================================================================================
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 March 31, 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)
Delaware 06-1424716
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
20 Horseneck Lane
Greenwich, Connecticut 06830
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code: (203) 862-4300
411 West Putnam Avenue, Greenwich, CT 06830
- --------------------------------------------------------------------------------
(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.
Class Outstanding at March 31, 1997
----- -----------------------------
Common Stock, $.01 par value 17,022,192
================================================================================
<PAGE>
RISK CAPITAL HOLDINGS, INC.
INDEX
Page No.
--------
PART I. Financial Information
Review Report of Independent Accountants 1
Consolidated Statement of Income 2
For the three month periods ended March 31, 1997 and 1996
Consolidated Balance Sheet 3
March 31, 1997 and December 31, 1996
Consolidated Statement of Changes in Stockholders' Equity 4
For the three month periods ended March 31, 1997 and 1996
Consolidated Statement of Cash Flows 5
For the three month periods ended March 31, 1997 and 1996
Notes to Consolidated Financial Statements 6
Management's Discussion and Analysis 10
of Financial Condition and Results of Operations
PART II. Other Information
Item 6. Exhibits and Reports on Form 8-K 17
Signatures 18
<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 March 31, 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 March 31, 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
April 28, 1997
1
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF INCOME
(in thousands, except per share data)
(unaudited)
Three Months Ended
March 31,
1997 1996
------------ ------------
Premiums and Other Revenues
Net premiums written $ 33,866 $ 7,103
Increase in unearned premiums (12,794) (5,330)
------------ ------------
Net premiums earned 21,072 1,773
Net investment income 3,451 3,408
Net investment losses (25) (194)
------------ ------------
Total revenues 24,498 4,987
Expenses
Claims and claims expenses 14,540 1,249
Commissions and brokerage 6,111 562
Other operating expenses 3,745 2,491
------------ ------------
Total expenses 24,396 4,302
Income Before Income Taxes and Equity
in Net Loss of Investee 102 685
Federal income taxes:
Current 288 68
Deferred (474) (190)
------------ ------------
Income tax benefit (186) (122)
------------ ------------
Income Before Equity in Net Loss of Investee 288 807
Equity in net loss of investee (90)
------------ ------------
Net Income $ 198 $ 807
============ ============
Per Share Data
Primary and fully diluted:
Net income $ 0.01 $ 0.05
============ ============
Average shares outstanding 17,025,058 16,941,290
============ ============
See Notes to Consolidated Financial Statements.
2
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
(in thousands except share data)
(unaudited)
March 31, December 31,
1997 1996
--------- -----------
ASSETS
Investments:
Fixed maturities $ 102,370 $ 140,381
(amortized cost: 1997, $103,463; 1996,
$140,128)
Publicly traded equity securities 131,325 117,360
(cost: 1997, $113,600; 1996, $108,580)
Privately held securities 34,329 28,847
(cost: 1997, $29,427; 1996, $23,363)
Short-term investments 121,748 104,886
--------- ---------
Total investments 389,772 391,474
Cash 10,566 1,466
Accrued investment income 1,526 2,151
Premiums receivable 35,401 23,669
Reinsurance recoverable on unearned premiums 849 576
Reinsurance recoverable 851 522
Deferred policy acquisition costs 10,299 7,018
Other assets 6,614 5,610
--------- ---------
$ 455,878 $ 432,486
========= =========
LIABILITIES
Claims and claims expenses $ 31,805 $ 20,770
Unearned premiums 50,415 37,348
Reinsurance premiums payable 536 536
Contingent commissions payable 3,545 2,734
Investment accounts payable 4,167 10,598
Deferred income tax liability 4,960 3,026
Other liabilities 2,928 5,261
--------- ---------
TOTAL LIABILITIES 98,356 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 and 1996, 17,031,246 shares issued) 170 170
Additional paid-in capital 340,435 340,435
Unrealized appreciation of investments, net of
income tax 13,997 9,436
Deferred compensation under stock award plan (2,257) (2,959)
Retained earnings 5,329 5,131
Less treasury stock, at cost (1997, 9,054 shares) (152)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 357,522 352,213
--------- ---------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $ 455,878 $ 432,486
========= =========
See Notes to Consolidated Financial Statements.
3
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
(unaudited)
Three Months Ended
March 31,
1997 1996
--------- ---------
Common Stock
Balance at beginning of year $ 170 $ 169
Issuance of common stock
--------- ---------
Balance at end of period 170 169
--------- ---------
Additional Paid-in Capital
Balance at beginning of year 340,435 338,737
Issuance of common stock 167
--------- ---------
Balance at end of period 340,435 338,904
--------- ---------
Unrealized Appreciation of Investments,
Net of Income Tax
Balance at beginning of year 9,436 3,731
Change in unrealized appreciation (depreciation) 4,561 (825)
--------- ---------
Balance at end of period 13,997 2,906
--------- ---------
Deferred Compensation Under Stock Award Plan
Balance at beginning of year (2,959) (3,441)
Restricted common stock issued (167)
Compensation expense recognized 702 463
--------- ---------
Balance at end of period (2,257) (3,145)
--------- ---------
Retained Earnings
Balance at beginning of year 5,131 1,019
Net income 198 807
--------- ---------
Balance at end of period 5,329 1,826
--------- ---------
Treasury Stock, At Cost
Balance at beginning of year
Purchase of treasury shares (152)
--------- ---------
Balance at end of period (152)
--------- ---------
Total Stockholders' Equity
Balance at beginning of year 352,213 340,215
Issuance of common stock 167
Change in unrealized appreciation (depreciation)
of investments, net of income tax 4,561 (825)
Change in deferred compensation 702 296
Net income 198 807
Purchase of treasury stock (152)
--------- ---------
Balance at end of period $ 357,522 $ 340,660
========= =========
See Notes to Consolidated Financial Statements.
4
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(unaudited)
Three Months Ended
March 31,
1997 1996
-------- --------
OPERATING ACTIVITIES
Net income $ 198 $ 807
Adjustments to reconcile net income
to net cash provided by operating activities:
Liability for claims and claims expenses, net 11,035 1,186
Unearned premiums 13,067 5,330
Premiums receivable (11,732) (4,237)
Accrued investment income 626 (175)
Contingent commissions payable 811
Reinsurance balances, net (602) 304
Deferred policy acquisition costs (3,281) (1,652)
Net investment losses 25 194
Deferred income tax asset (522) (189)
Other liabilities (2,333) (339)
Other items, net (1,237) (608)
-------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES 6,055 621
-------- --------
INVESTING ACTIVITIES
Purchases of fixed maturity investments (49,591) (81,622)
Sales of fixed maturity investments 78,953 79,362
Net (purchases) sales of short-term investments (15,502) 35,586
Purchases of equity securities (12,361) (34,216)
Sales of equity securities 1,763 358
Purchases of furniture and equipment (65) (93)
-------- --------
NET CASH PROVIDED BY (USED FOR) INVESTING ACTIVITIES 3,197 (625)
-------- --------
FINANCING ACTIVITIES
Common stock issued 167
Purchase of treasury stock (152)
Deferred compensation on restricted stock (167)
-------- --------
NET CASH USED FOR FINANCING ACTIVITIES (152) 0
-------- --------
Increase (decrease) in cash 9,100 (4)
Cash beginning of year 1,466 982
-------- --------
Cash end of period $ 10,566 $ 978
======== ========
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 issued 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.
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 March 31, 1997, the publicly
traded equity portfolio consisted of 10 investments, with estimated fair values
ranging individually from $6.6 million to $16.6 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.
7
<PAGE>
Privately held securities consisted of the following:
(in thousands)
March 31, December 31,
1997 1996
-------- -----------
Equity Securities:
Carried under the equity method:
Island Heritage Insurance Company, Ltd. $ 4,124 $ 4,269
Insurance Investment Group, L.P. 180 180
First American Financial Corporation 6,200
New Europe Insurance Ventures 1
Carried at fair value:
Peregrine Russell Miller Insurance Fund
of Asia Limited 7,887 7,465
Terra Nova (Bermuda) Holdings, Ltd. 14,874 15,870
Venton Holdings, Ltd. 1,063
------- -------
Total privately held equities $34,329 $28,847
======= =======
At March 31, 1997, the Company had investment commitments relating to its
privately held securities totaling approximately $31 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 first quarter
of 1997:
First American Financial Corporation
In February 1997, the Company invested $6.2 million in the equity securities of
First American Financial Corporation ("FAFC"), representing an approximately 35%
interest. FAFC is a holding company for First American Insurance Company
("FAIC"), an insurer located in Kansas City, Missouri. FAIC is rated A- by A.M.
Best and writes commercial and private passenger automobile liability and
automobile physical damage, with emphasis placed on collateral protection.
New Europe Insurance Ventures
In March 1997, the Company made an investment commitment of $5 million,
representing a 33% interest in New Europe Insurance Ventures, a Scottish limited
partnership that will target private equity investments in insurance and
insurance-related companies in Eastern Europe.
8
<PAGE>
The Company will carry this investment under the equity method of accounting and
will be required to apply the specialized accounting practices for investment
companies. Unrealized gains and losses on investments, consisting mostly of
foreign exchange fluctuations, will be recorded in the income statement when
such investments are revalued into U.S. dollars each quarter.
5. STATUTORY DATA
The statutory capital and surplus of Risk Capital Reinsurance at March 31, 1997
was $339.0 million, compared to $334.3 million at December 31, 1996. The
statutory net loss for the three month period ended March 31, 1997 was $3.5
million, compared to a net loss of $1.0 million in the prior year period.
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
General
The Company
RCHI is the holding company for Risk Capital Reinsurance, its wholly owned
subsidiary which is domiciled in Nebraska. RCHI was incorporated in March 1995
and commenced operations during September 1995 upon completion of 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. As of March 31, 1997, the statutory
surplus of Risk Capital Reinsurance was approximately $339 million.
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. The January 1, 1997 renewal period was 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 May 1, 1997, the Company had 58 in-force treaties, with approximately $141
million of annualized in-force premiums. Such in-force premiums represent
estimated annualized premiums from treaties entered into during 1996 and the
January 1, 1997 renewal period that are expected to generate net premiums
written during calendar year 1997. All except one of such treaties are subject
to renewal. Without taking into account the possibility that (x) several of the
treaties entered into during 1996 that are scheduled to expire during the
remainder of 1997 may be renewed and (y) additional new treaties may be bound
during 1997, it is estimated that the Company will record approximately $120
million of net premiums written over the twelve month period ending December 31,
1997 from such treaties. Such estimates of in-force premiums and net premiums
written at January 1, 1997 do not include the unearned premium portfolios and
other non-recurring transactions reflected in the Company's net premiums written
for 1996 because such portfolios and transactions will not generate any net
premiums written during 1997.
Results of Operations
For the three month periods ended March 31, 1997 and 1996, the Company had
consolidated net income of approximately $198,000, or $0.01 per share, and
$807,000, or $0.05 per share, respectively. After-tax realized investment losses
of $16,000 (less than one cent per share), and $0.1 million, or $0.01 per share,
were also included in net income for the first quarter of 1997 and 1996 periods,
respectively. First quarter net income for 1997 included a loss of $0.1 million,
or $0.01 per share, representing the Company's equity in the net loss of an
investee company which is accounted for under the equity method of accounting.
The Company believes that the results of operations for the three months ended
March 31, 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, 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.
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
components 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 three month periods ended March 31, 1997 and 1996
were as follows:
(In thousands)
Three Months Ended
March 31,
----------------------
1997 1996
---------- ----------
Property $3.8 $4.9
Casualty 18.3 2.2
Multi-line 7.2
Specialty 4.6
---------- ----------
Total $33.9 $7.1
========== ==========
Approximately 38% of net premiums written in the 1997 first quarter was from
non-U.S. clients, compared with 20% in the 1996 first quarter.
Set forth below is the Company's statutory composite ratios for the three month
periods ended March 31, 1997 and 1996:
(In thousands)
Three Months Ended
March 31,
----------------------
1997 1996
--------- ----------
Claims and claims expense ratio 69.0% 70.4%
Commissions and brokerage ratio 27.7% 31.2%
Operating expense ratio 10.9% 34.3%
--------- ----------
Statutory composite ratio 107.6% 135.9%
========= ==========
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.
12
<PAGE>
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.
Other operating expenses increased to $3.7 million for the 1997 first quarter,
compared to $2.5 million for the 1996 first quarter. Assuming the successful
execution of the Company's business strategy, the Company expects other
operating expenses to grow commensurate with maturing 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.
Investment Results
At March 31, 1997, approximately 59% 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 three
months of 1997 was approximately $3.5 million, compared to $3.4 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 1997 and 1996 first quarters are less
than the 35% statutory rate on pre-tax operating income due to tax exempt income
and the dividends received deductions. The 1997 and 1996 first quarter gross
deferred income tax benefits of approximately $474,000 and $190,000,
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.
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 cyclically 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 March 31, 1997, cash and invested assets totaled approximately $400.3
million, consisting of $132.3 million of cash and short-term investments, $102.4
million of publicly traded fixed maturity investments, $131.3 million of
publicly traded equity securities and $34.3 million of privately held
securities.
14
<PAGE>
During the first three months of 1997, the Company allocated approximately $4.1
million from its short term portfolio to publicly traded equity securities, and
an additional $6.4 million to fund investments in privately held securities. 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 March 31, 1997, the publicly traded equity portfolio consisted of investments
in 10 publicly traded domestic insurers, reinsurers, or companies providing
services to the insurance industry. The estimated fair values of such
investments ranged individually from $6.6 million to $16.6 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 1.9 years.
The Company's pre-tax and net of tax investment yields in the first three months
of 1997 were 3.8% and 2.7%, respectively, compared to 4.1% and 3.1%,
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 three months ended March 31,
1997 was $6.1 million, compared with $621,000 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 March 31, 1997, the Company's consolidated stockholders' equity totaled
$357.5 million, or $21.00 per share. At such date, statutory surplus of Risk
Capital Reinsurance was approximately $339 million. Based on data available as
of December 31, 1996 from the Reinsurance Association of America, Risk Capital
Reinsurance is the twelfth largest domestic broker market oriented reinsurer as
measured by statutory surplus.
16
<PAGE>
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit No. Description
----------- ---------------------------------------
15 Accountants' Awareness Letter and
Limitation of Liability (regarding
unaudited interim financial information)
27 Financial Data Schedule
(b) Reports on Form 8-K.
There were no reports filed on Form 8-K for the three month period ended
March 31, 1997.
Omitted from this Part II are items which are inapplicable or to which the
answer is negative for the period covered.
17
<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)
/s/ Mark D. Mosca
-------------------------------------
Date: May 13, 1997 MARK D. MOSCA
President
/s/ Paul J. Malvasio
-------------------------------------
Date: May 13, 1997 PAUL J. MALVASIO
Chief Financial Officer
18
<PAGE>
EXHIBIT INDEX
Exhibit
No. Description
- ------- ------------------------------------------------
15 Accountants' Awareness Letter and Limitation of
Liability (regarding unaudited interim
financial information)
27 Financial Data Schedule
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 April 28, 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 April 28, 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
May 13, 1997
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains summary financial information extracted from the
Quarterly Report on Form 10-Q for the three-month period ended March 31, 1997 of
Risk Capital Holdings, Inc. and is qualified in its entirety by reference to
such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<DEBT-HELD-FOR-SALE> 102,370
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 165,654
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 389,772
<CASH> 10,566
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 10,299
<TOTAL-ASSETS> 455,878
<POLICY-LOSSES> 31,805
<UNEARNED-PREMIUMS> 50,415
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 0
<OTHER-SE> 357,522
<TOTAL-LIABILITY-AND-EQUITY> 455,878
21,072
<INVESTMENT-INCOME> 3,451
<INVESTMENT-GAINS> (25)
<OTHER-INCOME> 0
<BENEFITS> 14,540
<UNDERWRITING-AMORTIZATION> 6,111
<UNDERWRITING-OTHER> 3,745
<INCOME-PRETAX> 102
<INCOME-TAX> (186)
<INCOME-CONTINUING> 288
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> (90)
<NET-INCOME> 198
<EPS-PRIMARY> .01
<EPS-DILUTED> .01
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 3,835
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 30,954
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
