<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________to ____________
COMMISSION FILE NUMBER 0-15022
FRONTIER INSURANCE GROUP, INC.
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 14-1681606
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
195 LAKE LOUISE MARIE ROAD, ROCK HILL, NEW YORK 12775-8000
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (914) 796-2100
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on which Registered
Common Stock, $.01 par value New York Stock Exchange
</TABLE>
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.
[x] Yes [ ] 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 voting stock (Common Stock, $.01 par value)
held by nonaffiliates of the Registrant was $439,327,720 on March 17, 1999,
based on the closing sales price of the Common Stock on such date.
The aggregate number of shares of the Registrant's Common Stock, $.01 par value,
outstanding on March 17, 1999, was 36,233,214.
Documents incorporated by reference:
None
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"SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995: This Annual Report on Form 10-K contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934 which are not historical facts, and involve
risks and uncertainties that could cause actual results to differ materially
from those expected and projected. Such risks and uncertainties include the
following: general economic conditions and conditions specific to the property
and casualty insurance industry including its cyclical nature, regulatory
changes and conditions, rating agency policies and practices, competitive
factors, claims development and the impact thereof on loss reserves and the
Company's reserving policies, the adequacy of the Company's reinsurance
programs, developments in the securities markets and the impact on the Company's
investment portfolio, the success of the Company's acquisition program, changes
in generally accepted accounting principles and the risk factors listed herein
and from time to time in the Company's Securities and Exchange Commission
filings. Accordingly, there can be no assurance that the actual results will
conform to the forward-looking statements in this Annual Report.
--------------------
PART I
ITEM 1. BUSINESS.
DESCRIPTION OF BUSINESS
Frontier Insurance Group, Inc. (the "Company"), a Delaware corporation
incorporated in 1986, is an insurance holding company which, through its direct
and indirect wholly-owned subsidiaries, conducts business in all 50 states, the
District of Columbia, Puerto Rico, Mexico, Greece, Guam and the Virgin Islands
as a specialty insurer underwriting various specialty property/casualty
coverages. These specialty coverages include medical and dental malpractice,
surety, general liability, non-standard automobile, manufactured housing,
workers' compensation, environmental and pollution liability, and credit-related
and other specialty insurance products. The principal subsidiaries through which
the Company offers such coverages include Frontier Insurance Company
("Frontier"), Frontier Pacific Insurance Company ("Frontier Pacific"), Lyndon
Insurance Group ("Lyndon"), United Capitol Insurance Company ("United Capitol"),
Western Indemnity Insurance Company ("Western"), Regency Insurance Company
("Regency") and Acceleration Life Insurance Company ("Acceleration"), all of
which, other than Frontier and Frontier Pacific, were purchased since May 1996
(see Note C of the Notes to the Consolidated Financial Statements).
The Company's business strategy is to achieve an underwriting profit by
identifying niche markets and specialty insurance programs which it believes
afford favorable opportunities for profitability due to limited potential
competition and the Company's innovative underwriting and value added services,
including coverage enhancements, risk management, loss control and specialized
claims management.
2
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REPORTABLE SEGMENTS
The Company currently writes in excess of 150 insurance programs through six
reportable segments: Health Care; Surety; Alternative Risk; Specialty Programs;
Environmental, Excess and Surplus Lines; and Personal and Credit-Related. The
Company's reportable segments are divisions that offer different types of
coverages and are managed separately because of the specialized nature of the
related products underwritten for each division.
The following chart provides examples by reportable segment and customer type,
of typical niche markets/programs underwritten by the Company:
<TABLE>
<CAPTION>
SEGMENT CUSTOMER TYPE COVERAGE/LINE OF BUSINESS HYPOTHETICAL CLAIM
<S> <C> <C> <C>
Health Care Doctors and dentists Professional liability Patient injured
Health Care Social service agencies Professional liability, Client sues agency or professional
general liability, fire
Surety Small-construction contractors Surety bonds Electrician or plumber fails to
complete job
Surety Importers Customs bonds Importer fails to pay duty
Alternative Risk Self-insured employers Excess workers' Workers' compensation loss
compensation/employer's exceeds employer's self-
liability insured retention
Specialty Crane operators General liability Crane damages a third-party's
Programs property
Specialty Alarm installers General liability House is burglarized
Programs through faulty alarm installation
Environmental, Environmental remediation Professional liability Site remains contaminated after
Excess and contractors contractor completed
Surplus Lines remediation project
Personal and Borrowers from financial Credit-related property Damage to property taken as
Credit-Related institutions collateral
</TABLE>
Health Care Division
This segment underwrites a full range of property and casualty products for
healthcare providers and related companies and institutions. Products offered
include general liability, commercial multi-peril and medical malpractice
coverages. Additionally, this segment serves the medical professional community
through the design and distribution of products and services which target the
unique exposures of medical and dental professional risks, and include such
exposures as physicians, internists, dentists, chiropractors, psychiatrists and
other specialists. This division also underwrites a specialty program for
physicians unable to attain traditional malpractice coverages due to excessive
malpractice claims, professional disciplinary proceedings and/or drug or
alcohol abuse. Additionally, this segment offers and underwrites a program
for daycare liability.
Physician and dental coverages are generally marketed by the Company through
endorsed national, state or county societies. Such societies include, the
International Chiropractors' Association, the American Academy of Child and
Adolescent Psychiatrists, the New York Society of Internal Medicine, and The
Academy of General Dentistry. Physicians covered under the social services care
facilities are employees of the facility. Other coverages in this segment are
produced by specialty independent agents and brokers. The business produced by
this segment is underwritten primarily through Frontier, Frontier Pacific, and
Western.
3
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Surety Division
This segment underwrites bonds for small contractors, customs bonds, contractor
license bonds, bail bonds, license and permit bonds, landfill, subdivision, and
self insured employers' workers' compensation bonds.
License and permit bonds are primarily produced by a Company's wholly-owned
subsidiary . Bail bonds are produced by a 50% owned bail agency and customs
bonds are produced by a specialty bond agent that has an exclusive underwriting
agreement with the Company. All other business for this segment is produced
through independent agents and brokers.
The business produced by this segment is predominantly underwritten through
Frontier Pacific and Frontier.
Alternative Risk Division
This segment underwrites excess workers' compensation and stop loss coverage for
self-insured medical and group accident and health plans. In addition, a full
range of risk management services, including the formation and management of
off-shore captive and rent-a-captive insurance entities, which underwrite a
broad range of coverages, is provided by this segment.
Stop loss coverages are produced by agents specializing in these types of
coverages. All other coverages, including those written through captive and
rent-a-captive arrangements, are produced by independent specialty agents and
brokers.
The business produced by this segment is predominantly underwritten through
Frontier.
Specialty Programs Division
This segment produces a wide variety of specialty coverages, including
manufactured housing, crane operators, pest control, artisan contractors,
childrens' summer camps, alarms and guards, outdoor recreation, demolition
contractors, nonstandard auto physical damage and white water rafting.
The manufactured housing program is produced by an independent agency
specializing in this type of coverage. The nonstandard auto physical damage
coverage is predominantly produced by a 50% owned managing general agency. All
other business is produced by program agency underwriters that are experts in
underwriting the underlying coverages.
The business produced by this segment is predominantly underwritten through
Frontier, Frontier Pacific, and Regency.
Environmental, Excess and Surplus Lines Division
This segment underwrites, predominantly, commercial general liability, pollution
and professional liability for contractors, consultants and engineers engaged in
the remediation of environmentally impaired properties, including those
contractors and consultants involved in the abatement of asbestos. This segment
also provides pollution liability for facilities engaged in managing waste or
the use of hazardous substances.
Commercial general liability coverage is also provided to residential and
commercial contractors, predominantly in California, as well as product
liability coverage for manufacturers and distributors of a wide array of
products. This segment also underwrites property and ocean marine coverages.
4
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The Company's environmental coverages are produced by various specialty program
administrators, two wholly-owned subsidiaries, and contracted brokers.
California residential and commercial contractors and ocean marine coverages
are produced by an independent program administrator. Property and products
liability coverages are produced predominantly by contracted surplus lines
brokers.
The business produced by this segment is predominantly underwritten through
United Capitol.
Personal and Credit-Related Division
This segment underwrites coverages for collateral protection, extended warranty,
extended service contracts, credit property, involuntary unemployment,
non-standard auto physical damage, residual value, mechanical breakdown, credit
life, credit property, and credit accident and health.
The nonstandard auto physical damage program is in run-off and was previously
written through managing general agents. Extended warranty and service contracts
are primarily distributed through financial institutions and auto dealers. Other
coverages written in this segment are produced through independent agents and
brokers.
These coverages are underwritten primarily through Lyndon, Acceleration and
Regency.
Segment Results
The Company evaluates segment performance based on profit or loss before the
effects of the Zurich Reinsurance (North America), Inc. ("Zurich N.A.")
reinsurance agreements, (see "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Zurich Reinsurance (North America) Stop
Loss Agreements"), investment income (including capital gains/losses and net
or interest on funds held), interest expense, other corporate expenses and
income taxes. The accounting policies of the reportable segments are principally
the same as those described in Note B to the Consolidated Financial Statements,
except certain amounts are allocated to the segments based upon allocation
methods deemed appropriate by management, including time studies, square
footage, number of personnel and premiums written and earned.
The following is a summary of premiums earned and profit (loss) by segment:
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------------------------
(in thousands)
<S> <C> <C> <C>
Premiums earned by segment:
Health Care $197,170 $167,447 $164,909
Surety 73,790 64,788 54,010
Alternative Risk 35,312 35,747 23,735
Specialty Programs 70,131 58,316 45,469
Environmental, Excess and
Surplus Lines 54,517 34,459 9,768
Personal and Credit-Related 108,945 43,729 2,230
Less premiums ceded under Zurich
N.A. stop loss agreements (46,811) (37,642) (34,132)
--------------------------------------------
Net premiums earned $493,054 $366,844 $265,989
============================================
Segment profit (loss):
Health Care $(224,666) $(41,163) $(2,377)
Surety 11,563 15,366 10,558
Alternative Risk 3,174 4,447 2,980
Specialty Programs (7,705) 2,090 137
Environmental, Excess and
Surplus Lines 9,866 10,010 2,775
Personal and Credit-Related 7,146 9,711 (706)
--------------------------------------------
Total segment profit (loss) (200,622) 461 13,367
Reconciling items:
Net effect of Zurich N.A.
agreements, excluding interest
on funds held 58,828 2,349 8,302
Total net investment income 76,538 60,344 38,933
Interest expense (11,931) (11,842) (4,247)
Other corporate (expenses)
income, net (13,688) (5,463) 304
--------------------------------------------
Consolidated income (loss) before
income taxes $(90,875) $45,849 $56,659
============================================
</TABLE>
5
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Although the Company considers returns on investments in the overall management
of its operations, assets are not allocated to individual segments for
analytical purposes . (See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Asset Portfolio Review".)
Other corporate expenses include expenses of the parent cCompany and directly
owned non-insurance subsidiaries, reduced by other miscellaneous income.
RISK FACTORS
Adequacy of Loss Reserves
Liabilities for unpaid losses and loss adjustment expenses are estimated
utilizing methods and procedures which management believes are reasonable and
in compliance with regulatory requirements. These liabilities are necessarily
subject to the impact of developments in the frequency and severity of claims,
as well as numerous other factors, such as judicial and legislative trends and
actions, economic factors and changes in estimates based on these factors.
Most or all of these factors are not directly quantifiable, particularly on a
prospective basis. Over the extended period of time during which losses are
reported and settled, these liabilities may not conform to the assumptions
underlying management's estimates and, accordingly, may vary significantly from
the estimated amounts included in the financial statements. To the extent that
the emerging loss experience varies from such estimates, these liabilities are
adjusted to reflect actual experience. These adjustments, to the extent they
occur, are reported in the period recognized.
In December 1998, the Company increased its liabilities for unpaid losses and
loss adjustment expenses by $155 million to reflect revised estimates for these
liabilities. This increase was recognized in the fourth quarter of 1998 and
resulted in a corresponding charge to pre-tax earnings. (See Note H of the Notes
to the Consolidated Financial Statements.)
Emphasis on Insurance Company Ratings
Increased public and regulatory concerns with the financial stability of
insurers have resulted in a greater focus by policyholders and their insurance
agents upon insurance company ratings and a potential competitive advantage for
carriers with higher ratings. Rating organizations periodically review the
financial performance and condition of insurers and reevaluate their ratings.
A.M. Best Company, Inc. ("A.M. Best") has currently rated all of the Company's
insurance subsidiaries as A- ("Excellent"), except for Lyndon Life and Gulfco
Life which they have rated as B++ ("Very Good") and Acceleration which they
have rated B+ ("Very Good"). The Company cannot assure that its insurance
subsidiaries will maintain their ratings and any downgrade could materially
adversely affect their operations.
Highly Competitive Market
The property and casualty insurance business is highly competitive with respect
to a number of factors, including overall financial strength of the insurer,
ratings by rating agencies, premium rates, policy terms and conditions, services
offered, reputation and broker compensation. Although the Company's business
strategy is to achieve an underwriting profit by identifying niche markets
and specialty programs that it believes afford favorable opportunities for
profitability due to limited potential competition, the Company nevertheless
encounters competition from carriers engaged in insuring risks in the broader
lines of business that encompass niche markets and specialty programs. The
Company expects that type of competition will increase as it expands its
operations.
6
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Fluctuations in Industry Results
The financial results of property and casualty insurers historically have been
subject to significant fluctuations. Profitability is affected significantly by
volatile and unpredictable developments (including catastrophes), changes in
loss reserves resulting from changing legal environments as different types of
claims arise and judicial interpretations develop relating to the scope of
insurers' liability, fluctuations in interest rates and other changes in the
investment environment which affect returns on invested capital, and
inflationary pressures that affect the size of losses. Further, underwriting
results have been cyclical in the property and casualty insurance industry, with
protracted periods of overcapacity accompanied by lower premium rates and
operating results followed by periods of undercapacity accompanied by higher
premium rates and operating results. The property and casualty insurance
industry is currently experiencing a protracted period of overcapacity and lower
premium rates, and the Company cannot assure when or if this period will end
and when premium rates will increase.
Reliance Upon Reinsurance
To moderate the impact of unusually severe or frequent losses, the Company's
insurance subsidiaries cede (i.e., transfer) a portion of their gross premiums
to reinsurers in exchange for the reinsurers' agreements to share covered losses
with the subsidiaries. Although reinsurance makes the assuming reinsurer liable
to the extent of the risk ceded, the Company's insurance subsidiaries are not
relieved of their primary liability to their insureds and, therefore, bear a
credit risk with respect to their reinsurers. Although the Company's insurance
subsidiaries place reinsurance only with reinsurers they believe to be
financially sound, the Company cannot assure that these reinsurers will pay
all reinsurance claims on a timely basis, if at all. Further, although the
Company believes our insurance subsidiaries are adequately reinsured, it cannot
be certain that they will continue to be able to obtain reinsurance on
satisfactory terms.
Dependence Upon Investment Income
Similar to other property and casualty insurance companies, the Company depends
on income from its investment portfolio for a substantial portion of our
earnings. A significant decline in investment yields could have a material
adverse effect on the Company's financial results.
Concentration in Ownership
Mr. Harry W. Rhulen, Chairman of the Board and President of the Company, members
of Mr. Rhulen's family and other directors and officers of the Company owned, as
of March 1999, approximately 25% of the outstanding shares of Common Stock. As a
result, these persons are in a position to influence the Company's management
and affairs and, collectively, may be able to prevent a proposed change in
control of the Company.
Restrictions Under Insurance Regulations
The Company subject to regulation under applicable insurance statutes, including
insurance holding company statutes, of the various states in which its insurance
subsidiaries write insurance. Insurance regulation is intended to provide
safeguards for policyholders rather than to protect investors in insurance
companies or their holding companies. Regulators oversee matters relating to
trade practices, policy forms, claims practices, mandated participation in
shared markets, types and amounts of investments, reserve adequacy, insurer
solvency, minimum amounts of capital and surplus, transactions with related
parties and changes in control. The rates that the Company's insurance
subsidiaries can charge for certain lines of business are also subject to
regulation and, therefore, may not keep pace with inflation. Changes in any
of these laws and regulations could materially adversely affect the Company's
operations.
7
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Dependence Upon Dividends and Other Distributions from Subsidiaries
Because the Company is a holding company, its ability to pay dividends or fund
other expenditures depends significantly on the payment of dividends and
management fees to it by its subsidiaries. However, the Company's insurance
subsidiaries are subject to regulations designed to protect their solvency that
restrict the amount of dividends or other distributions they may make to the
Company. In addition, the Company's current policy involves the retention by
its insurance subsidiaries of their capital for growth rather than the payment
of dividends.
REINSURANCE ACTIVITIES
The Company assumes business under reinsurance treaties and through mandatory
participation in various states' residual market pools and reinsurance
facilities. The Company assumes, primarily on a quota share basis, homeowners',
commercial auto, other liability and contract surety business also assumes ocean
marine and international property business, over 90% of which is retroceded to
other insurers.
The Company cedes business under various reinsurance agreements which are
generally related to specific programs. Reinsurance serves the purposes of
limiting losses, minimizing exposure to catastrophes, providing additional
capacity for future growth and facilitating relationships with other insurance
entities. The Company purchases reinsurance primarily on an excess of loss basis
for individual loss occurrences in excess of specified dollar amounts or loss
ratios. In addition, since 1995, the Company has had in place an aggregate
excess of loss agreement, for specific lines of business, to limit loss and loss
adjustment expense ("LAE") ratios to contractually agreed benchmarks. (See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Zurich Reinsurance (North America) Stop Loss Agreements"). Effective
December 31, 1998, the Company terminated the 1998-1999 stop loss agreement as
it relates to the 1999 accident year. (see Note I of the Notes to the
Consolidated Financial Statements) The Company generally reinsures its business
with reinsurers who are admitted to do business in the jurisdictions in which
its insurance subsidiaries are licensed and which have an A.M. Best rating of A-
or higher. Security is obtained from reinsurers who do not meet these criteria.
Certain business produced by the Company's Alternative Risk division is
reinsured by captive or rent-a-captive facilities. Under the terms of such
reinsurance programs, which are by the Company, the producing agents will
participate in the underwriting experience of their own business by purchasing
preferred shares in a captive reinsurance company. In addition, premiums ceded
to the captive will be used to purchase a letter of credit or deposited into a
trust fund to secure the liabilities ceded to the reinsurer.
8
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The following table summarizes as of December 31, 1998 the maximum amount of
loss typically retained by the Company's insurance subsidiaries (exclusive of
facultative reinsurance and the aggregate excess of loss agreement with Zurich
N.A.):
<TABLE>
<CAPTION>
MAXIMUM
RETAINED LOSS
PER
OCCURRENCE/
RISK/PRINCIPAL
---------------
(in thousands)
<S> <C>
Property lines $ 500
Casualty lines (excluding
medical malpractice, health
specialties, and social
services) 1,000
Medical malpractice, health
specialties and social
services 1,000(1)
Workers' compensation 1,000
Surety 1,000(2)
Umbrella liability 1,000
Group accident and health 450
Excess workers' compensation 1,000(3)
Earthquake 2,500
Homeowners' 2,000(2)
Ocean marine 250
Directors' and officers'
liability 1,000
Commercial auto liability 250
Nonstandard auto liability 25
</TABLE>
(1) For certain risks and policy years, the maximum retained loss per
occurrence is $0.5 million and, on a very limited basis, $2 million.
(2) Does not reflect Company's co-insurance participation in
amounts ceded in excess of its retention.
(3) Subject to a catastrophe retention of $3 million per
occurrence.
DISTRIBUTION
The Company relies on multiple distribution channels to market its insurance
products, primarily through independent insurance agencies and brokerage firms,
no one of which accounts for more than 5% of such premiums. The following
tables set forth for the three years ended December 31, 1998, the gross and
net premiums written produced by internal and affiliated sources, independent
agencies and brokerage firms:
<TABLE>
<CAPTION>
1998 1997 1996
-----------------------------------------------------------------------------
PREMIUMS PERCENT PREMIUMS PERCENT PREMIUMS PERCENT
WRITTEN OF TOTAL WRITTEN OF TOTAL WRITTEN OF TOTAL
-----------------------------------------------------------------------------
(dollar amounts in thousands)
<S> <C> <C> <C> <C> <C> <C>
Gross premiums:
Internal and
affiliated $104,957 12.6% $79,772 13.6% $78,411 19.5%
All others 728,201 87.4 507,863 86.4 324,388 80.5
-----------------------------------------------------------------------
Total $833,158 100.0% $587,635 100.0 $402,799 100.0%
=======================================================================
Net premiums:
Internal and
affiliated $65,627 12.5% $60,776 15.6% $56,511 18.1%
All others 461,378 87.5 328,240 84.4 255,352 81.9
----------------------------------------------------------------------
Total $527,005 100.0% $389,016 100.0 $311,863 100.0%
======================================================================
</TABLE>
9
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Internally and affiliated produced premiums include business written through the
Company's wholly-owned agencies, as well as agencies in which the Company holds
a noncontrolling equity interest. All other premiums are produced through
independent insurance agencies and brokerages specializing in particular
coverages.
OPERATING RATIOS
Statutory Combined Ratio
The statutory combined ratio is the traditional measure of underwriting
experience for property/casualty insurance companies. The combined ratio is
obtained by adding an expense ratio to a loss and LAE ratio. The expense ratio
is defined as the ratio of other underwriting expenses incurred to net premiums
written and the loss and LAE ratio is defined as the ratio of losses and LAE
incurred to net premiums earned. Generally, if the statutory combined ratio is
below 100%, an insurance company has an underwriting profit and if it is above
100%, the insurer has an underwriting loss.
The following table reflects the consolidated statutory loss ratios, expense
ratios and combined ratios of the Company's primary property and casualty
insurance operating subsidiaries, Frontier, Frontier Pacific, United Capitol
from May 1996, Regency from September 1996 and, from July and December 1997,
Lyndon Property Insurance Company ("Lyndon Property") and Western, respectively,
determined in accordance with statutory accounting practices for the years
indicated:
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
----------------------------------------
<S> <C> <C> <C> <C> <C>
Loss and LAE ratio 95.0% 65.2% 58.7% 60.0% 69.9%
Expense ratio 38.2 35.7 32.2 31.1 28.2
========================================
Combined ratio 133.2% 100.9% 90.9% 91.1% 98.1%
========================================
</TABLE>
The combined ratios in 1998 and 1997 reflect the effects of increased reserves
of approximately $155 million and $35 million, respectively, primarily related
to the Company's medical malpractice business. (See Note H of the Notes to the
Consolidated Financial Statements)
Premium-to-Surplus Ratio
While there are no statutory provisions governing premium-to-surplus ratios,
regulatory authorities regard this ratio as an important indicator since the
lower the ratio, the greater the insurer's ability to withstand abnormal loss
experience. Guidelines established by the National Association of Insurance
Commissioners ("NAIC") provide that an insurer's premium-to-surplus ratio is
satisfactory if it is below 3 to 1. However, in consideration of maintaining
Frontier's current A.M. Best rating of A- ("Excellent"), the Company has
committed to maintain a premium-to-surplus ratio for Frontier no greater than
1.75 to 1.
10
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The following table sets forth the ratio of net premiums written during the year
to policyholders' surplus at the end of the year for the Company's property and
casualty subsidiaries for the years indicated:
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
---------------------------------------------------------
(dollar amounts in thousands)
<S> <C> <C> <C> <C> <C>
Frontier:
Net premiums written
during the year $287,733 $275,127 $255,446 $205,614 $179,058
Policyholders' surplus
at end of year $251,841 $276,390 $262,899 $171,361 $104,871
Ratio 1.14/1 .99/1 .97/1 1.20/1 1.71/1
Frontier Pacific:
Net premiums written
during the year $ 28,170 $ 30,282 $ 32,040 $ 15,143 $ 8,230
Policyholders' surplus
at end of year $ 34,920 $ 31,171 $ 25,985 $ 17,155 $ 16,127
Ratio .81/1 .97/1 1.23/1 .88/1 .51/1
United Capitol:
Net premiums written
during the year $ 61,855 $ 40,793 $ 25,930 $ 10,981 $ 17,051
Policyholders' surplus
at end of year $ 65,966 $ 60,122 $ 53,355 $ 68,026 $ 61,750
Ratio .94/1 .68/1 .49/1 .16/1 .28/1
Lyndon Property:
Net premiums written
during the year $ 79,805 $ 45,167 $ 72,043 $ (41,623) $ (2,225)
Policyholders' surplus
at end of year $100,296 $ 90,989 $ 71,104 $ 54,054 $ 90,762
Ratio .80/1 .50/1 1.01/1 N/A N/A
Western:
Net premiums written
during the year $ 23,396 $ 32,064 $ 33,010 $ 34,635 $ 30,347
Policyholders' surplus
at end of year $ 35,935 $ 34,348 $ 50,000 $ 45,873 $ 41,048
Ratio .65/1 .93/1 .66/1 .76/1 .74/1
Regency:
Net premiums written
during the year $ 13,418 $ 4,942 $ 4,489 $ 4,441 $ 4,804
Policyholders' surplus
at end of year $ 8,133 $ 10,341 $ 5,105 $ 4,667 $ 4,521
Ratio 1.65/1 .48/1 .88/1 .95/1 1.06/1
Lyndon Southern:
Net premiums written
during the year $ 1,602 -- $ -- $ -- $ --
Policyholders' surplus
at end of year $ 3,137 $ 3,495 $ 3,495 $ -- $ --
Ratio .51/1 N/A N/A N/A N/A
</TABLE>
Loss and LAE Reserves
Significant periods of time, ranging up to several years, may elapse between the
occurrence of an insured loss, the reporting of the loss to the Company and its
payment of such loss. Medical malpractice and general liability usually have a
much longer period of time between occurrence of a loss and payment than
property lines. To recognize liabilities for unpaid losses, the Company
establishes reserves, which are balance sheet liabilities representing estimates
of amounts needed to pay claims and related expenses with respect to insured
events that have occurred, including those not yet reported ("IBNR").
11
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When a claim is reported, the Company's claims adjusting personnel establish a
formula loss and LAE reserve based on historical average claim costs. As more
information related to the claim is obtained, claims adjusting personnel update
the formula reserve to a case basis reserve. This case basis reserve is an
estimate of the amount of ultimate payment of the claims , based on the
Company's reserving practices and the experience and knowledge of such personnel
regarding the nature and value of the specific type of claim. Additionally,
reserves are established by the Company on an aggregate basis to provide for
IBNR losses and to maintain the overall adequacy of reserves. Reserves and
payments on high exposure cases are reviewed and approved by a claims ommittee
comprised of members of senior management, claims examiners, attorneys and
underwriters. The Company does not discount its reserves either on the basis of
generally accepted accounting practices ("GAAP") or statutory accounting
practices.
The reserves for losses and LAE are estimated using loss evaluations and
actuarial projections and represent estimates of the ultimate net cost of all
unpaid losses and LAE incurred through December 31 of each year. These estimates
are subject to the effects of trends in claims severity and frequency and are
continually reviewed. As part of this process, historical data is reviewed and
consideration is given to the anticipated impact of various factors, such as
legal developments, changes in social attitudes, and economic conditions,
including the effects of inflation and anticipated subrogation recoveries. As
experience develops and other data becomes available, these estimates are
revised, as required, resulting in increases or decreases in reserves for
insured events of prior years. Future adjustments, if any, will be reflected in
the results of operations in the period recognized.
The following table reflects the Company's property and casualty loss and LAE
reserve development, net of estimated subrogation recoverable through December
31, 1998, for each of the preceding ten years:
<TABLE>
<CAPTION>
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
-------------------------------------------------------------------------------------------------------
(amounts in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Reserves for unpaid
losses and LAE $64,971 $92,384 $120,096 $161,263 $185,074 $216,486 $263,202 $294,393 $373,606 $483,539 $ 632,850
Reserves reestimated
at December 31:
1 year later 67,486 93,419 119,875 162,121 188,387 230,360 255,689 289,914 386,893 618,054
2 years later 68,793 91,457 120,550 158,746 196,005 229,334 252,678 314,558 492,247 --
3 years later 66,532 91,527 115,310 163,537 191,401 214,712 282,016 399,069 -- --
4 years later 66,656 86,508 114,790 154,217 172,654 234,172 345,459 -- -- --
5 years later 64,254 87,795 107,907 133,768 182,660 276,137 -- -- -- --
6 years later 64,700 79,459 88,803 142,630 214,006 -- -- -- -- --
7 years later 55,300 62,667 91,777 168,342 -- -- -- -- -- --
8 years later 42,687 66,438 113,268 -- -- -- -- -- -- --
9 years later 45,492 82,694 -- -- -- -- -- -- -- --
10 years later 59,144 -- -- -- -- -- -- -- -- --
Cumulative redundancy
(deficiency) 5,827 9,690 6,828 (7,079) (28,932) (59,651) (82,257) (104,676) (118,641) (134,515)
Cumulative amount of
liability paid through
December 31:
1 year later 9,611 16,823 8,129 41,486 38,300 56,986 80,507 102,160 147,013 216,534
2 years later 20,006 13,230 35,864 62,175 74,113 113,471 148,513 195,052 274,307 --
3 years later 11,196 32,987 45,973 80,888 112,017 154,548 204,252 263,107 -- --
4 years later 24,825 39,166 58,043 104,672 139,333 188,495 233,254 -- -- --
5 years later 30,919 50,406 74,659 122,863 161,417 198,801 -- -- -- --
6 years later 39,664 61,276 86,405 137,059 163,429 -- -- -- -- --
7 years later 47,784 67,429 93,835 133,519 -- -- -- -- -- --
8 years later 50,119 71,769 89,686 -- -- -- -- -- -- --
9 years later 53,676 64,145 -- -- -- -- -- -- -- --
10 years later 46,150 -- -- -- -- -- -- -- -- --
Net reserve--December 31 $373,606 $483,539 $ 632,850
Reinsurance recoverables 165,467 283,727 439,545
------------------------------
Gross reserve $539,073 $767,266 $1,072,395
==============================
</TABLE>
12
<PAGE>
<PAGE>
The loss and LAE reserves of Frontier, Frontier Pacific, United Capitol, Lyndon
Property, Lyndon Southern, Western and Regency as reported in their Annual
Statements prepared in accordance with statutory accounting practices and filed
with state insurance departments are identical with those reflected in the
Company's financial statements prepared in accordance with GAAP included herein,
before elimination of intercompany transactions. For additional disclosures
regarding loss and LAE reserves, see Note H of the Notes to the Consolidated
Financial Statements.
INVESTMENTS
The Company's investment portfolio is managed in a conservative manner to
provide portfolio credit quality, diversification and liquidity. The Company's
investment strategy is to maximize after-tax income while limiting investments
primarily to investment grade securities with high liquidity characteristics.
The Company has established investment guidelines approved by the Board of
Directors. In establishing such guidelines, consideration was given to projected
surplus, estimated duration of liabilities, liquidity needs, projected tax
status, expected rates of return on various asset classes, expected inflation,
and correlation of returns among asset classes. The guidelines diversification
of assets, credit quality, duration limits, and exposure to single issuers. In
addition, all insurance subsidiaries must meet the applicable state regulatory
requirements with respect to their investments.
The investment portfolio is divided into two major components. The majority of
invested assets are maintained in the core portfolio which consists primarily of
high quality investment grade fixed income securities and cash equivalents,
principally U.S. Government and agency securities, corporate and municipal
obligations, mortgage-backed and asset-backed securities and sinking fund
preferred stock. At December 31, 1998, the core portfolio represented 90.7% of
the total investment portfolio and had an average credit rating from Moody's of
Aa1.
The other major component of the investment portfolio is an aAlternative
investment portfolio which consists of asset classes other than investment grade
fixed income securities and is designed to provide income and potential capital
appreciation. Alternative investment portfolio asset classes include convertible
bonds and convertible preferred stock, BB rated bonds, preferred stock, limited
partnership interests, and common stock. At December 31, 1998, the alternative
investment portfolio represented 9.3% of the total investment portfolio.
Most of the core portfolio is managed internally. Investment advisory firms are
retained to manage asset classes, primarily in the alternative investment
portfolio. Currently, the Company retains Asset Allocation and Management
Company, General Re/New England Asset Management Company, Hartford Investment
Management Company, and Wellington Management L.P. to manage portions of the
investment portfolio within the investment strategy and guidelines
establishedprovided by the Company.
13
<PAGE>
<PAGE>
The following table contains information concerning the Company's fixed maturity
and equity investment portfolio all of which were classified as available for
sale at December 31, 1998:
<TABLE>
<CAPTION>
FAIR CARRYING PERCENT
COST (1) VALUE VALUE OF TOTAL
----------------------------------------
(dollar amounts in thousands)
<S> <C> <C> <C> <C>
Fixed maturity
securities:
U.S. Treasury securities and
obligations of U.S. Government
corporations and agencies $ 69,951 $ 72,371 $ 72,371 5.8%
Obligations of states and political
subdivisions 330,276 342,344 342,344 27.2
Corporate securities 381,053 393,091 393,091 31.3
Mortgage-backed securities 384,659 391,278 391,278 31.1
-------------------------------------------
Total fixed maturity securities 1,165,939 1,199,084 1,199,084 95.4
Equity securities 49,973 57,328 57,328 4.6
-------------------------------------------
Total $1,215,912 $1,256,412 $1,256,412 100.0%
===========================================
</TABLE>
(1) Original cost of equity securities and, as to fixed maturities, original
cost reduced by repayments and adjusted for amortization of premiums or
accrual of discounts.
The following table sets forth a profile of the Company's fixed maturity
investment portfolio by rating at December 31, 1998:
<TABLE>
<CAPTION>
FAIR CARRYING PERCENT
S&P/MOODY'S RATING VALUE VALUE OF TOTAL
- ---------------------------------------------------------------
(dollar amounts in thousands)
<S> <C> <C> <C>
AAA/Aaa (including U.S.
Treasuries of $52,894) $ 638,094 $ 638,094 53.2%
AA/Aa 201,221 201,221 16.8
A/A 239,840 239,840 20.0
BBB/Baa 91,368 91,368 7.6
All other 28,561 28,561 2.4
-------------------------------
Total $1,199,084 $1,199,084 100.0%
===============================
<CAPTION>
The following table sets forth the maturity profile of the Company's portfolio
of fixed maturity investments at December 31, 1998:
</TABLE>
<TABLE>
<CAPTION>
FAIR CARRYING PERCENT
MATURITY VALUE VALUE OF TOTAL
- ------------------------------------------------------------------
(dollar amounts in thousands)
<S> <C> <C> <C>
Due in one year or less $ 17,724 $ 17,724 1.4%
Due after one year to five years 271,676 271,676 22.7
Due after five years to ten years 232,430 232,430 19.4
Due after ten years 285,976 285,976 23.9
Mortgage-backed securities 391,278 391,278 32.6
================================
Total $1,199,084 $1,199,084 100.0%
================================
</TABLE
14
<PAGE>
<PAGE>
The following table summarizes the Company's investment results for the five
years ended December 31, 1998, calculated using the mean of total investments as
of the first and last day of each calendar quarter:
</TABLE>
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
----------------------------------------------------
(dollars amounts in thousands)
<S> <C> <C> <C> <C> <C>
Total net investment income $76,538 $60,344 $38,933 $30,055 $22,975
Average annual pre-tax yield 6.6% 6.4% 6.4% 6.4% 6.6%
Average annual after-tax yield 4.7% 4.6% 4.8% 4.9% 5.4%
Effective federal
income tax rate on
total net investment income 28.6% 26.9% 24.8% 23.7% 19.8%
</TABLE>
REGULATION AND PREMIUM RATES
The Company's insurance subsidiaries are subject to varying degrees of
regulation and supervision in the jurisdictions in which they transact business
under statutes which delegate regulatory, supervisory and administrative powers
to state insurance commissioners. Such regulation generally is designed to
protect policyholders rather than investors and relates to such matters as the
standards of solvency which must be met and maintained; the licensing of
insurance companies and their agents; the nature and examination of the affairs
of insurance companies, which includes periodic market conduct examinations by
the regulatory authorities; annual and other reports, prepared on a statutory
basis, required to be filed with respect to the financial condition of insurance
; establishment and maintenance of reserves for unearned premiums and losses;
restrictions on dividends and other distributions; and requirements regarding
numerous other matters. (See "Managements Discussion and Analysis of Financial
Condition and Results of Operations--Solvency and Surplus Matters.")
Regulatory requirements applying to premium rates vary from state to state, but
generally provide that rates not be "excessive, inadequate or unfairly
discriminatory." In general, the Company's insurance subsidiaries must file all
rates for insurance directly underwritten with the insurance department of each
state in which they operate on an admitted basis.
Subject to regulatory requirements, the Company's management determines the
premium rates for its policies based on a variety of factors, including loss and
LAE experience, inflation, taxes , and anticipated changes in the legal
environment. Methods for arriving at prices vary by type of business, exposure
assumed and size of risk. Underwriting profitability is affected by the accuracy
of these estimates and the willingness of insurance regulators to approve
changes in those rates which they control, and by such other matters as
underwriting selectivity and expense control.
The Company is also subject to statutes governing insurance holding company
systems in various jurisdictions. Typically, such statutes require the Company
to file information periodically with the state insurance regulatory
authorities, including information concerning its capital structure, ownership,
financial condition and general business operations. Under the terms of
applicable state statutes, any person or entity desiring to purchase more than a
specified percentage (commonly 10%) of the Company's outstanding voting
securities is required to obtain regulatory approval for the purchase. Article
15 of the New York Insurance Law relating to holding companies, to which the
Company is subject, requires, inter alia, disclosure of transactions between
Frontier and the Company or any of its subsidiaries, that such transactions
satisfy certain standards, including that they be fair, equitable and
reasonable, and that certain material transactions be specifically
nondisapproved by the New York Department of Insurance (the "Department").
Further, prior approval by the Department is required of affiliated sales,
purchases, exchanges, loans or extensions of credit, or investments, any of
which involve 5% or more of Frontier's admitted assets as of the preceding
December 31st. In addition, any documents relating to the offering of securities
by the Company, the proceeds of which will be used for, or in the operations of
Frontier, must be approved by the Department. With respect to Frontier Pacific,
United Capitol, Lyndon, Western, Regency and Acceleration, the laws of their
states of domicile with respect to holding companies are substantially
equivalent to that of New York.
15
<PAGE>
<PAGE>
In their ongoing effort to improve solvency regulation, the NAIC and individual
states have enacted certain laws and statutory financial statement reporting
requirements. For example, NAIC rules require audited statutory financial
statements as well as actuarial certification of loss and LAE reserves therein.
Other activities are focused on greater disclosure of an insurance company's
reliance on reinsurance and changes in its reinsurance programs and stricter
rules on accounting for certain overdue reinsurance. In addition, the NAIC has
implemented risk-based capital ("RBC") requirements for insurance companies. An
insurance company that does not meet threshold RBC measurement standards could
be required to reduce the scope of its operations and ultimately could become
subject to statutory receivership proceedings. (See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Solvency and Surplus
Matters.") These regulatory initiatives and the overall focus on solvency may
intensify the restructuring and consolidation of the insurance industry. It is
also possible that Congress may enact legislation regulating the insurance
industry. While the impact of these regulatory efforts on the Company's
operations cannot be quantified until enacted, the Company believes it will be
adequately positioned to compete in an environment of more stringent regulation.
COMPETITION
Health Care Division
The business in this segment is highly competitive, principally in terms of
price and extent of coverage. In New York State, there are three major
competitors, as well as a number of other insurers, writing medical malpractice
insurance for physicians . However, the Company benefits from the endorsement or
approval of various medical associations, many of whose physician members are
insured by the Company. Moreover, the Company's program, unlike those of its
competitors, is limited to specified classes of physicians. Dental malpractice
coverage in all jurisdictions is significantly more competitive than medical
malpractice with respect to rates and terms of coverage. Although the Company's
underwriting strategy is to underwrite specialty programs for niche markets, it
nevertheless encounters competition from carriers engaged in insuring risks in
the broader lines of business which encompass niche programs.
Surety Division
The Company, through this segment, is one of the top ten surety underwriters
in the United States. There are approximately 200 active surety companies,
each which underwrite in excess of $3 million in annual premiums.
This segment faces competition from the large national multi-line carriers as
well as smaller, regional mono-line and multi-line companies. Underwriting
terms, commissions and pricing are the primary competitive factors.
Alternative Risk Division
Due to the diversity of the programs underwritten, this segment faces
competitive pressures from a variety of sources, ranging from specialty niche
carriers, to the more traditional, standard carriers.
The market for both excess and primary workers' compensation, a significant
portion of this segment's business, has become increasingly competitive over the
past few years. In response to this competitive environment, the Company has
focused on underwriting very specialized books of business from select
producers, thereby attempting to avoid the more competitive lines.
Other lines of business underwritten by this segment also face significant
competition, which the Company attempts to avoid by focusing on specialty
niches.
16
<PAGE>
<PAGE>
Specialty Programs Division
This segment is facing strong competition in many of its program lines due to
the continued soft pricing in the property/casualty market. Size of accounts is
a key factor contributing to the competitive pricing for this segment with most
medium (approximately $25,000 or more in premiums) to large accounts being
difficult to renew at current and adequate rates. The Company's strategy in
retaining and attracting these accounts is to provide superior service, enhanced
coverages, and risk management assistance, rather than attempting to compete on
price alone, and to utilize specialized agents with national prominence in their
respective product lines as producers.
Smaller accounts (less than $10,000 in premiums), which make up over half of the
programs underwritten by this segment, tend to be less sensitive to price. By
providing superior service and enhanced coverages, this segment has experienced
strong premium growth with respect to such smaller accounts.
Environmental, Excess and Surplus Lines Division
This segment has limited competition with respect to environmental coverages due
to a shortage of experienced underwriters who possess both the environmental and
insurance knowledge required to successfully underwrite this class of business.
Currently, there are four major competitors underwriting such coverages. The
Company employs, and continues to seek, underwriters with a high degree of both
environmental and insurance knowledge.
The competition in California with respect to coverage for residential and
commercial contractors is fairly limited due to past poor experience by
insurance companies in this class. The Company has been successful writing this
coverage by utilizing a highly restrictive manuscript policy form and
implementing stringent underwriting controls.
Coverages for property, product liability and ocean marine are highly
competitive. The Company attempts to limit its underwriting risks through the
utilization of manuscripted policy forms and endorsements, deductibles,
self-insured retentions and individual risk pricing.
Personal and Credit-Related Division
This segment focuses on providing products for insurance programs with respect
to credit, sales finance and loan transactions which are marketed through banks,
credit unions, finance companies, automobile dealers and recreational vehicle
dealers. Products include extended service contracts, credit life and
disability, credit property, involuntary unemployment, residual value, GAP and
collateral protection. Business for this segment is produced internally by
direct sales, general agents, other insurance companies, third party
administrators and brokers.
This segment has a limited number of competitors with competition primarily
related to service, financial strength and relationships. In the credit-related
market, the number of competitors continues to decline due to consolidations.
EMPLOYEES
The Company currently has approximately 1,250 full-time employees, eight of whom
are executive management, and 64 part-time employees. The Company is not a party
to any collective bargaining agreement and believes its relationship with its
employees to be good.
17
<PAGE>
<PAGE>
ITEM 2. PROPERTIES
The Company owns a three-story office building in Rock Hill, New York, in which
its executive offices and insurance operations for Frontier are located, a
one-story building in Rock Hill, New York, which it uses for storage, a portion
of which is rented, and a one-story office building in Charlotte, North
Carolina from which Regency conducts its operations. The Company also
owns an airplane and a hanger at a local airport.
The Company leases office space at 39 locations in 18 states at an aggregate
monthly rental of approximately $376,000.
ITEM 3. LEGAL PROCEEDINGS
See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Shareholder Litigation".
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
18
<PAGE>
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
SECURITY HOLDER MATTERS
The Company's Common Stock is traded on the New York Stock Exchange under the
symbol FTR. The following table sets forth the high and low sales prices for the
Company's Common Stock, as reported by the New York Stock Exchange, for each
calendar quarter during the periods indicated, as adjusted to reflect stock
dividends paid and stock splits:
<TABLE>
<CAPTION>
HIGH LOW
--------------------
<S> <C> <C>
1997:
First quarter $20.28 $16.65
Second quarter 29.77 19.60
Third quarter 35.45 27.16
Fourth quarter 35.68 18.18
1998:
First quarter $25.11 $20.34
Second quarter 25.39 20.73
Third quarter 23.75 12.63
Fourth quarter 18.50 11.63
1999:
First quarter (through $15.25 $12.13
March 17, 1999)
</TABLE>
On March 17,1999, the Company had approximately 1,315 holders of record of its
Common Stock, which did not include beneficial owners for shares registered in
nominee or street name.
During 1998, the Company declared four quarterly cash dividends of $.07 per
share, constituting the twenty-fourth consecutive quarterly cash dividend.
During 1997, the Company declared one quarterly cash dividend of $.065 and three
quarterly cash dividends of $.07 per share. (See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Solvency and Surplus
Matters" for restrictions on the payment of dividends by the Company's insurance
subsidiaries).
19
<PAGE>
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are derived from the Company's
consolidated financial statements and should be read in conjunction with the
consolidated financial statements, related notes, and other financial
information included elsewhere in this Annual Report.
Income Statement Data:
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
--------------------------------------------------------
(DOLLAR AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Revenues:
Gross premiums written $833,158 $587,635 $402,799 $264,314 $198,892
========================================================
Net premiums written $527,005 $389,016 $311,863 $220,757 $187,288
========================================================
Net premiums earned $493,054 $366,844 $265,989 $196,220 $156,755
Net investment income 73,528 56,122 37,226 30,035 24,453
Net realized capital gains (losses) 3,010 4,222 1,707 20 (1,478)
Net proceeds from Company owned life insurance
policy 4,400 -- -- -- --
--------------------------------------------------------
Total revenues 573,992 427,188 304,922 226,275 179,730
Expenses:
Losses and loss adjustment expenses 442,853 234,568 155,991 119,255 110,918
Amortization of policy acquisition costs,
underwriting and other expenses 210,083 134,929 88,025 62,845 47,482
Minority interest in income of subsidiary trust 10,966 11,017 2,277 -- --
Interest expense 965 825 1,970 895 --
--------------------------------------------------------
Total expenses 664,867 381,339 248,263 182,995 158,400
--------------------------------------------------------
Income (loss) before income taxes (90,875) 45,849 56,659 43,280 21,330
Income tax expense (benefit) (40,833) 13,567 16,592 12,069 4,350
--------------------------------------------------------
Net income (loss) $(50,042) $ 32,282 $ 40,067 $ 31,211 $ 16,980
========================================================
Net income (loss) per share -- basic $ (1.34) $ .94 $ 1.26 $ .99 $ .54
========================================================
Net income (loss) per share -- diluted $ (1.34) $ .92 $ 1.23 $ .98 $ .54
========================================================
Cash dividends declared per share $ .28 $ .28 $ .25 $ .24 $ .23
========================================================
</TABLE>
Balance Sheet Data:
<TABLE>
<CAPTION>
DECEMBER 31
------------------------------------------------------------------
1998 1997 1996 1995 1994
------------------------------------------------------------------
(DOLLAR AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Total investments $1,459,312 $1,249,823 $ 838,320 $ 552,714 $ 407,618
Total assets 2,553,777 2,009,666 1,259,227 777,616 601,604
Liabilities for gross unpaid losses and
loss adjustment expenses 1,092,282 780,044 539,073 367,436 312,637
Total liabilities 1,992,404 1,389,258 823,700 547,883 411,340
Guaranteed preferred beneficial interest in
Company's convertible subordinated
debentures 167,153 166,703 166,953 -- --
Total shareholders' equity 394,220 453,705 268,574 229,733 190,264
- ------------------------
Supplemental diluted earnings per share
data:
Realized capital gains (losses) -- net
of tax $ .05 $ .06 $ .04 $ -- $ (.03)
Operating income (loss) (1.39) .86 1.19 .98 .57
------------------------------------------------------------------
Net income (loss) $ (1.34) $ .92 $ 1.23 $ .98 $ .54
==================================================================
Book value per share $ 10.70 $ 12.16 $ 8.34 $ 7.29 $ 6.05
==================================================================
Statutory combined ratio 133.2% 100.9% 90.9% 91.1% 98.1%
GAAP combined ratio 131.9% 101.0% 91.8% 92.7% 101.0%
Ratio of earnings to combined fixed charges
and preferred stock dividends (6.3)x 4.7x 13.3x 39.1x N/A
</TABLE>
20
<PAGE>
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
consolidated financial statements and notes thereto included elsewhere in this
Annual Report.
RESULTS OF OPERATIONS
The following table sets forth the Company's net premiums earned by principal
lines of insurance for the three years indicated and the dollar amount and
percentage of change therein from year to year:
<TABLE>
<CAPTION>
INCREASE (DECREASE)
--------------------------------
1998 TO 1997 1997 TO 1996
1998 1997 1996 AMOUNT % AMOUNT %
- ------------------------------------------------------------------------------------------
(dollar amounts in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
General liability $ 131,545 $111,515 $ 78,641 $ 20,030 18.0% $32,874 41.8%
Medical malpractice 107,149 109,470 105,217 (2,321) (2.1) 4,253 4.0
Surety 66,119 56,327 51,368 9,792 17.4 4,959 9.7
Workers' compensation 11,338 6,724 7,025 4,614 68.6 (301) (4.3)
Commercial multi-peril 28,470 16,465 11,006 12,005 72.9 5,459 49.6
Commercial earthquake 5,708 7,522 8,217 (1,814) (24.1) (695) (8.5)
Specialty personal lines 57,241 27,975 4,122 29,266 104.6 23,853 578.7
Credit-related products 50,079 15,068 -- 35,011 232.4 15,068 --
Other 35,405 15,778 393 19,627 124.4 15,385 3,914.8
---------------------------------------- --------
Total $ 493,054 $366,844 $ 265,989 $126,210 34.4% $100,855 37.9%
======================================== ========
</TABLE>
The following table sets forth the expense components of the Company's combined
ratio calculated as a percentage of net premiums earned on the basis of
generally accepted accounting principles ("GAAP Combined Ratio") for the three
years indicated:
<TABLE>
<CAPTION>
1998 1997 1996
---------------------------
<S> <C> <C> <C>
Losses 58.0% 45.9% 36.5%
Loss adjustment expenses ("LAE") 37.0 19.7 22.2
--------------------------
Losses and LAE 95.0 65.6 58.7
Underwriting and other operating
expenses 36.9 35.4 33.1
--------------------------
GAAP Combined Ratio 131.9% 101.0% 91.8%
==========================
</TABLE>
CALENDAR YEAR 1998 COMPARED TO CALENDAR YEAR 1997
A variety of factors accounted for the 34.4% growth in net premiums earned, the
principal factor being increases in the Company's core and new program
businesses in the general liability, surety, workers' compensation, and
commercial multi-peril lines of business. Net premiums earned also grew due
to the acquisitions of Lyndon in May 1997 and Acceleration in January 1998,
which provide credit-related products, Western in December 1997, which offers
medical malpractice coverage and Environmental Commercial Insurance Agency, Inc.
("ECI") in December 1997 which produces policies for environmental risks in
the general liability line. This increase was partially offset by a decrease
in medical malpractice business, commercial earthquake business, the planned
decrease in a general liability program for apartment owners and to increased
premiums ceded under the aggregate excess of loss reinsurance treaty.
The increase in general liability net premiums earned was primarily attributable
to increased business written in the Environmental, Excess and Surplus Lines
Division, primarily due to the acquisition of ECI, and to increased writings in
the Specialty Programs Division in various programs such as camp, pest control
and artisan contractors. These increases were partially offset by decreases in
the Specialty Programs Division, primarily due to a discontinued program for
apartment owners, and to decreased writings of excess workers' compensation
in the Alternative Risk Division due to competition.
21
<PAGE>
<PAGE>
Medical malpractice net premiums earned in the Health Care Division decreased,
primarily due to the sale of the Florida physicians business in December 1997.
This decrease was partially offset by the increase in business from the
acquisition of Western, and to increased writings for physicians, dentists and
psychiatrists due to geographic expansion.
The growth in the surety line was primarily attributable to expanded writings
of license and permit bonds, service contract bonds, customs bonds, lost
instrument bonds, self insured workers' compensation bonds, landfill bonds and
subdivision bonds, partially offset by a decrease in the contract bond business
for small contractors due to increased price competition.
Net premiums earned for the workers' compensation line increased due to
increased writings in the Alternative Risk Division, primarily in the captive
and rent-a-captive programs, and to business acquired in the Western acquisition
and written in the Health Care Division.
The growth in commercial multi-peril net premiums earned was due to increased
writings in the Health Care Division, primarily in day care and other health
care facilities and institutions.
Net premiums earned in the commercial earthquake line written in the Alternative
Risk Division decreased primarily due to the planned decrease in this program.
The growth in specialty personal lines and credit-related products was due to
increased volume as a result of the acquisitions of Lyndon and Acceleration and
to increased business in the mobile homeowners program.
Net premiums earned in the other lines of business increased, primarily due to
an increase in volume written in the Alternative Risk, Specialty Programs, and
Health Care Divisions, primarily in the group accident and health, ocean marine,
international property and commercial auto liability lines of business.
Net investment income before realized capital gains and losses increased 31.0%
due principally to increased cash flow from operations and the contribution to
net investment income from the acquisitions made in 1997, partially offset by
the interest charge on funds held by the Company for the benefit of the
reinsurer of the Company's aggregate excess of loss reinsurance contract.
Total revenues increased 34.4% as a result of the above.
Total expenses increased 74.4%, compared to the 34.4% increase in net premiums
earned. Losses and LAE increased 88.8% as a result of a 66.5% increase in losses
and a 141.5% increase in LAE. Amortization of policy acquisition costs,
underwriting and other expenses increased 55.7% as a result of a 46.9%
increase in amortization of policy acquisition costs and a 70% increase in
underwriting and other expenses.
The increase in losses and LAE was primarily due to a $155 million reserve
strengthening in the medical malpractice, general liability and surety lines of
business. The increase in medical malpractice losses and LAE was primarily due
to poor results in business written for individual physician malpractice in
various states, primarily in the state of Ohio, and to adverse reserve
development in the large account program. The increase in losses and LAE in
the general liability and surety lines was primarily due to adverse reserve
development in LAE for accident years prior to 1998 in the Alternative
Risk, Health Care, and Specialty Programs Divisions for general liability and
for surety in the Surety Division.
22
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<PAGE>
Amortization of policy acquisition costs, underwriting and other expenses
("Expenses") increased in the Health Care Division primarily due to the
acquisition of Western and to increases in staffing, and marketing expenses.
Expenses in the Surety Division increased due to increased policy acquisition
costs and to the move of this division to Nashville early in the fourth quarter
of 1998. The increases in Expenses in the Alternative Risk and Environmental,
Excess and Surplus Lines Divisions were in direct proportion to the
increase in net premiums earned. Expenses in the Specialty Programs Division
increased due to the costs associated with the opening of a new start-up
operation and to increased staffing and marketing costs. Expenses in the
Personal and Credit-Related Division increased due to the acquisition of
Acceleration in January 1998, partially offset by the recognition of $8.3
million of amortization of the excess of net assets over the purchase price
associated with the Lyndon acquisition.
Expenses increased due to a $10 million charge to cancel the aggregate excess
stop loss agreement for the 1999 treaty year, an increase of approximately
$3.5 million in the allowance for doubtful accounts and a $0.3 million
restructuring charge related to the closing of one of the Company's Health
Care Division Offices.
The increase in interest expense was primarily the result of additional
borrowings under the line of credit during 1998.
The foregoing changes resulted in a net loss before taxes of $90.9 million for
the year ended 1998 versus net income before taxes of $45.8 million for 1997.
CALENDAR YEAR 1997 COMPARED TO CALENDAR YEAR 1996
A variety of factors accounted for the 37.9% growth in net premiums earned, the
principal factor being increases in the Company's core and new program
businesses in the general liability, surety, medical malpractice and commercial
multi-peril lines of business. Net premiums earned also grew due to the
acquisitions of Lyndon, which writes personal lines and credit-related products,
United Capitol, which provides general liability coverage for environmental and
artisan contractors and, to a lesser degree Western, which offers medical
malpractice coverage. This increase was partially offset by a decrease in
workers' compensation, particularly the cotton gin program and social service
programs that the Company discontinued during 1996 due to price competition.
The increase in general liability net premiums earned was primarily attributable
to increase business written in the Environmental, Excess and Surplus Lines
Division, primarily due to the acquisition of United Capitol, growth in programs
in the Specialty Programs Divisions, primarily in the artisan's contractor and
demolition contractor programs, and to growth in the excess employers' liability
program in the Alternative Risk Division. These increases were partially offset
by decreases in the specialty programs division, primarily due competition in
the crane operators' liability program and to decreased writings for umbrella
coverages.
Medical malpractice net premiums earned in the Health Care Division increased
4.1%, primarily attributable to an increase in the number of physicians insured
in the programs for psychiatrists and alternative risks, geographical expansion
in Ohio, Texas, Michigan, and Illinois and growth in the dental program endorsed
by the Academy of General Dentistry and, to a lesser degree, the acquisition of
Western in December 1997. These increases were partially offset by a decrease in
Florida business due to rate increases, the sale of the Florida medical
malpractice business and from the reclassification of certain medical
malpractice business to the general liability line.
The 9.8% growth in the surety line was primarily attributable to expanded
writings of license and permit bonds, service contract bonds, customs bonds,
lost instrument bonds, self insured workers' compensation bonds, landfill
bonds and subdivision bonds. The growth in the Surety Division was partially
offset by decrease in the contract bond business for small contractors due to
price competition.
23
<PAGE>
<PAGE>
Net premiums earned for the workers' compensation line decreased primarily as a
result of decreases in the specialty niche programs for the cotton gin and feed
lots written in the Specialty Programs Division and in the Health Care Division
in programs associated with social services due to price competition. This
decrease was partially offset by increases in the captive and rent-a-captive
programs written in the Alternative Risk Division.
The growth in the commercial multi-peril net premiums earned was due to
increased writings in the Health Care Division, primarily due to an increase in
business written for day care and other healthcare related facilities and
institutions.
Net premiums earned in the commercial earthquake line written in the Alternative
Risk Division decreased 8.6%, primarily due to the planned decrease in this
business.
The growth in specialty personal lines and in the credit-related products lines
was due to increased volume written in the Personel and Credit-Related Division
as a result of the acquisition of Lyndon and to increased business in the mobile
homeowner's program.
Net premiums earned in the other lines of business increased, primarily due to
an increase in volume written in the Alternative Risk, Specialty Programs, and
Health Care Division, primarily in the group accident and health, ocean marine,
international property and commercial auto liability lines.
Net investment income before realized capital gains and losses increased 50.8%
due principally to increases in invested assets resulting from proceeds of the
Common Stock offering in August 1997, the Convertible Trust Originated Preferred
Securities ("Convertible TOPrS") offering in October 1996, cash flow from
operations and the contribution to net investment income from the acquisitions
made in 1997, partially offset by the interest charge on funds held by the
Company for the benefit of the reinsurer of the Company's aggregate excess of
loss reinsurance contract.
Total revenues increase 40.1% as a result of the above.
Total expenses increased 53.6%, compared to the 37.9% increase in net premiums
earned. Losses and LAE increased at a 50.4% rate as a result of a 70.0% increase
in losses and a 18.1 % increase in LAE. Amortization of policy acquisition
costs, underwriting and other expenses increased 53.2% rate as a result of a
45.2% increase in amortization of policy acquisition costs and a 68.1% increase
in underwriting and other expenses.
The increase in losses and LAE was primarily due to a $35 million reserve
increase in the medical malpractice line in the Health Care Division, primarily
due to adverse reserve development in accident years prior to 1995.
Amortization and policy acquisition costs, underwriting and other expenses
("Expenses") increased in the Health Care Division, primarily due to the
acquisition of Western in December 1997 and to increased staffing and
marketing expenses related to expansion, and salary increases. Expenses in the
Personal and Credit-Related Division increased due to the acquisition of
Lyndon in 1997 and Regency in 1996, partially offset by the recognition of $5.8
million of the amortization of the excess of net assets over the purchase price
associated with the Lyndon acquisition. Expenses in the Environmental, Excess
and Surplus Lines Division increased primarily due to the acquisition of United
Capitol in 1996 and to increased staffing and marketing expenses related to
expansion. Expenses in the Surety, Specialty Programs and Alternative Risk
Divisions increased due to increased staffing and marketing expenses related to
expansion, and salary increases.
24
<PAGE>
<PAGE>
The decrease in interest expense was primarily the result of the repayment and
termination of the line of credit in the fourth quarter of 1996, partially
offset by the interest expense associated with the draw-down of $62 million from
a revolving credit facility that the Company obtained on June 3, 1997.
The foregoing changes resulted in net income before taxes of $45.8 million for
the year ended 1997, a 19.1% decrease from the comparable 1996 period.
ASSET PORTFOLIO REVIEW
The Company invests primarily in fixed income securities with the objective of
maximizing after-tax investment income and total investment returns within
approved investment guidelines. The core investment portfolio contains fixed
maturity securities which are rated investment grade. At December 31, 1998, the
Company held investment grade rated securities with a carrying value of $1.17
billion, representing 97.6% of total fixed maturity investments. Fixed maturity
investments with credit ratings below investment grade, which are maintained as
part of the alternative iInvestment portfolio, totaled $28.6 million at December
31, 1998 and represented the 2.4% balance of the total fixed maturity
investments.
At December 31, 1998 and 1997, the Company's fixed maturity investments included
mortgage-backed securities of $391.3 million and $368.6 million, respectively,
which are subject to risks associated with variable prepayments of the
underlying mortgage loans that differ from typical fixed maturities. Securities
that have an amortized cost greater than par value that are backed by mortgages
that prepay faster than expected will incur a reduction in yield, while
securities that have an amortized cost less than par value that are backed by
mortgages that prepay faster than expected will generate an increase in yield.
The degree to which a security is susceptible to either gains or losses is
influenced by the difference between amortized cost and par value, the relative
sensitivity of the underlying mortgages backing the assets to prepayment risk
and the repayment priority of the securities in the overall structure of a
securitization.
The Company limits the extent of its credit risk by purchasing securities backed
by stable collateral with enhanced priority in the securitization structure. The
credit risk is minimized as the majority of the Company's mortgage-backed
portfolio is guaranteed by U.S. government-sponsored entities or are supported
in the securitization structure by junior securities resulting in bonds with
high investment grade ratings. The portfolio is actively managed to minimize the
Company's exposure to prepayment and extension risk. As of December 31, 1998,
the Company's asset and mortgage-backed holdings were rated Aa1 and Aaa,
respectively, by Moody's.
The alternative investment portfolio includes investments in limited
partnerships with carrying values of $27.3 million and $17.8 million at December
31, 1998 and 1997, respectively. The partnerships have varying investment
strategies and these investments were made by the Company with the objective of
long-term capital appreciation. The investments generally contain lock-up
provisions which require the Company to hold the investments for a specified
time horizon and have limited liquidity.
LIQUIDITY AND CAPITAL RESOURCES
The Company is a holding company, receiving cash principally through sales of
its securities, borrowings and management fees charged to its subsidiaries.
The Company's insurance subsidiaries are subject to dividend restrictions as
described in Note Q of the Notes to the Consolidated Financial Statements. The
ability of insurance companies to underwrite insurance is based on maintaining
liquidity and capital resources sufficient to pay claims and expenses as they
become due.
25
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<PAGE>
The liquidity needs of the Company's insurance subsidiaries are generally met
through cash provided by operating activities. However, during 1998, additional
funds of approximately $62.6 million were contributed to the insurance
subsidiaries as a result of significant reserve strengthening and the need to
maintain certain minimum surplus levels. Such funds were obtained through the
Company's $150 million credit facility with Deutsche Bank AG, New York Branch,
of which $58 million remained available to the Company at December 31, 1998.
Under the terms of the credit facility, the Company is subject to certain
financial and non-financial covenants, some of which restrict its ability to
dispose of assets, incur additional indebtedness and require the maintenance
of a minimum level of consolidated shareholders' equity.
Cash flow needs at the holding company level primarily include corporate
operating expenses and interest payments on outstanding debt, for which funding
is provided through management fees charged to the Company's subsidiaries. Net
proceeds of $144.5 million from a Common Stock offering in 1997 and $166.7
million from the sale of Convertible TOPrS during 1996 provided the principal
funding for the strategic acquisitions completed during the three years ended
December 31, 1998 (see Note C of the Notes to the Consolidated Financial
Statements).
The Company has authorized a stock repurchase plan for up to 3 million shares of
its Common Stock under which it repurchased 668,300 shares at a cost of $8.5
million during 1998. Although the Company plans to continue to repurchase its
Common to the extent market conditions make such repurchases strategically
advantageous, it has no commitment or obligation to purchase any particular
number of shares and the program may be suspended at the Company's discretion.
The Company continually monitors existing and alternative financing sources to
support the Company's capital and liquidity needs, including, but not limited to
debt issuance and preferred or Common Stock issuance.
RATING AGENCIES
Ratings assigned by nationally recognized agencies are major factors in the
Company's ability to market the products of its insurance subsidiaries to its
agents and customers since rating information is broadly disseminated and
generally used throughout the industry.
All of the Company's insurance subsidiaries, except Lyndon Life, Gulfco Life and
Acceleration, are currently rated A- ("Excellent") by A.M. Best Company, Inc.
("A.M. Best"). A.M. Best's current ratings for Lyndon Life and Gulfco Life are
B++ ("Very Good"), and its rating for Acceleration is B+("Very ). Standard &
Poor's ("S&P") has assigned a financial strength rating of A+ ("Strong") to all
of the Company's insurance subsidiaries, except for Regency, which is rated A
("Strong") and Acceleration and Gulfco, which have not been assigned ratings by
S&P.
In order to maintain Frontier's current rating with A.M. Best, the Company has
made certain commitments, including maintaining a minimum statutory surplus
level of $250 million and limiting its premium-to-surplus ratio to no more
than 1.75 to 1.
A.M. Best's and S&P's ratings are based on an analysis of financial condition
and operations of an insurance company as they relate to the industry in
general, are not designed for the protection of investors and do not constitute
recommendations to buy, sell, or hold any security.
SOLVENCY AND SURPLUS MATTERS
In its ongoing effort to improve solvency regulation, the NAIC and individual
states have enacted certain laws and financial statement changes. The NAIC has
adopted Risk-Based Capital ("RBC") requirements for insurance companies to
evaluate the adequacy of statutory capital and surplus in relation to investment
and insurance risks, such as asset quality, mortality and morbidity, asset and
liability matching, benefit and loss reserve adequacy, and other business
factors. The RBC formula is used by state insurance regulators as an early
26
<PAGE>
<PAGE>
warning tool to identify, for the purpose of initiating regulatory action,
insurance companies that potentially are inadequately capitalized. In addition,
the formula defines minimum capital standards that supplement the current system
of low fixed minimum capital and surplus requirements on a state-by-state basis.
Regulatory compliance is determined by a ratio of the enterprise's regulatory
total adjusted capital, as defined by the NAIC, to its authorized control level
RBC, as defined by the NAIC. Companies below specific trigger points or ratios
are classified within certain levels, each of which requires specific corrective
action. The levels and ratios are as follows:
YYY
<TABLE>
<CAPTION>
RATIO OF TOTAL ADJUSTED
CAPITAL TO AUTHORIZED
CONTROL LEVEL RBC
REGULATORY EVENT (LESS THAN OR EQUAL TO)
- --------------------- ------------------------
<S> <C>
Company action level 2*
Regulatory action level 1.5
Authorized control level 1
Mandatory control level 0.7
</TABLE>
*Or, 2.5 with negative trend.
At December 31, 1998 and 1997, the ratios of total adjusted capital to
authorized control level RBC for the Company's insurance subsidiaries were in
excess of 2.5 to 1.
In addition, state insurance statutes typically place restrictions on the
maximum amount of dividends or other distributions that may be made by insurance
companies to their shareholders without obtaining prior regulatory approval.
Such restrictions are typically related to the insurance companies statutory
capital and surplus. (See Note Q of the Notes to the Consolidated Financial
Statements.)
In 1998, the NAIC adopted codified statutory accounting principles
("Codification"). Codification will likely change, to some extent, prescribed
statutory accounting practices and may result in changes to the accounting
practices that the Ccompany's insurance subsidiaries use to prepare their
statutory-basis financial statements. Codification will require adoption by the
various states before it becomes the prescribed statutory basis of accounting
for insurance companies domesticated within those states. Accordingly, before
Codification becomes effective for the Company's insurance subsidiaries, their
respective state of domicile must adopt Codification as the prescribed basis of
accounting for domestic insurers to report their statutory-basis results to the
insurance department. At this time, it is unclear which of the various states
will adopt Codification. Management has not yet determined the impact of
Codification on the statutory surplus of the Company's insurance subsidiaries.
The thrust of these regulatory efforts is to improve the solvency of insurance
companies. These regulatory initiatives, and the overall focus on solvency, may
intensify the restructuring and consolidation of the insurance industry. While
the impact of these regulatory efforts on the Company's operations cannot be
quantified until enacted, the Company believes it will be adequately positioned
to compete in an environment of more stringent regulation.
ZURICH REINSURANCE (NORTH AMERICA) STOP LOSS AGREEMENTS
Effective January 1, 1995, the Company entered into a stop loss reinsurance
agreement with Zurich Reinsurance (North America), Inc. ("Zurich N.A."),
formerly Centre Reinsurance Company of New York for accident years
commencing 1995. Under the agreement, Zurich N.A. provides reinsurance
protection within certain accident year and contract aggregate dollar limits for
losses and LAE in excess of a predetermined ratio of these expenses to net
premiums earned for a given accident year for all subject business. The loss and
LAE ratio above which the reinsurance provides coverage is 66%, 65%, and 64% for
accident years 1995 through 1997, respectively. The maximum amount recoverable
for an accident year is 175% of the reinsurance premium paid for the accident
year, or $162.5 million in the aggregate for the three years. As of December 31,
1998, the Company had exceeded the aggregate limits of the contract. (See Note I
of the Notes to the Consolidated Financial Statements.)
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Effective January 1, 1998, the Company entered into a stop loss reinsurance
agreement with Zurich N.A. for the 1998 and 1999 accident years. The new
agreement included selected programs underwritten by United Capitol, Western,
and selected core programs of Frontier and Frontier Pacific, which were not part
of the original 1995-1997 reinsurance agreement. Under the terms of the new
agreement, Zurich N.A. provided reinsurance protection within certain contract
aggregate dollar limits for losses and LAE in excess of a predetermined ratio of
these expenses to earned premiums for a given accident year for the covered
insurance programs.
Effective December 31, 1998, the Company and Zurich N.A. agreed to terminate
this agreement for the 1999 accident year. (See Note I of the Notes to the
Consolidated Financial Statements.)
LITIGATION WITH THE STATE OF NEW YORK
Over the past decade, the Company has been engaged in litigation with the State
of New York as to whether physician medical school faculty members at the State
University of New York ("SUNY") engaged in the clinical practice of medicine at
a SUNY medical school facility, corollary to such physicians' faculty
activities, were within the scope of their employment by SUNY, and thereby
protected against malpractice claims arising out of such activity by the State,
or by the Company under its medical malpractice policies insuring the SUNY
physicians. As a result of favorable judicial decisions, the Company recorded
subrogation recoverables for claims previously paid and reserves established
with respect to such malpractice claims of approximately $19 million on December
31, 1995 and $13 million on June 30, 1996. The Company and the State reached
an agreement with respect to 83 cases pursuant to which the State paid $15
million to the Company in September 1998 and the Company agreed to forego
$5.1 in interest. As a result, the amount of subrogation recoverables recorded
at December 31, 1998 amounted to approximately $12 million.
Discussions are continuing with respect to the cases not included in the
agreement with the State and, to the extent the amount of the actual recovery
varies from the recorded subrogation recoveries of $12 million, such difference
will be reported in the period recognized. The Company is continuing to defend
all SUNY faculty members against malpractice claims that have been asserted and
is maintaining reserves adjusted for the anticipated recoveries.
IMPACT OF INFLATION
Property and casualty insurance premiums are established before the amount of
losses and LAE, or the extent to which inflation may affect such expenses, are
known. Consequently, the Company attempts, in establishing its premiums, to
anticipate the potential impact of inflation. However, for competitive and
regulatory reasons, the Company may be limited in raising its premiums
commensurate with anticipated inflation, in which event the Company, rather than
its insureds, would absorb inflation costs. Inflation also affects the rate of
investment return on the Company's investment portfolio with a corresponding
effect on the Company's investment income.
THE YEAR 2000
The Company has a committee comprised of senior management from the corporate
office and from each of its subsidiaries to develop and implement a uniform and
complete Year 2000 compliance plan. An assessment of all systems that could be
affected by Year 2000 issues has been completed. For its information technology
("IT") exposures, the Company is nearing completion of the remediation of its
systems. Those remediated systems which have been implemented have been tested
for compliance for: 20th century system dates with current and 21st century data
and, with the exception of one system, 21st century system dates with 20th and
21st century data. Processes and procedures are currently in place to ensure
that all future IT development and testing follow Year 2000 standards; that all
projects undertaken in the interim deliver Year 2000 compliant solutions; that
all future third-party hardware and software acquisitions are Year 2000
compliant; and that all commercial third-party service providers, including
agents and program administrators, are queried regarding their Year 2000
compliance plans.
28
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To date, the costs related to Year 2000 compliance efforts are approximately $2
million and have been expensed as incurred. Total costs are not expected to
exceed $3 million and will continue to be funded out of operating cash flows.
However, anticipated costs could be adversely affected by the continued need for
availability of personnel and system resources, as well as any failure by
third-party vendors, service providers, or agencies to properly address Year
2000 issues. The impact of achieving Y2K compliance has not caused a significant
delay in other IT related development efforts.
The Company has also conducted a comprehensive review of its underwriting
guidelines and is seeking regulatory approval of an endorsement to be added to
all commercial property and casualty policies which would clarify that coverage
is not afforded losses resulting from Year 2000 noncompliance by insureds. Upon
approval, this endorsement is being added to each policy at either issuance or
renewal. Underwriting policy and protocol have been developed to address
nonapproving states and business situations that cannot be endorsed. To date,
the Company has received endorsement approval from 41 states and the District of
Columbia. For these reasons, the Company believes its exposure to Year 2000
claims will not be material to its operations or financial condition. However,
due to social and legal trends, it is impossible to predict what, if any,
exposure insurance companies generally may have relating to Year 2000 claims.
A contingency plan is currently being developed which will delineate the
Company's responsibilities in the event that Year 2000 compliance is not
achieved due to internal or external factors. These plans involve, among other
things, manual workarounds, additional paper-based report development and
adjusting staffing strategies. The Company recognizes the need for a contingency
plan, but given the status of its current Y2K efforts does not anticipate having
to rely on the plan. The Company expects to continue to conduct periodic tests
of its systems throughout 1999 to complete testing for various conditions, and
to further ensure continued Year 2000 compliance is maintained.
The Company believes it has an effective program in place to resolve Year 2000
issues in a timely manner. However, risks remain that as yet untested or
undiscovered computer system problems will emerge. In addition, disruptions in
the economy generally resulting from the Year 2000 could also materially
adversely affect the Company, rendering it unable to receive premiums or settle
its insureds' claims in a timely manner. In addition, the Company could be
subject to litigation for claims related to its insureds' Year 2000 exposures.
ENVIRONMENTAL ISSUES
The Company, through its subsidiary United Capitol, in the ordinary course of
business, writes insurance on accounts which have hazardous, unique or unusual
risk characteristics. Since United Capitol's organization in 1986, its liability
policies have included an absolute pollution coverage exclusion, except for
policies specifically designed and underwritten to cover environmental exposures
pollution. In addition, United Capitol's product liability and other primary
general liability policies contain exclusions for coverage of claims for bodily
injury or property damage caused by exposure to asbestos, other than for the
policies providing coverage to asbestos abatement contractors for third party
claims alleging bodily injury or property damage as a result of exposure to
asbestos. Employees of the insured contractor and others required to be in the
abatement area are excluded from coverage.
Although the Company believes that such policies, together with the Company's
general, professional and other liability policies, do not subject it to
material exposure for environmental pollution claims, there can be no assurance
of the Company's continued protection in view of the expansion of liability for
environmental claims in recent litigation in the insurance industry.
29
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SHAREHOLDER LITIGATION
Following the Company's November 5, 1994 announcement of its third-quarter
financial results, the Company was served with seven purported class actions
alleging violations of federal securities laws by the Company and, in some
cases, by certain of its officers and directors. In September 1995, a pre-trial
order was signed which consolidated all actions in the Eastern District of New
York, appointed three law firms as co-lead counsel for the plaintiffs and set
forth a timetable for class certification, motion practice and discovery. In
November 1995, plaintiffs served a consolidated amended complaint alleging
violations by the Company of Section 10(b) of the Securities Exchange Act of
1934 and Rule 10(b)(5) thereunder, seeking to impose controlling person
liability on certain of the Company's officers and directors, and further
alleging insider sales, all premised on negative financial information that
should have been publicly disclosed earlier. Plaintiffs seek an unspecified
amount in damages to be proven at trial, reasonable attorney fees and expert
witness costs. In April 1997, the Court certified the class. Plaintiffs have
subpoenaed documents and deposed outside auditors and analysts. Plaintiffs have
also taken depositions from current or former officers, directors and employees
of the Company. The Company believes the suit is without merit, has retained
special legal counsel to contest this suit vigorously and believes that the
Company's exposure to liability, if any, thereunder would not have a material
adverse effect on the Company's financial condition.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Frontier's investment portfolio is subject to market risk arising from the
potential change in the value of the various securities held within the
portfolio. Market risk comprises many factors, such as interest rate risk,
liquidity risk, prepayment risk, credit risk and equity price risk. Analytical
tools and monitoring systems are in place to assess these market risks. The
market risks which most affect the Company's investment portfolio are interest
rate risk and equity price risk.
Interest rate risk is the price sensitivity of a fixed income security or
portfolio to changes in interest rates. Table 1 below sets forth the impact of
hypothetical interest rate changes on the fair value of fixed maturity
securities held at December 31, 1998. The sensitivity analysis measures the
change in fair values arising from immediate changes in selected interest rate
scenarios. Hypothetical parallel shifts in the yield curve of plus or minus 50
and 100 basis points (bp) were employed in the . Additionally, based upon the
yield curve shifts, estimations of prepayment speeds for the mortgage-backed
securities and the likelihood of call or put options being exercised were also
employed in this analysis.
TABLE 1--SENSITIVITY ANALYSIS (IN THOUSANDS)
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
ASSET +100 BP +50 BP BASE -50 BP -100 BP
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
U.S. Treasury and
government agency $ 70,419 $ 71,387 $ 72,371 $ 73,375 $ 74,403
- ---------------------------------------------------------------------------------------
Mortgage-backed 380,409 386,220 391,278 395,472 399,359
- ---------------------------------------------------------------------------------------
Municipal securities 327,806 335,341 342,344 350,852 358,894
- ---------------------------------------------------------------------------------------
Corporate securities 377,386 385,041 393,091 401,632 410,733
- ---------------------------------------------------------------------------------------
Total $1,156,020 $1,177,989 $1,199,084 $1,221,331 $1,243,389
- ---------------------------------------------------------------------------------------
</TABLE>
Table 2 details the effect on fair value for a positive or negative 10% price
change on the Company's common equity portfolio.
TABLE 2 (IN THOUSANDS)
<TABLE>
<CAPTION>
- ---------------------------------------------------
ASSET +10% BASE -10%
- ---------------------------------------------------
<S> <C> <C> <C>
Common equity $63,061 $57,328 $51,595
- ---------------------------------------------------
</TABLE>
30
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See List of Financial Statements and Financial Statement Schedules
on Page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table lists each director and each executive officer of the
Company, together with their respective age and office(s) held:
<TABLE>
<CAPTION>
NAME AGE OFFICE
- ------------------------------------------------------------------
<S> <C>
Harry W. Rhulen 35 President, Chief Executive Officer and
Chairman of the Board
Suzanne Rhulen 38 Executive Vice President--Chief
Loughlin Administrative Officer
and Director
Patrick W. Kenny 56 Executive Vice President--Finance and
Planning
James W. Satterfield 50 Executive Vice President--Chief
Operating Officer
Joseph P. Loughlin 39 Executive Vice President--Chief Claims
Officer
Richard F. Seyffarth 51 Executive Vice President--Chief
Investment Officer
Douglas C. Moat 67 Executive Vice President--Mergers and
Acquisitions and Director
Mark H. Mishler 40 Vice President--Chief Financial Officer
Peter L. Rhulen 60 Director
Lawrence B. O'Brien 58 Director
Alan Gerry 70 Director
Paul B. Guenther 58 Director
</TABLE>
Harry W. Rhulen, a director of the Company since October 1997, was elected
President and Chief Executive Officer in January 1998 and Chairman of the Board
in February 1998 following the illness and subsequent death of his father,
Walter A. Rhulen, the former Chairman of the Board, President and Chief
Executive Officer of the Company. Mr. Harry Rhulen has been an employee of the
Company since June 1989, was elected a Vice President in June 1990, Executive
Vice President in October 1996 and Chief Operating Officer in May 1997.
Suzanne Rhulen Loughlin was elected Executive Vice President- Chief
Administrative Officer and Director in February 1998. Prior thereto, Ms.
Loughlin was the managing attorney of the Company's in-house law firm of Dubois,
Billig, Loughlin, Conaty and Weisman since 1992, and an employee of the Company
since January 1991.
Patrick W. Kenny was elected Executive Vice President--Finance and Planning
upon joining the Company in September 1998. From 1994 to 1998, Mr. Kenny was the
Senior Vice President of Corporate Development for SS&C Technologies, Inc., the
Chief Financial Officer of Aetna Life and Casualty from 1988 to 1994, and prior
thereto had been a Senior Audit Partner of KPMG Peat Marwick, where he spent 21
years.
31
<PAGE>
<PAGE>
James W. Satterfield was elected Executive Vice President--Chief Operating
Officer in 1998, having been President of United Capitol since 1996. Prior
thereto, Mr. Satterfield held various executive officer positions in the
insurance industry with URC Environmental Specialty Underwriters, The Home
Insurance Company and Reliance Reinsurance.
Joseph P. Loughlin was elected Executive Vice President - Chief Claims Officer
in February 1998 and has been the Corporate Secretary since 1993. Mr. Loughlin
served as a member of the Company's in-house law firm of Dubois, Billig,
Loughlin, Conaty and Weisman since 1990, and as the managing attorney for the
Company's legal offices in Ft. Lauderdale and Orlando and a Vice President of
Frontier responsible for medical malpractice claims since January 1997.
Richard E. Seyffarth was elected Executive Vice President - Chief Investment
Officer in February 1998, having joined the Company in 1996. Prior thereto, Mr.
Seyffarth served as Vice President of The Home Insurance Company for over seven
years.
Douglas C. Moat has been a director of the Company since August 1991 and since
February 1998, has served as Executive Vice President--Mergers and Acquisitions.
Mr. Moat, a JD, CLU, and FLMI, is Chairman of the Manhattan Group, Inc., an
insurance and financial services firm, and has over 40 years experience in
insurance and financial services sales and management, including 13 years as a
private consultant. During his career, he has held positions as Executive Vice
President, The Home Group; Director--Financial Services Corporate Staff, ITT
Corp.; Vice President, USLIFE Corp., and President of USLIFE's mutual fund
subsidiary; Vice President, The Glens Falls Group and the National Life
Assurance Company of Canada. Mr. Moat is a member of the New York State Bar
Association, serves on several insurance and banking committees, and writes and
speaks extensively on insurance topics, often acting as an expert witness.
Mark H. Mishler was elected Vice President -Chief Financial Officer of the
Company in May 1997, having been the Vice President - Finance and Treasurer
since October 1996, the Vice President and Controller of Frontier since 1995
and an employee of the Company since 1987. Mr. Mishler has more than 17 years
experience in the insurance business.
Peter L. Rhulen has been a director of the Company since
commencement of its operations in July 1986. Mr. Rhulen was
formerly Vice Chairman of Markel/Rhulen, a position he held from
October 1989 to September 1992.
Lawrence E. O'Brien has been a director of the Company since June 1990 and a
member of the Audit Committee since that date. Mr. O'Brien, a CPCU, is the
President of O'Brien Management Company, Inc., an insurance consulting firm, a
position he has held since January 1988, and was a co-founder and a director of
Underwriter Management Associates, a managing general insurance agency with
which he had been associated since its inception in 1983 until its sale in
September 1990. From 1976 to 1987, Mr. O'Brien was Executive Vice President of
Associated Risk Managers, a New York statewide affiliation of independent
insurance agents marketing specialized insurance programs.
Alan Gerry was elected a director of the Company in March 1996. Mr. Gerry was
the founder, Chairman of the Board and Chief Executive Officer of Cablevision
Industries Corporation, the eighth largest multiple cable system operator in the
United States until its merger with Time Warner Entertainment in January 1996,
and now acts as a private investor. Mr. Gerry was a founding member of the Board
of the Cable Alliance for Education and is a past President of the New York
State Cable Television Association.
32
<PAGE>
<PAGE>
Paul B. Guenther, was elected a director of the Company in March 1998 and is
also a member of the Audit Committee. Mr. Guenther currently serves as the
Chairman of the Philharmonic-Symphony Society of New York, a position he has
held since September 1996. Prior thereto, Mr. Guenther served as the President
of PaineWebber Incorporated from 1988 to 1994, and from 1994 through 1995 served
as the President of PaineWebber Group, Inc. Mr. Guenther also serves as
Chairman of the Board of Trustees of Fordham University, is on the Board of
Overseers for the Columbia University Business School and other charitable
entities. Mr Guenther is also a director of Consolidated Freightways and
serves as an advisory Committee member and investor in Walden Capital
Partners LP.
Mr. Harry Rhulen and Ms. Suzanne Loughlin are brother and sister, Mr. Joseph
Loughlin is the husband of Suzanne Loughlin, and Mr. Peter Rhulen is their
uncle.
All directors hold office until the next annual meeting of shareholders and
until their successors are elected and qualified. Officers are elected annually
and serve at the pleasure of the Board of Directors, subject to rights, if any,
under contracts of employment.
33
<PAGE>
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth a summary of the compensation earned by the
Company's Chief Executive Officer and its four other most highly compensated
executive officers during the year ended December 31, 1998 and the two preceding
years.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
ANNUAL LONG-TERM ALL
NAME AND COMPENSATION COMPENSATION OTHER
PRINCIPAL SALARY BONUS AWARDS COMPENSATION
POSITION YEAR ($) ($) OPTION (#) ($)(1)
- ---------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Harry W. Rhulen 1998 $459,000 $ - 1,025,356(2)(5) $34,100
President, 1997 188,000 150,000 15,400(4) 17,500
Chief 1996 126,000 65,000 14,000
Executive
Officer and
Chairman of
the Board
Douglas C. Moat 1998 250,000 100,000 30,644(2)(3) 5,000
Executive 1997 - - - -
Vice 1996 - - - -
President
James W. 1998 284,000 100,000 21,216(2) 21,400
Satterfield 1997 257,000 75,000 5,500(4) 19,500
Executive 1996 90,000 100,000 11,000(6) 200
Vice
President
Richard F. 1998 193,000 100,000 14,300(2) 14,400
Seyffarth 1997 143,000 40,000 4,400(4) 9,500
Executive 1996 38,000 - 6,600(7) 800
Vice
President
Mark H. Mishler 1998 209,000 75,000 15,714(2) 16,000
Vice 1997 143,000 30,000 11,000(4) 16,300
President, 1996 106,000 60,000 - 11,300
Treasurer
and Chief
Financial
Officer
Walter A. 1998 - - - -
Rhulen* 1997 519,000 200,000 275,000(8) 59,800
Former 1996 500,000 415,500 - 30,000
President,
Chief Executive
Officer and
Chairman of
the Board
</TABLE>
*Deceased January 31, 1998.
- -----------
(1) Represents the allocable amount accrued for contribution by the Company to
its profit sharing plan and the allocable amount of the Company's
contribution to its 401k plan. The allocable amount accrued for contribution
to the Company's profit sharing plan for Messrs. Rhulen, Moat, Satterfield,
Seyffarth and Mishler was $15,700, $5,000, $10,000, $6,700 and $7,600,
respectively, and the allocable amount contributed to the Company's 401k
Plan for Messrs. Rhulen, Satterfield, Seyffarth and Mishler was $18,400,
$11,400, $7,700 and $8,400, respectively.
(2) Exercisable cumulatively at the rate of 25% of the underlying shares per
year, commencing December 31, 1999, by Messrs Rhulen, Moat, Satterfield,
Seyffarth and Mishler with respect to 35,356, 19,644, 21,216, 14,300 and
15,714 shares, respectively.
(3) 11,000 shares exercisable through December 31, 2000.
(4) Exercisable cumulatively at the rate of 25% of the underlying shares per
year, commencing May 22, 1998.
(5) 990,000 shares exercisable at prices ranging from $30.00 to $50.00 through
December 31, 2004.
(6) Exercisable through August 13, 2001.
(7) Exercisable cumulatively at the rate of 25% of the underlying shares per
year, commencing November 21, 1998.
(8) Exercisable through December 31, 2001 by the Estate of Walter A. Rhulen.
-----------------
34
<PAGE>
<PAGE>
The following table sets forth certain information concerning options granted
during 1998 to the individuals named in the Summary Compensation table:
<TABLE>
<CAPTION>
OPTION GRANTS IN 1998
POTENTIAL REALIZABLE VALUE
NUMBER OF % OF TOTAL OF ASSUMED ANNUAL RATES OF
SECURITIES OPTIONS STOCK PRICE APPRECIATION
UNDERLYING GRANTED EXERCISE FOR OPTION TERM
OPTIONS TO ALL PRICE EXPIRATION ------------------------
NAME GRANTED(#) EMPLOYEES ($/SHARE) DATE 5%($) 10%($)
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Harry W. Rhulen 35,356 1.9 12.88 12/31/03 125,766 277,909
990,000 54.6 30.00-50.00 12/31/04 - -
Douglass C. Moat 19,644 1.1 12.88 12/31/03 69,876 154,408
11,000 0.6 20.80 12/31/00 36,057 75,716
James W. Satterfield 21,216 1.2 12.88 12/31/03 75,468 166,764
Richard F. Seyffarth 14,300 0.8 12.88 12/31/03 50,867 112,403
Mark H. Mishler 15,714 0.9 12.88 12/31/03 55,897 123,517
</TABLE>
The following table presents the value of unexercised options held at December
31, 1998 by the individuals named in the Summary Compensation Table:
OPTIONS VALUE TABLE
<TABLE>
<CAPTION>
VALUE OF
UNEXERCISED
NUMBER OF IN-THE-MONEY
UNEXERCISED OPTIONS OPTIONS AT
AT YEAR-END (#) YEAR-END ($)*
EXERCISABLE (E)/ EXERCISABLE (E)/
NAME UNEXERCISABLE (U) UNEXERCISABLE (U)
- --------------------------------------------------------------
<S> <C> <C>
Harry W. Rhulen 1,226,776(E)(1) 21,481 (E)
46,904(U) - (U)
Douglas C. Moat 17,050(E) 21,481 (E)
19,644(U) - (U)
James W.Satterfield 12,375(E) - (E)
25,341(U) - (U)
Richard F. Seyffarth 4,400(E) - (E)
20,900(U) - (U)
Mark H. Mishler 8,800 E) 21,481(E)
23,964(U) - (U)
</TABLE>
* Values are calculated by subtracting the exercise price from the fair market
value of the stock at year end.
(1) Includes 226,875 shares purchasable at $20.66 per share upon
exercise of options granted to Mr. Walter A. Rhulen, and
gifted to his son, Mr. Harry W. Rhulen.
35
<PAGE>
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The following table sets forth the beneficial ownership of the Company's Common
Stock at December 31, 1998 by (i) each person known by the Company to own
beneficially five percent or more of such shares, (ii) each director, (iii) each
person named in the Summary Compensation Table under "Executive Compensation" on
page 37, and (iv) all directors and executive officers as a group, together with
their respective percentage ownership of the outstanding shares:
<TABLE>
<CAPTION>
AMOUNT AND NATURE OF BENEFICIAL OWNERSHIP
------------------------------------------------
ACQUIRABLE
CURRENTLY WITHIN 60 PERCENT OF
NAME AND ADDRESS OWNED DAYS (1) OUTSTANDING
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Harry W. Rhulen 178,534(3) 1,226,776(6) 3.8%
Peter L. Rhulen(2) 1,672,156(4) - 4.5
Lawrence E. O'Brien 62,462 6,050 *
Alan Gerry 30,000 6,050 *
Douglas C. Moat 21,713 17,050 *
Paul B. Guenther 20,500 - *
Suzanne R. Loughlin 211,891(5) 234,575(6) 1.2
James W. Satterfield 10,608 12,375 *
Richard F. Seyffarth 7,650 4,400 *
Mark H. Mishler 11,850 8,800 *
Wellington Management
Company
75 State Street
Boston, MA 02109 2,980,008(7) -- 8.1
All directors and
executive officers
as a group (12
persons) 2,264,039 1,757,126 10.9
</TABLE>
- -----------------------------
* Less than 1%
(1) Reflects number of shares of Common Stock acquirable upon
exercise of options.
(2) Address is 195 Lake Louise Marie Road, Rock Hill, NY
12775-8000.
(3) Includes 8,883 and 1,144 shares owned by a daughter and son of Mr. Harry W.
Rhulen, respectively, for whom he acts as custodian under the Uniform Gifts
to Minors Act. Does not include 15,642 shares owned by Mr. Rhulen's wife,
as to which Mr. Rhulen disclaims beneficial ownership.
(4) Does not include 26,432 shares and 22,810 shares owned respectively,
by Mr.Rhulen's spouse and The Eileen and Peter Rhulen Foundation,Inc., for
which Mr. Rhulen acts as President. Mr. Rhulen disclaims beneficial
ownership of such shares.
(5) Includes 49,544 shares owned by the children of Ms. Suzanne R. Loughlin,
for whom she acts as custodian under the Uniform Gifts to Minors Act. Does
not include 25,389 shares owned by Ms. Loughlin's husband, as to which Ms.
Loughlin disclaims beneficial ownership.
(6) Includes 226,875 shares purchasable at $20.66 per share upon
exercise of options granted to the late Mr. Walter A. Rhulen,
his and her father, and gifted to each of them.
(7) Information is from Schedule 13G, dated December 31, 1998, filed by
Wellington Management Company, which reflects shared dispositive power with
respect to 2,980,008 shares.
36
<PAGE>
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In June 1998, the Company guaranteed a loan of $1.25 million for Thomas J.
Dietz, an executive officer of the Company, which guarantee was outstanding on
December 31, 1998.
In August 1998, the Company guaranteed a loan of $1.0 million and, in December
1998, guaranteed an additional $0.8 million for Peter L. Rhulen, a director of
the Company, which $1.8 million of guarantees was outstanding on December 31,
1998.
In November 1998, the Company acquired 180 shares of the capital stock of Metro
Partners, Inc. ("Metro Partners") from Metro Partners, representing 30% of Metro
Partners' outstanding capital stock, for $600,000. Thereafter and during 1998,
the Company loaned approximately $1.0 million at an 8.75% interest rate to Metro
Partners, delivered a $250,000 letter of credit to Metro Partners' landlord as
collateral for its real estate lease, and purchased $500,000 of Metro Partners'
preferred stock. Metro Partners, organized in 1998, provides administrative
services to insurance agents and brokers. Douglas C. Moat, an executive officer
and director of the Company, and Peter L. Rhulen, a director of the Company,
are principal shareholders (Mr. Rhulen with members of his immediate family and
Mr. Moat through a corporation in which he is a principal shareholder) and
directors of Metro Partners.
During 1998, the Company loaned an aggregate of $150,000 at a 6.5% interest rate
to, and guaranteed a loan of $150,000 for, Film Backers, a company in which
Anthony Rhulen, the brother of Harry Rhulen and Suzanne Loughlin, is a
principal. The loans and guarantee were outstanding on December 31, 1998.
In December 1998, the Company initiated a program to facilitate the purchase of
its Common Stock by key managment executives. Under the program, a financial
insitution will loan funds to the executive for such purchase in an annual
amount up to 200% of the executive's salary, depending on the executive's level
of responsibility at the Company. The shares purchased will be pledged with
the financial institution as collateral for the loan by the executive, who will
be responsible for its repayment and payment of the related interest. The
Company will guarantee the loan as long as the executive is in the employ of the
Company. The Company has also agreed to grant the executive an option on
December 31st of each year to purchase an equivalent number of shares at the
fair market value on such date as the executive purchased during the calendar
year under the program, twenty-four management executives have elected to
participate in this program. Pending finalization of the loan documents with
the financial institution, the Company provided a loan facility for the
participating management executives. Mr. Richard Seyffarth, an Executive Vice
President of the Company and its Chief Investment Officer acted as the
nominee for such management executives to borrow funds on their behalf.
Through December 31, 1998, an aggregate of $2,250,000 was borrowed pursuant to
this loan facility and 176,653 shares of Common Stock were purchased on the
New York Stock Exchange with the proceeds on the behalf of the twenty-four
management executives participating in the program. The Company's eight
executive officers are participating in the program and on December 31, 1998,
loans outstanding from the Company on their behalf were as follows: Mr. Harry
W. Rhulen, $225,000; Ms. Suzanne Rhulen Loughlin $100,000; Mr. Patrick W.
Kenny, $150,000; Mr. James W. Satterfield, $135,000; Mr. Joseph P. Loughlin,
Esq., $87,500; Mr. Richard F. Seyffarth, $91,000; Mr. Douglas C. Moat, $125,000;
and Mr. Mark H. Mishler, $100,000. Once the arrangements with the financial
institution are finalized, the loan proceeds from the financial institution
will be applied to repay the loans by the Company.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS
ON FORM 8-K
(a) List of documents filed as part of this Report.
(1), (2) Financial Statements and Schedules.
See List of Financial Statements and Financial Statement
Schedules on page F-1.
(3) The list of exhibits required to be filed with this Report is set forth
in the Index to Exhibits herein.
(b) Reports on Form 8-K.
Report on Form 8-K for an event (the issuance of a press release announcing
pre-tax reserve, reinsurance and restructuring charges) which occurred
December 16, 1998.
(c) Exhibits.
See Index to Exhibits
37
<PAGE>
<PAGE>
ANNUAL REPORT ON FORM 10-K
ITEM 8, ITEM 14(a)(1) and (2), (c), and (d)
LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FINANCIAL STATEMENT SCHEDULES
YEAR ENDED DECEMBER 31, 1998
FRONTIER INSURANCE GROUP, INC.
ROCK HILL, NEW YORK
<PAGE>
<PAGE>
Form 10-K--Item 14(a)(1) and (2)
Frontier Insurance Group, Inc. and Subsidiaries
List of Financial Statements and Financial Statement Schedules
The following consolidated financial statements and supplemental data of
Frontier Insurance Group, Inc. and subsidiaries are included in Item 8:
<TABLE>
<S> <C>
Consolidated Balance Sheets--December 31, 1998 and 1997...................... F-3
Consolidated Statements of Operations and Comprehensive Income--Years Ended
December 31, 1998, 1997 and 1996........................................... F-5
Consolidated Statements of Shareholders' Equity--Three Years Ended
December 31, 1998.......................................................... F-6
Consolidated Statements of Cash Flows--Years Ended
December 31, 1998, 1997 and 1996........................................... F-7
Notes to the Consolidated Financial Statements............................... F-8
Supplemental Data--Quarterly Results of Operations (Unaudited)............... F-35
The following consolidated financial statement schedules of Frontier Insurance
Group, Inc. and subsidiaries are included in Item 14(a):
Schedule II--Condensed Financial Information of Registrant.................. F-36
Schedule IV--Reinsurance.................................................... F-39
Schedule V--Valuation and Qualifying Accounts............................... F-40
Schedule VI--Supplemental Information Concerning
Property/Casualty Insurance Operations.................................... F-41
</TABLE>
All other schedules for which provision is made in Article 7 of Regulation S-X
are not required under the related instructions, are inapplicable, or required
information is included in the consolidated financial statements, and therefore,
have been omitted.
F-1
<PAGE>
<PAGE>
Report of Independent Auditors
Board of Directors and Shareholders
Frontier Insurance Group, Inc.
We have audited the accompanying consolidated balance sheets of Frontier
Insurance Group, Inc. and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of operations and comprehensive income,
shareholders' equity, and cash flows for each of the three years in the period
ended December 31, 1998. Our audits also included the financial statement
schedules listed in the Index at Item 14(a). These financial statements and
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedules based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the 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
Frontier Insurance Group, Inc. and subsidiaries at December 31, 1998 and 1997,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedules, when considered in relation to the basic
financial statements taken as a whole, present fairly, in all material respects,
the information set forth therein.
/S/ Ernst & Young LLP
New York, New York
March 31, 1999
F-2
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Consolidated Balance Sheets
(dollar amounts in thousands)
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
----------------------
<S> <C> <C>
ASSETS
Investments:
Fixed maturity securities, available for sale $1,199,084 $1,079,740
Equity securities, available for sale 57,328 20,281
Limited investment partnerships 27,291 17,758
Equity investees 16,930 14,108
Real estate and mortgage loans 9,131 368
Short-term investments 149,548 117,568
-------------------------
Total investments 1,459,312 1,249,823
Cash 28,335 11,804
Premiums and agents' balances receivable,
less allowances for doubtful accounts
(1998--$6,025; 1997--$2,791) 114,389 96,196
Reinsurance recoverables on:
Paid losses and loss adjustment expenses 30,626 21,460
Unpaid losses and loss adjustment expenses 448,424 291,734
Prepaid reinsurance premiums 137,790 111,927
Accrued investment income 16,517 14,970
Federal income taxes recoverable 24,775 7,292
Deferred policy acquisition costs 96,597 55,634
Deferred federal income taxes 46,434 29,045
Property, equipment and software 54,188 48,298
Intangible assets 54,782 29,885
Other assets 41,608 41,598
--------------------------
TOTAL ASSETS $2,553,777 $2,009,666
==========================
</TABLE>
See notes to the consolidated financial statements.
F-3
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Consolidated Balance Sheets (continued)
(dollar amounts in thousands, except per share data)
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
----------------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Policy liabilities:
Unpaid losses $831,839 $635,719
Unpaid loss adjustment expenses 260,443 144,325
Unearned premiums 507,046 404,042
----------------------
Total policy liabilities 1,599,328 1,184,086
Funds withheld under reinsurance contracts 182,211 111,879
Bank debt 92,000 -
Reinsurance balances payable 35,773 33,953
Cash dividend payable to shareholders 2,578 2,375
Other liabilities 80,514 56,965
----------------------
TOTAL LIABILITIES 1,992,404 1,389,258
Guaranteed preferred beneficial interest in
Company's convertible subordinated
debentures 167,153 166,703
Shareholders' equity:
Preferred Stock, par value $.01 per share
(shares authorized and unissued;
1,000,000) - -
Common Stock, par value $.01 per share
(shares authorized: 1998--150,000,000;
1997--50,000,000
shares issued: 1998--37,594,709;
1997--37,419,298) 376 340
Additional paid-in capital 450,347 367,914
Accumulated other comprehensive income,
net of tax 26,635 20,238
Retained earnings (deficit) (73,833) 65,995
----------------------
403,525 454,487
Treasury Stock--at cost (1998--766,912
shares; 1997--99,495 shares) (9,305) (782)
----------------------
TOTAL SHAREHOLDERS' EQUITY 394,220 453,705
----------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $2,553,777 $2,009,666
======================
</TABLE>
See notes to the consolidated financial statements.
F-4
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Consolidated Statements of Operations and Comprehensive Income
(dollar amounts in thousands, except per share data)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
------------------------------
<S> <C> <C> <C>
REVENUES
Premiums earned $493,054 $366,844 $265,989
Net investment income 73,528 56,122 37,226
Net realized capital gains 3,010 4,222 1,707
------------------------------
Total net investment income 76,538 60,344 38,933
Net proceeds from company owned life
insurance policy 4,400 - -
------------------------------
Total revenues 573,992 427,188 304,922
EXPENSES
Losses 274,748 164,972 97,058
Loss adjustment expenses 168,105 69,596 58,933
Amortization of policy acquisition
costs 122,813 83,586 57,540
Underwriting and other expenses 87,270 51,343 30,485
Minority interest in income of
consolidated subsidiary trust 10,966 11,017 2,277
Interest expense 965 825 1,970
------------------------------
Total expenses 664,867 381,339 248,263
------------------------------
Income (loss) before income taxes (90,875) 45,849 56,659
Provision for income taxes:
State 743 2,053 723
Federal (41,576) 11,514 15,869
------------------------------
Total income tax expense (benefit) (40,833) 13,567 16,592
------------------------------
Net income (loss) (50,042) 32,282 40,067
Other comprehensive income (loss),
net of tax 6,397 15,431 (3,148)
------------------------------
Total comprehensive income (loss) $(43,645) $47,713 $36,919
==============================
Earnings (loss) per common share:
Basic $(1.34) $.94 $1.26
==============================
Diluted $(1.34) $.92 $1.23
==============================
Weighted average common shares outstanding (in thousands):
Basic 37,293 34,195 31,797
Diluted 37,293 42,845 33,706
</TABLE>
See notes to the consolidated financial statements.
F-5
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Equity
(dollar amounts in thousands, except per share data)
<TABLE>
<CAPTION>
THREE YEARS ENDED DECEMBER 31, 1998
-----------------------------------------------------------------------------------
ACCUMULATED
ADDITIONAL OTHER RETAINED TOTAL
COMMON PAID-IN COMPREHENSIVE EARNINGS TREASURY SHAREHOLDERS'
STOCK CAPITAL INCOME (DEFICIT) STOCK EQUITY
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balances at January 1, 1996 $ 260 $ 167,457 $ 7,955 $ 54,849 $ (788) $ 229,733
Net income -- -- -- 40,067 -- 40,067
Common stock dividend (10%) 28 45,208 -- (45,236) -- --
Stock options exercised 2 1,101 -- -- -- 1,103
Issuance of common stock related
to acquisition 4 8,071 -- -- -- 8,075
Change in net unrealized gains
on investments (net of tax) -- -- (3,148) -- -- (3,148)
Cash dividends paid and accrued
($.25 per share) -- -- -- (7,256) -- (7,256)
-------------------------------------------------------------------------------------
Balances at December 31, 1996 294 221,837 4,807 42,424 (788) 268,574
Net income -- -- -- 32,282 -- 32,282
Stock options exercised 1 1,582 -- -- -- 1,583
Issuance of common stock related
to public offering 45 144,482 -- -- -- 144,527
Change in net unrealized gains
on investments (net
of tax) -- -- 15,431 -- -- 15,431
Cash dividends paid and accrued
($.275 per share) -- -- -- (8,711) -- (8,711)
Reissuance of treasury stock -- 13 -- -- 6 19
-------------------------------------------------------------------------------------
Balances at December 31, 1997 340 367,914 20,238 65,995 (782) 453,705
Net loss -- -- -- (50,042) -- (50,042)
Stock options exercised 2 1,946 -- -- -- 1,948
Change in net unrealized gains
on investments (net of tax) -- -- 6,397 -- -- 6,397
Cash dividends paid and accrued
($.28 per share) -- -- -- (9,965) -- (9,965)
Common stock dividend (10%) 34 79,787 -- (79,821) -- --
Net (Purchase) reissuance of treasury stock -- 12 -- -- (8,523) (8,511)
Tax benefit from disqualifying dispositions -- 688 -- -- -- 688
-------------------------------------------------------------------------------------
Balances at December 31, 1998 $ 376 $ 450,347 $ 26,635 $ (73,833) $(9,305) $394,220
=====================================================================================
</TABLE>
See notes to the consolidated financial statements.
F-6
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(dollar amounts in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
---------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $(50,042) $32,282 $40,067
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Increase in policy liabilities 349,508 127,568 145,636
Increase in reinsurance balances (173,640) (26,953) (35,473)
Increase in agents' balances and premiums receivable (17,497) (12,796) (21,402)
Increase in deferred policy acquisition costs (40,963) (20,318) (14,366)
Increase in accrued investment income (1,314) (7) (1,369)
Deferred federal income tax expense (benefit) (23,714) 2,800 2,279
Depreciation and amortization 19,185 7,417 3,687
Realized capital gains (3,010) (4,222) (1,707)
Other 67,443 (10,627) (895)
---------------------------------
Net cash provided by operating activities 125,956 95,144 116,457
INVESTING ACTIVITIES
Proceeds from sales of fixed maturity securities 140,221 102,409 129,523
Proceeds from calls, paydowns and maturities of fixed
maturity securities 163,161 108,768 191,888
Proceeds from sales of equity securities 31,117 18,738 15,256
Purchases of fixed maturity securities (387,952) (285,634) (430,713)
Purchases of equity securities (59,876) (21,396) (5,533)
Purchases of wholly-owned subsidiaries, net of cash acquired (43,756) (138,293) (28,996)
Purchases of mortgage loans and real estate investments (8,922) - -
Short-term investments, net 9,001 26,673 (108,889)
Purchases of property, equipment and software (11,110) (14,673) (10,609)
Purchases of limited investment partnerships (10,512) (15,571) -
Purchases of equity investees (5,495) (10,303) (2)
Other (978) 176 430
-------------------------------
Net cash used in investing activities (185,101) (229,106) (247,645)
FINANCING ACTIVITIES
Proceeds from (costs of) guaranteed preferred beneficial
interest in Company's convertible subordinated
debentures - (455) 166,914
Proceeds from bank borrowings 92,000 62,000 7,100
Repayment of bank borrowings - (62,000) (33,792)
Issuance of common stock 1,948 146,110 1,103
Cash dividends paid (9,761) (8,240) (6,920)
Reissue (purchase) of treasury stock (8,511) 19 -
---------------------------------
Net cash provided by financing activities 75,676 137,434 134,405
---------------------------------
Increase in cash 16,531 3,472 3,217
Cash at beginning of year 11,804 8,332 5,115
---------------------------------
Cash at end of year $28,335 $11,804 $8,332
=================================
</TABLE>
See notes to the consolidated financial statements.
F-7
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements
December 31, 1998
NOTE A--ORGANIZATION AND BASIS OF PRESENTATION
Organization
Frontier Insurance Group, Inc. (with its subsidiaries, the "Company"), is
principally a specialty property and casualty insurer operating in all 50
states, the District of Columbia, Puerto Rico, Greece, Guam, and the Virgin
Islands. The Company's principal lines of business and related net premiums
earned are disclosed in "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Results of Operations" of the Company's
1998 Form 10-K. Primarily all lines of business written by the Company are
marketed through independent agents. Also, refer to "Business--Description
of Business--Reportable Segments" of the Company's 1998 Form 10-K for
additional disclosures regarding the Company's reportable segments.
Basis of Presentation
The accompanying financial statements have been prepared in accordance with
generally accepted accounting principles ("GAAP") which, as to insurance
companies, differ from the statutory accounting practices prescribed or
permitted by regulatory authorities. The consolidated financial statements
include the accounts and operations of Frontier Insurance Group, Inc. and all
subsidiaries in which the ownership interests exceed 50%. All significant
intercompany accounts and transactions have been eliminated in consolidation.
NOTE B--SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies followed by the Company are as follows:
Use of Estimates
The preparation of financial statements requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Such estimates and assumptions could change in the future as
more information becomes known, which could impact the amounts reported and
disclosed herein.
Recognition of Premium Revenues
Property and casualty premiums are earned pro rata over the terms of the related
insurance policies. Credit life premiums are earned over the life of the
contracts, principally using the sum-of-the-months-digits method, warranty
insurance premiums are earned as the related losses are incurred, while credit
accident and health premiums are principally recognized using the mean of the
sum-of-the-months-digits method and the pro-rata method over the time period to
which the premiums relate.
F-8
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE B--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Investments
Investments in fixed maturity and equity securities are classified as
available-for-sale and reported at fair value with unrealized gains and losses
included in other comprehensive income, net of deferred federal income taxes.
Fair values for fixed maturity and equity securities are based on quoted market
prices, where available, or estimated using values obtained from independent
pricing services. For mortgage backed securities, the Company considers
estimates of future principal prepayments in the calculation of the constant
effective yield necessary to apply the interest method. If a difference arises
between theprepayments anticipated and actual prepayments received, the Company
recalculates the effective yield to reflect the actual payments received and the
anticipated future payments.
Limited investment partnerships and investments in entities for which the
Company has a 20% to 50% interest or less than a 20% interest but has the
ability to exercise significant control ("equity investees") are accounted for
using the equity method.
Mortgage loans are reported at unpaid principal balances and investment real
estate is reported at cost, net of accumulated depreciation.
Short-term investments are carried at cost, which approximates fair value.
Realized gains and losses from the sales or liquidation of investments are
determined using the specific identification method. Changes in the fair value
of investments are reflected as accumulated other comprehensive income in
shareholders' equity, net of deferred federal income tax.
Property, Equipment and Software
Property, equipment and software is stated at cost, net of accumulated
depreciation and amortization computed on a straight-line basis over estimated
useful lives ranging from 3 to 31.5 years. At December 31, 1998 and 1997, the
related accumulated depreciation and amortization on property, equipment and
software was $19,769,000 and $15,075,000, respectively. During 1998, 1997 and
1996, depreciation and amortization expense related to property, equipment and
software was $4,702,000, $3,963,000 and $3,413,000, respectively.
In April 1993, the Company put into service and began to occupy its new home
office facility. In July 1998, the Company completed the construction and began
to occupy an addition to its home office building. The cost of the facility's
construction was financed internally by the Company. However, to receive
favorable tax status, title to the facility (including the recently completed
addition) resides with the County of Sullivan Industrial Development Agency
("IDA") which, in turn, issued to the Company its twenty-year bonds with a face
value equal to the total cost of the facility. Under the provisions of related
agreements, title to the facility reverts to the Company on maturity of the
bonds, or sooner for a nominal fee, should the Company so desire. Accordingly,
as a result of these agreements, the home office facility is included with
property, equipment and software in the balance sheets. As of December 31,
1998, the outstanding par value of the IDA bonds was $30,670,000, which
approximates the carrying values of the Company's home office.
F-9
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE B--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Intangible Assets
Insurance renewal rights and goodwill are stated at cost, net of accumulated
amortization, computed on a straight-line basis over estimated useful lives
ranging from two to seven years for insurance renewal rights and five to fifteen
years for goodwill. The present value of future profits ("PVFP") associated with
the purchase of Acceleration was approximately $20,500,000 and is carried at
cost, net of accumulated amortization, computed based on unearned premiums
at the time of purchase. The Company assesses the recoverability of
intangible assets by determining whether the amortization of the balance over
its remaining life can be recovered through the undiscounted future operating
cash flows of the acquired operations or assets. At December 31, 1998 and 1997,
the related accumulated amortization on intangible assets was $19,071,000 and
$4,770,000, respectively. During 1998, 1997 and 1996, amortization expense
relating to intangible assets was $14,301,000, $2,744,000 and $1,437,000,
respectively.
Deferred Policy Acquisition Costs
Recoverable policy acquisition costs that vary with and are directly related to
the production of business, such as commissions and premium taxes, net of
reinsurance allowances, are deferred and amortized as the related premiums are
earned. Anticipated losses, loss adjustment expenses ("LAE"), and policy
maintenance expenses, based on historical and current experience, are considered
in determining the recoverability of such deferred policy acquisition costs.
When the anticipated losses, LAE, acquisition and policy maintenance expenses
exceed the related unearned premiums, after consideration of anticipated
investment income, a provision for the indicated deficiency is recorded.
Unpaid Losses and LAE
The liabilities for unpaid property and casualty losses and LAE represent the
estimated liabilities for reported claims, claims incurred but not yet reported
("IBNR"), and the related LAE. The liabilities for property and casualty unpaid
losses and LAE are determined using case-basis evaluations and actuarial
analyses and represent estimates of the ultimate expected cost of all losses and
LAE unpaid at the balance sheet dates.
The liabilities for unpaid losses and LAE have been reduced by estimated salvage
and subrogation recoverable and have not been reduced from their ultimate values
by the effects of discounting estimated ultimate payments to their present
value.
F-10
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE B--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Reinsurance
Assumed and ceded reinsurance premiums, commissions, and unpaid losses are
accounted for based principally on the reports received from the ceding
insurance companies and in a manner consistent with the terms of the related
reinsurance agreements. Liabilities for unpaid losses, LAE and unearned premiums
are stated gross of ceded reinsurance recoverables. Deferred policy acquisition
costs are stated net of the amounts of reinsurance ceded, as are premiums
earned, losses and LAE incurred, and amortized acquisition costs.
Contingent Reinsurance Commissions
Contingent reinsurance commissions are accounted for on an earned basis and are
accrued in accordance with the terms of the applicable reinsurance agreement
based on the estimated level of profitability relating to the subject business.
The profitability of the reinsured business is continually reviewed and as
adjustments become necessary they are reflected in current operations.
Contingent reinsurance commissions are included in other assets and other
liabilities.
Income Taxes
Income tax provisions are based on income reported for financial statement
purposes, adjusted for permanent differences between financial and taxable
income. Deferred federal income taxes are recognized using the liability method,
whereby tax rates are applied to the temporary differences between the financial
reporting and tax bases of assets and liabilities. Deferred federal income tax
assets and liabilities are adjusted for changes in tax rates or laws, and the
adjustment is reflected in income during the period in which such change is
enacted.
Cash and Cash Equivalents
Short-term investments are not considered to be cash equivalents for the
purposes of preparing the statements of cash flows.
Impact of Recently Issued Accounting Standards
In December 1997, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position No. 97-3 Accounting by Insurance and
Other Enterprises for Insurance-related Assessments ("SOP 97-3"). SOP 97-3
establishes standards for accounting for guaranty fund and certain other
insurance related assessments. SOP 97-3 is effective for fiscal years beginning
after December 15, 1998 and requires any impact of adoption to be reported as a
change in accounting principle. The adoption of this statement is not expected
to have a material effect on the Company's results of operations or financial
condition.
F-11
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE B--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In March 1998, the AICPA issued SOP 98-1, Accounting For the Costs of Computer
Software Developed For or Obtained for Internal use. The Company will adopt the
SOP on January 1, 1999. The SOP will require the capitalization of certain costs
incurred after the date of adoption in connection with developing or obtaining
software for internal use. The Company currently expenses such costs as
incurred. The adoption of this statement is not expected to have a material
effect on the Company's results of operations or financial condition.
In June 1998, the Financial Accounting Standards Board issued Statement No. 133,
Accounting for Derivative Instruments and Hedging Activities, which is required
to be adopted in years beginning after June 15, 1999. Because of the Company's
minimal use of derivatives, management does not anticipate that the adoption of
this statement will have a significant effect on earnings or the financial
position of the Company.
Reclassifications
Certain prior year amounts have been reclassified to conform to the 1998
presentation.
NOTE C--ACQUISITIONS
During 1996, 1997 and 1998, the Company completed the following acquisitions,
all of which were accounted for under the purchase method:
In May 1996, the Company purchased United Capitol Holding Company ("United
Capitol Holding") and its wholly-owned subsidiaries, United Capitol Insurance
Company ("United Capitol"), United Capitol Managers, Inc. (renamed Olympic
Underwriting Managers, Inc.) and Fischer Underwriting Group, Inc., for
$31,020,000, which exceeded the fair value of the net assets acquired by
approximately $7,700,000. These entities underwrite specialty risks such as
asbestos abatement, environmental liability and directors' and officers'
liability.
In September 1996, the Company purchased Regency Insurance Company ("Regency")
an underwriter of non-standard automobile and manufactured housing insurance and
Emrol Installment Premium Discount, Inc. ("Emrol") in exchange for 523,788
shares of the Company's Common Stock, which had a market value per share of
$15.42 on June 11, 1996, the effective date of the agreement. The purchase
price, which was inclusive of $221,000 of capitalized acquisition costs,
exceeded the fair value of the net assets acquired by approximately $2,400,000.
Emrol finances premiums primarily for policyholders of Regency.
In June 1997, the Company purchased Lyndon Property Insurance Company and its
six subsidiaries, Lyndon Life Insurance Company, Twin Mercury Life Insurance
Company, Gulfco Life Insurance Company, Lyndon Southern Insurance Company,
Lyndon - DFS Warranty Services, Inc. and Lyndon General Agency of Texas, Inc.
(collectively, "Lyndon") for approximately $92,000,000. The Company also
included $420,000 of capitalized acquisition costs in the purchase price. The
total cost was less than the fair value of the net assets acquired by
$29,421,000. Lyndon provides credit-related and specialty insurance products for
financial institutions and specialty insurance markets.
F-12
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE C--ACQUISITIONS (CONTINUED)
In December 1997, the Company purchased Western Indemnity Insurance Company
("Western") for approximately $48,452,000, which exceeded the fair value of net
assets acquired by approximately $15,754,000. The purchase price is subject to a
downward adjustment if the seller (Galtney Group) does not meet specified
premium writing targets of $75,000,000 over a three year period, capped at
$2,000,000. Western is a specialized carrier in the health care provider market,
underwriting both physician and hospital coverages.
In December 1997, the Company, through United Capitol, purchased Environmental
and Commercial Insurance Agency, Inc. ("ECI") for $4,500,000. The purchase
price exceeded the fair value of the net assets acquired by $4,208,000. ECI is
an underwriting manager of environmental errors and omissions and construction
specialties and places the majority of its written business with United Capitol.
In January 1998, the Company, through Lyndon, purchased Acceleration Life
Insurance Company, Dublin International Limited and Acceleration National
Services Corporation (collectively, "Acceleration") from Acceleration National
Insurance Company ("ANIC") for approximately $30,258,000. The purchase price
exceeded the fair value of net assets acquired, which included approximately
$20,500,000 in PVFP, by approximately $9,900,000. Acceleration underwrites
credit life and credit accident and health insurance primarily through auto
dealers. In conjunction with this transaction, the Company also purchased a book
of warranty business for $10,300,000 and a separate reinsurance agreement was
executed with ANIC, whereby ANIC transferred the unearned premiums and loss
reserves and related assets to the Company as of January 1, 19988.
During 1998, the Company purchased several small insurance agencies specializing
in the sale of surety and title insurance. The combined purchase price of these
acquisitions was approximately $5,030,000 and consisted almost entirely of
goodwill. The operations of these agencies are not material to the Company's
consolidated financial statements.
F-13
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE C--ACQUISITIONS (CONTINUED)
The assets acquired, liabilities assumed and the related goodwill of the
companies purchased in 1998, 1997 and 1996, are summarized as follows (in
thousands):
<TABLE>
<CAPTION>
1998 ACCELERATION OTHER TOTAL
------------------------------
<S> <C> <C> <C>
Purchase price $ 40,558 $ 5,030 $ 45,588
Assets acquired:
Invested assets 67,998 -- 67,998
Other assets 67,798 313 68,111
-----------------------------
Total assets acquired 135,796 313 136,109
Liabilities assumed:
Unpaid losses and LAE 13,625 -- 13,625
Other liabilities 91,538 237 91,775
-----------------------------
Total liabilities assumed 105,163 237 105,400
-----------------------------
Net assets acquired 30,633 76 30,709
-----------------------------
Excess of purchase price
over net assets
acquired $ 9,925 $ 4,954 $ 14,879
=============================
<CAPTION>
1997 LYNDON WESTERN ECI TOTAL
--------------------------------------------
<S> <C> <C> <C> <C>
Purchase price $ 92,420 $ 48,452 $ 4,500 $ 145,372
Assets acquired:
Invested assets 205,677 101,597 445 307,719
Other assets 183,517 42,811 1,728 228,056
--------------------------------------------
Total assets acquired 389,194 144,408 2,173 535,775
Liabilities assumed:
Unpaid losses and LAE 51,233 87,491 -- 138,724
Other liabilities 216,120 24,219 1,881 242,220
--------------------------------------------
Total liabilities assumed 267,353 111,710 1,881 380,944
--------------------------------------------
Net assets acquired 121,841 32,698 292 154,831
--------------------------------------------
Purchase price (under)
over net assets
acquired $ (29,421) $ 15,754 $ 4,208 $ (9,459)
=============================================
<CAPTION>
UNITED REGENCY
1996 CAPITOL AND TOTAL
HOLDING EMROL
---------------------------
<S> <C> <C> <C>
Purchase price $31,020 $8,296 $39,316
Assets acquired:
Invested assets 74,966 4,168 79,134
Other assets 49,797 11,833 61,630
---------------------------
Total assets acquired 124,763 16,001 140,764
Liabilities assumed:
Unpaid losses and LAE 84,823 4,163 88,986
Other liabilities 16,604 5,944 22,548
---------------------------
Total liabilities assumed 101,427 10,107 111,534
---------------------------
Net assets acquired 23,336 5,894 29,230
---------------------------
Excess of purchase price
over net assets
acquired $ 7,684 $ 2,402 $10,086
===========================
</TABLE>
F-14
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE C--ACQUISITIONS (CONTINUED)
The following summarizes the Company's pro forma unaudited results of operations
for the years ended December 31, 1997 and 1996, assuming the purchases of
Lyndon, Western and ECI had been consummated as of January 1, 1997 and United
Capitol Holding, Regency and Emrol had been consummated as of January 1, 1996
(in thousands, except per share data):
<TABLE>
<CAPTION>
1997 1996
--------------------
(Unaudited)
<S> <C> <C>
Net premiums earned $430,307 $386,910
Net investment income (including net
capital gains and losses) 69,495 54,262
Other revenues - 55
------------------
Total revenues 499,802 441,227
Losses and LAE 271,772 208,498
Amortization of policy acquisition costs 102,395 52,540
Underwriting and other expenses 66,495 61,431
Minority interest in income of
consolidated subsidiary trust 11,017 2,277
Interest expense 3,187 5,715
--------------------
Total expenses 454,866 330,461
--------------------
Income before income taxes 44,936 110,766
Income tax expense 11,689 29,360
--------------------
Net income $33,247 $81,406
====================
Earnings per common share:
Basic $ .97 $ 2.53
====================
Diluted $ .95 $ 2.43
====================
</TABLE>
The foregoing pro forma financial information has been prepared for
informational purposes only. It includes certain adjustments for all years
relating to investment income and amortization of goodwill, in addition to
adjustments for 1997 and 1996 relating to interest expense, amortization of
policy acquisition costs and PVFP which is included in underwriting and other
expenses, together with the related income tax effects. The pro forma financial
information is not necessarily indicative of the results of operations had the
transactions been consummated on the assumed dates.
F-15
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE D--EARNINGS PER COMMON SHARE
The following table sets forth the computation of basic and diluted earnings
(loss) per common share (amounts in thousands, except per share data):
<TABLE>
<CAPTION>
1998 1997 1996
------------------------------
<S> <C> <C> <C>
NUMERATOR
Net income (loss) $(50,042) $ 32,282 $ 40,067
=============================
Numerator for basic earnings
(loss) per share--income (loss)
available to common shareholders $(50,042) $ 32,282 $ 40,067
Effect of dilutive securities:
Minority interest in income of
consolidated subsidiary trust -- 7,027 1,480
-----------------------------
Numerator for diluted earnings
(loss) per share--income (loss)
available to common shareholders
after assumed conversions $(50,042) $39,309 $41,547
=============================
DENOMINATOR
Denominator for basic earnings
(loss) per share--weighted
average shares 37,293 34,195 31,797
Effect of dilutive securities:
Convertible Trust Originated
Preferred Securities -- 8,094 1,685
Employee stock options -- 556 224
-----------------------------
Dilutive potential common shares -- 8,650 1,909
-----------------------------
Denominator for diluted earnings
(loss) per share--adjusted
weighted-average shares and
assumed conversions 37,293 42,845 33,706
=============================
Earnings (loss) per common share:
Basic $ (1.34) $ .94 $ 1.26
=============================
Diluted $ (1.34) $ .92 $ 1.23
=============================
</TABLE>
The weighted average shares outstanding have been adjusted retroactively to
reflect the effects of stock splits and stock dividends. For additional
disclosures regarding the Convertible Trust Originated Preferred Securities and
employee stock options, see Notes K and N, respectively.
F-16
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE E--COMPREHENSIVE INCOME
During 1998, the Company adopted Financial Accounting Standards Board's
Statement No. 130, Reporting Comprehensive Income. Statement 130 establishes new
rules for the reporting and display of comprehensive income and its components;
however, the adoption of this statement has no impact on net income or
shareholders' equity. Statement 130 requires unrealized gains or losses, which
prior to adoption were reported separately in shareholders' equity, to be
included in other comprehensive income. Prior year financial statements have
been reclassified to conform to requirements of Statement 130.
The components of comprehensive income (loss) for each of the years ended
December 31, are as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
------------------------------
<S> <C> <C> <C>
Net income (loss) $(50,042) $ 32,282 $ 40,067
Other comprehensive income (loss):
Net unrealized gains (losses) 9,965 23,740 (4,844)
Deferred taxes related to net
unrealized (gains) losses (3,568) (8,309) 1,696
-------------------------------
Total other comprehensive income
(loss) 6,397 15,431 (3,148)
-------------------------------
Total comprehensive income (loss) $(43,645) $ 47,713 $ 36,919
==============================
</TABLE>
For 1998, the reclassification adjustment for realized capital gains and losses
previously included in accumulated other comprehensive income and related
deferred tax expense was $2,157,000 and $755,000, respectively.
The components of accumulated other comprehensive income for each of the years
ended December 31, are as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997
--------------------
<S> <C> <C>
Net unrealized gains $ 41,100 $ 31,135
Deferred federal income taxes (14,465) (10,897)
--------------------
Total accumulated other comprehensive
income $ 26,635 $ 20,238
====================
</TABLE>
F-17
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE F--INVESTMENTS
The major categories of total net investment income are summarized as follows
(in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------
<S> <C> <C> <C>
Interest, dividends and equity in earnings:
Fixed maturity securities $74,127 $55,520 $37,623
Equity securities 1,646 832 1,190
Limited investment partnerships 838 637 -
Equity investees 1,805 179 2
Short-term and other investments 6,652 8,433 3,830
Interest expense on funds held (10,017) (7,160) (4,307)
--------------------------
Investment income before expenses 75,051 58,441 38,338
Less investment expenses 1,523 2,319 1,112
--------------------------
Net investment income 73,528 56,122 37,226
Net realized capital gains (losses):
Fixed maturity securities 3,958 2,495 1,245
Equity securities 3,009 1,727 462
Other investments (3,957) - -
--------------------------
Total net realized capital gains 3,010 4,222 1,707
--------------------------
Total net investment income $76,538 $60,344 $38,933
==========================
</TABLE>
Gross realized capital gains on sales of available-for-sale securities in 1998,
1997 and 1996 were $7,947,000, $4,552,000 and $3,814,000, respectively. Gross
realized capital losses on sales of available-for-sale securities in 1998, 1997
and 1996 were $1,643,000, $1,126,000 and $1,884,000, respectively.
The change in net unrealized gains (losses) on fixed-maturity securities was
$6,945,000, $21,204,000 and $(6,350,000) in 1998, 1997 and 1996, respectively;
the corresponding amounts for equity securities were $4,330,000, $625,000 and
$1,508,000.
At December 31, 1998, bonds and notes with an amortized cost of $48,939,000 were
on deposit with various regulatory authorities to meet statutory requirements.
F-18
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE F--INVESTMENTS (CONTINUED)
Investments in available-for-sale securities are summarized as follows (in
thousands):
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------------------------------------
<S> <C> <C> <C> <C>
AT DECEMBER 31, 1998
Fixed maturity securities:
U.S. Treasury securities
and obligations of U.S.
government corporations
and agencies $ 69,951 $ 2,458 $ 38 $ 72,371
Obligations of states and
political subdivisions 330,276 12,128 60 342,344
Corporate securities 381,053 15,220 3,182 393,091
Mortgage-backed securities 384,659 7,428 809 391,278
----------------------------------------
Total fixed maturity
securities 1,165,939 37,234 4,089 1,199,084
Equity securities 49,973 8,405 1,050 57,328
----------------------------------------
Total $1,215,912 $45,639 $ 5,139 $1,256,412
========================================
AT DECEMBER 31, 1997
Fixed maturity securities:
U.S. Treasury securities
and obligations of U.S.
government corporations
and agencies $ 69,561 $ 1,255 $ 21 $ 70,795
Obligations of states and
political subdivisions 283,064 9,219 237 292,046
Corporate securities 339,138 9,742 590 348,290
Mortgage-backed securities 361,777 7,333 501 368,609
----------------------------------------
Total fixed maturity
securities 1,053,540 27,549 1,349 1,079,740
Equity securities 17,256 3,512 487 20,281
----------------------------------------
Total $1,070,796 $31,061 $1,836 $1,100,021
========================================
</TABLE>
At December 31, 1998, the amortized cost and fair value of fixed maturity
securities, by contractual maturity, are shown below (in thousands). 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>
AMORTIZED FAIR
COST VALUE
--------------------
<S> <C> <C>
Due in one year or less $ 17,336 $ 17,724
Due after one year to five years 263,136 271,676
Due after five years to ten years 224,583 232,430
Due after ten years 276,225 285,976
Mortgage-backed securities 384,659 391,278
----------------------
Total $1,165,939 $1,199,084
======================
</TABLE>
F-19
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE F--INVESTMENTS (CONTINUED)
At December 31, 1998 and 1997, the cost of the Company's investments in limited
partnerships was $25,888,000 and $15,571,000, respectively. At December 31,
1998, the Company had unfunded commitments to certain individual partnerships of
$12,000,000 to be funded over the next several years.
At December 31, 1998 and 1997, the total cost of the Company's investment in
equity investees was approximately $17,154,000 and $14,384,000, respectively.
NOTE G--INCOME TAXES
The components of federal income tax (benefit) expense are as follows (in
thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---------------------------
<S> <C> <C> <C>
Federal income tax (benefit)
expense:
Current $(17,862) $8,714 $13,590
Deferred (23,714) 2,800 2,279
---------------------------
Total federal income tax $(41,576) $11,514 $15,869
(benefit) expense ===========================
</TABLE>
A reconciliation of federal income tax, based on the prevailing corporate income
tax rate of 35%, to the federal income tax expense reflected in the accompanying
financial statements is as follows (in thousands):
1998 1997 1996
-----------------------------
Tax rate applied to pre-tax
income (loss) $(31,806) $16,047 $19,831
Add (deduct) tax effect of:
Tax-exempt interest income (4,709) (3,770) (3,026)
Proceeds from COLI death
benefits 1,750) -- --
Dividends received deduction (809) (846) (752)
State income taxes (260) (718) (253)
Other (2,242) 801 69
------------------------------
Federal income tax
(benefit) expense $(41,576) $11,514 $15,869
==============================
F-20
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE G--INCOME TAXES (CONTINUED)
Significant components of the Company's deferred federal income tax assets and
liabilities at December 31, are as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997
--------------------
<S> <C> <C>
Deferred federal income tax assets:
Reserve discounting, including salvage
and subrogation $38,437 $36,790
Unearned premium reserve 17,560 24,086
Net operating loss carryforward 34,703 -
Alternative minimum tax credit 1,450 -
Other 2,375 1,402
--------------------
Total deferred federal income tax assets 94,525 62,278
Deferred federal income tax liabilities:
Deferred policy acquisition costs 25,405 19,472
Goodwill 2,807 -
Net unrealized gains 14,465 10,897
Other 5,414 2,864
--------------------
Total deferred federal income tax
liabilities 48,091 33,233
--------------------
Net deferred federal income tax asset $46,434 $29,045
====================
</TABLE>
Deferred federal income taxes result from timing differences in the recognition
of certain income and expenses for tax and financial statement purposes and
are summarized as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
------------------------------
<S> <C> <C> <C>
Reserve discounting, including
salvage and subrogation $ (1,647) $(1,866) $ 119
Unearned premium reserve 6,526 (582) (3,211)
Net operating loss carryforward (34,703) - -
Alternative minimum tax credit (1,450) - -
Deferred policy acquisition costs 5,933 2,933 4,666
Goodwill 2,807 - -
Other (1,180) 2,315 705
------------------------------
Total deferred federal income tax
expense (benefit) $(23,714) $2,800 $2,279
==============================
</TABLE>
As of December 31, 1998, the Company has a net operating loss carryforward for
federal income tax purposes of approximately $99,000,000, which expires in 2018.
Federal income tax payments (refunds) amounted to $(1,401,000), $13,928,000 and
$17,021,000 in 1998, 1997 and 1996, respectively.
State income taxes represent the amount of current state income taxes incurred.
F-21
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE H--UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
The liabilities for unpaid losses and LAE are estimated by management utilizing
methods and procedures which they believe are reasonable. These liabilities are
necessarily subject to the impact of future changes in claim severity and
frequency, as well as numerous other factors. Although management believes that
the estimated liabilities for unpaid losses and LAE are reasonable, because of
the extended period of time over which such losses are reported and settled, the
subsequent development of these liabilities may not conform to the assumptions
inherent in their determination and, accordingly, may vary from the estimated
amounts included in the accompanying financial statements. To the extent that
the actual emerging loss experience varies from the assumptions used in the
determination of these liabilities, they are adjusted to reflect actual
experience. Such adjustments, to the extent they occur, are reported in the
period recognized.
The anticipated effect of inflation is implicitly considered when estimating
reserves for losses and LAE. Although anticipated price increases due to
inflation are considered in estimating the ultimate claim costs, the increase in
average severities of claims is caused by a number of factors that vary with the
types of policies written. Average severities are projected based on historical
trends adjusted for implemented changes in underwriting standards, policy
provisions, and general economic trends. Those anticipated trends are monitored
based on actual development and are adjusted as necessary. The effects of such
adjustments are reported in the period recognized.
The Company writes insurance on accounts which have hazardous, unique or unusual
risk characteristics. These liability policies generally exclude absolute
pollution coverage, except for policies providing pollution liability coverage
to contractors involved in the remediation of pre-existing pollution. The
Company believes that such risks do not represent a material exposure related to
environmental pollution claims but there can be no assurance of the Company's
continued protection in view of the expansion of liability for environmental
claims in recent litigation in the insurance industry.
The Company's property and casualty subsidiaries have exposure to insured losses
caused by hurricanes, windstorms and other catastrophic events, primarily in
Florida and North Carolina, and has earthquake exposure limited to California.
A continuous assessment of the catastrophic exposures is made to ensure that
liabilities associated with the events can be minimized.
The liabilities for unpaid losses and LAE as of December 31, 1998 and 1997, and
the incurred losses and LAE for each of the years ended December 31, 1998, 1997
and 1996 are as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---------------------------------------------------------------------
INCURRED INCURRED INCURRED
RESERVES LOSSES AND LAE RESERVES LOSSES AND LAE LOSSES AND LAE
---------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Property and casualty $1,072,395 $431,915 $767,266 $231,588 $155,991
Credit life 19,887 10,938 12,778 2,980 --
---------------------------------------------------------------------
Totals $1,092,282 $442,853 $780,044 $234,568 $155,991
=====================================================================
</TABLE>
F-22
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE H--UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES (CONTINUED)
The following table sets forth a reconciliation of the beginning and ending
property and casualty loss and LAE reserve balances, net of reinsurance ceded,
for each of the three years in the period ended December 31, 1998 (in
thousands):
<TABLE>
<CAPTION>
1998 1997 1996
------------------------------
<S> <C> <C> <C>
Net reserves for losses and LAE, beginning of year $ 483,539 $ 373,606 $ 294,393
Total acquired reserves -- 76,023 53,008
---------------------------------
Incurred losses and LAE for claims relating to:
Current year 297,400 218,301 160,470
Prior years 134,515 13,287 (4,479)
---------------------------------
Total incurred losses and LAE 431,915 231,588 155,991
---------------------------------
Loss and LAE payments for claims relating to:
Current year 66,070 50,665 27,626
Prior years 216,534 147,013 102,160
---------------------------------
Total payments 282,604 197,678 129,786
---------------------------------
Net reserves for losses and LAE, end of year 632,850 483,539 373,606
Total reinsurance recoverable on unpaid losses and LAE 439,545 283,727 165,467
---------------------------------
Gross reserves for losses and LAE, end of year $1,072,395 $767,266 $539,073
=================================
</TABLE>
The net $134,515,000 increase in prior years' reserves was primarily
attributable to a $155,000,000 reserve strengthening, resulting from an in-depth
actuarial analysis of the Company's loss and LAE reserves completed during the
fourth quarter of 1998. This analysis indicated significant deficiencies in
loss and LAE reserves in the Company's medical malpractice line of business for
individual physician related coverages in various states where the business is
written, primarily in Ohio, and LAE reserve development related to general
liability and surety lines.
The net $13,287,000 increase in prior years' reserves in 1997 was attributed to
reserve strengthening of $35,000,000. Included in the net development was a
decrease in prior year reserves in the general liability line of business
written by United Capitol.
The net $4,479,000 decrease in prior years' reserves in 1996 was the result of
favorable claims development on the workers' compensation line of business.
Included in the net development is an increase in prior years' reserves of
approximately $13,000,000 which was entirely offset by subrogation recoverables
recognized in connection with a favorable court ruling in 1995.
F-23
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE H--UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES (CONTINUED)
Litigation with the State of New York
Over the past decade, the Company has been engaged in litigation with the State
of New York as to whether physician medical school faculty members at the State
University of New York ("SUNY") engaged in the clinical practice of medicine at
a SUNY medical school facility, corollary to such physicians' faculty
activities, were within the scope of their employment by SUNY, and thereby
protected against malpractice claims arising out of such activity by the State,
or by the Company under its medical malpractice policies insuring the SUNY
physicians. As a result of favorable judicial decisions, the Company recorded
subrogation recoverables for claims previously paid and reserves established
with respect to such malpractice claims of approximately $19,000,000 on December
31, 1995 and $13,000,000 on June 30, 1996. The Company and the State have
reached an agreement with respect to 83 cases pursuant to which the State paid
$15,000,000 to the Company in September 1998, and the Company agreed to forego
$5,100,000 in interest which it had previously reserved for at December 31,
1997. As a result of the foregoing, the amount of subrogation recoverables
recorded at December 31, 1998 amounted to $12,000,000.
Discussions are continuing with respect to the cases not included in the
agreement with the State and, to the extent the amount of the actual recovery
varies from the recorded subrogation recoverable of $12,000,000, such difference
will be reported in the period recognized. The Company is continuing to defend
all SUNY faculty members against malpractice claims that have been asserted and
is maintaining reserves adjusted for the anticipated recoveries.
NOTE I--REINSURANCE
The Company's insurance subsidiaries assume and cede reinsurance with other
companies and are members of various pools and associations. A large portion of
the reinsurance is effected under contracts known as treaties and in some
instances negotiated on an individual risk basis, also known as facultative
reinsurance. These contracts consist of excess of loss and catastrophe contracts
which protect against losses over stipulated amounts arising from any one
occurrence or event.
Effective January 1, 1995, the Company entered into a three year stop loss
reinsurance agreement with Zurich N.A. Under the agreement, Zurich N.A. provides
reinsurance protection within certain accident year and contract aggregate
dollar limits for losses and LAE in excess of a predetermined ratio of these
expenses to net premiums earned for a given accident year for specified classes
of business. The loss and LAE ratio above which the reinsurance provides
coverage is 66%, 65%, and 64% for accident years 1995 through 1997,
respectively. The maximum amount recoverable for an accident year is 175% of the
reinsurance premium paid for the accident year, or $162,500,000 in the aggregate
for the three years. As of December 31, 1998, the Company had exceeded the
aggregate limits of the agreement.
F-24
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE I--REINSURANCE (CONTINUED)
Effective January 1, 1998, the Company entered into a stop loss reinsurance
agreement with Zurich N.A. for the 1998 and 1999 accident years. The new
agreement includes selected programs underwritten by United Capitol, Western,
and additonal selected core programs of Frontier and Frontier Pacific, which
were not part of the original 1995-1997 reinsurance agreement. Under the terms
of the new agreement, Zurich N.A. provides reinsurance protection within certain
contract aggregate dollar limits for losses and LAE in excess of a predetermined
ratio of these expenses to earned premiums for a given accident year for covered
insurance programs.
Effective December 31, 1998, the Company and Zurich N.A. agreed to terminate
this agreement as it relates to the 1999 accident year. As consideration, the
Company agreed to pay Zurich N.A. a $10,000,000 termination fee, limit the
aggregate treaty maximum to $85,000,000, and modify the terms to limit the
period of claim cession to December 31, 1999. Accordingly, the Company will
account for any future claim cessions under the treaty after December 31, 1998,
retrospectively.
Although reinsurance companies are liable to the Company for amounts reinsured,
the Company remains liable to its insureds for the full amount of the policies
written whether or not the reinsurance companies meet their obligations. To
minimize its exposure to significant losses from reinsurance insolvencies, the
Company evaluates the financial condition of its reinsurers and monitors
concentration of credit risk from similar geographic regions, activities or
economic characteristics of the reinsurers. At December 31, 1998, the Company
had outstanding gross reinsurance recoverables of $226,405,000 from its largest
reinsurer, Zurich N.A.; however, under the terms of the reinsurance
arrangements, the Company is withholding $159,175,000 of funds due Zurich N.A.
Accordingly, the net outstanding recoverable from Zurich N.A. is $67,230,000. Of
the remaining net reinsurance recoverables balance, approximately 26% is due
from three reinsurers; one rated A++ (Superior), one rated A+ (Superior) and one
rated A (Excellent) by A.M. Best Company, Inc.
In 1998, 1997 and 1996 the Company recognized and accrued reinsurance
contingent profit commissions earned of $455,000, $792,000 and $773,000,
respectively.
The effect of reinsurance on premiums written and earned is as follows (in
thousands):
<TABLE>
<CAPTION>
1998 1997 1996
-----------------------------------------------------------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
-----------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Direct $ 784,629 $ 735,407 $ 566,496 $ 532,248 $ 394,057 $ 332,345
Assumed 48,529 46,859 21,139 29,353 8,742 7,287
Ceded (306,153) (289,212) (198,619) (194,757) (90,936) (73,643)
---------------------------------------------------------------------
Net premiums $ 527,005 $ 493,054 $ 389,016 $ 366,844 $ 311,863 $ 265,989
=====================================================================
</TABLE>
F-25
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE I--REINSURANCE (CONTINUED)
The effect of reinsurance ceded reduced incurred losses and LAE as
follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
------------------------------
<S> <C> <C> <C>
Incurred losses $247,593 $118,489 $56,597
Incurred LAE 44,156 17,739 18,240
</TABLE>
NOTE J--CREDIT FACILITY AND OTHER DEBT
In June 1997, the Company entered into a five year, $100,000,000 revolving loan
credit facility agreement with Deutsche Bank AG, New York Branch ("Deutsche
Bank"). Under the terms of the agreement, the Company is subject to certain
financial and nonfinancial covenants. In addition, the Company pays a quarterly
commitment fee at an annual rate of .125%, which is being expensed as incurred.
During 1997, the Company borrowed $62,000,000 under this agreement at an initial
floating interest rate of 6.04% per annum, based on Eurodollar interest rates,
which was fully repaid in August 1997. During 1998, the Company borrowed
$92,000,000 at LIBOR-based interest rates ranging from 5.385% to 5.975%, which
amount was outstanding at December 31, 1998. Also, during 1998, the Company
increased the facility to $150,000,000, and extended the maturity to June 2003.
During 1996, the Company extinguished a total of $33,792,000 in debt, which
arose from borrowings related to a previous credit facility agreement with the
Bank of New York. The Bank of New York credit facility agreement was terminated
in 1996.
During 1998, 1997 and 1996, the Company paid interest of $699,000, $825,000 and
$1,970,000, respectively.
NOTE K--GUARANTEED PREFERRED BENEFICIAL INTEREST IN COMPANY'S
CONVERTIBLE SUBORDINATED DEBENTURES
In October 1996, the Company completed a $172,500,000 offering of 3,450,000
shares of 6 1/4% Convertible Trust Originated Preferred Securities ("TOPrS")
through its wholly-owned consolidated subsidiary, Frontier Financing Trust, a
statutory business trust formed by the Company for the sole purpose of issuing
the TOPrS and investing the proceeds thereof in an equivalent amount of 6 1/4%
Convertible Subordinated Debentures (the "Debentures") of the Company which
mature on October 16, 2026. Under the terms of the offering, the Company is
subject to certain financial and non-financial covenants. The initial
purchasers' discount of $4,744,000 was deducted from the proceeds of the
offering. The Company also incurred $1,032,000 of additional offering costs in
connection with this transaction, resulting in net proceeds of $166,724,000 to
the Company. The total offering costs have been capitalized and are being
amortized on a straight-line basis over a 30 year period, in conjunction with
the maturity date of the Debentures. The TOPrS are carried on the balance sheet
net of the unamortized offering costs, which, at December 31, 1998 and 1997,
amounted to approximately $5,347,000 and $5,800,000, respectively.
F-26
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE K--GUARANTEED PREFERRED BENEFICIAL INTEREST IN COMPANY'S
CONVERTIBLE SUBORDINATED DEBENTURES (CONTINUED)
The TOPrS are mandatorily redeemable under certain conditions and amounts due to
holders are fully and unconditionally guaranteed by the Company. The Debentures
(the sole assets of the trust) are subordinate to all Company debt and to the
claims of creditors and policyholders of the Company's subsidiaries. The TOPrS
are convertible into shares of the Company's Common Stock at an initial
conversion rate of 2.3461 shares of Company Common Stock for each preferred
share, which is equivalent to a conversion price of $21.30 per share (or
8,093,842 shares of Common Stock in total). Holders of the TOPrS have no voting
rights.
The Debentures are redeemable by the Company, at its option, in whole or in part
at a redemption price on or after October 16, 1999, provided the closing price
of the Company's Common Stock is at least 150% of the per share conversion
price, for a minimum of 20 trading days within a period of 30 consecutive
trading days ending on the fifth trading day prior to the notice of redemption
or anytime on or after October 16, 2000. The Company has the right to defer
interest payments on the Debentures at any time by extending the interest
payment date for up to 20 consecutive quarters, but not beyond the maturity date
of the Debentures.
Holders of the TOPrS are entitled to receive cumulative cash distributions at an
annual rate of 6 1/4% of the liquidation amount of $50 per share, accruing from
the date of original issuance and payable quarterly in arrears. Such
distributions are made from interest received on the Debentures, which have
terms that parallel the terms of the TOPrS. During 1998, 1997 and 1996, the
Company recorded expenses related to the cumulative cash distributions net of
amortization of capitalized offering costs of $184,000, $205,000 and $39,000,
respectively. The corresponding expenses are reported as "Minority interest in
income of consolidated subsidiary trust" in the accompanying consolidated
statements of operations and comprehensive income.
NOTE L--RELATED PARTY TRANSACTIONS
In April 1994, the Company completed the acquisition of certain assets of
Spencer Douglass Insurance Associates, Inc. constituting the Company's
California license and permit bond insurance agency business for $3,200,000. In
conjunction with the purchase, the Company entered into a five-year consulting
agreement with the seller, R. Spencer Douglass III ("Douglass"), for $360,000
per year.
In May 1995, the Company and Douglass formed a California limited liability
company, Douglass/Frontier LLC ("Douglass/Frontier"), a bail bond insurance
agency. The Company and Douglass, who is also an employee of Douglass/Frontier,
share equally in the results of Douglass/Frontier. In addition, Douglass owns
two retail bail bond agencies that produce business for Douglass/Frontier, which
in 1998, 1997 and 1996 amounted to less than 3% of the gross bail bond premiums
produced by Douglass/Frontier.
All of the Company's bail bond business is produced through Douglass/Frontier.
In 1998, 1997 and 1996, premiums written through Douglass/Frontier amounted to
approximately $1,054,000, $3,744,000 and $7,608,000, respectively, and the
related premium balances due the Company at December 31, 1998 and 1997, were
$83,000 and $2,225,000, respectively.
F-27
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE L--RELATED PARTY TRANSACTIONS (CONTINUED)
At December 31, 1997, Douglass/Frontier had notes payable to the Company of
approximately $8,200,000. During 1998, such notes were repaid from the proceeds
of an $8,200,000 bank loan obtained directly by Douglass/Frontier and guaranteed
by the Company. Additionally, during 1998, the Company issued a guaranty for a
$2,200,000 personal obligation of Douglass. Such guarantees were outstanding at
December 31, 1998.
All of the Company's homeowners' multi-peril business is produced by Tower Hill
Insurance Group ("Tower Hill"), a managing general agency specializing in such
business, whose principal owner is also an officer and director of Regency.
During 1998, 1997 and 1996, premiums written through Tower Hill were
approximately $27,972,000, $7,170,000 and $2,233,000, respectively, and the
related commissions paid to Tower Hill were $7,622,000, $1,809,000 and $558,000,
respectively. The premium balances due the Company at December 31, 1998 and
1997, were $2,981,000 and $115,000, respectively.
During 1998, the Company purchased, at a cost of $600,000, a 30% interest in
Metro Partners Inc. ("Metro Partners"), a management agency which provides
various administrative services to insurance agencies and brokers. Two of the
principals of Metro Partners serve as directors of the Company. In addition,
the Company purchased $500,000 of Metro Partners preferred stock, and
delivered a letter of credit for $250,000 to Metro Partners' landlord as
collateral for its real estate lease. At December 31, 1998, the Company has
notes receivable from Metro Partners of $1,021,000 at a stated interest rate of
8.75%.
The Company owns a 50% interest in Ward Insurance Services ("Ward"), a personal
auto line producer. During 1998, total premiums produced by Ward for
the Company werewas $11,066,000 and the related commissions paid to Ward
$2,213,000. At December 31, 1998, premium balances due the Company amounted to
$3,745,000 and other receivable balances due from Ward were $308,000.
At December 31, 1998 and 1997, the Company owned a 50% interest in Terramar
Insurance Agency (the "Agency") and a 19.9% interest in Terramar Insurance
Company ("Terramar"). Business produced through the Agency is written by the
Company's insurance subsidiaries. Approximately 90% of such business is ceded to
Terramar. During 1998 and 1997, premiums produced by the Agency were $18,277,000
and $6,860,000 and commissions paid to the Agency were $6,054,000 and
$3,544,000, respectively. Premium balances due the Company were $3,925,000 and
$1,923,000 at December 31, 1998 and 1997, respectively. In addition, at
December 31, 1998 Terramar owed the Company $1,500,000 as a result of a loan
made during the year.
In December 1998, the Company initiated a program to facilitie the purchase
of its Common Stock by key management executives. Under the program, a
financial institution will loan funds to the executive for such purchase and
the shares purchased will be pledged with the financial institution as
collateral for the loan by the executive, who will be responsible for its
repayment and payment of the related interest. The Company will guarantee the
loan as long as the executive is in the employ of the Company. Pending
finalization of the loan documents with the financial institution, the Company
provided a loan facility for the participating management executives. An
Executive Vice President of the Company acted as the nominee for such
management executives to borrow funds on their behalf and through December 31,
1998, an aggregate of $2,250,000 was borrowed pursuant to this loan facility
and 176,653 shares of Common Stock were purchased on behalf of the management
executives participating in the program. Once the arrangements with the
financial institution are finalized, the loan proceeds form the financial
institution will be applied to repay the loans by the Company.
F-28
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE L--RELATED PARTY TRANSACTIONS (CONTINUED)
During 1998, the Company issued guarantees on loans issued by banks for an
officer and a director for $1,250,000 and $1,800,000, respectively.
NOTE M--PREFERRED AND COMMON STOCK
The Company's Preferred Stock may be issued from time to time by the Board of
Directors in one or more series and classes and with such dividend rights,
conversion rights, voting rights, redemption provisions, liquidation
preferences, and other rights and restrictions as the Board of Directors may
determine.
During 1998, the Company's shareholders approved an increase in the number of
shares of the Company's authorized Common Stock from 50,000,000 to 150,000,000.
NOTE N--STOCK OPTIONS
The Company has elected to follow Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees ("APB 25") and related interpretations
in accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under FASB Statement No. 123,
Accounting for Stock-Based Compensation, requires use of option valuation models
that were not developed for use in valuing employee stock options. Under APB 25,
because the exercise price of the Company's employee stock options equals the
market price of the underlying stock on the date of grant, no compensation
expense is recognized.
The Company has adopted stock option plans (the "Plans") under which 1,435,789
shares of Common Stock are reserved for issuance upon exercise of options
granted pursuant to the Plans. Under the Plans, incentive stock options may be
granted to employees and nonqualified stock options may be granted to employees,
directors, and such other persons as the Board of Directors (or a committee
appointed by the Board) determines will assist the Company's business endeavors,
at exercise prices equal to at least 100% of the fair market value of the common
stock on the date of grant. Incentive stock options granted under the Plans are
not exercisable until one year after grant and expire five years after the date
of grant. In addition to selecting the optionees, the Board (or such committee
designated by the Board) determines the number of shares subject to each option,
the expiration date and vesting periods of nonqualified stock options and
otherwise administers the Plans. Certain of the Company's officers are
ineligible to participate in the Plans. Incentive stock options have been
granted at various times and for varying amounts.
F-29
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE N--STOCK OPTIONS (CONTINUED)
In 1998, the Company granted the President and Chairman of the Board, and an
Executive Vice President, separate stock options outside the Plans to purchase
990,000 and 495,000 shares, respectively, of the Company's Common Stock at
prices ranging from $30.00 to $50.00 per share, exercisable at any time through
December 31, 2004. In August 1998, the Executive Vice President resigned and
under the terms of the option grant, the 495,000 shares were forfeited and
canceled. Accordingly, the option to purchase 990,000 shares was outstanding
at December 31, 1998.
In 1998, the Company also granted an Executive Vice President a separate stock
option outside the Plans to purchase 235,000 shares of the Company's Common
Stock at prices ranging from $17.00 to $43.00 exercisable at any time, which
option was outstanding at December 31, 1998.
In 1997, the Company granted the then President and Chairman of the Board, since
deceased, a separate stock option outside the Plans to purchase 275,000 shares
of the Company's Common Stock at $36.36 per share at any time through December
31, 2001, which option was outstanding at December 31, 1998.
During 1993, the Company granted the then President and Chairman of the Board,
since deceased, and a Vice President, separate stock options outside of the
Plans to purchase 907,500 and 163,350 shares, respectively, of the Company's
Common Stock at $20.66 per share at any time through December 31, 1999, which
options were outstanding at December 31, 1998.
Pro forma information regarding net income and earnings per share is required by
FASB Statement 123, which also requires that the information be determined as if
the Company had accounted for its employee stock options granted subsequent to
December 31, 1994 under the fair value method of that Statement. The fair value
for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions for 1998,
1997 and 1996 respectively: risk-free interest rates of 4.97%, 6.58% and 6.20%;
a dividend yield of 2.18%, 1.25% and 1.25%; volatility factors of the expected
market price of the Company's Common Stock of .337, .335 and .25; and an
expected life of the option of 5 years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions, including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
F-30
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE N--STOCK OPTIONS (CONTINUED)
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows (in thousands, except per share data):
<TABLE>
<CAPTION>
1998 1997 1996
------------------------------
<S> <C> <C> <C>
Pro forma net income $(50,372) $32,064 $39,813
Pro forma basic earnings (loss)
per common share $(1.35) $ .94 $ 1.25
Pro forma diluted earnings (loss)
per common share $(1.35) $ .91 $ 1.23
</TABLE>
For purposes of pro forma disclosure, the estimated fair value of the options is
amortized to expense over the options' vesting period and does not include
grants prior to January 1, 1995. As such, the pro forma net income (loss) and
earnings (loss) per share are not indicative of future years.
A summary of the Company's stock option activity, and related information for
each of the three years ended December 31, follows:
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------------------------------------------------------------------------
OPTIONS WEIGHTED-AVERAGE OPTIONS WEIGHTED-AVERAGE OPTIONS WEIGHTED AVERAGE
(000) EXERCISE PRICE (000) EXERCISE PRICE (000) EXERCISE PRICE
--------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of year 1,036 $ 19 715 $ 11 768 $ 9
Granted 635 13 500 25 152 15
Exercised (175) 11 (150) 11 (183) 6
Canceled (84) 18 (29) 15 (22) 10
----- ----- -----
Outstanding at end
of year 1,412 17 1,036 17 715 11
===== ===== =====
Exercisable at end
of year 317 16 257 11 238 11
===== ===== =====
</TABLE>
The weighted average fair value of options granted during 1998, 1997 and 1996
were $4.83, $8.81 and $4.66, respectively.
Options Outstanding and Exercisable
by Price Range
as of December 31, 1998
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- -----------------------------------------------------------------------------------------------------------------
OUTSTANDING WEIGHTED-AVERAGE EXERCISABLE
RANGE OF AS OF DECEMBER REMAINING WEIGHTED AVERAGE AS OF DECEMBER WEIGHTED AVERAGE
EXERCISE PRICES 31, 1998 CONTRACTUAL LIFE EXERCISE PRICE 31, 1998 EXERCISE PRICE
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 5.01 - $10.00 202,303 1.2 $ 8.57 132,224 $8.57
$10.01 - $15.00 573,276 4.7 13.64 27,224 12.92
$15.01 - $20.00 67,950 3.2 17.45 33,550 17.00
$20.01 - $25.00 558,479 4.1 23.96 121,929 23.81
$25.01 - $30.00 6,600 3.2 27.27 1,649 27.27
$30.01 - $35.00 3,575 3.6 30.63 893 30.63
--------- --------
1,412,183 3.9 $17.29 $317,469 $15.85
========= ========
</TABLE>
F-31
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE O--COMMITMENTS AND CONTINGENCIES
At December 31, 1998, the future minimum payments under noncancellable operating
leases are as follows (in thousands):
<TABLE>
<S> <C>
1999 $4,507
2000 4,322
2001 4,003
2002 3,308
2003 2,707
Thereafter 3,006
=======
Total $21,853
=======
</TABLE>
These leases are for the rental of office space, the initial terms of which run
five years, with a negotiated renewal option at the end of the term. Total
rental expense for 1998, 1997, and 1996 amounted to $4,666,000, $2,580,000 and
$1,112,000, respectively.
Following the Company's November 5, 1994 announcement of its third-quarter
financial results, the Company was served with seven purported class actions
alleging violations of federal securities laws by the Company and, in some
cases, by certain of its officers and directors. In September 1995, a pre-trial
order was signed which consolidated all actions in the Eastern District of New
York, appointed three law firms as co-lead counsel for the plaintiffs and set
forth a timetable for class certification motion practice and discovery. In
November 1995, plaintiffs served a consolidated amended complaint alleging
violations by the Company of section 10(b) of the Securities Exchange Act of
1934 and Rule 10(b)(5) thereunder, seeking to impose controlling person
liability on certain of the Company's officers and directors, and further
alleging insider sales all premised on negative financial information that
should have been publicly disclosed earlier. Plaintiffs seek an unspecified
amount in damages to be proven at trial, reasonable attorneys fees' and expert
witness costs. In April 1997, the Court certified the class. Plaintiffs have
subpoenaed documents and deposed outside auditors and analysts. Plaintiffs have
also taken depositions from current or former officers, directors and employees
of the Company. The Company believes the suit is without merit, has retained
special legal counsel to contest this suit vigorously and believes that the
Company's exposure to liability if any, thereunder would not have a material
adverse effect on the Company's financial condition.
The Company is involved in other unrelated litigation which is considered
incidental to its business. The ultimate outcome of all litigation is not
expected to be material in relation to the Company's financial position and
results of operations.
The Company's insurance subsidiaries record guaranty assessments when such
assessments are billed by the respective guaranty funds. In addition, each
insurance subsidiary's policy is to accrue for any significant insolvencies when
the loss is probable and the assessment amount can be reasonably estimated. In
the case of most insurance insolvencies, the ability of each insurance
subsidiary to reasonably estimate the insolvent insurer's liabilities or develop
a meaningful range of the insolvent's liabilities is significantly impaired by
inadequate financial data with respect to the state of the insolvent company as
supplied by the guaranty funds.
F-32
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE O--COMMITMENTS AND CONTINGENCIES (CONTINUED)
On November 10, 1994, the Company authorized a stock repurchase program to
purchase up to 1,000,000 shares of its Common Stock. On June 30, 1998, the
Company amended the stock repurchase program to permit the purchase of up to
3,000,000 shares of its Common Stock at such times and prices the Company deems
advantageous in compliance with SEC Rule 10b-18 at the joint determination of
the Chairman of the Board and Chief Investment Officer. There is no commitment
or obligation on the part of the Company to purchase any particular number of
shares, and the program may be suspended at any time at the Company's
discretion. In 1998, in conjunction with this repurchase program, the Company
acquired 668,300 shares at a cost of $8,530,000. Any shares so repurchased will
be held as treasury shares and be available for general corporate purposes.
NOTE P--STATUTORY FINANCIAL INFORMATION
A comparison of the consolidated amounts of the insurance subsidiaries'
policyholders' surplus as of December 31, 1998 and 1997, and net income (loss)
for each of the years ended December 31, 1998, 1997 and 1996, on a statutory
accounting practices ("SAP") basis as reported to insurance regulatory
authorities, and the GAAP shareholders' equity and net income included in
the accompanying consolidated financial statements, is as follows (in
thousands):
<TABLE>
<CAPTION>
1998 1997 1996
----------------------------------------------------------------------------------
NET NET NET
SURPLUS/EQUITY INCOME (LOSS) SURPLUS/EQUITY INCOME (LOSS) INCOME (LOSS)
==================================================================================
<S> <C> <C> <C> <C> <C>
Insurance
subsidiaries'
consolidated SAP
amounts $396,205 $(70,889) $412,069 $32,730 $28,874
==================================================================================
Insurance
subsidiaries'
consolidated GAAP
amounts $612,723 $(32,373) $573,103 $41,970 $41,099
Parent company, its
noninsurance
subsidiaries and
eliminations (218,503) (17,669) (119,398) (9,688) (1,032)
----------------------------------------------------------------------------------
Consolidated GAAP
amounts $394,220 $(50,042) $453,705 $32,282 $40,067
==================================================================================
</TABLE>
NOTE Q--DIVIDEND AND CAPITAL RESTRICTIONS
The Company's insurance subsidiaries are subject to certain regulatory
supervision by their respective domiciliary states. Such regulation is generally
designed to protect policyholders and includes such matters as maintenance of
minimum statutory surplus and restrictions on the payments of dividends. At
December 31, 1998, the amount of restricted net assets of the Company's
insurance subsidiaries was approximately $357,600,000 and the maximum dividend
that may be paid to the Company in 1998 without regulatory approval was
approximately $38,600,000.
Additionally, the insurance subsidiaries are subject to certain Risk-Based
Capital ("RBC") requirements as specified by the NAIC. Under those requirements,
the amount of capital and surplus maintained by the insurance subsidiaries is
to be determined based on the various risk factors related to it. At December
31, 1998, the Company met the RBC requirements.
F-33
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE R--EMPLOYEE BENEFIT PLANS
The Company sponsors an employee savings plan (401(k)) whereby the Company
contributes a base of 2% of the salary of all full-time employees and matches
50% of the employee's personal contribution up to 2% of the employee's salary.
The maximum Company contribution, base and match, is 4% of an employee's salary.
In addition, the Company has a noncontributory profit sharing plan. At the
discretion of the Board of Directors, the Company may contribute up to 4% of the
eligible salaries of full-time employees who have completed one year of service.
The Company's total expense related to employee benefit plan contributions for
1998, 1997 and 1996 was $4,203,000, $2,635,000 and $1,691,000, respectively.
NOTE S--SUBSEQUENT EVENTS
In January 1999, the Company entered into a reinsurance agreement with Everest
Reinsurance Company for new and renewal policies written in its medical
malpractice book of business. Under the terms of the agreement, the reinsurer
assumes losses in the amount of $750,000 per insured/per occurrence, in excess
of $250,000 per insured/per occurrence. The agreement provides for the Company
to retain a corridor deductible under certain specific conditions. The
reinsurer's exposure in excess of the corridor deductible is unlimited.
Effective February 3, 1999, the Company entered into a 3.5 year interest rate
swap agreement for a notional amount of $45,000,000. Under the terms of the
agreement, the Company will pay a fixed interest rate of 5.21% and receive the
LIBOR interest rate it currently pays under its line of credit facility.
From January 1, 1999 through March 29, 1999, in connection with its stock
repurchase program, the Company acquired an additional 1,866,100 shares of its
Common Stock at an aggregate cost of $22,605,000. Additionally, on
March 29, 1999, the Company borrowed $15,000,000 under its Deutsche Bank
credit facility.
F-34
<PAGE>
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Supplemental Data
Quarterly Results of Operations (Unaudited)
The following is a summary of unaudited quarterly results of operations for 1998
and 1997 (in thousands, except per share data):
<TABLE>
<CAPTION>
1998 1997
-------------------------------------------------------------------------------
1ST 2ND 3RD 4TH 1ST 2ND 3RD 4TH
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net premiums earned $117,212 $122,576 $128,001 $125,265 $77,807 $76,017 $103,216 $109,804
Total net investment income 20,850 20,724 15,525 19,439 12,614 13,319 14,786 19,625
Net income (loss) 17,743 17,465 14,193 (99,443) 11,904 15,419 14,758 (9,799)
Earnings (loss) per common share:
Basic .52 .47 .38 (2.69) .37 .48 .43 (.26)
Diluted .47 .42 .35 (2.69) .34 .42 .38 (.26)
</TABLE>
Due to changes in the number of average Common Stock and equivalent shares
outstanding, quarterly earnings per share may not add to the totals for the
years.
In the fourth quarters of 1998 and 1997, the Company increased reserves by
approximately $155,000,000 and $35,000,000, respectively. Such increases were
primarily due to adverse experience in the Company's medical malpractice line of
business (see Note H of the Notes to the Consolidated Financial Statements).
Other charges incurred during the fourth quarter of 1998, included $10,000,000
related to the termination of the Company's 1998-1999 stop loss reinsurance
agreement (see Note I of the Notes to the Consolidated Financial Statements),
and to an increase of approximately $3,500,000 in the allowance for doubtful
accounts and and a $300,000 restructuring charge related to the closing of
one of the Company's Health Care Division offices.
F-35
<PAGE>
<PAGE>
Schedule II-Condensed Financial Information of Registrant
Frontier Insurance Group, Inc. (Parent Company)
Balance Sheets
(dollar amounts in thousands, except per share data)
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
------------------------
<S> <C> <C>
ASSETS
Investments in subsidiaries $ 623,854 $ 581,002
Fixed maturity securities 3,335 --
Equity securities, available for sale 2,948 --
Equity investees 12,574 11,938
Short-term investments 11,716 5,550
Cash (overdraft) (1,356) 2,498
Property, equipment and software, less
accumulated depreciation and amortization
(1998--$6,950; 1997--$4,985) 11,790 6,974
Intangible assets, less accumulated
amortization (1998--$3,173; 1997--$2,237) 1,157 1,621
Other assets 15,687 18,482
-------------------------
TOTAL ASSETS $681,705 $628,065
=========================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Convertible subordinated debentures due to
subsidiary trust $167,153 $166,703
Bank debt 92,000 --
Accrued expenses and other liabilities 25,754 5,282
Cash dividend payable to shareholders 2,578 2,375
--------------------------
TOTAL LIABILITIES 287,485 174,360
Shareholders' equity:
Preferred stock, par value $01 per share;
(authorized and unissued: 1,000,000 shares) -- --
Common stock; par value $.01 per share;
(shares authorized: 1998--150,000,000;
1997--50,000,000, shares issued:
1998--37,594,709; 1997--37,419,298) 376 340
Additional paid-in capital 450,347 367,914
Accumulated other comprehensive income, net
of tax 26,635 20,238
Retained earnings (deficit) (73,833) 65,995
-------------------------
403,525 454,487
Treasury stock--at cost (1998--766,912
shares; 1997--99,495 shares) (9,305) (782)
-------------------------
Total shareholders' equity 394,220 453,705
-------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $681,705 $628,065
==========================
</TABLE>
These condensed financial statements should be read in conjunction with the
accompanying consolidated financial statements and notes thereto.
F-36
<PAGE>
<PAGE>
Schedule II-Condensed Financial Information of Registrant (continued)
Frontier Insurance Group, Inc. (Parent Company)
Statements of Operations and Comprehensive Income
(dollar amounts in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
------------------------------
<S> <C> <C> <C>
REVENUES
Dividend income from subsidiary $ -- $ -- $1,500
Investment income (including net
realized gains (losses)) (1,116) 4,125 1,256
Net proceeds from company owned life
insurance policy 4,400 -- --
------------------------------
Total revenues 3,284 4,125 2,756
EXPENSES
Operating and administrative 22,061 7,018 582
Interest expense 11,931 11,842 4,169
------------------------------
Total expenses 33,992 18,860 4,751
------------------------------
Loss before federal income tax
benefit and equity in
undistributed income (loss) of
subsidiaries (30,708) (14,735) (1,995)
Federal income tax benefit (1) (11,298) (5,324) (2,337)
------------------------------
Income (loss) before equity in
undistributed income
(loss) of subsidiaries (19,410) (9,411) 342
Equity in undistributed income
(loss) of subsidiaries (30,632) 41,693 39,725
------------------------------
Net income (loss) (50,042) 32,282 40,067
Other comprehensive income (loss),
net of tax 6,397 15,431 (3,148)
==============================
Total comprehensive income (loss) $(43,645) $47,713 $36,919
==============================
</TABLE>
(1) Under the terms of its tax-sharing agreement with its subsidiaries, income
tax provisions for the individual companies are computed on a
separate company basis. Accordingly, the Company's income tax benefit
reflects the utilization of the parent company separate return loss to
reduce the consolidated taxable income of the Company and its subsidiaries
or, for 1998, the deferred tax benefit of its share of the consolidated net
operating loss carryforward.
These condensed financial statements should be read in conjunction with the
accompanying consolidated financial statements and notes thereto.
F-37
<PAGE>
<PAGE>
Schedule II-Condensed Financial Information of Registrant (continued)
Frontier Insurance Group, Inc. (Parent Company)
Statements of Cash Flows
(dollar amounts in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
---------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Income (loss) before equity in
undistributed income
of subsidiaries $(19,410) $ (9,411) $ 342
Adjustments to reconcile net income
(loss) to net cash provided by
(used in) operating activities:
Change in federal income taxes (3,242) (2,796) (1,558)
Change in due from subsidiaries 9,752 (2,407) (215)
Depreciation and amortization 3,353 2,618 2,287
Net realized losses 2,857 -- --
Other 13,819 (1,522) (1,692)
---------------------------------------------
Net cash provided by (used in)
operating activities 7,129 (13,518) (836)
INVESTING ACTIVITIES
Capital contributions to
subsidiaries (62,580) (29,644) (69,800)
Purchases of wholly-owned subsidiaries (5,030) (140,499) (221)
Short-term investments, net (6,166) 58,352 (62,726)
Change in other investments (5,630) (9,001) (2)
Purchases of property, equipment and
software (6,781) (1,362) (2,181)
Other (472) 314 (8)
---------------------------------------------
Net cash used in investing activities (86,659) (121,840) (134,938)
FINANCING ACTIVITIES
Proceeds from convertible debentures -- -- 166,914
Proceeds from bank borrowings 92,000 62,000 7,100
Repayment of bank borrowings -- (62,000) (32,100)
Issuance of common stock 1,948 146,110 1,103
Cash dividends paid (9,761) (8,240) (6,920)
Reissuance (purchases) of treasury stock (8,511) 19 --
Other -- (455) --
---------------------------------------------
Net cash provided by financing
activities 75,676 137,434 136,097
---------------------------------------------
Increase (decrease) in cash (3,854) 2,076 323
Cash at beginning of year 2,498 422 99
---------------------------------------------
Cash (overdraft) at end of year $ (1,356) $ 2,498 $ 422
==============================================
</TABLE>
These condensed financial statements should be read in conjunction with the
accompanying consolidated financial statements and notes thereto.
F-38
<PAGE>
<PAGE>
Schedule IV-Reinsurance
Frontier Insurance Group, Inc. and Subsidiaries
(dollar amounts in thousands)
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
COL. A COL. B COL. C COL. D COL. E
- ---------------------------------------------------------------------------------------------------------------------------------
PERCENTAGE
CEDED TO ASSUMED OF AMOUNT
OTHER FROM OTHER NET ASSUMED TO
DESCRIPTION DIRECT COMPANIES COMPANIES AMOUNT NET
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1998
Premiums written
General liability $180,881 $ 45,948 $ 547 $135,480 0.4%
Medical malpractice 139,408 35,980 715 104,143 0.7
Specialty personal lines 123,619 72,511 8,332 59,440 14.0
Credit related products 93,461 46,768 17,383 64,076 27.1
Surety 91,956 16,144 633 76,445 0.8
Workers' compensation 40,854 31,533 1,995 11,316 17.6
Commercial earthquake 20,614 11,471 37 9,180 0.4
Other 93,836 45,798 18,887 66,925 28.2
------------------------------------------------------------------------------
Total $784,629 $306,153 $ 48,529 $527,005 9.2%
==============================================================================
YEAR ENDED DECEMBER 31, 1997
Premiums written:
General liability $165,471 $ 40,434 $ 5,480 $130,517 4.2%
Medical malpractice 120,867 20,597 134 100,404 0.1
Specialty personal lines 67,477 40,543 8,136 35,070 23.2
Credit related products 45,144 32,778 310 12,676 2.4
Surety 75,862 14,620 626 61,868 1.0
Workers' compensation 24,196 17,565 715 7,346 9.7
Commercial earthquake 14,688 6,726 -- 7,962 --
Other 52,791 25,356 5,738 33,173 17.4
------------------------------------------------------------------------------
Total $566,496 $198,619 $ 21,139 $389,016 5.4%
==============================================================================
YEAR ENDED DECEMBER 31, 1996
Premiums written:
General liability $108,984 $ 19,443 $ 4,439 $ 93,980 4.7%
Medical malpractice 139,233 19,580 -- 119,653 --
Specialty personal lines 7,405 6,772 32 665 4.8
Surety 65,074 8,749 307 56,632 0.5
Workers' compensation 25,125 19,176 304 6,253 4.9
Commercial earthquake 16,396 4,637 145 11,904 1.2
Other 31,840 12,579 3,515 22,776 15.4
------------------------------------------------------------------------------
Total $394,057 $ 90,936 $ 8,742 $311,863 2.8%
==============================================================================
</TABLE>
F-39
<PAGE>
<PAGE>
Schedule V--Valuation and Qualifying Accounts
Frontier Insurance Group, Inc. and Subsidiaries
(dollar amounts in thousands)
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
COL. A COL. B COL. C COL. D COL. E
- ---------------------------------------------------------------------------------------------------------------------
ADDITIONS
---------------------------------
(1) (2)
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING OF COSTS OTHER DEDUCTIONS END OF
DESCRIPTION PERIOD AND EXPENSES ACCOUNTS--DESCRIBE DESCRIBE PERIOD
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1998:
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful accounts $2,791 $3,311 $ 77(A) $6,025
Allowance for possible
reinsurance uncollectible amounts 310 150 310(A) 150
Year ended December 31, 1997:
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful accounts $2,285 $ 541 $ 35(A) $2,791
Allowance for possible
reinsurance uncollectible amounts 517 66 273(A) 310
Year ended December 31, 1996:
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful accounts $3,391 $ 365 $1,471(A) $2,285
Allowance for possible
reinsurance uncollectible amounts 115 402 -- 517
</TABLE>
(A) Amounts charged off.
F-40
<PAGE>
<PAGE>
Schedule VI-Supplemental Information Concerning
Property/Casualty Insurance Operations
Frontier Insurance Group, Inc. and Subsidiaries
(Net of Reinsurance)
(dollar amounts in thousands)
<TABLE>
<CAPTION>
DECEMBER 31
- ----------------------------------------------------------------------------------------------------------------------------------
COL. A COL. B COL. C COL. D COL. E COL. F COL. G
- ----------------------------------------------------------------------------------------------------------------------------------
UNPAID
CLAIMS DISCOUNT,
DEFERRED AND IF ANY
AFFILIATION POLICY CLAIM DEDUCTED NET
WITH ACQUISITION ADJUSTMENT IN UNEARNED EARNED INVESTMENT
REGISTRATION COSTS EXPENSES COLUMN C PREMIUMS PREMIUMS INCOME
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Registrant and
consolidated
subsidiaries:
1998 $ 96,597 $643,858 $369,256 $493,054 $76,538
1997 55,634 488,310 292,115 366,844 60,344
1996 32,871 373,606 153,325 265,989 38,933
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31
- ----------------------------------------------------------------------------------------------------------------------------------
COL. H COL. I COL. J COL. K
- ----------------------------------------------------------------------------------------------------------------------------------
CLAIMS AND CLAIM
ADJUSTMENT EXPENSES
INCURRED RELATED TO
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
AMORTIZATION PAID
OF CLAIMS
DEFERRED AND
(1) (2) POLICY CLAIM
CURRENT PRIOR ACQUISITION ADJUSTMENT PREMIUMS
YEAR YEAR COSTS EXPENSES WRITTEN
- ----------------------------------------------------------------------------------------------------------------------------------
Registrant and
consolidated
subsidiaries:
1998 $297,400 $134,515 $122,813 $282,604 $527,005
1997 218,301 13,287 83,586 197,678 389,016
1996 160,470 (4,479) 57,540 129,786 311,863
</TABLE>
F-41
<PAGE>
<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.
FRONTIER INSURANCE GROUP, INC.
By: /s/ HARRY W. RHULEN
-------------------------
Harry W. Rhulen
Chairman of the Board and President
Date: March 31, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this annual
report on Form 10-K has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature and Title Date
------------------- -----
<S> <C>
/s/ HARRY W. RHULEN March 31, 1999
- ------------------------------------
Harry W. Rhulen
Chairman of the Board, President
and Director
(Principal Executive Officer)
/s/ SUZANNE RHULEN LOUGHLIN March 31, 1999
- ------------------------------------
Suzanne Rhulen Loughlin
Executive Vice President
and Director
/s/ DOUGLAS C. MOAT March 31, 1999
- ------------------------------------
Douglas C. Moat
Executive Vice President
and Director
/s/ PETER L. RHULEN March 31, 1999
- ------------------------------------
Peter L. Rhulen
Director
/s/ LAWRENCE E. O'BRIEN March 31, 1999
Lawrence E. O'Brien
Director
/s/ ALAN GERRY March 31, 1999
- ------------------------------------
Alan Gerry
Director
/s/ PAUL B. GUENTHER March 31, 1999
- ------------------------------------
Paul B. Guenther
Director
/s/ MARK H. MISHLER March 31, 1999
- ------------------------------------
Mark H. Mishler
Vice President - Treasurer and
Chief Financial Officer
(Principal Financial and Accounting Officer)
</TABLE>
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC.
----------------
EXHIBITS TO
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED
DECEMBER 31, 1998
<PAGE>
<PAGE>
<TABLE>
<CAPTION>
INDEX TO EXHIBITS
<S> <C>
3.1(a) Copy of Registrant's Restated Certificate of Incorporation........................................(1)
3.2 Copy of Registrant's By-Laws as amended...........................................................(2)
4.1 Indenture dated as of October 16, 1996 between the Registrant and The Bank
of New York, as trustee, with form of Debenture attached as Exhibit A thereto.................(6)
10.1 Copy of Registrant's Stock Option Plan, including forms of option.................................(1)
10.6 Copy of Registrant's Profit Sharing Plan..........................................................(2)
10.10 Copy of Registrant's 1992 Incentive and Non-Incentive
Stock Option Plan.............................................................................(3)
10.12 Description of Registrant's Executive Bonus Plan..................................................(4)
10.14 Stock Purchase Agreement dated February 29, 1996 among Frontier Insurance
Company Acquisition Corp. and, for purposes of Section 2.3(c) and Article 11 only,
Capsure Holdings Corp.........................................................................(5)
10.15 United Capitol Holding Company and Subsidiaries Financial Statements as of
December 31, 1995 and 1994 (with Independent Auditors' Report thereon)
and Unaudited Interim Condensed Consolidated Financial Statements as of
March 31, 1996................................................................................(5)
10.15(a) Stock Purchase Agreement dated March 28, 1997 between Mercury Finance
Company and Frontier Insurance Group, Inc.....................................................(7)
10.15(b) First Amendment to Stock Purchase Agreement dated May 29, 1997....................................(7)
10.15(c) Second Amendment to Stock Purchase Agreement dated June 3, 1997...................................(7)
10.16 Frontier Insurance Group, Inc. and Subsidiaries' Unaudited Pro Forma
Condensed Consolidated Statements of Income for the Year Ended December
31, 1995 and Three Months Ended March 31, 1996, and Balance Sheet as of
March 31, 1996 together with the related Notes thereto........................................(7)
10.16(a) Credit Agreement dated June 3, 1997 between Frontier Insurance Group, Inc.
and Deutsche Bank AG, New York Branch and/or Cayman Islands Branch,
individually and as administrative agent, ("Deutsche Bank Credit Agreement")..................(7)
10.16(b) First Amendment to Deutsche Bank Credit Agreement dated April 2, 1998.............................
10.16(c) Second Amendment to Deutsche Bank Credit Agreement dated October 1, 1998..........................
10.16(d) Third Amendment to Deutsche Bank Credit Agreement dated December 30, 1998.........................
</TABLE>
<PAGE>
<PAGE>
<TABLE>
<S> <C>
10.17 Amended and Restated Declaration of Trust dated as of October 16,
1996 among Registrant, as sponsor. Walter A. Rhulen and Peter H.
Foley, as regular trustees. The Bank of New York, as property
trustee, and The Bank of New York (Delaware), as Delaware
trustee, with the terms of the Preferred Securities
attached as Annex I thereto, and the form of Preferred Security attached as
Exhibit A-1 thereto...........................................................................(6)
10.17(a) Stock Purchase Agreement dated October 3, 1997 among The Galtney Group,
Inc., Galtney Holdings, Inc., Healthcare Insurance Services, Inc. and Registrant..............(9)
10.18 Preferred Securities Guarantee Agreement dated as of October 16, 1996 between
the Registrant and The Bank of New York, as trustee for the benefit of the holders
from time to time of the Preferred Securities.................................................(6)
10.18(a) Asset Purchase Agreement dated December 1, 1997 by and between Medical
Professional Liability Agency, Ltd. and FPIC Insurance Company, Inc. and for
purposes of Sections 5.1, 5.2, 5.3 and 5.4 only, Frontier Insurance Company...................(8)
10.19 Registration Rights Agreement dated as of October 16, 1996 among Registrant,
Frontier Financing Trust, and Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner
& Smith Incorporated, Donaldson , Lufkin & Jenrette Securities Corporation,
Oppenheimer & Co., Inc. and Stephens Inc., as representatives of the initial
purchasers of the Preferred Securities........................................................(6)
10.19(a) Stock Acquisition Agreement dated October 20, 1997 among Lyndon Insurance
Group, Inc., Lyndon Life Insurance Company and ACCEL International Corporation................(8)
10.20 Asset Purchase Agreement dated October 20, 1997 among Lyndon Property
Insurance Company, ACCEL International Corporation and Acceleration National
Insurance Company.............................................................................(9)
10.21 Amended copy of Registrant's 1992 Incentive and Non-Incentive Stock Option Plan...................(9)
10.22 Copy of Employment Agreement between Registrant and Harry W. Rhulen..............................
12 Statement RE: Computation of Ratio of Earnings to Fixed Charges.................................
21(a) List of Registrant's Subsidiaries.................................................................
23 Consent of Independent Auditors...................................................................
27 Financial data schedule...........................................................................
28 Schedule P of Annual Statement for year ended December 31, 1998, filed as a paper
format exhibit on Form SE pursuant to Section 232.311 of Regulation ST, of Frontier
Insurance any, Frontier Pacific Insurance Company, Lyndon Property Insurance
Company and Western Indemnity Insurance Company, as filed with the New York
State Department of Insurance, the California Department of Insurance, the Missouri
Department of Insurance and the Texas Department of Insurance respectively....................
</TABLE>
- ----------------
(1) Filed as the same numbered Exhibit to the Registrant's Registration
Statement on Form S-1 (File No. 33-7340) and incorporated herein by
reference.
(2) Filed as the same numbered Exhibit to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1988 and incorporated herein by
reference.
(3) Filed as the same numbered Exhibit to the Registrant's Annual Report on
Form 10-K for the year ended
<PAGE>
<PAGE>
December 31, 1992 and incorporated herein by reference.
(4) Filed as the same numbered Exhibit to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1993 and incorporated herein by
reference.
(5) Filed as the same numbered Exhibit to the Registrant's Report on Form 8-K
dated May 22, 1996 and incorporated herein by reference.
(6) Filed as the same numbered Exhibit to the Registrant's Report on Form 8-K
dated October 16, 1996 and incorporated herein by reference.
(7) Filed as the same numbered exhibit to the Registrant's Report on Form 8-K
dated June 3, 1997 and incorporated herein by reference.
(8) Filed as the same numbered exhibit to the Registrant's Report on Form 8-K
dated December 1, 1997 and incorporated herein by reference.
(9) Filed as the same numbered exhibit to the Registrant's Report on Form 10-K
dated December 31, 1997 and incorporated herein by reference.
<PAGE>
<PAGE>
EXECUTION COPY
FIRST AMENDMENT
FIRST AMENDMENT (this "Amendment"), dated as of April 2, 1998,
among Frontier Insurance Group, Inc. (the "Borrower"), the lending institutions
party to the Credit Agreement referred to below (each a "Bank" and,
collectively, the "Banks"), and Deutsche Bank AG, New York Branch and/or Cayman
Islands Branch, as Administrative Agent (the "Administrative Agent"). All
capitalized terms used herein and not otherwise defined herein shall have the
respective meanings provided such terms in the Credit Agreement.
W I T N E S S E T H :
WHEREAS, the Borrower, the Banks and the Administrative Agent
are party to a Credit Agreement, dated as of June 3, 1997 (as amended, modified
and supplemented prior to the date hereof, the "Credit Agreement"); and
WHEREAS, the Borrower has requested that the Banks provide the
amendments provided for herein and the Banks have agreed to provide such
amendments on the terms and conditions set forth herein;
NOW, THEREFORE, it is agreed:
1. On the Amendment Effective Date (as hereinafter defined),
the Commitment of each Bank shall be modified to be the amount set forth
opposite the name of such Bank on Annex I hereto. In connection with the
foregoing, on the Amendment Effective Date, the Borrower shall, in coordination
with the Admininstrative Agent and the Banks, repay outstanding Revolving Loans
of certain Banks and incur additional Revolving Loans from other Banks, in each
case if necessary so that the Banks participate in each Borrowing of Revolving
Loans pro rata on the basis of their Commitments (after giving effect to this
Section 1). It is hereby agreed that the breakage costs incurred by the Banks in
connection with the repayment of Revolving Loans contemplated by this Section 1,
if any, shall be for the account of the Borrower. On the Amendment Effective
Date, Annex I to the Credit Agreement shall be deemed amended to read as set
forth in Annex I attached hereto to give effect to the foregoing.
2. The following definition contained in Section 9 of the
Credit Agreement is hereby amended to read in its entiretly as follows:
"Final Maturity Date" shall mean June 2, 2003.
3. In order to induce the Banks to enter into this Amendment,
the Borrower hereby represents and warrants that (i) no Default or Event of
Default exists as of the Amendment Effective Date (as defined below) after
giving effect to this Amendment and (ii) on the Amendment Effective Date, both
before and after giving effect to this Amendment, all representations and
warranties contained in the Credit Agreement and in the other Credit
<PAGE>
<PAGE>
Documents are true and correct in all material respects, except (a) to the
extent such representations and warranties expressly relate to an earlier date,
in which case such representations and warranties are true and correct in all
material respects as of such earlier date, and (b) in the case of Section
5.08(e) of the Credit Agreement, for the matters described in the press releases
of the Borrower dated October 6, 1997, February 2, 1998 and February 17, 1998,
copies of which are attached hereto as Annex II.
4. This Amendment shall become effective on the date (the
"Amendment Effective Date") when:
(a) the Borrower and each Bank shall have signed a counterpart
hereof (whether the same or different counterparts) and shall have
delivered (including by way of facsimile transmission) the same to the
Adiministrative Agent at its Notice Office;
(b) the Borrower shall have delivered to the Administrative
Agent a new Note for each Bank whose Commitment is increasing as a
result of this Amendment, reflecting its increased Commitment, which
Note shall be issued in exchange for the Note currently held by such
Bank; and
(c) the Borrower shall have delivered to the Agent a certified
copy of resolutions duly adopted by the Borrower authorizing the
increase in the Total Commitment contemplated by this Amendment.
5. This Amendment is limited as specified and shall not
constitute a modification, acceptance or waiver of any other provision of the
Credit Agreement or any other Credit Document.
6. This Amendment may be executed in any number of
counterparts and by the different parties hereto on separate counterparts, each
of which counterparts when executed and delivered shall be an original, but all
of which shall together constitute one and the same instrument. A complete set
of counterparts shall be lodged with the Borrower and the Administrative Agent.
7. THIS AMENDMENT AND THE RIGHTS AND OBLIGATIONS OF THE
PARTIES HEREUNDER SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS
OF THE STATE OF NEW YORK
* * *
-2-
<PAGE>
<PAGE>
IN WITNESS WHEREOF, each of the parties hereto has caused a
counterpart of this Amendment to be duly executed and delivered as of the date
hereof.
FRONTIER INSURANCE GROUP, INC.
By:________________________________
Title:
DEUTSCHE BANK AG, NEW YORK
BRANCH AND/OR CAYMAN ISLANDS
BRANCH,
Individually and as Administrative Agent
By:_________________________________
Title:
By:_________________________________
Title:
BANK OF AMERICA NT & SA
By:________________________________
Title:
THE BANK OF NEW YORK
By:________________________________
Title:
THE FIRST NATIONAL BANK OF
CHICAGO
By:________________________________
Title:
FIRST UNION NATIONAL BANK
By:________________________________
Title:
UNION BANK OF CALIFORNIA
By:________________________________
Title:
-3-
<PAGE>
<PAGE>
ANNEX I
LIST OF BANKS AND COMMITMENTS
<TABLE>
<CAPTION>
Bank Commitment Percentage
- ---- ---------- -----------
<S> <C> <C>
Deutsche Bank AG, New York Branch
and/or Cayman Islands Branch $ 37,500,000 25%
Bank of America NT & SA $ 21,000,000 14%
The Bank of New York $ 21,000,000 14%
The First National Bank of Chicago $ 21,000,000 14%
First Union National Bank $ 21,000,000 14%
Union Bank of California $ 28,500,000 19%
Total: $ 150,000,000 100%
</TABLE>
-4-
<PAGE>
<PAGE>
SECOND AMENDMENT
SECOND AMENDMENT (this "Amendment"), dated as of October 1, 1998,
among Frontier Insurance Group, Inc. (the "Borrower"), the lending institutions
party to the Credit Agreement referred to below (each a "Bank" and,
collectively, the "Banks"), and Deutsche Bank AG, New York Branch and/or Cayman
Islands Branch, as Administrative Agent (the "Administrative Agent"). All
capitalized terms used herein and not otherwise defined herein shall have the
respective meanings provided such terms in the Credit Agreement.
W I T N E S S E T H :
WHEREAS, the Borrower, the Banks and the Administrative Agent are
party to a Credit Agreement, dated as of June 3, 1997 (as amended, modified and
supplemented prior to the date hereof, the "Credit Agreement" March 29, 1999);
and
WHEREAS, the Borrower has requested that the Banks provide the
amendments provided for herein and the Banks have agreed to provide such
amendments on the terms and conditions set forth herein;
NOW, THEREFORE, it is agreed:
1. Section 7.04 of the Credit Agreement is hereby amended by (a)
deleting the word "and" at the end of Subsection (i) thereof, (b) deleting the
period at the end of Subsection (j) thereof and inserting in lieu thereof a
semi-colon and the word "and", as follows: "; and", and (c) inserting the
following Subsection 7.04(k) immediately after Subsection 7.04(j) as so amended:
"(k) Indebtedness of Douglass Frontier, LLC of up to $8,500,000
and the guarantee of such Indebtedness by the Borrower."
2. Subsection 7.05(e) of the Credit Agreement is hereby amended
to read in its entirety as follows:
"(e) the transactions described in each of Section 7.02 and
Subsection 7.06(a)(iv) shall be permitted;"
3. Subsection 7.06(a)(iv) of the Credit Agreement is hereby
amended to read in its entirety as follows:
"(iv) the Borrower may repurchase or otherwise acquire its common
stock and/or options or warrants to purchase its common stock, in the public
market or otherwise, provided that (x) no Default or Event of Default exists at
the time of any such purchase or would result therefrom and (y) the aggregate
amount expended by the Borrower pursuant to this clause (iv) at any time,
<PAGE>
<PAGE>
when added to the aggregate amount theretofore expended pursuant to this clause
(iv) after the Effective Date, shall not exceed 10% of the Borrower's
Consolidated Net Worth as of the last day of the most recently ended fiscal
year."
4. In order to induce the Banks to enter into this Amendment, the
Borrower hereby represents and warrants that (i) no Default or Event of Default
exists as of the Amendment Effective Date (as defined below) after giving effect
to this Amendment and (ii) on the Amendment Effective Date, both before and
after giving effect to this Amendment, all representations and warranties
contained in the Credit Agreement and in the other Credit Documents are true and
correct in all material respects except (a) to the extent such representations
and warranties expressly relate to an earlier date, in which case such
representations and warranties are true and correct in all material respects as
of such earlier date, and (b) in the case of Section 5.08(e) of the Credit
Agreement, for the matters described in the press releases of the Borrower dated
October 6, 1997, February 2, 1998 and February 17, 1998.
5. This Amendment is limited as specified and shall not constitute
a modification, acceptance or waiver of any other provision of the Credit
Agreement or any other Credit Document.
6. This Amendment may be executed in any number of counterparts
and by the different parties hereto on separate counterparts, each of which
counterparts when executed and delivered shall be an original, but all of which
shall together constitute one and the same instrument. A complete set of
counterparts shall be lodged with the Borrower and the Administrative Agent.
7. THIS AMENDMENT AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES
HEREUNDER SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE
STATE OF NEW YORK.
IN WITNESS WHEREOF, each of the parties hereto has caused a
counterpart of this Amendment to be duly executed and delivered as of thc date
hereof.
FRONTIER INSURANCE GROUP, INC.
By:
-----------------------------------
Title:
DEUTSCHE BANK AG, NEW YORK
BRANCH AND/OR CAYMAN ISLANDS
BRANCH,
Individually and as Administrative Agent
By:
-----------------------------------
Title:
<PAGE>
<PAGE>
EXECUTION COPY
THIRD AMENDMENT
THIRD AMENDMENT (this "Amendment"), dated as of December 30,
1998, among Frontier Insurance Group, Inc. (the "Borrower"), the lending
institutions party to the Credit Agreement referred to below (each a "Bank" and,
collectively, the "Banks"), and Deutsche Bank AG, New York Branch and/or Cayman
Islands Branch, as Administrative Agent (the "Administrative Agent"). All
capitalized terms used herein and not otherwise defined herein shall have the
respective meanings provided such terms in the Credit Agreement.
W I T N E S S E T H :
WHEREAS, the Borrower, the Banks and the Administrative Agent
are party to a Credit Agreement, dated as of June 3, 1997 (as amended, modified
and supplemented prior to the date hereof, the "Credit Agreement"); and
WHEREAS, the Borrower has requested that the Banks provide the
amendment provided for herein and the Banks have agreed to provide such
amendment on the terms and conditions set forth herein;
NOW, THEREFORE, it is agreed:
1. Section 7.04 of the Credit Agreement is hereby amended by
(a) deleting the word "and" at the end of clause (j) of said Section, (b)
deleting the period at the end of clause (k) of said Section and inserting a
semicolon in lieu thereof immediately followed by the word "and" and (c) by
inserting the following text at the end of said Section:
"(l) Indebtedness of the Borrower constituting guaranties of
loans and advances to officers and employees of the Borrower and its
Subsidiaries the proceeds of which are used to purchase capital stock
of the Borrower, so long as the aggregate outstanding principal amount
of such Indebtedness, when added to the aggregate amount of loans and
advances outstanding under Section 7.05(d)(y), does not exceed (i)
$10,000,000 from the Amendment Effective Date to December 31, 1999,
(ii) $15,00,000 from January 1, 2000 to December 31, 2000, (iii)
$20,000,000 from January 1, 2001 until the Final Maturity Date and (iv)
notwithstanding the foregoing, 5% of the Borrower's Consolidated Net
Worth at any time."
2. In order to induce the Banks to enter into this Amendment,
the Borrower hereby represents and warrants that (i) no Default or Event of
Default exists as of the Amendment Effective Date (as defined below) after
giving effect to this Amendment and (ii) on the Amendment Effective Date, both
before and after giving effect to this Amendment, all representations and
warranties contained in the Credit Agreement and in the other Credit Documents
are true and correct in all material respects, except (a) to the extent such
<PAGE>
<PAGE>
representations and warranties expressly relate to an earlier date, in which
case such representations and warranties are true and correct in all material
respects as of such earlier date, and (b) in the case of Section 5.08(e) of the
Credit Agreement, for the matters described in the press releases of the
Borrower dated October 6, 1997, February 2, 1998 and February 17, 1998.
3. This Amendment shall become effective on the date (the
"Amendment Effective Date") when the Borrower and the Required Banks shall have
signed a counterpart hereof (whether the same or different counterparts) and
shall have delivered (including by way of facsimile transmission) the same to
the Administrative Agent at its Notice Office.
4. This Amendment is limited as specified and shall not
constitute a modification, acceptance or waiver of any other provision of the
Credit Agreement or any other Credit Document.
5. This Amendment may be executed in any number of
counterparts and by the different parties hereto on separate counterparts, each
of which counterparts when executed and delivered shall be an original, but all
of which shall together constitute one and the same instrument. A complete set
of counterparts shall be lodged with the Borrower and the Administrative Agent.
6. THIS AMENDMENT AND THE RIGHTS AND OBLIGATIONS OF THE
PARTIES HEREUNDER SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS
OF THE STATE OF NEW YORK.
7. From and after the Amendment Effective Date, all references
in the Credit Agreement and each of the Credit Documents to the Credit Agreement
shall be deemed to be references to such Credit Agreement as amended hereby.
* * *
-2-
<PAGE>
<PAGE>
IN WITNESS WHEREOF, each of the parties hereto has caused a
counterpart of this Amendment to be duly executed and delivered as of the date
hereof.
FRONTIER INSURANCE GROUP, INC.
By:____________________________
Title:
DEUTSCHE BANK AG, NEW YORK
BRANCH AND/OR CAYMAN ISLANDS
BRANCH,
Individually and as Administrative Agent
By:_________________________________
Title:
By:_________________________________
Title:
BANK OF AMERICA NT & SA
By:________________________________
Title:
THE BANK OF NEW YORK
By:________________________________
Title:
THE FIRST NATIONAL BANK OF CHICAGO
By:________________________________
Title:
FIRST UNION NATIONAL BANK
By:________________________________
Title:
UNION BANK OF CALIFORNIA
By:________________________________
Title:
<PAGE>
<PAGE>
EMPLOYMENT AGREEMENT
--------------------
EMPLOYMENT AGREEMENT made as of the 1st day of January, 1998, by and
between FRONTIER INSURANCE GROUP, INC., a Delaware corporation, with offices at
195 Lake Louise Marie Road, Rock Hill, New York 12775-8000 (the "Company") and
HARRY W. RHULEN ("Rhulen").
W I T N E S S E T H:
--------------------
WHEREAS, the Company and Rhulen are desirous of evidencing the terms
of Rhulen's employment as President and Chief Executive Officer in a written
employment agreement;
NOW, THEREFORE, the Company and Rhulen hereby agree as follows:
1. Employment
(a) The Company hereby employs Rhulen as its President and Chief
Executive Officer to perform such duties as the Board of Directors may from time
to direct, provided such duties are commensurate with Rhulen's position as
President and Chief Executive Officer of the Company.
(b) Rhulen hereby accepts said employment and agrees to devote
substantially all of his time, energy and skill during regular business hours to
the affairs of the Company and its subsidiaries and to perform and discharge his
duties and responsibilities faithfully, diligently and to the best of his
ability.
2. Compensation
(a) As compensation for all services to be rendered by Rhulen
hereunder, the Company shall:
(i) pay to Rhulen a base salary of $450,000 per annum,
to be reviewed annually, payable in equal biweekly
installments, or in such other installments as may
be agreed upon between the parties;
(ii) determine, at the sole discretion of its Board of
Directors, the extent to which Rhulen shall
participate in the Company's executive bonus pool
for purposes of his annual bonus; and
(iii) grant Rhulen a seven-year stock option to purchase
900,000 shares of the Company's Common Stock,
subject to approval by the Company's stockholders,
comprised of 100,000 shares at $33.00 per share,
300,000 shares at $44.00 per share and 500,000
shares at $55.00 per share, as more particularly
set forth in the Stock Option Agreement being
executed concurrently herewith.
<PAGE>
<PAGE>
(b) Rhulen shall be entitled to participate, to the extent that
he qualifies, in any life insurance, health insurance, accident insurance,
disability insurance, retirement plan, profit sharing plan, stock option plan,
pension plan, or other employment benefit plan adopted, or which may be adopted,
by the Company.
3. Term.
The term of employment hereunder commenced on January 1, 1998 and
shall continue until December 31, 2000.
4. Termination for Cause.
Rhulen's employment as President and Chief Executive Officer of
the Company may be terminated by the Company only for "cause," which shall mean
(i) the conviction of Rhulen of a felony, (ii) the failure or refusal of Rhulen
to perform, in a material respect, his duties for the Company hereunder, (iii)
the commission by Rhulen of any willful act or series of acts which materially
injures the reputation, business or business relationships of the Company (iv)
material insubordination or misconduct by Rhulen in connection with his
employment by the Company hereunder, or (v) any other material breach by Rhulen
of this Agreement as determined, with respect to clauses (ii) - (v) above, by
the Company's Board of Directors whose determination shall be conducted in a
reasonable manner and shall be conclusive.
5. Non-Compete; Non-Disclosure and Non-Enticement of Employees.
(a) Rhulen hereby agrees that during his employment by the
Company and for a period of one year after Rhulen ceases to be employed by the
Company, but in any event until December 31, 2001, Rhulen will not, without the
express prior written consent of the Company, directly or indirectly, (i) own,
alone or as a member of a partnership, greater than a 1% equity or ownership
interest in, or (ii) operate, manage, join or control, be employed by, engage in
the ownership, management, operation or control of, or (iii) be involved with,
whether as an officer, director, agent, employee, consultant or otherwise, any
insurance brokerage, insurance agency or insurance company within the
continental United States wherein his duties and/or responsibilities relate in
other than an incidental and minor way to the sale, underwriting, placement or
writing of the specialty types of insurance underwritten, placed or insured by
the Company; provided, however, that nothing herein shall prohibit Rhulen from
owning or investing in the securities of any company with a class of securities
that is publicly traded so long as such holdings do not constitute more than 5%
of the public company's securities and Rhulen does not in fact have power to
control such company.
(b) Rhulen hereby covenants and agrees that he will not (i) at
any time during, or following termination of his employment by the Company,
reveal, divulge, or make known to any person, firm or corporation, or use for
his or another's benefit, any confidential information
2
<PAGE>
<PAGE>
whatsoever in connection with the Company or its business or anything connected
therewith, unless such information has become public knowledge, or (ii) for a
period of two years following termination of his employment by the Company, but
in any event until December 31, 2001, (x) entice away from the Company's
employment or otherwise interfere with the Company's relationship with any
employee of the Company, or (y) solicit any "customer" of the Company, its
subsidiaries or affiliates for any specialty type of insurance coverage provided
by the Company, its subsidiaries or affiliates. For purposes hereof, the term
"customer" shall mean any person or entity for whom the Company, its
subsidiaries or affiliates provided insurance coverage during the one-year
period preceding the termination of Rhulen's employment.
(c) Rhulen acknowledges the provisions of clauses (a) and (b)
above are in addition to any common law obligations applicable to him with
respect thereto and further acknowledges that his skills and knowledge relating
to the business of the Company are of such a unique and critical nature that the
Company would be irreparably harmed by Rhulen's violation of the provisions set
forth in paragraphs (a) and (b) above and, accordingly, in addition to any other
rights or remedies available to the Company at law, the Company will be entitled
to equitable relief including, without limitation, a temporary or permanent
injunction restraining an actual or threatened breach by Rhulen with respect to
the foregoing.
6. Disability
In the event of Rhulen's disability (as defined in the Company's
disability policy or program) during the term of this Agreement, Rhulen shall be
entitled to his full compensation after deducting the amount of any payments
provided him pursuant to any disability policy or program maintained by the
Company.
7. Life Insurance.
The Company may, at its discretion, apply for and procure in its
own name and for its own benefit insurance in any amount or amounts considered
advisable on the life of Rhulen, and Rhulen agrees that he shall have no right,
title or interest therein and further agrees to submit to any medical or other
examination and to execute and deliver any application or other instruments in
writing reasonably necessary to effectuate such insurance.
8. Entire Agreement.
This Agreement contains the entire understanding between the
parties and may not be modified, altered or terminated except by an instrument
in writing signed by the parties.
9. Binding Agreement.
This Agreement shall be binding upon the parties hereto and their
successors.
3
<PAGE>
<PAGE>
10. Enforceability.
In the event any provision in this Agreement is determined to be
invalid or unenforceable by a court of competent jurisdiction due to its
geographic scope, period of duration or any other provision, such provision
shall be deemed deleted, amended or modified, as necessary, in order to render
same valid and enforceable to the fullest extent permissible. The invalidity,
unenforceability, deletion, amendment or modification of any such provision
shall not impair the enforceability of the remainder of this Agreement
11. Construction.
This Agreement shall be construed in accordance with the laws of the
State of New York.
12. Headings.
The paragraph headings contained in this Agreement are for
convenience of reference only and are not intended to define, limit or describe
the scope or intent of any provision of this Agreement.
IN WITNESS WHEREOF, the parties hereto have duly executed this
Agreement this day of February, 1998.
FRONTIER INSURANCE GROUP, INC.
By:
---------------------------------------
Mark H. Mishler, Vice President
-Treasurer and Chief Financial
Officer
---------------------------------------
Harry W. Rhulen
4
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. 1998 FORM 10-K EXHIBIT 12
Computation of Ratio of Earnings to Fixed Charges
(in thousands)
<TABLE>
<CAPTION>
Year Ended December 31
-------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Income (loss) before income taxes
and cumulative effect of change
in accounting principle $(90,875) $45,849 $56,659 $43,280 $21,330
Add:
Minority interest and interest expense 11,931 11,842 4,247 895 -
Interest portion of rental expense 500 500 371 240 -
--------- ------- ------- ------- --------
Earnings available for payment of combined
fixed charges and preferred stock dividends $(78,444) $58,191 $61,277 $44,415 $21,330
========= ======= ======= ======= =======
Combined fixed charges:
Minority Interest and interest expense $11,931 $11,842 $4,247 $ 895 $ -
Interest portion of rental expense 500 500 371 240 -
------- ------- ------ ----- ----------
Total combined fixed charges $12,431 $12,342 $4,618 $ 1,135 $
======= ======= ====== ===== ==========
Ratio of earnings to combined fixed charges (1) (6.3) 4.7 13.3 39.1 N/A
</TABLE>
For purposes of determining this ratio, earnings consist of income before
federal income taxes, plus fixed charges. Fixed Charges consist of 1) minority
interest-preferred securities of subsidiary trust, and interest expense on
short-term debt, 2) amortization of debt issuance costs and 3) the portion of
rental expense that is representative of the interest factor.
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC 1998 FORM 10-K EXHIBIT 21(a)
LIST OF REGISTRANT'S SUBSIDIARIES
The following is a list of Registrant's subsidiaries, all of which are
wholly-owned, except as noted.
<TABLE>
<CAPTION>
State of Jurisdiction
Name and Incorporation
<S> <C>
Frontier Insurance Company New York
Medical Professional Liability Agency, Ltd. New York
Pioneer Claim Management, Inc. New York
Frontier Pacific Insurance Company California
Spencer Douglass Insurance Associates California
United Capitol Holding Company Delaware
United Capitol Insurance Company Illinois
Olympic Underwriting Managers, Inc. Delaware
Fischer Underwriting Group, Inc. New Jersey
Regency Financial Corporation (1) Delaware
Regency Insurance Company North Carolina
Emrol Premium Finance Company North Carolina
Lyndon Financial Corporation Missouri
Lyndon Insurance Group, Inc. Missouri
Lyndon Property Insurance Company Missouri
Lyndon Life Insurance Company Missouri
Lyndon Southern Insurance Company Louisiana
Lyndon - DFS Warranty Services, Inc. (2) Missouri
Gulfco Life Insurance Company Louisiana
Lyndon American, Inc. Missouri
</TABLE>
<PAGE>
<PAGE>
<TABLE>
<CAPTION>
State of Jurisdiction
Name and Incorporation
<S> <C>
Twin Mercury Life Insurance Company Arizona
Acceleration Life Insurance Company Ohio
Acceleration National Service Corporation Ohio
Lyndon General Agency of Texas, Inc. Texas
Dublin International Limited Island of Nevis
Environmental and Commercial Insurance Agency, Inc. Ohio
London and European Title Insurance Services Limited England
Western Indemnity Insurance Company Texas
Surety Bond Connection Agency Texas
Agents Bond Connection Agency Texas
</TABLE>
(1) The Company owns 94% interest.
(2) The Company owns 95% interest.
<PAGE>
<PAGE>
FRONTIER INSURANCE GROUP, INC. 1998 FORM 10-K EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Forms S-8 No. 33-30217, No. 33-39638, and No. 33-77332) pertaining to the
Incentive and Non-Incentive Stock Option Plans of Frontier Insurance Group, Inc.
of our report dated March 31, 1999, with respect to the consolidated financial
statements and schedules of Frontier Insurance Group, Inc. included in this
Annual Report (Form 10-K) for the year ended December 31, 1998.
/S/ Ernst & Young LLP
New York, New York
March 31, 1999
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 1,199,084
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 57,328
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 1,459,312
<CASH> 28,335
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 96,597
<TOTAL-ASSETS> 2,553,777
<POLICY-LOSSES> 1,092,282
<UNEARNED-PREMIUMS> 507,046
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 92,000
<COMMON> 376
0
0
<OTHER-SE> 402,214
<TOTAL-LIABILITY-AND-EQUITY> 2,553,777
493,054
<INVESTMENT-INCOME> 73,528
<INVESTMENT-GAINS> 3,010
<OTHER-INCOME> 4,400
<BENEFITS> 442,853
<UNDERWRITING-AMORTIZATION> 122,813
<UNDERWRITING-OTHER> 87,270
<INCOME-PRETAX> (90,875)
<INCOME-TAX> (40,833)
<INCOME-CONTINUING> (50,042)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (50,042)
<EPS-PRIMARY> (1.34)
<EPS-DILUTED> (1.34)
<RESERVE-OPEN> 483,539
<PROVISION-CURRENT> 297,400
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 66,070
<PAYMENTS-PRIOR> 216,534
<RESERVE-CLOSE> 632,850
<CUMULATIVE-DEFICIENCY> 134,515
</TABLE>
