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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 June 30, 1997.
[ ] 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 August 8, 1997, there were 9,569,868 shares of Executive Risk Inc.
Common Stock, $0.01 par value, outstanding, net of treasury shares.
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EXECUTIVE RISK INC.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION PAGE
- ------------------------------ ----
<S> <C>
Item 1. Financial Statements
Independent Accountants' Review Report ............................... 2
Consolidated Balance Sheets -
June 30, 1997 and December 31, 1996 .................................. 3
Consolidated Statements of Income -
Three Months and Six Months Ended June 30, 1997 and 1996 ............. 4
Consolidated Statements of Cash Flows -
Six Months Ended June 30, 1997 and 1996 .............................. 5
Notes to Consolidated Financial Statements ........................... 6-7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ................................................ 7-11
PART II - OTHER INFORMATION
Item 4. Submission of Matters to Vote of Securityholders............... 11-12
Item 6. Exhibits and Reports on Form 8-K .............................. 12-13
Signatures ............................................................. 14
Exhibit 15.1 - Independent Accountants' Acknowledgment Letter .......... --
Exhibit 27 - Financial Data Schedule ................................... --
</TABLE>
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements. This Form 10-Q, the Company's Annual Report on
Form 10-K, its Annual Report to Stockholders, any subsequent Form 10-Q, any
Current Report on Form 8-K or any other oral or written statements of, by or on
behalf of the Company may include forward-looking statements which reflect the
Company's current views with respect to future events and financial performance.
The forward-looking statements are subject to uncertainties and other factors
that could cause actual results to differ materially from such statements. These
include, but are not limited to, uncertainties relating to cyclical industry
conditions, government and regulatory policies, the reserving process, the legal
and competitive environments in which the Company operates, international
operations, interest rate fluctuations and the uncertainties related to the
Company's possible entrance into new insurance lines and new geographic markets.
The words "believe," "expect," "anticipate," "project" 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. The Company undertakes no obligation to publicly update or revise any
forward looking statement, whether as a result of new information, future events
or otherwise.
1
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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 June 30, 1997, and the related consolidated
statements of income for the three-month and six-month periods ended June 30,
1997 and 1996 and the consolidated statements of cash flows for the six-month
periods ended June 30, 1997 and 1996. 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 review, 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, 1996, 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 7, 1997, we expressed an
unqualified opinion on those consolidated financial statements.
/S/ ERNST & YOUNG LLP
Stamford, Connecticut
August 1, 1997
2
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EXECUTIVE RISK INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(Unaudited)
June 30, December 31,
(In thousands, except share data) 1997 1996
----------- ---------
<S> <C> <C>
ASSETS
Fixed maturities available for sale, at fair value
(amortized cost: 1997 - $682,786 and 1996 - $610,589) $ 700,651 $ 628,564
Equity securities available for sale, at fair value
(cost: 1997 - $37,250 and 1996 - $27,820) 54,729 37,705
Cash and short-term investments, at cost which approximates market 62,923 24,706
----------- ---------
TOTAL CASH AND INVESTED ASSETS 818,303 690,975
Premiums receivable 42,242 26,757
Reinsurance recoverables 116,600 77,724
Accrued investment income 10,847 10,126
Investment in UPEX 1,051 1,087
Deferred acquisition costs 29,357 22,696
Prepaid reinsurance premiums 74,209 66,088
Deferred income taxes 26,251 26,269
Other assets 28,264 19,525
----------- ---------
TOTAL ASSETS $ 1,147,124 $ 941,247
=========== =========
LIABILITIES
Loss and loss adjustment expenses $ 545,951 $ 457,063
Unearned premiums 238,999 205,348
Note payable to bank 70,000
Ceded balances payable 26,747 26,402
Accrued expenses and other liabilities 39,254 37,659
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TOTAL LIABILITIES 850,951 796,472
Company obligated mandatorily redeemable preferred securities of subsidiary
Executive Risk Capital Trust holding solely $125,000,000 aggregate principal
amount of 8.675% Series B Junior Subordinated Deferrable Interest Debentures
of the Company due February 1, 2027 and $3,866,000 aggregate principal amount
of 8.675% Series A Junior Subordinated Deferrable Interest Debentures of the
Company due February 1, 2027 125,000
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STOCKHOLDERS' EQUITY
Common Stock, $.01 par value; authorized - 52,500,000 shares;
issued - 1997 - 10,619,027 shares and 1996 - 10,439,628 shares
outstanding - 1997 - 9,504,606 shares and 1996 - 9,325,207 shares 106 104
Additional paid-in capital 99,223 93,651
Unrealized gains on investments, net of tax 22,971 18,382
Currency translation adjustments (556) (186)
Retained earnings 81,989 65,384
Cost of shares in treasury, at cost:
1997 and 1996 - 1,114,421 shares (32,560) (32,560)
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TOTAL STOCKHOLDERS' EQUITY 171,173 144,775
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TOTAL LIABILITIES, PREFERRED SECURITIES OF EXECUTIVE
RISK CAPITAL TRUST AND STOCKHOLDERS' EQUITY $ 1,147,124 $ 941,247
=========== =========
</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 June 30, Six Months Ended June 30,
(In thousands, except per share data) 1997 1996 1997 1996
--------- -------- --------- ---------
REVENUES
<S> <C> <C> <C> <C>
Gross premiums written $ 111,753 $ 90,357 $ 194,788 $ 148,039
Premiums ceded (39,512) (33,043) (72,810) (51,874)
--------- -------- --------- ---------
Net premiums written 72,241 57,314 121,978 96,165
Change in unearned premiums (22,035) (20,889) (25,543) (25,827)
--------- -------- --------- ---------
NET PREMIUMS EARNED 50,206 36,425 96,435 70,338
Net investment income 11,255 7,450 21,360 14,825
Net realized capital gains (losses) 335 (1,308) 1,341 (354)
Other (losses) income (31) 195 115 287
--------- -------- --------- ---------
TOTAL REVENUES 61,765 42,762 119,251 85,096
EXPENSES
Loss and loss adjustment expenses 33,789 24,607 65,110 47,501
Policy acquisition costs 7,961 6,225 15,442 12,969
General and administrative expenses 6,546 3,912 12,085 7,080
Long-term incentive compensation 187
Interest expense 1,296 1,419 1,874
Minority interest in
Executive Risk Capital Trust 2,711 4,337
--------- -------- --------- ---------
TOTAL EXPENSES 51,007 36,040 98,393 69,611
--------- -------- --------- ---------
Income Before Taxes 10,758 6,722 20,858 15,485
Income tax expense (benefit)
Current 4,477 3,899 6,754 5,634
Deferred (2,287) (2,737) (2,878) (2,934)
--------- -------- --------- ---------
2,190 1,162 3,876 2,700
--------- -------- --------- ---------
NET INCOME $ 8,568 $ 5,560 $ 16,982 $ 12,785
========= ======== ========= =========
Earnings per common and common equivalent share $ 0.83 $ 0.57 $ 1.66 $ 1.17
Weighted average shares outstanding 10,263 9,809 10,217 10,910
Earnings per common and common equivalent share -
assuming full dilution $ 0.83 $ 0.56 $ 1.66 $ 1.17
Weighted average shares outstanding -
assuming full dilution 10,280 9,856 10,241 10,950
Dividends declared per common share $ 0.02 $ 0.02 $ 0.04 $ 0.04
</TABLE>
NOTE: The sum of the 1996 quarters' earnings per share does not equal the
year-to-date per share amount.
The accompanying notes are an integral part of the
consolidated financial statements.
4
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EXECUTIVE RISK INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended June 30,
<TABLE>
<CAPTION>
(In thousands) 1997 1996
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<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 16,982 $ 12,785
Adjustments to reconcile net income to net
cash provided by operating activities:
Amortization and depreciation 1,113 826
Share of income of UPEX (115) (60)
Deferred income taxes (2,878) (2,934)
Amortization of bond premium 760 739
Net realized (gains) losses on investments (1,341) 354
Stock based compensation plans 2,250 1,283
Amortization of loan arrangement fees 910
Other (217) (476)
Change in:
Premiums receivable, net of ceded balances payable (15,140) (11,046)
Accrued investment income (721) 833
Deferred acquisition costs (6,661) (3,180)
Loss and loss adjustment expenses, net of reinsurance recoverables 50,012 40,215
Unearned premiums, net of prepaid reinsurance premiums 25,530 25,827
Accrued expenses and other liabilities (10,229) (3,566)
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 60,255 61,600
INVESTING ACTIVITIES
Proceeds from sales of fixed maturities available for sale 141,182 114,129
Proceeds from sales of equity securities available for sale 1,370
Proceeds from maturities of investment securities 17,661 12,560
Purchase of investment securities (234,610) (130,777)
Net capital expenditures (3,203) (1,804)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (77,600) (5,892)
FINANCING ACTIVITIES
Proceeds from exercise of options 2,189 233
Cost of repurchase of Common Stock (75,025)
Placement fees and other (1,250) (136)
Repayment of note payable to bank (70,000) (25,000)
Note payable to bank 70,000
Loan arrangement fees (980)
Proceeds from Capital Securities offering 125,000
Proceeds from Over-allotment option exercise 9,675
Dividends paid on Common Stock (377) (416)
--------- ---------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 55,562 (21,649)
--------- ---------
NET INCREASE IN CASH AND SHORT-TERM INVESTMENTS 38,217 34,059
--------- ---------
Cash and short-term investments at beginning of period 24,706 20,244
--------- ---------
CASH AND SHORT-TERM INVESTMENTS AT END OF PERIOD $ 62,923 $ 54,303
========= =========
</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
JUNE 30, 1997
(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, 1996.
Certain prior year amounts have been reclassified to conform with the 1997
presentation.
NOTE 2 - REDEEMABLE PREFERRED STOCKS
On February 5, 1997, the Company formed Executive Risk Capital Trust (the
"Trust"), a Delaware statutory business trust, the common securities of which
are owned by the Company. The Trust sold 125,000 8.675% Series A Capital
Securities ($1,000 per Capital Security) (the "Capital Securities") to certain
institutional accredited investors pursuant to SEC Rule 144A. The Trust used the
$125 million of proceeds received from the sale of the Capital Securities to
purchase Junior Subordinated Debentures (the "Debentures") from the Company. The
Company utilized the $123.5 million of net proceeds as follows: $70 million to
repay the amount outstanding under the term loan portion of a senior credit
facility arranged through The Chase Manhattan Bank, $45 million to make a
surplus contribution to Executive Risk Indemnity Inc. and $8.5 million for
general corporate purposes. On May 29, 1997, all of the Capital Securities were
exchanged for Series B Capital Securities. The terms of the Series B Capital
Securities are identical in all material respects to the terms of the Series A
Capital Securities, except that the Series B Capital Securities have been
registered under the Securities Act of 1933 and will not be subject to the
$100,000 minimum liquidation amount transfer restriction and certain other
transfer restrictions applicable to the Series A Capital Securities. The sole
assets of the Trust are the Debentures.
Holders of the Capital Securities will be entitled to receive cumulative cash
distributions, accumulating from the date of original issuance and payable
semi-annually in arrears on February 1 and August 1 of each year at an annual
rate of 8.675%. Interest on the Debentures, and hence distributions on the
Capital Securities, may be deferred to the extent set forth in the applicable
instrument. The Capital Securities are subject to mandatory redemption on
February 1, 2027, at a redemption price equal to the principal amount of, plus
accrued but unpaid distributions on, the Debentures.
The Capital Securities are also prepayable in certain other specified
circumstances at a prepayment price which includes a make-whole premium and in
certain other cases without a make-whole premium. Payments of distributions and
other amounts due on the Capital Securities have been guaranteed by the Company
to the extent set forth in the applicable guarantee instrument.
NOTE 3 - RELATIONSHIP WITH AETNA CASUALTY AND SURETY COMPANY
On February 13, 1997, the Company and The Aetna Casualty and Surety Company
("Aetna") entered into a series of agreements whereby the Company released Aetna
from its contractual obligation to issue Directors and Officers liability
insurance ("D&O") exclusively through Executive Risk Management Associates
("ERMA") until December 31, 1999, and Aetna may therefore compete with the
6
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EXECUTIVE RISK INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997
(UNAUDITED)
NOTE 3 - RELATIONSHIP WITH AETNA CASUALTY AND SURETY COMPANY, CONTINUED
Company on D&O sooner than it otherwise could have. In exchange, Aetna has
agreed that, effective January 1, 1997, Aetna is no longer a 12.5% quota share
reinsurer of the Company's direct D&O business. Additionally, effective January
1, 1997, the Company assumes 100% of the D&O written by ERMA on Aetna policies
as compared to 50% in 1996 and prior years. Due to these changes, in 1997 the
Company pays less in ceded premiums, and generally retains more risk, than if it
had continued the prior reinsurance agreements with Aetna.
NOTE 4 - NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS
128"), which is required to be adopted on December 31, 1997. At that time, the
Company will be required to change the method currently used to compute earnings
per share ("EPS") and to restate all prior periods. SFAS 128 replaces primary
EPS with basic EPS. Basic EPS is calculated as net income available to common
stockholders divided by the weighted average number of common shares outstanding
during the period. The dilutive effect of stock options and contingent shares is
excluded from basic EPS. The impact of SFAS 128 is expected to result in basic
earnings per share for the quarters ended June 30, 1997 and 1996 of $0.91 and
$0.61 per share, respectively, and $1.81 and $1.25 for the six months ended June
30, 1997 and 1996, respectively. Under SFAS 128, fully diluted EPS is replaced
with diluted EPS. The impact of SFAS 128 on the calculation of diluted EPS for
these quarters is not expected to be material.
In June 1997, the FASB issued Statement of Financial Accounting Standards No.
130, "Reporting Comprehensive Income" ("SFAS 130") and Statement of Financial
Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and
Related Information," ("SFAS 131"). SFAS 130 establishes standards for the
reporting and display of comprehensive income and its components in a full set
of general-purpose financial statements. Comprehensive income is defined as the
change in equity during the financial reporting period of a business enterprise
resulting from non-owner sources. SFAS 131 establishes standards for the
reporting of operating segment information in both annual financial reports and
interim financial reports issued to shareholders. Operating segments are
components of an entity for which separate financial information is available
and is evaluated regularly by the entity's chief operating management. Both
Statements are effective for fiscal years beginning after December 15, 1997 and
are not expected to have a material impact on the Company.
NOTE 5 - SUBSEQUENT EVENT
On August 12, 1997 the Company filed a registration statement on Form S-3 with
respect to the issuance in an underwritten public offering of 1,000,000 shares
of its Common Stock (plus an additional 150,000 shares which the underwriters
will have an option to purchase from the Company solely to cover
over-allotments, if any). There can be no assurance as to whether such issuance
will be consummated, or, if so, as to the net proceeds which the Company will
receive. In addition, the Company currently expects to issue up to $75,000,000
aggregate principal amount of debt securities during the third or fourth
calendar quarters of 1997. There can be no assurance that such debt securities
will be issued, or, if issued, as to the terms thereof, including without
limitation the interest rate and other financial terms.
The Company expects to use the proceeds of the Common Stock offering and of any
debt securities to make surplus contributions to current and newly-formed
insurance company subsidiaries of the Company in order to support existing
business lines and to finance entry into new business lines and for general
corporate purposes. A registration statement relating to the above-described
offering of Common Stock has been filed with the Securities and Exchange
Commission but has not yet become effective. Such securities may not be sold nor
may offers to buy be accepted prior to the time such registration statement
becomes effective. This shall not constitute an offer to sell or the
solicitation of an offer to buy, nor shall there be any sale of such securities
in any state in which such offer, solicitation or sale would be unlawful prior
to registration or qualification under the securities laws of any such state.
Prospectuses may be obtained from the Company at the address set forth on the
cover hereof.
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 six
months ended June 30, 1997 with the corresponding periods in 1996. 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"), Executive Risk
N.V., and Vulcan Indemnity Inc., a newly formed insurance company owned by ERII,
which will be renamed upon its becoming licensed by the Connecticut Insurance
Department. In addition, the Company's results include Executive Risk Capital
Trust, a Delaware statutory business trust (the "Trust"), and a 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 ("UAP"), a subsidiary of AXA-UAP Group. This interest is
reported using the equity method of accounting.
7
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The joint venture agreement between the Company and UAP with respect to UPEX
may be terminated by either party as of December 31 of any year commencing in
1997. Upon any such termination, UAP may demand that the Company not, for a
period of two years, compete with UAP on policies underwritten by UPEX and in
force on the date of notice of such termination. If UAP were to make such a
demand, UAP would be required to pay to ERI, as consideration, an amount equal
to 20% of the gross written premiums of UPEX for the calendar year ending on
the date of termination, if UAP were the terminating party, and 10% of such
gross written premiums if ERI were the terminating party. The Company is
currently in discussions with AXA-UAP Group regarding the status of UPEX. While
there can be no assurance as to the continuation of the Company's joint venture
with UAP, the Company believes that termination of the agreement with UAP would
not have a material adverse effect on the Company's business or financial
condition.
RESULTS OF OPERATIONS
The Company's net income for the second quarter of 1997 was $8.6 million, or
$0.83 per share on a fully diluted basis, as compared to $5.6 million, or $0.56
per share on a fully diluted basis, earned in the second quarter of 1996. For
the six months ended June 30, 1997 and 1996, net income was $17.0 million and
$12.8 million, respectively. Fully diluted earnings per share were
$1.66 and $1.17 for the corresponding periods. The Company's earnings,
calculated as net income before realized capital gains or losses, net of tax,
were $8.4 million, or $0.81 per share on a fully diluted basis, for the quarter
ended June 30, 1997 and $6.4 million, or $0.65 per share on a fully diluted
basis, for the quarter ended June 30, 1996. For the six months ended June 30,
1997, operating earnings were $16.1 million, or $1.57 per share on a fully
diluted basis, as compared to $13.0 million, or $1.19 per share on a fully
diluted basis, for the first half of 1996.
Gross premiums written increased by $21.4 million, or 24%, to $111.8 million in
the second quarter of 1997 from $90.4 million in the second quarter of 1996. The
increase was due to growth in sales in all of the Company's key lines of
business, including domestic directors and officers liability insurance ("D&O")
and miscellaneous professional liability errors and omissions insurance ("E&O"),
partially offset by a slight decrease in international D&O. For the first half
of 1997, gross premiums written were $194.8 million as compared to $148.0
million in the first half of 1996.
Ceded premiums increased $6.5 million, or 20%, to $39.5 million in the second
quarter of 1997 from $33.0 million in the second quarter of 1996. The rate of
growth in ceded premiums in the second quarter of 1997 was below that of gross
premiums written due to a reduction in direct D&O cessions to The Aetna Casualty
and Surety Company ("Aetna") partially offset by increased cessions on E&O and
certain D&O products as a result of increased premiums written. Pursuant to a
restructuring of the Company's relationship with Aetna entered into on February
13, 1997 and effective January 1, 1997, Aetna is no longer a 12.5% quota share
reinsurer of the Company's direct D&O business. For the first six months of
1997, ceded premiums totaled $72.8 million, representing a 40% increase over
1996. The rise in year-to-date ceded premiums is due to increased cessions on
E&O and certain D&O products resulting from increased premiums written.
As a result of the foregoing, net premiums written increased $14.9 million, or
26%, to $72.2 million for the quarter ended June 30, 1997 from $57.3 million for
the quarter ended June 30, 1996. For the first six months of 1997, net premiums
written totaled $122.0 million, as compared to $96.2 million for the six months
ended June 30, 1996. Net premiums earned for the second quarter increased to
$50.2 million in 1997 from $36.4 million in 1996. Year-to-date, net premiums
earned increased to $96.4 million in 1997 from $70.3 million in 1996.
Net investment income increased by $3.9 million, or 51%, to $11.3 million for
the quarter ended June 30, 1997 from $7.4 million for the quarter ended June 30,
1996. For the first half of 1997 and 1996, net investment income was $21.4
million and $14.8 million, respectively. These increases resulted principally
from growth in invested assets, measured on an amortized cost basis, from $561.6
million at June 30, 1996 to $783.0 million at June 30, 1997. The nominal
portfolio yield of the fixed maturity portfolio at June 30, 1997 was 6.24%,
compared to 6.29% at June 30, 1996. The tax equivalent yields on the fixed
maturity portfolio were 7.98% and 8.36% for these periods, respectively.
8
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The Company's net realized capital gains were $0.4 million in the second quarter
of 1997, as compared to net realized capital losses of $1.3 million in the
second quarter of 1996. For the six months ended June 30, 1997, net realized
capital gains totaled $1.3 million as compared to net realized capital losses of
$0.4 million for the six months ended June 30, 1996. In 1997, net capital gains
were realized principally from the sale of fixed maturity investments, equity
mutual fund distributions and certain limited partnership investments.
Loss and loss adjustment expenses ("LAE") increased by $9.2 million, or 37%,
from $24.6 million in the second quarter of 1996 to $33.8 million in the
comparable period of 1997, due to higher premiums earned. For the six months
ended June 30, 1997 and 1996, loss and LAE were $65.1 million and $47.5 million,
respectively. The Company's loss ratio was 67.3% in the second quarter of 1997
and 67.5% for the first six months of 1997 as compared to 67.6% in the second
quarter of 1996 and 67.5% for the first six months of 1996. 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 $4.3 million, or $0.27
per share on a fully diluted basis, in the first half of 1997. In the first half
of 1996, the Company reduced its unpaid loss and LAE reserves for prior report
years by $3.1 million, or $0.18 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 $1.8 million, or 28%, to $8.0 million for
the quarter ended June 30, 1997 from $6.2 million for the quarter ended June 30,
1996. For the first half of 1997 and 1996, policy acquisition costs totaled
$15.4 million and $13.0 million, respectively. The Company's ratio of policy
acquisition costs to net premiums earned decreased from 17.1% in the second
quarter of 1996 to 15.9% in the second quarter of 1997. Year-to-date, the policy
acquisition cost ratio decreased from 18.4% in 1996 to 16.0% in 1997. The
decrease in the policy acquisition cost ratio was primarily attributable to
higher ceding commissions earned on the Company's reinsurance programs.
General and administrative ("G&A") expenses increased $2.6 million, or 67%, to
$6.5 million in the second quarter of 1997 from $3.9 million in the second
quarter of 1996. For the six months ended June 30, 1997 and 1996, G&A expenses
totaled $12.1 million and $7.1 million, respectively. The increase in G&A costs
is due largely to increased compensation, benefit and related overhead costs
associated with the growth in premium volume. The ratio of G&A expenses to
premiums earned increased from 10.1% for the first six months of 1996 to 12.6%
for the first six months of 1997.
The GAAP combined ratio increased to 96.2% in the second quarter of 1997 from
95.4% in the second quarter of 1996. For the first half of 1997, the GAAP
combined ratio was 96.1%, as compared to 96.0% for the first half of 1996. The
increase of 0.8 percentage points for the second quarter of 1997 was
attributable to the increase in the G&A ratio, partially offset by decreases in
the policy acquisition cost and loss ratios as discussed above. A combined ratio
below 100% 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 of $1.4 million for the first half of 1997 and $1.9 million for
the first half of 1996 was attributable principally to the outstanding balances
under the Company's bank credit agreement. The outstanding balances were $25
million from January 1, 1996 through March 26, 1996 and $70 million from March
26, 1996 through February 5, 1997. On February 5, 1997, in connection with a
capital securities offering by the Trust, the Company repaid the $70 million
outstanding under the term loan portion of a senior credit facility (the "Senior
Credit Facility") arranged through The Chase Manhattan Bank ("Chase"). In
addition, interest expense for the first six months of 1997 includes $0.9
million of loan arrangement fees paid to Chase in 1996 which were fully
amortized in connection with the repayment of the Senior Credit Facility. See
"Liquidity and Capital Resources."
Minority interest in the Trust is attributable to distributions payable on the
common securities of the Trust. See "Liquidity and Capital Resources."
9
<PAGE> 11
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, to pay interest and principal under the
terms of the Company's indebtedness for borrowed money and to pay dividends to
Common Stock holders.
Net cash flows from operating activities were $60.3 million for the six months
ended June 30, 1997 and $61.6 million for the six months ended June 30, 1996.
The decrease in net operating cash flows resulted principally from a $9.5
million return of funds held to an insured under a funds withheld arrangement as
well as higher losses and G&A expenses paid. Rising loss payments are expected
of a maturing professional liability underwriter. The decrease in net operating
cash flows was partially offset by increased net premiums received resulting
from higher net premiums written.
The Company believes that it has sufficient liquidity to meet its anticipated
insurance obligations as well as its operating and capital expenditure needs.
Such capital expenditure needs are likely to include the costs of an addition to
the Company-owned office headquarters building in Simsbury, Connecticut.
Construction of such addition, which is targeted for completion in 1999, has not
begun, nor have bids been received. Based on preliminary estimates, however, the
Company expects to spend up to $15 million on such addition.
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 June 30, 1997 and
December 31, 1996 was 4.9 and 4.6 years, respectively, as compared to an
expected loss reserve duration of 5.0 to 5.5 years for such dates. The Company's
short-term investment pool was $62.9 million (7.7% of the total investment
portfolio) at June 30, 1997 and $24.7 million (3.6%) at December 31, 1996. The
short-term investment pool has increased in order to fund fixed maturity
purchases anticipated to settle early in the third quarter of 1997 as well as
expected near-term cash outflow needs.
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. The market value
of the portfolio was 103% of amortized cost at June 30, 1997 and December 31,
1996. At June 30, 1997 and December 31, 1996, stockholders' equity was increased
by $11.6 million and $11.9 million, respectively, to report the Company's fixed
maturity investment portfolio at fair value, net of applicable taxes. At June
30, 1997, the Company owned no derivative instruments, except for certain
mortgage and other asset backed securities and two equity collars as described
below.
On March 10, 1997, the Company and J.P. Morgan Securities Inc. ("J.P. Morgan")
entered into two agreements providing for "costless collars" on the Company's
equity mutual fund holdings in order to reduce the Company's exposure to future
market fluctuations. The first collar has a range of 90.00% to 112.88% of the
Standard and Poor's ("S&P") 500 index on a notional value of $22.5 million. The
second collar has a range of 90.00% to 108.48% of a custom index on a notional
value of $9.5 million. This custom index combines 50% of the S&P Midcap index
and 50% of the Russell 2000 index. The terms of the collars provide that the
Company will receive payments from J.P. Morgan should the collar indices decline
beyond the low points of the respective ranges indicated above, and the Company
will make payments to J.P. Morgan should the indices appreciate beyond the high
points of the ranges. At any level within the collar indices, the collars will
expire with no cash to be received or paid by the Company. At June 30, 1997, the
market values of the equity mutual fund holdings were within the range of the
collar indices. The collars mature on December 31, 1997. The fair value of the
collars is not recognized in the financial statements.
On February 5, 1997, the Company formed the Trust, the common securities of
which are owned by the Company. The Trust sold the Capital Securities to certain
institutional accredited investors pursuant to
10
<PAGE> 12
SEC Rule 144A. The Trust used the $125 million of proceeds received from the
sale of the Capital Securities to purchase the Debentures from the Company. The
Company utilized the $123.5 million of net proceeds as follows: $70 million to
repay the amount outstanding under the term loan portion of the Senior Credit
Facility, $45 million to make a surplus contribution to ERII and $8.5 million
for general corporate purposes. On May 29, 1997, all of the Capital Securities
were exchanged for fully registered Series B Capital Securities. The terms of
the Series B Capital Securities are identical in all material respects to the
terms of the Series A Capital Securities, except that the Series B Capital
Securities have been registered under the Securities Act of 1933 and will not be
subject to the $100,000 minimum liquidation amount transfer restriction and
certain other transfer restrictions applicable to the Series A Capital
Securities. The sole assets of the Trust are the Debentures.
Holders of the Capital Securities will be entitled to receive cumulative cash
distributions, accumulating from the date of original issuance and payable
semi-annually in arrears on February 1 and August 1 of each year at an annual
rate of 8.675%. Interest on the Debentures, and hence distributions on the
Capital Securities, may be deferred to the extent set forth in the applicable
instrument. The Capital Securities are subject to mandatory redemption on
February 1, 2027, at a redemption price equal to the principal amount of, plus
accrued but unpaid distributions on, the Debentures.
The Capital Securities are also prepayable in certain other specified
circumstances at a prepayment price which includes a make-whole premium and in
certain other cases without a make-whole premium. Payments of distributions and
other amounts due on the Capital Securities have been guaranteed by the Company
to the extent set forth in the applicable guarantee instrument.
On May 9, 1997, the Company declared its second quarter dividend on the
Company's Common Stock of $.02 per share, which was paid on June 30, 1997 to
stockholders of record as of June 15, 1997. Such dividends totaled $0.2 million.
On August 12, 1997, the Company filed a registration statement on Form S-3 with
respect to the issuance in an underwritten public offering of 1,000,000 shares
of its Common Stock (plus an additional 150,000 shares which the underwriters
will have an option to purchase from the Company to cover over-allotments, if
any). There can be no assurance as to whether such issuance will be consummated,
or, if so, as to the net proceeds which the Company will receive.
In addition, the Company currently expects to issue up to $75,000,000 aggregate
principal amount of debt securities during the third or fourth calendar quarters
of 1997. There can be no assurance that such debt securities will be issued, or,
if issued, as to the terms thereof, including without limitation the interest
rate and other financial terms.
The Company expects to use the proceeds of the Common Stock offering and of any
debt securities to make surplus contributions to current and newly-formed
insurance company subsidiaries of the Company in order to support existing
business lines and to finance entry into new business lines and for general
corporate purposes.
A registration statement relating to the above-described offering of common
stock has been filed with the Securities and Exchange Commission but has not yet
become effective. Such securities may not be sold nor may offers to buy be
accepted prior to the time such registration statement become effective. This
shall not constitute an offer to sell or the solicitation of an offer to buy,
nor shall there be any sale of such securities in any state in which such offer,
solicitation or sale would be unlawful prior to registration or qualification
under the securities laws of such state. Prospectuses may be obtained from the
Company at the address set forth on the cover hereof.
PART II - OTHER INFORMATION
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 9, 1997, the Company held its annual meeting of stockholders in Avon,
Connecticut. The stockholders voted on nominees for election to the Board of
Directors and on five other matters.
The following votes were cast for nominees for election of directors, and all
such nominees were elected.
11
<PAGE> 13
<TABLE>
<CAPTION>
Votes for Votes Withheld
--------- --------------
<S> <C> <C>
John G. Crosby 7,427,117 135,848
Robert V. Deutsch 7,423,117 139,848
Patrick A. Gerschel 7,427,117 135,848
Peter Goldberg 7,425,517 137,448
Robert H. Kullas 7,427,117 135,848
</TABLE>
The votes cast on the approval of the Company's Amended and Restated
Certificate of Incorporation were as follows:
<TABLE>
<S> <C>
7,481,352 In Favor
81,337 Against
276 Abstain
</TABLE>
The votes cast on approval of the amendment and restatement of the Company's
Performance Share Plan were as follows:
<TABLE>
<S> <C>
5,649,214 In Favor
1,912,316 Against
1,435 Abstain
</TABLE>
The votes cast on approval of the amendment and restatement of the Company's
Incentive Compensation Plan (Pool A) were as follows:
<TABLE>
<S> <C>
7,222,736 In Favor
336,253 Against
3,976 Abstain
</TABLE>
The votes cast on approval of the amendment and restatement of the Company's
Nonqualified Stock Option Plan were as follows:
<TABLE>
<S> <C>
5,721,033 In Favor
1,837,956 Against
3,976 Abstain
</TABLE>
The votes cast on the approval of Ernst & Young LLP as the Independent Auditors
for the Company for the 1997 fiscal year were as follows:
<TABLE>
<S> <C>
7,547,376 In Favor
15,263 Against
-0- Abstain
</TABLE>
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
a) EXHIBIT INDEX
12
<PAGE> 14
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<S> <C>
15.1 Independent Accountant's Acknowledgment Letter
27 Financial Data Schedule
</TABLE>
b) REPORTS ON FORM 8-K
On June 5, 1997, the Company filed a Current Report on Form 8-K, which
discussed the adoption of the Company's Second Amended and Restated Certificate
of Incorporation at the 1997 Annual Meeting of Stockholders on May 9, 1997.
13
<PAGE> 15
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
_______________________ Chairman and Director August 12, 1997
Robert H. Kullas
/s/ Robert V. Deutsch
_________________________ Executive Vice President, Chief Financial Officer, August 12, 1997
Robert V. Deutsch Chief Actuary, Treasurer and Assistant Secretary
(Principal Financial and Accounting Officer)
and Director
</TABLE>
14
<PAGE> 1
EXHIBIT 15.1
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 August 1, 1997 relating to
the unaudited consolidated interim financial statements of Executive Risk Inc.
which are included in its Form 10-Q for the quarter ended June 30, 1997.
/S/ ERNST & YOUNG LLP
Stamford, Connecticut
August 1, 1997
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000
<CURRENCY> 0
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<EXCHANGE-RATE> 1
<DEBT-HELD-FOR-SALE> 700,651
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 54,729
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 755,380
<CASH> 62,923
<RECOVER-REINSURE> 1,174
<DEFERRED-ACQUISITION> 29,357
<TOTAL-ASSETS> 1,147,124
<POLICY-LOSSES> 545,951
<UNEARNED-PREMIUMS> 238,999
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
125,000
0
<COMMON> 106
<OTHER-SE> 171,067
<TOTAL-LIABILITY-AND-EQUITY> 1,147,124
96,435
<INVESTMENT-INCOME> 21,360
<INVESTMENT-GAINS> 1,341
<OTHER-INCOME> 115
<BENEFITS> 65,110
<UNDERWRITING-AMORTIZATION> 15,442
<UNDERWRITING-OTHER> 17,841
<INCOME-PRETAX> 20,858
<INCOME-TAX> 3,876
<INCOME-CONTINUING> 16,982
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 16,982
<EPS-PRIMARY> 1.66
<EPS-DILUTED> 1.66
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
