CONFORMED COPY
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
Annual Report under Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 1998
Commission file number 0-16090
HALLMARK FINANCIAL SERVICES, INC.
(Name of Small Business Issuer in Its Charter)
Nevada 87-0447375
(State or Other Jurisdiction (I.R.S. Employer I.D. No.)
of Incorporation or Organization)
14651 Dallas Parkway, Suite 900 75240
Dallas, Texas (Zip Code)
(Address of Principal Executive Offices)
Issuer's Telephone Number, Including Area Code: (972) 404-1637
Securities registered under Section 12(b) of the Exchange Act:
Title of Each Class Name of Each Exchange on Which Registered
Common Stock, 3 cents par value American Stock Exchange Emerging Company
Marketplace
Securities registered under Section 12(g) of the Exchange Act: None
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the 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 XX No
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of the registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of this
Form 10-KSB or any amendment to this Form 10-KSB. Yes XX No
State issuer's revenues for its most recent fiscal year - $16,587,550.
State the aggregate market value of the voting stock held by non-affiliates
- - $4,258,823 as of March 19, 1999.
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date. Common Stock, 3 cents par
value - 11,048,133 shares outstanding as of March 19, 1999.
<PAGE>
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III is incorporated by reference from the
Registrant's definitive proxy statement to be filed with the Commission
pursuant to Regulation 14A not later than 120 days after the end of the
fiscal year covered by this report.
Risks Associated with Forward-Looking Statements Included in this Form 10-
KSB
This Form 10-KSB contains certain forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of
the Securities Exchange Act of 1934, which are intended to be covered by
the safe harbors created thereby. These statements include the plans and
objectives of management for future operations, including plans and
objectives relating to future growth of the Company's business activities
and availability of funds. The forward-looking statements included herein
are based on current expectations that involve numerous risks and
uncertainties. Assumptions relating to the foregoing involve judgments
with respect to, among other things, future economic, competitive and
market conditions, regulatory framework, and future business decisions, all
of which are difficult or impossible to predict accurately and many of
which are beyond the control of the Company. Although the Company believes
that the assumptions underlying the forward-looking statements are
reasonable, any of the assumptions could be inaccurate and, therefore,
there can be no assurance that the forward-looking statements included in
this Form 10-KSB will prove to be accurate. In light of the significant
uncertainties inherent in the forward-looking statements included herein,
the inclusion of such information should not be regarded as a
representation by the Company or any other person that the objectives and
plans of the Company will be achieved.
Item 1. Description of Business.
Introduction
Hallmark Financial Services, Inc. ("HFS") and its wholly owned
subsidiaries (collectively, the "Company") engage in the sale of property
and casualty insurance products. The Company's business primarily involves
marketing, underwriting and premium financing of non-standard automobile
insurance, as well as claims adjusting and other insurance related
services.
Overview
The Company pursues its business activities through an integrated
insurance group (collectively, the "Insurance Group"), the members of which
are an authorized Texas 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 premium finance company, Hallmark Finance Corporation
("HFC"); a claims handling and adjusting firm, Hallmark Claims Service,
Inc. ("HCS"); and from April 1996 until December 31, 1997, a commercial
excess and surplus lines affiliated managing general agency, Hallmark
Underwriters, Inc. ("HUI"). The Company operates only in Texas.
<PAGE>
Hallmark writes non-standard automobile liability and physical damage
coverages. Hallmark provides insurance through a reinsurance arrangement
with an unaffiliated company, State & County Mutual Fire Insurance Company
("State & County"). Through State & County, Hallmark provides insurance
primarily for high risk drivers who do not qualify for standard-rate
insurance.
AHGA, a managing general agency, holds an appointment from State &
County to manage the sale and servicing of State & County policies.
Hallmark reinsures 100% of the State & County policies produced by AHGA
under a related reinsurance agreement. AHGA markets the policies produced
by Hallmark through the Hallmark Agencies and through independent agents
operating under their own names. Additionally, AHGA provides premium
processing, underwriting, reinsurance accounting, and cash management for
unaffiliated managing general agents ("MGAs").
HFC offers premium financing for policies sold by the Hallmark
Agencies and independent agents managed by AHGA. Beginning late-June 1997,
HFC began offering its own premium finance notes. Prior to June 1997, HFS
had a financing and servicing arrangement with an unaffiliated premium
finance company.
HCS provides fee-based claims adjustment, salvage and subrogation
recovery, and litigation services to Hallmark and unaffiliated third
parties.
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. Due to highly competitive market conditions
principally as a result of an uncharacteristically strong presence of
standard commercial insurers in the Texas marketplace, HUI's operations
ceased as of December 31, 1997.
Insurance Group Operations
Formed in 1987, HFS commenced its current operations in 1990 when it
acquired, through several acquisitions, most of the companies now referred
to as the Insurance Group. HFS manages Hallmark, AHGA, the Hallmark
Agencies, HFC and HCS as an integrated Insurance Group that shares common
management, computer facilities and corporate offices. AHGA manages the
sale of State & County policies by the Hallmark Agencies and by independent
agents and provides premium processing, underwriting, reinsurance
accounting, and cash management to unaffiliated third parties. HFC offers
premium finance programs for State & County policies marketed by the
Hallmark Agencies and independent agents managed by AHGA. HCS provides
claims services to Hallmark and unaffiliated third parties.
The Company offers both liability and physical damage (comprehensive
and collision) coverages. Hallmark's bodily injury liability coverage is
limited to $20,000 per person and $40,000 per accident, and property damage
liability coverage is limited to $15,000 per accident. Physical damage
coverage is limited to $40,000 and $30,000 for vehicles insured under
annual/six-month and monthly policies, respectively.
Substantially all purchasers of Hallmark policies are individuals.
No single customer or group of related customers has accounted for more
than 1% of its net premiums written during any of the last three years.
<PAGE>
The Company writes annual, monthly and since mid-1997, six-month
policies. The Company's core net premium volume was composed of a policy
mix of 46% annual, 49% monthly and 5% six-month policies in 1998, and 49%
annual, 47% monthly and 4% six-month policies in 1997. The Company's
typical customer is unable or unwilling to pay either a half- or full-
year's premium in advance, and thus a monthly policy, or an annual or six-
month policy subject to financing, suits his/her budgetary needs.
The Company finances annual and six-month policy premiums produced by
AHGA through a premium finance program offered by HFC. During 1998,
approximately 92% of Hallmark's annual and six-month policyholders financed
their premiums through HFC's premium finance program. During 1997 and
1996, approximately 91% and 90%, respectively, of Hallmark's annual and
six-month policyholders financed their premiums through HFC's premium
finance program.
HCS provides claims adjustment and related litigation services to
both the Company and unaffiliated MGAs. Hallmark currently assumes a
portion of the business produced by these unaffiliated MGAs. Fees are
charged either on a per-file basis, as a percentage of earned premiums or,
in certain instances, a combination of both methods. When the Company
receives notice of a loss, HCS personnel establish a claim file and an
estimated loss reserve. HCS's adjusters review, investigate and initiate
claim payments, with the Company utilizing a third-party claims service
only in unusual circumstances. The Company has an in-house legal staff and
thus handles much of its claims-related litigation in-house. Management
believes that the Company achieves superior efficiency and cost
effectiveness by utilizing its own trained employee-adjusters and in-house
litigation staff in most instances.
Underwriting and Other Ratios
An insurance company's underwriting experience is traditionally
measured by the statutory "combined ratio." The combined ratio under
statutory accounting practices ("SAP") is the sum of (1) the ratio of net
losses and loss adjustment expenses ("LAE") incurred to net premiums earned
(referred to as the "statutory loss ratio"), and (2) the ratio of
underwriting and operating expenses to net premiums written (referred to as
the "statutory expense ratio"). The approximate SAP underwriting profit or
loss is affected to the extent the combined ratio is less or more than
100%. During 1998, 1997 and 1996, Hallmark experienced statutory loss
ratios of 69.0%, 65.9% and 64.1%, respectively. During the same periods,
it experienced statutory expense ratios of 38.2 %, 39.2% and 31.9%,
respectively, and statutory combined ratios of 107%, 105% and 96%,
respectively. These statutory ratios do not reflect the deferral of policy
acquisition costs, investment income, premium finance revenues, or the
elimination of intercompany transactions required by generally accepted
accounting principles ("GAAP").
Hallmark's 1998 statutory loss ratio increased in relation to 1997.
This increase is principally due to the increased assumption of
unaffiliated MGA business by Hallmark during 1998. The overall loss ratio
on the assumed business produced by the unaffiliated MGAs is higher than
the loss ratio on the core State & County business. The increase in the
1997 calendar year statutory loss ratio compared to 1996 is principally due
to changes in incurred but not reported ("IBNR") reserves based, in part,
upon a greater-than-anticipated development of 1996 accident-year losses.
<PAGE>
The decrease in the 1998 statutory expense ratio as compared to 1997
is primarily attributable to decreased overhead expenses as a result of
cost saving measures initiated by management during 1998 in light of
decreased premium volumes of the core State & County business. The
increase in the 1998 and 1997 statutory expense ratios in relation to the
1996 statutory expense ratio is primarily attributable to decreased ceding
commission income (recorded as an offset to underwriting expenses) along
with increased retention of premium taxes and State & County ceding fees
under reinsurance treaties effective July 1, 1996. Changes in 1997 IBNR,
along with the change in reinsurance agreements which reduced ceding
commission income, adversely impacted the 1997 expense ratio.
Under Texas Department of Insurance ("TDI") guidelines, casualty
insurance companies are expected to maintain a premium-to-surplus ratio of
not more than 3 to 1. The premium-to-surplus ratio measures the
relationship between net premiums written in a given period (premiums
written, less returned premiums and reinsurance ceded to other carriers) to
surplus (admitted assets less liabilities), all determined on the basis of
SAP. For 1998, 1997, and 1996, Hallmark's premium-to-surplus ratios were
2.13 to 1, 2.35 to 1 and 2.21 to 1, respectively. The decrease in the 1998
premium-to-surplus ratio is attributable to the decreased premium volumes
of the core State & County business. Hallmark had a slight increase in its
1997 premium-to-surplus ratio due to the combined effect of only an 8%
increase in net premiums written and a 2% increase in 1997 surplus over the
previous year. Hallmark's 1997 surplus increased (despite a statutory net
loss) primarily due to a reduction in a 1996 charge to surplus permitted by
TDI for 1997.
Reinsurance Arrangements
Hallmark shares its claims risk with non-affiliated insurance
companies. Commencing March 1, 1992, Hallmark and AHGA entered into a
reinsurance arrangement with State & County. Effective July 1, 1996, this
arrangement was supplemented by separate risk-sharing agreements between
Hallmark and three unaffiliated companies, all of which are rated A- or
better by A.M. Best: Kemper Reinsurance Company ("Kemper"), Dorinco
Reinsurance Company ("Dorinco"), and Odyssey Reinsurance Corporation
("Odyssey"). Effective July 1, 1997, the treaty was renewed with Kemper
and Dorinco under substantially the same terms and conditions. Between
March 1, 1992 and July 1, 1996, Hallmark's principal quota-share
reinsurance was with Vesta Fire Insurance Corporation ("Vesta"), an
unaffiliated company with an A.M. Best rating of A.
Under the Company's arrangement with State & County, AHGA is a
managing general agent appointed by State & County to issue State & County
policies, as well as to appoint producing agents to sell these policies.
AHGA issues State & County policies in accordance with Hallmark's
underwriting standards and pursuant to rates approved by State & County.
Although State & County is required to file periodic rate adjustments with
the state, TDI approval is not required.
As compensation for acting as managing general agent, AHGA receives
commissions equal to a percentage of premiums written. It uses the
majority of these commissions to compensate its producing agents for
selling State & County policies. State & County receives ceding fees from
Hallmark on the State & County policies AHGA produces equal to a percentage
of premiums written assumed by Hallmark. The fee rate decreases as the
<PAGE>
annual volume of premiums written exceeds specified levels. As permitted
by law, AHGA charges policy origination fees on behalf of Hallmark in
addition to premiums.
Pursuant to the reinsurance agreement, Hallmark reinsures 100% of the
State & County business produced by AHGA. Under related reinsurance
agreements effective July 1, 1997, Kemper and Dorinco, collectively, assume
75% of the claims risk on State & County business produced by AHGA. From
July 1, 1996 through June 30, 1997, Kemper, Dorinco and Odyssey,
collectively, assumed 75% of the State & County business. In addition,
these reinsurers unconditionally guarantee Hallmark's and AHGA's
obligations to State & County. From August 1, 1993 through June 30, 1996,
Vesta assumed 75% of the State & County business.
Under the 1996 and 1997 reinsurance agreements between Hallmark and
the reinsurers, Hallmark retains 62.5% and cedes only 37.5% of the policy
origination fees (rather than ceding 75% of the policy origination fees as
under the Vesta treaty), pays premium taxes and ceding fees on 100% of the
business produced (rather than premium taxes and front fees on only its
retained business under the Vesta treaty), and receives a 30% provisional
commission on the portion of the business ceded (rather than 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 1996 and
1997 treaties is adjusted annually over a three year rating period on a
sliding scale based on annual loss ratios. Under the 1996 and 1997
reinsurance agreements, Hallmark can earn maximum commissions of 33.5% and
34.5%, respectively, and, prior to July 1998, was guaranteed minimum
commissions of 26% and 23%, respectively, regardless of loss experience.
Effective July 1, 1998, the 1996 and 1997 reinsurance agreements were
amended to lower the maximum commissions on both to 33.5% and increase the
guaranteed minimum commissions to 28% and 25%, respectively. Effective
January 1, 1999, the reinsurance treaties have been amended whereby
Hallmark retains 100% of policy fees and the guaranteed minimum commissions
have been increased to 29% and 26%, respectively.
Marketing
Customers for non-standard automobile insurance typically fall into
two groups. The first are drivers who have had standard auto insurance but
no longer qualify due to reasons such as driving record, claims history,
residency status or deterioration in credit history. The second group are
drivers who live in areas of Texas in which standard-rate insurers do not
write insurance, do not meet credit guidelines, or are declined coverage
because of the standard-rate insurers' limits on the amount of coverage
they write for new customers. Although these drivers may qualify for the
lower standard rates, they cannot obtain standard coverage.
As managing general agent, AHGA manages the marketing of the
Company's non-standard automobile insurance program through a retail
network of affiliated and independent agencies. At December 31, 1998,
there were seven affiliated offices operating under the American Hallmark
Agencies name in Amarillo, Corpus Christi, Lubbock and the Dallas
metropolitan area. During 1998, the Company restructured the American
Hallmark Agencies in order to concentrate management and advertising
resources in certain geographic areas. The restructure included, among
other things, closure of seven existing offices and limited expansion in
<PAGE>
two selected areas. In addition, the Company is represented by more than
600 independent agents with offices located throughout the State of Texas.
The Hallmark Agencies' business is developed primarily through
advertising in regional and local publications, direct-mail, telephone
solicitation and referrals from standard agents and existing customers. In
addition, field marketing representatives promote the Company's insurance
programs to prospective independent agents and service existing agents.
Both the Hallmark Agencies and the independent agents represent other
insurers and sell other insurance products in addition to Hallmark
policies. The Company's appointed independent agents are located
throughout Texas in major cities, as well as suburban and some rural areas,
with an emphasis in the central and southern regions of Texas.
Competition
Information available from industry sources indicates that the
private passenger automobile insurance market in Texas is approximately
$8.2 billion in annual premium volume. Annual premium volume of the non-
standard automobile policies written in Texas exceeded $2.4 billion,
according to 1997 data. The Company s gross premiums written were
approximately $32 million in 1998, $40 million in 1997 and $43 million in
1996. The Texas non-standard automobile insurance market has become
increasingly competitive in recent years as evidenced by a significant
number of new companies in the market place, introduction of new programs
by existing competitors and more competitive pricing of new and existing
programs. This has been caused predominately by excess capital and surplus
in major insurance and reinsurance companies. To compete in this
environment, the Company attempts to promptly set rates that are directed
toward the lower-risk segment of the non-standard auto market, to
continually improve its underwriting criteria and to provide superior
service to its agents and insureds.
Insurance Regulation
The operations of Hallmark, AHGA and HFC are regulated by TDI. HFC
is also subject to further regulation under the Texas Credit Code.
Hallmark is required to file quarterly and annual statements of its
financial condition with TDI, prepared in accordance with SAP. Hallmark's
financial condition, including the adequacy of its surplus, premium-to-
surplus ratio, loss reserves, deposits and investments, is subject to
review by TDI. Since Hallmark does not write its insurance directly, but
rather writes through a county mutual, its premium rates and underwriting
guidelines are not subject to the same degree of regulation imposed on
standard insurance companies. However, State & County must file rate
changes with TDI. AHGA and the producing agents who staff the Hallmark
Agencies offices are also subject to TDI's licensing requirements. In
addition, HFC is subject to licensing, financial reporting and certain
financial requirements required by TDI. Interest rates, note forms and
disclosures, among other things used by HFC, are regulated by the Office of
Consumer Credit Commissioner.
TDI has broad authority to enforce its laws and regulations through
examinations, administrative orders, civil and criminal enforcement
proceedings, and suspension or revocation of an insurer's Certificate of
Authority or an agent's license. In extreme cases, including actual or
pending insolvency, TDI may take over, or appoint a receiver to take over,
the management or operations of an insurer or an agent's business or
<PAGE>
assets. In addition, all insurance companies which write insurance in the
State of Texas are subject to assessments for a state administered fund
which covers the claims and expenses of insolvent or impaired insurers.
The size of the assessment is determined each year by the total claims on
the fund that year. Each insurer is assessed a pro-rata share based on its
direct premiums written. Payments to the fund may be recovered by the
insurer through deductions from its premium taxes at a rate of 10% per year
over ten years. There were no assessments during 1998 and 1997, and thus
Hallmark made no payments to the fund during those years.
HFS is also regulated as an insurance holding company under the Texas
Insurance Code. Financial transactions between HFS or any of its
affiliates and Hallmark are subject to regulation by TDI. Applicable
regulations require TDI's approval of management and expense sharing
contracts, intercompany loans and asset transactions, investments in the
Company's securities by Hallmark and similar transactions. Further,
dividends and distributions by Hallmark to HFS are restricted.
On May 13, 1996, TDI issued its formal report on the results of TDI's
regular, triennial examination of Hallmark's books and records as of
September 30, 1995. The report indicated that no significant items or
discrepancies were noted during the examination. During late-April 1999,
TDI is scheduled to begin its triennial examination of Hallmark as of
December 31, 1998. The Company anticipates that a formal report will be
issued by TDI during the fall of 1999.
Effective December 31, 1994, the National Association of Insurance
Commissioners ("NAIC") requested property/casualty insurers to file a risk-
based capital ("RBC") calculation according to a specified formula. The
purpose of the NAIC-designed formula is twofold: (1) to assess the adequacy
of an insurer s statutory capital and surplus based upon a variety of
factors such as potential risks related to investment portfolio, ceded
reinsurance and product mix; and (2) to assist state regulators under the
RBC for Insurers Model Act (the "Model Act") by providing thresholds at
which a state commissioner is authorized and expected to take regulatory
action. TDI adopted the Model Act during 1998. Hallmark s 1998 adjusted
capital under the RBC calculation exceeds the minimum TDI requirement by
46%.
Analysis of Hallmark's Losses and LAE
The Company's consolidated financial statements include an estimated
reserve for unpaid losses and LAE of the Company's non-standard automobile
insurance subsidiary, Hallmark. Hallmark estimates its reserve for unpaid
losses and LAE by using case-basis evaluations and statistical projections,
which include inferences from both losses paid and losses incurred.
Hallmark also uses recent historical cost data, periodic reviews of
underwriting standards and claims management to modify the statistical
projections. Hallmark gives consideration to the impact of inflation in
determining its loss reserves, but does not discount reserve balances.
The amount of Hallmark's reserves represents management's estimates
of the ultimate net cost of all unpaid losses and LAE incurred through
December of each year. These estimates are subject to the effect of trends
in claim severity and frequency. Management continually reviews the
estimates and adjusts them as claims experience develops and new
information becomes known. Such adjustments are included in current
operations, including increases and decreases, net of reinsurance, in the
<PAGE>
estimate of ultimate liabilities for insured events of prior years. (See
Note 1 to the Consolidated Financial Statements.)
The Company seeks to continually improve its loss estimation process
by refining its ability to analyze loss development patterns, claim
payments, and other information within a legal and regulatory environment
which affects development of ultimate liabilities. Beginning mid-1995, the
Company implemented significant changes and enhancements in its claims
operations. These changes have resulted in, among other things, (1) faster
payment of claims, (2) increased conservatism in case reserving procedures
to more promptly reflect estimated, ultimate claim-settlements and LAE
costs, and (3) more aggressive claims handling resulting in a significantly
lower average liability claim payments. The 1998 accident-year continues
to be favorably affected by these changes. During late-1997 and 1998, the
Company significantly accelerated its use of voluntary mediations (prior to
court-ordered mediations) and began to more aggressively participate in
"settlement weeks" sponsored by the courts in various counties throughout
the state. These actions have increased the timeliness with which
litigation claims settle and favorably impacted ultimate settlements.
Changes in loss development patterns and claim payments can
significantly affect the ability of insurers to estimate reserves for
unpaid losses and related expenses. Future changes in estimates of claim
costs may adversely affect future period operating results; however, such
effects cannot be reasonably estimated currently.
Reconciliation of Reserve for Unpaid Losses and LAE. The following table
provides a 1998 and 1997 reconciliation of the beginning and ending reserve
balances, on a gross-of-reinsurance basis, to the gross amounts reported in
the Company's balance sheet.
<PAGE>
<TABLE>
1998 1997
(Thousands of dollars)
<S> <C> <C>
Reserve for unpaid losses and $ 4,668 $ 5,096
LAE, net of reinsurance
recoverables, at beginning
of year
Provision for losses and LAE 8,130 7,568
for claims occurring in the
current period
Increase in reserve for unpaid 317 738
losses and LAE for claims
occurring in prior periods
Payments for losses and LAE,
net of reinsurance:
Current period (5,209) (4,408)
Prior periods (3,326) (4,326)
(8,535) (8,734)
Reserve for unpaid losses and $ 4,580 $ 4,668
LAE, net of reinsurance
recoverables, at end of year
Reinsurance recoverables on 11,435 13,064
unpaid losses and LAE,
at end of year
Reserve for unpaid losses and $ 16,015 $ 17,732
LAE, gross of reinsurance
recoverables on unpaid losses,
at end of year
</TABLE>
<PAGE>
SAP/GAAP Reserve Reconciliation. The differences between the reserves
for unpaid losses and LAE reported in the Company's consolidated financial
statements prepared in accordance with GAAP and those reported in the
annual statement filed with TDI in accordance with SAP for years 1998 and
1997 are summarized below:
<TABLE>
1998 1997
(Thousands of Dollars)
<S> <C> <C>
Reserve for unpaid losses and $ 4,409 $ 4,689
LAE on a SAP basis (net of
reinsurance recoverables on
unpaid losses)
Add estimated future ULAE reserve 171 172
for which HCS is contractually
liable
Deduct estimated salvage and - (193)
subrogation recoveries reported
on a cash basis for SAP purposes
and on an accrual basis for GAAP
purposes
Reserve for unpaid losses and $ 4,580 $ 4,668
LAE on GAAP basis (net of
reinsurance recoverables on
unpaid losses)
</TABLE>
Beginning in 1998, Hallmark recorded anticipated salvage and subrogation
for statutory purposes in conformity with policies prescribed by the NAIC
Accounting Practices and Procedures Manual.
Analysis of Loss and LAE Reserve Development
The following table shows the development of Hallmark's loss
reserves, net of reinsurance, for 1988 through 1998. Section A of the
table shows the estimated liability for unpaid losses and LAE, net of
reinsurance, recorded at the balance sheet date for each of the indicated
years. This liability represents the estimated amount of losses and LAE
for claims arising in prior years that are unpaid at the balance sheet
date, including losses that have been incurred but not yet reported to
Hallmark. Section B of the table shows the re-estimated amount of the
previously recorded liability, based on experience as of the end of each
succeeding year. The estimate is increased or decreased as more
information becomes known about the frequency and severity of claims.
Cumulative Redundancy/Deficiency (Section C of the table) represents
the aggregate change in the estimates over all prior years. Thus, changes
in ultimate development estimates are included in operations over a number
of years, minimizing the significance of such changes in any one year. The
effects on income in the past three years of changes in estimates of the
liabilities for losses and LAE are shown in the table under reconciliation
of reserves for unpaid losses and LAE.
<PAGE>
<TABLE>
ANALYSIS OF LOSS AND LAE DEVELOPMENT
(Thousands of dollars)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Year
Ended
December 31 '88 '89 '90 '91 '92 '93 '94 '95 '96 '97 98
A. Reserve
for Unpaid
Losses &
LAE, Net
of Rein-
surance
Recover-
ables 2365 3039 2968 3353 4374 4321 4297 5923 5096 4668 4580
B. Net
Reserve
Re-esti-
mated as
of:
One year
later 4264 3186 3126 2815 3423 4626 5175 5910 6227 4985
Two
years
later 4486 3353 3001 2885 3285 4499 5076 6086 6162
Three
years
later 4556 3374 3090 2813 3147 4288 5029 6050
Four
years
later 4606 3408 3052 2700 3095 4251 5034
Five
years
later 4595 3384 2988 2699 3067 4238
Six
years
later 4593 3363 2994 2685 3065
Seven
years
later 4585 3359 2987 2686
Eight
years
later 4582 3359 2990
Nine
years
later 4582 3359
Ten
years
later 4582
<PAGE>
C. Net
Cumula-
tive
Redun-
dancy
(Defi-
ciency)(2217) (320) (22) 667 1309 83 (737) (127) (1066)(317)
D. Cumula-
tive
Amount
of
Claims
Paid, Net
of
Reserve
Recoveries,
Through:
One
year
later 3490 1991 2100 1958 2109 3028 3313 3783 4326 3326
Two
years
later 4155 2994 2760 2472 2768 3883 4442 5447 5528
Three
years
later 4457 3285 2956 2654 2956 4147 4861 5856
Four
years
later 4569 3363 2990 2668 3027 4207 4975
Five
years
later 4587 3369 2983 2669 3054 4218
Six
years
later 4590 3361 2981 2685 3056
Seven
years
later 4583 3359 2987 2686
Eight
years
later 4582 3359 2990
Nine
years
later 4582 3359
Ten
years
later 4582
</TABLE>
<PAGE>
<TABLE>
<S> <C> <C>
Net Reserve - December 31 $ 4,668 $ 4,580
Reinsurance Recoverables 13,064 11,435
Gross Reserve - December 31 $17,732 $16,015
Net Re-estimated Reserve 4,985
Re-estimated Reinsurance Recoverable 13,284
Gross Re-estimated Reserve $18,269
Gross Cumulative Deficiency $ ( 537)
</TABLE>
Investment Policy
Hallmark's investment objective is to maximize current yield while
maintaining safety of capital together with sufficient liquidity for
ongoing insurance operations. Accordingly, the investment portfolio is
composed of fixed income securities: U.S. Government and U.S. Government
agency debentures and agency mortgage-backed securities, municipal
securities and U.S. Government bond mutual funds. The average maturity of
the portfolio (after taking into account current assumptions regarding
anticipated principal prepayments on mortgage-backed securities and the
call dates of certain securities held), including short-term investments,
is approximately three years, which approximates Hallmark's claims payment
patterns. It is Hallmark's intent to hold investments until maturity.
Maturities, bond calls and prepayments of mortgage-backed securities
totaling $1,497,432 represents the securities liquidated in 1998. In
addition, as part of the Company's overall investment strategy, the Company
utilizes an integrated cash management system to maximize investment
earnings on all available cash. During 1998, the Company's investment
income totaled $778,932 compared to $788,155 for 1997.
Employees
On December 31, 1998, the Company employed 123 people on a full-time basis.
None of the Company's employees are represented by labor unions. The
Company considers its employee relations to be good.
Item 2. Description of Property.
The Company's corporate headquarters are located at 14651 Dallas
Parkway, Suite 900, Dallas, Texas. This suite also houses Hallmark's
operations, AHGA's administrative staff, HFC and HCS's operations, and the
Company's computer center. The suite is located in a high-rise office
building and contains approximately 23,641 square feet of space. Effective
January 1, 1995, the Company renegotiated its lease for a period of 71
months to expire November 30, 2000. The rent is currently $27,858 per
month, and will increase 3% to 4% annually to a maximum of $28,307 per
month. The Hallmark Agencies' offices are located in six Texas cities,
including Corpus Christi, Amarillo, Lubbock and the Dallas metropolitan
area. These offices are located in office buildings, shopping centers,
store fronts and similar commercial structures in low and middle income
neighborhoods. They contain an average of 900 square feet. All are
leased, some on a month-to-month basis and others for remaining terms
ranging up to 36 months. The type of space the Hallmark Agencies occupy is
generally available at moderate rentals. The Company does not consider the
location of any particular agency office to be material to its insurance
marketing operations.
<PAGE>
Item 3. Legal Proceedings.
Except for routine litigation incidental to the business of the
Company and as described in Note 12 of the Notes to Consolidated Financial
Statements, 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 4. Submission of Matters to a Vote of Security Holders.
During the fourth quarter of 1998, the Company did not submit any
matter to a vote of its security holders.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters.
The Company's Common Stock has traded on the American Stock
Exchange's Emerging Company Marketplace under the symbol "HAF.EC" since
January 6, 1994. The following table shows the Common Stock's high and low
sales prices on the AMEX Emerging Company Marketplace for each quarter
since January 1, 1997.
<TABLE>
Period High Sale Low Sale
<S> <C> <C>
1997
First Quarter $ .94 $ .63
Second Quarter .88 .56
Third Quarter .94 .56
Fourth Quarter 1.50 .75
1998
First Quarter $1.44 $1.00
Second Quarter 1.38 .94
Third Quarter 1.13 .56
Fourth Quarter .81 .38
1999
First Quarter $ .69 $ .19
(through March 19)
</TABLE>
On March 19, 1999 there were 172 record holders of the Company's
Common Stock.
The Company has never paid dividends on its Common Stock. The Board
of Directors intends to continue this policy for the foreseeable future in
order to retain earnings for development of the Company's business.
<PAGE>
Item 6. Management's Discussion and Analysis or Plan of Operation.
The following discussion of the Company's financial condition and the
results of its operations should be read in conjunction with the
consolidated financial statements and related notes included in this
report.
Financial Condition and Liquidity
The Company's sources of funds are principally derived from insurance
related operations. Major sources of funds from operations include
premiums collected (net of policy cancellations and premiums ceded), ceding
commissions, processing fees, premium finance service charges and service
fees. Other sources of funds are from financing and investment activities.
Net cash flow utilized by the Company's consolidated operations for
the year ended December 31, 1998 was approximately $1.5 million while net
cash flow provided by the Company's consolidated operations for the year
ended December 31, 1997 was approximately $3.1 million. Under existing
reinsurance treaties with Dorinco and Kemper, the first annual settlement
of the ceding commission adjustment (as discussed in Item 1- Description of
Business - Reinsurance Arrangements) between Hallmark and the reinsurers
occurred during the third quarter of 1998 whereby Hallmark remitted
approximately $1.8 million to the reinsurers in return ceding commission.
Net cash flow was further adversely impacted by decreased premium volumes
which, in turn, decreased net unearned premium reserve, reinsurance
recoverable, and reinsurance balances payable.
Net cash provided by investing activities for 1998 was approximately
$3.5 million as compared to net cash utilized by investing activities for
1997 of $9.8 million. The significant increase in 1998 investing cash flow
is due principally to its premium finance activities. Due to decreased
annual policy premium volume during 1998, HFC received more funds in
premium finance payments than it originated in premium finance notes.
Additional funds were provided by the collection of a note receivable from
Peregrine Premium Finance L.C. ("Peregrine"), an unaffiliated premium
finance company, which was originated in connection with the termination of
the Company s premium finance program with Peregrine in 1997.
Net cash used by financing activities for 1998 was approximately $1.0
million as compared to net cash provided by financing activities for 1997
of $7.8 million. During 1997, the Company received loan proceeds of $7.0
million from Dorinco and a $1.0 million advance under its bank credit line.
In 1998, the Company repaid the bank credit line in full.
On a consolidated basis, the Company's liquidity remained steady as
of December 31, 1998 as compared to December 31, 1997. The Company's total
cash, cash equivalents and investments at December 31, 1998 and 1997 were
$14,629,134 and $13,903,465, respectively, excluding restricted cash of
$1,768,927 and $1,340,937, respectively.
A substantial portion of the Company's 1998 liquid assets are held by
Hallmark and are not available for general corporate purposes. Of the
Company's consolidated liquid assets of $14,629,134 at December 31, 1998,
$2,791,757 (as compared to $1,523,452 in 1997) represents non-restricted
cash. Since state insurance regulations restrict financial transactions
between an insurance company and its affiliates, HFS is limited in its
<PAGE>
ability to use Hallmark funds for its own working capital purposes.
Furthermore, dividends and loans by Hallmark to HFS are also restricted
and, in certain instances, subject to TDI approval. Based on surplus at
December 31, 1998, Hallmark could pay a dividend of up to $539,953 to HFS
during 1999 without TDI approval. In addition, TDI has sanctioned the
payment of management fees, commissions and claims handling fees by
Hallmark to HFS and other affiliates. Accordingly, management fees of
$610,000 were paid or accrued in 1998, and management fees of $820,000 were
paid or accrued in 1997. Management anticipates that Hallmark will
continue to pay management fees periodically during 1999, and this should
continue to be a moderate source of unrestricted liquidity. While the
Company has never received a dividend from Hallmark and there is no
immediate plan to pay a dividend, management is re-examining its current
dividend policy.
Commissions from the Company s annual policy program for independent
agents represent a source of unrestricted liquidity. Under this program,
AHGA offers independent agents the ability to write annual policies and,
since mid-1997, six-month policies, but commissions to most independent
agents are paid monthly on an "earned" basis. However, consistent with
customary industry practice, Hallmark pays total commissions up-front to
AHGA based on the entire annual/six-months premiums written. Independent
agent production of annual policies was approximately $11.0 million in 1998
compared to $15.0 million in 1997. During 1998, AHGA received $2.5 million
in commissions related to this annual policy program from Hallmark, of
which $0.5 million will be paid to independent agents during 1999 as
earned.
Ceding commission income represents a significant source of funds to
the Company. Ceding commission income for 1998 decreased approximately
$1.8 million (representing a 25% decrease) as compared to 1997. This
decrease is attributable to the decreased premium volume of the core State
& County business. 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 decreased to approximately $1.4 million at
December 31, 1998, from $2.3 million at December 31, 1997. The reduction
in deferred ceding commission income is principally due to the decrease in
the Company's core State & County premium volume. Deferred policy
acquisition costs as of December 31, 1998 decreased in relation to the
prior year. This decrease is also primarily attributable to the decrease
in the Company's core State & County premium volume.
Prepaid reinsurance premiums, unpaid losses and LAE and reinsurance
recoverable generally decreased as expected in relation to decreased
premium writings. (See Notes 3 and 4 to the Consolidated Financial
Statements.)
At December 31, 1998, the Company reported approximately $7.1 million
in notes payable as compared to $8.2 million at December 31, 1997. During
the fourth quarter of 1998, the Company repaid the outstanding balance on
the bank credit line (used to fund premium finance notes of HFC) and
amended the agreement to reduce the maximum amount available to $1.0
million and to extend the expiration date until February 15, 1999. The
bank credit line has not been renewed. Assuming a modest growth in premium
volumes, the Company intends to fund its premium finance notes with
internally generated funds during 1999. According to the Dorinco loan
agreement, principal payments on the Dorinco loan were to commence on March
<PAGE>
31, 1999. In March 1999, the loan agreement has been amended whereby the
commencement of principal payments has been delayed until September 30,
1999.
Accrued litigation costs reported in 1997 reflect management's
estimate of loss contingencies related to a lawsuit currently being
appealed. (See Note 12 to the Consolidated Financial Statements.)
At December 31, 1998, Hallmark reported statutory capital and surplus
of approximately $5.4 million, which reflects an increase of $.1 million
over the $5.3 million reported at December 31, 1997. Although Hallmark
reported a statutory net loss of $19,777 for 1998, surplus did not decrease
accordingly. During 1998, Hallmark recorded anticipated salvage and
subrogation for accident years 1997 and 1998. In accordance with the
statutory accounting guidelines, this change has been recorded as a change
in accounting principle. The cumulative effect on prior years was reported
as an increase of $83,000 to surplus, and the change in the reserve
calculated for the current year was included in net income in 1998. At
December 31, 1998, Hallmark showed a premium-to-surplus ratio of 2.13 to 1,
as compared to 2.35 to 1 for the year ended December 31, 1997.
Certain provisions of the 1996 and 1997 reinsurance treaties could
impact the Company s future liquidity. Under the agreements between
Hallmark and its reinsurers, Hallmark retains 62.5% and cedes only 37.5% of
the policy fees, pays premium taxes and front fees on 100% of the business
produced, and receives a 30% provisional commission on the portion of the
business ceded. Policy fees are up-front, fully earned fees that the
Company is permitted by law to charge in addition to premiums to cover and
defray certain costs associated with producing policies. Terms of the
1996 agreements include that 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. Under the 1996 and 1997
treaties, Hallmark can earn maximum commissions of 33.5% and 34.5%,
respectively, based on loss experience, and is guaranteed minimum
commissions of 26% and 23%, respectively, regardless of loss experience.
Under the July 1, 1997 renewal with Dorinco and Kemper, the first annual
settlement was extended to two years. During 1998, Hallmark paid an
aggregate of approximately $1.8 million to Dorinco and Kemper in connection
with the first adjustment of the provisional commisions. Effective July 1,
1998, the 1996 and 1997 reinsurance agreements were amended to lower the
maximum commissions to 33.5% and increase the guaranteed minimum
commissions to 28% and 25%, respectively. Effective January 1, 1999, the
reinsurance treaties have been amended whereby Hallmark retains 100% of
policy fees and the guaranteed minimum commissions have been increased to
29% and 26%, respectively.
Changing market conditions in the non-standard industry adversely
impacted premium volumes during 1997 and 1998. Management has taken steps
to stimulate volumes and more closely correlate expenses with premium
volumes. Although volumes trended downward beginning in April 1998, an
upward trend began in December 1998 and has continued into 1999. However,
market conditions remain volatile and a reversal in the most recent upward
volume trend could negatively impact liquidity. The Company s liquidity
remained steady during 1998 despite a soft market. Management expects that
1999 liquidity generated from its current core State & County business and
third party service contract income will, at a minimum, remain constant
with 1998.
<PAGE>
The Company continues to pursue third party claims handling and
administrative contracts. The Company also continues to provide its
program administration and claims handling services under a contract
effective January 1, 1997 with an unaffiliated MGA. Under this three-year
contract, the Company, as program administrator, performs certain
administrative functions, including but not limited to, cash management,
underwriting and rate-setting reviews, and claims handling. Hallmark is
assuming a 20% pro-rata share of the business produced under this
unaffiliated MGA's program with the remaining 80% of the business being
assumed by Hallmark s principal reinsurers, Dorinco and Kemper.
Additionally, two agreements with other unaffiliated MGAs began April 1,
1998 and September 1, 1998, respectively, with the Company providing not
only program administration and claims handling, but also underwriting and
policy processing. Hallmark assumes, respectively, 25% and 15% pro-rata
share in the business produced, with Hallmark s principal reinsurers
assuming the remainder. The premium volume ceded from these three
programs is considered a part of Hallmark s premium volume commitment to
Dorinco.
Management believes that, although current capital would be
sufficient to maintain the present level of operations during 1999,
additional funding will be required to achieve future growth of the
Company s business. The Company has previously announced the signing of a
letter of intent with Onyx Insurance Group, Inc. ("Onyx"), a diversified
insurance and financial services company, pursuant to which Onyx is
expected to acquire a majority stake in HFS in return for an approximately
$8 million equity investment. If the transaction is consummated,
management expects the capital provided by Onyx to be utilized primarily to
implement growth strategies which may include increasing the exposure of
the Company s existing product lines in Texas, adding new product lines
and/or expanding operations outside of Texas. However, the completion of
the proposed transaction is subject to the execution of definitive
agreements, shareholder and regulatory approval and other customary
conditions. Therefore, there can be no assurance that such additional
capital will be available to the Company or that such growth plans will be
effected.
Results of Operations
Gross premiums written (prior to reinsurance) of approximately $32.5
million for the year ended December 31, 1998 were $8.0 million lower than
gross premiums written of $40.5 million in 1997, representing a decrease of
approximately 20%. The decrease in gross premiums written during 1998 was
primarily due to changing market conditions in the Texas non-standard
industry (as discussed in Item 1 - Description of Business - Competition)
which adversely impacted premium volumes. Net premiums written (after
reinsurance) decreased only 7% during 1998 as compared to 1997 due to
assumption of business written by third party unaffiliated managing general
agencies which helped to lessen the impact on net premiums written (after
reinsurance), since only the Company's core State & County business is
ceded to reinsurers.
Premiums earned (prior to reinsurance) of $36.3 million decreased
approximately 10% during 1998 as compared to 1997, and net premiums earned
(after reinsurance) increased slightly. The disparate change in premiums
earned prior to and after reinsurance is due to the assumption of premiums
produced by the third party unaffiliated MGAs which are fully retained by
the Company, and thus have a greater impact on net premiums earned. The
<PAGE>
overall decrease in premiums earned (prior to reinsurance) is due to the
decrease in the core State & County premium volume.
Incurred loss ratios (computed on premiums earned both prior to and
after reinsurance), on a GAAP basis, for the year ended December 31, 1998,
were approximately 70% and 67%, respectively, as compared to 70% prior to
and 63% after reinsurance for 1997. During 1998, Hallmark increased its
assumption of unaffiliated MGA business by adding two additional contracts,
one effective April 1998 and the other effective September 1998. The
overall loss ratio on the assumed business produced by the unaffiliated
MGAs is higher than the loss ratio on the core State & County business and,
since this business is fully retained by Hallmark, has a greater impact on
the net loss ratio.
Finance charges, which increased 95% during 1998, represent interest
earned on premium notes issued by HFC. Prior to June 1997, HFC only
directly financed premium notes for the Company s excess and surplus line
subsidiary (the operations of which were discontinued as of December 31,
1997). Beginning late-June 1997, HFC began financing premiums for Hallmark
which has resulted in increased finance interest income during 1998.
Interest income - note receivable represents interest received from
Peregrine on funds loaned to Peregrine to extinguish its premium finance
bank debt. This note receivable was paid in full during the second quarter
of 1998. Interest expense on the Dorinco loan and the bank credit line
accounts for the increase in interest expense during 1998.
Processing and service fees, which increased 23% during 1998,
primarily represent income earned on third party processing and servicing
contracts. Processing and service fees for 1997 primarily represent
income earned by HFC pursuant to its financing and servicing arrangement
with Peregrine. This arrangement was terminated in June 1997 as HFC began
issuing its own premium finance notes. As expected, these fees have
significantly decreased during 1998 as the premium notes of Peregrine were
paid in full during the second quarter of 1998, and thus no processing fees
have been received from Peregrine since that time. However, service fees
in 1998 increased 177% over 1997 primarily as a result of the Company's
contracts with unaffiliated MGAs.
Other acquisition and underwriting expenses decreased approximately
19% as compared to the prior year. The decrease in other acquisition and
underwriting expenses is primarily due to decreases in salaries and related
benefit expenses, agent commission expense, front fees and premium taxes
due to lower premium volume, and management resources spent on non-
insurance operations. Management resources have been used to develop third
party processing and program administration business and are reallocated to
operating expenses (as discussed in the following paragraph). The decrease
in these expenses is partially offset by decreased ceding commission income
related to decreased core State & County premium volume and increases in
commission expense related to assumption of business written by third party
MGAs.
Operating expenses include non-insurance operations expenses related
to premium finance operations, general corporate overhead, and third party
administrative and claims handling contracts. Related revenues are derived
from finance charges and service/consulting fees, which, collectively,
increased 51%. Operating expenses increased 51% in relation to the prior
year. The majority of this increase in operating expenses is attributable
<PAGE>
to the deployment of management and staff resources devoted to the
development, administration and/or processing of third party contracts.
Acquisition costs, net represents the amortization of acquisition
costs (and credits) deferred over the past twelve months and the deferral
of acquisition costs (and credits) incurred in the current period.
Acquisition costs, net increased during 1998 compared to 1997 primarily due
to both lower acquisition costs and a lower deferral rate during 1998 than
in 1997 principally as a result of lower State & County core premium
volumes. This is partially offset by lower ceding commission income in
1998 than in 1997.
As of December 31, 1997, the Company accrued $315,000 of
restructuring costs related to the closure of seven of its thirteen agency
offices as well as the ceasing of the operations of HUI as of December 31,
1997. During 1998 the Company restructured the American Hallmark Agencies
by closing seven of its offices and opening two new offices in early 1998
(one of which was subsequently closed in late 1998 while the other was
closed in early 1999). The reserve, among other things, was established to
absorb ongoing obligations of closed agency locations. During 1998 these
offices were transferred to an independent agent who assumed the ongoing
obligations. The excess of the restructuring reserve over the costs
actually incurred was recorded as a reduction of expenses in 1998.
Year 2000 Compliance
General. The Year 2000 problem concerns the inability of some
computerized systems to properly recognize and process date-sensitive
information on and after January 1, 2000, due to the use of only the last
two digits to identify a year. During 1998, the Company implemented a Year
2000 compliance program to assess and remedy Year 2000 issues affecting the
Company. As a result, the Company presently expects that all of its
material systems and equipment will be ready for the Year 2000 transition.
State of Readiness. The Company s primary information technology
systems may be classified in the following categories:
Insurance Systems: These systems consist of mainframe hardware and
the Company s proprietary software programs that support its day-to-day
insurance operations (including policy issuance, premiums collection and
claims handling) and periodic batch processing and regulatory reporting.
Premium Finance Systems: These systems consist of personal computer
software programs from a third-party vendor which support HFC's premium
finance activities.
Investment Portfolio Systems: These systems consist of personal
computer software programs from a third-party vendor which support the
tracking and management of the Company's investment portfolio.
General Ledger Systems: These systems consist of personal computer
software programs from a third-party vendor which support the Company's
accounting and management information functions.
All of the Company's insurance systems have been modified to be Year
2000 compliant. Year 2000 modifications and additional enhancements to the
programs supporting day-to-day insurance operations have been written,
tested and demonstrated to be fully operational. Modifications to the
<PAGE>
programs supporting periodic batch processing and regulatory reporting have
been written and are being implemented and tested as such applications are
required in the course of the Company s business. The Company presently
expects that all such periodic batch processing and regulatory reporting
programs will be fully tested and operational by the end of the third
quarter of 1999.
The Company s premium finance systems and investment portfolio
systems have been certified by the vendors to be Year 2000 compliant and
are fully implemented. The vendor of the general ledger systems has
delivered upgraded software which is Year 2000 compliant. The Company
expects to install this new software and convert its existing data to the
upgraded general ledger systems during the second quarter of 1999.
In addition, the Company has tested all material equipment and
facilities known to contain embedded computer chips and believes them to be
Year 2000 compliant. The Company has also corresponded with all of its
major reinsurers to assure their Year 2000 readiness.
Costs to Address Year 2000 Issues. The Company is executing its Year
2000 program primarily with existing internal resources. The principal
costs associated with these internal resources are payroll and benefits of
employees engaged in Year 2000 projects as a part of their normal duties.
The Company does not separately track these internal costs attributable to
its Year 2000 program.
The Company has also incurred costs for outside consultants and
systems upgrades in connection with its Year 2000 program. As a result of
Year 2000 issues, the Company elected to upgrade its premium finance
systems and general ledger systems during 1998 and 1999, respectively. No
other significant projects have been accelerated or deferred due to Year
2000 issues. The costs of these consultants and upgrades have not been, and
are not expected to be in the future, material to the results of operations
or financial condition of the Company. All costs of Year 2000 compliance
have been recorded as an expense in the period incurred.
Risks and Contingency Plans. The Company believes that its most
critical information technology systems are presently Year 2000 compliant
and expects the remainder of its Year 2000 program to be completed as
scheduled. Therefore, any adverse consequences from Year 2000 issues will
result from presently unforeseen circumstances. As a result, the Company
has not made an assessment of worst case Year 2000 scenarios or developed
any contingency plans.
Although the Company believes that it is adequately addressing the
Year 2000 issue, there can be no assurance that Year 2000 problems will not
have a material adverse affect on its business, financial condition or
results of operations. In addition, disruptions in the economy generally
resulting from Year 2000 failures could have a material adverse affect on
the Company.
<PAGE>
Item 7. Financial Statements.
The following consolidated financial statements of the Company and
its subsidiaries are filed as part of this report.
Description Page Number
Report of Independent Accountants F-2
Consolidated Balance Sheets at
December 31, 1998 and 1997 F-3
Consolidated Statements of
Operations for the Years Ended
December 31, 1998 and 1997 F-4
Consolidated Statements of
Stockholders' Equity for the Years
Ended December 31, 1998 and 1997 F-5
Consolidated Statements of Cash Flows
for the Years Ended
December 31, 1998 and 1997 F-6
Notes to Consolidated Financial Statements F-7
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
<PAGE>
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act.
The information required by Part III, Item 9 is incorporated by
reference from the Registrant's definitive proxy statement to be filed with
the Commission pursuant to Regulation 14A not later than 120 days after the
end of the fiscal year covered by this report.
Item 10. Executive Compensation.
The information required by Part III, Item 10 is incorporated by
reference from the Registrant's definitive proxy statement to be filed with
the Commission pursuant to Regulation 14A not later than 120 days after the
end of the fiscal year covered by this report.
Item 11. Security Ownership of Certain Beneficial Owners and Management.
The information required by Part III, Item 11 is incorporated by
reference from the Registrant's definitive proxy statement to be filed with
the Commission pursuant to Regulation 14A not later than 120 days after the
end of the fiscal year covered by this report.
Item 12. Certain Relationships and Related Transactions.
The information required by Part III, Item 12 is incorporated by
reference from the Registrant's definitive proxy statement to be filed with
the Commission pursuant to Regulation 14A not later than 120 days after the
end of the fiscal year covered by this report.
Item 13. Exhibits and Reports on Form 8-K.
(a) Exhibits. The exhibits listed in the Exhibit Index appearing at
page 20 of this report are filed with or incorporated by reference in this
Report.
(b) Reports on Form 8-K. The Company did not file any Form 8-K
Current Reports during the fourth quarter of 1998.
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
HALLMARK FINANCIAL SERVICES, INC.
(Registrant)
Date: March 29, 1999 /s/ Ramon D. Phillips
Ramon D. Phillips, President (Chief Executive
Officer)
Date: March 29, 1999 /s/ Johnny J. DePuma
Johnny J. DePuma, Vice President
(Chief Financial Officer/Principal Accounting
Officer)
In accordance with the Exchange Act, this report has been signed
below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
Date: March 29, 1999 /s/ Ramon D. Phillips
Ramon D. Phillips, Director
Date: March 29, 1999 /s/ Linda H. Sleeper
Linda H. Sleeper, Director
Date: March 29, 1999 /s/ Raymond A. Kilgore
Raymond A. Kilgore, Director
Date: March 29, 1999 /s/ Jack R. Daugherty
Jack R. Daugherty, Director
Date: March 29, 1999 /s/ Kenneth H. Jones, Jr.
Kenneth H. Jones, Jr., Director
Date: March 29, 1999 /s/ Samuel W. Rizzo
Samuel W. Rizzo, Director
Date: March 29, 1999 /s/ A. R. Dike
A. R. Dike, Director
Date: March 29, 1999 /s/ James H. Graves
James H. Graves, Director
Date: March 29, 1999 /s/ C. Jeffrey Rogers
C. Jeffrey Rogers, Director
Date: March 29, 1999 /s/ George R. Manser
George R. Manser, Director
<PAGE>
EXHIBIT INDEX
The following exhibits are either filed with this report or
incorporated by reference.
Exhibit
Number Description
3(a) Articles of Incorporation of the registrant, as amended
(incorporated by reference to Exhibit 3(a) to the registrant's
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1993).
3(b) By-Laws of the registrant, as amended (incorporated by reference
to Exhibit 3(b) to the registrant's Annual Report on Form 10-KSB
for the fiscal year ended December 31, 1993).
4 Specimen certificate for Common Stock, 3 cents par value, of the
registrant (incorporated by reference to Exhibit 4 to the
registrant's Annual Report on Form 10-KSB for the fiscal year
ended December 31, 1991).
10(a) Office Lease for 14651 Dallas Parkway, Suite 900, dated January 1,
1995, between American Hallmark Insurance Company of Texas and
Fults Management Company, as agent for The Prudential Insurance
Company of America (incorporated by reference to Exhibit 10(a)
to the registrant's Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1994).
10(b) 100% Quota Share Reinsurance Agreement, as Restated, between
State & County Mutual Fire Insurance Company and American Hallmark
Insurance Company of Texas, effective March 1, 1992 (incorporated
by reference to Exhibit 10(a) to Amendment No. 1 on Form 8 to the
registrant's Quarterly Report on Form 10-QSB for the quarter ended
September 30, 1992).
10(c) General Agency Agreement, effective March 1, 1992, between State
& County Mutual Fire Insurance Company and Brokers General, Inc.
(incorporated by reference to Exhibit 10(b) to Amendment No. 1 on
Form 8 to the registrant's Quarterly Report on Form 10-QSB for the
quarter ended September 30, 1992).
10(d) Quota Share Retrocession Agreement, effective March 1, 1992,
between American Hallmark Insurance Company of Texas and Liberty
National Fire Insurance Company (incorporated by reference to
Exhibit 10(c) to Amendment No. 1 on Form 8 to the registrant's
Quarterly Report on Form 10-QSB for the quarter ended September 30,
1992).
10(e) 1991 Key Employee Stock Option Plan of the registrant (incorporated
by reference to Exhibit C to the definitive Proxy Statement relating
to the registrant's Annual Meeting of Shareholders held May 20,
1991).
10(f) 1994 Key Employee Long Term Incentive Plan (incorporated by reference
to Exhibit 10(f) to the registrant's Annual Report on Form 10-KSB
for the fiscal year ended December 31, 1994).
<PAGE>
10(g) 1994 Non-employee Director Stock Option Plan (incorporated by
reference to Exhibit 10(g) to the registrant's Annual Report on
Form 10-KSB for the fiscal year ended December 31, 1994).
10(h) Reverse Split-Dollar Agreement, dated April 12, 1991, between the
registrant and Ramon D. Phillips (incorporated by reference to
Exhibit 10(I) to the registrant's Annual Report on Form 10-KSB
for the fiscal year ended December 31, 1991).
10(i) Addendum No. 2 to the Quota Share Retrocession Agreement,
effective March 1, 1993, between American Hallmark Insurance
Company of Texas and Liberty National Fire Insurance Company
(incorporated by reference to Exhibit 10(o) to the registrant's
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1993).
10(j) Addendum No. 3 to the Quota Share Retrocession Agreement,
effective August 1, 1993, between American Hallmark Insurance
Company of Texas and Liberty National Fire Insurance Company
(incorporated by reference to Exhibit 10(p) to the registrant's
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1993).
10(k) Administrative Services and Consulting Agreement, dated December 23,
1993, between American Southwest Insurance Managers, Inc., Liberty
National Fire Insurance Company, Hallmark Financial Services, Inc.,
Brokers General, Inc. and Citizens Adjustment and Reporting Service,
Inc. (incorporated by reference to Exhibit 10(q) to the registrant's
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1993).
10(l) Form of Executive Compensation Agreement representing respective
agreements dated August 23, 1994, between registrant and Ramon D.
Phillips, Raymond A. Kilgore, Linda H. Sleeper, and Johnny J. DePuma
(incorporated by reference to Exhibit 10(p) to the registrant's
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1994).
10(m) Addendum No. 1 to the 100% Quota Share Reinsurance Agreement,
as restated between State & County Mutual Fire Insurance Company
and American Hallmark Insurance Company of Texas effective November
22, 1994 (incorporated by reference to Exhibit 10(q) to the
registrant's Annual Report on Form 10-KSB for the fiscal year
ended December 31, 1994).
10(n) Second, Third, Fourth and Fifth Amendments to Office Lease for
14651 Dallas Parkway, Suite 900, dated January 1, 1995, between
American Hallmark Insurance Company of Texas and Fults Management
Company, as agent for The Prudential Insurance Company of America
(incorporated by reference to Exhibit 10(t) to the registrant's
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1995).
10(o) Form of Shareholders Agreement dated January 1, 1996, between
American Hallmark General Agency, Inc., Robert D. Campbell,
Margaret Jones and American Hallmark Agencies, Inc. (incorporated
by reference to Exhibit 10(u) to the registrant's Annual Report
on Form 10-KSB for the fiscal year ended December 31, 1995).
<PAGE>
10(p) Form of Facilities & Services Agreement dated January 1, 1996,
between American Hallmark General Agency, Inc., Robert D. Campbell,
Margaret Jones and American Hallmark Agencies, Inc. (incorporated
by reference to Exhibit 10(v) to the registrant's Annual Report on
Form 10-KSB for the fiscal year ended December 31, 1995).
10(q) Form of Indemnification Agreement dated January 1, 1996, between
American Hallmark General Agency, Inc., Hallmark Financial
Services, Inc., Robert D. Campbell, Margaret Jones and American
Hallmark Agencies, Inc. (incorporated by reference to Exhibit
10(w) to the registrant's Annual Report on Form 10-KSB for the
fiscal year ended December 31, 1995).
10(r) Form of Shareholders Agreement dated January 3, 1996,
between American Hallmark General Agency, Inc., Robert D.
Campbell, Richard Mason, Sr. and Hallmark Underwriters, Inc.
(incorporated by reference to Exhibit 10(x) to the registrant's
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1995).
10(s) Form of Facilities and Services Agreement dated January 3 1996,
between American Hallmark General Agency, Inc., Robert D. Campbell,
Richard Mason, Sr. and Hallmark Underwriter, Inc. (incorporated by
reference to Exhibit 10(y) to the registrant's Annual Report on
Form 10-KSB for the fiscal year ended December 31, 1995).
10(t) Form of Indemnification Agreement dated January 3, 1996, between
American Hallmark General Agency, Inc., Hallmark Financial Services,
Inc., Robert D. Campbell, Richard Mason, Sr. and Hallmark
Underwriters, Inc. (incorporated by reference to Exhibit 10(z)
to the registrant's Annual Report on Form 10-KSB for the fiscal
year ended December 31, 1995).
10(u) Form of 100% Quota Share Reinsurance Agreement between State &
County Mutual Fire Insurance Company and American Hallmark
Insurance Company of Texas effective July 1, 1996 (incorporated
by reference to Exhibit 10(a) to the registrant's Quarterly Report
on Form 10-QSB for the quarter ended June 30, 1996).
10(v) Form of Quota Share Retrocession Agreement between American
Hallmark Insurance Company of Texas and the Reinsurer
(specifically identified as follows: Dorinco, Kemper and Skandia),
effective July 1, 1996 (incorporated by reference to Exhibit 10(b)
to the registrant's Quarterly Report on Form 10-QSB for the quarter
ended June 30, 1996).
10(w) Guaranty Agreement effective July 1, 1996 provided by Dorinco
Reinsurance Company in favor of State & County Mutual Fire
Insurance Company (incorporated by reference to Exhibit 10(c)
to the registrant's Quarterly Report on Form 10-QSB for the
quarter ended June 30, 1996).
10(x) Guaranty Agreement effective July 1, 1996 provided by Kemper
Reinsurance Company in favor of State & County Mutual Fire
Insurance Company (incorporated by reference to Exhibit 10(d)
to the registrant's Quarterly Report on Form 10-QSB for the
quarter ended June 30, 1996).
<PAGE>
10(y) Guaranty Agreement effective July 1, 1996 provided by Skandia
America Reinsurance Corporation in favor of State & County Mutual
Fire Insurance Company (incorporated by reference to Exhibit 10(e)
to the registrant's Quarterly Report on Form 10-QSB for the
quarter ended June 30, 1996).
10(z) Form of Guaranty of Performance and Hold Harmless Agreement
effective July 1, 1996 between Hallmark Financial Services, Inc.
and Dorinco America Reinsurance Corporation (incorporated by
reference to Exhibit 10(f) to the registrant's Quarterly Report
on Form 10-QSB for the quarter ended June 30, 1996).
10(aa) Form of Guaranty of Performance and Hold Harmless Agreement
effective July 1, 1996 between Hallmark Financial Services, Inc.
and Kemper Reinsurance Company (incorporated by reference to
Exhibit 10(g) to the registrant's Quarterly Report on Form 10-QSB
for the quarter ended June 30, 1996).
10(ab) Form of Guaranty of Performance and Hold Harmless Agreement
effective July 1, 1996 between Hallmark Financial Services, Inc.
and Skandia America Reinsurance Corporation (incorporated by
reference to Exhibit 10(h) to the registrant's Quarterly Report
on Form 10-QSB for the quarter ended June 30, 1996).
10(ac) Form of Addendum No. 4 - Termination to Quota Share
Retrocession Agreement between American Hallmark Insurance
Company of Texas and Vesta Fire Insurance Company (incorporated
by reference to Exhibit 10(I) to the registrant's Quarterly Report
on Form 10-QSB for the quarter ended June 30, 1996).
10(ad) Form of Addendum No. 3 - Termination to 100% Quota Share
Reinsurance Agreement between American Hallmark Insurance Company
and State & County Mutual Fire Insurance Company (incorporated by
reference to Exhibit 10(j) to the registrant's Quarterly Report on
Form 10-QSB for the quarter ended June 30, 1996).
10(ae) Automobile Physical Damage Catastrophe Excess of Loss Reinsurance
Agreement effective July 1, 1996 between American Hallmark Insurance
Company of Texas and Kemper Reinsurance Company (incorporated by
reference to Exhibit 10(a) to the registrant's Quarterly Report on
Form 10-QSB for the quarter and ended September 30, 1996).
10(af) Form of 100% Quota Share Reinsurance Agreement, effective January
1, 1997, between State & County Mutual Fire Insurance Company,
Vaughn General Agency, Inc. and American Hallmark General Agency,
Inc. (incorporated by reference to Exhibit 10(am) to the
registrant's Annual Report on Form 10-KSB for the fiscal year
ended December 31, 1996).
10(ag) Form of General Agency Agreement, effective January 1, 1997,
between Dorinco Reinsurance Company, State & County Mutual Fire
Insurance Company and Vaughn General Agency, Inc. (incorporated
by reference to Exhibit 10(an) to the registrant's Annual Report
on Form 10-KSB for the fiscal year ended December 31, 1996).
<PAGE>
10(ah) Form of Administrative Services Agreement between State &
County Mutual Fire Insurance Company, Vaughn General Agency, Inc.
and American Hallmark General Agency, Inc. (incorporated by
reference to Exhibit 10(ao) to the registrant's Annual Report on
Form 10-KSB for the fiscal year ended December 31, 1996).
10(ai) Form of Loan Agreement dated March 11, 1997, between Hallmark
Financial Services, Inc. and Dorinco Reinsurance Company
(incorporated by reference to Exhibit 10(ap) to the registrant's
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1996).
10(aj) Form of Promissory Note dated March 11, 1997, with Hallmark
Financial Services, Inc. as Maker and Dorinco Reinsurance Company
as Payee (incorporated by reference to Exhibit 10(aq) to the
registrants Annual Report on Form 10-KSB for the year ended
December 31, 1996).
10(ak) Stock Pledge and Security Agreement dated March 11, 1997,
between ACO Holdings, Inc. and Dorinco Reinsurance Company
(incorporated by reference to Exhibit 10(ar) to the registrant's
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1996).
10(al) Form of Loan Agreement between Hallmark Finance Corporation
and NationsBank of Texas, N.A., dated March 17, 1997 (incorporated
by reference to Exhibit 10(as) to the registrant's Annual Report on
Form 10-KSB for the fiscal year ended December 31, 1996).
10(am) Form of Promissory Note, dated March 17, 1997, with NationsBank
of Texas, N.A. as Bank and Hallmark Finance Corporation as Borrower
(incorporated by reference to Exhibit 10(at) to the registrant's
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1996).
10(an) Form of Security Agreement dated March 17, 1997, between
NationsBank of Texas, N.A. and Hallmark Finance Corporation
(incorporated by reference to Exhibit 10(au) to the registrant's
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1996).
10(ao) Form of Endorsement No. 1, effective July 1, 1996, to the 100%
Quota Share Reinsurance Agreement between State & County Mutual
Fire Insurance Company and American Hallmark Insurance Company of
Texas, effective July 1, 1996 (incorporated by reference to
Exhibit 10(a) to the registrant's Quarterly Report on Form 10-QSB
for the quarter ended June 30, 1997).
10(ap) Form of Endorsement No 1, effective July 1, 1997, to the Guaranty
of Performance and Hold Harmless Agreement between Hallmark Financial
Services, Inc. and Skandia America Reinsurance Corporation, effective
July 1, 1996 (incorporated by reference to Exhibit 10(b) to the
registrant's Quarterly Report on Form 10-QSB for the quarter ended
June 30, 1997).
<PAGE>
10(aq) Form of Endorsement No. 1, effective July 1, 1997, to the Guaranty
Agreement provided by Skandia America Reinsurance Corporation in
favor of State & County Mutual Fire Insurance Company, effective
July 1, 1996 (incorporated by reference to Exhibit 10(c) to the
registrant's Quarterly Report on Form 10-QSB for the quarter ended
June 30, 1997).
10(ar) Form of Endorsement No. 1, effective July 1, 1997, to the Guaranty
Agreement provided by Dorinco Reinsurance Corporation in favor of
State & County Mutual Fire Insurance Company, effective July 1, 1996
(incorporated by reference to Exhibit 10(d) to the registrant's
Quarterly Report on Form 10-QSB for the quarter ended June 30, 1997).
10(as) Form of Endorsement No. 1 - Termination, effective January 1, 1997,
to the Quota Share Retrocession Agreement between American Hallmark
Insurance Company of Texas and the Reinsurers (Dorinco Reinsurance
Company and Odyssey Reinsurance Corporation), effective July 1, 1996
(incorporated by reference to Exhibit 10(e) to the registrant's
Quarterly Report on Form 10-QSB for the quarter ended June 30, 1997).
10(at) Form of Quota Share Retrocession Agreement between American
Hallmark Insurance Company of Texas and Dorinco Reinsurance
Company, effective January 1, 1997 (incorporated by reference to
Exhibit 10(f) to the registrant's Quarterly Report on Form 10-QSB
for the quarter ended June 30, 1997).
10(au) Form of Endorsement No. 1, effective January 1, 1997, to the
Quota Share Retrocession Agreement between American Hallmark
Insurance Company of Texas and Dorinco Reinsurance Company,
effective January 1, 1997 (incorporated by reference to Exhibit
10(g) to the registrant's Quarterly Report on Form 10-QSB for the
quarter ended June 30, 1997).
10(av) Form of Endorsement No. 1, effective July 1, 1997, to the Quota
Share Retrocession Agreement between American Hallmark Insurance
Company of Texas and the Reinsurer (Dorinco Reinsurance Company),
effective July 1, 1996 (incorporated by reference to Exhibit 10(h)
to the registrant's Quarterly Report on Form 10-QSB for the quarter
ended June 30, 1997).
10(aw) Form of First Amendment to Loan Agreement between Hallmark
Finance Corporation and NationsBank of Texas, N.A., dated July 31,
1997 (incorporated by reference to Exhibit 10(a) to the
registrant s Quarterly Report on Form 10-QSB for the quarter ended
September 30, 1997).
10(ax) Form of Second Amendment to Loan Agreement between Hallmark
Finance Corporation and NationsBank of Texas, N.A., dated October 1,
1997 (incorporated by reference to Exhibit 10(b) to the
registrant's Quarterly Report on Form 10-QSB for the quarter ended
September 30, 1997).
10(ay) Automobile Physical Damage Catastrophe Excess of Loss Reinsurance
Agreement effective July 1, 1997 between American Hallmark Insurance
Company and Kemper Reinsurance Company (incorporated by reference
to Exhibit 10(bf) to the registrant's Annual Report on Form 10-KSB
for the fiscal year ended December 31, 1997).
<PAGE>
10(az) Endorsement No. 1, effective July 1, 1997, to the Quota Share
Retrocession Agreement between American Hallmark Insurance Company
of Texas and Kemper Reinsurance Company, effective July 1, 1996
(incorporated by reference to Exhibit 10(bg) to the registrant's
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1997).
10(ba) Endorsement No. 2, effective January 1, 1997, to the Quota Share
Retrocession Agreement between American Hallmark Insurance Company
of Texas and Dorinco Reinsurance Company, effective January 1, 1997
(incorporated by reference to Exhibit 10(bh) to the registrant's
Annual Report on Form 10-KSB for the fiscal year ended December 31,
1997).
10(bb) Endorsement No. 1, effective January 1, 1997, to the 100% Quota
Share Reinsurance Agreement between State & County Mutual Fire
Insurance Company, Vaughn General Agency, Inc. and American
Hallmark General Agency, Inc. (incorporated by reference to Exhibit
10(bi) to the registrant's Annual Report on Form 10-KSB for the
fiscal year ended December 31, 1997).
10(bc) Form of Endorsement No. 2, effective July 1, 1997, to the 100%
Quota Share Reinsurance Agreement between State & County Mutual
Fire Insurance Company, Vaughn General Agency, Inc., American
Hallmark General Agency, Inc. and the Reinsurers (Dorinco
Reinsurance Company and Kemper Reinsurance Company) effective
July 1, 1997 (incorporated by reference to Exhibit 10(bj) to the
registrant's Annual Report on Form 10-KSB for the fiscal year
ended December 31, 1997).
10(bd) Form of Third Amendment to Loan Agreement between Hallmark
Finance Corporation and NationsBank of Texas, N.A., dated
October 1, 1997 (incorporated by reference to Exhibit 10(a)
to the registrant's Quarterly Report on Form 10-QSB for the
quarter ended September 30, 1998).
10(be) Form of Fourth Amendment to Loan Agreement between Hallmark
Finance Corporation and NationsBank of Texas, N.A., dated
October 1, 1997 (incorporated by reference to Exhibit 10(b)
to the registrant's Quarterly Report on Form 10-QSB for the
quarter ended September 30, 1998).
10(bf) Form of Fifth Amendment to Loan Agreement between Hallmark
Finance Corporation and NationsBank of Texas, N.A., dated
October 1, 1997.
10(bg) Form of Amendment No. 1 to the Loan Agreement dated March 11,
1997, between Hallmark Financial Services, Inc. and Dorinco
Reinsurance Company.
10(bh) Form of Retrocession Agreement effective March 1, 1998,
between American Hallmark Insurance Company of Texas, Dorinco
Reinsurance Company and Associated General Agency, Inc.
10(bi) Form of Retrocession Agreement effective June 1, 1998,
between American Hallmark Insurance Company of Texas, Dorinco
Reinsurance Company and Harold Loving, d/b/a Texas Insurance
Facilities.
<PAGE>
10(bj) Form of Quota Share Retrocession Agreement effective
September 1, 1998, between American Hallmark Insurance Company
of Texas, Dorinco Reinsurance Company and Van Wagoner Companies,
Inc.
22 List of subsidiaries of the registrant (incorporated by reference
to Exhibit 22 to the registrant's Annual Report on Form 10-KSB for
the fiscal year ended December 31, 1991).
28 Schedule P of American Hallmark Insurance Company of Texas as
filed with the Texas Department of Insurance for the year ended
December 31, 1998.
<PAGE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page Number
Report of Independent Accountants F-2
Consolidated Balance Sheets at
December 31, 1998 and 1997 F-3
Consolidated Statements of Operations F-3
for the Years Ended December 31, 1998
and 1997
Consolidated Statements of Stockholders' F-5
Equity for the Years Ended December 31,
1998 and 1997
Consolidated Statements of Cash Flows for the Years F-6
Ended December 31, 1998 and 1997
Notes to Consolidated Financial Statements F-7
<PAGE>
Report of Independent Accountants
To the Board of Directors
Hallmark Financial Services, Inc.:
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, stockholders equity, and
cash flows, present fairly, in all material respects, the financial
position of Hallmark Financial Services, Inc. and Subsidiaries (the
"Company") at December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the two years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the
Company s management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
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, assessing the
accounting principles used and significant estimates made by managment, and
evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Dallas, Texas
March 26, 1999
<PAGE>
<TABLE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1998 and 1997
ASSETS 1998 1997
<S> <C> <C>
Investments:
Debt securities, held-to-maturity,
at amortized cost $ 4,444,606 $ 4,966,141
Equity securities, available-for-sale,
at market value 151,375 152,359
Short-term investments, at cost
which approximates market value 3,256,879 2,970,838
Total investments 7,852,860 8,089,338
Cash and cash equivalents 6,776,274 5,814,127
Restricted cash 1,768,927 1,340,937
Prepaid reinsurance premiums 5,110,204 8,414,250
Premium finance notes receivable 5,287,945 7,878,758
(net of allowance for doubtful accounts
of $52,119 in 1998 and $83,788 in 1997)
Premiums receivable 1,048,689 844,140
Note receivable - 1,149,280
Reinsurance recoverable 13,900,496 16,549,352
Deferred policy acquisition costs 2,088,902 3,143,378
Excess of cost over net assets acquired
(net of accumulated amortization of
$1,328,065 in 1998 and $1,171,050
in 1997) 4,902,149 5,059,164
Current federal income tax recoverable 150,031 639,216
Deferred federal income taxes 43,636 72,615
Accrued investment income 68,042 42,780
Other assets 622,798 788,232
$ 49,620,953 $ 59,825,567
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Notes payable $ 7,098,383 $ 8,157,297
Unpaid losses and loss adjustment
expenses 16,014,569 17,732,289
Unearned premiums 7,733,624 11,603,482
Reinsurance balances payable 2,097,564 2,960,040
Deferred ceding commissions 1,349,142 2,256,669
Drafts outstanding 739,817 721,413
Accrued ceding commission refund 744,686 1,623,395
Accounts payable and other accrued
expenses 1,958,920 2,949,724
Accrued litigation costs 950,000 950,000
Total liabilities 38,686,705 48,954,309
Commitments and contingencies (Note 12)
<PAGE>
Stockholders' equity:
Common stock, $.03 par value, authorized
100,000,000 shares; issued 11,854,610
shares in 1998 and 10,962,277 shares
in 1997 355,638 328,868
Capital in excess of par value 10,875,212 10,349,665
Retained earnings 755,994 802,580
Accumulated other comprehensive income (9,429) (9,855)
Treasury stock, 806,477 shares in 1998
and 300,000 shares in 1997, at cost ( 1,043,167) (600,000)
Total stockholders' equity 10,934,248 10,871,258
$ 49,620,953 $ 59,825,567
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
<PAGE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
for the years ended December 31, 1998 and 1997
<TABLE>
1998 1997
<S> <C> <C>
Gross premiums written $ 32,477,325 $ 40,457,427
Ceded premiums written (20,956,533 (28,035,956)
Net premiums written $ 11,520,792 $ 12,421,471
Revenues:
Gross premiums earned $ 36,347,183 $ 40,164,195
Ceded premiums earned (24,260,579) (28,101,962)
Net premiums earned 12,086,604 12,062,233
Investment income, net of expenses 778,932 788,155
Finance charges 1,658,226 849,231
Interest income - note receivable 14,047 374,305
Processing and service fees 1,611,510 1,310,986
Other income 438,231 442,195
Total revenues 16,587,550 15,827,105
Benefits, losses and expenses:
Losses and loss adjustment expenses 25,568,892 27,994,391
Reinsurance recoveries (17,442,185) (20,380,355)
Net losses and loss adjustment
expenses 8,126,707 7,614,036
Acquisition costs, net 146,854 (718,409)
Other acquisition and underwriting
expenses 5,151,527 6,387,451
Operating expenses 2,510,813 1,664,405
Interest expense 745,573 570,213
Amortization of intangible assets 183,765 237,264
Litigation cost - 950,000
Restructuring costs (171,673) 315,000
Total benefits, losses and expenses 16,693,566 17,019,960
Loss from operations before federal
income taxes (106,016) (1,192,855)
Federal income tax benefit (59,430) (360,533)
Operating loss before extraordinary item (46,586) (832,322)
Extraordinary item, net of tax effects - 292,071
Net loss $ (46,586) $ (540,251)
Basic and diluted earnings per share
Operating loss $ - $ (0.08)
Extraordinary item - 0.03
Net loss $ - $ (0.05)
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
<PAGE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
for the years ended December 31, 1998 and 1997
<TABLE>
Accumulated
Common Stock Capital Other Total
Number in Comprehen- Stock-
of Par Excess of Retained sive Treas. holders Comp.
Shares Value Par Value Earnings Income Stock Equity Loss
($) ($) ($) ($) ($) ($) ($)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Bal.
at
12/31/
96 10,962,277 328,868 10,349,665 1,342,831 (9,780) (600,000) 11,411,584
Compre-
hensive
Loss
Net loss (540,251) (540,251)(540,251)
Other
compre-
hensive
loss,
net of
tax
Unrealized
losses on
securities,
net of tax
of ($38) (75) (75) (75)
Comprehensive
Loss (540,326)
Bal. at
12/31/
97 10,962,277 328,868 10,349,665 802,580 (9,855) (600,000) 10,871,258
Compre-
hensive
Loss
Net loss (46,586) (46,586) (46,586)
Other
compre-
hensive
income,
net of tax
Unrealized
gains
on
securities,
net of tax
of $219 426 426 426
<PAGE>
Comprehensive Loss ($46,160)
Issuance
of
common
stock 6,000 180 1,970 2,150
Exercise
of
outstand-
ing
stock
war-
rants 886,333 26,590 416,577 443,167
Purchase of
treasury
stock (443,167)(443,167)
Expiration
of stock
warrants 107,000 107,000
Bal. at
12/31/98:
11,854,610 355,638 10,875,212 755,994 (9,429) (1,043,167) 10,934,248
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements.
<PAGE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 1998 and 1997
<TABLE>
1998 1997
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (46,586) $ (540,251)
Adjustments to reconcile net loss
to cash provided by (used in)
operating activities: Depreciation
and amortization expense 369,331 424,704
Extraordinary item - (380,187)
Change in deferred Federal income taxes 28,979 263,179
Change in prepaid reinsurance premiums 3,304,046 66,007
Change in premiums receivable (204,549) 1,680,798
Change in deferred policy acquisition
costs 1,054,476 (606,814)
Change in deferred ceding commissions (907,527) (111,595)
Change in unpaid losses and loss
adjustment expenses (1,717,720) (3,099,104)
Change in unearned premiums (3,869,858) 293,232
Change in reinsurance recoverable 2,648,856 3,508,710
Change in reinsurance balances payable (862,476) 14,006
Change in current federal income tax
recoverable 489,185 (476,942)
Change in accrued ceding commission
refund (878,709) 1,211,584
Change in accrued litigation costs - 950,000
Change in all other liabilities (865,400) (227,861)
Change in all other assets 815 73,599
Net cash provided by (used in)
operating activities (1,457,137) 3,043,065
Cash flows from investing activities:
Purchases of property and equipment (72,531) (59,771)
Premium finance notes originated (24,079,880) (13,127,658)
Premium finance notes repaid 26,670,692 5,248,900
Purchase of note receivable - (6,513,156)
Repayment of note receivable 1,149,280 5,363,876
Change in restricted cash (427,990) (1,340,937)
Purchases of debt securities (974,913) (2,041,979)
Maturities and redemptions of
investment securities 1,497,432 2,235,862
Purchase of short-term investments (12,797,720) (8,988,673)
Maturities of short-term investments 12,511,679 9,397,894
Net cash provided by (used in)
investing activities 3,476,049 (9,825,642)
Cash flows from financing activities:
Issuance of common stock 2,150 -
Proceeds from notes payable 750,000 8,000,000
Repayment of short-term borrowings (1,808,915) (53,368)
Payment of borrowing cost - (99,316)
Cash (used in) provided by
financing activities (1,056,765) 7,847,316
<PAGE>
Increase in cash and cash equivalents 962,147 1,064,739
Cash and cash equivalents at
beginning of year 5,814,127 4,749,388
Cash and cash equivalents at
end of year $ 6,776,274 $ 5,814,127
Supplemental cash flow information:
Interest paid $ 704,021 $ 518,144
Income taxes paid $ 100,000 $ 200,000
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
<PAGE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Accounting Policies:
General
Hallmark Financial Services, Inc. ("HFS") and its subsidiaries
(collectively, the "Company"), are engaged primarily in the marketing,
underwriting and premium financing of non-standard automobile insurance, as
well as claims adjusting and other insurance related services. The Company
pursues its business activities through an integrated insurance group
(collectively, the "Insurance Group"), the members of which are an
authorized Texas 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 premium finance company, Hallmark Finance Corporation
("HFC"); a claims handling and adjusting firm, Hallmark Claims Service,
Inc. ("HCS"); and from April 1996 until December 31, 1997, a comercial
excess and surplus lines affiliated managing general agency, Hallmark
Underwriters, Inc. ("HUI"). The Company operates only in Texas.
Principles of Consolidation
The accompanying consolidated financial statements include the
accounts and operations of HFS and its wholly-owned subsidiaries.
Intercompany accounts and transactions have been eliminated.
Basis of Presentation
The accompanying consolidated financial statements have been prepared
in conformity with generally accepted accounting principles which, as to
Hallmark, differ from statutory accounting practices prescribed or
permitted for insurance companies by insurance regulatory authorities.
Investments
Debt securities are reported at amortized cost. The Company has the
intent and ability to hold all investments in debt securities to maturity.
Provisions for possible losses are recorded only on other-than-temporary
declines in the value of an investment.
Equity securities available-for-sale are reported at market value.
Unrealized gains and losses are recorded as a component of stockholder's
equity.
Short-term investments are carried at cost which approximates market.
Short-term investments include U.S. Government securities maturing within
one year.
Realized investment gains and losses are recognized in operations on
the specific identification method.
<PAGE>
Recognition of Premium Revenues
Insurance premiums are earned pro rata over the terms of the
policies. Effective late-July 1998, the Company changed its recognition of
policy fees on annual policies from a fully-earned policy fee at the time
of issuance to a pro rata earned policy fee over the term of the policy to
reflect changed contractual terms. Upon cancellation, any unearned premium
and policy fee is refunded to the insurer. Prior to the change in July
1998, policy fees were fully-earned and not refunded to the insurer.
Insurance premiums written include gross policy fees of $3,559,557 and
$4,054,879 and policy fees, net of reinsurance, of $2,285,286 and
$2,567,924 for the years ended December 31, 1998 and 1997, respectively.
Finance Charges
The majority of Hallmark's annual insurance premiums are financed
through the Company's premium finance program offered by its wholly-owned
subsidiary, HFC. Finance charges on the premium finance notes are recorded
as interest earned. This interest is earned on the Rule of 78's method
which approximates the interest method for such short-term notes. Under a
discontinued servicing and financing arrangement with an unaffiliated
company, during 1997 HFC received a processing fee which was paid and
recognized on an earned basis.
Cash Equivalents
The Company considers all highly liquid investments with a maturity
of three months or less when purchased to be cash equivalents.
Property and Equipment
Property and equipment, aggregating $1,281,231 and $1,155,112, at
December 31, 1998 and 1997, respectively, included in other assets, is
recorded at cost and is depreciated using the straight-line method over the
estimated useful lives of the assets (five to ten years). Depreciation
expense for 1998 and 1997 was $141,636 and $135,371, respectively.
Accumulated depreciation was $888,616 and $746,980 at December 31, 1998 and
1997, respectively.
Premium Finance Notes Receivable
Premium finance notes receivable is composed of notes receivable from
insureds for premiums on annual and six-month policies produced by AHGA and
financed by HFC.
Premiums Receivable
The majority of the balance in premiums receivable is premiums due to
Hallmark on unaffiliated MGA business assumed from Dorinco. (See Note 4.)
Deferred Policy Acquisition Costs
Policy acquisition costs (mainly commissions, underwriting and
marketing expenses) that vary with, and are primarily related to, the
production of new and renewal business, are deferred and charged to
operations over periods in which the related premiums are earned. The
method followed in computing deferred acquisition costs limits the amount
of such deferred costs to their estimated realizable value. In determining
<PAGE>
estimated realizable value, the computation gives effect to the premium to
be earned, related investment income, losses and loss expenses and certain
other costs expected to be incurred as the premiums are earned. Ceding
commissions from reinsurers, which include expense allowances, are deferred
and recognized over the period premiums are earned for the underlying
policies reinsured. The change in deferred ceding commission income is
netted against the change in deferred acquisition costs.
Losses and Loss Adjustment Expenses
Losses and loss adjustment expenses represent the estimated ultimate
net cost of all reported and unreported losses incurred through December
31, 1998 and 1997. The liabilities for unpaid losses and loss adjustment
expenses are estimated using individual case-basis valuations and
statistical analyses.
These estimates are subject to the effects of trends in loss severity
and frequency. Although considerable variability is inherent in such
estimates, management believes that the liabilities for unpaid losses and
loss adjustment expenses are adequate. The estimates are continually
reviewed and adjusted as necessary as experience develops or new
information becomes known; such adjustments are included in current
operations. The liabilities for unpaid losses and loss adjustment expenses
at December 31, 1998 and 1997, are reported net of recoverables for salvage
and subrogation of approximately $122,000 and $193,000, respectively.
Reinsurance
Hallmark is routinely involved in reinsurance transactions with other
companies. 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. (See
Note 4 for further discussion.)
Income Taxes
The Company files a consolidated federal income tax return. Deferred
federal income taxes reflect the future tax consequences of differences
between the tax bases of assets and liabilities and their financial
reporting amounts at each year end. Deferred taxes are recognized using
the liability method, whereby tax rates are applied to cumulative temporary
differences based on when and how they are expected to affect the tax
return. Deferred tax assets and liabilities are adjusted for tax rate
changes.
Net Income Per Share
The computation of net income per share is based upon the weighted
average number of common shares outstanding during the period, plus (in
periods in which they have a dilutive effect) the effect of common shares
potentially issuable, primarily from stock options and exercise of
warrants. (See Notes 7 and 9.)
Intangible Assets
When Hallmark, AHGA, HFC, and HCS were purchased by HFS, the excess
cost over the fair value of the net assets acquired was recorded as
goodwill and is being amortized on a straight-line basis over forty years.
<PAGE>
Other intangible assets consist of a trade name, a managing general agent's
license, and non-compete arrangements all of which were fully amortized at
December 31, 1998.
The Company continually reevaluates the propriety of the carrying
amount of goodwill and other intangibles as well as the amortization period
to determine whether current events and circumstances warrant adjustments
to the carrying value and/or revised estimates of useful lives. At this
time, the Company believes that no significant impairment of the goodwill
has occurred and that no reduction of the estimated useful life is
warranted.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at
the date(s) of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could
differ from those estimates.
Fair Value of Financial Instruments
Cash and Short-term Investments: The carrying amounts reported in
the balance sheet for these instruments approximate their fair values.
Investment Securities: Fair values are obtained from an independent
pricing service. (See Note 2.)
Premium Finance Notes Receivable: The carrying amounts reported in
the balance sheet for these instruments approximate their fair values as
the terms of the receivables are one year or less.
Notes Payable: The carrying amounts reported in the balance sheet for
these instruments approximate their fair values. (See Note 5.)
Stock-based Compensation
The Company recognizes its compensation expense for grants of stock,
stock options, and other equity instruments in accordance with Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees
("APB 25"). (See Note 9.)
Recently Adopted Accounting Pronouncement
The Company has adopted SFAS No. 130, Reporting Comprehensive Income.
SFAS No. 130 requires that all items that are required to be recognized
under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same
prominence as other financial statements. The Company has disclosed
comprehensive income in the Consolidated Statements of Stockholder's
Equity.
New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard, 131, "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS 131"). This
<PAGE>
statement specifies revised guidelines for determination of an entity's
operating segments and the type and level of financial information to be
disclosed. SFAS 131 is effective for periods ending after December 15,
1997, including interim periods. The Company s adoption of SFAS 131 has
not had any impact on its current financial reporting practices as the
Company considers its operations to be one segment.
Reclassification
Certain previously reported 1997 amounts have been reclassified to
conform to current year presentation. Such reclassification had no effect
on net income or stockholder s equity.
2. Investments:
Major categories of net investment income are summarized as follows:
<TABLE>
Years ended December 31,
1998 1997
<S> <C> <C>
Debt securities $ 285,281 $ 287,766
Equity securities 8,588 10,791
Short-term investments 288,585 288,678
Cash equivalents 190,492 180,117
Other 6,706 22,032
779,652 789,384
Investment expenses (720) (1,229)
Net investment income $ 778,932 $ 788,155
</TABLE>
No investment in any entity or its affiliates exceeded 10% of stockholders'
equity at December 31, 1998 and 1997, respectively.
The amortized cost and estimated market value of investments in debt and
equity securities by category is as follows:
<PAGE>
<TABLE>
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
At December 31, 1998
<S> <C> <C> <C> <C>
U.S. Treasury securities
and obligations of U.S.
government corporations
and agencies $3,248,987 $ 18,014 ($ 1,710) $3,265,291
Mortgage Backed
Securities 1,120,630 14,885 ( 2,034) 1,133,480
Obligations of state
and local governments 74,989 948 - 75,938
Total debt securities 4,444,606 33,847 ( 3,744) 4,474,709
Equity securities 165,661 - (14,286) 151,375
Total debt and
equity securities $4,610,267 $ 33,847 ($18,030) $4,626,084
At December 31, 1997
U.S. Treasury securities
and obligations of U.S.
government corporations
and agencies $3,131,395 $ 13,892 ($ 6,543) $3,138,744
Mortgage Backed
Securities 1,759,784 28,512 (14,968) 1,773,328
Obligations of state
and local governments 74,962 3,205 - 78,167
Total debt securities 4,966,141 45,609 (21,511) $4,990,239
Equity securities 167,290 - (14,931) 152,359
Total debt and
equity securities $5,133,431 $ 45,609 ($36,442) $5,142,598
</TABLE>
The amortized cost and estimated market value of debt securities at
December 31, 1998, by contractual maturity, are as follows. Expected
maturities may differ from contractual maturities because certain borrowers
may have the right to call or prepay obligations with or without penalties.
<TABLE>
Amortized Market
Maturity Cost Value
<S> <C> <C>
Due in one year or less $2,042,912 $2,048,950
Due in one year through five years 1,029,413 1,028,540
Due after five years through ten years 74,989 75,938
Due after ten years 176,662 187,801
Mortgage backed securities 1,120,630 1,133,480
$4,444,606 $4,474,709
</TABLE>
<PAGE>
At December 31, 1998 and 1997, investments in debt securities, with
an approximate carrying value of $100,000 were on deposit with the Texas
Department of Insurance (the "TDI") as required by insurance regulations.
Proceeds from investment securities of $1,497,432 and $2,235,862
during 1998 and 1997, respectively, were primarily from maturities, bond
calls and prepayments of mortgage-backed securities.
3. Liability for Unpaid Losses and Loss Adjustment Expenses:
Activity in the liability for unpaid losses and loss adjustment
expenses (in thousands) is summarized as follows:
<TABLE>
1998 1997
(S> <C> <C>
Balance at January 1 $ 17,732 $ 20,831
Less reinsurance recoverables 13,064 15,735
Net Balance at January 1 4,668 5,096
Incurred related to:
Current year 8,130 7,568
Prior years 317 738
Total incurred 8,447 8,306
Paid related to:
Current year 5,209 4,408
Prior years 3,326 4,326
Total paid 8,535 8,734
Net Balance at December 31 4,580 4,668
Plus reinsurance recoverables 11,435 13,064
Balance at December 31 $ 16,015 $ 17,732
</TABLE>
4. Reinsurance:
Hallmark is involved in the assumption and cession of reinsurance
from/to other companies. The Company remains obligated to its
policyholders in the event that the reinsurers do not meet their
obligations under the reinsurance agreements.
Effective March 1, 1992, Hallmark entered into a reinsurance
arrangement with State & County Mutual Fire Insurance Company ("State &
County"), an unaffiliated company, to assume 100% of the nonstandard auto
business produced by AHGA and underwritten by State & County. The earned
premiums assumed under this agreement in 1998 and 1997 were $34,010,499 and
$39,541,555, respectively. Funds generated from business produced under
this agreement are maintained in accounts for the benefit of State &
County. At December 31, 1998 and 1997, Hallmark held for the benefit of
State & County, cash and cash equivalents of $2,727,611 and $2,855,841,
respectively, and investment securities at amortized cost of $6,447,083 and
$6,145,413, respectively.
<PAGE>
The arrangement is supplemented by a separate retrocession agreement
effective July 1, 1997 between Hallmark, Kemper Reinsurance Company
("Kemper") and Dorinco Reinsurance Company ("Dorinco"). From July 1, 1996
to June 30, 1997, Hallmark supplemented this arrangement with a separate
retrocession agreement with Kemper, Dorinco and Odyssey Reinsurance
Corporation ("Odyssey"). Prior to July 1, 1996, Hallmark had a separate
retrocession agreement with Vesta Fire Insurance Corporation ("Vesta").
Under each of the agreements, Hallmark retains 25% and cedes 75% of the
risk to the reinsurers.
Under the retrocession agreement with Kemper and Dorinco, Hallmark
receives a provisional ceding commission of 30%. This provisional
commission is 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 maximum commissions of 33.5% and 34.5%, respectively, and
is guaranteed minimum commissions of 28% and 25%, respectively, regardless
of loss experience on business reinsured by Kemper and Dorinco. Under a
July 1, 1997 renewal, the first annual settlement of the provisional
commission was extended to two years (with the exception of the percentage
reinsured by Odyssey). As of December 31, 1998 and 1997, the accrued
ceding commission refund was $744,686 and $1,623,395, respectively. This
accrual represents the difference between the ceding commission received
and the ceding commission earned based on current loss ratios. The first
settlement of the provisional commission between Hallmark and Kemper and
Dorinco was made in August 1998. Hallmark paid return commission of
approximately $1.8 million.
Effective July 1, 1997, Hallmark renewed its Excess of Loss
Reinsurance Agreement with Kemper whereby Kemper reinsures Hallmark for
physical damage catastrophe losses in excess of 95% of the ultimate net
loss over and above an initial ultimate net loss of $100,000 on each and
every loss occurrence, subject to a limit of liability to Kemper of
$142,500 on each and every loss occurrence. Prior to July 1996, Hallmark's
catastrophic occurrences were reinsured under an agreement with Vesta.
There were no catastrophic losses during 1998 and 1997.
Hallmark assumes business from Dorinco on various unaffiliated MGA
programs. Under these programs, HCS also provides claims processing, and
AHGA provides premium processing. At December 31, 1998 and 1997, Dorinco
held cash of $451,470 and $76,979, respectively, to secure balances ceded
to Hallmark. These amounts were included in restricted cash in the
accompanying Consolidated Balance Sheets.
5. Notes Payable:
A summary of the Company's notes payable is as follows:
<TABLE>
December 31,
1998 1997
<S> <C> <C>
Note payable to unaffiliated insurance
company $7,000,000 $7,000,000
Funds drawn on bank credit line - 1,000,000
Note payable to individual 98,383 157,297
Total $7,098,383 $8,157,297
</TABLE>
<PAGE>
Scheduled annual principal payments on the foregoing borrowings are
as follows:
Year
1999 $ 531,734
2000 1,433,303
2001 1,400,004
2002 1,400,004
2003 1,400,004
2004 933,334
Total $ 7,098,383
Effective March 11, 1997, the Company entered into a loan agreement
with Dorinco, whereby the Company borrowed $7,000,000 (the "Dorinco Loan")
to contribute to HFC. Proceeds from this loan have been used by HFC
primarily to fund premium finance notes. (See Note 6.) The loan agreement
provides for a seven-year term at a fixed interest rate of 8.25%. Interest
only is payable monthly through August 31, 1999, with principal and
interest payments commencing September 30, 1999 and continuing through
September 30, 2004. A penalty ranging from $80,000 to $120,000 is charged
for prepaying the loan prior to the fourth anniversary date except that,
after the second anniversary date, up to 40% of the outstanding balance may
be prepaid without penalty.
As long as certain financial covenants defined as "triggering events"
are maintained, collateral for the Dorinco Loan is limited to the stock of
HFC and a covenant by the Company not to pledge the stock of Hallmark or
AHGA. To avoid a triggering event, Hallmark must (1) maintain a combined
ratio and loss ratio which do not exceed 107% and 83%, respectively; (2)
maintain statutory surplus of $4,200,000 and experience no decreases to
surplus in any one year that exceeds 15% of the prior year surplus; and (3)
cause HFC to maintain a certain interest coverage ratio and stockholders
equity levels as defined in the agreement. If a triggering event should
occur, the Company has ten days to pledge the stock of AHGA and Hallmark as
additional collateral for the Dorinco Loan. The loan agreement also
contains covenants which require the Company to satisfy certain financial
ratios which are less restrictive than the triggering event ratios and,
among other things, restrict capital expenditures, payment of dividends,
and incurrence of additional debt. For the years ended December 31, 1998
and 1997, the Company was in compliance with the covenants of the loan. To
remain in compliance with the covenants, the loan agreement requires that
Hallmark increase future volume of business ceded to Dorinco under its
reinsurance treaty and satisfy certain annual volume levels ceded over the
seven year term of the loan agreement.
Effective March 17, 1997, HFC entered into a loan agreement ("Bank
Credit Line") with a bank whereby the bank committed to provide a revolving
credit facility of $8,000,000 for funding of up to 60% of premium finance
notes outstanding for State & County policies. Beginning late-June 1997,
upon completion of a required 90-day cancellation notification period to
Peregrine Premium Finance L.C. ("Peregrine"), HFC commenced funding all new
notes issued by HFC with proceeds from both the Dorinco loan and the Bank
Credit Line.
The Bank Credit Line provided for an eighteen-month term which
expired September 17,1998. Upon its expiration, the Bank Credit Line was
extended to December 15, 1998, and subsequently to February 15, 1999.
During the fourth quarter of 1998, HFC repaid the outstanding balance of
<PAGE>
approximately $1.8 million. The bank credit line has not been renewed.
Assuming a moderate growth in premium volume, the Company intends to fund
its premium finance notes with internally generated funds during 1999.
The note payable to an individual is collateralized by most assets of
AHGA and requires monthly principal and interest payments of $6,000 through
May 1, 2000, with interest at 10%.
At December 31, 1996, the Company had a note payable to an
unaffiliated finance company that was in dispute prior to the Company
acquiring the Insurance Group in 1990. Based on legal advice that the note
was no longer enforceable, the Company recorded extinguishment of the note
payable balance and related accrued interest in a total amount of $442,532
during 1997. This write off, less tax effect of $150,461, is treated as an
extraordinary item on the Company s Consolidated Statements of Operations
for 1997.
6. Note Receivable:
During 1997, approximately $6,500,000 in proceeds from a $7,000,000
loan from Dorinco was used to repay external borrowing by Peregrine
incurred to fund premium finance notes pursuant to the financing and
servicing arrangement between HFC and Peregrine. The balance of this note
receivable was repaid during the second quarter of 1998.
7. Earnings per Share:
The Company has adopted the provisions of SFAS No. 128, Earnings Per
Share, requiring presentation of both basic and diluted earnings per share.
A reconciliation of the numerators and denominators of the basic and
diluted per-share computations (does not include outstanding options or
warrants as these were determined to be anti-dilutive), as required by SFAS
No. 128 is presented below:
<TABLE>
Income Shares Per-Share
(Numerator) (Denominator) Amount
<S> <C> <C> <C>
For the year ended
December 31, 1998:
Basic Earnings per Share
Income available to common
stockholders:
Operating loss ($ 46,586) 11,048,133 $ -
Extraordinary
item, net of
tax effects - - -
Net loss ($ 46,586) 11,048,133 $ -
Effect of Dilutive
Securities
Options and warrants - - -
<PAGE>
Diluted Earnings per Share
Income available to common
stockholders
+ assumed conversions:
Operating loss ($ 46,586) 11,048,133 $ -
Extraordinary item,
net of tax effects - - -
Net loss ($ 46,586) 11,048,133 $ -
For the year ended
December 31, 1997:
Basic Earnings per
Share
Income available to
common stockholders:
Operating loss ($832,322) 10,662,277 ($ 0.08)
Extraordinary item,
net of tax effects 292,071 10,662,277 0.03
Net loss ($540,251) 10,662,277 ($ 0.05)
Effect of Dilutive
Securities
Options and warrants - - -
Diluted Earnings per Share
Income available to common
stockholders + assumed
conversions:
Operating loss ($832,322) 10,662,277 ($ 0.08)
Extraordinary item,
net of tax effects 292,071 10,662,277 0.03
Net loss ($540,251) 10,662,277 ($ 0.05)
</TABLE>
8. Regulatory Capital Restrictions:
Hallmark's 1998 and 1997 net loss and stockholders' equity (capital
and surplus), as determined in accordance with statutory accounting
practices, were ($19,777) and ($76,191), and $5,399,528 and $5,287,785,
respectively. During 1998, Hallmark recorded anticipated salvage and
subrogation for accident years 1997 and 1998. In accordance with statutory
accounting principles, this change to the net method has been recorded as a
change in accounting principle. The cumulative effect on prior years of
$83,000 was reported as an increase to statutory surplus with the change
for the current year of $39,000 being included in statutory net income for
1998. During 1997, Hallmark obtained from the TDI a permitted practice
exception allowing Hallmark to limit the policy fees included in the excess
statutory over statement reserves computation to the extent that related
underwriting risk is retained. This exception differs from prescribed
accounting practices in that Hallmark was able to exclude 37.5% of fully
earned policy fees from the calculation. This permitted practice exception
resulted in excess statutory over statement reserves of $334,560 instead of
$1,353,090 as calculated per prescribed accounting practices. No permitted
practice exception was needed for 1998. The minimum statutory capital and
surplus required for Hallmark by the TDI is $2,000,000. Texas state law
limits the payment of dividends to stockholders by property and casualty
insurance companies. The maximum dividend that may be paid without prior
approval of the Commissioner of Insurance is limited to the greater of 10%
<PAGE>
of statutory surplus as regards policyholders as of the preceding calendar
year end or the statutory net income of the preceding calendar year. No
dividends were declared or paid by Hallmark in 1998 or 1997.
9. Stock Option Plans:
The Company has two stock option plans for key employees, the 1991
Key Employee Stock Option Plan and the 1994 Key Employee Long Term
Incentive Plan, and a non-qualified plan for non-employee directors. The
number of shares reserved for future issuance under the 1991 employee plan,
the 1994 employee plan and the non-employee director plan is 500,000,
1,500,000 and 1,350,000, respectively. The option prices under the plans
are not to be less than the closing price of the common stock on the day
preceding the grant date. Pursuant to the stock option plans, the Company
has granted incentive stock options under Section 422 of the Internal
Revenue Code of 1986. The stock options granted to employees vest over a 3
year period on a graded schedule, 40% in the first 6 months and 20% on each
anniversary date of the grant date. The stock options granted to the
directors vest over a 6 year period on a graded schedule, 40% in the first
6 months and 10% on each anniversary date of the grant date. In accordance
with APB 25, the Company has not recognized compensation expense for the
stock options granted in 1998 and 1997.
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 was assigned to
these warrants. The Guaranty Warrants were fully exercisable between
October 2, 1992 and October 1, 1996, at which time they would have expired
to the extent not exercised. On March 28, 1996, the Board of Directors
extended the exercisability of the Guaranty Warrants through October 1,
1998. On October 1, 1998, the Guaranty Warrants were exercised to purchase
an aggregate of 886,333 shares of the Company s common stock. In payment
of the exercise price of $0.50 per share, 506,476 outstanding shares were
surrendered at a price of $0.875 per share, and subsequently recorded as
treasury stock by the Company.
Pursuant to SFAS No. 123, Accounting for Stock-based Compensation, a
company may elect to continue expense recognition under APB 25, or to
recognize compensation expense for grants of stock, stock options, and
other equity instruments to employees based on fair value methodology
outlined in SFAS No. 123. The Company has elected to continue expense
recognition pursuant to APB 25.
A summary of the status of the Company s stock options and warrants
as of December 31, 1998 and December 31, 1997 and the changes during the
years ended on those dates is presented below:
<PAGE>
<TABLE>
1998 1997
Number Number
of Shares of Weighted of Shares of Weighted
Underlying Average Underlying Average
Options and Exercise Options and Exercise
Warrants Prices Warrants Prices
<S> <C> <C> <C> <C>
Outstanding at begin-
ning of the year 2,857,333 $ .52 2,846,333 $ .53
Granted at the money - - 16,000 .75
Total Granted - - 16,000 $ .75
Exercised (892,333) $ .499 - -
Forfeited ( 1,000) $ 1.188 - -
Expired (124,000) $ .497 (5,000) $ .375
Outstanding at end
of year 1,840,000 $ .535 2,857,333 $ .52
Exercisable at end
of year 1,546,100 $ .494 2,460,733 $ .49
</TABLE>
<TABLE>
1998 1997
<S> <C> <C>
Weighted-average FV
of options
granted at the money $ - $ .55
Weighted-average FV
of all options
granted during the year $ - $ .55
</TABLE>
The fair value of each stock option granted is estimated on the date
of grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions for grants in 1997: no dividend yield; risk-
free interest rates are different for each grant and range from 5.54% to
7.82%; the expected life of options is 5 years for 1997; and volatility of
92% for 1997 for all grants. There were no options granted in 1998.
The following table summarizes information about stock options
outstanding at December 31, 1998:
<TABLE>
Options Outstanding Options Exercisable
Weighted
Avg. Weighted Weighted
Range of Remaining Avg. Exercis- Avg.
Exercise Outstanding Contr. Actual Exercise able at Exercise
Prices At 12/31/98 Life Price 12/31/98 Price
<C> <C> <C> <C> <C> <C>
$.25 to
$.70 1,474,000 5.50 $ .42 1,326,500 $ .41
$.71 to
$1.188 366,000 7.07 $ .99 219,600 $ .99
$.25 to
$1.188 1,840,000 5.81 $ .54 1,546,100 $ .49
</TABLE>
<PAGE>
The pro forma effects on net income and earnings per share for 1998
and 1997 from compensation expense computed pursuant to SFAS No. 123 is as
follows:
<TABLE>
December 31, 1998 December 31, 1997
As Reported Pro Forma As Reported Pro Forma
<S> <C> <C> <C> <C>
SFAS No. 123 charge - $ 83,211 - $ 93,678
Net loss $ ( 46,586) $ (101,505) $ (540,251) $(602,078)
Net loss per common
share $ - $ (.01) $ (0.05) $ (0.06)
</TABLE>
The effects of applying SFAS No. 123 in this pro forma disclosure are
not indicative of future amounts. SFAS No. 123 does not apply to awards
prior to 1995, and the Company anticipates making awards in the future
under its stock-based compensation plan.
10. Income Taxes:
The composition of deferred tax assets and liabilities and the
related tax effects as of December 31, 1998 and 1997, are as follows:
<TABLE>
1998 1997
<S> <C> <C>
Deferred tax liabilities:
Deferred policy acquisition costs ($ 710,227) ($1,068,749)
Other ( 101,107) ( 27,903)
Total deferred tax liabilities ( 811,334) ( 1,096,652)
Deferred tax assets:
Unearned premiums 178,939 216,868
Loss reserve discounting,
net of salvage and subrogation 151,702 132,670
Deferred ceding commissions 458,709 767,267
Unrealized gains (losses) on securities 4,857 5,076
Net operating loss carry forward 33,171 33,171
Other 60,762 47,393
Total deferred tax assets 888,140 1,202,445
Net deferred tax asset 76,806 105,793
Valuation allowance 33,170 33,178
Net deferred tax asset $ 43,636 $ 72,615
</TABLE>
A valuation allowance is provided against the Company's deferred tax
asset to the extent that management does not believe it is more likely than
not that future taxable income will be adequate to realize these future tax
benefits.
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 years ended December 31, 1998 and
1997, is as follows excluding the tax effect on the extraordinary item in
1997:
<PAGE>
<TABLE>
1998 1997
<S> <C> <C>
Computed expected income tax expense
at statutory regulatory tax rate ($ 36,045) ($405,571)
Amortization of excess cost over
net assets acquired 53,385 53,385
Meals and entertainment 11,183 8,844
Adjustment to prior year s deferred taxes ( 91,088) ( 24,672)
Other 3,135 7,481
Income tax benefit ($ 59,430) ($360,533)
</TABLE>
The Company has available, for federal income tax purposes, unused
net operating losses of $97,562 at December 31, 1998, which may be used to
offset future taxable income. The net operating losses will expire, if
unused, as follows:
Year
2002 $ 1,325
2003 96,237
$ 97,562
11. Restructuring Costs:
As of December 31, 1997, the Company accrued $315,000 of
restructuring costs related to the closure of seven of its thirteen agency
offices as well as the ceasing of the operations of HUI as of December 31,
1997. During 1998 the Company restructured the American Hallmark Agencies
by closing seven of its offices and opening two new offices in early 1998
(one of which was subsequently closed in late 1998 while the other was
closed in early 1999.) The reserve, among other things, was established to
absorb ongoing obligations of closed agency locations. During 1998 these
offices were transferred to an independent agent who assumed the ongoing
obligations. The excess of the restructuring reserve over the costs
actually incurred was recorded as a reduction of expenses in 1998.
12. Commitments and Contingencies:
The Company has several leases, primarily for office facilities and
computer equipment, which expire in various years through 2002. Certain of
these leases contain renewal options. Rental expense amounted to $650,268
and $728,466 for the years ended December 31, 1998 and 1997 respectively.
Future minimum lease payments under noncancelable operating leases as
of December 31, 1998 are as follows:
Year
1999 $ 483,170
2000 388,845
2001 29,520
2002 7,440
Total minimum lease payments $ 908,975
<PAGE>
The Company has a 401(K) savings plan. Employees who have completed
three months of service are eligible to participate. Under this plan
employees may contribute a portion of their compensation, and the Company
may contribute a discretionary amount each year. The Company's
contribution for 1998 to be paid in 1999 was $28,000 and for 1997 was
$60,000.
In March 1997, a jury returned a verdict against the Company and in
favor of a former director and officer of Hallmark in the amount of
approximately $517,000 on the basis of contractual and statutory
indemnification claims. The court subsequently granted the plaintiff s
motion for attorneys fees of approximately $271,000, court costs of
approximately $39,000 and pre-judgment and post-judgment interest, and
rendered final judgment on the verdict. The Company believes the outcome
in this case was both legally and factually incorrect and has appealed the
judgment. During the fourth quarter of 1997, the Company deposited
$1,248,758 into the registry of the court in order to stay execution on the
judgment pending the result of such appeal. The amount on deposit with the
court of $1,317,456 as of December 31, 1998 has been included as restricted
cash in the accompanying balance sheet.
Although the Company intends to aggressively pursue its appeal, the
Company is presently unable to determine the likelihood of a favorable
result. Further, a favorable ruling on some portions of the appeal could
entail the necessity for a new trial. Therefore, the Company established a
reserve of $950,000 during the fourth quarter of 1997 for loss
contingencies related to this case. This reserve remains unchanged at
December 31, 1998. The possible range of loss in the event of an
ultimately unfavorable outcome to this case exceeds the amount presently
reserved. Conversely, in the event of a favorable resolution of the case,
the expenses incurred could be less than the reserve amount. Therefore,
future adjustments to the reserve may be required.
The Company is involved in various other claims and legal actions
arising in the ordinary course of business. In the opinion of management,
the ultimate disposition of these matters will not have a material adverse
effect on the Company's financial position or results of operations.
From time to time, assessments are levied on the Company by the
guaranty association of the State of Texas. Such assessments are made
primarily to cover the losses of policyholders of insolvent or
rehabilitated insurers. These assessments can be partially recovered
through a reduction in future premium taxes. There were no assessments for
1998 and 1997.
13. Concentrations of Credit Risk:
The Company maintains cash equivalents in accounts with two financial
institutions in excess of the amount insured by the Federal Deposit
Insurance Corporation.
All of the Company's business activity is with customers and
independent agents located within the State of Texas.
<PAGE>
14. Subsequent Event:
The Company announced in February 1999 the signing of a letter of
intent with Onyx Insurance Group, Inc. ("Onyx"), a diversified insurance
and financial services company, pursuant to which Onyx is expected to
acquire a majority stake in HFS in return for an approximately $8 million
equity investment. The completion of the proposed transaction is subject
to the execution of definitive agreements, shareholder and regulatory
approval and other customary conditions.
<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 and Other assets. Refer to actual 10KSB
submission.
</LEGEND>
<MULTIPLIER> 1
<CURRENCY> $
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<DEBT-HELD-FOR-SALE> 0
<DEBT-CARRYING-VALUE> 4,444,606
<DEBT-MARKET-VALUE> 3,259,879
<EQUITIES> 151,375
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 7,852,860
<CASH> 6,776,274
<RECOVER-REINSURE> 13,900,496
<DEFERRED-ACQUISITION> 739,760
<TOTAL-ASSETS> 49,620,953
<POLICY-LOSSES> 0
<UNEARNED-PREMIUMS> 7,733,624
<POLICY-OTHER> 2,097,564
<POLICY-HOLDER-FUNDS> 4,393,423
<NOTES-PAYABLE> 7,098,383
0
0
<COMMON> 355,638
<OTHER-SE> 10,578,610
<TOTAL-LIABILITY-AND-EQUITY> 49,620,953
12,086,604
<INVESTMENT-INCOME> 778,932
<INVESTMENT-GAINS> 0
<OTHER-INCOME> 3,722,014
<BENEFITS> 8,126,707
<UNDERWRITING-AMORTIZATION> 146,854
<UNDERWRITING-OTHER> 8,420,005
<INCOME-PRETAX> (106,016)
<INCOME-TAX> (59,430)
<INCOME-CONTINUING> (46,586)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (46,586)
<EPS-PRIMARY> 0.00
<EPS-DILUTED> 0.00
<RESERVE-OPEN> 17,732,289
<PROVISION-CURRENT> 24,810,079
<PROVISION-PRIOR> 473,311
<PAYMENTS-CURRENT> (13,695,688)
<PAYMENTS-PRIOR> (13,305,422)
<RESERVE-CLOSE> 16,014,569
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
FIFTH AMENDMENT TO LOAN AGREEMENT
AND GUARANTOR CONSENT
THIS FIFTH AMENDMENT TO LOAN AGREEMENT AND GUARANTOR CONSENT (the
"Fifth Amendment") is made as of December 15, 1998, among HALLMARK FINANCE
CORPORATION, referred to herein as the "Borrower," HALLMARK FINANCIAL
SERVICES, INC., HALLMARK CLAIMS SERVICE, INC., AMERICAN HALLMARK GENERAL
AGENCY, INC., ACO HOLDINGS, INC., and AMERICAN HALLMARK AGENCIES, INC.
(collectively, the "Guarantors"), and NATIONSBANK, N.A., a national banking
association previously known as NationsBank of Texas, N.A., referred to
herein as the "Lender."
R E C I T A L S:
A. The Borrower and the Lender are parties to a Loan Agreement
dated as of March 17, 1997 (the "Original Loan Agreement").
B. The Guarantors executed Guaranty Agreements in favor of the
Lender pursuant to the Original Loan Agreement.
C. The Original Loan Agreement has been amended pursuant to that
certain First Amendment to Loan Agreement and Guarantor Consent (the "First
Amendment") dated as of July 31, 1997, by that certain Second Amendment to
Loan Agreement and Guarantor Consent (the "Second Amendment") dated as of
October 1, 1997, by that certain Third Amendment to Loan Agreement and
Guarantor Consent ("Third Amendment") dated as of September 17, 1998, and
dby that certain Fourth Amendment to Loan Agreement and Guarantor Consent
dated November 1, 1998 ("Fourth Amendment") among the Borrower, the
Guarantors, and the Lender (the Original Loan Agreement, as amended by the
First Amendment, the Second Amendment, and the Third Amendment, and the
Fourth Amendment is hereinafter called the "Loan Agreement").
D. The Borrower has requested that the Expiration Date (as defined
in the Loan Agreement) of 2:00 p.m. (Dallas, Texas time) on December 15,
1998 be extended to 2:00 p.m. (Dallas, Texas time) on February 15, 1999.
The Lender is willing to amend the Loan Agreement to so extend such
maturity date on the condition that all other terms, conditions and
covenants of the Loan Agreement, as amended hereby, continue unaffected,
but such amendment shall be subject to the terms and conditions set forth
below.
E. Each of the Guarantors desires to consent to such amendment.
NOW, THEREFORE, in consideration of the premises and for other good
and valuable consideration, the receipt and sufficiency of which are hereby
acknowledged, the parties hereto agree as follows:
1. Same Terms. All terms used herein which are defined in
the Loan Agreement have the same meanings when used herein unless the
context hereof otherwise requires or provides. In addition, all references
in the Loan Documents to the "Agreement" mean the Original Loan Agreement,
as amended by the First Amendment, the Second Amendment, the Third
Amendment, and the Fourth Amendment, and this Fifth Amendment and as the
same are hereafter amended from time to time.
2. Amendment to Loan Agreement. Effective as of the date
above, the Loan Agreement is hereby amended as follows:
<PAGE>
(a) Section 1.0, Certain Definitions, is amended to
delete the definition of "Expiration Date" contained therein and
substituting in lieu thereof the following:
"Expiration Date" means 2 p.m. (Dallas, Texas time) on
February 15, 1999 or any other date on which the Loans become due and
payable pursuant to the terms of this Agreement.
3. Certain Representations. The Borrower and each of the
Guarantors, jointly and severally, represents and warrants that, as of the
date hereof:
(a) the representations and warranties contained in the
Loan Agreement as amended hereby are true and correct on and as of the date
hereof as made on and as of such date;
(b) no event has occurred and is continuing which
constitutes a Default or an Event of Default;
(c) The Borrower represents and warrants that, as of
the date hereof: (i) the Borrower has full power and authority to execute
this Fifrth Amendment, and this Fifth Amendment constitutes the legal,
valid and binding obligation of the Borrower enforceable in accordance with
its terms, except as enforceability may be limited by applicable
bankruptcy, insolvency, reorganization, moratorium, and other similar laws
affecting the enforcement of creditors' rights generally; and (ii) no
authorization, approval, consent or other action by, notice to, or filing
with, any governmental authority or other person is required for the
execution, delivery and performance by the Borrower of this Fifth
Amendment.
(d) Each Guarantor represents and warrants that, as of
the date hereof: (i) such Guarantor has full power and authority to
execute this Fifth Amendment, and this Fifth Amendment constitutes the
legal, valid and binding obligation of such Guarantor enforceable in
accordance with its terms, except as enforceability may be limited by
applicable bankruptcy, insolvency, reorganization, moratorium, and other
similar laws affecting the enforcement of creditors' rights generally; and
(ii) no authorization, approval, consent or other action by, notice to, or
filing with, any governmental authority or other person is required for the
execution, delivery and performance by such Guarantor of this Fifth
Amendment.
4. Guarantors Acknowledgment. By signing below, each of
the Guarantors: (i) acknowledges and consents to the execution, delivery
and performance of this Fourth Amendment; (ii) agrees that its obligations
in respect of its Guaranty are not released, modified, impaired or affected
in any manner by this Fifth Amendment or any of the provisions contemplated
herein; (iii) acknowledges that it has no claims or offsets against, or
defenses or counterclaims to, its Guaranty; and (iv) agrees, ratifies, and
affirms that the Renewal Promissory Note in the original principal amount
of $1,000,000 and payable by the Borrower to the Lender, upon being
executed by Borrower and delivered to Lender as required below shall be an
"Obligation" of each Guarantor under each of the respective Guarantees.
5. Conditions of Effectiveness. This Fifth Amendment shall
be effective as of the date and year first above written, subject to the
following:
<PAGE>
(a) The Lender shall have received this Fifth Amendment
executed by Borrower and each Guarantor;
(b) The Lender shall have received certificates of
incumbency and containing specimen signatures of all officers of the
Borrower and each of the Guarantors who will be authorized to execute or
attest to any of the documents contemplated hereby on behalf of the
Borrower and each of the Guarantors executed by the President and by the
Secretary of the Borrower and each of the Guarantors on the date hereof,
and such certification may be conclusively relied upon by the Lender until
the Lender receives notice in writing from the borrower and each fo the
Guarantors to the contrary and providing a substitute certificate
conforming to the requirements hereof;
(c) All of the conditions precedent set forth in
Section 4.0, Conditions Precedent to Subsequent Loans, of the Loan
Agreement shall be satisfied; and
(d) The Lender shall have received such other
documents, opinions, certifications, consents, waivers, agreements, and
evidence as the Lender may reasonably request.
6. Limitation on Agreements. The modifications set forth
herein are limited precisely as written and shall not be deemed: (a) to be
a consent under or a waiver of or an amendment to any other term or
condition in the Loan Agreement or any of the other Loan Documents; or (b)
to prejudice any right or rights which the Lender now has or may have in
the future under or in connection with the Loan Agreement and the other
Loan Documents, each as amended hereby, or any of the other documents
referred to herein or therein. This Fifth Amendment constitutes a Loan
Document for all purposes. The Loan Agreement, as amended by this Fifth
Amendment, and all of the other Loan Documents executed in connection
therewith, shall remain in full force and effect and are each hereby
ratified and confirmed.
7. ARBITRATION. ANY CONTROVERSY OR CLAIM BETWEEN OR AMONG
THE PARTIES HERETO INCLUDING BUT NOT LIMITED TO THOSE ARISING OUT OF OR
RELATING TO THIS AGREEMENT OR ANY RELATED AGREEMENTS OR INSTRUMENTS,
INCLUDING ANY CLAIM BASED ON OR ARISING FROM AN ALLEGED TORT, SHALL BE
DETERMINED BY BINDING ARBITRATION IN ACCORDANCE WITH THE FEDERAL
ARBITRATION ACT (OR IF NOT APPLICABLE, THE APPLICABLE STATE LAW). THE
RULES OF PRACTICE AND PROCEDURE FOR THE ARBITRATION OF COMMERCIAL DISPUTES
OF JUDICIAL ARBITRATION AND MEDIATION SERVICES, INC. (J.A.M.S.), AND THE
SPECIAL RULES SET FORTH BELOW. IN THE EVENT OF ANY INCONSISTENCY, THE
SPECIAL RULES SHALL CONTROL. JUDGMENT UPON ANY ARBITRATION AWARD MAY BE
ENTERED IN ANY COURT HAVING JURISDICTION. ANY PARTY TO THIS AGREEMENT MAY
BRING AN ACTION, INCLUDING A SUMMARY OR EXPEDITED PROCEEDING, TO COMPEL
ARBITRATION OF ANY CONTROVERSY OR CLAIM TO WHICH THIS AGREEMENT APPLIES IN
ANY COURT HAVING JURISDICTION OVER SUCH ACTION.
A. SPECIAL RULES. THE ARBITRATION SHALL BE CONDUCTED IN THE
CITY OF THE BORROWER'S DOMICILE AT TIME OF THIS AGREEMENT'S EXECUTION AND
ADMINISTERED BY J.A.M.S. WHO WILL APPOINT AN ARBITRATOR; IF J.A.M.S. IS
UNABLE OR LEGALLY PRECLUDED FROM ADMINISTERING THE ARBITRATION, THEN THE
AMERICAN ARBITRATION ASSOCIATION WILL SERVE. ALL ARBITRATION HEARINGS WILL
BE COMMENCED WITHIN 90 DAYS OF THE DEMAND FOR ARBITRATION; FURTHER, THE
ARBITRATOR SHALL ONLY, UPON A SHOWING OF CAUSE, BE PERMITTED TO EXTEND THE
COMMENCEMENT OF SUCH HEARING FOR UP TO AN ADDITIONAL 60 DAYS.
<PAGE>
B. RESERVATION OF RIGHTS. NOTHING IN THIS AGREEMENT SHALL
BE DEEMED TO: (I) LIMIT THE APPLICABILITY OF ANY OTHERWISE APPLICABLE
STATUTES OF LIMITATION OR REPOSE AND ANY WAIVERS CONTAINED IN THIS
AGREEMENT; OR (II) BE A WAIVER BY THE BANK OF THE PROTECTION AFFORDED TO
IT BY 12 U.S.C. SEC. 91 OR ANY SUBSTANTIALLY EQUIVALENT STATE LAW; OR (III)
LIMIT THE RIGHT OF THE BANK HERETO: (A) TO EXERCISE SELF HELP REMEDIES SUCH
AS (BUT NOT LIMITED TO) SET OFF; OR (B) TO FORECLOSE AGAINST ANY REAL OR
PERSONAL PROPERTY COLLATERAL; OR (C) TO OBTAIN FROM A COURT PROVISIONAL OR
ANCILLARY REMEDIES SUCH AS (BUT NOT LIMITED TO) INJUNCTIVE RELIEF, WRIT OF
POSSESSION OR THE APPOINTMENT OF A RECEIVER. THE BANK MAY EXERCISE SUCH
SELF HELP RIGHTS, FORECLOSE UPON SUCH PROPERTY, OR OBTAIN SUCH PROVISIONAL
OR ANCILLARY REMEDIES BEFORE, DURING OR AFTER THE PENDENCY OF ANY
ARBITRATION PROCEEDING BROUGHT PURSUANT TO THIS AGREEMENT. NEITHER THIS
EXERCISE OF SELF HELP REMEDIES NOR THE INSTITUTION OR MAINTENANCE OF AN
ACTION FOR FORECLOSURE OR PROVISIONAL OR ANCILLARY REMEDIES SHALL
CONSTITUTE A WAIVER OF THE RIGHT OF ANY PARTY, INCLUDING THE CLAIMANT IN
ANY SUCH ACTION, TO ARBITRATE THE MERITS OF THE CONTROVERSY OR CLAIM
OCCASIONING RESORT TO SUCH REMEDIES.
8. Entirety, Etc. This instrument together with all of the
other Loan Documents embodies the entire agreement between the parties.
THIS AGREEMENT AND ALL OF THE OTHER LOAN DOCUMENTS REPRESENT THE FINAL
AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF
PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE
ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES.
IN WITNESS WHEREOF, the parties hereto have executed this Fifth
Amendment to Loan Agreement to be effective as of the date and year first
above written.
BORROWER:
Address: HALLMARK FINANCE CORPORATION
14651 Dallas Parkway
Suite 900
Dallas, Texas 75240 By:____________________________
Name:__________________________
Title:_________________________
GUARANTORS:
Address: HALLMARK FINANCIAL SERVICES,
INC.
14651 Dallas Parkway
Suite 900
Dallas, Texas 75240 By:____________________________
Name:__________________________
Title:_________________________
<PAGE>
Address: HALLMARK CLAIMS SERVICE, INC.
14651 Dallas Parkway
Suite 900
Dallas, Texas 75240 By:____________________________
Name:__________________________
Title:_________________________
Address: AMERICAN HALLMARK GENERAL
AGENCY, INC.
14651 Dallas Parkway
Suite 900
Dallas, Texas 75240 By:____________________________
Name:__________________________
Title:_________________________
Address: ACO HOLDINGS, INC.
14651 Dallas Parkway
Suite 900
Dallas, Texas 75240 By:____________________________
Name:__________________________
Title:_________________________
Address: AMERICAN HALLMARK AGENCIES,
INC.
14651 Dallas Parkway
Suite 900
Dallas, Texas 75240 By:____________________________
Name:__________________________
Title:_________________________
LENDER:
Address: NATIONSBANK OF TEXAS, N.A.
NationsBank Plaza
900 Main Street, 7th Floor
Dallas, Texas 75202 By:____________________________
Susan M. Raher, Senior Vice
President
AMENDMENT NO. 1
Loan Agreement Between
Hallmark Financial Services, Inc. and
Dorinco Reinsurance Company
This AMENDMENT to the Loan Agreement ("Agreement"), dated March 10,
1997, by and between Hallmark Financial Services, Inc., ("Borrower") and
Dorinco Reinsurance Company ("Lender"), hereby amends the following
paragraphs to the Agreement as follows:
4. Conditions to this Agreement.
e. Reinsurance Treaty. Borrower shall have caused AH to
offer, for the time period set forth in the table contained in this
paragraph, to reinsure a portion of its Personal Lines Auto Quota Share
Reinsurance with Lender, the form and content of such reinsurance treaty to
be substantially similar to Exhibit D attached to and made a part of this
Agreement, in amounts sufficient to allow for the following schedule of
ceded premiums:
Treaty Years Ceded Premium
07/01/97 to 06/30/99 $ 41,600,000
07/01/99 to 06/30/00 $ 23,328,000
07/01/00 to 06/30/01 $ 25,194,240
07/01/01 to 06/30/02 $ 27,209,779
07/01/02 to 06/30/03 $ 29,386,562
07/01/03 to 06/30/04 $ 31,737,486
-AND-
6. Affirmative Covenants.
o. Reinsurance Treaty. Borrower shall cause AH to continue
to offer, for the time period set forth in the table contained in this
paragraph, to reinsure a portion of its Personal Lines Auto Quota Share
Reinsurance with Lender, the form and content of such reinsurance treaty to
be substantially similar to Exhibit D attached hereto, in amounts
sufficient to allow for the following schedule of ceded premiums:
Treaty Years Ceded Premium
07/01/97 to 06/30/99 $ 41,600,000
07/01/99 to 06/30/00 $ 23,328,000
07/01/00 to 06/30/01 $ 25,194,240
07/01/01 to 06/30/02 $ 27,209,779
07/01/02 to 06/30/03 $ 29,386,562
07/01/03 to 06/30/04 $ 31,737,486
All portions of the Agreement not herein amended shall remain in full
force and effect.
IN WITNESS WHEREOF, Lender and Borrower have executed this Amendment
No. 1 to the Loan Agreement, dated March 10, 1997, and have indicated their
acceptance and incorporation by reference into said Loan Agreement by
signing below.
<PAGE>
Borrower:
HALLMARK FINANCIAL SERVICES, INC.
By: _________________________________ Witness:______________________
Title:_______________________________ Title:________________________
Date:________________________________
Lender:
DORINCO REINSURANCE COMPANY
By: _________________________________ Witness:______________________
Title:_______________________________ Title:________________________
Date:________________________________
RETROCESSION CONTRACT
This RETROCESSION CONTRACT is made and entered into by and between DORINCO
REINSURANCE COMPANY, Midland, Michigan (hereinafter referred to as the
"Retrocedant") and AMERICAN HALLMARK INSURANCE COMPANY OF TEXAS, Dallas,
Texas (hereinafter referred to as the "Retrocessionaire").
WHEREAS the Retrocedant reinsures business produced and underwritten by or
through Associated General Agency, Inc., Arlington, Texas for and on behalf
of STATE AND COUNTY MUTUAL FIRE INSURANCE COMPANY, Fort Worth, Texas
(hereinafter called the "Underlying Reinsured") under a Reinsurance
Agreement styled 100% Quota Share Reinsurance Agreement (reference no.
S22902-070) (hereinafter called the "Underlying Agreement") and;
WHEREAS the Retrocedant desires to retrocede a portion of its liability
thereunder, the parties hereto, in consideration of the mutual covenants
hereinafter contained, agree as follows:
ARTICLE I
The Retrocedant agrees to retrocede to the Retrocessionaire and the
Retrocessionaire agrees to accept and does hereby accept from the
Retrocedant a 40.00% quota share of the Retrocedant's liability arising
from the Underlying Agreement.
ARTICLE II
A copy of the Underlying Agreement is attached to and made part of this
Retrocession Contract. The Retrocedant agrees to furnish the
Retrocessionaire with any material changes in the Underlying Agreement.
ARTICLE III
The liability of the Retrocessionaire will commence at 12:01 a.m., Central
Standard Time, March 1, 1998 and will follow in all respects the terms and
conditions of the Underlying Agreement and any amendments added thereto,
except as may be provided herein. The Retrocessionaire agrees to follow
the Retrocedant in all matters pertaining to the Underlying Agreement.
It is understood and agreed by the parties that if the Underlying Agreement
is terminated for any reason, this Contract shall terminate automatically
at the same time. In the event the Contract is terminated because the
Underlying Agreement is terminated, the same termination provisions
applicable to the Underlying Agreement will apply to this Contract.
ARTICLE IV
A. 1. The Retrocedant shall furnish the Retrocessionaire an account
within 45 days following the end of each month. The Retrocedant shall
include in this report for informational purposes, the amount of ceded
unearned premium and outstanding loss reserves. The Retrocessionaire's
proportion (i.e., the percent stipulated in ARTICLE I) of the Retrocedant's
net premiums under the Underlying Agreement, less a ceding commission of
<PAGE>
24.0% of net premiums and less loss and loss adjustment expense paid on
losses ascribed to the Underwriting Year, shall be paid by the debtor party
to the creditor within 75 days following the end of each month.
2. In the event any amounts remain unpaid for more than 90 days,
the Retrocessionaire shall be subrogated to the Retrocedant s rights
against Texas Insurance Facilities.
B. 1. The final ceding commission shall be determined by the loss
experience under this Contract. The Retrocedant will calculate an adjusted
ceding commission for each Underwriting Year within 60 days following 24
months from the inception of the Underwriting Year based on premiums earned
and losses incurred. The provisional ceding commission will be adjusted
between the parties as appropriate. Adjustments for each Underwriting Year
will continue to be made annually until all losses ascribed to the
Underwriting Year have been paid or closed, at which time the ceding
commission will become final.
2. Premium earned for the Underwriting Year shall mean all Net
Premium ceded to this Contract and ascribed to the Underwriting Year (less
cancellations and returns) less the unearned premium reserve at the time of
the adjustment, if any.
3. Losses incurred for the Underwriting Year shall mean the loss
and loss expense paid by the Retrocessionaire (less salvages and recoveries
received) on losses ascribed to the Underwriting Year, plus loss and loss
expense reserves outstanding on losses ascribed to the Underwriting Year,
and plus or minus any credit or debit carry forward as provided in this
Article.
C. 1. Should the ratio of losses incurred to premium earned be 68.5%
or higher, then the adjusted ceding commission shall be 24.0%.
2. Should the ratio of losses incurred to premium earned be less
than 68.5%, then the adjusted commission shall be determined by adding one
percent to the ceding commission for each one percent reduction of loss
ratio subject to a ceding commission of 30.0% at a loss ratio of 62.5%.
3. Should the ratio of losses incurred to premium earned be less
than 62.5%, then the commission shall be further adjusted by adding one
half of one percent (.5%) to the ceding commission for each one percent
reduction of loss ratio below 62.5%, subject to a maximum ceding commission
of 35.0% at a loss ratio of 52.5% or less.
4. Should the ratio of losses incurred to premium earned be
greater than 68.5% or less than 52.5%, the difference between the actual
loss ratio and 68.5% or 52.5%, as the case may be, will be multiplied by
the earned premium for the Underwriting Year and carried forward as a debit
or credit to the ensuing Underwriting Year calculation.
D. 1. Upon termination, any period of less than 12 months from
inception shall be considered as an Underwriting Year for purposes of this
Article; any period of less than 12 months from anniversary will be
considered as part of the preceding Underwriting Year.
<PAGE>
2. Should this Contract be terminated on a run-off basis wherein
the Retrocessionaire is liable for losses occurring after the date of
termination, then such run-off period shall be considered as part of the
last Underwriting Year.
ARTICLE V
The term "Underwriting Year" as used in this Agreement shall mean those
Policies with inception, renewal or anniversary date during each 12-month
period commencing with each March 1, and all premium attributable to, and
all loss arising out of such Policies from such inception, renewal or
anniversary date until expiration, cancellation, or next anniversary,
whichever occurs first, will be ascribed to the Underwriting Year.
ARTICLE VI
All reinsurance falling under this Contract shall be subject to the same
terms, rates, conditions and waivers, and to the same modifications,
alterations and cancellations as the Policies to which such reinsurances
relate, and to liability whether or not incurred within the terms of such
Policies arising out of loss occurrences, the true intent of this Contract
being that the Retrocessionaire shall, in every case to which this Contract
applies and in the proportion specified herein, follow the fortunes of the
Retrocedant.
ARTICLE VII
The Retrocedant agrees to advise the Retrocessionaire promptly of all
claims coming under this Contract as provided by the Underlying Agreement.
The Retrocessionaire agrees to repay the Retrocedant the Retrocessionaire's
proportion (i.e., the percentage stipulated in ARTICLE I), of all losses
and/or loss expenses incurred by the Retrocedant as respects losses
ascribed to the under the Underlying Agreement. The Retrocedant shall
remit to the Retrocessionaire the Retrocessionaire's pro rata share of all
salvage and/or other recoveries received by the Retrocedant under the
Underlying Agreement.
ARTICLE VIII
The Retrocedant shall furnish the Retrocessionaire accounts and all
necessary reports and statistics on the reinsurance ceded under this
Contract.
ARTICLE IX
The reinsurance provided by this Contract shall be payable by the
Retrocessionaire directly to the Retrocedant or to is liquidator, receiver
or statutory successor on the basis of the liability of the Retrocedant
under the Underlying Agreement without diminution because of the insolvency
of the Retrocedant. In the event of the insolvency of the Retrocedant, the
liquidator or receiver or statutory successor of the Retrocedant shall give
written notice of the pendency of each claim against the Retrocedant under
<PAGE>
the Underlying Agreement within a reasonable time after such claim is filed
in the insolvency proceeding; and during the pendency of such claim, the
Retrocessionaire may investigate such claim and interpose, at its own
expense, in the proceeding where such claim is to be adjudicated, any
defense or defenses which it may deem available to the Retrocedant, its
liquidator or statutory successor. The expense thus incurred by the
Retrocessionaire shall be chargeable, subject to court approval, against
the Retrocedant as part of the expense of liquidation to the extent of such
proportionate share of the benefit as shall accrue to the Retrocedant
solely as a result of the defense undertaken by the Retrocessionaire. The
reinsurance shall be payable as hereinbefore in this paragraph provided
except as otherwise provided by Section 4118(a) (relating to Fidelity and
Surety) of the Insurance Law of New York or except (a) where the contract
specifically provides another payee of such reinsurance in the event of the
insolvency of the Retrocedant, and (b) where the Retrocessionaire with the
consent of the direct insured or insureds has assumed such policy
obligations of the Retrocedant as direct obligations of the
Retrocessionaire to the payees under such policies and in substitution for
the obligations of the Retrocedant to such payees.
ARTICLE X
As a condition precedent to any right of action hereunder, any
irreconcilable dispute between the parties to this Contract will be
submitted for decision to a board of arbitration composed of two
arbitrators and an umpire meeting at the Home Office of the Retrocedant.
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 Contract. 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.
<PAGE>
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.
ARTICLE XI
This Article applies only to Retrocessionaires domiciled outside the United
States of America.
In the event of the failure of the Retrocessionaire to pay any amount due
hereunder the Retrocessionaire shall, upon the request of the Retrocedant,
submit to the jurisdiction of any court of competent jurisdiction within
the United States, and will comply with all requirements necessary to give
such court jurisdiction, and all matters arising hereunder shall be
determined in accordance with the law and practice of such court.
Service of process may be made upon Mendes & Mount, 750 Seventh Avenue, New
York, New York, who are authorized and directed to accept service of
process in any such suit, and give a written undertaking to the Retrocedant
that they will enter a general appearance upon the Retrocessionaire's
behalf.
Further, pursuant to any statute of any state, territory or district of the
United States which makes provisions therefor, the Retrocessionaire 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 Retrocedant or any beneficiary hereunder arising out of
this Contract, 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.
ARTICLE XII
In consideration of the terms under which this Contract is issued, the
Retrocedant undertakes not to claim any deduction in respect of the premium
hereon when making tax returns other than Income or Profits Tax returns to
any state or territory or the District of Columbia.
Federal Excise Tax of 1%, as applicable, will be paid by the
Retrocessionaire, it being understood and agreed that in the event of any
return of premium becoming due hereunder the Retrocessionaire will deduct
1% from the amount of the return and the Retrocedant or its agent will take
steps to recover the Tax from the U.S. Government.
ARTICLE XIII
Sedgwick Re, Inc., is hereby recognized as the Intermediary negotiating
this Contract for all business hereunder. All communications including
notices, premiums, return premiums, commissions, taxes, losses, loss
adjustment expenses, salvages and loss settlements relating thereto shall
be transmitted to the Retrocessionaire or the Retrocedant through Sedgwick
Re, Inc. 1501 Fourth Avenue, Suite 1400, Seattle, Washington 98101.
Payments by the Retrocedant to the Intermediary shall be deemed to
constitute payment to the Retrocessionaire. Payments by the
<PAGE>
Retrocessionaire to the Intermediary shall be deemed only to constitute
payment to the Retrocedant to the extent that such payments are actually
received by the Retrocedant.
IN WITNESS WHEREOF, the parties hereto, by their authorized
representatives, have executed this Contract as of the following dates:
In Midland, Michigan, this _____ day of ______________, 1998.
DORINCO REINSURANCE COMPANY
By_________________________________________
(signature)
___________________________________________
(name)
___________________________________________
(title)
In Dallas, Texas, this ______ day of ______________, 1998.
AMERICAN HALLMARK INSURANCE COMPANY OF TEXAS
By_________________________________________
(signature)
___________________________________________
(name)
___________________________________________
(title)
RETROCESSION CONTRACT
This RETROCESSION CONTRACT is made and entered into by and between DORINCO
REINSURANCE COMPANY, Midland, Michigan (hereinafter referred to as the
"Retrocedant") and AMERICAN HALLMARK INSURANCE COMPANY OF TEXAS, Dallas,
Texas (hereinafter referred to as the "Retrocessionaire").
WHEREAS the Retrocedant reinsures business produced and underwritten by or
through Harold Loving, d/b/a Texas Insurance Facilities, Tyler, Texas for
and on behalf of STATE AND COUNTY MUTUAL FIRE INSURANCE COMPANY, Fort
Worth, Texas (hereinafter called the "Underlying Reinsured") under a
Reinsurance Agreement styled 100% Quota Share Reinsurance Agreement
(reference no. S22903-070) (hereinafter called the "Underlying Agreement")
and;
WHEREAS the Retrocedant desires to retrocede a portion of its liability
thereunder, the parties hereto, in consideration of the mutual covenants
hereinafter contained, agree as follows:
ARTICLE I
The Retrocedant agrees to retrocede to the Retrocessionaire and the
Retrocessionaire agrees to accept and does hereby accept from the
Retrocedant a 40.00% quota share of the Retrocedant's liability arising
from the Underlying Agreement.
ARTICLE II
A copy of the Underlying Agreement is attached to and made part of this
Retrocession Contract. The Retrocedant agrees to furnish the
Retrocessionaire with any material changes in the Underlying Agreement.
ARTICLE III
The liability of the Retrocessionaire will commence at 12:01 a.m., Central
Standard Time, June 1, 1998 and will follow in all respects the terms and
conditions of the Underlying Agreement and any amendments added thereto,
except as may be provided herein. The Retrocessionaire agrees to follow
the Retrocedant in all matters pertaining to the Underlying Agreement.
It is understood and agreed by the parties that if the Underlying Agreement
is terminated for any reason, this Contract shall terminate automatically
at the same time. In the event the Contract is terminated because the
Underlying Agreement is terminated, the same termination provisions
applicable to the Underlying Agreement will apply to this Contract.
ARTICLE IV
A. 1. The Retrocedant shall furnish the Retrocessionaire an account
within 45 days following the end of each month. The Retrocedant shall
include in this report for informational purposes, the amount of ceded
unearned premium and outstanding loss reserves. The Retrocessionaire's
proportion (i.e., the percent stipulated in ARTICLE I) of the Retrocedant's
<PAGE>
net written premiums under the Underlying Agreement, less a provisional
ceding commission of 24.0% of net written premiums and less loss and loss
adjustment expense paid on losses ascribed to the Underwriting Year, shall
be paid by the debtor party to the creditor within 75 days following the
end of each month.
2. In the event any amounts remain unpaid for more than 90 days,
the Retrocessionaire shall be subrogated to the Retrocedant's rights
against Texas Insurance Facilities.
B. 1. The final ceding commission shall be determined by the loss
experience under this Contract. The Retrocedant will calculate an adjusted
ceding commission for each Underwriting Year within 60 days following 18
months from the inception of the Underwriting Year based on premiums earned
and losses incurred. The provisional ceding commission will be adjusted
between the parties as appropriate. Adjustments for each Underwriting Year
will continue to be made annually until all losses ascribed to the
Underwriting Year have been paid or closed, at which time the ceding
commission will become final.
2. Premium earned for the Underwriting Year shall mean all net
written premium ceded to this Contract and ascribed to the Underwriting
Year (less cancellations and returns) less the unearned premium reserve at
the time of the adjustment, if any.
3. Losses incurred for the Underwriting Year shall mean the loss
and loss expense paid by the Retrocessionaire (less salvages and recoveries
received) on losses ascribed to the Underwriting Year, plus loss and loss
expense reserves outstanding on losses ascribed to the Underwriting Year,
and plus or minus any credit or debit carry forward as provided in this
Article.
C. 1. Should the ratio of losses incurred to premium earned be 68.5%
or higher, then the adjusted ceding commission shall be 24.0%.
2. Should the ratio of losses incurred to premium earned be less
than 68.5%, then the adjusted commission shall be determined by adding one
percent to the ceding commission for each one percent reduction of loss
ratio subject to a ceding commission of 28.0% at a loss ratio of 64.5%.
3. Should the ratio of losses incurred to premium earned be less
than 64.5%, then the commission shall be further adjusted by adding one
half of one percent (.5%) to the ceding commission for each one percent
reduction of loss ratio below 64.5%, subject to a maximum ceding commission
of 35.0% at a loss ratio of 50.5% or less.
4. Should the ratio of losses incurred to premium earned be
greater than 68.5% or less than 50.5%, the difference between the actual
loss ratio and 68.5% or 50.5%, as the case may be, will be multiplied by
the earned premium for the Underwriting Year and carried forward as a debit
or credit to the ensuing Underwriting Year calculation.
D. 1. Upon termination, any period of less than 12 months from
inception shall be considered as an Underwriting Year for purposes of this
Article; any period of less than 12 months from anniversary will be
considered as part of the preceding Underwriting Year.
<PAGE>
2. Should this Contract be terminated on a run-off basis wherein
the Retrocessionaire is liable for losses occurring after the date of
termination, then such run-off period shall be considered as part of the
last Underwriting Year.
ARTICLE V
The term "Underwriting Year" as used in this Agreement shall mean those
Policies with inception, renewal or anniversary date during each 12-month
period commencing with each June 1, and all premium attributable to, and
all loss arising out of such Policies from such inception, renewal or
anniversary date until expiration, cancellation, or next anniversary,
whichever occurs first, will be ascribed to the Underwriting Year.
ARTICLE VI
All reinsurance falling under this Contract shall be subject to the same
terms, rates, conditions and waivers, and to the same modifications,
alterations and cancellations as the Policies to which such reinsurances
relate, and to liability whether or not incurred within the terms of such
Policies arising out of loss occurrences, the true intent of this Contract
being that the Retrocessionaire shall, in every case to which this Contract
applies and in the proportion specified herein, follow the fortunes of the
Retrocedant.
ARTICLE VII
The Retrocedant agrees to advise the Retrocessionaire promptly of all
claims coming under this Contract as provided by the Underlying Agreement.
The Retrocessionaire agrees to repay the Retrocedant the Retrocessionaire's
proportion (i.e., the percentage stipulated in ARTICLE I), of all losses
and/or loss expenses incurred by the Retrocedant as respects losses
ascribed to the Underlying Agreement. The Retrocedant shall remit to the
Retrocessionaire the Retrocessionaire s pro rata share of all salvage
and/or other recoveries received by the Retrocedant under the Underlying
Agreement.
ARTICLE VIII
The Retrocedant shall furnish the Retrocessionaire accounts and all
necessary reports and statistics on the reinsurance ceded under this
Contract.
ARTICLE VIX
The reinsurance provided by this Contract shall be payable by the
Retrocessionaire directly to the Retrocedant or to is liquidator, receiver
or statutory successor on the basis of the liability of the Retrocedant
under the Underlying Agreement without diminution because of the insolvency
of the Retrocedant. In the event of the insolvency of the Retrocedant, the
liquidator or receiver or statutory successor of the Retrocedant shall give
written notice of the pendency of each claim against the Retrocedant under
<PAGE>
the Underlying Agreement within a reasonable time after such claim is filed
in the insolvency proceeding; and during the pendency of such claim, the
Retrocessionaire may investigate such claim and interpose, at its own
expense, in the proceeding where such claim is to be adjudicated, any
defense or defenses which it may deem available to the Retrocedant, its
liquidator or statutory successor. The expense thus incurred by the
Retrocessionaire shall be chargeable, subject to court approval, against
the Retrocedant as part of the expense of liquidation to the extent of such
proportionate share of the benefit as shall accrue to the Retrocedant
solely as a result of the defense undertaken by the Retrocessionaire. The
reinsurance shall be payable as hereinbefore in this paragraph provided
except as otherwise provided by Section 4118(a) (relating to Fidelity and
Surety) of the Insurance Law of New York or except (a) where the contract
specifically provides another payee of such reinsurance in the event of the
insolvency of the Retrocedant, and (b) where the Retrocessionaire with the
consent of the direct insured or insureds has assumed such policy
obligations of the Retrocedant as direct obligations of the
Retrocessionaire to the payees under such policies and in substitution for
the obligations of the Retrocedant to such payees.
ARTICLE X
As a condition precedent to any right of action hereunder, any
irreconcilable dispute between the parties to this Contract will be
submitted for decision to a board of arbitration composed of two
arbitrators and an umpire meeting at the Home Office of the Retrocedant.
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 Contract. 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.
<PAGE>
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.
ARTICLE XI
This Article applies only to Retrocessionaires domiciled outside the United
States of America.
In the event of the failure of the Retrocessionaire to pay any amount due
hereunder the Retrocessionaire shall, upon the request of the Retrocedant,
submit to the jurisdiction of any court of competent jurisdiction within
the United States, and will comply with all requirements necessary to give
such court jurisdiction, and all matters arising hereunder shall be
determined in accordance with the law and practice of such court.
Service of process may be made upon Mendes & Mount, 750 Seventh Avenue, New
York, New York, who are authorized and directed to accept service of
process in any such suit, and give a written undertaking to the Retrocedant
that they will enter a general appearance upon the Retrocessionaire's
behalf.
Further, pursuant to any statute of any state, territory or district of the
United States which makes provisions therefor, the Retrocessionaire 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 Retrocedant or any beneficiary hereunder arising out of
this Contract, 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.
ARTICLE XII
In consideration of the terms under which this Contract is issued, the
Retrocedant undertakes not to claim any deduction in respect of the premium
hereon when making tax returns other than Income or Profits Tax returns to
any state or territory or the District of Columbia.
Federal Excise Tax of 1%, as applicable, will be paid by the
Retrocessionaire, it being understood and agreed that in the event of any
return of premium becoming due hereunder the Retrocessionaire will deduct
1% from the amount of the return and the Retrocedant or its agent will take
steps to recover the Tax from the U.S. Government.
ARTICLE XIII
Sedgwick Re, Inc., is hereby recognized as the Intermediary negotiating
this Contract for all business hereunder. All communications including
notices, premiums, return premiums, commissions, taxes, losses, loss
adjustment expenses, salvages and loss settlements relating thereto shall
be transmitted to the Retrocessionaire or the Retrocedant through Sedgwick
Re, Inc. 1501 Fourth Avenue, Suite 1400, Seattle, Washington 98101.
Payments by the Retrocedant to the Intermediary shall be deemed to
constitute payment to the Retrocessionaire. Payments by the
<PAGE>
Retrocessionaire to the Intermediary shall be deemed only to constitute
payment to the Retrocedant to the extent that such payments are actually
received by the Retrocedant.
IN WITNESS WHEREOF, the parties hereto, by their authorized
representatives, have executed this Contract as of the following dates:
In Midland, Michigan, this ______ day of _________________, 1998.
DORINCO REINSURANCE COMPANY
By_________________________________________
(signature)
___________________________________________
(name)
___________________________________________
(title)
In Dallas, Texas, this ______ day of ___________________, 1998.
AMERICAN HALLMARK INSURANCE COMPANY OF TEXAS
By_________________________________________
(signature)
___________________________________________
(name)
___________________________________________
(title)
QUOTA SHARE RETROCESSION CONTRACT
This QUOTA SHARE RETROCESSION CONTRACT is made and entered into by and
between DORINCO REINSURANCE COMPANY, Midland, Michigan (hereinafter
referred to as the "Retrocedant") and AMERICAN HALLMARK INSURANCE COMPANY
OF TEXAS, Dallas, Texas (hereinafter referred to as the
"Retrocessionaire").
WHEREAS the Retrocedant reinsures business produced and underwritten by or
through Van Wagoner Companies, Inc., Plano, Texas for and on behalf of
STATE AND COUNTY MUTUAL FIRE INSURANCE COMPANY, Fort Worth, Texas
(hereinafter called the "Underlying Reinsured") under a Reinsurance
Agreement styled 100% Quota Share Reinsurance Agreement (reference no.
S22907-070) (hereinafter called the "Underlying Agreement") and;
WHEREAS the Retrocedant desires to retrocede a portion of its liability
thereunder, the parties hereto, in consideration of the mutual covenants
hereinafter contained, agree as follows:
ARTICLE I
The Retrocedant agrees to retrocede to the Retrocessionaire and the
Retrocessionaire agrees to accept and does hereby accept from the
Retrocedant a 26.09% quota share of the Retrocedant s liability arising
from the Underlying Agreement.
ARTICLE II
A copy of the Underlying Agreement is attached to and made part of this
Retrocession Contract. The Retrocedant agrees to furnish the
Retrocessionaire with any material changes in the Underlying Agreement.
ARTICLE III
The liability of the Retrocessionaire will commence at 12:01 a.m., Central
Standard Time, September 1, 1998 and will follow in all respects the terms
and conditions of the Underlying Agreement and any amendments added
thereto, except as may be provided herein. The Retrocessionaire agrees to
follow the Retrocedant in all matters pertaining to the Underlying
Agreement.
It is understood and agreed by the parties that if the Underlying Agreement
is terminated for any reason, this Contract shall terminate automatically
at the same time. In the event the Contract is terminated because the
Underlying Agreement is terminated, the same termination provisions
applicable to the Underlying Agreement will apply to this Contract.
ARTICLE IV
A. 1. The Retrocedant shall furnish the Retrocessionaire an account
within 45 days following the end of each month. The Retrocedant shall
include in this report for informational purposes, the amount of ceded
unearned premium and outstanding loss reserves. The Retrocessionaire's
<PAGE>
proportion (i.e., the percent stipulated in ARTICLE I) of the Retrocedant's
net written premiums under the Underlying Agreement, less a provisional
ceding commission of 24.0% of net written premiums and less loss and loss
adjustment expense paid on losses ascribed to the Underwriting Year, shall
be paid by the debtor party to the creditor within 75 days following the
end of each month.
2. In the event any amounts remain unpaid for more than 90 days,
the Retrocessionaire shall be subrogated to the Retrocedant's rights
against Texas Insurance Facilities.
B. 1. The final ceding commission shall be determined by the loss
experience under this Contract. The Retrocedant will calculate an adjusted
ceding commission for each Underwriting Year within 60 days following 24
months from the inception of the Underwriting Year based on premiums earned
and losses incurred. The provisional ceding commission will be adjusted
between the parties as appropriate. Adjustments for each Underwriting Year
will continue to be made annually until all losses ascribed to the
Underwriting Year have been paid or closed, at which time the ceding
commission will become final.
2. Premium earned for the Underwriting Year shall mean all net
written premium ceded to this Contract and ascribed to the Underwriting
Year (less cancellations and returns) less the unearned premium reserve at
the time of the adjustment, if any.
3. Losses incurred for the Underwriting Year shall mean the loss
and loss expense paid by the Retrocessionaire (less salvages and recoveries
received) on losses ascribed to the Underwriting Year, plus loss and loss
expense reserves outstanding on losses ascribed to the Underwriting Year,
and plus or minus any credit or debit carry forward as provided in this
Article.
C. 1. Should the ratio of losses incurred to premium earned be 68.5%
or higher, then the adjusted ceding commission shall be 24.0%.
2. Should the ratio of losses incurred to premium earned be less
than 68.5%, then the adjusted commission shall be determined by adding one
percent to the ceding commission for each one percent reduction of loss
ratio subject to a ceding commission of 30.0% at a loss ratio of 62.5%.
3. Should the ratio of losses incurred to premium earned be less
than 62.5%, then the commission shall be further adjusted by adding one
half of one percent (.5%) to the ceding commission for each one percent
reduction of loss ratio below 62.5%, subject to a maximum ceding commission
of 35.0% at a loss ratio of 52.5% or less.
4. Should the ratio of losses incurred to premium earned be
greater than 68.5% or less than 52.5%, the difference between the actual
loss ratio and 68.5% or 52.5%, as the case may be, will be multiplied by
the earned premium for the Underwriting Year and carried forward as a debit
or credit to the ensuing Underwriting Year calculation.
D. 1. Upon termination, any period of less than 12 months from
inception shall be considered as an Underwriting Year for purposes of this
Article; any period of less than 12 months from anniversary will be
considered as part of the preceding Underwriting Year.
<PAGE>
2. Should this Contract be terminated on a run-off basis wherein
the Retrocessionaire is liable for losses occurring after the date of
termination, then such run-off period shall be considered as part of the
last Underwriting Year.
ARTICLE V
The term "Underwriting Year" as used in this Agreement shall mean those
Policies with inception, renewal or anniversary date during each 12-month
period commencing with each September 1, and all premium attributable to,
and all loss arising out of such Policies from such inception, renewal or
anniversary date until expiration, cancellation, or next anniversary,
whichever occurs first, will be ascribed to the Underwriting Year.
ARTICLE VI
All reinsurance falling under this Contract shall be subject to the same
terms, rates, conditions and waivers, and to the same modifications,
alterations and cancellations as the Policies to which such reinsurances
relate, and to liability whether or not incurred within the terms of such
Policies arising out of loss occurrences, the true intent of this Contract
being that the Retrocessionaire shall, in every case to which this Contract
applies and in the proportion specified herein, follow the fortunes of the
Retrocedant.
ARTICLE VII
The Retrocedant agrees to advise the Retrocessionaire promptly of all
claims coming under this Contract as provided by the Underlying Agreement.
The Retrocessionaire agrees to repay the Retrocedant the Retrocessionaire's
proportion (i.e., the percentage stipulated in ARTICLE I), of all losses
and/or loss expenses paid by the Retrocedant as respects losses ascribed to
the Underlying Agreement. The Retrocedant shall remit to the
Retrocessionaire the Retrocessionaire s pro rata share of all salvage
and/or other recoveries received by the Retrocedant under the Underlying
Agreement.
ARTICLE VIII
The Retrocedant shall furnish the Retrocessionaire accounts and all
necessary reports and statistics on the reinsurance ceded under this
Contract.
ARTICLE VIX
The reinsurance provided by this Contract shall be payable by the
Retrocessionaire directly to the Retrocedant or to is liquidator, receiver
or statutory successor on the basis of the liability of the Retrocedant
under the Underlying Agreement without diminution because of the insolvency
of the Retrocedant. In the event of the insolvency of the Retrocedant, the
liquidator or receiver or statutory successor of the Retrocedant shall give
written notice of the pendency of each claim against the Retrocedant under
<PAGE>
the Underlying Agreement within a reasonable time after such claim is filed
in the insolvency proceeding; and during the pendency of such claim, the
Retrocessionaire may investigate such claim and interpose, at its own
expense, in the proceeding where such claim is to be adjudicated, any
defense or defenses which it may deem available to the Retrocedant, its
liquidator or statutory successor. The expense thus incurred by the
Retrocessionaire shall be chargeable, subject to court approval, against
the Retrocedant as part of the expense of liquidation to the extent of such
proportionate share of the benefit as shall accrue to the Retrocedant
solely as a result of the defense undertaken by the Retrocessionaire. The
reinsurance shall be payable as hereinbefore in this paragraph provided
except as otherwise provided by Section 4118(a) (relating to Fidelity and
Surety) of the Insurance Law of New York or except (a) where the contract
specifically provides another payee of such reinsurance in the event of the
insolvency of the Retrocedant, and (b) where the Retrocessionaire with the
consent of the direct insured or insureds has assumed such policy
obligations of the Retrocedant as direct obligations of the
Retrocessionaire to the payees under such policies and in substitution for
the obligations of the Retrocedant to such payees.
ARTICLE X
As a condition precedent to any right of action hereunder, any
irreconcilable dispute between the parties to this Contract will be
submitted for decision to a board of arbitration composed of two
arbitrators and an umpire meeting at the Home Office of the Retrocedant.
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 Contract. 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.
<PAGE>
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.
ARTICLE XI
This Article applies only to Retrocessionaires domiciled outside the United
States of America.
In the event of the failure of the Retrocessionaire to pay any amount due
hereunder the Retrocessionaire shall, upon the request of the Retrocedant,
submit to the jurisdiction of any court of competent jurisdiction within
the United States, and will comply with all requirements necessary to give
such court jurisdiction, and all matters arising hereunder shall be
determined in accordance with the law and practice of such court.
Service of process may be made upon Mendes & Mount, 750 Seventh Avenue, New
York, New York, who are authorized and directed to accept service of
process in any such suit, and give a written undertaking to the Retrocedant
that they will enter a general appearance upon the Retrocessionaire's
behalf.
Further, pursuant to any statute of any state, territory or district of the
United States which makes provisions therefor, the Retrocessionaire 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 Retrocedant or any beneficiary hereunder arising out of
this Contract, 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.
ARTICLE XII
In consideration of the terms under which this Contract is issued, the
Retrocedant undertakes not to claim any deduction in respect of the premium
hereon when making tax returns other than Income or Profits Tax returns to
any state or territory or the District of Columbia.
Federal Excise Tax of 1%, as applicable, will be paid by the
Retrocessionaire, it being understood and agreed that in the event of any
return of premium becoming due hereunder the Retrocessionaire will deduct
1% from the amount of the return and the Retrocedant or its agent will take
steps to recover the Tax from the U.S. Government.
ARTICLE XIII
Sedgwick Re, Inc., is hereby recognized as the Intermediary negotiating
this Contract for all business hereunder. All communications including
notices, premiums, return premiums, commissions, taxes, losses, loss
adjustment expenses, salvages and loss settlements relating thereto shall
be transmitted to the Retrocessionaire or the Retrocedant through Sedgwick
Re, Inc. 1501 Fourth Avenue, Suite 1400, Seattle, Washington 98101.
Payments by the Retrocedant to the Intermediary shall be deemed to
<PAGE>
constitute payment to the Retrocessionaire. Payments by the
Retrocessionaire to the Intermediary shall be deemed only to constitute
payment to the Retrocedant to the extent that such payments are actually
received by the Retrocedant.
IN WITNESS WHEREOF, the parties hereto, by their authorized
representatives, have executed this Contract as of the following dates:
In Midland, Michigan, this ______ day of ____________, 1998.
DORINCO REINSURANCE COMPANY
By_________________________________________
(signature)
___________________________________________
(name)
___________________________________________
(title)
In Dallas, Texas, this ______ day of ____________, 1998.
AMERICAN HALLMARK INSURANCE COMPANY OF TEXAS
By_________________________________________
(signature)
___________________________________________
(name)
___________________________________________
(title)
