SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
Quarterly report under Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended September 30, 1996
Commission file number 0-16090
Hallmark Financial Services, Inc.
(Exact name of small business issuer as specified in its charter)
Nevada 87-0447375
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
14651 Dallas Parkway, Suite 900
Dallas, Texas 75240
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (972) 404-1637
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act during the past 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
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: Common Stock, par value $.03 per
share - 10,662,277 shares outstanding as of November 11, 1996.
<PAGE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30 December 31
ASSETS 1996 1995
(unaudited)
<S> <C> <C>
Investments:
Debt securities, held-to-maturity $ 5,714,627 $ 6,409,544
Equity securities, available-for-sale 169,827 171,727
Short-term investments, at cost which
approximates market value 3,776,160 3,615,327
Total investments 9,660,614 10,196,598
Cash and cash equivalents 6,010,299 4,257,755
Prepaid reinsurance premiums 9,232,164 11,726,968
Premium notes receivable 3,110,099 5,342,507
Reinsurance recoverable 23,292,663 19,335,746
Deferred policy acquisition costs 2,535,751 2,999,541
Excess of cost over net assets
acquired, net of accumulated
amortization 5,257,286 5,373,983
Other intangible assets 3,333 10,000
Deferred federal income taxes 453,194 567,969
Accrued investment income 60,284 55,765
Other assets 903,472 788,216
Total assets $60,519,159 $60,655,048
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Notes payable $ 603,376 $ 639,162
Unpaid losses and loss
adjustment expenses 25,324,727 22,323,090
Unearned premiums 12,314,807 15,659,897
Reinsurance balances payable 3,693,452 3,489,357
Deferred ceding commissions 2,632,015 3,518,227
Drafts outstanding 1,057,052 684,430
Accounts payable and
other accrued expenses 3,814,902 3,969,288
Total liabilities 49,440,331 50,283,451
Stockholders' equity:
Common stock, $.03 par value,
authorized 100,000,000 shares;
(issued 10,962,277 shares in
1996 and 1995) 328,868 328,868
Capital in excess of par value 10,349,665 10,349,665
Retained Earnings 1,000,295 293,064
Treasury stock (600,000) (600,000)
Total stockholders' equity 11,078,828 10,371,597
</TABLE> $60,519,159 $60,655,048
<PAGE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE> Unaudited
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
1996 1995 1996 1995
<S> <C> <C> <C> <C>
Gross premiums written $10,880,687 $14,755,421 $33,135,617 $37,713,656
Ceded premiums written (7,716,384) (11,057,747) (24,404,903) (28,249,846)
Net premiums written $ 3,164,303 $ 3,697,674 $ 8,730,714 $ 9,463,810
Revenues:
Premiums earned $11,898,965 $11,788,841 $36,480,706 $31,077,131
Premiums ceded (8,479,588) (8,811,801) (26,899,707) (23,175,509)
Net premiums earned 3,419,377 2,977,040 9,580,999 7,901,622
Investment income,
net of expenses 224,912 148,778 671,996 363,662
Finance service charges 1,194 136,047 25,509 560,975
Processing fees 423,584 626,598 1,477,779 842,031
Service fees 28,419 8,003 73,714 70,173
Other income 15,954 20,581 41,242 71,360
Total revenues 4,113,440 3,917,047 11,871,239 9,809,823
Benefits, losses and expenses:
Losses and loss
adjustment expenses 8,492,819 6,845,301 24,909,437 23,297,876
Reinsurance recoveries (6,393,702) (4,727,172) (18,759,990) (17,160,101)
Net losses and loss
adjustment expenses 2,099,117 2,118,129 6,149,447 6,137,775
Amortization of
acquisition costs (278,921) 178,950 (422,422) 407,552
Other acquisition, underwriting
and operating expenses 2,063,189 855,863 4,904,955 2,058,979
Interest expense 10,449 9,026 32,308 31,636
Amortization expense 40,566 46,328 123,364 144,383
Total benefits, losses
and expenses 3,934,400 3,208,296 10,787,652 8,780,325
Income from operations before
federal income taxes 179,040 708,751 1,083,587 1,029,498
Federal income tax (Note 3) 61,014 201,351 376,356 125,207
Net income $ 118,026 $ 507,400 $ 707,231 $ 904,291
Net income per share
of common stock $ .01 $ .05 $ .06 $ .08
Weighted average shares
outstanding 12,167,846 10,662,277 12,167,846 10,662,277
</TABLE>
<PAGE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
<TABLE> CONSOLIDATED STATEMENTS OF CASH FLOWS
<CAPTION>
Nine Months Ended
September 30
1996 1995
<S> <C> <C>
Cash flows from operating activities:
Net income $707,231 $904,291
Adjustments to reconcile net income to
cash provided by operating activities:
Depreciation and amortization expense 208,447 221,393
Change in deferred federal income taxes 114,775 (506,512)
Change in prepaid reinsurance premiums 2,494,804 (5,074,336)
Change in premium notes receivable 2,232,408 (5,043,386)
Change in installment premiums receivable - 6,452,737
Change in deferred policy acquisition costs 463,790 (1,105,408)
Change in ceding income (886,212) 1,512,960
Change in unpaid losses and loss
adjustment expenses 3,001,637 5,905,988
Change in unearned premiums (3,345,090) 6,317,875
Change in reinsurance recoverable (3,956,917) (5,540,281)
Change in reinsurance balances payable 204,095 2,560,058
Change in all other liabilities 218,236 1,897,884
Change in all other assets 118,952 (372,338)
Net cash provided by operating activities 1,576,156 8,130,925
Cash flows from investing activities:
Purchases of property and equipment (320,839) (151,880)
Loss on sale of assets (2,970) -
Purchases of debt securities (526,020) (2,932,347)
Maturities and redemptions of debt securities 1,224,737 1,906,982
Maturities and redemptions of common stock (1,900) 2,501
Purchase of short-term investments (3,300,389) (7,879,803)
Maturities of short-term investments 3,139,555 2,420,000
Net cash used in investing activities 212,174 (6,634,547)
Cash flows from financing activities:
Repayment of short-term borrowings (35,786) (182,363)
Cash used in financing activities (35,786) (182,363)
Increase (decrease) in cash and cash equivalents 1,752,544 1,314,015
Cash and cash equivalents at beginning of period 4,257,755 1,800,762
Cash and cash equivalents at end of period $6,010,299 $3,114,777
Supplemental cash flow information:
Cash paid during the period for interest $ 21,859 $ 31,637
</TABLE>
<PAGE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
ITEM 1. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED).
NOTE 1 - SUMMARY OF ACCOUNTING POLICIES
In the opinion of management, the accompanying consolidated financial
statements contain all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly the financial position of Hallmark
Financial Services, Inc. and subsidiaries (the "Company") as of September 30,
1996 and the consolidated results of operations and cash flows for all periods
presented. The accompanying financial statements have been prepared by the
Company without audit.
Certain information and disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. Reference is made to the Company's annual
consolidated financial statements for the year ended December 31, 1995 for a
description of all other accounting policies. Certain items in the 1995 interim
financial statements have been reclassified to conform to the 1996 presentation.
The results of operations for the period ended September 30, 1996 are not
necessarily indicative of the operating results to be expected for the full
year.
NOTE 2 - INVESTMENTS
Debt securities, held-to-maturity, for the reporting period include
investments in U.S. Government securities totaling $5,714,627, which includes
special revenue bonds of $326,692. Net proceeds received are included in cash
and cash equivalents at September 30, 1996. Short-term investments include
certificates of deposits and federal discount notes of $3,776,160. Short-term
investments mature within one year.
Realized investment gains and losses are recognized in operations on the
specific identification method. The Company has the ability and intent to hold
all investments to maturity. Provisions for possible losses are recorded only
on other-than-temporary declines in the value of an investment.
<PAGE>
NOTE 3 - FEDERAL INCOME TAXES
The composition of deferred tax assets and liabilities and the related tax
effects as of September 30, 1996 and 1995 is as follows:
<TABLE>
DEFERRED TAX LIABILITIES: 1996 1995
<S> <C> <C>
Deferred acquisition costs, deductible for tax ($ 862,155) ($1,094,518)
Other - (58)
Total deferred tax liabilities ( 862,155) ($1,094,576)
DEFERRED TAX ASSETS:
Property and equipment basis $ 27,680 $ 7,117
Unearned premiums 209,620 283,503
Loss reserve discounting 131,243 127,924
Deferred ceding commissions, non-deductible for tax 895,062 1,259,641
Net operating loss carryforward 33,171 49,655
AMT credit - 6,200
Other 8,696 61,183
Total deferred tax assets $ 1,305,471 $1,795,223
Net deferred tax assets $ 443,316 $ 700,647
Valuation allowance ( 9,878) 194,135
Net deferred tax asset $ 453,194 $506,512
</TABLE>
A reconciliation of the income tax provisions based on the prevailing
corporate tax rate of 34 percent to the provision reflected in the consolidated
financial statements for the period ended September 30, 1996 and 1995 is as
follows:
<TABLE>
1996 1995
<S> <C> <C>
Computed expected income tax expense at
statutory regulatory tax rate $ 368,420 $ 350,029
Amortization of excess cost 39,837 41,440
Tax-exempt interest (1,477) (2,954)
Change in valuation allowance (48,288) (273,065)
Other 17,864 9,757
Deferred tax liability $376,356 $125,207
</TABLE>
The Company has available, for federal income tax purposes, unused net
operating losses of $97,562 at September 30, 1996 and $146,044 at September 30,
1995 which may be used to offset future taxable income. The net operating
losses will expire, if unused, as follows:
<TABLE>
1996 1995
<S> <C> <C>
Year
2002 $ 1,325 $ 1,325
2003 96,237 96,237
2004 - 48,482
$ 97,562 $ 146,044
</TABLE>
<PAGE>
NOTE 4 - WARRANTS OUTSTANDING
In October 1992, the Company issued warrants to purchase 981,333 shares of
its Common Stock ("Guaranty Warrants") to executive officers and directors in
consideration for the recipients' agreement to pledge outstanding shares of the
Company's common stock they owned as security for a working capital line of
credit the Company proposed to obtain from a commercial bank. The Company
subsequently abandoned its efforts to obtain the working capital line of credit.
Each Guaranty Warrant covered the same number of shares the recipient agreed to
pledge. No value has been assigned to these warrants. The Guaranty Warrants
were initially exercisable between October 2, 1992 and October 1, 1994, but have
been extended to October 1, 1998, at which time they will expire to the extent
not exercised. The exercise price is $.50 per share, an amount equal to the
last reported sale price of the Common Stock on the American Stock Exchange's
Emerging Company Marketplace prior to October 2, 1992. The Guaranty Warrants
are not transferrable, but may be exercised only by their recipients (or by a
recipient's estate in the event of his/her death).
NOTE 5 - REINSURANCE
American Hallmark Insurance Company of Texas ("Hallmark") is involved in
the cession of reinsurance to other companies. The Company remains obligated to
its policyholders in the event that reinsurers do not meet their obligations
under the reinsurance agreements.
Effective March 1, 1992, Hallmark entered into a reinsurance arrangement
with State and County Mutual Fire Insurance Company ("State & County"), an
unaffiliated company, to assume 100% of the nonstandard auto business produced
by American Hallmark General Agency, Inc. ("AHGA") and written on State & County
policies. The arrangement is supplemented by a separate retrocession agreement
between Hallmark and Vesta Fire Insurance Corporation ("Vesta"). Hallmark and
Vesta share the risk on the State & County policies with Hallmark retaining 25%.
This retrocession agreement with Vesta was terminated on a run-off basis
effective June 30, 1996.
Effective July 1, 1996, Hallmark renewed its reinsurance arrangement with
State & County and entered into new retrocession agreements with Kemper
Reinsurance Company ("Kemper"), Dorinco Reinsurance Company ("Dorinco") and
Skandia America Reinsurance Corporation ("Skandia"). Under the new retrocession
agreements, Hallmark continues to retain 25%.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
INTRODUCTION
Hallmark Financial Services, Inc. (HFS) engages in the sale of consumer
products and services on credit terms, primarily to lower and middle income
customers. Its target market encompasses the substantial number of Americans
who either are denied credit from banks, credit card companies and other
conventional credit sources, or have never established a bank account or credit
history. Currently, the Company's business primarily involves marketing,
underwriting and premium financing of non-standard automobile insurance.
Secondarily, the Company provides fee-based claims adjusting and related
services for affiliates and third parties. (HFS and its wholly owned
subsidiaries are collectively referred to herein as the "Company").
The Company conducts these activities through an integrated insurance
group, the dominant members of which are a property and casualty insurance
company, American Hallmark Insurance Company of Texas ("Hallmark"); a managing
general agent, American Hallmark General Agency, Inc. ("AHGA"); a network of
affiliated insurance agencies known as the American Hallmark Agencies ("Hallmark
Agencies"); a commercial excess and surplus lines affiliated managing general
agency, Hallmark Underwriters, Inc. ("HUI"); a premium finance company, Hallmark
Finance Corporation ("HFC"); and a claims handling and adjustment firm, Hallmark
Claims Service, Inc., ("HCS"). The Company operates only in Texas.
Hallmark provides non-standard automobile liability and physical damage
insurance through reinsurance arrangements with several unaffiliated companies.
Through arrangements with State & County Mutual Fire Insurance Company ("State &
County"), Hallmark provides insurance primarily for high risk drivers who do not
q u alify for standard-rate insurance. Under supplementary quota-share
reinsurance agreements, Hallmark cedes a substantial portion of its risks and
retains the balance. From March 1, 1992 through June 30, 1996, Hallmark ceded a
portion of its risk to Vesta Fire Insurance Corporation ("Vesta") (60% between
March 1, 1992 and July 31, 1993 and 75% between August 1, 1993 and June 30,
1996). Effective July 1, 1996, Hallmark entered into new reinsurance treaties
w i th Kemper Reinsurance Company ("Kemper"), Dorinco Reinsurance Company
("Dorinco") and Skandia America Reinsurance Corporation ("Skandia"), ceding a
total of 75% of its risk. HFC, through a financing and servicing arrangement
with an unaffiliated premium finance company, offers premium financing to
Hallmark policyholders. AHGA manages the marketing of Hallmark policies
through a network of retail insurance agencies which operates under the American
Hallmark Agencies name, and through independent agents operating under their own
respective names.
HUI, formed to market and produce commercial excess and surplus lines
("E&S") insurance on behalf of unaffiliated E&S insurers, began operations in
late April 1996. HUI is expected to generate commission income by producing E&S
insurance business through the network of the Company's thirteen retail
agencies, certain agents from the Company's current independent agent group, and
other selected independent agents not currently representing the Company.
FINANCIAL CONDITION AND LIQUIDITY
The Company's sources of funds are principally derived from insurance
related operations. Major sources of funds are from premiums collected (net of
policy cancellations and premiums ceded), external funding of premium notes,
ceding commissions, processing fees, premium finance service charges and
investment activities. On a consolidated basis, the Company reported net cash
<PAGE>
from operations of $1,576,156 for the nine months ended September 30, 1996,
representing an 81% decrease in relation to the same period in 1995. The
decrease in cash flow is primarily due to (1) lower premium volumes for the nine
months ended September 30, 1996 as compared to the same 1995 period (the
significantly higher premium volumes for the nine months ended September 30,
1995 is principally a result of the Texas Automobile Insurance Plan Association
(TAIPA) increasing its rates substantially, which in turn, directed business
into the voluntary market as compared to the same period in 1994); and (2) a
change in policy mix resulting in an increase in monthly policy production and a
decrease in annual policy production during the 1996 period and to an increase
in annual policy production and a decrease in monthly production during the same
period in 1995 compared to the comparable period in 1994.
On a consolidated basis, the Company's liquidity increased during the nine
months ended September 30, 1996, with bonds, equities, short-term investments
and cash totaling $15,670,913 at September 30, 1996, compared to $14,454,353 at
December 31, 1995. The Company's increased liquidity during 1996 is primarily
due to more timely funding of annual policy premiums under HFC's premium finance
program started in 1995 and expanded during 1996 than under Hallmark's direct-
bill program (which has been phased out), partially offset by the absence of
unusually high premium volumes which occurred in the third quarter of 1995.
Under HFC's premium finance program, premiums for annual policies due
Hallmark are funded-in-full in approximately 30 days and immediately invested.
Premium notes receivable decreased at September 30, 1996 compared to December
31, 1995 principally due to an increase in monthly policy mix in 1996 and to an
increase in first quarter premium cancellations related to annual policies
written in high-volume months of 1995. As expected, balances due under the
direct bill program (which are included in premium notes receivable at December
31, 1995) have decreased from $299,182 at December 31, 1995 to $0 at September
30, 1996. During the first nine months of 1996 and 1995, the Company received
e x t ernal funds, net of cancellations, of $23,666,926 and $11,731,626,
respectively, from its premium finance program to fund premiums generated by the
Company.
At September 30, 1996, the Company reported $603,376 in notes payable,
$392,710 of which is due before December 31, 1996. The Company expects to repay
these notes with cash from operations. However, the amount to be paid in 1996
may be less than the $392,710 reflected in the notes payable balance. Included
in this amount is a disputed obligation of $380,000 in connection with a
financing transaction which occurred prior to the Company's acquisition of the
insurance group. Further, if any portion of the approximately $380,000 is
ultimately deemed owing, the Company believes that it has the right of offset
against a related receivable in the sum of $240,000.
A substantial portion of the Company's liquid assets are held by Hallmark
and are not available for general corporate purposes. Of the Company's
consolidated liquid assets at September 30, 1996, $1,486,016 represents non-
restricted cash (compared to $2,131,582 at December 31, 1995). Since state
insurance regulations limit financial transactions between an insurance company
and its affiliates, the Company is limited in its ability to use Hallmark funds
for its own working capital purposes. Furthermore, dividends and loans by
Hallmark to the Company are restricted and subject to Texas Department of
Insurance ("TDI") approval. However, TDI has sanctioned the payment of
management fees, commissions and claims handling fees by Hallmark to the Company
and affiliates. During the latter part of 1993, the Company initiated measures
to strengthen Hallmark's surplus in order to insure its compliance with
regulatory guidelines and to provide surplus balances necessary to accommodate
<PAGE>
premium growth. Some of the measures taken were a temporary abatement or
reduction of the management fee and a reduction of commissions payable by
Hallmark to the Company and AHGA, respectively. These measures have continued
into subsequent years. During the first nine months of 1996, Hallmark paid or
accrued $675,000 in management fees as compared to $350,000 during the first
nine months of 1995. While management fees for 1996 are anticipated to be
higher than the fees paid or accrued in 1995, they should be less than the
amounts authorized by TDI. While management fees from Hallmark should continue
to be a moderate source of unrestricted liquidity, management intends to
continue to restrict payment of management fees as necessary to insure the
surplus strength of Hallmark.
Commissions from annual policy production by independent agents also
represent a source of unrestricted liquidity. Under this program, AHGA offers
independent agents the ability to write annual policies, but generally pays
commissions to independent agents monthly on an "earned" basis. However,
consistent with customary industry practice, Hallmark pays total commissions up-
front to AHGA based on the entire annual premiums written. Independent agent
production of annual policies was approximately $9.7 million for the nine months
ended September 30, 1996. During the first nine months of 1996, AHGA received
$4.9 million in commissions related to this program from Hallmark, and will pay
$1.3 million to independent agents. During 1995, AHGA received $7.6 million in
commissions related to this annual policy program from Hallmark, of which
approximately $1.9 million is being paid to independent agents during 1996 as
earned.
Ceding commission income represents a significant source of funds to the
Company. During the first nine months of 1996, and during 1995, ceding
c o mmission income exceeded agent commissions and other direct expenses
associated with the cost of producing new business (i.e., policy acquisition
costs). Ceding commission income for the nine months ended September 30, 1996
decreased $1,520,325 to $6,954,629 representing an 18% decrease compared to the
first nine months of 1995. Although ceding commission income exceeded policy
acquisition costs for the nine months ended September 30, 1996, ceding
commission income was less than policy acquisition costs for the quarter ended
September 30, 1996. This was due primarily to the combined effect of lower
premium volumes in the third quarter of 1996 compared to the same quarter in
1995 and lower ceding commission income recognized under the new reinsurance
treaties effective July 1, 1996.
In accordance with GAAP, a portion of ceding commission income and policy
acquisition costs is deferred and recognized as income and expense,
respectively, as related net premiums are earned. Deferred ceding commission
income also decreased to $2,632,015 at September 30, 1996 from $3,518,227 at
December 31, 1995. This decrease is principally due to lower annual premiums
written during the first nine months of 1996 compared to 1995. Similarly,
deferred policy acquisition costs of $2,535,751 as of September 30, 1996 were
$463,790 less than at December 31, 1995. Deferred policy acquisition costs were
$96,264 less than deferred ceding commission income at September 30, 1996.
At September 30, 1996, Hallmark reported statutory capital and surplus of
$5,080,984, which shows an increase of $306,540 over the $4,774,444 reported at
December 31, 1995. On an annualized-premium basis, Hallmark's premium-to-
surplus ratio at September 30, 1996 was 2.29 to 1 as compared to 2.58 to 1 at
December 31, 1995. It is management's opinion that Hallmark should not require
additional capital during 1996. Management anticipates that Hallmark is
positioned to maintain and strengthen statutory surplus through increased
earnings from insurance operations. Management believes that loss ratios for
<PAGE>
the first nine months of 1996 are beginning to reflect results of steps taken to
address an unfavorable loss trend reported during 1995. For the nine months
ended September 30, 1996, the statutory loss ratio was approximately 70.6%
compared to 81.8% and 82.5% for the twelve and nine months ended December 31,
1995 and September 30, 1995, respectively. Hallmark implemented rate increases
for business written in certain territories effective September 15, 1995,
January 1, 1996 and August 15, 1996, respectively. These rate changes were
designed to further reduce loss ratios while maintaining the Company's
competitive status.
As previously mentioned, effective July 1, 1996, Hallmark entered into new
reinsurance treaties (the "New Treaties") with Kemper, Dorinco, and Skandia.
Certain provisions of the New Treaties could impact the Company's liquidity.
Under the New Treaties, Hallmark retains 50% and cedes only 50% of the policy
origination fees (vs. ceding 100% of the policy origination fees under the Vesta
treaty), pays premiums taxes and front fees on 100% of the business produced
(vs. premium taxes and front fees on only its retained business under the Vesta
treaty), and receives a 30% provisional ceding commission (vs. a guaranteed 30%
ceding commission under the Vesta treaty). Policy origination fees are up-
front, fully earned fees that the Company is permitted by law to charge in
addition to premiums to cover or defray certain costs associated with producing
policies. The provisional commission paid under the New Treaties will be
adjusted annually over a three year rating period on a sliding scale based on
annual loss ratios. Based upon its loss experience, Hallmark can earn a maximum
commission of 33.5% and is guaranteed a minimum commission of 26% regardless of
loss experience. Currently, the company is recognizing the minimum commission.
Management has focused on premium rate-setting and enhanced claims handling
procedures designed to strengthen the performance of the Company's core State &
County business. If loss ratios improve and ceding commissions increase
accordingly, there could be a positive impact on liquidity. However, if loss
ratios do not improve, related ceding commissions will remain at the minimum,
and could adversely affect liquidity in future periods.
Unearned premiums decreased approximately 21% as of September 30, 1996
compared to December 31, 1995. This decrease was principally due to higher
first quarter cancellations associated with annual premiums written during high-
volume months of 1995, a decrease at September 30, 1996 in the remaining
unearned portion of annual premiums written during high-volume months of 1995,
and to an increase in monthly policy production. As expected, prepaid
reinsurance premiums decreased proportionately.
Unpaid losses and loss adjustment expenses at September 30, 1996, increased
a p proximately 13% as compared to December 31, 1995, primarily due to
implementation of a more conservative case reserving methodology. Accordingly,
reinsurance recoverable at September 30, 1996, increased approximately 20% as
compared to December 31, 1995.
Effective January 1, 1995, the Company began financing annual policy
premiums produced by the Hallmark Agencies through a premium finance program
offered by its formerly dormant premium finance subsidiary, HFC, and independent
agents began financing premiums through HFC's premium finance program in May of
1995. Financing of the premium notes is provided by an unaffiliated premium
finance company, Peregrine Premium Finance L.C. ("Peregrine"), on a secured
basis. Peregrine has obtained an external credit facility of $13,500,000 for
the purpose of financing State & County policies produced by AHGA (the "Notes").
At September 30, 1996, $2,630,032 was available under Peregrine's credit
facility to fund the Notes which should be sufficient to fund projected State &
County activity of this premium finance program during 1996. HFC's premium
<PAGE>
financing program is expected to continue to positively impact liquidity during
1996.
During 1996, management expects that Company liquidity will continue to be
favorably impacted by a continued focus on strengthening the performance of the
Company's core State & County business with particular emphasis on enhancement
of HCS's procedures and staffing. The Company has increased its claims staff
and hired additional, experienced claims adjusters and supervisory personnel
that, in turn, should lower loss and LAE payments. This focus, along with the
Company's ongoing ability to identify and retain quality independent agents and
to respond on a timely basis to rate-change indications arising from both loss
experience and competitive market considerations, is expected to enhance
earnings and liquidity during 1996. Management further anticipates that an
integrated cash management system implemented in late-1995 will continue to
positively impact 1996 liquidity.
The Company continues to pursue third party claims handling and
administrative contracts. HCS entered into a small claims-handling and
consulting contract with an unaffiliated independent agent in 1995. The
unaffiliated agent is revising and expanding its program during 1996, which will
favorably impact fees. However, it is still not anticipated that fees from this
contract will have a significant impact on 1996 earnings. The Company continues
to earn fees for handling claims-related litigation of an unaffiliated agency
under a 1993 contract with Vesta. Although the Company is actively pursuing
additional third party claims handling business, it does not have any other
definitive agreements at this time.
Beginning late-April 1996, the Company began marketing E&S insurance
produced by HUI through the Company's marketing arm, AHGA. This business will
be produced by the Hallmark Agencies and a select group of independent agents,
and some portion of the premiums will be financed by HFC. No entity within the
Company will bear any underwriting risk. The E&S policies will be written on
behalf of A-rated (A.M. Best rating) unaffiliated insurance companies.
Management anticipates that the growth of this business will be gradual, and
does not expect a significant liquidity contribution in 1996. HFC will offer
premium financing for E&S business produced by HUI. The Company anticipates
financing E&S premium notes with internally generated funds through at least
mid-1997.
Management intends to continue to investigate opportunities for future
growth and expansion. However, the Company currently has no growth plans which
would require significant external funding during the remainder of 1996.
RESULTS OF OPERATIONS
As expected, gross premiums written (prior to reinsurance) for the three
and nine months ended September 30, 1996 were 26% and 12% lower than the same
periods in 1995. Net written premiums (after reinsurance) for the three and
nine months ended September 30, 1996 were approximately 14% and 8% lower,
respectively, than the same periods in 1995. The comparison of the three month
period indicates a decrease in gross and net written premium due to lower
premium volumes during 1996 compared to 1995. However, third quarter 1995
premium volumes were unusually high due to increased production of the Company's
core State & County business by independent agents during 1995. The high
volumes of 1995, particularly in the third quarter, began to level off toward
the end of 1995 and have remained relatively constant during 1996.
<PAGE>
Gross premiums earned (prior to reinsurance) for the three and nine months
ended September 30, 1996, respectively, were 1% and 17% higher than the
comparable periods in 1995. For the three and nine months ended September 30,
1996, net earned premiums (after reinsurance) increased 15% and 21%,
respectively, in relation to the same periods of 1995. The disproportionate
increase in premiums earned before and after reinsurance is primarily the result
of Hallmark's New Treaties whereby the Company retains 50% of policy origination
fees which are fully earned thus increasing earned premiums during the third
quarter of 1996. This is partially offset by the TAIPA premium allocations to
the company being insignificant in 1996 as compared to 1995. Thus, 1995 earned
premiums reflect a higher proportion of TAIPA business which is retained 100% by
the Company and is not subject to reinsurance.
Net incurred loss ratios (computed on net premiums earned after
reinsurance) for the three and nine months ended September 30, 1996 was 61% and
64%, respectively, as compared to 71% and 78% for the same respective 1995
periods. The decrease in the loss ratios between 1996 and 1995 is the combined
result of improved loss experience on the Company's core State & County
business, retention of 50% of the policy origination fees, insignificant TAIPA
premium allocations during 1996, and more favorable loss development in 1996 of
the TAIPA business written in prior years. It should be noted that the impact
of any change in TAIPA loss experience is intensified because TAIPA losses are
100% retained by Hallmark and are not included in Hallmark's quota-share
reinsurance agreements.
Other acquisition, underwriting and operating expenses for the three and
nine months ended September 30, 1996, increased $1,207,327 and $2,845,976,
respectively, as compared to the prior year. This increase is principally due
to an almost 18% decrease in ceding commission income (as discussed in the
Financial Condition and Liquidity section), as well as higher operating costs
related to expanded premium finance operations in 1996 (which was a start-up
operation beginning January 1995), start-up costs of E&S operations, higher
operating costs related to increased staffing and professional development of
claims personnel, along with increases in consulting and professional fees.
Investment income for the three and nine months ended September 30, 1996
increased by approximately 51% and 85% respectively over the comparable period
in 1995 as a result of an increase in funds available for investment and an
increase in the percentage of funds invested. Invested funds have increased
principally due to increased premium volumes during 1995, more timely funding of
premiums under HFC's premium finance program and enhanced utilization of funds
due to an improved cash management system implemented late-1995.
Processing fees for the three and nine months ended September 30, 1996 were
$423,584 and $1,477,779, respectively. While processing fees for the third
quarter of 1996 decreased by $203,014 over the comparable period of 1995, year-
to-date processing fees increased $635,748 over the same comparable period of
1995. The decrease in the third quarter processing fees is primarily related
to the decreased premium volume of Hallmark during the third quarter of 1996
compared to 1995. These processing fees represent income earned by HFC pursuant
to its premium finance program commenced January 1, 1995. The overall increase
in 1996 is due to the program currently including financing of independent
agency business, as well as Hallmark Agencies' premium production.
<PAGE>
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
Except for routine litigation incidental to the business of the Company,
neither the Company, nor any of the properties of the Company was subject
to any material pending or threatened legal proceedings as of the date of
this report.
Item 2. Changes in Securities.
None
Item 3. Defaults upon Security Securities.
None
Item 4. Submission of Matters to a Vote of Security-Holders.
None
Item 5. Other Information.
None
Item 6. Exhibits and Reports on Form 8-K.
(a) The exhibit listed in the Exhibit Index which appears on sequential
page 17 is filed herewith.
(b) The Company did not file a Current Report on Form 8-K to report any
events which occurred during the quarter ended September 30, 1996.
<PAGE>
EXHIBIT INDEX
EXHIBIT DESCRIPTION
10(a) Automobile Physical Damage Catastrophe Excess of Loss Reinsurance
Agreement effective July 1, 1996 between American Hallmark Insurance
Company of Texas and Kemper Reinsurance Company.
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant has
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
HALLMARK FINANCIAL SERVICES, INC.
(Registrant)
Date: November 13, 1996 /s/ Ramon D. Phillips
Ramon D. Phillips, President (Chief Executive
Officer)
Date: November 13, 1996 /s/ John J. DePuma
John J. DePuma, Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
Due to format constraints of this Financial Data Schedule (FDS) certain Balance
Sheet items were omitted: i.e. Prepaid reinsurance premiums, Premium notes
receivable, Installment premiums receivable, Excess of cost over net assets
acquired & Other assets. Refer to actual 10-KSB submission.
</LEGEND>
<MULTIPLIER> 1
<CURRENCY> $
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<EXCHANGE-RATE> 1
<DEBT-HELD-FOR-SALE> 0
<DEBT-CARRYING-VALUE> 9,490,787
<DEBT-MARKET-VALUE> 9,504,000
<EQUITIES> 169,827
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 9,660,614
<CASH> 6,010,299
<RECOVER-REINSURE> 23,292,663
<DEFERRED-ACQUISITION> (96,264)
<TOTAL-ASSETS> 60,519,159
<POLICY-LOSSES> 0
<UNEARNED-PREMIUMS> 12,314,807
<POLICY-OTHER> 3,693,452
<POLICY-HOLDER-FUNDS> 4,871,954
<NOTES-PAYABLE> 603,376
0
0
<COMMON> 328,868
<OTHER-SE> 10,749,960
<TOTAL-LIABILITY-AND-EQUITY> 60,519,159
33,135,617
<INVESTMENT-INCOME> 671,996
<INVESTMENT-GAINS> 1,890
<OTHER-INCOME> 1,618,244
<BENEFITS> 6,149,447
<UNDERWRITING-AMORTIZATION> (422,422)
<UNDERWRITING-OTHER> 5,060,627
<INCOME-PRETAX> 1,083,587
<INCOME-TAX> 376,356
<INCOME-CONTINUING> 707,231
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 707,231
<EPS-PRIMARY> .06
<EPS-DILUTED> .06
<RESERVE-OPEN> 22,323,090
<PROVISION-CURRENT> 25,719,544
<PROVISION-PRIOR> (876,526)
<PAYMENTS-CURRENT> 11,460,550
<PAYMENTS-PRIOR> 10,380,831
<RESERVE-CLOSE> 25,324,727
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
POOLS, ASSOCIATIONS AND SYNDICATES EXCLUSION CLAUSE
SECTION 1
Excluding:
(A) All business derived directly or indirectly from any Pool, Association or
Syndicate which maintains its own reinsurance facilities.
(B) Any Pool or Scheme (whether voluntary or mandatory) formed after March 1,
1968 for the purpose of insuring Property whether on a countrywide basis or
in respect of designated areas. This exclusion shall not apply to so-
called Automobile Insurance Plans or other Pools formed to provide coverage
for Automobile Physical Damage.
SECTION 2
It is agreed that business written by the Company for the same perils, which is
known at the time to be insured by, or in excess of underlying amounts placed in
the following Pools, Associations or Syndicates, whether by way of insurance or
reinsurance, is excluded hereunder:
Industrial Risk Insurers (successor to Factory Insurance Association and
Oil Insurance Association); Associated Factory Mutuals; Improved Risk
Mutuals.
Any Pool, Association or Syndicate formed for the purpose of writing Oil,
Gas or Petro-Chemical Plants and/or Oil or Gas Drilling Rigs.
United States Aircraft Insurance Group, Canadian Aircraft Insurance Group,
Associated Aviation Underwriters, American Aviation Underwriters.
Section 2 does not apply:
(A) Where the Total Insured Value over all interests of the risk in question is
less than $250,000,000.
(B) To interests traditionally underwritten as Inland Marine or Stock and/or
Contents written on a blanket basis.
(C) To Contingent Business Interruption, except when the Company is aware that
the key location is known at the time to be insured in any Pool, Association or
Syndicate named above, other than as provided for under Section 2 (A).
(D) To risks as follows: Offices, Hotels, Apartments, Hospitals, Educational
Establishments, Public Utilities (other than Railroad Schedules) and Builders
Risks on the classes of risks specified in this sub-section (D) only.
SECTION 3
Nevertheless the Reinsurers specifically agree that liability accruing to the
Company from its/their participation in residual market mechanisms including but
not limited to,
<PAGE>
(A) The following so-called "Coastal Pools"
Alabama Insurance Underwriting Association
Florida Windstorm Underwriting Association (FWUA)
Louisiana Insurance Underwriting Association
Mississippi Windstorm Underwriting Association
North Carolina Insurance Underwriting Association
South Carolina Windstorm and Hail Underwriting Association
Texas Catastrophe Property Insurance Association,
(B) All "Fair Plan" and/or "Rural Risk Plan" business
and
(C) Florida Property and Casualty Joint Underwriting Association (FPCJUA)
and Residential Property and Casualty Joint Underwriting Association (RPCJUA),
for all perils otherwise protected hereunder shall not be excluded herefrom,
except however that this reinsurance does not include any increase in such
liability resulting from:
(D) The inability of any other participant in such residual market
mechanisms to meet its liability.
(E) Any claim against such residual market mechanisms, or any participant
therein, including the Company, whether by way of subrogation or otherwise,
brought by or on behalf of any insolvency fund (as defined in the Insolvency
Funds Exclusion Clause incorporated in this Agreement).
SECTION 4
Notwithstanding Section 3 above, in respect of the FWUA, FPCJUA and RPCJUA,
where an assessment is made against the Company by the FWUA, the FPCJUA, the
RPCJUA, or any combination thereof, the maximum loss that the Company may
include in the Ultimate Net Loss in respect of any Loss Occurrence hereunder
shall not exceed the lesser of:
1. The Company's assessment from the relevant entity (FWUA, FPCJUA and/or
RPCJUA) for the accounting year in which the Loss Occurrence commenced, or
2. The product of the following:
a) The Company's percentage participation in the relevant entity for the
accounting year in which the Loss Occurrence commenced; and
b) The relevant entity's total losses in such Loss Occurrence.
Any assessments for accounting years subsequent to that in which the Loss
Occurrence commenced may not be included in the Ultimate Net Loss hereunder.
Moreover, notwithstanding Section 3 above, in respect of the FWUA, the FPCJUA
and/or the RPCJUA, the Ultimate Net Loss hereunder shall not include any monies
expended to purchase or retire bonds as a consequence of being a member of the
FWUA, the FPCJUA and/or the RPCJUA.
For the purposes of this Contract, the Company may not include in the Ultimate
Net Loss any assessment or any percentage assessment levied by the FWUA, the
FPCJUA and/or the RPCJUA to meet the obligations of an insolvent insurer member
or other party, or to meet any obligations arising from the deferment by the
FWUA, FPCJUA and/or RPCJUA of the collection of monies.
<PAGE>
NOTE: Wherever used herein, the term "Company" shall be understood to mean
"Reinsured," "Reassured" or whatever other term is used in the attached
Agreement to designate the reinsured company. The term "Agreement" shall be
understood to mean "Contract," "Policy" or whatever other term is used to
designate the attached reinsurance document. The term "Reinsurers" shall be
understood to mean "Reinsurers," "Underwriters" or whatever other term is used
in the attached Agreement to designate the reinsurer or reinsurers.
NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE - U.S.A.
1. This Contract does not cover any loss or liability accruing to the
Reassured, directly or indirectly and whether as Insurer or Reinsurer, from any
Pool of Insurers or Reinsurers formed for the purpose of covering Atomic or
Nuclear Energy risks.
2. Without in any way restricting the operation of paragraph (1) of this
Clause, this Contract does not cover any loss or liability accruing to the
Reassured, directly or indirectly and whether as Insurer or Reinsurer, from any
i n s u rance against Physical Damage (including business interruption or
consequential loss arising out of such Physical Damage) to:
I. Nuclear reactor power plants including all auxiliary property on
the site, or
II. Any other nuclear reactor installation, including laboratories
handling radioactive materials in connection with reactor installations, and
"critical facilities" as such, or
III. Installations for fabricating complete fuel elements or for
processing substantial quantities of "special nuclear material," and for
reprocessing, salvaging, chemically separating, storing or disposing of "spent"
nuclear fuel or waste materials, or
IV. Installations other than those listed in paragraph (2) III above
using substantial quantities of radioactive isotopes or other products of
nuclear fission.
3. Without in any way restricting the operations of paragraphs (1) and (2)
hereof, this Contract does not cover any loss or liability by radioactive
contamination accruing to the Reassured, directly or indirectly, and whether as
Insurer or Reinsurer, from any insurance on property which is on the same site
as a nuclear reactor power plant or other nuclear installation and which
normally would be insured therewith except that this paragraph (3) shall not
operate
(a) where the Reassured does not have knowledge of such nuclear reactor
power plant or nuclear installation, or
(b) where said insurance contains a provision excluding coverage for
damage to property caused by or resulting from radioactive contamination,
however caused. However on and after 1st January 1960 this sub-paragraph (b)
shall only apply provided the said radioactive contamination exclusion provision
has been approved by the Governmental Authority having jurisdiction thereof.
<PAGE>
4. Without in any way restricting the operations of paragraphs (1), (2) and
(3) hereof, this Contract does not cover any loss or liability by radioactive
contamination accruing to the Reassured, directly or indirectly, and whether as
Insurer or Reinsurer, when such radioactive contamination is a named hazard
specifically insured against.
5. It is understood and agreed that this Clause shall not extend to risks
using radioactive isotopes in any form where the nuclear exposure is not
considered by the Reassured to be the primary hazard.
6. The term "special nuclear material" shall have the meaning given it in
the Atomic Energy Act of 1954 or by any law amendatory thereof.
7. The Reassured to be sole judge of what constitutes:
(a) substantial quantities, and
(b) the extent of installation, plant or site.
Note. Without in any way restricting the operation of paragraph (1) hereof,
it is understood and agreed that
(a) all policies issued by the Reassured on or before 31st December 1957
shall be free from the application of the other provisions of this Clause until
expiry date or 31st December 1960 whichever first occurs whereupon all the
provisions of this Clause shall apply,
(b) with respect to any risk located in Canada policies issued by the
Reassured on or before 31st December 1958 shall be free from the application of
the other provisions of this Clause until expiry date or 31st December 1960
whichever first occurs whereupon all the provisions of this Clause shall apply.
NUCLEAR INCIDENT EXCLUSION CLAUSE
PHYSICAL DAMAGE - REINSURANCE - CANADA
1. This Agreement does not cover any loss or liability accruing to the
Company directly or indirectly, and whether as Insurer or Reinsurer, from any
Pool of Insurers or Reinsurers formed for the purpose of covering Atomic or
Nuclear Energy risks.
2. Without in any way restricting the operation of paragraph 1 of this
clause, this Agreement does not cover any loss or liability accruing to the
Company, directly or indirectly, and whether as Insurer or Reinsurer, from any
i n s u rance against Physical Damage (including business interruption or
consequential loss arising out of such Physical Damage) to:
(a) nuclear reactor power plants including all auxiliary property on
the site, or
(b) any other nuclear reactor installation, including laboratories
handling radioactive materials in connection with reactor installations, and
critical facilities as such, or
(c) installations for fabricating complete fuel elements or for
p r o c e s sing substantial quantities of prescribed substances, and for
reprocessing, salvaging, chemically separating, storing or disposing of spent
nuclear fuel or waste materials, or
<PAGE>
(d) installations other than those listed in (c) above using
substantial quantities of radioactive isotopes or other products of nuclear
fission.
3. Without in any way restricting the operation of paragraphs 1 and 2 of
this clause, this Agreement does not cover any loss or liability by radioactive
contamination accruing to the Company, directly or indirectly, and whether as
Insurer or Reinsurer, from any insurance on property which is on the same site
as a nuclear reactor power plant or other nuclear installation and which
normally would be insured therewith, except that this paragraph 3 shall not
operate:
(a) where the Company does not have knowledge of such nuclear reactor
power plant or nuclear installation, or
(b) where the said insurance contains a provision excluding coverage
for damage to property caused by or resulting from radioactive contamination,
however caused.
4. Without in any way restricting the operation of paragraphs 1, 2 and 3 of
this clause, this Agreement does not cover any loss or liability by radioactive
contamination accruing to the Company, directly or indirectly, and whether as
Insurer or Reinsurer, when such radioactive contamination is a named hazard
specifically insured against.
5. This clause shall not extend to risks using radioactive isotopes in any
form where the nuclear exposure is not considered by the Company to be the
primary hazard.
6. The term "prescribed substances" shall have the meaning given to it by
the Atomic Energy Control Act R.S.C. 1985 (c), A-16 or by any law amendatory
thereof.
7. Company to be sole judge of what constitutes:
(a) substantial quantities, and
(b) the extent of installation, plant or site.
8. Without in any way restricting the operation of paragraphs 1, 2, 3 and 4
of this clause, this Agreement does not cover any loss or liability accruing to
the Company, directly or indirectly, and whether as Insurer or Reinsurer caused:
(a) by any nuclear incident as defined in the Nuclear Liability Act
or any other nuclear liability act, law or statute, or any law amendatory
thereof or nuclear explosion, except for ensuing loss or damage which results
directly from fire, lightening or explosion of natural, coal or manufactured
gas;
(b) by contamination by radioactive material.
Note: Without in any way restricting the operation of paragraphs 1, 2, 3 and 4
of this clause, paragraph 8 of this clause shall only apply to all original
contracts of the Company whether new, renewal or replacement which become
effective on or after December 31, 1992.
<PAGE>
NORTH AMERICAN WAR EXCLUSION CLAUSE (REINSURANCE)
As regards interests which at time of loss or damage are on shore, no liability
shall attach hereto in respect of any loss or damage which is occasioned by war,
i n v asion, hostilities, acts of foreign enemies, civil war, rebellion,
insurrection, military or usurped power, or martial law or confiscation by order
of any government or public authority.
This War Exclusion Clause shall not, however, apply to interests which at time
of loss or damage are within the territorial limits of the United States of
America (comprising the fifty States of the Union, the District of Columbia, and
including bridges between the U.S.A. and Mexico provided they are under United
States ownership), Canada, St. Pierre and Miquelon, provided such interests are
insured under policies, endorsements or binders containing a standard war or
hostilities or warlike operations exclusion clause.
LOSS FUNDING
This clause is only applicable to those Reinsurers who cannot qualify for credit
by the State having jurisdiction over the Company's loss reserves.
As regards policies or bonds issued by the Company coming within the scope of
this Agreement, the Company agrees that when it shall file with the insurance
department or set up on its books reserves for losses covered hereunder which it
shall be required to set up by law it will forward to the Reinsurer a statement
showing the proportion of such loss reserves which is applicable to them.
The Reinsurer hereby agrees that it will apply for and secure delivery to the
Company a clean irrevocable and unconditional Letter of Credit issued by a bank
chosen by the Reinsurer and acceptable to the appropriate insurance authorities,
in an amount equal to the Reinsurer's proportion of the loss reserves in respect
of known outstanding losses that have been reported to the Reinsurer and
allocated loss expenses relating thereto as shown in the statement prepared by
the Company. Under no circumstances shall any amount relating to reserves in
respect of losses or loss expenses Incurred But Not Reported be included in the
amount of the Letter of Credit.
The Letter of Credit shall be "Evergreen" and shall be issued for a period of
not less than one year, and shall be automatically extended for one year from
its date of expiration or any future expiration date unless thirty (30) days
prior to any expiration date, the bank shall notify the Company by certified or
registered mail that it elects not to consider the Letter of Credit extended for
any additional period.
The Company, or its successors in interest, undertakes to use and apply any
amounts which it may draw upon such Credit pursuant to the terms of the
Agreement under which the Letter of Credit is held, and for the following
purposes only:
(a) To pay the Reinsurer's share or to reimburse the Company for the
Reinsurer's share of any liability for loss reinsured by this Agreement, the
payment of which has been agreed by the Reinsurer and which has not otherwise
been paid.
(b) To make refund of any sum which is in excess of the actual amount
required to pay the Reinsurer's share of any liability reinsured by this
Agreement.
<PAGE>
(c) In the event of expiration of the Letter of Credit as provided for
above, to establish deposit of the Reinsurer's share of known and reported
outstanding losses and allocated expenses relating thereto under this Agreement.
Such cash deposit shall be held in an interest bearing account separate from the
Company's other assets, and interest thereon shall accrue to the benefit of the
Reinsurer. It is understood and agreed that this procedure will be implemented
only in exceptional circumstances and that, if it is implemented, the Company
will ensure that a rate of interest is obtained for the Reinsurers on such a
deposit account that is at least equal to the rate which would be paid by
Citibank N.A. in New York, and further that the Company will account to the
Reinsurers on an annual basis for all interest accruing on the cash deposit
account for the benefit of the Reinsurer.
The bank chosen for the issuance of the Letter of Credit shall have no
responsibility whatsoever in connection with the propriety of withdrawals made
by the Company or the disposition of funds withdrawn, except to ensure that
withdrawals are made only upon the order of properly authorized representatives
of the Company.
At annual intervals, or more frequently as agreed but never more frequently than
semiannually, the Company shall prepare a specific statement, for the sole
purpose of amending the Letter of Credit, of the Reinsurer's share of known and
reported outstanding losses and allocated expenses relating thereto. If the
statement shows that the Reinsurer's share of such losses and allocated loss
expenses exceeds the balance of credit as of the statement date, the Reinsurer
shall, within thirty (30) days after receipt of notice of such excess, secure
delivery to the Company of an amendment of the Letter of Credit increasing the
amount of credit by the amount of such difference. If, however, the statement
shows that the Reinsurer's share of known and reported outstanding losses plus
allocated loss expenses relating thereto is less than the balance of credit as
of the statement date, the Company shall, within thirty (30) days after receipt
of written request from the Reinsurer, release such excess credit by agreeing to
secure an amendment to the Letter of Credit reducing the amount of credit
available by the amount of such excess credit.
NOTE: Wherever used herein the terms:
"Company" shall be understood to mean "Company," "Reinsured," "Reassured" or
whatever other term is used in the attached reinsurance agreement to designate
the reinsured company. "Agreement" shall be understood to mean "Contract,"
"Agreement," "Policy" or whatever other term is used to designate the attached
reinsurance document. "State" shall be understood to mean the state, province
or Federal authority having jurisdiction over the Company's loss reserves.
<PAGE>
SERVICE OF SUIT
This Clause applies only to a reinsurer domiciled outside the United States of
America or should the Company be authorized to do business in the State of New
York, a reinsurer unauthorized in New York as respects suits instituted in New
York.
It is agreed that in the event of the failure of the Reinsurer hereon to pay any
amount claimed to be due hereunder, the Reinsurer hereon, at the request of the
Company, will submit to the jurisdiction of a court of competent jurisdiction
within the United States. Nothing in this Clause constitutes or should be
understood to constitute a waiver of the Reinsurer's right to commence an action
in any court of competent jurisdiction in the United States, to remove an action
to a United States district court or to seek a transfer of a case to another
court as permitted by the laws of the United States or of any state in the
United States.
It is further agreed that service of process in such suit may be made upon
Messrs. Mendes & Mount, 750 Seventh Avenue, New York, New York 10019-6829 and
that in any suit instituted against the Reinsurer upon this Agreement, the
Reinsurer will abide by the final decision of such court or of any appellate
court in the event of an appeal.
The above-named are authorized and directed to accept service of process on
behalf of the Reinsurer in any such suit and/or upon the request of the Company
to give a written undertaking to the Company that they will enter a general
appearance upon the Reinsurer's behalf in the event such a suit shall be
instituted.
Further, pursuant to any statute of any state, territory or district of the
United States which makes provision therefor, the Reinsurer hereon hereby
designates the superintendent, commissioner or director of insurance or other
officer specified for that purpose in the statute or his successor or successors
in office as its true and lawful attorney upon whom may be served any lawful
process in any action, suit or proceeding instituted by or on behalf of the
Company or any beneficiary hereunder arising out of this Agreement, and hereby
designates the above-named as the person to whom the said officer is authorized
to mail such process or a true copy thereof.
Note: Wherever used herein the terms:
"Company" shall be understood to mean "Company," "Reinsured," "Reassured" or
whatever other term is used in the attached reinsurance Agreement to designate
the reinsured company. "Agreement" shall be understood to mean "Contract,"
"Agreement," "Policy" or whatever other term is used to designate the attached
reinsurance document.
<PAGE>
INSOLVENCY CLAUSE
In the event of the insolvency of the Company, reinsurance under this Agreement
shall be payable by the Reinsurer on the basis of the liability of the Company
under Policy or Policies reinsured without diminution because of the insolvency
of the Company, to the Company or to its liquidator, receiver, or statutory
successor except as provided by Section 4118(a) of the New York Insurance Law or
except when the Agreement specifically provides another payee of such
reinsurance in the event of the insolvency of the Company and when the Reinsurer
with the consent of the direct insured or insureds has assumed such Policy
obligations of the Company as direct obligations of the Reinsurer to the payees
under such Policies and in substitution for the obligations of the Company to
such payees.
It is agreed, however, that the liquidator or receiver or statutory successor of
the insolvent Company shall give written notice to the Reinsurer of the pendency
of a claim against the insolvent Company on the Policy or Policies reinsured
within a reasonable time after such claim is filed in the insolvency proceeding
and that during the pendency of such claim, the Reinsurer may investigate such
claim and interpose, at its own expense, in the proceeding when such claim is to
be adjudicated, any defense or defenses which it may deem available to the
Company or its liquidator or receiver or statutory successor. The expense thus
incurred by the Reinsurer shall be chargeable, subject to court approval,
against the insolvent Company as part of the expense of liquidation to the
extent of a proportionate share of the benefit which may accrue to the Company
solely as a result of the defense undertaken by the Reinsurer.
When two or more reinsurers are involved in the same claim and a majority in
interest elect to interpose defense to such claim, the expense shall be
apportioned in accordance with the terms of this Agreement as though such
expense had been incurred by the insolvent Company.
Should the Company go into liquidation or should a receiver be appointed, the
Reinsurer shall be entitled to deduct from any sums which may be due or may
become due to the Company under this reinsurance Agreement any sums which are
due to the Reinsurer by the Company under this reinsurance Agreement and which
are payable at a fixed or stated date as well as any other sums due the
Reinsurer which are permitted to be offset under applicable law.
Note: Wherever used herein the terms:
"Company" shall be understood to mean "Company," "Reinsured," "Reassured" or
whatever other term is used in the attached reinsurance Agreement to designate
the reinsured Company. "Agreement" shall be understood to mean "Contract,"
"Agreement," "Policy" or whatever other term is used to designate the attached
reinsurance document.
<PAGE>
ARBITRATION CLAUSE
As a condition precedent to any right of action hereunder, any irreconcilable
dispute between the parties to this Agreement will be submitted for decision to
a board of arbitration composed of two arbitrators and an umpire.
Arbitration shall be initiated by the delivery of a written notice of demand for
arbitration by one party to the other within a reasonable time after the dispute
has arisen.
The members of the board of arbitration shall be active or retired disinterested
officials of insurance or reinsurance companies, or Underwriters at Lloyd's,
London, not under the control or management of either party to this Agreement.
Each party shall appoint its arbitrator and the two arbitrators shall choose an
umpire before instituting the hearing. If the respondent fails to appoint its
arbitrator within four weeks after being requested to do so by the claimant, the
latter shall also appoint the second arbitrator. If the two arbitrators fail to
agree upon the appointment of an umpire within four weeks after their
nominations, each of them shall name three, of whom the other shall decline two,
and the decision shall be made by drawing lots.
The claimant shall submit its initial brief within 45 days from appointment of
the umpire. The respondent shall submit its brief within 45 days thereafter and
the claimant may submit a reply brief within 30 days after filing of the
respondent's brief.
The board shall make its decision with regard to the custom and usage of the
insurance and reinsurance business. The board shall issue its decision in
writing based upon a hearing in which evidence may be introduced without
following strict rules of evidence but in which cross-examination and rebuttal
shall be allowed. The board shall make its decision within 60 days following
the termination of the hearings unless the parties consent to an extension. The
majority decision of the board shall be final and binding upon all parties to
the proceeding. Judgment may be entered upon the award of the board in any
court having jurisdiction.
Each party shall bear the expense of its own arbitrator and shall jointly and
equally bear with the other party the expense of the umpire. The remaining
costs of the arbitration proceedings shall be allocated by the board.
Note: Wherever used herein, the term "Company" shall be understood to mean
"Reinsured," "Reassured" or whatever other term is used in the attached
Agreement to designate the reinsured company. The term "Agreement" shall be
understood to mean "Contract," "Policy" or whatever other term is used to
designate the attached reinsurance document.
