<PAGE> 1
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Quarterly Report Pursuant to Section 13 of the
Securities Exchange Act of 1934
For the quarterly period ended September 30, 1996
Commission file number 0-19347
HOME HOLDINGS INC.
(Exact name of registrant as specified in its charter)
Delaware 13-3584978
(State of incorporation) (I.R.S. Employer
Identification No.)
59 Maiden Lane, New York, New York 10038-4548
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (212) 530-6600
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 of the Securities Exchange Act of 1934 during the
preceding 12 months and (2) has been subject to such filing requirements for the
past 90 days.
YES X NO
--- ---
At September 30, 1996, there were 14,114,500 shares of registrant's Series A
Common Stock, par value $.01 per share, outstanding.
<PAGE> 2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HOME HOLDINGS INC.
Consolidated Statements of Income
Third Quarter and Nine Months ended September 30,
(Unaudited)
($ millions)
<TABLE>
<CAPTION>
Third Quarter Nine Months
---------------------- ----------------------
1996 1995 1996 1995
------- ------- ------- -------
<S> <C> <C> <C> <C>
REVENUES:
Net earned premiums (note 2) $ 13 $ 203 $ 126 $ 826
Insurance net investment income 34 36 115 169
Insurance realized capital gains (losses) -- -- 10 (207)
Securities broker-dealer operations 91 122 330 338
------- ------- ------- -------
Total revenues 138 361 581 1,126
------- ------- ------- -------
OPERATING EXPENSES:
Losses and loss adjustment expenses (note 2) 68 237 259 1,083
Policy acquisition and other insurance expenses 32 86 113 290
Securities broker-dealer operations 89 111 309 315
Corporate interest expense 13 11 37 34
Other expenses -- 1 -- 24
------- ------- ------- -------
Total expenses 202 446 718 1,746
------- ------- ------- -------
Loss before income taxes (64) (85) (137) (620)
Income tax expense -- (2) (2) (5)
------- ------- ------- -------
NET LOSS $ (64) $ (87) $ (139) $ (625)
======= ======= ======= =======
</TABLE>
- ------------------
See notes to consolidated financial statements.
1
<PAGE> 3
HOME HOLDINGS INC.
Consolidated Balance Sheets
($ millions)
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
------- -------
(Unaudited)
<S> <C> <C>
ASSETS
Insurance investments at fair value:
Portfolio swap receivable (note 5) $ 1,391 $ 2,130
Fixed maturities available for sale
(cost $31 and $33) 31 33
Equity securities (cost $18 and $24) (note 5) 23 24
Short-term investments 2 2
------- -------
Total insurance investments 1,447 2,189
Cash 105 34
Premiums receivable 320 384
Funds held by affiliate 260 265
Reinsurance receivables 2,179 2,383
Prepaid reinsurance premiums 1 24
Securities broker-dealer investments 401 539
Receivable from brokers, dealers and customers 2,060 1,896
Other assets 206 289
------- -------
Total assets $ 6,979 $ 8,003
======= =======
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Liabilities:
Unpaid losses and loss adjustment expenses $ 4,957 $ 5,814
Unearned premiums 14 141
Payables to brokers, dealers and customers 1,871 1,621
Securities of broker-dealer sold under
agreements to repurchase -- 131
Debt of securities broker-dealer 240 304
Corporate debt (note 4) 550 517
Other liabilities 558 552
------- -------
Total liabilities 8,190 9,080
------- -------
Litigation and contingencies (note 6)
Stockholders' deficiency: (note 3)
Series A preferred stock, $.01 par value; 170
shares authorized, issued and outstanding -- --
Series A common stock, $.01 par value;
40,000,000 shares authorized;
14,114,500 shares outstanding -- --
Series B convertible stock, $.01 par value;
15,000,000 shares authorized;
11,425,177 shares outstanding -- --
Paid-in capital 777 777
Deficit (1,991) (1,852)
Unrealized gains on insurance investments (note 5) 5 --
Unrealized currency translation adjustments (2) (2)
------- -------
Total stockholders' deficiency (1,211) (1,077)
------- -------
Total liabilities and stockholders' deficiency $ 6,979 $ 8,003
======= =======
</TABLE>
- -------
See notes to consolidated financial statements.
2
<PAGE> 4
HOME HOLDINGS INC.
Consolidated Statements of Cash Flows
Nine Months ended September 30,
(Unaudited)
($ millions)
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (139) $ (625)
Adjustments to reconcile net loss to net cash
used for operating activities:
Insurance realized capital (gains) losses (10) 207
Unpaid losses and loss adjustment expenses (857) (307)
Premiums and reinsurance receivables 291 438
Funds held by affiliate 5 (249)
Unearned premiums (127) (489)
Broker-dealer investments and receivables,
net of payables 158 (244)
Other 30 169
------- -------
Net cash used for operating
activities (649) (1,100)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Portfolio swap receivable 739 817
Sales of fixed maturities 1 6
Sales of equity securities 16 4
Other (5) (6)
------- -------
Net cash provided by investing
activities 751 821
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in debt of broker-dealer (64) 118
Increase in corporate debt 33 222
Decrease in corporate debt -- (170)
Stock repurchase -- (92)
Issuance of preferred stock -- 98
Other -- (9)
------- -------
Net cash provided by financing
activities (31) 167
------- -------
Net increase (decrease) in cash 71 (112)
Cash at beginning of period 34 144
------- -------
CASH AT END OF PERIOD $ 105 $ 32
======= =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW:
Corporate interest paid $ 12 $ 14
Broker-dealer interest paid $ 60 $ 56
Income taxes paid $ 2 $ 7
</TABLE>
- ------------------
See notes to consolidated financial statements.
3
<PAGE> 5
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
1. ACCOUNTING POLICIES
Home Holdings Inc. (the "Company") follows the accounting policies
set forth in the 1995 Annual Report on Form 10-K ("Annual Report") filed
with the Securities and Exchange Commission (the "Commission"). Users of
financial information produced for interim periods are encouraged to
refer to the footnotes contained in the Annual Report when reviewing
interim financial results, and to note 1 of such Annual Report for
discussion of the Company's recapitalization and related terms mentioned
herein.
The accompanying interim consolidated financial statements are
unaudited. These financial statements reflect all adjustments, consisting
of normal recurring adjustments, necessary for a fair presentation of
financial position and results of operations. Results of interim periods
are not necessarily indicative of results for the full year.
2. PREMIUMS AND LOSSES
Premium and loss information for the third quarter and nine months
ended September 30, follows:
<TABLE>
<CAPTION>
Third Quarter Nine Months
------------- -----------
1996 1995 1996 1995
------- ------- ------- -------
($ millions)
<S> <C> <C> <C> <C>
Written premiums:
Direct $ 3 $ (14) $ 12 $ 3
Assumed 2 11 28 603
Ceded (1) (16) (18) (193)
------- ------- ------- -------
Net $ 4 $ (19) $ 22 $ 413
======= ======= ======= =======
Earned premiums:
Direct $ 8 $ 127 $ 46 $ 660
Assumed 6 136 122 435
Ceded (1) (60) (42) (269)
------- ------- ------- -------
Net $ 13 $ 203 $ 126 $ 826
======= ======= ======= =======
Losses and loss adjustment expenses:
Direct $ 20 $ 133 $ 194 $ 801
Assumed 38 156 116 301
Ceded 10** (52) (51)** (19)*
------- ------- ------- -------
Net $ 68 $ 237 $ 259 $ 1,083
======= ======= ======= =======
</TABLE>
* Includes a decrease to ceded losses and loss adjustment expenses of
$189 million, related to the commutation and assignment of the stop
loss treaty.
** During the third quarter the estimates of ceded reserves to insolvent
and commuted reinsurers for Asbestos/Pollution Policies were refined,
resulting in a decrease of $35 million to ceded losses and loss
adjustment expenses.
4
<PAGE> 6
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
In connection with the Recapitalization as defined in note 1 of the
1995 Annual Report, on December 24, 1994, Zurich Insurance Company's U.S.
Branch ("Zurich American"), the Company and Trygg-Hansa AB, a corporation
organized under the laws of Sweden ("Trygg-Hansa") entered into the
Facultative Reinsurance Facility Agreement (the "Facility Agreement").
Pursuant to the Facility Agreement, Zurich American agreed to issue
facultative reinsurance certificates and related cut-through endorsements
with respect to policies issued by The Home Insurance Company and its
insurance subsidiaries ("Home Insurance"), if requested by Home Insurance
and if such risks met Zurich American's underwriting criteria.
On February 9, 1995, the Facility Agreement was amended to provide
that existing or prospective insureds of Home Insurance that decline a
Zurich American reinsurance certificate would be offered a Zurich
American insurance policy with associated premiums and liabilities being
assumed by Home Insurance through a 100% quota share reinsurance
agreement.
On June 12, 1995, the Facility Agreement was further amended to
provide for settlements of balances after June 12, 1995 due between Home
Insurance and Zurich American and to delete a provision for a 1% renewal
premium payable by Zurich American with respect to direct policies issued
by Zurich American under the Facility Agreement. The Facility Agreement
terminated as of June 12, 1995.
The effect of the Facility Agreement for the third quarter and nine
months ended September 30, follows:
($ millions)
<TABLE>
<CAPTION>
Third Quarter Nine Months
------------- -----------
1996 1995 1996 1995
----- ----- ----- -----
<S> <C> <C> <C> <C>
Written premiums:
Direct** $ -- $ 3 $ (6) $(202)
Assumed 1 (6) 17 540
Ceded -- (1) (5) (35)
----- ----- ----- -----
Net $ 1 $ (4) $ 6 $ 303
===== ===== ===== =====
Earned premiums
Direct** $ -- 1 $ (6) $(138)
Assumed 1 8 17 205
Ceded -- (6) (5) (27)
----- ----- ----- -----
Net $ 1 $ 3 $ 6 $ 40
===== ===== ===== =====
</TABLE>
** Negative direct premiums is due to policies cancelled and subsequently
assumed.
5
<PAGE> 7
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
Asbestos/Pollution Losses and Loss Adjustment Expenses
The 1996 third quarter and nine months incurred loss and loss
adjustment expenses relating to policies which have been alleged to
contain asbestos/pollution exposure ("Asbestos/Pollution Policies") were
$41 million for both periods compared with $17 million and $52 million,
respectively, for the same periods in 1995. The 1996 nine months incurred
loss for Asbestos/Pollution Policies reflected $69 million of paid
losses, partially offset by decreases of $28 million to unpaid losses and
loss adjustment expenses. The 1996 third quarter incurred loss reflected
$27 million of paid losses and $14 million of net increases to unpaid
losses and loss adjustment expenses. This $14 million of net increases to
unpaid losses and loss adjustment expenses for Asbestos/Pollution
Policies in the third quarter includes an increase of $35 million due to
refinement of estimates of ceded reserves to insolvent and commuted
reinsurers.
Estimation of loss reserves for Asbestos/Pollution Policies is one of
the most difficult aspects of establishing reserves, especially in view
of changes in the legal and tort environment which affect the development
of loss reserves. There is a high degree of uncertainty with respect to
future exposure from these types of claims because significant issues
exist as to the liabilities of the insureds, the extent to which
insurance coverage exists, diverging legal interpretations and judgments
state by state relating to, among other things, when the loss occurred
and what policies provide coverage; what claims are covered; whether
there is an insurer obligation to defend; how policy limits are
determined; how policy exclusions are applied and interpreted; and
whether clean-up costs represent insured property damage, and other
matters. Home Insurance is engaged in litigation over the interpretation
of policy coverage and other liability issues. If the courts expand the
intent of the policies and the scope of coverage, as they sometimes have
in the past, additional liabilities may emerge. Conversely, proposals for
regulatory reform may serve to reduce or limit future liabilities. Among
other complications, there are uncertainties regarding the number and
identity of insureds with potential exposure, lack of historical data and
long reporting delays. Management believes these issues are not likely to
be resolved in the near future. Given these uncertainties, management
believes that it is virtually impossible to determine ultimate losses in
this area and no meaningful range for adequate reserves for such ultimate
losses can be established at this time.
With respect to claims involving exposures to asbestos and certain
other toxic torts, the development of the legal insurance coverage issues
is more advanced and insurance companies have had a longer history in
defending and settling such claims. As a result, Home Insurance
establishes specific case reserves for these asbestos and toxic tort
claims at such time as Home Insurance is able to estimate the probable
ultimate cost to Home Insurance over reasonably foreseeable future
periods of time. Pollution claims, however, continue to present the range
of issues presented above. Policyholders generally do not make available
sufficient information from which the
6
<PAGE> 8
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
reasonable costs of clean-up or remediation, even if covered by a Home
Insurance policy, might be estimated. Moreover, successful defense by
Home Insurance on coverage issues might eliminate all coverage for a
particular claim or group of claims. Accordingly, the development of a
factual basis from which a claim can be evaluated with respect to
exposure and coverage can take months to years from receipt of an initial
claim. Thus, reserves with respect to specific pollution cases typically
are set, if at all, only after substantial factual discovery is completed
in the action.
In 1995, Risk Enterprise Management Limited, in its capacity as
manager of Home Insurance's operations, established a single
Environmental and Mass Tort Division, which includes a new team to merge
legal, actuarial and financial expertise in collaborating with
policyholders and reinsurers to find alternative resolutions to claims in
the environmental and mass tort areas. Management believes that these
organizational changes will increase operational efficiency, while
assuring that Home Insurance takes a unified and consistent approach to
these claims. This division is also preparing an inventory of potential
exposures for Asbestos/Pollution Policies, which Home Insurance will
utilize to evaluate its use of industry benchmarks to establish reserves.
Losses for such claims are likely to be reflected in future years
and, due to the uncertainties discussed above, the ultimate losses may
vary materially from current reserves and could have a materially adverse
effect on the Company's financial condition and results of operations.
The process of estimating reserve requirements is necessarily
imperfect and involves an evaluation of a large number of variables
discussed above. Therefore, there can be no assurance that the ultimate
liability will not exceed amounts reserved. However, on the basis of (i)
current legal interpretations, and political, economic and social
conditions, (ii) Home Insurance's internal procedures, which analyze Home
Insurance's experience with similar cases and historical trends, such as
reserving patterns, loss payments, pending levels of unpaid claims and
product mix, and (iii) management's judgments of the relevant factors
regarding reserve requirements for claims relating to Asbestos/Pollution
Policies, management believes that adequate provision has been made for
Home Insurance's loss reserves.
Excess of Loss Reinsurance Agreement
Home Insurance and Centre Reinsurance Dublin entered into the Excess
of Loss Reinsurance Agreement, dated as of June 12, 1995. Home Insurance
is provided with an aggregate limit of $1.3 billion subject to certain
adjustments, attaching at the point that Home Insurance has no remaining
cash or assets readily convertible into cash to pay any of its
obligations. Among such adjustments, in the event that Home Insurance
pays any dividends to the Company prior to the third anniversary of the
Closing of the Recapitalization to fund interest payments on the Public
Indebtedness, the limit will be
7
<PAGE> 9
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
increased by the amount of such dividends plus interest thereon at the
rate of 7.5% per annum, compounded, from the date such dividends were
paid to the date the reinsurer commences making payments under the Excess
of Loss Reinsurance Agreement. Also, up to $290 million of additional
coverage provided by the Excess of Loss Reinsurance Agreement shall be
linked to certain factors including dividend payments from Home Insurance
to the Company funding principal payments on the Public Indebtedness and
the New Notes (as defined in note 1 to the 1995 Annual Report) as such
debts become payable.
Based on cash flow forecasts at December 31, 1995 and the present
value of certain 1996 adjustments to loss reserves, the Company is
projecting that $1,245 million of coverage limits of the Excess of Loss
Reinsurance Agreement will be exhausted, and due to these projected
future recoveries, loss reserves with a net present value of $445 million
were recorded as of September 30, 1996 as a recoverable from the Excess
of Loss Reinsurance Agreement, including an additional $30 million during
1996. The $30 million increase represents the estimated present value of
cash flows relating to adjustments to Asbestos/Pollution Policies and
assumed reinsurance business.
3. LIQUIDITY AND STATUTORY SURPLUS
Dividend Restrictions
The Company has been notified by the New Hampshire Insurance
Department (the "New Hampshire Department") that, in light of the
Recapitalization, Home Insurance cannot pay any dividends without prior
approval of the New Hampshire Department. If the New Hampshire Department
rejects future dividend payments, the Company will be forced to raise
cash through capital infusions, the issuance of additional debt, or the
sale of assets in order to meet its current obligations; however, there
are no assurances that such sources will be available. Under the terms of
the Recapitalization Agreement, Centre Finance Dublin ("Centre Finance"),
an affiliate of Zurich Insurance Company, agreed to purchase up to $46
million aggregate principal amount of the Company's 7% Series B Senior
Working Capital Notes to fund interest payments through December 1996 on
the Public Indebtedness. Such Series B Senior Working Capital Notes will
be purchased by Centre Finance on the applicable interest payment dates
for the Public Indebtedness. As of September 30, 1996 the Company has
issued $35 million of the Series B Senior Working Capital Notes. See note
4 for further discussion of the Series B Senior Working Capital Notes.
Based on the Company's most current cash flow projections, funds on
hand and funds that can be used from the issuance of Series B Senior
Working Capital Notes should be sufficient to meet the Company's cash
flow needs through the end of 1996.
8
<PAGE> 10
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
The preparation of cash flow projections, however, requires many
assumptions and estimates by management, and the actual outcome and
results can vary materially from such estimates. While there should be
sufficient funds to meet its cash needs through 1996, there can be no
assurances that events or circumstances described herein or unforeseen
will not result in a cash shortfall before December 31, 1996. The Company
is currently reviewing its cash needs and cash sources for 1997. Without
dividends from Home Insurance, the Company is unlikely to be able to meet
its cash needs during 1997.
Statutory Surplus
The accounting practices of insurance companies are prescribed or
permitted by certain regulatory authorities. Certain of these practices
differ from the generally accepted accounting principles used in
preparing the consolidated financial statements of the Company.
Home Insurance's consolidated policyholders' surplus, determined in
accordance with statutory practices, was $191 million at September 30,
1996 compared with $230 million at December 31, 1995. The remaining
amount of coverage in the Excess of Loss Reinsurance Agreement, as
discussed in note 2, is $55 million on an undiscounted statutory basis.
In connection with the New Hampshire Department's involvement in
approving the Recapitalization, it has appointed a representative to act
as an on-site monitor for the Company's operations, with certain rights
of access and cooperation from the Company and Risk Enterprise Management
Limited.
The Company's loss reserves are determined through a process of
estimation which is necessarily imperfect, and ultimate losses may exceed
such estimates. See note 3 of the Company's Annual Report for further
discussion. As the Company's statutory surplus levels have continued to
decline since December 31, 1995, management can give no assurance that
statutory surplus levels will be sufficient to absorb materially
deficient estimates of loss reserves, if any. Management continues to
believe that its provision for loss and loss adjustment expense reserves
is adequate, and the Company is currently performing its standard
comprehensive review of reserves in order to further evaluate adequacy of
its reserve estimates.
The New Hampshire Department also continues to direct a consulting
actuarial firm to perform a review of Home Insurance's loss reserves, and
has retained a second actuarial firm to perform a peer review of the
findings. Such reviews are expected to be completed by the first quarter
of 1997. Management cannot predict whether reserve estimates to be
prepared by these consultants, or by the Company, as the result of its
own reviews, will change either management's or the New Hampshire
Department's view of oversight or regulatory intervention required for
Home Insurance.
9
<PAGE> 11
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
4. CORPORATE DEBT
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
------------- ------------
($ millions)
<S> <C> <C>
7% Senior Notes due in 1998, net of
unamortized discount of $1 in 1996 and 1995 $ 99 $ 99
77/8% Senior Notes due in 2003, net of
unamortized discount of $1 in 1996
and $2 in 1995 178 177
77/8% Senior Notes due in 2003, net of
unamortized discount of nil in 1996 and 1995 1 1
12% Senior Subordinated Notes, issued at
original issue discount, $303 million
principal value due in 2004 114 105
8% Junior Subordinated Notes, issued at
original issue discount, $171 million
principal value due in 2004 89 84
12% Senior Subordinated Working Capital
Notes, issued at original issue discount,
$46 million principal value due in 2004 18 16
7% Series A Senior Working Capital Notes 16 12
7% Series B Senior Working Capital Notes 35 23
---- ----
Total Corporate Debt $550 $517
==== ====
</TABLE>
Interest on the Series A and Series B Senior Working Capital Notes is
payable quarterly, and at September 30, 1996, approximately $3 million of
interest was accrued but not paid by the Company and accordingly is
overdue. On any overdue payment of principal or interest, the interest
rate is adjusted upwards to the greater of (i) the rate of interest on
the notes, plus 3% or (ii) the prime rate plus 3%. Non-payment of
interest at the due date additionally constitutes an event of default
under the terms of the Series A and Series B Senior Working Capital Notes
which, among other things, would remove Centre Finance's obligation to
fund additional Series A and Series B Senior Working Capital Notes.
Centre Finance and its affiliates have waived their rights and privileges
with respect to a default of an interest payment, except interest rate
adjustments, through December 31, 1996.
Principal on the Series A and Series B Senior Working Capital Notes
of approximately $16 million and $23 million, respectively, was due June
1996. Pursuant to the Standby Working Capital Credit Agreement, dated as
of April 26, 1995, the Company, on May 21, 1996, elected to extend the
due date of such principal until June 1997. Additionally, $12 million of
Series B Senior Working Capital Notes issued on June 15, 1996, matures on
June 15, 1997.
10
<PAGE> 12
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
Neither Centre Finance nor Zurich Insurance Company have any
obligations pursuant to the Recapitalization or otherwise to provide any
capital or other financial support to the Company or its subsidiaries
other than the limited amounts specifically provided for pursuant to the
Recapitalization and related agreements. Centre Finance and Zurich
Insurance Company have informed the Company that they do not intend to
provide any financial support beyond such limited amounts as may be
required pursuant to the Recapitalization.
5. PORTFOLIO SWAP RECEIVABLE AND OTHER INSURANCE INVESTMENTS
The Portfolio Value Swap Agreements (the "Swap") are designed to
transfer control and market risk of the portfolio to Centre Reinsurance
Dublin. The Company has accounted for the Swap as if the investments
covered by the Swap were sold to Centre Reinsurance Dublin. The Company,
however, continues to retain legal ownership. As a result, the Company
has reclassified its investments covered by the Swap to a balance
receivable from Centre Reinsurance Dublin ("Portfolio Swap Receivable"),
valued at the fair value of the portfolio investments on the effective
date (January 1, 1995) less withdrawals made to fund operations plus the
total return of 7.5%. Centre Reinsurance Dublin bears the market risk and
will reimburse the Company or be reimbursed by the Company for any
changes in the fair value of securities underlying the Swap as discussed
below.
As of September 30, 1996, the Company has recorded, as a component of
the Portfolio Swap Receivable, an amount due from Centre Reinsurance
Dublin of $58 million because of a negative difference from the 7.5%
target return. The negative difference since January 1, 1996 resulted
from the net of (i) a $47 million difference in favor of the Company due
to a decrease in the fair value of investments underlying the Swap and
(ii) a $11 million difference in favor of the Company for investment
income representing an upward adjustment to reach the 7.5% target yield.
Actual investment income before such adjustments was $104 million.
Securities and cash totaling $210 million were transferred to Centre
Reinsurance Dublin on January 22, 1996, to settle the 1995 Swap
liability.
In the nine months ended September 30, 1996, the Company recognized
$5 million in unrealized gains on insurance equity investments not
underlying the Swap.
11
<PAGE> 13
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
In the second quarter of 1996, Zurich Investment Management Inc.
("ZIM") replaced its affiliate, Centre Investment Services Limited, as
manager of the Company's cash and invested assets. The fair value of
securities managed by ZIM and underlying the Portfolio Swap Receivable
from Centre Reinsurance Dublin as of September 30, 1996 is as follows:
<TABLE>
<CAPTION>
Estimated
Fair
Value
($ millions)
<S> <C>
Fixed Maturities:
U.S. Government and agency $ 414
Mortgage-backed 366
Corporate 431
Foreign governments 53
Other 3
------
Total 1,267
Short-term investments 66
------
Total Swap investments 1,333
Receivable from Centre Reinsurance Dublin 58
------
Portfolio Swap Receivable $1,391
======
</TABLE>
6. LITIGATION AND CONTINGENCIES
Home Insurance, in common with the insurance industry, is subject to
litigation, including claims for punitive damages and for
extra-contractual damages, in the normal course of its business. Gruntal
Financial Corporation ("Gruntal"), in the ordinary course of its
business, has been named as a defendant or co-defendant in a number of
lawsuits, including class actions and arbitration proceedings, some of
which involve claims for damages of substantial or unspecified amounts.
In the ordinary course of its business, Home Insurance is involved in
insurance litigation, including claims litigation involving the defense
of policyholders arising from suits brought by third parties, litigation
or arbitration to recover sums due from reinsurers, actions brought by
policyholders alleging the improper failure to settle or defend suits,
and actions to recover premiums due from insureds, including premiums due
under retrospectively-rated insurance policies and premium balances due
from agents or brokers. In addition, Home Insurance is involved in
non-insurance litigation arising out of investments and
employment-related matters.
12
<PAGE> 14
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
While the aggregate dollar amounts involved in these legal
proceedings cannot be determined with certainty, if the Company or its
subsidiaries were required to pay the amounts at issue, such payment or
payments could have a material adverse effect on the Company's financial
condition or results of operations. However, in the opinion of
management, the ultimate aggregate liability in these actions is not
expected to exceed the amounts currently reserved in an amount which
would have a material adverse effect on the Company's financial condition
or results of operations. There are no assurances that the outcome of
these matters will not vary materially from management's estimates.
A petition was filed on December 13, 1993, in the District Court of
Dallas County, Texas, joining Home Insurance as a defendant in a
previously filed action. The action seeks certification of both plaintiff
and defendant classes. The purported plaintiff class consists of all
Texas insureds who were charged premiums above state-approved rates for
casualty coverage through the use of retrospectively-rated policies for a
period beginning prior to May 15, 1987, through April 1, 1992. Plaintiffs
seek to certify a defendant class of all insurers doing business in Texas
who charged the alleged excessive rates, plus certain brokers and the
National Council on Compensation Insurance. The Complaint alleges that
defendants entered into a conspiracy to devise various methods of
charging and collecting the allegedly excessive rates and, in doing so,
breached their contracts with plaintiffs, breached their fiduciary duty
and violated the Texas Insurance Code and the Deceptive Trade Practices
Act. Compensatory and punitive damages are sought in unspecified amounts
plus treble damages.
A settlement between fourteen of the primary defendants, including
Home Insurance, has been reached. Home Insurance has contributed
approximately $8 million, which had been accrued as of December 31, 1995,
under a trust agreement pending final court approval. On July 5, 1996 the
Texas District Court gave preliminary approval to the settlement. The
defendants submitted to a verification process of their damage
calculations. The court gave final approval to the settlement on October
30, 1996. Final orders of approval will be issued.
A complaint and temporary restraining order issued from the New York
State Supreme Court were served upon Home Insurance by Bertholon-Rowland
Corp., a large producer of Home Insurance's professional liability
business in New York and Massachusetts. The action arises out of the
producer's decision to terminate its business relationship with Home
Insurance on six months' notice, and Home Insurance's subsequent
immediate suspension of the producer's authority to act on its behalf.
The complaint seeks an injunction and damages nullifying the suspension
of authority and enforcing the producer's contractual rights to its
customer accounts and commissions. Compensatory and punitive damages are
sought. By stipulation of the parties the restraining order was dissolved
and legal proceedings stayed pending submission of the dispute to an
arbitration panel. Home Insurance obtained a preliminary injunction
against Bertholon-Rowland preventing it from issuing
13
<PAGE> 15
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
cancellations and non-renewal notices to Home Insurance insureds pending
the arbitration hearing which was conducted in June and July of 1995. The
final award of the arbitration panel dated August 7, 1995 ordered, among
other things, that Bertholon- Rowland's damages claim against Home
Insurance be denied. Home Insurance's motion to confirm the arbitration
award was submitted to the court on October 12, 1995. On November 8,
1995, Bertholon-Rowland obtained a court order temporarily restraining
alleged violations of its ownership rights to policy expirations, and
filed a motion for a preliminary injunction against Home Insurance and
Zurich-American Insurance Group and Professional Liability Underwriting
Managers Inc. due to the alleged violations and seeking other relief as
well. Subsequently, Bertholon-Rowland filed a motion to amend the
temporary restraining order based upon alleged continuing violations of
its expiration rights. The motions are pending before the court. The
Company does not believe that the outcome of this action will have a
material adverse effect on its financial condition or results of
operations.
On February 13, 1991, Home Insurance and its subsidiaries were
acquired from AmBase (the "Acquisition") pursuant to a stock purchase
agreement (the "Stock Purchase Agreement"). As part of the Stock Purchase
Agreement, as amended, AmBase provided Home Insurance a tax
indemnification for certain taxes assessed against AmBase and its
consolidated group, which included Home Insurance, for all periods ending
on or before December 31, 1989. The Stock Purchase Agreement, as amended,
also provided for a "hold-back" of a portion of the purchase
consideration by the Company to be used to pay (i) liabilities for
federal or state income taxes, including interest thereon, assessed
against AmBase, Home Insurance or any other member of the AmBase
affiliated group for years ending on or before December 31, 1989, and
(ii) certain other liabilities, and to the extent not used for these
purposes, to be paid to AmBase.
Home Insurance, as a member of the AmBase affiliated group, joined in
filing consolidated federal income tax returns with AmBase during tax
years through February 13, 1991, and is severally liable for any federal
income tax, including interest, ultimately assessed against AmBase for
years during such period. In the event AmBase federal income tax and
interest assessments exceed the amount held back pursuant to the Stock
Purchase Agreement, as amended, and AmBase does not have sufficient
financial resources to pay the excess amount, Home Insurance would be
severally liable for such excess amount.
AmBase federal tax years through 1991 have been examined and settled
by the Internal Revenue Service, with the exception of a "Fresh Start"
issue for the 1987 tax year and no additional assessments can be made.
Based upon public disclosures by AmBase and information provided by
AmBase to the Company under the terms of the Stock Purchase Agreement, as
amended, (i) AmBase believes that it has meaningful defenses with respect
to the "Fresh Start" tax issue that is material to AmBase and (ii) the
Company believes that if AmBase does not have sufficient financial
resources
14
<PAGE> 16
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
to pay federal income tax and interest assessments for the 1987 tax year
for which Home Insurance is severally liable and for the additional
AmBase withholding tax issue still open for which Home Insurance believes
it is not liable, any liability of Home Insurance for such amounts in
excess of the amount held back pursuant to the Stock Purchase Agreement,
as amended, would not have a material adverse effect on the Company's or
Home Insurance's financial condition or results of operations. No amounts
have been accrued by Home Insurance or the Company in excess of the
amount held back pursuant to the Stock Purchase Agreement, as amended.
Home Insurance is involved in a dispute with its landlord, Olympia
and York Maiden Lane Company (the "Landlord"), with respect to its lease
of its principal offices at 59 Maiden Lane, New York, New York. The
Landlord is in default of certain bond obligations that are secured by
the building and, consequently, the Landlord has made an assignment of
rents to the trustee (the "Trustee") representing the Landlord's
bondholders. On June 24, 1996, the Landlord's bondholders obtained a
judgment of foreclosure and it is anticipated that the Landlord's
bondholders will complete the foreclosure, and gain possession of the
building shortly.
On June 1, 1996, Home Insurance began withholding rent and tax
payments to the Landlord. Subsequently, the Trustee and the Landlord
issued several notices to Home Insurance threatening to terminate its
lease and/or seek possession of the premises. On July 19, 1996, Home
Insurance brought an action against the Landlord and the Trustee in its
capacity as trustee in New York State Supreme Court entitled, The Home
Insurance Company v. Olympia & York Maiden Lane Company, et al., seeking
a preliminary injunction to prohibit the Landlord from terminating the
lease or beginning an independent rent action in Landlord-Tenant court.
In this action, Home Insurance seeks damages from the Landlord for rent
overcharges, refusal to obtain tax relief which would benefit Home
Insurance, failure to maintain the building including certain life safety
systems, and failure to meet its obligations (including statutory and
regulatory obligations) with respect to The Americans with Disabilities
Act and asbestos in the building.
The Court granted a temporary restraining order on July 19, 1996, in
favor of Home Insurance. On August 9, 1996 the Court entered a decision
and interim order, which, as amended through September 12, 1996,
appointed a mediator and provided that Home Insurance deposit in escrow
with a receiver approximately $7.4 million representing the June and July
rent and June tax payment. The order states that the escrow payment
"shall not per se constitute a secured claim under New Hampshire Revised
Statutes Annotated 402 - C: 3 but may be subject to the provisions of New
Hampshire Insurance Laws, Chapter 402 - C in the event of proceedings
thereunder or similar proceedings in this or any other jurisdiction".
Home Insurance made this escrow payment and the mediation proceeded. On
October 21, the mediator suspended the mediation while the parties or the
Court attempt to resolve the conditions subject to which a further escrow
payment of $3.2 million requested by the Court through the mediator,
may be made by Home Insurance.
15
<PAGE> 17
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
Subsequently, the Landlord moved for summary judgment for past due
rent. This motion is returnable November 18. Home Insurance is opposing
the Landlord's motion and is moving to amend and supplement its complaint
(i) to add a claim for constructive eviction from approximately 23% of
its premises, where its environmental expert has identified
"significantly damaged" asbestos containing materials ("ACM"); (ii) to
join the bondholders as a class of defendants in this action; and (iii)
to increase the amount of damages sought by Home Insurance for the
Landlord's refusal to obtain tax relief to more than $20 million. Home
Insurance is also moving to consolidate the foreclosure action brought by
the Trustee against the Landlord with Home Insurance's action.
Management believes that it is too early to predict with certainty
the ultimate outcome of this dispute, however, an unfavorable outcome
could have a material adverse impact on the Company's financial
condition.
Home Insurance is involved in a dispute with the National Council
on Compensation Insurance ("NCCI"). The NCCI is a licensed rating or
advisory organization for the workers' compensation line of insurance
in a majority of states. One function it performs is to administer the
National Workers' Compensation Reinsurance Pool ("the Pool"). The Pool
collects premium and pays losses for various residual market plans
around the country. The premium is supposed to be distributed to pool
members in proportion to their market share and held in reserve. The NCCI
sends a quarterly invoice to each pool member for its share of the losses
as calculated and paid by the Pool in that quarter.
Home Insurance is a participant in the Pool, and, as of September
30, 1996, is carrying undiscounted loss reserves of approximately $270
million allocated to the Pool. Home Insurance has had several
discussions with the NCCI over the past year concerning the extent of
its obligation and the possibility of a commutation. Home Insurance has
refused to pay the NCCI's two most recent quarterly invoices totalling
approximately $22 million and requested an audit of the Pool's
calculations and of the NCCI's administration of the Pool. The NCCI has
refused to permit the requested audit but has offered to allow Home
Insurance, at its expense, to meet with the Pool's auditors. The NCCI
has also asked Home Insurance to put the aforementioned invoiced but
unpaid amount in escrow. Management believes it is too early to predict
with certainty the ultimate outcome of this matter; however, an
unfavorable outcome could have a material adverse impact on the
Company's financial condition.
In or about October 1994, Gruntal discovered a defalcation in its
back office operations area. Gruntal notified the New York Stock Exchange
Inc. ("NYSE"), the Commission and the United States Attorney's Office for
the Southern District of New York ("USAO"). Gruntal also undertook an
inquiry into the circumstances and facts of the defalcation and into
related matters. Gruntal presently believes that approximately $14
million, consisting in substantial part of funds that should have or
potentially could have been abandoned property under the laws of various
states ("Abandoned Property"), was embezzled or improperly diverted,
including approximately $5 million in such funds that was used in
substantial part to benefit Gruntal. Gruntal has submitted claims to its
insurer, Home Insurance, under the applicable insurance policy and to
date, approximately $8.5 million has been advanced to Gruntal by the
carrier. Home Insurance's net retention on the claim was approximately $1
million, with the balance reinsured.
Based upon information furnished by Gruntal, inquiries were
undertaken by the NYSE, the Commission and USAO. Gruntal discussed its
investigation relating to Abandoned Property with the governmental and
self-regulatory bodies involved. In addition, Gruntal advised the NYSE,
the Commission, USAO and the National Association of Securities Dealers,
Inc. ("NASD") that it was conducting a separate review relating to the
execution and reporting of certain Over-the-Counter ("OTC") orders.
In April 1996, pursuant to a settlement entered into between Gruntal
and the Commission, and without admitting or denying the allegations
therein, Gruntal consented to the entry of an administrative order in
which the Commission found that Gruntal's practices with respect to
Abandoned Property violated antifraud and broker-dealer reporting and
recordkeeping provisions of the federal securities laws, and aided and
abetted violations of the federal securities laws by the Company. The
Commission order censured Gruntal and required Gruntal to pay $5.5
million in disgorgement and prejudgment interest and a monetary fine of
$4 million, and reimburse any customers
16
<PAGE> 18
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
determined by an independent consultant acceptable to the Commission to
have been financially harmed by Gruntal's OTC execution and reporting
practices. The disgorgement fund will be administered and disbursed by a
fund administrator pursuant to a report and a plan which will be
submitted to the Commission and require court approval. Under the terms
of the settlement, the fund administrator is also required to verify
Gruntal's representation to the Commission that it has repaid,
recredited, escheated or segregated and scheduled for escheatment $6.7
million which Gruntal has identified as escheatable, or presently
believes to be escheatable, or has identified as belonging to customers,
contra-parties, vendors and other third parties. In June 1996, at the
direction of the Commission and as approved by the order of the United
States District Court for the Southern District of New York in SEC v.
Gruntal & Co., Incorporated, et al., 96 Civ. 2514, James R. Doty, Esq., a
partner in the law firm of Baker & Botts, LLP and a former General
Counsel of the Commission, was engaged to serve as Fund Administrator
(hereinafter, the "Fund Administrator").
In June 1996, with the approval of the Commission, the NYSE and the
NASD, Gruntal engaged Irving M. Pollack, Esq., a former Commissioner of
the Commission, to serve as Independent Consultant (hereinafter the
"Independent Consultant"), pursuant to the settlement with the
Commission, and, additionally, pursuant to other settlements with the
Commission, NYSE and NASD, described below. The Independent Consultant
will review Gruntal's operating policies and procedures with respect to
the operations and OTC areas and recommend further changes, if deemed
appropriate. In performing these reviews, the Fund Administrator and
Independent Consultant are authorized to rely upon work performed or to
be performed by the Quality Assurance Task Force established by Gruntal's
Chief Executive Officer to conduct a diagnostic review of Gruntal's
departments and business activities, and upon work by other
representatives of Gruntal.
Gruntal also entered into a separate settlement with the Commission
in April 1996, pursuant to which Gruntal consented, without admitting or
denying the allegations therein, to the entry of an administrative order
in which the Commission found that Gruntal violated antifraud and
recordkeeping provisions of the federal securities laws in connection
with the execution of certain transactions for investment advisory
clients and the non-disclosure to advisory clients of the receipt of
certain payments for order flow. The Commission's order censured Gruntal
and required Gruntal to pay a monetary fine of $1 million, reimburse any
clients determined by the Independent Consultant to have been financially
harmed as a result of the violations, and pay into the United States
Treasury the amount of payment that the Independent Consultant determines
Gruntal received for order flow on transactions executed for advisory
client accounts plus accrued interest thereon. Under the terms of the
settlement, the Independent Consultant also will review Gruntal's
policies and procedures with respect to the execution of orders for
advisory client accounts and the coding, and reporting on client
confirmations and internal Gruntal records, of transactions executed by
Gruntal and recommend further changes, if deemed appropriate. In
performing this review, the
17
<PAGE> 19
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
Independent Consultant is entitled to rely upon work performed or to be
performed by Gruntal's Quality Assurance Task Force and upon work by
other representatives of Gruntal.
In addition, Gruntal entered into a stipulation with the NYSE staff
in March 1996 to resolve the NYSE's investigation of Abandoned Property
and other issues relating to the supervision of pricing and valuation of
certain collateralized mortgage obligations and certain proprietary
trading accounts, as well as the accuracy of FOCUS reports previously
filed with the NYSE and the late filing of certain other required reports
with the NYSE. Pursuant to the stipulation, which was approved by the
NYSE in April 1996, Gruntal was censured and required to pay a $1 million
fine to the NYSE. Gruntal also agreed to retain the Independent
Consultant to review Gruntal's systems and procedures and make
recommendations for additional systems and procedures, if necessary,
reasonably designed to ensure Gruntal's compliance with federal
securities laws and NYSE rules and to prevent the recurrence of the
violations described in the stipulation.
In April 1996, pursuant to a consent between Gruntal and the NASD,
and without admitting or denying the allegations therein, Gruntal also
consented, among other things, to findings by the NASD that during 1995
through the date of the consent, Gruntal violated certain provisions of
the NASD Bylaws and Rules of Fair Practice by trading ahead of certain
customer limit orders, failing to report or timely report certain trading
transactions and failing to enforce written supervisory procedures
relating to the execution of limit orders. Pursuant to the terms of the
consent, Gruntal was censured and required to pay a fine of $200,000, up
to $100,000 of which may be waived to the extent of payment by Gruntal to
customers harmed by certain trading practices, as discussed below. In
addition, Gruntal agreed to retain the Independent Consultant to review
and, if appropriate, make recommendations with respect to Gruntal's
practices and written procedures pertaining to Gruntal's trading,
execution and reporting practices in Nasdaq securities. Gruntal is also
required to pay to each customer identified by the Independent Consultant
as harmed by practices described above the amount by which each customer
was harmed plus accrued interest.
The disgorgement amounts and fines described above in connection with
the Commission, NYSE and NASD regulatory matters were accrued in the
December 1995 financial statements. The Company has made timely payments
of the disgorgement amounts and fines as required under these
settlements.
As discussed above, the USAO undertook a separate investigation
relating to the Abandoned Property matter. Based upon the information
presently available, Gruntal cannot predict whether the USAO will charge
Gruntal with any criminal violations. Gruntal believes that any decision
by the USAO to prosecute Gruntal would have a materially adverse impact
on Gruntal's financial condition. Gruntal has advised the USAO of its
views and has also communicated a number of factors that in Gruntal's
18
<PAGE> 20
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
view would support a decision not to indict Gruntal, including Gruntal's
self-reporting to, and cooperation with, governmental, regulatory and
self-regulatory bodies, remediation of past non-compliance with state
abandoned property laws and recrediting of customer accounts, adoption of
new policies and procedures, management and personnel changes, ongoing
review of its business practices, and willingness to agree to the
appointment of an independent monitor with authority to review Gruntal's
business activities and recommend further changes in policies and
procedures.
Gruntal has also brought the Abandoned Property and other matters
referred to above to the attention of the Commodity Futures Trading
Commission ("CFTC") and the North American Securities Administrators
Association, a national association of state securities regulators. These
matters could result in additional investigations and proceedings by the
CFTC and state securities regulators, in connection with which such
authorities may seek to impose additional sanctions against Gruntal.
Although the ultimate outcome cannot be predicted with certainty,
management presently believes that any such sanctions would not have a
materially adverse effect on the consolidated financial condition of
Gruntal or the Company.
During the third quarter of 1996, Gruntal discovered that
approximately 2,800 principal transactions involved customers that were
employee benefit plans or individual retirement arrangements under the
Employee Retirement Income Security Act of 1974, as amended ("ERISA") or
parallel provisions of the Internal Revenue Code. In the absence of an
available exemption, these transactions would be "prohibited
transactions" under Section 406 of ERISA and Section 4975 of the Code.
Gruntal is examining the availability of certain exemptions. Management
believes it is too early to predict with certainty the ultimate outcome
of this matter and it is not yet able to reasonably estimate any costs
that it may ultimately incur. Management does not believe that such costs
will have a material adverse effect on the financial position of the
Company.
19
<PAGE> 21
HOME HOLDINGS INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The following should be read in conjunction with the consolidated financial
statements.
CONSOLIDATED
Consolidated revenues were $138 million and $581 million in the third
quarter and nine months ended September 30, 1996, respectively, compared
with $361 million and $1,126 million, respectively, in the same periods of
1995. The net loss was $64 million and $139 million in the third quarter
and nine months ended September 30, 1996, respectively, as compared to $87
million and $625 million, respectively, during the same periods in 1995.
The 1995 nine months net loss reflected losses of $418 million related to
transactions in connection with the Recapitalization, including (i) a loss
of $189 million due to the commutation and assignment of the Stop Loss
Treaty, (ii) net realized capital losses of $208 million, pertaining to
previously recorded unrealized losses covered under the Portfolio Swap
Agreement and (iii) transaction expenses of $21 million.
HOME INSURANCE
Insurance revenues and pre-tax loss were as follows:
<TABLE>
<CAPTION>
Third Quarter Nine Months
------------- -----------
1996 1995 1996 1995
----- ----- ----- -----
($ millions)
<S> <C> <C> <C> <C>
Net earned premiums $ 13 $ 203 $ 126 $ 826
Net investment income 34 36 115 169
Realized capital gains (losses) -- -- 10 (207)
----- ----- ----- -----
Insurance revenues $ 47 $ 239 $ 251 $ 788
===== ===== ===== =====
Underwriting loss $(117) $(120) $(276) $(547)
Excess of Loss Reinsurance Agreement 30 -- 30 --
Net investment income 34 36 115 169
Realized capital gains (losses) -- -- 10 (207)
----- ----- ----- -----
Insurance pre-tax loss $ (53) $ (84) $(121) $(585)
===== ===== ===== =====
</TABLE>
20
<PAGE> 22
HOME HOLDINGS INC.
Underwriting Results
In connection with the Recapitalization which closed on June 12, 1995,
Home Insurance ceased writing new and renewal business except for limited
risks that Home Insurance is obligated to continue writing for an interim
period. All Home Insurance operations are being run-off subsequent to June
12, 1995. Prior to the Closing of the Recapitalization, the Company had
attempted to mitigate the effect of the downgrades by the rating agencies
by entering into a Facility Agreement which allowed Home Insurance's
clients to have access to the security of Zurich American, a Company that
is A+ rated by A.M. Best. The Facility Agreement terminated June 12, 1995.
Net earned premiums and underwriting results by product were as follows:
<TABLE>
<CAPTION>
Net Earned Premiums
-------------------
Third Quarter Nine Months
------------- -----------
1996 1995 1996 1995
---- ---- ---- ----
($ millions)
<S> <C> <C> <C> <C>
Commercial casualty $ 9 $ 98 $ 77 $450
Commercial property 1 13 10 41
---- ---- ---- ----
Commercial accounts group 10 111 87 491
Professional liability 1 37 14 145
Other specialty lines 1 45 15 160
---- ---- ---- ----
Specialty lines group 2 82 29 305
Run-off operations 1 10 10 30
---- ---- ---- ----
Total $ 13 $203 $126 $826
==== ==== ==== ====
</TABLE>
<TABLE>
<CAPTION>
Underwriting Loss
-----------------
Third Quarter Nine Months
------------- -----------
1996 1995 1996 1995
----- ----- ----- -----
($ millions)
<S> <C> <C> <C> <C>
Commercial casualty $ (42) $ (66) $(122) $(144)
Commercial property (2) (3) (44) (45)
----- ----- ----- -----
Commercial accounts group (44) (69) (166) (189)
Professional liability (6) (28) (24) (73)
Other specialty lines (3) 1 (11) (13)
----- ----- ----- -----
Specialty lines group (9) (27) (35) (86)
----- ----- ----- -----
Run-off operations (64) (24) (75) (83)
----- ----- ----- -----
Total before the commutation
and assignment of the
stop loss treaty (117) (120) (276) (358)
Commutation and assignment of the
stop loss treaty -- -- -- (189)
----- ----- ----- -----
Total $(117) $(120) $(276) $(547)
===== ===== ===== =====
</TABLE>
21
<PAGE> 23
HOME HOLDINGS INC.
Underwriting losses were $117 million and $276 million in the third
quarter and nine months of 1996, respectively, compared with $120 million
and $547 million in the same periods of 1995. The 1996 underwriting losses
were primarily due to lower earned premiums and expenses incurred in
managing the run-off of Home Insurance's operations. Also, the 1996 third
quarter loss includes $60 million of net adjustments relating to loss
reserves for Pollution/Asbestos Policies and assumed reinsurance business,
as reflected in the discussion of run-off operations below. The 1995 nine
months results include a loss of $189 million due to the commutation and
assignment of the Stop Loss Treaty, in connection with the
Recapitalization.
The commercial accounts group underwriting loss was $44 million and $166
million, respectively, in the third quarter and nine months of 1996,
compared with $69 million and $189 million, respectively, in the same
periods of 1995. The 1996 underwriting losses includes commercial casualty
losses of $42 million and $122 million in the third quarter and nine
months, respectively, compared to $66 million and $144 million,
respectively, in the same periods of 1995. Commercial property losses of $2
million and $44 million in the third quarter and nine months, respectively,
were also included in the 1996 underwriting loss compared with $3 million
and $45 million for the same 1995 periods. The 1996 commercial accounts
group losses were primarily due to lower earned premiums and expenses
incurred in managing the run-off of its operations. The 1995 result
reflected unfavorable loss experience and providing for higher loss ratios
for 1995 business.
The specialty lines group losses were $9 million and $35 million in the
third quarter and nine months of 1996, respectively, compared with $27
million and $86 million, respectively, in the same periods of 1995. The
1996 specialty lines group losses were primarily due to lower earned
premiums and expenses incurred in managing the run-off of its operations.
The 1995 underwriting losses were primarily due to professional liability's
unfavorable loss experience and providing for higher loss ratios for 1995
business.
The run-off operations losses were $64 million and $75 million in the
third quarter and nine months of 1996, respectively, compared with $24
million and $83 million, respectively, in the same periods of 1995.
Underwriting losses from Asbestos/Pollution Policies for the third quarter
and nine months of 1996 were $41 million for both periods compared to $17
million and $52 million, respectively, in the same 1995 periods. During the
third quarter, the estimates of ceded reserves to insolvent and commuted
reinsurers for Asbestos/Pollution Policies were refined, resulting in an
increase of $35 million to net asbestos and pollution loss reserves.
Additionally, loss reserves relating to assumed reinsurance business were
increased $25 million, based on a reallocation of exposures by accident
year.
Excess of Loss Reinsurance Agreement
Home Insurance recorded an additional $30 million recoverable from the
Excess of Loss Reinsurance Agreement during the 1996 third quarter. The
increase represents the estimated present value of cash flows relating to
the $60 million of adjustments to Asbestos/Pollution Policies and assumed
reinsurance business, as discussed above. As of
22
<PAGE> 24
HOME HOLDINGS INC.
September 30, 1996, loss reserves with a net present value of $445 million
were recorded as a recoverable from the Excess of Loss Reinsurance
Agreement. See Financial Condition for additional information on the Excess
of Loss Reinsurance Agreement.
Investments
As of September 30, 1996, the Company has recorded, as a component of the
Portfolio Swap Receivable, an amount due from Centre Reinsurance Dublin of
$58 million because of a negative difference from the 7.5% target return.
The negative difference since January 1, 1996 resulted from the net of (i)
a $47 million difference in favor of the Company due to a decrease in the
fair value of investments underlying the Swap and (ii) a $11 million
difference in favor of the Company for investment income representing an
upward adjustment to reach the 7.5% target yield. Actual investment income
before such adjustments was $104 million.
In the nine months ended September 30, 1996, the Company recorded $5
million in unrealized gains on insurance equity investments not underlying
the Swap.
GRUNTAL
An analysis of broker-dealer results for the third quarter ended
September 27, is set forth in the following table:
<TABLE>
<CAPTION>
Third Quarter Nine Months
------------- -----------
1996 1995 1996 1995
---- ---- ---- ----
($ millions)
<S> <C> <C> <C> <C>
Commissions $ 18 $ 24 $ 69 $ 65
Principal transactions 25 54 117 148
Underwriting and investment banking 9 8 27 22
Interest 31 29 91 84
Other 8 7 26 19
---- ---- ---- ----
Total revenues 91 122 330 338
Total expenses 89 111 309 315
---- ---- ---- ----
Income before income taxes $ 2 $ 11 $ 21 $ 23
==== ==== ==== ====
</TABLE>
Total broker-dealer revenues decreased by $31 million and $8 million from
the third quarter and nine months of 1996 to $91 million and $330 million
in 1996, respectively. The decreases were primarily due to lower principal
transaction revenues.
23
<PAGE> 25
HOME HOLDINGS INC.
Principal transaction revenues decreased $29 million and $31 million for
the third quarter and nine months ended September 30, 1996 to $25 million
and $117 million, respectively. The decrease was primarily due to the
exiting of proprietary equity trading units and decreases of over the
counter sales.
The decrease in Gruntal's expenses for the third quarter and nine months
of 1996, in comparison to the 1995 periods of $22 million and $6 million,
respectively, can be attributed to decreased compensation directly related
to compensable revenues.
OTHER
Corporate interest expense was $13 million and $37 million in the third
quarter and nine months ended September 30, 1996, respectively, compared
with $11 million and $34 million, respectively, in the same periods of
1995.
Other expenses were nil in the third quarter and nine months of 1996,
compared to $1 million and $24 million, respectively, in the same periods
of 1995. The 1995 expenses were primarily comprised of transaction expenses
related to the Recapitalization.
Income tax expense of nil and $2 million, respectively in the third
quarter and nine months of 1996 compared with expense of $2 million and $5
million, respectively, in the same periods of 1995. Taxes in 1996 and 1995
were comprised of state and foreign taxes. The Company was unable to
recognize a federal income tax benefit against its 1996 or 1995 pre-tax
losses because there was no available taxable income in the carryback
period.
24
<PAGE> 26
HOME HOLDINGS INC.
FINANCIAL CONDITION
Consolidated
Following the closing of the Recapitalization, Home Insurance has
generally ceased writing new or renewal insurance or reinsurance business,
except for limited risks that Home Insurance is obligated to continue
writing for an interim period. The Company has been notified by the New
Hampshire Department that, in light of the Recapitalization, Home Insurance
cannot pay any dividends without prior approval of the New Hampshire
Department.
If the New Hampshire Department rejects future dividend payments, the
Company will be forced to raise cash through capital infusions, the
issuance of additional debt, or the sale of assets in order to meet its
current obligations; however there are no assurances that such sources will
be available. Under the terms of the Recapitalization Agreement, Centre
Finance agreed to purchase up to $46 million aggregate principal amount of
the Company's 7% Series B Senior Working Capital Notes to fund interest
payments occurring through December 1996 on the Public Indebtedness as
described in note 1 of the 1995 Annual Report. Such Series B Senior Working
Capital Notes will be purchased by Centre Finance on the applicable
interest payment dates for the Public Indebtedness. As of September 30,
1996 the Company has issued $35 million of the Series B Senior Working
Capital Notes.
To fund additional cash requirements incurred in connection with the
Equity Repurchase Transaction, the Recapitalization and other extraordinary
needs, Centre Finance and Zurich Centre Investments Limited ("ZCI")
purchased $15 million principal amount of the Company's 12% Senior
Subordinated Working Capital Notes due and $12 million principal amount of
the Company's 7% Series A Senior Working Capital Notes, pursuant to the
Standby Working Capital Credit Agreement, dated as of April 26, 1995, by
and between the Company and Zurich Home Investments Limited, ("ZHI"). The
Company, ZHI and Trygg- Hansa agreed that the Company may issue and ZHI may
purchase, additional Series A Senior Working Capital Notes having an
aggregate principal amount of $4 million, and during 1996 the Company has
issued $3.8 million of these notes.
Interest on the Series A and Series B Senior Working Capital Notes is
payable quarterly, and, at September 30, 1996, approximately $3 million of
interest was accrued but not paid by the Company and accordingly is
overdue. On any overdue payment of principal or interest, the interest rate
is adjusted upwards to the greater of (i) the rate of interest on the
notes, plus 3% or (ii) the prime rate plus 3%. Non-payment of interest at
the due date additionally constitutes an Event of Default under the terms
of the Series A and Series B Senior Working Capital Notes which, among
other things, would remove Centre Finance's obligation to fund additional
Series A and Series B Senior Working Capital Notes. Centre Finance and its
affiliates have waived their rights and privileges with respect to a
default of an interest payment, except interest rate adjustments, through
December 31, 1996.
25
<PAGE> 27
HOME HOLDINGS INC.
Principal on the Series A and Series B Senior Working Capital Notes of
approximately $16 million and $23 million, respectively was due June 1996.
Pursuant to the Standby Working Capital Credit Agreement, dated as of April
26, 1995, the Company, on May 21, 1996, elected to extend the due date
until June 1997. Additionally, $12 million of Series B Senior Working
Capital Notes issued on June 15, 1996, matures on June 15, 1997.
Neither Centre Finance nor Zurich Insurance Company have any obligations
pursuant to the Recapitalization or otherwise to provide any capital or
other financial support to the Company or its subsidiaries other than the
limited amounts specifically provided for pursuant to the Recapitalization
and related agreements. Centre Finance and Zurich Insurance Company have
informed the Company that they do not intend to provide any financial
support beyond such limited amounts as may be required pursuant to the
Recapitalization.
The sources of funds of the Company consist primarily of dividends from
Home Insurance. Accordingly, the Company's ability to pay its obligations
depends on the receipt of sufficient funds from Home Insurance. Since Home
Insurance is subject to regulatory restrictions on the amount of dividends
that can be paid as described above, its assets are not necessarily
available to the Company on a current basis. The Company did not receive
common stock dividends from Home Insurance in 1996 or 1995.
Based on the Company's most current cash flow projections, funds on hand
and funds that can be used from the issuance of Series B Senior Working
Capital Notes should be sufficient to meet the Company's cash flow needs
through the end of 1996. The preparation of cash flow projections, however,
requires many assumptions and estimates by management, and the actual
outcome and results can vary materially from such estimates. While there
should be sufficient funds to meet its cash needs through 1996, there can
be no assurances that events or circumstances described herein or
unforeseen will not result in a cash shortfall before December 31, 1996.
The Company is currently reviewing its cash needs and cash sources for
1997. Without dividends from Home Insurance, the Company is unlikely to be
able to meet its cash needs during 1997.
At September 30, 1996 and December 31, 1995, the Company's outstanding
corporate debt was $550 million and $517 million, respectively.
Home Insurance and Centre Reinsurance Dublin entered into the Excess of
Loss Reinsurance Agreement, dated as of June 12, 1995. Home Insurance is
provided with an aggregate limit of $1.3 billion subject to certain
adjustments, attaching at the point that Home Insurance has no remaining
cash or assets readily convertible into cash to pay any of its obligations.
Among such adjustments, in the event that Home Insurance pays any dividends
to the Company prior to the third anniversary of the Closing of the
Recapitalization to fund interest payments on the Public Indebtedness, the
limit will be increased by the amount of such dividends plus interest
thereon at the rate of 7.5% per annum, compounded, from the date such
dividends were paid to the date the reinsurer commences making payments
under the Excess of Loss Reinsurance Agreement. Also, up to $290 million of
additional coverage provided by the Excess of Loss Reinsurance Agreement
shall be linked
26
<PAGE> 28
HOME HOLDINGS INC.
to certain factors including dividend payments from Home Insurance to the
Company funding principal payments on the Public Indebtedness and the New
Notes (as defined in note 1 to the 1995 Annual Report) as such debts become
payable.
Based on cash flow forecasts at December 31, 1995 and the present value
of certain 1996 adjustments to loss reserves, the Company is projecting
that $1,245 million of coverage limits of the Excess of Loss Reinsurance
Agreement will be exhausted, and due to these projected future recoveries,
loss reserves with a net present value of $445 million were recorded as of
September 30, 1996 as a recoverable from the Excess of Loss Reinsurance
Agreement, including an additional $30 million during 1996. The $30 million
increase represents the estimated present value of cash flows relating to
adjustments to Asbestos/Pollution Policies and assumed reinsurance
business.
Beginning June 1996, as discussed in note 6, Home Insurance is
withholding rent and tax payments to its Landlord. Amounts withheld for
rent of approximately $3 million per month, are being accrued pending
resolution of litigation. Home Insurance was required to deposit in escrow
with a court appointed receiver approximately $7.4 million covering base
rent for the months of June and July of 1996 and a June tax payment.
Home Insurance
Following the closing of the Recapitalization, Home Insurance has
generally ceased accepting business except as required by regulation or
contractual obligations. As a result, payment of future claims and
operating expenses would be met by primarily earning investment income,
collection of premiums receivable and reinsurance receivables, collection
of the Portfolio Swap Receivable and sales of assets. At September 30,
1996, the Portfolio Swap Receivable of $1,391 million was available to
provide for any foreseeable immediate cash requirements.
Cash used for insurance operating activities was $807 million for the
nine months ended September 30, 1996 compared with $856 million in the 1995
period. The cash used for operating activities in 1996 was due primarily to
lower premiums collections resulting from the run-off of operations, and
1995 was impacted by low premium collections and payments for the Excess of
Loss Reinsurance Agreement. Cash used for operating activities was funded
primarily from sales of fixed maturities, underlying the Swap.
Home Insurance's statutory surplus at September 30, 1996 was $191 million
compared with $230 million at December 31, 1995. The remaining amount of
coverage in the Excess of Loss Reinsurance Agreement is $55 million on an
undiscounted statutory basis.
The Company's loss reserves are determined through a process of
estimation which is necessarily imperfect, and ultimate losses may exceed
such estimates. See note 3 of the Company's Annual Report for further
discussion. As the Company's statutory surplus levels have continued to
decline since December 31, 1995, management can give no assurance
27
<PAGE> 29
HOME HOLDINGS INC.
that statutory surplus levels will be sufficient to absorb materially
deficient estimates of loss and loss adjustment expense reserves, if any.
Management continues to believe that its provision for loss reserves is
adequate, and the Company is currently performing its standard
comprehensive review of reserves in order to further evaluate adequacy of
its reserve estimates.
The New Hampshire Department also continues to direct a consulting
actuarial firm to perform a review of Home Insurance's loss reserves, and
has retained a second actuarial firm to perform a peer review of the
findings. Such reviews are expected to be completed by the first quarter of
1997. Management cannot predict whether reserve estimates to be prepared by
these consultants, or by the Company as the result of its own reviews, will
change either management's or the New Hampshire Department's view of
oversight or regulatory intervention required for Home Insurance.
Sterling Forest Corporation ("Sterling Forest")
On May 15, 1996 an agreement in principle was announced for the sale of a
substantial part of Sterling Forest lands for public parkland. A letter of
intent between Sterling Forest, as seller, and Trust for Public Land and
Open Space Institute, as purchaser, was later signed and contract
preparation is underway. Under the terms of the agreement, more than 15,000
acres will be acquired as parkland, at a total acquisition cost of $55
million, and Sterling Forest will continue to own approximately 2,220 acres
of land and existing improvements, for future development. There is no
accounting recognition of the sale in the financial statements until the
transaction is consummated, however, no material impact on net income is
anticipated upon consummation.
Securities Broker-Dealer
Certain minimum amounts of capital must be maintained by Gruntal's
broker-dealer subsidiaries to satisfy the requirements of the Uniform Net
Capital Rule (Rule 15c3-1) of the Commission and the capital rules of other
regulatory authorities. At September 30, 1996, Gruntal & Co.'s net capital
as defined by the Commission and other regulatory authorities was $126
million, which was $106 million in excess of the aggregate minimum
required.
28
<PAGE> 30
HOME HOLDINGS INC.
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
None.
29
<PAGE> 31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HOME HOLDINGS INC.
By: /s/ RICHARD H. HERSHMAN
-----------------------------------------
November 14, 1996 Richard H. Hershman
Treasurer
(Principal Financial and Accounting Officer
through the Services Agreement with
Risk Enterprise Management Limited)
30
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