-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RujyUih261nxl+jhDLVPaUHOQsTx1m18zuboSQ/k9g+1MDAuE6FJhpQnBPGGc3dk LoeGFfRbQVWOiZGzk9EHKA== 0001003957-98-000028.txt : 19981118 0001003957-98-000028.hdr.sgml : 19981118 ACCESSION NUMBER: 0001003957-98-000028 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981116 FILER: COMPANY DATA: COMPANY CONFORMED NAME: RISCORP INC CENTRAL INDEX KEY: 0001003957 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 650335150 STATE OF INCORPORATION: FL FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-27462 FILM NUMBER: 98752006 BUSINESS ADDRESS: STREET 1: ONE SARASOTA TOWER STREET 2: SUITE 608 CITY: SARASOTA STATE: FL ZIP: 34236 BUSINESS PHONE: 9419512022 MAIL ADDRESS: STREET 1: 1390 MAIN STREET CITY: SARASOTA STATE: FL ZIP: 34236 10-Q 1 RISCORP, INC. 10-Q AS OF SEPTEMBER 30, 1998 FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 0-27462 RISCORP, INC. (Exact name of registrant as specified in its charter) FLORIDA 65-0335150 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) One Sarasota Tower Suite 608 2 North Tamiami Trail Sarasota, Florida 34236 (Address of principal executive offices) (Zip Code) (941) 366-5015 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. X Yes No . Number of shares outstanding of the issuer's Common Stock: Class Outstanding at October 31, 1998 Class A Common Stock, $.01 par value 14,258,671 Class B Common Stock, $.01 par value 24,334,443 1
INDEX Page No. Part I Financial Information Item 1. Financial Statements Consolidated Balance Sheets - September 30, 1998 and December 31, 1997 3-4 Consolidated Statements of Operations - For the three months ended September 30, 1998 and 1997 5 Consolidated Statements of Operations - For the nine months ended September 30, 1998 and 1997 6 Consolidated Statements of Cash Flows - For the nine months ended September 30, 1998 and 1997 7 Notes to Consolidated Financial Statements 8-14 Item 2. Management's Discussion and Analysis of Financial 15-24 Condition and Results of Operations Part II Other Information Item 1. Legal Proceedings 24-26 Item 2. Changes to Securities 27 Item 3. Defaults Upon Senior Securities 27 Item 4. Submission of Matters to a Vote of Security Holders 27 Item 5. Other Information 27 Item 6. Exhibits and Reports on Form 8-K 27 Signatures 28
2 Part I Financial Information Item 1. Financial Statements
RISCORP, INC. AND SUBSIDIARIES Consolidated Balance Sheets September 30, 1998 and December 31, 1997 (in thousands) September 30, December 31, 1997 ----------------- 1998 Assets (Unaudited) Investments: Fixed maturities available for sale, at fair value (amortized cost $11,065 in 1998 and $142,876 in 1997) $ 11,127 $ 145,571 Fixed maturities available for sale, at fair value (amortized cost $0 in 1998 and $53,437 in 1997)-restricted -- 53,820 Fixed maturities held to maturity, at amortized cost (fair value $9,643 in 1998 and $24,347 in 1997) 9,321 24,090 Fixed maturities held to maturity, at amortized cost (fair value $6,098 in 1998 and $0 in 1997)-restricted 6,150 -- Total investments 26,598 223,481 Cash and cash equivalents 1,541 16,858 Cash and cash equivalents-restricted 15,457 13,295 Premiums receivable, net -- 100,183 Accounts receivable--other 2,634 16,720 Recoverable from Florida Special Disability Trust Fund, net -- 45,211 Reinsurance recoverables -- 184,251 Prepaid expenses 5,365 -- Prepaid reinsurance premiums -- 29,982 Prepaid managed care fees -- 8,420 Accrued reinsurance commissions -- 37,188 Receivable from Zenith 105,083 -- Deferred income taxes 23,394 22,120 Property and equipment, net 345 26,665 Goodwill -- 15,286 Other assets 8,820 9,990 ----- ----- Total assets $ 189,237 $ 749,650 ============== ============= See accompanying notes to consolidated financial statements.
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RISCORP, INC. AND SUBSIDIARIES Consolidated Balance Sheets September 30, 1998 and December 31, 1997 (in thousands) September 30, December 31, 1997 1998 Liabilities and Shareholders' Equity (Unaudited) Liabilities: Losses and loss adjustment expenses $ -- $ 437,038 Unearned premiums -- 56,324 Notes payable of parent company -- 15,000 Notes payable of subsidiaries 167 609 Deposit balances payable -- 5,512 Investments held for Zenith 6,150 -- Accrued expenses and other liabilities 33,870 65,885 Net assets in excess of cost of business acquired -- 5,749 Total liabilities 40,187 586,117 --------------- --------------- Shareholders' equity: Class A Common Stock, $.01 par value, 100,000,000 shares authorized; shares issued and outstanding: 14,258,671 in 1998 and 11,855,917 in 1997 146 120 Class B Common Stock, $.01 par value, 100,000,000 shares authorized; shares issued and outstanding; 24,334,443 in 1998 and 1997 243 243 Preferred stock, $.01 par value, 10,000,000 shares authorized; 0 shares issued and outstanding -- -- Additional paid-in capital 140,688 135,974 Retained earnings 7,934 25,195 Treasury stock - at cost, 112,582 shares (1) (1) Accumulated Other Comprehensive Income: Net unrealized gains on investments 40 2,002 -- ----- Total shareholders' equity 149,050 163,533 -------------- --------------- Total liabilities and shareholders' equity $ 189,237 $ 749,650 ============= ============== See accompanying notes to consolidated financial statements.
4
RISCORP, INC. AND SUBSIDIARIES Consolidated Statements of Operations For the three months ended September 30, 1998 and 1997 (in thousands, except share and per share data) 1998 1997 --------------- --------------- (Unaudited) (Unaudited) Revenue: Premiums earned $ -- $ 40,417 Fee income -- 7,008 Net realized gains 74 55 Net investment income 2,297 4,049 Other income 141 -- Total revenue 2,512 51,529 ----- ------ Expenses: Losses and loss adjustment expenses -- 31,219 Unallocated loss adjustment expenses -- 3,195 Commissions, underwriting and administrative expenses 3,835 15,291 Interest expense 147 473 Depreciation and amortization 39 2,418 -- ----- Total expenses 4,021 52,596 ----- ------ Loss before income taxes 1,509 1,067 Income tax expense (benefit) 189 (433) --- ----- Net loss $ 1,698 $ 634 === Per share data: Net loss per common share - basic $ 0.05 $ 0.02 ==== ==== Net loss per common share - diluted $ 0.05 0.02 ==== ==== Weighted average common shares outstanding 37,062,558 36,868,114 ========== =========== Weighted average common and common share equivalents outstanding 37,062,558 36,868,114 ========== =========== See accompanying notes to consolidated financial statements.
5
RISCORP, INC. AND SUBSIDIARIES Consolidated Statements of Operations For the nine months ended September 30, 1998 and 1997 (in thousands, except share and per share data) 1998 1997 ---------------- ---------------- (Unaudited) (Unaudited) Revenue: Premiums earned $ 25,819 $ 133,882 Fee income 5,723 17,969 Net realized gains 4,268 380 Net investment income 7,927 12,177 Other income 234 -- Total revenue 43,971 164,408 ------ ------- Expenses: Losses and loss adjustment expenses 24,016 87,140 Unallocated loss adjustment expenses 2,561 11,295 Commissions, underwriting and administrative expenses 30,703 51,862 Interest expense 624 1,442 Depreciation and amortization 3,139 6,257 ----- ----- Total expenses 61,043 157,996 ------ ------- (Loss) income before income taxes (17,072) 6,412 Income taxes 189 2,602 --- ----- Net (loss) income $(17,261) $3,810 ======== ===== Per share data: Net (loss) income per common share-basic $ (0.47) $ 0.10 ====== ==== Net (loss) income per common share-diluted $ (0.47) $ 0.10 ====== ==== Weighted average common shares outstanding 36,949,133 36,868,114 ========== ========== Weighted average common shares and common share equivalents outstanding 36,949,133 37,331,665 ========== ========== See accompanying notes to consolidated financial statements.
6
RISCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows For the nine months ended September 30, 1998 and 1997 (in thousands) 1998 1997 --------------- -------------- (Unaudited) (Unaudited) Net cash used in operating activities $ (33,735) $ (24,228) ---------- ---------- Cash flows from investing activities: Purchase of property and equipment (940) (3,112) Proceeds from the sale of equipment 255 658 Purchase of fixed maturities available for sale (51,070) (86,170) Purchase of fixed maturities held to maturity (5,874) -- Proceeds from sale of fixed maturities available for sale 57,824 120,424 Proceeds from maturities of fixed maturities available for sale 6,029 9,868 Proceeds from maturities of fixed maturities held to maturity 6,000 1,000 Purchase of equity securities -- (637) Proceeds from sale of equity securities 1,324 3,431 Purchase of Maryland Fund, net of cash acquired -- 134 Cash received from Zenith for sale of net assets 35,000 -- Cash assets sold to Zenith (29,308) -- Investments to be transferred to Zenith -- -- ------------- -------------- Net cash provided by investing activities 19,240 45,596 ----------- ------------ Cash flows from financing activities: Principal repayments of notes payable (245) (501) (Decrease) increase in deposit balances payable (1,599) 725 Unearned compensation--stock options -- 547 Purchase of treasury stock -- (2,100) Other, net -- (222) Transfer of cash and cash equivalents to restricted 1,022 -- ------------ --------------- Net cash used in financing activities (822) (1,551) ------------- ------------- Net (decrease) increase in cash and cash equivalents (15,317) 19,817 Cash and cash equivalents, beginning of period 16,858 26,307 ----------- ------------ Cash and cash equivalents, end of period $ 1,541 $ 46,124 =========== =========== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 479 $ 1,447 ============ ============ Income taxes $ 3,644 $ 3,445 =========== ============ Supplemental schedule of noncash investing and financing activities: The Company sold substantially all of its insurance assets and liabilities to Zenith (see Note 5). In conjunction with the sale, a receivable from Zenith was recorded as follows: Book value of net assets sold $ 140,083 Cash received from Zenith at closing (35,000) ------------- Receivable from Zenith $ 105,083 =========== See accompanying notes to consolidated financial statements.
7 RISCORP, INC. AND SUBSIDIARIES Notes to Consolidated Condensed Financial Statements (Unaudited) (1) Basis of Presentation RISCORP, Inc.'s (the "Company" or "RISCORP") consolidated unaudited interim financial statements have been prepared on the basis of generally accepted accounting principles ("GAAP") and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the Company's financial condition, results of operations and cash flows for the periods presented. 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 disclosures of contingent assets and liabilities at the date of the financial statements and the reported revenues and expenses during the reporting period. Actual results could differ from those estimates. On April 1, 1998, the Company and certain of its subsidiaries consummated the sale of substantially all of their assets to Zenith Insurance Company ("Zenith") and ceased substantially all of their former business operations. See Note 5 below for further discussion of the Zenith transaction. Accordingly, the results of operations for the nine months ended September 30, 1998 will not be indicative of the results that are expected for the full year ending December 31, 1998. These consolidated financial statements and notes should be read in conjunction with the financial statements and notes included in the audited consolidated financial statements of RISCORP, Inc. and subsidiaries for the year ended December 31, 1997 contained in the Company's Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 27, 1998. The consolidated financial statements include the accounts of the Company and each of its subsidiaries. All significant intercompany balances have been eliminated. (2) Sale of Joint Venture Joint Venture Arrangement In January 1996, the Company, through its wholly-owned subsidiary, RISCORP of Illinois, entered into a joint venture arrangement with Health Care Service Corporation ("HCSC"), a subsidiary of Blue Cross and Blue Shield of Illinois, to underwrite and sell managed care workers' compensation insurance in Illinois. The Company and HCSC each held 50 percent ownership in the joint venture known as Third Coast Holding Company ("Third Coast"). The Company contributed the use of its expertise, insurance systems and intellectual property, while HCSC contributed cash of $10.0 million. The Company's contributed property in Third Coast was valued at $10.0 million; however, the Company's cost basis in the contributed property was $0 and as of December 31, 1996, the Company recorded its initial investment in Third Coast at $0. The Company's investment in Third Coast at December 31, 1997 was $0. The Company accounted for its 50 percent investment in Third Coast on the equity basis of accounting, whereby the Company's recorded investment was adjusted for its proportionate share of earnings or losses of Third Coast. The Company discontinued the use of the equity method of 8 accounting for Third Coast in the first quarter of 1997 when the cumulative losses reduced the Company's investment in Third Coast to $0. In addition, the Company made no financial guarantees relating to Third Coast and made no financial commitments to provide any future funding to Third Coast. The Company and HCSC entered into an agreement dated March 11, 1998 for the purchase of the Company's 50 percent interest in Third Coast for $1,324,001. The effective date of the transaction was January 1, 1998. The gain on the sale of Third Coast of $1,324,001 was included in net realized gains at March 31, 1998 and in the accompanying Consolidated Statements of Operations for the nine months ended September 30, 1998. The Company received all the funds due in connection with this transaction on April 3, 1998. In connection with the closing of the sale to Zenith, the Company received notice that Zenith believes that it is entitled to the proceeds from the sale of Third Coast. The Company disputes Zenith's entitlement to these proceeds and intends to vigorously defend any claim asserted by Zenith related to the Third Coast transaction. (3) Issuance of Additional Shares of Stock In September 1996, the Company purchased all of the outstanding stock of Independent Association Administrators, Inc. ("IAA") and Risk Inspection Services and Consulting, Inc. ("RISC") in exchange for approximately $11.5 million, consisting primarily of 790,336 shares of the Company's Class A Common Stock valued at approximately $10.9 million on the date of acquisition. IAA and RISC are workers' compensation management services companies offering services in Alabama. Under the IAA acquisition agreement, the former IAA shareholders received 790,336 shares of the Company's Class A Common Stock. Pursuant to the acquisition agreement, if the former IAA shareholders own all of such Class A Common Stock on September 17, 1998, the Company was obligated to issue additional shares of the Company's Class A Common Stock in an amount sufficient to make the value of all shares of the Company's Class A Common Stock held by the former IAA shareholders equal to an aggregate fair market value of $10.9 million on September 17, 1998. However, in no event would the number of additional shares issued to the former IAA shareholders exceed 790,336 shares. Due to decreases in the market value of the Company's Class A Common Stock, 790,336 additional shares of the Company's Class A Common Stock valued at $642,148 were issued on January 9, 1998 to the former shareholders of IAA. The market value of the stock on January 9, 1998 was $0.8125 per share. The $642,148 fair market value of the stock issued was recorded by the Company as goodwill amortization in the March 31, 1998 financial statements and in the accompanying Consolidated Statements of Operations for the nine months ended September 30, 1998. This amount was recorded as an amortization expense because it could not be recovered from the remaining future profitability of the workers' compensation business that was still under contract on January 9, 1998. (4) Commitments and Contingencies Between November 20, 1996 and January 31, 1997, nine shareholder class action lawsuits were filed against RISCORP, Inc. and other defendants in the United States District Court for the Middle District of Florida (the "Securities Litigation"). In March 1997, the court consolidated these lawsuits and appointed co-lead plaintiffs and co-lead counsel. The plaintiffs subsequently filed a consolidated complaint. The consolidated complaint named as defendants RISCORP, Inc., three of its executive officers, one non-officer director and three of the underwriters for 9 RISCORP, Inc.'s initial public offering. The plaintiffs in the consolidated complaint purport to represent the class of shareholders who purchased RISCORP, Inc. Class A Common Stock between February 28, 1996 and November 14, 1996. The consolidated complaint alleges that RISCORP, Inc.'s Registration Statement and Prospectus of February 28, 1996, as well as subsequent statements, contained false and misleading statements of material fact and omissions, in violation of sections 11 and 15 of the Securities Act and sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder. The consolidated complaint seeks unspecified compensatory damages. Pursuant to court ordered mediation, counsel for the parties have engaged in discussions in an effort to resolve the Securities Litigation. On January 14, 1998, counsel for the Company, counsel for William D. Griffin and counsel for the plaintiffs reached an oral agreement on terms to recommend to their clients to settle this litigation. This agreement was confirmed in a written Memorandum of Understanding executed by counsel for the respective parties as of April 29, 1998. The proposed settlement is contingent upon the following: execution of a definitive settlement agreement and implementing pleadings and other documentation; consummation of the transactions contemplated by the Purchase Agreement with Zenith; disclosure of certain documents to plaintiff's counsel and interviews by them of various individuals to verify information relating to the settlement; certification of a settlement class; satisfaction of all requirements for settlement under Rule 23 of the Federal Rules of Civil Procedures; payment by RISCORP of $21.0 million into a settlement fund for the benefit of the settlement class; and release by members of the settlement class of all claims against the defendants. Counsel to the parties are in the process of finalizing the initial settlement documents. The initial settlement documents have been finalized and the appropriate pleadings filed with the court. On July 29, 1998, the court issued a Preliminary Approval Order in which it certified the purported class for settlement purposes and scheduled a Settlement Fairness Hearing for October 8, 1998. Through no fault of the Company, approximately 350 members of the class did not receive timely notice and the Settlement Fairness Hearing has been rescheduled for December 15, 1998. The Company estimates that $8.0 million of insurance proceeds will be available for contribution to the settlement amount, as well as related costs and expenses. The Company recognized the $21.0 million proposed settlement and the related insurance proceeds in the December 31, 1997 financial statements. Given the preliminary nature of this settlement and the various contingencies relating to its consummation, there can be no assurance that this litigation will be ultimately settled on this basis. On August 20, 1997, Occupational Safety Association of Alabama Workers' Compensation Fund (the "Fund") filed a breach of contract and fraud action against the Company and others. The Fund is an association of self-insured employers who agreed to transfer, in a Loss Portfolio Transfer Agreement (the "Agreement") dated August 26, 1996, substantially all of its assets and liabilities to the Company. Co-defendant Peter D. Norman was a principal and officer of IAA. The complaint alleges that Norman and IAA breached certain fiduciary duties owed to the Fund in connection with the subject agreement and transfer. The complaint alleges that the Company has breached certain provisions of the Agreement and owes the Fund monies under the terms of the Agreement. The Fund claims, per a Loss Portfolio Evaluation dated February 26, 1998, that the Fund overpaid RISCORP by approximately $6.0 million in the subject transaction. The court has granted defendant's Motion to Compel Arbitration per the terms and provisions of the Agreement. The other defendants, including IAA, have appealed the trial court's denial of their motions to compel arbitration. These appeals are pending before the Alabama Supreme Court. Assuming mediation fails, the dispute between the Company and the Fund will be resolved through arbitration. The Company intends to vigorously defend this claim, and believes that application of appropriate accounting and actuarial principles and methodologies to the calculation at issue may indicate that monies are instead owed to the Company by the Fund. 10 On or about April 13, 1998, the Fund filed a Motion for Preliminary Injunction which seeks to enjoin the Company from distributing any dividends or making any type of distributions to shareholders, withdrawing any proceeds from the escrow account established with certain proceeds received from Zenith, or dissolving the Company. Although somewhat confusing, the motion appears to be based on the failure of the Company to specifically identify this lawsuit in its proxy statement issued in connection with the sale to Zenith. The motion was denied on June 12, 1998. In June 1997, the Company terminated a number of employees in connection with the workforce reduction. As a result of the workforce reduction and the sale to Zenith, a number of former employees have initiated proceedings, including arbitration, against the Company for certain severance benefits. The Company intends to vigorously defend these suits; however, there can be no assurance that it will prevail in these proceedings. On March 13, 1998, RIC and RISCORP Property & Casualty Insurance Company ("RPC") were added as defendants in a purported class action filed in the United States District Court for the Southern District of Florida, styled Bristol Hotel Management Corporation, et. al., v. Aetna Casualty & Surety Company, a/k/a Aetna Group, et. al. Case No. 97-2240-CIV-MORENO. The plaintiffs purport to bring this action on behalf of themselves and a class consisting of all employers in the State of Florida who purchased or renewed retrospectively rated or adjusted workers' compensation policies in the voluntary market since 1985. The suit was originally filed on July 17, 1997, against approximately 174 workers' compensation insurers as defendants. The complaint was subsequently amended to add the RISCORP defendants. The amended complaint named a total of approximately 161 insurer defendants. The suit claims that the defendant insurance companies violated the Sherman Antitrust Act, the Racketeer Influenced and Corrupt Organizations Act ("RICO"), the Florida Antitrust Act and committed breach of contract, civil conspiracy and were unjustly enriched by unlawfully adding improper and illegal charges and fees onto retrospectively rated premiums and otherwise charging more for those policies than allowed by law. The suit seeks compensatory and punitive damages, treble damages under the Antitrust and RICO claims, and equitable relief. RIC and RPC moved to dismiss the amended complaint and also adopted certain motions to dismiss the amended complaint filed by various other defendants. On August 26, 1998, the district court issued an order dismissing the entire suit against all defendants. The plaintiffs filed a motion to reconsider the dismissal order, which was denied by Judge Moreno on September 10, 1998. Most recently, on September 13, 1998, the plaintiffs filed a Notice of Appeal. Management will continue to monitor the progress of the appeals process as necessary. The Company, in the normal course of business, is party to various lawsuits which management believes will not materially affect the financial position of the Company. Based upon information presently available, and in light of legal and other defenses available to the Company, contingent liabilities arising from threatened and pending litigation are not presently considered by management to be material. However, no assurance can be given, or may be taken that material adverse judgments will not be rendered against the Company as a result of the aforementioned matters. Other than as noted above, no provision had been made in the Company's financial statements for the above matters at December 31, 1997 and 1996. In addition, certain of the lawsuits and related legal expenses may be covered under directors and officers' insurance coverage maintained by the Company. During February 1998, the FDOI completed an examination of the statutory books and records of RIC and RPC as of December 31, 1996. The FDOI issued a final report on the December 31, 1996 examination of RIC and RPC on October 16, 1998. There were no adjustments to the capital and surplus of RPC and $3.5 million of adjustments which reduced the capital and surplus of RIC. The most significant examination adjustment to the capital and 11 surplus of RIC was the non-admission by the FDOI examiners of $2.2 million of investments that were held by a bank outside of Florida. The remaining $1.3 million of adjustments related primarily to certain related party receivables that were either collected or charged to expense in 1997. These statutory adjustments have no material impact on the accompanying GAAP financial statements. The Company has historically met its cash requirements and financed its growth through cash flow generated from operations and borrowings. The Company's primary sources of cash flow from operations were premiums and investment income, and its cash requirements consisted primarily of payment of losses and loss adjustment expenses, support of its operating activities including various reinsurance agreements and managed care programs and services, capital surplus needs for its insurance subsidiaries, and other general and administrative expenses. As discussed more fully in Note 5 on April 1, 1998, the Company and certain of its subsidiaries have sold substantially all of their assets and transferred certain liabilities to Zenith in exchange for cash. In connection with this sale to Zenith, the Company and its subsidiaries ceased substantially all of its former business operations and, accordingly, since April 1, 1998, the Company's cash requirements have been, and will continue to be, satisfied through investment income and the liquidation of investments and other assets. (5) Sale to Zenith Insurance Company ("Zenith") Pursuant to an Asset Purchase Agreement dated June 17, 1997, by and among RISCORP, Inc. ("RISCORP"), certain of its subsidiaries named therein, and Zenith, RISCORP and its subsidiaries sold substantially all of their operating assets and transferred certain liabilities to Zenith. The closing of the transaction occurred on April 1, 1998. In connection with the closing of this transaction, Zenith paid $35.0 million in cash, of which $10.0 million was placed in escrow pursuant to the terms of the Asset Purchase Agreement. The final purchase price to be paid by Zenith will be the excess, if any, of the book value of the transferred assets over the transferred liabilities assumed by Zenith at closing. On June 9, 1998, RISCORP delivered to Zenith a closing date balance sheet (the "Proposed Business Balance Sheet") representing the audited statement of transferred assets and transferred liabilities as of Apri1 1, 1998. The Proposed Business Balance Sheet indicated RISCORP's calculation of the final purchase price to be approximately $141.0 million, less the $35.0 million previously paid by Zenith. Pursuant to the terms of the Asset Purchase Agreement, on July 9, 1998, Zenith provided to RISCORP a list of suggested adjustments to the Proposed Business Balance Sheet. These suggested adjustments totaled $209.1 million and principally related to differences in the estimation of losses and loss adjustment expense reserves and the estimate of the allowance for uncollectible receivables. The adjustments proposed by Zenith reflect Zenith's position that the aggregate value of the liabilities assumed by Zenith exceeded the value of the assets transferred by as much as $68.0 million. Zenith subsequently proposed approximately $2.5 million in additional adjustments, increasing the total adjustments proposed by Zenith to approximately $211.6 million. RISCORP believes that, pursuant to the terms of the Asset Purchase Agreement, it is impermissible for Zenith to assert these additional proposed adjustments. The parties have engaged a nationally recognized independent accounting firm to serve as neutral auditors and neutral actuaries to resolve the items in dispute related to the determination of the final purchase price. Pursuant to the terms of this engagement, each party has delivered two written submissions to the neutral auditors and neutral actuaries setting forth each party's analysis of the issues in dispute and have 12 responded to various questions raised by the neutral auditors and neutral actuaries in analyzing these issues. In addition, the neutral auditors and neutral actuaries have requested written responses from both RISCORP and Zenith to numerous questions raised in connection with their review of the disputed issues. Based on RISCORP's review of the submissions tendered by Zenith, RISCORP has agreed to aggregate adjustments to the Proposed Business Balance Sheet of $971,323. These adjustments were recorded in the June 30, 1998 Consolidated Statements of Operations and in the accompanying Consolidated Statements of Operations for the nine months ended September 30, 1998. In addition, these adjustments reduced the receivable from Zenith included in the Proposed Business Balance Sheet from $141,054,796 to $140,083,473. RISCORP believes that the other adjustments proposed by Zenith are without merit and RISCORP intends to vigorously dispute each such proposed adjustment in connection with the determination of the final purchase price to be paid by Zenith. Notwithstanding the foregoing, if Zenith should prevail in the dispute resolution process, it is possible that the final purchase price for this transaction could be the $35.0 million already received by RISCORP. In connection with the closing of this transaction, the parties entered into a letter agreement dated April 1, 1998, pursuant to which RISCORP retained certain assets necessary for each of its insurance subsidiaries to maintain the minimum capital and surplus required by law to remain in good standing in the State where each company is located (the "Definite Exclusions"). In accordance with the provisions of this letter agreement, RISCORP's insurance subsidiaries retained marketable securities with carrying values of $11.4 million as of April 1, 1998. Zenith has disputed RISCORP's determination of the amount of minimum capital and surplus required to be retained by it pursuant to the letter agreement. In addition to the minimum capital and surplus amounts, in the event that RISCORP is unable to transfer to Zenith (i) certain certificates of deposit and securities held by regulatory authorities, (ii) the stated capital of the selling entities other than the insurance subsidiaries, or (iii) certain certificates of deposit and securities held in trust under certain reinsurance agreements prior to the date that Zenith is required to pay the final purchase price, such assets, at Zenith's option and in its sole discretion, shall be deemed not to be transferred to Zenith (the "Possible Exclusions"). As of September 30, 1998, the amortized cost of such certificates of deposit and securities that were still in process of being transferred to Zenith totaled $6,149,854. If the retention by RISCORP of the Definite Exclusions or any of the Possible Exclusions results in the value of the Transferred Liabilities exceeding the value of the Transferred Assets, the minimum purchase price specified in the Asset Purchase Agreement will be reduced. Pursuant to various provisions of the Asset Purchase Agreement, Zenith has provided notice to RISCORP of certain alleged breaches of the representations, warranties or covenants made by RISCORP therein. RISCORP has disputed the allegations asserted by Zenith and has also provided notice to Zenith of the occurrence of various indemnifiable events for which RISCORP believes it is entitled to seek indemnification from Zenith. In addition to disputes with respect to each party's right to be indemnified, RISCORP anticipates a dispute with Zenith with respect to its entitlement to the previously described security deposits held by various state insurance departments and other regulatory agencies that were not transferred to Zenith at closing. While it is impossible to predict the ultimate outcome of the issues currently in dispute with Zenith, RISCORP intends to vigorously defend all allegations asserted by Zenith with respect to these and other matters and intends to take such actions as it deems necessary to ensure that Zenith fully complies with its obligations under the Asset Purchase Agreement. (6) Comprehensive Income As of January 1, 1998, the Company adopted Statement of Financial Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). This Standard establishes new rules for the reporting and display of 13 comprehensive income and its components; however, the adoption of this standard had no impact on the Company's net income or shareholders' equity. In addition to certain other adjustments, SFAS 130 requires unrealized gains or losses on the Company's available for sale securities, which prior to adoption were reported separately in shareholders' equity to be included in other comprehensive income. The components of comprehensive income, net of related income taxes, for the nine months ended September 30, 1998 and year ended 1997, respectively are as follows (in thousands):
1998 1997 ------------- ------------- Net (loss) income $ (17,261) $ 1,479 Unrealized gains (losses) on securities available for sale: Unrealized holding gains (losses) during the period 40 (1,555) Reclassification adjustment for realized gains included in net earnings 4,268 - Comprehensive loss $ (12,953) $ (76)
(7) Reclassifications Certain amounts in the financial statements presented have been reclassified from amounts previously reported in order to be comparable between periods. These reclassifications have no effect on previously reported shareholders' equity or net income during the periods involved. 14 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements This report contains statements that constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. The words "believe," "estimate," "intend," "anticipate," and similar expressions and variations thereof identify certain of such forward-looking statements, which speak only as of the dates of which they were made. RISCORP undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those indicated in the forward-looking statements as a result of various factors. Readers are cautioned not to place undue reliance on these forward-looking statements, which are subject to a number of risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include but are not limited to the following: (I) uncertainties with respect to the final purchase price to be paid by Zenith under the Asset Purchase Agreement; (ii) the value of the transferred assets and the transferred liabilities; (iii) the ability of RISCORP to recover any amounts from Zenith as a result of the occurrence of indemnifiable events; (iv) Zenith's ability to recover from RISCORP certain assets not transferred to it at closing or Zenith's ability to prevail with respect to its claims against RISCORP alleging the occurrence of various indemnifiable events; (v) projections of revenues, income, losses and cash flows related to operations; (vi) estimates concerning the effects of litigation or other disputes; and (vii) other risks detailed herein and from time to time in RISCORP's other reports and filings with the Securities and Exchange Commission. Recent Developments Asset Purchase Agreement with Zenith See Part 1, Item 1, Notes to Consolidated Financial Statements, Note 5 for further discussion of the Zenith transaction. Legal Developments See "Part II, Item 1, Legal Proceedings." Overview General As discussed more fully in Note 5, the Company and certain of its subsidiaries sold substantially all of their assets and transferred certain liabilities to Zenith on April 1, 1998. In connection with this sale to Zenith, the Company and its subsidiaries ceased substantially all of its former business operations, including its insurance operations, effective April 1, 1998. Accordingly, after April 1, 1998, the operations of the Company consisted primarily of the administration of the day-to-day activities of the surviving corporate entities, compliance with the provisions of the Asset Purchase Agreement, and the investment, protection and maximization of the remaining assets of the Company. Since April 1, 1998, the Company has had no employees or insurance operations, and has provided no services to self-insurance funds or other insurance related entities. Because of these significant changes in the 15 operating activities of the Company after April 1, 1998, a comparison of the results of operations for the three months and nine months ended September 30, 1998 to the comparable period in 1997 is meaningless. Therefore, the results of operations for the three months and six months ended September 30, 1998 are explained separately with no comparison to the comparable prior periods. The results of operations of the Company prior to the April 1, 1998 sale to Zenith, compared to the comparable period in 1997 are included to comply with the requirements of the Securities Exchange Act of 1934, as amended, and the rules and regulations of the Securities and Exchange Commission; however, those results of operations are not indicative of the operations of the Company since April 1, 1998 and are not indicative of the anticipated future operations by the Company. Results of Operations April 1, 1998 to September 30, 1998 During the three months ended September 30, 1998, the Company's primary operating activities were the defense of the Proposed Business Balance Sheet, the investment of the $25.0 million initial payment received from Zenith on April 2, 1998, the investment of other invested assets retained by the Company, compliance with the provisions of the Asset Purchase Agreement and the administration of the day-to-day activities of the surviving corporate entities. Compliance with the provisions of the Asset Purchase Agreement included the transfer of all of the assets and liabilities, not retained by the Company, to Zenith, and assisting with the orderly transition of the Company's insurance operations to Zenith. At September 30, 1998, the Company had investments totaling approximately $26.6 million, of which approximately $6.2 million consisted of securities to be transferred to Zenith. Those securities were primarily regulatory deposits and securities held in trust in connection with certain reinsurance agreements. The Company is awaiting the release of the securities by the regulatory agencies and the reinsurers. Upon their release, the securities will be transferred to Zenith in accordance with the terms of the Asset Purchase Agreement. A liability was recorded as of September 30, 1998 for the transfer of these securities to Zenith. The following is an analysis of other balances contained on the September 30, 1998 balance sheet. Restricted cash and cash equivalents consisted primarily of the $10.0 million initial purchase price payment which is being held in escrow under the terms of the Asset Purchase Agreement. The Receivable from Zenith in the amount of $105.1 million represents the remaining purchase price to be received from Zenith as determined by the Company in connection with the preparation of the Proposed Business Balance Sheet. Deferred income taxes of $23.4 million consisted of federal and state income taxes that are anticipated to be recovered in future years. At this time, this asset is expected to be fully recoverable. Other assets of $8.8 million consisted primarily of $4.8 million of certain insurance recoverables which will be received when the accrued legal settlements discussed below are actually paid, and $3.7 million of accrued investment income. Prepaid expenses of $5.4 million consisted primarily of prepaid insurance coverages $4.3 million and retainers paid to certain professionals and consultants of $1.1 million. 16 Accounts receivable-other of $2.6 million consisted primarily of a receivable of $2.3 million which will be realized upon the redemption of the Company's outstanding stock. Accrued expenses and other liabilities totaled approximately $33.5 million and consisted primarily of $20.5 million of an accrued legal settlement, $1.0 million of trade accounts payable, $0.7 million of unpaid restructuring cost relating to the June 1997 Corporate restructuring, $1.7 million of accrued legal, accounting, auditing and actuarial expenses that primarily relate to the defense of the Proposed Business Balance Sheet, $2.9 million of consulting expenses relating to a tax gross up payment for a previous stock award, $1.8 million of income taxes payable and $4.9 million of other accruals and payables. The Company's operating results for the six months ended September 30, 1998 resulted in a net loss of $7.9 million. The following is an analysis of the Company's revenues and expenses for the six months ended September 30, 1998. Net realized gains for the six months ended September 30, 1998 were $2.8 million. The net realized gains consisted primarily of gains on the sale of securities transferred to Zenith in connection with the Asset Purchase Agreement. For the nine months ended September 30, 1998, net realized gains were $4.3 million, of which $1.3 million was the gain on the sale of Third Coast recognized in the first quarter of 1998, more fully discussed in Note 2 of the consolidated financial statements contained in this document. Realized gains or losses during the first three quarters of 1997 were $0.4 million. Investment income for the three months and the nine months ended September 30, 1998 and 1997 consisted entirely of earnings from the investment portfolio, excluding unrealized gains & losses. Net investment income for the six months ended September 30, 1998 was $4.8 million. Net investment income consisted of interest income on the $105.1 million receivable from Zenith of $3.2 million, interest income on the $10.0 million balance in escrow of $0.3 million and other investment income of $1.3 million. Operating expenses for the six months ended September 30, 1998 totaled approximately $15.4 million. This amount included three significant non-recurring expenses that arose due to the sale to Zenith. The first non-recurring expense totaled approximately $3.4 million and consisted of severance payments to certain of the Company's former executives and employees. The second expense totaled approximately $4.1 million and consisted of the issuance of RISCORP stock to Phoenix Management Company, Ltd. ("Phoenix") in accordance with a Restricted Stock Award Agreement. The third expense totaled approximately $2.9 million and represented a payment for a tax gross up related to the issuance of the restricted stock award to Phoenix. The remaining $5.0 million of operating expenses consisted of $0.3 million of transition expenses incurred as a result of the sale to Zenith; $1.0 million of adjustments to the Proposed Business Balance Sheet (discussed more fully in Note 5); $0.6 million of management expenses; $0.7 million of accounting and auditing expenses; $1.1 million of recurring operating expenses such as rent, telephone, insurance and similar costs and $1.3 million of other expenses. In September 1998, the Company received a reimbursement of approximately $1.2 million of legal fees incurred in 1997 and 1998 in connection with payments made on behalf of certain former officers and directors of the Company. This reimbursement was included as a reduction in commission, underwriting and administrative expenses in the accompanying consolidated statement of operations for the three months ended September 30, 1998. 17 Depreciation and amortization expense for the six months ended September 30, 1998 was $0.3 million. The Company transferred all assets subject to amortization to Zenith in connection with the sale and retained approximately $0.4 million of fixed assets (consisting primarily of computer equipment) which is being depreciated over three years. Interest expense for the six months ended September 30, 1998 was $0.2 million. The Company remains liable under one note agreement in the amount of $0.2 million through November 1998. This note bears interest at 14.85%. Net investment income for the nine months ended September 30, 1998 was $7.9 million compared to $12.1 million for the same period in 1997, a net decrease of $4.2 million. The decline in investment income was due to a decline in invested assets (including the receivable from Zenith) of approximately $77.5 million for the nine month period ended September 30, 1998 compared to the same period in 1997. The decrease in invested assets was primarily due to the sale to Zenith and the decline in written premiums as discussed below. The effective tax rate for the nine months ended September 30, 1998 was 0 percent compared to 40.6 percent for the same period in 1997. The decline in the tax rate was primarily due to the Company's uncertainty of its ability to recover the tax benefit pertaining to losses incurred after April 1, 1998. The weighted average common and common share equivalents outstanding for the three months ended September 30, 1998 was 36,062,558 versus 36,868,114 for the three months ended September 30, 1997. Prior to April 1, 1998 The discussion that follows relates to the operations and operating philosophy of the Company's activities which existed prior to April 1, 1998 and includes the results for the three months ended September 30, 1997 and the nine months ended September 30, 1998 compared to the nine months ended September 30, 1997. Prior to 1996, the Company's at-risk operations were focused in Florida. During 1996, the Company acquired RISCORP National Insurance Company ("RNIC") and its 19 licenses and assumed business from several self insurance funds outside of Florida which allowed the Company to diversify its at-risk operations. A comparison of the Company's direct written premiums for the nine months ended September 30, 1998 and the calendar year ended December 31, 1997, 1996 and 1995 (prior to reinsurance cessions or assumptions) by state is presented below: Direct Premiums Written (a) (Ddollars in millions) 1998 (b) 1997 1996 1995 Florida $ 29.2 $ 180.8 $ 270.8 $ 284.8 Alabama 4.1 39.1 21.7 -- North Carolina 4.4 32.2 41.4 -- Other 1.0 28.4 22.8 -- --------- --------- --------- -------- Total $ 38.7 $ 280.5 $ 356.7 $ 284.8 ======= ======= ======= ======= (a) Includes RIC, RPC and RNIC for 1996, RIC and RPC for 1995. (b) 1st quarter 1998, prior to the sale to Zenith. Direct written premiums were reduced by specific reinsurance cessions (1996 and 1995), the 50 percent AmRe quota share reinsurance agreement for the Company's Florida workers' compensation business (1996 and 1995) and the 65 percent quota share reinsurance agreement (effective October 1, 1996), with another reinsurer for certain non-Florida business. This 18 quota share reinsurance agreement was reduced to 60 percent effective January 1, 1997 and was cancelled on a run-off basis on December 31, 1997. The majority of the Company's premiums were written in Florida, a regulated pricing state where premiums for guaranteed cost products were based on state-approved rates. However, prior to the sale to Zenith, the Company also offered policies which were subject to premium reductions as high deductible plans, participating dividend plans, or other loss sensitive plans. Pricing for these plans tended to be more competitively based, and the Company experienced increased competition during 1997 and 1998 in pricing these plans. In addition, in October 1996, the Florida Insurance Commissioner ordered workers' compensation providers to reduce rates by an average of 11.2 percent for new and renewal policies written on or after January 1, 1997. Concurrently, with the premium reduction effective January 1, 1997, the 10 percent managed care credit was phased out. This credit had been offered since 1994 to employers who met certain criteria for participating in a qualified workers' compensation managed care arrangement. In addition, on October 9, 1997, Florida further reduced premium rates by 1.7 percent for new and renewal policies written on or after January 1, 1998. The State of North Carolina approved a 13.7 percent decrease in loss costs effective April 1, 1997. The Company adopted the loss costs in October 1997, which resulted in an overall effective rate reduction of 8.4 percent. The Company experienced increased pricing pressures during 1997. During 1997, the Company made the strategic decision to discontinue writing business owners' protection, commercial multiple peril and auto and focus on its core workers' compensation business. Net written premiums on these lines of business were less than $1.0 million during 1997 and were less than $0.5 million in 1996. In addition, in June 1997, the Company implemented a strategic plan to consolidate several of its field offices and announced its intention to close all field offices, except Charlotte, North Carolina, and Birmingham, Alabama, by the end of 1997, and to cease writing new business in certain states including Oklahoma, Virginia, Missouri, Mississippi, Louisiana and Kansas. The estimated impact of the decision to discontinue writing business in those states was a reduction of approximately $16.0 million in direct premiums written. The Company attempted to lower claims costs by applying managed care techniques and programs to workers' compensation claims, particularly by providing prompt medical intervention, integrating claims management and customer service, directing care of injured employees through a managed care provider network, and availing itself of potential recoveries under subrogation and other programs. Part of the Company's claims management philosophy was to seek recoveries for claims which were reinsured or which could be subrogated or submitted for reimbursement under various states' recovery programs. As a result, the Company's losses and loss adjustment expenses were offset by estimated recoveries from reinsurers under specific excess of loss and quota share reinsurance agreements, subrogation from third parties and state "second disability" funds, including the Florida Special Disability Trust Fund ("SDTF"). 19 The following table shows direct, assumed, ceded and net earned premiums by quarter for 1998 and 1997 (in thousands):
Three Months Ended ----------------------------------------------------------------------------------- 9-30-98 6-30-98 3-31-98 3-31-97 6-30-97 9-30-97 12-31-97 ----------- ---------- ---------- ----------- ----------- ---------- ----------- Direct premiums earned $ $ $ 48,416 $ 91,516 $ 91,761 $ 77,169 $ 67,800 0 0 Assumed premiums earned 0 0 79 2,827 2,064 1,118 12,500 Premiums ceded to reinsurers 0 0 (22,676) (47,529) (47,173) (37,870) (34,700) Net premiums earned $ 0 $ 0 $ 25,819 $ 46,814 $ 46,652 $ 40,417 $ 45,600 ============ ============ ======== ======== ======== ======== ========
The number of inforce policies were: Quarter Ended 1996 1997 1998 March 31 22,777 30,141 18,145 June 30 26,002 29,602 0 September 30 28,772 25,649 0 December 31 30,081 22,357 N/A The decrease in direct earned premiums for the last six months of 1997 and the first quarter of 1998 was primarily due to the decrease in new and renewal premiums that the Company experienced in the second, third and fourth quarters of 1997 from the adverse publicity pertaining to the A.M. Best ratings of the Company's insurance subsidiaries, the Company's inability to file its 1996 Form 10-K, 1997 10-Q's and 1996 audited statutory financial statements in a timely manner, and the delisting of the Company's stock by NASDAQ. This is illustrated by the decrease in direct premiums earned of $77.2 million for the three months ended September 30, 1997 from $84.2 million for the same period in 1996, a net decrease of $7.0 million. Direct premiums earned increased to $260.4 million for the nine months ended September 30, 1997 from $236.4 million for the same period in 1996, a net increase of $24.0 million. The increase in the direct premiums earned for the nine months ended September 30, 1997 was primarily the result of the following factors: The infusion of approximately $68.9 million of capital into the Company's insurance subsidiaries from the initial public offering ("IPO") proceeds allowed the insurance subsidiaries to increase their premium writing capacity and, as a result, the Company was able to increase premiums during the last nine months of 1996 due to its expanded premium writing capabilities. Written premiums were earned pro rata over the policy period (usually 12 months) therefore, increased premiums written during the last nine months of 1996 had a positive impact on earned premiums in 1996 and 1997. Written premiums increased in the third and fourth quarters of 1996 and the first quarter of 1997 from the assumption reinsurance and loss portfolio agreements entered into by the Company and from the acquisitions made by the Company during 1996. Enhanced marketing initiatives implemented by the Company after the IPO to increase the number of policies and to write accounts with larger premiums. In September 1995, the Company entered into a fronting agreement with another insurer which enabled the Company to begin expansion into states where its insurance subsidiaries were not licensed. The fronting agreement was cancelled effective December 31, 1997. The cancellation of the fronting agreement and the sale to Zenith were the primary reasons that the assumed premiums decreased to $79 from $6,009 for the nine months ended September 30, 1998 from the same period in 1997. The increase in assumed premiums earned during the fourth quarter of 1997 from previous quarters was primarily the result of the Company recording $11.4 million of earned premiums from the National Council on Compensation Insurance, Inc. ("NCCI") pool participation. The assumed 20 premiums from the fronting agreement were approximately $1.1 million and $2.4 million for the three months ended September 30, 1997 and September 30, 1996, respectively. While the company assumed premiums from several insurers, the fronting agreement generated the majority of the assumed premiums. For the years ended December 31, 1997 and 1996, the Company ceded approximately 50 percent of its Florida premiums to AmRe under a quota share reinsurance agreement and 60 percent of the business written by RNIC under a separate quota share agreement (65 percent during 1996) with Chartwell. The Company terminated the agreement with Chartwell at December 31, 1997; however, the reinsurer continues to receive premiums and to be responsible for their portion of all losses incurred on policies effective before the termination date. The decrease in ceded premiums to $22.7 million for the nine months ended September 30, 1998 from $132.6 million for the same period in 1997 was due primarily to the decrease in direct premiums earned discussed above. Fee income for the nine months ended September 30, 1998 was $5.7 million compared to $18.0 million for the same period in 1997, a net decrease of $12.3 million. The decrease in fee income was primarily due to sale of the insurance operations to Zenith. Fee income for the first quarter of 1998 was comparable to fee income for the first quarter of 1997. Fee income for the three months ended September 30, 1997 was $7.0 million compared to $7.1 million for the same period in 1996, a net decrease of $0.1 million. The decrease between 1996 and 1997 was primarily due to the loss of service fees from the conversion of the National Alliance for Risk Management ("NARM") self insurance funds of North Carolina and Virginia (which were previously managed by the Company) to at-risk business via loss portfolio transfers and decreases in RISCORP West Incorporated ("RWI") service fee income from the termination of RWI's Mississippi and Louisiana service contracts. The decrease in fee income was partially offset by new fees generated from the CompSource acquisition, the fronting agreement, the new service agreement with Third Coast Insurance Company and growth in other existing fee products. Realized gains or losses during the third quarter of 1997 were $55,097 and $380,524 for the nine months ended September 30, 1997. Investment income for the nine months ended September 30, 1997 was $12.6 million compared to $7.6 million for the same period in 1996, a net increase of $5.0 million. Investment income consists entirely of earnings from the investment portfolio, excluding realized gains and losses. The actual yield on invested assets is comparable between quarters. The loss ratio for the nine months ended September 30, 1998, 1997 and 1996 was 93.0 percent, 65.1 percent and 67.9 percent, respectively. The increase in the 1998 loss ratio of 27.9 percent was due primarily to adverse gross loss development during the first quarter of 1998 in the 1997 and prior accident years from certain business written in Florida of approximately $10.3 million, gross favorable loss development in Alabama and North Carolina of approximately $2.6 million and gross adverse loss development of $0.3 million in business written by RNIC and RPC in several smaller states. The increase in the 1997 loss ratio was due to adverse loss development in 1996 and prior accident years from certain business written in Alabama of approximately $4.0 million, adverse loss development of approximately $1.8 million in certain business written by RNIC in several smaller states, and favorable loss development of $2.5 million from business written in North Carolina. Losses and loss adjustment expenses for the nine months ended September 30, 1997, were $87.1 million compared to $89.5 million for the same period in 1996, a net decrease of $2.4 million, which is considered comparable. Unallocated loss adjustment expenses for the nine months ended September 30, 1997, were $11.3 million compared to $9.2 million for the same period in 1996, a net increase of $2.1 million. This increase was primarily due to the increased premium volume, increased loss reserves during this period and unfavorable loss development. The unallocated loss adjustment expense ratio for the nine months ended September 30, 1998, 1997 and 1996 21 was 9.9 percent, 7.9 percent and 6.6 percent, respectively. The 9.9 percent ratio at March 31, 1998 is comparable to the December 31, 1997 year to date ratio of 10.7 percent. The 1.2 percent increase in the 1997 ratio was primarily due to increased personnel and personnel related costs. Commissions, general and administrative expenses for the three months ended September 30, 1998 are discussed above. Such expenses for the three months ended March 31, 1998 were $15.5 million compared to $14.4 million for the same period in 1997. The net increase of $1.1 million from 1997 to 1998 was primarily attributable to a $4.3 million decrease in personnel expenses, a $4.4 million increase in legal and consulting expenses, and a $1.0 million increase in premium taxes, agents commissions, ceding commission income and underwriting expenses. Commissions, underwriting and administrative expenses for the three months ended September 30, 1997 were $15.3 million compared to $13.2 million for the same period in 1996, a net increase of $2.1 million. In addition, such costs were $14.4 million for the three months ended March 31, 1997. During the second quarter of 1997 the Company recorded a charge to earnings of $5.9 million in connection with the workforce reduction and restructuring. This non-recurring charge consisted of $5.1 million of personnel expenses (primarily severance costs), $0.7 million of occupancy costs (primarily lease cancellations) and $0.1 million of other restructuring costs. These restructuring costs were included in the accompanying financial statements with commissions, underwriting and administrative expenses. The remaining net increase of $3.0 million ($8.9 million including the restructuring charges) from 1996 to 1997 is attributable to increases in commissions, premium taxes and personnel costs caused by higher premiums generated from acquisitions and new and renewal premium growth, increased operating expenses from the addition of employees and increases in legal expenses from actions initiated in 1996. The Company's total employees were 0, 619 and 805 at September 30, 1998, 1997 and 1996, respectively. Interest expense for the nine months ended September 30, 1997 was $1.4 million compared to $2.1 million for the same period in 1996. The decrease was due to the repayment of approximately $28.6 million of debt in March 1996 using the proceeds from the initial public offering. Depreciation and amortization expense for the nine months ended September 30, 1997 and 1996 were $6.3 million. The amortization expense for the nine months ended September 30, 1996 contained an impairment loss of $2.7 million related to the goodwill reported in connection with the purchase of SISB. The effective tax rate for the nine months ended September 30, 1997 was 40.6 percent compared to 42.1 percent for the same period in 1996. The weighted average common and common share equivalents outstanding for the three months ended September 30, 1997 was 36,868,114 versus 37,485,691 for the three months ended September 30, 1996. The weighted average common shares outstanding for the nine months ended September 30, 1997 and 1996 were 37,331,665 and 35,720,088, respectively. The increase in the weighted average number of shares for the nine months ended September 30, 1997, was due primarily to the inclusion of the shares issued in connection with the February 29, 1996 IPO for the entire first, 22 second and third quarters of 1997 versus inclusion of such shares for only seven months for the first, second and third quarters of 1996, and the inclusion of certain contingent shares reserved for issuance in connection with the acquisitions of CompSource and IAA, as more fully discussed in Note 3 of the consolidated financial statements included in this document. The increase was partially offset by a decrease in common stock equivalents for option shares assumed to be exercised. Liquidity and Capital Resources The Company has historically met its cash requirements and financed its growth through cash flow generated from operations and borrowings. The Company's primary sources of cash flow from operations were premiums and investment income, and its cash requirements consisted primarily of payment of losses and loss adjustment expenses, support of its operating activities including various reinsurance agreements and managed care programs and services, capital surplus needs for its insurance subsidiaries, and other general and administrative expenses. As discussed more fully in Note 5, the Company and certain of its subsidiaries sold substantially all of their assets and transferred certain liabilities to Zenith in exchange for cash on April 1, 1998. In connection with this sale to Zenith, the Company and its subsidiaries ceased substantially all of its former business operations and, accordingly, after April 1, 1998, the Company's primary source of cash flow will be generated from investment income. The Company's future cash requirements will be satisfied through investment income and the liquidation of investments. Cash flow from operations for the nine months ended September 30, 1998 and 1997 was $(33.7) million and $(24.2) million, respectively. The decrease from January 1, 1998 to September 30, 1998 was due primarily to reductions in unearned premiums resulting from a decrease in direct premiums written and increases in losses and loss adjustment expenses, unallocated loss adjustment expenses and commissions, underwriting and administration expenses in relation to premiums earned during the first quarter of 1998 and due to the expenses related to the sale to Zenith. These expenses included severance payments to certain employees, the payment of accrued employee benefits and the payment of other expenses related to the sale. The Company has projected cash flows through December 1998 and believes it has sufficient liquidity and capital resources to support its operations. As of September 30, 1998 and 1997, the Company's insurance subsidiaries had combined statutory capital and surplus of approximately $134.9 million and $92.6 million, respectively. The individual capital and surplus of each of the Company's insurance subsidiaries exceeded the minimum statutory capital and surplus required by their state of domicile. In addition, the liquidity of the Company could be materially adversely affected if Zenith should prevail in the dispute resolution process with respect to the determination of the final purchase price, as well as by certain legal issues or any material delay in the Company's receipt of the final payment of the ultimate purchase price determined to be payable by Zenith. See "Sale to Zenith," "Legal Proceedings" and "Recent Developments." The National Association of Insurance Commissioners has adopted risk-based capital standards to determine the capital requirements of an insurance carrier based upon the risks inherent in its operations. The standards, which have not yet been adopted in Florida, require the computation of a risk-based capital amount which is then compared to a carrier's actual total adjusted capital. The computation involves applying factors to various financial data to address four primary risks: asset risk, insurance underwriting risk, credit risk, and off-balance 23 sheet risk. These standards provide for regulatory intervention when the percentage of total adjusted capital to authorized control level risk-based capital is below certain levels. At September 30, 1998 and December 31, 1997, the Company's insurance subsidiaries' statutory surplus was in excess of any risk-based capital action level requirements. Year 2000 Effective April 1, 1998, RISCORP ceased substantially all of its former business operations, including its core insurance and managerial services operations. As more fully described above, the Company and certain of its subsidiaries entered into an Asset Purchase Agreement for the sale of substantially all of the assets and the assumption of certain liabilities to Zenith in exchange for cash. RISCORP's computer systems and proprietary computer software, including the policy issue and management system and the claims systems, were included in the assets sold to Zenith. The computer programs retained by RISCORP to support its current operations are presently Year 2000 compliant. Part II Other Information Item 1. Legal Proceedings Between November 20, 1996 and January 31, 1997, nine shareholder class action lawsuits were filed against RISCORP, Inc. and other defendants in the United States District Court for the Middle District of Florida (the "Securities Litigation"). In March 1997, the court consolidated these lawsuits and appointed co-lead plaintiffs and co-lead counsel. The plaintiffs subsequently filed a consolidated complaint. The consolidated complaint named as defendants RISCORP, Inc., three of its executive officers, one non-officer director and three of the underwriters for RISCORP, Inc.'s initial public offering. The plaintiffs in the consolidated complaint purport to represent the class of shareholders who purchased RISCORP, Inc. Class A Common Stock between February 28, 1996 and November 14, 1996. The consolidated complaint alleges that RISCORP, Inc.'s Registration Statement and Prospectus of February 28, 1996, as well as subsequent statements, contained false and misleading statements of material fact and omissions, in violation of sections 11 and 15 of the Securities Act and sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder. The consolidated complaint seeks unspecified compensatory damages. Pursuant to court ordered mediation, counsel for the parties have engaged in discussions in an effort to resolve the Securities Litigation. On January 14, 1998, counsel for the Company, counsel for William D. Griffin and counsel for the plaintiffs reached an oral agreement on terms to recommend to their clients to settle this litigation. This agreement was confirmed in a written Memorandum of Understanding executed by counsel for the respective parties as of April 29, 1998. The proposed settlement is contingent upon the following: execution of a definitive settlement agreement and implementing pleadings and other documentation; consummation of the transactions contemplated by the Purchase Agreement with Zenith; disclosure of certain documents to plaintiff's counsel and interviews by them of various individuals to verify information relating to the settlement; certification of a settlement class; satisfaction of all requirements for settlement under Rule 23 of the Federal Rules of Civil Procedures; payment by RISCORP of $21.0 million into a settlement fund for the benefit of the settlement class; and release by members of the settlement class of all claims against the defendants. Counsel to the parties are in the process of finalizing the initial settlement documents. The initial settlement documents have been finalized and the appropriate pleadings filed with the court. On July 29, 1998, the court issued a Preliminary Approval Order in which it certified the purported class for settlement purposes and scheduled a Settlement Fairness Hearing for October 8, 1998. Through no fault of the Company, approximately 350 members of the class did not receive timely notice and the Settlement Fairness Hearing has been rescheduled for December 15, 1998. 24 The Company estimates that $8.0 million of insurance proceeds will be available for contribution to the settlement amount, as well as related costs and expenses. The Company recognized the $21.0 million proposed settlement and the related insurance proceeds in the December 31, 1997 financial statements. Given the preliminary nature of this settlement and the various contingencies relating to its consummation, there can be no assurance that this litigation will be ultimately settled on this basis. On August 20, 1997, Occupational Safety Association of Alabama Workers' Compensation Fund (the "Fund") filed a breach of contract and fraud action against the Company and others. The Fund is an association of self-insured employers who agreed to transfer, in a Loss Portfolio Transfer Agreement (the "Agreement") dated August 26, 1996, substantially all of its assets and liabilities to the Company. Co-defendant, Peter D. Norman, was a principal and officer of IAA. The complaint alleges that Norman and IAA breached certain fiduciary duties owed to the Fund in connection with the subject agreement and transfer. The complaint alleges that the Company has breached certain provisions of the Agreement and owes the Fund monies under the terms of the Agreement. The Fund claims, per a Loss Portfolio Evaluation dated February 26, 1998, that the Fund overpaid RISCORP by approximately $6.0 million in the subject transaction. The court has granted defendant's Motion to Compel Arbitration per the terms and provisions of the Agreement. The other defendants, including IAA, have appealed the trial court's denial of their motions to compel arbitration. These appeals are pending before the Alabama Supreme Court. Assuming mediation fails, the dispute between the Company and the Fund will be resolved through arbitration. The Company intends to vigorously defend this claim, and believes that application of appropriate accounting and actuarial principles and methodologies to the calculation at issue may indicate that monies are instead owed to the Company by the Fund. On or about April 13, 1998, the Fund filed a Motion for Preliminary Injunction which seeks to enjoin the Company from distributing any dividends or making any type of distributions to shareholders, withdrawing any proceeds from the escrow account established with certain proceeds received from Zenith, or dissolving the Company. Although somewhat confusing, the motion appears to be based on the failure of the Company to specifically identify this lawsuit in its proxy statement issued in connection with the sale to Zenith. The motion was denied on June 12, 1998. In June 1997, the Company terminated a number of employees in connection with the workforce reduction. As a result of the workforce reduction and the sale to Zenith, a number of former employees have initiated proceedings, including arbitration, against the Company for certain severance benefits. The Company intends to vigorously defend these suits; however, there can be no assurance that it will prevail in these proceedings. On March 13, 1998, RIC and RISCORP Property & Casualty Insurance Company ("RPC") were added as defendants in a purported class action filed in the United States District Court for the Southern District of Florida, styled Bristol Hotel Management Corporation, et. al., v. Aetna Casualty & Surety Company, a/k/a Aetna Group, et. al. Case No. 97-2240-CIV-MORENO. The plaintiffs purport to bring this action on behalf of themselves and a class consisting of all employers in the State of Florida who purchased or renewed retrospectively rated or adjusted workers' compensation policies in the voluntary market since 1985. The suit was originally filed on July 17, 1997, against approximately 174 workers' compensation insurers as defendants. The complaint was subsequently amended to add the RISCORP defendants. The amended complaint named a total of approximately 161 insurer defendants. The suit claims that the defendant insurance companies violated the Sherman Antitrust Act, the Racketeer Influenced and Corrupt Organizations Act ("RICO"), the Florida Antitrust Act and committed breach of contract, civil conspiracy and were unjustly enriched by unlawfully adding improper and illegal charges and fees onto 25 retrospectively rated premiums and otherwise charging more for those policies than allowed by law. The suit seeks compensatory and punitive damages, treble damages under the Antitrust and RICO claims, and equitable relief. RIC and RPC moved to dismiss the amended complaint and also adopted certain motions to dismiss the amended complaint filed by various other defendants. On August 26, 1998, the district court issued an order dismissing the entire suit against all defendants. The plaintiffs filed a motion to reconsider the dismissal order, which was denied by Judge Moreno on September 10, 1998. Most recently, on September 13, 1998, the plaintiffs filed a Notice of Appeal. Management will continue to monitor the progress of the appeals process as necessary. The Company, in the normal course of business, is party to various lawsuits which management believes will not materially affect the financial position of the Company. Based upon information presently available, and in light of legal and other defenses available to the Company, contingent liabilities arising from threatened and pending litigation are not presently considered by management to be material. However, no assurance can be given, or may be taken that material adverse judgments will not be rendered against the Company as a result of the aforementioned matters. Other than as noted above, no provision had been made in the Company's financial statements for the above matters at December 31, 1997 and 1996. In addition, certain of the lawsuits and related legal expenses may be covered under directors and officers' insurance coverage maintained by the Company. During February 1998, the FDOI completed an examination of the statutory books and records of RIC and RPC as of December 31, 1996. The FDOI issued a final report on the December 31, 1996 examination of RIC and RPC on October 16, 1998. There were no adjustments to the capital and surplus of RPC and $3.5 million of adjustments which reduced the capital and surplus of RIC. The most significant examination adjustment to the capital and surplus of RIC was the non-admission by the FDOI examiners of $2.2 million of investments that were held by a bank outside of Florida. The remaining $1.3 million of adjustments related primarily to certain related party receivables that were either collected or charged to expense in 1997. These statutory adjustments have no material impact on the accompanying GAAP financial statements. The Company has historically met its cash requirements and financed its growth through cash flow generated from operations and borrowings. The Company's primary sources of cash flow from operations were premiums and investment income, and its cash requirements consisted primarily of payment of losses and loss adjustment expenses, support of its operating activities including various reinsurance agreements and managed care programs and services, capital surplus needs for its insurance subsidiaries, and other general and administrative expenses. As discussed more fully in Note 5, the Company and certain of its subsidiaries have sold substantially all of their assets and transferred certain liabilities to Zenith in exchange for cash on April 1, 1998. In connection with this sale to Zenith, the Company and its subsidiaries ceased substantially all of its former business operations and, accordingly, after April 1, 1998, the Company's primary source of cash flow will be generated from investment income. The Company's future cash requirements will be satisfied through investment income and the liquidation of investments. Item 2. Changes to Securities None. Item 3.Defaults Upon Senior Securities None. 26 Item 4.Submission of Matters to a Vote of Security Holders None. Item 5. Other Information Shareholder Proposals The proxy statement to be solicited by management of the Company with respect to the 1999 Annual Meeting of Shareholders will confer discretionary authority to vote on proposals of shareholders of the Company intended to be presented for consideration at such Annual Meeting that are submitted to the Company after May 14, 1999. Item 6.Exhibits and Reports on Form 8-K a) Exhibits 11 Statement Re Computation of Per Share Earnings 27 Financial Data Schedules b) Reports on Form 8-K The Company filed a Form 8-K on July 20, 1998 in connection with the consummation of the transactions contemplated in the Asset Purchase Agreement and the determination of the final purchase price, as described more fully in Part 1, Item 1 of this Form 10-Q. 27 SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. RISCORP, INC. (Registrant) By: /s/Walter E. Riehemann Walter E. Riehemann Senior Vice President and Secretary Date: November 16, 1998 By: /s/Edward W. Buttner, IV Edward W. Buttner IV, CPA Principal Accounting Officer Date: November 16, 1998 28 EX-11 2 RISCORP, INC. PER SHARE EARNINGS AS OF 9/30/98
Exhibit 11 RISCORP, INC. AND SUBSIDIARIES Statement Re. Computation of Per Share Earnings For the three months ended September 30, 1998 and 1997 (in thousands, except share and per share amounts) 1998 1997 --------------- ---------------- (Unaudited) (Unaudited) Net loss $ 1,698 $ 634 ============== =============== Weighted average common and common share equivalents outstanding: Average number of common shares outstanding 36,868,114 36,077,778 Redemption contingency for CompSource acquisition -- -- Redemption contingency for IAA acquisition -- 790,336 Restricted stock vested 194,444 -- Weighted average common shares outstanding - (basic) 37,062,558 36,868,114 Common stock equivalents--assumed exercise of stock options -- -- Weighted average common and common share equivalents outstanding - (diluted) 37,062,558 36,868,114 =========== =========== Net loss per common share--basic $ 0.05 $ 0.02 ================ ================ Net loss per common share--diluted $ 0.05 $ 0.02 ================ ================
Exhibit 11 RISCORP, INC. AND SUBSIDIARIES Statement Re. Computation of Per Share Earnings For the nine months ended September 30, 1998 and 1997 (in thousands, except share and per share amounts) 1998 1997 --------------- ---------------- (Unaudited) (Unaudited) Net (loss) income $ (17,261) $ 3,810 =============== ============== Weighted average common and common share equivalents outstanding: Average number of common shares outstanding 36,868,114 36,077,778 Redemption contingency for CompSource acquisition -- -- Redemption contingency for IAA acquisition -- 790,336 Restricted stock vested 81,019 -- Weighted average common shares outstanding - (basic) 36,949,133 36,868,114 Common stock equivalents--assumed exercise of stock options -- 263,922 Weighted average common and common share equivalents outstanding - (diluted) 36,949,133 37,331,665 ============ =========== Net (loss) income per common share--basic $ (0.47) $ 0.10 Net (loss) income per common share--diluted $ (0.47) $ 0.10
EX-27 3 FINANCIAL DATA SCHEDULE
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FINANCIAL STATEMENTS AS OF AND FOR THE PERIOD ENDED SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1000 9-MOS DEC-31-1998 SEP-30-1998 11,127 15,471 15,741 0 0 0 26,598 16,998 0 0 189,237 0 0 0 0 167 0 0 389 148,661 189,237 25,819 7,927 4,268 234 26,577 0 30,703 (17,072) 189 (17,261) 0 0 0 (17,261) (.47) (.47) 437,038 0 0 0 0 0 0 Net investment income is reported net of any realized gains and losses in the Statement of Income. Financial Data Schedule information for the year ending December 31, 1997 is incorporated by reference herein to FORM 10-K annual report as filed with the Securities and Exchange Commission by the Company on March 27, 1998. Amounts inapplicable or not disclosed as a separate line on the Statement of Financial Position or Results of Operations are reported as 0 herein.
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