<PAGE> 1
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, 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 November 7, 1997, there were 10,810,627 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
PART I - FINANCIAL INFORMATION PAGE
Item 1. Financial Statements
Independent Accountants' Review Report................................. 2
Consolidated Balance Sheets -
September 30, 1997 and December 31, 1996............................... 3
Consolidated Statements of Income -
Three Months and Nine Months Ended September 30, 1997 and 1996......... 4
Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 1997 and 1996.......................... 5
Notes to Consolidated Financial Statements............................. 6-8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................. 8-12
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K................................. 12
SIGNATURES................................................................ 13
Exhibit 15.1 - Independent Accountants' Acknowledgment Letter............. 14
Exhibit 27 - Financial Data Schedule...................................... --
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 September 30, 1997, and the related consolidated
statements of income for the three-month and nine-month periods ended September
30, 1997 and 1996 and the consolidated statements of cash flows for the
nine-month periods ended September 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
November 3, 1997
2
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EXECUTIVE RISK INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(Unaudited)
September 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 - $775,699 and 1996 - $610,589) $ 801,374 $ 628,564
Equity securities available for sale, at fair value
(cost: 1997 - $37,755 and 1996 - $27,820) 56,138 37,705
Cash and short-term investments, at cost which approximates market 98,537 24,706
----------- -----------
TOTAL CASH AND INVESTED ASSETS 956,049 690,975
Premiums receivable 36,815 26,757
Reinsurance recoverables 138,270 77,724
Accrued investment income 11,934 10,126
Investment in UPEX 1,081 1,087
Deferred acquisition costs 32,385 22,696
Prepaid reinsurance premiums 84,077 66,088
Deferred income taxes 25,342 26,269
Other assets 29,418 19,525
----------- -----------
TOTAL ASSETS $ 1,315,371 $ 941,247
=========== ===========
LIABILITIES
Loss and loss adjustment expenses $ 591,058 $ 457,063
Unearned premiums 263,164 205,348
Note payable to bank 70,000
Ceded balances payable 31,546 26,402
Accrued expenses and other liabilities 46,739 37,659
----------- -----------
TOTAL LIABILITIES 932,507 796,472
Company obligated mandatorily redeemable preferred securities of 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
----------- -----------
STOCKHOLDERS' EQUITY
Common Stock, $.01 par value;
authorized - 1997 - 50,000,000 shares and 1996 - 52,500,000 shares;
issued - 1997 - 11,854,564 shares and 1996 - 10,439,628 shares;
outstanding - 1997 - 10,740,143 shares and 1996 - 9,325,207 shares 119 104
Additional paid-in capital 171,558 93,651
Unrealized gains on investments, net of tax 28,636 18,382
Currency translation adjustments (578) (186)
Retained earnings 90,689 65,384
Cost of shares in treasury, at cost:
1997 and 1996 - 1,114,421 shares (32,560) (32,560)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 257,864 144,775
----------- -----------
TOTAL LIABILITIES, PREFERRED SECURITIES OF EXECUTIVE RISK
CAPITAL TRUST AND STOCKHOLDERS' EQUITY $ 1,315,371 $ 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 September 30, Nine Months Ended September 30,
(In thousands, except per share data) 1997 1996 1997 1996
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
REVENUES
Gross premiums written $ 113,692 $ 81,472 $ 308,480 $ 229,511
Premiums ceded (44,606) (28,790) (117,416) (80,664)
--------- --------- --------- ---------
Net premiums written 69,086 52,682 191,064 148,847
Change in unearned premiums (14,299) (11,616) (39,842) (37,443)
--------- --------- --------- ---------
Net premiums earned 54,787 41,066 151,222 111,404
Net investment income 11,682 8,389 33,042 23,214
Net realized capital gains (losses) 587 (218) 1,928 (572)
Other income 35 (152) 150 135
--------- --------- --------- ---------
TOTAL REVENUES 67,091 49,085 186,342 134,181
EXPENSES
Loss and loss adjustment expenses 36,433 27,778 101,543 75,279
Policy acquisition costs 9,085 7,262 24,527 20,231
General and administrative expenses 8,249 4,624 20,334 11,704
Long-term incentive compensation 187
Interest expense 27 1,318 1,446 3,192
Minority Interest in Executive Risk Capital Trust 2,772 7,109
--------- --------- --------- ---------
TOTAL EXPENSES 56,566 40,982 154,959 110,593
--------- --------- --------- ---------
INCOME BEFORE TAXES 10,525 8,103 31,383 23,588
Income tax expense (benefit)
Current 3,751 3,511 10,505 9,145
Deferred (2,141) (2,152) (5,019) (5,086)
--------- --------- --------- ---------
1,610 1,359 5,486 4,059
--------- --------- --------- ---------
NET INCOME $ 8,915 $ 6,744 $ 25,897 $ 19,529
========= ========= ========= =========
Earnings per common and common equivalent share -
assuming full dilution $ 0.83 $ 0.67 $ 2.49 $ 1.83
Weighted average shares outstanding -
assuming full dilution 10,689 10,094 10,410 10,668
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) 1997 1996
--------- ---------
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 25,897 $ 19,529
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization and depreciation 1,816 1,153
Share of income of UPEX (150) (135)
Deferred income taxes (5,019) (5,086)
Amortization of bond premium 1,259 895
Net realized (gains) losses on investments (1,928) 572
Stock based compensation plans 4,380 1,576
Amortization of loan arrangement fees 910
Other 51 (973)
Change in:
Premiums receivable, net of ceded balances payable (4,914) 4,184
Accrued investment income (1,808) 513
Deferred acquisition costs (9,689) (4,743)
Loss and loss adjustment expenses, net of reinsurance recoverables 73,449 64,835
Unearned premiums, net of prepaid reinsurance premiums 39,827 37,443
Accrued expenses and other liabilities (5,046) (4,384)
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 119,035 115,379
INVESTING ACTIVITIES
Proceeds from sales of fixed maturities available for sale 206,782 146,967
Proceeds from sales of equity securities available for sale 1,434
Proceeds from maturities of investment securities 31,678 24,818
Purchase of fixed maturities available for sale (392,234) (235,861)
Purchase of equity securities available for sale (10,102) (8,715)
Net capital expenditures (4,763) (2,369)
Acquisition of the assets of Sullivan, Kelly & Associates, Inc. (2,204)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (169,409) (75,160)
FINANCING ACTIVITIES
Proceeds from exercise of options 3,192 268
Cost of repurchase of Common Stock (75,025)
Placement fees and other (1,476) (191)
Repayment of note payable to bank (70,000) (25,000)
Note payable to bank 70,000
Loan arrangement fees (980)
Proceeds from issuance of Common Stock 68,080
Proceeds from Capital Securities offering 125,000
Proceeds from Over-allotment option exercise 9,675
Dividends paid on Common Stock (591) (602)
--------- ---------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 124,205 (21,855)
--------- ---------
NET INCREASE IN CASH AND SHORT-TERM INVESTMENTS 73,831 18,364
--------- ---------
Cash and short-term investments at beginning of period 24,706 20,244
--------- ---------
CASH AND SHORT-TERM INVESTMENTS AT END OF PERIOD $ 98,537 $ 38,608
========= =========
</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, 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) to certain institutional accredited
investors pursuant to SEC Rule 144A. The Trust used the $125 million of proceeds
received from the sale of the Series A 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 ("Chase"), $45 million to make a
surplus contribution to Executive Risk Indemnity Inc. ("ERII") and $8.5 million
for general corporate purposes. On May 29, 1997, all of the Series A Capital
Securities were exchanged for fully registered Series B Capital Securities (the
"Capital Securities"). The terms of the Capital Securities are identical in all
material respects to the terms of the Series A Capital Securities, except that
the 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.
6
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EXECUTIVE RISK INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
(UNAUDITED)
NOTE 3 - RELATIONSHIP WITH THE 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
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 - COMMON STOCK OFFERING
On September 12, 1997, the Company completed an underwritten public offering of
1,000,000 shares of its Common Stock at $62.25 per share less underwriting
discounts and commissions of $3.05 per share. In connection with this offering,
the Company granted to the underwriters an option to purchase an additional
150,000 shares of its Common Stock, at the same price per share, to cover
over-allotments. Such over-allotment option was exercised in full. In connection
with the offering, the Company received $67.8 million in net proceeds, which
have been used to make capital and surplus contributions to ERII and Executive
Risk (Bermuda) Ltd., a newly formed Bermuda insurance company, which is an
indirect wholly owned subsidiary of the Company, principally utilized as a
reinsurer of ERII business, in order to support existing business lines and to
finance entry into new business lines, and for general corporate purposes.
NOTE 5 - 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 September 30, 1997 and 1996 of $0.91
and $0.72 per share, respectively, and $2.72 and $1.97 for the nine months ended
September 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.
7
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EXECUTIVE RISK INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
(UNAUDITED)
NOTE 6 - SUBSEQUENT EVENT
The Company currently expects to issue up to $75,000,000 aggregate principal
amount of debt securities during the fourth calendar quarter of 1997 or the
first calendar quarter of 1998. 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 debt securities to make surplus contributions
to current 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. On October 27, 1997, in connection with the
anticipated issuance of the debt securities, the Company and Chase entered into
a $50,000,000 sixty day lock based on the ten year United States Treasury note
yield at an annual rate of 6.065%. In the event that the Company does not issue
debt securities prior to the end of the sixty-day period, the Company may elect
to extend the rate lock agreement or enter into a new similar agreement.
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, 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., Quadrant Indemnity Company, a newly formed Connecticut
insurance company owned by ERII, and Executive Risk (Bermuda) Ltd., a newly
formed Bermuda insurance company owned by Executive Re. In addition, the
Company's results include Executive Risk Capital Trust, a Delaware statutory
business trust (the "Trust"), Sullivan Kelly Inc., a California corporation
formed in September 1997 to acquire the assets of Sullivan, Kelly & Associates,
Inc., Insurance Brokers ("Sullivan Kelly") a California underwriting agency and
insurance broker, 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 in UPEX is reported using the equity method of
accounting.
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. The Company is currently in discussions with
AXA-UAP Group regarding the status of UPEX, and it anticipates that the UPEX
joint venture agreement will be terminated as of December 31, 1997. While there
can be no assurance as to the final resolution of these discussions or the terms
of any agreement to terminate or to continue the Company's joint venture with
respect to UPEX, the Company believes that termination of the UPEX joint venture
agreement 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 third quarter of 1997 was $8.9 million, or
$0.83 per share on a fully diluted basis, as compared to $6.7 million, or $0.67
per share on a fully diluted basis, earned in the third quarter of 1996. For the
nine months ended September 30, 1997 and 1996, net income was $25.9 million and
$19.5 million, respectively. Fully diluted earnings per share were $2.49 and
$1.83 for the corresponding periods. The Company's operating earnings,
calculated as net income before one-time expenses associated with the
acquisition of the assets of Sullivan Kelly and realized capital gains or
losses, both net of tax, were $8.9 million, or $0.83 per share on a fully
diluted basis, for the quarter ended September 30, 1997, and $6.9 million, or
$0.68 per share on a fully diluted basis, for the quarter ended
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<PAGE> 10
September 30, 1996. For the nine months ended September 30, 1997, operating
earnings were $25.0 million, or $2.40 per share on a fully diluted basis, as
compared to $19.9 million, or $1.87 per share on a fully diluted basis, for the
first nine months of 1996.
Gross premiums written increased by $32.2 million, or 40%, to $113.7 million in
the third quarter of 1997 from $81.5 million in the third 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").
For the first nine months of 1997, gross premiums written were $308.5 million,
as compared to $229.5 million in the first nine months of 1996.
Ceded premiums increased $15.8 million, or 55%, to $44.6 million in the third
quarter of 1997 from $28.8 million in the third quarter of 1996. The rate of
growth in ceded premiums in the third quarter of 1997 exceeded that of gross
premiums written due to increased cessions on E&O and certain D&O products
partially offset by a reduction in direct D&O cessions to The Aetna Casualty and
Surety Company ("Aetna"). 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 nine months of 1997, ceded premiums totaled
$117.4 million, representing a 46% increase over total ceded premiums of $80.7
million in 1996.
As a result of the foregoing, net premiums written increased $16.4 million, or
31%, to $69.1 million for the quarter ended September 30, 1997 from $52.7
million for the quarter ended September 30, 1996. For the first nine months of
1997, net premiums written totaled $191.1 million, as compared to $148.8 million
for the nine months ended September 30, 1996. Net premiums earned for the third
quarter increased to $54.8 million in 1997 from $41.1 million in 1996.
Year-to-date, net premiums earned increased to $151.2 million in 1997 from
$111.4 million in 1996.
Net investment income increased by $3.3 million, or 39%, to $11.7 million for
the quarter ended September 30, 1997 from $8.4 million for the quarter ended
September 30, 1996. For the first nine months of 1997 and 1996, net investment
income was $33.0 million and $23.2 million, respectively. These increases
resulted principally from growth in invested assets, measured on an amortized
cost basis, from $606.2 million at September 30, 1996 to $912.0 million at
September 30, 1997. The nominal portfolio yield of the fixed maturity portfolio
at September 30, 1997 was 6.16%, compared to 6.26% at September 30, 1996. The
tax equivalent yields on the fixed maturity portfolio were 7.76% and 8.23% for
these periods, respectively.
The Company's net realized capital gains were $0.6 million in the third quarter
of 1997, as compared to net realized capital losses of $0.2 million in the third
quarter of 1996. For the nine months ended September 30, 1997, net realized
capital gains totaled $1.9 million as compared to net realized capital losses of
$0.6 million for the nine months ended September 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 $8.6 million, or 31%,
from $27.8 million in the third quarter of 1996 to $36.4 million in the
comparable period of 1997, due to higher premiums earned. For the nine months
ended September 30, 1997 and 1996, loss and LAE were $101.5 million and $75.3
million, respectively. The Company's loss ratio was 66.5% in the third quarter
of 1997 and 67.1% for the first nine months of 1997 as compared to 67.6% in the
third quarter and first nine 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 $7.4 million, or $0.46 per share on a
fully diluted basis, in the first nine months of 1997. In the first nine months
of 1996, 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. 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 25%, to $9.1 million for
the quarter ended September 30, 1997 from $7.3 million for the quarter ended
September 30, 1996. For the first nine months of 1997 and 1996, policy
acquisition costs totaled $24.5 million and $20.2 million, respectively. The
Company's
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<PAGE> 11
ratio of policy acquisition costs to net premiums earned decreased from 17.7% in
the third quarter of 1996 to 16.6% in the third quarter of 1997. Year-to-date,
the policy acquisition cost ratio decreased from 18.2% in 1996 to 16.2% 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 $3.6 million, or 78%, to
$8.2 million in the third quarter of 1997 from $4.6 million in the third quarter
of 1996. For the nine months ended September 30, 1997 and 1996, G&A expenses
totaled $20.3 million and $11.7 million, respectively. The increase in G&A costs
is due largely to increased compensation, benefit and related overhead costs
associated primarily with the growth in premium volume and the development of
new products. In addition, $0.5 million of one-time expenses were incurred in
the third quarter of 1997 in connection with the acquisition of the assets of
Sullivan Kelly. The ratio of G&A expenses to premiums earned increased from
10.4% for the first nine months of 1996 to 13.5% for the first nine months of
1997.
The GAAP combined ratio increased to 98.1% in the third quarter of 1997 from
96.6% in the third quarter of 1996. For the first nine months of 1997, the GAAP
combined ratio was 96.8%, as compared to 96.2% for the first nine months of
1996. The increase of 1.5 percentage points for the third 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 nine months of 1997 and $3.2
million for the first nine months 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 nine 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
securities of the Trust. See "Liquidity and Capital Resources."
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 $119.0 million for the nine months
ended September 30, 1997 and $115.4 million for the nine months ended September
30, 1996. The modest increase in net operating cash flows resulted principally
from increased net premiums and investment income received partially offset by
higher losses and G&A expenses paid as well as a $9.5 million return of funds
held to an insured under a funds withheld arrangement. 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.
Such capital expenditure needs will include the costs of an addition to the
Company-owned office headquarters building in Simsbury, Connecticut. Site
improvements have begun and bids have been accepted on the first $4 million of
the total estimated cost of $20 million. The project is targeted for completion
in 1999.
10
<PAGE> 12
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,
1997 and December 31, 1996 was 4.8 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 $98.5 million (10.3% of the total
investment portfolio) at September 30, 1997 and $24.7 million (3.6%) at December
31, 1996. The increase in the short-term investment pool was due principally to
that portion of the net proceeds received from a Common Stock offering completed
on September 12, 1997, as discussed below, which has not yet been invested
long-term.
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 September 30, 1997 and December
31, 1996. At September 30, 1997 and December 31, 1996, stockholders' equity was
increased by $16.7 million and $11.9 million, respectively, to report the
Company's fixed maturity investment portfolio at fair value, net of applicable
taxes. At September 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 October 27, 1997, in connection with the
anticipated issuance of debt securities, the Company and Chase entered into a
$50,000,000 sixty day lock based on the ten year United States Treasury note
yield at an annual rate of 6.065%. In the event that the Company does not issue
debt securities prior to the end of the sixty-day period, the Company may elect
to extend the rate lock agreement or enter into a new similar agreement.
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 September 30,
1997, the market values of the equity mutual fund holdings were above the range
of the collar indices by $2.5 million. 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 125,000 8.675% Series A Capital
Securities ($1,000 per Capital Security) to certain institutional accredited
investors pursuant to SEC Rule 144A. The Trust used the $125 million of proceeds
received from the sale of the Series A 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 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 Series A Capital Securities were
exchanged for fully registered Series B Capital Securities (the "Capital
Securities"). The terms of the Capital Securities are identical in all material
respects to the terms of the Series A Capital Securities, except that the
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
11
<PAGE> 13
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 September 12, 1997, the Company completed an underwritten public offering of
1,000,000 shares of its Common Stock at $62.25 per share less underwriting
discounts and commissions of $3.05 per share. In connection with this offering,
the Company granted to the underwriters an option to purchase an additional
150,000 shares of its Common Stock, at the same price per share, to cover
over-allotments. Such over-allotment option was exercised in full. The Company
received $67.8 million in net proceeds from the offering which have been used to
make capital and surplus contributions to ERII and Executive Risk (Bermuda) Ltd.
in order to support existing business lines and to finance entry into new
business lines, and for general corporate purposes.
In addition, the Company currently expects to issue up to $75,000,000 aggregate
principal amount of debt securities during the fourth calendar quarter of 1997
or the first calendar quarter of 1998. 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 debt securities to make surplus contributions
to current 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. On October 27, 1997, in connection with the
anticipated issuance of the debt securities, the Company and Chase entered into
a $50,000,000 sixty day lock based on the ten year United States Treasury note
yield at an annual rate of 6.065%. In the event that the Company does not issue
debt securities prior to the end of the sixty-day period, the Company may elect
to extend the rate lock agreement or enter into a new similar agreement.
On August 8, 1997, the Company declared its third quarter dividend on the
Company's Common Stock of $0.02 per share, which was paid on September 30, 1997
to stockholders of record as of September 15, 1997. Such dividends totaled $0.2
million.
On November 7, 1997, Irving B. Yoskowitz was elected as a member of the Board of
Directors for a term ending at the 1998 annual meeting of stockholders.
PART II - OTHER INFORMATION
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
a) EXHIBIT INDEX
Exhibit No. Description
----------- -----------
15.1 Independent Accountant's Acknowledgment Letter
27 Financial Data Schedule
b) REPORTS ON FORM 8-K
There were no reports on Form 8-K filed during the quarter ended September 30,
1997.
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.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Robert H. Kullas Chairman and Director November 14, 1997
Robert H. Kullas
/s/ Robert V. Deutsch Executive Vice President, November 14, 1997
Robert V. Deutsch Chief Financial Officer,
Chief Actuary, Treasurer
and Assistant Secretary
(Principal Financial
and Accounting Officer)
and Director
13
<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 November 3, 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 September 30, 1997.
/S/ ERNST & YOUNG LLP
Stamford, Connecticut
November 3, 1997
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
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<DEBT-HELD-FOR-SALE> 801,374
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 56,138
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 857,512
<CASH> 98,537
<RECOVER-REINSURE> 2,752
<DEFERRED-ACQUISITION> 32,385
<TOTAL-ASSETS> 1,315,371
<POLICY-LOSSES> 591,058
<UNEARNED-PREMIUMS> 263,164
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
125,000
0
<COMMON> 119
<OTHER-SE> 257,745
<TOTAL-LIABILITY-AND-EQUITY> 1,315,371
151,222
<INVESTMENT-INCOME> 33,042
<INVESTMENT-GAINS> 1,928
<OTHER-INCOME> 150
<BENEFITS> 101,543
<UNDERWRITING-AMORTIZATION> 24,527
<UNDERWRITING-OTHER> 28,889
<INCOME-PRETAX> 31,383
<INCOME-TAX> 5,486
<INCOME-CONTINUING> 25,897
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 25,897
<EPS-PRIMARY> 2.50
<EPS-DILUTED> 2.49
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
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</TABLE>
