<PAGE>
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, 1999
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 1-10584
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)
</TABLE>
Registrant's telephone number, including area code: (914) 796-2100
Securities registered pursuant to Section 12(b) of the Act:
<TABLE>
<S> <C>
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 $35,929,599 on April 6, 2000, 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 April 6, 2000, was 33,816,093.
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: recent rating agency downgrades, lack of liquidity, regulatory agency
oversight, need to renegotiate financial covenants, 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, 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, short-term auto rental, nonstandard automobile,
manufactured housing, excess workers' compensation, environmental and pollution
liability, and until January 2000, credit-related 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 1996 (see Note C of the Notes to the
Consolidated Financial Statements). Effective January 20, 2000, the Company sold
its ownership interest in Lyndon and Acceleration to Protective Life Insurance
Company (see Note S of the Notes to the Consolidated Financial Statements).
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RISK FACTORS
Restrictions Under Insurance Regulations
The Company is 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.
Risk-Based Capital ("RBC") is a measure developed by the National Association of
Insurance Commissioners ("NAIC") and used by state insurance regulators to
identify insurance companies that potentially are inadequately capitalized. The
RBC guidelines define minimum capital standards determined by a ratio of a
company's regulatory Total Adjusted Capital to its Authorized Control Level RBC,
as defined by the NAIC. Companies below specific ratios may be subject to
various levels of regulatory action or oversight by the insurance commissioner
in their state of domicile.
Frontier, the Company's largest insurance subsidiary, is domiciled in New York
State. The New York State Department of Insurance (the "Department") utilizes
its own methodology for computing capital adequacy and has not adopted the NAIC
RBC guidelines. However, many of the other states in which Frontier writes
business have adopted the NAIC RBC guidelines. In accordance with the NAIC RBC
guidelines, at December 31, 1999, Frontier was at the Authorized Control Level.
The Authorized Control Level authorizes the Commissioner of a state insurance
department to take whatever regulatory actions it considers necessary
to protect the best interests of the policyholders and creditors of an insurer,
which could include placing Frontier under regulatory control (i.e.,
rehabilitation or liquidation). In addition, failure to meet capital
requirements and other requirements which may be imposed by the insurance
department, or further unfavorable operating results in future periods, could
expose Frontier to regulatory sanctions that may include restrictions on
operations and growth and/or mandatory asset dispositions.
The Company has submitted a Corrective Action Plan to the superintendent of the
Department and to many of the other state insurance departments in states for
which Frontier writes business. It is uncertain what actions, if any, the
insurance department will take with respect to Frontier. While the Company
expects to maintain or improve the current RBC ratio level of its insurance
subsidiaries, it cannot predict all events that could cause this ratio to
decrease to the point of increased oversight by the Department or by the
departments of the state in which the Company's subsidiaries are domiciled
(see Management's Discussion and Analysis of Financial Condition and Results
of Operations--Solvency and Surplus Matters).
Debt Covenants and Liquidity
The Company is subject to various financial and nonfinancial covenants under the
terms of its revolving credit facility and certain guaranty agreements (see
Notes J, L and O of the Notes to the Consolidated Financial Statements). Among
other things, the covenants restrict the Company's ability to dispose of assets,
incur additional indebtedness and pay dividends. Certain of the covenants also
require the maintenance of minimum debt-to-equity, interest coverage, and net
written premiums-to-statutory surplus ratios. Violation of these covenants allow
the lenders to elect to accelerate repayment of all amounts owed or guaranteed
by the Company under the agreements. At December 31, 1999, the Company violated
certain covenants which were waived by the banks. In addition, due to its
significantly weakened financial condition and the expected negative impact on
operations resulting from recent rating downgrades, the Company expects to
violate certain revised
3
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covenants during 2000. The Company has received a waiver of these expected
violations through April 30, 2000 and is currently negotiating revised covenants
with the banks. Should the Company be unable to obtain waivers of such covenants
and be in violation thereof, the banks could elect to accelerate repayment of
the amounts outstanding under the credit facility and exercise their rights with
respect to the stock and ownership interests pledged as collateral.
The Company's insurance subsidiaries, the primary source of liquidity, are
restricted in the amount of dividends or other distributions they may make
without the prior approval of the insurance commissioners of their domiciliary
states. Currently, the only insurance subsidiary that can pay dividends to the
holding company without the prior approval of the insurance commissioner is
Regency. The maximum dividend that Regency could pay during 2000 without prior
approval is approximately $293,000.
Given the limited liquidity at the holding company, the Company has elected to
defer interest payments on its Convertible Trust Originated Preferred Securities
("TOPrS") beginning with the payment scheduled for April 2000 (see Note K of the
Notes to the Consolidated Financial Statements). The Company is also actively
pursuing the sale of Western, Regency and its Surety Division operations which
should provide liquidity at the holding company level to allow it to meet its
obligations. However, should the Company be unable to liquidate such assets in a
timely manner its financial condition would be materially adversely impacted.
(see Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources and Note A of the Notes to the
Consolidated Financial Statements.)
Emphasis on Insurance Company Ratings
In December 1999, the Company was downgraded by A.M. Best from A- (Excellent) to
B++ (Very Good). In March 2000, the Company was further downgraded by A.M. Best
to B (Fair). A.M. Best indicated that failure to execute additional asset sales
or the continuation of poor operating performance could result in further
downward rating adjustments. In March 2000, Standard & Poor's ("S&P") suspended
its counterparty credit rating and financial strength rating on the Company,
(see Management's Discussion and Analysis of Financial Condition and Results of
Operations - Rating Agencies). 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. The Company
has entered into reinsurance arrangements with insurance companies that have a
higher A.M. Best rating in order to provide additional security to policyholders
who may require it. However, these arrangements increase the Company's
acquisition costs, thus putting pressure on its ability to compete with higher
rated insurance companies. Failure to execute additional asset sales to provide
holding company liquidity and increase the capital and surplus of Frontier, or a
continuation of poor operating performance may result in further downward
ratings adjustments. The Company cannot assure that its insurance subsidiaries
will maintain their current ratings and any further downgrade could materially
adversely affect their operations.
Adequacy of Loss Reserves
Liabilities for unpaid losses and loss adjustment expenses are estimated
utilizing methods and procedures which management believe 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
4
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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.
Also refer to Note H in the Consolidated Financial Statements - Unpaid Loss and
Loss Adjustment Expenses for additional disclosure regarding loss reserves.
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 identify niche markets and specialty programs that the Company
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 our niche markets and specialty programs. As a result of the Company's
weakened financial position and downgrades by certain rating agencies,
the Company expects that the effect of competitive pressure on its ability to
retain and produce new business will increase within the broader lines and niche
markets.
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 its insurance subsidiaries are adequately reinsured, the Company cannot
be certain that it 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 its
earnings. A significant decline in investment yields could have a material
adverse effect on the Company's financial results.
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.
5
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Concentration in Ownership
Mr. Harry W. Rhulen, President and Chief Executive Officer, members of Mr.
Rhulen's family and other directors and officers owned, as of April 6, 2000,
approximately 20% 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.
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.
The following table 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
general liability, fire professional
Surety Small-construction contractors Surety bonds Electrician or plumber
fails to complete job
Surety Importers Customs bonds Importer fails to pay duty
duty
Alternative Risk Self-insured employers Excess workers' Workers' compensation loss
compensation/employer's loss exceeds
liability employer's self-
insured retention
Specialty Programs Crane operators General liability Crane damages a
party's property
Specialty Programs Alarm installers General liability House is burglarized
through faulty alarm
installation
Specialty Programs Rental car companies Auto physical damage/ Damage to vehicle while in
auto liability in rental car company
parking lot
Environmental, Excess Environmental remediation Professional liability Site remains contaminated
Excess and contractors contaminated after
Surplus Lines contractor completed
remediation project
Personal and Credit- Borrowers from financial Credit-related property Damage to property taken as
Related institutions taken as collateral
</TABLE>
6
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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 medical malpractice, general liability and commercial multi-peril
coverages. Additionally, this segment serves the medical professional community
through the design and distribution of products and services which target the
unique exposures for medical and dental professional risks, and include such
exposures for physicians, internists, dentists, chiropractors, psychiatrists and
other specialists. 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. Continued evaluation has
led the Company to discontinue certain classifications of medical malpractice
and exposures in certain states. The business produced by this segment is
underwritten primarily through Frontier, Frontier Pacific, and Western.
Surety Division
This segment underwrites bonds for small contract bonds, license and permit
bonds, subdivision bonds, service contract bonds, workers' compensation self
insurance bonds, high deductible guarantee bonds, landfill closure bonds, custom
bonds, bail bonds, fidelity bonds and various forms of miscellaneous guarantee
contracts.
License and permit bonds are primarily produced by a wholly-owned subsidiary.
Bail bonds are produced by a 50% owned bail agency and custom and fidelity bonds
are produced by specialty bond agents which have exclusive underwriting
agreements with the Company. During 1998 and 1999, the Company has acquired a
number of small previously independent surety agencies. 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, this
segment provides a full range of risk management services, including the
formation and management of off-shore captive and rent-a-captive entities, which
underwrite a broad range of coverages.
Excess workers' compensation provides specific and aggregate coverage for
individuals, public entities and association self-insureds who demonstrate
pro-active participation in risk management and claim control. This program is
underwritten using a select number of producers to minimize exposure to those
agents who shop their business in order to dominate the market and sell solely
on price.
Excess medical stop loss provides coverage to companies, associations and public
entities that elect to self-insure their employees' medical coverage for losses
within specified levels. The Company currently uses a single agent to produce
this business.
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Captive and rent-a-captive programs offer flexible and innovative alternatives
to the traditional insurance market for most classes of business and major lines
of business. These programs are produced by independent agents who specialize in
these types of coverages.
The business produced by this segment is predominantly underwritten through
Frontier.
Specialty Programs Division
This segment produces a wide variety of specialty coverages, including crane
operators, tow truck operators, pest control, artisan contractors, childrens'
summer camps, alarms and guards, outdoor recreation, demolition contractors,
nonstandard auto coverage and white water rafting. Additionally, this segment
underwrites a short term auto rental program.
The nonstandard auto coverage is predominantly produced by a 50% owned managing
general agency. All other business written by the segment is produced by
in-house program agency underwriters that specialize in underwriting the
underlying coverages.
The business produced by this segment is predominantly underwritten through
Frontier and Frontier Pacific.
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, on a limited basis, 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.
The Company's environmental coverages are produced by various specialty program
administrators, contracted brokers and two wholly-owned insurance agencies.
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, homeowners multi-peril, credit property, involuntary
unemployment, nonstandard auto coverage, 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.
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These coverages are underwritten primarily through Lyndon, Acceleration and
Regency. However, effective January 20, 2000 the Company sold its ownership
interest in Lyndon and Acceleration. In addition, in April 2000, the Company has
signed a letter of intent for the sale of Regency. As such, the credit insurance
operations of this segment will be eliminated effective January 20, 2000 and the
personal line coverages are expected to be significantly reduced beginning in
the second quarter of 2000, contingent upon the outcome of regulatory approval
and standard closing conditions. (See Note S of the Notes to the Consolidated
Financial Statements.)
Segment Results
The Company evaluates segment performance based on profit or loss before
investment income (including equity in net income of investees accounted for
under the equity method, capital gains/losses and net of interest on funds
held), interest expense, other corporate expenses and income taxes.
Additionally, depreciation and amortization expense are included in the
evaluation of segment performance. 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>
1999 1998 1997
----------------------------------------------
(in thousands)
<S> <C> <C> <C>
Premiums earned by segment:
Health Care $ 160,207 $ 197,170 $ 167,447
Surety 96,410 73,790 64,788
Alternative Risk 20,337 35,312 35,747
Specialty Programs 127,519 70,131 58,316
Environmental, Excess and Surplus Lines 71,502 54,517 34,459
Personal and Credit-Related (1) 94,953 108,945 43,729
Premiums ceded under Zurich N.A. stop loss agreements (2) - (46,811) (37,642)
---------------------------------------------
Net premiums earned $ 570,928 $ 493,054 $ 366,844
=============================================
Segment profit (loss):
Health Care $ (142,395) $ (224,666) $ (41,163)
Surety (11,964) 11,563 15,366
Alternative Risk (8,426) 3,174 4,447
Specialty Programs (64,469) (7,705) 2,090
Environmental, Excess and Surplus Lines 5,333 9,866 10,010
Personal and Credit-Related (1) (9,405) 7,146 9,711
---------------------------------------------
Total segment profit (loss) (231,326) (200,622) 461
Reconciling items:
Net effect of Zurich N.A. agreements (2) - 58,828 2,349
Total net investment income 80,735 76,538 60,344
Interest expense (18,479) (11,931) (11,842)
Other corporate (expenses) income, net (5,015) (13,688) (5,463)
---------------------------------------------
Consolidated income (loss) before income taxes $ (174,085) $ (90,875) $ 45,849
=============================================
</TABLE>
(1) Lyndon accounted for $77.5 million, $101.2 million and $38.9 million of the
net premiums earned of the Personal and Credit-Related segment for years
1999, 1998 and 1997, respectively, and the related profit (loss) was $(5.2)
million, $8.9 million and $10.7 million for years 1999, 1998 and 1997,
respectively.
(2) Program terminated effective December 31, 1998.
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".)
9
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Other corporate expenses include expenses of the parent company and directly
owned noninsurance subsidiaries, reduced by other miscellaneous income.
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 and 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 lines of business or underwriting 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, from 1995 through 1998,
the Company 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"). 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 designed by the Company, the producing agents
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 are used to purchase a letter of credit or deposited into a trust
fund to secure the liabilities ceded to the reinsurer.
Certain policyholders and prospective policyholders of the Company may require
their risks be insured by an insurance company rated "A-" or higher by A.M.
Best. In response to A.M. Best's downgrade of the Company's rating during 1999,
the Company entered into "cut-through" reinsurance agreements effective December
1, 1999 with "A" rated insurance companies, Clarendon Insurance Group
("Clarendon") and, for surety business, a subsidiary of NAC Reinsurance
Corporation ("NAC Re"). This cut-through arrangement effectively provides
assurance to the Company's insureds that Clarendon or NAC Re will pay claims
in the event of the Company's insolvency.
Also, in connection with the Clarendon cut-through agreement, the Company
deposited $50 million into a trust account and provided a $35 million letter of
credit as security for the Company's obligations under the agreement. The
Company's secured obligations to Clarendon include claims expenses incurred by
Clarendon and any unpaid fees and commissions. Under the terms of the trust
agreement, the Company must deposit additional assets to the trust account as
needed to ensure its obligations to Clarendon are fully secured.
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The following table summarizes as of December 31, 1999 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 $ 1,000(2)
Casualty lines (excluding medical malpractice, health
specialties, and social services) 1,000(3)
Medical malpractice, health specialties and social services 250(1)
Workers' compensation 1,000(3)
Surety -(4)
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 1,000(3)
Nonstandard auto liability 25
</TABLE>
--------------------------
(1) Does not reflect Company's maximum corridor deductible aggregate retention
of approximately $7.5 million under its professional liability reinsurance
treaty that may accrue under certain circumstances. Also, 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) Maximum retained loss is $500,000 for occurrences subsequent to December 1,
1999.
(4) The Company writes a wide variety of surety bonds with significantly
different retention levels. Generally, contract, subdivision, self-insured
workers' compensation, recreation, deductible guaranty and deferred
compensation and certain low limit bonds are covered under the Company's
surety excess of loss treaties which limit the Company's retention to $1
million per principal, not including a maximum co-insurance participation
of $400,000. The Company also issues other larger limit surety bonds,
primarily related to the waste management and energy industries, for which
its retention per bond ranges from approximately $4.5 million to $26
million. At December 31, 1999, over 200 of such bonds were outstanding
which have varying amounts of collateral supporting the bonds.
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DISTRIBUTION
The Company relies on multiple distribution channels to market its insurance
products, primarily independent insurance agencies and brokerage firms, none of
which account for more than 5% of the Company's net premiums written. The
following tables set forth for the three years ended December 31, 1999, the
gross and net premiums written produced by internal and affiliated sources,
independent agencies and brokerage firms:
<TABLE>
<CAPTION>
1999 1998 1997
---------------------------------------------------------------------------
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 $ 110,166 10.8% $ 104,957 12.6% $ 79,772 13.6%
All others 907,638 89.2 728,201 87.4 507,863 86.4
---------------------------------------------------------------------------
Total $1,017,804 100.0% $ 833,158 100.0% $ 587,635 100.0%
===========================================================================
Net premiums:
Internal and affiliated $ 85,323 12.6% $ 65,627 12.5% $ 60,776 15.6%
All others 589,478 87.4 461,378 87.5 328,240 84.4
---------------------------------------------------------------------------
Total $ 674,801 100.0% $ 527,005 100.0% $ 389,016 100.0%
===========================================================================
</TABLE>
Premiums produced by internal and affiliated sources 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 brokerage firms 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
calculated by adding the expense ratio to the 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>
1999 1998 1997 1996 1995
-------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Loss and LAE ratio 94.9% 95.0% 65.2% 58.7% 60.0%
Expense ratio 36.5 38.2 35.7 32.2 31.1
-------------------------------------------------------------------
Combined ratio 131.4% 133.2% 100.9% 90.9% 91.1%
===================================================================
</TABLE>
12
<PAGE>
The combined ratios in 1999, 1998 and 1997 reflect the effects of increased
reserves of approximately $136 million, $155 million and $35 million,
respectively. (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.
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>
1999 1998 1997 1996 1995
-------------------------------------------------------------------
(dollar amounts in thousands)
<S> <C> <C> <C> <C> <C>
Frontier:
Net premiums written during the year $ 380,039 $ 287,733 $ 275,127 $ 255,446 $ 205,614
Policyholders' surplus at end of year $ 172,026 $ 251,841 $ 276,390 $ 262,899 $ 171,361
Ratio 2.21/1 1.14/1 .99/1 .97/1 1.20/1
Frontier Pacific:
Net premiums written during the year $ 46,225 $ 28,170 $ 30,282 $ 32,040 $ 15,143
Policyholders' surplus at end of year $ 25,649 $ 34,920 $ 31,171 $ 25,985 $ 17,155
Ratio 1.80/1 .81/1 .97/1 1.23/1 .88/1
United Capitol:
Net premiums written during the year $ 71,817 $ 61,855 $ 40,793 $ 25,930 $ 10,981
Policyholders' surplus at end of year $ 58,006 $ 65,966 $ 60,122 $ 53,355 $ 68,026
Ratio 1.24/1 .94/1 .68/1 .49/1 .16/1
Lyndon Property:
Net premiums written during the year $ 94,199 $ 79,805 $ 45,167 $ 72,043 $ (41,623)
Policyholders' surplus at end of year $ 96,018 $ 100,296 $ 90,989 $ 71,104 $ 54,054
Ratio .98/1 .80/1 .50/1 1.01/1 N/A
Western:
Net premiums written during the year $ 22,359 $ 23,396 $ 32,064 $ 33,010 $ 34,635
Policyholders' surplus at end of year $ 31,366 $ 35,935 $ 34,348 $ 50,000 $ 45,873
Ratio .71/1 .65/1 .93/1 .66/1 .76/1
Regency:
Net premiums written during the year $ 13,776 $ 13,418 $ 4,942 $ 4,489 $ 4,441
Policyholders' surplus at end of year $ 8,444 $ 8,133 $ 10,341 $ 5,105 $ 4,667
Ratio 1.63/1 1.65/1 .48/1 .88/1 .95/1
Lyndon Southern:
Net premiums written during the year $ 2,388 $ 1,602 $ - $ - $ -
Policyholders' surplus at end of year $ 3,757 $ 3,137 $ 3,495 $ 3,495 $ -
Ratio .64/1 .51/1 N/A N/A N/A
</TABLE>
13
<PAGE>
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").
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 claim, 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 committee 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 ("SAP"), except
with regard to Frontier's medical malpractice reserves which are discounted for
statutory accounting purposes.
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, 1999, for each of the preceding ten years:
<TABLE>
<CAPTION>
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
-----------------------------------------------------------------------------------------------------------
(amounts in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Reserves for unpaid
losses and LAE $92,384 $120,096 $161,263 $185,074 $216,486 $263,202 $294,393 $373,606 $483,539 $632,850 $828,923
Reserves reestimated
at December 31:
1 year later 93,419 119,875 162,121 188,387 230,360 255,689 289,914 386,893 618,054 721,711
2 years later 91,457 120,550 158,746 196,005 229,334 252,678 314,558 492,247 677,604 -
3 years later 91,527 115,310 163,537 191,401 214,712 282,016 399,069 533,822 - -
4 years later 86,508 114,790 154,217 172,654 234,172 345,459 429,978 - - -
5 years later 87,795 107,907 133,768 182,660 276,137 353,325 - - - -
6 years later 79,459 88,803 142,630 214,006 277,303 - - - - -
7 years later 62,667 91,777 168,342 211,863 - - - - - -
8 years later 66,438 113,268 164,864 - - - - - - -
9 years later 82,694 110,040 - - - - - - - -
10 years later 78,928 - - - - - - - - -
Cumulative redundancy
(deficiency) 13,456 10,056 (3,601) (26,789) (60,817) (90,123) (135,485) (160,216) (194,065) (88,861)
</TABLE>
14
<PAGE>
<TABLE>
<CAPTION>
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
------------------------------------------------------------------------------------------------------
(amounts in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Cumulative amount of
liability paid through
December 31:
1 year later 16,823 8,129 41,486 38,300 56,986 80,507 102,160 147,013 216,534 219,505
2 years later 13,230 35,864 62,175 74,113 113,471 148,513 195,052 274,307 368,106 -
3 years later 32,987 45,973 80,888 112,017 154,548 204,252 263,107 347,987 - -
4 years later 39,166 58,043 104,672 139,333 188,495 233,254 296,732 - - -
5 years later 50,406 74,659 122,863 161,417 198,801 259,847 - - - -
6 years later 61,276 86,405 137,059 163,429 214,921 - - - - -
7 years later 67,429 93,835 133,519 173,112 - - - - - -
8 years later 71,769 89,686 138,999 - - - - - - -
9 years later 64,145 92,621 - - - - - - - -
10 years later 66,627 - - - - - - - - -
Net reserve--December 31 $216,486 $263,202 $294,393 $373,606 $483,539 $ 632,850 $ 828,923
Reinsurance 57,549 49,435 73,043 165,467 283,727 439,545 465,622
-------------------------------------------------------------------
Gross reserve $274,035 $312,637 $367,436 $539,073 $767,266 $1,072,395 $1,294,545
===================================================================
</TABLE>
The loss and LAE reserves of Frontier Pacific, United Capitol, Lyndon Property,
Lyndon Southern, Western and Regency as reported on a SAP basis are
identical with those reflected in the Company's financial statements prepared in
accordance with GAAP included herein, before elimination of intercompany
transactions. Frontier's loss and LAE reserves in their 1999 Annual Statement
are reported net of a $53 million discount on its medical malpractice reserves.
The adverse development in reserves for unpaid losses and LAE during 1999, 1998
and 1997 for all prior accident years and the related cumulative deficiencies
for calendar years 1991 through 1998 were primarily attributable to unfavorable
experience in the individual physician medical malpractice business and, to a
lesser extent for 1999 and 1998, unfavorable experience in the general liability
lines. During 1999, 1998 and 1997, the Company increased reserves relating to
prior years by approximately $89 million, $135 million and $13 million,
respectively. Reserve decreases totaling $32 million during 1996 and 1995
resulted from the recognition of subrogation recoverable arising from medical
malpractice claims filed by certain physicians employed by the State University
of New York ("SUNY"). During 1999, the SUNY subrogation recoverable was reduced
by approximately $15.5 million as a result of an unfavorable court ruling. (See
Note H of the Notes to the Consolidated Financial Statements).
INVESTMENTS
The Company's investment portfolio is managed in a conservative manner as
evidenced by the 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 cover
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, 1999, the core
15
<PAGE>
portfolio represented 87.3% 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 alternative
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, 1999, the alternative
investment portfolio represented 12.7% 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 established
by the Company.
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, 1999:
<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 $ 137,407 $ 132,960 $ 132,960 10.7%
Obligations of states and
political subdivisions 250,483 245,938 245,938 19.8
Corporate securities 431,801 413,965 413,965 33.4
Mortgage-backed securities 378,257 368,792 368,792 29.7
-------------------------------------------------
Total fixed maturity securities 1,197,948 1,161,655 1,161,655 93.6
Equity securities 81,742 79,712 79,712 6.4
-------------------------------------------------
Total $1,279,690 $1,241,367 $1,241,367 100.0%
=================================================
</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, 1999:
<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 $111,616) $ 626,682 $ 626,682 54.0%
AA/Aa 164,340 164,340 14.1
A/A 238,047 238,047 20.5
BBB/Baa 102,056 102,056 8.8
All other 30,530 30,530 2.6
-------------------------------------------------
Total $ 1,161,655 $ 1,161,655 100.0%
=================================================
</TABLE>
16
<PAGE>
The following table sets forth the maturity profile of the Company's portfolio
of fixed maturity investments at December 31, 1999:
<TABLE>
<CAPTION>
FAIR CARRYING PERCENT
MATURITY VALUE VALUE OF TOTAL
- ---------------------------------------------------------------------------------------------
(dollar amounts in thousands)
<S> <C> <C> <C>
Due in one year or less $ 44,321 $ 44,321 3.8%
Due after one year to five years 273,113 273,113 23.5
Due after five years to ten years 224,652 224,652 19.3
Due after ten years 250,777 250,777 21.6
Mortgage-backed securities 368,792 368,792 31.8
-------------------------------------------------
Total $ 1,161,655 $ 1,161,655 100.0%
=================================================
</TABLE>
The following table summarizes the Company's investment results for the five
years ended December 31, 1999, calculated using the mean of total investments as
of the first and last day of each calendar quarter:
<TABLE>
<CAPTION>
1999 1998 1997 1996 1995
------------------------------------------------------------------
(dollars amounts in thousands)
<S> <C> <C> <C> <C> <C>
Total net investment income $80,735 $76,538 $60,344 $38,933 $30,055
Average annual pre-tax yield 6.3% 6.6% 6.4% 6.4% 6.4%
Average annual after-tax yield 4.5% 4.7% 4.6% 4.8% 4.9%
Effective federal income tax rate on
total net investment income(1) 29.1% 28.6% 26.9% 24.8% 23.7%
</TABLE>
(1) Effective federal income tax rate does not reflect the effects of net
operating losses or any related deferred tax valuation allowances. It is
intended to show the benefit of investments in tax-exempt securities,
based on a statutory tax rate of 35%.
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 matters such 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
companies; establishment and maintenance of reserves for unearned premiums and
losses; restrictions on dividends and other distributions; and requirements
regarding numerous other matters. (See "Management's 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
17
<PAGE>
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 "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, Western and Regency, the laws of
their states of domicile with respect to holding companies are similar to those
of New York.
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 "RBC" requirements for insurance
companies. An insurance company that does not meet threshold RBC measurement
standards could be exposed to regulatory sanctions that may include
restrictions on operations and growth, mandatory asset dispositions, and
regulatory control (i.e. rehabilitation or liquidation). (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. The
impact of these regulatory efforts on the Company's operations cannot be
quantified until enacted.
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
18
<PAGE>
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.
A number of the competitors in this segment have A.M. Best ratings less than A-.
As such, recent ratings downgrades of the Company's insurance subsidiaries are
not expected to have a significant impact on this segment's premium volume or
results of operations.
Surety Division
There are approximately 200 active surety companies, each which underwrite in
excess of $3 million in annual premiums. The Company, through this segment, is
one of the top ten surety underwriters, as measured by premium volume, in the
United States. 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.
This segment's premium volume and/or profitability may be adversely affected by
the recent ratings downgrades by A.M. Best and S&P.
In addition, certain bonds, primarily subdivision, customs and miscellaneous
guarantee bonds, may be required by the principal or obligee to be bonded by an
insurance company with a United States Treasury Listing ("T-Listing") with the
Surety Bond Branch of the United States Treasury (the "Treasury"). The Treasury
establishes the maximum limit up to which an insurance company may write bonds
that require a T-Listing. The ability to maintain a T-Listing is based upon an
insurance company's financial strength which is evaluated on an annual basis by
the Treasury. The T-Listing for Company's insurance subsidiaries is up for
renewal on July 1, 2000. Given the weakened financial condition of the Frontier,
it is likely that its current T-Listing may be reduced or possibly cancelled.
The loss of the T-Listing by Frontier and any of the Company's insurance
subsidiaries could have a materially adverse affect on the surety segment's
operating results.
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.
Recent ratings downgrades of the Company's insurance subsidiaries will likely
have a significant impact on this segment's results in terms of lower premium
volume and/or higher acquisition costs due to the need to utilize reinsurance
arrangements with higher rated insurance companies for certain policyholders.
Specialty Programs Division
Although there are occasional signs of a hardening market, 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 with moderate rate increases. The Company's strategy in retaining and
attracting these accounts is to provide superior service, enhanced coverages,
and risk
19
<PAGE>
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.
Recent downgrades of the Company's insurance subsidiaries are expected to have a
moderate impact on this segment's results due to higher acquisition costs
related to the utilization or reinsurance arrangements with higher rated
insurance companies.
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 account pricing.
The recent ratings downgrade is expected to have a significant negative impact
on this segment since most of the competitors are large, nationally recognized,
highly rated companies. Due to the quality of the competition and the
longer-tailed nature of the business, agents in this segment generally require
an A.M. Best rating of at least A-. As such, the Company expects not only a
significant reduction in premium volume, but also higher acquisition costs due
to extensive use of reinsurance arrangements with higher rated insurance
companies.
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.
Effective January 20, 2000, the Company sold its ownership interest in Lyndon
and Acceleration, the principal entities through which business is this segment
is produced. In addition, in April 2000, the Company signed a letter of intent
for the sale of Regency. (See Note S of the Notes of the Consolidated Financial
Statements).
20
<PAGE>
EMPLOYEES
The Company currently has approximately 1,240 full-time employees, nine of whom
are executive management, and 51 part-time employees. The Company is not a party
to any collective bargaining agreement and believes its relationship with its
employees to be good.
ITEM 2. PROPERTIES
The Company owns several properties in Rock Hill, New York, consisting of a
three-story office building in which its executive offices and the insurance
operations of Frontier are located and three one-story buildings used for the
corporate day care center, a facilities and maintenance building and a building
used for off site storage. The Company also owns a two-story office building in
Monticello, New York, a motel in Rock Hill and a hanger at a local airport. In
addition, the Company has a five unit single story office complex in Charlotte,
North Carolina, from which Regency conducts its operations.
The Company leases office space at 35 locations in 17 states at an aggregate
monthly rental of approximately $411,700.
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.
21
<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>
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 $ 15.25 $ 11.13
Second quarter 17.19 11.13
Third quarter 15.81 8.38
Fourth quarter 9.13 2.50
2000:
First quarter $ 3.50 $ 0.88
Second quarter (through April 6, 2000) 1.13 0.88
</TABLE>
On April 6, 2000, the Company had approximately 1,119 holders of record of its
Common Stock, which did not include beneficial owners for shares registered in
nominee or street name.
During 1999 and 1998 the Company declared three and four quarterly cash
dividends of $.07 per share, respectively. On December 17, 1999, the Company
announced that its Board of Director voted to suspend the Company's quarterly
common stock dividend (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).
22
<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>
1999 1998(3) 1997(2) 1996(1) 1995
-------------------------------------------------------------------
(dollar amounts in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Revenues:
Gross premiums written $1,017,804 $833,158 $587,635 $402,799 $264,314
===================================================================
Net premiums written $ 674,801 $527,005 $389,016 $311,863 $220,757
===================================================================
Net premiums earned $ 570,928 $493,054 $366,844 $265,989 $196,220
Net investment income 77,622 73,528 56,122 37,226 30,035
Net realized capital gains (losses) 3,113 3,010 4,222 1,707 20
Net proceeds from Company owned
life insurance policy - 4,400 - - -
-------------------------------------------------------------------
Total revenues 651,663 573,992 427,188 304,922 226,275
Expenses:
Losses and loss adjustment expenses 539,378 442,853 234,568 155,991 119,255
Amortization of policy acquisition
costs, underwriting and
other expenses 267,891 210,083 134,929 88,025 62,845
Minority interest in income of
subsidiary trust 10,974 10,966 11,017 2,277 -
Interest expense 7,505 965 825 1,970 895
-------------------------------------------------------------------
Total expenses 825,748 664,867 381,339 248,263 182,995
-------------------------------------------------------------------
Income (loss) before income taxes (174,085) (90,875) 45,849 56,659 43,280
Income tax expense (benefit) 59,179 (40,833) 13,567 16,592 12,069
-------------------------------------------------------------------
Net income (loss) $ (233,264) $(50,042) $ 32,282 $ 40,067 $ 31,211
===================================================================
Net income (loss) per share-basic $ (6.65) $(1.34) $ .94 $ 1.26 $ .99
===================================================================
Net income (loss) per share-diluted $ (6.65) $(1.34) $ .92 $ 1.23 $ .98
===================================================================
Cash dividends declared per share $ .21 $ .28 $ .28 $ .25 $ .24
===================================================================
</TABLE>
23
<PAGE>
Balance Sheet Data:
<TABLE>
<CAPTION>
DECEMBER 31
------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------------------------------------------------------------------
(dollar amounts in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Total investments $ 1,414,680 $ 1,459,312 $1,249,823 $ 838,320 $ 552,714
Total assets 2,635,537 2,553,777 2,009,666 1,259,227 777,616
Liabilities for gross unpaid losses and loss
adjustment expenses 1,313,310 1,092,282 780,044 539,073 367,436
Total liabilities 2,389,639 1,992,404 1,389,258 823,700 547,883
Guaranteed preferred beneficial interest in
Company's convertible subordinated
debentures 167,345 167,153 166,703 166,953 -
Total shareholders' equity 78,553 394,220 453,705 268,574 229,733
- --------------------------
Supplemental diluted earnings per share data (4):
Realized capital gains--net of tax $ .06 $ .05 $ .06 $ .04 $ -
Operating income (loss) (6.71) (1.39) .86 1.19 .98
-----------------------------------------------------------------------
Net income (loss) $ (6.65) $(1.34) $ .92 $ 1.23 $ .98
=======================================================================
Book value per share $ 2.32 $10.70 $ 12.16 $ 8.34 $ 7.29
=======================================================================
Statutory combined ratio 131.4% 133.2% 100.9% 90.9% 91.1%
GAAP combined ratio 141.4% 132.4% 100.8% 91.7% 92.8%
Ratio of earnings to combined fixed charges and
preferred stock dividends (8.2)x (6.3)x 4.7x 13.3x 39.1x
</TABLE>
(1) In May and September 1996, the Company acquired United Capitol Holding and
Regency, respectively.
(2) In June and December 1997, the Company acquired Lyndon and Western,
respectively.
(3) In January 1998, the Company acquired Acceleration.
(4) The presentation of realized capital gains--net of tax per share and
operating income (loss) per share is not an alternative to GAAP as an
indicator of the Company's performance.
24
<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 reportable
segment for the three years indicated and the dollar amount and percentage of
change therein from year to year:
<TABLE>
<CAPTION>
INCREASE (DECREASE)
------------------------------------------------
1999 TO 1998 1998 TO 1997
------------------------------------------------
1999 1998 1997 AMOUNT % AMOUNT %
---------------------------------------------------------------------------------------
(dollar amounts in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Health Care $ 160,207 $197,170 $ 167,447 $ (36,963) (18.7)% $ 29,723 17.8%
Surety 96,410 73,790 64,788 22,620 30.7 9,002 13.9
Alternative Risk 20,337 35,312 35,747 (14,975) (42.4) (435) (1.2)
Specialty Programs 127,519 70,131 58,316 57,388 81.8 11,815 20.3
Environmental, Excess
and Surplus Lines 71,502 54,517 34,459 16,985 31.2 20,058 58.2
Personal and Credit-Related 94,953 108,945 43,729 (13,992) (12.8) 65,216 149.1
Premiums ceded under
Zurich N.A. stop loss
agreements - (46,811) (37,642) 46,811 (100.0) (9,169) 24.4
---------------------------------------------------------------------------------------
Total $ 570,928 $ 493,054 $ 366,844 $ 77,874 15.8% $ 126,210 34.4%
=======================================================================================
</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>
1999 1998 1997
--------------------------------------
<S> <C> <C> <C>
Losses 64.2% 55.7% 45.0%
Loss adjustment expenses ("LAE") 30.3 34.1 19.0
--------------------------------------
Losses and LAE 94.5 89.8 64.0
Underwriting and other operating expenses 46.9 42.6 36.8
--------------------------------------
GAAP Combined Ratio 141.4% 132.4% 100.8%
======================================
</TABLE>
CALENDAR YEAR 1999 COMPARED TO CALENDAR YEAR 1998
NET PREMIUMS EARNED
The $78 million or 15.8% increase in net premiums earned during 1999
compared to 1998 was primarily attributable to continued growth in certain core
and new programs within the Surety, Specialty Programs and Environmental, Excess
and Surplus Lines Divisions. The growth in these divisions was offset by planned
decreases in unprofitable programs within the Health Care and Personal and
Credit Related Divisions and, to a lesser extent, a decline in business in the
Alternative Risk Division due to a discontinued earthquake program and
competitive conditions in the excess workers' compensation market.
25
<PAGE>
Net premiums earned for the Health Care Division decreased 19% from $197 million
in 1998 to $160 million in 1999. Beginning in 1998, the Company began taking
various actions to improve the results of its medical malpractice business. Such
actions included exiting certain classes, terminating agents, increasing rates,
and implementing more stringent underwriting guidelines for both new and renewal
business. These actions contributed to an approximate $23 million decrease in
earned premiums in 1999 when compared to 1998. The remaining decrease of
approximately $14 million in the Health Care Division was primarily attributable
to lower retention of premiums under a new reinsurance contract and competitive
pricing conditions in the health and human services sector of the market.
Net premiums earned for the Surety Division continued to grow in all programs
due to geographic expansion and the acquisition of several bond agencies with a
31% increase from approximately $74 million in 1998 to $96 million in 1999.
Growth in net premiums earned occurred primarily in the contract and license and
permit bond programs, which programs showed increases of approximately $9
million and $5 million, respectively.
The Alternative Risk Division discontinued an earthquake program in 1998 which
resulted in an approximate $4 million decrease in earned premium in 1999 when
compared to 1998. The remaining decrease in net premiums earned of approximately
$11 million was primarily attributable to more competitive market conditions in
the excess workers' compensation sector.
The increase in net premiums earned for the Specialty Programs Division was
primarily attributable to the Company's focus on certain specialty sectors of
the commercial auto market since 1998. Most notably the company began a short
term auto rental program in early 1999 that generated approximately $20 million
in net premiums earned. A variety of smaller commercial auto related programs
introduced in late 1998 generated an additional increase of $11 million of net
premiums earned in 1999. In addition, a California workers' compensation program
was introduced in 1999 which generated approximately $10 million of net premiums
earned for the year. The remaining $16 million increase in net premiums earned
was attributable to growth in a number of smaller programs including a summer
camp program, an ice cream vendor program, a municipality program, and a New
York mercantile program, none of which were individually significant.
The increase in net premiums earned for the Environmental Excess and Surplus
Lines Division was primarily driven by growth in the California contractors'
liability and environmental and pollution liability programs, which had
increases of $10 million and $7 million, respectively, in 1999 compared to 1998.
The decrease in net premiums earned for the Personal and Credit-Related Division
was primarily due to the discontinuance of certain nonstandard auto and
collateral protection programs. This decrease amounting to approximately $32
million was partially offset by increases of $7 million for an extended warranty
program and $8 million for a mobile homeowner program written through one
managing general agent.
NET INVESTMENT INCOME
Net investment income before realized capital gains and losses increased 5.6% in
1999. The primary reason for the increase was a capital infusion of $60 million
on December 31, 1998. This increase was partially offset by increased interest
costs related to Zurich N.A., reinsurance agreements.
26
<PAGE>
LOSS AND LOSS ADJUSTMENT EXPENSES
Loss and LAE as a percentage of net earned premiums increased from 89.8% in 1998
to 94.5% in 1999. The primary reason for such increase related to certain
performance and payment bonds written in 1999 for three entertainment events
that did not occur which resulted in losses of approximately 38.5 million.
Additionally, during 1999 the Company incurred approximately $4 million of
storm losses related for Hurricane Floyd. (See Note H of the Consolidated
Financial Statements).
AMORTIZATION OF POLICY ACQUISITION COSTS
Amortization of policy acquisition costs represented 25.1% of net premiums
earned during 1999 compared to 23.1% for 1998. This increase was due primarily
to higher acquisition costs related to increased writings in the Surety and
Environmental, Excess and Surplus Lines Divisions partially offset by the
effects of lower acquisition costs due to direct writings through several
purchased agencies in late 1998 and 1999. Also during 1999, the Company
recognized approximately $2.2 million less of negative goodwill amortization
related to the acquisition of Lyndon as compared to 1998 and incurred costs
relative to the Clarendon cut-through and other reinsurance arrangements of
approximately $6.1 million. Partially offsetting these increases were premium
tax refunds claimed by the Company for years 1998 and prior totaling
approximately $3.6 million.
UNDERWRITING AND OTHER EXPENSES
Underwriting and other expenses increased as a percentage of net premiums earned
from 19.5% in 1998 to 21.9% in 1999 due to a variety of factors, including
increased personnel count, an impairment charge related to intangible assets, a
reallocation of certain corporate overhead expenses, an increase in the
provision for doubtful accounts, and technological initiatives.
Since the second quarter of 1998, the Company increased its personnel count by
approximately 260 employees, including several members of senior management and
the formation of several underwriting units, resulting in increased salary
expenses of approximately in 1999 $16 million.
The Company periodically evaluates the recoverability of its intangible assets.
During 1999, the Company determined that the undiscounted cash flows related to
Western and Regency were not sufficient to support the related goodwill.
Accordingly, goodwill for Western and Regency of approximately $13.6
million and $1.5 million, respectively, was charged to operations during 1999.
During the third quarter of 1999, the Company recorded a $5.3 million
adjustment resulting from a reallocation of certain corporate overhead and
administrative expenses which were previously included in LAE allocated to the
Company's underwriting departments. This reallocation was based on a recently
completed time study performed in connection with the Company's third quarter
reserve analysis and related claim study, which concluded that certain corporate
and administrative personnel were not spending as much time adjusting losses as
they previously had. When the allocations being used were updated, the result
was a decrease in LAE and a corresponding increase in underwriting and other
expenses.
27
<PAGE>
Underwriting and other expenses include a provision for doubtful accounts during
1999 of approximately $3.8 million. In connection with the reorganization of the
administrative structure of its premiums receivable area, the Company changed
certain procedures utilized in the analysis of doubtful accounts and increased
its aggressiveness in the collection and adjustment of delinquent premium
balances. While the changes have resulted in improved cash flow for
traditionally delinquent accounts, it also resulted in accelerating the
identification, assessment and provision for outstanding balances deemed
uncollectible.
During 1999, the Company incurred approximately $5.7 million in expenses in
connection with several technological and e-commerce initiatives.
The overall increase in underwriting and operating expenses was partially offset
by approximately $1.7 million due to the net impact of two recently adopted
accounting standards (see Note B of the Notes to the Consolidated Financial
Statements - Impact of Recently Issued Accounting Standards). Additionally, 1998
expenses were negatively impacted by a $10 million charge to cancel the
aggregate excess stop loss agreement for the 1999 treaty year.
INTEREST EXPENSE
The increase in interest expense in 1999 over 1998 was due to increased amounts
borrowed under the Deutsche Bank credit facility. During 1999, the Company
borrowed an additional $50.8 million, under the credit facility which combined
with the $92 million balance at December 31, 1998, resulted in significantly
higher interest expense during 1999.
INCOME TAXES
During 1999, the Company established a valuation allowance related to its
deferred tax asset of approximately $123.6 million. For additional disclosure
regarding income taxes, see Note G of the Notes to the Consolidated Financial
Statements).
CALENDAR YEAR 1998 COMPARED TO CALENDAR YEAR 1997
The 34% increase in net premiums earned during 1998 compared to 1997 was
primarily attributable to the acquisition of several new subsidiaries, including
the purchase of Lyndon in May 1997, Acceleration in January 1998, and Western
Indemnity and Environmental Commercial Insurance Agency, Inc. ("ECI") in
December 1997. In addition, business has increased in some of the Company's core
programs in the Surety and Specialty Programs Divisions as a result of
geographical expansion.
Net premiums earned for the Health Care Division increased 18% from $167 million
in 1997 to $197 million in 1998. Psychiatry and counseling programs showed an
increase of approximately $12 million in 1998 compared to 1997 mainly due to a
new business relationship with the American Professional Agency which began in
late 1997. In addition, the Company purchased Western Indemnity in December of
1997 which generated an increase in net premiums earned of $23 million. Net
earned premiums for dental and daycare programs increased approximately $1
million and $11 million, respectively, as a result of geographic expansion.
These increases were slightly offset by the Company's planned decrease in
writings for less profitable classes, mainly physicians, including the sale of
the Company's Florida physicians business in December of 1997.
Net premiums earned for the Surety Division continued to grow in most programs
due to geographic expansion and the acquisition of several bond agencies with a
14% increase from $65 million in 1997 to $74 million in 1998. This growth
occurred primarily in the custom bonds, subdivision bonds, license and
28
<PAGE>
permit, and landfill programs and was partially offset by a decline in contract
bond business for small contractors amounting to approximately $4 million.
Net premiums earned for the Alternative Risk Division were relatively flat in
1998 compared to 1997. This was primarily due to the discontinuance of an
earthquake program in 1998, which resulted in an approximate $2 million decrease
in earned premium offset by modest growth in several smaller programs.
The increase in net premiums earned for the Specialty Programs Division was due
to growth in many small programs. Our focus on a variety of small commercial
auto related programs introduced in late 1998 generated approximately $2 million
of earned premium during the year and the Company's investment in the Ward
Agency resulted in an additional $2 million of earned premiums in 1998.
Geographic expansion of the title agents program resulted in an additional $5
million in net premiums earned in 1998 over 1997. The remaining increase of
approximately $3 million in earned premium is attributable to growth in a number
of smaller programs such as a summer camp program and an artisan contractors
program, none of which were individually significant.
The increase in net premiums earned for the Environmental, Excess and Surplus
Lines Division was primarily attributable to growth in the environmental and
pollution liability program. Net premiums earned for the program increased
approximately $15 million from 1997 to 1998 due to the acquisition of the ECI
Agency. In addition, the California contractors liability program showed an
increase of $1 million from 1997 to 1998. The remaining increase was due to
organic growth in existing programs.
The increase in net earned premium for the Personal and Credit Related Division
was primarily attributable to the acquisition of Lyndon in May 1997 and
Acceleration in January 1998, generating approximately $62 million in additional
net premiums earned in 1998 when compared to 1997.
NET INVESTMENT INCOME
Net investment income before realized capital gains and losses increased 31% 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.
LOSSES AND LOSS ADJUSTMENT EXPENSES
During the fourth quarter of 1998, the Company completed an in-depth analysis of
its loss and LAE reserves. As a result, the Company increased its reserves for
unpaid losses and LAE by approximately $155 million. The analysis indicated
significant deficiencies in loss and LAE in the Company's medical malpractice,
general liability and surety lines of business. The increase in the medical
malpractice loss and LAE reserves was primarily due to poor results in business
written for individual physicians in various is states, most notably Ohio,
Illinois, Texas and Michigan. The increase in general liability and surety
reserves was due to unfavorable development in LAE reserves. For additional
disclosure regarding this reserve charge and loss and LAE reserves refer to Note
H of the Notes to the Consolidated Financial Statements - Unpaid Loss and Loss
Adjustment Expenses.
AMORTIZATION OF POLICY ACQUISITION COSTS
Amortization of policy acquisition costs as a percentage of net premiums earned
increased from 20.6% in 1997 to 23.1% in 1998. This increase was due primarily
to the acquisition of Acceleration, which for the 1998 year
29
<PAGE>
incurred approximately $9.1 million of policy acquisition costs. Also
contributing to this increase was increased premium volume in the Surety
Division where commission rates paid to agents tend to be higher.
UNDERWRITING AND OTHER EXPENSES
Underwriting and other expenses as a percentage of net premiums earned increased
from 16.2% in 1997 to 19.5% in 1998. The increase is primarily due to a
$10 million termination fee relative to the Company's aggregate excess stop loss
agreement for the 1999 treaty year, an increase in the allowance for doubtful
accounts of approximately $3.5 million and a restructuring charge of
$0.3 million related to the closing of one of the Company's Health Care Division
offices. Underwriting and other expenses were also higher in 1998 due to the
move of the Surety Division to Nashville and costs incurred related to a
start-up business unit within the Specialty Programs Division.
INTEREST EXPENSE
The increase in interest expense was due to increased amounts borrowed under the
Deutsche Bank credit facility.
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, 1999, the
Company held investment grade rated securities with a carrying value of $1.13
billion, representing 97.4% of total fixed maturity investments. Fixed maturity
investments with credit ratings below investment grade, which are maintained as
part of the alternative investment portfolio, totaled $30.5 million at December
31, 1999 and represented the 2.6% balance of the total fixed maturity
investments.
At December 31, 1999 and 1998, the Company's fixed maturity investments included
mortgage-backed securities of $368.8 million and $391.3 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, 1999,
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 $43.1 million and $27.3 million at December
31, 1999 and 1998, respectively. The partnerships have varying investment
strategies and these investments were made by the Company with the objective of
long-term capital
30
<PAGE>
appreciation. The investments generally contain lock-up provisions which require
the Company to hold the investments for a specified time horizon, thus limiting
their liquidity.
The Company treats the partnership interests as available for sale and limits
recognition of income and capital gains to that which is realized by the
individual partnerships. At December 31, 1999, the partnership investments had
an unrealized gain of $10.8 million. In addition, the Company had unfunded
commitments to limited partnerships of $6.2 million to be funded over the next
four years. All partnership investments are consistently reviewed and monitored
by internal investment personnel.
LIQUIDITY AND CAPITAL RESOURCES
The Company is a holding company that historically has funded its cash
requirements through sales of its common stock and borrowings. The Company's
insurance subsidiaries have not historically been a source of liquidity for the
Company and are subject to dividend restrictions as described in Note Q of the
Notes to the Consolidated Financial Statements. Currently, the only insurance
subsidiary that can pay dividends to the Company without the prior approval of
the insurance commissioner of its domicile is Regency. The maximum dividend that
Regency can pay without such prior approval is approximately $0.3 million.
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 and,
until the end of 1999, the Company's revolving credit facility with a bank group
consisting of five banks headed by Deutsche Bank AG, New York Branch ("Deutsche
Bank"). Funds borrowed under the credit facility during 1999 amounted to
approximately $50.8 million and were primarily used to purchase treasury stock
and several small insurance agencies. As a result of the significant reserve
charge during the third quarter of 1999, Deutsche Bank suspended any further
loans to the Company under the facility until certain credit terms could be
renegotiated. In January 2000, terms of the credit agreement were amended and
the commitment under the facility was permanently reduced to $67.5 million and,
pursuant to the terms of an amendment to the credit facility, the Company
applied $75 million of the net proceeds from the sale of Lyndon (see Note S of
the Notes to the Consolidated Financial Statements) to repay outstanding loans
under the facility. In addition, the common stock of Frontier and Western
and other ownership interests in certain noninsurance subsidiaries
were pledged by the Company as collateral for amounts outstanding under the
credit facility.
Under the revised terms of the credit facility, the Company is subject to
certain financial and nonfinancial 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. At December 31, 1999,
the Company violated certain covenants which were waived by the banks. In
addition, due to its significantly weakened financial condition and the expected
negative impact on operations resulting from recent rating downgrades, the
Company expects to violate certain revised covenants during 2000. The Company
has received a waiver of these expected violations through April 30, 2000 and is
currently negotiating revised covenants with the banks. Should the Company be
unable to obtain waivers of such covenants and be in violation thereof, the
banks could elect to accelerate repayment of the amounts outstanding under the
credit facility and exercise their rights with respect to the stock and
ownership interests pledged as collateral.
The net proceeds of $144.5 million from a common stock offering in 1997, and
$166.7 million from the sale of convertible trust originated preferred
securities during 1996, provided the principal funding for the strategic
acquisitions completed during 1998 and 1999 (see Note C of the Notes to the
Consolidated Financial Statements).
31
<PAGE>
The liquidity needs of the Company's insurance subsidiaries are generally met
through cash provided by operating activities. However, during 1998 and in
January of 2000, additional funds of approximately $62.6 million and $80 million
were contributed to the Company's insurance subsidiaries in order to maintain
certain minimum surplus levels after significant reserve charges in 1998 and
1999. The $62.6 million capital contribution was funded through the Company's
credit facility and the $80 million capital contribution was funded by the net
proceeds received from the sale of Lyndon.
The Company has authorized a stock repurchase program to purchase 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 and 2,135,446 shares at a cost of $25.9
million in 1999. The Company has no commitment or obligation to purchase any
particular number of shares and, given its current financial condition, has
suspended the program indefinitely.
Due to the Company's current financial condition it is likely that traditional
sources of financing such as the issuance of debt or equity securities may not
be available. The Company is currently pursuing the sale of Regency, Western
and its Surety Division operations, which, if completed, would provide
sufficient funding for its liquidity and capital needs. However, the successful
consummation of such sales cannot be assured. Additionally, any significant
transactions involving the disposition of insurance subsidiaries or their assets
would require the approval of insurance regulators and the Company's creditors.
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 are currently rated B ("Fair") by
A.M. Best Company, Inc. ("A.M. Best"), which has advised the Company that the
Company's failure to sell additional assets to provide holding company liquidity
and/or bolster the capital of Frontier, or a continuation of poor operating
performance, may result in further downward ratings adjustments.
S&P has suspended its financial strength rating of BB+ ("Marginal") on all of
the Company's insurance subsidiaries, which currently are not rated by S&P.
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
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, to its Authorized Control Level RBC, as defined by the
NAIC. Companies below specific trigger points or ratios are classified
32
<PAGE>
within certain levels, each of which may require specific corrective action
depending upon the insurer's state of domicile. The levels and ratios are as
follows:
<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, 1999, all of the Company's insurance subsidiaries,
with the exception of Frontier, met the RBC requirements. Frontier, the
Company's largest insurance subsidiary, is domiciled in New York State. The
Department utilizes its own methodology for computing capital adequacy and does
not follow the NAIC RBC guidelines. However, many of the other states in which
Frontier writes business have adopted the NAIC RBC guidelines. In accordance
with the NAIC RBC guidelines, at December 31, 1999, Frontier was at the
Authorized Control Level. The Authorized Control Level authorizes the
commissioner of a state insurance department to take whatever regulatory actions
it considers necessary to protect the best interest of the policyholders and
creditors of an insurer, which could include placing Frontier under regulatory
control (i.e., rehabilitation or liquidation). In addition, failure to meet
capital requirements and other requirements which may be imposed by the
insurance departments, or further unfavorable operating results in future
periods, could expose Frontier to regulatory sanctions that may include
restrictions on operations and growth and/or mandatory asset dispositions.
The Company has submitted a Corrective Action Plan to the
superintendent of the Department and to many of the other state insurance
departments in states for which Frontier writes business. It is uncertain what
actions, if any, the insurance departments will take with respect to Frontier.
While the Company expects to maintain or improve the current RBC ratio level of
its insurance subsidiaries, it cannot predict all events that could cause this
ratio to decrease to the point of increased oversight by the Department or by
other departments of the states in which the Company's subsidiaries are
domiciled.
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 SAP ("Codification"). Codification will
change, to some extent, prescribed SAP and may result in changes to the
accounting practices that the Company's insurance subsidiaries use to prepare
their statutory-basis financial statements. Codification requires 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 states of domicile must adopt Codification as the
prescribed basis of accounting for domestic insurers to report their
statutory-basis results to the insurance department. As of December 31, 1999,
all of the states of domicile for the Company's insurance subsidiaries had
adopted or indicated their intent to adopt Codification, in whole or in part,
with an effective date of January 1, 2001. Management has not yet determined the
impact of Codification on the statutory surplus of the Company's insurance
subsidiaries.
33
<PAGE>
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. The
impact of these regulatory efforts on the Company's operations cannot be
quantified until enacted.
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 1995 through
1997. Under the agreement, Zurich N.A. provided 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 was 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.)
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. In addition there are line of business specific aggregate
limits for medical malpractice and excess workers' compensation. As of December
31, 1998, the Company had exceeded these aggregates.
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 in the New York Court of
Claims (the "Court of Claims") which were ultimately affirmed by the State's
highest court, the Court of Appeals, 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.
In September 1998, the Company and the State reached an agreement with respect
to the 83 cases currently being litigated in the Court of Claims pursuant to
which the Company received $15 million.
In addition to the action in the Court of Claims, the Company was pursuing
litigation in the New York Supreme Court (the "Supreme Court") that would
require the State to defend SUNY faculty members. The Supreme Court litigation
differed from the Court of Claims litigation, in that the Company was not
attempting to recover funds spent on the settlement of claims. In 1997, the
Company received an adverse determination on its action in the Supreme Court.
34
<PAGE>
In December 1999, on a procedural motion in the Court of Claims, the Court
linked the 1997 adverse decision on the duty to defend litigation to the
Company's right to reimbursement and ruled that the Supreme Court decision would
govern the future outcome of any cases in the Court of Claims. Although the
Company is continuing to seek recovery from the State in the Court of Claims,
the December 1999 ruling may have a significant adverse impact on the Company's
ability to recover amounts paid by the Company on behalf of SUNY physicians. As
a result, at December 31, 1999 the amount of subrogation recoverables recorded
by the Company related to the SUNY litigation was approximately $1.5 million,
reflecting an approximate $15.5 million reduction from the amount recorded at
December 31, 1998.
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.
IMPACT OF THE YEAR 2000
In prior filings, the Company discussed the nature and progress of its plans to
become Year 2000 ready. In late 1999, the Company completed its remediation and
testing of its information technology ("IT") systems. As a result of those
planning and implementation efforts, the Company experienced no significant
disruptions in mission critical IT systems and believes those systems
successfully responded to the Year 2000 date change.
Costs incurred in connection with remediating the Company's systems, amounted to
approximately $3 million, including approximately $1 million during 1999. The
Company is not aware of any material problems resulting from Year 2000 issues,
either with its internal systems, or the products and services of third parties.
The Company will continue to monitor its mission critical computer applications
and those of its suppliers and vendors throughout the year 2000 to ensure that
any latent Year 2000 matters that may arise are addressed promptly.
The Company also conducted a comprehensive review of its underwriting guidelines
and obtained regulatory approval from most jurisdictions to add an endorsement
to commercial property and casualty policies to clarify that coverage is not
afforded losses resulting from Year 2000 noncompliance by insureds. This
endorsement was added to the majority of commercial policies issued or renewed
in 1999. Underwriting policy and protocol were developed to address nonapproving
jurisdictions and business situations that cannot be endorsed. To date, Year
2000 claims reported to the Company have been minimal. 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.
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. In addition, United Capitol's product liability and other primary
general liability policies contain exclusions for coverage of claims for bodily
injury
35
<PAGE>
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.
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.
In June 1999, plaintiffs were granted permission to amend their complaint and to
reopen discovery to take additional depositions and request additional
documents. The additional depositions have been taken. In February 2000, the
plaintiffs made an additional motion to amend their complaint wherein they seek
to have the class period, which presently runs from February 10, 1994 through
November 8, 1994, extended to November 15, 1999. The motion also seeks to add an
additional plaintiff and defendant. Plaintiffs also seek to allege that
increases in reserves taken by the Company in various reporting periods
subsequent to November 1994 evidence an ongoing fraud. The Court has not ruled
on this motion.
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 or results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The main objectives in managing the investment portfolios of the Company and its
subsidiaries are to maximize after-tax investment income and total investment
returns. Investment strategies are developed based on a number of factors,
including estimated duration of reserve liabilities, short and long-term
liquidity needs, projected tax status, general economic conditions, expected
rates of inflation, and regulatory requirements. Investment decisions are
managed based on investment guidelines approved by Company management.
The Company'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. The market
risks which most effect the Company investment portfolios are interest rate risk
and equity price risk.
36
<PAGE>
Interest rate risk is the price sensitivity of a fixed income security or
portfolio to changes in interest rates. These potential changes in price are
analyzed within the overall context of asset and liability management. Our
actuaries estimate the payout pattern of its liabilities to determine their
duration which is the present value of the weighted average payments expressed
in years. Duration targets for the fixed income portfolios are established after
consideration of the duration of these liabilities and other factors, which
management believes mitigates the overall effect of interest rate risk to the
Company. Analytical tools and monitoring systems are in place to evaluate
interest rate risk.
Set forth below is Table 1 which details the material impact of hypothetical
interest rate changes on the fair value of certain core fixed income segments
held at December 31, 1999. 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 simulations. Additionally, based upon the
yield curve shifts, estimates of prepayment speeds for the mortgage related
products and likelihood of call or put options being exercised were employed in
the simulations.
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 $ 128,031 $ 130,437 $ 132,960 $ 135,601 $ 138,370
- --------------------------------------------------------------------------------------------------------------
Mortgage-backed securities 355,248 362,024 368,792 375,374 381,568
- --------------------------------------------------------------------------------------------------------------
Municipal securities 234,585 240,259 245,938 251,702 257,615
- --------------------------------------------------------------------------------------------------------------
Corporate securities 400,166 406,863 413,965 421,651 430,025
- --------------------------------------------------------------------------------------------------------------
Total $1,118,030 $1,139,583 $1,161,655 $1,184,328 $1,207,578
- --------------------------------------------------------------------------------------------------------------
</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 $87,683 $79,712 $71,741
- -----------------------------------------------------------------------------------------
</TABLE>
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.
37
<PAGE>
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> <C>
Jerry E. Goldress 69 Director and Chairman of the Board (Non-executive)
Harry W. Rhulen 36 President, Chief Executive Officer and Director
Suzanne Rhulen Loughlin 39 Executive Vice President--Chief Administrative Officer
and Director
Patrick W. Kenny 57 Executive Vice President--Chief Financial Officer and Treasurer
James W. Satterfield 51 Executive Vice President--E-Commerce
Joseph P. Loughlin 40 Executive Vice President--Chief Claims Officer and Secretary
Richard F. Seyffarth 52 Executive Vice President--Chief Investment Officer
Douglas C. Moat 68 Executive Vice President--Mergers and Acquisitions and Director
Mark H. Mishler 41 Executive Vice President and President of Frontier Insurance Company
Peter L. Rhulen 61 Director
Lawrence B. O'Brien 59 Director
Ronald L. Bornhuetter 67 Director
</TABLE>
Jerry E. Goldress was appointed Chairman of the Board (Non-executive) in
February 2000. Mr. Goldress is Chairman of the Board and Chief Executive Officer
of Grisanti, Galef and Goldress, Inc. ("GGG"), a company specializing in
corporate turnarounds. Prior to joining GGG, Mr. Goldress held senior management
positions with Raytheon, General Electric, and General Motors.
Harry W. Rhulen, a director of the Company since October 1997, was elected
President, Chief Executive Officer and Director 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. Rhulen resigned his position as Chairman
of the Board in February 2000. Mr. 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, and in February 2000, was elected Chief
Financial Officer. 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.
38
<PAGE>
James W. Satterfield was elected Executive Vice President--Chief Operating
Officer in 1998 and, in February 2000, was elected Executive Vice President of
E-Commerce, 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, 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 an Executive Vice President and President of
Frontier in February 2000, having served as Vice President--Chief Financial
Officer of the Company since May 1997, Vice President--Finance and Treasurer
since October 1996, Vice President and Controller of Frontier since 1995 and an
employee of the Company since 1987. Mr. Mishler has more than 18 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.
Ronald L. Bornhuetter was appointed director in April 2000. Since 1987, Mr.
Burnhuetter had been Chairman of the Board of NAC Re Corporation, where he was
also Chief Executive Officer until 1998. He retired from NAC Re Corporation in
July 1999, at which time the corporation merged with XL Capital Ltd., where he
is currently a Director and member of the finance Committee. Prior to joining
NAC Re, Mr. Burnhuetter was Chief Financial Officer of General Re Corporation.
Mr. Bornhuetter is a Fellow of the Casualty Actuarial Society, a member of
the American Academy of Actuaries and the International Actuarial Association. A
former President of both the Casualty Actuarial Society and the American Academy
of Actuaries, Mr. Bornhuetter is co-author of the "Borhuetter/Ferguson" loss
reserve approach.
39
<PAGE>
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.
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, 1999 and the two preceding
years.
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
- --------------------------------------------------------------------------------------------------------------
LONG-TERM
NAME AND ANNUAL COMPENSATION COMPENSATION ALL OTHER
PRINCIPAL SALARY BONUS AWARDS COMPENSATION
POSITION YEAR ($) ($) OPTION (#) ($) (1)
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Harry W. Rhulen 1999 $533,000 $ 60,000 34,807(7) $17,000
President and Chief 1998 459,000 150,000 1,025,356(2)(5) 34,100
Executive Officer 1997 188,000 150,000 15,400(4) 17,500
Douglas C. Moat 1999 303,000 40,000 20,922(7) 8,000
Executive Vice President 1998 250,000 100,000 30,644(2)(3) 5,000
1997 - - - -
James W. Satterfield 1999 332,000 40,000 279,999(7)(6) 13,000
Executive Vice President 1998 284,000 100,000 21,216(2) 21,400
1997 257,000 75,000 5,500(4) 19,500
Richard F. Seyffarth 1999 282,000 40,000 274,067(7)(6) 12,300
Executive Vice President 1998 193,000 100,000 14,300(2) 14,400
1997 143,000 40,000 4,400(4) 9,500
Theodore J. Rupley 1999 271,000 100,000 1,711(7) 12,100
Executive Vice President 1998 - - - -
(resigned February 2000) 1997 - - - -
Walter A. Rhulen* 1999 - - - -
Former President, Chief 1998 - - - -
Executive Officer and 1997 519,000 200,000 275,000(8) 59,800
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 401(k) plan. In 1999, contribution for 401(k) plan
only.
(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.
40
<PAGE>
(6) 258,500 shares each exercisable at prices ranging from $14.12 to $35.31
through December 31, 2005.
(7) Exercisable cumulatively at the rate of 25% of the underlying shares per
year, commencing December 31, 2000, by Messrs. Rhulen, Moat, Satterfield,
Seyffarth, and Rupley with respect to 34,807, 20,922, 21,499, 15,567 and
1,711 shares, respectively.
(8) Exercisable through December 31, 2001 by the Estate of Walter A. Rhulen.
The following table sets forth certain information concerning options granted
during 1999 to the individuals named in the Summary Compensation table:
OPTION GRANTS IN 1999
<TABLE>
<CAPTION>
NUMBER OF % OF TOTAL POTENTIAL REALIZABLE VALUE
SECURITIES OPTIONS OF ASSUMED ANNUAL RATES OF
UNDERLYING GRANTED EXERCISE STOCK PRICE APPRECIATION
OPTIONS TO ALL PRICE EXPIRATION FOR OPTION TERM
NAME GRANTED (#) EMPLOYEES ($/SHARE) DATE 5% ($) 10% ($)
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Harry W. Rhulen 34,807 .85% $3.44 12/31/2004 $ 33,057 $ 73,047
Douglas C. Moat 20,922 .51 3.44 12/31/2004 19,870 43,907
James W. Satterfield 258,500 6.29 14.12-35.31 12/31/2005 - -
21,499 .52 3.44 12/31/2004 20,418 45,118
Richard F. Seyffarth 258,500 6.29 14.12-35.31 12/31/2005 - -
15,567 .38 3.44 12/31/2004 14,784 32,669
Theodore J. Rupley 1,711 .04 3.44 12/31/2004 1,625 3,591
</TABLE>
The following table presents the value of unexercised options held at December
31, 1999 by the individuals named in the Summary Compensation Table:
OPTIONS VALUE TABLE
<TABLE>
<CAPTION>
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT YEAR-END (#) MONEY OPTIONS AT YEAR-END
EXERCISABLE (E)/ ($)* EXERCISABLE (E)/
UNEXERCISABLE UNEXERCISABLE(U)
- --------------------------------------------------------------------------------
<S> <C> <C>
Harry W. Rhulen 1,012,590 (E) (1) - (E)
69,023 (U) - (U)
Douglas C. Moat 21,961 (E) - (E)
35,655 (U) - (U)
James W. Satterfield 277,554 (E) - (E)
40,161 (U) - (U)
Richard F. Seyffarth 269,225 (E) - (E)
30,142 (U) - (U)
Theodore J. Rupley - (E) - (E)
1,711 (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.
41
<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, 1999 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 34, 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 210,658(3) 1,239,465(6) 4.3%
Peter L. Rhulen (2) 1,305,173(4) 6,250 3.9
Lawrence E. O'Brien 56,784 12,300 *
Douglas C. Moat 42,954 21,961 *
Suzanne R. Loughlin 268,760(5) 498,653(6) 2.3
James W. Satterfield 20,437 277,554 *
Richard F. Seyffarth 14,316 269,225 *
Theodore J. Rupley - - *
Joan R. Farrow
34 Benton Avenue
Monticello, NY 12701 1,809,249(9) - 5.4
HAES Investment Limited Partnership
c/o Judith Rhulen
471 Starlight Road
Monticello, NY 12701 2,010,401(10) - 5.9
West Highland Capital, Inc.
300 Drake's Landing Rd., Suite 290
Greenbrae, CA 94904 2,000,000(7) - 5.9
Dimensional Fund Advisors, Inc.
1299 Ocean Avenue 11th Fl.
Santa Monica, CA 90401 2,010,457(8) - 5.9
All directors and executive officers as
a group (13 persons) 2,365,644 2,616,691 14.7
</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 1,159 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 20,365 shares owned by Ms. Loughlin's husband, as to which Ms.
Loughlin disclaims beneficial ownership.
42
<PAGE>
(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 10, 1999, filed by West
Highland Capital, Inc., which reflects shared dispositive power with
respect to 2,000,000 shares.
(8) Information is from Schedule 13G dated February 3, 2000, filed by
Dimensional Fund Advisors, Inc., which reflects shared dispositive power
with respect to 2,010,457 shares as of December 31, 1999.
(9) Information supplied by American Stock Transfer & Title Company, transfer
agent of the Company's Common Stock.
(10) A limited partnership in which Judith Rhulen is a general partner and
limited partners are Harry W. Rhulen, Anthony Rhulen, Erik Rhulen and
Suzanne R. Loughlin.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Metro Partners, Inc.
During 1998, the Company purchased 180 shares of Metro Partners, Inc. ("Metro
Partners") for $600,000 representing a 30% interest in Metro Partners. Metro
Partners was organized in 1998 and 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 organized Metro Partners
and were 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.
In April 1999, the Company purchased an additional 180 shares representing a 30%
interest in Metro Partners common stock from Mr. Rhulen for $210,000.
Accordingly, the Company's ownership interest in Metro Partners at December 31,
1999 was 60%. The Company also loaned Metro Partners an additional $1.4 million
during 1999 with interest rates ranging from 8.75% to 9.25%, bringing the total
loans outstanding to Metro Partners to $2.4 million, including accrued interest,
at December 31, 1999. The Company also has an outstanding letter of credit of
$250,000 issued to Metro Partners' landlord as collateral for its real estate.
In addition to its common stock ownership, at December 31, 1999, the Company
owns $500,000 of Metro Partners preferred stock.
Prior to the Company's acquisition of its 60% controlling interest, the Company
recorded a net investment loss of approximately $180,000. Subsequent to its
acquisition, the accounts and operation of Metro Partners, after elimination of
intercompany accounts and transactions, have been consolidated with the Company.
The Company's share of Metro Partners' net loss from operations since
acquisition of its 60% interest, amounts to approximately $795,000. In addition,
during 1999 the Company also wrote-off approximately $1.3 million in goodwill
relating to its investment in Metro Partners.
During the first quarter of 2000, the Company purchased Emmis Holdings, a
holding company which owns 30% of Metro Partners for approximately $97,000, thus
increasing the Company's ownership to 90%. Mr. Moat owned 27.5% of Emmis
Holdings.
43
<PAGE>
Director and Officer Loans and Guarantees
In June 1998, the Company guaranteed a loan of $1.25 million for Thomas J. Dietz
("Dietz"), an officer of the Company, which guaranty was outstanding at December
31, 1998 and secured by United States Treasury Notes (the "Notes") pledged as
collateral. During 1999, the Company increased its guaranty to $2 million, the
amount of the guaranty outstanding at December 31, 1999. Under a Security and
Indemnity Agreement (the "Agreement") between the Company and Dietz executed in
December 1999, Dietz granted the Company a security interest in his unpledged
personal assets as security for the Company's guaranty. At December 31, 1999,
the Company has established an allowance of $750,000 for its exposure to the
Dietz guaranty.
In February 2000, after a principal repayment of $250,000 by Dietz to his
creditor, the Company's guaranty was reduced to $1.75 million. In March 2000,
the Company, in exchange for the extinguishment of its remaining guaranty,
transferred $1.8 million in Notes pledged as collateral to a Dietz account
maintained by the creditor free and clear of any interest to the Company. In
exchange, Dietz transferred 97,338 personally owned shares of the Company's
Common Stock with a market value of $200,000 to the Company. In connection with
these transfers, Dietz executed an amendment to the Agreement under which he
promised to pay an additional $250,000 in principal to the creditor during 2000
and $250,000 every year thereafter until the obligation is repaid. As such
payments are made, the Notes will be returned to the Company.
In August 1998, the Company guaranteed a loan of $1 million and, in December
1998, guaranteed an additional $800,000 for Peter L. Rhulen ("Rhulen"), a
director of the Company, which guarantees were outstanding at December 31, 1998
and secured by United States Treasury Notes (the "Treasuries"). During 1999, and
prior to November 1999, the Company increased the guarantees for Rhulen to $12.5
million. In November 1999, the Company, in exchange for the extinguishment of
one of its guarantees, transferred $4.5 million of the Treasuries to a Rhulen
account maintained by Rhulen's creditor, free and clear of any interest to the
Company. In exchange, Rhulen transferred 930,212 personally owned shares of the
Company's Common Stock with a market value approximating the value of the
transferred Treasuries to the Company. Under a Security and Indemnity
Agreement between the Company, Rhulen and his wife, the Company was granted a
security interest in their unpledged personal assets as security for the
Company's guaranty. After these transactions, approximately $8.6 million of
guarantees remained outstanding at December 31, 1999.
During the first quarter of 2000, the Company purchased certain investments from
Rhulen for approximately $7.6 million which represented approximately 95% of
such investments estimated fair value. At the same time, Rhulen repaid his
creditor approximately $8.2 million of his outstanding obligation. As such, at
March 31, 2000, the Company's outstanding guarantees for Rhulen were reduced to
$400,000.
Film Bond International ("FBI")
During 1998, the Company loaned an aggregate of $150,000 at a 6.5% interest rate
to FBI, a company that Anthony Rhulen, the brother of Harry Rhulen and Suzanne
Loughlin, subsequently joined as a principal and Chief Executive Officer. During
1999, the Company loaned FBI an additional $455,000 at a 6.5% interest rate and
guaranteed a loan to FBI for $150,000. The loss of Frontier's A- rating from
A.M. Best contributed to the inability of FBI to continue operating. As such,
the Company has since forgiven the loans, and related accrued interest to FBI
and has assumed full responsibility for the amount of the guaranty resulting in
a charge of approximately $800,000 during 1999.
44
<PAGE>
Officer Loan Program
In December 1998, the Company initiated a program to facilitate the purchase of
its Common Stock by key management executives. Under the program, a financial
institution loans funds to the executive for such purchase, depending on the
executive's level of responsibility at the Company. Borrowings under the credit
facility are guaranteed by the Company and the shares purchased are pledged with
the financial institution as collateral for the loan by the executive, who is
responsible for its repayment and payment of the related interest. As
part of the program, the Company grants the executives options on December 31 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.
At December 31, 1999, 222,321 options were granted to participating executives
as of that date with an exercise price of $3.44. At December 31, 1999, the total
amount borrowed by executives and guaranteed by the Company was approximately
$4,418,000 which exceeded the fair market value of the 335,653 shares of common
stock pledged as collateral by $3,277,000. Also, at December 31, 1999 amounts
due from executives for interest paid on their behalf related to the outstanding
loans was approximately $254,000.
The Company's nine executive officers are participating in the program and on
December 31, 1999, loans outstanding to them and guaranteed by the Company were
as follows: Mr. Harry W. Rhulen, $450,000; Ms. Suzanne Rhulen Loughlin $200,000;
Mr. Patrick W. Kenny, $300,000; Mr. James W. Satterfield, $270,000; Mr. Joseph
P. Loughlin, Esq., $175,000; Mr. Richard F. Seyffarth, $182,000; Mr. Douglas C.
Moat, $250,000; and Mr. Mark H. Mishler, $200,000.
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 filed on February 4, 2000 for an event (the disposition
of assets - sale of Lyndon Insurance Group, Inc. to Protective Life
Insurance Company) which occurred January 20, 2000.
(c) Exhibits.
See Index to Exhibits
45
<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, 1999
FRONTIER INSURANCE GROUP, INC.
ROCK HILL, NEW YORK
<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, 1999 and 1998.................................................... F-3
Consolidated Statements of Operations and Comprehensive Income--Years Ended
December 31, 1999, 1998 and 1997........................................................................ F-5
Consolidated Statements of Shareholders' Equity--Years Ended
December 31, 1999, 1998 and 1997........................................................................ F-6
Consolidated Statements of Cash Flows--Years Ended
December 31, 1999, 1998 and 1997........................................................................ F-7
Notes to the Consolidated Financial Statements............................................................. F-8
Supplemental Data--Quarterly Results of Operations (Unaudited)............................................. F-48
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-49
Schedule IV--Reinsurance................................................................................... F-52
Schedule V--Valuation and Qualifying Accounts.............................................................. F-53
Schedule VI--Supplemental Information Concerning
Property/Casualty Insurance Operations.................................................................. F-54
</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>
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, 1999 and 1998, 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, 1999. 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 auditing standards generally accepted
in the United States. 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, 1999 and 1998,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 1999, in conformity with
accounting principles generally accepted in the United States. 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.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As more fully described in Note A to
the financial statements, the Company has incurred recurring operating losses,
has weakened insurance operation capitalization and parent holding company
liquidity, and is in noncompliance with certain covenants of loan agreements
with banks. These conditions raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans as to these
matters are also described in Note A. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
/s/ Ernst & Young
New York, New York
April 7, 2000
F-2
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Consolidated Balance Sheets
(dollar amounts in thousands)
<TABLE>
<CAPTION>
DECEMBER 31
1999 1998
--------------------------------------
<S> <C> <C>
ASSETS
Investments:
Fixed maturity securities, available for sale $ 1,161,655 $ 1,199,084
Equity securities, available for sale 79,712 57,328
Limited investment partnerships 43,085 27,291
Equity investees 16,968 16,930
Real estate and mortgage loans 8,016 9,131
Short-term investments 105,244 149,548
--------------------------------------
Total investments 1,414,680 1,459,312
Cash 43,219 28,335
Premiums and agents' balances receivable, less allowances
for doubtful accounts (1999--$9,864; 1998--$6,025) 183,589 114,389
Reinsurance recoverables on:
Paid losses and loss adjustment expenses 45,025 30,626
Unpaid losses and loss adjustment expenses 473,633 448,424
Prepaid reinsurance premiums 176,607 137,790
Accrued investment income 16,848 16,517
Federal income taxes recoverable 647 24,775
Deferred policy acquisition costs 129,746 96,597
Deferred federal income taxes 10,565 46,434
Property, furniture, equipment and software 57,987 54,188
Intangible assets 44,217 54,782
Other assets 38,774 41,608
--------------------------------------
TOTAL ASSETS $ 2,635,537 $ 2,553,777
======================================
</TABLE>
See notes to the consolidated financial statements.
F-3
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Consolidated Balance Sheets (continued)
(dollar amounts in thousands, except per share data)
<TABLE>
<CAPTION>
DECEMBER 31
1999 1998
--------------------------------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Policy liabilities:
Unpaid losses $ 982,123 $ 831,839
Unpaid loss adjustment expenses 331,187 260,443
Unearned premiums 649,736 507,046
--------------------------------------
Total policy liabilities 1,963,046 1,599,328
Funds withheld under reinsurance contracts 137,894 182,211
Bank debt 142,800 92,000
Reinsurance balances payable 65,103 35,773
Cash dividend payable to shareholders - 2,578
Other liabilities 80,796 80,514
--------------------------------------
TOTAL LIABILITIES 2,389,639 1,992,404
Guaranteed preferred beneficial interest in Company's
convertible subordinated debentures 167,345 167,153
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: 150,000,000;
shares issued: 1999--37,646,663; 1998--37,594,709) 376 376
Additional paid-in capital 450,886 450,347
Accumulated other comprehensive income (loss), net of tax (18,617) 26,635
Retained deficit (314,431) (73,833)
--------------------------------------
118,214 403,525
Treasury Stock--at cost (1999--3,830,570 shares;
1998--766,912 shares) (39,661) (9,305)
--------------------------------------
TOTAL SHAREHOLDERS' EQUITY 78,553 394,220
--------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,635,537 $ 2,553,777
======================================
</TABLE>
See notes to the consolidated financial statements.
F-4
<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
1999 1998 1997
-----------------------------------------------------
<S> <C> <C> <C>
REVENUES
Premiums earned $ 570,928 $ 493,054 $ 366,844
Net investment income 77,622 73,528 56,122
Net realized capital gains 3,113 3,010 4,222
-----------------------------------------------------
Total net investment income 80,735 76,538 60,344
Net proceeds from company owned life insurance policy - 4,400 -
-----------------------------------------------------
Total revenues 651,663 573,992 427,188
EXPENSES
Losses 366,548 274,748 164,972
Loss adjustment expenses 172,830 168,105 69,596
Amortization of policy acquisition costs 143,092 114,076 75,666
Underwriting and other expenses 124,799 96,007 59,263
Minority interest in income of consolidated subsidiary trust 10,974 10,966 11,017
Interest expense 7,505 965 825
-----------------------------------------------------
Total expenses 825,748 664,867 381,339
-----------------------------------------------------
Income (loss) before income taxes (174,085) (90,875) 45,849
Provision for income taxes:
State 1,156 743 2,053
Federal 58,023 (41,576) 11,514
-----------------------------------------------------
Total income tax expense (benefit) 59,179 (40,833) 13,567
-----------------------------------------------------
NET INCOME (LOSS) (233,264) (50,042) 32,282
Other comprehensive income (loss), net of tax (45,252) 6,397 15,431
=====================================================
TOTAL COMPREHENSIVE INCOME (LOSS) $ (278,516) $ (43,645) $ 47,713
=====================================================
Earnings (loss) per common share:
Basic $ (6.65) $(1.34) $.94
=====================================================
Diluted $ (6.65) $(1.34) $.92
=====================================================
Weighted average common shares outstanding (in thousands):
Basic 35,068 37,293 34,195
Diluted 35,068 37,293 42,845
</TABLE>
See notes to the consolidated financial statements.
F-5
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Equity
(dollar amounts in thousands, except per share data)
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER RETAINED TOTAL
COMMON PAID-IN COMPREHENSIVE EARNINGS TREASURY SHAREHOLDERS'
STOCK CAPITAL INCOME (LOSS (DEFICIT) STOCK EQUITY
-----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
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 ($.28 per share) - - - (9,965) - (9,965)
Common stock dividend (10%) 34 79,787 - (79,821) - -
Net (purchase) reissuance of treasury stock - 12 - - (8,523) (8,511)
Tax benefit from disqualifying dispositions - 688 - - - 688
-----------------------------------------------------------------------
-----------------------------------------------------------------------
Balances at December 31, 1998 376 450,347 26,635 (73,833) (9,305) 394,220
Net loss - - - (233,264) - (233,264)
Issuance of common stock under employee stock purchase plan
purchase plan - 144 - - - 144
Stock options exercised - 246 - - - 246
Issuance of common stock related to acquisition - 102 - - - 102
Change in net unrealized gains on investments (net
of tax) - - (45,252) - - (45,252)
Cash dividends paid and accrued ($.21 per share) - - - (7,334) (7,334)
Net (purchase) reissuance of treasury stock - 47 - - (30,356) (30,309)
=======================================================================
Balances at December 31, 1999 $376 $450,886 $ (18,617) $ (314,431) $(39,661) $ 78,553
=======================================================================
</TABLE>
See notes to the consolidated financial statements.
F-6
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(dollar amounts in thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1999 1998 1997
----------------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $ (233,264) $ (50,042) $ 32,282
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Increase in policy liabilities 363,718 349,508 127,568
Increase in reinsurance balances (93,412) (173,640) (26,953)
Increase in agents' balances and premiums receivable (69,200) (17,497) (12,796)
Increase in deferred policy acquisition costs (33,149) (40,963) (20,318)
Increase in accrued investment income (331) (1,314) (7)
Deferred federal income tax expense (benefit) 60,432 (23,714) 2,800
Impairment of goodwill 15,034 - -
Depreciation and amortization 22,006 19,185 7,417
Realized capital gains (3,113) (3,010) (4,222)
Other 22,652 67,443 (10,627)
----------------------------------------------------------
Net cash provided by operating activities 51,373 125,956 95,144
INVESTING ACTIVITIES
Proceeds from sales of fixed maturity securities 207,869 140,221 102,409
Proceeds from calls, paydowns and maturities of fixed
maturity securities 124,288 163,161 108,768
Proceeds from sales of equity securities 45,511 31,117 18,738
Proceeds from sale of equipment 11,943 - -
Purchases of fixed maturity securities (369,528) (387,952) (285,634)
Purchases of equity securities (65,288) (59,876) (21,396)
Purchases of wholly-owned subsidiaries, net of
cash acquired (18,542) (43,756) (138,293)
Purchases of mortgage loans and real estate investments (1,000) (8,922) -
Short-term investments, net 44,304 9,001 26,673
Purchases of property, furniture, equipment and software (22,411) (11,110) (14,673)
Purchases of limited investment partnerships (6,723) (10,512) (15,571)
Purchases of equity investees (466) (5,495) (10,303)
Other 2,482 (978) 176
----------------------------------------------------------
Net cash used in investing activities (47,561) (185,101) (229,106)
FINANCING ACTIVITIES
Issuance costs related to convertible subordinate debentures
debentures - - (455)
Proceeds from bank borrowings 50,800 92,000 62,000
Repayment of bank borrowings - - (62,000)
Issuance of common stock 539 1,948 146,110
Cash dividends paid (9,911) (9,761) (8,240)
Reissue (purchase) of treasury stock, net (30,356) (8,511) 19
----------------------------------------------------------
Net cash provided by financing activities 11,072 75,676 137,434
----------------------------------------------------------
Increase in cash 14,884 16,531 3,472
Cash at beginning of year 28,335 11,804 8,332
----------------------------------------------------------
Cash at end of year $ 43,219 $ 28,335 $ 11,804
==========================================================
</TABLE>
See notes to the consolidated financial statements.
F-7
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements
December 31, 1999
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 reportable segments 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 1999 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 1999 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
accounting principles generally accepted in the United States ("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 exceeds 50%. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
Going Concern
For the years ended December 31, 1999 and 1998, the Company incurred net losses
of $233,264,000 and $50,042,000, respectively. Shareholders' equity has
decreased from $394,220,000 at December 31, 1998 to $78,553,000 at December 31,
1999. The Company's losses and weakened capitalization are the result of
aggressive growth and significant under-pricing, predominantly in the medical
malpractice line of business. In addition, the insurance subsidiaries'
uncertainty with respect to continued adverse loss reserve development and their
inability to pay dividends further weaken the parent holding company, which is
highly leveraged and has liquidity issues with limited financial flexibility. As
a result of the operating losses, the Company was in violation of certain loan
covenants at December 31, 1999 and is expected to be in violation of revised
covenants at March 31, 2000. The covenant violations have been waived through
April 30, 2000 and the Company is currently in the process of establishing
revised covenants with the banks.
F-8
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE A--ORGANIZATION AND BASIS OF PRESENTATION (CONTINUED)
GOING CONCERN
As discussed in Note Q, the Company's insurance subsidiaries are subject to
certain RBC requirements as specified by the NAIC. Frontier, the Company's
largest insurance subsidiary, is domiciled in New York State. The Department
utilizes its own methodology for computing capital adequacy and does not follow
the NAIC RBC guidelines. However, many of the other states in which Frontier
writes business have adopted the NAIC RBC guidelines. In accordance with the
NAIC RBC guidelines, at December 31, 1999, Frontier was at the Authorized
Control Level. The Authorized Control Level authorizes the commissioner of a
state insurance department to take whatever regulatory actions it considers
necessary to protect the best interest of the policyholders and creditors of an
insurer, which could include placing Frontier under regulatory control (i.e.,
rehabilitation or liquidation). In addition, failure to meet capital
requirements and other requirements which may be imposed by the insurance
departments, or further unfavorable operating results in future periods, could
expose Frontier to regulatory sanctions that may include restrictions on
operations and growth and/or mandatory asset dispositions.
The Company has submitted a Corrective Action Plan to the superintendent of the
Department and to many of the other state insurance departments in states for
which Frontier writes business. It is uncertain what actions, if any, the
insurance departments will take with respect to Frontier. While the Company
expects to maintain or improve the current RBC ratio level of its insurance
subsidiaries, it cannot predict all events that could cause this ratio to
decrease to the point of increased oversight by the Department or by other
departments of the states in which the Company's subsidiaries are domiciled.
In December 1999, the Company was downgraded by A.M. Best from A- (Excellent) to
B++ (Very Good). In March 2000, the Company was further downgraded by A.M. Best
to B (Fair). A.M. Best indicated that failure to execute additional asset sales
or the continuation of poor operating performance could result in further
downward rating adjustments. In March 2000, Standard & Poor's suspended its
counterparty credit rating and financial strength rating on the Company. It is
uncertain the impact these actions will have on the Company's operations.
The above conditions and events raise substantial doubt about the Company's
ability to continue as a going concern. The ability of the Company to continue
as a going concern is dependent on many factors, one of which is regulatory
action, including compliance with requirements of the Department. Management's
plans to address these concerns include significant asset sales to provide
parent holding company liquidity and/or bolster the capital of Frontier and
expense reductions.
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.
F-9
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE B--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
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 the prepayments 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 in 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 taxes.
Property, Furniture, Equipment and Software
Property, furniture, equipment and software are stated at cost, net of
accumulated depreciation and amortization, computed on a straight-line basis
over their estimated useful lives. During 1999, 1998 and 1997, depreciation
expense related to property, furniture and equipment was $6,058,000, $3,896,000
and $3,297,000, respectively, and amortization expense related to software was
$921,000, $806,000 and $666,000, respectively.
F-10
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE B--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Property, furniture, equipment and software at December 31 are summarized as
follows (dollar amounts in thousands):
<TABLE>
<CAPTION>
1999 1998 ESTIMATED USEFUL LIVES
------------ ------------- ----------------------------
<S> <C> <C> <C>
Property and land $ 42,310 $ 39,123 5 to 31.5 years
Furniture and equipment 32,595 30,591 5 to 7 years
Software 8,154 4,243 3 years
------------ -------------
Total, at cost 83,059 73,957
Accumulated depreciation and amortization (25,072) (19,769)
============ =============
Total, net $ 57,987 $ 54,188
============ =============
</TABLE>
In connection with the construction and expansion of its home office and the
acquisition of its corporate jet and one other property, the Company entered
into agreements with the Sullivan County Industrial Development Agency (the
"IDA") in order to obtain certain state and local tax benefits. One of the
requirements of these agreements is that legal title to the underlying assets
reside with the IDA. However, at the Company's option, it may obtain the legal
title from the IDA at any time for the payment of a nominal amount. Should the
Company exercise its option, the underlying property would be returned to the
tax rolls and the Company would be liable for the applicable state and local
taxes from which it was previously exempt. Since the beneficial ownership of the
underlying property resides with the Company, the underlying assets are included
with property, furniture, equipment and software in the accompanying balance
sheets.
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.
F-11
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE B--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Intangible Assets
Goodwill, which represents the excess of cost over the fair value of the net
assets of a purchased company is stated at cost, net of impairment write-downs
and accumulated amortization, computed on a straight-line basis over estimated
useful lives ranging from five to fifteen years. Insurance renewal rights
represent amounts paid to acquire the right to solicit and renew the underlying
policies of certain books of insurance business and are stated at cost, net of
accumulated amortization, computed on a straight-line basis over estimated
useful lives ranging from two to seven years.
The actuarially determined net cash flows to be realized from insurance
contracts in force at the date of acquisition is recorded as the present value
of future profits ("PVFP") and, relative to the acquisition of Acceleration, was
approximately $20,519,000. PVFP is amortized over the respective policy terms in
a manner similar to deferred policy acquisition costs. The following summarizes
the net balance of PVFP at December 31, 1999 and 1998 and activity for the
year then ended (in thousands):
<TABLE>
<CAPTION>
1999 1998
------------------------------------
<S> <C> <C>
Balance at beginning of year $ 13,362 $ 2,997
Current year acquisition 801 20,519
Current year amortization (6,877) (10,154)
====================================
Balance at end of year $ 7,286 $ 13,362
====================================
</TABLE>
The Company periodically evaluates the recoverability of its intangible assets
by determining whether the unamortized balance of the asset can be recovered
through the undiscounted cash flows of the acquired company or, in the case of
insurance renewal rights, through the appropriate operating segment writing such
business. If, in management's judgment, the undiscounted cash flow is less than
the carrying value of the asset, the carrying value is reduced to fair value,
with a corresponding charge to current operations.
In accordance with this policy, the Company determined that the undiscounted
cash flows related to Western and Regency were not sufficient to support the
related goodwill. Accordingly, during 1999 goodwill for Western and Regency
of approximately $13,600,000 and $1,500,000, respectively, was charged to
operations and is included in underwriting and other expenses in the
accompanying Consolidated Statements of Operations.
At December 31, 1999 and 1998, the related accumulated amortization on
intangible assets (including PVFP) was $33,017,000 and $19,071,000,
respectively. During 1999, 1998 and 1997, amortization expense relating to
intangible assets (including PVFP) was $13,980,000, $14,301,000 and $2,744,000,
respectively.
F-12
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE B--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 but have not been reduced from their ultimate values
by the effects of discounting estimated ultimate payments to their present
value.
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 policy acquisition costs.
Contingent Reinsurance Commissions
Contingent reinsurance commissions are accounted for in accordance with the
terms of the applicable reinsurance agreement. All of the Company's current
contracts that contain provisions for contingent commissions base such
commissions on the profitability of the underlying policies, calculated using
earned premiums. The profitability of the reinsured business is continually
reviewed and as adjustments become necessary they are reflected in current
operations. During 1999, 1998 and 1997, the Company recognized contingent
reinsurance commission income of approximately $1,718,000, $455,000 and
$792,000, respectively. Contingent reinsurance commissions are included in
amortization of policy acquisition costs. However, related amounts due to/from
reinsurers are reported as other assets or liabilities since the subject
premiums have already been earned and, as such, there would be no unearned
premiums or deferred acquisition costs at the time the contingent commissions
are calculated.
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.
F-13
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE B--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Cash and Cash Equivalents
Short-term investments are not considered to be cash equivalents for the purpose
of preparing the statements of cash flows.
Impact of Recently Issued Accounting Standards
Effective January 1, 1999, the Company adopted 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 the recognition and measurement
of liabilities for guaranty funds and certain other insurance related
assessments. The cumulative effect of this change in accounting principle was
not material to the Company's results of operations or financial condition as
of, or for the quarter ended March 31, 1999. The effect of the SOP 97-3 was to
increase the Company's net loss by approximately $612,000, or $.02 per share,
for the year ended December 31, 1999.
Effective January 1, 1999 the Company adopted Statement of Position No. 98-1,
Accounting for the Costs of Computer Software Developed or Obtained for Internal
Use ("SOP 98-1"). SOP 98-1 requires the capitalization of certain costs incurred
after the date of adoption in connection with developing or obtaining software
for internal use. Prior to the adoption of SOP 98-1, the Company expensed all
internal use software related costs as incurred. The effect of adopting the SOP
was to decrease the Company's net loss by approximately $2,341,000, or $.07 per
share, for the year ended December 31, 1999.
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative
Instruments and Hedging Activities subsequently amended by SFAS No. 137. This
statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities. It requires that all derivatives be
recognized as either assets or liabilities in the statement of financial
position and that such instruments be measured at fair value. In addition, all
hedging relationships must be designated, reassessed and documented pursuant to
the provisions of SFAS No. 133. This statement is effective for the Company for
the first quarter of 2001. Based on the Company's current investment policies
and practices, the Company anticipates that the adoption of the provisions of
SFAS No. 133 will not have a significant effect on results of operations,
financial condition or cash flows.
Reclassifications
Certain prior year amounts have been reclassified to conform to the 1999
presentation.
F-14
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE C--ACQUISITIONS
During 1997, 1998 and 1999, the Company completed the following acquisitions,
all of which were accounted for under the purchase method:
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.
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 its subsidiary, United Capitol Insurance
Company ("United Capital"), 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, 1998.
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-15
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE C--ACQUISITIONS (CONTINUED)
During 1999, the Company purchased additional small insurance agencies
specializing in the sale of surety insurance and other insurance service related
operations. The combined purchase price of these acquisitions was approximately
$18,542,000 and consisted almost entirely of goodwill, which is being amortized
over periods up to five years. The operations of these agencies are not material
to the Company's consolidated financial statements.
The assets acquired, liabilities assumed and the related goodwill of the
companies purchased in 1998 and 1997 are summarized as follows (in thousands):
<TABLE>
<CAPTION>
ACCELERATION OTHER TOTAL
--------------------------------------------
<S> <C> <C> <C>
1998
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
============================================
</TABLE>
<TABLE>
<CAPTION>
LYNDON WESTERN ECI TOTAL
----------------------------------------------------------
<S> <C> <C> <C> <C>
1997
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)
==========================================================
</TABLE>
F-16
<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 year ended December 31, 1997, assuming the purchases of Lyndon, Western
and ECI had been consummated as of January 1, 1997 (in thousands, except per
share data):
<TABLE>
<CAPTION>
1997
-----------------
(unaudited)
<S> <C>
Net premiums earned $ 430,307
Net investment income (including net capital gains and losses) 69,495
-----------------
Total revenues 499,802
Losses and LAE 271,772
Amortization of policy acquisition costs 102,395
Underwriting and other expenses 66,495
Minority interest in income of consolidated subsidiary trust 11,017
Interest expense 3,187
-----------------
Total expenses 454,866
-----------------
Income before income taxes 44,936
Income tax expense 11,689
-----------------
Net income $ 33,247
=================
Earnings per common share:
Basic $ .97
=================
Diluted $ .95
=================
</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, interest expense and amortization of goodwill,
policy acquisition costs and PVFP, 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 January 1, 1997.
F-17
<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>
1999 1998 1997
---------------------------------------------
<S> <C> <C> <C>
NUMERATOR
Net income (loss) $ (233,264) $ (50,042) $ 32,282
=============================================
Numerator for basic earnings (loss) per share--income (loss)
available to common shareholders $ (233,264) $ (50,042) $ 32,282
Effect of dilutive securities:
Minority interest in income of consolidated
subsidiary trust - - 7,027
---------------------------------------------
Numerator for diluted earnings (loss) per share--income (loss)
available to common shareholders after assumed
conversions $ (233,264) $ (50,042) $ 39,309
=============================================
DENOMINATOR
Denominator for basic earnings (loss) per share--
weighted average shares 35,068 37,293 34,195
Effect of dilutive securities:
Convertible Trust Originated Preferred Securities - - 8,094
Employee stock options - - 556
---------------------------------------------
Dilutive potential common shares - - 8,650
---------------------------------------------
Denominator for diluted earnings (loss) per
share--adjusted weighted-average shares and
assumed conversions 35,068 37,293 42,845
=============================================
Earnings (loss) per common share:
Basic $ (6.65) $ (1.34) $ .94
=============================================
Diluted $ (6.65) $ (1.34) $ .92
=============================================
</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-18
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE E--COMPREHENSIVE INCOME
The components of comprehensive income (loss) for each of the years ended
December 31, are as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
-----------------------------------------------
<S> <C> <C> <C>
Net income (loss) $ (233,264) $(50,042) $32,282
Other comprehensive income (loss):
Net unrealized gains (losses) (70,282) 9,965 23,740
Deferred taxes related to net unrealized (gains) losses 25,030 (3,568) (8,309)
-----------------------------------------------
Total other comprehensive income (loss) (45,252) 6,397 15,431
-----------------------------------------------
Total comprehensive income (loss) $ (278,516) $(43,645) $47,713
===============================================
</TABLE>
The reclassification adjustments for realized capital gains and losses
previously included in accumulated other comprehensive income and related
deferred tax expense was $8,846,000 and $3,096,000, respectively, for 1999 and
$2,157,000 and $755,000, respectively, for 1998.
The components of accumulated other comprehensive income for each of the years
ended December 31, are as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998
--------------------------------
<S> <C> <C>
Net unrealized gains (losses) $(29,182) $ 41,100
Deferred federal income taxes 10,565 (14,465)
--------------------------------
Total accumulated other comprehensive income $(18,617) $ 26,635
================================
</TABLE>
F-19
<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>
1999 1998 1997
---------------------------------------------
<S> <C> <C> <C>
Interest, dividends and equity in earnings:
Fixed maturity securities $ 75,960 $ 74,127 $ 55,520
Equity securities 5,061 1,646 832
Limited investment partnerships 1,621 838 637
Equity investees 1,571 1,805 179
Short-term and other investments 6,565 6,652 8,433
Interest expense on funds held (10,337) (10,017) (7,160)
---------------------------------------------
Investment income before expenses 80,441 75,051 58,441
Less investment expenses 2,819 1,523 2,319
---------------------------------------------
Net investment income 77,622 73,528 56,122
Net realized capital gains (losses):
Fixed maturity securities (388) 3,958 2,495
Equity securities 6,503 3,009 1,727
Other investments (3,002) (3,957) -
---------------------------------------------
Total net realized capital gains 3,113 3,010 4,222
---------------------------------------------
Total net investment income $ 80,735 $ 76,538 $ 60,344
=============================================
</TABLE>
Gross realized capital gains on sales of available-for-sale securities in 1999,
1998 and 1997 were $9,761,000, $7,947,000 and $4,552,000, respectively. Gross
realized capital losses on sales of available-for-sale securities in 1999, 1998
and 1997 were $2,851,000, $1,643,000 and $1,126,000, respectively.
The change in net unrealized gains (losses) on fixed-maturity securities was
$(69,438,000), $6,945,000 and $21,204,000 in 1999, 1998 and 1997, respectively;
the corresponding amounts for equity securities were $(9,385,000), $4,330,000
and $625,000.
At December 31, 1999, bonds and notes with an amortized cost of $60,529,000 were
on deposit with various regulatory authorities to meet statutory requirements.
Also, in connection with the Clarendon cut-through agreement, at December 31,
1999, the Company deposited $50 million into a trust account and provided a $35
million letter of credit as security for the Company's obligation under the
agreement (see Note I--Reinsurance).
F-20
<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, 1999
Fixed maturity securities:
U.S. Treasury securities and obligations of
U.S.government corporations and agencies $ 137,407 $ 181 $ 4,628 $ 132,960
Obligations of states and political subdivisions 250,483 1,532 6,077 245,938
Corporate securities 431,801 2,671 20,507 413,965
Mortgage-backed securities 378,257 733 10,198 368,792
------------------------------------------------------------
Total fixed maturity securities 1,197,948 5,117 41,410 1,161,655
Equity securities 81,742 7,130 9,160 79,712
------------------------------------------------------------
Total $1,279,690 $12,247 $ 50,570 $1,241,367
===============-============================================
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
============================================================
</TABLE>
At December 31, 1999, 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 $ 44,398 $ 44,321
Due after one year to five years 277,175 273,113
Due after five years to ten years 235,328 224,652
Due after ten years 262,790 250,777
Mortgage-backed securities 378,257 368,792
===================================
Total $ 1,197,948 $ 1,161,655
===================================
</TABLE>
F-21
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE F--INVESTMENTS (CONTINUED)
At December 31, 1999 and 1998, the cost of the Company's investments in limited
partnerships was $32,266,000 and $25,888,000, respectively. At December 31,
1999, the Company had unfunded commitments to certain individual partnerships of
$6,177,000 to be funded over the next four years.
At December 31, 1999 and 1998, the cost of the Company's investments in equity
investees was approximately $18,098,000 and $17,154,000, respectively. At
December 31, 1999, the Company's investments in equity investees included a
25% interest in American Country Holdings, Inc. ("American Country"). Carrying
value of America Country at December 31, 1999 was approximately $9,600,000.
NOTE G--INCOME TAXES
The components of federal income tax (benefit) expense are as follows (in
thousands):
<TABLE>
<CAPTION>
1999 1998 1997
-----------------------------------------------------
<S> <C> <C> <C>
Federal income tax (benefit) expense:
Current $ (2,409) $(17,862) $ 8,714
Deferred 60,432 (23,714) 2,800
-----------------------------------------------------
Total federal income tax expense (benefit) $ 58,023 $(41,576) $ 11,514
=====================================================
</TABLE>
A reconciliation of federal income tax, based on the prevailing corporate income
tax rate of 35%, to the federal income tax expense (benefit) reflected in the
accompanying financial statements is as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
-----------------------------------------------------
<S> <C> <C> <C>
Tax rate applied to pre-tax (loss) income $ (60,962) $(31,806) $16,047
Add (deduct) tax effect of:
Valuation allowance for deferred tax assets 123,638 - -
Tax-exempt interest income (4,806) (4,709) (3,770)
Proceeds from COLI death benefits - (1,750) -
Goodwill 1,656 588 365
Dividends received deduction (594) (809) (846)
State income taxes (404) (260) (718)
Other (505) (2,830) 436
-----------------------------------------------------
Federal income tax expense (benefit) $ 58,023 $(41,576) $11,514
=====================================================
</TABLE>
F-22
<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>
1999 1998
----------------------------------
<S> <C> <C>
Deferred federal income tax assets:
Reserve discounting, including salvage and subrogation $ 29,534 $ 38,437
Unearned premium reserve 44,344 17,560
Net operating loss carryforward 115,726 34,703
Alternative minimum tax credit 1,397 1,450
Net unrealized losses 10,565 -
Allowance for doubtful accounts 4,645 2,150
Start-up costs 1,436 -
Goodwill 4,215 -
Other 2,655 225
----------------------------------
Total deferred federal income tax assets 214,517 94,525
Deferred federal income tax liabilities:
Deferred policy acquisition costs 75,396 25,405
Goodwill - 2,807
Net unrealized gains - 14,465
Other 4,918 5,414
----------------------------------
Total deferred federal income tax liabilities 80,314 48,091
----------------------------------
Net deferred federal income tax asset before valuation allowance 134,203 46,434
----------------------------------
Valuation allowance 123,638 -
----------------------------------
Net deferred federal income tax asset after valuation allowance $ 10,565 $ 46,434
==================================
</TABLE>
During 1999, the Company established a valuation allowance of approximately
$123,638,000 related to its $134,203,000 net deferred tax asset. Based on the
results of operations, management does not currently believe that it is more
likely than not that these tax benefits will be realized in the near future. The
remaining deferred tax asset of approximately $10,565,000 relates to unrealized
losses on investments and management believes it is more likely than not that
the Company will be able to realize the related tax benefits in the future due
to available tax planning strategies.
F-23
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE G--INCOME TAXES (CONTINUED)
As of December 31, 1999, the Company has a net operating loss carryforward for
federal income tax purposes of approximately $331,000,000, of which
approximately $95,000,000 expires in 2018 and approximately $236,000,000 expires
in 2019.
Federal income tax payments (refunds) amounted to $(26,593,000), $(1,401,000)
and $13,928,000 in 1999, 1998 and 1997, respectively.
State income taxes represent the amount of current state income taxes incurred.
NOTE H--UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
The liabilities for unpaid losses and loss adjustment expenses ("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 the liabilities for unpaid losses and LAE represent management's best
estimate of the ultimate cost to settle the underlying claims, 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. Accordingly, these liabilities may vary from
the estimated amounts included in the accompanying financial statements. To the
extent 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.
F-24
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE H--UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES (CONTINUED)
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 similar 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. During 1999, the
Company incurred losses of approximately $4,000,000 due to catastrophe losses
related to Hurricane Floyd. No significant losses were incurred during 1998 or
1997 as a result of similar catastrophic events.
During 1999, the Company issued performance and payment surety bonds covering
obligations arising from three separate and unrelated one-time entertainment
events scheduled to occur in the fourth quarter of 1999. None of the events
occcured as planned and, as such, the obligees have made demands for payment
under the surety bonds. The Company has denied payment for two of the bonds and
is seeking declaratory relief. The Company believes it has valid defenses and
has retained special legal counsel to vigorously contest the claims. During
1999, the Company has incurred approximately $38,500,000 in losses on these
bonds.
The liabilities for unpaid losses and LAE as of December 31, 1999 and 1998, and
the incurred losses and LAE for each of the years ended December 31, 1999, 1998
and 1997 are as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
----------------------------------------------------------------------------------------
INCURRED INCURRED INCURRED
LOSSES AND LOSSES AND LOSSES AND
RESERVES LAE RESERVES LAE LAE
----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Property and casualty $ 1,294,545 $ 525,058 $1,072,395 $431,915 $231,588
Credit life 18,765 14,320 19,887 10,938 2,980
----------------------------------------------------------------------------------------
Totals $ 1,313,310 $ 539,378 $1,092,282 $442,853 $234,568
========================================================================================
</TABLE>
F-25
<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, 1999 (in
thousands):
<TABLE>
<CAPTION>
1999 1998 1997
----------------------------------------------------
<S> <C> <C> <C>
Net reserves for losses and LAE, beginning of year $ 632,850 $ 483,539 $ 373,606
Total acquired reserves - - 76,023
Incurred losses and LAE for claims relating to:
Current year 436,197 297,400 218,301
Prior years 88,861 134,515 13,287
----------------------------------------------------
Total incurred losses and LAE 525,058 431,915 231,588
Loss and LAE payments for claims relating to:
Current year 109,480 66,070 50,665
Prior years 219,505 216,534 147,013
----------------------------------------------------
Total payments 328,985 282,604 197,678
----------------------------------------------------
Net reserves for losses and LAE, end of year 828,923 632,850 483,539
Total reinsurance recoverable on unpaid losses and LAE 465,622 439,545 283,727
----------------------------------------------------
Gross reserves for losses and LAE, end of year $ 1,294,545 $ 1,072,395 $ 767,266
====================================================
</TABLE>
Prior to 1995, the Company's principal market for medical malpractice business
was New York State, a market in which insurance rates are generally set by the
Department of Insurance and for which the Company had historically experienced
favorable underwriting results. Coverage provided in New York was generally
limited to individual physicians associated with specific medical associations,
universities or teaching hospitals which provided the physician with medical
malpractice insurance, thus limiting the Company's exposure to the physicians'
part-time practices. Further contributing to the Company's historically
favorable experience in New York was the effective utilization of in-house
defense counsel experienced in New York medical malpractice litigation. However,
beginning in 1995, the Company began to expand its medical malpractice writings
in certain states with rate setting structures and legal environments much
different than New York. At the same time, the Company also began offering
coverages to individual physicians who were not associated with the
aforementioned types of institutions, thus increasing the Company's exposure.
The rates charged by the Company in these new markets, most notably for
individual physicians located in Ohio, Illinois, Texas, and Michigan, ultimately
proved to be insufficient to cover the risks assumed.
F-26
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE H--UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES (CONTINUED)
The approximate $13,300,000 increase in prior years' reserves in 1997 was
primarily attributable to reserve strengthening of approximately $35,000,000 due
to a deterioration in the results of the Company's medical malpractice line of
business noted during its 1997 year-end actuarial analysis. The noted
deterioration was identified primarily with claims-made policies issued to
individual physicians prior to 1995 in the Company's new markets. The adverse
development resulted from the actual experience in these new markets, especially
with regards to the physicians' claims-made business, being worse than
historical experience in the Company's traditional medical malpractice business.
Offsetting the adverse development in the medical malpractice line was some
favorable development in the general liability line of United Capitol. The
favorable development in United Capitol's general liability line was mostly
attributable to case reserves established in prior years for asbestos abatement
contractors which proved redundant upon final settlement of the underlying
claims.
During 1998, the Company's interim actuarial analyses indicated potential
adverse development in the medical malpractice line of business. However, the
results were subject to considerable uncertainty due to several conflicting
trends related to the claim settlement process. These conflicting trends
included an increasing ratio of closed claims to reported claims, an
acceleration of indemnity and loss adjustment payments and an increase in
average case reserve per open claim. The actuarial technique of estimating
ultimate losses and LAE based on historical experience becomes more difficult,
and the results more uncertain, when changes in claim settlement practices occur
and create significant instability in loss and LAE development patterns. Other
factors contributing to the uncertainties were the inclusion of Phen-Fen claims
in the underlying loss data, changes in allocation methods for LAE, changes in
the loss adjustment settlement practices (e.g., increased utilization of
in-house counsel) and fluctuations in claim closing patterns due to various
changes in claim department practices (e.g., settlement of larger claims more
quickly with clear liability).
To address these uncertainties, the Company, with the assistance of its
independent actuaries, expanded its detailed analysis of the adequacy of its
loss and LAE reserves to include additional analysis of its business segregated
by state and coverage and a study of its claim settlement practices. This study
included a review of case reserve redundancies, large claim settlements and
estimates of future legal medical malpractice expenses. In addition, the
expanded analysis continued to refine the Company's statistical capabilities in
the accumulation, stratification and analysis of loss experience.
The results of the expanded actuarial analysis, which was completed during the
fourth quarter of 1998, provided the Company with greater insight as to the
operating results of the medical malpractice line of business by state and the
overall impact of the numerous changes in the claim department and related
settlement practices. Specifically, the Company determined that case reserves
were not as adequate as initially estimated and claim severity on older claims
was higher than initially estimated. The results of this analysis were directly
attributable to the differences in the business written in states other than New
York for which the
F-27
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE H--UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES (CONTINUED)
historical experience available to, and used by, the Company to project the
estimated ultimate losses proved to be insufficient for this purpose. Further
contributing to the results noted in the expanded analysis was significant
adverse development experienced during the third and fourth quarters of 1998.
The results of the above indicated the need for a $155,000,000 reserve charge
which the Company recorded during the fourth quarter of 1998 and was the primary
reason for the net $134.5 million increase in prior years' reserve.
During the second quarter of 1999, the Company's reserve analysis indicated
potential additional adverse development, principally in its medical malpractice
and general liability lines of business. However, the indicated potential
adverse development was accompanied by certain contradictory trends related to
the Company's claim settlement processes, the effects of which could not be
quantified at that time. The Company determined that additional analysis during
the third quarter, beyond the customary analysis performed at interim periods,
was required for the following reasons: the indicated adverse development was
based on only six months of actual experience in 1999; the Company had just
completed a very extensive actuarial analysis resulting in the $155,000,000
reserve charge in the fourth quarter of 1998; and other analyses included
positive trends. Specifically, while the Company was experiencing a significant
increase in savings on closed claims during 1999 it was also experiencing
continued growth in its case reserves for prior year medical malpractice claims.
Changes in trends such as these, along with the impact on the actuarial analysis
from other changes in business mix and claim department practices, create
significant challenges in the actuarial estimation process.
The Company expanded its customary interim reserve analysis during the third
quarter, including an in-depth study of its claim department practices, to
resolve and better understand the contradictory results and resulting
uncertainty in reserve adequacy. The results of this in-depth study of claim
department practices indicated that case reserves were not as adequate as
initially estimated and that certain changes within the claim department were
not having the effect of decreasing LAE as anticipated. Accordingly, as a result
of the expanded reserve review and related claims study completed during the
third quarter, the Company increased its loss and LAE reserves by approximately
$136,000,000 at September 30, 1999. This increase related primarily to adverse
loss and LAE development in the Company's medical malpractice, general
liability, and commercial auto lines of business which amounted to approximately
$81,000,000, $43,000,000, and $11,000,000, respectively.
During 1998 and early 1999, the Company initiated various actions to improve the
profitability of its individual physician medical malpractice business,
including exiting certain classes, terminating agents, reunderwriting its
existing book of business, and implementing significant rate increases. While
these actions have shown some success with regards to business written in 1999,
the effects have emerged slower than anticipated, and prior years' medical
malpractice loss and LAE reserves continued to display adverse development
during 1999 with a substantial portion of the $81,000,000 increase in medical
malpractice reserves being related to prior accident years.
F-28
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE H--UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES (CONTINUED)
Regarding the $43,000,000 increase in reserves for general liability,
approximately $34,000,000 related to higher than expected costs in the
adjustment of the underlying claims, $19,000,000 of which was associated with
claims incurred prior to 1999. The higher than expected loss adjustment expenses
were due to changes made by management to enhance the Company's claims
settlement processes having a lesser impact than expected. The remaining
$9,000,000 increase was due primarily to the effects of settling claims incurred
in prior years for amounts that were more than expected.
The majority of the $11,000,000 increase in reserves for commercial auto during
the third quarter related to the effects of higher than expected claim frequency
on a short-term auto rental program introduced during the first quarter of 1999.
The $136,000,000 reserve charge during the third quarter was the primary reason
for the approximate $88,900,000 increase in prior years' reserves on a
year-to-date basis during 1999. The increases in the prior year reserves for
medical malpractice, general liability and commercial auto during the third
quarter were partially offset by approximately $10,000,000 and $7,000,000 in
favorable development during the year related to Western's medical malpractice
reserves and United Capitol's general liability reserves, respectively.
The $10,000,000 in favorable development in Western's medical malpractice
reserves related to accident years prior to 1998 and was primarily due to
Western's focus on non-traditional and less competitive markets. Western
underwrites medical malpractice on an excess and surplus lines basis and for
risk retention groups, which differs from traditional medical malpractice
markets where significant competition contributed to less favorable underwriting
results.
The approximate $7,000,000 reduction in general liability reserves during the
year was primarily related to general liabilitiy coverages for asbestos
abatement contractors for accident years prior to 1998. This reduction reflects
the effects of reported claims for those years being significantly less than
expected.
Finally, during the fourth quarter of 1999, the Company continued to refine its
actuarial reserving techniques with regards to estimating unallocated loss
adjustment expenses ("ULAE"). This resulted in a decrease of approximately
$10,000,000 in ULAE reserves for prior years with a corresponding increase of
approximately the same amount for 1999.
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
F-29
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE H--UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES (CONTINUED)
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 in the New York Court of Claims (the "Court of Claims") which
were ultimately affirmed by the State's highest court, the Court of Appeals, 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.
In September 1998, the Company and the State reached an agreement with respect
to the 83 cases currently being litigated in the Court of Claims pursuant to
which the Company received $15,000,000.
In addition to the action in the Court of Claims, the Company was pursuing
litigation in the New York Supreme Court (the "Supreme Court") that would
require the State to defend SUNY faculty members. The Supreme Court litigation
differed from the Court of Claims litigation in that the Company was not
attempting to recover funds spent on the settlement of claims. In 1997, the
Company received an adverse determination on its action in the Supreme Court.
In December 1999, on a procedural motion in the Court of Claims, the Court
linked the 1997 adverse decision on the duty to defend litigation to the
Company's right to reimbursement and ruled that the Supreme Court decision would
govern the future outcome of any cases in the Court of Claims. Although the
Company is continuing to seek recovery from the State in the Court of Claims,
the December 1999 ruling may have a significant adverse impact on the Company's
ability to recover amounts paid by the Company on behalf of SUNY physicians. As
a result, at December 31, 1999 the amount of subrogation recoverables recorded
by the Company related to the SUNY litigation was reduced by approximately
$1,500,000 reflecting an approximate $15,500,000 reduction from the amount
recorded at December 31, 1998. This reduction is included in the net $88,900,000
increase in prior years' reserves in 1999.
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. provided
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,
F-30
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE I--REINSURANCE (CONTINUED)
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.
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 additional 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 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, 1998. Accordingly, the Company will
account for any future claim cessions under the treaty after December 31, 1998,
retrospectively. Under the terms of the cancellation agreement, the additional
premium provision of the contract was amended. Under the revised provision, if
the Company's net retained loss and LAE ratio exceeds 73.5%, the Company would
be required to pay Zurich N.A. an additional premium equal to 33.3% of the
difference between the actual net loss and LAE ratio and 69.4%. This would
result in a minimum additional premium of approximately $3,200,000 due Zurich
N.A. in the event of any adverse loss and LAE development in covered lines,
other than medical malpractice. No additional premium was incurred during 1999.
Policyholders and prospective policyholders of the Company may require their
risks be insured by an insurance company rated "A-" or higher by A.M. Best. In
response to A.M. Best's downgrade of the Company, during 1999, the Company
entered into "cut-through" reinsurance agreements effective December 1, 1999
with "A" rated insurance companies, Clarendon Insurance Group ("Clarendon") and,
for surety business, NAC Reinsurance Corporation ("NAC Re"). This cut-through
arrangement effectively provides coverage to the Company's insureds in that
Clarendon or NAC Re will pay claims in the event of the Company's insolvency.
F-31
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE I--REINSURANCE (CONTINUED)
As compensation for the cut-through contracts, Clarendon and NAC Re receive fees
equal to 5% and 2.5%, respectively, of the direct premium associated with the
covered policies. At December 31, 1999, approximately $3,500,000 of fees were
incurred and included in underwriting and other expenses in connection with
these agreements.
Also in connection with the Clarendon cut-through agreement, at December 31,
1999 the Company had deposited $50 million into a trust account and provided a
$35 million letter of credit as security for the Company's obligations under the
agreement. The Company's secured obligations to Clarendon include claims
expenses incurred by Clarendon and any unpaid fees and commissions. Under the
terms of the trust agreement, the Company must deposit additional assets to the
trust account as needed to ensure its obligations to Clarendon are fully
secured.
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, 1999, the Company
had outstanding gross reinsurance recoverables of $186,421,000 from its largest
reinsurer, Zurich N.A.; however, under the terms of the reinsurance
arrangements, the Company is withholding $98,077,000 of funds due Zurich N.A..
Accordingly, the net outstanding recoverable from Zurich N.A. is $88,344,000. Of
the remaining net reinsurance recoverables balance, approximately 31% is due
from three reinsurers; one rated A++ (Superior), and two rated A+ (Superior) by
A.M. Best Company, Inc.
The effect of reinsurance on premiums written and earned is as follows (in
thousands):
<TABLE>
<CAPTION>
1999 1998 1997
------------------------------------------------------------------------------------
WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Direct $ 950,787 $ 837,294 $784,629 $735,407 $566,496 $532,248
Assumed 67,017 40,508 48,529 46,859 21,139 29,353
Ceded (343,003) (306,874) (306,153) (289,212) (198,619) (194,757)
------------------------------------------------------------------------------------
Net premiums $ 674,801 $ 570,928 $527,005 $493,054 $389,016 $366,844
====================================================================================
</TABLE>
The effect of reinsurance ceded reduced incurred losses and LAE as follows (in
thousands):
<TABLE>
<CAPTION>
1999 1998 1997
-----------------------------------------------------
<S> <C> <C> <C>
Incurred losses $207,499 $247,593 $118,489
Incurred LAE 24,469 44,156 17,739
</TABLE>
F-32
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE J--CREDIT FACILITY
In June 1997, the Company entered into a five year, $100,000,000 revolving loan
credit facility with a group of five banks, the head of which is Deutsche Bank
AG, New York Branch ("Deutsche Bank"). Subsequent amendments entered into during
1998 and 1999 increased the credit facility to $175,000,000 and extended its
maturity to June 2003. Under the terms of the agreement, the Company is subject
to certain financial and nonfinancial covenants. Amounts borrowed under the
facility are subject to LIBOR-based interest rates that ranged from 5.8625% to
6.6125% for the $142,800,000 principal amount outstanding at December 31, 1999.
In addition, the Company pays a quarterly commitment fee at a an annual rate of
.125% of the unused balance, which is being expensed as incurred.
Under the provisions of the credit facility, the Company is required to maintain
minimum debt-to-equity, interest coverage and net written premiums-to-statutory
surplus ratios. At December 31, 1999, the Company violated certain covenants
which were waived by the banks. In addition, due to its significantly weakened
financial condition and the expected negative impact on operations resulting
from recent rating downgrades, the Company expects to violate certain revised
convenants during 2000. The Company has received a waiver of these expected
violations through April 30, 2000 and is currently negotiating revised
convenants with the banks. Should the Company be unable to obtain waivers of
such convenants and be in violation thereof, the banks could elect to accelerate
repayment of the amounts outstanding under the credit facility and exercise
their rights with respect to the stock and ownership interests pledged as
collateral.
In addition, the Company and Deutsche Bank also signed a pledge agreement
whereby the Company collateralized the credit facility by providing a
first priority security interest in the capital stock of Frontier, Western and
its ownership interests in certain noninsurance subsidiaries.
The Company is currently evaluating several capital raising alternatives,
including the sale of Regency, Western and the Surety Division operations in
order to improve its cash position and further reduce its obligation under the
credit facility (See Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources).
Additionally, the total commitment under the credit facility was reduced to
$67,500,000 and the maturity date was changed to December 31, 2002. The Company,
under terms of the amendment, repaid $75,000,000 of the outstanding line of
credit from the net proceeds of the sale of Lyndon (See Note S--Subsequent
Events).
During 1999, 1998 and 1997, the Company paid interest of $7,308,000, $699,000
and $825,000, respectively.
F-33
<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
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 nonfinancial 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, 1999 and 1998, amounted to
approximately $5,155,000 and $5,347,000, respectively.
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.
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 1999, 1998 and 1997, the
Company recorded expenses related to the cumulative cash distributions net of
amortization of capitalized offering costs of $193,000, $184,000, and $205,000,
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.
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. On March 23, 2000, the
Company announced it was deferring payment of its April 15, 2000 TOPrS
distribution. The deferred distribution amounts plus accrued interest thereon
must be paid in cash to holders of the TOPrS at the end of the deferral period.
F-34
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE L--RELATED PARTY TRANSACTIONS
In May 1995, the Company and R. Spencer Douglass III ("Douglass") formed a
California limited liability company, Douglass/Frontier LLC
("Douglass/Frontier"). Douglass/Frontier acts as a managing general agent to
administer the Company's bail bond business as a wholesale agent. As a wholesale
agent, Douglass/Frontier manages the reporting and remittance of bail bond
premiums, maintains direct and supervising agents collateral, and adjusts claims
for which it receives a servicing commission of the related bond premium. 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
1999, 1998 and 1997 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 1999, 1998 and 1997, premiums written through Douglass/Frontier amounted to
approximately $1,077,000, $1,054,000 and $3,744,000, respectively, and the
related premium balances due the Company at December 31, 1999 and 1998, were
$147,000 and $83,000, respectively.
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, 1999.
During 1999, the Company and Douglass formed a limited liability company, Bond
America LLC ("Bond America"). Bond America, a retail bail bond agency purchases
bail bonds through wholesale agents and during 1999 paid bond costs to
Douglass/Frontier of approximately $335,000. The Company and Douglass own an 80%
and 20% interest, respectively, in Bond America.
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 has a 6% interest in Regency. During 1999, 1998
and 1997, direct premiums written through Tower Hill were approximately
$44,718,000, $27,972,000 and $7,170,000, respectively, and the related
commissions paid to Tower Hill were $12,171,000, $7,622,000, and $1,809,000,
respectively. The premium balances due the Company at December 31, 1999 and
1998, were $6,276,000 and $2,981,000, respectively.
The Company owns a 50% interest in Ward Insurance Services ("Ward"), a personal
auto line producer. During 1999 and 1998, total premiums produced by Ward for
the Company were $6,373,000 and $11,066,000, respectively, and the related
commissions paid to Ward were $2,363,000 and $2,213,000, respectively. As
December 31, 1999 and 1998, premium balances due the Company amounted to
$2,702,000 and $3,745,000. At December 31, 1998 the Company had other receivable
balances due from Ward of $308,000.
F-35
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE L--RELATED PARTY TRANSACTIONS (CONTINUED)
During 1999, the Company and Paul Ward, who owns the other 50% of Ward, formed a
limited liability Company, Award Insurance Services LLC ("Award") in which the
Company and Paul Ward have ownership interest of 80% and 20%, respectively.
Award, is a personal lines agency specializing in nonstandard automobile
coverages primarily in North Carolina, Texas and Colorado. During 1999, total
premiums produced by Award for the Company were $3,850,000 and the related
commissions paid Award amounted to $435,000.
At December 31, 1999 and 1998, 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 underwritten by
the Company's insurance subsidiaries, approximately 90% of which is ceded to
Terramar. During 1999, 1998 and 1997, premiums produced by the Agency were
$22,305,000, $18,277,000 and $6,860,000 and commissions paid to the Agency were
$4,950,000, $6,054,000 and $3,544,000, respectively. Premium balances due the
Company were $11,504,000 and in 1998 $3,925,000 at December 31, 1999 and 1998,
respectively. In addition, in 1998 Terramar issued a 6% 1,500,000 note to the
Company which matures October 31, 2000.
Metro Partners, Inc.
During 1998, the Company purchased 180 shares of Metro Partners, Inc. ("Metro
Partners") for $600,000, representing a 30% interest in Metro Partners, and
loaned Metro Partners $1,000,000. Metro Partners, which provides administrative
services to insurance agents and brokers, was organized in 1998 by Douglas C.
Moat, an executive officer and director of the Company, and Peter L. Rhulen, a
director of the Company who were 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.
In April 1999, the Company purchased an additional 180 shares of Metro Partners,
representing a 30% interest in Metro Partners, from Mr. Rhulen for $210,000.
Accordingly, the Company's ownership interest in Metro Partners at December 31,
1999 was 60%. The Company also loaned Metro Partners an additional $1,400,000
during 1999 at interest rates ranging from 8.75% to 9.25%, bringing the total
loans outstanding by the Company to Metro Partners at December 31, 1999 to
$2,400,000, including accrued interest. The Company also provided an outstanding
letter of credit of $250,000 to Metro Partners' landlord as collateral for Metro
Partner's leasehold obligations.
In addition to its common stock ownership, at December 31, 1999, the Company
owned $500,000 of Metro Partners preferred stock.
F-36
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE L--RELATED PARTY TRANSACTIONS (CONTINUED)
Prior to the acquiring its 60% controlling interest in Metro Partners, the
Company recorded a net investment loss of approximately $180,000. Following such
acquisition, the accounts and operation of Metro Partners, after elimination of
intercompany accounts and transactions, have been consolidated with the Company.
The Company's share of Metro Partners' net loss from operations since
acquisition of its 60% interest, amounts to approximately $795,000. In addition,
the Company also wrote-off approximately $1,300,000 in goodwill relating to its
investment in Metro Partners.
During the first quarter of 2000, the Company purchased Emmis Holdings, a
holding company which owns 30% of Metro Partners for approximately $97,000, thus
increasing the Company's ownership to 90%. Mr. Moat owned 27.5% of Emmis
Holdings.
Director and Officer Loans and Guarantees
In June 1998, the Company guaranteed a loan of $1,250,000 for Thomas J. Dietz
("Dietz"), an officer of the Company, which guaranty was outstanding at December
31, 1998 and secured by United States Treasury Notes (the "Notes") pledged as
collateral. During 1999, the Company increased its guaranty to $2,000,000, the
amount of the guaranty outstanding at December 31, 1999. Under a Security and
Indemnity Agreement (the "Agreement") between the Company and Dietz executed in
December 1999, Dietz granted the Company a security interest in his unpledged
personal assets as security for the Company's guaranty. At December 31, 1999,
the Company has established an allowance of $750,000 for its exposure to the
Dietz guaranty.
In February 2000, after a principal repayment of $250,000 by Dietz to his
creditor, the Company's guaranty was reduced to $1,750,000. In March 2000, the
Company, in exchange for the extinguishment of its remaining guaranty,
transferred $1,800,000 in Notes pledged as collateral to a Dietz account
maintained by the creditor, free and clear of any interest by the Company. In
exchange, Dietz transferred 97,338 shares of the Company's Common Stock with a
market value at the date of transfer of $200,000 to the Company. In connection
with these transfers, Dietz executed an amendment to the Agreement under which
he promised to pay an additional $250,000 in principal to the creditor during
2000 and $250,000 every year thereafter until the obligation is repaid. As such
payments are made, the Notes will be returned to the Company.
In August 1998, the Company guaranteed a loan of $1,000,000, and in December
1998, guaranteed an additional $800,000 of loans, to Peter L. Rhulen ("Rhulen"),
a director of the Company, which guarantees were outstanding at December 31,
1998 and secured by United States Treasury Notes (the "Treasuries"). During
1999, and prior to November 1999, the Company increased the guarantees for
Rhulen to $12,500,000. In November 1999, the Company, in exchange for the
extinguishment of one of its guarantees, transferred $4,500,000 of the
Treasuries to a Rhulen account maintained by Rhulen's creditors, free and clear
of any interest by the Company, and Rhulen transferred 930,212 shares of the
F-37
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE L--RELATED PARTY TRANSACTIONS (CONTINUED)
Company's Common Stock with a market value approximating the value of the
transferred Treasuries to the Company. The exchange was accounted for as a
purchase of treasury stock. Under a Security and Indemnity Agreement, Rhulen and
his wife granted the Company a security interest in their unpledged personal
assets as security for the Company's remaining guaranties. Approximately
$8,600,000 of guarantees remained outstanding at December 31, 1999.
During the first quarter of 2000, the Company purchased certain investments from
Rhulen for approximately $7,600,000 which represented approximately 95% of such
investments, estimated fair value. At the same time, Rhulen repaid approximately
$8,200,000 of his outstanding loans. At March 31, 2000, the Company's
outstanding guarantees of loans to Rhulen were reduced to $400,000. As such
payments are made, the Treasuries will be returned to the Company. Pursuant to
the agreement $8,200,000 of Treasuries were returned to the Company.
During 1998, the Company advanced funds and received two demand notes from a
senior vice president, for approximately $160,000 and $80,000. The $160,000 note
is unsecured and interest free, while the $80,000 note bears interest at 8% and
is secured by personal assets. At December 31, 1998 and 1999, the aggregate
outstanding balances of these notes, including accrued interest was
approximately $147,000 and $155,000, respectively.
Film Bond International ("FBI")
During 1998, the Company loaned an aggregate of $150,000 at a 6.5% interest rate
to FBI, a company in which the brother of the Company's Chief Executive Officer
and an Executive Vice President subsequently joined as a principal and Chief
Executive Officer. During 1999, the Company loaned FBI an additional $455,000 at
a 6.5% interest rate and guaranteed a loan to FBI for $150,000. The loss of
Frontier's A- rating from A.M. Best contributed to the inability of FBI to
continue operating. The Company has forgiven the loans and related accrued
interest to FBI and has assumed full responsibility for the amount of the
guaranty resulting in a charge of approximately $800,000 during 1999.
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.
F-38
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
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 9,407,047
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.
During 1999, the Company implemented an Employee Stock Purchase Plan ("ESPP").
Under the terms of the ESPP, eligible employees, through payroll deductions, may
purchase the Company's Common Stock on the last business day of each quarter (up
to $25,000 in fair market value per calendar year). The purchase price of such
shares will be 85% of the fair market value ("FMV") of the Company's Common
Stock on the trading day immediately preceding the first business day of such
calendar quarter or the last business day of such calendar quarter, whichever is
lower. The FMV will be the closing price of the Company's Common Stock on the
New York Stock Exchange. Shares under the ESPP may be purchased on the open
market or issued from the Company's treasury stock and/or authorized but
unissued shares. Additionally, the Company will grant to each participating
employee, stock options under the Company's Stock Option Plan in an amount equal
to the number of shares purchased during the year through the ESPP and owned at
December 31 of such year.
During 1999, 133,175 shares were purchased under the ESPP.
In 1999, the Company granted certain executive officers and members of senior
management separate stock options outside the plans to purchase approximately
3,646,000 shares of the Company's Common Stock at prices ranging from $14.13 to
$35.31 per share, exercisable at any time through December 31, 2005, which
options were outstanding at December 31, 1999.
F-39
<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 were outstanding at
December 31, 1999.
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, 1999.
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, 1999.
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 1999,
1998 and 1997 respectively: risk-free interest rates of 4.90%, 4.97% and 6.58%;
a dividend yield of 2.00%, 2.18%, and 1.25%; volatility factors of the expected
market price of the Company's Common Stock of .528, .337, and .335; and an
expected life of the option of five 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.
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>
1999 1998 1997
----------------------------------------------------
<S> <C> <C> <C>
Pro forma net income (loss) $(238,150) $(50,372) $32,064
Pro forma basic earnings (loss) per common share $ (6.79) $ (1.35) $ .94
Pro forma diluted earnings (loss) per common share $ (6.79) $ (1.35) $ .91
</TABLE>
F-40
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE N--STOCK OPTIONS (CONTINUED)
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>
1999 1998 1997
-------------------------- -------------------------- ---------------------------
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 1,412 $17 1,036 $19 715 $11
Granted 4,265 27 635 13 500 25
Exercised (29) 9 (175) 11 (150) 11
Canceled (190) 19 (84) 18 (29) 15
--------- --------- --------
Outstanding at end of year 5,458 25 1,412 17 1,036 17
========= ========= ========
Exercisable at end of year 4,286 29 317 16 257 11
========= ========= ========
</TABLE>
The weighted average fair value of options granted during 1999, 1998 and 1997
were $3.19, $4.83, and $8.81, respectively.
OPTIONS OUTSTANDING AND EXERCISABLE
BY PRICE RANGE
AS OF DECEMBER 31, 1999
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- --------------------------------------------------------------------------------- --------------------------------
OUTSTANDING EXERCISABLE
AS OF DECEMBER WEIGHTED-AVERAGE AS OF DECEMBER
RANGE OF 31, 1999 REMAINING WEIGHTED-AVERAGE 31, 1999 WEIGHTED-AVERAGE
EXERCISE PRICES (000) CONTRACTUAL LIFE EXERCISE PRICE (000) EXERCISE PRICE
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
$0.00 - $ 5.00 339 4.9 $ 3.44 - $ -
$ 5.01 - $10.00 171 0.5 8.56 158 8.57
$10.01 - $15.00 837 3.8 13.68 349 13.77
$15.01 - $20.00 143 2.7 16.03 61 16.39
$20.01 - $25.00 854 4.0 22.67 607 22.14
$25.01 - $30.00 1,157 6.0 28.25 1,156 28.25
$30.01 - $35.00 4 2.6 30.63 2 30.63
$35.01 - $40.00 1,953 6.0 35.31 1,953 35.31
------------------------------------------------------------------------------------------
5,458 5.0 25.19 4,286 28.53
==========================================================================================
</TABLE>
F-41
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE O--COMMITMENTS AND CONTINGENCIES
Leases
At December 31, 1999, the future minimum payments under noncancellable operating
leases are as follows (in thousands):
2000 $ 5,815
2001 5,265
2002 4,206
2003 3,131
2004 2,789
Thereafter 3,566
===============
Total $ 24,772
===============
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 1999, 1998, and 1997 amounted to $5,542,000, $4,666,000 and
$2,580,000, respectively.
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 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.
In June 1999, plaintiffs were granted permission to amend their complaint and to
reopen discovery to take additional depositions and request additional
documents. The additional depositions have been taken. In February 2000, the
plaintiffs made an additional motion to amend their complaint wherein they seek
to have the class period, which presently runs from February 10, 1994 through
November 8, 1994, extended to November 15, 1999. The motion also seeks to add an
additional plaintiff and defendant. Plaintiffs also seek to allege that
increases in reserves taken by the Company in various reporting periods
subsequent to November 1994 evidence an ongoing fraud. The court has not ruled
on this motion.
F-42
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE O--COMMITMENTS AND CONTINGENCIES (CONTINUED)
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 or results of operations.
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 or
results of operations.
Officer Loan Program
In December 1998, the Company initiated a program to facilitate the purchase of
its Common Stock by key management executives. Pending finalization of the loan
document, which was completed in June 1999, the Company provided a loan facility
to a designated officer to borrow funds on behalf of participating management
executives for the purpose of acquiring the Company's Common Stock in the open
market. At December 31, 1998, $2,250,000 was borrowed under this facility with
which 176,653 shares were purchased by participating officers.
In June 1999, a four year, $10,000,000 bank credit facility was established
against which participating officers may borrow directly in order purchase the
Company's Common Stock. Loans under the facility are collateralized by the stock
purchased. In addition, borrowings under the credit facility are guaranteed by
the Company. During 1999, loans under the bank credit facility were used by
officers to repay the Company's loans of $2,250,000 and to purchase additional
shares of Company stock in the open market. As part of the program, at
December 31, 1999 222,321 options, were granted to participating executives with
an exercise price of $3.44. At December 31, 1999, the Company has guaranteed
loans totaling $4,418,000, which exceeded the fair market value of the 335,653
shares of Common Stock pledged as collateral by $3,277,000. Also, at
December 31, 1999, amounts due from executives for interest paid on their
behalf related to the outstanding loans was approximately $254,000.
Under the provisions of the guaranty on the $10,000,000 credit facility
discussed above, the Company is required to maintain certain nonfinancial and
financial covenants including a specified leverage, interest coverage and net
premiums written-to-statutory surplus ratios. Noncompliance with any of these
covenants may result in early termination of the loans by the lender. At
December 31, 1999, the Company was not in compliance with any of these financial
covenants of the guaranty. The Company has obtained a waiver of these
covenants through April 30, 2000 and is currently negotiating revised covenants.
F-43
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE O--COMMITMENTS AND CONTINGENCIES (CONTINUED)
Stock Repurchase Program
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. As of December 31, 1999, 2,900,358 shares had been purchased under
the repurchase program at a cost of approximately $35,100,000. Any shares so
repurchased are held as treasury shares and are available for general corporate
purposes.
NOTE P--STATUTORY FINANCIAL INFORMATION
The Company's insurance subsidiaries prepare their statutory financial
statements in accordance with accounting practices prescribed or permitted by
the insurance department of their respective domiciliary states. Prescribed
statutory accounting include a variety of publications by the National
Association of Insurance Commissioners ("NAIC"), as well as state laws and
regulations. Permitted statutory accounting practices encompass all accounting
practices not so prescribed but which the appropriate regulatory agency has
allowed in practice.
On January 21, 2000, the Company contributed $80,000,000 in cash to Frontier.
Frontier, in preparation of its 1999 Annual Statement, requested permission from
the New York State Department of Insurance (the "Department") to include such
contribution in its capital and surplus at December 31, 1999, with a
corresponding $80,000,000 reported as a surplus contribution receivable.
Additionally, Frontier requested permission from the Department to discount its
unpaid loss and LAE reserves for its medical malpractice line of business using
an interest rate of 5%. The impact of discounting such reserves was to increase
Frontier's statutory capital and surplus by approximately $53,600,000 at
December 31,1999 and decrease its 1999 statutory net loss by approximately
$11,100,000. The Department approved both requests which differs from prescribed
statutory accounting procedures and, accordingly, these amounts have been
reflected in Frontier's statutory capital and surplus at December 31, 1999.
F-44
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE P--STATUTORY FINANCIAL INFORMATION (CONTINUED)
A comparison of the consolidated amounts of the insurance subsidiaries'
policyholders' surplus as of December 31, 1999 and 1998, and net income (loss)
for each of the three years ended December 31, 1999, on a statutory accounting
practices ("SAP") basis and the GAAP shareholders' equity and net income (loss)
included in the accompanying consolidated financial statements, is as follows
(in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
---------------------------------------------------------------------------------
NET NET NET
SURPLUS/EQUITY LOSS SURPLUS/EQUITY LOSS INCOME (LOSS)
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Insurance subsidiaries'
consolidated SAP amounts $ 307,855 $ (131,049) $ 396,205 $ (70,889) $32,730
=================================================================================
Insurance subsidiaries'
consolidated GAAP amounts $ 463,630 $ (201,703) $ 612,723 $ (32,373) $41,970
Parent company, its noninsurance
subsidiaries and eliminations (385,077) (31,561) (218,503) (17,669) (9,688)
---------------------------------------------------------------------------------
Consolidated GAAP amounts $ 78,553 $ (233,264) $ 394,220 $ (50,042) $32,282
=================================================================================
</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 payments of dividends or loans on
advances to the parent. At December 31, 1999, the amount of restricted net
assets of the Company's insurance subsidiaries was approximately $307,562,000
and the maximum dividend that may be paid to the Company in 2000 without
regulatory approval was approximately $293,000.
Additionally, the insurance subsidiaries are subject to certain RBC requirements
as developed by the NAIC and adopted by the various state Department of
Insurances. Under these requirements, the adequacy of statutory capital and
surplus is evaluated in relation to various risk factors of an insurance
company. At December 31, 1999, all of the Company's insurance subsidiaries,
with the exception of Frontier, met the minimum RBC requirements. At
December 31, 1999, Frontier's ratio of Total Adjusted Capital to Authorized
Control Level RBC placed it at the Authorized Control Level, as defined by the
NAIC.
The Department utilizes its own methodology for computing capital adequacy and
does not follow the NAIC RBC guidelines. However, many of the other states in
which Frontier writes business have adopted the NAIC RBC guidelines. In
accordance with the NAIC RBC guidelines, at December 31, 1999, Frontier was at
the Authorized Control Level. The Authorized Control Level authorizes the
commissioner of a state insurance department to take whatever regulatory actions
it considers necessary to protect the best interest of the policyholders and
creditors of an insurer, which could include placing Frontier under regulatory
control (i.e., rehabilitation or liquidation). In addition, failure to meet
capital requirements and other requirements which may be imposed by the
insurance departments, or further unfavorable operating results in future
periods, could expose Frontier to regulatory sanctions that may include
restrictions on operations and growth and/or mandatory asset dispositions.
The Company has submitted a Corrective Action Plan to the superintendent of the
Department and to many of the other state insurance departments in states for
which Frontier writes business. It is uncertain what actions, if any, the
insurance departments will take with respect to Frontier. While the Company
expects to maintain or improve the current RBC ratio level of its insurance
subsidiaries, it cannot predict all events that could cause this ration to
decrease to the point of increased oversight by the Department or by other
departments of the states in which the Company's subsidiaries are domiciled.
F-45
<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 did not contribute to the profit sharing plan for the year 1999.
The Company's total expense related to employee benefit plan contributions for
1999, 1998 and 1997 was $2,706,000, $4,203,000 and $2,635,000, respectively,
including discretionary contributions of $1,881,000 and $1,225,000 in 1998 and
1997, respectively.
NOTE S--SUBSEQUENT EVENTS
On January 20, 2000, the Company completed the sale of Lyndon Insurance Group,
Inc. to Protective Life Insurance Company for $163,500,000 in cash, subject to
certain purchase price adjustments. The Company contributed $80,000,000 of the
proceeds to Frontier and used $75,000,000 to repay a portion of its Deutsche
Bank Credit Facility. Also, in connection with the sale, Frontier and Lyndon
entered into a loss and unearned premium portfolio transfer agreement effective
January 1, 2000, under which Frontier assumed the loss and LAE reserves and
unearned premiums for certain personal lines business. Total reserves assumed
in these agreements were approximately $4,700,000. In addition, Frontier entered
into an excess loss ratio reinsurance agreement effective February 1, 2000,
under which Frontier assumes net losses in excess of 115% related to certain
warranty business. As consideration, Frontier received approximately
$2,000,000 in premiums.
Following is a summary of the assets and liabilities related to Lyndon which are
included in the accompanying balance sheets (in thousands).
<TABLE>
<CAPTION>
DECEMBER 31,
1999 1998
--------------------------------------
<S> <C> <C>
ASSETS
Invested assets $ 306,420 $ 270,443
Other assets 214,817 217,684
--------------------------------------
Total assets 521,237 488,127
======================================
LIABILITIES
Unpaid losses and LAE 46,168 64,580
Unearned premiums 286,178 234,603
Other liabilities 38,139 40,000
--------------------------------------
Total liabilities 370,485 339,183
Shareholders' equity 150,752 148,944
--------------------------------------
Total liabilities and shareholders' equity $ 521,237 $ 488,127
======================================
</TABLE>
F-46
<PAGE>
Frontier Insurance Group, Inc. and Subsidiaries
Notes to the Consolidated Financial Statements (continued)
NOTE S--SUBSEQUENT EVENTS (CONTINUED)
In April 2000, the Company has signed a letter of intent for the sale of
Regency. Terms of a definitive sales agreement which would be subject to
applicable regulatory approval and standard closing conditions, are currently
being finalized.
During September 1999, the Company entered into a definitive agreement to
purchase ManagedComp Holdings, Inc. ("ManagedComp"), a managed care workers'
compensation service company for $33,600,000. In January 2000, the Company
advanced $4,000,000 to ManagedComp in exchange for a promissory note due March
31, 2000 and bearing interest at 7%. However, on February 10, 2000, the Company
announced that it had terminated the purchase of ManagedComp. Under the terms of
the termination agreement, the Company agreed to pay a termination fee of
$4,500,000, extend the due date of the $4,000,000 promissory note to February 1,
2005, and provide certain underwriting facilities to ManagedComp.
In connection with expense reduction and cost containment initiatives undertaken
during the first quarter of 2000, the Company eliminated a number of positions,
and closed several office locations. As a result, the Company recorded a
restructuring charge of approximately $2,700,000 in the first quarter of 2000.
F-47
<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 1999
and 1998 (in thousands, except per share data):
<TABLE>
<CAPTION>
1999 1998
-------------------------------------------------------------------------------------
1ST 2ND 3RD 4TH 1ST 2ND 3RD 4TH
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net premiums earned $140,255 $137,922 $150,181 $142,570 $117,212 $122,576 $128,001 $125,265
Total net investment income 20,945 21,471 21,058 17,261 20,850 20,724 15,525 19,439
Net income (loss) 16,420 16,356 (175,829) (90,211) 17,743 17,465 14,193 (99,443)
Earnings (loss) per common share:
Basic 0.45 0.47 (5.06) (2.63) .52 .47 .38 (2.65)
Diluted 0.41 0.42 (5.06) (2.63) .47 .42 .35 (2.65)
</TABLE>
Due to changes in the number of average common stock and equivalent shares
outstanding, quarterly earnings (loss) per share may not add to the totals for
the years.
In the third quarter of 1999 and fourth quarter of 1998, the Company increased
reserves by approximately $136,000,000 and $155,000,000, respectively. Such
increases were primarily due to adverse experience in the Company's medical
malpractice and general liability lines in 1999 and medical malpractice line of
business in 1998. Also, during the fourth quarter of 1999, the Company incurred
approximately $38,500,000 in losses related to certain performance and payment
surety bonds covering three separate entertainment events that did not occur as
scheduled. Additionally, during the fourth quarter of 1999, the Company reduced
subrogation recoverables related to the SUNY litigation by approximately
$15,500,000. (see Note H of the Notes to the Consolidated Financial Statements).
The net loss for the third quarter of 1999 includes the establishment of a
valuation allowance of approximately $89,000,000 related to the Company's net
deferred tax asset. This allowance was increased to approximately $123,600,000
during the fourth quarter of 1999. (see Note G of the Notes to the Consolidated
Financial Statements). The Company's fourth quarter of 1999 results also reflect
the write-off of approximately $15,000,000 in goodwill related to Regency and
Western.
Other charges incurred during the fourth quarter of 1998, included the
$10,000,000 termination fee related to the cancellation of the Company's
1998-1999 stop loss reinsurance agreement (see Note I of the Notes to the
Consolidated Financial Statements), and an increase of approximately $3,500,000
in the allowance for doubtful accounts.
F-48
<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
1999 1998
----------------------------------
<S> <C> <C>
ASSETS
Investments in subsidiaries $ 458,732 $ 623,854
Fixed maturity securities, available for sale (1) 11,959 3,335
Equity securities, available for sale - 2,948
Equity investees 12,690 12,574
Short-term investments 156 11,716
Cash (overdraft) 5,369 (1,356)
Federal income taxes recoverable - 6,892
Property, furniture, equipment and software, less accumulated
depreciation and amortization (1999--$10,673; 1998--$6,950) 15,349 11,790
Intangible assets, less accumulated amortization
(1999--$5,208;1998--$3,173) 8,176 1,157
Other assets 4,597 11,401
----------------------------------
TOTAL ASSETS $ 517,028 $ 684,311
==================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Convertible subordinated debentures due to subsidiary trust $ 167,345 $ 167,153
Bank debt 142,800 92,000
Due to subsidiaries and affiliates 106,989 2,606
Federal income taxes payable 11,998 -
Cash dividend payable to shareholders - 2,578
Accrued expenses and other liabilities 9,343 25,754
----------------------------------
TOTAL LIABILITIES 438,475 290,091
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: 150,000,000;
shares issued: 1999--37,646,663; 1998--37,594,709) 376 376
Additional paid-in capital 450,886 450,347
Accumulated other comprehensive income, net of tax (18,617) 26,635
Retained deficit (314,431) (73,833)
----------------------------------
118,214 403,525
Treasury stock--at cost (1999--3,830,570 shares; 1998--766,912 shares) (39,661) (9,305)
----------------------------------
Total shareholders' equity 78,553 394,220
==================================
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 517,028 $ 684,311
==================================
</TABLE>
(1)--At December 31, 1999 fixed maturity securities were pledged as collateral
for a director and an officer (see Note L of Notes to the Consolidated
Financial Statements.)
These condensed financial statements should be read in conjunction with the
accompanying consolidated financial statements and notes thereto.
F-49
<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
1999 1998 1997
---------------------------------------------------
<S> <C> <C> <C>
REVENUES
Management fees $ 51,406 $ 14,127 $ -
Investment income (including net realized gains (losses)) 1,926 (1,116) 4,125
Net proceeds from company owned life insurance policy - 4,400 -
---------------------------------------------------
Total revenues 53,332 17,411 4,125
EXPENSES
Operating and administrative 57,606 36,188 7,018
Interest expense 18,479 11,931 11,842
---------------------------------------------------
Total expenses 76,085 48,119 18,860
---------------------------------------------------
Loss before federal income tax benefit and equity in
undistributed income (loss) of subsidiaries (22,753) (30,708) (14,735)
Federal income tax expense (benefit) (2) 10,543 (11,298) (5,324)
---------------------------------------------------
Income (loss) before equity in undistributed income
(loss) of subsidiaries (33,296) (19,410) (9,411)
Equity in undistributed income (loss) of subsidiaries (199,968) (30,632) 41,693
---------------------------------------------------
Net income (loss) (233,264) (50,042) 32,282
Other comprehensive income (loss), net of tax (45,252) 6,397 15,431
===================================================
Total comprehensive income (loss) $ (278,516) $ (43,645) $47,713
===================================================
</TABLE>
(2) 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 for 1997
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. For 1999, federal income tax expense
reflects the effects of the establishment of a valuation allowance for
the Company's deferred tax asset for which management does not currently
believe it is more likely than not will be realized on a consolidated
basis in the near term.
These condensed financial statements should be read in conjunction with
the accompanying consolidated financial statements and notes thereto.
F-50
<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
1999 1998 1997
---------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Loss before equity in undistributed income
of subsidiaries $ (33,296) $ (19,410) $ (9,411)
Adjustments to reconcile net loss to net cash provided by (used
in) operating activities:
Change in federal income taxes 18,890 (3,242) (2,796)
Change in due from subsidiaries and affiliates 24,383 9,752 (2,407)
Depreciation and amortization 2,234 3,353 2,618
Net realized losses 564 2,857 -
Other (8,145) 13,819 (1,522)
---------------------------------------------------
Net cash provided by (used in) operating activities 4,630 7,129 (13,518)
INVESTING ACTIVITIES
Capital contributions to subsidiaries - (62,580) (29,644)
Purchases of wholly-owned subsidiaries (7,053) (5,030) (140,499)
Short-term investments, net 11,560 (6,166) 58,352
Change in other investments (6,197) (5,630) (9,001)
Purchases of property, furniture, equipment and software (12,286) (6,781) (1,362)
Proceeds from sale of property, equipment and software 5,000 - -
Other - (472) 314
---------------------------------------------------
Net cash used in investing activities (8,977) (86,659) (121,840)
FINANCING ACTIVITIES
Proceeds from bank borrowings 50,800 92,000 62,000
Repayment of bank borrowings - - (62,000)
Issuance of common stock 539 1,948 146,110
Cash dividends paid (9,911) (9,761) (8,240)
Reissuance (purchases) of treasury stock, net (30,356) (8,511) 19
Other - - (455)
---------------------------------------------------
Net cash provided by financing activities 11,072 75,676 137,434
---------------------------------------------------
Increase (decrease) in cash 6,725 (3,854) 2,076
Cash (overdraft) at beginning of year (1,356) 2,498 422
===================================================
Cash (overdraft) at end of year $ 5,369 $ (1,356) $ 2,498
===================================================
</TABLE>
These condensed financial statements should be read in conjunction with the
accompanying consolidated financial statements and notes thereto.
F-51
<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, 1999
Life insurance in force: $ 14,510,863 $13,465,296 $ - $1,045,567 0.0%
Premiums written:
Life insurance $ 33,093 $ 19,706 $ 362 $ 13,749 2.6%
Accident & health insurance 64,178 37,983 829 27,023 3.1
Property & liability insurance 853,516 285,314 65,827 634,029 10.4
----------------------------------------------------------------------
Total premiums written $ 950,787 $ 343,003 $ 67,017 $ 674,801 9.9%
======================================================================
YEAR ENDED DECEMBER 31, 1998
Life insurance in force: $ 15,845,945 $14,613,013 $ - $1,232,932 0.0%
Premiums written:
Life insurance $ 23,523 $ 13,326 $ (591) $ 9,606 (6.2)%
Accident & health insurance 45,388 23,130 (813) 21,445 (3.8)
Property & liability insurance 715,718 269,697 49,933 495,954 10.1
----------------------------------------------------------------------
Total premiums written $ 784,629 $ 306,153 $ 48,529 $ 527,005 9.2%
======================================================================
YEAR ENDED DECEMBER 31, 1997
Life insurance in force: $ 16,460,492 $14,295,737 $ - $ 2,164,755 0.0%
Premiums written:
Life insurance $ 5,808 $ 6,701 $ (2,027) $ (2,920) 69.4%
Accident & health insurance 14,637 12,668 453 2,423 18.7
Property & liability insurance 546,051 179,250 22,712 389,513 5.8
----------------------------------------------------------------------
Total premiums written $ 566,496 $ 198,619 $ 21,139 $ 389,016 5.4%
======================================================================
</TABLE>
F-52
<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
DESCRIPTION BEGINNING OF COSTS AND THER ACCOUNTS DEDUCTIONS END OF
PERIOD EXPENSES --DESCRIBE DESCRIBE PERIOD
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Year ended December 31, 1999:
Reserves and allowances deducted from asset accounts:
Allowance for doubtful accounts $ 6,025 $ 3,947 $ 108(A) $9,864
Allowance for possible reinsurance uncollectible amounts 150 321 - 471
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
</TABLE>
(A) Amounts charged off.
F-53
<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
DEFERRED CLAIMS DISCOUNT, IF
POLICY AND CLAIM ANY NET
AFFILIATION WITH ACQUISITION ADJUSTMENT DEDUCTED IN UNEARNED EARNED INVESTMENT
REGISTRATION COSTS EXPENSES COLUMN C PREMIUMS PREMIUMS INCOME
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Registrant and
consolidated
subsidiaries:
1999 $82,190 $828,923 $364,508 $533,619 $70,845
1998 69,126 632,850 267,323 454,811 66,079
1997 49,271 483,539 226,154 354,911 55,804
</TABLE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------
YEAR ENDED DECEMBER 31
- -------------------------------------------------------------------
COL. H COL. I COL. J COL. K
- -------------------------------------------------------------------
CLAIMS AND CLAIM AMORTIZATION
ADJUSTMENT EXPENSES OF DEFERRED PAID CLAIMS
INCURRED RELATED TO POLICY AND CLAIM
(1) (2) ACQUISITION ADJUSTMENT PREMIUMS
CURRENT YEAR PRIOR YEAR COSTS EXPENSES WRITTEN
- ----------------------------------------------------------------------
<S> <C> <C> <C> <C>
$436,197 $ 88,861 $131,417 $328,985 $630,804
297,400 134,515 107,639 282,604 495,979
218,301 13,287 79,311 197,678 381,142
</TABLE>
F-54
<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
President, Chief Executive Officer
and Director
Date: April 14, 2000
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/ JERRY E. GOLDRESS
---------------------
Jerry E. Goldress April 14, 2000
Chairman of the Board (Non-executive)
/s/ HARRY W. RHULEN April 14, 2000
-------------------
Harry W. Rhulen
President, Chief Executive Officer
and Director
(Principal Executive Officer)
/s/ SUZANNE RHULEN LOUGHLIN April 14, 2000
----------------------------
Suzanne Rhulen Loughlin
Executive Vice President
and Director
/s/ DOUGLAS C. MOAT April 14, 2000
-------------------
Douglas C. Moat
Executive Vice President
and Director
/s/ PETER L. RHULEN April 14, 2000
-------------------
Peter L. Rhulen
Director
/s/ LAWRENCE E. O'BRIEN April 14, 2000
------------------------
Lawrence E. O'Brien
Director
/s/ RONALD L. BORNHUETTER
-------------------------
Ronald L. Bornhuetter April 14, 2000
Director
/s/ PATRICK W. KENNY April 14, 2000
--------------------
Patrick W. Kenny
Executive Vice President - Treasurer and
Chief Financial Officer
(Principal Financial Officer)
/s/ JEFFREY C. GORDON
---------------------
Jeffrey C. Gordon April 14, 2000
Vice President - Controller
(Principal Accounting Officer and
Duly Authorized Officer)
</TABLE>
<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)
10.16(c) Second Amendment to Deutsche Bank Credit Agreement dated October 1, 1998..........................(10)
10.16(d) Third Amendment to Deutsche Bank Credit Agreement dated December 30, 1998.........................(10)
10.16(e) Fourth Amendment to Deutsche Bank Credit Agreement dated April 14, 1999...........................
10.16(f) Fifth Amendment to Deutsche Bank Credit Agreement dated January 11, 2000..........................
10.16(g) Pledge Agreement with Deutsche Bank AG, New York dated January 21, 2000...........................
</TABLE>
<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...............................
10.23 Stock Purchase Agreement dated October 20, 1999 by and between the Registrant
and Protective Life Insurance Company.........................................................(11)
10.23(a) First Amendment to Stock Purchase Agreement dated January 20, 2000 by and between
the Registrant and Protective Life Insurance Company..........................................(11)
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, 1999, filed as a paper
format exhibit on Form SE pursuant to Section 232.311 of Regulation ST, of Frontier
Insurance Company, 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>
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.
(10) Filed as the same numbered exhibit to the Registrant's Report on Form 10-K
dated December 31, 1998 and incorporated herein by reference.
(11) Stock Purchase Agreement dated October 20, 1999 and First Amendment to
Stock Purchase Agreement dated January 20, 2000 filed as Exhibits 2.1 and
2.2, respectively, on Form 8-K dated February 4, 2000 and incorporated
herein by reference.
<PAGE>
FOURTH AMENDMENT
FOURTH AMENDMENT (this "Amendment"), dated as of April 14,
1999, 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. 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. Section 9 of the Credit Agreement is hereby amended as
follows:
(i) by deleting the table appearing in the definition of
"Applicable Eurodollar Rate Margin" in its entirety and inserting the following
new table in lieu thereof:
<TABLE>
<CAPTION>
Applicable Rating Period Applicable Eurodollar Rate Margin
------------------------ ---------------------------------
<S> <C>
Category A Period 0.300%
Category B Period 0.350%
Category C Period 0.425%
Category D Period 0.500%"; and
</TABLE>
<PAGE>
(ii) by deleting the table appearing in the definition of
"Applicable Facility Fee Percentage" in its entirety and inserting the following
new table in lieu thereof:
<TABLE>
<CAPTION>
Applicable Rating Period Applicable Facility Fee Percentage
------------------------ ----------------------------------
<S> <C>
Category A Period 0.100%
Category B Period 0.150%
Category C Period 0.200%
Category D Period 0.250%
</TABLE>
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 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.
4. This Amendment shall become effective on the date (the
"Amendment Effective Date") when:
(a) the Borrower, the Required Banks and each Bank whose
Commitment is increasing as a result of this Amendment 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;
(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
-2-
<PAGE>
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.
8. The Borrower hereby covenants and agrees that, so long as
the Amendment Effective Date occurs, it shall pay each Bank which executes and
delivers to the Administrative Agent a counterpart hereof by the later to occur
of (x) the close of business on the Amendment Effective Date or (y) 5:00 p.m.
(New York time) on April 12, 1999, a cash fee in an amount equal to 10 basis
points (.10%) of an amount equal to the increase to the Commitment of such Bank
pursuant to this Amendment, in each case as same is in effect on the Amendment
Effective Date. All fees payable pursuant to this Section 8 shall be paid by the
Borrower to the Administrative Agent for distribution to the Banks not later
than the first Business Day following the Amendment Effective Date.
* * *
-3-
<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:
-4-
<PAGE>
FIRST UNION NATIONAL BANK
By:________________________________
Title:
UNION BANK OF CALIFORNIA
By:________________________________
Title:
-5-
<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 $ 48,500,000 27.714286%
Bank of America NT & SA $ 21,000,000 12%
The Bank of New York $ 21,000,000 12%
The First National Bank of Chicago $ 28,000,000 16%
First Union National Bank $ 28,000,000 16%
Union Bank of California $ 28,500,000 16.285714%
Total: $175,000,000 100%
</TABLE>
-6-
<PAGE>
FIFTH AMENDMENT AND WAIVER
FIFTH AMENDMENT AND WAIVER (this "Amendment"), dated as of
January 11, 2000, 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 and waiver provided for herein and the Banks have agreed to provide
such amendment and waiver on the terms and conditions set forth herein;
NOW, THEREFORE, it is agreed:
1. On the Amendment Effective Date (as defined below), the
Commitment of each Bank shall be modified to be the amount set forth opposite
the name of such Bank on Annex I hereto. 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 Banks hereby waive any Default or Event of Default that
has arisen or will arise under the Credit Agreement solely as a result of the
failure of the Borrower to comply with the requirements of Sections 7.08, 7.09
and 7.10 of the Credit Agreement through and including December 31, 1999;
provided that the waiver set forth in this Section 2 shall terminate on January
28, 2000 unless, on or prior to such date, the Borrower has consummated the sale
of Lyndon in accordance with the provisions of Section 8(iii) of this Amendment.
3. Prior to the consummation of the sale of Lyndon referred to
below in this Amendment, the Borrower shall not be permitted to incur additional
Loans under the Credit Agreement.
4. Section 1.09 of the Credit Agreement is hereby amended by
inserting the text "the Applicable Base Rate Margin plus" immediately following
the text "shall at all times be" appearing in clause (a) thereof.
5. Section 2.03 of the Credit Agreement is hereby amended by
inserting at the end thereof the following new clauses (c), (d) and (e):
<PAGE>
"(c) In addition to any other mandatory commitment reductions
pursuant to this Section 2.03, on each date on or after the Fifth
Amendment Effective Date upon which the Borrower or any of its
Subsidiaries receives any cash proceeds from any incurrence by the
Borrower or any of its Subsidiaries of Indebtedness (including, without
limitation, convertible Indebtedness) pursuant to Section 7.04(k), the
Net Debt Proceeds of such incurrence shall be applied as follows: (i)
the Borrower may retain the first $32,500,000 of Net Debt Proceeds from
such incurrence (or, if more than one such incurrence occurs, the first
$32,500,000 in the aggregate from all such incurrences), and (ii) of
the Net Debt Proceeds in excess of $32,500,000 from all such
incurrences, the Total Commitment shall be permanently reduced on the
date of each such incurrence by an amount equal to 50% of such excess.
(d) In addition to any other mandatory commitment reductions
pursuant to this Section 2.03, on each date on or after the Fifth
Amendment Effective Date upon which the Borrower or any of its
Subsidiaries receives any cash proceeds from any sale or issuance of
its equity (other than capital contributions made to a Subsidiary by
the Borrower or another Subsidiary), the Total Commitment shall be
permanently reduced on such date by an amount equal to 25% of the Net
Equity Proceeds of the respective sale or issuance.
(e) Each partial reduction to the Total Commitment pursuant to
this Section 2.03 shall apply proportionately to the Commitment of each
Bank."
6. Section 5 of the Credit Agreement is hereby amended by
inserting the following new Section 5.18 immediately following Section 5.17
thereof:
"5.18 Pledge Agreement. On and after January 21, 2000, the
security interests created in favor of the Collateral Agent, as
pledgee, for the benefit of the Secured Creditors, under the Pledge
Agreement constitute first priority perfected security interests in the
Pledge Agreement Collateral described therein, subject to no security
interests of any other Person."
7. Section 6 of the Credit Agreement is hereby amended by
inserting the following new Section 6.09 immediately following Section 6.08
thereof:
"6.09 Pledge of Certain Subsidiaries. The Borrower shall
promptly (and, in any event, before January 21, 2000) (i) grant to the
Administrative Agent, for the benefit of the Banks, a first priority
security interest in all of the capital stock of Frontier Insurance
Company, Western Indemnity Insurance Company and each Non-Regulated
Insurance Company, in each case pursuant to documentation in form and
substance reasonably satisfactory to the Administrative Agent (it being
understood that such documentation shall provide that remedies under
the Pledge Agreement shall only be exercisable upon an Event of Default
of the type set forth in Sections 8.01 or 8.05) and (ii) enter into
such amendments to this Agreement and/or other documentation in
connection with the creation of such security interests as the
Administrative Agent shall reasonably request; provided that (w) the
banks party to the DF Credit Agreement (as creditors of the
-2-
<PAGE>
Borrower as a result of the Borrower's guaranty of such DF Credit
Agreement), (x) the banks party to the RSD Loan Agreement (as
creditors of the Borrower as a result of the Borrower's guaranty of
such RSD Loan Agreement), (y) the banks party to the D&O Credit
Agreement (as creditors of the Borrower as a result of the Borrower's
guaranty of such D&O Credit Agreement) and (z) the Banks (and/or their
affiliates) party to the Interest Rate Agreements, shall share in the
security interests created by this Section 6.09 on an equal and
ratable basis; provided further that (x) the aggregate principal
amount of DF Credit Agreement Obligations (as defined in the Pledge
Agreement) secured by the Pledge Agreement shall not exceed
$7,850,000, (y) the aggregate principal amount of RSD Loan Agreement
Obligations (as defined in the Pledge Agreement) secured by the Pledge
Agreement shall not exceed $1,680,000 and (z) the aggregate principal
amount of D&O Credit Agreement Obligations (as defined in the Pledge
Agreement) secured by the Pledge Agreement shall not exceed
$4,417,650."
8. Section 7.02 of the Credit Agreement is hereby amended by:
(i) deleting the word "and" appearing at the end of clause (f);
(ii) deleting the period at the end of clause (g) thereof and
inserting in lieu thereof the text "; and";
(iii) inserting the following new clause (h) immediately
following clause (g):
"(h) The Borrower may sell Lyndon so long as (i) no
Default or Event of Default exists at such time or would exist
immediately after giving effect thereto, (ii) such sale is for
fair market value (as determined in good faith by the
management of the Borrower), (iii) $75,000,000 of the net sale
proceeds therefrom is utilized concurrently with the
consummation of such sale to repay outstanding Loans and (iv)
upon the consummation of such sale, the Total Commitment is
permanently reduced to $67,800,000."; and
(iv) inserting the following text at the end of said
Section 7.02:
"To the extent the Required Banks (or, to the extent required
by Section 11.12, each Bank) waive the provisions of this
Section 7.02 with respect to the sale or other disposition of
any Collateral, or any Collateral is sold as permitted by this
Section 7.02, such Collateral in each case shall be sold or
otherwise disposed of free and clear of the Liens created by
the Pledge Agreement and the Administrative Agent shall take
such actions (including, without limitation, directing the
Collateral Agent to take such actions) as are reasonably
requested by the Borrower in connection therewith."
9. Section 7.03 of the Credit Agreement is hereby amended by
(i) deleting the word "and" appearing at the end of clause (l) thereof, (ii)
deleting the period appearing at the end of clause (m) and inserting in lieu
thereof the text "; and" and (iii) inserting the following new clause (n):
-3-
<PAGE>
"(n) Liens created pursuant to the Pledge Agreement."
10. Section 7.04 of the Credit Agreement is hereby amended by
(i) deleting the word "and" appearing at the end of clause (i) thereof, (ii)
deleting the period appearing at the end of clause (j) and inserting in lieu
thereof the text "; and" and (iii) inserting at the end thereof the following
new clause (k):
"(k) additional Indebtedness (including, without limitation,
Indebtedness which is convertible into equity of the Borrower)
of the Borrower not otherwise permitted hereunder, so long as
(i) the aggregate outstanding principal amount of such
Indebtedness does not exceed $82,500,000 at any time, (ii)
such Indebtedness is subordinated to the Obligations hereunder
on terms reasonably satisfactory to the Administrative Agent
and the Required Banks and (iii) the terms and conditions of
such Indebtedness are approved by the Administrative Agent and
the Required Banks, which approval shall not be unreasonably
withheld or delayed."
11. Section 7.08 of the Credit Agreement is hereby amended by
deleting such Section in its entirety and inserting in lieu thereof the
following new Section 7.08:
"7.08 Leverage Ratio. The Borrower will not permit the ratio
of (i) Consolidated Indebtedness to (ii) Total Capitalization
at (a) any time on or prior to December 31, 2000 to be greater
than 0.35:1.00, (b) any time after December 31, 2000 and on or
prior to December 31, 2001 to be greater than 0.325:1.00 and
(c) any time after December 31, 2001 to be greater than
0.30:1.00; provided that for purposes of this Section 7.08,
any outstanding Indebtedness described in Section 7.04(k)
shall be excluded from the calculation of Consolidated
Indebtedness".
12. Section 7.09 of the Credit Agreement is hereby amended by
deleting such Section in its entirety and inserting in lieu thereof the
following new Section 7.09:
"7.09 Interest Coverage Ratio. The Borrower will not permit
the Interest Coverage Ratio for any Test Period ending on the
last day of a fiscal quarter described below to be less than
the amount set forth opposite such fiscal quarter below:
<TABLE>
<S> <C>
Fiscal Quarter Ending Ratio
March 31, 2000 1.50:1.00
June 30, 2000 1.50:1.00
September 30, 2000 1.50:1.00
December 31, 2000 1.50:1.00
March 31, 2001 1.75:1.00
June 30, 2001 1.75:1.00
September 30, 2001 1.75:1.00
December 31, 2001 1.75:1.00
March 31, 2002 and thereafter 2.00:1.00
</TABLE>
-4-
<PAGE>
provided that for purposes of this Section 7.09, interest on
any outstanding Indebtedness described in Section 7.04(k)
shall be excluded from the calculation of Interest Expense."
13. Section 7.10 of the Credit Agreement is hereby amended by
deleting the ratio "2.0:1.0" appearing therein and inserting in lieu thereof the
ratio "2.5:1.0".
14. Section 8 of the Credit Agreement is hereby amended by (i)
inserting the word "or" at the end of Section 8.08 thereof and (ii) inserting
the following new Section 8.09 immediately following Section 8.08 thereof:
"8.09 Pledge Agreement. At any time after January 21, 2000,
the Pledge Agreement shall cease to be in full force and effect, or
shall cease to give the Collateral Agent the Liens, rights, powers and
privileges purported to be created thereby (including, without
limitation, a first priority perfected security interest in, and Lien
on, all of the Collateral subject thereto, in favor of the Collateral
Agent, superior to and prior to the rights of all third Persons and
subject to no other Liens), or the Borrower shall default in the due
performance or observance of any term, covenant or agreement on its
part to be performed or observed pursuant to the Pledge Agreement;".
15. Section 9 of the Credit Agreement is hereby amended as
follows:
(i) by deleting the table appearing in the definition of
"Applicable Eurodollar Rate Margin" in its entirety and inserting the
following new table in lieu thereof:
<TABLE>
"Applicable Rating Period Applicable Eurodollar Rate Margin
------------------------- ---------------------------------
<S> <C>
Category A Period 0.800%
Category B Period 1.000%
Category C Period 1.750%
Category D Period 2.000%";
</TABLE>
(ii) by deleting the table appearing in the definition of
"Applicable Facility Fee Percentage" in its entirety and inserting the
following new table in lieu thereof:
<TABLE>
"Applicable Rating Period Applicable Facility Fee Percentage
------------------------- ---------------------------------
<S> <C>
Category A Period 0.200%
Category B Period 0.220%
Category C Period 0.250%
Category D Period 0.350%";
</TABLE>
(iii) by inserting the text ", the Pledge Agreement"
immediately following the word "Agreement" appearing in the definition
of "Credit Documents";
-5-
<PAGE>
(iv) by deleting the date "June 2, 2003" appearing in the
definition of "Final Maturity Date" and inserting in lieu thereof the
date "December 31, 2002";
(v) by deleting the text "Cash Flow" appearing in the
definition of "Interest Coverage Ratio" and inserting in lieu thereof
the text "Consolidated EBIT";
(vi) by inserting the word "and" at the end of clause (i) of
the definition of "Consolidated Net Income", by inserting a period at
the end of clause (ii) thereof, and by deleting clause (iii) thereof;
(vii) by amending the definition of "Interest Expense" to read
in its entirety as follows:
"Interest Expense" shall mean, for any period, the sum of all
interest expense of the Borrower and its Subsidiaries for such
period (including, without limitation, interest paid in
connection with the Convertible Debentures) determined on a
consolidated basis in accordance with GAAP.;
(viii) by amending the definition of "Test Period" by (i)
deleting the date "June 30, 1998" and inserting in lieu thereof the
date "September 30, 2000" and (ii) deleting the date "September 30,
1997" in each place where such date appears and inserting in lieu
thereof, in each such place, the date "March 31, 2000"; and
(ix) by inserting the following new definitions in their
appropriate alphabetical order:
"Applicable Base Rate Margin" shall mean, for any day, the
rate per annum set forth below opposite the Applicable Rating Period
then in effect:
<TABLE>
Applicable Rating Period Applicable Base Rate Margin
------------------------- ---------------------------------
<S> <C>
Category A Period 0%
Category B Period 0%
Category C Period 0.750%
Category D Period 1.000%
</TABLE>
"Collateral" shall mean all of the Collateral as defined in
the Pledge Agreement.
"Collateral Agent" shall mean the Administrative Agent acting
as collateral agent for the Banks.
"D&O Credit Agreement" shall mean the Credit Agreement dated
as of June 24, 1999 among various directors and officers of the
Borrower, the various lenders party thereto and Bank of America
National Trust and Savings Association.
-6-
<PAGE>
"DF Credit Agreement" shall mean the Credit Agreement dated as
of December 15, 1998 among Douglass/Frontier, LLC, the various lenders
party thereto and Deutsche Bank AG, New York Branch and/or Cayman
Islands Branch, as Administrative Agent.
"Consolidated EBIT" shall mean, for any period, the
Consolidated Net Income of the Borrower for such period, before
interest expense and provision for taxes based on income and without
giving effect to any extraordinary gains or losses or gains or losses
from sales of assets other than assets sold in the ordinary course of
business.
"Fifth Amendment Effective Date" shall mean the Amendment
Effective Date under and as defined in the Fifth Amendment and Waiver
to this Agreement, dated as of January 11, 2000.
"Net Debt Proceeds" shall mean, with respect to each
incurrence of Indebtedness by any Person, the cash proceeds (net of
underwriting discounts and commissions and other reasonable costs
associated therewith) received by such Person from the respective
incurrence of such Indebtedness.
"Net Equity Proceeds" shall mean, with respect to each
issuance or sale of any equity by any Person or any capital
contribution to such Person, the cash proceeds (net of underwriting
discounts and commissions and other reasonable costs associated
therewith) received by such Person from the respective sale or issuance
of its equity or from the respective capital contribution.
"Pledge Agreement" shall mean the pledge agreement to be
entered into pursuant to Section 6.09 hereof.
"RSD Loan Agreement" shall mean the Loan Agreement dated as
of April 15, 1998 between Robert Spencer Douglass, III and Union
Bank of California, N.A.
"Secured Creditors" shall have the meaning provided in the
Pledge Agreement.
16. Section 11.12 of the Credit Agreement is hereby amended by
(i) deleting the word "or" appearing immediately before clause (iii) and
inserting in lieu thereof a comma, and (ii) inserting the following text
immediately following clause (iii) thereof:
"or (iv) release all or any material part of the Collateral (except as
expressly provided in this Agreement)".
17. 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
-7-
<PAGE>
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.
18. 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.
19. 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.
20. 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.
21. 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.
22. The Borrower hereby covenants and agrees that, so long as
the Amendment Effective Date occurs, it shall pay each Bank which executes and
delivers to the Administrative Agent a counterpart hereof by the later to occur
of (x) the close of business on the Amendment Effective Date or (y) 5:00 p.m.
(New York time) on January 14, 1999, a cash fee in an amount equal to 10 basis
points (.10%) of an amount equal to the Commitment of such Bank, in each case as
same is in effect on the Amendment Effective Date after giving effect to this
Amendment. All fees payable pursuant to this Section 22 shall be paid by the
Borrower to the Administrative Agent for distribution to the Banks not later
than the first Business Day following the Amendment Effective Date.
* * *
<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:________________________________
Name:
Title:
DEUTSCHE BANK AG, NEW YORK
BRANCH AND/OR CAYMAN ISLANDS
BRANCH,
Individually and as Administrative Agent
By:_________________________________
Name:
Title:
By:_________________________________
Name:
Title:
BANK OF AMERICA, N.A.
By:________________________________
Name:
Title:
THE BANK OF NEW YORK
By:________________________________
Name:
Title:
BANK ONE, N.A. (main office - Chicago)
(f/k/a The First National Bank of Chicago)
By:________________________________
Name:
Title:
<PAGE>
FIRST UNION NATIONAL BANK
By:________________________________
Name:
Title:
UNION BANK OF CALIFORNIA, N.A.
By:________________________________
Name:
Title:
<PAGE>
ANNEX I
LIST OF BANKS AND COMMITMENTS
<TABLE>
Bank Commitment
- ---- -----------
<S> <C>
Deutsche Bank AG, New York Branch
and/or Cayman Islands Branch $ 39,575,999.91
Bank of America NT & SA $ 17,136,000.00
The Bank of New York $ 17,136,000.00
Bank One, N.A. (main office - Chicago) $ 22,848,000.00
First Union National Bank $ 22,848,000.00
Union Bank of California, N.A. $ 23,256,000.09
Total: $142,800,000.00
</TABLE>
<PAGE>
PLEDGE AGREEMENT
PLEDGE AGREEMENT, dated as of January 21, 2000 (as same may be
amended, amended and restated, modified or supplemented from time to time, this
"Agreement"), made by each of the undersigned Pledgors (each a "Pledgor" and,
together with any other entity that becomes a party hereto pursuant to Section
28 hereof, the "Pledgors") to Deutsche Bank AG, New York Branch, not in its
individual capacity but solely as Collateral Agent (including any successor
collateral agent, the "Pledgee") for the benefit of the Secured Creditors
referred to below. Except as otherwise defined herein, terms used herein and
defined in the Credit Agreement shall be used herein as so defined.
W I T N E S S E T H:
WHEREAS, Frontier Insurance Group, Inc. (the "Borrower"), the
financial institutions from time to time party thereto (the "Banks") and
Deutsche Bank AG, New York Branch and/or Cayman Islands Branch, as
Administrative Agent (in its capacity as Administrative Agent, being herein
referred to as the "Administrative Agent") have entered into a Credit Agreement,
dated as of June 3, 1997 (as used herein, the term "Credit Agreement" means the
Credit Agreement described above in this paragraph, as the same may be amended,
amended and restated, modified or supplemented from time to time, and including
any successor agreement extending the maturity of, or restructuring of all or
any portion of the Indebtedness under such agreement or any successor
agreements), providing for the making of Loans to the Borrower (the Banks, the
Administrative Agent and the Pledgee are hereinafter called the "Bank
Creditors");
WHEREAS, Douglass/Frontier, LLC ("Douglass/Frontier"), the
financial institutions from time to time party thereto (the "DF Banks") and
Deutsche Bank AG, New York Branch and/or Cayman Islands Branch, as
administrative agent (in its capacity as administrative agent, being herein
referred to as the "DF Administrative Agent") have entered into a Credit
Agreement, dated as of December 15, 1998 (as used herein, the term "DF Credit
Agreement" means the Credit Agreement described above in this paragraph, as the
same may be amended, amended and restated, modified or supplemented from time to
time, and including any successor agreement extending the maturity of, or
restructuring of all or any portion of the indebtedness under such agreement or
any successor agreements) providing for the making of loans to Douglass/Frontier
(the DF Banks and the DF Administrative Agent are hereinafter called the "DF
Bank Creditors");
WHEREAS, Robert Spencer Douglass, III and Union Bank of
California, N.A. (the "RSD Bank") have entered into a Loan Agreement, dated as
of April 15, 1998 (as used herein, the term "RSD Loan Agreement" means the Loan
Agreement described above in this paragraph, as the same may be amended, amended
and restated, modified or supplemented from time to time, and including any
successor agreement extending the maturity of, or restructuring of all or any
portion of the indebtedness under such agreement or any successor agreements),
<PAGE>
providing for the making of a loan to Robert Spencer Douglass, III and the
guaranty of such loan by the Borrower (the RSD Bank is hereinafter also called
the "RSD Bank Creditor");
WHEREAS, various directors and officers of the Borrower, the
financial institutions from time to time party thereto (the "D&O Banks") and
Bank of America, N.A., as administrative agent (in its capacity as
administrative agent, being herein referred to as the "D&O Administrative
Agent") have entered into a Credit Agreement, dated as of June 24, 1999 (as used
herein, the term "D&O Credit Agreement" means the Credit Agreement described
above in this paragraph, as the same may be amended, amended and restated,
modified or supplemented from time to time, and including any successor
agreement extending the maturity of, or restructuring of all or any portion of
the indebtedness under such agreement or any successor agreements), providing
for the making of loans to certain directors and officers of the Borrower and
the guaranty of such loans by the Borrower (the D&O Banks and the D&O
Administrative Agent are hereinafter called the "D&O Bank Creditors");
WHEREAS, the Borrower may from time to time be party to one or
more Interest Rate Agreements with one or more Banks or any affiliate thereof
(each such Bank or affiliate, even if the respective Bank subsequently ceases to
be a Bank under the Credit Agreement for any reason, together with such Bank's
or affiliate's successors and assigns, if any, collectively, the "Interest Rate
Creditors," and together with the Bank Creditors, the DF Bank Creditors, the RSD
Bank Creditor and the D&O Bank Creditors, the "Secured Creditors");
WHEREAS, the Pledgors are required under the terms of the
Credit Agreement, the DF Credit Agreement, the RSD Loan Agreement and the D&O
Credit Agreement to execute and deliver to the Pledgee this Agreement; and
WHEREAS, the Pledgors will obtain benefits from the incurrence
of loans under each of the Credit Agreement, the DF Credit Agreement, the RSD
Loan Agreement and the D&O Credit Agreement and the Borrower's entering into
Interest Rate Agreements and, accordingly, desires to execute this Agreement in
order to satisfy the requirements described in the preceding paragraph;
NOW, THEREFORE, in consideration of the benefits accruing to
each Pledgor, the receipt and sufficiency of which are hereby acknowledged, each
Pledgor hereby makes the following representations and warranties to the Pledgee
and hereby covenants and agrees with the Pledgee as follows:
1. SECURITY FOR OBLIGATIONS. This Agreement is made by each
Pledgor for the benefit of the Secured Creditors to secure:
(i) the full and prompt payment when due (whether at the
stated maturity, by acceleration or otherwise) of all obligations,
liabilities and indebtedness (including, without limitation,
indemnities, Fees and interest thereon) owing to the Bank Creditors,
whether now existing or hereafter incurred under, arising out of, or in
connection with the Credit Agreement and the other Credit Documents,
and the due performance and compliance with all of the terms,
conditions and agreements contained in the Credit
-2-
<PAGE>
Agreement and such other Credit Documents (all such obligations,
liabilities and indebtedness under this clause (i) being herein
collectively called the "Credit Agreement Obligations");
(ii) the full and prompt payment when due (whether at the
stated maturity, by acceleration or otherwise) of all obligations,
liabilities and indebtedness (including, without limitation,
indemnities, fees and interest thereon) owing to the DF Bank Creditors,
whether now existing or hereafter incurred under, arising out of, or in
connection with the DF Credit Agreement and the other Credit Documents
(as such term is defined in the DF Credit Agreement, the "DF Credit
Documents"), and the due performance and compliance with all of the
terms, conditions and agreements contained in the DF Credit Agreement
and such other DF Credit Documents (all such obligations, liabilities
and indebtedness under this clause (ii) being herein collectively
called the "DF Credit Agreement Obligations"; provided that the
aggregate principal amount of DF Credit Agreement Obligations secured
by this Agreement shall not exceed $7,850,000);
(iii) the full and prompt payment when due (whether at the
stated maturity, by acceleration or otherwise) of all obligations,
liabilities and indebtedness (including, without limitation,
indemnities, fees and interest thereon) owing to the RSD Bank Creditor,
whether now existing or hereafter incurred under, arising out of, or in
connection with the RSD Loan Agreement and the other loan documents
executed in connection therewith (such other loan documents, the "RSD
Loan Documents"), and the due performance and compliance with all of
the terms, conditions and agreements contained in the RSD Loan
Agreement and such other RSD Loan Documents (all such obligations,
liabilities and indebtedness under this clause (iii) being herein
collectively called the "RSD Loan Agreement Obligations"; provided that
the aggregate principal amount of RSD Loan Agreement Obligations
secured by this Agreement shall not exceed $1,680,000);
(iv) the full and prompt payment when due (whether at the
stated maturity, by acceleration or otherwise) of all obligations,
liabilities and indebtedness (including, without limitation,
indemnities, fees and interest thereon) owing to the D&O Bank
Creditors, whether now existing or hereafter incurred under, arising
out of, or in connection with the D&O Credit Agreement and the other
Loan Documents (as such term is defined in the D&O Credit Agreement,
the "D&O Credit Documents"), and the due performance and compliance
with all of the terms, conditions and agreements contained in the D&O
Credit Agreement and such other D&O Credit Documents (all such
obligations, liabilities and indebtedness under this clause (iv) being
herein collectively called the "D&O Credit Agreement Obligations";
provided that the aggregate principal amount of D&O Credit Agreement
Obligations secured by this Agreement shall not exceed $4,417,650);
(v) the full and prompt payment when due (whether at stated
maturity, by acceleration or otherwise) of all obligations, liabilities
and indebtedness (including, without limitation, indemnities, fees and
interest thereon) owing to the Interest Rate
-3-
<PAGE>
Creditors, now existing or hereafter incurred under, arising out of or
in connection with any Interest Rate Agreement, whether such Interest
Rate Agreement is now in existence or hereinafter arising, and the due
performance and compliance with the terms, conditions and agreements of
each such Interest Rate Agreement (all such obligations, liabilities
and indebtedness under this clause (v) being herein collectively called
the "Interest Rate Obligations");
(vi) any and all reasonable sums advanced by the Pledgee in
order to preserve the Collateral (as hereinafter defined) and/or
preserve its security interest therein;
(vii) in the event of any proceeding for the collection of the
Obligations (as defined below) or the enforcement of this Agreement,
after an Event of Default shall have occurred and be continuing, the
reasonable out-of-pocket expenses of retaking, holding, preparing for
sale or lease, selling or otherwise disposing of or realizing on the
Collateral, or of any exercise by the Pledgee of its rights hereunder,
together with reasonable attorneys' fees and court costs; and
(viii) all amounts paid by any Indemnitee to which such
Indemnitee has the right to reimbursement under Section 11 of this
Agreement.
all such obligations, liabilities, indebtedness, sums and expenses set forth in
clauses (i) through (viii) of this Section 1 being collectively called the
"Obligations", it being acknowledged and agreed that the "Obligations" shall
include extensions of credit of the types described above, whether outstanding
on the date of this Agreement or extended from time to time after the date of
this Agreement.
2. DEFINITIONS; ANNEXES. (a) Unless otherwise defined herein,
all capitalized terms used herein and defined in the Credit Agreement shall be
used herein as therein defined. Reference to singular terms shall include the
plural and vice versa.
(b) The following capitalized terms used herein shall have
the definitions specified below:
"Administrative Agent" has the meaning set forth in the
Recitals hereto.
"Adverse Claim" has the meaning given such term in Section
8-102(a)(1) of the UCC.
"Agreement" has the meaning set forth in the first paragraph
hereof.
"Bank Creditors" has the meaning set forth in the first
paragraph hereof.
"Banks" has the meaning set forth in the Recitals hereto.
"Certificated Security" has the meaning given such term in
Section 8-102(a)(4) of the UCC.
-4-
<PAGE>
"Clearing Corporation" has the meaning given such term in
Section 8-102(a)(5) of the UCC.
"Collateral" has the meaning set forth in Section 3.1 hereof.
"Collateral Accounts" means any and all accounts established
and maintained by the Pledgee in the name of any Pledgor to which Collateral may
be credited.
"Credit Agreement" has the meaning set forth in the Recitals
hereto.
"Credit Agreement Obligations" has the meaning set forth in
Section 1 hereof.
"DF Administrative Agent" has the meaning set forth in the
Recitals hereto.
"DF Bank Creditors" has the meaning set forth in the Recitals
hereto.
"DF Banks" has the meaning set forth in the Recitals hereto.
"DF Credit Agreement" has the meaning set forth in the
Recitals hereto.
"DF Credit Agreement Obligations" has the meaning set forth
in Section 1 hereof.
"DF Credit Documents" has the meaning set forth in Section 1
hereof.
"Douglass/Frontier" has the meaning set forth in the Recitals
hereto.
"D&O Administrative Agent" has the meaning set forth in the
Recitals hereto.
"D&O Bank Creditors" has the meaning set forth in the
Recitals hereto.
"D&O Banks" has the meaning set forth in the Recitals hereto.
"D&O Credit Agreement" has the meaning set forth in the
Recitals hereto.
"D&O Credit Agreement Obligations" has the meaning set forth
in Section 1 hereof.
"D&O Credit Documents" has the meaning set forth in Section 1
hereof.
"Event of Default" means (i) any event of the type described
in Section 8.05 of the Credit Agreement and (ii) any payment default (after
expiration of any applicable grace period) on any of the Obligations.
"Financial Asset" has the meaning given such term in Section
8-102(a)(9) of the UCC.
"Indemnitees" has the meaning set forth in Section 11 hereof.
-5-
<PAGE>
"Instrument" has the meaning given such term in Section
9-105(1)(i) of the UCC.
"Interest Rate Agreements" has the meaning set forth in the
first paragraph hereof.
"Interest Rate Creditors" has the meaning set forth in the
Recitals hereto.
"Interest Rate Obligations" has the meaning set forth in
Section 1 hereof.
"Investment Property" has the meaning given such term in
Section 9-115(f) of the UCC.
"Limited Liability Company Assets" means all assets, whether
tangible or intangible and whether real, personal or mixed (including, without
limitation, all limited liability company capital and interest in other limited
liability companies), at any time owned or represented by any Limited Liability
Company Interest.
"Limited Liability Company Interests" means the entire
limited liability company membership interest at any time owned by any Pledgor
in any limited liability company which is Frontier Insurance Company, Western
Indemnity Insurance Company or any Non-Regulated Insurance Company.
"Obligations" has the meaning set forth in Section 1 hereof.
"Partnership Assets" means all assets, whether tangible or
intangible and whether real, personal or mixed (including, without limitation,
all partnership capital and interest in other partnerships), at any time owned
or represented by any Partnership Interest.
"Partnership Interest" means the entire general partnership
interest or limited partnership interest at any time owned by any Pledgor in any
general partnership or limited partnership, in each case which is Frontier
Insurance Company, Western Indemnity Insurance Company or any Non-Regulated
Insurance Company.
"Pledged Entity" means each of Frontier Insurance Company,
Western Indemnity Insurance Company and each Non-Regulated Insurance Company.
"Pledgee" has the meaning set forth in the first paragraph
hereof.
"Pledgor" has the meaning set forth in the first paragraph
hereof.
"Proceeds" has the meaning given such term in Section
9-306(l) of the UCC.
"Required Secured Creditors" shall mean, at any time, Secured
Creditors having outstanding Obligations which constitute at least a majority of
all outstanding Obligations at such time.
"RSD Bank" has the meaning set forth in the Recitals hereto.
-6-
<PAGE>
"RSD Bank Creditor" has the meaning set forth in the Recitals
hereto.
"RSD Loan Agreement" has the meaning set forth in the
Recitals hereto.
"RSD Loan Agreement Obligations" has the meaning set forth in
Section 1 hereof.
"RSD Loan Documents" has the meaning set forth in Section 1
hereof.
"Secured Creditors" has the meaning set forth in the first
paragraph hereof.
"Secured Debt Agreements" has the meaning set forth in
Section 5 hereof.
"Securities Account" has the meaning given such term in
Section 8-501(a) of the UCC.
"Securities Act" means the Securities Act of 1933, as
amended, as in effect from time to time.
"Security Entitlement" has the meaning given such term in
Section 8-102(a)(17) of the UCC.
"Stock" means all of the issued and outstanding shares of
capital stock or other ownership interests of Frontier Insurance Company,
Western Indemnity Insurance Company and each Non-Regulated Insurance Company at
any time owned by the Pledgor.
"Termination Date" has the meaning set forth in Section 19
hereof.
"UCC" means the Uniform Commercial Code as in effect in the
State of New York from time to time; provided that all references herein to
specific sections or subsections of the UCC are references to such sections or
subsections, as the case may be, of the Uniform Commercial Code as in effect in
the State of New York on the date hereof.
"Uncertificated Security" has the meaning given such term in
Section 8-102(a)(18) of the UCC.
3. PLEDGE OF SECURITY INTEREST, ETC.
3.1. Pledge. To secure the Obligations now or hereafter owed
or to be performed, each Pledgor does hereby grant, pledge and assign to the
Pledgee for the benefit of the Secured Creditors, and does hereby create a
continuing security interest (subject to those liens permitted to exist with
respect to the Collateral pursuant to the terms of all Secured Debt Agreements
then in effect) in favor of the Pledgee for the benefit of the Secured Creditors
in, all of the right, title and interest in and to the following, whether now
existing or hereafter from time to time acquired (collectively, the
"Collateral"):
-7-
<PAGE>
(a) each of the Collateral Accounts, including any and all
assets of whatever type or kind deposited by such Pledgor in such
Collateral Account, whether now owned or hereafter acquired, existing or
arising, including, without limitation, all Financial Assets, Investment
Property, moneys, checks, drafts, Instruments, Stock or interests
therein of any type or nature deposited or required by the Credit
Agreement or any other Secured Debt Agreement to be deposited in such
Collateral Account, and all investments and all certificates and other
Instruments (including depository receipts, if any) from time to time
representing or evidencing the same, and all dividends, interest,
distributions, cash and other property from time to time received,
receivable or otherwise distributed in respect of or in exchange for any
or all of the foregoing;
(b) all Stock of such Pledgor from time to time;
(c) all Limited Liability Company Interests of such Pledgor
from time to time and all of its right, title and interest in each
limited liability company to which each such interest relates, whether
now existing or hereafter acquired, including, without limitation:
(A) all the capital thereof and its interest in all
profits, losses, Limited Liability Company Assets and other
distributions to which such Pledgor shall at any time be
entitled in respect of such Limited Liability Company
Interests;
(B) all other payments due or to become due to such
Pledgor in respect of Limited Liability Company Interests,
whether under any limited liability company agreement or
otherwise, whether as contractual obligations, damages,
insurance proceeds or otherwise;
(C) all of its claims, rights, powers, privileges,
authority, options, security interests, liens and remedies, if
any, under any limited liability company agreement or
operating agreement, or at law or otherwise in respect of such
Limited Liability Company Interests;
(D) all present and future claims, if any, of such
Pledgor against any such limited liability company for moneys
loaned or advanced, for services rendered or otherwise;
(E) all of such Pledgor's rights under any limited
liability company agreement or operating agreement or at law
to exercise and enforce every right, power, remedy, authority,
option and privilege of such Pledgor relating to such Limited
Liability Company Interests, including any power to terminate,
cancel or modify any limited liability company agreement or
operating agreement, to execute any instruments and to take
any and all other action on behalf of and in the name of such
Pledgor in respect of such Limited Liability Company Interests
and any such limited liability company, to make
determinations, to exercise any election (including, but not
limited to, election of remedies) or option or to give or
receive any notice, consent, amendment, waiver or approval,
together with full power and authority to demand, receive,
enforce, collect or receipt for any of the
-8-
<PAGE>
foregoing or for any Limited Liability Company Asset, to
enforce or execute any checks, or other instruments or orders,
to file any claims and to take any action in connection with
any of the foregoing; and
(F) all other property hereafter delivered in
substitution for or in addition to any of the foregoing, all
certificates and instruments representing or evidencing such
other property and all cash, securities, interest, dividends,
rights and other property at any time and from time to time
received, receivable or otherwise distributed in respect of or
in exchange for any or all thereof;
(d) all Partnership Interests of such Pledgor from time to
time and all of its right, title and interest in each partnership to
which each such interest relates, whether now existing or hereafter
acquired, including, without limitation:
(A) all the capital thereof and its interest in all
profits, losses, Partnership Assets and other distributions to
which such Pledgor shall at any time be entitled in respect of
such Partnership Interests;
(B) all other payments due or to become due to such
Pledgor in respect of Partnership Interests, whether under any
partnership agreement or otherwise, whether as contractual
obligations, damages, insurance proceeds or otherwise;
(C) all of its claims, rights, powers, privileges,
authority, options, security interests, liens and remedies, if
any, under any partnership agreement or operating agreement,
or at law or otherwise in respect of such Partnership
Interests;
(D) all present and future claims, if any, of such
Pledgor against any such partnership for moneys loaned or
advanced, for services rendered or otherwise;
(E) all of such Pledgor's rights under any
partnership agreement or operating agreement or at law to
exercise and enforce every right, power, remedy, authority,
option and privilege of such Pledgor relating to such
Partnership Interests, including any power to terminate,
cancel or modify any partnership agreement or operating
agreement, to execute any instruments and to take any and all
other action on behalf of and in the name of such Pledgor in
respect of such Partnership Interests and any such
partnership, to make determinations, to exercise any election
(including, but not limited to, election of remedies) or
option or to give or receive any notice, consent, amendment,
waiver or approval, together with full power and authority to
demand, receive, enforce, collect or receipt for any of the
foregoing or for any Partnership Asset, to enforce or execute
any checks, or other instruments or orders, to file any claims
and to take any action in connection with any of the foregoing
(with all of the foregoing rights only to be exercisable upon
the occurrence and during the continuation of an Event of
Default); and
-9-
<PAGE>
(F) all other property hereafter delivered in
substitution for or in addition to any of the foregoing, all
certificates and instruments representing or evidencing such
other property and all cash, securities, interest, dividends,
rights and other property at any time and from time to time
received, receivable or otherwise distributed in respect of or
in exchange for any or all thereof; and
(e) all Proceeds of any and all of the foregoing.
Nothing in this Agreement is to be construed as a pledge of
any tangible or intangible asset or right of any Pledged Entity, however, this
Agreement includes the pledge of all capital stock and other equity interests
issued by each Pledged Entity.
3.2 Procedures. (a) To the extent that any Pledgor at any time
or from time to time owns, acquires or obtains any right, title or interest in
any Collateral, such Collateral shall automatically (and without the taking of
any action by the respective Pledgor) be pledged pursuant to Section 3.1 of this
Agreement and, in addition thereto, such Pledgor shall (to the extent provided
below) take the following actions as set forth below (as promptly as practicable
and, in any event, within 10 days after it obtains such Collateral) for the
benefit of the Pledgee and the Secured Creditors:
(vii) with respect to a Certificated Security (other than a
Certificated Security credited on the books of a Clearing Corporation),
the respective Pledgor shall physically deliver such Certificated
Security to the Pledgee, endorsed to the Pledgee or endorsed in blank;
(ii) with respect to an Uncertificated Security (other than an
Uncertificated Security credited on the books of a Clearing
Corporation), the respective Pledgor shall cause the issuer of such
Uncertificated Security to duly authorize and execute, and deliver to
the Pledgee, an agreement for the benefit of the Pledgee and the
Secured Creditors substantially in the form of Annex F hereto
(appropriately completed to the satisfaction of the Pledgee and with
such modifications, if any, as shall be satisfactory to the Pledgee)
pursuant to which such issuer agrees to comply with any and all
instructions originated by the Pledgee without further consent by the
registered owner and not to comply with instructions regarding such
Uncertificated Security (and any Partnership Interests and Limited
Liability Company Interests issued by such issuer) originated by any
other Person other than a court of competent jurisdiction;
(iii) with respect to a Certificated Security, Uncertificated
Security, Partnership Interest or Limited Liability Company Interest
credited on the books of a Clearing Corporation (including a Federal
Reserve Bank, Participants Trust Company or The Depository Trust
Company), the respective Pledgor shall promptly notify the Pledgee
thereof and shall promptly take all actions required (i) to comply with
the applicable rules of such Clearing Corporation and (ii) to perfect
the security interest of the Pledgee under applicable law (including,
in any event, under Sections 9-115 (4)(a) and (b), 9-115 (1)(e) and
8-106 (d) of the UCC). The respective Pledgor further agrees to take
such actions as the Pledgee deems necessary or desirable to effect the
foregoing;
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<PAGE>
(iv) with respect to a Partnership Interest or a Limited
Liability Company Interest (other than a Partnership Interest or
Limited Liability Interest credited on the books of a Clearing
Corporation), (1) if such Partnership Interest or Limited Liability
Company Interest is represented by a certificate, the procedure set
forth in Section 3.2(a)(i), and (2) if such Partnership Interest or
Limited Liability Company Interest is not represented by a certificate,
the procedure set forth in Section 3.2(a)(ii); and
(v) with respect to cash, (i) establishment by the Pledgee of
a cash account in the name of such Pledgor over which the Pledgee shall
have exclusive and absolute control and dominion (and no withdrawals or
transfers may be made therefrom by any Person except with the prior
written consent of the Pledgee) and (ii) deposit of such cash in such
cash account.
(b) In addition to the actions required to be taken pursuant
to preceding Section 3.2(a), each Pledgor shall take the following additional
actions with respect to the Stock and Collateral (as defined below):
(i) with respect to all Collateral of such Pledgor whereby or
with respect to which the Pledgee may obtain "control" thereof within
the meaning of Section 8-106 of the UCC (or under any provision of the
UCC as same may be amended or supplemented from time to time, or under
the laws of any relevant State other than the State of New York), the
respective Pledgor shall take all reasonable actions as may be
requested from time to time by the Pledgee so that "control" of such
Collateral is obtained and at all times held by the Pledgee; and
(ii) each Pledgor shall from time to time cause appropriate
financing statements (on Form UCC-1 or other appropriate form) under
the Uniform Commercial Code as in effect in the various relevant
States, covering all Collateral hereunder (with the form of such
financing statements to be satisfactory to the Pledgee), to be filed in
the relevant filing offices so that at all times the Pledgee has a
security interest in all Collateral that is Investment Property, which
is perfected by the filing of such financing statements (in each case
to the maximum extent perfection by filing may be obtained under the
laws of the relevant States, including, without limitation, Section
9-115(4)(b) of the UCC).
3.3 Subsequently Acquired Collateral. If any Pledgor shall
acquire (by purchase, stock dividend or otherwise) any additional Collateral at
any time or from time to time after the date hereof, such Collateral shall
automatically (and without any further action being required to be taken) be
subject to the pledge and security interests created pursuant to Section 3.1
and, furthermore, such Pledgor will promptly thereafter take (or cause to be
taken) all action with respect to such Collateral in accordance with the
procedures set forth in Section 3.2, and will promptly thereafter deliver to the
Pledgee (i) a certificate executed by a principal executive officer of such
Pledgor describing such Collateral and certifying that the same has been duly
pledged in favor of the Pledgee (for the benefit of the Secured Creditors)
hereunder and (ii)
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<PAGE>
supplements to Annexes A through E hereto as are necessary to cause such annexes
to be complete and accurate at such time.
3.4 Transfer Taxes. Each pledge of Collateral under Section
3.1 or Section 3.3 shall be accompanied by any transfer tax stamps required in
connection with the pledge of such Collateral.
3.5 Certain Representations and Warranties Regarding the
Collateral. Each Pledgor represents and warrants that on the date hereof (i)
each Subsidiary of such Pledgor, and the direct ownership thereof, is listed in
Annex A hereto; (ii) the Stock held by such Pledgor consists of the number and
type of shares of the stock of the corporations as described in Annex B hereto;
(iii) such Stock constitutes that percentage of the issued and outstanding
capital stock of the issuing corporation as is set forth in Annex B hereto; (iv)
the Limited Liability Company Interests held by such Pledgor consist of the
number and type of interests of the Persons described in Annex C hereto; (v)
each such Limited Liability Company Interest constitutes that percentage of the
issued and outstanding equity interest of the issuing Person as set forth in
Annex C hereto; (vi) the Partnership Interests held by such Pledgor consist of
the number and type of interests of the Persons described in Annex D hereto;
(vii) each such Partnership Interest constitutes that percentage or portion of
the entire partnership interest of the Partnership as set forth in Annex D
hereto; (viii) such Pledgor has complied with the respective procedure set forth
in Section 3.2(a) with respect to each item of Collateral described in Annexes A
through D hereto; and (ix) on the date hereof, such Pledgor owns no other Stock,
Limited Liability Company Interests or Partnership Interests.
4. APPOINTMENT OF SUB-AGENTS; ENDORSEMENTS, ETC. The Pledgee
shall have the right to appoint one or more sub-agents for the purpose of
retaining physical possession of the Collateral, which may be held (in the
discretion of the Pledgee) in the name of the relevant Pledgor, endorsed or
assigned in blank or in favor of the Pledgee or any nominee or nominees of the
Pledgee or a sub-agent appointed by the Pledgee.
5. VOTING, ETC., WHILE NO EVENT OF DEFAULT. Unless and until
there shall have occurred and be continuing an Event of Default, each Pledgor
shall be entitled to exercise all voting rights attaching to any and all
Collateral owned by it, and to give consents, waivers or ratifications in
respect thereof provided that no vote shall be cast or any consent, waiver or
ratification given or any action taken which would violate, result in breach of
any covenant contained in, or be inconsistent with, any of the terms of this
Agreement, the Credit Agreement, the DF Credit Agreement, the RSD Loan
Agreement, the D&O Credit Agreement, any other Credit Document, any other DF
Credit Document, any other RSD Loan Document, any other D&O Credit Document or
any Interest Rate Agreement (collectively, the "Secured Debt Agreements"), or
which would have the effect of impairing the value of the Collateral or any part
thereof in any material respect or the position or interests of the Pledgee or
any Secured Creditor therein. All such rights of each Pledgor to vote and to
give consents, waivers and ratifications shall cease in case an Event of Default
shall occur and be continuing and Section 7 hereof shall become applicable.
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6. DIVIDENDS AND OTHER DISTRIBUTIONS. Unless and until an
Event of Default shall have occurred and be continuing, all cash dividends, cash
distributions, cash Proceeds and other cash amounts payable in respect of the
Collateral shall be paid to the respective Pledgor. Subject to Section 3.2
hereof, the Pledgee shall be entitled to receive directly, and to retain as part
of the Collateral:
(i) all other or additional stock, limited liability company
interests, partnership interests, instruments or other securities or
property (including, but not limited to, cash dividends other than as
set forth above) paid or distributed by way of dividend or otherwise in
respect of the Collateral;
(ii) all other or additional stock, limited liability company
interests, partnership interests, instruments or other securities or
property (including, but not limited to, cash) paid or distributed in
respect of the Collateral by way of stock-split, spin-off, split-up,
reclassification, combination of shares or similar rearrangement; and
(iii) all other or additional stock, limited liability company
interests, partnership interests, instruments or other securities or
property (including, but not limited to, cash) which may be paid in
respect of the Collateral by reason of any consolidation, merger,
exchange of stock, conveyance of assets, liquidation or similar
corporate reorganization.
Nothing contained in this Section 6 shall limit or restrict in any way the
Pledgee's right to receive the proceeds of the Collateral in any form in
accordance with Section 3 of this Agreement. All dividends, distributions or
other payments which are received by any Pledgor contrary to the provisions of
this Section 6 or Section 7 shall be received in trust for the benefit of the
Pledgee, shall be segregated from other property or funds of such Pledgor and
shall be forthwith paid over to the Pledgee as Collateral in the same form as so
received (with any necessary endorsement).
7. REMEDIES IN CASE OF AN EVENT OF DEFAULT OR CERTAIN
DEFAULTS. In case an Event of Default shall have occurred and be continuing, the
Pledgee shall be entitled to exercise all of the rights, powers and remedies
(whether vested in it by this Agreement or by any other Secured Debt Agreement
or by law) for the protection and enforcement of its rights in respect of the
Collateral, including, without limitation, all the rights and remedies of a
secured party upon default under the Uniform Commercial Code of the State of New
York, and the Pledgee shall be entitled, without limitation, to exercise any or
all of the following rights:
(i) to receive all amounts payable in respect of the
Collateral otherwise payable under Section 6 to the respective Pledgor;
(ii) to transfer all or any part of the Collateral into the
Pledgee's name or the name of its nominee or nominees;
(iii) to vote all or any part of the Collateral (whether or
not transferred into the name of the Pledgee) and give all consents,
waivers and ratifications in respect of the
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Collateral and otherwise act with respect thereto as though it were the
outright owner thereof (each Pledgor hereby irrevocably constituting
and appointing the Pledgee the proxy and attorney-in-fact of such
Pledgor, with full power of substitution to do so);
(iv) at any time or from time to time to sell, assign and
deliver, or grant options to purchase, all or any part of the
Collateral, or any interest therein, at any public or private sale,
without demand of performance, advertisement or notice of intention to
sell or of the time or place of sale or adjournment thereof or to
redeem or otherwise (all of which are hereby waived by each Pledgor),
for cash, on credit or for other property, for immediate or future
delivery without any assumption of credit risk, and for such price or
prices and on such terms as the Pledgee in its absolute discretion may
determine; provided that at least 10 days' notice of the time and place
of any such sale shall be given to the respective Pledgor. The Pledgee
shall not be obligated to make such sale of Collateral regardless of
whether any such notice of sale has theretofore been given. Each
purchaser at any such sale shall hold the property so sold absolutely
free from any claim or right on the part of the respective Pledgor, and
each Pledgor hereby waives and releases to the fullest extent permitted
by law any right or equity of redemption with respect to the
Collateral, whether before or after sale hereunder, all rights, if any,
of marshaling the Collateral and any other security for the Obligations
or otherwise, and all rights, if any, of stay and/or appraisal which it
now has or may at any time in the future have under rule of law or
statute now existing or hereafter enacted. At any such sale, unless
prohibited by applicable law, the Pledgee on behalf of all Secured
Creditors (or certain of them) may bid for and purchase (by bidding in
Obligations or otherwise) all or any part of the Collateral so sold
free from any such right or equity of redemption. Neither the Pledgee
nor any Secured Creditor shall be liable for failure to collect or
realize upon any or all of the Collateral or for any delay in so doing
nor shall any of them be under any obligation to take any action
whatsoever with regard thereto; and
(v) to set-off any and all Collateral against any and all
Obligations, and to withdraw any and all cash or other Collateral from
any and all Collateral Accounts and to apply such cash and other
Collateral to the payment of any and all Obligations.
Any and all remedies and rights notwithstanding, in the event of default and
acceleration of any Obligations hereunder and under any Secured Debt Agreement,
neither the Pledgee nor any Secured Creditor shall vote, sell, or in any manner
exercise control as to any Regulated Insurance Company pledged as Collateral
without first making all required filings with, and obtaining written prior
approval from, each applicable insurance regulatory authority.
8. REMEDIES, ETC., CUMULATIVE. Each right, power and remedy of
the Pledgee provided for in this Agreement or any other Secured Debt Agreement,
or now or hereafter existing at law or in equity or by statute shall be
cumulative and concurrent and shall be in addition to every other such right,
power or remedy. The exercise or beginning of the exercise by the Pledgee or any
Secured Creditor of any one or more of the rights, powers or remedies provided
for in this Agreement or any other Secured Debt Agreement or now or hereafter
existing at law or in equity or by statute or otherwise shall not preclude the
simultaneous or later
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exercise by the Pledgee or any Secured Creditor of all such other rights, powers
or remedies, and no failure or delay on the part of the Pledgee or any Secured
Creditor to exercise any such right, power or remedy shall operate as a waiver
thereof. Unless otherwise required by the Credit Documents, no notice to or
demand on any Pledgor in any case shall entitle such Pledgor to any other or
further notice or demand in similar or other circumstances or constitute a
waiver of any of the rights of the Pledgee or any Secured Creditor to any other
or further action in any circumstances without demand or notice. The Secured
Creditors agree that this Agreement may be enforced only by the action of the
Pledgee, acting upon the instructions of the Required Secured Creditors and that
no other Secured Creditor shall have any right individually to seek to enforce
or to enforce this Agreement or to realize upon the security to be granted
hereby, it being understood and agreed that such rights and remedies may be
exercised by the Pledgee for the benefit of the Secured Creditors upon the terms
of this Agreement and the other Secured Debt Agreements.
9. APPLICATION OF PROCEEDS. (a) All moneys collected by the
Pledgee upon any sale or other disposition of the Collateral pursuant to the
terms of this Agreement, together with all other moneys received by the Pledgee
hereunder, shall be applied as follows:
(i) first, to the payment of all Obligations owing the Pledgee
of the type provided in clauses (vi) and (vii) of the definition of
Obligations contained in Section 1 hereof;
(ii) second, to the extent proceeds remain after the
application pursuant to the preceding clause (i), an amount equal to
the outstanding Obligations shall be paid to the Secured Creditors as
provided in Section 9(c) hereof with each Secured Creditor receiving an
amount equal to its outstanding Obligations or, if the proceeds are
insufficient to pay in full all such Obligations, its Pro Rata Share
(as defined below) of the amount remaining to be distributed; and
(iii) third, to the extent proceeds remain after the
application pursuant to the preceding clauses (i) and (ii) and
following the termination of this Agreement pursuant to Section 19
hereof, to the respective Pledgor or, to the extent directed by such
Pledgor or a court of competent jurisdiction, to whomever may be
lawfully entitled to receive such surplus.
(b) For purposes of this Agreement, "Pro Rata Share" shall
mean, when calculating a Secured Creditor's portion of any distribution or
amount, that amount (expressed as a percentage) equal to a fraction the
numerator of which is the then unpaid amount of such Secured Creditor's
Obligations and the denominator of which is the then outstanding amount of all
Obligations.
(c) All payments required to be made to the Bank Creditors,
the DF Bank Creditors, the RSD Bank Creditor or the D&O Bank Creditors
hereunder, as the case may be, shall be made to (i) the Administrative Agent
under the Credit Agreement for the account of the Bank Creditors, (ii) the DF
Administrative Agent for the account of the DF Bank Creditors, (iii) the RSD
Bank for the account of the RSD Bank Creditor or (iv) the D&O Administrative
Agent
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for the account of the D&O Bank Creditors, as the case may be. All payments
required to be made to the Interest Rate Creditors hereunder shall be made
directly to the respective Interest Rate Creditors.
(d) For purposes of applying payments received in accordance
with this Section 9, the Pledgee shall be entitled to rely upon (i) the
Administrative Agent under the Credit Agreement, (ii) the DF Administrative
Agent under the DF Credit Agreement, (iii) the RSD Bank under the RSD Loan
Agreement, (iv) the D&O Administrative Agent under the D&O Credit Agreement and
(v) the Interest Rate Creditors for a determination (which the Administrative
Agent, the DF Administrative Agent, the RSD Bank, the D&O Administrative Agent,
each Interest Rate Creditor and the Secured Creditors agree (or shall agree) to
provide upon request of the Collateral Agent) of the outstanding Obligations
owed to the Bank Creditors, the DF Bank Creditors, the RSD Bank Creditor, the
D&O Bank Creditors or the Interest Rate Creditors, as the case may be. Unless it
has actual knowledge (including by way of written notice from a Bank Creditor, a
DF Bank Creditor, the RSD Bank Creditor, a D&O Bank Creditor or an Interest Rate
Creditor) to the contrary, the Administrative Agent under the Credit Agreement,
the DF Administrative Agent under the DF Credit Agreement, the RSD Bank under
the RSD Loan Agreement and the D&O Administrative Agent under the D&O Credit
Agreement, in furnishing information pursuant to the preceding sentence, and the
Collateral Agent, in acting hereunder, shall be entitled to assume that (v) no
Credit Agreement Obligations other than principal, interest and regularly
accruing fees are owing to any Bank Creditor, (w) no DF Credit Agreement
Obligations other than principal, interest and regularly accruing fees are owing
to any DF Bank Creditor, (x) no RSD Loan Agreement Obligations other than
principal, interest and regularly accruing fees are owing to the RSD Bank
Creditor, (y) no D&O Credit Agreement Obligations other than principal, interest
and regularly accruing fees are owing to any D&O Bank Creditor and (z) no
Interest Rate Agreement, or Interest Rate Obligations in respect thereof, are in
existence.
(e) Nothing in this Agreement shall release any Pledgor from
its obligations (if any) under any Secured Debt Agreement, all of which shall
remain in full force and effect as if this Agreement had not been entered into.
10. PURCHASERS OF COLLATERAL. Upon any sale of the Collateral
by the Pledgee hereunder (whether by virtue of the power of sale herein granted,
pursuant to judicial process or otherwise), the receipt of the Pledgee or the
officer making the sale shall be a sufficient discharge to the purchaser or
purchasers of the Collateral so sold, and such purchaser or purchasers shall not
be obligated to see to the application of any part of the purchase money paid
over to the Pledgee or such officer or be answerable in any way for the
misapplication or nonapplication thereof.
11. INDEMNITY. The Borrower agrees (i) to indemnify and hold
harmless the Pledgee, each Secured Creditor and their respective successors,
assigns, employees, agents and servants (individually an "Indemnitee", and
collectively, the "Indemnitees") from and against any and all claims, demands,
losses, judgments and liabilities (including liabilities for penalties) of
whatsoever kind or nature, and (ii) to reimburse each Indemnitee for all
reasonable out-of-
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pocket costs and expenses, including reasonable attorneys' fees, in each case
arising out of or resulting from this Agreement or the exercise by any
Indemnitee of any right or remedy granted to it hereunder or under any other
Secured Debt Agreement (but excluding any claims, demands, losses, judgments and
liabilities (including liabilities for penalties) or expenses of whatsoever kind
or nature to the extent incurred or arising by reason of gross negligence or
willful misconduct of such Indemnitee). In no event shall any Indemnitee
hereunder be liable, in the absence of gross negligence or willful misconduct on
its part, for any matter or thing in connection with this Agreement other than
to account for monies or other property actually received by it in accordance
with the terms hereof. If and to the extent that the obligations of the Borrower
under this Section 11 are unenforceable for any reason, the Borrower hereby
agrees to make the maximum contribution to the payment and satisfaction of such
obligations which is permissible under applicable law. The indemnity obligations
of the Borrower contained in this Section 11 shall continue in full force and
effect notwithstanding the termination of all Interest Rate Agreements and the
payment of all Obligations and notwithstanding the discharge thereof.
12. FURTHER ASSURANCES; POWER OF ATTORNEY. (a) Each Pledgor
agrees that it will join with the Pledgee in executing and, at such Pledgor's
own expense, file and refile under the Uniform Commercial Code such financing
statements, continuation statements and other documents in such offices as the
Pledgee (acting on its own or on the instructions of the Required Secured
Creditors) may reasonably deem necessary or appropriate and wherever required or
permitted by law in order to perfect and preserve the Pledgee's security
interest in the Collateral hereunder and hereby authorizes the Pledgee to file
financing statements and amendments thereto relative to all or any part of the
Collateral without the signature of such Pledgor where permitted by law, and
agrees to do such further acts and things and to execute and deliver to the
Pledgee such additional conveyances, assignments, agreements and instruments as
the Pledgee may reasonably require or deem advisable to carry into effect the
purposes of this Agreement or to further assure and confirm unto the Pledgee its
rights, powers and remedies hereunder or thereunder.
(b) Each Pledgor hereby appoints the Pledgee such Pledgor's
attorney-in-fact, with full authority in the place and stead of such Pledgor and
in the name of such Pledgor or otherwise, from time to time after the occurrence
and during the continuance of an Event of Default, in the Pledgee's discretion
to take any action and to execute any instrument which the Pledgee may deem
necessary or advisable to accomplish the purposes of this Agreement.
13. THE PLEDGEE AS COLLATERAL AGENT. The Pledgee will hold in
accordance with this Agreement all items of the Collateral at any time received
under this Agreement. It is expressly understood and agreed that the obligations
of the Pledgee as holder of the Collateral and interests therein and with
respect to the disposition thereof, and otherwise under this Agreement, are only
those expressly set forth in this Agreement. The Pledgee shall act hereunder on
the terms and conditions set forth herein and in Section 10 of the Credit
Agreement.
14. TRANSFER BY THE PLEDGORS. No Pledgor will sell or
otherwise dispose of, grant any option with respect to, or mortgage, pledge or
otherwise encumber any of
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the Collateral or any interest therein (except in accordance with the terms of
this Agreement and the Secured Debt Agreements).
15. REPRESENTATIONS, WARRANTIES AND COVENANTS OF THE PLEDGORS.
(a) Each Pledgor represents, warrants and covenants that:
(i) it is the legal, beneficial and record owner of, and has
good and valid title to, all Collateral consisting of Stock and that it
has sufficient interest in all Collateral in which a security interest
is purported to be created hereunder for such security interest to
attach (subject, in each case, to no pledge, lien, mortgage,
hypothecation, security interest, charge, option, Adverse Claim or
other encumbrance whatsoever, except the liens and security interests
created by this Agreement);
(ii) it has full power, authority and legal right to pledge
all the Collateral pledged by it pursuant to this Agreement;
(iii) this Agreement has been duly authorized, executed and
delivered by such Pledgor and constitutes a legal, valid and binding
obligation of such Pledgor enforceable against such Pledgor in
accordance with its terms, except to the extent that the enforceability
thereof may be limited by applicable bankruptcy, insolvency,
reorganization, moratorium or other similar laws generally affecting
creditors' rights and by equitable principles (regardless of whether
enforcement is sought in equity or at law);
(iv) except to the extent already obtained or made, no consent
of any other party (including, without limitation, any stockholder or
creditor of such Pledgor or any of its Subsidiaries) and no consent,
license, permit, approval or authorization of, exemption by, notice or
report to, or registration, filing or declaration with, any
governmental authority is required to be obtained by such Pledgor in
connection with (a) the execution, delivery or performance of this
Agreement, (b) the validity or enforceability of this Agreement (except
as set forth in clause (iii) above), (c) the perfection or
enforceability of the Pledgee's security interest in the Collateral or
(d) the exercise by the Pledgee of any of its rights or remedies
provided herein, except as may be required in connection with the
disposition of the Stock by laws affecting the offering and sale of
securities generally;
(v) the execution, delivery and performance of this Agreement
will not violate any provision of any applicable law or regulation or
of any order, judgment, writ, award or decree of any court, arbitrator
or governmental authority, domestic or foreign, applicable to such
Pledgor, or of the certificate of incorporation, operating agreement,
limited liability company agreement or by-laws of such Pledgor or of
any securities issued by such Pledgor or any of its Subsidiaries, or of
any mortgage, deed of trust, indenture, lease, loan agreement, credit
agreement or other contract, agreement or instrument or undertaking to
which such Pledgor or any of its Subsidiaries is a party or which
purports to be binding upon such Pledgor or any of its Subsidiaries or
upon any of their respective assets and will not result in the creation
or imposition of (or the obligation to create or impose) any lien or
encumbrance on any of the assets of such Pledgor or any of its
Subsidiaries except as contemplated by this Agreement;
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(vi) all of the Collateral (consisting of Stock, Limited
Liability Company Interests or Partnership Interests) has been duly and
validly issued, is fully paid and non-assessable and is subject to no
options to purchase or similar rights;
(vii) the pledge, collateral assignment and delivery to the
Pledgee of the Collateral consisting of certificated securities
pursuant to this Agreement creates a valid and perfected first priority
security interest in such Stock, and the proceeds thereof, subject to
no prior Lien or encumbrance or to any agreement purporting to grant to
any third party a Lien or encumbrance on the property or assets of such
Pledgor which would include the Stock and the Pledgee is entitled to
all the rights, priorities and benefits afforded by the UCC or other
relevant law as enacted in any relevant jurisdiction to perfect
security interests in respect of such Collateral; and
(viii) "control" (as defined in Section 8-106 of the UCC) has
been obtained by the Pledgee over all Collateral consisting of Stock
with respect to which such "control" may be obtained pursuant to
Section 8-106 of the UCC.
(b) Each Pledgor covenants and agrees that it will defend the
Pledgee's right, title and security interest in and to the Stock and the
proceeds thereof against the claims and demands of all persons whomsoever; and
each Pledgor covenants and agrees that it will have like title to and right to
pledge any other property at any time hereafter pledged to the Pledgee as
Collateral hereunder and will likewise defend the right thereto and security
interest therein of the Pledgee and the Secured Creditors.
(c) Each Pledgor covenants and agrees that it will take no
action which would violate any of the terms of any Secured Debt Agreement.
16. CHIEF EXECUTIVE OFFICE; RECORDS. The chief executive
office of each Pledgor is located at the address specified in Annex E hereto. No
Pledgor will move its chief executive office except to such new location as such
Pledgor may establish in accordance with the last sentence of this Section 16.
The originals of all documents in the possession of such Pledgor evidencing all
Collateral, including but not limited to all Limited Liability Company Interests
and Partnership Interests, and the only original books of account and records of
such Pledgor relating thereto are, and will continue to be, kept at such chief
executive office at the location specified in Annex E hereto, or at such new
locations as such Pledgor may establish in accordance with the last sentence of
this Section 16. All Limited Liability Company Interests and Partnership
Interests are, and will continue to be, maintained at, and controlled and
directed (including, without limitation, for general accounting purposes) from,
such chief executive office location specified in Annex E hereto, or such new
locations as such Pledgor may establish in accordance with the last sentence of
this Section 16. No Pledgor shall establish a new location for such offices
until (i) it shall have given to the Collateral Agent not less than 30 days'
prior written notice of its intention so to do, clearly describing such new
location and providing such other information in connection therewith as the
Collateral Agent may reasonably request and (ii) with respect to such new
location, it shall have taken all action, satisfactory to the Collateral Agent,
to maintain the security interest of the Collateral Agent in the Collateral
intended to be
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granted hereby at all times fully perfected and in full force and effect.
Promptly after establishing a new location for such offices in accordance with
the immediately preceding sentence, such Pledgor shall deliver to the Pledgee a
supplement to Annex E hereto so as to cause such Annex E hereto to be complete
and accurate.
17. PLEDGORS' OBLIGATIONS ABSOLUTE, ETC. The obligations of
each Pledgor under this Agreement shall be absolute and unconditional and shall
remain in full force and effect without regard to, and shall not be released,
suspended, discharged, terminated or otherwise affected by, any circumstance or
occurrence whatsoever (other than termination of this Agreement pursuant to
Section 19 hereof), including, without limitation:
(i) any renewal, extension, amendment or modification of, or
addition or supplement to or deletion from any Secured Debt Agreement
(other than this Agreement in accordance with its terms), or any other
instrument or agreement referred to therein, or any assignment or
transfer of any thereof;
(ii) any waiver, consent, extension, indulgence or other
action or inaction under or in respect of any such agreement or
instrument or this Agreement (other than a waiver, consent or extension
with respect to this Agreement in accordance with its terms);
(iii) any furnishing of any additional security to the Pledgee
or its assignee or any acceptance thereof or any release of any
security by the Pledgee or its assignee;
(iv) any limitation on any party's liability or obligations
under any such instrument or agreement or any invalidity or
unenforceability, in whole or in part, of any such instrument or
agreement or any term thereof; or
(v) any bankruptcy, insolvency, reorganization, composition,
adjustment, dissolution, liquidation or other like proceeding relating
to any Pledgor or any Subsidiary of any Pledgor, or any action taken
with respect to this Agreement by any trustee or receiver, or by any
court, in any such proceeding, whether or not such Pledgor shall have
notice or knowledge of any of the foregoing.
18. REGISTRATION, ETC. (a) If an Event of Default shall have
occurred and be continuing and any Pledgor shall have received from the Pledgee
a written request or requests that such Pledgor cause any registration,
qualification or compliance under any Federal or state securities law or laws to
be effected with respect to all or any part of the Collateral consisting of
Stock, Limited Liability Company Interests or Partnership Interests, such
Pledgor as soon as practicable and at its expense will use its best efforts to
cause such registration to be effected (and be kept effective) and will use its
best efforts to cause such qualification and compliance to be effected (and be
kept effective) as may be so requested and as would permit or facilitate the
sale and distribution of such Collateral consisting of Stock, Limited Liability
Company Interests or Partnership Interests, including, without limitation,
registration under the Securities Act of 1933, as then in effect (or any similar
statute then in effect), appropriate qualifications under applicable blue sky or
other state securities laws and appropriate compliance with any other
governmental requirements; provided, that the Pledgee shall furnish to such
Pledgor such
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information regarding the Pledgee as such Pledgor may request in writing and as
shall be required in connection with any such registration, qualification or
compliance. Each Pledgor will cause the Pledgee to be kept reasonably advised in
writing as to the progress of each such registration, qualification or
compliance and as to the completion thereof, will furnish to the Pledgee such
number of prospectuses, offering circulars and other documents incident thereto
as the Pledgee from time to time may reasonably request, and will indemnify, to
the extent permitted by law, the Pledgee and all other Secured Creditors
participating in the distribution of such Collateral consisting of Stock,
Limited Liability Company Interests or Partnership Interests against all claims,
losses, damages and liabilities caused by any untrue statement (or alleged
untrue statement) of a material fact contained therein (or in any related
registration statement, notification or the like) or by any omission (or alleged
omission) to state therein (or in any related registration statement,
notification or the like) a material fact required to be stated therein or
necessary to make the statements therein not misleading, except insofar as the
same may have been caused by an untrue statement or omission based upon
information furnished in writing to such Pledgor by the Pledgee expressly for
use therein.
(b) If at any time when the Pledgee shall determine to
exercise its right to sell all or any part of the Collateral consisting of
Stock, Limited Liability Company Interests or Partnership Interests pursuant to
Section 7, and such Collateral or the part thereof to be sold shall not, for any
reason whatsoever, be effectively registered under the Securities Act of 1933,
as then in effect, the Pledgee may sell such Collateral or part thereof by
private sale in such manner and under such circumstances as the Pledgee may deem
necessary or advisable in order that such sale may legally be effected without
such registration. Without limiting the generality of the foregoing, in any such
event the Pledgee: (i) may proceed to make such private sale notwithstanding
that a registration statement for the purpose of registering such Collateral or
part thereof shall have been filed under such Securities Act; (ii) may approach
and negotiate with a single possible purchaser to effect such sale; and (iii)
may restrict such sale to a purchaser who will represent and agree that such
purchaser is purchasing for its own account, for investment, and not with a view
to the distribution or sale of such Collateral or part thereof. In the event of
any such sale, the Pledgee shall incur no responsibility or liability for
selling all or any part of the Collateral at a price which the Pledgee may in
good faith deem reasonable under the circumstances, notwithstanding the
possibility that a substantially higher price might be realized if the sale were
deferred until the registration as aforesaid.
19. TERMINATION; RELEASE. (a) On the Termination Date (as
defined below), this Agreement shall terminate (provided that all indemnities
set forth herein including, without limitation, in Section 11 hereof shall
survive any such termination) and the Pledgee, at the request and expense of any
Pledgor, will execute and deliver to such Pledgor a proper instrument or
instruments acknowledging the satisfaction and termination of this Agreement
(including, without limitation, UCC termination statements and instruments of
satisfaction, discharge and/or reconveyance), and will duly assign, transfer and
deliver to such Pledgor (without recourse and without any representation or
warranty) such of the Collateral as may be in the possession of the Pledgee and
as has not theretofore been sold or otherwise applied or released pursuant to
this Agreement, together with any moneys at the time held by the Pledgee or any
of its sub-agents hereunder and, with respect to any Collateral consisting of an
Uncertificated Security (other than an Uncertificated
-21-
<PAGE>
Security credited on the books of a Clearing Corporation), a Partnership
Interest or a Limited Liability Company Interest, a termination of the agreement
relating thereto executed and delivered by the issuer of such Uncertificated
Security pursuant to Section 3.2(a)(ii) or by the respective partnership or
limited liability company pursuant to Section 3.2(a)(iv). As used in this
Agreement, "Termination Date" shall mean the date upon which the total
commitments under each of the Credit Agreement, the DF Credit Agreement, the RSD
Loan Agreement and the D&O Credit Agreement and all Interest Rate Agreements
have been terminated and all Obligations have been paid in full.
(b) In the event that any part of the Collateral is sold or
otherwise disposed of in connection with a sale or disposition permitted by the
Credit Agreement, the DF Credit Agreement, the RSD Loan Agreement and the D&O
Credit Agreement or is otherwise released at the direction of the Required
Secured Creditors (but including all of the Banks if required by Section 11.12
of the Credit Agreement), and the proceeds of such sale or sales or from such
release are applied in accordance with the terms of the Secured Debt Agreements
to the extent required to be so applied, the Pledgee, at the request and expense
of any Pledgor will duly assign, transfer and deliver to such Pledgor (without
recourse and without any representation or warranty) such of the Collateral as
is then being (or has been) so sold or released and as may be in possession of
the Pledgee and has not theretofore been released pursuant to this Agreement.
(c) At any time that any Pledgor desires that Collateral be
released as provided in the foregoing Section 19(a) or (b), it shall deliver to
the Pledgee a certificate signed by an executive officer of such Pledgor stating
that the release of the respective Collateral is permitted pursuant to Section
19(a) or (b). If reasonably requested by the Pledgee (although the Pledgee shall
have no obligation to make any such request), such Pledgor shall furnish
appropriate legal opinions (from counsel reasonably acceptable to the Pledgee)
to the effect set forth in the immediately preceding sentence.
(d) The Pledgee shall have no liability whatsoever to any
Secured Creditor as the result of any release of Collateral by it in accordance
with this Section 19.
20. NOTICES, ETC. All notices and other communications
hereunder shall be in writing and shall be delivered or mailed by first class
mail, postage prepaid, addressed:
(i) if to any Pledgor, at its address set forth opposite its
signature below;
(ii) if to the Pledgee, at:
Deutsche Bank AG, New York Branch
31 West 52nd Street
New York, New York 10019
Attention: Susan Maros
Tel. No.: (212) 469-8104
Fax No.: (212) 469-8366
-22-
<PAGE>
(iii) if to any Bank, at such address as such Bank shall have
specified in the Credit Agreement;
(iv) if to any DF Bank, at such address as such DF Bank shall
have specified in the DF Credit Agreement;
(v) if to the RSD Bank, at such address as the RSD Bank shall
have specified in the RSD Loan Agreement;
(vi) if to any D&O Bank, at such address as such D&O Bank
shall have specified in the D&O Credit Agreement; and
(vii) if to any Interest Rate Creditor, at such address as
such Interest Rate Creditor shall have specified in writing to the
Borrower and the Pledgee;
or at such address as shall have been furnished in writing by any Person
described above to the party required to give notice hereunder.
21. THE PLEDGEE. The Pledgee will hold, directly or indirectly
in accordance with this Agreement, all items of the Collateral at any time
received by it under this Agreement. It is expressly understood and agreed that
the obligations of the Pledgee with respect to the Collateral, interests therein
and the disposition thereof, and otherwise under this Agreement, are only those
expressly set forth in the UCC and this Agreement.
22. WAIVER; AMENDMENT. Except as contemplated in Section 28
hereof, none of the terms and conditions of this Agreement may be changed,
waived, discharged or terminated in any manner whatsoever unless such change,
waiver, discharge or termination is in writing duly signed by each Pledgor to be
bound thereby and the Pledgee (with the consent of the Required Secured
Creditors), provided, however, that no such change, waiver, modification or
variance shall be made to Section 9 hereof or this Section 22 without the
consent of each Secured Creditor adversely affected thereby, provided further
that any change, waiver, modification or variance affecting the rights and
benefits of a single Class (as defined below) of Secured Creditors (and not all
Secured Creditors in a like or similar manner) shall require the written consent
of the Requisite Creditors of such Class of Secured Creditors. For the purpose
of this Agreement, the term "Class" shall mean each class of Secured Creditors,
i.e., whether (i) the Bank Creditors as holders of the Credit Agreement
Obligations, (ii) the DF Bank Creditors as holders of the DF Credit Agreement
Obligations, (iii) the RSD Bank Creditor as holder of the RSD Loan Agreement
Obligations, (iv) the D&O Bank Creditors as holders of the D&O Credit Agreement
Obligations or (v) the Interest Rate Creditors as holders of the Interest Rate
Obligations. For the purpose of this Agreement, the term "Requisite Creditors"
of any Class shall mean each of (i) with respect to the Credit Agreement
Obligations, the Required Banks, (ii) with respect to the DF Credit Agreement
Obligations, the Required Banks (as defined therein), (iii) with respect to the
RSD Loan Agreement Obligations, the RSD Bank, (iv) with respect to the D&O
Credit Agreement Obligations, the Required Banks (as defined therein) and (v)
with respect to the Interest Rate Obligations, the holders of 51% of all
obligations outstanding from time to time under the Interest Rate Agreements.
-23-
<PAGE>
23. MISCELLANEOUS. This Agreement shall create a continuing
security interest in the Collateral and shall (i) remain in full force and
effect, subject to release and/or termination as set forth in Section 19, (ii)
be binding upon each Pledgor, its successors and assigns; provided, however,
that no Pledgor shall assign any of its rights or obligations hereunder without
the prior written consent of the Pledgee (with the prior written consent of the
Required Secured Creditors), and (iii) inure, together with the rights and
remedies of the Pledgee hereunder, to the benefit of the Pledgee, the Secured
Creditors and their respective successors, transferees and assigns. THIS
AGREEMENT SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE LAW OF THE
STATE OF NEW YORK. The headings of the several sections and subsections in this
Agreement are for purposes of reference only and shall not limit or define the
meaning hereof. This Agreement may be executed in any number of counterparts,
each of which shall be an original, but all of which together shall constitute
one instrument. In the event that any provision of this Agreement shall prove to
be invalid or un enforceable, such provision shall be deemed to be severable
from the other provisions of this Agreement which shall remain binding on all
parties hereto.
24. WAIVER OF JURY TRIAL. Each Pledgor hereby irrevocably
waives all right to a trial by jury in any action, proceeding or counterclaim
arising out of or relating to this agreement or the transactions contemplated
hereby.
25. RECOURSE. This Agreement is made with full recourse to
each Pledgor and pursuant to and upon all the representations, warranties,
covenants and agreements on the part of the Pledgors contained herein and in the
other Secured Debt Agreements and otherwise in writing in connection herewith or
therewith.
26. LIMITED OBLIGATIONS. It is the desire and intent of the
Pledgors and the Secured Creditors that this Agreement shall be enforced against
each Pledgor to the fullest extent permissible under the laws and public
policies applied in each jurisdiction in which enforcement is sought.
27. NOT A PARTNER OR LIMITED LIABILITY COMPANY MEMBER. (a)
Nothing herein shall be construed to make the Pledgee or any other Secured
Creditor liable as a member of any limited liability company or partnership and
neither the Pledgee nor any other Secured Creditor by virtue of this Agreement
or otherwise (except as referred to in the following sentence) shall have any of
the duties, obligations or liabilities of a member of any limited liability
company or partnership. The parties hereto expressly agree that, unless the
Pledgee shall become the absolute owner of Collateral consisting of a Limited
Liability Company Interest or Partnership Interest pursuant hereto, this
Agreement shall not be construed as creating a partnership or joint venture
among the Pledgee, any other Secured Creditor and/or any Pledgor.
(b) Except as provided in the last sentence of paragraph (a)
of this Section 27, the Pledgee, by accepting this Agreement, did not intend to
become a member of any limited liability company or partnership or otherwise be
deemed to be a co-venturer with respect to any Pledgor or any limited liability
company or partnership either before or after an Event of Default shall have
occurred. The Pledgee shall have only those powers set forth herein and the
Secured
-24-
<PAGE>
Creditors shall assume none of the duties, obligations or liabilities of
a member of any limited liability company or partnership or any Pledgor except
as provided in the last sentence of paragraph (a) of this Section 27.
(c) The Pledgee and the other Secured Creditors shall not be
obligated to perform or discharge any obligation of any Pledgor as a result of
the pledge hereby effected.
(d) The acceptance by the Pledgee of this Agreement, with all
the rights, powers, privileges and authority so created, shall not at any time
or in any event obligate the Pledgee or any other Secured Creditor to appear in
or defend any action or proceeding relating to the Collateral to which it is not
a party, or to take any action hereunder or thereunder, or to expend any money
or incur any expenses or perform or discharge any obligation, duty or liability
under the Collateral.
28. ADDITIONAL PLEDGORS. It is understood and agreed that any
Subsidiary of the Borrower that is required to execute a counterpart of this
Agreement after the date hereof pursuant to any Secured Debt Agreement shall
automatically become a Pledgor hereunder by executing a counterpart hereof and
delivering the same to the Pledgee.
* * *
-25-
<PAGE>
IN WITNESS WHEREOF, each Pledgor and the Pledgee have caused
this Agreement to be executed by their duly elected officers duly authorized as
of the date first above written.
Addresses:
195 Lake Louise Marie Road FRONTIER INSURANCE GROUP, INC.,
Rock Hill, NY 12775-8000 as Pledgor
Attention: Mark H. Mishler
Tel. No. (914) 796-2100
Fax. No. (914) 796-1904
By:
-------------------------------
Name:
Title:
DEUTSCHE BANK AG, NEW YORK
BRANCH, as Pledgee
By:
-------------------------------
Name:
Title:
<PAGE>
ANNEX A
LIST OF SUBSIDIARIES
[BORROWER TO LIST SUBSIDIARIES]
<PAGE>
ANNEX B
LIST OF STOCK
<TABLE>
<CAPTION>
Name of
Issuing Type of Number of Certificate Percentage Sub-clause of Section 3.2(a)
Corporation Shares Shares No. Owned of Pledge Agreement
----------- ------ -------- ----------- ---------- ----------------------------
<S> <C> <C> <C> <C> <C>
[TO BE PROVIDED BY THE BORROWER]
</TABLE>
<PAGE>
ANNEX C
LIST OF LIMITED LIABILITY COMPANY INTERESTS
<PAGE>
ANNEX D
LIST OF PARTNERSHIP INTERESTS
<TABLE>
<CAPTION>
Name of Type of Sub-clause of Section 3.2(a)
Partnership Interest Percentage Owned of Pledge Agreement
----------- -------- ---------------- -------------------
<S> <C> <C> <C>
[TO BE PROVIDED BY THE BORROWER]
</TABLE>
<PAGE>
ANNEX E
LIST OF CHIEF EXECUTIVE OFFICES
<PAGE>
Annex F
Form of Agreement Regarding Uncertificated Securities, Limited Liability
Company Interests and Partnership Interests
AGREEMENT (as amended, modified or supplemented from time to
time, this "Agreement"), dated as of _________ __, _____, among each of the
undersigned pledgors (each a "Pledgor" and collectively, the "Pledgors"),
DEUTSCHE BANK AG, NEW YORK BRANCH, not in its individual capacity but solely as
Collateral Agent (the "Pledgee"), and __________, as the issuer of the
Uncertificated Securities, Limited Liability Company Interests and/or
Partnership Interests (each as defined below) (the "Issuer").
W I T N E S S E T H :
WHEREAS, each Pledgor and the Pledgee are entering into a
Pledge Agreement, dated as of January 21, 2000 (as amended, amended and
restated, modified or supplemented from time to time, the "Pledge Agreement"),
under which, among other things, in order to secure the payment of the
Obligations (as defined in the Pledge Agreement), each Pledgor will pledge to
the Pledgee for the benefit of the Secured Creditors (as defined in the Pledge
Agreement), and grant a security interest in favor of the Pledgee for the
benefit of the Secured Creditors in, all of the right, title and interest of
such Pledgor in and to any and all (1) "uncertificated securities" (as defined
in Section 8-102(a)(18) of the Uniform Commercial Code, as adopted in the State
of New York) ("Uncertificated Securities"), (2) Partnership Interests (as
defined in the Pledge Agreement) and (3) Limited Liability Company Interests (as
defined in the Pledge Agreement), in each case issued from time to time by the
Issuer, whether now existing or hereafter from time to time acquired by such
Pledgor (with all of such Uncertificated Securities, Partnership Interests and
Limited Liability Company Interests being herein collectively called the "Issuer
Pledged Interests"); and
WHEREAS, each Pledgor desires the Issuer to enter into this
Agreement in order to perfect the security interest of the Pledgee under the
Pledge Agreement in the Issuer Pledged Interests, to vest in the Pledgee control
of the Issuer Pledge Interests and to provide for the rights of the parties
under this Agreement;
NOW THEREFORE, in consideration of the premises and the mutual
promises and agreements contained herein, and for other valuable consideration,
the receipt and sufficiency of which are hereby acknowledged, the parties hereto
hereby agree as follows:
1. Each Pledgor hereby irrevocably authorizes and directs the
Issuer, and the Issuer hereby agrees, to comply with any and all reasonable
instructions and reasonable orders originated by the Pledgee (and its successors
and assigns) regarding any and all of the Issuer Pledged Interests without the
further consent by the registered owner (including the respective Pledgor), and
not to comply with any instructions or orders regarding any or all of the Issuer
Pledged Interests originated by any person or entity other than the Pledgee (and
its successors and assigns) or a court of competent jurisdiction.
<PAGE>
Annex F
Page 2
2. The Issuer hereby certifies that (i) no notice of any
security interest, lien or other encumbrance or claim affecting the Issuer
Pledged Interests (other than the security interest of the Pledgee) has been
received by it, and (ii) the security interest of the Pledgee in the Issuer
Pledged Interests has been registered in the books and records of the Issuer.
3. The Issuer hereby represents and warrants that (i) the
pledge by the Pledgors of, and the granting by the Pledgors of a security
interest in, the Issuer Pledged Interests to the Pledgee, for the benefit of the
Secured Creditors, does not violate the charter, by-laws, partnership agreement,
membership agreement or any other agreement governing the Issuer or the Issuer
Pledged Interests, and (ii) the Issuer Pledged Interests are fully paid and
nonassessable.
4. All notices, statements of accounts, reports, prospectuses,
financial statements and other communications to be sent to any Pledgor by the
Issuer in respect of the Issuer will also be sent to the Pledgee at the
following address:
Deutsche Bank AG, New York Branch
31 West 52nd Street
New York, New York 10019
Attention: Susan Maros
Tel No.: (212) 469-8104
Fax No.: (212) 469-8366
5. Until the Pledgee shall have delivered written notice to
the Issuer that all of the Obligations have been paid in full and this Agreement
is terminated, the Issuer will send any and all redemptions, distributions,
interest or other payments in respect of the Issuer Pledged Interests from the
Issuer for the account of the Pledgor only by wire transfers to the following
address:
----------------------------
----------------------------
----------------------------
ABA No.:
Account in the Name of:
Account No.:
6. Except as expressly provided otherwise in Sections 4 and 5,
all notices, instructions, orders and communications hereunder shall be sent or
delivered by mail, telex, telecopy or overnight courier service and all such
notices and communications shall, when mailed, telexed, telecopied or sent by
overnight courier, be effective when deposited in the mails or delivered to the
overnight courier, prepaid and properly addressed for delivery on such or the
next Business Day, or sent by telex or telecopier. All notices and other
communications shall be in writing and addressed as follows:
<PAGE>
Annex F
Page 3
(a) if to any Pledgor, at:
c/o Frontier Insurance Group, Inc.
195 Lake Louise Marie Road
Rock Hill, New York 12775-8000
Attention: Mark H. Mishler
Tel. No.: (914) 796-2100
Fax No.: (914) 796-1904
(b) if to the Pledgee, at:
Deutsche Bank AG, New York Branch
31 West 52nd Street
New York, New York 10019
Attention: Susan Maros
Tel No.: (212) 469-8104
Fax No.: (212) 469-8366
(c) if to the Issuer, at:
-----------------------
-----------------------
-----------------------
Attention: ______________
Tel. No.: ___________
Fax No.: ___________
or at such other address as shall have been furnished in writing by any Person
described above to the party required to give notice hereunder. As used in this
Section 6, "Business Day" means any day other than a Saturday, Sunday, or other
day in which banks in New York are authorized to remain closed.
7. This Agreement shall be binding upon the successors and
assigns of each Pledgor and the Issuer and shall inure to the benefit of and be
enforceable by the Pledgee and its successors and assigns. This Agreement may be
executed in any number of counterparts, each of which shall be an original, but
all of which shall constitute one instrument. In the event that any provision of
this Agreement shall prove to be invalid or unenforceable, such provision shall
be deemed to be severable from the other provisions of this Agreement which
shall remain binding on all parties hereto. None of the terms and conditions of
this Agreement may be changed, waived, modified or varied in any manner
whatsoever except in writing signed by the Pledgee, the Issuer and any Pledgor
which at such time owns any Issuer Pledged Interests.
8. This Agreement shall be governed by and construed in
accordance with the laws of the State of New York, without regard to its
principles of conflict of laws.
<PAGE>
Annex F
Page 4
IN WITNESS WHEREOF, each Pledgor, the Pledgee and the Issuer
have caused this Agreement to be executed by their duly elected officers duly
authorized as of the date first above written.
--------------------------,
as Pledgor
By
----------------------------------
Name:
Title:
DEUTSCHE BANK AG, NEW YORK BRANCH,
not in its individual capacity but solely as Collateral
Agent and Pledgee
By
----------------------------------
Name:
Title:
[ ],
the Issuer
By
----------------------------------
Name:
Title:
<PAGE>
FRONTIER INSURANCE GROUP, INC. 1999 FORM 10-K EXHIBIT 12
Computation of Ratio of Earnings to Fixed Charges
(in thousands)
<TABLE>
<CAPTION>
Year Ended December 31
--------------------------------------------------------------
1999 1998 1997 1996 1995
---------- ----------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Income (loss) before income taxes
and cumulative effect of change
in accounting principle $(174,085) $(90,875) $45,849 $56,659 $43,280
Add:
Minority interest and interest expense 18,479 11,931 11,842 4,247 895
Interest portion of rental expense 500 500 500 371 240
--------- -------- ------- ------- -------
Earnings available for payment of combined
fixed charges and preferred stock dividends $(155,106) $(78,444) $58,191 $61,277 $44,415
========== ========= ======= ======= =======
Combined fixed charges:
Minority Interest and interest expense $ 18,479 $11,931 $11,842 $4,247 $ 895
Interest portion of rental expense 500 500 500 371 240
--------- ------- ------- ------ -----
Total combined fixed charges $ 18,979 $12,431 $12,342 $4,618 $ 1,135
========= ======= ======= ====== =====
Ratio of earnings to combined fixed charges (1) (8.2) (6.3) 4.7 13.3 39.1
</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>
FRONTIER INSURANCE GROUP, INC 1999 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>
<TABLE>
<CAPTION>
State of Jurisdiction
Name and Incorporation
<S> <C>
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(3) England
Western Indemnity Insurance Company Texas
One Stop.com Delaware
FPC Advertising New York
RMH Company, Inc. Kentucky
Brook Smith Agency, Inc. Kentucky
Award Insurance Services, LLC(4) Colorado
Bond America(4) California
Gulfco Insurance Services, Inc. Louisiana
Advantage Casualty & Health Agency Texas
Surety Bond Connection Agency Texas
Agents Bond Connection Agency Texas
</TABLE>
(1) The Company owns 94% interest.
(2) The Company owns 95% interest.
(3) The Company owns 85% interest.
(4) The Company owns 80% interest.
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
(Forms S-8 No. 33-30217, No. 33-39638, No. 33-77332 and No. 333-75515)
pertaining to the Incentive and Non-Incentive Stock Option Plans and Employee
Stock Purchase Plan of Frontier Insurance Group, Inc. of our report dated
April 7, 2000, 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, 1999.
/s/ Ernst & Young LLP
New York, New York
April 13, 2000
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<DEBT-HELD-FOR-SALE> 1,161,655
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 79,712
<MORTGAGE> 0
<REAL-ESTATE> 8,016
<TOTAL-INVEST> 1,414,680
<CASH> 43,219
<RECOVER-REINSURE> 518,658
<DEFERRED-ACQUISITION> 129,746
<TOTAL-ASSETS> 2,635,537
<POLICY-LOSSES> 1,313,310
<UNEARNED-PREMIUMS> 649,736
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 142,800
<COMMON> 376
0
0
<OTHER-SE> 78,177
<TOTAL-LIABILITY-AND-EQUITY> 2,635,537
570,928
<INVESTMENT-INCOME> 77,622
<INVESTMENT-GAINS> 3,113
<OTHER-INCOME> 0
<BENEFITS> 539,378
<UNDERWRITING-AMORTIZATION> 143,092
<UNDERWRITING-OTHER> 124,799
<INCOME-PRETAX> (174,085)
<INCOME-TAX> 59,179
<INCOME-CONTINUING> (233,264)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (233,264)
<EPS-BASIC> (6.65)
<EPS-DILUTED> (6.65)
<RESERVE-OPEN> 632,850
<PROVISION-CURRENT> 452,697
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 109,480
<PAYMENTS-PRIOR> 219,505
<RESERVE-CLOSE> 828,923
<CUMULATIVE-DEFICIENCY> (72,361)
</TABLE>
