUBSIDIARIES
Under California insurance company statutes and regulations, California
Indemnity and Commercial Casualty are restricted as to the amount of dividends
they may pay on their common stock to their parent companies. No dividends may
be paid without at least ten business days prior notice to the Insurance
Commissioner. Unless specially approved by the Insurance Commissioner prior to
payment, dividends may be paid only out of accumulated earned surplus,
excluding any earned surplus attributable to unrealized appreciation in assets
or an exchange of assets.
If a dividend or other distribution is contemplated which, along with all
other dividends or distributions made within the preceding twelve months,
exceeds the greater of 10% of the insurance company's policyholders' surplus
as of the end of the prior calendar year or net income for such calendar year,
at least 30 days prior notice to the Commissioner must be given, and no
payment of the dividend or distribution may be made unless and until (i) the
Commissioner has approved it or (ii) the 30 days have elapsed and the
Commissioner has not disapproved the proposed payment.
Based on its financial position as of December 31, 1994, California
Indemnity cannot pay any shareholder dividend to CII Financial during 1995
without the prior approval of the California Insurance Commissioner as
California Indemnity has no accumulated earned surplus. Commercial Casualty,
on the other hand, may pay up to $1,874,000 in shareholder dividends to
California Indemnity in 1995 without prior approval from the California
Insurance Commissioner.
Policyholders' surplus of California Indemnity and Commercial Casualty on a
consolidated statutory accounting basis at December 31, 1994 and 1993 was
$61,821,000 and $51,459,000, respectively. Consolidated statutory net income
(loss) was $12,199,000, $7,174,000 and $(32,162,000) for the periods ended
December 31, 1994, 1993 and 1992, respectively.
The National Association of Insurance Commissioners adopted risk-based
capital guidelines for property-casualty insurance companies whereby required
statutory surplus would be based, in part, on a formula based risk assessment
of the individual investments held in the insurance company's portfolio. These
regulations became effective in 1995 and are applied to the statutory Annual
Statement for the year ended December 31, 1994. The Company's risk-based
capital results for the year ended December 31, 1994 exceeded the minimum
surplus required under the regulations.
NOTE 9--EMPLOYEE COMPENSATION
Profit Sharing, 401(k) and Supplemental Benefit Plans
The Company maintains a qualified profit sharing plan that covers all
eligible employees. It also maintains a 401(k) Plan that is available to all
eligible employees. A nonqualified supplemental benefit plan is maintained for
certain officers and key employees of the Company.
During the years ended December 31, 1994, 1993 and 1992, the Company
expensed: (i) $1,841,000, $1,199,000 and zero, respectively, for the profit
sharing plan; (ii) $345,000, $244,000 and $178,000, respectively, under the
401(k) Plan; and (iii) $114,000, $45,000 and $42,000, respectively, for the
supplemental benefit plan.
F-19
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 9--EMPLOYEE COMPENSATION (CONTINUED)
Executive Retirement Plans
The Company maintains a Supplemental Executive Retirement Plan and a
Supplemental Senior Executive Retirement Plan. Eligibility for participation
in both plans is limited to officers and key employees selected and approved
by the Board of Directors. During the years ended December 31, 1994, 1993 and
1992, the Company expensed $530,000, $279,000 and $279,000, respectively,
under these plans.
Employee Incentive Plan
The Company maintains a nonqualified cash bonus plan pursuant to which
certain officers and key employees are eligible to receive cash bonuses based
upon individual and Company performance. During the years ended December 31,
1994, 1993 and 1992, the Company expensed $849,000, $689,000 and $21,000,
respectively, for the employee incentive plan.
Employment Contracts
As of December 31, 1994, the Company has employment contracts with eight
employees expiring December 1995 through March 2001. Minimum aggregate cash
compensation obligations under these contracts are: 1995--$1,052,000; 1996--
$1,052,000; 1997--$1,052,000; 1998--$1,052,000; 1999--$1,502,000 and
thereafter--$1,753,000.
NOTE 10--STOCK OPTION PLANS
Employees
In 1993, 1991, 1989 and 1988 CII Financial adopted various incentive and
non-qualified stock option plans. Options are issued to officers and key
employees for the purchase of CII Financial Common Stock. All of the
outstanding options were granted at 100% of the market price of CII
Financial's Common Stock on the date of grant. Subject to certain conditions,
such as continued employment, the exercise of the options is not restricted
and the options expire ten to twenty years from the date of grant unless
accelerated under certain conditions, such as termination of employment.
Substantial portions of the options vest ratably over five to ten years and
may become fully vested under certain circumstances, such as a change in
control.
Additional information with respect to options issued under these plans is
as follows:
<TABLE>
<CAPTION>
OPTION PRICE
NUMBER OF -------------------------
SHARES PER SHARE TOTAL
--------- -------------- ----------
<S> <C> <C> <C>
Outstanding at January 1, 1993......... 622,000 $3.330-$10.000 $2,183,000
Granted................................ 904,000 $5.750-$ 6.750 5,680,000
Cancelled.............................. (123,000) $3.330-$ 3.350 (412,000)
Exercised.............................. (58,000) $3.330-$ 3.500 (193,000)
--------- ----------
Outstanding at December 31, 1993....... 1,345,000 $3.330-$10.000 7,258,000
Granted................................ 97,000 $5.375-$ 5.750 557,000
Cancelled.............................. (3,000) $3.330-$ 3.500 (12,000)
Exercised.............................. (16,000) $3.330-$ 3.500 (57,000)
--------- ----------
Outstanding at December 31, 1994....... 1,423,000 $3.500-$10.000 $7,746,000
========= ==========
</TABLE>
F-20
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 10--STOCK OPTION PLANS (CONTINUED)
As of December 31, 1994, there were 751,000 options that could have been
exercised. The remainder of the outstanding options first become exercisable
as follows: 1995--84,000; 1996--104,000; 1997--77,000; 1998--58,000; 1999--
76,000 and thereafter 273,000. At December 31, 1994 there were a total of
484,000 options available to grant under the four plans.
Directors
In November 1994, CII Financial adopted the CII Financial, Inc. Non-Employee
Director Stock Option Plan ("Director Plan") which provides for the grant of
nonqualified stock options to non-employee directors who have a minimum of two
years of continuance service on the Board of CII Financial, Inc. Under the
Director Plan, each eligible non-employee director will automatically receive,
on each of the second through fifth anniversaries of the date the director
joined the board, an annual nonqualified stock option to purchase a specified
number of shares of CII Financial's Common Stock, ranging from 750 to 6,750
shares, depending on such non-employee director's years of continuance service
on the board. Options were granted at a price equal to the market price of CII
Financial's Common Stock on the date of grant. Subject to certain conditions,
such as continued service as a director, the exercise of the options is not
restricted and the options expire ten years from date of grant. For each year
of service on the board, 20% of the options are exercisable.
In addition, CII Financial adopted the CIIC Non-Employee Director Stock
Option Plan ("CIIC Plan") in November 1994 which provides for the grant of
nonqualified stock options to purchase shares of CII Financial Common Stock to
non-employee directors of California Indemnity Insurance Company and
Commercial Casualty Insurance Company who have a minimum of two years of
continuance service on the CIIC board of directors. The CIIC Plan is similar
to the Director Plan described above except that the number of shares of CII
Financial Common Stock subject to options granted each year range from 500 to
4,500.
As of December 31, 1994, for both plans, there were 97,300 options granted,
outstanding and presently exercisable at prices ranging from $5.375 to $5.750.
There were 112,000 options available for grant as of December 31, 1994.
NOTE 11--RELATED PARTY TRANSACTIONS
The Company leases two automobiles from an entity which is owned by two of
the Company's officers, who are also directors, in lieu of a car allowance.
Lease rental costs for the years ended December 31, 1994, 1993 and 1992 were
$16,000 each. See Note 13.
A director of CII Financial was an employee of a company that, in 1991,
assumed certain investment management responsibilities with respect to
California Indemnity's investment portfolio. For the years ended December 31,
1994, 1993 and 1992, California Indemnity expensed approximately $381,000,
$361,000 and $352,000 related to such services. The aforementioned agreement
was terminated in December 1994.
In connection with CII Financial's relocation of its principal executive
offices to Pleasanton, California in July 1992, to retain certain key officers
and employees, California Indemnity extended mortgage loans for the purchase
of such officers' and employees' principal residences. In March, 1994, the
terms of the loans were changed for those borrowers who were still actively
employed. The interest rate was reduced to a fixed rate of 3% per annum; the
maturity date was fixed to March 2009; and the loan was made assumable, one
time, by a qualified purchaser of the employee's residence. The amendments
resulted in substantial amounts of unintended imputed income to the employees
for the year ended December 31, 1994 which resulted in significant adverse
personal income tax consequences to the employees.
The present value of future cash flows of the relocation mortgage loans at
December 31, 1994, approximates the unpaid principal balance.
F-21
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 12--EARNINGS PER SHARE
Earnings per share are based upon the weighted average number of common
shares outstanding during each period. The number of shares used in the years
ended December 31, 1994, 1993 and 1992 in the computation of both primary and
fully diluted earnings per share are 7,181,000, 7,142,000 and 7,168,000,
respectively. The Company's outstanding options and Convertible Subordinated
Debentures were excluded from the fiscal 1992 computation due to their anti-
dilutive effect.
NOTE 13--COMMITMENTS AND CONTINGENCIES
The Company leases its office facilities under noncancellable operating
leases expiring through October 1999. Gross minimum rental commitments of the
leases as of December 31, 1994 are as follows:
<TABLE>
<CAPTION>
YEAR AMOUNT
---- ----------
<S> <C>
1995........................................................... $1,859,000
1996........................................................... 1,814,000
1997........................................................... 1,731,000
1998........................................................... 1,390,000
1999........................................................... 572,000
----------
Total.......................................................... $7,366,000
==========
</TABLE>
Rent expense consists of:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1994 1993 1992
---------- ---------- ----------
<S> <C> <C> <C>
Office................................... $1,601,000 $1,345,000 $1,172,000
Automobiles.............................. 16,000 16,000 16,000
---------- ---------- ----------
Total rent expense................... $1,617,000 $1,361,000 $1,188,000
========== ========== ==========
</TABLE>
NOTE 14--OFF-BALANCE-SHEET AND CREDIT RISK
The Company controls credit risk through adequate deposits, credit
approvals, limits and monitoring procedures.
The Company's investment portfolio of debt securities consists of investment
grade securities.
At December 31, 1994 and 1993, the Company had reinsurance contracts with
unrelated insurers amounting to $29,342,000 and $25,841,000, respectively, for
reinsurance recoverables on unpaid losses. The Company performs due diligence
to ensure that amounts due from reinsurers are collectible.
NOTE 15--SUPPLEMENTAL DISCLOSURES FOR CONSOLIDATED STATEMENTS OF CASH FLOWS
Supplemental disclosures for the consolidated statements of cash flows are:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1994 1993 1992
---------- ---------- ----------
<S> <C> <C> <C>
Cash paid for:
Income taxes........................... $ 100,000 $ 330,000 $ --
========== ========== ==========
Interest............................... $4,458,000 $4,260,000 $4,209,000
========== ========== ==========
</TABLE>
F-22
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 16--DISCONTINUED OPERATIONS
In June 1993, the Company purchased an 80% interest in InteLock Technologies
("InteLock"), a start-up manufacturer of electronic key-optional door locks.
This acquisition, which amounted to $2,200,000, was accounted for using the
purchase method of accounting. Since its acquisition, InteLock incurred
increasingly larger operating losses and required significant amounts of cash
to fund its operations. In the latter part of 1994, the Company's board of
directors authorized the engagement of consultants to evaluate InteLock as a
viable entity which were not completed until the second quarter of 1995. In
May 1995, the Company made a determination to either dispose or liquidate its
interest in InteLock based on the results of the evaluations and analyses.
Accordingly, the accompanying consolidated financial statements reflect
InteLock as a discontinued operation.
On June 13, 1995, the Company entered into an agreement to sell its equity
interest in InteLock for a combination of common stock, warrants, and cash
totalling approximately $1 million. For the six months ended June 30, 1995,
operating losses are estimated at $2,010,000 and the loss on disposal is
estimated to be $4,590,000. No income tax benefit is recognized on the loss
from discontinued operations due to the valuation allowance provided on
potential deferred tax assets. The loss on disposal includes the write off of
the remaining investment in InteLock of approximately $2,000,000, operating
losses subsequent to the discontinued operation measurement date of
approximately $350,000, and accrued estimated run-off and other disposal costs
in accordance with the terms of the sales agreement of approximately
$2,240,000.
InteLock's assets, net of liabilities, are shown on the accompanying
consolidated balance sheets as "Net assets of discontinued operations." The
following table sets forth the summarized financial position of InteLock at
December 31, 1994 and 1993:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1994 1993
---------- ----------
<S> <C> <C>
Cash...................................................... $ 91,000 $ 122,000
Accounts receivable....................................... 234,000 339,000
Property and equipment.................................... 87,000 65,000
Inventory................................................. 1,598,000 456,000
Patents................................................... 181,000 217,000
Goodwill.................................................. 907,000 1,320,000
Other Assets.............................................. 337,000 371,000
---------- ----------
Total Assets............................................ 3,435,000 2,890,000
---------- ----------
Accounts payable.......................................... 450,000 191,000
Other liabilities......................................... 390,000 478,000
---------- ----------
Total Liabilities....................................... 840,000 669,000
---------- ----------
Net Assets.............................................. $2,595,000 $2,221,000
========== ==========
</TABLE>
F-23
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following table sets forth InteLock's summarized operating results for
the year ended December 31, 1994 and the seven months (from date of
acquisition) ended December 31, 1993:
<TABLE>
<CAPTION>
YEAR ENDED SEVEN MONTHS
DEC. 31, ENDED DEC. 31,
1994 1993
----------- --------------
<S> <C> <C>
Gross revenues...................................... $ 2,035,000 $ 849,000
Total costs and expenses............................ 4,536,000 1,253,000
----------- ---------
Loss from discontinued operations................... $(2,501,000) $(404,000)
=========== =========
</TABLE>
NOTE 17--QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table sets forth the unaudited data regarding operations for
each quarter of 1994 and 1993. In the opinion of management, such unaudited
data includes all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly the information presented. The
Company's operating results for any quarter are not necessarily indicative of
the operating results for any future period.
<TABLE>
<CAPTION>
1994
---------------------------------------------------
4TH QUARTER 3RD QUARTER 2ND QUARTER 1ST QUARTER
----------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
Net earned premiums...... $21,503,000 $23,378,000 $22,202,000 $ 23,717,000
Net investment income.... 3,261,000 3,352,000 3,034,000 3,145,000
Other revenues........... 956,000 622,000 586,000 524,000
----------- ----------- ----------- ------------
Total revenues........... 25,720,000 27,352,000 25,822,000 27,386,000
Costs and expenses....... 21,070,000 23,894,000 24,181,000 26,090,000
----------- ----------- ----------- ------------
Income before federal in-
come tax benefit........ 4,650,000 3,458,000 1,641,000 1,296,000
Federal income tax bene-
fit..................... (3,695,000) -- -- --
----------- ----------- ----------- ------------
Income from continuing
operations.............. 8,345,000 3,458,000 1,641,000 1,296,000
Loss from discontinued
operations.............. (1,328,000) (494,000) (400,000) (279,000)
----------- ----------- ----------- ------------
Net income............... $ 7,017,000 $ 2,964,000 $ 1,241,000 $ 1,017,000
=========== =========== =========== ============
Income from continuing
operations per share:
Primary................ $ 1.16 $ 0.48 $ 0.23 $ 0.18
=========== =========== =========== ============
Fully diluted.......... $ 0.95 $ 0.48 $ 0.23 $ 0.18
=========== =========== =========== ============
Loss from discontinued
operations per share:
Primary................ $ (0.18) $ (0.07) $ (0.06) $ (0.04)
=========== =========== =========== ============
Fully diluted.......... $ (0.14) $ (0.07) $ (0.06) $ (0.04)
=========== =========== =========== ============
Net income per share:
Primary................ $ 0.98 $ 0.41 $ 0.17 $ 0.14
=========== =========== =========== ============
Fully diluted.......... $ 0.81 $ 0.41 $ 0.17 $ 0.14
=========== =========== =========== ============
</TABLE>
F-24
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)
NOTE 17--QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) (CONTINUED)
In the fourth quarter, the Company re-evaluated its valuation allowance on
the deferred tax asset in light of the operating results for the year and
considering projected operating results for the next three years. As a result,
the valuation allowance was reduced by $4,000,000. Also in the fourth quarter,
due to operating losses at InteLock, the Company reduced the number of years
for amortizing the goodwill in InteLock to reflect a more realistic period.
Along with other valuation allowances and expense accruals, total adjustments
recorded in the fourth quarter for InteLock were approximately $600,000.
<TABLE>
<CAPTION>
1993
--------------------------------------------------
4TH QUARTER 3RD QUARTER 2ND QUARTER 1ST QUARTER
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net earned premiums........ $29,133,000 $30,194,000 $26,003,000 $24,284,000
Net investment income...... 3,168,000 3,170,000 3,833,000 3,660,000
Other revenues............. 543,000 457,000 450,000 458,000
----------- ----------- ----------- -----------
Total revenues............. 32,844,000 33,821,000 30,286,000 28,402,000
Costs and expenses......... 30,385,000 32,685,000 29,014,000 28,067,000
----------- ----------- ----------- -----------
Income before federal in-
come tax expense.......... 2,459,000 1,136,000 1,272,000 335,000
Federal income tax expense. 196,000 -- -- --
----------- ----------- ----------- -----------
Income from continuing op-
erations.................. 2,263,000 1,136,000 1,272,000 335,000
Loss from discontinued op-
erations.................. (227,000) (129,000) (48,000) --
----------- ----------- ----------- -----------
Net income................. $ 2,036,000 $ 1,007,000 $ 1,224,000 $ 335,000
=========== =========== =========== ===========
Income from continuing op-
erations per share:
Primary and fully diluted. $ 0.31 $ 0.16 $ 0.18 $ 0.05
=========== =========== =========== ===========
Loss from discontinued op-
erations per share:
Primary and fully diluted. $ (0.03) $ (0.02) $ (0.01) --
=========== =========== =========== ===========
Net income per share:
Primary and fully dilut-
ed...................... $ 0.28 $ 0.14 $ 0.17 $ 0.05
=========== =========== =========== ===========
</TABLE>
F-25
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT
SCHEDULES
To the Board of Directors
CII Financial, Inc.
Pleasanton, California
The audits referred to in our report dated February 17, 1995 relating to the
consolidated financial statements of CII Financial, Inc. and Subsidiaries
included the audits of the financial statement schedules. These financial
statement schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statement schedules
based upon our audit.
In our opinion, such financial statement schedules present fairly, in all
material respects, the information set forth therein.
/s/ BDO SEIDMAN, LLP
BDO SEIDMAN, LLP
Los Angeles, California
February 17, 1995
F-26
<PAGE>
CII FINANCIAL, INC. AND SUBSIDIARIES
SCHEDULE I--SUMMARY OF INVESTMENTS--OTHER
THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1994
<TABLE>
<CAPTION>
AMOUNT AT
WHICH
SHOWN IN
AMORTIZED MARKET THE BALANCE
TYPE OF INVESTMENT COST VALUE SHEET
------------------ ------------ ------------ ------------
<S> <C> <C> <C>
Fixed maturities:
Bonds:
United States government and
government agencies and
authorities........................ $ 69,111,000 $ 68,373,000 $ 69,112,000
State, municipalities and political
subdivisions....................... 114,456,000 116,090,000 115,033,000
All other corporate bonds........... 17,241,000 16,229,000 16,763,000
------------ ------------ ------------
Total fixed maturities............ 200,808,000 200,692,000 200,908,000
Relocation mortgage loans from
employees.............................. 5,841,000 4,456,000 5,841,000
Equity securities....................... 1,765,000 479,000 479,000
Short-term investments including trading
portfolio.............................. 14,490,000 14,489,000 14,489,000
------------ ------------ ------------
Total investments................. $222,904,000 $220,116,000 $221,717,000
============ ============ ============
</TABLE>
F-27
<PAGE>
CII FINANCIAL, INC. (PARENT ONLY)
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEET INFORMATION
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1994 1993
------------ ------------
<S> <C> <C>
ASSETS
Cash............................................... $ 1,631,000 $ 61,000
Investment in subsidiaries......................... 74,183,000 58,530,000
Investments........................................ 479,000 6,903,000
Property and equipment, less accumulated deprecia-
tion of $1,979,000 and $1,399,000................. 2,690,000 3,357,000
Net receivable from subsidiaries................... 11,489,000 10,737,000
Other assets....................................... 1,496,000 1,725,000
------------ ------------
Total assets................................... $ 91,968,000 $ 81,313,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Convertible subordinated debentures.............. $ 56,800,000 $ 56,800,000
Interest payable................................. 1,243,000 1,243,000
Accounts payable and accrued expenses............ 1,673,000 1,064,000
Deferred federal income taxes payable............ 1,081,000 517,000
Federal income taxes payable..................... 2,636,000 4,363,000
------------ ------------
Total liabilities.............................. 63,433,000 63,987,000
------------ ------------
CONTINGENT LIABILITIES
SHAREHOLDERS' EQUITY:
Common stock, stated value $.50 per share; shares
authorized--100,000,000; outstanding--7,187,000
and 7,113,000................................... 3,593,000 3,585,000
Additional paid-in capital....................... 58,563,000 58,523,000
Unrealized losses on marketable equity securi-
ties............................................ (1,187,000) (109,000)
Accumulated deficit.............................. (32,434,000) (44,673,000)
------------ ------------
Total shareholders' equity..................... 28,535,000 17,326,000
------------ ------------
Total liabilities and shareholders' equity..... $ 91,968,000 $ 81,313,000
============ ============
</TABLE>
See accompanying note to condensed financial information.
F-28
<PAGE>
CII FINANCIAL, INC. (PARENT ONLY)
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENT OF OPERATIONS INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1994 1993 1992
------------ ------------ ------------
<S> <C> <C> <C>
REVENUES:
Investment income................. $ 32,000 $ 213,000 $ 312,000
Other............................. 1,567,000 1,581,000 1,204,000
------------ ------------ ------------
Total revenues.................. 1,599,000 1,794,000 1,516,000
------------ ------------ ------------
EXPENSES:
Interest.......................... 4,260,000 4,260,000 4,274,000
Administrative and other.......... 2,204,000 1,163,000 1,995,000
------------ ------------ ------------
Total expenses.................. 6,464,000 5,423,000 6,269,000
------------ ------------ ------------
LOSS BEFORE FEDERAL INCOME TAX
EXPENSE, EXTRAORDINARY GAIN AND
EQUITY IN NET INCOME (LOSS) OF
SUBSIDIARIES....................... (4,865,000) (3,629,000) (4,753,000)
FEDERAL INCOME TAX EXPENSE (BENE-
FIT)............................... (2,074,000) (512,000) 1,231,000
EXTRAORDINARY GAIN.................. -- -- 457,000
EQUITY IN NET INCOME (LOSS) OF SUB-
SIDIARIES.......................... 15,030,000 7,719,000 (36,595,000)
------------ ------------ ------------
NET INCOME (LOSS)................... 12,239,000 4,602,000 (42,122,000)
ACCUMULATED DEFICIT, beginning of
period............................. (44,673,000) (49,275,000) (7,153,000)
------------ ------------ ------------
ACCUMULATED DEFICIT, end of period.. $(32,434,000) $(44,673,000) $(49,275,000)
============ ============ ============
</TABLE>
See accompanying note to condensed financial information.
F-29
<PAGE>
CII FINANCIAL, INC. (PARENT ONLY)
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1994 1993 1992
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................... $ 12,239,000 $ 4,602,000 $(42,122,000)
------------ ------------ ------------
Adjustments to reconcile net income
(loss) to net cash provided by (used
in) operating activities:
Equity in net (income) loss of sub-
sidiaries.......................... (15,030,000) (7,719,000) 36,595,000
Depreciation and amortization...... 828,000 793,000 664,000
Extraordinary gain................. -- -- (457,000)
Loss on the sale of investments.... (3,000) -- 248,000
Loss on the sale of property and
equipment.......................... 14,000 -- 64,000
Compensatory stock options......... (8,000) -- (78,000)
Increase (decrease) in cash from
changes in:
Other assets...................... 56,000 (34,000) 70,000
Accounts payable and accrued ex-
penses........................... 609,000 (180,000) 1,024,000
Federal income tax, net........... (1,163,000) (842,000) 7,579,000
------------ ------------ ------------
Total adjustments................ (14,697,000) (7,982,000) 45,709,000
------------ ------------ ------------
Net cash provided by (used in) oper-
ating activities.................... (2,458,000) (3,380,000) 3,587,000
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of available for sale in-
vestments........................... (130,338,000) -- --
Disposal of available for sale in-
vestments........................... 135,587,000 -- --
Purchase of short-term investments.. -- (538,833,000) (177,035,000)
Disposal of short-term investments.. -- 533,452,000 190,344,000
Increase in investment in subsidiar-
ies................................. (525,000) -- --
Purchase of property and equipment.. -- (536,000) (1,680,000)
Disposal of property and equipment.. 8,000 22,000 64,000
------------ ------------ ------------
Net cash provided by (used in) in-
vesting activities.................. 4,732,000 (5,895,000) 11,693,000
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from the exercise of
stock options....................... 48,000 193,000 40,000
Repurchase and retire common stock.. -- (3,000) (405,000)
Repurchase of subordinated deben-
tures............................... -- -- (993,000)
Net transfers to subsidiaries....... (752,000) (535,000) (4,331,000)
------------ ------------ ------------
Net cash provided by (used in) fi-
nancing activities.................. (704,000) (345,000) (5,689,000)
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH...... 1,570,000 (9,620,000) 9,591,000
CASH, beginning of period............ 61,000 9,681,000 90,000
------------ ------------ ------------
CASH, end of period.................. $ 1,631,000 $ 61,000 $ 9,681,000
============ ============ ============
</TABLE>
See accompanying note to condensed financial information.
F-30
<PAGE>
CII FINANCIAL, INC. (PARENT ONLY)
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
NOTE TO CONDENSED FINANCIAL INFORMATION
The parent only financial statements present CII Financial's balance sheets,
operations and cash flows by accounting for the investment in its consolidated
subsidiaries on the equity method.
The accompanying condensed financial information should be read with the
consolidated financial statements and notes to consolidated financial
statements.
F-31
<PAGE>
ANNEX A
EXECUTION COPY
--------------------------------------------------------------------------------
AGREEMENT AND PLAN OF MERGER
AMONG
SIERRA HEALTH SERVICES, INC.
HEALTH ACQUISITION CORP.
AND
CII FINANCIAL, INC.
--------------------------------------------------------------------------------
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
ARTICLE I
THE MERGER................................................................ 1
1.1. Effective Time of the Merger......................................... 1
1.2. Closing.............................................................. 1
1.3. Effects of the Merger................................................ 1
ARTICLE II
EFFECT OF THE MERGER ON THE CAPITAL STOCK OF THE CONSTITUENT
CORPORATIONS; EXCHANGE OF CERTIFICATES................................... 2
2.1. Effect on Capital Stock.............................................. 2
(a) Capital Stock of Sierra Sub...................................... 2
(b) Cancellation of Sierra-Owned Stock............................... 2
(c) Exchange Ratio for CII Common Stock.............................. 2
(d) Shares of Dissenting Holders..................................... 3
2.2. Exchange of Certificates............................................. 3
(a) Exchange Agent................................................... 3
(b) Exchange Procedures.............................................. 3
(c) Distributions with Respect to Unexchanged Shares................. 4
(d) Lost, Stolen or Destroyed Certificates........................... 4
(e) No Further Ownership Rights in CII Common Stock.................. 4
(f) No Fractional Shares............................................. 4
(g) Termination of Exchange Fund..................................... 4
(h) No Liability..................................................... 4
ARTICLE III
REPRESENTATIONS AND WARRANTIES............................................ 5
3.1. Representations and Warranties of CII................................ 5
(a) Organization, Standing and Power................................. 5
(b) Capital Structure................................................ 5
(c) Authority........................................................ 5
(d) SEC Documents.................................................... 6
(e) Information Supplied............................................. 6
(f) Compliance with Applicable Laws.................................. 7
(g) Financial Statements of Subsidiaries............................. 8
(h) Litigation....................................................... 8
(i) Labor and Employment Matters..................................... 9
(j) Absence of Certain Changes....................................... 9
(k) Material Contracts............................................... 10
(l) Officers and Directors and Employees............................. 11
(m) Title to and Condition of Properties and Assets.................. 12
(n) Patents, Copyrights, Service Marks and Trademarks................ 12
(o) Employee Benefit Plans........................................... 12
(p) Transactions with Officers, Directors and Others................. 13
(q) Insurance Agents................................................. 14
(r) Policyholders.................................................... 14
(s) Insurance Matters................................................ 14
(t) Taxes............................................................ 14
(u) Opinion of Financial Advisor..................................... 18
(v) Section 1203 of the CGCL Not Applicable.......................... 18
</TABLE>
i
<PAGE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
(w) Vote Required..................................................... 18
(x) Accounting Matters................................................ 18
(y) No Change in Capital Structure.................................... 18
(z) Investment Company Act............................................ 18
3.2. Representations and Warranties of Sierra and Sierra Sub............... 18
(a) Organization; Standing and Power.................................. 18
(b) Capital Structure................................................. 19
(c) Authority......................................................... 19
(d) SEC Documents..................................................... 20
(e) Information Supplied.............................................. 20
(f) Compliance with Applicable Laws................................... 20
(g) Litigation........................................................ 21
(h) Absence of Certain Changes or Events.............................. 21
(i) Opinions of Financial Advisors.................................... 21
(j) Accounting Matters................................................ 21
(k) Ownership of CII Common Stock..................................... 21
(l) Interim Operations of Sierra Sub.................................. 21
(m) No Change in Capital Structure.................................... 21
(n) Investment Company Act............................................ 21
(o) Representations Relating to Tax-Free Reorganization............... 21
ARTICLE IV
COVENANTS RELATING TO CONDUCT OF BUSINESS.................................. 22
4.1. Covenants of CII...................................................... 22
(a) Ordinary Course................................................... 22
(b) Dividends; Changes in Stock....................................... 22
(c) Issuance of Securities............................................ 22
(d) Governing Documents............................................... 23
(e) No Solicitations.................................................. 23
(f) No Acquisitions................................................... 23
(g) No Dispositions................................................... 23
(h) Indebtedness...................................................... 24
(i) Other Actions..................................................... 24
(j) Advice of Changes; SEC Filings.................................... 24
(k) Access to Information............................................. 24
(l) Affiliates........................................................ 24
ARTICLE V
ADDITIONAL AGREEMENTS...................................................... 24
5.1. Preparation of S-4 and the Proxy Statement........................... 24
5.2. Letter of CII's Accountants.......................................... 25
5.3. Meetings............................................................. 25
5.4. Legal Conditions to Merger........................................... 25
5.5. Stock Exchange Listing............................................... 25
5.6. Employee Benefit Plans............................................... 25
5.7. Stock Options........................................................ 25
5.8. Brokers or Finders................................................... 26
5.9. Access to Sierra Records............................................. 26
5.10. Employment Agreements................................................ 26
5.11. Indemnification; Directors' and Officers' Insurance.................. 27
5.12. Additional Agreements; Reasonable Efforts............................ 28
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5.13. Pooling.............................................................. 28
5.14. No Actions Inconsistent With Tax-Free Reorganization................. 28
ARTICLE VI
CONDITIONS PRECEDENT....................................................... 28
6.1. Conditions to Each Party's Obligation To Effect the Merger............ 28
(a) Approval.......................................................... 28
(b) NYSE Listing...................................................... 28
(c) Other Approvals................................................... 28
(d) S-4............................................................... 28
(e) No Injunctions or Restraints...................................... 28
(f) Tax Returns....................................................... 28
(g) Supplemental Indenture............................................ 29
6.2. Conditions of Obligations of Sierra and Sierra Sub.................... 29
(a) Representations and Warranties.................................... 29
(b) Performance of Obligations of CII................................. 29
(c) Letter from CII Affiliates........................................ 29
(d) Tax Opinion....................................................... 29
(e) Consents Under Agreements......................................... 29
(f) No Amendments to Resolutions...................................... 29
6.3. Conditions of Obligations of CII...................................... 29
(a) Representations and Warranties.................................... 29
(b) Performance of Obligations of Sierra and Sierra Sub............... 30
(c) Tax Opinion....................................................... 30
(d) Consents Under Agreements......................................... 30
(e) No Amendments to Resolutions...................................... 30
ARTICLE VII
TERMINATION AND AMENDMENT.................................................. 30
7.1. Termination........................................................... 30
7.2. Effect of Termination................................................. 31
7.3. Amendment............................................................. 31
7.4. Extension; Waiver..................................................... 31
7.5. Fees and Expenses..................................................... 31
ARTICLE VIII
GENERAL PROVISIONS......................................................... 32
8.1. Nonsurvival of Representations, Warranties and Agreements............. 32
8.2. Notices............................................................... 32
8.3. Interpretation........................................................ 33
8.4. Counterparts.......................................................... 33
8.5. Entire Agreement; No Third Party Beneficiaries; Rights of Ownership... 33
8.6. Governing Law......................................................... 33
8.7. No Remedy in Certain Circumstances.................................... 34
8.8. Publicity............................................................. 34
8.9. Assignment............................................................ 34
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EXHIBIT 1.3(a)(ii) Form of Certificate of Amendment to CII's Articles of Incorporation 36
EXHIBIT 4.1(1) Form of CII Affiliate Letter 37
EXHIBIT 5.10(x) Persons with whom employment agreements are to be entered into
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AGREEMENT AND PLAN OF MERGER dated as of June 12, 1995, among Sierra Health
Services, Inc., a Nevada corporation ("Sierra"), Health Acquisition Corp., a
California corporation and a wholly owned subsidiary of Sierra ("Sierra Sub"),
and CII Financial, Inc., a California corporation ("CII").
WHEREAS the respective Boards of Directors of Sierra, Sierra Sub and CII
have approved the merger of CII and Sierra Sub;
WHEREAS, to effect such transaction, the respective Boards of Directors of
Sierra, Sierra Sub and CII, and Sierra acting as the sole shareholder of
Sierra Sub, have approved the merger of CII and Sierra Sub (the "Merger"),
pursuant to the terms and conditions of this Agreement, whereby each issued
and outstanding share of Common Stock, stated value $.50 per share, of CII
("CII Common Stock") not owned directly or through a wholly-owned Subsidiary
by Sierra or directly by CII will be converted into the right to receive
Common Stock, par value $.005 per share, of Sierra ("Sierra Common Stock"),
all as provided herein;
WHEREAS Sierra, Sierra Sub and CII desire to make certain representations,
warranties and agreements in connection with the Merger and also to prescribe
various conditions to the Merger;
WHEREAS, for Federal income tax purposes, it is intended that the Merger
shall qualify as a reorganization under the provisions of Section 368 of the
Internal Revenue Code of 1986, as amended (the "Code"); and
WHEREAS, for accounting purposes, it is intended that the Merger shall be
accounted for as a "pooling of interests";
NOW, THEREFORE, in consideration of the foregoing and the respective
representations, warranties, covenants and agreements set forth in this
Agreement, the parties agree as follows:
ARTICLE I
THE MERGER
1.1. Effective Time of the Merger. Subject to the provisions of this
Agreement, the respective officers certificate of each of Sierra Sub and CII
required by Section 1103 of the California General Corporation Law (the
"CGCL") shall be duly prepared, executed and acknowledged by Sierra Sub or
CII, as appropriate, and this Agreement, having been duly executed, with such
officers' certificates attached (such documents and any other documents
necessary to effect the Merger in accordance with the CGCL shall be referred
to as the "Merger Filings") shall be delivered by the Surviving Corporation
(as defined in Section 1.3) to the Secretary of State of the State of
California for filing. The Merger shall become effective upon the filing of
the Merger Filings with the Secretary of State of the State of California (the
"Effective Time").
1.2. Closing. The closing of the Merger (the "Closing") will begin at 10:00
a.m. on a date to be specified by the parties, which shall be no later than
the fifth business day after satisfaction of the latest to occur of the
conditions set forth in Sections 6.1, 6.2(b) (other than the delivery of the
officers' certificates referred to therein), 6.2(e), 6.3(b) (other than the
delivery of the officers' certificates referred to therein) and 6.3(e)
(provided that the other closing conditions set forth in Article VI have been
met or waived as provided in Article VI at or prior to the Closing) (the
"Closing Date"), at the offices of Morgan, Lewis & Bockius, 801 South Grand
Avenue, Los Angeles, CA 90017-4615 unless another date or place is agreed to
in writing by the parties hereto.
1.3. Effects of the Merger. (a) At the Effective Time, (i) the separate
existence of Sierra Sub shall cease and Sierra Sub shall be merged with and
into CII (Sierra Sub and CII are sometimes referred to herein as the
"Constituent Corporations" and CII is sometimes referred to herein as the
"Surviving Corporation"), (ii) the Articles of Incorporation of CII shall be
amended by filing a Certificate of Amendment pursuant to Sections 900 and 907
of the CGCL, substantially in the form attached as Exhibit 1.3(a)(ii), so that
Article IV of such Articles of Incorporation shall read in its entirety as
follows: "The corporation is authorized to issue only one class of
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shares of stock which shall be designated as "Common Stock;" and the total
number of shares which this Corporation is authorized to issue is one thousand
(1,000)," and, as so amended, the Articles shall be the Articles of
Incorporation of the Surviving Corporation and (iii) the By-laws of CII as in
effect immediately prior to the Effective Time shall be the By-laws of the
Surviving Corporation.
(b) At and after the Effective Time, in accordance with Section 1107 of the
CGCL, the Surviving Corporation shall possess all the rights and property of
the Constituent Corporations and be subject to all the debts and liabilities
of the Constituent Corporations as if the Surviving Corporation had itself
incurred them; all rights of creditors and all liens upon any property of
either of the Constituent Corporations shall be preserved unimpaired, provided
that such liens upon property of a disappearing corporation shall be limited
to the property affected thereby immediately prior to the Effective Time; and
any action or proceeding pending by or against any disappearing corporation
may be prosecuted to judgment, which shall bind the Surviving Corporation, or
the Surviving Corporation may be proceeded against or substituted in its
place.
ARTICLE II
EFFECT OF THE MERGER ON THE CAPITAL STOCK OF THE
CONSTITUENT CORPORATIONS; EXCHANGE OF CERTIFICATES
2.1. Effect on Capital Stock. As of the Effective Time, by virtue of the
Merger and without any action on the part of the holder of any shares of CII
Common Stock or capital stock of Sierra Sub:
(a) Capital Stock of Sierra Sub. Each issued and outstanding share of the
capital stock of Sierra Sub shall be converted into and become one fully
paid and nonassessable share of Common Stock, stated value $.50 per share,
of the Surviving Corporation.
(b) Cancellation of Sierra-Owned Stock. All shares of CII Common Stock
that are owned by Sierra, Sierra Sub or any other wholly-owned Subsidiary
of Sierra shall be canceled and retired and shall cease to exist and no
stock of Sierra or other consideration shall be delivered in exchange
therefor. As used in this Agreement, the word "Subsidiary" means any
corporation or other organization, whether incorporated or unincorporated,
of which a party to this Agreement or any other Subsidiary of such a party
(i) is a general partner (in the case of a partnership), or (ii) holds
directly or indirectly at least a majority of the securities or other
interests having by their terms ordinary voting power to elect a majority
of the Board of Directors or others performing similar functions with
respect to such corporation or other organization.
(c) Exchange Ratio for CII Common Stock. (i) Subject to Section 2.2(f),
each issued and outstanding share of CII Common Stock (other than shares to
be canceled in accordance with Section 2.1(b)) shall be converted into the
right to receive .370 (the "Conversion Number") of a fully paid and
nonassessable share of Sierra Common Stock, including the corresponding
percentage of a right (the "Right") to purchase shares of Series A Junior
Participating Preferred Stock of Sierra (the "Sierra Series A Preferred")
pursuant to the Rights Agreement dated as of June 14, 1994, between Sierra
and Continental Stock Transfer & Trust Company, as Rights Agent (the
"Rights Agreement"). Prior to the Distribution Date (as defined in the
Rights Agreement) all references in this Agreement to the Sierra Common
Stock to be received pursuant to the Merger shall be deemed to include the
Rights. All such shares of CII Common Stock shall no longer be outstanding
and shall automatically be canceled and retired and shall cease to exist,
and each holder of a certificate representing any such shares shall cease
to have any rights with respect thereto, except the right to receive the
shares of Sierra Common Stock to be issued in consideration therefor upon
the surrender of such certificate in accordance with Section 2.2, without
interest.
(ii) With respect to CII's 7 1/2% Convertible Subordinated Debentures Due
2001 (the "CII Debentures") issued pursuant to the Indenture (the
"Indenture") dated as of September 15, 1991 between CII and Manufacturers
Hanover Trust Company, as Trustee (the "Trustee"), and pursuant to an
indenture
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supplemental thereto to be executed by CII, Sierra and the Trustee as of
the Closing Date, at the Effective Time, the CII Debentures will no longer
be convertible into CII Common Stock and will be convertible into Sierra
Common Stock. The price at which such shares of Sierra Common Stock shall
be delivered upon conversion of the CII Debentures shall be the quotient of
the "conversion price" (as defined in the Indenture) in effect immediately
prior to the Effective Time divided by the Conversion Number, subject to
further adjustment as provided in the Indenture.
(d) Shares of Dissenting Holders. (i) Notwithstanding anything to the
contrary contained in this Agreement, any holder of CII Common Stock with
respect to which dissenters' rights, if any, are granted by reason of the
Merger under the CGCL and who does not vote in favor of the Merger and who
otherwise complies with Chapter 13 of the CGCL ("CII Dissenting Shares"),
shall not be entitled to receive shares of Sierra Common Stock pursuant to
Section 2.1(c) hereof, unless such holder fails to perfect, effectively
withdraws or loses his right to dissent from the Merger under the CGCL.
Such holder shall be entitled to receive only the payment provided for by
Chapter 13 of the CGCL. If any such holder so fails to perfect, effectively
withdraws or loses his dissenters' rights under the CGCL, his CII
Dissenting Shares shall thereupon be deemed to have been converted, as of
the Effective Time, into the right to receive shares of Sierra Common Stock
pursuant to Section 2.1(c).
(ii) Any payments relating to CII Dissenting Shares shall be made solely
by the Surviving Corporation and no funds or other property have been or
will be provided by Sierra Sub or any of its other direct or indirect
Subsidiaries for such payment.
2.2. Exchange of Certificates. (a) Exchange Agent. As of the Effective Time,
Sierra shall deposit with Continental Stock Transfer & Trust Company, or
another bank or trust company designated by Sierra and reasonably acceptable
to CII (the "Exchange Agent"), for the benefit of the holders of shares of CII
Common Stock, for exchange in accordance with this Article II, through the
Exchange Agent: (i) certificates representing the appropriate number of shares
of Sierra Common Stock and (ii) cash to be paid in lieu of fractional shares
of Sierra Common Stock (such shares of Sierra Common Stock and such cash are
hereinafter referred to as the "Exchange Fund") issuable pursuant to Section
2.1 in exchange for outstanding shares of CII Common Stock.
(b) Exchange Procedures. As soon as reasonably practicable after the
Effective Time, the Exchange Agent shall mail to each holder of record of a
certificate or certificates which immediately prior to the Effective Time
represented outstanding shares of CII Common Stock (the "Certificates") whose
shares were converted into the right to receive shares of Sierra Common Stock
pursuant to Section 2.1 and whose shares are not CII Dissenting Shares: (i) a
letter of transmittal (which shall specify that delivery shall be effected,
and risk of loss and title to the Certificates shall pass, only upon delivery
of the Certificates to the Exchange Agent and shall be in such form and have
such other provisions as Sierra and CII may reasonably specify) and (ii)
instructions for use in effecting the surrender of the Certificates in
exchange for certificates representing shares of Sierra Common Stock. Upon
surrender of a Certificate for cancellation to the Exchange Agent or to such
other agent or agents as may be appointed by Sierra and Sierra Sub, together
with such letter of transmittal, duly executed, the holder of such Certificate
shall be entitled to receive in exchange therefor a certificate representing
that number of whole shares of Sierra Common Stock and, if applicable, a check
representing the cash consideration to which such holder may be entitled on
account of a fractional share of Sierra Common Stock, which such holder has
the right to receive pursuant to the provisions of this Article II, and the
Certificate so surrendered shall forthwith be canceled. In the event of a
transfer of ownership of CII Common Stock which is not registered in the
transfer records of CII, a certificate representing the proper number of
shares of Sierra Common Stock may be issued to a transferee if the Certificate
representing such CII Common Stock is presented to the Exchange Agent,
accompanied by all documents required to evidence and effect such transfer and
by evidence that any applicable stock transfer taxes have been paid. Until
surrendered as contemplated by this Section 2.2, each Certificate shall be
deemed at any time after the Effective Time to represent only the right to
receive upon such surrender the certificate representing shares of Sierra
Common Stock and cash in lieu of any fractional shares of Sierra Common Stock
as contemplated by this Section 2.2.
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(c) Distributions with Respect to Unexchanged Shares. No dividends or other
distributions declared or made after the Effective Time with respect to Sierra
Common Stock with a record date after the Effective Time shall be paid to the
holder of any unsurrendered Certificate with respect to the shares of Sierra
Common Stock represented thereby and no cash payment in lieu of fractional
shares shall be paid to any such holder pursuant to Section 2.2(f) until the
holder of record of such Certificate shall surrender such Certificate. Subject
to the effect of applicable laws, following surrender of any such Certificate,
there shall be paid to the record holder of the certificates representing
whole shares of Sierra Common Stock issued in exchange therefor, without
interest, (i) at the time of such surrender, the amount of any cash payable in
lieu of a fractional share of Sierra Common Stock to which such holder is
entitled pursuant to Section 2.2(f) and the amount of dividends or other
distributions with a record date after the Effective Time theretofore paid
with respect to such whole shares of Sierra Common Stock, and (ii) at the
appropriate payment date, the amount of dividends or other distributions with
a record date after the Effective Time but prior to surrender and a payment
date subsequent to surrender payable with respect to such whole shares of
Sierra Common Stock.
(d) Lost, Stolen or Destroyed Certificates. In the event that any
certificate for CII Common Stock shall have been lost, stolen or destroyed,
the Exchange Agent shall issue in exchange therefor, upon the making of an
affidavit of that fact by the holder thereof such shares of Sierra Common
Stock and cash in lieu of fractional shares, if any, as may be required
pursuant to this Agreement provided, however, that Sierra may, in its
discretion, require the delivery of a suitable bond or indemnity.
(e) No Further Ownership Rights in CII Common Stock. All shares of Sierra
Common Stock issued upon the surrender for exchange of shares of CII Common
Stock in accordance with the terms hereof (including any cash paid pursuant to
Section 2.2(c) or 2.2(f)) shall be deemed to have been issued in full
satisfaction of all rights pertaining to such shares of CII Common Stock,
subject, however, to the Surviving Corporation's obligation to pay any
dividends or make any other distributions with a record date prior to the
Effective Time which may have been declared or made by CII on such shares of
CII Common Stock in accordance with the terms of this Agreement or prior to
the date hereof and which remain unpaid at the Effective Time, and there shall
be no further registration of transfers on the stock transfer books of the
Surviving Corporation of the shares of CII Common Stock which were outstanding
immediately prior to the Effective Time. If, after the Effective Time,
Certificates are presented to the Surviving Corporation for any reason, they
shall be canceled and exchanged as provided in this Article II.
(f) No Fractional Shares. No fractions of a share of Sierra Common Stock
shall be issued in the Merger, but in lieu thereof each holder of shares of
CII Common Stock otherwise entitled to a fraction of a share of Sierra Common
Stock shall, upon surrender of his certificate or certificates, be entitled to
receive an amount of cash (without interest) determined by multiplying the
closing price for Sierra Common Stock as reported on the New York Stock
Exchange ("NYSE") Composite Transactions on the business day two days prior to
the Effective Date by the fractional share interest to which such holder would
otherwise be entitled. The parties acknowledge that payment of the cash
consideration in lieu of issuing fractional shares was not separately
bargained for consideration but merely represents a mechanical rounding off
for purposes of simplifying the corporate and accounting problems which would
otherwise be caused by the issuance of fractional shares.
(g) Termination of Exchange Fund. Any portion of the Exchange Fund which
remains undistributed to the shareholders of CII for six months after the
Effective Time shall be delivered to Sierra, upon demand, and any shareholders
of CII who have not theretofore complied with this Article II shall thereafter
look only to Sierra for payment of their claim for Sierra Common Stock, as the
case may be, any cash in lieu of fractional shares of Sierra Common Stock and
any dividends or distributions with respect to Sierra Common Stock.
(h) No Liability. Neither Sierra nor CII shall be liable to any holder of
shares of CII Common Stock, or Sierra Common Stock, as the case may be, for
such shares (or dividends or distributions with respect thereto) or cash from
the Exchange Fund delivered to a public official pursuant to any applicable
abandoned property, escheat or similar law.
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ARTICLE III
REPRESENTATIONS AND WARRANTIES
3.1. Representations and Warranties of CII. CII represents and warrants to
Sierra and Sierra Sub as follows:
(a) Organization, Standing and Power. Each of CII and its Subsidiaries is
a corporation, duly organized, validly existing and in good standing under
the laws of its jurisdiction of organization, has all requisite power and
authority to own, lease and operate its properties and to carry on its
business, including in the case of California Indemnity Insurance Company,
a California corporation, Commercial Casualty Insurance Company, a
California corporation, Financial Assurance Company, Ltd., a Cayman Islands
corporation (collectively, the "Insurance Subsidiaries"), their respective
insurance businesses, as now being conducted, and is duly qualified and in
good standing to do business in each jurisdiction in which the nature of
its business or the ownership or leasing of its properties makes such
qualification necessary except when the failure to be so qualified would
not have a material adverse effect on such entity. As used in this
Agreement, any reference to any event, change or effect being material with
respect to any entity means an event, change or effect having a material
effect on the condition (financial or otherwise), properties, assets,
liabilities, businesses or operations of such entity.
(b) Capital Structure. As of the date hereof, the authorized capital
stock of CII consists of 100,000,000 shares of CII Common Stock. At the
close of business on June 9, 1995: (i) 7,187,721 shares of CII Common Stock
were outstanding, 1,480,560 shares of CII Common Stock were reserved for
issuance upon the exercise of outstanding stock options or pursuant to
CII's other benefit plans (such stock options and such benefit plans,
collectively, the "CII Stock Plans"), (ii) 2,597,641 shares of CII Common
Stock were reserved for issuance upon conversion of the outstanding
$56,800,000 principal amount of CII Debentures, (iii) no shares of CII
Common Stock were held by its wholly-owned Subsidiaries, and (iv) except as
set forth on Schedule 3.1(b), no warrants, bonds, debentures, notes or
other indebtedness or other security having the right to vote (or, except
for the CII Debentures, convertible into or exercisable for securities
having the right to vote) on any matters on which shareholders may vote
("Voting Debt"), were issued or outstanding. All outstanding shares of CII
capital stock are validly issued, fully paid and nonassessable and not
subject to preemptive rights. As of the date of this Agreement, except for
this Agreement, the CII Stock Options (as defined in Section 5.7) and the
CII Debentures, there are no options, warrants, calls, rights, or
agreements to which CII or any Subsidiary of CII is a party or by which it
or any such Subsidiary is bound obligating CII or any Subsidiary of CII to
issue, deliver or sell, or cause to be issued, delivered or sold,
additional shares of capital stock or any Voting Debt of CII or of any
Subsidiary of CII or obligating CII or any Subsidiary of CII to grant,
extend or enter into any such option, warrant, call, right or agreement.
Assuming compliance by Sierra with Section 5.7 after the Effective Time,
there will be no option, warrant, call, right or agreement obligating CII
or any Subsidiary of CII to issue, deliver or sell, or cause to be issued,
delivered or sold, any shares of capital stock or any Voting Debt of CII or
any Significant Subsidiary of CII, or obligating CII or any Subsidiary of
CII to grant, extend or enter into any such option, warrant, call, right or
agreement.
(c) Authority. CII has all requisite corporate power and authority to
enter into this Agreement and subject to approval of this Agreement and the
Merger by the shareholders of CII, to consummate the transactions
contemplated hereby. The execution and delivery of this Agreement and the
consummation of the transactions contemplated hereby have been duly
authorized by all necessary corporate action on the part of CII, subject to
such approval of this Agreement by the shareholders of CII. This Agreement
has been duly executed and delivered by CII and, subject to such approval
of this Agreement by the shareholders of CII, constitutes a valid and
binding obligation of CII enforceable against it in accordance with its
terms. The execution and delivery of this Agreement does not, and the
consummation of the transactions contemplated hereby will not, conflict
with, or result in any violation of, or default (with or without notice or
lapse of time, or both) under, or give rise to a right of termination,
cancellation or acceleration of any obligation or the loss of a material
benefit under, or the creation of a lien, pledge,
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security interest or other encumbrance on assets (any such conflict,
violation, default, right of termination, cancellation or acceleration,
loss or creation, a "Violation"), pursuant to any provision of the Articles
of Incorporation or By-laws of CII or any Subsidiary of CII or, except (i)
as set forth on Schedule 3.1(c) hereto or (ii) as contemplated by the next
sentence hereof, result in any Violation of any loan or credit agreement,
note, mortgage, indenture, lease, Designated Plan (as defined in Section
3.1(o)) or other agreement, obligation, instrument, permit, concession,
franchise, license, judgment, order, decree, statute, law, ordinance, rule
or regulation applicable to CII or any Subsidiary of CII or their
respective properties or assets which Violation would have a material
adverse effect on CII and its Subsidiaries taken as a whole. No consent,
approval, order or authorization of, or registration, declaration or filing
with, any court, administrative agency or commission or other governmental
authority or instrumentality, domestic or foreign (a "Governmental
Entity"), is required by or with respect to CII or any of its Subsidiaries
in connection with the execution and delivery of this Agreement by CII, or
the consummation by CII of the transactions contemplated hereby, the
failure to obtain which would have a material adverse effect on CII and its
Subsidiaries taken as a whole, except for (i) the filing of a premerger
notification report by CII under the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended (the "HSR Act"), (ii) the filing with
the SEC of (A) a proxy statement in definitive form relating to the meeting
of CII's shareholders, and, if required, a meeting of Sierra's
shareholders, to be held in connection with the Merger (the "Proxy
Statement") and (B) such reports under Sections 13(a), 13(d) and 16(a) of
the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as
may be required in connection with this Agreement and the transactions
contemplated hereby, (iii) the filing of the Merger Filings and appropriate
documents with the relevant authorities of other states in which CII is
qualified to do business, (iv) such filings, authorizations, orders and
approvals (the "Insurance Approvals") as may be required by foreign, state
or local governmental authorities including those in connection with CII's
insurance business and (v) such filings, authorizations, orders and
approvals (the "State Takeover Approvals") as may be required by state
takeover laws.
(d) SEC Documents. CII has delivered or made available to Sierra a true
and complete copy of each material report, schedule, registration statement
and definitive proxy statement filed by CII with the SEC since January 1,
1992 (as such documents have since the time of their filing been amended,
the "CII SEC Documents") which are all the documents (other than
preliminary material) that CII has been required to file with the SEC since
such date. As of their respective dates, the CII SEC Documents complied in
all material respects with the requirements of the Securities Act of 1933,
as amended (the "Securities Act"), or the Exchange Act, as the case may be,
and the rules and regulations of the SEC thereunder applicable to such CII
SEC Documents and none of the CII SEC Documents contained any untrue
statement of a material fact or omitted to state a material fact required
to be stated therein or necessary to make the statements therein, in light
of the circumstances under which they were made, not misleading. The
consolidated financial statements of CII included in the CII SEC Documents
comply as to form in all material respects with applicable accounting
requirements and with the published rules and regulations of the SEC with
respect thereto, have been prepared in accordance with generally accepted
accounting principles applied on a consistent basis during the periods
involved (except as may be indicated in the notes thereto or, in the case
of the unaudited statements, as permitted by Form 10-Q of the SEC) and
fairly present (subject, in the case of the unaudited statements, to
normal, recurring audit adjustments) the consolidated financial position of
CII and its consolidated Subsidiaries as at the dates thereof and the
consolidated results of their operations and cash flows for the periods
then ended.
(e) Information Supplied. None of the information supplied or to be
supplied by CII for inclusion or incorporation by reference in (i) the
registration statement on Form S-4 to be filed with the SEC by Sierra in
connection with the issuance of shares of Sierra Common Stock in the Merger
(the "S-4") will, at the time the S-4 is filed with the SEC and at the time
it becomes effective under the Securities Act, contain any untrue statement
of a material fact or omit to state any material fact required to be stated
therein or necessary to make the statements therein not misleading, and
(ii) the Proxy Statement will, at the date mailed to shareholders and at
the times of the meeting or meetings of shareholders to be held in
connection with the Merger, contain any untrue statement of a material fact
or omit to state any material fact required to be
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stated therein or necessary in order to make the statements therein, in
light of the circumstances under which they are made, not misleading. The
Proxy Statement will comply as to form in all material respects with the
provisions of the Exchange Act and the rules and regulations thereunder.
(f) Compliance with Applicable Laws. Except as set forth on Schedule
3.1(f), the businesses of CII and each of its Subsidiaries have been and
are being conducted in compliance with all applicable laws, rules,
ordinances, regulations, licenses, judgments, orders or decrees of federal,
state, local and foreign governmental authorities, including, but not
limited to, the California Insurance Code, except for possible violations
which individually or in the aggregate do not, and, insofar as reasonably
can be foreseen, in the future will not, have a material adverse effect on
CII and its Subsidiaries taken as a whole. CII and each of its Subsidiaries
hold all certificates of authority, franchises, grants, permits, licenses,
easements, consents, certificates, variances, exemptions, orders and
approvals from all Governmental Entities (collectively, "CII Permits")
which are necessary to own, lease and operate the assets and properties
they currently own, lease and operate and to conduct their respective
businesses and operations in the manner heretofore conducted and as
proposed to be conducted, except for those CII Permits, the absence of
which would not have a material adverse effect on CII and its Subsidiaries
taken as a whole. Schedule 3.1(f) contains a list of all CII Permits which
are material to CII and any of its Subsidiaries, including the
jurisdictions in which CII or one or more of its Subsidiaries hold a
license or are otherwise authorized to conduct insurance business and the
types or lines of insurance which CII or one of its Subsidiaries is
permitted to write in such jurisdictions. Except as described on Schedule
3.1(f), neither CII nor any of its Subsidiaries conducts any insurance
business in any other jurisdiction nor does CII or any such Subsidiary
write any other type or line of insurance in any jurisdiction other than
that or those in or for which it or any such Subsidiary is currently
licensed or otherwise authorized, except such activities as would not have
an material adverse effect on CII and its Subsidiaries taken as a whole.
Each of the Insurance Subsidiaries has filed all statements and reports
with insurance regulatory authorities required by the laws, regulations,
licensing requirements and orders administered or issued by such regulatory
authorities, except where the failure to so file would not, individually or
in the aggregate, materially and adversely affect the condition (financial
or otherwise), operations (present or prospective), business (present or
prospective), properties, assets or liabilities of such Insurance
Subsidiary. Within the last five years, neither of the Insurance
Subsidiaries has been involved in any voluntary proceeding to revoke,
restrict or suspend any of the licenses or other qualification in any
jurisdiction of such Insurance Subsidiary, nor are there any proceedings
pending which could have that effect. Schedule 3.1(f) sets forth the most
recent date of the last completed insurance regulatory examination and
audit, as to CII and of its Subsidiaries for the jurisdictions listed
therein, and copies of the most recent reports of such examinations have
heretofore been delivered or made available to Sierra. Except as set forth
on Schedule 3.1(f), neither of the Insurance Subsidiaries is aware of any
material violations reported upon by any insurance examiner in respect of
the activities of such Insurance Subsidiary which could, individually or in
the aggregate, materially and adversely affect the condition (financial or
otherwise), operations, business, properties, assets or liabilities of such
Insurance Subsidiary. Except as set forth on Schedule 3.1(f), there are no
outstanding orders applicable to CII or any of its Subsidiaries issued by
any regulatory authority (other than regulations generally applicable to
companies in the same line of business as CII or any of its Subsidiaries)
that restrict CII or such Subsidiaries' ability to pay dividends on its
capital stock or regulate or establish levels of reserves or other
financial ratios. After due inquiry of management, no event has occurred
with respect to any of such CII Permits which would permit revocation,
termination or suspension of any such CII Permits or would result in any
material impairment of the rights of the holder of any such CII Permits.
Except as set forth on Schedule 3.1(f), no notice has been received and,
after due inquiry of management, no investigation or review is pending or,
to CII's knowledge, threatened by any Governmental Entity with regard to
(i) any alleged violation by CII or any of its Subsidiaries of any law,
rule, regulation, ordinance, CII Permit, judgment, order or decree or (ii)
any alleged failure to have or any violation of any CII Permit, which
violation or failure would have a material adverse effect on CII and its
Subsidiaries taken as a whole. Neither CII nor any of its Subsidiaries nor
to CII's knowledge any of its or their respective executive officers,
directors or employees (in their capacities as such) has engaged in any
activity constituting fraud or abuse under the laws relating to health
care, insurance or the regulation of professional corporations.
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(g) Financial Statements of Subsidiaries. (A) CII has delivered, or (if
not yet available) will promptly deliver when available (and in any event
prior to the Effective Time), to Sierra complete and correct copies of (i)
the balance sheets of CII and each of its then-existing Subsidiaries as at
December 31, 1994, 1993, 1992, 1991, 1990, and the related audited
statements of income and shareholders' equity and cash flows, for the
fiscal years ended on those dates, together with all footnotes and (ii) the
unaudited interim financial statements for CII and each of its Subsidiaries
as at, and for the fiscal periods ended on March 31, 1995 and 1994 and each
subsequent quarterly reporting date. All of such financial statements
fairly present or when delivered will fairly present, as the case may be
(subject, in the case of unaudited interim financial statements, to normal,
recurring adjustments) which are not expected to be, individually or in the
aggregate, materially adverse to CII and its Subsidiaries taken as a whole
the financial position, results of operations and cash flows of CII and
each of its Subsidiaries as at the respective dates of such balance sheets
and for each of the respective periods then ended, in conformity with (A)
in the case of InteLock Technologies ("InteLock"), generally accepted
accounting principles prevailing in the United States ("U.S. GAAP") and (B)
in the case of each of the Insurance Subsidiaries, statutory or other
accounting practices prescribed or permitted by the insurance regulatory
authorities in the State of California or the Cayman Islands, as
appropriate, in each case applied on a basis consistent throughout the
reported periods.
(B) Except as set forth on Schedule 3.1(g), neither such financial
statements nor the financial statements of CII included in the CII SEC
Documents (i) contain or when delivered will contain, as the case may be,
any item of extraordinary or non-recurring income or expense (except as
specified therein); (ii) reflect or when delivered will reflect, as the
case may be, uncollectible accounts receivable without a reserve fairly
stated for uncollectible amounts; and (iii) reflect or when delivered will
reflect, as the case may be, any write-off or revaluation of assets (except
as specified therein). As at the respective dates of the balance sheets
included in all such financial statements, there was no liability,
indebtedness or obligation of any nature or in any amount that should
properly be reflected or provided for in financial statements prepared in
conformity with U.S. GAAP or statutory accounting practices prescribed or
permitted by the insurance regulatory authorities in the State of
California, whichever is appropriate, applied on a basis consistent with
that for prior periods, which was not fully reflected in such financial
statements.
(C) Reserves. The reserves recorded in the accounting records of each of
the Insurance Subsidiaries for insurance policy benefits, losses, claims
and expenses and any other reserves were prepared in accordance with the
statutory or other accounting practices prescribed or permitted by the
insurance regulatory authorities of the State of California and of all the
jurisdictions in which the Insurance Subsidiaries are licensed to transact
an insurance business and make good and sufficient provisions for all
insurance obligations of CII and its Subsidiaries. Such reserves have been
opined upon as reasonable and adequate as of December 31, 1994, and have
been reviewed as of March 31, 1995, by Timothy B. Perr, a duly qualified
actuary who is a member in good standing in the American Academy of
Actuaries.
(h) Litigation. Except (i) as set forth on Schedule 3.1(h), (ii) as
disclosed in the SEC Documents and (iii) for actions and suits arising in
the ordinary course of the insurance business, none of which if decided
adversely to CII or its Subsidiaries would have a material adverse effect
on CII or any such Subsidiary, there is no action, suit, proceeding or
investigation, either at law or in equity, at or before any commission or
other administrative authority in any domestic or foreign jurisdiction, of
any kind now pending or, to CII's knowledge, threatened, involving CII, any
of its Subsidiaries or any of the respective properties or assets of CII or
any Subsidiary of CII that (i) if asserted and decided adversely to CII or
any such Subsidiary could, individually or in the aggregate, materially and
adversely affect the condition (financial or otherwise), operations,
business, properties, assets or liabilities of CII and its Subsidiaries
taken as a whole, (ii) questions the validity of this Agreement or (iii)
seeks to delay, prohibit or restrict in any manner the Merger or any action
taken or to be taken by CII or any of its Subsidiaries under this
Agreement. Except as set forth on Schedule 3.1(h), none of CII nor any of
its Subsidiaries, nor any of their respective properties or assets, is
subject to any continuing order of, consent decree, settlement agreement or
other similar written agreement (other than agreements related to the
settlement of insurance claims in the ordinary course of business),
continuing investigation (other than regularly scheduled audits) by any
court, Governmental Entity, or any judicial, administrative or arbitral
judgment, order, writ, decree, injunction, restraint, or award
8
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of any court Governmental Entity or arbitrator, including without
limitation cease-and-desist or other orders. Neither CII nor any of its
Subsidiaries has agreed to, or is bound by, any extension or waiver of the
statute of limitations relating to any pending or potential action, suit,
claim, proceeding or investigation involving CII or any of its Subsidiaries
(other than extensions or waivers in connection with the settlement of
insurance claims in the ordinary course of business).
(i) Labor and Employment Matters. Neither CII nor any of its Subsidiaries
has employees who are represented by a labor union or organization, no
labor union or organization has been certified or recognized as a
representative of any such employees, and neither CII nor any of its
Subsidiaries is a party to or has any obligation under any collective
bargaining agreement or other contract or agreement with any labor union or
organization. There are no pending or, to CII's knowledge, threatened,
representation campaigns, elections or proceedings or questions concerning
union representation involving any employees of either CII or any of its
Subsidiaries. Neither CII nor any of its Subsidiaries has any knowledge of
any activities or efforts of any labor union or organization (or
representatives thereof) to organize any of its employees, any demands for
recognition or collective bargaining, any strikes, slowdowns, work
stoppages or lock-outs of any kind, or threats thereof, by or with respect
to any employees of CII or any of its Subsidiaries, and no such activities,
efforts, demands, strikes, slowdowns, work stoppages or lock-outs occurred
during a three-year period preceding the date hereof. Neither CII nor any
of its Subsidiaries has engaged in, admitted committing, or been held in
any administrative or judicial proceeding to have committed any unfair
labor practice under the National Labor Relations Act, as amended. Except
as set forth on Schedule 3.1(i), neither CII nor any of its Subsidiaries is
involved in any industrial or trade dispute or any dispute or negotiation
regarding a claim of material importance with any labor union or
organization concerning its employees, and there are no controversies,
claims, demands or grievances of material importance pending or, so far as
CII is aware, threatened, between CII or any of its Subsidiaries and any of
their respective employees.
(j) Absence of Certain Changes. Since December 31, 1994, except (i) as
set forth in Schedule 3.1(j), (ii) for the execution and delivery of this
Agreement and changes in its properties or business attributable to the
transactions contemplated by this Agreement, (iii) as disclosed in CII's
financial statements or in the CII SEC Reports previously delivered or made
available to Sierra and Sierra Sub and (iv) sales and purchases of
investment securities in the ordinary course, neither CII nor any of its
Subsidiaries:
(i) had any change in its condition (financial or otherwise),
operations, business, properties, assets or liabilities, other than
changes in the ordinary course of business, none of which has been,
individually or in the aggregate, materially adverse to CII or any such
Subsidiary;
(ii) suffered any damage, destruction or loss of physical property
(not adequately covered by insurance) that, individually or in the
aggregate, materially and adversely affects the condition (financial or
otherwise), operations, business, assets or liabilities of CII and its
Subsidiaries taken as a whole;
(iii) issued, sold or otherwise disposed of, or redeemed, purchased
or otherwise acquired, or agreed to issue, sell or otherwise dispose
of, redeem, purchase or otherwise acquire, any capital stock or any
other security of CII or any of its Subsidiaries or granted or agreed
to grant any option, warrant or other right to subscribe for or to
purchase any capital stock or any other security of CII or any of its
Subsidiaries;
(iv) incurred or agreed to incur any material indebtedness for
borrowed money or any other liabilities;
(v) paid or obligated itself to pay in excess of $1,000,000 in the
aggregate for any fixed assets;
(vi) suffered any material loss or waived any material right, other
than in the ordinary course of its insurance business;
(vii) sold, transferred, leased or otherwise disposed of, or agreed
to sell, transfer, lease or otherwise dispose of, (A) any properties or
assets to any director, officer or of CII or of any Subsidiary of CII
or any member of the family or any other affiliate of any of the
foregoing or (B) any properties or assets having a fair market value of
$250,000 or agreed to sell, transfer, lease or otherwise dispose
9
<PAGE>
of, any assets (other than securities) having a fair market value at
the time of sale, transfer or disposition of $250,000;
(viii) mortgaged, pledged or subjected to any charge, lien, claim or
encumbrance, or agreed to mortgage, pledge or subject to any charge,
lien, claim or encumbrance, any of its material properties or assets;
(ix) declared, set aside or paid any dividend or made any
distribution (whether in cash, property or stock) with respect to any
of its capital stock;
(x) (A) increased, or agreed to increase, the compensation or bonuses
or special compensation of any kind of any of its directors, officers,
employees, (other than insurance agents or independent contractors)
over the rate being paid to them on December 31, 1994, as set forth in
CII's Proxy Statement for the 1995 Annual Meeting of Shareholders
("CII's 1995 Proxy Statement"), other than normal merit and cost-of-
living increases pursuant to customary arrangements consistently
followed, or (B) since December 31, 1994, paid or made provision for
the payment of any bonus or similar compensation to any director,
officer, employee (other than any insurance agent or independent
contractor) of CII or any subsidiary of CII, or (C) entered into any
employment, consulting or severance agreement or arrangement with any
director, officer, employee (other than any agent or independent
contractor) or adopted or increased any benefit under any insurance,
pension or other employee benefit plan, payment or arrangement made to,
for or with any director, officer, employee (other than any agent or
independent contractor);
(xi) except as otherwise required or provided for in this Agreement
and except in the ordinary course of business, made or permitted any
material amendment or termination of any material contract, lease,
concession, franchise, license, indenture, instrument, mortgage, note,
loan or credit agreement or other obligation to which it is a party;
(xii) had any resignation or termination of employment of any of its
key officers or employees, or become aware of any impending or
threatened termination of employment, that would, individually or in
the aggregate, have a material adverse effect on its condition
(financial or otherwise), operations (present or prospective), business
(present or prospective), properties, assets or liabilities;
(xiii) had any labor trouble or concerted work stoppage or knows of
any impending or threatened labor trouble or concerted work stoppage;
(xiv) cancelled, or agreed to cancel, any debts or claims over
$250,000 in the aggregate or $50,000 individually other than in the
ordinary course of business;
(xv) made any material change in its accounting methods or practices
with respect to its condition, operations, business, or practices with
respect to its condition, operations, business, properties, assets or
liabilities;
(xvi) conducted its business or entered into any transaction not in
the ordinary course of its business;
(xvii) made any charitable or political contribution or pledge in
excess of $100,000 in the aggregate;
(xviii) agreed or committed to do, or authorized or approved any
action looking to, any of the foregoing;
(xix) paid aggregate commissions to insurance agents and independent
contractors for policies issued in 1995 and with normal anniversary
dates of January 1, 1995 or subsequent thereto in excess of 12% of
direct premiums written; or
(xx) made any material cash payments to insurance agents, independent
contractors or brokers other than pursuant to a Producer Profit Share
Agreement.
(k) Material Contracts. Except as set forth in Schedule 3.1(k), neither
CII nor any of its Subsidiaries is a party to any written or oral:
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(i) collective bargaining agreement or other agreement or
understanding with any labor organization;
(ii) employment or consulting contract or other contract for services
involving a payment of more than $250,000 annually and that is not
terminable without cost upon thirty (30) days' prior written notice;
(iii) material lease, franchise or concession [providing for a
payment by any person of more than $250,000 annually];
(iv) loan agreement, mortgage, indenture, promissory note, financing
lease or other instrument relating to any debt (in excess of $25,000
and which in the aggregate, do not amount to more than $250,000);
(v) contract of purchase or sale involving more than $50,000 and that
is not in the ordinary course of business;
(vi) partnership, joint venture, material license or similar
agreement;
(vii) stand-by letter of credit, guarantee or performance bond;
(viii) contract restricting the ability of any person from freely
engaging in any business or competing anywhere in the world;
(ix) other material contract or commitment not made in the ordinary
course of business;
(x) other contract, except contracts for inventories, supplies or
services not involving more than $250,000 and which can be terminated
within one year without cost;
(xi) any plan or contract or arrangement, written or oral, providing
for bonuses, pensions, deferred compensation, retirement payments,
profit-sharing or the like.
Except as set forth on Schedule 3.1(k), neither CII nor any of its
Subsidiaries is a party to any contract that, individually or in the
aggregate, materially and adversely affects, nor the performance of which
will likely so affect, the condition (financial or otherwise), operations,
business, properties, assets or liabilities of CII and its Subsidiaries
taken as a whole. Each contract or other agreement listed in schedules
hereto is in full force and effect and is valid and enforceable by CII or a
Subsidiary of CII, as the case may be, in accordance with its terms.
Neither CII nor any of its Subsidiaries is in default in the observance or
the performance of any term or obligation to be performed by it under any
contract listed in the schedules hereto except the effect of which defaults
singly or in the aggregate would not have a material adverse effect on CII
and its Subsidiaries taken as a whole. To the knowledge of CII, no other
person is in default in the observance or the performance of any term or
obligation to be performed by it under any contract listed in the schedules
hereto. There is currently no outstanding bid or contract proposal by CII
or any of its Subsidiaries which, if accepted or entered into, might
reasonably be expected to result in a loss to either CII or any of its
Subsidiaries, except with respect to losses occurring in the ordinary
course of the insurance business. CII has delivered or made available to
Sierra and Sierra Sub copies of all contracts listed in the schedules
hereto.
(l) Officers and Directors and Employees. Other than as set forth in
CII's 1995 Proxy Statement, Schedule 3.1(l) sets forth a list of:
(i) The names of all directors and officers of CII and each of its
Subsidiaries;
(ii) The name and current annual rate of compensation (including
bonuses and other forms of compensation) paid by CII and its
Subsidiaries to each of its respective officers, directors and
employees whose annual rate of base compensation exceeded $100,000 for
the year ended December 31, 1994; and
(iii) The names of all persons who have written employment,
consulting or severance agreements or arrangements with CII or any of
its Subsidiaries; and CII has provided complete and correct copies of
such agreements to Sierra.
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(m) Title to and Condition of Properties and Assets.
(i) CII and its Subsidiaries have good and marketable title to their
respective properties and assets, whether owned or leased, including,
without limitation, (A) all those used in their respective businesses,
and (B) those reflected in the consolidated balance sheet of CII and
its consolidated Subsidiaries as at March 31, 1995 most recently
delivered to Sierra (except as since sold or otherwise disposed of in
the ordinary course of business), in each case subject to no mortgage,
pledge, conditional sales contract, lien, security interest, right of
possession in favor of any third party, claim or other encumbrance
(collectively "Liens"), except for (x) the lien of current Taxes (as
hereinafter defined) not yet due and payable and (y) with respect to
leased property, the provisions of such leases. Except as described on
Schedule 3.1(m), subsequent to December 31, 1994, neither CII nor any
of its Subsidiaries has sold or disposed of any of their respective
properties or assets or obligated themselves to do so except in the
ordinary course of business. The facilities, machinery, furniture,
office and other equipment of CII and each of its Subsidiaries that are
used in their respective businesses are in good operating condition and
repair, subject only to the ordinary wear and tear of those businesses.
(ii) All of the real property owned or leased by CII or any
Subsidiary has been maintained by CII in compliance with all federal,
state and local environmental protection, occupational, health and
safety or similar laws, ordinances, restrictions, licenses and
regulations, except where the failure to so maintain the property would
not have a material adverse effect on CII and its Subsidiaries taken as
a whole.
(n) Patents, Copyrights, Service Marks and Trademarks. Neither CII nor
any of its Subsidiaries owns or licenses any patent, copyright, service
mark, trademark or other intellectual property right, other than such
patents, copyrights, service marks, trademarks and other intellectual
property rights as are described in Schedule 3.1(n). Except as set forth on
Schedule 3.1(n) and other than such as would have a material adverse effect
on CII and its Subsidiaries taken as a whole: (i) CII and its Subsidiaries
own or license all patents, copyrights, service marks, trademarks and other
intellectual property rights that are necessary to the conduct of their
respective businesses, (ii) all names under which CII or any of its
Subsidiaries have conducted or currently conducts business are set forth in
Schedule 3.1(n), (iii) no claim has been made, and to CII's knowledge no
basis for any such claim exists, that CII or any of its Subsidiaries has
infringed any patent, copyright, service mark, trademark or other
intellectual property right of any other person and (iv) no claim has been
made, and to CII's knowledge no basis for any such claim exists, that any
person has infringed on any patent, copyright, service mark, trademark or
other intellectual property right of CII or any of its Subsidiaries.
(o) Employee Benefit Plans.
(i) List of Plans. Except as disclosed on Schedule 3.1(o) (the
"Designated Plans"), neither CII nor any "Controlled Company" sponsors,
maintains or contributes to any employee benefit plan ("Plan"), as
defined in Section 3(3) of the Employee Retirement Income Security Act
of 1974, as amended ("ERISA"), or any material benefit arrangement that
is not a Plan ("Benefit Arrangement"), including, but not limited to
(A) any employment or consulting agreement, (B) any incentive bonus or
deferred bonus arrangement, (C) any arrangement providing termination
allowance, severance or similar benefits, (D) any equity compensation
plan, and (E) any deferred compensation plan, for the benefit of any of
their employees or former employees. For purposes of this Section
3.1(o), "Controlled Company" shall mean any entity that, together with
CII as of the relevant determination date under ERISA, is or was
required to be treated as a single employer under Section 414 of the
Code and any reference to CII in this Section 3.1(o) shall also include
a reference to a Controlled Company.
(ii) No Title IV Plans. CII does not contribute to or have any
obligation or liability under or with respect to, any Plan (whether or
not terminated) regulated under Title IV of ERISA.
(iii) Disclosed Plans. With respect to any Designated Plans, CII has
delivered to Sierra, true and complete copies of (A) all written
documents comprising such Plans and Benefit Arrangements (including
amendments and individual agreements relating thereto); (B) the three
most recent Federal
12
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Form 5500 series (including all schedules thereto) filed with respect
to each such Plan; (C) the most recent financial statements, if any,
prepared with respect to such Plans and Benefit Arrangements; (D) any
currently effective Internal Revenue Service determination letter; and
(E) the summary plan description currently in effect and all material
modifications thereto, if any, for each such Plan. All information
provided by CII and its Subsidiaries to the individuals who prepared
any such financial statements was true, correct and complete in all
respects. Each financial or other report delivered to Sierra pursuant
hereto is accurate in all material respects, and there have been no
material adverse changes in the financial status of any Designated Plan
since the date of the most recent report provided with respect thereto.
(iv) Compliance with Law. CII has operated, and has caused its
appointees and nominees to operate, each Designated Plan in a manner
which is in material compliance with the terms thereof and with all
applicable law, regulations and administrative agency rulings and
requirements applicable thereto.
(v) Contributions. Full payment has been made of all amounts which
CII is required, under applicable law or under any Designated Plan or
any agreement related to any Designated Plan to which CII is a party,
to have paid as contributions thereto as of the last day of the most
recent fiscal year of each Designated Plan ended prior to the date
hereof. Benefits under all Designated Plans are as represented in the
governing instruments provided pursuant to (i) above, and have not been
increased subsequent to the date as of which documents have been
provided.
(vi) Tax Qualification. Each Designated Plan intended to be qualified
under Sections 401(a), 401(k) and 501(a) of the Code either has been
determined to be so qualified by the Internal Revenue Service or has
been submitted to the Internal Revenue Services for a determination
with respect to such qualified status. Each Designated Plan that has
been submitted to the Internal Revenue Service for a determination with
respect to its qualified status has been submitted in a timely manner
so that any amendments necessary to qualify the plan from its inception
can be made within the remedial amendment period established under
Section 401(b) of the Code. To the knowledge of CII, nothing has
occurred since such determination, or submission, as applicable, to
affect adversely the qualification of any such Plan.
(vii) Tax or Civil Liability. CII has not participated in any conduct
that could result in the imposition upon CII of any excise tax under
Section 4971 through 4980B of the Code or civil liability under Section
502(i) of ERISA with respect to any Designated Plan.
(viii) Claims Liability. There is no action, claim or demand of any
kind (other than routine claims for benefits) that has been brought or
threatened against any Designated Plan, or the assets thereof, against
any fiduciary of any such Designated Plan, or against CII with respect
to any Designated Plan, and CII has no knowledge of any pending
investigation or administrative review by any Governmental Entity that
could result in the imposition on CII of any penalty or assessment in
connection with any Designated Plan.
(ix) Retiree Welfare Coverage. Except as set forth in Schedule
3.1(o), no Designated Plan provides any health, life or other welfare
coverage to employees of CII beyond termination of their employment
with CII by reason of retirement or otherwise, other than coverage as
may be required under Section 4980B of the Code or Part 6 of ERISA, or
under the continuation of coverage provisions of the laws of any state
or locality.
(x) Reporting and Disclosure Obligations. CII has complied with all
applicable reporting and disclosure requirements of Title I of ERISA
with respect to all Designated Plans.
(p) Transactions with Officers, Directors and Others. Except as set forth
on Schedule 3.1(p), no director, officer or affiliate of CII, or any member
of the immediate family or any other affiliate of any of the foregoing, is
a party to business arrangements or relationships of any kind with CII or
its Subsidiaries, or, to the knowledge of CII, owns or has an ownership
interest in any corporation (in excess of 5% of any publicly traded
corporation) or other entity that is a party to, or in any property which
is the subject of any such business arrangements.
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(q) Insurance Agents. (i) Schedule 3.1(q) contains a list of all "key" or
"preferred" insurance agents of CII and its Subsidiaries as at December 31,
1994 and 1993 together with the amounts of premiums produced by each for
the years ended December 31, 1994 and 1993. CII has provided Sierra with
access to copies of such agency agreements and a list setting forth the
names of such agents and agencies is set forth in Schedule 3.1(q). The
current underwriting and binding authorities of insurance agents is set
forth on Schedule 3.1(q).
(r) Policyholders. Schedule 3.1(r) contains a list of each policyholder
(or related groups of policyholders) of CII and its Subsidiaries accounting
for $125,000 or more per annum in premium volume of the Insurance
Subsidiaries' proforma statutory direct premiums written for each such
policyholder (or group) for the years ended December 31, 1994 and 1993.
(s) Insurance Matters.
(i) Reinsurance and Coinsurance. Schedule 3.1(s) contains a list of
all reinsurance or coinsurance treaties or agreements to which CII or
any of its Subsidiaries is a party. All such treaties or agreements as
set forth in such Schedule are valid, binding and in full force and
effect in accordance with their terms (except as the enforceability
thereof may be limited by applicable bankruptcy, insolvency,
reorganization, moratorium or other similar laws affecting creditors'
rights generally or by the principles governing the availability of
equitable remedies); and neither CII nor its Insurance Subsidiaries
nor, to CII's knowledge, any other party thereto is in material default
as to any provision thereof, and none of such agreements contains any
provision (A) providing that any other party thereto may terminate such
agreement or declare a default or seek damages thereunder by reason of
the transactions contemplated by this Agreement or (B) which would be
altered or otherwise become applicable by reason of such transactions.
There is no reason to believe that the financial condition of any party
to any such agreement is impaired to such extent that a default
thereunder may reasonably be anticipated.
(ii) Premiums Receivable and Agents' Balances.
Not more than 33% of "premiums receivable and agents' balances" shown
on the combined balance sheet of California Indemnity Insurance Company
and Commercial Casualty Insurance Company will consist of "premiums
receivable and agents' balances" which on the Closing Date are more
than 90 days past due.
(iii) Statutory Statements.
CII has furnished Sierra with true and complete copies of each of the
Insurance Subsidiaries' Annual Statutory Financial Statements for the
years ended December 31, 1994 and 1993, and the first quarter ended
March 31, 1995, respectively (collectively, the "Statutory
Statements"). The Statutory Statements (A) have been prepared in
accordance with the books and records of each respective Insurance
Subsidiary, (B) are prepared in accordance with the statutory
provisions of the insurance law of California and the accounting
practices prescribed or permitted by the insurance law of California,
and (C) are consistent with prior periods, except, as provided for
therein and, for any changes required by the insurance law of
California or accounting practices referenced in clause (B) hereof.
Such Statutory Statements, when read in conjunction with the notes
thereto, present fairly in all material respects the statutory
financial condition of each Insurance Subsidiary at December 31, 1994
and 1993, and the first quarter ended March 31, 1995 respectively, and
the statutory results of their respective operations for the periods
then ended.
(t) Taxes.
(i) Definitions. For purposes of this Agreement:
(A) "Code" means the Internal Revenue Code of 1986, as amended.
(B) "Returns" means any returns, reports or statements (including
any information returns) required to be filed for purposes of a
particular Tax.
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(C) "Tax" or "Taxes" means all federal, state, local or foreign
net or gross income, gross receipts, net proceeds, premium, capital,
sales, use, ad valorem, value added, franchise, bank shares,
withholding, payroll, employment, disability, workers' compensation,
excise, property, alternative or add-on minimum, environmental or
other taxes, assessments, duties, fees, levies or other governmental
charges of any nature whatever, whether disputed or not, together
with any interest, penalties, additions to tax or additional amounts
with respect thereto.
(D) "Taxing Authority" means any governmental agency, board,
bureau, body, department or authority of any United States federal,
state or local jurisdiction, or any foreign jurisdiction, having or
purported to exercise jurisdiction with respect to any Tax.
(ii) Tax Representations. Except as set forth in Disclosure Schedule
3.1(t):
(A) All Returns required to have been filed by or with respect to
CII or any of its Subsidiaries or any affiliated, combined,
consolidated, unitary or similar group of which CII or its
Subsidiaries is or was a member (a "Relevant Group") with any Taxing
Authority have been duly and timely filed, and each such Return
correctly and completely reflects the income, franchise or other Tax
liability and all other material information required to be reported
thereon. All Taxes owed by CII or its Subsidiaries or any member of
a Relevant Group (whether or not shown on any Return) have been paid
or are duly reserved for in the financial statements of CII and its
Subsidiaries delivered to Sierra pursuant to Section 3.1(g) of this
Agreement.
(B) The reserves for Taxes due by CII and its Subsidiaries (as
opposed to any reserve for deferred Taxes established to reflect
timing differences between book and Tax income) in CII's financial
statements delivered to Sierra pursuant to Section 3.1(g) of this
Agreement are sufficient in all material respects for all unpaid
Taxes, whether or not disputed, of CII and its Subsidiaries.
(C) Neither CII nor any of its Subsidiaries is a party to an
agreement extending the time within which to file any Tax Return or
extending the statute of limitations for any period with respect to
any Tax to which CII or any of its Subsidiaries may be subject. No
claim has ever been made by any Taxing Authority in a jurisdiction
in which CII or any of its Subsidiaries does not file Tax Returns
that it is or may be subject to taxation by that jurisdiction.
(D) CII and each of its Subsidiaries has withheld and paid all
Taxes required to have been withheld and paid in connection with
amounts paid or owing to any employee, creditor, independent
contractor or other third party.
(E) CII does not expect any Taxing Authority to propose or assess
any additional material Taxes against or in respect of it or any of
its Subsidiaries for any past period. There is no dispute or claim
concerning any Tax liability of CII or any of its Subsidiaries
either (1) claimed or raised by any Taxing Authority or (2)
otherwise known to CII or any of its Subsidiaries. No issues have
been raised in any examination by any Taxing Authority with respect
to CII or any of its Subsidiaries which, by application of similar
principles, reasonably could be expected to result in a material
deficiency for any other period not so examined. Schedule 3.1(t)
lists all federal, state, local and foreign income Tax Returns filed
by or with respect to CII and its Subsidiaries for all taxable
periods ended on or after December 31, 1989, indicates those
Returns, if any, that have been audited, and indicates those Returns
that currently are the subject of audit. CII has delivered to Sierra
complete and correct copies of all federal, state, local and foreign
income Tax Returns filed by, and all Tax examination reports and
statements of deficiencies assessed against or agreed to by, CII and
its Subsidiaries for all taxable periods ended on or after December
31, 1989.
(F) Neither CII nor any of its Subsidiaries has waived any statute
of limitations in respect of Taxes or agreed to any extension of
time with respect to any Tax assessment or deficiency.
(G) Neither CII nor any of its Subsidiaries has made any payments,
is obligated to make any payments, or is a party to any agreement
that under certain circumstances could require it to make any
payments, that are not deductible under Section 280G of the Code.
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(H) Neither CII nor any of its Subsidiaries is a party to any Tax
allocation or sharing agreement.
(I) There are no material Tax Liens on any assets of CII or any of
its Subsidiaries.
(J) None of the assets of CII or any of its Subsidiaries
constitutes tax-exempt bond financed property or tax-exempt use
property, within the meaning of Section 168 of the Code. Neither CII
nor any of its Subsidiaries is a party to any "safe harbor lease"
that is subject to the provisions of Section 168(f)(8) of the
Internal Revenue Code as in effect prior to the Tax Reform Act of
1986, or to any "long-term contract" within the meaning of Section
460 of the Code.
(K) Neither CII nor any of its Subsidiaries is a "consenting
corporation" within the meaning of Section 341(f)(1) of the Code, or
comparable provisions of any state statutes, and none of the assets
of CII or its Subsidiaries is subject to an election under Section
341(f) of the Code or comparable provisions of any state statutes.
(L) Neither CII nor any of its Subsidiaries is a party to any
joint venture, partnership or other arrangement that is treated as a
partnership for federal income Tax purposes.
(M) Neither CII nor any of its Subsidiaries has any material (1)
deferred gain or loss arising out of any deferred intercompany
transaction or (2) income which will be reportable in a period
ending after the Closing Date which is attributable to a transaction
occurring in, or a change in accounting method made for, a period
ending on or prior to the Closing Date.
(N) Neither CII nor any of its Subsidiaries has received or
requested any ruling of a Taxing Authority related to Taxes or
entered into any written or legally binding agreement with a Taxing
Authority relating to Taxes.
(O) CII and each of its Subsidiaries has disclosed (in accordance
with Section 6662(d)(2)(B)(ii) of the Code) on its federal income
Tax Returns all positions taken therein that could give rise to a
substantial understatement of federal income Tax within the meaning
of Section 6662(d) of the Code.
(P) Neither CII nor any of its Subsidiaries has any material
liability for Taxes of any person other than CII or its Subsidiaries
(1) under Section 1.1502-6 of the Treasury Regulations (or any
similar provision of state, local or foreign law), (2) as a
transferee or successor, (3) by contract or (4) otherwise.
(Q) Neither CII nor any of its Subsidiaries has participated in or
cooperated with an international boycott within the meaning of
Section 999 of the Code, the effect of which will be material to CII
or any of its Subsidiaries.
(R) Neither CII nor any of its Subsidiaries has been a United
States real property holding corporation within the meaning of
Section 897(c)(2) of the Code during any applicable period specified
in Section 897(c)(1)(A)(ii) of the Code.
(S) Neither CII nor any of its Subsidiaries (1) has or is
projected to have a material amount includable in its income for the
current taxable year under Section 951 of the Code, (2) has been a
passive foreign investment company within the meaning of Section
1296 of the Code, and neither CII nor any of its Subsidiaries is a
shareholder, directly or indirectly, in a passive foreign investment
company or (3) has a material unrecaptured overall foreign loss
within the meaning of Section 904(f) of the Code.
(T) Neither CII nor any of its Subsidiaries is, or at any time has
been, subject to (1) the dual consolidated loss provisions of
Section 1503(d) of the Code, (2) the overall foreign loss provisions
of Section 904(f) of the Code or (3) the recharacterization
provisions of Section 952(c)(2) of the Code.
(U) There currently are no limitations on the utilization of the
net operating losses, built-in losses, capital losses, tax credits
or other similar items of CII or any of its Subsidiaries
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(collectively, the "Losses") under (1) Section 382 of the Code, (2)
Section 383 of the Code, (3) Section 384 of the Code, (4) Section
269 of the Code, (5) Section 1.1502-15 and Section 1.1502-15A of the
Treasury regulations, (6) Section 1.1502-21 and Section 1.1502-21A
of the Treasury regulations or (7) Section 1.1502-91 through 1.1502-
99 of the Treasury regulations, in each case as in effect both prior
to and following the Tax Reform Act of 1986 and treating any
proposed provision as if it were in effect currently.
(V) There are no facts or circumstances that exist on the date of
this Agreement that could reduce the amount of the Tax attributes
referred to in Section 3.1(t)(iii) below and listed in Disclosure
Schedule 3.1(t) or could limit, restrict or eliminate their
availability as carryovers. There are no pending, or to the best
knowledge of CII and its Subsidiaries, threatened actions or
proceedings by any Taxing Authority challenging the amount or
availability as carryovers of any of the Tax attributes listed in
Disclosure Schedule 3.1(t).
(W) Neither CII nor any of its Subsidiaries is a party to any
written, oral or implied agreement or obligation to provide any
"covered employee," as defined in Section 162(m)(3) of the Code,
with remuneration in excess of $1 million, that would be disallowed
as a deduction for federal income tax purposes pursuant to Section
162(m) of the Code.
(iii) Carryover Tax Attributes. As of December 31, 1994, CII and its
Subsidiaries had aggregate Losses (as defined in Section 3.1(t)(ii)(U)
above) for federal and state income Tax purposes in the amounts, for
the years, with the expiration dates, and for the jurisdictions, as
accurately set forth in Disclosure Schedule 3.1(t).
(iv) Representations Relating to Tax-Free Reorganization.
(A) As of the Effective Time of the Merger, CII will hold at least
90 percent of the maximum fair market value of its net assets and at
least 70 percent of the maximum fair market value of its gross
assets held at any time during the period commencing on April 3,
1995 and ending immediately prior to the Merger (the "Transaction
Period"), such fair market values to exclude changes in fair market
values due solely to changes in the market value of CII's investment
portfolio during the Transaction Period and such fair market values
to include amounts (I) paid or payable with respect to CII
Dissenting Shares, (II) used by CII to pay reorganization expenses,
and (III) paid or payable in connection with any redemptions and
distributions (except regular and normal dividends) made by CII
during the Transaction Period.
(B) In the Merger, shares of CII Common Stock representing control
of CII, as defined in Section 368(c)(1) of the Code, will be
exchanged solely for voting stock of Sierra; for purposes of this
representation, shares of CII Common Stock exchanged for cash or
other property originating with Sierra will be treated as
outstanding CII Common Stock at the Effective Time of the Merger.
(C) CII is not an investment company within the meaning of Section
368(a)(2)(F)(iii) of the Code.
(D) Neither CII nor any of its Subsidiaries is under the
jurisdiction of a court in a Title 11 or similar case within the
meaning of Section 368(a)(3)(A) of the Code.
(E) Neither CII nor any of its Subsidiaries know of any plan or
intention on the part of CII shareholders to sell, exchange or
otherwise dispose of a number of shares of Sierra Common Stock
received by them for shares of CII Common Stock pursuant to the
Merger, nor to enter into any puts, calls, straddles, spreads or
similar transactions with respect to Sierra's Common Stock, that
would reduce CII shareholders' ownership for U.S. federal income tax
purposes of Sierra's Common Stock to a number of shares having a
value, as of the Effective Time of the Merger, of less than 50
percent of the value of all of the formerly outstanding stock of CII
as of the same date. For purposes of this representation, shares of
CII Common Stock exchanged for cash or other property, surrendered
by dissenters or exchanged for cash in lieu of fractional shares of
Sierra Common Stock are treated as outstanding shares of CII Common
Stock at the Effective Time of
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<PAGE>
the Merger. Moreover, shares of CII Common Stock and shares of
Sierra Common Stock held by CII shareholders and otherwise sold,
redeemed, or disposed of during the Transaction Period are to be
considered in making this representation.
(F) At the Effective Time of the Merger, the fair market value of
the assets of CII will exceed the sum of its liabilities, plus the
amount of liabilities, if any, to which such assets are subject.
(G) At the Effective Time of the Merger, CII will not have
outstanding any warrants, options, convertible securities, or any
other type of right pursuant to which any person could acquire stock
in CII that, if exercised or converted, would affect Sierra's
acquisition or retention of control of CII as defined in Section
368(c)(1) of the Code.
(H) At the Effective Time of the Merger, and at no time prior to
such date, was there or will there be any intercorporate
indebtedness existing between Sierra and CII or between Sierra Sub
and CII.
(I) CII, CII shareholders and Subsidiaries will pay their own
respective expenses, if any, incurred in connection with the Merger.
(J) CII will not make any extraordinary dividend payments to its
shareholders prior to the Effective time of the Merger, or in
contemplation of the Merger.
(u) Opinion of Financial Advisor. CII has received the opinion of Vector
Securities International, Inc. dated the date hereof, to the effect that
the consideration to be received in the Merger by CII's shareholders is
fair to CII's shareholders from a financial point of view. CII has
delivered a true and complete copy of this opinion to Sierra.
(v) Section 1203 of the CGCL Not Applicable. The provisions of Section
1203 of the CGCL will, prior to the termination of this Agreement, assuming
the accuracy of the representations contained in Sections 3.2(b) and 3.2(k)
(without giving effect to the knowledge qualification thereof) do not apply
to this Agreement, the Merger or to the transactions contemplated hereby.
(w) Vote Required. The affirmative vote of a majority of the votes that
holders of the outstanding shares of CII Common Stock are entitled to cast
is the only vote of the holders of any class or series of CII capital stock
or Voting Debt necessary to approve this Agreement and the transactions
contemplated hereby (assuming the accuracy of the representations contained
in Sections 3.2(b) and 3.2(k), without giving effect to the knowledge
qualification thereof).
(x) Accounting Matters. Neither CII nor to the best of its knowledge, any
of its affiliates, has through the date of this Agreement, taken or agreed
to take any action that would prevent Sierra from accounting for the
business combination to be effected by the Merger as a pooling of
interests.
(y) No Change in Capital Structure. There has been no material change in
the information set forth in the second sentence of Section 3.1(b) between
the close of business on June 9, 1995, and the date hereof.
(z) Investment Company Act. Neither CII nor any of its Subsidiaries is an
"investment company", or a company "controlled" by an "investment company",
within the meaning of the Investment Company Act of 1940, as amended.
3.2. Representations and Warranties of Sierra and Sierra Sub. Sierra and
Sierra Sub represent and warrant to CII as follows:
(a) Organization; Standing and Power. Each of Sierra and Sierra Sub and
any other Subsidiary of Sierra is a corporation duly organized, validly
existing and in good standing under the laws of its state of incorporation
or organization and has all requisite power and authority to own, lease and
operate its properties and to carry on its business as now being conducted,
and is duly qualified and in good standing to do business in each
jurisdiction in which the nature of its business or the ownership of
leasing of its properties makes such qualification necessary, except where
the failure to be so qualified would not have a material adverse effect on
such entity.
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(b) Capital Structure. As of the date hereof, the authorized capital
stock of Sierra consists of 40,000,000 shares of Sierra Common Stock and
1,000,000 shares of Sierra Series A Preferred Stock. As of the close of
business on June 9, 1995: (i) 14,821,184 shares of Sierra Common Stock were
outstanding, (ii) 2,891,376 shares of Sierra Common Stock were reserved for
issuance pursuant to the Sierra stock option plans and Sierra restricted
stock plans (collectively, "Sierra Stock Plans"), (iii) 100,200 shares of
Sierra Common Stock were held by Sierra in its treasury, (iv) 177,126
shares of Sierra Series A Preferred were reserved for issuance upon
exercise of the Rights and (v) no warrants, bonds, debentures, notes or
other indebtedness or other security having the right to vote on any
matters on which shareholders may vote ("Voting Debt") were issued or
outstanding. All outstanding shares of Sierra capital stock are, and the
shares of Sierra Common Stock (x) to be issued pursuant to or as
specifically contemplated by this Agreement, and (y) when issued in
accordance with this Agreement, upon exercise of CII Stock Options, in
accordance with actions permitted by Section 4.1(c) and upon conversion of
CII Debentures, will be, validly issued, fully paid and nonassessable and
not subject to preemptive rights. As of the date of this Agreement, except
for this Agreement, the Sierra Stock Plans, and the Rights Agreement, there
are no options, warrants, calls, rights or agreements to which Sierra or
any Subsidiary of Sierra is a party or by which it or any such Subsidiary
is bound obligating Sierra or any Subsidiary of Sierra to issue, deliver or
sell, or cause to be issued, delivered or sold, additional shares of
capital stock or any Voting Debt of Sierra or of any Subsidiary of Sierra
or obligating Sierra or any Subsidiary of Sierra to issue, deliver or sell,
or cause to be issued, delivered or sold, additional shares of capital
stock of Sierra or of any Subsidiary of Sierra to grant, extend or enter
into any such option, warrant, call, right or agreement. As of the date
hereof, the authorized capital stock of Sierra Sub consists of 1,000 shares
of Common Stock, stated value $.50 per share, of which 100 shares are
issued and outstanding.
(c) Authority. Sierra and Sierra Sub have all requisite corporate power
and authority to enter into this Agreement and to consummate the
transactions contemplated hereby. The execution and delivery of this
Agreement and the consummation of the transactions contemplated hereby have
been duly authorized by all necessary corporate action on the part of
Sierra and Sierra Sub, except that the approval of Sierra's shareholders of
this Agreement and the Merger and the transactions contemplated hereby may
be required. This Agreement has been duly executed and delivered by Sierra
and Sierra Sub and each constitutes a valid and binding obligation of
Sierra and Sierra Sub enforceable against each in accordance with its
terms. The execution and delivery of this Agreement does not, and the
consummation of the transactions contemplated hereby will not, conflict
with, or result in any Violation pursuant to any provision of the Articles
of Incorporation or By-laws of Sierra, except (i) as set forth on Schedule
3.2(c) hereto or (ii) as contemplated by the next sentence hereof, result
in any Violation of any material loan or credit agreement, note, mortgage,
indenture, lease, Designated Plan or other material agreement, obligation,
instrument, permit, concession, franchise, license, judgment, order,
decree, statute, law, ordinance, rule or regulation applicable to Sierra or
any Subsidiary of Sierra or their respective properties or assets, which
Violation would have a material adverse effect on Sierra and its
Subsidiaries taken as a whole. No consent, approval, order or authorization
of, or registration, declaration or filing with, any Governmental Entity is
required by or with respect to Sierra or any of its Subsidiaries in
connection with the execution and delivery of this Agreement by Sierra and
Sierra Sub or the consummation by Sierra and Sierra Sub of the transactions
contemplated hereby, the failure to obtain which would have a material
adverse effect on Sierra and its Subsidiaries, taken as a whole, except for
(i) the filing of a premerger notification report by Sierra under the HSR
Act, (ii) the filing with the SEC of the S-4, the Proxy Statement (if the
approval of Sierra's shareholders is required) and such reports under
Sections 13(a), 13(d) and 16(a) of the Exchange Act, as may be required in
connection with this Agreement, and the transactions contemplated hereby
and the obtaining from the SEC of such orders as may be so required, (iii)
the filing of such documents with, and the obtaining of such orders from,
the various state authorities, including state securities authorities, that
are required in connection with the transactions contemplated by this
Agreement, (iv) the filing of the Merger Filings with the Secretary of
State of the State of California and appropriate documents with the
relevant authorities of other states in which Sierra is qualified to do
business and (v) the Insurance Approvals and State Takeover Approvals.
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(d) SEC Documents. Sierra has delivered or made available to CII a true
and complete copy of each material report, schedule, registration statement
and definitive proxy statement filed by Sierra with the SEC since January
1, 1992 (as such documents have since the time of their filing been
amended, the "Sierra SEC Documents") which are all the documents (other
than preliminary material) that Sierra was required to file with the SEC
since such date. As of their respective dates, the Sierra SEC Documents
complied in all material respects with the requirements of the Securities
Act or the Exchange Act, as the case may be, and the rules and regulations
of the SEC thereunder applicable to such Sierra SEC Documents, and none of
the Sierra SEC Documents contained any untrue statement of a material fact
or omitted to state a material fact required to be stated therein or
necessary to make the statements therein, in light of the circumstances
under which they were made, not misleading. The consolidated financial
statements of Sierra and its consolidated Subsidiaries included in the
Sierra SEC Documents comply as to form in all material respects with
applicable accounting requirements and with the published rules and
regulations of the SEC with respect thereto, have been prepared in
accordance with generally accepted accounting principles applied on a
consistent basis during the periods involved (except as may be indicated in
the notes thereto or, in the case of the unaudited statements, as permitted
by Form 10-Q of the SEC) and fairly present (subject, in the case of the
unaudited statements, to normal, recurring audit adjustments) the
consolidated financial position of Sierra and its consolidated Subsidiaries
as at the dates thereof and the consolidated results of their operations
and cash flows for the periods then ended.
(e) Information Supplied. None of the information supplied or to be
supplied by Sierra or Sierra Sub for inclusion or incorporation by
reference in (i) the S-4 will, at the time the S-4 is filed with the SEC
and at the time it becomes effective under the Securities Act, contain any
untrue statement of a material fact or omit to state any material fact
required to be stated therein or necessary to make the statements therein
not misleading and (ii) the Proxy Statement will, at the date mailed to
shareholders and at the times of the meeting or meetings of shareholders to
be held in connection with the Merger, contain any untrue statement of a
material fact or omit to state any material fact required to be stated
therein or necessary in order to make the statements therein, in light of
the circumstances under which they are made, not misleading. The Proxy
Statement will comply as to form in all material respects with the
provisions of the Exchange Act and the rules and regulations thereunder,
and the S-4 will comply as to form in all material respects with the
provisions of the Securities Act and the rules and regulations thereunder.
(f) Compliance with Applicable Laws. Except as set forth on Schedule
3.2(f), the businesses of Sierra and each of its Subsidiaries have been and
are being conducted in compliance with all applicable laws, rules,
ordinances, regulations, licenses, judgments, orders or decrees of federal,
state, local and foreign governmental authorities, except for possible
violations which individually or in the aggregate do not, and, insofar as
reasonably can be foreseen, in the future will not, have a material adverse
effect on Sierra and its Subsidiaries taken as a whole. Sierra and each
Subsidiary of Sierra hold all certificates of authority, franchises,
grants, permits, licenses, easements, consents, certificates, variances,
exemptions, orders and approvals from all Governmental Entities
(collectively, "Sierra Permits") which are necessary to own, lease and
operate the assets and properties they currently own, lease and operate and
to conduct their respective businesses and operations in the manner
heretofore conducted and as proposed to be conducted, except for those
Sierra Permits, the absence of which would not have a material adverse
effect on Sierra and its Subsidiaries taken as a whole. Except as set forth
on Schedule 3.2(f), there are no outstanding orders applicable to Sierra or
any of its Subsidiaries issued by any regulatory authority (other than
regulations generally applicable to companies in the same line of business
as Sierra or any of its Subsidiaries) that restrict Sierra or such
Subsidiaries' ability to pay dividends on its capital stock or regulate or
establish levels of reserves or other financial ratios. After due inquiry
of management, no event has occurred with respect to any of such Sierra
Permits which would permit revocation, termination or suspension of any
such Sierra Permits or would result in any impairment of the rights of the
holder of any such Sierra Permits. No notice has been received and, after
due inquiry of management, no investigation or review is pending or, to
Sierra's knowledge, threatened by any Governmental Entity with regard to
(i) any alleged violation by Sierra or any of its Subsidiaries of any law,
rule, regulation, ordinance, Sierra Permit, judgment, order or decree or
(ii)
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any alleged failure to have or any violation of any Sierra Permit which
violation or failure would have a material adverse effect on Sierra and its
Subsidiaries taken as a whole.
(g) Litigation. Except (i) as set forth on Schedule 3.2(g), (ii) as
disclosed in the Sierra SEC Documents and (iii) for actions and suits
arising in the ordinary course of business, there is no action, suit,
proceeding or investigation, either at law or in equity, at or before any
commission or other administrative authority in any domestic or foreign
jurisdiction, of any kind now pending or, to the best of Sierra's or Sierra
Sub's knowledge, threatened, involving Sierra, Sierra Sub or any other
Subsidiary of Sierra, or any of the respective properties or assets of
Sierra or Sierra Sub that (i) if asserted and decided adversely to Sierra
or Sierra Sub, could, individually or in the aggregate, materially and
adversely affect the condition (financial or otherwise), operations,
business, properties, assets or liabilities of Sierra and its Subsidiaries,
taken as a whole, (ii) questions the validity of this Agreement, or (iii)
seeks to delay, prohibit or restrict in any manner any action taken or to
be taken by Sierra or Sierra Sub under this Agreement. None of Sierra nor
any Subsidiary of Sierra, nor any of their respective properties or assets
is subject to any material continuing order of, consent decree, settlement
agreement or other similar written agreement (other than agreements in the
ordinary course of business), continuing investigation (other than
regularly scheduled audits) by any court, Governmental Entity, or any
judicial administrative or arbitral judgment, order, writ, decree,
injunction, restraint, or award of any court, Governmental Entity or
arbitrator, including without limitation cease-and-desist or other orders.
(h) Absence of Certain Changes or Events. Except as disclosed in the
Sierra SEC Documents filed prior to or subsequent to the date of this
Agreement or in the audited consolidated balance sheets of Sierra and its
Subsidiaries and the related consolidated statements of income,
shareholders' equity and cash flows as of and for the period ended December
31, 1994 (the "Sierra 1994 Financials"), true and correct copies of which
have been delivered to CII, or except as contemplated by this Agreement,
since March 31, 1995, Sierra and its Subsidiaries have conducted their
respective businesses only in the ordinary and usual course, and, as of the
date of this Agreement, Sierra has not undergone or suffered any change in
its financial condition, properties, business or results of operations
which has been, individually or in the aggregate, materially adverse to
Sierra and its Subsidiaries, taken as a whole.
(i) Opinions of Financial Advisors. Sierra has received the opinion of
Bear, Stearns & Co., dated the date hereof, to the effect that the
financial terms of the Merger are fair to Sierra and its shareholders from
a financial point of view. Sierra has delivered or will deliver, promptly
after it receives the same, a true and complete copy of this opinion to
CII.
(j) Accounting Matters. Neither Sierra nor, to the best of its knowledge,
any of its affiliates, has through the date of this Agreement taken or
agreed to take any action that would prevent Sierra from accounting for the
business combination to be effected by the Merger as a pooling of
interests.
(k) Ownership of CII Common Stock. As of the date hereof, neither Sierra
nor, to the best of its knowledge, any of its affiliates or associates, (i)
beneficially owns, directly or indirectly, or (ii) are parties to any
agreement, arrangement or understanding for the purpose of acquiring,
holding, voting or disposing of, in each case, shares of capital stock of
CII, which in the aggregate, represent 10% or more of the outstanding
shares of capital stock of CII entitled to vote generally in the election
of directors.
(l) Interim Operations of Sierra Sub. Sierra Sub was formed solely for
the purpose of engaging in the transactions contemplated hereby, has
engaged in no other business activities and has conducted its operations
only as contemplated hereby.
(m) No Change in Capital Structure. There has been no material change in
the information set forth in the second sentence of Section 3.2(b) between
the close of business on June 9, 1995, and the date hereof.
(n) Investment Company Act. Neither Sierra nor Sierra Sub is an
"investment company", or a company "controlled" by an "investment company",
within the meaning of the Investment Company Act of 1940, as amended.
(o) Representations Relating to Tax-Free Reorganization. Prior to and at
the Effective Time, Sierra will be in "control" of Sierra Sub within the
meaning of Section 368(c) of the Code and Sierra has no plan
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or intention to cause CII to issue additional shares of capital stock
following the Effective Time that would result in Sierra losing "control"
(as so defined) of CII; Sierra has no plan or intention to reacquire any of
its stock issued pursuant to the Merger; Sierra has no plan or intention to
liquidate CII, to merge CII with or into another corporation including
Sierra or its affiliates, to sell, distribute or otherwise dispose of any
of the capital stock of CII (other than a transfer of such stock to a
corporation controlled by Sierra) or to cause CII to sell or otherwise
dispose of any material amount of its assets, except for dispositions made
in the ordinary course of business or payment of expenses, including
payments to holders of CII Dissenting Shares, incurred by CII pursuant to
the Merger; neither Sierra nor Sierra Sub is an "investment company" within
the meaning of Section 368(a)(2)(F)(iii) of the Code; neither Sierra nor
Sierra Sub is under the jurisdiction of a court in a Title 11 or similar
case within the meaning of Section 368(a)(3)(A) of the Code; the
liabilities of Sierra Sub assumed by CII and the liabilities to which the
transferred assets of Sierra Sub are subject were incurred by Sierra Sub in
the ordinary course of its business; following the Effective Time, Sierra
shall cause CII to either continue the historic business of CII or use a
significant portion of CII's historic business assets in a business; any
amounts paid with respect to CII Dissenting Shares will be paid by CII
solely from CII's pre-merger assets and without reimbursement therefor by
Sierra or Sierra Sub; neither Sierra nor any affiliate of Sierra owns, or
has owned during the past five (5) years, directly or indirectly, any
shares of CII's capital stock or the right to acquire or vote any such
shares; no shareholder of CII is acting as agent for Sierra in connection
with the Merger or the approval thereof; other than as specifically
provided in this Agreement, Sierra will not reimburse any shareholder of
CII for CII's capital stock such shareholder may have purchased or for
other obligations such shareholder may have incurred; no shares of Sierra
Sub (or, following the Effective Time, CII) have been or will be used as
consideration or issued to shareholders of CII pursuant to the Merger.
ARTICLE IV
COVENANTS RELATING TO CONDUCT OF BUSINESS
4.1. Covenants of CII. During the period from the date of this Agreement and
continuing until the Effective Time, CII agrees as to itself and its
Subsidiaries that (except as expressly contemplated or permitted by this
Agreement, or to the extent that the other party shall otherwise consent in
writing and except with respect to employment and compensation arrangements
entered into by CII):
(a) Ordinary Course. CII and its Subsidiaries shall carry on their
respective businesses in the usual, regular and ordinary course in
substantially the same manner as heretofore conducted and use all
reasonable efforts to preserve intact their present business organizations,
keep available the services of their present officers and employees and
preserve their relationships with customers, suppliers and others having
business dealings with them to the end that their goodwill and ongoing
businesses shall not be impaired in any material respect at the Effective
Time.
(b) Dividends; Changes in Stock. CII shall not, nor shall it permit any
of its Subsidiaries to, nor shall CII propose to, (i) declare or pay any
dividends on or make other distributions in respect of any of its capital
stock, except for dividends by a wholly-owned Subsidiary of CII or such
Subsidiary, (ii) split, combine or reclassify any of its capital stock or
issue or authorize or propose the issuance of any other securities in
respect of, in lieu of or in substitution for shares of its capital stock
or (iii) repurchase or otherwise acquire, or permit any Subsidiary to
purchase or otherwise acquire, any shares of its capital stock.
(c) Issuance of Securities. CII shall not, nor shall CII permit any of
its Subsidiaries to, issue, deliver or sell, or authorize or propose the
issuance, delivery or sale of, any shares of its capital stock or any
securities convertible into, or any rights, warrants or options to acquire,
any such shares, or convertible securities, other than the issuance of CII
Common Stock upon the exercise of outstanding stock options or stock grants
under CII Stock Plans, and the conversion of CII Debentures in each case in
accordance with their present terms.
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(d) Governing Documents. CII shall not amend nor shall it permit its
Subsidiaries (except, with the consent of Sierra, to the extent required by
relevant authorities to become admitted to engage in the insurance business
in the jurisdictions in which CII and its Subsidiaries are currently
admitted) to amend or propose to amend its Articles of Incorporation or By-
laws.
(e) No Solicitations. CII shall not, nor shall CII permit any of its
Subsidiaries to, nor shall it authorize or permit any of its or their
officers, directors or employees or any investment banker, financial
advisor (including the persons named in Sections 3.1(u)), attorney,
accountant or other representative retained by it or any of its
Subsidiaries to, solicit or encourage (including by way of furnishing
information), or take any other action to facilitate, any inquiries or the
making of any proposal which constitutes, or may reasonably be expected to
lead to, any takeover proposal, or agree to or endorse any takeover
proposal, or participate in any discussions or negotiations, or provide
third parties with any nonpublic information, relating to any such inquiry
or proposal. CII shall promptly advise Sierra orally and in writing of any
such inquiries or proposals. As used in this Agreement, "takeover proposal"
shall mean any tender or exchange offer, proposal for a merger,
consolidation or other business combination involving CII or any subsidiary
of CII or any proposal or offer to acquire in any manner a substantial
equity interest in, or a substantial portion of the assets of, CII or any
of its Insurance Subsidiaries other than the transactions contemplated by
this Agreement. Nothing contained in this Section 4.1(e) or in any other
provision of this Agreement shall, however, prohibit CII or its Board of
Directors from (i) taking and disclosing to CII's shareholders a position
with respect to a takeover proposal pursuant to Rules 14d-9 and 14e-2
promulgated under the Exchange Act or (ii) making such disclosures to CII's
shareholders as are required under applicable law. Subject to compliance
with the provisions of Section 7.1, nothing contained in this Section
4.1(e) shall prohibit the Board of Directors of CII from furnishing
information to, or entering into discussions or negotiations with, any
person or entity that makes a bona fide unsolicited offer to acquire the
Company pursuant to a merger, consolidation, tender offer, share exchange,
business combination, stock or asset purchase or other similar transaction
(a "Competing Offer") if: (A) the Board of Directors of CII, after
consultation with and receiving the advice of its legal counsel and
financial advisors, determines in good faith that such action is necessary
or required for the Board of Directors of CII to comply with its fiduciary
duties to CII's shareholders under applicable law, (B) before furnishing
such information to, or entering into discussions or negotiations with,
such person or entity, CII discloses to Sierra that it is furnishing
information to, or entering into discussions or negotiations with, such
person or entity, which notice shall describe the terms thereof (but need
not identify the person or entity making the offer), (C) prior to
furnishing such information to such person or entity, CII receives from
such person or entity an executed confidentiality agreement, with terms no
less favorable to CII than those contained in the Confidentiality Agreement
dated April 13, 1995, between Sierra and CII (the "Confidentiality
Agreement"), and (D) CII keeps Sierra informed promptly of the status
(including the terms, but any disclosure of terms shall be covered by the
Confidentiality Agreement) of any such discussions or negotiations
(provided that, CII shall not be required to disclose to Sierra
confidential information concerning the business or operations of the
person making the expression of interest). Subject to compliance with the
provisions of Section 7.1 and the preceding sentence, the Board of
Directors may approve and recommend to CII's shareholders a Competing
Offer.
(f) No Acquisitions. CII shall not, nor shall CII permit any of its
Subsidiaries to, acquire or agree to acquire by merging or consolidating
with, or by purchasing a substantial equity interest in or a substantial
portion of the Assets of, or by any other manner, any business or any
corporation, partnership, association or other business organization or
division thereof or otherwise acquire or agree to acquire any assets in
each case which are material, individually or in the aggregate, to CII or
any such Subsidiary.
(g) No Dispositions. Other than (i) the possible sale of InteLock, (ii)
as may be required by law to consummate the transactions contemplated
hereby or (iii) in the ordinary course of business consistent with prior
practice, CII shall not, nor shall CII permit any of its Subsidiaries to,
without the prior consent of Sierra, sell, lease, encumber or otherwise
dispose of, or agree to sell, lease, encumber or otherwise dispose of, any
of its assets, which are material, individually or in the aggregate, to CII
or any of its Subsidiaries
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taken as a whole. The transaction described in clause (i) above is not in
contemplation of the Merger and the Merger is not dependent upon the
consummation of such transaction.
(h) Indebtedness. CII shall not, nor shall CII permit any of its
Subsidiaries to, incur (which shall not be deemed to include entering into
credit agreements, lines of credit or similar arrangements until borrowings
are made under such arrangements) any indebtedness for borrowed money or
guarantee any such indebtedness or issue or sell any debt securities or
warrants or rights to acquire any debt securities of such party or any of
its Subsidiaries or guarantee any debt securities of others other than (i)
in each case in the ordinary course of business consistent with prior
practice and (ii) refinancing of existing credit lines and borrowings
thereunder.
(i) Other Actions. CII shall not, nor shall CII permit any of its
Subsidiaries to, take any action that would or is reasonably likely to
result in any of its representations and warranties set forth in this
Agreement being untrue as of the date made (to the extent so limited), or
in any of the conditions to the Merger set forth in Article VI not being
satisfied.
(j) Advice of Changes; SEC Filings. CII shall confer with Sierra on a
regular and frequent basis and report on operational matters and promptly
advise Sierra of any change or event having, or which, insofar as can
reasonably be foreseen, could have, a material adverse effect on CII or any
of its Subsidiaries. CII shall promptly provide Sierra (or its counsel)
copies of all filings made by such party with any state or federal
Governmental Entity in connection with this Agreement and the transactions
contemplated hereby.
(k) Access to Information. Upon reasonable notice, CII shall (and shall
cause its Subsidiaries to) afford to the officers, employees, accountants,
counsel and other representatives of Sierra, access, during normal business
hours during the period prior to the Effective Time, to all its properties,
books, contracts, commitments and records and, during such period, CII
shall (and shall cause its Subsidiaries to) furnish promptly to Sierra (a)
a copy of each report, schedule, registration statement and other document
filed or received by it during such period pursuant to the requirements of
Federal securities laws and (b) all other information concerning its
business, properties and personnel as such other party may reasonably
request. Unless otherwise required by law, Sierra will hold any such
information which is nonpublic in confidence until such time as such
information otherwise becomes publicly available through no wrongful act of
either party, and in the event of termination of this Agreement for any
reason Sierra shall promptly return all nonpublic documents obtained from
CII or its Subsidiaries, and any copies made of such documents, to CII.
(l) Affiliates. Prior to the Closing Date, CII shall deliver to Sierra a
letter identifying all persons who are, at the time this Agreement is
submitted for approval to the shareholders of CII, "affiliates" of CII for
purposes of Rule 145 under the Securities Act. CII shall use its best
efforts to cause each such person to deliver to Sierra on or prior to the
Closing Date a written agreement, substantially in the form attached as
Exhibit 4.1(l) hereto.
ARTICLE V
ADDITIONAL AGREEMENTS
5.1. Preparation of S-4 and the Proxy Statement. Sierra and CII shall
promptly prepare and file with the SEC the Proxy Statement and Sierra shall
prepare and file with the SEC the S-4, in which the Proxy Statement will be
included as a prospectus. Each of Sierra and CII shall use its best efforts to
have the S-4 declared effective under the Securities Act as promptly as
practicable after such filing. Sierra shall also take any action (other than
qualifying to do business in any jurisdiction in which it is now not so
qualified) required to be taken under any applicable state securities laws in
connection with the issuance of Sierra Common Stock in the Merger and upon the
exercise of CII Stock Options (as defined in Section 5.7), and CII shall
furnish all information concerning CII and the holders of CII Common Stock as
may be reasonably requested in connection with any such action.
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5.2. Letter of CII's Accountants. CII shall use its best efforts to cause to
be delivered to Sierra a letter of BDO Siedman, CII's independent auditors,
dated a date within two business days before the date on which the S-4 shall
become effective and addressed to Sierra, in form and substance reasonably
satisfactory to Sierra and customary in scope and substance for letters
delivered by independent public accountants in connection with registration
statements similar to the S-4.
5.3. Meetings. CII and, if required, Sierra shall call a meeting of its
respective shareholders to be held as promptly as practicable for the purpose
of voting upon this Agreement and related matters. CII and Sierra Sub and, if
a vote of Sierra's shareholders is required, Sierra will, through their
respective Boards of Directors, subject to their fiduciary duties to their
shareholders under applicable law, recommend to their respective shareholders
approval of such matters. CII and Sierra shall coordinate and cooperate with
respect to the timing of such meetings and shall use their best efforts to
hold such meetings on the same day and as soon as practicable after the date
hereof.
5.4. Legal Conditions to Merger. Each of CII, Sierra and Sierra Sub will
take all reasonable actions necessary to comply promptly with all legal
requirements which may be imposed on itself with respect to the Merger
(including furnishing all information required under the HSR Act, in
connection with the Approvals and in connection with approvals of or filings
with any other Governmental Entity) and will promptly cooperate with and
furnish information to each other in connection with any such requirements
imposed upon any of them or any of their Subsidiaries in connection with the
Merger. Each of CII, Sierra and Sierra Sub will, and will cause its
Subsidiaries to, take all reasonable actions necessary to obtain (and will
cooperate with each other in obtaining) any consent, authorization, order or
approval of, or any exemption by, any Governmental Entity or other public or
private third party, required to be obtained or made by Sierra, CII or any of
their Subsidiaries in connection with the Merger or the taking of any action
contemplated thereby or by this Agreement.
5.5. Stock Exchange Listing. Sierra shall use all reasonable efforts to
cause the shares of Sierra Common Stock to be issued in the Merger and the
shares of Sierra Common Stock to be reserved for issuance upon exercise of CII
Stock Options and upon conversion of CII Debentures to be approved for listing
on the NYSE, subject to official notice of issuance, prior to the Closing
Date.
5.6. Employee Benefit Plans. CII agrees to take all necessary steps at or
prior to the Closing to terminate effective as of the Closing, the following
Designated Plans (as disclosed on Schedule 3.1(o)): (i) the Profit Sharing
Plan, (ii) the Supplemental Benefit Plan, (iii) the Supplemental Executive
Retirement Plan, (iv) the Supplemental Senior Executive Retirement Plan, (v)
the Employee Incentive Plan, (vi) the Stock Purchase Match Plan and (vii) the
1993 Stock Option Plan, the Supplemental Executive Retirement Plan, the
Founders' Bonus Plan and the Phantom Stock Bonus Plan of InteLock. CII also
agrees that, on or after the date of this Agreement, it will not issue any
stock option or any other award pursuant to the 1988 Stock Option Plan, the
1989 Stock Option Plan, the 1991 Employee Stock Incentive Plan, the 1993
Employee Stock Incentive Plan, or the Non-Employee Directors Stock Option
Plans. Sierra and CII agree that the remaining Designated Plans will continue
subsequent to the Closing, but may be terminated at any time thereafter
provided that at such time the employees of CII are either covered under a
plan, if any, providing benefits of the same nature that is maintained by
either Sierra or a Subsidiary for its employees or by a plan comparable to any
such plan.
5.7. Stock Options. (a) At the Effective Time, each outstanding option to
purchase shares of CII Common Stock (a "CII Stock Option" or collectively,
"CII Stock Options") issued pursuant to the 1988 Stock Option Plan, the 1989
Employee Incentive Stock Option Plan, the 1991 Employee Stock Incentive Plan,
the 1993 Employee Stock Incentive Plan and the Non-Employee Director Stock
Option Plans (collectively, the "CII Plans"), whether vested or unvested,
shall be assumed by Sierra. Each CII Stock Option shall be deemed to
constitute an option to acquire, on the same terms and conditions as were
applicable under such CII Stock Option, the same number of shares of Sierra
Common Stock as the holder of such CII Stock Option would have been entitled
to receive pursuant to the Merger had such holder exercised such option in
full immediately prior to the Effective Time, at a price per share equal to
(y) the aggregate exercise price for the shares of CII Common Stock otherwise
purchasable pursuant to such CII Stock Option divided by (z) the number of
full shares of Sierra
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Common Stock deemed purchasable pursuant to such CII Stock Option; provided,
however, that in the case of any option to which section 421 of the Code
applies by reason of its qualification under section 422 of the Code
("incentive stock options"), the option price, the number of shares
purchasable pursuant to such option and the terms and conditions of exercise
of such option shall be determined in order to comply with section 424(a) of
the Code.
(b) As soon as practicable after the Effective Time, Sierra shall deliver to
the holders of CII Stock Options appropriate notices setting forth such
holders' rights pursuant to the respective CII Plans and the agreements
evidencing the grants of such Options shall continue in effect on the same
terms and conditions (subject to the adjustments required by this Section 5.7
after giving effect to the Merger). Sierra shall comply with the terms of the
CII Plans and ensure, to the extent required by, and subject to the provisions
of, such Plans, that CII Stock Options which qualified as incentive stock
options prior to the Effective Time continue to qualify as qualified stock
options after the Effective Time.
(c) Sierra shall take all corporate action necessary to reserve for issuance
a sufficient number of shares of Sierra Common Stock for delivery upon
exercise of CII Stock Options assumed in accordance with this Section 5.7. As
soon as practicable after the Effective Time, Sierra shall file a registration
statement on Form S-3 or Form S-8, as the case may be (or any successor or
other appropriate forms), or another appropriate form with respect to the
shares of Sierra Common Stock subject to such options and shall use its best
efforts to maintain the effectiveness of such registration statement or
registration statements (and maintain the current status of the prospectus or
prospectuses contained therein) for so long as such options remain
outstanding. With respect to those individuals who subsequent to the Merger
will be subject to the reporting requirements under Section 16(a) of the
Exchange Act, where applicable, Sierra shall administer CII Plans assumed
pursuant to this Section 5.7 in a manner that complies with Rule 16b-3
promulgated under the Exchange Act to the extent the applicable CII Plan
complied with such rule prior to the Merger.
5.8. Brokers or Finders. Each of Sierra and CII represents, as to itself,
its Subsidiaries and its affiliates, that no agent, broker, investment banker,
financial advisor or other firm or person is or will be entitled to any
broker's or finder's fee or any other commission or similar fee in connection
with any of the transactions contemplated by this Agreement, except Vector
Securities International, Inc. whose fees and expenses will be paid by CII in
accordance with CII's agreement with such firm (copies of which have been
delivered by CII to Sierra prior to the date of this Agreement), and Bear,
Stearns & Co., whose fees and expenses will be paid by Sierra in accordance
with Sierra's agreement with such firm (copies of which have been delivered by
Sierra to CII prior to the date of this Agreement), and each of Sierra and CII
respectively agree to indemnify and hold the other harmless from and against
any and all claims, liabilities or obligations with respect to any other fees,
commissions or expenses asserted by any person on the basis of any act or
statement alleged to have been made by such party or its affiliate.
5.9. Access to Sierra Records. Upon reasonable notice, Sierra shall (and
shall cause its Subsidiaries to) afford to the officers, employees,
accountants, counsel and other representatives of CII, access, during normal
business hours during the period prior to the Effective Time, to all its
properties, books, contracts, commitments and records and, during such period,
Sierra shall (and shall cause its Subsidiaries to) furnish promptly to CII (a)
a copy of each report, schedule, registration statement and other document
filed or received by it during such period pursuant to the requirements of
Federal securities laws and (b) all other information concerning its business,
properties and personnel as such other party may reasonably request. Unless
otherwise required by law, CII will hold any such information which is
nonpublic in confidence until such time as such information otherwise becomes
publicly available through no wrongful act of either party, and in the event
of termination of this Agreement for any reason CII shall promptly return all
nonpublic documents obtained from Sierra or its Subsidiaries, and any copies
made of such documents, to Sierra.
5.10. Employment Agreements. CII and Sierra shall, as of or prior to the
Effective Time, enter into employment contracts with the persons set forth on
Exhibit 5.10(x) on substantially the terms set forth in the form of Employment
Agreements agreed to as of the date hereof.
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5.11. Indemnification; Directors' and Officers' Insurance. (a) From and
after the Effective Time, Sierra and the Surviving Corporation shall
indemnify, defend and hold harmless each person who is now, or has been at any
time prior to the date hereof or who becomes prior to the Effective Time, an
officer, director or employee of CII or any of its Subsidiaries (the
"Indemnified Parties") against (i) all losses, claims, damages, costs,
expenses (including attorney's fees), liabilities or judgments or amounts that
are paid in settlement (which settlement shall require the prior written
consent of Sierra, which consent shall not be unreasonably withheld) of or in
connection with any claim, action, suit, proceeding or investigation (a
"Claim") in which an Indemnified Party is, or is threatened to be made, a
party or a witness based in whole or in part on or arising in whole or in part
out of the fact that such person is or was an officer, director or employee of
CII or any of its Subsidiaries, whether such Claim pertains to any matter or
fact arising, existing or occurring at or prior to the Effective Time
(including, without limitation, the Merger and other transactions contemplated
by this Agreement), regardless of whether such Claim is asserted or claimed
prior to, at or after the Effective Time (the "Indemnified Liabilities"), and
(ii) all Indemnified Liabilities based in whole or in part on, or arising in
whole or in part out of, or pertaining to this Agreement or the transactions
contemplated hereby, in each case to the full extent CII would have been
permitted under California law and its Articles of Incorporation and Bylaws to
indemnify such person (and Sierra shall pay expenses in advance of the final
disposition of any such action or proceeding to each Indemnified Party to the
full extent permitted by law and under such Articles of Incorporation or
Bylaws, upon receipt of any undertaking required by such Articles of
Incorporation, Bylaws or applicable law). Any Indemnified Party wishing to
claim indemnification under this Section 5.11(a), upon learning of any Claim,
shall notify Sierra (but the failure so to notify Sierra shall not relieve it
from any liability which Sierra may have under this Section 5.11(a) except to
the extent such failure prejudices Sierra) and shall deliver to Sierra any
undertaking required by such Articles of Incorporation, Bylaws or applicable
law. Sierra shall use its best efforts to assure, to the extent permitted
under applicable law, that all limitations of liability existing in favor of
the Indemnified Parties as provided in CII's Articles of Incorporation and
Bylaws, as in effect as of the date hereof, with respect to claims or
liabilities arising from facts or events existing or occurring prior to the
Effective Time (including, without limitation, the transactions contemplated
by this Agreement), shall survive the Merger. The obligations of Sierra
described in this Section 5.11(a) shall continue in full force and effect,
without any amendment thereto, for a period of not less than six years from
the Effective Time; provided, however, that all rights to indemnification in
respect of any Claim asserted or made within such period shall continue until
the final disposition of such Claim; and provided further that nothing in this
Section 5.11(a) shall be deemed to modify applicable California law regarding
indemnification of former officers and directors. The Indemnified Parties as a
group may retain only one law firm to represent them with respect to each such
matter unless there is, under applicable standards of professional conduct, a
conflict on any significant issue between the positions of any two or more
Indemnified Parties.
(b) Sierra and the Surviving Corporation shall cause to be maintained in
effect for not less than six years from the Effective Time the current
policies of directors' and officers' liability insurance maintained by CII and
its Subsidiaries (provided that Sierra and the Surviving Corporation may
substitute therefor policies of at least the same coverage containing terms
and conditions which are no less advantageous to the Indemnified Parties in
all material respects so long as no lapse in coverage occurs as a result of
such substitution) with respect to all matters, including the transactions
contemplated hereby, occurring prior to, and including, the Effective Time,
provided that, in the event that any Claim is asserted or made within such
six-year period, such insurance shall be continued in respect of any such
Claim until final disposition of any and all such Claims, provided further
that, Sierra shall not be obligated to make annual premium payments for such
insurance to the extent such premiums exceed 200% of the premiums paid as of
the date hereof by Sierra for such insurance. Notwithstanding anything to the
contrary contained elsewhere herein, Sierra's agreement set forth above shall
be limited to cover claims only to the extent that those claims are not
covered under CII's directors' and officers' insurance policies (or any
substitute policies permitted by this Section 5.11(b)).
(c) The obligations of Sierra and the Surviving Corporation under this
Section 5.11 are intended to benefit, and be enforceable against Sierra and
the Surviving Corporation directly by, the Indemnified Parties, and shall be
binding on all respective successors of Sierra and the Surviving Corporation.
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5.12. Additional Agreements; Reasonable Efforts. Subject to the terms and
conditions of this Agreement, each of the parties hereto agrees to use all
reasonable efforts to take, or cause to be taken, all action and to do, or
cause to be done, all things necessary, proper or advisable under applicable
laws and regulations to consummate and make effective the transactions
contemplated by this Agreement, subject to the appropriate vote of
shareholders of Sierra, if such vote is required, and of CII described in
Section 6.1(a), including cooperating fully with the other party, including by
provision of information and making of all necessary filings in connection
with, among other things, the Insurance Approvals and under the HSR Act, and
including assumption by Sierra of the obligation to issue shares of Sierra
Common Stock upon conversion of CII Debentures. In case at any time after the
Effective Time any further action is necessary or desirable to carry out the
purposes of this Agreement or to vest the Surviving Corporation with full
title to all properties, assets, rights, approvals, immunities and franchises
of either of the Constituent Corporations, the proper officers and directors
of each party to this Agreement shall take all such necessary action.
5.13. Pooling. Sierra and CII each agrees that it will not knowingly take
any action which would have the effect of jeopardizing the treatment of the
Merger as a "pooling-of-interests" for accounting purposes.
5.14. No Actions Inconsistent With Tax-Free Reorganization. CII and each of
its Subsidiaries, Sierra and Sierra Sub shall (and, following the Effective
Time, Sierra shall cause the Surviving Corporation to) take no action with
respect to the capital stock, assets or liabilities of the Surviving
Corporation that would cause the Merger not to qualify as a "reorganization"
within the meaning of Sections 368(a)(1)(A) and (a)(2)(E) of the Code.
ARTICLE VI
CONDITIONS PRECEDENT
6.1. Conditions to Each Party's Obligation To Effect the Merger. The
respective obligation of each party to effect the Merger shall be subject to
the satisfaction prior to the Closing Date of the following conditions:
(a) Approval. This Agreement and the Merger shall have been approved and
adopted by the affirmative vote of a majority of the votes that the holders
of the outstanding shares of CII Common Stock are entitled to cast and, if
their approval is required, shall have been approved by the affirmative
vote of the requisite number of holders of the outstanding shares of Sierra
Common Stock. Not more than ten percent (10%) of the holders of the
outstanding shares of CII Common Stock shall have delivered to CII written
demands for appraisal of such shares prior to the taking of the vote by the
shareholders of CII on the Merger.
(b) NYSE Listing. The shares of Sierra Common Stock issuable to CII
shareholders pursuant to this Agreement and such other shares required to
be reserved for issuance in connection with the Merger shall have been
authorized for listing on the NYSE upon official notice of issuance.
(c) Other Approvals. The filings provided for by Section 1.1, the
Insurance Approvals and the State Takeover Approvals and all
authorizations, consents, orders or approvals of, or declarations or
filings with, or expirations of waiting periods imposed by, any
Governmental Entity the absence of which would have a material adverse
effect on Sierra, the Surviving Corporation or any Subsidiary of CII shall
have been filed, have occurred or been obtained.
(d) S-4. The S-4 shall have become effective under the Securities Act and
shall not be the subject of any stop order or proceedings seeking a stop
order.
(e) No Injunctions or Restraints. No temporary restraining order,
preliminary or permanent injunction or other order issued by any court of
competent jurisdiction or other legal restraint or prohibition (an
"Injunction") preventing the consummation of the Merger shall be in effect.
(f) Tax Returns. CII and its Subsidiaries shall have filed all necessary
Returns (as defined in Section 3.1(t)(i)(B)) required to amend Returns
previously filed by CII and its Subsidiaries for the Tax year ended
December 31, 1991 with respect to an adjustment under Section 847 of the
Code (and any other related
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provision), prior to the earlier of (i) the date that is three years from
the day on which CII and its Subsidiaries filed their 1991 Tax Returns or
(ii) the Closing Date, subject to the approval of Sierra, which shall not
be unreasonably withheld, in order to properly reflect the taxable income
of CII and its Subsidiaries.
(g) Supplemental Indenture. Each of Surviving Corporation, CII, Sierra
and the Trustee shall have executed and delivered a supplemental indenture
pursuant to the provisions of the Indenture.
6.2. Conditions of Obligations of Sierra and Sierra Sub. The obligations of
Sierra and Sierra Sub to effect the Merger are subject to the satisfaction of
the following conditions unless waived by Sierra and Sierra Sub:
(a) Representations and Warranties. The representations and warranties of
CII set forth in this Agreement shall be true and correct in all material
respects as of the date of this Agreement and (except to the extent such
representations and warranties speak as of an earlier date) as of the
Closing Date as though made on and as of the Closing Date, except as
otherwise contemplated by this Agreement, and Sierra shall have received a
certificate signed on behalf of CII by the chief executive officer and by
the chief financial officer of CII to such effect.
(b) Performance of Obligations of CII. CII shall have performed in all
material respects all obligations required to be performed by it under this
Agreement at or prior to the Closing Date, and Sierra shall have received a
certificate signed on behalf of CII by the chief executive officer and by
the chief financial officer of CII to such effect.
(c) Letter from CII Affiliates. Sierra shall have received from each
person named in the letter referred to in Section 4.1(l) an executed copy
of an agreement substantially in the form of Exhibit 4.1(l) hereto.
(d) Tax Opinion. The opinion of Morgan, Lewis & Bockius, counsel to
Sierra, to the effect that the Merger will be treated for Federal income
tax purposes as a reorganization within the meaning of Section 368(a) of
the Code, and that Sierra, Sierra Sub and CII will each be a party to that
reorganization within the meaning of Section 368(b) of the Code, dated on
or about the date that is two business days prior to the date the Proxy
Statement is first mailed to shareholders of CII and, if their approval is
required, to the shareholders of Sierra, shall not have been withdrawn or
modified in any material respect.
(e) Consents Under Agreements. CII shall have obtained the consent or
approval of each person whose consent or approval shall be required in
order to permit the succession by the Surviving Corporation pursuant to the
Merger to any obligation, right or interest of CII or any Subsidiary of CII
under any loan or credit agreement, note, mortgage, indenture, lease or
other agreement or instrument, except those for which failure to obtain
such consents and approvals would not, in the reasonable opinion of Sierra,
individually or in the aggregate, have a material adverse effect (x) on CII
and its Subsidiaries taken as a whole or (y) on the Surviving Corporation
and its Subsidiaries taken as a whole upon the consummation of the
transactions contemplated hereby.
(f) No Amendments to Resolutions. Neither the Board of Directors of CII
nor any committee thereof shall have amended, modified, rescinded or
repealed the resolutions adopted by the Board of Directors on June 12, 1995
(accurate and complete copies of which will be provided to Sierra) and
shall not have adopted any other resolutions in connection with this
Agreement and the transactions contemplated hereby inconsistent with such
resolutions.
6.3. Conditions of Obligations of CII. The obligation of CII to effect the
Merger is subject to the satisfaction of the following conditions unless
waived by CII:
(a) Representations and Warranties. The representations and warranties of
Sierra and Sierra Sub set forth in this Agreement shall be true and correct
in all material respects as of the date of this Agreement and (except to
the extent such representations speak as of an earlier date) as of the
Closing Date as though made on and as of the Closing Date, except as
otherwise contemplated by this Agreement, and CII shall have received a
certificate signed on behalf of Sierra by the Chief Executive Officer or
the President or the Vice Chairman or and by the chief financial officer of
Sierra to such effect.
29
<PAGE>
(b) Performance of Obligations of Sierra and Sierra Sub. Sierra and
Sierra Sub shall have performed in all material respects all obligations
required to be performed by them under this Agreement at or prior to the
Closing Date, and CII shall have received a certificate signed on behalf of
Sierra by the Chief Executive Officer or the President or the Vice Chairman
and by the chief financial officer of Sierra to such effect.
(c) Tax Opinion. The opinion of Gibson, Dunn & Crutcher, counsel to CII,
to the effect that the Merger will be treated for Federal income tax
purposes as a reorganization within the meaning of Section 368(a) of the
Code, and that Sierra, Sierra Sub and CII will each be a party to that
reorganization within the meaning of Section 368(b) of the Code, dated on
or about the date that is two business days prior to the date the Proxy
Statement is first mailed to shareholders of CII and, if required, of
Sierra, shall not have been withdrawn or modified in any material respect.
(d) Consents Under Agreements. Sierra shall have obtained the consent or
approval of each person whose consent or approval shall be required in
connection with the transactions contemplated hereby under any loan or
credit agreement, note, mortgage, indenture, lease or other agreement or
instrument, except those for which failure to obtain such consents and
approvals would not, in the reasonable opinion of CII, individually or in
the aggregate, have a material adverse effect on Sierra and its
Subsidiaries, taken as a whole, or upon the consummation of the
transactions contemplated hereby.
(e) No Amendments to Resolutions. Neither the Board of Directors of
Sierra nor any committee thereof shall have amended, modified, rescinded or
repealed the resolutions adopted by the Board of Directors at a meeting
duly called and held on June 12, 1995 (accurate and complete copies of
which will be provided to CII), and shall not have adopted any other
resolutions in connection with this Agreement and the transactions
contemplated hereby inconsistent with such resolutions.
ARTICLE VII
TERMINATION AND AMENDMENT
7.1. Termination. This Agreement may be terminated at any time prior to the
Effective Time, whether before or after approval of the matters presented in
connection with the Merger by the shareholders of CII or, if their approval is
required, by the shareholders of Sierra:
(a) by mutual consent of Sierra and CII;
(b) by either Sierra or CII if there has been a material breach of any
representation, warranty, covenant or agreement on the part of the other
set forth in this Agreement which breach has not been cured within five
business days following receipt by the breaching party of notice of such
breach, or if any permanent injunction or other order of a court or other
competent authority preventing the consummation of the Merger shall have
become final and non-appealable;
(c) by either Sierra or CII if the Merger shall not have been consummated
before December 31, 1995;
(d) by either Sierra or CII if any required approval of the shareholders
of CII or of Sierra shall not have been obtained by reason of the failure
to obtain the required affirmative vote at a duly held meeting of
shareholders or at any adjournment thereof;
(e) by CII, if the Board of Directors of CII shall have adopted and
recommended a Competing Offer to its shareholders; or
(f) by Sierra, if (i) the Board of Directors of CII withdraws, modifies
or changes its recommendation of this Agreement or the Merger in a manner
adverse to Sierra or Sierra Sub or shall have resolved to do so, or (ii)
the Board of Directors of CII shall have recommended to the shareholders of
CII any Competing Transaction or resolved to do so, or (iii) a tender offer
or exchange offer for ten percent or more of the outstanding shares of
capital stock of CII is commenced, and the Board of Directors of CII,
within 10 business days after such tender offer or exchange offer is so
commenced, either fails to recommend against acceptance of such tender
offer or exchange offer by its shareholders or takes no position with
respect to the acceptance of such tender offer or exchange offer by its
shareholders.
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For purposes of this Agreement, "Competing Transaction" shall mean any of
the following involving CII or any of its Subsidiaries (other than the
transactions contemplated by this Agreement): (i) any merger, consolidation,
share exchange, business combination, or other similar transaction; (ii) any
sale, lease, exchange, mortgage, pledge, transfer or other disposition of
twenty percent or more of the assets of CII and its Subsidiaries, taken as a
whole, in a single transaction; (iii) any tender offer or exchange offer for
ten percent or more of the outstanding shares of capital stock of CII or the
filing of a registration statement under the Securities Act in connection
therewith; (iv) any solicitation of proxies in opposition to approval by CII's
shareholders of the Merger; (v) any person shall have acquired beneficial
ownership or the right to acquire beneficial ownership of, or any "group" (as
such term is defined under Section 13(d) of the Exchange Act) shall have been
formed which beneficially owns or has the right to acquire beneficial
ownership of, ten percent or more of the then outstanding shares of capital
stock of CII; or (vi) any agreement to, or public announcement by CII of a
proposal, plan or intention to, do, facilitate (including by way of providing
information) or recommend any of the foregoing.
7.2. Effect of Termination. In the event of termination of this Agreement by
either CII or Sierra as provided in Section 7.1, this Agreement shall
forthwith become void and there shall be no liability or obligation on the
part of Sierra, Sierra Sub or CII or their respective officers or directors
except (y) with respect to the last sentence of Section 4.1(k) and 5.9, and
Sections 7.5 and 5.8, and (z) to the extent that such termination results from
the willful breach by a party hereto of any of its representations,
warranties, covenants or agreements set forth in this Agreement except as
provided in Section 8.7.
7.3. Amendment. This Agreement may be amended by the parties hereto, by
action taken or authorized by their respective Boards of Directors, at any
time before or after approval of the matters presented in connection with the
Merger by the shareholders of CII or, if their approval is required, the
shareholders of Sierra, but, after any such approval, no amendment shall be
made which by law requires further approval by such shareholders without such
further approval. This Agreement may not be amended except by an instrument in
writing signed on behalf of each of the parties hereto.
7.4. Extension; Waiver. At any time prior to the Effective Time, the parties
hereto, by action taken or authorized by their respective Board of Directors,
may, to the extent legally allowed, (a) extend the time for the performance of
any of the obligations or other acts of the other parties hereto, (b) waive
any inaccuracies in the representations and warranties contained herein or in
any document delivered pursuant hereto and (c) waive compliance with any of
the agreements or conditions contained herein. Any agreement on the part of a
party hereto to any such extension or waiver shall be valid only if set forth
in a written instrument signed on behalf of such party.
7.5. Fees and Expenses. (a) All costs and expenses incurred in connection
with this Agreement and the transactions contemplated hereby shall be paid by
the party incurring such expense, and, in connection therewith, each of Sierra
and CII shall pay, with its own funds and not with funds provided by the other
party, any and all property or transfer taxes imposed on such party or any
real property tax imposed by State of California on any holder of shares in
such party resulting from the Merger, except that expenses incurred in
connection with printing and mailing the Proxy Statement and the S-4 shall be
shared equally by Sierra and CII.
(b) CII agrees that (i) if CII shall terminate this Agreement pursuant to
Section 7.1(e), or (ii) if Sierra or CII shall terminate this Agreement
pursuant to Section 7.1(d) due to the failure of CII's shareholders to approve
and adopt this Agreement, and (A) at the time of such failure so to approve
and adopt this Agreement there shall exist a Competing Transaction and (B)
prior to such failure so to approve and adopt this Agreement the Board of
Directors of CII shall have withdrawn, modified or changed its recommendation
of the Agreement or the Merger in a manner adverse to Sierra and Sierra Sub,
or shall have resolved to do any of the foregoing, or shall have recommended
to the shareholders of CII any Competing Transaction or shall have resolved to
do so, or (iii) if Sierra terminates this Agreement pursuant to Section
7.1(f), then on the Payment Date (as defined below), CII shall pay to Sierra
an amount equal to $5,000,000 plus all of Sierra's Expenses, including
Sierra's share of the Expenses described in Section 7.5(a), which sum CII and
Sierra agree is reasonable under the circumstances
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since it would be impracticable and extremely difficult to fix the actual
damage to Sierra in the case of such a termination. For purposes of this
Section 7.5(b), the "Payment Date" is the date 10 days following the earliest
of the following to occur: (1) the closing of any transaction resulting from a
Competing Transaction, (2) the date as of which CII publicly announces that
the Competing Transaction will not proceed, and (3) the date twelve months
following a termination of this Agreement by Sierra or CII giving rise to
payment under this Section 7.5(b). CII shall not be obligated to pay the
amounts set forth in the first sentence of this Section 7.5(b) if CII
terminates this Agreement pursuant to Section 7.1(b) or 7.1(c) due to the
failure of the conditions set forth in Section 6.1 or Section 6.3 to be
satisfied (unless the condition that is not satisfied is the condition set
forth in Section 6.1(a) and the events set forth in sub-clauses (A) and (B) of
clause (i) of this Section 7.5(b) have occurred).
(c) CII and Sierra each agree that (i) the payment provided for in Section
7.5(b) shall be the sole and exclusive remedy of Sierra upon any termination
of this Agreement as described in Section 7.5(b) and such remedies shall be
limited to the sum stipulated in Section 7.5(b) regardless of the
circumstances (including willful or deliberate conduct) giving rise to such
termination, and (ii) with respect to any termination of this Agreement
pursuant to Section 7.1(b) as a direct result of a material, intentional
breach by a party of any of its representations, warranties, covenants or
agreements contained in this Agreement, all remedies available to the other
party either in law or equity shall be preserved and survive the termination
of this Agreement.
(d) Any payment required to be made pursuant to Section 7.5(b) shall be made
to Sierra not later than two business days after delivery to CII of notice of
demand for payment and an itemization setting forth in reasonable detail all
Expenses of Sierra (which itemization maybe supplemented and updated from time
to time by Sierra until the 60th day after Sierra delivers such notice of
demand for payment), and shall be made by wire transfer of immediately
available funds to an account designated by Sierra in the notice of demand for
payment delivered pursuant to this Section 7.5(d).
ARTICLE VIII
GENERAL PROVISIONS
8.1. Nonsurvival of Representations, Warranties and Agreements. None of the
representations, warranties and agreements in this Agreement or in any
instrument delivered pursuant to this Agreement shall survive the Effective
Time, except for the agreements contained in Sections 2.1, 2.2, 5.6 through
5.12, the last sentence of Section 7.3 and Article VIII, 7.5 and the
agreements of the "affiliates" of CII delivered pursuant to Section 4.1(l).
8.2. Notices. All notices and other communications hereunder shall be in
writing and shall be deemed given if delivered personally, telecopied (which
is confirmed) or mailed by registered or certified mail (return receipt
requested) to the parties at the following addresses (or at such other address
for a party as shall be specified by like notice):
(a) if to Sierra or Sierra Sub, to
Sierra Health Services, Inc.
or
Health Acquisition Corp.
2724 North Tenaya Way
Las Vegas, NV 89128
Telecopy No. (702) 242-7915
Attention: Anthony M. Marlon, M.D.
Chairman of the Board and
Chief Executive Officer
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with a copy to
Stephen P. Farrell, Esq.
Morgan, Lewis & Bockius
101 Park Avenue
New York, N.Y. 10178
Telecopy No. (212) 309-6273
and
(b) if to CII, to
CII Financial, Inc.
5627 Gibraltar Drive
P.O. Box 9025
Pleasanton, CA 94588
Telecopy No. (510) 460-8538
Attention: Joseph G. Havlick
Chairman, President and
Chief Executive Officer
with a copy to
Richard A. Strong, Esq.
Gibson, Dunn & Crutcher
333 South Grand Avenue
Los Angeles, CA 90071-3197
Telecopy No. (213) 229-7520
8.3. Interpretation. When a reference is made in this Agreement to Sections,
such reference shall be to a Section of this Agreement unless otherwise
indicated. The table of contents and headings contained in this Agreement are
for reference purposes only and shall not affect in any way the meaning or
interpretation of this Agreement. Whenever the words "include", "includes" or
"including" are used in this Agreement, they shall be deemed to be followed by
the words "without limitation". The phrase "made available" in this Agreement
shall mean that the information referred to has been made available if
requested by the party to whom such information is to be made available. The
phrases "the date of this Agreement", "the date hereof", and terms of similar
import, unless the context otherwise requires, shall be deemed to refer to the
date set forth on the last page of this Agreement.
8.4. Counterparts. This Agreement may be executed in two or more
counterparts, all of which shall be considered one and the same agreement and
shall become effective when two or more counterparts have been signed by each
of the parties and delivered to the other parties, it being understood that
all parties need not sign the same counterpart.
8.5. Entire Agreement; No Third Party Beneficiaries; Rights of
Ownership. This Agreement (including the documents and the instruments
referred to herein) (a) constitutes the entire agreement and supersedes all
prior agreements and understandings, both written and oral, among the parties
with respect to the subject matter hereof, (b) except as provided in Section
5.7, is not intended to confer upon any person other than the parties hereto
any rights or remedies hereunder. The parties hereby acknowledge that, except
as hereinafter agreed to in writing, no party shall have the right to acquire
or shall be deemed to have acquired shares of common stock of the other party
pursuant to the Merger until consummation thereof.
8.6. Governing Law. This Agreement, the transactions contemplated hereby and
the rights of the parties hereunder and under statutory and common law with
respect to the transactions contemplated hereby shall be governed and
construed in accordance with the laws of the State of California.
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8.7. No Remedy in Certain Circumstances. Each party agrees that, should any
court or other competent authority hold any provision of this Agreement or
part hereof or thereof to be null, void or unenforceable, or order any party
to take any action inconsistent herewith or not to take any action required
herein, the other party shall not be entitled to specific performance of such
provision or part hereof or thereof or to any other remedy, including but not
limited to money damages, for breach hereof or thereof or of any other
provision of this Agreement or part hereof or thereof as a result of such
holding or order.
8.8. Publicity. Except as otherwise required by law or the rules of the NYSE
and the American Stock Exchange, so long as this Agreement is in effect,
neither CII nor Sierra shall, or shall permit any of its Subsidiaries to,
issue or cause the publication of any press release or other public
announcement with respect to the transactions contemplated by this Agreement
without reviewing the same with the other party.
8.9. Assignment. Neither this Agreement nor any of the rights, interests or
obligations hereunder shall be assigned by any of the parties hereto (whether
by operation of law or otherwise) without the prior written consent of the
other parties, except that Sierra Sub may assign, in its sole discretion, any
or all of its rights, interests and obligations hereunder to Sierra or to any
direct or indirect wholly owned Subsidiary of Sierra. Subject to the preceding
sentence, this Agreement will be binding upon, inure to the benefit of and be
enforceable by the parties and their respective successors and assigns.
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<PAGE>
IN WITNESS WHEREOF, Sierra, Sierra Sub and CII have caused this Agreement to
be signed by their respective officers thereunto duly authorized, all as of
June 12, 1995.
Sierra Health Services, Inc.
/s/ Erin E. MacDonald
By __________________________________
ERIN E. MACDONALD
PRESIDENT
Attest:
/s/ Frank E. Collins
_____________________________________
FRANK E. COLLINS
SECRETARY
Health Acquisition Corp.
/s/ Erin E. MacDonald
By __________________________________
ERIN E. MACDONALD
PRESIDENT
Attest:
/s/ Frank E. Collins
_____________________________________
FRANK E. COLLINS
SECRETARY
CII Financial, Inc.
/s/ Joseph G. Havlick
By __________________________________
JOSEPH G. HAVLICK
CHAIRMAN OF THE BOARD,
CHIEF EXECUTIVE OFFICER AND
PRESIDENT
Attest:
/s/ Richard E. Dobson
_____________________________________
RICHARD E. DOBSON
SECRETARY
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<PAGE>
EXHIBIT 1.3(a)(ii)
CERTIFICATE OF AMENDMENT
OF
ARTICLES OF INCORPORATION
OF
CII FINANCIAL, INC.
Joseph G. Havlick and Richard E. Dobson certify that:
1. They are the President and the Secretary, respectively, of CII
Financial, Inc., a California corporation.
2. Article IV of the Articles of Incorporation of this corporation is
amended to read in its entirety as follows:
"The corporation is authorized to issue only one class of shares of
stock which shall be designated as "Common Stock," and the total number
of shares which this corporation is authorized to issue is one thousand
(1,000)."
3. The foregoing amendment of Articles of Incorporation has been duly
approved by the Board of Directors.
4. The foregoing amendment of articles of incorporation has been duly
approved by the required vote of shareholders in accordance with Section
902 of the Corporations Code. The total number of outstanding shares of the
corporation is 100. The holder of all the outstanding shares voted in favor
of the amendment, which vote exceeded that required.
We further declare under penalty of perjury under the laws of the State of
California that the matters set forth in this certificate are true and correct
of our own knowledge.
DATE: _______________
_____________________________________
Joseph G. Havlick, President
_____________________________________
Richard E. Dobson, Secretary
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<PAGE>
EXHIBIT 4.1(1)
Sierra Health Services, Inc.
2724 North Tenaya Way
Las Vegas, NV 89128
Attention: Frank E. Collins, Esq.
Re: Agreement and Plan of Merger dated as of June 12, 1995 (the "Merger
Agreement"), among Sierra Health Services, Inc., Health Acquisition Corp.
and CII Financial, Inc.
Ladies and Gentlemen:
The undersigned, a holder of shares of Common Stock, stated value $.50 per
share (the "CII Common Stock"), of CII Financial, Inc., a California
corporation ("CII"), is entitled to receive in connection with the merger (the
"Merger") of CII with Health Acquisition Corp., a California corporation
("Sierra Sub") pursuant to the Merger Agreement, Common Stock, par value $.005
per share (the "Sierra Common Stock"), of Sierra Health Services, Inc., a
Nevada corporation ("Sierra"), including the corresponding percentage of a
right to purchase shares of Series A Junior Participating Preferred Stock of
Sierra pursuant to the Rights Agreement dated as of June 14, 1994, between
Sierra and Continental Stock Transfer & Trust Company, as Rights Agent. The
undersigned acknowledges that the undersigned may be deemed an "affiliate" of
CII within the meaning of Rule 145 ("Rule 145") promulgated under the
Securities Act of 1933, as amended (the "Act"), although nothing contained
herein should be construed as an admission of such fact.
If in fact the undersigned were an affiliate under the Act, the
undersigned's ability to sell, assign or transfer the Sierra Common Stock
received by it in exchange for any shares of the CII Common Stock pursuant to
the Merger may be restricted unless such transaction is registered under the
Act or an exemption from such registration is available. The undersigned
understands that such exemptions are limited and the undersigned has obtained
advice of counsel as to the nature and conditions of such exemptions,
including information with respect to the applicability to the sale of such
securities of Rules 144 and 145(d) promulgated under the Act.
The undersigned hereby represents to and covenants with the Sierra and
Sierra Sub that it will not sell, assign or transfer any of the shares of the
Sierra Common Stock received by it in exchange for shares of the CII Common
Stock pursuant to the Merger (nor will it acquire, issue or enter into any
puts, calls, straddles, short-sales, spreads or similar transactions with
respect to the shares) except (i) pursuant to an effective Registration
Statement under the Act, (ii) in a transaction made in conformity with the
provisions of Rule 145(d) under the Act, or (iii) in a transaction which, in
the opinion of independent counsel reasonably satisfactory to Sierra (the
reasonable fees of which counsel will be paid by Sierra) or as described in a
"no-action" or interpretive letter from the Staff of the Securities and
Exchange Commission (the "Commission"), is not required to be registered under
the Act.
The undersigned understands that the acquisition of CII by Sierra is to be
accounted for as a pooling-of-interests, that such accounting treatment is
material to Sierra and, because of the rules applicable to such accounting
treatment, it is prohibited for the period described below from selling,
transferring or otherwise disposing of, or in any other way reducing or
hedging our risk relative to, any shares of the Sierra Common Stock it is to
receive. Accordingly, the undersigned understands and agrees that it will not
acquire, issue or engage in any put, call, short-sale, straddle, spread or
other market transactions of any kind with respect to any Sierra Common Stock,
whether such transactions are conducted on an established U.S. or foreign
securities exchange, in the over-the-counter market or on a privately
negotiated basis. The undersigned agrees that this prohibition will remain in
effect at least until such time as financial results covering at least 30 days
of combined operations of Sierra and CII on a consolidated basis have been
published by Sierra and filed with the
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Commission, but that further restrictions may be imposed on the undersigned
for federal income tax or other purposes.
The undersigned is executing this letter and making the agreements herein
upon the representation of Sierra that if the Closing of the Merger occurs
during the month of September, Sierra will publish financial results covering
the combined operations of Sierra and CII on a consolidated basis for the
months ending October 31, 1995 and if such Closing occurs during the month of
October, Sierra will publish financial results for at least the month ended
November 30, 1995.
The undersigned represents to and covenants with Sierra and Sierra Sub that
it has not within the preceding 30 days--
(i) sold, transferred or otherwise disposed of any shares of the CII
Common Stock held by it and that it will not sell, transfer or otherwise
dispose of any shares of the Sierra Common Stock received by it in the
Merger until after such time as results covering at least 30 days of
combined operations of CII and Sierra have been published by Sierra, in the
form of a quarterly earnings report, an effective registration statement
filed with the Commission, a report to the Commission on Form 10-K, 10-Q,
or 8-K, or any other public filing or announcement which includes such
combined results of operations;
(ii) attempted to reduce or hedge and it will not attempt to reduce or
hedge the undersigned's risk relative to any shares of the Sierra Common
Stock it is to receive; or
(iii) engaged in nor will it engage in any put, call, short-sale,
straddle, spread or other market transactions of any kind with respect to
any Sierra Common Stock
--either on an established U.S. or foreign securities exchange, in the over-
the-counter market or on a privately negotiated basis.
In the event of a sale or other disposition pursuant to Rule 145, the
undersigned will supply Sierra with evidence of compliance with such Rule, in
the form of a letter in the form of Exhibit A hereto. The undersigned
understands that Sierra may instruct its transfer agent to withhold the
transfer of any securities disposed of by it, but that upon receipt of such
letter the transfer agent shall effectuate the transfer of the shares
indicated as sold in the letter.
The undersigned acknowledges and agrees that the following legend will be
placed on certificates representing the Sierra Common Stock received by the
undersigned in the Merger:
"The shares represented by this certificate were issued in a transaction to
which Rule 145 under the Securities Act of 1933 applies. The shares
represented by this certificate may only be transferred in accordance with
the terms of an agreement dated as of June , 1995, between the registered
holder and Sierra Health Services, Inc., a copy of which agreement is on
file at the principal offices of Sierra Health Services, Inc."
The undersigned acknowledges that (i) it has carefully read this letter and
understands the requirements hereof and the limitations imposed upon the
distribution, sale, transfer or other disposition of shares of the Sierra
Common Stock and (ii) the receipt by Sierra of this letter is an inducement
and a condition to Sierra's obligations to consummate the Merger.
Very truly yours,
_____________________________________
Dated: ______________
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<PAGE>
EXHIBIT A TO EXHIBIT 4.1(1)
[DATE]
Sierra Health Services, Inc.
2724 North Tenaya Way
Las Vegas, NV 89128
Attention: Frank E. Collins, Esq.
Ladies and Gentlemen:
On , 199 I sold shares of capital stock ("Capital Stock") of Sierra
Health Services, Inc. (the "Company") received by me in connection with the
merger of Health Acquisition Corp., a subsidiary of the Company, with and into
CII Financial, Inc.
Based upon the most recent report or statement filed by the Company with the
Securities and Exchange Commission, the shares of Capital Stock sold by me
were within the prescribed limitations set forth in paragraph (e) of Rule 144
promulgated under the Securities Act of 1933, as amended (the "Act").
I hereby represent that the above-described shares of Capital Stock were
sold in "brokers' transactions" within the meaning of Section 4(4) of the Act
or in transactions directly with a "market maker" as that term is defined in
Section (3)(a)(38) of the Securities Exchange Act of 1934, as amended. I
further represent that I have not solicited or arranged for the solicitation
of orders to buy the above-described shares of Capital Stock, and that I have
not made any payment in connection with the offer or sale of such shares to
any person other than to the broker who executed the order in respect of such
sale.
Very truly yours,
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SUMMARY OF SCHEDULES
CII FINANCIAL, INC.
Schedule 3.1(b) lists certain information about the capital structure of CII
not otherwise set forth in Section 3.1(b) of the Merger Agreement.
Schedule 3.1(c) lists certain conflicts, violations, defaults or
accelerations that may result from the execution and delivery of the Merger
Agreement or the consummation of the transactions contemplated thereby.
Schedule 3.1(f) lists certain material non-compliance and limitations with
respect to the businesses of CII and each of its subsidiaries, material
permits of CII and any of its subsidiaries and certain recent examinations.
Schedule 3.1(g) lists certain items not previously reported in the financial
statements of CII's subsidiaries.
Schedule 3.1(h) lists any material litigation involving CII or any of its
subsidiaries.
Schedule 3.1(i) lists any labor dispute or claim concerning employees of CII
or any of its subsidiaries.
Schedule 3.1(j) lists material changes to CII or any of its subsidiaries
since December 31, 1994.
Schedule 3.1(k) lists the material contracts and agreements to which CII or
any of its subsidiaries is a party.
Schedule 3.1(l)(i) lists the names of all directors and officers of CII and
each of its subsidiaries.
Schedule 3.1(l)(ii) lists the name and current annual rate of compensation
paid by CII and its subsidiaries to certain officers, directors and employees.
Schedule 3.1(l)(iii) lists the names of all persons who have written
employment, consulting or severance agreements or arrangements with CII or any
of its subsidiaries.
Schedule 3.1(n) lists patents, trademarks, copyrights and other intellectual
property rights owned or licensed by CII or its subsidiaries, all names under
which CII or any of its subsidiaries conducts or has conducted business, and
possible intellectual property related claims.
Schedule 3.1(o) lists the employee benefit plans of CII and any "Controlled
Company", as that term is defined in the Merger Agreement.
Schedule 3.1(p) lists transactions involving CII or any of its subsidiaries
and directors, officers and certain other persons.
Schedule 3.1(q) lists certain insurance agents of CII and its subsidiaries,
the amounts of premiums produced by each agent listed thereto and the current
underwriting and binding authorities of insurance agents.
Schedule 3.1(r) lists each policyholder accounting for a certain amount per
annum in premium volume.
Schedule 3.1(s) lists all reinsurance or coinsurance treaties or agreements
to which CII or any of its subsidiaries is a party.
Schedule 3.1(t) sets forth information with respect to the tax matters of
CII and its subsidiaries, as required by Section 3.1(t) of the Merger
Agreement.
SIERRA HEALTH SERVICES, INC.
Schedule 3.2(f) lists certain recent examinations involving the businesses
of Sierra and its subsidiaries.
Schedule 3.2(g) lists any material litigation involving Sierra or any of its
subsidiaries.
40
<PAGE>
ANNEX B
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------
FORM 10-K/A
(Mark One)
[X] Amendment No. 1 to Annual report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Fiscal Year Ended December 31, 1994 or
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 (no fee required)
For the transition period from ___________ to__________
Commission File Number 0-18324
--------------------------------------------------------------------------------
CII FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
California 95-4188244
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
5627 Gibraltar Drive
Pleasanton, California 94588
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (510) 416-8700
--------------------------------------------------------------------------------
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
------------------- -------------------
Common Stock American Stock Exchange
7 1/2% Convertible Subordinated
Debentures Due 2001 American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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 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 the Common Stock held by non-affiliates
of the registrant on March 20, 1995, based on the last sales price on that date,
was $44,923,256.
At March 20, 1995, there were 7,187,721 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates information by reference from the registrant's
Proxy Statement for its 1995 Annual Meeting of Shareholders.
===============================================================================
<PAGE>
CII FINANCIAL, INC.
FORM 10-K/A
For the Fiscal Year Ended December 31, 1994
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I
Page
----
<S> <C>
Item 1. Business..................................................... 1
Item 2. Properties................................................... 14
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 Stock and Related
Stockholders Matters......................................... 15
Item 6. Selected Financial Data...................................... 16
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.......................... 17
Item 8. Financial Statements and Supplemental Data................... 26
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure.......................... 27
PART III
Item 10. Directors and Executive Officers of the Registrant........... 27
Item 11. Executive Compensation and Other Information................. 27
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................... 27
Item 13. Certain Relationships and Related Transactions............... 27
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K.................................................. 27
Index to Consolidated Financial Statements............................ 37
</TABLE>
<PAGE>
THIS FORM 10-K/A AMENDS AND RESTATES REGISTRANT'S FORM 10-K FOR THE FISCAL YEAR
ENDED DECEMBER 31, 1994 INCLUDING THE FINANCIAL STATEMENTS AND SCHEDULES
THERETO. IT DOES NOT INCLUDE EXHIBITS, ALL OF WHICH WERE PREVIOUSLY FILED WITH
REGISTRANT'S FORM 10-K OR INCORPORATED BY REFERENCE AS INDICATED THEREIN.
PART I
ITEM 1. BUSINESS
GENERAL
CII Financial, Inc. ("CII Financial") was incorporated in the State of
California on September 15, 1988. CII Financial is a holding company primarily
engaged in writing workers' compensation insurance through its wholly-owned
subsidiaries, California Indemnity Insurance Company ("California Indemnity")
and Commercial Casualty Insurance Company ("Commercial Casualty"). CII
Financial is also engaged in the electronic door lock manufacturing business
through its 80% owned subsidiary, InteLock Technologies ("InteLock") and in the
insurance premium finance business through its wholly-owned subsidiary, CII
Premium Finance Company ("CIIPF"). In addition, CII Financial has two operating
insurance agencies, neither of which are significant to the consolidated
financial statements, and in December 1994, formed a managing general agent for
a small start-up operation to write property-casualty insurance. For the year
ended December 31, 1994, the Company operated in two reportable segments (i)
workers' compensation and (ii) door lock manufacturing. For business segment
information see Note 16 to Notes to Consolidated Financial Statements. The term
the "Company" means CII Financial, Inc. and its subsidiaries, and the term "CII
Financial" means CII Financial, Inc., exclusive of such subsidiaries.
WORKERS' COMPENSATION INSURANCE
The Company is engaged in writing workers' compensation insurance in
the states of California, Colorado, Nebraska, New Mexico and Utah primarily
through independent insurance agents and brokers. The Company has licenses and
has applications pending for licenses in other states. The Company will
continue to expand to other states where it believes business will be
profitable. California represented approximately 86% of the Company's direct
written premiums in 1994.
For the year ended December 31, 1994, the Company's average direct
written premium per policy was approximately $12,490 compared to approximately
$12,462 for the year ended December 31, 1993. In prior years, the Company
concentrated on workers' compensation insurance accounts in the small to medium-
size range; however, with the introduction of open rating in California in
1995, the Company is actively pursuing accounts of all sizes.
Workers' compensation is a statutory system that requires an employer
to provide its employees with medical care and other specified benefits for
work-related injuries, even though the injuries may have resulted from the
negligence or wrongs of any person, including the employee. Employers typically
purchase workers' compensation insurance to provide these benefits. The
benefits payable are generally established by statute.
In California, prior to 1995, standard or "manual" premium rates for
approximately 650 separate employment classifications were recommended by the
Workers' Compensation Insurance Rating Bureau ("WCIRB") and were subject to
approval by the California Department of Insurance. These rates were expressed
as a rate per hundred dollars of payroll for each classification. Manual rates
were subject to modification (increase or decrease) in accordance with
experience modification factors determined by the WCIRB for each eligible
employer and based on that employer's specific loss experience in each payroll
classification applicable to its business. California workers' compensation
insurers could charge rates higher than manual rates multiplied by the
applicable experience modification factors promulgated by the WCIRB, but the
minimum rate law prohibited them from charging less than such rates and factors.
Changes in manual rates and the levels of benefit payments were subject to
review and public hearing by the California Insurance Commissioner and were
changed from time to time to reflect industry experience and benefit level
changes.
The minimum rate law was repealed by the California legislature
effective with policies issued or renewed on or after January 1, 1995. Without
the minimum rate structure, every insurer must establish its own rate structure.
Each insurer is able to charge whatever rate that insurer wishes to use, subject
only to the requirements that the rate used (i) may not impair or threaten the
solvency of the insurer, (ii) may not create a monopoly, (iii) may not be
unfairly discriminatory and (iv) be filed with the California Department of
Insurance.
<PAGE>
In establishing its own rate structure, an insurer is permitted to base
its rates on pure loss cost factors developed by the WCIRB. Pure loss cost
factors represent the estimated dollar costs, expressed as a rate per $100,
needed to pay losses and loss adjustment expenses ("LAE"). These loss cost
factors are developed for each employment classification from the experience of
the workers' compensation industry as reported through mandatory participation
by every insurer in uniform statistical reporting plans. Insurers are allowed
to develop classification subdivisions, but are required to report losses in
compliance with the uniform classification system. An insurer's operating
expenses and a profit factor are added to the pure loss cost factors to derive
base premium rates. The base premium rate is then subject to modification and
adjustments as filed by an insurer. Insurers are permitted to develop their own
rating plans to modify or adopt base premium rates which may include, but are
not limited to (i) schedule rating credits or debits, (ii) loss rating, (iii)
retrospective rating, (iv) minimum premiums, (v) premium discounts, (vi) claim
deductibles and (vii) expense constants. As with the prior rate law, insurers
are required to apply an insured's experience modification factor to derive the
final premium.
Workers' compensation reform laws, enacted in 1993, also increased
certain benefits for injured workers over a three-year period that commenced
July 1, 1994 and at the same time purportedly would decrease the costs of
claims. The reduction in the costs of claims is to be accomplished by additional
anti-fraud measures and by reducing some of the perceived abusive cost drivers
in the workers' compensation system. These include, but are not limited to,
placing restrictions on stress and strain claims, limiting the number of
medical-legal evaluations and capping the amount paid for vocational
rehabilitation services.
California law permits workers' compensation insurers to issue
participating policies, that allow the insurer to declare and pay dividends to a
policyholder after the expiration of the policy. Workers' compensation
insurance carriers are prohibited by law from promising policyholders future
policyholders' dividends or stating the amount or rate of dividends to be paid;
however, companies may compete by informing policyholders of the amount of
dividends historically paid. CIIC has not paid any policyholder dividends since
May 1992 due to regulatory restrictions. Under the new open rating system
effective January 1, 1995, the Company believes that policyholders' dividends
will become a minimal factor in the marketing of workers' compensation policies
in California. In light of this development, the Company began issuing only
non-participating policies effective January 1, 1995.
UNDERWRITING
Prior to insuring a particular risk, the Company reviews, among other
factors, the employer's prior loss experience and premium payment history.
Additionally, the Company determines whether the employer's employment
classifications are among the classifications that the Company has elected to
insure generally and if the amounts of the premiums for the classifications are
within the Company's guidelines. The Company reviews these classifications
periodically to evaluate whether they are profitable. Of the approximately 650
employment classifications in California, the Company is willing to insure
approximately two-thirds. The remaining classifications are either excluded by
the Company's reinsurance treaty or are believed by the Company to be too
hazardous or not profitable. In addition, the Company increases its
requirements for certain classifications to increase the likelihood of
profitability. For example, the Company may require a higher premium on certain
employment classifications or may require a minimum aggregate premium of a
specified amount prior to insuring such classifications. Often, a member of the
Company's loss control department conducts an on-site safety inspection before
the Company insures the employer. The Company generally initiates this
inspection for enterprises with manufacturing or construction classifications.
The Company may also initiate inspections if the enterprise previously has had a
high loss ratio or frequent losses. If the on-site inspection reveals hazards
that can be corrected, and an agreement can be reached with the employer that
these hazards will be corrected in a time frame established by the Company's
Underwriting Department, the Company may issue a policy subject to corrections
of those hazards. In the event the Company has issued a policy where no
previous inspection has been conducted, and subsequently learns through an
inspection the employer has hazards that must be corrected, the Company will
request that the employer correct the hazards within a specified period of time.
If these hazards are not corrected, the Company may cancel the policy for non-
compliance of the hazard correction. With regard to new business, the agent or
broker will usually submit the claims history on the prospective account. In
those situations where the claims history is not supplied by the agent or
broker, other sources (such as the prior insurer) are used to obtain the
appropriate claims history if possible.
In California, under open rating as it becomes effective for
policyholders in 1995, the Company has subdivided many of the standard
classifications. These subclassifications have been determined on the Company's
2
<PAGE>
perception of differences in risk exposure. As a result, different rates have
been filed for each of these subclassifications. The use of these
subclassifications requires more detailed information than was required prior to
open rating. The Company ascertains characteristics of various employers
through the use of questionnaires and telephone inquiries by underwriters. The
responses are used to properly subclassify. Subclassifications are subject to
verification by loss control and premium audits.
Once an employer has been insured by the Company, the Company's loss
control department may assist the insured in developing and maintaining safety
programs and procedures to minimize on-the-job injuries and industrial health
hazards. The safety programs and procedures vary from insured to insured. The
Company's loss control department may recommend to the employer that a safety
committee consisting of members of the employer's management staff and its
general labor force be established. The Company's loss control department may
then assist the committee members in isolating safety hazards, advising the
committee on how to correct the hazards and assisting the employer in
establishing procedures to enforce the corrections. The Company's loss control
department may also revisit the employer to determine whether the recommended
corrections and procedures have been implemented. Depending upon the size,
classifications and loss experience of the employer, the Company's loss control
department will periodically inspect the employer's places of business and may
recommend changes that could prevent industrial accidents. In addition, severe
or recurring injuries may also warrant on-site inspections. In certain
instances, members of the Company's loss control department may conduct special
educational training sessions for insured employees to assist in the prevention
of on-the-job injuries. For example, employers engaged in manufacturing may be
offered a training session on how to prevent back injuries or employers engaged
in contracting may be offered a training session on general first aid and
prevention of injuries to specific work exposures.
The Company is not committed to write any specified portion of its
agents' or brokers' book of business. An insurance broker must obtain the
Company's permission before binding it to any risk. All of the Company's
agents, on the other hand, have the authority to bind the Company on certain
employment classifications for ten days. The Company may decline to further
insure an employer after the 10-day binding period. Insurance agents do not
have authority to bind the Company with respect to employment classifications
that are specifically excluded from the Company's excess reinsurance treaties
because the Company will not accept a risk that may expose it to a catastrophic
loss for which it is not reinsured. Agents are not permitted to bind the
Company to certain employment classifications that the Company has determined
are generally too hazardous or not profitable. Furthermore, an agent is not
permitted to bind any account that was previously canceled by any insurance
company or which any insurance company has declined to insure.
CLAIMS
The claims operation is organized into regional claims service offices.
Most claims are handled to their conclusion at these service offices. However,
major claims, those of high severity, complex nature and/or which are expected
to exceed applicable reinsurance retention levels, are handled directly (or
supervised) by the Home Office reinsurance claims staff.
The Company has sought to reduce its claims and claims settlement costs
by (i) using statewide medical provider networks, the members of which have
agreed to provide hospital, physician and pharmaceutical services at reduced
scheduled fees; (ii) handling its defense litigation obligations with an in-
house claims defense unit consisting of attorneys, hearing representatives and
support staff, representing the majority of the claims previously referred to
outside law firms in Southern California; and (iii) utilizing a medical billing
review service, which advises the Company of any excess charges submitted by
providers. The Company, under open rating, has filed with the California
Department of Insurance to offer claim deductible plans.
LOSSES AND LOSS ADJUSTMENT EXPENSES
Often, several years may elapse between the occurrence of a loss, the
reporting of a loss to the Company and the final settlement of the loss. To
recognize liabilities for unpaid losses, the Company establishes reserves, which
are balance sheet liabilities representing estimates of future amounts needed to
pay claims and related expenses for insured events, including reserves for
events that are incurred but have not yet been reported to the Company ("IBNR").
When a claim is reported, the Company's claims personnel initially
establish reserves on a case-by-case basis for the estimated amount of the
ultimate payment. These estimates reflect the judgment of the claims personnel
based
3
<PAGE>
on their experience and knowledge of the nature and value of the specific type
of claim and the available facts at the time of reporting as to severity of
injury and initial medical prognosis. Included in these reserves are estimates
of the expenses of settling claims, including legal and other fees, and the
general expenses of administering the claims adjustment process. Claims
personnel adjust the amount of the case reserves as the claim develops and as
the facts warrant.
IBNR reserves are established for unreported claims and loss
development relating to current and prior accident years. In the event that a
claim that occurred during a prior accident year was not reported until the
current accident year, the case reserve for such claim typically will be
established out of previously established IBNR reserves for that prior accident
year.
The National Association of Insurance Commissioners requires that the
Company submit a formal actuarial opinion concerning loss reserves with each
statutory annual report. The annual report must be filed with each applicable
state department of insurance on or before March 1 of the succeeding year. The
actuarial opinion must be signed by a qualified actuary as determined by the
California Insurance Commissioner. The Company has retained the services of a
qualified independent actuary to review its loss reserves. Both California
Indemnity and Commercial Casualty received an unqualified opinion from that
actuary as of December 31, 1994.
The Company and its independent actuary test the adequacy of its
reserves using generally accepted actuarial methods. Both paid loss and
incurred loss methods are used to estimate the amount of the ultimate reserves.
The Company also tests its reserves by comparing its paid losses and incurred
losses to similar data provided by the WCIRB for all California workers'
compensation insurance companies.
The Company reviews the adequacy of its reserves with its independent
actuary at the end of each quarter and considers external forces such as changes
in the rate of inflation, the regulatory environment, the judicial
administration of claims, medical costs and other factors that could cause
actual losses and LAE to change. The actuarial projections include a range of
estimates reflecting the uncertainty of projections. Management evaluates the
reserves in the aggregate, based upon the actuarial indications and makes
adjustments where appropriate. The consolidated financial statements of the
Company provide for reserves based on the anticipated ultimate cost of losses.
Unlike losses in general liability insurance, certain costs covered by
workers' compensation insurance are relatively predictable. For example, weekly
indemnity rates for temporary and permanent disability as well as the rates for
medical fees are established by law, resulting in a more predictable basis for
establishing loss reserves. Complicating factors relating to psychological
impairment or pre-existing health conditions are generally unpredictable and
result in a less quantifiable damage assessment for reserving purposes. The
Company has sought to moderate claims costs through medical cost containment
strategies such as discounts through preferred provider arrangements, medical
bill review, and retrospective bill audits. Additional cost containment
measures include vocational rehabilitation of the injured workers and employer
incentives, such as premium discounts, for providing modified jobs to suit the
physical limitations of the injured workers.
The following table sets forth the number of claims reported to the
Company for the accident years ended December 31, 1994, 1993 and 1992, net
earned premiums for the same years and the number of claims per million dollars
of net earned premium (claims frequency).
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1994 1993 1992
----- ------ ------
<S> <C> <C> <C>
Number of claims reported for the accident year 8,300 8,100 8,700
Net earned premiums (in millions) $90.8 $109.6 $103.2
Claims frequency 91.4 73.9 84.3
</TABLE>
The claims frequency for accident year 1994 increased by approximately
24% compared to 1993 and was due primarily to a reduction in the net earned
premiums. The number of claims reported for accident year 1994 also increased
slightly compared to 1993. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
4
<PAGE>
The following table sets forth, for the years ended December 31, 1994,
1993 and 1992, the cumulative loss ratio for each accident year and also shows
the "development" for each of these accident years' loss ratio(s).
<TABLE>
<CAPTION>
Cumulative Loss Ratio(s)
Year ended December 31,
------------------------
Accident Year 1994 1993 1992
---------------- ------- ------- -------
<S> <C> <C> <C>
1990 and prior 89.99% 89.47% 88.74%
1991 100.98% 100.80% 100.31%
1992 75.34% 83.30% 88.63%
1993 72.88% 79.02%
1994 74.50%
</TABLE>
Despite the fact that the claims for which reserves are established may
not be paid for many years, the reserves for losses and LAE payments are not
discounted for financial reporting purposes.
The following table provides a reconciliation of the beginning and
ending reserve balances for unpaid losses and loss adjustment expenses on a net
of reinsurance basis.
RECONCILIATION OF LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------
1994 1993 1992
-------- -------- --------
(In thousands)
<S> <C> <C> <C>
Net beginning loss and LAE reserve $174,515 $158,253 $112,749
Net provision for:
Insured events incurred in current period 67,642 86,617 91,430
Insured events incurred in prior periods (13,953) (3,865) 28,066
-------- -------- --------
Total net provision 53,689 82,752 119,496
-------- -------- --------
Net payments for losses and LAE:
Attributable to insured events incurred in current year 16,374 16,130 16,381
Attributable to insured events incurred in prior years 50,210 50,360 57,611
-------- -------- --------
Total net payments 66,584 66,490 73,992
-------- -------- --------
Net ending loss and LAE reserve 161,620 174,515 158,253
Reinsurance recoverable/(1)/ 29,342 25,841 20,207
-------- -------- --------
Gross ending loss and LAE reserve $190,962 $200,356 $178,460
======== ======== ========
</TABLE>
-------------
(1) See footnote (1) to the following table -- Analysis of Losses and Loss
Adjustment Expense Development.
In 1994, the Company experienced a favorable loss development trend on
prior accident years 1992 and 1993 which resulted in a net reduction in the
prior accident years' reserves of $13,953,000. The favorable development on the
1992 accident year was primarily due to the Company's aggressive actions to
settle claims. The favorable development on the 1993 accident year appears to be
aided in part by the legislative reforms that were enacted in July 1993. In
1993, a favorable development on the prior accident years resulted in a net
reduction to the incurred losses of $3,865,000. There can be no assurances that
such favorable development, nor the magnitude of any favorable development, will
continue in the future.
During the first and second quarters of 1992 and the fourth quarter of
1991, the Company significantly increased its loss reserves for 1991 and prior
accident years. This was primarily due to the increased frequency and severity
of stress and strain claims and the increased use of forensic medical
examinations associated with litigation of claims.
5
<PAGE>
Anticipated inflation is implicitly considered in establishing and
evaluating the adequacy of reserves through the analyses of cost trends and
historical development. The reserves for unpaid losses and LAE are not
discounted to present value. Loss and LAE reserves are computed in the same
manner for both generally accepted accounting principles ("GAAP") and statutory
accounting principles bases. However, the balance sheet presentation of reserves
differ between the two methods by the amount of reinsurance recoverables on
unpaid losses and LAE. Statutory accounting principles require that reinsurance
recoverables on unpaid losses and LAE be netted against the related gross loss
and LAE reserves. Starting with the balance sheet at December 31, 1992, under
GAAP, these reinsurance recoverables are now shown as an asset.
The following table discloses the development of the liability for
losses and LAE of the Company for the seven years ended December 31, 1994.
ANALYSIS OF LOSSES AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------------------------------------------
1994 1993 1992 1991 1990 1989 1988
-------- -------- -------- -------- ------- ------- -------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Loss and LAE reserve
reported on balance sheet $190,962 $200,356 $178,460 $112,749 $67,593 $37,466 $10,277
Less reinsurance
recoverables/(1)/ 29,342 25,841 20,207
-------- -------- --------
Net loss and LAE
reserve 161,620 174,515 158,253
Net reserve re-
estimated as of:
One year later 160,562 154,388 140,815 83,841 37,463 10,072
Two years later 147,167 142,447 96,011 39,753 9,902
Three years later 143,433 97,142 43,528 9,598
Four years later 97,942 44,404 9,330
Five years later 45,027 10,042
Six years later 10,110
Cumulative redundancy
(deficiency) 13,953 11,086 (30,684) (30,349) (7,561) 167
Cumulative net paid
as of:
One year later 50,210 50,360 57,611 39,118 14,820 3,954
Two years later 84,465 89,177 65,165 28,657 6,609
Three years later 108,849 76,988 36,579 8,198
Four years later 83,822 39,345 8,938
Five years later 41,043 9,235
Six years later 9,398
</TABLE>
(Continued on next page)
6
<PAGE>
ANALYSIS OF LOSSES AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT (Continued)
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------------------------------------
1994 1993 1992 1991 1990 1989 1988
------- ------- ------- ------- ------- ------- -------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Net reserve 161,620 174,515
Reinsurance recoverables 29,342 25,841
------- -------
Gross reserve 190,962 200,356
Net re-estimated reserve 160,562
Re-estimated reinsurance
recoverables 19,995
-------
Gross re-estimated reserve 180,557
-------
Gross cumulative redundancy
(deficiency) 19,799
------------
</TABLE>
(1) The Company adopted Financial Accounting Standards Board ("FASB") Statement
No. 113, "Accounting and Reporting for Short-Duration and Long-Duration
Reinsurance Contracts" for the year ended December 31, 1992. As permitted,
prior financial statements have not been restated. Reinsurance recoverables
on unpaid losses and LAE are now shown as an asset on the balance sheets at
December 31, 1994 and 1993. However, for purposes of the reconciliation and
development tables, loss and LAE information will be shown net of
reinsurance.
The first line of the preceding table depicts the estimated ultimate
liability for unpaid losses and LAE recorded at the balance sheet date for each
of the indicated periods. This liability represents the estimated amount of
losses and LAE for claims arising in all prior years that are unpaid as of the
balance sheet date, including IBNR losses. The preceding table also shows the
reestimated amount of the previously recorded liability based on experience as
of the end of each succeeding year. The "cumulative redundancy (deficiency)"
represents the aggregate change in the estimates over all prior years. The
impact on the results of operations, for the past three years, on changes in
reserve estimates is shown in the reconciliation table above the development
table. It should be noted that the development 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.
Conditions and trends that have historically affected the Company's
claims may not necessarily indicate conditions and trends that will affect
future claims. Accordingly, it may not be appropriate to extrapolate future
redundancies or deficiencies based on the results set forth above.
INVESTMENTS
First Quadrant Corp. assumed certain investment management
responsibilities with respect to California Indemnity's portfolio from 1991
through 1994. The Company established guidelines (that applied to both
California Indemnity and Commercial Casualty) requiring 90% or more of its
investment portfolio to be invested in cash, U.S. Treasury securities, state and
municipal obligations, certificates of deposit issued by commercial banks,
repurchase agreements with commercial banks backed by the U.S. Treasury or
federal agency obligations, and other similar investments. The Company does not
currently use an outside investment manager. It does not have any material
investments in real estate, derivative-type financial instruments or high-yield
debt securities. Investments are maintained in one or more custodial accounts
with commercial banks or other financial institutions authorized to act as
custodians.
During the period in which First Quadrant Corp. served as investment
manager, a portion of the available excess cash was invested in a bond trading
portfolio. Investment grade bonds that had the potential to generate a short-
term capital gain were targeted for acquisition. Trading activity during 1994
was significantly lower compared to 1993 and resulted in a decrease in the
trading gains. The Company eliminated the bond trading portfolio in December
1994.
7
<PAGE>
The following table reflects investments, interest earned thereon and the
average annual yield on investments for the periods indicated:
Year ended December 31,
------------------------------
1994 1993 1992
-------- -------- --------
(Dollars in thousands)
Total investments at end of period $221,717 $207,487 $183,987
Net investment income including net
realized gains and losses before taxes 12,792 13,831 11,746
Average annual yield on investment
portfolio (before realized gains and taxes) 5.7% 5.7% 6.1%
The following table sets forth information concerning the composition of
the Company's investment portfolio at December 31, 1994:
Percent of
Amount portfolio
-------- ----------
Fixed maturities: (Dollars in thousands)
U.S. government and government agencies $ 69,112 31.2%
AAA 72,390 32.6
AA 35,666 16.1
A 22,592 10.2
Less than A 1,148 0.5
-------- -----
Total fixed maturities 200,908 90.6
Investment grade short-term investments/(1)/ 14,489 6.6
Equity securities 479 0.2
Mortgage loans receivables 5,841 2.6
-------- -----
Total investments $221,717 100.0%
======== =====
------------
(1) As used above, "investment grade" means rated as such by any nationally-
recognized rating agency.
The following table sets forth the expected maturity profile of the
Company's investment portfolio other than equity securities at December 31,
1994:
Percent of
Maturity Amount portfolio
-------- --------- -----------
(Dollars in thousands)
One year or less $ 49,058 22.2%
More than one year, through five years 45,460 20.5
More than five years, through ten years 78,668 35.6
More than ten years, through fifteen years 40,725 18.4
More than fifteen years 7,327 3.3
-------- -----
Total $221,238 100.0%
======== =====
REINSURANCE
The Company follows the customary industry practice of reinsuring part
of its risks. Insurance is ceded principally to reduce the liability on
individual risks and to protect against catastrophic losses.
The Company maintains in force "excess" reinsurance treaties. The
principal advantage of excess reinsurance treaties is to protect the Company
from sustaining a large loss with respect to a single risk or occurrence. In
essence, the reinsurer reimburses the Company for large losses above a certain
level. Under reinsurance treaties relating to losses occurring from 1992
through 1995, the reinsurers assume liability on the portion of loss that
exceeds $250,000 up to a maximum of $60,000,000 per occurrence. The Company
selects its reinsurers based upon ratings, pricing and other factors. The
Company requires each reinsurer assuming the first $10,000,000 of liability
(currently only General Reinsurance Corporation) to be rated A or better by the
A.M. Best Company ("A.M. Best") and each reinsurer assuming
8
<PAGE>
liability above that amount to be rated B or better by A.M. Best. The Company's
current reinsurers are General Reinsurance Corporation, Insurance Company of
North America, Federal Insurance Company and Continental Casualty Insurance
Company. The Company annually reviews its reinsurers' financial statements,
rating information and other publicly available documents to monitor such
reinsurers' financial condition and claims paying ability.
The Company is liable for losses above the maximum amount reinsured.
Reinsurance does not discharge an insurer from direct responsibility for payment
of the full amount of any covered loss, but the reinsurers are liable to the
insurer for the portion they have assumed. Excess reinsurance treaties enable
the Company to write a greater amount of business because of the reduction of
risk; however, the Company must pay a premium to its reinsurers.
MARKETING
The Company's insurance policies are sold primarily through independent
insurance agents and brokers, who may also represent other insurance companies.
The Company believes that independent insurance agents and brokers choose to
market the Company's insurance policies because of the quality of service that
the Company provides, the commissions the Company pays and the uniqueness of the
Company's rating plans under the new open rating environment. The Company
employs full-time employees as marketing representatives to make personal
contacts with agents and brokers, to maintain regular communication with them,
to advise them of the Company's services and products, and to recruit additional
agents and brokers. The Company currently has relationships with approximately
490 agents and 30 brokers and pays its agents and brokers commissions based on a
percentage of the gross written premium produced by such agents and brokers. In
1995, the Company anticipates a reduction in the number of agents resulting from
more stringent volume and profitability standards enacted by the Company.
The Company maintains standard commission plans for its agents and
brokers that vary by state. In addition to the standard commission plans,
agents and brokers may be eligible to receive additional commissions in certain
instances. Commissions payable, including additional commissions if any, are
negotiated on an individual policy basis. No one agent or broker accounted for
more than 7.5% of the Company's total premiums in force at December 31, 1994,
and no one policy accounted for more than 3.3%. From time to time, the Company
also uses direct mail, institutional advertising and participation in insurance
trade association functions to maintain existing relationships and develop new
ones.
In 1994, the first year it was eligible to receive an A.M. Best Company
("A.M. Best") rating, the Company's insurance subsidiaries received a rating of
B+. This rating is assigned to those companies, which in the opinion of A.M.
Best, "have achieved very good overall performance when compared to the norms of
the property/casualty insurance industry."
A.M. Best is a widely recognized insurance rating organization. To be
eligible for an initial letter rating from A.M. Best, an insurance company must
have a minimum statutory policyholders' surplus of $1,500,000 and have had a
minimum of five consecutive years of representative operating experience. A.M.
Best assigns a total of 15 letter ratings ranging from a low of F (in
liquidation) to A++ (superior). The letter ratings are further grouped into
"secure ratings" (consisting of B+ or better) and "vulnerable ratings"
(consisting of B or less). The B+ rating is the sixth highest rating in the
A.M. Best letter rating system. While meeting the minimum surplus requirements,
the Company's insurance subsidiaries did not meet the minimum operating
experience requirement until they had completed the 1993 fiscal year.
9
<PAGE>
The following tables set forth information concerning the percentages of
premiums and policies in force with the Company by geographic area as of
December 31, 1994, 1993 and 1992:
<TABLE>
<CAPTION>
December 31,
------------------------------
1994 1993 1992
-------- -------- ---------
(Dollars in thousands)
<S> <C> <C> <C>
Percent of premiums in force:
Southern California (excluding San Diego) 31% 29% 40%
Northern California 48 54 47
San Diego 8 9 11
Colorado 12 8 2
Other States 1 -- --
------- -------- -------
Total 100% 100% 100%
======= ======== =======
Total premiums in force $94,091 $105,944 $96,897
Percent of policies in force:
Southern California (excluding San Diego) 28% 27% 33%
Northern California 59 60 55
San Diego 8 10 11
Colorado 4 3 1
Other States 1 -- --
------- -------- --------
Total 100% 100% 100%
======= ======== =======
Total policies in force 7,500 9,000 8,900
</TABLE>
The Company will continue to expand into other states as the opportunity
to write profitable business arises.
COMPETITION
The California workers' compensation insurance industry is extremely
competitive. Based upon data provided by the WCIRB as of December 31, 1993,
which is the latest data available, there were approximately 230 insurance
companies writing workers' compensation insurance in California. Many of the
Company's competitors have been in business longer, have a larger volume of
business, offer a more diversified line of insurance coverage, have greater
financial resources and have greater distribution capability than the Company.
The largest writer of workers' compensation insurance in California is the State
Compensation Insurance Fund. Prior to 1995, the Company concentrated on
insuring workers' compensation accounts in the small to medium-size range.
Under the current open rating environment, the Company is actively pursuing
accounts of all sizes.
Prior to 1995, many workers' compensation insurance companies competed
in California primarily based on quotations of policyholders' dividends and by
providing services to the agents and policyholders such as loss control and
flexible billings. In 1994, with the rate reductions in the California minimum
manual rates, the Company's competitors used the new lower minimum rates. The
Company did not follow the rest of the industry by quoting all policies at the
new lower rates. Instead, the Company attempted to maintain a profitable book
of business through risk selection and the use of premium surcharges. This
affected the Company's ability to effectively compete for some business because
its prices were higher than those quoted by the competition. To a greater
extent, the Company's volume was adversely impacted by the Company's inability
to pay policyholder dividends and the Company not applying the July 1993 7% rate
reduction. See "Regulation" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations." The Company also extended its
extra commission programs to attract profitable accounts.
The Company believes that under open rating, the price of the workers'
compensation policy will probably become the dominant deciding factor. A
secondary factor will be how an insured can either reduce its loss experience or
prevent future industrial accidents from occurring. This can be accomplished by
the loss control prevention services that an insurer can provide to an insured
and by cost reduction plans, such as medical cost savings, pre-employment
physicals
10
<PAGE>
and on-going substance abuse screenings. The Company's insurance subsidiaries'
operating costs were higher than the industry average due to the extra
commissions and the staff required to provide what the Company believes to be
better services to agents and insureds.
In the other states in which the Company is currently writing business,
competition for workers' compensation insurance is primarily driven by price and
secondarily by services provided to insureds and agents. Commissions are
normally not a dominant competitive factor. In those states, the National
Council on Compensation Insurance ("NCCI") is usually the designated rating
organization. Like the WCIRB in California, the NCCI accumulates statistical
information and recommends pure loss costs to the state's Department of
Insurance. As in California under the new open rating environment, the Company
then adds loss cost multipliers or expense loads to derive premium rates. Rating
plans in those states are more "standardized" and are usually based on plans
developed by the NCCI. Unlike California, where the Company has developed
subclasses, the Company will use standard classes in the other states.
In Colorado, approximately 200 companies write workers' compensation
insurance. The Colorado Compensation Insurance Authority (a.k.a. State
Compensation Fund) is the largest writer of workers' compensation insurance and
wrote just under 50% of the total workers' compensation premiums in 1993.
Commissions paid to agents and brokers in Colorado are lower than in California
and the Company issues only non-participating policies.
PROPERTY AND CASUALTY DIVISION
As of December 9, 1994, the Company, through a wholly-owned subsidiary,
entered into an agreement with Prudential General Insurance Company ("Prudential
General"), an affiliate of Prudential Reinsurance Corporation of Newark, N.J.
("Prudential Reinsurance"), to act as program administrator for the marketing,
underwriting, and servicing of property and general liability coverages to be
offered in business packages to small and medium sized business owners
throughout the state of California. Business written in 1994 was insignificant.
This newly created property and casualty division underwrites risks
within carefully selected business classifications that the Company believes
will be profitable. The rules, rates and forms of Prudential General are used
to provide business package policies to owners of apartments, restaurants,
motels, taverns and lessors/owners of retail, industrial and office properties.
Prudential General will cede this business to Prudential Reinsurance
which will, by way of a concurrent agreement with the Company, retrocede 50% of
the business to a Company subsidiary. The Company subsidiary has obtained
excess treaty reinsurance for protection above $100,000 on the portion of risk
it will assume from Prudential Reinsurance.
The Prudential General policies are marketed through independent brokers
who have a profitable, existing volume of the types of business being targeted
and an expertise for marketing speciality program type products. The Company
believes that the independent brokers who qualify for marketing the products of
the property and casualty division will choose to do so because of the
division's focus on outstanding service, quality protection at reasonable
pricing levels and professional treatment from an experienced staff that seeks
continual improvement. Brokers are paid a commission of 15% on the annual
premiums they place with the division. No binding authority is granted to
anyone other than the division's underwriting staff.
The material risks associated with the property and general liability
business are (i) the unpredictable nature of the costs of loss and LAE; (ii) the
exposure to the catastrophic elements of nature; (iii) the potential for
significant lapses of time between the occurrence of a loss, the reporting of a
loss to the Company and the final settlement of the loss; and (iv) the
unpredictable nature of court interpretations and/or jury awards in litigated
claims.
The Company and Prudential General, in this affiliation, have attempted
to address, minimize and control these risks by selecting types of operations in
which the normal hazards expose the Company to risk that manifests in claims for
damages or loss within a relatively short time following the occurrence. The
claim for damage or loss does not normally involve complex coverage and/or
exposure issues; and many catastrophic exposures, such as earthquake, flood, and
pollution and contamination are excluded by the Prudential General policy forms.
11
<PAGE>
In addition to selection of risk with hazards that are generally more
predictable in nature than a broad cross section of all property and liability
operations, the claims personnel of the division will set reserves for damages
and expenses on a case by case basis, reflecting the experienced judgement of
the nature and value of each specific case, and the Company will set reserves
for IBNR and loss development to be tested regularly by the Company and its
independent actuary.
INSURANCE PREMIUM FINANCE
CIIPF issues insurance premium finance loans for commercial insurance
policies, such as property-casualty and liability insurance policies. An
insurance premium finance loan is a secured installment loan made to finance
commercial insurance premiums that have prepaid cash equity available upon
cancellation of the insurance policy. A premium finance company retains a
security interest in the return premium and the right to cancel the insurance
policy in certain circumstances (for example, failure by the insured to make
installment payments when due). Return premiums are sent directly to the
premium finance company by the insurer, and not to the insured, upon
cancellation. Assuming prompt cancellation of an insurance policy by the
premium finance company upon failure by the insured to make installment payments
when due, the amount of the return premium, when combined with payment made by
the insured prior to cancellation, will exceed the amount of the earned premium
at the time of cancellation. The average financed premium at December 31, 1994
was approximately $5,600, with an average deposit premium of 20% to 28% of the
total premium based on the length of the financed loan, which varies between
seven and nine months. The interest rates on the Company's insurance premium
finance loans are fixed and range from 7% to 24% per annum. Under California
law, an insurance premium finance company may charge an unlimited amount of
interest on any insurance premium finance loan having an initial principal
balance of $2,500 or more. On loans having an initial principal balance of less
than $2,500, an insurance premium finance company may charge interest not to
exceed the greater of (i) 1.6% per month on the outstanding principal balance or
(ii) 2% per month on the then current outstanding principal balance up to and
including $1,000 and 1% per month on the excess over $1,000.
The material risks associated with the business of insurance premium
financing are (i) failure by the insurance premium finance company to timely
cancel the insurance policy after the borrower defaults and (ii) financial
failure of the insurance company underwriting the financed policy. The Company
reduces these risks by establishing and maintaining an internal control
structure and procedures by which policy cancellations are timely made. In
addition, the Company has established internal policies that are designed to
ensure that the policies it finances are issued by financially sound insurance
companies.
As of December 31, 1994, CIIPF had approximately 7,600 loans in force
representing an aggregate outstanding principal balance of approximately
$15,576,000. CIIPF finances part of its operations with debt. Debt incurred by
CIIPF as of December 31, 1994 consisted of a line of credit from First
Interstate Bank of California with a balance as of December 31, 1994 of
$8,000,000 and a loan and advances from CII Financial of $8,533,000. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
INTELOCK
In June 1993, the Company acquired an 80% interest in InteLock, a
manufacturer of electronic door locks. The cost of the acquisition was not
significant and results of operations of InteLock did not materially affect the
consolidated financial statements for the year ended December 31, 1993.
InteLock is approximately three years old and manufactures battery-
powered, electronic key-optional door locks that are primarily targeted for the
consumer market. The locks are designed to replace existing standard bored-hole
household locks without the need to re-drill holes in many cases. The door lock
models consist of (i) single entry, (ii) combination with deadbolt, and, most
recently, a (iii) stand alone deadbolt. The lock mechanism, including the
deadbolt, can be engaged from the outside without a key and can be opened by
either entering the proper digital combination number or conventionally with a
key. This technology is patented in the United States and in various foreign
countries with additional patents pending.
InteLock's door locks are unique in that they are the only known
electronic locks that are specifically targeted to the consumer market.
However, the consumer market is dominated by the less expensive conventional
mechanical door lock. In the electronic commercial lock market, InteLock will
face strong competition from much larger
12
<PAGE>
and more established companies. Most commercial locks are mortise type locks
whereas InteLock uses a bored-hole type lock which is usually easier to install.
However, from a security standpoint, the mortise lock offers more protection
than the bored-hole lock.
The majority of InteLock's sales occur through three primary sources:
warehouse-type hardware retailers, the QVC Home Shopping Network and locksmith
distributors. In 1994, these three sources represented approximately 59%, 16%
and 10%, respectively, of total net sales. Other sales distributions are
through hardware stores, catalog sales, and independent locksmiths. Foreign
sales have been minimal to date. Customers who represent more than 10% of total
net sales are Home Depot (39.7%) and QVC (16.1%). Approximately 72% of
InteLock's sales occurred during the months of September through March. Sales
in the United States by region were fairly equally distributed. Sales backlog
at December 31, 1994 was immaterial. In 1995, InteLock intends to develop a
lock to market to commercial and lodging sales establishments. InteLock uses
independent commissioned sales representatives to market its products, and
advertising is primarily limited to sales brochures.
The locks use some "standard" locking mechanisms (e.g., cylinders,
deadbolts etc.) that are purchased from other lock manufacturers. The majority
of the parts, however, are unique to InteLock products. These parts are
manufactured in the United States and Taiwan using tools owned by InteLock. The
lock is then assembled in its Pleasanton plant. InteLock has had problems with
one major Taiwan supplier resulting in higher manufacturing costs and is phasing
out its relationship with this supplier as it brings on line new lock designs.
InteLock's new stand alone digital deadbolt was scheduled to be marketed
in the fourth quarter of 1994. However, one of the vendors of a critical part
could not meet its production commitment. A replacement vendor was obtained
which delayed the production of the new lock. This delay also prevented
InteLock from marketing the lock during the fall buying season. The lock is now
in production and is currently being shipped.
REGULATION
The Company is subject to extensive governmental regulation and
supervision in each state in which it does business. The primary purpose of
such regulation and supervision is to provide safeguards for policyholders and
injured workers rather than protect the interests of shareholders. The extent
and form of the regulation may vary, but generally has its source in statutes
that establish regulatory agencies and delegate to the regulatory agencies broad
regulatory, supervisory and administrative authority. Typically, state
regulations extend to such matters as licensing companies; restricting the types
or quality of investments; requiring triennial financial examinations and market
conduct surveys of insurance companies; licensing agents; regulating aspects of
a company's relationship with its agents; restricting use of some underwriting
criteria; regulating rates, forms and advertising; limiting the grounds for
cancellation or nonrenewal of policies, solicitation and replacement practices;
and specifying what might constitute unfair practices.
In the normal course of business, the Company and the various state
agencies that regulate the activities of the Company may disagree on
interpretations of laws and regulations, policy wording and disclosures, or
other related issues. These disagreements, if left unresolved, could result in
administrative hearings and/or litigation. The Company attempts to resolve all
issues with the regulatory agencies, but is willing to litigate issues where it
believes it has a strong position. The ultimate outcome of these disagreements
could result in sanctions and/or penalties and fines assessed against the
Company. Currently, there are no litigation matters pending with any department
of insurance. However, the Company is currently in discussion with the
California Department of Insurance ("CADOI") regarding the application of the
7% rate reduction which was mandated by the July 1993 workers' compensation
legislative reforms. The Company's position is that the 7% rate reduction is
only applicable to new and renewal policies issued on or after the date the
legislation became effective. The Company believes that it does not have to
reduce the premiums mid-term on inforce policies especially if those policies
were issued at a surcharge or had marginal prior loss experience. The Company
is attempting to negotiate this issue with the CADOI and, if necessary, will
litigate the matter. The unaccrued liability, if any, related to this issue
will not adversely affect, in any material respect, the accompanying
consolidated financial statements at December 31, 1994.
State holding company acts also regulate changes in control of insurance
holding companies, such as CII Financial, and transactions and dividends between
an insurance company and its parent or affiliates. Although the specific
provisions vary, holding company acts generally prohibit a person from acquiring
a controlling interest in an insurer unless the insurance authority has approved
the proposed acquisition pursuant to applicable regulations. In many states,
including California, where the insurance subsidiaries are incorporated,
"control" is presumed to exist if 10% or more of the voting
13
<PAGE>
securities of the insurance holding company are owned or controlled by one
person or entity. In addition, the insurance authority may find that "control"
in fact does or does not exist where one person or entity owns or controls
either a lesser or a greater amount of securities. The holding company acts
also impose standards on certain transactions with related companies and
individuals which include, among other requirements, that all transactions are
to be fair and reasonable and that transactions exceeding specified limits
receive prior regulatory approval.
Typically, states mandate participation in insurance guaranty
associations, which assess solvent insurance companies in order to fund claims
of policyholders of insolvent insurance companies. Under this arrangement,
insurers can be assessed up to 1% (or 2% in certain states) of premiums written
for workers' compensation insurance in that state each year to pay losses and
LAE on covered claims of insolvent insurers. In California and certain other
states, insurance companies are allowed to recoup such assessments from
policyholders while several states allow an offset against premium taxes.
Potential assessment expenses, net of recoupment, if any, for insolvencies are
not accrued until after an insolvency has occurred since the likelihood and the
amount of the assessment expense cannot be reasonably determined or estimated.
In California, there have been no new assessments for insolvent workers'
compensation insurance companies since 1990.
California's Insurance Holding Company Act regulates the payment of
shareholder dividends by insurance companies. See Note 8 to the Notes to
Consolidated Financial Statements. To date, the insurance subsidiaries have not
paid dividends to CII Financial.
Besides state insurance laws, the Company is subject to general business
and corporation laws, federal and state securities laws, consumer protection
laws, fair credit reporting acts and other laws.
EMPLOYEES
As of December 31, 1994, the Company employed approximately 410
employees, of which 38 were employed by InteLock. The Company believes its
relationship with its employees is good.
ITEM 2. PROPERTIES
The Company's principal executive offices and Northern California branch
office, as well as InteLock Technologies plant, comprised of approximately
74,300 square feet of office space leased through October 31, 1999, are located
in Pleasanton, California. The Company's Southern California branch office and
CIIPF's principal executive offices, comprised of approximately 45,000 square
feet of office space leased through September 30, 1998, are located in Burbank,
California. The Company also leases space in other locations where it has
operations and monitors to assure it has adequate facilities for its needs.
ITEM 3. LEGAL PROCEEDINGS
The insurance subsidiaries are parties to various legal proceedings, all
of which are considered routine and incidental to the Company's business and are
not material to the financial condition and operation of the business. No
litigation to which the Company is a party is expected to have a material
adverse affect upon the Company's business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of the Company's fiscal year ended December 31, 1994.
14
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER
MATTERS
MARKET INFORMATION
CII Financial's Common Stock is traded on the American Stock Exchange
under the symbol CII. The following table sets forth, for each period indicated
during 1994 and 1993, the high and low sale prices for the Common Stock, as
reported on the American Stock Exchange.
<TABLE>
<CAPTION>
High Low
------ ------
<S> <C> <C>
1994:
First Quarter $7.375 $4.750
Second Quarter 6.250 4.625
Third Quarter 6.375 5.000
Fourth Quarter 6.250 4.750
High Low
------ ------
1993:
First Quarter $6.875 $4.625
Second Quarter 7.000 5.125
Third Quarter 6.250 5.000
Fourth Quarter 7.500 5.250
</TABLE>
HOLDERS
As of March 20, 1995, there were 211 registered holders of record of
CII Financial's Common Stock. This number does not include shares held in
custodial, nominee or brokerage accounts.
DIVIDENDS
CII Financial has never paid a dividend to shareholders and does not
anticipate paying cash dividends on its Common Stock in the foreseeable future.
In addition, as an insurance holding company, CII Financial's internal source of
funds would be dependent upon dividends received from its insurance and other
subsidiaries, and the payment of shareholder dividends by its insurance
subsidiaries is subject to regulation under California law. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources" and Note 8 to Notes to Consolidated Financial
Statements.
15
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain selected consolidated financial data of
the Company for the years ended December 31, 1994, 1993, 1992, 1991 and 1990.
The table should be read in conjunction with, and is qualified in its entirety
by, the consolidated financial statements and the notes thereto, and
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------------------------------
1994 1993 1992 1991 1990
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
(In thousands, except per share and percentages)
INCOME STATEMENT DATA:
Direct written premiums $ 92,983 $113,954 $103,226 $110,582 $ 89,386
======== ======== ======== ======== ========
Net written premiums $ 89,098 $109,541 $ 99,078 $104,685 $ 85,303
======== ======== ======== ======== ========
Net earned premiums $ 90,800 $109,614 $103,166 $101,701 $ 81,172
Net investment income 12,792 13,831 11,746 9,455 6,087
Other revenues 4,723 2,757 1,591 1,083 --
-------- -------- -------- -------- --------
Total revenues 108,315 126,202 116,503 112,239 87,259
Total costs and expenses 99,771 121,404 157,727 131,001 79,163
-------- -------- -------- -------- --------
Income (loss) before
federal income taxes and
extraordinary item 8,544 4,798 (41,224) (18,762) 8,096
Federal income tax expense
(benefit) (3,695) 196 1,355 (2,542) 1,662
Extraordinary gain -- -- 457 -- --
-------- -------- -------- -------- --------
Net income (loss) $ 12,239 $ 4,602 $(42,122) $(16,220) $ 6,434
======== ======== ======== ======== ========
Income (loss) per share
before extraordinary gain $ 1.70 $ .64 $ (5.94) $ (2.25) $ 1.22
Extraordinary gain per share -- -- 0.06 -- --
-------- -------- -------- -------- --------
Net income (loss) per share,
fully diluted $ 1.70 $ .64 $ (5.88) $ (2.25) $ 1.22
======== ======== ======== ======== ========
Weighted average number of
shares outstanding 7,181 7,142 7,168 7,210 5,275
======== ======== ======== ======== ========
Ratio of earnings to fixed
charges/(1)/ 3x 2x --/(2)/ --/(2)/ 47x
UNDERWRITING RATIOS:
GAAP Combined Ratio:
Loss ratio 59.1% 75.5% 115.8% 100.7% 70.2%
Underwriting expense ratio/(3)/ 37.8 29.0 31.0 25.4 27.0
-------- -------- -------- -------- --------
Combined ratio 96.9% 104.5% 146.8% 126.1% 97.2%
======== ======== ======== ======== ========
Statutory Combined Ratio:
Loss ratio 59.1% 75.5% 115.8% 100.7% 70.2%
Underwriting expense ratio/(3)/ 39.5 29.3 31.4 27.7 23.7
-------- -------- -------- -------- --------
Combined ratio 98.6% 104.8% 147.2% 128.4% 93.9%
======== ======== ======== ======== ========
BALANCE SHEET DATA:
Total investments $221,717 $207,487 $183,987 $192,799 $125,331
Total assets 307,827 295,356 265,735 248,187 160,378
Total long-term debt 56,800 56,800 56,800 58,250 --
Total liabilities 279,292 278,030 253,682 193,825 89,123
Total shareholders' equity 28,535 17,326 12,053 54,362 71,255
------------
</TABLE>
(1) For the purpose of calculating the ratio of earnings to fixed charges,
earnings consist of income before federal income taxes and fixed charges.
Fixed charges consist of interest expense and a representative portion of
rental expense.
(2) Earnings were inadequate to cover fixed charges by $45,686,000 and
$20,337,000 for the years ended December 31, 1992 and 1991, respectively.
(3) Includes policyholders' dividends which are immaterial.
16
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The profitability of the Company is affected by many factors, including
(i) competition; (ii) the severity and frequency of claims; (iii) state
regulation of business activities, including premium rates and benefits payable
for injuries and losses; and (iv) general business conditions. The historical
information presented may not necessarily be comparable to or indicative of
future results of operations of the Company.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1994
COMPARED TO THE YEAR ENDED DECEMBER 31, 1993
Total revenues of the Company for the year ended December 31, 1994
decreased 14.2% to $108,315,000 compared to $126,202,000 for the year ended
December 31, 1993. The decrease in revenues during this period was primarily
attributable to decreased premium writings and realized investment gains.
Comparing the 1994 and 1993 year end periods, net earned premiums decreased by
$18,814,000, net investment income, excluding investment gains, increased by
$871,000, net investment gains decreased by $1,910,000, InteLock net sales
increased by $1,186,000, premium finance revenues increased by $210,000, and
other revenues, consisting primarily of agency commissions, increased by
$570,000.
Direct written premiums for the year ended December 31, 1994 decreased
by 18.4% to $92,983,000 compared to $113,954,000 for the year ended December 31,
1993 and was primarily due to a decrease in business written in California,
partially offset by an increase in business written in other states. During
1994, direct written premiums in the six county area of Southern California
decreased by $11,526,000 or 30.4% to $26,369,000 from 1993 while direct written
premiums in other areas of California decreased by $13,865,000 or 20.5% to
$53,809,000. Total California direct written premiums decreased by $25,391,000
or 24.1% compared to 1993. Direct written premiums in Colorado and other states
increased by $4,420,000 or 52.7% to $12,805,000. For the year ended December
31, 1994, approximately 40% of the total direct written premiums were for new
business compared to approximately 53% for the prior year.
The decrease in California writings was primarily due to (i) the
Company's inability to pay policyholders' dividends because of regulatory
restrictions, (ii) the Company not fully applying the 7% rate reduction to
inforce policies and (iii) the decreases in the manual rates. The legislative
reforms enacted in July 1993 included a rate reduction of 7%. The 7% rate
reduction was applied to policies issued after the effective date of July 16,
1993. However, the Company disagrees with the California Department of
Insurance as to the application of the rate reduction to inforce policies. To
date, this issue has not been resolved and the Company believes that the net
unaccrued cost will not materially affect the consolidated financial statements.
Additional rate reductions were ordered by the California Insurance Commissioner
effective January 1, 1994 of 12.7% and 16% effective October 1, 1994. Unlike
the competition, which appeared to readily accept the rate reductions, the
Company attempted to maintain a profitable book of business through risk
selection and the use of premium surcharges. The latter had an adverse impact
on premium writings as some of the Company's premium quotes were uncompetitive.
The competition also appeared to focus on maintaining premium volume in
anticipation of the open rating environment in California which begins in 1995.
The pricing of accounts became much more aggressive through the use of higher
commission payments that the agent could voluntarily rebate commissions to lower
the premium cost to the policyholder.
The average number of policies in force decreased by 9.8% from 8,696 for
the year ended December 31, 1993 to 7,847 for the year ended December 31, 1994
and was primarily related to a loss in smaller accounts which had relatively
more surcharges imposed compared to the larger premium size accounts. The
average written premiums per policy slightly increased from $12,462 in 1993 to
$12,490 in 1994 and was attributable to the writing of larger size accounts in
Colorado and other states and offset by a reduction in similar size accounts in
California. During 1994, the Company expanded its workers' compensation
insurance writings into the states of Nebraska and New Mexico.
Geographically, at December 31, 1994, 31.2% of the total inforce
premiums were written in the six county area of Southern California, 55.8% in
all other areas of California, 12.1% in Colorado and 0.9% in other states.
Comparable geographic percentages at December 31, 1993 were 29.2% for Southern
California, 63.1% for all other areas of California, and 7.6% for Colorado and
0.1% for other states.
17
<PAGE>
Net written premiums were $89,098,000 for the year ended December 31,
1994, a decrease of 18.7% from $109,541,000 for the prior year end. As a
percentage of direct earned premiums, 1994 reinsurance costs were slightly
higher than 1993 due to the higher reinsurance cost for Colorado and other
states.
An increase or decrease in the unearned premium reserve is primarily
related to the increase or decrease in inforce premiums. Inforce premiums at
December 31, 1994 were $94,091,000 or 11.2% less compared to $105,944,000 for
the prior year. The change in the unearned premium reserve for the year ended
December 31, 1994 was a decrease of $1,701,000 compared to a decrease of $73,000
in 1993 and was due to a continuing downward trend in the inforce premiums
during the year. Net earned premiums decreased 17.2% to $90,800,000 compared to
$109,614,000 for the prior year.
Prior to 1995, all workers' compensation insurers writing in California
operated under what was known as the minimum rate law by which insurers could
not charge a premium which was less than the published rate manual premiums.
These minimum premium rates were developed from aggregate industry loss
experience and included provisions for expenses and profits. Under the minimum
rate law, California workers' compensation insurers competed primarily on
providing service to insureds and agents and the payment of commissions and
policyholders' dividends. However, the Company has not paid policyholders'
dividends since May 1992 due to regulatory restrictions.
The workers' compensation legislative reforms enacted in July 1993
repealed the minimum rate law effective January 1, 1995 and replaced it with
"open rating" rules. Under the open rating environment, each California
workers' compensation insurer must determine and file with the Department of
Insurance the premiums and rating plans it will use. The Department of
Insurance can only disapprove a filed rate if it determines that the rate will
threaten an insurer's solvency or if it will lead to a monopoly which is defined
to be 20% or more of the total workers' compensation market. This open rating
environment brings workers' compensation pricing into conformance with other
property and casualty lines of business.
This new environment also brings uncertainties as to premium revenues
and continued operating profits due to increased price competition and the risk
of incurring adverse loss experience over a smaller premium base. Under the
minimum rate law, an insurer was better able to absorb an adverse loss since an
insured was not able to realize an immediate benefit for consistent low loss
experience. Upon the expiration of the policy, the insured may have received a
portion of the premiums in the form of a dividend if the account generated a
profit for the insurer. However, under open rating, the insured's prior
favorable loss experience can result in an immediate reduction in premiums and
the insurer runs the risk of incurring adverse losses without a corresponding
premium and without the option of not declaring a dividend. An insurer may
attempt to issue a policy on a retrospective rating basis to recoup part of its
losses but competitive pressures will usually result in an insured being able to
obtain coverage elsewhere without this feature. To be successful in this open
rating environment, an insurer must carefully underwrite each account and
consider the insured's risk characteristics, prior loss experience, loss
prevention plans and other underwriting considerations to determine the proper
premium to charge. Regular visits by loss control consultants may be necessary
to ensure continued adherence to accident prevention policies and/or to identify
preventable risk situations.
Net sales by InteLock Technologies for the year ended December 31, 1994
were $2,035,000 compared to $849,000 for the seven months ended December 31,
1993.
Premium finance revenues increased by $210,000 to $2,015,000 for the
year ended December 31, 1994 and is attributable to increased financing
activity. At December 31, 1994, financed premiums receivables increased by
$2,703,000 to $15,576,000 compared to the prior year end balance. The increase
in lending activity was partially affected by a general decline in interest
rates during 1993 through the middle part of 1994. The Company intends to
continue the expansion of its profitable insurance premium finance business
through the use of both internal and external borrowings. Subsequent to December
31, 1994, CIIPF lost four agents who accounted for approximately 15% of its 1994
premium finance revenues. CIIPF has replaced the lost business through its
ongoing marketing programs.
Net investment income, together with net realized gains, decreased 7.5%
to $12,792,000 for the year ended December 31, 1994 compared to $13,831,000
during 1993. This decrease was due to a decrease in net realized investment
gains of $1,310,000 and a decrease of $600,000 in trading portfolio gains.
Excluding investment gains, net investment income increased by $871,000 or 7.5%
due to an increase in investable funds. The average yields of the Company's
investment portfolio, including realized and unrealized gains, were 5.3% and
7.0% for the years ended December 31, 1994
18
<PAGE>
and 1993, respectively. The reduction in the average yield is due to a
reduction in realized gains and an increase in unrealized losses. Excluding
realized and unrealized gains, the average yields of the Company's investment
portfolio were 5.7% for 1994 and 1993.
Effective January 1, 1994, the Company adopted Statement of Financial
Accounting Standards No. 115, Accounting for Certain Investments in Debt and
Equity Securities. This Statement requires that security investments be
classified as follows: "held to maturity", "available for sale", or "trading".
Held to maturity investments are valued at amortized cost. Available for sale
investments are valued at fair value with the net unrealized gain or loss
reported as a separate component of shareholders' equity. Trading investments
are also reported at fair value but the net unrealized gain or loss is included
in earnings.
Prior to 1994, the Company had an identifiable bond trading portfolio.
The remaining investment portfolio was classified into held to maturity and
available for sale based on security ratings and other factors such as the
ability and intent of the Company to hold to maturity. Due to the increase in
interest rates and a decline in the market value of the equity investments, the
overall market value of the available for sale has decreased. As a result, net
unrealized losses of $1,187,000 are reflected in shareholders' equity at
December 31, 1994. Prior years' balance sheets are not restated in accordance
with the Statement.
The Company's investment policy is to invest in securities that are
investment grade and carry a rating of "A" or better. The Company does not have
any significant investments in derivative-type financial instruments nor did the
Company have any investments in Orange County, California bonds during 1994.
Prior to 1994, except for the bond trading portfolio, the bond investment
portfolio was normally purchased with the intent to hold to maturity. However,
investments were sold from time to time that failed to meet the Company's
investment criteria and/or that of the California Department of Insurance for
deposit requirements. For workers' compensation deposit purposes, the State of
California had only accepted "book entry" bonds issued by the United States
government and its agencies. To meet the statutory deposit requirements, part
of the Company's portfolio of non-U.S. government "book entry" bonds were sold
in 1993 and replaced with certificated and U.S. Treasury bonds which resulted in
realized gains of approximately $1,413,000.
Due to a change in investment strategy, the Company liquidated its bond
trading portfolio in December 1994 compared to a balance of $10,921,000 at
December 31, 1993. Trading activity was substantially less in 1994 compared to
1993 and net trading gains of $186,000 were realized in 1994 compared to
$786,000 in 1993.
For the year ended December 31, 1994 as compared to the prior year,
under GAAP, the insurance subsidiaries' loss and LAE ratio decreased by 16.4
percentage points to 59.1% and the underwriting expense ratio increased 8.8
percentage points to 37.8% for a total decrease in the combined ratio of 7.6
percentage points to 96.9% compared to 104.5% for the prior year.
The significant decrease in the loss and LAE ratio resulted from
favorable loss development on prior accident year's (primarily the 1992 and 1993
accident years) of approximately $13,953,000. This compares to favorable loss
development on prior accident years for the year ended December 31, 1993 of
$3,865,000. In addition, the loss ratio established for the 1994 accident year
is 4.5 percentage points below the loss ratio established for the 1993 accident
year as of December 31, 1993. The favorable development is a product of the
Company's strategic plans to improve results that included reducing the
geographic mix of risk sensitive business in the Southern California area,
limiting exposures in those classes of business identified as riskier or more
hazardous, and, where appropriate, surcharging accounts to obtain adequate
premium rates. In addition, the legislative reforms enacted in California in
1993 appear to have contributed to the decrease in the loss and LAE ratio
although the exact extent cannot be quantified. Management, in consultation
with its independent actuary, considers the frequency and severity of losses and
establishes reserve levels based upon generally accepted actuarial projection
methods.
The Company's reserves for losses and LAE, after deducting reinsurance
recoverables on unpaid losses and LAE, decreased 7.4% to $161,620,000 at
December 31, 1994 compared to $174,515,000 at December 31, 1993. The decrease
in reserves is primarily attributable to the decrease in premium writings and
the favorable loss development. While the Company has experienced favorable loss
development in each of the years ended December 31, 1994 and 1993, there can be
no assurance of the magnitude or continuation of any future favorable
development. Estimated amounts for reinsurance recoverables on unpaid losses
and LAE increased by $3,501,000 to $29,342,000 are due to additional claims
incurred above the Company's retention. The increase in estimated reinsurance
recoverables is not expected to affect
19
<PAGE>
operations or liquidity in the future as the Company believes actual reinsured
losses will be fully recoverable. All reinsurance recoverable amounts are due
from General Reinsurance Corporation, which is rated A++ by the A.M. Best
Company. See Note 3 of Notes to Consolidated Financial Statements. The reserve
for losses and LAE represents estimates of the ultimate net cost of all unpaid
losses and LAE at any given point in time. The Company used the services of an
independent consulting actuary and received an unqualified opinion on its loss
and LAE reserve balances at December 31, 1994 and 1993.
Claims frequency, which is defined as the number of claims reported per
million dollars of net earned premium, increased for the 1994 accident year by
approximately 24% to 91.4 compared to 73.9 for the 1993 accident year reported
in 1993. The increase was primarily due to a reduction in net earned premiums
without a corresponding reduction in the number of claims reported. While the
overall number of reported claims did not significantly change between the two
accident years, the mix between indemnity and small medical-only claims resulted
in a reduction in the overall severity of the reported claims. The reduction in
the severity, however, was also impacted by a change in the way case reserves
are initially established. Case reserves are now established based upon the
facts of each case considering the extent of the injury and the initial medical
prognosis. Throughout much of 1993, initial case reserves were being
established on a more conservative basis. This also had an effect on the number
of claims classified as medical-only and could account for the decrease in
indemnity claims and the increase in medical-only claims in 1994.
The 1993 California workers' compensation legislative reforms increased
certain benefits paid to claimants starting in 1994. The monthly temporary
disability indemnity maximum payment increased by 20.8% to $406 effective July
1, 1994. Additional increases of 11.7% to $448 and 9.4% to $490 are effective
July 1, 1995 and 1996, respectively. Also in 1993, legislative reforms were
enacted as an attempt to offset these benefits increases; however, the impact of
these reforms cannot be determined at this time.
In the fourth quarter of 1994, the California Supreme Court unanimously
overturned the appellate court decisions of Wong v. State Compensation Insurance
Fund and La Jolla Beach & Tennis Club v. Industrial Indemnity Insurance Company.
These two cases would have significantly broadened the requirement that a
workers' compensation insurer must provide for legal defense costs of non-
workers' compensation civil actions if there was a potential workers'
compensation injury implied by the facts of the lawsuit.
Policy acquisition costs increased $1,656,000 or 7.7% to $23,238,000 for
the year ended December 31, 1994. As a percentage of net earned premiums,
policy acquisition costs were 25.6% for the year ended December 31, 1994
compared to 19.7% for the prior year. The increase in both the dollar amount
and the policy acquisition cost percentage is primarily due to an increase in
commission expenses due to commission incentive programs and a lower earned
premium base without a corresponding proportional decrease in acquisition costs.
General and administrative expenses increased by $5,774,000 or 33.8% to
$22,844,000 for the year ended December 31, 1994. The increase was primarily
due to an increase in InteLock's net sales in 1994 and its corresponding
increase in cost of goods sold and operating expenses which are included in
general and administrative expenses. Included in InteLock's general and
administrative expenses was approximately $613,000 in research and development
costs incurred for the year ended December 31, 1994. This amount was primarily
spent on developing a second generation consumer door lock, which is designed to
have higher gross margins, and the commercial lock prototype.
In 1994, the insurance subsidiaries experienced a 10.1% increase in
underwriting and general expenses to $34,996,000. Certain of the Company's
costs are relatively fixed including director's fees, rental expense and
payments under equipment leases. Other costs are variable and are directly
proportional with premium writings such as commissions to brokers, boards and
bureaus association dues, and premium taxes. A significant portion of the
Company's expenses ("semi-variable expenses") are subject to some, but not as
significant, variation, including salaries and benefits for employees,
allowances to agents, advertising, insurance, equipment and supplies, telephone,
legal and accounting fees, and license fees. Changes in semi-variable expenses
are not directly proportional to increases or decreases in premiums written. For
the year ended December 31, 1994, the Company estimates that the insurance
subsidiaries' underwriting expenses (and its percentage of the total) consisted
of approximately $15,387,000 (44.0%), $17,668,000 (50.5%) and $1,941,000 (5.5%)
in variable, semi-variable and fixed costs, respectively, compared to
$14,286,000 (44.9%), $15,798,000 (49.7%) and $1,703,000 (5.4%), respectively,
for the prior year.
The insurance subsidiaries' GAAP underwriting expense ratio was affected
by a 7.7% increase in variable costs, an 11.8% increase in semi-variable costs,
and a 14.0% increase in fixed costs. The increase in the variable costs was
20
<PAGE>
primarily due to the payment of higher commissions as noted earlier. The
increase in semi-variable costs was primarily due to an increase in salaries in
anticipation of the new open rating environment and related employee benefits
for profit sharing and employee incentive plan expenses due to the improved
profitability of the Company. In addition, in 1994, the Company amended the
mortgage loans previously made to certain officers and key employees of the
Company. The amendments resulted in substantial amounts of unintended imputed
income to the employees for the year ended December 31, 1994 which resulted in
significant adverse personal income tax consequences to the employees. The
increase in semi-variable costs also included the bonuses paid to reimburse the
employees for payment of substantially all taxes relating to the imputed
interest and the new bonus. In addition, semi-variable cost for 1993 benefited
from a credit for a previous year's overaccrual of expenses. The increase in
fixed costs was due to expansion of the home office facilities and normal rental
operating cost adjustments. The Company reviews its operating expenses
attempting to keep such costs in line with anticipated premium writings and the
Company believes it can selectively reduce its operating expenses without
adversely affecting its ability to effectively compete in the workers'
compensation marketplace.
Included in consolidated income is a loss of $2,501,000 for the
operating results of InteLock. This loss was due to lower than expected sales
of existing products, much higher than expected manufacturing and overhead costs
and, to a much lesser degree, a delay in the production of new products. Sales
of existing products were less than expected due to overly optimistic sales
projections which were predicated on being able to get more regional hardware
stores to carry the products. In 1994, InteLock experienced problems with a
major Taiwanese parts supplier on its existing lock products which led to higher
manufacturing costs. InteLock is phasing out its relationship with this
supplier as it shifts production into new lock products. The new locks were
designed to have higher gross margins than the existing product line. InteLock's
new digital deadbolt was delayed due to the unexpected withdrawal of a critical
parts vendor which resulted in InteLock missing the traditionally strong fall
1994 sales market. A replacement vendor was procured and the lock is now in
production and is being shipped. InteLock is currently developing a new lock
prototype that is expected to be tested and marketed in late 1995. This new
prototype will also become the basis for a new commercial line of locks.
InteLock is currently instituting price increases to all its customers which
will most likely be passed on to the ultimate purchaser. The effect of these
price increases may result in reduced sales as the product may become too costly
from the buyer's perspective.
The Company has retained the services of consultants to help it evaluate
alternatives for its investment in InteLock. This evaluation will include
product, market and sales analyses to determine if InteLock can be profitable or
whether it should be discontinued and either sold or liquidated. This
evaluation is anticipated to be completed in the second quarter of 1995. The
Company anticipates that InteLock will incur an operating loss in 1995 while it
undergoes this evaluation. The operating loss for the first quarter of 1995 is
anticipated to be approximately $750,000.
The Company had income before federal income taxes for the year ended
December 31, 1994 of $8,544,000 compared to income before federal income taxes
of $4,798,000 for the prior year. The Company is currently in a loss
carryforward position primarily due to the operating loss incurred for the year
ended December 31, 1992. The net operating loss carryforward balance as of
December 31, 1994 was $20,041,000 compared to $18,127,000 as of December 31,
1993. The net operating loss carryforward is available to offset future taxable
income until December 31, 2008.
The Company's major temporary tax differences that are expected to
reverse are the discount on loss reserves, the 20% limitation on unearned
premiums, deferred policy acquisition costs and allowances for doubtful
accounts. The majority of the temporary differences reverse in the year
subsequent to their establishment. The discount on the loss reserves is the
only significant temporary difference that extends beyond a one year period and
will reverse as the related loss reserves are either paid or reduced. The
estimated amounts of discount on loss reserves that will become deductible in
the next three years are $11,472,000 in 1995, $6,840,000 in 1996 and $4,366,000
in 1997. However, the Company expects new temporary differences to be
established in these years which will either significantly reduce or exceed the
reversing temporary differences.
Primarily because of alternative minimum taxes on tax-exempt interest
income and other tax preference items, the Company recorded a current tax
provision of $305,000 for the year ended December 31, 1994 compared to a current
provision of $196,000 for the prior year.
At December 31, 1993, the Company established a 100% valuation allowance
on the deferred tax receivables because it could not conclude that it was more
likely than not that any part of the deferred tax assets would be realized.
With the improved operating results for the year ended December 31, 1994, a re-
evaluation of the valuation
21
<PAGE>
allowance was made. The probability of future taxable income was evaluated
based on current projections of future operating results through 1997 in light
of the profits earned in 1993 and 1994 and considering the uncertainties of the
new open rating environment in California. In addition, the evaluation
considered projections of both the establishment and reversal of permanent and
temporary differences. Tax planning strategies were not a factor in the
evaluation although they are available if necessary. As a result of the re-
evaluation, a partial reduction of the deferred tax valuation allowance was
recognized in 1994. Included in the 1994 tax provision is a deferred tax
benefit of $4,000,000. See Note 7 to Notes to Consolidated Financial
Statements.
The Company had net income of $12,239,000 for the year ended December
31, 1994 compared to net income of $4,602,000 for 1993.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1993
COMPARED TO THE YEAR ENDED DECEMBER 31, 1992
Total revenues of the Company for the year ended December 31, 1993
increased 8.3% to $126,202,000 compared to $116,503,000 for the year ended
December 31, 1992. Revenue growth during this period was primarily attributable
to increased premium writings and realized investment gains.
Direct written premiums for the year ended December 31, 1993 increased
by 10.4% to $113,954,000 compared to $103,226,000 for the year ended December
31, 1992 and was primarily due to an increase in business written in Colorado
and Northern California, partially offset by the planned reduction of business
written in Southern California. During 1993, direct written premiums in the six
county area of Southern California decreased by $10,077,000 or 21.0% to
$37,895,000 from 1992 while direct written premiums in all other areas increased
by $20,805,000 or 37.7% to $76,059,000. The increase in direct written premiums
was also due to writing larger policies. While the average policy counts
decreased from 9,956 for the year ended December 31, 1992 to 8,696 for the year
ended December 31, 1993, the average direct written premiums per policy
increased from $10,638 in 1992 to $12,462 in 1993. The overall increases in
premium writings were negatively affected by a 7% reduction in the minimum rates
enacted by the July 16, 1993 California workers' compensation legislative
reforms.
Net written premiums increased 10.6% from $99,078,000 to $109,541,000.
As a percentage of direct earned premiums, 1993 reinsurance costs were
essentially the same as 1992.
The increase or decrease in the unearned premium reserve is primarily
related to the increase or decrease in inforce premiums. Inforce premiums at
December 31, 1993 were $105,944,000 compared with $96,897,000 for the prior
year. Despite the 9.3% increase in inforce premiums, the change in the unearned
premium reserve for the year ended December 31, 1993 was a decrease of $73,000
compared to a decrease of $4,088,000 in 1992 and was due to the downward trend
in the inforce premiums during the last five months of 1993. Net earned
premiums increased 6.3% to $109,614,000 compared to $103,166,000 for the prior
year.
For the year ended December 31, 1993, direct written premiums with
respect to new business were $60,138,000 or 52.8% whereas $53,815,000 was
written on renewal business. For the prior year, the comparable new and renewal
premium writings were $63,336,000 or 61.4% and $39,890,000, respectively.
The Company implemented a strategic plan in early 1992 to change its
geographic mix of business by reducing its writings in the Southern California
areas (other than San Diego) while targeting Northern California and other
states for its growth. The Company believes that the problems of the California
workers' compensation insurance system were less pervasive in Northern
California. At December 31, 1993, inforce premiums in the Southern California
areas represented 29.2% of the total compared to 39.7% at December 31, 1992.
The Company began writing workers' compensation insurance in Colorado in
July 1992. At December 31, 1993, Colorado inforce premiums represented 7.7% of
the total. For the year ended December 31, 1993, net earned premiums from
Colorado represented 6.8% of the total. In December 1993, the Company commenced
writing workers' compensation insurance in Utah, which was minimal.
The California Workers' Compensation Insurance Rating Bureau ("WCIRB")
accumulates premium, loss and expense statistics to recommend to the California
Department of Insurance minimum manual rates. From its analysis,
22
<PAGE>
the WCIRB determined that the January 1, 1994 manual rates should be increased
by 2.1% and that the unexpired portion of the 1993 inforce policies should be
increased by 1.5%. However, the California workers' compensation insurance
reform legislation enacted in July 1993 prohibited any rate increases until
January 1, 1995. Despite the indicated need for a rate increase, the California
Insurance Commissioner ordered a 12.7% reduction in the manual rates for
policies with effective dates on and after January 1, 1994.
Premium finance revenues, included in other revenues, increased by
$214,000 to $1,805,000 for the year ended December 31, 1993. The general
decline in interest rates affected the overall growth in loan revenues. The
Company intends to continue the expansion of its profitable insurance premium
finance business.
Net investment income, together with net realized gains, increased 17.8%
to $13,831,000 for the year ended December 31, 1993 compared to $11,746,000
during 1992. This increase was due primarily to an increase in net realized
gains of $1,586,000 resulting from the sale of a part of the bond portfolio and
an increase of $679,000 in the trading portfolio gains. The average yields of
the Company's investment portfolio, including realized and unrealized gains,
were 7.0% and 6.1% for the years ended December 31, 1993 and 1992, respectively.
Excluding realized gains, the average yields of the Company's investment
portfolio were 5.7% and 6.1%, respectively. Due to its current loss
carryforward, the 1993 average yield reflects the Company's decision to invest
more of its available excess cash in investment grade taxable securities instead
of tax-exempt bonds, the effect of which was offset by an overall decline in
interest rates.
The Company's investment policy is to invest in securities that are
investment grade and carry a rating of "A" or better. Except for the bond
trading portfolio, the bond investment portfolio is normally purchased with the
intent to hold to maturity. However, investments will be sold from time to time
that fail to meet the Company's investment criteria and/or that of the
California Department of Insurance for deposit requirements. In recent years,
many new bond offerings were being issued in "book entry" form where the bond is
electronically maintained. In 1993, the State of California would only accept
"book entry" bonds issued by the United States government and its agencies. To
meet the statutory deposit requirements, part of the Company's portfolio of
"book entry" bonds were sold in 1993 and replaced with certificated and U.S.
Treasury bonds that accounted for most of the realized gains.
During 1992, California Indemnity's board of directors authorized its
outside investment manager to use a portion of its available cash as a bond
"trading" portfolio. Investment grade bonds that had the potential to generate
short-term capital gains were targeted for purchase. At December 31, 1993,
California Indemnity had approximately $10,921,000 in this portfolio compared to
$10,785,000 at December 31, 1992. Trading activity was greater in 1993 compared
to 1992 and resulted in net trading gains of $786,000 in 1993 compared to
$107,000 in 1992.
For the year ended December 31, 1993 as compared to the prior year,
under GAAP, the insurance subsidiaries' loss and LAE ratio decreased by 40.3
percentage points to 75.5% and the underwriting expense ratio decreased 2.0
percentage points to 29.0%, for a total decrease in the combined ratio of 42.3
percentage points to 104.5%.
The significant decrease in the loss and LAE ratio resulted from the
Company's strategic plans to improve results that included reducing the
geographic mix of risk sensitive business in the Southern California area,
limiting exposures in those classes of business identified as riskier or more
hazardous, and, where appropriate, surcharging accounts to obtain adequate
premium rates. Reflected in the incurred loss and LAE amount for the year ended
December 31, 1993 is favorable loss development on prior accident years of
$3,865,000. This compares to adverse loss development on prior accident years
for the year ended December 31, 1992 of $28,066,000.
The Company's reserves for losses and LAE, after deducting reinsurance
recoverables on unpaid losses and LAE, increased 10.3% to $174,515,000 at
December 31, 1993 compared to $158,253,000 at December 31, 1992. The increase
in reserves was primarily attributable to the increase in premium writings.
Estimated amounts for reinsurance recoverables on unpaid losses and LAE
increased by $5,634,000 to $25,841,000 and is due to additional claims incurred
above the Company's retention. The reserve for losses and LAE represents
estimates of the ultimate net cost of all unpaid losses and LAE at any given
point in time. In addition, the Company used the services of an independent
consulting actuary and received an unqualified opinion on its loss and LAE
reserve balances at December 31, 1993 and 1992.
As a percentage of net earned premiums, policy acquisition costs for the
year ended December 31, 1993 were 19.7% compared to 20.0% for the prior year.
General and administrative expenses decreased by $490,000 or 2.8%
23
<PAGE>
to $17,070,000. The decreases were primarily due to the absence of the charges
related to the relocation of the Company's principal executive offices and the
class action litigation costs incurred in 1992.
In 1993, the insurance subsidiaries experienced a .5% decrease in
underwriting and general expenses to $31,787,000. Certain of the Company's
costs are relatively fixed including director's fees, rental expense and
payments under equipment leases. Other costs are variable and are directly
proportional with premium writings such as commissions to brokers, boards and
bureaus association dues, and premium taxes. A significant portion of the
Company's expenses ("semi-variable expenses") are subject to some, but not as
significant, variation, including salaries and benefits for employees,
allowances to agents, advertising, insurance, equipment and supplies, telephone,
legal and accounting fees, and license fees. Changes in semi-variable expenses
are not directly proportional to increases or decreases in premiums written. For
the year ended December 31, 1993, the Company estimates that the insurance
subsidiaries' underwriting expenses consisted of approximately $14,286,000
(44.9%), $15,798,000 (49.7%) and $1,703,000 (5.4%) in variable, semi-variable
and fixed costs, respectively, compared to $13,503,000 (42.2%), $16,924,000
(53.0%) and $1,527,000 (4.8%), respectively, for the prior year.
The insurance subsidiaries' GAAP underwriting expense ratio was affected
by a 6.7% decrease in semi-variable costs and an 11.5% increase in fixed costs.
The decrease in semi-variable costs was primarily the result of the absence of
the charges arising out of costs associated with the relocation of the Company's
principal executive offices in 1992. The increase in fixed costs reflects the
rent for the Denver office and normal rental operating cost adjustments.
The Company had income before federal income taxes for the year ended
December 31, 1993 of $4,798,000 compared to a loss before federal income taxes
and extraordinary gain of $41,224,000 for the prior year. Due to the operating
loss incurred for the year ended December 31, 1992, the Company was in a loss
carryforward position. Primarily because of alternative minimum taxes on tax-
exempt interest income and other tax preference items, the Company recorded a
tax provision of $196,000 for the year ended December 31, 1993 compared to a
provision of $1,355,000 for the prior year. During the first quarter of 1992,
the Company repurchased $1,450,000 of its outstanding Convertible Subordinated
Debentures that resulted in an extraordinary gain of $457,000. The Company had
net income of $4,602,000 for the year ended December 31, 1993 compared to net
loss of $42,122,000 for 1992.
LIQUIDITY AND CAPITAL RESOURCES
Between January 1, 1988 and December 31, 1994, the primary sources of
cash funds have been public and private sales of Common Stock of $60,452,000,
sales of Convertible Subordinated Debentures of $56,147,000 and positive cash
flow from operations of $128,375,000 (including investment income of
$54,762,000). Other sources of cash funds include a bank loan to CII Financial
of $650,000 that was repaid in June 1990, bank borrowings of $1,241,000 by CIIPF
that were repaid in December 1991 and a bank borrowing of $8,000,000 by CIIPF in
September 1994 that is still outstanding.
The amount of premiums that a workers' compensation insurance company
may write is dependent upon the amount of its policyholders' surplus. The
"standard" established by the National Association of Insurance Commissioners
("NAIC") is a net premiums written to policyholders' surplus ratio of less than
3 to 1. For the year ended December 31, 1994, the Company's ratio of net
premiums written to policyholders' surplus was approximately 1.4 to 1. In the
past, the capital sources described above have enabled the Company to maintain
an adequate level of policyholders' surplus. Policyholders' surplus (calculated
on a consolidated statutory accounting basis) at December 31, 1994 was
$61,821,000 compared with $51,459,000 at December 31, 1993. Currently, the
Company has no plans, and believes it would be difficult, to raise additional
funds. The Company believes its rate of growth and size of operations can be
managed to balance capital resources with capital needs.
The NAIC formulated a risk-based capital test for property-casualty
insurance companies as another means of monitoring insurer solvency. Risk-based
capital is designed to measure the minimum statutory surplus that an insurer
would need to support its overall business operations considering its size and
risk profile. The four major categories of risk are (i) Asset Risk, which
measures the risk of investment defaults or fluctuations in market value; (ii)
Credit Risk, which measures the risk of uncollectible receivables; (iii)
Underwriting Risk, which measures the risk of under-estimating reserves or
inadequate pricing of current business; and (iv) Off-Balance Sheet Risk, which
measures the risk associated with items such as excessive premium growth,
contingent liabilities, and other non-recorded balance sheet items. An
insurer's risk-based capital is calculated by applying factors to various
assets, premiums and reserves. The derived risk-based capital is then compared
to an insurer's actual surplus to determine if the minimum surplus requirement
is met. Risk-
24
<PAGE>
based capital regulations became effective in 1995 for use on the statutory
Annual Statements for the year ended December 31, 1994. The Company's insurance
subsidiaries' risk-based capital results for 1994 exceeded the minimum threshold
level.
The NAIC also has developed the Insurance Regulatory Information System
("IRIS") which assists the state insurance departments in overseeing the
financial condition of insurance companies operating in their respective states.
The IRIS includes a statistical phase consisting of twelve financial ratios from
data reported in the statutory Annual Statements. The NAIC has developed a
"usual range" of results for each financial ratio based on studies of companies
which either became insolvent or had experienced financial difficulties in
recent years. A financial ratio that falls outside the usual range does not
necessarily indicate a failing result but is intended to act as a flag to the
state insurance departments to possibly do further inquiries and investigations.
For the year ended December 31, 1994, the Company's insurance subsidiaries had
no results that were outside the usual range of values.
Liquidity is maintained by holding investment grade securities with
staggered maturities. See "Business-Investments".
Net cash from operating activities decreased by $1,242,000 to
$18,796,000 for the year ended December 31, 1994 compared to $20,038,000 for the
prior year. This decrease was primarily due to lower net premium collections of
$13,543,000, attributable to the decreased premium writings, offset primarily by
net federal income taxes received of $5,546,000 and a net increase in operating
cash of $10,853,000 due to liquidation of the trading portfolio. For the year
ended December 31, 1993, net cash from operating activities was $16,900,000 more
than the prior year. The increase was primarily due to higher premium
collections of $8,233,000, attributable to the increased premium writings, and
lower loss and LAE payments of $7,502,000 that were attributable to improved
loss experience.
In the normal course of business, the Company invests any excess cash
not needed for operations. Conversely, any operating cash shortfalls would be
funded primarily from matured investments. For the year ended December 31, 1994
investing activities used $30,140,000. The additional usage of $4,262,000
compared to 1993 is primarily due to increased purchases of investments and
increased financed premiums. For the year ended December 31, 1993, investing
activities used cash of $25,878,000 compared to cash provided by investing
activities of $12,985,000 for the year ended December 31, 1992. Most of the
1993 activity was due to an increase in invested assets, excluding the trading
portfolio that is included as part of operating activities, of $23,364,000 from
$173,202,000 at December 31, 1992 to $196,566,000 at December 31, 1993. Between
December 31, 1991 to December 31, 1992, total invested assets, excluding the
trading portfolio, decreased by $19,597,000.
The Company has a $12,000,000 revolving line of credit agreement with a
bank which expires on August 1, 1995. During the term of the agreement, the
Company can borrow at the bank's prime rate plus one-half percent or a fixed
LIBOR rate plus two and a half percent, payable monthly. Advances are available
up to 80% of eligible loans receivable, and are collateralized by installment
loans receivable. A commitment fee of one-tenth percent per annum is payable on
the $12,000,000. The Company is required to maintain a compensating balance of
fifteen percent of the revolving line of credit. Under this agreement, the
Company borrowed $8,000,000, at the LIBOR rate plus two and one-half percent
(8.5% at December 31, 1994), maturing on June 12, 1995 which accounts for the
majority of the financing activity for the year ended December 31, 1994.
The revolving line of credit agreement requires compliance with certain
loan covenants including, but not limited to, minimum tangible net worth, debt
leverage ratio, and current ratio. The revolving line of credit of $12,000,000
is guaranteed by CII Financial, Inc. (the "Parent Company"). In addition, the
Parent Company subordinated $2,000,000 of its debt. As of December 31, 1994,
the Company was in compliance with all financial and non-financial covenants,
however at September 30, 1994, the Company obtained a waiver for noncompliance
with the debt leverage ratio covenant.
Net cash from financing activities was minimal during the year ended
December 31, 1993. During the year ended December 31, 1992, net cash used in
financing activities totalled $1,531,000 and was primarily due to the repurchase
of Common Stock and Debentures on the open market.
On a stand alone basis, CII Financial has had negative cash from
operations in each of the years ended December 31, 1994 and 1993 of $2,458,000
and $3,380,000, respectively. The primary reason for the negative cash flow
25
<PAGE>
was due to the annual interest payment of $4,260,000 on the 7 1/2% Convertible
Subordinated Debentures. Based on quoted market price, the fair value of the
Debentures was $38,624,000 or 68% of the total principal amount at December 31,
1994. The fair value reflects the market risks of the stated interest rate and
the potential non-payment of the annual interest and/or the principal upon
maturity in September 2001. See Note 5 of Notes to Consolidated Financial
Statements. CII Financial currently does not have sufficient liquid assets to
meet its expenses, including the semiannual interest payments on the Debentures,
for the current year. As of December 31, 1994, CII Financial had a loan and
advances to CIIPF totalling $8,533,000 to fund the premium finance loans and
advances to InteLock totalling $3,122,000 to fund inventory purchases and
operations. CII Financial is exploring alternatives to convert its intercompany
receivables to cash to enable it to pay its ongoing expenses for the next few
years. After the application of its existing liquid assets, CII Financial would
become dependent upon dividends received from its subsidiaries to pay its
expenses. California Indemnity and Commercial Casualty are subject to state
insurance regulations that restrict their ability to pay dividends to CII
Financial. Currently, these regulations restrict California Indemnity from
paying any shareholder dividends without prior approval from the California
Department of Insurance. See Note 8 of Notes to Consolidated Financial
Statements. To date, no dividends have been paid to CII Financial by any of its
subsidiaries.
EFFECTS OF INFLATION
Inflation can be expected to affect the operating performance and
financial condition of the Company in several aspects. Inflation can reduce the
market value of the investment portfolio; however, the Company's insurance
subsidiaries typically hold their investments to maturity. Inflation adversely
affects the portion of loss reserves that relates to hospital and medical
expenses, as these expenses normally increase during inflationary periods (and
in recent years workers' compensation medical costs have increased at a greater
rate than prevailing inflation). Loss reserves relating to indemnity benefits
for lost wages are not directly affected by inflation, as these amounts are
established by statute. To the extent that loss reserves and payments increase
due to inflation, rates have historically increased by operation of the rate
setting process, which establishes the minimum rates in effect in California;
however, the workers' compensation legislative reforms enacted in July 1993 have
repealed the minimum rate law effective January 1, 1995. Workers' compensation
insurance companies must now determine their own premium rates and assess the
impact of inflation on those rates. Another predictable result of inflation is
an escalation of wages paid to employees. Since the Company's inception,
inflation has not had a material adverse effect on the Company.
RECENT ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards No. 119, Disclosure about
Derivative Financial Instruments and Fair Value of Financial Instruments,
increases the disclosures about derivative financial instruments which include
futures, forward, swap, or option contracts or other financial instruments with
similar characteristics. The Statement is effective for financial statements
issued for fiscal years ending after December 15, 1994.
The Company does not have any significant investments in derivative
financial instruments. The Company does not invest in futures, forward, swap,
or option contracts nor does the Company invest in hedging or risk adjustment
financial instruments. In addition, there are no material off-balance sheet
instruments. See Notes 13 and 14 to Notes to Consolidated Financial Statements.
Statement of Financial Accounting Standards No. 114, Accounting by
Creditors for Impairment of a Loan, requires that impaired loans be measured at
the present value of anticipated future cash flows, discounted at the loan's
effective interest rate. Statement of Financial Accounting Standards No. 118,
Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosure, amends the disclosure requirements in Statement No. 114 to require
information on certain impaired loans and how a creditor recognizes income on
these impaired loans. Both Statements are effective for fiscal years beginning
after December 15, 1994. The financial impact to the Company from implementing
these pronouncements will be immaterial.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
The consolidated financial statements and related financial information
required to be filed hereunder are indexed on Page 36 and are incorporated
herein by reference.
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<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in or disagreements with accountants on
accounting and financial disclosure.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to this item is incorporated herein by
reference to the "Information Concerning Nominees," "Executive Officers" and
"Compliance with Section 16(a) of the Exchange Act" sections of the Registrant's
Proxy Statement for its 1995 Annual Meeting of Shareholders (the "Proxy
Statement"). No other part of the Proxy Statement is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION AND OTHER INFORMATION
Information with respect to this item is incorporated herein by
reference to the "Executive Compensation" section of the Proxy Statement. No
other part of the Proxy Statement is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with respect to this item is incorporated herein by
reference to the "Security Ownership of Certain Beneficial Owners and
Management" section of the Proxy Statement. No other part of the Proxy
Statement is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information with respect to this item is incorporated herein by
reference to the "Certain Relationships and Related Transactions" section of the
Proxy Statement. No other part of the Proxy Statement is incorporated herein by
reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
Reference is made to the Index to the Consolidated Financial Statements
and Schedules on page 37.
(a) 2. Financial Statement Schedules
Reference is made to the Index to the Consolidated Financial Statements
and Schedules on page 37.
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<PAGE>
(a) 3. Exhibits
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S>
3.1 Articles of Incorporation of CII Financial, filed as Exhibit
3.1 to CII Financial's Registration Statement on Form S-1
(Registration No. 33-32574) and by this reference is
incorporated herein and made a part hereof
3.2 Bylaws of CII Financial, filed as Exhibit 3.2 to CII
Financial's Registration Statement on Form S-1 (Registration
No. 33-32574) and by this reference is incorporated herein and
made a part hereof
3.3 Amendment No. 1 to the Bylaws of CII Financial, dated October
14, 1992, filed as Exhibit 3.3 to CII Financial's 1992 Annual
Report on Form 10-K and by this reference is incorporated
herein and made a part hereof
4.1 Specimen Stock Certificate of CII Financial, filed as Exhibit
4 to CII Financial's Registration Statement on Form S-1
(Registration No. 33-32574) and by this reference is
incorporated herein and made a part hereof
4.2 Form of Indenture, filed as Exhibit 4.2 to CII Financial's
Registration Statement on Form S-1 (Registration No. 33-42114)
and by this reference is incorporated herein and made a part
hereof
4.3 Form of Debenture, filed as Exhibit 4.3 to CII Financial's
Registration Statement on Form S-1 (Registration No. 33-42114)
and by this reference is incorporated herein and made a part
hereof
10.01 Automobile Lease between Teejay Corporation, Lessor, and CII
Financial, Lessee, dated January 1, 1993, filed as Exhibit
10.16 to CII Financial's 1993 Annual Report on Form 10-K and
by this reference is incorporated herein and made a part
hereof
10.02 Office Lease and Addendum by and between Charles P. Cusamano
and Roger A. Cusamano, Landlord, and California Indemnity,
Tenant dated April 19, 1991, filed as Exhibit 10.17 to CII
Financial's 1993 Annual Report on Form 10-K and by this
reference is incorporated herein and made a part hereof
10.03 Assignment of Lease dated June 22, 1992, filed as Exhibit
10.18 to CII Financial's 1993 Annual Report on Form 10-K and
by this reference is incorporated herein and made a part
hereof
10.04 Tenant Estopped Certificated dated in 1992, filed as Exhibit
10.19 to CII Financial's 1993 Annual Report on Form 10-K and
by this reference is incorporated herein and made a part
hereof
10.05 Subordination, Nondisturbance and Attornment Agreement dated
July 2, 1992, filed as Exhibit 10.20 to CII Financial's 1993
Annual Report on Form 10-K and by this reference is
incorporated herein and made a part hereof
10.06 Office Lease by and between Hacienda Venture, Landlord, and
CII Financial, Tenant dated April 20, 1992, filed as Exhibit
10.19 to CII Financial's 1992 Annual Report on Form 10-K and
by this reference is incorporated herein and made a part
hereof
10.07 Commencement Date Memorandum by and between Hacienda Venture,
Landlord, and CII Financial, Tenant, signed September 1, 1992,
filed as Exhibit 10.20 to CII Financial's 1992 Annual Report
on Form 10-K and by this reference is incorporated herein and
made a part hereof
10.08 First Amendment to Office Lease by and between Hacienda
Venture and CII Financial dated April 20, 1992, effective
August 22, 1994, filed herewith
10.09 Office Lease by and between Hacienda Venture and CII Financial
dated August 22, 1994, filed herewith
</TABLE>
28
<PAGE>
<TABLE>
<C> <S>
10.10 Office Lease by and between Hacienda Venture and InteLock
Technologies dated August 22, 1994, filed herewith
10.11 First Amendment to Office Lease by and between Hacienda
Venture and InteLock Technologies dated August 22, 1994,
effective September 8, 1994, filed herewith
10.12 Lease Guaranty by and between Hacienda Venture and CII
Financial, executed September 8, 1994 guarantying the Office
Lease by and between Hacienda Venture and InteLock
Technologies dated August 22, 1994 and amended September 8,
1994, filed herewith
10.13 Policy of Insurance (Directors' and Officers' Liability)
issued by Lloyd's Underwriters to CII Financial effective May
1, 1994, filed herewith
10.14 Investment Manager's Agreement between First Quadrant Corp.
and California Indemnity dated January 3, 1991, filed as
Exhibit 10.47 to CII Financial's Registration Statement on
Form S-1 (Registration No. 33-42114) and by this reference is
incorporated herein and made a part hereof
10.15 Letter of Amendment to Investment Manager's Agreement between
First Quadrant Corp. and California Indemnity Insurance
Company dated November 21, 1991, filed as Exhibit 10.23 to CII
Financial's 1992 Annual Report on Form 10-K and by this
reference is incorporated herein and made a part hereof
10.16 Letter of Termination to Investment Manager's Agreement
between First Quadrant Corp. and California Indemnity
Insurance Company dated December 8, 1994, filed herewith
10.17 Purchase Agreement among California Indemnity, InteLock
Technologies, Thomas E. Corder and Gary S. Sturm, dated as of
June 3, 1993, without exhibits, filed as Exhibit 10.26 to CII
Financial's 1993 Annual Report on Form 10-K and by this
reference is incorporated herein and made a part hereof
10.18 Stock Purchase Agreement among CII Financial, James O. Petty,
Jr. and Harvey J. Halvorsen, dated as of June 8, 1993, without
exhibits, filed as Exhibit 10.27 to CII Financial's 1993
Annual Report on Form 10-K and by this reference is
incorporated herein and made a part hereof
10.19 Tax Allocation Agreement by and between CII Financial and
California Indemnity Insurance Company, Commercial Casualty
Insurance Company, CII Premium Finance Company, CII Leasing,
Inc., Oliver D. Smith Insurance Agency and InteLock
Technologies dated December 16, 1993, filed herewith
10.20 Loan Agreement by and among CII Premium Finance Company and
First Interstate Bank of California dated August 29, 1994,
filed herewith
10.21 Subordination Agreement by and among First Interstate Bank of
California, CII Premium Finance Company and CII Financial
dated Angst 29, 1994, filed herewith
10.22 Security Agreement and Assignment of Premium Finance
Agreements by and between CII Premium Finance Company and
First Interstate Bank of California, filed herewith
10.23 Program Administrator Agreement between Prudential General
Insurance Company and Oliver D. Smith Insurance Agency dated
December 9, 1994, filed herewith
</TABLE>
29
<PAGE>
<TABLE>
<C> <S>
MANAGEMENT CONTRACTS AND COMPENSATORY PLANS AND ARRANGEMENTS
(EXHIBITS 10.24 TO 10.109)
10.24 CII Financial 1988 Stock Option Plan, filed as Exhibit 10.9 to
CII Financial's Registration Statement on Form S-1
(Registration No. 33-32574) and by this reference is
incorporated herein and made a part hereof
10.25 Form of CII Financial 1988 Non-Qualified Stock Option
Agreement, filed as Exhibit 10.25 to CII Financial's 1992
Annual Report on Form 10-K and by this reference is
incorporated herein and made a part hereof
10.26 Form of CII Financial 1989 Employee Incentive Stock Option
Plan, filed as Exhibit 10.8 to CII Financial's Registration
Statement on Form S-1 (Registration No. 33-32574) and by this
reference is incorporated herein and made a part hereof
10.27 CII Financial 1989 Non-Qualified Stock Option Agreement with
Joseph G. Havlick, filed as Exhibit 10.15 to CII Financial's
Registration Statement on Form S-1 (Registration No. 33-32574)
and by this reference is incorporated herein and made a part
hereof
10.28 CII Financial 1989 Non-Qualified Stock Option Agreement with
Tanna P. Handley, filed as Exhibit 10.16 to CII Financial's
Registration Statement on Form S-1 (Registration No. 33-32574)
and by this reference is incorporated herein and made a part
hereof
10.29 Form of CII Financial 1989 Employee Incentive Stock Option
Agreement filed as Exhibit 10.29 to CII Financial's 1992
Annual Report on Form 10-K and by this reference is
incorporated herein and made a part hereof
10.30 CII Financial 1991 Employee Stock Incentive Plan, filed as
Exhibit 10.38 to CII Financial's Registration Statement on
Form S-1 (Registration No. 33-42114) and by this reference is
incorporated herein and made a part hereof
10.31 Form of CII Financial 1991 Employee Stock Incentive Agreement
filed as Exhibit 10.31 to CII Financial's 1992 Annual Report
on Form 10-K and by this reference is incorporated herein and
made a part hereof
10.32 CII Financial 1993 Employee Stock Incentive Plan, filed
herewith
10.33 Form of CII Financial 1993 Employee Incentive Stock Option
Agreement, filed herewith
10.34 Form of CII Financial 1993 Employee Incentive Stock Option
Agreement for key employees, filed herewith
10.35 Form of CII Financial 1993 Non-Qualified Stock Option
Agreement, filed herewith
10.36 Form of CII Financial 1993 Non-Qualified Stock Option
Agreement for key employees, filed herewith
10.37 CII Financial Non-Employee Director Stock Option Plan, filed
herewith
10.38 Form of CII Financial Non-Employee Director Non-Qualified
Stock Option Agreement, filed herewith
10.39 California Indemnity Insurance Company Non-Employee Director
Stock Option Plan, filed herewith
10.40 Form of California Indemnity Insurance Company Non-Employee
Director Non-Qualified Stock Option Agreement, filed herewith
</TABLE>
30
<PAGE>
<TABLE>
<C> <S>
10.41 InteLock Technologies 1993 Employee Stock Incentive Plan,
filed herewith
10.42 CII Financial Supplemental Executive Retirement Plan as
Amended and Restated Effective May 24, 1993, filed as Exhibit
10.37 to CII Financial's 1993 Annual Report on Form 10-K and
by this reference is incorporated herein and made a part
hereof
10.43 Form of Participation Agreement under the CII Financial
Supplemental Executive Retirement Plan as Amended and Restated
Effective May 24, 1993, filed as Exhibit 10.38 to CII
Financial's 1993 Annual Report on Form 10-K and by this
reference is incorporated herein and made a part hereof
10.44 CII Financial Supplemental Senior Executive Retirement Plan,
filed as Exhibit 10.21 to CII Financial's Registration
Statement on Form S-1 (Registration No. 33-32574) and by this
reference is incorporated herein and made a part hereof
10.45 Participation Agreement under the CII Financial Supplemental
Senior Executive Retirement Plan, among CII Financial,
California Indemnity and Joseph G. Havlick, effective January
1, 1990, filed as Exhibit 10.21 to CII Financial's
Registration Statement on Form S-1 (Registration No. 33-32574)
and by this reference is incorporated herein and made a part
hereof
10.46 Amendment No. 1 to the Participation Agreement under the CII
Financial Supplemental Senior Executive Retirement Plan among
CII Financial, California Indemnity and Joseph G. Havlick,
effective February 21, 1991, filed as Exhibit 10.37 to CII
Financial's 1992 Annual Report on Form 10-K and by this
reference is incorporated herein and made a part hereof
10.47 InteLock Technologies Supplemental Executive Retirement Plan,
filed herewith
10.48 Participation Agreement under the InteLock Technologies
Supplemental Executive Retirement Plan, filed herewith
10.49 CII Financial Employee Incentive Plan, as amended and restated
effective January 1, 1990, filed as Exhibit 10.38 to CII
Financial's 1992 Annual Report on Form 10-K and by this
reference is incorporated herein and made a part hereof
10.50 InteLock Technologies Founders' Bonus Plan, filed herewith
10.51 InteLock Technologies Phantom Stock Bonus Plan, filed herewith
10.52 Participation Agreement under the InteLock Technologies
Phantom Stock Bonus Plan, filed herewith
10.53 InteLock Technologies Cash Bonus Plan, filed herewith
10.54 CII Financial Supplemental Benefit Plan, as amended and
restated effective January 1, 1995, filed herewith
10.55 First Amendment to the Supplemental Benefit Plan, as amended
and restated effective January 1, 1995, filed herewith
10.56 Form of Waiver of Benefits and Consent to Amendment of the CII
Financial Supplemental Benefit Plan, filed herewith
10.57 Form of Employee Deferral Agreement under the Supplemental
Benefit Plan, as amended and restated effective January 1,
1995, filed herewith
10.58 Form of Director Deferral Agreement under the Supplemental
Benefit Plan, as amended and restated effective January 1,
1995, filed herewith
10.59 Trust Agreement for CII Financial Supplemental Benefit Plan,
as amended and restated effective
</TABLE>
31
<PAGE>
<TABLE>
<C> <S>
January 1, 1995, filed herewith
10.60 CII Financial 401(K) Plan, as amended and restated effective
April 1, 1994, filed herewith
10.61 First Amendment to the CII Financial 401(k) Plan, as amended
and restated effective April 1, 1994, filed herewith
10.62 Trust Agreement for CII Financial 401(k) Plan, as amended and
restated effective April 1, 1994, filed herewith
10.63 CII Financial Profit Sharing Plan, as amended and restated
effective April 1, 1994, filed herewith
10.64 First Amendment to the CII Financial Profit Sharing Plan, as
amended and restated effective April 1, 1994, filed herewith
10.65 Trust Agreement for CII Financial Profit Sharing Plan, as
amended and restated effective April 1, 1994, filed herewith
10.66 Stock Purchase Match Plan dated December 15, 1993, filed as
Exhibit 10.49 to CII Financial's 1993 Annual Report on Form
10-K and by this reference is incorporated herein and made a
part hereof
10.67 Stock Ownership Plan dated December 15, 1993, filed as Exhibit
10.50 to CII Financial's 1993 Annual Report on Form 10-K and
by this reference is incorporated herein and made a part
hereof
10.68 Split-Dollar Insurance Agreement dated May 23, 1991, among CII
Financial, California Indemnity, and Lawrence S. Havlick and
Michael G. Havlick, as trustees under that certain Trust
Agreement by and between Joseph G. Havlick and Tanna P.
Handley-Havlick, as trustors, and Lawrence S. Havlick and
Michael J. Havlick, as trustees, dated April 15, 1991, filed
as Exhibit 10.49 to CII Financial's Registration Statement on
Form S-1 (Registration No. 33-42114) and by this reference is
incorporated herein and made a part hereof
10.69 Employment Agreement among CII Financial, California Indemnity
and Joseph G. Havlick dated March 1, 1991, filed as Exhibit
10.29 to CII Financial's Registration Statement on Form S-1
(Registration No. 33-42114) and by this reference is
incorporated herein and made a part hereof
10.70 Amendment No. 1 to Employment Agreement among CII Financial,
California Indemnity and Joseph G. Havlick, dated December 16,
1991, filed as Exhibit 10.52 to CII Financial's 1991 Annual
Report on Form 10-K (Commission File No. 0-18324) and by
reference is incorporated herein and made a part hereof
10.71 Amendment No. 2 to Employment Agreement among CII Financial,
California Indemnity and Joseph G. Havlick, dated July 1,
1992, filed as Exhibit 10.48 to CII Financial's 1992 Annual
Report on Form 10-K and by this reference is incorporated
herein and made a part hereof
10.72 Amendment No. 3 to Employment Agreement among CII Financial,
California Indemnity and Joseph G. Havlick, dated August 3,
1993, filed as Exhibit 10.55 to CII Financial's 1993 Annual
Report on Form 10-K and by this reference is incorporated
herein and made a part hereof
10.73 Form of Amendment No. 4 to Employment Agreement among CII
Financial, California Indemnity and Joseph G. Havlick dated
November 10, 1993, filed as Exhibit 10.56 to CII Financial's
1993 Annual Report on Form 10-K and by this reference is
incorporated herein and made a part hereof
10.74 Waiver No. 1 to Employment Agreement among CII Financial,
California Indemnity and Joseph G. Havlick, dated December 16,
1991, filed as Exhibit 10.49 to CII Financial's 1992 Annual
Report on Form 10-K and by this reference is incorporated
herein and made a part hereof
10.75 Waiver No. 2 to Employment Agreement among CII Financial,
California Indemnity and Joseph
</TABLE>
32
<PAGE>
<TABLE>
<C> <S>
G. Havlick, dated December 7, 1992, filed as Exhibit 10.50 to
CII Financial's 1992 Annual Report on Form 10-K and by this
reference is incorporated herein and made a part hereof
10.76 Waiver No. 3 to Employment Agreement among CII Financial,
California Indemnity and Joseph G. Havlick, dated February 9,
1993, filed as Exhibit 10.59 to CII Financial's 1993 Annual
Report on Form 10-K and by this reference is incorporated
herein and made a part hereof
10.77 Employment Agreement among CII Financial, California Indemnity
and Tanna P. Handley dated March 1, 1991, filed as Exhibit
10.30 to CII Financial's Registration Statement on Form S-1
(Registration No. 33-42114) and by this reference is
incorporated herein and made a part hereof
10.78 Amendment No. 1 to Employment Agreement among CII Financial,
California Indemnity and Tanna P. Handley, dated December 16,
1991, filed as Exhibit 10.53 to CII Financial's 1992 Annual
Report on Form 10-K (Commission File No. 0-18324) and by
reference is incorporated herein and made a part hereof
10.79 Amendment No. 2 to Employment Agreement among CII Financial,
California Indemnity and Tanna P. Handley, dated July 7, 1992,
filed as Exhibit 10.53 to CII Financial's 1992 Annual Report
on Form 10-K and by this reference is incorporated herein and
made a part hereof
10.80 Amendment No. 3 to Employment Agreement among CII Financial,
California Indemnity and Tanna P. Handley, dated March 15,
1993; effective April 15, 1992, filed as Exhibit 10.54 to CII
Financial's 1992 Annual Report on Form 10-K and by this
reference is incorporated herein and made a part hereof
10.81 Amendment No. 4 to Employment Agreement among CII Financial,
California Indemnity and Tanna P. Handley, dated November 10,
1993, filed herewith
10.82 Amendment No. 5 to Employment Agreement among CII Financial,
California Indemnity and Tanna P. Handley, dated March 1,
1994, filed herewith
10.83 Amendment No. 6 to Employment Agreement among CII Financial,
California Indemnity and Tanna P. Handley, dated July 1, 1994,
filed herewith
10.84 Waiver No. 1 to Employment Agreement among CII Financial,
California Indemnity and Tanna P. Handley, dated December 16,
1991, filed as Exhibit 10.55 to CII Financial's 1992 Annual
Report on Form 10-K and by this reference is incorporated
herein and made a part hereof
10.85 Waiver No. 2 to Employment Agreement among CII Financial,
California Indemnity and Tanna P. Handley, dated December 7,
1992, filed as Exhibit 10.56 to CII Financial's 1992 Annual
Report on Form 10-K and by this reference is incorporated
herein and made a part hereof
10.86 Waiver No. 3 to Employment Agreement among CII Financial,
California Indemnity and Tanna P. Handley, dated February 9,
1993, filed as Exhibit 10.67 to CII Financial's 1993 Annual
Report on Form 10-K and by this reference is incorporated
herein and made a part hereof
10.87 Employment Agreement among CII Financial, California Indemnity
and Lee W. Spitler, Jr. dated March 1, 1991, filed as Exhibit
10.31 to CII Financial's Registration Statement on Form S-1
(Registration No. 33-42114) and by this reference is
incorporated herein and made a part hereof
10.88 Amendment No. 1 to Employment Agreement among CII Financial,
California Indemnity and Lee W. Spitler, Jr., dated December
16, 1991, filed as Exhibit 10.54 to CII Financial's 1991 Form
10-K (Commission File No. 0-18324) and by reference is
incorporated herein and made a part hereof
10.89 Amendment No. 2 to Employment Agreement among CII Financial,
California Indemnity and Lee W. Spitler, Jr., dated July 1,
1992, filed as Exhibit 10.59 to CII Financial's 1992 Annual
Report on Form 10-K and by this reference is incorporated
herein and made a part hereof
</TABLE>
33
<PAGE>
<TABLE>
<C> <S>
10.90 Amendment No. 3 to Employment Agreement among CII Financial,
California Indemnity and Lee W. Spitler, Jr., dated July 7,
1992, filed as Exhibit 10.60 to CII Financial's 1992 Annual
Report on Form 10-K and by this reference is incorporated
herein and made a part hereof
10.91 Amendment No. 4 to Employment Agreement among CII Financial,
California Indemnity and Lee W. Spitler, Jr., dated November
10, 1993, filed herewith
10.92 Amendment No. 5 to Employment Agreement among CII Financial,
California Indemnity and Lee W. Spitler, Jr., dated March 1,
1994, filed herewith
10.93 Waiver No. 1 to Employment Agreement among CII Financial,
California Indemnity and Lee W. Spitler, Jr., dated December
16, 1991, filed as Exhibit 10.61 to CII Financial's 1992
Annual Report on Form 10-K and by this reference is
incorporated herein and made a part hereof
10.94 Waiver No. 2 to Employment Agreement among CII Financial,
California Indemnity and Lee W. Spitler, Jr., dated December
7, 1992, filed as Exhibit 10.62 to CII Financial's 1992 Annual
Report on Form 10-K and by this reference is incorporated
herein and made a part hereof
10.95 Waiver No. 3 to Employment Agreement among CII Financial,
California Indemnity and Lee W. Spitler, Jr., dated February
9, 1993, filed as Exhibit 10.75 to CII Financial's 1993 Annual
Report on Form 10-K and by this reference is incorporated
herein and made a part hereof
10.96 Employment Agreement among CII Financial, California Indemnity
and Richard E. Dobson, dated March 1, 1994, filed herewith
10.97 Amendment No. 1 to Employment Agreement among CII Financial,
California Indemnity and Richard E. Dobson, dated March 24,
1995, effective July 1, 1994, filed herewith
10.98 Employment Agreement among CII Financial, California Indemnity
and John F. Okita, dated March 1, 1994, filed herewith
10.99 Amendment No. 1 to Employment Agreement among CII Financial,
California Indemnity and John F. Okita, dated March 24, 1995,
effective July 1, 1994, filed herewith
10.100 Employment Agreement by and between InteLock Technologies and
Thomas E. Corder, dated June 3, 1993, filed herewith
10.101 Guaranty Agreement by and among California Indemnity, Thomas
E. Corder and InteLock Technologies, dated June 3, 1993, filed
herewith
10.102 Assignment of Interest in Promissory Note and Deed of Trust by
CII Financial to California Indemnity dated October 26, 1992
and recorded November 23, 1992, filed as Exhibit 10.64 to CII
Financial's 1992 Annual Report on Form 10-K and by this
reference is incorporated herein and made a part hereof
10.103 Adjustable Rate Secured Promissory Note by and between the
Havlick Family Trust under Trust dated September 7, 1985 and
CII Financial, dated May 1, 1992, filed as Exhibit 10.66 to
CII Financial's 1992 Annual Report on Form 10-K and by this
reference is incorporated herein and made a part hereof
10.104 Modification of Adjustable Rate Secured Promissory Note by and
between the Havlick Family Trust under Trust dated September
7, 1985 and CII Financial, dated March 1, 1994, filed herewith
10.105 Deed of Trust by and between Joseph G. Havlick and Tanna P.
Handley-Havlick Trustees of the Havlick Family Trust dated
September 7, 1985 and Placer Title Company in Favor of CII
Financial, dated and recorded May 1, 1992, filed as Exhibit
10.68 to CII Financial's 1992 Annual Report on Form 10-K and
by this reference is incorporated herein and made a part
hereof
</TABLE>
34
<PAGE>
<TABLE>
<C> <S>
10.106 Assignment of Interest in Promissory Note and Deed of Trust by
CII Financial to California Indemnity dated October 26, 1992
and recorded November 23, 1992, filed as Exhibit 10.67 to CII
Financial's 1992 Annual Report on Form 10-K and by this
reference is incorporated herein and made a part hereof
10.107 Adjustable Rate Secured Promissory Note by and between Lee W.
Spitler, Jr. and Sheri Spitler and California Indemnity, dated
August 27, 1992, filed as Exhibit 10.69 to CII Financial's
1992 Annual Report on Form 10-K and by this reference is
incorporated herein and made a part hereof
10.108 Modification of Adjustable Rate Secured Promissory Note by and
between Lee W. Spitler, Jr. and Sheri Spitler and California
Indemnity, dated March 1, 1994, filed herewith
10.109 Deed of Trust by and between Lee W. Spitler, Jr. and Sheri
Spitler and Placer Title Company in favor of California
Indemnity, dated August 21, 1992 and recorded August 28, 1992,
filed as Exhibit 10.70 to CII Financial's 1992 Annual Report
on Form 10-K and by this reference is incorporated herein and
made a part hereof
11.0 Statement Regarding Computation of Per Share Earnings, filed
herewith
12.0 Calculation of ratio of earnings to fixed charges, filed
herewith
21.0 Subsidiaries of CII Financial, filed herewith
29.0 Schedule P - Analysis of Losses and Loss Expenses, filed
herewith
</TABLE>
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the last quarter of the
fiscal year ended December 31, 1994.
35
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized this 16th day of
August, 1995.
CII FINANCIAL, INC.
By /s/ John F. Okita
--------------------------------
John F. Okita
Chief Financial Officer
36
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
The Consolidated Financial Statements of CII Financial, Inc. and
Subsidiaries have been omitted from this copy of the Form 10K/A of
CII Financial, Inc. for the Year Ended December 31, 1994 because complete
financial statements, restated to conform to subsequent interim financial
information have been included in the Joint Proxy Statement/Prospectus to which
this 10K/A is attached.
37
<PAGE>
ANNEX C
FORM 10-Q/A
AMENDMENT NO. 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
FOR QUARTER ENDED JUNE 30, 1995
COMMISSION FILE NUMBER: 0-18324
CII FINANCIAL, INC.
(Exact name of registrant as specified in charter)
CALIFORNIA 95-4188244
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5627 GIBRALTAR DRIVE PLEASANTON, CALIFORNIA 94566-9025
(Address of principal executive offices) (Zip Code)
(510) 416-8700
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES x NO ____
-----
At August 11, 1995, there were 7,203,221 shares of Common Stock outstanding.
<PAGE>
PART I - FINANCIAL INFORMATION
CII FINANCIAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
<TABLE>
<CAPTION>
June 30, December 31,
1995 1994
-------- ------------
<S> <C> <C>
ASSETS:
Investments:
Held to maturity, at amortized cost
(fair value $111,994 and $107,535) $107,020 $107,751
Available for sale, at fair value
(amortized cost $106,945 and $109,311) 109,118 108,125
Relocation mortgage loans from employees 5,557 5,841
-------- --------
Total investments 221,695 221,717
Cash 6,054 6,845
Reinsurance recoverables 29,574 29,407
Premiums receivables, less allowances of $1,522 and $2,192 12,996 12,789
Financed premiums receivables, less allowances of $83 and $100 12,773 15,576
Investment income receivables 3,604 3,170
Deferred policy acquisition costs 2,633 2,285
Earned but unbilled receivables 1,210 2,244
Deferred income tax 4,750 4,000
Property and equipment, less accumulated
depreciation of $2,650 and $2,253 3,621 4,035
Other assets 5,370 4,919
-------- --------
TOTAL ASSETS $304,280 $306,987
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY:
LIABILITIES:
Loss and loss adjustment expense reserves $184,603 $190,962
Unearned premiums 9,995 8,940
Ceded reinsurance premiums payable 774 543
Convertible subordinated debentures 56,800 56,800
Note payable to bank 7,000 8,000
Federal income tax payable - 291
Other liabilities 16,746 12,916
-------- --------
TOTAL LIABILITIES 275,918 278,452
-------- --------
SHAREHOLDERS' EQUITY:
Common stock:
Stated value $.50 per share; authorized 100,000;
issued and outstanding 7,203 and 7,187 3,602 3,593
Additional paid-in capital 58,613 58,563
Unrealized gains (losses) on securities 937 (1,187)
Accumulated deficit (34,790) (32,434)
-------- --------
TOTAL SHAREHOLDERS' EQUITY 28,362 28,535
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $304,280 $306,987
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
<PAGE>
PART I - FINANCIAL INFORMATION
CII FINANCIAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1995 1994
------- -------
<S> <C> <C>
REVENUES:
Net earned premiums $41,037 $45,919
Net investment income 7,022 6,179
Other income 1,686 1,110
------- -------
Total revenues 49,745 53,208
------- -------
COSTS AND EXPENSES:
Net loss and loss adjustment expenses 24,225 31,635
Policy acquisition, general and administrative 19,572 16,506
Interest expense 2,454 2,130
------- -------
Total costs and expenses 46,251 50,271
------- -------
INCOME BEFORE TAXES AND DISCONTINUED OPERATIONS 3,494 2,937
Federal income tax expense (benefit) (750) -
------- -------
INCOME BEFORE DISCONTINUED OPERATIONS 4,244 2,937
Net operating loss from discontinued operations (2,010) (679)
Net loss on disposal of discontinued operations (4,590) -
------- -------
Total loss from discontinued operations (6,600) (679)
------- -------
NET INCOME (LOSS) $(2,356) $ 2,258
======= =======
EARNINGS PER SHARE:
Income before discontinued operations: Primary $ .57 $ .41
====== ======
Fully diluted $ .55 $ .41
====== ======
Discontinued operations: Primary ($ .90) ($ .10)
====== ======
Fully diluted ($ .88) ($ .10)
====== ======
Net income (loss): Primary and fully diluted ($ .33) $ .31
====== ======
</TABLE>
See accompanying notes to condensed consolidated financial statements
3
<PAGE>
PART I - FINANCIAL INFORMATION
CII FINANCIAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended
June 30,
1995 1994
------- -------
<S> <C> <C>
REVENUES:
Net earned premiums $20,753 $22,202
Net investment income 3,521 3,034
Other income 828 586
------- -------
Total revenues 25,102 25,822
------- -------
COSTS AND EXPENSES:
Net loss and loss adjustment expenses 12,373 14,361
Policy acquisition, general and administrative 10,403 8,755
Interest expense 1,224 1,065
------- -------
Total costs and expenses 24,000 24,181
------- -------
INCOME BEFORE TAXES AND DISCONTINUED OPERATIONS 1,102 1,641
Federal income tax expense (benefit) (750) -
------- -------
INCOME BEFORE DISCONTINUED OPERATIONS 1,852 1,641
Net operating loss from discontinued operations (1,046) (400)
Net loss on disposal of discontinued operations (4,590) -
------- -------
Total loss from discontinued operations (5,636) (400)
------- -------
NET INCOME (LOSS) $(3,784) $ 1,241
======= =======
EARNINGS PER SHARE:
Income before discontinued operations: Primary $ .25 $ .23
====== ======
Fully diluted $ .24 $ .23
====== ======
Discontinued operations: Primary ($ .78) ($ .06)
====== ======
Fully diluted ($ .77) ($ .06)
====== ======
Net income (loss): Primary and fully diluted ($ .53) $ .17
====== ======
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
PART I - FINANCIAL INFORMATION
CII FINANCIAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1995 1994
-------- ---------
<S> <C> <C>
CASH PROVIDED BY OPERATING ACTIVITIES: $ (3,202) $ 19,047
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of held to maturity investments - (14,301)
Purchase of available for sale investments (386,526) (898,649)
Disposal of held to maturity investments upon maturity or call 780 4,938
Disposal of available for sale investments 385,973 883,198
Financed premiums receivables 2,820 (4,746)
Mortgage loan receipts from employees 283 68
Purchase of property and equipment (8) (255)
Proceeds on disposal of property and equipment 5 1
--------- ---------
Net cash provided by (used in) investing activities 3,327 (29,746)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from stock options exercised 58 55
Issuance of note payable to bank - 3,000
Payment of note payable to bank (1,000) -
Other 1 -
--------- ---------
Net cash provided by (used in) financing activities (941) 3,055
--------- ---------
NET INCREASE (DECREASE) IN CASH (816) (7,644)
Cash, beginning of period 6,870 10,110
--------- ---------
Cash, end of period $ 6,054 $ 2,466
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE>
PART I - FINANCIAL INFORMATION
CII FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
============================================
The information furnished in this report reflects all adjustments which are, in
the opinion of management, necessary to a fair statement of the results for the
interim periods presented.
NOTE 1 - INTERIM FINANCIAL STATEMENTS
The interim financial statements for the six and three months ended June 30,
1995 and 1994 are unaudited. In the opinion of management, such statements
reflect all adjustments (consisting only of normal recurring adjustments)
necessary for a fair presentation of the results of such periods. The results
of operations for the six and three months ended June 30, 1995 are not
necessarily indicative of the results for the entire year.
NOTE 2 - INVESTMENTS
The investment portfolio is classified into three categories -- held to
maturity, available for sale, and trading -- based on the ratings of the
security and other factors. Held to maturity investments are reported at
amortized cost. Available for sale investments are reported at fair values and
the net unrealized gain or loss, net of deferred taxes, is included in
shareholders' equity. Trading investments are also reported at fair values but
the net unrealized gain or loss is included in net investment income. At June
30, 1995, the available for sale portfolio had a net unrealized gain of
$937,000.
NOTE 3 - NOTE PAYABLE TO BANK
The Company has a $12,000,000 revolving line of credit agreement with a bank
which expires on August 1, 1995. During the term of the agreement, the Company
can borrow at the bank's variable prime rate plus 0.5% or a fixed LIBOR rate
plus 2.5%, payable monthly. Advances are available up to 80% of eligible loans
receivable and are collateralized by installment loans receivable. A commitment
fee of 0.1% per annum is payable on the $12,000,000 and the Company is required
to maintain a compensating balance of 15% of the revolving line of credit.
Under this agreement, the Company borrowed $8,000,000 at the fixed LIBOR rate
plus 2.5% (total of 8.25%) maturing on June 12, 1995. The Company paid down the
principal balance by $1,000,000 in May 1995. The remaining $7,000,000 was
renewed at the LIBOR rate plus 2.5% (total of 8.5625%) on June 12, 1995 and the
note matures August 1, 1995. The Company intends to renew the line of credit
agreement for another one year period.
6
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 3 - NOTE PAYABLE TO BANK (Continued)
The revolving line of credit agreement requires compliance with certain loan
covenants including, but not limited to, minimum tangible net worth, debt
leverage ratio, and current ratio. The revolving line of credit of $12,000,000
is guaranteed by CII Financial, Inc. (the "Parent Company"). In addition, the
Parent Company subordinated $2,000,000 of its debt.
NOTE 4 - FEDERAL INCOME TAXES
The total current tax provision for the six months ended June 30, 1995 was zero
and the total deferred tax benefit was $750,000. The net current tax provision
for the three months ended June 30, 1995 was a credit of $503,000 and the net
deferred tax benefit was $247,000. The current tax provision for continuing
operations reflects the tax exempt interest income and other permanent and
temporary differences. The deferred tax asset valuation allowance was evaluated
to determine that it was more likely than not that the deferred tax assets will
be realized in the future. As a result, the valuation allowance was reduced
during the three months ended June 30, 1995. There was no tax provision for the
six and three months ended June 30, 1994 because of tax exempt interest income,
utilization of loss carryforwards and other tax credits.
NOTE 5 - DISCONTINUED OPERATIONS
In May 1995, the Company made a determination to dispose of its equity interest
in its majority-owned electronic door lock subsidiary, InteLock Technologies, by
either a sale or liquidation. Accordingly, this reportable segment was
classified as a discontinued operation. On June 13, 1995, the Company entered
into an agreement to sell its equity interest in InteLock for a combination of
common stock, warrants, and cash totalling approximately $1 million. For the
six months ended June 30, 1995, InteLock had gross revenues of $925,000 compared
to $1,000,000 for the comparable prior year period. For the
six months ended June 30, 1995, operating losses were $2,010,000 and the loss on
disposal was an additional $4,590,000. There was no income tax benefit
recognized on the loss from discontinued operations due to the valuation
allowance provided on potential deferred tax assets. The loss on disposal
includes the write off of the remaining investment in InteLock of approximately
$2,000,000, operating losses subsequent to the discontinued operation
measurement date of approximately $350,000, and accrued estimated run-off and
other disposal costs in accordance with the terms of the sales agreement of
approximately $2,240,000. For the three months ended June 30, 1995, InteLock had
gross revenues of $384,000 compared to $467,000 for the comparable prior year
period. For the three months ended June 30, 1995, the operating loss was
$1,046,000 and the loss on disposal was $4,590,000, net of zero income taxes.
NOTE 6 - NET EARNINGS PER COMMON SHARE
For the six and three months ended June 30, 1995, income before discontinued
operations per common share has been calculated by dividing income before
discontinued operations by the weighted average number of common shares
outstanding during the period, including common
7
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 6 - NET EARNINGS PER COMMON SHARE (Continued)
stock equivalents. For the six and three months ended June 30, 1995, net loss
per common share is based only on the weighted average common shares issued
during the periods and do not include common stock equivalents as their
inclusion would be anti-dilutive. For the six and three months ended June 30,
1994, all earnings per share calculations are based on the weighted average
number of common shares issued during the periods and do not include common
stock equivalents as their effects were not material. Convertible subordinated
debentures for the six and three months ended June 30, 1995 and 1994 are
excluded from the calculations of fully diluted earnings per share as their
inclusion would be anti-dilutive.
The number of common shares used for computing primary and fully diluted income
before discontinued operations per share were as follows:
<TABLE>
<CAPTION>
1995 1994
--------- ---------
<S> <C> <C>
Six months ended June 30,
Primary.................................................................................... 7,406,193 7,172,849
Fully diluted.............................................................................. 7,725,001 7,172,849
Three months ended June 30,
Primary.................................................................................... 7,517,518 7,180,065
Fully diluted.............................................................................. 7,726,033 7,180,065
</TABLE>
The number of common shares used for computing primary and fully diluted net
income (loss) per share were as follows:
<TABLE>
<CAPTION>
1995 1994
--------- ---------
<S> <C> <C>
Six months ended June 30,
Primary and fully diluted.................................................................. 7,188,058 7,172,849
Three months ended June 30,
Primary and fully diluted.................................................................. 7,189,090 7,180,065
</TABLE>
NOTE 7 - PENDING MERGER
On June 13, 1995, CII Financial, Inc. ("CII") and Sierra Health Services, Inc.
("Sierra") signed a definitive agreement whereby CII would ultimately become a
wholly-owned subsidiary of Sierra. Each common stock of CII would be exchanged
for Sierra common stock at a fixed exchange rate of one CII share to 0.37 Sierra
share. In addition, while remaining an obligation of CII, the 7 1/2%
Convertible Subordinated Debentures will become convertible into Sierra common
stock with the conversion price adjusted for the exchange ratio. The merger is
subject to the approval of shareholders of both CII and Sierra and is currently
awaiting approval by regulatory authorities.
8
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 7 - PENDING MERGER (Continued)
A class action complaint has been filed against CII and its directors in the
Superior Court, Alameda County, California, on this pending merger. The
complaint alleges, among other claims, that by entering into this definitive
agreement the directors breached their fiduciary duties. Sierra is also a named
defendant as an aider and abetter. CII believes the complaint is without merit
and intends to defend it.
NOTE 8 - RECLASSIFICATION OF PRIOR AMOUNTS
Certain amounts in the accompanying Condensed Consolidated Financial Statements
for prior years have been reclassified to conform to those classifications used
in 1995.
9
<PAGE>
PART I - FINANCIAL INFORMATION
CII FINANCIAL, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION
============================================
The profitability of CII Financial, Inc. and its subsidiaries (collectively, the
"Company") is affected by many factors, including the severity and frequency of
claims, state regulation of premium rates and benefits payable for injuries and
losses, general business conditions, and competition. The historical
information presented may not necessarily be comparable to or indicative of
future results of operations of the Company. Current and prior financial
information related to InteLock Technologies is now being shown as a
discontinued operation.
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 1995 AS COMPARED TO THE
SIX MONTHS ENDED JUNE 30, 1994
For the six months ended June 30, 1995, the Company had income from continuing
operations of $4,244,000 or $.57 per share primary and $.55 per share fully
diluted compared to $2,937,000 or $.41 per share primary and fully diluted for
the comparable prior year period. Including the discontinued operation, for the
six months ended June 30, 1995, the Company had a net loss of $2,356,000 or $.33
per share primary/fully diluted compared to net income of $2,258,000 or $.31 per
share primary/fully diluted for the comparable prior year period.
Continuing Operations
---------------------
Total revenues of the Company for the six months ended June 30, 1995 decreased
6.5% to $49,745,000 compared to $53,208,000 for the six months ended June 30,
1994. The decrease in revenues was primarily due to a decrease in premium
revenues. Comparing the 1995 and 1994 six month periods, net earned premiums
decreased $4,882,000, net investment income, excluding investment gains,
increased by $931,000, net realized investment and trading gains decreased by
$89,000, premium finance revenues decreased by $84,000, and other revenues,
consisting primarily of commission income, increased by $661,000.
Net earned premiums decreased 10.6% to $41,037,000 for the six months ended June
30, 1995, compared to $45,919,000 for the corresponding period of the preceding
year. The decrease in net earned premiums was due to a decrease in business
written in California which was partially offset by an increase in business
written in Colorado and other states. Direct written premiums in California for
the six months ended June 30, 1995 decreased 13.7% to $36,668,000 compared to
$42,488,000 for the comparable prior year period. Direct written premiums in
Colorado and other states for the six months ended June 30, 1995 increased 33.1%
to $7,299,000 compared to $5,485,000 for the comparable prior year period.
10
<PAGE>
Reflected in the decrease in California net earned premiums are the effects of
intense price competition from "open rating" for policies effective on or after
January 1, 1995 and from rate decreases ordered by the California Insurance
Commissioner in 1994 of 12.7% effective January 1, 1994 and a further 16%
effective October 1, 1994.
For the six months ended June 30, 1995, premiums in force have decreased by
$554,000 compared to a decrease of $7,153,000 for the corresponding period of
the preceding year. Premiums in force at June 30, 1995 were $93,536,000 compared
to $98,790,000 at June 30, 1994. The number of policies in force increased in
the six months ended June 30, 1995 by 607 compared to a decrease of 1,207 for
the comparable prior year period. The decrease in inforce premiums was due to a
decrease in business written in all areas except for the Bay Area of Northern
California and in other states. In total, the average inforce premium for the
six months ended June 30, 1995 decreased by 8.0% to $11,562 compared to an
increase of 7.7% to $12,643 for the comparable prior year period.
Geographically, at June 30, 1995, 28.2% of the total in force premiums were
written in the six county area of Southern California (excluding San Diego),
57.1% were written in Northern California and San Diego, and 14.7% were written
in Colorado and other states. Comparable geographic percentages at June 30,
1994 were 30.3% for Southern California, 58.7% for Northern California and San
Diego, and 11.0% for Colorado and other states. The Company believes that
workers' compensation insurance opportunities now exist in Texas and is in the
process of establishing a branch service office in that state. The Company is
also investigating writing workers' compensation in other states, primarily in
the west.
The workers' compensation legislative reforms enacted in July 1993 repealed the
minimum rate law effective January 1, 1995 and replaced it with open rating
rules. Under the open rating environment, each California workers' compensation
insurer must determine and file with the Department of Insurance the premiums
and rating plans it will use. The Department of Insurance can only disapprove a
filed rate if it determines that the rate will threaten an insurer's solvency or
if it will lead to a monopoly which is defined to be 20% or more of the total
workers' compensation market.
The new open rating environment has resulted in intense price competition for
"good" accounts where premium rates are substantially reduced compared to the
rates under the old minimum rate law. At this time, the Company estimates that
earned premiums for the full year of 1995 will be approximately 10% below 1994
because of the price competition.
The new open rating environment also brings uncertainties as to continued
operating profits due to the risk of incurring adverse loss experience over a
smaller premium base. Under the minimum rate law, an insurer was better able to
absorb an adverse loss since an insured was not able to realize an immediate
benefit for consistent low loss experience. Upon the expiration of the policy,
the insured may have received a portion of the premiums in the form of a
dividend if the account generated a profit for the insurer. Under open rating,
the insured's prior favorable loss experience can result in an immediate
reduction in premiums and the insurer runs the risk of incurring adverse losses
without a corresponding premium and
11
<PAGE>
without the option of not declaring a dividend. An insurer may attempt to issue
a policy on a retrospective rating basis to recoup part of its losses but
competitive pressures will usually result in an insured being able to obtain
coverage elsewhere without this feature. To be successful in this open rating
environment, an insurer must carefully underwrite each account and consider the
insured's risk characteristics, prior loss experience, loss prevention plans and
other underwriting considerations to determine the proper premium to charge.
Regular visits by loss control consultants may be necessary to ensure continued
adherence to accident prevention policies and/or to identify preventable risk
situations.
Net investment income, including realized gains and losses, increased 13.6% to
$7,022,000 for the six months ended June 30, 1995 from $6,179,000 for the
corresponding prior year period. The increase was primarily due to an increase
in investment yields due to higher interest rates. Excluding realized gains,
which were negligible for both six month periods, net investment income for the
six months ended June 30, 1995 was up $931,000 or 15.5% compared to the
comparable prior year period. The average yield in the Company's investment
portfolio, excluding realized and unrealized gains, was 6.5% for the six months
ended June 30, 1995 compared to an average yield of 5.5% for the comparable
prior year period. The increase in the average yield reflects the overall
general increase in interest rates.
At June 30, 1995, the Company's investment portfolio included investments in the
available for sale portfolio which had a market value totalling $109,118,000
compared to an amortized book value totalling $106,945,000. At June 30, 1995,
included in shareholders' equity is an unrealized gain of $937,000 compared to
an unrealized gain of $374,000 for the comparable prior year period. The
unrealized gain is due to principally to an increase in the value of the equity
investments.
For the six months ended June 30, 1995 as compared to the corresponding period
in the prior year, under generally accepted accounting principles, the insurance
subsidiaries' loss and loss adjustment expense ratio decreased 9.9 percentage
points to 59.0%, and the underwriting expense ratio increased 11.7 percentage
points to 46.7% for a total increase in the combined ratio of 1.8 percentage
points to 105.7% compared to 103.9% for the comparable prior year period.
The decrease in the loss and loss adjustment expense ratio resulted from
favorable loss development on prior accident years which was partially offset by
a strengthening of the current accident year reserves. The net favorable
development for all years totalled $8,693,000 compared to favorable loss
development of $3,870,000 for the comparable prior year period. The loss and
loss adjustment expense ratio for the six months ended June 30, 1995 reflects
the Company's current judgment of the ultimate costs of claims occurring in the
current as well as prior accident years and is within the range of reserves
recommended by our independent consulting actuary. The loss ratio for accident
year 1995 was strengthened to reflect an estimate for the reduction in premium
rates resulting from the intense competitive effects of open rating and the 16%
manual rate reduction effective October 1, 1994.
12
<PAGE>
The increase in the underwriting expense ratio was principally due to lower
earned premiums which was compounded by an increase in underwriting expense
dollars. The commission expense ratio (including allowances to agents) for the
six months ended June 30, 1995 increased 2.9 percentage points to 15.7% compared
to the comparable prior year period. This increase was due to marketing plans
aimed at attracting more profitable accounts in 1994. In addition, included in
the insurance companies' underwriting expenses is the payment of approximately
$1,200,000 to certain employees for the unintentional adverse tax consequences
arising from changes that were made in 1994 to the relocation mortgage loans.
However, on a consolidated basis, this payment had no financial impact as it was
previously accrued at the parent company level. The Company is continuing to
review and selectively reduce its operating costs to keep it in line with
anticipated premium writings without adversely affecting the Company's ability
to provide services to insureds and agents.
The Company's insurance subsidiaries have not paid any policyholders' dividends
since the second quarter of 1992 primarily because of regulatory restrictions.
With the advent of the open rating environment in California, the Company
believes that policyholders' dividends will no longer be a marketing
consideration. Consequently, the Company is now issuing only non-participating
policies in California effective January 1, 1995.
For the six months ended June 30, 1995, the Company recorded a net tax benefit
of $750,000, all of which was for a deferred tax benefit. The tax benefit was
due to a reduction in the deferred tax asset valuation allowance based on on-
going evaluations of the realization of this asset. The current tax provision
for the six months ended June 30, 1995 was zero due to tax exempt interest
income and other permanent and temporary timing differences. For the six months
ended June 30, 1994, there was no tax provision because of tax exempt interest
income, utilization of loss carryforwards and other tax credits.
Deferred tax assets arise principally from the net loss carryforward, discount
on loss reserves, and other temporary differences. A valuation allowance has
been established for the majority of the deferred tax asset and is based on
evaluations that it is more likely than not that the deferred tax assets will be
realized in the future. Such evaluations considered, among other factors, the
probability of future profitability and the establishment and reversal of
permanent and temporary differences. The uncertainties of the new open rating
environment were also considered.
Discontinued Operations
-----------------------
In May 1995, the Company made a determination to dispose its majority-owned
electronic door lock, InteLock Technologies ("InteLock"), by either a sale or
liquidation. Accordingly, this reportable segment was classified as a
discontinued operation. On June 13, 1995, the Company entered into an agreement
to sell its equity interest in InteLock for a combination of stocks, warrants
and cash totalling approximately $1 million. The sale was subsequently
completed in July. The determination to dispose InteLock was a culmination of
the analyses and evaluations of InteLock's viability as a continuing operating
entity which began in the last half of 1994. Operating losses for the six
months ended June 30, 1995 for InteLock were
13
<PAGE>
$2,010,000 compared to $679,000 for the comparable prior year period. The loss
on disposal of InteLock was an additional $4,590,000.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 1995 AS COMPARED TO
THE THREE MONTHS ENDED JUNE 30, 1994
For the three months ended June 30, 1995, the Company had net income from
continuing operations of $1,852,000 or $.25 per share primary and $.24 per share
fully diluted compared to $1,641,000 or $.23 per share primary/fully diluted for
the comparable prior year period. Including the discontinued operation, for the
three months ended June 30, 1995, the Company had a net loss of $3,784,000 or
$.53 per share primary/fully diluted compared to net income of $1,241,000 or
$.17 per share primary/fully diluted for the comparable prior year period.
Continuing Operations
---------------------
Total revenues of the Company for the three months ended June 30, 1995 were
$25,102,000 compared to $25,822,000 for the three months ended June 30, 1994.
Comparing the 1995 and 1994 second quarter periods, net earned premiums
decreased $1,448,000, net investment income, excluding investment gains,
increased by $542,000, net investment gains decreased by $55,000, premium
finance revenues decreased by $59,000 and other income, consisting primarily of
agents' commission income, increased by $300,000.
Net earned premiums decreased 6.5% to $20,753,000 for the three months ended
June 30, 1995, compared to $22,201,000 for the corresponding period of the
preceding year. The decrease in net earned premiums was due to a further
decrease in business written in California, as explained above, which was
partially offset by an increase in business written in Colorado and other
states.
For the three months ended June 30, 1995, premiums in force have decreased by
$1,767,000 or 1.9% compared to a decrease of $1,989,000 for the corresponding
period of the preceding year. The number of policies in force has increased in
the three months ended June 30, 1995 by 397 compared to a decrease of 381 for
the comparable prior year period. The decrease in inforce premiums is due
primarily to a reduction in business written in Southern California and was
partially offset by increases in all other areas. In total, the average inforce
premium for the three months ended June 30, 1995 decreased by 6.7% to $11,562
compared to an increase of 2.8% to $12,643 for the comparable prior year period.
Net investment income, including investment gains and losses, increased 16.0% to
$3,521,000 for the three months ended June 30, 1995 from $3,034,000 for the
corresponding prior year period. The increase was primarily due to an increase
in investment yields. Excluding investment gains, net investment income
increased 18.6%to $3,450,000 for the three months ended June 30, 1995 compared
to $2,908,000 for the comparable prior year period. The average yield in the
Company's investment portfolio, excluding realized and unrealized gains, was
6.6% for the three months ended June 30, 1995 compared to an average yield of
5.5% for the comparable prior year period.
14
<PAGE>
The net unrealized gains or losses on the "available for sale" investment
portfolio is shown as a separate component of shareholders' equity. For the
three months ended June 30, 1995, the change in net unrealized gains on the
"available for sale" investment portfolio was an increase of $1,292,000 to
$937,000.
For the three months ended June 30, 1995 as compared to the corresponding period
in the prior year, under generally accepted accounting principles, the insurance
subsidiaries' loss and loss adjustment expense ratio decreased 5.1 percentage
points to 59.6%, and the underwriting expense ratio increased 8.4 percentage
points to 46.1% for a total increase in the combined ratio of 3.3 percentage
points to 105.7% compared to 102.4% for the comparable prior year period.
The decrease in the loss and loss adjustment expense ratio resulted primarily
from favorable loss development on prior accident years which was partially
offset by a strengthening of the current accident year reserves. The net
favorable loss development for all years was approximately $4,243,000 compared
to favorable loss development of approximately $2,170,000 for the comparable
prior year period. The 1995 accident year loss ratio in the second quarter of
1995 was increased on a precautionary basis to address the effects of lower
premium rates resulting from the continued intense price competition of the open
rating environment in California.
As was explained above, the increase in the underwriting expense ratio was
principally due to lower earned premiums compounded by an increase in
underwriting expense dollars. The commission expense ratio (including
allowances to agents) for the three months ended June 30, 1995 was 3.1
percentage points higher to 16.4% compared to the comparable prior year period.
For the three months ended June 30, 1995, there was a net tax benefit of
$750,000. Reflected in the net tax benefit is a current benefit of $503,000,
for the reversal of the provision established in the three months ended March
31, 1995 and a deferred tax benefit of $247,000, which was primarily due to a
reduction in the deferred tax valuation allowance but offset by a reversal of
the deferred tax benefit for the three months ended March 31, 1995. There was no
tax provision for the three months ended June 30, 1994 because of tax exempt
interest income, utilization of loss carryforwards and other tax credits.
Discontinued Operations
-----------------------
As noted above, the Company sold its equity interest in InteLock in June 1995.
The loss from operations for InteLock for the three months ended June 30, 1995
was $1,046,000 and $400,000 for the comparable prior year period. The loss on
disposal was an additional $4,590,000.
15
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The amount of premiums that a workers' compensation insurance company may write
is dependent upon the amount of its policyholders' surplus. The Company's
sources of cash funds have been primarily sales of common stock, sales of
convertible subordinated debentures, and net positive cash flow from operations.
These capital sources have enabled the Company to maintain an adequate level of
policyholders' surplus. Policyholders' surplus (calculated on a statutory
accounting basis) at June 30, 1995 was $58,620,000 compared to $61,821,000 at
December 31, 1994 and $53,643,000 at June 30, 1994. The decrease in statutory
surplus between December 31, 1994 and June 30, 1995 was principally due to the
net loss from the disposal of InteLock Technologies. Currently, the Company has
no plans and believes it would be difficult to raise additional funds. The
Company believes its rate of growth and size of operations can be managed to
balance capital resources with capital needs.
The Company had negative cash flow from continuing operations for the six months
ended June 30, 1995 of $3,202,000 compared to positive cash flow of $19,047,000
for the comparable prior year period. The negative 1995 cash flow in 1995 was
due primarily to a reduction in premium collections resulting from a decrease in
premium writings. The positive cash flow for the six months ended June 30, 1994
was primarily due to a reduction in the trading portfolio from $10,921,000 at
December 31, 1993 to zero at June 30, 1994 and the collection of income tax
receivables of $5,272,000.
In the normal course of business, the Company invests any excess cash not needed
for operations. Conversely, any operating cash shortfalls would be funded
primarily from matured investments. For the six months ended June 30, 1995,
investing activities provided net cash of $3,327,000 compared to cash used of
$29,746,000 for the comparable prior year period. Total investments decreased
by $22,000 and financed premiums decreased by $2,803,000 during the six months
ended June 30, 1995.
For the six months ended June 30, 1995 net cash from financing activities
consisted primarily of a partial payment on the premium finance note payable to
bank of $1,000,000. For the six months ended June 30, 1994 net cash from
financing activities consisted primarily of a borrowing of $3,000,000 on the
premium finance bank line of credit.
The Company's bond investment portfolio consists of investment grade securities
with staggered maturities designed to meet anticipated cash needs.
CII Financial, Inc. (parent company) currently has insufficient liquid assets to
meet its expenses, including the semi-annual interest payments on the
Convertible Subordinated Debentures, for the remainder of the current year.
However, CII Financial expects to meet its expense obligations for the next
twelve months by the receipt of payment of intercompany receivables. As of June
30, 1995, CII Financial had a loan and advances to CIIPF totalling $9,880,000 to
fund the premium finance loans and is exploring alternative funding sources for
it premium finance operation. After the application of its existing liquid
assets, CII Financial would become dependent upon dividends received from its
subsidiaries to pay its expenses.
16
<PAGE>
California Indemnity and Commercial Casualty are subject to state insurance
regulations which restrict their ability to pay dividends to CII Financial and
California Indemnity, respectively. Currently, these regulations restrict
California Indemnity from paying any shareholder dividends without prior
approval from the California Department of Insurance. To date, no dividends
have been paid to CII Financial, Inc. by any of its subsidiaries.
EFFECTS OF INFLATION
Inflation can be expected to affect the operating performance and financial
condition of the Company in several aspects. Inflation can reduce the market
value of the investment portfolio; however, the Company's insurance subsidiaries
typically hold much of their investments to maturity. Inflation adversely
affects the portion of loss reserves which relates to hospital and medical
expenses, as these expenses normally increase during inflationary periods (and
in recent years have increased at a greater rate than prevailing inflation).
Loss reserves relating to indemnity benefits for lost wages are not directly
affected by inflation as these amounts are established by statute. Prior to
1995, to the extent that loss reserves and payments increase as a result of
inflation, rates have historically increased by operation of the rate setting
process, which established the minimum rates in effect in California; however,
workers' compensation legislative reforms enacted in July 1993 repealed the
minimum rate law effective January 1, 1995. Workers' compensation insurance
companies must now determine their own premium rates and assess the impact of
inflation on those rates. Another predictable result of inflation is an
escalation of wages paid to employees. To the extent that wages increase,
premium revenues will proportionately increase because rates are generally
applied as a charge per one hundred dollars of payroll. Since the Company's
inception, inflation has not had a material adverse effect on the Company.
PENDING MERGER
On June 13, 1995, CII Financial, Inc. ("CII") and Sierra Health Services, Inc.
("Sierra") signed a definitive agreement whereby CII would ultimately become a
wholly-owned subsidiary of Sierra. Each common stock of CII would be exchanged
for Sierra common stock at a fixed exchange rate of one CII share to 0.37 Sierra
share. In addition, while remaining an obligation of CII, the 7 1/2%
Convertible Subordinated Debentures will become convertible into Sierra common
stock with the conversion price adjusted for the exchange ratio. The merger is
subject to the approval of shareholders of both CII and Sierra and is currently
awaiting approval by regulatory authorities.
A class action complaint has been filed against CII and its directors in the
Superior Court, Alameda County, California, on this pending merger. The
complaint alleges, among other claims, that by entering into this definitive
agreement the directors breached their fiduciary duties. Sierra is also a named
defendant as an aider and abetter. CII believes the complaint is without merit
and intends to defend it.
17
<PAGE>
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-k.
a) Exhibit 11 Computation of per share earnings attached.
b) Previously filed Reports on Form 8-k as of June 13, 1995 are incorporated by
reference.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CII FINANCIAL, INC.
August 31, 1995 /s/ John F. Okita
--------------------- --------------------------------------------
Date John F. Okita
Chief Financial Officer
19
<PAGE>
EXHIBIT 11
CII FINANCIAL, INC. AND SUBSIDIARIES
COMPUTATION OF EARNINGS PER SHARE
<TABLE>
<CAPTION>
Six Months Ended Three Months Ended
June 30, June 30,
1995 1994 1995 1994
------- ------- ------- -------
(In thousands, except per share and market price data)
<S> <C> <C> <C> <C>
PRIMARY EARNINGS PER SHARE:
Common stock equivalents (3)
Options granted and unexercised 831 418 1,462 418
Assumed buyback of options (1) (613) (256) (1,133) (273)
------- ------- ------- -------
Total common stock equivalents 218 162 329 145
Total weighted average shares issued (4) 7,188 7,173 7,189 7,180
------- ------- ------- -------
Weighted average shares outstanding 7,406 7,335 7,518 7,325
======= ======= ======= =======
Income before discontinued operations reported $4,244 $2,937 $1,852 $1,641
Loss on discontinued operations reported ($6,600) ($ 679) ($5,636) ($ 400)
Net income (loss) reported ($2,356) $2,258 ($3,784) $1,241
Primary earnings per share: (5)
Income before discontinued operations $ .57 $ .41 $ .25 $ .23
Loss on discontinued operations ($ .90) ($ .10) ($ .78) ($ .06)
Net income (loss) ($ .33)(2) $ .31 ($ .53)(2) $ .17
FULLY DILUTED EARNINGS PER SHARE:
Common stock equivalents (3)
Options granted and unexercised 1,462 418 1,462 418
Assumed buyback of options (1) (925) (256) (925) (272)
------- ------- ------- -------
Total common stock equivalents 537 162 537 145
Convertible debentures assumed converted (2) 0 0 0 0
Total weighted average shares issued (4) 7,188 7,173 7,189 7,180
------- ------- ------- -------
Weighted average shares outstanding 7,725 7,335 7,726 7,325
======= ======= ======= =======
Income before discontinued operations reported $4,244 $2,937 $1,852 $1,641
Net income (loss) reported ($2,356) $2,258 ($3,784) $1,241
Fully diluted earnings per share: (5)
Income before discontinued operations $ .55 $ .41 $ .24 $ .23
Loss on discontinued operations ($ .88) ($ .10) ($ .77) ($ .06)
Net income (loss) ($ .33)(2) $ .31 ($ .53)(2) $ .17
</TABLE>
(1) Assumed buyback of stock options:
Primary common stock equivalents are assumed to be repurchased at average
market price. Fully diluted common stock equivalents are assumed to be
repurchased at the greater of average or ending market price.
<TABLE>
<S> <C> <C> <C> <C>
Average market price per common share $6.318 $5.720 $7.038 $5.370
Ending market price per common share $8.625 $5.375 $8.625 $5.375
</TABLE>
(2) Calculations exclude common stock equivalents and/or convertible debentures
as inclusion would be anti-dilutive.
(3) Convertible debentures are not common stock equivalents because they were
issued to yield 7.5% which was more than 67% of the average Aa corporate
bond yield.
(4) Total weighted average shares issued:
<TABLE>
<S> <C> <C> <C> <C>
Shares outstanding at beginning of year 7,187 7,170 7,187 7,170
Net weighted average shares issued and retired
in previous quarter 0 0 0 0
Weighted average shares issued during the period 1 3 2 10
Weighted average shares retired during the period 0 0 0 0
----- ----- ----- -----
Total weighted average shares issued 7,188 7,173 7,189 7,180
===== ===== ===== =====
</TABLE>
(5) Earnings per share are computed using the treasury stock method, by which
the number of shares outstanding reflects an assumed use of proceeds from
the assumed exercise of stock options, to repurchase shares of the
Company's common stock.
20
<PAGE>
ANNEX D
SELECTED SECTIONS OF THE CALIFORNIA GENERAL CORPORATION LAW
CHAPTER 13. DISSENTERS' RIGHTS
1300 REORGANIZATION OR SHORT-FORM MERGER; DISSENTING SHARES; CORPORATE
PURCHASE AT FAIR MARKET VALUE; DEFINITIONS--(a) If the approval of the
outstanding shares (Section 152) of a corporation is required for a
reorganization under subdivisions (a) and (b) or subdivision (e) or (f) of
Section 1201, each shareholder of the corporation entitled to vote on the
transaction and each shareholder of a subsidiary corporation in a short-form
merger may, by complying with this chapter, require the corporation in which
the shareholder holds shares to purchase for cash at their fair market value
the shares owned by the shareholder which are dissenting shares as defined in
subdivision (b). The fair market value shall be determined as of the day
before the first announcement of the terms of the proposed reorganization or
short-form merger, excluding any appreciation or depreciation in consequence
of the proposed action, but adjusted for any stock split, reverse stock split,
or share dividend which becomes effective thereafter.
(b) As used in this chapter, "dissenting shares" means shares which come
within all of the following descriptions:
(1) Which were not immediately prior to the reorganization or short-form
merger either (A) listed on any national securities exchange certified by the
Commissioner of Corporations under subdivision (o) of Section 25100 or (B)
listed on the list of OTC margin stocks issued by the Board of Governors of
the Federal Reserve System, and the notice of meeting of shareholders to act
upon the reorganization summarizes this section and Sections 1301, 1302, 1303
and 1304; provided, however, that this provision does not apply to any shares
with respect to which there exists any restriction on transfer imposed by the
corporation or by any law or regulation; and provided, further, that this
provision does not apply to any class of shares described in subparagraph (A)
or (B) if demands for payment are filed with respect to 5 percent or more of
the outstanding shares of that class.
(2) Which were outstanding on the date for the determination of shareholders
entitled to vote on the reorganization and (A) were not voted in favor of the
reorganization or, (B) if described in subparagraph (A) or (B) of paragraph
(1) (without regard to the provisos in that paragraph), were voted against the
reorganization, or which were held of record on the effective date of a short-
form merger; provided, however, that subparagraph (A) rather than subparagraph
(B) of this paragraph applies in any case where the approval required by
Section 1201 is sought by written consent rather than at a meeting.
(3) Which the dissenting shareholder has demanded that the corporation
purchase at their fair market value, in accordance with Section 1301.
(4) Which the dissenting shareholder has submitted for endorsement, in
accordance with Section 1302.
(c) As used in this chapter, "dissenting shareholder" means the recordholder
of dissenting shares and includes a transferee of record.
1301 NOTICE TO HOLDERS OF DISSENTING SHARES IN REORGANIZATIONS; DEMAND FOR
PURCHASE; TIME; CONTENTS--(a) If, in the case of a reorganization, any
shareholders of a corporation have a right under Section 1300, subject to
compliance with paragraphs (3) and (4) of subdivision (b) thereof, to require
the corporation to purchase their shares for cash, such corporation shall mail
to each such shareholder a notice of the approval of the reorganization by its
outstanding shares (Section 152) within 10 days after the date of such
approval, accompanied by a copy of Sections 1300, 1302, 1303, 1304 and this
section, a statement of the price determined by the corporation to represent
the fair market value of the dissenting shares, and a brief description of the
procedure to be followed if the shareholder desires to exercise the
shareholder's right under such sections. The statement of price constitutes an
offer by the corporation to purchase at the price stated any dissenting shares
as defined in subdivision (b) of Section 1300, unless they lose their status
as dissenting shares under Section 1309.
(b) Any shareholder who has a right to require the corporation to purchase
the shareholder's shares for cash under Section 1300, subject to compliance
with paragraphs (3) and (4) of subdivision (b) thereof, and who desires
D-1
<PAGE>
the corporation to purchase such shares shall make written demand upon the
corporation for the purchase of such shares and payment to the shareholder in
cash of their fair market value. The demand is not effective for any purpose
unless it is received by the corporation or any transfer agent thereof (1) in
the case of shares described in clause (i) or (ii) of paragraph (1) of
subdivision (b) of Section 1300 (without regard to the provisos in that
paragraph), not later than the date of the shareholders' meeting to vote upon
the reorganization, or (2) in any other case within 30 days after the date on
which the notice of the approval by the outstanding shares pursuant to
subdivision (a) or the notice pursuant to subdivision (i) of Section 1110 was
mailed to the shareholder.
(c) The demand shall state the number and class of the shares held of record
by the shareholder which the shareholder demands that the corporation purchase
and shall contain a statement of what such shareholder claims to be the fair
market value of those shares as of the day before the announcement of the
proposed reorganization or short-form merger. The statement of fair market
value constitutes an offer by the shareholder to sell the shares at such
price.
1302 SUBMISSION OF SHARE CERTIFICATES FOR ENDORSEMENT; UNCERTIFICATED
SECURITIES--Within 30 days after the date on which notice of the approval by
the outstanding shares or the notice pursuant to subdivision (i) of Section
1110 was mailed to the shareholder, the shareholder shall submit to the
corporation at its principal office or at the office of any transfer agent
thereof, (a) if the shares are certificated securities, the shareholder's
certificates representing any shares which the shareholder demands that the
corporation purchase, to be stamped or endorsed with a statement that the
shares are dissenting shares or to be exchanged for certificates of
appropriate denomination so stamped or endorsed or (b) if the shares are
uncertificated securities, written notice of the number of shares which the
shareholder demands that the corporation purchase. Upon subsequent transfers
of the dissenting shares on the books of the corporation, the new
certificates, initial transaction statement, and other written statements
issued therefor shall bear a like statement, together with the name of the
original dissenting holder of the shares.
1303 PAYMENT OF AGREED PRICE WITH INTEREST; AGREEMENT FIXING FAIR MARKET
VALUE; FILING; TIME OF PAYMENT--(a) If the corporation and the shareholder
agree that the shares are dissenting shares and agree upon the price of the
shares, the dissenting shareholder is entitled to the agreed price with
interest thereon at the legal rate on judgments from the date of the
agreement. Any agreements fixing the fair market value of any dissenting
shares as between the corporation and the holders thereof shall be filed with
the secretary of the corporation.
(b) Subject to the provisions of Section 1306, payment of the fair market
value of dissenting shares shall be made within 30 days after the amount
thereof has been agreed or within 30 days after any statutory or contractual
conditions to the reorganization are satisfied, whichever is later, and in the
case of certificated securities, subject to surrender of the certificates
therefor, unless provided otherwise by agreement.
1304 ACTION TO DETERMINE WHETHER SHARES ARE DISSENTING SHARES OR FAIR MARKET
VALUE; LIMITATION; JOINDER; CONSOLIDATION; DETERMINATION OF ISSUES;
APPOINTMENT OF APPRAISERS.--(a) If the corporation denies that the shares are
dissenting shares, or the corporation and the shareholder fail to agree upon
the fair market value of the shares, then the shareholder demanding purchase
of such shares as dissenting shares or any interested corporation, within six
months after the date on which notice of the approval by the outstanding
shares (Section 152) or notice pursuant to subdivision (i) of Section 1110 was
mailed to the shareholder, but not thereafter, may file a complaint in the
superior court of the proper county praying the court to determine whether the
shares are dissenting shares or the fair market value of the dissenting shares
or both or may intervene in any action pending on such a complaint.
(b) Two or more dissenting shareholders may join as plaintiffs or be joined
as defendants in any such action and two or more such actions may be
consolidated.
(c) On the trial of the action, the court shall determine the issues. If the
status of the shares as dissenting shares is in issue, the court shall first
determine that issue. If the fair market value of the dissenting shares is in
issue, the court shall determine, or shall appoint one or more impartial
appraisers to determine, the fair market value of the shares.
D-2
<PAGE>
ANNEX E
BEAR STEARNS BEAR, STEARNS & CO. INC.
--------------------------------------------------------------------------------
245 PARK AVENUE
NEW YORK, NEW YORK 10167
(212) 272-2000
ATLANTA -- BOSTON
CHICAGO -- DALLAS -- LOS ANGELES
NEW YORK -- SAN FRANCISCO
FRANKFURT -- GENEVA -- HONG KONG
LONDON -- PARIS -- TOKYO
September 19, 1995
Sierra Health Services, Inc.
2724 N. Tenaya Way
Las Vegas, Nevada 89128
Attention: Anthony M. Marlon, M.D.
Chief Executive Officer and Chairman of the Board
Dear Sirs:
We understand that Sierra Health Services, Inc. ("Sierra") and CII
Financial, Inc. ("CII") have entered into an Agreement and Plan of Merger (the
"Merger Agreement") dated as of June 12, 1995, pursuant to which CII
shareholders will receive 0.37 shares of Sierra common stock in exchange for
each CII share held (the "Transaction"). We further understand that the
Transaction will be accounted for as a pooling-of-interests. You have provided
us with the proxy statement/prospectus, which includes the Merger Agreement,
in substantially the form to be sent to the shareholders of Sierra and CII
(the "Joint Proxy Statement/Prospectus").
You have asked us to render our opinion as to whether the Transaction is
fair, from a financial point of view, to the shareholders of Sierra.
In the course of our analyses for rendering this opinion, we have:
1. reviewed the Joint Proxy Statement/Prospectus and the Merger
Agreement;
2. reviewed Sierra's and CII's Annual Reports to Shareholders and
Annual Reports on Form 10-K for the fiscal years ended December 31,
1990 through 1994, and their Quarterly Reports on Form 10-Q for the
periods ended March 31, and June 30, 1995;
3. reviewed CII's statutory financial statements for the years ended
December 31, 1990 through 1994, and its statutory financial
statements for the quarters ended March 31, and June 30, 1995;
4. reviewed CII's Initial Public Offering Prospectus dated March 7,
1990, its Secondary Common Stock Offering Prospectus dated December
14, 1990, and its 7 1/2% Convertible Subordinated Debentures
Prospectus dated September 15, 1991;
5. reviewed certain operating and financial information, including
projections, relating to Sierra's and CII's businesses and prospects
provided to us by their respective managements;
6. met with certain members of Sierra's and CII's senior managements to
discuss their respective operations, historical financial statements
and future prospects;
1
<PAGE>
7. met with certain members of Sierra's senior management to discuss
(i) CII's operations, historical financial statements and results,
and future prospects and (ii) Sierra's plan for CII post-
acquisition, including projections and expected medical management
cost savings;
8. discussed CII's loss and loss adjustment expense reserve philosophy
and adequacy with CII's management and Timothy B. Perr, its
independent actuary, and with Sierra's management and Tillinghast,
Towers, Perrin ("Tillinghast"), its independent actuary;
9. reviewed Tillinghast's report dated August 24, 1995 on the adequacy
of CII's loss and loss adjustment expense reserves as of March 31,
1995;
10. visited certain of Sierra's and CII's facilities;
11. reviewed the historical prices and trading volumes of the common
shares of Sierra and CII and of the 7 1/2% Convertible Subordinated
Debentures of CII;
12. reviewed publicly available financial data and stock market
performance data of companies which we deemed generally comparable
to Sierra and CII;
13. reviewed the terms of recent acquisitions of companies which we
deemed generally comparable to CII; and
14. conducted such other studies, analyses, inquiries and
investigations as we deemed appropriate.
In the course of our review, we have relied upon and assumed, without
independent verification, the accuracy and completeness of the financial and
other information provided or otherwise made available to us by Sierra, CII,
and their respective independent actuaries. Sierra and CII produced financial
projections for their respective companies. In addition, Sierra, with the
assistance of Bear Stearns, modified projections for CII based on assumptions
provided by Sierra. With respect to these projected financial results, we have
assumed that they have been reasonably prepared on bases reflecting the best
currently available estimates and judgments of the managements of Sierra and
CII as to the expected future performance of Sierra and CII, respectively. We
have not assumed any responsibility for the information or projections
provided to us and we have further relied upon the assurances of the
managements of Sierra and CII that they are unaware of any facts that would
make the information or projections provided to us incomplete or misleading.
We are not actuaries and, accordingly, we have relied upon, without
independent verification, on Tillinghast's analysis of reserves. In arriving
at our opinion, we have not performed or obtained any independent appraisal of
the assets of Sierra or CII. Our opinion is necessarily based on economic,
market and other conditions, and the information made available to us, as of
the date hereof.
Based on the foregoing, it is our opinion that the Transaction is fair, from
a financial point of view, to the shareholders of Sierra.
We have acted as financial advisor to Sierra in connection with the
Transaction and will receive a fee for such services, payment of a significant
portion of which is contingent upon the consummation of the Transaction.
Very truly yours,
BEAR, STEARNS & CO. INC.
By: /s/ Brian McCarthy
---------------------------
Managing Director
2
<PAGE>
ANNEX F
VECTOR VECTOR SECURITIES INTERNATIONAL, INC.
SECURITIES 1751 Lake Cook Road, Suite 350
INTERNATIONAL Deerfield, Illinois 60015
Telephone (708) 940-1970
Fax (708) 940-0774
June 12, 1995
The Board of Directors
CII Financial, Inc.
5627 Gibraltar Drive
Pleasanton, California 94588
Members of the Board:
You have requested our opinion as investment bankers with respect to the
fairness, from a financial point of view as of the date hereof, to the
shareholders of CII Financial, Inc., a California corporation ("CII"), of the
consideration to be received by such shareholders pursuant to the Agreement
and Plan of Merger (the "Agreement"), dated as of June 12, 1995, by and among
CII, Sierra Health Services, Inc., a Nevada corporation ("Sierra"), and a
newly-formed, wholly-owned subsidiary of Sierra ("Acquisition").
Under the terms and conditions of the Agreement, Acquisition will merge with
and into CII (the "Merger"), whereby CII will become a wholly-owned subsidiary
of Sierra. As a result of the Merger, holders of CII Common Stock will receive
0.3700 of a share of Sierra Common Stock, including the corresponding
percentage of a right to purchase shares of Series A Junior Participating
Preferred Stock of Sierra, as set forth in the Agreement. All unexpired and
unexercised options to purchase CII Common Stock outstanding immediately prior
to the Merger will be converted into options to purchase Sierra Common Stock,
as set forth in the Agreement. The obligations relating to the 7 1/2%
Convertible Subordinated Debentures due 2001 (the "Debentures") of CII
outstanding immediately prior to the Merger will remain an obligation of CII
following the Merger; however, such Debentures will become convertible into
Sierra Common Stock, as set forth in the Agreement. The terms and conditions
of the Merger are more fully set forth in the Agreement.
In arriving at the opinion set forth herein, we have, among other things:
(i) reviewed the Agreement; (ii) held discussions with the management of CII
and Sierra concerning the business, operations and prospects of each company;
(iii) reviewed certain business and financial information on CII and Sierra,
including financial forecasts, prepared and provided by the respective
managements of CII and Sierra; (iv) reviewed documents filed by CII and Sierra
since 1990 with the Securities and Exchange Commission pursuant to the
Securities Exchange Act of 1934; (v) compared certain financial data of CII
and Sierra with such other publicly traded companies as we deemed comparable;
(vi) reviewed the price and trading history of the Common Stock of CII and
Sierra; (vii) compared the financial terms of the Merger with those of other
transactions which we deemed comparable; (viii) reviewed the pro forma impact
of the Merger on the financial results and condition of Sierra; and (ix)
performed such other studies and analyses as we deemed appropriate.
In connection with our opinion, we have not assumed any responsibility for
independent verification of any information supplied or otherwise made
available to us regarding CII and Sierra and we have assumed and relied on
such information being accurate and complete. We have not undertaken an
independent evaluation or appraisal of the assets of CII or Sierra, nor have
we been furnished with any such evaluations or appraisals. With respect to the
financial projections referred to above, we have assumed that they have been
reasonably prepared on bases reflecting the best available estimates and
judgments of the respective managements of CII and Sierra as to the future
financial performance of CII and Sierra, respectively. We have assumed that
the receipt of Sierra Common Stock by CII shareholders in the Merger will be
tax-free to such holders pursuant to (S)368 of the Internal Revenue Code of
1986, as amended, and that the Merger will qualify as a "pooling of interests"
under
<PAGE>
CII Financial, Inc.
June 12, 1995
Page 2
United States Generally Accepted Accounting Principles. Our conclusions are
based solely on information available to us on or before the date hereof and
reflect economic, market and other conditions as of such date. Our opinion
does not represent an opinion as to what the market value of the Sierra Common
Stock will be when such Common Stock is delivered to the shareholders of CII
upon consummation of the Merger or the prices at which such Common Stock will
trade subsequent to the Merger. In rendering our opinion, we assumed that the
transaction contemplated by the Merger will be consummated on the terms
described in the Agreement, without any material waiver of or modification by
CII, and that obtaining any necessary regulatory approvals for the transaction
will not have an adverse effect on CII and Sierra.
We are familiar with CII, having acted as its financial advisor in
connection with the Agreement, for which we will receive a fee, substantially
all of which is contingent on the closing of the transaction contemplated by
the Agreement. In addition, CII has agreed to indemnify us for certain
liabilities arising out of our advisory services and the rendering of this
opinion. Vector Securities International, Inc. is a full service securities
firm and in the course of its normal trading activities may from time to time
effect transactions and hold positions in securities of CII and/or Sierra.
Our opinion set forth below is directed to the Board of Directors of CII and
does not constitute a recommendation to any shareholder of CII with respect to
the approval of the transaction contemplated by the Merger. Our opinion is not
to be reproduced, quoted or published in any manner without our prior written
consent, except that this letter may be reproduced in full in the proxy
statement to be filed with the Securities and Exchange Commission in
connection with the Merger.
On the basis of and subject to the foregoing, and based upon such other
matters as we consider relevant, it is our opinion that the consideration to
be received by the shareholders of CII in the Merger is fair to such
shareholders from a financial point of view as of the date hereof.
Very truly yours,
VECTOR SECURITIES INTERNATIONAL,
INC.
By: /s/ Shahab Fatheazam
-------------------------
Shahab Fatheazam
Vice President
<PAGE>
ANNEX G
INFORMATION CONCERNING PROPOSED DIRECTORS AND MANAGEMENT OF CII
DIRECTORS AFTER THE MERGER
After the Merger, the Board of Directors of CII will consist of the
following five directors. Each director will serve until the next annual
shareholder meeting of CII and until his or her successor is elected and
qualified.
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION DURING THE PAST
NAME AGE FIVE YEARS
---- --- ------------------------------------
<C> <C> <S>
Frank E. Collins 41 General Counsel and Secretary of
Sierra since 1986.
Joseph G. Havlick 64 Chairman of the Board, Chief Executive
Officer, President and a Director of
CII since 1988.
Erin E. MacDonald 48 President and Chief Operating Officer
of Sierra since 1994; Senior Vice
President of Operations of Sierra from
1992 to 1994; a Director of Sierra
since 1992.
Lee W. Spitler, Jr. 43 Senior Vice President and Treasurer of
CII since 1988; Chief Financial
Officer of CII from 1991 to 1992.
James L. Starr 32 Vice President of Finance, Chief
Financial Officer and Treasurer of
Sierra since 1994; Assistant Vice
President--Controller from 1993 to
1994; Director of Finance and
Corporate Controller of Sierra since
1989.
</TABLE>
Additional information about these proposed directors of CII is contained in
Sierra's and CII's Proxy Statements for their respective 1994 Annual Meetings
of Shareholders, relevant portions of which are incorporated by reference in
this Joint Proxy Statement/Prospectus pursuant to Sierra's and CII's Annual
Reports on Form 10-K for the year ended December 31, 1994, as amended on Form
10-K/A filed with the Commission on September 1, 1995 and August 16, 1995,
respectively. See "Available Information" and "Incorporation of Certain
Documents by Reference."
Directors of CII will not receive any remuneration for their services as
such.
MANAGEMENT OF CII FOLLOWING THE MERGER
After the Merger, Sierra anticipates that the following persons will
continue as executive officers of CII in the respective offices set forth
below.
<TABLE>
<CAPTION>
NAME OFFICE
---- ------
<S> <C>
Joseph G. Havlick Chairman of the Board, Chief Executive Officer and President
Lee W. Spitler, Jr. Senior Vice President and Treasurer
Richard E. Dobson Executive Vice President, General Counsel and Secretary
John F. Okita Chief Financial Officer
Jerry B. Katz Vice President
</TABLE>
Additional information about the executive officers of CII is contained in
CII's Proxy Statement for its 1994 Annual Meeting of Shareholders, relevant
portions of which are incorporated by reference in this Joint Proxy
Statement/Prospectus pursuant to CII's Annual Report on Form 10-K for the year
ended December 31, 1994, as amended on Form 10-K/A filed with the Commission
on August 16, 1995. See "Available Information" and "Incorporation of Certain
Documents by Reference."
Neither Sierra nor CII is aware of any material relationship between Sierra
or its directors or executive officers and CII or its directors or executive
officers, except as described in this Joint Proxy Statement/Prospectus. See
"The Merger--Interests of Certain Persons in the Merger."
<PAGE>
SIERRA HEALTH SERVICES, INC.
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
FOR THE SPECIAL MEETING OF STOCKHOLDERS ON OCTOBER 24, 1995
The undersigned holder of shares of Common Stock of SIERRA HEALTH SERVICES,
INC. (the "Company") hereby appoints Anthony M. Marlon, M.D. and Erin E.
MacDonald or either of them acting singly in the absence of the other, with
full power of substitution, the Proxies of the undersigned at the Special
Meeting of Stockholders of the Company to be held October 24, 1995 and at any
adjournments or postponements thereof with respect to the following matters:
1. To approve the Agreement and Plan of Merger, dated as of June 12, 1995,
attached as Annex A to the accompanying Joint Proxy Statement/Prospectus,
providing for the merger of Health Acquisition Corp., a wholly-owned
subsidiary of the Company, with and into CII Financial, Inc., pursuant to
which each share of Common Stock of CII will be converted into 0.37 of a
share of Common Stock, par value $.005 per share, of the Company (the
"Common Stock"), and the approval of the issuance of shares of Common Stock
pursuant to such Agreement upon exercise of outstanding options and
conversion of outstanding debentures; and
[_] FOR [_] AGAINST [_] ABSTAIN
2. To transact such other business as may properly be brought before the
Special Meeting of Stockholders.
(Continued and to be signed on reverse side)
THIS PROXY WHEN PROPERLY EXECUTED WILL BE VOTED IN THE MANNER DIRECTED HEREIN
BY THE UNDERSIGNED STOCKHOLDER. IF NO DIRECTION IS MADE, THIS PROXY WILL BE
VOTED "FOR" ITEM 1. THE PROXIES WILL VOTE IN ACCORDANCE WITH THEIR BEST
JUDGMENT WITH RESPECT TO ANY MATTERS REFERRED TO IN ITEM 2.
NOTE: PLEASE SIGN EXACTLY AS YOUR
NAME OR NAMES APPEAR HEREIN. WHEN
SIGNING AS AN EXECUTOR,
ADMINISTRATOR, CORPORATION,
OFFICER, ATTORNEY, AGENT, TRUSTEE
OR GUARDIAN, ETC., PLEASE ADD
YOUR FULL TITLE TO YOUR
SIGNATURE.
__________________________________
Signature
__________________________________
Signature
Date _____________________________
