<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
____________________
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-25984
____________________
SUPERIOR NATIONAL INSURANCE GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CALIFORNIA 95-3994873
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
26601 AGOURA ROAD
CALABASAS, CA 91302
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(818) 880-1600
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
____________________
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
Number of shares of Common Stock, without par value, outstanding as of
close of business on November 18, 1996: 3,437,523 shares.
<PAGE> 2
SUPERIOR NATIONAL INSURANCE GROUP, INC.
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed consolidated balance sheets as of
September 30, 1996 (unaudited) and December 31, 1995 . . . . . . . . . . . . . . . . . . . . . . . 3
Condensed consolidated statements of income for the three and nine months ended
September 30, 1996 (unaudited) and September 30, 1995 (unaudited) . . . . . . . . . . . . . . . . . 4
Condensed consolidated statement of changes in shareholders' equity
for the nine months ended September 30, 1996 (unaudited) . . . . . . . . . . . . . . . . . . . . . 5
Condensed consolidated statements of cash flows for the nine months ended
September 30, 1996 (unaudited) and September 30, 1995 (unaudited) . . . . . . . . . . . . . . . . . 6
Notes to condensed consolidated financial statements (unaudited) . . . . . . . . . . . . . . . . . . . . . . 7
Item 2. Management's Discussion and Analysis of Consolidated Financial Condition and
Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
PART II. OTHER INFORMATION
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
SIGNATURE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
EXHIBIT INDEX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
</TABLE>
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SUPERIOR NATIONAL INSURANCE GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
<TABLE>
<CAPTION>
September 30, December 31,
ASSETS 1996 1995
------------ -----------
(Unaudited) (*)
<S> <C> <C>
Investments:
Bonds and notes:
Available-for-sale, at market
(cost: 1996, $35,898; 1995, $41,800) $ 35,608 $ 42,053
Equity securities, at market
Common stock (cost: $686; 1996 and 1995) 769 689
Funds withheld from reinsurers, at amortized cost
Bonds and notes, at amortized cost
(market: 1996, $77,505; 1995, $117,073) 79,018 114,921
Invested cash (certificates of deposit and other
short-term instruments) 451 -
Invested cash (certificates of deposit and other
short-term instruments) 32,228 6,045
Restricted investment 1,520 1,700
-------- --------
TOTAL INVESTMENTS 149,594 165,408
Cash (Restricted cash: 1996, $595; 1995, $2,686) 2,332 2,952
Reinsurance receivable 38,217 38,892
Premiums receivables (less allowance for doubtful
accounts: 1996, $300; 1995, $500) 15,371 14,724
Deferred policy acquisition costs 3,120 2,780
Income taxes 9,536 10,085
Other assets 9,924 9,501
-------- --------
TOTAL ASSETS $228,094 $244,342
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Claims and claim adjustment expenses $113,539 $140,774
Unearned premiums 9,808 10,220
Long-term debt 7,630 8,530
Policyholder dividends 4,517 8,094
Repurchase transaction 3,596 -
Accounts payable and other liabilities 20,980 12,199
-------- --------
TOTAL LIABILITIES 160,070 179,817
PREFERRED SECURITIES ISSUED BY AFFILIATE;
authorized 1,100,000 shares; issued and outstanding
966,860 shares in 1996 and 922,137 shares in 1995 22,921 21,045
Shareholders' Equity:
Common stock, no par value; authorized
25,000,000 shares; issued and outstanding
3,433,473 shares in 1996 and 3,430,373 shares in 1995 15,956 15,943
Unrealized gain (loss) on investments, net of taxes (137) 169
Paid in capital - warrants 2,206 2,206
Retained earnings 27,078 25,162
-------- --------
TOTAL SHAREHOLDERS' EQUITY 45,103 43,480
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $228,094 $244,342
======== ========
</TABLE>
* Derived from audited financial statements.
See Notes to Condensed Consolidated Financial Statements.
3
<PAGE> 4
SUPERIOR NATIONAL INSURANCE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ----------------------
1996 1995 1996 1995
------- ------- ------- -------
<S> <C> <C> <C> <C>
REVENUES:
Premiums written, net of reinsurance ceded $23,337 $22,571 $66,133 $68,822
(Increase) decrease in net unearned
premiums 330 51 93 748
------- ------- ------- -------
Net premiums earned 23,007 22,520 66,040 68,074
Net investment income 2,129 2,530 6,394 7,330
------- ------- ------- -------
TOTAL REVENUES 25,136 25,050 72,434 75,404
EXPENSES:
Claims and claim adjustment expenses,
net of reinsurance recoveries 14,201 17,095 36,801 40,937
Commissions, net of reinsurance
commissions 2,607 3,043 7,865 9,251
Policyholder dividends (715) (2,528) (2,121) (5,706)
Interest expense 2,126 2,434 6,922 7,310
General and administrative expenses
Underwriting 5,304 4,542 18,681 12,127
Other 173 124 (216) 380
------- ------- ------- -------
TOTAL EXPENSES 23,696 24,710 67,932 64,299
------- ------- ------- -------
INCOME BEFORE INCOME TAXES AND PREFERRED
SECURITIES DIVIDENDS AND ACCRETION AND
DISCONTINUED OPERATIONS 1,440 340 4,502 11,105
Income tax expense (benefit) 300 198 1,348 (142)
------- ------- ------- -------
INCOME BEFORE PREFERRED SECURITIES
DIVIDENDS AND ACCRETION AND DISCONTINUED
OPERATIONS 1,140 142 3,154 11,247
Preferred securities dividends and
accretion, net of income taxes (428) (382) (1,238) (1,105)
Loss from operation of discontinued
property and casualty operations, net of
income taxes - - - (9,842)
------- ------- ------- -------
NET INCOME $ 712 $ (240) $ 1,916 $ 300
======= ====== ======= =======
EARNINGS PER COMMON AND DILUTIVE
COMMON EQUIVALENT SHARES:
INCOME BEFORE PREFERRED SECURITIES
DIVIDENDS AND ACCRETION, AND
DISCONTINUED OPERATIONS $ 0.23 $ 0.04 $ 0.64 $ 3.28
Preferred securities dividends and (0.08) (0.11) (0.23) (0.32)
accretion
Loss from discontinued property and
casualty operations - - - (2.87)
------- ------- ------- -------
NET INCOME $ 0.15 $ 0.07 $ 0.41 $ 0.09
======= ======= ======= =======
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
4
<PAGE> 5
SUPERIOR NATIONAL INSURANCE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(Amounts in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Net Unrealized Paid in Total
Common Gain (loss) on Capital- Retained Shareholders'
Stock Investments Warrants Earnings Equity
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995 $15,943 $169 $2,206 $25,162 $43,480
Net income - - - 1,916 1,916
Change in unrealized gain
(loss) on investments, net
of taxes - (306) - - (306)
Common stock issued 13 - - - 13
--------------------------------------------------------------------------------
Balance at September 30, 1996 $15,956 ($137) $2,206 $27,078 $45,103
================================================================================
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
5
<PAGE> 6
SUPERIOR NATIONAL INSURANCE GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
------------------------------
1996 1995
--------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,916 $ 300
-------- --------
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Amortization of bonds and preferred stock (705) (2,922)
(Gain)/loss on sale of investments (33) 504
(Gain) on sale of funds withheld investments (2,261) (2,859)
Preferred securities dividends and accretion 1,876 1,675
Decrease in reinsurance receivables 675 19,002
(Increase) decrease in premiums receivables (647) 7,622
(Increase) in deferred policy acquisition costs (340) (488)
Decrease (increase) in income taxes 706 (4,065)
(Decrease) in claims and claim adjustment
expense reserves (27,235) (19,037)
(Decrease) increase in unearned premium reserves (412) 375
(Decrease) in policyholder dividends payable (3,577) (8,007)
(Decrease) in discontinued operations - (4,223)
(Decrease) in other liabilities, net of other assets 8,358 939
-------- --------
Total adjustments (23,595) (11,484)
-------- --------
Net cash (used in) operating activities (21,679) (11,184)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Retirement of long-term debt (900) (900)
Proceeds from repurchase transaction 3,596 -
Paid in capital - stock options exercised 13 -
-------- --------
Net cash provided by (used in) financing activities 2,709 (900)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of bonds and notes:
Investments available-for-sale (29,119) (4,386)
Investment funds withheld from reinsurers (71,061) (76,588)
Investments allocated to discontinued operations - (1,581)
Sales of bonds and notes: Investments available-for-sale 22,414 13,717
Maturities of bonds and notes: Investments available-for sale 12,286 1,091
Maturities of bonds and notes: Investments held to maturity - 5,495
Sales and maturities of bonds and notes held to maturity
Funds withheld from reinsurers 110,098 76,734
Net (increase) in invested cash (25,817) (1,680)
Net (increase) in invested cash for funds withheld from
reinsurers (451) -
-------- --------
Net cash provided by investing activities 18,350 12,802
-------- --------
Net (decrease) increase in cash (620) 718
Cash at beginning of period 2,952 2,533
-------- --------
Cash at end of period $ 2,332 $ 3,251
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes $ 4 $ 4
======== ========
Cash paid during the year for interest $ 488 $ 653
======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
6
<PAGE> 7
SUPERIOR NATIONAL INSURANCE GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1996
(UNAUDITED)
NOTE A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A.1 Basis of Presentation
Superior National Insurance Group, Inc. ("SNIG") is a holding company
that, through its wholly-owned subsidiary, Superior National Insurance Company
("SNIC"), is engaged in writing workers' compensation insurance principally in
the State of California, and until September 30, 1993, was engaged in writing
commercial property and casualty insurance. The "Company" refers to SNIG and
its subsidiaries.
The accompanying unaudited condensed consolidated financial statements
of the Company have been prepared in accordance with generally accepted
accounting principles for interim financial information and with the
instructions to Form 10-Q and Article 10 of regulation S-X. Accordingly, they
do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the
opinion of management, all adjustments, including normally occurring accruals,
considered necessary for a fair presentation have been included. Certain
reclassifications of prior year amounts have been made to conform with the 1996
presentation. Operating results for the nine months ended September 30, 1996
are not necessarily indicative of the results to be expected for the year ended
December 31, 1996. For further information, refer to the consolidated
financial statements and footnotes thereto included in SNIG's annual report on
Form 10-K for the year ended December 31, 1995.
A.2 EARNINGS PER SHARE ("EPS")
Earnings per common and dilutive common equivalent shares for the three
and nine months ended September 30, 1996 and 1995 are based on the average
number of common shares outstanding during each period and assuming conversion
of all stock options and warrants which are common stock equivalents. Common
share equivalents included in the computation represent shares issuable upon
assumed exercise of stock options and warrants which would have a dilutive
effect. If the calculation of income per share including all common stock
equivalents is antidilutive, such common stock equivalents are excluded from the
EPS amounts. The number of shares used in the EPS calculations are 5,316,873
shares for the three and nine months ended September 30, 1996; and 3,429,873
shares for the three and nine months ended September 30, 1995.
A.3 CLAIMS AND CLAIM ADJUSTMENT EXPENSES RESERVES
The liability for unpaid claims and claim adjustment expenses is based
on an evaluation of reported losses and on estimates of incurred but unreported
losses. The reserve liabilities are determined using adjusters' individual case
estimates and statistical projections, which can be affected by many external
factors that are difficult to predict, including changes in the economy, trends
in medical treatments and litigation, changes in regulatory environment, medical
services, and employment rights. The liability is reported net of estimated
salvage and subrogation recoverable. Adjustments to the liability resulting
from subsequent developments or revisions to the estimate are reflected in
results of operations in the period in which such adjustments become known.
While there can be no assurance that reserves at any given date are adequate to
meet SNIG's obligations, the amounts reported on the balance sheet are
management's best estimate of that amount.
A.4 ACQUISITION OF PAC RIM HOLDING CORPORATION
On September 17, 1996, the Company entered into a definitive agreement
to acquire Pac Rim Holding Corporation ("Pac Rim") for a total consideration of
approximately $54 million in cash, which consideration would result in payment
of approximately $3.00 to $3.10 per share to each of Pac Rim's common
stockholders and debenture holders (based upon the number of shares of Pac Rim
common stock ("Pac Rim Common Stock") into which the debentures are
convertible), with holders of warrants and options to receive an amount equal to
the spread between the exercise price of their options or warrants and the per
share payment amount to holders of Pac Rim Common Stock. The actual purchase
price per share of Pac Rim Common Stock is subject to a final analysis of Pac
Rim's loss reserves immediately prior to closing. Consummation of the
transaction is subject to regulatory and SNIG shareholder and Pac Rim
stockholder approvals, and various other conditions. The transaction is
projected to close late in the fourth quarter of 1996 or the first quarter of
1997.
7
<PAGE> 8
A.5 SUBSEQUENT EVENT
On November 13, 1996, the Company consummated a three-part financing
transaction, involving Centre Reinsurance Limited ("Centre Re") and The Chase
Manhattan Bank ("Chase"). Chase extended a $93.1 million term loan (net of
transaction costs) to the Company collateralized by future reinsurance
recoveries due from Centre Re to SNIC. The proceeds from the financing were
used by the Company to purchase reinsurance receivables due to SNIC from Centre
Re, and SNIC utilized a portion of the proceeds to extinguish a $71 million
liability for reinsurance premiums due to Centre Re. The transaction was
approved by the California Department of Insurance.
8
<PAGE> 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS:
The following selected financial data and analysis provide an
assessment of SNIG's financial results for the three months ended September 30,
1996 as compared to the three months ended September 30, 1995. Certain prior
period amounts have been reclassified to conform to the current period
presentation.
Selected financial data as reported for the three months ended September 30,
1996 and 1995 are presented below.
<TABLE>
<CAPTION>
Three Months Ended September 30,
------------------------------
(Dollars in thousands) 1996 1995
-------- ---------
<S> <C> <C>
Gross premiums written $ 25,534 $ 24,208
Net premiums written $ 23,337 $ 22,571
Net premiums earned $ 23,007 $ 22,520
Less: Net claims and claim adjustment expenses (14,201) (17,095)
Underwriting expenses (7,911) (7,585)
Policyholder dividends 715 2,528
-------- --------
Underwriting profit 1,610 368
Net investment income 2,117 2,565
Net investment gains (losses) 12 (35)
Interest expense (2,126) (2,434)
Other (173) (124)
-------- --------
Income before income taxes 1,440 340
Income tax expense (benefit) 300 198
-------- --------
Income before preferred securities dividends and
accretion 1,140 142
Preferred securities dividends and accretion, net of
taxes (428) (382)
-------- --------
Net Income (loss) $ 712 $ (240)
======== ========
Underwriting ratios (GAAP Basis):
Net claims and claim adjustment expense ratio 61.7% 75.9%
Underwriting expense ratio 34.4% 33.7%
Policyholder dividends ratio (3.1%) (11.2%)
-------- --------
Combined ratio 93.0% 98.4%
======== ========
</TABLE>
9
<PAGE> 10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Gross premiums written increased $1.3 million or 5% in the third
quarter of 1996 as compared to the same period in 1995. The increase was
encouraging as this may indicate the Company's workers' compensation portfolio
is stabilizing after almost two years of decline due to intense price
competition. The competitive market conditions were brought on by California's
elimination of its minimum rate law in favor of an open rating system effective
January 1, 1995. At the end of the third quarter of 1996, production measured
in policy counts was 21% higher than it was in the third quarter of 1995, and
the estimated annual premium associated with those policies increased 5%. The
Company is continuing to make strenuous efforts to increase production, subject
to the constraints of sound underwriting standards, and to reduce the Company's
fixed and semi-fixed expense ratios commensurate with premium levels.
Net premiums written increased $0.8 million or 3% in the third quarter
of 1996. The increase in net premiums written is reflective of the increase in
gross premiums written as discussed above.
Net premiums earned increased $0.5 million or 2% in the third quarter
of 1996. The increase in net premiums earned reflects the increase in net
premiums written described above.
Net claims and claim adjustment expenses decreased $2.9 million or 17%
in the third quarter of 1996 as compared to the same period in 1995. The net
claims and claim adjustment expense ratio decreased 14.2 percentage points to
61.7% in the third quarter of 1996 from 75.9% in the same period in 1995. The
14.2 percentage points improvement in the third quarter of 1996 was due
primarily to improved net claims and claim adjustment expense margins on the
1996 accident year as a result of lower frequency of reported claims.
Underwriting expenses, excluding policyholder dividends, increased
$0.3 million or 4% in the third quarter of 1996 as compared to the same period
in 1995. The underwriting expense ratio deteriorated 0.7 of a percentage
point to 34.4% for the third quarter of 1996 from 33.7% for the corresponding
period in 1995. General and administrative expenses for the third quarter of
1996 were comparable to the corresponding period in 1995.
Policyholder dividend expense continued to decline in importance and
size in the third quarter of 1996 to $0.7 million as compared to $2.5 million
for the same period in 1995. Prior to open rating, policyholder dividends
served both as an economic incentive to employers for safe operations and as a
means of price differentiation. As a result of consumers' preference for the
lowest net price at the policy's inception under open rating, dividends are no
longer a significant factor in the marketing of workers' compensation insurance
in California.
Underwriting profit from continuing operations increased $1.2 million
to $1.6 million in the third quarter of 1996 from $0.4 million in the same
period in 1995. The improvement of $1.2 million in the third quarter of 1996
was due primarily to improved net claims and claim adjustment expense margins
on the 1996 accident year. The improved underwriting results in 1996 also
reflect the Company's focus on maintaining underwriting margins by controlling
writings that are not within the Company's underwriting guidelines, curtailing
writings in unprofitable agencies, and emphasizing loss control management.
Net investment income decreased $0.4 million or 17% in the third
quarter of 1996 compared to the same period in 1995. The decrease in net
investment income is due to a decrease in the average investable assets of
$18.4 million, and a decline in the average portfolio investment yield as a
result of generally lower market interest rates in 1996, as compared to 1995.
See the discussion in "Liquidity and Capital Resources," below.
Interest expense for the third quarter of 1996 was $2.1 million as
compared to $2.4 million for the same period in 1995. The decrease of $0.3
million was a result of lower interest expense due to declining funds withheld
balances and a declining bank term loan as a result of principal paydown.
10
<PAGE> 11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Selected financial data as reported for the nine months ended September 30,
1996 and 1995 are presented below.
<TABLE>
<CAPTION>
Nine Months Ended September 30,
------------------------------
(Dollars in thousands) 1996 1995
--------- --------
<S> <C> <C>
Gross premiums written $ 72,663 $ 74,090
Net premiums written $ 66,133 $ 68,822
Net premiums earned $ 66,040 $ 68,074
Less: Net claims and claim adjustment expenses (36,801) (40,937)
Underwriting expenses (26,546) (21,378)
Policyholder dividends 2,121 5,706
--------- --------
Underwriting profit 4,814 11,465
Net investment income 6,361 7,834
Net investment gains (losses) 33 (504)
Interest expense (6,922) (7,310)
Other 216 (380)
--------- --------
Income before income taxes 4,502 11,105
Income tax expense (benefit) 1,348 (142)
--------- --------
Income before preferred securities dividends and accretion 3,154 11,247
and discontinued operations
Preferred securities dividends and accretion, net of taxes (1,238) (1,105)
Loss from operation of discontinued property and
casualty, net of taxes - (9,842)
--------- --------
Net Income $ 1,916 $ 300
========= ========
Underwriting ratios (GAAP Basis):
Net claims and claim adjustment expense ratio 55.7% 60.2%
Underwriting expense ratio 40.2% 31.4%
Policyholder dividends ratio (3.2%) (8.4%)
--------- --------
Combined ratio 92.7% 83.2%
========= ========
</TABLE>
Gross premiums written decreased $1.4 million or 2% in the first nine
months of 1996 as compared to the same period in 1995. Although premiums
written for the third quarter of 1996 were higher than they were for the same
period in the prior year as addressed in the "Results of Operations - Three
months ended September 30, 1996 and 1995" section, the premium shortfall of
$5.6 million during the first quarter of 1996 as compared to the prior year
quarter, caused the year-to-date premiums for 1996 to fall below last year's
level. The decrease was expected as a result of the lack of mandated rates due
to the replacement of California's minimum rate law by an open rating system
effective January 1, 1995. The competitive market conditions have been further
intensified by certain carriers who are willing to underwrite business at rates
that in management's opinion are inadequate. For the nine months ended
September 30, 1996, estimated annual premiums decreased 2% as compared to the
corresponding period in 1995, but production measured in policy counts
associated to those premiums increased by 18%. The Company's average policy
size decreased 21% to $8,987 as of September 1996 from $11,383 as of September
1995. While it appears the decline in premium volume has reversed, it is
uncertain whether this stabilization of premium
11
<PAGE> 12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
rates will continue due to continued volatility of premium pricing, regulatory
changes, or changes in competition. The Company chooses not to sacrifice
margin and shareholder return for the sake of market share, and the Company
will remain cautious in its premium production consistent with its disciplined
underwriting philosophy. The Company will remain focused on small to medium
size customers employing a pricing strategy adequate to produce a reasonable
profit. SNIC believes the rates it has filed with the Department of Insurance
(the "DOI") are adequate, but it is unable to predict the degree to which such
rates are competitive in the marketplace given the intense competition among
insurers.
Net premiums written decreased $2.7 million or 4% in the first nine
months of 1996. The decrease in net premiums written is reflective of the
decrease in gross premiums written as discussed above.
Net premiums earned decreased $2.0 million or 3% in the first nine
months of 1996. The decrease in net premiums earned reflects the decrease in
net premiums written described above.
Net claims and claim adjustment expenses decreased $4.1 million or 10%
to $36.8 million in the first nine months of 1996 from $40.9 million in the
same period in 1995. The net claims and claim adjustment expense ratio
decreased to 55.7% in the first nine months of 1996 from 60.2% in the same
period of 1995. However, the 1995 claims and claim adjustment expenses include
a $6 million decrease in the estimated ultimate claims and claim adjustment
expenses on accident years prior to 1995 as a result of continued decreases in
the Company's estimates of frequency and severity of claims incurred for those
years. The net claims and claim adjustment expense ratio, excluding the $6
million favorable development, was 68.9% for the nine months ended September
1995, as compared to 55.7% for the same period in 1996. The 13.2 percentage
point improvement in 1996 was due primarily to improved net claims and claim
adjustment expense margins on the 1996 accident year as a result of lower
frequency of reported claims.
Underwriting expenses, excluding policyholder dividends, increased
$5.2 million or 24% in the first nine months of 1996 as compared to the same
period in 1995. The increase was due primarily to a $5.3 million adjustment
recorded in the second quarter of 1996 for accrued costs related to the
settlement of funds withheld amounts associated with a reinsurance contract.
Underwriting expenses for the first nine months of 1996, excluding the $5.3
million in accrued costs, were $21.2 million as compared to $21.4 million for
the same period in 1995. The underwriting expense ratio, excluding the $5.3
million in accrued costs, increased to 32.1% in the first nine months of 1996
from 31.4% for the corresponding period in 1995, due primarily to a decrease in
premium production without a commensurate decrease in general and
administrative expenses.
Policyholder dividends reductions in the first nine months of 1996
increased income by $2.1 million as compared to $5.7 million for the same
period in 1995. Prior to open rating, policyholder dividends served both as an
economic incentive to employers for safe operations and as a means of price
differentiation. As a result of consumers' preference for the lowest net price
at the policy's inception under open rating, dividend paying is no longer a
significant factor in the marketing or selling of workers' compensation
insurance in California. The Company is continuing to observe, analyze and
react to the issue of policyholder dividends in the context of varying pricing
philosophies emerging from open rating.
Underwriting profit from continuing operations decreased $6.7 million
to $4.8 million in the first nine months of 1996 from $11.5 million in the same
period in 1995. The change in underwriting results for the first nine months
of 1996 is attributable to a $6 million decrease in workers' compensation
reserves and a $5.7 million reduction in policyholder dividends recorded in the
first nine months of 1995. The underwriting results for the first nine months
of 1996 also included $5.3 million in accrued costs related to the settlement
of funds withheld amounts associated with a reinsurance contract, which was
partially offset by a $2 million reduction in policyholder dividends reserves.
Underwriting profit (loss) for the nine months ended September 1996 and 1995,
excluding the above discussed adjustments, were $8.1 million and $(0.2)
million, respectively. The improvement of $8.3 million in the first nine
months of 1996 is due primarily to improved net claims and claim adjustment
expense margins on the 1996 accident year. The improved underwriting results
also reflect the Company's focus on maintaining underwriting margins by
controlling writings that are not within the Company's underwriting guidelines,
curtailing writings in unprofitable agencies, and emphasizing loss control
management.
12
<PAGE> 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Net investment income decreased $1.5 million or 19% in the first nine
months of 1996 as compared to the same period in 1995. The decrease is
attributable to a decrease in the average investable assets of $14.8 million,
and a decline in the average portfolio investment yield as a result of
generally lower market interest rates, in the first nine months of 1996 as
compared to the same period in 1995. See the discussion in "Liquidity and
Capital Resources," below.
A summary of net investment income, excluding capital gains (losses),
for the three and nine months ended September 30, 1996 and 1995 are as follows:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
---------------------- ------------------------
(Dollars in thousands) 1996 1995 1996 1995
------ ------ ------ ------
<S> <C> <C> <C> <C>
Interest on debt 1,909 $1,753 $6,060 $6,448
instrument
Interest on invested 324 851 656 1,597
cash
------ ------ ------ ------
Total investment income 2,233 2,604 6,716 8,045
Investment expense 116 39 355 211
------ ------ ------ ------
Net investment income $2,117 $2,565 $6,361 $7,834
====== ====== ====== ======
</TABLE>
The distribution of SNIG's consolidated investment portfolio is as
follows (in thousands):
<TABLE>
<CAPTION>
September 30, 1996 December 31, 1995
--------------------------- ---------------------
Amortized Market Amortized Market
--------- ------ ---------- ------
Available for Sale: Cost Value Cost Value
----- ----- ----- -----
<S> <C> <C> <C> <C>
U.S. Government
Agencies & Authorities $17,783 $17,519 $22,549 $22,524
Collateralized Mortgage Obligations 10,030 9,764 10,753 10,779
Corporate Instruments 6,985 7,200 7,398 7,612
State & Political Subdivisions 1,100 1,125 1,100 1,138
-------- -------- -------- --------
Total Available for Sale $35,898 $35,608 $41,800 $42,053
======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
September 30, 1996 December 31, 1995
--------------------------- ---------------------
Amortized Market Amortized Market
--------- ------ --------- ------
Funds Withheld from Reinsurers Cost Value Cost Value
---- ----- ----- -----
<S> <C> <C> <C> <C>
U.S. Government
Agencies & Authorities $71,799 $70,615 $103,496 $105,554
Collateralized Mortgage Obligations 2,001 2,001 2,306 2,316
Special Revenue - - 2,118 2,183
Corporate Instruments 5,218 4,889 7,001 7,020
------- -------- --------- ---------
Total Bonds and Notes 79,018 77,505 114,921 117,073
Invested Cash 451 451 - -
----- ------ --------- ---------
Total Funds Withheld From Reinsurers $79,469 $ 77,956 $114,921 $117,073
======= ======== ======== ========
</TABLE>
13
<PAGE> 14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
<TABLE>
<CAPTION>
September 30, 1996 December 31, 1995
-------------------------- --------------------------
Market Market
Invested Cash Cost Value Cost Value
------- ------- ----- ------
<S> <C> <C> <C> <C>
Invested Cash $33,748 $33,748 $7,745 $7,745
------- ------- ----- ------
Total $33,748 $33,748 $7,745 $7,745
======= ======= ====== ======
</TABLE>
<TABLE>
<CAPTION>
September 30, 1996 December 31, 1995
------------------------ ---------------------
Market Market
Equity Securities Cost Value Cost Value
---- ------ ---- ------
<S> <C> <C> <C> <C>
Corporate $686 $769 $686 $689
---- ---- ---- ----
Total $686 $769 $686 $689
==== ==== ==== ====
</TABLE>
The Company's management monitors the matching of assets and
liabilities and attempts to maintain its investment duration at the midpoint
of the length of its net claim and claim adjustment expenses payout pattern.
Investment duration is the weighted average measurement of the current maturity
of a fixed income security, in terms of time, of the present value of the
future payments to be received from that security. However, in selecting
assets to purchase for its investment portfolio, the Company considers each
security's modified duration and the effect of that security's modified
duration on the portfolio's overall modified duration. Modified duration is a
measurement that estimates the percentage change in market value of an
investment for a small change in interest rates. The modified duration of
fixed maturities at September 30, 1996 was 2.56 years compared to 4.69 years at
December 31, 1995. At September 30, 1996, 98% of the carrying values of
investments in the fixed maturities portfolio were rated as investment grade by
the Securities Valuation Office of the National Association of Insurance
Commissioners.
Interest expense for the first nine months of 1996 was $6.9 million as
compared to $7.3 million for the same period in 1995. The decrease of $0.4
million was due to lower interest expense on the bank term loan as a result of
principal paydown.
DISCONTINUED OPERATIONS:
Discontinued operations claims have continued to stabilize during the
third quarter after seven months of heavy activity beginning September 1995
associated with a California Supreme Court decision affecting construction
defect claim coverage. The Company has significant exposure to construction
defect liabilities on casualty insurance policies underwritten from 1986 to
1991. Management continues to closely monitor its potential exposure to
construction defect claims. Management believes its current reserves are
adequate to cover this increase in claims activity depending on the length of
time the recent reporting trends continue. There can be no assurance,
therefore, that further upward development of ultimate loss costs associated
with construction defect claims will not occur. The Company will continue to
closely monitor the adequacy of its loss reserves in the discontinued
operations.
LIQUIDITY AND CAPITAL RESOURCES:
Liquidity is a measure of an entity's ability to secure sufficient
cash to meet its contractual obligations and operating needs. The Company's
cash inflows are generated from cash collected for policies sold, investment
income on the existing portfolio and sales and maturities of investments. The
Company's cash outflows consist primarily of payments for policyholders'
claims, operating expenses and dividend obligations.
During the first nine months of 1996, the Company used $21.7 million
in its operations versus $11.2
14
<PAGE> 15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
million during the same period in 1995. The $10.5 million decline in cash from
operating activities was due primarily to a decrease in premiums received and an
increase in claim payments for workers' compensation. It is management's belief
that the Company has sufficient cash, short-term investments, readily marketable
investment grade securities, and borrowings under its existing line of credit to
meet its future cash needs through at least December 31, 1997. As of September
30, 1996, the Company had total cash, cash equivalents and investments of $151.9
million. This amount includes $79.5 million in funds withheld from Centre Re
and $1.5 million in restricted cash. The Company's remaining invested assets
were comprised of $35.6 million in bonds and notes, held at market value; $0.8
million in equity securities; $32.2 million in invested cash, including
certificates of deposit with maturities less than one year and money market
deposits; and $2.3 million in cash.
The Company generated $2.7 million in cash from financing activities
for the nine months ended September 30, 1996 and used $0.9 million for the
corresponding period in 1995. The cash generated by financing activities in
the first nine months of 1996 was funded by the proceeds received from a
repurchase transaction which was partially offset by the principal paydown of
the bank term note.
Early in 1995, SNIC entered into an agreement with a national
brokerage house to allow it to enter into $5 million in repurchase agreements
that are secured by either U.S. treasury bonds or government agency bonds. This
type of financing allows SNIC a great deal of flexibility to manage short-term
investments, avoiding the unnecessary realization of losses to satisfy short
term cash needs. As of September 30, 1996, the book value including accrued
interest for repurchase agreement outstanding was $3.6 million. The market
value of the security underlying the agreement was $3.6 million. The agreement
matures in December, 1996 and bears an interest rate of 5.45%.
Because SNIG depends on dividends from SNIC, its insurance subsidiary,
for its net cash flow requirements, absent other sources of cash flow, SNIG
cannot pay dividends materially in excess of the amount of dividends that could
be paid by SNIC to SNIG. Insurance companies are also subject to restrictions
affecting the amount of shareholder dividends and advances that may be paid
within any one year without the prior approval of the DOI. The California
Insurance Code provides that amounts may be paid as dividends on an annual
noncumulative basis (generally based on the greater of (1) net income for the
preceding year or (2) 10% of statutory surplus as regards policyholders as of
the preceding December 31) without prior notice to, or approval by, the DOI. No
ordinary dividends were paid during the nine months ended September 30, 1996.
SNIC is a party to various leases principally associated with the
Company's home and branch office space. Such leases contain provisions for
scheduled lease charges and escalations in base rent over the lease term. The
Company's minimum commitment with respect to these leases in 1996 is
approximately $1.9 million. These leases expire from 1996 to 2001.
Other than the Company's obligations to pay claims, policyholder
dividends, ceded reinsurance premiums, lease expenses, principal and interest
on the bank debt, and its commitment to acquire Pac Rim, the Company has no
significant cash commitments. See Note A.4 under "Notes to the Condensed
Consolidated Financial Statements for the Three and Nine Months Ended September
30, 1996," above, for a discussion of the Company's proposed acquisition of Pac
Rim.
15
<PAGE> 16
PART II. OTHER INFORMATION
ITEM 5. OTHER INFORMATION
PRO FORMA FINANCIAL INFORMATION
On September 17, 1996, the Company entered into a definitive agreement
to acquire Pac Rim for a total consideration of approximately $54 million in
cash, which consideration would result in payment of approximately $3.00 to
$3.10 per share to each of Pac Rim's common stockholders and debenture holders
(based upon the number of shares of Pac Rim Common Stock into which the
debentures are convertible), with holders of warrants and options to receive an
amount equal to the spread between the exercise price of their options or
warrants and the per share payment amount to holders of Pac Rim Common Stock.
The actual purchase price per share of Pac Rim Common Stock is subject to a
final analysis of Pac Rim's loss reserves immediately prior to closing.
Consummation of the transaction is subject to regulatory and SNIG shareholder
and Pac Rim stockholder approvals, and various other conditions. The
transaction is projected to close late in the fourth quarter of 1996 or the
first quarter of 1997.
The Company has determined that it is in the best interests of its
shareholders to provide in this report certain pro forma financial information
that assumes the successful completion of the Company's acquisition of Pac Rim.
Set forth below are unaudited pro forma condensed balance sheets and statements
of income, presented at June 30, 1996 and at September 30, 1996. The unaudited
pro forma combined balance sheets data assumes the acquisition of Pac Rim by the
Company took place on the date presented, and combines the Company's balance
sheet data with Pac Rim's balance sheet data on such date using the purchase
method of accounting. The unaudited pro forma statements of operations data
assumes that the acquisition of Pac Rim by the Company took place as of the
beginning of each of the periods presented using the allocation of the purchase
information calculated as of the end of such period, and combines the statement
of operations data for the Company and for Pac Rim for the year ended December
31, 1995 and for either the six-month period ended June 30, 1996 or the
nine-month period ended September 30, 1996. The June 30, 1996 presentation was
provided to the Company's shareholders in the Company's Proxy Statement, dated
November 11, 1996.
The unaudited pro forma financial information is not necessarily
indicative of future operations and should not be construed as representative
of future operations of the combined companies.
In reviewing the pro forma statements, the Company's management urges
shareholders to consider the following:
(1) Reserve Adjustment. The updated pro forma financial information
reflects a $4.5 million addition to claims and claim adjustment expenses for the
1990-1993 accident years that was recorded by Pac Rim in the third quarter of
1996. Management, in performing its due diligence and analyzing Pac Rim's
reserves, contemplated such an adjustment.
(2) Maintenance of Premium Volume. The strategic and financial benefits
expected to be realized as a result of the Company's acquisition of Pac Rim are
dependent on insurance market reception to the combination of the two companies,
and on other factors beyond the Company's control. The ability of the combined
companies to maintain an acceptable percentage of the volume of premiums
historically written by the individual companies, as well as their ability to
maintain gross margins in the face of expected price competition, is uncertain.
It is unlikely the combined entity will maintain the premium volume of the
companies as they existed independently.
(3) Realization of Cost Reductions and Cash Flow Increases. The senior
management of the Company has identified cost reductions that they believe can
be achieved. The Board of Directors of the Company took into account this
expectation in deciding to approve the acquisition of Pac Rim. There can be no
assurance that the Company will be able to realize the expected cost reductions,
or do so within any particular time frame, or to generate additional revenue to
offset any unanticipated inability to realize such expected cost reductions.
(4) Coordination of Operations. The success of the acquisition of Pac Rim
in enhancing long-term shareholder value depends in part on the ability of the
management of the Company to coordinate and integrate the operations of the
business enterprises of the Company and Pac Rim. As in every business
combination, such coordination will require the dedication of management
resources, which may temporarily divert attention from the day-to-day business
of the Company. There can be no assurance that the coordination necessary to
realize the expected benefits of the acquisition of Pac Rim will be achieved.
16
<PAGE> 17
PRO FORMA FINANCIAL INFORMATION
ACQUISITION OF PAC RIM HOLDING CORPORATION BY SUPERIOR NATIONAL INSURANCE
GROUP, INC.
PURCHASE ACCOUNTING METHOD
UNAUDITED PRO FORMA CONDENSED BALANCE SHEET
AS OF JUNE 30, 1996
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Purchase
SNIG Accounting Pro Forma
SNIG Pac Rim Adjustments Adjustments Combined
-------- -------- ----------- ----------- --------
<S> <C> <C> <C> <C> <C>
ASSETS
Investments:
Bonds and notes:
Available-for sale, at market . . $51,543 $112,277 $163,820
Equity securities, at market . . . 643 643
Funds withheld from reinsurers, at
amortized cost . . . . . . . . . 87,359 87,359
Invested cash . . . . . . . . . . . 15,198 4,777 19,975
-------- -------- -------- -------- --------
Total Investments . . . . . . . . 154,743 117,054 0 0 271,797
Cash . . . . . . . . . . . . . . . 2,290 1,493 54,070 (d) (57,100)(k) 753
Reinsurance receivables . . . . . . 32,054 4,275 36,329
Premiums receivable (less allowance
for doubtful accounts) . . . . . 15,513 13,650 29,163
Deferred policy acquisition costs . 3,062 1,241 4,303
Income taxes . . . . . . . . . . . 9,847 10,482 (139)(h) 20,190
Goodwill . . . . . . . . . . . . . -- -- 1,062 (l) 1,062
Other assets . . . . . . . . . . . 9,530 15,294 (1,265 (e) 23,109
(450 (f)
-------- -------- -------- -------- --------
Total Assets . . . . . . . . . . $227,039 $163,489 $54,070 $(57,892) $386,706
======== ======== ======== ======== ========
LIABILITIES AND SHAREHOLDERS'
EQUITY
Liabilities:
Claims and claim adjustment
expenses . . . . . . . . . . . . $122,650 $90,709 $213,359
Unearned premiums . . . . . . . . . 9,633 5,586 15,219
Long-term debt - Imperial Bank . . 7,930 (7,930)(a)
Debentures payable . . . . . . . . 18,769 (18,769)(g) 0
Term loan - The Chase Manhattan
Bank . . . . . . . . . . . . . . 44,000 (b) 44,000
Policyholder dividends . . . . . . 6,187 233 6,420
Accounts payable and other
liabilities . . . . . . . . . . . 14,436 6,369 2,700 (i) 23,505
-------- -------- -------- -------- --------
Total Liabilities . . . . . . . . 160,836 121,666 36,070 (16,069) 302,503
Preferred securities issued by
affiliate; authorized 1,100,000
shares: issued and outstanding
966,860 shares in 1996 . . . . . 22,272 22,272
Shareholders' Equity:
Common stock and additional paid-
in-capital . . . . . . . . . . . . 15,943 29,719 18,000 (c) (29,719)(j) 33,943
Unrealized (loss) on investments . (584) (270) 270 (j) (584)
Paid in capital - warrants . . . . 2,206 1,800 (1,800)(j) 2,206
Retained earnings . . . . . . . . . 26,366 10,574 (10,574)(j) 26,366
-------- -------- -------- -------- --------
Total Shareholders' Equity . . . 43,931 41,823 18,000 (41,823) 61,931
-------- -------- -------- -------- --------
Total Liabilities and
Shareholders' Equity . . . . . . $227,039 $163,489 $54,070 $(57,892) $386,706
======== ======== ======== ======== ========
</TABLE>
See accompanying explanatory notes to pro forma financial statements.
17
<PAGE> 18
PRO FORMA FINANCIAL INFORMATION
ACQUISITION OF PAC RIM HOLDING CORPORATION BY SUPERIOR NATIONAL INSURANCE
GROUP, INC.
PURCHASE ACCOUNTING METHOD
UNAUDITED PRO FORMA CONDENSED BALANCE SHEET
AS OF SEPTEMBER 30, 1996
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Purchase
SNIG Accounting Pro Forma
SNIG Pac Rim Adjustments Adjustments Combined
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
ASSETS
Investments:
Bonds and notes:
Available-for-sale, at market $ 35,608 $ 110,136 $ 145,744
Equity securities, at market 769 - 769
Funds withheld from reinsurers, at amortized 79,469 - 79,469
cost
Invested cash 33,748 2,405 36,153
----------- ----------- ----------- ----------- -----------
Total Investments 149,594 112,541 - - 262,135
Cash 2,332 732 54,370 (d) (57,100) (k) 334
Reinsurance receivables 38,217 4,076 42,293
Premiums receivable (less allowance for
doubtful accounts) 15,371 21,204 36,575
Deferred policy acquisition cost 3,120 1,255 4,375
Income taxes 9,536 9,660 (109) (h) 19,087
Goodwill - - 5,998 (l) 5,998
Other assets 9,924 12,995 (1,164) (e) 21,305
(450) (f)
----------- ----------- ----------- ----------- -----------
Total Assets $ 228,094 $ 162,463 $ 54,370 $ (52,825) $ 392,102
=========== =========== =========== =========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Claims and claim adjustment expenses $ 113,539 $ 92,517 $ 206,056
Unearned premiums 9,808 7,088 16,896
Long-term debt - Imperial Bank 7,630 (7,630) (a) -
Debentures payable 18,854 (18,854) (g) -
Term loan - The Chase Manhattan Bank 44,000 (b) 44,000
Policyholder dividends 4,517 247 4,764
Accounts payable and other liabilities 24,576 7,086 2,700 (i) 34,362
----------- ----------- ----------- ----------- -----------
Total Liabilities 160,070 125,792 36,370 (16,154) (306,078)
Preferred securities issued by affiliate;
authorized 1,100,000 shares: issued
and outstanding 966,860 shares in 1996 22,921 22,921
Shareholders' Equity:
Common stock and additional paid-in-capital 15,956 29,719 18,000 (c) (29,719) (j) 33,956
Unrealized (loss) on investments (137) (211) 211 (j) (137)
Paid in capital - warrants 2,206 1,800 (1,800) (j) 2,206
Retained earnings 27,078 5,363 (5,363) (j) 27,078
----------- ----------- ----------- ----------- -----------
Total Shareholders' Equity 45,103 36,671 18,000 (36,671) 63,103
----------- ----------- ----------- ----------- -----------
Total Liabilities and Shareholders' Equity $ 228,094 $ 162,463 $ 54,370 $ (52,825) $ 392,102
=========== =========== =========== =========== ===========
</TABLE>
See accompanying notes to pro forma financial statements.
18
<PAGE> 19
PRO FORMA FINANCIAL INFORMATION
ACQUISITION OF PAC RIM HOLDING CORPORATION BY SUPERIOR NATIONAL INSURANCE
GROUP, INC.
PURCHASE ACCOUNTING METHOD
UNAUDITED PRO FORMA CONDENSED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Year Ended December 31, 1995 Six Months Ended June 30, 1996
--------------------------------------------- ------------------------------------------------
Pro
Pro Forma Forma Pro Forma Pro Forma
SNIG(1) Pac Rim(1) Adjustments Combined SNIG Pac Rim Adjustment Combined
------ --------- ----------- -------- ---- ------- ---------- --------
Inc. (Decr) Inc. (Decr)
(In thousands, except for share and per share amounts)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
REVENUES:
Net premiums earned . . $89,735 $76,016 $165,751 $43,033 41,259 $84,292
Net investment income
and capital gains . . 9,784 8,542 -- 18,326 4,265 3,696 7,961
-------- -------- -------- -------- -------- --------
Total Revenues . . . 99,519 84,558 184,077 47,298 44,955 92,253
EXPENSES:
Claims and claim
adjustment expenses,
net of reinsurance . 56,605 50,957 107,562 22,600 31,132 53,732
Underwriting and
general and
administrative
expenses . . . . . . 27,348 30,309 57,657 18,246 13,424 31,670
Policyholder dividends (5,742) 132 (5,610) (1,406) (141) (1,547)
Goodwill amortization . -- -- 39(a) 39 -- -- 20 (a) 20
Interest expense . . . 9,619 2,306 (2,306)(b) 12,329 4,796 1,165 1,165)(b) 6,111
(800)(c) (319)(c)
3,510(d) 1,634 (d)
-------- -------- -------- -------- -------- -------- -------- --------
TOTAL EXPENSES . . . 87,830 83,704 443 171,977 44,236 45,580 170 89,986
-------- -------- -------- -------- -------- -------- -------- --------
Income before income
taxes, preferred
securities dividends
and accretion,
discontinued
operations,
extraordinary items,
and cumulative effect
of change in
accounting for income
taxes . . . . . . . . 11,689 854 (443) 12,100 3,062 (625) (170) 2,267
Income tax expense
(benefit) . . . . . . (12) 279 (151)(e) 116 1,048 (185) (58)(e) 805
Income (loss) before
preferred securities
dividends and
accretion,
discontinued
operations,
extraordinary items,
and cumulative effect
of change in
accounting for income
taxes . . . . . . . . 11,701 575 (292) 11,984 2,014 (440) (112) 1,462
Preferred securities
dividends and
accretion, net of
income tax benefit . . (1,488) -- -- (1,488) (810) -- -- (810)
-------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) from
continuing operations $10,213 $575 $(292) $10,496 $1,204 $(440) $(112) $652
======== ======== ======== ======== ======== ======== ======== ========
Per common share:
Income (loss) from
continuing operations $2.98 $0.06 $1.51 $0.27 $(0.05) $0.10
Weighted average shares
outstanding . . . . . 3,430,373 9,528,000 7,103,711 5,318,118 9,528,000 7,236,211
</TABLE>
(1) Derived from audited financial statements.
See accompanying explanatory notes to pro forma financial statements.
19
<PAGE> 20
PRO FORMA FINANCIAL INFORMATION
ACQUISITION OF PAC RIM HOLDING CORPORATION BY SUPERIOR NATIONAL INSURANCE
GROUP, INC.
PURCHASE ACCOUNTING METHOD
UNAUDITED PRO FORMA CONDENSED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995 NINE MONTHS ENDED SEPTEMBER 30, 1996
-------------------------------------------- --------------------------------------------
PRO FORMA PRO FORMA
ADJUST- PRO FORMA ADJUST- PRO FORMA
SNIG(1) PAC RIM(1) MENTS COMBINED SNIG PAC RIM MENT COMBINED
------- ---------- --------- --------- ---- ------- --------- ---------
INC.(DECR) INC.(DECR)
(In thousands, except for share and per share amounts)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
REVENUES:
Net premiums earned 89,735 76,016 165,751 66,040 63,415 129,455
Net investment income and
capital gains 9,784 8,542 18,326 6,394 5,597 11,991
---------- ---------- ------ ---------- ---------- ---------- ------ ----------
Total Revenues 99,519 84,558 184,077 72,434 69,012 141,446
EXPENSES:
Claims and claim adjustment
expenses, net of reinsurance 56,605 50,957 107,562 36,801 51,886 88,687
Underwriting and general and
administrative expenses 27,348 30,309 57,657 26,330 20,551 46,881
Policyholder dividends (5,742) 132 (5,610) (2,121) (127) (2,248)
Goodwill amortization - - 222 (a) 222 - - 167 (a) 167
Interest expense 9,619 2,306 (2,306) (b) 12,329 6,922 1,752 (1,752) (b) 8,900
(800) (c) (475) (c)
3,510 (d) 2,453 (d)
---------- ---------- ------ ---------- ---------- ---------- ------ ----------
TOTAL EXPENSES 87,830 83,704 626 172,160 67,932 74,062 393 142,387
---------- ---------- ------ ---------- ---------- ---------- ------ ----------
Income before income taxes,
preferred securities
dividends and accretion,
discontinued operations,
extraordinary items, and
cumulative effect of change in
accounting for income taxes 11,689 854 (626) 11,917 4,502 (5,050) (393) (941)
Income tax expense (benefit) (12) 279 (213) (e) 54 1,348 606 (134) (e) 1,820
---------- ---------- ------ ---------- ---------- ---------- ------ ----------
Income (loss) before
preferred securities
dividends and accretion,
discontinued operations,
extraordinary items, and
cumulative effect of
change in accounting for
income taxes 11,701 575 (413) 11,863 3,154 (5,656) (259) (2,761)
Preferred securities
dividends and accretion,
net of income tax benefit (1,488) - - (1,488) (1,238) - (1,238)
---------- ---------- ------ ---------- ---------- ---------- ------ ----------
Net income (loss) from
continuing operations $ 10,213 $575 ($413) ($10,375) $1,916 ($5,656) ($259) ($3,999)
========== ========== ====== ========== ========== ========== ====== ==========
Per common share:
Income (loss) from
continuing operations $ 2.98 $ 0.06 $1.51 $0.41 ($0.59) ($0.69)
Weighted average shares
outstanding 3,430,373 9,528,200 7,103,711 5,316,873 9,528,200 5,827,989
</TABLE>
(1) Derived from audited financial statements.
See accompanying explanatory notes to pro forma financial statements.
20
<PAGE> 21
EXPLANATORY NOTES: DESCRIPTION OF PRO FORMA ADJUSTMENTS
1) The following descriptions reference the adjustments as labeled on the
unaudited pro forma condensed balance sheets as of June 30, 1996 and
September 30, 1996:
(a) Adjustment to long-term debt to reflect the redemption of
SNIG's outstanding loan with Imperial Bank.
(b) Adjustment to senior debt payable to reflect a $44 million
credit facility from one or more banks including Chase
(the "Term Loan").
(c) Adjustment to reflect the shares of the Company's Common Stock
to be issued and sold (the "Newly Issued Stock") pursuant to
the terms of the Stock Purchase Agreement (as defined in "Item
6. Exhibits and Reports on Form 8-K," below).
(d) The increase in cash represents total funds provided by the
$62 million obtained from the Term Loan and the Newly Issued
Stock, less the repayment of $7.630 million of Imperial Bank
debt.
(e) Adjustment to other assets to write-off the unamortized
debenture issuance costs resulting from the redemption of Pac
Rim's Series A Convertible Debentures (the "Convertible
Debentures").
(f) Adjustment to other assets reflects a netting of receivables
due from the Chief Executive Officer of Pac Rim against
associated severance payments.
(g) Adjustment to debentures payable to reflect the redemption of
the Convertible Debentures.
(h) Adjustment to deferred tax assets to write-off the deferred
tax asset relating to the unrealized loss on investments.
(i) Adjustment to accounts payable and other liabilities to
reflect assumption of amounts payable to officers of Pac Rim,
gross of the receivable referred to in (f) above.
(j) Adjustment to common stock and additional paid-in-capital to
reflect the elimination of Pac Rim stockholder equity interest.
(k) Reduction of cash to reflect the following items: i) purchase
of Pac Rim Common Stock for $28.6 million, ii) redemption of
the Pac Rim Series 1, 2 and 3 Detachable Warrants and options
for $3.5 million, iii) redemption of the Convertible
Debentures for $20.0 million, and iv) direct costs of the
acquisition of Pac Rim of $5 million.
(l) The excess of the purchase price paid for Pac Rim over the
amounts assigned to identifiable assets acquired less
liabilities assumed is recorded as goodwill.
2) The following descriptions reference the adjustments as labeled on the
unaudited pro forma condensed statements of operations for the year
ended December 31, 1995 and either the six months ended June 30, 1996
or the nine months ended September 30, 1996:
(a) Adjustment represents amortization of goodwill on a straight
line basis over an estimated 27-year period.
(b) Adjustment represents the elimination of interest expense on
the Convertible Debentures payable as if the redemption of the
Convertible Debentures had been effective on January 1, 1995.
(c) Adjustment represents the elimination of interest expense on
the Company's term loan with Imperial Bank as if the repayment
of such term loan had been effective on January 1, 1995.
(d) Adjustment represents the interest expense on the Company's
Term Loan as if the Term Loan had been effective on January 1,
1995.
(e) Adjustment represents the tax effect of pro forma adjustments
at an effective tax rate of 34%.
21
<PAGE> 22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit Description
------- -----------
[S] [C]
2 Agreement and Plan of Merger dated as of
September 17, 1996 among the Company,
Pac Rim and SNTL Acquisition Corp.*
10.29 Stock Purchase Agreement dated as of September
17, 1996 among the Company, Insurance
Partners, L.P., Insurance Partners Offshore
(Bermuda), L.P., TJS Partners, L.P., and
certain members of the Company's management,
as amended (the "Stock Purchase Agreement").**
27 Financial Data Schedule
*Previously filed as Exhibit 2 to the Company's Schedule 13D,
filed with the Securities and Exchange Commission ("SEC") on
September 26, 1996, and amended by the Company's Amendment No.1
to Schedule 13D, filed with the SEC on October 24, 1996, and
incorporated herein by reference.
**Previously filed as Exhibit G to Exhibit 2 to the Company's
Schedule 13D, filed with the SEC on September 26, 1996, and
amended by the Company's Amendment No. 1 to Schedule 13D, filed
with the SEC on October 24, 1996, and incorporated herein by
reference.
(b) Reports on Form 8-K:
On September 24, 1996, the Company filed a Current Report on
Form 8-K (File No. 0-25984), under "Item 5. Other Events," in
order to report the adoption by the Company's Board of
Directors of resolutions in connection with the preservation of
the full availability of the Company's net operating loss
carryforwards under Section 382 of the Internal Revenue Code of
1986, as amended ("Section 382"), which resolutions contemplate
either the amending of the Company's Articles of Incorporation
or the Company's reincorporation in the State of Delaware, in
order to prohibit an "ownership change," as defined in Section
382. Also reported in such Form 8-K under "Item 7. Financial
Statements and Exhibits" was the delivery by the Company to its
5% shareholders of a letter informing them of the Section 382
issues discussed above, a copy of which was attached thereto as
an exhibit.
22
<PAGE> 23
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: November 19, 1996 SUPERIOR NATIONAL INSURANCE GROUP, INC.
By /s/ J. Chris Seaman
----------------------------
Name: J. Chris Seaman
Title: Executive Vice President and
Chief Financial Officer
23
<PAGE> 24
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Description Page
- ------- ----------- ----
<S> <C>
2 Agreement and Plan of Merger dated as of
September 17, 1996 among the Company, Pac Rim
and SNTL Acquisition Corp. *
10.29 Stock Purchase Agreement dated as of
September 17, 1996 among the Company, Insurance
Partners, L.P., Insurance Partners Offshore
(Bermuda), L.P., TJS Partners, L.P., and
certain members of the Company's management,
as amended. **
27 Financial Data Schedule
</TABLE>
*Previously filed as Exhibit 2 to the Company's Schedule 13D,
filed with the SEC on September 26, 1996, and amended by the
Company's Amendment No. 1 to Schedule 13D, filed with the SEC
on October 24, 1996, and incorporated herein by reference.
**Previously filed as Exhibit G to Exhibit 2 to the Company's
Schedule 13D, filed with the SEC on September 26, 1996, and
amended by the Company's Amendment No. 1 to Schedule 13D, filed
with the SEC on October 24, 1996, and incorporated herein by
reference.
24
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<DEBT-HELD-FOR-SALE> 35,608
<DEBT-CARRYING-VALUE> 79,018
<DEBT-MARKET-VALUE> 77,505
<EQUITIES> 769
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 149,594
<CASH> 2,332
<RECOVER-REINSURE> 54
<DEFERRED-ACQUISITION> 3,120
<TOTAL-ASSETS> 228,094
<POLICY-LOSSES> 113,539
<UNEARNED-PREMIUMS> 9,808
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 4,517
<NOTES-PAYABLE> 7,630
22,921
0
<COMMON> 15,956
<OTHER-SE> 29,147
<TOTAL-LIABILITY-AND-EQUITY> 228,094
66,040
<INVESTMENT-INCOME> 6,361
<INVESTMENT-GAINS> 33
<OTHER-INCOME> 0
<BENEFITS> 36,801
<UNDERWRITING-AMORTIZATION> 12,248
<UNDERWRITING-OTHER> 14,298
<INCOME-PRETAX> 4,502
<INCOME-TAX> 1,348
<INCOME-CONTINUING> 3,154
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,916
<EPS-PRIMARY> 0
<EPS-DILUTED> 0.41
<RESERVE-OPEN> 140,774
<PROVISION-CURRENT> 43,988
<PROVISION-PRIOR> (6,020)
<PAYMENTS-CURRENT> 12,488
<PAYMENTS-PRIOR> 52,715
<RESERVE-CLOSE> 113,539
<CUMULATIVE-DEFICIENCY> (6,020)
</TABLE>
