<PAGE>
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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 quarterly period ended September 30, 1997.
Or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period __________________ to _____________________
Commission file number: 0-26456
RISK CAPITAL HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
Delaware 06-1424716
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
20 Horseneck Lane
Greenwich, Connecticut 06830
(Address of principal executive offices) (Zip Code)
</TABLE>
Registrant's telephone number, including area code: (203) 862-4300
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
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___
Indicate the number of shares outstanding of each of the issuer's classes of
common stock.
<TABLE>
Class Outstanding at September 30, 1997
----- ----------------------------------
<S> <C>
Common Stock, $.01 par value 17,034,753
</TABLE>
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RISK CAPITAL HOLDINGS, INC.
INDEX
<TABLE>
<CAPTION>
PAGE
NO.
-----
<S> <C>
PART I. Financial Information
Item 1--Consolidated Financial Statements
Review Report of Independent Accountants 1
Consolidated Statement of Income 2
For the three and nine month periods ended September 30, 1997 and 1996
Consolidated Balance Sheet 3
September 30, 1997 and December 31, 1996
Consolidated Statement of Changes in Stockholders' Equity
For the nine month periods ended September 30, 1997 and 1996 4
Consolidated Statement of Cash Flows
For the nine month periods ended September 30, 1997 and 1996 5
Notes to Consolidated Financial Statements 6
Item 2--Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
PART II. Other Information
Item 6--Exhibits and Reports on Form 8-K 18
Signatures 19
</TABLE>
<PAGE>
REVIEW REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Risk Capital Holdings, Inc.
We have reviewed the accompanying interim consolidated balance sheet of Risk
Capital Holdings, Inc. and its subsidiary as of September 30, 1997, and the
related consolidated statements of income, of changes in stockholders' equity
and of cash flows for the period from January 1, 1997 to September 30, 1997.
This financial information is the responsibility of the Company's management.
We conducted our review 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, the objective of which is
the expression of an opinion regarding the 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 information for it to
be in conformity with generally accepted accounting principles.
We previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet as of December 31, 1996, and the
related consolidated statements of income, of retained earnings, and of 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. In our opinion, the information set forth in the
accompanying condensed consolidated balance sheet as of December 31, 1996, is
fairly stated in all material respects in relation to the consolidated balance
sheet from which it has been derived.
PRICE WATERHOUSE LLP
New York, New York
October 29, 1997
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF INCOME
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ---------------------------------
1997 1996 1997 1996
------------ -------------- ------------------ -------------
<S> <C> <C> <C> <C>
Premiums and Other Revenues
Net premiums written............................. $ 34,906 $ 29,938 $ 98,862 $ 53,509
Increase in unearned premiums.................... (10,251) (17,310) (33,234) (35,270)
------------ -------------- ------------------ ------------
Net premiums earned.............................. 24,655 12,628 65,628 18,239
Net investment income............................ 3,798 3,289 10,774 9,833
Net investment gains/(losses).................... 4,062 (109) 3,617 145
------------ -------------- ------------------ ------------
Total revenues................................... 32,515 15,808 80,019 28,217
Expenses
Claims and claims expenses....................... 18,041 8,240 45,992 12,286
Commissions and brokerage........................ 6,217 3,752 17,740 5,241
Other operating expenses......................... 3,397 2,894 10,842 8,018
------------ -------------- ------------------ ------------
Total expenses................................... 27,655 14,886 74,574 25,545
Income Before Income Taxes and Equity in Net
Losses of Investees............................ 4,860 922 5,445 2,672
Federal income taxes:
Current.......................................... 507 600 1,182 1,477
Deferred......................................... 930 (597) (7) (1,516)
------------ -------------- ------------------ ------------
Income tax expense (benefit)..................... 1,437 3 1,175 (39)
------------ -------------- ------------------ ------------
Income Before Equity in Net Loss of Investees.... 3,423 919 4,270 2,711
Equity in net loss of investees.................. (168) (473)
------------ -------------- ------------------ ------------
Net Income....................................... $ 3,255 $ 919 $ 3,797 $ 2,711
------------ -------------- ------------------ ------------
------------ -------------- ------------------ ------------
Per Share Data Primary and fully diluted
Net income....................................... $ 0.19 $ 0.05 $ 0.22 $ 0.16
------------ -------------- ------------------ ------------
------------ -------------- ------------------ ------------
Operating income: net income excluding net
investment gains/(losses) and equity in net
loss of investees.............................. $ 0.05 $ 0.06 $ 0.11 $ 0.15
------------ -------------- ------------------ ------------
------------ -------------- ------------------ ------------
Average shares outstanding....................... 17,034,977 16,994,948 17,027,778 16,971,827
------------ -------------- ------------------ ------------
------------ -------------- ------------------ ------------
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
(in thousands, except per share data)
<TABLE>
<CAPTION>
(unaudited)
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
ASSETS
Investments:
Fixed maturities
(amortized cost: 1997, $131,393; 1996, $140,128)................................................... $ 132,945 $ 140,381
Publicly traded equity securities
(cost: 1997, $115,101; 1996, $108,580)............................................................. 174,302 117,360
Privately held securities
(cost: 1997, $44,043; 1996, $23,363)............................................................... 57,760 28,847
Short-term investments............................................................................... 110,893 104,886
--------- ---------
Total investments.................................................................................. 475,900 391,474
--------- ---------
Cash................................................................................................. 4,090 1,466
Accrued investment income............................................................................ 2,706 2,151
Investment accounts receivable....................................................................... 1,738 560
Premiums receivable.................................................................................. 47,296 23,669
Prepaid reinsurance premiums......................................................................... 1,296 576
Reinsurance recoverable.............................................................................. 353 522
Deferred policy acquisition costs.................................................................... 15,500 7,018
Other assets......................................................................................... 8,309 5,050
--------- ---------
Total Assets......................................................................................... $ 557,188 $ 432,486
--------- ---------
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LIABILITIES
Claims and claims expenses........................................................................... $ 52,733 $ 20,770
Unearned premiums.................................................................................... 71,301 37,348
Reinsurance premiums payable......................................................................... 536
Contingent commissions payable....................................................................... 5,964 2,734
Investment accounts payable.......................................................................... 2,649 10,598
Deferred income tax liability........................................................................ 23,747 3,026
Other liabilities.................................................................................... 4,594 5,261
--------- ---------
Total liabilities.................................................................................. 160,988 80,273
--------- ---------
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value:
20,000,000 shares authorized (none issued)
Common stock, $.01 par value:
80,000,000 shares authorized
(1997, 17,045,246; 1996, 17,031,246 shares issued)................................................. 170 170
Additional paid-in capital........................................................................... 340,715 340,435
Unrealized appreciation of investments, net of income tax............................................ 48,406 9,436
Deferred compensation under stock award plan......................................................... (1,841) (2,959)
Retained earnings.................................................................................... 8,928 5,131
Less treasury stock, at cost (1997, 10,493 shares)................................................... (178)
--------- ---------
Total stockholders' equity........................................................................... 396,200 352,213
--------- ---------
Total liabilities & stockholders' equity............................................................. $ 557,188 $ 432,486
--------- ---------
--------- ---------
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3
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RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------
<S> <C> <C>
1997 1996
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Common Stock
Balance at beginning of year............................................................ $ 170 $ 169
Issuance of common stock................................................................ 1
---------- ----------
Balance at end of period................................................................ 170 170
---------- ----------
Additional Paid-in Capital
Balance at beginning of year............................................................ 340,435 338,737
Issuance of common stock................................................................ 280 1,197
---------- ----------
Balance at end of period................................................................ 340,715 339,934
---------- ----------
Unrealized Appreciation of Investments, Net of Income Tax
Balance at beginning of year............................................................ 9,436 3,731
Change in unrealized appreciation....................................................... 38,970 3,780
---------- ----------
Balance at end of period................................................................ 48,406 7,511
---------- ----------
Deferred Compensation Under Stock Award Plan
Balance at beginning of year............................................................ (2,959) (3,441)
Restricted common stock issued.......................................................... (280) (1,196)
Compensation expense recognized......................................................... 1,398 1,559
---------- ----------
Balance at end of period................................................................ (1,841) (3,078)
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Retained Earnings
Balance at beginning of year............................................................ 5,131 1,019
Net income.............................................................................. 3,797 2,711
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Balance at end of period................................................................ 8,928 3,730
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Treasury Stock, At Cost
Balance at beginning of year
Purchase of treasury shares............................................................. (178)
---------- ----------
Balance at end of period................................................................ (178)
---------- ----------
Total Stockholders' Equity
Balance at beginning of year............................................................ 352,213 340,215
Issuance of common stock................................................................ 280 1,198
Change in unrealized appreciation of investments, net of income tax..................... 38,970 3,780
Change in deferred compensation......................................................... 1,118 363
Net income.............................................................................. 3,797 2,711
Purchase of treasury stock.............................................................. (178)
---------- ----------
Balance at end of period................................................................ $ 396,200 $ 348,267
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</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------
<S> <C> <C>
1997 1996
---------- ----------
OPERATING ACTIVITIES
Net income................................................................................ $ 3,797 $ 2,711
Adjustments to reconcile net income to net cash provided by operating activities:
Liability for claims and claims expenses, net........................................... 31,963 11,125
Unearned premiums....................................................................... 33,953 35,270
Premiums receivable..................................................................... (23,627) (15,372)
Funds held receivable................................................................... (625) (615)
Accrued investment income............................................................... (555) 313
Contingent commissions payable.......................................................... 3,230
Reinsurance balances, net............................................................... (1,086) 279
Deferred policy acquisition costs....................................................... (8,482) (5,701)
Net investment gains.................................................................... (3,617) (145)
Deferred income tax asset............................................................... (261) (1,516)
Other liabilities....................................................................... (667) (65)
Other items, net........................................................................ (3,341) (1,758)
---------- ----------
NET CASH PROVIDED BY OPERATING ACTIVITIES................................................. 30,682 24,526
---------- ----------
INVESTING ACTIVITIES
Purchases of fixed maturity investments................................................... (172,367) (199,355)
Sales of fixed maturity investments....................................................... 172,973 188,449
Net (purchases)/sales of short-term investments........................................... (2,830) 81,096
Purchases of equity securities............................................................ (55,853) (103,876)
Sales of equity securities................................................................ 30,740 9,017
Purchases of furniture and equipment...................................................... (543) (702)
---------- ----------
NET CASH USED FOR INVESTING ACTIVITIES.................................................... (27,880) (25,371)
---------- ----------
FINANCING ACTIVITIES
Common stock issued....................................................................... 280 1,198
Purchase of treasury stock................................................................ (178)
Deferred compensation on restricted stock................................................. (280) (1,196)
---------- ----------
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES...................................... (178) 2
---------- ----------
Increase (decrease) in cash............................................................... 2,624 (843)
Cash beginning of year.................................................................... 1,466 982
---------- ----------
Cash end of period........................................................................ $ 4,090 $ 139
---------- ----------
---------- ----------
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
Risk Capital Holdings, Inc. ("RCHI"), incorporated in March 1995 under the
laws of the State of Delaware, is a holding company whose wholly owned
subsidiary, Risk Capital Reinsurance Company ("Risk Capital Reinsurance"), a
Nebraska corporation, was formed to provide, on a global basis, property and
casualty reinsurance and other forms of capital, either on a stand-alone
basis or as part of integrated capital solutions for insurance companies with
capital needs that cannot be met by reinsurance alone. (RCHI and Risk Capital
Reinsurance are collectively referred to herein as the "Company.") In
September 1995, through its initial public offering, related exercise of the
underwriters' over-allotment option and direct sales of an aggregate of
16,750,625 shares of RCHI's common stock, par value $.01 per share (the
"Common Stock"), at $20 per share, and the issuance of warrants, RCHI was
capitalized with net proceeds of approximately $335.0 million, of which
$328.0 million was contributed to the statutory capital of Risk Capital
Reinsurance.
Class A warrants to purchase an aggregate of 2,531,079 shares of Common Stock
and Class B warrants to purchase an aggregate of 1,920,601 shares of Common
Stock were issued in connection with the direct sales. Class A warrants are
immediately exercisable at $20 per share and expire September 19, 2002. Class
B warrants are exercisable at $20 per share during the seven year period
commencing September 19, 1998, provided that the Common Stock has traded at
or above $30 per share for 20 out of 30 consecutive trading days.
2. GENERAL
The accompanying interim consolidated financial statements have been prepared
in conformity with generally accepted accounting principles and in the
opinion of management, reflect all adjustments necessary (consisting of
normal recurring accruals) for a fair presentation of results for such
periods. These consolidated financial statements should be read in
conjunction with the 1996 consolidated financial statements and related notes
contained in the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1996.
3. PER SHARE DATA
Earnings per share are computed based on the weighted average number of
shares of Common Stock and common stock equivalents outstanding during the
period using the modified treasury stock method. Stock options and Class A
and B warrants to purchase Common Stock are considered to be common stock
equivalents. The common stock equivalents were anti-dilutive, and thus not
included in the weighted average shares outstanding.
6
<PAGE>
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128 "Earnings Per
Share." This statement replaces the historical presentation of "primary"
earnings per share with the caption "basic" earnings per share. Basic
earnings per share excludes dilution and is computed by dividing net income
by the weighted average number of shares outstanding for the period. SFAS No.
128 is effective for financial statements issued for periods ending after
December 15, 1997, with early adoption prohibited. Upon adoption, all prior
period earnings per share amounts will be restated.
The Company's primary and fully diluted earnings per share amounts as
previously reported are not expected to differ materially from the basic and
diluted amounts required by SFAS No. 128.
In June 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive Income".
This statement establishes standards for the reporting of comprehensive
income and its components. Comprehensive income is defined as the change in
equity during a period resulting from transactions and other events from
nonowner sources. SFAS No. 130 is effective for fiscal years beginning after
December 15, 1997. Reclassification of financial statements for earlier
periods provided for comparative purposes is required. The Company will apply
the provisions of the statement beginning in 1998.
Currently, comprehensive income for the Company would consist of net income
and the change in unrealized appreciation or depreciation of investments, net
of income tax, as follows:
<TABLE>
<CAPTION>
(IN THOUSANDS)
---------------------------------
NINE MONTHS ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
-------------------- ----------------------
1997 1996 1996 1995 (1)
--------- --------- --------- -----------
<S> <C> <C> <C> <C>
Net income............................................................... $ 3,797 $ 2,711 $ 4,112 $ 1,019
Change in unrealized appreciation (depreciation), net of income tax...... 38,970 3,780 5,705 3,731
--------- --------- --------- -----------
Comprehensive income (loss).............................................. $ 42,767 $ 6,491 $ 9,817 $ 4,750
--------- --------- --------- -----------
--------- --------- --------- -----------
Per share amounts:
Net income............................................................... $ 0.22 $ 0.16 $ 0.24 $ 0.06
Change in unrealized appreciation (depreciation), net of income tax...... 2.29 .22 0.34 0.22
--------- --------- --------- -----------
Comprehensive income (loss).............................................. $ 2.51 $ 0.38 $ 0.58 $ 0.28
--------- --------- --------- -----------
--------- --------- --------- -----------
</TABLE>
- ------------------------
(1) For the period from June 23, 1995 (date of inception) to December 31, 1995
7
<PAGE>
4. INVESTMENT INFORMATION
The Company classifies all of its publicly traded fixed maturity and equity
securities as "available for sale" and accordingly, they are carried at
estimated fair value. The fair value of publicly traded fixed maturity
securities and publicly traded equity securities is estimated using quoted
market prices or dealer quotes. Short-term investments, which have a maturity
of one year or less at the date of acquisition, are carried at cost, which
approximates fair value.
All of the Company's publicly traded equity securities and privately held
securities were issued by insurance and reinsurance companies or companies
providing services to the insurance industry. At September 30, 1997, the
publicly traded equity portfolio consisted of 11 investments, with estimated
fair values ranging individually from $2.8 million to $25.1 million.
Investments in privately held securities, issued by privately and publicly
held companies, may include both equity securities and securities convertible
into, or exercisable for, equity securities (some of which may have fixed
maturities). Privately held securities are subject to trading restrictions or
are otherwise illiquid and do not have readily ascertainable market values.
The risk of investing in such securities is generally greater than the risk
of investing in securities of widely held, publicly traded companies. Lack of
a secondary market and resale restrictions may result in the Company's
inability to sell a security at a price that would otherwise be obtainable if
such restrictions did not exist and may substantially delay the sale of a
security which the Company seeks to sell. Such investments are classified as
"available for sale" and carried at estimated fair value, except for
investments in which the Company believes it has the ability to exercise
significant influence (generally defined as investments in which the Company
owns 20% or more of the outstanding voting common stock of the issuer), which
are carried under the equity method of accounting. Under this method, the
Company records its proportionate share of income or loss for such
investments in results of operations.
The estimated fair value of investments in privately held securities, other
than those carried under the equity method, is initially equal to the cost of
such investments until the investments are revalued based principally on
substantive events or other factors which could indicate a diminution or
appreciation in value, such as an arm's-length third party transaction
justifying an increased valuation or adverse development of a significant
nature requiring a write down. The Company periodically reviews the valuation
of investments in privately held securities with Marsh & McLennan Risk
Capital Corp., its equity investment advisor.
8
<PAGE>
Privately held securities consisted of the following:
<TABLE>
<CAPTION>
(IN THOUSANDS)
---------------------------
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
<S> <C> <C>
Equity Securities:
Carried under the equity method:
The ARC Group, LLC.................................................................. $ 9,855
Capital Protection Insurance Services, LLC.......................................... 144
First American Financial Corporation................................................ 6,362
Insurance Investment Group, L.P..................................................... $ 180
Island Heritage Insurance Company, Ltd.............................................. 4,019 4,269
New Europe Insurance Ventures....................................................... 743
Providers' Assurance Corporation.................................................... 3,749
Carried at fair value:
Peregrine Russell Miller Insurance Fund of Asia Limited............................. 6,591 7,465
Terra Nova (Bermuda) Holdings, Ltd.................................................. 21,590 15,870
Sovereign Risk Insurance, Ltd....................................................... 237
Venton Holdings, Ltd................................................................ 4,470 1,063
------------- ------------
Total privately held equities..................................................... $ 57,760 $ 28,847
------------- ------------
------------- ------------
</TABLE>
At September 30, 1997, the Company had investment commitments relating to its
privately held securities totaling approximately $18 million, compared to $22
million at December 31, 1996.
Set forth below is certain information relating to each of the Company's
investments in privately held securities which occurred during the third
quarter of 1997:
INSURANCE INVESTMENT GROUP, LP
During the 1997 third quarter, the Company determined to terminate its
participation in this investment and recorded a realized loss of $312,000
during the quarter, which represents the Company's initial funding amount of
$180,000 and an estimate of additional costs the Company expected to incur in
exiting the partnership.
Sovereign Risk Insurance, Ltd.
In July 1997, the Company purchased its 9.5% ownership interest in Sovereign
Risk Insurance Ltd. ("Sovereign Risk") for $237,500. Sovereign Risk is
located in Bermuda and was formed to provide underwriting services for
political risk insurance coverages for ACE Insurance Company, Ltd., X.L.
Insurance Company, Ltd. and Risk Capital Reinsurance.
5. STATUTORY DATA
The statutory capital and surplus of Risk Capital Reinsurance at September
30, 1997 was $386.1 million, compared to $334.3 million at December 31, 1996.
The statutory net loss for the nine month period ended September 30, 1997 was
$4.3 million, compared to a net loss of $4.5 million in the prior year
period. The growth in surplus during the first nine months of 1997 is
primarily from unrealized appreciation of the Company's public equity
portfolio.
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
General
THE COMPANY
Risk Capital Holdings, Inc. ("RCHI") is the holding company for Risk Capital
Reinsurance Company ("Risk Capital Reinsurance"), RCHI's wholly owned
subsidiary which is domiciled in Nebraska. (RCHI and Risk Capital Reinsurance
are collectively referred to herein as the "Company".) RCHI was incorporated
in March 1995 and commenced operations during September 1995 upon completion
of its initial public offering and related exercise of the underwriters'
over-allotment option and direct sales of an aggregate of 16,750,625 shares
of RCHI's common stock, par value $.01 per share, at $20 per share, and the
issuance of warrants (collectively, the "Offerings"). RCHI received aggregate
net proceeds from the Offerings of approximately $335.0 million, of which
$328.0 million was contributed to the capital of Risk Capital Reinsurance. On
November 6, 1995, Risk Capital Reinsurance was licensed under the insurance
laws of the State of Nebraska.
RECENT INDUSTRY PERFORMANCE
The property and casualty reinsurance industry has been highly cyclical. This
cyclicality has produced periods characterized by intense price competition
due to excessive underwriting capacity as well as periods when shortage of
capacity permitted favorable premium levels. Demand for reinsurance is
influenced significantly by underwriting results of primary property and
casualty insurers and prevailing general economic and market conditions, all
of which affect liability retention decisions of primary insurers and
reinsurance premium rates. The supply of reinsurance is related directly to
prevailing prices and levels of surplus capacity, which, in turn, may
fluctuate in response to changes in rates of return on investments being
realized in the reinsurance industry. The cyclical trends in the industry and
the industry's profitability can also be affected significantly by volatile
and unpredictable developments, including changes in the propensity of courts
to grant larger awards, natural disasters (such as catastrophic hurricanes,
windstorms, earthquakes, floods and fires), fluctuations in interest rates
and other changes in the investment environment that affect market prices of
investments and the income and returns on investments, and inflationary
pressures that may tend to affect the size of losses experienced by ceding
primary insurers.
Reinsurance treaties that are placed by intermediaries are typically for one
year terms with a substantial number that are written or renewed on January 1
each year. Other significant renewal dates include April 1, July 1 and
October 1. Thus far, the 1997 renewal periods have been marked by continuing
intensified competitive conditions in terms of premium rates and treaty terms
and conditions in both the property and casualty segments of the marketplace.
These conditions have worsened due to large domestic primary companies
retaining more of their business and ceding less premiums to reinsurers.
While the Company is initially somewhat disadvantaged compared with many of
its competitors, which are larger, have greater resources and longer
operating histories than the Company, it believes it has been able to
generate attractive opportunities in the marketplace due to its substantial
unencumbered capital base, experienced management team and relationship with
its equity investment advisor as well as its strategic focus on generating a
small number of large reinsurance treaty transactions that may also be
integrated with an equity investment in client companies.
10
<PAGE>
As of October 30, 1997, the Company had 72 in-force treaties, with
approximately $160 million of annualized in-force premiums. Such in-force
premiums represent estimated annualized premiums from treaties entered into
during 1996 and the 1997 renewal periods that are expected to generate net
premiums written during calendar year 1997. All except one of such treaties
are subject to renewal.
RESULTS OF OPERATIONS
For the nine month periods ended September 30, 1997 and 1996, the Company had
consolidated net income of approximately $3.8 million, or $0.22 per share,
and $2.7 million, or $0.16 per share, respectively. After-tax realized
investment gains of $2.4 million, or $0.14 per share, for the first nine
months of 1997, compare with a net investment gain of $94,000, or $0.01 per
share, for the same prior year period. Net income for the first nine months
of 1997 included an after-tax loss of $0.5 million, or $0.02 per share,
representing the Company's equity in the net loss of investee companies,
which are accounted for under the equity method of accounting.
The Company believes that the results of operations for the nine months ended
September 30, 1997 are not necessarily indicative of its future financial
results due to a number of factors, including (i) the increase in net
premiums written indicated by the Company's January 1 and subsequent 1997
renewal season activity, (ii) the Company's emphasis on targeting casualty
business that is longer-tail than its current mix of business and (iii) the
Company's investment strategy. Increased premium writings, particularly
longer-tail casualty business, can generally be expected to generate higher
underwriting losses because of the related requirement to establish claims
liabilities that are adequate to cover the costs of anticipated future claim
payments without taking into account the time value of money.
The amount of investment income earned that may offset underwriting losses
from quarter to quarter could vary and diminish as the Company continues to
employ its strategy of investing a substantial portion of its investment
portfolio in publicly traded and privately held equity securities of
insurance companies and insurance-related entities. Investments in equity
securities yield less current investment income than fixed maturity
investments. Variability and declines in the Company's results of operations
could be further exacerbated by private equity investments in start-up
companies which are accounted for under the equity method. Such start-up
companies may be expected to initially generate operating losses. The
Company's results may also be impacted by currency gains and losses for
business transacted in currencies other than U.S. dollars. Accordingly, the
Company's results of operations for the year ending December 31, 1997 may
vary from quarter to quarter and from the financial results reported by the
Company in 1996, and could also produce operating losses.
At September 30, 1997, primary and fully-diluted book value per share were
$23.26 and $22.35, respectively, which compare with primary and fully-diluted
book value per share of $20.68 at December 31, 1996. For the first nine
months of 1997, unrealized appreciation increased by $39.0 million, net of
tax, or $2.29 per share. Included in the change in unrealized appreciation
for the 1997 nine-month period is an unrealized gain, net of tax, of $2.2
million, or $0.13 per share, relating to the Company's privately held equity
investment in Venton Holdings, Ltd.
11
<PAGE>
Unrealized appreciation or depreciation of investments to the extent that it
occurs for investments carried at fair value is recorded in a separate component
of stockholders' equity, net of related deferred income taxes. Such gains or
losses are recorded in net income to the extent investments are sold. The timing
and recognition of such gains and losses are unpredictable and not indicative of
future operating results.
NET PREMIUMS WRITTEN
Net premiums written for the nine month periods ended September 30, 1997 and
1996 were as follows:
<TABLE>
<CAPTION>
(IN MILLIONS)
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Property....................................... $ 14.1 $ 12.4
Casualty....................................... 50.8 11.3
Multi-line..................................... 24.6 18.7
Specialty...................................... 8.1 11.1
Marine......................................... 1.3
--------- ---------
Total.......................................... $ 98.9 $ 53.5
--------- ---------
--------- ---------
</TABLE>
Approximately 29% of net premiums written in the first nine months of 1997
was from non-U.S. clients, compared with 32% in the first nine months of 1996.
Set forth below is the Company's statutory composite ratios for the nine
month periods ended September 30, 1997 and 1996:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Claims and claims expense ratio............................ 70.1% 67.4%
Commissions and brokerage ratio............................ 26.5% 20.4%
Operating expense ratio.................................... 10.0% 14.7%
--------- ---------
Statutory composite ratio.................................. 106.6% 102.5%
--------- ---------
--------- ---------
</TABLE>
Given the low level of premium volume the Company may initially generate and
the long-term nature of the casualty business which the Company seeks to
write, it is likely that earned premiums will be insufficient to cover claims
costs, acquisition costs and operating expenses, thereby resulting in
continued underwriting losses in 1997.
In pricing its reinsurance treaties, the Company focuses on many factors,
including exposure to claims and commissions and brokerage expenses.
Commissions and brokerage expenses are acquisition costs that generally vary
by the type of treaty and line of business, and are considered by the
Company's underwriting and actuarial staff in evaluating the adequacy of
premium writings.
12
<PAGE>
Other operating expenses increased to $10.8 million for the first nine months
of 1997, compared to $8.0 million for the 1996 prior year period. Assuming
the successful execution of the Company's business strategy, the Company
expects other operating expenses to grow commensurate with growing
operations, but expects other operating expenses to decline moderately as a
percentage of net premiums written because increases in premium writings are
generally expected to exceed the growth in such expenses.
Included in 1997 other operating expenses is a pre-tax foreign exchange loss
of $654,000. Such loss is principally related to assets and premiums
receivable of approximately $5.8 million denominated in European Currency
Units ("ECU's"), which is recorded separately from statutory underwriting
results and therefore excluded from the statutory composite ratio. Unhedged
monetary assets and liabilities are translated at the exchange rate in effect
at the balance sheet date, with the resulting foreign exchange gains or
losses recognized in income. Such future gains or losses are unpredictable,
and could be material.
INVESTMENT RESULTS
At September 30, 1997, approximately 51% of the Company's invested assets,
short-term investments and cash consisted of fixed maturity and short-term
investments compared to 63% at the end of 1996. Net investment income for the
first nine months of 1997 was approximately $10.8 million, compared to $9.8
million for the prior year period. The amount of investment income from
quarter to quarter could vary and diminish as the Company continues to employ
its strategy of investing a substantial portion of its investment portfolio
in publicly traded and privately held equity securities of insurance
companies which generally yield less current investment income than fixed
maturity investments. Unrealized appreciation or depreciation of such
investments to the extent that it occurs is recorded in a separate component
of stockholders' equity, net of related deferred income taxes. Gains or
losses are recorded in net income to the extent investments are sold, but the
recognition of such gains and losses is unpredictable and not indicative of
future operating results.
INCOME TAXES
The Company's effective tax rates for the first nine months of 1997 and 1996
are less than the 35% statutory rate on pre-tax operating income due to tax
exempt income and the dividends received deductions. The gross deferred
income tax benefits for the first nine months of 1997 and 1996 of
approximately $262,000 and $1.5 million, respectively, which are assets
considered recoverable from future taxable income, resulted principally from
temporary differences between financial and taxable income. Temporary
differences include, among other things, charges for restricted stock grants
which are not deductible for income tax purposes until vested (vesting of
existing restricted stock grants will occur over a five-year period), as well
as charges for a portion of unearned premiums and claims reserves and equity
in net loss of investees.
13
<PAGE>
INVESTMENTS
A principal component of the Company's investment strategy is investing a
significant portion of invested assets in publicly traded and privately held
equity securities, primarily issued by insurance and reinsurance companies
and companies providing services to the insurance industry. Cash and fixed
maturity investments and, if necessary, the sale of publicly traded equity
securities will be used to support shorter-term liquidity requirements.
As a significant portion of the Company's investment portfolio will generally
be equity securities issued by insurance and reinsurance companies and
companies providing services to the insurance industry, the equity portfolio
lacks industry diversification and will be particularly subject to the
cyclicallity of the insurance industry. Unlike fixed income securities,
equity securities such as common stocks, including the equity securities in
which the Company may invest, generally are not and will not be rated by any
nationally recognized rating service. The values of equity securities
generally are more dependent on the financial condition of the issuer and
less dependent on fluctuations in interest rates than are the values of fixed
income securities. The market value of equity securities generally is
regarded as more volatile than the market value of fixed income securities.
The effects of such volatility on the Company's equity portfolio could be
exacerbated to the extent that such portfolio is concentrated in the
insurance industry and in relatively few issuers.
As the Company's investment strategy is to invest a significant portion of
its investment portfolio in equity securities, its investment income in any
fiscal period may be smaller, as a percentage of investments, and less
predictable than that of other insurance companies, and net realized and
unrealized gains (losses) on investments may have a greater effect on the
Company's results of operations or stockholders' equity at the end of any
fiscal period than other insurance and/or reinsurance companies. Because the
realization of gains and losses on equity investments is not generally
predictable, such gains and losses may differ significantly from period to
period.
Investments included in the Company's private portfolio include securities
issued by privately held companies and securities issued by public companies
that are generally restricted as to resale or are otherwise illiquid and do
not have readily ascertainable market values. The risk of investing in such
securities is generally greater than the risk of investing in securities of
widely held, publicly traded companies. Lack of a secondary market and resale
restrictions may result in the Company's inability to sell a security at a
price that would otherwise be obtainable if such restrictions did not exist
and may substantially delay the sale of a security the Company seeks to sell.
At September 30, 1997, cash and invested assets totaled approximately $480.0
million, consisting of $115.0 million of cash and short-term investments,
$132.9 million of publicly traded fixed maturity investments, $174.3 million
of publicly traded equity securities and $57.8 million of privately held
securities.
14
<PAGE>
During the first nine months of 1997, the Company allocated approximately
$5.3 million from its short-term portfolio to publicly traded equity
securities, and an additional $22.6 million to fund investments in privately
held securities. Funds allocated from the short-term portfolio to publicly
traded equity securities are net of proceeds generated from sales in the
public portfolio. See Note 4 under the caption "Investment Information" of
the accompanying Notes to Consolidated Financial Statements for certain
information regarding the Company's privately held securities and their
carrying values. During the remainder of 1997 and over the long-term, the
Company intends to continue to allocate a substantial portion of its cash and
short-term investments into publicly traded and privately held equity
securities, subject to market conditions and opportunities in the marketplace.
At September 30, 1997, the publicly traded equity portfolio consisted of
investments in 11 publicly traded domestic insurers, reinsurers, or companies
providing services to the insurance industry. The estimated fair values of
such investments ranged individually from $2.8 million to $25.1 million. The
fixed maturity and short-term investments were all rated investment grade by
Moody's Investors Service, Inc. or Standard & Poor's Corporation and have an
average quality rating of AA and an average duration of approximately 2.2
years.
The Company's pre-tax and net of tax investment yields in the first nine
months of 1997 were 3.7% and 2.7%, respectively, compared to 3.8% and 2.8%,
respectively, for the same prior year period. Assuming a stable interest rate
environment, the Company anticipates such yields to moderately decline as
funds invested in short-term securities are allocated into equity securities.
The Company has not invested in derivative financial instruments such as
futures, forward contracts, swaps, or options or other financial instruments
with similar characteristics such as interest rate caps or floors and
fixed-rate loan commitments.
Liquidity and Capital Resources
RCHI is a holding company and has no significant operations or assets other
than its ownership of all of the capital stock of Risk Capital Reinsurance,
whose primary and predominant business activity is providing reinsurance, and
other forms of capital, to insurance and reinsurance companies and making
investments in insurance-related companies. RCHI will rely on cash dividends
and distributions from Risk Capital Reinsurance to pay any cash dividends to
stockholders of RCHI and to pay any operating expense that RCHI may incur.
The payment of dividends by RCHI will be dependent upon the ability of Risk
Capital Reinsurance to provide funds to RCHI. The ability of Risk Capital
Reinsurance to pay dividends or make distributions to RCHI is dependent upon
its ability to achieve satisfactory underwriting and investment results and
to meet certain regulatory standards of the State of Nebraska. There are
presently no contractual restrictions on the payment of dividends or the
making of distributions by Risk Capital Reinsurance to RCHI.
15
<PAGE>
Nebraska insurance laws provide that, without prior approval of the Nebraska
Director of Insurance (the "Nebraska Director"), Risk Capital Reinsurance
cannot pay a dividend or make a distribution (together with other dividends
or distributions paid during the preceding 12 months) that exceeds the
greater of (i) 10% of statutory surplus as of the preceding December 31 or
(ii) statutory net income from operations from the preceding calendar year
not including realized capital gains. Net income (exclusive of realized
capital gains) not previously distributed or paid as dividends from the
preceding two calendar years may be carried forward for dividends and
distribution purposes. Any proposed dividend or distribution in excess of
such amount is called an "extraordinary" dividend or distribution and may not
be paid until either it has been approved, or a 30-day waiting period has
passed during which it has not been disapproved, by the Nebraska Director.
Notwithstanding the foregoing, Nebraska insurance laws provide that any
distribution that is a dividend may be paid by Risk Capital Reinsurance only
out of earned surplus arising from its business, which is defined as
unassigned funds (surplus) as reported in the statutory financial statement
filed by Risk Capital Reinsurance with the Nebraska Insurance Department for
the most recent year. In addition, Nebraska insurance laws also provide that
any distribution that is a dividend and that is in excess of Risk Capital
Reinsurance's unassigned funds, exclusive of any surplus arising from
unrealized capital gains or revaluation of assets, will be deemed an
"extraordinary" dividend subject to the foregoing requirements.
RCHI and Risk Capital Reinsurance file consolidated federal income tax
returns and have entered into a tax sharing agreement (the "Tax Sharing
Agreement"), allocating the consolidated income tax liability on a separate
return basis. Pursuant to the Tax Sharing Agreement, Risk Capital Reinsurance
makes tax sharing payments to RCHI based on such allocation.
Net cash flow from operating activities for the nine months ended September
30, 1997 was $30.7 million, compared with $24.5 million in the prior year
period.
The primary sources of liquidity for Risk Capital Reinsurance are net cash
flow from operating activities, principally premiums received, the receipt of
dividends and interest on investments and proceeds from the sale or maturity
of investments. The Company's cash flow is also affected by claims payments,
some of which could be large. Therefore, the Company's cash flow could
fluctuate significantly from period to period.
The Company does not currently have any material commitments for any capital
expenditures over the next 12 months other than in connection with the
further development of the Company's infrastructure. The Company expects that
its financing and operational needs for the foreseeable future will be met by
the Company's balance of cash and short-term investments, as well as by funds
generated from operations. However, no assurance can be given that the
Company will be successful in the implementation of its business strategy.
At September 30, 1997, the Company's consolidated stockholders' equity
totaled $396.2 million, or $23.26 per share. At such date, statutory surplus
of Risk Capital Reinsurance was approximately $386.1 million. Based on data
available as of June 30, 1997 from the Reinsurance Association of America,
Risk Capital Reinsurance is the thirteenth largest domestic broker market
oriented reinsurer as measured by statutory surplus.
16
<PAGE>
Safeharbor Statement Under the Private Securities Litigation Reform Act of
1995
Except for the historical information contained herein, the matters discussed
in this Form 10-Q include forward looking statements that involve risks and
uncertainties, including, but not limited to, quarterly fluctuations in
results and other risks detailed from time to time in the Company's
Securities and Exchange Commission filings. Among the factors that could
cause such forward looking statements not to be realized include, without
limitation, acceptance in the market of the Company's reinsurance products;
the availability of investments on terms that are attractive to the Company;
pricing competition; the amount of underwriting capacity from time to time in
the market; general economic conditions and conditions specific to the
reinsurance and investment markets in which the Company operates; regulatory
changes and conditions; rating agency policies and practices; claims
development and loss of key executives. Actual results may differ materially
from management expectations. The Company assumes no obligation to update any
forward looking statement or other information contained in this report.
17
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- --------------- -----------------------------------------------------------------------------------------------------
<C> <S>
15 Accountants' Awareness Letter and Limitation of Liability (regarding unaudited interim financial
information)
27 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K.
There were no reports filed on Form 8-K for the three month period ended
September 30, 1997.
Omitted from this Part II are items which are inapplicable or to which the
answer is negative for the period covered.
18
<PAGE>
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.
RISK CAPITAL HOLDINGS, INC.
----------------------------------
(Registrant)
----------------------------------
Date: November 13, 1997 MARK D. MOSCA
President
----------------------------------
Date: November 13, 1997 PAUL J. MALVASIO
Chief Financial Officer
19
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ----------- ---------------------------------------------------------------------------------------------------------
<C> <S>
15 Accountants' Awareness Letter and Limitation of Liability (regarding unaudited interim financial
information)
27 Financial Data Schedule
</TABLE>
20
<PAGE>
Exhibit 15
ACCOUNTANTS' AWARENESS LETTER AND LIMITATION OF LIABILITY
We are aware of the incorporation by reference in the Registration Statement
on Form S-8 (Registration No. 33-99974) of Risk Capital Holdings, Inc. of our
report dated October 29, 1997 (issued pursuant to the provisions of Statement
on Auditing Standards No. 71) appearing in this Form 10-Q. We are also aware
of our responsibilities under the Securities Act of 1933.
We are not subject to the liability provisions of section 11 of the
Securities Act of 1933 for our report dated October 29, 1997 (issued pursuant
to the provisions of Statement on Auditing Standards No. 71) on the unaudited
interim consolidated financial information of Risk Capital Holdings, Inc.
because our report is not a "report" or a "part" of the Registration
Statement on Form S-8 (Registration No. 33-99974) prepared or certified by us
within the meaning of sections 7 and 11 of the Securities Act of 1933.
PRICE WATERHOUSE LLP
New York, New York
November 13, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<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> 132,945
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 232,062
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 475,900
<CASH> 4,090
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 15,500
<TOTAL-ASSETS> 557,188
<POLICY-LOSSES> 52,733
<UNEARNED-PREMIUMS> 71,301
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 0
<OTHER-SE> 396,200
<TOTAL-LIABILITY-AND-EQUITY> 557,188
65,628
<INVESTMENT-INCOME> 10,774
<INVESTMENT-GAINS> 3,617
<OTHER-INCOME> 0
<BENEFITS> 45,992
<UNDERWRITING-AMORTIZATION> 17,740
<UNDERWRITING-OTHER> 10,842
<INCOME-PRETAX> 5,445
<INCOME-TAX> 1,175
<INCOME-CONTINUING> 4,270
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> (473)
<NET-INCOME> 3,797
<EPS-PRIMARY> .22
<EPS-DILUTED> .22
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 13,860
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 52,733
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
