<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, 1997
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, 1997, 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
------------------ ------------------
1997 1996 1997 1996
----- ----- ----- -----
<S> <C> <C> <C> <C>
Revenues:
Net earned premiums (note 3) $ 3 $ 13 $ 11 $ 126
Insurance net investment income 21 34 73 115
Insurance realized capital gains (loss) -- -- (1) 10
Securities broker-dealer operations -- 91 -- 330
----- ----- ----- -----
Total revenues 24 138 83 581
----- ----- ----- -----
Operating expenses:
Losses and loss adjustment expenses (note 3) -- 68 (174) 259
Policy acquisition and other insurance expenses 10 32 48 113
Corporate interest expense 14 13 40 37
Securities broker-dealer operations -- 89 -- 309
----- ----- ----- -----
Total expenses 24 202 (86) 718
----- ----- ----- -----
Income before equity in income (loss) of
securities broker-dealer and income taxes -- (64) 169 (137)
Equity in income (loss) of securities broker-dealer 3 -- 2 --
----- ----- ----- -----
Income (loss) before income taxes 3 (64) 171 (137)
Income tax expense (1) -- (1) (2)
----- ----- ----- -----
Net income (loss) $ 2 $ (64) $ 170 $(139)
===== ===== ===== =====
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE> 3
HOME HOLDINGS INC.
Consolidated Balance Sheets
($ millions)
<TABLE>
<CAPTION>
September 30, December 31,
Assets 1997 1996
------- -------
(Unaudited)
<S> <C> <C>
Insurance investments at fair value:
Portfolio swap receivable (note 6) $ 672 $ 1,243
Fixed maturities available for sale
(cost $26 and $26) 27 28
Equity securities (cost $15 and $17) 25 21
------- -------
Total insurance investments 724 1,292
Cash 20 36
Premiums receivable 255 290
Funds held by affiliate 211 248
Reinsurance receivables 2,581 2,765
Securities broker-dealer investments -- 392
Receivables from brokers, dealers and customers -- 2,258
Investment in securities broker-dealer (note 7) 160 --
Other assets 207 312
------- -------
Total assets $ 4,158 $ 7,593
======= =======
Liabilities and Stockholders' Deficiency
Liabilities:
Unpaid losses and loss adjustment expenses $ 4,690 $ 5,687
Payables to brokers, dealers and customers -- 2,060
Debt of securities broker-dealer -- 246
Corporate debt (note 5) 586 567
Other liabilities 246 572
------- -------
Total liabilities 5,522 9,132
------- -------
Litigation and contingencies (note 8)
Stockholders' deficiency: (note 4)
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 (2,150) (2,320)
Unrealized gains on insurance investments (note 6) 11 6
Unrealized currency translation adjustments (2) (2)
------- -------
Total stockholders' deficiency (1,364) (1,539)
------- -------
Total liabilities and stockholders' deficiency $ 4,158 $ 7,593
======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 4
HOME HOLDINGS INC.
Consolidated Statements of Cash Flows
Nine Months ended September 30,
(Unaudited)
($ millions)
<TABLE>
<CAPTION>
1997 1996
----- -----
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 170 $(139)
Adjustments to reconcile net loss to net cash
used for operating activities:
Insurance realized capital (gains) loss 1 (10)
Unpaid losses and loss adjustment expenses (996) (857)
Premiums and reinsurance receivables 220 291
Funds held by affiliate 37 5
Unearned premiums (5) (127)
Broker-dealer investments and receivables,
net of payables -- 158
Other (36) 30
----- -----
Net cash used for operating
activities (609) (649)
----- -----
Cash flows from investing activities:
Portfolio swap receivable 571 739
Sales of equity securities 1 16
Sales of fixed maturities 1 1
Other 1 (5)
----- -----
Net cash provided by investing
activities 574 751
----- -----
Cash flows from financing activities:
Increase in corporate debt 19 33
Decrease of debt of broker-dealer -- (64)
----- -----
Net cash provided by financing
activities 19 (31)
----- -----
Net increase (decrease) in cash (16) 71
Cash at beginning of period 36 34
----- -----
Cash at end of period $ 20 $ 105
===== =====
Supplemental disclosures of cash flow:
Corporate interest paid $ 12 $ 12
Broker-dealer interest paid $ -- $ 60
Income taxes paid (received) $ (3) $ 2
</TABLE>
See accompanying notes to consolidated financial statement
4
<PAGE> 5
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
1. General
Home Holdings Inc., a Delaware corporation (the "Company"), is a
holding company for its wholly-owned subsidiaries, The Home Insurance Company, a
New Hampshire corporation, and its insurance subsidiaries ("Home Insurance").
Home Insurance generally ceased writing new or renewal insurance on June 12,
1995 in connection with a recapitalization agreement (the "Recapitalization
Agreement" or the "Recapitalization") as defined in note 1b to the 1996 Annual
Report on Form 10-K ("Annual Report") filed with the Securities and Exchange
Commission (the "Commission"). Home Insurance also owns Home Financial Corp., a
holding company for a securities brokerage business, and Sterling Forest
Corporation, a property development business, which on June 27 was reorganized
as a limited liability company and changed its name to Sterling Forest LLC
("Sterling Forest"). See note 7 for discussion of the restructuring of Gruntal.
Order of Supervision
- - --------------------
On March 3, 1997, Home Insurance was placed under formal supervision by
the New Hampshire Insurance Department (the "Department"). The Department states
in its Order of Supervision (the "Order") that this action was taken in response
to Home Insurance's Risk-Based Capital ("RBC") report filed with the Department
which indicates that a mandatory control level event has occurred within the
meaning of New Hampshire Revised Statutes of Annotated 404-F:6 (a "Mandatory
Control Level Event"). The Order establishes that the Department will oversee
and supervise Home Insurance for the purpose of continuing and intensifying an
economic, actuarial and accounting review of the books, records and business
affairs of Home Insurance so as to determine what future actions may be
appropriate. The Order provides that Home Insurance may not take certain actions
without the prior approval of the Department, including, but not limited to:
i) Make any single claim payment in excess of $1 million except
under conditions specified therein.
ii) Make any payment to creditors or other persons in excess of
$500,000, except as set forth in clause (i) above.
iii) Make any single payment to cedents or reinsurers (a) in excess
of $250,000 or (b) out of the ordinary course of business, or
any commutation of any amount with any cedents or reinsurers.
iv) Release any obligation or collateral in excess of $500,000.
v) Materially change the terms of any contracts or enter into any
new contracts in excess of $500,000.
vi) Engage in any transactions with the Company, Risk Enterprise
Management Limited ("REM"), Zurich Home Investments Limited
("ZHI"), Zurich Insurance Company ("Zurich") or Trygg-Hansa AB
("Trygg-Hansa") or any subsidiaries, other affiliates or
agents of such entities.
5
<PAGE> 6
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
In addition, without limiting the general authority of the Department as set
forth above, the Department shall have the final authority to approve,
disapprove or control (including the power to direct) the following:
i) The initiation, settlement or withdrawal of any action,
dispute, arbitration, litigation, or proceeding of any kind
involving Home Insurance other than in the ordinary course of
business.
ii) The location and material terms of all banking, investment,
trust, deposit and custodial accounts for assets of Home
Insurance, including but not limited to reserves.
2. Accounting Policies
The Company follows the accounting policies set forth in the 1996
Annual Report. 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.
As a result of a reorganization, which closed on March 28, 1997,
between Gruntal and The 1880 Group LLC (the "Reorganization Agreement"), as
described in note 7, Home Insurance will report its investment in its securities
broker-dealer under the equity method of accounting in 1997. The 1997
consolidated statement of income reflects the equity in the income of the
securities broker-dealer as if the transaction was effective January 1, 1997.
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.
6
<PAGE> 7
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
3. Premiums and Losses
Premium and loss information for the third quarter and nine months
ended September 30, follows:
<TABLE>
<CAPTION>
Third Quarter Nine Months
------------------ ------------------
1997 1996 1997 1996
----- ----- ----- -----
($ millions)
<S> <C> <C> <C> <C>
Earned premiums:
Direct $ 1 $ 8 $ 9 $ 46
Assumed 2 6 2 122
Ceded -- (1) -- (42)
----- ----- ----- -----
Net $ 3 $ 13 $ 11 $ 126
===== ===== ===== =====
Losses and loss adjustment expenses:
Direct $ (1) $ 20 $ 24 $ 194
Assumed 2 38 (161) 116
Ceded (1) 10* (37) (51)*
----- ----- ----- -----
Net $ -- $ 68 $(174) $ 259
===== ===== ===== =====
</TABLE>
* During the third quarter of 1996, 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.
Settlement with National Council on Compensation Insurance ("NCCI")
- - -------------------------------------------------------------------
As discussed further in note 8, Home Insurance entered into an
agreement with NCCI, the National Workers' Compensation Reinsurance Pool ("the
Pool") and its participants to commute $228 million of undiscounted loss and
loss adjustment expense reserves and settle $43 million of losses payable to
NCCI for $60 million. The payment of $60 million was made by Home Insurance in
connection with the settlement in August 1997. The Company recognized a gain of
$174 million from the settlement based upon generally accepted accounting
principles, reported as a reduction to loss and loss adjustment expenses.
Included in the September 1997 statutory surplus is a benefit of $115 million
relating to the settlement with NCCI. The impact to statutory surplus of the
NCCI settlement reflects related adjustments to tabular and non-tabular
discount.
7
<PAGE> 8
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
Asbestos/Pollution Losses and Loss Adjustment Expenses
- - ------------------------------------------------------
The 1997 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 nil. The 1996
third quarter and nine months incurred loss and loss adjustment expenses for
Asbestos/Pollution Policies were $41 million for both periods. The 1997 third
quarter and nine months incurred loss for Asbestos/Pollution Policies reflected
$16 million and $39 million of paid losses, respectively, offset by decreases of
$16 million and $39 million, respectively, to unpaid losses and loss adjustment
expenses. 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
increase 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 the 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
8
<PAGE> 9
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
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 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, REM, 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 financial, legal and environmental engineering
expertise in negotiation with policyholders and reinsurers to find alternative
resolutions to claims in the environmental and mass tort areas. Management
believes that these organizational changes increase operational efficiency,
while assuring that Home Insurance takes a unified and consistent approach to
these claims. This division has also prepared an inventory of potential
exposures for Asbestos/Pollution Policies, which Home Insurance has utilized 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 and Stop Loss Treaty
- - ---------------------------------------------------------
In connection with the recapitalization 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
9
<PAGE> 10
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
anniversary of the Closing 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 reinsurers commence making payments under the Excess
of Loss Reinsurance Agreement. See the 1996 Annual Report - note 4 to the
consolidated financial statements for discussion of dividend restrictions. Also,
up to $290 million of additional coverage provided by the Excess of Loss
Reinsurance Agreement is linked to certain factors including dividend payments
from Home Insurance to the Company funding principal payments on the Public
Indebtedness as such debts become payable. The Excess of Loss Reinsurance
Agreement became effective on June 12, 1995 upon (i) the payment by Home
Insurance to Centre Reinsurance Dublin of $63 million and (ii) the transfer by
Home Insurance of $166 million to Centre Reinsurance Dublin, representing the
respective amounts received by Home Insurance from Zurich International
(Bermuda) Ltd. and Centre Reinsurance Limited as a reinsurance commutation
(exclusive of refunds of security costs). In 1996 an additional $43 million was
transferred to Centre Reinsurance Dublin, representing the amount received by
Home Insurance from Trygg-Hansa Insurance Company Limited, a subsidiary of
Trygg-Hansa, as a reinsurance commutation.
Based on cash flow forecasts at December 31, 1996, the Company is
projecting that the coverage limits of the Excess of Loss Reinsurance Agreement
will be exhausted. Due to these projected future recoveries, loss reserves with
a net present value of $787 million were recorded as of September 30, 1997 and
December 31, 1996 as a recoverable from the Excess of Loss Reinsurance
Agreement.
4. Liquidity and Statutory Surplus
Dividend Restrictions and Liquidity
- - -----------------------------------
The Company did not receive common stock dividends from Home Insurance
in 1996 and during the first six months of 1997. On July 14, 1997, the Company
received an $11.7 million dividend from Home Insurance for the purpose of
funding the payment of interest by the Company on its Public Indebtedness due
June 15, 1997, plus 29 days interest thereon. As discussed in note 3, the
dividend will have no effect on Home Insurance's statutory surplus, as it
increases the aggregate limit of the Excess of Loss Reinsurance Agreement.
The Company was notified in 1995 by the Department that, in light of
the Recapitalization, Home Insurance cannot pay any dividends without prior
approval of the Department. If the Department rejects future dividends filings,
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. Based on the Company's most current cash flow projections, without
dividends from Home Insurance, the Company will not meet its cash flow needs
during 1997. Under the terms of the Recapitalization Agreement, Centre Finance
Dublin ("Centre Finance")
10
<PAGE> 11
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
has purchased approximately $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.
Statutory Surplus
The accounting practices of insurance companies are prescribed or
permitted by certain regulatory authorities. Certain of these practices differ
from generally accepted accounting principles ("GAAP") used in preparing the
consolidated financial statements of the Company. The Department gave Home
Insurance permission to include in the 1996 Statutory Annual Statement a
non-tabular discount which results from discounting all loss reserves, and
allocated and unallocated loss adjustment expense reserves at 7%. Home Insurance
has sufficient assets that will earn 7% to meet the expected stream of loss and
loss adjustment expense payments. Home Insurance calculated that the non-tabular
discount is $314 million and $469 million at September 30, 1997 and December 31,
1996, respectively. The non-tabular discount is not included in the Company's
consolidated financial statements prepared under GAAP. Home Insurance's
consolidated policyholders' surplus determined in accordance with statutory
practices, and after reflecting the benefit of non-tabular discount, was $101
million at September 30, 1997 compared with $55 million at December 31, 1996.
Included in the September 1997 statutory surplus is a benefit of $115 million
relating to the settlement with NCCI (see note 3). The impact to statutory
surplus of the NCCI settlement reflects related adjustments to tabular and
non-tabular discount.
On March 3, 1997, Home Insurance was placed under formal supervision by
the Department. The Department states in its Order that this action was taken in
response to Home Insurance's RBC report filed with the Department, as discussed
below, which indicates that a Mandatory Control Level Event has occurred. The
Order establishes that the Department will oversee and supervise Home Insurance
for the purpose of continuing and intensifying an economic, actuarial and
accounting review of the books, records and business affairs of Home Insurance
so as to determine what future actions may be appropriate. The Order also
provides that Home Insurance may not take certain actions without the prior
approval of the Department, including, among other matters, payment of claims
and other obligations within certain dollar limits, and changes in the terms and
conditions of certain existing contracts and entering into of certain new
contracts.
In connection with the Department's involvement in approving the
Recapitalization, it had appointed in 1995, 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 REM.
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 for further discussion. Management can give no assurance
that statutory surplus levels will be sufficient to absorb materially deficient
estimates of loss and loss adjustment expenses
11
<PAGE> 12
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
reserves, if any. Management continues to believe that its provision for loss
reserves is adequate.
The Department also continues to direct a consulting actuarial firm to
perform a review of Home Insurance's loss reserves, and the completion date has
not yet been determined. Management cannot predict whether reserve estimates to
be prepared by the consultants will change the Department's view of the level of
regulatory intervention required for Home Insurance.
5. Corporate Debt
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
---- ----
($ millions)
<S> <C> <C>
7% Senior Notes due in 1998, net of
unamortized discount of nil in 1997
and 1996 $100 $100
7 7/8% Senior Notes due in 2003, net of
unamortized discount of $1 million in 1997
and $2 million 1996 178 177
7 7/8% Senior Notes due in 2003, net of
unamortized discount of nil in 1997 and 1996 1 1
12% Senior Subordinated Notes, issued at
original issue discount, $303 million
principal value due in 2004 129 118
8% Junior Subordinated Notes, issued at
original issue discount, $171 million
principal value due in 2004 96 91
12% Senior Subordinated Working Capital
Notes, issued at original issue discount,
$46 million principal value due in 2004 20 18
7% Series A Senior Working Capital Notes 16 16
7% Series B Senior Working Capital Notes 46 46
---- ----
Total Corporate Debt $586 $567
==== ====
</TABLE>
During 1995 and 1996, the Company issued to Centre Finance
approximately $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. The principal on these notes is due on
the successive one year anniversaries of the Closing date; however, the date can
be extended for annual periods at the option of
12
<PAGE> 13
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
either Centre Finance or the Company until December 15, 2003. The Company
elected in 1997 to extend the due date until June of 1998.
In addition, effective December 31, 1996, each of the Series A and
Series B Senior Working Capital Notes, was amended to change the timing of the
payment of interest. Prior to such amendment, interest was payable quarterly.
However, according to the amended terms, interest shall not be due or payable
until seven business days following the receipt by the Company of written demand
from holders of these notes, or when the principal of the Series A and Series B
Senior Working Capital Notes becomes due and payable. If interest is not paid
within seven business days of such written demand, all interest accrued shall be
deemed overdue and shall immediately become due and payable. If interest becomes
overdue, 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%. As of September
30, 1997, approximately $7 million of interest has been accrued but not paid on
the Series A and Series B Senior Working Capital Notes. As a result of the
amended terms, the interest is not overdue.
Neither Centre Finance nor Zurich nor Trygg-Hansa has 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, Zurich and Trygg-Hansa 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.
6. Portfolio Swap Receivable and Other Insurance Investments
The Portfolio Value Swap Agreement (the "Swap") is 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 underlying 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 underlying the Swap to a Portfolio Swap 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%. Subsequent
changes to fair value of securities have not and will not be recognized, as
Centre Reinsurance Dublin bears the market risk.
As of September 30, 1997, the Company has recorded, as a component of
the Portfolio Swap Receivable, an amount due to Centre Reinsurance Dublin of $1
million because of a positive difference from the 7.5% target return. The
positive difference since January 1, 1997 resulted from the net of (i) a $7
million difference unfavorable to the Company due to an increase in the fair
value of investments underlying the Swap and (ii) a $6 million difference in
favor of the Company for investment income representing an upward
13
<PAGE> 14
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
adjustment to reach the 7.5% target yield. Actual investment income before such
adjustments was $67 million.
The Company received $48 million from Centre Reinsurance Dublin on
January 21, 1997, to settle the 1996 Swap receivable. Securities and cash
totaling $210 million were transferred to Centre Reinsurance Dublin on January
22, 1996, to settle the 1995 Swap liability.
The fair value of securities managed by Zurich Investment Management
Inc. ("ZIM") and underlying the Portfolio Swap Receivable from Centre
Reinsurance Dublin as of September 30, 1997 is as follows:
<TABLE>
<CAPTION>
Estimated
Fair
Value
-----
($ millions)
<S> <C>
Fixed Maturities:
U.S. Government and agency $ 281
Mortgage-backed securities 93
Corporate securities 203
Foreign governments 40
Other 1
-----
Total 618
Equity securities 1
Short-term investments 54
-----
Total Swap investments 673
Payable to Centre Reinsurance Dublin (1)
-----
Portfolio Swap Receivable $ 672
=====
</TABLE>
7. Securities Broker-Dealer
On February 24, 1997, Gruntal Financial Corp. ("Gruntal"), and The 1880
Group LLC, a limited liability company organized under the laws of Delaware,
("The 1880 Group"), entered into the Reorganization Agreement. The Gruntal
reorganization was consummated on March 28, 1997. The reorganization resulted in
Gruntal transferring its securities broker-dealer operating companies, Gruntal &
Co. and The GMS Group, to a newly formed limited liability company, Gruntal
Financial, LLC ("Gruntal Financial"). In connection with the
14
<PAGE> 15
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
reorganization, Gruntal changed its name to Home Financial Corp. ("Home
Financial") on April 1, 1997. Home Insurance is the sole owner of Home
Financial.
The Reorganization involved the issuance of several classes of
securities to Home Financial and The 1880 Group, including preferred securities,
in an aggregate nominal amount of $235 million as follows: (i) Gruntal Financial
issued to Home Financial securities called Preferred A Interests in a nominal
amount of $155.9 million and securities called Preferred B Interests in a
nominal amount of $70 million; and (ii) Gruntal Financial issued to The 1880
Group securities called Preferred C Interests in a nominal amount of $9 million.
The nominal amount of the Preferred A Interest was adjusted from the amount
previously disclosed of $155.5 million to reflect actual March 1997 results and
final transaction expenses. As a result of the Reorganization, Home Financial
owns 40% of the common interest of Gruntal Financial and The 1880 Group owns 60%
of the common interest of Gruntal Financial. In connection with the issuance of
certain preferred securities to Home Financial, Home Insurance and Centre
Reinsurance Dublin entered into a swap agreement intended to ensure that Home
Insurance's investment in Gruntal Financial yields at least $155.9 million plus
a 7.5% per annum rate of return thereon, subject to certain modifications with
respect to certain distributions and sales proceeds of the common and preferred
interests of Gruntal Financial. The Company accrued $8 million of income from
the swap during the second and third quarters of 1997. Expenses incurred by
Gruntal in connection with the transaction were $9 million. There was no gain or
loss to Home Insurance from the Reorganization after the impact to Gruntal of
the transaction expenses.
In connection with the Reorganization, the members of The 1880 Group
entered into management services agreements with The 1880 Group which, in turn,
will provide such services to Gruntal Financial.
15
<PAGE> 16
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
Summarized financial information of Gruntal Financial for the third quarter and
nine months ended September 30 is set forth in the following tables:
<TABLE>
<CAPTION>
Third Quarter Nine Months
------------------ ------------------
1997 1996 1997 1996
----- ----- ----- -----
($ millions)
<S> <C> <C> <C> <C>
Summarized Income Statement
Commissions $ 27 $ 18 $ 73 $ 69
Principal transactions 36 25 101 117
Underwriting and investment banking 11 9 29 27
Interest 34 31 97 91
Other 8 8 24 26
----- ----- ----- -----
Total revenues 116 91 324 330
Total expenses (113) (89) (330) (309)
----- ----- ----- -----
Income (loss) before income taxes 3 2 (6) 21
----- ----- ----- -----
Income from swap agreement -- -- 8 --
----- ----- ----- -----
Total income (loss) from broker-dealer $ 3 $ 2 $ 2 $ 21
===== ===== ===== =====
</TABLE>
Summarized Balance Sheet
<TABLE>
<CAPTION>
September 30,
1997
<S> <C>
Cash $ --
Investments 483
Receivables from brokers, dealers and customers 2,340
Total assets 2,933
Payables to brokers, dealers and customers 2,099
Debt 308
Total liabilities 2,781
Stockholders' equity 152
</TABLE>
16
<PAGE> 17
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
8. 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.
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.
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.
Pursuant to the Order, the Department has the final authority to
approve, disapprove or otherwise control (including the power to direct) the
initiation, settlement or withdrawal of any action, dispute, arbitration,
litigation or proceeding of any kind involving Home Insurance other than in the
ordinary course of business. In addition, pursuant to the Order, Home Insurance
is prohibited from making certain payments, as specified in the Order, without
the prior approval of the Department.
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 sought certification of both plaintiff and defendant
classes. The purported plaintiff class consisted 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 sought 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
("NCCI"). The Complaint alleged 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
17
<PAGE> 18
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
Deceptive Trade Practices Act. Compensatory and punitive damages were sought in
unspecified amounts plus treble damages.
A settlement between fourteen of the primary defendants, including Home
Insurance, was reached. Home Insurance 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. Final orders of approval were issued by the court
on November 1, 1996. The settlement is being implemented through distributions
to insureds and refunds to insurers, which is ongoing.
On January 13, 1997 Home Insurance was served with suit papers issued
from the Chancery Court of Davidson County, Tennessee in a purported class
action. The allegations of the complaint are similar to those in the Texas
litigation case that was recently settled.
Plaintiffs allege that from 1987 until the present, the defendants,
individually, and in conspiracy with each other, used rates of premium and
policy forms for workers compensation retro policies other than those filed
with, and approved by, the Tennessee Commissioner of Insurance. Specifically,
the companies are alleged to have illegally passed through residual market
changes to their insureds during the class period. NCCI is alleged to be the
conduit for sharing of information and the instrumentality for making the
illegal filings.
The principal causes of action are for breach of contract, fraud,
misrepresentation, conspiracy, unjust enrichment, and violation of the Tennessee
Consumer Protection and Trade Practices Acts. Compensatory and punitive damages
are sought in unspecified amounts plus treble damages. The action was removed to
federal court. Motions to remand the actions to state court and add 150
defendants are pending.
A class action complaint naming the same party plaintiffs was filed in
the Superior Court of Richmond Country, Georgia. It includes the same common law
causes of action that are asserted in the Tennessee complaint, and others that
allege violation of various provisions of the Georgia statutory code, as well as
RICO. Compensatory, punitive, and treble damages are sought. The court recently
granted plaintiffs' motion to add 150 defendants to the action, and remanded the
case to state court.
With respect to the Tennessee and Georgia actions discussed above, it
is too early to predict the outcome of these actions and whether or not they
will have a material adverse impact on the Company's financial condition.
An action was recently instituted in the Massachusetts Superior Court,
Suffolk County by Service of a Verified Complaint and preliminary Injunction
papers seeking to have Home Insurance immediately: 1) pay $756,961.53 to the
Massachusetts Workers' Compensation Assigned Risk Pool ("Assigned Risk Pool"),
as its billed but unpaid assessment for the Fourth Quarter of 1996, 2) deposit
$17,854,205.30 in past premium payments from the Assigned
18
<PAGE> 19
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
Risk Pool to Home Insurance into an escrow fund, to be held in trust to cover
Home Insurance's obligations for losses and expenses as they become due and
owing.
The complaint alleges that the Assigned Risk Pool, established under
G.L.c Section 152 65A, is subject to supervision by the Massachusetts Insurance
Commissioner, who has designated the Workers Compensation Rating Bureau ("WCRB")
as administrator. It is further alleged that the WCRB and the Insurance
Commissioner both previously directed the defendants to pay all outstanding
amounts, and to pay the remainder of all prior premium payments to Home
Insurance into a trust account for the benefit of the Assigned Risk Pool. The
complaint contains four counts asserting statutory violations, unjust
enrichment, declaratory relief, and breach of fiduciary obligation.
On June 20, 1997, Justice Peter Lauriat of the Massachusetts Superior
Court denied plaintiff's Motion for a Preliminary Injunction. Plaintiffs' Motion
for Reconsideration was denied. Plaintiffs' Petition for Interlocutory Relief to
the Appeals Court seeking reversal of the denial of plaintiffs' prior requests
for relief was denied. Plaintiffs have sent a letter to the Insurance
Commissioner of the State of Massachusetts requesting that she initiate an
administrative proceeding against the defendants. Home Insurance has filed a
Motion to Dismiss the complaint for failure to exhaust administrative remedies.
Management believes it is too early to predict the ultimate outcome of this
action and whether an unfavorable outcome will have a material adverse impact on
the Company's financial condition.
A Petition in Intervention has been filed by Sandwich Chef of Texas,
Inc. in its own right and on behalf of others similarly situated, against its
insurer, Reliance Insurance Company, and dozens of insurance companies,
including Home Insurance, that are alleged to be members of the Texas Workers'
Compensation Insurance Facility ("TWCIF"). The purported class action seeks to
have a surplus in the amount of $467 million that was returned by the TWCIF to
its member insurance companies for the 1992-1994 years, refunded to the members'
respective retro insureds.
The TWCIF is alleged to be an unincorporated association of insurers
that served as the Texas workers' compensation insurer of last resort from
January 1, 1991 through December 31, 1993 for employers unable to obtain
coverage in the voluntary market. It is alleged that the Texas Department of
Insurance ("TDI") was required to establish an appropriate pass through
allowance so that each retro rated risk written during the calendar year would
get a proportion of any assessment or rebate made by the TWCIF to its member
companies. The Petition seeks a declaratory judgment and formation of a
constructive trust against Reliance and the insurer defendants, and asserts
antitrust and tortious interference claims against them.
By order of the Texas Insurance Commissioner, Elton Bomer, effective
August 6, 1997 rules were issued directing insurers to refund $272 million in
premium to Texas employers who purchased retro workers' compensation insurance
policies with effective dates between May 1, 1991 through December 31, 1994.
Insurers have 6 months from the effective date to make the refunds based on
surpluses received since 1991.
19
<PAGE> 20
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
Numerous insurance companies thereafter filed a new lawsuit in the
District Court of Travis County, Texas against the TDI and the Commissioner
challenging the new rules insofar as they apply to the 1991 and 1992 policy
years. The two actions have been consolidated. A Motion for a Temporary
Injunction prohibiting the TDI from enforcing the rules is pending. Class
certification hearings have been scheduled. Pre-hearing discovery is being
conducted. Motions to Dismiss the class action claims on jurisdictional grounds
are to be filed. Management believes it is too early to predict with certainty
the ultimate outcome of this dispute, and whether an unfavorable outcome could
have a material adverse impact on the Company's financial condition.
A purported class action complaint has been filed in the U.S. District
Court for the Southern District of Miami against dozens of insurance companies,
including Home Insurance, and the NCCI seeking redress for an alleged wrongful
scheme, combination and conspiracy perpetrated by the defendants in the sale of
retrospectively rated workers' compensation policies. The representative class
plaintiffs are alleged to be insureds of AIG, CIGNA, CNA and Hartford companies.
The class action is brought on behalf of all persons who purchased or renewed
retrospective workers' compensation policies from the insurer defendants from
January 1, 1988 until the present, covering risks located in Florida.
The defendants are alleged to have conspired with each other to charge
unlawful fees, charges and assessments that varied from filings made and
approved by the Insurance Commissioner. Specifically, the defendants are alleged
to have illegally charged their insureds for their own residual market losses
through various means. The NCCI is alleged to be both the instrumentality for
the alleged scheme, and a direct participant in the illegal activity. The
complaint contains causes of action for violation of the Sherman Antitrust Act,
violation of the Florida antitrust statute, RICO counts, breach of contract,
civil conspiracy and unjust enrichment. It seeks compensatory, punitive, and
treble damages. Motions to dismiss the complaint for lack of standing and
subject matter jurisdiction are pending, along with motions to dismiss the
antitrust and fraudulent concealment counts. Management believes it is too early
to predict with certainty the ultimate outcome of this dispute, and whether an
unfavorable outcome could have a material adverse impact on the Company's
financial condition.
A purported class action complaint was recently served upon The Home
Insurance, dozens of other insurance companies, and NCCI. The action has been
filed in the Circuit Court of Cole County, State of Missouri.
The lawsuit has been instituted on behalf of approximately 10,000
Missouri employers who purchased workers' compensation insurance in Missouri
between September 1, 1991 through December 31, 1993. No individual member of the
class is alleged to have a claim in excess of $75,000.
The Missouri Department of Insurance issued an order on August 1, 1991
effective September 1, 1991 under which two components of rate increases could
be assessed against employers, i.e., an overall base rate increase, and a swing
limit that permitted
20
<PAGE> 21
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
increases or decreases off of the base rate. It is alleged that during the
relevant time, the defendants did not assess the swing limit correctly and the
employers, as a class, were overcharged premiums as a result. Inflated premiums
were alleged to have been paid throughout 1992 and 1993.
NCCI is alleged to have been responsible for setting premium rates and
ensuring that premiums were correctly applied by the carriers. NCCI filed a set
of revised rates and rating values in response to the Missouri Department of
Insurance order of August 1, 1991 that allegedly exceeded the permitted
increases. The defendant insurers are alleged to have (i) followed NCCI's rates
and (ii) charged amounts that exceeded NCCI's filings.
The complaint sets forth counts for breach of contract, intentional
misrepresentation, and negligent administration of the rates against NCCI.
Compensatory damages, interest, and costs are sought. Management believes it is
too early to predict with certainty the ultimate outcome of this dispute, and
whether an unfavorable outcome could have material adverse impact on the
Company's financial conditions.
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 to pay federal income tax and interest
assessments for the 1987 tax year for which Home Insurance is severally liable
and for the
21
<PAGE> 22
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
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 or otherwise 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.
Following a hearing set on July 1, 1997, the Court issued an Order and
Judgment and Decision and Order, both dated July 2, 1997 granting judgment in
the sum of $18,795,262.33 against Home Insurance and in favor or O & Y Maiden,
together with statutory interest (9%) per annum from September 1, 1996, and
providing for the deposit of certain additional rent payments with the
court-appointed Temporary Receiver of Rents . The Court continued to stay entry
until July 7, 1997.
On July 7, 1997, Home Insurance filed a Notice of Motion for a stay of
the judgment or for an injunction against enforcement of the judgment or an
attachment of any assets executed upon and for a preference in the hearing of
the appeal with the Supreme Court of the State of New York, Appellate Division,
First Department. On that day, the Appellate Division ordered the stay to be
continued pending a decision on the motion. On July 24, 1997, the Appellate
Division denied Home Insurance's motion, but continued the stay for ten days
until August 4, 1997.
22
<PAGE> 23
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
Home Insurance has entered into an agreement in principle to settle the
litigation under which Home Insurance's prior rent obligation will be reduced by
at least $44 million, and Home Insurance will be allowed to retain a reduced
amount of space at 59 Maiden Lane at a lower rental rate. The settlement is
subject to approval by O & Y Maiden's bondholders and the Department. While the
settlement agreement is being negotiated, the partners have entered into a
series of standstill agreements providing that the judgment will not be
executed upon.
On or about January 17, 1997, Marine Midland (the trustee in the action
described above), brought an action entitled Marine Midland Bank v. Zurich
Insurance Company, et al. in New York State Supreme Court against Zurich and
certain affiliates, Home Insurance and REM alleging, among other things, that
the conveyance to Zurich of the right to write renewal business on policies of
Home Insurance constituted a fraudulent transfer under New York State law
because Home Insurance purportedly was rendered insolvent as a result and did
not receive adequate consideration from Zurich for this right. Plaintiff in its
complaint disregards that the transaction, which permitted the conveyance of
this right to Zurich, was approved by the Department in April 1995. The
complaint, which does not seek any relief against Home Insurance, demands
judgment against Zurich and certain of its affiliates for all past and future
rent due under the lease between Home Insurance and its landlord, not paid by
Home Insurance, plus interest, or alternatively, for the imposition of a
constructive trust upon the proceeds obtained by Zurich from the conveyance
noted above, which according to plaintiff would secure the repayment of Home
Insurance's purported obligations under its lease, as well as attorneys' fees.
The complaint also seeks from REM damages in the amount of all rents due and
owing under the lease plus interest, as well as, a declaration that REM is
obligated to make all future rent payments. On March 27, 1997, Zurich, REM and
Home Insurance moved to dismiss the complaint. Marine Midland Bank served its
responsive papers on May 9, 1997. Management believes that it is too early to
predict with certainty the ultimate outcome of this dispute.
Home Insurance was involved in a dispute with NCCI as administrator of
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. 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 was a participant in the Pool, and, as of March 31,
1997, Home Insurance was carrying loss reserves, calculated on an undiscounted
basis, of approximately $251 million allocated to the Pool. On May 6, 1997, Home
Insurance received notice from NCCI that the Pool's invoices totaling
$35,324,555 were due and unpaid and that the Board of Governors of the Pool had
voted on April 28, 1997 to approve (i) NCCI's determination that Home
Insurance's allocable share of outstanding reserve obligations to the Pool was
$236,237,269 and (ii) the acceleration of such amount. On May 7, 1997, Home
Insurance received from NCCI a demand that Home Insurance obtain a letter of
credit to secure this alleged obligation to the Pool of $271,561,824.
Home Insurance disputed the extent of its obligations to the Pool, and
believed that it had meaningful legal defenses to both the acceleration and the
demand for security. In addition, Home Insurance had on several occasions
demanded an audit to determine the
23
<PAGE> 24
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
actual amount of its obligation. Home Insurance's demands for an audit were
refused. On June 4, 1997, the NCCI served its Summons and Complaint upon Home
Insurance, seeking to recover the total amount alleged to be due and owing. On
August 8, 1997, Home Insurance, NCCI, the Pool and its participants entered into
an agreement to settle and release all of Home Insurance's obligations in
connection with this dispute pursuant to which Home Insurance made a payment of
$60 million, resulting in a statutory surplus benefit to Home Insurance of $115
million.
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 $9 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's 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 determined by an
independent consultant acceptable to the Commission (identified below) to have
been financially harmed by Gruntal's OTC execution and reporting practices. 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
vs. Gruntal & Co., Incorporated, et al., 96 Civ. 2514, James R. Doty, Esq., a
partner in the law firm of Baker and Botts, LLP and a former General Counsel of
the Commission, was engaged to serve as Fund Administrator (hereinafter, the
"Fund Administrator"). The disgorgement fund is being administered and disbursed
by the Fund Administrator pursuant to the Report of the Fund Administrator, the
Fund Administrator's Conclusions and Recommendations and the Proposed Plan of
Distribution dated October, 1997 which was submitted to the Commission and the
United States District Court, Southern District of New York, for approval. A
hearing has been scheduled. 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.
24
<PAGE> 25
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
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 has reviewed Gruntal's operating policies and
procedures with respect to the operations and OTC areas and has made
recommendations which Gruntal is in the process of implementing. In performing
these reviews, the Fund Administrator and Independent Consultant were 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 has also reviewed 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 has made recommendations which Gruntal is
in the process of implementing. In performing this review, the Independent
Consultant was 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.
25
<PAGE> 26
HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
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 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 North American Securities
Administrators Association ("NASAA"), a national association of state securities
regulators, and the Commodity Futures Trading Commission ("the CFTC"). After
completing its review, a NASAA task force reported that measures taken by
Gruntal and addressed by prior regulatory orders should ensure that customers
will be made whole for any losses and made further recommendations which are
presently being reviewed by Gruntal. The CFTC is also presently reviewing the
above matters and has commenced discussions with Gruntal which could result in
additional sanctions by the CFTC. These matters could also result in additional
investigations and proceedings by 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 sanctions against Gruntal would not have a
materially adverse effect on the consolidated financial condition of Gruntal or
the Company.
26
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HOME HOLDINGS INC.
Notes to Consolidated Financial Statements
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, but management does not believe that such costs
will have a material adverse effect on the financial position of Gruntal or the
Company.
REM's service agreement with the Company provides that REM will receive
a contingent fee amounting to 15% in excess of its actual costs, accumulating
with interest, as follows: 100% of the annual amounts for the years 1995 through
2000 and 33% of the amounts from years 2000 until 2005, payable on and after
2005. The fee is payable by Home Insurance contingent upon prior approval of the
Department. Based on the issuance of the Order, and based on projections that
the Excess of Loss Reinsurance Agreement will be fully exhausted, the payment of
such fees is considered remote and therefore has not been accrued in the
consolidated financial statements. The contingent liability as of September 30,
1997 was $48 million.
9. Subsequent Event
The Board of Directors has been advised by ZHI, one of the Company's principal
shareholders, that ZHI has been having negotiations with an unofficial
committee of holders of the Public Indebtedness in connection with a
contemplated reorganization of the Company. ZHI and Trygg-Hansa the other
principal shareholder, have also been having negotiations on issues relating to
the contemplated reorganization. The Company, while not a party to either
negotiations, has been informed by ZHI and Trygg-Hansa, about these
negotiations. No final proposal for a reorganization has been presented to the
Company and its Board of Directors for consideration, and accordingly,
management cannot predict the outcome of these negotiations nor whether or when
a final proposal will be made to the Company by its principal shareholders and
the unofficial committee of holders of the Public Indebtedness.
27
<PAGE> 28
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.
Insurance revenues were $ 24 million and $83 million in the third
quarter and nine months ended September 30, 1997, respectively, compared with
$47 million and $251 million, in the same periods of 1996. Net income was $2
million and $170 million in the third quarter and nine months ended September
30, 1997, respectively, as compared to losses of $64 million and $139 million,
respectively, during the same periods in 1996. Net income for the nine months
ended September 30, 1997 includes a gain of $174 million from the settlement
with NCCI.
Insurance revenues and pre-tax income (loss) were as follows:
<TABLE>
<CAPTION>
Third Quarter Nine Months
------------------ ------------------
1997 1996 1997 1996
----- ----- ----- -----
($ millions)
<S> <C> <C> <C> <C>
Net earned premiums $ 3 $ 13 $ 11 $ 126
Net investment income 21 34 73 115
Realized capital gains (loss) -- -- (1) 10
----- ----- ----- -----
Insurance revenues $ 24 $ 47 $ 83 $ 251
===== ===== ===== =====
Underwriting income (loss) $ (7) $(117) $ 137 $(276)
Excess of Loss Reinsurance Agreement -- 30 -- 30
Net investment income 21 34 73 115
Realized capital gains (loss) -- -- (1) 10
----- ----- ----- -----
Insurance pre-tax income (loss) $ 14 $ (53) $ 209 $(121)
===== ===== ===== =====
</TABLE>
28
<PAGE> 29
HOME HOLDINGS INC.
Underwriting Results
In connection with the Recapitalization which closed on June 12, 1995,
Home Insurance ceased writing new and renewal business except for limited risks
that Home Insurance is obligated to continue writing for an interim period. All
Home Insurance operations are being run-off subsequent to June 12, 1995.
Underwriting results by product were as follows:
Underwriting Income (Loss)
<TABLE>
<CAPTION>
Third Quarter Nine Months
-------------------- --------------------
1997 1996 1997 1996
------ ------ ------ ------
($ millions)
<S> <C> <C> <C> <C>
Commercial casualty $ (7) $ (42) $ 152 $ (122)
Commercial property -- (2) (4) (44)
------ ------ ------ ------
Commercial accounts group (7) (44) 148 (166)
Professional liability -- (6) (4) (24)
Other specialty lines -- (3) (4) (11)
------ ------ ------ ------
Specialty lines group -- (9) (8) (35)
------ ------ ------ ------
Run-off operations -- (64) (3) (75)
------ ------ ------ ------
Total $ (7) $ (117) $ 137 $ (276)
====== ====== ====== ======
</TABLE>
Underwriting loss was $7 million in the third quarter and underwriting
income was $137 million in the nine months of 1997, compared to losses of $117
million and $276 million in the same periods of 1996. Underwriting results for
the nine months ended September 30, 1997 includes a gain of $174 million from
the settlement with NCCI, partially offset by general expenses incurred managing
the run-off. 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 commercial accounts group underwriting loss was $7 million in the
third quarter and underwriting income was $148 million in the nine months of
1997, compared with losses of $44 million and $166 million, respectively, in the
same periods of 1996. The 1997 loss included commercial casualty of $7 million
in the third quarter and underwriting income of $152 million in the nine months
compared to losses of $42 million and $122 million, respectively, in the same
periods of 1996. Commercial property losses of nil and $4 million in the third
quarter and nine months, respectively, were also included in the 1997
29
<PAGE> 30
HOME HOLDINGS INC.
underwriting loss compared with $2 million and $44 million for the same 1996
periods. The 1997 commercial accounts group income was primarily due to the gain
of $174 million from the settlement with NCCI, partially offset by general
expenses incurred in managing the run-off of its operations. The 1996 losses
were primarily due to lower earned premiums and expenses incurred in managing
the run-off of its operations.
The specialty lines group losses were nil and $8 million in the third
quarter and nine months of 1997, respectively, compared with $9 million and $35
million, respectively, in the same periods of 1996. The 1997 specialty lines
group loss was due to general expenses incurred in managing the run-off of its
operations. The 1996 loss was primarily due to lower earned premiums and
expenses incurred in managing the run-off of its operations.
The run-off operations losses were nil and $3 million in the third
quarter and nine months of 1997, respectively, compared with $64 million and $75
million, respectively, in the same periods of 1996. Underwriting losses from
Asbestos/Pollution Policies for the third quarter and nine months of 1997 were
nil. Underwriting losses from Asbestos/Pollution Policies for the third quarter
and nine months of 1996 were $41 million for both periods. During the third
quarter of 1996, 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, in 1996, loss reserves relating to assumed reinsurance business
were increased $25 million, based on a reallocation of exposures by accident
year.
Investments
As of September 30, 1997, the Company has recorded, as a component of
the Portfolio Swap Receivable, an amount due to Centre Reinsurance Dublin of $1
million because of a positive difference from the 7.5% target return. The
positive difference since January 1, 1997 resulted from the net of (i) a $7
million difference unfavorable to the Company due to an increase in the fair
value of investments underlying the Swap and (ii) a $6 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 $67 million.
In the nine months ended September 30, 1997, the Company recorded a $5
million increase in unrealized gains on insurance equity investments not
underlying the Swap.
Other
Corporate interest expense was $14 million and $40 million in the third
quarter and nine months ended September 30, 1997, respectively, compared with
$13 million and $37 million, respectively, in the same periods of 1996.
Equity in the income of the securities broker-dealer was income of $3
million and $2 million in the third quarter and nine months ended September 30,
1997, respectively.
30
<PAGE> 31
HOME HOLDINGS INC.
The second quarter and nine months of 1997 included $8 million of income from
the swap. The gain for the nine months ended September 30, 1997 included $9
million of transaction expenses relating to the restructuring of Gruntal. See
note 7 of the consolidated financial statements for further discussion.
Income tax expense was $1 million in the third quarter and nine months
of 1997, respectively, compared with an expense of nil and $2 million,
respectively, in the same periods of 1996. Taxes in 1997 and 1996 were comprised
of state and foreign taxes. The Company was unable to recognize a federal income
tax benefit against its 1997 or 1996 pre-tax losses because there was no
available taxable income in the carryback period.
31
<PAGE> 32
HOME HOLDINGS INC.
FINANCIAL CONDITION
Consolidated
- - ------------
Following the Closing, 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 Department that, in light of the Recapitalization, Home
Insurance cannot pay any dividends without prior approval of the Department.
On March 3, 1997, Home Insurance was placed under formal supervision by
the Department. The Department states in its Order that this action was taken in
response to Home Insurance's RBC report filed with the Department which
indicates that a Mandatory Control Level Event has occurred. The Order
establishes that the Department will oversee and supervise Home Insurance for
the purpose of continuing and intensifying an economic, actuarial and accounting
review of the books, records and business affairs of Home Insurance so as to
determine what future actions may be appropriate. The Order also provides that
Home Insurance may not take certain actions without the prior approval of the
Department, including, among other matters, payment of claims and other
obligations within certain dollar limits, and changes in the terms and
conditions of certain existing contracts and entering into of certain new
contracts.
If the Department rejects future dividends filings, 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. Based on the Company's
most current cash flow projections, without dividends from Home Insurance, the
Company will not be able to meet its cash flow needs during the fourth quarter
of 1997, which includes an interest payment on the Public Indebtedness of $11.6
million due on December 15, 1997. On July 14, 1997, the Company received an
$11.7 million dividend from Home Insurance for the purpose of funding the
payment of interest by the Company on its Public Indebtedness due June 15, 1997,
plus 29 days interest thereon. As discussed in note 3 to the consolidated
financial statements, the dividend will have no effect on Home Insurance's
statutory surplus, as it increases the aggregate limit of the Excess of Loss
Reinsurance Agreement. Under the terms of the Recapitalization Agreement, Centre
Finance has purchased approximately $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.
To fund additional cash requirements incurred in connection with the
Equity Repurchase Transaction, as defined in note 1b to the 1996 Annual Report,
the Recapitalization and other extraordinary needs, Centre Finance and ZCI
purchased, in 1995 and 1996, $15 million principal amount of the Company's 12%
Senior Subordinated Working
32
<PAGE> 33
HOME HOLDINGS INC.
Capital Notes due and $16 million principal amount of the Company's 7% Series A
Senior Working Capital Notes.
Effective December 31, 1996, each of the Series A and Series B Senior
Working Capital Notes, was amended to change the timing of the payment of
interest. Prior to such amendment, interest was payable quarterly. However,
according to the amended terms, interest shall not be due or payable until seven
business days following the receipt by the Company of written demand from
holders of these notes, or when the principal of the Series A and Series B
Senior Working Capital Notes becomes due and payable. If interest is not paid
within seven business days of such written demand, all interest accrued shall be
deemed overdue and shall immediately become due and payable. If interest becomes
overdue, 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%. As of September
30, 1997, approximately $7 million of interest has been accrued but not paid on
the Series A and Series B Senior Working Capital Notes. As a result of the
amended terms, the interest is not overdue.
Neither Centre Finance nor Zurich nor Trygg-Hansa has 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, Zurich and Trygg-Hansa 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. Home Insurance
is subject to regulatory restrictions on the amount of dividends that must be
paid as described above. The Company did not receive any common stock dividends
from Home Insurance in 1996 and for the first six months of 1997. However, on
July 14, 1997, the Company received an $11.7 million dividend from Home
Insurance for the purpose of funding the payment of interest by the Company on
its Public Indebtedness, which dividend will have no effect on Home Insurance's
statutory surplus, as it increases the aggregate limit of the Excess of Loss
Reinsurance Agreement, as discussed below. Based on the Company's most current
cash flow projections, without dividends from Home Insurance, the Company will
not be able to meet its cash flow needs during the fourth quarter of 1997.
At September 30, 1997, the Company's outstanding corporate debt was
$586 million and, at December 31, 1996, was $567 million. As part of the
Recapitalization, Trygg-Hansa refinanced the sum of $178 million of indebtedness
outstanding under the Credit Agreement ($170 million) and the Interest Deferral
Agreement ($8 million). In exchange the Company issued $98 million of 12% Senior
Subordinated Notes, at original issue discount ($303 million principal value)
and $80 million of 8% Junior Subordinated Notes at original issue discount ($171
million principal value). The principal repayments under the Public Indebtedness
are $100 million in 1998 and $180 million in 2003. However the repayment of the
2003 Senior Notes have changed as a result of an exchange (see discussion
below). The Company
33
<PAGE> 34
HOME HOLDINGS INC.
would need to fund the required principal payments for the Public Indebtedness
through dividend income from Home Insurance.
Pursuant to the Bondholder Agreement, in exchange for the consent by
each Bondholder to the waivers and amendments to the indentures governing the
Public Indebtedness necessary to consummate the Recapitalization, the Company
completed an exchange offer on August 25, 1995, in which approximately $179
million principal value of the 2003 Senior Notes were exchanged for the New
Notes, which provide for sinking fund payments (to be applied to the mandatory
retirement of the New Notes) in installments of approximately $36 million each
in year 1999 through 2003. All other terms and conditions of the New Notes are
substantially the same as the 2003 Senior Notes.
In March 1997, Moody's lowered its rating of the Company's debt
security to Ca from B3, and Standard and Poor's Corporation ("S&P") lowered its
ratings to CC from B-. S&P lowered its rating to D on June 15, 1997 following
the nonpayment of interest due on the Public Indebtedness, and the rating was
restored to CC on November 7, 1997 to reflect the payment of such interest on
July 14, 1997.
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 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 reinsurers commenced 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 1b to the 1996 Annual Report, as such debts become
payable.
Based on cash flow forecasts at December 31, 1996, the Company is
projecting that the coverage limits of the Excess of Loss Reinsurance Agreement
will be exhausted. Due to these projected future recoveries, loss reserves with
a net present value of $787 million were recorded as of September 30, 1997 and
December 31, 1996 as a recoverable from the Excess of Loss Reinsurance
Agreement.
Beginning June 1996, 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
$10.7 million. See note 8 to the consolidated financial statements for further
discussion. In August 1997, Home Insurance has entered into an agreement in
principle to settle the litigation under which Home Insurance's prior rent
obligation will be reduced by at least $44 million, and Home Insurance will be
allowed to
34
<PAGE> 35
HOME HOLDINGS INC.
retain a reduced amount of space at 59 Maiden Lane at a lower rent rate. The
settlement is subject to approval by O & Y Maiden's bondholders and the
Department.
Home Insurance has settled its dispute with NCCI. Home Insurance
entered into an agreement with NCCI to commute $228 million of undiscounted loss
and loss adjustment expense reserves and settle $43 million of losses payable to
NCCI for $60 million. The payment of $60 million was made by Home Insurance in
connection with this settlement in August 1997. The Company recognized a gain of
$174 million from the settlement reported as a reduction to loss and loss
adjustment expenses.
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 sale of assets. At September 30, 1997, the Portfolio Swap
Receivable of $672 million was available to provide for any foreseeable
immediate cash requirements.
On March 3, 1997, Home Insurance was placed under formal supervision by
the Department. The Department states in its Order that this action was taken in
response to Home Insurance's RBC report filed with the Department which
indicates that a Mandatory Control Level Event has occurred. The Order
establishes that the Department will oversee and supervise Home Insurance for
the purpose of continuing and intensifying an economic, actuarial and accounting
review of the books, records and business affairs of Home Insurance so as to
determine what future actions may be appropriate. The Order also provides that
Home Insurance may not take certain actions without the prior approval of the
Department, including, among other matters, payment of claims and other
obligations within certain dollar limits, and changes in the terms and
conditions of certain existing contracts and entering into of certain new
contracts.
Cash used for insurance operating activities was $627 million in the
nine months ended September 30, 1997 compared with $807 million in the same
period in 1996. The net outflows in 1997 and 1996 were primarily due to paid
losses and lower premium collections, resulting from the run-off of operations.
The Department gave Home Insurance permission to include in the 1996
Statutory Annual Statement a non-tabular discount which results from discounting
all loss reserves, and allocated and unallocated loss adjustment expense
reserves at 7%. Home Insurance has sufficient assets that will earn 7% to meet
the expected stream of loss and loss adjustment expense payments. Home Insurance
calculated that the non-tabular discount is $314 million and $469 million at
September 30, 1997 and December 31, 1996, respectively. The non-tabular discount
is not included in the Company's consolidated financial statements
35
<PAGE> 36
HOME HOLDINGS INC.
prepared under GAAP. Home Insurance's consolidated policyholders' surplus
determined in accordance with statutory practices, and after reflecting the
benefit of non-tabular discount, was $ 101 million and $55 million at September
30, 1997 and December 31, 1996, respectively. Included in September 30, 1997
statutory surplus is a gain of $115 million from the settlement with NCCI, which
is net of non-tabular discount of $70 million.
The Company's loss reserves are determined through a process of
estimation which is necessarily imperfect, and involves an evaluation of a large
number of variables. 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. See note 3 to the
consolidated financial statements for further discussion.
The Department also continues to direct a consulting actuarial firm to
perform a review of Home Insurance's loss reserves, and the completion date has
not yet been determined. Management cannot predict whether reserve estimates to
be prepared by the consultants will change the Department's view of the level of
regulatory intervention required for Home Insurance.
Securities Broker-Dealer
- - ------------------------
Certain minimum amounts of capital must be maintained by securities
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 26, 1997, Gruntal & Co.'s net capital, as
defined by the Commission and other regulatory authorities, was approximately
$116 million, which was $92 million in excess of the aggregate minimum required.
On February 24, 1997, Gruntal, and The 1880 Group LLC a limited
liability company organized under the laws of Delaware, ("The 1880 Group"),
entered into the Reorganization Agreement. The Gruntal reorganization was
consummated on March 28, 1997. The reorganization resulted in Gruntal
transferring its securities broker-dealer operating companies, Gruntal & Co. and
The GMS Group, to a newly formed limited liability company, Gruntal Financial,
LLC ("Gruntal Financial"). In connection with the reorganization, Gruntal
changed its name to Home Financial Corp. ("Home Financial") on April 1, 1997.
Home Insurance is the sole owner of Home Financial.
The Reorganization involved the issuance of several classes of
securities to Home Financial and The 1880 Group, including preferred securities,
in an aggregate nominal
36
<PAGE> 37
HOME HOLDINGS INC.
amount of $235 million as follows: (i) Gruntal Financial issued to Home
Financial securities called Preferred A Interests in a nominal amount of $155.9
million and securities called Preferred B Interests in a nominal amount of $70
million; and (ii) Gruntal Financial issued to The 1880 Group securities called
Preferred C Interests in an nominal amount of $9 million. The nominal amount of
the Preferred A Interest was adjusted from the amount previously disclosed of
$155.5 million, to reflect actual March 1997 results and final transaction
expenses. As a result of the Reorganization, Home Financial owns 40% of the
common interest of Gruntal Financial and The 1880 Group owns 60% of the common
interest of Gruntal Financial. In connection with the issuance of certain
preferred securities to Home Financial, Home Insurance and Centre Reinsurance
Dublin entered into a swap agreement intended to ensure that Home Insurance's
investment in Gruntal Financial yields at least $155.9 million plus a 7.5% per
annum rate of return thereon, subject to certain modifications with respect to
certain distributions and sales proceeds of the common and preferred interests
of Gruntal Financial. The company accrued $8 million of income from the swap
during the second and third quarter of 1997. Expenses incurred by Gruntal in
connection with the transaction were $9 million. There was no gain or loss to
Home Insurance from the Reorganization after the impact to Gruntal of the
transaction expenses.
Sterling Forest
- - ---------------
On May 15, 1996, Governors Pataki of New York and Whitman of New
Jersey, and Speaker of the House Gingrich, announced an agreement in principle
for the purchase and sale of a substantial part of Sterling Forest lands for
public parkland. In connection therewith, a Purchase and Sale Agreement between
Sterling Forest and Sterling Lake Associates, as seller, and Trust for Public
Land and Open Space Institute, as buyer, was signed on February 18, 1997 (the
"Sterling Forest Agreement").
Under the terms of the Sterling Forest Agreement more than 15,000 acres
of Sterling Forest land will be acquired as parkland by the state of New York
under the management of the Palisades Interstate Park Commission, at a total
purchase price of $55 million. Under the Sterling Forest Agreement the buyers
have up to two years to raise the funding. The purchase price for any lands not
yet acquired, however, will increase annually if the purchase has not been fully
consummated by the first anniversary of the agreement. A total of $49 million
has been committed, as of May 14, 1997, by a combination of federal and state
governments, and one not-for-profit conservation foundation. On August 11, 1997,
the sale of approximately 1,400 acres to the not-for-profit conservation
foundation was consummated, resulting in estimated net proceeds of $4.8 million.
The projected closing for the sale of the remaining property is projected to
occur during February, 1998. Sterling Forest will continue to own approximately
2,200 acres of land and existing improvement for future sale or development.
37
<PAGE> 38
HOME HOLDINGS INC.
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
At the annual meeting of stockholders of the Company held on May 13, 1997 (The
"Annual Meeting"), the following matters were submitted to a vote of security
holders:
(i) the election of directors
(ii) amendments to the Restated Certificate of Incorporation of the Company;
and
(iii) amendments to the By-Laws of the Company.
All of the present directors of the Company, including Mr. Jan Bruneheim, Mr.
Steven D. Germain, Mr. Michael Palm and Mr. Zaid O.B. Pedersen, were elected to
serve as directors of the Company until their successors are duly elected and
qualified. Amendments to the Restated Certificate of Incorporation of the
Company and amendments to the By-Laws of the Company were approved.
With respect to the election of directors, 12,586,697 shares of Series A Common
Stock were voted in favor of the slate of directors nominated for re-election.
There were no votes cast against any of the directors, nor were there any
abstentions.
With respect to the amendments to the Restated Certificate of Incorporation of
the Company, 12,586,697 shares of Series A Common Stock of the Company were
voted in favor of the proposed amendments and 11,425,177 shares of Series B
Convertible Stock of the Company were voted in favor of the proposed amendments.
There were no votes cast against any of the amendments, nor were there any
abstentions.
With respect to the amendments to the By-Laws of the Company, 12,586,697 Shares
of Series A Common Stock of the Company were voted in favor of the proposed
amendments and 11,425,177 shares of Series B Convertible Stock of the Company
were voted in favor of the proposed amendments. There were no votes cast against
any of the amendments, nor were there any abstentions.
38
<PAGE> 39
HOME HOLDINGS INC.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits
10.1 Term Sheet dated August 1, 1997, in connection with the settlement of 59
Maiden Lane litigation (incorporated by reference to the Registrant's Report on
Form 8-K filed on August 4, 1997).
10.2 Form of Settlement Agreement by and among Home Insurance, REM, Centre
Reinsurance Dublin, the National Council on Compensation Insurance, Inc., the
National Workers' Compensation Reinsurance Pool and the participants in the
National Workers' Compensation Reinsurance Pool (incorporated by reference to
the Registrant's Report on Form 8-K filed on August 11, 1997).
99.1 Press release issued on July 15, 1997, announcing that the New Hampshire
Insurance Commissioner approved a dividend payment to the Registrant by Home
Insurance to enable the Registrant to make the June 15 interest payment on the
Public Indebtedness (incorporated by reference to the Registrant's Report on
Form 8-K filed on July 16, 1997).
99.2 Press release issued on August 4, 1997, announcing that Home Insurance
entered into an agreement in principle to settle litigation regarding 59 Maiden
Lane (incorporated by reference to the Registrant's Report on Form 8-K filed on
August 4, 1997).
99.3 Press release issued on August 11, 1997, announcing that Home Insurance has
entered into an agreement to settle and release its obligations to the National
Council on Compensation Insurance, Inc., the National Workers' Compensation
Reinsurance Pool and the participants in the National Workers' Compensation
Reinsurance Pool (incorporated by reference to the Registrant's Report on Form
8-K filed on August 11, 1997).
Form 8-K
Reports on Form 8-K were filed by the Company on July 10, 1997, July 16, 1997,
August 5, 1997 and August 11, 1997.
39
<PAGE> 40
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, 1997 Richard H. Hershman
Treasurer
(Principal Financial and Accounting
Officer through the Services Agreement
with Risk Enterprise Management Limited)
40
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