================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the Fiscal Year Ended December 31, 1997
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from to
Commission File No. 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
incorporation or organization) Identification No.)
20 Horseneck Lane
Greenwich, Connecticut 06830
----------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (203) 862-4300
Securities registered pursuant to Section 12(b) of the Act:
Name of each Exchange
Title of Each Class on which Registered
------------------- --------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. /X/
The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of March 20, 1998 was approximately $238,533,913 based on the
closing price on the Nasdaq National Market on that date.
As of March 20, 1998, there were 17,059,795 shares of the Registrant's
Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates certain information by reference to the Registrant's
definitive proxy statement to be filed with respect to the Registrant's Annual
Meeting of Stockholders to be held on May 12, 1998, which proxy statement will
be filed with the Securities and Exchange Commission within 120 days of the
close of the Registrant's fiscal year ended December 31, 1997.
================================================================================
<PAGE>
RISK CAPITAL HOLDINGS, INC.
TABLE OF CONTENTS
Item Page
- ---- ----
Part I
1. Business................................................................. 1
2. Properties............................................................... 24
3. Legal Proceedings........................................................ 24
4. Submission of Matters to a Vote of Security Holders...................... 24
Part II
5. Market for Registrant's Common Equity and Related Stockholder Matters.... 24
6. Selected Financial Data.................................................. 26
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................... 27
8. Financial Statements and Supplementary Data.............................. 35
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure............................................ 35
Part III
10. Directors and Executive Officers of the Registrant....................... 35
11. Executive Compensation................................................... 35
12. Security Ownership of Certain Beneficial Owners and Management........... 36
13. Certain Relationships and Related Transactions........................... 36
Part IV
14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.......... 36
----------
Cautionary Note Regarding Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements. This Form 10-K, the Company's Annual
Report to Stockholders, any proxy statement, any Form 10-Q or any Form 8-K of
the Company or any other written or oral statements made by or on behalf of the
Company may include forward-looking statements which reflect the Company's
current views with respect to future events and financial performance. Such
statements include forward-looking statements both with respect to the Company
and the insurance sector in general (both as to underwriting and investment
opportunities). All forward-looking statements address matters that involve
risks and uncertainties. Accordingly, there are or will be important factors
that could cause actual results to differ materially from those indicated in
such statements. The Company believes that these factors include, but are not
limited to, acceptance in the market of the Company's reinsurance products;
competition from new products (including products that may be offered by the
capital markets); the availability of investments on attractive terms;
competition, including increased competition (both as to underwriting and
investment opportunities); changes in the performance of the insurance sector of
the public equity markets or market professionals' views as to such sector; 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;
-i-
<PAGE>
regulatory changes and conditions; rating agency policies and practices; claims
development, including as to the frequency or severity of claims and the timing
of payments; and loss of key personnel. Changes in any of the foregoing may
affect the Company's ability to realize its business strategy or may result in
changes in the Company's business strategy. The foregoing review of important
factors should not be construed as exhaustive and should be read in conjunction
with other cautionary statements that are included herein or elsewhere. The
Company undertakes no obligation to publicly update or revise any
forward-looking statement, whether as a result of new information, future events
or otherwise.
* * * *
-ii-
<PAGE>
Part I
ITEM 1. BUSINESS
Certain terms used below are defined in the "Glossary of Selected Insurance
Terms" appearing on pages 20-23 of this Report.
General
The Company
Risk Capital Holdings, Inc. ("RCHI") was incorporated in March 1995 under
the laws of the State of Delaware with the objective of becoming a global
reinsurance company which integrates sound reinsurance underwriting with an
investment strategy focused on the insurance industry. RCHI believes that
reinsurance underwriting and investment skills can be mutually reinforcing and
that successfully employing such skills in an integrated manner can result in
enhanced stockholder returns. RCHI operates through its wholly owned subsidiary,
Risk Capital Reinsurance Company ("Risk Capital Reinsurance" and, together with
RCHI, unless the context otherwise requires, the "Company"), whose primary focus
is on traditional and finite risk property and casualty reinsurance treaty
coverages, including excess of loss reinsurance and quota share or proportional
reinsurance. Based upon data available from the Reinsurance Association of
America ("RAA"), Risk Capital Reinsurance is the eleventh largest United States
based broker market oriented reinsurer as measured by statutory surplus at
December 31, 1997. As of that date, Risk Capital Reinsurance had statutory
capital and surplus of $385.0 million.
In September 1995, RCHI completed an (i) initial public offering of
9,775,000 shares of its common stock, par value $0.01 per share (the "Common
Stock"), and (ii) concurrent direct sales of (x) an aggregate of 6,975,625
shares of Common Stock and (y) warrants to purchase 4,451,680 shares of Common
Stock (of which 2,531,079 shares are subject to immediately exercisable
warrants) for aggregate proceeds, net of underwriting expenses, of approximately
$335.0 million (collectively, the "Offerings"). RCHI contributed $328.0 million
of such proceeds to the capital of Risk Capital Reinsurance. In November 1995,
Risk Capital Reinsurance was licensed under the insurance laws of the State of
Nebraska.
Marsh & McLennan Risk Capital Corp. ("Risk Capital Corp."), a subsidiary of
Marsh & McLennan Companies, Inc. (together with its subsidiaries, unless the
context otherwise requires, "Marsh & McLennan"), is the Company's equity
investment advisor. Risk Capital Corp. and its affiliates have successfully
invested in various newly-formed insurance and reinsurance ventures, principally
ACE Limited, EXEL Limited ("EXEL"), Mid Ocean Limited and Centre Reinsurance
Holdings Limited. Risk Capital Corp. is also the investment advisor to The
Trident Partnership, L.P. ("Trident"), a $667.0 million investment fund
capitalized by institutional investors, including Marsh & McLennan, to invest
selectively on a global basis in the insurance and reinsurance industry.
The stockholders of RCHI owning the largest number of shares of Common
Stock are (i) EXEL, which owns 4,755,000 shares of Common Stock, or
approximately 27.9% of the outstanding Common Stock (21.2% assuming the exercise
of all outstanding warrants and options to purchase Common Stock); and (ii)
Marsh & McLennan Risk Capital Holdings, Ltd. ("MMRCH"), which owns 1,395,625
shares of Common Stock, or approximately 8.2% of the outstanding Common Stock,
and warrants to purchase 2,825,998 shares of Common Stock, which, if fully
exercised, would increase MMRCH's ownership of the Common Stock to 18.8%
assuming the exercise of all outstanding warrants and options to purchase Common
Stock.
Pursuant to Trident's registration rights, the Company registered for sale
by Trident 1,750,000 shares of Common Stock owned by Trident under a shelf
registration statement which was declared effective by the Securities and
Exchange Commission (the "SEC") in September 1997. Under such registration
statement, Trident sold 1,500,000 shares of Common Stock, of which 1,000,000
were sold to EXEL. As of the date of this Report, Trident continues to own
250,000 shares of Common Stock and warrants to purchase 1,386,079 shares of
Common Stock, which represent, in the aggregate, approximately 7.3% of the
Common Stock assuming the exercise of all outstanding warrants and options to
purchase Common Stock.
-1-
<PAGE>
The Company's offices are located at 20 Horseneck Lane, Greenwich,
Connecticut 06830, and its telephone number is (203) 862-4300.
Business Strategy
The Company's integrated strategic focus on reinsurance and investments in
the insurance sector is designed to allow the Company to take advantage of the
opportunities arising from the extensive changes taking place in the insurance
industry worldwide. These changes are occurring principally as a result of
increasing globalization of insurance and other markets, the need of insurers
and reinsurers to reduce costs, and unprecedented catastrophic and other losses.
Such losses in particular have affected underwriting capacity, increased demand
for financially strong insurance and reinsurance capacity, contributed to the
restructuring of insurance companies and markets, including Lloyd's of London
("Lloyd's"), and raised concerns about the adequacy of the capital of certain
insurance companies. The Company believes that it is in a position to capitalize
on these opportunities because:
o as a relatively new company, its distribution and overhead structure,
as well as its organizational philosophy, is not encumbered with a
traditional, territorial outlook; rather the Company is positioned to
respond to the functional and global approach to the placement of
insurance and reinsurance;
o a small, centralized staff is well motivated by incentive compensation
and is assisted by new information technology;
o management seeks to use both the Company's traditional and finite risk
reinsurance underwriting capacity and its investment portfolio to
provide increased capacity to insurers through the provision of
reinsurance and other forms of capital;
o the extensive experience and relationships of the Company's management
and Risk Capital Corp. assist in identifying and taking advantage of
underwriting and investment opportunities; and
o the Company believes that attractive underwriting opportunities are
presented to it in connection with the investment activities of the
Company and Risk Capital Corp. as the Company's equity investment
advisor, and that investment opportunities can arise from the
Company's underwriting activities.
Reinsurance Underwriting
Strategy
The principal components of the Company's underwriting strategy are: (i)
identifying and committing the Company's underwriting capacity to those types of
reinsurance where management believes that above average underwriting results
can be achieved; (ii) promoting client loyalty by providing a full range of
sophisticated risk management products closely tailored to its clients' needs;
(iii) conserving capacity to react to changing market conditions; (iv)
soliciting business primarily through reinsurance intermediaries; (v) taking
advantage of underwriting opportunities that may arise in connection with the
Company's and Risk Capital Corp.'s equity investment activities; (vi) providing
reinsurance to insurers in which the Company invests, where appropriate; (vii)
maintaining a small, highly skilled, performance-motivated staff; and (viii)
maintaining a low expense structure.
The Company seeks to write "large lines" (i.e., significant portions) on a
limited number of traditional and finite risk property and casualty reinsurance
treaties with a select number of insurance and reinsurance companies located
throughout the world (although the Company's principal focus is on large United
States and European-based insurance and reinsurance companies) and with select
Lloyd's syndicates. The Company may also provide credit enhancement, time and
distance and other risk management products, the nature and demand for which
will vary over time depending on existing capacity, profitability, tax,
regulatory and accounting aspects, and other circumstances pertaining to such
products.
The Company focuses its efforts on treaty reinsurance. The Company believes
in the value of long-term mutually profitable treaty relationships. The Company
intends to continue to establish and cultivate such long-term relationships with
its reinsureds and believes it will be assisted therein by the extensive
experience of its management and Risk Capital Corp. In addition, the Company
intends to write conservatively in terms of the Company's surplus capacity. The
Company does not currently intend for its premium-to-surplus ratio to exceed
0.7x. However, depending on business opportunities and the mix of business that
may comprise
-2-
<PAGE>
the Company's portfolio, the Company may consider underwriting at a higher
premium-to-surplus ratio. Underwriting conservatively in terms of surplus
capacity will help enable the Company to maintain underwriting capacity and
flexibility. The Company believes that these objectives should, if realized,
place the Company in a position (without being overly dependent on the
underwriting cycle) to take advantage of underwriting opportunities that are
generally only available to well-capitalized reinsurers willing to underwrite
large lines.
The Company participates at Lloyd's through the provision of whole account
quota share reinsurance to selected Lloyd's syndicates. The Company may
participate in other ways, including through investments in Lloyd's corporate
members and/or managing agents. In 1996, the Company acquired an equity interest
in an indirect owner of a Lloyd's managing agent and corporate name. (See Note 3
under the caption "Investment Information" of the accompanying Notes to
Consolidated Financial Statements of the Company.)
The Company determines the aggregate amount of reinsurance it writes based
upon market and other factors, including its assessment of underwriting
opportunities and its premium-to-surplus ratio at the time of determination. The
Company believes that insurance companies with certain identifiable
characteristics have historically performed better than the industry throughout
the underwriting cycle and believes that the experience of the Company's
management and Risk Capital Corp. assist in focusing on such companies for
reinsurance and investment opportunities. The Company believes that these
characteristics include underwriting performance, underwriting focus and
discipline (irrespective of the underwriting cycle), the ability to take
advantage of opportunities and changing circumstances in the insurance industry,
low expense ratio, specialization, the ability to take a lead role in
structuring substantial insurance and reinsurance contracts, substantial
capacity and effective use of reinsurance.
The Company employs a disciplined, multi-disciplinary and highly analytical
approach to underwriting designed to specify premium that is intended to be
commensurate with the amount of its capital the Company estimates it is placing
at risk. As part of its underwriting process, the Company focuses on the
financial characteristics (including capital needs) and reputation of the
proposed cedent, the likelihood of establishing a long-term relationship with
the cedent, the geographic area in which the cedent does business, the cedent's
market share, historical loss data for the cedent and, where available, for the
industry as a whole in the relevant regions in order to compare the cedent's
historical loss experience to industry averages.
Operations
The Company's mix of business on the basis of net premiums written for 1997
and 1996 is set forth in the following table:
Net Premiums Written
(Dollars in millions)
Years Ended December 31,
------------------------------------------------
1997 1996
----------------------- -----------------------
Amount % Amount %
Property ............... $17.8 12.3% $19.4 27%
Casualty ............... 69.7 48.1 17.6 24
Multi-line.............. 45.9 31.7 21.8 30
Specialty............... 10.0 6.9 13.7 19
Marine ................. 1.4 1.0 -- --
------ ----- ----- ---
Total.............. $144.8 100.0% $72.5 100%
====== ===== ===== ===
Approximately 28.5% and 5.2% of net premiums written in 1997 and 1996,
respectively, were generated from companies in which the Company has invested or
committed to invest funds. For 1997 and 1996, approximately 28% and 30%,
respectively, of net premiums written was from non-United States clients, which
are Lloyd's syndicates or are located in the United Kingdom or Continental
Europe.
Reinsurance is provided by the Company both on a quota share and excess of
loss basis. In 1997, quota share reinsurance and excess of loss reinsurance
amounted to 71% and 29%, respectively, of the Company's net premiums written,
compared to 58% and 42%, respectively, during 1996. In the future, the mix of
quota share and excess of loss reinsurance will depend on market conditions and
other relevant factors and cannot
-3-
<PAGE>
be predicted with accuracy. Depending on future conditions, the Company may also
write other types of reinsurance.
Consistent with the Company's strategy of writing a small number of large
treaties for its core business, five clients contributed approximately $68
million, or 45%, of the Company's 1997 net premiums written, with the largest
client contributing approximately 18% and the remaining four clients each
contributing an amount ranging from 5% to 8%. One client that contributed 8% of
1997 net premiums written is expected to retain most of the business it
previously ceded to the Company. While not anticipated, the reduction or loss of
business assumed from one or more large clients could have a material adverse
effect on the Company's results of operations to the extent not offset by new
business.
In 1997, the Company extended its business into marine and aerospace
reinsurance underwriting. Marine and aerospace risks involve primarily property
damage, although certain marine and aerospace risks may involve casualty
coverage.
Approximately $32.9 million, or 46%, of net premiums written for 1996
resulted from unearned premium portfolios and other non-recurring transactions.
This amount included $11.9 million of specialty premiums written from contracts
pursuant to which the Company reinsures a portion of one underlying policy for
multiple years. Such premiums will be earned over the multiple periods as the
exposures expire. In 1997, there were no significant unearned premium portfolios
or other non-recurring transactions included in net premiums written.
For a discussion of the Company's in-force business at January 1, 1998, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--General--Recent Industry Performance."
Investments
Strategy
The Company's investment goals are to support the Company's reinsurance
activities and enhance the Company's long-term profitability. The principal
components of the Company's strategy to achieve these goals include: (i)
supporting short-term liquidity requirements through cash and fixed income
investments and, if necessary, through the sale of marketable equity securities
from the Company's investment portfolio; (ii) investing a significant portion of
the Company's assets in publicly traded and privately held equity securities
principally issued by insurance and reinsurance companies and companies
providing services to the insurance industry; (iii) identifying trends and
investment opportunities in the insurance industry that could lead to superior
returns; (iv) utilizing Risk Capital Corp., an experienced insurance industry
advisor, as equity investment advisor; (v) investing in insurers to which the
Company provides reinsurance, where appropriate; and (vi) when available,
co-investing with Trident, a dedicated insurance industry private equity fund,
and an entity to which Risk Capital Corp. also provides equity investment
advisory services.
The Company intends to invest a substantial portion of its investment
portfolio in equity securities, principally issued by insurance and reinsurance
companies and companies providing services to the insurance industry pursuant to
advice from Risk Capital Corp. The Company does not believe that the provision
of reinsurance to insureds in which the Company invests should subject the
Company to any significant additional investment risk; however, the operating
performance of an insured in which the Company also invests could affect the
Company more than an entity in which the Company only invests or to which the
Company only provides reinsurance. The Company believes that, over the long
term, a portfolio of equity securities offers a greater potential return and
growth in book value than one comprised of fixed maturity securities, and that
such a portfolio should most effectively maximize long term stockholders'
equity. The Company also believes that an equity portfolio is appropriate for
the Company because of the long-tail nature of certain of the reinsurance
business that the Company may write and the Company's conservative
premium-to-surplus ratio.
The Company has entered into an equity investment advisory agreement (the
"Equity Advisory Agreement") with Risk Capital Corp. with respect to the
management of the Company's equity investment portfolio and a fixed income
investment advisory agreement (the "Fixed Income Advisory Agreement") with The
Putnam Advisory Company, Inc. ("Putnam"), a subsidiary of Marsh & McLennan, with
respect to the management of the Company's fixed income securities and
short-term cash portfolios. Subject to investment guidelines determined from
time to time by the Investment/Finance Committee of the Board of Directors of
-4-
<PAGE>
the Company (the "Investment Committee"), Risk Capital Corp. and Putnam have the
authority, among other things, to buy, sell, retain or exchange the type of
investments for which they have been retained to manage. The Equity Advisory
Agreement provides that, subject to general guidelines established from time to
time by the Investment Committee, the Company may not invest in, purchase or
dispose of equity securities unless such investment, purchase or disposition
(including the terms thereof) has been approved by Risk Capital Corp. Equity
securities include common stocks, preferred stocks and securities (including
debt securities) convertible into or exercisable or exchangeable for common
stocks or preferred stocks, and any similar securities or instruments, and any
debt securities that were originally issued together with any such securities or
instruments. The Company may, however, make strategic investments without the
approval of Risk Capital Corp. Strategic investments are generally acquisitions
(not being made for resale) of securities of companies engaged in the
reinsurance business or other businesses, provided that the Company obtains
control of such companies.
Under the Equity Advisory Agreement, Risk Capital Corp. receives
compensation on both public securities owned by the Company (the "Public
Portfolio") and private equity securities owned by the Company (the "Private
Portfolio"). With respect to equity securities in the Public Portfolio, the
Company pays an annual fee equal to 0.35% of the daily average of the market
prices of such securities. With respect to the Private Portfolio, the Company
pays an annual fee equal to the sum of (i) 1.5% per annum on the first
$250,000,000 in carrying value of securities in the Private Portfolio and (ii)
1.0% per annum on the carrying value of such securities in the Private Portfolio
that exceeds $250,000,000. Risk Capital Corp. is also entitled to annual
compensation equal to the excess, if any, of (x) 7.5% of cumulative net realized
gains (as defined in the Equity Advisory Agreement) on equity securities in the
Private Portfolio over (y) cumulative incentive compensation previously paid in
prior years on cumulative net realized gains. The Equity Advisory Agreement
provided for a minimum aggregate cash fee to Risk Capital Corp. of $500,000 per
annum through December 31, 1997. Fees incurred under the Equity Advisory
Agreement during fiscal years 1997 and 1996, and partial fiscal year 1995 were
approximately $1,300,000, $686,000 and $151,000, respectively.
Under the Fixed Income Advisory Agreement, the Company pays annual fees,
based on the market value of assets included in the Company's fixed income
portfolio, at the following rates: 0.35% per annum on the first $50,000,000,
0.30% per annum on the next $50,000,000, 0.20% per annum on the next
$100,000,000 and 0.15% per annum on the market value of assets that exceed
$200,000,000. For the short-term cash portfolio, the Company pays a fee equal to
0.15% per annum of the total monthly average market value of such portfolio.
Fees incurred under the Fixed Income Advisory Agreement during 1997, 1996 and
1995 were approximately $493,000, $547,000 and $190,000, respectively.
Risk Capital Corp. serves as investment manager to Trident and,
accordingly, certain restrictions exist with respect to Risk Capital Corp.'s
ability to make investment recommendations to the Company with respect to
investments which would be suitable for both Trident and the Company. Under the
Trident partnership agreement, until the earlier of May 6, 2000 or the date on
which at least 75% of the aggregate capital of Trident has been drawn, neither
Risk Capital Corp. nor any of its affiliates may organize, or invest in, any new
or existing risk assumption entity unless Trident is first offered a reasonable
opportunity to invest in such entity. Such restrictions may also apply to the
Company. Such limitation, however, does not apply to investments in any such new
entity where the total invested capital of such entity does not exceed
$10,000,000.
Pursuant to the Trident partnership agreement, where Trident has elected to
make part, but not all, of the full investment otherwise available to it, the
Company may not be offered the opportunity to participate in such investment
unless Trident first offers at least all Trident partners with capital
commitments of at least $50,000,000 the right to participate in such additional
investment on a pro rata basis. Pursuant to the terms of the Equity Advisory
Agreement, Risk Capital Corp. has agreed that it will not invest in such
opportunities, and will not offer any such opportunities to its affiliates,
without first offering the Company an opportunity to make such investment.
Fixed income investments will be used to provide shorter-term liquidity and
current returns. The fixed income securities portfolio generally will be
invested in high quality, liquid securities, including securities issued by
United States government agencies and United States government guaranteed
securities.
In addition, the Company allocated in early 1998 approximately $35,000,000
for investing in a diversified portfolio of high yielding fixed maturity
investments managed by Miller Anderson & Sherrerd, LLP
-5-
<PAGE>
("MAS"), a subsidiary of Morgan Stanley & Co. Such amount was taken from funds
that were previously allocated for investing in short-term securities. MAS will
manage the portfolio subject to investment guidelines established from time to
time by the Investment Committee.
Since 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 portfolio will lack
industry diversification and will be particularly subject to the performance of
the insurance industry. Such performance will affect the market prices of a
significant portion of the Company's investment portfolio and the income and
return on such investments, all of which could negatively affect the Company's
underwriting capacity. 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 other competitor reinsurance companies,
which tend to invest primarily in fixed income investments. 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 its competitor reinsurance companies.
Operations
At December 31, 1997, cash and invested assets totaled approximately $505.7
million, consisting of $98.2 million of cash and short-term investments, $132.2
million of publicly traded fixed maturity investments, $180.1 million of
publicly traded equity securities and $95.3 million of privately held
securities.
Note 3 under the caption "Investment Information" of the accompanying Notes
to Consolidated Financial Statements of the Company provides a table summarizing
the components of net investment income for the years ended December 31, 1997
and 1996.
The Company's investments on a consolidated basis at December 31, 1997 and
December 31, 1996 consisted of the following:
(Dollars in thousands)
December 31,
---------------------------------------------
1997 1996
-------------------- ---------------------
Estimated Estimated
Fair Value Percent Fair Value Percent
---------- ------- ---------- -------
Cash and short-term .............. $ 98,181 19% $106,352 27%
-------- --- -------- ---
Fixed maturities:
U.S. government and government
agencies .................... 44,135 9 35,796 9
Municipal bonds ................ 37,637 7 60,041 15
Corporate bonds ................ 19,323 4 17,316 5
Mortgage and asset-backed
securities .................. 30,487 6 26,709 7
Foreign governments ............ 577 519
-------- --- -------- ---
Sub-total, fixed maturities . 132,159 26 140,381 36
Equity securities:
Publicly traded ................ 180,052 36 117,360 30
Privately held ................. 95,336 19 28,847 7
-------- --- -------- ---
Sub-total, equity securities 275,388 55 146,207 37
-------- --- -------- ---
Total ................... $505,728 100% $392,940 100%
======== === ======== ===
Guidelines established by the Company restrict the portion of the fixed
maturities portfolio that can be held in lower quality securities. At December
31, 1997, substantially all of the fixed maturity and short-term investments
were rated investment grade by Moody's Investors Service, Inc. ("Moody's") or
Standard & Poor's Corporation ("Standard & Poor's") and had an average quality
rating of AA and an average duration of approximately 2.9 years.
-6-
<PAGE>
Contractual maturities of the Company's consolidated fixed maturity
securities are shown below. Expected maturities, which are management's best
estimates, will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties.
(In thousands)
December 31, 1997
-------------------------
Estimated Amortized
Fair Value Cost
------------ ----------
Available for sale:
Due in one year or less....................... $22,507 $22,481
Due after one year through five years......... 42,358 41,807
Due after five years through 10 years......... 16,626 16,069
Due after 10 years............................ 20,181 19,448
------ ------
Sub-total.................................. 101,672 99,805
Mortgage and asset-backed securities.......... 30,487 30,082
------ ------
Total.................................... $132,159 $129,887
======== ========
At December 31, 1997, the Company's investment portfolio included
approximately $180.1 million of publicly traded equity securities and 15
investments in privately held securities totaling approximately $95.3 million,
with additional investment portfolio commitments in an aggregate amount of
approximately $22.6 million. At such date, all of the Company's equity
investments were in securities issued by insurance and reinsurance companies or
companies providing services to the insurance industry.
See Note 3 under the caption "Investment Information" of the accompanying
Notes to Consolidated Financial Statements of the Company for certain
information regarding the Company's publicly traded and privately held
securities and their carrying values, and commitments made by the Company
relating to its privately held securities. 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.
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. The Company's portfolio includes market sensitive instruments,
such as mortgage-backed securities, which are subject to prepayment risk and
changes in market value in connection with changes in interest rates. The
Company's investments in mortgage-backed securities, which amounted to
approximately $30.5 million at December 31, 1997, or 6% of cash and invested
assets, are classified as available for sale and are not held for trading
purposes.
Marketing
The Company obtains substantially all of its reinsurance business through
intermediaries representing the cedent in negotiations for the purchase of
reinsurance. The process of effecting a brokered reinsurance placement typically
begins when a cedent enlists the aid of an intermediary in structuring a
reinsurance program. Often the intermediary will consult with one or more lead
reinsurers as to the pricing and contract terms of the reinsurance protection
being sought. Once the cedent has approved the terms quoted by the lead
reinsurer, the intermediary will offer participation to qualified reinsurers
until the program is fully subscribed to by reinsurers at terms agreed upon by
all parties.
By working through intermediaries to originate its business, the Company
need not maintain a substantial sales organization which, during periods of
reduced premium volume, would comprise a significant and non-productive part of
overhead. In addition, management believes that submissions from the
intermediary market are more numerous and diverse, including certain targeted
specialty coverages, than would be available through a salaried sales
organization and that the Company is able to exercise greater selectivity than
would be possible in dealing directly with cedents.
-7-
<PAGE>
The Company pays commissions to intermediaries based on negotiated
percentages of the premium it writes. Direct writers of reinsurance typically
incur higher fixed costs that are included in their underwriting expenses.
Reinsurers using intermediaries can lower these costs during a downturn in the
market by writing less business and incurring lower brokerage costs.
Intermediaries do not generally have the authority to bind the Company with
respect to reinsurance agreements nor does the Company generally commit in
advance to accept any portion of the business that intermediaries submit to it.
Reinsurance business from any cedent, whether new or renewal, is generally
subject to acceptance by the Company.
In 1997, (i) affiliates of Marsh & McLennan, including Balis & Co., Inc.,
Guy Carpenter & Company, Inc., Carpenter Bowring Ltd. and Marsh & McLennan
FINPRO, and (ii) the Aon Group accounted for approximately 47.3% and 25.2%,
respectively, of the Company's assumed net premiums written. In 1996, U.S.
Reinsurance Corporation, Balis & Co., Inc. and Minet Re accounted for
approximately 27.7%, 13.7%, and 12.1%, respectively, of the Company's assumed
net premiums written. Loss of all or a substantial portion of the business
provided by any of these intermediaries could have a short-term material adverse
effect on the business and operations of the Company. The Company does not
believe that the loss of such business would have a long-term material adverse
effect due to the Company's competitive position within the broker reinsurance
market and the availability of business from other intermediaries. The terms
relating to the Company's intermediary arrangements with affiliates of Marsh &
McLennan have been negotiated on an arm's-length basis.
In addition to investment opportunities arising from the activities of Risk
Capital Corp. as the Company's equity investment advisor, the Company is
provided with investment opportunities by reinsurance brokers and traditional
financing sources, including investment banking firms, venture capital firms and
other banking and financing sources, both acting as principal investors and
intermediaries. Underwriting opportunities may arise from such sources in
connection with the Company's investment activities as part of integrated
transactions.
Retrocessional Arrangements
Reinsurance companies enter into retrocessional arrangements for many of
the same reasons primary insurers seek reinsurance, including reducing the
effect of individual or aggregate losses and increasing premium writings and
risk capacity without requiring additional capital.
Given the Company's current level of surplus, under its current
underwriting guidelines, the maximum net retention per risk for property
treaties and per occurrence for casualty treaties is generally $10,000,000.
Other than the Company's participation in "common account" retrocessional
arrangements for certain reinsurance treaties and as provided below, the Company
does not maintain retrocessional arrangements on a per risk or per treaty basis,
or for the purpose of limiting its exposure with respect to catastrophe losses
or unusual accumulations of losses resulting from a single occurrence involving
two or more reinsured policies. The Company believes that such exposures are
currently adequately managed through appropriate terms and conditions and
pricing of reinsurance contracts. Common account reinsurance arrangements are
arrangements whereby the ceding company enters into the reinsurance market and
purchases a cover for the benefit of the ceding company and the reinsurers on
the reinsurance treaty. Common account retrocessional arrangements reduce the
effect of individual or aggregate losses to all participating companies with
respect to a reinsurance treaty, including the cedent.
In connection with the Company's expansion into marine and aerospace
reinsurance underwriting in 1997, the Company entered into excess of loss
retrocessional arrangements in late 1997 and early 1998 covering aggregate
exposures on the Company's marine and aerospace business. For marine risks,
under its current underwriting guidelines, the Company may retain a maximum of
approximately $1,500,000 any one loss, net of retrocessional protection. For
aerospace risks, under its current underwriting guidelines, the Company may
retain a maximum of $1,000,000 any one loss, net of retrocessional protection.
Retrocessional protections for marine and aerospace business are purchased by
the Company on a limited aggregate basis. In addition, the Company purchased
retrocessional protection for its Florida property portfolio, which provides
coverage in the event of a catastrophe that results in industry-wide losses in
Florida equal to or exceeding $25 billion.
The Company will continue to evaluate its retrocessional requirements
periodically in relation to many factors, including its surplus, gross line
capacity and changing market conditions. Retrocessional arrangements do not
relieve the Company from its obligations to the insurers and reinsurers from
which it assumes business.
-8-
<PAGE>
The failure of retrocessionaires to honor their obligations could result in
losses to the Company. All retrocessionaires must conform to the Company's
standards and must be specifically approved by the Company's Security Committee,
which consists of five members of senior management, including the President.
The evaluation process involves financial analysis of current audited financial
data and comparative analysis of such data in accordance with guidelines
established by the Company. Business may not be conducted with retrocessionaires
that are not approved by the Security Committee.
For an additional discussion regarding the Company's risk management
policies, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Results of Operations--Risk Retention."
Claims Administration
Claims are managed by the Company's professional claims staff whose
responsibilities include the review of initial loss reports, creation of claim
files, determination of whether further investigation is required, establishment
and adjustment of case reserves and payment of claims. In addition, the claims
staff conducts comprehensive claims audits of both specific claims and overall
claims procedures at the offices of selected ceding companies. In certain
instances, as part of a comprehensive risk evaluation process, a claims audit
may be performed prior to assuming reinsurance business or entering into an
investment transaction.
Reserves for Unpaid Claims and Claims Expenses
As a reinsurance company, the Company is required to establish and maintain
reserves to cover its estimated ultimate liability for unpaid claims and claims
expenses with respect to reported and unreported claims incurred as of the end
of each accounting period (net of estimated related salvage and subrogation
claims and retrocession recoverables (if any) of the Company). These reserves
are estimates involving actuarial and statistical projections at a given time of
what the Company expects the ultimate settlement and administration of claims to
cost based on facts and circumstances then known, predictions of future events,
estimates of future trends in claims severity and other variable factors such as
inflation and new concepts of liability. For certain types of claims, it may
over time be necessary to revise estimated potential loss exposure and therefore
the Company's unpaid claims and claims expense reserves. The inherent
uncertainties of estimating claims and claims expense reserves are exacerbated
for reinsurers by the significant periods of time (the "tail") that often elapse
between the occurrence of an insured claim, the reporting of the claim to the
primary insurer and ultimately to the reinsurer, and the primary insurer's
payment of that claim and subsequent indemnification by the reinsurer. As a
consequence, actual claims and claims expenses paid may deviate, perhaps
substantially, from estimates reflected in the Company's reserves in its
financial statements. The estimation of reserves by new reinsurers, such as the
Company, may be less reliable than the reserve estimations of a reinsurer with
an established volume of business and loss history. To the extent reserves prove
to be inadequate, the Company may have to augment such reserves and incur a
charge to earnings. Such a development, while not anticipated, could result in a
material charge to earnings or stockholders' equity in future periods.
When a claim is reported to an insurance company that cedes business to the
Company, its claims personnel establish a "case reserve" for the estimated
amount of the ultimate payment. The estimate reflects the informed judgment of
such personnel based on general insurance reserving practices and on the
experience and knowledge of such personnel regarding the nature and value of the
specific type of claim. The Company, in turn, typically establishes a case
reserve when it receives a notice of a claim from the ceding company. Such
reserves are based on an independent evaluation by the Company, taking into
consideration coverage, liability, severity of injury or damage, jurisdiction,
the Company's assessment of the ceding company's ability to evaluate and handle
the claim and the amount of reserves recommended by the ceding company. Case
reserves are adjusted periodically by the Company based on subsequent
developments and audits of ceding companies.
In accordance with industry practice, the Company maintains incurred but
not reported ("IBNR") reserves. Such reserves are established to provide for
future case reserves and loss payments on incurred claims which have not yet
been reported to an insurer or reinsurer. In calculating its IBNR reserves, the
Company uses generally accepted actuarial reserving techniques that take into
account quantitative loss experience data, together, where appropriate, with
qualitative factors. IBNR reserves are based on loss experience of the Company
and the industry, and are grouped both by class of business and by accident
year.
-9-
<PAGE>
IBNR reserves are also adjusted to take into account certain factors such
as changes in the volume of business written, reinsurance contract terms and
conditions, the mix of business, claims processing and inflation that can be
expected to affect the Company's liability for losses over time.
The reconciliation of claims and claims expense reserves for the years
ended December 31, 1997 and December 31, 1996 is as follows:
(In thousands)
Years Ended
December 31,
-------------------
1997 1996
-------- --------
At beginning of year:
Gross claims and claims expense reserves............... $20,770 --
Reinsurance recoverables............................... 522 --
-------- --------
Net claims and claims expense reserves............... 20,248 --
Net claims and claims expenses incurred relating to:
Current year........................................... 73,385 $24,079
Prior year............................................. 22 --
-------- --------
Total.............................................. 73,407 24,079
Net paid claims and claims expenses incurred relating to:
Current year........................................... 13,649 3,831
Prior year............................................. 9,238 --
------- --------
Total.............................................. 22,887 3,831
At end of year:
Net claims and claims expense reserves current year.... 70,768 20,248
Reinsurance recoverables............................... -- 522
-------- --------
Gross claims and claims expense reserves........... $70,768 $20,770
======== ========
The Company believes that its exposure, if any, to environmental impairment
liability and asbestos-related claims is minimal since no business has been
written prior to 1996. The Company does not currently discount its reserves to
reflect the present value of claims that may eventually be paid.
Subject to the foregoing, the Company believes that the reserves for claims
and claims expenses are adequate to cover the ultimate cost of claims and claims
expenses incurred through December 31, 1997. The estimates will be continuously
reviewed and as adjustments to these reserves become necessary, such adjustments
will be reflected in current operations.
Overview of the Reinsurance Industry
Reinsurance is a form of insurance in which a reinsurer indemnifies a
primary insurer against part or all of the liability assumed by the primary
insurer under one or more insurance policies. Reinsurance is a contractual
agreement whereby an insurer or reinsurer (ceding company) remits a portion of
the premium it receives to a reinsurer (assuming company) as payment for the
assuming company's agreement to indemnify the ceding company for a portion of
the risk. Reinsurance provides insurers with several benefits which include the
following: reduction in net liability on individual risks, protection against
catastrophic losses and assistance in maintaining acceptable regulatory ratios
and additional underwriting capacity in that the primary insurer can accept
larger risks and can expand the book of business it writes at a faster rate than
would be possible without a corresponding increase in its capital and surplus
position. Reinsurance does not legally discharge the ceding company from its
liability with respect to its obligation to the insured.
There are two principal types of reinsurance: treaty reinsurance and
facultative reinsurance. Treaty reinsurance is a contractual arrangement,
usually renewable annually, between a primary insurer and a reinsurer under
which the primary insurer must cede and the reinsurer must assume a specified
portion of a type or category of risks. Facultative reinsurance is the
reinsurance of individual risks. Rather than agreeing to reinsure all or a
portion of a class of risk, the reinsurer separately rates and underwrites each
risk. In the underwriting of treaty reinsurance, the reinsurer need not
separately evaluate each of the individual risks assumed, as it must in the
underwriting of facultative reinsurance, and in general depends on the original
underwriting decisions made by the reinsured.
-10-
<PAGE>
Both facultative and treaty reinsurance can be written on both an excess of
loss and a quota share basis. In quota share reinsurance, the reinsurer assumes
from the reinsured a percentage specified in the treaty of each risk in the
reinsured class of risk. Premiums that the reinsured pays to the reinsurer are
proportional to the portion of the risk that the reinsurer assumes, and the
reinsurer generally pays the reinsured a ceding commission to reimburse the
reinsured for the expenses incurred in obtaining the business. The ceding
commission may also contain a profit component. In quota share reinsurance, the
reinsurer may receive the benefit of common account reinsurance and, therefore,
the reinsurer will have credit risk with respect to the underlying reinsurers
providing such common account reinsurance. In excess of loss treaty reinsurance,
the reinsurer indemnifies the reinsured for a portion of the losses on
underlying policies which exceed a specified loss retention amount up to an
amount per loss specified in the treaty. Premiums that the reinsured pays to the
reinsurer for excess of loss coverage are not directly proportional to the
premiums that the reinsured receives because the reinsurer does not assume a
proportionate risk. The reinsurer generally does not pay any commission to the
reinsured in connection with excess of loss reinsurance. Excess of loss treaty
reinsurance can, in turn, be written on a per risk or catastrophe basis. Per
risk excess of loss reinsurance protects the reinsured against a loss resulting
from a single risk or location. Catastrophe excess of loss reinsurance protects
a reinsured from an accumulation or large number of related losses resulting
from a variety of risks which may occur in a given catastrophe and hence is a
highly volatile business.
Excess of loss reinsurance is often written in layers, with one reinsurer
taking the risk from the primary insurer's retention layer up to a specified
amount, at which point another reinsurer takes over the excess liability or the
excess liability reverts back to the primary insurer. The reinsurer taking on
the risk just above the primary insurer's retention layer is said to write
"working" or "low layer" excess of loss reinsurance. A loss that reaches just
beyond the primary insurer's retention layer will create a loss for the lower
layer reinsurer, but not for the reinsurers on higher layers. Losses incurred in
low layer reinsurance tend to be more predictable than those in high layers due
to the availability of greater actuarial data.
Excess of loss and pro rata reinsurance are priced differently because the
probability of loss is different for the two types of coverage. Premiums that
the ceding company pays to the reinsurer for excess of loss reinsurance are not
directly proportional to the premiums that the ceding company receives because
the reinsurer does not assume a proportionate risk. In contrast, premiums that
the ceding company pays to the reinsurer for pro rata reinsurance are
proportional to the premiums that the ceding company receives, consistent with
the proportional sharing of risk. In addition, in pro rata reinsurance the
reinsurer generally pays the ceding company a ceding commission. The ceding
commission generally is based on the ceding company's cost of acquiring the
business being reinsured (commissions, premium taxes, assessments and
miscellaneous administrative expense) and also may include a profit factor.
Since facultative reinsurance, unlike treaty reinsurance, usually involves
the assumption of selected, individual risks and is sold in separate
transactions, facultative reinsurance is typically priced for higher profit
margins than treaty business. However, the reinsurer's losses may be higher for
facultative business because the reinsurer may assume a higher potential
liability and because the risks involved may be more volatile. In addition,
underwriting expenses and, in particular, personnel costs, are higher on
facultative business because each risk is individually underwritten and
administered. Facultative reinsurance is normally purchased by insurance
companies for individual risks not covered by their reinsurance treaties, for
excess losses on risks covered by their reinsurance treaties, and for unusual
risks. The demand for facultative reinsurance is typically inversely related to
the supply of treaty reinsurance.
Reinsurers may also purchase reinsurance, known as retrocessional
reinsurance, to cover their own risk exposure. Reinsurance companies enter into
retrocessional agreements for reasons similar to those that cause ceding
companies to purchase reinsurance.
The reinsurance market has two basic segments: reinsurers which primarily
obtain their business directly from insurers and other reinsurers ("direct
writers"), and those which, like the Company, primarily obtain business through
reinsurance intermediaries or brokers.
Competition
The property and casualty reinsurance business is highly competitive.
Competition is based on many factors, including the perceived overall financial
strength of the reinsurer, premiums charged, contract terms and conditions,
services offered, ratings assigned by independent rating agencies, speed of
claims payment
-11-
<PAGE>
and reputation and experience. The Company, in pursuing its investment strategy,
also competes with venture capitalists, buyout funds, merchant banking firms,
investment banking firms and other banking and financing sources for investment
opportunities in publicly traded and privately held equity securities.
Competition is based on many factors, including the ability to identify trends
and investment opportunities that could lead to superior returns, financial and
personnel resources of the investor, the ability to negotiate investment terms
effectively, and the ability of the investor to provide expertise and advice to
companies targeted for investment.
The Company competes in the United States and international reinsurance
markets and, in the United States markets, competes with both United States and
internationally domiciled reinsurers. The Company's competitors include
independent reinsurance companies, subsidiaries or affiliates of established
worldwide insurance companies, reinsurance departments of certain primary
insurance companies and domestic and international underwriting syndicates, many
of which have substantially greater financial resources than the Company.
Competitors include direct writers and those that, like the Company, write
primarily through reinsurance intermediaries.
Significant competitors of the Company in the direct market include
American Re-Insurance Company, Employers Reinsurance Corporation, General
Reinsurance Corporation and Swiss Reinsurance Company. Significant competitors
of the Company in the intermediary/broker market include Constitution
Reinsurance Corporation, Everest Reinsurance Company, Kemper Reinsurance
Company, NAC Reinsurance Company, PMA Reinsurance Corporation, The St. Paul
Companies, Inc., TIG Reinsurance Corporation, Transatlantic Reinsurance Company,
Trenwick America Reinsurance Corporation, Underwriters Reinsurance Company and
Zurich Re North America. In addition, the Company competes with Lloyd's
syndicates and certain companies operating in the London reinsurance market. The
Company may also face competition from other market participants that determine
to devote greater amounts of capital to the types of business written by the
Company.
The Company believes that the reinsurance industry is consolidating, and
the largest reinsurers are writing a larger proportion of total industry
premiums as ceding companies place increasing importance on size and financial
strength in the selection of reinsurers.
The Company may also compete with new market entrants, including possibly
other companies organized by (or that may, in the future, be organized by)
certain of the Company's initial investors, including Risk Capital Corp., EXEL
and Trident, their affiliates or entities that they advise or in which such
initial investors, their affiliates or entities that they advise, have (or may,
in the future, have) significant investments. In addition, affiliates of Risk
Capital Corp. engage in activities in support of their ongoing business
strategies, which activities may compete with those of the Company.
A.M. Best ("Best") is generally considered to be a significant rating
agency with respect to the evaluation of insurance and reinsurance companies.
Best's ratings are based on a quantitative evaluation of performance with
respect to profitability, leverage and liquidity and a qualitative evaluation of
spread of risk, reinsurance program, investments, reserves and management.
Unlike many of the Company's competitors, the Company has not been rated by
Best. Best generally will not assign a rating to a company until it has
accumulated representative operating performance. Insurance ratings are used by
insurers and reinsurance intermediaries as an important means of assessing the
financial strength and quality of reinsurers. In addition, a ceding company's
own rating may be adversely affected by the lack of a rating of its reinsurer.
Therefore, the lack of a rating may dissuade a ceding company from reinsuring
with the Company and may influence a ceding company to reinsure with a
competitor of the Company that has an insurance rating.
The Company does not believe that the absence of a rating by Best has had a
material adverse effect on the Company's ability to compete in the reinsurance
markets in which it operates. There can be no assurances, however, that
increased competitive pressure from current reinsurers and future entrants and
the lack of a rating by Best or other insurance rating agencies will not
adversely affect the Company.
In March 1997, Demotech, Inc., an Ohio-based ratings firm ("Demotech"),
issued to Risk Capital Reinsurance a 1997 Financial Stability Rating of A double
prime Unsurpassed, Demotech's highest financial stability rating. The Company
cannot predict whether the financial stability rating assigned to Risk Capital
Reinsurance by Demotech will increase Risk Capital Reinsurance's ability to
compete in the reinsurance markets in which it operates.
-12-
<PAGE>
Insurance Regulation
General
The terms and conditions of reinsurance agreements generally are not
subject to regulation by any governmental authority with respect to rates or
policy terms. This contrasts with primary insurance policies and agreements, the
rates and terms of which generally are closely regulated by state insurance
regulators. As a practical matter, however, the rates charged by primary
insurers do have an effect on the rates that can be charged by reinsurers.
State Regulation
Risk Capital Reinsurance, in common with other insurers, is subject to
extensive governmental regulation and supervision in the various states and
jurisdictions in which it transacts business. The laws and regulations of the
State of Nebraska, the domicile of Risk Capital Reinsurance, have the most
significant impact on its operations. This regulation and supervision is
designed to protect policyholders rather than investors and relates to, among
other things, the standards of solvency which must be met and maintained, the
nature of and limitations on investments, restrictions on the size of risk which
may be insured under a single policy, and reserves and provisions for unearned
premiums, losses and other purposes.
Some states are considering legislative proposals which would authorize the
establishment of an interstate compact concerning various aspects of insurer
insolvency proceedings, including interstate governance of receiverships and
guaranty funds. As of March 1998, such legislation had been adopted by three
states, including Illinois, Michigan and Nebraska.
Insurance departments also conduct periodic examinations of the affairs of
insurance companies and require the filing of annual and other reports relating
to the financial condition of companies and other matters. Risk Capital
Reinsurance has not been examined by the Nebraska Insurance Department other
than in connection with the receipt of its insurance license in November 1995.
Credit for Reinsurance
A primary insurer ordinarily will enter into a reinsurance agreement only
if it can obtain credit for the reinsurance ceded on its statutory financial
statements. In general, credit for reinsurance is allowed in the following
circumstances: (i) if the reinsurer is licensed in the state in which the
primary insurer is domiciled and, in some instances, in certain states in which
the primary insurer is licensed; (ii) if the reinsurer is an "accredited" or
otherwise approved reinsurer in the state in which the primary insurer is
domiciled and, in some instances, in certain states in which the primary insurer
is licensed; (iii) in some instances, if the reinsurer (a) is domiciled in a
state that is deemed to have substantially similar credit for reinsurance
standards as the state in which the primary insurer is domiciled and (b) meets
certain financial requirements; or (iv) if none of the above apply, to the
extent that the reinsurance obligations of the reinsurer are collateralized
appropriately, typically through the posting of a letter of credit for the
benefit of the primary insurer or the deposit of assets into a trust fund
established for the benefit of the primary insurer. Therefore, as a result of
the requirements relating to the provision of credit for reinsurance, the
Company is indirectly subject to certain regulatory requirements imposed by
jurisdictions in which ceding companies are licensed.
As of March 23, 1998, Risk Capital Reinsurance is licensed or is an
accredited or otherwise approved reinsurer in 36 states as follows: Arkansas,
Connecticut, Delaware, District of Columbia, Florida, Hawaii, Idaho, Illinois,
Indiana, Iowa, Kentucky, Louisiana, Maryland, Michigan, Mississippi, Missouri,
Montana, Nebraska (state of domicile), Nevada, New Hampshire, New Jersey, New
Mexico, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island,
South Carolina, South Dakota, Tennessee, Texas, Utah, Vermont, Virginia and
Wisconsin. In addition, Risk Capital Reinsurance is also an authorized reinsurer
in the Argentine Republic. Risk Capital Reinsurance has applications pending for
licenses or reinsurance authorizations in Alaska, Georgia, Minnesota, New York,
West Virginia, Wyoming and the United States Treasury Department for surety
business. Risk Capital Reinsurance intends to apply for licenses or reinsurance
authorizations in the remainder of the states as applicable requirements are
met. If necessary, and until such time that all remaining reinsurance
authorizations are granted, Risk Capital Reinsurance intends to appropriately
collateralize its reinsurance obligations. The Company cannot predict if and
when such authorizations will be granted.
-13-
<PAGE>
Investment Limitations
The Nebraska insurance laws contain rules governing the types and amounts
of investments that are permissible for Nebraska-domiciled insurers, including
Risk Capital Reinsurance. These rules are designed to ensure the safety and
liquidity of an insurer's investment portfolio. Investments in excess of
statutory guidelines do not constitute "admitted assets" (i.e., assets permitted
by the Nebraska insurance laws to be included in a domestic insurer's statutory
financial statements), unless special approval is obtained from the Nebraska
Director of Insurance (the "Nebraska Director"). Non-admitted assets do not
count for the purposes of various financial ratios and tests, including those
governing solvency and the ability to write premiums. An insurer may hold an
investment authorized under more than one provision of the Nebraska insurance
laws under the provision of its choice (except as otherwise expressly provided
by law).
Subject to the "basket" clause described below, the maximum amount of an
insurer's authorized investments in preferred stock and common stock of
insurance companies for calculation of admitted assets in Nebraska is the lesser
of (i) the amount by which admitted assets exceed required capital and
liabilities or (ii) 50% of policyholders surplus. At December 31, 1997, such
amounts for Risk Capital Reinsurance were $380.0 million and $192.5 million,
respectively. Stock of insurance companies is valued for these purposes at cost.
Unrealized appreciation of such securities does not count for the purpose of
determining the percentage of certain admitted assets attributable to insurance
stock investments.
While there is a concentration restriction which precludes investment of
more than 5% of the insurer's admitted assets in any one issuer, this
restriction does not apply to investments in common and preferred stock of other
insurers whose senior debt obligations have received a designation of 1 or 2
from the Securities Valuation Office (the "SVO") of the National Association of
Insurance Commissioners (the "NAIC"). Designations assigned by the SVO range
from class 1 to class 6, with class 1 as the highest quality rating. Generally,
SVO designations of 1 and 2 are comparable to investment grade ratings by
Moody's and Standard & Poor's, and SVO designations of 3 to 6 are comparable to
below investment grade ratings by such rating organizations.
Other concentration restrictions preclude investment of more than 3%, 2%,
1% or 1/2% of an insurer's admitted assets in any one person whose senior debt
obligations have received a designation of 3, 4, 5 or 6, respectively, from the
SVO. In addition, an insurer's investments in debt obligations having a 4, 5 or
6 designation from the SVO may not exceed 4%, 2% or 1%, respectively, of the
Company's admitted assets. Aggregate investments in obligations having any
combination of 3, 4, 5 and 6 designations from the SVO may not exceed, in the
aggregate, 15% of the insurer's admitted assets.
An insurer's investments in equity interests of business entities (e.g.,
corporations, partnerships, limited liability companies and partnerships,
trusts, joint ventures, etc.; including insurance companies) that are created or
existing under the laws of the United States or Canada are also authorized under
the Nebraska insurance laws, provided that, in the case of an investment in a
business entity other than an insurance company, (i) the insurer may generally
not invest in more than 10% of the total equity interests of such entity and
(ii) the investment will be subject to the concentration restrictions described
above. In the case of an investment in a business entity that is a corporation,
such entity must also meet certain requirements regarding retained earnings and
dividend payment history.
Authorized foreign investments by an insurer in foreign jurisdictions whose
sovereign debt has a designation of 1, 2 or 3 from the SVO may not exceed, in
the aggregate, 15% of the insurer's admitted assets. Investments may not be made
in foreign jurisdictions whose sovereign debt has a designation of 4, 5 or 6
from the SVO. In addition, authorized foreign investments denominated in foreign
currencies may not exceed, in the aggregate, 5% of the insurer's admitted
assets. Authorized foreign investments must also have a minimum designation of 1
or 2 from the SVO (or corresponding investment grade rating from any rating
organization recognized by the SVO, including Moody's and Standard & Poor's),
and must be aggregated with investments of the same kinds and classes made under
the Nebraska insurance laws (except for the "basket" clause) for purposes of
determining compliance with the limitations contained in other sections.
Notwithstanding the foregoing or any other limitations under the Nebraska
insurance laws, there is a "basket" clause under which investments "not
otherwise authorized" are permitted up to a maximum of the greater of (i) the
lesser of (a) 25% of the amount by which admitted assets exceed total
liabilities, excluding capital, or (b) 5% of admitted assets (investments
authorized under this subsection of the "basket" clause may
-14-
<PAGE>
not include obligations with SVO designations of 3, 4, 5 or 6), or (ii) that
portion of policyholders surplus which is in excess of 50% of the insurer's
annual net written premiums. Derivative instruments otherwise authorized under
the Nebraska insurance laws may not be authorized under the "basket" clause. As
of December 31, 1997, the "basket" clause would have allowed Risk Capital
Reinsurance to make investments not otherwise authorized under the Nebraska
insurance laws up to a maximum amount of $312.6 million.
The Nebraska insurance laws provide that the Nebraska Director may waive
any of the legal investment limitations upon application by an insurer. The
Nebraska Director is required to consider the following factors in determining
whether to approve or disapprove any such application: (i) the credit risk
quality of the proposed investment; (ii) the liquidity of the proposed
investment and of the insurer's entire investment portfolio; (iii) the extent of
the diversification of the insurer's investment portfolio; (iv) the yield of the
proposed investment; (v) the reasonableness of the insurer's policyholders
surplus in relation to the insurer's outstanding liabilities and financial
needs; and (vi) any other relevant considerations. From time to time, it may be
necessary for the Company to seek waivers from the Nebraska Director of the
legal investment limitations imposed by the Nebraska insurance laws; no
assurances can be given that such waivers can be obtained.
States in which Risk Capital Reinsurance may become licensed or authorized
may also seek to impose their legal investment laws on Risk Capital Reinsurance.
Such laws vary from state to state and may not permit investments that are
permitted under Nebraska law. To the extent that any state disallows an
investment that is permitted under Nebraska law, Risk Capital Reinsurance's
statutory surplus reflected in its statutory financial statements filed in such
state would be reduced by the amount of such disallowance.
Holding Company Acts
State insurance holding company statutes provide a regulatory apparatus
which is designed to protect the financial condition of domestic insurers
operating within a holding company system. All holding company statutes require
disclosure and, in some instances, prior approval of significant transactions
between the domestic insurer and an affiliate. Such transactions typically
include sales, purchases, exchanges, loans and extensions of credit, and
investments between an insurance company and its affiliates, involving in the
aggregate certain percentages of a company's admitted assets or policyholders
surplus, or dividends that exceed certain percentages of the company's surplus
or income.
The Nebraska insurance laws and the insurance laws of other states
generally regard an issuer as an "affiliate" of one of its investors if it is
controlled by, or is under common control with, the investor. Generally,
"control" means the possession of the power to direct or cause the direction of
the management and policies of the issuer, whether through the ownership of
voting securities, by contract or otherwise. Control is generally presumed to
exist if the investor, directly or indirectly, owns or controls 10% or more of
the voting securities of the issuer. The Nebraska insurance laws and the
insurance laws of other states generally allow investors to rebut this
presumption by filing a "disclaimer" that sets forth the bases for disclaiming
affiliation. In certain states, such as Nebraska, a disclaimer is deemed
effective once filed unless it is specifically disallowed by the respective
insurance department (after the parties in interest have been provided notice
and an opportunity to be heard). In other states, a disclaimer must be
specifically approved by the relevant insurance department. In cases where Risk
Capital Reinsurance may be presumed to "control," and therefore deemed an
affiliate of, an insurer under applicable holding company statutes, Risk Capital
Reinsurance intends to continue to file disclaimers with respect to such insurer
unless prevented by the surrounding circumstances.
Typically, the holding company statutes also require each of the insurance
subsidiaries periodically to file information with state insurance regulatory
authorities, including information concerning capital structure, ownership,
financial condition and general business operations. Under the terms of
applicable state statutes, any person or entity desiring to acquire control of a
domestic insurer is required first to obtain approval of the applicable state
insurance regulator.
Liquidation of Insurers
The liquidation of insurance companies, including reinsurers, is generally
conducted pursuant to state insurance law. In the event of the liquidation of
Risk Capital Reinsurance, such liquidation would be conducted by the Nebraska
Director as the domestic receiver of the properties, assets and business of Risk
Capital Reinsurance. Liquidators located in other states (known as ancillary
liquidators) in which Risk
-15-
<PAGE>
Capital Reinsurance conducts business may have jurisdiction over assets or
properties located in such states under certain circumstances. Under Nebraska
law, all creditors of Risk Capital Reinsurance, including but not limited to
reinsureds under its reinsurance agreements, would be entitled to payment of
their allowed claims in full from the assets of Risk Capital Reinsurance before
RCHI, as a stockholder of Risk Capital Reinsurance, would be entitled to receive
any distribution therefrom.
Regulation of Dividends and Other Payments from Insurance Subsidiaries
As an insurance holding company, RCHI will be largely dependent on
dividends and other permitted payments from Risk Capital Reinsurance to meet its
obligations. The ability of Risk Capital Reinsurance to pay dividends or make
other distributions is subject to insurance regulatory limitations of Nebraska,
the state in which Risk Capital Reinsurance is domiciled. The Nebraska insurance
laws provide that dividends or other distributions, together with other
dividends or distributions paid during the preceding 12 months, may not exceed
the greater of (i) 10% of statutory surplus as of the preceding December 31 or
(ii) statutory net income from operations for 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 dividend 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, the
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, the
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. See Note 10 of the Notes to the Consolidated Financial Statements
of the Company.
The Nebraska insurance laws also require that the statutory surplus of Risk
Capital Reinsurance following any dividend or distribution be reasonable in
relation to its outstanding liabilities and adequate to its financial needs. The
Nebraska Director is required to apply certain factors in determining the
adequacy of an insurer's surplus, including, among other things, the size of the
insurer, the extent to which the insurer's business is diversified, the number
and size of risks insured by each line of business, the extent of geographical
dispersion of insured risks and the reinsurance program, and characteristics of
the investment portfolio. In addition, the Nebraska insurance laws require that
each insurer give notice to the Nebraska Director of all dividends and other
distributions within five business days following declaration thereof and that
any such dividend or other distribution may not be paid within 10 business days
of such notice (the "Notice Period") unless for good cause shown the Nebraska
Director has approved such payment within the Notice Period.
Insurance Regulatory Information System Ratios
The NAIC's Insurance Regulatory Information System ("IRIS") was developed
by a committee of state insurance regulators and is intended primarily to assist
state insurance departments in executing their statutory mandates to oversee the
financial condition of insurance companies operating in their respective states.
IRIS identifies 11 industry ratios and specifies "usual values" for each ratio.
Departure from the usual values of the ratios can lead to inquiries from
individual state insurance commissioners as to certain aspects of an insurer's
business. For the year ended December 31, 1997, Risk Capital Reinsurance's
results were within the usual values for nine of the 11 ratios. The "change in
writings" ratio was outside the usual value due to the fact that Risk Capital
Reinsurance commenced writing reinsurance business in 1996. The "investment
yield" ratio was outside the usual value primarily due to Risk Capital
Reinsurance's investment strategy of investing a significant portion of its
investment portfolio in equity securities, which generally yield less current
investment income than fixed maturity investments. Due to Risk Capital
Reinsurance's limited operating history, its current IRIS ratios are not
meaningful indicators of its financial condition or of the IRIS ratios it may
experience in the future.
-16-
<PAGE>
Accreditation
The NAIC has instituted its Financial Regulatory Accreditation Standards
Program ("FRASP") in response to federal initiatives to regulate the business of
insurance. FRASP provides a set of standards designed to establish effective
state regulation of the financial condition of insurance companies. Under FRASP,
a state must adopt certain laws and regulations, institute required regulatory
practices and procedures, and have adequate personnel to enforce such items in
order to become an "accredited" state. If a state was not accredited by January
1, 1994, accredited states are not able to accept certain financial examination
reports of insurers prepared solely by the regulatory agency in such
unaccredited state. The State of Nebraska is accredited under FRASP; however,
there can be no assurance that it or any other state will remain accredited.
Risk-Based Capital Requirements
In order to enhance the regulation of insurer solvency, the NAIC adopted in
December 1993 a formula and model law to implement risk-based capital
requirements for property and casualty insurance companies. Effective January 1,
1994, Nebraska adopted risk-based capital legislation for property and casualty
companies which is similar to the NAIC risk-based capital requirements. These
risk-based capital requirements are designed to assess capital adequacy and to
raise the level of protection that statutory surplus provides for policyholder
obligations. The risk-based capital model for property and casualty insurance
companies measures three major areas of risk facing property and casualty
insurers: (i) underwriting, which encompasses the risk of adverse loss
developments and inadequate pricing; (ii) declines in asset values arising from
credit risk; and (iii) declines in asset values arising from investment risks.
Insurers having less statutory surplus than required by the risk-based capital
calculation will be subject to varying degrees of regulatory action, depending
on the level of capital inadequacy. Equity investments in common stock typically
are valued at 85% of their market value under the risk-based capital guidelines.
For equity investments in an insurance company affiliate, the risk-based capital
requirement for the equity securities of such affiliate would generally be the
Company's proportionate share of the affiliate's risk-based capital requirement.
For a discussion of "affiliate" status under the insurance laws, see
"Business--Insurance Regulation--Holding Company Acts."
The Company's surplus (as calculated for statutory annual statement
purposes) is well above the risk-based capital thresholds that would require
either company or regulatory action.
Regulation of Certain Reinsurance Intermediaries
Certain states, including Nebraska, have adopted legislation or regulation
that, in effect, places additional requirements upon insurance and reinsurance
intermediaries and brokers when, on behalf of an insured, they place business
with an insurance or reinsurance company that is affiliated with such
intermediary or broker. While the Company believes that there is no such
affiliation between the Company and reinsurance intermediaries that may be
affiliated with Marsh & McLennan, no assurances can be given that other persons
(including such intermediaries) may not take a contrary position. While the
Company believes that compliance with such regulations would not be burdensome
upon an intermediary or broker, no assurances can be given as to whether a
broker or intermediary would decide to place or continue to place business with
the Company if such regulations were viewed to be applicable.
Federal Regulation
Although the federal government does not directly regulate the insurance or
reinsurance industries, federal initiatives often affect the insurance business
in a variety of ways. Although state regulation remains the dominant form of
regulation, the federal government has shown increasing concern over the
adequacy of state regulation.
It is not possible to predict the future impact of any of these or other
possible laws or regulations on Risk Capital Reinsurance's capital and
operations, and such laws or regulations could materially adversely affect its
business.
-17-
<PAGE>
Legislative and Regulatory Proposals
From time to time various regulatory and legislative changes have been
proposed in the insurance and reinsurance industry, some of which could have an
effect on reinsurers. Among the proposals that have in the past been or are at
present being considered are the possible introduction of federal regulation in
addition to, or in lieu of, the current system of state regulation of insurers
and proposals in various state legislatures (some of which proposals have been
enacted) to conform portions of their insurance laws and regulations to various
model acts adopted by the NAIC. The Company is unable to predict whether any of
these laws and regulations will be adopted, the form in which any such laws and
regulations would be adopted, or the effect, if any, these developments would
have on the operations and financial condition of the Company.
Senior Management
The Company's senior management team consists of:
Name Age Position
---- --- --------
Mark D. Mosca 44 President, Chief Executive Officer and Director
Robert Clements 65 Chairman and Director
Peter A. Appel 36 Managing Director, General Counsel and Secretary
Bonnie L. Boccitto 48 Managing Director and Chief Underwriting Officer*
Paul J. Malvasio 51 Managing Director, Chief Financial Officer and
Treasurer
----------
* Chief Underwriting Officer of Risk Capital Reinsurance.
Mark D. Mosca was elected President and Director of RCHI in June 1995 and
Chief Executive Officer of RCHI in March 1998, and President, Chief Executive
Officer and Director of Risk Capital Reinsurance in August 1995. Prior to that
time, he was Senior Vice President and Chief Underwriting Officer of Zurich
Reinsurance Centre Holdings, Inc. since the completion of its initial public
offering in May 1993. Prior thereto, Mr. Mosca served as a Vice President of NAC
Re Corporation ("NAC Re"), where he was manager of the Treaty Division since
February 1986. From 1975 to 1986, Mr. Mosca was employed by General Reinsurance
Corporation where he was a Vice President. Mr. Mosca holds an A.B. degree from
Harvard University.
Robert Clements was elected Chairman and Director of RCHI at its formation
in March 1995 and Chairman and Director of Risk Capital Reinsurance in September
1995. He is currently an advisor to Risk Capital Corp., with whom he served as
Chairman and Chief Executive Officer from January 1994 to March 1996. Prior
thereto, he served as President of Marsh & McLennan Companies, Inc. since 1992,
having been Vice Chairman during 1991. He was Chairman of J&H Marsh & McLennan,
Incorporated (formerly Marsh & McLennan, Incorporated), a subsidiary of Marsh &
McLennan Companies, Inc., from 1988 until March 1992. He joined Marsh &
McLennan, Ltd., a Canadian subsidiary of Marsh & McLennan Companies, Inc., in
1959. Mr. Clements is a director of EXEL Limited and Hiscox plc. He is Chairman
of the Board of Trustees of The College of Insurance and a member of Rand Corp.
President's Council.
Peter A. Appel has been a Managing Director, General Counsel and Secretary
of both RCHI and Risk Capital Reinsurance since November 1995. From September
1987 to November 1995, Mr. Appel practiced law with the New York firm of Willkie
Farr & Gallagher, where he was a partner from January 1995. He holds an A.B.
degree from Colgate University and a law degree from Harvard University.
Bonnie L. Boccitto has been a Managing Director of RCHI and a Managing
Director and Chief Underwriting Officer of Risk Capital Reinsurance since
October 1995. From September 1993 to September 1995, Ms. Boccitto was a Senior
Vice President of Everest Reinsurance Holdings, Inc. (formerly Prudential
Reinsurance Holdings, Inc.) and its reinsurance subsidiary, Everest Re (formerly
Prudential Reinsurance Company), where she was responsible for all United States
broker treaty and facultative operations. From 1989 to September 1993, she
served as a Vice President of Everest Re, where she was manager of the treaty
casualty department. She joined Everest Re in 1979 in the actuarial department
and became an underwriter in the treaty department in 1983. Ms. Boccitto holds a
B.S. degree in Mathematics from Dana College and a M.Ed. degree in Mathematics
Education from Rutgers University.
-18-
<PAGE>
Paul J. Malvasio has been a Managing Director, Chief Financial Officer and
Treasurer of both RCHI and Risk Capital Reinsurance since September 1995 and a
Director of Risk Capital Reinsurance since November 1995. Prior to that time, he
was Senior Vice President and Chief Financial Officer of NAC Re since the
completion of NAC Re's initial public offering in February 1986. From 1967 to
1986, Mr. Malvasio was employed by the public accounting firm of Coopers &
Lybrand, where he was an audit partner from October 1979. Mr. Malvasio is a
certified public accountant and holds a B.B.A. degree in Accounting from St.
Francis College.
Employees
At March 23, 1998, the Company employed a total of 37 full-time employees.
The Company will continue to increase its staff over time commensurate with the
expansion of operations. The Company's employees are not represented by a labor
union and the Company believes that its employee relations are good.
-19-
<PAGE>
GLOSSARY OF SELECTED INSURANCE TERMS
Admitted assets.................Assets permitted by state law to be included
as "assets" in an insurance company's annual
statement.
Annual Statement................A report that an insurance company must file
annually with the state insurance
commissioner in its domiciliary state and
each other state in which it does business.
The statement shows the current status of
reserves, expenses, assets, total liabilities
and investment portfolio.
Assume..........................To take from an insurer or reinsurer (a
ceding company) all or part of a risk
underwritten by such person, along with the
related premiums, losses and expenses.
Attachment point................The amount of loss (per occurrence or in the
aggregate, as the case may be) above which
excess of loss coverage becomes operative.
Broker market reinsurer.........A reinsurer that markets and sells
reinsurance through brokers rather than
through its own employees.
Case reserves...................Loss reserves established with respect to
individual reported claims.
Casualty insurance..............Insurance which is primarily concerned with
the losses caused by injuries to third
persons (in other words, persons other than
the policyholder) and the legal liability
imposed on the insured resulting therefrom.
Catastrophe reinsurance.........A form of excess of loss reinsurance that,
subject to a specified limit, indemnifies the
ceding company for the amount of loss in
excess of a specified retention with respect
to an accumulation of losses resulting from a
catastrophic event. The actual reinsurance
document is called a "catastrophe cover."
Cede; Cedent; Ceding company....When a party reinsures all or part of its
risks with another, it "cedes" business and
is referred to as the "cedent" or "ceding
company."
Common account reinsurance......Arrangements whereby the ceding company
enters the reinsurance market and purchases a
cover for the benefit of the ceding company
and the reinsurers on the reinsurance treaty.
A pro rata portion of the costs of this
protection is deducted from the ceded
premium.
Credit enhancement..............Use of financial guaranty to upgrade the
quality of a security through the use of an
insurance policy or letter of credit or other
means.
Direct underwriter;
Direct writer.................An insurer or reinsurer that markets and
sells insurance directly to its insureds or
reinsureds without the assistance of brokers.
Excess of loss reinsurance......A generic term describing reinsurance that
indemnifies the reinsured against all or a
specified portion of losses on underlying
insurance policies in excess of a specified
amount, which is called a "level" or
"retention." Also known as non-proportional
reinsurance. Excess of loss reinsurance is
written in layers. A reinsurer or group of
reinsurers accepts a band of coverage up to a
specified amount. The total coverage
purchased by the cedent is referred to as a
"program" and will typically be placed with
predetermined reinsurers in prenegotiated
layers. Any liability exceeding the outer
limit of the program reverts to the ceding
company, which also bears the credit risk of
a reinsurer's insolvency.
Facultative reinsurance.........The reinsurance of all or a portion of the
insurance provided by a single policy. Each
policy reinsured is separately negotiated.
-20-
<PAGE>
Finite risk reinsurance........Similar to traditional reinsurance with the
exception that there is a finite risk to the
reinsurer with respect to minimum and maximum
exposure in relation to the premium to be
received.
Gross premiums written.........Total premiums for insurance and reinsurance
assumed during a given period.
Incurred but not reported
("IBNR").....................Reserves for estimated losses that have been
incurred by insureds and reinsureds but not
yet reported to the insurer or reinsurer,
including unknown future developments on
losses which are known to the insurer or
reinsurer.
In-force premiums..............The total of estimated annualized premiums of
all policies in force as of a certain date
which would be anticipated to generate net
premiums written during the annual period
being considered.
Intermediary/broker............One who negotiates contracts of insurance
between an insured and a primary insurer on
behalf of the insured and/or contracts of
reinsurance between a primary insurer or
other reinsured and a reinsurer on behalf of
the primary insurer or reinsured, in each
case receiving a commission for placement and
other services rendered.
Lloyd's syndicate..............Underwriting members of Lloyd's (which can be
individual "names" and/or dedicated corporate
members) that group together annually to form
a syndicate to underwrite insurance coverage.
Each syndicate is managed by a
Lloyd's-approved managing agent, which
appoints one or more active or named
underwriters who have the authority to bind
the syndicate to contracts of insurance, pay
claims and effect recoveries.
Net premiums written...........Gross premiums written for a given period
less premiums ceded to retrocessionaires
during such period.
Primary insurer................An insurance company that contracts with the
insured to provide insurance coverage. Such
insurer may then cede a portion of its
business to reinsurers.
Probable maximum loss..........Under Risk Capital Reinsurance's current
guidelines, probable maximum loss is the
anticipated maximum exposure to an event of a
magnitude such that it would be expected to
occur once in 100 years.
Quota share or proportional
reinsurance..................A generic term describing all forms of
reinsurance in which the reinsurer shares a
proportional part of the original premiums
and losses of the reinsured. (Also known as
pro rata reinsurance or participating
reinsurance.) In proportional reinsurance,
the reinsurer generally pays the ceding
company a ceding commission. The ceding
commission generally is based on the ceding
company's cost of acquiring the business
being reinsured (including commissions,
premium taxes, assessments and miscellaneous
administrative expenses) and also may include
a profit factor. Generally, the reinsurer
gets the benefit of common account
reinsurance.
RAA............................Reinsurance Association of America, a trade
association of medium and large property and
casualty reinsurers doing business in the
United States. The RAA provides statistical
data concerning the markets, which
voluntarily provide such information to the
RAA.
Reinsurance....................An arrangement in which an insurance company,
the reinsurer, agrees to indemnify another
insurance or reinsurance company, the ceding
company, against all or a portion of the
insurance or
-21-
<PAGE>
reinsurance risks underwritten by the ceding
company under one or more policies.
Reinsurance can provide a ceding company with
several benefits, including a reduction in
net liability on individual risks and
catastrophe protection from large or multiple
losses. Reinsurance also provides a ceding
company with additional underwriting capacity
by permitting it to accept larger risks and
write more business than would be possible
without a concomitant increase in capital and
surplus, and facilitates the maintenance of
acceptable financial ratios by the ceding
company. Reinsurance does not legally
discharge the ceding company from its
liability with respect to its obligations to
the insured.
Reserves.......................Liabilities established by insurers and
reinsurers to reflect the estimated costs of
claims payments and the related expenses that
the insurer or reinsurer will ultimately be
required to pay in respect of insurance or
reinsurance it has written. Reserves are
established for losses and for unpaid claims
and claims expenses and for unearned
premiums. Loss reserves consist of case
reserves and IBNR reserves. For reinsurers,
unpaid claims and claims expense reserves are
generally not significant because
substantially all of the unpaid claims and
claims expenses associated with particular
claims are incurred by the primary insurer
and reported to reinsurers as losses.
Unearned premium reserves constitute the
portion of premiums paid in advance for
insurance or reinsurance that has not yet
been provided.
Retention......................The amount or portion of risk that an insurer
retains for its own account. Losses in excess
of the retention level are paid by the
reinsurer. In proportional treaties, the
retention may be a percentage of the original
policy's limit. In excess of loss business,
the retention is a dollar amount of loss, a
loss ratio or a percentage.
Retrocession...................A transaction whereby a reinsurer cedes to
another reinsurer (the "retrocessionaire")
all or part of the reinsurance that the first
reinsurer has assumed. Retrocessions do not
legally discharge the ceding reinsurer from
its liability with respect to its obligations
to the reinsured. Reinsurance companies cede
risks to retrocessionaires for reasons
similar to those that cause primary insurers
to purchase reinsurance: to reduce net
liability on individual risks, to protect
against catastrophic losses, to stabilize
financial ratios and to obtain additional
underwriting capacity.
Statutory accounting
principles ("SAP")............The rules and procedures prescribed or
permitted by United States state insurance
regulatory authorities including the NAIC,
which govern the preparation of financial
statements. Such rules and procedures
generally reflect a liquidating, rather than
going concern, concept of accounting.
Statutory composite ratio......Provides an overall indication of
underwriting profitability. The ratio is the
sum of: the ratio of commissions and other
underwriting expenses to premiums written,
and the ratio of claims and claims expenses
to premiums earned. A statutory composite
ratio under 100% indicates underwriting
profitability, while a composite ratio
exceeding 100% indicates an underwriting loss.
Statutory surplus..............The excess of admitted assets over total
liabilities (including loss reserves),
determined in accordance with SAP.
-22-
<PAGE>
Tail...........................The period of time that elapses between the
writing of the applicable insurance policy or
the loss event (or the insurer's knowledge of
the loss event) and the payment in respect
thereof.
Treaties.......................The reinsurance of a specified type or
category of risks defined in a reinsurance
agreement (a "treaty") between an insurer and
a reinsurer or between a reinsurer and a
retrocessionaire. In treaty reinsurance the
cedent is typically obligated to offer, and
the reinsurer or retrocessionaire is
obligated to accept, a specified portion of a
type or category of risks insured by the
ceding company as set forth in the governing
contract. Treaty reinsurance may provide for
proportional or non-proportional reinsurance.
Underwriting...................The insurer's or reinsurer's process of
reviewing applications submitted for
insurance coverage, deciding whether to
accept all or part of the coverage requested
and determining the applicable premiums.
Underwriting capacity..........The maximum amount that an insurance company
can underwrite. The limit is generally
determined by the company's policyholders or
statutory surplus, which depends, among other
things, on the insurer's admitted assets.
Reinsurance serves to increase a company's
capacity by reducing its exposure from
particular risks.
-23-
<PAGE>
ITEM 2. PROPERTIES
In March 1996, the Company entered into a sublease agreement initially
expiring in October 2002 for approximately 40,000 square feet of office space in
Greenwich, Connecticut, at which the Company's offices are located. Future
minimum rental charges for the remaining term of the sublease, exclusive of
escalation clauses and maintenance costs and net of rental income, will be
approximately $2.8 million. The Company's rental expense, net of sublease
income, during 1997 and 1996 was approximately $643,000 and $613,000,
respectively.
Commencing in 1996, the Company subleased approximately 13,000 square feet
of the office space to Risk Capital Corp. for a term expiring in October 2002.
Future minimum rental income under the remaining term of the sublease, exclusive
of escalation clauses and maintenance costs, will be approximately $2.1 million.
Rental income for 1997 and 1996 was $430,000 and $264,000, respectively. Risk
Capital Corp. also reimbursed the Company approximately $574,000 in 1997 for
Risk Capital Corp.'s pro rata share of improvement and maintenance costs under
the sublease. In addition, commencing in 1997, the Company subleased
approximately 6,000 square feet of the office space to another tenant for a term
expiring in October 2002. Future minimum rental income under the remaining term
of the sublease, exclusive of escalation clauses and maintenance costs, will be
approximately $689,000. Rental income for 1997 was $117,000, of which $44,000
was paid to Risk Capital Corp. as its pro rata share of such income.
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to litigation and arbitration in the ordinary course
of its business. The Company is not currently involved in any litigation or
arbitration.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to a vote of security holders during the
fourth quarter of 1997.
Part II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
Shares of the Common Stock are traded on the Nasdaq National Market tier of
The Nasdaq Stock Market under the symbol "RCHI." For the periods presented
below, the high and low sales prices and closing prices for the Common Stock as
reported on the Nasdaq National Market were as follows:
Three Months Ended
---------------------------------------------------------
December 31, September 30, June 30, March 31,
1997 1997 1997 1997
------------- ------------- ------------ ------------
High ............... $23.375 $23.375 $21.000 $19.250
Low ................ 20.875 20.500 16.000 16.125
Close .............. 22.250 23.000 21.000 17.000
Three Months Ended
---------------------------------------------------------
December 31, September 30, June 30, March 31,
1996 1996 1996 1996
------------- ------------- ------------ ------------
High ............... $19.875 $20.750 $20.500 $23.250
Low ................ 15.875 16.500 19.125 19.750
Close .............. 19.375 19.000 19.625 20.500
-24-
<PAGE>
On March 20, 1998, the high and low sales prices and the closing price for
the Common Stock as reported on the Nasdaq National Market were $23.375, $22.750
and $23.125, respectively.
Holders
As of March 20, 1998, there were 45 holders of record of the Common Stock
and approximately 1,501 beneficial holders of the Common Stock.
Dividends
The Company has not declared any dividends since its formation in 1995. The
declaration and payment of dividends will be at the discretion of the Board of
Directors of RCHI and will depend upon the Company's results of operations and
cash flows, the financial position and capital requirements of the Company,
general business conditions, legal, tax and regulatory restrictions on the
payment of dividends, and other factors the Board of Directors of RCHI deems
relevant. There is no requirement or assurance that dividends will be declared
or paid in the future. The payment of dividends by RCHI will be dependent upon
the ability of Risk Capital Reinsurance to provide funds to RCHI. For a
description of the restrictions on the ability of Risk Capital Reinsurance to
pay dividends or make distributions to RCHI, see "Business--Insurance
Regulation--Regulation of Dividends and Other Payments from Insurance
Subsidiaries," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and Note 10 of the Notes to the Consolidated Financial
Statements of the Company.
-25-
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
Set forth below is certain selected consolidated financial information for
fiscal years 1997 and 1996, and the period from June 23, 1995 (date of
inception) to December 31, 1995. This information should be read in conjunction
with the accompanying Consolidated Financial Statements of the Company and the
Notes thereto and Management's Discussion and Analysis of Financial Condition
and Results of Operations.
Years Ended December 31, Period from
-------------------------- June 23, 1995 to
1997 1996 December 31, 1995
------------- ---------- -----------------
(In thousands, except share data)
Income Statement Data
Net premiums earned ............ $107,372 $35,761
Net investment income .......... 14,360 13,151 $4,578
Net realized investment
gains (losses) ............. (760) 1,259 397
Total revenues ................. 120,972 50,171 4,975
Net income ..................... 2,039 4,112 1,019
Average shares outstanding
Basic ...................... 17,032,601 16,981,724 16,747,084
Diluted .................... 17,085,788 16,983,909 16,990,425
Net income per share
Basic ...................... $0.12 $0.24 $0.06
Diluted .................... 0.12 0.24 0.06
At December 31,
-----------------------------------------------
1997 1996 1995
------------ ------------ --------------
(In thousands, except share data)
Balance Sheet Data
Total assets ................... $581,247 $432,486 $350,986
Total stockholders' equity ..... 401,031 352,213 340,215
Shares outstanding
Basic ...................... 17,058,462 17,031,246 16,941,125
Diluted .................... 17,601,608 17,065,406
Book value per share
Basic ...................... $23.51 $20.68 $20.08
Diluted .................... 22.79 20.64
-26-
<PAGE>
ITEM 7. 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 December 31, 1997, the
statutory surplus of Risk Capital Reinsurance was approximately $385 million.
Recent Industry Performance
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. Perceived surplus capacity has led to
pressure on pricing and other terms, which pressure is expected to continue in
1998. 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. The reinsurance industry is highly competitive and dynamic,
and market changes may affect, among other things, demand for the Company's
products, changes in investment opportunities (and the performance thereof),
changes in the products offered by the Company or changes in the Company's
business strategy. (See "Cautionary Note Regarding Forward-Looking Statements.")
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, 1998 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 been 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 to 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, relationship with its equity investment advisor and strategic
focus on generating a small number of large reinsurance treaty transactions that
may also be integrated with an equity investment in client companies as well as
its expansion into the marine and aerospace lines of business commencing late in
1997.
At January 1, 1998, the Company had approximately 200 renewable reinsurance
treaties that are in force, with approximately $170 million of estimated
annualized net premiums written, compared to $128 million at January 1, 1997.
Such in-force premiums at January 1, 1998 represent estimated annualized
premiums from treaties entered into during 1997 and the January 1, 1998 renewal
period that are expected to generate net premiums written during 1998. Such
renewable treaties at January 1, 1998 are estimated to generate approximately
$113 million of net premiums written over the 12-month period ending December
31, 1998 without taking into account certain factors, including the possibility
that (i) several treaties entered into in 1997 that are scheduled to expire
during the remainder of 1998 may be renewed and (ii) additional treaties may be
bound during 1998.
-27-
<PAGE>
Results of Operations
For the years ended December 31, 1997 and 1996 and for the period June 23,
1995 (date of inception) to December 31, 1995, the Company had consolidated net
income of approximately $2.0 million, or $0.12 per share, $4.1 million, or $0.24
per share, and $1.0 million, or $0.06 per share, respectively. After-tax
realized investment gains (losses) of ($0.5 million), or ($0.03) per share, $0.8
million, or $0.05 per share, and $0.3 million, or $0.02 per share, were also
included in net income for the 1997, 1996 and 1995 periods, respectively. Net
income for each of the years ended 1997 and 1996 included losses of $0.2
million, or $0.01 per share, representing the Company's equity in the net loss
of investee companies accounted for under the equity method of accounting.
Net Premiums Written
Net premiums written for the year ended December 31, 1997 compared to 1996
was as follows:
(In millions)
Years Ended
December 31,
--------------------------------------
1997 1996
--------------- -----------------
Property............... $17.8 $19.4
Casualty............... 69.7 17.6
Multi-line............. 45.9 21.8
Specialty.............. 10.0 13.7
Marine................. 1.4 --
=============== =================
Total.............. $144.8 $72.5
=============== =================
Approximately 28.5% and 5.2% of net premiums written in 1997 and 1996,
respectively, were generated from companies in which the Company has invested or
committed to invest funds. Approximately 28% and 30% of net premiums written in
1997 and 1996, respectively, were from non-United States clients, which are
Lloyd's syndicates or are located in the United Kingdom and Continental Europe.
Consistent with the Company's strategy of writing a small number of large
treaties for its core business, five clients contributed approximately $68
million, or 45%, of the Company's 1997 net premiums written, with the largest
client contributing approximately 18% and the remaining four clients each
contributing an amount ranging from 5% to 8%. One client that contributed 8% of
1997 net premiums written is expected to retain most of the business it
previously ceded to the Company. While not anticipated, the reduction or loss of
business assumed from one or more large clients could have a material adverse
effect on the Company's results of operations to the extent not offset by new
business.
Approximately $32.9 million, or 46%, of net premiums written in 1996
resulted from unearned premium portfolios and other non-recurring transactions.
This amount included $11.9 million of specialty premiums written from contracts
pursuant to which the Company reinsures a portion of one underlying policy for
multiple years. Such premiums will be earned over the multiple periods as the
exposures expire. In 1997, there were no significant unearned premium portfolios
or other non-recurring transactions included in net premiums written.
Operating Costs and Expenses
One traditional means of measuring the underwriting performance of a
property/casualty insurer, such as the Company, is the statutory composite
ratio. This ratio, which is based upon statutory accounting principles (which
differ from generally accepted accounting principles in several respects),
reflects underwriting experience, but does not reflect income from investments.
A statutory composite ratio under 100% indicates underwriting profitability,
while a composite ratio exceeding 100% indicates an underwriting loss.
-28-
<PAGE>
Set forth below are the Company's statutory composite ratios for the years
ended December 31, 1997 and 1996 and the estimated aggregate statutory composite
ratio for domestic reinsurers based on data reported by the RAA as of such
dates:
Years Ended
December 31,
--------------------------------
1997 1996
-------------- --------------
Claims and claims expenses......... 68.4% 67.3%
Commissions and brokerage.......... 28.8 23.7
-------------- --------------
97.2 91.0
Other operating expenses........... 9.1 15.3
============== ==============
Statutory composite ratio.......... 106.3% 106.3%
============== ==============
Domestic reinsurer aggregate
statutory composite ratios:...... 102.3% 103.1%
============== ==============
The Company's 1997 statutory composite ratio, while essentially unchanged
from the 1996 ratio, contains a higher aggregate claims and claims expenses and
commissions and brokerage ratio component in 1997, which reflects a business mix
with a higher casualty content. Such increase was offset by a lower other
operating expenses ratio as the Company continues to leverage its infrastructure
with increased premium writings. There was no significant favorable or
unfavorable claims development from 1996.
Claims and claims expenses generally represent the Company's most
significant and uncertain costs. Reserves for these expenses are estimates
involving actuarial and statistical projections at a given time of what the
Company expects the ultimate settlement and administration of claims to cost
based on facts and circumstances then known. The reserves are based on estimates
of claims and claims expenses incurred and, therefore, the amount ultimately
paid may be more or less than such estimates. The inherent uncertainties of
estimating claim reserves are exacerbated for reinsurers by the significant
periods of time (the "tail") that often elapse between the occurrence of an
insured loss, the reporting of the loss to the primary insurer and, ultimately,
to the reinsurer, and the primary insurer's payment of that loss and subsequent
indemnification by the reinsurer. As a consequence, actual claims and claims
expenses paid may deviate, perhaps substantially, from estimates reflected in
the Company's reserves reported in its financial statements. The estimation of
reserves by new reinsurers, such as the Company, may be less reliable than the
reserve estimations of a reinsurer with an established volume of business and
claims history. To the extent reserves prove to be inadequate, the Company may
have to augment such reserves and incur a charge to earnings. Such a
development, while not anticipated, could occur and result in a material charge
to earnings or stockholders' equity in future periods. Subject to the foregoing,
the Company believes that the reserves for claims and claims expenses are
adequate to cover the ultimate cost of claims and claims expenses incurred
through December 31, 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. In a number
of reinsurance treaties, provisional commissions are initially paid and
subsequently increased or decreased, subject to a minimum and maximum amount,
depending upon the claims and claims expenses experience of the assumed
business. The Company records the commission increase or decrease in accordance
with contractual terms based on the expected ultimate experience of the
contract.
Other operating expenses increased to $14.2 million in 1997, compared to
$11.3 million for the year ended December 31, 1996 and $3.9 million for the
period June 23, 1995 (date of inception) to December 31, 1995. 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
-29-
<PAGE>
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 $682,000. Such loss is principally related to assets and premiums
receivable of approximately $5.8 million denominated in European Currency Units,
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.
Risk Retention
Given the Company's current level of surplus, under its current
underwriting guidelines, the maximum net retention per risk for property
treaties and per occurrence for casualty treaties is generally $10.0 million.
The Company monitors its earthquake and wind exposures and continuously
reevaluates its estimated probable maximum pre-tax loss for such exposures
through the use of modeling techniques. The Company generally seeks to limit its
probable maximum pre-tax loss to no more than 10% of its statutory surplus for
severe catastrophic events that could be expected to occur once in every 100
years. This limitation includes combined exposure to underwriting losses,
reinstatement costs for retrocessional arrangements which may be in force at the
time of the losses resulting from the catastrophic event, and losses that the
Company may be exposed to as a result of its privately held investments in
insurance and insurance-related entities. While the Company believes its risk
management techniques are adequate, there can be no assurances that the Company
will not suffer pre-tax losses greater than 10% of its statutory surplus from a
catastrophic event due to the inherent uncertainties in estimating the frequency
and severity of such exposures. In addition, the Company believes that it cannot
reasonably estimate its exposure to unrealized investment losses (if any) that
may result from the Company's investments in publicly traded securities of
insurance and insurance-related entities.
With respect to integrated transactions (where the Company combines an
equity or equity-like investment in a client company with the purchase by such
client of reinsurance from the Company), the Company generally limits its
combined underwriting and investment exposure to pre-tax losses on any
individual client to no more than 10% of its total statutory surplus, and
subjects these commitments to scrutiny by the combined professional staffs of
both the Company and Risk Capital Corp.
Investment Results
At December 31, 1997, approximately 45% of the Company's invested assets
consisted of fixed maturity and short-term investments, compared to 63% at
December 31, 1996. Net investment income was approximately $14.4 million in
1997, compared to $13.2 million in 1996 and $4.6 million for the period June 23,
1995 (date of inception) to December 31, 1995. The amount of investment income
from quarter to quarter may vary and could 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, which
generally yield less current investment income than fixed maturity investments.
The Company's investment yields at amortized cost were as follows for the
periods set forth below:
Years Ended
December 31, June 23, 1995
-------------------------- (date of inception) to
1997 1996 December 31, 1995
------------ ------------- ----------------------
Investment yields:
Pre-tax............ 3.7% 3.8% 4.8%
Net of tax......... 2.7% 2.8% 3.5%
Assuming a stable interest rate environment, the Company anticipates such
yields to slightly decline as funds invested in short-term securities continue
to be allocated into investments in equity securities, which yield less current
income than fixed maturity investments. Additionally, such investment yields
exclude the Company's equity in the net income or loss of private equity
investments accounted for under the equity method.
-30-
<PAGE>
Income Taxes
The Company's 1997 income tax benefit and effective tax rates of 7% for the
year ended December 31, 1996 and 7% for the period June 23, 1995 (date of
inception) to December 31, 1995 are less than the 35% statutory rate on pre-tax
operating income due to tax exempt income and the dividends received deductions.
The 1997, 1996 and 1995 gross deferred income tax benefits of approximately $2.1
million, $1.8 million and $0.2 million, respectively, which are assets
considered recoverable from future taxable income, result from temporary
differences between financial and taxable income.
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 marketable equity securities will be
used to support shorter-term liquidity requirements.
As a significant portion of the Company's investment portfolio will
generally consist of equity securities issued by insurance and reinsurance
companies and companies providing services to the insurance industry, the equity
portfolio will lack industry diversification and will be particularly subject to
the performance 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 and/or reinsurance 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. 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 initially to generate operating losses.
Investments that are or will be included in the Company's private portfolio
include securities issued by privately held companies and by publicly traded
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 an inability by the Company 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 December 31, 1997, cash and invested assets totaled approximately $505.7
million, consisting of $98.2 million of cash and short-term investments, $132.2
million of publicly traded fixed maturity investments, $180.1 million of
publicly traded equity securities and $95.3 million of privately held
securities. Included in privately held securities are investments totaling $53.8
million which are accounted for under the equity method.
See Note 3 under the caption "Investment Information" of the accompanying
Notes to Consolidated Financial Statements of the Company for certain
information regarding the Company's publicly traded and privately held
securities and their carrying values, and commitments made by the Company
relating to its privately held securities. 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.
-31-
<PAGE>
At December 31, 1997, substantially all of the Company's fixed maturity and
short-term investments were rated investment grade by Moody's or Standard &
Poor's and had an average quality rating of AA and an average duration of
approximately 2.9 years.
At December 31, 1997, the Company is obligated under letters of credit
approximating $46.5 million, which secure certain reinsurance obligations and
investment commitments in amounts of approximately $30.8 million and $15.7
million, respectively. Securities with a carrying value of approximately $38.2
million have been pledged as collateral for a portion of these letters of
credit.
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. The Company's portfolio includes market sensitive instruments,
such as mortgage-backed securities, which are subject to prepayment risk and
changes in market value in connection with changes in interest rates. The
Company's investments in mortgage-backed securities, which amounted to
approximately $30.5 million at December 31, 1997, or 6% of cash and invested
assets, are classified as available for sale and are not held for trading
purposes.
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 Risk Capital
Reinsurance's 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.
The Nebraska insurance laws provide that, without prior approval of 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, the 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, the 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. See "Business--Insurance
Regulation--Regulation of Dividends and Other Payments from Insurance
Subsidiaries" and Note 10 of the accompanying Notes to the Consolidated
Financial Statements of the Company.
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 years ended December 31,
1997 and 1996 was approximately $49 million and $31 million, respectively,
consisting principally of premiums received, investment income and net
investment gains, offset by operating costs and expenses.
-32-
<PAGE>
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 December 31, 1997, the Company's consolidated stockholders' equity
totaled $401.0 million, or $23.51 per share based on issued and outstanding
shares and $22.79 per share on a diluted basis which includes outstanding
dilutive warrants and options. At such date, statutory surplus of Risk Capital
Reinsurance was approximately $385 million. Based on data available as of
December 31, 1997 from the RAA, Risk Capital Reinsurance is the eleventh largest
domestic broker market oriented reinsurer as measured by statutory surplus.
Accounting Pronouncements
Earnings per share are computed in accordance with Financial Accounting
Standards Board ("FASB") Statement No. 128 "Earnings Per Share," which was
retroactively adopted in the 1997 fourth quarter. All earnings per share amounts
for all periods have been presented, and where appropriate, restated to conform
to the new accounting requirements. (See Notes 2, 12 and 14 of the accompanying
Notes to the Consolidated Financial Statements of the Company.)
Effective in the 1998 first quarter, the Company will adopt the provisions
of FASB Statement No. 130 "Reporting Comprehensive Income." This statement
establishes standards for reporting and displaying comprehensive income and its
components in a full set of general purpose financial statements. Comprehensive
income for the Company consists of net income and changes in unrealized
appreciation or depreciation, net of tax. Reclassification of financial
statements of earlier periods for comparative purposes is required. (See Note 13
of the accompanying Notes to the Consolidated Financial Statements of the
Company.)
The Company is evaluating the applicability of FASB Statement No. 131
"Disclosure About Segments of an Enterprise and Related Information" to its
Consolidated Financial Statements, which statement will be effective in the
first quarter of 1998. This statement establishes standards for the way that
public business enterprises report information about operating segments in
annual and interim financial reports to stockholders. It also establishes
standards for related disclosures about products and services, geographic areas
and major customers. (See Note 13 of the accompanying Notes to the Consolidated
Financial Statements of the Company.)
The Company elected in 1996 to continue to account for its stock-based
compensation under Accounting Principles Board Opinion ("APB") No. 25
"Accounting for Stock Issued to Employees" and related interpretations under APB
No. 25. The Company does not recognize any compensation expense for its grants
of employee stock options because the exercise price of the Company's employee
stock options equals the market price of the underlying stock on the date of
grant. In addition, under APB No. 25, the Company does not recognize
compensation expense for stock issued to employees under its stock purchase
plan. The alternative to APB No. 25 is FASB No. 123 "Accounting for Stock-Based
Compensation," which requires fair value accounting for stock-based
compensation.
-33-
<PAGE>
Set forth below is pro forma information regarding net income and earnings
per share, assuming the Company had accounted for its employee stock options
under FASB No. 123 using a Black-Scholes option valuation model:
(In thousands, except per share data)
Years Ended
December 31, June 23, 1995
-------------------------- (date of inception) to
1997 1996 December 31, 1995
------------ ------------- ----------------------
Net income, as reported.. $2,039 $4,112 $1,019
Pro forma net income..... 994 3,569 911
Earnings per share,
as reported
Basic and diluted.... 0.12 0.24 0.06
Pro forma earnings
per share
Basic and diluted.... 0.06 0.21 0.05
The effect on net income and earnings per share after applying FASB No.
123's fair valuation method to stock issued under the Company's employee stock
purchase plan does not materially differ from the pro forma information set
forth above with respect to the Company's employee stock options. (See Note 8 of
the accompanying Notes to the Consolidated Financial Statements of the Company.)
The Year 2000 Issues
Many existing computer programs use only two digits to identify a year in
the date field. These programs were designed and developed without considering
the impact of the upcoming change in the century. If not corrected, many
computer applications could fail or create erroneous results by or at the year
2000. The year 2000 issue affects virtually all companies and organizations.
Many companies must undertake major projects to address the year 2000
issue. Each company's potential costs and uncertainties will depend on a number
of factors, including its software and hardware and the nature of its industry.
Companies also must coordinate with other entities with which they
electronically interact, both domestically and globally, including suppliers,
customers, creditors, borrowers and financial service organizations. If a
company does not successfully address its year 2000 issues, it may face material
adverse consequences.
The Company is presently assessing its information systems to ensure that
they are capable of processing information for the year 2000 and beyond. Based
on information currently available, the cost of this internal effort, while not
quantified, is not expected to have a material adverse effect on the Company's
results of operations. However, due to the interdependent nature of computer
systems, the Company may be adversely impacted depending upon whether other
entities not affiliated with the Company (e.g., vendors and business partners)
address this issue successfully. Where practicable, the Company intends to
assess and attempt to mitigate its risks in the event that these entities fail
to be year 2000 compliant. The effect, if any, on the Company's results of
operations from the possible failure of these entities to be year 2000 compliant
is not determinable.
In addition, property and casualty reinsurance companies may have
underwriting exposure related to the year 2000. While the Company continues to
review these potential exposures, the Company is unable to determine at this
time whether the adverse impact, if any, in connection with the foregoing would
be material to the Company.
Insurance Regulation
Risk Capital Reinsurance, in common with other insurers, is subject to
extensive governmental regulation and supervision in the various states and
jurisdictions in which it transacts business. The laws and regulations of the
State of Nebraska, the domicile of Risk Capital Reinsurance, have the most
significant impact on its operations.
-34-
<PAGE>
From time to time various regulatory and legislative changes have been
proposed in the insurance and reinsurance industry, some of which could have an
effect on reinsurers. Among the proposals that have in the past been, or are at
present being considered, are (i) the possible introduction of federal
regulation in addition to, or in lieu of, the current system of state regulation
of insurers and (ii) proposals in various state legislatures (some of which
proposals have been enacted) to conform portions of their insurance laws and
regulations to various model acts adopted by the NAIC. The Company is unable to
predict whether any of these laws and regulations will be adopted, the form in
which any such laws and regulations would be adopted, or the effect, if any,
these developments would have on the operations and financial condition of the
Company. See "Business--Insurance Regulation."
The NAIC is presently considering adopting a codification of statutory
accounting principles that would generally be applied to all insurance and
reinsurance company financial statements filed with insurance regulatory
authorities as early as the 1999 statutory filings. Although the codification is
not expected to materially affect many existing statutory accounting practices
presently followed by most insurers and reinsurers such as the Company, there
are several accounting practices that may be changed. The most significant
change would involve accounting for deferred income taxes, which change would
require a deferred tax liability to be recorded for unrealized appreciation of
invested assets, net of available deferred tax assets, that would result in a
reduction to statutory surplus. If this requirement had been in effect in 1997,
the statutory surplus of the Company would have been reduced by approximately
$15 million for a net deferred tax liability, from $385 million to $370 million
at December 31, 1997.
Effects of Inflation
The effects of inflation on the Company will be implicitly considered in
pricing and estimating reserves for unpaid claims and claims expenses. The
actual effects of inflation on the results of the Company cannot be accurately
known until claims are ultimately settled.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See the Consolidated Financial Statements and Notes thereto and required
financial statement schedules on pages F-1 through F-34 and S-1 through S-7
below.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated herein by reference to the captions "Election of
Directors--Directors and Executive Officers--Nominees," "--Continuing Directors
and Executive Officers" and "Election of Directors--Security Ownership of
Certain Beneficial Owners and Management--Section 16(a) Beneficial Ownership
Reporting Compliance" in the Company's definitive proxy statement for the
Company's Annual Meeting of Stockholders to be held on May 12, 1998 (the "Proxy
Statement"), which statement the Company intends to file with the SEC within 120
days after December 31, 1997.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by reference to the captions "Election of
Directors--Directors and Executive Officers--Compensation of Directors,"
"Election of Directors--Executive Compensation" and "--Performance Graph" in the
Proxy Statement.
-35-
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference to the caption "Election of
Directors--Security Ownership of Certain Beneficial Owners and Management"
in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Incorporated herein by reference to the captions "Election of
Directors--Executive Compensation--Compensation Committee Interlocks and
Insider Participation" and "Election of Directors--Certain Relationships and
Related Transactions" in the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
Financial Statements and Schedules
Financial Statements and Schedules listed in the accompanying Index to
Financial Statements and Schedules on page F-1 are filed as part of this Report,
and are included in Item 8.
Exhibits
The exhibits listed in the accompanying Exhibit Index are filed as part of
this Report. Such exhibits include, without limitation, certain management
contracts and compensatory plans as therein described.
Reports on Form 8-K
No Reports on Form 8-K were filed by the Company during the fourth quarter
of 1997.
-36-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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)
By: /s/ Mark D. Mosca
-------------------------------------
Mark D. Mosca,
Dated: March 23, 1998 President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Mark D. Mosca President and Chief Executive March 23, 1998
- ------------------------------- Officer (Principal Executive
Mark D. Mosca Officer) and Director
/s/ Robert Clements* Chairman and Director March 23, 1998
- -------------------------------
Robert Clements
/s/ Paul J. Malvasio Managing Director, Chief March 23, 1998
- ------------------------------- Financial Officer and
Paul J. Malvasio Treasurer (Principal
Financial Officer and Principal
Accounting Officer)
/s/ Michael P. Esposito, Jr.* Director March 23, 1998
- -------------------------------
Michael P. Esposito, Jr.
/s/ Lewis L. Glucksman* Director March 23, 1998
- -------------------------------
Lewis L. Glucksman
/s/ Ian R. Heap* Director March 23, 1998
- -------------------------------
Ian R. Heap
/s/ Thomas V. A. Kelsey* Director March 23, 1998
- -------------------------------
Thomas V. A. Kelsey
/s/ Mark N. Williamson* Director March 23, 1998
- -------------------------------
Mark N. Williamson
<PAGE>
Signature Title Date
--------- ----- ----
/s/ Philip L. Wroughton* Director March 23, 1998
- -------------------------------
Philip L. Wroughton
- ----------
* By Paul J. Malvasio, as attorney-in-fact and agent, pursuant to a power of
attorney, a copy of which has been filed with the Securities and Exchange
Commission as Exhibit 24 hereto.
/s/ Paul J. Malvasio
------------------------------
Name: Paul J. Malvasio
Attorney-in-Fact
<PAGE>
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Risk Capital Holdings, Inc. and Subsidiary Pages
-----
Report of Independent Accountants on Financial Statements.... F-2
Consolidated Balance Sheet at December 31, 1997 and 1996..... F-3
Consolidated Statement of Income for the years ended
December 31, 1997, 1996 and for the period from
June 23, 1995 (date of inception) to December 31, 1995....... F-4
Consolidated Statement of Changes in Stockholders'
Equity for the years ended December 31, 1997, 1996
and for the period from June 23, 1995 (date of inception)
to December 31, 1995......................................... F-5
Consolidated Statement of Cash Flows for the years ended
December 31, 1997, 1996 and the period from June 23, 1995
(date of inception) to December 31, 1995..................... F-6
Notes to Consolidated Financial Statements................... F-7
Schedules
Report of Independent Accountants on Financial Statement Schedules S-1
I. Summary of Investments Other Than Investments in Related
Parties at December 31, 1997 ........................... S-2
II. Condensed Financial Information of Registrant........... S-3 to
III. Supplementary Insurance Information for the years
ended December 31, 1997 and 1996........................ S-6
IV. Reinsurance for the years ended December 31, 1997 and
1996.................................................... S-7
Schedules other than those listed above are omitted for the reason that
they are not applicable.
F-1
<PAGE>
Report of Independent Accountants
To the Board of Directors and Stockholders of
Risk Capital Holdings, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, of changes in stockholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Risk Capital Holdings, Inc. and its subsidiary at December 31, 1997 and 1996,
and the results of their operations and their cash flows for the years ended
December 31, 1997 and 1996 and for the period from June 23, 1995 (date of
inception) to December 31, 1995, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ Price Waterhouse LLP
New York, New York
January 30, 1998
F-2
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
(Dollars in thousands)
<TABLE>
<CAPTION>
December 31,
-----------------------------------
1997 1996
-------------- ----------------
<S> <C> <C>
Assets
Investments:
Fixed maturities (amortized cost: 1997, $129,887; 1996, $140,128) $132,159 $140,381
Publicly traded equity securities (cost: 1997, $116,258; 1996, $108,580) 180,052 117,360
Privately held securities (cost: 1997, $77,550; 1996, $23,363) 95,336 28,847
Short-term investments 89,167 104,886
-------------- ----------------
Total investments 496,714 391,474
Cash 9,014 1,466
Accrued investment income 2,781 2,151
Premiums receivable 47,507 23,669
Reinsurance recoverable on unearned premiums 576
Reinsurance recoverable 522
Deferred policy acquisition costs 17,292 7,018
Other assets 7,939 5,610
============== ================
Total Assets $581,247 $432,486
============== ================
Liabilities
Claims and claims expenses $70,768 $20,770
Unearned premiums 74,234 37,348
Reinsurance premiums payable 211 536
Contingent commissions payable 682 2,734
Investment accounts payable 1,996 10,598
Deferred income tax liability 25,090 3,026
Other liabilities 7,235 5,261
-------------- ----------------
Total Liabilities 180,216 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
(issued: 1997, 17,069,845; 1996, 17,031,246) 171 170
Additional paid-in capital 341,162 340,435
Unrealized appreciation of investments, net of income tax 54,504 9,436
Deferred compensation under stock award plan (1,778) (2,959)
Retained earnings 7,170 5,131
Less treasury stock, at cost (1997, 11,383 shares) (198)
-------------- ----------------
Total Stockholders' Equity 401,031 352,213
-------------- ================
Total Liabilities and Stockholders' Equity $581,247 $432,486
============== ================
</TABLE>
See Notes to Consolidated Financial Statements
F-3
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF INCOME
(In thousands, except per share data)
<TABLE>
<CAPTION>
Years Ended June 23, 1995
December 31, (date of inception) to
1997 1996 December 31, 1995
---------------- ----------------- -------------------------
<S> <C> <C> <C>
Revenues
Net premiums written $144,834 $72,532
Increase in unearned premiums (37,462) (36,771)
--------------- ---------------- ----------------
Net premiums earned 107,372 35,761
Net investment income 14,360 13,151 $4,578
Net realized investment gains (losses) (760) 1,259 397
--------------- ---------------- ----------------
Total revenues 120,972 50,171 4,975
--------------- ---------------- ----------------
Operating Costs and Expenses
Claims and claims expenses 73,407 24,079
Commissions and brokerage 31,467 10,197
Other operating expenses 14,205 11,285 3,884
--------------- ---------------- ----------------
Total operating costs and expenses 119,079 45,561 3,884
--------------- ---------------- ----------------
Income
Income before income taxes and equity in net
loss of investees 1,893 4,610 1,091
--------------- ---------------- ----------------
Federal income taxes:
Current 1,761 2,147 230
Deferred (2,099) (1,810) (158)
--------------- ---------------- ----------------
Income tax expense (benefit) (338) 337 72
--------------- ---------------- ----------------
Income before equity in net loss of investees 2,231 4,273 1,019
Equity in net loss of investees (192) (161)
--------------- ---------------- ----------------
Net income $2,039 $4,112 $1,019
=============== ================ ================
Per Share Data
Average shares outstanding
Basic 17,032,601 16,981,724 16,747,084
=============== ================ ================
Diluted 17,085,788 16,983,909 16,990,425
=============== ================ ================
Net income per share
Basic $0.12 $0.24 $0.06
=============== ================ ================
Diluted $0.12 $0.24 $0.06
=============== ================ ================
</TABLE>
See Notes to Consolidated Financial Statements
F-4
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands)
<TABLE>
<CAPTION>
Years Ended June 23, 1995
December 31, (date of inception) to
1997 1996 December 31, 1995
---------------- --------------- --------------------------
<S> <C> <C> <C>
Common Stock
Balance at beginning of year $170 $169
Issuance of common stock $168
Restricted common stock issued 1 1 1
---------------- --------------- ------------------
Balance at end of year 171 170 169
---------------- --------------- ------------------
Additional Paid-in Capital
Balance at beginning of year 340,435 338,737
Issuance of common stock, and in 1995, Class A
and B warrants 727 1,698 338,737
---------------- --------------- ------------------
Balance at end of year 341,162 340,435 338,737
---------------- --------------- ------------------
Unrealized Appreciation of Investments, Net of
Income Tax
Balance at beginning of year 9,436 3,731
Change in unrealized appreciation 45,068 5,705 3,731
---------------- --------------- ------------------
Balance at end of year 54,504 9,436 3,731
---------------- --------------- ------------------
Deferred Compensation Under Stock Award Plan
Balance at beginning of year (2,959) (3,441)
Restricted common stock issued (506) (1,487) (3,895)
Compensation expense recognized 1,687 1,969 454
---------------- --------------- ------------------
Balance at end of year (1,778) (2,959) (3,441)
---------------- --------------- ------------------
Retained Earnings
Balance at beginning of year 5,131 1,019
Net income 2,039 4,112 1,019
---------------- --------------- ------------------
Balance at end of year 7,170 5,131 1,019
---------------- --------------- ------------------
Treasury Stock, At Cost
Balance at beginning of year
Purchase of treasury shares (198)
---------------- --------------- ------------------
Balance at end of year (198)
---------------- --------------- ------------------
Total Stockholders' Equity
Balance at beginning of year 352,213 340,215
Issuance of common stock, and in 1995, Class A
and B warrants 728 1,699 338,906
Change in unrealized appreciation of investments,
net of income tax 45,068 5,705 3,731
Change in deferred compensation 1,181 482 (3,441)
Net income 2,039 4,112 1,019
Purchase of treasury shares (198)
---------------- --------------- ------------------
Balance at end of year $401,031 $352,213 $340,215
================ =============== ==================
</TABLE>
See Notes to Consolidated Financial Statements
F-5
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Years Ended June 23, 1995
December 31, (date of inception) to
1997 1996 December 31, 1995
--------- --------- ----------------------
<S> <C> <C> <C>
Operating Activities
Net income $ 2,039 $ 4,112 $ 1,019
Adjustments to reconcile net income to net cash
provided by (used for) operating activities:
Liability for claims and claims expenses, net 49,998 20,770
Unearned premiums 36,886 37,348
Premiums receivable (23,838) (23,669)
Accrued investment income (630) 291 (2,442)
Contingent commissions payable (2,052) 2,734
Reinsurance balances, net 773 (562)
Deferred policy acquisition costs (10,274) (7,018)
Net realized investment (gains)/losses 760 (1,259) (397)
Deferred income tax asset (2,202) (1,897) (158)
Other liabilities 1,974 1,826 2,959
Other items, net (4,396) (1,687) (1,048)
-------- -------- --------
Net Cash Provided By (Used For) Operating
Activities 49,038 30,989 (67)
-------- -------- --------
Investing Activities
Purchases of fixed maturity investments (239,395) (232,568) (177,950)
Sales of fixed maturity investments 241,035 226,927 43,587
Net sales (purchases) of short-term investments 20,390 53,982 (155,116)
Purchases of equity securities (95,738) (110,551) (46,107)
Sales of equity securities 33,104 34,352 1,228
Purchases of furniture, equipment and
leasehold improvements (910) (2,859) (124)
-------- -------- --------
Net Cash Used For Investing Activities (41,514) (30,717) (334,482)
-------- -------- --------
Financing Activities
Net cash proceeds from initial public offering
and direct sales 322,073
Proceeds from issuance of Class B warrants 13,458
Common stock issued 728 1,699 3,895
Purchase of treasury shares (198)
Deffered compensation on retricted stock (506) (1,487) (3,895)
-------- -------- --------
Net Cash Provided By Financing Activities 24 212 335,531
-------- -------- --------
Increase in cash 7,548 484 982
Cash beginning of year 1,466 982
-------- -------- --------
Cash end of year $9,104 $1,466 $982
======== ======== ========
</TABLE>
See Notes to Consolidated Financial Statements
F-6
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Formation and Capitalization
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
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.
The Company generally seeks to write a small number of large
reinsurance treaty transactions that may also be integrated with an equity
investment in client companies. Such reinsurance may include traditional
and finite risk property and casualty reinsurance treaty coverages,
including excess of loss reinsurance and quota share or proportional
reinsurance. The Company also writes treaty reinsurance for ocean marine
and aviation and satellite risks. The Company's investment strategy is
focused on the insurance industry. A principal component of this strategy
is investing a significant portion of invested assets in publicly traded
and privately held equity securities issued by insurance and reinsurance
companies and companies providing services to the insurance industry.
The Company obtains substantially all of its reinsurance through
intermediaries which represent the cedent in negotiations for the purchase
of reinsurance. In addition to investment opportunities arising from the
activities of Marsh & McLennan Risk Capital Corp. ("Risk Capital Corp."),
as the Company's equity investment advisor, the Company is provided with
investment opportunities by reinsurance brokers and traditional financing
sources, including investment banking firms, venture capital firms and
other banking and financing sources, both acting as principal investors and
intermediaries. Underwriting opportunities may arise from such sources in
connection with the Company's investment activities as part of integrated
transactions.
2. Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements have been prepared in conformity
with generally accepted accounting principles ("GAAP") and include the
accounts of RCHI and Risk Capital Reinsurance. All intercompany
transactions and balances have been eliminated in consolidation. The
preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
F-7
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
2. Summary of Significant Accounting Policies (continued)
Premium Revenues and Related Expenses
Premiums are recognized as income on a pro rata basis over the terms
of the related reinsurance contracts. These amounts are based on reports
received from ceding companies, supplemented by the Company's own estimates
of premiums for which ceding company reports have not been received.
Unearned premium reserves represent the portion of premiums written that
relates to the unexpired terms of contracts in force. Certain of the
Company's contracts include provisions that adjust premiums based upon the
experience under the contracts. Premiums written and earned as well as
related acquisition expenses under these contracts are recorded based upon
the expected ultimate experience under these contracts.
Acquisition costs, which vary with and are primarily related to the
acquisition of policies, consisting principally of commissions and
brokerage expenses incurred at the time a contract is issued, are deferred
and amortized over the period in which the related premiums are earned.
Deferred acquisition costs are limited to their estimated realizable value
based on the related unearned premiums and take into account anticipated
claims and claims expenses, based on historical and current experience, and
anticipated investment income.
Investments
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.
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 Risk Capital
Corp., its equity investment advisor.
Realized investment gains or losses on the sale of investments are
determined by the specific identification method and recorded in net
income. Unrealized appreciation or depreciation of securities which are
carried at fair value is excluded from net income and recorded as a
separate component of stockholders' equity, net of applicable deferred
income tax.
F-8
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
2. Summary of Significant Accounting Policies (continued)
Net investment income, consisting of dividends and interest, net of
investment expenses, is recognized when earned. The amortization of premium
and accretion of discount for fixed maturity investments is computed
utilizing the interest method. Anticipated prepayments and expected
maturities are used in applying the interest method for certain investments
such as mortgage and other asset-backed securities. When actual prepayments
differ significantly from anticipated prepayments, the effective yield is
recalculated to reflect actual payments to date and anticipated future
payments. The net investment in the security is adjusted to the amount that
would have existed had the new effective yield been applied since the
acquisition of the security. Such adjustments, if any, are included in net
investment income.
Claims and Claims Expenses
The reserve for claims and claims expenses consists of unpaid reported
claims and claims expenses and estimates for claims incurred but not
reported. These reserves are based on reports received from ceding
companies, supplemented by the Company's estimates of reserves for which
ceding company reports have not been received, and the Company's own
historical experience. To the extent that the Company's own historical
experience is inadequate for estimating reserves, such estimates will be
determined based upon industry experience and management's judgment. The
ultimate liability may vary from such estimates, and any adjustments to
such estimates are reflected in income in the period in which they become
known. Reserves are recorded without consideration of potential salvage or
subrogation recoveries which are estimated to be immaterial. Such
recoveries, when realized, are reflected as a reduction of claims incurred.
Foreign Exchange
The United States dollar is the functional currency for the Company's
foreign business. Gains and losses on the translation into United States
dollars of amounts denominated in foreign currencies are included in net
income. Foreign currency revenue and expenses are translated at average
exchange rates during the year. Assets and liabilities denominated in
foreign currencies are translated at the rate of exchange in effect at the
balance sheet date. Foreign currency gains (losses) recorded in other
operating expenses in 1997, 1996 and 1995 were ($682,000), $104,000, and
$0, respectively.
Income Taxes
The Company utilizes the liability method of accounting for income
taxes. Deferred income taxes reflect the net tax effect of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and amounts used for income tax purposes. A
valuation allowance is recorded using the "more-likely-than-not" criteria
when some or all of a deferred tax asset may not be realized.
Earnings Per Share Data
Earnings per share are computed in accordance with Financial
Accounting Standards Board ("FASB") Statement No. 128 "Earnings Per Share"
which was retroactively adopted in the 1997 fourth quarter. All earnings
per share amounts for all periods have been presented and, where
appropriate, restated to conform to the new accounting requirements.
Basic earnings per share excludes dilution and is computed by dividing
income available to common stockholders by the weighted average number of
shares of Common Stock outstanding for the periods. Diluted earnings per
share reflect the potential dilution that could occur if Class A and B
warrants and employee stock options were exercised or converted into Common
Stock.
F-9
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
2. Summary of Significant Accounting Policies (continued)
Furniture, Equipment and Leasehold Improvements
The costs of furniture and equipment are charged against income over
their estimated service lives. Leasehold improvements are amortized over
the term of the office lease. Depreciation and amortization are computed on
the straight-line method. Maintenance and repairs are charged to expense as
incurred.
Employee Stock Options
The Company follows Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees" ("APB No. 25") and related
interpretations in accounting for its employee stock options because the
alternative fair value accounting provided for under FASB Statement No. 123
"Accounting for Stock-Based Compensation" ("FASB No. 123") requires use of
option valuation models that were not developed for use in valuing employee
stock options (see Note 8). Under APB No. 25, no compensation expense is
recognized by the Company because the exercise price of the Company's
employee stock options equal the market price of the underlying stock on
the date of grant. In addition, under APB No. 25, the Company does not
recognize compensation expense for stock issued to employees under its
stock purchase plan.
Goodwill
In connection with its acquisitions of privately held equity
securities recorded under the equity method of accounting, the Company
amortizes goodwill on a straight line basis over 25 years. Goodwill at
December 31, 1997 was $12,566,000. Amortization of goodwill included in
equity in net loss of investees in 1997 was $248,000. There was no goodwill
recorded in 1996 and 1995.
Reclassifications
The Company has reclassified the presentation of certain prior year
information to conform with the current presentation.
3. Investment Information
Net Investment Income
The components of net investment income were derived from the
following sources:
<TABLE>
<CAPTION>
(In thousands)
Years Ended June 23, 1995
December 31, date of inception) to
1997 1996 December 31, 1995
----------- ----------- ----------------------
<S> <C> <C> <C>
Fixed maturity securities $7,105 $7,470 $1,464
Publicly traded equity securities 3,272 1,606 118
Privately held equity securities 157 56
Short-term investments 6,039 5,491 3,339
----------- ----------- -----------------
Gross investment income 16,573 14,623 4,921
Investment expenses 2,213 1,472 343
----------- ----------- -----------------
Net investment income $14,360 $13,151 $4,578
=========== =========== =================
</TABLE>
F-10
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
3. Investment Information (continued)
Realized and Unrealized Investment Gains (Losses)
Realized investment gains (losses) were as follows:
<TABLE>
<CAPTION>
(In thousands)
Years Ended June 23, 1995
December 31, (date of inception) to
1997 1996 December 31, 1995
------------- ------------- -------------------------
<S> <C> <C> <C>
Net realized investment gains (losses):
Fixed maturity securities $275 ($359) $397
Publicly traded equity securities 3,878 1,549
Privately held securities (4,913) 69
------------- ------------ ----------------
Sub-total (760) 1,259 397
------------- ------------ ----------------
Income tax expense (benefit) (266) 441 139
------------- ------------ ----------------
Net realized investment gains (losses),
net of tax ($494) $818 $258
============= ============ ================
</TABLE>
The following tables reconcile estimated fair value and carrying value
to the amortized cost of fixed maturity and equity securities:
<TABLE>
<CAPTION>
(In thousands)
December 31, 1997
--------------------------------------------------------------------------
Estimated
Fair Value
and Gross Gross
Carrying Unrealized Unrealized Amortized
Value Gains (Losses) Cost
--------------- --------------- -------------- -----------------
<S> <C> <C> <C> <C>
Fixed maturities:
U.S. government and
government agencies $44,135 $303 ($3) $43,835
Municipal bonds 37,637 1,104 36,533
Mortgage and asset backed securities 30,487 408 (3) 30,082
Corporate bonds 19,323 419 (21) 18,925
Foreign governments 577 65 512
--------------- --------------- -------------- ----------------
Sub-total fixed maturities 132,159 2,299 (27) 129,887
Equity securities:
Publicly traded 180,052 63,794 116,258
Privately held 95,336 17,786 77,550
--------------- --------------- -------------- ----------------
Sub-total equity securities 275,388 81,580 193,808
--------------- --------------- -------------- ----------------
Total $407,547 $83,879 ($27) $323,695
=============== =============== ============== ================
</TABLE>
F-11
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
3. Investment Information (continued)
Realized and Unrealized Investment Gains (Losses)
<TABLE>
<CAPTION>
(In thousands)
December 31, 1996
--------------------------------------------------------------------------
Estimated
Fair Value
and Gross Gross
Carrying Unrealized Unrealized Amortized
Value Gains (Losses) Cost
--------------- --------------- -------------- -----------------
<S> <C> <C> <C> <C>
Fixed maturities:
U.S. government and government
agencies $35,796 $42 ($153) $35,907
Foreign governments 519 10 509
Municipal bonds 60,041 339 (49) 59,751
Corporate bonds 17,316 81 (124) 17,359
Mortgage and asset backed securities 26,709 133 (26) 26,602
-------------- ------------- ----------- -------------
Sub-total fixed maturities 140,381 605 (352) 140,128
Equity securities:
Publicly traded 117,360 12,036 (3,256) 108,580
Privately held 28,847 7,001 (1,517) 23,363
-------------- ------------- ----------- -------------
Sub-total equity securities 146,207 19,037 (4,773) 131,943
-------------- ------------- ----------- -------------
Total $286,588 $19,642 ($5,125) $272,071
============== ============= =========== =============
</TABLE>
At December 31, 1997, all of the Company's equity investments were in
securities issued by insurance and reinsurance companies or companies providing
services to the insurance industry.
F-12
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
3. Investment Information (continued)
At December 31, 1997, the publicly traded equity portfolio consisted
of the following:
<TABLE>
<CAPTION>
(In thousands)
December 31, 1997
------------------------------------------------------------
Estimated
Fair Value
and Net
Carrying Unrealized
Value Gains Cost
---------------- ---------------- ----------------
<S> <C> <C> <C>
Common Stocks:
ACE Limited $25,823 $13,773 $12,050
American International Group, Inc. 20,820 9,016 11,804
Arthur J. Gallagher 12,053 1,153 10,900
Centris Group 2,109 96 2,013
EXEL Limited 24,716 12,031 12,685
E.W. Blanch Holdings, Inc. 18,441 7,081 11,360
IPC Holdings, Ltd. 3,026 569 2,457
LaSalle Re Holdings, Ltd. 7,075 1,321 5,754
Trenwick Group Inc. 11,382 952 10,430
USF&G Corp. 15,741 3,743 11,998
Vesta Insurance Group, Inc. 24,106 10,544 13,562
Preferred Stock:
St. Paul Companies, 6% Convertible 14,760 3,515 11,245
---------------- ---------------- ----------------
Total $180,052 $63,794 $116,258
================ ================ ================
</TABLE>
F-13
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
3. Investment Information (continued)
Privately held securities consisted of the following:
<TABLE>
<CAPTION>
(In thousands)
December 31,
Percentage -------------------------------
Ownership 1997 1996
------------------ ------------ -----------
<S> <C> <C> <C>
Carried under the equity method:
The ARC Group, LLC 27.0% $10,341
Arx Holding Corp. 35.2% 2,425
Capital Protection Insurance Services, LLC 51.0% 182
First American Financial Corporation 35.5% 6,572
Insurance Investment Group, L.P. 28.6% - 180
Island Heritage Insurance Company, Ltd. 33.0% 3,950 4,269
LARC Holdings, Ltd. 23.9% 24,496
New Europe Insurance Ventures 14.6% 730
Providers' Assurance Corporation 34.3% 3,637
Sunshine State Holding Corporation 21.5% 1,424
------------ -----------
Sub-total 53,757 4,449
------------ -----------
Carried at fair value:
GuideStar Health Systems, Inc. 2.6% 1,000
Peregrine Russell Miller Insurance Fund of
Asia Limited 44.0% 4,399 7,465
Sovereign Risk Insurance Ltd. 9.0% 246
Terra Nova (Bermuda) Holdings, Ltd. 3.6% 23,250 15,870
TRG Associates, LLC 8.8% 4,875
Venton Holdings, Ltd. 9.9% 7,809 1,063
------------ -----------
Sub-total 41,579 24,398
------------ -----------
Total $95,336 $28,847
============ ===========
</TABLE>
In addition, the Company had investment commitments relating to its
privately held securities which were $22.6 million and $22.1 million at
December 31, 1997 and 1996, respectively.
Set forth below is certain information relating to each of the
Company's investments and investment commitments in privately held
securities at December 31, 1997.
Investments Carried Under The Equity Method:
The ARC Group, LLC
In July 1997, the Company completed its acquisition, effective May
1997, of a 27.0% economic and voting interest in The ARC Group, LLC
("ARC"), a Long Island-based wholesaler of specialty insurance for
approximately $9.5 million. ARC, founded in 1986, is an independent
whole-sale insurance broker and managing general agent specializing in the
placement of professional liability insurance, primarily directors and
officers liability coverage. The Company is a co-investor with Marsh &
McLennan Risk Capital Holdings, Ltd. ("MMRCH"), Risk Capital Corp's.
parent, and ARC's founders, who continue to have managerial control over
the daily operations.
F-14
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
3. Investment Information (continued)
The Company records its equity in the operating results of ARC on a
two-month lag basis.
The Company's equity in net income, net of goodwill amortization and
net of tax, for the period recorded in 1997 was $561,000, or $0.03 per
share.
Arx Holding Corp.
In December 1997, the Company acquired a 35.2% economic and voting
interest in Arx Holding Corp. ("ARX"), a Florida-based company for
$2,425,000. ARX, through its recently formed wholly owned subsidiary
American Strategic Insurance Corp., will underwrite homeowners policies in
the State of Florida produced in the open market, and may also seek to
offer other lines of insurance in Florida and other states.
The Company will also provide reinsurance for ARX. A subsidiary of
EXEL is a co-investor in ARX and will also provide reinsurance for ARX.
Capital Protection Insurance Services, LLC
In May 1997, the Company acquired a 51% economic interest (49% voting
interest) in Capital Protection Insurance Services, LLC ("CPI"), a newly
formed underwriting management company headquartered in New York City
offering specialty risk and alternative market insurance solutions. The
Company co-invested with CPI's founders who have managerial control over
daily operations.
At December 31, 1997, the Company's investment in CPI, excluding long
term loans of $478,200 to the founders, totaled $612,000. At such date the
Company had an additional capital commitment to CPI of $663,000 (excluding
potential long term loans to the founders).
The Company has also guaranteed CPI's rental obligations under a five
year lease expiring in 2002. CPI's minimum rental obligations are
approximately $400,000 annually.
The Company records its equity in the operating results of CPI on a
one-month lag basis.
For the period recorded in 1997, the Company's equity in the net loss,
net of tax, was $279,786, or $0.02 per share.
The Company also provides reinsurance capacity for the business CPI
develops. The Company's net premiums written and net premiums earned from
business developed by CPI recorded in 1997 were $857,399 and $178,527,
respectively.
First American Financial Corporation
In February 1997, the Company acquired a 35.5% voting and economic
interest in First American Financial Corporation ("First American") for
$6.5 million.
First American, a Missouri-based company, through its wholly owned
subsidiaries including First American Insurance Company, underwrites
specialty vehicle property and casualty insurance coverages with emphasis
placed on collateral protection. The Company's economic interest in First
American is subject to adjustment based on various factors, including loss
development relating to First American's claim liabilities existing prior
to the Company's acquisition date.
The Company records its equity in the operating results of First
American on a quarter-lag basis.
For the period recorded in 1997, the Company's equity in the net
income, net of goodwill amortization and net of tax, was $32,036.
F-15
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
3. Investment Information (continued)
Insurance Investment Group, L.P.
In March 1996, the Company committed to pay $12 million over the long
term to fund its 28.6% partnership interest in Insurance Investment Group,
L.P. (the "Partnership"), a private limited partnership.
During the 1997 third quarter, the Company decided to terminate its
participation in this investment and recorded a realized loss, net of tax,
of $202,000, or $0.01 per share, which represents the Company's initial
funding amount and an estimate of additional costs expected to be incurred
by the Company in exiting the Partnership.
Island Heritage Insurance Company, Ltd.
In April 1996, the Company acquired a 33% economic interest (9.75%
voting interest) in Island Heritage Insurance Company, Ltd. ("Island
Heritage"), a Cayman Islands insurer, for an aggregate purchase price of
$4.5 million, which was funded through $1.7 million in cash and a trust
account in an amount equal to $2.8 million. Island Heritage commenced
operations in May 1996 as an insurer which writes high value personal and
commercial property insurance in the Caribbean. Certain directors of the
Company and other investors invested in the securities of Island Heritage
at the same per share price as that paid by the Company. The Company's
Chairman and President are two of the five directors of Island Heritage.
The investment in Island Heritage is recorded under the equity method
of accounting since the Company believes it has the ability to exercise
significant influence over the operating and financial policies of Island
Heritage due to the Company's participation on the Board of Directors and
through certain consent rights attaching to the Company's holdings of
non-voting shares.
The Company records its equity in the operating results of Island
Heritage on a quarter-lag basis.
For the 1997 year and the period recorded in 1996, the Company's
equity in the net loss, net of tax, was $195,922, or $0.01 per share, and
$161,000, or $0.01 per share, respectively.
LARC Holdings, Ltd.
In November 1997, the Company acquired a 23.9% economic interest (9.9%
voting interest) in LARC Holdings, Ltd. ("LARC"), a newly formed holding
company located in Bermuda, for $24.5 million. LARC, through its
newly-formed wholly owned Bermuda subsidiary, Latin American Reinsurance
Company, Ltd. ("LARe"), provides multi-line reinsurance to the Latin
American reinsurance market, emphasizing short-tail, multi-peril property
reinsurance and, to a limited extent, casualty, marine, aviation and other
lines of reinsurance. LARe may also seek to enter other reinsurance niches
on both a treaty and facultative basis.
The Company co-invested with a subsidiary of EXEL, which holds a
majority interest in LARC, and the founders of LARC.
The investment in LARC is recorded under the equity method of
accounting since the Company believes it has the ability to exercise
significant influence over the operating and financial policies of LARC due
to the Company's participation on the Board of Directors and through
certain consent rights attaching to the Company's holdings of non-voting
shares.
The Company records its equity in the operating results of LARC on a
one-month lag basis.
For the period recorded in 1997, the Company's equity in the net loss,
net of tax, was $18,936.
F-16
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
3. Investment Information (continued)
New Europe Insurance Ventures
In March 1997, the Company, through a wholly owned special purpose
subsidiary, committed to pay $5 million over the long term to fund its
partnership interest, currently at 14.6%, in New Europe Insurance Ventures
("NEIV"), a Scottish limited partnership that targets private equity
investments in insurance and insurance-related companies in Eastern Europe.
The Company records its participation in this partnership under the
equity method of accounting and applies the specialized accounting
practices for investment companies. Unrealized gains and losses on private
equity investments, expected to consist mostly of foreign exchange
fluctuations, will be recorded in the income statement when such
investments are revalued into United States dollars each quarter.
The $730,509 investment balance at December 31, 1997 consists mostly
of unamortized organizational costs, placement fees and other start-up
expenses and a funding of approximately $506,000 for an investment in a
Polish reinsurance company. The unfunded commitment remaining at December
31, 1997 was approximately $4.2 million.
The Company records its equity in the operating results of NEIV on a
quarter-lag basis.
For the period recorded in 1997, the Company's equity in the net loss,
net of tax, was $54,532.
Providers' Assurance Corporation
In April 1997, the Company acquired a 34.3% economic and voting
interest in Providers' Assurance Corporation ("Providers"), a Nashville
Tennessee-based underwriting management company with a Bermuda insurance
subsidiary, for $4 million. Providers, formed in June 1995, develops and
markets workers' compensation insurance programs through joint operating
arrangements with community-based healthcare providers, and offers other
workers' compensation-related consulting services to the healthcare
community. Under the agreements with Providers, the Company has the right
to provide certain reinsurance on insurance programs developed by Providers
during specified time periods.
Providers has experienced operating losses since its formation, which
losses are expected to continue into 1998.
The Company records its equity in the operating results of Providers
on a two-month lag basis.
For the period recorded in 1997, the Company's equity in the net loss,
net of goodwill amortization and net of tax, was $236,104, or $0.01 per
share.
The Company's net premiums written and net premiums earned from
business developed by Providers recorded in 1997 were $344,118 and $86,030,
respectively.
Sunshine State Holding Corporation
In December 1997, the Company acquired a 21.5% economic and voting
interest in Sunshine State Holding Corporation ("Sunshine State"), a newly
formed Florida-based company, for $1.4 million.
Sunshine State and its subsidiaries, which includes Sunshine State
Insurance Company, a Florida domiciled insurer, will initially underwrite
homeowners policies in the State of Florida obtained from the Florida
Residential Property and Casualty Joint Underwriting Association in
accordance with the Market Challenge Program of the Florida Department of
Insurance. Sunshine State may also insure homeowners policies produced
through the open market and may seek to offer other lines of insurance in
Florida and other states. In connection with the investment, the Company
will also provide reinsurance for Sunshine State during specified periods.
A subsidiary of EXEL invested in Sunshine State and will also provide
reinsurance for Sunshine State during specified periods.
F-17
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
3. Investment Information (continued)
Investments Carried at Fair Value:
GuideStar Health Systems, Inc.
In December 1997, the Company acquired a 2.6% economic and voting
interest in GuideStar Health Systems, Inc. ("GuideStar"), an Alabama-based
managed care organization, for $1 million.
Founded in late 1995, GuideStar provides comprehensive managed care
services to employers and individuals through strategic alliances with
selected insurance companies and health care providers. GuideStar develops
health care provider networks, and provides claims processing, customer
relations and comprehensive utilization management services.
At December 31, 1997, the Company has an additional capital commitment
of $1 million to fund GuideStar's operations.
The Trident Partnership, L.P. ("Trident"), a dedicated insurance
industry private equity fund managed by Risk Capital Corp., also invested
in GuideStar.
Peregrine Russell Miller Insurance Fund of Asia Limited
In March 1996, the Company acquired a 44% economic interest (18%
voting interest) in the Peregrine Russell Miller Insurance Fund of Asia
Limited ("Asian Fund") for $9.0 million. The Asian Fund, based in Hong
Kong, invested in publicly traded and privately held insurance companies
incorporated or operating in Asia.
MMRCH co-invested in the Asian Fund. At December 31, 1996, the Company
had recorded its investment in the Asian Fund based on the Company's
interest in the unaudited net asset value of the Asian Fund reported in
United States dollars at November 29, 1996.
During the fourth quarter of 1997, the Asian Fund discontinued
investment operations and commenced liquidating its investments. At
December 31, 1997, in excess of 90% of the Asian Fund assets consisted of
cash in United States dollars.
In February 1998, the Company's investment in the Asian Fund was
redeemed.
At December 31, 1997, the Company recorded a net realized investment
loss, net of tax, of $3.0 million, or $0.18 cents per share, based on the
Company's interest in the unaudited net asset value of the Asian Fund
reported in United States dollars on January 6, 1998.
Sovereign Risk Insurance Ltd.
In July 1997, the Company acquired a 9.0% voting and economic interest
in Sovereign Risk Insurance Ltd. ("Sovereign Risk"), a newly formed
Bermuda-based managing general agency, for $237,500.
Sovereign Risk provides underwriting services for political risk
insurance coverages for the Company, ACE Insurance Company, Ltd. and a
subsidiary of EXEL, who are also co-investors in Sovereign Risk.
The Company's net premiums written and net premiums earned from
business developed by Sovereign Risk recorded in 1997 were $175,000 and
$51,130, respectively.
Terra Nova (Bermuda) Holdings, Ltd.
In October 1995, the Company acquired a 3.6% voting and economic
interest in Terra Nova (Bermuda) Holdings, Ltd. ("Terra Nova") for $8.9
million.
F-18
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
3. Investment Information (continued)
Terra Nova, based in Bermuda, is a holding company for two principal
operating insurance companies located in Bermuda and London that write
property and casualty reinsurance. In April 1996, Terra Nova completed the
initial public offering of its common stock, which is traded on the New
York Stock Exchange ("NYSE").
At December 31, 1997, the Company recorded its investment in Terra
Nova at the closing price reported on the NYSE on such date. Since Terra
Nova became a publicly traded company, the Company recorded its investment
at each quarter end at the closing price reported on the NYSE on such date,
net of discounts for certain trading restrictions which expired in October
1997. At December 31, 1996, a 17.5% discount from the closing price was
applied. Prior to Terra Nova becoming publicly traded, the Company recorded
its investment in Terra Nova at fair value, which was determined to equal
cost.
Dividend income recorded in 1997 and 1996 received from Terra Nova was
$157,000 and $56,000, respectively.
TRG Associates, LLC
In October 1997, the Company acquired an 8.8% economic interest (7.7%
voting interest) in TRG Associates, LLC ("LLC"), a new limited liability
company formed for the purpose of holding all of the Class 1 common stock
of TRG Holding Corporation ("TRG Holdings"), for $4,875,000. TRG Holdings
acquired all of the common stock of The Resolution Group, Inc. ("TRG") in
exchange for $150 million in cash (funded by $50 million from the LLC and
$100 million of debt incurred by TRG Holdings) and $462 million face amount
of the Class 2 common stock of TRG Holdings.
TRG, located in Chicago, was formed to manage and pay off claims
liabilities on policies that insurance subsidiaries of Talegen Holdings,
Inc., a subsidiary of Xerox Corporation, had written prior to 1993. Such
liabilities include substantial amounts of claims from asbestos,
environmental and other latent exposures which are subject to significantly
greater uncertainty than normally associated with the establishment of
claims liabilities for other exposures.
The investors in LLC are entitled to receive an annual 10% dividend
return, which is dependent upon various factors, including the adequacy of
claims liabilities, the availability of funds and the satisfaction of
certain conditions, including the required payment of interest and
principal on debt as well as board approval. Subject to additional
considerations, LLC may also share in further dividends. At the present
time, there can be no assurance that LLC investors will receive dividends.
Venton Holdings, Ltd.
In April 1996, the Company acquired a 9.9% voting and economic
interest in Venton Holdings, Ltd. ("Venton"), a Bermuda-based holding
company, which owns a managing agency at Lloyd's of London ("Lloyd's") and
a corporate capital vehicle at Lloyd's that provides dedicated underwriting
capacity. The Company's initial investment in Venton was made for a
combination of $1.1 million in cash and a $4.2 million capital contribution
commitment to Venton to fund its capital requirements at Lloyd's. The
Company's additional capital commitment was increased from $4.2 million to
$8.7 million at December 31, 1996. The Company is a co-investor with
Trident, which is a majority shareholder of Venton, and a subsidiary of
EXEL.
In June 1997, the Company recorded an increase of $3.4 million in the
carrying value of its investment in Venton to $4.5 million to partially
reflect the purchase price paid by the subsidiary of EXEL for its 20%
ownership in Venton. The new carrying value was established by taking the
mid-point between the per share purchase price paid by the Company in April
1996 and the per share purchase price paid by the subsidiary of EXEL in
July 1997.
F-19
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
3. Investment Information (continued)
In December 1997, the Company participated at its existing 9.9%
economic interest with Trident and the subsidiary of EXEL in a rights
offering issued by Venton. In that connection, the Company made an
additional cash investment of $3.3 million and increased its capital
contribution commitment to $13.3 million.
The Company's $13.3 million capital contribution commitment at
December 31, 1997, in effect, supports the Company's pro rata portion of a
$122.9 million letter of credit in favor of Lloyd's supporting Venton's
1998 corporate underwriting vehicles. The letter of credit was provided by
a bank with the credit backing of EXEL's subsidiary. Trident has a similar
commitment under the letter of credit. The Company and Trident agreed to
pay their pro rata portion of any draw downs under the letter of credit
based on their percentage ownership in Venton.
The financing will provide Venton with additional capacity to support
the continued growth in Venton's business at Lloyd's and to increase the
retention of Venton's premiums that would have otherwise been reinsured.
The Company also reinsured certain Lloyd's Syndicates managed by
Venton. The Company's net premiums written and net premiums earned from
such Lloyd's Syndicates were $11.8 million and $6.8 million, respectively,
in 1997 and $2.9 million and $1.0 million, respectively, in 1996.
Several reinsurance treaties, which represent a substantial majority
of the premiums assumed by the Company from Lloyd's Syndicates managed by
Venton, have not been renewed in 1998 due to the above mentioned increase
in Venton's underwriting capacity.
Fixed Maturities
Contractual maturities of fixed maturity securities at December 31,
1997 are shown below. Expected maturities, which are management's best
estimates, will differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or
prepayment penalties.
(In thousands)
December 31, 1997
Estimated Fair Amortized
Value Cost
-------------- -----------
Available for sale:
Due in one year or less $22,507 $22,481
Due after one year through five years 42,358 41,807
Due after five years through 10 years 16,626 16,069
Due after 10 years 20,181 19,448
----------- -----------
Sub-total 101,672 99,805
Mortgage and asset-backed securities 30,487 30,082
----------- -----------
Total $132,159 $129,887
=========== ===========
As of December 31, 1997, the weighted average contractual and expected
maturities of the fixed maturity investments, based on fair value, were
11.3 years and 7.3 years, respectively.
Proceeds from the sale of fixed maturity securities during 1997, 1996
and 1995 were approximately $241 million, $227 million and $44 million,
respectively. Gross gains of $858,000, $1,071,000 and $410,000 were
realized on those sales during 1997, 1996 and 1995, respectively. Gross
losses of $583,000, $1,430,000 and $13,000 were realized during 1997, 1996
and 1995, respectively.
F-20
<PAGE>
3. Investment Information (continued)
Substantially all fixed maturity investments held by the Company at
December 31, 1997 were considered investment grade by Standard & Poor's
Corporation or Moody's Investors Service, Inc.
There are no investments in any entity in excess of 10% of the
Company's stockholders' equity at December 31, 1997 other than investments
issued or guaranteed by the United States government or its agencies.
Securities Pledged and on Deposit
Securities with a carrying value of approximately $38.2 million have
been pledged as collateral for letters of credit obtained in connection
with certain reinsurance obligations of the Company (see Note 5).
At December 31, 1997, securities with a face amount of $1,725,000 were
on deposit with the Insurance Department of the State of Nebraska and other
states in order to comply with insurance laws.
4. Agreements with Related Parties
Investment Advisory Agreements
The Company has an investment advisory agreement with Risk Capital
Corp. for management of the Company's portfolios of equity securities
(including convertible securities) that are publicly traded ("Public
Portfolio") and privately held ("Private Portfolio"). The Private Portfolio
includes equity securities which at the time of acquisition do not have a
readily ascertainable market or are subject to certain trading
restrictions. Risk Capital Corp. is also an investment advisor to Trident,
a dedicated insurance industry private equity fund organized by Risk
Capital Corp. and three other sponsors. Risk Capital Corp.'s direct parent,
MMRCH, owns 1,395,625 shares, or approximately 8.2% of the outstanding
Common Stock, and Class A warrants and Class B warrants to purchase 905,397
and 1,920,601 shares of RCHI Common Stock, respectively. At December 31,
1997, Trident owns 750,000 shares, or approximately 4.4% of the outstanding
Common Stock, and Class A warrants to purchase 1,386,079 shares of RCHI
Common Stock.
The Company pays an annual fee equal to 0.35% of the daily average
market value of the Public Portfolio. With respect to the Private
Portfolio, the Company pays an annual fee equal to the sum of (i) 1.5% per
annum on the first $250.0 million in carrying value of the Private
Portfolio and (ii) 1.0% per annum on the carrying value of the Private
Portfolio that exceeds $250.0 million. Risk Capital Corp. is also entitled
to annual compensation, equal to the excess, if any, of (x) 7.5% of
cumulative net realized gains including dividends, interest and other
distributions, received on the Private Portfolio over (y) cumulative
compensation previously paid in prior years on cumulative net realized
gains.
The agreement has an initial term expiring on December 31, 2001 and
will be automatically renewed for successive one-year terms thereafter,
unless either party delivers written notice of termination at least one
year prior to the end of the then current term. The agreement provided for
a minimum aggregate cash fee to Risk Capital Corp. of $500,000 per annum
through December 31, 1997. Fees incurred under the agreement during fiscal
years 1997, 1996 and partial fiscal year 1995 were approximately $1.3
million, $686,000 and $151,000, respectively. In addition, in 1997 and
1996, unrealized appreciation in the Private Portfolio is net of accrued
fees of approximately $1.4 million and $443,000, respectively.
F-21
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
4. Agreements with Related Parties (continued)
The Company has an investment advisory agreement with The Putnam
Advisory Company, Inc. ("Putnam"), an affiliate of Risk Capital Corp., for
the management of the Company's fixed income securities and short term cash
portfolios. For the fixed income securities portfolio, the Company pays a
fee equal to the sum of 0.35% per annum of the first $50 million of the
market value of the portfolio, 0.30% per annum on the next $50.0 million,
0.20% per annum on the next $100 million and 0.15% per annum of the market
value of assets that exceeds $200 million. For the short term cash
portfolio, the Company pays a fee equal to 0.15% per annum of the total
monthly average market value. Fees incurred under the agreement during
1997, 1996 and 1995 were approximately $493,000, $547,000 and $190,000,
respectively. The agreement is subject to termination by either party upon
30 days' written notice.
Reinsurance Treaties
In addition to business assumed from insurance companies where the
Company has a private equity investment as described in Note 3, the Company
also assumed premiums written and premiums earned of $5.5 million and $2.5
million, respectively, in 1997 from EXEL, which owns 4,755,000 shares, or
approximately 27.9% of the outstanding Common Stock, and premiums written
and premiums earned of $12.3 million and $6.8 million, respectively, in
1997 from majority-owned insurance companies of Trident.
Other Agreements
The Company reimbursed Risk Capital Corp. approximately $1,579,000 in
1995 for certain expenses incurred by Risk Capital Corp. in connection with
the formation and initial public offering of the Company.
Commencing in 1996, Risk Capital Corp. subleased office space from the
Company for a term expiring in October 2002. Future minimum rental income,
exclusive of escalation clauses and maintenance costs, under the remaining
term of the sublease will be approximately $2,077,000. Rental income for
1997 and 1996 was $430,000 and $264,000, respectively.
In addition in 1997, Risk Capital Corp. reimbursed the Company
approximately $530,000 (net of $44,000 for certain sublease income
allocated to Risk Capital Corp.) for their pro-rata share of improvement
and maintenance costs under the sublease.
5. Commitments
Lease Agreement
The Company has a sublease agreement for office facilities for a term
expiring in October 2002. Future minimum rental charges under the remaining
term of the sublease, exclusive of escalation clauses and maintenance costs
and net of rental income, are as follows:
(In thousands)
----------------------
1998 $ 576
1999 576
2000 574
2001 572
2002 476
----------
$2,774
==========
During 1997, 1996 and 1995, rental expense, net of income from
subleases, was approximately $643,000, $613,000, and $54,000, respectively.
F-22
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
5. Commitments (continued)
Letters of Credit
At December 31, 1997, the Company is obligated under letters of credit
in an aggregate amount of approximately $46.5 million, which secure certain
of the Company's reinsurance obligations and investment commitments (see
Note 3).
Severance Arrangements
The Company has adopted a program for all employees that provides for
certain severance payments and continuation of benefits in the event of
termination of employment resulting from a change in control. The extent of
such payments depends on the position of the employee and, in the case of
certain employees, length of employment.
Employment Agreements
The Company has employment agreements with its executive officers. One
of these agreements has a five-year term initially expiring in September
2000, and the remaining agreements may be terminated upon notice by either
party. These agreements provide for compensation in the form of base
salary, annual bonus, stock-based awards under the Stock Plan (as
hereinafter defined), participation in the Company's employee benefit
programs and the reimbursement of certain expenses. Under one of the
agreements, the Company guaranteed loans in the amount of $500,000 made to
an executive by a financial institution to fund such executive's purchase
of 25,000 shares of Common Stock and related tax liability under such
stock's vesting provisions. In connection with such guarantee, the Company
is entitled to customary subrogation rights.
6. Claims and Claims Expenses
The reconciliation of claims and claims expense reserves is as
follows:
<TABLE>
<CAPTION>
(In thousands)
December 31,
1997 1996
---------------- -----------------
<S> <C> <C>
At beginning of year:
Gross claims and claims expense reserves $20,770 --
Reinsurance recoverables 522 --
---------------- -----------------
Net claims and claims expense reserves 20,248
Net claims and claims expenses incurred relating to:
Current year 73,385 $24,079
Prior year 22 --
---------------- -----------------
Total 73,407 24,079
Net paid claims and claims expenses incurred relating to:
Current year 13,649 3,831
Prior year 9,238 --
---------------- -----------------
Total 22,887 3,831
At end of year:
Net claims and claims expense reserves current year 70,768 20,248
Reinsurance recoverables -- 522
---------------- -----------------
Gross claims and claims expense reserves $70,768 $20,770
================ =================
</TABLE>
F-23
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
6. Claims and Claims Expenses (continued)
The Company believes that its exposure, if any, to environmental
impairment liability and asbestos-related claims is minimal since no
business has been written for periods prior to 1996.
Subject to the following, the Company believes that the reserves for
claims and claims expenses are adequate to cover the ultimate cost of
claims and claims expenses incurred through December 31, 1997. The reserves
are based on estimates of claims and claims expenses incurred and,
therefore, the amount ultimately paid may be more or less than such
estimates. The inherent uncertainties of estimating claims and claims
expense reserves are exacerbated for reinsurers by the significant periods
of time (the "tail") that often elapse between the occurrence of an insured
claim, the reporting of the claim to the primary insurer and, ultimately,
to the reinsurer, and the primary insurer's payment of that claim and
subsequent indemnification by the reinsurer. As a consequence, actual
claims and claims expenses paid may deviate, perhaps substantially, from
estimates reflected in the Company's reserves reported in its financial
statements. The estimation of reserves by new reinsurers, such as the
Company, may be less reliable than the reserve estimations of a reinsurer
with an established volume of business and claims history. To the extent
reserves prove to be inadequate, the Company may have to augment such
reserves and incur a charge to earnings. Such a development, while not
anticipated, could occur and result in a material charge to earnings or
stockholders' equity in future periods.
7. Retrocession Agreements
The Company utilizes retrocession agreements for the purpose of
limiting its exposure with respect to multiple claims arising from a single
occurrence or event. The Company also participates in "common account"
retrocessional arrangements for certain treaties. Such arrangements reduce
the effect of individual or aggregate losses to all companies participating
on such treaties including the reinsurer, such as the Company, and the
ceding company.
Reinsurance recoverables are recorded as assets, predicated on the
retrocessionaires' ability to meet their obligations under the
retrocessional agreements. If the retrocessionaries are unable to satisfy
their obligations under the agreements, the Company would be liable for
such defaulted amounts.
The effects of reinsurance on written and earned premiums and claims
and claims expenses are as follows:
(In thousands)
Years Ended
December 31,
1997 1996
---------------- -----------------
Assumed premiums written $147,878 $73,685
Ceded premiums written 3,044 1,153
---------------- -----------------
Net premiums written $144,834 $72,532
================ =================
Assumed premiums earned 110,992 36,337
Ceded premiums earned 3,620 576
---------------- -----------------
Net premiums earned $107,372 $35,761
================ =================
Assumed claims and claims
expenses incurred 73,407 24,601
Ceded claims and claims
expenses incurred 522
---------------- -----------------
Net claims and claims
expenses incurred $73,407 $24,079
================ =================
F-24
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
7. Retrocession Agreements (continued)
At December 31, 1997, the Company's balance sheet reflects reinsurance
recoverable balances as follows:
(In thousands)
Years Ended
December 31,
1997 1996
--------- ---------
Reinsurance recoverable balances:
Unpaid claims and claim expenses $522
Ceded balances payable ($211) (536)
--------- ---------
Reinsurance balances, net ($211) ($14)
========= =========
Reinsurance recoverable on unearned premium -- $576
========= =========
8. Employee Benefits and Compensation Arrangements
1995 Long Term Incentive and Share Award Plan
In September 1995, the Company adopted the 1995 Long Term Incentive
and Share Award Plan (the "Stock Plan") which is administered by the
Compensation Committee of the Board of Directors. The Company may grant,
subject to certain restrictions, stock options, stock appreciation rights,
restricted shares, restricted share units payable in shares of Common Stock
or cash, stock awards in lieu of cash awards, and other stock-based awards
to eligible employees of the Company. Awards relating to not more than
1,700,000 shares of Common Stock may be made over the five-year term of the
Stock Plan.
Restricted Stock
During 1997, 1996 and 1995, the Company granted an aggregate of
24,000, 76,000 and 190,500 shares, respectively, of restricted stock under
the Stock Plan. Grants of restricted stock generally vest at a rate of 20%
per year over five years commencing on the first anniversary of the date of
grant. The Company records a deferred expense equal to the market value of
the shares at the date of grant which is amortized and charged to income
over the vesting period. The deferred expense was $506,000, $1,487,000 and
$3,895,000, and the amortization of the deferred expense was $1,687,000,
$1,969,000 and $454,000, for 1997, 1996 and 1995, respectively.
Stock Options
The Company issues incentive stock options and/or non-qualified stock
options at fair market values at the grant dates to officers and
non-employee directors. Options to officers generally vest and become
exercisable at a rate of 20% per year over five years from the date of
grant. Incentive stock options expire ten years after the grant date and
non-qualified stock options expire seven years after vesting. Initial
options granted to non-employee directors vest and become exercisable in
three equal installments, commencing on the date of grant and annually
thereafter. Annual options granted to non-employee directors in office on
January 1 of each year vest on the first anniversary of the date the option
is granted.
F-25
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
8. Employee Benefits and Compensation Arrangements (continued)
Information relating to the Company's stock options is set forth
below:
<TABLE>
<CAPTION>
(In thousands)
Years Ended June 23, 1995
December 31, (date of inception) to
1997 1996 December 31, 1995
-------------- -------------- -----------------------------
<S> <C> <C> <C>
Number of options
Outstanding, beginning of year 628,950 192,700 --
Granted 371,700 436,350 192,900
Canceled (39,500) -- (200)
Exercised (500) (100) --
Outstanding, end of year 960,650 628,950 192,700
Exercisable, end of year 178,611 39,500 800
Average exercise price
Granted $22.86 $17.98 $20.44
Canceled 17.63 -- 20.00
Exercised 17.63 20.00 --
Outstanding, end of year 20.38 18.74 20.44
Exercisable, end of year 19.32 20.43 20.12
</TABLE>
Exercise prices for options outstanding at December 31, 1997 ranged
from $16.63 to $23.38. The weighted average remaining contractual life of
these options is approximately nine years.
Employee Stock Purchase Plan
Effective December 1, 1995, the Company established a tax-qualified
employee stock purchase plan (the "Purchase Plan"). An aggregate of 120,000
shares of Common Stock have been reserved for issuance under the Purchase
Plan. Eligible employees may elect to participate in an annual offering
period under the Purchase Plan by authorizing after-tax payroll deductions
of up to 20% (in whole percentages) of their eligible compensation for the
purchase of shares of Common Stock at 85% of the lesser of the market value
per share of the Common Stock at the beginning or end of the annual
offering period, subject to certain restrictions. During 1997 and 1996,
employees purchased approximately 14,100 and 14,000 shares respectively, of
Common Stock under the Purchase Plan.
Pro Forma Information
Pro forma information regarding net income and earnings per share is
required by FASB Statement No. 123. Such information has been determined
for the Company as if the Company has accounted for its employee stock
options under the fair value method of this Statement. The fair value for
the Company's employee stock options has been estimated at the date of
grant using a Black-Scholes option valuation model with the following
weighted-average assumptions for options issued in 1997, 1996 and 1995,
respectively; (i) dividend yield: 0.0%; (ii) volatility factor: 25.0%;
(iii) average expected option life: 6 years for all years; and (iv) risk
free interest rates of 5.8%, 6.0% and 6.0% respectively. The
weighted-average fair value of options granted for the years ended December
31, 1997 and 1996 and for the period from June 23, 1995 (date of inception)
to December 31, 1995 was $3.2 million, $3.0 million and $1.5 million,
respectively.
F-26
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
8. Employee Benefits and Compensation Arrangements (continued)
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting
restrictions and are fully transferable. In addition, option valuation
models, such as the Black-Scholes model, require the input of highly
subjective assumptions (particularly with respect to the Company, which has
a limited stock-trading history), including expected stock price
volatility. As the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes
in the subjective input assumptions can materially affect the fair value
estimate, the Company believes that the existing option valuation models,
such as the Black-Scholes model, may not necessarily provide a reliable
single measure of the fair value of employee stock options.
For purposes of the required pro forma information, the estimated fair
value of employee stock options is amortized to expense over the options'
vesting period. The Company's pro forma information regarding net income
and earnings per share follows:
<TABLE>
<CAPTION>
(In thousands, except per share data)
Years Ended June 23, 1995
December 31, (date of inception) to
1997 1996 December 31, 1995
-------------- ------------- -------------------------------
<S> <C> <C> <C>
Net income, as reported $2,039 $4,112 $1,019
Pro forma net income $994 $3,569 $911
Earnings per share as reported:
Basic and diluted $0.12 $0.24 $0.06
Pro forma earnings per share:
Basic and diluted $0.06 $0.21 $0.05
</TABLE>
The effects of applying FASB 123 as shown in the pro forma disclosures
may not be representative of the effects on reported net income for future
years.
The effect on net income and earnings per share after applying FASB
Statement No. 123's fair valuation method to stock issued to employees
under the Purchase Plan does not materially differ from the pro forma
information set forth above with respect to the Company's employee stock
options.
Retirement Plans
Effective as of January 1, 1996, the Company adopted a tax-qualified,
non-contributory defined contribution money purchase pension plan (the
"Pension Plan") under which the Company contributes for each eligible
employee an amount equal to the sum of (i) 4% of eligible compensation up
to the taxable wage base (as such term is defined in the Pension Plan; for
1997 and 1996, amounts were set at $65,400 and $62,700 respectively) and
(ii) 8% of eligible compensation in excess of the taxable wage base (up to
the applicable compensation limit (the "compensation limit") imposed by
Section 401(a)(17) of the Internal Revenue Code of 1986, as amended (the
"Code"), which for 1997 and 1996 were $160,000 and $150,000, respectively).
Substantially all employees of the Company are eligible for participation
in the Pension Plan. In 1997 and 1996, the Company expensed $168,000 and
$90,000, respectively, related to the Pension Plan.
Effective as of January 1, 1996, the Company adopted a tax-qualified,
employee savings plan (the "Savings Plan"). Pursuant to Section 401(k) of
the Code, eligible employees of the Company are able to make deferral
contributions of up to 15% of their eligible compensation, subject to
limitations under applicable law. The Company matches 100% of the first 3%
of eligible compensation deferred by employees and 50% of the next 3% of
eligible compensation so deferred. Substantially all employees of the
Company are eligible for participation in the Savings Plan. In 1997 and
1996, the Company expensed $123,000 and $75,000, respectively, related to
the Savings Plan.
F-27
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
8. Employee Benefits and Compensation Arrangements (continued)
Effective as of January 1, 1996, the Company adopted a supplemental,
non-qualified executive savings and retirement plan (the "Supplemental
Plan") under which the Company contributes 8% of eligible compensation in
excess of the compensation limit for eligible officers of the Company.
Participants may also defer certain amounts of eligible base compensation
and bonus. Under the Supplemental Plan, the Company matches 100% of the
first 3% of eligible base compensation in excess of the compensation limit
that is deferred by participants under the Supplemental Plan, and provides
a 50% matching contribution for the next 3% of such excess eligible
compensation so deferred. In 1997 and 1996, the Company expensed $74,000
and $46,000, respectively, related to the Supplemental Plan.
9. Income Taxes
RCHI and Risk Capital Reinsurance file a consolidated federal income
tax return and have 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.
The provision for federal income taxes has been determined on the
basis of a consolidated tax return consisting of RCHI and Risk Capital
Reinsurance.
An analysis of the Company's effective tax rate for the years ended
December 31, 1997, 1996 and for the period June 23, 1995 (date of
inception) to December 31, 1995 is as follows:
<TABLE>
<CAPTION>
(In thousands)
June 23, 1995
Years Ended (date of inception)
December 31, to
1997 1996 December 31, 1995
-------------- -------------- ---------------------------
Amount Amount Amount
--------------- ------------- -------------------
<S> <C> <C> <C>
Income taxes computed on pre-tax income $663 $1,614 $381
Reduction in income taxes resulting from:
Tax-exempt investment income (524) (979) (285)
Dividend received deduction (650) (341) (24)
Other 173 43
--------------- ------------- -------------------
Income tax expense (benefit) on pre-tax income ($338) $337 $72
=============== ============= ===================
</TABLE>
The Company's current federal tax expense (benefit) for 1997, 1996 and
1995 was based on regular taxable income. Federal income taxes paid in 1997
and 1996 were $1.4 million and $1.7 million, respectively.
F-28
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
9. Income Taxes (continued)
The net deferred income tax liability reflects temporary differences
between the carrying amounts of assets and liabilities for financial
reporting and income tax purposes, net of a valuation allowance for any
portion of the deferred tax asset that management believes will not be
realized. Significant components of the Company's deferred income tax
assets and liabilities as of December 31, 1997 and 1996 were as follows:
(In thousands)
Years Ended
December 31,
1997 1996
--------- ---------
Deferred income tax assets:
Net claim reserve discount $4,036 $1,275
Net unearned premium reserve 5,197 2,574
Compensation liabilities 675 575
Foreign currency 239
Equity in net loss of investees, net 190 87
--------- ---------
Total deferred tax assets 10,337 4,511
--------- ---------
Deferred income tax liabilities:
Deferred policy acquisition cost (6,052) (2,456)
Unrealized appreciation of investments (29,348) (5,081)
Other (27)
--------- ---------
Total deferred tax liabilities (35,427) (7,537)
--------- ---------
Net deferred income tax liability ($25,090) ($3,026)
========= =========
10. Statutory Information
The Insurance Department of the State of Nebraska issued to Risk
Capital Reinsurance its domiciliary insurance license on November 6, 1995.
Statutory net income and surplus of Risk Capital Reinsurance, as reported
to insurance regulatory authorities, differ in certain respects from the
amounts prepared in accordance with GAAP. The following tables reconcile
statutory net income and surplus to consolidated GAAP net income and
stockholders' equity:
<TABLE>
<CAPTION>
(In thousands)
Years Ended June 23, 1995
December 31, (date of inception) to
1997 1996 December 31, 1995
-------------- -------------- --------------------------
<S> <C> <C> <C>
Net Income:
Insurance Subsidiary
Statutory net income (loss) ($5,649) ($4,636) $910
GAAP adjustments:
Deferred acquisition costs 10,273 7,018
Realized loss (4,601)
Deferred income taxes 2,099 1,810 158
Equity in net loss of investees (192) (161)
-------------- -------------- --------------------
GAAP net income 1,930 4,031 1,068
RCHI (parent company only) operations 109 81 (49)
-------------- -------------- --------------------
Consolidated GAAP net income $2,039 $4,112 $1,019
============== ============== ====================
</TABLE>
F-29
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
10. Statutory Information (continued)
(In thousands)
December 31,
-------------------------
1997 1996
--------- ---------
Stockholders' Equity:
Statutory surplus $ 385,007 $ 334,309
Deferred acquisition costs 17,292 7,272
Unrealized appreciation 7,464 252
Deferred income tax liability, net (25,079) (3,026)
Non-admitted assets 4,899 3,799
--------- ---------
Investment in insurance subsidiary, GAAP 389,583 342,606
RCHI (parent company only):
Other net assets 11,448 9,607
--------- ---------
Consolidated stockholders' equity, GAAP $ 401,031 $ 352,213
========= =========
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. 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 expenses 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 Risk Capital Reinsurance's 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.
Nebraska insurance laws provide that, without prior approval of the
Nebraska Director of Insurance ("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 ($385.0 million as
of December 31, 1997) or (ii) statutory net income from operations from the
preceding calendar year not including after tax realized capital gains ($7.8
million loss for 1997). 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
only be paid out of earned surplus arising from its business, which is defined
as unassigned funds (surplus) as reported in the statutory statement for the
most recent years ($56.9 million as of December 31, 1997). 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 ($14.3
million deficit as of December 31, 1997) will be deemed an "extraordinary"
dividend subject to the foregoing requirements. Therefore, Risk Capital
Reinsurance cannot make a distribution that is a dividend without the prior
approval of the Nebraska Director during 1998.
F-30
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
10. Statutory Information (continued)
Nebraska insurance laws also require that the statutory surplus of Risk
Capital Reinsurance following any dividend or distribution be reasonable in
relation to its outstanding liabilities and adequate to its financial needs. In
addition, Nebraska insurance laws require that each insurer give notice to the
Nebraska Director of all dividends and other distributions within five business
days following declaration thereof and that any such dividend or other
distribution may not be paid within 10 business days of such notice (the "Notice
Period") unless for good cause shown the Nebraska Director has approved such
payment within the Notice Period.
11. Business Information
The Company operates from one domestic location and has one business
segment, which is providing capital and/or property casualty reinsurance to
insurance and reinsurance companies and making investments in insurance and
insurance-related entities on a global basis.
During 1997, one client company contributed approximately $25.9 million,
or 18%, of net premiums written and $15.1 million, or 14%, of net premiums
earned.
During 1997, affiliates of Marsh & McLennan Companies, Inc. (which include
Balis & Co., Inc., Guy Carpenter & Company, Inc., Carpenter Bowring Ltd., and
Marsh & McLennan FINPRO) and the Aon Group generated 47.3% and 25.2% of the
Company's assumed net premiums written. U.S. Reinsurance Corporation, Balis &
Co., Inc. and Minet Re generated approximately 27.7%, 13.7%, and 12.1%,
respectively, of the Company's assumed net premiums written for 1996.
Net premiums written and earned recorded from client companies located in
Europe or Lloyd's Syndicates (some of which are denominated in United States
dollars) were $40.1 million and $25.8 million, respectively, in 1997 and $21.8
million and $4.6 million, respectively, in 1996.
12. Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share:
<TABLE>
<CAPTION>
(In thousands, except per share data)
Years Ended June 23, 1995
December 31, (date of inception) to
1997 1996 December 31, 1995
----------- ----------- ----------------------
<S> <C> <C> <C>
Basic Earnings Per Share:
Net income $ 2,039 $ 4,112 $ 1,019
Divided by:
Weighted average shares
outstanding for the period 17,032,601 16,981,724 16,747,084
Basic earnings per share $ 0.12 $ 0.24 $ 0.06
Diluted Earnings Per Share:
Net income $ 2,039 $ 4,112 $ 1,019
Divided by:
Weighted average shares
outstanding for the period 17,032,601 16,981,724 16,747,084
Effect of dilutive securities:
Warrants 24,836 238,867
Employee stock options 28,351 2,185 4,474
----------- ----------- -----------
Total shares 17,085,788 16,983,909 16,990,425
=========== =========== ===========
Diluted earnings per share $ 0.12 $ 0.24 $ 0.06
</TABLE>
F-31
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
12. Earnings Per Share (continued)
Employee stock options to purchase 448,250, 251,850 and 40,500 shares of
Common Stock at per share prices averaging $22.62, $20.40 and $21.46 were
outstanding as of December 31, 1997, 1996 and 1995, respectively. These options
were not included in the computation of diluted earnings per share because the
options' average exercise prices were greater than the average market prices of
the Common Stock of $20.11, $18.99 and $21.13 for the years ended December 31,
1997, 1996 and for the period September 13, 1995 through December 31, 1995. In
addition, warrants to purchase 4,451,680 shares of Common Stock at $20 per share
were outstanding as of December 31, 1997, 1996 and 1995 but were not included in
the computation of diluted earnings per share for the year ended December 31,
1996 because the warrants' exercise price was greater than the average market
price of the Common Stock for such year.
13. Accounting Pronouncements
Comprehensive Income
In June 1997, the FASB issued Statement No. 130 "Reporting Comprehensive
Income". This Statement establishes standards for the reporting and display of
comprehensive income and its components in a full set of general purpose
financial statements. Comprehensive income is defined as the change in equity
during a period resulting from transactions and other events from non-owner
sources. The Statement is effective for fiscal years beginning after December
15, 1997. Reclassification of financial statements for earlier periods for
comparative purposes is required. The Company will adopt the provisions of this
Statement beginning in 1998.
Comprehensive income for the Company would consist of net income and the
change in unrealized appreciation or depreciation, net of income tax, as
follows:
<TABLE>
<CAPTION>
(In thousands, except per share data)
Years Ended June 23, 1995
December 31, (date of inception) to
1997 1996 December 31, 1995
------- ------- ----------------------
<S> <C> <C> <C>
Net income $ 2,039 $ 4,112 $ 1,019
Other comprehensive income net of tax:
Unrealized appreciation (depreciation) of
investments:
Unrealized holdings gains arising during
period 44,574 6,523 3,989
Less, reclassification adjustment for
net realized (gains) losses included in
net income 494 (818) (258)
------- ------- -------
Other comprehensive income 45,068 5,705 3,731
------- ------- -------
Comprehensive income $47,107 $ 9,817 $ 4,750
======= ======= =======
Comprehensive income per share $ 2.77 $ .58 $ .28
======= ======= =======
</TABLE>
Segment Information
In June 1997, the FASB issued Statement No. 131 "Disclosure About Segments
of an Enterprise and Related Information". This Statement establishes standards
for the way that public business enterprises report information about operating
segments in annual and interim financial reports issued to stockholders. It also
establishes standards for related disclosures about products and services,
geographic areas and major customers.
F-32
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
13. Accounting Pronouncements
Operating segments are defined as components of an enterprise for which
separate financial information is available that is evaluated regularly by the
chief operating decision maker for purposes of deciding how to allocate
resources and in assessing performance. Generally, financial information is
required to be reported on the basis for which it is used internally for
evaluating segment performance and determining how to allocate resources to
segments.
This Statement is effective for financial statements for periods beginning
after December 15, 1997. In the initial year of application, comparative
information for earlier years is to be restated. This Statement need not be
applied to interim financial statements in the initial year of its application,
but comparative information for interim periods in the initial year of
application is to be reported in financial statements for interim periods in the
second year of application.
The Company is evaluating the applicability of this standard to its
financial statements which is required to be adopted in 1998.
14. Quarterly Financial Information (Unaudited)
The following is a summary of unaudited quarterly financial data, restated
where applicable, to conform to FASB Statement No. 128:
<TABLE>
<CAPTION>
(In thousands except per share data)
Quarter Quarter Quarter
Ended Ended Ended Quarter
December 31, September 30, June 30, Ended
1997 1997 1997 March 31, 1997
----------- ------- ------- --------------
<S> <C> <C> <C> <C>
Income Statement Data:
Net premiums written $45,972 $34,906 $30,090 $33,866
Net premiums earned 41,744 24,655 19,901 21,072
Net investment income 3,586 3,798 3,525 3,451
Net realized investment
gains (losses) (4,377) 4,062 (420) (25)
Operating expenses 44,505 27,655 22,523 24,396
Equity in net income (loss) of
investees 281 (168) (215) (90)
Net income (loss) ($1,758) $3,255 $344 $198
Per Share Data:
Basic earnings (loss) per share ($0.10) $0.19 $0.02 $0.01
Diluted earnings (loss) per share ($0.10) $0.19 $0.02 $0.01
Primary and fully-diluted
earnings per share as
previously reported: ($0.10) $0.19 $0.02 $0.01
Stockholders' equity per share
Basic $23.51 $23.26 $22.26 $21.00
Diluted 22.79 22.35 21.91 21.00
Common Stock Prices:
High $23.38 $23.38 $21.00 $19.25
Low 20.88 20.50 16.00 16.13
Close 22.25 23.00 21.00 17.00
</TABLE>
F-33
<PAGE>
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
14. Quarterly Financial Information (Unaudited)
<TABLE>
<CAPTION>
(In thousands except per share data)
Quarter Quarter Quarter Quarter
Ended Ended Ended Ended
December 31, September 30, June 30, March 31,
1996 1996 1996 1996
------------ ------------- -------- ---------
<S> <C> <C> <C> <C>
Income Statement Data:
Net premiums written $19,023 $29,938 $16,468 $7,103
Net premiums earned 17,522 12,628 3,838 1,773
Net investment income 3,244 3,363 3,136 3,408
Net realized investment
gains (losses) 1,114 (109) 448 (194)
Operating expenses 20,016 14,886 6,357 4,302
Equity in net loss of investees (113) (48)
Net income 1,401 919 985 807
Per Share Data:
Basic earnings per share 0.08 0.05 0.06 0.05
Diluted earnings per share 0.08 0.05 0.06 0.05
Primary and fully-diluted
earnings per share as
previously reported: $0.08 $0.05 $0.06 $0.05
Stockholders' equity per share
Basic $20.68 $20.48 $20.07 $20.10
Diluted 20.64 20.48 20.07 19.97
Common Stock Prices:
High $19.88 $20.75 $20.50 $23.25
Low 15.88 16.50 19.13 19.75
Close 19.38 19.00 19.63 20.50
</TABLE>
F-34
<PAGE>
Report of Independent Accountants on
Financial Statement Schedules
To the Board of Directors of
Risk Capital Holdings, Inc.
Our audit of the consolidated financial statements referred to in our report
dated January 30, 1998 appearing on Page F-2 of this Annual Report on Form 10-K
also included an audit of the Financial Statement Schedules listed on Page F-1
of this Form 10-K. In our opinion, these Financial Statement Schedules present
fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements.
/s/ Price Waterhouse LLP
New York, New York
January 30, 1998
S-1
<PAGE>
SCHEDULE I
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
(In thousands)
<TABLE>
<CAPTION>
December 31, 1997
---------------------------------
Amount
at which
shown in
Amortized Fair the Balance
Cost Value Sheet
--------- ---- -----------
<S> <C> <C> <C>
Type of Investment:
FIXED MATURITY SECURITIES
U.S. government and government
agencies and authorities $ 43,835 $ 44,135 $ 44,135
Foreign governments 512 577 577
Mortgage and asset-backed securities 30,082 30,487 30,487
States, municipalities and political subdivisions 36,533 37,637 37,637
Corporate bonds 18,925 19,323 19,323
-------- -------- --------
Total Fixed Maturities 129,887 132,159 132,159
EQUITY SECURITIES
Publicly traded 116,258 180,052 180,052
Privately held 77,550 95,336 95,336
-------- -------- --------
Total Equity Securities 193,808 275,388 275,388
SHORT-TERM INVESTMENTS 89,167 89,167 89,167
-------- -------- --------
Total Investments $412,862 $496,714 $496,714
======== ======== ========
</TABLE>
S-2
<PAGE>
SCHEDULE II
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEET
(Parent Company Only)
(Dollars in thousands)
December 31,
----------------------
1997 1996
--------- ---------
Assets
Investment in wholly owned subsidiary $ 389,583 $ 342,606
Fixed maturities (amortized cost: $7,011) 7,043
Short-term investments 2,073 6,705
Cash 1,471 938
Due from subsidiary 813 1,977
Other assets 268 332
--------- ---------
Total Assets $ 401,251 $ 352,558
========= =========
Liabilities
Accounts payable and other liabilities 220 345
Stockholders' Equity
Preferred stock, $0.01 par value:
20,000,000 shares authorized (none issued)
Common stock, $0.01 par value:
80,000,000 shares authorized
(issued and outstanding; 1997, 17,069,845;
1996, 17,031,246) 171 170
Additional paid-in capital 341,162 340,435
Unrealized appreciation of investments, net
of income tax 54,504 9,436
Deferred compensation under stock award plan (1,778) (2,959)
Retained earnings 7,170 5,131
Less treasury stock at cost (1997, 11,383 shares) (198)
--------- ---------
Total Stockholders' Equity 401,031 352,213
--------- ---------
Total Liabilities and Stockholders' Equity $ 401,251 $ 352,558
========= =========
S-3
<PAGE>
SCHEDULE II
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (continued)
Statement of Income
(Parent Company Only)
(Dollars In thousands)
<TABLE>
<CAPTION>
Years Ended June 23, 1995
December 31, (date of inception) to
1997 1996 December 31, 1995
------- ------- ----------------------
<S> <C> <C> <C>
Revenues
Net investment income $ 524 $ 317 $ 216
Operating Costs and Expenses
Operating expenses 357 193 291
------- ------- -------
Income (loss) before income tax expense (benefit) 167 124 (75)
Income tax expense (benefit) 58 43 (26)
------- ------- -------
Net income (loss) before equity in net income of
wholly owned subsidiary 109 81 (49)
Equity in net income of wholly owned subsidiary 1,930 4,031 1,068
------- ------- -------
Net income $ 2,039 $ 4,112 $ 1,019
======= ======= =======
</TABLE>
S-4
<PAGE>
SCHEDULE II
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (continued)
Statement of Cash Flows
(Parent Company Only)
(In thousands)
<TABLE>
<CAPTION>
Years Ended June 23, 1995
December 31, (date of inception) to
1997 1996 December 31, 1995
--------- --------- ----------------------
<S> <C> <C> <C>
Operating Activities
Net income (loss) from operations $ 109 $ 81 ($49)
Adjustments to reconcile net income
(loss) to net cash
used for operating activities:
Net change in other assets and liabilities (650) 723 (1,238)
--------- --------- ---------
Net cash provided by (used for) operating activities (541) 804 (1,387)
Investing activities:
Purchases of fixed maturities (11,014)
Sales of fixed maturities 4,000
Net change in short-term investments 4,697 (905) (5,800)
Capital contribution to subsidiary (328,071)
--------- --------- ---------
Net Cash Used For Investing Activities (2,317) (905) (333,871)
Financing activities:
Net cash proceeds from initial public offering
and direct sales 322,073
Proceeds from issuance of Class B warrants 13,458
Common stock issued 727 1,699 3,895
Purchase of treasury shares (197)
Deferred compensation on restricted stock awarded (506) (1,487) (3,895)
Amortization of deferred compensation collected 3,367 454
--------- --------- ---------
Net Cash Provided By Financing Activities 3,391 666 335,531
Increase in cash 533 565 373
Cash at beginning of period 938 373
--------- --------- ---------
Cash at end of period $ 1,471 $ 938 $ 373
========= ========= =========
</TABLE>
S-5
<PAGE>
SCHEDULE III
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
SUPPLEMENTARY INSURANCE INFORMATION
(In thousands)
<TABLE>
<CAPTION>
Future
Policy
Benefits, Benefits, Amortization
Deferred Losses, Claims, of Deferred
Policy Claims and Net Losses and Policy Other
Acquisition Claims Unearned Premium Investment Settlement Acquisition Operating Premiums
Costs Expenses Premiums Revenue Income Expenses Costs Expenses Written
----------- ---------- -------- ------- ---------- ---------- ------------ --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
December 31, 1997
Property-Casualty $ 17,292 $ 70,768 $ 74,234 $107,372 $ 14,360 $ 73,407 $ 31,467 $ 13,523 $144,834
Accident and Health
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total $ 17,292 $ 70,768 $ 74,234 $107,372 $ 14,360 $ 73,407 $ 31,467 $ 13,523 $144,834
======== ======== ======== ======== ======== ======== ======== ======== ========
December 31, 1996
Property-Casualty $ 7,018 $ 20,770 $ 37,348 $ 35,761 $ 13,151 $ 24,079 $ 10,197 $ 11,285 $ 72,532
Accident and Health
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total $ 7,018 $ 20,770 $ 37,348 $ 35,761 $ 13,151 $ 24,079 $ 10,197 $ 11,285 $ 72,532
======== ======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
S-6
<PAGE>
SCHEDULE IV
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
REINSURANCE
(In thousands)
Percentage
Ceded to Assumed of Amount
Gross Other From Other Assumed to
Amount Companies Companies Net Amount Net
------ --------- ---------- ---------- ----------
December 31, 1997
Premiums Written:
Property and Casualty $ 3,044 $147,878 $144,834 102.1%
Accident and Health
------- -------- -------- -------- -----
Total $ 3,044 $147,878 $144,834 102.1%
======= ======== ======== ======== =====
December 31, 1996
Premiums Written:
Property and Casualty $ 1,153 $ 73,685 $ 72,532 101.6%
Accident and Health
------- -------- -------- -------- -----
Total $ 1,153 $ 73,685 $ 72,532 101.6%
======= ======== ======== ======== =====
S-7
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description
- ------- -----------
3.1 Amended and Restated Certificate of Incorporation of
Risk Capital Holdings, Inc.(a)
3.2 Amended and Restated Bylaws of Risk Capital Holdings,
Inc.(b)
4.1 Specimen Common Stock Certificate(a)
4.2.1 Class A Common Stock Purchase Warrants issued to Marsh &
McLennan Risk Capital Holdings, Ltd. on September 19,
1995(b) and September 28, 1995(c)
4.2.2 Class A Common Stock Purchase Warrants issued to The
Trident Partnership, L.P. on September 19, 1995(b) and
September 28, 1995(c)
4.2.3 Class A Common Stock Purchase Warrants issued to Taracay
Investors on September 19, 1995(b) and September 28,
1995
4.3 Class B Common Stock Purchase Warrants issued to Marsh &
McLennan Risk Capital Holdings, Ltd. on September 19,
1995(b) and September 28, 1995(c)
10.1.1 Employment Agreement, between Risk Capital Holdings,
Inc. and Mark D. Mosca(b)+
10.1.2 Employment Agreement, between Risk Capital Holdings,
Inc. and Peter A. Appel(b)+
10.1.3 Employment Agreement, between Risk Capital Holdings,
Inc. and Bonnie L. Boccitto(b)+
10.1.4 Employment Agreement, between Risk Capital Holdings,
Inc. and Paul J. Malvasio(b)+
10.1.5 Termination Agreement, between Risk Capital Holdings,
Inc. and Richard D. Robinson(c)
10.2 Amended and Restated Subscription Agreement, between
Risk Capital Holdings, Inc. and The Trident Partnership,
L.P.(b)
10.3 Amended and Restated Subscription Agreement, between
Risk Capital Holdings, Inc. and Marsh & McLennan Risk
Capital Holdings, Ltd.(b)
10.4 Amended and Restated Subscription Agreement, between
Risk Capital Holdings, Inc. and Taracay Investors(b)
10.5 Purchase Agreement between Risk Capital Holdings, Inc.
and X.L. Insurance Company, Ltd. (b)
10.6.1 Investment Advisory Agreement, between Risk Capital
Holdings, Inc. and Marsh & McLennan Risk Capital
Corp.(b)
10.6.2 Investment Advisory Agreement, between Risk Capital
Reinsurance Company and Marsh & McLennan Risk Capital
Corp.(b)
- ----------
(a) Incorporated by reference to Amendment No. 3 to the Registrant's
Registration Statement on Form S-1 (No. 33-94184), as filed with the
Securities and Exchange Commission (the "SEC") on August 11, 1995.
(b) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1995, as filed with the SEC on March 30,
1996.
(c) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1996, as filed with the SEC on March 31,
1997.
<PAGE>
Exhibit
Number Description
- ------- -----------
10.7 Management Agreement, among Risk Capital Holdings, Inc.,
Risk Capital Reinsurance Company and The Putnam Advisory
Company, Inc.(b)
10.8.1 Sublease Agreement, dated as of March 18, 1996, between
Risk Capital Reinsurance Company and Coca-Cola Bottling
Company of New York, Inc.(b)
10.8.2 Sublease Amendment Agreement and Consent, dated as of
November 11, 1997, between Risk Capital Reinsurance
Company and Coca-Cola Bottling Company of New York, Inc.
10.9 Tax Sharing Agreement, between Risk Capital Holdings,
Inc. and Risk Capital Reinsurance Company (amended)
10.10.1 Risk Capital Holdings, Inc. 1995 Long Term Incentive and
Share Award Plan (the "1995 Stock Plan")(b)+
10.10.2 First Amendment to the 1995 Stock Plan(c)+
10.10.3 Restricted Stock Agreements--Executive Officers(d)+
10.10.4 Stock Option Agreements--Executive Officers (1995 and
1996 grants)(d)+
10.10.5 Stock Option Agreement--Chairman (1996 grant)(d)
10.10.6 Stock Option Agreement--Chairman (1997 grant)
10.10.7 Stock Option Agreements--Non-Employee Directors (initial
grants)(c)
10.10.8 Stock Option Agreements--Non-Employee Directors (1996
and 1997 annual grants)(c)
10.10.9 Stock Option Agreements--Non-Employee Directors (1998
annual grants)
10.11 Risk Capital Holdings, Inc. 1995 Employee Stock Purchase
Plan(e)+
10.12.1 Risk Capital Reinsurance Company Money Purchase Pension
Plan (the "Pension Plan")(b)+
10.12.2 Amendment and Restatement of the Adoption Agreement
relating to the Pension Plan(c)+
10.13.1 Risk Capital Reinsurance Company Employee Savings Plan
(the "Savings Plan")(b)+
10.13.2 Amendment and Restatement of the Adoption Agreement
relating to the Savings Plan(c)+
10.14.1 Risk Capital Reinsurance Company Executive Supplemental
Non-Qualified Savings and Retirement Plan (the
"Supplemental Plan") and related Trust Agreement(b)+
- ----------
(d) Incorporated by reference to the Registrant's Report on Form 10-Q for the
period ended June 30, 1997, as filed with the SEC on August 14, 1997.
(e) Incorporated by reference to the Registrant's Registration Statement on
Form S-8 (No. 33-99974), as filed with the SEC on December 4, 1995.
(f) Incorporated by reference to Amendment No. 2 to the Registrant's
Registration Statement on Form S-1 (No. 33-94184), as filed with the SEC
on August 4, 1995.
+ A management contract or compensatory plan or arrangement required to be
filed pursuant to Item 14(c) of Form 10-K.
E-2
<PAGE>
Exhibit
Number Description
- ------- -----------
10.14.2 Amendment to the Adoption Agreement relating to the
Supplemental Plan(c)+
21 Subsidiaries of the Registrant(f)
23 Consent of Price Waterhouse LLP
24 Power of Attorney
27 Financial Data Schedule
E-3
Exhibit 4.2.3
CLASS A COMMON STOCK PURCHASE WARRANTS - TARACAY INVESTORS
Class A Warrants to purchase 3,623 shares of common stock, par value $.01
per share (the "Common Stock"), of Risk Capital Holdings, Inc. ("RCHI") issued
to Taracay Investors ("Taracay") on September 28, 1995, are substantially
identical in all material respects to the Class A Warrants to purchase 35,980
shares of Common Stock issued to Taracay on September 19, 1995 (the "September
19th Warrant"). A copy of the September 19th Warrant has been previously filed
as an exhibit to RCHI's Annual Report on Form 10-K for the year ended December
31, 1995.
Exhibit 10.8.2
SUBLEASE AMENDMENT AGREEMENT
AND CONSENT
AGREEMENT made as of this 11th day of November, 1997, by and between, THE
COCA-COLA BOTTLING COMPANY OF NEW YORK, INC., a Delaware corporation having a
place of business at Two Stamford Plaza, Stamford, Connecticut 06902
("Sublandlord"), and RISK CAPITAL REINSURANCE COMPANY, a Delaware corporation,
having a place of business at 20 Horseneck Lane, Greenwich, CT ("Subtenant").
Capitalized terms not otherwise defined herein shall have the meaning ascribed
to them in the Sublease.
W I T N E S S E T H
WHEREAS, Sublandlord entered into a Lease with Horseneck Associates (the
"Over Landlord") dated as of April 8, 1982 (the "Over Lease"), for the lease of
the land and Building (as defined in the Over Lease) commonly known as 20
Horseneck Lane, Greenwich, Connecticut (the "Demised Premises); and
WHEREAS, Sublandlord and Subtenant entered into a Sublease, dated as of
March 18, 1996 (the "Sublease"), for the lease of the entire Demised Premises;
and
WHEREAS, Sublandlord and Subtenant desire to modify and amend the Sublease
as hereinafter set forth and Subtenant desires to obtain Sublandlord's consent
to certain proposed renovations and improvements to the front entry of the
Building as hereinafter set forth (the "Proposed Work"); and
WHEREAS, Sublandlord and Subtenant desire to obtain the written consent of
Over Landlord to the proposed Sublease amendment and the Proposed Work;
NOW, THEREFORE, in consideration of the covenants herein contained, in
consideration of the sum of ONE ($1.00) DOLLAR and other consideration, and the
provisions herein contained, the parties hereby stipulate and agree as follows:
1. Section 3. a. i) of the Sublease is hereby deleted and the following is
substituted therefor:
"a. i) As used herein, "Operating Expense Base" shall mean Operating
Expenses incurred in accordance with this Paragraph during the period September
1, 1997 to August 31, 1998."
2. Sublandlord hereby consents to Subtenant's Proposed Work, which
Proposed Work is more particularly shown and described on the plans and
specifications referred to in Schedule A annexed hereto and made a part hereof.
Sublandlord agrees to pay Subtenant the sum of SIX THOUSAND AND 00/100
($6,000.00) DOLLARS (which sum is being paid to satisfy certain repair
obligations of Sublandlord under the Sublease) which amount shall be
1
<PAGE>
applied by Subtenant towards the cost of the Proposed Work. Sublandlord and
Subtenant acknowledge and agree that the Proposed Work shall constitute a
capital item or expense pursuant to Section 3. a. vii) (10) of the Sublease.
3. Subtenant agrees that the Proposed Work shall be completed at
Subtenant's sole cost and expense and in accordance with the provisions of the
Section 6 of the Sublease.
4. This Sublease Amendment Agreement and Consent may be executed in any
number of counterparts, each of which shall constitute one and the same
instrument.
INTENDING HEREBY to modify and amend the Sublease in accordance with the
foregoing, but not to alter or amend the terms and conditions thereof in any
other particular, all such other terms and conditions being hereby ratified and
confirmed.
IN WITNESS WHEREOF, the parties hereto have hereunto set their hands and
seals as of the date first above written.
Signed, Sealed and Delivered THE COCA-COLA BOTTLING
in the presence of: COMPANY OF NEW YORK, INC.
/s/ Ronald Pelletier By: /s/ Charles J. Smith
- ------------------------------ ----------------------------
Name: Charles J. Smith
Title: Facility Manager
RISK CAPITAL REINSURANCE
COMPANY
/s/ Carmela Forgione By: /s/ Charlene A. Heffernan
- ------------------------------ ----------------------------
Name: Charlene A. Heffernan
Title: Vice President,
Operations
The undersigned hereby consents to this Sublease Amendment Agreement and the
Proposed Work referred to therein as of: November 7, 1997.
HORSENECK ASSOCIATES
/s/ Norman L. Peck
- ----------------------------
Name: Norman L. Peck
Title: Partner
2
<PAGE>
STATE OF CONNECTICUT )
) ss:
COUNTY OF FAIRFIELD )
Personally appeared Charles J. Smith, who acknowledged himself or herself
to be the Facility Manager of THE COCA-COLA BOTTLING COMPANY OF NEW YORK, INC,
and that, being authorized so to do, he or she executed the foregoing instrument
on behalf of the corporation for the purposes therein contained by signing the
name of the corporation by himself or herself as a duly authorized officer, this
10th day of November, 1997.
/s/ Lisa M. Chardain
-----------------------------
Notary Public
Commissioner of the Superior Court
STATE OF CONNECTICUT )
) ss:
COUNTY OF FAIRFIELD )
Personally appeared Charlene A. Heffernan, who acknowledged himself or
herself to be the Vice President, Operations of RISK CAPITAL REINSURANCE
COMPANY, and that, being authorized so to do, he or she executed the foregoing
instrument on behalf of the corporation for the purposes therein contained by
signing the name of the corporation by himself or herself as a duly authorized
officer, this 10th day of November, 1997.
/s/ Lisa M. Chardain
-----------------------------
Notary Public
Commissioner of the Superior Court
STATE OF CONNECTICUT )
) ss:
COUNTY OF FAIRFIELD )
Personally appeared Norman L. Peck, who acknowledged himself or herself to
be a general partner of HORSENECK ASSOCIATES, and that, being authorized so to
do, he or she executed the foregoing instrument on behalf of the partnership for
the purposes therein contained by signing the name of the partnership by himself
or herself as a duly authorized general partner, this 11th day of November,
1997.
/s/ Lila Hagenlocker
-----------------------------
Notary Public
Commissioner of the Superior Court
3
Exhibit 10.9
TAX SHARING AGREEMENT
THIS TAX SHARING AGREEMENT is entered into as of September 19, 1995, as
amended and restated as of June 1, 1997, by and between Risk Capital Holdings,
Inc., a Delaware corporation ("Parent"), Risk Capital Reinsurance Company, a
Nebraska corporation ("Risk Re"), and each other Subsidiary.
WHEREAS, Parent and Risk Re are members of an affiliated group of
corporations (within the meaning of Section 1504(a) of the Code) of which Parent
is the common parent; and
WHEREAS, Parent, Risk Re and each other Subsidiary desire, to the extent
permitted by the Code, and the regulations promulgated thereunder, to be
included in the filing of consolidated Federal income tax returns on behalf of
the Parent Group; and
WHEREAS, Parent, Risk Re and each other Subsidiary wish to allocate and
settle among themselves in an equitable manner the consolidated Federal income
tax liability of the Parent Group; and
WHEREAS, Parent, Risk Re and each other Subsidiary desire to participate,
to the extent permitted by applicable state or local law, in combined state and
local income tax returns if so requested by Parent, and to allocate and settle
in an equitable manner the state or local income tax liability shown on such
combined returns.
NOW, THEREFORE, in consideration of the mutual covenants contained herein,
the parties agree as follows:
<PAGE>
-2-
1. Definitions
1.1 For purposes of this Agreement, the terms set forth below shall be
defined as follows:
1.1.1 "Code" shall mean the Internal Revenue Code 1986, as amended
from time to time.
1.1.2 "Consolidated U.S. Tax Liability" shall mean all taxes shown
on the Federal Return as filed, or as revised by administrative or judicial
determination or redetermination. For purposes of this definition "taxes" shall
mean all corporate income tax imposed by the Code on the Parent Group, as
reduced by all offsets and credits allowed by the Code.
1.1.3 "Federal Return" shall mean the consolidated corporation
income tax return filed by Parent pursuant to Section 1501 of the Code.
1.1.4 "Parent Group" shall mean Parent and all corporations (whether
now existing or hereafter formed or acquired) that have consented or are
required to join with Parent (or any successor common parent corporation) in
filing the Federal Return.
1.1.5 "Subsidiary" shall mean each corporation other than Parent
(including Risk Re) that is a member of the Parent Group and signatory to this
Agreement.
1.1.6 "Taxes Payable" shall, with respect to a Subsidiary, mean the
federal income tax liability of such Subsidiary as determined under paragraph 4
of this Agreement.
1.2 Other terms used in this Agreement shall have the meanings ascribed to
them in the Code, and the regulations and rulings issued thereunder, as from
time to time in effect. Except as
<PAGE>
-3-
otherwise provided herein, this Agreement shall be interpreted in accordance
with the Code and the regulations and rulings issued thereunder then in effect.
2. Effective Date and Other Agreements
2.1 Effective Date. Except as otherwise provided in this Agreement, this
Agreement is applicable for all taxable periods ending after December 31, 1994.
2.2 Prior Agreements. This Agreement shall supersede all prior agreements
and understandings, if any, concerning tax sharing between Parent and each of
the Subsidiaries.
3. Matters Concerning the Federal Return
3.1 Agreement to File the Federal Return. Unless this Agreement is
terminated as provided in Section 11 hereof, each Subsidiary agrees to join with
Parent in filing the Federal Return for each taxable year for which it is
eligible to do so under the Code.
3.2 Filing the Federal Return. Parent shall file the Federal Return, and
any amended returns, for each taxable year in accordance with the Code and
regulations promulgated thereunder.
3.3 Payment of Taxes. For each taxable period, Parent shall timely pay or
discharge, or cause to be timely paid or discharged, the Consolidated U.S. Tax
Liability for such taxable period and any estimated taxes due on such taxable
period (and, also, the combined state or local income tax liability shown on any
combined return which Parent elects or is required to file).
3.4 Decisions and Actions Incidental to Filing the Federal Return. Each
Subsidiary irrevocably appoints Parent to be its sole and exclusive agent to the
maximum extent permitted under the Code, duly authorized to act on its behalf in
all matters relating to the Federal Return (including
<PAGE>
-4-
any refunds thereunder) for each taxable year and agrees that Parent, after
consultation with such Subsidiary, shall in its sole discretion make any and all
decisions and take any and all actions incidental to preparing and filing the
Federal Return for each taxable year, including, but not limited to, preparing
the Federal Return, requesting extensions of time to file the Federal Return,
making elections under the Code and compromising, settling or litigating
disputes (including any claim for refund) with the Internal Revenue Service.
Nothing herein shall be construed as requiring Parent to file combined state or
local income tax returns with any Subsidiary for any period.
Each Subsidiary further agrees to (i) furnish Parent with any and all
information requested by Parent in order to carry out the provisions of this
Agreement, (ii) cooperate with Parent in executing and filing any return,
statement, election, or consent provided for in the Code, and the regulations
and rulings issued thereunder, (iii) take such action as Parent may request,
including, but not limited to, the filing of requests for extension of time
within which to file tax returns, and (iv) cooperate in connection with any
refund claim, audit, administrative, judicial or other proceeding.
3.5 Certain Expenses. Each Subsidiary shall reimburse Parent for its pro
rata share of all legal and accounting expenses incurred by Parent in the course
of the conduct of any audit or contest regarding the Consolidated U.S. Tax
Liability, and for all expenses incurred by Parent in the course of any
litigation relating thereto. The pro rata share of each Subsidiary shall be
determined by Parent in its sole discretion based on such Subsidiary's share of
the tax liability giving rise to such expense.
3.6 Access to Necessary Information. Each Subsidiary shall furnish to
Parent in a timely manner such information and documents as Parent may
reasonably request for purposes of preparing the Federal Return.
<PAGE>
-5-
4. Tax Calculation
4.1 Tax Sharing. Taxes Payable for each Subsidiary under this Agreement
shall be determined as if such Subsidiary filed a separate return on a
stand-alone basis for the applicable taxable year or part thereof during which
such Subsidiary was a member of the Parent Group.
4.1.1 Any penalty included in the Consolidated U.S. Tax Liability shall be
allocated to a Subsidiary to the extent such Subsidiary would have been liable
for such penalty had it filed a separate U.S. federal income tax return (or a
consolidated U.S. federal income tax return as an affiliated group separate from
the Parent Group); provided, however, that the aggregate penalty allocated to
all Subsidiaries with respect to a tax year shall not exceed any penalty imposed
upon the Parent Group for such year.
4.2 Subsidiary Taxes Payable. Each Subsidiary shall pay Parent the amount
of its Taxes Payable for any taxable period (including for this purpose
estimated taxes that would be payable by such Subsidiary) as determined under
paragraph 4.1 hereof before the end of the calendar month in which Parent makes
any payments (either separately or as a component of the Consolidated U.S. Tax
Liability) under paragraph 3.3 hereof, but in no event later than three days
prior to the date on which Parent is required to make such payment. If the
amount of any estimated tax payments which are paid by any Subsidiary to Parent
for any taxable year exceeds the Taxes Payable of such Subsidiary for such tax
year, Parent shall refund such excess (without interest) to such Subsidiary
within 30 days after the filing of the applicable Federal Return.
4.3 Changes in Taxes Payable. The amount of Taxes Payable described in
this Section 4 shall be recomputed whenever necessary to reflect adjustments
from among other things: (A) a carryback or carryforward of an unused net
operating loss, capital loss, investment tax credit, general
<PAGE>
-6-
business credit, foreign tax credit or other income offsets or tax credits
available for such taxable year; (B) a revision, adjustment or redetermination
arising from any administrative or judicial determination; (C) a filing of an
amended return; and (D) a filing of a claim for refund. The changes to Taxes
Payable (including any interest and penalties attributable thereto) so
recomputed shall be paid by the applicable Subsidiary to Parent or paid by
Parent to the applicable Subsidiary within 30 days of the date the deficiency is
paid or the refund is received by Parent. Any such payments shall not accrue
interest for such 30-day period.
4.4 State Income Taxes. In the event one or more Subsidiaries are included
in a combined, joint, consolidated, unitary or similar state income or franchise
tax return with Parent or any other Subsidiary (the "Filing Corporation"), the
Filing Corporation shall file such returns, pay the taxes, and make decisions
and take actions incidental to the filing of any such returns on a
state-by-state basis in a manner consistent with the approach provided with
respect to the Federal Return by this Agreement.
4.5 Computation and Payment of Taxes. Computations of Taxes Payable as
hereinabove described shall be made quarterly by Parent. When the Federal Return
and the state income or franchise tax returns for each year have been filed by
Parent (or, with respect to state returns, other applicable Filing Corporation),
Parent shall recompute the Taxes Payable (and the state income and franchise
taxes payable) based on the tax returns as filed. Except as specifically
provided in paragraphs 4.2 through 4.4, the quarterly payments, payments based
on the Federal Return and any payments resulting from redeterminations shall be
paid by Parent or the applicable Subsidiary, as the case may be, before the end
of the calendar month in which payments are due, such returns are filed, the
deficiency is paid or the refund is received, as the case may be.
<PAGE>
-7-
5. Resolution of Disputes
Any dispute concerning the calculation or basis of determination of any
payment provided for hereunder shall be resolved by the independent certified
public accountants for Parent, whose judgment shall be conclusive and binding
upon the parties, in the absence of manifest error.
6. Adjudications
In any audit, conference, or other proceeding with the Internal Revenue
Service or the relevant state or local authorities, or in any judicial
proceedings concerning the determination of the Federal income tax liabilities
of the Parent Group (or any Subsidiaries) or the state or local income tax
liability of any combined group including Parent (or any Subsidiaries), Parent
or the applicable Subsidiary shall be represented by persons selected by Parent.
The settlement of any issues relating to such proceeding shall be in the sole
discretion of Parent, and each Subsidiary hereby appoints Parent as its agent
for the purpose of proposing and concluding any such settlement.
7. Construction
The provisions of this Agreement shall be administered by Parent. Parent
shall exercise such discretion as is necessary to interpret and construe the
provisions of this Agreement to equitably reflect the costs and benefits of the
inclusion of the Subsidiaries in the Federal Returns filed on behalf of the
Parent Group and any state returns filed by or on behalf of the Subsidiaries.
8. Effect of This Agreement
This Agreement shall determine the liability of Parent and each Subsidiary
to each other as to the matters provided for herein, whether or not such
determination is effective for purposes of the Code or state or local revenue
laws (and regardless of the actual method for allocating federal income tax
<PAGE>
-8-
liabilities for purposes of calculating earnings and profits specified in
Treasury Regulations Sections 1.1552-1(a) and 1.1502-33(d)(2) elected, or deemed
elected, by the Parent Group), financial reporting purposes or other purposes.
9. Counterparts
This Agreement may be executed in two or more counterparts, each of which
shall be deemed to be an original, but which together shall constitute one and
the same instrument.
10. New Members
Each of the parties to this Agreement recognizes that from time to time
new subsidiaries may be added to the Parent Group. Each of the parties agrees
that any new subsidiary that qualifies hereunder as a Subsidiary shall become a
party to this Agreement, upon signing this Agreement, without the express
written consent of the other parties, for all purposes of this Agreement with
respect to taxable periods ending after such Subsidiary was added to the Parent
Group.
11. Termination
11.1 This Agreement shall continue in effect with respect to any
Subsidiary unless and until such Subsidiary ceases to be a member of the Parent
Group.
11.2 If any Subsidiary which has been a member of the Parent Group ceases
to be a member of the Parent Group, this Agreement shall cease to apply to any
income, loss, deductions or credits of that Subsidiary after it ceases to be a
member of the Parent Group.
11.3 The termination of this Agreement as hereinabove provided shall not
affect the rights or obligations of any party arising hereunder with respect to
pre-termination taxable years, or any
<PAGE>
-9-
transaction entered into prior to the effective date of such termination,
including, but not limited to, any right or obligation recorded in an
intercompany account, or as a loan between the parties.
12. Waiver
Except as specifically provided elsewhere in this Agreement, Parent and
each Subsidiary hereby waives (a) any failure or delay on the part of the other
in asserting or enforcing any right which it may have at any time under this
Agreement and (b) any notice of presentment, demand for payment, notice of
nonpayment or default, protest and notice of protest and all other notices to
which it might be entitled by law in connection with any obligation of one party
to the other.
13. Miscellaneous
13.1 Successors. This Agreement shall be binding upon, and shall inure to
the benefit of, the parties hereto and their respective successors and assigns.
13.2 Governing Law. This Agreement and all rights and obligations
hereunder shall be governed by and construed and enforced in accordance with the
laws of the State of Delaware.
13.3 Amendment. This Agreement may not be amended or supplemented except
by an instrument in writing signed by the parties.
13.4 Headings. All headings herein are for convenience of reference only
and shall be disregarded in the interpretation hereof.
<PAGE>
-10-
IN WITNESS WHEREOF, the parties have caused this Agreement to be executed
on the 1st day of June, 1997.
RISK CAPITAL HOLDINGS, INC.
By: /s/ Paul J. Malvasio
---------------------------------------
Name: Paul J. Malvasio
Title: Managing Director, Chief
Financial Officer and Treasurer
RISK CAPITAL REINSURANCE COMPANY
By: /s/ Paul J. Malvasio
---------------------------------------
Name: Paul J. Malvasio
Title: Managing Director, Chief
Financial Officer and Treasurer
NEIV HOLDINGS, INC.
By: /s/ Paul J. Malvasio
---------------------------------------
Name: Paul J. Malvasio
Title: Managing Director and Treasurer
Exhibit 10.10.6
STOCK OPTION AGREEMENT--CHAIRMAN (1997 GRANT)
FOR GOOD AND VALUABLE CONSIDERATION, receipt of which is hereby
acknowledged, Risk Capital Holdings, Inc. (the "Company"), a Delaware
corporation, hereby grants to Robert Clements, a director of the Company on the
date hereof (the "Option Holder"), the option to purchase common stock, $.01 par
value per share, of the Company ("Shares"), upon the following terms:
WHEREAS, the following terms reflect the Company's 1995 Long Term
Incentive and Share Award Plan, as amended by the First Amendment thereto (the
"Plan");
(a) Grant. The Option Holder is hereby granted an option (the
"Option") to purchase 54,100 Shares (the "Option Shares") pursuant to the Plan,
the terms of which are incorporated herein by reference. The Option is granted
as of November 18, 1997 (the "Date of Grant") and such grant is subject to the
terms and conditions herein and the terms and conditions of the applicable
provisions of the Plan. Such Option shall not be treated as an incentive stock
option under Section 422 of the Internal Revenue Code of 1986, as amended.
(b) Status of Option Shares. The Option Shares shall upon issue rank
equally in all respects with the other Shares.
(c) Option Price. The purchase price for the Option Shares shall be,
except as herein provided, $23.00 per Option Share, hereinafter sometimes
referred to as the "Option Price," payable immediately in full upon the exercise
of the Option.
(d) Term of Option. The Option may be exercised only during the
period (the "Option Period") commencing in accordance with paragraph (f) below
and shall continue for seven years from the date the Option, or portion thereof,
becomes exercisable; thereafter the Option Holder shall cease to have any rights
in respect thereof. The right to exercise the Option may be subject to sooner
termination as provided in paragraph (j) below.
(e) No Rights of Shareholder. The Option Holder shall not, by virtue
hereof, be entitled to any rights of a shareholder in the Company, either at law
or in equity.
(f) Exercisability. One-fifth of the Option shall become exercisable
on each of the first, second, third, fourth and fifth anniversary of the Date of
Grant, subject to paragraph (j) below; provided that such Option, to the extent
not already exercisable in full, shall become immediately and fully exercisable
(1) to the extent provided in paragraph (j) below and (2) upon a Change in
Control. Subject to paragraph (j) below, the Option may be exercised at any time
or from time to time during the Option Period in regard to all or any portion of
the Option which is then exercisable, as may be adjusted pursuant to paragraph
(g) below.
"Change in Control" means and shall be deemed to have occurred if:
a. any person (within the meaning of the Securities Exchange
Act of 1934, as amended (the "Exchange Act")), other than a
Permitted Person or Initial Investor, is or becomes the "beneficial
owner" (as defined in Rule 13d-3 under the Exchange Act),
<PAGE>
directly or indirectly, of Voting Securities representing 35% or
more of the total voting power of all the then outstanding Voting
Securities; or
b. any Initial Investor is or becomes the "beneficial owner"
(as defined in Rule 13d-3 under the Exchange Act), directly or
indirectly, of Voting Securities representing 50% or more of the
total voting power of all the then outstanding Voting Securities; or
c. the individuals who, as of the Date of Grant, constitute
the Board of Directors of the Company (the "Board") together with
those who become directors subsequent to such date and whose
recommendation, election or nomination for election to the Board was
approved by a vote of at least a majority of the directors then
still in office who either were directors as of such date or whose
recommendation, election or nomination for election was previously
so approved, cease for any reason to constitute a majority of the
members of the Board; or
d. the required stockholders of the Company approve a merger,
consolidation, recapitalization, liquidation, sale or disposition by
the Company of all or substantially all of the Company's assets, or
reorganization of the Company (provided that all material regulatory
approvals have been obtained), or consummation of any such
transaction, other than any such transaction which would (x) result
in at least 60% of the total voting power represented by the voting
securities of the surviving entity outstanding immediately after
such transaction being beneficially owned by the former stockholders
of the Company and (y) not otherwise be deemed a Change in Control
under subparagraphs a, b, c or e of this paragraph (f); or
e. the Board adopts a resolution to the effect that, for
purposes hereof, a Change in Control has occurred.
(i) "Initial Investors" means (A) X.L. Insurance
Company, Ltd.; (B) The Trident Partnership, L.P.; (C) Marsh &
McLennan Risk Capital Holdings, Ltd.; or (D) any
majority-owned subsidiary or parent (or equivalent in the case
of a non-corporate entity) of the foregoing.
(ii) "Permitted Persons" means (A) the Company; (B) any
Related Party; or (C) any group (as defined in Rule 13d-3
under the Exchange Act) comprised of any or all of the
foregoing.
(iii) "Related Party" means (A) a majority-owned
subsidiary of the Company; (B) a trustee or other fiduciary
holding securities under an employee benefit plan of the
Company or any majority-owned subsidiary of the Company; or
(C) a corporation owned directly or indirectly by the
stockholders of the Company in substantially the same
proportion as their ownership of Voting Securities.
(iv) "Voting Security" means any security of the Company
which carries the right to vote generally in the election of
directors.
(g) Adjustments for Recapitalization and Dividends. In the event
that, prior to the expiration of the Option, any dividend in Shares,
recapitalization, Share split, reverse split,
-2-
<PAGE>
reorganization, merger, consolidation, spin-off, combination, repurchase, or
share exchange, or other such change affects the Shares such that they are
increased or decreased or changed into or exchanged for a different number or
kind of shares, other securities of the Company or of another corporation or
other consideration, then in order to maintain the proportionate interest of the
Option Holder and preserve the value of the Option, (i) there shall
automatically be substituted for each Share subject to the unexercised Option
the number and kind of shares, other securities or other consideration into
which each outstanding Share shall be changed or for which each such Share shall
be exchanged, and (ii) the exercise price shall be increased or decreased
proportionately so that the aggregate purchase price for the Shares subject to
the unexercised Option shall remain the same as immediately prior to such event.
(h) Transferability. The Option may not be assigned or otherwise
transferred, disposed of or encumbered by the Option Holder, other than by will
or by the laws of descent and distribution. During the lifetime of the Option
Holder, the Option shall be exercisable only by the Option Holder or by his or
her guardian or legal representative. Notwithstanding the foregoing, the Option
may be transferred by the Option Holder to members of his or her "immediate
family" or to a trust established for the exclusive benefit of solely one or
more members of the Option Holder's "immediate family." Any Option held by the
transferee will continue to be subject to the same terms and conditions that
were applicable to the Option immediately prior to the transfer, except that the
Option will be transferable by the transferee only by will or the laws of
descent and distribution. For purposes hereof, "immediate family" means the
Option Holder's children, stepchildren, grandchildren, parents, stepparents,
grandparents, spouse, siblings (including half brothers and sisters), in-laws,
and relationships arising because of legal adoption.
(i) Exercise of Option. In order to exercise the Option, the Option
Holder shall submit to the Company an instrument in writing signed by the Option
Holder, specifying the number of Option Shares in respect of which the Option is
being exercised, accompanied by payment, in a manner acceptable to the Company,
of the Option Price for the Option Shares for which the Option is being
exercised. Payment to the Company in cash or Shares already owned by the Option
Holder (provided that the Option Holder has owned such Shares for a minimum
period of six months) and having a total Fair Market Value (as defined below)
equal to the exercise price, or in a combination of cash and such Shares, shall
be deemed acceptable. Option Shares will be issued accordingly by the Company
within 15 business days, and a share certificate dispatched to the Option Holder
within 30 days.
The Company shall not be required to issue fractional Shares upon
the exercise of the Option. If any fractional interest in a Share would be
deliverable upon the exercise of the Option in whole or in part but for the
provisions of this paragraph, the Company, in lieu of delivering any such
fractional share therefor, shall pay a cash adjustment therefor in an amount
equal to their Fair Market Value (or if any Shares are not publicly traded, an
amount equal to the book value per share at the end of the most recent fiscal
quarter) multiplied by the fraction of the fractional share which would
otherwise have been issued hereunder. Anything to the contrary herein
notwithstanding, the Company shall not be obligated to issue any Option Shares
hereunder if the issuance of such Option Shares would violate the provision of
any applicable law, in which event the Company shall, as soon as practicable,
take whatever action it reasonably can so that such Option Shares may be issued
without resulting in such violations of law. For purposes hereof, Fair Market
Value shall mean the mean between the high and low selling prices per Share on
the immediately preceding date (or, if the Shares were not traded on that day,
the next preceding day that the Shares were traded) on the principal exchange on
which the Shares are traded, as such prices are officially quoted on such
exchange.
-3-
<PAGE>
(j) Termination of Service. In the event the Option Holder ceases to
be a director of the Company (i) due to retirement after attainment of age 65 or
(ii) due to death or disability, the Option, to the extent not already
exercisable in full, shall become immediately and fully exercisable at the time
of such termination of service, and the Option may be exercised at any time
during the Option Period. Subject to paragraph (f) above, if the Option Holder
ceases to be a director of the Company for any other reason, the portion of the
Option which is not then exercisable shall be cancelled on the date service
terminates, and the portion of the Option which is then exercisable may be
exercised at any time within six months after the date of such termination, but
not later than termination of the Option Period.
(k) Obligations as to Capital. The Company agrees that it will at
all times maintain authorized and unissued share capital sufficient to fulfill
all of its obligations under the Option.
(l) Transfer of Shares. The Option, the Option Shares, or any
interest in either, may be sold, assigned, pledged, hypothecated, encumbered, or
transferred or disposed of in any other manner, in whole or in part, only in
compliance with the terms, conditions and restrictions as set forth in the
governing instruments of the Company, applicable United States federal and state
securities laws and the terms and conditions hereof. Each certificate for Option
Shares issued upon exercise of the Option, unless at the time of exercise such
Option Shares are registered under the Securities Act of 1933, as amended, shall
bear the following legend or such other legend as the Company deems appropriate:
"The securities evidenced hereby have not been registered under the
Securities Act of 1933, as amended (the 'Act'), and may not be
offered, sold or otherwise transferred except (i) in compliance with
the provisions of any applicable state securities or 'Blue Sky' laws
and (ii) (A) pursuant to an effective registration under the Act,
(B) in compliance with Rule 144 under the Act, (C) inside the United
States to a Qualified Institutional Buyer in compliance with Rule
144A under the Act, (D) outside the United States in compliance with
Rule 904 of Regulation S under the Act or (E) inside the United
States to an institutional 'accredited investor' as defined in Rule
501(a)(1), (2), (3) or (7) under the Act in a transaction which, in
the opinion of counsel reasonably satisfactory to the Company,
qualifies as an exempt transaction under the Act and the rules and
regulations promulgated thereunder."
Any certificate issued at any time in exchange or substitution for any
certificate bearing such legend or such other legend deemed appropriate by the
Company shall also bear such legend unless, in the opinion of counsel for the
Company, the securities represented thereby need no longer be subject to the
restrictions set forth therein. The provisions of this paragraph (l) shall be
binding upon all subsequent holders of certificates bearing the above legend and
all subsequent holders of the Option, if any.
(m) Expenses of Issuance of Option Shares. The issuance of stock
certificates upon the exercise of the Option in whole or in part, shall be
without charge to the Option Holder. The Company shall pay, and indemnify the
Option Holder from and against any issuance, stamp or documentary taxes (other
than transfer taxes) or charges imposed by any governmental body, agency or
official (other than income taxes) by reason of the exercise of the Option in
whole or in part or the resulting issuance of the Option Shares.
-4-
<PAGE>
(n) Withholding. The Option Holder agrees to make appropriate
arrangements with the Company for satisfaction of any applicable tax withholding
requirements, or similar requirements, arising out of the Option.
(o) References. References herein to rights and obligations of the
Option Holder shall apply, where appropriate, to the Option Holder's legal
representative or estate without regard to whether specific reference to such
legal representative or estate is contained in a particular provision of this
Option.
(p) Settlement of Disputes. Any dispute between the parties arising
from or relating to the terms of this Option shall be resolved by arbitration
held in the State of Connecticut in accordance with the rules of the American
Arbitration Association. All costs associated with any arbitration, including
all legal expenses, for both parties shall be borne by the Company.
(q) No Mitigation. To the extent that the vesting of any portion of
the Option is accelerated upon a Change in Control or upon a termination of
service as provided herein, neither the Option, nor any Option Shares nor any
interest in either, shall be reduced by any compensation received by the Option
Holder in connection with any other employment.
(r) Notices. Any notice required or permitted to be given under this
agreement shall be in writing and shall be deemed to have been given when
delivered personally or by courier, or sent by certified or registered mail,
postage prepaid, return receipt requested, duly addressed to the party concerned
at the address indicated below or to such changed address as such party may
subsequently by similar process give notice of:
If to the Company:
Risk Capital Holdings, Inc.
20 Horseneck Lane
Greenwich, CT 06830
Attn: Secretary
If to the Option Holder:
[Address of Option Holder]
(s) Governing Law. This agreement shall be governed by and construed
in accordance with the laws of the State of New York, without giving effect to
principles of conflict of laws.
(t) Entire Agreement. This agreement constitutes the entire
agreement among the parties relating to the subject matter hereof, and any
previous agreement or understanding among the parties with respect thereto is
superseded by this agreement.
(u) Counterparts. This agreement may be executed in two
counterparts, each of which shall constitute one and the same instrument.
-5-
<PAGE>
IN WITNESS WHEREOF, the undersigned have duly executed this agreement as
of the Date of Grant.
RISK CAPITAL HOLDINGS, INC.
By: /s/ Peter A. Appel
--------------------------------------
Peter A. Appel
Managing Director, General Counsel
and Secretary
/s/ Robert Clements
-----------------------------------------
Robert Clements
-6-
Exhibit 10.10.9
STOCK OPTION AGREEMENTS -- NON-EMPLOYEE DIRECTORS
(1998 ANNUAL GRANTS)
Each of the non-employee directors of Risk Capital Holdings, Inc. ("RCHI")
listed below has entered into a Stock Option Agreement with RCHI that is
substantially identical in all material aspects to the agreement, dated as of
January 1, 1998, between RCHI and Michael P. Esposito, Jr., a copy of which is
being filed herewith in this Exhibit 10.10.9.
Robert Clements
Lewis L. Glucksman
Ian R. Heap
Thomas V. A. Kelsey
Mark N. Williamson
Philip L. Wroughton
* * * *
<PAGE>
RISK CAPITAL HOLDINGS, INC.
Director Option Agreement
FOR GOOD AND VALUABLE CONSIDERATION, receipt of which is hereby
acknowledged, Risk Capital Holdings, Inc. (the "Company"), a Delaware
corporation, hereby grants to Michael P. Esposito, Jr., a director of the
Company on the date hereof (the "Option Holder"), the option to purchase common
stock, $.01 par value per share, of the Company ("Shares"), upon the following
terms:
WHEREAS, the following terms reflect the Company's 1995 Long Term
Incentive and Share Award Plan, as amended by the First Amendment thereto (the
"Plan");
Grant. The Option Holder is hereby granted an option (the
"Option") to purchase 500 Shares (the "Option Shares") pursuant to the Plan, the
terms of which are incorporated herein by reference. The Option is granted as of
January 1, 1998 (the "Date of Grant") and such grant is subject to the terms and
conditions herein and the terms and conditions of the applicable provisions of
the Plan. Such Option shall not be treated as an incentive stock option under
Section 422 of the Internal Revenue Code of 1986, as amended.
Status of Option Shares. The Option Shares shall upon issue
rank equally in all respects with the other Shares.
Option Price. The purchase price for the Option Shares shall
be, except as herein provided, $22.25 per Option Share, hereinafter sometimes
referred to as the "Option Price," payable immediately in full upon the exercise
of the Option.
Term of Option. The Option may be exercised only during the
period (the "Option Period") commencing in accordance with paragraph (f) below
and shall continue until January 1, 2008; thereafter the Option Holder shall
cease to have any rights in respect thereof. The right to exercise the Option
may be subject to sooner termination as provided in paragraph (j) below.
No Rights of Shareholder. The Option Holder shall not, by
virtue hereof, be entitled to any rights of a shareholder in the Company, either
at law or in equity.
Exercisability. The Option shall become exercisable on January
1, 1999, subject to paragraph (j) below; provided that such Option, to the
extent not already exercisable in full, shall become immediately and fully
exercisable (1) to the extent provided in paragraph (j) below and (2) upon a
Change in Control. Subject to paragraph (j) below, the Option may be exercised
at any time or from time to time during the Option Period in regard to all or
any portion of the Option which is then exercisable, as may be adjusted pursuant
to paragraph (g) below.
"Change in Control" means and shall be deemed to have occurred if:
a. any person (within the meaning of the Securities Exchange
Act of 1934, as amended (the "Exchange Act")), other than a
Permitted Person or Initial Investor, is or becomes the "beneficial
owner" (as defined in Rule 13d-3 under the Exchange Act), directly
or indirectly, of Voting Securities representing 35% or more of the
total voting power of all the then outstanding Voting Securities; or
<PAGE>
b. any Initial Investor is or becomes the "beneficial owner"
(as defined in Rule 13d-3 under the Exchange Act), directly or
indirectly, of Voting Securities representing 50% or more of the
total voting power of all the then outstanding Voting Securities; or
c. the individuals who, as of the Date of Grant, constitute
the Board of Directors of the Company (the "Board") together with
those who become directors subsequent to such date and whose
recommendation, election or nomination for election to the Board was
approved by a vote of at least a majority of the directors then
still in office who either were directors as of such date or whose
recommendation, election or nomination for election was previously
so approved, cease for any reason to constitute a majority of the
members of the Board; or
d. the required stockholders of the Company approve a merger,
consolidation, recapitalization, liquidation, sale or disposition by
the Company of all or substantially all of the Company's assets, or
reorganization of the Company (provided that all material regulatory
approvals have been obtained), or consummation of any such
transaction, other than any such transaction which would (x) result
in at least 60% of the total voting power represented by the voting
securities of the surviving entity outstanding immediately after
such transaction being beneficially owned by the former stockholders
of the Company and (y) not otherwise be deemed a Change in Control
under subparagraphs a, b, c or e of this paragraph (f); or
e. the Board adopts a resolution to the effect that, for
purposes hereof, a Change in Control has occurred.
(i) "Initial Investors" means (A) X.L. Insurance
Company, Ltd.; (B) The Trident Partnership, L.P.; (C) Marsh &
McLennan Risk Capital Holdings, Ltd.; or (D) any
majority-owned subsidiary or parent (or equivalent in the case
of a non-corporate entity) of the foregoing.
(ii) "Permitted Persons" means (A) the Company; (B) any
Related Party; or (C) any group (as defined in Rule 13d-3
under the Exchange Act) comprised of any or all of the
foregoing.
(iii) "Related Party" means (A) a majority-owned
subsidiary of the Company; (B) a trustee or other fiduciary
holding securities under an employee benefit plan of the
Company or any majority-owned subsidiary of the Company; or
(C) a corporation owned directly or indirectly by the
stockholders of the Company in substantially the same
proportion as their ownership of Voting Securities.
(iv) "Voting Security" means any security of the Company
which carries the right to vote generally in the election of
directors.
Adjustments for Recapitalization and Dividends. In the
event that, prior to the expiration of the Option, any dividend in Shares,
recapitalization, Share split, reverse split, reorganization, merger,
consolidation, spin-off, combination, repurchase, or share exchange, or other
such change affects the Shares such that they are increased or decreased or
changed into or exchanged for
-2-
<PAGE>
a different number or kind of shares, other securities of the Company or of
another corporation or other consideration, then in order to maintain the
proportionate interest of the Option Holder and preserve the value of the
Option, (i) there shall automatically be substituted for each Share subject to
the unexercised Option the number and kind of shares, other securities or other
consideration into which each outstanding Share shall be changed or for which
each such Share shall be exchanged, and (ii) the exercise price shall be
increased or decreased proportionately so that the aggregate purchase price for
the Shares subject to the unexercised Option shall remain the same as
immediately prior to such event.
Transferability. The Option may not be assigned or otherwise
transferred, disposed of or encumbered by the Option Holder, other than by will
or by the laws of descent and distribution. During the lifetime of the Option
Holder, the Option shall be exercisable only by the Option Holder or by his or
her guardian or legal representative. Notwithstanding the foregoing, the Option
may be transferred by the Option Holder to members of his or her "immediate
family" or to a trust established for the exclusive benefit of solely one or
more members of the Option Holder's "immediate family." Any Option held by the
transferee will continue to be subject to the same terms and conditions that
were applicable to the Option immediately prior to the transfer, except that the
Option will be transferable by the transferee only by will or the laws of
descent and distribution. For purposes hereof, "immediate family" means the
Option Holder's children, stepchildren, grandchildren, parents, stepparents,
grandparents, spouse, siblings (including half brothers and sisters), in-laws,
and relationships arising because of legal adoption.
Exercise of Option. In order to exercise the Option, the
Option Holder shall submit to the Company an instrument in writing signed by the
Option Holder, specifying the number of Option Shares in respect of which the
Option is being exercised, accompanied by payment of the Option Price for the
Option Shares for which the Option is being exercised in cash or Shares already
owned by the Option Holder (provided that the Option Holder has owned such
Shares for a minimum period of six months) and having a total Fair Market Value
(as defined below) equal to the exercise price, or in a combination of cash and
such Shares. Option Shares will be issued accordingly by the Company within 15
business days, and a share certificate dispatched to the Option Holder within 30
days.
The Company shall not be required to issue fractional Shares upon
the exercise of the Option. If any fractional interest in a Share would be
deliverable upon the exercise of the Option in whole or in part but for the
provisions of this paragraph, the Company, in lieu of delivering any such
fractional share therefor, shall pay a cash adjustment therefor in an amount
equal to their Fair Market Value (or if any Shares are not publicly traded, an
amount equal to the book value per share at the end of the most recent fiscal
quarter) multiplied by the fraction of the fractional share which would
otherwise have been issued hereunder. Anything to the contrary herein
notwithstanding, the Company shall not be obligated to issue any Option Shares
hereunder if the issuance of such Option Shares would violate the provision of
any applicable law, in which event the Company shall, as soon as practicable,
take whatever action it reasonably can so that such Option Shares may be issued
without resulting in such violations of law. For purposes hereof, Fair Market
Value shall mean the mean between the high and low selling prices per Share on
the immediately preceding date (or, if the Shares were not traded on that day,
the next preceding day that the Shares were traded) on the principal exchange on
which the Shares are traded, as such prices are officially quoted on such
exchange.
Termination of Service. In the event the Option Holder ceases
to be a director of the Company (i) due to retirement after attainment of age 65
or (ii) due to death or disability, the Option, to the extent not already
exercisable in full, shall become immediately and fully exercisable at the time
of such termination of service, and the Option may be exercised at any time
during the Option Period.
-3-
<PAGE>
Subject to paragraph (f) above, if the Option Holder ceases to be a director of
the Company for any other reason, the portion of the Option which is not then
exercisable shall be cancelled on the date service terminates, and the portion
of the Option which is then exercisable may be exercised at any time within six
months after the date of such termination, but not later than termination of the
Option Period.
Obligations as to Capital. The Company agrees that it will at
all times maintain authorized and unissued share capital sufficient to fulfill
all of its obligations under the Option.
Transfer of Shares. The Option, the Option Shares, or any
interest in either, may be sold, assigned, pledged, hypothecated, encumbered, or
transferred or disposed of in any other manner, in whole or in part, only in
compliance with the terms, conditions and restrictions as set forth in the
governing instruments of the Company, applicable United States federal and state
securities laws and the terms and conditions hereof. Each certificate for Option
Shares issued upon exercise of the Option, unless at the time of exercise such
Option Shares are registered under the Securities Act of 1933, as amended, shall
bear the following legend or such other legend as the Company deems appropriate:
"The securities evidenced hereby have not been registered under the
Securities Act of 1933, as amended (the 'Act'), and may not be
offered, sold or otherwise transferred except (i) in compliance with
the provisions of any applicable state securities or 'Blue Sky' laws
and (ii) (A) pursuant to an effective registration under the Act,
(B) in compliance with Rule 144 under the Act, (C) inside the United
States to a Qualified Institutional Buyer in compliance with Rule
144A under the Act, (D) outside the United States in compliance with
Rule 904 of Regulation S under the Act or (E) inside the United
States to an institutional 'accredited investor' as defined in Rule
501(a)(1), (2), (3) or (7) under the Act in a transaction which, in
the opinion of counsel reasonably satisfactory to the Company,
qualifies as an exempt transaction under the Act and the rules and
regulations promulgated thereunder."
Any certificate issued at any time in exchange or substitution for any
certificate bearing such legend or such other legend deemed appropriate by the
Company shall also bear such legend unless, in the opinion of counsel for the
Company, the securities represented thereby need no longer be subject to the
restrictions set forth therein. The provisions of this paragraph (l) shall be
binding upon all subsequent holders of certificates bearing the above legend and
all subsequent holders of the Option, if any.
Expenses of Issuance of Option Shares. The issuance of stock
certificates upon the exercise of the Option in whole or in part, shall be
without charge to the Option Holder. The Company shall pay, and indemnify the
Option Holder from and against any issuance, stamp or documentary taxes (other
than transfer taxes) or charges imposed by any governmental body, agency or
official (other than income taxes) by reason of the exercise of the Option in
whole or in part or the resulting issuance of the Option Shares.
Withholding. The Option Holder agrees to make appropriate
arrangements with the Company for satisfaction of any applicable tax withholding
requirements, or similar requirements, arising out of the Option.
(o) References. References herein to rights and obligations of the
Option Holder shall apply, where appropriate, to the Option Holder's legal
representative or estate without regard to
-4-
<PAGE>
whether specific reference to such legal representative or estate is contained
in a particular provision of this Option.
(p) Settlement of Disputes. Any dispute between the parties arising
from or relating to the terms of this Option shall be resolved by arbitration
held in the State of Connecticut in accordance with the rules of the American
Arbitration Association. All costs associated with any arbitration, including
all legal expenses, for both parties shall be borne by the Company.
(q) No Mitigation. To the extent that the vesting of the Option is
accelerated upon a Change in Control or upon a termination of service as
provided herein, neither the Option, nor any Option Shares nor any interest in
either, shall be reduced by any compensation received by the Option Holder in
connection with any other employment.
(r) Notices. Any notice required or permitted to be given under this
agreement shall be in writing and shall be deemed to have been given when
delivered personally or by courier, or sent by certified or registered mail,
postage prepaid, return receipt requested, duly addressed to the party concerned
at the address indicated below or to such changed address as such party may
subsequently by similar process give notice of:
If to the Company:
Risk Capital Holdings, Inc.
20 Horseneck Lane
Greenwich, CT 06830
Attn: Secretary
If to the Option Holder:
[Address of Option Holder]
(s) Governing Law. This agreement shall be governed by and construed
in accordance with the laws of the State of New York, without giving effect to
principles of conflict of laws.
(t) Entire Agreement. This agreement constitutes the entire
agreement among the parties relating to the subject matter hereof, and any
previous agreement or understanding among the parties with respect thereto is
superseded by this agreement.
(u) Counterparts. This agreement may be executed in two
counterparts, each of which shall constitute one and the same instrument.
-5-
<PAGE>
IN WITNESS WHEREOF, the undersigned have duly executed this agreement as
of the Date of Grant.
RISK CAPITAL HOLDINGS, INC.
By: /s/ Peter A. Appel
-------------------------------------
Peter A. Appel
Managing Director, General Counsel
and Secretary
/s/ Michael P. Esposito, Jr.
-----------------------------------------
Michael P. Esposito, Jr.
-6-
Exhibit 23
[Letterhead of Price Waterhouse LLP]
Consent of Independent Accountants
We hereby consent to 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 January 30, 1998 appearing on page F-2 of the Company's
Annual Report on Form 10-K for the year ended December 31, 1997. We also consent
to the incorporation by reference of our report on the Financial Statement
Schedules, also dated January 30, 1998, which appears on page S-1 of the
Company's Annual Report on Form 10-K for the year ended December 31, 1997. We
also consent to the reference to us under the heading "Experts" in such
Registration Statement.
/s/ Price Waterhouse LLP
New York, New York
March 25, 1998
<PAGE>
[Letterhead of Price Waterhouse LLP]
Consent of Independent Accountants
We hereby consent to the incorporation by reference in the Prospectus
constituting part of this Registration Statement on Form S-3 (Registration No.
33-34499) of Risk Capital Holdings, Inc. of our report dated January 30, 1998
appearing on page F-2 of the Company's Annual Report on Form 10-K for the year
ended December 31, 1997. We also consent to the incorporation by reference of
our report on the Financial Statement Schedules, also dated January 30, 1998,
which appears on page S-1 of the Company's Annual Report on Form 10-K for the
year ended December 31, 1997. We also consent to the reference to us under the
heading "Experts" in such Prospectus.
/s/ Price Waterhouse LLP
New York, New York
March 25, 1998
Exhibit 24
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Mark D. Mosca, Paul J. Malvasio and Peter A.
Appel, and each of them, with full power to act without the other, his true and
lawful attorney-in-fact and agent, with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign the Annual Report of Risk Capital Holdings, Inc. on Form
10-K for the fiscal year ended December 31, 1997, including one or more
amendments to such Form 10-K, which amendments may make such changes as such
person deems appropriate, and to file the same, with all exhibits thereto, and
other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, and each of them,
full power and authority to do and perform each and every act and thing
requisite and necessary to be done in connection therewith, as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents or any of them, or their
or his substitutes or substitute, may lawfully do or cause to be done by virtue
hereof.
IN WITNESS WHEREOF, the undersigned has executed this Power-of-Attorney on
the date set opposite his respective name.
Signature Title Date
--------- ----- ----
/s/ Mark D. Mosca President and Chief Executive March 17, 1998
- ----------------------------- Officer and Director
Mark D. Mosca (Principal Executive Officer)
/s/ Robert Clements Chairman and Director March 17, 1998
- -----------------------------
Robert Clements
/s/ Paul J. Malvasio Managing Director, Chief March 17, 1998
- ----------------------------- Financial Officer and
Paul J. Malvasio Treasurer (Principal
Financial Officer and
Principal Accounting Officer)
/s/ Michael P. Esposito, Jr. Director March 17, 1998
- -----------------------------
Michael P. Esposito, Jr.
/s/ Lewis L. Glucksman Director March 17, 1998
- -----------------------------
Lewis L. Glucksman
/s/ Ian R. Heap Director March 17, 1998
- -----------------------------
Ian R. Heap
/s/ Thomas V. A. Kelsey Director March 17, 1998
- -----------------------------
Thomas V. A. Kelsey
/s/ Mark N. Williamson Director March 17, 1998
- -----------------------------
Mark N. Williamson
/s/ Philip L. Wroughton Director March 17, 1998
- -----------------------------
Philip L. Wroughton
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
RISK CAPITAL HOLDINGS, INC.
Article 7 of Regulation S-X
Insurance Companies
Twelve month period ended December 31, 1997 (Dollars in thousands,
except per share amounts.)
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET OF RISK CAPITAL HOLDINGS, INC. AND ITS SUBSIDIARY AT
DECEMBER 31, 1997, AND THE RELATED STATEMENT OF INCOME, AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<DEBT-HELD-FOR-SALE> 132,159
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 275,388
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 496,714
<CASH> 9,014
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 17,292
<TOTAL-ASSETS> 581,247
<POLICY-LOSSES> 70,768
<UNEARNED-PREMIUMS> 74,234
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 171
<OTHER-SE> 400,860
<TOTAL-LIABILITY-AND-EQUITY> 581,247
107,372
<INVESTMENT-INCOME> 14,360
<INVESTMENT-GAINS> (760)
<OTHER-INCOME> 0
<BENEFITS> 73,407
<UNDERWRITING-AMORTIZATION> 31,467
<UNDERWRITING-OTHER> 14,205
<INCOME-PRETAX> 1,893
<INCOME-TAX> (338)
<INCOME-CONTINUING> 2,039
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,039<F1>
<EPS-PRIMARY> .12
<EPS-DILUTED> .12
<RESERVE-OPEN> 20,248
<PROVISION-CURRENT> 73,385
<PROVISION-PRIOR> 22
<PAYMENTS-CURRENT> 13,649
<PAYMENTS-PRIOR> 9,238
<RESERVE-CLOSE> 70,768
<CUMULATIVE-DEFICIENCY> 22
<FN>
<F1> Includes equity in net loss of investees of ($192).
</FN>
</TABLE>
