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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934..........................FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
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)
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DELAWARE 95-4610936
(STATE OF INCORPORATION) (I.R.S. EMPLOYER
IDENTIFICATION NO.)
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26601 AGOURA ROAD, CALABASAS, CA 91302
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
TELEPHONE: (818)880-1600
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
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TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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Common Stock, $0.01 Par Value Registered -- The Nasdaq National Market
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulations S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the Common Stock of the registrant held by
non-affiliates of the registrant on March 25, 1998, based on the closing price
of $17.875 per share of the Common Stock on The Nasdaq National Market on such
date was $60,514,829.
The number of shares of the registrant's Common Stock outstanding as of March 1,
1998 was 5,962,766.
DOCUMENTS INCORPORATED BY REFERENCE
None.
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SUPERIOR NATIONAL INSURANCE GROUP, INC.
INDEX TO FORM 10-K
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PART I PAGE
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ITEM 1. Business.................................................... 1
ITEM 2. Business Properties......................................... 26
ITEM 3. Legal Proceedings........................................... 26
ITEM 4. Submission of Matters to a Vote of Security Holders......... 26
PART II
ITEM 5. Market Price of and Dividends on the Company's Common Equity
and Related Stockholder Matters........................... 27
ITEM 6. Selected Financial Data..................................... 29
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 32
ITEM 8. Financial Statements and Supplementary Data................. F-1
ITEM 9. Changes in and Disagreements with Accountants on Equity and
Related Accounting and Financial Disclosure............... 38
PART III
ITEM 10. Directors and Executive Officers of the Company............. 39
ITEM 11. Executive Compensation...................................... 44
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 48
ITEM 13. Certain Relationships and Related Transactions.............. 54
PART IV
ITEM 14. Exhibits, Financial Statements Schedules, and Reports on
Form 8-K.................................................. 57
Signatures.................................................. 63
Glossary of Terms........................................... 64
Index to Consolidated Financial Statements.................. F-1
Financial Statements and Supplementary Data................. F-1
Independant Auditors' Report................................ F-2
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PART 1
Certain statements in this Annual Report on Form 10-K are forward-looking
and are identified by the use of phrases such as "intended," "will be
positioned," "expects," is or are "expected," "anticipates," and "anticipated."
These forward-looking statements are based on the Company's current
expectations. To the extent any of the information contained herein constitutes
a "forward-looking statement" as defined in Section 27 A(i)(1) of the Securities
Act, the factors set forth under " -- Risk Factors" are cautionary statements
identifying important factors that could cause results to differ materially from
those in the forward-looking statement. Further, see Glossary of Terms.
ITEM 1. BUSINESS
OVERVIEW
Superior National Insurance Group, Inc. ("SNIG") is a holding company that,
through its wholly-owned subsidiaries, Superior National Insurance Company
("SNIC") and Superior Pacific Casualty Company ("SPCC"), underwrites and markets
workers' compensation insurance principally in the State of California and,
until September 30, 1993, was engaged in the underwriting and marketing of
commercial property and casualty ("P&C") insurance. The Company was incorporated
in California in March 1985 under the name Coastal Holdings, Ltd. SNIC and SPCC
conduct business under the "Superior Pacific" trade name. Unless the context
indicates otherwise, "Superior Pacific," as used herein, refers to SNIC and SPCC
and their combined operations from April 1997 to the present, and refers only to
SNIC and its operations for all prior periods. The "Company" refers to SNIG and
its subsidiaries.
In April 1997, SNIG acquired Pac Rim Holding Corporation ("Pac Rim"), the
parent company of The Pacific Rim Assurance Company (subsequently renamed
Superior Pacific Casualty Company). SPCC's Southern California operations
complement SNIC's historical focus on Central and Northern California. As a
result of the acquisition of SPCC (the "Acquisition"), the Company believes
that, excluding the California State Compensation Insurance Fund (the "State
Fund"), it is the eighth largest California workers' compensation insurer
overall, based upon 1996 direct premiums written. Pro forma for the Acquisition,
the Company would have had direct premiums written of $182.2 million and $179.7
million for the years ended December 31, 1996 and 1997, respectively.
In connection with the Acquisition, the Company agreed with the California
Department of Insurance ("DOI") that SPCC would operate in a "run-off" situation
and that all new or renewal business would be written only by SNIC. As a result,
the Company has been integrating SPCC's pre-Acquisition operations into SNIC's
operations and has substantially completed the process. The Acquisition has
enabled the Company to increase its book of California workers' compensation
business and generate significant expense savings through the consolidation of
the back office operations of the two companies.
In addition to California, Superior Pacific is also licensed to write
business in Arizona, Arkansas, Colorado, District of Columbia, Georgia, Indiana,
Iowa, Kentucky, Maryland, Mississippi, Missouri, Montana, Nevada, New Mexico,
Oregon, South Dakota, Texas, Utah, and Wyoming, but virtually all of Superior
Pacific's current premium is generated in California (94%) and Arizona (6%).
Following the Acquisition, SPCC's operations in states other than California and
Arizona were discontinued and are currently in run-off.
OPERATING STRATEGY
The Company specializes in writing workers' compensation insurance,
principally in the State of California, which allows management to respond in a
timely manner to the changing competitive and regulatory environment in the
state. The key elements of its operating strategy are as follows:
Focus on Specialized Market Segments. The Company's business focuses on
selected policy sizes and employment classifications that management believes
provide the greatest opportunity for profitability.
POLICY SIZE. The Company concentrates its marketing efforts on policies
with annual premium under $50,000, principally to avoid the extreme price
competition usually associated with larger accounts. As of
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December 31, 1997, the Company's average annual premium per policy was
approximately $8,300. In 1998, the Company initiated a program to market
coverage to selected large accounts that meet the Company's underwriting
criteria.
EMPLOYMENT CLASSIFICATIONS. While the Company underwrites many employment
classifications, it targets specific classifications that management
believes to be profitable. The Company believes that by focusing on certain
employment classifications, it can provide claim management and
standardized loss control services at a level appropriate to each
policyholder. As of December 31, 1997, five employment classifications,
made up primarily of office and clerical, hospitality, agricultural,
garment, and health care workers, represented 35% of the Company's premium
in force. The Company excludes most employment classifications that
represent historically higher risk exposure, including the manufacturing,
handling, and shipping of explosives; oil rig and derrick work; subway
construction; and navigation of marine vessels.
Underwriting Discipline. Following the advent of open rating in California
in 1995, some California insurers have reduced premium rates in order to
increase or maintain market share. The Company has not followed this practice
and has maintained consistently stringent underwriting policies in order to
maintain gross profit margins. As a result, from 1993 to 1997 the Company's
combined ratio from continuing operations has improved from 100.2% to 90.9%.
Relationship with Producers. The Company markets its insurance products
primarily through approximately 250 small to medium-sized independent insurance
agencies, referred to as "producers," most of which have an ongoing relationship
with the Company. The Company is one of the primary underwriters of workers'
compensation insurance for most of its producers. For the policy year ended
December 31, 1997, no single producer controlled more than 5.0% of premium in
force.
Data Processing Systems. The Company believes that its data processing
systems give it a significant competitive advantage by (i) enhancing the
effectiveness of its employees' underwriting, policy administration, and claims
activities, (ii) providing detailed, real-time and near real-time information to
management for control and administration purposes, and (iii) providing
marketing benefits through improved customer service.
COMPANY STRUCTURE
SNIG has two direct, wholly-owned active subsidiaries: Superior Pacific
Insurance Group, Inc. ("SPIG") and Superior National Capital Trust I (the
"Trust"), a statutory business trust created under the laws of the State of
Delaware. SPIG has four, direct, wholly-owned active subsidiaries: SNIC, SPCC,
InfoNet Management Systems, Inc. ("InfoNet"), and Superior (Bermuda) Ltd.
("SBL"). InfoNet provides data processing purchasing services to SNIG and its
subsidiaries. SBL was formed in September 1995 to facilitate the management of
the run-off of SNIC's P&C business.
The Trust was formed by the Company in December 1997 and exists solely for
the purpose of issuing 10 3/4% Trust Preferred Securities (the "Trust Preferred
Securities"), having an aggregate liquidation amount of $105 million, and
investing the proceeds thereof in an equivalent amount of 10 3/4% Senior
Subordinated Notes due 2017 of the Company (the "Senior Subordinated Notes").
The Company owns directly all of the common securities issued by the Trust,
which it purchased for an aggregate consideration of approximately $3.25
million. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."
SNIC's only subsidiary is wholly owned Western Select Service Corp., which
currently provides vocational rehabilitation, legal, paralegal, and other
services to SNIC and SPCC. SPCC has no active subsidiaries.
CALIFORNIA WORKERS' COMPENSATION MARKET
Workers' Compensation. Workers' compensation is a no-fault statutory
system under which an employer is required to provide its employees with medical
care and other specified benefits for work-related injuries and diseases. There
are four types of benefits payable under workers' compensation policies:
disability,
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vocational rehabilitation, medical and death benefits. The amount of benefits
payable for various types of claims are established by statute and vary with the
nature, severity of the injury or disease, wages, occupation and age of the
employee. While no dollar limitations are set for medical benefits and dollar
limitations apply only under certain circumstances to vocational rehabilitation
benefits, reinsurance typically covers liability in excess of a specified dollar
amount.
California Marketplace. California is the country's largest workers'
compensation insurance market, with total direct premiums written of $5.0
billion in 1996. The California market is composed of (i) the State Fund, (ii)
companies that write workers' compensation insurance in California but have
significant writings in other lines of business and/or in other states
("Multi-Line, Multi-State Writers"), and (iii) the Company, which is the one
private sector company that writes exclusively workers' compensation insurance
specifically focused in California. The State Fund, which is obligated to write
workers' compensation insurance for any applicant, including those turned down
by the private sector carriers, is the largest underwriter of workers'
compensation insurance in California, accounting for approximately 19% of the
direct premiums written in California in 1996. Because the State Fund must
accept all risks, its combined ratios have historically been much higher than
those of the private sector carriers. Although the State Fund regularly competes
with the Company for profitable underwriting business, the Company views the
State Fund's role as the insurer of last resort to be a significant benefit
because it eliminates the need to create an assigned risk plan in which the
Company and other insurers conducting business in California would be required
to participate.
Pricing. Prior to January 1, 1995, the DOI set minimum premium rates for
workers' compensation insurance in order to provide a stable environment for the
pricing of such insurance. On January 1, 1995, the State of California formally
converted to a system of "open rating" for workers' compensation insurance
written within the state. Insurance companies now file and use their own
actuarially defensible rates. Following the introduction of open rating, total
direct written premiums in the California market decreased from $9.0 billion in
1993 to $5.0 billion in 1996 as many carriers engaged in price competition.
Under open rating, the DOI sets "pure premium" (effectively, the estimated
claim and allocated claim adjustment expense) rates for each employment
classification. Carriers then apply their own multipliers to the pure premium
rate to adjust for that carrier's anticipated unallocated claim adjustment and
underwriting expenses. These rates are then subject to further adjustment on a
policyholder by policyholder basis to account for historical loss experience,
the presence of stricter safety programs, differing dividend and commission
plans, and other factors.
Recent Developments. While competitive pressures in the California's
workers' compensation market increased with the implementation of open rating in
January 1995, certain fundamentals of the workers' compensation market have
recently improved. In 1996, the total direct workers' compensation premiums
written in California leveled out at approximately $5.0 billion as compared to
$9.0 billion in 1993, as the market began to experience rate stabilization. This
trend has continued into 1997, as demonstrated by a slight improvement in
premium pricing of 0.5% for the year ended December 31, 1997 over 1996.
Additionally, anti-fraud legislation passed by the State of California in 1993
continues to have a positive effect on the market's losses by controlling
fraudulent claims and medical and legal expense levels. These improvements have
resulted in a reduction in the frequency of claims in the California workers'
compensation market. However, during 1997, the Company has recognized an
increase in claims severity for injuries sustained in 1995 and thereafter.
Management has taken steps to address this issue by undertaking the Claims
Severity Management Program. See "-- Claims Severity Management Program" and "--
Claim and Claim Adjustment Expense Reserves" and "Risk Factors -- Uncertainty
Associated with Estimating Reserves for Unpaid Claim and Claim Adjustment
Expenses."
Superior Pacific Within the California Workers' Compensation Market. The
Company believes that it is better positioned than its competitors to compete
successfully in the post-open rating California workers' compensation insurance
market. Because the Company specializes in underwriting workers' compensation
insurance in California, the Company believes that it can be more responsive to
the changing competitive and regulatory environment in California than the
Multi-Line, Multi-State Writers for which California workers' compensation
insurance is one of many lines of business written, representing a smaller
portion of their total
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premium. In addition, Multi-Line, Multi-State Writers typically price and sell
workers' compensation insurance as part of a package policy which may also
include various forms of other liability and health insurance. The Company sells
strictly workers' compensation insurance and, therefore, prices and underwrites
its policies specifically on that basis.
MARKETING
Superior Pacific primarily markets its insurance products through
approximately 250 small to medium-sized producers located throughout California
and Arizona, most of which have an ongoing relationship with the Company's
executives. Because these producers also represent one or more competing
insurance companies, Superior Pacific views the producers as its marketing
target and delivers service the Company believes surpasses normal industry
levels. Superior Pacific's percentage of business with each of its producers, in
terms of premium volume, has a significant effect on a producer's efforts,
because management believes companies that represent a significant volume of a
producer's business typically receive the highest quality business. The Company
is one of the primary underwriters of workers' compensation insurance for most
of its producers. During the year ended December 31, 1997, no single producer
controlled more than 5.0% of premium in force.
While the Company's principal marketing strategy is to meet the business
needs of Superior Pacific's producers by providing the insurance coverage and
services needed by their customers, the Company concentrates its marketing
efforts on policies with annual premium under $50,000, principally to avoid the
extreme price competition usually associated with larger insureds. As of
December 31, 1997, the Company's average annual premium per policy was
approximately $8,300. In 1998, the Company initiated a program to market
coverage to selected large accounts that meet the Company's underwriting
criteria.
Approximately 65.7% of the Company's premium in force is concentrated in
400 non-group policies and 55 group programs that each provide annual premium in
excess of $50,000. The average annual premium volume generated by each of
Superior Pacific's group programs is approximately $820,000 and in the aggregate
these programs represent 31.1% of the Company's premium in force. Because
policies issued through group programs reflect some of the attributes of smaller
non-group policies, marketing workers' compensation insurance through such
programs to reach smaller policyholders is a means by which the Company can
implement its strategy to underwrite smaller policies. For example, individual
policies within a group typically possess rate adequacy associated with small
non-group accounts. Moreover, renewal rates within a group are generally
superior to non-group business. However, group programs, because of their
overall premium, also reflect some of the attributes of large non-group
policies, mainly their greater vulnerability to price competition than the
individual accounts within the group.
The average size of Superior Pacific's non-group policies that exceed
$50,000 in annual premium is approximately $129,000 and in the aggregate
represent 34.6% of premium in force. Most of these policies were obtained by the
Company upon its acquisition of Pac Rim. The Company's strategy is to maintain
adequate pricing on accounts regardless of their size, and in pursuing this
strategy the Company has not been able to retain a portion of these large
non-group policies. However, the Company expects to replace many of them with
new, smaller accounts through its newly acquired relationships with
policyholders and producers previously associated with Pac Rim, and with larger
accounts (where adequate pricing can be obtained) through the Company's new
large account marketing program.
Superior Pacific closely monitors its producers through its on-line
management information systems, with special attention given to the volume and
profitability of business written through Superior Pacific. Relationships with
producers who consistently write unprofitable business, or do not meet the
minimum guideline of annual premium per year, may be terminated. Superior
Pacific believes that by continually monitoring and improving the quality of the
business acquired through its producers, long-term profitability will be
enhanced. See "-- Information Services."
The marketing staff, along with the branch office managers and the
underwriting, loss control, and regional claim staffs, work closely with
producers and frequently make joint presentations with producers to
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potential workers' compensation policyholders. Superior Pacific conducts its
marketing by territory to enable its marketing representatives to better address
the specific types of accounts located in each region.
Producer commissions are generally determined by negotiation and are
dependent on the size and profit potential of the producer's accounts. Superior
Pacific's average direct commission rate was 11.1% for the years ended December
31, 1997, 1996, and 12.0% in 1995. The Company believes the stabilization in the
average direct commission rate for the year ended December 31, 1997, was due
primarily to a combination of firming prices and a greater use by larger
policyholders of fee-based arrangements (as opposed to traditional commission
arrangements) with their insurance brokers. Superior Pacific's producers are not
permitted to bind Superior Pacific with respect to any account. All new and
renewal policyholder applications must be submitted to Superior Pacific for
approval. Superior Pacific is not committed to accept a fixed portion of any
producer's business.
UNDERWRITING
Because the types of accounts that Superior Pacific insures vary among
different geographic regions, Superior Pacific conducts its underwriting
activities through branch offices that are focused on the local economies. While
Superior Pacific underwrites over 400 of the approximately 500 employment
classifications established by the Workers' Compensation Insurance Bureau (the
"WCIRB"), it targets specific classifications that management believes to be
profitable. The Company believes that by focusing on certain employment
classifications, it can provide claim management and standardized loss control
services at a level appropriate to each policyholder. For the year ended
December 31, 1997, four employment classifications, made up primarily of office
and clerical, hospitality, agricultural, garment, and health care workers,
represented 35% of Superior Pacific's premium in force. The Company excludes
most employment classifications that represent historically higher risk
exposure, including the manufacturing, handling, and shipping of explosives; oil
rig and derrick work; subway construction; and navigation of marine vessels.
Classifications that require the approval of Superior Pacific's principal
underwriting officer include those that represent potential exclusions from
Superior Pacific's reinsurance treaties, unusual hazards or catastrophic
exposures such as taxicab fleets, carnivals, ski resorts, and detective
agencies. Certain risks, such as the transportation of groups of employees, are
generally ceded to reinsurers under separate reinsurance agreements.
Prior to insuring an account, Superior Pacific's underwriting department
reviews, inter alia, the employer's prior loss experience and safety record,
premium payment and credit history, operations, geographic location, and
employment classifications. Superior Pacific verifies employment classifications
principally through information provided by the WCIRB and, in many instances,
through its own on-site surveys of the employer's place of business.
The Company's underwriting system is a fully-integrated rating, quoting,
and policy issuance system for use both internally and remotely from producers'
offices. The system contains edit and blocking features that prohibit
underwriters from issuing policies associated with business that is deemed
inappropriate or undesirable by management, or that may be inappropriately
priced. See " -- Information Services."
SPCC historically underwrote larger accounts than SNIC, and in a more
limited range of risk classification codes. Since SPCC's acquisition, Superior
Pacific has been re-underwriting SPCC's book of business at policy renewal dates
in conformity with SNIC's historic underwriting standards and pricing
guidelines. SPCC's average policy size has declined significantly, standing at
approximately $17,000 for the policy year ended December 31, 1997, versus
approximately $20,300 for the policy year ended December 31, 1996. Management
believes that the re-underwriting of SPCC's business will produce a new book of
business mirroring SNIC's historical book of business, both as to size and range
of risk classifications, by the end of 1998.
Virtually all of SPCC's business is located in urban and suburban Southern
California. Until 1993, claim experience in Southern California was more
volatile and less favorable than the remainder of the state. Further, since open
rating began in 1995, the relatively large accounts that SPCC has underwritten
have been subject to extreme price competition consequently, the nature of
SPCC's historical book of business may
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cause historical claim reserves to be subject to more uncertainty versus claim
reserves established on prospective business.
LOSS CONTROL
In addition to its responsibility for risk evaluation as part of the
underwriting process, Superior Pacific's loss control department may assist
policyholders in developing and maintaining safety programs and procedures to
minimize on-the-job injuries and health hazards. After analyzing the
policyholder's loss profile, Superior Pacific's loss control consultants will
help develop a loss control program and establish accident reporting and claim
follow-up activities for the policyholder. Superior Pacific's loss control
personnel may also consult with policyholder management about safety and health
issues, as well as about the effectiveness of the policyholder's loss prevention
procedures.
CLAIMS SEVERITY MANAGEMENT PROGRAM
Effective December 31, 1997, the Company entered into agreements with Risk
Entire Management Limited ("REM") and Zurich Reinsurance (North America), Inc.
("ZRNA"), affiliates of Zurich, to provide claims management services ("Claims
Severity Management Program" or "CSMP"). Under the CSMP, REM acting as a third
party administrator ("TPA"), will provide claim processing and management
services to Superior Pacific, and ZRNA will provide Superior with protection
predicated on REM's ability to reduce Superior Pacific's severity. The Company
may terminate the contract with six months notice after the initial three year
term of the contract, with a penalty that will not exceed $250,000 plus REM's
reasonable expenses to unwind the agreement.
REM in its capacity of a TPA will provide certain claims management
services, while the Company will provide claims facilities and data processing
systems. The terms of the agreement bind REM to certain operational restrictions
and performance standards designed to assure quality claims administration. The
Company believes that combining REM's claims management techniques with the
Company's claims processing systems should produce material improvements in the
Company's claims severity, more than off-setting the cost of such services. The
Company believes the Claims Severity Management Program will reduce the
Company's ultimate severity with favorable cost-benefit trade-offs.
Under the agreement with ZRNA, ZRNA will credit the Company's direct claim
costs, up to an aggregate of $30 million to the extent that REM is unsuccessful
in minimizing the claims severity. The Company's open indemnity claims severity
on average through 1997 exceeds $39,912.
The Company and REM will continue to work closely with policyholders to
return injured workers to the job quickly as is medically appropriate. The
Company and REM intend to continue to maintain the Company's four full service
claim service offices (CSO) in California located in Woodland Hills, Fresno,
Pleasanton and Sacramento. Additionally, the Company maintains CSO in Phoenix,
Arizona. Each CSO is managed by a claims manager. The claims technical staffs
are organized into units with, generally, one supervisor supervising four claims
examiners and two claims assistance per unit.
The Company's Claims Department relies extensively on the Company's data
processing systems. The Company's data processing systems were developed
internally through a joint effort of the Claim and Management Information
Systems departments' personnel with three goals in mind: capture timely and
meaningful data; reduce the possibility of human error through a series of
system prompts and edit checks; and the automation of manual functions. An
additional benefit of the claims system is the increased productivity, as a
result of claims examiners handling larger case loads.
Superior Pacific's claims handling also includes a specialized subrogation
function. Claims examiners are responsible for the identification of potential
recoupments from third parties responsible for a work-related accident, after
which the examiner notifies a subrogation specialist of this potential. The
subrogation specialist determines whether a subrogation situation exists, and,
if so, assumes responsibility for all aspects of subrogation to finalization.
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CLAIM AND CLAIM ADJUSTMENT EXPENSE RESERVES
Several years or more may elapse between the occurrence of a workers'
compensation loss, the reporting of the loss, and final payment of the loss.
Claim and claim adjustment expense reserves are estimates of what an insurer
expects to pay claimants. Superior Pacific is required to maintain reserves for
payment of estimated claim and claim adjustment expense for both reported claims
and claims which have been incurred but not reported ("IBNR"). Superior
Pacific's ultimate liability may be materially more or less than current reserve
estimates.
Reserves for reported claims are established on a case-by-case basis.
Case-by-case reserve amounts are determined by claim examiners, based on the
examiner's judgment and experience, and on Superior Pacific's reserving
practices, which take into account the type of risk, the circumstances
surrounding the claim or policy provisions relating to type of loss, and
historical paid claims and claim adjustment expense data for similar claims.
Case-by-case reserves are not established for claim adjustment expense, and the
entire reserve for claim adjustment expense is established primarily based upon
the Company's historical paid data. Superior Pacific's claims department
regularly monitors reserve adequacy for claims which have occurred and been
reported to it and adjusts such reserves as necessary.
Claim and claim adjustment expense reserves for IBNR are estimated based on
many variables including historical and statistical information, inflation,
legal developments, the regulatory environment, benefit levels, economic
conditions, judicial administration of claims, general frequency and severity
trends, medical costs, and other factors affecting the adequacy of loss
reserves. See "Risk Factors -- Uncertainty Associated with Estimating Reserves
for Unpaid Claim and Claim Adjustment Expense." The senior officers of the
Company review and adjust IBNR reserves monthly.
Adjustments in aggregate reserves are reflected in the operating results of
the period during which such adjustments are made. Although claims for which
reserves are established may not be paid for several years or more, the reserves
are not discounted, except to calculate taxable income as required by the
Internal Revenue Code of 1986, as amended (the "Code").
The following table provides a reconciliation of the beginning and ending
claim and claim adjustment expense reserves for each of the years in the
three-year period ended December 31, 1997, computed in accordance with GAAP.
RECONCILIATION OF LIABILITY FOR CLAIM AND CLAIM ADJUSTMENT EXPENSE
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YEARS ENDED DECEMBER 31,
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1997 1996 1995
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(AMOUNTS IN THOUSANDS)
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Beginning reserve, gross of reinsurance.................. $115,529 $141,495 $171,258
Less: Reinsurance recoverable on unpaid losses........... 24,986 27,076 31,897
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Beginning reserve, net of reinsurance.................... 90,543 114,419 139,361
Pac Rim reserves at acquisition.......................... 104,588 -- --
Provision for net claim and claim adjustment expenses
For claims occurring in current year................... 95,826 57,614 58,842
For claims occurring in prior years.................... (5,379) (1,976) (4,872)
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Total claim and claim adjustment expenses.............. 90,447 55,638 53,970
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Payments for net claim and claim adjustment expense:
Attributable to insured events incurred in current
year................................................ (37,945) (19,816) (19,732)
Attributable to insured event incurred in prior
years............................................... (95,533) (59,698) (59,180)
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Total claim and claim adjustment expense payments...... (133,478) (79,514) (78,912)
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Ending reserves, net of reinsurance...................... 152,100 90,543 114,419
Reinsurance recoverable on unpaid losses................. 49,155 24,986 27,076
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Ending reserves, gross of reinsurance.................... $201,255 $115,529 $141,495
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During 1997, the Company continued to experience decreased frequency of
claims and at the same time experienced an increase in claims severity for
accident years 1995 and thereafter. The Company's net claim and claim adjustment
expense ratio for accident year 1997 at the end of calendar year 1997 was 68.0%,
versus 65.0% and 65.6% for accident years 1996 and 1995, at their respective
calendar year ends.
In 1997, the Company experienced approximately $5.4 million in favorable
development on net claim and claim adjustment expense reserves estimated at
December 31, 1996. This $5.4 million favorable development is the result of a
$10.8 million favorable development on ceded reserves for accident years 1996
and prior. The $10.8 million favorable development on ceded reserves is
attributable to SPCC and due to the post-acquisition review of all open claim
files and the subsequent adjustment to reserves, which caused many claims to
have incurred claim and claim adjustment expenses in excess of the retention on
SPCC's reinsurance treaties. The $10.8 million favorable development is offset
by a $5.4 million adverse development on direct reserves attributable to the
accident years 1995 and 1996. Similar adverse development due to an increase in
claims severity has been experienced throughout the California workers'
compensation industry.
In 1996, the Company experienced approximately $2.0 million in favorable
development on net claims and claim adjustment expense reserves estimated at
December 31, 1995. This $2.0 million favorable development is the result of $8.4
million in favorable development on direct reserves for accident years 1994 and
prior. The favorable development was offset in part by $4.1 million adverse
development on direct reserves for accident year 1995 accident year net claims
and claim adjustment expense ratio for accident year 1995 at the end of calendar
year 1995 was 65.6%, verses 74.6% at the end of the 1996 calendar year. Similar
adverse development has been experienced throughout the California workers'
compensation industry.
During 1995, the Company experienced approximately $8.6 million of
favorable development on direct claim and claim adjustment expense reserves
estimated at December 31, 1994. Management believes the favorable development
resulted from the Company's improved claims management controls and decreased
claim severity, particularly in the medical component of the workers'
compensation line. Similar favorable development on pre-1995 losses has been
experienced elsewhere in the California workers' compensation industry.
Offsetting the favorable direct development in large part was the re-estimation
during 1995 of reinsurance receivables recorded at December 31, 1994, from
approximately $66.2 million to approximately $59.9 million at December 31, 1995.
8
<PAGE> 11
On April 11, 1997, the Company acquired SPCC. The claim and claim
adjustment expenses related to SPCC for this analysis are reflected in the
Company's 1997 claim and claim adjustment expense balances regardless of the
year the claim was previously reported to SPCC. To the extent that claims
develop in the future or close favorably, the result will be reflected in the
calendar year development to which it relates.
The following table discloses the development of direct workers'
compensation claim and claim adjustment expense reserves of Superior Pacific
from December 31, 1987 through December 31, 1997.
ANALYSIS OF DIRECT CLAIM AND CLAIM ADJUSTMENT EXPENSE DEVELOPMENT
<TABLE>
<CAPTION>
CALENDAR YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------
1987 1988 1989 1990 1991 1992 1993
------- ------- ------- ------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Reserve for Unpaid Losses and
Loss Adjustment Expenses,
Gross of Reinsurance
Recoverables Reserve......... $21,969 $42,268 $60,615 $88,270 $116,811 $136,102 $171,038
Reserve Re-estimated as of:
One Year Later............... 24,241 43,581 68,718 112,160 144,676 162,634 171,960
Two Years Later.............. 26,120 46,788 79,059 111,151 143,912 148,906 161,262
Three Years Later............ 29,140 50,955 74,619 117,506 138,607 152,420 148,654
Four Years Later............. 29,423 47,696 78,112 113,029 137,939 144,898 148,983
Five Years Later............. 29,541 49,297 75,475 112,840 135,074 146,867
Six Years Later.............. 29,082 47,554 75,913 109,655 138,048
Seven Years Later............ 27,759 49,470 74,149 111,871
Eight Years Later............ 27,846 48,653 75,898
Nine Years Later............. 27,573 49,451
Ten Years Later.............. 27,803
Cumulative (Deficiency)
Redundancy................... (5,834) (7,183) (15,283) (23,601) (21,237) (10,765) 22,055
Cumulative Amount of Reserve
Paid Through
One Year Later............... $ 9,447 $17,698 $24,478 $42,627 $ 53,914 $ 57,348 $ 60,726
Two Years Later.............. 14,482 19,879 35,195 51,160 56,299 61,648 66,077
Three Years Later............ 15,777 25,830 38,067 52,761 63,354 63,523 64,464
Four Years Later............. 18,666 26,165 38,261 57,332 64,703 66,547 66,754
Five Years Later............. 19,384 26,026 40,794 59,093 68,152 66,750
Six Years Later.............. 19,660 27,181 42,032 59,917 69,052
Seven Years Later............ 20,707 27,202 43,146 60,749
Eight Years Later............ 20,803 27,947 42,898
Nine Years Later............. 21,123 27,857
Ten Years Later.............. 20,899
Gross Reserve -- December 31............................................................... 171,038
Reinsurance Recoverables................................................................... 28,971
--------
142,067
Reclassification of Amounts Recoverable from Centre Re..................................... 42,032
--------
Net Reserve -- December 31................................................................. 100,035
========
Gross Re-estimated Reserve................................................................. 148,983
Re-estimated Reinsurance Recoverables...................................................... 25,775
--------
123,208
Reclassification of Amounts Recoverable from Centre Re..................................... 42,032
--------
Net Re-estimated Reserve................................................................... 81,176
========
Net Cumulative Redundancy.................................................................. 18,859
========
<CAPTION>
CALENDAR YEARS ENDED DECEMBER 31,
-----------------------------------------
1994 1995 1996 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Reserve for Unpaid Losses and
Loss Adjustment Expenses,
Gross of Reinsurance
Recoverables Reserve......... $171,258 $141,495 $115,529 $201,255
Reserve Re-estimated as of:
One Year Later............... 162,635 137,242 120,999
Two Years Later.............. 145,626 145,209
Three Years Later............ 144,173
Four Years Later.............
Five Years Later.............
Six Years Later..............
Seven Years Later............
Eight Years Later............
Nine Years Later.............
Ten Years Later..............
Cumulative (Deficiency)
Redundancy................... 27,085 (3,714) (5,470)
Cumulative Amount of Reserve
Paid Through
One Year Later............... $ 67,757 $ 63,587 $ 69,658
Two Years Later.............. 61,952 72,946
Three Years Later............ 67,388
Four Years Later.............
Five Years Later.............
Six Years Later..............
Seven Years Later............
Eight Years Later............
Nine Years Later.............
Ten Years Later..............
Gross Reserve -- December 31.. 171,258 141,495 115,529 201,255
Reinsurance Recoverables...... 31,897 27,076 24,986 49,155
-------- -------- -------- --------
139,361 114,419 90,543 152,100
Reclassification of Amounts Re 34,269 11,696 -- --
-------- -------- -------- --------
Net Reserve -- December 31.... 105,092 102,723 90,543 152,100
======== ======== ======== ========
Gross Re-estimated Reserve.... 144,173 145,209 120,999
Re-estimated Reinsurance Recov 34,083 35,648 35,835
-------- -------- --------
110,090 109,561 85,164
Reclassification of Amounts Re 34,269 11,696 --
-------- -------- --------
Net Re-estimated Reserve...... 75,821 97,865 85,164
======== ======== ========
Net Cumulative Redundancy..... 29,271 4,858 5,379
======== ======== ========
</TABLE>
The first line of the preceding table depicts the estimated liability for
unpaid claim and claim adjustment expense recorded on the balance sheets of
Superior Pacific at the indicated balance sheet dates. This liability
9
<PAGE> 12
represents the estimated amount of claim and claim adjustment expense for claims
arising during all years prior to the indicated balance sheet date that are
unpaid as of that balance sheet date, gross of reinsurance recoverables,
including losses that have been incurred but not yet reported. The table also
shows the re-estimated liability as of the end of each succeeding year through
the latest balance sheet date, and the cumulative payments made for such claims,
at annual intervals after the initial indicated balance sheet date. The claim
and claim adjustment expense liability estimates change as more information
becomes known about the frequency and severity of claims for each year. A direct
reserve redundancy or deficiency is displayed for each balance sheet date in the
center of the table when the initial liability estimate is greater (or less)
than the re-estimated liability at the latest balance sheet date. A
net-of-reinsurance redundancy is displayed for each of the years ended December
31, 1993, 1994, 1995, and 1996 at the bottom of the table.
The direct reserve deficiencies associated with the years ended December
31, 1987 and 1988 were due to the lack of claim and claim adjustment expense
history, which prevented management from accurately estimating ultimate claim
costs. The direct deficiencies associated with reserves as of December 31, 1989,
1990, 1991, and 1992 were due to unexpected increases in claims costs resulting
from increased litigation in the California workers' compensation system, an
economic recession in California, and workers' compensation laws that at the
time effectively encouraged workers to file unwarranted psychiatric stress and
fraudulent claims. The direct redundancies associated with the years ended
December 31, 1993 and 1994 occurred as a result of significant reforms in the
California workers' compensation laws that became effective January 1, 1993 and
an improvement in the California economy that were not anticipated when reserves
were established. The direct reserve deficiencies associated with the years
ended December 31, 1995 and 1996 occurred as a result of unexpected increases in
severity affecting claims occurring in 1995 and 1996.
Superior Pacific's experience with direct reserve deficiencies occurring
for the years ended December 31, 1989 through 1992, 1995, and 1996 and direct
redundancies occurring for the years ended December 31, 1993 and 1994 is
consistent with the results experienced by the California workers' compensation
industry during the same time periods. The underlying improvement in claims
frequency and severity during the years ended December 31, 1993 and 1994 that
caused Superior Pacific to develop direct redundant reserves is also consistent
with industry experience. The direct reserve deficiencies occurring for the
years ended December 31, 1995 and 1996 resulted from unexpected increases in
claims severity, consistent with some California workers' compensation insurers'
experience. The net-of-reinsurance redundancies displayed at the bottom of the
table reflect Superior Pacific's per risk excess of loss, quota share, and
aggregate excess of loss reinsurance, the effects of which were to reduce
Superior Pacific's direct redundancies/deficiencies due to the cession of a
portion of Superior Pacific's favorable development.
Currently, management prepares on a monthly basis a comprehensive analysis
of workers' compensation experience, and the process of estimating claim and
claim adjustment expense liabilities is continually modified to consider
additional information regarding trends in pricing, frequency, and severity.
Further, conditions and trends that have historically affected Superior
Pacific's claims may not necessarily be indicative of conditions and trends that
will affect future claims, and it is not appropriate to extrapolate future
reserve redundancies or deficiencies based on the data set forth above.
By frequently reviewing reserves, management is generally able to detect
trends in claim and claim adjustment expenses and take appropriate actions in a
timely manner to avoid having to increase substantially reserves at a later
date. For example, the Company was one of the first to recognize and quantify
the increase in claims severity appearing in claims with 1995 and subsequent
dates of injury. Recognition of this shift has enabled management to take
pro-active steps, an example of which is its undertaking of the Claims Severity
Management Program. See "-- Claims Severity Management Program."
DISCONTINUED OPERATIONS
Superior Pacific's discontinued operations consist of P&C business that was
discontinued effective September 30, 1993. The discontinued operations
liabilities principally pertain to contractors' general liability policies
underwritten during the years 1986 through 1990. There is often a significant
lag between the date of loss of construction-related claims and the date such
claims are reported to Superior Pacific. Superior Pacific
10
<PAGE> 13
believes the existing provision is sufficient to cover future claims, but there
is significant uncertainty associated with the reporting and severity of
construction claims. Management estimates that discontinued operations will
essentially have "run-off" by the year 2000.
In 1993, the Company recorded a pre-tax charge to income of $4.5 million
for estimated operating losses during the phase-out period. During the second
quarter of 1995, the Company increased by approximately $15.0 million its
reserves for discontinued operations for accident years 1993 and prior and has
not increased them since.
The following table provides a reconciliation of the beginning and ending
claim and claim adjustment expense reserves for discontinued operations for each
of the years in the three-year period ended December 31, 1997, computed in
accordance with GAAP.
RECONCILIATION OF LIABILITY FOR DISCONTINUED OPERATIONS CLAIM AND CLAIM
ADJUSTMENT EXPENSE
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
------- -------- --------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C>
Beginning reserve, gross of reinsurance................... $25,466 $ 40,526 $ 36,410
Less: Reinsurance recoverable on unpaid losses............ 6,976 9,159 8,777
------- -------- --------
Beginning reserve, net of reinsurance..................... 18,490 31,367 27,633
Provision for net claim and claim adjustment expenses
For claims occurring in current year.................... -- -- --
For claims occurring in prior years..................... -- -- 15,006
------- -------- --------
Total claim and claim adjustment expenses............... -- -- 15,006
------- -------- --------
Payments for net claim and claim adjustment expense
For claims occurring in current year.................... -- -- --
For claims occurring in prior years..................... (5,020) (12,877) (11,272)
------- -------- --------
Total claim and claim adjustment expense................ (5,020) (12,877) (11,272)
------- -------- --------
Ending reserves, net of reinsurance....................... 13,470 18,490 31,367
Reinsurance recoverable on unpaid losses.................. 5,216 6,976 9,159
------- -------- --------
Ending reserves, gross of reinsurance..................... $18,686 $ 25,466 $ 40,526
======= ======== ========
</TABLE>
11
<PAGE> 14
The following table discloses the development of direct discontinued
operations claims and claim adjustment expense reserves from December 31, 1987
through December 31, 1997.
ANALYSIS OF DISCONTINUED OPERATIONS DIRECT CLAIM AND CLAIM ADJUSTMENT EXPENSE
DEVELOPMENT
<TABLE>
<CAPTION>
CALENDAR YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------------
1987 1988 1989 1990 1991 1992 1993
-------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Reserve for Direct Unpaid
Claim and Claim
Adjustment Expenses,
Gross of Reinsurance
Recoverables Reserve........ $ 12,678 $ 25,935 $ 41,088 $ 56,735 $ 65,629 $ 66,532 $ 54,898
Re-estimated as of:
One Year Later.............. 19,879 32,395 56,093 73,295 83,770 73,298 56,041
Two Years Later............. 25,865 43,160 60,679 89,336 91,453 73,067 75,703
Three Years Later........... 30,455 43,585 72,860 98,206 90,717 96,531 76,079
Four Years Later............ 30,134 52,261 82,218 102,538 117,215 92,569 82,026
Five Years Later............ 34,215 61,539 84,304 126,431 113,084 99,009
Six Years Later............. 38,051 63,072 103,326 123,722 119,112
Seven Years Later........... 38,844 77,080 104,428 130,055
Eight Years Later........... 44,129 78,938 108,897
Nine Years Later............ 44,866 80,906
Ten Years Later............. 45,315
Cumulative (Deficiency)...... (32,637) (54,971) (67,809) (73,320) (53,483) (32,477) (27,128)
Cumulative Amount of Reserve
Paid Through One Year
Later....................... 7,529 13,754 19,839 27,397 29,274 26,473 23,043
Two Years Later............. 13,146 15,301 26,399 35,278 29,165 23,483 16,203
Three Years Later........... 15,900 19,844 32,188 39,203 28,136 18,380 19,649
Four Years Later............ 18,915 23,007 37,758 42,135 23,255 17,777 19,263
Five Years Later............ 22,329 28,609 38,798 41,835 22,047 18,276
Six Years Later............. 26,129 31,715 37,585 42,943 23,104
Seven Years Later........... 27,645 31,247 42,260 42,363
Eight Years Later........... 27,791 37,394 40,796
Nine Years Later............ 27,780 41,325
Ten Years Later............. 29,163
Gross Reserve -- December 31.................................................................. 54,898
Reinsurance Recoverables...................................................................... 8,379
--------
Net Reserve -- December 31.................................................................... 46,519
========
Gross Re-estimated Reserve.................................................................... 82,026
Re-estimated Reinsurance Recoverables......................................................... 21,249
--------
Net Re-estimated Reserve...................................................................... 60,777
========
Net Cumulative (Deficiency)................................................................... ($14,258)
========
<CAPTION>
CALENDAR YEARS ENDED DECEMBER 31,
--------------------------------------
1994 1995 1996 1997
-------- ------- ------- -------
<S> <C> <C> <C> <C>
Reserve for Direct Unpaid
Claim and Claim
Adjustment Expenses,
Gross of Reinsurance
Recoverables Reserve........ $ 36,410 $40,526 $25,466 $18,686
Re-estimated as of:
One Year Later.............. 54,855 41,293 30,693
Two Years Later............. 55,622 46,520
Three Years Later........... 60,849
Four Years Later............
Five Years Later............
Six Years Later.............
Seven Years Later...........
Eight Years Later...........
Nine Years Later............
Ten Years Later.............
Cumulative (Deficiency)...... (24,439) (5,994) (5,227)
Cumulative Amount of Reserve
Paid Through One Year
Later....................... 14,329 15,827 10,717
Two Years Later............. 16,765 10,717
Three Years Later........... 11,857
Four Years Later............
Five Years Later............
Six Years Later.............
Seven Years Later...........
Eight Years Later...........
Nine Years Later............
Ten Years Later.............
Gross Reserve -- December 31. 36,410 40,526 25,466 18,686
Reinsurance Recoverables..... 8,777 9,159 6,976 5,216
-------- ------- ------- -------
Net Reserve -- December 31... 27,633 31,367 18,490 13,470
======== ======= ======= =======
Gross Re-estimated Reserve... 60,849 46,520 30,693
Re-estimated Reinsurance Reco 18,210 15,153 12,203
-------- ------- -------
Net Re-estimated Reserve..... 42,639 31,367 18,490
======== ======= =======
Net Cumulative (Deficiency).. (15,006) $ -- $ --
======== ======= =======
</TABLE>
The first line of the preceding table depicts the estimated liability for
unpaid claims and claim adjustment expense for discontinued operations recorded
for each of the indicated periods. The table follows the form of the table
depicting workers' compensation reserve development in "Analysis of Direct
Claims and Claim Adjustment Expense Development," above.
From 1987 to 1990, the increase in ultimate claims and claim adjustment
expense for discontinued operations was due to the lack of Company history, as
well as changes in economic and legal environments which prevented management
from reasonably estimating ultimate loss costs. Thereafter, a full actuarial
12
<PAGE> 15
analysis has been performed semi-annually taking into account the Company's
history of reserve development, industry claim experience, and the effects of
litigation on future loss costs.
The predominant number of the Company's pre-1991 discontinued operations
claims are attributable to construction defect claims associated with commercial
package policies sold to general contractors, developers, and artisan
contractors underwritten from 1986 to 1993. Other carriers writing these same
lines of business have also been negatively affected by the unfavorable increase
in claims frequency and severity that occurred as a result of changes in the
economic and legal environment during this time. At December 31, 1997
approximately $16.8 million of the total $18.7 million (approximately 90%) of
direct reserves for discontinued operations were attributable to construction
defect claims.
The Company began to monitor separately the effects of construction defect
claims beginning in 1993. Prior to 1993 the effects of construction defect
claims were combined with all other general liability business for reserve
valuation purposes. The frequency, severity, and time lag between the occurrence
and reporting dates of such claims vary significantly from the statistics
associated with all other lines and sublines of the Company's claims and claim
adjustment expense reserves for discontinued operations. Effective June 30,
1995, the Company recorded a pre-tax charge of approximately $15.0 million ($9.8
million net of tax) for discontinued property and casualty operations due
principally to an increase in management's estimates of IBNR construction defect
claims.
The frequency of newly reported construction defect claims increased
significantly in July 1995. Management believes the increase in new construction
defect claims was attributable to the California Supreme Court decision in
Montrose Chemical Corporation v. Admiral Insurance Company ("Montrose") handed
down in July 1995. The Montrose decision effectively broadened the definition of
"loss occurrence" to include the entire period beginning with the construction
date and ending with the date of judgment associated with defective
construction. Since July 1995 the Company has received notices of claims on
allegedly defective construction projects where the manifestation of the loss,
the immediate cause of the loss, and the first report of the loss, all fall
outside of the Company's policy terms. Regardless, under the California Supreme
Court's ruling, the Company is compelled to defend the "insured" and contribute
to loss settlements.
Management cannot predict the volume of future Montrose-related claims, the
cost of handling the claims, or the ultimate severity of loss associated with
such claims, but 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, however, that further
upward development of ultimate loss costs associated with construction defect
claims will not occur.
The Company has also experienced significant development with respect to
loss costs for components of discontinued operations other than construction
defect claims. While these other claims are generally more predictable than
construction defect claims, there can be no assurance that further upward
development of loss costs associated with such claims will not occur.
REINSURANCE
Reinsurance is generally used to reduce the liability on individual risks
and to protect against individual risk or aggregate catastrophic losses.
Superior Pacific follows the industry practice of reinsuring a portion of its
risks. The availability and cost of reinsurance are subject to prevailing market
conditions and may affect Superior Pacific's profitability. Superior Pacific's
reinsurance program is based on the security of the reinsurers, coverage, and
price. Superior Pacific monitors its reinsurers' financial condition carefully
and recoverable losses are pursued aggressively. Occasionally, Superior Pacific
is involved in disputes with reinsurers, which, if not settled, may be resolved
in arbitration. At December 31, 1997, there were no disputes related to the
workers' compensation operations.
Superior Pacific maintains excess of loss reinsurance contracts with
various reinsurers and a quota-share contract with ZRNA, an affiliate of Zurich.
Under its current excess of loss contracts (with multiple reinsurers), various
reinsurers collectively assume liability on that portion of each loss that
exceeds $500,000 on a per occurrence basis, up to a maximum of $150.0 million
per occurrence.
13
<PAGE> 16
Effective January 1, 1994, SNIC entered into a quota-share reinsurance
contract (the "Quota-Share Contract") with ZRNA. Under the Quota-Share Contract,
ZRNA may provide Superior Pacific with an Assumption of Liability Endorsement
("ALE") facility, or, effective January 1, 1997, Superior Pacific may write
directly on policy forms of ZC Insurance Company ("ZCIC"), an affiliate of
Zurich (the "ZCIC Front"). The ceding rate under the contract was 20% for 1994,
and ZRNA and Superior Pacific mutually agreed to reduce the quota-share
participation to 5% for 1995 and 1996. Further, Superior Pacific received ceding
commissions ranging between 22.5% and 24.5% for premiums ceded to ZRNA under the
1994 -1997 contracts. The purpose of the ceding commission is to cover Superior
Pacific's cost of acquiring new business and may be changed as a result of
changes in market conditions on a quarterly basis.
Effective January 1, 1997, the terms of the Quota Share Contract were
amended whereby ZRNA increased its participation from 5% of premiums written in
1996 to 6.5% in 1997. In exchange for the increased participation, ZRNA no
longer received a separate fee for policies written on ALEs, but received an
additional 2% of premiums written on ZCIC Front policies only.
Effective January 1, 1998, the terms of the quota share contract were
amended whereby the ceding commission was increased to 27.5% for non-ZCIC and an
ALE premium. The ceding commission on ZCIC policies remained at 20%. Further,
the additional 2% of premium paid on ZCIC front policies was eliminated.
Effective February 1, 1998, Superior Pacific entered into an unrelated
quota share reinsurance contract under which it cedes 100% of premiums and claim
and claim adjustment expenses associated with policies having $100,000 or more
of estimated annual premium. Superior Pacific receives a 35% ceding commission
on premiums ceded under this contract.
Superior Pacific entered into a contract with Centre Re effective June 30,
1997, under which Centre Re assumed $10 million of reserves associated with
claims open for future medical payments from Superior Pacific in consideration
of $1 million in cash and the assignment of the rights of Superior Pacific's
contribution and subrogation recoveries during the term of the contract. The
contract is accounted for as a deposit, and no gain will be recognized until net
cash payments from Centre Re are either greater than Superior Pacific's $1
million premium. See "Management Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources."
Reinsurance makes the assuming reinsurer liable to the insurer to the
extent of the reinsurance ceded, but it generally does not legally discharge an
insurer of its primary liability for the full amount of the policy liability
(except for ALEs). If a reinsurer fails to meet its obligations under the
reinsurance agreement, the ceding company is required to pay the loss. With
respect to policies with an ALE, however, in the event that Superior Pacific is
unable to meet its claim payment obligations, ZRNA assumes all responsibility
for the payment of losses related to the policy. All of the excess of loss
reinsurance is with non-affiliated reinsurers.
Superior Pacific generally enters into its contracts on an annual basis.
Superior Pacific has maintained reinsurance contracts with many reinsurers for a
number of years. In general, Superior Pacific's reinsurance contracts cover
specified underwritten risks. Superior Pacific also from time to time purchases
reinsurance covering specific liabilities or policies underwritten. As of
December 31, 1997, ZRNA and General Reinsurance Corporation accounted for 24.5%
and 21.6%, respectively, of total amounts recoverable by Superior Pacific from
all reinsurers on paid and unpaid claims and claim adjustment expenses, and were
the only reinsurers that accounted for more than 10% of such amounts.
INVESTMENTS
The amount and types of investments that may be made by the Company are
regulated under the California Insurance Code and rules and regulations
promulgated by the DOI. The investments of the Company are primarily managed
externally, based upon guidelines and strategies approved by management. The
Company's consolidated portfolio consisted almost entirely of fixed income
securities as of December 31, 1997. The bond portfolio is heavily weighted
toward short to intermediate term, investment grade securities rated "A" or
better, with approximately 91% rated "AA" or better.
14
<PAGE> 17
Funds withheld assets having carrying and market values of $114.9 million
and $117.1 million, respectively, at December 31, 1995, were withheld from
Centre Re as collateral under an excess of loss reinsurance contract. These
assets were carried as held to maturity until they were returned to Centre Re in
1996 upon the commutation of the reinsurance contract. All investment income and
market value risk associated with such assets was Centre Re's. Interest expense
in the amount $6.1 million and $8.8 million was paid to Centre Re during 1996
and 1995, respectively. In November 1996, the Company entered into a financing
transaction involving Centre Re and The Chase Manhattan Bank ("Chase") pursuant
to which Chase extended a $93.1 million term loan, net of transaction costs. The
Company used proceeds from the transaction to purchase from SNIC reinsurance
receivables due from Centre Re. On June 30, 1997, the Company reached an
agreement under which the Company agreed to transfer reinsurance receivables to
Chase in exchange for the cancellation of the Company's debt to Chase. As a
result of these actions, the Company's investable assets increased by $93.1
million.
The table below contains information concerning the composition of the
Company's investment portfolio at December 31, 1997:
<TABLE>
<CAPTION>
CARRYING
AMOUNT MARKET
TYPE OF INVESTMENT (1) VALUE
------------------ -------- --------
(IN THOUSANDS)
<S> <C> <C>
Bonds (2)
U.S. government and agencies................................ $165,273 $165,273
AA/Aa rated................................................. 21,127 21,127
A rated..................................................... 12,584 12,584
BBB/Baa rated............................................... 2,150 2,150
BB/Ba rated................................................. 4,080 4,080
-------- --------
Total Bonds............................................... 205,214 205,214
Invested cash and short-term investments.................... 35,376 35,376
Common stocks............................................... 1,526 1,526
-------- --------
Total..................................................... $242,116 $242,116
======== ========
</TABLE>
(1) Carrying amount is amortized cost for bonds held to maturity and short-term
investments. Market value is used for bonds held for sale and common
stocks.
(2) Standard & Poor's Corporation defines "AAA" rated securities as "highest
rating, extremely strong security," "AA" rated securities as "very strong
security," "A" as "strong security," "BBB" as "adequate security," and "BB"
as "low quality." Moody's Investor Services, Inc. defines "Aaa" rated
securities as "best quality," "Aa" as "high quality," "A" as "strong
security," "Baa" as "adequate security," and "Ba" as "low quality."
The table below reflects investments and interest earned thereon and
average annual yield on investments for each year in the five-year period ended
December 31, 1997.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(DOLLAR AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Total investments at end of period.......... $242,116 $149,440 $163,951 $174,345 $144,778
Net investment income before taxes.......... $ 12,674 $ 7,769 $ 9,784 $ 9,049 $ 9,550
Average annual yield on ending investment
portfolio (before taxes).................. 5.2% 5.2% 5.9% 5.2% 6.6%
</TABLE>
In monitoring its asset and liability match, the Company attempts to keep
the investment duration at the mid-point of its anticipated payout pattern of
claims. As of December 31, 1997, the investments under the Company's management
had a duration of 2.90 years.
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<PAGE> 18
The table below sets forth the maturity profile of the Company's bond
portfolio at market value as of December 31, 1997:
<TABLE>
<CAPTION>
BONDS RATED (1)
----------------------------------------------------------
AAA/AAA AA/AA A BBB/BAA BB/BA TOTAL
-------- ------- ------- ------- ------ --------
(DOLLAR AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
1 year or less........................... $ 25,086 $ 25,086
More than 1 year, through 3 years........ 9,038 5,544 14,582
More than 3 years, through 5 years....... 11,988 15,120 3,020 30,128
More than 5 years, through 10 years...... 26,519 6,007 4,020 2,150 4,080 42,776
More than 10 years, through 15 years..... 2,866 2,866
More than 15 years....................... 89,776 89,776
-------- ------- ------- ------ ------ --------
Total.................................... $165,273 $21,127 $12,584 $2,150 $4,080 $205,214
======== ======= ======= ====== ====== ========
</TABLE>
(1) Standard & Poor's Corporation defines "AAA" rated securities as "highest
rating, extremely strong security," "AA" rated securities as "very strong
security," "A" as "strong security," "BBB" as "adequate security," and "BB"
as "low quality." Moody's Investor Services, Inc. defines "Aaa" rated
securities as "best quality," "Aa" as "high quality," "A" as "strong
security," "Baa" as "adequate security," and "Ba" as "low quality."
INFORMATION SERVICES
Superior Pacific emphasizes the development of personal computer based
information and processing systems for use in all areas of its business and to
that end strives to maintain a creative, flexible, and dynamic data processing
capability that (i) enhances the effectiveness of its employees' underwriting,
policy administration, and claims activities, (ii) provides detailed, real-time
and near real-time information to management for control and administration
purposes, and (iii) provides marketing benefits through improved customer
service. The Company believes that these systems give it a significant
competitive advantage over competitors that lack such systems. Superior Pacific
expensed or capitalized 3.7%, 4.2%, and 3.3% of direct premiums written in 1997,
1996, 1995, respectively.
Data Warehouse Decision Support System. In 1993 the Company developed
SWAMI(R), its proprietary "data warehouse decision support" system. Beginning
with the installation of SWAMI(R), Superior Pacific adjusted the Company's
monitor and feedback cycle to no less frequently than weekly, and, in many
respects, to a daily basis. Management believes this to be necessary due to the
information intensive nature of the insurance business; lack of information
represents a major aspect of underwriting risk. Accordingly, SWAMI(R) was
developed to provide quality, detailed, real-time and near real-time information
to management as needed to reduce the risk represented by lack of information.
The SWAMI(R) system has been constantly enhanced since its implementation.
Management believes that SWAMI(R) is the first comprehensive "data warehouse
decision support" system developed in the insurance industry.
Underwriting. The Company's underwriting system is a fully-integrated
rating, quoting, and policy issuance system for use both internally and remotely
from producers' offices. The system contains edit and blocking features that
prohibit underwriters from issuing policies associated with business that is
deemed inappropriate or undesirable by management, or that may be
inappropriately priced. Detailed information for each producer can be
instantaneously reviewed on an accident year, policy year, or calendar year
basis. The system provides analytical information as to producers, underwriters,
or branch operations, which management uses to take corrective action with
respect to unprofitable producers or ineffective staff. The system permits
management to evaluate commissions, in force business, collections activity, and
product pricing, in detail, utilizing information that is no more than 24 hours
old.
Policy Administration. Policy administration, including premium collection
and audit activities, is fully automated. In addition to traditional "agency"
billing services, the Company's collections capabilities also include direct
bill, automatic withdrawals from policyholders' bank accounts, and credit card
billings, which, management believes, dramatically improve credit experience and
policy persistency.
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<PAGE> 19
Claims Administration. The core of the claims system is a proprietary
document imaging system that, combined with sophisticated workflow protocols,
improves the productivity of the Company's claims staff.
The Company has comprehensive physical and virtual safeguards for its
information and processing systems. Disaster recovery programs and back-up
procedures include nightly back-up storage of all transactions and changes to
the system's database. At the end of each business day, the Company transfers
this information to tapes that are stored off site. The Company maintains
back-up systems in the branch offices to use if the main system fails. Computer
access is restricted by use of codes and passwords.
The Company does not believe that it will incur any material expenditures
or liabilities as a result of the "year 2000" problem in computer software. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Year 2000 Strategy."
COMPETITION
California is the country's largest workers' compensation insurance market.
Competitive pressures in the California workers' compensation market increased
with the implementation of open rating in January, 1995. As a result, total
direct premiums written for the California market decreased from $9.0 billion in
1993 to $5.0 billion in 1996. More recently, certain fundamentals of the
workers' compensation market in California have improved, as demonstrated by an
actual improvement in premium pricing of 0.5% for the year ended December 31,
1997, as compared to the same period in 1996.
The workers' compensation insurance industry in California is extremely
competitive. Many of Superior Pacific's competitors have been in business
longer, have a larger volume of business, offer more diversified types of
insurance coverage, have greater financial resources, and have greater
distribution capabilities than Superior Pacific. Of the approximately 300
companies that report to the WCIRB that they write workers' compensation
insurance, the Company believes that Liberty Mutual Insurance Companies,
California Compensation Insurance Company, and American International Group are
the largest private sector underwriters of workers' compensation insurance in
California. Superior Pacific believes the dominant competitor in the California
workers' compensation industry is the State Fund. As a result of the
Acquisition, the Company believes that, excluding the State Fund, it is the
eighth largest California workers' compensation insurer overall, based upon 1996
direct premiums written.
The workers' compensation market is commodity-oriented, highly fragmented,
and reflective of intense price competition. Nevertheless, because each risk is
unique in terms of insurance exposure, different insurers can develop widely
divergent estimates of prospective losses. Most insurers attempt to segment
classes within markets so that they target the more profitable sub-classes with
lower, although adequate, rates given the estimated profitability of the
segment. In some cases, no statistics are available for the sub-classes
involved, and the insurer implements discounted rate structures based solely on
theoretical judgment. Finally, different insurers have widely-divergent internal
expense positions, due to distribution methods, economies of scale, and
efficiency of operations. Therefore, although workers' compensation insurance is
a commodity, the price of insurance does not necessarily reflect commodity
pricing. Superior Pacific's existing and prospective customer bases are
vulnerable to competition, especially from larger insurers that at any time are
capable of penetrating Superior Pacific's markets with products priced at levels
substantially below Superior Pacific's.
RATINGS
Superior Pacific is currently rated "BBB" by S&P, a claims paying rating it
has held since 1995. Insurance companies rated "BBB" are considered by S&P to
offer adequate financial security, but capacity to meet policyholder obligations
is susceptible to adverse economic and underwriting conditions. A.M. Best has
currently assigned a "B+" (Very Good) rating to Superior Pacific, a rating it
has held since 1995. A.M. Best's ratings are based upon an evaluation of a
company's: (i) financial strength (leverage/capitalization, capital
structure/holding company, quality, appropriateness of reinsurance program,
adequacy of loss/policy reserves, quality, diversification of assets, and
liquidity); (ii) operating performance (profitability, revenue composition, and
management experience and objectives); and (iii) market profile (market risk,
competitive market position, spread of risk, and event risk). A "B+" rating is
assigned to companies that have on balance, in
17
<PAGE> 20
A.M. Best's opinion, very good financial strength, operating performance, and
market profile when compared to the standards established by A.M. Best, and have
a good ability to meet their ongoing obligations to policyholders. "B+" is A.M.
Best's sixth highest rating classification out of 15 ratings. A.M. Best's and
S&P's ratings represent an independent opinion of a company's financial strength
and ability to meet its obligations to policyholders and are not based upon
factors concerning investors. Such ratings are subject to change and are not
recommendations to buy, sell, or hold securities. One factor in an insurer's
ability to compete effectively is its A.M. Best rating. The Company's A.M. Best
rating is lower than that of many of its competitors. There can be no assurance
that such ratings or future changes therein will not affect the Company's
competitive position.
In addition, the Company currently maintains a facility that allows it to
offer certain policyholders insurance policies written by a Zurich affiliate
having an A.M. Best "A" rating.
REGULATION
SNIG and its insurance subsidiaries are subject to extensive governmental
regulation and supervision. Regulations relate to such matters as the filing of
premium rates and policy forms, adequacy of reserves, types and quality of
investments, minimum capital and surplus requirements, deposits of securities
for the protection of policyholders, statutory financial reporting, and
restrictions on shareholder dividends. SNIG and its insurance subsidiaries are
also subject to periodic examination by the DOI. In addition, assessments are
made against Superior Pacific to cover liabilities to policyholders of insolvent
insurance companies. The regulation and supervision of insurance companies by
state agencies is designed principally for the benefit of policyholders, not
shareholders. SNIG believes that it and its subsidiaries are in material
compliance with state regulatory requirements that are relevant to their
respective businesses.
The DOI Triennial Examination of SNIC, which covered the three years ended
December 31, 1994, was completed in 1996 and indicated no material issues or
actions needed to be taken by SNIC in either its operations or financial
statements. SPCC's Triennial Examination, which was completed in 1996, resulted
in an additional $18.5 million of claim and claim adjustment expense reserves
being recorded as of December 31, 1996. An additional $12.0 million in claim and
claim adjustment expense was recorded by SPCC in the first quarter of 1997.
These events preceded SPCC's acquisition on April 11, 1997.
The California Insurance Code requires the DOI to approve any proposed
change of control of the Company. For such purposes, "control" is presumed to
exist if any person, directly or indirectly, owns, controls, holds with the
power to vote, or holds proxies representing more than 10% of the voting
securities of the Company.
The California Insurance Code also limits the amount of dividends or
distributions an insurance subsidiary may pay without DOI approval in any
12-month period to the greater of (a) net income for the preceding year or (b)
10% of statutory policyholders' surplus as of the preceding December 31.
Payments of greater amounts require the approval of the DOI. The maximum
dividends permitted under the California Insurance Code are not necessarily
indicative of an insurer's actual ability to pay dividends or other
distributions to a parent company, which also may be constrained by business and
regulatory considerations, such as the impact of dividends on surplus, which
could affect an insurer's competitive position, the amount of premiums that can
be written, and the ability to pay future dividends. Further, the California
Insurance Code requires that the statutory surplus of an insurance company
following any dividend or distribution by such company be reasonable in relation
to its outstanding liabilities and adequate for its financial needs.
In 1989, 1991, 1993 and 1995, various workers' compensation reform laws
that were passed into law by the California Legislature materially impacted the
Company's rates, claims experience, financial condition and results of
operations.
Under the last important measure, adopted in 1993 and declared effective as
of January 1995, California's minimum rate law was replaced by an open rating
system. Under this new rating system, individual insurance companies file rates
and rules not less than 30 days prior to their effective date, and such rates
and rules can only be disapproved by the DOI after a hearing and only on the
basis of solvency, market share, or improper filing. Superior Pacific cannot
predict the ultimate effect of open rating on its workers' compensation
business,
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<PAGE> 21
but during the first three years of open rating, the intense price competition
that ensued led to lower average premiums per policy. Rates stabilized in 1996,
and appeared to increase slightly during 1997. Superior Pacific believes the
rates it has filed with the DOI are adequate, but it is unable to predict the
degree to which such rates are competitive in the marketplace.
The California legislature passed, and the DOI has issued its guidelines
with respect to the implementation of, Assembly Bill 1913 ("AB 1913"). AB 1913
causes, among other things, the experience modification factor of a current
workers' compensation policy and the immediately preceding two policies
(regardless of carrier) to be subject to revision if a claim used in a
modification closes on or after January 1, 1995, for a value of 60% or less of
its highest earlier reported value, if the highest reported incurred value was
$10,000 or more. This was amended effective January 1, 1998. Under the new rules
of AB 1913, if the aggregate amount of incurred claims changes by more than 60%
or less, than the WCIRB will calculate a new experience modification factor.
Such a change in the experience modification factor will require the current
workers' compensation carrier to return a portion of a policyholders' premium
for the current and preceding two policies' periods regardless if the current
carrier was the insured's previous carrier. WCIRB estimates of the ultimate cost
to California workers' compensation underwriters range from 1% to 2.5% of 1996
premium; however, these estimates are based upon broad industry estimates and
could vary significantly from company to company based upon the type of claims
incurred, size of employer, and employer industry group. Because of the
uncertainty and variability regarding the effects of AB 1913, no reasonable
estimate of the cost can be made. The Company paid approximately $2.0 million in
AB 1913 refunds in the year ending December 31, 1997.
Proposed federal legislation has been introduced from time to time in
recent years that would provide the federal government with substantial power to
regulate property and casualty insurers, including state workers' compensation
systems, primarily through the establishment of uniform solvency standards.
Proposals also have been discussed to modify or repeal the antitrust exemption
for insurance companies provided by the McCarran-Ferguson Act. The adoption of
such proposals could have a material adverse impact upon the operations of the
Company.
In order to enhance the regulation of insurer solvency, the National
Association of Insurance Commissioners (the "NAIC") has adopted a formula and
model law to implement risk-based capital ("RBC") requirements for property and
casualty insurance companies designed to assess minimum capital requirements and
to raise the level of protection that statutory surplus provides for
policyholder obligations. The NAIC model law has been incorporated into the
California Insurance Code. The RBC formula for property and casualty insurance
companies measures four major areas of risk: (i) underwriting, which encompasses
the risk of adverse loss developments and inadequate pricing, (ii) declines in
asset values arising from credit risk, (iii) declines in asset values arising
from investment risks, and (iv) off-balance sheet risk arising from adverse
experience from non-controlled assets, guarantees for affiliates, contingent
liabilities and reserve and premium growth. Pursuant to the model law, insurers
having less statutory surplus than that required by the RBC calculation will be
subject to varying degrees of regulatory action, depending on the level of
capital inadequacy.
The RBC model law provides for four levels of regulatory action. The extent
of regulatory intervention and action increases as the level of surplus as a
percentage of the RBC amount falls. The first level, the Company Action Level
(as defined by the NAIC), requires an insurer to submit a plan of corrective
actions to the regulator if surplus falls below 200% of the RBC amount. The
Regulatory Action Level (as defined by the NAIC) requires an insurer to submit a
plan containing corrective actions and requires the relevant insurance
commissioner to perform an examination or other analysis and issue a corrective
order if surplus falls below 150% of the RBC amount. The Authorized Control
Level (as defined by the NAIC) gives the relevant insurance commissioner the
option either to take the aforementioned actions or to rehabilitate or liquidate
the insurer if surplus falls below 100% of the RBC amount. The fourth action
level is the Mandatory Control Level (as defined by the NAIC) which requires the
relevant insurance commissioner to rehabilitate or liquidate the insurer if
surplus falls below 70% of the RBC amount. Based on the foregoing formulae, as
of December 31, 1997, the RBC ratios of SNIC and SPCC were in excess of the
Company Action Level, the first trigger level that would require regulatory
action.
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<PAGE> 22
The NAIC's Insurance Regulatory Information System ("IRIS") was developed
by a committee of state insurance regulators and is primarily intended to assist
state insurance departments in executing their statutory mandates to oversee the
financial condition of insurance companies operating in their respective states.
IRIS identifies eleven industry ratios and specifies "usual values" for each
ratio. Departure from the usual values on four or more of the ratios may lead to
increased regulatory oversight. Based on its 1997 statutory financial statement,
SNIC was within the usual range of all twelve IRIS tests, and SPCC fell outside
the usual range of three of the twelve IRIS tests. SPCC was outside of the usual
range of the tests measuring change in net writings, two-year overall operating
ratio, and two-year reserve development to surplus. The unusual values were the
result of 1996 claim and claim adjustment expense reserve increases, and the
runoff of SPCC's premium in force during 1997.
Early in 1998, the NAIC completed a project to codify SAP, as prior SAP
does not address all accounting issues and differed from state to state. The
codification replaced prescribed or permitted practices as the new comprehensive
statutory basis of accounting for insurance companies. Final implementation of
codification is required as of December 31, 1999. Due to the recent
implementation of the project, the Company has not yet quantified the impact
such changes may have on the statutory capital and surplus or statutory results
of operations of SNIC and SPCC. The impact of adopting this new comprehensive
statutory basis of accounting may, however, materially impact statutory capital
and surplus.
It is not possible to predict the future impact of changing state and
federal regulation on the Company's operations and there can be no assurance
that laws and regulations enacted in the future will not be more restrictive
than existing laws.
EMPLOYEES
As of December 31, 1997, the Company had approximately 410 employees, none
of whom was covered by a collective bargaining agreement.
RISK FACTORS
The following risk factors should be carefully reviewed in addition to the
other information included in this Annual Report on Form 10-K.
Uncertainty Associated with Estimating Reserves for Unpaid Claim and Claim
Adjustment Expenses
The reserves for unpaid claim and claim adjustment expenses established by
the Company are estimates of amounts needed to pay reported and unreported claim
and related claim adjustment expenses based on facts and circumstances then
known. These reserves are based on estimates of trends in claims severity,
judicial theories of liability, market conditions and other factors. The
establishment of adequate reserves is an inherently uncertain process, and there
can be no assurance that the ultimate liability will not materially exceed the
Company's reserves for claim and claim adjustment expenses and have a material
adverse effect on the Company's results of operations and financial conditions.
Although the Company has recently experienced reduced claims frequency, there
has been an increase in claims severity for injuries sustained in 1995 and
thereafter. In response, the Company has undertaken the Claims Severity
Management Program. There can be no assurance that such program will have the
effect the Company anticipates. See "Business -- Claims Severity Management
Program." Due to the inherent uncertainty of estimating reserve amounts, it has
been necessary, and may over time continue to be necessary, to revise estimates
of the Company's reserves for claim and claim adjustment expenses in response to
trends in claim severity, judicial theories of liability, market conditions and
other factors. The historic development of reserves for claim and claim
adjustment expenses may not necessarily reflect future trends in the development
of these amounts. Accordingly, it may not be appropriate to extrapolate
redundancies or deficiencies based on historical information. See "Business --
Claim and Claim Adjustment Expense Reserves."
20
<PAGE> 23
Uncertain Pricing and Profitability
One of the distinguishing features of the insurance industry, including the
workers' compensation insurance industry, is that its products generally are
priced before its costs are known because premium rates usually are determined
before losses are reported. Premium rate levels are related in part to the
availability of insurance coverage, which varies according to the level of
surplus in the industry. Increases in surplus have generally been followed by
increased price competition among workers' compensation insurers. For these
reasons, together with the commencement of open rating in January, 1995, the
California workers' compensation insurance business in recent years has
experienced very competitive pricing conditions and there can be no assurance as
to the Company's ability to achieve adequate pricing for its policies. Changes
in case law, the passage of new statutes or the adoption of new regulations
relating to the interpretation of insurance contracts can retroactively and
dramatically affect the liabilities associated with known risks after an
insurance contract is in place. Product enhancements also present special issues
in establishing appropriate premium levels in the absence of sufficient
experience with such products' performance. See "Business -- California Workers'
Compensation Market" and "-- Underwriting."
The number of competitors and the similarity of products offered, as well
as regulatory constraints, limit the ability of workers' compensation insurers
to increase prices in response to declines in profitability or market demand. In
addition, the reported profits and losses of a workers' compensation insurance
company are also determined, in part, by the establishment of, and adjustments
to, reserves reflecting estimates made by management as to the amount of claim
and claim adjustment expenses that will ultimately be incurred in the
settlement. of claims. The ultimate liability of the insurer for all claim and
claim adjustment expenses reserved at any given time will likely be greater or
less than these estimates, and differences in the estimates may have a material
adverse effect on the insurer's financial position, results of operations or
cash flows in the future periods. See "Business -- Claim and Claim Adjustment
Expense Reserves."
Risks of Acquisitions
The Company may pursue acquisitions of insurance companies or other
companies related to the California workers' compensation insurance market that
can be acquired on acceptable terms and which the Company believes can be
operated profitably. Some of these acquisitions could be material in size and
scope. The Company believes that its future growth may depend, in part, upon the
successful implementation of this strategy. While the Company will continually
be searching for acquisition opportunities, there can be no assurance that the
Company will be successful in identifying suitable acquisitions. If any
potential acquisition opportunities are identified, there can be no assurance
that the Company will consummate such acquisitions. The Company may in the
future face increased competition for acquisition opportunities, which may
inhibit its ability to consummate suitable acquisitions or increase the expense
of completing acquisitions. In addition, to the extent that the Company's
strategy results in the acquisition of businesses, such acquisitions could pose
a number of special risks, including the diversion of management's attention,
the assimilation of the operations and personnel of the acquired companies, the
integration of acquired assets with existing assets, adverse short-term effects
on reported operating results, the amortization of acquired intangible assets,
and the loss of key employees. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Overview" and "-- Year Ended
December 31, 1997 as compared to year ended December 31, 1996."
Leverage
As of December 31, 1997, the Company had $113 million of long term debt
outstanding, comprised of $105 million in Senior Subordinated Notes and $7.6
million in the form of a capital lease. The Company's ratio of earnings to fixed
charges and distributions on Preferred Securities was 1.98 to 1.
The Indenture pursuant to which the Senior Subordinated Notes were issued
permits the Company to incur additional indebtedness, subject to certain
limitations. Management believes that cash flow from operations and existing
funds available for payments of principal and interest will be adequate to
permit the Company to make its required payments of principal and interest on
its indebtedness, although there can be no
21
<PAGE> 24
assurance that this will be the case. To the extent that cash flow from
operations is insufficient to satisfy the Company's cash requirements, the
Company may seek to raise funds from additional borrowings or equity financings,
by restructuring, or by acquiring other businesses that would provide cash flow
(in all such cases to the extent permitted by the Indenture). See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources." There can be no assurance that such actions
could be effected on satisfactory terms, in a timely manner, or at all, that
would enable the Company to make any payments due on the Senior Subordinated
Notes or that any such actions would be permitted under the related Indenture.
The degree to which the Company is leveraged could have adverse
consequences, including the following: (i) a substantial portion of the
Company's cash flow from operations must be dedicated to the payment of
principal and interest on its indebtedness, thereby reducing the funds available
to the Company for other purposes, (ii) the Company's ability to obtain
additional financing in the future for working capital, acquisitions or other
purposes may be impaired, (iii) certain of the Company's borrowings may be at
variable rates of interest, which would expose the Company to the risk of higher
interest rates, (iv) the Company's flexibility in planning for or reacting to
changes in market conditions may be limited, (v) the Company may be
substantially more leveraged than certain of its competitors, which may place
the Company at a competitive disadvantage, and (vi) the Company may be more
vulnerable in the event of a downturn in its business. The Company's ability to
satisfy its obligations will be dependent upon its future performance, which
will be subject to prevailing economic conditions and to financial, business and
other factors, including factors beyond the control of the Company.
Variability of Workers' Compensation Insurance Business
The workers' compensation insurance business is affected by many factors
that can cause fluctuations in the results of operations of companies
participating in this business. Many of these factors are not subject to the
control of the Company. For example, an economic downturn in California could
result in an increase in the number of claims and less demand for workers'
compensation insurance. These factors, together with competitive pricing and
other considerations, could result in fluctuations in the Company's underwriting
results and net income. See "Business -- Regulation" and "-- Ratings."
Highly Competitive Businesses
The Company writes exclusively workers' compensation insurance, which is a
highly competitive business. Many of the Company's competitors have
substantially greater financial and other resources than the Company, and there
can be no assurance the Company will be able to compete effectively against such
competitors in the future. The Company's competitors include other companies
which, like the Company, serve the independent agency market, as well as
companies which sell insurance directly to insureds. Direct writers may have
certain competitive advantages over agency writers, including increased name
recognition, loyalty of the customer base to the insurer rather than an
independent agency and, potentially, reduced acquisition costs. In addition,
certain competitors of the Company have decreased their prices from time to time
in an attempt to gain market share. The Company believes that to compete
successfully in the workers' compensation business it will have to market and
service a level of premiums sufficiently large to enable the Company to continue
to realize operating efficiencies in conducting its business. No assurance can
be given the Company will be able to compete successfully if its current level
of premiums decreases significantly. See "Business -- Competition."
Importance of an A.M. Best Rating
One factor in an insurer's ability to compete effectively is its A.M. Best
rating. The Company's A.M. Best, "B+" (Very Good), rating is lower than that of
many of its competitors. A "B+" rating is assigned to companies which have on
balance, in A.M. Best's opinion, very good financial strength, operating
performance and market profile when compared to the standards established by
A.M. Best, and have a good ability to meet their ongoing obligations to
policyholders. "B+" is A.M. Best's sixth highest rating classification out of 15
ratings. A.M. Best bases its ratings on factors that concern policyholders and
not upon factors concerning
22
<PAGE> 25
investors. Such ratings are subject to change and are not recommendations to
buy, sell or hold securities. There can be no assurance that such ratings or
future changes therein will not affect the Company's competitive position. See
"Business -- Ratings."
Geographic Concentration
The Company writes workers' compensation insurance almost exclusively in
the State of California; consequently, the Company will be significantly
affected by changes in the regulatory and business climate in California. See
"Business -- Regulation."
Availability of Net Operating Loss Carryforwards
As of December 31, 1997, SNIG had available approximately $130.2 million in
net operating loss carryforwards ("NOLs") to offset taxable income recognized by
it for periods after December 31, 1997. For federal income tax purposes, these
NOLs will expire in material amounts beginning in the year 2006. SNIG's ability
to pay interest on the Senior Subordinated Notes may be dependent on the
continued availability of the NOLs until their normal expiration. On April 11,
1997, SNIG reincorporated in Delaware and in doing so adopted certain
restrictions on the transfer of its Common Stock in its Certificate of
Incorporation, intended to prevent a change in ownership under Section 382 of
the Internal Revenue Code, which change could materially limit the availability
of the NOLs. In addition, all holders of outstanding warrants to purchase SNIG
common stock entered into a Standstill Agreement in which they agreed not to
exercise such warrants until such time as their exercise would not result in a
change of ownership for purposes of Section 382. The transfer restrictions
adopted in SNIG's Certificate of Incorporation and the Standstill Agreement
serve to reduce, but not necessarily eliminate, the risk that Section 382 would
be applied to limit the availability of the Company's NOLs. In the event that
transfers occur in violation of the transfer restrictions, there can be no
assurance the Internal Revenue Service ("IRS") will not assert such transfers
have federal income tax significance notwithstanding the transfer restrictions,
or that a court might hold the transfer restrictions to be unenforceable. In
addition, the Board of Directors of SNIG has the power to waive the transfer
restrictions and enter into a transaction that may result in an ownership change
for purposes of Section 382 that would limit the use of the NOLs. The Board of
Directors would only permit such transaction after making a determination that
the issuance or transfer of equity securities is in the best interests of the
Company, after consideration of the risk that an ownership change might occur
and any additional factors that the Board of Directors deems relevant (including
possible future events). See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Taxes" and "Certain Relationships and
Related Transactions -- Transactions with IP and Limitations on Related Party
control."
Future Growth and Continued Operations Dependent on Access to Capital
The underwriting of workers' compensation insurance is a capital intensive
business. The Company must maintain minimum levels of surplus in SNIC and SPCC
in order to continue to write business and meet the other related standards
established by insurance regulatory authorities and insurance rating bureaus.
The Company achieved premium growth in 1997 as a result of its acquisition
of SPCC. It intends to continue to pursue acquisition and internal growth
opportunities. Among the factors that may restrict the Company's future growth
is the availability of capital. Such capital will likely have to be obtained
through debt or equity financing or retained earnings. There can be no assurance
that the Company will have access to sufficient capital to support future growth
and also satisfy the capital requirements of rating agencies and regulators. In
addition, the Company may require additional capital to finance future
acquisitions. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources."
Importance of Reinsurance
In order to reduce its underwriting risk, the Company purchases
reinsurance. SNIC and SPCC follow the industry practice of reinsuring a portion
of their respective risks. Reinsurance does not relieve the Company of
23
<PAGE> 26
liability to its insureds for the risks ceded to reinsurers. As such, the
Company is subject to credit risk with respect to amounts not recoverable from
reinsurers. Although the Company places its workers' compensation reinsurance
with reinsurers that are "A" rated or higher by A.M. Best and which the Company
generally believes to be financially stable, a significant reinsurer's
insolvency or inability to make payments under the terms of a reinsurance treaty
could have a material adverse effect on the Company's financial condition or
results of operations.
The amount and cost of reinsurance available to companies specializing in
workers' compensation insurance are subject, in large part, to prevailing market
conditions beyond the control of such companies. The Company's ability to
provide insurance at competitive premium rates and coverage limits on a
continuing basis depends upon its ability to obtain adequate reinsurance in
amounts and at rates that will not adversely affect its competitive position.
Due to continuing market uncertainties regarding reinsurance capacity, no
assurances can be given as to the Company's ability to maintain its current
reinsurance facilities, which generally are subject to annual renewal. If the
Company is unable to renew such facilities upon their expiration, the Company
may need to reduce the levels of its underwriting commitments. See "Business --
Reinsurance."
Risks Associated with Investments
The Company's results of operations depend in part on the performance of
its invested assets. As of December 31, 1997, virtually all of the Company's
investment portfolio was invested in fixed-income securities. Certain risks are
inherent in connection with fixed-income securities, including loss upon
default, price volatility in reaction to changes in interest rates and general
market factors, and in the case of certain asset backed securities, prepayment
and reinvestment risk. See "Business -- Investments."
Comprehensive State Regulation
The Company is subject to comprehensive regulation by government agencies
in California and Arizona. The nature and extent of that regulation typically
involve prior approval of the acquisition of control of an insurance company or
of any company controlling an insurance company, regulation of certain
transactions entered into by an insurance company with any of its affiliates,
limitations on dividends, filing of premium rates and policy forms, solvency
standards, minimum amounts of capital and surplus which must be maintained,
limitations on types and amounts of investments, restrictions on the size of
risks which may be insured by a single company, limitation of the right to
cancel or nonrenew policies in some lines, regulation of the right to withdraw
from markets, requirements to participate in residual markets, licensing of
insurers and agents, deposits of securities for the benefit of policyholders,
reporting and satisfying certain regulatory standards with respect to financial
condition, and other matters. In addition, state insurance department examiners
perform periodic financial and market conduct examinations of insurance
companies and dictate the accounting practices to be used by insurance companies
when reporting to regulatory authorities. Such regulation is generally intended
for the protection of policyholders rather than security holders. No assurance
can be given that future legislative or regulatory changes will not adversely
affect the Company. See "Business -- Regulation."
Holding Company, Structure; Dividend and Other Restrictions
SNIG is a holding company whose principal asset is the capital stock of its
subsidiaries. SNIG relies primarily on dividends and other payments from SNIC
and SPCC to meet its obligations to creditors and to pay corporate expenses,
including the principal and interest on the Senior Subsidiaries Notes. SNIC and
SPCC are domiciled in the State of California, which limits the payment of
dividends and other distributions by insurance companies. Under California law
the maximum aggregate amount of dividends permitted to be paid in 1998 without
regulatory approval by SNIC is $7.2 million and by SPCC is $3.1 million. In
addition, state insurance laws and regulations require that the statutory
surplus of an insurance company following any dividends or distribution by such
company be reasonable in relation to its outstanding liabilities and adequate
24
<PAGE> 27
for its financial needs. See "Business -- Overview" and "-- Regulation" and
"Managements Discussion and Analysis of Financial Condition and Results of
Operations."
Dependence Upon Producers
Superior Pacific depends on outside producers to provide it with insurance
business. The renewal rights of all of such business written are owned by the
producers, and not by Superior Pacific. While Superior Pacific believes that its
relationships with its producers are generally excellent, there can be no
assurance that producers will not move business currently written by Superior
Pacific to another carrier. If renewal rates were to drop significantly at
Superior Pacific as a result of producers moving business to other carriers, or
if producers were to deliver less business of the type Superior Pacific prefers
to underwrite, then the earnings of Superior Pacific could be adversely
affected.
Approximately $39.3 million (26.8%), $47.0 million (25.0%), and $44.0
million (26.0%) of Superior Pacific's premiums for the years ended December 31,
1997, 1996 and 1995, respectively, were derived from 10 producers. The loss of
any of these producers could have a material adverse effect on Superior Pacific.
See "Business -- Marketing."
Premium Volume Concentration
Approximately 65.7% of the Company's premium in force is concentrated in
400 non-group policies and 55 group programs that provide annual premium in
excess of $50,000. While marketing through group programs to reach smaller
policyholders is a means by which the Company can pursue its strategy to
underwrite smaller policies, group programs, like large non-group policies, are
vulnerable to price competition. If the Company is not able to retain a
sufficient number of group programs, the loss of overall premium by the Company
could materially and adversely affect the Company's ability to achieve
profitability. While the Company expects to write many new, small accounts
through its newly acquired relationships with policyholders and producers
previously associated with Pac Rim, if the Company fails to underwrite a
sufficient number of smaller accounts to offset in part the expected loss of
premium from the loss of some of SPCC's larger policies, the loss of overall
premium by the Company could materially and adversely affect the Company's
ability to achieve profitability. See "Business -- Marketing."
Significant Ownership by Affiliates of Zurich and Related Parties
Certain affiliates of Zurich collectively own approximately 21% of the
Company's Common Stock, on a diluted basis, and less than one percent of the
Company's issued and outstanding Common Stock on a non-diluted basis. In
addition, Insurance Partners, L.P. and Insurance Partners Offshore (Bermuda),
L.P. (collectively, "IP"), own approximately 24% of the Company's Common Stock,
on a diluted basis, and approximately 36% of the Company's issued and
outstanding Common Stock on a non fully-diluted basis. Certain affiliates of
Zurich are limited partners of IP, holding approximately 23% of IP's limited
partnership interests. Further, International Insurance Investors, L.P., ("III")
owns all of the outstanding Voting Notes (as defined herein) issued by SNIG.
Certain affiliates of Zurich are limited partners of III and hold approximately
32% of III's limited partnership interests. See "Security Ownership of Certain
Beneficial Owners and Management" and "Certain Relationships and Related
Transactions -- Transactions with IP-Limitation on Related Party Control." Five
of the Company's eleven directors have relationships with such parties.
Consequently, such parties have significant influence over the management of the
Company and have a significant portion of the votes needed to approve any action
requiring stockholder approval, including adopting amendments to SNIG's
Certificate of Incorporation and approving certain actions, such as mergers or
sales of all or substantially all of the Company's assets, which could cause a
Change of Control or otherwise materially affect the Company's financial
condition.
Dependence on Key Personnel in Connection with Future Success
The future success of the Company depends significantly upon the efforts of
certain key management personnel, including William L. Gentz, a director and the
President and Chief Executive Officer, J. Chris
25
<PAGE> 28
Seaman, a director, an Executive Vice President and the Chief Financial Officer,
and Arnold J. Senter, an Executive Vice President and the Chief Operating
Officer. A loss of any of these officers or other key employees could materially
and adversely affect the Company's business. See "Management -- Executive
Officers."
ITEM 2. BUSINESS PROPERTIES
The Company's principal executive offices are located in Calabasas,
California and are subject to a lease that expires in 2000. The Company also
leases space for branch offices in Woodland Hills, Pleasanton, Sacramento, and
Fresno (all in California). Such leases expire in 2002, 2003, 2001, and 2000,
respectively.
ITEM 3. LEGAL PROCEEDINGS
SNIG and its subsidiaries are parties to various legal proceedings, all of
which are considered routine and incidental to the business of the Company and
are not material to the financial condition and operation of the business.
Neither SNIG nor any of its subsidiaries is a party to any litigation expected
to have a material adverse effect upon the Company's business or financial
position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders of SNIG's,
through the solicitation of proxies or otherwise, during the fourth quarter of
1997.
26
<PAGE> 29
PART II
ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE COMPANY'S
COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
SNIG's common stock (the "Common Stock") is listed and traded on The Nasdaq
National Market under the trading symbol "SNTL". "The Nasdaq National Market" or
"Nasdaq" is a highly-regulated electronic securities market comprised of
competing Market Makers whose trading is supported by a communications network
linking them to a quotation dissemination, trade reporting, and order execution
system. This market also provides specialized automation services for
screen-based negotiations of transactions, on-line comparison of transactions,
and a range of informational services tailored to the needs of the securities
industry, investors and issuers. Nasdaq consists of two distinct market tiers:
The Nasdaq National Market and The Nasdaq SmallCap Market. Nasdaq is operated by
The Nasdaq Stock Market, Inc., a wholly-owned subsidiary of the National
Association of Securities Dealers, Inc. Set forth below are the quarterly high
and low closing sale prices for the Common Stock as reported to SNIG by those
broker-dealers believed by SNIG to be most active in making a market in the
Common Stock. As SNIG's Common Stock was not approved for listing on The Nasdaq
National Market until March 5, 1996, quotations prior to SNIG's being listed on
Nasdaq are inter-dealer prices (giving effect to the May 25, 1995, four-into-one
reverse stock split), without retail mark-up, mark-down, or commission and may
not necessarily represent actual transactions.
<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C> <C>
1997
Fourth quarter........................................... $15.25 $14.00
Third quarter............................................ $15.50 $13.25
Second quarter........................................... $13.63 $11.63
First quarter............................................ $15.25 $11.25
1996
Fourth quarter........................................... $13.75 $ 9.88
Third quarter............................................ $10.75 $ 7.13
Second quarter........................................... $ 8.00 $ 4.87
First quarter............................................ $ 5.63 $ 4.87
1995
Fourth quarter........................................... $ 6.00 $ 4.75
Third quarter............................................ $ 5.50 $ 4.75
Second quarter........................................... $ 5.00 $ 4.00
First quarter............................................ $ 5.40 $ 4.60
</TABLE>
As of March 1, 1998, the number of shareholders of record of SNIG's Common
Stock was 261 and 5,962,766 shares of Common Stock were outstanding on that
date.
The Company believes the increase in price in the third and fourth quarter
of 1996 and the first quarter of 1997 was primarily due to the announcement of
the Pac Rim acquisition. The Pac Rim acquisition was completed on April 11,
1997.
The Company's current policy is to retain its earnings for use in its
business; it has paid no cash dividends to its stockholders in its two most
recent fiscal years and has no present intention of paying cash dividends in the
foreseeable future. The payment of dividends in the future is subject to the
discretion of the Board of Directors and will depend on the Company's operating
results, financial condition and capital requirements, general business
conditions, and other relevant factors, including legal restrictions applicable
to the payment of dividends by SNIC and SPCC. The California Insurance Code
restricts the dividends or distributions an insurance subsidiary may pay in any
12-month period to the greater of (a) net income for the preceding year, or (b)
10% of statutory policyholders' surplus as of the preceding December 31.
Payments of greater amounts require the approval of the DOI. Because the Company
conducts no substantial business other than through
27
<PAGE> 30
SNIC and SPCC, SNIG would be dependent upon dividends from SNIC and SPCC in
order to pay dividends to SNIG's stockholders.
During the fiscal year ended December 31, 1997, the Company, through a
series of grants to certain employees pursuant to its 1995 Stock Incentive Plan,
awarded (a) an aggregate of 36,450 shares of restricted Common Stock, which
shares are subject to the Company's right of repurchase, and (b) options to
purchase an aggregate of 132,257 shares of Common Stock, vesting in equal annual
increments of 20% from the date of grant of such option and having exercise
prices ranging from $11.38 to $14.875 per share. In issuing such securities, the
Company relied on a Registration Statement on Form S-8, promulgated pursuant to
the Securities Act.
UNREGISTERED SALES OF SNIG'S EQUITY SECURITIES DURING LAST FISCAL YEAR
On December 3, 1997, the Trust, a direct subsidiary of SNIG, issued and
sold $105.0 million in aggregate liquidation amount of its 10 3/4% Trust
Preferred Securities in reliance upon the exemption provided by Section 4(2) of
the Securities Act of 1933, as amended (the "Securities Act"), and Regulations D
and S thereunder, as transactions exempt from the registration requirements of
the Securities Act to persons reasonably believed by Donaldson, Lufkin &
Jenrette Securities Corporation and Chase Securities Inc., as the initial
purchasers (the "Initial Purchasers") of the Trust Preferred Securities, to be
"qualified institutional buyers" (as defined by Rule 144A under the Securities
Act), other institutional "accredited investors" (as defined in Rule 501(a)(1),
(2), (3) or (7) under the Securities Act) or in transactions complying with the
provisions of Regulation S under the Securities Act. In view of the fact that
the proceeds of the sale of the Trust Preferred Securities were invested in the
Senior Subordinated Notes, the Company paid the Initial Purchasers, as
compensation, $29.50 per Trust Preferred Security (or approximately $3.01
million in the aggregate). The Trust Preferred Securities are traded in the
Private Offering, Resales and Trading through Automated Linkages ("PORTAL")
Market. See Note (9) to the Notes to Consolidated Financial Statements and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
Pursuant to its agreement with the Initial Purchasers, the Company and the
Trust filed with the SEC a registration statement (the "Registration Statement")
covering an offer to exchange the Trust Preferred Securities, Senior
Subordinated Notes and related Company Guarantee (as defined herein) for
substantially similar securities. The Registration Statement was declared
effective on January 16, 1998 and in February 1998, the exchange offer was
completed, with the participation of substantially all of such securities.
28
<PAGE> 31
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA -- YEARS ENDED 1993 THROUGH 1997
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS.)
<TABLE>
<CAPTION>
OPERATIONS FOR THE YEAR ENDED DECEMBER 31:
--------------------------------------------------------------
1997(1) 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
REVENUES:
Gross premiums written............. $ 159,352 $ 99,282 $ 97,084 $ 134,769 $ 157,986
Net premiums written............... 136,929 87,715 89,139 105,946 154,431
Net premiums earned................ 140,920 88,648 89,735 110,418 153,585
Net investment income (excluding
capital gains and losses)....... 12,630 7,738 10,309 9,014 8,481
Net capital gain (loss)............ 44 31 (525) 35 1,069
Other income (expense), net........ (817) 186 (536) (340) (743)
---------- ---------- ---------- ---------- ----------
Total revenues.................. 152,777 96,603 98,983 119,127 162,392
EXPENSES:
Claim and claim adjustment
expenses, net of reinsurance.... 90,447 55,638 53,970 78,761 113,817
Underwriting and general and
administrative expenses......... 37,695 34,138 29,447 21,660 28,779
Policyholder dividends............. -- (5,927) (5,742) 4,983 11,371
Goodwill amortization.............. 1,039 -- -- -- --
Interest expense................... 6,335 7,527 9,619 8,726 6,221
Income from continuing operations
before preferred securities and
extraordinary
items -- pre-tax................ 17,261 5,227 11,689 4,997 2,204
Income tax benefit (expense)....... 1,788 (739) 5,849 (4) 2,304
Accretion on preferred
securities -- pre-tax........... (4,650) (2,525) (2,255) (1,035) --
(Loss) from operations of
discontinued P&C
operations -- pre-tax(2)........ -- -- (14,912) -- (4,532)
Extraordinary (loss) -- pre-tax.... (19,540) -- -- (3,064) (686)
Cumulative effect of change in
accounting for income taxes..... -- -- -- -- 2,297
---------- ---------- ---------- ---------- ----------
Net income (loss)(4)............ $ (5,141) $ 1,963 $ 371 $ 894 $ 1,587
BASIC EPS(3)
Income before items below -- after
all taxes....................... $ 3.63 $ 1.31 $ 5.12 $ 1.45 $ 1.31
Preferred Securities -- pre-tax.... (0.89) (0.74) (0.66) (0.30) --
Discontinued Operations --
pre-tax......................... -- -- (4.35) -- (1.32)
Extraordinary Items -- pre-tax..... (3.72) -- -- (0.89) (0.20)
Cumulative Effect of Change in
Accounting -- pre-tax........... -- -- -- -- 0.67
---------- ---------- ---------- ---------- ----------
Net income (loss).................. $ (0.98) $ 0.57 $ 0.11 $ 0.26 $ 0.46
========== ========== ========== ========== ==========
</TABLE>
29
<PAGE> 32
<TABLE>
<CAPTION>
OPERATIONS FOR THE YEAR ENDED DECEMBER 31:
--------------------------------------------------------------
1997(1) 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
DILUTED EPS(3)
Income before items below -- after
all taxes....................... $ 2.71 $ 0.93 $ 4.44 $ 0.97 $ 0.94
Preferred Securities -- pre-tax.... (0.66) (0.52) (0.57) (0.20) --
Discontinued Operations --
pre-tax......................... -- -- (3.78) -- (0.95)
Extraordinary Items -- pre-tax..... (2.79) -- -- (0.60) (0.14)
Cumulative Effect of Change in
Accounting pre-tax.............. -- -- -- -- 0.48
---------- ---------- ---------- ---------- ----------
Net income (loss).................. $ (0.74) $ 0.41 $ 0.09 $ 0.17 $ 0.33
========== ========== ========== ========== ==========
OTHER DATA:
EBITDA(5).......................... 24,749 14,727 22,652 15,276 9,300
GAAP RATIOS:(6)
Claim and claim adjustment expense
ratio........................... 64.2% 62.8% 60.1% 71.3% 74.1%
Expense ratio...................... 26.7% 31.8% 26.4% 24.1% 26.1%
---------- ---------- ---------- ---------- ----------
Continuing operations combined
ratios, net of reinsurance...... 90.9% 94.6% 86.5% 95.4% 100.2%
========== ========== ========== ========== ==========
Ratio of earnings to combined fixed
charges and accretion on
preferred securities(7)......... 1.98x 1.27x 1.87x 1.36x 1.33x
FINANCIAL POSITION:
Total cash and investments(8)
Carrying value.................. $ 242,116 $ 149,440 $ 163,951 $ 176,878 $ 150,179
Market value.................... 242,116 149,440 166,103 172,706 156,744
Total assets....................... 416,569 306,569 240,781 286,776 264,098
Long-term debt..................... 30 98,961 8,530 9,730 6,743
Claim and claim adjustment expense
liability....................... 201,225 115,529 141,495 171,258 171,038
Total liabilities.................. 255,474 237,807 176,256 227,622 224,044
Preferred securities issued by
affiliate....................... 101,277 23,571 21,045 18,790 --
Net stockholders' equity........... 59,818 45,191 43,480 40,364 40,055
Book value per share(3)............ $ 10.19 $ 13.11 $ 12.68 $ 11.77 $ 11.68
Outstanding shares(3).............. 5,871,279 3,446,492 3,430,373 3,429,873 3,429,873
</TABLE>
- ---------------
(1) The information for the year ended December 31, 1997 includes the financial
data of SPCC for the period beginning April 1, 1997.
(2) The Company's losses from discontinued operations resulted principally from
contractors' and developers' liability business underwritten from 1986 to
1991.
(3) Adjusted to reflect a four-into-one reverse stock split effective as of May
24, 1995.
(4) Since the Company's inception it has not declared or paid any dividends to
its stockholders. Income before items below -- after all taxes has been
calculated to include the tax benefits related to the items following.
(5) EBITDA consists of earnings before interest, taxes, minority interest,
depreciation, and amortization. EBITDA is presented here not as a measure
of operating results, but rather as a measure of the Company's cash flow
and debt service ability, and should not be considered as an alternative to
net earnings and cash flows determined in accordance with GAAP. Because the
Company's ability to obtain dividends from its insurance subsidiaries may
be subject to certain restrictions, EBITDA is not necessarily indicative of
the Company's ability to service its indebtedness.
30
<PAGE> 33
(6) These ratios are for continuing operations. The claim and claim adjustment
expense ratio is calculated by dividing the claim and claim adjustment
expenses by net premiums earned. The expense ratio is calculated by
dividing the sum of commissions (net of reinsurance ceding commissions),
policyholder dividends, and general and administrative expenses by net
premiums earned. The combined ratio is the sum of the claim and claim
adjustment expense ratio and the expense ratio.
(7) For purposes of calculating the ratio of earnings to combined fixed charges
and preferred stock dividends, earning represent income before the
provision (benefit) for income taxes, plus fixed charges. Fixed charges
consist of interest expense, amortization of financing costs and the
portion of rental expense on operating leases which the Company estimates
to be representative of the interest factor attributable to the leases.
Preferred stock dividends consist of dividends on approximately $26.6
million in preferred securities having an effective interest rate of 11.7%
issued in June 1994 by an affiliate.
(8) Investments as of December 31, 1997 and 1996 are reflected at market value.
As of December 31, 1995 and 1994 a portion of the portfolio was classified
as held to maturity and was therefore reflected at amortized cost and the
remaining portfolio was shown at market value. Investments as of December
31, 1993 are reflected at amortized cost. The changes in portfolio
valuation reflect the adoption of Statement of Financial Accounting
Standard No. 115, effective for fiscal years following December 15, 1993.
31
<PAGE> 34
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis provides information that management
believes to be relevant for an understanding of the Company's consolidated
results of operations and financial condition. The discussion should be read in
conjunction with the consolidated financial statements and the notes thereto.
OVERVIEW
During 1997, the Company entered into three significant extraordinary
transactions: the acquisition of Pac Rim Holding Corporation, the parent of
SPCC, completed April 11, 1997, the prepayment of approximately $88.6 million of
long term debt completed June 30, 1997, and the issuance of $105 million in
Trust Preferred Securities by the Trust completed December 3, 1997. The
Company's income before preferred securities' dividends and accretion,
discontinued operations and extraordinary items was $10.8 million in 1997, as
compared to $3.6 million in 1996. The increase of $7.2 million in income before
income taxes, preferred securities' dividends and accretion, discontinued
operations and extraordinary items was primarily the result of a $4.9 million
increase in investment income. The increase of $4.9 million in net investment
income is primarily due to increases of $92.7 million and $93.1 million in
assets available for investment that resulted, respectively, from the
acquisition of SPCC and the November 1996 financing transaction. See
"-- Liquidity and Capital Resources."
For the year ended December 31, 1997, the Company recorded a net loss of
$5.1 million after preferred securities' dividends and accretion, discontinued
operations, and extraordinary items, as compared to income of $2.0 million for
the year ended December 31, 1996. Net loss per share for the year ended December
31, 1997 was $0.74 (diluted) versus net income per share of $0.41 diluted in
1996. The Company recorded during 1997, $12.9 million in extraordinary losses,
net of income tax benefits, as a result of the prepayment of debt or the
retirement of debt instruments, as compared to 1996, when no extraordinary
losses were recorded. Further, during 1997, the Company recorded $3.0 million in
dividend expense and accretion on preferred securities, as compared to $1.7
million in 1996.
For the year ended December 31, 1996, the Company's net income was $2.0
million, diluted as compared to $0.4 million in 1995. Net income per share for
the year ended December 31, 1996 was $0.41 versus $0.09 for the year ended
December 31, 1995. Income before preferred securities' dividends and accretion,
discontinued operation, and extraordinary loss was $3.6 million for the year
ended December 31, 1996, versus $11.7 million in 1995. The decrease in 1996 was
due principally to a $5.3 million fee for reinsurance, as well as an increase of
$1.7 million from 1995 claims and claims adjustment expense. Income before
preferred securities' dividends and accretion, discontinued operations, and
extraordinary loss, excluding the above discussed adjustments, was $10.6 million
for the year ended December 31, 1996, as compared to $11.7 million for the
comparable period of 1995.
YEAR ENDED DECEMBER 31, 1997 AS COMPARED TO YEAR ENDED DECEMBER 31, 1996
Gross premiums written for the years ended December 31, 1997 and 1996 were
$159.4 million and $99.3 million, respectively. This increase in gross premiums
written represents an increase of $60.1 million or 60.5% for the 1997 policy
year as compared to the 1996 policy year. Substantially all of this increase can
be attributed to business written related to SPCC. Net premiums written
increased $49.2 million or 56.1% to $136.9 million for the year ended December
31, 1997, as compared to the year ended December 31, 1996. This increase
reflects the increase in gross premiums written. Net premiums earned increased
$52.3 million or 59.0% to $140.9 million for the year ended December 31, 1997,
as compared to the year ended December 31, 1996.
For the year ended December 31, 1997, net claim and claim adjustment
expenses increased $34.8 million or 62.6% to $90.4 million as compared to $55.6
million for the year ended December 31, 1996. The entire increase of claim and
claim adjustment expense relates to the acquisition of SPCC. The net claim and
claim adjustment expense ratio increased to 64.2% for the year ended December
31, 1997, as compared to 62.8% for the year ended December 31, 1996. The
increase in the claim and claim adjustment expense ratio is due
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<PAGE> 35
primarily to the 1997 accident year. Although the Company has continued to
experience a reduction in the frequency of claims, at the same time there has
been an increase in claims severity for injuries sustained in 1995 and
thereafter. To address the increasing severity trend, management has put into
place the Claims Severity Management Program that is intended to reduce the
Company's average ultimate per claim and claim adjustment expense for 1995 and
subsequent dates of injury. See "Business -- Claims Severity Management
Program."
Underwriting and general and administrative expenses, excluding
policyholder dividends, increased $3.6 million or 10.4% to $37.7 million for the
year ended December 31, 1997, as compared to the same period in 1996. This
increase primarily resulted from the SPCC acquisition. Excluding the onetime
expense of $5.3 million for the cancellation in 1996 of a reinsurance contract,
underwriting expenses for 1997 increased $8.9 million or 30.9%. The Company's
expense ratio decreased to 26.7% from 38.5% for the year ended December 31,
1997, as compared to 1996. The decrease in the expense ratio from 1997 to 1996
is due to the 1996 one-time charge of $5.3 million previously mentioned, and an
increase in premium without a corresponding increase in expense resulting from
the SPCC acquisition.
No policyholder dividends were paid during the year ended December 31,
1997, as compared to $1.3 million of such dividends during fiscal 1996. 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 price at a policy's inception
under open rating, dividends are currently no longer a significant factor in the
marketing of workers' compensation insurance in California. In 1995, as a result
of the diminishing value of policyholder dividends as a marketing tool, the
Company's management declared a moratorium in the payment of policyholder
dividends for California policies. In December 1996, the Company discontinued
dividend payments. Estimated amounts to be returned to policyholders were
accrued when the related premium was earned by the Company. Dividends were paid
to the extent that a surplus was accumulated from premium on workers'
compensation policies.
Net investment income increased $4.9 million or 63.1% to $12.7 million for
the year ended December 31, 1997, as compared to the year ended December 31,
1996. The increase in investment income is due to a $92.7 million increase in
assets available for investment that resulted from the acquisition of SPCC.
Interest expense decreased 15.8% to $6.3 million for the year ended
December 31, 1997, as compared to the year ended December 31, 1996. The decline
in interest expense is due primarily to the elimination of funds withheld
balance, which was partially off-set by the issuance of $105 million of Senior
Subordinated Notes in November 1997.
Discontinued operations claim counts and losses as of December 31, 1997
were 215 and $13.5 million, respectively. These amounts and estimates are
consistent with management's expectations. The Company has significant exposure
to construction defect liabilities on P&C insurance policies underwritten from
1986 to 1993. Management continues to monitor closely its potential exposure to
construction defect claims and has not changed its estimates of ultimate claim
and claim adjustment expense on discontinued operations since 1995. Management
believes its current reserves are adequate to cover its claim liabilities. There
can be no assurance, however, that further upward development of ultimate loss
costs associated with construction defect claims will not occur. See "Business
- -- Discontinued Operations."
YEAR ENDED DECEMBER 31, 1996 AS COMPARED TO YEAR ENDED DECEMBER 31, 1995
Gross premiums written increased $2.2 million or 2.3% to $99.3 million in
1996 from 1995. The increase in gross premiums written in 1996 was due primarily
to the Company's continued strategy of underwriting smaller risks where the
competition has been less fierce, as compared to larger policies. Net premiums
written decreased $1.4 million or 1.6% to $87.7 million reflecting an increased
amount of premiums ceded to reinsurers. Net premiums earned decreased $1.1
million or 1.2% to $88.6 million in 1996 from 1995, reflecting in part, an
increase in ceded premiums.
Claim and claim adjustment expenses increased $1.7 million or 3.1% to $55.6
million in 1996 from 1995, due principally to adverse development in claim and
claim adjustment expense reserves related to the 1995
33
<PAGE> 36
accident year. The claim and claim adjustment expense ratio as a percentage of
net earned premium increased slightly to 62.8% in 1996 from 60.1% in the 1995
accident year.
Underwriting and general and administrative expenses, excluding
policyholder dividends, increased $4.7 million or 16% to $34.1 million in 1996
from 1995. The increase in underwriting and general and administrative expenses,
excluding policyholder dividends, was due primarily to a $5.3 million adjustment
recorded in the second quarter of 1996 for accrued costs related to the
cancellation of a reinsurance contract. Underwriting and general and
administrative expenses for 1996, excluding the $5.3 million in accrued costs,
were $28.8 million as compared to $29.4 million in 1995. The Company's expense
ratio, excluding the $5.3 million in accrued costs and policyholder dividends,
was 32.5% for 1996, which is comparable to 32.8% in 1995.
Policyholder dividend expenses for 1996 were comparable to 1995,
constituting a decrease in underwriting expense of $5.9 million in 1996 as
compared to $5.7 million in 1995.
Underwriting profit from continuing operations decreased $7.3 million or
60% to $4.8 million in 1996 from 1995, principally due to a $4.7 million
increase in underwriting expense. The increase in underwriting and general and
administrative expenses was due primarily to the cost of canceling the
reinsurance contract discussed above, and $2.0 million in claim and claim
adjustment expense due as a result of adverse development on reserves related to
prior accident years.
Net investment income decreased $2.0 million or 20% to $7.8 million in 1996
as compared to 1995. The decline in investment income was due to a decrease in
the average investable assets of $11.3 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. While a financing transaction involving Chase
Manhattan Bank and an affiliate of Zurich entered into in November 1996
substantially increased the size of the investment portfolio on which the
Company retained investment income, it occurred too late in 1996 to have a
material effect on 1996 net investment income results. See "-- Liquidity and
Capital Resources."
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash inflows are generated from cash collected from policies
sold, investment income generated from its existing portfolio, and sales and
maturities of investments. The Company's cash outflows consist primarily of
payments for policyholders' claims, operating expenses and debt service. For
their insurance operations, SNIC and SPCC must have available cash and liquid
assets to meet their obligation to policyholders and claimants in accordance
with contractual obligations in addition to meeting their ordinary operating
costs. Absent adverse material changes in the workers' compensation insurance
market, management believes the Company's present cash resources are sufficient
to meet its needs for the foreseeable future.
During the year ended December 31, 1997, the Company used $52.4 million of
cash in its operations versus $14.9 million in the year ended December 31, 1996.
The Company's continued negative cash flow is the result of the Company's
premium in force being significantly higher historically versus its current
level. The Company anticipates that it will continue to experience the negative
cash flow from operations until the claims related to the historically higher
premium base have been paid out. The $37.5 million increase in cash used in
operations during the year ended December 31, 1997 is primarily due to the
addition of the SPCC operations. The Company believes that it has adequate
short-term investments and readily marketable investment grade securities to
cover both claim payments and expenses. At December 31, 1997, the Company had
total cash and cash equivalents, and investments of $242.1 million and had 99.4%
of its investment portfolio invested in cash, cash equivalents, and fixed
maturities. In addition, 90.8% of the Company's fixed-income portfolio had
ratings of "AA" or equivalent or better and 98.0% had ratings of "BBB" or
equivalent or better.
The Company generated $77.3 million from financing activities during the
year ended December 31, 1997, as compared to $90.5 million in 1996. The 1996
financing activities consisted primarily of the transaction with The Chase
Manhattan Bank discussed below. During 1997, the Company's financing activities
were used to fund the acquisition of SPCC, to repay outstanding bank debt, to
redeem outstanding preferred stock issued by an affiliate and to refinance
existing debt. The Company generated the necessary
34
<PAGE> 37
cash to acquire SPCC from the proceeds of a $44.0 million term loan and the sale
of approximately $18.0 million in common stock. Of the approximately $62.0
million raised in such financing transactions, approximately $42.0 million was
used to fund the acquisition of SPCC, approximately $6.6 million was used to
repay an existing bank loan, $10.0 million was contributed to as capital to
SPCC, with the remainder of the funds being used for general corporate purposes,
including the payment of related transaction costs.
On December 3, 1997, the Trust, a wholly owned subsidiary of SNIG, issued
its Trust Preferred Securities, having an aggregate liquidation amount of $105
million, in a private placement and also issued to SNIG, for an aggregate
consideration of approximately $3.25 million, all of the Trust's common
securities. The proceeds from the sale of these securities were used to purchase
SNIG's Senior Subordinated Notes, all of which were issued in connection with
such transaction. In addition, the Company entered into several contractual
undertakings which, the Company believes, when taken together, guarantee (the
"Company Guarantee") to the holders of such securities a full and unconditional
right to enforce the payment of the distributions with respect to such
securities. On January 16, 1998, SNIG and the Trust completed the registration
with the Securities and Exchange Commission of an exchange offer for the
outstanding Trust Preferred Securities, Senior Subordinated Notes and Company
Guarantee, pursuant to which substantially all of such securities were exchanged
for substantially similar securities. SNIG used the proceeds it received from
the issuance of the Senior Subordinated Notes to repay the $40.3 million
outstanding balance on the term loan used to acquire SPCC, to redeem
approximately $27.7 million in preferred stock issued by a SNIG affiliate to an
affiliate of Zurich, to pay approximately $4.0 million in related transaction
costs, and for general corporate purposes, including a $15.0 million
contribution to the surplus of SNIC.
Distributions on the Trust Preferred Securities (and interest on the
related Senior Subordinated Notes) are payable semi-annually, in arrears, on
June 1 and December 1 of each year, commencing June 1, 1998. Subject to certain
conditions, on or after December 1, 2005, SNIG has the right to redeem the
Senior Subordinated Notes, in whole or in part at any time, at call prices
ranging from 105.375% at December 1, 2005 to 101.792% at December 1, 2007, and
100% thereafter. The proceeds from any such redemption will be immediately
applied by the Trust to redeem Trust Preferred Securities and the Trust's common
securities at such redemption prices. In addition, SNIG has the right, at any
time, subject to certain conditions, to defer payments of interest on the Senior
Subordinated Notes for Extension Periods (as defined in the Indenture), each not
exceeding 10 consecutive semi-annual periods; provided that no Extension Period
may extend beyond the maturity date of the Senior Subordinated Notes. As a
consequence of any such extension by SNIG of the interest payment period,
distributions on the Trust Preferred Securities would be deferred (though such
distributions would continue to accrue interest at a rate of 10.75% per annum
compounded semi-annually). Upon the termination of any Extension Period and the
payment of all amounts then due, SNIG may commence a new Extension Period,
subject to certain requirements.
In addition, during 1997 the Company repaid approximately $0.6 million of
an existing bank loan and $3.7 million of the principal of the term loan used to
acquire SPCC.
In November 1996, the Company entered into a financing transaction
involving Centre Re and The Chase Manhattan Bank ("Chase") pursuant to which
Chase extended a $93.1 million term loan, net of transaction costs. The Company
used the proceeds from the transaction to purchase from SNIC reinsurance
receivables due from Centre Re. On June 30, 1997, the Company and Chase reached
an agreement under which the Company agreed to transfer such reinsurance
receivables to Chase in exchange for the cancellation of the Company's debt to
Chase. As a result of these actions, the Company's investable assets increased
$93.1 million. The additional investments contributed to the increase in
investment income in 1997.
The Company has a reverse purchase facility with a national securities
brokerage firm that allows it to engage in up to $20.0 million in reverse
purchase transactions secured by either U.S. Treasury instruments, U.S. Agency
debt, or corporate debt. This arrangement provides the Company with additional
short-term liquidity. Reverse purchase transactions may be rolled from one
period to the next, at which time the transaction is repriced. This type of
financing allows Superior Pacific a great deal of flexibility to manage
short-term investments, avoiding unnecessary realization of losses to satisfy
short-term cash needs. Further,
35
<PAGE> 38
this method of financing is less expensive than bank debt. As of December 31,
1997, the Company had no obligation outstanding under this facility.
SNIG, as a holding company, depends on dividends and intercompany tax
allocation payments from Superior Pacific for its net cash flow requirements,
which consist primarily of periodic payments on its outstanding debt
obligations. Absent other sources of cash flow, SNIG cannot expend funds
materially in excess of the amount of dividends or tax allocation payments that
could be paid to it by Superior Pacific. Further, insurance companies are
subject to restrictions affecting the amount of shareholder dividends and
advances that may be paid within any 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 up to the greater of (i) net income for
the preceding year and (ii) 10% of statutory surplus as regards policyholders as
of the preceding December 31) without prior notice to, or approval by, the DOI.
No dividends were paid during 1997; however SNIC paid $2.9 million to SNIG for
its current income taxes.
The Company is party to several leases principally associated with the
Company's home and branch office space, as well as its fixed assets. Such leases
contain provisions for scheduled lease charges and escalations in base rent over
the lease term. The Company's minimum lease commitment with respect to these
leases in 1998 is approximately $7.0 million. These leases expire from 2000 to
2003.
While the Company does not presently foresee any expenditures during the
next twelve months other than those arising in the normal course of business,
the Company may seek to expand market share without deviating from its pricing
strategy, by seeking strategic alliances, investment opportunities or
acquisitions. However there can be no assurances any such opportunities will be
realized.
The effect of inflation on the revenues and net income of the Company
during the years ended December 31, 1997, 1996, and 1995 was not significant.
TAXES
As of December 31, 1997, the Company has available $130.2 million in NOLs
to offset taxable income recognized by the Company in periods after December 31,
1997. For federal income tax purposes, these NOLs will expire in material
amounts beginning in the year 2006. Any 5% shift in the current ownership of the
Company may result in a "change of ownership" under Section 382 of the Code, and
severely limit the Company's ability to utilize NOLs. In an effort to protect
these NOLs, the Company's charter documents prohibit 5% owners of the Company's
common stock (including holders of options and warrants) from acquiring
additional stock and prohibit any additional person or entity from becoming a 5%
holder of common stock. The prohibition against changes in ownership by the 5%
holders of common stock expires in April 2000. See "Business -- Risk Factors --
Availability of Net Operating Loss Carryforwards."
PRIMARY DIFFERENCES BETWEEN GAAP AND SAP
The financial statements contained herein have been prepared in conformity
with Generally Accepted Accounting Principles ("GAAP"), as opposed to Statutory
Accounting Practices ("SAP") prescribed or permitted for insurance companies by
regulatory authorities. SAP differs from GAAP principally in the following
respects: (a) premium income is taken into operations over the periods covered
by the policies, whereas the related acquisition and commission costs are
expensed when incurred; (b) deferred income taxes are not recognized under SAP;
(c) certain assets such as agent's balances over ninety days due and prepaid
expenses are nonadmitted assets for statutory reporting purposes; (d)
policyholder dividends are accrued when declared; (e) the cash flow statement is
not consistent with classifications and the presentation under GAAP; (f) bonds
are recorded at amortized cost, regardless of trading activities; (g) loss and
loss adjustment expense reserves and unearned premium reserves are stated net of
reinsurance; and (h) minimum statutory reserves for losses in excess of the
Company's estimates are required.
In March 1998, the NAIC approved the codification of statutory accounting
practices. Included in the codification of statutory accounting practices is the
change in the definition of prescribed versus permitted
36
<PAGE> 39
statutory accounting policies that insurance companies use to prepare their
statutory financial statements. The company has not yet determined the impact of
the adoption of the codification project.
YEAR 2000 STRATEGY
A significant percentage of the software that runs most of the computers in
the United States and the rest of the world relies on two-digit date codes to
perform computations and decision making functions. Commencing January 1, 2000,
these computer programs may fail from an inability to interpret date codes
properly, misinterpreting "00" as the year 1900 rather than 2000. The Company is
in the process of identifying all necessary software changes to ensure that it
does not experience any loss of critical business functionality due to the year
2000 issue. The Company has appointed an internal Year 2000 project manager and
adopted a three phase approach of assessment, correction and testing. The scope
of the project includes all internal software, hardware, and operating systems,
and assessment of risk to the business from producers, vendors and other
partners in Year 2000 issues. The Company believes that this formal assessment
of risk (including the prioritization of business risk), correction (including
conversions to new software), and testing of necessary changes will minimize the
business risk of Year 2000 from internal systems. The Company plans to complete
its Year 2000 conversion not later than December 31, 1998. Although the Company
has not completed its Year 2000 project, the Company does not believe the Year
2000 issue will cause any system problems that could have a material adverse
effect on the operations of the Company. The Company does not expect the cost
associated with its year 2000 project to be material.
SUPPLEMENTARY DATA
Summarized quarterly financial data for 1997 and 1996 is as follows (in
thousands, except per share data):
<TABLE>
<CAPTION>
QUARTER-TO-DATE ENDED
------------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
------------- --------------- ------------- -------------
<S> <C> <C> <C> <C>
1997
Earned premiums.................................. $ 18,978 $ 45,410 $ 34,760 $ 41,772
Income before income taxes, preferred securities
dividends and accretion and extraordinary
items.......................................... $ 1,881 $ 382 $ 5,460 $ 9,538
Net income (loss)................................ $ 756 $ (10,530) $ 2,132 $ 2,501
Basic earnings per share......................... $ 0.22 $ (1.80) $ 0.36 $ 0.42
Diluted earnings per share....................... $ 0.14 $ (1.39) $ 0.28 $ 0.32
1996
Earned premiums.................................. $ 18,897 $ 24,136 $ 23,007 $ 22,608
Income before income taxes, preferred securities
dividends and accretion and extraordinary
items.......................................... $ 1,656 $ 1,406 $ 1,440 $ 725
Net income (loss)................................ $ 678 $ 526 $ 712 $ 47
Basic earnings per share......................... $ 0.20 $ 0.15 $ 0.21 $ 0.02
Diluted earnings per share....................... $ 0.17 $ 0.12 $ 0.15 $ 0.01
</TABLE>
NEW ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 128, "Earnings per Share" ("SFAS 128"),
which was adopted for the year ended December 31, 1997. The Company has changed
its method used to compute per share results and restated all prior periods. The
impact of SFAS 128 did not have a material effect on the Company's earnings per
share.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 130, "Reporting Comprehensive Income" ("SFAS
130"). SFAS 130 is effective for periods ending after December 15, 1997,
including interim periods. SFAS 130 requires companies to report comprehensive
income and its components in a financial statement and display the accumulated
balance of
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<PAGE> 40
other comprehensive income separately from retained earnings and additional
paid-in-capital. Comprehensive income includes all changes in equity during a
period except those resulting from investments by stockholders and distributions
to stockholders. The Company has not determined the impact of SFAS 130.
Also, in June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard, 131, "Disclosures about Segments of
an Enterprise and Related Information" ("SFAS 131"). This statement specifies
revised guidelines for determination of an entity's operating segments and the
type and level of financial information to be disclosed. SFAS 131 is effective
for periods ending after December 15, 1997, including interim periods. The
Company's adoption of SFAS 131 will not have any impact on its current financial
reporting practices.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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<PAGE> 41
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
DIRECTORS
Information is set forth below concerning the directors of the Company and
the year in which each was first elected as a director of the Company.
<TABLE>
<CAPTION>
DIRECTOR
NAME AGE POSITION WITH THE COMPANY SINCE
---- --- ------------------------- --------
<S> <C> <C> <C>
C. Len Pecchenino(1)............. 70 Director, Chairman of the Board 1988
Steven D. Germain(2)............. 44 Director 1995
Thomas J. Jamieson(1)(3)......... 54 Director 1985
Gordon E. Noble(2)............... 69 Director 1990
Craig F. Schwarberg(1)(3)........ 42 Director 1992
Robert A. Spass.................. 42 Director 1992
Bradley E. Cooper(2)(3).......... 31 Director 1992
William Gentz.................... 57 President, Chief Executive 1994
Officer and Director
J. Chris Seaman(3)............... 43 Executive Vice President, Chief 1993
Roger W. Gilbert................. 66 Director 1997
</TABLE>
- ---------------
(1) Member of Audit Committee
(2) Member of Compensation Committee
(3) Member of Investment Committee
No arrangement or understanding exists between any director and any other
person pursuant to which any director holds such position. None of the directors
has any family relationship to any other director or executive officer of the
Company.
C. Len Pecchenino became a director of the Company in May 1988 and was
elected as Chairman in June 1994. He served as the Company's Chief Executive
Officer from September 1991 to February 1992 and as the President and Chief
Executive Officer from February 1994 to May 1994. He also served as the Chairman
from September 1991 to August 1992. Mr. Pecchenino held various executive
officer positions, including President and Chief Operating Officer, with IC
Industries, Inc. and Pneumo Corporation until his retirement in 1986.
Steven D. Germain was elected to the Company's Board of Directors in April
1995. From 1988 to 1994 he served as General Counsel to the Centre Reinsurance
Group of Companies. Since 1994 he has served as Managing Director of Zurich
Centre Group L.L.C., a company that provides management services to the Centre
Reinsurance Group of Companies. Mr. Germain continues to serve as a director and
as Managing Director, General Counsel and Secretary to Centre Re and as a
director, Senior Vice President and Secretary of CentreLine. Mr. Germain is also
a director, President, and Chief Executive Officer of Home Holdings, Inc. and a
director of certain of its subsidiaries.
Thomas J. Jamieson has been a director of the Company since December 1985.
Since 1971, he has served as President of Jaco Oil Company, and has been a
director of Berry Oil Co. since 1993.
Gordon E. Noble became a director of the Company in October 1990. Since
July 1990, he has been Chairman and Chief Executive Officer of Commodore
Insurance Services and previously served as Executive Vice President and as a
director and member of the Executive Committee of Sedgwick James, an
international insurance brokerage and risk management firm.
Craig F. Schwarberg was appointed to the Board of Directors in March 1992.
From 1991 to 1997, Mr. Schwarberg worked for International Insurance Advisors,
Inc. ("IIA"), serving as a Managing Director
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<PAGE> 42
through February 1994. From 1994 to March 1996, Mr. Schwarberg was a director
and Chairman of the Board of NACOLAH Holding Corporation. Prior to 1991, he held
various positions at Lehman Brothers Inc., most recently as Senior Vice
President.
Robert A. Spass was appointed to the Board of Directors in March 1992.
Since 1990, Mr. Spass has served as President and Chief Executive Officer, and a
director, of IIA. From 1994 to the present, Mr. Spass has been a Managing
Partner of Insurance Partners Advisors, L.P. Prior to 1990, Mr. Spass held
various positions at Salomon Brothers Inc, most recently as a Director. Since
January 1996, he has served as a director of Highlands Insurance Group, Inc.
Since January 1998, he has served as a director of MMI Companies, Inc. From 1990
to 1996, he served as a director of National Reinsurance Holdings Corp. From
1994 to 1997, he served as a director of Unionamerica Holdings plc and from 1994
to 1996 he served as a director of NACOLAH Holding Corporation.
Bradley E. Cooper became a director of the Company in May 1992. Currently,
Mr. Cooper is a Partner of Insurance Partners Advisors, L.P., joining at its
formation in 1994. From May 1990 to February 1994, Mr. Cooper served as Vice
President of IIA. Prior to 1990, Mr. Cooper was an analyst with Salomon Brothers
Inc. Since January 1996, he has served as a director of Highlands Insurance
Group, Inc.
William Gentz became a director of the Company in June 1994. Mr. Gentz has
held the position of President and Chief Executive Officer since mid-1994. Mr.
Gentz joined the Company after seventeen years at Zenith Insurance Company where
he was responsible for marketing, underwriting, loss control, and field
operations for Zenith's workers' compensation operations. Mr. Gentz began his
insurance career in 1958, and from 1958 to 1968 worked in the marketing and
underwriting departments of a variety of insurance companies in the mid-west and
California.
J. Chris Seaman became a director of the Company in March 1993. Mr. Seaman
has held the positions of Executive Vice President since February 1995 and Chief
Financial Officer since July 1991. Prior to joining the Company, Mr. Seaman was
the CFO of a private company engaged in insurance company acquisitions following
ten years with Ernst & Whinney. Mr. Seaman previously held staff and management
positions at Industrial Indemnity Insurance Company and Allianz of America
Corporation, respectively.
Steven B. Gruber became a director of the Company in April 1997. He was a
founder of, and since February 1994, has served as a Managing Partner of,
Insurance Partners Advisors, L.P. From May 1990 to present, Mr. Gruber has
served as the Managing Director of Oak Hill Partners, Inc. and from October 1992
to present, has served as a Vice President of Keystone, Inc. From 1981 to April
1990 he was associated with Lehman Brothers Inc., most recently as Managing
Director and Co-Head of high-yield securities. From 1994 to 1997 he served as a
director of Unionamerica Holdings plc. He is also a director of Reliant Building
Products, Inc. and MVE Inc.
Roger W. Gilbert became a director of the Company in April 1997. From May
1988 until his retirement in June 1993, Mr. Gilbert served simultaneously as the
Chief Executive Officer and Chairman of the Board of TIC Indemnity Co., the
Chief Executive Officer of TMIC Insurance Co. Inc., and a California Special
Deputy Insurance Commissioner, a position to which he was appointed by the
California Insurance Commissioner. Prior to 1988, Mr. Gilbert served as Senior
Vice President and director of Great American Insurance Companies, and as
President of Great America West Inc.
EXECUTIVE OFFICERS
Set forth in the table below are the names, ages and current offices held
by all executive officers of the Company and Superior Pacific. Unless
specifically noted, the positions named are held at both the Company and at
Superior Pacific.
40
<PAGE> 43
<TABLE>
<CAPTION>
EXECUTIVE
OFFICER
NAME AGE POSITION WITH THE COMPANY SINCE
---- --- ------------------------- ---------
<S> <C> <C> <C>
William L. Gentz............... 57 President and Chief Executive Officer 1994
Executive Vice President and Chief Financial
J. Chris Seaman................ 43 Officer 1991
Executive Vice President and Chief Operating
Arnold J. Senter............... 56 Officer 1997
Thomas I. Boggs, Jr............ 51 Senior Vice President -- Underwriting 1995
Karl O. Johnson................ 66 Senior Vice President, Superior Pacific 1989
Douglas R. Roche............... 58 Senior Vice President 1990
Senior Vice President, General Counsel and
Robert E. Nagle................ 49 Secretary 1996
James L. Cinney................ 57 Senior Vice President, Superior Pacific 1994
Edward C. Shoop................ 53 Senior Vice President and Chief Actuary 1997
Matthew Natalizio.............. 43 Vice President, Finance and Treasurer 1994
Sue A. Binder.................. 50 Vice President, Superior Pacific 1992
Harold J. Fedora............... 47 Vice President, Superior Pacific 1993
Curtis H. Carson............... 37 Vice President, Superior Pacific 1997
Jack W. Solomon (1)............ 64 Resident Vice President, Superior Pacific 1991
Robert J. Niebur............... 62 Resident Vice President, Superior Pacific 1995
</TABLE>
- ---------------
(1) Mr. Solomon retired from the Company on February 6, 1998.
Executive officers of the Company are elected by and serve at the
discretion of the Board. No arrangement exists between any executive officer and
any other person or persons pursuant to which any executive officer was or is to
be selected as an executive officer. None of the executive officers has any
family relationship to any director or to any other executive officer of the
Company. Set forth below is a brief description of the business experience for
the previous five years of all of the executive officers.
William L. Gentz has held the positions of President and Chief Executive
Officer since mid-1994, and has served as a director of the Company since June
1994. Mr. Gentz joined the Company after seventeen years at Zenith Insurance
Company where he was responsible for marketing, underwriting, loss control, and
field operations for Zenith's workers' compensation operations. Mr. Gentz began
his insurance career in 1958, and from 1958 to 1968 worked in the marketing and
underwriting departments of a variety of insurance companies in the mid-west and
California.
J. Chris Seaman has held the positions of Executive Vice President since
February 1995 and Chief Financial Officer since July 1991, and has served as a
director of the Company since March 1993. Prior to joining the Company, Mr.
Seaman was the CFO of a private company engaged in insurance company
acquisitions, following ten years with Ernst & Whinney. Mr. Seaman previously
held staff and management positions at Industrial Indemnity Insurance Company
and Allianz of America Corporation, respectively.
Arnold J. Senter has held the positions of Executive Vice President and
Chief Operating Officer since February 1997. Prior to joining the Company, Mr.
Senter most recently served as Senior Vice President, Southwest and Southeast
Operations, at Zenith National Insurance Company, and had previously held
various operational positions in nearly every functional area for Zenith since
1981. Mr. Senter has 30 years experience with both regional and national
carriers.
Thomas I. Boggs, Jr. was appointed Senior Vice President of Workers'
Compensation Underwriting effective March 1995. From October 1993 to March 1995,
he served as Assistant Vice President of Fremont Compensation Insurance Company
and from October 1991 to October 1993, served as Business Development Executive
for the Southern California CIC Commercial Insurance Center for Fireman's Fund
Insurance Company. Prior to October 1991, Mr. Boggs held various underwriting
and marketing positions at Cypress Insurance Company, Industrial Indemnity
Insurance Company, and Safeco.
41
<PAGE> 44
Karl O. Johnson has been responsible for SNIC's Central California
Operations since 1989. He was promoted to Senior Vice President in 1994. Mr.
Johnson has served with various insurance organizations in loss control and
marketing capacities since 1955; he joined the Company in 1987.
Douglas R. Roche was appointed Senior Vice President -- Management
Information Systems in 1994 and served in such position until January 1997 at
which point he was appointed Senior Vice President -- Claims. He served in such
position until September 1997 when he was reappointed Senior Vice President --
Management Information Systems. Before 1994, he served as Vice President of
Internal Operations from the time he joined the Company in 1990. From 1987 to
1990, Mr. Roche sold software and provided systems consulting services to the
insurance industry. From 1969 to 1987 he held a variety of management positions
in various insurance companies' systems analysis operations.
Robert E. Nagle has held the positions of Senior Vice President, General
Counsel, and Secretary since January 1996. From 1986 until he joined the
Company, Mr. Nagle was corporate counsel and senior corporate counsel for
Farmers Group, Inc.
James L. Cinney has held the position of Senior Vice President -- Loss
Control of SNIC since 1994. Before joining the Company, Mr. Cinney was
self-employed in the hospitality industry for one year. Prior to that, he was
Vice President, responsible for loss control, at Industrial Indemnity Insurance
Company. Mr. Cinney has 30 years of workers' compensation loss control
experience in a variety of staff and management positions with Industrial
Indemnity Insurance Company, Zenith Insurance Company, Employee Benefits
Insurance Company, and Hanover Cal/Comp Insurance Company.
Edward C. Shoop was appointed Senior Vice President and Chief Actuary in
October 1997. From April 1995 to August 1997 he served as Senior Vice President
and Actuary with Zenith Insurance Company, and from March 1994 to April 1995
served as Vice President and Actuary with Great States Insurance Company. Prior
to that, Mr. Shoop was Vice President and Actuary with the Workers' Compensation
Insurance Rating Bureau of Massachusetts from November 1991 to March 1994. Mr.
Shoop's 31 years of actuarial experience also includes working for Fireman's
Fund Insurance Company and Royal Insurance Company of Canada, as a Vice
President, and Aetna Life and Casualty Company.
Matthew Natalizio has held the position of Vice President -- Finance and
Treasurer since 1994. From 1988 until he joined the Company, Mr. Natalizio was
employed by KPMG Peat Marwick LLP.
Sue A. Binder has held the position of Home Office Claims Manager of SNIC
since 1991 and was appointed a Vice President in 1992. Prior to 1991, Ms. Binder
held a variety of claims department staff and management positions at Fremont
Indemnity Company where she had been employed since 1977.
Harold J. Fedora, Jr. has held the position of Vice President -- Claims
Services of SNIC since 1993, prior to which he was Calabasas Branch Claims
Manager. From 1975 to 1987 Mr. Fedora was employed at several insurance
companies in various claims department staff and management positions.
Curtis H. Carson has held the position of Vice President -- Human Resources
since January 1997. From 1984 until he joined the Company, Mr. Carson was
employed by Farmers Insurance, most recently as Manager -- Human Resources.
Jack W. Solomon held the position of Vice President of SNIC and Phoenix
Manager since 1995 until he retired from the Company on February 6, 1998. From
1990 until 1995, Mr. Solomon was the Sacramento Branch Manager. Prior to joining
the Company, Mr. Solomon had 30 years experience in workers' compensation
underwriting, marketing, and executive level management in a variety of
insurance companies, principally in the mid-west.
Robert J. Niebur became Resident Vice President of SNIC, in charge of the
South San Francisco branch, in July 1995. Prior to joining the Company, he was
Workers' Compensation Manager for Flinn, Gray & Herterich, an insurance
brokerage firm, from 1994 to 1995, and operated his own insurance consulting
business from 1993 to 1994. Prior to forming his own company, Mr. Niebur was an
operating executive with Great States Insurance Company and held various staff
and executive positions with Zenith Insurance Company.
42
<PAGE> 45
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act ("Section 16(a)") requires the Company's
directors and certain of its officers, and persons who own more than ten percent
of a registered class of the Company's equity securities (collectively,
"Insiders"), to file reports of ownership and changes in ownership with the SEC.
Insiders are required by SEC regulations to furnish the Company with copies of
all Section 16(a) forms they file.
Based solely on its review of the copies of such forms received by it, or
written representations from certain reporting persons that no Forms 5 were
required for those persons, the Company believes that its Insiders complied with
all applicable Section 16(a) filing requirements for fiscal 1997, with the
exception of (i) Curtis H. Carson, an executive officer of the Company, who
filed a Form 5 to report one transaction that was not reported on a Form 4 on a
timely basis and (ii) International Insurance Advisors, Inc. and International
Insurance Investors (Bermuda) Limited, each of which filed a late Form 4 to
report the same two transactions.
43
<PAGE> 46
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth certain information concerning the
compensation for services in all capacities to the Company for the fiscal years
ended December 31, 1997, 1996, and 1995, of those persons who were, at December
31, 1997, (i) the chief executive officer and (ii) the other four most highly
compensated executive officers of the Company.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
-------------------------------------------------
OTHER
ANNUAL
COMPEN-
NAME AND PRINCIPAL POSITION YEAR SALARY(1) BONUS(2) SATION($)
--------------------------- ---- --------------- --------------- -------------
<S> <C> <C> <C> <C>
William L. Gentz..................... 1997 $ 298,300 $ -- --
President and Chief 1996 298,300 278,500 --
Executive Officer 1995 294,508 203,500 --
J. Chris Seaman...................... 1997 231,616 -- --
Executive Vice President 1996 235,298 128,500 --
and Chief Financial Officer 1995 215,600 128,500 --
Arnold J. Senter(7).................. 1997 229,335 -- --
Executive Vice President 1996 -- -- --
and Chief Operating Officer 1995 -- -- --
Matthew Natalizio.................... 1997 183,292 -- --
Vice President 1996 131,004 35,000 --
1995 138,504 30,000 --
Thomas I. Boggs, Jr.................. 1997 164,261 -- --
Senior Vice President(9) 1996 155,800 32,000 --
1995 115,917 7,000 --
<CAPTION>
LONG TERM COMPENSATION
-----------------------------------------
AWARDS PAYOUT
----------- ---------
RESTRICTED SECURITIES ALL OTHER
STOCK UNDERLYING COMPEN-
AWARDS OPTIONS/ LTIP SATION
NAME AND PRINCIPAL POSITION ($)(3) SARS(#) PAYOUT(#) ($)(4)
--------------------------- --------------- ----------- --------- ----------
<S> <C> <C> <C> <C>
William L. Gentz..................... $ 121,250(5) 18,800 -- 2,250
President and Chief 46,874 17,875 -- 2,250
Executive Officer 53,690 19,175 -- 2,250
J. Chris Seaman...................... 109,125(6) 17,500 -- 2,250
Executive Vice President 36,223 13,813 -- 2,250
and Chief Financial Officer 40,170 39,325 -- 2,250
Arnold J. Senter(7).................. -- 25,000 -- 2,250
Executive Vice President -- -- -- --
and Chief Operating Officer -- -- -- --
Matthew Natalizio.................... 18,188(8) 2,786 -- 2,250
Vice President 20,058 6,500 -- 1,875
7,280 2,600 -- 2,078
Thomas I. Boggs, Jr.................. 30,313(10) 4,643 -- 2,250
Senior Vice President(9) 21,306 8,125 -- 2,163
13,000 12,150 -- 1,098
</TABLE>
- ---------------
(1) The amounts set forth for fiscal year 1997 include salary and other cash
compensation paid in that year, other than amounts listed in the column
entitled "Bonus."
(2) Bonus amounts represent cash payments and are presented in the year to
which they apply, although payment typically is made in March of the
subsequent year. Bonus amounts for fiscal year 1997 have not yet been
declared.
(3) Represents the fair market value of the underlying shares on the date of
grant.
(4) Other than as specifically noted, represents the employer's contribution
under the Company's 401(k) Plan.
(5) Represents a grant of 10,000 shares of restricted stock that vests in nine
equal annual increments following the date of grant. As of December 31,
1997, Mr. Gentz held an aggregate of 29,950 shares of restricted stock
valued at $434,275, based upon the $14.50 per share fair market value of
the Common Stock on such date.
(6) Represents a grant of 9,000 shares of restricted stock that vests in nine
equal annual increments following the date of grant. As of December 31,
1997, Mr. Seaman held an aggregate of 24,163 shares of restricted stock
valued at $350,364, based upon the $14.50 per share fair market value of
the Common Stock on such date.
(7) Mr. Senter began his employment with the Company in February 1997.
(8) Represents a grant of 1,500 shares of restricted stock that vests in nine
equal increments following the date of grant. As of December 31, 1997, Mr.
Natalizio held an aggregate of 6,399 shares of restricted stock valued at
$92,786, based upon the $14.50 per share fair market value of the Common
Stock on such date.
44
<PAGE> 47
(9) Mr. Boggs began his employment with the Company in March 1995.
(10) Represents a grant of 2,500 shares of restricted stock that vests in nine
equal annual increments following the date of grant. As of December 31,
1997, Mr. Boggs held an aggregate of 9,375 shares of restricted stock
valued at $135,938, based upon the $14.50 per share fair market value of
the Common Stock on such date.
EMPLOYMENT AGREEMENTS
The Company has in effect employment agreements with the following
officers:
William L. Gentz, President and Chief Executive Officer. Mr. Gentz's
agreement expires on June 1, 1999, but is subject to automatic renewal in
one-year increments unless notification of non-renewal is given sixty days prior
to the expiration of the then-current term. His salary was set as of June 1,
1994 at $275,000 annually, plus benefits and incidentals generally provided to
officers of the Company, and is thereafter as determined by the Board. Mr.
Gentz's annual salary was increased to $287,500 effective August 1, 1995. If Mr.
Gentz's employment is terminated by the Company other than for cause, he is
entitled to payments of his salary and benefits for the then-remaining term of
his agreement. In the event of a change in control of the Company, Mr. Gentz
would be deemed terminated without cause and his employment agreement would be
deemed to have a three-year remaining term.
Arnold J. Senter, Executive Vice President and Chief Operating Officer. Mr.
Senter's agreement expires on February 17, 1999, but is subject to automatic
renewal in one-year increments unless notification of non-renewal is given sixty
days prior to the expiration of the then-current term. His salary was set as of
February 17, 1997 at $200,000 annually, plus benefits and incidentals generally
provided to officers of the Company, and is thereafter as determined by the
Board. If Mr. Senter's employment is terminated by the Company other than for
cause, he is entitled to payments of his salary and benefits for the
then-remaining term of his agreement. In the event of a change in control of the
Company, Mr. Senter would be deemed terminated without cause and his employment
agreement would be deemed to have a three-year remaining term.
J. Chris Seaman, Executive Vice President and Chief Financial Officer. Mr.
Seaman's agreement expires on June 1, 1998, but is subject to automatic renewal
in one-year increments unless notification of non-renewal is given sixty days
prior to the expiration of the then-current term. His annual salary under the
agreement is $200,000, plus benefits and incidentals generally provided to
officers of the Company, and is thereafter as determined by the Board. If Mr.
Seaman's employment is terminated by the Company other than for cause, he is
entitled to payments of his salary and benefits for the then-remaining term of
his agreement. In the event of a change in control of the Company, Mr. Seaman
would be deemed terminated without cause and his employment agreement would be
deemed to have a three-year remaining term.
Edward C. Shoop, Senior Vice President-Chief Actuary. Mr. Shoop's agreement
expires on October 6, 1999 and provides that, if his employment with the Company
is terminated as a result of a change in control, he will be entitled to his
salary and benefits for two years from the date of his termination.
Matthew Natalizio, Vice President, Finance and Treasurer. Mr. Natalizio's
agreement is open-ended. His compensation and benefits are determined by the
Board. If Mr. Natalizio's employment is terminated by the Company other than for
cause, he is entitled to payments of his salary and benefits for one year from
the date of the termination. Mr. Natalizio's agreement does not provide any
special rights in the event of a change in control.
DIRECTOR COMPENSATION
Each director who is not an officer of the Company is paid a fee of $4,000
for each regular Board of Directors meeting attended and $500 for each committee
meeting attended.
In addition, in May 1997, the Board of Directors of the Company approved
the payment to C. Len Pecchenino, the Chairman of the Board, of an annual salary
of $50,000 so long as he remains Chairman of the
45
<PAGE> 48
Board and serves on the Audit Committee of the Board of Directors. This salary
is to be paid in addition to the compensation he normally receives for
attendance at regularly scheduled Board of Directors meetings. Mr. Pecchenino
was paid $50,000 in September 1997 and from thereafter will receive this salary
in four equal quarterly installments.
CHANGE-IN-CONTROL ARRANGEMENTS
In addition to the rights described above with respect to Messrs. Gentz,
Senter, Seaman, and Shoop, the only change-in-control arrangement in place is in
connection with the Company's stock incentives. Under the terms of the 1986
Non-Statutory Stock Option and 1986 Non-Statutory Stock Purchase Plan (the "1986
Plan"), upon a change of control of the Company, unless replacement options to
purchase stock in the new or recapitalized entity are offered, all option
holders will have thirty days to exercise their outstanding options, excluding
those that have then not yet vested. Under the terms of the 1995 Stock Incentive
Plan (the "1995 Plan"), under similar circumstances, the Option Committee of the
Board of Directors (the "Option Committee") may, in its discretion, allow each
person holding an option or restricted stock who did not receive a replacement
equity incentive grant to exercise that option without regard to its vesting
provisions, or to retain that restricted stock without regard to the Company's
repurchase right, as applicable.
EQUITY INCENTIVE GRANTS
Officers, key employees, including directors who are key employees, and
consultants chosen by the Compensation Committee (which acts as the Option
Committee under the terms of the 1986 Plan and 1995 Plan) are eligible to
participate in the 1995 Plan.
Under the 1995 Plan, officers, key employees, and consultants of the
Company or its subsidiaries may be granted options to purchase shares of Common
Stock or they may be given the opportunity to purchase restricted stock of the
Company. The 1995 Plan permits the granting both of options that qualify for
treatment as incentive stock options ("Incentive Stock Options") under Section
422 of the Code, and options that do not qualify as Incentive Stock Options
("Nonqualified Stock Options").
In 1986, the Company adopted the 1986 Plan, which allowed the Company to
issue to employees of the Company and its subsidiaries Nonqualified Stock
Options and rights to purchase Common Stock. The purchase right aspect of the
1986 Plan was terminated by the Board of Directors in 1989. Following the
adoption of the 1995 Plan, the Board of Directors determined to make no further
grants pursuant to the 1986 Plan.
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth information concerning options granted
during fiscal 1997 to each of the executive officers named in the Summary
Compensation Table set forth above under "Executive Compensation."
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
-----------------------------------------------------------
NUMBER OF
SECURITIES % OF TOTAL EXERCISE POTENTIAL REALIZABLE
UNDERLYING OPTIONS/SARS OR BASE VALUE AT ASSUMED
OPTIONS/SARS GRANTED TO EMPLOYEES PRICE EXPIRATION ANNUAL RATES OF STOCK PRICE
NAME GRANTED (#) IN FISCAL YEAR ($/SH)(1) DATE APPLICATION FOR OPTION TERM
---- ------------ -------------------- --------- ---------- -----------------------------
0% 5%($)(3) 10%($)(3)
---- --------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
William L. Gentz..... 18,800(4) 14.9 12.125 3/31/07 0 143,414 363,294
J. Chris Seaman...... 17,500(4) 13.8 12.125 3/31/07 0 133,497 338,172
Arnold J. Senter..... 25,000(4) 19.8 11.380 2/17/07 0 178,920 434,795
Matthew Natalizio.... 2,786(4) 2.2 12.125 3/31/07 0 21,244 53,837
Thomas I. Boggs,
Jr................. 4,643(4) 3.7 12.125 3/31/07 0 35,419 89,722
</TABLE>
- ---------------
(1) Represents the fair market value of the underlying shares of Common Stock at
the time of the grant.
46
<PAGE> 49
(2) Unless the stock price increases, which will benefit all stockholders
commensurately, an option holder will realize no gain.
(3) Represents the value of the shares of Common Stock issuable upon the
exercise of the option, assuming the stated rates of price appreciation for
ten years, compounded annually, with the aggregate exercise price deducted
from the final appreciated value. The 5% and 10% rates are established by
the SEC as examples only and are not intended to forecast future
appreciation in the Company's stock price.
(4) Represents a ten-year, incentive stock option grant, vesting at a rate of
20% per year for five years from the date of grant, granted pursuant to the
1995 Plan.
OPTION EXERCISES AND YEAR-END VALUE
The following table sets forth information concerning the aggregate number
of options exercised during fiscal 1997 by each of the executive officers named
in the Summary Compensation Table set forth above under "Executive
Compensation," and outstanding options held by each such officer as of December
31, 1997.
<TABLE>
<CAPTION>
NUMBER OF
SECURITIES VALUE OF
UNDERLYING UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS/SARS AT OPTIONS/SARS AT
FISCAL YEAR-END(#) FISCAL YEAR-END(1)
------------------- --------------------
SHARE ACQUIRED VALUE EXERCISABLE EXERCISABLE
NAME ON EXERCISE(#) REALIZED($) UNEXERCISABLE UNEXERCISABLE
---- --------------- ----------- ------------------- --------------------
<S> <C> <C> <C> <C>
William Gentz..................... -- -- 29,995/57,105 $280,133/405,606
J. Chris Seaman................... -- -- 40,591/45,047 392,016/304,878
Arnold J. Senter.................. -- -- 0/25,000 0/78,000
Matthew Natalizio................. -- -- 8,340/13,546 78,068/104,719
Thomas I. Boggs, Jr............... -- -- 6,485/18,433 60,847/141,419
</TABLE>
- ---------------
(1) Uses a fair market value at December 31, 1997 of $14.50 per share, with the
aggregate exercise price deducted from the total value of the stock
underlying the options.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee during the fiscal year ended December 31, 1997
consisted of Messrs. Noble, Cooper and Germain, each of whom was a non-employee
director. Mr. Cooper is an employee and beneficial owner of less than one
percent of the equity securities of IIA, which was paid $250,000 by the Company
in fiscal 1997 for investment banking and financial consulting services. Mr.
Germain is an officer and a director of Centre Re, which was involved in several
transactions with the Company during 1997 involving payments in excess of
$60,000. See "Certain Relationships and Related Transactions."
During fiscal 1997, no officers participated in deliberations of the
Company's Compensation Committee concerning executive officer compensation,
except William Gentz, the Company's President and Chief Executive Officer.
COMPANY PERFORMANCE
The graph below compares the cumulative total shareholder return of the
Company with the cumulative total return on the The Nasdaq National Market (U.S.
Companies) Index and the Nasdaq Insurance Stocks Index for the period from June
30, 1995 (the date on which the Company's registration statement under Section
12 of the Exchange Act became effective) through December 31, 1997.
47
<PAGE> 50
COMPARISON OF CUMULATIVE TOTAL RETURN
<TABLE>
<CAPTION>
NASDAQ
MEASUREMENT PERIOD NASDAQ STOCK INSURANCE STOCK
(FISCAL YEAR COVERED) MARKET INDEX INDEX SNTL
<S> <C> <C> <C>
6/30/95 100.00 100.00 100.00
12/31/95 112.72 122.72 113.89
12/31/96 138.97 139.12 283.33
12/31/97 170.08 170.69 322.22
Superior National Insurance Group, Inc. Common Stock........ $322.22
Nasdaq Insurance Stocks Index............................... $170.69
The Nasdaq National Market (U.S. Companies) Index........... $170.08
</TABLE>
Assumes that $100 was invested on June 30, 1995 (the date on which the
Company's registration statement under Section 12 of the Exchange Act became
effective) in each of the Company's Common Stock, The Nasdaq National Market
(U.S. Companies) Index, and the Nasdaq Insurance Stocks Index, and that all
dividends were reinvested.
The Company believes that the Company's total stockholder return improved
during 1997 primarily as a result of the consumation of the acquisition of SPCC
and the anticipated savings that will result from the transaction.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
The table below sets forth certain information regarding the beneficial
ownership of the Company's voting securities as of March 1, 1998 by each person
who is known by the Company to be the beneficial owner of more than 5% of the
indicated classes of the Company's voting securities. On March 31, 1992, the
Company issued its 14.5% Senior Subordinated Voting Notes due April 1, 2002 (the
"Voting Notes") in connection with a transaction wherein the Company issued its
14.5% Senior Subordinated promissory notes in an aggregate principal amount of
$11.0 million, together with warrants to purchase approximately 1,616,886 shares
of the Company's Common Stock. The Company redeemed all of those promissory
notes with a prepayment, effective June 30, 1994, except for the Voting Notes,
with respect to which prepayment is prohibited. See "Certain Relationships and
Related Transactions -- Transactions with Zurich, Including Centre Re." The
outstanding principal amount of the Voting Notes is $30,000. The number of votes
attaching to the Voting Notes is equal to the number of shares of Common Stock
that may be purchased upon exercise of the warrants that were issued in that
March 31, 1992 transaction and remain outstanding and are unexercised as of the
applicable record date for a stockholder vote. As of March 1, 1998, the number
of votes held by the holder of the Voting Notes was equivalent to 1,566,465
shares of Common Stock. The Voting Notes are permitted to vote only in director
elections, director removals, votes on amending that right to vote,
48
<PAGE> 51
and changes to the number of authorized directors. As a result of the
cancellation of a portion of the relevant warrants, the number of common stock
equivalent votes held by the Voting Notes has decreased somewhat since March 31,
1992. The specific voting rights of the Voting Notes are set forth in the
Company's Certificate of Incorporation and Bylaws.
CERTAIN BENEFICIAL OWNERS
<TABLE>
<CAPTION>
COMMON STOCK(1) VOTING NOTES
----------------------- ---------------------
SHARES-
NAME AND ADDRESS SHARES PERCENT(2) EQUIVALENT PERCENT
---------------- --------- ---------- ---------- -------
<S> <C> <C> <C> <C>
"III"............................................ 217,942(3) 3.53% 1,566,465(3) 100%
International Insurance Investors, L.P.,
a Bermuda limited partnership
c/o International Insurance Investors
(Bermuda) Limited, General Partner
Cumberland House
One Victoria Street
Hamilton HM HX, Bermuda
"IP Delaware".................................... 1,375,547(4) 23.07% -- --
Insurance Partners, L.P.
201 Main Street
Suite 2600
Ft. Worth, Texas 76102
"IIA"............................................ 1,243,332(5) 17.25% -- --
International Insurance Advisors, Inc.
One Chase Manhattan Plaza
44th Floor
New York, New York 10005
"IP Bermuda"..................................... 765,304(6) 12.83% -- --
Insurance Partners Offshore (Bermuda), L.P.
Cedar House
41 Cedar Avenue
P.O. Box HM 1179
Hamilton HM HX, Bermuda
"TJS"............................................ 529,652(7) 8.88% -- --
TJS Partners, L.P.
115 East Putnam
Greenwich,Connecticut 06830
"CentreLine"..................................... 579,356(8) 8.86% -- --
CentreLine Reinsurance Limited,
a Bermuda corporation
Cumberland House
One Victoria Street
Hamilton HM HX, Bermuda
"Centre Re"...................................... 395,128(9) 6.21% -- --
Centre Reinsurance Limited,
One Victoria Street
Seventh Floor
Hamilton HM HX, Bermuda
"Bishop Estate".................................. 326,552(10) 5.19% -- --
Trustees of the Estate of Bernice P. Bishop
567 South King Street
Suite 200
Honolulu, Hawaii 96813
</TABLE>
- ---------------
(1) Includes warrants expiring on April 1, 2002 to purchase 1,566,465 shares of
Common Stock (the "Warrants") and a warrant expiring on April 1, 2002 to
purchase 579,356 shares of Common Stock
49
<PAGE> 52
described more fully in footnote 8, below. All such warrants are subject to
an agreement among all warrant holders, which prohibits the exercise or
transfer of any such warrants until April 2000 unless prior approval from
the Company's Board of Directors is obtained. The Warrants were issued on
March 31, 1992 in a transaction in which the Company issued (a) Warrants to
purchase approximately 1,616,886 shares of Common Stock and (b) promissory
notes in the aggregate principal amount of $11.0 million to III and certain
members of the Company's management. The Warrants are exercisable at $4.00
per share. The Warrants purchased by III, initially exercisable into
1,474,306 shares of Common Stock, were originally issued to IIA, as agent
for each of the limited partners and the general partner of III. The
Warrants have since been distributed to the partners of III; however, IIA's
revocable agency relationship with such partners was reestablished after
the distribution. Since the distribution, several such partners sold their
Warrants to certain third parties that do not have such an agency
relationship with IIA. See footnote 5 below. The Company has retired
certain Warrants issued to members of management no longer employed by the
Company.
(2) Percent ownership is based on the number of shares outstanding as of March
1, 1998, which number is 5,962,766 shares, plus any shares issuable
pursuant to warrants held by the entity in question which may be exercised
within 60 days after March 1, 1998. See footnote 1 above regarding certain
contractual provisions that restrict the ability of warrant holders to
exercise such warrants.
(3) Robert A. Spass, Craig F. Schwarberg, and Bradley E. Cooper, each of whom
is a director of the Company, beneficially owns limited partnership
interests in III of 0.583%, 0.225%, and 0.075%, respectively. In addition,
Mr. Spass has voting power over all of the voting capital stock of
International Insurance Investors (Bermuda) Limited ("III (Bermuda)"), the
general partner of III; however, pursuant to an agreement between the Board
of Directors of III (Bermuda) and Mr. Spass, the Board of Directors (with
Mr. Spass abstaining) is entitled to make all voting and investment
decisions with respect to the Warrants held by III (Bermuda) and the Common
Stock issuable upon the exercise thereof. III (Bermuda) beneficially owns
Warrants to purchase 13,183 shares of Common Stock that are held by IIA, as
its agent. In addition, as contemplated by the terms of III's limited
partnership agreement, the limited partners and III (Bermuda) transferred
Warrants to purchase an aggregate of 204,759 shares of Common Stock to III
to be held by III (subject to IIA's revocable agency relationship) in
reserve for the payment to III (Bermuda) of its incentive fee under such
limited partnership agreement. Upon the occurrence of certain events,
Messrs. Spass, Schwarberg and Cooper, Centre Re and others will be entitled
to a distribution of the Warrants presently held by III (subject to IIA's
revocable agency relationship) in amounts to be determined at the time of
distribution. Each such party presently disclaims beneficial ownership (as
defined in Rule 13d-3 under the Exchange Act) of all such Warrants. See
footnote 5 below. See also "Certain Relationships and Related Transactions
-- Transactions with IP and Limitations on Related Party Control" regarding
restrictions on III's ability to acquire additional equity securities of
the Company or exercise such Warrants.
(4) Represents shares of Common Stock held by IP Delaware. Robert A. Spass and
Steven B. Gruber, directors of the Company, are the President and a Vice
President, respectively, of Insurance GenPar MGP, Inc. ("GenPar Inc."), the
general partner of Insurance GenPar MGP, L.P. ("GenPar MGP"), the general
partner of Insurance GenPar, L.P. ("GenPar" and, together with GenPar MGP
and IP Delaware, the "Delaware Partnerships"), which is the general partner
of IP Delaware. Robert A. Spass owns 40% and Messrs. Gruber and Daniel L.
Doctoroff each own 30% of the voting capital stock of GenPar Inc. In
addition, Messrs. Spass, Gruber, Doctoroff and Bradley E. Cooper, a
director of the Company, own direct or indirect limited partnership
interests in certain of the Delaware Partnerships. Each of Messrs. Spass,
Gruber and Cooper, as well as Mr. Doctoroff, disclaims beneficial ownership
(as defined in Rule 13d-3 under the Exchange Act) of all shares of Common
Stock held by IP Delaware. See "Certain Relationships and Related
Transactions -- Transactions with IP and Limitations on Related Party
Control" regarding restrictions on IP Delaware's ability to acquire
additional equity securities of the Company.
(5) Represents Warrants to purchase shares of Common Stock that are held by
IIA, as agent for each of the limited partners and for the general partner
of III, as discussed in footnotes 1 and 3 above. As agent for such
partners, IIA has the revocable authority to exercise rights set forth in
the Warrants and to vote
50
<PAGE> 53
any shares of Common Stock issuable upon exercise of the Warrants. Robert
A. Spass, a director of the Company, is an officer of IIA and as such, has
the authority to exercise these rights. The partners who, upon revocation
of IIA's authority, would be entitled to exercise Warrants covering more
than 5% of the Common Stock are Centre Re and Bishop Estate, in the share
amounts and percentages stated. See "Certain Relationships and Related
Transactions -- Transactions with IP and Limitations on Related Party
Control" regarding restrictions on IIA's ability to acquire additional
equity securities of the Company or exercise warrants to purchase Common
Stock. The reported number of shares issuable upon exercise of Warrants
varies slightly from previously reported numbers as a result of differences
in rounding due to the four-into-one reverse split that SNIG's Common Stock
underwent in May 1995 and subsequent distributions of such Warrants to the
partners of III.
(6) Represents shares of Common Stock held by IP Bermuda. Robert A. Spass and
Steven B. Gruber, directors of the Company, are the President and a Vice
President, respectively, of Insurance GenPar (Bermuda) MGP, Ltd. ("GenPar
(Bermuda) Ltd."), the general partner of Insurance GenPar (Bermuda) MGP,
L.P. ("GenPar (Bermuda) MGP"), the general partner of Insurance GenPar
(Bermuda), L.P. ("GenPar (Bermuda)" and, together with GenPar (Bermuda) MGP
and IP Bermuda, the "Bermuda Partnerships"), which is the general partner
of IP Bermuda. Robert A. Spass owns 40% and Messrs. Gruber and Doctoroff
each own 30% of the voting capital stock of GenPar (Bermuda) Ltd. In
addition, each of Messrs. Spass, Gruber, Doctoroff and Bradley E. Cooper, a
director of the Company, owns direct or indirect limited partnership
interests in certain of the Bermuda Partnerships. Each of Messrs. Spass,
Gruber, and Cooper, as well as Mr. Doctoroff, disclaims beneficial
ownership (as defined in Rule 13d-3 under the Exchange Act) of all shares
of Common Stock held by IP Bermuda. See "Certain Relationships and Related
Transactions -- Transactions with IP and Limitations on Related Party
Control" regarding restrictions on IP Bermuda's ability to acquire
additional equity securities of the Company.
(7) TJS Corporation and its controlling stockholder, sole director, and
executive officer, Thomas J. Salvatore, are the general partners of TJS
Management, L.P., the general partner of TJS, and exercise voting control
and dispositive power over all shares presently owned and are the
beneficial owners of all such shares. The information contained in this
footnote is based, in part, on an Amendment No. 2 to Schedule 13D/A, filed
with the SEC in May 1997. Does not include 173,223 shares issuable upon the
exercise of Warrants acquired since May 1997 that are subject to an
agreement among all holders of Company warrants, which prohibits the
exercise or transfer of such warrants until April 2000 unless prior
approval from the Company's Board of Directors is obtained. See footnote 1
above. Because of such restrictions, TJS, TJS Management, L.P., TJS
Corporation, and Thomas J. Salvatore disclaim beneficial ownership (as
defined in Rule 13d-3 under the Exchange Act) of such Warrants.
(8) Represents a warrant to purchase 579,356 shares of Common Stock issued as
of June 30, 1994 (the "CentreLine Warrant"). CentreLine is an affiliate of
Centre Re. See footnote 9 below for information regarding Centre Re's
beneficial ownership of securities of the Company. The CentreLine Warrant
was issued in connection with a $20.0 million investment in the Company
(and its affiliate, Superior National Capital, L.P.) by CentreLine and a
second Centre Re affiliate, Centre Reinsurance Services (Bermuda) III
Limited. The CentreLine Warrant is exercisable at $5.20 per share. Steven
D. Germain, a director of the Company, is an officer and a director of both
Centre Re and CentreLine. In addition to Mr. Germain, each of Steven M.
Gluckstern, Michael D. Palm, and David A. Brown, is an officer and/or
director of both Centre Re and CentreLine. Messrs. Germain, Gluckstern,
Palm and Brown disclaim any beneficial interest in the CentreLine Warrant
and the Common Stock issuable upon its exercise, and in the Warrants held
by IIA, as agent for Centre Re (as described in footnote 9 below), and the
shares of Common Stock issuable upon the exercise of such Warrants.
However, as officers and/or directors of both Centre Re and CentreLine,
such persons share voting and/or investment power over such securities
(subject to the agency appointment described in footnotes 1 and 5 above).
See "Certain Relationships and Related Transactions -- Transactions with IP
and Limitations on Related Party Control" regarding restrictions on
CentreLine's ability to acquire additional equity securities of the Company
or exercise the CentreLine Warrant.
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<PAGE> 54
(9) Represents Warrants to purchase shares of Common Stock received upon the
distribution by III to its partners of the Warrants, as described in
footnote 1 above. See footnote 5 above for information concerning Centre
Re's agency relationship with IIA with respect to such Warrants and see
footnote 8 above for information concerning Centre Re's relationships with
Steven D. Germain and CentreLine. See also "Certain Relationships and
Related Transactions -- Transactions with IP and Limitations on Related
Party Control" regarding restrictions on Centre Re's ability to acquire
additional equity securities of the Company or exercise the Warrants. The
reported number of shares issuable upon exercise of Warrants does not
include Warrants to purchase 75,262 shares of Common Stock held by III
(subject to IIA's revocable agency relationship) in reserve for the payment
to III (Bermuda) of its incentive fee under III's limited partnership
agreement. See footnote 3 above.
(10) Represents Warrants to purchase shares of Common Stock received upon the
distribution by III to its partners of the Warrants as described in
footnote 1 above. Richard S.H. Wong, Oswald K. Stender, Lokelani Lindsey,
Gerard A. Jervis, and Henry H. Peters, the trustees of the Bishop Estate,
share voting and/or investment power over securities held by the Bishop
Estate. Mr. Peters is a director of IIA. The reported number of shares
issuable upon exercise of Warrants does not include Warrants to purchase
62,200 shares of Common Stock held by III (subject to IIA's revocable
agency relationship) in reserve for the payment to III (Bermuda) of its
incentive fee under III's limited partnership agreement. See footnote 3
above.
SECURITY OWNERSHIP OF MANAGEMENT
The following table sets forth certain information regarding the beneficial
ownership of the Common Stock as of March 1, 1998 by (i) each director and
certain executive officers of the Company, individually, and (ii) all directors
and executive officers as a group:
OWNERSHIP OF MANAGEMENT
<TABLE>
<CAPTION>
PERCENT OF COMMON
NAME SHARES OWNED(1) STOCK(2)
---- --------------- -----------------
<S> <C> <C>
William L. Gentz............................................ 109,099(3) 1.81%
J. Chris Seaman............................................. 175,309(4) 2.88%
Arnold J. Senter............................................ 7,000(5) *
Matthew Natalizio........................................... 25,539(6) *
Thomas I. Boggs, Jr......................................... 24,166(7) *
Thomas J. Jamieson.......................................... 245,300(8) 4.11%
Gordon E. Noble............................................. 10,000 *
C. Len Pecchenino........................................... 14,250 *
Robert A. Spass............................................. 15,216(9) *
Craig F. Schwarberg......................................... 2,790(10) *
Bradley E. Cooper........................................... 4,930(11) *
Steven D. Germain........................................... 980,964(12) 14.14%
Steven B. Gruber............................................ --(13) --
Roger W. Gilbert............................................ -- --
Directors and Executive Officers as a Group (23 persons).... 1,762,752(14) 24.24%
</TABLE>
- ---------------
* Less than 1%
(1) Shares owned by the executive officers do not reflect shares of restricted
stock that the Company anticipates it will grant in the Spring of 1998 to
such officers.
(2) Percent ownership is based on the number of shares outstanding as of March
1, 1998 which number is 5,962,766 shares, plus any shares issuable pursuant
to options or warrants held by the person in question that may be exercised
within 60 days after March 1, 1998.
52
<PAGE> 55
(3) Includes 41,165 shares issuable upon exercise of stock options that are
exercisable within 60 days of March 1, 1998, in addition to 29,950
restricted stock grants awarded under the 1995 Plan, of which the
restrictions have lapsed as to 6,698 shares.
(4) Includes 58,795 shares issuable upon exercise of Warrants and 49,719 shares
issuable upon exercise of stock options, each of which is exercisable
within 60 days of March 1, 1998, in addition to 24,163 restricted stock
grants awarded under the 1995 Plan, of which the restrictions have lapsed
as to 5,240 shares.
(5) Includes 5000 shares issuable upon exercise of stock options that are
exercisable within 60 days of March 1, 1998.
(6) Includes 11,914 shares issuable upon exercise of stock options that are
exercisable within 60 days of March 1, 1998, in addition to 6,399
restricted stock grants awarded under the 1995 Plan, of which the
restrictions have lapsed as to 1,425 shares.
(5) Includes 11,471 shares issuable upon exercise of stock options that are
exercisable within 60 days of March 1, 1998, in addition to 9,375
restricted stock grants awarded under the 1995 Plan, of which the
restrictions have lapsed as to 2,102 shares.
(8) Includes 98,050 shares owned of record by Jaco Oil Company, an entity
controlled by Mr. Jamieson.
(9) Includes 8,000 shares of Common Stock owned directly by Mr. Spass. Also
includes Warrants to purchase 7,216 shares of Common Stock held by IIA, as
agent, as described in footnote 3 of the preceding "Certain Beneficial
Owners." Mr. Spass disclaims beneficial ownership (as defined in Rule 13d-3
under the Exchange Act) of Warrants to purchase 13,183 shares of Common
Stock held by III (Bermuda) (subject to IIA's revocable agency
relationship) and Warrants to purchase 1,375 held by III (subject to IIA's
revocable agency relationship) in reserve for the payment to III (Bermuda)
of its incentive fee under III's limited partnership agreement. See
footnotes 3 and 5 of the preceding "Certain Beneficial Owners" table. Mr.
Spass is an officer of IIA and is the beneficial owner of less than one
percent of the equity securities of IIA. IIA holds, as agent for the
partners of III, Warrants to purchase 1,243,332 shares of Common Stock. In
addition, see footnote 3 to the preceding "Certain Beneficial Owners" table
concerning Mr. Spass' voting power with respect to the Voting Notes.
Separately, 1,375,547 shares of Common Stock are beneficially owned by IP
Delaware and 765,304 shares of Common Stock are beneficially owned by IP
Bermuda. Mr. Spass is the President of GenPar Inc. and GenPar (Bermuda)
Ltd., the ultimate general partners of IP Delaware and IP Bermuda,
respectively. Mr. Spass disclaims beneficial ownership (as defined in Rule
13d-3 under the Exchange Act) of all shares of Common Stock that are held
by IP Delaware and IP Bermuda. See footnotes 4 and 6 to the preceding
"Certain Beneficial Owners" table for information concerning such
partnerships. Pursuant to the terms of the stock purchase agreement under
which IP Delaware and IP Bermuda purchased their shares of Common Stock, so
long as certain conditions apply, each of IP Delaware and IP Bermuda has
agreed that Mr. Spass will abstain from votes of the investment committees
of each of IP Delaware and IP Bermuda with respect to each such entity's
holdings of shares of Common Stock. See "Certain Relationships and Related
Transactions -- Transactions with IP and Limitations on Related Party
Control."
(10) Represents Warrants to purchase 2,790 shares of Common Stock held by IIA,
as agent, as described in footnote 5 of the preceding "Certain Beneficial
Owners" table. In addition, Mr. Schwarberg is the beneficial owner of less
than one percent of IIA's equity securities.
(11) Includes 4,000 shares of Common Stock owned directly by Mr. Cooper. Also
includes Warrants to purchase 930 shares of Common Stock held by IIA, as
agent, as described in footnote 5 of the preceding "Certain Beneficial
Owners" table. In addition, Mr. Cooper is the beneficial owner of less than
one percent of IIA's equity securities.
(12) Includes (i) 5,600 shares of Common Stock owned directly, (ii) 880 shares
of Common Stock owned indirectly as custodian for the benefit of his
children under the New York Uniform Gift to Minors Act, and (iii) warrants
to purchase Common Stock, consisting of the CentreLine Warrant to purchase
579,356 shares and the Warrants to purchase 395,128 shares held by IIA as
agent for Centre Re. See the preceding "Certain Beneficial Owners" table
and footnotes 8 and 9 thereto. Mr. Germain is an
53
<PAGE> 56
officer and director of both Centre Re and CentreLine. As such, he shares
voting and/or dispositive control over such securities (subject to the
termination of the agency relationship with IIA by Centre Re). Mr. Germain
disclaims any beneficial interest in the CentreLine Warrant, the Warrants
held by IIA as agent for Centre Re, and the Common Stock issuable upon
their exercise.
(13) Mr. Gruber, a director of the Company, is a Vice President of each of
GenPar Inc. and GenPar (Bermuda) Ltd., the ultimate general partners of IP
Delaware and IP Bermuda, respectively. IP Delaware beneficially owns
1,375,547 shares of Common Stock and IP Bermuda beneficially owns 765,304
shares of Common Stock. Mr. Gruber disclaims beneficial ownership (as
defined in Rule 13d-3 under the Exchange Act) of all shares of Common Stock
held by IP Delaware and IP Bermuda. See footnotes 4 and 6 to the preceding
"Certain Beneficial Owners" table for information concerning such
partnerships.
(14) Includes (i) 1,048,477 shares issuable upon exercise of warrants and (ii)
183,928 shares issuable upon exercise of stock options, each of which are
exercisable within 60 days of March 1, 1998. Also includes 99,873 shares
subject to the Company's right of repurchase, of which the restrictions
have lapsed as to 22,013 shares. Refer to footnotes 7 through 10 for
information regarding beneficial interests in the Warrants and the
CentreLine Warrant held by certain directors.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
TRANSACTIONS WITH IIA
Messrs. Spass and Cooper, directors of the Company, are employees of IIA
and, together with Mr. Schwarberg, also a director of the Company, are each the
beneficial owner of less than one percent of IIA's equity securities. Mr. Spass
is also an officer and director of IIA. IIA was paid $250,000 by the Company
during fiscal 1997 for investment banking and financial consulting services
pursuant to a consulting agreement entered into in 1992 that continues through
1998.
TRANSACTIONS WITH AFFILIATES OF ZURICH, INCLUDING CENTRE RE
As of June 30, 1994, the Company completed a $20.0 million financing
transaction (the "1994 Transaction") with CentreLine and another affiliate of
Centre Re involving the sale to an affiliate of Centre Re of preferred shares
(the "SNCLP Preferred Shares") of Superior National Capital, L.P., a Bermuda
limited partnership ("SNCLP"), an entity controlled by the Company, together
with the issuance of the CentreLine Warrant. See "Security Ownership of Certain
Beneficial Owners and Management -- Security Ownership of Certain Beneficial
Owners." The proceeds of the 1994 Transaction were loaned by SNCLP to Superior
National and partially contributed to the capital of SNIC. The SNCLP Preferred
Securities paid a 9.7% annual rate of return, in semi-annual installments and
were required to be redeemed on or before June 30, 2001. SNCLP issued an
additional 49,167 shares of SNCLP Preferred Stock in 1997 as a dividend on the
outstanding SNCLP Preferred Stock to an affiliate of Centre Re in connection
with the 1994 Transaction. In December 1997, the Company used a portion of the
proceeds it received from the sale of the Senior Subordinated Notes to redeem
all of the approximately $26.6 million face amount of the then outstanding SNCLP
Preferred Securities.
Effective January 1, 1994, SNIC entered into a quota-share reinsurance
contract (the "Quota-Share Contract") with ZRNA, an affiliate of Zurich, which
also applies to business written by SPCC since April 1, 1997. Under the
Quota-Share Contract, ZRNA may provide Superior Pacific with an Assumption of
Liability Endorsement ("ALE") facility, or, effective January 1, 1997, Superior
Pacific may write directly on policy forms of ZC Insurance Company ("ZCIC"), an
affiliate of ZRNA (the "ZCIC Front"). The ceding rate under the contract was 20%
for 1994, and ZRNA and Superior Pacific mutually agreed to reduce the
quota-share participation to 5% for 1995 and 1996. Further, Superior Pacific
receives ceding commissions ranging between 22.5% and 24.5% for premiums ceded
to ZRNA. The purpose of the ceding commission is to cover Superior Pacific's
cost of acquiring new business and may be changed as a result of changes in
market conditions on a quarterly basis. Effective January 1, 1997, the terms of
the Quota Share Contract were amended. Under the amended terms of the Quota
Share Contract, ZRNA increased its participation from 5%
54
<PAGE> 57
of premiums written in 1996 to 6.5% in 1997. In exchange for the increased
participation, ZRNA will no longer receive a separate fee for policies written
on ALEs, but will receive 2% of premiums written on ZCIC Front policies only.
Superior Pacific entered into a reinsurance transaction with Centre Re
effective June 30, 1997 under which Centre Re assumed $10 million of reserves
associated with claims open for future medical payments only from Superior
Pacific in consideration of $1 million in cash and the assignment of the rights
of Superior Pacific's contribution and subrogation recoveries during the term of
the contract. The contract is accounted for as a deposit, and no gain will be
recognized until net cash payments from (or to) Centre Re are either greater (or
less) than Superior Pacific's $1 million premium.
Effective December 31, 1997, the Company entered into agreements with Risk
Entire Management Limited ("REM") and Zurich Reinsurance (North America), Inc.
("ZRNA"), affiliates of Zurich, to provide claims management services ("Claims
Severity Management Program" or "CSMP"). Under the CSMP, REM acting as a third
party administrator ("TPA"), will provide claim processing and management
services to Superior Pacific, and ZRNA will provide Superior with protection
predicated on REM's ability to reduce Superior Pacific's severity. The Company
may terminate the contract with six months notice after the initial three year
term of the contract, with a penalty that will not exceed $250,000 plus REM's
reasonable expenses to unwind the agreement.
In December 1997, an affiliate of Zurich purchased $10 million of the Trust
Preferred Securities.
TRANSACTIONS WITH IP AND LIMITATIONS ON RELATED PARTY CONTROL
Messrs. Spass and Gruber, directors of the Company, are executive officers
of the ultimate general partner of each of IP Delaware and IP Bermuda
(collectively, "IP"). In April 1997, IP purchased an aggregate of 2,124,834
shares of Common Stock at $7.53 per share, for an aggregate purchase price of
$16.0 million, pursuant to the Stock Purchase Agreement dated as of September
17, 1996, as amended and restated effective as of February 17, 1997 (the "Stock
Purchase Agreement"), among the Company, IP, TJS, and certain members of the
Company's management. The Company used the proceeds to fund, in part, its
acquisition of Pac Rim. The price of the Common Stock was determined based on
its per share price as quoted on The Nasdaq National Market during a certain
period preceding the September 17, 1996 announcement of the Pac Rim acquisition,
and represented in April 1997, a significant discount to the then current market
price of the Common Stock. Mr. Gruber's election as a director of the Company
was effective upon the consummation of the acquisition of Pac Rim. The Company's
Board of Directors (without Messrs. Gentz, Seaman, Spass, Germain, and Cooper,
who disclosed their conflict of interest, withdrew from the discussion and
abstained from the vote) unanimously approved the Stock Purchase Agreement. The
negotiations were conducted by Mr. Pecchenino on behalf of the Company.
The Stock Purchase Agreement contains, in addition to customary terms and
provisions, certain covenants by IP that shall remain effective so long as IP
and its Associates beneficially own an aggregate of 15% or more of SNIG's Common
Stock on a fully diluted basis. For purposes of the Stock Purchase Agreement,
"Associates" means each of CentreLine, Centre Re, III, IIA, and any person or
entity that controls, is under common control with, or is controlled by IP or
such persons or entities, and all individuals who are officers, directors, or
control persons of any such entities, including IP. One such covenant, with
certain limited exceptions, prohibits IP or any of its Associates from acquiring
any additional shares of Common Stock, entering into a merger or business
combination involving the Company, participating in any solicitation of proxies,
or participating in any group with respect to the foregoing, without a two-third
majority vote of either the non-Associate and non-employee directors or the
Company's stockholders (excluding those shares held by IP and its Associates and
by executive officers having to report transactions in Common Stock under
securities laws). Other covenants provide that IP and its Associates will not
elect more than five directors (or the highest number that is less than a
majority of the Board of Directors) and that IP and its Associates will not
transfer any of its shares except in certain types of specified transactions.
55
<PAGE> 58
In connection with the Stock Purchase Agreement. All holders of SNIG's
outstanding warrants entered into an agreement pursuant to which such holders
are prohibited from exercising their warrants until April 2000 unless prior
approval of the Company's Board of Directors is obtained. This restriction was
implemented in order to reduce the risk that the Company would undergo an
ownership change for purposes of Section 382 of the Code and thus be limited in
its ability to use its NOLs. See "Business -- Risk Factors -- Availability of
Net Operating Loss Carryforwards."
In addition, each of Messrs. Spass and Gruber are executive officers of
Insurance Partners Advisors, L.P. ("IPA"). On April 11, 1997, IPA received a
transaction fee from the Company of $625,000, representing a percentage of all
of the funds raised in connection with the acquisition of Pac Rim.
MANAGEMENT PURCHASE OF EQUITY
In April 1997, certain members of the Company's management (30 persons) and
TJS, a 10% or greater stockholder of the Company, purchased an aggregate of
265,604 shares of the Company Common Stock at $7.53 per share for an aggregate
purchase price of $2.0 million under the Stock Purchase Agreement. As is its
policy, IP requested that management participate with IP in its purchase of
Common Stock under the same Stock Purchase Agreement. Of the 2,390,438 shares of
Common Stock issued in the financing transaction, 2,124,834 shares were acquired
by IP, as discussed above, 132,802 shares were acquired by TJS, 25,234 were
acquired by William Gentz (a director and the President and Chief Executive
Officer of the Company), 25,232 were acquired by J. Chris Seaman (a director, an
Executive Vice President and Chief Financial Officer of the Company), 9,296 were
acquired by Joseph P. Wolonsky (who was then a Senior Vice President of the
Company, but who subsequently resigned from the Company as of June 30, 1997),
9,296 were acquired by Karl O. Johnson (a Senior Vice President of Superior
Pacific), 9,296 were acquired by Douglas R. Roche (a senior Vice President of
the Company) and 54,448 were acquired by other members of management.
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<PAGE> 59
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K
(A)(1) FINANCIAL STATEMENTS:
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 Changes in 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
(A)(2) FINANCIAL STATEMENT SCHEDULES:
Summary of Investments -- Other than Investments in Related Parties
Condensed Financial Information of Registrant, Superior National Insurance
Group, Inc.
Supplemental Insurance Information
Reinsurance
Valuation and Qualifying Accounts and Reserves
Supplemental Property and Casualty Insurance Information
(A)(3) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
<C> <S>
2 Amended and Restated Agreement and Plan of Merger dated as
of February 17, 1997 among the Company, SNTL Acquisition
Corp., and Pac Rim Holding Corporation*****
3.1 Certificate of Incorporation of the Company, as currently in
effect++
3.2 By-laws of the Company, as currently in effect++
4.1 Amended and Restated Declaration of Trust of the Trust dated
as of December 3, 1997, including the Trust's Certificate of
Trust and the forms of Trust Common Securities, Trust
Preferred Securities and Exchange Trust Preferred
Securities(4)
4.3 Senior Subordinated Indenture, including forms of the Senior
Subordinated Notes and Exchange Senior Subordinated Notes,
dated as of December 3, 1997 between the Company and
Wilmington Trust Company, as trustee, providing for the sale
by the Company to the Trust of the Senior Subordinated
Notes(4)
4.4 Guarantee Agreement dated as of December 3, 1997 between the
Company and Wilmington Trust Company, as trustee, with
respect to the Trust Preferred Securities(4)
4.5 Guarantee Agreement with Respect to Common Securities dated
as of December 3, 1997 by the Company(4)
4.6 Form of Exchange Guarantee Agreement between the Company and
Wilmington Trust Company, as trustee, with respect to the
Exchange Trust Preferred Securities(4)
EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS
10.1 Employment Agreement, dated June 1, 1997, by and between Mr.
William L. Gentz, President and Chief Executive Officer of
the Company, and the Company+++++
10.2 Employment Agreement, dated February 17, 1997, by and
between Mr. Arnold J. Senter, Executive Vice President and
Chief Operating Officer of the Company, and the Company+
10.3 Employment Agreement, dated June 1, 1997, by and between J.
Chris Seaman, Executive Vice President and Chief Financial
Officer of the Company, and the Company+++++
10.4 1986 Non-Statutory Stock Option and 1986 Non-Statutory Stock
Purchase Plan***
</TABLE>
57
<PAGE> 60
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
<C> <S>
10.5 1995 Stock Incentive Plan***
OTHER MATERIAL CONTRACTS
10.6 Aggregate Excess of Loss Cover entered into on the 30th day
of August 1991, between Centre Reinsurance Limited (Centre
Re) and the Company, as amended*
10.7 Multi-year Prospective Accident Year Stop Loss Reinsurance
Contract effective the 1st of January 1993, between Centre
Reinsurance International Company and the Company (the "1993
Centre Re Contract")*
10.8 Letter dated March 28, 1996 from the Company canceling the
1993 Centre Re Contract effective January 1, 1996***
10.9 Workers' Compensation and Employers' Liability Quota Share
Insurance Contract No. 30006A effective January 1, 1994,
between the Company and Zurich Reinsurance Centre, as
amended (the "ZRC Contract")*
10.10 Addendum No. 4 to the ZRC Contract effective as of January
1, 1996***
10.11 Addendum No. 1 to the Retrocession Agreement (an ancillary
agreement to the ZRC Contract) effective as of January 1,
1996***
10.12 Lease, dated 27th day of October 1988, by and between
Corporate Center at Malibu Canyon, a California Limited
Partnership and the Company, relating to the lease of the
Company's home office and Calabasas Branch Facilities*
10.13 Lease, dated 27th of July 1993, by and between TOMOE
Investment and Development, Inc. and the Company, relating
to the lease of its South San Francisco Facility*
10.14 Lease, dated 14th of November 1991, by and between Dean
Witter Reynolds and the Company relating to the lease of its
Fresno Facilities*
10.15 Lease, dated 23rd of February 1993, by and between Shaw
Avenue Associates, a California Limited Partnership and the
Company relating to the lease of its Fresno Facilities*
10.16 Lease, dated 14th of February 1994, by and between Contra
Costa County Employees Retirement Association and the
Company relating to its Sacramento Facility*
10.17 Agreement in Principle dated 29th of March 1994 by and
between the Company and Centre Reinsurance Limited or one of
its affiliates*
10.18 Limited Partnership Agreement of Superior National Capital,
L.P. with certificate of Limited Partnership and Certificate
of Exempted Partnership, all as filed on the 28th of June
1994, with the Registrar of Companies of Bermuda*
10.19 Termination and Release Agreement dated as of December 3,
1997 among the Company, Superior Pacific Insurance Group,
Inc., the subsidiaries of the Company signatories thereto,
The Chase Manhattan Bank and certain financial institutions
with respect to the Credit Agreement dated as of April 11,
1997(4)
10.20 Purchase warrant, dated as of the 30th of June 1994,
entitling Centreline Reinsurance Limited to purchase 579,356
shares of the Company's common stock*
10.21 Form of Common Stock Purchase Warrant, held by those members
of the Company's management and other parties set forth on
the schedule attached thereto, to purchase an aggregate of
1,566,465 shares of the Company common stock(4)
10.22 Stock Purchase Agreement dated as of September 17, 1996, as
amended and restated effective as of February 17, 1997,
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*****
</TABLE>
58
<PAGE> 61
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
<C> <S>
10.23 Registration Rights Agreement dated as of April 11, 1997
among the Company, Insurance Partners, L.P. and Insurance
Partners Offshore (Bermuda), L.P.+++
10.24 Registration Rights Agreement dated as of December 3, 1997
among the Company, the Trust and the Initial Purchasers
named therein(4)
10.25 Letter Agreement dated November 25, 1996 among the Company
and the shareholders and holders of warrants party thereto,
relating to such warrants and certain registration rights+++
10.26 Agreement with Prime Advisors regarding investment
Management Services provided to the Company dated April 12,
1997+++
10.27 Addendum No. 2 to the Retrocession Agreement between
Superior National Insurance Company and Zurich Reinsurance
Centre, Inc. effective January 1, 1997(4)
10.28 State of California Department of Insurance Amended
Certificate of Authority+++++
10.29 The Pacific Rim Assurance Company 401(k) Plan (incorporated
by reference from Exhibit 10.11 of Pac Rim Holding
Corporation's Registration Statement on Form S-1)(1)
10.33 Office Space Lease dated February 11, 1991 between Rancon
Realty Fund V and The Pacific Rim Assurance Company(1)
10.34 Office building lease dated January 21, 1992 between The
Pacific Rim Assurance Company and Trizec Warner, Inc. for
office space in Woodland Hills, California, and related
Guaranty of Pac Rim Holding Corporation(1)
10.35 Addendum No. 2 dated as of September 2, 1992 of Office
Building Lease between The Pacific Rim Assurance Company and
Trizec Warner, Inc.(1)
10.36 Office Building Lease dated October 2, 1992, between The
Pacific Rim Assurance Company and Richard V. Gunner & George
Andros, for office space in Fresno, California(1)
10.37 Sublease dated February 3, 1994 between The Pacific Rim
Assurance Company and the Federal Emergency Management
Agency, for office space in Woodland Hills, California(1)
10.38 Sublease dated February 25, 1994 between The Pacific Rim
Assurance Company and The Money Store, for office space in
Woodland Hills, California(1)
10.39 Lease Amendment #1, dated April 1, 1993, to the Office
Property Lease between Rancon Realty Fund V, and The Pacific
Rim Assurance Company(1)
10.40 Sublease dated May 1, 1994 between The Pacific Rim Assurance
Company and Group Data Services, Incorporated(1)
10.41 Office lease between L.A.X. Business Center, and Pac Rim
Holding Corporation dated June 1, 1995(1)
10.42 Certificate of Authority from Department of Insurance, State
of Arizona to transact the business of Casualty With
Workers' Compensation Insurance(1)
10.43 Certificate of Authority from Department of Insurance, State
of Texas to transact the business of casualty with workers'
compensation insurance(1)
10.44 Sublease dated August 15, 1995 between The Pacific Rim
Assurance Company and the General Services Administration(1)
10.45 Sales, License and Service Agreement dated November 14, 1995
between Macess Corporation and The Pacific Rim Assurance
Company for equipment purchases, software license and
professional prepaid support and software maintenance(1)
10.47 Certificate of Authority from the State of Georgia Office of
Commissioner of Insurance, to transact the business of
Property and Casualty (including Workers' Compensation)(1)
</TABLE>
59
<PAGE> 62
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
<C> <S>
10.48 Producer agreement between Regional Benefits Insurance
Services, a subsidiary of Superior Pacific Casualty Company,
and Hull & Co., Inc., dated May 15, 1996(2)
10.49 Producer agreement between Regional Benefits Insurance
Services, and Gulf Atlantic Management Group, Inc., dated
May 15, 1996(2)
10.50 Office lease between Gulf Atlantic Investment Group, Inc.
and Regional Benefits Insurance Services, Inc., dated May
20, 1996(2)
10.51 Employment Agreement between Pac Rim Holding Corporation and
Stanley Braun, dated April 15, 1994, as amended March 27,
1995, and March 30, 1996(3)
10.52 Third Amendment to Employment Agreement between Pac Rim
Holding Corporation and Stanley Braun, dated as of April 10,
1997++++
10.53 Agreement for Services between REM and SNIC, relating to the
Claims Severity Management Program
10.54 Average Existing Claim Severity Agreement Effective:
December 31, 1997 between ZRNA and Superior Pacific
10.55 Lease dated October 29, 1997 between Property California OB
One Corporation and SNIC, relating to the lease of its
Pleasanton, California, facility
21 Subsidiaries of the Company(4)
27.1 Financial Data Schedule
99.1 Form of Letter of Transmittal(4)
99.2 Form of Notice of Guaranteed Delivery(4)
99.3 Form of Exchange Agent Agreement(4)
</TABLE>
- ---------------
* Previously filed as an exhibit to the Company's Registration Statement on
Form 10, as filed with the Securities and Exchange Commission ("SEC") on
May 1, 1995 (File No. 0-25984).
** Previously filed as an exhibit to Amendment No. 2 to the Company's
Registration Statement on Form 10/A, as filed with the SEC on November 1,
1995 (File No. 0-25984).
*** Previously filed as an exhibit to the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1995, as filed with the SEC on
March 29, 1996.
***** Previously filed as an exhibit to the Company's statement on Schedule 13D,
as filed with the SEC on February 27, 1997.
+ Previously filed as an exhibit to the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1996, as filed with the SEC on
March 10, 1997.
++ Previously filed as an exhibit to the Company's Current Report on Form
8-K, as filed with the SEC on April 24, 1997.
+++ Previously filed as an exhibit to the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 1997, as filed with the SEC on May
15, 1997.
++++ Previously filed as an exhibit to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1997, as filed with the SEC on August
14, 1997.
60
<PAGE> 63
+++++ Previously filed as an exhibit to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 1997, as filed with the SEC on
November 13, 1997.
(1) Incorporated by reference from the Exhibits to the Annual Report on Form
10-K of Pac Rim Holding Corporation for the year ended December 31, 1995.
(2) Previously filed with the Quarterly Report on Form 10-Q of Pac Rim Holding
Corporation, for the quarter ended June 30, 1996.
(3) Previously filed as Exhibit K to Annex C of the Company's Proxy Statement
on Schedule 14A dated March 10, 1997.
(4) Previously filed as an exhibit to the Company's and the Trust's
Registration Statement on Form S-4 (Registration No. 333-43505) on
December 30, 1997.
61
<PAGE> 64
(b) Reports on Form 8-K: On November 19, 1997, the Company filed a Current
Report on Form 8-K in order to file with the Securities and Exchange
Commission a press release issued by the Company announcing the Trust's
intent to offer to sell the Trust Preferred Securities in a private
placement.
On December 5, 1997, the Company filed a Current Report on Form 8-K in
order to file with the Securities and Exchange Commission a press
release issued by the Company announcing the completion of the Trust's
issuance and sale of the Trust Preferred Securities in a private
placement.
(c) The page numbers of the Exhibits filed in response to this portion of
Item 14 are listed on an Index of Exhibits that follows the signature
page.
(d) The response to this portion of Item 14 is presented in response to
Item 8 of this report.
62
<PAGE> 65
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form
10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 27, 1998
SUPERIOR NATIONAL INSURANCE GROUP,
INC.
/s/ J. CHRIS SEAMAN
By:
--------------------------------------
J. Chris Seaman
Executive Vice President and
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Annual Report on Form 10-K has been signed below by the following persons on
behalf of the Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ WILLIAM GENTZ Director, President and Chief March 27, 1998
- --------------------------------------------- Executive Officer (Principal Executive
William Gentz Officer)
/s/ J. CHRIS SEAMAN Director, Executive Vice President and March 27, 1998
- --------------------------------------------- Chief Financial Officer (Principal
J. Chris Seaman Financial Accounting Officer)
/s/ STEVEN D. GERMAIN Director March 27, 1998
- ---------------------------------------------
Steven D. Germain
/s/ THOMAS J. JAMIESON Director March 27, 1998
- ---------------------------------------------
Thomas J. Jamieson
/s/ GORDON E. NOBLE Director March 27, 1998
- ---------------------------------------------
Gordon E. Noble
/s/ C. LEN PECCHENINO Director March 27, 1998
- ---------------------------------------------
C. Len Pecchenino
/s/ CRAIG F. SCHWARBERG Director March 27, 1998
- ---------------------------------------------
Craig F. Schwarberg
/s/ ROBERT A. SPASS Director March 27, 1998
- ---------------------------------------------
Robert A. Spass
/s/ BRADLEY E. COOPER Director March 27, 1998
- ---------------------------------------------
Bradley E. Cooper
/s/ STEVEN B. GRUBER Director March 27, 1998
- ---------------------------------------------
Steven B. Gruber
/s/ ROGER W. GILBERT Director March 27, 1998
- ---------------------------------------------
Roger W. Gilbert
</TABLE>
63
<PAGE> 66
GLOSSARY OF TERMS
DEFINED TERMS AND SELECTED INSURANCE TERMS
Admitted Assets............ Assets recognized and accepted by state insurance
regulatory authorities for their purposes in
determining the financial condition of an insurance
company.
Centre Re.................. Centre Reinsurance Limited.
Claim and Claim Adjustment
Expenses................. The estimated ultimate cost of claims, whether
reported or unreported, charged against earnings
when claims occur, including the estimated expenses
of settling claims (claim adjustment expenses).
Claim and Claim Adjustment
Expense Ratio............ The ratio of claim and claim adjustment expenses to
net premiums earned.
Code....................... Internal Revenue Code of 1986, as amended.
Combined Ratio............. The sum of the claim and claim adjustment expense
ratio and the expense ratio for continuing
operations. A combined ratio under 100% generally
indicates an underwriting profit, and a combined
ratio over 100% generally indicates an underwriting
loss.
Common Stock............... Common Stock of SNIG.
Company.................... Superior National Insurance Group, Inc., a Delaware
corporation, including, if the context requires,
its subsidiaries, on a consolidated basis.
Direct Premiums Written.... Direct premiums written include all premiums
arising from policies issued by the Company acting
as primary insurance carrier, adjusted for any
return or additional premiums arising from
endorsements, cancellations, audits and
retrospective rating plans.
DOI........................ California Department of Insurance.
EBITDA..................... Earnings before interest, taxes, minority interest,
depreciation, and amortization.
Exchange Act............... Securities Exchange Act of 1934, as amended.
Expense Ratio.............. The ratio of commissions (net of reinsurance ceding
commissions), policyholder dividends, and general
and administrative expenses to net premiums earned.
GAAP....................... Generally accepted accounting principles of the
United States of America, including those set forth
in: (i) the opinions and pronouncements of the
Accounting Principles Board of the American
Institute of Certified Public Accounts, (ii)
statements and pronouncements of the Financial
Accounting Standards Board, (iii) in such other
statements by such other entity as approved by a
significant segment of the accounting profession,
and (iv) the rules and regulations of the SEC
governing the inclusion of financial statements in
periodic reports required to be filed pursuant to
Section 13 of the Exchange Act, including opinions
and pronouncements in staff accounting bulletins
and similar written statements from the accounting
staff of the SEC.
Gross Premiums Written..... Gross premiums written include all premiums arising
from policies issued by the Company acting as
primary insurance carrier and policies
64
<PAGE> 67
issued through fronting facilities, adjusted for
any additional or return premiums arising from
endorsements, cancellations, audits and
retrospective rating plans.
IIA........................ International Insurance Advisors, Inc., a New York
corporation, investment advisors to III.
III........................ International Insurance Investors, L.P., a Bermuda
limited partnership, owner of the Voting Notes.
IP......................... IP Bermuda and IP Delaware, collectively.
IP Bermuda................. Insurance Partners Offshore (Bermuda), L.P., a
Bermuda limited partnership.
IP Delaware................ Insurance Partners, L.P., a Delaware limited
partnership.
IRS........................ Internal Revenue Service.
NAIC....................... National Association of Insurance Commissioners.
Net Premiums Earned........ The portion of net premiums written applicable to
the insurance coverage provided in any particular
accounting period.
Net Premiums Written....... Premiums retained by an insurance company after
deducting premiums on business reinsured with
others.
P&C........................ Property and casualty.
Pac Rim.................... Pac Rim Holding Corporation, and where the context
requires, its subsidiaries including The Pacific
Rim Assurance Company.
Policy Acquisition Costs... Agents' or brokers' commissions, premium taxes,
marketing, underwriting, and other expenses
associated with the production of premium.
Premium in Force........... Premium in force is the sum of the estimated annual
gross written premiums for policies on which the
Company is currently providing workers'
compensation coverage.
Reinsurance................ An agreement whereby an insurer transfers ("cedes")
a portion of the insurance risk to a reinsurer in
exchange for the payment of a premium. Reinsurance
can be effected by "treaties," which automatically
cover all risks of a defined category, amount, and
type, or by "facultative reinsurance," which is
negotiated between an original insurer and the
reinsurer on an individual, contract-by-contract
basis.
REM........................ Risk Enterprise Management Limited, a Delaware
corporation, an affiliate of Zurich.
SEC........................ Securities and Exchange Commission.
Securities Act............. Securities Act of 1933, as amended.
SNIC....................... Superior National Insurance Company, a wholly-owned
insurance subsidiary of SNIG.
SNIG....................... Superior National Insurance Group, Inc., a Delaware
corporation, the holding company of SNIC and SPCC.
SPCC....................... Superior Pacific Casualty Company, a wholly-owned
insurance subsidiary of SNIG.
65
<PAGE> 68
Statutory Accounting
Practices
("SAP").................. An accounting method prescribed or permitted by
state insurance regulators. The more significant
differences from GAAP are: (a) premium income is
taken into operations over the periods covered by
the policies, whereas the related acquisition and
commission costs are expensed when incurred; (b)
deferred income taxes are not recognized; (c)
certain assets such as agents' balances over ninety
days due and prepaid expenses are nonadmitted
assets for statutory reporting purposes; (d)
policyholder dividends are accrued when declared;
(e) the cash flow statement is not consistent with
classifications and the presentation under GAAP;
(f) bonds are recorded at amortized cost,
regardless of trading activities; (g) loss and loss
adjustment expense reserves and unearned premium
reserves are stated net of reinsurance; and (h)
minimum statutory reserves for losses in excess of
the Company's estimates are required.
Superior Pacific........... SNIC and SPCC, the principal operating subsidiaries
of the Company. In addition, "Superior Pacific" is
the trade name under which SNIC and SPCC conduct
business.
Triennial Examination...... A regularly scheduled triennial review of the
operations and financial condition of a regulated
California insurance company by the DOI as required
under various provisions of the California
Insurance Code.
Underwriting............... The process whereby an insurer reviews applications
submitted for insurance coverage, determines
whether it will accept all or part of the coverage
requested, and determines the premiums to be
charged.
Underwriting Expenses...... The aggregate of commissions and other policy
acquisition costs, as well as the portion of
administrative, general, and other expenses
attributable to the underwriting operations.
Underwriting Profit
(Loss)..................... The excess (deficiency) resulting from the
difference between net premiums earned and the sum
of claim and claim adjustment expenses,
underwriting expenses, and policyholder dividends.
Unpaid Claim and Claim
Adjustment Expenses...... An estimate of claims that have occurred, both
reported and unreported (including claim adjustment
expenses), and have been charged against earnings
but remain unpaid.
WCIRB...................... Workers' Compensation Insurance Rating Bureau.
ZRNA....................... Zurich Reinsurance (North America), Inc., a
Connecticut corporation, an affiliate of Zurich.
ZCIC....................... Zurich Centre Insurance Company, an affiliate of
Zurich.
Zurich..................... Zurich Reinsurance Centre Holdings, Inc., a
Delaware corporation.
66
<PAGE> 69
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
SUPERIOR NATIONAL INSURANCE GROUP, INC.
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS.................. F-1
INDEPENDENT AUDITORS' REPORT................................ F-2
AUDITED CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of December 31, 1997 and
1996................................................... F-3
Consolidated Statements of Operations for the years ended
December 31, 1997, 1996 and 1995....................... F-4
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 1997, 1996 and 1995... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995....................... F-6
Notes to Consolidated Financial Statements................ F-7
FINANCIAL STATEMENTS SCHEDULES:
Schedule I: Condensed Financial Information of Registrant,
Superior National Insurance Group, Inc. ...... F-28
Schedule II: Valuation and Qualifying Accounts and
Reserves..................................... F-32
Schedule V: Supplemental Insurance Information,
Reinsurance and Supplemental Property and
Casualty Insurance Information................ F-33
</TABLE>
F-1
<PAGE> 70
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Superior National Insurance Group, Inc.:
We have audited the consolidated financial statements of Superior National
Insurance Group, Inc. and subsidiaries as listed in the accompanying index. In
connection with our audits of the consolidated financial statements, we also
have audited the financial statement schedules as listed in the accompanying
index. These consolidated financial statements and financial statement schedules
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements and financial
statement schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Superior
National Insurance Group, 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. Also, in our opinion, the related
financial statement schedules, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly, in all
material respects, the information set forth therein.
KPMG PEAT MARWICK LLP
Los Angeles, California
March 27, 1998
F-2
<PAGE> 71
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(IN THOUSANDS, EXCEPT
SHARE DATA)
<S> <C> <C>
ASSETS
Investments:
Bonds and Notes
Available-for-sale, at market (cost: 1997, $203,373;
1996, $46,549)......................................... $205,214 $ 46,330
Equity securities, at market
Common stock (cost: 1997, $1,356; 1996, $1,199)......... 1,526 1,173
Cash and Invested cash (Restricted cash: 1997, $651; 1996,
$297)................................................... 35,376 100,487
Restricted investment..................................... -- 1,450
-------- --------
TOTAL INVESTMENTS.................................. 242,116 149,440
Reinsurance recoverable:
Paid and unpaid claims and claim adjustment expenses...... 53,082 25,274
Premiums receivable (less allowance for doubtful accounts
of $800 in 1997 and $300 in 1996)....................... 24,364 9,390
Earned but unbilled premiums receivable................... 12,524 5,251
Accrued investment income................................. 2,661 1,035
Deferred policy acquisition costs......................... 5,879 3,042
Deferred income taxes..................................... 12,200 9,520
Funds held by reinsurer................................... 5,152 1,948
Receivable from reinsurer................................. -- 93,266
Prepaid reinsurance premiums.............................. 1,598 1,039
Goodwill.................................................. 35,887 --
Prepaid and other......................................... 21,106 7,364
-------- --------
TOTAL ASSETS....................................... $416,569 $306,569
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Claims and claim adjustment expenses...................... $201,255 $115,529
Unearned premiums......................................... 12,913 9,702
Reinsurance payable....................................... 3,412 874
Long-term debt............................................ 30 98,961
Policyholder dividends.................................... 1,370 --
Capital lease obligation.................................. 7,626 --
Accounts payable and other liabilities.................... 28,868 12,741
-------- --------
TOTAL LIABILITIES.................................. 255,474 237,807
1994 PREFERRED SECURITIES ISSUED BY AFFILIATE; authorized
1,100,000 shares; issued and outstanding 1,013,753 shares
in 1996................................................... -- 23,571
COMPANY-OBLIGATED TRUST PREFERRED SECURITIES OF SUBSIDIARY
TRUST HOLDING SOLELY SENIOR SUBORDINATED NOTES OF SNIG;
$1,000 face per share; issued and outstanding 105,000
shares in 1997............................................ 101,277 --
STOCKHOLDERS' EQUITY
Common stock, $0.01 par value; authorized 25,000,000 shares;
issued and outstanding 5,871,279 shares in 1997 and
3,446,492 shares in 1996.................................. 59 34
Paid-in capital excess of par............................... 34,242 15,988
Unrealized (loss) gain on investments, net of taxes......... 1,327 (162)
Paid-in capital -- warrants................................. 2,206 2,206
Retained earnings........................................... 21,984 27,125
-------- --------
NET STOCKHOLDERS' EQUITY........................... 59,818 45,191
-------- --------
TOTAL LIABILITIES, PREFERRED SECURITIES AND NET
STOCKHOLDERS' EQUITY.............................. $416,569 $306,569
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 72
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
-------- ------- -------
(IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS)
<S> <C> <C> <C>
REVENUES:
Premiums written, net of reinsurance ceded................ $136,929 $87,715 $89,139
Net change in unearned premiums........................... 3,991 933 596
-------- ------- -------
Net premiums earned....................................... 140,920 88,648 89,735
Net investment income..................................... 12,674 7,769 9,784
-------- ------- -------
TOTAL REVENUES...................................... 153,594 96,417 99,519
-------- ------- -------
EXPENSES:
Claims and claim adjustment, net of reinsurance recoveries
of $32,383, $6,064 and $2,418 in 1997, 1996 and 1995
respectively............................................ 90,447 55,638 53,970
Commissions, net of reinsurance ceding commissions of
$4,868, $2,030 and $1,350 in 1997, 1996 and 1995
respectively............................................ 13,838 10,426 11,881
Policyholder dividends.................................... -- (5,927) (5,742)
Interest.................................................. 6,335 7,527 9,619
General and administrative
Underwriting............................................ 23,857 23,712 17,566
Other................................................... 817 (186) 536
Goodwill................................................ 1,039 -- --
-------- ------- -------
TOTAL EXPENSES...................................... 136,333 91,190 87,830
-------- ------- -------
Income before income taxes, preferred securities dividends
and accretion, discontinued operations, and extraordinary
items..................................................... 17,261 5,227 11,689
Income tax expense (benefit)................................ 6,437 1,597 (12)
-------- ------- -------
Income before preferred securities dividends and accretion,
discontinued operations and extraordinary items........... 10,824 3,630 11,701
Preferred Securities dividends and accretion, net of income
tax benefit of $1,260, $858 and $767 in 1997, 1996 and
1995 respectively......................................... (2,445) (1,667) (1,488)
Trust Preferred Securities dividends and accretion, net of
income tax benefit of $321 in 1997........................ (624) -- --
Loss from operations of discontinued property and casualty
operations, net of income tax benefit of $5,070 in 1995... -- -- (9,842)
Extraordinary loss on retirement of long-term debt, net of
income tax benefit of $5,315.............................. (10,317) -- --
Extraordinary loss on retirement of long-term debt, net of
income tax benefit of $785................................ (1,524) -- --
Extraordinary loss on redemption of Pac Rim's outstanding
debentures, net of income tax benefit of $327............. (635) -- --
Extraordinary loss on retirement of preferred securities,
net of income tax benefit of $134......................... (259) -- --
Extraordinary loss on early retirement of Imperial Bank loan
net of income tax benefit of $83.......................... (161) -- --
-------- ------- -------
NET (LOSS) INCOME................................... $ (5,141) $ 1,963 $ 371
======== ======= =======
BASIC EARNINGS PER SHARE:
Income before preferred securities dividends and
accretion, and extraordinary items...................... $ 2.06 $ 1.06 $ 3.41
Preferred securities dividends and accretion.............. (0.58) (0.49) (0.43)
Discontinued operations................................... -- -- (2.87)
Extraordinary items....................................... (2.46) -- --
-------- ------- -------
NET (LOSS) INCOME................................... $ (0.98) $ 0.57 $ 0.11
======== ======= =======
DILUTED EARNINGS PER SHARE:
Income before preferred securities dividends and
accretion, and extraordinary items...................... $ 1.54 $ 0.75 $ 2.97
Preferred securities dividends and accretion.............. (0.44) (0.34) (0.38)
Discontinued operations................................... -- -- (2.50)
Extraordinary items....................................... (1.84) -- --
-------- ------- -------
NET INCOME.......................................... $ (0.74) $ 0.41 $ 0.09
======== ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 73
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
NET
UNREALIZED UNREALIZED
COMMON STOCK GAIN GAIN (LOSS)
-------------------- (LOSS) ON AVAILABLE- PAID IN TOTAL
SHARES $.01 PAR ON EQUITY FOR-SALE CAPITAL -- RETAINED STOCKHOLDERS'
ISSUED VALUE SECURITIES INVESTMENTS WARRANTS EARNINGS EQUITY
--------- -------- ---------- ------------- ---------- -------- -------------
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1994..................... 3,429,873 $15,941 -- $(2,574) $2,206 $24,791 $40,364
Net Income................. -- -- -- -- -- 371 371
Unrealized gain on equity
securities............... -- -- 2 -- -- -- 2
Change in unrealized loss
on available-for-sale
investments, net of
taxes.................... -- -- -- 2,741 -- -- 2,741
Stock issued under stock
option plan.............. 500 2 -- -- -- -- 2
--------- ------- ---- ------- ------ ------- -------
Balance at December 31,
1995..................... 3,430,373 15,943 2 167 2,206 25,162 43,480
--------- ------- ---- ------- ------ ------- -------
Net Income................. -- -- -- -- -- 1,963 1,963
Unrealized gain on equity
securities............... -- -- (19) -- -- -- (19)
Change in unrealized loss
on available-for-sale
investments, net of
taxes.................... -- -- -- (312) -- -- (312)
Stock issued under a stock
option plan.............. 3,100 12 -- -- -- -- 12
Common stock issued under a
stock incentive plan..... 13,019 67 -- -- -- -- 67
--------- ------- ---- ------- ------ ------- -------
Balance at December 31,
1996..................... 3,446,492 16,022 (17) (145) 2,206 27,125 45,191
--------- ------- ---- ------- ------ ------- -------
Net Loss................... -- -- -- -- -- (5,141) (5,141)
Unrealized gain on equity
securities............... -- -- 129 -- -- -- 129
Change in unrealized gain
on available-for-sale
investments, net of
taxes.................... -- -- -- 1,360 -- -- 1,360
Common stock issued........ 2,390,438 18,000 -- -- -- -- 18,000
Stock issued under a stock
option plan.............. 22,127 105 -- -- -- -- 105
Common stock issued under a
stock incentive plan..... 12,222 174 -- -- -- -- 174
--------- ------- ---- ------- ------ ------- -------
Balance at December 31,
1997..................... 5,871,279 $34,301 $112 $ 1,215 $2,206 $21,984 $59,818
========= ======= ==== ======= ====== ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 74
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- ---------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income......................................... $ (5,141) $ 1,963 $ 371
-------- -------- ---------
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Amortization of bonds and preferred stock............... (1,073) (1,581) (3,575)
Amortization of long-term debt.......................... 68 -- --
Loss/(gain) on sale of investments...................... 98 (31) 525
Gain on sale of Centre Re investments................... -- (2,036) (4,891)
Amortization of goodwill................................ 1,039 -- --
Extraordinary loss...................................... 12,896 -- --
Interest expense on long-term debt...................... 3,581 -- --
Preferred securities dividends and accretion............ 3,069 2,526 2,255
(Increase) decrease in reinsurance balances
receivable............................................. (23,789) 14,339 28,516
(Increase) decrease in premiums receivable.............. (1,848) 2,184 6,901
(Increase) decrease in earned but unbilled premiums
receivable............................................. (3,131) (2,101) 3,336
(Increase) decrease in accrued investment income........ (986) 792 (491)
(Increase) decrease in deferred policy acquisition
costs.................................................. (2,837) (262) 125
Decrease in income taxes receivable..................... -- -- 1,721
Decrease (increase) in deferred taxes................... 6,433 735 (5,853)
Increase in funds held by reinsurer..................... (3,204) (976) (972)
Increase in prepaid reinsurance premiums................ (2,406) (287) (88)
Decrease (increase) in other assets..................... 1,637 (1,287) (1,413)
Decrease in claims and claim adjustment expense
reserves............................................... (24,523) (25,966) (29,763)
Decrease in unearned premium reserves................... (3,648) (645) (508)
Increase (decrease) in reinsurance payable.............. 2,538 504 (2,835)
Decrease in policyholder dividends payable.............. -- (8,094) (10,970)
Decrease in discontinued operations..................... -- -- (4,223)
(Decrease) increase in accounts payable and other
liabilities............................................ (11,143) 5,321 (1,994)
-------- -------- ---------
Total adjustments....................................... (47,229) (16,865) (24,197)
-------- -------- ---------
Net cash used in operating activities............... (52,370) (14,902) (23,826)
-------- -------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Paid-in-capital -- stock options taken.................. 279 79 2
Proceeds from issuance of common stock.................. 18,000 -- --
Proceeds from Trust Preferred Securities net of $3.7
million issuance....................................... 101,272 -- --
Long-term debt -- Chase Manhattan Bank.................. 41,257 -- --
Retirement of long-term debt -- Chase Manhattan Bank.... (44,000) -- --
Retirement of 1994 Preferred Securities................. (27,668) -- --
Retirement of long-term debt............................ (7,250) (2,660) (1,200)
Prepayment penalty on long-term debt.................... (244) -- --
Funding of discontinued operations...................... (4,357) -- --
Proceeds from Chase Financing........................... -- 93,091 --
-------- -------- ---------
Net cash provided by (used in) financing
activities.......................................... 77,289 90,510 (1,198)
-------- -------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of bonds and notes:
Investments available-for-sale.......................... (226,749) (43,257) (4,611)
Investment funds withheld from reinsurers............... -- (88,568) (204,577)
Purchases of common stock................................. (1,496) (513) (680)
(Increase) in receivable from reinsurer................... -- (93,266) --
Purchase of Pacific Rim Holding Company................... (44,016) -- --
Investments and cash allocated to discontinued
operations.............................................. -- -- (1,581)
Sales of bonds and notes: Investments
available-for-sale...................................... 109,082 25,343 17,643
Maturities of bonds and notes:
Investments held-to-maturity............................ -- -- 2,250
Investments available-for-sale.......................... 15,042 12,771 3,035
Sales and maturities of funds withheld from reinsurers.... -- 206,548 191,238
Sales of equity securities................................ 1,197 -- --
Net decrease in invested cash............................. 55,460 983 26,062
-------- -------- ---------
Net cash (used in) provided by investing activities....... (91,480) 20,041 28,779
-------- -------- ---------
Net (decrease) increase in cash........................... (66,561) 95,649 3,755
Cash and invested cash at beginning of period............. 101,937 6,288 2,533
-------- -------- ---------
Cash and invested cash at end of period................... $ 35,376 $101,937 $ 6,288
======== ======== =========
Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes.............. $ 4 $ 4 $ 4
======== ======== =========
Cash paid during the year for interest.................. $ 2,803 $ 641 $ 808
======== ======== =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 75
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Superior
National Insurance Group, Inc. ("SNIG") and all subsidiaries (together with
SNIG, the "Company"). The Company's principal insurance subsidiaries
(collectively referred to as "Superior Pacific"), Superior National Insurance
Company ("SNIC") and Superior Pacific Casualty Company ("SPCC"), are licensed to
write workers' compensation insurance and commercial property and casualty
insurance in 20 states and the District of Columbia.
During the third quarter of 1993, the Company adopted a plan to discontinue
underwriting commercial property and casualty risks. Earned premiums reported in
1997, 1996, and 1995 reflect workers' compensation premiums from policies that
were primarily located in California.
The Company's consolidated financial statements have been prepared on the
basis of generally accepted accounting principles that vary in certain respects
from accounting practices prescribed or permitted by state insurance regulatory
authorities. The results of all significant intercompany transactions have been
eliminated.
Certain reclassifications have been made to prior year financial statements
to conform to the 1997 presentation.
Acquisition
On April 11, 1997, the Company acquired all of the outstanding stock of Pac
Rim Holding Corporation ("Pac Rim") for aggregate consideration of $42.0 million
in cash. This consideration resulted in payments of $20.0 million to Pac Rim
stockholders, $20.0 million to Pac Rim's convertible debenture holders, and $2.0
million to Pac Rim's warrant and option holders. In addition, the Company
incurred $2.0 million in transaction fees and related expenses. The Company
financed the acquisition of Pac Rim through a $44.0 million term loan and the
sale of $18 million of newly issued shares of common stock. The term loan was
subsequently retired from funds raised from the sale of $105 million of 10.75%
Trust Preferred Securities. As a result of the term loan's being retired the
Company recorded an extraordinary loss, net of federal income taxes, of $1.5
million.
The transaction resulted in $36.9 million in goodwill that is being
amortized on a straight line basis over 27.5 years. The transaction was
accounted for using the purchase method and the results of operations since the
date of the acquisition have been included in operations. The transaction's
designated accounting effective date is April 1, 1997.
The balance sheet of Pac Rim at the acquisition date included the following
assets: investments of $105,913, cash of $2,627, receivables of $17,268, and
other assets of $22,272. Liabilities assumed in the acquisition included
unearned premiums of $6,859, claims and claim adjustment expense reserves of
$107,743, and other liabilities of $32,289.
F-7
<PAGE> 76
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The unaudited proforma condensed consolidated results of operations
presented below assume the transaction occurred had the acquisition taken place
at the beginning of each period presented.
<TABLE>
<CAPTION>
PRO FORMA RESULTS FOR THE YEAR
ENDED DECEMBER 31,
-------------------------------
1997 1996
------------ ------------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C>
Revenues.................................................... $174,550 $187,732
Loss before income taxes, preferred securities dividends and
accretion, and extraordinary items........................ $ (253) $(18,620)
Net (loss).................................................. $(23,280) $(23,226)
Basic earnings per share.................................... $ (4.43) $ (3.01)
Diluted earnings per share.................................. $ (3.32) $ (2.55)
</TABLE>
These unaudited proforma results are not necessarily indicative of the
results of operations that would have occurred had the acquisition taken place
at the beginning of each period or of future operations of the combined
companies.
Reverse Stock Split
Effective May 25, 1995, shareholders of SNIG approved a four-into-one
reverse split of SNIG's common stock. The purpose of the reverse split was to
increase the per-share price of the SNIG common stock in order to enhance public
trading of the common stock upon the effectiveness of the Company's registration
with the Securities and Exchange Commission. Consequently, the shares of common
stock and stock options information included in the accompanying consolidated
financial statements were prepared assuming the reverse stock split had been
outstanding at the beginning of all periods presented.
Cash and Invested Cash
Cash includes currency on hand and demand deposits with financial
institutions. Invested cash represents short-term, highly liquid investments,
readily convertible to known amounts of cash and near maturity such that there
is insignificant risk of changes in value because of changes in interest rates.
Invested cash is carried at cost, which approximates market.
Investments
Investments in debt instruments consist primarily of bonds and
collateralized mortgage obligations. Debt instruments and equities are
classified as (i) "held-to-maturity" (carried at amortized cost); (ii) "trading"
(carried at market with differences between cost and market being reflected in
the results of operations); or (iii) if not otherwise classified, as
"available-for-sale" (carried at market with differences between cost and market
being reflected as a separate component of stockholders' equity, net of
applicable income tax effect). The premiums and discounts on fixed maturities
and collateralized mortgage obligations are amortized using the scientific
method. Amortization and accretion of premiums and discounts on collateralized
mortgage obligations are adjusted for principal paydowns and changes in expected
maturities. Current market values of investments are obtained from published
sources. Declines in market value that are considered other than temporary are
charged to operations.
The Company does not own any investments that qualify as derivatives as
defined by Statement of Financial Accounting Standard No. 119, "Disclosure About
Derivative Financial Investments and Fair Value of Financial Investments."
Securities not designated as held-to-maturity have been designated as available-
for-sale. The Company did not have any investments categorized as trading
securities. For determining realized gains or losses on securities sold, cost is
based on average cost.
F-8
<PAGE> 77
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Investments in equity securities are carried at fair value. Unrealized
gains or losses on equity securities are reflected, net of applicable tax, in
stockholders' equity.
Premiums Receivable
Superior Pacific records premiums receivable for both billed and unbilled
amounts. Unbilled premiums receivable, which are substantially all earned,
primarily represent Superior Pacific's estimate of the difference between
amounts billed on installment policies and the amount to be ultimately billed on
the policy. Unbilled premiums receivable also include estimated billings on
payroll reporting policies which were earned but not billed prior to year end.
Superior Pacific uses its historical experience to estimate earned but unbilled
amounts which are recorded as premiums receivable. These unbilled amounts are
estimates, and while the Company believes such amounts are reasonable, there can
be no assurance that the ultimate amounts received will equal the recorded
unbilled amounts.
The ultimate collectability of the unbilled receivables can be affected to
a greater degree by general changes in the economy and the regulatory
environment than billed receivables due to the increased time required to
determine the billable amount. The Company attempts to consider these factors
when estimating the receivable for unbilled premiums.
Deferred Policy Acquisition Costs
Acquisition costs, consisting principally of commissions, premium taxes,
and certain marketing, policy issuance, and underwriting costs related to the
production of SNIC's workers' compensation business, are deferred and amortized
ratably over the terms of the policies. If recoverability of such costs is not
anticipated, the amounts not considered recoverable are charged to income. In
determining estimated recoverability, the computation gives effect to the
premium to be earned, related investment income, claims and claim adjustment
expenses, and certain other costs expected to be incurred as the premium is
earned.
Policy acquisition costs incurred and amortized into income are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Balance at beginning of year....................... $ 3,042 $ 2,780 $ 2,905
Cost deferred during the year...................... 22,814 17,132 18,163
Amortization charged to expense.................... (19,977) (16,870) (18,288)
-------- -------- --------
Balance at end of year............................. $ 5,879 $ 3,042 $ 2,780
======== ======== ========
</TABLE>
Claims and Claim Adjustment Expenses
Claims and claim adjustment expenses are based on case-basis estimates of
reported claims and on estimates, based on experience and industry data, for
unreported claims and claim adjustment expenses. The provision for unpaid claims
and claim adjustment expenses, net of estimated salvage and subrogation, has
been established to cover the estimated net cost of incurred claims. The amounts
are necessarily based on estimates, and accordingly, there can be no assurance
the ultimate liability will not differ from such estimates.
There is a high level of uncertainty inherent in the evaluation of the
required claims and claim adjustment expense reserves. Management has selected
ultimate claim and claim adjustment expenses that it believes will reasonably
reflect anticipated ultimate experience. The ultimate costs of such claims are
dependent upon future events, the outcomes of which are affected by many
factors. Claims reserving procedures and settlement philosophy, current and
perceived social and economic factors, inflation, current and future court
rulings and jury attitudes, and many other economic, scientific, legal,
political, and social factors all can have significant effects on the ultimate
costs of claims. Changes in Company operations and management philosophy also
may cause actual developments to vary from the past.
F-9
<PAGE> 78
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Policyholder Dividends
Prior to the inception of open rating in January 1995, policyholder
dividends served both as an economic incentive to employers for safe operations
and as a means of price differentiation; however, since open rating, the
consumer's preference has been for the lowest net price at a policy's inception.
This is evidenced by the decline in participating policies written by Superior
Pacific as a percent of total policies from 24% of workers' compensation
premiums in force at December 31, 1995 to 1% at December 31, 1996. A small
increase in the percentage of participating policies to 3% at December 31, 1997
is attributable to policies written in Arizona. In 1995, as a result of the
diminishing value of policyholder dividends, Superior Pacific's management
declared a moratorium in the payment of policyholder dividends. In December
1996, the Company discontinued policyholder dividend payments. Estimated amounts
to be returned to policyholders were accrued when the related premium was earned
by Superior Pacific. Dividends were paid to the extent that a surplus was
accumulated from premiums on workers' compensation policies.
Premium Income Recognition
Insurance premiums are earned ratably over the terms of the policies.
Unearned premiums are computed on a daily pro-rata basis.
Income Taxes
The Company files a consolidated Federal income tax return which includes
all qualifying subsidiaries.
Deferred income taxes are provided for temporary differences between
financial statement and tax return bases using the asset and liability method,
in accordance with Statement of Financial Accounting Standard No. 109,
"Accounting for Income Taxes" ("SFAS 109"). Under the asset and liability
method, deferred taxes are measured using enacted tax rates in effect for the
year in which those temporary differences are expected to be settled. Tax rate
changes are accounted for in the year in which the tax law is enacted.
Earnings per Share ("EPS")
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 128, "Earnings per Share", which
requires presentation of basic and diluted earnings per share for all publicly
traded companies effective for fiscal years ending after December 15, 1997. Note
16 contains the required disclosures which make up the calculation of basic and
diluted earnings per share. The required restatement of prior years earnings per
share reflect an immaterial difference.
Property, Equipment, Leasehold Improvements and Assets Under Capital Lease
Property, equipment, and leasehold improvements are stated at cost, net of
accumulated depreciation and amortization. The accumulated depreciation and
amortization as of December 31, 1997 and 1996 was $2,207 and $4,289
respectively. Depreciation and amortization are provided principally on the
straight-line method over the estimated useful lives of the assets, or, if less,
the term of the lease. Property, equipment, and leasehold improvements are
included as a component of "Prepaid and other assets" on the consolidated
balance sheets.
Use of Management Estimations
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts of assets, liabilities, and disclosures of
contingent assets and liabilities at the date of the financial statements. The
Company has provided such estimates for its workers' compensation claims and
claim adjustment expenses; discontinued operations; policyholder dividends;
earned but unbilled premiums; and deferred taxes balances in its financial
F-10
<PAGE> 79
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
statements. While these estimates are based upon analyses performed by
management, outside consultants, and actuaries, the amounts the Company will
ultimately pay may differ materially from the amounts presently estimated.
Stock-Based Compensation
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25") and Related
Interpretations in accounting for its employee stock options.
Business Relationships with Zurich
Certain affiliates of Zurich Reinsurance Centre Holdings, Inc., a Delaware
corporation ("Zurich"), collectively own approximately 45% of SNIG's common
stock on a diluted basis, and approximately 36% of SNIG's issued and outstanding
common stock on a non-diluted basis.
In March 1992, the Company issued warrants (the "Warrants") to purchase
1,616,886 shares of Common Stock in connection with the sale of its 14.5% Senior
Subordinated promissory notes in an aggregate principal amount of $11.0 million,
which notes have since been redeemed. The Warrants are exercisable at $4.00 per
share and expire April 1, 2002. International Insurance Investors, L.P. ("III"),
an affiliate of Zurich, originally purchased 1,474,306 of such Warrants (which
are held by International Insurance Advisers, Inc. pursuant to a revocable
agency relationship) with the remaining 142,580 Warrants being issued to
management. As of December 31, 1997 Warrants to purchase 1,566,465 shares of
Common Stock were outstanding, as Warrants to purchase 50,421 shares of Common
Stock held by management have since been retired upon the termination of their
employment with the Company.
In June 1994 in connection with a $20.0 million investment in the Company
(and its affiliate, Superior National Capital, L.P.) by CenterLine Reinsurance
Limited ("CenterLine"), an affilate of Zurich, the Company issued to CenterLine
a warrant to purchase 579,356 shares of Common Stock at an exercise price of
$5.20 per share, which expires April 1, 2002.
(2) INVESTMENTS
The amortized cost and market values of bonds and notes classified as
available-for-sale at December 31, 1997 are as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
Available-for-sale:
United States government agencies and
authorities........................ $ 89,884 $ 420 $(207) $ 90,097
Collateralized mortgage obligations... 72,478 1,100 (97) 73,481
Corporate instruments................. 41,011 657 (32) 41,636
State and political subdivisions...... -- -- -- --
-------- ------ ----- --------
Total available-for-sale.............. $203,373 $2,177 $(336) $205,214
======== ====== ===== ========
</TABLE>
F-11
<PAGE> 80
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The market values of equity securities as of December 31, 1997 are as
follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ------
<S> <C> <C> <C> <C>
Equity Securities:
Corporate Instruments................... $1,356 $171 $(1) $1,526
------ ---- --- ------
Total Equity Securities................. $1,356 $171 $(1) $1,526
====== ==== === ======
</TABLE>
The amortized cost and estimated market values of investments classified as
available for sale at December 31, 1997 by contractual maturity are shown below.
Expected maturities are likely to differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
penalty. Mortgage-backed securities are included based upon the expected payout
pattern and duration of the fixed income security. Changes in interest rates,
investor expectations, and political agendas could cause the ultimate payout
pattern to differ.
<TABLE>
<CAPTION>
AVAILABLE FOR SALE
---------------------
AMORTIZED FAIR
COST VALUE
--------- --------
<S> <C> <C>
Due in one year or less..................................... $ 25,044 $ 25,086
Due after one year through five years....................... 44,254 44,710
Due after five years through ten years...................... 42,101 42,776
Due after ten years......................................... 91,974 92,642
-------- --------
Total....................................................... $203,373 $205,214
======== ========
</TABLE>
The amortized cost and market values of bonds and notes classified as
available for sale at December 31, 1996 are as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -------
<S> <C> <C> <C> <C>
Available-for-sale:
United States government agencies and
authorities......................... $22,596 $ 62 $(174) $22,484
Collateralized mortgage obligations.... 12,989 -- (134) 12,855
Corporate instruments.................. 9,864 23 (20) 9,867
State and political subdivisions....... 1,100 24 -- 1,124
------- ---- ----- -------
Total available-for-sale............... $46,549 $109 $(328) $46,330
======= ==== ===== =======
</TABLE>
The market value of equity securities as of December 31, 1996 are as
follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ------
<S> <C> <C> <C> <C>
Equity Securities:
Corporate Instruments................... $1,199 $73 $(99) $1,173
------ --- ---- ------
Total Equity Securities................. $1,199 $73 $(99) $1,173
====== === ==== ======
</TABLE>
F-12
<PAGE> 81
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of net investment income for the years ended December 31, are as
follows:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------ -------
<S> <C> <C> <C>
Interest on bonds and notes............................ $ 9,124 $6,628 $ 9,310
Interest on invested cash.............................. 4,068 1,609 1,297
Realized gains (losses)................................ 44 31 (525)
Other.................................................. 190 -- --
------- ------ -------
Total investment income................................ 13,426 8,268 10,082
Investment expense..................................... (752) (499) (298)
------- ------ -------
Net investment income.................................. $12,674 $7,769 $ 9,784
======= ====== =======
</TABLE>
Realized gains (losses) on investments for the years ended December 31, are
as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- -----
<S> <C> <C> <C>
Bonds and notes............................................. $44 $31 $(525)
Equity securities........................................... -- -- --
--- --- -----
Total....................................................... $44 $31 $(525)
=== === =====
</TABLE>
The changes in unrealized gains (losses) on debt instruments held as
available-for-sale and equity security investments at December 31, are as
follows:
<TABLE>
<CAPTION>
1997 1996 1995
------ ----- ------
<S> <C> <C> <C>
Bonds and notes........................................... $2,060 $(472) $4,154
Equity securities......................................... 196 (29) 2
------ ----- ------
Total..................................................... $2,256 $(501) $4,156
====== ===== ======
</TABLE>
Proceeds from sales of bonds and notes held as available-for-sale for the
years ended December 31, 1997, 1996, and 1995 were $109,082, $25,343, and
$17,643, respectively. Gross gains of $176 and gross losses of $132 were
realized on those sales in 1997. Gross gains of $44 and gross losses of $13 were
realized on those sales in 1996. Gross gains of $4 and gross losses of $529 were
realized on those sales in 1995.
Bonds and other securities with a market value of $180,447 at December 31,
1997, $127,112 at December 31, 1996 and $143,462 at December 31, 1995, were on
deposit with various insurance regulatory authorities. Additionally, see Note
(7) regarding investments held related to reinsurance contracts.
(3) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table represents the carrying amounts and estimated fair
values of the Company's financial liabilities at December 31, 1997 and 1996.
Statement of Financial Accounting Standard No. 107, "Disclosure about Fair Value
of Financial Instruments," ("SFAS 107") defines the fair value of a financial
instrument as the amount at which the instrument could be exchanged in a current
transaction between willing parties. Fair values with respect to investments are
presented in Note (2) and the fair value of all other investments approximates
their fair value.
F-13
<PAGE> 82
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The carrying amounts shown in the table below are included in the
Consolidated Balance Sheet under the indicated options:
<TABLE>
<CAPTION>
1997 1996
-------------------- -------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- -------- -------- -------
<S> <C> <C> <C> <C>
Financial liabilities:
Chase financing agreement................. $ -- $ -- $91,681 $91,374
Imperial Bank debt........................ $ -- $ -- $ 7,250 $ 7,541
1994 Preferred Securities issued by
affiliate............................... $ -- $ -- $23,571 $19,998
Trust Preferred Securities issued by
affiliate............................... $101,277 $104,990 $ -- $ --
</TABLE>
Fair value is estimated based on the quoted market prices for similar
issues or by discounting expected cash flows at the rates currently offered to
the Company for debt of the same remaining maturities. However, there can be no
assurances that in the event the assets and liabilities would be required to be
liquidated that the amounts received or due would be the amounts reflected
herein.
(4) CLAIM AND CLAIM ADJUSTMENT EXPENSE RESERVES
The activity in the claim and claim adjustment expense reserve account is
summarized as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C>
Beginning reserve, gross of reinsurance............ $115,529 $141,495 $171,258
Less: Reinsurance recoverable on unpaid losses..... 24,986 27,076 31,897
-------- -------- --------
Beginning reserve, net of reinsurance.............. 90,543 114,419 139,361
Pac Rim reserves at acquisition.................... 104,588 -- --
Provision for net claims and claim adjustment
expenses
For claims occurring in current year............. 95,826 57,614 58,842
For claims occurring in prior years.............. (5,379) (1,976) (4,872)
-------- -------- --------
Total claims and claim adjustment expenses....... 90,447 55,638 53,970
-------- -------- --------
Payments for net claims and claim adjustment
expense:
Attributable to insured events incurred in
current year.................................. (37,945) (19,816) (19,732)
Attributable to insured events incurred in prior
years......................................... (95,533) (59,698) (59,180)
-------- -------- --------
Total claims and claim adjustment expense
payments...................................... (133,478) (79,514) (78,912)
-------- -------- --------
Ending reserves, net of reinsurance................ 152,100 90,543 114,419
Reinsurance recoverable on unpaid losses........... 49,155 24,986 27,076
-------- -------- --------
Ending reserves, gross of reinsurance.............. $201,255 $115,529 $141,495
======== ======== ========
</TABLE>
During 1997, the Company continued to experience decreased frequency of
claims and at the same time experienced an increase in claims severity for
accident years 1995 and thereafter. The Company's net claim and claim adjustment
expense ratio for accident year 1997 at the end of calendar year 1997 was 68.0%,
versus 65.0% and 65.6% for accident years 1996 and 1995, at their respective
calendar year ends.
In 1997, the Company experienced approximately $5.4 million in favorable
development on net claim and claim adjustment expense reserves estimated at
December 31, 1996. This $5.4 million favorable development is the result of a
$10.8 million favorable development on ceded reserves for accident years 1996
and prior. The $10.8 million favorable development on ceded reserves is
attributable to SPCC and due to the post-acquisition
F-14
<PAGE> 83
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
review of all open claim files and the subsequent adjustment to reserves, which
caused many claims to have incurred claim and claim adjustment expenses in
excess of the retention on SPCC's reinsurance treaties. The $10.8 million
favorable development is offset by a $5.4 million adverse development on direct
reserves attributable to the accident years 1995 and 1996.
In 1996, the Company experienced approximately $2.0 million in favorable
development on net claims and claim adjustment expense reserves estimated at
December 31, 1995. This $2.0 million favorable development is the result of $8.4
million in favorable development on direct reserves for accident years 1994 and
prior. The favorable development was offset in part by $4.1 million adverse
development on direct reserves for accident year 1995, and $2.3 million adverse
development on ceded reserves for accident years 1995 and prior. The Company's
1995 accident year net claims and claim adjustment expense ratio for accident
year 1995 at the end of calendar year 1995 was 65.6%, verses 74.6% at the end of
the 1996 calendar year. Offsetting the favorable development in large part was
the re-estimation during 1995 of reinsurance receivables recorded at December
31, 1994, from approximately $66.2 million to approximately $59.9 million at
December 31, 1995.
During 1995, the Company experienced approximately $8.6 million of
favorable development on direct claim and claim adjustment expense reserves
estimated at December 31, 1994. Management believes the favorable development
resulted from the Company's improved claims management controls and decreased
claim severity, particularly in the medical component of the workers'
compensation line.
(5) DISCONTINUED OPERATIONS
During the third quarter of 1993, the Company adopted a plan to discontinue
underwriting commercial property and casualty risks. As a result, the Company
recorded a pre-tax charge to income of $2,991 for estimated operating losses
during the phase-out period.
During the second quarter of 1995, the Company increased its reserves by
approximately $15 million for discontinued operations for accident years 1994
and prior. This increase in claims and claim adjustment expense reserves from
the original estimate at the measurement date resulted from increased frequency
and severity of claims incurred from those years relative to previous
expectations, which in turn caused an increase in the estimated ultimate claims
and claim adjustment expense reserves related to 1994 and prior years.
At December 31, 1997 and 1996, liabilities of discontinued operations
relating to unpaid claim and claim adjustment expenses, off-set by certain
assets, have been reclassified in the balance sheet. Management estimates the
discontinued operations will be "run off" by the year 2000. The assets and
liabilities of discontinued operations are summarized below.
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1997 1996
------- -------
<S> <C> <C>
Assets:
Reinsurance recoverables.................................. $ 5,937 $ 8,604
Deferred tax asset........................................ 12,904 --
Investments and other assets.............................. -- 17,261
------- -------
Total Assets...................................... $18,841 $25,865
======= =======
Liabilities:
Claims and claim adjustment expense reserves.............. $18,686 $25,466
Other liabilities......................................... 155 399
------- -------
Total Liabilities................................. $18,841 $25,865
======= =======
</TABLE>
F-15
<PAGE> 84
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(6) INCOME TAXES
Total income tax expense (benefit) for the years ended December 31, 1997,
1996, and 1995 was allocated as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------ -------
<S> <C> <C> <C>
Continuing operations.................................. $ 6,437 $1,597 $ (12)
Dividend accrued on preferred securities............... (1,581) (858) (767)
Discontinued operations................................ -- -- (5,070)
Extraordinary items.................................... (6,643) -- --
------- ------ -------
Total........................................ $(1,787) $ 739 $(5,849)
======= ====== =======
</TABLE>
Income tax expense (benefit) from continuing operations for the years ended
December 31, 1997, 1996, and 1995 is composed of the following amounts:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ----
<S> <C> <C> <C>
Current.................................................... $ 4 $ 4 $ 4
Deferred................................................... 6,433 1,593 (16)
------ ------ ----
Total............................................ $6,437 $1,597 $(12)
====== ====== ====
</TABLE>
Taxes computed at the statutory rate of 34% varied from the amounts
reported in the consolidated statements of income at December 31, as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ -------
<S> <C> <C> <C>
Income taxes at statutory rates......................... $5,869 $1,777 $ 3,974
Effect of tax-exempt interest........................... (10) (22) (15)
Effect of meals and entertainment....................... 42 38 38
Effect of goodwill amortization......................... 353 -- --
Research and development credit......................... 179 (200) --
Change in valuation allowance for tax assets............ -- -- (4,013)
Other................................................... 4 4 4
------ ------ -------
Total......................................... $6,437 $1,597 $ (12)
====== ====== =======
</TABLE>
F-16
<PAGE> 85
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities at December 31, are
presented below:
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Deferred tax assets:
Original issue discount................................... $ -- $ 5,764
Net operating loss carryforward........................... 43,918 29,062
Alternate minimum tax credit carryforward................. 1,035 701
Loss reserve discounting.................................. 7,787 --
Unearned premium liability................................ 878 660
Policyholder dividends.................................... 466 --
Deferred gain on capital lease............................ 546 --
Unrealized loss on available-for-sale securities.......... -- 84
Research and development credit........................... 21 200
Other..................................................... 403 281
-------- --------
Total gross deferred tax assets........................... 55,054 36,752
Less: Valuation allowance................................. (8,129) --
-------- --------
Total............................................. 46,925 36,752
-------- --------
Deferred tax liabilities:
Loss reserves............................................. -- (9,139)
Discontinued operations................................... (3,039) (1,245)
Reinsurance experience refunds............................ (15,300) (15,300)
Deferred acquisition costs................................ (1,999) (1,034)
Direct collection allowance............................... (799) (510)
Unrealized gain on available-for-sale investments......... (684) --
Reinsurance payable....................................... -- (4)
-------- --------
Total gross deferred tax liabilities...................... (21,821) (27,232)
-------- --------
Net deferred tax asset................................. 25,104 9,520
Net deferred tax asset allocated to discontinued
operations............................................. (12,904) --
-------- --------
Net deferred tax asset -- continuing operations........ $ 12,200 $ 9,520
======== ========
</TABLE>
Management believes it is more likely than not that the existing net
deductible temporary differences will reverse during the periods in which the
Company generates net taxable income. However, there can be no assurance the
Company will generate any earnings or any specific level of continuing earnings
in future years. Certain tax planning strategies could be implemented to
supplement income from operations to fully realize recorded tax benefits.
At December 31, 1997, the Company had a tax net operating loss carryforward
of $130.2 million that begins to expire in the year 2006.
(7) REINSURANCE
Superior Pacific cedes claims and claim adjustment expenses to reinsurers
under various contracts that cover individual risks, classes of business, or
claims that occur during specified periods of time. Reinsurance is ceded on
pro-rata, per-risk, excess-of-loss, and aggregate bases. These reinsurance
arrangements provide greater diversification of risk and limit SNIC's claims
arising from large risks or from hazards of an unusual nature. Superior Pacific
is contingently liable to the extent that any reinsurer becomes unable to meet
its
F-17
<PAGE> 86
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
contractual obligations. Therefore, the Company evaluates the financial
condition of its reinsurers and monitors concentrations of credit risks arising
from reinsurance activities and economic characteristics to minimize its
exposure to significant losses from reinsurer insolvencies.
As of December 31, 1997, SNIC was involved in a dispute with certain of its
reinsurers, which, if not settled, may be resolved in arbitration. SNIC's
dispute exists with its property and casualty reinsurers as to the existence of
coverage related to a claim in the amount of $456. Management expects to recover
the entire disputed amount from the reinsurers. At December 31, 1997, there were
no disputes related to the workers' compensation operations.
Effective June 30, 1991, SNIC entered into an aggregate excess of loss
reinsurance contract ("1991 Contract") with Centre Reinsurance Limited ("Centre
Re"). Under the 1991 Contract, SNIC purchased for $50 million reinsurance for
claims and claim adjustment expenses incurred on or prior to June 30, 1991 to
the extent that these amounts were unpaid at June 30, 1991. The coverage
obtained amounted to $87.5 million in excess of SNIC's retention. Additionally,
SNIC ceded approximately $69.1 million of earned premiums to Centre Re through
December 31, 1992. Claims and claim adjustment expenses occurring prior to
December 31, 1992 were ceded to Centre Re in the amount of $165.6 million under
the 1991 Contract. Prospective cessions of premium and claims were terminated by
mutual consent of SNIC and Centre Re effective December 31, 1992; however, all
other terms of the 1991 Contract remained in effect until the treaty was
commuted in June 1997.
In 1996, as a result of the transaction entered into between the Company,
Centre Re, and Chase Manhattan Bank (see Note 8), the reinsurance receivables
related to the 1991 Contract no longer qualify as reinsurance receivables under
the conditions established in SFAS 113. Therefore, in 1996 the receivables were
reclassified as receivables from reinsurer on the balance sheet.
Effective January 1, 1993, SNIC entered into an aggregate excess of loss
reinsurance contract ("1993 Contract") with Centre Re. From SNIC's perspective,
the 1993 Contract substantively operated as a one-year contract with at least
four one-year options to renew that were exercisable solely at the Company's
election during the first five years of the contract. Subsequent to January 1,
1998, the 1993 Contract could have been terminated by either SNIC or Centre Re
upon 30 days notice. The 1993 Contract required the Company to cede not less
than $15 million and not more than $20 million of premium to Centre Re with
respect to any covered accident year. Claims and allocated claim adjustment
expenses occurring during the accident year are ceded to Centre Re in excess of
a variable percentage of earned premium (60%, 56.5%, and 57.5% for the 1995,
1994, and 1993 accident years, respectively) and are subject to a limit of 130%
of ceded earned premium, such limit not to exceed $26 million for any accident
year. Effective January 1, 1996, the 1993 Contract was canceled at the Company's
election. In 1997, the Company paid $5.3 million related to the cancellation of
the 1993 Contract.
Effective January 1, 1994, SNIC entered into a quota-share reinsurance
contract ("Quota-Share Contract") with Zurich Reinsurance (North America), Inc.,
("ZRNA") an affiliate of Zurich. Under the Quota-Share Contract, ZRNA may
provide Superior Pacific with an Assumption of Liability Endorsement facility
("ALE"), or, effective January 1, 1997, Superior Pacific may write directly on
policy forms of ZC Insurance Company ("ZCIC"), an affiliate of Zurich (the "ZCIC
Front"). The ceding rate under the Quota-Share Contract was 20% for 1994, and
ZRNA and Superior Pacific mutually agreed to reduce the quota-share
participation to 5% for 1995 and 1996. Further, Superior Pacific receives ceding
commissions ranging between 22.5% and 24.5% for premiums ceded to ZRNA. The
purpose of the ceding commission is to cover Superior Pacific's cost of
acquiring new business and may be changed as a result of changes in market
conditions on a quarterly basis.
Effective January 1, 1997, the terms of the Quota-Share Contract were
amended. Under the amended terms of the Quota-Share Contract, ZRNA increased its
participation from 5% of premiums written in 1996
F-18
<PAGE> 87
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
to 6.5% in 1997. In exchange for the increased participation, ZRNA will no
longer receive a separate fee for policies written on ALEs, but will receive 2%
of premiums written on ZCIC Front policies only.
Superior Pacific entered into a reinsurance contract with Centre Re
effective June 30, 1997, under which Centre Re assumed $10 million of reserves
associated with claims open for future medical payments from Superior Pacific in
consideration of $1 million in cash and the assignment of the rights of Superior
Pacific's contribution and subrogation recoveries during the term of the
contract. The contract is accounted for as a deposit, and no gain will be
recognized until net cash payments from Centre Re are greater than Superior
Pacific's $1 million premium.
Superior Pacific's contracts are generally entered into on an annual basis.
Superior Pacific has maintained reinsurance treaties with many reinsurers for a
number of years. In general, Superior Pacific's reinsurance contracts are of the
treaty variety, and cover underwritten risks specified in the treaties. Superior
Pacific also from time to time purchases facultative reinsurance covering
specific liabilities or policies underwritten. As of December 31, 1997, ZRC,
General Reinsurance Corporation, and Allstate Insurance account for 24.5%,
21.6%, and 10.4%, respectively, of total amounts recoverable from all reinsurers
on paid and unpaid claims and claim adjustment expenses.
Amounts included in the income and expense accounts in continuing
operations in connection with all ceded reinsurance at December 31, are as
follows:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- -------
<S> <C> <C> <C>
Net Premiums written:
Premiums written.................................. $159,352 $ 99,282 $97,084
Premiums ceded.................................... (22,423) (11,567) (7,945)
-------- -------- -------
Net premiums written........................... $136,929 $ 87,715 $89,139
======== ======== =======
Net change in unearned premiums:
Direct............................................ $ (3,649) $ (645) $ (381)
Ceded............................................. (342) (288) (215)
-------- -------- -------
Net change in unearned premiums................ $ (3,991) $ (933) $ (596)
======== ======== =======
Net claims and claim adjustment expenses:
Claims and claim adjustment expenses.............. $122,830 $ 61,702 $56,388
Reinsurance recoveries............................ (32,383) (6,064) (2,418)
-------- -------- -------
Net claims and claim adjustment expenses....... $ 90,447 $ 55,638 $53,970
======== ======== =======
</TABLE>
(8) LONG-TERM DEBT
The following is a summary of the Company's long-term debt balances at
December 31:
<TABLE>
<CAPTION>
1997 1996
---- -------
<S> <C> <C>
Chase Financing Agreement -- 6.87% due through 2004......... $-- $91,681
Imperial Bank debt -- 8.25% due through 2001................ -- 7,250
Voting Notes due 2002....................................... 30 30
--- -------
Balance at end of period.................................... $30 $98,961
=== =======
</TABLE>
Effective June 30, 1994, the Company entered into a $10 million term loan
agreement ("1994 Loan") with Imperial Bank, which was used to retire
subordinated notes issued during 1992. This term loan was to be fully amortized
over seven years with quarterly payments of $300 plus interest per quarter for
years one and two, $350 plus interest per quarter for years three and four, and
$400 plus interest per quarter for years five, six
F-19
<PAGE> 88
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and seven. Effective July 1, 1995, the borrowing rate was changed from Imperial
Bank's prime rate plus one-half percent to a fixed rate of 8% per annum.
Additionally, under the amended terms of the 1994 Loan, the Company could not
prepay it until July 1, 1996.
The Company adhered to certain requirements and provisions in compliance
with the terms of the 1994 Loan. The provisions required SNIC to maintain
certain financial ratios and SNIG to maintain Imperial Bank certificates of
deposit in an amount equal to 20% of the Company's outstanding balance under the
1994 Loan. At December 31, 1996, the Imperial Bank certificates of deposit were
$1.5 million, all of which was restricted. On April 11, 1997, the Company
retired its outstanding 1994 Loan with Imperial Bank. As a result of the early
extinguishment, the Company recognized an extraordinary loss of $0.2 million,
net of a tax benefit of $0.1 million.
During 1996, the Company entered into a financing transaction involving
Centre Re and Chase. Chase extended a $93.1 million term loan (net of
transaction costs). The Company used the proceeds from the financing to purchase
from SNIC reinsurance receivables due from Centre Re. The principal balance of
the loan was collateralized by receivables due from the reinsurer and amortized
based upon the payout pattern of the underlying claims of the reinsurance
receivables. In June 1997, the $93.1 million term loan was retired, offsetting
the entire amount due against the reinsurance receivable balance. The retirement
of this collateralized financing resulted in the Company's recognizing a $10.3
million extraordinary loss, net of income taxes.
Voting notes ("Voting Notes") in the amount of $30 related to SNIG's 14.5%
Senior Subordinated Series A and Series B Notes ("14.5% Senior Subordinated
Notes") were still outstanding as of December 31, 1997. The 14.5% Senior
Subordinated Notes were retired in 1994. The Voting Notes of $30 will mature in
the year 2002. Warrants related to the 14.5% Senior Subordinated Notes remain
outstanding and provide their holders the right to purchase 1,566,465 shares of
SNIG common stock at a strike price of $4 per share. These warrants, which are
currently exercisable and expire on April 1, 2002, are held by senior management
and a nominee for III.
The Company has an agreement with a national brokerage house to allow it to
enter into $20 million of reverse repurchase transactions that must be secured
by either U.S. treasuries, government agency bonds, or corporate debt. There
were no outstanding transactions at December 31, 1997.
(9) PREFERRED SECURITIES ISSUED BY AFFILIATES
On June 30, 1994, SNIG completed the sale of $20 million of preferred
securities and warrants to affiliates of Centre Re in a transaction approved by
the shareholders and the California Department of Insurance ("DOI"). The
preferred securities were subordinate to the 1994 Loan. A special purpose
investment partnership, Superior National Capital, L.P. (the "Limited
Partnership"), was formed in Bermuda to issue $20 million face amount of 9.7%
redeemable preferred securities ("1994 Preferred Securities") to Centre
Reinsurance Services (Bermuda) III, Limited in exchange for $18 million.
CentreLine Reinsurance Limited paid the Company $2 million for warrants to
purchase 579,357 shares of SNIG's common shares at $5.20 per share, representing
a fully-diluted 10 percent interest in SNIG. The warrants may be exercised at
any time and expire in 2002.
In December 1997, SNIG formed a trust, whose sole purpose was to issue
10 3/4% Trust Preferred Securities (the "Trust Preferred Securities"), having an
aggregate liquidation amount of $105 million, and to invest the proceeds thereof
in an equivalent amount of 10 3/4% Senior Subordinated Notes due 2017 of the
Company (the "Senior Subordinated Notes"). The Company owns directly all of the
common securities issued by the Trust, which it purchased for an aggregate
consideration of $3.25 million. The proceeds from the sale of the Trust
Preferred Securities were used solely to purchase SNIG's Senior Subordinated
Notes. In addition, the Company entered into several contractual undertakings,
that when taken together, guarantee to the holders of the Trust Preferred
securities an unconditional right to enforce the payment of the distributions
F-20
<PAGE> 89
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
with respect to such securities. Holders of the Trust Preferred Securities are
entitled to receive cumulative cash distributions at an annual rate of 10 3/4%
of the stated liquidation amount of $1,000 per Trust Preferred Security,
accruing from the date of original issuance of the Trust Preferred Securities
and payable semi-annually, in arrears, commencing on June 1, 1998. The Company
has the right to defer payments at any time or from time to time for a period
not exceeding 10 consecutive semi-annual periods, provided that no extension
period may extend beyond the stated maturity date. In the event there is a
change in control, holders of the Trust Preferred Securities may redeem their
securities at 101% of the principal.
The Company used the net proceeds from the sale of the 10 3/4% Senior
Subordinated Notes in the amount of approximately $101.2 million, (i) to repay
outstanding debt, consisting of $40.8 million of bank debt and interest incurred
in connection with the acquisition of Pac Rim that would have matured in April
2003, bearing an average effective interest rate of 10.2%, (ii) to redeem from
an affiliate of Zurich $27.7 million Preferred of principal and interest, with
an effective rate of 11.7%, of the 1994 Securities, and (iii) to make a $15
million capital contribution to SNIC. The remaining proceeds are invested in
short-term, income-generating, investment-grade securities.
The difference between the face value and the carrying value of the Trust
Preferred Securities is amortized over their nineteen-year maturity using the
scientific method. The amortization, net of tax benefits and accrued dividends,
is charged to current year income after continuing operations, net of taxes.
The following is a summary of the preferred securities balance as of
December 31:
<TABLE>
<CAPTION>
1997 1996
-------- -------
<S> <C> <C>
Beginning balance........................................... $ 23,571 $21,045
Dividends and accretion..................................... 3,709 2,526
Retirement of 1994 Preferred Securities..................... (27,275) --
Issuance of Trust Preferred Securities...................... 101,272 --
-------- -------
Balance at end of period.................................... $101,277 $23,571
======== =======
</TABLE>
(10) STATUTORY SURPLUS AND DIVIDEND RESTRICTIONS
SNIC and SPCC are domiciled in the State of California and prepare their
statutory financial statements in accordance with accounting practices
prescribed or permitted by the DOI. Prescribed statutory accounting practices
include a variety of publications of the National Association of Insurance
Commissioners ("NAIC"), as well as state laws, regulations, and general
administrative rules. Permitted statutory accounting practices encompass all
accounting practices not so prescribed.
SNIC's statutory policyholders' surplus as reported to regulatory
authorities was $71,663 and $51,998 at December 31, 1997, and 1996,
respectively. SNIC's statutory net income, as reported to regulatory
authorities, was $2,888, $791 and $1,050 for the years ended December 31, 1997,
1996, and 1995 respectively.
SPCC's statutory policyholders' surplus as reported to regulatory
authorities was $30,542 and $20,930 at December 31, 1997 and 1996, respectively.
SPCC's statutory net income, as reported to regulatory authorities, was
$(6,074), $(13,069), and $4,879 for the years ended December 31, 1997, 1996, and
1995 respectively.
Insurance companies are subject to insurance laws and regulations
established by the states in which they transact business. The laws of various
states establish supervisory agencies with broad administrative and supervisory
powers. Most states have also enacted legislation regulating insurance holding
company systems, including acquisitions, extraordinary dividends, the terms of
affiliate transactions, and other related matters. The Company and Superior
Pacific have registered as holding company systems pursuant to such legislation
in California. The NAIC has formed committees and appointed advisory groups to
study and formulate regulatory proposals on such diverse issues as the use of
surplus debentures and accounting for reinsurance
F-21
<PAGE> 90
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
transactions. It is not possible to predict the future impact of changing state
and federal regulation on the operations of the Company and Superior Pacific.
The Risk Based Capital Model ("RBC") for property and casualty insurance
companies was adopted by the NAIC in December 1993, and starting in 1995,
companies were required to report their RBC ratios to the NAIC. SNIC and SPCC
have calculated and met their RBC requirements.
Insurance companies are also subject to restrictions affecting the amount
of stockholder dividends and advances that may be paid within any one year
without the prior approval of the DOI. The California Insurance Code provides
that the maximum amount that may be paid as dividends on an annual noncumulative
basis without prior notice to, or approval by, the DOI is 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. At December 31, 1997, SNIC and
SPCC could pay approximately $7.2 million and $3.1 million, respectively, in
dividends and advances to the Company without the DOI's prior approval based on
10% of reported statutory surplus.
In 1995, after receiving prior approval from the DOI, SNIC made an
extraordinary dividend distribution to SNIG of 100% of its shares in Superior
(Bermuda) Limited, which represented $15 million of SNIC's statutory capital and
surplus.
(11) EMPLOYEE BENEFIT PLANS
SNIG has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
Interpretations in accounting for its employee stock options. As discussed below
in management's opinion, the alternative fair value accounting provided for
under SFAS 123, requires use of option valuation models that were not developed
for use in valuing employee stock options. Under APB 25, because the exercise
price of the Company's employee stock options equals the market price of the
underlying stock on the date of the grant, no compensation expense is
recognized.
SNIG has two equity option plans, the 1986 Stock Option Plan ("1986 Plan")
and the 1995 Stock Incentive Plan ("1995 Plan"). The terms of the 1986 Plan
permit SNIG, at the Board of Directors' discretion, to grant options to its
management to purchase up to 225,000 shares of common stock. Options granted
under the 1986 Plan are not intended to qualify as incentive stock options
within the meaning of Section 422 of the Internal Revenue Code ("Code"). The
1995 Plan permits the granting of both options that qualify for treatment as
incentive stock options under Section 422 of the Code and options that do not
qualify as incentive stock options. Under the 1995 Plan, officers and key
employees of the Company may be granted options to purchase shares of SNIG
common stock or may be given the opportunity to receive restricted stock of
SNIG. Under the 1995 Plan, the aggregate number of shares of common stock that
may be granted, either through the exercise of options or the issuance of
restricted stock, is 625,000 shares. Under both plans, the exercise price of
each option equals the market price of SNIG's stock on the date of grant and
options have a maximum term of ten years. The Board of Directors may grant
options at any point during a year and the options generally vest over five
years.
Pro forma information regarding net income and earnings per share is
required by SFAS 123, and has been determined as if the Company had accounted
for its employee stock options under the fair value method of that Statement.
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted-average
assumptions. The risk free interest rate used in the calculation is the 10 year
Treasury Note rate on the date the options were granted. The risk free interest
rate range used for options granted during 1997, 1996, and 1995 was 5.8% to
6.9%, 6% to 6.79%, and 6% to 7.11%, respectively. The volatility factors for the
expected market price of the common stock of 65%, 70%, and 77% were used for
options granted in 1997, 1996, and 1995 respectively. A weighted average
expected life of ten years was used as the Company has little history of
options' being exercised prior to their expiration.
F-22
<PAGE> 91
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that do not have vesting
restrictions and are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions including the expected stock
price volatility. Because the Company's stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the value of an estimate, in
management's opinion the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized into expense over the options' vesting period. The
Company's pro forma information follows (in thousands except for earnings per
share information):
<TABLE>
<CAPTION>
1997 1996
------- ------
<S> <C> <C>
Pro forma net income........................................ $(5,366) $1,857
Pro forma earnings per share
Basic..................................................... (1.02) 0.54
Diluted................................................... $ (0.77) 0.38
</TABLE>
A summary of the Company's stock option activity, and related information
for the years ended December 31, follows:
<TABLE>
<CAPTION>
1997 1996 1995
-------------------------- -------------------------- --------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
NUMBER AVERAGE NUMBER AVERAGE NUMBER AVERAGE
OF SHARES EXERCISE PRICE OF SHARES EXERCISE PRICE OF SHARES EXERCISE PRICE
--------- -------------- --------- -------------- --------- --------------
<S> <C> <C> <C> <C> <C> <C>
Stock options outstanding
beginning of year......... 389,516 $ 5.13 252,500 $4.90 138,750 $4.47
Stock options granted....... 132,257 12.43 146,516 5.46 135,000 5.20
Stock options exercised..... (22,127) 4.74 (3,100) 4.00 (500) 4.00
Stock options canceled...... (38,567) 5.94 (6,400) 4.61 (20,750) 4.00
-------- -------- --------
Stock options outstanding,
end of year............... 461,079 $ 7.17 389,516 $5.13 252,500 4.90
======== ====== ======== ===== ======== =====
Exercisable at end of
year...................... 152,525 -- 102,200 -- 56,690 --
Weighted-average fair value
of options granted during
the year.................. $ 9.76 $ 4.41 $ 4.40
</TABLE>
F-23
<PAGE> 92
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Exercise prices for options outstanding as of December 31, 1997 ranged from
$4 to $14.875. The weighted-average remaining contractual life of those options
is 8.3 years. Since the range of exercise prices is wide, the following is a
summary of information for each exercise price range:
<TABLE>
<CAPTION>
WEIGHTED-AVERAGE
NUMBER WEIGHTED-AVERAGE NUMBER OF EXERCISE PRICE
OF OPTIONS REMAINING OPTIONS (SHARES) OF CURRENTLY
EXERCISE PRICE (SHARES) WEIGHTED-AVERAGE CONTRACTUAL LIFE CURRENTLY EXERCISABLE
RANGE OUTSTANDING EXERCISE PRICE (YEARS) EXERCISABLE OPTIONS
- --------------- ----------- ---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C>
$ 4.00-$ 4.99 111,566 $ 4.54 7.56 48,261 $ 4.25
$ 5.00-$ 5.99 176,450 5.18 7.68 95,130 5.18
$ 6.00-$ 6.99 40,112 6.25 9.00 7,864 6.25
$ 7.00-$11.99 28,850 10.89 9.85 770 7.70
$12.00-$12.99 81,851 12.16 10.00 500 12.75
$13.00-$14.99 22,250 14.64 10.00 -- --
------- -------
461,079 $ 7.17 8.30 152,525 $ 4.98
======= ====== ===== ======= ======
</TABLE>
The following is a summary of the transactions under the 1986 Plan for the
years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
----------------------- ----------------------- -----------------------
NUMBER OPTION NUMBER OPTION NUMBER OPTION
OF SHARES PRICE OF SHARES PRICE OF SHARES PRICE
--------- ----------- --------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Stock options
outstanding beginning
of year.............. 120,000 $4.00-$5.20 127,500 $4.00-$5.20 138,750 $4.00-$5.20
Stock options
granted.............. -- -- -- -- 10,000 5.20
Stock options
exercised............ (9,125) 4.00 (3,100) 4.00 (500) 4.00
Stock options
canceled............. (2,125) 4.00 (4,400) 4.00-5.20 (20,750) 4.00
------- ------- ---------
Stock options
outstanding, end of
year................. 108,750 $4.00-$5.20 120,000 $4.00-$5.20 127,500 $4.00-$5.20
======= =========== ======= =========== ========= ===========
</TABLE>
At December 31, 1997, 72,475 vested options were exercisable under the 1986
Plan. No additional options or purchase rights will be granted under the 1986
Plan.
The following is a summary of the transactions under the 1995 Plan for the
years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
------------------------- ----------------------- ------------------
NUMBER OPTION NUMBER OPTION NUMBER OPTION
OF SHARES PRICE OF SHARES PRICE OF SHARES PRICE
--------- ------------- --------- ----------- --------- ------
<S> <C> <C> <C> <C> <C> <C>
Stock Options:
Stock options
outstanding
beginning of
year............ 269,516 $5.20-$7.70 125,000 $5.20 -- --
Stock options
granted......... 132,257 11.375-14.875 146,516 5.20-7.70 125,000 $5.20
Stock options
exercised....... (13,002) 4.87-7.70 -- -- -- --
Stock options
canceled........ (36,442) 4.87-12.125 (2,000) 5.20 -- --
------- ------- -------
Stock options
outstanding end
of year......... 352,329 $4.87-$14.875 269,516 $5.20-$7.70 125,000 $5.20
======= ============= ======= =========== ======= =====
</TABLE>
F-24
<PAGE> 93
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
1997 1996 1995
------------------------- ----------------------- ------------------
NUMBER OPTION NUMBER OPTION NUMBER OPTION
OF SHARES PRICE OF SHARES PRICE OF SHARES PRICE
--------- ------------- --------- ----------- --------- ------
<S> <C> <C> <C> <C> <C> <C>
Restricted Options:
Shares outstanding
beginning of
year............ 69,265 $4.87-$6.25 36,350 $5.20 -- --
Shares granted..... 36,450 12.125 45,934 4.87-6.25 36,350 $5.20
Shares issued...... (12,222) 4.87-12.125 (13,019) 4.87-5.20 -- --
Shares canceled.... (9,813) 4.87-12.125 -- -- -- --
------- ------- -------
Shares outstanding
end of year..... 83,680 $4.87-$12.125 69,265 $4.87-$6.25 36,350 5.20
======= ============= ======= =========== ======= =====
</TABLE>
At December 31, 1997, 80,050 vested options were exercisable under the 1995
Plan. Shares available for future grants under the 1995 Plan at December 31,
1997 were 188,991.
Effective January 1, 1990, the Company implemented a 401(k) Plan ("Company
Plan") which is available for substantially all employees and under which the
Company matches a percentage of the participant's compensation. The employer
contributions are discretionary and vest over a five year period. The employer
contributions for plan years 1997, 1996, and 1995 were $186, $170, and $150,
respectively.
The Company has no formal post-employment retirement benefit plans;
however, the Company has entered into severance contracts with certain former
employees for which approximately $366, $48, and $322 of accrued expenses were
recorded at December 31, 1997, 1996, and 1995, respectively.
The Pac Rim Assurance Company 401(k) Plan ("Pac Rim Plan") permits
employees of Pac Rim who attain the age of 21 and complete 30 days of employment
to elect to make tax-deferred contributions of a specified percentage of their
compensations during each year through payroll deductions. As of December 31,
1997, there were 38 participants in the Pac Rim Plan employed by the Company.
Under the Pac Rim Plan, the Company, as successor to Pac Rim, has discretion to
make additional contributions. The Company made a $200 discretionary employer
contribution to the Pac Rim Plan in April 1997. The Company plans to merge the
Pac Rim Plan into the Company Plan by the end of December 31, 1998.
(12) COMMITMENTS
The Company occupies offices under various operating leases and leases
substantially all of its fixed assets through a capital lease. The future
minimum lease payments at December 31, 1997, are as follows:
<TABLE>
<CAPTION>
OPERATING CAPITAL INTEREST ON CAPITAL TOTAL LEASE
COMMITMENTS COMMITMENTS COMMITMENTS COMMITMENTS
----------- ----------- ------------------- -----------
<S> <C> <C> <C> <C>
1998........................ $ 4,655 $1,659 $ 685 $ 6,999
1999........................ 4,681 2,005 552 7,238
2000........................ 3,414 2,232 325 5,971
2001........................ 3,083 1,797 16 4,896
2002........................ 1,279 -- -- 1,279
------- ------ ------ -------
$17,112 $7,693 $1,578 $26,383
======= ====== ====== =======
</TABLE>
Rental expenses totaled approximately $4,020, $1,918, and $1,772 for the
years ended December 31, 1997, 1996, and 1995 respectively.
Effective December 1, 1997, the Company entered into an $8,000 capital
lease with BancBoston for substantially all of the property and equipment of
both SNIC and SPCC acquired on or before March 31, 1997. The transaction
resulted in a deferred gain of $1,651 that will be amortized over 36 months.
F-25
<PAGE> 94
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In a transaction associated with the sale of the 14.5% Senior Subordinated
Notes to III, the Company and SNIC agreed to pay International Insurance
Advisors, Inc., agent for each of the III limited partners and for the general
partner of III, a consulting fee in the amount of $250 beginning on April 1,
1993, and on each April 1 thereafter, to and including April 1, 1998. The
retirement of the 14.5% Senior Subordinated Notes in 1994 did not affect the
obligation of the Company and SNIC to pay the consulting fee.
(13) LITIGATION
The Company is subject to various litigation which arises in the ordinary
course of business. Management is of the opinion that such litigation will not
have a material adverse effect on the consolidated financial position of the
Company or its consolidated results of operations.
(14) PREPAID AND OTHER ASSETS
A summary of prepaid and other assets at December 31, are as follows:
<TABLE>
<CAPTION>
1997 1996
------- ------
<S> <C> <C>
Furniture and fixtures, net................................. $ 7,970 $1,260
Data processing equipment, net.............................. 71 3,560
Prepaid and advances........................................ 2,178 1,091
Funds due from lender....................................... 8,000 --
Other....................................................... 2,887 1,453
------- ------
$21,106 $7,364
======= ======
</TABLE>
(15) ACCOUNTS PAYABLE AND OTHER LIABILITIES
A summary of accounts payable and other liabilities at December 31, are as
follows:
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Escheatment payable......................................... $ 1,401 $ 333
Rent and lease liability.................................... 371 527
Accounts payable............................................ 15,526 8,683
Liabilities associated with Pac Rim acquisition............. 7,608 --
Other liabilities........................................... 3,962 3,198
------- -------
$28,868 $12,741
======= =======
</TABLE>
F-26
<PAGE> 95
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(16) EARNINGS PER SHARE RECONCILIATION
The following is an illustration of the reconciliation of the numerators
and denominators of the basic and diluted earnings per share (EPS) computations:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED 1997 FOR THE YEAR ENDED 1996
------------------------------------------ ------------------------------------------
INCOME SHARES PER SHARE INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- --------- -------------- ------------- ---------
(IN THOUSANDS) (IN THOUSANDS
<S> <C> <C> <C> <C> <C> <C>
BASIC EPS
Income before items
below................. $ 10,824 5,249,736 $ 2.06 $ 3,630 3,432,679 $ 1.06
Preferred Securities.... (3,069) (0.58) (1,667) (0.49)
Discontinued
Operations............ -- -- -- --
Extraordinary Items..... (12,896) (2.46) -- --
-------- ------ ------- ------
Net Income.............. $ (5,141) $(0.98) $ 1,963 $ 0.57
======== ====== ======= ======
EFFECT OF DILUTIVE
SECURITIES
Options................. 295,065 266,183
Warrants................ 1,471,364 1,167,178
DILUTED EPS
Income before items
below................. $ 10,824 7,016,165 $ 1.54 $ 3,630 4,826,040 $ 0.75
Preferred Securities.... (3,069) (0.44) (1,667) (0.34)
Discontinued
Operations............ -- -- -- --
Extraordinary Items..... (12,896) (1.84) -- --
-------- ------ ------- ------
Net Income............... $ (5,141) $(0.74) $ 1,963 $ 0.41
======== ====== ======= ======
<CAPTION>
FOR THE YEAR ENDED 1995
------------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
-------------- ------------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
BASIC EPS
Income before items
below................. $11,701 3,429,915 $ 3.41
Preferred Securities.... (1,488) (0.43)
Discontinued
Operations............ (9,842) (2.87)
Extraordinary Items..... -- --
------- ------
Net Income.............. $ 371 $ 0.11
======= ======
EFFECT OF DILUTIVE
SECURITIES
Options................. 47,052
Warrants................ 464,627
DILUTED EPS
Income before items
below................. $11,701 3,941,594 $ 2.97
Preferred Securities.... (1,488) (0.38)
Discontinued
Operations............ (9,842) (2.50)
Extraordinary Items..... -- --
------- ------
Net Income............... $ 371 $ 0.09
======= ======
</TABLE>
Options to purchase 1,250 shares at $14.81, 12,500 shares at $14.875, 7,250
shares at $14.25, and 1,250 shares at $14.31 were outstanding during the last
quarter of 1997 but were not included in the computation of diluted EPS because
the options' exercise price was greater than the average market price of the
common shares. The options, which expire in 2002, were still outstanding at the
end of year 1997.
F-27
<PAGE> 96
SCHEDULE I.1
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
SUPERIOR NATIONAL INSURANCE GROUP, INC.
BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1997 1996
--------- ---------
(AMOUNTS IN THOUSANDS,
EXCEPT SHARE DATA)
<S> <C> <C>
ASSETS
INVESTMENTS
Bonds and Notes:
Available-for-sale, at market (cost: 1997, $7,539)........ $ 7,533 $ --
Cash and short-term instruments (certificates of deposit
and other short-term instruments)...................... 5,404 1,787
-------- --------
TOTAL INVESTMENTS................................. 12,937 1,787
Accrued investment income................................. 38 1
Receivable from reinsurer................................. -- 110,527
Investment in subsidiaries................................ 168,856 72,788
Intercompany receivable................................... 91 91
Deferred income taxes..................................... 1,884 4,957
Other..................................................... 174 1,087
-------- --------
TOTAL ASSETS...................................... $183,980 $191,238
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Long-term debt.............................................. $ 30 $ 98,961
Intercompany liability...................................... 21,462 23,465
Accounts payable and other liabilities...................... 1,393 50
-------- --------
TOTAL LIABILITIES................................. 22,885 122,476
-------- --------
1997 PREFERRED SECURITIES ISSUED BY AFFILIATE;
authorized 105,000 shares in 1997......................... 101,277 --
1994 PREFERRED SECURITIES ISSUED BY AFFILIATE;
authorized 1,100,000 shares: issued and outstanding
1,013,753 shares in 1996.................................. -- 23,571
STOCKHOLDERS' EQUITY
Common stock, $0.01 par value; authorized 25,000,000 shares:
issued and outstanding 5,871,279 shares in 1997 and
3,446,492 shares in 1996.................................. 59 34
Paid-in capital excess of par............................... 34,242 15,988
Paid in capital -- warrants................................. 2,206 2,206
Unrealized gain on equity securities, net of taxes.......... 112 (17)
Unrealized gain (loss) on available-for-sale investments,
net of income taxes....................................... 1,215 (145)
Retained earnings........................................... 21,984 27,125
-------- --------
TOTAL STOCKHOLDERS' EQUITY........................ 59,818 45,191
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........ $183,980 $191,238
======== ========
</TABLE>
See notes to condensed financial information
F-28
<PAGE> 97
SCHEDULE I.2
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
SUPERIOR NATIONAL INSURANCE GROUP, INC.
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED
DECEMBER 31,
------------------------------
1997 1996 1995
-------- ------- -------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C>
REVENUES:
Net investment income..................................... $ (112) $ 89 $ 330
-------- ------- -------
TOTAL REVENUES.................................... (112) 89 330
EXPENSES:
Interest expense.......................................... 5,965 1,465 804
Other operating expenses.................................. 518 (446) 304
-------- ------- -------
TOTAL EXPENSES.................................... 6,483 1,019 1,108
-------- ------- -------
LOSS BEFORE INCOME TAXES, PREFERRED SECURITIES DIVIDENDS AND
ACCRETION, AND EXTRAORDINARY ITEMS........................ (6,595) (930) (778)
Income tax expense.......................................... 8,246 858 767
-------- ------- -------
INCOME BEFORE PREFERRED SECURITIES DIVIDENDS AND ACCRETION,
AND EXTRAORDINARY ITEMS................................... (14,841) (1,788) (1,545)
Equity in net income of subsidiaries........................ 25,709 5,418 3,404
1994 Preferred securities dividends and accretion, net of
income tax benefit of $1,260 and $858 in 1997 and 1996,
respectively.............................................. (2,445) (1,667) (1,488)
1997 Preferred securities dividends and accretion, net of
income tax benefit of $321 in 1997........................ (624) -- --
Extraordinary loss on retirement of long-term debt, net of
income tax benefit of $5,338 in 1997...................... (10,361) -- --
Extraordinary loss on retirement of long-term debt, net of
income tax benefit of $785 in 1997........................ (1,524) -- --
Extraordinary loss on redemption of Pac Rim's outstanding
debentures, net of income tax benefit of $327 in 1997..... (635) -- --
Extraordinary loss on retirement of preferred securities,
net of income tax benefit of $134 in 1997................. (259) -- --
Extraordinary loss on early retirement of Imperial Bank Loan
net of income tax benefit of $83 in 1997.................. (161) -- --
-------- ------- -------
NET INCOME (LOSS)................................. $ (5,141) $ 1,963 $ 371
======== ======= =======
</TABLE>
See notes to condensed financial information
F-29
<PAGE> 98
SCHEDULE I.3
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
SUPERIOR NATIONAL INSURANCE GROUP, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED
DECEMBER 31,
------------------------------
1997 1996 1995
-------- --------- -------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income......................................... $ (5,141) $ 1,963 $ 371
-------- --------- -------
Adjustments to reconcile net (loss) income to net cash
used in operating activities:
Amortization of bonds and preferred stock............... -- -- (1)
Loss on sale of investment.............................. 7 5 --
Income from subsidiaries................................ (25,709) (5,418) (3,404)
Extraordinary loss...................................... 12,940 -- --
Interest expense on long-term debt...................... 3,581 -- --
Preferred securities dividends and accretion............ 3,069 2,525 2,255
Increase in current income taxes........................ -- -- 1,721
(Increase) decrease in accrued investment income........ (37) 8 1
Decrease in deferred income taxes....................... 8,247 -- --
(Increase) decrease in other assets..................... 2,209 (994) (11)
Increase in accounts payable and other liabilities...... 446 19,334 78
-------- --------- -------
Total adjustments..................................... 4,753 15,460 639
-------- --------- -------
Net cash (used in) provided by operating activities... (388) 17,423 1,010
-------- --------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Paid-in-capital -- restricted stock....................... 279 78 2
Proceeds from issuance of common stock.................... 18,000 -- --
Proceeds from 1997 Trust Preferred Securities............. 101,272 -- --
Long-term debt -- Chase Manhattan Bank.................... 41,257 -- --
Retirement of long-term debt -- Chase Manhattan Bank...... (44,000) -- --
Retirement of 1994 Preferred Securities................... (27,668) -- --
Retirement of long-term debt -- Imperial Bank............. (7,250) (1,250) (1,200)
Prepayment penalty on long-term debt...................... (244) -- --
Proceeds from Chase financing............................. -- 93,091 --
Retirement of long-term debt -- Chase Financing........... -- (1,410) --
-------- --------- -------
Net cash provided by (used in) financing activities... 81,646 90,509 (1,198)
-------- --------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of bonds and notes:
Investments available-for-sale.......................... (7,539) -- (1,496)
Increase in receivable from reinsurer................... -- (110,527) --
Purchase of Pacific Rim Holding Company................... (44,016) -- --
Investment in subsidiary.................................. (1,175) -- --
Sales of bonds and notes: Investments available for
sale.................................................... -- 1,493 --
Capital contribution to subsidiaries...................... (25,000) -- (1,500)
Net decrease in invested cash............................. 89 -- --
-------- --------- -------
Net cash used in investing activities................. (77,641) (109,034) (2,996)
-------- --------- -------
Net increase (decrease) in cash....................... 3,617 (1,102) (3,184)
Cash and invested cash at beginning of period............. 1,787 2,889 6,073
-------- --------- -------
Cash and invested cash at end of period................... $ 5,404 $ 1,787 $ 2,889
======== ========= =======
Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes.............. $ 1 $ 1 $ 1
======== ========= =======
Cash paid during the year for interest.................. $ 2,433 $ 641 $ 808
======== ========= =======
</TABLE>
See notes to condensed financial information
F-30
<PAGE> 99
SCHEDULE I.4
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
SUPERIOR NATIONAL INSURANCE GROUP, INC.
NOTES TO CONDENSED FINANCIAL INFORMATION
1. BASIS OF PRESENTATION
In accordance with the requirements of Regulation S-X of the Securities and
Exchange Commission, the financial statements of the registrant are condensed
and omit many disclosures presented in the consolidated financial statements and
the notes thereto.
2. LONG TERM DEBT
The following is a summary of the long-term debt balances at December 31:
<TABLE>
<CAPTION>
1997 1996
---- -------
<S> <C> <C>
Chase Financing Agreement -- 6.87% due through 2004......... $-- $91,681
Imperial Bank Debt -- 8.25% due through 2001................ -- 7,250
Voting Notes due 2002....................................... 30 30
--- -------
Balance at end of period.................................... $30 $98,961
=== =======
</TABLE>
The voting notes of $30 will mature in the year 2002.
3. DIVIDENDS FROM SUBSIDIARIES
During 1997, 1996, and 1995, there were no dividends paid to SNIG by its
consolidated subsidiaries; however SNIC paid SNIG $2.9 million for its current
income taxes.
4. CONTINGENCIES
The Company is subject to various litigation which arises in the ordinary
course of business. Based upon discussions with counsel, management is of the
opinion that such litigation will not have a material adverse effect on the
consolidated financial position of the Company or its consolidated results of
operations.
5. RECONCILIATION -- RECEIVABLE FROM REINSURER
The following is a reconciliation between the Condensed Financial
Information of Registrant Balance Sheet and the Consolidated Balance Sheet for
Receivable from reinsurer.
<TABLE>
<CAPTION>
RECEIVABLE FROM
REINSURER
----------------
1997 1996
---- --------
<S> <C> <C>
Balance per Consolidated Balance Sheet...................... $-- $ 93,266
Add: Elimination for Discontinued Operations................ -- 17,261
--- --------
Balance per Condensed Balance Sheet......................... $-- $110,527
=== ========
</TABLE>
F-31
<PAGE> 100
SCHEDULE II
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
-------- ---------- ------------------------- ---------- ---------
ADDITIONS
-------------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE
BEGINNING COSTS OTHER AT END
OF PERIOD AND EXPENSES ACCOUNTS DEDUCTIONS OF PERIOD
---------- ------------ ---------- ---------- ---------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1997
Allowance for possible losses on
premiums receivable............... $300 $2,311 -- $(1,811) $800
==== ====== ===== ======= ====
Allowance for possible losses on
reinsurance recoverable........... -- -- -- -- --
==== ====== ===== ======= ====
Year ended December 31, 1996
Allowance for possible losses on
premiums receivable............... $500 $1,369 -- $(1,569) $300
==== ====== ===== ======= ====
Allowance for possible losses on
reinsurance recoverable........... -- -- -- -- --
==== ====== ===== ======= ====
Year ended December 31, 1995
Allowance for possible losses on
premiums receivable............... $900 $1,531 -- $(1,931) $500
==== ====== ===== ======= ====
Allowance for possible losses on
reinsurance recoverable........... -- -- -- -- --
==== ====== ===== ======= ====
</TABLE>
F-32
<PAGE> 101
SCHEDULE V.1
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
SUPPLEMENTAL INSURANCE INFORMATION
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G COLUMN H
-------- ----------- -------------- -------- ------------ -------- ---------- ----------
FUTURE POLICY BENEFITS,
DEFERRED BENEFITS, OTHER POLICY CLAIMS,
POLICY LOSSES, CLAIMS CLAIMS AND NET LOSSES AND
ACQUISITION AND LOSS UNEARNED BENEFITS PREMIUM INVESTMENT SETTLEMENT
COSTS EXPENSES PREMIUM PAYABLE REVENUE INCOME EXPENSES
----------- -------------- -------- ------------ -------- ---------- ----------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
1997
Workers' Compensation.......... $5,879 $201,255 $12,913 $ -- $140,920 $12,674 $90,447
====== ======== ======= ====== ======== ======= =======
1996
Workers Compensation........... $3,042 $115,529 $ 9,702 $ -- $ 88,648 $ 7,769 $55,638
====== ======== ======= ====== ======== ======= =======
1995
Workers' Compensation.......... $2,780 $141,495 $10,347 $ -- $ 89,735 $ 9,784 $53,970
====== ======== ======= ====== ======== ======= =======
<CAPTION>
COLUMN A COLUMN I COLUMN J COLUMN K
-------- ------------ --------- --------
AMORTIZATION
OF DEFERRED
POLICY OTHER
ACQUISITION OPERATING PREMIUMS
COSTS EXPENSES WRITTEN
------------ --------- --------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C>
1997
Workers' Compensation.......... $19,977 $25,909 $136,929
======= ======= ========
1996
Workers Compensation........... $16,870 $24,609 $ 87,715
======= ======= ========
1995
Workers' Compensation.......... $18,288 $21,314 $ 89,139
======= ======= ========
</TABLE>
F-33
<PAGE> 102
SCHEDULE V.2
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
REINSURANCE
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F
-------- -------- --------- ------------ -------- -------------
PERCENTAGE OF
CEDED TO ASSUMED FROM AMOUNT
GROSS OTHER OTHER NET ASSUMED
AMOUNT COMPANIES COMPANIES AMOUNT TO NET
-------- --------- ------------ -------- -------------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1997
Premiums:
Workers' compensation insurance... $152,253 $22,081 $10,748 $140,920 8.3%
-------- ------- ------- -------- ---
Total premiums................. $152,253 $22,081 $10,748 $140,920 8.3%
======== ======= ======= ======== ===
Year ended December 31, 1996
Premiums:
Workers' compensation insurance... $ 97,270 $11,280 $ 2,658 $ 88,648 3.0%
-------- ------- ------- -------- ---
Total Premiums................. $ 97,270 $11,280 $ 2,658 $ 88,648 3.0%
======== ======= ======= ======== ===
Year ended December 31, 1995
Premiums:
Workers' compensation insurance... $ 96,630 $ 7,730 $ 835 $ 89,735 0.9%
-------- ------- ------- -------- ---
Total premiums................. $ 96,630 $ 7,730 $ 835 $ 89,735 0.9%
======== ======= ======= ======== ===
</TABLE>
F-34
<PAGE> 103
SCHEDULE V.3
SUPERIOR NATIONAL INSURANCE GROUP, INC. AND SUBSIDIARIES
SUPPLEMENTAL PROPERTY AND CASUALTY INSURANCE INFORMATION
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G COLUMN H
-------- ----------- ---------- ----------- -------- -------- ---------- ---------------------
DISCOUNT
IF ANY,
DEDUCTED
RESERVES IN RESERVES CLAIMS AND CLAIM
FOR UNPAID FOR UNPAID ADJUSTMENT EXPENSES
DEFERRED CLAIMS AND CLAIMS AND INCURRED RELATED TO:
POLICY CLAIMS CLAIM NET ---------------------
ACQUISITION ADJUSTMENT ADJUSTMENT UNEARNED EARNED INVESTMENT CURRENT PRIOR
COSTS EXPENSES EXPENSES PREMIUM PREMIUM INCOME YEAR YEAR
----------- ---------- ----------- -------- -------- ---------- --------- ---------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1997
Workers' Compensation.... $5,879 $201,255 $ -- $12,913 $140,920 $12,674 $95,826 $(5,379)
====== ======== ====== ======= ======== ======= ======= =======
1996
Workers' Compensation.... $3,042 $115,529 $ -- $ 9,702 $ 88,648 $ 7,769 $57,614 $(1,976)
====== ======== ====== ======= ======== ======= ======= =======
1995
Workers' Compensation.... $2,780 $141,495 $ -- $10,347 $ 89,735 $ 9,784 $58,842 $(4,872)
====== ======== ====== ======= ======== ======= ======= =======
</TABLE>
F-35
<PAGE> 1
EXHIBIT 10.53
AGREEMENT FOR SERVICES
RISK ENTERPRISE MANAGEMENT LIMITED, 59 Maiden Lane, New York, New York 10038
(hereafter referred to as "TPA") hereby agrees to provide services as described
herein ("Services") for SUPERIOR NATIONAL INSURANCE COMPANY, 26601 Agoura Road,
Calabasas, California 91302 (hereinafter referred as "Client") in connection
with the administration of [existing] claims against policies written by Client
or claims that have loss dates or are reported or transferred to TPA during the
term of this agreement. All claims shall be handled in accordance and in full
compliance with the requirements of all applicable regulatory authorities.
ARTICLE 1. INDEPENDENT CONTRACTOR
1.01 The term ("Term") of this agreement ("Agreement") shall commence March __,
1998 and continue for a minimum period of three (3) years until March 31, 2001
("Minimum Period"), and thereafter may canceled by either party giving to the
other six (6) months written notice.
1.02 TPA enters into this Agreement, and will remain throughout the term of this
Agreement, as an independent contractor. TPA agrees that this Agreement does not
create with Client an employer-employee, partner, or joint venture relationship.
TPA agrees that it, and its employees and agents, are not entitled to the rights
or benefits afforded to Client's employees including disability or unemployment
insurance, workers compensation insurance, medical insurance, sick leave or any
other employment benefit.
1.03 Client shall pay all taxes and tariffs, assessed or levied by any
governmental entity, if any, that are now or may become applicable to the
Services rendered hereunder or measured by payments made by Client to TPA
hereunder, or are required to be collected by TPA or paid by TPA to tax
authorities. This includes, but is not limited to, sales, use, excise, gross
receipt and personal property taxes or any other form of tax based on the
Services performed or equipment or services used by TPA solely to perform
Services for Client, but does not include taxes based upon TPA's net income.
Client shall also pay any interest or penalties on such taxes and tariffs,
provided, however, Client shall not be responsible for any interest or penalties
resulting from TPA's failure to forward tax funds received from Client to the
applicable tax authority. TPA is responsible for paying all income taxes,
incurred as a result of compensation paid by Client to TPA for Services under
this Agreement. On request, TPA will provide Client with proof of timely
payment. TPA agrees to indemnify Client for any claims, costs, losses, fees,
penalties, interest, or damages suffered by Client, including attorneys fees and
all related costs, resulting from TPA's failure to comply with this provision.
ARTICLE 2. NOTICES
2.01 All notices given related to this Agreement must be delivered either by
personal delivery by messenger or by mail, registered or certified, postage
pre-paid with return receipt requested. Mailed notices must be addressed to the
parties at the addresses appearing in paragraph 2.02 of this Agreement, but each
party may change the address by giving written notice in accordance with this
paragraph. Notices given personally will be deemed communicated on the day
evidenced by receipted delivery; notices given by mail will be deemed
communicated on the date of actual receipt, or on the fifth day after mailing,
whichever is earlier.
1.
<PAGE> 2
2.02 Notices under this Agreement are to be given to the following persons:
To Client: Chief Claims Executive
Superior National Insurance Company
Vice President Claims
26601 Agoura Road
Calabasas, Ca. 91302
To TPA: Risk Enterprise Management Limited
59 Maiden Lane
New York, NY 10038
Attn.: General Counsel, 28th Floor
ARTICLE 3. QUALIFICATIONS
3.01 TPA represents that it has the qualifications and skills necessary to
perform the services under this Agreement in a competent, professional manner
and that it, and its staff, are sufficiently familiar with the applicable
statutes, regulations and case law authorities relating to the area of workers'
compensation, specifically relating to the handing of workers' compensation
claims, to permit the services to be so provided. Failure to perform any of the
requirements mandated by this Article may be considered a material breach of the
Agreement.
ARTICLE 4. IN CONSIDERATION OF THE PROVISIONS, STIPULATIONS, COVENANTS AND
CONDITIONS OF THIS AGREEMENT, TPA AGREES:
4.01 To adjust workers' compensation claims on a timely basis as required by the
workers' compensation laws of California; to avoid unnecessary liability to
Client; to close claims in a timely and cost effective manner, and to provide
designated services for the described program, which includes Client's
requirements for claim reporting, legal, investigation, vocational
rehabilitation, medical management, bill review, subrogation, fraud and medical
cost containment programs.
4.02 To investigate all reported claims and losses to the extent deemed
necessary in the judgment of TPA and to adjust, settle, resist or otherwise
handle all such claim or losses from inception through closure (with the
exception noted in this Agreement) within the authority granted by Client.
4.03 To investigate all reported claims and losses to the extent deemed
necessary in the judgment of TPA in order to be in full compliance with the
Audit Regulations of the Division of Workers' Compensation and to adjust,
settle, resist or otherwise handle all such claims or losses that are in excess
of the authority granted with prior approval of Client, all pursuant to the
TPA's Claim Handling Guidelines.
4.04 To establish and maintain case reserves in accordance with Client's
reserving guidelines.
4.05 To exclusively utilize Client's computer system and enter therein all
reported losses involving Client's policyholders in accordance with Client's
systems procedures. Said computer system will be upgraded by Client, at Client's
expense, during the term of this Agreement. TPA agrees to be trained and
otherwise become familiar with the upgraded computer system at the time it is
made available at
2.
<PAGE> 3
Client's expense. TPA may not load any unauthorized software into the computer
equipment provided by Client. Client's equipment is for the sole purpose of
providing access to systems related to the handling of Client's claims. All
computer equipment remains the sole property of Client to be returned at time of
upgrade or termination of Agreement. The computer systems referenced herein
include the intellectual property of Client and permission to use same, as
granted herein, in no way represents a waiver of any intellectual property and
or confidentiality rights held by the Client.
4.06 To return the information maintained on each claim under this Agreement
regardless of whether it exists in electronic format through use of Client's
equipment or in hard copy ("Claim Files") to the Client, at Client's expense, at
the time of their closure; provided, however, in the event that a reopening of
Claim Files is required for further processing or a dispute arises between
Client and TPA, TPA shall have the right at any time after closing the Claim
File or the termination of this Agreement to obtain the Claim Files returned to
Client, in so far as such Claim Files relate to the additional processing or to
the dispute, and, at TPA's cost in the event of a dispute, to make copies
thereof or extracts therefrom; and provided, further, that nothing in this
Article 4 shall supersede, preclude or otherwise limit any discovery rights
otherwise available to TPA or Client.
4.07 To refer any Claim File, where the issue of potential fraud has been
identified, to the Client's SIU Examiner responsible for that territory where
the claimant is located.
4.08 To exclusively utilize the services of outside vendors, as directed by
Client, for legal services (refer to Client's legal department for assignment of
defense counsel), investigations (refer to Client's Home Office, Investigation
Unit), vocational rehabilitation services (refer to Client's Rehabilitation
Unit), medical services, photocopy services and bill review. TPA cannot make a
promise to an Insured for assignment of a particular vendor. All vendor
assignments are at the direction of the Client. Medical management services will
be assigned from panel of nurses provided by Client
4.09 {To return all claims to Client for handling in accordance with the
authority levels which may be specified from time to time by Client. The file,
if any, will be returned to the Client's claim office in Woodland Hills.}
4.10 To provide status reports and file review summaries, at no additional cost
to Client.
4.12 To allow Client to review its files on-site at any time and to respond to
Client's recommendations/questions within three (3) business days. At all times
the Claim Files remain the property of Client.
4.13 To return any client file within three (3) business days of request.
4.14 To pay any and all fine(s), penalty(ies), assessment(s), award(s) and/or
damage(s) arising from and solely attributable in accordance with Article 10
herein to TPA's negligent or intentional errors and omissions the handling of
any claim under its dominion or control (assessed in accordance with Title 8,
CCR 10112).
4.15 To submit "Denials" of coverage or compensability to Client's TPA
Supervisor in accordance with Client's then current procedures.
4.16 To bill the Client monthly.
3.
<PAGE> 4
4.17 To assure that Client is given timely notice of all meetings and file
reviews with policyholders and/or agents/brokers and permitted the opportunity
to participate is such meetings and file reviews, at its discretion.
4.18 To report all new losses to Client through the KWIK Report process (800)
579-1300.
4.19 To display the Client post office box address along with the TPA Examiner
name and phone number on all correspondence and forms generated by Client's
claim system. All outgoing correspondence from TPA must display the same
information.
4.20 To send all original correspondence received by TPA, within one (1)
business day of receipt, to Client for document imaging processing.
4.21 To notify Client immediately (within one (1) business day) upon receipt of
inquiry and/or notice of audit, relative to Clients files, by the Department of
Industrial Relations Division of Workers' Compensation Audit Unit.
4.25 To receive full handling fee for all files, even if returned to Client.
4.26 To remit invoice for service fees to Client as soon as practical each month
for new files received as well as pending files as of the last day of the
previous month.
4.27 To apply the pricing described herein to those claims that occur during the
Agreement period and are reported to TPA or Client's KWIK Report within the
Term.
4.28 That it is expressly understood and agreed that all information relating to
any Employer/ Employees shall be used for the purpose of administering workers'
compensation claims under California's workers' compensation laws and shall not
be released to any other party except in accordance with the California
Confidentiality of Medical Information Act. The parties further agree that all
confidential information, including the proprietary business information, names
of insured and payment rates paid to providers, and all other such confidential
information, released either intentionally or unintentionally by Client, shall
be held in strict confidence by TPA and shall be specifically protected from
disclosure to other clients, insurance brokers and any other third parties.
4.29 That if any existing Claim Files are transferred to TPA, TPA shall notify
all parties of record on each file of the change in claims administrator. All
open files shall be administered by TPA from the date of their receipt through
to their final resolution and closure, within the Term.
4.30 That Client will be responsible for the cost of any communications lines
and/or on-line charges for the computer interface with Client.
4.32 In the event there is a conflict of interest which arises on a particular
file (e.g. TPA handles two carriers and there is a disagreement over
contribution), TPA shall immediately advise Client and obtain a conflict waiver
within ten (10) business days. If a conflict waiver cannot be obtained, TPA
shall assure that the file is returned to Client immediately, assuring that the
claim is handled properly and in accordance with the workers' compensation
statutes, regulations and case law authorities through the time of transfer.
4.
<PAGE> 5
4.33 TPA will maintain management and staffing at levels necessary to provide
Services in accordance with Client's contractual obligations, regulatory
requirements and generally accepted industry standards.
ARTICLE 5. IN CONSIDERATION OF THE PROVISIONS, STIPULATIONS, COVENANTS AND
CONDITIONS OF THIS AGREEMENT, CLIENT AGREES:
5.01 To cooperate with TPA with respect to the performance of Services,
including, but not limited to, responding to TPA's requests for any and all
information promptly; promptly forwarding, or causing to be forwarded to TPA for
handling by TPA, all claims, claim forms, demands, notices, inquiries or
correspondence concerning or related to Claims; meeting with TPA, as may be
needed, and making decisions on Claims matters, as required by this Agreement
and within such time period as to allow TPA to meet all legal requirements
applicable to the handling of such Claims;
5.02 To provide TPA, during TPA's business hours, with Systems, personnel,
service, maintenance, and training sufficient to permit TPA to execute fully
Services. To the extent Client fails to meet this requirement, and fines or
penalties are imposed on TPA, Client will pay all such fines or penalties. For
purposes of this Agreement, "Systems" shall mean Client's claims system and
workstations, document imaging center, database, data, software applications
processing, word processing software, spreadsheet software, E-Mail,
communications lines, and related systems necessary for TPA to provide Services.
5.03 To issue unit statistical reports, annual claim log reports, and financial
reports to the appropriate regulatory agencies.
5.04 To pay TPA the per claim fees ("Fees") shown in the following table:
<TABLE>
<CAPTION>
====================================================================================================
PER CLAIM FEES
--------------------------------------------
TYPE OF CLAIM ASSIGNED TO TPA INITIAL CHARGE CARRYING CHARGE
====================================================================================================
<S> <C> <C> <C>
Workers' Comp. Indemnity Within 60 days of 1st $216.00 $86.00
Notice to Client
----------------------------------------------------------------------------------------------------
Workers' Comp. Indemnity 60 days after 1st $86.00 $86.00
Notice to Client
----------------------------------------------------------------------------------------------------
Workers' Comp. Medical Only Not Applicable $90.00 No additional charge
====================================================================================================
</TABLE>
The Initial Charge shall be deemed fully earned in the month a Claim is assigned
to TPA by Client, notwithstanding any expiration or sooner termination of this
Agreement. The Carrying Charge shall be assessed for each claim open at the end
of each month, including the month the claim is opened by TPA. All amounts due
TPA shall be stated and payable in US dollars. Each invoice issued by TPA shall
be paid by Client to TPA within thirty (30) days from the date of such invoice.
Amounts which remain unpaid in excess of thirty (30) days from the date of
billing shall be subject to a late charge which shall be computed from the date
due at the lesser of (i) 1% per month or (ii) the highest rate permitted by law.
Such Fees and expenses shall exclude all claims and losses, unallocated loss
adjustment expenses, and allocated loss adjustment expenses as defined herein -
all such costs shall be paid by Client.
5.
<PAGE> 6
5.05 To pay all claims and losses, unallocated loss adjustment expenses, and
allocated loss adjustment expenses as defined herein, in addition to the claims
service fees as provided for in this Agreement. For the purposes of this
Agreement, allocated loss adjustment expense(s) ("Allocated Loss Adjustment
Expense(s)") shall mean any expense which is chargeable or attributable to the
investigation, coverage analysis, adjustment, negotiation, settlement, defense
or general handling of any Claim(s) or action(s) related thereto, or to the
protection and/or perfection of Client's insured's right of subrogation,
contribution or indemnification, all as reasonably determined by TPA, whether
incurred for services provided by TPA, its affiliates, subsidiaries, or third
parties and shall include, but is not limited to, the following: legal fees,
court costs, photocopy costs, subpoena fees, bill review fees, investigation
costs, court reported and transcription fees, witness fees and witness travel
expenses, all outside expense items required for subrogation and/or recovery
activities on behalf of the Client, and such other and further expenses,
including but not limited to, expert fees that are necessary to properly handle
matters assigned to TPA which are not possible nor feasible to TPA to provide
with its own employees.
(A) With respect to TPA's determination that an expense(s) incurred pursuant to
this Agreement is an Allocated Loss Adjustment Expense, TPA makes no
representation or warranty and assumes no responsibility that such determination
(i) is in compliance with or meets the requirements of any statistical plan
filing, statutory, regulatory, or insurance industry reporting scheme or the
definition of "Allocated Loss Adjustment Expense" thereunder; (ii) is or could
be characterized as payment of loss or indemnity; or (iii) is or is not subject
to insurance or reinsurance coverage or limits. Client agrees that it is
responsible for making all such judgments and for complying with any and all
such requirements.
ARTICLE 6. PROPRIETARY RIGHTS
6.01 TPA agrees that all designs, plans, reports, process, and other
information, whether derived from the above referenced computer system, or
otherwise, produced by TPA as Services under this Agreement are the sole and
exclusive property of Client and Client's assigns, successors and nominees.
ARTICLE 7. CONFIDENTIALITY OF DATA
7.01 Any written, printed, graphic or electronically or magnetically recorded
information furnished by a party is the sole property of that party and
considered to be extremely confidential and proprietary, and includes the trade
secrets of that party. This proprietary information includes but is not limited
to information derived from access to Client's computer system. This proprietary
information also includes a party's specific insured requirements, marketing
information and information concerning a party's employees, products, services,
prices, operations and subsidiaries.
7.02 Each party will maintain all confidential information in the strictest
confidence, and will not disclose it by any means to any person or entity
without the other party's express written approve and only to the extent
necessary to perform the services under this Agreement. This prohibition applies
to all Client's and TPA's employees, agents and subcontractors. On termination
of this Agreement, each party will return any confidential information to the
other party immediately upon request.
7.03 TPA agrees that all information communicated to it by Client with respect
to the work conducted by or for the Client, whether or not that information was
directly or intentionally communicated, is considered confidential, as well. All
information, conclusions, recommendations,
6.
<PAGE> 7
reports, advise or other documents generated by TPA is confidential. All such
confidential information belongs solely to the Client. TPA agrees to use its
best efforts to prevent inadvertent disclosure of any confidential information
by taking all reasonable and prudent steps in accordance with its good faith
obligations under the terms and conditions outlined in this Agreement.
ARTICLE 8. OWNERSHIP OF CLAIM FILES
8.01 All records of the Claim Files, referenced above, whether in hard copy or
electronic form, relating whatsoever to the handling of the claims, whether
prepared by TPA or Client, shall be the exclusive property of the Client.
ARTICLE 9. SURETY BOND AND INSURANCE
9.01 TPA shall furnish to Client evidence of a fidelity bond conditioned on the
rendering of a true account by TPA of all moneys, goods or other property that
may come into the custody, charge, control or possession of the TPA. Said
fidelity bond must cover the dishonest act of the TPA's employees, including,
but not limited, to coverage for conversion, theft of moneys, instruments,
equipment, software and other tangible and intangible items in an amount not
less than Five Million ($5,000,000) dollars per occurrence and Ten Million
($10,000,000) dollars in the aggregate.
9.02 Client's own fidelity bond coverage will be excess over the bond furnished
by TPA pursuant to this Article.
9.03 TPA shall furnish to Client evidence of a General Liability policy, said
policy must include coverage for personal injury, naming the TPA as the insured
with limits of not less than Five Hundred Thousand ($500,000) dollars.
9.04 TPA shall furnish to Client evidence of an Automobile Insurance policy
naming TPA as the insured, covering all drivers and automobiles used by TPA in
the course of performing Services, with limits of not less than Five Hundred
Thousand ($500,000) dollars.
9.05 TPA shall furnish to Client evidence of a Workers' Compensation policy
naming TPA as the insured.
9.06 TPA shall furnish to Client evidence of an Errors and Omissions policy
naming TPA as the insured with limits of not less than One Million ($1,000,000)
dollars.
9.07 TPA agrees that all of the policies referenced in this Article, including
the fidelity bond, shall be written and maintained by carriers with ratings, as
defined by Best, initially acceptable to Client.
9.08 TPA agrees that all of the insurance requirements referenced in this
Article shall be in full force and effect for the time period of the life of any
claim upon which TPA has provided Services.
9.09 If, for any reason any of the insurance coverage policies mandated in this
Article terminate, TPA agrees that it will immediately replace the coverage and
that in any such circumstance, TPA agrees that it will hold Client free and
harmless from any and all claims that may arise during a period of lapsed or
terminated coverage.
7.
<PAGE> 8
9.10 The failure of TPA to maintain the insurance coverage referenced in this
Article shall represent a breach of the Agreement which shall permit Client to
purchase the coverage and charge TPA for the cost of same. This provision (9.10)
in no way, manner or form, constitutes a waiver of rights held by Client in the
event of a breach of this article; or any provision in the Agreement.
10. INDEMNIFICATION
10.01 TPA shall indemnify, defend and hold harmless Client from and against any
and all costs, expenses, liabilities losses, damages, injunctions, suits,
actions, fines, penalties, levies, assessments (excluding any levy or assessment
of any tax on earnings or capital gains arising out of any function of Client
under this Agreement) and claims and demands of every kind or nature, including
legal costs and attorneys fees, made by or on behalf of any party, person or
governmental authority, arising out of or resulting from: the inaccuracy or
breach of any representation or warranty of TPA contained in this Agreement, any
breach or default by TPA of any material covenant, obligation or agreement of
TPA contained in this Agreement; any material act or omission by TPA or any of
its agents or employees; or any negligent, fraudulent or dishonest act or
omission of TPA or its agents or employees.
10.02 Client shall indemnify, defend and hold harmless TPA from and against any
and all costs, expenses, liabilities, losses, damages, injunctions, suits,
actions, fines, penalties, levies, assessments (excluding any levy or assessment
of any tax on earnings or capital gains arising out of any function of TPA under
this Agreement) and claims and demands of every kind or nature, including legal
costs and attorneys fees, made by or on behalf of any party, person or
governmental authority arising out of or resulting from: the inaccuracy or
breach of any representation or warranty of Client contained in this Agreement;
any breach or default by Client of any material covenant, obligation or
agreement of Client contained in the Agreement, any material act or omission by
Client or any of its agents or employees, or any negligent, fraudulent or
dishonest act or omission of Client or its agents or employees.
10.03 Pursuant to this Article 10, when the indemnified party receives notice of
a claim or suit with respect to claims resulting from the assertion of liability
by a third party for which indemnification is provided by this Section, the
indemnified Party will promptly notify the indemnifying party and provide a copy
of the claim notice, summons and complaint, or other relevant documents. The
indemnified party shall cooperate fully with the defense of any such claim. The
indemnifying party shall consult with the indemnified party concerning counsel
retained. Should the parties fail to reach agreement on selection of counsel,
the opinion of the indemnifying party shall govern the selection. The
indemnifying party shall control the conduct of the litigation and of other
proceedings. The indemnifying party shall instruct counsel to keep both parties
apprised of the status of the proceedings by promptly reporting all significant
developments and, in addition, by providing general status reports on a timely
basis. With regard to any claim for which indemnification is sought hereunder,
the parties shall mutually agree as to the acceptance of any settlement
offer(s), or alternatively, the indemnifying party shall decide whatever action
is to be taken regarding any settlement offer(s), provided, that, the
indemnifying party in such case shall obtain the complete and written release of
the indemnified Party with respect thereto.
10.04 As used in this Article 10, the terms "TPA" and "Client" shall include,
respectively, the directors, officers, attorneys, employees, contractors,
subcontractors, agents and other representatives of TPA or Client.
8.
<PAGE> 9
10.05 This Article shall survive the termination of this Agreement.
ARTICLE 11. ASSIGNMENT
11.01 This Agreement, including its benefits, duties and obligations, may not be
assigned or otherwise transferred, whether voluntarily or involuntarily, by
merger, consolidation, operation of law or otherwise, by TPA without the prior
written consent of the Client. In the event of such assignment or transfer
without such consent, Client may elect in its sole discretion, to terminate this
Agreement upon giving written notice thereof, without waiving any remedies it
may otherwise have at law, equity or under this Agreement.
11.02 This Agreement, including its benefits, duties and obligations, may not be
assigned or otherwise transferred, whether voluntarily or involuntarily, by
merger, consolidation, operation of law or otherwise, by Client without the
prior written consent of the TPA. In the event of such assignment or transfer
without such consent, TPA may elect in its sole discretion, to terminate this
Agreement upon giving written notice thereof, without waiving any remedies it
may otherwise have at law, equity or under this Agreement.
11.03 For purposes of these paragraphs 11.01 and 11.02 above, transfer (by one
or more transfers) in the aggregate of 51% or more of the issued and outstanding
shares of common stock of the assigning party, shall be deemed an assignment
thereunder; provided however, that any transfer of stock by TPA to an affiliate
of the Zurich Insurance Company shall not be deemed to be as assignment
hereunder.
ARTICLE 12. TERMINATION OF CONTRACT
12.01 This Agreement may be terminated by either party upon thirty (30) days
written notice to the other party if such party fails to perform or observe in
any material respect, or commits a material breach of, any material provision of
this Agreement and such failure or breach has not been cured to the reasonable
satisfaction of the other party within thirty (30) days after written notice
thereof.
12.02 Material breach pursuant to section 12.01 may be, but is not limited to, a
failure to comply with any of the provisions enumerated in Articles 3, 4, 5, 6,
7, 8, 9, 10 and 11.
ARTICLE 13. ENTIRE AGREEMENT
13.01 This Agreement supersedes any and all agreements, either oral or written
between the parties and contains all of the representations, covenants, and
agreements between the parties with respect to the rendering of the Services
specified in the Agreement. Each party acknowledges that no representations,
promises, agreements, orally or otherwise, have been made by any party, or
anyone acting on behalf of any party, which are not contained in this Agreement;
and that no agreement, statement or promise not contained in this Agreement will
be valid or binding.
13.02 Any modification of this Agreement will be effective only if it is in
writing signed by the party to be charged.
9.
<PAGE> 10
13.03 Any renewal of the Agreement may be subject to further negotiations
between the parties if there is a material change in circumstances.
ARTICLE 14. PARTIAL INVALIDITY AND CONTRACT INTERPRETATION
14.01 If any provision is held to be invalid by a court of competent
jurisdiction, the remaining provisions will continue in full force and effect
without being impaired or invalidated in any way.
14.02 This Agreement shall be interpreted and construed in accordance with the
laws of the State of California.
14.03 The failure of any party to enforce any of the provisions herein shall not
be construed as a waiver of the right to enforce any such provision.
ARTICLE 15. DISPUTE RESOLUTION PROCEDURE
15.01 NEGOTIATION. In the event of any dispute, claim, question, or disagreement
arising out of or relating to this Agreement or the breach thereof, the parties
hereto shall use their best efforts to settle such disputes, claims, questions,
or disagreement. To this effect, they shall consult and negotiate with each
other, in good faith and, recognizing their mutual interests, attempt to reach a
just and equitable solution satisfactory to both parties.
15.02 MEDIATION. If a dispute arises out of or relates to this Agreement, or the
breach thereof, and if said dispute cannot be settled through direct
discussions, the parties agree to first endeavor to settle the dispute in an
amicable manner by mediation administered by a mediator mutually agreeable to
all parties, before resorting to arbitration.
15.03 ARBITRATION. Thereafter, any unresolved controversy or claim arising out
of or relating to this Agreement, or breach thereof, shall be settled by
arbitration administered by and in accordance with the provisions of California
Code of Civil Procedure Sections 1280 et seq., and judgment upon the Award
rendered by the arbitrator(s) may be entered in any court having jurisdiction
thereof.
(a) The arbitration shall be held in Los Angeles, California or at such other
place as may be selected by mutual agreement.
(b) Within fifteen (15) days after the demand for commencement of arbitration,
each party shall select one person to act as arbitrator, and the two selected
shall select a third arbitrator within ten (10) days of their appointment who
will act as sole arbitrator of the dispute. If the arbitrators selected by the
parties are unable or fail to agree upon the third arbitrator, the third
arbitrator shall be appointed by a Superior Court judge pursuant to California
Code of Civil Procedure Section 1281.6 on petition of a party to the arbitration
agreement.
(c) The arbitrator will be selected from a panel of persons having experience
with and knowledge of workers' compensation insurance and the workers'
compensation insurance industry.
(d) The arbitrator shall have the authority to award any remedy or relief that a
court of this state could order or grant including, without limitation, specific
performance of any obligation created
10.
<PAGE> 11
under the agreement, the awarding of punitive damages, the issuance of an
injunction, or the imposition of sanctions for abuse or frustration of the
arbitration process.
(e) The arbitrators shall award to the prevailing party, if any, as determined
by the arbitrators, all of its costs and fees. "Costs and fees" means all
reasonable pre-award expenses of the arbitration, including the arbitrators'
fees, administrative fees, travel expense, out-of-pocket expenses such as
copying and telephone, court costs, witness fees and attorneys' fees.
(f) Neither party nor the arbitrators may disclose the existence, content, or
results of any arbitration hereunder without the prior written consent of both
parties.
(g) Limited civil discovery shall be permitted for the production of documents
and taking of depositions. All discovery shall be governed by the California
Rules of Civil Procedure. All issues regarding conformation with discovery
requests shall be decided by the arbitrators.
(h) The arbitration award shall be in writing and shall specify the factual and
legal bases for the award.
(i) Within twenty (20) days after receipt of the Notice of Decision by the
Arbitrator, either party may appeal the arbitration panel's award to an
appellate arbitrator by filing a written Notice of Appeal served on the opposing
party and the Arbitrator.
(j) Within fifteen (15) days after Notice of Appeal, each party shall select one
person to act as appellate arbitrator, and the two selected shall select a third
appellate arbitrator within ten (10) days of their appointment who will act as
sole arbitrator of the dispute. If the arbitrators selected by the parties are
unable or fail to agree upon the third appellate arbitrator, the third
arbitrator shall be appointed by a Superior Court judge pursuant to California
Code of Civil Procedure section 1281.6 on petition of a party to the Arbitration
agreement.
(k) The Appellate Arbitrator shall be a retired judge of a court of record in
the state in which the arbitration was held.
(l) Within twenty (20) days after selection of an Appellate Arbitrator, a
written brief, not to exceed twenty (20) pages stating the reasons why the
panel's decision should be reversed or modified shall be filed with the
Appellate Arbitrator and served to the opposing party. The opposing party shall
file with the Appellate Arbitrator and serve on the appealing party within
twenty (20) days after receiving the appeal brief, an opposition brief not to
exceed twenty (20) pages. Either party may request oral argument which must be
conducted within fourteen (14) days following the submission of the final brief.
The appellate arbitration shall be based only on the record of the initial
hearing and oral argument if any. The appellate arbitrator shall render a
written decision affirming, reversing, modifying or remanding the arbitration
panel's decision within thirty (30) days after receiving the final appellate
submission.
(m) The appellate arbitrator may reverse, modify or remand the matter for
further proceeding by the arbitration panel only on one of the following
grounds:
1. Any ground specified in 901 et. seq. of the California Code of
Civil Procedure;
2. If the award contains material errors of applicable law;
11.
<PAGE> 12
3. If the award is arbitrary or capricious;
4. If there is a demonstration of bias, prejudice or undisclosed
conflict of interest between the arbitrator and the prevailing party.
(n) The appellate arbitrator may render a final decision on appeal or remand the
matter for further proceedings by the arbitration panel
(o) The arbitrators shall award to the prevailing party, if any, as determined
by the arbitrators, all of its costs and fees. "Costs and fees" means all
reasonable pre-award expenses of the arbitration, including the arbitrators'
fees, administrative fees, travel expenses, out-of--pocket expenses such as
copying and telephone, court costs, witness fees and attorneys' fees.
CLIENT:
SUPERIOR NATIONAL INSURANCE COMPANY
a California Corporation
By: /s/ J. CHRIS SEAMAN
---------------------------------
Name: J. Chris Seaman
Title:
Date: 3/18/98
---------------------------------
TPA:
RISK ENTERPRISE MANAGEMENT LIMITED
By: /s/ MICHAEL RINEY
---------------------------------
Name: Michael Riney
---------------------------------
Title: Executive Vice President
---------------------------------
Date: 3/19/98
---------------------------------
<PAGE> 1
EXHIBIT 10.54
AVERAGE EXISTING CLAIM SEVERITY AGREEMENT
Effective: December 31, 1997
Parties: Zurich Reinsurance (North America), Inc., a Connecticut domiciled
company ("Zurich Re") and Superior National Insurance Company and
Superior Pacific Casualty Company, each a California domiciled
company (hereinafter individually or collectively "Superior")
Coverage: Claims arising under Superior's Policies occurring prior to
January 1, 1998 and closing subsequent to December 31, 1997.
Term: Continuous, effective 11:59 A.M., Standard Time, December 31,
1997 until terminated by either party in accordance with the
provisions herein.
"Standard Time" shall be defined in accordance with the original
Policies.
Territory: As per the original Policies.
Exclusions: 1. Claims which Superior has fully and finally settled and paid
prior to January 1, 1998.
2. Claims for which Superior has determined the final settlement
amount but which have not been fully and finally closed prior to
January 1, 1998.
Protection
Amounts: To pay up to $4,166 each Average Covered Existing Claim in excess
of $39,912 each Average Covered Existing Claim, but not to exceed
$30,000,000 in the aggregate for all Average Covered Existing
Claims during the entire term of this Agreement.
Consideration: $100,000 shall be payable on the date that this Agreement is
executed.
Termination: This Agreement may be terminated by mutual agreement of the
parties. Further, this Agreement may also be terminated in
accordance with the Special Termination Article, attached
hereto.
Termination shall constitute a complete and final release of
Zurich Re in respect of any and all of its obligations of any
nature whatsoever to Superior under or related to this Agreement.
<PAGE> 2
SPECIAL CONDITIONS: 1. In the event that Superior enters into any transaction,
agreement or commitment regarding structured
settlements or other similar arrangements or purchases
insurance or reinsurance that materially affects the
payout patterns of claims, as contemplated by Zurich Re
(any of the foregoing transactions, agreements or
commitments individually or collectively referred to as
the "Transaction"), any such Transaction shall have no
effect whatsoever in determining the liability of
Zurich Re as respects the calculation of Average
Covered Existing Claims.
2. Superior shall not materially change its underwriting
and claims administration practices, policies and
procedures in place at the inception of this Agreement
without Zurich Re's prior written consent.
3. Superior hereby acknowledges that it has entered into
a claims/medical management and administration
services agreement with Risk Enterprise Management
Limited to provide such services for Superior's claims
arising under its Policies, and this Agreement is
contingent upon the continuation of the agreement with
Risk Enterprise Management Limited.
DEFINITIONS: 1. "Covered Existing Claim" shall mean any claim for
indemnity, including claims for medical expense and/or
allocated loss adjustment expense, under Superior's
Policies which occurs prior to January 1, 1998 and
which closes subsequent to December 31, 1997.
2. "Average Covered Existing Claim" shall be determined
by the fraction whose numerator is the total amount
paid by Superior in respect of all Covered Existing
Claims during the term of this Agreement, after the
deduction of recoveries by Superior from any
reinsurance applicable to such Covered Existing
Claims, whether or not such amount is actually
recoverable. For purposes of this calculation, the
maximum amount of any one Covered Existing Claim shall
not exceed $500,000, before the deduction of any
inuring reinsurance and regardless of the number of
claimants, insureds, policies or risks involved in an
occurrence giving rise to a Covered Existing Claim;
and whose denominator is the greater of: (i) 70,089;
or (ii) the actual number of ultimate Covered Existing
Claims paid by Superior during the term of this
Agreement; less 62,888. Notwithstanding anything to
the contrary herein, Covered Existing Claims under
this Agreement shall be not be recoverable from Zurich
Re until the amount of Superior's ultimate Average
Covered Existing Claims are known and fully and
finally determined.
3. "Policy" shall mean all policies, binders, contracts
or certificates of insurance written and classified by
Superior as workers' compensation, including
employers' liability.
<PAGE> 3
General Provisions: Access to Records (as per clause attached)
Arbitration (Venue: New York, New York)
Errors and Omissions
Insolvency
Salvage and Subrogation (as per clause attached)
Offset (as per clause attached)
Overdue Payments (as per clause attached)
Special Termination (as per clause attached)
No Third Party Rights
Signed in New York, New York
For and on behalf of Zurich Reinsurance (North America), Inc.
Signed by: /s/ [illegible]
----------------------------------
Signed in Calabasas, CA
For and on behalf of Superior National Insurance Company
Superior Pacific Casualty Company
Signed by: /s/ [illegible]
----------------------------------
<PAGE> 4
OFFSET
Zurich Re and Superior may offset at any time or from time to time any balances
or amounts due from one party to the other under this Agreement or any other
contract heretofore or hereafter entered into between said parties whether
acting as assuming or ceding insurer or otherwise.
The offset rights as set forth above shall not be contingent upon the exercise
of such rights or affected in any manner whatsoever by the insolvency of any
party to this Agreement.
<PAGE> 5
ACCESS TO RECORDS
Zurich Re or its designated representatives shall have access, at any
reasonable time during the currency of this Agreement and at any time
thereafter, to all records of Superior which pertain in any way to this
Agreement.
<PAGE> 6
SALVAGE AND SUBROGATION
Zurich Re shall be credited with its proportionate share of salvage or
subrogation recoveries on account of claims or settlements involving the
protection hereunder. Salvage or subrogation recoveries shall mean
reimbursement obtained or recovery made by Superior, less the actual cost,
excluding salaries of officials and employees of Superior, of obtaining such
reimbursement or making such recovery.
<PAGE> 7
OVERDUE PAYMENTS
Interest rate as determined by the one year United States Treasury Bill, (as
quoted in the Wall Street Journal on the first business day of the month for
which the calculation is made) plus 1% per month, as calculated on a daily
basis, shall be payable by Superior or Zurich Re on any consideration or claims
unpaid more than fifteen (15) days after the dates provided for herein.
<PAGE> 8
SPECIAL TERMINATION
This Agreement may be terminated in the event that:
a. Any legal authority orders Superior or Zurich Re to cease writing business.
b. The Employment status of J. Chris Seaman, Executive Vice President & Chief
Financial Officer or William Gentz, President & Chief Executive Officer of
Superior have materially and adversely changed in any manner whether by
reassignment, relocation, termination or otherwise and whether for cause or
otherwise.
c. Superior's surplus falls below 200% of the required amount of Risk Based
Capital in accordance with the Company Action Level, as defined by the
National Association of Insurance Commissioners.
d. The agreement with Risk Enterprise Management Limited to provide
claims/medical management and administration services is not continued.
As respects the events set forth above, the non-breaching party shall have the
right to terminate this Agreement by giving not less than thirty (30) days
notice of its intention to do so. Any notice of termination pursuant to the
foregoing provisions above shall be sent by certified mail return receipt
requested. Such notice period shall commence upon the date that such notice of
termination was dispatched.
<PAGE> 1
EXHIBIT 10.55
DIABLO CENTER
OFFICE LEASE
between
PROPERTY CALIFORNIA OB ONE CORPORATION
("LANDLORD")
and
SUPERIOR NATIONAL INSURANCE COMPANY
("TENANT")
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<S> <C> <C>
1. USE....................................................................... 1
2. TERM...................................................................... 2
3. POSSESSION................................................................ 3
4. RENT...................................................................... 3
5. RULES AND REGULATIONS..................................................... 5
6. PARKING................................................................... 6
7. EXPENSES OF OPERATION, MANAGEMENT, AND MAINTENANCE........................ 6
8. REPAIR AND MAINTENANCE.................................................... 11
9. ACCEPTANCE AND SURRENDER OF PREMISES...................................... 11
10. ALTERATIONS AND ADDITIONS................................................. 12
11. UTILITIES AND SERVICES.................................................... 13
12. TAXES..................................................................... 13
13. LIABILITY INSURANCE....................................................... 15
14. TENANT'S PERSONAL PROPERTY INSURANCE AND WORKER'S
COMPENSATION INSURANCE.................................................... 16
15. PROPERTY INSURANCE........................................................ 16
16. INDEMNIFICATION........................................................... 17
17. COMPLIANCE................................................................ 17
18. LIENS..................................................................... 17
19. ASSIGNMENT AND SUBLETTING................................................. 18
20. SUBORDINATION AND MORTGAGES............................................... 19
21. ENTRY BY LANDLORD ........................................................ 19
</TABLE>
i
<PAGE> 3
<TABLE>
<S> <C> <C>
22. BANKRUPTCY AND DEFAULT.................................................... 19
23. ABANDONMENT............................................................... 22
24. DESTRUCTION .............................................................. 22
25. EMINENT DOMAIN............................................................ 23
26. SALE OR CONVEYANCE BY LANDLORD............................................ 24
27. ATTORNMENT TO LENDER OR THIRD PARTY....................................... 24
28. HOLDING OVER.............................................................. 24
29. CERTIFICATE OF ESTOPPEL................................................... 24
30. CONSTRUCTION CHANGES...................................................... 25
31. RIGHT OF LANDLORD TO PERFORM.............................................. 25
32. ATTORNEYS' FEES........................................................... 25
33. WAIVER.................................................................... 26
34. NOTICES................................................................... 26
35. EXAMINATION OF LEASE...................................................... 26
36. DEFAULT BY LANDLORD....................................................... 26
37. CORPORATE AUTHORITY....................................................... 27
38. LIMITATION OF LIABILITY................................................... 27
39. BROKERS................................................................... 28
40. SIGNS..................................................................... 28
41. ASSESSMENTS............................................................... 28
42. MORTGAGEE PROTECTION CLAUSE............................................... 29
43. HAZARDOUS MATERIALS....................................................... 29
</TABLE>
ii
<PAGE> 4
<TABLE>
<S> <C> <C>
44. MISCELLANEOUS AND GENERAL PROVISIONS...................................... 30
45. LEASE OPTION TO EXTEND.................................................... 31
46. LEASE OPTION TO EXPAND.................................................... 33
47. LEASE OPTION TO TERMINATE................................................. 33
</TABLE>
iii
<PAGE> 5
TABLE OF EXHIBITS
Exhibit A The Premises
Exhibit B The Property
Exhibit C Work Letter
Exhibit D Rules and Regulations
Exhibit E Reserved Spaces
iv
<PAGE> 6
LEASE AGREEMENT
This Lease is made this ____ day of ________________ 1997, by and between
PROPERTY CALIFORNIA OB ONE CORPORATION, an Oregon corporation ("Landlord"), and
SUPERIOR NATIONAL INSURANCE COMPANY, a California corporation ("Tenant").
WITNESSETH:
Landlord hereby leases to Tenant and Tenant hereby hires and takes from Landlord
those certain premises (the "Premises") cross-hatched on Exhibit A more
particularly described as follows:
Approximately 21,000 rentable square feet on the ground floor of the
building ("Building") located at 5775 West Las Positas, Pleasanton,
California, consisting of a total area of approximately Thirty-Nine
Thousand Three Hundred Six (39,306) rentable square feet together with
the non-exclusive right to use the Common Area of the Building and the
Outside Area of the Property. As used herein, the term "Property" shall
mean the land shown on Exhibit B and all of the buildings, improvements,
fixtures and equipment now or hereafter situated on said land, commonly
known as "Diablo Center". The Property is part of a larger group of
land, buildings and improvements referred to as "Hacienda Business Park"
or the "Park".
"Rentable square feet" as used in this Lease refers to an area calculated in
accordance with the BOMA method for measuring the Building. Within 60 days of
the Commencement Date, as defined herein, the Premises shall be remeasured and
this Lease shall be amended by restatement to reflect. the rentable square feet
determined by such remeasurement, including changes to the Basic Rent, parking
spaces, Tenant's Building Percentage, and Tenant's Property Percentage.
Landlord agrees to construct the Tenant Improvements set forth in the Work
Letter (the "Work Letter") attached hereto as Exhibit C, and upon such terms and
conditions as set forth in the Work Letter.
Said leasing and hiring is upon and subject to the terms, covenants and
conditions hereinafter set forth and Tenant covenants as a material part of the
consideration for this Lease to perform and observe each and all of said terms,
covenants and conditions. This Lease is made upon the condition of such
performance and observance.
1. USE. Tenant shall use the Premises only in conformance with applicable
governmental laws, regulations, rules and ordinances for the purpose of general
office use and for no other purpose. Tenant shall not do or permit to be done in
or about the Premises or the Property, nor bring or keep or permit to be brought
or kept in or about the Premises or the Property, anything which is prohibited
by or will in any way increase the existing rate, or cause a cancellation of,
fire or any other insurance covering the Property or any of its contents. Tenant
shall not do or permit to be done anything in, on or about the Premises or the
Property which will in any way obstruct or interfere with the rights of other
tenants or occupants of the Building or injure or annoy them, or
1
<PAGE> 7
use or allow the Premises to be used for any improper, immoral, unlawful or
objectionable purpose, nor shall Tenant cause, maintain or permit any nuisance
in, on or about the Premises or the Property. No sale by auction shall be
permitted on the Premises. Tenant shall not place any loads upon the floors,
walls, or ceiling, which endanger the structure, or place any harmful fluids or
other materials in the drainage system of the Building, or overload existing
electrical or other mechanical systems. No waste materials or refuse shall be
dumped upon or permitted to remain upon any part of the Premises or outside of
the Building, except in trash containers placed inside exterior enclosures
designated by Landlord for that purpose or inside of the Building where
designated by Landlord. No materials, supplies, equipment, finished products or
semifinished products, raw materials or articles of any nature shall be stored
upon or permitted to remain outside the Premises or on any portion of the
Outside Area of the Property. No loudspeaker or other device, system or
apparatus which can be heard outside the Premises shall be used in or at the
Premises without the prior written consent of Landlord. Tenant shall not commit
or suffer to be committed any waste in or upon the Premises. Tenant shall
indemnify, defend and hold Landlord harmless against any loss, expense, damage,
attorneys' fees, or liability arising out of failure of Tenant to comply with
any law applicable to Tenant or Tenant's business. The provisions of this
paragraph are for the benefit of Landlord only and shall not be construed to be
for the benefit of any tenant or occupant of the Building. Tenant acknowledges
that it has received and read a copy of the Declaration of Covenants, Conditions
and Restrictions for Hacienda Business Park (No. 2) recorded January 24, 1985 as
Instrument No. 85-14396, Official Records of Alameda County, California (the
"CC&R's"). Tenant shall comply with the CC&R's.
Tenant's initials: _____________
2. TERM.
A. The term of this Lease shall be for a period of approximately five
(5) years (unless sooner terminated as hereinafter provided) beginning on the
Commencement Date, as defined below, and ending on the day before the fifth (5)
anniversary of the Commencement Date.
B. Possession of the Premises shall be deemed tendered and the term of
this Lease shall commence on the date ("Commencement Date") which is the earlier
of.
(i) Three business days after certification by Landlord's
architect or contractor that the Tenant Improvements have been substantially
completed; or
(ii) The first day that the Premises are occupied for business by
Tenant.
Upon determination of the Commencement Date Landlord and Tenant shall execute a
commencement date memorandum. Tenant shall have the right to enter the Premises
prior to the Commencement Date for the purpose of installing telecommunications
and data cabling, and for delivery and installation of its furniture, fixtures,
and equipment, provided that such installation and delivery shall not interfere
with the construction of the Tenant Improvements.
2
<PAGE> 8
3. POSSESSION. If Landlord, for any reason whatsoever, cannot deliver possession
of the Premises to Tenant by the anticipated Commencement Date, this Lease shall
not be void or voidable, no obligation of Tenant shall be affected thereby; nor
shall Landlord or Landlord's agents be liable to Tenant for any loss or damage
resulting therefrom; but in that event the commencement and termination dates of
this Lease, and all other dates affected thereby shall be revised to conform to
the date of Landlord's delivery of possession, as specified in Paragraph 2.B
above. The above is, however, subject to the provision that the period of delay
of delivery of the Premises shall not exceed ninety (90) days from the
anticipated Commencement Date (except those delays caused by Tenant (as defined
in the Work Letter), acts of God, strikes, war, lack of utilities, weather,
unavailable materials, delays caused solely by governmental bodies, and other
delays beyond Landlord's control shall be excluded in calculating such period),
in which instance Tenant, at its option, may by written notice to Landlord
terminate this Lease. Notwithstanding anything contained herein, if the
Commencement Date does not occur by January 31, 1997 for reasons other than
delays caused by Tenant, Tenant shall be entitled to one day of free rent for
every one day of delay beyond the such date.
4. RENT.
A. BASIC RENT. Tenant agrees to pay to Landlord at such place as
Landlord may designate without deduction, offset, prior notice, or demand, and
Landlord agrees to accept as Basic Rent for the leased Premises in lawful money
of the United States of America, payable as follows:
<TABLE>
<CAPTION>
Months of Term Monthly Basic Rent
-------------- -------------------
<S> <C>
1-24 $32,130.00 ($1.53 square foot)
25-36 $34,230.00 ($1.63 square foot)
37-60 $36,330.00 ($1.73 square foot)
</TABLE>
B. TIME FOR PAYMENT. Within five (5) business days of the execution of
this Lease, Tenant shall pay to Landlord the Basic Rent due for the first month
of the term in the amount of $32,130.00 Thereafter, Basic Rent shall be due on
or before the first day of each calendar month of the term. If the term of this
Lease commences on a date other than the first day of a calendar month, on the
Commencement Date, Tenant shall pay to Landlord as rent for the period from the
Commencement Date to the first day of the next succeeding calendar month that
proportion of the monthly rent hereunder which the number of days between the
Commencement Date and the first day of the next succeeding calendar month bears
to thirty (30). If the term of this Lease ends on a date other than the last day
of a calendar month, on the first day of the last calendar month of the term
hereof Tenant shall pay to Landlord as rent for the period from said first day
of said last calendar month to and including the last day of the term hereof
that proportion of the monthly rent hereunder which the number of days between
said first day of said last calendar month and the last day of the term hereof
bears to thirty (30).
C. LATE CHARGE. Notwithstanding any other provision of this Lease, if
Tenant fails to pay any Rent when due, and such Rent is not received by Landlord
within ten (10) days after the date such Rent is due, Tenant shall pay to
Landlord, in addition to the delinquent Rent, a late
3
<PAGE> 9
charge equal to ten percent (10%) of the delinquent Rent. In addition to the
foregoing late charge, if any Rent remains unpaid for 30 days or more after the
date due, such Rent shall accrue interest at the rate of ten percent (10%) per
annum until paid.
D. ADDITIONAL RENT. Tenant shall pay to Landlord in addition to the
Basic Rent and as Additional Rent the following:
(a) Tenant's Building Percentage of Building Operating Expenses
and Tenant's Property Percentage of Outside Area Expenses; and
(b) All other charges, costs and expenses which Tenant is
required to pay hereunder, together with all interest and penalties, costs and
expenses, including attorneys' fees and legal expenses, that may accrue thereto
in the event of Tenant's failure to pay such amounts. And all damages,
reasonable costs and expenses which Landlord may incur by reason of default of
Tenant or failure on Tenant's part to comply with the terms of this Lease. In
the event of nonpayment by Tenant of Additional Rent, Landlord shall have all
the rights and remedies with respect thereto as Landlord has for nonpayment of
Rent, as defined below.
The Additional Rent due under Paragraph 7 shall be paid to Landlord or
Landlord's agent in accordance with Paragraph 7. The Additional Rent for any
item payable under a provision other than Paragraph 7 shall be paid to Landlord
or Landlord's agent within twenty (20) days after receipt of an invoice to
Tenant setting forth the Additional Rent due. If requested, Landlord shall
provide reasonable supporting documentation for the Additional Rent. The
respective obligations of Landlord and Tenant under this paragraph shall survive
the expiration or other termination of the term of this Lease.
As used herein, Rent shall mean Basic Rent plus Additional Rent.
E. PLACE OF PAYMENT OF RENT. All Rent hereunder shall be paid to
Landlord at the office of Landlord, c/o R & B Commercial Real Estate Services,
Inc., 4637 Chabot Drive, Suite 100, Pleasanton, CA 94588, or to such other
person or to such other place as Landlord may from time to time designate in
writing.
F. SECURITY DEPOSIT. Concurrently with Tenant's execution of this Lease,
Tenant shall deposit with Landlord the sum of Thirty-Six Thousand Three Hundred
Thirty and no/100s Dollars ($36,330). Said sum shall be held by Landlord as a
Security Deposit for the faithful performance by Tenant of all of the terms,
covenants and conditions of this Lease to be kept and performed by Tenant during
the term hereof. Twelve months from the Commencement Date, provided Tenant is
not in default, Tenant may provide Landlord with financial statements and
Landlord agrees to review such statements to determine whether, in Landlord's
sole discretion, the Security Deposit may be returned to Tenant. In the event
that Tenant has paid all Rent when due from execution of this Lease through the
24th month from the Commencement Date and Tenant is not in default hereunder,
Landlord agrees to return the Security Deposit, or any balance thereof, to
Tenant. If Tenant defaults with respect to any provision of this Lease,
including, but not limited to, the provision relating to the payment of rent and
any of the monetary sums due
4
<PAGE> 10
herewith, Landlord may (but shall not be required to) use, apply or retain all
or any part of this Security Deposit for the payment of any rent or other sum in
default, the repair of any damage to the Premises caused by Tenant, or the
payment of any other amount which Landlord may spend or become obligated to
spend by reason of Tenant's default or to compensate Landlord for any other loss
or damage which Landlord may suffer by reason of Tenant's default to the full
extent permitted by law. Tenant hereby waives any restriction on the use or
application of the Security Deposit by Landlord as set forth in California Civil
Code Section 1950.7. If any portion of the Security Deposit is used or applied,
Tenant shall, within ten (10) days after written demand therefor, deposit cash
with Landlord in the amount sufficient to restore the Security Deposit to its
original amount. Tenant's failure to do so shall be a material breach of this
Lease. Landlord shall not be required to keep this Security Deposit separate
from its general funds, and Tenant shall not be entitled to interest on the
Security Deposit. If Tenant fully and faithfully performs every provision of
this Lease to be performed by it, the Security Deposit or any balance of it
shall be returned to Tenant (or at Landlord's option, to the last assignee of
Tenant's interest hereunder) at the expiration of the Least term and after
Tenant has vacated the Premises. In the event of termination of Landlord's
interest in this Lease, Landlord shall transfer the Security Deposit to
Landlord's successor-in-interest whereupon Tenant agrees to release Landlord
from liability for the return of the Security Deposit or the accounting
therefor.
5. RULES AND REGULATIONS. Subject to the terms and conditions of this Lease and
such rules and regulations as Landlord may from time to time prescribe, Tenant
and Tenant's employees, invitees and customers shall, in common with other
occupants of the Building, and their respective employees, invitees and
customers, and others entitled to the use thereof, have the non-exclusive right
to use the access roads, parking areas, and facilities provided and designated
by Landlord for the general use and convenience of the occupants of the
Property, which areas and facilities and all other landscaped areas, service
areas, trash disposal facilities and similar areas and facilities within the
Property are referred to herein as the "Outside Area". This right shall
terminate upon the termination of this Lease. Landlord reserves the right from
time to time to make changes in the shape, size, location, amount and extent of
Outside Area. Landlord further reserves the right to promulgate such reasonable
rules and regulations, and amendments thereto, relating to the use of the
Outside Area, and any part or parts thereof, as Landlord may deem appropriate
for the best interests of the occupants of the Property. The use of the Building
and the Outside Area shall initially be subject to the Rules and Regulations
attached hereto as Exhibit D. The Rules and Regulations shall be binding upon
Tenant upon delivery of a copy of them to Tenant, and Tenant shall abide by them
and cooperate in their observance. Such Rules and Regulations may be amended by
Landlord from time to time, with or without advance notice, and all amendments
shall be effective upon delivery of a copy to Tenant. Landlord shall not be
responsible to Tenant for the nonperformance by any other tenant or occupant of
the Property of any of said Rules and Regulations. In the event that the Rules
and Regulations are changed by Landlord subsequent to the execution of this
Lease and there is a conflict between this Lease and the Rules and Regulations,
this Lease shall govern.
6. PARKING. Tenant shall have the right to use with other tenants or occupants
of the Building parking spaces, the number of which shall be based on a ratio of
3.5 spaces per 1,000 square feet of leased premises in the common parking area
of the Property, five of which shall be
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designated, reserved stalls in reasonable proximity to the Premises and shown on
the attached Exhibit E (the "Reserved Spaces"), and Tenant and Tenant's
employees, customers, and other invitees shall have exclusive use of such
spaces. Tenant's parking spaces shall be provided without charge by Landlord.
Any parking charges assessed or imposed by the City of Pleasanton or other
governmental entity shall be billed to Tenant as an Outside Area Expense
pursuant to Paragraph 7.F. Tenant agrees that Tenant, Tenant's employees,
agents, representatives and invitees shall not use parking spaces in excess of
the spaces allocated to Tenant hereunder. Landlord shall have the right, at
Landlord's sole discretion, to specifically designate the location of Tenant's
parking spaces within the common parking areas of the Property in the event of a
dispute among the tenants occupying the Building, in which event Tenant agrees
that Tenant, Tenant's employees, agents, representatives and/or invitees shall
not use any parking spaces other than those parking spaces specifically
designated by Landlord for Tenant's use. Said parking spaces, if specifically
designated by Landlord to Tenant, may be relocated by Landlord at any time and
from time to time. Landlord reserves the right, at Landlord's sole discretion,
to rescind any specific designation of parking spaces, thereby returning
Tenant's parking spaces to the common parking area; provided that Landlord shall
not rescind Tenant's right to the Reserved Spaces but may relocate the Reserved
Spaces as provided herein within reasonable proximity to the existing Reserved
Spaces. Landlord shall give Tenant reasonable prior written notice of any change
in Tenant's parking spaces. Tenant shall not, at any time, park, or permit to be
parked, any trucks or vehicles adjacent to the loading areas so as to interfere
in any way with the use of such areas, nor shall Tenant at any time park, or
permit the parking of Tenant's trucks or vehicles or the trucks and vehicles of
Tenant's suppliers or others, in any portion of the Outside Area not designated
by Landlord for such use by Tenant. Tenant shall not park nor permit to be
parked, any inoperative vehicles or equipment on any portion of the Outside
Area. Tenant agrees to assume responsibility for compliance by its employees
with the parking provisions contained herein. If Tenant or its employees park in
other than such designated parking areas, then Landlord may charge Tenant, as an
additional charge, and Tenant agrees to pay, Ten and no/100ths Dollars ($10.00)
per day for each day or partial day each such vehicle is parked in any area
other than that designated after prior notice. Tenant hereby authorizes Landlord
at Tenant's sole expense to tow away from the Property any vehicle belonging to
Tenant or Tenant's employees parked in violation of these provisions, or to
attach violation stickers or notices to such vehicles. Tenant shall use the
parking areas for vehicle parking only, and shall not use the parking areas for
storage.
7. EXPENSES OF OPERATION, MANAGEMENT, AND MAINTENANCE.
A. OUTSIDE AREA/COMMON AREA. The term "Outside Area" shall mean all
areas and facilities within the Property provided and designated by Landlord for
the general use and convenience of Tenant and other tenants and occupants of the
Property such as access roads, parking areas, sidewalks, landscaped area,
service areas, trash disposal facilities, and similar areas and facilities. The
term "Common Area" shall refer to those portions of the Building designated by
Landlord for the general use and convenience of all tenants of the Building,
such as hallways, stairs, elevators, entrances and exits, lobbies, restrooms,
the common pipes, wires and appurtenant equipment serving the Building.
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B. TENANT'S PERCENTAGE. The term "Tenant's Building Percentage" shall
mean the percentage of the rentable area of the Premises to the total rentable
area of the Building. Tenant's Building Percentage is agreed to be Fifty-Three
and 43/100ths percent (53.43%) for purposes of this Lease. The total rentable
area of the Building is Thirty-Nine Thousand Three Hundred Six) (39,306) square
feet. The term "Tenant's Property Percentage" shall mean the percentage of the
rentable area of the Premises to the total rentable area of all buildings on the
Property. Tenant's Property Percentage is agreed to be Seventeen and 59/100ths
percent (17.59%) for purposes of this Lease. The total rentable area of the
Property is approximately One Hundred Nineteen Thousand, Four Hundred Three
(119,403) square feet.
C. PAYMENT BY TENANT. Commencing on January 1, 1999, Tenant shall pay to
Landlord, as Additional Rent, Tenant's Building Percentage of the Building
Operating Expenses and Tenant's Property Percentage Outside Area Expenses in
excess of the Expense Base, as hereinafter defined.
D. BUILDING OPERATING EXPENSES. The term "Building Operating Expenses"
shall mean all expenses, costs and disbursements (but not capital investment
items, except as provided in subparagraph (ix) below, or specific costs
especially billed to and paid by specific tenants) of every kind and nature
which Landlord shall pay or become obligated to pay because of or in connection
with the ownership, management, maintenance, repair and operation of the
Building and the Common Area, including, but not limited to, the following:
(i) Wages and salaries of all employees engaged in the operation,
maintenance and security of the Building and Common Area, including taxes,
insurance and benefits relating thereto; and the rental cost and overhead of any
office and storage space in the Park used to provide such services;
(ii) Cost of all supplies, materials and labor used in the
operation, repair, replacement and maintenance of the Building and Common Area;
(iii) Cost of all utilities, including surcharges, which are not
paid directly by Tenant for the Building and Common Area, including the cost of
water, sewer, gas, power, heating, lighting, air conditioning and ventilating;
(iv) Cost of all maintenance and service agreements for services
not paid directly by Tenant the Building and Common Area and the equipment
thereon, including but not limited to, security and energy management services,
window cleaning, floor waxing, elevator maintenance, janitorial service,
services by engineers and gardeners, and trash removal services;
(v) Cost of all insurance which Landlord or Landlord's lender
deems necessary for the Building and Common Area such as the cost of "All-Risk"
property insurance, including, at Landlord's option, flood coverage, insurance
against loss of rents on an "All-Risk" basis, a lender's loss payable
endorsement in favor of Landlord's lender and naming Landlord and its
subsidiaries, directors, agents, officers, partners and employees as named
insureds; and casualty and liability insurance applicable to the Building and
Landlord's personal property used in
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connection therewith, naming Landlord and its subsidiaries, directors, agents,
officers, partners and employees as additional insureds;
(vi) Cost of repairs and general maintenance of the Building and
Common Area (excluding repairs and general maintenance paid for by proceeds of
insurance or by Tenant or other third parties);
(vii) A reasonable management fee of four percent (4%) for the
manager of the Building;
(viii) The cost of any additional services not provided to the
Building and Common Area at the Commencement Date but thereafter provided by
Landlord in its management of the same; and
(ix) The cost of any capital improvements made to the Building
and the Common Area after the Commencement Date that reduce operating expenses,
or are required under any governmental law or regulation that was not applicable
to the Building at the Commencement Date, such cost thereof to be amortized over
the useful life of the improvement, using a market rate of interest, as Landlord
shall determine consistent with applicable governmental requirements.
The cost of additional or extraordinary services provided to Tenant at
Tenant's request and not paid or payable by Tenant pursuant to other provisions
of this Lease shall be payable by Tenant and may be included by Landlord with
Tenant's Building Percentage of Building Operating Expenses payable by Tenant on
a monthly basis or may be billed to Tenant separately, in a lump sum, as
Landlord shall elect.
Building Operating Expenses shall not include (i) the cost of any
additional or extraordinary services provided to other tenants of the Building
or the cost of tenant improvements for other tenants in the Building; (ii) costs
paid for directly by Tenant or any other tenant; (iii) principal and interest
payments on loans secured by deeds of trust recorded against the Building; (iv)
real estate sales or leasing brokerage commissions and other marketing costs;
(v) capital improvements other than those specified in Paragraph 7.D(ix) above,
(vi) any costs reimbursed by insurance or any third-party, (vii) Landlord's
general corporate overhead and general administrative expenses and executive
salaries of personnel employed by Landlord (not including the management fee
referenced in Paragraph 7.D(vii) above) located outside of the Park, (viii)
costs, fees, and other expenses arising from the presence or removal of any
Hazardous Materials on the Property not brought to the Property by Tenant or
Tenant's agents, representatives, or invitees, and (ix) taxes on utilities to
the extent that Tenant has paid them directly, including through payment of a
flat tax covering governmental services. Tenant agrees to cooperate with
Landlord to obtain any exemption on such taxes that Landlord may be entitled to
by virtue of Tenant's payment of such flat tax.
E. OUTSIDE AREA EXPENSES. The term "Outside Area Expenses" shall mean
all expenses, costs and disbursements (except as provided below) of every kind
and nature which
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Landlord shall pay or become obligated to pay because of or in connection with
the ownership, management, maintenance, repair and operation of the Property and
the Outside Area including, but not limited to, the cost of any policies of
insurance covering the Outside Area, the Real Property Taxes for the Property,
CC&R assessments and dues and the cost of labor, materials, supplies and
services used or consumed in owning, managing, maintaining, repairing and
operating the Outside Area, including, without limitation, the following:
(i) Maintaining and repairing landscaping and sprinkler systems;
(ii) Maintaining and repairing concrete walkways, driveways and
paved parking areas;
(iii) Maintaining and repairing electrical systems and signs and
site lighting of the Outside Area;
(iv) Providing all utilities to the Outside Areas, and all
license, permit and inspection fees in connection therewith; and
(v) The rental cost and overhead of any office and storage space
in the Park used to provide such service.
Outside Area Expenses shall not include: (i) the cost of any additional or
extraordinary services provided to other tenants of the Property or the cost of
tenant improvements for other tenants in the Property; (ii) costs paid for
directly by Tenant or any other tenant; (iii) principal and interest payments on
loans secured by deeds of trust recorded against the Property; (iv) real estate
sales or leasing brokerage commissions and other marketing costs; (v) capital
improvements other than those specified in Paragraph 7.D(ix) above, (vi) any
costs reimbursed by insurance or any third-party, (vii) Landlord's general
corporate overhead and general administrative expenses and executive salaries of
personnel employed by Landlord (not including the management fee referenced in
Paragraph 7.D(vii) above) located outside of the Park, (viii) costs, fees, and
other expenses arising from the presence or removal of any Hazardous Materials
on the Property not brought to the Property by Tenant or Tenant's agents,
representatives, or invitees, and (ix) taxes on utilities to the extent that
Tenant has paid them directly, including through payment of a flat tax covering
governmental services. Tenant agrees to cooperate with Landlord to obtain any
exemption on such taxes that Landlord may be entitled to by virtue of Tenant's
payment of such flat tax.
F. ADJUSTMENT.
(i) Expense Base. The Basic Rent referred to in Paragraph 4.A
shall include Tenant's Building Percentage of the actual Building Operating
Expenses and Tenant's Property Percentage of the actual Outside Area Expenses
for the calendar year 1998 (the "Expense Base"). Landlord currently maintains
earthquake insurance and such insurance shall be included in the Expense Base.
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(ii) Monthly Payments. Commencing January 1, 1999, Tenant shall
pay to Landlord on the first day of each calendar month for the remainder of the
term an amount estimated by Landlord to be Tenant's Building Percentage of the
monthly Building Operating Expenses and Tenant's Property Percentage of the
actual Outside Area Expenses (collectively, the "Expenses") in excess of the
Expense Base. The Expenses shall be estimated in good faith by Landlord and
Tenant shall be notified of Landlord's estimate at least thirty (30) days prior
to the first day such payment is due, and thereafter at least thirty (30) days
prior to the beginning of each calendar year. Such estimate may be adjusted by
Landlord at the end of any calendar quarter on the basis of Landlord's
experience and reasonably anticipated costs. Any such adjustment shall be
effective as of the calendar month next succeeding receipt by Tenant of notice
of such adjustment to the estimated Expenses; provided that, if such calendar
month is earlier than 30 days from the date of such notice, the adjustment shall
be effective the second calendar month.
(iii) Accounting. If Tenant's Building Percentage of Building
Operating Expenses or Tenant's Property Percentage of the actual Outside Area
Expenses paid or incurred by Landlord for any calendar year exceeds the Expense
Base, Tenant shall pay such excess as Additional Rent. Within one hundred twenty
(120) days following the end of each calendar year, Landlord shall furnish
Tenant a reasonably detailed statement of Tenant's Building Percentage of the
actual Building Operating Expenses and Tenant's Property Percentage of the
actual Outside Area Expenses (the "Actual Expenses") for the calendar year and
the payments made by Tenant with respect to such period. If the statement
furnished by Landlord shows that the amount paid by Tenant as Expenses was less
than the Actual Expenses for each category, then Tenant shall pay to Landlord
the deficiency within twenty (20) days after delivery of such statement. If the
statement shows that the amount paid by Tenant as Expenses exceeded the Actual
Expenses, then Landlord shall either offset the excess against the amount next
thereafter to become due to Landlord, or shall refund the amount of the
overpayment to Tenant, in cash, within twenty (20) days after delivery to Tenant
of such statement, as Landlord shall elect. In the event of Tenant's overpayment
of Tenant's Percentage of Actual Expenses for the last calendar year of this
Lease, Landlord shall refund in cash the amount of the overpayment to Tenant,
within twenty (20) days of delivery of such statement to Tenant. All statements
provided by Landlord and all determinations of costs and charges that Tenant is
required to pay pursuant to this Lease shall be computed in accordance with
generally accepted accounting principles consistently applied.
(iv) Proration. Tenant's obligation to pay the Expenses shall be
prorated on the basis of a three hundred sixty-five (365) day year to account
for any fractional portion of a calendar year included at the commencement or
expiration of the term of this Lease or for any fractional portion of a calendar
year in which Tenant is not liable for payment of Expenses in excess of the
Expense Base.
(v) Audit. Tenant at its expense shall have the right at all
reasonable times and upon reasonable notice to Landlord to audit Landlord's
books and records relating to Tenant's obligations to pay Additional Rent for
any year of the term of this Lease, provided that Landlord shall not be
obligated to retain its books and records for any year for more than three (3)
years. If any statement of Additional Rent previously furnished Tenant reflects
greater than one hundred
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five percent (105%) of actual Additional Rent expenses shown by such audit,
Landlord shall pay the reasonable cost of such audit, up to five hundred dollars
($500).
(vi) Survival. Provided that Tenant is furnished a statement in
accordance with Paragraph 7.F(iii), Tenant's obligations to pay for any increase
above the Expenses paid pursuant to this Paragraph 7.A shall survive any
termination of this Lease. Landlord's obligations to refund any excess amounts
paid above the Actual Expenses pursuant to this Paragraph 7.A shall survive any
termination of this Lease.
8. REPAIR AND MAINTENANCE.
A. LANDLORD'S OBLIGATIONS.
(i) Building and Common Area. Landlord shall maintain the
Building and Common Area in good condition and repair, and shall make all
repairs and replacements, including those to the structure and the basic
plumbing, heating, ventilating air conditioning and electrical systems installed
or furnished by Landlord. There shall be no liability of Landlord by reason of
any injury to or interference with Tenant's business arising from the making of
any repairs, alterations or improvements in or to or maintenance of any portion
of the Building or the Common Area or in or to fixtures, appurtenances and
equipment therein. The cost of such repair and maintenance shall be included in
the Building Operating Expenses pursuant to Paragraph 7.
(ii) Outside Area. Landlord shall maintain the Outside Area in
good condition and repair. Landlord shall at all times have exclusive control of
the Outside Area subject to Tenant's rights under this Lease to use the Outside
Area. In exercising any such rights, Landlord shall make a reasonable effort to
minimize any disruption of Tenant's business. The cost of all such maintenance
and repair shall be included in the Outside Area Expenses pursuant to Paragraph
7.
B. TENANT'S OBLIGATIONS. Tenant shall keep and maintain the Premises,
including carpeting, in good and sanitary condition, normal wear and tear and
casualty excepted. Carpet areas of excessive wear shall be replaced at Tenant's
sole expense upon Lease termination. Tenant hereby waives all rights under and
benefits of Subsection I of Section 1932 and Sections 1941 and 1942 of the
California Civil Code and under any similar law, statute or ordinance now or
hereafter in effect.
9. ACCEPTANCE AND SURRENDER OF PREMISES. By entry hereunder, Tenant accepts the
Premises as being in good and sanitary order, condition and repair, and accepts
the Building and improvements included in the Premises in their present
condition and without representation or warranty by Landlord as to the condition
of such Building or as to the use or occupancy which may be made thereof,
subject to the punch fist items referred to in the Work Letter and the
conditions of this Lease. Any exceptions to the foregoing must be by written
agreement executed by Landlord and Tenant. Except as agreed to by Landlord in
writing, Tenant agrees on the last day of the Lease term, or on the sooner
termination of this Lease, to surrender the Premises promptly and peaceably to
Landlord in good condition and repair (damage by acts of
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God, fire, normal wear and tear excepted), with all interior walls painted, or
cleaned so that they appear freshly painted, and repaired and replaced if
damaged; all floors cleaned and waxed; all carpets cleaned and shampooed; the
air conditioning and heating equipment serviced by a reputable and licensed
service firm and in good operating condition (provided the maintenance of such
equipment has been Tenant's responsibility during the term of this Lease)
together with alterations, additions, and improvements which may have been made
in, to or on the Premises (except movable trade fixtures installed at the
expense of Tenant) except that with respect to any alterations made by Tenant
without Landlord's consent, as provided in Section 10, Tenant shall ascertain
from Landlord within thirty (30) days before the end of the term of this Lease
whether Landlord desires to have the Premises or any part thereof restored to
their condition and configuration as when the Premises were delivered to Tenant
and if Landlord shall so desire, then Tenant shall restore the Premises or such
portion thereof before the end of the term at Tenant's sole cost and expense.
Tenant, on or before the end of the term or sooner termination of this Lease
shall remove all of Tenant's personal property and trade fixtures from the
Premises, and all property not so removed on or before the end of the term or
sooner termination of this Lease, may be removed and stored by Landlord, at
Tenant's sole cost, and Landlord may repair any damage caused by such removal at
Tenant's sole cost. After thirty (30) days, Landlord may sell such personal
property and trade fixtures and apply any funds received first to Landlord's
costs for the removal, storage, and sale of such property, and then remit the
balance to Tenant. Tenant hereby waives any claim or right it may have against
Landlord with respect to such removal, storage or sale whether such claim is at
law or equity. If the Premises are not surrendered at the end of the term or
sooner termination of this Lease, Tenant shall indemnify Landlord against loss
or liability resulting from the delay by Tenant in so surrendering the Premises
including, without limitation, any claims made by any succeeding tenant founded
on such delay. Nothing contained herein shall be construed as an extension of
the term hereof or as a consent of Landlord to any holding over by Tenant. The
voluntary or other surrender of this Lease or the Premises by Tenant or a mutual
cancellation of this Lease shall not work as a merger and, at the option of
Landlord, shall either terminate all or any existing subleases or subtenancies
or operate as an assignment to Landlord of all or any such subleases or
subtenancies.
10. ALTERATIONS AND ADDITIONS. Tenant shall not make, or suffer to be made, any
alteration or addition to the Premises, or any part thereof without the prior
written consent of Landlord, which consent shall not be unreasonably withheld,
and which alteration or addition shall be at the cost of Tenant; provided that,
Tenant may make any alteration that does not exceed ten thousand dollars
($10,000) on a per occurrence basis and that does not affect the mechanical or
electrical systems in the building, by providing Landlord with reasonable prior
written notice of such alteration. Any addition to, or alteration of, the
Premises, except moveable furniture and trade fixtures, shall at once become
part of the Premises and belong to Landlord, unless otherwise agreed to prior to
the installation thereto. Landlord reserves the right to reasonably approve all
contractors and mechanics proposed by Tenant to make such alterations and
additions. Tenant shall retain title to all moveable furniture and trade
fixtures placed in the Premises. All heating, lighting, electrical, air
conditioning, partitioning, drapery, carpeting, and floor installations made by
Tenant, together with all property that has become an integral part of the
Premises, shall not be deemed trade fixtures, unless otherwise agreed to prior
to the installation thereto. Tenant agrees that it will not proceed to make any
alterations or additions without having obtained consent from
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Landlord to do so which consent shall include notice to Tenant of whether
Landlord will require the Premises to be restored at termination of this Lease,
and until five (5) days from receipt of such consent, in order that Landlord may
post appropriate notices to avoid any liability to contractors or material
suppliers for payment for Tenant's improvements. Tenant will at all times permit
such notices to be posted and to remain posted until the completion of work. For
any alterations requiring consent of the Landlord, Tenant shall, if required by
Landlord, secure at Tenant's own cost and expense, a completion and lien
indemnity bond, satisfactory to Landlord, for such work. Tenant further
covenants and agrees that any mechanic's lien filed against the Premises or
against the Property for work claimed to have been done for, or materials
claimed to have been furnished to Tenant, will be discharged by Tenant, by bond
or otherwise, within ten (10) days after the filing thereof, at the cost and
expense of Tenant. Any exceptions to the foregoing must be made in writing and
executed by both Landlord and Tenant.
11. UTILITIES AND SERVICES. Tenant shall be responsible for providing janitorial
and waste removal services to the Premises. Payment for these services shall be
remitted directly to the utility or service provider. Landlord shall pay for the
installation of any required separate meter. Tenant shall pay promptly, as the
same may become due, all charges for waste removal, janitorial services, water,
gas, electricity, telephone, and other electronic communications services
furnished directly or used by Tenant during the term of this Lease. Tenant shall
have the right to enter the building and use the HVAC system, lighting and any
and all other services to the Premises 24 hours per day, seven (7) days per
week. Landlord shall not be liable for and Tenant shall not be entitled to any
abatement or reduction of Rent by reason of any interruption or failure of
utility services to the Building when such interruption or failure, is caused by
fire, casualty, acts of God, strike, lockout, other labor troubles or inability
to secure materials, governmental law or regulation or other cause of whatever
kind beyond Landlord's reasonable control, and Tenant shall not be entitled to
any damages nor, shall any such failure relieve Tenant of the obligation to pay
Rent provided for herein, or constitute or be construed as a constructive or
other eviction of Tenant. In the event that such interruption or failure is the
direct result of Landlord's negligence or willful misconduct, and if any portion
of the Premises is rendered unusable by Tenant for forty-eight (48) hours or
longer, Tenant shall be entitled to an abatement of Rent in proportion to the
disturbance to the conduct of Tenant's business until the use of such portion of
the Premises is restored to Tenant.
12. TAXES.
A. REAL PROPERTY TAXES. Tenant shall pay to Landlord Tenant's
proportionate share of all Real Property Taxes, as provided for in Paragraph 7
hereof Tenant's proportionate share of Real Property Taxes shall be Tenant's
Building Percentage of the Real Property Taxes levied or assessed against the
Building plus Tenant's Complex Percentage of the Real Property Taxes levied or
assessed against Outside Area of the Complex. The term "Real Property Taxes", as
used herein, shall mean (i) all taxes, assessments, levies and other charges of
any kind or nature whatsoever, general and special, foreseen and unforeseen
(including all installments of principal and interest required to pay any
general or special assessment for public improvements and any increases
resulting from reassessments caused by any change in ownership of the Property)
now or hereafter imposed by any governmental or quasi-governmental authority or
special district
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having the direct or indirect power to tax or levy assessments, which are levied
or assessed against, or with respect to the value, occupancy or use of, all or
any portion of the Property (as now constructed or as may at any time hereafter
be constructed, altered, or otherwise changed) or Landlord's interest therein;
any improvements located within the Property (regardless of ownership); the
fixtures, equipment and other property of Landlord, real or personal, that are
an integral part of and located in the Property; or parking areas or public
utilities, within the Property, and (ii) all costs and fees including attorneys'
fees, incurred by Landlord in contesting any Real Property Tax and in
negotiating with public authorities as to any Real Property Tax. If at any time
during the term of this Lease the taxation or assessment of the Property
prevailing as of the Commencement Date of this Lease shall be altered so that in
lieu of or in addition to any Real Property Tax described above there shall be
levied, assessed or imposed (whether by reason of a change in the method of
taxation or assessment, creation of a new tax or charge, or any other cause) an
alternate or additional tax or charge (i) on the value, use or occupancy of the
Property or Landlord's interest therein or (ii) on or measured by the gross
receipts, income or rentals from the Property, on Landlord's business of leasing
the Property, or computed in any manner with respect to the operation of the
Property, then any such tax or charge, however designated, shall be included
within the meaning of the term "Real Property Taxes" for purposes of this Lease.
If any Real Property Tax is based upon property or rents unrelated to the
Property, then only that part of such Real Property Tax that is fairly allocated
to the Property shall be included within the meaning of the term "Real Property
Taxes." Notwithstanding the foregoing, the term "Real Property Taxes" shall not
include estate, inheritance, gift or franchise taxes of Landlord or the federal
or state net income tax imposed on Landlord's income from all sources.
B. TAXES ON TENANT'S PROPERTY.
(i) Tenant shall be liable for and shall pay before delinquency,
taxes levied against any personal property or trade fixtures placed by Tenant in
or about the Premises. If any such taxes on Tenant's personal property or trade
fixtures are levied against Landlord or Landlord's property or if the assessed
value of the Premises is increased by the inclusion therein of a value placed
upon such personal property or trade fixtures of Tenant and if Landlord, after
notice to Tenant, pays the taxes based on such increased assessment, which
Landlord shall have the right to do regardless of the validity thereof, but only
under proper protest if requested by Tenant, Tenant shall within twenty (20)
days of Landlord's written notice to Tenant, such notice to include reasonable
documentation of such taxes, as the case may be, repay to Landlord the taxes so
levied against Landlord, or the proportion of such taxes resulting from such
increase in the assessment; provided that in any such event Tenant shall have
the right, in the name of Landlord and with Landlord's full cooperation, to
bring suit in any court of competent jurisdiction to recover the amount of any
such taxes so paid under protest, and any amount so recovered shall belong to
Tenant.
(ii) If the Tenant Improvements in the Premises, whether
installed and/or paid for by Landlord or Tenant and whether or not affixed to
the real property so as to become part thereof, are assessed for real property
tax purposes at a valuation higher than the valuation at which standard office
improvements in other space in the Building are assessed, then the Real Property
Taxes levied against Landlord or the Property by reason of such excess assessed
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valuation shall be deemed to be taxes levied against personal property of Tenant
and shall be governed by the provisions of 13.B(i) above. If the records of the
County Assessor are available and sufficiently detailed to serve as a basis for
determining whether said Tenant Improvements are assessed at a higher valuation
than standard office improvements in other space in the Building, such records
shall be binding on both Landlord and Tenant. If the records of the County
Assessor are not available or sufficiently detailed to serve as a basis for
making such determination, the actual cost of construction shall be used.
13. LIABILITY INSURANCE.
A. Tenant INSURANCE REQUIREMENTS. Tenant, at Tenant's expense, agrees to
keep in force during the term of this Lease a policy of commercial general
liability insurance with limits in the amount of One Million Dollars
($1,000,000) per occurrence and Two Million Dollars ($2,000,000) annual
aggregate for injuries to or death of persons occurring in, on or about the
Premises or the Property, and property damage insurance with limits of Five
Hundred Thousand Dollars ($500,000). Tenant shall also procure umbrella excess
liability insurance, on an occurrence basis, with minimum limit of Five Million
Dollars ($5,000,000) on a per occurrence and annual aggregate basis. Duly
executed certificates evidencing such insurance, copies of which shall be
furnished to Landlord, shall name Landlord and Landlord's agents and
representatives as additional insureds, and shall insure any liability of
Landlord, contingent or otherwise, as respects the acts or omissions of Tenant,
its agents, employees or invitees or otherwise by any conduct or transactions of
any such persons in or about or concerning the Premises, including any failure
of Tenant to observe or perform any of its obligations hereunder; shall be
issued by an insurance company admitted to transact business in the State of
California; and shall provide that the insurance effected thereby shall not be
canceled, except upon thirty (30) days' prior notice to Landlord. If, during the
term of this Lease, in the reasonable opinion of Landlord's lender, insurance
advisor or counsel, the amount of insurance described in this Paragraph 13 is
not adequate, Tenant agrees to increase such coverage to such reasonable amount
as Landlord's tender, insurance advisor or counsel shall deem adequate.
B. TENANT INSURER REQUIREMENTS. All of Tenant's insurance shall be
carried with companies acceptable to Landlord that have a general policy
holder's rating of not less than "A" and a financial rating of not less than
Class "X" in the most current edition of Best's Insurance Reports; shall provide
that such policies shall not be subject to material alteration or cancellation
except after at least ten (10) days prior written notice to Landlord; and shall
be primary as to Landlord. The policy or policies, or duly executed certificates
for them, together with satisfactory evidence of payment of the premium thereon,
shall be deposited with Landlord prior to the commencement date of this Lease,
and upon renewal of such policies, not less than thirty (30) days prior to the
expiration of such policies. If Tenant fails to maintain the insurance required
hereunder, Landlord may, but shall not be required to, after three (3) business
days notice to Tenant, order such insurance at Tenant's expense and Tenant's
reimbursement to Landlord for such amounts shall be deemed Additional Rent. Such
reimbursement shall include all sums disbursed, incurred or deposited by
Landlord including Landlord's costs and expenses with interest thereon (at the
rate of ten percent (10%) per annum, but in no event to exceed the
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maximum rate allowed by law) and any reasonable attorneys' fees for collection
if reasonably necessary.
C. LANDLORD INSURANCE. Landlord shall procure and maintain commercial
general liability insurance. Such insurance shall be in addition to and not in
lieu of insurance maintained by Tenant pursuant to this Lease and shall be in an
amount not less than that required of Tenant. Landlord shall not name Tenant as
an additional insured on any insurance maintained by Landlord.
14. TENANT'S PERSONAL PROPERTY INSURANCE, WORKER'S COMPENSATION INSURANCE AND
BUSINESS INCOME INSURANCE. Tenant agrees to maintain, at its own expense, fire
and extended coverage, malicious mischief and vandalism insurance in causes of
loss - special form with a sprinkler leakage endorsement insuring Tenant's
personal property located at the Premises, including inventory and trade
fixtures, for the full replacement cost thereof. The proceeds from any of such
policies shall be used for the repair or replacement of such items so insured.
Tenant shall also maintain a policy or policies of worker's compensation
insurance and any other employee benefit insurance sufficient to comply with all
laws.
15. PROPERTY INSURANCE.
A. BUILDING. Landlord shall purchase and keep in force a policy or
policies of insurance covering loss or damage to the Building and the Property,
including the Tenant Improvements but excluding Tenant's personal property and
any alterations, additions or improvements made by Tenant at its expense, in the
amount of the full replacement cost thereof, providing protection against those
perils included within the classification of causes of loss - special form
property insurance. Landlord shall also purchase rental income insurance. If the
cost of the property insurance or rental income insurance is increased due to
Tenant's use of the Premises, Tenant agrees to pay to Landlord the full cost of
such increase. Tenant shall have no interest in nor any right to the proceeds of
any insurance procured by Landlord for the Building or the Property.
B. WAIVER OF SUBROGATION. Landlord and Tenant do each hereby
respectively release the other, to the extent of insurance coverage of the
releasing party, from any liability for loss or damage caused by fire or any of
the extended coverage casualties included in the releasing party's insurance
policies, irrespective of the cause of such fire or casualty; provided, however,
that if the insurance policy of either releasing party prohibits such waiver,
then this waiver shall not take effect until consent to such waiver is obtained.
If such waiver is so prohibited, the insured party affected shall promptly
notify the other party thereof.
16. INDEMNIFICATION. Landlord shall not be liable to Tenant and Tenant hereby
waives all claims against Landlord for any injury to or death of any person or
damage to or destruction of property in or about the Premises or the Property by
or from any cause whatsoever, including, without limitation, gas, fire, oil,
electricity or leakage of any character from the roof, walls, basement or other
portion of the Premises or the Property, but excluding, however, the negligence
or willful misconduct of Landlord, its agents, servants, employees, invitees,
or contractors of
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which negligence Landlord has knowledge and reasonable time to correct. Except
as to injury to persons or damage to property the principal cause of which is
the negligence or willful misconduct of Landlord, Tenant shall indemnify, defend
and hold Landlord harmless from and against any and all expenses, including
reasonable attorneys' fees, in connection therewith, arising out of any injury
to or death of any person or damage to or destruction of property occurring in,
on or about the Premises, or any part thereof, from any cause whatsoever.
Landlord shall indemnify, defend and hold Tenant harmless from and against any
and all expenses, including reasonable attorneys' fees, in connection therewith,
arising out of any injury to or death of any person or damage to or destruction
of property occurring in, on or about the Premises, or any part thereof,
resulting from the negligence or willful misconduct of Landlord.
17. COMPLIANCE. Tenant, at its sole cost and expense, shall promptly comply with
all laws, statutes, ordinances and governmental rules, regulations or
requirements now or hereafter in effect; with the requirements of any board of
fire underwriters or other similar body now or hereafter constituted; and with
any direction or occupancy certificate issued pursuant to law by any public
officer; provided, however, that no such failure shall be deemed a breach of
this provision if Tenant, immediately upon notification, commences to remedy or
rectify said failure. The judgment of any court of competent jurisdiction or the
admission of Tenant in any action against Tenant, whether Landlord be a party
thereto or not, that Tenant has violated any such law, statute, ordinance or
governmental rule, regulation, requirement, direction or provision, shall be
conclusive of that fact as between Landlord and Tenant. This paragraph shall not
be interpreted as requiring Tenant to make structural changes or improvements
except to the extent such structural changes or improvements are required as a
result of Tenant's use of the Premises. Tenant shall, at its sole cost and
expense, comply with any and all requirements pertaining to Tenant's use of the
Premises, of any insurance organization or company, necessary for the
maintenance of reasonable fire and public liability insurance covering the
Premises. Landlord represents and warrants that to the best of Landlord's
knowledge, the Building and the Property are in material compliance with all
applicable laws, statutes, ordinances, governmental rules and regulations,
including the Americans with Disabilities Act, in effect as of the date of this
Lease, and Tenant's use of the Premises as office space is permitted under
applicable laws and other encumbrances affecting the Property.
18. LIENS. Tenant shall keep the Premises and the Property free from any liens,
arising out of any work performed, materials furnished or obligation incurred by
Tenant. In the event that Tenant shall not, within ten (10) business days
following the imposition of such lien, cause the same to be released of record,
Landlord shall have, in addition to all other remedies provided herein and by
law, the right, but no obligation, to cause the same to be released by such
means as it shall deem proper, including payment of the claim giving rise to
such lien. AU sums paid by Landlord for such purpose, and all expenses incurred
by it in connection therewith, shall be payable to Landlord by Tenant within
twenty (20) days of Landlord's written notice to Tenant, with interest at the
prime rate of interest as quoted by the Bank of America.
19. ASSIGNMENT AND SUBLETTING. Tenant shall not assign, transfer, or hypothecate
the leasehold estate under this Lease, or any interest therein, and shall not
sublet the Premises, or any part thereof, or any right or privilege appurtenant
thereto, or suffer any other person or entity
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to occupy or use the Premises, or any portion thereof, without, in each case,
the prior written consent of Landlord which consent shall not be unreasonably
withheld; provided, however, that Landlord's consent shall not be required for
any assignment or sublease to a subsidiary or affiliate of Tenant or to any
entity resulting from the merger or consolidation of Tenant with another entity
so long as Tenant gives Landlord prior written notice of any such assignment or
sublease and, in the event of an assignment (i) the assignee has a net worth, at
the time of such assignment, that is equal to or greater than the net worth of
Tenant immediately prior to such assignment, and (ii) the assignee assumes, in
writing, for the benefit of Landlord all of Tenant's obligations under the
Lease. As a condition for granting its consent to any assignment, transfer, or
subletting, Landlord may require Tenant to pay to Landlord, as Additional Rent,
fifty percent (50%) all rents or additional consideration received by Tenant
from its assignees, transferees or subtenants in excess of the rent payable by
Tenant to Landlord hereunder. Additionally, in the event of any default
hereunder by Tenant, Landlord may require any subtenant or assignee to pay
directly to Landlord on a monthly basis the rent and any other sums due to
Tenant by such assignee or subtenant. Tenant shall, by sixty (60) days' prior
notice, advise Landlord of its intent to assign this Lease or to sublet the
Premises or any portion thereof for any part of the term hereof. Within fifteen
(15) business days after receipt of Tenant's notice, Landlord may, in its sole
discretion, elect to terminate this Lease as to the portion of the Premises
described in Tenant's notice on the date specified in Tenant's notice by giving
written notice of such election to terminate. If no such notice to terminate is
given to Tenant within such fifteen (15) business day period, Tenant may
proceed to locate an acceptable subtenant, assignee or other transferee for
presentment to Landlord for Landlord's approval, all in accordance with the
terms, covenants and conditions of this Paragraph 19. If Tenant intends to
sublet the entire Premises and Landlord elects to terminate this Lease, this
Lease shall be terminated on the date specified in Tenant's notice. If, however,
this Lease shall terminate pursuant to the foregoing with respect to less than
all the Premises, the Basic Rent shall be adjusted on a pro rata basis to the
area of the Premises retained by Tenant, and this Lease as so amended shall
continue in full force and effect. In the event Tenant is allowed to assign,
transfer or sublet the whole or any part of the Premises, with the prior written
consent of Landlord, no assignee, transferee or subtenant shall assign or
transfer this Lease, or either in whole or in part sublet the Premises, without
also having obtained the prior written consent of Landlord. A consent of
Landlord to one assignment, transfer, hypothecation, subletting, occupation or
use by any other person shall not release Tenant from any of Tenant's
obligations hereunder or be deemed to be a consent to subsequent similar or
dissimilar assignment, transfer, hypothecation, subletting, occupation or use by
any other person. Any such assignment, transfer, hypothecation, subletting,
occupation or use without such consent shall be void and shall constitute a
breach of this Lease by Tenant and shall, at the option of Landlord exercised by
written notice to Tenant, terminate this Lease. The leasehold estate under this
Lease shall not, nor shall any interest therein, be assignable for any purpose
by operation of law without the written consent of Landlord. As a condition to
its consent, Landlord may require Tenant to pay all expenses in connection with
the assignment, and Landlord may require Tenant's assignee or transferee (or
other assignees or transferees) to assume in writing all of the obligations
under this Lease.
20. SUBORDINATION, MORTGAGES AND QUIET ENJOYMENT. If Landlord's title or
leasehold interest is now or hereafter encumbered by a deed of trust, upon the
interest of
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Landlord in the Property, to secure a loan from a lender (hereinafter referred
to as "Lender") to Landlord, Tenant shall, at the request of Landlord or Lender,
execute in writing an agreement subordinating its rights under this Lease to the
lien of such deed of trust, or, if so requested, agree that the lien of Lender's
deed of trust shall be or remain subject and subordinate to the rights of Tenant
under this Lease, provided that such agreement provides that Tenant's tenancy
shall not be disturbed so long as Tenant is not in default under this Lease.
Notwithstanding any such subordination, Tenant's possession under this Lease
shall not be disturbed if Tenant is not in default and so long as Tenant shall
pay all Rent and observe and perform all of the provisions set forth in this
Lease. Landlord represents and warrants to Tenant that, as of the date of this
Lease, neither the Building nor any portion of the Property is encumbered by any
mortgages or deeds of trust.
Landlord represents and warrants that (a) it has full right and
authority to enter into this Lease, and (b) Tenant, subject to its obligation to
pay rent and to perform its other covenants and agreements under this Lease,
shall have sole and actual possession of the Premises, from the Commencement
Date and shall peaceably and quietly have, hold and enjoy the Premises free from
eviction or disturbance until expiration or earlier termination of this Lease.
21. ENTRY BY LANDLORD. Landlord reserves, and shall at all reasonable times have
the right to enter the Premises to inspect them; to perform any services
provided by Landlord hereunder; to submit the Premises to prospective
purchasers, mortgagors or tenants; to post notices of nonresponsibility; and to
alter, improve or repair the Premises and any portion of the Building, all
without abatement of Rent. Landlord may erect scaffolding and other necessary
structures in or through the Premises when reasonably required by the character
of the work to be performed; provided, however, that the business of Tenant
shall be interfered with to the least extent that is reasonably practical. For
each of the foregoing purposes, Landlord shall at all times have and retain a
key with which to unlock all of the doors in an emergency in order to obtain
entry to the Premises, and any entry to the Premises obtained by Landlord by any
of said means, or otherwise, shall not under any circumstances be construed or
deemed to be forcible or unlawful entry into or a detainer of the Premises or an
eviction, actual or constructive, of Tenant from the Premises or any portion
thereof.
22. BANKRUPTCY AND DEFAULT.
A. BANKRUPTCY. The commencement of a bankruptcy action or liquidation
action or reorganization action or insolvency action or an assignment of or by
Tenant for the benefit of creditors, or any similar action undertaken by Tenant,
or the insolvency of Tenant, shall, at Landlord 's option, constitute a breach
of this Lease by Tenant. If the trustee or receiver appointed to serve during a
bankruptcy, liquidation, reorganization, insolvency or similar action elects to
reject Tenant's unexpired Lease, the trustee or receiver shall notify Landlord
in writing of its election within thirty (30) days after an order for relief in
a liquidation action or within thirty (30) days after the commencement of any
action.
Within thirty (30) days after court approval of the assumption of this
Lease, the trustee or receiver shall cure (or provide adequate assurance to the
reasonable satisfaction of Landlord that
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the trustee or receiver shall cure) any and all previous defaults under the
unexpired Lease and shall compensate Landlord for all actual pecuniary loss and
shall provide adequate assurance of future performance under the Lease to the
reasonable satisfaction of Landlord. Adequate assurance of future performance,
as used herein, includes, but shall not be limited to: (i) assurance of source
and payment of Rent, and other consideration due under this Lease; (ii)
assurance that the assumption or assignment of this Lease will not breach
substantially any provision, such as radius, location, use, or exclusivity
provision, in any agreement relating to the Premises.
Nothing contained in this section shall affect the existing right of
Landlord to refuse to accept an assignment upon commencement of or in connection
with a bankruptcy, liquidation, reorganization or insolvency action or an
assignment of Tenant for the benefit of creditors or other similar act. Nothing
contained in this Lease shall be construed as giving or granting or creating an
equity in the demised Premises to Tenant. In no event shall the leasehold estate
under this Lease, or any interest therein, be assigned by voluntary or
involuntary bankruptcy proceeding without the prior written consent of Landlord.
In no event shall this Lease or any rights or privileges hereunder be an asset
of Tenant under any bankruptcy, insolvency or reorganization proceedings.
B. DEFAULT. The failure to perform or honor any covenant, condition or
representation made under this Lease shall constitute a default hereunder by
Tenant upon expiration of the appropriate grace period hereinafter provided.
Tenant shall have a period of five (5) business days from the date of written
notice from Landlord within which to cure any default in the payment of Rent.
Tenant shall have a period of ten (10) business days from the date of written
notice from Landlord within which to cure any other default under this Lease;
provided that, if Tenant such default cannot be cured within such ten business
day time period and Tenant is proceeding diligently to cure such default, such
cure period shall be extended to 30 days. Any notice given pursuant to this
Paragraph 22.B shall be in addition to any notice required under Section 1161 of
the California Code of Civil Procedure regarding unlawful detainer actions. Upon
an uncured default of this Lease by Tenant, Landlord shall have the following
rights and remedies in addition to any other rights or remedies available to
Landlord at law or in equity:
(i) The rights and remedies provided for by California Civil Code
Section 1951.2, including but not limited to, recovery of the worth at the time
of award of the amount by which the unpaid rent for the balance of the term
after the time of award exceeds the amount of rental loss for the same period
that Tenant proves could be reasonably avoided, as computed pursuant to
subsection (b) of said Section 1951.2. Any proof by Tenant under subparagraph
(2) and (3) of Section 1951.2 of the California Civil Code of the amount of
rental loss that could be reasonably avoided shall be made in the following
manner: Landlord and Tenant shall each select a licensed real estate broker in
the business of renting property of the same type and use as the Premises and in
the same geographic vicinity. Such two real estate brokers shall select a third
licensed real estate broker, and the three licensed real estate brokers so
selected shall determine the amount of the rental loss that could be reasonably
avoided from the balance of the term of this Lease after the time of award. The
decision of the majority of said licensed real estate brokers shall be final and
binding upon the parties hereto.
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(ii) The rights and remedies provided by California Civil Code
Section 1951.4 which allows Landlord to continue the Lease in effect and to
enforce all of its rights and remedies under this Lease, including the right to
recover rent as it becomes due, for so long as Landlord does not terminate
Tenant's right to possession; acts of maintenance or preservation, efforts to
relet the Premises, or the appointment of a receiver upon Landlord's initiative
to protect its interest under this Lease shall not constitute a termination of
Tenant's right to possession.
(iii) The right to terminate this Lease by giving notice to
Tenant in accordance with applicable law.
(iv) The right and power, as attorney-in-fact for Tenant, to
enter the Premises and remove therefrom all persons and property, to store such
property in a public warehouse or elsewhere at the cost of and for the account
of Tenant, and to sell such property and apply such proceeds therefrom pursuant
to applicable California law. Landlord, as attorney-in-fact for Tenant, may from
time to time sublet the Premises or any part thereof for such term or terms
(which may extend beyond the term of this Lease) and at such rent and such other
terms as Landlord in its sole discretion may deem advisable, with the right to
make alterations and repairs to the Premises. Upon each subletting, (a) Tenant
shall be immediately liable to pay Landlord, in addition to indebtedness other
than rent due hereunder, the cost of such subletting, including, but not limited
to, reasonable attorneys' fees, and any real estate commissions actually paid,
and the cost of such alterations and repairs incurred by Landlord and the
amount, if any, by which the rent hereunder for the period of such subletting
(to the extent such period does not exceed the term hereof) exceeds the amount
to be paid as rent for the Premises for such period, or (b) at the option of
Landlord, rents received from such subletting shall be applied first to payment
of indebtedness other than rent due hereunder from Tenant to Landlord; second,
to the payment of any costs of such subletting and of such alterations and
repairs; third, to payment of rent due and unpaid hereunder; and the residue, if
any, shall be held by Landlord and applied in payment of future rent as the same
becomes due hereunder. If Tenant has been credited with any rent to be received
by such subletting under option (a) and such rent shall not be promptly paid to
Landlord by the subtenant(s), or if such rentals received from such subletting
under option (b) during any month be less than that to be paid during that month
by Tenant hereunder, Tenant shall pay any such deficiency to Landlord. Such
deficiency shall be calculated and paid monthly. For all purposes set forth in
this Paragraph 22.B(iv), Landlord is hereby irrevocably appointed
attorney-in-fact for Tenant, with power of substitution. No taking possession of
the Premises by Landlord, as attorney-in-fact for Tenant, shall be construed as
an election on its part to terminate this Lease unless a notice of such
intention be given to Tenant. Notwithstanding any such subletting without
termination, Landlord may at any time hereafter elect to terminate this Lease
for such previous breach.
23. ABANDONMENT. Except if Tenant continues to pay Rent and is not in default
under this Lease and cooperates with Landlord to maintain the Premises in such a
manner that the Premises appear occupied, Tenant shall not vacate or abandon the
Premises, at any time during the term of this Lease; and if Tenant shall
abandon, vacate or surrender the Premises, or be dispossessed by the process of
law, or otherwise, any personal property belonging to Tenant and
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left on the Premises shall be deemed to be abandoned, at the option of Landlord,
except such property as may be mortgaged to Landlord.
24. DESTRUCTION. In the event the Premises are destroyed in whole or in part
from any cause, except for routine maintenance and repairs and incidental damage
and destruction caused from vandalism and accidents for which Tenant is
responsible under Paragraph 10, Landlord may, at its option:
(a) Rebuild or restore the Premises to their condition prior to the
damage or destruction; or
(b) Terminate this Lease.
Landlord shall give Tenant notice in writing within thirty (30) days from the
destruction of the Premises of its election to either rebuild and restore the
Premises, or to terminate this Lease. Such notice shall provide an estimate of
the time required to complete the required repairs. If such estimate is for a
period greater than one hundred eighty (180) days, Tenant may elect to terminate
this Lease by giving written notice within ten (10) business days to Landlord.
If Landlord elects to rebuild or restore the Premises and Tenant has not elected
to terminate as provided herein, Landlord agrees, at its expense, promptly to
rebuild or restore the Premises in a timely manner to their condition prior to
the damage or destruction. Tenant shall be entitled to a reduction in Rent while
such repair is being made in the proportion that the area of the Premises
rendered untenantable by such damage bears to the total area of the Premises. If
Landlord does not complete the rebuilding or restoration within one hundred
eighty (180) days following the date of destruction (such period to be extended
for delays caused by the fault or neglect of Tenant or because of acts of God,
acts of public agencies, labor disputes, strikes, fires, freight embargoes,
rainy or stormy weather, inability to obtain materials, supplies or fuels, acts
of contractors or subcontractors, or delay of the contractors or subcontractors
due to such causes or other contingencies beyond the control of Landlord), then
Tenant shall have the right to terminate this Lease by written notice to
Landlord within ten (10) days after the expiration of such one hundred eighty
(180) day period. Notwithstanding anything herein to the contrary, Landlord's
obligation to rebuild or restore shall be limited to the Building and interior
improvements constructed by Landlord as they existed as of the Commencement Date
and shall not include restoration of Tenant's trade fixtures, equipment,
merchandise, or any improvements, alterations or additions made by Tenant to the
Premises, which Tenant shall replace or fully repair at Tenant's sole cost and
expense provided this Lease is not terminated according to the provisions above.
Unless this Lease is terminated pursuant to the foregoing provisions, this
Lease shall remain in full force and effect. Tenant hereby expressly waives the
provisions of Section 1932, Subdivision 2 of Section 1933, Subdivision 4 of the
California Civil Code.
If the Building is damaged or destroyed to the extent of not less than
thirty-three percent (33%) of the replacement cost thereof, Landlord may elect
to terminate this Lease, whether the Premises be injured or not. If the
destruction of the Premises is caused by Tenant, Tenant shall pay the deductible
portion of Landlord's insurance proceeds.
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Notwithstanding anything contained herein, in the event of minor damage, such
damage to be damage less than 10% of the full insurable value of the Building
the repair of which shall be estimated at less than 180 days, and provided that
such damage is not caused by Tenant, Landlord shall be obligated to make repairs
and shall proceed in a timely manner to make such repairs.
25. EMINENT DOMAIN. If all or any part of the Premises is taken by any public or
quasi-public authority under the power of eminent domain or conveyance in lieu
thereof, this Lease shall terminate as to any portion of the Premises so taken
or conveyed on the date title vests in the condemnor. Landlord shall be entitled
to any and all payment, income, rent, award, or any interest therein whatsoever
which may be paid or made in connection with such taking or conveyance, and
Tenant shall have no claim against Landlord or otherwise for the value of any
unexpired term of this Lease. Notwithstanding the foregoing, any compensation
specifically awarded to Tenant for loss of business, Tenant's personal property,
moving cost or loss of goodwill, shall be and remain the property of Tenant.
Tenant shall have the right to appear, claim, prove and receive any award by the
condemning authority for loss of business, Tenant's personal property, or moving
cost or loss of goodwill, provided that such award does not result in a
reduction of the award to Landlord and does not interfere with Landlord's
proceedings in connection with such taking or conveyance.
If (i) any action or proceeding is commenced for such taking of the Premises or
any part thereof, or (ii) any of the foregoing events occur with respect to the
taking of any space in the Building not leased hereby, or if any such spaces so
taken or conveyed in lieu of such taking and Landlord shall decide to
discontinue the use and operation of the Building, or decide to demolish, alter
or rebuild the Building, then, in any of such events Landlord shall have the
right to terminate this Lease by giving Tenant written notice thereof within
sixty (60) days of the date of receipt of such written advice, or commencement
of such action or proceeding, or taking conveyance, which termination shall take
place as of the first to occur of the last day of the calendar month next
following the month in which such notice is given or the date on which title to
the Premises shall vest in the condemnor.
In the event of such a partial taking or conveyance of the Premises, if the
portion of the Premises so taken or conveyed is so substantial that Tenant can
no longer reasonably conduct its business, Tenant shall have the privilege of
terminating this Lease within sixty (60) days from the date of such taking or
conveyance, upon written notice to Landlord of its intention to do so, and upon
giving of such notice this Lease shall terminate on the last day of the calendar
month next following the month in which such notice is given, upon payment by
Tenant of the Rent from the date of such taking or conveyance to the date of
termination.
If a portion of the Premises is taken by condemnation or conveyance in lieu
thereof and neither Landlord nor Tenant shall terminate this Lease as provided
herein, this Lease shall continue in full force and effect as to the part of the
Premises not taken or conveyed, and the Rent shall be apportioned as of the date
of such taking or conveyance so that thereafter the Rent to be paid by Tenant
shall be in the ratio that the area of the Premises not taken or conveyed bears
to the total area of the Premises prior to such taking or conveyance.
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26. SALE OR CONVEYANCE BY LANDLORD. In the event of a sale or conveyance of the
Property or any interest therein, by any owner of the reversion then
constituting Landlord, the transferor shall thereby be released from any further
liability upon any of the terms, covenants or conditions (express or implied)
herein contained in favor of Tenant, and in such event, insofar as such transfer
is concerned. Tenant agrees to look solely to the successor in interest of such
transferor in and to the Property and this Lease. This Lease shall not be
affected by any such sale or conveyance, and Tenant agrees to attorn to the
successor in interest of such transferor.
27. ATTORNMENT TO LENDER OR THIRD PARTY. In the event the interest of Landlord
in the Property (whether such interest of Landlord is a fee title interest or a
leasehold interest) is encumbered by deed of trust, and such interest is
acquired by the lender or any third party through judicial foreclosure or by
exercise of a power of sale at private trustee's foreclosure sale, Tenant hereby
agrees to attorn to the purchaser at any such foreclosure sale and to recognize
such purchaser as the Landlord under this Lease. In the event the lien of the
deed of trust securing the loan from a lender to Landlord is prior and paramount
to the Lease, this Lease shall nonetheless continue in full force and effect for
the remainder of the unexpired term hereof, at the same rental herein reserved
and upon all the other terms, conditions and covenants herein contained.
28. HOLDING OVER. Any holding over by Tenant after expiration or other
termination of the term of this Lease with the written consent of Landlord
delivered to Tenant shall not constitute a renewal or extension of the Lease or
give Tenant any rights in or to the leased Premises except as expressly provided
in this Lease. Any holding over after the expiration or other termination of the
term of this Lease, with the consent of Landlord, shall be construed to be a
tenancy from month to month, on the same terms and conditions herein specified
insofar as applicable except that the monthly Basic Rent shall be increased to
an amount equal to one hundred fifty percent (150%) of the monthly Basic Rent
required during the last month of the Lease term.
29. CERTIFICATE OF ESTOPPEL. Tenant shall at any time upon not less than ten
(10) days prior notice from Landlord execute, acknowledge and deliver to
Landlord a statement in writing in such form as requested by Landlord, or
Landlord's lender (i) certifying that this Lease is unmodified and in full force
and effect (or, if modified, stating the nature of such modification and
certifying that this Lease, as so modified, is in full force and effect) and
the date to which the Rent and other charges are paid in advance, if any, and
(ii) acknowledging that there are not, to Tenant's knowledge, any uncured
defaults on the party of Landlord hereunder, or specifying such defaults, if any
are claimed. Any such statement may be conclusively relied upon by any
prospective purchaser or encumbrancer of the Premises. Tenant's failure to
deliver such statement within such time shall be conclusive upon Tenant that
this Lease is in full force and effect, without modification except as may be
represented by Landlord; that there are no uncured defaults in Landlord's
performance, and that not more than one month's Rent has been paid in advance.
30. CONSTRUCTION CHANGES. It is understood that the description of the Premises
and the location of the ductwork, plumbing and other facilities therein are
subject to such minor
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changes as Landlord or Landlord's architect determines to be desirable in the
course of construction of the Premises, and no such changes, or any changes in
plans for any other portions of the Property shall affect this Lease or entitle
Tenant to any reduction of rent hereunder or result in any liability of Landlord
to Tenant. Landlord does not guaranty the accuracy of any drawings supplied to
Tenant and verification of the accuracy of such drawings rests with Tenant.
31. RIGHT OF LANDLORD TO PERFORM. All terms, covenants and conditions of this
Lease to be performed or observed by Tenant shall be performed or observed by
Tenant at Tenant's sole cost and expense and without any reduction of Rent. If
Tenant shall fail to pay any sum of money, or other rent, required to be paid by
Tenant hereunder or shall fail to perform any other term or covenant hereunder
on its part to be performed, and such failure shall continue for five (5) days
after written notice from Landlord, Landlord, without waiving or releasing
Tenant from any obligation of Tenant hereunder, may, but shall not be obligated
to, make any such payment or perform any such other term or covenant on Tenant's
part to be performed. All sums so paid by Landlord and all necessary costs of
such performance by Landlord together with interest thereon at the rate of the
prime rate of interest per annum as quoted by the Bank of America from the date
of such payment or performance by Landlord, shall be paid (and Tenant covenants
to make such payment) to Landlord on demand by Landlord, and Landlord shall have
(in addition to any other right or remedy of Landlord) all the rights and
remedies in the event of nonpayment by Tenant as in the case of failure by
Tenant in the payment of rent hereunder.
32. ATTORNEYS' FEES. In the event of any legal action or proceeding to enforce
or interpret any provision of this Lease or to protect or establish any right or
remedy of any party, the unsuccessful party to such action or proceeding,
whether settled or prosecuted to final judgment, shall pay to the prevailing
party as finally determined, all costs and expenses, including attorneys' fees
and costs (including attorneys' fees on appeal, and costs and expenses incurred
in out-of-court negotiations, workouts and/or settlements or in seeking relief
from stay or otherwise seeking to protect its rights in any bankruptcy
proceeding) incurred by such prevailing party in such action or proceeding, in
enforcing such judgment, and in connection with any appeal from such judgment.
Attorneys' fees and costs incurred in enforcing any judgment or in connection
with any appeal shall be recoverable separately from and in addition to any
other amount included in such judgment. This Paragraph 32 is intended to be
severable from the other provisions of this Lease, and the prevailing party's
rights under this Paragraph 32 shall not merge into any judgment and any
judgment shall survive until all such fees and costs have been paid.
33. WAIVER. The waiver by either party of the other party's failure to perform
or observe any term, covenant or condition herein contained to be performed or
observed by such waiving party shall not be deemed to be a waiver of such term,
covenant or condition or of any subsequent failure of the party failing to
perform or observe the same or any other such term, covenant or condition
therein contained, and no custom or practice which may develop between the
parties hereto during the term hereof shall be deemed a waiver of, or in any way
affect, the right of either party to insist upon performance and observance by
the other party in strict accordance with the terms hereof.
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34. NOTICES. All notices, demands, requests, advices or designations which may
be or are required to be given by either party to the other hereunder shall be
in writing. All notices demands, requests, advices or designations by Landlord
to Tenant shall be sufficiently given, made or delivered if personally served on
Tenant by leaving the same at the Premises, or if sent by United States
certified or registered mail, postage prepaid, addressed to Tenant at the
Premises, with a copy to Superior National Insurance, 26601 Agoura Road,
Calabasas, California 91302, Attn: General Counsel. All notices, demands,
requests, advices or designations by Tenant to Landlord shall be sent by United
States certified or registered mail, postage prepaid, or any other nationally
recognized reputable delivery service, addressed to Landlord c/o R & B
Commercial Real Estate Services, Inc., 4637 Chabot Drive, Suite 100, Pleasanton,
CA 94588. Each notice, request, demand, advice or designation referred to in
this paragraph shall be deemed received on the date of the personal service or
mailing thereof if mailed in the manner herein provided, as the case may be.
35. EXAMINATION OF LEASE. Submission of this instrument for examination or
signature by Tenant does not constitute a reservation of or option for a lease,
and this instrument is not effective as a lease or otherwise until its execution
and delivery by both Landlord and Tenant.
36. DEFAULT BY LANDLORD. Landlord shall not be in default unless Landlord fails
to perform obligations required of Landlord within a reasonable time, but in no
event earlier than thirty (30) days after written notice by Tenant to Landlord
and the holder of any first mortgage or deed of trust covering the Premises
whose name and address shall have heretofore been furnished to Tenant in
writing, specifying wherein Landlord has failed to perform such obligations;
provided, however, that if the nature of Landlord's obligations is such that
more than thirty (30) days are required for performance, then Landlord shall not
be in default if Landlord commences performing within such thirty (30) day
period and thereafter diligently prosecutes the same to completion.
In the event that Landlord defaults as provided hereunder, if Landlord shall not
in good faith have commenced the curing or remedying of such default within such
thirty (30) day period, and shall not thereafter proceed to completion with due
diligence, Tenant shall have the right to make such repairs ten (10) business
days after providing prior written notice to Landlord of its intent to do so and
shall send Landlord an invoice for the cost of such repairs with reasonable
supporting documentation. Landlord shall either pay such invoice within thirty
(30) days of receipt or provide written notice to Tenant of its objection to
such costs. If Landlord objects to such costs, the issue shall be determined by
arbitration pursuant to the requirements of Paragraph 44.C. If Landlord does not
provide notice to Tenant of its objections to such invoice, Landlord shall be
deemed to have accepted such invoice and Tenant may apply the invoice to sums
due after 20 days written notice to Landlord of its intent to do so.
37. CORPORATE AUTHORITY. If Tenant is a corporation (or a partnership), Tenant
represents that each individual executing this Lease on behalf of said
corporation (or partnership) is duly authorized to execute and deliver this
Lease on behalf of said corporation (or partnership) in accordance with the
by-laws of such corporation (or partnership in accordance with the
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partnership agreement) and that this Lease is binding upon said corporation (or
partnership) in accordance with its terms. Tenant shall, within thirty (30) days
after execution of this Lease, deliver to Landlord either a certified copy of
the resolution of the Board of Directors of said corporation authorizing or
ratifying the execution of this Lease or a certificate of its corporate
secretary regarding the incumbency and authority of the individual executing
this Lease on behalf of Tenant.
38. LIMITATION OF LIABILITY. In consideration of the benefits accruing
hereunder, Tenant and all successors and assigns covenant and agree that, in the
event of any actual or alleged failure, breach or default hereunder by Landlord:
(i) the sole and exclusive remedy shall be against Landlord and
Landlord's assets;
(ii) no partner, shareholder, director, or officer of Landlord
shall be sued or named as a party in any suit or action (except as may be
necessary to secure jurisdiction of Landlord);
(iii) no service of process shall be made against any partner,
shareholder, director, or officer of Landlord (except as may be necessary to
secure jurisdiction of Landlord);
(iv) no partner, shareholder, director, or officer of Landlord
shall be required to answer or otherwise plead to any service of process;
(v) no judgment will be taken against any partner, director, or
officer of Landlord; (vi) any judgment taken against any partner, shareholder,
director, or officer of Landlord may be vacated and set aside at any time
without hearing;
(vii) no writ of execution will ever be levied against the assets
of any partner, director, or officer of Landlord;
(viii) these covenants and agreements are enforceable both by
Landlord and also by any partner, shareholder, director, or officer of Landlord.
Tenant agrees that each of the foregoing covenants and agreements shall be
applicable to any covenant or agreement either expressly contained in this Lease
or imposed by statute or at common law.
39. BROKERS. Tenant warrants that Corporate Realty Associates, Inc. is the only
real estate broker or agent with whom it dealt in connection with the
negotiation of this Lease and that Tenant knows of no other real estate broker
or agent who is entitled to a commission in connection with this Lease. Landlord
warrants that Colliers Parrish is the only real estate broker or agent with whom
it dealt in connection with the negotiation of this Lease and that Landlord
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knows of no other real estate broker or agent who is entitled to a commission in
connection with this Lease.
40. SIGNS. No sign, placard, picture, advertisement, name or notice shall be
inscribed, displayed or printed or affixed on or to any part of the outside of
the Premises or to any exterior windows of the Premises without the written
consent of Landlord first had and obtained and Landlord shall have the right to
remove any such sign, placard, picture, advertisement, name or notice without
notice to and at the expense of Tenant. If Tenant is allowed to print or affix
or in any way place a sign in, on, or about the Premises, upon expiration or
other sooner termination of this Lease, Tenant at Tenant's sole cost and
expense, shall both remove such sign and repair all damage in such manner as to
restore all aspects of the appearance of the Premises to the condition prior to
the placement of said sign. All approved signs or lettering on outside doors
shall be printed, painted, affixed or inscribed at the expense of Tenant by a
person approved of by Landlord. Tenant shall not place anything or allow
anything to be placed near the glass of any window, door, partition or wall
which may appear unsightly from outside the Premises.
Subject to the conditions of this Section 40, including Landlord's prior
written consent of the sign design, which shall not be unreasonably withheld,
Tenant shall be permitted to assume the monument sign on West Las Positas at
Tenant's sole cost and expense. Any signage shall be in compliance with all
applicable laws and regulations and Tenant shall maintain such signage in good
repair and condition.
41. ASSESSMENTS.
A. ASSESSMENT DISTRICTS. Tenant acknowledges that the Property is
subject to assessment districts, including, but not limited to, improvement
districts, maintenance districts, public utility districts, special utility
districts, special service zones or districts or any combination thereof
(collectively "Assessment Districts"), for the construction, alteration,
expansion, improvements, completion, repair, operation or maintenance, as the
case may be, of on-site or offsite improvements, or services, or any combination
thereof, as required by the City of Pleasanton as a condition of approving the
development of Hacienda Business Park, of which the Property is a part. These
Assessment Districts may provide, among other things, the following improvements
or services: streets, curbs, interchanges, highways, traffic noise studies and
mitigation measures, traffic control systems and expansion of city facilities to
operate same, landscaping and lighting maintenance services, maintenance of
flood control facilities, water storage and distribution facilities, and fire
apparatus, manpower and other fire safety facilities.
B. CONSENT TO FORMATION. Tenant hereby consents to the formation of any
and all of the Assessment Districts and waives any and all rights of notice and
any and all rights of protest in connection with formation of the Assessment
Districts and agrees to execute all documents, including, but not limited to,
formal waivers of notice and protest evidencing such consent and waiver upon
request of Landlord or the City of Pleasanton.
42. MORTGAGEE PROTECTION CLAUSE. Tenant agrees to give any mortgagees and/or
trust deed holders ("Holders"), by registered mail, a copy of any notice of
default served upon the Landlord, provided that prior to such notice Tenant has
been notified, in writing (by way
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of notice of assignment of rents and leases, or otherwise) of the address of
such Holders. Tenant further agrees that if Landlord shall have failed to cure
such default within the time provided for in this Lease, then the Holders shall
have an additional sixty (60) days within which to cure such default or if such
default cannot be cured within that time, then such additional time as may be
necessary if within such sixty (60) days, any Holder has commenced and is
diligently pursuing the remedies necessary to cure such default (including but
not limited to commencement of foreclosure proceedings, if necessary to effect
such cure) in which event this Lease shall not be terminated while such remedies
are being so diligently pursued.
43. HAZARDOUS MATERIALS.
A. "Hazardous Materials" shall mean any substance or material which has
been determined by any state, federal or local governmental authority to be
capable of posing a risk of injury to health, safety or property, including all
of those materials and substances designated as hazardous or toxic by any
municipal, county, state or federal rule, law, or regulation. Without limiting
the generality of the foregoing, the term "Hazardous Materials" shall include
asbestos or asbestos containing material, polychlorinated biphenyls in
concentrations greater than 50 parts per million, hazardous waste identified in
accordance with Section 3001 of the Federal Resource Conservation and Recovery
Act of 1976, as amended, substances defined as "hazardous substances" or "toxic
substances" in the Comprehensive Environmental Response, Compensation and
Liability Act of 1980, as amended, 42 U.S.C. Sec. 9061; et seq.; Hazardous
Materials Transportation Act, 49 U.S.C. Sec. 1802; and Resource Conservation and
Recovery Act, 42 U. S.C. Sec. 6901 et seq., and all of those materials and
substances defined as "hazardous waste" in California Health and Safety Code
Section 25117 and Section 66160 of Title 26 of the California Code of
Regulations, Division 22, as the same shall be amended from time to time, or any
other materials requiring remediation under federal, state or local statutes,
ordinances, regulations or policies.
B. Tenant shall not introduce any Hazardous Materials in, on or adjacent
to the Premises or the Property without complying with all applicable federal,
state and local laws, rules, regulations, and policies relating to the storage,
use, release, disposal, and clean-up of Hazardous Materials, including, but not
limited to, the obtaining of proper permits. Tenant shall immediately notify
Landlord of any inquiry, test, investigation, or enforcement proceeding by or
against Tenant or the Premises concerning any Hazardous Materials. If Tenant's
storage, use, release or disposal of any Hazardous Materials in, on or adjacent
to the Premises or the Property results in any contamination of the Premises,
the Property, or the soil or surface or groundwater in or about the Property,
Tenant shall remove the contamination at its expense. Tenant further agrees to
indemnify, defend and hold Landlord harmless from and against any claims, suits,
causes of action, costs, fees, judgments and liabilities, including attorneys'
fees and costs, arising out of or in connection with any clean-up work, inquiry
or enforcement proceeding in connection therewith, and any Hazardous Materials
used, stored or disposed of by Tenant or its agents, employees, contractors or
invitees. Tenant's obligations under this Paragraph 43 shall survive termination
of this Lease. Tenant shall also pay to Landlord upon demand, the cost of any
inspections ordered by Landlord should the results of those inspections indicate
that Tenant caused or permitted any of the contamination found in the Premises
or the Property. Landlord agrees to indemnify, defend
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and hold Tenant harmless from and against any claims, suits, causes of action,
costs, fees, judgments and liabilities, including attorneys' fees and costs,
arising out of or in connection with any clean-up work, inquiry or enforcement
proceeding in connection and any Hazardous Materials used, stored or disposed of
by Landlord or its agents and employees in violation of laws governing Hazardous
Materials. Landlord's obligations under this Paragraph 43 shall survive
termination of this Lease.
C. Landlord warrants and represents that, to the best of its knowledge,
there are no Hazardous Materials located on the Premises, and Landlord agrees to
indemnify, defend and hold Tenant harmless from and against any claims, suits,
causes of action, costs, fees, judgments and liabilities, including attorneys'
fees and costs, arising out of or in connection with breach of this warranty.
44. MISCELLANEOUS AND GENERAL PROVISIONS.
(a) Tenant shall not, without the written consent of Landlord, use the
name of the Building, Property, or Park for any purpose other than as the
address of the business conducted by Tenant in the Premises.
(b) This Lease shall in all respects be governed by and construed in
accordance with the laws of the State of California. If any provision of this
Lease shall be invalid or unenforceable or ineffective for any reason
whatsoever, all other provisions hereof shall be and remain in full force and
effect.
(c) The term "Premises" includes the space leased hereby and any
improvements now or hereafter installed therein or attached thereto. The term
"Landlord" or any pronoun used in place thereof includes the plural as well as
the singular and the successors and assigns of Landlord. The term "Tenant" or
any pronoun used in place thereof includes the plural as well as the singular
and individuals, firms, associations, partnerships, and corporations, and their
and each of their respective heirs, executors, administrators, successors and
permitted assigns, according to the context hereof, and the provisions of this
Lease, shall inure to the benefit of and bind such heirs, executors,
administrators, successors and permitted assigns. The term "person" includes the
plural as well as the singular and individuals, firms, associations,
partnerships and corporations. Words used in any gender include other genders.
If there be more than one Tenant the obligations of Tenant hereunder are joint
and several. The paragraph headings of this Lease are for convenience or
reference only and shall have no effect upon the construction or interpretation
of any provision hereof.
(d) Time is of the essence of this Lease and of each and all of its
provisions.
(e) At the expiration or earlier termination of this Lease, Tenant shall
execute, acknowledge and deliver to Landlord, within ten (10) days after written
demand by Landlord to Tenant, any quitclaim deed or other document required by
any reputable title company, licensed to operate in the State of California, to
remove the cloud or encumbrance created by this Lease from the real property of
which Tenant's Premises are a part.
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(f) This instrument along with any exhibits and attachments hereto
constitute the entire agreement between Landlord and Tenant relative to the
Premises and this agreement and the exhibits and attachments may be altered,
amended or revoked only by an instrument in writing signed by both Landlord and
Tenant. Landlord and Tenant agree hereby that all prior or contemporaneous oral
agreements between and among themselves and their agents or representatives
relative to the leasing of the Premises are merged in or revoked by this
agreement.
(g) Neither Landlord nor Tenant shall record this Lease or a short form
memorandum hereof without the consent of the other.
(h) Tenant further agrees to execute any amendments required by a tender
to enable Landlord to obtain financing, so long as Tenant's rights hereunder are
not substantially affected.
(i) Except as provided herein, Landlord and Tenant agree that each has
had an opportunity to determine to its satisfaction the actual area of the
Premises and the Building. All measurements of area contained in this Lease are
conclusively agreed to be correct and binding on the parties, even if a
subsequent measurement of one of these areas determines that it is more or less
than the area reflected in this Lease. Any such subsequent determination that
the area is more or less than the area shown in this Lease shall not result in a
change in any of the computations of rent, Tenant's Building Percentage and
Tenant's Property Percentage, improvement allowances, or any other matters
described in this Lease where area is a factor.
(j) Clauses, plats and riders, if any, signed by Landlord and Tenant and
endorsed on or affixed to this Lease are a part hereof.
(k) Tenant covenants and agrees that no diminution or shutting off of
light, air or view by any structure which may be hereafter erected (whether or
not by Landlord) shall in any way affect this Lease, entitle Tenant to any
reduction of rent hereunder or result in any liability of Landlord to Tenant.
45. LEASE OPTION TO EXTEND.
A. OPTION PERIOD. Provided that Tenant is not in default hereunder,
either at the time of exercise or at the time the extended term commences,
Tenant shall have the option to extend the initial five (5) year term of this
Lease for an additional period of three (3) years ("Lease Option Period") on the
same terms, covenants and conditions provided herein, except that upon such
renewal the Basic Rent due hereunder shall be determined pursuant to Paragraph
46.B. Tenant shall exercise its option by giving Landlord written notice ("Lease
Option Notice") no sooner than three hundred (300) days, and no later than one
hundred eighty (180) days, prior to the expiration of the initial term of this
Lease.
B. LEASE OPTION PERIOD BASIC RENT. The Basic Rent for the Lease Option
Period shall be the Prevailing Market Rental Rate for comparable space in the
Hacienda Business Park determined as of the commencement of the option term.
"Prevailing Market Rental Rate" shall
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mean an amount per rentable square foot that shall be determined with reference
to the base annual rentals then being charged for space then being offered for
rent in the Hacienda Business Park taking into account and adjusting for (i) the
term of this Lease with respect to which Prevailing Market Rental Rate is being
determined, (ii) the rental structure under this Lease and the leases for such
other space, (iii) the size and location of the Premises and the age and quality
of construction of the Premises and the leasehold improvements therein compared
with such other space, (iv) the load factor consisting of the ratio of the
usable area to the rentable area on each floor of the space; (v) an appropriate
discount for payments or credits that would be made on such other space with
respect to leasing commissions then customarily paid by Landlord for renewals at
the time of the commencement of the option term, rental concessions or other
inducements or improvement allowances offered on such other space and that are
not required to be made by Landlord, and (vi) any other relevant terms and
conditions relative to the leases of such other space; provided that in no event
shall the Prevailing Market Rental Rate be less than the Basic Rent due in the
last month of the initial term of this Lease.
C. DETERMINATION OF PREVAILING MARKET RENTAL RATE. Within thirty (30)
days after Landlord's receipt of the Lease Option Notice, Landlord shall give
Tenant notice of Landlord's determination of the Prevailing Market Rental Rate
for the space in question. If Tenant disputes Landlord's determination of the
Prevailing Market Rental Rate, Tenant shall so notify Landlord within ten (10)
business days following Landlord's notice to Tenant of the Prevailing Market
Rental Rate and such dispute shall be resolved as follows:
(i) Within thirty (30) days following Landlord's notice to Tenant
of the Prevailing Market Rental Rate, Landlord and Tenant shall meet no less
than two (2) times, at a mutually agreeable time and place, to attempt to
resolve any such disagreement.
(ii) If within this thirty (30) day period Landlord and Tenant
cannot reach agreement as to the Prevailing Market Rental Rate, they shall each
select one appraiser to determine the Prevailing Market Rental Rate. Each such
appraiser shall arrive at a determination of the Prevailing Market Rental Rate
and submit his conclusions to Landlord and Tenant within thirty (30) days of the
expiration of the thirty (30) day consultation period described in (i) above.
(iii) If only one appraisal is submitted within the requisite
time period, it shall be deemed to be the Prevailing Market Rental Rate. If both
appraisals are submitted within such time period, and if the two appraisals so
submitted differ by less than ten percent (10%) of the higher of the two, the
average of the two shall be the Prevailing Market Rental Rate. If the two
appraisals differ by more than ten percent (10%) of the higher of the two, then
the two appraisers shall immediately select a third appraiser, acceptable to
both Landlord and Tenant, who will within thirty (30) days of his selection make
a determination of the Prevailing Market Rental Rate and submit such
determination to Landlord and Tenant. This third appraisal will then be averaged
with the closer of the two previous appraisals and the result shall be the
Prevailing Market Rental Rate.
(iv) All appraisers specified pursuant hereto shall be members
of the American Institute of Real Estate Appraisers with not less than five (5)
years experience appraising
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commercial properties in the vicinity of and in the City of Pleasanton and
County of Alameda. Each party shall pay the cost of the appraiser selected by
such party and one-half of the cost of the third appraiser plus one-half of any
other costs incurred in the arbitration.
46. LEASE OPTION TO EXPAND. Provided that Tenant is not in default hereunder,
Tenant shall have the option to expand to space immediately contiguous to the
Premises, as follows. In the event that any space contiguous to the Premises
becomes available and such space is not subject to any rights of a third party
granted by Landlord prior to the date of this Lease, Landlord shall provide
Tenant with written notice (the "Expansion Notice Letter") that such space (the
"Expansion Space") will be available. Tenant shall have thirty (30) days from
the date of the Expansion Notice Letter to determine whether to exercise its
option to expand. If Tenant exercises its option in accordance with the
foregoing terms, then the Expansion Space shall be incorporated into the
Premises by Landlord and the commencement date for Tenant's lease of the
Expansion Space shall be as set forth in the Expansion Notice Letter, or as
otherwise determined by the parties. Rent for the Expansion Space shall be
determined pursuant to Section 45 hereof.
47. LEASE OPTION TO TERMINATE. Provided that Tenant is not in default under this
Lease, Tenant shall have the right to terminate this Lease at the end of the
thirty-sixth (36th) month by giving Landlord notice prior to March 1, 2000.
Tenant shall pay Landlord on the date of such termination the sum equal to all
unamortized costs of the lease transaction (including leasing commissions and
tenant improvements) plus six month's Basic Rent at the rental rate effective
the thirty-seventh (37th) month. If Tenant exercises its option to terminate and
does not vacate the Premises by the end of the thirty-sixth (36th ) month, such
tenancy shall be treated as a holdover under Section 28 hereof.
IN WITNESS WHEREOF, Landlord and Tenant have executed and delivered this
Lease as of the day and year first above written.
LANDLORD TENANT
- -------- ------
PROPERTY CALIFORNIA OB ONE SUPERIOR NATIONAL INSURANCE
CORPORATION, an Oregon corporation COMPANY, a California corporation
By LASALLE ADVISORS LIMITED, its duly
authorized agent By /s/ WILLIAM L. LUNTZ
-------------------------------------
By /s/ DIANE R. MCMAHON Its C.E.O.
--------------------------------- -----------------------------------
Its VICE PRESIDENT Date 10/17/97
-------------------------------- -----------------------------------
Date 10/29/97
-------------------------------
By /s/ WILLIAM W. BARENDRICK, JR.
---------------------------------
Its PRINCIPAL
--------------------------------
Date 10/29/97
-------------------------------
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EXHIBIT A
THE PREMISES
[SCHEMATIC]
<PAGE> 40
EXHIBIT B
THE PROPERTY
Diablo Center
Exhibit B
Page 1 of 2
<PAGE> 41
Diablo South
5775 West Las Positas Boulevard
Pleasanton, California
39,306 Square Feet
Exhibit B
Page 2 of 2
<PAGE> 42
SCHEDULE 1
Final Plans and Specifications for
Superior National Insurance
Tenant Improvements
5
<PAGE> 43
EXHIBIT D
RULES AND REGULATIONS
1. No sign, placard, picture, advertisement, name or notice shall be
installed or displayed on any part of the outside or inside of the
Building without the prior written consent of Landlord. Landlord shall
have the right to remove, at Tenant's expense and without notice, any
sign installed or displayed in violation of this rule. All approved
signs or lettering on doors and walls shall be printed, painted, affixed
or inscribed at the expense of Tenant by a person chosen by Landlord.
2. If Landlord objects in writing to any curtains, blinds, shades, screens
or hanging plants or other similar objects attached to or used in
connection with any window or door of the Premises, Tenant shall
immediately discontinue such use. No awning shall be permitted on any
part of the Premises. Tenant shall not place anything against or near
glass partitions or doors or windows which may appear unsightly from
outside the Premises.
3. Tenant shall not obstruct any sidewalks, halls, passages, exits,
entrances, elevators, escalators, or stairways of the Building. The
halls, passages, exits, entrances, shopping malls, elevators, escalators
and stairways are not open to the general public. Landlord shall in all
cases retain the right to control and prevent access thereto of all
persons whose presence in the judgment of Landlord would be prejudicial
to the safety, character, reputation and interest of the Building and
its tenants; provided that nothing herein contained shall be construed
to prevent such access to persons with whom any tenant normally deals in
the ordinary course of its business, unless such persons are engaged in
illegal activities. No tenant and no employee or invitee of any tenant
shall go upon the roof of the Building.
4. The directory of the Building will be provided exclusively for the
display of the name and location of Tenant only, and Landlord reserves
the right to exclude any other names therefrom.
5. Tenant may provide cleaning and janitorial services for the Premises.
Such cleaning and janitorial service contractors shall be licensed and
prior to providing services, such contractors shall provide Landlord
with a certificate of insurance, and except with the written consent of
Landlord, no person or persons other than those approved by Landlord
shall be employed by Tenant or permitted to enter the Building for the
purpose of cleaning the same. Tenant shall not cause any unnecessary
labor by carelessness or indifference to the good order and cleanliness
of the Premises. Landlord shall not in any way be responsible to any
tenant for any loss of property on the Premises, however occurring, or
for any damage to any Tenant's property by the janitor or any other
employee or any other person.
6. Landlord will furnish Tenant, free of charge, with two keys to each door
lock in the Premises. Landlord may make a reasonable charge for any
additional keys. Tenant shall
1
<PAGE> 44
not make or have made additional keys, and Tenant shall not alter any
lock or install a new additional lock or bolt on any door of its
Premises. Tenant, upon the termination of its tenancy, shall deliver to
Landlord the keys of all doors which have been furnished to Tenant, and
in the event of loss of any keys so furnished, shall pay Landlord
therefor.
7. If Tenant requires telegraphic, telephonic, burglar alarm or similar
services, Tenant shall first obtain, and comply with, Landlord's
instructions in their installation.
8. Any freight elevator shall be available for use by all tenants in the
Building, subject to such reasonable scheduling as Landlord in its
discretion shall deem appropriate. No equipment, materials, furniture,
packages, supplies, merchandise or other property will be received in
the Building or carried in the elevators except between such hours and
in such elevators as may be designated by Landlord.
9. Tenant shall not place a load upon any floor of the Premises which
exceeds the load per square foot which such floor was designed to carry
and which is allowed by law. Landlord shall have the right to prescribe
the weight, size and position of all equipment, materials, furniture or
other property brought into the Building. Heavy objects shall, if
considered necessary by Landlord, stand on such platforms as determined
by Landlord to be necessary to properly distribute the weight. Business
machines and mechanical equipment belonging to Tenant, which cause noise
or vibration that may be transmitted to the structure of the Building or
to any space therein to such a degree as to be objectionable to Landlord
or to any tenants in the Building, shall be placed and maintained by
Tenant, at Tenant's expense, on vibration eliminators or other devices
sufficient to eliminate noise or vibration. The persons employed to
move such equipment in or out of the Building must be acceptable to
Landlord. Landlord will not be responsible for loss of, or damage to,
any such equipment or other property from any cause, and all damage done
to the Building be maintaining or moving such equipment or other
property shall be repaired at the expense of Tenant.
10. Tenant shall not use or keep in the Premises any kerosene, gasoline or
other inflammable or combustible fluid or material other than those
limited quantities necessary for the operation or maintenance of office
equipment. Tenant shall not use or permit to be used in the Premises any
foul or noxious gas or substance, or permit or allow the Premises to be
occupied or used in a manner offensive or objectionable to Landlord or
other occupants of the Building by reason of noise, odors or vibrations,
nor shall Tenant bring into or keep in or about the Premises any birds
or animals.
11. Tenant shall not use any method of heating or air-conditioning other
than that supplied by Landlord.
12. Tenant shall not waste electricity, water or air-conditioning and agrees
to cooperate fully with Landlord to assure the most effective operation
of the Buildings heating and air-conditioning and to comply with any
governmental energy-saving rules, laws or regulations of which Tenant
has actual notice, and shall refrain from adjusting controls.
2
<PAGE> 45
Tenant shall keep corridor doors closed, and shall close window
coverings at the end of each business day.
13. Landlord reserves the right, exercisable without notice and without
liability to Tenant, to change the name and street address of the
Building.
14. Landlord reserves the right to exclude from the Building between the
hours of 6 p.m. and 7 a.m. the following day, or such other hours as may
be established from time to time by Landlord, and on Sundays and legal
holidays, any person unless that person is known to the person or
employee in charge of the Building and has a pass or is properly
identified. Tenant shall be responsible for all persons for whom it
requests passes and shall be liable to Landlord for all acts of such
persons. Landlord shall not be liable for damages for any error with
regard to the admission to or exclusion from the Building of any person.
Landlord reserves the right to prevent access to the Building in case of
invasion, mob, riot, public excitement or other commotion by closing the
doors or by other appropriate action.
15. Tenant shall close and lock the doors of its Premises and entirely shut
off all water faucets or other water apparatus, and electricity, gas or
air outlets before tenant and its employees leave the Premises. Tenant
shall be responsible for any damage or injuries sustained by other
tenants or occupants of the Building or by Landlord for noncompliance
with this rule.
16. Tenant shall not obtain-for use on the Premises ice, drinking water,
food, beverage, towel or other similar services or accept barbering or
bootblacking service upon the Premises, except at such hours and under
such regulations as may be fixed by Landlord.
17. The toilet rooms, toilets, urinals, wash bowls and other apparatus shall
not be used for any purpose other than that for which they were
constructed and no foreign substance of any kind whatsoever shall be
thrown therein. The expense of any breakage, stoppage or damage
resulting from the violation of this rule shall be borne by the tenant
who, or whose employees or invitees, shall have caused it.
18. Tenant shall not sell, or permit the sale at retail, of newspapers,
magazines, periodicals, theater tickets or any other goods or
merchandise to the general public in or on the Premises. Tenant shall
not make any room-to-room solicitation of business from other tenants in
the Building. Tenant shall not use the Premises for any business or
activity other than that specifically provided for in Tenant's Lease.
19. Tenant shall not install any radio or television antenna, loudspeaker or
other devise on the roof or exterior walls of the Building. Tenant shall
not interfere with radio or television broadcasting or reception from or
in the Building or elsewhere.
20. Tenant shall not mark, drive nails, screw or drill into the partitions,
woodwork or plaster or in any way deface the Premises or any part
thereof. Landlord reserves the right to direct electricians as to where
and how telephone and telegraph wires are to be introduced to the
3
<PAGE> 46
Premises. Tenant shall not cut or bore holes for wires. Tenant shall not
affix any floor covering to the floor of the Premises in any manner
except as approved by Landlord. Tenant shall repair any damage resulting
from noncompliance with this rule.
21. Tenant shall not install, maintain or operate upon the Premises any
vending machine without the written consent of Landlord.
22. Canvassing, soliciting and distribution of handbills or any other
written material, and peddling in the Building are prohibited, and each
tenant shall cooperate to prevent same.
23. Landlord reserves the right to exclude or expel from the Building any
person who, in Landlord's judgment, is intoxicated or under the
influence of liquor or drugs or who is in violation of any of the Rules
and Regulations of this Building.
24. Tenant shall store all its trash and garbage within its Premises. Tenant
shall not place in any trash box or receptacle any material which cannot
be disposed of in the ordinary and customary manner of trash and garbage
disposal. All garbage and refuse disposal shall be made in accordance
with directions issued from time to time by Landlord.
25. The Premises shall not be used for the storage of merchandise held for
sale to the general public, or for lodging or for manufacturing of any
kind, nor shall the Premises be used for any improper, immoral or
objectionable purpose. No cooking shall be done or permitted by any
tenant on the Premises, except that use by Tenant of Underwriters'
Laboratory approved equipment for brewing coffee, tea, hot chocolate and
similar beverages shall be permitted, provided that such equipment and
use is in accordance with all applicable federal, state, county and city
laws, codes, ordinances, rules and regulations.
26. Tenant shall not use in any space or in the public halls of the Building
any hand trucks except those equipped with rubber tires and side guards
or such other material-handling equipment as Landlord may approve.
Tenant shall not bring any other vehicles of any kind into the Building.
27. Without the written consent of Landlord, Tenant shall not use the name
of the Building in connection with or in promoting or advertising the
business of Tenant except as Tenant's address.
28. Tenant shall comply with all safety, fire protection and evacuation
procedures and regulations established by Landlord or any governmental
agency.
29. Tenant assumes any and all responsibility for protecting its Premises,
from theft, robbery and pilferage, which includes keeping doors locked
and other means of entry to the Premises closed.
30. The requirements of Tenant will be attended to only upon appropriate
application to the office of the Building by an authorized individual.
Employees of Landlord shall not
4
<PAGE> 47
perform any work or do anything outside of their regular duties unless
under special instructions from Landlord, and no employee of Landlord
will admit any person (Tenant or otherwise) to any office without
specific instructions from Landlord.
31. Tenant shall not park its vehicles in any parking areas designated by
Landlord as areas for parking by visitors to the Building. Tenant shall
not leave vehicles in the Building parking areas overnight nor park any
vehicles in the Building parking areas other than automobiles,
motorcycles, motor driven or non-motor driven bicycles or four-wheeled
trucks.
32. Landlord may waive any one or more of these Rules and Regulations for
the benefit of Tenant or any other tenant, but no such waiver by
Landlord shall be construed as a continuous waiver of such Rules and
Regulations against any or all of the tenants of the Building.
33. These Rules and Regulations are in addition to, and shall not be
construed to in any way modify or amend in whole or in part, the terms,
covenants, agreements and conditions of any lease of premises in the
Building 34. Landlord reserves the right to make such other reasonable
Rules and Regulations as, in its judgment, may from time to time be
needed for safety and security, for care and cleanliness of the Building
and for the preservation of good order therein. Tenant agrees to abide
by all such Rules and Regulations hereinabove stated and any additional
rules and regulations which are adopted.
35. Tenant shall be responsible for the observance of all of the foregoing
rules by Tenant's employees, agents, clients, customers, invitees and
guests.
5
<PAGE> 48
EXHIBIT C
WORK LETTER AGREEMENT
(TURN KEY)
In connection with the improvements to be installed in the Premises (the
"Tenant Improvements") the parties hereby agree as follows:
1. Plans and Specifications. Tenant shall prepare and submit to
Landlord not later than October 24, 1997, for Landlord's review and approval a
space plan for Tenant's proposed Tenant Improvements to the Premises (the "Space
Plan"). Within five (5) business days after receipt of Tenant's Space Plan,
Landlord shall notify Tenant of Landlord's approval or disapproval thereof,
specifying in reasonable detail the basis for Landlord's disapproval, if
applicable. Tenant shall cause the Landlord-approved architect (AD Architecture
Design) to prepare final working architectural and engineering plans and
specifications for the Tenant Improvements ("Final Plans and Specifications")
based upon the approved Space Plan and such Final Plans and Specifications shall
be reviewed by Landlord's architect. Tenant shall cooperate diligently with
Landlord's architect and shall furnish, within five (5) business days after
written request therefor, all information required by the architect for the
completion of the Final Plans and Specifications. Landlord and Tenant shall
indicate their approval of the Final Plans and Specifications by initialing them
and attaching them hereto as Schedule 1.
2. Landlord to Construct. Landlord shall complete construction of the
Tenant Improvements in a good and workmanlike manner, substantially in
accordance with the Final Plans and Specifications approved by Landlord and
Tenant.
(a) Selection of Contractor. A contractor acceptable to Landlord
shall be the contractor, and as of the date of this Work Letter Agreement,
P.D. Larson Company shall be designated as the "Contractor" selected to
complete the Tenant Improvements. Landlord shall endeavor to instruct the
Contractor to use competitive bidding for completion of the Tenant
Improvements. Landlord shall use its best efforts to enter into a "cost
plus 12%" agreement with Contractor for completion of the Tenant
Improvements which provides that the Contractor's overhead, insurance,
general conditions, supervision and profit are included in the 12% amount.
Landlord shall pay, without reimbursement from Tenant or the Tenant
Improvements Allowance, all fees charged by Contractor in excess of such
12%. Landlord and Tenant may mutually agree to select an alternate
Contractor to complete the Tenant Improvements.
3. Payment of Tenant Improvement Costs. Landlord shall provide Tenant
with an allowance of Three Hundred Fifteen Thousand and no/100 Dollars
($315,000.00) ($15 per rentable square foot) for the design and construction of
the Tenant Improvements ("Tenant Improvements Allowance"). The Tenant
Improvements Allowance shall be the maximum
1
<PAGE> 49
contribution by Landlord for the Tenant Improvement Cost (defined below) and
shall be applied as primary payment. Any Tenant Improvement Cost in excess of
the Tenant Improvements Allowance shall be paid to Landlord by Tenant within
thirty (30) days after Landlord's written request therefor accompanied by
itemized invoices evidencing the excess costs to be paid by Tenant along with
prior written acceptance of such costs by Tenant. If Tenant pays any Tenant
Improvement Costs directly, Landlord shall reimburse Tenant for such costs,
subject to the Tenant Improvements Allowance limits.
4. Tenant Improvements Cost. The Tenant Improvements cost ("Tenant
Improvement Cost") shall include all costs of designing and constructing the
Tenant Improvements, including but not limited to:
(a) All costs of preliminary and final architectural and engineering
plans, if any, and specifications for the Tenant Improvements, including review
by Landlord's architect, design build costs, and engineering costs associated
with completion of the State of California energy utilization calculations
under Title 24 legislation.
(b) All costs of obtaining building permits and other necessary
authorizations from the City of Pleasanton.
(c) All costs of interior design and finish schedule plans and
specifications, including as-built drawings.
(d) All direct and indirect costs of procuring, constructing and
installing the Tenant Improvements in the Premises, including but not limited
to the construction fee for overhead and profit and the cost of on-site
supervisory and administrative staff, office, equipment and temporary services
rendered by Landlord's Contractor in connection with construction of the
Tenant Improvements.
(e) All fees payable to Tenant's architect and engineering firm if
they are required by Tenant to redesign any portion of the Tenant Improvements.
(f) A construction management fee, such fee not to exceed three
percent (3%) of the first $315,000.00 of Tenant Improvement Cost. Tenant agrees
to pay Landlord a construction management fee of 1.5% of any Tenant Improvement
Costs exceeding $315,000.00.
(g) Landlord agrees to pay its architect, outside of the Tenant
Improvement Allowance, for any architectural review fee of the Final Plans and
Specifications.
(h) Tenant agrees to pay one-half of the total costs of separating
the mechanical systems related to the Premises and Landlord agrees to pay
one-half of the total costs of separating the mechanical systems and all
costs associated with separating or sub-metering the electrical systems
relating to the Premises. The Landlord's cost under this subsection (h) shall
be outside the Tenant Improvement Allowance.
2
<PAGE> 50
(i) All costs of furnishing and installing cabling for Tenant's
voice and data systems; provided that Tenant shall observe all covenants set
forth in Section 10 of the Lease regarding installation of Tenant's cabling
(and any other alterations), and shall ensure that all work performed by Tenant
or at Tenant's direction is carried out expeditiously and in a good and
workmanlike manner, is uniformly of high quality, complies with all applicable
government codes and regulations, and Tenant shall remain liable for any damage
to the Premises or Building in connection therewith.
In no event shall the Tenant Improvements Cost include any costs of
procuring, constructing or installing in the Premises any of Tenant's personal
property.
5. Change Requests. No revisions to the approved Space Plan or the
Final Plans and Specifications shall be made by either Landlord or Tenant
unless approved in writing by both parties. Landlord agrees to make all
changes: (i) required by any public agency to conform with governmental
regulations or (ii) requested in writing by Tenant and approved in writing by
Landlord, which approval shall not be unreasonably withheld. Any costs related
to such changes in (ii) above in excess of the Tenant Improvements Allowance
shall be paid for by Tenant as set forth in Paragraph 3. The billing for such
additional costs shall be accompanied by evidence of the amounts billed as is
customarily used in the business. Costs related to such changes shall include,
without limitation, any architectural or design fees and Landlord's
Contractor's price for effecting the change.
6. Termination. If the Lease is terminated prior to completion of the
Tenant Improvements due to the default of the Tenant, Tenant shall pay to
Landlord, within five (5) days after receipt of a statement therefor, any costs
incurred by Landlord through the date of such termination in connection with
the Tenant Improvements.
7. Tenant Delays. The Commencement Date shall not be delayed due to
delays caused by Tenant, including (i) Tenant's failure to furnish information
for the preparation of plans and drawings; (ii) Tenant's request for special
materials, finishes or installations which are not readily available; (iii)
Tenant's changes in plans and/or working drawings after their approval by
Landlord; (iv) Tenant's failure to complete its own improvement work to the
extent Tenant delays completion by the City of Pleasanton of its final
inspection and approval of the Tenant Improvements; or (v) interference with
Landlord's work caused by Tenant or Tenant's contractors or subcontractors.
8. Punch-List. Within ten (10) days after completion of the Tenant
Improvements, Tenant shall conduct a walk-through inspection of the Premises
with Landlord and complete a punch-list of items needing additional work.
Landlord shall complete all items on the punch-list as soon as reasonably
possible. Upon completion of such punch-list items, Tenant shall approve such
completed items in writing to Landlord. If Tenant fails to reject such items
within seven (7) days of completion, such items shall be deemed approved by
Tenant. If Tenant fails to submit a punch-list to Landlord within such ten (10)
day period, it shall be deemed that there are no items needing additional work
or repair.
3
<PAGE> 51
9. Landlord agrees to adopt and to pursue a plan intended to comply with
the Americans with Disabilities Act ("A.D.A.") as applicable to the Tenant
Improvements being completed on the Premises. Landlord shall be responsible for
all expenses relating to A.D.A. compliance with the Tenant Improvements. Tenant
acknowledges that (a) compliance of the Premises with the A.D.A. depends upon
the uses of the Premises, the location of each use within the Premises, and
changes to these factors over time, and (b) Tenant may have obligations under
the A.D.A. as an employer which may differ from its obligations as the operator
of the Premises. Tenant agrees that after completion of the Tenant Improvements
and delivery of the Premises by Landlord to Tenant, Tenant shall comply with all
requirements of the A.D.A. related to any subsequent alterations and
improvements to the Premises at the expense of Tenant and that Tenant shall make
only such uses of the Premises in a manner that comply with the A.D.A.
LANDLORD TENANT
PROPERTY CALIFORNIA OB ONE SUPERIOR NATIONAL INSURANCE
CORPORATION, an Oregon corporation COMPANY, a California corporation
By LASALLE ADVISORS LIMITED,
its duly authorized agent By /s/ [SIG]
--------------------------------
By /s/ [SIG] Its Corporate Secretary
---------------------------- --------------------------------
Its Vice President Date October 28, 1997
---------------------------- --------------------------------
Date October 29, 1997
----------------------------
By /s/ [SIG]
----------------------------
Its Principal
----------------------------
Date October 29, 1997
----------------------------
4
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101,277
0
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140,920
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