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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
COMMISSION FILE NUMBER 0-16748
INTERCARGO CORPORATION
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 36-3414667
(State or other jurisdiction (I.R.S. employer
of incorporation) identification no.)
</TABLE>
1450 AMERICAN LANE
20TH FLOOR
SCHAUMBURG, ILLINOIS 60173
(Address of principal executive office and zip code)
Registrant's telephone number, including area code: 847-517-2990
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
TITLE OF CLASS
Common Stock, $1.00 Par Value
Indicate by check mark whether 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 Regulation S-K is not contained herein, and will not be contained to the
best of Registrant's knowledge, in the definitive proxy statement incorporated
by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
Aggregate Market Value of Voting Stock held by nonaffiliates as of March
10, 1999: $82,964,484
Number of Shares of Common Stock outstanding as of March 10, 1999:
7,293,581
DOCUMENTS INCORPORATED BY REFERENCE
None
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PART I
Statements made in this document that present information that is not
historic, including among other things, anticipated financial performance,
sources and extent of liquidity and capital, anticipated business activities,
impact of Year 2000 issues, business prospects, new products and markets, and
business relationships are "forward looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. These statements can be
identified by the use of forward-looking terminology such as "may", "will",
"expect", "anticipate", "estimate", or "continue" or the negative thereof or
other variations thereon, or comparable terminology. There are numerous risks
and uncertainties that could cause actual results to differ materially from
those in the forward-looking statements.
ITEM 1. BUSINESS.
On December 1, 1998 the Company and X.L. America, Inc., ("XL") a
wholly-owned subsidiary of XL Capital Ltd ("XL Capital"), entered into an
Agreement and Plan of Merger pursuant to which the Company will be acquired by
XL Capital through the merger of XL (or a wholly owned subsidiary of XL) with
and into the Company ("the Merger"). Pursuant to the Merger the shares of common
stock of Intercargo issued and outstanding immediately prior to the Merger will
be converted into $12.00 in cash. Consummation of the Merger is subject to
regulatory and shareholder approvals and to specified closing conditions.
Further information is contained in the Company's definitive Proxy Statement for
the Special Meeting of Stockholders relating to the Merger.
The Company, through Intercargo Insurance Company ("IIC"), its U.S.
insurance company subsidiary, and Intercargo Insurance Company H.K. Limited, a
subsidiary of IIC, is engaged in the business of underwriting specialized
insurance coverages for international trade. This includes U.S. Customs bonds,
commercial surety, cargo insurance, general liability, workers compensation,
truck liability, professional liability and property and casualty insurance.
U.S. Customs bonds guarantee payment of duties on imported goods and cargo
insurance protects shippers from loss or damage to goods in transit.
Appointed independent insurance agents market the Company's products to
customs brokers, freight forwarders, logistics providers, intermodal carriers,
importers and exporters. Contract surety is marketed to contractors and building
tradesmen through independent agents. Prior to the sale on April 30, 1998 of
seven subsidiaries of International Advisory Services, Inc. ("IAS"), which
remains a wholly-owned subsidiary, IIC's products were distributed primarily
through IAS and these subsidiaries under the trade name of Trade Insurance
Services, Inc.
IIC opened a branch office in London in April, 1994. This office
underwrites marine cargo insurance through independent insurance brokers. In
October, 1995, the Company acquired Eastern Insurance Limited, a Hong Kong
licensed insurer and renamed the company Intercargo Insurance Company H.K.
Limited, and commenced operations in May, 1996. The Hong Kong subsidiary
underwrites marine cargo and professional liability insurance through
independent brokers.
In December, 1995 the Company participated in an initial public offering by
the Company's Canadian subsidiary, Kingsway Financial Services, Inc.
("Kingsway") and as a result of this and the underwriters' overallotment
exercised in January 1996, the Company's ownership interest in Kingsway was
reduced from 100% to 47%. In October 1996 Kingsway completed a secondary public
offering in which the Company also participated. As a result of this, the
ownership interest was further reduced to 31.5%. In August 1997 the Company sold
4,018,180 of its remaining total holdings in Kingsway of 4,180,000 shares,
thereby reducing its ownership interest to less than 1%. The Company no longer
considers Kingsway to be a subsidiary.
Unless the context otherwise requires, the term the "Company" shall mean
Intercargo Corporation and/or its subsidiaries.
U.S. CUSTOMS BONDS
U.S. Customs bonds guarantee that the importer will pay all attendant
duties and taxes at the time of entry of merchandise, pay any supplemental
duties assessed and observe the laws governing imports. U.S.
<PAGE> 3
Customs bonds are a form of security required by the U.S. Customs Service
("Customs") from virtually all importers of merchandise into the United States.
U.S. Customs bonds facilitate the flow of goods by permitting importers to take
possession of such goods prior to final determination of Customs duties and of
related regulatory issues.
U.S. Customs bonds are of two types, either continuous or single
transaction. The required bond amounts are set by Customs directives. Continuous
bond amounts are set on an annual basis at 10% of the duties, taxes and fees
paid by the importer to Customs in the previous calendar year. Single
transaction bond amounts are determined based on specific transactions or
entries to be secured. Most often, single transaction bonds are set at an amount
equal to the entered value plus estimated duties, taxes and fees.
The average duty payment required on an import shipment, which is payable
by the importer within ten business days of entry, is approximately 4% to 5% of
the value of the shipment. However, if Customs disagrees with the importer's
classification or valuation of the shipment, the importer will be required to
pay additional duty. Customs also is authorized to assess fines and damages
against importers which fail to comply with certain import laws and regulations.
These laws and regulations include import quota restrictions, labeling laws,
Food and Drug Administration regulations and the regulations of other government
agencies. Although the importer remains liable for these adjustments, fines and
damages, Customs makes demand for payment upon the insurance company that issued
the bond in the event of a default by the importer.
The Company carefully evaluates the information available from its database
and operating experience in establishing its underwriting parameters. All U.S.
Customs bond risks must meet these parameters or be specifically approved by
designated underwriters. This evaluation is based on a number of factors
including the size of the U.S. Customs bond, the financial strength of the
importer, the type of transaction, the type of commodity, the commodity's
country of origin and the importer's loss history. The Company has developed a
database which integrates information received from production sources with
detailed information received from Customs on a weekly basis. The Company uses
this database extensively as it provides enhanced capabilities for underwriting
control and claims handling. The Company also enhances its underwriting
selectivity by declining business written through subproducers which have
historically failed to file complete documentation with Customs in a timely
manner and through its understanding of the laws and regulations which affect
imported cargo.
MARINE CARGO INSURANCE
A marine cargo policy issued by the Company insures the shipper or
consignee against physical loss or damage to cargo while in transit. The
Company's marine cargo policies provide coverage for general commercial and
industrial goods of all types, but exclude among other things, oil shipments and
bulk commodities (such as grain shipments). A small portion of the Company's
marine business also consists of overland carrier and warehouseman's cargo
liability insurance. Marine risks are underwritten based on a number of factors,
including type of commodity to be insured (susceptibility to theft and damage),
adequacy of packaging, country of origin and destination, extent and type of
coverage required, method of transportation and shipping practices and loss
experience of the shipper and consignee. The Company issues marine cargo
policies primarily for shipments from the U.S. to foreign ports, from foreign
ports to the U.S. and, to a limited extent, from one foreign port to another.
The Company, however, endeavors to avoid coverage for troubled parts of the
world.
Marine cargo policies are issued by the Company for an indefinite period of
time. The policy insures individual shipments for amounts up to the policy
limits at premium rates determined by the Company based upon the factors
mentioned above. Premium written on individual shipments is considered to be
earned when reported to the Company.
PROFESSIONAL LIABILITY INSURANCE
The Company provides professional liability coverage for customs brokers,
freight forwarders and other service firms engaged in the international movement
of cargo. Professional liability insurance policies protect these firms against
certain claims arising from the unintentional errors or omissions of their
operations that
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result in financial injury to their clients. These policies exclude coverage for
punitive damages and are issued on a "claims made" basis, which means that
claims involving alleged negligent acts must be reported during the stated
policy term. The Company's professional liability program has been endorsed by
the National Customs Brokers and Forwarders Association of America since 1989.
The Company introduced a modified version of its professional liability
coverage in 1993. This coverage, referred to as international transit liability
(ITL) insurance, includes marine legal liability insurance in addition to
professional liability. IIC is the first U.S. based insurance company to offer
this type of coverage. The program was developed to compete in new international
markets. Unlike the traditional professional liability policy, this policy is
issued on an "occurrence" basis, which means the covered proximate cause of loss
must occur during the policy period.
OTHER PROPERTY AND CASUALTY INSURANCE
The Company markets commercial property and casualty products to customs
brokers, freight forwarders and other service firms engaged in the international
movement of cargo. The Company is authorized to write these coverages in 48
states. The product is designed to meet the specific requirements of the
broker/forwarder industry.
The Company markets property and casualty products, miscellaneous trucking
bonds and cargo insurance to meet the needs of the trucking industry. These
products are sold through independent insurance agents.
SURETY
The Company sells bid, performance and payment bonds for construction and
other types of contracts. The Company also underwrites license and permit bonds,
miscellaneous financial guarantees, court bonds and specialty fidelity bonds.
The Company has developed what it believes is an industry leading data
processing system that enhances the quality of underwriting while reducing the
costs and time of processing business.
FOREIGN OPERATIONS
See Note 14 of Notes to Consolidated Financial Statements for information
relating to revenues, operating income and identifiable assets related to the
Company's operations in the United Kingdom and Hong Kong, which information is
found in Item 8.
MARKETING AND DISTRIBUTION
On April 30, 1998, IAS transferred to The Roanoke Companies, Inc.
("Roanoke") all of the insurance brokerage agency business of IAS. The
transaction was effected through the sale of the capital stock of seven
subsidiaries of IAS. These subsidiaries had operated under the trade name of
Trade Insurance Services. As a result of this, Roanoke generated approximately
29.5% of the Company's gross written premium in 1998. Roanoke has also agreed
for a period lasting at least until November 5, 2001, to continue to place with
the Company all U.S. Customs bonds, marine and other coverages generated from
the IAS customers existing at the time of the sale. The Company uses other
independent agents to produce additional business.
REINSURANCE
The Company follows the industry practice of reinsuring a portion of its
insured risks, paying to the reinsurer a portion of the premiums received on all
policies. Insurance is ceded principally to reduce the net liability on
individual risks and to protect against catastrophic losses. The Company
endeavors to place reinsurance with reinsurance companies which have been
approved by the U.S. Treasury (in the case of U.S. Customs bonds) and which have
been rated "A" or better by A.M. Best Company.
Excess of loss reinsurance on the Company's Customs bond business is
provided through contracts with four reinsurance companies: American
Re-Insurance Company ("American Re"), First Excess and Reinsurance Corporation
("First Excess"), Employers Reinsurance Corporation ("Employers Re") and
Transatlantic Reinsurance Company ("Transatlantic"). Excess of loss reinsurance
is a form of reinsurance which
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indemnifies the ceding insurer up to an agreed amount against all or a portion
of the amount of loss in excess of a specified retention. The Company now
retains risks up to $500,000 per bond or per principal. Under the contracts, the
reinsurers automatically assume the risk of losses on the Company's bonds
between $500,000 and $3,700,000 on any one principal. Bonds written for amounts
greater than $3,700,000 must be submitted to the reinsurers for acceptance on a
case-by-case basis and the Company may not fully reinsure all exposures above
$3,700,000.
Excess of loss reinsurance on the Company's marine cargo insurance consists
of two reinsurance treaties. Under the first treaty, NAC Reinsurance
Corporation, Transatlantic, St. Paul Fire & Marine Insurance Company and
Employers Re assume the risk of losses between $200,000 and $5 million on any
occurrence. Under the second treaty, losses in excess of $5 million up to $25
million are assumed by ten Lloyd's of London syndicates, Commercial Union
Assurance Company Plc ("Commercial Union"), XL Mid Ocean Reinsurance Company
Ltd, ERC Frankona Reinsurance Limited, Mapfre Re Compania de Reaseguros S.A. and
Reliance National Insurance Company (Europe) Limited. These same excess of loss
reinsurance treaties also cover property losses arising from the Company's other
property insurance coverages.
The reinsurance on the Company's professional liability program is placed
with Kemper Reinsurance Company ("Kemper Re") and Transatlantic. The reinsurers
provide reinsurance of $800,000 in excess of the first $200,000 and also provide
$2,000,000 additional capacity as needed. Air cargo legal liability reinsurance
includes quota share coverage wherein the Company retains 35% of the first $2
million of loss per sending or $4 million per occurrence. Reinsurance is
provided through Commercial Union, Terra Nova Insurance Company Limited ("Terra
Nova"), Zurich Reinsurance (London) Limited and several Lloyd's of London
syndicates.
Reinsurance on the Company's other property and casualty insurance, in
addition to the previously discussed excess of loss coverage on property
insurance, consists of quota share and casualty excess of loss. Under the quota
share coverage for umbrella liability policies the Company retains 5% of losses
up to $5 million. The reinsurance is provided by Kemper Re and CNA Reinsurance
Company. Under the casualty excess of loss reinsurance, the Company retains up
to $200,000 of losses for each occurrence and Employers Re assumes additional
risk up to $5 million.
Reinsurance on the Company's base trucking program consists of excess of
loss coverage where the Company cedes losses in excess of $200,000 to a limit of
$1 million. This reinsurance is provided by Continental Casualty Company
("Continental Casualty"), First Excess, Folksamerica Reinsurance Company,
Hartford Fire Insurance Company ("Hartford"), Kemper Re and Trenwick America
Reinsurance Corporation. Under the Company's long haul trucking program
reinsurance consists of both quota share and excess of loss. Under the quota
share reinsurance the Company retains 15% of the first $150,000 of losses for
physical damage and 15% of the first $100,000 of losses for liability. Under the
excess of loss coverage the Company retains 15% of the liability losses in
excess of $100,000 per occurrence to a limit of $1 million. Reinsurance is
provided by Continental Casualty, Kemper Re, Transatlantic, Lloyd's Syndicate
Number 1141, CNA Reinsurance Company Limited, Hannover
Ruckversicherungs-Aktiengesellschaft, Terra Nova and Zurich Reinsurance (London)
Limited.
Reinsurance on the Company's contract and miscellaneous surety products
consists of excess of loss reinsurance for losses in excess of $250,000 to a
limit of $10 million. Reinsurers providing this coverage include Hartford,
Kemper Re, Republic Western Insurance Company, Risk Capital Reinsurance and
Transatlantic. The Company also has a quota share agreement with Monroe Guaranty
Insurance Company ("Monroe Guaranty") where the Company retains 50% of the
surety business produced by agents recruited by Monroe Guaranty.
The ceding of reinsurance does not discharge the original insurer from its
primary liability to the policyholder. The ceding company is required to pay
losses even if the reinsurer fails to meet its obligations under the reinsurance
agreement. The Company also remains liable for losses which exceed the limits of
coverage afforded by its reinsurance agreements. In addition to the per
occurrence limits set forth above, the annual aggregate limit on the Company's
Customs bond reinsurance contract is $6.4 million and the annual aggregate limit
on the marine cargo reinsurance contract is $25.0 million.
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<PAGE> 6
LOSSES AND LOSS RESERVES
Claims on the Company's marine, professional liability, and contract bond
lines are adjusted by Company personnel. Claims on property and casualty
business are processed by a third party. Adjustment procedures include
verification of the coverage, investigation of the loss, evaluation of the
exposure and final settlement of the claim. The Company's general policy is to
adjust and settle claims as quickly as possible. For marine cargo claims,
salvage and subrogation are important factors in minimizing loss experience.
Substantially all U.S. Customs bond losses are paid to Customs as the party
indemnified by the bond. The Company receives periodic notices of importer
defaults from Customs in the normal course of business. Because of the nature of
the U.S. Customs bond business, the majority of claim notices received from
Customs typically do not result in actual claim payments by the Company because
of payment by the principal, adequate defenses of the principal or the Company
with respect to the claim or the correction of a non-compliance situation.
The two major types of bond claims received from Customs are assessment of
additional duty and liquidated damages. The Company's claim adjustment
procedures for additional duty assessments include identifying the bond related
to the claim, obtaining supporting Customs' entry documentation, reviewing
Customs' assessment of higher duty and contacting the importer of record in an
attempt to secure payment. Claims for liquidated damages are more complex and
require the implementation of several claim adjustment procedures. By working
with the Customs broker that filed the import entry and produced the bond, the
Company seeks to correct the non-compliance situation. If compliance is not
achieved, the Company performs final adjustment procedures or makes payment. The
principal remains liable for all claims paid by the Company. The Company's
policy is to aggressively pursue the principal under rights of subrogation on
any bond that results in a claim payment.
The Company maintains reserves for the payment of losses and loss
adjustment expenses ("LAE") for all lines of business, on an undiscounted basis.
The determination of reserves for losses and LAE is dependent on receipt of
information regarding claims and the historical loss experience of the business.
Generally, there is a lag between the time losses are incurred and the time they
are reported to the Company.
The liability for losses and LAE is an estimate of the ultimate unpaid net
cost of all losses incurred through December 31 of each year. Since the
provision is necessarily based on estimates, the ultimate liability may be more
or less than such provision. These estimates include the anticipated recovery of
salvage and subrogation based on historical patterns. Case reserves for
individual claims are generally not established for the U.S. Customs bond
business because of the historical problems of attempting to establish case
reserves for small losses coupled with: (i) frequent errors in Customs claims,
(ii) lack of or erroneous documentation furnished to the Company by Customs, and
(iii) the experience of the Company that in excess of 90% of all claims
initially reported by Customs are either canceled or settled by the principal.
When there is sufficient evidence to document the validity of a claim, it is
promptly paid by the Company. As a result, the Company estimates its ultimate
losses on U.S. Customs bonds by projecting from its paid claim data. The
combination of paid loss projections and the length of time to ultimate
settlement adds a high degree of judgment to the reserving process. The reserves
established for bond losses are regularly evaluated and adjusted when conditions
in loss patterns indicate an adjustment is required. The reserves established
for marine losses and professional liability losses are evaluated against cases
reported, and adjustments to the reserves, including a provision for claims
incurred but not yet reported ("IBNR"), are recorded as deemed appropriate.
Reserves for the Company's automobile and commercial and property and casualty
lines are established on a case-by-case basis and include a provision for IBNR.
The individual case reserves are reviewed periodically and
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adjusted as deemed necessary. The following table presents Company reserve
balances for the periods indicated (net of ceded reinsurance):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1998 1997 1996
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Unpaid Losses and LAE at beginning of year, net of
reinsurance recoverables of $11,970, $9,980, and
$3,138.......................................... $ 43,385 $37,057 $33,155
Provision for Losses and LAE for claims occurring
during:
Current year.................................... 31,680 34,260 31,876
Prior years..................................... 988 585 431
-------- ------- -------
Total............................................. 32,668 34,845 32,307
-------- ------- -------
Less Loss and LAE payments for claims occurring
during:
Current year.................................... (10,646) (10,896) (10,798)
Prior years..................................... (20,873) (17,621) (17,607)
-------- ------- -------
Total............................................. (31,519) (28,517) (28,405)
-------- ------- -------
Unpaid Losses and LAE at end of year, net of
reinsurance recoverables of $11,980 $11,970 and
$9,980.......................................... $ 44,534 $43,385 $37,057
======== ======= =======
</TABLE>
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Any adjustments to reserves are reflected in operating results for the period in
which they are made.
The following table presents development of total Company reserves and
liability paid for the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------
1988 1989 1990 1991 1992 1993 1994 1995
---- ---- ---- ---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Liability for unpaid losses
and LAE..................... $11,459 $12,584 $14,133 $25,867 $23,940 $26,289 $35,006 $33,155
Cumulative amount of
liability paid through:
One Year Later.............. 6,019 5,216 6,039 12,611 12,531 14,244 20,205 17,608
Two Years Later............. 8,826 8,748 10,893 18,471 17,711 22,819 25,890 23,825
Three Years Later........... 11,396 12,106 13,079 21,521 24,280 26,934 28,244 27,415
Four Years Later............ 14,375 13,525 13,782 28,746 25,908 28,254 30,099
Five Years Later............ 15,224 13,906 21,892 29,131 26,694 29,116
Six Years Later............. 15,488 14,179 22,223 29,599 27,219
Seven Years Later........... 15,766 14,432 22,382 29,775
Eight Years Later........... 15,830 14,590 22,473
Nine Years Later............ 15,937 14,599
Ten Years Later............. 15,916
Liability re-estimated as of:
One Year Later.............. 11,629 13,592 13,367 26,551 25,728 28,426 41,110 33,586
Two Years Later............. 14,011 13,301 16,666 25,974 24,667 29,851 41,491 34,193
Three Years Later........... 14,502 16,273 15,613 25,060 23,289 31,883 41,286 33,895
Four Years Later............ 17,499 15,351 14,966 24,192 24,208 31,394 41,472
Five Years Later............ 16,656 14,790 14,765 24,536 23,542 31,429
Six Years Later............. 16,038 14,209 15,225 23,947 23,607
Seven Years Later........... 15,774 14,613 14,644 23,932
Eight Years Later........... 16,010 14,302 14,606
Nine Years Later............ 15,829 14,248
Ten Years later............. 15,797
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1996 1997 1998
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Liability for unpaid losses
and LAE..................... $37,057 $43,385 $44,534
Cumulative amount of
liability paid through:
One Year Later.............. 17,622 20,873
Two Years Later............. 25,633
Three Years Later...........
Four Years Later............
Five Years Later............
Six Years Later.............
Seven Years Later...........
Eight Years Later...........
Nine Years Later............
Ten Years Later.............
Liability re-estimated as of:
One Year Later.............. 37,642 44,373
Two Years Later............. 38,663
Three Years Later...........
Four Years Later............
Five Years Later............
Six Years Later.............
Seven Years Later...........
Eight Years Later...........
Nine Years Later............
Ten Years later.............
</TABLE>
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<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------
1988 1989 1990 1991 1992 1993 1994 1995
---- ---- ---- ---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Cumulative deficiencies
(Redundancies).............. $ 4,338 $ 1,664 $ 473 $(1,935) $ (333) $ 5,140 $ 6,466 $ 740
======= ======= ======= ======= ======= ======= ======= =======
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1996 1997 1998
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Cumulative deficiencies
(Redundancies).............. $ 1,606 $ 988
======= ======= =======
</TABLE>
Generally accepted accounting principles (GAAP) require insurance
liabilities on the balance sheet be reported without reduction for anticipated
recoverables under reinsurance contracts. Statutory accounting practices
continue to permit reporting on a net basis. The following table sets forth the
reconciliation of GAAP reported reserves to reserves net of reinsurance as shown
above.
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1998 1997 1996
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Gross loss and loss adjustment expense reserves.... $56,514 $55,355 $47,037
Ceded to other insurance companies(1).............. 11,980 11,970 9,980
------- ------- -------
Net liability as stated above...................... $44,534 $43,385 $37,057
======= ======= =======
</TABLE>
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(1) Before reduction for funds held from reinsurers
As indicated in the above tables, the Company has experienced adverse loss
development for policy years other than 1991 and 1992. Reserve deficiencies for
1990 and prior have developed primarily in the U.S. Customs bond line of
business. Historical reserve deficiencies resulted from several causes,
including modifications in the administrative procedures utilized by Customs in
the claims assessment and collection area; the previously described
computerization of the claims administration process by Customs; certain court
decisions regarding claims administration procedures that were decided favorably
to Customs and certain extraordinary losses experienced by the Company. The
extraordinary losses were related to a discontinued line of bond business for
environmental and safety requirements for imported automobiles, a discontinued
program for travel agents and a Customs determination on certain steel
importations involving countervailing duty and anti-dumping issues. (In
accordance with Customs procedures operative at the time, these risks were
primarily secured by many single entry bonds.) The aggregate cumulative losses
on these items is approximately $5,500,000, net of reinsurance ceded. The
Customs regulations have been modified to restrict such aggregation of liability
in the future. Moreover, the database now permits the Company to track and
control such aggregations on a more timely basis.
As prior period reserve inadequacies became apparent, the Company took
several actions to strengthen its reserve posture by increasing its premium
rate, adjusting its current reserve practices and affecting lump sum increases
to the reserves.
During 1995, it became apparent that the estimated unpaid claims for
liabilities established at December 31, 1994 on Kingsway's business lines would
exceed initial expectations and loss reserves were increased accordingly by $4.0
million. In addition, the reserves reported to Kingsway by the Canadian Facility
Association Risk Sharing Pool as at December 31, 1994 increased substantially
during 1995. The Risk Sharing Pool was created by legislation in Ontario to
ensure the availability of automobile insurance to every motorist in Ontario.
Every insurer writing automobile insurance is required to share in these losses
in proportion to their business in the Province.
Also, during 1995, loss experience related to U.S. operations for 1994 and
prior suggested reserve increases amounting to $5.2 million were required for
the marine cargo, contract surety and other property and casualty lines. These
increases were offset by savings of $3.1 million on 1994 and prior U.S. Customs
bonds reserve estimates.
During 1996, further adverse development for prior years emerged. Increases
totaling $2.4 million were made in the contract surety, marine and professional
liability product lines. These increases were partially
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offset by reductions totaling $814,000 to U.S. Customs bonds and other property
and casualty reserve estimates.
During 1997, $3.0 million was added to loss and loss adjustment expense
reserves across several lines. Loss and loss adjustment expense reserves are
estimated using a range of values. The overall reserves carried by the Company
have been within such ranges. Management nevertheless considered it prudent to
further strengthen these reserves so as to provide greater margins in the event
of adverse development arising from unanticipated events.
During 1998, $4.2 million was added to reserves in the marine, professional
liability and other property and casualty segments. This addition was done to
reflect emerging experience as well as to provide for additional margin. Loss
and LAE reserves are estimated using a range of values and include a select
point which represents the level of reserves deemed most likely to ultimately
develop. The Company has consistently carried the overall level of reserves
within the estimated ranges. The actions in 1998 served to move the overall
level of reserves to approximately the select point.
Claims experience tends to be dependent upon the frequency of claims and
the severity of individual claims. Severity exposures are the subject of certain
excess of loss reinsurance treaties as described above. Until recent Customs'
automation, obtaining reliable information on the frequency of claims was
difficult and was further compounded by the historically long delays in Customs'
claims assessment and processing. Currently, Customs forwards a computer tape of
outstanding bills for additional duty and liquidated damages to the Company on a
weekly basis. This data is input to the Company's computer and used to initiate
claims handling procedures.
The Company's bond and marine cargo losses are generally tied to the value
of the goods as of the date of shipment and generally are not adversely affected
by inflation; however, LAE is subject to the effects of inflation. LAE is
composed primarily of hourly fee costs for attorneys, adjusters and survey
firms. Such professional services typically are subject to rate increases at the
discretion of the provider. While the Company makes every effort to control the
rates and hours of service, it is imperative to retain qualified personnel
familiar with the business of the Company and the insurance industry.
COMPETITION
The insurance industry is highly competitive. The Company faces competition
from bond underwriters, marine and non-marine insurers and numerous other
insurance companies. These insurers vary in terms of size, quality, operating
histories and financial, marketing and management resources. Many of these
competitors are larger, have more agents and have substantially greater
financial resources than the Company.
The U.S. Customs bond business is highly specialized and requires
significant technical knowledge in order to properly underwrite and respond to
claims. Additionally, the automated processing systems which the U.S. Customs
Service has installed for its own use necessitate that surety companies also be
automated for claims. In addition to the ability to use the data tapes, and data
base information, the time frames available for collection and payment have been
shortened, requiring sureties to respond on a daily basis.
There are over 300 companies in the United States Department of the
Treasury's approved list of companies acceptable as sureties and reinsurers of
federal bonds including U.S. Customs bonds. While there is no reliable data
available from which to determine the amount or volume of U.S. Customs bonds
written by these companies, the Company believes that it and one of its
competitors, Washington International Insurance Company, are the dominant
underwriters for U.S. Customs bonds.
Many major insurance companies, agents and brokers compete for marine cargo
insurance business. The Company believes that its ability to compete in this
market is enhanced by its relationships with customs brokers and freight
forwarders.
In past years the Company had few competitors in the U.S. for its
professional liability product. Recently more competitors have emerged with a
similar product. Outside of the U.S., alternative coverages are marketed by
competitors in conjunction with a broad form marine and liability policy. The
Company
8
<PAGE> 10
developed a new form, the International Transit Liability Policy ("ITL"), to be
more compatible to these market expectations. The Company believes that its
ability to provide prompt, efficient service to customs brokers and freight
forwarders, as well as its expertise and understanding of the risks involved in
those industries, provide a competitive advantage over other carriers in both
its professional liability lines and its property and casualty lines.
REGULATION
U.S. Federal Regulation. U.S. Customs bonds are sold pursuant to federal
regulations requiring virtually every importer of goods into the United States
to post a bond. IIC currently maintains a Certificate of Authority as a surety
company qualified to write U.S. Customs bonds pursuant to federal law and
applicable regulations promulgated by the U.S. Department of Treasury (the
"Treasury"). The Treasury determines the maximum amount of risk retention per
bond for each qualified insurance company. IIC is qualified to write U.S.
Customs bonds and retain an aggregate liability up to $2,939,000 on any one
bond.
Although no specific statutory requirements exist, the Treasury generally
recommends no greater than a three to one ratio of net premiums written to
statutory surplus for sureties licensed to write U.S. Customs bonds. The Company
continues to meet this guideline.
Insurance companies issuing U.S. Customs bonds and customs brokers selling
such bonds are extensively regulated by the Treasury, including an annual review
of their financial statements. As a result of extensive federal regulation, the
Company believes that under the McCarran Ferguson Act, its U.S. Customs bonds
business is exempt from state regulation. No state has taken any action to
require the Company's compliance with its licensure requirements with respect to
its U.S. Customs bond business.
State Regulation. The Company and its U.S. insurance subsidiary are subject
to regulation under the various state insurance laws where the subsidiary is
licensed, including each particular state's insurance holding company law
("Holding Company Law"). Such regulation is designed generally to protect
policyholders rather than investors and relates to such matters as the standards
of solvency which must be met and maintained; the licensing of insurers and
their agents; the nature of and examination of the affairs of insurance
companies, which includes periodic financial and market conduct examinations by
regulatory authorities; annual and other reports, prepared on a statutory
accounting basis, required to be filed on the financial condition of insurers or
for other purposes; establishment and maintenance of reserves for unearned
premiums and losses; and requirements regarding numerous other matters. In
general, the Company's insurance subsidiary must file rates for insurance
directly underwritten with the insurance department of each state in which it
operates. Further, state insurance statutes typically place limitations on the
amount of dividends or other distributions payable by domiciled insurance
companies in order to protect their solvency.
Holding Company Laws impose standards on certain transactions between
registered insurers and their affiliates, which include, among other things,
that the terms of the transactions be fair and reasonable and that the books,
accounts and records of each party be maintained so as to clearly and accurately
disclose the precise nature and details of the transactions. Holding Company
Laws also generally require that any person or entity desiring to acquire more
than a specified percentage (commonly 10%) of the Company's outstanding voting
securities is required first to obtain approval of the applicable state
insurance regulators.
The National Association of Insurance Commissioners (NAIC) facilitates the
regulation of multi-state companies through uniform reporting requirements,
standardized procedures for financial examinations, and uniform regulatory
procedures embodied in model acts and regulations. Certain of these regulations
address the reporting and regulation of the adequacy of capital and surplus. At
December 31, 1998, IIC's required risk-based capital was $7,194,000, and
reported capital and surplus was $32,615,000.
Foreign Regulation. In the U.K. the Company is subject to regulation by the
Insurance Division, Department of Trade and Industry. In Hong Kong, the Company
is subject to regulation by the Office of the Commissioner of Insurance under
the Insurance Companies Ordinance and related amendments. Violations of the
provisions under which these foreign locations operate can lead to various
regulatory actions, up to and including the loss of the ability to operate.
9
<PAGE> 11
INVESTMENT POLICY
The Company's investment policy requires that fixed income invested assets
be comprised of investment grade securities of short to medium term. The Company
does not invest in real estate or real estate securities, "high yield" bonds or
derivatives. The Company's philosophy is to hold its investments to maturity
when feasible, but will redeploy assets when market conditions dictate.
Substantially all of the Company's investment portfolio is comprised of
investment grade securities issued by the U.S. Treasury, various federal
agencies, various state and local governments and major U.S. corporations.
EMPLOYEES
At December 31, 1998, the Company had 134 U.S. employees. Except for 6
part-time employees, all such persons are employed on a full-time basis. The
Company has 5 employees in its U.K. operations and 10 employees in Hong Kong.
The Company believes that it enjoys favorable relations with its employees.
ITEM 2. PROPERTIES
The Company occupies leased space in Schaumburg, Illinois where its
principal executive offices are located. IIC leases space in London where a
branch office is maintained. IIC also leases space for regional offices in New
York City, Tampa, Florida and Woodland Hills, California. Intercargo Insurance
Company H.K. Ltd. leases office space in Hong Kong.
ITEM 3. LITIGATION
During the month of January 1998, the president of IAS resigned and with
several other employees formed Avalon Risk Management, Inc. Avalon's announced
purpose is to compete with IAS in the marketing and distribution of
transportation related insurance and surety products. The Company has filed suit
in the Chancery Division of the Circuit Court of Cook County, Illinois against
the ex-president alleging breach of fiduciary duty, theft of confidential
information and other unlawful activities, and seeking injunctive relief and
damages. The action is pending and its outcome at this point is not certain.
In February 1999, certain purported shareholders of the Company filed a
lawsuit against the Company and its directors, seeking class action status and
claiming, among other things, the directors breached their fiduciary duties to
the Company's shareholders in approving the definitive agreement to merge
between the Company and a subsidiary of XL Capital and that they failed to
adequately explore alternative transactions and maximize shareholder value. The
lawsuit requests, among other things, injunctive relief and payment of damages
to the class members. The Company believes that the lawsuit is without merit and
intends to contest it vigorously.
There are no other pending material legal proceedings to which the Company
or its subsidiaries is a party or of which any of the properties of the Company
or its subsidiaries is subject, except for claims arising in the ordinary course
of business. In the ordinary course of business, the Company is involved in
certain litigation. In the opinion of management, the ultimate resolution of
such litigation will not have a material effect on the financial condition of
the Company.
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
None.
10
<PAGE> 12
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock, par value $1.00, is traded on the NASDAQ
National Market under the symbol ICAR. The table shown below contains the range
of high and low closing sale prices of the common stock of the Company as
reported by NASDAQ for each calendar quarter for the last two fiscal years.
<TABLE>
<CAPTION>
QUARTER HIGH LOW
- ------- ---- ---
<S> <C> <C>
4th 1998.................................................... 12.00 9.38
3rd 1998.................................................... 11.88 9.13
2nd 1998.................................................... 13.00 11.34
1st 1998.................................................... 13.50 11.38
4th 1997.................................................... 14.13 12.88
3rd 1997.................................................... 14.25 10.38
2nd 1997.................................................... 12.00 9.13
1st 1997.................................................... 10.13 8.50
</TABLE>
The number of holders of record of Company common stock on March 8, 1999,
was 79. Certain information made available to the Company from Automatic Data
Processing (ADP) and broker dealers holding securities in street name indicates
there are approximately 738 beneficial owners of the Company's common stock.
The Company paid dividends of $0.18 per share, or $1.4 million in 1998,
1997 and 1996. Any future dividends will depend upon the earnings and financial
position of the Company and its principal operating subsidiary, IIC, as well as
legal and contractual restrictions. In addition, the insurance laws of Illinois,
the domicile of IIC, require that dividends from IIC to the Company be paid only
out of earned surplus, and are limited to the greater of (i) 10% of the prior
year's statutory surplus or (ii) statutory net income, as defined. The Agreement
and Plan of Merger limits the payment of any regular semi-annual dividend to
$0.09 per share unless consent thereto is granted by XL Capital.
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31:
--------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Revenues(1).............................. $ 61,297 $112,159 $ 68,241 $ 94,186 $ 80,885
Operating income (loss)(1)............... $ (5,421) $ 46,141 $ 3,705 $ 4,050 $ 7,359
Net income (loss)........................ $ (3,372) $ 31,788 $ 6,404 $ 2,139 $ 4,981
Total assets............................. $163,400 $165,412 $133,710 $116,166 $128,423
Total stockholders' equity............... $ 72,975 $ 82,201 $ 48,012 $ 43,621 $ 39,921
Per Share Amounts
Net income (loss) from continuing
operations............................. $(0.44) $4.14 $0.84 $0.28 $0.65
Dividends................................ $ 0.18 $0.18 $0.18 $0.18 $0.18
Combined ratio(2)........................ 117.9% 112.9% 103.9% 103.6% 97.5%
</TABLE>
- -------------------------
(1) 1997 amounts reflect revenues from the Company's sale of its investment in
Kingsway Financial Services, Inc. (See Note 1 of the Notes to Consolidated
Financial Statements).
(2) Combined ratios have been computed for all years on a GAAP basis (see Item
7 -- Management's Discussion and Analysis).
11
<PAGE> 13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
The Company, through its subsidiaries, is engaged in the business of
underwriting specialty insurance coverages for international trade. This
includes U.S. Customs bonds, marine cargo insurance, professional liability
insurance, and property and casualty insurance. The Company has a subsidiary in
Hong Kong and a branch office in the United Kingdom. Until December 18, 1995,
the Company was the sole parent company of Kingsway Financial Services, Inc.
("Kingsway"), an underwriter of automobile, and property and casualty insurance
in Canada. On December 18, 1995 Kingsway sold 1.8 million shares of its common
stock in an initial public offering. The Company participated in that
transaction as a selling shareholder, reducing its equity interest in Kingsway
from 100% to 50%. In January, 1996, as a result of the exercise of the
underwriters' over allotment option, the Company's equity in Kingsway was
reduced to 47.0%. In October, 1996, Kingsway conducted a secondary offering in
which the Company participated. As a result of this, the Company's equity in
Kingsway was further reduced to 31.5%. In August, 1997 Kingsway conducted
another secondary offering in which the Company participated. As a result of
this, the Company's equity in Kingsway was reduced to less then 1%. During all
of 1996 and 1997 until August 25, 1997 this investment had been accounted for by
the equity method.
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
1998 resulted in a net loss of $3.4 million or $0.44 per share as compared
to net income of $31.8 million or $4.14 per share in 1997 and $6.4 million or
$0.84 per share in 1996. During 1998 the Company faced many challenges. The
insurance market in the U.S. remains highly capitalized which continues to
foster soft market conditions for product pricing and intense competition for
premiums. In January of 1998 the president of IAS resigned and with several
other employees formed an operation whose announced purpose is to compete with
IAS in the marketing and distribution of transportation related insurance and
surety products. Litigation costs related to this added to the overall operating
costs. The departure of these employees presented the Company with the
opportunity to re-evaluate its focus. To this end the Company determined that it
should concentrate its focus on underwriting and that its primary distribution
method should be the use of independent brokers and agents. This led to the
decision to sell all of the domestic insurance brokerage agency business of IAS
in consideration for cash, convertible preferred stock and a secured installment
note, totaling approximately $7.9 million. The transaction was effected through
the sale of the capital stock of seven subsidiaries of IAS. The purchase price,
which is equivalent to approximately one times the commission revenue of the
transferred agencies, is subject to adjustment based on the commission revenue
of the transferred agencies for the twelve month period ending June 30, 1999.
In order to provide the necessary level of service to independent agents
and brokers and to enhance the ability to expand the number of independent
producers, the Company opened four regional offices. The immediate impact of
these openings was an increase to underwriting costs. The Company believes,
however, that the regional offices are a necessary factor to increase premium
writings and to provide enhanced customer service.
During the course of 1998 the Company was involved in an extensive review
of strategic alternatives. This review included among other things potential
acquisitions by the Company, as well as strategic alliances and mergers with
other entities. These efforts culminated with the Company entering into an
Agreement and Plan of Merger with XL noted in Item 1 of this Statement.
Additional information is contained in the Registrant's definitive Proxy
Statement for the Special Meeting of Shareholders relating to the Merger. As
part of this review the Company incurred costs for financial consulting and
legal services which impacted underwriting expenses.
12
<PAGE> 14
REVENUES
Insurance Premium Income
Net premiums written by segment are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Surety............................................. $18,768 $16,688 $23,177
Marine............................................. 27,594 28,247 27,470
Professional liability............................. 2,834 3,196 2,212
Other Property and Casualty........................ 6,325 9,061 5,594
------- ------- -------
Total......................................... $55,521 $57,192 $58,453
======= ======= =======
</TABLE>
Surety (U.S. Customs bonds, contract and miscellaneous surety bonds) net
premium written increased 12.5% in 1998. Contract and miscellaneous surety net
premium written increased $3.2 million or 116.1% due to an increase of $845
thousand or 13.3% in gross premium written and to the discontinuance of a 50%
quota share reinsurance treaty under which the Company had ceded business prior
to 1998. U.S. Customs bonds net premium written declined $1.2 million or 8.4%
due to competitive pressures. Such pressures are expected to continue for both
U.S. Customs bonds and contract surety bonds. In 1997, surety net premium
written declined 28.0%. Gross premiums written for U.S. Customs bonds were $3.1
million or 17.4% lower in 1997 than 1996. This was due to the move to rates
which are net of brokers' commissions, and to competitive pressures on overall
price structures. Gross premiums written for contract and miscellaneous surety
bonds were $2.4 million or 27.7% lower in 1997 than 1996. During the first half
of 1997 the Company was reviewing the strategic position of the contract and
miscellaneous surety line. During that period of evaluation marketing and sales
efforts remained static, and some sales momentum was lost. The Company
subsequently determined that these products can be viable and should remain a
part of the overall product portfolio. Sales and marketing efforts were then
reinvigorated, resulting in the increased premium volume shown in 1998. Marine
net written premium declined 2.4% in 1998, while it had increased only 2.8% in
1997. These results reflect the market pressures on price levels. It is expected
that the marine cargo insurance line will continue to experience such pressures
in the foreseeable future. Professional liability net written premium decreased
11.3% in 1998 after having increased 44.5% in 1997. The decline in 1998 is due
primarily to the continuing efforts to re-underwrite this line of business. At
the time of renewal unprofitable accounts are being given appropriate rate
increases or are being cancelled. The increase in 1997 was attributable to
significant rate actions taken late in 1996 and extending into 1997 as well as
the circumstance that 1996 net written premiums were negatively impacted by $1.4
million in retrospective reinsurance premiums applicable to the development of
prior period coverages. Other property and casualty net premium written
decreased 30.2% in 1998 as compared to an increase of 62.8% in 1997. The
decrease in 1998 is due to a decrease of $4.5 million in net premium written
related to a program providing liability coverage on cranes. This same program
was the primary factor affecting the increase in net premiums written in 1997.
Absent the effects of this crane liability program, other property and casualty
net premiums written would have increased $1.8 million or 42.8% in 1998 due
primarily to increased volume in truck liability and physical damage coverages.
Insurance premium income, or earned premium, decreased $4.9 million or 8.6%
in 1998 to $52.5 million. In 1997, earned premium declined $3.6 million or 6.0%
to $57.4 million from $61.0 million in 1996. Premiums are earned over the
effective period of policy coverages and reflect the recognition of income from
the changing levels of net premium written.
INVESTMENT INCOME AND REALIZED GAINS
Net investment income was $6.1 million in 1998 as compared to $4.9 million
in 1997 and $4.0 million in 1996. The increase in 1998 was attributable to
earnings on the cash equivalents portion of the investment portfolio. In August
of 1997 the Company sold 4,018,000 of its shares in Kingsway Financial Services.
The 1998 results benefited from a full year of investment of the resultant
proceeds, as compared to approximately
13
<PAGE> 15
four months in 1997. Yields in 1998 on the long-term portion of the portfolio
were down slightly versus 1997. Net investment income was $4.9 million in 1997
as compared to $4.0 million in 1996, an increase of $900 thousand. The increase
is attributable to the increase in the fixed income portion of the investment
portfolio and to investment income on the proceeds from the Kingsway sale,
offset somewhat by a decline in average yield due to the general decline in
interest rates. Realized investment gains in 1998 were $2.1 million as compared
to $48.9 million in 1997 and $2.4 million in 1996. In 1997, the Company sold
4,018,000 of its shares in Kingsway giving rise to a gain net of related
expenses of $49.4 million. The 1998 and 1996 realized gains include $900
thousand and $2.4 million, respectively, in gains related to sales of Kingsway
shares. Also included in the 1998 amount is $1.1 million in gain from the sale
of certain IAS subsidiaries.
EXPENSES AND OTHER
Loss and Loss Adjustment Expenses
The following chart depicts loss and loss adjustment expenses ("LAE") by
segment.
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
OTHER
PROFESSIONAL PROPERTY &
SURETY MARINE LIABILITY CASUALTY TOTAL
---------------- ---------------- ---------------- ---------------- ----------------
LOSS LOSS LOSS LOSS LOSS
LOSSES RATIO LOSSES RATIO LOSSES RATIO LOSSES RATIO LOSSES RATIO
YEAR INCURRED (%) INCURRED (%) INCURRED (%) INCURRED (%) INCURRED (%)
- ---- -------- ----- -------- ----- -------- ----- -------- ----- -------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1998 $4,124 23.7 $19,832 76.9 $3,490 130.5 $5,222 79.1 $32,668 62.3
1997 $5,087 28.3 $19,482 69.8 $3,752 117.0 $6,524 78.1 $34,845 60.7
1996 $7,455 28.8 $17,759 65.9 $2,714 102.7 $4,379 77.8 $32,307 52.9
</TABLE>
In 1998 loss and LAE decreased 6.3% following an increase of 7.9% in 1997.
While the dollar level of loss and LAE declined in 1998, the overall loss ratio
increased to 62.3% from 60.7% in 1997. During 1998 overall loss and LAE reserves
were increased by $4.2 million. Reserves for certain lines were adjusted to
reflect developing experience. Reserves were also increased to provide for
additional margin. Loss and LAE reserves are estimated using a range of values
and include a select point which represents the level of reserves deemed most
likely to ultimately develop. The Company has consistently carried the overall
level of reserves within such ranges. The actions taken in 1998 served to move
the overall level of reserves to approximately the select point. Reserves in the
surety segment were reduced $1.8 million reflecting ongoing development of U.S.
Customs bonds claims. Marine loss reserves were increased $3.4 million to
reflect emerging poor development primarily on current year business.
Professional liability loss and LAE reserves were increased approximately $1.6
million to reflect emerging prior years' losses as well as to move the reserve
level to a higher point in the range. Other property and casualty reserves were
increased approximately $1.0 million. Workers' compensation reserves were
decreased $631 thousand to reflect continuing favorable development. Reserves
for the discontinued crane liability program were increased approximately $1.7
million to reflect adverse development. In 1997, loss and LAE increased $2.5
million or 7.9% as compared to 1996. During 1997, $3.0 million was added to loss
and LAE reserves across several lines. This was done in response to the
development of losses as well as to provide additional margins for adverse
development. The loss ratio for the surety segment has shown improvement
reflecting positive development for U.S. Customs bonds as well as the enhanced
underwriting plus premium growth in contract and miscellaneous surety. The
marine segment loss ratio deterioration is a reflection of the intense
competitive pressures on pricing. The loss ratio in the professional liability
segment in 1998 was negatively impacted by the increase in loss and LAE reserves
noted previously. The Company continues to seek more appropriate pricing for
covered risks under the professional liability program as it continues the
efforts to improve the performance of this segment. The loss ratio for the other
property and casualty segment of 79.1% for 1998 includes the previously
mentioned reserve increase related to the crane liability program. Had this not
been necessary the loss ratio for 1998 would have been 53.9%. This improvement
reflects the continued positive development in the loss and LAE reserves in the
workers' compensation line.
14
<PAGE> 16
POLICY ACQUISITION COSTS
Policy acquisition and other issue costs were $16.1 million, $14.3 million
and $17.4 million for 1998, 1997 and 1996 respectively. These costs as a
percentage of earned premiums were 30.8%, 24.8% and 28.5% in 1998, 1997 and
1996, respectively. The rise in the percentage for 1998 is the result of two
major factors. Prior to their April 30, 1998 sale, the Trade Insurance Services
("TIS") subsidiaries had produced a significant portion of the Company's
premiums, accounting for 69% of the 1997 volume. Intercompany commission income
of TIS was eliminated in consolidation against the commission expense of IIC.
After the sale of TIS, such commissions are now paid to unrelated entities and,
therefore, are no longer eliminated in consolidation. The other major factor
changing in 1998 was the discontinuance of a quota share reinsurance agreement
on contract surety business. Under that agreement, the Company received ceding
allowances which served to offset a portion of acquisition expenses. Excluding
these two items, the 1998 acquisition expenses would have been approximately
23.5% of earned premiums. The reduction in the percentage relationship of
acquisition costs to earned premiums in 1997 was attributable to the change in
the commission structure as pricing for certain products moved to a rate
structure net of brokers' commissions.
OTHER UNDERWRITING EXPENSES
Other underwriting expenses increased approximately $1.5 million, or 9.0%
in 1998 to $17.9 million from $16.4 million in 1997. During 1998 the company was
in the process of reviewing strategic alternatives, as described previously
herein. Costs associated with this endeavor were approximately $1.25 million.
Litigation and investigation costs relating to the departure of certain IAS
employees and the resultant litigation were approximately $800 thousand. Costs
associated with the development of regional offices were approximately $689
thousand. In addition, as the Company refocused on underwriting, the decision
was made to discontinue an agency operation, TRM Insurance Services("TRM"). TRM
has been sold effective February 28, 1999. Included in the assets of TRM was the
value of an agreement with the former owner to not engage in a similar business
nor solicit TRM's customer base for a stated period should this person leave
TRM. With the discontinuance of agency operations the contract no longer had a
basis for the value. Accordingly, the remaining carrying value of $390 thousand
was written off. This charge was included in other underwriting expenses.
Offsetting these costs somewhat was a reduction in other underwriting expenses
of $805 thousand as a result of the sale of certain IAS subsidiaries. In
addition, expense initiatives undertaken during the course of the year have
reduced headcount by 9.6% in addition to employee reduction resulting from the
sale of IAS subsidiaries. The Company is continuing its expense initiative in
the current year. Other underwriting expenses increased $2.3 million or 16.3% in
1997 to $16.4 million from $14.1 million in 1996. Insurance company operations
in 1997 showed an increase of $3.2 million. This was due to an increase in
insurance company bad debt expense in 1997 over 1996 of $2.0 million as the
result of the financial failure of certain producers. The Company generally
anticipates such failures when establishing allowances for bad debts. These
particular failures were unusual in magnitude and such occurrences in the future
are expected to be minimal. Also, salary and related benefits increased $972
thousand due in part to approximately $450 thousand associated with changes in
management during 1997. Agency operations expenses decreased approximately $909
thousand. Bad debt expense in the agency operations for 1997 was $504 thousand
less than 1996 as collection efforts were enhanced. Salary expense for the
agency operations in 1997 was down $261 thousand from 1996 due to staffing
changes.
15
<PAGE> 17
RESULTS BY SEGMENT
Operating income by segment is shown in the chart below. Additional
information on business segments is included in Note 20 of the Notes to
Consolidated Financial Statements which are included in this document.
Operating Income (Loss)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Surety............................................. $ 2,265 $ 1,081 $ 4,214
Marine............................................. (6,422) (3,599) (3,363)
Professional liability............................. (3,005) (2,379) (1,315)
Other property and casualty........................ (2,240) (2,518) (1,903)
Investment and other............................... 3,981 53,556 6,072
------- ------- -------
Operating income (loss).......................... $(5,421) $46,141 $ 3,705
======= ======= =======
</TABLE>
A significant factor in evaluating insurance company performance is the
combined ratio. The combined ratio is a comparison of claims costs plus other
expenses as a percentage of premiums earned.
SEGMENTS
<TABLE>
<CAPTION>
SURETY MARINE PROFESSIONAL LIABILITY
------------------- ------------------- -----------------------
PREMIUM COMBINED PREMIUM COMBINED PREMIUM COMBINED
YEAR EARNED RATIO (%) EARNED RATIO (%) EARNED RATIO (%)
- ---- ------- --------- ------- --------- ------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
1998................. $17,398 87.0 $25,791 124.9 $2,674 212.4
1997................. 17,947 94.0 27,906 112.9 3,206 174.2
1996................. 25,846 83.7 26,932 112.5 2,644 149.7
<CAPTION>
OTHER PROPERTY &
CASUALTY TOTAL
------------------- -------------------
PREMIUM COMBINED PREMIUM COMBINED
YEAR EARNED RATIO (%) EARNED RATIO (%)
- ---- ------- --------- ------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
1998................. $6,601 133.9 $52,464 117.9
1997................. 8,351 130.2 57,410 112.9
1996................. 5,631 133.8 61,053 103.9
</TABLE>
Combined ratios on a GAAP basis are presented here as the Company feels
this provides a conservative and consistent representation of the operational
performance as a whole. A combined ratio of less than 100% generally indicates
an underwriting profit. It's not uncommon in the property and casualty industry
to have combined ratios well in excess of 100%. No assurance is made that loss
and loss adjustment expense accruals upon which the Company's combined ratios
are based may not prove to vary significantly from the ultimate results.
IMPACT OF YEAR 2000
The year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have time sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations including, among
other things, a temporary inability to process transactions, send invoices,
calculate earned premiums or engage in similar normal business activities.
STATE OF READINESS
The Company began evaluating its readiness for the year 2000 in 1997 with a
review of the operating and application software. The Company uses software that
has been developed internally as well as software developed by third party
vendors. During 1998 the Company received written certification from its primary
third party vendors that their software is compliant with year 2000. The Company
established a Year 2000 Steering Committee, chaired by the Vice President of
Operations, which includes internal managers as well as
16
<PAGE> 18
external consultants. A project plan has been developed which consists of four
phases. These phases include (a) an inventory to identify software applications,
technology platforms and interfaces, and business partners, and rating each on
their potential business impact; (b) an initial assessment of the approach to be
used in determining year 2000 compliance; (c) remediation where non-compliant
items are reprogrammed or replaced; and (d) testing and certification of code
modifications and new inventory with other associated systems, including date
testing and quality assurance testing to ensure functioning in the post-1999
time frame. These phases are overlapping with one another and portions may be
done simultaneously.
The various hardware, software and embedded chip inventories will be
completed by the end of the first quarter of 1999, along with an initial
assessment of the approaches to be taken in determining compliance with year
2000. Remediation, testing and certification is targeted for completion by the
end of the third quarter of 1999. The Company believes that its year 2000
project is generally on schedule.
EXTERNAL RELATIONSHIPS
The Company also faces the risk that various customers or suppliers
("external relationships") will not be able to interact with the Company due to
the third party's inability to resolve circumstances arising from year 2000
issues they may have failed to address. The Company has completed an inventory
of business partners and risk rated the potential business impact. These include
significant producers as well as suppliers of such services as
telecommunications and banking. The Company is attempting to determine the
overall year 2000 readiness of these external relationships.
The Company has initiated a program to inform its customers of the
potential impact that year 2000 issues may have on their operations. Should
customer operations insured by the Company be unable to adequately perform their
services due to circumstances arising from year 2000 issues they may have failed
to address, the Company may be adversely impacted. This may include, but not be
limited to, such items as inability or failure of customers to remit premiums,
and additional incurred claims under various insurance policies issued by the
Company. While the Company may seek to limit its exposure to such claims, there
is uncertainty as to the acceptance of these limitations by regulators and the
legal system. The economic impact of these uncertainties cannot be determined at
this time.
The Company does not have sufficient information at this time to predict
whether its external relationships will be year 2000 compliant. There can be no
guarantee that the systems of other companies on which the Company's systems
rely will be timely converted and would not have an adverse affect on the
Company's systems.
COSTS TO ADDRESS YEAR 2000 ISSUES
The Company incurred expenses of approximately $155,000 (before tax) in
1998 related to year 2000 initiatives. Such costs for 1999 are currently
estimated to range from $265,000 to $664,000 depending upon the extent of
remediation or replacement necessary. The Company expects to fund these costs
through operating cash flows.
CONTINGENCY PLANNING
The Company is attempting to limit the potential impact of year 2000 issues
by monitoring the progress of its own year 2000 project and those of its
critical external relationships by developing contingency and recovery plans.
The Company is addressing such areas as revenue collection, claims processing,
financial reporting and outside service suppliers. In some instances manual
processes can be used. The Company is expecting to have contingency plans in
place by the end of the third quarter of 1999.
RISKS AND OTHER FACTORS REGARDING YEAR 2000
The costs of the year 2000 project and the date on which the Company
believes it will complete the year 2000 modifications are based on management's
best estimates, which were derived using numerous assumptions of future events,
including the continued availability of certain resources, third party
modification
17
<PAGE> 19
plans, and other factors. However, there can be no guarantee that these
estimates will be achieved and actual results could differ materially from those
anticipated. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of personnel trained
in this area, the ability to locate and correct all relevant computer codes, and
similar uncertainties.
The Company cannot guarantee that it will be able to resolve all of its
year 2000 issues. Any critical year 2000 issues at the Company or its external
relationships could have material adverse effect on the Company's results of
operations, liquidity or financial condition.
INFLATION AND OTHER FACTORS
Periods of inflation have varying effects on the Company and other
companies in the insurance industry. Because premium rates for the Company's
U.S. Customs bond and marine cargo insurance products are usually tied to the
value of cargo being imported or exported, an increase in price levels may
result in revenue increases. In periods of inflation, the property and casualty
industry generally experiences higher losses, loss adjustment expenses and
operating costs. In contrast, the Company's U.S. Customs bond and marine cargo
premiums and losses are tied to the value of goods as of the date of shipment
and generally are not adversely affected by inflation.
The value of the dollar relative to other world currencies also affects the
Company's U.S. Customs bond and marine cargo business. When the dollar is strong
relative to other world currencies, imports generally increase and U.S. Customs
bond volume increases. When the dollar is weak relative to other world
currencies, exports generally increase and marine cargo insurance volume
increases. The company's foreign operations expose the Company to changes in the
relative value of the U.S. dollar to the local currencies. (Refer to Foreign
Operations in Notes to the Consolidated Financial Statements.)
FEDERAL INCOME TAXES
The Company's effective tax rates for the years 1998, 1997 and 1996 were
37.8%, 38.4% and 20.4% respectively. The effective tax rate differs from the
U.S. federal corporate tax rate due to the Company's investments in tax exempt
securities, changes in the valuation allowance related to deferred tax assets,
and the differential in book and tax bases of assets disposed (including the
disposal of Kingsway) (see accompanying Notes to Consolidated Financial
Statements).
LIQUIDITY AND CAPITAL RESOURCES
The capacity of an insurance company to underwrite insurance is based upon
maintaining liquidity and capital resources sufficient to pay claims and
expenses as they become due. The Company has historically generated adequate
capital resources to support its current operations. This position is further
enhanced by its investment policy which emphasizes high quality, short to medium
term investments. The primary sources of the Company's liquidity are funds
generated from insurance premiums, investment income, and proceeds from
investment maturities. The principal application of such funds are payments of
losses and loss adjustment expenses, investments, reinsurance, and operating
expenses.
Operations in 1998, in a departure from recent years, used cash of
approximately $7.9 million. In 1997 and 1996, cash flow from operations amounted
to $575 thousand and $6.3 million, respectively. The use of cash in 1998 was due
to factors including a net loss for the year as well as to increases in the
level of premiums receivable, due to a temporary change in remittance terms, and
in taxes recoverable. The decrease in the level of cash provided from operating
activities in 1997 as compared to 1996 was due to higher levels of reinsurance
balances recoverable and to decreases in various liabilities including accounts
payable.
In 1998 the Company repurchased 406,400 of its own shares for treasury at
an average price of $9.95 per share, utilizing approximately $4.04 million of
cash. Despite the net use of cash in 1998, the Company's level of cash and cash
equivalents remains significantly higher than the historical norm. This high
level of cash and cash equivalents is primarily the result of gross proceeds
from the sale of Kingsway common stock amounting to $67.7 million in 1997. A
portion of these proceeds were used to extinguish debt, increase the statutory
18
<PAGE> 20
capital and surplus of Intercargo Insurance Company, finance short term
investment and general corporate purposes, including payment of related income
taxes of $18.5 million on the gain from sale. Proceeds from the sale of Kingsway
common stock in 1996 were used to increase the statutory capital and surplus of
IIC and for general corporate purpose.
The Company has discontinued its $15.0 million line of credit in light of
its current high level of available funds.
The Company does not have any material commitments for capital
expenditures. However, under terms of its Agreement and Plan of Merger with XL
Capital, the Company is required to have at least $24 million in cash and cash
equivalents at the consummation of the subject merger.
FINANCIAL INSTRUMENTS AND MARKET RISK
A financial instrument is cash or a contract that imposes or conveys a
contractual obligation or right to deliver or receive cash or another financial
instrument. Included at Note 17 of the Notes to Consolidated Financial
Statements is information summarizing the Company's financial instruments and
their estimated fair values. As indicated in the Note, the fair values of the
Company's financial instruments approximate their carrying values.
The Company is subject to market risk exposures of varying correlations and
volatilities, including foreign exchange rate risk, interest rate risk and
equity price risk. The following disclosure reflects estimates of future
performance and economic conditions. Actual results may differ.
The Company is subject to foreign exchange rate risk associated with
translating financial statements of its foreign subsidiaries and branches into
U.S. dollars. The Company's primary exposures are associated with the British
Pound and the Hong Kong dollar. The Company does not use hedging transactions in
managing these risks due to the relatively low level of exposure. Revenues from
foreign operations of $5.8 million in 1998 and $4.9 million in 1997 represented
10.4% and 4.6% of total revenues, respectively, in those years. Identifiable
foreign assets of $10.5 million at December 31, 1998 and $10.0 million at
December 31, 1997 represented 6.9% and 6.4%, respectively, of total consolidated
assets at those dates. A decrease of 10% in the foreign exchange rates would
have increased net income by $14,000 in 1998 and $65,000 in 1997 due to net
losses in foreign operations in those years. Such a decrease in foreign exchange
rates would have reduced equity by $284,000 and $304,000 at year-end 1998 and
1997, respectively.
The valuation of the Company's fixed maturity portfolio is subject to
long-term interest rate risk. In order to reduce the impact of changes in
long-term interest rates on the market value of its portfolio, the Company
invests in medium term obligations and endeavors to spread the maturity dates
over its investment horizon. A hypothetical increase of 100 basis points in
interest rates over the yield curve spectrum would decrease the market value of
the fixed maturity portfolio at December 31, 1998 by approximately $345,000.
The valuation of the Company's equity portfolio is subject to market risk.
At December 31, 1998 the equity portfolio had a fair value of $4.9 million,
which was 3.0% of total assets. Of this amount, $2.5 million represented a
private placement issue with limited market risk exposure. The Company has not
entered into any transactions to hedge the price risk on the equity portfolio
due to the relatively low level of exposure when compared to total assets.
19
<PAGE> 21
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Intercargo Corporation
We have audited the accompanying consolidated balance sheets of Intercargo
Corporation and subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years then ended. Our audits also included the financial statement schedules
listed in the index at Item 14(a). These financial statements and schedules are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Intercargo Corporation and subsidiaries at December 31, 1998 and 1997, and the
consolidated results of their operations and their cash flows for the years then
ended, in conformity with generally accepted accounting principles. Also, in our
opinion, the related 1998 and 1997 financial statement schedules, when
considered in relation to the basic financial statements taken as a whole,
present fairly in all material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
Chicago, Illinois
March 19, 1999
20
<PAGE> 22
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders of
Intercargo Corporation:
We have audited the accompanying consolidated statements of operations,
stockholders' equity, and cash flows of Intercargo Corporation and subsidiaries
for the year ended December 31, 1996. In connection with our audits of the
aforementioned consolidated financial statements, we also audited the related
consolidated supplementary financial statement schedules as listed in the
accompanying index for 1996. 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 audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the results of operations and the cash
flows of Intercargo Corporation and subsidiaries for the year ended December 31,
1996, in conformity with generally accepted accounting principles. Also, in our
opinion, the aforementioned supplementary 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.
/s/ KPMG LLP
Chicago, Illinois
February 21, 1997
21
<PAGE> 23
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INTERCARGO CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
INVESTMENTS
Fixed maturities at fair value (amortized cost $57,990 in
1998 and $59,814 in 1997).............................. $ 59,584 $ 60,676
Equity securities at fair value (amortized cost $3,761 in
1998 and $1,833 in 1997)............................... 4,856 4,234
-------- --------
Total investments................................. 64,440 64,910
Cash and cash equivalents................................... 39,087 49,400
Premiums receivable......................................... 19,306 15,677
Accrued investment income................................... 1,195 1,023
Deferred policy acquisition costs........................... 4,140 2,939
Reinsurance recoverable on losses and loss adjustment
expenses:
Paid claims............................................... 4,115 1,137
Unpaid claims............................................. 11,980 11,970
Prepaid reinsurance premiums................................ 4,344 5,119
Notes receivable............................................ 3,587 99
Income tax recoverable...................................... 895 1,365
Deferred income tax......................................... 4,530 2,226
Equipment, at cost, less accumulated depreciation........... 1,324 1,933
Goodwill.................................................... 393 1,991
Other assets................................................ 4,064 5,623
-------- --------
Total assets...................................... $163,400 $165,412
======== ========
LIABILITIES
Losses and loss adjustment expenses......................... $ 56,514 $ 55,355
Unearned premiums........................................... 20,241 17,948
Funds held by Company....................................... 422 372
Supplemental duty deposits.................................. 1,703 2,016
Accrued expenses and other liabilities...................... 11,545 7,520
-------- --------
Total liabilities................................. 90,425 83,211
-------- --------
Commitments and Contingencies............................... -- --
STOCKHOLDERS' EQUITY
Common stock -- $1 par value; authorized 20,000,000 shares;
issued 7,699,981 shares; outstanding 7,293,581 shares in
1998 and 7,699,981 shares in 1997......................... 7,700 7,700
Additional paid-in capital.................................. 24,400 24,400
Treasury stock, at cost; 406,400............................ (4,044) --
Accumulated other comprehensive income...................... 1,752 2,176
Retained earnings........................................... 43,167 47,925
-------- --------
Total stockholders' equity........................ 72,975 82,201
-------- --------
Total liabilities and stockholders' equity........ $163,400 $165,412
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
22
<PAGE> 24
INTERCARGO CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
REVENUES
Insurance premium income.................................... $52,464 $ 57,410 $61,053
Net investment income....................................... 6,122 4,911 3,985
Realized investment gains................................... 2,139 48,871 2,379
Commission income........................................... 435 675 686
Other income................................................ 137 292 138
------- -------- -------
Total.................................................. 61,297 112,159 68,241
------- -------- -------
LOSSES AND EXPENSES
Losses and loss adjustment expenses......................... 32,668 34,845 32,307
Policy acquisition and other issue costs.................... 16,149 14,258 17,410
Other underwriting expenses................................. 17,901 16,427 14,051
Interest expense............................................ -- 488 768
------- -------- -------
Total.................................................. 66,718 66,018 64,536
------- -------- -------
Operating income (loss)..................................... (5,421) 46,141 3,705
Income tax expense (benefit)................................ (2,049) 17,710 755
------- -------- -------
Net income (loss) before equity in net income of investee... (3,372) 28,431 2,950
Equity in net income of investee............................ -- 3,357 3,454
------- -------- -------
Net income (loss)........................................... $(3,372) $ 31,788 $ 6,404
======= ======== =======
Net income (loss) per share -- basic and diluted............ $ (0.44) $ 4.14 $ 0.84
======= ======== =======
</TABLE>
See accompanying notes to consolidated financial statements.
23
<PAGE> 25
INTERCARGO CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER TOTAL
NUMBER COMMON PAID-IN TREASURY COMPREHENSIVE RETAINED STOCKHOLDERS'
OF SHARES STOCK CAPITAL STOCK INCOME (LOSS) EARNINGS EQUITY
--------- ------ ---------- -------- ------------- -------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1995.......... 7,641 $7,641 $24,104 $ -- $ (612) $12,488 $43,621
Net income............................ 6,404 6,404
Change in foreign currency
translation......................... 201 201
Change in unrealized gain (loss) on
investments......................... (933) (933)
-------
Comprehensive income.................. 5,672
-------
Dividends paid to stockholders ($0.18
per share).......................... (1,376) (1,376)
Employee stock options exercised...... 19 19 76 95
----- ------ ------- ------- ------- ------- -------
BALANCE AT DECEMBER 31, 1996.......... 7,660 7,660 24,180 -- (1,344) 17,516 48,012
Net income............................ 31,788 31,788
Change in foreign currency
translation......................... 1,001 1,001
Change in unrealized gain (loss) on
investments......................... 2,519 2,519
-------
Comprehensive income.................. 35,308
-------
Dividends paid to stockholders ($0.18
per share).......................... (1,379) (1,379)
Employee stock options exercised...... 40 40 220 260
----- ------ ------- ------- ------- ------- -------
BALANCE AT DECEMBER 31, 1997.......... 7,700 7,700 24,400 -- 2,176 47,925 82,201
Net loss.............................. (3,372) (3,372)
Change in foreign currency
translation......................... (45) (45)
Change in unrealized gain (loss) on
investments......................... (379) (379)
-------
Comprehensive loss.................... (3,796)
-------
Dividends paid to stockholders ($0.18
per share).......................... (1,386) (1,386)
Purchase of treasury stock............ (406) (4,044) (4,044)
----- ------ ------- ------- ------- ------- -------
BALANCE AT DECEMBER 31, 1998.......... 7,294 $7,700 $24,400 $(4,044) $ 1,752 $43,167 $72,975
===== ====== ======= ======= ======= ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
24
<PAGE> 26
INTERCARGO CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................................... $(3,372) $ 31,788 $ 6,404
Adjustments to reconcile net income (loss) to net cash
provided from (used in) operating activities:
Realized gains............................................ (2,139) (48,871) (2,379)
Depreciation and amortization............................. 1,474 1,521 1,546
Amortization of premiums on investments................... 122 48 102
Write-off of intangible asset............................. 390 -- --
Undistributed income of affiliate......................... -- (3,357) (3,454)
Increase in premiums receivable........................... (3,629) (52) (1,311)
Decrease (increase) in deferred policy acquisition
costs................................................... (1,201) 946 1,014
Increase in reinsurance balances.......................... (2,213) (3,602) (8,380)
Decrease (increase) in notes receivable................... 10 116 (323)
Change in income tax accounts............................. (1,639) 15,390 20
Decrease (increase) in other assets....................... 306 (793) (56)
Increase in liability for losses and loss adjustment
expenses................................................ 1,159 8,318 10,744
Increase (decrease) in unearned premiums.................. 2,293 332 (74)
Increase (decrease) in funds held......................... 50 (120) (257)
Decrease in supplemental duty deposits.................... (313) (342) (311)
Increase (decrease) in accrued expenses and other
liabilities............................................. 1,062 (519) 3,051
Other, net................................................ (236) (228) (16)
------- -------- --------
Net cash provided from (used in) operating
activities......................................... (7,876) 575 6,320
------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Fixed maturities:
Purchases................................................. (23,139) (30,380) (27,314)
Sales..................................................... 8,192 18,908 13,332
Maturities and calls...................................... 16,755 3,478 5,370
Equity securities:
Purchases................................................. (460) (498) (502)
Sales..................................................... 1,875 822 2,140
Calls..................................................... 152 188 185
Net sales (purchases) of short-term investments............. -- (1) 510
Sale of subsidiaries........................................ (165) -- --
Purchase of subsidiary, net of cash acquired................ -- (237) --
Sale of Kingsway common stock (net of taxes of $18,500 in
1997)..................................................... -- 49,140 4,573
Purchase of property and equipment, net..................... (217) (233) (1,319)
------- -------- --------
Net cash provided from (used in) investing
activities......................................... 2,993 41,187 (3,025)
------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of notes payable.................................... -- (9,735) --
Proceeds from the exercise of stock options................. -- 260 95
Purchase of treasury stock.................................. (4,044) -- --
Dividends paid to stockholders.............................. (1,386) (1,379) (1,376)
------- -------- --------
Net cash used in financing activities................ (5,430) (10,854) (1,281)
------- -------- --------
Net increase (decrease) in cash and cash equivalents........ (10,313) 30,908 2,014
Cash and cash equivalents:
Beginning of the year..................................... 49,400 18,492 16,478
------- -------- --------
End of the year........................................... $39,087 $ 49,400 $ 18,492
======= ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
25
<PAGE> 27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION
Intercargo Corporation ("the Company") is an insurance holding company
incorporated in the State of Delaware whose wholly owned subsidiaries at
December 31, 1998 consist of Intercargo Insurance Company ("IIC"), International
Advisory Services, Inc. ("IAS"), and Intercargo International Limited ("IIL").
IIC is a property and casualty insurer based in the United States, which
primarily writes U.S. Customs bonds, commercial surety, marine cargo,
professional liability and other property and casualty insurance. IIC conducts
business in the United Kingdom through a branch office operation. Its products
are sold to importers and exporters through customs brokers, freight forwarders,
and other service firms engaged in the international and domestic movement of
cargo. IIC also conducts business in Hong Kong through its wholly-owned
subsidiary, Intercargo Insurance Company H.K. Limited ("IIC -- H.K.").
IIC -- H.K. is a Hong Kong licensed insurer that underwrites marine cargo and
professional liability insurance.
In January 1996, the Company sold 60 thousand shares of its fifty percent
investment in Kingsway Financial Services, Inc. ("Kingsway") stock. This reduced
the Company's ownership percentage to approximately 47%. In October 1996, the
Company participated in a secondary offering of Kingsway stock by selling 250
thousand shares, which along with the new shares issued by Kingsway, reduced its
equity interest in Kingsway to approximately 31%.
In August 1997 a two-for-one stock split increased the Company's shares of
Kingsway to 4.2 million. The Company then sold 4.0 million shares reducing its
ownership interest to less than 1%. Prior to August 1997, the Company recorded
its share of Kingsway's operating results as equity in net income of investee.
On April 30, 1998, IAS transferred to the Roanoke Companies, Inc.
("Roanoke") all of the insurance brokerage agency business of IAS in
consideration for cash, convertible preferred stock and a secured installment
note totaling approximately $7.9 million. The transaction was effected through
the sale of the capital stock of seven subsidiaries of IAS. The purchase price,
which is equivalent to approximately one times the commission revenue of the
transferred agencies, is subject to adjustment based on commission revenue of
the transferred agencies for the 12 month period ending June 30, 1999. The
subject commission revenue since the date of sale has been less than
anticipated. Market factors may continue to impact this commission revenue.
Based on these factors the Company estimates that the initial purchase price may
be ultimately reduced by 35% to 40%. Accordingly, $3.0 million of the estimated
gain on the sale has been deferred until determination of the final purchase
price.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of Presentation
The consolidated financial statements of the Company have been prepared in
accordance with generally accepted accounting principles. All significant
intercompany balances and transactions have been eliminated.
The preparation of financial statements in conformity with generally
accepted accounting principles requires the use of estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
(b) Investment Valuations
All fixed maturities and equity securities are classified as
available-for-sale and reported at fair value. Unrealized gains and losses are
excluded from earnings and reported directly in stockholders' equity net of
deferred income taxes.
Gains and losses on sales of investments are computed on the specific
identification method and are reflected in net income. Fair values are based
upon quoted market prices or values obtained from independent pricing sources.
26
<PAGE> 28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(c) Investment in Investee
The Company does not recognize into income its equity share of changes in
an investee's reported net assets resulting from an investee's issuance of
stock. Unconsolidated investees between 20% and 50% owned are accounted for
under the equity method of accounting.
(d) Cash and Cash Equivalents
Cash equivalents consist of investments with an original or remaining
maturity of three months or less at purchase.
(e) Premium Trust Funds
Premiums collected from insureds but not yet remitted to insurance carriers
are restricted as to use by laws in certain states in which IAS operates. The
amount of cash and cash equivalents so restricted was $1.2 million and $5.4
million at December 31, 1998, and 1997, respectively.
(f) Premiums Receivable
Premiums receivable are stated net of allowances for uncollectible accounts
of approximately $1.4 million and $1.0 million at December 31, 1998 and 1997,
respectively.
(g) Policy Acquisition Costs
Policy acquisition costs are costs such as commissions and certain other
underwriting and agency expenses which vary with and are directly related to the
production of business. Such costs are deferred to the extent recoverable from
future earned premiums and are amortized ratably over the terms of the related
policies. Costs deferred and amortized over the past three years are summarized
as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Deferred policy acquisition costs, beginning of year........ $ 2,939 $ 3,884 $ 4,898
Deferred:
Direct commissions........................................ 12,668 8,007 11,415
Premium taxes............................................. 1,115 887 883
Other direct underwriting expenses........................ 1,328 5,229 5,604
Ceding commissions........................................ (807) (1,709) (1,617)
-------- -------- --------
Net deferred................................................ 14,304 12,414 16,285
Amortized................................................... (13,103) (13,359) (17,299)
-------- -------- --------
Deferred policy acquisition costs, end of year.............. $ 4,140 $ 2,939 $ 3,884
======== ======== ========
</TABLE>
(h) Federal Income Tax
Deferred tax assets and liabilities are recognized for the estimated future
tax consequences attributable to differences between the financial statement
bases of assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates in effect for the
year in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period in which the change is enacted.
27
<PAGE> 29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(i) Goodwill and Other Intangible Assets
Goodwill is the excess of the fair value of consideration paid for
companies acquired over the fair value of the related net assets acquired.
Goodwill is amortized using the straight-line method over periods not exceeding
20 years.
Intangible assets relate to the acquisition of licenses, customer lists,
non-compete agreements, and employment agreements and are amortized using the
straight-line method over periods not exceeding 20 years.
(j) Liability for Losses and Loss Adjustment Expenses
The liability for losses and loss adjustment expenses represents estimates
of the ultimate unpaid cost of all claims incurred through December 31,
including claims incurred but not yet reported. These estimates are based upon
historical experience of the business written by the Company and other direct
writers reinsured by the Company, adjusted for current trends. Management
believes that the provision for losses and loss adjustment expenses is adequate
to cover the ultimate liability; however, such estimates may be more or less
than the amount ultimately paid when the claims are settled. Reinsurance
recoverables on unpaid losses and ceded unearned premiums are reported as assets
instead of netting these against related reserves (see note 4).
(k) Premium Recognition
Insurance premiums are recognized as revenue ratably over the terms of the
policies. Unearned premiums are computed on the daily pro rata basis.
Prospective reinsurance premiums, losses and loss adjustment expenses are
accounted for on bases consistent with those used in accounting for the original
policies issued and the terms of the reinsurance contracts.
(l) Foreign Exchange
Assets and liabilities relating to foreign operations are translated to
U.S. dollars using current exchange rates. Revenues and expenses are translated
to U.S. dollars using the average exchange rate as determined on a yearly basis.
Translation adjustments for financial reporting in U.S. dollars are reported
directly in stockholders' equity.
(m) Commission Income
The Company recognizes commission income when the premiums are billed to
the customer, or the effective date of the policy, whichever is later.
(n) Stock-Based Compensation
The Company applies the intrinsic value method prescribed by Accounting
Principles Board Opinion No. 25 ("APB No. 25") and related Interpretations in
accounting for its stock-based compensation plans. Accordingly, no compensation
cost has been recognized as the exercise prices of the options equaled the
market prices at the grant dates. The effect of recording compensation cost for
the Company's stock-based compensation plans based on the fair value method in
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation" ("SFAS No. 123") results in net income and earnings
per share that are not materially different from amounts reported.
(o) Earnings Per Share
Basic earnings per share are computed based upon the weighted average
number of shares of common stock outstanding each year. Diluted earnings per
share are computed based upon the weighted average number of shares of common
stock and common stock equivalents (to the extent dilutive) outstanding each
year. Common stock equivalents consist of shares issuable under the Company's
stock option plan.
28
<PAGE> 30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In 1998, as a result of the net loss, the incremental shares from assumed
conversions at average market price are antidilutive and are therefore excluded
from diluted earnings per share.
The computations of basic and diluted earnings per share are presented
below (in thousands for net income):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Basic earnings per share:
Net income (loss)......................................... $ (3,372) $ 31,788 $ 6,404
Average common shares outstanding......................... 7,609,773 7,670,759 7,645,578
--------- --------- ---------
Per common share amount................................... $ (0.44) $ 4.14 $ 0.84
========= ========= =========
Diluted earnings per share:
Net income (loss)......................................... $ (3,372) $ 31,788 $ 6,404
Average common shares outstanding......................... 7,609,773 7,670,759 7,645,578
Incremental shares from assumed conversions at average
market price........................................... -- 6,702 11,011
--------- --------- ---------
7,609,773 7,677,461 7,656,589
--------- --------- ---------
Per common share amount................................... $ (0.44) $ 4.14 $ 0.84
========= ========= =========
</TABLE>
(p) Comprehensive Income
The Company adopted SFAS No. 130 "Reporting Comprehensive Income" ("SFAS
No. 130") in 1998. SFAS No. 130 requires net unrealized gains or losses on
investments and net foreign exchange translation adjustments, which previously
were reported directly in stockholders' equity, to be included in accumulated
other comprehensive income in the consolidated balance sheets and in the
disclosure of comprehensive income. The totals of other comprehensive income
items and comprehensive income (which includes net income), are displayed
separately in the consolidated statements of stockholders' equity. The adoption
of SFAS No. 130 had no effect on net income (loss) or stockholders' equity. The
components of other comprehensive income (loss), and the related tax effects are
as follows (in thousands):
<TABLE>
<CAPTION>
AMOUNT INCOME TAX AMOUNT
BEFORE (EXPENSE) NET OF
YEAR ENDED DECEMBER 31, 1998 TAXES BENEFIT TAXES
---------------------------- ------ ---------- ------
<S> <C> <C> <C>
Unrealized holdings gains arising during the
year............................................. $ 467 $(159) $ 308
Less: Reclassification adjustment.................. 1,041 (354) 687
------ ----- -----
Net unrealized investment loss..................... (574) 195 (379)
Foreign currency translation adjustment............ (68) 23 (45)
------ ----- -----
Total other comprehensive loss..................... $ (642) $ 218 $(424)
====== ===== =====
</TABLE>
<TABLE>
<CAPTION>
AMOUNT INCOME TAX AMOUNT
BEFORE (EXPENSE) NET OF
YEAR ENDED DECEMBER 31, 1997 TAXES BENEFIT TAXES
---------------------------- ------ ---------- ------
<S> <C> <C> <C>
Unrealized holdings gains arising during the
year............................................. $3,700 $(1,258) $2,442
Less: Reclassification adjustment.................. (116) 39 (77)
------ ------- ------
Net unrealized investment gain..................... 3,816 (1,297) 2,519
Foreign currency translation adjustment............ 1,517 (516) 1,001
------ ------- ------
Total other comprehensive income................... $5,333 $(1,813) $3,520
====== ======= ======
</TABLE>
29
<PAGE> 31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
AMOUNT INCOME TAX AMOUNT
BEFORE (EXPENSE) NET OF
YEAR ENDED DECEMBER 31, 1996 TAXES BENEFIT TAXES
---------------------------- ------ ---------- ------
<S> <C> <C> <C>
Unrealized holdings losses arising during the
year............................................ $(1,297) $ 441 $(856)
Less: Reclassification adjustment................. 117 (40) 77
------- ----- -----
Net unrealized investment loss.................... (1,414) 481 (933)
Foreign currency translation adjustment........... 305 (104) 201
------- ----- -----
Total other comprehensive loss.................... $(1,109) $ 377 $(732)
======= ===== =====
</TABLE>
Components of accumulated other comprehensive income at December 31, 1998,
1997 and 1996 are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net unrealized gain (loss) on foreign currency
translation........................................ $ (22) $ 23 $ (978)
Net unrealized gain (loss) on securities............. 1,774 2,153 (366)
------ ------ -------
Accumulated other comprehensive income (loss)........ $1,752 $2,176 $(1,344)
====== ====== =======
</TABLE>
(q) Segment Reporting
The Company adopted SFAS No. 131 "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS No. 131") in 1998. SFAS No. 131
supersedes SFAS No. 14 "Financial Reporting for Segments of a Business
Enterprise". SFAS No. 131 establishes standards for the way that public business
enterprises report information about operating segments in annual financial
statements and requires that those enterprises report selected information about
operating segments in interim financial reports. SFAS No. 131 also establishes
standards for related disclosures about products and services, geographic areas,
and major customers. The adoption of SFAS No. 131 did not affect results of
operations or financial position, but did affect the disclosure of segment
information (see note 20).
(r) Impact of New Accounting Standards
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"),
which is required to be adopted in years beginning after June 15, 1999. SFAS No.
133 permits early adoption as of the beginning of any fiscal quarter after its
issuance. The Company expects to adopt the new statement effective January 1,
2000. The Company does not anticipate that the adoption of SFAS No. 133 will
have a significant effect on its results of operations or financial position, as
it currently does not use derivative instruments.
(s) Reclassifications
Certain reclassifications have been made to the prior years' financial
statements to conform with the current presentation.
30
<PAGE> 32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(3) INVESTMENTS
Amortized cost, unrealized gains and losses, and estimated fair value of
investments as of December 31, 1998 and 1997, are summarized as follows (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1998
--------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Fixed maturities:
U.S. Government and Agency obligations............. $19,668 $ 342 $(27) $19,983
State, municipal, and other tax advantaged
securities...................................... 19,262 698 (2) 19,958
Corporate securities............................... 18,762 597 (24) 19,335
Other.............................................. 298 10 -- 308
------- ------ ---- -------
Total fixed maturities............................... 57,990 1,647 (53) 59,584
Equity securities.................................... 3,761 1,098 (3) 4,856
------- ------ ---- -------
Total................................................ $61,751 $2,745 $(56) $64,440
======= ====== ==== =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997
--------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Fixed maturities:
U.S. Government and Agency obligations............. $23,139 $ 137 $ (81) $23,195
State, municipal, and other tax advantaged
securities...................................... 20,774 538 (15) 21,297
Corporate securities............................... 14,649 257 (22) 14,884
Other.............................................. 1,252 48 1,300
------- ------ ----- -------
Total fixed maturities............................... 59,814 980 (118) 60,676
Equity securities.................................... 1,833 2,428 (27) 4,234
------- ------ ----- -------
Total................................................ $61,647 $3,408 $(145) $64,910
======= ====== ===== =======
</TABLE>
Amortized cost and estimated fair value for fixed maturities held as of
December 31, 1998, summarized by maturity, are as follows (in thousands):
<TABLE>
<CAPTION>
ESTIMATED
AMORTIZED FAIR
COST VALUE
--------- ---------
<S> <C> <C>
Due in one year or less.................................... $ 1,835 $ 1,855
Due after one year through five years...................... 24,104 24,477
Due after five years through ten years..................... 29,516 30,531
Due after ten years........................................ 2,535 2,721
------- -------
$57,990 $59,584
======= =======
</TABLE>
Actual maturities may differ from contractual maturities because certain
borrowers may have the right to call or to prepay obligations with or without
call or prepayment penalties. Investment securities carried at $9.9 million and
$9.4 million at December 31, 1998 and 1997, respectively, were on deposit or
pledged to governmental authorities as required by law.
31
<PAGE> 33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The sources of net investment income are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Fixed maturities in excess of one year................ $3,646 $3,470 $3,001
Short-term investments and cash equivalents........... 2,493 1,611 976
Equity securities..................................... 182 141 169
Investment expenses................................... (199) (311) (161)
------ ------ ------
Net investment income................................. $6,122 $4,911 $3,985
====== ====== ======
</TABLE>
The sources of net realized gains are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Gain on sale of Kingsway common stock................ $ 892 $49,443 $2,394
Gain on sale of subsidiaries......................... 1,102 -- --
Fixed maturities:
Gross gains........................................ 117 94 228
Gross losses....................................... (8) (178) (46)
Equity securities:
Gross gains........................................ 41 -- 10
Gross losses....................................... (1) (32) (75)
Other................................................ (4) (456) (132)
------ ------- ------
Realized investment gains............................ $2,139 $48,871 $2,379
====== ======= ======
</TABLE>
At December 31, 1998 and 1997, the net unrealized gains on
available-for-sale securities were net of deferred tax liabilities of $915
thousand and $1.1 million, respectively. At December 31, 1996, the net
unrealized loss on available-for-sale securities was net of a deferred tax
benefit of $189 thousand.
(4) REINSURANCE
In the normal course of business, the Company assumes and cedes reinsurance
with other insurers. Reinsurance is ceded primarily to limit losses from large
exposures and to permit recovery of a portion of direct losses; however, such a
transfer does not relieve the originating insurance company of contingent
liability.
The majority of the Company's ceded reinsurance is placed with a limited
number of reinsurers; however, the Company evaluates the financial condition of
its reinsurers and monitors concentrations of credit risk to minimize its
exposure to significant losses from insolvencies. A contingent liability exists
to the extent that the Company's reinsurers are unable to meet their contractual
obligations. Management makes provision for uncollectible reinsurance when
warranted and is of the opinion that no additional liability will accrue to the
Company with respect to this contingency. The effects of reinsurance on premiums
written, premiums earned,
32
<PAGE> 34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and loss and loss adjustment expenses incurred for the three years ended
December 31, 1998, 1997, and 1996, are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 DIRECT CEDED ASSUMED NET
---------------------------- ------ ----- ------- ---
<S> <C> <C> <C> <C>
Year ended December 31, 1998
Premiums written......................................... $66,778 $12,894 $1,637 $55,521
Premiums earned.......................................... 62,868 12,902 2,498 52,464
Loss and loss adjustment expenses incurred............... 42,369 11,330 1,629 32,668
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
----------------------------
<S> <C> <C> <C> <C>
Premiums written......................................... 67,602 14,909 4,499 57,192
Premiums earned.......................................... 67,802 14,548 4,156 57,410
Loss and loss adjustment expenses incurred............... 42,641 8,730 934 34,845
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
----------------------------
<S> <C> <C> <C> <C>
Premiums written......................................... 67,933 12,514 3,034 58,453
Premiums earned.......................................... 68,206 10,163 3,010 61,053
Loss and loss adjustment expenses incurred............... 45,500 14,910 1,717 32,307
</TABLE>
(5) INCOME TAX
The components of income tax expense (benefit) are as follows (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Current............................................ $ -- $18,859 $ 1,827
Deferred........................................... (2,049) (1,149) (1,072)
------- ------- -------
$(2,049) $17,710 $ 755
======= ======= =======
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the Company's net deferred tax asset at December 31, 1998 and 1997,
are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1998 1997
---- ----
<S> <C> <C>
Deferred tax assets:
Loss reserves............................................. $1,736 $ 1,701
Unearned premium reserves................................. 1,064 865
Future benefit of net operating losses.................... 2,173 968
Deferred gain on sale of subsidiaries..................... 1,007 --
Foreign tax credit........................................ 1,235 1,235
Other..................................................... 326 233
Less: valuation allowance................................. (617) (617)
------ -------
Deferred tax assets.................................... 6,924 4,385
------ -------
Deferred tax liabilities:
Deferred policy acquisition costs......................... (1,351) (919)
Unrealized investment gain................................ (915) (1,109)
Depreciation.............................................. (128) (128)
Other..................................................... -- (3)
------ -------
Deferred tax liabilities............................... (2,394) (2,159)
------ -------
Net deferred tax asset................................. $4,530 $ 2,226
====== =======
</TABLE>
33
<PAGE> 35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The valuation allowance of approximately $617 thousand at December 31, 1998
and 1997 pertains to foreign tax credits. The valuation allowance has been
established to reduce the deferred tax asset related to foreign tax credits to
the amount that, based upon available evidence, is, in management's judgment,
more likely than not to be realized. The foreign tax credit carryforwards begin
expiring in the year 2001.
Net operating losses of IAS ($2.4 million and $2.9 million at December 31,
1998 and 1997, respectively) are considered to have arisen in separate return
limitation years (SRLY) and under Federal tax law can only be utilized against
future taxable income generated by IAS. The Company also has net operating
losses of $4.0 million for the year ended December 31, 1998 that will be carried
forward and utilized against future taxable income of the Company. The net
operating losses of IAS begin expiring in 2004 and the net operating loss of the
Company will expire in 2020.
Income taxes paid (net of taxes recovered) were $201 thousand, $20.6
million, and ($88) thousand in 1998, 1997, and 1996, respectively. The actual
income tax expense for 1998, 1997, and 1996 differed from the "expected" tax
expense for those years as described below (in thousands). "Expected" tax
expense is computed by applying the U.S. Federal corporate tax rate of 35% in
1997 and 34% in 1998 and 1996 to operating income.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Computed expected tax (benefit)..................... $(1,843) $16,149 $1,260
State taxes......................................... -- 662 57
Difference between book and tax bases of Kingsway
investment........................................ -- 6,313 --
Foreign tax rate differential....................... -- 176 131
Tax exempt interest and dividend received
deduction......................................... (340) (329) (323)
Foreign source income............................... 111 288 207
Deferred tax valuation allowance.................... -- (121) (738)
Tax credits......................................... -- (5,618) --
Other............................................... 23 190 161
------- ------- ------
$(2,049) $17,710 $ 755
======= ======= ======
</TABLE>
The Company and its U.S. subsidiaries file a consolidated tax return.
Federal income tax expenses are calculated on an entity basis and are allocated
accordingly.
(6) RELATED PARTY TRANSACTIONS
Certain of the Company's reinsurers are affiliated insurance companies. The
Company ceded to these affiliates premiums written of $15 thousand, $414
thousand, and $649 thousand in 1998, 1997, and 1996, respectively.
(7) COMMITMENTS AND CONTINGENCIES
During the month of January 1998, the president of IAS resigned and with
several other employees formed Avalon Risk Management, Inc. Avalon's announced
purpose is to compete with IAS in the marketing and distribution of
transportation related insurance and surety products. The Company has filed suit
in the Chancery Division of the Circuit Court of Cook County, Illinois against
the ex-president, Avalon and certain of the defecting employees alleging breach
of fiduciary duty, theft of confidential information and other unlawful
activities, and seeking injunctive relief and damages. The action is pending,
and its outcome at this point is not certain.
In February 1999, certain purported shareholders of the Company filed a
lawsuit against the Company and its directors, seeking class action status and
claiming, among other things, the directors breached their
34
<PAGE> 36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
fiduciary duties to the Company's shareholders in approving the definitive
agreement to merge between the Company and a subsidiary of XL Capital and that
they failed to adequately explore alternative transactions and maximize
shareholder value. The lawsuit requests, among other things, injunctive relief
and payment of damages to the class members. The Company believes that the
lawsuit is without merit and intends to contest it vigorously.
There are no other significant pending material legal proceedings to which
the Company or its subsidiaries is a party or of which any of the properties of
the Company or its subsidiaries is subject, except for claims arising in the
ordinary course of business. In the opinion of management, the ultimate
resolution of such litigation will not have a material effect on the financial
condition of the Company.
(8) RECONCILIATIONS TO STATUTORY ACCOUNTING
The Company's insurance subsidiaries are required to file statutory
financial statements with insurance regulatory authorities. Accounting
principles used to prepare these statutory financial statements differ from
financial statements prepared on the basis of generally accepted accounting
principles.
Reconciliations of combined net income (loss) and statutory capital and
surplus as determined using statutory accounting principles to the amounts
included in the accompanying financial statements are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Statutory net income (loss) of insurance
subsidiaries..................................... $(2,979) $(1,312) $ 2,645
Increases (decreases):
Net income (loss) from non-insurance
operations.................................... (4,012) 32,512 3,323
Deferred policy acquisition costs................ 1,212 (933) (1,034)
Deferred income taxes............................ 2,109 1,149 1,072
Provision for uncollectible balances............. 400 4 139
Consolidating eliminations and other adjustments,
net........................................... (102) 368 259
------- ------- -------
Consolidated net income (loss) as reported
herein........................................... $(3,372) $31,788 $ 6,404
======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1998 1997
---- ----
<S> <C> <C>
Statutory capital and surplus of insurance subsidiaries.... $32,615 $34,357
Increases (decreases):
Non-insurance net assets................................. 27,723 35,578
Non-admitted assets and other statutory adjustments,
net................................................... 1,335 1,888
Deferred policy acquisition costs........................ 4,140 2,939
Costs in excess of net assets of purchased businesses.... 393 1,991
Deferred income taxes.................................... 4,530 2,226
Unrealized gain (loss) on foreign currency translation... (22) 23
Adjustment to GAAP fair values of investments............ 2,665 3,249
Consolidating eliminations and other adjustments......... (404) (50)
------- -------
Stockholders' equity as reported herein.................... $72,975 $82,201
======= =======
</TABLE>
The statutory capital and surplus of the Company's U.S. insurance
subsidiary is sufficient to satisfy current regulatory requirements. Dividend
payments to the Company from its insurance subsidiary are restricted by
insurance laws as to the amount that may be paid without prior approval of
insurance regulatory authorities. Under the insurance regulations of Illinois,
IIC's state of domicile, ordinary dividends are limited to the greater of (i)
10% of statutory surplus or (ii) statutory net income, as defined, for the prior
twelve
35
<PAGE> 37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
month period. The estimated dividend distribution which can be made to the
Company by its subsidiary in 1999 based on these regulatory guidelines is
approximately $3.3 million.
The Company's U.S. insurance subsidiary, IIC, is required to file annual
statements with insurance regulatory authorities which are prepared on an
accounting basis prescribed or permitted by such authorities. Prescribed
statutory accounting practices include state laws, regulations, and general
administrative rules, as well as a variety of publications of the National
Association of Insurance Commissioners ("NAIC"). Permitted statutory accounting
practices encompass all accounting practices that are not prescribed; such
practices differ from state to state, may differ from company to company within
a state, and may change in the future. IIC does not currently use permitted
statutory accounting practices in its statutory financial statements.
Furthermore, the NAIC has completed a project to codify statutory accounting
practices ("Codification"), the result of which will constitute the only source
of "prescribed" statutory accounting practices after December 31, 2000. Upon
adoption by the State of Illinois, Codification will change the definition of
what comprises prescribed versus permitted statutory accounting practices, and
will result in changes to the accounting policies that insurance enterprises use
to prepare their statutory financial statements.
(9) UNAUDITED INTERIM FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
<S> <C> <C> <C> <C>
1998
Revenues........................................... $13,496 $16,065 $15,397 $16,338
------- ------- ------- -------
Net income (loss).................................. 369 1,331 (771) (4,301)
======= ======= ======= =======
Net income (loss) per share, basic and diluted..... $ 0.05 $ 0.17 $ (0.10) $ (0.59)
======= ======= ======= =======
1997
Revenues........................................... $14,981 $15,140 $63,220 $18,817
------- ------- ------- -------
Net income from operations......................... $ 828 $ 608 $26,978 $ 17
Net income from investee........................... 967 1,436 954 --
------- ------- ------- -------
Net income......................................... $ 1,795 $ 2,044 $27,932 $ 17
======= ======= ======= =======
Net income per share, basic and diluted............ $ 0.23 $ 0.27 $ 3.64 $ 0.00
======= ======= ======= =======
</TABLE>
During the fourth quarter of 1998 the Company increased its loss reserves
by $4.2 million on a pre-tax basis for emerging development on marine, other
property and casualty, and professional liability lines of business. The Company
incurred $1.0 million of pre-tax expenses related to the merger agreement with a
subsidiary of XL Capital Ltd. The Company also increased its bad debt reserves
by $761 thousand and wrote off certain intangible assets of $390 thousand
related to its agency business. The Company realized a pre-tax gain of $504
thousand on sales of Kingsway shares.
(10) STOCK OPTIONS
On July 28, 1987, the Company's stockholders approved the Company's 1987
Non-Qualified and Incentive Stock Option Plan ("Option Plan"). The Option Plan
has been extended through May 15, 2007. A total of 600 thousand shares of common
stock have been authorized for issuance under the Option Plan.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumption used for grants in 1998, 1997 and 1996, respectively: dividend yields
of 1.9 percent, 1.9 percent and 2.1 percent; risk free interest rates of 5.5
percent,
36
<PAGE> 38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5.5 percent and 6.2 percent; expected volatility of 40 percent, 43 percent and
38 percent; and expected lives of 2.5 years, 4.5 years and 4.5 years.
For the purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting periods. The Company's
pro forma information is as follows (in thousands, except per share data):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Pro forma net income (loss)................................. $(3,464) $31,762 $6,379
Pro forma net income (loss) per share, basic and diluted.... $ (0.46) $ 4.14 $ 0.83
</TABLE>
Activity related to stock options is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------------- ------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------ -------- ------ -------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding at the beginning of
the year............................. 99,650 $11.62 155,000 $11.51 183,000 $10.93
Options granted........................ 116,500 12.08 44,650 10.74 6,000 8.33
Options exercised...................... -- -- (40,000) 6.50 (19,000) 5.00
Options forfeited...................... 20,250 12.34 (60,000) 14.08 (15,000) 11.50
------- ------ ------- ------ ------- ------
Options outstanding at the end of the
year................................. 195,900 $11.82 99,650 $11.62 155,000 $11.51
======= ====== ======= ====== ======= ======
Options exercisable at the end of the
year................................. 42,913 27,000 94,000
======= ======= =======
Weighted average fair value of options
granted during the year.............. $ 3.32 $ 3.93 $ 2.87
====== ====== ======
</TABLE>
Options outstanding and options exercisable at December 31, 1998 are as
follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------- -----------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISE PRICE OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
-------------- ----------- ---------------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$8.00 -- 14.50.................. 195,900 8.1 years $11.82 42,913 $12.54
</TABLE>
(11) COMMITMENTS
The Company has obligations under long-term operating leases for its office
premises in the United States, Hong Kong, and the United Kingdom. The future
minimum lease payments are as follows (in thousands):
<TABLE>
<S> <C>
1999........................................................ $1,221
2000........................................................ 1,192
2001........................................................ 1,006
2002........................................................ 144
2003........................................................ 74
Thereafter.................................................. --
------
$3,637
======
</TABLE>
37
<PAGE> 39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Included in other underwriting expenses is rental expense of $1.4 million,
$1.7 million, and $1.5 million for 1998, 1997, and 1996, respectively.
(12) CAPITALIZATION
At December 31, 1996, the Company had a $15.0 million revolving bank line
of credit. The outstanding balance on the line of credit amounted to
approximately $9.7 million. In August 1997, this balance was extinguished using
a portion of the proceeds from the Company's sale of a significant part of its
holdings in Kingsway. The revolving line of credit has been discontinued.
The Company paid interest of $0, $489 thousand and $768 thousand in 1998,
1997 and 1996, respectively.
(13) SUPPLEMENTAL DUTY DEPOSITS
Supplemental duty deposits are security deposits held by IAS until the
insured bond principal (Depositor) has settled duty charges imposed by U.S.
Customs. Under the terms of the agreement with the Depositor, the Depositor is
not entitled to a refund of its deposit until it has provided competent written
legal evidence that the conditions of each and every bond connected with the
deposit have been fully satisfied.
(14) DOMESTIC AND FOREIGN OPERATIONS
Revenues, operating income, and identifiable assets included in the
accompanying consolidated financial statements related to U.S. and foreign
operations as of and for the years ended December 31, 1998, 1997, and 1996, were
as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
------------------- ------------------- -------------------
U.S. FOREIGN U.S. FOREIGN U.S. FOREIGN
---- ------- ---- ------- ---- -------
<S> <C> <C> <C> <C> <C> <C>
Revenues............................. $ 55,501 $ 5,796 $107,227 $4,932 $ 64,365 $3,876
Operating income (loss).............. (5,095) (326) 46,827 (686) 3,782 (77)
Identifiable assets.................. 152,896 10,504 155,443 9,969 124,199 9,511
</TABLE>
(15) LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
Loss and loss adjustment expense reserves are based on long-range
projections which are subject to uncertainty. Uncertainty regarding reserves of
a given accident year is gradually reduced as new information emerges each
succeeding year, allowing more reliable reevaluations of such reserves. While
management believes that reserves as of December 31, 1998 are adequate,
uncertainties in the reserving process could cause such reserves to develop
favorably or unfavorably as new or additional information emerges. Any
adjustments to reserves are reflected in the operating results of the periods in
which they are made. Movements in reserves which are small relative to the
amount of such reserves could significantly impact future reported earnings of
the Company.
38
<PAGE> 40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Activity related to unpaid loss and loss adjustment expenses (LAE) follows
(in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Unpaid losses and LAE at beginning
of year, net of reinsurance recoverables of $11,970,
$9,980, and $3,138........................................ $ 43,385 $ 37,057 $ 33,155
Provision for losses and LAE for claims occurring during:
Current year.............................................. 31,680 34,260 31,876
Prior years............................................... 988 585 431
-------- -------- --------
Total.................................................. 32,668 34,845 32,307
-------- -------- --------
Less loss and LAE payments for claims occurring during:
Current year.............................................. (10,646) (10,896) (10,798)
Prior years............................................... (20,873) (17,621) (17,607)
-------- -------- --------
Total.................................................. (31,519) (28,517) (28,405)
-------- -------- --------
Unpaid losses and LAE at end of year, net of reinsurance
recoverables of $11,980, $11,970 and $9,980............... $ 44,534 $ 43,385 $ 37,057
======== ======== ========
</TABLE>
(16) EMPLOYEE BENEFIT PLAN
The Company sponsors a defined contribution plan covering substantially all
employees. The plan provides for Company contributions at the discretion of the
board of directors. For 1998, the Company contributed $1.00 for each $1.00
contributed by the participants up to 2.5% of employee base compensation. For
1997 and 1996, the Company contributed $0.50 for each $1.00 contributed by the
participants up to 5% of employee base compensation. The Company's cost of this
plan was $201 thousand, $139 thousand, and $116 thousand in 1998, 1997 and 1996,
respectively.
(17) FINANCIAL INSTRUMENTS
In the normal course of business, the Company invests in various financial
assets and incurs various financial liabilities. The fair value estimates of
financial instruments presented below are not necessarily indicative of the
amounts the Company might pay or receive in actual market transactions.
Potential taxes and other transaction costs have not been considered in
estimating fair value. As a number of the Company's significant assets and
liabilities are not considered financial instruments, the disclosures that
follow do not reflect the fair value of the Company as a whole.
The estimated fair values of the Company's financial instruments at
December 31, 1998 are as follows (in thousands):
<TABLE>
<CAPTION>
CARRYING FAIR
VALUE VALUE
-------- -----
<S> <C> <C>
Assets:
Fixed maturities......................................... $59,584 $59,584
Equity securities........................................ 4,856 4,856
Cash and cash equivalents................................ 39,087 39,087
Premiums receivable...................................... 19,306 19,306
Reinsurance recoverable on paid claims................... 4,115 4,115
Notes receivable......................................... 3,587 3,587
Income tax recoverable................................... 895 895
Liabilities:
Funds held by Company.................................... 422 422
Supplemental duty deposits............................... 1,703 1,703
</TABLE>
39
<PAGE> 41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The estimated fair values of the Company's financial instruments at
December 31, 1997 are as follows (in thousands):
<TABLE>
<CAPTION>
CARRYING FAIR
VALUE VALUE
-------- -----
<S> <C> <C>
Assets:
Fixed maturities......................................... $60,676 $60,676
Equity securities........................................ 4,234 4,234
Cash and cash equivalents................................ 49,400 49,400
Premiums receivable...................................... 15,677 15,677
Reinsurance recoverable on paid claims................... 1,137 1,137
Notes receivable......................................... 99 99
Income tax recoverable................................... 1,365 1,365
Liabilities:
Funds held by Company.................................... 372 372
Supplemental duty deposits............................... 2,016 2,016
</TABLE>
Fixed maturities and equity securities are valued at quoted market prices,
where available, or from independent pricing sources. Cash and cash equivalents,
premiums receivable, reinsurance recoverable on paid claims, funds held, income
tax recoverable and supplemental duty deposits are valued at their carrying
value due to their short-term nature. The carrying value of notes receivable
approximates fair value as the notes bear floating rates of interest or are at
current market rates.
(18) FOREIGN CURRENCY TRANSLATION
The net assets of the Company's foreign operations are translated into U.S.
dollars using exchange rates in effect at each year end. An analysis of the
foreign currency translation adjustment included in other comprehensive income
is as follows (amounts in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Beginning amount of cumulative translation
adjustments......................................... $ 23 $ (978) $(1,179)
Included in Kingsway's basis at sale.................. 18 1,045 189
Aggregate adjustment for the year resulting from
translation adjustments............................. (63) (44) 12
---- ------ -------
Net aggregate translation adjustment included in
stockholders' equity................................ (45) 1,001 201
---- ------ -------
Ending amount of cumulative translation adjustments... $(22) $ 23 $ (978)
==== ====== =======
</TABLE>
(19) INVESTMENT IN KINGSWAY
Kingsway is a property and casualty insurance holding company based in
Canada which primarily writes and assumes commercial and other automobile
insurance considered to be non-standard, and other specialty insurance for
commercial properties through its 100% owned subsidiaries, Kingsway General
Insurance Company and York Fire & Casualty Insurance Company.
40
<PAGE> 42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following presents summary financial data for Kingsway for the year
ended December 31, 1996 (in thousands).
<TABLE>
<S> <C>
Revenues:
Net premiums earned....................................... $78,972
Other revenues............................................ 8,103
-------
Total revenues.................................... 87,075
-------
Expenses:
Claims incurred........................................... 51,257
Other expenses............................................ 24,263
-------
Total expenses.................................... 75,520
-------
Income before income taxes.................................. 11,555
Income taxes................................................ 3,369
-------
Net income.................................................. $ 8,186
=======
</TABLE>
(20) BUSINESS SEGMENTS
DESCRIPTION OF THE TYPES OF PRODUCTS FROM WHICH EACH REPORTABLE SEGMENT DERIVES
ITS REVENUES
The Company has four operating segments based on the type of product and a
fifth nonoperating segment. The operating segments are: surety, marine,
professional liability and other property and casualty. The surety segment
provides various surety coverages, primarily U.S. Customs bonds, contract surety
and miscellaneous surety. The marine segment provides ocean and inland marine
cargo coverage and bill of lading liability coverage. The professional liability
segment provides professional liability coverage for customs brokers and freight
forwarders. The other property and casualty segment provides commercial property
and casualty products to customs brokers, freight forwarders and other service
firms engaged in the international movement of cargo. It also provides such
products to meet the needs of the trucking industry.
MEASUREMENT OF SEGMENT PROFIT OR LOSS AND SEGMENT ASSETS
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. The Company evaluates
performance based on profit or loss from operations before income taxes.
Revenues are all from external customers. Indirect costs of support units are
allocated to segments. Investment income and realized investment gains are not
allocated to segments and such income is not a component used to evaluate
segments. Invested assets and cash are not allocated to segments.
41
<PAGE> 43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FACTORS USED TO IDENTIFY THE ENTERPRISES REPORTABLE SEGMENTS
The Company's reportable segments are business units that each offer
different types of insurance coverage with different types of risk exposures.
<TABLE>
<CAPTION>
OTHER
PROFESSIONAL PROPERTY &
SURETY MARINE LIABILITY CASUALTY ALL OTHER TOTAL
------ ------ ------------ ---------- --------- -----
<S> <C> <C> <C> <C> <C> <C>
1998
REVENUES:
Insurance Premium Income.............. $17,398 $25,791 $ 2,674 $ 6,601 $ 52,464
Investment Income & Realized Gains.... $ 8,261 $ 8,261
Other Revenues........................ 572 572
------- ------- ------- ------- -------- --------
Total Revenues........................ 17,398 25,791 2,674 6,601 8,833 61,297
Losses and LAE........................ 4,124 19,832 3,490 5,222 32,668
Amortization & Depreciation........... 458 487 118 171 630 1,864
Other Expenses........................ 10,551 11,894 2,071 3,448 4,222 32,186
------- ------- ------- ------- -------- --------
Operating Income (Loss)............... 2,265 (6,422) (3,005) (2,240) 3,981 (5,421)
Identifiable Assets................... $13,279 $16,295 $10,864 $ 8,168 $114,794 $163,400
------- ------- ------- ------- -------- --------
1997
REVENUES:
Insurance Premium Income.............. $17,947 $27,906 $ 3,206 $ 8,351 $ 57,410
Investment Income & Realized Gains.... $ 53,782 53,782
Other Revenues........................ 967 967
------- ------- ------- ------- -------- --------
Total Revenues........................ 17,947 27,906 3,206 8,351 54,749 112,159
Losses and LAE........................ 5,087 19,482 3,752 6,524 34,845
Amortization & Depreciation........... 568 522 259 172 1,521
Interest Expense...................... 488 488
Other Expenses........................ 11,211 11,501 1,574 4,173 705 29,164
------- ------- ------- ------- -------- --------
Operating Income (Loss)............... 1,081 (3,599) (2,379) (2,518) 53,556 46,141
Identifiable Assets................... $13,926 $14,719 $ 5,656 $ 9,124 $121,987 $165,412
------- ------- ------- ------- -------- --------
1996
REVENUES:
Insurance Premium Income.............. $25,846 $26,932 $ 2,644 $ 5,631 $ 61,053
Investment Income & Realized Gains.... $ 6,364 6,364
Other Revenues........................ 824 824
------- ------- ------- ------- -------- --------
Total Revenues........................ 25,846 26,932 2,644 5,631 7,188 68,241
Losses and LAE........................ 7,455 17,759 2,714 4,379 32,307
Amortization & Depreciation........... 616 706 58 166 1,546
Interest Expense...................... 768 768
Other Expenses........................ 13,561 11,830 1,187 2,989 348 29,915
------- ------- ------- ------- -------- --------
Operating Income (Loss)............... 4,214 (3,363) (1,315) (1,903) 6,072 3,705
Identifiable Assets................... $17,755 $12,876 $ 3,302 $ 7,525 $ 92,252 $133,710
------- ------- ------- ------- -------- --------
</TABLE>
42
<PAGE> 44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On February 26, 1997, the Board, upon the advice of its Audit Committee,
elected to not retain KPMG LLP as its independent public accountant for fiscal
year 1997. The decision to change accountants was based upon a cost analysis of
services provided. There were no disagreements between management of the Company
and the former accountants on any matters of accounting principles or practices,
financial statement disclosures, or auditing scopes or procedures during fiscal
years 1996 and 1995 or any subsequent interim period preceding the dismissal.
The accountant's reports on the financial statements of the Company in the 1996
and 1995 fiscal years were unqualified, not modified as to uncertainty, audit
scope or accounting principles, and did not express any adverse opinion or
disclaimer of opinion. KPMG LLP issued a letter dated February 21, 1997 to the
Board of Directors of the Company describing a material weakness in internal
control as detail accounts receivable and intercompany receivables and payables
were not properly reconciled on a regular basis.
In addition, on February 26, 1997, the Audit Committee recommended, and the
Board of Directors approved, the appointment of Ernst & Young LLP as the
Company's new independent accountants, effective for fiscal 1997. This
appointment was ratified by stockholders on May 15, 1997. The selection of Ernst
& Young LLP was through a request for proposal process with no consideration
requested or made on the application of accounting principles, the type of audit
opinion that might be rendered on the financial statements, or any other factor
for reaching a decision as to accounting, auditing or financial reporting
issues.
43
<PAGE> 45
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table lists the directors of the Company.
<TABLE>
<CAPTION>
POSITION WITH COMPANY, BUSINESS
NAME AGE EXPERIENCE AND OTHER DIRECTORSHIPS
---- --- ----------------------------------
<S> <C> <C>
George J. Weise...................... 50 Director of the Company since October 1997. Mr. Weise
has been a partner in the firm of Washington Counsel,
P.C. since August 1997. From 1993 through August 2,
1997, Mr. Weise was a U.S. Customs Commissioner.
Michael L. Sklar..................... 60 Director of the Company since May 1995. Mr. Sklar has
practiced law in Chicago, Illinois for more than 25
years. Mr. Sklar is currently, and since 1996 has been,
a partner of the law firm of Rudnick & Wolfe. From 1989
through March 1996, Mr. Sklar was a partner in the law
firm of Keck, Mahin & Cate. In 1998, Rudnick & Wolfe
served as principal outside legal counsel to the
Company.
Robert B. Sanborn.................... 70 Director of the Company since February 1994. Mr.
Sanborn is, and since 1994 has been, Senior Executive
Consultant to Orion Capital Corporation ("Orion"), a
property and casualty insurance company. From 1987
through 1994, Mr. Sanborn served as the President and
Chief Operating Officer of Orion. Mr. Sanborn is also a
director of Orion, Guaranty National Corporation, Nobel
Insurance Limited, and HOG Lloyd's Investment Trust,
and is a member of many professional associations
within the insurance industry.
Arthur J. Fritz, Jr.................. 58 Director of the Company since December 1985. Mr. Fritz
is a former President of the National Customs Brokers &
Forwarders Association of America. Mr. Fritz is
currently the Chairman of Logicorp Inc., and is a
director of Arkansas Best Corporation and Landstar,
Inc.
Arthur L. Litman..................... 55 Director of the Company since December 1985. Mr. Litman
is currently Vice President for Regulatory Affairs and
Compliance Services for Tower Group International, Inc.
("Tower Group"), a position he has held since March
1996. From 1991 to March 1996 Mr. Litman was Vice
President for the Western Region for Tower Group. Mr.
Litman is a past President and senior counsel for the
board of the National Customs Brokers & Forwarders
Association of America.
Albert J. Gallegos................... 57 Director of the Company since January 1988. Since 1986,
Mr. Gallegos has been an independent consultant to the
insurance industry.
Kenneth A. Bodenstein................ 62 Director of the Company since September 1987. Mr.
Bodenstein has served as Senior Vice President and
Managing Director of Duff & Phelps Financial Consulting
Co., a financial services company, for more than the
past five years.
</TABLE>
44
<PAGE> 46
<TABLE>
<CAPTION>
POSITION WITH COMPANY, BUSINESS
NAME AGE EXPERIENCE AND OTHER DIRECTORSHIPS
---- --- ----------------------------------
<S> <C> <C>
Stanley A. Galanski.................. 40 Mr. Galanski was elected President and Chief Executive
Officer and appointed a director of the Company on July
7, 1997. From February 1995 to June 1997, Mr. Galanski
was President of New Hampshire Insurance Company, a
property and casualty insurer. From July 1980 to
January 1995 Mr. Galanski served in various capacities
with the Chubb Group of Insurance Companies.
</TABLE>
THE BOARD OF DIRECTORS AND ITS STANDING COMMITTEES
The Company's Board of Directors has the responsibility to review the
overall operations and proposed plans and business objectives of the Company.
The Board meets regularly four times each year, once each quarter. During 1998,
the Board met 4 times, and on 8 occasions there were telephonic special
meetings. All directors attended at least 75% of the aggregate of the total
number of meetings of the Board of Directors and meetings held by each committee
of the Board on which such directors served, except for Mr. Fritz, who
participated by telephone.
The Board has a standing Executive Committee, Audit Committee, Compensation
and Stock Option Committee and Investment Committee.
The Executive Committee was formed in December 1996, to review and monitor
ongoing activity as deemed appropriate between quarterly meetings of the Board
of Directors. The Executive Committee reports directly to the Board and is
comprised of Mr. Galanski and three non-employee directors, Messrs. Sanborn,
Bodenstein and Sklar. There were three meetings of the Executive Committee in
1998.
The Audit Committee recommends to the Board the appointment of the
independent certified public accountants for the following year. The Audit
Committee reviews with the auditors: (i) the scope of the Company's annual
audit, (ii) the annual financial statements of the Company and the auditors'
report with respect thereto, (iii) corporate and accounting practices and
policies, and (iv) overall accounting and financial controls. In addition, the
Audit Committee is available to the independent auditors during the year for
consultation purposes. The Committee, which reports directly to the Board, is
comprised of four non-employee directors, Messrs. Bodenstein, Gallegos, Weise
and Fritz. The Audit Committee met two times during 1998.
The Compensation and Stock Option Committee reviews recommendations
regarding overall salaries and compensation of Company officers and certain key
employees and is responsible for awarding stock options to those officers and
key employees under, and administering, the Company's 1987 Non-Qualified and
Incentive Stock Option Plan. This Committee also reviews the President's
performance pursuant to the Executive Incentive Compensation Plan. The
Compensation and Stock Option Committee reports directly to the Board and is
comprised of four non-employee directors, Messrs. Litman, Weise, Sanborn and
Fritz. The Compensation and Stock Option Committee met two times during 1998.
The Investment Committee develops investment policies for the Company and
reviews performance of the investment portfolio and management thereof. The
Investment Committee reports directly to the Board and is comprised of Mr.
Galanski and four non-employee directors, Messrs. Gallegos, Sklar, Bodenstein
and Litman. The Investment Committee met once during 1998.
All directors whose terms are not expiring serve as the ad hoc Nominating
Committee of the Board for the purpose of considering nominees to the Board of
Directors. The Company's by-laws set forth the required procedure for
considering nominees recommended by stockholders. Director nominations by
stockholders for the annual meeting must be delivered to the Company's Secretary
either by personal delivery or certified mail, postage prepaid, return receipt
requested, 90 days in advance of the annual meeting. Each such notice must set
forth: (a) the name and address of the stockholder who intends to make the
nomination; (b) the person or persons to be nominated; (c) a representation that
the stockholder is a holder of record of stock of the
45
<PAGE> 47
Company entitled to vote at such meeting and intends to appear in person or by
proxy at the meeting to nominate the person or persons specified in the notice;
(d) a description of all arrangements or understandings between the stockholder
and each nominee and any other person or persons (naming such person or persons)
pursuant to which the nomination or nominations are to be made by the
stockholder; (e) such other information regarding each nominee proposed by such
stockholder which would be required to be included in a proxy or information
statement filed with the Securities and Exchange Commission pursuant to the
proxy rules promulgated under the Securities Exchange Act of 1934, as amended,
or any successor statutes thereto, had the nominee been nominated or intended to
be nominated by the Board; and (f) the manually signed consent of each nominee
to serve as a Director of the Company if elected. The presiding officer of the
meeting of the Stockholders may refuse to acknowledge the nomination of any
person not made in compliance with the foregoing procedures.
DIRECTORS' COMPENSATION
The Company pays directors fees in the amount of $2,000 per meeting of the
Board and $750 for any committee meeting other than the Executive committee, for
which fees are $1,250 per meeting. During 1998, all committee meetings were held
in conjunction with Board meetings, except those of the Executive Committee.
Each director who is not an employee of the Company is entitled to receive
annually non-qualified options to purchase 1,000 shares of Common Stock on the
date of the Board meeting first following the date of the Annual Meeting of
Stockholders. The exercise price of such options is the fair market value of a
share of Common Stock on the date of grant of the option. Options granted under
this program vest in four equal annual installments beginning the third
anniversary of the date of grant. On August 10, 1998 each of Messrs. Sanborn,
Fritz, Litman, Gallegos, Bodenstein, Weise and Sklar were granted options under
this program.
46
<PAGE> 48
EXECUTIVE OFFICERS
The following table lists all current non-director executive officers of
the Company. Executive Officers are elected to serve until their successors are
duly elected and qualified.
<TABLE>
<CAPTION>
POSITION WITH COMPANY, BUSINESS
NAME AGE EXPERIENCE AND OTHER DIRECTORSHIPS
---- --- ----------------------------------
<S> <C> <C>
Robert S. Kielbas.................... 48 Mr. Kielbas is currently Senior Vice President
International Business Development. From April 1, 1996
to September 1, 1997 Mr. Kielbas was the Chief Executive
Officer of the Company's Hong King subsidiary. Since
1994, Mr. Kielbas has also served as Director of
International Operations for Intercargo Insurance
Company, the Company's primary U.S. subsidiary ("IIC"),
and until April 1, 1996 was the Managing Director for
the U.K. branch office. From 1987 to 1994 Mr. Kielbas
served as the Vice President-Marine of IIC with
responsibility for developing marine business with
direct shippers and alternative agency arrangements.
Robert M. Lynyak..................... 56 Mr. Lynyak was appointed Senior Vice President of the
Company on February 9, 1998. For over thirty three years
prior to joining the Company, he served in various
capacities at the Chubb Group of Insurance Companies,
most recently as Deputy Chief Underwriting Officer and
Managing Director of Chubb & Son, Inc.
Michael L. Rybak..................... 46 Mr. Rybak has served as Chief Financial Officer,
Secretary and Treasurer of the Company since August,
1996. From 1987 to 1996 Mr. Rybak was the Vice
President, Chief Financial Officer of United Chambers
Administrators.
</TABLE>
47
<PAGE> 49
ITEM 11. EXECUTIVE COMPENSATION
The Summary Compensation Table below includes, for each of the fiscal years
ended December 31, 1998, 1997 and 1996, individual compensation for services to
the Company and its subsidiaries paid to: (i) the Chief Executive Officer; and
(ii) the other former and continuing executive officers of the Company (the
"1998 Named Executives"). No other executive officer of the Company received
annual compensation in excess of $100,000 in fiscal 1998.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
AWARDS
------------
ANNUAL COMPENSATION SECURITIES
----------------------------- UNDERLYING ALL OTHER
NAME & PRINCIPAL POSITION YEAR SALARY(1) BONUS(1) OTHER OPTIONS/SARS COMPENSATION
------------------------- ---- --------- -------- ----- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Stanley A. Galanski(4)............. 1998 $265,000(4) $ 25,000 (2) 20,000 $ 6,423(10)
Chief Executive Officer and 1997 $147,340 (2) 20,000
President
James R. Zuhlke.................... 1998 $ 79,891(12) -- (2) -- --
Former Chief Executive Officer 1997 $303,797 $ 31,500 (2) -- $69,384(3)
1996 $300,000 $ 31,500 (2) $21,680(3)
Robert S. Kielbas.................. 1998 $210,000 15,250 (2) 15,000 $ 1,788(6)
Senior Vice President 1997 $233,173 -- $70,968(5) -- $ 3,787(6)
1996 $202,000 -- $64,620(5) -- $ 1,394(6)
Gary J. Bhojwani................... 1998 $ 4,615(13) -- (2) -- $ 192(7)
Former President of IAS 1997 $200,000 $156,250 (2) -- $ 1,673(7)
1997 $200,000 $ 50,071(8) (2) -- $ 1,538(7)
Michael L. Rybak................... 1998 $132,000 $ 11,250 (2) 5,000 $ 3,137(9)
Vice President, Chief Financial 1997 $120,000 $ 3,000 (2) 4,000 $10,961(9)
Officer, Treasurer & Secretary 1996 $ 47,630 (2) -- --
Robert M. Lynyak................... 1998 $172,308 -- (2) 20,000 $ 3,077(11)
Senior Vice President
</TABLE>
- -------------------------
(1) See "Board Compensation Committee Report on Executive Compensation" for
more detailed information regarding the determination of compensation for
the Named Executives.
(2) The total amount of perquisites and other non-cash personal benefits did
not exceed the lesser of $50,000 or 10% of total annual salary and bonus
for any of the Named Executives for any year shown.
(3) Includes: Directors fees paid to Mr. Zuhlke of: $ 8,000 in 1997, and
$10,000 in 1996; director's fees paid to Mr. Zuhlke by Kingsway Financial
Services, Inc. of: $9,807 in 1997, and $11,680 in 1996; insurance premiums
of $3,410 and $48,167 of airline passes in 1997.
(4) Mr. Galanski was elected President and Chief Executive Officer of the
Company in July, 1997. The 1997 salary listed above is the amount of a
$260,000 annual salary payable to Mr. Galanski under his Employment
Agreement actually paid in 1997.
(5) Amounts shown for 1997 and 1996 include $61,968 and $55,620, respectively,
paid to Mr. Kielbas for cost of living and tax equalization adjustment in
connection with his overseas posting to the Company's Hong Kong operations
and a cash car allowance of $9,000 and $9,000, respectively.
(6) Amounts shown represent the Company's matching contribution for Mr. Kielbas
to the Company's 401(K) Savings Plan in the amount of $1,788 in 1998,
$1,669 in 1997, $1,394 in 1996 and officers life insurance premium of
$2,118 in 1997.
(7) Amount shown represents the Company's matching contribution for Mr.
Bhojwani to the Company's 401(k) Savings Plan in the amount of $192 in
1998, $1,673 in 1997 and $1,538 in 1996.
(8) Amount shown represents bonus related to 1995 performance and paid in 1996.
48
<PAGE> 50
(9) Amount shown represents Company's matching contribution for Mr. Rybak to
the Company's 401(k) Savings Plan of $3,137 and $1,154 for 1998 and 1997,
respectively, and Kingsway directors fees paid of $9,807 in 1997.
(10) Amount shown represents the Company's matching contribution for Mr.
Galanski to the Company's 401(k) Savings Plan.
(11) Amount shown represents the Company's matching contribution for Mr. Lynyak
to the Company's 401(k) Savings Plan.
(12) Amount shown represents payments made until discontinuance of Mr. Zuhlke's
severance payments.
(13) Amount represents salary through Mr. Bhojwani's date of resignation from
the Company.
STOCK OPTIONS
OPTION GRANTS IN FISCAL YEAR 1998
The following table sets forth information with respect to stock options
granted during the fiscal year ended December 31, 1998 held by the 1998 Named
Executives.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
-----------------------------------------------------------------------------
POTENTIAL REALIZABLE
$ VALUE ASSUMING
ANNUAL RATES OF
STOCK PRICE
NO. OF APPRECIATION FOR
SECURITIES % OF TOTAL OPTION TERM
UNDERLYING OPTIONS EXERCISE EXPIRATION --------------------
NAME GRANT GRANTED PRICE $/SH DATE 5% 10%
---- ---------- ---------- ---------- ---------- -- ---
<S> <C> <C> <C> <C> <C> <C>
Mr. Galanski...................... 20,000 17.1% 11.375 07/06/08 143,074 362,576
Mr. Kielbas....................... 5,000 12.8% 12.25 02/05/08 42,895 101,992
10,000 11.50 11/05/08 73,573 184,530
Mr. Rybak......................... 5,000 4.3% 12.25 02/05/08 42,895 101,992
Mr. Lynyak........................ 20,000 17.1% 12.375 02/08/08 175,651 414,451
Mr. Zuhlke........................ 0
Mr. Bhojwani...................... 0
</TABLE>
49
<PAGE> 51
Shown below is information for the 1998 Named Executives with respect to
options and SARs exercised during fiscal year 1998 and unexercised options to
purchase the Company's Common Stock and SARs held at December 31, 1998.
AGGREGATED OPTION/SAR EXERCISES IN FISCAL YEAR 1998
AND FISCAL YEAR END OPTION/SAR VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
SHARES UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS/SARS
ACQUIRED ON VALUE OPTIONS/SARS AT 12/31/98 AT 12/31/98(1)
NAME EXERCISE(#) REALIZED($) EXERCISABLE/UNEXERCISABLE(#) EXERCISABLE/UNEXERCISABLE($)
---- ----------- ----------- ---------------------------- ----------------------------
<S> <C> <C> <C> <C>
Mr. Galanski............ -- -- 4,000/36,000 --/--
Mr. Rybak............... -- -- 1,000/8,000 2,250/6,750
Mr. Lynyak.............. -- -- 0/20,000 --/--
Mr. Zuhlke.............. -- -- 0/0 --/--
Mr. Kielbas............. -- -- 13,250/16,250 --/--
Mr. Bhojwani............ -- -- 0/0 --/--
</TABLE>
- -------------------------
(1) Based on the closing sale price of $11.375 as quoted on the NASDAQ National
Market on December 31, 1998.
EMPLOYMENT CONTRACTS
On July 7, 1997 the Company entered into an employment agreement with its
President and Chief Executive Officer, Stanley A. Galanski. This employment
agreement was for a one year period and continues on a bi-weekly basis
thereafter unless otherwise terminated due to Mr. Galanski's death or disability
or by the Company for "cause", as defined in the employment agreement. If the
employment agreement is terminated other than for cause (including a change in
control) or due to death or disability, Mr. Galanski shall be entitled to his
annual salary for a period of 12 months after such termination. The employment
provides for a base salary of $260,000, subject to increase in the sole
discretion of the Board of Directors, a bonus for 1997 of $25,000, eligibility
for bonuses under the Executive Incentive Compensation Plan, an option to
acquire 20,000 shares of Intercargo common stock, certain benefits, vacation of
four weeks annually and "carry over" of up to two weeks of unused vacation days
to the following year. It also contains restrictive covenants and non-
competition provisions for the period of twelve months after termination.
Effective January 1, 1998 the Company entered into an agreement with Mr.
Kielbas to serve as President of Trade Insurance Services, Inc. and be
responsible for all aspects of the Company's agency and marketing operations as
well as other duties as may be assigned by the President of Intercargo. This
employment agreement was for a one year period and continues on a month-to-month
basis thereafter unless otherwise terminated with thirty days written notice. If
terminated by the Company without cause Mr. Kielbas shall be entitled to his
annual salary for a period of one year. The employment agreement provides for a
base salary of $215,000 annually subject to increase at the sole discretion of
the President of Intercargo, certain benefits, eligibility for bonuses under any
Executive Incentive Compensation Plan and an option to acquire 10,000 shares of
Intercargo common stock. It also contains restrictive covenants and
non-competition provisions for a period of twelve months after termination.
On August 12, 1996 the Company entered into an employment agreement (the
"Employment Agreement") with its Chief Financial Officer, Michael L. Rybak. The
Employment Agreement was for a one year period and continues on a month-to-month
basis thereafter unless otherwise terminated due to Mr. Rybak's death or
disability or by the Company for "cause", as defined in the Employment
Agreement. The Employment Agreement provides for a base salary of $120,000,
subject to increases during subsequent renewal terms, certain benefits,
eligibility for bonuses under the Executive Incentive Compensation Plan, and
entrance into the vacation entitlement schedule as if he were a five year
employee. It also contains restrictive covenants and non-competition provisions
for the period of two years after termination. On November 18, 1998 the Company
executed a letter agreement with Mr. Rybak entitling him to a payment of $50,000
upon
50
<PAGE> 52
the earlier of (i) 180 days following a change in control of the Company or (ii)
the involuntary termination of Mr. Rybak, other than for cause. This letter
agreement can be terminated by the Company if a change in control has not
occurred prior to June 30, 1999.
On February 9, 1998 the Company entered into an employment agreement with
Mr. Lynyak to serve as Senior Vice President. This employment agreement was for
a one year period and continues in effect thereafter unless terminated with
thirty days written notice. If terminated by the Company without cause Mr.
Lynyak shall be entitled to his annual salary for a period of one year. The
employment agreement provides for a base salary of $200,000 annually subject to
increase at the sole discretion of the President of Intercargo, certain
benefits, eligibility for bonuses under any Executive Incentive Compensation
Plan and an option to acquire 20,000 shares of Intercargo common stock. It also
contains restrictive covenants and non-competition provisions for a period of
twelve months after termination.
OFFICER LOANS
IAS has provided loans to certain of its officers which loans are evidenced
by promissory notes dated August 25, 1993 bearing interest at a rate equal to
the prime lending rate plus 1%, as determined from time to time. The only notes
issued by a 1997 Named Executive was made by James Zuhlke in the original
principal amount of $96,110. This note was paid in full in 1997.
TOTAL RETURN COMPARISON
The following graph sets forth a five-year comparison of cumulative total
returns for: (i) the Company; (ii) the Standard & Poor's Total Return Index for
the Nasdaq Stock Market (U.S. Companies); and (iii) a Peer Group selected by the
Company (the "Peer Group").
Performance Graph
<TABLE>
<CAPTION>
INTERCARGO CORPORATION SELECTED STOCK LIST NASDAQ MARKET INDEX
---------------------- ------------------- -------------------
<S> <C> <C> <C>
12/31/93 100.00 100.00 100.00
12/30/94 71.75 73.41 104.99
12/29/95 88.60 95.61 136.18
12/31/96 77.46 126.99 169.23
12/31/97 121.90 137.83 207.00
12/31/98 106.41 112.65 291.96
</TABLE>
All returns were calculated assuming dividend reinvestment. The returns of
each company in the Peer Group have been weighted according to market
capitalization.
The Peer Group consists of the following companies: AmWest Insurance Group,
Inc.; NYMAGIC, Inc.; HCC Insurance Holdings, Inc.; and Navigators Group, Inc.
51
<PAGE> 53
BOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
The Compensation Committee is comprised of four non-employee directors:
Messrs. Litman, Fritz, Sanborn and Weise. The 1998 compensation for the
executive officers is comprised of the following components:
- Base Salary;
- Annual incentive compensation (i.e. bonus) based on individual
performance and Company performance; and
- Long term incentive compensation in the form of stock options granted
pursuant to the 1987 Non-Qualified Incentive Stock Option Plan (the
"Option Plan").
Based on recommendations of Stanley Galanski, President, the Compensation
Committee set the 1998 base salaries of all officers (other than Mr. Galanski).
The Compensation Committee set the 1998 base salary of the President. Factors
considered in the setting of salaries include historical salary levels and
salary levels at comparable companies. After approval by the Compensation
Committee, salaries are approved by the Board of Directors.
With respect to Mr. Galanski, the Compensation Committee established a base
salary for 1998 at $265,000.
Bonuses for all officers are determined pursuant to the Incentive Plan,
which directly links executive compensation with Company performance. The
Incentive Plan creates a bonus fund based on a percentage of the aggregate base
salaries of all eligible employees. The percentage is determined pursuant to a
sliding scale based on the return on equity ("ROE") of the Company and is
measured against the equity at the beginning of the bonus year.
The Incentive Plan provides a formula for the determination of bonus
amounts which in all cases includes ROE as one measurement. Other measurements
include departmental goals (for underwriters and salespeople) and intangible or
qualitative objectives. The weight given to each measurement varies with the
position of the individual.
ROE is assigned a 70% weight factor for the President, a 30% weight factor
for insurance underwriters and salespeople, and a 50% weight factor for the
Chief Financial Officer. Intangibles are assigned a 30% weight factor for the
President, a 20% factor for insurance underwriters and salespeople, and a 50%
weight factor for the Chief Financial Officer. Departmental goals are assigned a
50% weight factor and only apply to insurance underwriters and salespeople. The
weight factors which apply to intangibles and departmental goals are further
multiplied by a performance factor which reflects the level of achievement of
pre-set goals. Intangible goals, as well as what constitutes their fulfillment,
are set each year by the President and the individual officer. Departmental
goals are set by the President. The goals of the President are set by the
Compensation Committee, and the Committee determines the degree to which the
President has fulfilled those goals.
The available bonus fund is allocated among the eligible employees
according to the attainment of specific performance goals and application of the
ROE factor. Each individual's bonus is subject to a limit equal to the
percentage of base salary established by the ROE factor. Accordingly, the total
bonus of each 1998 Named Executive, other than Mr. Galanski, is limited to his
base salary multiplied by the maximum bonus percentage established by the ROE.
Based on the parameters of the Incentive Plan and at the discretion of the
Committee, bonuses were awarded for 1998 performance pursuant to the Incentive
Plan to Mr. Kielbas $15,000 and Mr. Lynyak $15,000. A 1998 bonus for Mr.
Galanski of $125,000 was approved which includes recognition for his efforts in
pursuing the strategic alternatives available to the Company.
The 1987 Non-Qualified Incentive Stock Option Plan (the "Option Plan") also
links individual compensation to Company performance. Because the exercise price
of the options granted under the Option Plan may not be less than fair market
value at the date of the grant, the executives have incentive to enhance
52
<PAGE> 54
Company performance as measured by the price of the Company's Common Stock. In
granting options to executives, the Compensation Committee considers the
recommendations of the President as well as the number of options already held
by each person. Taking into consideration various factors including the number
of shares subject to option and/or SAR's previously granted, the Compensation
Committee determined to grant options to purchase 49,750 shares of Common Stock
to a total of 9 officers and 37 other employees of the Company during fiscal
year 1998 in addition to options granted pursuant to the employment agreements
of Messrs. Galanski, Kielbas and Lynyak.
Effective January 1, 1994, the allowable deduction for federal income tax
purposes of compensation paid by the Company to the 1998 Named Executives is
$1,000,000 per executive per year. This limitation does not apply to
compensation that is based upon the attainment of performance goals or paid
pursuant to a written contract that was in effect on February 17, 1993. These
limitations have not affected the Company's ability to deduct all taxable
compensation paid to its 1998 Named Executives and is not expected to affect
these deductions in the foreseeable future.
Respectfully submitted,
INTERCARGO CORPORATION
Compensation Committee
Arthur J. Fritz, Jr.
Arthur L. Litman
Robert Sanborn
George Weise
53
<PAGE> 55
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
The following table shows with respect to (i) each person who is known to
be the beneficial owner of more than 5% of the Common Stock; (ii) each director
of the Company; (iii) the Chief Executive Officer and the four most highly
compensated executive officers of the Company during fiscal year 1998 and (iv)
all present executive officers and directors as a group: (a) the amount of
shares of Common Stock beneficially owned as of March 8, 1999; and (b) the
percent of the class so owned as of the same date:
<TABLE>
<CAPTION>
AMOUNT OF SHARES
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIALLY OWNED PERCENTAGE(1)
------------------------------------ ------------------ -------------
<S> <C> <C>
Orion Capital Corporation(2)................................ 1,899,223 26.04%
600 Fifth Avenue New York, NY 10020
Fenimore Asset Management(3)................................ 522,850 7.17%
118 North Grand Street P.O. Box 310 Cobleskill, NY 12043
Dimensional Fund Advisors, Inc.(4).......................... 366,200 5.02%
1299 Ocean Avenue, 11th Floor Santa Monica, CA 90401
AIC Limited(5).............................................. 370,549 5.08%
1375 Kerns Road Burlington, Ontario Canada
Stanley A. Galanski(6)...................................... 4,500 *
Arthur J. Fritz, Jr.(6)(7).................................. 250,250 3.43%
Kenneth A. Bodenstein(6)(8)................................. 20,250 *
Arthur L. Litman(6)......................................... 42,916 *
Albert J. Gallegos(6)(9).................................... 3,150 *
Robert S. Kielbas(6)(10).................................... 63,181 *
Robert B. Sanborn(6)........................................ 250 *
Michael L. Sklar(6)......................................... 3,250 *
George Weise(6)............................................. -- *
Michael L. Rybak(6)......................................... 3,250 *
Robert M. Lynyak(6)......................................... 4,000 *
All Directors and Executive Officers as a group (11
persons)(11).............................................. 394,997 5.40%
</TABLE>
- -------------------------
* Less than 1% of common stock outstanding
(1) Calculated pursuant to Rule 13d-3 of the Securities Exchange Act of 1934.
Unless otherwise stated herein, each such person has sole voting and
investment power with respect to all such shares. Under Rule 13d-3(d),
shares not outstanding which are subject to options, warrants, rights or
conversion privileges exercisable within 60 days are deemed outstanding for
the purpose of calculating the number and percentage owned by such person,
but are not deemed outstanding for the purpose of calculating the
percentage owned by each other person listed. As of December 31, 1998, the
total number of the Company's outstanding shares was 7,293,581.
(2) As reported in Orion Capital Corporation's Schedule 13D, as amended through
December 2, 1998. These shares are held by Security Insurance Company of
Hartford, a Connecticut corporation, wholly-owned by Orion Capital
Corporation. These shares are deemed to be beneficially owned by Robert B.
54
<PAGE> 56
Sanborn, a director of the Company, who as Senior Executive Consultant and
a director of Orion Capital Corporation, may be deemed to have shared power
to vote and dispose of these shares. Pursuant to the Stockholder Agreement,
Orion has agreed to vote all of its shares of Common Stock in favor of the
Merger. See "The Stockholder Agreement."
(3) As reported in Fenimore Asset Management Inc.'s Schedule 13G, dated
February 5, 1999.
(4) As reported in Dimensional Fund Advisors Inc.'s Schedule 13G, dated
February 11, 1999.
(5) As reported in AIC Limited's Schedule 13G, dated March 23, 1999.
(6) Messrs. Galanski, Kielbas, Rybak, Gallegos, Litman, Bodenstein, Fritz,
Sklar, Sanborn, Weise and Lynyak are directors and/or executive officers of
the Company.
(7) Includes 12,000 shares held by a family limited partnership in which Mr.
Fritz is one of the general partners.
(8) Includes 6,000 shares held by a charitable foundation as to which Mr.
Bodenstein exercises voting power.
(9) Held in the name of Mr. Gallegos' wife.
(10) Includes 74 shares of Common Stock held in the name of Mr. Kielbas' wife.
(11) See footnote (1) and Footnotes (6) -- (10) above.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Mr. Sklar, a director, is a partner of Rudnick & Wolfe, the principal law
firm engaged by the Company in 1998. Legal fees paid to Rudnick & Wolfe during
1998 totaled $848,865.
55
<PAGE> 57
INTERCARGO 10-K
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) Consolidated Balance Sheets as of December 31, 1998 and 1997.
Consolidated Statements of Operations for the Years Ended December
31, 1998, 1997 and 1996.
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1998, 1997 and 1996.
Consolidated Statements of Cash Flows for the Years Ended December
31, 1998, 1997 and 1996.
Notes to Consolidated Financial Statements.
Report of Ernst & Young LLP, Independent Auditors.
Report of KPMG LLP, Independent Auditors
(a)(2) The following consolidated financial statement schedules of the
Company listed below are contained in the index to Financial
Statement Schedules on page FS-1 herein:
Schedule I Summary of investments -- other than investments in
related parties
Schedule II Condensed financial information of registrant
Schedule III Supplementary insurance information
Schedule IV Reinsurance
Schedule VI Supplemental information concerning property/casualty
operations
(b) Reports on Form 8-K
The Company filed a Form 8-K on December 4, 1998. The report
addressed the Company entering into an Agreement and Plan of Merger
("Merger") dated as of December 1, 1998 with X.L. America, Inc., a
wholly owned subsidiary of XL Capital Ltd. Pursuant to the Merger,
the shares of common stock of Intercargo issued and outstanding
prior to the Merger will be converted to $12.00 in cash. The Merger
is subject to standard approvals and conditions.
(c) Exhibits. See Exhibit Index immediately following financial
statement schedules.
56
<PAGE> 58
INTERCARGO CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
SCHEDULES
Summary of Investments -- Other than Investments in Related
Parties (Schedule I)...................................... FS-2
Condensed Financial Information of Registrant (Schedule
II)....................................................... FS-3
Supplementary Insurance Information (Schedule III).......... FS-6
Reinsurance (Schedule IV)................................... FS-7
Supplemental Information Concerning Property/Casualty
Insurance Operations (Schedule VI)........................ FS-8
</TABLE>
FS-1
<PAGE> 59
SCHEDULE I
INTERCARGO CORPORATION AND SUBSIDIARIES
SUMMARY OF INVESTMENTS -- OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
AMOUNT AT WHICH
FAIR SHOWN IN THE
TYPE OF INVESTMENT COST(1) VALUE BALANCE SHEETS
------------------ ------- ----- ---------------
<S> <C> <C> <C>
Fixed Maturities:
U.S. Government and Agency obligations................... $19,668 $19,983 $19,983
State, municipal, and other tax advantaged securities.... 19,262 19,958 19,958
Corporate securities..................................... 18,762 19,335 19,335
Other fixed maturity investments......................... 298 308 308
------- ------- -------
Total fixed maturities.............................. 57,990 59,584 59,584
Equity securities.......................................... 5,231 4,856 4,856
------- ------- -------
Total investments..................................... $63,221 $64,440 $64,440
======= ======= =======
</TABLE>
- -------------------------
(1) Investments in fixed maturities are reflected at cost, adjusted for
amortization of premium or accretion of discounts.
See notes to consolidated financial statements.
FS-2
<PAGE> 60
SCHEDULE II
INTERCARGO CORPORATION
CONDENSED BALANCE SHEETS (REGISTRANT ONLY)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1998 1997
---- ----
<S> <C> <C>
ASSETS
Investment in equity securities............................. $ 1,445 $ 3,050
Cash and cash equivalents................................... 28,009 32,459
Equipment, at cost less accumulated depreciation............ 405 513
Investments in subsidiaries................................. 35,216 36,502
Notes receivable
Due from affiliates....................................... 8,260 8,260
Due from non-affiliates................................... 83 83
Federal income tax recoverable.............................. -- 275
Deferred income tax......................................... 998 --
Other assets................................................ 2,778 1,311
------- -------
Total assets........................................... $77,194 $82,453
======= =======
LIABILITIES
Accrued expenses and other liabilities...................... $ 3,136 $ 252
Federal income tax payable.................................. 1,083 --
------- -------
Total liabilities...................................... 4,219 252
------- -------
STOCKHOLDERS' EQUITY
Common stock -- $1 par value; authorized 20,000,000 shares;
issued 7,699,981 shares; outstanding 7,293,581 shares in
1998 and 7,699,981 shares in 1997......................... 7,700 7,700
Additional paid-in capital.................................. 24,400 24,400
Treasury stock, at cost; 406,400 shares..................... (4,044) --
Accumulated other comprehensive income...................... 1,752 2,176
Retained earnings........................................... 43,167 47,925
------- -------
Total stockholders' equity............................. 72,975 82,201
------- -------
Total liabilities and stockholders' equity............. $77,194 $82,453
======= =======
</TABLE>
See notes to consolidated financial statements.
FS-3
<PAGE> 61
SCHEDULE II -- CONTINUED
INTERCARGO CORPORATION
CONDENSED STATEMENTS OF OPERATIONS (REGISTRANT ONLY)
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
REVENUES
Net investment and other income............................. $ 2,346 $ 1,349 $ 757
Realized investment gains................................... 892 48,987 2,394
Revenues from affiliates.................................... -- -- 12
------- -------- ------
Total.................................................. 3,238 50,336 3,163
------- -------- ------
EXPENSES
Interest expense............................................ -- 488 715
General and administrative expense.......................... 4,513 2,576 676
------- -------- ------
Total.................................................. 4,513 3,064 1,391
------- -------- ------
Operating gain (loss)....................................... (1,275) 47,272 1,772
Income tax benefit (expense)................................ 399 (18,972) (606)
Equity in the operating earnings (losses) of subsidiaries
and affiliate, net of income taxes........................ (2,496) 3,488 5,238
------- -------- ------
Net income (loss)........................................... $(3,372) $ 31,788 $6,404
======= ======== ======
</TABLE>
See notes to consolidated financial statements.
FS-4
<PAGE> 62
SCHEDULE II -- CONTINUED
INTERCARGO CORPORATION
CONDENSED STATEMENTS OF CASH FLOW (REGISTRANT ONLY)
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)......................................... $(3,372) $ 31,788 $ 6,404
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Realized gains......................................... (892) (48,987) (2,394)
Equity in operating (earnings) losses of subsidiaries
and affiliate, net of income tax..................... 2,496 (3,488) (5,238)
Depreciation and amortization.......................... 93 175 --
Change in income tax accounts.......................... (4) 18,826 682
Decrease in notes receivable........................... -- 25 101
Increase in accrued expenses and other liabilities..... 2,884 19 49
Other, net............................................. (1,451) (1,289) 197
------- -------- -------
Net cash used in operating activities................ (246) (2,931) (199)
------- -------- -------
Cash flows from investing activities:
Contribution of capital to subsidiaries................... -- (4,050) (3,000)
Sales of equity securities................................ 1,207 -- --
Sale of Kingsway common stock (net of taxes of $18,500 in
1997).................................................. -- 49,140 4,573
(Purchase) sale of equipment, net......................... 19 (81) (38)
------- -------- -------
Net cash provided from investing activities.......... 1,226 45,009 1,535
------- -------- -------
Cash flows from financing activities:
Proceeds from exercise of stock options................... -- 260 95
Dividends paid to stockholders............................ (1,386) (1,379) (1,376)
Purchase of treasury stock................................ (4,044) -- --
Payment of loans.......................................... -- (9,735) --
------- -------- -------
Net cash used in financing activities................ (5,430) (10,854) (1,281)
------- -------- -------
Net increase (decrease) in cash and cash equivalents........ (4,450) 31,224 55
Cash and cash equivalents:
Beginning of the year..................................... 32,459 1,235 1,180
------- -------- -------
End of the year........................................... $28,009 $ 32,459 $ 1,235
======= ======== =======
</TABLE>
See notes to consolidated financial statements.
FS-5
<PAGE> 63
SCHEDULE III
INTERCARGO CORPORATION AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
(IN THOUSANDS)
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G COLUMN H COLUMN I
-------- ----------- --------- -------- ------------ -------- ---------- ---------- ------------
FUTURE
POLICY BENEFITS,
BENEFITS, CLAIMS, AMORTIZATION
DEFERRED LOSSES, LOSSES OF DEFERRED
POLICY CLAIMS OTHER NET AND POLICY
ACQUISITION AND LOSS UNEARNED POLICYHOLDER EARNED INVESTMENT SETTLEMENT ACQUISITION
COST EXPENSES PREMIUMS FUNDS PREMIUMS INCOME EXPENSES COSTS
----------- --------- -------- ------------ -------- ---------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
December 31, 1998
Surety................ $2,852 $17,132 $ 8,117 $-- $17,398 $ -- $ 4,124 $ 6,303
Marine................ 1,113 18,281 4,659 -- 25,791 -- 19,832 6,065
Professional
Liability........... -- 9,244 3,175 -- 2,674 -- 3,490 --
Other Property &
Casualty............ 175 11,857 4,290 -- 6,601 -- 5,222 735
All Other............. -- -- -- -- 6,122 -- -- 4,852
------ ------- ------- --- ------- ------ ------- -------
$4,140 $56,514 $20,241 $-- $52,464 $6,122 $32,668 $13,103
====== ======= ======= === ======= ====== ======= =======
December 31, 1997
Surety................ $1,930 $17,086 $ 7,854 $-- $17,947 $ -- $ 5,087 $ 6,437
Marine................ 634 19,853 2,970 -- 27,906 -- 19,482 5,835
Professional
Liability........... -- 6,577 3,510 -- 3,206 -- 3,752 --
Other Property &
Casualty............ 375 11,839 3,614 -- 8,351 -- 6,524 1,087
All Other............. -- -- -- -- -- 4,911 -- --
------ ------- ------- --- ------- ------ ------- -------
$2,939 $55,355 $17,948 $-- $57,410 $4,911 $34,845 $13,359
====== ======= ======= === ======= ====== ======= =======
December 31, 1996
Surety................ $3,160 $18,523 $ 9,481 $-- $25,846 $ -- $ 7,455 $ 9,518
Marine................ 597 13,658 2,599 -- 26,932 -- 17,759 6,972
Professional
Liability........... -- 5,996 2,570 -- 2,644 -- 2,714 --
Other Property &
Casualty............ 127 8,860 2,967 -- 5,631 -- 4,379 809
All Other............. -- -- -- -- -- 3,985 -- --
------ ------- ------- --- ------- ------ ------- -------
$3,884 $47,037 $17,617 $-- $61,053 $3,985 $32,307 $17,299
====== ======= ======= === ======= ====== ======= =======
<CAPTION>
COLUMN A COLUMN J COLUMN K
-------- --------- --------
OTHER
OPERATING PREMIUMS
EXPENSES WRITTEN
--------- --------
<S> <C> <C>
December 31, 1998
Surety................ $ 4,706 $18,768
Marine................ 6,316 27,594
Professional
Liability........... 2,189 2,834
Other Property &
Casualty............ 2,884 6,325
All Other............. --
------- -------
$20,947 $55,521
======= =======
December 31, 1997
Surety................ $ 5,342 $16,688
Marine................ 6,188 28,247
Professional
Liability........... 1,833 3,196
Other Property &
Casualty............ 3,258 9,061
All Other............. 1,193 --
------- -------
$17,814 $57,192
======= =======
December 31, 1996
Surety................ $ 4,659 $23,177
Marine................ 5,564 27,470
Professional
Liability........... 1,245 2,212
Other Property &
Casualty............ 2,346 5,594
All Other............. 1,116 --
------- -------
$14,930 $58,453
======= =======
</TABLE>
FS-6
<PAGE> 64
SCHEDULE IV
INTERCARGO CORPORATION AND SUBSIDIARIES
REINSURANCE
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F
- -------------------------------------------------- -------- --------- ---------- -------- ----------
PERCENTAGE
CEDED TO ASSUMED OF AMOUNT
GROSS OTHER FROM OTHER NET ASSUMED
AMOUNT COMPANIES COMPANIES AMOUNT TO NET
------ --------- ---------- ------ ----------
<S> <C> <C> <C> <C> <C>
Year ended:
December 31, 1998................................. $62,868 $12,902 $2,498 $52,464 4.76%
December 31, 1997................................. $67,802 14,548 4,156 57,410 7.24%
December 31, 1996................................. $68,206 10,163 3,010 61,053 4.93%
</TABLE>
FS-7
<PAGE> 65
SCHEDULE VI
INTERCARGO CORPORATION AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION
(IN THOUSANDS)
[CAPTION]
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G COLUMN H COLUMN I
-------- ----------- -------- -------- -------- -------- -------- --------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
CLAIMS AND
CLAIM
RESERVES ADJUSTMENT
FOR EXPENSES
UNPAID INCURRED
CLAIMS DISCOUNT, RELATED TO AMORTIZATION
DEFERRED AND IF ANY, --------------- OF DEFERRED
POLICY CLAIM DEDUCTED NET (1) (2) POLICY
AFFILIATION WITH ACQUISITION ADJUSTMENT IN UNEARNED EARNED INVESTMENT CURRENT PRIOR ACQUISITION
REGISTRANT COSTS EXPENSES COLUMN C PREMIUMS PREMIUMS INCOME YEAR YEAR COSTS
- --------------------- ----------- -------- -------- -------- -------- -------- ------- ----- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Consolidated
property-casualty
entities
Year ended:
December 31, 1998.... $4,140 $56,514 $-- $20,241 $52,464 $6,122 $31,680 $988 $13,103
December 31, 1997.... $2,939 55,355 -- 17,948 57,410 4,911 34,260 585 $13,359
December 31, 1996.... $3,884 47,037 -- 17,617 61,053 3,985 31,876 431 $17,299
<CAPTION>
PAID
CLAIMS AND
CLAIM
AFFILIATION WITH ADJUSTMENT PREMIUMS
REGISTRANT EXPENSES WRITTEN
- --------------------- ---------- --------
<S> <C> <C>
Consolidated
property-casualty
entities
Year ended:
December 31, 1998.... $31,519 $55,521
December 31, 1997.... 28,517 57,192
December 31, 1996.... 28,405 58,453
</TABLE>
FS-8
<PAGE> 66
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Dated: March 30, 1999 INTERCARGO CORPORATION
By: /s/ STANLEY A. GALANSKI
------------------------------------
Stanley A. Galanski, President and
Chief Executive Officer
<TABLE>
<CAPTION>
SIGNATURE DATE
--------- ----
<S> <C>
/s/ STANLEY A. GALANSKI March 30, 1999
- -----------------------------------------------------
Stanley A. Galanski
President, Chief Executive Officer and a Director
(Principal Executive Officer)
/s/ MICHAEL L. SKLAR March 30, 1999
- -----------------------------------------------------
Michael L. Sklar
Director
/s/ ARTHUR J. FRITZ, JR. March 30, 1999
- -----------------------------------------------------
Arthur J. Fritz, Jr.
Director
/s/ ARTHUR L. LITMAN March 30, 1999
- -----------------------------------------------------
Arthur L. Litman
Director
/s/ KENNETH A. BODENSTEIN March 30, 1999
- -----------------------------------------------------
Kenneth A. Bodenstein
Director
/s/ ALBERT J. GALLEGOS March 30, 1999
- -----------------------------------------------------
Albert J. Gallegos
Director
/s/ ROBERT B. SANBORN March 30, 1999
- -----------------------------------------------------
Robert B. Sanborn
Director
/s/ GEORGE J. WEISE March 30, 1999
- -----------------------------------------------------
George J. Weise
Director
/s/ MICHAEL L. RYBAK March 30, 1999
- -----------------------------------------------------
Michael L. Rybak
Chief Financial Officer, Vice President
(Principal Financial and Accounting Officer)
</TABLE>
<PAGE> 67
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <S>
3.1 Certificate of Incorporation of the Company, including
amendments thereto.(1)
3.2 Bylaws of the Company, including amendments thereto.(1)
4 Specimen Certificate of Common Stock.(2)
10.1 Form of Company's 1987 Non-Qualified and Incentive Stock
Option Plan.(1)
*10.2 Executive Incentive Compensation Plan.(3)
10.3 [Intentionally Blank]
10.4 [Intentionally Blank]
10.5 [Intentionally Blank]
*10.6 Indemnification Agreements between the Company and the
following directors: Kenneth A. Bodenstein, Arthur L.
Litman, Arthur J. Fritz, Jr., Albert J. Gallegos and James
R. Zuhlke.(3)
10.7 [Intentionally Blank]
10.8 [Intentionally Blank]
*10.9 Employment Agreement dated August 12, 1996 between the
Company and Michael L. Rybak.(5)
*10.10 Supplemental Life Insurance Policy for Robert S. Kielbas.(4)
*10.11 Indemnification Agreement dated February 18, 1994 between
the Company and Robert B. Sanborn.(4)
*10.12 Indemnification Agreement dated August 12, 1996 between the
Company and Michael L. Rybak.(5)
*10.13 Employment Agreement as of January 1, 1998 between the
Company and Robert S. Kielbas (filed herewith).
*10.14 Employment Agreement dated February 9, 1998 between the
Company and Robert M. Lynyak (filed herewith).
*10.15 Employment agreement dated July 7, 1997 between Company and
Stanley A. Galanski. (6)
*10.16 Letter agreement as of November 18, 1998 between Company and
Michael L. Rybak (filed herewith)
11 Statement regarding Computation of Per Share Earnings.
(filed herewith)
12 Statement regarding Computation of Ratios. (filed herewith)
13 Key Financial Information. (filed herewith)
21 Subsidiaries of the Company. (filed herewith)
23.1 Consent of Ernst & Young LLP, Independent Auditors (filed
herewith)
23.2 Consent of KPMG LLP, Independent Auditors (filed herewith)
27 Financial Data Schedule. (filed herewith)
</TABLE>
- -------------------------
(1) Filed with the Company's Registration Statement on Form S-18, Registration
No. 33-21270C and incorporated herein by reference.
(2) Filed with Amendment No. 1 to the Company's Registration Statement on Form
S-18, Registration No. 33-21270C and incorporated herein by reference.
(3) Filed with the Company's Registration Statement on Form S-2, Registration
No. 33-45658 and incorporated herein by reference.
(4) Filed with the Company's Form 10-K for the year ended December 31, 1994, and
incorporated herein by reference.
(5) Filed with the Company's Form 10-K for the year ended December 31, 1996 and
incorporated herein by reference.
(6) Filed with the Company's Form 10-K for the year ended December 31, 1997 and
incorporated herein by reference.
* Management contract or compensatory plan required to be filed as an exhibit
to this Annual Report on Form 10-K pursuant to Item 14(c) of Form 10-K.
<PAGE> 1
EMPLOYMENT AGREEMENT
AGREEMENT made the 1st day of January, 1998 between
INTERCARGO CORPORATION, a Delaware corporation (hereinafter referred to as
"Intercargo" or "Employer") and ROBERT KIELBAS (hereinafter referred to as the
"Employee").
WHEREAS, Intercargo is an insurance holding company which itself or
through its related or affiliated entities, sells and/or underwrites surety
bonds (including U.S. customs bonds), marine cargo insurance, errors and
omissions insurance and other lines, and through its own agency and various
sub-producers sells the said insurance products of Intercargo and of its related
or affiliated entities and of other insurance companies, and engages in such
other lawful business which it may pursue from time to time:
WHEREAS, Employee wishes to be employed by Intercargo to perform
management and executive services for it and its subsidiaries; and
WHEREAS, Employee is willing to be employed by Intercargo, and
Intercargo is willing to employ Employee, on the terms and conditions
hereinafter set forth.
WHEREAS, Intercargo and Employee agree that this Agreement will
supersede the terms and conditions of any and all prior understandings and past
practices between them regarding employment, whether written or oral.
NOW, THEREFORE, intending to be legally bound and in consideration of
the mutual covenants contained herein and other valuable consideration, the
receipt of which is hereby acknowledged, Intercargo and Employee hereby agree as
follows:
1. TERM. The term of this Agreement (the "Term") shall commence on the date
hereof and, subject to the terms and conditions contained herein, shall
continue for a period of one (1) year. Thereafter, should Employee wish to
remain employed and should Intercargo wish to continue to employ Employee,
this Agreement shall continue and have full force and effect, except that
either party may terminate the Agreement for any reason and at anytime,
with 30 days' written notice to the other party. Upon termination of
Employee's employment, all conditions and covenants of this Agreement
remain in full force and effect.
2. DUTIES. Employee shall serve as President of Trade Insurance Services, Inc.
("TIS"), and will be responsible for all aspects of management of
Intercargo's agency operations, including administrative, sales, marketing,
other executive services and other duties which may be assigned by the
President of Intercargo. Employee shall faithfully, industriously and the
best of his ability and talent perform all duties that may be required of
and from
<PAGE> 2
him. Employee agrees to devote substantially all of his business
time and attention (except for permitted vacation periods and reasonable
periods of illness) to the business and affairs of Intercargo and its
subsidiaries.
3. COMPENSATION. For all the services to be rendered by Employee hereunder,
Intercargo agrees to pay Employee:
(A) BASE SALARY.
i. An annual salary of Two Hundred Fifteen Thousand Dollars
($215,000.00), payable periodically in accordance with
Intercargo's regular compensation payment schedule;
ii. Employee shall be entitled to an annual salary review beginning in
January 1998; however, whether Employee shall receive any
increase in salary is in the discretion of the President of
Intercargo and subject to approval of the Compensation Committee
of the Board of Directors.
(B) BONUS. Employee shall be eligible to participate in any Executive
Incentive Compensation Plan for calendar years 1998 and beyond.
Whether Employee shall receive a bonus at any time shall be in the
sole discretion of the President of Intercargo subject to approval of
the Compensation Committee of the Board of directors.
(C) EMPLOYEE BENEFITS. Employee shall be entitled to benefits under and in
accordance with the terms and conditions of any pension or profit
sharing plan, disability income plan, group insurance plan, hospital
and surgical benefit plan, or any other incentive, retirement or
employee benefit plan for which senior executive employees of
Intercargo generally are eligible. Nothing herein, however, shall be
construed to either create an employee benefit if none presently
exists or prevent the alteration or termination of an employee benefit
for similarly situated employees of Intercargo.
(D) VACATION: TIME OFF. Employee shall be entitled to take such holidays
and sick leave as Intercargo may reasonably determine, consistent with
the performance of his duties hereunder and the then current policies
of Intercargo in respect to such matters. Notwithstanding any current
policies of Intercargo with respect to vacation, however, Employee
shall be entitled to four weeks vacation "annually." Annually shall be
defined by the term year. Employee may "carry over" up to two weeks of
unused vacation days to the following contract year. In no event,
however, shall employee be entitled to accumulate a total of more than
two weeks of time from prior contract years.
(E) EXPENSES. Intercargo agrees to pay reasonable expenses of Employee
incurred in connection with Employee's execution of his duties
hereunder.
<PAGE> 3
(F) AUTOMOBILE. Employee shall be entitled to an Intercargo leased
automobile or an auto allowance not to exceed $750 per month.
(G) COUNTRY CLUB MEMBERSHIP. Employee shall be entitled to use of an
Intercargo owned country club membership at Royal Melbourne Country
Club so long as Intercargo maintains a corporate country club
membership at that country club. In the event Intercargo elects to
terminate it's corporate membership, Employee shall have the
opportunity to convert the membership to one for his individual use,
and Employee shall be responsible for the costs of converting and
maintaining that membership.
(H) STOCK OPTIONS. In consideration of this Agreement and pursuant to
Intercargo Corporation's Non-Qualified and Incentive Stock Option Plan
dated July 28, 1987, as amended, (the "Plan"), Employee shall be
issued an award agreement dated as of the date of this Agreement (the
"Award Agreement"), granting Employee the option rights to acquire
10,000 shares of common stock of Intercargo ("Common Stock"). The
Award Agreement shall provide that the stock options exercise rights
shall vest at a rate of 2,000 shares on each of the following dates
provided that Employee remains employed by Intercargo in the years
1998, 1999, 2000, 2001 and 2002, and may otherwise be exercisable
thereafter within the maximum period allowed by applicable law and the
terms of the Plan. The purchase price for a share of Common Stock
under the Award Agreement shall be based on the closing market price
on the signing date of this Agreement.
4. TERMINATION FOR CAUSE. During the first year of this Agreement, Employer
may terminate this Agreement and immediately discharge Employee for the
following reasons: failure to properly service the business assigned to or
produced by Employee; failure to meet performance standards or sales goals;
any violation of any rule or regulation that may be established from time
to time for the conduct of Employer's business; failure of Employee to
perform any of his duties or obligations under this Agreement; breach of
any covenants or agreements under this Agreement; failure to render
services satisfactory to Employer; or failure of Employee to conduct all of
his activities, both business and personal, with full ethical and moral
propriety. Any termination by Employer pursuant to this paragraph shall be
made by Employer in its sole discretion, but shall be made reasonably and
in good faith.
5. TERMINATION UPON DISABILITY. If Employee is unable to perform the essential
functions of his or her position by reason of illness or incapacity for a
period in excess of any absence authorized by Employer, but not less than
six (6) months or, in the event of a disability as defined under the
American with Disabilities Act which materially interferes with Employee's
ability to perform the essential tasks of his responsibilities, even with
Employer's reasonable accommodation of Employee's disability (unless
reasonable accommodation would
<PAGE> 4
present undue hardship to Employer), this Agreement shall be terminated.
Employee shall be entitled to participate in Employer's long-term
disability program, to the extent Employee is qualified and entitled.
6. TERMINATION UPON DEATH DURING EMPLOYMENT. If Employee dies during the term
of this employment, this Agreement shall terminate and Employer shall pay
to the estate of Employee the compensation which would otherwise be payable
to Employee up to the date of Employee's death, subject to the right of
Employer to set-off any amounts due and owing by Employee to Employer.
7. PROPERTY RIGHTS. For purposes of this paragraph 7 and paragraphs 8 through
13, the term Intercargo shall include Intercargo and all related and
affiliated entities, and references to Intercargo shall also be deemed
references to such related and affiliated entities as the context may
require.
(a) All information determined by the facts and applicable law to be
confidential which relates to the business of Intercargo, which may
include, but not be limited to policy forms, agency and sub-producer
relationships, product and financial plans, information on pricing and
customers, fees and services provided therefore, shall be treated as
confidential by Employee both during and after the termination of
Employee's employment.
(b) All data, whether written or electronically stored, computer
print-outs and other records and written material prepared or compiled
by Employee or furnished to Employee while in the employ of Intercargo
and which relate to the business of Intercargo are the property of
Intercargo, and shall be the sole and exclusive property of Intercargo
and none of such data, computer printouts or other records, or copies
thereof, shall be retained by Employee upon separation of his
employment for any reason.
8. CONFIDENTIALITY: NON-SOLICITATION OF EMPLOYEES: NON-DISPARAGEMENT.
From and after the date hereof,
(a) Employee will maintain in confidence and will not, directly or
indirectly, use, publish or otherwise disclose to any competitor of
Intercargo or other third party, except as required by law or as may
be expressly permitted by Intercargo, any trade secrets, confidential,
proprietary, and other non-public information of a similar nature
belonging to Intercargo or to which Intercargo has any rights, except
to the extent, if any, that any such information is or becomes
generally known or is readily ascertainable by proper means
("Confidential Information"), whether or not such Confidential
Information is in written or electronic form, or exists as "know how"
or as knowledge gained through his employment by Intercargo. Such
Confidential Information includes, but is not limited to, proprietary
technical and business information relating to any non-public
financial information, business or product plans or costs, existing or
prospective customers or customer lists, pricing data or other terms
of sales, customer requirements, buying history or underwriting
<PAGE> 5
or risk assessment information, the identity of agents or customers or
prospective agents or customers, products, coverages, the terms of any
reinsurance, fronting or other agreements of Intercargo, subject to
the same exception stated in the preceding sentence;
(b) Employee will not solicit or induce, either directly or through
others, any employees of Intercargo to terminate such relationship, or
make contact with any such employees with the principal purpose of
violating this section; and
(c) Employee shall not disparage the business, employees, officers or
directors of Intercargo. All duties and obligations set forth herein
shall be in addition to those which exist by common law or statute.
Employee's obligations under this Agreement with respect to
Confidential Information shall extend to information belonging to any
client, vendor or customer of Intercargo and their agents and
employees, where such information is considered by such client, vendor
or customer of Intercargo and by their agents and employees to be
Confidential.
9. NON-COMPETITION: NON-SOLICITATION OF CUSTOMERS AND AGENTS.
(a) Employee shall not for 12 months following his separation from
Intercargo for any reason ("Restricted Period"), call upon, or solicit
through any independent agent, any person, entity or business who was
an existing insured of Intercargo at any time during the period
commencing sixty (60) months prior to Employee's separation from
Intercargo's employment through the end of the Restricted Period for
the purpose of selling to or through such customers or agents any
insurance coverages or surety bonds of a type offered by Intercargo
during such period. The term "existing or prospective customers" of
Intercargo as used in this paragraph shall be defined and construed to
mean any and all persons, corporations, partnerships, firms,
associations, businesses or other entities for whom or through whom
Intercargo engages in the business of providing insurance, surety
bonds or conducting related business or for whom or through whom
Intercargo actively sought or seeks to engage in such business during
the period commencing sixty (60) months prior to Employee's separation
from Intercargo's employment through the end of the Restricted Period
and shall include agents and subagents of Intercargo notwithstanding
that such persons or entities may have been induced to become
customers and/or agents and given their patronage to Intercargo by the
efforts and solicitations of Employee, or someone on his behalf;
(b) Employee shall not, during the Restricted Period, directly or
indirectly, own an interest in, manage, operate, join, control, lend
money or render financial or other assistance to or participate in or
be connected with, as an officer, employee, partner, agent,
stockholder, consultant, independent contractor or otherwise, any
<PAGE> 6
individual, partnership, firm, corporation, proprietorship,
association or other business organization or entity which causes the
diversion of the business of Intercargo to competitors.
The restrictions in this paragraph 9 shall be limited to any county of any
state of the United States or any comparable jurisdiction of any foreign
country in which Intercargo, directly or through subsidiaries during the
Term of this Agreement or the Restricted Period, has been or is engaged in
the business described in the Recitals or this paragraph.
10. EMPLOYEE ACKNOWLEDGEMENT. Employee has carefully considered the nature and
extent of the restrictions upon him and the rights and remedies conferred
upon Intercargo under this Agreement, and hereby acknowledges and agrees
that the same is reasonable in time and territory, are designed to
eliminate competition which otherwise would be unfair to Intercargo, do not
stifle the inherent skill and experience of Employee, do not operate as a
bar to Employee's sole means of support, are fully required to protect the
legitimate interest of Intercargo and do not confer a benefit upon
Intercargo disproportionate to the detriment of the Employee.
11. EXTENSION OF DURATION. In addition to the remedies Intercargo may seek and
obtain pursuant to paragraph 13 hereof, the restrictions of paragraphs 8
and 9 shall be extended by any and all periods during which the Employee
shall have been found by a court possessing personal jurisdiction over
Employee to have been in violation of the covenants in paragraphs 8 and 9.
12. JUDICIAL MODIFICATION. The parties hereby agree that if the scope or
enforceability of the covenants in paragraphs 8 and 9 hereof are in any way
disputed at any time, a court or other trier of fact may modify and enforce
said covenants to the extent that it believes them to be reasonable under
circumstances existing at that time.
13. INJUNCTIVE RELIEF. Employee acknowledges that compliance with the
restrictive covenants herein is necessary to protect the business and good
will of Intercargo, and that a breach of these restrictions will cause
irreparable damage to Intercargo for which monetary damages may not be
adequate. Consequently, Employee agrees that in the event that he breaches
or threatens to breach any of the restrictive covenants contained herein,
Intercargo shall be entitled to both (i) a temporary, preliminary and/or
permanent injunction in order to prevent the continuation of such harm, and
(ii) money damages insofar as they can be determined. Notwithstanding any
of the foregoing, nothing in this Agreement shall be construed to prohibit
Intercargo or Employee from also pursuing any other remedy, the parties
having agreed that all remedies are to be cumulative. As money damages for
the period of time during which Employee violates the restrictive
covenants, Intercargo shall be
<PAGE> 7
entitled to recover the amount of fees, compensation or other remuneration
earned by Employee as a result of any such breach.
14. NOTICES. Any and all notices required or permitted to be given under this
Agreement will be sufficient if furnished in writing, sent by personal
delivery, telex, telecopier or certified mail, return receipt requested, to
the applicable address set forth below (or such other address as may from
time to time be designated by notice by any party hereto for such purpose):
To Employee: Robert Kielbas
1610 Galloway
Barrington, IL 60010
To Intercargo: Intercargo Corporation
Attn: President
1450 E. American Lane, 20th Floor
Schaumburg, IL 60173
Copy to: Rudnick & Wolfe
203 North LaSalle Street, Suite 1800
Chicago, IL 60001
Attn: Michael L. Sklar
Notice shall be deemed given, if by personal delivery, on the date of
such delivery or, if by telex or telecopy, on the business day
following receipt of answer back or telecopy confirmation or, if by
certified mail, on the date shown on the applicable return receipt.
15. MISCELLANEOUS.
(a) Except for other documents referenced in this Agreement, this written
Agreement contains the sole and entire Agreement between the parties,
and supersedes any and all other agreements between them.
(b) The waiver by either party of a breach of any provision of this
Agreement, shall not operate as, or be construed a waiver of any
subsequent breach thereof. No waiver or modification of this Agreement
or of any covenant, condition or limitation herein contained shall be
valid unless in writing and duly executed by the party to be charged
therewith.
(c) In case any one or more of the provisions contained in this Agreement
shall for any reason be held to be invalid, illegal or unenforceable
in any respect, such invalidity, illegality or unenforceability shall
not affect any other provision thereof and this Agreement shall be
construed as if such invalid, illegal or unenforceable provision had
never been contained herein.
(d) In any action, special proceedings or other proceedings that may be
brought arising out of, in connection with, or by reason of this
Agreement, the laws of the State of Illinois shall be applicable and
shall govern to the exclusion of the law of any other forum, without
regard to the jurisdiction in which the action or special proceeding
may be instituted.
(e) The section headings contained herein are inserted for ease of
reference only and shall not control or affect the meaning or
construction of the provisions hereof.
(f) This Agreement shall be binding on and inure to the benefit of the
respective parties and their respective heirs, legal representatives,
successors and assigns.
<PAGE> 8
IN WITNESS WHEREOF, Intercargo has hereunto caused this Agreement to be
executed by its duly authorized officers and the Employee has hereunto set his
hand, all being done in duplicate originals with one being delivered to each
party on the 5th day of March, 1998.
Executed at Schaumburg, Illinois on the date first above written.
INTERCARGO CORPORATION EMPLOYEE
By: /s/ Stanley A. Galanski /s/ Robert Kielbas
------------------------ ---------------------------
Its: President Robert Kielbas
<PAGE> 1
EMPLOYMENT AGREEMENT
AGREEMENT made the 9th day of February, 1998 between INTERCARGO
CORPORATION, a Delaware corporation (hereinafter referred to as "Intercargo" or
"Employer") and ROBERT LYNYAK (hereinafter referred to as the "Employee").
WHEREAS, Intercargo is an insurance holding company which itself or
through its related or affiliated entities, sells and/or underwrites surety
bonds (including U.S. customs bonds), marine cargo insurance, errors and
omissions insurance and other lines, and through its own agencies, independent
agencies and/or various sub-producers sells the said insurance products of
Intercargo and of its related or affiliated entities and of other insurance
companies, and engages in such other lawful business which it may pursue from
time to time:
WHEREAS, Employee wishes to be employed by Intercargo to perform
management and executives services for it and subsidiaries; and
WHEREAS, Employee is willing to be employed by Intercargo, and
Intercargo is willing to employ Employee, on the terms and conditions
hereinafter set forth.
WHEREAS, Intercargo and Employee agree that this Agreement will
supersede the terms and conditions of any and all prior understandings and past
practices between them regarding employment, whether written or oral.
NOW, THEREFORE, intending to be legally bound and in consideration of
the mutual covenants contained herein and other valuable consideration, the
receipt of which is hereby acknowledged, Intercargo and Employee hereby agree as
follows:
1. TERM. The term of this Agreement (the "Term") shall commence on the
date hereof and, subject to the terms and conditions contained herein,
shall continue for a period of one (1) year. Thereafter, should
Employee wish to remain employed and should Intercargo wish to continue
to employ Employee, this Agreement shall continue and have full force
and effect, except that either party, subject to the provisions of
paragraphs 4, 5 and 6 herein, may terminate the Agreement for any
reason and at anytime, with 30 days' written notice to the other party.
The provisions of sections 7 through 12 shall survive termination.
2. DUTIES AND PLACE OF EMPLOYMENT.
(a) Employee shall serve as Senior Vice President of Intercargo
Corporation, Senior Vice President of Intercargo Insurance
Company, and President of Intercargo Insurance Company Hong
Kong Ltd., including administrative, sales, marketing, other
executive services and other duties which may be assigned by
the President of Intercargo. Initially, the Employee have the
responsibilities and goals set forth on Exhibit A attached
hereto. Employee shall faithfully, industriously and the best
of his ability and talent perform all duties that may be
required of and from him. Employee agrees to devote
substantially all of his business time and attention (except
for permitted vacation periods, reasonable time to pursue
passive personal investments and reasonable periods of
illness) to the business and affairs of Intercargo and its
subsidiaries.
(b) Employee while in the United States shall be permitted to
maintain office facilities in and perform his duties in and
from New York and New Jersey offices as well as Schaumburg,
Illinois.
<PAGE> 2
3. COMPENSATION. For all the services to be rendered by Employee
hereunder, Intercargo agrees to pay Employee:
(a) BASE SALARY.
i. An annual salary of Two Hundred Thousand Dollars
($200,000.00), payable periodically in accordance
with Intercargo's regular compensation payment
schedule;
ii. Employee shall be entitled to an annual salary review
beginning in January 1999; however, whether Employee
shall receive any increase in salary is in the
discretion of the President of Intercargo and subject
to approval of the Compensation Committee of the
Board of Directors.
(b) BONUS. Employee shall be eligible to participate in any
Executive Incentive Compensation Plan ("Plan") for calendar
years 1998 and beyond as a Vice President. The current Plan is
set forth on Exhibit B which is attached hereto. The Employer
reserves the right to amend, replace or terminate the Plan in
its sole discretion. Whether Employee shall receive a bonus at
any time shall be in the sole discretion of the President of
Intercargo subject to approval of the Compensation Committee
of the Board of directors.
(c) EMPLOYEE BENEFITS. Employee shall be entitled to benefits
under and in accordance with the terms and conditions of any
pension or profit sharing plan, disability income plan, group
insurance plan, hospital and surgical benefit plan, or any
other incentive, retirement or employee benefit plan for which
senior executive employees of Intercargo generally are
eligible. Nothing herein, however, shall be construed to
either create an employee benefit if none presently exists or
prevent the alteration or termination of an employee benefit
for similarly situated employees of Intercargo.
(d) VACATION: TIME OFF. Employee shall be entitled to take such
holidays and sick leave as Intercargo may reasonably
determine, consistent with the performance of his duties
hereunder and the then current policies of Intercargo in
respect to such matters. Notwithstanding any current policies
of Intercargo with respect to vacation, however, Employee
shall be entitled to four weeks vacation "annually." Annually
shall be defined by the term year. Employee may "carry over"
up to two weeks of unused vacation days to the following
contract year. In no event, however, shall employee be
entitled to accumulate a total of more than two weeks of time
from prior contract years.
(e) EXPENSES. Intercargo agrees to pay reasonable expenses of
Employee incurred in connection with Employee's execution of
his duties hereunder, including regular travel expenses
between Employee's home in New Jersey and Schaumburg,
Illinois.
(f) AUTOMOBILE. Employee shall be entitled to an Intercargo leased
automobile or an auto allowance not to exceed $750 per month.
(g) COMPANY LEASED APARTMENT. Intercargo agrees to provide you
with a company-leased apartment for your use during your
periods "in residence" in Schaumburg, Illinois.
<PAGE> 3
(h) STOCK OPTIONS. In consideration of this Agreement and pursuant
to Intercargo Corporation's Non-Qualified and Incentive Stock
Option Plan dated July 28, 1987, as amended, (the "Plan"),
Employee shall be issued an award agreement dated as of the
date of this Agreement (the "Award Agreement"), granting
Employee the option rights to acquire 20,000 shares of common
stock of Intercargo ("Common Stock"). The Award Agreement
shall provide that the stock options exercise rights shall
vest at a rate of 4,000 shares on each anniversary of this
Agreement in the years 1999, 2000, 2001, 2002, and 2003
provided that Employee is employed by Intercargo at such
times, and may otherwise be exercisable thereafter within the
maximum period allowed by applicable law and the terms of the
Plan. The purchase price for a share of Common Stock under the
Award Agreement shall be based on the closing market price on
the date you commence your employment with Intercargo.
4. TERMINATION.
(a) FOR CAUSE. During the initial term of this Agreement, Employer
may terminate this Agreement and immediately discharge
Employee for the following reasons: violation or the
provisions of paragraphs 7 or 8 herein; failure satisfy
mutually agreed upon reasonable goals for operating results or
performance standards ("financial cause"); breach of any
material covenants or agreements under this Agreement; failure
of Employee to conduct all of his activities, both business
and personal, with full ethical and moral propriety;
conviction of a crime or moral turpitude, or conduct
constituting fraud, dishonesty or non-disability substance
abuse; provided, however, that during the first year of this
Agreement, termination for "financial cause" as set forth
above shall not be considered "for cause." Any termination by
Employer pursuant to this paragraph shall be made by Employer
in its sole discretion, but shall be made reasonably and in
good faith. In the event of termination for cause, Employer
shall have no further financial obligation to Employee except
as may be required by law.
(b) WITHOUT CAUSE. In the event of termination by the Employer of
the Employee's employment for any reason other than for cause,
disability or death (all as defined herein), Employee shall
receive one year's compensation in periodic installments in
accordance with Intercargo's regular compensation plan.
5. TERMINATION UPON DISABILITY. If Employee is unable to perform the
essential functions of his or her position by reason of illness or
incapacity for a period in excess of any absence authorized by
Employer, but not less than six (6) months or, in the event of a
disability as defined under the American with Disabilities Act which
materially interferes with Employee's ability to perform the essential
tasks of his responsibilities, even with Employer's reasonable
accommodation of Employee's disability (unless reasonable accommodation
would present undue hardship to Employer) , this Agreement shall be
terminated. Employee shall be entitled to participate in Employer's
long-term disability program, to the extent Employee is qualified and
entitled.
6. TERMINATION UPON DEATH DURING EMPLOYMENT. If Employee dies during the
term of this employment, this Agreement shall terminate and Employer
shall pay to the estate of Employee the compensation which would
otherwise be payable to Employee up to the date of Employee's death,
subject to the right of Employer to set-off any amounts due and owing
by Employee to Employer.
<PAGE> 4
7. CONFIDENTIALITY: NON-SOLICITATION OF EMPLOYEES: NON-DISPARAGEMENT.
For purposes of this paragraph 7, and paragraphs 8 through 12, the term
Intercargo shall include Intercargo and all related and affiliated entities, and
references to Intercargo shall also be deemed references to such related and
affiliated entities as the context may require.
From and after the date hereof,
(a) Employee will maintain in confidence and will not, directly or
indirectly, use, publish or otherwise disclose to any
competitor of Intercargo or other third party, except as
required by law or as may be expressly permitted by
Intercargo, any trade secrets, confidential, proprietary, and
other non-public information of a similar nature belonging to
Intercargo or to which Intercargo has any rights
("Confidential Information"), except to the extent, if any,
that any such information is or becomes generally known or is
readily ascertainable by proper means, whether or not such
Confidential Information is in written or electronic form, or
exists as "know how" or as knowledge gained through his
employment by Intercargo. However stored or maintained, such
confidential Information includes, but is not limited to,
proprietary technical and business information relating to any
non-public financial information, business or product plans or
costs, existing or prospective customers or customer lists,
pricing data or other terms of sales, customer requirements,
buying history or underwriting or risk assessment information,
the identity of agents or customers or prospective agents or
customers, products, coverages, the terms of any reinsurance,
fronting or other agreements of Intercargo, and policy forms.
(b) Employee will not solicit or induce, either directly or
through others, any employees of Intercargo to terminate such
relationship, or make contact with any such employees with the
principal purpose of violating this section;
(c) Employee shall not disparage the business, employees, officers
or directors of Intercargo; and
(d) All duties and obligations set forth herein shall be in
addition to those which exist by common law or statute.
Employee's obligations under this Agreement with respect to
Confidential Information shall extend to information belonging
to any client, vendor or customer of Intercargo and by their
agents and employees to be Confidential.
<PAGE> 5
8. NON-COMPETITION: NON-SOLICITATION OF CUSTOMERS AND AGENTS.
(a) Employee shall not for 12 months following his separation from
Intercargo for any reason ("Restricted Period"), call upon, or
solicit through any independent agent, any person, entity or
business who was an existing insured of Intercargo at any time
during the period commencing sixty (60) months prior to
Employee's separation from Intercargo's employment through the
end of the Restricted Period for the purpose of selling to or
through such customers or agents any insurance coverages or
surety bonds of a type offered by Intercargo during such
period. The term "existing or prospective customers" of
Intercargo as used in this paragraph shall be defined and
construed to mean any and all persons, corporations,
partnerships, firms, associations, businesses or other
entities for whom or through whom Intercargo engages in the
business of providing insurance, surety bonds or conducting
related business or for whom or through whom Intercargo
actively sought or seeks to engage in such business during the
period commencing sixty (60) months prior to Employee's
separation from Intercargo's employment through the end of the
Restricted Period and shall include agents and subagents of
Intercargo notwithstanding that such persons or entities may
have been induced to become customers and/or agents and given
their patronage to Intercargo by the efforts and solicitations
of Employee, or someone on his behalf.
(b) Employee shall not, during the Restricted Period, directly or
indirectly, own an interest in, manage, operate, join,
control, lend money or render financial or other assistance to
or participate in or be connected with, as an officer,
employee, partner, agent, stockholder, consultant, independent
contractor or otherwise, any individual, partnership, firm,
corporation, proprietorship, association or other business
organization or entity which causes the diversion of the
business of Intercargo to competitors.
The restrictions in this paragraph 8 shall be limited to any county of
any state of the United States or any comparable jurisdiction of any
foreign country in which Intercargo, directly or through subsidiaries
or independent agencies or subproducers during the Term of this
Agreement or the Restricted Period, has been or is engaged in the
business described in the Recitals or this paragraph.
9. EMPLOYEE ACKNOWLEDGEMENT. Employee has carefully considered the nature
and extent of the restrictions upon him and the rights and remedies
conferred upon Intercargo under this Agreement, and hereby acknowledges
and agrees that the same is reasonable in time and territory, are
designed to eliminate competition which otherwise would be unfair to
Intercargo, do not stifle the inherent skill and experience of
Employee, do not operate as a bar to Employee's sole means of support,
are fully required to protect the legitimate interest of Intercargo and
do not confer a benefit upon Intercargo disproportionate to the
detriment of the Employee.
<PAGE> 6
10. EXTENSION OF DURATION. In addition to the remedies Intercargo may seek
and obtain pursuant to paragraph 12 hereof, the restrictions of
paragraphs 7 and 8 shall be extended by any and all periods during
which the Employee shall have been found by a court possessing personal
jurisdiction over Employee to have been in violation of the covenants
in paragraphs 7 and 8.
11. JUDICIAL MODIFICATION. The parties hereby agree that if the scope or
enforceability of the covenants in paragraphs 7 and 8 hereof are in any
way disputed at any time, a court or other trier of fact may modify and
enforce said covenants to the extent that it believes them to be
reasonable under circumstances existing at that time.
12. INJUNCTIVE RELIEF. Employee acknowledges that compliance with the
restrictive covenants herein is necessary to protect the business and
good will of Intercargo, and that a breach of these restrictions will
cause irreparable damage to Intercargo for which monetary damages may
not be adequate. Consequently, Employee agrees that in the event that
he breaches or threatens to breach any of the restrictive covenants
contained herein, Intercargo shall be entitled to both (i) a temporary,
preliminary and/or permanent injunction in order to prevent the
continuation of such harm, and (ii) money damages insofar as they can
be determined. Notwithstanding any of the foregoing, nothing in this
Agreement shall be construed to prohibit Intercargo or Employee from
also pursuing any other remedy, the parties having agreed that all
remedies are to be cumulative. As money damages for the period of time
during which Employee violates the restrictive covenants, Intercargo
shall be entitled to recover the amount of fees, compensation or other
remuneration earned by Employee as a result of any such breach.
13. NOTICES. Any and all notices required or permitted to be given under
this Agreement will be sufficient if furnished in writing, sent by
personal delivery, telex, telecopier or certified mail, return receipt
requested, to the applicable address set forth below (or such other
address as may from time to time be designated by notice by any party
hereto for such purpose):
To Employee: Robert Lynyak
4 Woodstone Road
Chester, NJ 07930
To Intercargo: Intercargo Corporation
Attn: President
1450 E. American Lane, 20th Floor
Schaumburg, IL 60173
Copy to: Rudnick & Wolfe
203 North LaSalle Street, Suite 1800
Chicago, IL 60001
Attn: Michael L. Sklar
<PAGE> 7
Notice shall be deemed given, if by personal delivery, on the
date of such delivery or, if by telex or telecopy, on the
business day following receipt of answer back or telecopy
confirmation or, if by certified mail, on the date shown on
the applicable return receipt.
14. MISCELLANEOUS.
(a) Except for other documents referenced in this Agreement, this
written Agreement contains the sole and entire Agreement
between the parties, and supersedes any and all other
agreements between them.
(b) The waiver by either party of a breach of any provision of
this Agreement, shall not operate as, or be construed a waiver
of any subsequent breach thereof. No waiver or modification of
this Agreement or of any covenant, condition or limitation
herein contained shall be valid unless in writing and duly
executed by the party to be charged therewith.
(c) In case any one or more of the provisions contained in this
Agreement shall for any reason be held to be invalid, illegal
or unenforceable in any respect, such invalidity, illegality
or unenforceability shall not affect any other provision
thereof and this Agreement shall be construed as if such
invalid, illegal or unenforceable provision had never been
contained herein.
(d) In any action, special proceedings or other proceedings that
may be brought arising out of, in connection with, or by
reason of this Agreement, the laws of the State of Illinois
shall be applicable and shall govern to the exclusion of the
law of any other forum without regard to the jurisdiction in
which the action or special proceeding may be instituted.
(e) The section headings contained herein are inserted for each of
reference only and shall not control or affect the meanings or
construction of the provisions hereof.
(f) This Agreement shall be binding on and inure to the benefit of
the respective parties and their respective heirs, legal
representatives, successors and assigns.
IN WITNESS WHEREOF, Intercargo has hereunto caused this Agreement
to be executed by its duly authorized officers and the Employee has hereunto set
his hand, all being done in duplicate originals with one being delivered to each
party on the 9th day of February, 1998.
Executed at Schaumburg, Illinois on the date first above written.
INTERCARGO CORPORATION EMPLOYEE
By: /s/ Stanley A. Galanski /s/ Robert Lynyak
------------------------- ----------------------
Its: President Robert Lynyak
-------------------
<PAGE> 8
EXHIBIT A
INITIAL RESPONSIBILITIES:
1. Complete operational responsibility for day to day management,
staffing, profitability and growth of the non-U.S. underwriting
operations. At present, this consists of the London branch office of
Intercargo Insurance Company; our Hong Kong subsidiary; and the
"joint-venture" with Kemper in Singapore.
2. Development of a strategy to expand our international underwriting
operations in Asia, Europe and South America so as to generate at least
$50 million U.S. in gross written premium annually by December 31,
2000.
3. New product development on a worldwide basis so as to introduce at
least three new products annually.
4. Management of U.S. exporter's package product introduction and
product line.
5. Additional underwriting management and marketing management
responsibility as assigned by the President of Intercargo Corporation.
POSITION REPORTS TO: President of Intercargo Corporation
<PAGE> 9
EXHIBIT B
EXECUTIVE INCENTIVE COMPENSATION PLAN
PART I
In order to provide meaningful and objective incentives for exceptional
executive performance which inures to the benefit of shareholders in the form of
greater earnings and equity accumulation, the following table shall represent
the allowable maximum bonus levels to be paid.
<TABLE>
<CAPTION>
Pre Bonus
Return on beginning equity Maximum bonus allotments
-------------------------- ------------------------
0-10.00% Up to 10% at the discretion
of the Compensation
Committee
<S> <C> <C>
12.50% 12.50%
14.00% 15.00%
15.50% 20.00%
17.00% 25.00%
18.00% 30.00%
19.00% 37.50%
20.00% 45.00%
21.00% 52.50%
22.00% 60.00%
23.00% 67.50%
24.00% 75.00%
25.00% 82.50%
26.00% 90.00%
27.00% 100.00%
</TABLE>
All return on equity (ROE) percentages are to be considered as thresholds of
achievement and there will be no interpolation of bonus percentage limitation
for fractional increases in return on equity. If ROE is below 10%, distribution
of the bonus allotment shall be at the discretion of the Compensation Committee.
Return on equity (ROE) for all eligible persons shall be defined as net
operating income of Intercargo Corporation on a GAAP basis after tax but without
the inclusion of extraordinary capital gains or losses arising from acquisition
or sale of,
<PAGE> 10
merger, reorganization or recapitalization of any operating entity divided
by Intercargo Corporation equity at the beginning of the measurement year.
Subject to the foregoing, the President shall be responsible for administration
of the plan in conformity with the following guidelines.
<PAGE> 11
PART II
Section 1. Eligibility. All officers and the Chief Financial Officer shall
be eligible for bonuses pursuant to the Plan.
Section 2. Measurement. The measurements shall include overall company
performance, individual quantitative departmental goals and intangible or
qualitative objectives. The relative weight of these measurements will vary by
position as follows:
<TABLE>
<CAPTION>
Weighted % of total bonus measurement
Return of Equity Departmental Intangible
<S> <C> <C>
Chairman/President 70% 30%
Underwriters/Sales/Other Vice 30% 50% 20%
Presidents
Chief Financial Officer 50% 50%
</TABLE>
Basic guidelines for establishing these objectives are as follows:
Departmental Goals. Individual performances will be measured based on function.
Underwriters will be measured based on underwriting gain ratios. Underwriters
should never be held directly accountable for volume as it undermines
underwriting policy and rates for the sake of volume. The individual departments
will be assigned underwriting gain ratio objectives based on historical and
industry standards. These ratios will include direct costs of the department but
will be adjusted to remove general and executive overhead. In this manner, they
are compelled to at least consider volume issues in order to cover direct costs
but are not being held accountable for costs beyond their control. This will
result in different underwriting gain ratio goals for different departments.
Marketing will be measured on sales/budget goals.
Intangibles. Some departments such as accounting do not have such easily
measured results. Measurements here might involve timeliness, lack of penalties,
cost of administration, investment income optimization, effective tax rate and,
reduction of accounting and legal fees. While tax rate and investment yield
might seem to be capable of quantitative review, it must be recognized that the
playing field is subject to rapidly changing outside factors.
Other important intangibles include departmental management, political
development, crisis intervention, complaint avoidance or resolution,
identification of underwriting or operational issues and the implementation of
cost effective/shareholder beneficial solutions.
Intangibles are to be agreed upon annually and must include at least 4 items
encompassing strategic long-term plans and administrative issues. This should
include both personal and departmental personnel improvements goals. What
constitutes fulfillment is to be also agreed. No item requiring less than 90
days to accomplish is to be included.
This section is intended to compel management to focus on itself and its systems
rather than dollars and cents. It is quality oriented objective as opposed to
quantity and is no less valuable to the long term health and competitiveness of
the company.
<PAGE> 12
Section 3. Mechanics. The final operation of the plan is limited at all times by
the ROE factor. Total executive bonuses cannot exceed that percentage of
compensation established by the ROE factor. Since it is unlikely that all
eligible personnel would receive maximum ratings on the departmental goals and
intangibles, the end cost will certainly be less than the ROE factor would
allow.
The mathematics are as follows.
(a) The ROE factor establishes a limiting percentage of compensation
available for bonuses.
(b) The ROE factor is multiplied times the weighted percentage given to
ROE, departmental goals or intangibles.
(c) In the case of departmental goals or intangibles, this resulting
percentage is multiplied times the performance/achievement matrix which
has been established.
(d) All results are multiplied by the individual's base salary.
For example, assume (1) ROE is 17%, which permits up to 20% of base
compensation as the upper limit for bonuses. (2) Underwriter scores 80%
on departmental and 60% on intangibles. (3) Base salary is $100,000.
The computation is:
<TABLE>
<CAPTION>
<S> <C> <C>
ROE + Departmental Intangibles
ROE x weight x salary ROE x weight x perf x salary ROE x weight x perf x salary
.20 x .30 x $100,000 .20 x .50 x .8 x $100,000 .20 x .2 x .6 x $100,000
= $6,000 = $8,000 = $2,400
</TABLE>
Total bonus for this individual would be $16,400.
<PAGE> 13
Section 4. Term. The plan will be in effect for calendar years 1992 through 1995
after which time the plan shall be subject to review. The plan is subject to
review and interruption or termination if the ratio of base salaries of eligible
employees to total expenses or base salaries to net income exceeds levels
approved for the 1992 budget.
<PAGE> 1
EXHIBIT 10.16
March 27, 1999
Mr. Michael Rybak
3949 Proctor Circle
Arlington Heights, IL 60004
Dear Mike:
The purpose of this letter is to confirm our agreement that upon a
Change in Control (as defined herein) of Intercargo Corporation ("Intercargo"),
Intercargo shall pay you $50,000 upon the earlier of (i) 180 days following such
Change in Control or (ii) your involuntary termination (other than for cause).
Such payment shall not be paid if you voluntarily terminate your employment or
your employment is terminated for cause. Such payment shall be made in a lump
sum within five (5) days of the date such payment becomes payable pursuant to
the terms hereof.
As used in this letter agreement, "cause" means (i) engaged in an act
of dishonesty with respect to Intercargo, including, but not limited to, an act
which directly or indirectly results in your gain or personal enrichment at the
expense of Intercargo or (ii) you willfully and substantially failed to perform
the services requested of you by Intercargo despite at least two written notices
of such failure and reasonable opportunity to cure such failure. As used in this
letter agreement, "Change in Control" means (i) a single entity or group of
affiliated entities acquires more than 50% of Intercargo's outstanding common
stock, (ii) Intercargo is involved in a merger or consolidation so that its
stockholders before the merger or consolidation own less than 50% of the voting
power of the surviving or acquiring corporation, (iii) the liquidation or
dissolution of Intercargo, (iv) the sale of all or substantially all of
Intercargo's assets, or (v) a change in the majority of Intercargo's Board of
Directors during any 24-month period without the approval of the a majority of
directors in office at the beginning of such period. Intercargo reserves the
right in the sole discretion of Intercargo to terminate this letter agreement if
a Change in Control of Intercargo has not occurred prior to June 30, 1999.
This letter supersedes all previous communications and constitutes the
entire understanding between us with respect to any severance obligations of
Intercargo upon a Change in Control. If you are in agreement with the foregoing,
please so indicate by signing the copy of this letter in the space provided
below and returning it to the undersigned.
Very truly yours,
INTERCARGO CORPORATION
/s/ Stanley A. Galanski
Stanley A. Galanski
President and CEO
Accepted and agreed to as of this
18th day of November, 1998
/s/ Michael L. Rybak
- -----------------------------------
<PAGE> 1
EXHIBIT 11
Intercargo Corporation and Subsidiaries
Computation of Net Income Per Common Share
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------------------------------
<S> <C> <C> <C>
Basic earnings per common share:
Average common shares outstanding 7,609,773 7,670,759 7,645,578
Net income (loss) $(3,372,000) 31,788,000 6,404,000
-----------------------------------------------------
Per common share amount $ (0.44) 4.14 0.84
=====================================================
Diluted earnings per common share:
Average common shares outstanding 7,609,773 7,670,759 7,645,578
Incremental shares from assummed conversions
at the average market prices of
$11.751, $11.319, and $8.771, respectively - 6,702 11,011
-----------------------------------------------------
Total 7,609,773 7,677,461 7,656,589
-----------------------------------------------------
Net income (loss) $ (3,372,000) 31,788,000 6,404,000
-----------------------------------------------------
Per common share amount $ (0.44) 4.14 0.84
=====================================================
</TABLE>
<PAGE> 1
EXHIBIT 12
Intercargo Corporation and Subsidiaries
Statement Regarding Computation of Ratios
The Combined Ratio, as Computed on a GAAP basis, is the ratio of total
underwriting expenses to insurance premium income. (1995 and prior
exclude U.K. and Hong Kong)
SURETY
<TABLE>
<CAPTION>
Year Total Insurance Combined
Ended Underwriting Premium Ratio
Dec. 31 Expenses Income %
- -------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1998 $15,133 $17,398 87.0
1997 16,866 17,947 94.0
1996 21,632 25,846 83.7
1995 20,631 24,700 83.5
1994 18,507 23,019 80.4
</TABLE>
MARINE
<TABLE>
<CAPTION>
Year Total Insurance Combined
Ended Underwriting Premium Ratio
Dec. 31 Expenses Income %
- -------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1998 $32,213 $25,791 124.9
1997 31,505 27,906 112.9
1996 30,295 26,932 112.5
1995 25,942 20,808 124.7
1994 17,125 14,996 114.2
</TABLE>
PROFESSIONAL LIABILITY
<TABLE>
<CAPTION>
Year Total Insurance Combined
Ended Underwriting Premium Ratio
Dec. 31 Expenses Income %
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1998 $5,679 $2,674 212.4
1997 5,585 3,206 174.2
1996 3,959 2,644 149.7
1995 4,920 3,069 160.3
1994 4,645 2,377 195.4
</TABLE>
<PAGE> 2
OTHER PROPERTY & CASUALTY
<TABLE>
<CAPTION>
Year Total Insurance Combined
Ended Underwriting Premium Ratio
Dec. 31 Expenses Income %
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1998 $8,841 $6,601 133.9
1997 10,869 8,351 130.2
1996 7,534 5,631 133.8
1995 8,073 5,498 146.8
1994 3,573 3,362 106.3
</TABLE>
TOTAL SURETY, MARINE, PROFESSIONAL LIABILITY AND
OTHER PROPERTY & CASUALTY
<TABLE>
<CAPTION>
Year Total Insurance Combined
Ended Underwriting Premium Ratio
Dec. 31 Expenses Income %
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1998 $61,866 $52,464 117.9
1997 64,825 57,410 112.9
1996 63,420 61,053 103.9
1995 59,566 54,075 110.2
1994 43,850 43,754 100.2
</TABLE>
<PAGE> 1
EXHIBIT 13
KEY FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Years ended December 31 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C> <C> <C>
Revenues $ 61,297 112,159 68,241 94,186 80,885
- ---------------------------------------------------------------------------------------------------------
Operating income (loss) $ (5,421) 46,141 3,705 4,050 7,359
- ---------------------------------------------------------------------------------------------------------
Net income (loss) $ (3,372) 31,788 6,404 2,139 4,981
- ---------------------------------------------------------------------------------------------------------
Total assets $ 163,400 165,412 133,710 116,166 128,423
- ---------------------------------------------------------------------------------------------------------
Total stockholder's equity $ 72,975 82,201 48,012 43,621 39,921
- ---------------------------------------------------------------------------------------------------------
(per share amounts)
Net income (loss) from
continuing operations $ (0.44) 4.14 0.84 0.28 0.65
- ---------------------------------------------------------------------------------------------------------
Dividends $ 0.18 0.18 0.18 0.18 0.18
- ---------------------------------------------------------------------------------------------------------
Combined ratio (1) 117.9% 112.9% 103.9% 103.6% 97.5%
- ---------------------------------------------------------------------------------------------------------
</TABLE>
(1) Combined ratios have been computed, for all years, on a GAAP basis (see
Management's Discussion and Analysis).
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES OF THE COMPANY
<TABLE>
<CAPTION>
STATE OR JURISDICTION
SUBSIDIARY OF INCORPORATION
- ---------- ----------------
<S> <C>
Intercargo Insurance Company Illinois
Intercargo Insurance Company H.K. Limited Hong Kong
Intercargo International Limited British Virgin Islands
International Advisory Services, Inc. (1) Illinois
</TABLE>
(1) International Advisory Services has three subsidiaries, two known as Trade
Insurance Services, Ltd., one known as TRM Insurance Services, Inc., all
operating as insurance agencies. These are located in Illinois, Canada and
Hong Kong.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Intercargo Corporation:
We consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 333-11867) pertaining to the 1987 Non-Qualified and Incentive Stock
Option Plan of Intercargo Corporation of our report dated March 19, 1999, with
respect to the consolidated financial statements and schedules of Intercargo
Corporation included in this Annual Report (Form 10-K) for the year ended
December 31, 1998.
/s/ ERNST & YOUNG LLP
Chicago, Illinois
March 26, 1999
<PAGE> 1
EXHIBIT 23.2
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders of
Intercargo Corporation:
We consent to incorporation by reference in the registration statement (No.
333-11867) on Form S-8 of Intercargo Corporation of our report dated February
21, 1997, relating to the consolidated statements of operations, stockholders'
equity, and cash flows for the year ended December 31, 1996, and related
schedules, which report appears in the 1998 annual report on Form 10-K of
Intercargo Corporation.
/s/ KPMG LLP
Chicago, Illinois
March 26, 1999
<TABLE> <S> <C>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 59,584
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 4,856
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 64,440
<CASH> 39,087
<RECOVER-REINSURE> 4,115
<DEFERRED-ACQUISITION> 4,140
<TOTAL-ASSETS> 163,400
<POLICY-LOSSES> 56,514
<UNEARNED-PREMIUMS> 20,241
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 7,700
<OTHER-SE> 65,275
<TOTAL-LIABILITY-AND-EQUITY> 163,400
52,464
<INVESTMENT-INCOME> 6,122
<INVESTMENT-GAINS> 2,139
<OTHER-INCOME> 572
<BENEFITS> 32,668
<UNDERWRITING-AMORTIZATION> 16,149
<UNDERWRITING-OTHER> 17,901
<INCOME-PRETAX> (5,421)
<INCOME-TAX> (2,049)
<INCOME-CONTINUING> (3,372)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,372)
<EPS-PRIMARY> (0.44)
<EPS-DILUTED> (0.44)
<RESERVE-OPEN> 43,385
<PROVISION-CURRENT> 31,680
<PROVISION-PRIOR> 988
<PAYMENTS-CURRENT> 10,646
<PAYMENTS-PRIOR> 20,873
<RESERVE-CLOSE> 44,534
<CUMULATIVE-DEFICIENCY> 988
</TABLE>
