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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________
FORM 10-K
(Mark One)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934. For the fiscal year ended December 31, 1998.
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the transition period from N/A to N/A.
--- ---
COMMISSION FILE NUMBER 0-18298
UNITRIN, INC.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 95-4255452
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
ONE EAST WACKER DRIVE
CHICAGO, ILLINOIS 60601
(Address of Principal Executive Offices) (Zip Code)
(312) 661-4600
(Registrant's Telephone Number, Including Area Code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.10 PAR VALUE
PREFERRED SHARE PURCHASE RIGHTS PURSUANT TO RIGHTS AGREEMENT
(Titles of classes)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Based on the closing market price of Registrant's common stock on March 1,
1999 the aggregate market value of such stock held by non-affiliates of
Registrant is approximately $1.9 billion. Solely for purposes of this
calculation, all executive officers and directors of Registrant are considered
affiliates.
Registrant had 36,733,851 shares of common stock outstanding as of March 1,
1999.
DOCUMENTS INCORPORATED BY REFERENCE
PART OF THE FORM 10-K
DOCUMENT INTO WHICH INCORPORATED
Portions of 1998 Annual Report to Shareholders Parts I, II and IV
Portions of Proxy Statement for 1999 Annual Meeting Part III
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PART I
ITEM 1. BUSINESS
Unitrin, Inc. ("Unitrin" or the "Company") was incorporated in Delaware in
1990. Unitrin's subsidiaries serve the basic financial needs of individuals,
families and small businesses by providing property and casualty insurance, life
and health insurance, and consumer finance services.
(a) General development of business
-------------------------------
Unitrin completed its acquisition of The Reliable Life Insurance Company
("Reliable") on May 29, 1998. Reliable is a life and health insurance company
headquartered in Webster Groves, Missouri which had annual premium revenue in
1998 of approximately $106 million calculated in accordance with statutory
insurance accounting practices. As consideration for the acquisition, Unitrin
issued approximately 3.8 million shares of its common stock and $0.7 million in
cash to the former shareholders of Reliable. Reliable's life and health
insurance products are primarily offered throughout Missouri, Arkansas and
Texas.
On September 30, 1998, Reserve National Insurance Company ("Reserve
National") and its parent company, NationalCare Insurance Company
("NationalCare"), were acquired by Unitrin's principal life and health insurance
subsidiary, United Insurance Company of America ("United"), for $98.5 million in
cash. Reserve National and NationalCare are based in Oklahoma City, Oklahoma
and specialize in the sale of limited benefit accident and health insurance
products primarily to rural residents in 31 states. In 1998, Reserve National
and NationalCare had consolidated annual statutory premium revenues of
approximately $115 million.
On February 10, 1999, Unitrin entered into a definitive agreement with Fund
American Enterprises Holdings, Inc. ("Fund American") under which Unitrin will
acquire Fund American's subsidiary, Valley Group, Inc. ("Valley Group"), in a
cash transaction. The purchase price is estimated to be $139 million after
payment of a special dividend by Valley Group to Fund American of approximately
$81 million prior to closing. The transaction, including the payment of the
special dividend, is subject to insurance department approvals and the
satisfaction of other customary closing conditions. Valley Group's principal
subsidiaries are Valley Insurance Company of Albany, Oregon, Charter Indemnity
Company of Dallas, Texas, and White Mountains Insurance Company of Manchester,
New Hampshire. These subsidiaries write personal and commercial lines property
and casualty insurance, primarily in the Pacific Northwest, California, Texas
and New England. In 1998, Valley Group had consolidated annual statutory
premium revenues of approximately $160 million.
On February 11, 1999, Unitrin's Board of Directors authorized a 2-for-1
stock split in the form of a dividend distribution of one new share of common
stock for each share of common stock outstanding on March 5, 1999, the record
date for the dividend. The stock dividend will be paid on March 26, 1999.
Based on the approximately 36.7 million shares outstanding at the record date,
the stock dividend will result in approximately 73.4 million shares outstanding.
During 1998, Unitrin repurchased 3.5 million shares of its common stock in
open market transactions at an aggregate cost of approximately $232.9 million.
Unitrin has repurchased approximately 22.3 million shares of its common stock at
an aggregate cost of approximately $1.1 billion since 1990. At March 1, 1999,
approximately 2.3 million shares of Unitrin common stock (4.6 million shares
following the stock split) remained under the Company's outstanding repurchase
authorizations.
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(b) Business segment financial data
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Financial information about the Company's business segments for the years
ended December 31, 1998, 1997, and 1996 is contained in the following portions
of Unitrin's 1998 Annual Report and is incorporated herein by reference: (i)
Note 17 to the Company's Consolidated Financial Statements, which financial
statements are further described in Item 14(a)1 hereto and filed as Exhibit 13.1
hereto and incorporated by reference into Item 8 hereof (the "Financial
Statements"), and (ii) "Management's Discussion and Analysis of Results of
Operations and Financial Condition," which is filed as Exhibit 13.2 hereto and
incorporated by reference into Item 7 hereof (the "MD&A").
(c) Description of business
-----------------------
Unitrin's subsidiaries operate in three segments: Property and Casualty
Insurance, Life and Health Insurance, and Consumer Finance. Unitrin and its
subsidiaries have approximately 7,500 full-time employees of which approximately
5,400 are employed in the Life and Health Insurance segment, 1,400 in the
Property and Casualty Insurance segment, and 600 in the Consumer Finance
segment.
PROPERTY AND CASUALTY INSURANCE
Trinity Universal Insurance Company ("Trinity"), together with its
subsidiaries and affiliates (collectively, the "Unitrin Property and Casualty
Group"), comprise a network of regional insurers operating in the southern,
midwestern and western United States. The Unitrin Property and Casualty Group
provides insurance coverage to over 600,000 policyholders in 32 states. The five
states which provided the largest amount of 1998 premium are Texas (29%),
California (15%), Wisconsin (8%), Illinois (7%), and Louisiana (6%).
Property insurance indemnifies an insured with an interest in physical
property for loss of such property or the loss of its income-producing
abilities. Casualty insurance primarily covers liability for damage to property
of, or injury to, a person or entity other than the insured.
Products and Distribution
The Unitrin Property and Casualty Group provides automobile, homeowners,
commercial multi-peril, motorcycle, boat and watercraft, fire, casualty, workers
compensation, and other types of property and casualty insurance to individuals
and businesses. Automobile insurance accounted for 36%, 40%, and 37% of
Unitrin's consolidated insurance premiums for the years ended December 31, 1998,
1997, and 1996, respectively.
Preferred and standard risk insurance products are marketed exclusively by
over 2,200 independent agents. These personal and commercial products are
designed and priced for those individuals and businesses that have demonstrated
favorable risk characteristics and loss history. Typical customers include
"main street" businesses and middle income families. Products are marketed
primarily in suburban and rural communities. Trinity and certain of Unitrin's
subsidiaries (Milwaukee Guardian Insurance, Inc., Milwaukee Safeguard Insurance
Company, Security National Insurance Company, Trinity Universal Insurance
Company of Kansas, Inc. and Union Automobile Indemnity Company) and affiliates
(Milwaukee Mutual Insurance Company and Trinity Lloyd's Insurance Company)
principally provide the Unitrin Property and Casualty Group's preferred and
standard products in 27 states including Texas, Wisconsin, Illinois, Louisiana,
Minnesota, and other southern, midwestern, and northwestern states. These
products accounted for approximately 72% of the Unitrin Property and Casualty
Group's 1998 premium revenue.
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Specialty insurance products are principally provided by two Trinity
subsidiaries, Financial Indemnity Company and Alpha Property & Casualty
Insurance Company, and include nonstandard personal and commercial automobile,
motorcycle, and specialty watercraft insurance. Nonstandard automobile
insurance is provided for individuals and companies that have had difficulty
obtaining standard or preferred risk insurance, usually because of their driving
records. Nonstandard automobile insurance products are marketed through
approximately 4,800 independent agents in California and 23 other states.
Storm Losses/Seasonality
Geographic location can have an impact on a property insurer's exposure to
losses from hazards such as hurricanes, tornadoes, windstorms, and hail.
Moreover, these storms add an element of seasonality to property insurance
claims, since windstorms and tornadoes tend to occur in the spring of the year,
while hurricanes generally occur in the summer and fall. Historically, the
Unitrin Property and Casualty Group wrote a sizable portion of its business in
Texas, the plains states, and certain coastal areas that are storm-prone. The
Unitrin Property and Casualty Group has endeavored to reduce its vulnerability
to storm losses through a combination of geographic expansion outside of these
areas and reduced concentration of business in storm-prone areas.
Pricing
Pricing levels for property and casualty insurance are influenced by many
factors, including the frequency and severity of claims, state regulation and
legislation, competition, general business conditions, inflation, expense
levels, and judicial decisions. In addition, many state regulators require
consideration of investment income when approving or setting rates, which
reduces underwriting margins.
Reinsurance
In accordance with the practice of the insurance industry, the Unitrin
Property and Casualty Group cedes insurance risk to other insurers. These
reinsurance arrangements limit the Unitrin Property and Casualty Group's
exposure arising from large risks or from hazards of a catastrophic nature.
Although such reinsurance does not discharge the Unitrin Property and Casualty
Group from its obligations on risks insured, so long as reinsurers meet their
obligations, the Unitrin Property and Casualty Group's net liability is limited
to the amount of risk it retains. See Note 18 to the Financial Statements.
Competition
Based on the most recent data published by A.M. Best Company ("A.M. Best")
as of the end of 1997, there were over 1,110 property and casualty insurance
groups in the United States, made up of more than 2,400 companies. The Unitrin
Property and Casualty Group ranked among the 75 largest property and casualty
insurance company organizations in the United States, measured by admitted
assets (66th), net premiums written (61st), and policyholders' surplus (49th).
In 1997, the industry's estimated net premiums written were over $276
billion, more than 74% of which were accounted for by 50 groups of companies.
The Unitrin Property and Casualty Group wrote less than 1% of the industry's
estimated 1997 premium volume.
In recent years, the property and casualty insurance industry has seen the
industry's capacity to write new business generally outpace demand for insurance
coverage. As a consequence,
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property and casualty insurance is a highly competitive business. In general,
the Unitrin Property and Casualty Group competes by using appropriate pricing,
selling to selected markets, controlling expenses, maintaining ratings from A.M.
Best, and providing competitive services to agents and policyholders.
LIFE AND HEALTH INSURANCE
Unitrin conducts its life and health insurance business through United and
United's subsidiaries, Union National Life Insurance Company, The Pyramid Life
Insurance Company ("Pyramid") and Reserve National, and Unitrin's subsidiary,
Reliable (collectively, the "Unitrin Life and Health Group"). The leading
product of the Unitrin Life and Health Group is ordinary life insurance,
including permanent and term insurance. This product accounted for 29%, 26% ,
and 28% of Unitrin's consolidated insurance premiums for the years ended
December 31, 1998, 1997, and 1996, respectively. Permanent policies are offered
primarily on a non-participating, guaranteed-cost basis.
Career Agents
Approximately 80 percent of the Unitrin Life and Health Group's premiums
result from insurance products offered and distributed by the group's career
agents. United's Career Agency Division, along with Reliable and Union National
Life Insurance Company, employ over 3,300 career agents to distribute
traditional whole life insurance products in 26 states. These career agents are
full-time employees who call on customers in their homes to sell products,
provide services related to policies in force and collect premiums, typically
monthly. Property insurance products written by United's subsidiaries, United
Casualty Insurance Company of America and Union National Fire Insurance Company,
are also distributed by the Group's career agents. Customers of Unitrin's career
agency companies generally are middle and lower income families.
Independent Agents
Pyramid and Reserve National together have over 2,300 independent agents
appointed to market and distribute health insurance products. In addition,
United's Worksite Products Division offers life insurance products through 175
independent agents and brokers. Pyramid focuses primarily on providing
insurance to the senior market. Its principal product is medicare supplement,
which it offers through independent agents and hospital networks. Reserve
National specializes in the sale of limited benefit accident and health
insurance products and medicare supplement, primarily to individuals living in
rural areas where health maintenance organizations and preferred provider
organizations are less prevalent.
Pricing
Premiums for life and health insurance products are based on assumptions
with respect to mortality, morbidity, investment yields, expenses, and lapses
and are also affected by state laws and regulations, as well as competition.
Pricing assumptions are based on the experience of the Unitrin Life and Health
Group, as well as the industry in general, depending upon the factor being
considered. The actual profit or loss produced by a product will vary from the
anticipated profit if the actual experience differs from the assumptions used in
pricing the product.
Premiums for policies sold through the Unitrin Life and Health Group's
career agents are set at levels designed to cover the relatively higher cost of
this method of distribution. As a result of such higher expenses, incurred
claims as a percentage of premium income tend to be lower for companies
utilizing this method of distribution than the insurance industry average.
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Premiums for medicare supplement and other accident and health policies
must take into account the rising costs of medical care. The annual rate of
medical cost inflation has historically been higher than the general rate of
inflation, necessitating frequent rate increases, most of which are subject to
approval by state regulatory agencies.
Reinsurance
In accordance with the practice of the insurance industry, the Unitrin Life
and Health Group cedes insurance risk to other insurers. These reinsurance
arrangements limit the Unitrin Life and Health Group's exposure on risks.
Although such reinsurance does not discharge the Unitrin Life and Health Group
from its obligations on risks insured, so long as reinsurers meet their
obligations, the Unitrin Life and Health Group's net liability is limited to the
amount of risk it retains. For descriptions of certain of the reinsurance
arrangements of the Unitrin Life and Health Group, see the MD&A and Note 18 to
the Financial Statements.
Lapse Ratio
The lapse ratio is a measure reflecting a life insurer's loss of existing
business. For a given year, this ratio is commonly computed as the total face
amount of individual life insurance policies lapsed, surrendered, expired and
decreased during such year, less policies increased and revived during such
year, divided by the total face amount of policies at the beginning of the year
plus the face amount of policies issued and reinsurance assumed in the prior
year. The Unitrin Life and Health Group's lapse ratios for individual life
insurance were 12%, 15%, and 19% for the years 1998, 1997, and 1996,
respectively.
The customer base served by the Unitrin Life and Health Group's career
agents and competing life insurance companies tends to have a higher incidence
of lapse than other demographic segments of the population. Thus, to maintain or
increase the level of its business, the Unitrin Life and Health Group's career
agent operation must continue to write a high volume of new policies.
Competition
Based on the most recent data published by A.M. Best as of the end of 1997,
there were approximately 600 life and health insurance company groups in the
United States, made up of more than 1,100 companies. The Unitrin Life and
Health Group ranked among the 100 largest life and health insurance company
groups, as measured by admitted assets (90th) and capital and surplus (47th).
Unitrin's insurance subsidiaries generally compete using appropriate
pricing, selling to selected markets, controlling expenses, maintaining ratings
from A.M. Best, and providing competitive services to agents and policyholders.
CONSUMER FINANCE
Unitrin is engaged in the consumer finance business through its subsidiary,
Fireside Thrift Co. ("Fireside Thrift"), which has 36 branches in California and
one loan production office in Arizona.
Fireside Thrift is organized under California law as an industrial loan
company and is a member of the Federal Deposit Insurance Corporation (the
"FDIC"). Industrial loan companies are sometimes also referred to as thrift and
loan companies and are distinct from both savings and loan associations and
banks. See also "Regulation" below.
Fireside Thrift's principal business is the financing of used automobiles
through the purchase of
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conditional sales contracts from automobile dealers. Fireside Thrift also makes
personal loans, mostly secured by automobiles. The borrowers under these
contracts and loans typically have marginal credit histories. However, Fireside
Thrift individually underwrites each loan application and historically has
declined to extend credit to more than three quarters of its loan applicants.
See the discussion of Fireside Thrift's loan loss reserves under the heading
"Consumer Finance" in the MD&A and Note 6 to the Financial Statements.
Fireside Thrift competes for loans primarily on the basis of timely service
to its customers and by offering flexible loan terms. Principal competitors
include banks, finance companies, "captive" credit subsidiaries of automobile
manufacturers, and other industrial loan companies.
Fireside Thrift's financing activities are funded primarily by thrift
investment certificates (i.e., interest-bearing instruments that may be redeemed
by the owner or repurchased by Fireside Thrift under certain circumstances)
ranging from thirty-one days to five years in maturity and money market
accounts. Fireside Thrift competes for funds primarily with banks, savings and
loan associations, and other industrial loan companies.
INVESTMENTS
The quality, nature, and amount of the various types of investments which
can be made by insurance companies are regulated by state laws. These laws
permit investments in qualified assets, including municipal, state and federal
government obligations, corporate bonds, real estate, preferred and common
stocks, and mortgages where the value of the underlying real estate exceeds the
amount of the loan.
Unitrin's investment strategy is based on current market conditions and
other factors that it reviews from time to time. Unitrin's consolidated
investment portfolio consists primarily of United States Government obligations,
investment-grade fixed maturities, equity securities and investments in
investees. The Company's investment in non-investment grade, fixed maturity
investments is insignificant. See the discussions of the Company's investments
under the headings "Investees," "Investment Results," and "Liquidity and Capital
Resources" in the MD&A and Notes 4 and 5 to the Financial Statements.
REGULATION
Unitrin is subject to the insurance holding company laws of several states.
Certain dividends and distributions by an insurance subsidiary to its holding
company are subject to approval by the insurance regulators of the state of
incorporation of such subsidiary. Other significant transactions between an
insurance subsidiary and its holding company or other subsidiaries of the
holding company may require approval by insurance regulators in the state(s) of
incorporation of one or more of the insurance subsidiaries participating in such
transactions.
Unitrin's insurance subsidiaries are subject to regulation in the states in
which they do business. Such regulation pertains to matters such as approving
policy forms and various premium rates, licensing agents, granting and revoking
licenses to transact business and regulating trade practices. The majority of
Unitrin's insurance operations are in states requiring prior approval by
regulators before proposed rates for property, casualty, or health insurance
policies may be implemented. However, rates proposed for life insurance
generally become effective immediately upon filing with a state, even though the
same state may require prior rate approval for other types of insurance.
Insurance regulatory authorities perform periodic examinations of an insurer's
market conduct and other affairs.
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State insurance regulators also prescribe the form and content of statutory
financial statements, perform periodic financial examinations of insurers, set
minimum reserve and loss ratio requirements, establish standards for the types
and amounts of investments and require minimum capital and surplus levels. Such
statutory capital and surplus requirements include risk-based capital ("RBC")
rules promulgated by the National Association of Insurance Commissioners (the
"NAIC"). Compliance with the RBC rules is determined by the ratio of total
adjusted capital to the authorized control level RBC, in each case as defined by
the NAIC. At December 31, 1998, the total adjusted capital of every one of
Unitrin's insurance subsidiaries significantly exceeded the minimum RBC
requirements.
The NAIC annually calculates certain statutory financial ratios for most
insurance companies in the United States. These calculations are known as the
Insurance Regulatory Information System ("IRIS") ratios. There presently are
twelve IRIS ratios. The primary purpose of the ratios is to provide an "early
warning" of any negative developments. The NAIC reports the ratios to state
regulators who may then contact the companies if three or more ratios fall
outside the NAIC's "usual ranges." At December 31, 1997, five companies within
the Unitrin Property and Casualty Group each had three IRIS ratios outside the
usual range primarily due to the one time effects of ceding certain business to
Trinity pursuant to intercompany reinsurance arrangements.
In addition, the Company's insurance subsidiaries are required under the
guaranty fund laws of most states in which they transact business to pay
assessments up to prescribed limits to fund policyholder losses or liabilities
of insolvent insurance companies. The Company's insurance subsidiaries also are
required to participate in various involuntary pools, principally involving
workers compensation and windstorms. In most states, the involuntary pool
participation of the Company's insurance subsidiaries is in proportion to their
voluntary writings of related lines of business in such states.
Fireside Thrift is regulated by the California Department of Financial
Institutions and is subject to the provisions of the California Industrial Loan
Law, which imposes minimum capitalization requirements, limits dividends,
regulates loan terms, collection practices and remedies, and mandates disclosure
of certain contract terms. In addition, since Fireside Thrift is a member of
the FDIC, it is subject to regulations imposed by the FDIC on member
institutions, including federal consumer credit regulations. Fireside Thrift is
also governed by Federal Reserve Board regulations applicable to non-member
state banks.
ITEM 2. PROPERTIES
Owned Properties
Unitrin's subsidiary, United, owns the 41-story office building at One East
Wacker Drive, Chicago, Illinois, that houses the executive offices of Unitrin
and United. Unitrin and United occupy approximately 135,000 square feet of the
527,000 rentable square feet in the building. In addition, Unitrin subsidiaries
together own 29 buildings located in 10 states consisting of approximately
498,000 square feet in the aggregate.
Leased Facilities
The Unitrin Life and Health Group leases facilities at 212 locations in 26
states with aggregate square footage of approximately 436,000. The latest
expiration date of the existing leases is November 2003.
The Unitrin Property and Casualty Group leases facilities at 14 locations
in 11 states with an aggregate square footage of approximately 292,000. The
latest expiration date of the existing leases is July 2007.
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Fireside Thrift occupies 38 leased facilities (including consumer finance
branches and main office buildings) with an aggregate square footage of
approximately 148,000. The latest expiration date of the existing leases is
December 2007.
The properties described above are in good condition and suitable for all
presently anticipated requirements of the Company.
ITEM 3. LEGAL PROCEEDINGS
Unitrin and its subsidiaries are parties to various legal actions
incidental to their businesses. Some of these actions seek substantial punitive
damages against Unitrin and its subsidiaries that bear no apparent relationship
to the actual damages alleged. Although no assurances can be given and no
determination can be made as of the date hereof as to the outcome of any
particular legal action, the Company and its subsidiaries believe that there are
meritorious defenses to these legal actions and are defending them vigorously.
Unitrin believes that resolution of these matters will not have a material
adverse effect on Unitrin's financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the quarter ended December 31, 1998, no matters were submitted to a
vote of shareholders.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Unitrin's common stock is traded on the National Market Tier of the Nasdaq
Stock Market. The high and low prices for Unitrin's common stock during each
quarterly period in 1998 and 1997 are incorporated herein by reference to Note
20 to the Financial Statements, captioned "Quarterly Financial Information
(Unaudited)."
Information as to the amount and frequency of cash dividends declared by
Unitrin on its common stock during 1998 and 1997 is incorporated herein by
reference to the following portions of the Financial Statements:
(a) Consolidated Statements of Shareholders' Equity and Comprehensive
Income, and
(b) Dividends Paid to Common Shareholders (Per Share) included in Note 20
under the caption "Quarterly Financial Information (Unaudited)."
Information as to restrictions on the ability of Unitrin's subsidiaries to
transfer funds to Unitrin in the form of cash dividends, loans, or advances is
incorporated herein by reference to the following items:
(a) Note 9 to the Financial Statements, captioned "Shareholders' Equity,"
and
(b) The "Liquidity and Capital Resources" section of the MD&A.
As of December 31, 1998, the approximate number of record holders of
Unitrin's common stock was 8,900.
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ITEM 6. SELECTED FINANCIAL DATA
Selected consolidated financial data for the five years ended December 31,
1998 is incorporated herein by reference to the data captioned "Financial
Highlights" on page 1 of Unitrin's 1998 Annual Report, which data are filed as
Exhibit 13.3 hereto.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The MD&A is incorporated herein by reference to Exhibit 13.2.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(a) Quantitative Information About Market Risk
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The Company's balance sheet includes four types of financial instruments
subject to the material market risk disclosures required by Item 7A of Form 10-
K: (1) investments in fixed maturities, (2) investments in equity securities,
(3) consumer finance receivables and (4) investment certificates. Investments
in fixed maturities, consumer finance receivables and investment certificates
are subject to material interest rate risk. The Company's investments in equity
securities include common and preferred stocks and, accordingly, are subject to
material equity price risk and interest rate risk, respectively.
For purposes of this disclosure market risk sensitive financial instruments
are divided into two categories: financial instruments entered into for trading
purposes and financial instruments entered into for purposes other than trading.
The Company's market risk sensitive financial instruments are classified as held
for purposes other than trading. The Company has no significant holdings of
derivatives.
The Company measures its sensitivity to market risk by evaluating the
change in its financial assets and liabilities relative to fluctuations in
interest rates and equity prices. The evaluation is made using instantaneous
changes in interest rates and equity prices on a static balance sheet to
determine the effect such changes would have on the Company's market value at
risk and the resulting pre-tax effect on shareholders' equity. The changes
chosen reflect the Company's view of adverse changes which are reasonably
possible over a one-year period. The selection of the changes chosen should not
be construed as the Company's prediction of future market events, but rather an
illustration of the impact of such events.
For the interest rate sensitivity analysis presented below, the Company
assumed an adverse and instantaneous increase of 100 basis points in market
interest rates for investments in fixed maturities, preferred stock equity
securities and consumer finance receivables from their levels at December 31,
1998 and an adverse and instantaneous decrease of 100 basis points in market
interest rates for investment certificates from their levels at December 31,
1998. All other variables were held constant. The Company measured equity
price sensitivity assuming an adverse and instantaneous 10% decrease in the
Standard & Poor's Stock Index (the "S&P 500") from its level of December 31,
1998, with all other variables held constant. The Company's investments in
common stock equity securities were correlated with the S&P 500 using the
portfolio's weighted average beta of 0.99. The portfolio's weighted average
beta was calculated using each security's beta for the five-year period ended
December 31, 1998 and weighted on the fair value of such securities at December
31, 1998. Beta measures a stock's relative volatility in relation to the rest
of the stock market with the S&P 500 having a beta coefficient of 1. The
following table reflects the estimated adverse effects on the market value of
the Company's financial instruments using these assumptions.
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<TABLE>
<CAPTION>
(Dollars in Millions at December 31, 1998) Pro Forma Increase (Decrease)
--------------------------------------------------------------
Interest Equity Total
Fair Rate Price Market
Value Risk Risk Risk
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<S> <C> <C> <C> <C>
ASSETS
- ------
Investments in Fixed Maturities $2,557.3 $(66.3) $ - $(66.03)
Investments in Equity Securities 786.3 (4.4) (68.6) (73.0)
Consumer Finance Receivables 531.2 (6.7) - (6.7)
LIABILITIES
- -----------
Investment Certificates $ 544.2 $ 4.2 $ - $ 4.2
</TABLE>
The market risk sensitivity analysis assumes that the composition of the
Company's interest rate sensitive assets and liabilities, including but not
limited to future contractual cash flows and credit quality, and equity price
sensitive assets existing at the beginning of the period remains constant over
the period being measured. It also assumes that a particular change in interest
rates is reflected uniformly across the yield curve regardless of the time to
maturity. Interest rates on certain types of assets and liabilities may
fluctuate in advance of changes in market interest rates, while interest rates
on other types may lag behind changes in market rates. Also, any future
correlation, either in the near term or the long term, between the Company's
common stock equity securities portfolio and the S&P 500 may differ from the
historical correlation as represented by the weighted average historical beta of
the common stock equity securities portfolio. Accordingly, the market risk
sensitivity analysis may not be indicative of, is not intended to provide, and
does not provide a precise forecast of the effect of changes of market rates on
the Company's income or shareholders' equity. Further, the computations do not
contemplate any actions the Company may undertake in response to changes in
interest rates or equity prices.
To the extent that any adverse 100 basis point change occurs in increments
over a period of time instead of instantaneously, the adverse impact on fair
values would be partially mitigated because some of the underlying financial
instruments would have matured. For example, proceeds from any maturing assets
could be reinvested and any new liabilities incurred at the then current
interest rates.
(b) Qualitative Information About Market Risk
-----------------------------------------
Market risk is a broad term related to economic losses due to adverse
changes in the fair value of a financial instrument and is inherent to all
financial instruments. Item 7A of Form 10-K focuses on only one element of
market risk -- price risk. Price risk relates to changes in the level of prices
due to changes in interest rates, equity prices, foreign exchange rates or other
factors that relate to market volatility of the rate, index, or price underlying
the financial instrument. The Company's primary market risk exposures are to
changes in interest rates and certain exposures to changes in equity prices.
The Company manages its interest rate exposures with respect to investments
in fixed maturities by investing primarily in investment-grade securities of
relatively short duration. The interest rate risks with respect to the fair
value of consumer finance receivables should be partially offset by the impact
of interest rate movements on investment certificates which are issued to fund
its receivables.
At December 31, 1998, $602.4 million, or over 75% of the Company's
investments in equity securities, which exclude the Company's investments in
investees, were concentrated in one single issuer, Baker Hughes Incorporated
("Baker Hughes"). Baker Hughes reported in its 1997 Annual Report on Form 10-K
that it "operates in three industry segments: oilfield, chemicals and process
equipment," and that in addition to these industry segments, it "manufactures
and sells other products and provides
10
<PAGE>
services to industries not related to either the petroleum, specialty chemical
or continuous process industries." Accordingly, the Company's investments in
equity securities are sensitive to the cyclical nature of Baker Hughes's
industry segments.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements (including their related notes and the report of
KPMG LLP) are incorporated herein by reference to Exhibit 13.1 hereto. On
February 11, 1999, Unitrin's Board of Directors declared a 2-for-1 stock split
in the form of a stock dividend payable on March 26, 1999 to shareholders of
record on March 5, 1999. Prior to the declaration of the 2-for-1 stock split,
the Company had released its Financial Statements for the year ended December
31, 1998. Accordingly, consistent with Topic 4.C. "Change in Capital
Securities" of Staff Accounting Bulletin 57, the retroactive effect of the stock
split has not been presented in such Financial Statements included in this Item
8.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There was no change in, or disagreement with, the Company's accountants
during or relating to the year ended December 31, 1998.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors and executive officers, including, to the
extent applicable, information required by Item 405 of Regulation S-K, is
incorporated herein by reference to the sections captioned "Election of
Directors" and "Executive Officers" in the Proxy Statement for the 1999 Annual
Meeting of Shareholders of Unitrin. Unitrin plans to file such proxy statement
within 120 days after December 31, 1998, the end of Unitrin's fiscal year.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding compensation of executive officers is incorporated
herein by reference to the section captioned "Compensation of Executive
Officers" in the Proxy Statement for the 1999 Annual Meeting of Shareholders of
Unitrin. Neither the joint report by the Compensation and Stock Option
Committees of Unitrin's Board of Directors nor the Unitrin stock performance
graph to be included in such proxy statement shall be deemed to be incorporated
herein by this reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This information is incorporated herein by reference to the section
captioned "Ownership of Common Stock" in the Proxy Statement for the 1999 Annual
Meeting of Shareholders of Unitrin.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information is incorporated herein by reference to the section
captioned "Compensation Committee Interlocks and Insider Participation" in the
Proxy Statement for the 1999 Annual Meeting of Shareholders of Unitrin.
11
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A) DOCUMENTS FILED AS PART OF THIS REPORT:
1. Financial Statements. The following financial statements, in response to
--------------------
Item 8 of the Form 10-K, have been filed as Exhibit 13.1 and are
incorporated by reference into Item 8 hereof:
The consolidated balance sheets of Unitrin and subsidiaries as of December
31, 1998 and 1997, and the consolidated statements of income, cash flows
and shareholders' equity and comprehensive income for the years ended
December 31, 1998, 1997 and 1996, together with the notes thereto and the
report of KPMG LLP thereon, dated January 8, 1999.
2. Financial Statement Schedules. The following four financial statement
-----------------------------
schedules are included on the following pages hereof. Schedules not listed
here have been omitted because they are not applicable or not material or
the required information is included in the Financial Statements.
Schedule I: Investments Other Than Investments in Related Parties
Schedule II: Parent Company Financial Statements
Schedule III: Supplementary Insurance Information
Schedule IV: Reinsurance Schedule
3. Exhibits. The following exhibits are either filed as a part hereof or are
--------
incorporated by reference. Exhibit numbers correspond to the numbering
system in Item 601 of Regulation S-K. Exhibits 10.1 through 10.7 relate to
compensatory plans filed or incorporated by reference as exhibits hereto
pursuant to Item 14(c) of Form 10-K.
2 Stock Acquisition Agreement dated as of February 10, 1999 by and
between Unitrin, Inc. and Fund American Enterprises Holdings, Inc.
3.1 Certificate of Incorporation (incorporated herein by reference to
Exhibit 3.1 to the Company's Registration Statement on Form 10 dated
February 15, 1990)
3.2 Amended and Restated By-Laws (incorporated herein by reference to
Exhibit 3.2 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1997)
4 Rights Agreement between Unitrin, Inc. and First Chicago Trust
Company of New York, as rights agent, dated as of August 3, 1994
(incorporated herein by reference to Exhibit 1 to the Company's
Registration Statement on Form 8-A dated August 3, 1994)
10.1 Unitrin, Inc. 1990 Stock Option Plan, as amended and restated
(incorporated herein by reference to Exhibit 10.1 to the Company's
1995 Annual Report on Form 10-K)
10.2 Unitrin, Inc. 1997 Stock Option Plan (incorporated herein by
reference to Exhibit A to the Proxy Statement dated April 9, 1997
for the Annual Meeting of Shareholders of Unitrin held May 14, 1997)
12
<PAGE>
10.3 Unitrin, Inc. 1995 Non-Employee Director Stock Option Plan
(incorporated herein by reference to Exhibit 10.3 to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1995)
10.4 Unitrin, Inc. Pension Equalization Plan (incorporated herein by
reference to Exhibit 10.4 to the Company's 1994 Annual Report on
Form 10-K)
10.5 Unitrin is a party to individual severance agreements (the form of
which is incorporated herein by reference to Exhibit 10.5 to the
Company's 1994 Annual Report on Form 10-K), with the following
executive officers:
Richard C. Vie (Chairman, President and Chief Executive Officer)
David F. Bengston (Vice President)
James W. Burkett (Vice President)
Eric J. Draut (Senior Vice President, Treasurer, and Chief
Financial Officer )
Thomas H. Maloney (Vice President)
Scott Renwick (General Counsel and Secretary)
Donald G. Southwell (Senior Vice President)
(Note: Each of the foregoing agreements is identical except that
the severance compensation multiple is 2.99 for Mr. Vie and 2.0 for
the other executive officers. The term of these agreements has been
extended by action of Unitrin's Board of Directors through January
1, 2000.)
10.6 Severance Compensation Plan After Change of Control (incorporated
herein by reference to Exhibit 10.6 to the Company's 1994 Annual
Report on Form 10-K; the term of this plan has been extended by
action of Unitrin's Board of Directors through January 1, 2000)
10.7 1998 Unitrin, Inc. Bonus Plan for Senior Executives (incorporated
herein by reference to Exhibit A to the Proxy Statement dated April
9, 1998, in connection with the Annual Meeting of Shareholders of
Unitrin held May 13, 1998)
10.8 Amended and Restated Credit Agreement, dated September 17, 1997
among Unitrin, Inc., the Lenders party thereto, and NationsBank of
Texas, N.A. (incorporated herein by reference to Exhibit 10.7 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1997)
13.1 Financial Statements (pages 23 through 47 of Unitrin's 1998 Annual
Report)
13.2 MD&A (pages 16 through 22 of Unitrin's 1998 Annual Report)
13.3 Financial Highlights (page 1 of Unitrin's 1998 Annual Report)
21 Subsidiaries of Unitrin, Inc.
23.1 Reports of KPMG LLP (included in Exhibit 13.1 hereof and filed as
Exhibit 23.1 hereof)
23.2 Consent of KPMG LLP
13
<PAGE>
24 Power of Attorney (included on the signature page hereof)
27 Financial Data Schedule
(b) Reports on Form 8-K. None
(c) Exhibits. Included in Item 14(a)3 above.
(d) Financial Statement Schedules. Included in Item 14(a)2 above.
14
<PAGE>
POWER OF ATTORNEY
Each person whose signature appears below hereby appoints each of Richard
C. Vie, Chairman of the Board, President and Chief Executive Officer, Eric J.
Draut, Senior Vice President, Treasurer and Chief Financial Officer, and Scott
Renwick, General Counsel and Secretary, his true and lawful attorney-in-fact
with authority together or individually to execute in the name of each such
signatory, and with authority to file with the Securities and Exchange
Commission, any and all amendments to this Annual Report on Form 10-K of
Unitrin, Inc., together with any and all exhibits thereto and other documents
therewith, necessary or advisable to enable Unitrin, Inc. to comply with the
Securities Exchange Act of 1934, as amended, and any rules, regulations, and
requirements of the Securities and Exchange Commission in respect thereof, which
amendments may make such other changes in the Annual Report on Form 10-K as the
aforesaid attorney-in-fact executing the same deems appropriate.
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, Unitrin, Inc. has duly caused this Annual Report on Form 10-K for the
fiscal year ended December 31, 1998 to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Chicago, State of
Illinois, on March 15, 1999.
UNITRIN, INC.
(Registrant)
By: /S/ Richard C. Vie
------------------
Richard C. Vie
Chairman of the Board, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of Unitrin, Inc.
in the capacities indicated on March 15, 1999.
<TABLE>
<CAPTION>
Signature Title
--------- -----
<S> <C>
/S/ Richard C. Vie Chairman of the Board, President, Chief Executive Officer
- -------------------------------------- and Director
Richard C. Vie
/S/ Eric J. Draut Senior Vice President, Treasurer and Chief Financial Officer
- ------------------------------------- (principal financial officer)
Eric J. Draut
/S/ Richard Roeske Corporate Controller
- ------------------------------------- (principal accounting officer)
Richard Roeske
/S/ James E. Annable Director
- -------------------------------------
James E. Annable
/S/ Reuben L. Hedlund Director
- ------------------------------------
Reuben L. Hedlund
/S/ Jerrold V. Jerome Director
- ------------------------------------
Jerrold V. Jerome
/S/ William E. Johnston, Jr. Director
- ------------------------------------
William E. Johnston, Jr.
/S/ George A. Roberts Director
- ------------------------------------
George A. Roberts
/S/ Fayez S. Sarofim Director
- ------------------------------------
Fayez S. Sarofim
/S/ Henry E. Singleton Director
- ------------------------------------
Henry E. Singleton
</TABLE>
15
<PAGE>
SCHEDULE I
UNITRIN, INC. AND SUBSIDIARES
INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31,1998
(Dollars in Millions)
<TABLE>
<CAPTION>
Amount
Amortized Fair Carried in
Cost Value Balance Sheet
--------------- ------------- -----------------
<S> <C> <C> <C>
Fixed Maturities:
Bonds and Notes:
United States Government and
Government Agencies and Authorities $ 1,903.9 $ 1,952.4 $ 1,952.4
States, Municipalities
and Political Subdivisions 142.8 146.3 146.3
Corporate Securities:
Other Bonds and Notes 338.5 348.9 348.9
Redemptive Preferred Stocks 107.3 109.7 109.7
-------------- ------------- -------------
Total Investments in Fixed Maturities 2,492.5 2,557.3 2,557.3
-------------- ------------- -------------
Equity Securities:
Common Stocks 743.1 693.0 693.0
Non-redemptive Preferred Stocks 88.1 93.3 93.3
-------------- ------------- -------------
Total Investments in Equity Securities 831.2 786.3 786.3
-------------- ------------- -------------
Investees (A)
Litton Industries, Inc. 341.6 826.7 341.6
UNOVA, Inc. 147.0 229.4 147.0
Curtiss-Wright Corporation 92.6 167.1 92.6
-------------- ------------- -------------
Total Investees 581.2 1,223.2 581.2
-------------- ------------- -------------
Loans, Real Estate and Short-term Investments 379.4 XXX.X 379.4
-------------- ------------- -------------
Total Investments $ 4,284.3 $ 4,304.2
============== =============
</TABLE>
(A) - Amortized Cost = Cost Plus Cumulative Undistributed Earnings.
See Accompanying Independent Auditors' Report.
<PAGE>
SCHEDULE II
UNITRIN, INC.
PARENT COMPANY BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
(Dollars in Millions)
<TABLE>
<CAPTION>
December 31,
---------------------------
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
- ------
Investment in Subsidiaries and Investees $ 2,288.5 $ 1,641.0
Equity Securities at Fair Value (Cost: 1998 - $310.0; 1997 - $50.0) 259.4 56.7
Short Term Investments 90.0 10.8
Other Assets 19.0 2.0
------------ ------------
Total Assets $ 2,656.9 $ 1,710.5
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Notes Payable - Revolving Credit Agreement $ 110.0 75.0
Notes Payable to Subsidiary, 6.75% Due 2008 450.0 -
Accrued Expenses and Other Liabilities 274.5 102.5
------------ ------------
Total Liabilities 834.5 177.5
------------ ------------
Shareholders' Equity:
Common Stock 3.8 3.8
Additional Paid-in Capital 428.2 217.8
Retained Earnings 1,377.2 1,209.7
Accumulated Other Comprehensive Income 13.2 101.7
------------ ------------
Total Shareholders' Equity 1,822.4 1,533.0
------------ ------------
Total Liabilities and Shareholders' Equity $ 2,656.9 $ 1,710.5
============ ============
</TABLE>
See Accompanying Independent Auditors' Report.
<PAGE>
SCHEDULE II
UNITRIN, INC.
PARENT COMPANY STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(Dollars in Millions)
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------------
1998 1997 1996
-------------- ------------- --------------
<S> <C> <C> <C>
Net Investment Income $ 2.4 $ 5.5 $ 7.1
Net Gains (Losses) on Sales of Investments (2.5) - -
-------------- ------------- --------------
Total Revenues (0.1) 5.5 7.1
-------------- ------------- --------------
Interest Expense 14.1 10.0 9.8
Other Operating (Income) Expenses (1.4) (2.7) 1.6
-------------- ------------- --------------
Total Operating Expenses 12.7 7.3 11.4
-------------- ------------- --------------
Income (Loss) Before Income Taxes and Equity
in Net Income of Subsidiaries and Investees (12.8) (1.8) (4.3)
Income Tax (Benefit) Expense (5.1) (2.0) (3.2)
-------------- ------------- --------------
Income (Loss) Before Equity in
Net Income of Subsidiaries and Investees (7.7) 0.2 (1.1)
Equity in Net Income of Subsidiaries and Investees 518.5 117.7 133.6
-------------- ------------- --------------
Net Income $ 510.8 $ 117.9 $ 132.5
============== ============= ==============
</TABLE>
See Accompanying Independent Auditors' Report.
<PAGE>
SCHEDULE II
UNITRIN, INC.
PARENT COMPANY STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(Dollars in Millions)
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------------------
1998 1997 1996
-------------------- ---------------------- ---------------
<S> <C> <C> <C>
Operating Activities:
Net Income $ 510.8 $ 117.9 $ 132.5
Adjustment Required to Reconcile Net Income
to Net Cash Provided by Operations:
Equity in Net Income of Subsidiaries and Investees (518.5) (117.7) (133.6)
Cash Dividends from Subsidiaries 26.0 181.1 149.8
Cash Dividends from Investee 2.3 2.2 1.4
Loss on Sale of Investments 2.5 - -
Other, Net 170.7 (95.8) 128.4
-------------------- ---------------------- ---------------
Net Cash Provided by Operating Activities 193.8 87.7 278.5
-------------------- ---------------------- ---------------
Investing Activities:
Purchase of Securities from Subsidiaries:
Curtiss-Wright Common Stock - - (95.4)
Baker Hughes Common Stock (310.0) - -
Redemption of Equity Securities 47.5 - -
Change in Short-term Investments (79.2) (10.8) -
Purchases of Property - - (3.7)
Other, Net (0.7) - -
-------------------- ---------------------- ---------------
Net Cash Used by Investing Activities (342.4) (10.8) (99.1)
-------------------- ---------------------- ---------------
Financing Activities:
Notes Payable Proceeds:
Revolving Credit Agreement 381.6 515.0 170.0
From Subsidiary 450.0 - -
Notes Payable Payments:
Revolving Credit Agreement (356.6) (493.0) (210.0)
Cash Dividends Paid (100.7) (89.9) (83.0)
Common Stock Repurchases (232.9) (20.7) (61.1)
Issuance of Unitrin Common Stock 7.2 11.7 4.7
-------------------- ---------------------- ---------------
Net Cash Provided (Used) by Financing Activities 148.6 (76.9) (179.4)
-------------------- ---------------------- ---------------
Increase (Decrease) in Cash - - -
Cash, Beginning of Year - - -
-------------------- ---------------------- ---------------
Cash, End of Year $ - $ - $ -
==================== ====================== ===============
</TABLE>
See Accompanying Independent Auditors' Report.
<PAGE>
SCHEDULE II
UNITRIN, INC.
PARENT COMPANY STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(Dollars in Millions)
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net Income $ 510.8 $ 117.9 $ 132.5
Other Comprehensive Income:
Gross Unrealized Holding Gains (Losses) Arising During Year:
Securities Held by Subsidiaries (11.5) 36.4 (54.8)
Securities Held by Parent (59.8) 3.1 2.1
Other 0.2 -- --
------------ ------------ ------------
Gross Unrealized Holding Gains (Losses) Arising During Year (71.1) 39.5 (52.7)
Income Tax Benefit (Expense) 25.0 (14.0) 18.5
------------ ------------ ------------
Unrealized Holding Gains (Losses) Arising During Year, Net (46.1) 25.5 (34.2)
------------ ------------ ------------
Reclassification Adjustment for Gross (Gains) Losses Realized in Net Income:
Securities Held by Subsidiaries (66.9) (2.5) (2.2)
Securities Held by Parent 2.5 -- --
------------ ------------ -------------
Reclassification Adjustment for Gross Gains Realized in Net Income (64.4) (2.5) (2.2)
Income Tax Expense 22.0 0.9 0.8
------------ ------------ ------------
Reclassification Adjustment for Gains Realized in Net Income, Net (42.4) (1.6) (1.4)
------------ ------------ ------------
Other Comprehensive Income (88.5) 23.9 (35.6)
------------ ------------ ------------
Total Comprehensive Income $ 422.3 $ 141.8 $ 96.9
============ ============ ============
</TABLE>
See Accompanying Independent Auditors' Report.
<PAGE>
SCHEDULE III
UNITRIN, INC. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
(Dollars in Millions)
<TABLE>
<CAPTION>
Insurance Amortization
Claims Of Deferred
Net and Policy Other
Premiums Investment Policyholders' Acquisition Insurance
Premiums Written Income Benefits Costs Expenses
------------------- ------------ ------------- -------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Year Ended December 31, 1998:
Life and Health (1) $ 580.0 $ N/A $ 139.9 $ 326.2 $ 50.5 $ 275.3
Property and Casualty 648.3 608.2 45.7 455.6 98.8 92.6
Other -- N/A 0.8 -- -- (9.5)
------------------- ------------ ------------- -------------- ------------- -------------
Total $ 1,228.3 $ N/A $ 186.4 $ 781.8 $ 149.3 $ 358.4
=================== ============ ============= ============== ============= =============
Year Ended December 31, 1997:
Life and Health (1) $ 499.1 $ N/A $ 124.6 $ 275.3 $ 55.3 $ 230.5
Property and Casualty 722.9 732.3 51.6 504.8 112.1 94.4
Other -- N/A 3.3 -- -- (11.9)
------------------- ------------ ------------- -------------- ------------- -------------
Total $ 1,222.0 $ N/A $ 179.5 $ 780.1 $ 167.4 $ 313.0
=================== ============ ============= ============== ============= =============
Year Ended December 31, 1996:
Life and Health (1) $ 546.9 $ N/A $ 127.6 $ 314.6 $ 62.9 $ 248.5
Property and Casualty 673.4 683.3 45.4 485.1 107.2 79.2
Other -- N/A 6.0 -- -- (11.6)
------------------- ------------ ------------- -------------- ------------- -------------
Total $ 1,220.3 $ N/A $ 179.0 $ 799.7 $ 170.1 $ 316.1
=================== ============ ============= ============== ============= =============
<CAPTION>
Deferred
Policy
Acquisition Insurance Unearned
Costs Reserves Premiums
------------- ------------- -------------
<S> <C> <C> <C>
Year Ended December 31, 1998:
Life and Health (1) $ 296.7 $ 2,086.2 $ 30.4
Property and Casualty 35.3 440.5 232.8
Other -- -- --
------------- ------------- -------------
Total $ 332.0 $ 2,526.7 $ 263.2
============= ============= =============
Year Ended December 31, 1997:
Life and Health (1) $ 195.5 $ 1,573.4 $ 7.3
Property and Casualty 41.6 462.6 272.2
Other -- -- --
------------- ------------- -------------
Total $ 237.1 $ 2,036.0 $ 279.5
============= ============= =============
</TABLE>
(1) The Company's Life and Health Insurance employee-agents also market certain
property and casualty insurance products under common management. Accordingly,
the Company includes the results of these property and casualty insurance
products in its Life and Health Insurance segment.
See Accompanying Independent Auditors' Report.
<PAGE>
SCHEDULE IV
UNITRIN, INC.
REINSURANCE SCHEDULE
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 and 1996
(Dollars in Millions)
<TABLE>
<CAPTION>
Percentage
Ceded to Assumed of Amount
Gross Other from Other Net Assumed to
Amount Companies Companies Amount Net
--------------- ------------ ------------- -------------- -------------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1998:
- ----------------------------
Life Insurance in Force $ 21,221.4 $ 1,567.2 $ - $ 19,654.2 -
Premiums
Life Insurance $ 378.1 $ 2.1 $ - $ 376.0 -
Accident and Health Insurance 140.7 5.4 0.2 135.5 0.1%
Property and Liability Insurance 651.2 16.2 81.8 716.8 11.4%
--------------- ------------ ------------ -------------- -------------
Total Premiums $ 1,170.0 $ 23.7 $ 82.0 $ 1,228.3 6.7%
=============== ============ ============ ============== =============
Year Ended December 31, 1997:
- ----------------------------
Life Insurance in Force $ 17,709.2 $ 1,797.8 $ - $ 15,911.4 -
Premiums
Life Insurance $ 350.7 $ 19.8 $ - $ 330.9 -
Accident and Health Insurance 119.1 3.3 - 115.8 -
Property and Liability Insurance 697.9 18.0 95.4 775.3 12.3%
--------------- ------------ ------------ -------------- -------------
Total Premiums $ 1,167.7 $ 41.1 $ 95.4 $ 1,222.0 7.8%
=============== ============ ============ ============== =============
Year Ended December 31, 1996:
- ----------------------------
Life Insurance in Force $ 18,747.2 $ 2,120.2 $ - $ 16,627.0 -
Premiums
Life Insurance $ 368.8 $ 9.4 $ - $ 359.4 -
Accident and Health Insurance 130.6 0.9 - 129.7 -
Property and Liability Insurance 643.4 21.8 109.6 731.2 15.0%
--------------- ------------ ------------ -------------- -------------
Total Premiums $ 1,142.8 $ 32.1 $ 109.6 $ 1,220.3 9.0%
=============== ============ ============ ============== =============
</TABLE>
See Accompanying Independent Auditors' Report.
<PAGE>
EXHIBIT 2
STOCK ACQUISITION AGREEMENT
UNITRIN, INC.
AND
FUND AMERICAN ENTERPRISES, INC.
<PAGE>
EXHIBIT 2
STOCK ACQUISITION AGREEMENT
STOCK ACQUISITION AGREEMENT dated as of February 10, 1999 ("Agreement") by
and between Unitrin, Inc., a Delaware corporation ("Buyer"), and Fund American
Enterprises Holdings, Inc., a Delaware corporation ("Seller"), for the
acquisition and conveyance of all of the outstanding capital stock of Valley
Group, Inc., an Oregon corporation and an indirect wholly owned subsidiary of
Seller (the "Company").
WHEREAS, the Company is the owner of all of the issued and outstanding
capital stock of each of Charter Group, Inc., a Texas corporation ("Charter"),
Valley Insurance Company, a California insurance company ("VIC"), Valley
Pacific, Inc., an Oregon corporation ("Valley Pacific"), and Valley Property &
Casualty Insurance Company, an Oregon insurance company ("VP&C") (Charter, VIC,
Valley Pacific and VP&C are sometimes hereinafter each individually referred to
as a "Subsidiary" and collectively referred to as the "Subsidiaries");
WHEREAS, Charter is the owner of all of the issued and outstanding capital
stock of Charter General Agency, Inc., a Texas corporation ("CGA"), Charter
Indemnity Company, a Texas insurance company ("CIC"), and NCM Management
Corporation, a Delaware corporation ("NCM");
WHEREAS, NCM controls Charter County Mutual Insurance Company, a Texas
insurance company ("Charter County Mutual") pursuant to a general agency
managerial contract;
WHEREAS, pursuant to that certain Stock Purchase Agreement dated as of
October 14, 1998 by and among Charter, Pinnacle Insurance Company, a Georgia
insurance company in rehabilitation ("Pinnacle"), and the Honorable John W.
Oxendine, Commissioner of the Georgia Department of Insurance and Safety Fire
acting solely in his capacity as the rehabilitator of Pinnacle (the "Pinnacle
Acquisition Agreement"), Charter has agreed to acquire all of the outstanding
shares of capital stock of Pinnacle;
WHEREAS, VIC is the owner of all of the issued and outstanding capital
stock of each of Valley National Insurance Company, a Kansas insurance company
("Valley National"), and White Mountains Insurance Company, a New Hampshire
insurance company ("WMIC");
WHEREAS, for the consideration and subject to the terms and conditions set
forth in this Agreement, Buyer desires to purchase or cause to be purchased from
Seller, and
<PAGE>
Seller desires to sell or cause to be sold to Buyer, all of the issued and
outstanding capital stock of the Company for the purpose of Buyer acquiring
control of the Company, the Subsidiaries and the following entities owned or
controlled by the Company, the Subsidiaries or their respective subsidiaries:
CGA, CIC, NCM, WMIC and Charter County Mutual (the Company, the Subsidiaries,
CGA, CIC, NCM, WMIC and Charter County Mutual are sometimes hereinafter each
individually referred to as a "Subject Entity" and collectively referred to as
the "Subject Entities," and VIC, VP&C, CIC, WMIC, and Charter County Mutual are
sometimes each individually referred to as an "Insurance Company" and
collectively referred to as the "Insurance Companies");
WHEREAS, in connection with Buyer's acquisition of control of the Subject
Entities, Buyer wishes to acquire the assets used, and immediately following
the Closing continue to employ those employees engaged, in the business
operations of the Subject Entities, subject to the terms and conditions set
forth in this Agreement; and
WHEREAS, Buyer does not wish to acquire ownership or control of either
Pinnacle or Valley National (Pinnacle and Valley National are hereinafter
collectively referred to as the "Excluded Subsidiaries"); provided, however,
that Buyer wishes to acquire the business of Valley National as in effect on the
Closing Date.
NOW, THEREFORE, in consideration of the covenants and mutual promises
herein contained, Buyer and Seller agree as follows:
1. SALE OF SHARES; RELATED TRANSACTIONS.
------------------------------------
1.01 Sale and Purchase of Shares. Subject to the terms and conditions of
---------------------------
this Agreement, Seller agrees to sell, transfer and convey (or cause to be sold,
transferred and conveyed) to Buyer, and Buyer agrees to purchase and accept (or
cause to be purchased and accepted) from Seller, for the aggregate purchase
price set forth below in Section 1.02 (the "Purchase Price"), all of the shares
of common stock of the Company beneficially owned by Seller, representing one
hundred percent of the issued and outstanding shares of capital stock of the
Company (the "Shares").
1.02 Purchase Price; Post-Closing Adjustment.
---------------------------------------
(A) Purchase Price. The Purchase Price for the Shares shall be an
--------------
amount equal to the sum of (i) $90,000,000 (ninety million dollars) plus
(ii) the sum of (x) the amount of the consolidated book value of the
Company determined in accordance with United States generally accepted
accounting principles ("GAAP") as applied by the Seller and the Company
consistent with the GAAP Consolidated Financial Statements described in
Section 2.09 ("GAAP Book
2
<PAGE>
Value") at the Closing Date, after taking into account all Related
Transactions completed at or prior to the Closing, and (y) the amount of
any and all bank indebtedness of the Company in respect of borrowed money
("Indebtedness") which is outstanding immediately prior to the Closing.
(B) Estimated Purchase Price. On the Closing Date, Buyer shall pay to
------------------------
Seller an amount equal to an estimate, prepared by Seller and delivered to
Buyer as described in the following sentence, of the Purchase Price (the
"Estimated Purchase Price"). Not later than five (5) business days prior to
Closing, Seller shall deliver to Buyer (i) a balance sheet reflecting GAAP
Book Value at the end of the month immediately preceding the Closing Date,
prepared in a manner consistent with the GAAP Consolidated Financial
Statements described in Section 2.09 (the "Prior Month-End Balance Sheet")
as adjusted on an estimated basis to give effect to the Related
Transactions, (ii) a schedule detailing the components of the Estimated
Purchase Price including, without limitation, the adjustments for the
Related Transactions and the amount of Indebtedness (if any), and (iii) a
certificate from Seller certifying that such Prior Month-End Balance Sheet
has been so prepared. At Closing, Buyer shall pay to Seller the Estimated
Purchase Price by wire transfer of immediately available funds to a bank
account or other accounts designated by Seller. Buyer and Seller agree
that, to the extent any amount of the Indebtedness is outstanding at
Closing, a portion of Purchase Price equal thereto shall be paid by Buyer
directly to the banking institution or institutions holding such
Indebtedness such that the Indebtedness is fully extinguished
contemporaneous with Closing.
(C) Post-Closing Determination of Actual Purchase Price. Not later
---------------------------------------------------
than forty-five (45) days after the Closing Date, Buyer shall deliver to
Seller (i) a balance sheet reflecting GAAP Book Value at the Closing Date
(taking into account all Related Transactions completed at or prior to the
Closing) prepared in a manner consistent with the GAAP Consolidated
Financial Statements described in Section 2.09 (the "Closing Date Balance
Sheet") and (ii) a certificate from Buyer certifying that such Closing Date
Balance Sheet has been so prepared. If GAAP Book Value as reflected on the
Closing Date Balance Sheet exceeds GAAP Book Value used to determine the
Estimated Purchase Price (as adjusted on an estimated basis to give effect
to the Related Transactions) by at least $250,000, then, subject to the
resolution of any disputes pursuant to Section 1.02(D), Buyer shall pay to
Seller such difference (including such $250,000 amount) within ten (10)
business days after the receipt of the Closing Date Balance Sheet by
Seller, together with interest thereon at an annual rate equal to the
average yield to maturity on United States Treasury securities with a
remaining maturity of one year as published from time to time by The Wall
Street Journal, calculated on the
3
<PAGE>
basis of the actual number of days elapsed over 365 (the "Interest Rate"),
from the Closing Date to the date of payment, by wire transfer of
immediately available funds to a bank account designated by Seller. If, on
the other hand, GAAP Book Value used to determine the Estimated Purchase
Price (as adjusted on an estimated basis to give effect to the Related
Transactions) exceeds GAAP Book Value as reflected on the Closing Date
Balance Sheet by at least $250,000, then, subject to the resolution of any
disputes pursuant to Section 1.02(D), Seller shall pay to Buyer such
difference (including such $250,000 amount) within ten (10) business days
after the receipt of the Closing Date Balance Sheet by Seller, together
with interest thereon at the Interest Rate, from the Closing Date to the
date of payment, by wire transfer of immediately available funds to a bank
account designated by Buyer. In the event that the GAAP Book Value as
reflected on the Closing Date Balance Sheet is neither $250,000 more nor
$250,000 less than the GAAP Book Value used to determine the Estimated
Purchase Price (as adjusted on an estimated basis to give effect to the
Related Transactions), then, subject to the resolution of any disputes
pursuant to Section 1.02(D), the Estimated Purchase Price paid by Buyer to
Seller at Closing shall be the Purchase Price.
(D) Dispute Resolution. Seller and Buyer shall seek in good faith to
------------------
resolve in writing any disputes which they may have as to the Closing Date
Balance Sheet, GAAP Book Value, the Purchase Price or the adjustments to
reflect the Related Transactions within thirty (30) days after the receipt
of the Closing Date Balance Sheet by Seller. Any such disputes that remain
unresolved at the end of any such 30-day period shall be referred to an
accounting firm of national standing and reputation mutually agreed to by
the parties in writing (the "Accounting Firm"). The fees of the Accounting
Firm agreed to shall be shared equally by Buyer and Seller. The Accounting
Firm shall be instructed to, within thirty (30) days after the submission
of any disputed matters by Seller and Buyer, review and resolve all such
disputed matters and to report in writing its resolution thereof to Seller
and Buyer. The determination of the Accounting Firm shall be final,
binding and conclusive with respect to Seller and Buyer, and Seller and
Buyer agree that judgment may be entered upon the determination of the
Accounting Firm in any court having jurisdiction over the party against
which such determination is to be enforced. Balances in dispute due from
either party shall be paid by wire transfer of immediately available funds
to a bank account designated by the payee within ten (10) business days
after the parties are notified in writing of the determination rendered by
the Accounting Firm.
1.03 Related Transactions. Seller shall use its reasonable best efforts
--------------------
to complete the following transactions (the "Related Transactions") at or prior
to Closing:
4
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(A) Distributable Assets.
--------------------
(i) Buyer and Seller acknowledge and agree that it is their mutual
intent that, subject to the receipt of all necessary regulatory and
governmental approvals therefor, at or prior to the Closing:
(1) (x) the assets set forth in Section 1.03(A)(i)(1) of the
Seller Schedule (as defined in Section 2)/1/, and
(y) all other property (other than cash) purchased by any
Subject Entity on or after December 31, 1998 that is designated by
Seller and/or Buyer as at the time of the purchase thereof as a
Distributable Asset (collectively, "Distributable Assets"), shall
be distributed, sold or otherwise transferred by the Subject
Entities; and
(2) subject to completion of the reinsurance transaction
described in this Section 1.03(A)(i)(2), the statutory capital and
surplus of CIC, VIC, WMIC, and VP&C remaining after all the
Distributable Assets have been distributed, sold or otherwise
transferred pursuant to (1), above, will be reduced by means of
investment asset distributions by each such company to its
respective parent company, as nearly as possible (leaving a
reasonable margin for error) to the minimum statutory amount
required to maintain in good standing the certificates of authority
of each such company to transact insurance or reinsurance in the
jurisdictions identified in Section 2.21 of the Seller Schedule
("Excess Capital Distributions"), and the parties agree that such
required minimum statutory amounts shall be as mutually agreed and
set forth in Section 1.03(A)(i)(2) of the Seller Schedule. Any
Subject Entity that receives an Excess Capital Distribution (as
defined below), or a distribution relating to a lower-tier Excess
Capital Distribution, from one or more Subject Entities shall
distribute such amount to its parent. Buyer and Seller acknowledge
that Buyer intends to arrange for the reinsurance cession of all
business of the foregoing Subject Entities to Trinity Universal
Insurance Company and/or another qualified reinsurer having
adequate capital and surplus to support such reinsurance, subject
to applicable regulatory approval. For purposes of determining the
Purchase Price, the GAAP Book Value shall be increased by the
amount of all of Seller's deferred policy acquisitions costs, net
of related deferred taxes, calculated in a manner consistent
__________________
/1/ to include all investment assets that Seller desires to retain and/or Buyer
does not wish to acquire and the capital stock of Valley National and
Pinnacle
5
<PAGE>
with the GAAP Consolidated Financial Statements described in
Section 2.09, related to the business transferred pursuant to such
reinsurance arrangement, if any. Buyer agrees to undertake such
reinsurance upon terms and conditions reasonably satisfactory to
Seller. The distributions made pursuant to this Section 1.03(A)
shall be treated as made pursuant to a plan of liquidation adopted
by each of the Subject Entities prior to such distributions and in
connection with the deemed liquidation of each of the Subject
Entities that is occurring by reason of the elections under Section
338(h)(10) of the IRC being filed with respect to each such entity
pursuant to Section 7.09
(ii) At the Closing, Seller shall deliver to Buyer its
calculation of the aggregate Distributable Asset Values (as defined below)
of all Distributable Assets, and, if and to the extent all necessary
regulatory and governmental approvals therefor shall have been obtained,
such Distributable Assets shall be transferred to Seller in the manner
described in Section 1.03(A)(i). "Distributable Asset Value" of any asset
at Closing means the carrying value of such asset, including related
receivables for interest and dividends, all determined in accordance with
GAAP as applied by Seller and the Company in a manner consistent with the
GAAP Consolidated Financial Statements described in Section 2.09.
(iii) In the event that any Distributable Assets (other than the
voting securities of Valley National and Pinnacle) are not transferred by
distribution to Seller (or its designee) in accordance with Section 1.03
(A)(i) at the Closing, then Seller (or its designee) shall buy, and Buyer
shall cause the Company or any other Subject Entity to sell, any or all
such remaining Distributable Assets, free and clear of any lien or
encumbrance, at a price equal to the Distributable Asset Value thereof
within one (1) business day following the date of the Closing. The sale
price of such Distributable Assets shall be payable by wire transfer of
immediately available funds to an account designated by Buyer.
(iv) If at any time after the Closing, the Company or any other
Subject Entity shall receive any cash or other property as a dividend,
distribution, return of capital or principal, premium or interest payment
(or similar payment) with respect to any Distributable Asset transferred by
way of distribution to Seller (or its designee) in accordance with Sections
1.03 (A)(i) or 1.03(A)(iii), the Company or such other Subject Entity shall
immediately transfer such cash or other property to Seller (or its
designee).
6
<PAGE>
(B) Asset Sale. Prior to the Closing, subject to the receipt of all
----------
necessary regulatory and governmental approvals therefor, Seller shall
cause Valley Pacific to sell to VIC all assets owned by or in the
possession of Valley Pacific that are located in the State of California in
exchange for an amount equal to the carrying value of such assets on the
date of sale determined in accordance with GAAP as applied by Seller and
the Company in a manner consistent with the GAAP Consolidated Financial
Statements described in Section 2.09 (the "Asset Sale").
2. REPRESENTATIONS AND WARRANTIES OF SELLER.
-----------------------------------------
For purposes of this Agreement:
the term "Company Material Adverse Effect" means a material adverse effect
on the business, assets, financial condition or results of operations of
the Subject Entities, taken as a whole (excluding any state of facts,
event, change or effect relating to (w) the economy or securities markets
in general, (x) this Agreement or the transactions contemplated hereby or
the announcement thereof, (y) the insurance industry in general (including
any changes in laws or regulations applicable to the insurance industry) or
(z) losses or loss adjustment expenses in the ordinary course of business;
and
the term "knowledge" with respect to Seller shall mean the actual knowledge
of the persons set forth on Schedule A hereto.
Seller represents and warrants to Buyer that, except as set forth in
the disclosure schedule of Seller attached hereto and made a part hereof (the
"Seller Schedule"):
2.01 Organization, Good Standing, Qualification of the Companies. Each of
-----------------------------------------------------------
the Subject Entities is duly organized, validly existing and in good standing
under the laws of the state of its organization and has all requisite corporate
power and authority to own or lease and operate its properties and assets and
carry on its business as now being conducted. Each of the Subject Entities is
duly qualified to transact business as a foreign corporation and is in good
standing in every jurisdiction in which such qualification is required by law to
carry on its business as now being conducted or to own, lease or operate its
properties and assets, except where the failure to so qualify or to be in good
standing would not, individually or in the aggregate, have a Company Material
Adverse Effect. Section 2.01 of the Seller Schedule lists each jurisdiction
where each Subject Entity is so qualified.
7
<PAGE>
2.02 Subsidiaries. Each of VIC, Charter, Valley Pacific and VP&C is a
------------
direct or indirect wholly-owned subsidiary of the Company. WMIC is a wholly-
owned subsidiary of VIC. CIC, CGA and NCM are wholly-owned subsidiaries of
Charter. Except as described in this Section 2.02 and except for investments in
the Excluded Subsidiaries and for the Distributable Assets, none of the Subject
Entities has any equity investment in any subsidiary, partnership, joint
venture, limited liability company or similar entity.
2.03 Authorized Stock.
----------------
(A) The authorized capital stock of the Company consists of 500
shares of common stock, no par value per share, of which 100 shares,
constituting the Shares, are issued and outstanding on the date hereof, all
of which are owned directly or indirectly by Seller. Section 2.03 of the
Seller Schedule sets forth the authorized and outstanding capital stock of
each Subject Entity other than the Company and Charter County Mutual.
(B) All of the issued and outstanding shares of the capital stock, if
any, of the Subject Entities have been validly issued and are fully paid,
nonassessable and free of preemptive rights and are owned free and clear of
any liens, claims, charges or encumbrances, and upon Closing, Buyer will
acquire directly or indirectly good and marketable title to all of such
shares.
(C) There is no contract, understanding, restriction or agreement,
including any voting trust or other agreement or understanding with respect
to the voting of any of the capital stock of the Subject Entities, or any
convertible, exchangeable or exercisable security, option, warrant, call,
or commitment on the part of the Subject Entities of any character relating
to issued or unissued shares of the capital stock of the Subject Entities.
2.04 Authorization. Seller has all requisite corporate power and
-------------
authority to enter into this Agreement, to perform its obligations hereunder and
to consummate the transactions contemplated hereby. All corporate acts and
other proceedings required to be taken by Seller or any of its affiliates (other
than the Subject Entities) to authorize the execution, delivery and performance
of this Agreement and the consummation of the transactions contemplated hereby
have been duly and properly taken. This Agreement has been duly executed and
delivered by Seller and constitutes a legal, valid and binding obligation of
Seller, enforceable against Seller in accordance with its terms.
2.05 Articles of Incorporation and By-laws. Seller has delivered to Buyer
-------------------------------------
true and complete copies of the articles or certificate of incorporation and by-
laws (or
8
<PAGE>
comparable constituent instruments) of each of the Subject Entities as in effect
as of the date hereof.
2.06 Consents and Approvals. Except for the consents and approvals listed
----------------------
on Section 2.06 of the Seller Schedule (the "Seller Consent Schedule") and
except for such filings, permits, authorizations, consents or approvals the
failure of which to obtain or make would not, individually or in the aggregate,
have a Company Material Adverse Effect, no filing with, and no permit,
authorization, consent or approval of, any public body or authority is necessary
for the consummation by Seller or any of its affiliates (other than the Subject
Entities) of the transactions contemplated by this Agreement.
2.07 Defaults and Conflicts. Neither Seller nor any of the Subject
----------------------
Entities is, or immediately prior to the Closing will be, in default under its
articles or certificate of incorporation or by-laws (or comparable constituent
instruments), or in default under any indenture or under any agreement or other
instrument to which it is a party or by which it or any of its properties is
bound or to which it is subject, which default would have a Company Material
Adverse Effect. Subject to the receipt of all consents and approvals
contemplated by this Agreement, neither the execution and delivery of this
Agreement, the consummation of the transactions contemplated hereby or the
fulfillment of and compliance with the terms and provisions hereof or thereof,
will (i) violate any judicial, administrative or arbitral order, writ, award,
judgment, injunction or decree involving Seller or any of the Subject Entities,
(ii) conflict with the terms, conditions or provisions of the certificate or
articles of incorporation or by-laws (or comparable constituent instruments) of
Seller or any of the Subject Entities, (iii) conflict with, result in a breach
of, constitute a default under or accelerate or permit the acceleration of the
performance required by, any indenture, agreement or other instrument that is
material to the business of any Subject Entity and to which Seller or any of the
Subject Entities is a party or by which any of them is bound (a "Material
Agreement"), (iv) result in the creation of any lien, charge or encumbrance upon
any of the assets of any of the Subject Entities under any such Material
Agreement, or (v) terminate or give any party thereto the right to terminate any
Material Agreement, except for any such violation, conflict, breach, default,
lien, charge, encumbrance, termination or other item which would not have a
Company Material Adverse Effect. Except as disclosed in Section 2.07 of the
Seller Schedule, no consent of any third party to any Material Agreement is
required in connection with this Agreement and the transactions contemplated
hereby.
2.08 Statutory Financial Statements. Each Subject Entity that is an
------------------------------
insurance company (each, an "Insurance Company") has filed all annual and
quarterly statements, together with all exhibits, interrogatories, notes,
schedules and any actuarial opinions, affirmations or certifications or other
supporting documents in connection therewith, required to be filed since
December 1, 1995 with or submitted to the appropriate
9
<PAGE>
regulatory authorities of the jurisdiction in which it is domiciled or
commercially domiciled on forms prescribed or permitted by such authorities.
Financial statements included in such statements, including amendments and the
notes thereto (the "Statutory Financial Statements"), were prepared in
conformity in all material respects with statutory accounting practices
prescribed or permitted by the applicable insurance regulatory authority ("SAP")
consistently applied for the periods covered thereby. The Statutory Financial
Statements, including, without limitation, the provisions made therein for
investments and the valuation thereof, reserves, policy and contract claims,
together with the notes, exhibits and schedules thereto, fairly present the
statement of admitted assets, liabilities and capital and surplus of the
applicable Insurance Company as of the dates thereof and the related statutory
basis statements of income, changes in capital and surplus, and cash flows for
the periods indicated in conformity with SAP, applied on a basis consistent with
prior periods, except as set forth therein. Each such Statutory Financial
Statement was in compliance in all material respects with applicable law when
filed and there were no material omissions therefrom.
2.09 GAAP Consolidated Financial Statements. Seller has delivered or will
--------------------------------------
deliver to Buyer, consolidated balance sheets of the Company and its
subsidiaries as of December 31, 1997, September 30, 1998, and December 31, 1998,
and the related consolidated statements of income, comprehensive income, cash
flows and shareholders' equity for the years ended December 31, 1997 and 1998
and the related statement of income for the nine months ended September 30,
1998, and in the case of the December 31, 1997 and 1998 financial statements the
notes related to each of the foregoing (the "GAAP Consolidated Financial
Statements"). The GAAP Consolidated Financial Statements have been prepared or
will be prepared in conformity with GAAP consistently applied and present
fairly, or will present fairly in all material respects, the consolidated
financial position of the Company and results of its operations. Such GAAP
Consolidated Financial Statements properly reflect and make adequate provision
for or will properly reflect and make adequate provision for (a) the carrying
value of investments, (b) balances due from policyholders, agents and reinsurers
net of any valuation allowance, (c) deferred policy acquisition costs, (d)
reserves for losses, loss adjustment expenses and unearned premiums, (e) current
and deferred Taxes (as defined in Section 2.17), (f) guaranty fund assessments,
and (g) other liabilities, including, but not limited to, accrued audit and
legal fees, accrued salary, bonus, vacation, sick pay, and post-retirement
benefits other than pensions. Transactions with reinsurers have been or will be
recorded in accordance with Statement of Financial Accounting Standards No. 113,
"Accounting and Reporting for Reinsurance of Short-duration and Long-duration
Contracts."
2.10 Absence of Certain Changes. Since September 30, 1998, except in
--------------------------
connection with this Agreement and the transactions contemplated hereby, the
Subject Entities have conducted their respective businesses only in, and have
not engaged in any
10
<PAGE>
material transaction other than in, the ordinary course of such businesses
consistent with past practice and there has not been (i) any change in the
business, assets, financial condition or results of operations of the Subject
Entities or any development or combination of developments of which Seller has
knowledge, that, individually or in the aggregate, has had or is reasonably
likely to have a Company Material Adverse Effect, (ii) any material change by
any Subject Entity in accounting principles, practices or methods, other than as
required by changes in GAAP or statutory accounting principles or practices
prescribed by insurance regulatory authorities, or (iii) any change by any
Subject Entity in the actuarial, investment, reserving, underwriting, or claims
administration policies, practices, procedures, methods, assumptions or
principles applied by such Subject Entity in conducting its business in the
usual and ordinary course other than as required by law or regulatory authority.
2.11 Properties.
----------
(A) Real Estate and Mortgages. Section 2.11(A) of the Seller Schedule
-------------------------
sets forth a list and summary description of (a) all real property owned by
the Subject Entities and all buildings and other structures located on such
real property, (b) all leases, subleases or other agreements under which
any Subject Entity is the lessor or lessee of any real property, (c) all
unexpired options held by any Subject Entity or contractual obligations on
its part to purchase or acquire any interest in real property, (d) all
unexpired options granted by any Subject Entity or contractual obligations
on its part to sell or dispose of any interest in real property, and (e)
all mortgages on properties owned by a Subject Entity, identifying all such
mortgages, if any, for which deficiency notices have been issued or that
are otherwise not current. Except as disclosed in Section 2.11(A) of the
Seller Schedule, all such leases, subleases, options and other agreements
are in full force and effect and no written notice of any default
thereunder has been received, except where the failure to be in full force
and effect and except where any such default would not have a Company
Material Adverse Effect.
(B) Investment Securities. Section 2.11(B) of the Seller Schedule
---------------------
sets forth, as of the date of this Agreement, the common stock, preferred
stock, bonds, notes, mortgage loans, limited partnerships interests, and
other securities and investments owned or held by the Subject Entities
("Investments"). The Investments are evidenced by appropriate written
instruments and certificates (except where in non-certificated form), and,
to the knowledge of Seller, are valid and genuine in all material respects
and are enforceable in accordance with their terms against all persons
against whom they purport to create an obligation, subject to bankruptcy,
receivership, insolvency, reorganization, moratorium, or other similar laws
affecting or relating to creditors' rights generally and subject to
11
<PAGE>
general principles of equity. Except as disclosed in Section 2.11(B) of the
Seller Schedule, all Investments that are held by an Insurance Company
constitute admitted assets of the holder pursuant to applicable insurance
laws. Except as disclosed in Section 2.11(B) of the Seller Schedule, none
of the obligors in respect of such Investments is in default in the payment
of principal, interest or other required distributions.
(C) Title to Property. Except as disclosed in Section 2.11(C) of the
-----------------
Seller Schedule, the Subject Entities have good and valid title to all real
properties and Investments reflected as owned by them in Sections 2.11(A)
and 2.11(B) of the Seller Schedule, all other assets and properties
reflected in the GAAP Consolidated Financial Statements for the period
ended September 30, 1998 and all other assets and properties acquired
subsequent to such date (except assets and properties disposed of in the
ordinary course of business subsequent to such date), in each case free of
all mortgages, liens, charges and encumbrances of any nature whatsoever,
other than (i) liens for Taxes not yet due and payable and (ii) such minor
liens, charges and encumbrances as, in the aggregate, do not and would not
if asserted have a Company Material Adverse Effect.
(D) Condition of Property. All real properties, equipment, fixtures,
---------------------
and other tangible properties owned, leased or used by the Subject Entities
in their respective businesses are in good operating condition and repair,
ordinary wear and tear excepted, and are, and at the Closing will be,
available for the operation of such businesses as now being conducted,
except where the failure to be in such condition and repair or to be so
available would not have a Company Material Adverse Effect.
2.12 Environmental Laws. Except as disclosed in Section 2.12 of the
------------------
Seller Schedule, the Subject Entities have conducted and are conducting their
businesses in compliance in all material respects with all applicable federal,
state, and local laws, regulations and requirements currently in force relating
to the protection of the environment ("Environmental Laws") and there is no
pending, or, to the knowledge of Seller, threatened, civil or criminal
litigation, written notice of violation, or administrative proceeding relating
to such Environmental Laws involving any Subject Entity which would reasonably
be expected to have a Company Material Adverse Effect. To the knowledge of
Seller, there is no condition existing with respect to the release, emission,
discharge or presence of hazardous substances in connection with the business or
properties of any Subject Entity which would subject any of them to any
proceeding under such Environmental Laws or would otherwise have a Company
Material Adverse Effect. The Subject Entities have received all approvals,
consents, licenses, and permits with respect to environmental matters necessary
to carry on their respective businesses
12
<PAGE>
substantially as currently conducted, other than any such approvals, consents,
licenses or permits the failure of which to receive would not, individually or
in the aggregate, have a Company Material Adverse Effect.
2.13 Proprietary Rights. Section 2.13 of the Seller Schedule discloses
------------------
all the trademarks, trade names and service marks (and all registrations and
applications with respect thereto) and all material computer software
(collectively the "Proprietary Rights") used in the businesses of the Subject
Entities. To the knowledge of Seller, except as otherwise disclosed in such
Section, the Subject Entities own or are duly licensed or otherwise authorized
to use all of such Proprietary Rights. To the knowledge of Seller, such
Proprietary Rights as used by the Subject Entities in their respective
businesses do not violate or infringe upon the proprietary rights of any third
party. There is no claim, action, proceeding or investigation pending or, to the
knowledge of Seller, threatened, against any of the Subject Entities with
respect to any such Proprietary Rights which claim, action, proceeding or
investigation would reasonably be expected to have a Company Material Adverse
Effect.
2.14 Agreements. Except for this Agreement and as set forth in Section
----------
2.14 of the Seller Schedule, and other than any Plans (as defined in Section
2.19), none of the Subject Entities is a party to or is bound by any (i) written
contract for the employment of any officer, director or employee with annual
compensation in excess of $100,000 which pursuant to its terms is not terminable
without liability on 30 days' (or less) notice or which provides for any further
payments following such termination, or contract with a former officer, director
or employee pursuant to which payments are required to be made at any time
following the date hereof, (ii) stock ownership, profit sharing, bonus, deferred
compensation, severance pay, pension, retirement or similar plan or agreement,
(iii) mortgage, indenture, note or installment obligation or other instrument
for or relating to any borrowing of money, (iv) guaranty of any obligation for
borrowings or otherwise, other than insurance policies, bonds, or other
contracts in connection with the conduct of the insurance business of the
Insurance Companies in the ordinary course, (v) agreement or arrangement for the
sale or lease of any material amount of the assets or business of any Subject
Entity or for the grant of preferential rights with respect thereto, (vi)
agreement or contract with any labor union or association representing any
employee, (vii) material agreement or contract with or for the benefit of any
Insurance Producer (as defined in Section 2.24) other than pursuant to the forms
of agreement described or included in Section 2.24 of the Seller Schedule, or
(viii) any Material Agreement not otherwise described above. All contracts,
plans, mortgages, indentures, notes, installment obligations, guaranties,
treaties and other agreements disclosed in Section 2.14 of the Seller Schedule
are in full force and effect, and no Subject Entity, nor, to the knowledge of
Seller, any other party thereto, is in default in any material respect as to any
provision thereof, and, except as disclosed in such Section 2.14, no party
thereto may terminate any
13
<PAGE>
of such agreements or other instruments by reason of the transactions
contemplated by this Agreement.
2.15 Litigation. There is no suit, action or proceeding pending or, to
----------
the knowledge of Seller, threatened against or affecting any of the Subject
Entities which would, individually or in the aggregate, be reasonably expected
to have a Company Material Adverse Effect, nor is there any judgment, verdict,
decree, injunction, rule or order of any court, governmental entity or
arbitrator outstanding against any of the Subject Entities which would,
individually or in the aggregate, have a Company Material Adverse Effect.
Section 2.15 of the Seller Schedule sets forth a description of (i) each lawsuit
in which punitive, exemplary or other extra-contractual damages are sought
against a Subject Entity, and (ii) each lawsuit not involving insurance policies
assumed, reinsured or issued by a Subject Entity.
2.16 Compliance with Laws. Each Subject Entity has complied with all
--------------------
laws, regulations, orders, ordinances, judgments or decrees of all governmental
authorities (federal, state, local, foreign or otherwise) applicable to its
businesses, except where the failure to have so complied would not, individually
or in the aggregate, have a Company Material Adverse Effect. Except as disclosed
in Section 2.16 of the Seller Schedule, neither Seller nor any Subject Entity
has received any written notification of any asserted material failure by a
Subject Entity to comply with any of such laws.
2.17 Taxes.
-----
(A) Each of the Subject Entities (i) has filed, or caused to be
filed, with the appropriate taxing authority all material Tax Returns (as
hereafter defined) required to be filed on or before the date hereof
(giving effect to any valid extension of time), and such Tax Returns were
true, correct and complete in all material respects when filed, and (ii)
has paid or caused to be paid in full, or has made or will make adequate
provision in the appropriate GAAP Consolidated Financial Statements and the
Prior Month-End Balance Sheet, for all material Taxes (as hereafter
defined) shown to be due on such Tax Returns. There are no material liens
for Taxes upon the assets of any of the Subject Entities except for
statutory liens for current Taxes not yet due.
(B) The United States federal income Tax Returns in which any Subject
Entity has joined have been audited by the Internal Revenue Service or are
closed by the applicable statute of limitations for all taxable years
through December 31, 1994. As of the date hereof, except as described in
Section 2.17 of the Seller Schedule, neither Seller nor any of the Subject
Entities has given, or been requested in writing to give, waivers or
extensions of any statute of limitations
14
<PAGE>
relating to any material Tax Returns filed by or on behalf of any of the
Subject Entities.
(C) All tax sharing agreements between the Subject Entities, on the
one hand, and Seller and its affiliates (other than the Subject Entities),
on the other hand, shall be terminated effective at Closing, and the
Subject Entities shall not be bound thereby and shall have no liability
after the Closing for amounts due or arising thereunder, other than in
respect of any Taxes (due or refundable) which are attributable to a pre-
Closing Tax period.
(D) The GAAP Consolidated Financial Statements and the Prior Month-
End Balance Sheet reflect or will reflect an adequate accrual for all
material Taxes due and accrued, or deferred in accordance with Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes,"
based on all activity prior to and including the date of such financial
statements.
For purposes of this Agreement, the term "Taxes" shall mean all taxes,
charges, fees, levies or other assessments, including, without limitation, all
net income, gross income, premium or privilege, gross receipts, sales, use, ad
valorem, transfer, franchise, profits, license, withholding, payroll,
employment, excise, estimated, severance, stamp, occupation, property or other
taxes, customs duties, fees, assessments, or charges of any kind whatsoever,
together with any interest and any penalties, additions to tax or additional
amounts imposed by any governmental authority (domestic or foreign) upon any
Subject Entity and the term "Tax Returns" shall mean all returns, declarations,
reports, estimates, and statements, regarding Taxes, required to be filed under
United States federal, state, local or any foreign laws.
2.18 Related Party Transactions. Except as disclosed in Section 2.18 of
--------------------------
the Seller Schedule, no Subject Entity has made any loan to any director,
officer, employee, or affiliate of Seller or any of its direct or indirect
subsidiaries (including the Subject Entities) which remains outstanding, nor has
any Subject Entity entered into any agreement for the purchase or sale of any
property or services from or to any such director, officer, employee or
affiliate.
2.19 Employee Benefit Plans.
----------------------
(A) Section 2.19 of the Seller Schedule sets forth a true and
complete list of each material employee benefit plan, as defined in Section
3(3) of the Employee Retirement Income Security Act of 1974, as amended
("ERISA") and each other material plan, arrangement and agreement providing
employee benefits (collectively the "Plans"), that covers current or former
employees of any of the
15
<PAGE>
Subject Entities (the "Employers") and is presently maintained by any of
them or by any trade or business, whether or not incorporated (an "ERISA
Affiliate"), which together with Employers would be deemed a "single
employer" within the meaning of Section 4001 of ERISA. None of the Plans is
a "multi-employer plan," as defined in Section 3(37) of ERISA.
(B) Each of the Plans and any related trust agreement, group annuity
contract, insurance policy or other funding arrangement, is in substantial
compliance both in form and operation with all applicable provisions of
law, including the IRC (as defined below), ERISA and the Age Discrimination
in Employment Act. Neither Employers nor any ERISA Affiliate currently
maintains or sponsors a defined benefit pension plan as defined in Section
414(j) of the Internal Revenue Code of 1986, as amended ("IRC"), and to the
knowledge of Seller neither Employers nor any ERISA Affiliate, except as
disclosed in Section 2.19 of the Seller Schedule, has ever maintained or
sponsored any such plan that could give rise to any liability against
Employers.
(C) No excise tax or penalty (federal or state) is owed by any person
(including, but not limited to, any Plan, any Plan fiduciary, Employers and
ERISA Affiliates) with respect to the operations of, or any transactions
with respect to, any Plan, including, but not limited to, the civil penalty
assessed pursuant to Section 409 or 502(i) of ERISA or a tax imposed
pursuant to Section 4975 or 4976 of the IRC or the tax imposed under
Section 4978 of the IRC. No reserve for any excise taxes or penalties has
been established with respect to any Plan, nor has any advice been given to
any person with respect to the need to establish such a reserve.
(D) There are no material (i) actions, suits, arbitrations or claims
(other than routine claims for benefits), (ii) legal, administrative or
other proceedings or governmental investigations or audits, or (iii)
complaints to or by any governmental entity, which are pending or, to the
knowledge of Seller, anticipated or threatened, against the Plans or their
assets.
(E) Neither Employers nor any ERISA Affiliate provides or, to
Seller's knowledge, has ever provided post-retirement medical or life
insurance benefits to any present or former employees of Employers, other
than COBRA continuation benefits required by ERISA, the IRC or state
continuation coverage laws and employee conversion of life insurance
benefits to an individual policy.
2.20 Insurance. All material tangible and real properties of the Subject
---------
Entities are covered by valid and currently effective insurance policies.
Section 2.20 of the Seller
16
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Schedule contains a list of all insurance policies covering the Subject
Entities, including the identity of the named insured and all loss payees.
Except as otherwise identified in Section 2.20 of the Seller Schedule and except
where the failure to be in full force and effect would not have a Company
Material Adverse Effect, all insurance policies listed on such schedule will
remain in full force and effect through the Closing Date.
2.21 Insurance Business. Each Insurance Company has all requisite power
------------------
and authority to carry on its insurance business pursuant to and to the extent
of the certificates of authority issued under the laws of the jurisdictions
listed in Section 2.21 of the Seller Schedule. Such Section indicates the line
or lines of insurance which are permitted to be written with respect to each
certificate of authority listed. Except as otherwise described in such Section
and except as a result of the transactions contemplated hereby, no certificate
of authority identified therein has been revoked, restricted, suspended, limited
or modified, nor is any certificate of authority the subject of, nor to the
knowledge of the Seller is there a basis for, a proceeding for revocation,
restriction, suspension, limitation or modification, nor is any Insurance
Company operating under any formal or informal agreement or understanding with
the licensing authority of any jurisdiction which restricts its authority to do
business or requires it to take, or refrain from taking, any action (or, in the
case of an agreement or understanding arising between the date hereof and the
Closing, any material action). Section 2.21 of the Seller Schedule identifies
each pending application for a certificate of authority submitted by or on
behalf of an Insurance Company and specifies the jurisdiction in which each
application is pending, the date of submission, the line or lines of business
for which authority is sought and the current status of such application.
Except as disclosed in Section 2.21 of the Seller Schedule, (i) all
policies of insurance issued, reinsured or assumed by each Insurance Company now
in force are, in all material respects to the extent required under applicable
law, on forms approved by applicable insurance regulatory authorities or which
have been filed and not objected to by such authorities within the period
provided for objection and (ii) any premium rates required to be filed with or
approved by insurance regulatory authorities have been so filed or approved in
all material respects, and premiums charged conform in all material respects
thereto.
Each Insurance Company has timely paid in full all guaranty fund and
other residual market assessments required by any regulatory authority to be
paid by it except for any failures to pay which would not, individually or in
the aggregate, have a Company Material Adverse Effect.
17
<PAGE>
2.22 Reinsurance; Pools, etc.
------------------------
(A) Section 2.22(A) of the Seller Schedule discloses all reinsurance
treaties or agreements to which any of the Insurance Companies is a party
or is a named reinsured or is the reinsurer, or was a party or was a named
reinsured or was the reinsurer. Except as disclosed in such Section, all
such treaties or agreements are in full force and effect through the
respective dates noted in such Section and no disputes are pending or
asserted in writing under any such treaties or agreements. None of the
Insurance Companies is in default under any treaty or agreement listed in
such Section nor, to the knowledge of Seller, is any other party in default
thereunder except as disclosed in such Section. Except as disclosed in
Section 2.22(A) of the Seller Schedule, no party may terminate any such
treaties or agreements by reason of the transactions contemplated by this
Agreement.
(B) Section 2.22(B) of the Seller Schedule discloses all pooling
agreements, assigned risk pools, joint underwriting associations or similar
arrangements and all fronting arrangements under which any Insurance
Company is now or, to the knowledge of Seller, has in the past been a
participant.
2.23 Regulatory Filings. Each Insurance Company has filed all reports,
------------------
statements, documents, registrations, filings or submissions required to be
filed by it with any governmental or regulatory body, except (i) those with
respect to which the imposition, levy or collection of all fines, penalties,
assessments, taxes, forfeitures, money judgments or sanctions of any type are
barred by statutes of limitation, (ii) with respect to which the failure to so
file, individually and in the aggregate, has not and would not have a Company
Material Adverse Effect, and (iii) as otherwise agreed to in writing by the
applicable governmental or regulatory body. Except as disclosed in Section 2.23
of the Seller Schedule, (A) all such registrations, filings and submissions were
in material compliance with applicable law when filed, and (B) no material
deficiencies have been asserted in writing by any such governmental or
regulatory body with respect to such registrations, filings and submissions that
have not been satisfied. Except as may be required for the transactions
contemplated by this Agreement, each Insurance Company has duly filed with
appropriate insurance authorities, to the extent that filing of the same is
required by laws, rules or regulations, all annual and quarterly statements and
other material statements, documents and reports (including, without limitation,
any filings required under applicable state insurance holding company systems
acts) required by the insurance and other applicable laws of its state of
domicile and in each of the states in which it is licensed to conduct an
insurance business. All such statements and filings were correct in all
material respects as of the date filed (or, if the statement or filing covers a
period of time prior to the date of filing, as of such date), and there are no
material omissions therefrom. Section 2.23 of the Seller Schedule sets forth
18
<PAGE>
all reports of examination (including, without limitation, all financial
examinations and market conduct examinations) issued since December 1, 1995 by
any department of insurance or regulatory body with respect to each Insurance
Company. Such Section contains a copy of each written notice by an issuer of any
such report to an Insurance Company that the issues raised in any such report
have been resolved.
2.24 Insurance Producers. All contracts between an Insurance Company and
-------------------
its insurance agents, managers, brokers, managing general agents and all other
insurance producers (collectively "Insurance Producers") listed or required to
be listed in Section 2.14 of the Seller Schedule are in full force and effect,
except for any failures to be in full force and effect as would not,
individually or in the aggregate, have a Company Material Adverse Effect. No
Insurance Company is, and to the knowledge of Seller, none of the Insurance
Producers are, in default in any material respect under any such contract. Set
forth in Section 2.24 of the Seller Schedule is a true and correct (i) summary
description of all material compensation arrangements with the Insurance
Producers and (ii) a list of all managing general agents appointed by any
Insurance Company. To the knowledge of Seller, each of the Insurance Producers
is duly licensed in every jurisdiction in which such licensing is required by
law to solicit, negotiate, effect, renew or bind policies of insurance, or
otherwise to act as an insurance agent, broker, producer or managing general
agent (as the case may be), and is in full compliance with applicable laws
governing the activities of the Insurance Producers, except for any failures to
be duly licensed or in full compliance as would not, individually or in the
aggregate, have a Company Material Adverse Effect.
2.25 Bank Accounts. Section 2.25 of the Seller Schedule sets forth the
-------------
name of each bank, trust company, safe deposit company, broker or dealer in or
with which any Subject Entity has or at the Closing will have an account or safe
deposit box and the names of all persons authorized to draw thereon, give
instructions with respect thereto, or to have access thereto.
2.26 Minute Books. The minute books of each Subject Entity contain true
------------
and complete minutes of all meetings of its board of directors, board committees
and shareholders and any written consents in lieu of such meetings since
December 1, 1995.
2.27 Powers of Attorney; Guarantees. Except as disclosed in Section 2.27
------------------------------
of the Seller Schedule, no Subject Entity has any obligation to act under any
outstanding power of attorney or any obligation or liability, either accrued,
accruing or contingent, as guarantor, surety, co-signer, endorser (other than
for purposes of collection in the ordinary course of business), co-maker or
indemnitor in respect of the obligation of any person, corporation, partnership,
joint venture, association, organization or other entity.
19
<PAGE>
2.28 Charter County Mutual. Charter County Mutual (i) is a Texas county
---------------------
mutual insurance company that is duly organized, validly existing and in good
standing under the laws of the State of Texas, (ii) has all requisite corporate
power and authority to own or lease and operate its properties and assets and
carry on its business as now being conducted, (iii) transacts no business
outside of the State of Texas, (iv) is a party to a general agency managerial
agreement with NCM (the "NCM Agreement") and a quota share reinsurance agreement
with CIC (the "CIC Agreement"), each of which is currently, and will at Closing
be, in full force and effect and a valid and binding agreement, enforceable
against the parties in accordance with its terms, and (v) is not a party to any
agreements with Seller or any of its direct or indirect subsidiaries (including
the Subject Entities) except for the NCM Agreement and the CIC Agreement.
2.29 Investment Advisors. Except as identified in Section 2.29 of the
-------------------
Seller Schedule, none of the Subject Entities has any written or oral agreement
or arrangement with, or utilizes the services of, any investment advisors or
consultants.
2.30 Year 2000. The computer software and hardware, used by the Subject
---------
Entities in the operation of their businesses are capable of providing or are in
the process of being adapted or replaced to accurately record, store, process
and present calendar dates falling on or after January 1, 2000, as well as date-
dependent data, without degradation of the functionality or performance of such
software or hardware, which would have a Company Material Adverse Effect.
Section 2.30 of the Seller Schedule lists all material computer software and
hardware used by the Subject Entities in operation of their businesses and
summarizes for such software and hardware, taken as a whole, their overall state
of readiness and estimated costs of remediation within the meaning of Release
No. 33-7558, dated August 4, 1998, of the Securities and Exchange Commission,
regarding disclosure of Year 2000 issues. None of the Subject Entities has made
any express written warranties to any third parties relating to the Year 2000
readiness of such Subject Entities, which warranties would reasonably be
expected to have a Company Material Adverse Effect. None of Seller or any of
the Subject Entities has received written notice that any vendor or other
provider of services upon which any of the Subject Entities is materially
dependent will not be Year 2000 compliant on a timely basis. None of the
Subject Entities has written or, to the knowledge of Seller, reinsured any
insurance policies that create a material exposure to either property or
liability claims for Year 2000 failures. Section 2.30 of the Seller Schedule
describes all Year 2000 coverage exclusions that have been, or are contemplated
to be, incorporated in insurance policies written or reinsured by any of the
Subject Entities.
2.31 Directors and Officers. The persons listed on Section 2.31 of the
----------------------
Seller Schedule (the "Directors and Officers Schedule") constitute, and at the
Closing will constitute, all of the directors and officers of the Subject
Entities.
20
<PAGE>
2.32 Charter General Agency, Inc. CGA (i) is a Texas corporation duly
---------------------------
organized, validly existing and in good standing under the Texas Business
Corporation Act or the Texas Professional Corporation Act, as applicable, (ii)
has its principal place of business in the State of Texas, and (iii) has as one
of its purposes the authority to act as an agent, general agent, local recording
agent or managing general agent ("Agent"), as the case may be, under Texas
insurance laws. CGA possesses a license to act as an Agent issued by the Texas
Department of Insurance.
2.33 Missouri Home Service Business. None of the Subject Entities has (i)
------------------------------
written, reinsured or otherwise acquired any home service life insurance
policies currently in force and covering lives in the State of Missouri, or (ii)
any home service insurance agents operating in the State of Missouri.
2.34 Disclosure. To the knowledge of Seller, no representation or
----------
warranty of Seller and no statement or information relating to the Subject
Entities or their respective businesses or properties contained in (i) this
Agreement, (ii) the Seller Schedule, or (iii) any certificate, schedule, list or
other document furnished or to be furnished by Seller to Buyer pursuant to this
Agreement contains or will contain any untrue statement of a material fact or
omits or will omit to state a material fact necessary to make the statements
made herein or therein, in light of the circumstances in which they were made,
not misleading.
3. REPRESENTATIONS AND WARRANTIES OF BUYER
---------------------------------------
Buyer represents and warrants to Seller as follows:
3.01 Organization of Buyer. Buyer is a corporation duly organized,
---------------------
validly existing and in good standing under the laws of the State of Delaware:
3.02 Authorization. Buyer has all requisite corporate power and authority
-------------
to enter into this Agreement, to perform its obligations hereunder and to
consummate the transactions contemplated hereby. All corporate acts and other
proceedings required to be taken by Buyer or any of its affiliates to authorize
the execution, delivery and performance of this Agreement and the consummation
of the transactions contemplated hereby have been duly and properly taken. This
Agreement has been duly executed and delivered by Buyer and constitutes a legal,
valid and binding obligation of Buyer, enforceable against Buyer in accordance
with its terms.
3.03 Defaults and Conflicts. Subject to the receipt of all consents and
----------------------
approvals contemplated by this Agreement, neither the execution and delivery of
this Agreement, the consummation of the transactions contemplated hereby or the
fulfillment of and
21
<PAGE>
compliance with the terms and provisions hereof will (i) violate any judicial,
administrative or arbitral order, writ, award, judgment, injunction or decree
involving Buyer, (ii) conflict with the terms, conditions or provisions of the
certificate of incorporation or by-laws of Buyer, (iii) conflict with, result in
a breach of, constitute a default under or accelerate or permit the acceleration
of the performance required by, any indenture or any material agreement or other
material instrument to which Buyer is a party or by which Buyer is bound, (iv)
result in the creation of any lien, charge or encumbrance upon any of the assets
of Buyer under any such agreement or instrument, or (v) terminate or give any
party thereto the right to terminate any such indenture, agreement or
instrument. No consent of any third party to any indenture or any material
agreement or other material instrument to which Buyer or any of its affiliates
is a party is required in connection with the execution and delivery of this
Agreement.
3.04 Acquisition for Investment. Buyer is acquiring the Shares for its
--------------------------
own account, for investment purposes and not with a view to, or for resale in
connection with, any distribution or public offering thereof within the meaning
of the Securities Act of 1933, as amended.
3.05 Consents and Approvals. Except for the consents and approvals listed
----------------------
on the schedule thereof attached hereto (the "Buyer Consent Schedule"), and
except for such filings, permits, authorizations, consents or approvals, the
failure of which to obtain or make would not, individually or in the aggregate,
have a Company Material Adverse Effect or delay or restrict the consummation of
the transactions contemplated hereby, no filing with, and no permit,
authorization, consent or approval of, any public body or authority is necessary
for the consummation by Buyer and its affiliates of the transactions
contemplated by this Agreement.
3.06 Funds Available. Buyer has, and at all times through the Closing
---------------
will have, available to it sufficient funds to consummate its purchase of the
Shares and the other transactions contemplated hereby.
4. ACCESS.
------
Subject to applicable law, Seller shall afford to the officers, employees
and authorized representatives of Buyer and its affiliates reasonable access,
during normal business hours and upon reasonable notice, to the offices,
properties, senior management, books and records of the Subject Entities;
provided, however, that such access does not unreasonably disrupt the normal
- -------- -------
business operations of Seller or the Subject Entities. Seller shall furnish
Buyer with such additional financial and operating data and other information as
to the assets, properties, and business of the Subject Entities as Buyer may
from time to time reasonably request. Seller shall cause the Subject Entities
to consent to
22
<PAGE>
the review by the officers, employees and authorized representatives of Buyer
and its affiliates of the reports and working papers of the Subject Entities'
independent auditors and to discussions by the officers, employees and
authorized representatives of Buyer and its affiliates with such independent
auditors.
5. COVENANTS OF SELLER
-------------------
5.01 Ordinary Course. Except with respect to the Related Transactions and
---------------
as otherwise expressly contemplated or permitted hereunder, between the date
hereof and the Closing, Seller shall cause the business of the Subject Entities
to be conducted in the ordinary course of business and consistent with past
practices.
5.02 Liabilities. Between the date hereof and the Closing, without the
-----------
prior written consent of Buyer, Seller shall not permit any of the Subject
Entities to incur or to become subject to any material liability or obligation
(absolute, contingent or otherwise) (including, without limitation, any surplus
notes) except (i) as set forth in Section 5.02 of the Seller Schedule; (ii)
liabilities or obligations incurred in the ordinary course of business (other
than bank indebtedness in excess of the bank indebtedness of the Company
outstanding on the date hereof, which excess shall not be deemed in the ordinary
course of business); (iii) as required by law or regulatory authority or as
contemplated hereunder; and (iv) other liabilities which shall not exceed
$250,000 in the aggregate. Nothing contained herein shall restrict Seller from
causing the Company to repay outstanding Indebtedness prior to the Closing.
5.03 Changes in Stock. Between the date hereof and the Closing, without
----------------
the prior written consent of Buyer, Seller shall not permit any of the Subject
Entities to (i) make any change in its authorized capital stock, (ii) issue any
stock, options, warrants, or other rights calling for the issue, transfer, sale
or delivery of its capital stock or other securities, (iii) pay any stock
dividend or make any reclassification in respect of its outstanding shares of
capital stock, (iv) issue, sell, exchange or deliver any shares of its capital
stock (or securities convertible into or exchangeable, with or without
additional consideration, for such capital stock), or (v) purchase or otherwise
acquire for consideration any outstanding shares of its capital stock.
5.04 New Agreement. Except (i) in the ordinary course of business or (ii)
-------------
as required by law or regulatory authority or (iii) as contemplated hereunder,
between the date hereof and the Closing, Seller shall not permit any of the
Subject Entities to, without the prior written consent of Buyer, amend in any
material respect or enter into any contract, agreement or other instrument of
the types described in Section 2.14 hereunder or increase the salary or base
compensation of, or pay any bonus or make any special awards to, or amend any
compensation agreements of, any of the directors, officers,
23
<PAGE>
employees, agents or affiliates of the Subject Entities other than in accordance
with regularly scheduled periodic increases in accordance with past practices or
as disclosed in Section 5.04 of the Seller Schedule. Except as required by law
or regulatory authority Seller shall not, and shall cause NCM not to, terminate,
cancel, amend, modify or otherwise alter the existing General Managerial
Contract between NCM and Charter County Mutual under which NCM controls Charter
County Mutual.
5.05 Consents. Seller shall, as soon as practicable, prepare or cause to
--------
be prepared and make all necessary filings with all governmental or regulatory
bodies or other entities and shall use its reasonable best efforts to obtain all
consents, waivers, approvals, authorizations, rulings or orders from all
governmental or regulatory bodies or other entities listed on the Seller Consent
Schedule and furnish true, correct and complete copies of each thereof to Buyer.
Prior to the Closing, Seller shall (and shall cause each of the Subject Entities
to) use its reasonable best efforts to obtain any required consents of the
parties to any Material Agreements.
5.06 Notice. Between the date hereof and Closing, Seller shall give
------
prompt notice to Buyer of (i) any notice or other communication received by
Seller or any of the Subject Entities relating to a default or event which, with
notice or lapse of time or both, would become a default, under any of the
Subject Entities' articles of incorporation, by-laws or comparable governing
instruments, or any Material Agreement, (ii) any notice or other communication
received by any of the foregoing from any third party alleging that the consent
of such third party is or may be required in connection with the transactions
contemplated hereby, (iii) any circumstances of which Seller or any Subject
Entity becomes aware that is reasonably likely to have a Company Material
Adverse Effect, and (iv) any matter which, if it had occurred prior to the date
hereof, would have been required to be included on the Seller Schedule.
5.07 Other Transactions. From the date of this Agreement to the Closing,
------------------
except for the Related Transactions, none of Seller, any Subject Entity nor any
other affiliate of Seller shall, nor shall they permit any of their respective
officers, directors, stockholders or other representatives to, directly or
indirectly, encourage, solicit, initiate or participate in discussions or
negotiations with, or provide any information or assistance to, any person or
group (other than Buyer, its affiliates and their representatives) concerning
any merger, sale of securities, sale of substantial assets or similar
transaction involving the Subject Entities. In the event that Seller, any
Subject Entity or any other affiliate of Seller receives a proposal relating to
any such transaction, Seller shall promptly notify Buyer of such proposal.
24
<PAGE>
5.08 Employee Matters.
----------------
(A) Transfer of Continuing Employees. On or prior to the Closing
--------------------------------
Date, subject to the receipt of any necessary regulatory approvals, Seller
shall cause (i) the transfer to VIC of all employees of Valley Pacific
located in California, and (ii) the transfer to WMIC of all employees of
Fund American or its affiliates (other than the Subject Entities) who
provide services to WMIC on a substantially full time basis. Each of such
transfers is hereafter collectively referred to as the "Employee Transfer."
(B) Seller Employee Obligations. Seller shall cause each of the
---------------------------
Subject Entities to take such actions as are necessary to terminate the
participation by the Subject Entities in the Valley Insurance Companies
Long Term Incentive Plan, the Charter Insurance Companies Long Term
Incentive Plan, the Valley Insurance Companies Annual Incentive Plan, the
Charter Insurance Companies Annual Incentive Plan, the Fund American
Enterprises Holdings, Inc. Long Term Incentive Plan, the Valley Group, Inc.
Voluntary Salary Reduction Agreement and the employee benefit plans of
Seller and White Mountains Holdings, Inc. in which any of them
participates, effective no later than the close of business on the Closing
Date. Following the Closing, Seller shall indemnify Buyer and its
affiliates against any Loss or Losses (as defined in Section 14.01)
(including funding deficiencies) arising under or in respect of any
employee benefit plan maintained or sponsored by any Subject Entity and for
any COBRA continuation coverage provided by any of the same, in each case
to the extent those liabilities, obligations and costs arise out of events
or circumstances prior to the Closing. Following the Closing, Buyer shall
be solely responsible for, and shall indemnify Seller and its affiliates
other than the Subject Entities against any Loss or Losses arising under
or in respect of any employee benefit plan maintained or sponsored by any
Subject Entity and for any COBRA continuation coverage provided by any of
the same to the extent those liabilities, obligations and costs arise out
of events or circumstances subsequent to the Closing.
5.09 December 31, 1998 Financial Statements. As soon as practicable, but
--------------------------------------
no later than the later of March 2, 1999 or the filing thereof with insurance
regulatory authorities, Seller shall provide to Buyer the Statutory Financial
Statements of each of the Insurance Companies for the year ended December 31,
1998, as filed with the departments of insurance of their respective states of
domicile, which shall be prepared in a manner consistent with the requirements
for Statutory Financial Statements specified in Section 2.08 above (the December
31, 1998 Statutory Financial Statements"). In the event the Closing occurs on
or after March 31, 1999, Seller shall provide Buyer with the GAAP Consolidated
Financial Statements for the year ended December 31, 1998, which
25
<PAGE>
shall be prepared in a manner which is consistent with the requirements for GAAP
Consolidated Financial Statements specified in Section 2.09 above together with
the actual audit opinion from the Company's independent auditors. The loss and
loss adjustment expense reserve amount shown on the December 31, 1998 Statutory
Financial Statements shall be determined in accordance with SAP.
5.10 Intercompany Agreements and Balances. As of or prior to the Closing,
------------------------------------
other than in respect of Taxes, Seller shall cause all intercompany balances
between or among the Subject Entities, on the one hand, and Seller and any of
the other affiliates of Seller, on the other hand, to be settled. Except as
contemplated by this Agreement, at or prior to the Closing, Seller shall
terminate, or cause to be terminated, each contract between or among the Subject
Entities, on the one hand, and Seller and any of the other affiliates of Seller,
on the other hand.
5.11 Name Change. No later than six (6) months after the Closing Date,
-----------
Seller shall cause Valley National to amend its articles of incorporation, to
change its corporate name and its doing business designations, in each state
where it is qualified to do business, to a different name that does not include
the word "Valley" in any form. Seller shall forthwith thereafter notify Buyer of
such changes and provide copies of all documents filed in connection therewith.
In addition, six (6) months after the Closing, Seller and its affiliates shall
cease using the name "Valley Group" or "Charter Group" in any manner for
commercial purposes.
5.12 Cooperation. Seller shall execute such documents and other papers,
-----------
provide such information, and take such further actions as may be reasonably
requested by Buyer to carry out the provisions hereof and to consummate the
transactions contemplated hereby. Seller shall use its reasonable best efforts
to obtain, or assist Buyer in obtaining, all applicable regulatory approval of
the reinsurance transaction described in Section 1.03(A)(i)(2).
5.13 Conditions Precedent. Seller shall use its reasonable best efforts
--------------------
to cause all of the conditions precedent to the consummation of the transactions
contemplated by this Agreement applicable to it to be met.
5.14 Shareholder Vote. Seller will cause its subsidiary, White Mountains
----------------
Holdings, Inc., and/or each transferee permitted under Section 17.04, to vote
all of its shares in the Company in favor of the sale of the Shares to Buyer and
will not permit White Mountain Holdings, Inc. to transfer any of its shares in
the Company to any other person or entity prior to Closing (except to the extent
permitted under Section 17.04).
26
<PAGE>
5.15 Termination of Investment Advisor Agreement. Seller agrees to cause
-------------------------------------------
all investment advisory agreements currently in effect between it and the
Subject Entities to be terminated at or prior to Closing.
5.16 Valley National. The Company and VIC have entered into a definitive
---------------
agreement, dated October 19, 1998, with Executive Risk Indemnity, Inc. ("ERII")
providing for the sale of all of the outstanding capital stock of Valley
National to ERII following the reinsurance cession of all of the insurance
business of Valley National to certain Subject Entities (the "Valley National
Sale Agreement"). Seller hereby agrees to indemnify, defend and hold Buyer and
its affiliates harmless from and against (i) any Loss or Losses (as defined in
Section 14.01)relating to or arising under the Valley National Sales Agreement
and (ii) any Loss or Losses of Valley National incurred prior to the closing of
the sale of Valley National pursuant to the Valley National Sale Agreement.
Seller agrees to use its best efforts to cause all rights, powers and
obligations under the Valley National Sale Agreement to be assigned to Seller or
an affiliate of Seller (other than the Subject Entities), thereby substituting
such assignee for the Company and VIC. If Seller shall determine that the sale
of Valley National to ERII is unlikely to be consummated prior to the
anticipated Closing Date, then Seller shall cause ownership of the stock of
Valley National to be transferred to Seller or an affiliate of Seller (other
than a Subject Entity), whether by dividend or otherwise, prior to the Closing
Date.
5.17 Pinnacle. Seller hereby agrees to indemnify, defend and hold Buyer
--------
and its affiliates (including, without limitation, following the Closing, each
of the Subject Entities) harmless from and against (i) any Loss or Losses
relating to or arising under the Pinnacle Acquisition Agreement and (ii) any
Loss or Losses of Pinnacle incurred prior to the Closing Date. Seller agrees to
use its reasonable best efforts to cause all rights, powers and obligations
under the Pinnacle Acquisition Agreement to be assigned to Seller or an
affiliate of Seller (other than the Subject Entities) in full substitution for
Charter. In the event that Charter acquires Pinnacle prior to the Closing Date,
Seller shall use its reasonable best efforts to cause ownership of the stock of
Pinnacle to be transferred to Seller or an affiliate of Seller (other than a
Subject Entity), whether by dividend or otherwise, prior to the Closing Date.
6. COVENANTS OF BUYER.
------------------
6.01 Consents. Buyer shall, as soon as practicable, prepare and make all
--------
necessary filings with all governmental or regulatory bodies or other entities
and shall use its reasonable best efforts to obtain all consents, waivers,
approvals, authorizations, rulings or orders from all governmental or regulatory
bodies or other entities listed on the Buyer Consent Schedule and furnish true,
correct and complete copies of each to Seller.
27
<PAGE>
6.02 Employee Matters. Immediately following the Closing, Buyer shall
----------------
cause the Subject Entities to continue the employment of all employees thereof
(including those employees subject to the Employee Transfer) at the same base
pay and on terms and conditions not materially less favorable to such employees
than those provided for immediately prior to the Closing. In addition, Buyer
will give each such person credit for all accrued but unused vacation and paid
time off that each such person had with Seller up through the Closing Date.
Nothing herein shall be construed as a change in the status of any such
employees as employees at will.
6.03 Name Change. No later than six months after the Closing Date, Buyer
-----------
shall cause WMIC to amend its articles of incorporation, to change its corporate
name and its doing business designation, in each state where it is qualified to
do business, to a different name that does not include the words "White
Mountains" in any form. Buyer shall forthwith thereafter notify Seller of such
changes and provide copies of all documents filed in connection therewith. In
addition, after June 30, 1999, Buyer and its affiliates shall cease using the
name "White Mountains" in any manner for commercial purposes. It is understood
and agreed that Seller shall retain all right, title and interest in and to the
"White Mountains" name.
6.04 Cooperation. Buyer shall execute such documents and other papers,
-----------
provide such information, and take such further actions as may be reasonably
requested by Seller to carry out the provisions hereof and to consummate the
transactions contemplated hereby.
6.05 Conditions Precedent. Buyer shall use its reasonable best efforts to
--------------------
cause all of the conditions precedent to the consummation of the transactions
contemplated by this Agreement applicable to it to be met.
6.06 Confidentiality. Buyer acknowledges that the information being
-----------------
provided to it in connection with the purchase and sale of the Shares and the
other transactions contemplated hereby is subject to the terms of a
confidentiality agreement between Buyer and Gill and Roeser on behalf of Seller
entered into in October, 1998 (the "Confidentiality Agreement"), the terms of
which are incorporated herein by reference as if Seller were a party thereto.
Effective upon, and only upon, the Closing, the Confidentiality Agreement shall
terminate with respect to information relating solely to the Subject Entities;
provided that Buyer acknowledges that any and all other information provided to
- --------
it by Seller or Seller's representatives concerning Seller or its affiliates
(other than the Subject Entities) shall remain subject to the terms and
conditions of the Confidentiality Agreement after the Closing Date.
28
<PAGE>
6.07 Indemnity. Buyer will indemnify and defend Seller with respect to
---------
the following claims: (1) any claim by an employee of any Subject Entity that he
or she was not employed as provided in Section 6.02 this Agreement; (2) any
claim for payment of vacation or paid time off accrued up through, as well as
after, the Closing Date; and (3) any claim by any person relating to employment
matters involving the Subject Entities and based on facts or circumstances
occurring after the Closing Date including, but not limited to, the termination
of employment of any employee of the Subject Entities after the Closing Date,
the compensation and benefits such person is entitled to upon termination of
employment after the Closing Date, or the compensation and benefits to which
such person is entitled by virtue of his or her employment with Buyer after the
Closing Date.
7. TAX COVENANTS OF SELLER AND BUYER.
---------------------------------
7.01 Seller shall prepare and file, or cause to be prepared and filed, all
material Tax Returns for taxable periods ending on or prior to the Closing Date
required to be filed (giving effect to any valid extensions of time) including,
but not limited to, all calendar year 1998 Tax Returns and those Tax Returns for
the short taxable period commencing on January 1, 1999, and ending on the
Closing Date and shall pay all Taxes shown thereon to be due. Seller shall
prepare such Tax Returns in a manner consistent with the Tax Returns of the
Subject Entities filed prior to the Closing for taxable periods ending on or
before December 31, 1997 (the "Prior Year Returns"). Buyer shall cause the
Subject Entities to pay, or shall itself pay or make provisions to pay on a
timely basis, all Taxes to the extent reflected as liabilities on the Closing
Date Balance Sheet as adjusted in accordance with Section 7.02. Such payment
will exclude any Taxes which are a result of the purchase transaction
contemplated herein, in accordance with the Section 338(h)(10) election
described in Section 7.09. However, the Closing Date Balance Sheet will not
reflect an accrual for the Taxes which result from the Section 338(h)(10)
election or other Taxes resulting from the purchase and sale of the Shares or by
the Related Transactions.
7.02 Buyer shall prepare and file, or cause to be prepared and filed, all
material Tax Returns for taxable periods including (but not ending on) the
Closing Date required to be filed (giving effect to any valid extensions of
time) and shall pay all Taxes due with respect to such Tax Returns; provided
--------
that Seller shall reimburse Buyer for any amount owed by Seller pursuant to
Section 14.01 within 30 days of Buyer's written notification to Seller of
Seller's liability pursuant to Section 14.01. Buyer shall prepare such Tax
Returns in a manner consistent with the Tax Returns of the Subject Entities
filed prior to the Closing and shall furnish such Tax Returns to the Seller for
the Seller's approval (which approval shall not be unreasonably delayed or
withheld) at least thirty (30) days prior to the due date for filing such Tax
Returns.
29
<PAGE>
All liabilities or refunds for Taxes for Tax periods covered in Sections
7.01 and 7.02 which are reflected or which should have been reflected on the
Closing Date Balance Sheet shall be adjusted to their correct amount based on
the Tax Returns as actually filed. Cash settlement of the difference between the
accruals on the Closing Date Balance Sheet and the actual Tax Returns shall be
made within 30 days of the filing of such Tax Returns.
Any and all Taxes that arise from this stock purchase transaction in
accordance with the Section 338(h)(10) election described in Section 7.09 below
shall be entirely borne by Seller.
7.03 Buyer and Seller agree to cause the Subject Entities to file all Tax
Returns for the period including the Closing Date on the basis that the relevant
taxable period ended as of the close of business on the Closing Date, unless the
relevant taxing authority will not accept a Tax Return filed on that basis.
7.04 Seller shall be responsible for filing any amended, consolidated,
combined or unitary Tax Returns for taxable years ending on or prior to the
Closing Date which are required as a result of examination adjustments made by
the Internal Revenue Service or by the applicable state or local taxing
authorities for such taxable years as finally determined. For those
jurisdictions in which separate Tax Returns are filed by any of the Subject
Entities, any required amended returns resulting from such examination
adjustments, as finally determined, shall be prepared by Seller and furnished to
such Subject Entity, as the case may be for approval (which approval shall not
be unreasonably withheld), signature and filing at least 30 days prior to the
due date for filing such returns.
7.05 Seller, each of the Subject Entities and Buyer shall reasonably
cooperate, and shall cause their respective affiliates, officers, employees,
agents, auditors and representatives reasonably to cooperate, in preparing and
filing all Tax Returns, including maintaining and making available to each other
all records necessary in connection with Taxes and in resolving all disputes and
audits with respect to all taxable periods relating to Taxes. Buyer and Seller
recognize that Seller and its affiliates will need access, from time to time,
after the Closing Date, to certain accounting and Tax records and information
held by the Subject Entities to the extent such records and information pertain
to events occurring prior to the Closing Date; therefore, Buyer agrees, and
agrees to cause each of the Subject Entities, (i) to use its best efforts to
properly retain and maintain such records until the applicable statute of
limitations has expired, and (ii) to allow Seller and its agents and
representatives (and agents or representatives of any of its affiliates), at
times and dates mutually acceptable to the parties, to inspect, review and
30
<PAGE>
make copies of such records as Seller may deem necessary or appropriate from
time to time, such activities to be conducted during normal business hours and
at Seller's expense.
Seller shall provide prompt notice (within thirty (30) days of receiving an
Internal Revenue Service Notice of Proposed Adjustment or similar notification
from any other taxing authority) to Buyer of any issue raised in any official
inquiry, examination or proceeding involving any Taxes relating to any of the
Subject Entities for any period prior to and including the Closing Date.
7.06 Any refunds or credits of Taxes other than those accrued on the
Closing Date Balance Sheet as adjusted pursuant to Section 7.02, of any of the
Subject Entities for any taxable period ending on or before the Closing Date
shall be for the account of Seller. Any refunds or credits of Taxes of any of
the Subject Entities for any taxable period beginning after the Closing Date
shall be for the account of the Buyer. Any refunds or credits of Taxes of any
of the Subject Entities for any Straddle Period (as defined in Section 14.01)
shall be equitably apportioned between Seller and Buyer as provided by Section
14.01. Buyer shall, if Seller so requests and at Seller's expense, cause any of
the Subject Entities to file for and obtain any refunds or credits to which
Seller is entitled under this Section 7.06. Buyer shall permit Seller to
control the prosecution of any such refund claim and, where deemed appropriate
by Seller, shall cause each of the Subject Entities to authorize by appropriate
powers of attorney such persons as Seller shall designate to represent such
Subject Entity with respect to such refund claim. Buyer shall cause each of the
Subject Entities to forward to Seller any such refund within 10 days after the
refund is received (or reimburse Seller for any such credit within 10 days after
the credit is allowed or applied against other Tax liability); provided,
--------
however, that any such amounts payable to Seller shall be net of any Tax cost or
- -------
benefit to Buyer or such Subject Entity, attributable to the receipt of such
refund and/or the payment of such amounts to Seller.
7.07 All sales and use Taxes incurred in connection with this Agreement
and the transactions contemplated hereby shall be paid by Buyer, and Seller and
Buyer shall cooperate in timely making all filings, returns, reports and forms
as may be required to comply with the provisions of such Tax laws.
7.08 On the Closing Date, Buyer shall cause each of the Subject Entities
to conduct its business in the ordinary course in substantially the same manner
as presently conducted and shall not permit any of the Subject Entities to
effect any extraordinary transactions (other than any such transactions
expressly required by applicable law or contemplated by this Agreement) that
could result in Tax liability to any of the Subject
31
<PAGE>
Entities in excess of Tax liability associated with the conduct of its business
in the ordinary course.
On or after the Closing Date, neither Buyer nor any of the Subject Entities
shall, with respect to any Pre-Closing Tax Period, (i) file any amended Tax
Return, or (ii) carry back any loss or other Tax attribute.
7.09 Buyer and Seller shall join in timely making an election under
Section 338(h)(10) of the IRC and similar elections under any applicable state
or local income Tax laws with respect to each Subject Entity. Buyer and Seller
shall report the transactions consistent with such election under Section
338(h)(10) of the IRC or any similar state or local Tax provision (the
"Elections"). Buyer and Seller shall timely execute any and all forms necessary
to effectuate the Elections (including, without limitation, Internal Revenue
Service Form 8023 and any similar forms under applicable state or local income
Tax laws (the "Section 338 Forms")).
Buyer and Seller agree to use all reasonable efforts to enter into an
agreement (the "Allocation Agreement") as soon as practicable after the Closing
to determine the Modified Aggregate Deemed Sale Price ("MADSP"), pursuant to
Section 338(h)(10) of the IRC and the regulations thereunder, of the assets of
the Subject Entities. Buyer shall initially prepare a statement(s) setting forth
a proposed computation and allocation of MADSP (the "Computation") and submit it
to Seller no later than 150 days after the Closing. If within 30 days of
Seller's receipt of the Computation, Seller shall not have objected in writing
to such Computation, the Computation shall become the Allocation Agreement. If
within 60 days of Seller's receipt of the Computation, Seller and Buyer have not
adopted an Allocation Agreement, the parties shall submit any disputed matter to
the Accounting Firm, and cause the Accounting Firm to deliver a final, binding
and conclusive written report resolving all such disputed matters within 30 days
of the submission thereof to the Accounting Firm. Seller and Buyer shall each
cause the Section 338 Forms to be duly executed by an authorized person for
Seller and Buyer, respectively, within 30 days prior to the date such Section
338 Forms are required to be filed, and shall duly and timely file the Section
338 Forms in accordance with applicable Tax laws and the terms of this
Agreement.
8. CLOSING AND CLOSING DOCUMENTS.
-----------------------------
8.01 Closing. The "Closing" under this Agreement shall be held at the
-------
offices of Buyer at 10:00a.m., Central Time, at the end of the month during
which all the terms and conditions contained in Sections 9, 10 and 11 of this
Agreement have been fulfilled or waived, or at such other place and time as may
be mutually agreed to by the parties (the day on which Closing takes place being
referred to as the "Closing Date").
32
<PAGE>
8.02 Seller Closing Matters. At the Closing, Seller shall deliver, or
----------------------
cause to be delivered, to Buyer or take, or cause to be taken, the following
actions, as the case may be:
(A) A certificate of Seller, signed by its President, which shall
confirm (i) the compliance by Seller in all material respects with its covenants
and agreements contained in this Agreement, (ii) the accuracy in all material
respects of the representations and warranties made by Seller in this Agreement
that are not qualified as to materiality, at and as of the Closing as if made at
such time (unless made as of a specific date), and (iii) the accuracy of the
representations and warranties made by Seller in this Agreement that are
qualified as to materiality, at and as of the Closing as if made at said time
(unless made as of a specific date).
(B) A certificate of Seller certifying that the GAAP Consolidated
Financial Statements for the year ended December 31, 1998 and the Prior Month-
End Balance Sheet have been prepared in accordance with GAAP on a basis
consistent with the GAAP Consolidated Financial Statements for the periods ended
December 31, 1997 and September 30, 1998 and in accordance with Section 2.09.
(C) Written resignations, effective at the Closing, of the directors
of each of the Subject Entities specified on the Directors and Officers
Schedule.
(D) Certificates representing the Shares being conveyed by Seller as
specified in Section 1 hereto, duly assigned or with executed stock powers
to transfer the shares evidenced thereby to Buyer on the stock transfer
records of the Company.
(E) The opinion of Brobeck, Phleger & Harrison, LLP, or other counsel
to Seller reasonably acceptable to Buyer dated the Closing Date, covering
the matters set forth in Exhibit 8.02(E).
(F) All minute books, stock record books and corporate seals of each
of the Subject Companies to the extent that they are not already in the
possession of the Subject Companies.
(G) Written evidence, reasonably satisfactory to Buyer, from the
banking institution or institutions holding the Indebtedness of the
extinguishment of the Indebtedness in full.
8.03 Buyer Closing Matters. At the Closing, Buyer shall deliver, or cause
---------------------
to be delivered, to Seller:
33
<PAGE>
(A) A certificate of Buyer, signed by its President, which shall
confirm (i) the compliance by Buyer in all material respects with its
covenants and agreements contained in this Agreement, (ii) the accuracy in
all material respects of the representations and warranties made by it in
this Agreement that are not qualified as to materiality, at and as of the
Closing as if made at such time (unless made as of a specific date), and
(iii) the accuracy of the representations and warranties made by Buyer in
this Agreement that are qualified as to materiality, at and as of the
Closing as if made at said time (unless made as of a specific date).
(B) The Estimated Purchase Price in the amount and manner of payment
specified in Section 1.02(B).
(C) The opinion of counsel to Buyer reasonably acceptable to Seller,
dated the Closing Date, covering the matters set forth in Exhibit 8.03(C).
9. CONDITIONS TO THE OBLIGATIONS OF BUYER.
--------------------------------------
The obligations of Buyer under this Agreement to cause this Agreement to
become effective and have the transactions contemplated hereby be consummated
are, at its option, subject to the conditions that:
9.01 Validity of Representations and Warranties. The representations and
------------------------------------------
warranties of Seller contained herein that are not qualified as to materiality
shall be true in all material respects on and at the Closing (unless made as of
a specific date) with the same force and effect as though made on and at the
Closing. The representations and warranties of Seller contained herein that are
qualified as to materiality shall be true on and at the Closing (unless made as
of a specific date) with the same force and effect as though made on and at the
Closing.
9.02 Consents. All consents, waivers, approvals, authorizations or orders
--------
listed on Seller Consent Schedule shall have been obtained by Seller in
substance reasonably satisfactory to Buyer and copies of the same (if reduced to
writing) shall have been delivered to Buyer.
9.03 Compliance with Covenants. Seller shall have performed in all
-------------------------
material respects all obligations and agreements and complied in all material
respects with all covenants and conditions contained in this Agreement to be
performed and complied with at or prior to the Closing (except that any
covenants and conditions which are qualified as to materiality shall have been
so performed and complied with in all respects).
34
<PAGE>
9.04 NCM/Charter County Mutual Relationship. The existing General Agency
--------------------------------------
Managerial Contract between NCM and Charter County Mutual under which NCM
controls Charter County Mutual shall be in full force and effect on the Closing
Date, and shall not have been amended, modified or otherwise altered between the
execution of this Agreement and the Closing Date. Except for NCM and the board
of directors and officers of Charter County Mutual, no individual, corporation,
partnership, joint venture, association, joint stock company, trust, or
unincorporated organization shall have any direct or indirect power or authority
to direct or cause the direction of the management and policies of Charter
County Mutual.
9.05 Resignations. The directors of each of the Subject Entities as
------------
specified on the Directors and Officers Schedule shall have tendered their
resignations in writing, effective at the Closing.
9.06 Transfer of Valley National and Pinnacle. All of the issued and
----------------------------------------
outstanding stock of each of Valley National and Pinnacle (if any) owned by any
of the Subject Entities shall have been sold or transferred (including by way of
dividend or distribution) to Seller or to an affiliate of Seller that is not a
Subject Entity or to a third party on terms and conditions reasonably
satisfactory to Buyer; provided, however, that in the event Pinnacle has not yet
-------- -------
been acquired by Charter as of the Closing Date, Seller shall have caused all
rights and obligations under the Pinnacle Acquisition Agreement to be assigned
to Seller or an affiliate of Seller (other than the Subject Entities).
9.07 Asset Sale/Employee Transfer. The Asset Sale and the Employee
----------------------------
Transfer shall have been completed in form and substance reasonably satisfactory
to Buyer.
9.08 Extinguishment of Indebtedness. The Indebtedness shall have been
------------------------------
extinguished in full.
10. CONDITIONS OF THE OBLIGATIONS OF SELLER.
---------------------------------------
The obligations of Seller under this Agreement to cause this Agreement to
become effective and have the transactions contemplated hereby be consummated
are, at its option, subject to the conditions that:
10.01 Validity of Representations and Warranties. The representations and
------------------------------------------
warranties of Buyer contained herein that are not qualified as to materiality
shall have been true in all material respects on and at the Closing (unless made
as of a specific date) with the same force and effect as though made on and at
the Closing. The representations and warranties of Buyer contained herein that
are qualified as to materiality shall be true
35
<PAGE>
on and at the Closing (unless made as of a specific date) with the same force
and effect as though made on and at the Closing.
10.02 Consents. All consents, waivers, approvals, authorizations or
--------
orders listed on the Buyer Consent Schedule shall have been obtained by Buyer in
substance reasonably satisfactory to Seller and copies of the same (if reduced
to writing) shall have been delivered to Seller.
10.03 Compliance with Covenants. Buyer shall have performed in all
-------------------------
material respects all obligations and agreements and complied in all material
respects with all covenants and conditions contained in this Agreement to be
performed and complied with by it at or prior to the Closing (except that any
covenants and conditions which are qualified as to materiality shall have been
so performed and complied with in all respects).
11. CONDITIONS APPLICABLE TO BUYER AND SELLER.
-----------------------------------------
The obligations of each of Buyer and Seller under this Agreement to cause
this Agreement to become effective and have the transactions contemplated hereby
be consummated are subject to the following terms and conditions:
11.01 Hart-Scott-Rodino Act. Any waiting period applicable to the
---------------------
consummation of the transactions contemplated by this Agreement under the Hart-
Scott-Rodino Antitrust Improvements Act of 1976, as amended, shall have expired
or been terminated, and no action instituted by the Department of Justice or
Federal Trade Commission challenging or seeking to enjoin the consummation of
such transactions shall be pending.
11.02 Governmental Approvals. A written order approving the purchase and
----------------------
sale of the Shares as contemplated by this Agreement from the insurance
departments listed on Seller's and Buyer's Consent Schedules and any additional
approvals thereof as may be required by other insurance regulatory authorities
for the purchase and sale of the Shares hereunder shall have been obtained at or
prior to the Closing.
11.03 Injunction. The consummation of the transactions contemplated by
----------
this Agreement shall not have been restrained, enjoined or prohibited by any
court or governmental authority of competent jurisdiction. No material
litigation or administrative proceeding shall be pending as of the Closing
seeking to restrain, enjoin or prohibit the consummation of the transactions
contemplated by this Agreement.
36
<PAGE>
11.04 Closing. The Closing shall occur no later than 5:00 p.m., Central
-------
Time, on June 30, 1999, or such other date as may be mutually agreed to by the
parties.
12. TERMINATION.
-----------
12.01 Termination. (a) Anything contained herein to the contrary
-----------
notwithstanding, this Agreement may be terminated and the transactions
contemplated hereby abandoned at any time prior to the Closing Date:
(i) by mutual written consent of Seller and Buyer;
(ii) by Seller if any of the conditions set forth in Section 10
shall have become incapable of fulfillment, and shall not have been waived
by Seller;
(iii) by Buyer if any of the conditions set forth in Section 9 shall
have become incapable of fulfillment, and shall not have been waived by
Buyer;
(iv) by either party if any of the conditions set forth in Section
11 (other than Section 11.04) shall have become incapable of fulfillment,
and shall not have been waived by the party seeking termination; or
(v) by either party if the Closing does not occur on or prior to
June 30, 1999;
provided, however, that the party seeking termination pursuant to clause
-------- -------
(ii), (iii), (iv) or (v) shall only be entitled to terminate this Agreement
if it is not in material breach of any of its representations, warranties,
covenants or agreements contained in this Agreement.
(b) In the event of termination by Seller or Buyer pursuant to this Section
12, written notice thereof shall forthwith be given to the other party and the
transactions contemplated by this Agreement shall be terminated, without further
action by either party. If the transactions contemplated by this Agreement are
terminated as provided herein:
(i) Buyer shall return all documents and other material received from
Seller or any Subject Entity relating to the transactions contemplated
hereby, whether so obtained before or after the execution hereof, to
Seller; and
(ii) all confidential information received by Buyer with respect to
the business of the Subject Entities shall be treated in accordance with
the terms of the
37
<PAGE>
Confidentiality Agreement, which shall remain in full force and effect in
accordance with its terms notwithstanding the termination of this
Agreement.
(c) If this Agreement is terminated and the transactions contemplated
hereby are abandoned as described in this Section 12, this Agreement shall
become null and void and of no further force or effect, except for the
provisions of (i) Section 6.06 relating to the obligation of Buyer to keep
confidential certain information and data obtained by it, (ii) Section 17.01
relating to certain expenses, (iii) Section 17.09 relating to attorney fees and
expenses, (iv) Section 17.06 relating to publicity, (v) Section 17.10 relating
to finder's fees and broker's fees, and (vi) this Section 12. Nothing in this
Section 12 shall be deemed to release either party from any liability for any
breach by such party of the terms and provisions of this Agreement or to impair
the right of either party to compel specific performance by the other party of
its obligations under this Agreement.
13. SURVIVAL OF REPRESENTATIONS AND WARRANTIES; COVENANTS.
-----------------------------------------------------
The representations and warranties in this Agreement and in any certificate
or schedule delivered pursuant hereto shall survive until the date which is
eighteen (18) months following the Closing Date; provided, however, that the
representations and warranties contained in Sections 2.12 (Environmental), 2.17
(Taxes) and 2.19 (Employee Benefits) shall survive until the expiration of the
relevant statutes of limitation, and the representations and warranties
contained in Sections 2.02 (Subsidiaries; the first two sentences only) and 2.03
(Authorized Stock), shall survive forever. Unless otherwise expressly provided
by this Agreement, all covenants and obligations under this Agreement to be
performed after the Closing shall survive the Closing in accordance with their
respective terms.
14. TAX INDEMNIFICATION.
-------------------
14.01 In addition to any indemnification obligations arising under Section
16 hereof, Seller hereby agrees upon the terms and conditions and in accordance
with the procedures set forth in this Agreement, to indemnify, defend and hold
Buyer and its affiliates (including, without limitation, each of the Subject
Entities) and their respective officers, directors, agents and employees (the
"Seller Indemnitees") harmless from and against any damages (including, without
limitation, extraordinary or punitive damages), deficiencies, costs,
liabilities, claims or expenses, including, without limitation, interest,
penalties and reasonable attorneys' fees (individually a "Loss" and collectively
the "Losses"), that any of the Seller Indemnitees shall incur or suffer,
regardless of whether Buyer had knowledge of such Loss or Losses at the time of
the Closing, resulting from or relating to any and all liability for Taxes (i)
of the Subject Entities related to any taxable period ending on or prior to the
Closing Date and the portion ending on the Closing Date
38
<PAGE>
of any taxable period that includes (but does not end on) such day ("Pre-Closing
Tax Period") and (ii) resulting from the Elections contemplated by Section 7.09
of this Agreement.
Notwithstanding the foregoing, Seller shall not indemnify any Seller
Indemnitee from any liability for Taxes attributable to any action taken after
the Closing by Buyer, any of its affiliates (including any of the Subject
Entities), or any transferee of Buyer or any of its affiliates (other than any
such action expressly required by applicable law or by this Agreement) (a "Buyer
Tax Act") or attributable to a breach by Buyer of its obligations under this
Agreement.
In the case of any taxable period that includes (but does not end on)
the Closing Date (a "Straddle Period"):
(i) real, personal and intangible property Taxes ("property Taxes")
of the Subject Entities for the Pre-Closing Tax Period shall be equal to
the amount of such property Taxes for the entire Straddle Period multiplied
by a fraction, the numerator of which is the number of days during the
Straddle Period that are in the Pre-Closing Tax Period and the denominator
of which is the number of days in the Straddle Period; and
(ii) the Taxes of the Subject Entities (other than property Taxes)
for the Pre-Closing Tax Period shall be computed as if such taxable period
ended as of the close of business on the Closing Date.
14.02 Buyer hereby agrees upon the terms and conditions and in accordance
with the procedures set forth in this Agreement to indemnify, defend and hold
Seller and its affiliates and its officers, directors, agents and employees (the
"Buyer Indemnitees") harmless from and against any Loss or Losses that any of
the Buyer Indemnitees shall incur or suffer, regardless of whether Seller had
knowledge of such Loss or Losses at the time of the Closing, resulting from or
relating to any and all liability for Taxes (i) of the Subject Entities related
to any taxable period ending after the Closing Date (except to the extent such
taxable period began before the Closing Date, in which case Buyer's indemnity
will cover only that portion of any such Taxes that are not for the Pre-Closing
Tax Period) and (ii) attributable to a Buyer Tax Act or to a breach by Buyer of
its obligations under this Agreement.
14.03 If a claim with respect to Taxes shall be made by any taxing
authority, which, if successful, might result in an indemnity payment to an
indemnified party pursuant to Section 14.01 or 14.02, the party receiving such
claim shall promptly notify the other party in writing of such claim (a "Tax
Claim"). If the indemnified party
39
<PAGE>
receives notification of a Tax Claim and fails to notify the indemnifying party
within a sufficient period of time to allow the indemnifying party to
effectively contest such Tax Claim, or in reasonable detail to apprise the
indemnifying party of the nature of the Tax Claim, in each case taking into
account the facts and circumstances with respect to such Tax Claim, the
indemnifying party shall not be liable to the indemnified party, any of its
affiliates or any of their respective officers, directors, agents or employees
to the extent that indemnifying party's position is actually prejudiced as a
result thereof.
With respect to any Tax Claim relating solely to a Pre-Closing Tax Period,
Seller shall control all proceedings taken in connection with such Tax Claim
(including selection of counsel) and, without limiting the foregoing, may in its
sole discretion pursue or forego any and all administrative appeals,
proceedings, hearings and conferences with any taxing authority with respect
thereto, and may, in its sole discretion, either pay the Tax claimed and sue for
a refund where applicable law permits such refund suits or contest the Tax Claim
in any permissible manner.
Buyer, the Subject Entities, and each of their respective affiliates shall
cooperate with Seller in contesting any Tax Claim, which cooperation shall
include the retention until the applicable statute of limitations has expired
and (upon Seller's request) the provision to Seller of records and information
which are reasonably relevant to such Tax Claim, and making their employees
available on a mutually convenient basis to provide additional reasonably
relevant information or explanation of any material provided hereunder or to
testify at proceedings relating to such Tax Claim.
In no case shall Buyer, the Subject Entities, or any of their respective
officers, directors, agents or employees settle or otherwise compromise any Tax
Claim relating to a Pre-Closing Tax Period (excluding Straddle Periods) without
Seller's prior written consent.
15. POST-CLOSING RESERVE ADJUSTMENTS.
--------------------------------
15.01 Calculation and Adjustment. As promptly as reasonably practicable
--------------------------
after it becomes available, Buyer shall deliver to Seller a true and complete
copy of each Annual and Quarterly Statement of each Subject Entity as filed with
the appropriate insurance regulatory authority for any period ending at or prior
to the Settlement Date (as defined in Section 15.02), together with any
actuarial opinion, affirmation or certification filed in connection therewith.
Not later than 90 days following the end of each calendar year until the
Settlement Date, and not later than 90 days following the Settlement Date, Buyer
shall provide Seller with a written report (the "Reserve Report") reflecting the
calculation contemplated by Section 15.02 ("Indicated Reserve Amount"), together
with all work papers and actuarial memoranda used in establishing the Indicated
Reserve Amount. The
40
<PAGE>
calculation of the Indicated Reserve Amount will be prepared in conformity with
GAAP as in effect on the Closing Date consistently applied and the books and
records of the Subject Entities (with the exception of ULAE which shall be
calculated in accordance with Section 15.02), and will present fairly the loss
and loss adjustment expense reserves of the Insurance Companies as of the
Settlement Date (or earlier date thereof). In the event that the Indicated
Reserve Amount reflected on the final Reserve Report prepared as of the
Settlement Date exceeds the loss and loss adjustment expense ("LAE") reserves,
net of related third party reinsurance, salvage and subrogation recoverables and
receivables, as shown in the Closing Date Balance Sheet ("Closing Reserves"), by
at least $500,000, Seller shall pay or cause to be paid to Buyer in immediately
available funds 90% of the amount (including such $500,000 amount) by which the
Indicated Reserve Amount exceeds the Closing Reserves (including such $500,000
amount). In the event that the Closing Reserves exceed the Indicated Reserve
Amount by at least $500,000, Buyer shall pay or cause to be paid to Seller in
immediately available funds 90% of the amount (including such $500,000 amount)
by which the Closing Reserves exceed the Indicated Reserve Amount (including
such $500,000 amount). Notwithstanding anything herein to the contrary, Seller
shall not in any event be required to pay any amounts hereunder which would
individually or in the aggregate exceed $50,000,000.
15.02 Calculation Methodology. The Indicated Reserve Amount will be equal
-----------------------
to the sum of (i) the Indicated Loss Reserve Amount as defined in Section 15.03
and (ii) the Indicated ALAE Reserve Amount as defined in Section 15.04 and (iii)
5.4% of the sum of (a) the Indicated Loss Reserve Amount plus (b) the Indicated
ALAE Reserve Amount, such percentage representing the agreed-upon unallocated
loss adjustment expenses ("ULAE") for the Subject Business, in the case of each
of (i) and (ii) and (iii) as of December 31, 2002 (the "Settlement Date") solely
with respect to insurance or reinsurance issued, underwritten or assumed prior
to the Closing Date by the Insurance Companies (the "Subject Business").
Notwithstanding anything herein to the contrary, and except as otherwise
provided by Section 15.07, the Indicated Reserve Amount shall exclude from
losses and LAE any losses and LAE liabilities (i) paid or incurred in excess of
the limits of any original policy, (ii) constituting an extra-contractual
liability, or (iii) arising from the negligence, fraud or bad faith of any
Insurance Company or any other of Buyer's affiliates in the handling of the
underlying claim, but only to the extent that any such losses and LAE
liabilities in the case of each of (i), (ii) and (iii) arise out of acts or
omissions occurring after the Closing Date.
15.03 Indicated Loss Reserve Amount. The Indicated Loss Reserve Amount
-----------------------------
will be the sum of (i) claims paid after the Closing Date for losses
occurring on or prior to the Closing Date with respect to the Subject Business,
(ii) case loss reserves held as of the Settlement Date for losses occurring on
or prior to the Closing Date with respect to the Subject Business, and (iii) the
bulk and incurred but not reported ("IBNR") loss
41
<PAGE>
reserves held as of the Settlement Date for losses occurring on or prior to the
Closing Date with respect to the Subject Business, less applicable third party
reinsurance, salvage and subrogation recoveries received or receivable after the
Closing Date and applicable to losses incurred on or prior to the Closing Date.
The loss reserves for the Subject Business will be calculated in accordance with
GAAP as in effect on the Closing Date consistently applied and generally
accepted actuarial practices consistently applied.
15.04 Indicated ALAE Reserve Amount. The Indicated ALAE Reserve Amount
-----------------------------
will be the sum of (i) allocated loss adjustment expenses ("ALAE") paid after
the Closing Date for losses occurring on or prior to the Closing Date with
respect to the Subject Business, (ii) case ALAE reserves held as of the
Settlement Date for losses occurring on or prior to the Closing Date with
respect to the Subject Business and (iii) bulk and IBNR ALAE reserves held as of
the Settlement Date for losses occurring on or prior to the Closing Date with
respect to the Subject Business, less applicable third party reinsurance,
salvage and subrogation recoveries received or receivable after the Closing Date
and applicable to losses incurred on or prior to the Closing Date. The ALAE
reserves for the Subject Business will be calculated in accordance with GAAP as
in effect on the Closing Date consistently applied and generally accepted
actuarial practices consistently applied.
15.05 Dispute Resolution. Following the delivery of the Reserve Report to
------------------
Seller, Buyer will cause the Subject Entities to allow Seller to have reasonable
access , during normal business hours and upon reasonable notice, to the books,
records and work papers of the Subject Entities relating to the Indicated
Reserve Amount and the Subject Business; provided, however, that such access
-------- -------
does not unreasonably disrupt the normal business operations of the Subject
Entities, Buyer or its other affiliates. In the event that the Seller has any
disagreement with the Indicated Reserve Amount reflected in the Reserve Report
then all unresolved disagreements shall be submitted to an independent actuarial
firm of national standing and reputation as the parties shall jointly select and
retain (the "Independent Actuary") for resolution in accordance with this
Agreement. In the event that the parties are unable to jointly select an
Independent Actuary, each of the Buyer, on the one hand, and the Seller, on the
other hand, shall select an independent certified public accounting firm of
national standing and reputation, which firms shall jointly select the
Independent Actuary for joint retention by the parties. The parties shall, and
Buyer shall cause the Subject Entities to, cooperate in good faith with the
Independent Actuary and shall give the Independent Actuary access to all books,
records, work papers and other information and documents relating to the items
in disagreement as the Independent Actuary may reasonably request for purposes
of such resolution. The Independent Actuary shall, within thirty (30) days
after its engagement, deliver to the parties a conclusive written resolution of
all disagreements submitted to it, which written resolution shall be in
accordance with this Agreement and shall be final and binding upon the parties
hereto. The Indicated Reserve Amount reflected in the Reserve Report shall
42
<PAGE>
be adjusted accordingly to reflect any such resolution and, as so adjusted,
shall be deemed final for purposes of the payments provided in Section 15.01.
Seller on the one hand, and Buyer on the other hand, shall each pay one-half of
the fees and expenses of the Independent Actuary.
15.06 Payment. Except for any amounts in dispute under Section 15.05,
-------
balances due from either party under Section 15.01 shall be paid within 30 days
of delivery by Buyer of the final Reserve Report contemplated by Section 15.01.
Balances in dispute shall be paid within 30 days after the parties are notified
of the determination rendered by the Independent Actuary. Any such amounts
shall bear interest at an annual rate equal to the Interest Rate from the date
of delivery of the aforesaid report until payment in full.
15.07 Certain Covenants. With respect to the Subject Business, from the
-----------------
Closing Date until the Settlement Date, Buyer agrees to cause each Insurance
Company to, in good faith, (i) pay and settle claims, and handle the defense of
pending or threatened claims, suits or proceedings, in accordance with its
standard past practices, but in no case on a basis less favorable to such
Insurance Company than those practices of affiliates of Buyer, except to the
extent as may otherwise be required by law, (ii) establish reserves for losses
and loss adjustment expenses in accordance with generally accepted actuarial
standards, but in no case on a basis less favorable to such Insurance Company
than those practices of other affiliates of Buyer, and (iii) not delegate any
claims adjustment or claims handling authority to any person or entity not
affiliated therewith, in each case, other than on a basis more favorable to and
involving lesser liabilities, obligations and other costs for such Insurance
Company. Notwithstanding anything contained in this Agreement to the contrary,
each of Buyer and Seller agree that all claims incurred by any Insurance Company
with respect to the Subject Business involving synthetic stucco (sometimes
referred to as Exterior and Insulation Finishing System (EIFS) or Dryvit) shall
be assigned a date of loss as of the inception of the policy period. While this
Section 15 is in effect, Seller shall have the right to inspect and copy, at its
own expense, through its duly authorized representatives, the books, records and
accounts of each Subject Entity pertaining to the Subject Business and payments
of losses and loss adjustment expenses in respect thereof during normal business
hours and upon reasonable notice; provided, however, such inspection and copying
-------- -------
shall not unreasonable disrupt the normal business operations of any Subject
Entity, Buyer or its other affiliates. During the term of this Agreement, Buyer
shall advise Seller promptly of any claim relating to the Subject Business and
any material subsequent developments pertaining thereto, to the extent Buyer or
any of its affiliates is required to notify any reinsurer, retrocessionaire or
other assuming company thereof. Upon the written request of Seller, Buyer will
afford Seller an opportunity to participate with the relevant Insurance Company,
at the sole expense of Seller, in the settlement of any such claim, and the
Insurance Company and Seller shall cooperate in every respect in such
settlement; provided, however, in the event
-------- -------
43
<PAGE>
that Seller participates in a settlement, and to the extent such participation
results in or contributes to (i) liabilities paid or incurred in excess of the
limits of any original policy, (ii) liabilities constituting extra-contractual
liabilities, or (iii) a finding of negligence, fraud or bad faith as
contemplated by Section 15.02, such settlement and all liabilities associated
therewith shall be included to such extent in the Indicated Reserve Amount.
16. INDEMNIFICATION.
---------------
16.01 Indemnification by Seller. In addition to any indemnification
-------------------------
obligations provided elsewhere herein, Seller hereby agrees upon the terms and
conditions and in accordance with the procedures set forth in this Agreement, to
indemnify, defend and hold Buyer and its affiliates (including, without
limitation, following the Closing, each of the Subject Entities) and their
respective officers, directors, agents and employees (the "Seller Indemnitees")
harmless from and against any Loss or Losses that any of the Seller Indemnitees
shall incur or suffer resulting from or relating to any breach of representation
or warranty, or non-fulfillment of any covenant or agreement, by Seller
contained in this Agreement or any certificate, schedule, list or other document
delivered by Seller to Buyer pursuant to this Agreement. Notwithstanding
anything in this Agreement to the contrary, Seller shall not be required
hereunder to indemnify, defend or hold Seller Indemnitees, any of their
affiliates or any other Person or entity harmless from or against any Losses
arising from or relating to (i) insurance or reinsurance losses or loss
adjustment expenses (including reserves in respect thereof), except to the
extent specifically provided in Section 15, or (ii) Taxes, except to the extent
specifically provided in Section 14, or (iii) any Losses reflected on the
Closing Date Balance Sheet.
16.02 Indemnification by Buyer. In addition to any indemnification
------------------------
obligations provided elsewhere herein, Buyer hereby agrees upon the terms and
conditions and in accordance with the procedures set forth in this Agreement to
indemnify, defend and hold Seller and its affiliates and their respective
officers, directors, agents and employees (the "Buyer Indemnitees") harmless
from and against any Loss or Losses that any of the Buyer Indemnitees shall
incur or suffer resulting from or relating to any breach of representation or
warranty, or non-fulfillment of any covenant or agreement, by Buyer contained in
this Agreement or any certificate, schedule, list or other document delivered by
Buyer to Seller pursuant to this Agreement.
16.03 Limits on Indemnification. Notwithstanding the foregoing, no party
-------------------------
shall be obligated pursuant to Section 16.01 or 16.02, respectively, (i) until
the aggregate Losses of the party suffering Loss is in the amount of $250,000 or
more, in which case the indemnified party shall be entitled to be indemnified
for all such Losses (including such $250,000 amount) and (ii) for any Losses in
excess of $5,000,000 in the aggregate for all Losses; provided, however, that
-------- -------
the limitation for any Loss or Losses resulting
44
<PAGE>
from or relating to any breach by Seller of the representations and warranties
contained in Sections 2.02 or 2.03 shall be an amount equal to the Purchase
Price, less any other amounts paid to Buyer pursuant to Section 16.01.
16.04 Indemnification Procedures. Any indemnified party entitled to
--------------------------
indemnification hereunder pursuant to this Section 16 shall (i) give prompt
written notice to the indemnifying party of any claim with respect to which it
seeks indemnification and (ii) unless in such indemnified party's judgment a
conflict of interest between such indemnified and indemnifying parties may exist
with respect to such claim, permit such indemnifying party to assume the defense
of such claim with counsel reasonably satisfactory to the indemnified party. If
such defense is assumed, the indemnifying party will not be subject to any
liability for any settlement made by the indemnified party without the
indemnifying party's prior written consent (but such consent will not be
unreasonably withheld). An indemnifying party who is not entitled to, or elects
not to, assume the defense of a claim will not be obligated to pay the fees and
expenses of more than one counsel for all parties indemnified by such
indemnifying party with respect to such claim, unless in the reasonable judgment
of any indemnified party a conflict of interest may exist between such
indemnified party and any other of such indemnified parties with respect to such
claim. The indemnified party shall have the right to be represented by counsel
at its own expense in any such contest, defense, litigation or settlement
conducted by the indemnifying party. The indemnifying party also agrees to make
such provisions, as are reasonably requested by any indemnified party, for
contribution to such party in the event the indemnifying party's indemnification
is unavailable for any reason.
17. MISCELLANEOUS.
17.01 Payment of Expenses. Except as otherwise expressly provided herein,
-------------------
whether or not this Agreement shall be consummated, each party hereto shall pay
its own expenses incident to preparing for, entering into and carrying out this
Agreement and to the consummation of the transactions contemplated hereby.
17.02 Entire Agreement. This Agreement (together with the Schedules and
----------------
Exhibits hereto and the documents referred to herein) contains, and is intended
as, a complete statement of all of the terms of the arrangements between the
parties with respect to the matters provided for herein, and supersedes any
previous agreements and understandings between the parties with respect to those
matters.
17.03 Modifications, Amendments and Waivers. At any time prior to the
-------------------------------------
Closing, the parties hereto may by written agreement (a) extend the time for the
performance of any of the obligations or other acts of the parties hereto, (b)
waive any inaccuracies in the representations and warranties contained in this
Agreement or in any
45
<PAGE>
document delivered pursuant hereto, (c) waive compliance with any of the
covenants or agreements contained in this Agreement, or (d) make any other
modification of this Agreement approved by Buyer and Seller. This Agreement
shall not be altered or otherwise amended except pursuant to an instrument in
writing executed and delivered on behalf of each of the parties hereto.
17.04 Assignment. This Agreement shall not be assignable by any of the
----------
parties hereto, except that (a) Seller shall have the right, without such
consent, to transfer ownership of the Company to another direct or indirect
wholly owned subsidiary of Seller prior to the Closing and to assign to such
other subsidiary its right and obligation hereunder to sell the Shares to Buyer
(provided, however, that, in the event of such assignment, Seller shall
-------- -------
guarantee the performance by such other subsidiary of such sale obligation and
will remain liable for all its other obligations hereunder) and (b) Buyer shall
have the right, without such consent, to assign to a direct or indirect wholly
owned subsidiary of Buyer its right and obligation hereunder to purchase the
Shares from Seller (provided, however, that, in the event of such assignment,
-------- -------
Buyer shall guarantee the performance by such subsidiary of such purchase
obligation and will remain liable for all its other obligations hereunder).
This Agreement shall be binding upon and inure to the benefit of and be
enforceable by the parties hereto and their respective successors and permitted
assigns.
17.05 Schedules. All information set forth in the Seller Schedule shall
---------
be deemed a representation and warranty of Seller as to the accuracy of such
information.
17.06 Publicity. Except as may otherwise be required by law, no press
---------
release or public announcement concerning this Agreement or the transactions
contemplated hereby shall be made prior to the Closing without advance written
approval thereof by Seller and Buyer. Seller and Buyer will cooperate with each
other in the development and distribution of all news releases and other public
information disclosures with respect to this Agreement or any of the
transactions contemplated hereby. Without limiting the foregoing, the parties
contemplate issuing a joint press release announcing this transaction promptly
upon execution of this Agreement.
17.07 Notices. Any notice, request, instruction or other document to be
-------
given hereunder by any party to the others shall be in writing and delivered
personally or sent by registered or certified mail, postage prepaid, overnight
express service or confirmed facsimile transmission, if to Buyer, addressed to
Unitrin, Inc., One East Wacker Drive, 10th Floor, Chicago, Illinois 60601,
Attention: Richard C. Vie, facsimile: (312) 661-4690 (with a copy to Unitrin,
Attention: Scott Renwick, Esq., facsimile: (312) 661-4941); and if to Seller
addressed to Fund American Enterprises Holdings, Inc., 80 South Main Street,
Hanover, New Hampshire 03755-2053, Attention: Ray Barrette, facsimile:
46
<PAGE>
(603) 643-4562, (with a copy to Brobeck, Phleger & Harrison LLP, Two Embarcadero
Place, 2200 Geng Road, Palo Alto, California 94303, Attention: Curtis L. Mo,
Esq., facsimile: (650) 496-2715 or to such other persons as may be designated in
writing by the parties.
17.08 Glossary. Attached hereto as Exhibit A is a glossary of certain
--------
defined terms used in this Agreement.
17.09 Attorney Fees. A party in breach of this Agreement shall, on
-------------
demand, indemnify and hold harmless the other party from and against all
reasonable out-of-pocket expenses, including legal fees, incurred by such other
party by reason of the enforcement and protection of its rights under this
Agreement. The payment of such expenses is in addition to any other relief to
which such other party may be entitled.
17.10 Brokers' Fees. Seller hereby represents and warrants that (a) the
----------------
only brokers or finders that have acted for Seller in connection with this
Agreement or the transactions contemplated hereby or that may be entitled to any
brokerage fee, finder's fee or commission in respect thereof are Gill & Roeser
and (b) Seller shall pay all fees or commissions which may be payable to Gill &
Roeser. Buyer hereby represents and warrants that (a) the only brokers or
finders that have acted for Buyer in connection with this Agreement or the
transactions contemplated hereby or that may be entitled to any brokerage fee,
finder's fee or commission in respect thereof are Search Information Services
and (b) Buyer shall pay all fees or commissions which may be payable to Search
Information Services.
17.11 Remedies. The parties hereto agree that money damages or other
--------
remedies at law would not be a sufficient or adequate remedy for any breach or
violation of, or a default under, this Agreement by them and that, in addition
to all other remedies available to them, each of them shall be entitled to an
injunction restraining such breach, violation or default or threatened breach,
violation or default and to any other equitable relief, including specific
performance, without bond or other security being required.
17.12 Severability. The invalidity or unenforceability of any provision
------------
of this Agreement in any jurisdiction shall not affect the validity or
enforceability of the remainder of this Agreement in that jurisdiction or the
validity or enforceability of this Agreement, including that provision, in any
other jurisdiction. If any restriction or provision of this Agreement is held
unreasonable, unlawful or unenforceable in any respect, such restriction or
provision shall be interpreted, revised or applied in a manner that renders it
lawful and enforceable to the fullest extent possible under law.
47
<PAGE>
17.13 Governing Law. This Agreement and the rights and obligations of the
-------------
parties hereto shall be governed by, and construed and enforced in accordance
with, the internal laws of the State of New York, without giving effect to the
principles of conflict of laws thereof.
17.14 Headings. The Section and paragraph headings in this Agreement are
--------
inserted for convenience of reference only, and shall not control or affect the
meaning or construction of any provision of this Agreement.
17.15 Counterparts. This Agreement may be executed by the parties hereto in
------------
separate counterparts, each of which when so executed and delivered shall be
deemed to be an original and all of which together shall constitute one and the
same instrument.
17.16 Non-Competition/Non-Solicitation. During the twenty-four (24) months
--------------------------------
immediately following the Closing Date, Seller agrees that neither it nor any of
its affiliates will, without the written consent of Buyer or its affiliates:
a) directly or indirectly acquire a majority controlling interest
(whether by merger, consolidation, purchase of stock or assets, or otherwise) of
any Competing Insurer (as defined below);
b) employ or solicit the employment of any employee of the Subject
Entities identified on Schedule 17.16 attached hereto; provided, however,
nothing herein shall prevent Seller or any of its affiliates from employing any
such employee that is terminated by a Subject Entity subsequent to the Closing
Date; or
c) induce or attempt to induce any agent of any Insurance Company as
of the Closing Date to terminate its agency relationship with such Insurance
Company or induce or attempt to induce any agent of any Insurance Company as of
the Closing Date to place the renewal of any insurance policies written or
assumed by any Insurance Company as of the Closing Date with another insurance
company that is owned or controlled by Seller or its affiliates.
For purposes of the above, a "Competing Insurer" shall mean an insurer
(or, if Seller or its affiliates acquire a majority controlling interest in any
group of affiliated insurers, such affiliated group of insurers) which derived a
majority of the gross written premiums, during the calendar year next preceding
the date of determination, from property and casualty insurance in Oregon or
non-standard automobile insurance in Texas.
48
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[page intentionally left blank]
49
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IN WITNESS WHEREOF, the parties have caused this Agreement to be executed
and delivered as of the day and year first above written.
UNITRIN, INC.
By: /S/ E. J. Draut
---------------------------
Name: E. J. Draut
-------------------------
Title: Senior Vice President
------------------------
FUND AMERICAN ENTERPRISES HOLDINGS, INC.
By: /S/ R. Barrette
---------------------------
Name: R. Barrette
-------------------------
Title: EVP & CFO
------------------------
* * * * *
This Exhibit 2 omits all schedules and similar attachments to the Stock
Acquisition Agreement. Such schedules consist of factual disclosures regarding
the Subject Entities and similar informational matters customary to acquisition
agreements. Unitrin agrees to furnish supplementally a copy of any omitted
schedule to the Commission upon request.
50
<PAGE>
EXHIBIT 13.1
CONSOLIDATED FINANCIAL STATEMENTS
OF
UNITRIN, INC. AND SUBSIDIARIES
The following pages reproduce pages 23 through 47 from Unitrin, Inc.'s 1998
Annual Report to Shareholders. On February 11, 1999, Unitrin's Board of
Directors declared a 2-for-1 stock split in the form of a stock dividend payable
on March 26, 1999 to shareholders of record on March 5, 1999. Prior to the
declaration of the 2-for-1 stock split, the Company had released its Financial
Statements for the year ended December 31, 1998. Accordingly, consistent with
Topic 4.C. "Change in Capital Securities" of Staff Accounting Bulletin 57, the
retroactive effect of the stock split has not been presented in such Financial
Statements attached hereto as Exhibit 13.1.
<PAGE>
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
To the Shareholders and Board of Directors of Unitrin, Inc.:
We have audited the accompanying consolidated balance sheets of Unitrin, Inc.
and subsidiaries as of December 31, 1998 and 1997 and the related consolidated
statements of income, cash flows and shareholders' equity and comprehensive
income for each of the years in the three-year period ended December 31, 1998.
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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Unitrin, Inc. and subsidiaries as of December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1998, in conformity with generally
accepted accounting principles.
KPMG LLP
Chicago, Illinois
January 8, 1999
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 23
<PAGE>
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
[Dollars in Millions] December 31,
- -------------------------------------------------------------------------------------------------------
1998 1997
<S> <C> <C>
ASSETS
Investments:
Fixed Maturities at Fair Value (Amortized Cost:
1998-$2,492.5; 1997-$2,274.4) $2,557.3 $2,315.4
Equity Securities at Fair Value (Cost: 1998-$831.2; 1997-$131.0) 786.3 245.7
Investees at Cost Plus Cumulative Undistributed
Earnings (Fair Value: 1998-$1,223.2; 1997-$2,031.7) 581.2 705.8
Other 379.4 181.6
-------- --------
Total Investments 4,304.2 3,448.5
-------- --------
Cash 8.6 14.5
Consumer Finance Receivables 532.0 543.6
Other Receivables 290.8 335.4
Deferred Policy Acquisition Costs 332.0 237.1
Cost in Excess of Net Assets of Purchased Businesses 298.1 237.3
Other Assets 144.2 104.3
-------- --------
Total Assets $5,909.9 $4,920.7
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Insurance Reserves:
Life and Health $2,079.0 $1,567.5
Property and Casualty 447.7 468.5
-------- --------
Total Insurance Reserves 2,526.7 2,036.0
-------- --------
Investment Certificates 544.6 566.4
Unearned Premiums 263.2 279.5
Accrued and Deferred Income Taxes 378.8 187.8
Notes Payable 116.2 81.1
Accrued Expenses and Other Liabilities 258.0 236.9
-------- --------
Total Liabilities 4,087.5 3,387.7
-------- --------
Shareholders' Equity:
Common Stock, $0.10 par value, 100 Million Shares
Authorized, 37,988,875 and 37,584,928 Shares Issued
and Outstanding at December 31, 1998 and 1997 3.8 3.8
Paid-in Capital 428.2 217.8
Retained Earnings 1,377.2 1,209.7
Accumulated Other Comprehensive Income 13.2 101.7
-------- --------
Total Shareholders' Equity 1,822.4 1,533.0
-------- --------
Total Liabilities and Shareholders' Equity $5,909.9 $4,920.7
======== ========
- -------------------------------------------------------------------------------------------------------
</TABLE>
The Notes to the Consolidated Financial Statements are an integral part of
these financial statements.
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 24
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------
[Dollars in Millions, Except Per Share Amounts] For the Years Ended December 31,
- --------------------------------------------------------------------------------------------
1998 1997 1996
<S> <C> <C> <C>
REVENUES
Premiums $1,228.3 $1,222.0 $1,220.3
Consumer Finance Revenues 113.8 125.0 120.4
Net Investment Income 186.4 179.5 179.0
Net Gains on Sales of Investments 557.4 3.6 3.4
-------- -------- --------
Total Revenues 2,085.9 1,530.1 1,523.1
-------- -------- --------
EXPENSES
Insurance Claims and Policyholders' Benefits 781.8 780.1 799.7
Insurance Expenses 507.7 480.4 486.2
Consumer Finance Expenses 95.6 116.7 99.6
Interest and Other Expenses 13.7 13.1 15.5
-------- -------- --------
Total Expenses 1,398.8 1,390.3 1,401.0
-------- -------- --------
Income before Income Taxes and Equity in
Net Income of Investees 687.1 139.8 122.1
Income Tax Expense 238.6 47.1 40.2
-------- -------- --------
Income before Equity in Net Income of Investees 448.5 92.7 81.9
Equity in Net Income of Investees (Note 5) 62.3 25.2 50.6
-------- -------- --------
NET INCOME $ 510.8 $ 117.9 $ 132.5
======== ======== ========
NET INCOME PER SHARE (NOTE 12) $ 13.11 $ 3.15 $ 3.51
======== ======== ========
NET INCOME PER SHARE ASSUMING DILUTION (NOTE 12) $ 13.02 $ 3.11 $ 3.47
======== ======== ========
- -------------------------------------------------------------------------------------------------------
</TABLE>
The Notes to the Consolidated Financial Statements are an integral part of
these financial statements.
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 25
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
[Dollars in Millions] For the Years Ended December 31,
- -------------------------------------------------------------------------------------------------------------
1998 1997 1996
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net Income $ 510.8 $ 117.9 $ 132.5
Adjustments to Reconcile Net Income to
Net Cash Provided by Operations:
Policy Acquisition Costs Deferred (142.2) (145.6) (149.1)
Amortization of Deferred Policy Acquisition Costs 149.3 167.4 170.1
Equity in Net Income of Investees before Taxes (95.0) (37.9) (77.1)
Cash Dividends from Investee 2.3 2.2 2.2
Amortization of Investments 23.9 23.1 24.6
Provisions for Losses on Consumer Finance Receivables 22.7 35.0 27.4
(Increase) Decrease in Other Receivables 32.0 8.5 (13.6)
Increase (Decrease) in Insurance Reserves and Unearned Premiums (21.9) 7.8 27.8
Increase in Accrued and Deferred Income Taxes 212.5 10.2 17.6
Decrease in Accrued Expenses and Other Liabilities (23.1) (40.0) (6.0)
Net Gains on Sales of Investments (557.4) (3.6) (3.4)
Other, Net 23.4 8.6 17.6
------- ------- -------
Net Cash Provided by Operating Activities 137.3 153.6 170.6
------- ------- -------
INVESTING ACTIVITIES
Sales and Maturities of Fixed Maturities 811.7 364.4 279.6
Purchases of Fixed Maturities (475.3) (478.2) (111.6)
Sales of Equity Securities 98.7 51.6 10.0
Purchases of Equity Securities (21.5) (12.2) (84.1)
Repayments of Consumer Finance Receivables 307.1 344.0 329.0
Acquisitions of Consumer Finance Receivables (316.6) (317.4) (417.9)
Change in Short-term Investments (103.7) 19.0 21.7
Acquisitions and Improvements of Investment Real Estate (11.4) (12.1) (2.9)
Acquisition of Businesses (99.2) - -
Other, Net (19.0) (25.2) (14.6)
------- ------- -------
Net Cash Provided (Used) by Investing Activities 170.8 (66.1) 9.2
------- ------- -------
FINANCING ACTIVITIES
Investment Certificate Deposits 178.2 203.7 229.7
Investment Certificate Withdrawals (200.0) (227.2) (158.8)
Universal Life and Annuity Receipts from Policyholders 13.5 14.1 21.0
Universal Life and Annuity Payments to Policyholders (3.5) (2.9) (7.6)
Universal Life and Annuity Payments to Reinsurer - - (76.1)
Notes Payable Proceeds 381.6 515.0 170.0
Notes Payable Payments (357.4) (493.8) (210.8)
Cash Dividends Paid (100.7) (89.9) (83.0)
Common Stock Repurchases (232.9) (20.7) (61.1)
Other, Net 7.2 11.7 4.8
------- ------- -------
Net Cash Used by Financing Activities (314.0) (90.0) (171.9)
------- ------- -------
Increase (Decrease) in Cash (5.9) (2.5) 7.9
Cash, Beginning of Year 14.5 17.0 9.1
------- ------- -------
Cash, End of Year $ 8.6 $ 14.5 $ 17.0
======= ======= =======
- -------------------------------------------------------------------------------------------------------------
</TABLE>
The Notes to the Consolidated Financial Statements are an integral part of these
financial statements.
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 26
<PAGE>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
[Dollars and Shares in Millions] For the Years Ended December 31, 1998, 1997 and 1996
- -------------------------------------------------------------------------------------------------------------------
Accumulated
Other Total
Number of Common Paid-in Retained Comprehensive Shareholders'
Shares Stock Capital Earnings Income Equity
BALANCE, DECEMBER 31, 1995 38.5 $ 3.8 $ 126.2 $ 1,281.1 $ 113.4 $ 1,524.5
<S> <C> <C> <C> <C> <C> <C>
Net Income - - - 132.5 - 132.5
Other Comprehensive
Income (Loss) (Note 11) - - - - (35.6) (35.6)
---------
Total Comprehensive Income $ 96.9
---------
Dividends to Common
Shareholders ($2.20 per share) - - - (83.0) - (83.0)
Repurchases of Unitrin
Common Stock (1.3) (0.1) (4.2) (56.8) - (61.1)
Exercise of Employee Stock Options,
Net of Shares Exchanged (Note 10) 0.1 - 11.0 (8.0) - 3.0
--------- --------- --------- --------- --------- ---------
BALANCE, DECEMBER 31, 1996 37.3 $ 3.7 $ 133.0 $ 1,265.8 $ 77.8 $ 1,480.3
Net Income - - - 117.9 - 117.9
Other Comprehensive
Income (Note 11) - - - - 23.9 23.9
---------
Total Comprehensive Income $ 141.8
---------
Acquisition of Union Automobile
Indemnity Company 0.4 0.1 18.5 - - 18.6
Dividends to Common
Shareholders ($2.40 per share) - - - (89.9) - (89.9)
Repurchases of Unitrin
Common Stock (0.4) (0.1) (1.5) (19.1) - (20.7)
Exercise of Employee Stock Options,
Net of Shares Exchanged (Note 10) 0.3 0.1 67.8 (65.0) - 2.9
--------- --------- --------- --------- --------- ---------
BALANCE, DECEMBER 31, 1997 37.6 $ 3.8 $ 217.8 $ 1,209.7 $ 101.7 $ 1,533.0
Net Income - - - 510.8 - 510.8
Other Comprehensive
Income (Loss) (Note 11) - - - - (88.5) (88.5)
---------
Total Comprehensive Income $ 422.3
---------
Acquisition of The Reliable Life
Insurance Company 3.8 0.4 197.3 - - 197.7
Dividends to Common
Shareholders ($2.60 per share) - - - (100.7) - (100.7)
Repurchases of Unitrin
Common Stock (3.5) (0.4) (38.4) (194.1) - (232.9)
Exercise of Employee Stock Options,
Net of Shares Exchanged (Note 10) 0.1 - 51.9 (48.5) - 3.4
Other, Net - - (0.4) - - (0.4)
--------- --------- --------- --------- --------- ---------
BALANCE, DECEMBER 31, 1998 38.0 $ 3.8 $ 428.2 $ 1,377.2 $ 13.2 $ 1,822.4
========= ========= ========= ========= ========= =========
- ----------------------------------------------------------------------------------------------------------------
The Notes to the Consolidated Financial Statements are an integral part of these financial statements.
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
Unitrin, Inc. and Subsidiaries 27
<PAGE>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. BASIS OF PRESENTATION
- --------------------------------------------------------------------------------
The Consolidated Financial Statements included herein have been prepared on the
basis of generally accepted accounting principles, which differ from statutory
insurance accounting practices, and include the accounts of Unitrin, Inc. and
its subsidiaries ("Unitrin" or the "Company"). All significant intercompany
accounts and transactions have been eliminated. Certain prior year amounts have
been reclassified to conform to the current year's presentation.
The preparation of financial statements in conformity with generally accepted
accounting principles requires the use of estimates and assumptions that affect
the reported amounts of assets and liabilities, the disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period.
NOTE 2. SUMMARY OF ACCOUNTING POLICIES
- --------------------------------------------------------------------------------
Investments Other Than Investees
Investments in Fixed Maturities include bonds, notes and redemptive preferred
stocks at fair value and are classified as Available for Sale. Investments in
Equity Securities include common and nonredemptive preferred stocks at fair
value and are classified as Available for Sale. Unrealized appreciation or
depreciation, net of applicable deferred income taxes, on Fixed Maturities and
Equity Securities is included in Shareholders' Equity. Other Investments
include fixed maturities which mature within one year from the date of
purchase, loans to policyholders, real estate, and mortgage loans and are
carried at cost or unpaid principal balance. Gains and losses on sales of
investments are computed on the specific identification method and are
reflected in Net Income.
Investments in Investees
Investments in Investees are accounted for by the equity method in the
accompanying financial statements. The Company's voting percentage and share of
earnings or losses of each investee company are determined using the most
recent publicly-available audited financial statements, subsequent unaudited
interim reports and other publicly-available information. As a result, the
amounts included in the Company's financial statements represent amounts
reported by the investee companies for periods ending two to three months
earlier. The Company recognizes into income its equity share of changes in an
investee's reported net assets resulting from an investee's issuance of stock
that is not part of a broader corporate reorganization.
Consumer Finance Receivables
Consumer Finance Receivables consists primarily of loans to California
residents which are secured by automobiles and is stated net of unearned
discount, loan fees and reserve for losses. Unearned discount arises when the
loan amount includes unearned precomputed interest. The reserve for losses on
Consumer Finance Receivables is maintained at a level which exceeds minimum
regulatory requirements and considers other factors, including actual loan loss
experience and economic conditions, to provide for estimated losses on Consumer
Finance Receivables.
Deferred Policy Acquisition Costs
Certain costs directly associated with the acquisition of new business,
principally commissions, are deferred. Deferred Policy Acquisition Costs also
include the costs of acquiring insurance in force from other companies.
Interest accreted on the cost of Insurance In Force Acquired is not material.
Costs deferred on property and casualty insurance products and health
insurance products are amortized over the term of the related policies. Costs
deferred on traditional life insurance products are primarily amortized over
the anticipated premium-paying period of the related policies in proportion to
the ratio of the annual premiums to the total premiums anticipated, which is
estimated using the same assumptions used in calculating policy reserves.
Cost in Excess of Net Assets of Purchased Businesses
Cost in Excess of Net Assets of Purchased Businesses of $143.2 million at
December 31, 1998, relating to acquisitions prior to November 1970, is not
being amortized. Amounts applicable to subsequent acquisitions are being
amortized ratably over 40 years.
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 28
<PAGE>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2. SUMMARY OF ACCOUNTING POLICIES [CONTINUED]
- --------------------------------------------------------------------------------
Impairment of Long-Lived Assets
The Company accounts for the impairment of long-lived assets in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of."
Insurance Reserves
Reserves for losses and loss adjustment expenses on property and casualty
coverage represent the estimated claim cost and loss adjustment expense
necessary to cover the ultimate net cost of investigating and settling all
losses incurred and unpaid and include provisions for adverse deviation. Such
estimates are based on individual case estimates for reported claims and
estimates for incurred but not reported losses. These estimates are adjusted in
the aggregate for ultimate loss expectations based on historical experience
patterns and current economic trends, with any change in the probable ultimate
liabilities being reflected in Net Income.
For traditional life insurance products, the reserves for future policy
benefits are primarily estimated on the net level premium method based on
expected mortality, interest and withdrawal rates, including provisions for
adverse mortality. These assumptions vary by such characteristics as plan, age
at issue and policy duration. Mortality assumptions reflect the Company's
historical experience and industry standards. Interest rate assumptions
principally range from 3.0 percent to 7.0 percent. Withdrawal assumptions are
based on actual and industry experience. Benefit reserves for universal life-
type products represent policy account balances before applicable surrender
charges.
Recognition of Premium Revenues and Related Expenses
Property and casualty insurance and health insurance premiums are recognized
ratably over the periods to which the premiums relate. Insurance Claims and
Policyholders' Benefits include provisions for reported claims, claims incurred
but not reported and loss adjustment expenses.
Traditional life insurance premiums are recognized as revenue when due.
Insurance Claims and Policyholders' Benefits are associated with related
premiums to result in recognition of profits over the periods that the benefits
are provided.
Premium revenues for universal life-type products consist of charges for
the cost of insurance, policy administration and policy surrenders that have
been assessed against policy account balances during the period. Benefit
payments in excess of policy account balances are expensed.
Reinsurance
In the normal course of business, the Company's insurance subsidiaries reinsure
certain risks above certain retention levels with other insurance enterprises.
Amounts recoverable from reinsurers for benefits and losses for which the
Company has not been relieved of its legal obligation to the policyholder are
included in Other Receivables.
Gains related to long-duration reinsurance contracts are deferred and
amortized over the life of the underlying reinsured policies. Losses related to
long-duration reinsurance contracts are recognized immediately. Any gain or loss
associated with reinsurance agreements for which the Company has been legally
relieved of its obligation to the policyholder is recognized in the current
period.
Consumer Finance Revenues and Expenses
Consumer Finance Revenues include interest on Consumer Finance Receivables and
Net Investment Income on Investments in Fixed Maturities made by the Company's
Consumer Finance Operations. Interest income on Consumer Finance Receivables is
recorded as interest is earned, using the effective yield method. Net Investment
Income included in Consumer Finance Revenues was $5.6 million, $5.4 million and
$2.7 million in 1998, 1997 and 1996, respectively.
Consumer Finance Expenses include interest expense on Investment
Certificates, Provisions for Losses on Consumer Finance Receivables, and general
and administrative expenses. Interest expense on Investment Certificates is
recorded using the effective yield method.
Income Taxes
Deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
in effect for the year in which those temporary
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 29
<PAGE>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2. SUMMARY OF ACCOUNTING POLICIES [CONTINUED]
- --------------------------------------------------------------------------------
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period in which the change is enacted.
Stock-Based Compensation
The Company accounts for its employee stock option plans in accordance with
Accounting Principles Board ("APB") Opinion No. 25 "Accounting for Stock Issued
to Employees." The Company has not issued stock options where the exercise price
is less than the market value of the Company's common stock on the date of grant
and, accordingly, no compensation expense has been recognized.
Fair Value of Financial Instruments
The Company has no derivative financial instruments subject to the provisions of
SFAS No. 119, "Disclosure About Derivative Financial Instruments and Fair Value
of Financial Instruments." The carrying values and fair values of the Company's
financial instruments are disclosed in Note 4--Investments Other Than Investees,
Note 5--Investments in Investees, Note 6--Consumer Finance Receivables and
Investment Certificates and Note 8--Notes Payable.
Accounting Changes
Effective January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income." Under SFAS No. 130, enterprises that provide a full set
of financial statements that report financial position, results of operations
and cash flows should also include a Statement of Comprehensive Income.
Effective January 1, 1998, the Company adopted SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information." Under SFAS No. 131,
public business enterprises are required to provide disclosures about operating
segments using the "management approach." The Company's Life and Health
Insurance employee-agents also market certain property and casualty insurance
products under common management. Accordingly, the Company now includes the
results of those property and casualty insurance products in its Life and Health
Insurance segment. It is the Company's management practice to allocate certain
corporate expenses to its operating units. Consistent with that practice, the
Company now includes those expenses in the results of its operating segments.
In February 1998, the Financial Accounting Standards Board issued SFAS No.
132, "Employers' Disclosures about Pensions and Other Postretirement Benefits."
SFAS No. 132 supersedes the disclosure requirements of SFAS No. 87, "Employers'
Accounting for Pensions," SFAS No. 88, "Employers' Accounting for Settlements
and Curtailments of Defined Benefit Pension Plans and Termination Benefits," and
SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than
Pensions." SFAS No. 132 is effective for fiscal years beginning after December
15, 1997. SFAS No. 132 does not address measurement or recognition and,
accordingly, has no effect on the Company's financial position or results of
operations.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and for Hedging Activities." SFAS No. 133
requires all derivatives to be recorded on the balance sheet at fair value and
establishes "special accounting" for the following three different types of
hedges: hedges of changes in the fair value of assets, liabilities or firm
commitments; hedges of the variable cash flows of forecasted transactions; and
hedges of foreign currency exposures of net investments in foreign operations.
SFAS No. 133 is effective for years beginning after June 15, 1999, with earlier
adoption permitted. The Company believes that the effect of adoption of SFAS No.
133 will not be material.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") No. 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." SOP No. 98-1 requires
companies to capitalize qualifying computer software costs incurred during the
application development stage. SOP No. 98-1 is effective for fiscal years
beginning after December 31, 1998, with earlier adoption permitted. The Company
intends to adopt SOP No. 98-1 in 1999. The Company has not determined the effect
of adoption.
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 30
<PAGE>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 3. ACQUISITIONS OF BUSINESSES
- --------------------------------------------------------------------------------
On May 29, 1998, the Company completed the acquisition of The Reliable Life
Insurance Company ("Reliable") whereby the Company acquired all of the then
outstanding shares of Reliable common stock in exchange for approximately 3.8
million shares of Unitrin common stock and cash. The purchase price determined
in accordance with Emerging Issues Task Force ("EITF") No. 95-19, "Determination
of the Measurement Date for the Market Price of Securities Issued In a Purchased
Business Combination," was:
- --------------------------------------------------------------------------------
[Dollars in Millions]
Value of Unitrin Common Stock Issued $ 197.7
Cash and Other Transaction Costs 0.7
-------
Purchase Price $ 198.4
=======
- --------------------------------------------------------------------------------
On September 30, 1998, United Insurance Company of America, a subsidiary of the
Company, completed its acquisition of NationalCare Insurance Company
("NationalCare") and its wholly-owned subsidiary, Reserve National Insurance
Company ("Reserve National"), in a cash transaction for $98.5 million.
The acquisitions have been accounted for by the purchase method and,
accordingly, the operations of Reliable and NationalCare are included in the
Company's financial statements from the date of acquisition. Based on the
Company's preliminary allocation of the purchase prices, assets acquired and
liabilities assumed in connection with the acquisitions were:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
The Reliable Life NationalCare
[Dollars in Millions] Insurance Company Insurance Company 1998
<S> <C> <C> <C>
Investments $ 537.8 $ 127.5 $ 665.3
Cash 1.2 -- 1.2
Other Receivables 14.7 2.7 17.4
Insurance In Force Acquired 97.3 4.5 101.8
Cost in Excess of Net Assets Acquired 39.3 25.1 64.4
Other Assets 34.7 7.2 41.9
Life and Health Insurance Reserves (452.0) (45.1) (497.1)
Unearned Premiums (1.7) (19.7) (21.4)
Accrued and Deferred Income Taxes (26.2) 0.7 (25.5)
Notes Payable (10.8) -- (10.8)
Accrued Expenses and Other Liabilities (35.9) (4.4) (40.3)
---------- ---------- ---------
Total Purchase Price $ 198.4 $ 98.5 $ 296.9
========== ========== =========
</TABLE>
- --------------------------------------------------------------------------------
On January 7, 1997, the Company completed the acquisition of Union Automobile
Indemnity Company ("Union") for approximately $18.6 million in Unitrin, Inc.
common stock valued in accordance with EITF No. 95-19. The acquisition has been
accounted for by the purchase method and, accordingly, the operations of Union
have been included in the Company's financial statements from the date of
acquisition.
Assets acquired and liabilities assumed in connection with the acquisition
of Union in 1997 were:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
[Dollars in Millions] 1997
<S> <C>
Investments $ 36.1
Other Receivables 2.3
Insurance In Force Acquired 0.9
Cost in Excess of Net Assets of Purchased Businesses 12.1
Accrued and Deferred Income Taxes 1.8
Property and Casualty Insurance Reserves (19.6)
Unearned Premiums (11.2)
Accrued Expenses and Other Liabilities (3.8)
-------
Total Purchase Price $ 18.6
=======
</TABLE>
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 31
<PAGE>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
NOTE 4. INVESTMENTS OTHER THAN INVESTEES
-----------------------------------------------------------------------------------------------------------------------------------
The amortized cost and estimated fair values of the Company's investments in Fixed Maturities at December 31, 1998 were:
-----------------------------------------------------------------------------------------------------------------------------------
[Dollars in Millions] Amortized Gross Unrealized Fair
Cost ---------------- Value
Gains Losses
<S> <C> <C> <C> <C>
U.S. Government and Government
Agencies and Authorities $1,903.9 $48.9 $(0.4) $1,952.4
States, Municipalities and Political Subdivisions 142.8 3.8 (0.3) 146.3
Corporate Securities:
Bonds and Notes 338.5 12.4 (2.0) 348.9
Redemptive Preferred Stocks 107.3 2.8 (0.4) 109.7
-------- ----- ----- --------
Investments in Fixed Maturities $2,492.5 $67.9 $(3.1) $2,557.3
======== ===== ===== ========
- ------------------------------------------------------------------------------------------------------------------------------------
The amortized cost and estimated fair values of the Company's investments in Fixed Maturities at December 31, 1997 were:
- ------------------------------------------------------------------------------------------------------------------------------------
Amortized Gross Unrealized Fair
Cost ------------------- Value
[Dollars in Millions] Gains Losses
U.S. Government and Government
Agencies and Authorities $2,000.1 $33.3 $(1.1) $2,032.3
States, Municipalities and Political Subdivisions 103.8 2.8 - 106.6
Corporate Securities:
Bonds and Notes 121.0 4.1 (0.1) 125.0
Redemptive Preferred Stocks 49.5 2.0 - 51.5
-------- ----- ----- --------
Investments in Fixed Maturities $2,274.4 $42.2 $(1.2) $2,315.4
======== ===== ===== ========
- ------------------------------------------------------------------------------------------------------------------------------------
The amortized cost and estimated fair values of the Company's investments in Fixed Maturities at December 31, 1998 by contractual
maturity were:
- ------------------------------------------------------------------------------------------------------------------------------------
[Dollars in Millions] Amortized Fair
Cost Value
Due in One Year or Less $ 240.7 $ 242.8
Due After One Year to Five Years 1,357.7 1,392.0
Due After Five Years to Fifteen Years 537.9 549.6
Due After Fifteen Years 356.2 372.9
-------- --------
Total Investments in Fixed Maturities $2,492.5 $2,557.3
======== ========
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The expected maturities may differ from the contractual maturities because
debtors may have the right to call or prepay obligations with or without call
or prepayment penalties.
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 32
<PAGE>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 4. INVESTMENTS OTHER THAN INVESTEES [CONTINUED]
- --------------------------------------------------------------------------------
At December 31, 1998, gross unrealized gains and gross unrealized losses on
Equity Securities were:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Gross Unrealized Fair
---------------------
[Dollars in Millions] Cost Gains Losses Value
<S> <C> <C> <C> <C>
Common Stocks $ 743.1 $ 54.9 $ (105.0) $ 693.0
Preferred Stocks 88.1 5.2 -- 93.3
-------- ------- --------- --------
Total $ 831.2 $ 60.1 $ (105.0) $ 786.3
======== ======= ========= ========
</TABLE>
- --------------------------------------------------------------------------------
At December 31, 1997, gross unrealized gains and gross unrealized losses on
Equity Securities were:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Gross Unrealized Fair
---------------------
[Dollars in Millions] Cost Gains Losses Value
<S> <C> <C> <C> <C>
Common Stocks $ 19.7 $ 57.4 $ -- $ 77.1
Preferred Stocks 111.3 57.5 (0.2) 168.6
------- ------- ------- -------
Total $ 131.0 $ 114.9 $ (0.2) $ 245.7
======= ======= ======= =======
</TABLE>
- --------------------------------------------------------------------------------
NOTE 5. INVESTMENTS IN INVESTEES
- --------------------------------------------------------------------------------
The Company's Investments in Investees and approximate voting percentages, based
on the most recent publicly available data at December 31, 1998 were:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Curtiss-Wright Litton
[Dollars in Millions] Corporation Industries, Inc. UNOVA, Inc. Total
<S> <C> <C> <C> <C>
Carrying Value $ 92.6 $ 341.6 $ 147.0 $ 581.2
Fair Value $ 167.1 $ 826.7 $ 229.4 $ 1,223.2
Approximate Voting Percentage 43.0% 27.9% 23.1%
</TABLE>
- --------------------------------------------------------------------------------
The Company's Investments in Investees and approximate voting percentages, based
on the most recent publicly available data at December 31, 1997 were:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Western Curtiss-Wright Litton
[Dollars in Millions] Atlas Inc. Corporation Industries, Inc. UNOVA, Inc. Total
<S> <C> <C> <C> <C> <C>
Carrying Value $ 188.8 $ 82.7 $ 291.0 $ 143.3 $ 705.8
Fair Value $ 936.7 $ 159.1 $ 727.8 $ 208.1 $ 2,031.7
Approximate Voting Percentage 23.2% 43.1% 27.5% 23.2%
</TABLE>
- --------------------------------------------------------------------------------
The Company's carrying value of its investment exceeded its equity in the
reported net assets of its investees by approximately $4.5 million at December
31, 1998. This difference is not being amortized.
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 33
<PAGE>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 5. INVESTMENTS IN INVESTEES [CONTINUED]
- --------------------------------------------------------------------------------
The carrying value of the Company's investment in Litton exceeded 10% of the
Company's Shareholders' Equity at December 31, 1998 and 1997.
The carrying value of the Company's investment in Western Atlas exceeded 10%
of the Company's Shareholders' Equity at December 31, 1997. Summarized
financial information for Litton and Western Atlas is presented below.
Unitrin accounts for its Investments in Investees under the equity method of
accounting using the most recent publicly-available financial reports.
The amounts included in Unitrin's financial statements for Litton represent
amounts reported by Litton for periods ending two months earlier. Accordingly,
amounts included in Unitrin's financial statements represent the amounts
reported by Litton for the twelve-month periods ending October 31, 1998, 1997
and 1996. Summarized financial information reported by Litton for such periods
was:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
[Dollars in Millions] 1998 1997 1996
<S> <C> <C> <C>
Revenues
Three Months Ended:
January 31, $ 973.9 $ 960.5 $ 739.4
April 30, 1,143.0 1,095.6 1,004.4
July 31, 1,244.0 1,070.6 1,031.5
October 31, 1,207.5 1,039.0 1,048.9
-------- -------- --------
Revenues for Twelve Months Ended October 31, $4,568.4 $4,165.7 $3,824.2
======== ======== ========
Cost of Sales
Three Months Ended:
January 31, $ 741.3 $ 750.4 $ 568.0
April 30, 885.1 864.6 789.2
July 31, 964.1 826.7 785.8
October 31, 945.2 800.0 824.8
-------- -------- --------
Cost of Sales for Twelve Months Ended October 31, $3,535.7 $3,241.7 $2,967.8
======== ======== ========
Income from Continuing Operations
Three Months Ended:
January 31, $ 40.6 $ 36.2 $ 32.7
April 30, 46.8 42.0 38.8
July 31, 50.5 44.0 42.7
October 31, 47.2 43.4 39.8
-------- -------- --------
Income from Continuing Operations
for Twelve Months Ended October 31, $ 185.1 $ 165.6 $ 154.0
======== ======== ========
Net Income
Three Months Ended:
January 31, $ 40.6 $ 36.2 $ 32.7
April 30, 46.8 42.0 38.8
July 31, 50.5 44.0 42.7
October 31, 47.2 43.4 39.8
-------- -------- --------
Net Income for Twelve Months Ended October 31, $ 185.1 $ 165.6 $ 154.0
======== ======== ========
Current Assets at October 31, $2,016.1 $1,801.4
======== ========
Non-current Assets at October 31, $2,100.2 $1,752.9
======== ========
Current Liabilities at October 31, $1,795.0 $1,638.5
======== ========
Non-current Liabilities at October 31, $1,100.1 $ 830.6
======== ========
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 34
<PAGE>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 5. INVESTMENTS IN INVESTEES [CONTINUED]
- --------------------------------------------------------------------------------
The amounts included in Unitrin's financial statements for Western Atlas
represent amounts reported by Western Atlas for periods ending three months
earlier. In August 1998, the Company exchanged its investment in Western Atlas
for common stock in Baker Hughes Incorporated ("Baker Hughes") upon the
acquisition of Western Atlas by Baker Hughes in a merger transaction.
Accordingly, amounts included in Unitrin's financial statements for the year
ended December 31, 1998 represent the amounts reported by Western Atlas for the
nine-month period ending June 30, 1998. Amounts included in Unitrin's financial
statements for the years ended December 31, 1997 and 1996 represent amounts
reported by Western Atlas for the twelve-month periods ending September 30,
1997 and 1996. Summarized financial information reported by Western Atlas for
such periods was:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
[Dollars in Millions] 1998 1997 1996
<S> <C> <C> <C>
Revenues $1,476.6 $1,602.7 $2,433.4
======== ======== ========
Income from Continuing Operations $ 101.7 $ 79.7 $ 115.8
======== ======== ========
Net Income $ 104.5 $ (61.1) $ 115.8
======== ======== ========
</TABLE>
- --------------------------------------------------------------------------------
On October 31, 1997, Western Atlas completed the distribution of all of the
common stock of UNOVA to Western Atlas' shareholders in the form of a tax-free
dividend. The Company owns more than 20% of UNOVA's common stock, and
accordingly, accounts for its investment in UNOVA under the equity method of
accounting. Prior to the October 31, 1997 distribution, the 1997 results of
UNOVA were reflected in Western Atlas' 1997 results as a discontinued
operation. Western Atlas' net income for the twelve months ended September 30,
1997 includes an after-tax loss of approximately $203 million related to the
write-off of recently acquired in-process research and development.
Equity in Net Income of Investees was $62.3 million, $25.2 million and $50.6
million in 1998, 1997 and 1996, respectively.
As result of the merger of Western Atlas into Baker Hughes, Equity in Net
Income of Investees in 1998 includes Unitrin's proportionate share of Western
Atlas' reported earnings for its nine-month period ended June 30, 1998. As a
result of the merger of Western Atlas into Baker Hughes, Unitrin owns less than
20% of Baker Hughes and the equity method does not apply. Accordingly, Unitrin
does not record a proportionate share of Baker Hughes' reported earnings into
Unitrin's earnings. However, dividends received from Baker Hughes are reflected
in Unitrin's Net Investment Income.
Equity in Net Income of Investees in 1997 includes a loss of $33.6 million
primarily resulting from Unitrin's proportionate share of the write-off of in-
process research and development activities at certain investees.
NOTE 6. CONSUMER FINANCE RECEIVABLES AND INVESTMENT CERTIFICATES
- --------------------------------------------------------------------------------
Consumer Finance Receivables consists primarily of loans to California
residents which are secured by automobiles and is stated net of unearned
discount, loan fees and reserve for losses.
The fair values of Consumer Finance Receivables have been estimated by
discounting the future cash flows using the current rates at which similar
loans would be made to borrowers with similar credit ratings and the same
remaining maturities. The differences between the carrying values and the
estimated fair values of Consumer Finance Receivables at December 31, 1998 and
1997 were not material.
The reserve for losses on Consumer Finance Receivables was $40.1 million and
$39.5 million at December 31, 1998 and 1997, respectively.
Investment Certificates are generally fixed in maturity. The fair values of
Investment Certificates have been estimated using the rates currently offered
for deposits of similar remaining maturities. The differences between the
carrying values and the estimated fair values of Investment Certificates at
December 31, 1998 and 1997 were not material.
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 35
<PAGE>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 7. PROPERTY AND CASUALTY INSURANCE RESERVES
- --------------------------------------------------------------------------------
Property and Casualty Insurance Reserve activity for the years ended December
31, 1998, 1997 and 1996 was:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
[Dollars in Millions] 1998 1997 1996
<S> <C> <C> <C>
Property and Casualty Insurance Reserves,
Net of Reinsurance--Beginning of Year $448.8 $417.9 $395.0
Acquired - 19.6 -
Incurred related to:
Current Year 497.9 540.7 550.4
Prior Years (16.8) (15.9) (40.4)
------ ------ ------
Total Incurred 481.1 524.8 510.0
------ ------ ------
Paid related to:
Current Year 326.3 303.8 314.6
Prior Years 171.2 209.7 172.5
------ ------ ------
Total Paid 497.5 513.5 487.1
------ ------ ------
Property and Casualty Insurance Reserves,
Net of Reinsurance--End of Year $432.4 $448.8 $417.9
====== ====== ======
</TABLE>
- --------------------------------------------------------------------------------
Reinsurance Recoverables were $15.3 million, $19.7 million and $36.9 million at
December 31, 1998, 1997 and 1996, respectively.
NOTE 8. NOTES PAYABLE
- --------------------------------------------------------------------------------
The Company has a $340 million unsecured revolving credit agreement with a
group of banks which expires in September 2002 and provides for fixed and
floating rate advances for periods up to 180 days at various interest rates.
The agreement contains various financial covenants, including limits on total
debt to total capitalization and minimum risk-based capital ratios for the
Company's direct insurance subsidiaries. The proceeds from advances under the
agreement may be used for general corporate purposes, including repurchases of
the Company's common stock.
At December 31, 1998 and 1997, the Company had outstanding borrowings under
the revolving credit agreement, classified as Notes Payable in the Consolidated
Balance Sheet, of $110.0 million and $75.0 million at weighted average interest
rates of 5.51% and 6.15% respectively. Other borrowings, principally a mortgage
note payable on a property occupied by the Company, were $6.2 million and $6.1
million at December 31, 1998 and 1997, respectively. The Company paid interest
of $5.0 million, $5.7 million and $6.8 million in 1998, 1997 and 1996,
respectively.
The differences between the carrying values and the estimated fair values of
Notes Payable at December 31, 1998 and 1997 were not material.
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 36
<PAGE>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 9. SHAREHOLDERS' EQUITY
- --------------------------------------------------------------------------------
The Company is authorized to issue 20 million shares of $0.10 par value
preferred stock and 100 million shares of $0.10 par value common stock. No
preferred shares were issued or outstanding at December 31, 1998.
On August 3, 1994, the Board of Directors declared a dividend distribution
of one preferred share purchase right for each outstanding share of common stock
of the Company, pursuant to a Shareholder Rights Plan. The description and terms
of the rights are set forth in a Rights Agreement between the Company and First
Chicago Trust Company of New York, as Rights Agent, dated as of August 3, 1994.
At December 31, 1998, there are approximately 2.3 million shares of the
Company's outstanding common stock that can be repurchased under the outstanding
repurchase authorizations of the Company's Board of Directors. Common stock can
be repurchased in open market or in privately negotiated transactions from time
to time subject to market conditions and other factors. The Company has
repurchased and retired 22.3 million shares of its common stock in open market
transactions at an aggregate cost of approximately $1.1 billion since 1990.
Common Stock, Paid-in Capital and Retained Earnings have been reduced on a pro
rata basis for the cost of the repurchased shares.
Various state insurance laws restrict the amount that an insurance
subsidiary may pay in the form of dividends, loans or advances without the prior
approval of regulatory authorities. Also, that portion of an insurance
subsidiary's net equity which results from differences between statutory
insurance accounting practices and generally accepted accounting principles
would not be available for cash dividends, loans or advances. Retained Earnings
at December 31, 1998 also includes $339.5 million representing the undistributed
earnings of investees.
The Company's insurance subsidiaries are required to file financial
statements prepared on the basis of statutory insurance accounting practices.
Statutory Capital and Surplus for the Company's Life and Health Insurance
subsidiaries was approximately $570 million and $850 million at December 31,
1998 and 1997, respectively. Statutory Capital and Surplus for the Company's
Property and Casualty Insurance subsidiaries was approximately $980 million and
$1,180 million at December 31, 1998 and 1997, respectively. Statutory Net Income
for the Company's Life and Health Insurance subsidiaries was approximately $220
million, $20 million and $34 million for the years ended December 31, 1998, 1997
and 1996, respectively. Statutory Net Income for the Company's Property and
Casualty Insurance subsidiaries was approximately $428 million, $63 million and
$67 million for the years ended December 31, 1998, 1997 and 1996, respectively.
Statutory Capital and Surplus and Statutory Net Income exclude the Company's
Consumer Finance and Parent Company operations.
The Company's subsidiaries paid dividends of $26.0 million to the Company
in 1998. In 1999, the Company's subsidiaries would be able to pay approximately
$651 million in dividends to the Company without prior regulatory approval.
NOTE 10. STOCK OPTION PLANS
- --------------------------------------------------------------------------------
On May 1, 1996, the Company's shareholders approved the Unitrin, Inc. 1995
Non-Employee Director Stock Option Plan (the "Director Plan") covering an
aggregate of 200,000 shares of Unitrin common stock. Under the Director Plan,
directors of the Company who are not employees and who first became directors
after November 1, 1993 will be granted an initial option to purchase 2,000
shares of the Company's common stock and thereafter, on the date of each of the
Company's annual meetings of shareholders, will automatically receive annual
grants of options to purchase the same number of shares for so long as they
remain eligible directors. Options granted under the Director Plan are
exercisable one year from the date of grant at an exercise price equal to the
fair market value of the Company's common stock on the date of grant and expire
10 years from the date of grant. In addition, each eligible director may elect
to convert his annual director's fees into stock options upon six months prior
notice to the Company. As of December 31, 1998 options for 20,000 common shares
were outstanding and options for 180,000 common shares were available for future
grant under the Director Plan.
On May 14, 1997, the Company's shareholders approved the Unitrin, Inc. 1997
Stock Option Plan (the "1997 Option Plan") covering an aggregate of 2,000,000
shares of Unitrin common stock. Under the 1997 Option Plan, options to purchase
shares of Unitrin common stock may be granted to key employees (including
employee directors) and other key persons providing services to the Company and
its subsidiaries or its affiliates ("Participants"). In February 1990, the
Company's Board of Directors adopted the 1990 Stock Option Plan (the "1990
Option Plan") covering an aggregate of 2,500,000 shares of Unitrin common stock.
Under the 1990 Option Plan, options to purchase shares of Unitrin common stock
may be granted to executives and other key employees of the Company. The Stock
- -------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 37
<PAGE>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTE 10. STOCK OPTION PLANS [CONTINUED]
- -------------------------------------------------------------------------------
Option Committee of the Board of Directors, at its discretion, may grant either
incentive stock options, non-qualified stock options, or stock appreciation
rights pursuant to either the 1997 Option Plan or the 1990 Option Plan. The
Stock Option Committee has sole discretion to determine the persons to whom
options are granted, the number of shares covered by such options and the
exercise price, vesting and expiration dates of such options.
Options are nontransferable and are exercisable in installments. Only non-
qualified stock options have been granted under both the 1997 Option Plan and
the 1990 Option Plan.
To encourage stock ownership by the Company's key employees, both the 1997
Option Plan and the 1990 Option Plan include a provision to automatically grant
restorative stock options (Restorative Options) to replace shares of previously-
owned Unitrin common stock that an exercising employee surrenders, either
actually or constructively, in order to satisfy the exercise price and/or tax
withholding obligations relating to the exercise. Restorative Options are
subject to the same terms and conditions as the original options, including the
expiration date, except that the option price of a Restorative Option is equal
to the fair market value of Unitrin common stock on the date of its grant.
Restorative Options cannot be exercised until six months after the date of
grant. The grant of a Restorative Option does not result in an increase in the
total number of shares and options held by an employee.
On August 6, 1997, the Stock Option Committee of the Board of Directors
revised the vesting schedule of all options then outstanding under the Company's
1990 Stock Option Plan so that such options shall vest in four annual
installments beginning six months after their respective dates of grant. As of
December 31, 1998, options for 361,111 common shares were outstanding and
options covering 1,634,879 common shares were available for future grant under
the 1997 Stock Option Plan. As of December 31, 1998, options for 1,720,121
common shares were outstanding and options covering 37,968 common shares were
available for future grant under the 1990 Stock Option Plan.
The following table summarizes information about stock options outstanding
at December 31, 1998:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
------------------------------------------------ -----------------------------
Number Weighted-Average Number
Range of Outstanding Remaining Weighted-Average Exercisable Weighted-Average
Exercise Prices at Year End Contractual Life Exercise Price at Year End Exercise Price
<S> <C> <C> <C> <C> <C>
$31.75 -- $47.00 131,488 3.8 years $38.83 122,738 $38.25
$47.50 -- $67.625 1,218,359 4.8 years $60.22 857,023 $62.49
$67.6875 -- $73.125 751,385 4.2 years $71.00 202,166 $70.46
- ---------------------------------------------------------------------------------------------------------
</TABLE>
Had the Company accounted for stock options granted in 1998, 1997 and 1996
under the provisions of SFAS No. 123, "Accounting for Stock-Based Compensation",
pro forma net income would have been $505.5 million, $110.7 million and $130.8
million for the years ended December 31, 1998, 1997 and 1996, respectively, and
pro forma net income per share would have been $12.97, $2.96 and $3.47 for the
years ended December 31, 1998, 1997 and 1996, respectively. Pro forma
compensation expense in 1998 includes $1.5 million for initial options granted
in 1998, $3.2 million for restorative options granted in 1998 and $3.4 million
for amortization of expense for grants made in 1995, 1996 and 1997. Pro forma
compensation expense in 1997 includes $1.3 million for initial options granted
in 1997, $3.6 million for restorative options granted in 1997, $3.0 million for
amortization of expense for grants made in 1996 and 1995 and $3.1 million for
the change in the vesting schedule. Pro forma compensation expense in 1996
includes $1.2 million for initial options granted in 1996, $0.3 million for
restorative options granted in 1996 and $1.2 million for amortization of expense
for grants made in 1995. Under the provisions of SFAS No. 123, the fair value of
initial option grants excludes any value attributable to the restorative
feature. These pro forma amounts may not be representative of the effects of
SFAS No. 123 on pro forma net income for future years because options vest over
several years and different levels of awards, including restorative awards, may
be granted in future years.
The Black-Scholes option pricing model was used to estimate the fair value
of each option on the date granted. The assumptions used in the pricing model
were as follows. For options granted in 1998, 1997 and 1996, the expected
dividend yield used was 4.39%, 4.51% and 3.46% respectively. The weighted
average expected volatility used was 20% for options granted in all three years.
The weighted average risk free interest rate used was the average yield on U.S.
Treasury securities with a maturity comparable to the expected life of each
option. The expected lives of the options ranged between 1 to 7 years. In the
case of options issued pursuant to the Director Plan, the expected lives equaled
the full contractual term of 10 years.
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 38
<PAGE>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
NOTE 10. STOCK OPTION PLANS [CONTINUED]
-----------------------------------------------------------------------------------------------------------------------------------
A summary of the status of the Company's three stock option plans as of December 31, 1998, 1997 and 1996, and stock option activity
for the years then ended is presented below:
-----------------------------------------------------------------------------------------------------------------------------------
Estimated Weighted
Average Fair Value of
Number Weighted-Average Options Exercisable Options Granted
of Shares Exercise Price at Year End during the Year
<S> <C> <C> <C> <C>
Outstanding at December 31, 1995 1,534,000 $38.91 440,500
Granted 640,472 50.80 $ 10.08
Exercised (290,754) 33.73
Forfeited (76,000) 47.20
---------- ------
Outstanding at December 31, 1996 1,807,718 $43.58 403,818
Granted 1,651,403 58.71 $ 5.55
Exercised (1,471,437) 44.71
Forfeited (75,046) 51.39
---------- ------
Outstanding at December 31, 1997 1,912,638 $55.47 522,200
Granted 1,222,960 68.80 $ 6.53
Exercised (971,365) 56.35
Forfeited (63,001) 58.50
---------- ------
Outstanding at December 31, 1998 2,101,232 $62.73 1,181,927
========== ======
-----------------------------------------------------------------------------------------------------------------------------------
Options granted in 1998 and 1997 include 822,960 and 1,173,903 Restorative Options, respectively.
</TABLE>
<TABLE>
<CAPTION>
NOTE 11. OTHER COMPREHENSIVE INCOME [LOSS]
-----------------------------------------------------------------------------------------------------------------------------------
Other Comprehensive Income (Loss) determined in accordance with SFAS No. 130 for the years ended December 31, 1998, 1997 and 1996
was:
- -----------------------------------------------------------------------------------------------------------------------------------
[Dollars in Millions] 1998 1997 1996
<S> <C> <C> <C>
Gross Unrealized Holding Gains (Losses) Arising During Year:
Fixed Maturities $ 27.5 $12.2 $(60.2)
Equity Securities (98.8) 27.3 7.5
Other 0.2 - -
------ ----- -----
Gross Unrealized Holding Gains (Losses) Arising During Year (71.1) 39.5 (52.7)
Income Tax Benefit (Expense) 25.0 (14.0) 18.5
------ ----- ------
Unrealized Holding Gains (Losses) Arising During Year, Net (46.1) 25.5 (34.2)
------ ----- ------
Reclassification Adjustment for Gross Gains Realized in Net Income:
Fixed Maturities (3.7) (2.2) (0.7)
Equity Securities (60.7) (0.3) (1.5)
------ ----- ------
Reclassification Adjustment for Gross Gains Realized in Net Income (64.4) (2.5) (2.2)
Income Tax Expense 22.0 0.9 0.8
------ ----- ------
Reclassification Adjustment for Gains Realized in Net Income, Net (42.4) (1.6) (1.4)
------ ----- ------
Other Comprehensive Income (Loss) $(88.5) $23.9 $(35.6)
====== ===== ======
</TABLE>
- --------------------------------------------------------------------------------
The Company's Investments in Investees are accounted for under the equity
method of accounting and, accordingly, changes in the fair value of the
Company's investments in Investees are excluded from the determination of Total
Comprehensive Income and Other Comprehensive Income (Loss) under SFAS No. 130.
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 39
<PAGE>
<TABLE>
<CAPTION>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------------------------------------------------------------
NOTE 12. NET INCOME PER SHARE
- -----------------------------------------------------------------------------------------------------------------------------------
The Company determined Net Income Per Share and Net Income Per Share Assuming Dilution in accordance with SFAS No. 128 for the
years ended December 31, 1998, 1997 and 1996 as follows:
- -----------------------------------------------------------------------------------------------------------------------------------
[Dollars and Shares in Millions, Except Per Share Amounts] 1998 1997 1996
<S> <C> <C> <C>
Net Income $510.8 $117.9 $132.5
Dilutive Effect on Net Income from
Investees' Equivalent Shares (1.2) (1.0) (1.0)
------ ------ -----
Net Income Assuming Dilution $509.6 $116.9 $131.5
====== ====== ======
Weighted Average Common Shares Outstanding 39.0 37.4 37.7
Dilutive Effect of Unitrin Stock Option Plans 0.1 0.2 0.2
------ ------ ------
Weighted Average Common Shares and
Equivalent Shares Outstanding Assuming Dilution 39.1 37.6 37.9
====== ====== ======
Net Income Per Share $13.11 $ 3.15 $ 3.51
====== ====== ======
Net Income Per Share Assuming Dilution $13.02 $ 3.11 $ 3.47
====== ====== ======
----------------------------------------------------------------------------------------------------------------------------------
Options outstanding at December 31, 1998, 1997 and 1996 to purchase 0.5 million, 0.2 million and 0.1 million shares, respectively,
of Unitrin common stock were excluded from the computation of Net Income Per Share Assuming Dilution in 1998, 1997 and 1996,
respectively, because the exercise price exceeded the average market price.
----------------------------------------------------------------------------------------------------------------------------------
NOTE 13. INCOME FROM INVESTMENTS
----------------------------------------------------------------------------------------------------------------------------------
Net Investment Income for the years ended December 31, 1998, 1997 and 1996 was:
- -----------------------------------------------------------------------------------------------------------------------------------
[Dollars in Millions] 1998 1997 1996
Interest and Dividends on Fixed Maturities $159.1 $147.2 $150.4
Dividends on Equity Securities 13.4 16.5 16.1
Other 30.7 30.4 24.6
------ ------ ------
Investment Income 203.2 194.1 191.1
Investment Expenses 16.8 14.6 12.1
------ ------ ------
Net Investment Income $186.4 $179.5 $179.0
====== ====== ======
- -----------------------------------------------------------------------------------------------------------------------------------
The components of Net Gains on Sales of Investments for the years ended December 31, 1998, 1997 and 1996 were:
- -----------------------------------------------------------------------------------------------------------------------------------
[Dollars in Millions] 1998 1997 1996
Fixed Maturities:
Gains $ 4.1 $ 2.4 $ 1.6
Losses (0.4) (0.2) (0.9)
Equity Securities:
Gains 61.4 0.4 1.5
Losses (0.7) (0.1) -
Investee:
Gains 487.4 - -
Other Investments:
Gains 5.6 1.1 1.2
------ ------- ------
Net Gains on Sales of Investments $557.4 $ 3.6 $ 3.4
====== ======= ======
----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Unitrin, Inc. and Subsidiaries 40
<PAGE>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 13. INCOME FROM INVESTMENTS [CONTINUED]
- --------------------------------------------------------------------------------
Net Gains on Sales of Investments in Equity Securities for the year ended
December 31, 1998 includes gains resulting primarily from the redemption of the
Company's investment in Navistar International Corporation $6.00 Cumulative
Convertible Preferred Stock, Series G and the disposition of the Company's
investment in ITT Corporation ("ITT") common stock in connection with the
acquisition of ITT by Starwood Hotels & Resorts Worldwide, Inc.
In August 1998, the Company exchanged its investment in its investee, Western
Atlas, for common stock in Baker Hughes upon the acquisition of Western Atlas
by Baker Hughes in a merger transaction. Net Gains on Sales of Investments in
Investees for the year ended December 31, 1998 includes a gain of $487.4
million resulting from this transaction.
NOTE 14. INSURANCE EXPENSES
- --------------------------------------------------------------------------------
Insurance Expenses for the years ended December 31, 1998, 1997 and 1996 were:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
[Dollars in Millions] 1998 1997 1996
<S> <C> <C> <C>
Commissions $ 245.1 $ 224.4 $ 233.7
General Expenses 230.9 207.3 203.9
Taxes, Licenses and Fees 24.6 26.9 27.6
-------- -------- --------
Total Costs Incurred 500.6 458.6 465.2
-------- -------- --------
Policy Acquisition Costs:
Deferred (142.2) (145.6) (149.1)
Amortized 149.3 167.4 170.1
-------- -------- --------
Net Policy Acquisition Costs Amortized 7.1 21.8 21.0
-------- -------- --------
Insurance Expenses $ 507.7 $ 480.4 $ 486.2
======== ======== ========
- --------------------------------------------------------------------------------
</TABLE>
Unitrin, Inc. and Subsidiaries 41
<PAGE>
<TABLE>
<CAPTION>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 15. INCOME TAXES
- --------------------------------------------------------------------------------
The tax effects of temporary differences that give rise to significant portions
of the Company's Net Deferred Tax Liability at December 31, 1998 and 1997 were:
- --------------------------------------------------------------------------------
[Dollars in Millions] 1998 1997
<S> <C> <C>
Deferred Tax Assets:
Insurance Reserves $ 63.6 $ 64.3
Unearned Premium Reserves 19.2 21.8
Tax Capitalization of Policy Acquisition Costs 59.1 45.1
Reserve for Losses on Consumer Finance Receivables 11.2 10.1
Postretirement Benefits Other Than Pensions 28.1 26.2
Other 21.8 17.9
------ ------
Total Deferred Tax Assets 203.0 185.4
------ ------
Deferred Tax Liabilities:
Deferred Policy Acquisition Costs 115.4 81.7
Fixed Maturities 32.8 18.7
Equity Securities 221.6 32.6
Investments in Investees 160.5 192.2
Pension Asset 21.7 13.1
Other 3.5 3.3
------ ------
Total Deferred Tax Liability 555.5 341.6
------ ------
Net Deferred Tax Liability 352.5 156.2
Current Tax Liability 26.3 31.6
------ ------
Accrued and Deferred Income Taxes $378.8 $187.8
====== ======
- --------------------------------------------------------------------------------
A deferred tax asset valuation allowance was not required at December 31, 1998
and 1997. Income taxes paid were $54.6 million, $41.7 million and $47.2
million in 1998, 1997 and 1996, respectively.
The Company has not provided Federal income taxes on a portion of the
Company's life insurance subsidiaries' income earned prior to 1984 which is not
subject to Federal income taxes under certain circumstances. Federal income
taxes would be paid on the amount of such income, approximately $206 million, if
it is distributed to shareholders in the future or if it does not continue to
meet certain limitations.
Comprehensive Income Tax Expense included in the Consolidated Financial
Statements for the years ended December 31, 1998, 1997 and 1996 was:
- --------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
[Dollars in Millions] 1998 1997 1996
<S> <C> <C> <C>
Income Tax Expense $238.6 $47.1 $ 40.2
Equity in Net Income of Investees 32.7 12.7 26.5
Unrealized Appreciation (Depreciation) on Securities (47.1) 13.1 (19.3)
Effect on Paid-in Capital from Exercise of Stock Options (3.7) (8.0) (1.8)
------ ----- ------
Comprehensive Income Tax Expense $220.5 $64.9 $ 45.6
====== ===== ======
- ------------------------------------------------------------------------------------------
</TABLE>
The components of Income Tax Expense for the years ended December 31, 1998,
1997 and 1996 were:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
[Dollars in Millions] 1998 1997 1996
<S> <C> <C> <C>
Current Tax Expense $ 47.7 $52.6 $50.0
Deferred Tax Expense (Benefit) 190.9 (5.5) (9.8)
------ ----- -----
Income Tax Expense $238.6 $47.1 $40.2
====== ===== =====
- ------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
Unitrin, Inc. and Subsidiaries 42
<PAGE>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 15. INCOME TAXES [CONTINUED]
- --------------------------------------------------------------------------------
Components of the effective income tax rate on pre-tax income for the years
ended December 31, 1998, 1997 and 1996 were:
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Statutory Federal Income Tax Rate 35.0% 35.0% 35.0%
Tax-exempt Income (0.7) (3.6) (5.0)
State Income Taxes 0.2 0.7 1.6
Amortization of Cost in Excess of Net
Assets of Purchased Businesses 0.2 1.6 0.9
Other, Net - - 0.4
-------- -------- --------
Effective Income Tax Rate 34.7% 33.7% 32.9%
======== ======== ========
</TABLE>
- -------------------------------------------------------------------------------
For the year ended December 31, 1998, the Company will file a consolidated
Federal income tax return with all of its subsidiaries except for Reliable and
its subsidiaries, and NationalCare and its subsidiaries. For the years ended
December 31, 1997 and 1996, the Company filed a consolidated Federal income tax
return with all of its subsidiaries.
NOTE 16. PENSION BENEFITS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
- --------------------------------------------------------------------------------
The Company sponsors several defined benefit pension plans covering most of its
employees. Participation in certain plans requires employee contributions of 3
percent of pay, as defined, per year. Benefits for contributory plans are based
on compensation during plan participation and the number of years of
participation. Benefits for non-contributory plans are based on years of service
and final average pay, as defined. The Company funds the pension plans in
accordance with the requirements of the Employee Retirement Income Security Act
of 1974, as amended.
The components of Pension Expense (Income) for the years ended December 31,
1998, 1997 and 1996 were:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
[Dollars in Millions] 1998 1997 1996
<S> <C> <C> <C>
Service Cost Benefits Earned During the Year $ 7.9 $ 5.4 $ 4.1
Interest Cost on Projected Benefit Obligation 10.9 7.4 7.0
Expected Return on Plan Assets (15.0) (10.5) (9.2)
Net Amortization and Deferral (1.8) (1.9) (2.3)
------ ------ ------
Pension Expense (Income) $ 2.0 $ 0.4 $ (0.4)
====== ====== ======
</TABLE>
- --------------------------------------------------------------------------------
The Company sponsors several postretirement benefit plans that provide medical
and life insurance benefits to approximately 1,000 retired and 2,000 active
employees. The Company is self-insured and the plans are not funded. The medical
plans generally provide for a limited number of years of medical insurance
benefits at retirement based upon the participant's attained age at retirement
and number of years of service until specified dates and are generally
contributory, with most contributions adjusted annually. Postretirement life
insurance benefits are generally contributory and generally limited to $10,000
per participant.
The components of Postretirement Benefits Other than Pensions Expense for the
years ended December 31, 1998, 1997 and 1996 were:
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
[Dollars in Millions] 1998 1997 1996
<S> <C> <C> <C>
Service Cost Benefits Earned During the Year $ 0.3 $ 0.1 $ 0.2
Interest Cost on Projected Benefit Obligation 4.3 4.5 4.6
Net Amortization and Deferral (0.8) (0.2) -
------ ------ ------
Postretirement Benefits Other than Pensions Expense $ 3.8 $ 4.4 $ 4.8
====== ====== ======
</TABLE>
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 43
<PAGE>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 16. PENSION BENEFITS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
[CONTINUED]
- --------------------------------------------------------------------------------
The actuarial assumptions used to develop both the components of Pension Expense
(Income) and Postretirement Benefits Other than Pensions Expense for the years
ended December 31, 1998, 1997 and 1996 were:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Discount Rate 7.0% 7.0% 7.0%
Rate of Increase in Future Compensation Levels 4.0% 4.0% 4.0%
Expected Long-term Rate of Return on Plan Assets 6.5% 6.5% 6.0%
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Changes in Fair Value of Plan Assets and Changes in Projected Benefit
Obligations for the Years Ended December 31, 1998 and 1997 were:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
Pension Benefits Postretirement Benefits Other than Pensions
--------------------------------------------------------------------------
[Dollars in Millions] 1998 1997 1998 1997
<S> <C> <C> <C> <C>
Fair Value of Plan Assets at Beginning of Year $ 174.3 $ 163.3 $ - $ -
Fair Value of Plan Assets of Acquired Business 104.5 - - -
Actual Return on Plan Assets 16.3 11.6 - -
Contributions by the Company - 5.4 4.1 3.4
Contributions by Plan Participants 1.6 1.3 0.6 0.5
Benefits Paid (8.5) (7.3) (4.7) (3.9)
---------- ---------- ----------- -----------
Fair Value of Plan Assets at End of Year $ 288.2 $ 174.3 $ - $ -
---------- ---------- ----------- -----------
Projected Benefit Obligations at Beginning of Year $ 115.9 $ 109.1 $ 67.5 $ 68.3
Projected Benefit Obligations of Acquired Business 78.1 - 5.6 -
Service Cost Benefits Earned During the Year 7.9 5.4 0.3 0.1
Interest Cost on Projected Benefit Obligations 10.9 7.4 4.3 4.5
Contributions by Plan Participants 1.6 1.3 0.6 0.5
Benefits Paid (8.5) (7.3) (4.7) (3.9)
Actuarial (Gains) Losses 10.9 - (3.0) (2.0)
----------- ----------- ----------- -----------
Projected Benefit Obligations at End of Year $ 216.8 $ 115.9 $ 70.6 $ 67.5
----------- ---------- ----------- -----------
Plan Assets in Excess (Deficit) of Projected
Benefit Obligations $ 71.4 $ 58.4 $ (70.6) $ (67.5)
========== ========== =========== ===========
Plan Assets in Excess (Deficit) of Projected
Benefit Obligations:
Amounts Recognized in the Balance Sheet:
Prepaid (Accrued) Benefit Cost $ 61.3 $ 37.0 $ (80.3) $ (75.1)
Amounts not Recognized in the Balance Sheet:
Unrecognized Net Actuarial Gain 6.5 16.1 9.7 7.6
Unrecognized Net Asset at Adoption,
Net of Amortization 3.6 5.3 - -
----------- ---------- ----------- -----------
Plan Assets in Excess (Deficit) of Projected
Benefit Obligations $ 71.4 $ 58.4 $ (70.6) $ (67.5)
========== ========== =========== ===========
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
For both the valuation of pension obligations and postretirement benefits other
than pensions obligations the discount rates assumed were 6.5 percent and 7.0
percent at December 31, 1998 and 1997, respectively.
For both the valuation of pension obligations and postretirement benefits
other than pensions obligations the rate of increase in future compensation
levels assumed was 4.0 percent at both December 31, 1998 and 1997.
The assumed health care cost trend rate used in measuring the Postretirement
Benefit Obligations at December 31, 1998 was 7.8 percent in 1998, gradually
declining to 5.0 percent in the year 2006 and remaining at that level
thereafter. The assumed health care cost trend rate used in measuring the
Postretirement Benefit Obligation at December 31, 1997 was 8.15 percent in 1997,
gradually declining to 5.0 percent in the year 2006 and remaining at that level
thereafter.
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 44
<PAGE>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 16. PENSION BENEFITS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
[CONTINUED]
- --------------------------------------------------------------------------------
A one pecentage point increase in the assumed health care cost trend rate for
each year would increase the Postretirement Benefit Obligation at December 31,
1998 by approximately $6.9 million and 1998 postretirement expense by $0.5
million. A one percentage point decrease in the assumed health care cost trend
for each year would decrease the Postretirement Benefit Obligation at December
31, 1998 by approximately $5.9 million and 1998 Postretirement expense by
approximately $0.4 million.
NOTE 17. BUSINESS SEGMENTS
- --------------------------------------------------------------------------------
The Company is engaged in the property and casualty insurance, life and
health insurance and consumer finance businesses. Insurance provided in the
Property and Casualty Insurance segment consists of automobile, homeowners,
motorcycle, watercraft, fire, casualty, workers compensation and other related
lines. The Life and Health Insurance segment includes individual life, accident,
health and hospitalization insurance. The Company's Life and Health Insurance
employee-agents also market certain property and casualty insurance products
under common management. The Company now includes the results of those property
and casualty insurance products in its Life and Health Insurance segment. The
Consumer Finance segment makes consumer loans primarily for the purchase of
automobiles and offers savings accounts in the form of investment certificates
and money market accounts.
Segment Revenues for the years ended December 31, 1998, 1997 and 1996 were:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
[Dollars in Millions] 1998 1997 1996
SEGMENT REVENUES
<S> <C> <C> <C>
Property and Casualty Insurance $ 694.0 $ 774.5 $ 718.8
Life and Health Insurance 719.9 623.7 674.5
Consumer Finance 113.8 125.0 120.4
----------- ----------- -----------
Total Segment Revenues 1,527.7 1,523.2 1,513.7
----------- ----------- -----------
Net Gains on Sales of Investments 557.4 3.6 3.4
Other 0.8 3.3 6.0
----------- ----------- -----------
Total Revenues $ 2,085.9 $ 1,530.1 $ 1,523.1
=========== =========== ===========
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Segment Operating Profit and Segment Assets for the years ended December 31,
1998, 1997 and 1996 were:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
[Dollars in Millions] 1998 1997 1996
SEGMENT OPERATING PROFIT
<S> <C> <C> <C>
Property and Casualty Insurance $ 47.0 $ 63.1 $ 46.9
Life and Health Insurance 67.9 62.6 48.9
Consumer Finance 20.1 13.9 26.1
----------- ----------- -----------
Total Segment Operating Profit 135.0 139.6 121.9
----------- ----------- -----------
Net Gains on Sales of Investments 557.4 3.6 3.4
Other (5.3) (3.4) (3.2)
----------- ----------- -----------
Income before Income Taxes and Equity in
Net Income of Investees $ 687.1 $ 139.8 $ 122.1
=========== =========== ===========
SEGMENT ASSETS
Property and Casualty Insurance $ 1,358.9 $ 1,025.9 $ 1,031.1
Life and Health Insurance 3,585.7 2,515.2 2,583.0
Consumer Finance 642.0 657.3 676.8
Investees and Other 323.3 722.3 580.2
----------- ----------- -----------
Total Assets $ 5,909.9 $ 4,920.7 $ 4,871.1
=========== =========== ===========
===================================================================================================================================
</TABLE>
Unitrin, Inc. and Subsidiaries 45
<PAGE>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTE 18. REINSURANCE
- -------------------------------------------------------------------------------
Effective January 1, 1997, United Insurance Company of America ("United"), one
of the Company's Life and Health Insurance segment subsidiaries, entered into a
long-duration reinsurance agreement to cede certain in-force life and health
insurance policies principally in the states of Arkansas and Missouri to
Reliable. At the time of the agreement, Reliable was an unaffiliated third
party. Accordingly as a result of this transaction, premiums in the Life and
Health Insurance segment decreased by approximately $10 million in 1997.
Effective May 31, 1998, the cession, as it pertained to the Missouri policies,
was commuted and United entered into a long-duration reinsurance agreement to
cede those policies to another third party.
Effective May 31, 1996, United entered into a long-duration reinsurance
agreement to cede certain in-force life insurance policies to a third party. As
a result of this transaction, premiums in the Life and Health Insurance segment
decreased by approximately $6 million and $7 million in 1997 and 1996,
respectively.
At December 31, 1998 and 1997, United had not been relieved of its primary
obligation to certain policyholders under these reinsurance agreements.
Accordingly, pursuant to the provisions of SFAS No. 113, "Accounting and
Reporting for Reinsurance of Short Duration and Long Duration Contracts," the
Company continues to include the life insurance reserves related to these
policyholders on its balance sheet along with a corresponding amount classified
as Other Receivables. Life insurance reserves related to these policyholders
were approximately $46 million and $78 million at December 31, 1998 and 1997,
respectively.
Premiums on short-duration policies assumed were $81.9 million, $95.4 million
and $109.6 million for the years ended December 31, 1998, 1997 and 1996,
respectively. Premiums on long-duration policies assumed were not material for
the years ended December 31, 1998, 1997 and 1996. Premiums ceded on short-
duration and long-duration policies were not material for the years ended
December 31, 1998, 1997 and 1996.
NOTE 19. CONTINGENCIES
- -------------------------------------------------------------------------------
The Company and its subsidiaries are defendants in various legal actions
incidental to their businesses. Some of these actions seek substantial punitive
damages that bear no apparent relationship to the actual damages alleged.
Although no assurances can be given and no determination can be made at this
time as to the outcome of any particular legal action, the Company and its
subsidiaries believe that there are meritorious defenses to these legal actions
and are defending them vigorously. The Company believes that resolution of these
matters will not have a material adverse effect on the Company's financial
position.
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 46
<PAGE>
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 20. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
[Dollars in Millions, Except Per Share Amounts] Three Months Ended
- ------------------------------------------------------------------------------------------------------------------------------------
March 31, June 30, Sept. 30, Dec. 31, Total
<S> <C> <C> <C> <C> <C>
1998
Premiums and Consumer Finance Revenues $ 318.2 $ 321.2 $ 341.9 $ 360.8 $ 1,342.1
Net Investment Income 41.8 45.2 48.3 51.1 186.4
Net Gains on Sales of Investments 60.9 5.6 488.1 2.8 557.4
-------- -------- -------- -------- ----------
Total Revenues $ 420.9 $ 372.0 $ 878.3 $ 414.7 $ 2,085.9
======== ======== ======== ======== ==========
Net Income:
From Operations $ 20.7 $ 15.5 $ 16.9 $ 32.4 $ 85.5
From Investees 15.2 16.4 18.2 12.5 62.3
From Sales of Investments 40.1 4.3 316.8 1.8 363.0
-------- -------- -------- -------- ----------
Total Net Income $ 76.0 $ 36.2 $ 351.9 $ 46.7 $ 510.8
======== ======== ======== ======== ==========
Net Income Per Share (A) $ 2.02 $ 0.93 $ 8.72 $ 1.19 $ 13.11
======== ======== ======== ======== ==========
Net Income Per Share Assuming Dilution (A) $ 2.00 $ 0.92 $ 8.69 $ 1.18 $ 13.02
======== ======== ======== ======== ==========
Dividends Paid to Common Shareholders
(Per Share) $ 0.65 $ 0.65 $ 0.65 $ 0.65 $ 2.60
======== ======== ======== ======== ==========
Common Stock Market Prices:
High 71 7/16 74 1/8 70 73 5/8 74 1/8
Low 57 3/4 66 1/8 55 9/16 59 1/2 55 9/16
Close 67 3/8 69 1/2 64 3/16 71 3/4 71 3/4
- ------------------------------------------------------------------------------------------------------------------------------------
1997
Premiums and Consumer Finance Revenues $ 338.4 $ 342.3 $ 338.7 $ 327.6 $ 1,347.0
Net Investment Income 42.4 46.4 43.8 46.9 179.5
Net Gains on Sales of Investments 1.3 1.8 0.1 0.4 3.6
-------- -------- -------- -------- ----------
Total Revenues $ 382.1 $ 390.5 $ 382.6 $ 374.9 $ 1,530.1
======== ======== ======== ======== ==========
Net Income:
From Operations $ 20.0 $ 18.1 $ 21.2 $ 31.0 $ 90.3
From Investees Before
One-Time Items 12.8 13.7 15.8 16.5 58.8
From Investees' One-Time Items - (31.8) - (1.8) (33.6)
From Sales Of Investments 0.9 1.2 - 0.3 2.4
-------- -------- -------- -------- ----------
Total Net Income $ 33.7 $ 1.2 $ 37.0 $ 46.0 $ 117.9
======== ======== ======== ======== ==========
Net Income Per Share (A) $ 0.90 $ 0.03 $ 0.99 $ 1.23 $ 3.15
======== ======== ======== ======== ==========
Net Income Per Share Assuming Dilution (A) $ 0.89 $ 0.03 $ 0.97 $ 1.21 $ 3.11
======== ======== ======== ======== ==========
Dividends Paid to Common Shareholders
(Per Share) $ 0.60 $ 0.60 $ 0.60 $ 0.60 $ 2.40
======== ======== ======== ======== ==========
Common Stock Market Prices:
High 55 3/4 62 7/8 66 1/4 68 1/2 68 1/2
Low 49 1/2 48 1/2 56 1/4 60 5/8 48 1/2
Close 49 3/4 61 65 64 5/8 64 5/8
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(A) The cumulative sum of quarterly Net Income Per Share and Net Income Per
Share Assuming Dilution amounts does not equal Total Net Income Per Share
and Total Net Income Per Share Assuming Dilution for the year due to
differences in weighted average shares and equivalent shares outstanding
for each of the periods presented.
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 47
<PAGE>
EXHIBIT 13.2
MANAGEMENT DISCUSSION AND ANALYSIS
OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following pages reproduce pages 16 through 22 from Unitrin, Inc.'s 1998
Annual Report to Shareholders.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
PROPERTY AND CASUALTY INSURANCE
- -----------------------------------------------------------------
[Dollars in Millions] 1998 1997 1996
<S> <C> <C> <C>
Premiums $ 648.3 $ 722.9 $ 673.4
Net Investment Income 45.7 51.6 45.4
------- ------- -------
Total Revenues $ 694.0 $ 774.5 $ 718.8
======= ======= =======
Operating Profit $ 47.0 $ 63.1 $ 46.9
======= ======= =======
- -----------------------------------------------------------------
</TABLE>
Premiums in the Property and Casualty Insurance segment decreased by $74.6
million in 1998 due primarily to lower volume, principally the result of
management actions taken to reduce exposures on certain classes of business. The
Company anticipates that the impact of these actions on Premiums will continue
in 1999.
Net Investment Income in the Property and Casualty Insurance segment
decreased by $5.9 million in 1998 due primarily to lower yields on investments.
Operating Profit in the Property and Casualty Insurance segment decreased
by $16.1 million in 1998 due primarily to higher storm damage.
Premiums in the Property and Casualty Insurance segment increased by $49.5
million in 1997. Premiums increased by $33.4 million as a result of the January
1997 acquisition of Union Automobile Indemnity Company ("Union"). Excluding the
Union acquisition, premiums increased due primarily to higher volume of
automobile insurance.
Operating Profit in the Property and Casualty Insurance segment increased
by $16.2 million in 1997. Losses directly attributed to storms decreased $15.3
million in 1997 partially resulting from the Company's continuing efforts to
reduce its concentration of business in storm prone areas. Excluding the effect
of storms, Operating Profit increased in 1997 due primarily to improved loss
experience in automobile insurance and the higher net investment income,
partially offset by expenses related to Year 2000 and other system development
costs.
<TABLE>
<CAPTION>
LIFE AND HEALTH INSURANCE
- ---------------------------------------------------------------------------
[Dollars in Millions] 1998 1997 1996
<S> <C> <C> <C>
Life Insurance Premiums $ 376.0 $ 330.9 $ 359.4
Accident and Health Insurance Premiums 135.5 115.8 129.7
Property Insurance Premiums 68.5 52.4 57.8
------- ------- -------
Total Premiums 580.0 499.1 546.9
Net Investment Income 139.9 124.6 127.6
------- ------- -------
Total Revenues $ 719.9 $ 623.7 $ 674.5
======= ======= =======
Operating Profit $ 67.9 $ 62.6 $ 48.9
======= ======= =======
- ---------------------------------------------------------------------------
</TABLE>
Premiums in the Life and Health Insurance segment increased by $80.9 million in
1998 due primarily to premiums resulting from the June 1998 acquisition of The
Reliable Life Insurance Company ("Reliable Life") and the September 1998
acquisition of Reserve National Insurance Company ("Reserve National") and its
parent NationalCare Insurance Company, partially offset by lower other premium
volume partially attributable to the Company's exit of certain markets.
Net Investment Income in the Life and Health Insurance segment increased by
$15.3 million in 1998 due primarily to the acquisitions of Reliable Life and
Reserve National.
Operating Profit in the Life and Health Insurance segment increased by $5.3
million in 1998 due primarily to the acquisitions of Reliable Life and Reserve
National, partially offset by lower amortization of gains deferred in 1997 and
1996 in connection with the cession of certain in-force life and health
insurance policies. Policy Acquisition Costs Amortized exceeded Policy
Acquisition Costs Deferred by $3.2 million in 1998 due to a lower volume of new
business written in 1998 and the continuing amortization of costs deferred in
prior years.
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 16
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
- --------------------------------------------------------------------------------
LIFE AND HEALTH INSURANCE [CONTINUED]
- --------------------------------------------------------------------------------
Life Insurance Premiums decreased by $28.5 million in 1997 due primarily to the
ceding of certain life insurance policies to third parties, as further described
below, and lower other volume. Accident and Health Insurance Premiums decreased
by $13.9 million due primarily to lower volume, partially offset by higher
prices. In 1997, the Company began exiting certain Accident and Health Insurance
markets.
Net Investment Income in the Life and Health Insurance segment decreased by
$3.0 million in 1997 due primarily to a lower level of investments as a result
of the ceding of certain life insurance policies to third parties.
Operating Profit in the Life and Health Insurance segment increased by
$13.7 million in 1997 due primarily to lower benefits as a percentage of
premiums. Policy Acquisition Costs Amortized exceeded Policy Acquisition Costs
Deferred by $23.3 million in 1997 due to a lower volume of new business written
in 1997 and the continuing amortization of costs deferred in prior years.
Effective January 1, 1997, United Insurance Company of America ("United"),
one of the Company's Life and Health Insurance segment subsidiaries, entered
into a long-duration reinsurance agreement to cede certain in-force life and
health insurance policies principally in the states of Arkansas and Missouri to
Reliable Life. At the time of the agreement, Reliable Life was an unaffiliated
third party. Accordingly, as a result of this transaction, premiums in the Life
and Health Insurance segment decreased by approximately $10 million in 1997.
Effective May 31, 1998, the cession, as it pertained to the Missouri policies,
was commuted and United entered into a long-duration reinsurance agreement to
cede those policies to another third party. See Note 18 to the Consolidated
Financial Statements.
Effective May 31, 1996, United entered into a long-duration reinsurance
agreement to cede certain in-force life insurance policies to a third party. As
a result of this transaction, premiums in the Life and Health Insurance segment
decreased by approximately $6 million and $7 million in 1997 and 1996,
respectively. See Note 18 to the Consolidated Financial Statements.
CONSUMER FINANCE
- --------------------------------------------------------------------------------
[Dollars in Millions] 1998 1997 1996
Revenues $ 113.8 $ 125.0 $ 120.4
======= ======= =======
Operating Profit $ 20.1 $ 13.9 $ 26.1
======= ======= =======
- --------------------------------------------------------------------------------
Consumer Finance Revenues decreased by $11.2 million in 1998 due primarily to a
lower level of loans outstanding. Operating Profit in the Consumer Finance
segment increased by $6.2 million due primarily to lower provision for loan
losses.
Consumer Finance Revenues increased by $4.6 million in 1997 due primarily
to a higher level of loans outstanding during the first half of the year and to
a higher level of investments. Operating Profit in the Consumer Finance segment
decreased by $12.2 million in 1997 due primarily to higher provisions for loan
losses.
Loans more than 90 days past due were $12.1 million and $17.8 million at
December 31, 1998 and 1997, respectively, while the reserve for loan losses was
$40.1 million and $39.5 million, respectively. Loans more than 90 days past due
decreased primarily due to lower level of loans outstanding at December 31,
1998, compared to December 31, 1997.
INVESTEES
- --------------------------------------------------------------------------------
Unitrin's investment portfolio at December 31, 1998 included equity securities
accounted for by the equity method of accounting ("investees"): Curtiss-Wright
Corporation ("Curtiss-Wright"), Litton Industries, Inc. ("Litton") and UNOVA,
INC. ("UNOVA"). Each of the investee companies is listed on the New York Stock
Exchange and is subject to the reporting requirements of the federal securities
laws. These securities are held for investment purposes primarily as part of the
investment portfolios of Unitrin and its insurance subsidiaries. The market
value of Unitrin's Investments in Investees was approximately $1.2 billion at
December 31, 1998, compared to an asset carrying value of $581 million under the
equity method of accounting.
Unitrin accounts for its Investments in Investees under the equity method
of accounting in accordance with Accounting Principles Board Opinion No. 18
using the most recent publicly-available financial reports. See Note 2
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 17
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
- --------------------------------------------------------------------------------
INVESTEES [CONTINUED]
- --------------------------------------------------------------------------------
to the Consolidated Financial Statements. The amounts included in Unitrin's
financial statements represent amounts reported by the investee companies for
periods ending two to three months earlier.
At December 31, 1998, Unitrin owned approximately 43.0% of Curtiss-Wright's
common stock. Curtiss-Wright stated in its 1997 annual report to shareholders
that it "is a diversified multi-national manufacturing and service concern that
designs, manufactures and overhauls precision components and systems and
provides highly engineered services to the aerospace, automotive, shipbuilding,
oil, petrochemical, agricultural equipment, power generation, metal working and
fire & rescue industries."
At December 31, 1998, Unitrin owned approximately 27.9% of Litton's common
stock. Litton stated in its 1998 annual report to shareholders that it is an
"aerospace, defense and commercial electronics company," that it provides
"advanced electronic, defense and information systems and is a primary builder
of large surface combatant ships for the U.S. Navy," and that it is "an
international supplier of connectors, multilayer circuit boards, laser crystals,
solder materials and other equipment used primarily in the telecommunications,
industrial and computer markets."
At December 31, 1998, Unitrin owned approximately 23.1% of UNOVA's common
stock. UNOVA stated in its December 31, 1997 annual report on Form 10-K that it
is "an industrial technologies company providing customers with solutions for
improving their efficiency and productivity," that its automated data systems
segment "comprises automated data collection and mobile computing products and
services, principally serving the industrial market," and that its industrial
automation systems segment "includes integrated manufacturing systems, body
welding and assembly systems, and precision grinding and abrasive operations,
primarily serving the worldwide automotive, off-road and diesel engine
manufacturing industries."
Unitrin's Equity in Net Income of Investees was $62.3 million, $25.2
million and $50.6 million in 1998, 1997 and 1996, respectively.
In August 1998, the Company exchanged its investment in its investee,
Western Atlas Inc. ("Western Atlas"), for common stock in Baker Hughes
Incorporated ("Baker Hughes") upon the acquisition of Western Atlas by Baker
Hughes in a merger transaction. Prior to the merger of Western Atlas into Baker
Hughes, the Company owned approximately 23.1% of Western Atlas and accounted for
its investment in Western Atlas under the equity method of accounting.
Accordingly, Equity in Net Income of Investees for the year ended December 31,
1998 includes the Company's proportionate share of Western Atlas' income earned
prior to the merger. As a result of the merger, the Company owns approximately
11% of Baker Hughes common stock. Since the Company owns less than 20% of Baker
Hughes, the equity method does not apply and, accordingly, the Company does not
record a pro-rata share of Baker Hughes' reported earnings in the Company's
earnings. However, dividends received from Baker Hughes are reflected in the
Company's earnings. As a result of this change, the Company estimates that its
annual net income would decrease by approximately $6.1 million based upon
Western Atlas' net income from continuing operations for its trailing twelve-
month period ended June 30, 1998 and assuming that Baker Hughes continues to pay
dividends at its current rate.
Unitrin's Equity in Net Income of Investees in 1997 includes after-tax
losses of $33.6 million primarily resulting from Unitrin's proportionate share
of the write-off of in-process research and development activities at certain
investees.
Summarized financial and other information about Unitrin's Investments in
Investees can be found in Note 5 to the Consolidated Financial Statements.
INVESTMENT RESULTS
- --------------------------------------------------------------------------------
Net Investment Income was $186.4 million, $179.5 million and $179.0 million in
1998, 1997 and 1996, respectively.
Net Investment Income increased by $6.9 million in 1998 due primarily to
the inclusion of Reliable Life and Reserve National investment income in 1998,
partially offset by lower investment income from the Company's investment in
Navistar International Corporation $6.00 Cumulative Convertible Preferred Stock,
Series G ("Navistar Preferred Stock") and lower yields on investments in fixed
maturities.
Net Investment Income increased by $0.5 million in 1997 due primarily to
the inclusion of Union net investment income in 1997 and interest resulting from
the settlement of prior year taxes, partially offset by lower investment income
from the Company's investment in Navistar Preferred Stock.
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 18
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
- --------------------------------------------------------------------------------
INVESTMENT RESULTS [CONTINUED]
- --------------------------------------------------------------------------------
Net Investment Income from the Company's investment in Navistar Preferred Stock
was $0.8 million in 1998, $5.7 million in 1997 and $7.1 million in 1996. It is
the Company's policy to record dividend income on its preferred and common stock
investments based on the ex-dividend date. Net Investment Income from the
Company's investment in Navistar Preferred Stock decreased by $4.9 million in
1998 due to the redemption of the Company's investment. Net Investment Income
from the Company's investment in Navistar decreased by $1.4 million in 1997 due
to the timing of the Navistar Preferred Stock ex-dividend date.
Net Gains on Sales of Investments was $557.4 million in 1998, $3.6 million
in 1997 and $3.4 million in 1996. Net Gains from Sales of Investments increased
by $553.8 million for the year ended December 31, 1998, compared to the same
period in 1997 primarily due to a gain resulting from the merger of Western
Atlas into Baker Hughes and gains on the sale and redemption of other equity
securities (See Note 13 to the Consolidated Financial Statements). The Company
cannot anticipate when or if investment gains or losses may occur in the future.
The Company's investment strategy is based on current market conditions and
other factors which it reviews from time to time. The Company's consolidated
investment portfolio consists primarily of United States Government obligations,
investment-grade fixed maturities, equity securities and investees. The
Company's investment in non-investment-grade fixed maturity investments is
insignificant.
LIQUIDITY AND CAPITAL RESOURCES
- --------------------------------------------------------------------------------
At December 31, 1998, there are approximately 2.3 million shares of the
Company's outstanding common stock that can be repurchased under the Company's
Board of Directors' outstanding repurchase authorizations. Common stock can be
repurchased in open market or in privately negotiated transactions from time to
time subject to market conditions and other factors. During 1998, the Company
repurchased and retired 3.5 million shares of its common stock in open market
transactions at an aggregate cost of $232.9 million. The Company has repurchased
and retired 22.3 million shares of its common stock in open market transactions
at an aggregate cost of approximately $1.1 billion since 1990.
On February 5, 1998, the Company's Board of Directors increased the
Company's quarterly dividend from $0.60 per common share to $0.65 per common
share.
The Company has a $340 million unsecured revolving credit agreement with a
group of banks which expires in September 2002. Proceeds from advances under the
agreement may be used for general corporate purposes, including repurchases of
the Company's common stock. The weighted average interest rate on the $110
million in advances outstanding under the agreement on December 31, 1998 was
5.51%. At December 31, 1998, the unused commitment under the Company's revolving
credit agreement was $230 million. In addition, the Company's subsidiaries in
1999 would be able to pay approximately $651 million in dividends to the Company
without prior regulatory approval.
The Company has no significant commitments for capital expenditures. The
Company's subsidiaries maintain levels of cash and liquid assets sufficient to
meet ongoing obligations to policyholders and claimants, as well as ordinary
operating expenses. The Company's reserves are set at levels expected to meet
contractual liabilities and provide a margin for adverse deviation. The Company
maintains adequate levels of liquidity and surplus capacity to manage the risks
inherent with any differences between the duration of its liabilities and
invested assets. At December 31, 1998, the Company had capacity to write
additional premiums relative to statutory capital and surplus requirements.
Litton and UNOVA do not presently pay dividends on their common stock. Cash
dividends received from Curtiss-Wright totaled $2.3 million, $2.2 million and
$2.2 million in 1998, 1997 and 1996, respectively. The Company cannot anticipate
when or if dividends will be paid by the investee companies in the future. The
Company's retained earnings at December 31, 1998 includes $339.5 million
representing the undistributed equity in net income of investees.
INTEREST AND OTHER EXPENSES
- --------------------------------------------------------------------------------
Interest and Other Expenses was $13.7 million, $13.1 million and $15.5 million
in 1998, 1997 and 1996, respectively. Interest Expense was $4.9 million, $5.3
million and $6.3 million in 1998, 1997 and 1996, respectively. Other corporate
expenses were $8.8 million, $7.8 million and $9.2 million in 1998, 1997 and
1996, respectively.
- --------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 19
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
-------------------------------------------------------------------------------
THE YEAR 2000 ISSUE
-------------------------------------------------------------------------------
The Year 2000 issue (i.e. the ability of computer systems to accurately
identify and process dates beginning with the year 2000 and beyond) affects
virtually all companies and organizations. Some of the Company's computer
systems are already Year 2000 compliant. However, certain of the Company's
computer systems use only two digits to identify a year in a date field. For
example, the year 2000 would be represented in these systems as "00," but in
many cases might be interpreted by the computer as "1900" rather than "2000,"
thereby potentially resulting in processing errors.
The ability to process information in a timely and accurate manner is vital
to the Company's data-intensive insurance and consumer finance businesses. The
Company recognizes that the computer systems used by these businesses must be
Year 2000 compliant by December 31, 1999 and, in some instances, well in
advance of that date. To meet this challenge, the Company and its subsidiaries
have instituted a four-phase Year 2000 program:
1) Assessment--Identifying all hardware, software and key service providers
posing a Year 2000 exposure and the prioritizing of related Year 2000
projects;
2) Remediation and Conversion--Procuring replacement Year 2000 compliant
hardware or software (including improvements in functionality in addition
to being Year 2000 compliant) or modifying existing software to be Year
2000 compliant;
3) Validation--Testing and certification, including review of documented
remediation work and test results by technical project teams and key
users, of all such critical hardware and software;
4) Production--Installing and placing into production all such critical new
or remediated hardware and software.
Each of the Company's business segments is responsible for developing and
implementing detailed project plans to address its Year 2000 exposure. Each
business segment's progress is monitored and reviewed by the Company's Year
2000 Certification Team. The Company's Year 2000 Certification Team is
comprised of senior members of the Company Information Systems Audit Group and
Data Systems Group and reports to the Company's senior management and Board of
Directors on a regular basis. In addition, the Company's insurance subsidiaries
are subject to oversight by state insurance regulatory bodies and its consumer
finance subsidiary is subject to oversight by the FDIC.
Each of the Company's business segments has completed the Assessment Phase
and is in varying stages of completion for the remaining phases. The Company's
Property and Casualty Insurance segment has substantially completed all four
phases for its mission critical projects and has completed all four phases for
50% of its non-mission critical projects. For purposes of this Year 2000
discussion, the term "mission critical" refers to key business functions, such
as the processing of business transactions, regulatory compliance and archival
of important records, upon which the Company is materially dependent.
The Company's Life and Health Insurance segment has completed all four phases
for 65% of its mission critical projects and all four phases for 60% of its
non-mission critical projects. Approximately 35% of the Company's Life and
Health Insurance segment's mission critical projects are in the Remediation and
Conversion Phase. The Company's Life and Health Insurance segment is comprised
primarily of three separate business units operating in different geographical
regions and offering similar insurance policies using employee-agents. Each
business unit has its unique set of mission critical applications which it uses
to process transactions. Should one or two of these business units not achieve
Year 2000 compliance, the Company contingently plans to transfer the processing
of that business unit's transactions to another of the Company's Life and
Health Insurance segment's business units and process transactions manually
until the transfer is complete.
The Company's Consumer Finance segment outsources its mission critical data
processing to Fiserv, Inc. ("Fiserv"). As a provider of third party data
processing services to the banking and financial services industry, Fiserv and
the data processing services it provides are subject to limited oversight by
the FDIC. By the end of the first quarter of 1999, the Company's Consumer
Finance segment is scheduled to migrate from its current Fiserv system to
another system that Fiserv has modified to be, and is in the process of
certifying as Year 2000 compliant. Should the migration of the Company's
Consumer Finance segment be unsuccessful, the Company contingently intends to
off-load all customer loan and deposit records prior to January 1, 2000 and
process customer loans and deposits manually at its branch offices.
-------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
-------------------------------------------------------------------------------
THE YEAR 2000 ISSUE [CONTINUED]
-------------------------------------------------------------------------------
The Company has not identified any Year 2000 problems associated with non-
information technology systems (e.g., telephone systems, elevators, etc.) that
have not either been remediated or replaced, or scheduled to be remediated or
replaced prior to January 1, 2000, or which are likely to pose any material
risks to the Company's operations.
The Company is also reviewing the Year 2000 issue with key service providers,
including banks, brokers and investment custodians, and continually updating
its risk assessment, readiness evaluation, action plans and contingency plans
related to these service providers. In addition, the Company is reviewing the
Year 2000 issue as it relates to its investee companies (Curtiss-Wright, Litton
and UNOVA; the "Investees") as well as its significant investment in Baker
Hughes by reviewing public disclosures concerning Year 2000 readiness made by
such companies. The Company has no representatives on any of the Investees' or
Baker Hughes' boards of directors and does not otherwise participate in the
management of the Investees or Baker Hughes. Accordingly, the Company does not
possess any non-public information concerning, assumes no responsibility for,
and has no contingency plans for, Year 2000 compliance by the Investees or
Baker Hughes.
The goal of the Company is for its Property and Casualty Insurance segment's
non-mission critical projects to be substantially Year 2000 compliant by March
31, 1999, for its Consumer Finance segment to be substantially Year 2000
compliant by March 31, 1999, and for its Life and Health Insurance segment to
be substantially Year 2000 compliant by April 30, 1999. However, there can be
no assurances that this goal will be met. If one or more of the Company's
business segments, key service providers, investee companies or Baker Hughes
fails to make its computer systems Year 2000 compliant by the necessary dates,
notwithstanding contingency plans currently contemplated, such failure could
materially adversely affect the Company's operations and financial results.
Each of the Company's three business segments depends heavily on its computer
systems to manage its operations. The Company believes that the most reasonably
likely worst case scenario would consist of a combination of Year 2000
failures, including but not limited to the failures discussed above, in the
Company's mission critical systems, coupled with Year 2000 failures at one or
more of the Investees or Baker Hughes. In such a scenario, the Company might be
forced to rely on the manual processing of transactions, or, if feasible, to
shift processing to other Company systems or third party data processing
vendors, which in either case would likely have a material adverse effect on
costs and produce an increased probability of errors and potential legal
exposures resulting from such errors. Such a scenario could also result in the
loss of revenues, the extent of which is not estimable. In addition, Year 2000
failures at one or more Investees or Baker Hughes could materially affect their
earnings, and therefore adversely affect the earnings of the Company and the
Company's carrying value of its investment in these companies.
Incremental expense recognized directly related to rewriting and testing
existing applications or converting to new Year 2000 compliant applications
totaled $10.4 million, $8.5 million and $3.0 million for the years ended
December 31, 1998, 1997 and 1996, respectively. Total incremental expense
recognized since inception of the Company's Year 2000 program directly related
to rewriting and testing existing applications or converting to new Year 2000
compliant applications totaled $23.7 million through December 31, 1998. The
Company estimates that the incremental expense necessary to complete its Year
2000 program and directly related to rewriting and testing existing
applications or converting to new Year 2000 compliant applications will be
approximately $2.9 million in 1999. In addition to the above incremental
expenses, upon completion of the Company's Year 2000 program, the Company
estimates that it will have made capital expenditures, which will be expensed
over the useful lives of the assets to which they relate, totaling
approximately $16 million to replace existing hardware or software.
NOTE: The foregoing discussion on Year 2000 issues shall be considered "Year
2000 Readiness Disclosure" for purposes of the Year 2000 Information and
Readiness Disclosure Act.
ACCOUNTING CHANGES
-------------------------------------------------------------------------------
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income." Under
SFAS No. 130, enterprises that provide a full set of financial statements that
report financial position, results of operations and cash flows should also
include a Statement of Comprehensive Income.
-------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
-------------------------------------------------------------------------------
ACCOUNTING CHANGES [CONTINUED]
-------------------------------------------------------------------------------
Effective January 1, 1998, the Company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." Under SFAS No. 131 public
business enterprises are required to provide disclosures about operating
segments using the "management approach." The Company's Life and Health
Insurance employee-agents also market certain property and casualty insurance
products under common management. Accordingly, the Company now includes the
results of those property and casualty insurance products in its Life and
Health Insurance segment. It is the Company's management practice to allocate
certain corporate expenses to its operating units. Consistent with that
practice, the Company now includes those expenses in the results of its
operating segments.
In February 1998, the Financial Accounting Standards Board issued SFAS No.
132, "Employers' Disclosures about Pensions and Other Postretirement Benefits."
SFAS No. 132 supersedes the disclosure requirements of SFAS No. 87, "Employers'
Accounting for Pensions," SFAS No. 88, "Employers' Accounting for Settlements
and Curtailments of Defined Benefit Pension Plans and Termination Benefits,"
and SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than
Pensions." SFAS No. 132 is effective for fiscal years beginning after December
15, 1997. SFAS No. 132 does not address measurement or recognition and,
accordingly, has no effect on the Company's financial position or results of
operations.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and for Hedging Activities." SFAS No.
133 requires all derivatives to be recorded on the balance sheet at fair value
and establishes "special accounting" for the following three different types of
hedges: hedges of changes in the fair value of assets, liabilities or firm
commitments; hedges of the variable cash flows of forecasted transactions; and
hedges of foreign currency exposures of net investments in foreign operations.
SFAS No. 133 is effective for years beginning after June 15, 1999, with earlier
adoption permitted. The Company believes that the effect of adoption of SFAS
No. 133 will not be material.
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") No. 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." SOP No. 98-1 requires
companies to capitalize qualifying computer software costs incurred during the
application development stage. SOP No. 98-1 is effective for fiscal years
beginning after December 31, 1998, with earlier adoption permitted. The Company
intends to adopt SOP No. 98-1 in 1999. The Company has not determined the
effect of adoption.
CAUTION REGARDING FORWARD-LOOKING STATEMENTS
-------------------------------------------------------------------------------
Management's Discussion and Analysis of Results of Operations and Financial
Condition and the accompanying Consolidated Financial Statements (including the
notes thereto) contain forward-looking statements, which usually include words
such as "believe(s)," "goal(s)," "target(s)," "estimate(s)," "anticipate(s)"
and similar expressions. Readers are cautioned not to place undue reliance on
such statements, which speak only as of the date of this Annual Report.
Forward-looking statements are subject to risks and uncertainties which could
cause actual results to differ materially from those contemplated in such
statements. Such risks and uncertainties include, but are not limited to, those
described in this Management's Discussion and Analysis of Results of Operations
and Financial Condition, changes in economic factors (such as interest rates),
changes in competitive conditions (including availability of labor with
required technical or other skills), the number and severity of insurance
claims (including those associated with catastrophe losses), governmental
actions (including new laws or regulations or court decisions interpreting
existing laws and regulations) and adverse judgments in litigation to which the
Company or its subsidiaries are parties. No assurances can be given that the
results contemplated in any forward-looking statements will be achieved. The
Company assumes no obligation to release publicly any revisions to any forward-
looking statements as a result of events or developments subsequent to the date
of this Annual Report.
-------------------------------------------------------------------------------
Unitrin, Inc. and Subsidiaries 22
<PAGE>
EXHIBIT 13.3
FINANCIAL HIGHLIGHTS
The following page reproduces page 1 from Unitrin, Inc.'s 1998 Annual Report to
Shareholders. On February 11, 1999, Unitrin's Board of Directors declared a 2-
for-1 stock split in the form of a stock dividend payable on March 26, 1999 to
shareholders of record on March 5, 1999. Prior to the declaration of the 2-for-1
stock split, the Company had released its Financial Statements for the year
ended December 31, 1998. Accordingly, consistent with Topic 4.C. "Change in
Capital Securities" of Staff Accounting Bulletin 57, the retroactive effect of
the stock split has not been presented in such Financial Highlights attached
hereto as Exhibit 13.3.
<PAGE>
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
[Dollars in Millions, Except Per Share Amounts] 1998 1997 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
FOR THE YEAR
Premiums and Consumer
Finance Revenues $1,342.1 $1,347.0 $1,340.7 $1,205.6 $1,140.2
Net Investment Income 186.4 179.5 179.0 186.6 207.2
Net Gains on Sales of Investments 557.4 3.6 3.4 55.2 18.1
-------- -------- -------- -------- --------
Total Revenues $2,085.9 $1,530.1 $1,523.1 $1,447.4 $1,365.5
======== ======== ======== ======== ========
Net Income:
From Operations $ 85.5 $ 90.3 $ 79.7 $ 69.4 $ 102.8
From Investees Before
One-Time Items 62.3 58.8 50.6 45.1 30.6
From Investees' One-Time Items -- (33.6) -- -- 3.2
From Sales of Investments 363.0 2.4 2.2 36.1 11.8
-------- -------- -------- -------- --------
Total Net Income $ 510.8 $ 117.9 $ 132.5 $ 150.6 $ 148.4
======== ======== ======== ======== ========
Net Income Per Share:
From Operations $ 2.19 $ 2.41 $ 2.11 $ 1.72 $ 2.05
From Investees Before
One-Time Items 1.60 1.57 1.34 1.12 0.61
From Investees' One-Time Items -- (0.90) -- -- 0.06
From Sales of Investments 9.32 0.07 0.06 0.89 0.24
-------- -------- -------- -------- --------
Total Net Income Per Share $ 13.11 $ 3.15 $ 3.51 $ 3.73 $ 2.96
======== ======== ======== ======== ========
Total Net Income Per Share
Assuming Dilution $ 13.02 $ 3.11 $ 3.47 $ 3.69 $ 2.94
======== ======== ======== ======== ========
Repurchases of
Unitrin Common Stock $ 232.9 $ 20.7 $ 61.1 $ 416.0 $ 245.3
Dividends Paid to Common
Shareholders $ 100.7 $ 89.9 $ 83.0 $ 80.7 $ 75.8
Dividends Paid to Common
Shareholders (Per Share) $ 2.60 $ 2.40 $ 2.20 $ 2.00 $ 1.50
AT YEAR END
Number of Employees 7,631 6,866 7,401 7,629 7,289
Investments $4,304.2 $3,448.5 $3,291.4 $3,409.7 $3,321.1
Total Assets 5,909.9 4,920.7 4,871.1 4,818.7 4,569.8
Insurance Reserves 2,526.7 2,036.0 2,053.8 2,007.3 1,828.3
Shareholders' Equity 1,822.4 1,533.0 1,480.3 1,524.5 1,765.1
Shares of Unitrin Common Stock
Outstanding (In Millions of Shares) 38.0 37.6 37.3 38.5 47.1
Book Value Per Share $ 47.97 $ 40.79 $ 39.64 $ 39.61 $ 37.51
Fair Value Per Share of
Investments in Investees
in Excess of Carrying Value 10.97 22.90 16.35 12.23 6.84
-------- -------- -------- -------- --------
Adjusted Book Value Per Share $ 58.94 $ 63.69 $ 55.99 $ 51.84 $ 44.35
======== ======== ======== ======== ========
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
Unitrin, Inc. and Subsidiaries 1
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF UNITRIN, INC.
-----------------------------
Subsidiaries of Unitrin, Inc., with their states of incorporation in
parentheses, are as follows:
1. Alpha Property & Casualty Insurance Company (Wisconsin)
2. Clayton Reinsurance Ltd. (Bermuda)
3. Clayton Reinsurance Ltd. (Missouri)
4. Family Security Funerals Company (Texas)
5. Financial Indemnity Company (California)
6. Fireside Mortgage Loans (California)
7. Fireside Securities Corporation (California)
8. Fireside Thrift Co. (California)
9. Milwaukee Guardian Insurance, Inc. (Wisconsin)
10. Milwaukee Insurance Group, Inc. (Wisconsin)
11. Milwaukee Safeguard Insurance Company (Wisconsin)
12. NationalCare Insurance Company (Oklahoma)
13. The Pyramid Life Insurance Company (Kansas)
14. The Reliable Life Insurance Company (Missouri)
15. The Reliable Life Insurance Company of Texas (Texas)
16. Reserve National Insurance Company (Oklahoma)
17. Security National Insurance Company (Texas)
18. Southern States Finance Corporation (Louisiana)
19. Southern States General Agency, Inc. (Louisiana)
20. Trinity Lloyd's Corporation (Texas)
21. Trinity Universal Insurance Company (Texas)
22. Trinity Universal Insurance Company of Kansas, Inc. (Kansas)
23. Union Automobile Indemnity Company (Illinois)
24. Union National Fire Insurance Company (Louisiana)
25. Union National Life Insurance Company (Louisiana)
26. United Casualty Insurance Company of America (Pennsylvania)
27. United Insurance Company of America (Illinois)
28. United Lloyd's Corporation (Texas)
29. Unitrin Services Company (Illinois)
<PAGE>
EXHIBIT 23.1
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors of Unitrin, Inc.:
Under date of January 8, 1999, we reported on the consolidated balance sheets of
Unitrin, Inc. and subsidiaries as of December 31, 1998 and 1997 and the related
consolidated statements of income, cash flows and shareholders' equity and
comprehensive income for each of the years in the three-year period ended
December 31, 1998. These consolidated financial statements and our report
thereon are incorporated by reference in the December 31, 1998 Annual Report on
Form 10-K of Unitrin, Inc. In connection with our audits of the aforementioned
consolidated financial statements, we also audited the related supplementary
financial statement schedules as listed in Item 14 of such Annual Report on Form
10-K. These supplementary financial statement schedules are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these supplementary financial statement schedules based on our audits.
In our opinion, such supplementary financial statement schedules, when
considered in relation to the basic consolidated financial statements taken as a
whole, present fairly, in all material respects, the information set forth
therein.
KPMG LLP
Chicago, Illinois
January 8, 1999
<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT AUDITORS
To the Shareholders and Board of Directors of Unitrin, Inc.:
We consent to incorporation by reference in Registration Statements 33-58300,
33-47530, 333-4530 and 333-38981 of Unitrin, Inc., on Form S-8, of our reports
dated January 8, 1999, relating to the consolidated balance sheets of Unitrin,
Inc. and subsidiaries as of December 31, 1998 and 1997 and the related
consolidated statements of income, cash flows and shareholders' equity and
comprehensive income and related financial statement schedules for each of the
years in the three-year period ended December 31, 1998, which reports appear or
are incorporated by reference in the December 31, 1998 Annual Report on Form 10-
K of Unitrin, Inc.
KPMG LLP
Chicago, Illinois
March 17, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 2,557,300
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 786,300
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 4,304,200
<CASH> 8,600
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 332,000
<TOTAL-ASSETS> 5,909,900
<POLICY-LOSSES> 2,526,700
<UNEARNED-PREMIUMS> 263,200
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 116,200
0
0
<COMMON> 3,800
<OTHER-SE> 1,818,600
<TOTAL-LIABILITY-AND-EQUITY> 5,909,900
1,228,300
<INVESTMENT-INCOME> 186,400
<INVESTMENT-GAINS> 557,400
<OTHER-INCOME> 113,800
<BENEFITS> 781,800
<UNDERWRITING-AMORTIZATION> 0
<UNDERWRITING-OTHER> 617,000<F1>
<INCOME-PRETAX> 687,100
<INCOME-TAX> 238,600
<INCOME-CONTINUING> 510,800<F2>
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 510,800
<EPS-PRIMARY> 13.11
<EPS-DILUTED> 13.02
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
<FN>
<F1>INCLUDES CONSUMER FINANCE EXPENSES OF $95.6 MILLION AND OTHER EXPENSES OF $13.7
MILLION
<F2>INCLUDES EQUITY IN NET INCOME OF INVESTEES OF $62.3 MILLION
</FN>
</TABLE>
