SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 8-K/A
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
----------
Date of report (Date of earliest event reported) September 28, 1998
GRYPHON HOLDINGS INC.
- ------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in Charter)
Delaware 0-5537 13-3287060
- ------------------------------------------------------------------------------
(State or Other Jurisdiction (Commission (IRS Employer
of Incorporation) File Number) Identification No.)
30 Wall Street, New York, New York 10005
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (212) 825-1200
-------------------------
- ------------------------------------------------------------------------------
(Former Name or Former Address, if Changed Since Last Report)
Item 2. Acquisition or Deposition of Assets.
On July 13, 1998, Gryphon Holdings Inc. ("Gryphon") completed the
acquisition from Dearborn Risk Management, Inc. ("Dearborn") of all of the
issued and outstanding shares (the "Shares") of capital stock of The First
Reinsurance Company of Hartford, Oakley Underwriting Agency, Inc., and F/I
Insurance Agency, Incorporated (collectively, the "Acquired Businesses"
operating as "First Re").
The total estimated consideration for the acquisition consists of (i)
$31,900,000 in cash, (ii) 15,440 shares of Series A 4.0% Cumulative Convertible
Preferred Stock of Gryphon and (iii) an earnout payment comprised of cash or
Gryphon preferred stock to be based on the earnings of the Program Business for
the 1998, 1999 and 2000 calendar years.
Gryphon Holdings Inc. operates through its main subsidiary, Gryphon
Insurance Group., as a specialty property and casualty underwriting
organization. The Company's wholly owned insurance company subsidiaries are
Associated International Insurance Company ("Associated") and Calvert Insurance
Company ("Calvert"), which operate in the property and casualty insurance
industry. Associated writes the majority of its property and casualty insurance
policies in the State of California. Calvert writes property and casualty
insurance policies throughout the United States and Canada.
The foregoing description does not purport to be complete and is qualified
in its entirety by reference to the Stock Purchase Agreement filed with the 8-K
dated February 9, 1998 as Exhibit 10.1.
Item 7. Financial Statements, Pro Forma Financial Information and Exhibits.
(a) Financial statements of the Acquired Businesses.
The following financial statements of the Acquired Businesses are filed as
part of the report:
Consolidated Balance Sheet at June 30, 1998 (Unaudited)
Consolidated Statements of Income for the Six Months Ended June 30,
1998 and 1997 (Unaudited)
Consolidated Statements of Cash Flows for the Six Months Ended June
30, 1998 and 1997 (Unaudited)
Notes to Consolidated Financial Statements (Unaudited)
Independent Auditor's Report
Combined Balance Sheets at December 31, 1997 and 1996
Combined Statements of Operations for the Year ended December 31, 1997
the Period September 6, 1996 to December 31, 1996 and the Period
January 1, 1996 to September 5, 1996.
Combined Statements of Shareholders' Equity for the Year ended
December 31, 1997 the Period September 6, 1996 to December 31, 1996
and the Period January 1, 1996 to September 5, 1996.
Combined Statements of Cash Flows for the Year ended December 31, 1997
the Period September 6, 1996 to December 31, 1996 and the Period
January 1, 1996 to September 5, 1996.
Notes to Combined Financial Statements
(b) Pro forma financial information.
The following pro forma condensed consolidated financial statements of
Gryphon are filed as part of this report:
Introduction
Pro Forma Consolidated Balance Sheet at June 30, 1998 (Unaudited)
Pro Forma Consolidated Statement of Income for the Year Ended December
31, 1997 (Unaudited)
Pro Forma Consolidated Statement of Income for the Six Months Ended
June 30, 1998 (Unaudited)
Notes to Pro Forma Consolidated Financial Statements (Unaudited)
(c) Exhibits.
99.1 Press Release, dated July 14, 1998, issued by Gryphon Holdings
Inc.
SIGNATURE
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 hereunto duly authorized.
GRYPHON HOLDINGS INC.
Dated: September 28, 1998 By: /s/ Robert P. Cuthbert
-----------------------
Robert P. Cuthbert
Senior Vice President &
Chief Financial Officer
<PAGE>
The First Reinsurance Company of Hartford
Consolidated Balance Sheet
(Unaudited)
As of June 30, 1998
(in thousands)
Assets
Investments:
Fixed maturities, available for sale, at fair value ........ $ 70,578
Short-term investments, at cost, which approximates market 2,439
--------
Total investments .......................................... 73,017
Cash and cash equivalents .................................. 3,335
Accrued investment income .................................. 1,002
Premiums receivable ........................................ 8,841
Reinsurance recoverable on paid losses ..................... 367
Reinsurance recoverable on unpaid losses ................... 10,435
Prepaid reinsurance premiums ............................... 11,086
Deferred policy acquisition costs .......................... 1,636
Deferred income taxes ...................................... 3,113
Income taxes receivable .................................... 6
Other assets ............................................... 7,221
--------
Total assets ............................................... $120,059
========
Liabilities and Stockholders' Equity
Policy liabilities:
Unpaid losses and loss adjustment expenses ............... $ 49,992
Unearned premiums ........................................ 18,878
--------
Total policy liabilities ................................... 68,870
Reinsurance balances payable ............................... 6,444
Income taxes payable
Long-term debt
Other liabilities .......................................... 3,455
--------
Total liabilities .......................................... 78,769
Commitments and contingencies
Stockholders' equity:
Common stock $.01 par value; 3,511,000 shares
authorized; 3,511,000 shares issued ..................... 3,511
Additional paid-in capital ................................. 37,657
Accumulated other comprehensive income, net of tax ......... 122
Retained earnings .......................................... --
--------
Total stockholders' equity ................................. 41,290
--------
Total liabilities and stockholders' equity ................. $120,059
========
See the notes to the Consolidated Financial Statements.
The First Reinsurance Company of Hartford
Consolidated Statements of Income
(unaudited)
(in thousands)
For the six months
Ended June 30,
1998 1997
Revenues
Net premiums earned .................................. $ 10,381 $ 7,525
Net investment income ................................ 2,392 2,043
Realized gains on investments ........................ 971 259
Other income ......................................... -- 2
-------- --------
Total revenues ....................................... 13,744 9,829
-------- --------
Expenses
Losses and loss adjustment expenses .................. 6,629 4,308
Underwriting, acquisition, and insurance expenses .... 6,293 3,663
Interest expense
-------- --------
Total expenses .................................... 12,922 7,971
-------- --------
Income (loss) before income taxes .................... 822 1,858
Provision for income taxes (benefit):
Current ......................................... 1,072 473
Deferred ........................................ (474) (150)
-------- --------
Total income taxes ................................... 598 323
-------- --------
Net income (loss) .................................... 224 1,535
Other comprehensive income, net of tax:
Unrealized investment gains (losses), net of
reclassification adjustments ................... (390) 191
Foreign currency translation adjustments ............. -- --
-------- --------
Comprehensive income (loss) .......................... $ (166) $ 1,726
======== ========
See the notes to the Consolidated Financial Statements
The First Reinsurance Company of Hartford
Consolidated Statements of Cash Flows
(Unaudited)
(in thousands)
For the six months
Ended June 30,
1998 1997
Operating activities
Net income ................................................ $ 224 $ 1,535
Adjustments to reconcile net income to net cash provided
by operating activities:
Increase in net policy liabilities ..................... 3,239 2,497
Increase in premiums receivable ........................ (2,924) 116
Decrease (increase) in deferred policy acquisition costs (322) (74)
Deferred income tax provision .......................... (474) (150)
Change in other assets and liabilities ................. 2,985 (1,395)
Amortization and depreciation .......................... 364 193
Amortization of bond discount, net ..................... (101) 72
Realized gains on investments .......................... (971) (259)
Increase (decrease) in reinsurance balances payable .... -- 626
Decrease (increase) in accrued investment income ....... (40) (69)
-------- --------
Net cash provided by (used in) operating activities ....... 1,980 3,092
-------- --------
Investing activities
Sales of fixed maturities ................................. 40,999 29,615
Purchases of fixed maturities ............................. (43,074) (38,046)
Purchases of equity securities ............................ -- 6,490
Captial expenditures ...................................... --
-------- --------
Net cash (used in) provided by investing activities ....... (2,075) (1,941)
-------- --------
Financing activities
Dividends ................................................. (500)
-------- --------
Net cash used in financing activities ..................... (500) --
-------- --------
Effect of exchange rate changes on cash ................... -- --
-------- --------
Increase (decrease) in cash and cash equivalents .......... (595) 1,151
Cash and cash equivalents at beginning of period .......... 3,930 3,772
-------- --------
Cash and cash equivalents at end of period ................ $ 3,335 $ 4,923
======== ========
See the notes to the Consolidated Financial Statements
The First Reinsurance Company of Hartford and Affiliated Companies
Notes to Consolidated Financial Statements (unaudited)
1. Basis of Presentation
The accompanying Consolidated financial statements include the accounts of
Oakley Underwriting Agency, Inc. ("Oakley") and F/I Agency, Inc. ("F/I") and The
First Reinsurance Company of Hartford collectively ("the "Company"). The
accompanying consolidated financial statements have been prepared on the basis
of generally accepted accounting principles, which as to the insurance company
differs from the statutory accounting practices prescribed or permitted by
regulatory authorities, and include the accounts of the Company and its
affiliates. All significant intercompany accounts and transactions have been
eliminated in consolidation.
2. Comprehensive Income
As of January 1, 1998, the Company adopted SFAS No.130, "Reporting
Comprehensive Income". This statement establishes standards for the reporting
and presentation of comprehensive income and its components in a full set of
financial statements. Comprehensive income encompasses all changes in
shareholders' equity (except those arising from transactions with shareholders)
and includes net income, net unrealized capital gains or losses on
available-for-sale securities and foreign currency translation adjustments, net
of taxes. This new standard changes only the presentation of certain information
in the financial statements and does not affect the Company's financial position
or results of operations.
The summary of the Accumulated other comprehensive income, net of tax, as
reported in the Consolidated Balance Sheet is as follows:
For the six months
ended June 30,
1998
(Dollars in thousands)
Unrealized investment gains, net of tax $122
Foreign currency translation adjustments, net of tax -----
Accumulated other comprehensive income, net of tax $122
=====
The summary of the Accumulated other comprehensive income, net of tax as
reported in the Consolidated Statements of Income are as follows:
For the Six Months
Ended June 30,
1998 1997
(Dollars in thousands)
Unrealized investment gains (losses) arising
during the period (net taxes of $(128) and $(186)
for 1998 and 1997 respectively) $ 250 $ 362
Less: reclassification adjustments for realized
gains included in net income (net of taxes of
$330 and $88 for 1998 and 1997 respectively) 640 171
------- -------
Net unrealized investment gains (losses) on
securities $ (390) $ 191
======= =======
3. Subsequent Event
In July 1998, the Company and its affiliates were acquired by Gryphon
Holdings Inc. for a combination of cash and preferred stock valued at $44.4
million, plus certain other performance-driven contingent consideration.
The purchase consideration of $44.4 million consisted of $31.9 million of
cash and $12.5 million fair value of a new issue of Gryphon perpetual
convertible preferred stock. The preferred stock, which has a face amount of
$15.4 million, is convertible into 688,077 shares of the Company's common stock,
reflecting a conversion price of $22.44 per share. No cash dividends will be
paid or owed during the first four and one-half years; a cash dividend at a rate
of 4.0% of the face amount will be paid thereafter. The preferred shares, which
are non-callable for three years, have no sinking fund or mandatory redemption
features. In connection with the transaction, Gryphon entered into a $55.0
million credit facility with a group of financial institutions, the proceeds of
which were used to pay the cash portion of the purchase price and to repay
existing bank borrowings.
In the third quarter of 1998, the acquisition will be accounted for by the
purchase method of accounting under Opinion No. 16, Business Combinations, of
the Accounting Principles Board of the American Institute of Certified Public
Accountants. Under this accounting method, any excess of purchase price over the
fair market value of identifiable assets acquired less liabilities assumed will
be recorded as goodwill and will be amortized over a 40 year period.
4. Unaudited Consolidated Financial Statements
In the opinion of management, the accompanying unaudited consolidated
financial statements contain all adjustments necessary to present fairly the
results of operations and financial position of the Company for the period ended
June 30, 1998 and 1997. The results of operations for the period presented are
not necessarily indicative of the results to be expected for the entire year.
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
The First Reinsurance Company of Hartford and Affiliates
Avon, Connecticut
We have audited the accompanying combined balance sheets of The First
Reinsurance Company of Hartford and Affiliates as of December 31, 1997 and 1996,
and the related combined statements of operations, stockholders' equity and cash
flows for the year ended December 31, 1997, the period September 6, 1996 to
December 31, 1996 and the period January 1, 1996 to September 5, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such combined financial statements present fairly, in all
material respects, the financial position of the Company and its affiliates as
of December 31, 1997 and 1996, and the results of their operations and their
cash flows for the year ended December 31, 1997, the period September 6, 1996 to
December 31, 1996 and the period January 1, 1996 to September 5, 1996 in
conformity with generally accepted accounting principles.
As discussed in Note 1, the financial statements reflect the effects of the
allocation of Castle Harlan Partners II, L.P.'s purchase price for Financial
Institutions Insurance Group, Ltd. as of September 6, 1996. Also, on July 13,
1998, The First Reinsurance Company of Hartford and Affiliates were sold.
/s/ Deloitte & Touche LLP
Hartford, Connecticut
May 8, 1998 except for Note 1, Recent Developments,
which is dated July 13, 1998
<PAGE>
The First Reinsurance Company of Hartford and Affiliates
<TABLE>
COMBINED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
(In Thousands)
<CAPTION>
1997 1996
<S> <C> <C>
Assets
Investments:
Fixed maturities, available for sale, at fair value
(amortized cost: 1997 - $ 69,623 ; 1996 - $ 53,064 ) ........................ $ 70,399 $ 53,140
Equity securities, available for sale, at fair value
(Cost: 1996 - $ 5,201 ) ...................................................... -- 5,550
Short-term investments, at market ................................................ -- 11,403
-------- --------
Total investments .................................................................. 70,399 70,093
Cash and cash equivalents .......................................................... 3,930 3,772
Accrued investment income .......................................................... 962 794
Premiums receivable ................................................................ 1,815 2,710
Reinsurance recoverable on paid losses, net of allowance of $250 and $243 .......... 737 295
Reinsurance recoverable on unpaid losses ........................................... 6,366 4,330
Prepaid reinsurance premiums ....................................................... 2,056 1,349
Deferred policy acquisition costs .................................................. 1,693 1,489
Deferred income taxes .............................................................. 2,438 2,181
Goodwill, less accumulated amortization of $322 and $80 ............................ 5,717 5,959
Receivable for securities sold ..................................................... 2,384 --
Other assets ....................................................................... 691 773
-------- --------
Total assets ....................................................................... $ 99,188 $ 93,745
======== ========
Liabilities and Stockholders' Equity
Policy liabilities:
Unpaid losses and loss adjustment expenses ....................................... $ 43,363 $ 37,339
Unearned premiums ................................................................ 9,539 7,811
-------- --------
Total policy liabilities ........................................................... 52,902 45,150
Reinsurance balances payable ....................................................... 2,342 2,842
Income taxes payable ............................................................... 460 355
Drafts outstanding ................................................................. 233 613
Funds held under reinsurance treaties .............................................. 351 479
Other accounts payable ............................................................. 945 1,726
-------- --------
Total liabilities .................................................................. 57,233 51,165
Commitments and contingencies ( Note 6 )
Stockholders' Equity:
Common Stock $1,000 par value; 3,511 authorized and outstanding .................. $ 3,511 $ 3,511
Additional paid-in capital ....................................................... 37,932 38,980
Retained earnings (deficit) ...................................................... -- (192)
Unrealized gain on investments, net of income tax of $264 in 1997 and $144 in 1996 512 281
-------- --------
Total Stockholders' Equity ......................................................... 41,955 42,580
-------- --------
Total Liabilities and Stockholders' Equity ......................................... $ 99,188 $ 93,745
======== ========
See notes to combined financial statements.
</TABLE>
<TABLE>
The First Reinsurance Company of Hartford and Affiliates
COMBINED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997 THE PERIOD SEPTEMBER 6, 1996 TO
DECEMBER 31, 1996 AND THE PERIOD JANUARY 1, 1996 TO SEPTEMBER 5, 1996
(in Thousands)
<CAPTION>
January 1 September 6 | January 1
to to | to
December 31, December 31, | September 5,
1997 1996 | 1996
<S> <C> <C> <C>
Revenues |
Net premiums written ............................ 16,547 3,995 | 11,232
(Increase) Decrease in unearned premium ......... (1,020) 870 | (315)
------ ------ | ------
Net premiums earned ............................. 15,527 4,865 | 10,917
Net investment income ........................... 3,916 1,384 | 2,784
Realized gains on investments - net ............. 1,671 49 | 2,264
Other income .................................... -- -- | 299
------ ------ | ------
Total revenues .................................. 21,114 6,298 | 16,264
------ ------ | ------
Claims and Expenses |
Losses and loss adjustment expenses ............. 8,468 3,912 | 4,666
Underwriting, acquisition, and insurance expenses 6,761 2,778 | 5,102
Merger related compensation expense ............. -- -- | 1,636
Merger related expenses ......................... -- -- | 802
Write-off of affiliate's stock .................. 1,672 -- | --
------ ------ | ------
Total expenses ................................ 16,901 6,690 | 12,206
------ ------ | ------
Income (loss) before income taxes ............... 4,213 (392) | 4,058
|
Provision (Benefit) for income taxes (Note 5) ... 1,819 (200) | 1,293
------ ------ | ------
Net income (loss) ............................... 2,394 (192) | 2,765
====== ====== | ======
See notes to combined financial statements.
</TABLE>
<TABLE>
The First Reinsurance Company of Hartford and Affiliates
COMBINED STATEMENTS OF STOCKHOLDERS' EQUITY
YEAR ENDED DECEMBER 31, 1997, THE PERIOD SEPTEMBER 6,1996 TO
DECEMBER 31, 1996 AND THE PERIOD JANUARY 1, 1996 TO SEPTEMBER 5, 1996
(In Thousands)
Unrealized
<CAPTION>
Additional Retained Gain (Loss)
Common Treasury Paid-In Earnings on
Stock Stock Capital (Deficit) Investments Total
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1996 ................ $ 3,901 $ (6,472) $ 43,202 $ 3,789 $ 1,543 $ 45,963
Change in unrealized appreciation
of investments, net of tax ........... -- -- -- -- (1,388) (1,388)
Net income .............................. -- -- -- 2,765 -- 2,765
Common stock issued ...................... -- 146 (77) -- -- 69
Dividends paid ........................... -- -- -- (481) -- (481)
-------- -------- -------- -------- -------- --------
Balance at September 5, 1996 .............. 3,901 (6,326) 43,125 6,073 155 46,928
Effect of acquisition .................... (390) 6,326 (4,145) (6,073) (155) (4,437)
Change in unrealized appreciation
of investments, net of tax ........... -- -- -- -- 281 281
Net loss ................................ -- -- -- (192) -- (192)
-------- -------- -------- -------- -------- --------
Balance at December 31, 1996 .............. 3,511 -- 38,980 (192) 281 42,580
Change in unrealized appreciation
of investments, net of tax ........... -- -- -- -- 231 231
Net income .............................. -- -- -- 2,394 -- 2,394
Dividends paid ........................... -- -- (1,048) (2,202) -- (3,250)
-------- -------- -------- -------- -------- --------
Balance at December 31, 1997 .............. $ 3,511 $ - $ 37,932 $ - $ 512 $ 41,955
======== ======== ======== ======== ======== ========
See notes to combined financial statements
</TABLE>
<TABLE>
The First Reinsurance Company of Hartford and Affiliates
COMBINED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, 1997, THE PERIOD SEPTEMBER 6,1996 TO
DECEMBER 31, 1996 AND THE PERIOD JANUARY 1, 1996 TO SEPTEMBER 5, 1996
(In Thousands)
<CAPTION>
January 1, September 6, | January 1,
to to | to
December 31, December 31, | September 5,
1997 1996 | 1996
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES: |
Net income (loss) ................................................. $2,394 $(192) | $2,765
Adjustments to reconcile net income (loss) |
to net cash provided by operating activities: |
Realized gain on investments .................................... (1,671) (49) | (2,264)
Write off of affiliate's common stock ........................... 1,672 -- | --
Deferred income tax ............................................. (376) 215 | (443)
Amortization of goodwill ........................................ 242 80 | (299)
Amortization of bond premium .................................... -- 273 | (135)
(Increase) Decrease deferred policy acquisition costs ........... (204) 154 | (59)
(Increase) Decrease in accrued investment income ................ (168) (165) | 127
(Increase) Decrease in reinsurance asset balances ............... (2,290) (735) | 839
(Increase) Decrease in other assets ............................. (2,669) (1,479) | (169)
Increase in unpaid claims ....................................... 6,024 3,010 | 1,874
Increase (Decrease) in unearned premiums ........................ 1,728 (679) | 344
(Increase) Decrease in reinsurance premiums payable ............. (500) -- | 1,503
(Increase) Decrease in funds held under reinsurance treaties .... (128) 966 | (2,206)
Decrease (Increase) in income taxes payable - current ........... 105 110 | 736
Increase (Decrease) in accounts payable ......................... (781) 734 | 120
Decrease in restricted cash ..................................... -- -- | 2,601
Decrease (Increase) in other - net .............................. 571 (890) | (1,849)
-------- -------- | --------
Net cash provided by operating activities .................. 3,949 1,353 | 3,485
-------- -------- | --------
CASH FLOWS FROM INVESTING ACTIVITIES: |
Proceeds from sales and maturities of fixed maturities ........... 26,470 10,467 | 35,808
Proceeds from sale of equity securities .......................... 5,293 925 | 8,579
Fixed maturities acquired ........................................ (40,916) (27,905) | (15,380)
Equity securities acquired ....................................... -- -- | (1,016)
Short-term investments - net ..................................... 8,612 17,687 | (21,101)
Investment in affiliate .......................................... -- (2,500) | --
-------- -------- | --------
Net cash provided by (used in) investing activities ........ (541) (1,326) | 6,890
-------- -------- | --------
CASH FLOWS FROM FINANCING ACTIVITIES: |
Dividend related to acquisition .................................. -- (10,000) | --
Dividends ........................................................ (3,250) -- | (481)
Other ............................................................ -- -- | 68
-------- -------- | --------
Net cash used in financing activities ...................... (3,250) (10,000) | (413)
-------- -------- | --------
|
NET INCREASE (DECREASE) IN CASH AND |
CASH EQUIVALENTS ........................................... 158 (9,973) | 9,962
|
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD .................... 3,772 13,745 | 3,783
-------- -------- | --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD .......................... $ 3,930 $ 3,772 | $ 13,745
-------- -------- | --------
SUPPLEMENTAL CASH FLOW INFORMATION: |
Cash paid (received) for federal income taxes ....................... $ 2,090 $ (520) | $ 1,000
======== ======== | ========
See notes to combined financial statements.
</TABLE>
THE FIRST REINSURANCE COMPANY OF HARTFORD AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997 AND 1996
1. ACQUISITIONS, MERGERS, AND RECENT DEVELOPMENTS
Basis of Presentation - The accompanying Combined financial statements
include the accounts of The First Reinsurance Company of Hartford ("First
Re"), Oakley Underwriting Agency, Inc., and F/I Insurance Agency Inc. all
wholly owned subsidiaries of Dearborn Risk Management Inc. ("DRM"). All
significant intercompany balances and transactions have been eliminated.
Financial Institutions Insurance Group, Ltd. Acquisition - Pursuant to the
terms of an Agreement dated April 12, 1996, Castle Harlan Partners II, L.P.
("CHP II"), a private investment partnership, acquired Financial
Institutions Insurance Group, Ltd. ("FIIG"), the parent of First Re, on
September 6, 1996 for a purchase price of $51.3 million plus expenses.
Subsequent to the FIIG acquisition, the name was changed to Oakley
Insurance Group, Inc. ("Oakley").
The FIIG acquisition was accounted for under the purchase method of
accounting in accordance with APB 16. The excess of the purchase price over
the fair market value of the net assets acquired resulted in goodwill of
approximately $6 million and was pushed down to First Re. Accordingly, the
1996 period, prior to the acquisition, is presented separately herein at
First Re's historical basis of accounting.
The Merger - On December 31, 1996, Homestead National Corporation ("HNC"),
a subsidiary of CHPII, was merged with and into Oakley, with Oakley being
the surviving corporation. Subsequent to the merger, the name was changed
to DRM.
Recent Developments - On July 13, 1998, The First Reinsurance Company of
Hartford and Affiliates (the "Company") was sold to Gryphon Holdings Inc.
for $31.9 million in cash and convertible preferred stock with a face value
of $14.4 million.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Major Customers - Oakley Underwriting Agency, Inc. ("Oakley") produces
business on behalf of Virginia Surety Company, Inc. ("VSC") which cedes a
significant portion of this premium to First Re. Oakley also produces
business on behalf of United National, which cedes a significant portion of
this premium to First Re.
Investments - Short-term investments, which have a maturity of one year or
less from date of acquisition, are carried at market, which approximates
cost. Equity securities are carried at market. The Company has designated
its fixed maturity investments as available-for-sale. Fixed maturities are
carried at their fair market values. Fair market value is determined based
on quoted market prices.
Realized gains or losses on the sale of investments are determined on the
first-in, first-out basis and are credited or charged to income. They are
presented in the statement of income as a separate component of total
revenues. Unrealized appreciation or depreciation of equity securities and
fixed maturities, net of deferred federal income tax, is credited or
charged directly to stockholders' equity.
Premium Revenue and Related Expenses - Premium revenue is recognized evenly
over the terms of the policies. Unearned premiums represent the portion of
premiums written applicable to the unexpired terms of policies in force.
Deferred Policy Acquisition Costs - Acquisition costs, such as commissions,
premium taxes and other costs that vary with the production of business are
deferred and amortized over the terms of the policies. Deferred policy
acquisition costs are reviewed annually to determine that they do not
exceed recoverable amounts, after allowing for anticipated investment
income.
Unpaid Losses and Loss Adjustment Expenses - Losses and loss adjustment
expenses represent the estimated ultimate net cost of all reported and
unreported losses incurred during the year. The Company does not discount
loss and loss adjustment expense reserves. The reserves for unpaid losses
and loss adjustment expenses are estimated using individual case-basis
valuations and statistical analyses. Those estimates are subject to the
effects of trends in loss severity and frequency. Although considerable
variability is inherent in such estimates, management believes that the
reserves for losses and loss adjustment expenses are adequate. The
estimates are continually reviewed and adjusted as necessary as experience
develops or new information becomes known, such adjustments are included in
current operations.
Reinsurance - Reinsurance premiums, losses and loss adjustment expenses are
accounted for on a basis consistent with that used in accounting for
original policies issued and the terms of the reinsurance contracts.
Liabilities for unpaid losses, loss adjustment expenses and unearned
premiums are stated gross of ceded reinsurance recoverables.
Income Taxes - The Company accounts for income taxes in accordance with
Financial Accounting Standard No. 109 ("SFAS No. 109"), Accounting for
Income Taxes. SFAS No. 109 prescribes an asset and liability approach for
financial accounting and reporting for deferred income taxes, the objective
of which is to recognize an asset or liability for the expected future tax
effects attributable to the temporary differences between the tax and
financial statement bases of assets and liabilities.
Statement of Cash Flows - For the purpose of the statements of cash flows,
the Company does not include short-term investments in cash and cash
equivalents. Cash equivalents are generally comprised of money market
funds.
Goodwill - Goodwill, the excess of cost over fair market value of net
assets acquired, is being amortized on a straight-line basis over 25 years.
The Company evaluates the carrying value of goodwill from expected future
cash flows and impairments are recognized in operating results if permanent
diminution of value occurs.
Use of Estimates - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates. Significant estimates included in these financial
statements include reserves for losses and amounts due from reinsurers.
New Pronouncements - In June 1997, the Financial Accounting Standards Board
issued SFAS No. 130, "Reporting Comprehensive Income". This statement
establishes standards for reporting and display of comprehensive income and
its components in the financial statements and is effective for all
financial statements for periods beginning after December 15, 1997. The
Company has not decided how to display comprehensive income for future
periods.
Reclassification - To facilitate comparisons with the current year, certain
amounts in the prior year have been reclassified.
3. INVESTMENTS
The components of net investment income for the year ended December 31,
1997, the period September 6, 1996 to December 31, 1996 and the period
January 1, 1996 to September 5, 1996 were as follows:
January 1, September 6, January 1,
to to to
December 31, December 31, September 5,
1997 1996 1996
(In Thousands)
Fixed Maturities $ 4,009 $ 435 $ 1,748
Equity securities 155 604 270
Short-term Investments 13 282 909
Cash and cash equivalents 62 253 --
------- ------- -------
Gross investment income 4,239 1,574 2,927
Investment expenses 323 190 143
------- ------- -------
Net Investment Income $ 3,916 $ 1,384 $ 2,784
======= ======= =======
Realized net investment gains for the year ended December 31, 1997, the
period September 6, 1996 to December 31, 1996 and the period January 1,
1996 to September 5, 1996 were as follows:
January 1, September 6, January 1,
to to to
December 31, December 31, September 5,
1997 1996 1996
(In Thousands)
Gross realized gains $ 1,772 $ 120 3,003
Gross realized losses (101) (71) (739)
------- ------- -------
Net realized investment gains $ 1,671 $ 49 $ 2,264
======= ======= =======
Certain investments (principally fixed maturities) are held in trust
accounts as required by various insurance regulatory authorities and
according to the terms of various reinsurance treaties. The amortized cost
of fixed maturities in trust accounts at December 31, 1997 and 1996 are as
follows:
1997 1996
(in Thousands)
Insurance regulatory authorities $ 2,555 $ 2,175
Ceding reinsurers 17,674 13,036
------- -------
$20,229 $15,211
======= =======
The cost basis and fair market values of investments at December 31, 1997
and 1996 are as follows:
<TABLE>
<CAPTION>
Gross Gross Fair
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
(In Thousands)
<S> <C> <C> <C> <C>
1997:
U.S. Treasury securities ............... $ 28,545 $ 345 $ (16) $28,874
Debt securities issued by
foreign governments .................. 1,053 -- -- 1,053
Municipal .............................. 13,293 260 (2) 13,551
Corporate .............................. 1,571 23 -- 1,594
Asset backed ........................... 8,685 124 (17) 8,792
Mortgage backed ........................ 16,476 65 (6) 16,535
-------- -------- -------- --------
Total fixed securities ................... $ 69,623 $ 817 $ (41) $ 70,399
======== ======== ======== ========
Gross Gross Fair
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
(In Thousands)
1996:
U.S. Treasury securities ............... $ 10,859 $ 96 $ (47) $ 10,908
Debt securities issued by
foreign governments .................. -- -- -- --
Municipal .............................. 6,492 19 (38) 6,473
Corporate .............................. 13,905 132 (105) 13,932
Asset backed ........................... 5,628 9 -- 5,637
Mortgage backed ........................ 16,180 76 (66) 16,190
-------- -------- -------- --------
Total fixed securities ................... 53,064 332 (256) 53,140
Short term investments ................... 11,403 -- -- 11,403
-------- -------- -------- --------
Equity securities ........................ 5,201 353 (4) 5,550
-------- -------- -------- --------
$ 69,668 $ 685 $ (260) $ 70,093
======== ======== ======== ========
</TABLE>
The amortized cost and estimated fair value of fixed maturities at December
31, 1997 by contractual maturity are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.
Amortized Estimated
Cost Fair Value
(In Thousands)
Due in one year or less ........................... $ 2,503 $ 2,503
Due after one year through five years ............. 22,251 22,575
Due after five years through ten years ............ 11,251 11,464
Due after ten years ............................... 8,457 8,530
Asset backed securities ........................... 8,685 8,792
Mortgage backed securities ........................ 16,476 16,535
------- -------
$69,623 $70,399
======= =======
4. LOSSES AND LOSS ADJUSTMENT EXPENSE RESERVES
The following table presents an analysis of reserves, reconciling the
beginning and ending reserve balances for the year ended December 31, 1997,
the period from September 6, 1996 to December 31, 1996 and the period from
January 1, 1996 to September 5, 1996:
<TABLE>
<CAPTION>
January 1, September 6, January 1,
to to to
December 31, December 31, September 5,
1997 1996 1996
(In Thousands)
<S> <C> <C> <C>
Gross reserves at beginning of period ................. $ 37,339 $ 34,330 $ 32,456
Reinsurance recoverable on unpaid losses and
loss adjustment expenses at beginning of period ..... 4,330 3,443 4,181
-------- -------- --------
Net reserves at beginning of period ................... 33,009 30,887 28,275
Provision for losses and loss adjustment expenses for
claims occurring in:
Current period .................................... 12,957 3,912 8,778
Prior period ...................................... (4,489) -- (4,112)
-------- -------- --------
Total provision for losses and loss adjustment expenses 8,468 3,912 4,666
Loss and loss adjustment expense payments for
claims occurring during:
Current period .................................... 1,057 537 --
Prior period ...................................... 3,423 1,253 2,054
-------- -------- --------
Total loss and loss adjustment expense payments ....... 4,480 1,790 2,054
Net reserves at end of period ......................... 36,997 33,009 30,887
Reinsurance recoverable on unpaid losses and
loss adjustment expenses at end of period ........... 6,366 4,330 3,443
-------- -------- --------
Gross reserves at end of period ....................... $ 43,363 $ 37,339 $ 34,330
======== ======== ========
</TABLE>
The 1997 and 1996 favorable loss development is primarily related to the
decrease in the estimated unpaid losses and loss adjustment expenses, net
of reinsurance, principally from reserve reductions for various
discontinued underwriting programs.
5. FEDERAL INCOME TAX
The taxable income or loss of the Company and affiliates is included in the
consolidated federal income tax return filed by DRM. The Company has a tax
sharing agreement which provides for an allocation of income tax expense or
benefit to each subsidiary in an amount equivalent to the tax liability or
recoverable, if any, of such subsidiary computed as if such subsidiary were
a separate corporation, with benefit given for net losses utilized in
consolidation.
The provision (benefit) for income taxes is comprised of:
January 1, September 6, January 1,
to to to
December 31, December 31, September 5,
1997 1996 1996
(In Thousands)
Current $2,195 $(415) $1,736
Deferred (376) 215 (443)
------ ----- ------
Total $1,819 $(200) $1,293
====== ===== ======
The provision (benefit) for federal income taxes gives effect to permanent
differences between financial reporting and taxable income (loss).
Accordingly, the effective income tax rate differs from the statutory
federal corporate tax rate. The following table reconciles the federal
statutory rate to the Company's effective rate on income (loss) before
taxes for the year ended December 31, 1997, the period September 6, 1996 to
December 31, 1996 and the period January 1, 1996 to September 5, 1996:
Pre-tax income (loss) ............................ $ 4,213 $ (392) $ 4,058
Tax provision (benefit) computed at statutory rate 1,432 (133) 1,380
Write off of affiliates stock .................... 568 -- --
Deferred tax adjustment .......................... (261)
Amortization of goodwill ......................... 109 27 (102)
Other ............................................ (29) (94) 15
------- ------ -------
Provision (benefit) for income taxes ............. $ 1,819 $ (200) $ 1,293
======= ====== =======
The tax effects of temporary differences that give rise to deferred tax
assets and liabilities at December 31, 1997 and 1996 are as follows:
1997 1996
(In Thousands)
Deferred tax assets:
Property and casualty unpaid claims .... $2,476 $2,354
Unearned premiums ...................... 509 439
Allowance for doubtful accounts ........ 85 83
Other .................................. 311 311
------ ------
Total ......................... 3,381 3,187
------ ------
Deferred tax liabilities:
Deferred policy acquisition costs ...... 576 506
Unrealized gains on investments ........ 264 144
Other .................................. 103 356
------ ------
Total ......................... 943 1,006
------ ------
Net deferred tax asset ................... $2,438 $2,181
------ ------
6. COMMITMENTS AND CONTINGENCIES
Rent Expense - At December 31, 1997, future minimum office rental payments
required under noncancellable operating leases were:
Year Ended December 31: (In Thousands)
1998 $ 118
1999 123
2000 117
-----
$ 358
=====
Total rent and related expense for the Company was $134,295 and $199,030
for the years ended December 31, 1997, and 1996, respectively.
On a month-to-month basis, the Company also leases space in Avon,
Connecticut at an annual cost of approximately $40,000.
Litigation - The Company is involved in various insurance-related claims
and legal actions arising from the normal conduct of its business. The
Company believes that the outcome of these proceedings will not have a
material effect on the financial position or results of operations of the
Company.
Letters of Credit - The Company may be required to issue letters of credit
to ceding insurers who file annual statements with certain states in which
the Company is not licensed. As of December 31, 1997, and 1996,
respectively, the Company had letters of credit outstanding of $417,000 and
$200,000. Outstanding letters of credit were collateralized by investments
with a market value of $417,000 and $200,000 at December 31, 1997, and
1996, respectively.
7. REINSURANCE
In the ordinary course of business, the Company reinsures certain portions
of its insurance coverages under excess of loss and quota share reinsurance
treaties in order to limit the amount of loss retention.
The impact of reinsurance on premiums for the year ended December 31, 1997,
the period September 6, 1996 to December 31, 1996 and the period January 1,
1996 to September 5, 1996 are as follows:
January 1, 1997 to December 31, 1997
Written Earned
(In Thousands)
Direct premiums ...................... $ 13,478 $ 11,344
Premiums assumed ..................... 7,536 9,263
Premiums ceded ....................... (4,467) (5,080)
-------- --------
Net premiums ......................... $ 16,547 $ 15,527
======== ========
September 6, 1996 to December 31, 1996
Written Earned
(In Thousands)
Direct premiums ...................... $ 2,249 $ 2,413
Premiums assumed ..................... 2,448 3,321
Premiums ceded ....................... (702) (869)
-------- --------
Net premiums ......................... $ 3,995 $ 4,865
======== ========
January 1, 1996 to September 5, 1996
Written Earned
(In Thousands)
Direct premiums ...................... $ 5,228 $ 4,603
Premiums assumed ..................... 7,671 7,943
Premiums ceded ....................... (1,667) (1,629)
-------- --------
Net premiums ......................... $ 11,232 $ 10,917
======== ========
Ceded incurred losses and loss adjustment expenses incurred were
$4,352,731, $468,312 and $1,344,216 for the year ended December 31, 1997,
the period September 6, 1996 to December 31, 1996 and the period January 1,
1996 to September 5, 1996.
First Re remains liable to their policyholders if their reinsurers are
unable to meet their contractual obligations under the applicable
reinsurance agreements. No single reinsurer has unsecured balances greater
than 3% of statutory surplus.
8. RELATED PARTY TRANSACTIONS
Castle Harlan, Inc. was paid $750,000 and $312,500 in management fees for
the year ended December 31, 1997, and the period September 6, 1996 to
December 31, 1996, respectively.
First Re Management Company, an affiliate, coordinates and manages the
Company's insurance and day-to-day administrative operations. All payroll
and administrative expenses are paid out of First Re Management Company and
are billed to the Company.
The Company wrote-off their $1,671,500 investment in Homestead Insurance
Company, and affiliate, since Homestead Insurance Company elected to place
itself in run-off, effective March 11, 1998.
9. EMPLOYEE BENEFIT PLANS
The Company has no employees. All employees are employed by First Re
Management Company, an affiliate, which offers a 401(k)-retirement savings
plan to all employees who are eligible to participate in the plan after
completing six months of service. Participants may make contributions on a
pretax basis of up 15% of annual compensation up to IRS limitations. The
First Re Management Company matches 50% of the employee's contribution (up
to 6%). The Company's allocated contributions were approximately $63,596
for 1997, approximately $14,310 for the period September 6, 1996 to
December 31, 1996 and $25,290 for the period January 1, 1996 to September
5, 1996.
The Company also contributed, by allocation, 6% of the amount of annual
compensation to employees to the 401(k) plan in lieu of pension. The amount
of that contribution was approximately $198,911 for 1997, approximately
$30,695 for the period September 6, 1996 to December 31, 1996 and $53,021
for the period January 1, 1996 to September 5, 1996.
10. STOCKHOLDERS' EQUITY AND DIVIDEND RESTRICTION
First Re's statutory capital and surplus was approximately $31 million at
December 31, 1997. Connecticut insurance laws restrict the amount of
dividends that can be paid by First Re without prior regulatory approval.
In general, the maximum amount of dividends that may be paid during a
twelve-month period, without prior regulatory approval, is limited to the
greater of 10% of statutory surplus, limited by unassigned surplus or 100%
of net income, measured as of the preceding December 31. Dividends
exceeding these limitations require regulatory approval. The maximum
dividend that can be paid by First Re in 1998 under these provisions is
approximately $4.3 million, however, as a result of the September 6, 1996
acquisition, approval is required for all dividends until September 6,
1998.
Total dividends paid in 1997 and for the period January 1,1996 to September
5, 1996 were $3.25 million and $4 million, respectively. In connection with
the FIIG acquisition, First Re paid an extraordinary dividend of $10
million.
7(b) Pro Forma Financial Information
On July 13, 1998, Gryphon Holdings Inc. ("Gryphon") completed the
acquisition from Dearborn Risk Management, Inc. ("Dearborn") of all of the
issued and outstanding shares (the "Shares") of capital stock of The First
Reinsurance Company of Hartford, Oakley Underwriting Agency, Inc., and F/I
Insurance Agency, Incorporated (collectively, the "Acquired Businesses"
operating as "First Re").
The total estimated consideration for the acquisition consists of (i)
$34,068,000 in cash including related direct costs, (ii) $12,507,000 estimated
fair value of 15,440 shares of Series A 4.0% Cumulative Convertible Preferred
Stock of Gryphon with a face amount of $15.4 million, is convertible into
688,077 shares of the Company's common stock, reflecting a conversion price of
$22.44 per share and (iii) an earnout payment comprised of cash or Gryphon
preferred stock to be based on the earnings of the Program Business for the
1998, 1999 and 2000 calendar years.
Gryphon Holdings Inc. operates through its main subsidiary, Gryphon
Insurance Group., as a specialty property and casualty underwriting
organization. The Company's wholly owned insurance company subsidiaries are
Associated International Insurance Company ("Associated") and Calvert Insurance
Company ("Calvert"), which operate in the property and casualty insurance
industry. Associated writes the majority of its property and casualty insurance
policies in the State of California. Calvert writes property and casualty
insurance policies throughout the United States and Canada.
The following Pro Forma Financial Information is based on the historical
financial statements of Gryphon Holdings Inc. and adjusted to give effect to the
acquisition. The Pro Forma Consolidated Statement of Income for the year ended
December 31, 1997 and the six months ended June 30, 1998, give effect to the
acquisition as if it had occurred on January 1, 1997. The Pro Forma Consolidated
Balance Sheet gives effect to the acquisition as if it had occurred on June 30,
1998. In the opinion of management, the historical consolidated financial
statements of Gryphon Holdings Inc. reflects all adjustments, which are of a
normal recurring nature, to present fairly Gryphon's financial position and
results of operations as of and for the twelve months ended December 31, 1997
and the six months ended June 30, 1998. The pro forma adjustments are based upon
available information and certain assumptions that management believes are
reasonable.
The acquisition was accounted for using the purchase method of accounting.
The purchase price for the acquisition has been allocated to tangible and
identifiable intangible assets and liabilities based upon management's
preliminary estimates of their fair value with the excess of purchase price over
fair value of assets acquired allocated to goodwill and amortized over 40 years.
The allocation of the purchase price for the acquisition is subject to revision
when additional information concerning asset and liability valuations are
obtained. For purposes of presenting pro forma results, no changes in revenues
and expenses have been made to reflect the results of any modification to
operations that might have been made had the acquisition been consummated on the
assumed effective date of the acquisition. The pro forma expenses include the
recurring cost, which are directly attributable to the acquisition, such as
interest expense, and amortization of goodwill.
The Pro Forma Financial Information does not purport to represent what
Gryphon's results of operations or financial position would actually have been
had the acquisition in fact occurred on January 1, 1997 or to project the
company's results of operations or financial position for or at any future
period or date.
<TABLE>
Gryphon Holdings Inc.
Pro Forma Consolidated Balance Sheet
(Unaudited)
June 30, 1998
(in thousands)
<CAPTION>
Pro Forma
Adjusting
Assets Gryphon (A) First Re Entries Proforma
<S> <C> <C> <C> <C>
Investments:
Fixed maturities, available for sale, at fair value ................ $ 300,082 $ 70,578 $ $370,660
Equity securities, available for sale, at fair value ............... 667 -- 667
Short-term investments, at cost, which approximates market ............ 233 2,439 2,672
--------- --------- -------- --------
Total investments ..................................................... 300,982 73,017 -- 373,999
Cash and cash equivalents ............................................. 18,990 3,335 22,325
Accrued investment income ............................................. 4,239 1,002 5,241
Premiums receivable ................................................... 25,526 8,841 34,367
Reinsurance recoverable on paid losses ................................ 18,480 367 18,847
Reinsurance recoverable on unpaid losses .............................. 164,086 10,435 174,521
Prepaid reinsurance premiums .......................................... 21,615 11,086 32,701
Deferred policy acquisition costs ..................................... 11,700 1,636 13,336
Deferred income taxes ................................................. 13,737 3,113 16,850
Income taxes receivable ............................................... 1,445 6 1,451
Other assets .......................................................... 8,731 7,221 5,285(C) 21,237
--------- --------- -------- ---------
Total assets .......................................................... $ 589,531 $ 120,059 $ 5,285 $ 714,875
========= ========= ======== =========
Liabilities and Stockholders' Equity
Policy liabilities:
Unpaid losses and loss adjustment expenses ......................... $ 364,582 $ 49,992 $ $ 414,574
Unearned premiums .................................................. 69,942 18,878 88,820
--------- --------- -------- ---------
Total policy liabilities .............................................. 434,524 68,870 $ 503,394
Reinsurance balances payable .......................................... 27,157 6,444 33,601
Income taxes payable .................................................. --
Long-term debt ........................................................ 19,375 34,068(B) 53,443
Other liabilities ..................................................... 9,998 3,455 13,453
--------- --------- -------- ---------
Total liabilities ..................................................... 491,054 78,769 34,068 603,891
Commitments and contingencies
Stockholders' equity:
Preferred stock ................................................... 12,507 (B) 12,507
Common stock ...................................................... 81 3,511 (3,511)(D) 81
Additional paid-in capital ........................................ 30,581 37,657 (37,657)(D) 30,581
Accumulated other comprehensive income, net of tax ................ 3,503 122 (122)(D) 3,503
Deferred compensation ............................................. (259) -- (259)
Retained earnings ................................................. 88,486 -- 88,486
Treasury stock, at cost; shares 1998: 1,407,821 ................... (23,915) -- (23,915)
--------- --------- -------- ---------
Total stockholders' equity ............................................ 98,477 41,290 (28,783) 110,984
--------- --------- -------- ---------
Total liabilities and stockholders' equity ............................ $ 589,531 $ 120,059 $ 5,285 $ 714,875
========= ========= ======== =========
(See accompanying Notes to Pro Forma Consolidated Financial Statements)
</TABLE>
<TABLE>
Gryphon Holdings Inc.
Pro Forma Consolidated Statement of Income
(Unaudited)
For the Year Ended December 31, 1997
(in thousands, except per share data)
<CAPTION>
Adjustments
for the
Gryphon First Re (A) Acquisition Pro Forma
<S> <C> <C> <C> <C>
Revenues
Net premiums earned ................................. $ 104,246 $ 15,527 $ 119,773
Net investment income ............................... 17,061 3,916 20,977
Realized gains on investments ....................... 6,188 1,671 7,859
Other income ........................................ 979 -- 979
--------- --------- --------- ---------
Total revenues ...................................... 128,474 21,114 -- 149,588
--------- --------- --------- ---------
Expenses
Losses and loss adjustment expenses ................. 71,015 8,468 79,483
Underwriting, acquisition, and insurance expenses ... 45,089 8,433 264 (B) 53,786
Interest expense .................................... 1,607 -- 2,601 (C) 4,208
--------- --------- --------- ---------
Total expenses ...................................... 117,711 16,901 2,865 137,477
--------- --------- --------- ---------
Income (loss) before income taxes ................... 10,763 4,213 (2,865) 12,111
Provision for income taxes (benefit):
Current ........................................ 2,395 2,195 1,003 (D) 5,593
Deferred ....................................... (426) (376) (802)
--------- --------- --------- ---------
Total income taxes .................................. 1,969 1,819 1,003 4,791
--------- --------- --------- ---------
Net income (loss) before Accretion of preferred stock $ 8,794 $ 2,394 (1,862) $ 9,326
Accretion of preferred stock ........................ (485)(E) $ (485)
--------- --------- --------- ---------
Net income (loss) attributable to common stockholders 8,794 2,394 (2,347) 8,841
Other comprehensive income, net of tax:
Unrealized investment gains, net of
reclassification adjustments ............... 259 231 490
Foreign currency translation adjustments ....... (127) (127)
========= ========= ========= =========
Comprehensive income (loss) ......................... $ 8,926 $ 2,625 $ (2,347) $ 9,204
========= ========= ========= =========
Basic net earnings per share ........................ $ 1.32 $ 1.32
========= =========
Diluted net earnings per share ...................... $ 1.32 $ 1.27
========= =========
Basic comprehensive income per share ................ $ 1.34 $ 1.38
========= =========
Diluted comprehensive income per share .............. $ 1.34 $ 1.32
========= =========
Weighted average shares outstanding ................. 6,680 6,680
========= =========
(See accompanying Notes to Pro Forma Consolidated Financial Statements)
</TABLE>
<TABLE>
Gryphon Holdings Inc.
Pro Forma Consolidated Statement of Income
(Unaudited)
For the Six Months Ended June 30, 1998
(in thousands, except per share data)
<CAPTION>
Adjustments
for the
Gryphon First Re(A) Acquisition Pro Forma
<S> <C> <C> <C> <C>
Revenues
Net premiums earned .................................. $ 44,431 $ 10,381 $ 54,812
Net investment income ................................ 8,402 2,392 10,794
Realized gains on investments ........................ 1,297 971 2,268
Other income ......................................... --
-------- -------- -------- --------
Total revenues ....................................... 54,130 13,744 -- 67,874
-------- -------- -------- --------
Expenses
Losses and loss adjustment expenses .................. 42,721 6,629 49,350
Underwriting, acquisition, and insurance expenses .... 22,176 6,293 132 (B) 28,601
Interest expense ..................................... 690 1,300 (C) 1,990
-------- -------- -------- --------
Total expenses ....................................... 65,587 12,922 1,432 79,941
-------- -------- -------- --------
Income (loss) before income taxes .................... (11,457) 822 (1,432) (12,067)
Provision for income taxes (benefit): ................ --
Current ......................................... (1,712) 1,072 (501)(D) (1,141)
Deferred ........................................ (3,166) (474) (3,640)
-------- -------- -------- --------
Total income taxes ................................... (4,878) 598 (501) (4,781)
-------- -------- -------- --------
Net income (loss) before Accretion of preferred stock $ (6,579) $ 224 $ (931) $ (7,286)
Accretion of preferred stock ......................... (254)(E) (254)
-------- -------- -------- --------
Net income (loss) attributable to common stockholders (6,579) 224 (1,185) (7,540)
Other comprehensive income, net of tax:
Unrealized investment gains (losses), net of
reclassification adjustments ................ (7) (390) (397)
Foreign currency translation adjustments ........ (75) (75)
-------- -------- -------- --------
Comprehensive income (loss) .......................... $ (6,661) $ (166) $ (1,185) $ (8,012)
======== ======== ======== ========
Basic net earnings (loss) per share .................. $ (0.98) $ (1.12)
======== ========
Diluted net earnings (loss) per share ................ $ (0.98) $ (1.12)
======== ========
Basic comprehensive income (loss) per share .......... $ (0.99) $ (1.19)
======== ========
Diluted comprehensive income (loss) per share ........ $ (0.99) $ (1.19)
======== ========
Weighted average shares outstanding .................. 6,718 6,718
======== ========
(See accompanying Notes to Pro Forma Consolidated Financial Statements)
</TABLE>
Notes to Pro Forma Consolidated Financial Statements
Pro Forma Consolidated Balance Sheets:
(A) First Re Balance Sheet as of June 30, 1998
(B) To record debt incurred to finance $34,068,000 of the purchase price
including related direct costs and to record the fair value $12,507,000 of
the Convertible Preferred Stock issued for the acquisition
(C) To record Goodwill of $10,882,000 and reverse the Goodwill on First Re's
historical financial statements of $5,597,000
(D) To eliminate equity of First Re
Pro Forma Statements of Income:
(A) Reflects the results of operations of First Re for the year ended December
31, 1997; and for the six months ended June 30, 1998
(B) To record the amortization of Goodwill related to the acquisition for the
year ended December 31, 1997 - $264,000; and for the six months ended June
30, 1998 - $132,000
(C) To record the interest expense related to the debt incurred to finance the
acquisition
(D) To record tax effect of the pro forma adjustments
(E) To record the accretion of preferred stock of $485,000 for the year ended
December 31, 1997; and $254,000 for the six months ended June 30, 1998
Contingent Arrangements
As part of the Stock Purchase Agreement the final determination of the purchase
price is subject to adjustment due to contingencies. The contingencies include
final determination and agreement as to the closing balance sheet amounts.
In addition, the seller may earn additional consideration over the next three
years at an amount equal to a multiple of net underwriting income, net of tax,
on certain program business renewed. Since any amounts that may become due to
the seller under this agreement are entirely contingent upon future performance,
no amount has been included in the pro forma financial statements.
Preferred Stock
Consideration paid for the acquisition includes cash and Series A cumulative 4%
convertible preferred shares. The preferred stock has been recorded in the pro
forma financial statements at its fair value. The 4% dividend is not due and
payable for 4 1/2 years, however, for financial statement purposes preferred
dividends are accreted for during this period as a reduction to retained
earnings and an increase to preferred stock. Basic EPS has been reduced by this
in substance preferred stock dividend.
Exhibit Index
Exhibit
Number Description Page
- ------ ----------- ----
99.1 Press Release, dated July 14, 1998, issued by Gryphon 31 - 32
Holdings Inc.
<PAGE>
PRESS RELEASE
GRYPHON HOLDINGS REPORTS CONSUMMATION OF ACQUISITION;
RESERVE STRENGTHENING AND RESTRUCTURING CHARGE TO BE INCLUDED IN
SECOND QUARTER RESULTS
New York, New York, July 14, 1998 -- Gryphon Holdings Inc. announced today that
it has closed its previously announced acquisition of The First Reinsurance
Company of Hartford and its affiliate, Oakley Underwriting Agency (collectively
"Oakley/First Re") from Dearborn Risk Management, Inc. ("Dearborn") for a
combination of cash and preferred stock valued at $43.6 million, plus certain
other performance-driven contingent consideration.
The purchase consideration of $43.6 million consists of $31.9 million of cash
and $11.7 fair value of a new issue of Gryphon perpetual convertible preferred
stock. The preferred stock, which will have a face amount of $14.4 million, will
be convertible into 643,672 shares of Gryphon common stock, reflecting a
conversion price of $22.44 per share. No cash dividends will be paid or owed
during the first four and one-half years; a cash dividend at the rate of 4.0% of
the face amount will be paid thereafter. Gryphon has borrowed $55.0 million from
a group of banks to finance the cash portion of the purchase price and repay
previously existing bank debt.
Oakley/First Re, which is based in Chicago, is a specialty insurer of
professional liability risks. It provides Directors & Officers and Errors &
Omissions coverages for corporations, professional firms, not-for-profit
institutions, and public entities. John A. Dore, President of Oakley/First Re,
will retain that position and become Executive Vice President of Gryphon and
Vice Chairman of Gryphon's main operating unit, Gryphon Insurance Group ("GIG").
Mr. Dore will also be elected to Gryphon's Board of Directors, as will John K.
Castle, Chairman of Castle Harlan, Inc., which manages a limited partnership,
that is the majority shareholder of Dearborn.
In making the announcement, Stephen A. Crane, President & Chief Executive
Officer of Gryphon, stated, "We are thrilled to consummate this transaction,
which fits perfectly with our strategy of developing expertise in highly focused
niches within the specialty property and casualty insurance business. John Dore
and his team are accomplished professionals and will add significantly to our
strength and depth."
The Company reiterated its expectation that the transaction will add
substantially to Gryphon's earnings per share.
Gryphon also reported today on the results of a formal review of operations and
reserves that it had conducted during the second quarter of 1998. The Company
indicated that second quarter results, which will be released early in August,
will include a pre-tax charge of approximately $10.6 million pertaining to
prior-year reserve strengthening. The Company also reported that it will incur a
restructuring charge of $750,000 in its second-quarter results in connection
with a staff reduction effected during the quarter.
The reserve strengthening followed a thorough and rigorous review that was
occasioned by the installation of a new senior operating management team in GIG.
GIG appointed new CEOs in each of its two profit centers earlier this year, as
well as a new Senior Vice President -- Claims. These individuals were encouraged
to identify reserving issues pertaining to previous years in an effort to
relieve future reporting periods from the burden of past losses.
The reserve strengthening of $10.6 million before taxes includes case reserves
as well as reserves for incurred but not reported losses for various lines of
business, including pre-1985 casualty coverages with environmental impairment
and asbestos-related exposures, nursing home liability, commercial automobile,
artisan contractors, and liquor liability in two states. Almost all of this
business had been previously discontinued.
The restructuring charge of $750,000 before taxes relates to the elimination of
16 positions during the second quarter, as well as the related write-off of
future office lease obligations on certain space that is no longer necessary.
The Company reported that it was able to streamline the organization as a result
of the acquisition of Oakley/First Re, and also because of the installation of a
new computer system. The Company estimated that the actions taken will reduce
annualized expenses by approximately $1.3 million.
Mr. Crane added, "It is important for Gryphon and its shareholders that we start
life together with Oakley/First Re without the burden of past problems. Although
in our business one can never speak with total certainty regarding the adequacy
of reserves to cover future claims, we believe we have addressed a substantial
majority of reserving issues. Now that we have closed the Oakley/First Re
transaction, we hope to report consolidated results that are unencumbered by
prior-year adverse development," Mr. Crane concluded.
Gryphon Holdings operates through its main subsidiary, Gryphon Insurance Group,
as a specialty property and casualty underwriting organization. The Company's
wholly owned insurance company subsidiaries are Associated International
Insurance Company, Calvert Insurance Company, and The First Reinsurance Company
of Hartford.
Forward-Looking Information: The Private Securities Litigation Reform Act of
1995 provides a "safe harbor" for forward-looking statements. This press release
or any other written or oral statements made by or on behalf of Gryphon may
include forward-looking statements which reflect Gryphon's current views with
respect to future events and financial performance. These forward-looking
statements are subject to certain uncertainties and other factors that could
cause actual results to differ materially from such statements. These
uncertainties and other factors (which are described in more detail elsewhere in
documents filed by Gryphon with the Securities and Exchange Commission) include,
but are not limited to, uncertainties relating to general economic conditions
and cyclical industry conditions, uncertainties relating to government and
regulatory policies, volatile and unpredictable developments (including storms
and catastrophes), the legal environment, the uncertainties of the reserving
process, and the competitive environment in which Gryphon operates. The words
"believe", "expect", "anticipate", "project", "plan", and similar expressions
identify forward-looking statements. Readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of their
dates. Gryphon undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events, or otherwise.
