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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Quarter Ended September 30, 1996.
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
Commission File Number 1-12800
EXECUTIVE RISK INC.
(Exact name of registrant as specified in its charter)
Delaware 06-1388171
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
82 Hopmeadow Street
Simsbury, Connecticut 06070
(Address of principal executive offices) (Zip Code)
(860) 408-2000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No .
_____ _____
As of Novmber 7, 1996, there were 9,319,107 shares of Executive Risk Inc.
Common Stock, $0.01 par value, outstanding.
As of November 7, 1996, there were --0-- shares of Executive Risk Inc.
Class B Common Stock, $0.01 par value, outstanding.
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EXECUTIVE RISK INC.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION PAGE
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<S> <C>
Item 1. Financial Statements
Independent Accountants' Review Report ................................ 2
Consolidated Balance Sheets -
September 30, 1996 and December 31, 1995 .............................. 3
Consolidated Statements of Income -
Three Months and Nine Months Ended September 30, 1996 and 1995 ........ 4
Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 1996 and 1995 ......................... 5
Notes to Consolidated Financial Statements ............................ 6-7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ................................................. 8-11
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K ................................ 12
Signatures ............................................................... 13
Exhibit 15 - Independent Accountants' Acknowledgement Letter ............. 14
</TABLE>
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ITEM 1. FINANCIAL STATEMENTS
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
To the Stockholders and Board of Directors
Executive Risk Inc.
We have reviewed the accompanying consolidated balance sheet of Executive Risk
Inc. and its subsidiaries as of September 30, 1996, and the related consolidated
statements of income for the three-month and nine-month periods ended September
30, 1996 and 1995 and the consolidated statements of cash flows for the
nine-month periods ended September 30, 1996 and 1995. These consolidated
financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, which will be performed
for the full year with the objective of expressing an opinion regarding the
consolidated financial statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying consolidated financial statements referred to above
for them to be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Executive Risk Inc. and
subsidiaries as of December 31, 1995, and the related consolidated statements of
income, stockholders' equity and cash flows for the year then ended (not
presented herein) and in our report dated February 2, 1996, we expressed an
unqualified opinion on those consolidated financial statements.
/s/ ERNST & YOUNG LLP
_________________________
Stamford, Connecticut
November 4, 1996
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EXECUTIVE RISK INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(Unaudited)
September 30, December 31,
(In thousands, except share data) 1996 1995
--------- ---------
<S> <C> <C>
ASSETS
Fixed maturities available for sale, at fair value
(amortized cost: 1996 - $537,992 and 1995 - $480,135) $ 551,396 $ 503,485
Equity securities available for sale, at fair value
(cost: 1996 - $29,570 and 1995 - $20,474) 38,285 26,123
Cash and short-term investments, at cost which approximates market 38,608 20,244
--------- ---------
TOTAL CASH AND INVESTED ASSETS 628,289 549,852
Premiums receivable 6,468 10,652
Reinsurance recoverables 63,864 33,781
Accrued investment income 8,896 9,409
Investment in UPEX 1,064 990
Deferred acquisition costs 20,987 16,244
Prepaid reinsurance premiums 51,296 32,303
Deferred income taxes 25,740 18,337
Other assets 20,702 16,269
--------- ---------
TOTAL ASSETS $ 827,306 $ 687,837
========= =========
LIABILITIES
Loss and loss adjustment expenses $ 419,334 $ 324,416
Unearned premiums 173,382 116,971
Note payable to bank 70,000 25,000
Accrued expenses and other liabilities 37,692 43,725
--------- ---------
TOTAL LIABILITIES 700,408 510,112
STOCKHOLDERS' EQUITY
Common Stock, $.01 par value; authorized - 52,500,000 shares;
issued - 1996 - 10,425,741 shares and 1995 - 11,626,766 shares
outstanding - 1996 - 9,311,320 shares and 1995 - 11,497,816 shares 104 116
Additional paid-in capital 87,902 87,228
Unrealized gains on investments, net of tax 14,593 19,156
Currency translation adjustments (136) 29
Retained earnings 56,995 74,315
Cost of shares in treasury, at cost: 1996 - 1,114,421 shares and
1995 - 128,950 shares (32,560) (3,119)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 126,898 177,725
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 827,306 $ 687,837
========= =========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
3
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EXECUTIVE RISK INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
(In thousands, except per share data) 1996 1995 1996 1995
-------- -------- --------- ---------
<S> <C> <C> <C> <C>
REVENUES
Gross premiums written $ 81,472 $ 60,779 $ 229,511 $ 148,031
Premiums ceded (28,790) (16,249) (80,664) (39,990)
-------- -------- --------- ---------
Net premiums written 52,682 44,530 148,847 108,041
Change in unearned premiums (11,616) (13,981) (37,443) (24,193)
-------- -------- --------- ---------
NET PREMIUMS EARNED 41,066 30,549 111,404 83,848
Net investment income 8,389 6,761 23,214 19,451
Net realized capital (losses) gains (218) 28 (572) 1,296
Other (losses) income (152) 34 135 41
-------- -------- --------- ---------
TOTAL REVENUES 49,085 37,372 134,181 104,636
EXPENSES
Loss and loss adjustment expenses 27,778 20,605 75,279 56,544
Policy acquisition costs 7,262 5,708 20,231 15,780
General and administrative expenses 4,624 2,781 11,704 7,655
Long-term incentive compensation 290 187 883
Interest expense 1,318 498 3,192 1,469
-------- -------- --------- ---------
TOTAL EXPENSES 40,982 29,882 110,593 82,331
-------- -------- --------- ---------
INCOME BEFORE INCOME TAXES 8,103 7,490 23,588 22,305
Income tax expense (benefit)
Current 3,511 3,379 9,145 6,625
Deferred (2,152) (2,081) (5,086) (2,879)
-------- -------- --------- ---------
1,359 1,298 4,059 3,746
-------- -------- --------- ---------
NET INCOME $ 6,744 $ 6,192 $ 19,529 $ 18,559
======== ======== ========= =========
Earnings per common and common equivalent share $ 0.67 $ 0.51 $ 1.84 $ 1.55
Weighted average shares outstanding 10,043 11,984 10,624 11,861
Earnings per common and common equivalent share -
assuming full dilution $ 0.67 $ 0.51 $ 1.83 $ 1.55
Weighted average shares outstanding -
assuming full dilution 10,094 12,053 10,668 11,926
Dividends declared per common share $ 0.02 $ 0.02 $ 0.06 $ 0.06
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
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EXECUTIVE RISK INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
(In thousands) 1996 1995
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<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 19,529 $ 18,559
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization and depreciation 1,153 655
Share of income of UPEX (135) (41)
Deferred income taxes (5,086) (2,879)
Amortization of bond premium 895 1,170
Net realized losses (gains) on investments 572 (1,296)
Other (973) (1,385)
Change in:
Premiums receivable 4,184 (9,462)
Accrued investment income 513 294
Deferred acquisition costs (4,743) (4,848)
Loss and loss adjustment expenses, net of reinsurance recoverables 64,835 24,682
Unearned premiums, net of prepaid reinsurance premiums 37,443 24,193
Accrued expenses and other liabilities (2,808) 161
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 115,379 49,803
INVESTING ACTIVITIES
Proceeds from sales of fixed maturities available for sale 146,967 85,498
Proceeds from maturities of investment securities 24,818 24,227
Purchase of investment securities (244,576) (159,736)
Net capital expenditures (2,369) (3,171)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (75,160) (53,182)
FINANCING ACTIVITIES
Placement fees and other (191)
Proceeds from exercise of options 268 26
Repayment of note payable to bank (25,000)
Note payable to bank 70,000
Loan arrangement fees (980)
Cost of repurchase of Common Stock (75,025)
Proceeds from Over-allotment option exercise 9,675
Dividends paid on Common Stock (602) (690)
--------- ---------
NET CASH USED IN FINANCING ACTIVITIES (21,855) (664)
--------- ---------
NET INCREASE (DECREASE) IN CASH AND SHORT-TERM INVESTMENTS 18,364 (4,043)
--------- ---------
Cash and short-term investments at beginning of period 20,244 24,567
--------- ---------
CASH AND SHORT-TERM INVESTMENTS AT END OF PERIOD $ 38,608 $ 20,524
========= =========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
5
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EXECUTIVE RISK INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1996
(UNAUDITED)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION: The accompanying unaudited interim consolidated financial
statements of Executive Risk Inc. (the "Company" or "ERI") have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and notes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting solely of normal
recurring accruals) considered necessary for a fair presentation of the
financial position, results of operations and cash flows for the interim periods
have been included. Operating results for any interim period are not necessarily
indicative of results that may be expected for the full year. These consolidated
financial statements should be read in conjunction with the audited consolidated
financial statements and related notes contained in the Company's Annual Report
to Shareholders incorporated by reference in the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1995.
STOCK PURCHASE & SECONDARY OFFERING: On March 22, 1996, ERI entered into a Stock
Purchase Agreement ("the Agreement") with Aetna Life and Casualty Company
("AL&C") and AL&C's wholly-owned subsidiary, The Aetna Casualty and Surety
Company ("Aetna"). Prior to the closing of the Agreement, Aetna owned 4,511,300
shares of the Company's capital stock, consisting of (i) 3,286,300 shares of
Common Stock and (ii) all 1,225,000 shares of the Class B Common Stock. Through
this investment and an option to purchase 100,000 shares of ERI Common Stock at
an exercise price of $12 per share, Aetna controlled approximately 40% of the
Company's capital stock. Pursuant to the Agreement, on March 26, 1996, the
Company purchased 1,286,300 shares of ERI Common Stock and 1,225,000 shares of
ERI Class B Common Stock from Aetna at a per share price of $29.875, or
approximately $75 million in the aggregate. Upon the closing of the Agreement,
2,000,000 shares of Common Stock, representing approximately 22% of the
Company's issued and outstanding Common Stock, remained under Aetna ownership.
Subsequently, in connection with the acquisition of Aetna by The Travelers
Insurance Group Inc., Aetna transferred ownership of the remaining Common Stock
to AL&C.
In connection with the Agreement, the Company secured a $70 million senior
credit facility (the "Senior Credit Facility") arranged through The Chase
Manhattan Bank ("Chase"). See "Credit Agreement."
The Agreement also contained provisions requiring that, except under certain
market and other conditions, the Company was obligated to file a registration
statement with respect to the remaining 2,000,000 shares of ERI Common Stock
under AL&C ownership and AL&C was obligated to sell all of these shares in an
underwritten secondary offering. The secondary offering was completed on June 7,
1996. In conjunction with the secondary offering, the Company granted to the
underwriters an option to purchase an additional 300,000 shares of ERI Common
Stock, at $34.00 per share less underwriting discounts and commissions of $1.75
per share, to cover over-allotments. Such over-allotment option was exercised in
full, and the Company received $9.7 million in proceeds. The 300,000 shares of
ERI Common Stock for the over-allotment option were issued from shares held in
treasury.
On May 10, 1996, the Board of Directors approved a resolution to retire the
1,225,000 shares of Class B Common Stock in treasury acquired in the Aetna stock
repurchase as described above.
CREDIT AGREEMENT: Until March 26, 1996 (the "Closing Date"), the Company had a
credit agreement with Chase, Morgan Guaranty Trust Company of New York and The
Fleet National Bank of Connecticut to borrow up to $50 million, of which $25
million was outstanding through the Closing Date. On the Closing Date, the
Company borrowed $70 million under the terms of the Senior Credit Facility with
Chase. The proceeds of the loan were utilized as follows: $38 million to
partially finance the repurchase of common stock from Aetna, $25 million to
refinance the Company's previously existing debt, and $7 million for general
corporate purposes. In addition, the Company has obtained through Chase a $25
million revolving credit facility. The Company has no current plans to draw
funds under the revolving credit facility. Interest accrues on principal
balances outstanding under the term loan and revolving credit facility at a rate
6
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EXECUTIVE RISK INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1996
(UNAUDITED)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
per annum equal to (a) the higher of (i) the federal funds rate plus a
stipulated percentage and (ii) Chase's prime rate or, (b) for London Interbank
Offered Rate ("LIBOR") based loans, LIBOR plus a stipulated percentage over
LIBOR based on the Company's debt-to-capital ratio and its then effective
Standard & Poor's claims-paying ability rating.
On May 31, 1996, as required under the term loan agreement in connection with
the Senior Credit Facility, the Company entered into an interest rate protection
agreement providing interest rate protection for an aggregate notional amount
equal to 50% of the principal outstanding under the term loan. This interest
rate protection agreement is structured in two parts with 3 month LIBOR as the
reference rate: a $35 million interest rate swap from May 31, 1996 to November
30, 1997 and an interest rate cap on 50% of the principal then outstanding under
the term loan with a strike rate of 7.75% from November 30, 1997 to May 31,
2002. The interest rate swap involves the receipt of floating rate interest
payments for a period of 18 months in exchange for fixed interest rate payments
for the same period of 18 months without an exchange of the $35 million
principal amount. In exchange for a premium payment, the interest rate cap
involves the Company receiving the maximum of zero or 3 month LIBOR less the
strike rate on the then outstanding principal amount under the term loan. The
differential to be paid or received is accrued as interest rates change and is
recognized as an adjustment to interest expense related to the debt. Under the
terms of the interest rate protection agreement, the all-in borrowing rate for
the Company is 7.10%. The fair value of the interest rate protection agreement
is not recognized in the financial statements.
In connection with the Senior Credit Facility, the Company has pledged the stock
of its direct subsidiary, Executive Re Inc. ("Executive Re"), and Executive Re
has pledged the stock of its direct subsidiary, Executive Risk Indemnity Inc.
("ERII"). The terms of the credit agreements require, among other things, that
the Company maintain certain defined minimum consolidated net worth and combined
statutory surplus levels, and certain debt leverage, premiums-to-surplus and
fixed charge ratios, and place restrictions on the payment of dividends, the
incurrence of additional debt, the sale of assets, the making of acquisitions
and the incurrence of liens.
NOTE 2 - PRO FORMA FINANCIAL DATA
The following table presents consolidated pro forma income statement data for
the nine months ended September 30, 1996 and 1995 and the full year 1995,
respectively, as adjusted to give pro forma effect to the stock repurchase of
2,511,300 shares of the Company's capital stock as if it had occurred on
January 1, 1996 and 1995 and the exercise of the 300,000 share over-allotment
option in the secondary offering, at $32.25 per share, as if it had occurred on
January 1, 1996 and 1995.
<TABLE>
<CAPTION>
Nine Months Ended Nine Months Ended Year Ended
(In thousands, except per share data,) September 30, 1996 September 30, 1995 December 31, 1995
---------------------- ---------------------- --------------------
<S> <C> <C> <C>
Total revenues $134,021 $103,760 $143,639
Net income 18,906 16,241 22,187
Weighted average shares outstanding-
assuming full dilution 10,062 9,715 9,767
Earnings per common share -
assuming full dilution $ 1.88 $ 1.67 $ 2.27
</TABLE>
7
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Management's discussion and analysis of financial condition and results of
operations compares certain financial results for the three months and nine
months ended September 30, 1996 with the corresponding periods in 1995. The
results of Executive Risk Inc. (the "Company" or "ERI") include the consolidated
results of Executive Risk Management Associates ("ERMA"), Executive Re Inc.
("Executive Re"), and Executive Re's insurance subsidiaries, Executive Risk
Indemnity Inc. ("ERII"), Executive Risk Specialty Insurance Company ("ERSIC"),
and Executive Risk, N.V., a Dutch insurance company incorporated in the
Netherlands. In addition, the Company's results include its 50% interest in UAP
Executive Partners ("UPEX"), a French underwriting agency which is a joint
venture between the Company and Union des Assurances de Paris --
Incendie-Accidents. This interest is reported using the equity method of
accounting.
On March 22, 1996, ERI entered into a Stock Purchase Agreement ("the Agreement")
with Aetna Life and Casualty Company ("AL&C") and AL&C's wholly-owned
subsidiary, The Aetna Casualty and Surety Company ("Aetna"). Prior to the
closing of the Agreement, Aetna owned 4,511,300 shares of the Company's capital
stock, consisting of (i) 3,286,300 shares of Common Stock and (ii) all 1,225,000
shares of the Class B Common Stock. Through this investment and an option to
purchase 100,000 shares of ERI Common Stock at an exercise price of $12 per
share, Aetna controlled approximately 40% of the Company's capital stock.
Pursuant to the Agreement, on March 26, 1996, the Company purchased 1,286,300
shares of ERI Common Stock and 1,225,000 shares of ERI Class B Common Stock from
Aetna at a per share price of $29.875, or approximately $75 million in the
aggregate. Upon the closing of the Agreement, 2,000,000 shares of Common Stock,
representing approximately 22% of the Company's issued and outstanding Common
Stock, remained under Aetna ownership. Subsequently, in connection with the
acquisition of Aetna by The Travelers Insurance Group Inc., Aetna transferred
ownership of the remaining Common Stock to AL&C.
In connection with the Agreement, the Company secured a $70 million senior
credit facility (the "Senior Credit Facility") arranged through The Chase
Manhattan Bank ("Chase"). See "Liquidity and Capital Resources."
The Agreement also contained provisions requiring that, except under certain
market and other conditions, the Company was obligated to file a registration
statement with respect to the remaining 2,000,000 shares of ERI Common Stock
under AL&C ownership and AL&C was obligated to sell all of these shares in an
underwritten secondary offering. The secondary offering was completed on June 7,
1996. In conjunction with the secondary offering, the Company granted to the
underwriters an option to purchase an additional 300,000 shares of ERI Common
Stock, at $34.00 per share less underwriting discounts and commissions of $1.75
per share, to cover over-allotments. Such over-allotment option was exercised in
full, and the Company received $9.7 million in proceeds. The 300,000 shares of
ERI Common Stock for the over-allotment option were issued from shares held in
treasury.
On May 10, 1996, the Board of Directors approved a resolution to retire the
1,225,000 shares of Class B Common Stock in treasury acquired in the Aetna stock
repurchase as described above.
Results of Operations
The Company's net income for the third quarter of 1996 was $6.7 million, or
$0.67 per share on a fully diluted basis, as compared to $6.2 million, or $0.51
per share, earned in the third quarter of 1995. For the nine months ended
September 30, 1996 and 1995, net income was $19.5 million and $18.6 million,
respectively. Fully diluted earnings per share were $1.83 and $1.55 for the
corresponding periods. The Company's operating earnings, calculated as net
income before realized capital gains or losses, net of tax, were $6.9 million,
or $0.68 per share on a fully diluted basis, for the quarter ended September 30,
1996 and $6.2 million, or $0.51 per share on a fully diluted basis, for the
quarter ended September 30, 1995. For the nine months ended September 30, 1996,
operating earnings were $19.9 million, or $1.87 per share on a fully diluted
basis, as compared to $17.7 million, or $1.48 per share on a fully diluted
basis, for the first nine months of 1995.
Gross premiums written increased by $20.7 million, or 34%, to $81.5 million in
the third quarter of 1996 from $60.8 million in the third quarter of 1995. For
the first nine months of 1996, gross premiums written were $229.5 million as
compared to $148.0 million in the first nine months of 1995. The increase was
due
8
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in part to growth in many of the Company's key lines of business, including
domestic directors and officers liability insurance ("D&O") and lawyers and
miscellaneous professional liability errors and omissions insurance ("E&O").
Also contributing to the rise in gross premiums written was the Company's
ability to issue ERII and ERSIC D&O policies, rather than Aetna policies, to
both new and renewing insureds. Writing a policy on ERII or ERSIC policies
rather than Aetna results in the Company receiving 100% of the gross premiums
written (and ceding 12.5% to Aetna) as compared to receiving 50% when reinsuring
Aetna's risks. In the first nine months of 1996, $162.6 million of gross D&O
premiums written were issued on ERII and ERSIC policies as compared to $67.5
million in the first nine months of 1995.
Ceded premiums increased $12.6 million, or 77%, to $28.8 million in the third
quarter of 1996 from $16.2 million in the third quarter of 1995. For the first
nine months of 1996, ceded premiums totaled $80.7 million, representing a 102%
increase over the $40.0 million of ceded premiums in the first nine months of
1995. The rise in ceded premiums was due principally to an increase in direct
premium volume, a portion of which is ceded to reinsurers under the Company's
various D&O and E&O treaties.
As a result of the foregoing, net premiums written increased $8.2 million, or
18%, to $52.7 million for the quarter ended September 30, 1996 from $44.5
million for the quarter ended September 30, 1995. For the nine months ended
September 30, 1996, net premiums written totaled $148.8 million as compared to
$108.0 million for the nine months ended September 30, 1995. Net premiums earned
for the third quarter increased from $30.5 million in 1995 to $41.1 million in
1996. Year-to-date, premiums earned increased from $83.8 million in 1995 to
$111.4 million in 1996.
Net investment income increased by $1.6 million, or 24%, to $8.4 million for the
quarter ended September 30, 1996 from $6.8 million for the quarter ended
September 30, 1995. For the first nine months of 1996 and 1995, net investment
income was $23.2 million and $19.5 million, respectively. These increases
resulted principally from growth in invested assets, measured on an amortized
cost basis, from $485.8 million at September 30, 1995 to $606.2 million at
September 30, 1996. The nominal portfolio yield of the fixed maturity portfolio
at September 30, 1996 was 6.26%, compared to 6.17% at September 30, 1995. The
tax equivalent yields on the fixed maturity portfolio were 8.23% and 8.45% on
these dates, respectively.
The Company's net realized capital losses were $0.2 million in the third quarter
of 1996 as compared to negligible net realized capital gains in the third
quarter of 1995. For the nine months ended September 30, 1996, net realized
capital losses totaled $0.6 million as compared to net realized capital gains of
$1.3 million for the nine months ended September 30, 1995. In the second and
third quarters of 1996, fixed maturities with relatively low yields were sold at
a loss to take advantage of expiring capital loss carrybacks and replaced with
higher yielding securities. Partially offsetting these realized capital losses
were capital gains realized from the sale of the fixed maturity portfolios of
ERI and Executive Re to provide available cash for the repurchase of common
stock from Aetna on March 22, 1996.
Loss and loss adjustment expenses ("LAE") increased by $7.2 million, or 35%,
from $20.6 million in the third quarter of 1995 to $27.8 million in the
comparable period of 1996 due to higher premiums earned. For the first nine
months of 1996 and 1995, loss and LAE were $75.3 million and $56.5 million,
respectively. The Company's loss ratio was 67.6% for both the third quarter and
first nine months of 1996 as compared to 67.5% for the third quarter of 1995 and
67.4% for the first nine months of 1995. In connection with the Company's normal
reserving review, which includes a reevaluation of the adequacy of reserve
levels for prior years' claims, the Company reduced its unpaid loss and LAE
reserves for prior report years by $4.9 million, or $0.30 per share on a fully
diluted basis, in the first nine months of 1996. In the first nine months of
1995, the Company reduced its unpaid loss and LAE reserves for prior report
years by $3.8 million, or $0.21 per share on a fully diluted basis. There can be
no assurance that reserve adequacy reevaluations will produce similar reserve
reductions and net income increases in future quarters.
Policy acquisition costs increased by $1.6 million, or 27%, to $7.3 million for
the quarter ended September 30, 1996 from $5.7 million for the quarter ended
September 30, 1995, and increased $4.4 million, or 28%, to $20.2 million for the
nine months ended September 30, 1996 from $15.8 million for the nine months
ended September 30, 1995. The Company's ratio of policy acquisition costs to net
premiums earned decreased slightly from 18.7% in the third quarter of 1995 to
17.7% in the third quarter of 1996. Year-to-date, the acquisition cost ratio
decreased from 18.8% in 1995 to 18.2% in 1996. The decrease in the acquisition
cost ratio is primarily attributable to the savings achieved by paying less in
override
9
<PAGE> 11
commissions to Aetna as a result of converting insureds from Aetna policies to
ERII and ERSIC policies. Under the Amended and Restated Agency and Insurance
Services Agreement among Aetna, the Company and ERMA, ERMA paid Aetna an
override commission equal to 3% of gross written premiums with respect to Aetna
D&O policies issued through ERMA through June 30, 1996. Pursuant to this
agreement, effective with respect to business written on or after July 1, 1996,
ERMA is no longer required to pay an override commission to Aetna.
General and administrative ("G&A") expenses increased $1.8 million, or 66%, to
$4.6 million for the quarter ended September 30, 1996 from $2.8 million for the
quarter ended September 30, 1995. For the nine months ended September 30, 1996
and 1995, G&A expenses were $11.7 million and $7.7 million, respectively. The
increase in G&A costs is due largely to increased compensation and related costs
associated with the growth of the business. The ratio of G&A expenses to earned
premium increased to 10.4% for the nine months ended September 30, 1996 from
9.2% for the nine months ended September 30, 1995.
The GAAP combined ratio for the third quarter 1996 was 96.6%, compared to 95.2%
for the comparable period in 1995. For the first nine months of 1996, the GAAP
combined ratio was 96.2%, as compared to 95.4% for the first nine months of
1995. A combined ratio below 100% generally indicates profitable underwriting
prior to the consideration of investment income, capital gains and interest
expense. A company with a combined ratio exceeding 100% can still be profitable
in that period due to such factors as investment income and capital gains
realized during that period.
Interest expense is incurred principally on the outstanding balances under the
Company's bank credit agreement. Higher outstanding balances on the debt in 1996
resulted in an increase in interest expense to $1.3 million for the quarter
ended September 30, 1996 as compared to $0.5 million for the quarter ended
September 30, 1995. Interest expense was $3.2 million for the first nine months
of 1996 and $1.5 million for the first nine months of 1995. The outstanding
balances were $25 million for the quarter and nine months ended September 30,
1995, $25 million from January 1, 1996 through March 26, 1996 and $70 million
from March 26 through September 30, 1996. See "Liquidity and Capital Resources."
Income tax expense increased $0.1 million, or 5%, from $1.3 million in the third
quarter of 1995 to $1.4 million in the third quarter of 1996. The Company's
effective tax rate decreased from 17.2% to 16.8% for the same periods. The
decrease in the effective tax rate was due to an increase in tax-exempt
investment income as a percentage of pretax income. Income tax expense was $4.1
million for the first nine months of 1996 and $3.7 million for the first nine
months of 1995.
Liquidity and Capital Resources
ERI is a holding company, the principal asset of which is equity in its
subsidiaries. ERI's cash flows depend primarily on dividends and other payments
from its subsidiaries. ERI's sources of funds consist primarily of premiums
received by the insurance subsidiaries, revenues received by ERMA under
insurance agency arrangements, investment income and proceeds from sales and
redemptions of investments. Funds are used primarily to pay claims and operating
expenses, to purchase investments, and to pay interest and principal under the
Company's bank indebtedness.
Cash flows from operating activities were $115.4 million for the nine months
ended September 30, 1996 and $49.8 million for the nine months ended September
30, 1995. The increase in operating cash flows resulted from the increase in net
premiums received resulting from higher net premiums written. In addition, the
Company settled fewer losses in the first nine months of 1996 than anticipated.
These losses could be settled in future quarters, depressing net cash flows for
future periods. Rising loss payments are expected of a maturing professional
liability underwriter.
The Company believes that it has sufficient liquidity to meet its anticipated
insurance obligations as well as its operating and capital expenditure needs.
The Company's investment strategy emphasizes quality, liquidity and
diversification. With respect to liquidity, the Company considers liability
durations, specifically loss reserves, when determining investment maturities.
Average investment duration of the fixed maturity portfolio at September 30,
1996 and December 31, 1995 was 4.8 and 4.6 years, respectively, as compared to
an expected loss reserve duration of 4.5 to 5.5 years. The Company's short-term
investment pool was $38.6 million (6.1% of the total investment portfolio) at
September 30, 1996 and
10
<PAGE> 12
$20.2 million (3.7%) at December 31, 1995. The increase
in the short-term investment pool was due to strong operating cash flows.
The Company's entire investment portfolio is classified as available for sale
under the provisions of Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," and is
reported at fair value, with the resulting unrealized gains or losses included
as a separate component of stockholders' equity until realized. Due to a rise in
interest rates, the market value of the portfolio at September 30, 1996 was 102%
of amortized cost versus 105% of amortized cost at December 31, 1995. At
September 30, 1996 and December 31, 1995, stockholders' equity was increased by
$8.8 million and $15.4 million, respectively, to record the Company's fixed
maturity investment portfolio at fair value. At September 30, 1996 and December
31, 1995, the Company owned no derivative instruments, except for certain
mortgage and other asset backed securities and an interest rate protection
agreement, described below, which was used to effectively convert a portion of
its floating rate debt to a fixed rate basis, thus reducing the impact of
interest rate changes on future income.
Until March 26, 1996 (the "Closing Date"), the Company had a credit agreement
with Chase, Morgan Guaranty Trust Company of New York and The Fleet National
Bank of Connecticut to borrow up to $50 million, of which $25 million was
outstanding through the Closing Date. On the Closing Date, the Company borrowed
$70 million under the terms of the Senior Credit Facility with Chase. The
proceeds of the loan were utilized as follows: $38 million to partially finance
the repurchase of common stock from Aetna, $25 million to refinance the
Company's previously existing debt, and $7 million for general corporate
purposes. In addition, the Company has obtained through Chase a $25 million
revolving credit facility. The Company has no current plans to draw funds under
the revolving credit facility. Interest accrues on principal balances
outstanding under the term loan and revolving credit facility at a rate per
annum equal to (a) the higher of (i) the federal funds rate plus a stipulated
percentage and (ii) Chase's prime rate or, (b) for London Interbank Offered Rate
("LIBOR") based loans, LIBOR plus a stipulated percentage over LIBOR based on
the Company's debt-to-capital ratio and its then effective Standard & Poor's
claims-paying ability rating.
On May 31, 1996, as required under the term loan agreement in connection with
the Senior Credit Facility, the Company entered into an interest rate protection
agreement providing interest rate protection for an aggregate notional amount
equal to 50% of the principal outstanding under the term loan. This interest
rate protection agreement is structured in two parts with 3 month LIBOR as the
reference rate: a $35 million interest rate swap from May 31, 1996 to November
30, 1997 and an interest rate cap on 50% of the principal then outstanding under
the term loan with a strike rate of 7.75% from November 30, 1997 to May 31,
2002. The interest rate swap involves the receipt of floating rate interest
payments for a period of 18 months in exchange for fixed interest rate payments
for the same period of 18 months without an exchange of the $35 million
principal amount. In exchange for a premium payment, the interest rate cap
involves the Company receiving the maximum of zero or 3 month LIBOR less the
strike rate on the then outstanding principal amount under the term loan. The
differential to be paid or received is accrued as interest rates change and is
recognized as an adjustment to interest expense related to the debt. Under the
terms of the interest rate protection agreement, the all-in borrowing rate for
the Company is 7.10%. The fair value of the interest rate protection agreement
is not recognized in the financial statements.
In connection with the Senior Credit Facility, the Company has pledged the stock
of its direct subsidiary, Executive Re, and Executive Re has pledged the stock
of its direct subsidiary, ERII. The terms of the credit agreements require,
among other things, that the Company maintain certain defined minimum
consolidated net worth and combined statutory surplus levels, and certain debt
leverage, premiums-to-surplus and fixed charge ratios, and place restrictions on
the payment of dividends, the incurrence of additional debt, the sale of assets,
the making of acquisitions and the incurrence of liens.
On August 9, 1996, the Company declared its third quarter dividend of $.02 per
share on the Company's Common Stock, which was paid on September 30, 1996 to
stockholders of record as of September 15, 1996.
Such dividends totaled $0.2 million.
11
<PAGE> 13
PART II - OTHER INFORMATION
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
A) EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description Page
----------- ----------- ----
<S> <C> <C>
15 Independent Accountant's Acknowledgement Letter 14
27 Financial Data Schedule 15
</TABLE>
B) REPORTS ON FORM 8-K
There were no reports on Form 8-K filed by the Company during the quarter ended
September 30, 1996.
12
<PAGE> 14
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.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------- ----- ----
<S> <C> <C>
/s/ Robert H. Kullas
- --------------------------- Vice Chairman, Chief Operating Officer and November 12, 1996
Robert H. Kullas Director
/s/ Robert V. Deutsch
- --------------------------- Executive Vice President, Chief Financial Officer, November 12, 1996
Robert V. Deutsch Chief Actuary, Treasurer and Assistant Secretary
(Principal Financial and Accounting Officer)
</TABLE>
13
<PAGE> 1
EXHIBIT 15
ACKNOWLEDGMENT LETTER
To the Stockholders and Board of Directors
Executive Risk Inc.
We are aware of the incorporation by reference in the Registration Statement
(Form S-8 No. 33-78414) pertaining to the Executive Risk Inc. Nonqualified Stock
Option Plan, Executive Risk Inc. Employee Incentive Nonqualified Stock Option
Plan, Executive Risk Inc. IPO Stock Compensation Plan, Executive Risk Inc.
Nonemployee Directors Stock Option Plan, and Option Agreements for Outside
Directors of Executive Re Inc. of our report dated November 4, 1996 relating to
the unaudited consolidated interim financial statements of Executive Risk Inc.
which are included in its Form 10-Q for the quarter ended September 30, 1996.
Pursuant to Rule 436(c) of the Securities Act of 1933, our report is not a part
of the registration statement prepared or certified by accountants within the
meaning of Section 7 or 11 of the Securities Act of 1933.
/s/ERNST & YOUNG LLP
Stamford, Connecticut
November 4, 1996
14
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains summary financial information extracted from the
Company's third quarter 10-Q and is qualified in its entirety by reference to
such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<EXCHANGE-RATE> 1
<DEBT-HELD-FOR-SALE> 551,396
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 38,285
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 589,681
<CASH> 38,608
<RECOVER-REINSURE> 63,864
<DEFERRED-ACQUISITION> 20,987
<TOTAL-ASSETS> 827,306
<POLICY-LOSSES> 419,334
<UNEARNED-PREMIUMS> 173,382
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 70,000
0
0
<COMMON> 104
<OTHER-SE> 126,794
<TOTAL-LIABILITY-AND-EQUITY> 827,306
111,404
<INVESTMENT-INCOME> 23,214
<INVESTMENT-GAINS> (572)
<OTHER-INCOME> 135
<BENEFITS> 75,279
<UNDERWRITING-AMORTIZATION> 20,231
<UNDERWRITING-OTHER> 15,083
<INCOME-PRETAX> 23,588
<INCOME-TAX> 4,059
<INCOME-CONTINUING> 19,529
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 19,529
<EPS-PRIMARY> 1.84
<EPS-DILUTED> 1.83
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
