UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 8-K
CURRENT REPORT
Pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported) January 15, 1999
MARKEL CORPORATION
(Exact name of registrant as specified in its charter)
Virginia
(State or other jurisdiction of incorporation or organization)
1-13051 54-0292420
(Commission (I.R.S. employer
file number) identification number)
4551 Cox Road, Glen Allen, Virginia 23060-3382
(Address of principal executive offices)
(Zip code)
(804) 747-0136
(Registrant's telephone number, including area code)
NONE
(Former name, former address and former fiscal year,
if changed since last report)
<PAGE>
Item 2. Acquisition or Disposition of Assets
On January 15, 1999 Markel Corporation (the Registrant) acquired Gryphon
Holdings Inc. and its subsidiaries (Gryphon) as a result of the completion of a
public tender offer. As of the termination of the offer, based on a preliminary
count from the depositary for the offer, approximately 5.9 million shares of
Gryphon common stock had been tendered and accepted for payment. These shares
together with the shares that the Registrant already owned, represent
approximately 98 percent of Gryphon's total issued and outstanding shares of
common stock. The Registrant intends to cause a wholly owned subsidiary of the
Registrant to effect a merger with Gryphon pursuant to which the remaining
shares of Gryphon common stock will be converted into the right to receive
$19.00 per share in cash. Markel currently expects the merger to be consummated
by the end of February 1999. The timing of the merger will depend upon, among
other things, whether the outstanding shares of Gryphon preferred stock are
redeemed, converted into shares of Gryphon common stock or purchased by Markel
in a negotiated transaction. Total consideration paid for Gryphon was
approximately $150.7 million. The Registrant funded the transaction with
available cash on hand of approximately $100.7 million and borrowings under
existing lines of credit. In addition, the Registrant subsequently refinanced
$55.0 million of Gryphon's debt.
Gryphon, which operates through its main subsidiary, Gryphon Insurance Group, is
a specialty property and casualty underwriting organization. Gryphon's
wholly-owned insurance subsidiaries are Associated International Insurance
Company, Calvert Insurance Company and The First Reinsurance Company of Hartford
(FRH). Gryphon acquired FRH on July 13, 1998.
Following the acquisition, the Registrant expects to significantly reorganize
Gryphon. The Registrant anticipates that certain unprofitable lines of business
will be discontinued which may materially reduce the amount of business written
by Gryphon.
"Safe Harbor" Statement
This is a "Safe Harbor" statement under the Private Securities Litigation Reform
Act of 1995. Certain statements that are contained herein are forward-looking
statements that involve risks and uncertainties. Future actual results may
materially differ from those in these statements because of many factors. For
instance, the registrant will be significantly reorganizing Gryphon's operations
and the scope and impact of these changes cannot be determined at this time.
Insurance industry price competition has made it more difficult to attract and
retain adequately priced business. State regulatory actions can impede the
Company's ability to charge adequate rates and efficiently allocate capital.
Also the frequency and severity of natural catastrophes are highly variable.
Economic conditions and interest rate volatility can have significant impacts on
the market value of fixed maturity and equity investments. The business
community's state of readiness for the Year 2000 and the Company's potential
underwriting exposure to Year 2000 claims are difficult to predict with any
certainty. Accordingly, the Company's premium growth, underwriting and investing
results have been and will continue to be potentially materially affected by
these factors.
Item 7. Financial Statements, Pro Forma Financial Information and Exhibits
(a) Financial Statements of Business Acquired
The following financial statements of Gryphon Holdings, Inc. are filed as part
of this report:
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 1997 and 1996
Consolidated Statements of Income for the Years Ended December 31, 1997,
1996 and 1995
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows for the Years Ended December 31,
1997, 1996 and 1995
Notes to Consolidated Financial Statements
<PAGE>
Consolidated Balance Sheets as of September 30, 1998 and December 31,
1997(Unaudited)
Consolidated Statements of Income for the Nine Months Ended September 30,
1998 and 1997 (Unaudited)
Consolidated Statements of Cash Flows for the Nine Months Ended September
30, 1998 and 1997 (Unaudited)
Notes to Consolidated Financial Statements (Unaudited)
(b) Pro Forma Financial Information (Unaudited)
The following pro forma financial information is included as part of this
report:
Introduction
Pro Forma Consolidated Balance Sheet as of September 30, 1998
Pro Forma Consolidated Statement of Income and Comprehensive Income for
the Nine Months Ended September 30, 1998
Pro Forma Consolidated Statement of Income and Comprehensive Income for
the Year Ended December 31, 1997.
Notes to Pro Forma Consolidated Financial Statements
(c) Exhibits
The Exhibits listed on the Exhibit Index are filed as part of this report.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
MARKEL CORPORATION
Date: January 29, 1999 By: Darrell D. Martin
---------------------
Executive Vice President
And Chief Financial Officer
EXHIBIT INDEX
4 Agreement and Plan of Merger among Markel Corporation, MG Acquisition
Corp. and Gryphon Holdings, Inc.*
23 Consent of KPMG LLP to the inclusion of their report as part of this
report on Form 8-K.
* Incorporated by reference from Exhibit (g)(6) to Amendment No. 7 to
Schedule 14D-1 filed by the Registrant on November 25, 1998.
<PAGE>
Item 7a. FINANCIAL STATEMENTS OF BUSINESS ACQUIRED
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
Gryphon Holdings Inc.
We have audited the accompanying consolidated balance sheets of Gryphon Holdings
Inc. and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the years in the three-year period ended December 31, 1997. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Gryphon Holdings
Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
KPMG LLP
New York, New York
February 24, 1998
<PAGE>
<TABLE>
<CAPTION>
Consolidated Balance Sheets
December 31,
1997 1996
(Dollars in thousands)
<S> <C> <C>
Assets
Investments:
Fixed maturities, available for sale, at fair value
(amortized cost: 1997 - $274,506; 1996 - $274,515) $ 280,553 $ 280,164
Short-term investments, at cost, which
approximates market 257 307
Total investments 280,810 280,471
Cash and cash equivalents 32,272 23,398
Accrued investment income 4,071 3,919
Premiums receivable 16,151 18,509
Reinsurance recoverable on paid losses 18,261 14,326
Reinsurance recoverable on unpaid losses 140,810 137,952
Prepaid reinsurance premiums 16,573 18,965
Deferred policy acquisition costs 11,849 12,415
Deferred income taxes 10,569 10,282
Other assets 7,619 6,747
Total assets $ 538,985 $ 526,984
Liabilities and Stockholders' Equity
Policy liabilities:
Unpaid losses and loss adjustment expenses $ 328,911 $ 309,259
Unearned premiums 62,351 68,683
Total policy liabilities 391,262 377,942
Reinsurance balances payable 12,179 16,207
Income taxes payable 389 55
Long-term debt 21,125 24,625
Other liabilities 9,521 13,019
Total liabilities 434,476 431,848
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value; 1,000,000 shares
authorized; none issued or outstanding
Common stock, $.01 par value; 15,000,000 shares
authorized; 8,148,050 shares issued 81 81
Additional paid-in capital 30,742 30,847
Foreign currency translation adjustment, net of tax (346) (219)
Net unrealized investment gains, net of tax 3,931 3,672
Deferred compensation (151) (257)
Retained earnings 95,065 86,271
Treasury stock, at cost; shares
1997: 1,461,169: 1996:1,487,075 (24,813) (25,259)
Total stockholders' equity 104,509 95,136
Total liabilities and stockholders' equity $ 538,985 $ 526,984
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
Consolidated Statements of Income
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996 1995
----------------------------------
(Dollars and shares in thousands,
except per-share data)
<S> <C> <C> <C>
Revenues
Net premiums earned $ 104,246 $ 87,929 $ 83,399
Net investment income 17,061 16,453 15,839
Realized gains on investments 6,188 1,203 3,647
Other income 979 1,059
Total revenues 128,474 106,644 102,885
Expenses
Losses and loss adjustment expenses 71,015 57,700 50,816
Underwriting, acquisition, and insurance expenses 45,089 40,967 34,590
Interest expense 1,607 1,761 595
Total expenses 117,711 100,428 86,001
Income before income taxes 10,763 6,216 16,884
Provision for income taxes (benefit):
Current 2,395 1,389 2,969
Deferred (426) (1,336) 990
Total income taxes 1,969 53 3,959
Net income $ 8,794 $ 6,163 $ 12,925
Basic earnings per share $ 1.32 $ 0.93 $ 1.69
Weighted average shares outstanding 6,680 6,656 7,648
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
Foreign Unrealized
Additional Currency Investment
Common Paid-in Translation Gains Deferred Retained Treasury
Stock Capital Adjustment (Losses) Compensation Earnings Stock Total
--------- ---------- ------------- ---------- ----------- -------- --------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Balances at
January 1, 1995 $ 81 $ 30,850 $ (259) $ (3,840) $ (242) $ 67,183 $ 93,773
Add (deduct):
Net income 12,925 12,925
Translation adjustment 50 50
Stock award plans 49 49
Net unrealized investment
gains, net of tax 11,903 11,903
Purchase of common stock
for treasury (25,478) (25,478)
Balances at
December 31, 1995 81 30,850 (209) 8,063 (193) 80,108 (25,478) 93,222
Add (deduct):
Net income 6,163 6,163
Translation adjustment (10) (10)
Stock award plans (3) (64) 219 152
Net unrealized investment
losses, net of tax (4,391) (4,391)
Balances at
December 31, 1996 81 30,847 (219) 3,672 (257) 86,271 (25,259) 95,136
Add (deduct):
Net income 8,794 8,794
Translation adjustment (127) (127)
Stock award plans (105) 106 446 447
Net unrealized investment
gains, net of tax 259 259
Balances at
December 31, 1997 $ 81 $ 30,742 $ (346) $ 3,931 $ (151) $ 95,065 $ (24,813) $104,509
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996 1995
------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Operating activities
Net income $ 8,794 $ 6,163 $ 12,925
Adjustments to reconcile net income to
net cash provided by operating activities:
Increase in net policy liabilities 8,919 32,239 4,958
Decrease (increase) in premiums receivable 2,358 (1,034) (3,196)
Decrease (increase) in deferred
policy acquisition costs 566 (233) (2,388)
Deferred income tax provision (426) (1,336) 990
Decrease (increase) in other
assets and liabilities (3,009) 1,543 (539)
Amortization and depreciation 781 595 402
Amortization of bond discount, net 498 944 370
Realized gains on investments (6,188) (1,203) (3,647)
Increase (decrease) in
reinsurance balances payable (4,028) (13,166) 12,341
Decrease (increase) in accrued
investment income (152) 161 (175)
Net cash provided by operating activities 8,113 24,673 22,041
Investing activities
Sales of fixed maturities 438,021 281,728 221,026
Purchases of fixed maturities (434,292) (310,660) (249,119)
Maturities or calls of fixed maturities 1,800 3,000 4,775
Net sales of Short-term investments 50 230
Capital expenditures (1,568) (2,111) (366)
Net cash provided by (used in) investing activities 4,011 (27,813) (23,684)
Financing activities
Proceeds from long-term debt 25,500
Common stock acquired for treasury (25,478)
Principal payment on long-term debt (3,500) (875)
Issuance of common stock 340 217
Deferred compensation 37 (131)
Net cash provided by (used in) financing activities (3,123) (789) 22
Effect of exchange rate changes on cash (127) (10) 50
Increase (decrease) in cash and cash equivalents 8,874 (3,939) (1,571)
Cash and cash equivalents at beginning of year 23,398 27,337 28,908
Cash and cash equivalents at end of year $ 32,272 $ 23,398 $ 27,337
Supplemental disclosure of cash flow information
Income taxes paid $ 1,855 $ 1,701 $ 2,783
Interest paid 1,607 1,761 586
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
1. Summary of Significant Accounting Policies
The significant accounting policies followed by the Company are
summarized below.
Basis of Presentation and Principles of Consolidation
Gryphon Holdings Inc. operates through its main subsidiary, Gryphon
Insurance Group Inc., as a specialty property and casualty underwriting
organization. The Company's wholly owned insurance company subsidiaries are
Associated International Insurance Company ("Associated") and Calvert Insurance
Company ("Calvert"), which operate in the property and casualty insurance
industry. Associated writes the majority of its property and casualty insurance
policies in the State of California. Calvert writes property and casualty
insurance policies throughout the United States and Canada.
The accompanying consolidated financial statements have been prepared on
the basis of generally accepted accounting principles ("GAAP"), which as to the
two insurance subsidiaries differ from the statutory accounting practices
("SAP") prescribed or permitted by regulatory authorities, and include the
accounts of the Company and its subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
The preparation of the consolidated financial statements in conformity
with GAAP requires the use of estimates and assumptions that affect amounts
reported in the consolidated financial statements and the accompanying notes.
Actual results could differ from such estimates.
Premium Revenues
Direct, assumed and ceded property and liability insurance premiums
written are recognized as earned on a pro rata basis over the terms of the
policies. Unearned premiums are calculated principally by the application of pro
rata fractions and represent the portion of premiums written that is applicable
to unexpired terms of policies in force.
Recoverable policy acquisition costs that vary with and are directly
related to the production of business, consisting of commissions, premium taxes
and other underwriting expenses incurred, net of ceding allowances, are deferred
and amortized to income as the related premiums are earned. The Company does not
consider anticipated investment income when determining the recoverability of
amounts deferred. Amortization of deferred policy acquisition costs amounted to
$34.0 million, $30.1 million, and $26.7 million for the years ended December 31,
1997, 1996 and 1995, respectively.
Reinsurance
Assumed reinsurance premiums written, commissions and unpaid losses and
loss adjustment expenses 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.
<PAGE>
To limit its risks, the Company acquires reinsurance coverage with
retentions and limits that management believes are appropriate for the
circumstances. Reinsurance arrangements effected under quota-share reinsurance
contracts and excess-of- loss reinsurance contracts provide for greater
diversification of business, allow management to control exposure to potential
losses arising from large risks, and provide additional capacity for growth. The
accompanying consolidated financial statements reflect premiums earned, losses
and loss adjustment expenses ("LAE") and underwriting, acquisition and insurance
expenses, net of reinsurance ceded. Amounts recoverable from reinsurers are
estimated in a manner consistent with the claim liability associated with the
reinsured policies.
Contingent commissions and retrospectively-rated premiums are accounted
for on an earned basis and are accrued, in accordance with the terms of the
applicable reinsurance agreement, based on the estimated ultimate level of
profitability relating to such reinsured business. Accordingly, the
profitability of the reinsured business is continually reviewed and as
adjustments become necessary, such adjustments are reflected in current
operations.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents.
Investments
The Company's securities are classified as available for sale and
reported at fair value, with unrealized gains and losses, net of deferred income
taxes, included in stockholders' equity.
Fair values are based on quoted market prices, when available, or
estimates based on market prices for similar securities, when quotes are not
available. Short-term investments are carried at cost, which approximates their
fair value. Realized gains and losses from sales or liquidations of investments
are determined on the basis of the specific identification method and are
included in net income. Investment income is recognized when earned. The
amortization of premium and accretion of discount for fixed maturity securities
are computed utilizing the interest method.
Losses and Loss Adjustment Expenses
The liabilities for unpaid losses and LAE are based on the Company's
estimates of the ultimate cost of unpaid losses reported prior to the close of
the accounting period, IBNR losses, and the related LAE. These liabilities are
estimated by management utilizing methods and procedures which it believes are
reasonable and necessarily are subject to the impact of future changes in claim
severity and frequency, as well as numerous other factors. Although management
believes that the estimated liabilities for losses and LAE are reasonable,
because of the extended period of time over which such losses are reported and
settled, the subsequent development of these liabilities may not conform to the
assumptions inherent in their determination and, accordingly, may vary from the
estimated amounts included in the accompanying consolidated financial
statements. To the extent that the actual emerging loss experience varies from
the assumptions used in the determination of these liabilities, they are
adjusted to reflect actual experience. Such adjustments, to the extent they
occur, are reported in the period recognized.
The Company's liabilities for unpaid losses and LAE include estimates
for certain types of latent exposures, such as environmental impairment and
asbestos-related claims, relating to business written prior to 1985 and which
are generally difficult to establish with traditional reserving techniques.
The Company wrote policies with environmental impairment and
asbestos-related exposures at high attachment levels and obtained reinsurance
coverage reducing its net retention to $50,000 per occurrence. Among the
complications of reserving for this type of business are a lack of sufficient
historical data, long reporting delays, uncertainty as to the number and
identity of insureds with potential exposure, and complex, unresolved legal
issues regarding policy coverage and the extent and timing of any such
contractual liability. Courts have reached different and sometimes inconsistent
conclusions as to when a loss occurred and which policies provide coverage,
which claims are covered, whether there is an insured obligation to defend, how
policy limits are determined, how policy exclusions are applied and interpreted,
and whether clean-up costs are includible as insured property damage. These
legal issues are not likely to be resolved in the near future.
<PAGE>
The establishment of appropriate reserves is an inherently uncertain
process, and there can be no assurance that the ultimate liability, particularly
with respect to latent exposures such as environmental impairment and asbestos,
will not materially exceed the Company's current liability for unpaid loss and
loss adjustment expense reserve estimates and have a material adverse effect on
its future results of operations and financial condition. Furthermore, due to
the inherent uncertainty of estimating such liabilities, particularly with
respect to such latent exposures, it has been, and may over time continue to be,
necessary to revise such estimated liabilities. However, on the basis of the
Company's internal procedures, which analyze, among other things, its experience
with similar cases and historical trends such as reserving patterns, loss
payments, pending levels of unpaid claims, and product mix, as well as court
decisions, economic conditions and public attitudes, management believes that
adequate provision has been made for the Company's liabilities for unpaid losses
and LAE as of December 31, 1997.
Foreign Currency
Transactions denominated in foreign currencies are translated at the
rate of exchange at the transaction date. Revenues and expenses are translated
at average exchange rates. Assets and liabilities are translated at the exchange
rates in effect at the balance sheet date.
Earnings per Share
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per
Share", which the Company implemented in 1997. SFAS No. 128 establishes
standards for computing and presenting earnings per share. Primary earnings per
share have been replaced by basic earnings per share and calculated by dividing
income available to common stockholders by the weighted average number of common
shares outstanding during the period. Fully diluted earnings per share have been
replaced by diluted earnings per share and calculated by including additional
common shares that would have been outstanding if potentially dilutive shares
had been issued during the period. Prior period earnings per share were not
affected by the adoption of SFAS No. 128.
New Accounting Standards
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income", which requires enterprises to disclose comprehensive income and its
components in a prominent position on the face of the financial statement. The
Company will implement this statement in 1998. This statement relates to
presentation of information and will have no impact on results of operations or
financial condition.
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments
of an Enterprise and Related Information", which will be effective for the
Company beginning January 1, 1998. SFAS No. 131 redefines how operating segments
are determined and requires disclosure of certain financial and descriptive
information about a company's operating segments. This statement relates to
presentation of information and will have no impact on results of operations or
financial condition. Interim financial information will be required beginning in
1999 (with comparative 1998 information). The Company is currently evaluating
the segment information disclosures required by SFAS No. 131.
In December of 1997, the American Institute of Certified Public
Accountants issued Statement of Position No. 97-3 "Accounting by Insurance and
Other Enterprises for Insurance- related Assessments" ("SOP 97-3"). SOP 97-3
establishes standards for accounting for guaranty-fund and certain other
insurance related assessments. SOP 97-3 is effective for fiscal years beginning
after December 15, 1998 and requires any impact of adoption to be reported as a
change in accounting principle. The adoption of this statement is not expected
to have a material effect on the Company's results of operations or financial
condition.
<PAGE>
2. Investments
The major categories of net investment income are summarized as follows:
Year ended December 31
1997 1996 1995
--------------------------------
(Dollars in thousands)
Fixed maturities $16,384 $ 16,256 $ 15,245
Cash, cash equivalents
and short-term investments 1,684 1,117 1,610
Total investment income 18,068 17,373 16,855
Less related expenses (1,007) (920) (1,016)
Net investment income $17,061 $ 16,453 $ 15,839
The gross realized gains and losses from sales of fixed maturity
securities are as follows:
Year ended December 31
1997 1996 1995
---------------------------------
(Dollars in thousands)
Gross realized gains $ 7,530 $ 3,074 $ 4,306
Gross realized losses (1,342) (1,871) (659)
Net realized gains on sales $ 6,188 $ 1,203 $ 3,647
At December 31, 1997 and 1996, the amortized cost and estimated fair
values of investments in fixed maturities, by categories of securities, and
short-term investments were as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ------------ ----------
(Dollars in thousands)
<S> <C> <C> <C> <C>
December 31, 1997
U.S. Treasury securities
and obligations of
U.S. government
corporations and agencies $ 78,623 $ 667 $ (22) $ 79,268
Debt securities issued
by foreign governments 5,857 130 (6) 5,981
Tax-exempt obligations of states
and political subdivisions 108,194 4,322 112,516
Mortgage-backed securities 47,488 501 (47) 47,942
Corporate securities 34,344 617 (115) 34,846
274,506 6,237 (190) 280,553
Short-term investments 257 257
$ 274,763 $ 6,237 $ (190) $ 280,810
</TABLE>
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C>
December 31, 1996
U.S. Treasury securities
and obligations of
U.S. government
corporations and agencies $ 55,845 $ 826 $ (87) $ 56,584
Debt securities issued by
foreign governments 5,747 186 (10) 5,923
Tax-exempt obligations of states
and political subdivisions 141,686 4,718 (69) 146,335
Mortgage-backed securities 43,381 294 (214) 43,461
Corporate securities 27,856 345 (340) 27,861
274,515 6,369 (720) 280,164
Short-term investments 307 307
$ 274,822 $ 6,369 $ (720) $ 280,471
</TABLE>
<PAGE>
At December 31, 1997, the amortized cost and estimated fair value of
fixed maturities, by contractual maturity, are shown below. Expected maturities,
which are best estimates, will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
prepayment penalties.
<TABLE>
<CAPTION>
December 31, 1997
Amortized Fair
Cost Value
--------- ------
(Dollars in thousands)
<S> <C> <C>
Due in one year or less $ 279 $ 286
Due after one year through five years 65,562 66,567
Due after five years through ten years 95,153 97,677
Due after ten years 66,024 68,081
227,018 232,611
Mortgage-backed securities 47,488 47,942
Total $274,506 $280,553
</TABLE>
At December 31, 1997, investments in Federal National Mortgage
Association securities aggregating $11.8 million represented the only
investments in any entity in excess of 10.0% of stockholders' equity other than
those investments issued or guaranteed by the U.S. government.
Securities on Deposit
At December 31, 1997 and 1996, securities with a fair value of
approximately $19.3 million and $18.6 million, respectively were on deposit with
various state or governmental insurance departments in order to comply with
statutory insurance laws.
3. Losses and Loss Adjustment Expenses
The following table provides a reconciliation of beginning and ending
loss and LAE reserve balances of the Company for each of the years in the
three-year period ended December 31, 1997 as computed in accordance with GAAP.
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Gross reserves for losses and
LAE at the beginning of the year $ 309,259 $ 308,886 $ 315,691
Ceded reserves for losses and
LAE at the beginning of the year 137,952 152,975 169,889
Net reserves for losses and
LAE at the beginning of the year 171,307 155,911 145,802
Add: Provision for losses and
LAE for claims occurring in:
The current year 64,222 53,402 50,424
Prior years 6,793 4,298 392
Total net incurred losses and LAE 71,015 57,700 50,816
Less: Losses and LAE payments
for claims occurring in:
The current year 13,932 11,520 11,796
Prior years 40,289 30,784 28,911
Total net paid losses and LAE 54,221 42,304 40,707
Reserves for net losses and
LAE at end of year 188,101 171,307 155,911
Reinsurance recoverable on unpaid losses 140,810 137,952 152,975
Reserves for gross losses
and LAE at end of year $ 328,911 $ 309,259 $ 308,886
</TABLE>
The provision for losses and LAE for claims occurring in prior years
shows an unfavorable development of $6.8 million in 1997. The unfavorable
development resulted principally from a pre-1985 book of Casualty business and
certain pre-1987 reinsurance-assumed business, both previously discontinued.
<PAGE>
The following table provides a reconciliation of beginning and ending
loss and LAE reserve balances of the Company for each of the years in the
three-year period ended December 31, 1997 for environmental impairment and
asbestos-related liabilities.
Reconciliation of Environmental Impairment and Asbestos-related
Liability for Loss and Loss Adjustment Expenses
(Dollars in thousands)
<TABLE>
<CAPTION>
Year ended December 31,
Environmental Impairment Liability
1997 1996 1995
---- ---- -----
<S> <C> <C> <C>
Gross reserves for losses and
LAE at the beginning of the year $ 12,981 $ 11,938 $ 14,200
Ceded reserves for losses and
LAE at the beginning of the year 4,177 3,958 5,100
Net reserves for losses and
LAE at the beginning of the year 8,804 7,980 9,100
Add: Provision for losses and
LAE for claims occurring in prior years (845) 1,598 3
Less: Losses and LAE payments
for claims occurring in prior years 1,159 774 1,123
Reserves for net losses and LAE at end of year 6,800 8,804 7,980
Reinsurance recoverable on unpaid losses 5,200 4,177 3,958
Reserves for gross losses and LAE at end of year $ 12,000 $ 12,981 $ 11,938
</TABLE>
<TABLE>
<CAPTION>
Year ended December 31,
Asbestos-related Liability
1997 1996 1995
---- ---- -----
<S> <C> <C> <C>
Gross reserves for losses and
LAE at the beginning of the year $ 4,121 $ 1,700 $ 4,050
Ceded reserves for losses and
LAE at the beginning of the year 3,110 1,060 3,350
Net reserves for losses and
LAE at the beginning of the year 1,011 640 700
Add: Provision for losses and
LAE for claims occurring in prior years 847 583 612
Less: Losses and LAE payments for
claims occurring in prior years 143 212 672
Reserves for net losses and LAE at end of year 1,715 1,011 640
Reinsurance recoverable on unpaid losses 2,500 3,110 1,060
Reserves for gross losses and LAE at end of year $ 4,215 $ 4,121 $ 1,700
</TABLE>
At December 31, 1997, the reserve for unpaid environmental impairment
losses and related LAE was approximately $6.8 million, net of reinsurance
recoverables deemed probable of collection by the Company of approximately $5.2
million. The range of gross reserves for unpaid environmental impairment losses
and LAE is estimated to be $12.0 million to $20.0 million and the range of
reserves, net of reinsurance recoverable, for unpaid environmental impairment
losses and LAE is estimated to be approximately $6.8 million to $9.5 million.
At December 31, 1997, the reserve for unpaid asbestos- related losses
and related LAE was $1.7 million, net of reinsurance recoverables deemed
probable of collection by the Company of approximately $2.5 million. The range
of gross reserves for unpaid asbestos-related losses and LAE is estimated to be
$4.2 million to $9.4 million and the range of reserves, net of reinsurance
recoverable, for unpaid asbestos-related losses and LAE is estimated to be
approximately $1.7 million to $3.3 million.
There are significant uncertainties in estimating the amount of the
Company's environmental impairment and asbestos- related liabilities resulting
from a lack of historical data, long reporting delays, uncertainty as to the
number and identity of insureds with potential exposure, and complex, unresolved
legal issues regarding policy coverage and the extent and timing of any such
contractual liability. Courts have reached different and sometimes inconsistent
conclusions as to when a loss occurred and what policies provide coverage, what
claims are covered, whether there is an insured obligation to defend, how policy
limits are determined, how policy exclusions are applied and interpreted, and
whether cleanup costs are includible as insured property damage. These issues
are not likely to be resolved in the near future. As a result of these issues,
the ultimate number and cost of these claims may generate losses that vary
materially from the amounts currently recorded and could have a material adverse
effect on the Company's results of operations and financial condition. While
management believes the Company's reserves for these coverages are appropriately
established, because of the uncertainty of circumstances surrounding many
critical factors that affect environmental impairment and asbestos-related
liabilities, there can be no assurance that the Company's reserves for and
losses from these claims will not increase in the future.
<PAGE>
4. Reinsurance
Certain premiums and losses are assumed from and ceded to other
insurance companies under various reinsurance agreements. The Company cedes a
portion of its business through quota share treaties, excess of loss treaties
and facultative placements, and generally retains net amounts of risk ranging
from $100,000 to $500,000 per risk.
The following table sets forth the significant reinsurance receivables
due from reinsurers as of December 31, 1997.
<TABLE>
<CAPTION>
Year ended December 31, 1997
(Dollars in thousands)
Reinsurance A.M. Best's
Reinsurer Receivables Rating
----------- -----------
<S> <C> <C>
American Re-Insurance Company $ 19,684 A+
Signet Star Reinsurance Corporation 10,853 A
Odyssey Reinsurance Corporation 10,507 A -
St. Paul Fire and Marine Insurance Company 10,224 A+
First Excess & Reinsurance Corporation 9,430 A
Lloyd's Underwriters 9,310 *
Great Lakes American Reinsurance Company 8,884 A -
Swiss Reinsurance America Corp. 7,589 A
</TABLE>
* A.M. Best does not assign ratings to Lloyd's syndicates.
The amount and cost of reinsurance available to companies specializing
in property and casualty insurance are subject, in large part, to prevailing
market conditions beyond the control of the Company. The Company's ability to
provide insurance at competitive premium rates and coverage limits on a
continuing basis depends to a significant extent upon its ability to obtain
adequate reinsurance in amounts and at rates that will not adversely affect its
competitive position.
For the years ended December 31, 1997, 1996 and 1995, amounts relating
to assumed and ceded reinsurance premiums written and earned and losses and LAE
incurred reflected in the accompanying consolidated statements of income
approximated the following:
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996 1995
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Premiums Written:
Assumed $ 3,315 $ 2,390 $ 2,076
Ceded 45,792 62,330 66,805
Premiums Earned:
Assumed $ 3,715 $ 2,209 $ 1,715
Ceded 48,179 63,824 66,064
Losses & LAE Incurred:
Assumed $ 14,617 $ 4,455 $ 2,585
Ceded 46,569 42,052 52,089
</TABLE>
At December 31, 1997 the Company held letters of credit of approximately
$7.7 million securing amounts due from reinsurers.
During 1997, Associated maintained a six-layer property catastrophe
reinsurance program which covered 95% of the annual aggregate amount of property
claims up to $138.0 million per occurrence, subject to a retention of $2.5
million per occurrence.
<PAGE>
Associated limits its net retention to $100,000 per risk for difference
in conditions ("DIC"). Until October 1, 1996, Associated retained $250,000 per
risk for casualty, architects' and engineers' professional liability, specialty
lines, and commercial auto and up to $500,000 per risk for non-DIC property
policies. Calvert reinsured various lines of business through quota share
treaties, excess of loss treaties and facultative placements which limited
Calvert's net retention per risk to a maximum of $200,000 for property and
casualty.
Effective October 1, 1996, the Company's reinsurance program was
restructured to provide protection for loss events covering property and
casualty classes of business, excluding DIC and certain other property business.
The program provides for $24.5 million of coverage in excess of a new retention
of $500,000 for each and every event. Certain business is covered by a quota
share treaty that limits the Company's net retention per risk to a maximum of
$250,000.
Reinsurance ceded contracts do not relieve the Company of its
obligations to policyholders. The Company remains liable to its policyholders
for the portion reinsured to the extent that any reinsurer does not meet its
obligations for reinsurance ceded to it under the reinsurance agreements.
Failure of reinsurers to honor their obligations could result in losses to the
Company. In addition, as is often the case in the normal course of business, the
Company is involved in disputes with reinsurers regarding certain loss
recoverables. Although the Company believes that such issues will be resolved in
the Company's favor, there can be no assurance that the Company will prevail; an
unfavorable resolution could have a material effect on the Company's financial
statements.
5. Federal Income Taxes
The Company uses an asset and liability approach for financial
accounting and reporting for income taxes. Under the asset and liability method,
deferred tax assets and liabilities are recorded based on the difference between
the financial statement and tax bases of assets and liabilities and the tax
rates in effect when these temporary differences are expected to reverse. The
principal assets and liabilities giving rise to such differences are loss and
LAE reserves, unearned premiums, deferred policy acquisition costs, and net
unrealized investment gains (losses).
The components of the net deferred income tax asset are as follows:
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996
---- ----
(Dollars in thousands)
<S> <C> <C>
Discount on loss reserves $ 12,769 $ 12,270
Unearned premium reserve 3,204 3,477
Alternative minimum tax credit 1,099 1,099
Other, net 130 129
Deferred income tax asset 17,202 16,975
Deferred policy acquisitions costs (4,147) (4,345)
Unrealized gains on investments (2,117) (1,977)
Other, net (369) (371)
Deferred income tax liability (6,633) (6,693)
Net deferred income tax asset $ 10,569 $ 10,282
</TABLE>
The Company has not established a valuation reserve because it believes,
based on its tax-planning strategies and projected future earnings, that it is
likely that the net deferred tax asset will be fully realized.
<PAGE>
A reconciliation of income taxes computed at the statutory federal
income tax rate to the income tax provision is presented below:
<TABLE>
<CAPTION>
1997 1996 1995
% of Pre-Tax % of Pre-Tax % of Pre-Tax
Amount Income Amount Income Amount Income
--------------- --------------- ---------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Taxes based on statutory
federal income tax rate $ 3,767 35.0% $ 2,176 35.0% $ 5,909 35.0%
Add (deduct):
Tax exempt interest (1,994) (18.5) (2,338) (37.6) (2,131) (12.6)
Other, net 196 1.8 215 3.5 181 1.1
Total income taxes $ 1,969 18.3% $ 53 0.9% $ 3,959 23.5%
</TABLE>
6. Long-Term Debt
In September 1995, the Company purchased 1.5 million shares of its
common stock beneficially owned by Willis Corroon Group plc for a purchase price
of $25.5 million, including related expenses. The Company financed its purchase
through an unsecured term loan from commercial lending institutions. This loan
matures in varying amounts through 2002 with interest payable at least
quarterly. The term loan interest rate is equivalent to either the bank's prime
rate or the London Interbank Offered Rate ("LIBOR") plus 1%, at the discretion
of the Company. The term loan agreement contains certain restrictive covenants,
including restrictions on the Company's ability to declare or pay any cash
dividends to its shareholders. As of December 31, 1997, the weighted average
interest rate was 6.89%, and the fair value of the loan approximated the
carrying value.
Principal payments due on the term loan are as follows:
Year ending December 31, Principal Amount
(Dollars in thousands)
1998 $ 3,625
1999 4,125
2000 4,625
2001 5,000
2002 3,750
Total $21,125
In October 1995, the Company entered into an interest rate swap
agreement with a commercial lending institution in order to reduce the impact of
interest rate fluctuations on the Company's term loan. The interest rate swap
was effected with respect to the first $15.5 million of scheduled principal
amortizations of the $25.5 million loan. The impact of the swap was to create an
effective fixed rate of 6.97% on the $15.5 million principal amount. As of
December 31, 1997, the fair value of the interest rate swap approximated the
carrying value.
7. Fair Value of Financial Instruments
The Company follows SFAS No. 119, "Disclosure about Derivative Financial
Instruments and Fair Value of Financial Instruments." SFAS No. 119 requires
disclosure of an estimate of the fair value of financial instruments. The
Statement defines the fair value of financial instruments as the amount at which
the instruments could be exchanged in a current transaction between willing
parties. The following table summarizes the carrying amount and estimated fair
value of the Company's financial instruments at December 31, 1997 and 1996.
<TABLE>
<CAPTION>
Year ended December 31
1997 1996
(Dollars in thousands)
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Financial assets:
Investments and cash $313,082 $313,082 $303,869 $303,869
Financial liabilities:
Long-term debt 21,125 21,129 24,625 24,651
</TABLE>
The following methods and assumptions were used to estimate the fair
value of each class of financial instrument:
Investments and cash
The fair values of fixed maturities are based on quoted market prices.
The fair value of short-term instruments approximates amortized cost. The fair
value of cash and cash equivalents approximates amortized cost.
<PAGE>
Long-term debt
The fair value of the Company's long-term debt is estimated based on the
quoted market prices for the same or similar issues or on current rates offered
to the Company for debt of the same maturities. The fair value includes the
effect of the interest rate swap.
8. Commitments and Contingencies
Leases
The Company and its subsidiaries lease certain office facilities and
computer equipment. Minimum rental commitments for these leases, exclusive of
escalations due to real estate taxes and operating expenses, are as follows:
Year ending December 31, (Dollars in thousands)
1998 $1,163
1999 1,130
2000 964
2001 755
2002 784
Thereafter 4,728
$9,524
Total rent expense for all leases was $1,469,000, $1,310,000 and
$959,000 in 1997, 1996 and 1995, respectively.
9. Dividends and Stockholders' Equity
Dividends
Associated, a California domiciled company, and Calvert, a Pennsylvania
domiciled company, are required to file with the Department of Insurance of
various states an annual convention statement, which is prepared in conformity
with accounting practices prescribed or permitted by the respective states.
These practices vary from GAAP principally in that policy acquisition costs are
charged to expense when incurred, deferred federal income taxes are not
recognized, investments are reflected at amortized cost, and nonadmitted assets
are excluded from the balance sheet.
Under state insurance laws of Pennsylvania, the maximum amount of
dividends which can be paid by Pennsylvania-domiciled insurance companies
without prior approval of the Insurance Commissioner is limited to the greater
of 10% of surplus as regards policyholders as of the preceding year end or the
insurance company's net income for the previous year. Under state insurance laws
of California, Associated is permitted to pay as dividends to the Company, after
advance notice to the California Insurance Department, an amount equal to the
greater of 10% of Associated's policyholders surplus at the end of the preceding
year or its statutory net income for the preceding year. Dividends in excess of
these amounts require the prior approval of the California Insurance Department.
Dividends may be paid only out of earned surplus. As such, at December 31, 1997,
the maximum amount of dividends that Associated could pay in 1998 without
California Insurance Department approval amounted to approximately $9.0 million
and the maximum amount of dividends that Calvert could pay in 1998 without
Pennsylvania Insurance Department approval amounted to approximately $2.0
million.
<PAGE>
Stockholders' Equity
A reconciliation of the two insurance subsidiaries' net income and
stockholders' equity for each of the years in the three years ended December 31,
1997 and as of December 31, 1997 and 1996, as reported to the various regulatory
authorities in accordance with SAP, to the related GAAP amounts included in the
accompanying consolidated financial statements is as follows:
<TABLE>
<CAPTION>
Stockholders'
Net Income Equity
1997 1996 1995 1997 1996
---- ---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Associated's and Calvert's
statutory basis amounts $ 11,013 $ 7,298 $ 13,876 $ 87,705 $ 82,566
Add (deduct):
Deferred policy
acquisition costs (566) 233 2,388 11,849 12,415
Deferred income taxes 426 341 (728) 11,602 11,175
Nonadmitted assets 2,781 3,090
Unauthorized reinsurance 3,862 3,980
Foreign currency
translation adjustment 7 (68) (110)
Unrealized investment gains 3,931 3,672
Net income - non
insurance subsidiaries 794 816
Other, net (197) (67) 25 98 (33)
Associated's and Calvert's
GAAP amounts 11,477 8,553 15,451 121,828 116,865
Holding Company:
Non-insurance
company expenses (2,683) (2,390) (2,526)
GAAP equity (17,319) (21,729)
Consolidated amounts
-- GAAP basis $ 8,794 $ 6,163 $ 12,925 $ 104,509 $ 95,136
</TABLE>
10. Shareholder Rights Plan
In June 1995, the Board of Directors declared a dividend of one right
for each outstanding share of Common Stock. Each right entitles the holder to
purchase from the Company a unit consisting of 1/100 of a share of Junior
Participating Cumulative Preferred Stock at a price of $50 per unit. Initially,
the rights will not be exercisable and will trade with the Common Stock. In the
event a person or group acquires 20% or more of the Common Stock, or commences a
tender offer for the outstanding shares, the rights become exercisable.
If a person or group acquires 20% or more of the Common Stock, the
rights will entitle a holder (other than the acquiring person or group of
acquiring persons) to buy shares of Common Stock having a market value of twice
the exercise price of the right. If the Company is subsequently involved in a
merger or other business combination with a holder of 20% or more of the stock
of the Company, the rights will entitle a holder to buy shares of common stock
of the acquiring corporation having a market value of twice the exercise price
of the right.
The rights may be redeemed by the Company at $.001 per right at any time
prior to the acquisition by any person or group of 20% or more of the Company's
shares. The rights have no voting power and will expire in June 2005, if not
previously redeemed.
11. Property and Equipment
Property and equipment is classified with other assets in the
accompanying consolidated balance sheets and is stated at cost, net of
accumulated depreciation and amortization. Depreciation is computed using the
straight-line method over the estimated useful lives of the related property and
equipment and ranges principally from three to seven years.
Property and equipment, included in Other assets in the balance sheet,
is comprised of the following:
<TABLE>
<CAPTION>
Year ended December 31,
1997 1996
---- ----
(Dollars in thousands)
<S> <C> <C>
Furniture, fixtures and leasehold improvements $ 2,539 $ 2,475
Computers 2,074 1,011
Office equipment 416 354
5,029 3,840
Less: Accumulated depreciation and amortization 1,715 1,116
$ 3,314 $ 2,724
</TABLE>
12. Stock Option and Restricted Stock Plans
The Company's stock option plans provide for granting of stock options
to key employees and non-employee directors. Options are granted at a price not
less than the market price on the date of grant. Options that have been granted
under the plans will become exercisable in four annual installments of 25% each
commencing on the second anniversary of the date of grant and will expire ten
years from the date of grant.
<PAGE>
The Company's restricted stock award plan provides for the granting of
up to 100,000 shares of common stock to key employees, subject to restrictions
as to continuous employment except in the case of death or normal retirement.
Restrictions generally expire over a five-year period from date of grant.
Compensation expense is recognized over the restriction period. As of December
31, 1997, 76,500 shares are available for issuance under the plan.
The Financial Accounting Standards Board issued SFAS No. 123,
"Accounting for Stock-Based Compensation." SFAS No. 123 provides an option
either to continue the Company's current method of accounting for stock-based
compensation, or to adopt the fair value method of accounting for stock-based
employee compensation plans, which would require the Company to expense the fair
value of its stock options at the date of grant over the vesting period.
The Company has continued to elect to follow Accounting Principle Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees", and related
interpretations in accounting for its stock option and restricted stock plans.
Accordingly, no compensation expense has been recognized for its stock-based
compensation plans other than for restricted stock awards. Although the Company
elected to continue to follow APB No. 25, it is required to provide additional
disclosures including pro forma net income and earnings per share as if the
Company adopted the fair value method for recognition purposes in 1995.
A summary of stock option activity as of December 31, 1997, follows:
<TABLE>
<CAPTION>
Weighted Average of
Available Exercise Price of
for Option Outstanding Outstanding Options
---------- ----------- ------------------
<S> <C> <C> <C>
Balance, December 31, 1994 34,000 366,000 $ 13.18
Authorized 100,000
Granted (114,000) 114,000 14.89
Cancelled 21,000 (21,000) 13.07
Balance, December 31, 1995 41,000 459,000 13.61
Authorized 250,000
Granted (162,500) 162,500 17.44
Exercised (3,925) 13.00
Cancelled 59,250 (59,250) 15.03
Balance, December 31, 1996 187,750 558,325 14.58
Granted (46,500) 46,500 16.02
Exercised -- (32,500) 13.00
Cancelled 41,250 (41,250) 15.18
Balance, December 31, 1997 182,500 531,075 14.76
</TABLE>
The following table summarizes outstanding and exercisable options as of
December 31, 1997.
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
Weighted
Range of Average Weighted Weighted
Year of Exercise Number Remaining Average Number Average
of Grant Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- ------- -------- ---------- ---------------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
1993 $13 209,825 6.00 $13.00 148,263 $13.00
1994 $13 - $15 57,500 6.45 14.11 28,750 14.11
1995 $13 - $16 100,250 7.48 14.88 50,125 14.88
1996 $14 - $20 122,000 8.36 17.44 30,500 17.44
1997 $13 - $17 41,500 9.85 16.31 - 16.31
531,075 257,638
</TABLE>
<PAGE>
The pro forma net income and basic earnings per share determined
consistent with SFAS No. 123 is as follows:
Pro forma (1) 1997 1996 1995
Net income $8,583 $5,974 $12,880
Basic earnings per share $1.28 $.90 $1.68
(1) During the initial phase-in period of SFAS No. 123, the effects of
applying the standard for either recognizing compensation cost or providing pro
forma disclosures are not likely to be representative of the effects on reported
net income for future years, based on the fact that options vest over several
years and additional awards generally are made each year.
The weighted average fair value of options granted during 1997, 1996 and
1995 were $6.62, $7.64 and $6.29, respectively. The Black-Scholes option-pricing
model was used with the following weighted average assumptions: volatility of
22.8%, and risk-free interest rate of 5.99% in 1997; volatility of 24.3%, and
risk-free interest rate of 6.81% in 1996; volatility of 24.3%, and risk-free
interest rate of 6.18% in 1995. For all periods, a seven-year life is assumed.
13. Employee Benefits and Incentive Bonus Plans
The Company maintains a defined contribution retirement 401(k) & Profit
Sharing Plan. Participation in the plan is available to all employees upon their
satisfaction of specified eligibility requirements. Under the 401(k) component
of the plan, the Company matches, on a dollar-for-dollar basis, each employee's
contribution up to 3% of eligible compensation. Under the profit sharing
component of the plan, annual contributions may be authorized by the Board of
Directors based upon the Company's performance for the relevant year. The
Company's costs are charged to income and amounted to $0.5 million in 1997, $0.5
million in 1996 and $0.4 million in 1995.
The Company maintains an annual incentive bonus plan for officers and
other key employees. Bonuses are based upon predetermined objectives established
by the Compensation Committee. The Company's total incentive bonus plan expense
for the years ended December 31, 1997, 1996 and 1995 was $0.4 million, $0.6
million and $1.6 million, respectively.
14. Concentrations of Business
Gross premiums written in the State of California amounted to
approximately $59,696,000, $68,663,000 and $76,396,000 in 1997, 1996 and 1995,
respectively. In the State of New York, the Company's gross premiums written
were $11,190,000, $11,975,000 and $20,141,000 for the years ended December 31,
1997, 1996 and 1995, respectively. Gross premiums written in any other state do
not exceed 10% of gross premiums written.
The Company's architects' and engineers' professional liability
insurance business is produced by Risk Administration and Management Company
("RAMCO"), an unaffiliated managing general agent. For the years ended December
31, 1997, 1996 and 1995, direct premiums written by RAMCO for the Company
amounted to approximately $17,704,000, $17,843,000 and $14,452,000,
respectively.
15. Quarterly Financial Information (unaudited)
Quarterly financial information (unaudited) for the year ended December
31, 1997 is presented below:
<TABLE>
<CAPTION>
Three months ended
March 31, June 30, Sept. 30, Dec. 31,
1997 1997 1997 1997
-------- -------- --------- --------
(Dollars and shares in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Gross premiums written $35,651 $40,747 $37,290 $32,438
Net premiums written 24,423 27,209 28,223 20,479
Net premiums earned 23,101 25,917 27,783 27,445
Net investment income 4,170 4,315 4,344 4,232
Realized gains on investments 17 12 2,601 3,558
Other income 242 256 296 185
Total revenues 27,530 30,500 35,024 35,420
Income before income taxes 2,740 2,475 5,019 529
Net income 2,171 2,167 3,697 759
Basic earnings per share $ 0.33 $ 0.32 $ 0.55 $ 0.11
Weighted average shares outstanding 6,663 6,688 6,688 6,686
</TABLE>
Quarterly financial information (unaudited) for the year
ended December 31, 1996 is presented below:
<TABLE>
<CAPTION>
Three months ended
March 31, June 30, Sept. 30, Dec. 31,
1996 1996 1996 1996
--------- -------- -------- ---------
(Dollars and shares in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Gross premiums written $ 34,919 $ 39,017 $ 44,807 $ 38,194
Net premiums written 21,213 22,585 28,165 22,644
Net premiums earned 21,951 21,180 22,292 22,506
Net investment income 4,159 3,921 4,065 4,308
Realized gains (losses)
on investments 802 (190) 4 587
Other income 270 285 389 115
Total revenues 27,182 25,196 26,750 27,516
Income (loss) before income taxes 4,658 (294) 2,249 (397)
Net income 3,505 337 1,986 335
Basic earnings per share (1) $ 0.53 $ 0.05 $ 0.30 $ 0.05
Weighted average shares outstanding 6,648 6,656 6,660 6,661
</TABLE>
(1) As a result of the Company's purchase of its Common Stock, the average
number of shares outstanding varies from quarter to quarter, and the sum of
the quarterly earnings per common share may not equal the total for the year.
<PAGE>
16. Subsequent Event
In February 1998, the Company agreed to acquire The First Reinsurance
Company of Hartford ("FRH") and certain affiliated entities from Dearborn Risk
Management, Inc. for a combination of cash and preferred stock valued at $43.6
million, plus certain other performance-driven contingent consideration.
The purchase consideration of $43.6 million consists of $31.9 million of
cash and $11.7 million fair value of a new issue of Gryphon perpetual
convertible preferred stock. The preferred stock, which will have a face amount
of $14.4 million, will be convertible into 643,672 shares of the Company's
common stock, reflecting a conversion price of $22.44 per share. No cash
dividends will be paid or owed during the first four and one-half years; a cash
dividend at the rate of 4.0% of the face amount will be paid thereafter. The
preferred shares, which are non- callable for three years, have no sinking fund
or mandatory redemption features. In connection with the transaction, Gryphon
intends to enter into a $55 million credit facility with a group of financial
institutions, the proceeds of which will be used to pay the cash portion of the
purchase price and to repay existing bank borrowings.
The acquisition will be accounted for by the purchase method of
accounting under Opinion No. 16, "Business Combinations," of the Accounting
Principles Board of the American Institute of Certified Public Accountants.
Under this accounting method, any excess of purchase price over the fair market
value of identifiable assets acquired less liabilities assumed will be recorded
as goodwill.
The transaction, which is subject only to regulatory approvals and other
customary conditions, is expected to close during the second quarter of 1998.
<PAGE>
<TABLE>
<CAPTION>
PART 1-FINANCIAL INFORMATION
Gryphon Holdings Inc. and Subsidiaries
Consolidated Balance Sheet
<CAPTION>
September 30, December 31,
Assets 1998 1997
---- ----
Investments: (Dollars in thousands)
<S> <C> <C>
Fixed maturities, available for sale,
at fair value (amortized cost: 9/30/98
- $371,714; 12/31/97 - $274,506) $ 385,403 $ 280,553
Short-term investments, at cost, which
approximates market 233 257
Equity securities, available for sale, at
fair value (cost: 9/30/98 - $882) 901 --
Total investments 386,537 280,810
Cash and cash equivalents 16,733 32,272
Accrued investment income 5,340 4,071
Premiums receivable 36,242 16,151
Reinsurance recoverable on paid losses 17,068 18,261
Reinsurance recoverable on unpaid losses 201,051 140,810
Prepaid reinsurance premiums 34,794 16,573
Deferred policy acquisition costs 12,746 11,849
Deferred income taxes 15,216 10,569
Income taxes receivable 1,030 --
Goodwill 11,368 1,409
Other assets 9,872 6,210
Total assets $ 747,997 $ 538,985
Liabilities and Stockholders' Equity
Policy liabilities:
Unpaid losses and loss adjustment expenses $ 448,636 $ 328,911
Unearned premiums 91,555 62,351
Total policy liabilities 540,191 391,262
Reinsurance balances payable 23,212 12,179
Income taxes payable -- 389
Long-term debt 55,000 21,125
Other liabilities 13,918 9,521
Total liabilities 632,321 434,476
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value; 1,000,000
shares authorized;14,444 issued and outstanding 11,741 --
Common stock, $.01 par value; 15,000,000 shares
authorized; 8,148,050 shares issued 81 81
Additional paid-in capital 30,581 30,742
Accumulated other comprehensive income,
net of tax 8,342 3,585
Deferred compensation (234) (151)
Retained earnings 89,080 95,065
Treasury stock, at cost; shares 1998:
1,407,821; 1997: 1,461,169 (23,915) (24,813)
Total stockholders' equity 115,676 104,509
Total liabilities and stockholders' equity $ 747,997 $ 538,985
</TABLE>
See accompanying notes to consolidated financial statements.
The interim financial statements are unaudited.
<PAGE>
<TABLE>
<CAPTION>
Gryphon Holdings Inc. and Subsidiaries
Consolidated Statements of Income
Three months ended Nine months ended
September 30, September 30,
1998 1997 1998 1997
---- ---- ---- ----
(Dollars and shares in thousand,
except per-share data)
<S> <C> <C> <C> <C>
Revenues
Gross premiums written $ 48,629 $ 37,290 $ 127,137 $ 113,688
Net premiums written 29,123 28,223 76,089 79,855
Net premiums earned 28,418 27,783 72,849 76,801
Net investment income 5,407 4,344 13,809 12,829
Realized gains on investments 648 2,601 1,945 2,630
Other income -- 296 -- 794
Total revenues 34,473 35,024 88,603 93,054
Expenses
Losses and loss adjustment
expenses 21,225 17,895 63,946 47,862
Underwriting, acquisition, and
insurance expenses 12,089 11,712 34,265 33,730
Interest expense 819 398 1,508 1,228
Total expenses 34,133 30,005 99,719 82,820
Income (loss) before income
taxes 340 5,019 (11,116) 10,234
Provision for income taxes
(benefit):
Current 486 872 (1,226) 2,070
Deferred (970) 450 (4,136) 129
Total income taxes (benefit) (484) 1,322 (5,362) 2,199
Net income (loss) before accretion
of preferred stock $ 824 $ 3,697 ($ 5,754) $ 8,035
Accretion of preferred stock 111 111
Net income (loss) attributable to
common stockholders 713 3,697 (5,865) 8,035
Other comprehensive income, net of tax:
Unrealized investment gains (losses),
net of reclassification
adjustments 4,879 1,284 4,872 698
Foreign currency translation
adjustments (162) 3 (237) (9)
Comprehensive income (loss) $ 5,430 $ 4,984 ($ 1,230) $ 8,724
Basic net earnings (loss)
per share $ 0.11 $ 0.55 ($ 0.87) $ 1.20
Diluted net earnings (loss)
per share $ 0.11 $ 0.55 ($ 0.87) $ 1.20
Basic comprehensive income (loss)
per share $ 0.81 $ 0.75 ($ 0.18) $ 1.31
Diluted comprehensive income (loss)
per share $ 0.75 $ 0.75 ($ 0.18) $ 1.31
Weighted average shares
outstanding 6,740 6,688 6,726 6,680
</TABLE>
See accompanying notes to consolidated financial statements.
These statements are unaudited.
<PAGE>
Gryphon Holdings Inc. and Subsidiaries
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Nine months ended September 30,
1998 1997
---- ----
(Dollars in thousands)
Operating activities
<S> <C> <C>
Net (loss) income ($ 5,865) $ 8,035
Adjustments to reconcile net income to
net cash provided by operating activities:
Deferred income tax provision (4,136) 129
Amortization and depreciation 696 573
Amortization of bond discount, net 747 352
Realized gains on investments (1,945) (2,630)
Change in assets and liabilities, net of
effect of purchase acquisition
Increase in net policy liabilities 24,678 2,811
Increase in premiums receivable (11,129) 1,263
Decrease (increase) in deferred
acquisition costs 739 (1,231)
Change in other assets and liabilities (2,005) (4,160)
Increase (decrease) in reinsurance balances
payable 4,589 (3,940)
Decrease (increase) in accrued investment
income (267) 272
Net cash provided by operating activities 6,102 1,474
Investing activities
Sales of fixed maturities 215,046 304,542
Purchases of fixed maturities (241,373) (298,471)
Maturities or calls of fixed maturities -- 1,800
Payment for the purchase acquisition,
net of cash acquired (39,924) --
Capital expenditures (562) (959)
Net cash (used in) provided by investing
activities (66,813) 6,912
Financing activities
Proceeds from long-term debt 55,000 --
Debt issue costs (686) --
Repayment of long-term debt (21,125) (2,625)
Issuance of common stock 738 342
Issuance of preferred stock 11,630 --
Deferred compensation (148) 60
Net cash used in financing activities 45,409 (2,223)
Effect of exchange rate changes on cash (237) (9)
Decrease in cash and cash equivalents (15,539) 6,154
Cash and cash equivalents at beginning
of period 32,272 23,398
Cash and cash equivalents at end
of period $ 16,733 $ 29,552
Supplemental disclosure of cash flow information
Income taxes paid $ 75 $ 530
Interest paid $ 1,508 $ 1,228
</TABLE>
See accompanying notes to consolidated financial statements.
These statements are unaudited.
<PAGE>
Gryphon Holdings Inc. and Subsidiaries
Notes to Consolidated Financial Statements
1. Basis of Presentation
Gryphon Holdings Inc. (the "Company") operates through its main subsidiary,
Gryphon Insurance Group Inc., as a specialty property and casualty underwriting
organization. The Company's wholly owned insurance company subsidiaries are
Associated International Insurance Company ("Associated"), Calvert Insurance
Company ("Calvert") and, since July 13, 1998, The First Reinsurance Company of
Hartford ("First Re"). The accompanying consolidated financial statements
include the accounts and operations of Gryphon Holdings Inc. and its
subsidiaries.
2. Principles of Consolidation
The accompanying consolidated financial statements have been prepared on the
basis of generally accepted accounting principles, which as to the three wholly
owned insurance company subsidiaries differ from the statutory accounting
practices prescribed or permitted by regulatory authorities, and include the
accounts of the Company and its subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
3. Acquisition
On July 13, 1998, the Company acquired all of the capital stock of The First
Reinsurance Company of Hartford, Oakley Underwriting Agency, Inc. and F/I
Insurance Agency, Incorporated (collectively, "First Re") from Dearborn Risk
Management, Inc. for a combination of cash and preferred stock with an estimated
value of $43.6 million, plus certain other performance-driven contingent
consideration. First Re, a Connecticut corporation with headquarters in Chicago,
is a specialty insurer of professional liability and program risks. Through its
affiliate, Oakley Underwriting Agency, First Re provides Directors & Officers
and Errors & Omissions coverages for corporations, professional firms,
not-for-profit entities, and public entities.
The total estimated purchase consideration of $43.6 million consisted of $31.9
million of cash and $11.7 million fair value of a new issue of Gryphon perpetual
convertible preferred stock. The preferred stock, which has a face amount of
$14.4 million, is convertible into 643,672 shares of the Company's common stock,
reflecting a conversion price of $22.44 per share. No cash dividends will be
paid or owed during the first four and one-half years; a cash dividend at a rate
of 4.0% of the face amount will be paid thereafter. The discount on the
preferred shares attributable to the period in which no cash dividends are paid
is accreted over that four and one-half years. The preferred shares, which are
non-callable for three years, have no sinking fund or mandatory redemption
features. In connection with the transaction, Gryphon entered into a $55.0
million credit facility with a group of financial institutions, the proceeds of
which were used to pay the cash portion of the purchase price, including related
expenses of the acquisition, and to repay existing bank borrowings.
The acquisition was accounted for by the purchase method of accounting under
Opinion No. 16, "Business Combinations," of the Accounting Principles Board of
the American Institute of Certified Public Accountants. Under this accounting
method, the results of First Re are included in the Financial Statements from
the date of the acquisition and any excess of purchase price and direct costs of
acquisition over management's preliminary estimates of the fair market value of
identifiable assets acquired less liabilities assumed have been recorded as
goodwill (approximately $10.0 million) and amortized over 40 years.
<PAGE>
As part of the Stock Purchase Agreement the final determination of the purchase
price is subject to adjustment due to contingencies. The contingencies include
final determination and agreement as to the closing balance sheet amounts. The
allocation of the purchase price of the acquisition is subject to revision when
additional information concerning asset and liability valuations are obtained.
In addition, the seller may earn additional consideration over the next three
years at an amount equal to a multiple of net underwriting income, net of tax,
on certain program business. Since any amounts that may become due to the seller
under this agreement are entirely contingent upon future performance, no
provision for such amounts has been included in the financial statements. The
pro forma financial data, which give effect to the acquisition of First Re as
though it had been completed January 1, 1997, for the nine months ended
September 30, 1998 and 1997 include revenues of $102.4 million and $103.0
million, net income (loss) attributable to common stockholders of $(6.8) million
and $8.1 million, basic net earnings (loss) per share of $(1.01) and $1.21, and
diluted net earnings (loss) per share of $(1.01) and $1.16, respectively.
The results of operations in the proforma financial data reflect adjustments to
give effect to the acquisition as if it had occurred on January 1, 1997, for the
amortization of goodwill, interest expense related to the debt incurred to
finance the acquisition and their tax effect. In addition, the accretion of
preferred stock has been reflected as if it had occurred from January 1, 1997.
The pro forma financial information does not purport to represent what Gryphon's
results of operations or financial position would actually have been had the
acquisition in fact occurred on January 1, 1997 or to project the company's
results of operations or financial position for or at any future period or date.
4. Investments
The Company's securities are classified as available for sale and reported at
fair value, with unrealized gains and losses, net of deferred income taxes,
included in stockholders' equity.
Fair values are based on quoted market prices, when available, or estimates
based on market prices for similar securities, when quotes are not available.
Short-term investments are carried at cost, which approximates their fair value.
Realized gains and losses from the sales or liquidation of investments are
determined on the basis of the specific identification method and are included
in net income. Investment income is recognized when earned. The amortization of
premium and accretion of discount for fixed maturity securities are computed
utilizing the interest method.
The major categories of net investment income are summarized as follows:
<TABLE>
<CAPTION>
For the three months For the nine months
ended September 30, ended September 30,
1998 1997 1998 1997
---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Fixed maturities $ 5,365 $ 4,151 $13,641 $12,212
Cash, cash equivalents and
short-term investments 340 441 975 1,353
Total investment income 5,705 4,592 14,616 13,565
Less related expenses 298 248 807 736
Net investment income $ 5,407 $ 4,344 $13,809 $12,829
</TABLE>
The gross realized gains and losses from sales of fixed maturity securities are
as follows:
<TABLE>
<CAPTION>
For the three months For the nine months
ended September 30, ended September 30,
1998 1997 1998 1997
---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Gross realized gains $ 1,703 $ 2,711 $ 3,332 $ 3,879
Gross realized losses (1,055) (110) (1,387) (1,249)
Net realized gain on sales $ 648 $ 2,601 $ 1,945 $ 2,630
</TABLE>
<PAGE>
At September 30, 1998 and December 31, 1997, the amortized cost and estimated
fair values of investments in fixed maturities and equity securities, by
categories of securities, and short-term investments were as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
(Dollars in thousands)
<S> <C> <C> <C> <C>
September 30, 1998
Fixed maturities
U.S. Treasury securities
and obligations of U.S.
government corporations and
agencies $ 69,770 $ 3,334 ($ 17) $ 73,087
Debt securities issued by
foreign governments 6,399 233 -- 6,632
Tax-exempt obligations of
states and political
subdivisions 148,990 6,699 (3) 155,686
Mortgage-backed securities 81,459 1,968 (131) 83,296
Corporate securities 65,096 2,091 (485) 66,702
Total fixed maturities 371,714 14,325 (636) 385,403
Equity securities
Preferred stock 882 19 -- 901
Short-term investments 233 -- -- 233
$ 372,829 $ 14,344 ($ 636) $ 386,537
December 31, 1997
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 78,623 $ 667 ($ 22) $ 79,268
Debt securities issued by
foreign governments 5,857 130 (6) 5,981
Tax-exempt obligations of states
and political subdivisions 108,194 4,322 -- 112,516
Mortgage-backed securities 47,488 501 (47) 47,942
Corporate securities 34,344 617 (115) 34,846
274,506 6,237 (190) 280,553
Short-term investments 257 -- -- 257
$ 274,763 $ 6,237 ($ 190) $ 280,810
</TABLE>
5. Long-Term Debt
In July 1998, the Company borrowed $55.0 million from a group of commercial
lending institutions to finance the cash portion of the purchase price,
including related expenses, of its acquisition of The First Reinsurance Company
of Hartford and its affiliates and repay previously existing bank debt. The loan
matures in varying amounts through 2004 with interest payable quarterly. The
initial term loan interest rate is equivalent to either the bank's prime rate
plus 62.5 basis points or the London Interbank Offered Rate ("LIBOR") plus 162.5
basis points, at the discretion of the Company. The term loan agreement contains
certain restrictive covenants, including restrictions on the Company's ability
to declare or pay any cash dividends to its shareholders. As of September 30,
1998, the fair value of the loan approximated the carrying value.
Principal payments due on the term loan are as follows:
Principal Amount
Year ending December 31, (Dollars in thousands)
------------------------ ----------------------
1998 $ 0
1999 0
2000 4,000
2001 6,000
2002 7,500
Thereafter 37,500
Total $ 55,000
The Company has entered into interest rate swap agreements with commercial
lending institutions in order to reduce the impact of interest rate fluctuations
on the Company's term loan. The interest rate swaps were effected with respect
to the first $43.5 million of scheduled principal amortizations of the $55.0
million loan. The impact of the swap was to create an effective fixed rate of
approximately 7.65% on the $43.5 million principal amount.
<PAGE>
6. Earnings Per Share
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share," which the Company implemented in 1997. SFAS No. 128 establishes
standards for computing and presenting earnings per share. Primary earnings per
share have been replaced by basic earnings per share and calculated by dividing
income available to common stockholders by the weighted average number of common
shares outstanding during the period. Fully diluted earnings per share have been
replaced by diluted earnings per share and calculated by including additional
common shares that would have been outstanding if potentially dilutive shares
had been issued during the period. Prior period earnings per share were not
affected by the adoption of SFAS No. 128.
7. Comprehensive Income
As of January 1, 1998, the Company adopted SFAS No. 130, "Reporting
comprehensive Income." This statement establishes standards for the reporting
and presentation of comprehensive income and its components in a full set of
financial statements. Comprehensive income encompasses all changes in
shareholders' equity (except those arising from transactions with shareholders)
and includes net income, net unrealized capital gains or losses on available-
for-sale securities and foreign currency translation adjustments, net of taxes.
This new standard changes only the presentation of certain information in the
financial statements and does not affect the Company's financial position or
results of operations.
The summary of the Accumulated other comprehensive income, net of tax, as
reported in the Consolidated Balance Sheets are as follows:
<TABLE>
<CAPTION>
As at September 30, As at December 31,
1998 1997
---- ----
(Dollars in thousands) (Dollars in thousands)
<S> <C> <C>
Unrealized investment gains,
net of tax $8,925 $3,931
Foreign currency translation
adjustments, net of tax (583) (346)
Accumulated other comprehensive
income, net of tax $8,342 $3,585
</TABLE>
The following table provides a summary of the components of net unrealized
investment gains (losses), as reported in the Consolidated Statements of Income:
<TABLE>
<CAPTION>
For the three months For the nine months
ended September 30, ended September 30,
1998 1997 1998 1997
---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Unrealized gains arising during
the period (net taxes of
$2,784 and $2,758 in 1998,
respectively and $567 and $187
in 1997, respectively) $ 5,172 $ 1,053 $ 5,122 $ 348
Less: reclassification
adjustments for realized
gains (losses) included in net
income (net of taxes of $158
and $134 in 1998, respectively
and $(124) and $(188) in 1997,
respectively) 293 (231) 250 (350)
Net unrealized investment gains
on securities $ 4,879 $ 1,284 $ 4,872 $ 698
</TABLE>
8. New Accounting Standards
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information". SFAS No. 131 redefines how operating
segments are determined and requires disclosure of certain financial and
descriptive information about a company's operating segments. This statement
relates to presentation of information and will have no impact on results of
operations or financial condition. An annual presentation is required for the
year ending December 31, 1998 and interim financial information will be required
beginning in 1999 (with comparative 1998 information). The Company is currently
evaluating the segment information disclosures required by SFAS No. 131.
<PAGE>
In December 1997, the American Institute of Certified Public Accountants issued
Statement of Position No. 97-3 "Accounting by Insurance and Other Enterprises
for Insurance-related Assessments" ("SOP 97-3"). SOP 97-3 establishes standards
for accounting for guaranty-fund and certain other insurance related
assessments. SOP 97-3 is effective for fiscal years beginning after December 15,
1998 and requires any impact of adoption to be reported as a change in
accounting principle. The adoption of this statement is not expected to have a
material effect on the Company's results of operations or financial condition.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", which requires
companies to record all derivatives on the balance sheet as either assets or
liabilities and measure those instruments at fair value. The manner in which
companies are to record gains or losses resulting from changes in the values of
those derivatives depends on the use of the derivative and whether it qualifies
for hedge accounting. This standard is effective January 1, 2000, with early
adoption permitted. The Company is currently evaluating the impact of the
adoption of this statement and the potential effect on its financial position
and results of operations.
9. Unaudited Consolidated Financial Statements
In the opinion of management, the accompanying unaudited consolidated financial
statements contain all adjustments necessary to present fairly the results of
operations and financial position of the Company for the periods ended September
30, 1998 and 1997. The unaudited consolidated financial statements should be
read in conjunction with the consolidated financial statements and related notes
to financial statements as contained in the Company's 1997 Annual Report on Form
10-K. The results of operations for the period presented are not necessarily
indicative of the results to be expected for the entire year.
<PAGE>
Item 7b. PRO FORMA FINANCIAL INFORMATION
Introduction
The following Pro Forma Financial Information is based on the historical
financial statements of Markel Corporation adjusted to give effect to the
acquisition of Gryphon Holdings, Inc. (Gryphon). The Consolidated Statements of
Income and Comprehensive Income for the nine months ended September 30, 1998 and
the year ended December 31, 1997 for Gryphon include the effect of Gryphon's
July 13, 1998 acquisition of First Reinsurance Company of Hartford as if that
acquisition had occurred on January 1, 1997. The Pro Forma Consolidated
Statements of Income and Comprehensive Income give effect to the Registrant's
acquisition of Gryphon as if it had occurred on January 1, 1997. The Pro Forma
Consolidated Balance Sheet gives effect to the acquisition as if it had occurred
on September 30, 1998. In the opinion of management, the historical consolidated
financial statements of Markel Corporation reflect all adjustments, which are of
a normal recurring nature, to present fairly Markel's financial position at
September 30, 1998 and results of operations for the nine months ended September
30, 1998 and the year ended December 31, 1997. The pro forma adjustments are
based upon available information and certain assumptions that management
believes are reasonable.
The acquisition of Gryphon was accounted for using the purchase method of
accounting. The purchase price for the acquisition has been allocated to
tangible and identifiable intangible assets and liabilities based upon
management's estimates of their fair value with the excess of purchase price
over fair value of net assets acquired allocated to goodwill and amortized over
20 years. For purposes of presenting pro forma results, no changes in revenues
and expenses have been made to reflect the results of any modification to
operations that might have been made had the acquisition been consummated on the
assumed effective date of the acquisition. The pro forma expenses include the
recurring costs, which are directly attributable to the acquisition, such as net
investment income forgone on cash and investments liquidated to complete the
acquisition, amortization of goodwill and interest expense.
The Pro Forma Financial Information does not purport to represent what Markel's
results of operations or financial position would actually have been had the
acquisition in fact occurred on January 1, 1997 or September 30, 1998 or to
project Markel's results of operations or financial position for or at any
future period or date.
<PAGE>
<TABLE>
MARKEL CORPORATION
Pro Forma Consolidated Balance Sheet
As of September 30, 1998
(dollars in thousands)
(Unaudited)
<CAPTION>
Markel and
Markel Gryphon Pro Forma Gryphon
(historical) (historical) Adjustments Pro Forma
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
ASSETS
Investments
Fixed maturities $ 1,115,280 $ 385,403 (60,305)(A) $ 1,440,378
Equity securities 281,981 901 (12,278)(A) 270,604
Short-term 65,599 233 (28,123)(A) 37,709
- ----------------------------------------------------------------------------------------------------------------------------
Total investments 1,462,860 386,537 (100,706) 1,748,691
- ----------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents 1,367 16,733 18,100
Receivables 73,691 36,242 109,933
Reinsurance recoverable on unpaid losses 199,957 201,051 401,008
Reinsurance recoverable on paid losses 17,844 17,068 34,912
Deferred policy acquisition costs 42,338 12,746 (3,000)(C) 52,084
Prepaid reinsurance premiums 41,997 34,794 76,791
Property and equipment 9,167 3,283 12,450
Intangible assets 35,806 11,368 42,635 (B) 89,809
Other assets 24,373 28,175 4,095 (E) 56,643
- ----------------------------------------------------------------------------------------------------------------------------
Total assets $ 1,909,400 $ 747,997 (56,976) $ 2,600,421
============================================================================================================================
LIABILITIES AND
SHAREHOLDERS' EQUITY
Unpaid losses and loss adjustment expenses $ 943,738 $ 448,636 $ 1,392,374
Unearned premiums 211,076 91,555 302,631
Payables to insurance companies 26,689 23,212 49,901
Long-term debt 93,205 55,000 50,000 (A) 198,205
Other liabilities 80,546 13,918 8,700 (D) 103,164
Company-Obligated Mandatorily Redeemable
Preferred Capital Securities of the Subsidiary
Trust Holding Solely Junior Subordinated
Deferrable Interest Debentures of Markel
Corporation 150,000 -- 150,000
- ----------------------------------------------------------------------------------------------------------------------------
Total liabilities 1,505,254 632,321 58,700 2,196,275
- ----------------------------------------------------------------------------------------------------------------------------
Shareholders' equity
Common stock 25,213 30,662 (30,662)(G) 25,213
Preferred Stock -- 11,741 (11,741)(F)(G) --
Retained earnings 286,757 88,846 (88,846)(G) 286,757
Accumulated other comprehensive income 92,176 8,342 (8,342)(G) 92,176
Treasury stock and other -- (23,915) 23,915 (G) --
- ----------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 404,146 115,676 (115,676) 404,146
- ----------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 1,909,400 $ 747,997 (56,976) $ 2,600,421
============================================================================================================================
</TABLE>
See accompanying Notes to Pro Forma Consolidated Financial Statements.
<PAGE>
<TABLE>
MARKEL CORPORATION
Pro Forma Consolidated Statement of Income and Comprehensive Income
Nine Months Ended September 30, 1998
(dollars in thousands, except per share data)
(Unaudited)
<CAPTION>
Markel and
Markel Gryphon Pro Forma Gryphon
(historical) (pro forma) Adjustments Pro Forma
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
OPERATING REVENUES
Earned premiums $ 248,089 $ 83,230 $ 331,319
Net investment income 53,137 16,201 (4,068)(H) 65,270
Net realized gains from investment sales 11,434 2,916 14,350
Other 665 -- 665
- ----------------------------------------------------------------------------------------------------------------------
Total operating revenues 313,325 102,347 (4,068) 411,604
- ----------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Losses and loss adjustment expenses 157,293 70,575 227,868
Underwriting, acquisition and insurance expenses 86,754 40,447 127,201
Amortization of intangible assets 1,525 243 1,782 (I) 3,550
- ----------------------------------------------------------------------------------------------------------------------
Total operating expenses 245,572 111,265 1,782 358,619
- ----------------------------------------------------------------------------------------------------------------------
Operating income 67,753 (8,918) (5,850) 52,985
Interest expense 15,290 2,809 4,331 (J) 22,430
- ----------------------------------------------------------------------------------------------------------------------
Income before income taxes 52,463 (11,727) (10,181) 30,555
Income taxes 12,591 (5,265) (2,940)(K) 4,386
Accretion of preferred stock -- 365 (365)(L) --
- ----------------------------------------------------------------------------------------------------------------------
Net income $ 39,872 $ (6,827) (6,876) $ 26,169
======================================================================================================================
OTHER COMPREHENSIVE INCOME
Unrealized gains on securities, net of taxes
Unrealized gains arising during the
period 14,349 6,258 20,607
Less reclassification adjustments for gains
included in net income (7,432) (1,776) (9,208)
Foreign currency translation adjustments (237) (237)
- ----------------------------------------------------------------------------------------------------------------------
Total Other Comprehensive Income 6,917 4,245 -- 11,162
- ----------------------------------------------------------------------------------------------------------------------
Comprehensive Income $ 46,789 $ (2,582) (6,876) $ 37,331
======================================================================================================================
Net income per share
- ----------------------------------------------------------------------------------------------------------------------
Basic $ 7.25 -- $ 4.76
======================================================================================================================
Diluted $ 7.07 -- $ 4.64
======================================================================================================================
</TABLE>
See accompanying Notes to Pro Forma Consolidated Financial Statements.
<PAGE>
<TABLE>
MARKEL CORPORATION
Pro Forma Consolidated Statement of Income and Comprehensive Income
Year Ended December 31, 1997
(dollars in thousands, except per share data)
(Unaudited)
<CAPTION>
Markel and
Markel Gryphon Pro Forma Gryphon
(historical) (pro forma) Adjustments Pro Forma
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
OPERATING REVENUES
Earned premiums $ 332,878 $ 119,773 $ 452,651
Net investment income 68,653 20,977 (6,042)(H) 83,588
Net realized gains from investment sales 15,834 7,859 23,693
Other 1,682 979 2,661
- ----------------------------------------------------------------------------------------------------------------------
Total operating revenues 419,047 149,588 (6,042) 562,593
- ----------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Losses and loss adjustment expenses 210,061 79,483 289,544
Underwriting, acquisition and insurance expenses 120,076 53,462 173,538
Amortization of intangible assets 2,435 324 2,376 (I) 5,135
- ----------------------------------------------------------------------------------------------------------------------
Total operating expenses 332,572 133,269 2,376 468,217
- ----------------------------------------------------------------------------------------------------------------------
Operating income 86,475 16,319 (8,418) 94,376
Interest 20,124 4,208 5,775 (J) 30,107
- ----------------------------------------------------------------------------------------------------------------------
Income before income taxes 66,351 12,111 (14,193) 64,269
Income taxes 15,924 2,785 (4,136)(K) 14,573
Accretion of preferred stock -- 485 (485)(L) --
- ----------------------------------------------------------------------------------------------------------------------
Net income $ 50,427 $ 8,841 (9,572) $ 49,696
======================================================================================================================
OTHER COMPREHENSIVE INCOME
Unrealized gains on securities, net of taxes
Unrealized gains arising during the
period 51,800 5,598 57,398
Less reclassification adjustments for gains
included in net income (10,292) (5,108) (15,400)
Foreign currency translation adjustments -- (127) (127)
- ----------------------------------------------------------------------------------------------------------------------
Total Other Comprehensive Income 41,508 363 -- 41,871
- ----------------------------------------------------------------------------------------------------------------------
Comprehensive Income $ 91,935 $ 9,204 (9,572) $ 91,567
======================================================================================================================
Net income per share
- ----------------------------------------------------------------------------------------------------------------------
Basic $ 9.20 -- $ 9.06
======================================================================================================================
Diluted $ 8.92 -- $ 8.79
======================================================================================================================
</TABLE>
See accompanying Notes to Pro Forma Consolidated Financial Statements.
<PAGE>
Notes to Pro Forma Consolidated Financial Statements
(Unaudited)
1. Basis of presentation
On January 15, 1999 Markel (the Registrant) acquired Gryphon through the
completion of a public tender offer. The purchase price was funded as follows
(in thousands):
Cash $ 100,706
Borrowings under existing lines of credit 50,000
----------
$ 150,706
==========
In addition, the Registrant subsequently refinanced $55.0 million of Gryphon's
debt.
The accompanying unaudited Pro Forma Consolidated Balance Sheet and Statements
of Income and Comprehensive Income are provided to illustrate the effect of the
acquisition on the Registrant and have been prepared using the purchase method
of accounting. The unaudited Pro Forma Consolidated Financial Statements reflect
how the balance sheet might have appeared at September 30, 1998 if the
acquisition had been consummated at that date and how the statements of income
and comprehensive income for the nine months ended September 30, 1998 and for
the year ended December 31, 1997 might have appeared if the acquisition had been
consummated on January 1, 1997. Certain reclassifications of Gryphon's
historical financial statements have been made to conform with the Registrant's
historical presentation.
Adjustments to Unaudited Pro Forma Consolidated Balance Sheet
The accompanying unaudited Pro Forma Consolidated Balance Sheet as of September
30, 1998 reflects certain adjustments which are explained below and are based on
assumptions made by management. These adjustments are required to give effect to
matters directly attributable to the acquisition. The explanations of these
adjustments are as follows:
(A) To record the cash paid and debt incurred to finance the acquisition.
(B) To adjust the intangible assets to reflect the excess of cost over the
fair value of net assets acquired resulting from the acquisition (in
thousands).
Fair value of net assets acquired $ 96,703
Excess of cost over fair value of net assets acquired 54,003
--------
Total purchase price $150,706
========
(C) To bring Gryphon's deferred policy acquisition cost accounting practices
into compliance with the Registrant's practices.
(D) To accrue severance as specified in various employment contracts,
investment banking expenses and legal fees.
(E) To record current and deferred tax assets relating to severance and other
acquisition costs and the adjustment of the deferred acquisition costs at
an assumed 35% statutory rate.
(F) To record the retirement or repurchase of Gryphon's convertible preferred
stock.
(G) To record consolidating and eliminating entries.
<PAGE>
Adjustments to Unaudited Pro Forma Consolidated Statements of Income and
Comprehensive Income
The accompanying unaudited Pro Forma Consolidated Statements of Income and
Comprehensive Income for the nine months ended September 30, 1998 and for the
year ended December 31, 1997 reflect certain adjustments which are explained
below and are based on assumptions made by management. These adjustments are
required to give effect to matters directly attributable to the purchase. The
explanations of these adjustments are as follows:
(H) Reduction in net investment income due to net cash used in funding the
transactions; the rate of return is calculated at 6%.
(I) Excess of cost over fair value of net assets acquired is amortized on a
straight line basis over 20 years.
(J) Interest on borrowed funds under existing lines of credit is assumed to be
5.5%.
(K) Taxes are calculated at an assumed 35% statutory rate.
(L) To record the retirement or repurchase of Gryphon's convertible preferred
stock.
Other Adjustments to unaudited statements
Other Matters
In the fourth quarter of 1998, Gryphon recorded a charge to earnings by
increasing losses and loss adjustment expenses reserves (loss reserves) for
environmental, asbestos and construction defect claims by $15.0 million. An
actuarial analysis completed in the fourth quarter indicated that additional
loss reserves were required.
Exhibit 23
Consent of Independent Auditors
The Board of Directors
Gryphon Holdings Inc.
We consent to the inclusion of our report dated February 24, 1998, with respect
to the consolidated balance sheets of Gryphon Holdings, Inc. and subsidiaries as
of December 31, 1997 and 1996, and the related consolidated statements of
income, stockholders' equity, and cash flows for each of the years in the
three-year period ended December 31, 1997, which report appears in the Form 8-K
of Markel Corporation dated January 29, 1999.
KPMG LLP
New York, New York
January 29, 1999
