-----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, NMJVbEvUjmvqxhq8VF3cCLObZLppVggwQFAm5g+1k/PHwQiDD9fbTO9jiWhZKiFQ NKCDpVzYZqAFshTM74z4cQ== 0000950150-98-000937.txt : 19980601 0000950150-98-000937.hdr.sgml : 19980601 ACCESSION NUMBER: 0000950150-98-000937 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 7 FILED AS OF DATE: 19980529 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: FINANCIAL PACIFIC INSURANCE GROUP INC CENTRAL INDEX KEY: 0001059803 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 680311660 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1/A SEC ACT: SEC FILE NUMBER: 333-50511 FILM NUMBER: 98634640 BUSINESS ADDRESS: STREET 1: PO BOX 292220 CITY: SACRAMENTO STATE: CA ZIP: 59829-2220 BUSINESS PHONE: 9166303800 MAIL ADDRESS: STREET 1: PO BOX 292220 CITY: SACRAMENTO STATE: CA ZIP: 59829-2220 S-1/A 1 AMENDMENT NO. 1 TO FORM S-1 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 29, 1998 REGISTRATION NO. 333-50511 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ AMENDMENT NO. 1 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ FINANCIAL PACIFIC INSURANCE GROUP, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 6331 68-0311660 (STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
3850 ATHERTON ROAD ROCKLIN, CA 95765 (916) 630-5000 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) ROBERT C. GOODELL PRESIDENT AND CHIEF EXECUTIVE OFFICER FINANCIAL PACIFIC INSURANCE GROUP, INC. 3850 ATHERTON ROAD ROCKLIN, CALIFORNIA 95765 (916) 630-5000 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) ------------------------ COPIES TO: JANIS B. SALIN, ESQ. MICHAEL J. CONNELL, ESQ. RIORDAN & MCKINZIE MORRISON & FOERSTER LLP 300 SOUTH GRAND AVENUE, 29TH FLOOR 555 W. FIFTH STREET, SUITE 3500 LOS ANGELES, CALIFORNIA 90071 LOS ANGELES, CALIFORNIA 90013 (213) 629-4824 (213) 892-5200
APPROPRIATE DATE OF COMMENCEMENT OF PROPOSED SALE OF THE SECURITIES TO THE PUBLIC: as soon as practicable after Registration Statement becomes effective. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [ ] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If the Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If delivery of the Prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. ================================================================================ 2 INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. PROSPECTUS Subject to completion, dated June , 1998 - -------------------------------------------------------------------------------- 2,500,000 SHARES (FINANCIAL PACIFIC LOGO) FINANCIAL PACIFIC INSURANCE GROUP, INC. Common Stock Of the shares of Common Stock offered hereby, 2,000,000 shares are being sold by the Company and 500,000 shares are being sold by the Selling Stockholders. The Company will not receive any proceeds from the sale of the shares by the Selling Stockholders. Prior to the Offering, there has been no public market for the Company's Common Stock. It is currently estimated that the initial public offering price will be between $9 and $11 per share. See "Underwriting" for information relating to the method of determining the initial public offering price. The Common Stock has been approved, subject to issuance, for quotation on the Nasdaq National Market under the symbol "FPAC". ------------------------------------ SEE "RISK FACTORS" BEGINNING ON PAGE 7 FOR CERTAIN INFORMATION THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED HEREBY. ------------------------------------ THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNDERWRITING PROCEEDS TO THE PRICE TO DISCOUNT AND PROCEEDS TO THE SELLING PUBLIC COMMISSION(1) COMPANY(2) STOCKHOLDERS - ------------------------------------------------------------------------------------------------------------------------- Per Share............ $ $ $ $ - ------------------------------------------------------------------------------------------------------------------------- Total(3)............. $ $ $ $ =========================================================================================================================
(1) See "Underwriting" for indemnification and other compensation arrangements with the Underwriters. (2) Before deducting expenses estimated at $700,000, which will be paid by the Company. (3) The Company has granted the Underwriters a 45-day option to purchase up to an aggregate of 375,000 additional shares to cover over-allotments, if any. If the option is exercised in full, the total Price to Public, Underwriting Discount and Proceeds to the Company will be $ , $ and $ , respectively. ------------------------------------ The shares of Common Stock are offered by the several Underwriters subject to receipt and acceptance by them and subject to their right to reject any order in whole or in part. It is expected that delivery of the shares of Common Stock will be made at the offices of EVEREN Securities, Inc. or through the facilities of the Depository Trust Company, New York, New York on or about June , 1998. EVEREN SECURITIES, INC. 3 (MAP OF UNITED STATES SHOWING STATES IN WHICH THE COMPANY IS LICENSED AND HAS LICENSE APPLICATIONS PENDING GOES HERE) Although the Company is licensed in all the states indicated, in 1997, 100% of its direct premiums written were produced in California. ------------------------ State insurance holding company statutes applicable to the Company generally prohibit any person from acquiring control of the Company, and thus, indirect control of its insurance subsidiary, without the prior approval of the appropriate insurance regulators. Generally, any person who acquires beneficial ownership of ten percent (10%) or more of the outstanding voting stock of the Company would be presumed to have acquired such control unless appropriate insurance regulators, upon application, determine otherwise. ------------------------ CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK INCLUDING THE PURCHASE OF THE COMMON STOCK FOLLOWING THE PRICING OF THE OFFERING TO COVER A SYNDICATE SHORT POSITION IN THE COMMON STOCK OR FOR THE PURPOSE OF MAINTAINING THE PRICE OF THE COMMON STOCK OR THE IMPOSITION OF PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING." ------------------------ 2 4 PROSPECTUS SUMMARY The following summary is qualified in its entirety by the more detailed information, including the consolidated financial statements and notes thereto, appearing elsewhere in this Prospectus. Unless the context otherwise indicates, the "Company" or "Financial Pacific" refers to Financial Pacific Insurance Group, Inc. (the "Group") and its consolidated subsidiaries including the Group's wholly owned insurance subsidiary, Financial Pacific Insurance Company ("FPIC"). Unless indicated otherwise, the information contained in this Prospectus (i) is presented in conformity with generally accepted accounting principles ("GAAP"); (ii) assumes the Underwriters' over-allotment option is not exercised; (iii) reflects a 394.375 for 1 stock split effected on April 14, 1998; (iv) assumes the conversion of all the outstanding shares of Series A Convertible Preferred Stock ("Series A Stock") into an aggregate of 1,735,251 shares of Common Stock of the Company (the "Common Stock"); and (v) assumes the exercise of certain outstanding Warrants, into an aggregate of 593,691 shares of Common Stock. Certain insurance terms used herein are defined in the "Glossary of Selected Insurance Terms." This Prospectus contains forward-looking statements that involve risks and uncertainties. Actual results could differ materially from those discussed in the forward-looking statements as a result of certain factors including those set forth under "Risk Factors" and elsewhere in this Prospectus. Prospective investors should carefully consider the information set forth under the heading "Risk Factors." THE COMPANY Financial Pacific is a regional, custom-underwriting insurance company. The Company writes policies for small and medium-sized commercial customers within specified niche markets which are typically overlooked by large insurance companies. During 1997, the Company derived direct premiums written from artisan contractors (40%), commercial property owners (5%), light industrial businesses (5%), a variety of other businesses (25%) and special programs (25%). The special programs were designed for refuse haulers, farm labor contractors, bowling centers and restaurants. For these programs, the Company has developed underwriting expertise and focused marketing materials and applies rate deviations or coverage extensions. The Company writes the vast majority of its business in rural markets in California. FPIC is currently rated A-(excellent) by A.M. Best Company ("A.M. Best"). Direct premiums written increased from $15.1 million in 1994, the Company's first full year of operation, to $39.5 million in 1997. Net income increased from $777,000 in 1994 to $2.3 million in 1997. The Company's combined ratio, which is a measure of underwriting profitability, was 92% in 1997, well below the industry average of 102%. Much of the Company's growth and profitability is attributable to its retention of renewal policies. Renewal retention rates were 81%, 83% and 84% in the three years ended 1995, 1996 and 1997, respectively. The Company markets insurance through 232 independent insurance agents, as of March 31, 1998, all of which are located in California. The Company believes its relationship with its agents allows it to provide ongoing and attentive service to its targeted customer base. The Company's strategy is to focus on writing policies that typically generate between $1,100 to $5,000 in annual premiums. These policies are typically written for small businesses having one to five employees and for medium-sized businesses having more than five but less than 50 employees. Management believes this market has been overlooked by many of the larger insurance companies as a result of lower annual premiums per policy, and in some cases, the remote locations of the policyholders and the agents. During 1997, FPIC wrote 100% of its business in California. In that year, approximately 58% of FPIC's direct premiums written was for Commercial Multi-Peril Liability ("CMP") coverages, 17% was for Commercial Automobile Liability coverages, 11% was for Commercial Property coverages, 6% was for Commercial Automobile Physical Damage coverages, and the remainder was for Inland Marine, Surety and Fidelity. The Company is also engaged, through its wholly owned insurance agency, Financial Pacific Insurance Agency ("FPIA"), in the mail order distribution of license and permit surety bonds in 36 states on behalf of Markel Corporation. These bonds are low limit surety commitments pledged to a regulatory agency as a condition of obtaining and maintaining a business license. 3 5 The Company has been able to maintain a high level of service and fast turnaround time by using its proprietary integrated tracking software ("QuoteTracker(TM)") which enables management to track each policy from initial application through renewal, along with tracking the performance of individual agents and employees. The system provides data on a real-time basis and allows for greater visibility of processing time and underwriting performance. The Company is raising capital through this Offering to allow for continued growth of its business and to repay its long-term debt. Insurance regulators and rating services presently recommend that the Company's ratio of annual net premiums written to surplus as regards policyholders not exceed 3 to 1. The Company's ratio at March 31, 1998 was 2.1 to 1. The Company's long term growth strategies, while continuing to emphasize small to medium-sized businesses as its primary target market, are to: - RETAIN MORE DIRECT PREMIUMS WRITTEN. Due to its limited capital, the Company has historically ceded as much as 43% of its annual direct premiums written to reinsurers. As a result of increased capital from this Offering, the Company will be able to retain a greater portion of premium income. - EXPAND EXISTING BUSINESS. The Company intends to pursue further growth in California by selectively appointing new agents and by attracting a larger percentage of business from each of its existing agents through cross-selling of its existing lines of business. - DEVELOP NEW PROGRAMS. The Company will continue to focus on developing new specialty insurance programs for carefully selected market segments in which the Company has identified niche opportunities. Such programs will replicate those successfully established in prior periods including those developed for refuse haulers, restaurants and bowling centers. - EXPAND SURETY BUSINESS. The Company began writing surety business in 1995 to complement CMP. This line of business provides payment or performance guarantees for construction contracts or other obligations. The Company wrote nearly $1.2 million in profitable surety premium with one staff underwriter in 1997. The Company plans to emphasize surety as a line of business by increasing its marketing efforts and adding to its staff. - EXPAND GEOGRAPHICALLY. The Company intends to expand its specialty insurance business into other states. Beginning with the states adjoining California, the Company will select and appoint agents in rural areas of those states to sell its products. Its marketing efforts will focus on the insurance programs in which the Company has developed an expertise in underwriting. The Company is licensed currently to do business in Arizona, California, Idaho, Missouri, Montana, Nebraska, Nevada, North Dakota, Oregon, South Dakota and Utah and has license applications pending in eight additional states. The Company is a Delaware corporation formed in 1993, whose offices are located at 3850 Atherton Road, Rocklin, California 95765; telephone (916) 630-5000; www.financialpacific.com. THE OFFERING Common Stock offered hereby: By the Company........... 2,000,000 shares By the Selling Stockholders............. 500,000 shares Common Stock to be outstanding after the Offering................. 4,816,897 shares(1) Use of proceeds............ To contribute additional capital to FPIC which will allow it to retain a greater portion of direct premiums written currently being ceded to reinsurers; to permit greater underwriting volume of its insurance products; to repay senior debt and for general corporate purposes. See "Use of Proceeds." Nasdaq National Market Symbol................... FPAC 4 6 - --------------- (1) Excludes 82,819 and 153,525 shares of Common Stock reserved for issuance upon exercise of options outstanding as of March 31, 1998 pursuant to grants to officers and employees of the Company and certain Warrants to purchase Common Stock, respectively, outstanding as of March 31, 1998. Includes 593,691 shares of Common Stock to be issued upon exercise of certain Warrants to purchase Common Stock and 1,735,251 shares of Common Stock to be issued upon the conversion of the Series A Stock concurrently with the closing of the Offering. See Notes to Consolidated Financial Statements. SUMMARY CONSOLIDATED FINANCIAL DATA(1)
THREE MONTHS ENDED YEARS ENDED DECEMBER 31, MARCH 31, --------------------------------------------------- ------------------ 1993(2) 1994 1995 1996 1997 1997 1998 ------- ------- -------- -------- --------- ------- -------- (In thousands, except per share data and ratios) INCOME STATEMENT DATA: Revenues: Direct premiums written............. $ 6,094 $15,072 $ 24,695 $ 31,927 $ 39,512 $ 9,203 $ 10,384 Premiums ceded...................... (2,345) (5,785) (10,653) (13,674) (12,576) (2,941) (3,096) ------- ------- -------- -------- --------- ------- -------- Net premiums written.......... 3,749 9,287 14,042 18,253 26,936 6,262 7,288 ------- ------- -------- -------- --------- ------- -------- Net premiums earned........... 2,380 6,701 12,060 14,987 22,854 4,741 6,583 Commissions......................... 159 213 105 628 709 170 207 Investment income, net of expenses.......................... 523 750 1,028 1,449 1,720 405 510 Net realized gains (losses) on sales of investments.................... 68 (246) 466 52 (46) -- -- Other income, net................... (107) 502 578 547 800 178 220 ------- ------- -------- -------- --------- ------- -------- Total revenues.................... 3,023 7,920 14,237 17,663 26,037 5,494 7,520 Expenses: Losses and loss adjustment expenses.......................... (273) 2,944 6,325 9,750 12,748 2,541 3,415 Policy acquisition costs............ 610 1,493 3,957 4,785 7,440 1,524 2,383 Contingent ceding commission........ -- (422) (1,246) (3,222) (1,511) (450) (62) General operating costs............. 731 2,297 1,712 1,929 2,443 760 437 Agency expenses..................... 136 253 145 688 721 167 202 Interest expense.................... 21 113 128 693 617 163 151 ------- ------- -------- -------- --------- ------- -------- Total expenses.................... 1,225 6,678 11,021 14,623 22,458 4,705 6,526 ------- ------- -------- -------- --------- ------- -------- Income before taxes................. 1,798 1,242 3,216 3,040 3,579 789 994 ------- ------- -------- -------- --------- ------- -------- Income tax provision.......... 588 465 1,066 1,037 1,237 271 341 ------- ------- -------- -------- --------- ------- -------- Net income.................... $ 1,210 $ 777 $ 2,150 $ 2,003 $ 2,342 $ 518 $ 653 ======= ======= ======== ======== ========= ======= ======== EARNINGS PER SHARE(3): Basic............................. $ 5.41 $ 1.60 $ 4.42 $ 4.12 $ 4.82 $ 1.06 $ 1.34 Diluted........................... $ 1.22 $ 0.40 $ 0.94 $ 0.69 $ 0.79 $ 0.17 $ 0.22 Weighted average diluted shares... 988 1,956 2,292 2,901 2,970 2,972 2,972 GAAP RATIOS(4): Loss ratio........................ (7.0)% 43.9% 52.4% 65.1% 55.8% 53.6% 51.9% Expense ratio..................... 56.1 52.0 36.6 23.3 36.3 38.7 41.7 ------- ------- -------- -------- --------- ------- -------- Combined ratio.................... 49.1% 95.9% 89.0% 88.4% 92.1% 92.3% 93.6% ======= ======= ======== ======== ========= ======= ======== STATUTORY RATIOS(4): Combined ratio.................... 35.6% 95.4% 89.3% 90.3% 92.3% 91.4% 92.8% ======= ======= ======== ======== ========= ======= ======== Industry combined ratio(5)........ 112.2% 110.1% 110.5% 111.0% 101.8% -- -- OTHER DATA: Underwriting profit(6)............ $ 1,312 $ 389 $ 1,585 $ 1,745 $ 1,734 $ 366 $ 410 Surplus as regards policyholders................... 5,890 5,773 12,387 13,788 14,262 12,970 14,075
5 7
MARCH 31, 1998 -------------------------- ACTUAL AS ADJUSTED(7) -------- --------------- (In thousands, except per share data and ratios) BALANCE SHEET AND OTHER DATA: Total cash and investments.................................. $34,855 $50,886 Total assets................................................ 72,651 88,682 Unpaid losses and loss adjustment expenses.................. 22,236 22,236 Total debt(8)............................................... 4,986 -- Stockholders' equity........................................ 14,088 35,119 Book value per common share(3).............................. $ 6.18 $ 7.29 Surplus as regards policyholders(9)......................... $14,075 $30,106 Ratio of annualized net premiums written to surplus as regards policyholders(10)................................. 2.1x 1.0x
- --------------- (1) Other than the statutory combined ratios, surplus as regards policyholders and ratio of net premiums written to surplus as regards policyholders, which are presented in accordance with statutory accounting principles ("SAP"), all data is presented in accordance with GAAP. See "Glossary of Selected Insurance Terms." (2) Effective November 12, 1993, the Group completed the acquisition of FPIC and FPIA pursuant to the Stock Purchase Agreement dated June 2, 1993. Because management of the Group had effective control of FPIC and FPIA as of May 26, 1993, the acquisition has been accounted for as of that date. Accordingly, the 1993 consolidated financial statements include results of operations for the period of May 26, 1993 through December 31, 1993. (3) All periods adjusted to reflect a 394.375 for 1 stock split effective April 14, 1998. Book value per common share is based on stockholders' equity adjusted for anticipated proceeds from the exercise of the Senior Note Warrants and outstanding shares as of the calculation date. Outstanding shares include Common Stock issued and outstanding as of the calculation date as well as Common Stock issued in conjunction with the anticipated conversion of Series A Stock and exercise of Senior Note Warrants. (4) During 1993, in conjunction with the acquisition, management determined that the Company's IBNR reserves were redundant and recorded a reserve reduction of $2.4 million. (5) Source: "Best's Insurance Reports Property/Casualty United States, 1997 Edition." The 1997 ratio is based on A.M. Best's estimate contained in January 1998, "Review Preview -- Property/Casualty." A comparison of a company's combined ratio with the industry combined ratio does not necessarily indicate that a company has performed well or poorly as compared with its peers. (6) Underwriting profit represents the difference between premiums earned and underwriting expenses. Underwriting profit may not provide an accurate comparison among companies because it is not necessarily computed identically by all companies. The use of such information is intended only to supplement the conventional income statement presentation and is not to be considered as an alternative to net income, cash flows or any other indicator of the Company's operating performance which is presented in accordance with GAAP. (7) Gives effect to the sale of 2,000,000 shares in the Offering (at an assumed initial public offering price of $10.00 per share) and the transactions contemplated under "Use of Proceeds." (8) Effective December 28, 1995, the Company issued $5 million in Senior Notes due January 1, 2001 (the "Senior Notes"). The Senior Notes were issued in conjunction with warrants for the purchase of 593,691 shares of the Company's Common Stock at the price of $5.61 per share (the "Senior Note Warrants"). The proceeds from the issuance of the Senior Notes were contributed to FPIC's capital. (9) Surplus as regards policyholders is derived from financial statements prepared in accordance with SAP prescribed or permitted by the California Department of Insurance (the "DOI"), a comprehensive basis of accounting other than GAAP. Statutory financial information, and the ratios derived from such information, should not be considered an alternative to information derived from financial position, results of operations or cash flows determined in accordance with GAAP. (10) Ratio of net premiums written to surplus as regards policyholders was calculated based on annualizing net premiums written for the quarter ended March 31, 1998 as compared to surplus as regards policyholders as of March 31, 1998. 6 8 RISK FACTORS In addition to the other information in this Prospectus, the following information should be considered carefully by potential purchasers in evaluating the Company, its business and the shares of Common Stock offered hereby. Certain statements included in this Prospectus, including, without limitation, statements containing the words "believes", "anticipates", "intends", "expects", "will" and words of similar import, constitute forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, the important factors set forth below and elsewhere in this Prospectus. Given these uncertainties, potential purchasers of the Common Stock offered hereby are cautioned not to place undue reliance on such forward-looking statements. NATURE OF THE COMPANY'S BUSINESS All of the Company's direct premiums written (which are the Company's largest source of revenue) are attributable to property/casualty insurance, which is cyclical in nature and has historically been characterized by periods of relatively high levels of price competition, less restrictive underwriting standards and generally low premium rates ("Soft Market"), followed by periods of capital shortages resulting in a lack of insurance availability, relatively low levels of competition, more selective underwriting of risks and relatively high premium rates ("Hard Market"). A Soft Market has existed for several years with premiums decreasing and competition remaining at high levels. Historically, the unpredictability and competitive nature of the property/casualty insurance industry have contributed to significant quarter-to-quarter and year-to-year fluctuations in underwriting results and net income. Many of the factors which have resulted in the current Soft Market in the property/casualty insurance industry continue and the Company cannot predict if, or when, the market conditions for the property/casualty insurance industry, including the product lines sold by the Company will improve. The Company's profitability is affected by many factors, including not only rate competition, but also severity and frequency of claims, fluctuations in interest rates that affect investment returns, regulation, court decisions, natural disasters, the legislative climate, and general economic conditions and trends, such as inflationary pressures that may affect the adequacy of reserves, all of which are substantially beyond the control of the Company. One of the distinguishing features of the property/casualty industry is that prices are set before costs are known because premium rates for individual policies are determined before losses for such policies are reported. Changes in statutory and case law can dramatically affect the liability associated with known risks after the insurance contract is in place. The number of competitors and the similarity of products offered, as well as regulatory constraints, limit the ability of property/casualty insurers such as the Company to increase prices in response to declines in profitability. In addition, during periods of high interest rates, some property/casualty insurers may be willing to absorb underwriting losses in order to generate funds for investment, thereby prolonging low premium rates which are not adequate to cover underwriting losses and expenses. As a result of these factors, the Company may experience significantly lower premiums in the future. Most insurance underwriting decisions are based on assumptions about events that will occur over a period of future years and are generally based on actuarial projections and historical data reflecting the collective experience of large groups of insureds. The actuarial projections may not accurately predict the aggregate obligations of any given insurer. Because the Company's experience represents an insignificant portion of the industry's experience, actuarial assumptions based on aggregate industry data may not be reflective of actual obligations to be incurred. With respect to underwriting experience (decisions concerning the issuance of its policies), the Company relies heavily on its own underwriting experience. GEOGRAPHIC AND PRODUCT LINE CONCENTRATION Virtually all of the Company's direct premiums written to date have been attributed to policies written in California. During the years ended December 31, 1995, 1996 and 1997, 95% to 100% of direct premiums written by the Company were derived from policies issued to insureds located in northern and central 7 9 California, where it is estimated that only 30% of California's population currently resides. The Company's revenues and profitability are therefore subject to prevailing economic, regulatory, demographic and other conditions in California. The Company is presently evaluating expansion into other states where management believes there are favorable insurance climates. The Company is currently licensed to transact property/ casualty insurance business in California and ten other states (Arizona, Idaho, Missouri, Montana, Nebraska, Nevada, North Dakota, Oregon, South Dakota and Utah). The Company has license applications pending in eight additional states (Arkansas, Colorado, Iowa, Kansas, Minnesota, New Mexico, Washington and Wisconsin). Management believes it will likely receive at least three of these state licenses before the end of 1998. The Company may need additional funds to finance any such expansion and there can be no assurance that such funds will be available. Even if the Company obtains the funds necessary to expand, there can be no assurance that the Company will be able to overcome competition and/or regulatory barriers or that any such expansion, if completed, will be successful. See "Business -- Competition" and "-- Regulation." REINSURANCE CONSIDERATIONS The Company depends upon its ability to reinsure certain risks insured by the Company. The amount, availability and cost of reinsurance are subject to prevailing market conditions beyond the control of the Company, and they affect the Company's ability to write additional premiums and its profitability. If the Company were unable to secure reinsurance at competitive prices and terms, the Company's results of operations could be adversely impacted. The maintenance of reinsurance does not affect the Company's direct liability to its policyholders on the business it writes. Although the Company's reinsurance is currently maintained with several reinsurers rated A- (excellent) or better by A.M. Best, one of the Company's reinsurer's insolvency or inability to make payments under the terms of a reinsurance treaty could have a material adverse effect on the Company. See "Business -- Reinsurance." RELIANCE ON INDEPENDENT INSURANCE AGENTS The failure or inability of independent insurance agents to market the Company's insurance programs successfully could have a material adverse effect on the Company's business, financial condition and results of operations. The Company principally markets its insurance programs through 232 independent insurance agents as of March 31, 1998. The agents are not obligated to promote the Company's products and many sell or promote competitors' insurance products in addition to the Company's products. Independent insurance agents produced 100% of the Company's direct premiums written during 1997. In 1997, 81% of the Company's business was produced by its top 90 agents. No agent accounted for more than 4% of the Company's direct premiums written in 1997. As a result, the Company's business depends in part on the marketing efforts of these agents and on the Company's ability to offer insurance programs and services that meet the requirements of the agents and customers of these agents. See "Business -- Marketing." ADEQUACY OF LOSS RESERVES The Company is required to maintain adequate reserves to cover its estimated ultimate liability for losses and loss adjustment expenses ("LAE") with respect to reported, and to Incurred But Not Reported ("IBNR"), claims as of the end of each accounting period. These reserves are estimates of what the Company expects the ultimate settlement and administration of claims will cost, and are based on facts and circumstances then known, predictions of future events, estimates of future trends in claims severity and other variable, subjective factors. There is no method for precisely estimating the ultimate liability. In recent years, a number of courts have issued decisions expanding civil liability. Such decisions have resulted in higher damage awards to injured parties. In many cases, such decisions have also resulted in liability and increased losses to property/casualty insurers. In addition, the Company relies on policy language, developed by the Company and by others, to exclude or limit coverage. If such language is held by a court to be invalid or unenforceable it could materially adversely affect the Company's financial position. This possibility of expansion of insurers' liability either through new concepts of liability or a refusal to accept restrictive policy language has added to the inherent uncertainty of reserving for losses. Although management believes that adequate provision has been made for loss reserves, the establishment of appropriate reserves is an inherently 8 10 uncertain process, and there can be no assurance that ultimate losses will not exceed the Company's loss reserves and have a material adverse effect on the Company's results of operations and financial condition. If the Company's reserves should be inadequate, the Company will be required to increase reserves with a corresponding increase in losses and LAE incurred and reduction in the Company's net income and stockholders' equity in the period in which the deficiency is identified. See "Business -- Reserves." RISKS RELATED TO EXPANSION STRATEGY Since 1993, the Company has experienced significant growth in its revenues, policyholders and scope of operations. This growth has required and will continue to require the Company to obtain additional capital, primarily to fund FPIC. The Company intends to use a significant portion of the net proceeds from this Offering to increase the surplus as regards policyholders of FPIC. If the Company is unable to generate sufficient capital, either internally or from outside sources, it could be required to slow its growth. The Company intends to pursue further growth opportunities through greater penetration in existing markets and expansion into new jurisdictions (see "Business -- Growth Strategy"). As the Company expands, it will be underwriting policies for insureds in industries and geographic areas less familiar to the Company. In addition, the Company may rely to a greater extent on third party providers for assistance in adjusting claims and various administrative matters in its new markets. The Company's growth has also resulted in, and is expected to continue to create, new and increased responsibilities for management personnel, as well as additional demands on the Company's operating and financial systems. The Company's further growth will depend on the efforts of key management personnel and on the Company's ability to attract and retain qualified persons, to enhance managerial systems for its operations, and to integrate successfully new employees and systems into its existing operations. If the Company is unable to continue to manage growth effectively, the Company's business, financial condition and results of operations could be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Business Strategy." COMPETITION The property/casualty insurance industry is highly competitive. The Company competes with other property/casualty insurers both in the recruitment and retention of qualified independent agents to sell its products. Success in recruiting and retaining independent agents willing to sell the Company's products or services is dependent upon the commission rates, services, and the ability of the insurer to provide products that meet the needs of the agent and the agent's customers. In selling its insurance products, the Company competes with other insurers through independent agents (including insurers represented by the independent agents who represent the Company), with insurers having their own agency organizations and with direct sellers of insurance products. There are numerous companies competing for business in the geographic areas in which the Company operates. No single company dominates the marketplace, but many of the Company's competitors have more established national reputations and substantially greater financial resources and market share than the Company. The Company pays its agents a base commission of 15% with additional commission for meeting increasing volume levels. Should other insurers begin paying higher commissions than the Company, this would present a competitive disadvantage in attracting and retaining high-quality agents. While recognizing the significance of the rate of commission, the Company believes its efforts to serve the agents and their customers by providing superior service in underwriting and claims processing will allow it to continue to compete with other insurers. See "Business -- Competition." IMPORTANCE OF AN A.M. BEST RATING A.M. Best, an independent insurance rating agency, assigned FPIC a B++ (very good) rating in 1994. In 1996, A.M. Best upgraded FPIC's rating to A- (excellent). An A- rating is assigned to companies which have a balance, in A.M. Best's opinion, of excellent financial strength, operating performance and market profile when compared to the standards established by A.M. Best and have a good ability to meet their 9 11 ongoing obligations to policyholders. A- is A.M. Best's fourth highest rating classification out of 15 ratings. While the Company does not expect any reduction in its A.M. Best rating, there can be no assurance that the Company will continue to be rated A-. Any significant decline in the Company's future ratings could have a material impact on its relationship with clients, and thus, a material adverse effect on the Company. A.M. Best rates firms both on quality and on size. The size categories range from I, which represents surplus as regards policyholders of less than $1 million, to XV, which represents surplus as regards policyholders of greater than $2 billion. Prior to the Offering, FPIC was financial size V, representing surplus as regards policyholders between $10 million and $25 million. Following this Offering, it is expected that FPIC will be category VI, representing surplus as regards policyholders between $25 million and $50 million. When considering whether to accept a Financial Pacific policy, customers often review both the rating and the financial size category. While many customers and potential customers view an A- rating as sufficient, there are others that require financial category sizes of VII and greater. There can be no assurance that customers will continue to accept FPIC's rating and financial category regardless of the Offering. See "Business -- Ratings." LIMITS ON WRITING INSURANCE The DOI and insurance regulators in all other states in which the Company is licensed, presently recommend that the Company's annual net premiums written not exceed three times (300%) its surplus as regards policyholders. As of March 31, 1998, the Company's annual net premiums written to surplus as regards policyholders was 2.1 to 1. This limitation could restrict the Company's future growth and profitability unless the Company is able to increase its surplus as regards policyholders or modify its reinsurance arrangements to cede more of its premiums. See "Use of Proceeds," "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources," "Business -- Regulation -- Limits on Writing Business" and "-- Surplus as Regards Policyholders." RELIANCE ON KEY PERSONNEL The Company depends, and will continue to depend, on the services of Robert C. Goodell, the Company's Chairman, President and Chief Executive Officer, as well as the other members of the senior management team. The Company has entered into an employment agreement with Mr. Goodell for a one-year term. This agreement will automatically renew at the end of such term and each anniversary thereof for a successive one-year term unless terminated in accordance with such agreement. See "Management -- Employment Agreements." In 1991, Mr. Goodell was diagnosed with a remitting, relapsing form of Multiple Sclerosis that is being treated with medication. While Mr. Goodell does not have any health problems today that materially affect his ability to perform his regular duties, his condition could deteriorate which could adversely affect his future performance. The Company is the sole beneficiary of a key man life insurance policy in the amount of $3.0 million which it maintains on Mr. Goodell. The loss of Mr. Goodell or any of the other senior managers could have a material adverse effect on the business of the Company. REGULATIONS, PENDING LEGISLATION AND CASE LAW The Company and FPIC, as a California domiciled insurer, are subject to extensive regulation by the DOI and the California Commissioner of Insurance ("Commissioner"). The Company is also subject to extensive regulation by the insurance regulatory agencies of Arizona, Idaho, Missouri, Montana, Nebraska, Nevada, North Dakota, Oregon, South Dakota and Utah. The Company will also become subject to regulation in each jurisdiction in which it becomes licensed to transact business. Such regulation is primarily for the protection of policyholders rather than stockholders and could limit the Company's ability to react to changes in its marketplace or take advantage of new opportunities in a timely manner. Changes in such regulation could materially and adversely affect the Company's operations and financial condition. The nature and extent of such regulation varies from jurisdiction to jurisdiction, but typically involves: (i) standards of solvency and minimum amounts of capital and surplus which must be maintained; (ii) limits on types and amounts of investments; (iii) restrictions on the size of risks which may be insured by a single company; (iv) licensing of insurers and their agents; (v) required deposits of securities for the benefit of policyholders; 10 12 (vi) approval of policy forms; (vii) establishment of statutory reporting practices and the form and content of statutory financial statements; (viii) establishment of methods for setting statutory loss and expense reserves; (ix) review, and in some instances, prior approval of premium rates; (x) limits on transactions among insurers and affiliates; (xi) approval of all proposed changes of control; (xii) approval of dividends; (xiii) setting and collecting guarantee fund assessments; and (xiv) required filing of annual and other reports with respect to the financial condition and operation of insurers. In addition, state regulatory examiners perform periodic financial and underwriting examinations of insurers. In recent years, the insurance regulatory framework has been subject to increased scrutiny by the National Association of Insurance Commissioners (the "NAIC"), state legislatures, state insurance regulators and the United States Congress. The NAIC is a voluntary organization of state regulators. Its principal mission is to encourage uniformity in state regulation of insurance through the drafting of model laws and the continuing refinement of insurance accounting practices and reporting procedures. None of the NAIC's pronouncements has any legal effect unless enacted by individual states. The NAIC recently approved codification of statutory accounting practices that change the definition of what constitutes prescribed statutory accounting practices and will result in changes to the accounting policies that insurance enterprises use to prepare their statutory financial statements. The codification becomes effective in 1999. The Company is unable to predict how codification will affect FPIC's statutory financial statements or how insurance rating agencies will interpret or react to any such changes. No assurance can be given that future legislative or regulatory changes resulting from such activities will not adversely affect the Company. See "Business -- Regulation." Currently, approximately 40% of the Company's business is related to artisan contractors. Accordingly, the law relating to construction defect liability can substantially affect the Company's business. Any changes in such laws, rules and regulations, including any attempt to find more fault with a contractor or subcontractor for problems with a project they worked on, could materially and adversely affect the operations of the Company. For example, in July of 1995, the California Supreme Court rendered its opinion on Montrose Chemical Corporation vs. Admiral Insurance Company (the "Montrose Decision"). In that decision, the Supreme Court ruled that in the case of a continuous and progressively deteriorating loss, such as pollution liability (or construction defect liability), an insurance company has a definitive duty to defend the policyholder until all uncertainty related to the severity and cause of the loss is extinguished. Therefore, multiple periods of coverage are triggered and often with multiple insurance companies. The Montrose Decision was in stark contrast to prior decisions wherein, only the carrier insuring the business when a loss first manifested itself was obligated to defend and/or provide indemnity relief. As a result of the Montrose Decision, the Company experienced a significant increase in construction defect liability cases, to which it would not have been subject under the old law. Once the new law was understood, the Company adjusted its underwriting guidelines to mitigate the risk. Management believes that the significant improvement in the results for accident years 1995 and following are attributed to changes in the Company's underwriting guidelines. The Company also relies on policy language, developed by the Company and by others, to exclude or limit coverage. If such language is held by a court to be invalid or unenforceable it could materially adversely affect the Company's financial position. The Company is unaware of any additional or amended legislation which is pending or contemplated concerning construction defect liability or other laws which, if adopted, could materially and adversely impact the Company's operations. See "Business -- Regulation" and "-- Reserves." HOLDING COMPANY STRUCTURE AND RESTRICTIONS ON DIVIDENDS As a holding company with no significant business operations of its own, the Group relies on dividends from its subsidiaries, which are domiciled in California, as the principal source of cash to meet its obligations, including the payment of principal and interest on its debt obligations and the payment of dividends to stockholders. California law places significant restrictions on the ability of FPIC to pay dividends to the Group. In particular, all dividends from FPIC require prior notice to the DOI. All "extraordinary" dividends must be approved in advance by the DOI. A dividend is deemed "extraordinary" if, when aggregated with all other dividends paid within the preceding 12 months, the dividend exceeds the greater of (i) FPIC's statutory 11 13 net income (excluding unrealized capital gains) for the preceding calendar year or (ii) 10% of surplus as regards policyholders as of the preceding December 31st. Additionally, unless approved in advance by the DOI, no dividend may be paid by FPIC except from unassigned funds or earned surplus. The DOI may disallow the payment of any dividend if, in the DOI's opinion, the payment would in any way violate the California Insurance Code (the "Code") or be hazardous to policyholders, creditors or the public. Based on these limitations and statutory results, as of December 31, 1997, the maximum dividend that could be paid by FPIC to the Group in 1998, without obtaining prior regulatory approval from the DOI, would be $1,426,000. A dividend in the amount of $300,000 was declared and paid on January 1, 1998 to fund the debt service on the Group's Senior Notes. There can be no assurance that dividends will be declared by the Group in the future or that any required approval for payment of dividends by FPIC will be obtained from the applicable state insurance departments. See "Dividend Policy," "Business -- Regulation" and "-- Regulation of Dividends and Other Payments from Insurance Subsidiaries." Income from FPIA is not subject to dividend restrictions; however, the income generated by FPIA has been de minimis in the past and is expected to be de minimis for several years. See "Business -- Financial Pacific Insurance Agency." RELIANCE ON TECHNOLOGY The Company relies heavily on computers in all aspects of its business including rating, issuing and billing policies. In the event of a disaster which results in the loss of some or all of the Company's computer hardware and/or software, the Company would incur significant recovery expense. While the Company purchases insurance against such an event, there can be no assurance that the Company would be fully compensated for the costs incurred in recovering to full operations, and as such, an event of this nature could materially adversely affect the Company's short-term operating results. CONTROL OF COMPANY After the completion of this Offering, Robert C. Goodell and the existing investors will still own approximately 46% of the Company's outstanding Common Stock. Mr. Goodell and the existing investors will have power to influence the Company, to select the Board of Directors and to approve any action requiring stockholder approval, including adopting amendments to the Company's Certificate of Incorporation and approving or disapproving mergers or sales of all the assets of the Company. As long as Mr. Goodell and the other original stockholders maintain their ownership of the Company's Common Stock, third parties will have a difficult time obtaining control of the Company through purchases of the Common Stock in the open market. "See Principal and Selling Stockholders," "Certain Transactions" and "Description of Capital Stock." POTENTIAL ANTI-TAKEOVER EFFECT OF REGULATION AND CERTAIN CHARTER PROVISIONS Under the terms of California law governing insurance holding companies, any person or entity desiring to acquire 10% or more of the Company's outstanding voting securities is required to obtain prior approval of the DOI. In addition, certain other factors may have the effect of deterring, delaying, or preventing a change in control of the Company without further action by the stockholders; may discourage bids for the Common Stock at a premium over the market price of the Common Stock; and may adversely affect the market price of, and the voting and other rights of the holders of, Common Stock. These factors include the absence of cumulative voting and the ability of the Company's directors to issue "blank check" preferred stock and provisions of Delaware law. See "Business -- Regulation -- Insurance Regulation Concerning Change or Acquisition of Control" and "Description of Capital Stock." ABSENCE OF PRIOR PUBLIC MARKET Prior to this Offering, there has been no public market for the Common Stock. There can be no assurance that an active trading market will develop or continue after this Offering. The initial public offering price has been determined by negotiations between the Company and the representative of the Underwriters and may 12 14 not be indicative of the market price for the Common Stock after this Offering. See "Underwriting" for a discussion of the factors considered in determining the initial public offering price. The market price of the Common Stock could be subject to significant fluctuations in response to variations in quarterly and yearly operating results, general trends in the Company's industry, the overall performance of the stock market and other factors. See "Underwriting." USE OF PROCEEDS Of the net proceeds to the Company from this Offering, estimated to be $17.7 million (or approximately $21.2 million if the Underwriters' over-allotment option is exercised in full), $16.0 million will be contributed by the Company to the capital of FPIC, thereby increasing its capacity to write additional premiums and retain a greater percentage of direct premiums written which has historically been ceded to reinsurers. Simultaneously with this Offering, all of the outstanding Senior Note Warrants will be exercised and the aggregate exercise price of $3.3 million will be offset against the $5 million outstanding principal balance of the Senior Notes. The balance of the Senior Notes, $1.7 million, will be paid with a portion of the proceeds from this Offering. The Senior Notes bear interest at an annual rate of 12% and mature on January 1, 2001. The remainder of the estimated net proceeds, if any, is expected to be utilized by the Company for general corporate purposes including expansion of its business. The portion of the proceeds contributed to FPIC will initially be invested in short-term, investment grade, interest-bearing securities pending orderly reinvestment in accordance with the Company's investment policies. See "Business -- Regulation -- Limits on Writing Business" and "Business -- Investments." The Company will not receive any proceeds from the sale of the shares by the Selling Stockholders. DIVIDEND POLICY The Company does not anticipate paying cash dividends on its Common Stock in the foreseeable future, but instead intends to retain its earnings in order to fund the continued development and growth of the Company's business. All dividends from FPIC require prior notice to the DOI. All "extraordinary" dividends must be approved in advance by the DOI. A dividend is deemed "extraordinary" if, when aggregated with all other dividends paid within the preceding 12 months, the dividend exceeds the greater of: (i) FPIC's statutory net income (excluding unrealized capital gains) for the preceding calendar year or (ii) 10% of surplus as regards policyholders as of the preceding December 31st. Additionally, unless approved in advance by the DOI, no dividend may be paid by FPIC except from unassigned funds or earned surplus. The DOI may disallow the payment of any dividend if, in the DOI's opinion, the payment would in any way violate the Code or be hazardous to policyholders, creditors or the public. See "Business -- Regulation of Dividends and Other Payments from Insurance Subsidiaries." For further discussion of these restrictions, see "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources," "Business -- Regulation" and Notes to Consolidated Financial Statements. 13 15 DILUTION At March 31, 1998, the outstanding shares of Common Stock had a pro forma net tangible book value per share of $6.18. Assuming the 2,000,000 shares of Common Stock offered by the Company hereby had been sold at March 31, 1998 and without reflecting the effect of operations subsequent to that date, the net tangible book value per share for all outstanding shares of Common Stock (after deducting estimated offering expenses, including underwriting discount) would have been $7.29. This represents an immediate increase in net tangible book value of $1.11 per share to existing stockholders and an immediate dilution of $2.71 per share to new investors, as illustrated in the following table: Estimated public offering price per share................... $10.00 ------ Pro forma net tangible book value per share before offering............................................... 6.18 Increase per share attributable to new investors.......... 1.11 ------ Pro forma net tangible book value per share after offering.................................................. 7.29 ------ Immediate dilution to new investors......................... 2.71 ------
If the Underwriters exercise in full their right to purchase an additional 375,000 shares of Common Stock to cover over-allotments, the net tangible book value after the Offering would be $7.43 per share of Common Stock, which would result in a dilution to public investors of $2.57 per share. The following table sets forth on a pro forma basis as of March 31, 1998, the number of shares of Common Stock purchased from the Company, the total consideration paid, and the average price per share paid by the existing stockholders and by purchasers of the shares of Common Stock offered hereby (giving effect to the conversion of Series A Stock outstanding as of March 31, 1998 into 1,735,251 shares of Common Stock, the exercise of Warrants to purchase 593,691 shares of Common Stock and the sale of 2,000,000 shares by the Company at an initial public offering price of $10.00 per share, before deducting the underwriting discount and offering expenses):
SHARES PURCHASED TOTAL CONSIDERATION -------------------- --------------------- AVERAGE PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE --------- ------- ---------- ------- ------------- Existing Stockholders........ 2,816,897 58.5% 8,286,451 29.3% $ 2.94 New Public Investors......... 2,000,000 41.5% 20,000,000 70.7% $10.00 --------- ----- ---------- ----- Total.............. 4,816,897 100.0% 28,286,451 100.0% ========= ===== ========== =====
The information set forth above does not give effect to the potential exercise of options to purchase an aggregate of 37,466 shares and Warrants to purchase 153,525 shares of Common Stock as of March 31, 1998 at exercise prices ranging from $2.54 to $4.82 per share to certain individuals, including certain of the Company's officers, employees and former employees. Some of these options can be exercised immediately. Purchasers of shares of Common Stock offered hereby will incur additional dilution to the extent outstanding stock options are exercised. See "Management." 14 16 CAPITALIZATION The following table sets forth the consolidated short-term debt and capitalization of the Company as of March 31, 1998, and as adjusted to reflect the restatement of the Company's Certificate of Incorporation to increase the authorized number of shares of Preferred Stock and Common Stock, effective April 14, 1998, a 394.375 for 1 split of the Common Stock effective on April 14, 1998, the sale by the Company of 2,000,000 shares of Common Stock to the public at an assumed initial offering price of $10.00 per share, and the application of the net proceeds of $17.7 million therefrom. See "Use of Proceeds."
MARCH 31, 1998 -------------------------- ACTUAL AS ADJUSTED ----------- ----------- Short-term debt............................................. $ -- $ -- =========== =========== Long-term debt.............................................. $ 4,985,848 $ -- ----------- ----------- Stockholders' equity: Preferred stock, $.001 par value, authorized 5,000 shares (2,000,000 as adjusted); issued and outstanding 4,400 shares (no shares as adjusted)......................... 5 -- Common stock, $.001 par value, authorized 10,000 shares (7,500,000 as adjusted); issued and outstanding 487,955 shares (4,816,897 shares as adjusted)(1)............... 488 4,817 Additional paid-in capital................................ 4,954,508 25,981,184 Net unrealized loss on available for sale securities, net of deferred federal income taxes....................... (1,862) (1,862) Retained earnings......................................... 9,134,820 9,134,820 ----------- ----------- Total stockholders' equity........................ 14,087,959 35,118,959 =========== =========== Total capitalization.............................. $19,073,807 $35,118,959 =========== ===========
- --------------- (1) Excludes 82,819 and 153,525 shares of Common Stock reserved for issuance upon exercise of options outstanding as of March 31, 1998 pursuant to grants to officers and employees of the Company and certain Warrants to purchase Common Stock, respectively, outstanding as of March 31, 1998. Includes 593,691 shares of Common Stock to be issued upon exercise of certain Warrants to purchase Common Stock and 1,735,251 shares of Common Stock to be issued upon the conversion of the Series A Stock concurrently with the closing of the Offering. See Notes to Consolidated Financial Statements. 15 17 SELECTED CONSOLIDATED FINANCIAL DATA The following table presents selected consolidated financial data of the Company at the dates and for the periods indicated. All information is presented in accordance with GAAP, except for the statutory property/ casualty ratios and surplus as regards policyholders, which are presented in accordance with SAP. The financial data is derived from the consolidated financial statements and accounting records of the Company. The consolidated financial statements as of December 31, 1996 and 1997 and for each of the years in the three-year period ended December 31, 1997 and the report thereon are included elsewhere in the Prospectus and have been audited by KPMG Peat Marwick, LLP, independent certified public accountants. The selected data presented below as of and for the three months ended March 31, 1997 and 1998 is derived from the unaudited consolidated financial statements of the Company. The information furnished with respect to the unaudited periods reflects all adjustments which, in the opinion of management, are necessary for a fair presentation of results for the interim periods. All such adjustments are, in the opinion of management, of a normal and recurring nature. The results for the three months ended March 31, 1998 are not necessarily indicative of the results to be expected for the year ending December 31, 1998. The industry combined ratio data presented under "Statutory Ratios" is unaudited. The selected consolidated financial data set forth below is qualified by reference to, and should be read in conjunction with, the consolidated financial statements of the Company and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations," appearing elsewhere in this Prospectus.
THREE MONTHS ENDED YEARS ENDED DECEMBER 31, MARCH 31, --------------------------------------------------- ------------------- 1993(1) 1994 1995 1996 1997 1997 1998 ------- ------- -------- -------- --------- -------- -------- (In thousands, except per share data and ratios) INCOME STATEMENT DATA: Revenues: Direct premiums written............... $ 6,094 $15,072 $ 24,695 $ 31,927 $ 39,512 $ 9,203 $ 10,384 Premiums ceded........................ (2,345) (5,785) (10,653) (13,674) (12,576) (2,941) (3,096) ------- ------- -------- -------- --------- -------- -------- Net premiums written............ 3,749 9,287 14,042 18,253 26,936 6,262 7,288 ------- ------- -------- -------- --------- -------- -------- Net premiums earned............. 2,380 6,701 12,060 14,987 22,854 4,741 6,583 Commissions........................... 159 213 105 628 709 170 207 Investment income, net of expenses.... 523 750 1,028 1,449 1,720 405 510 Net realized gains (losses) on sales of investments...................... 68 (246) 466 52 (46) -- -- Other income, net..................... (107) 502 578 547 800 178 220 ------- ------- -------- -------- --------- -------- -------- Total revenues...................... 3,023 7,920 14,237 17,663 26,037 5,494 7,520 Expenses: Losses and loss adjustment expenses... (273) 2,944 6,325 9,750 12,748 2,541 3,415 Policy acquisition costs.............. 610 1,493 3,957 4,785 7,440 1,524 2,383 Contingent ceding commission.......... -- (422) (1,246) (3,222) (1,511) (450) (62) General operating costs............... 731 2,297 1,712 1,929 2,443 760 437 Agency expenses....................... 136 253 145 688 721 167 202 Interest expense...................... 21 113 128 693 617 163 151 ------- ------- -------- -------- --------- -------- -------- Total expenses...................... 1,225 6,678 11,021 14,623 22,458 4,705 6,526 ------- ------- -------- -------- --------- -------- -------- Income before taxes................... 1,798 1,242 3,216 3,040 3,579 789 994 ------- ------- -------- -------- --------- -------- -------- Income tax provision............ 588 465 1,066 1,037 1,237 271 341 ------- ------- -------- -------- --------- -------- -------- Net income...................... $ 1,210 $ 777 $ 2,150 $ 2,003 $ 2,342 $ 518 $ 653 ======= ======= ======== ======== ========= ======== ======== EARNINGS PER SHARE(2): Basic............................... $ 5.41 $ 1.60 $ 4.42 $ 4.12 $ 4.82 $ 1.06 $ 1.34 Diluted............................. $ 1.22 $ 0.40 $ 0.94 $ 0.69 $ 0.79 $ 0.17 $ 0.22 Weighted average diluted shares..... 988 1,956 2,292 2,901 2,970 2,972 2,972 GAAP RATIOS(3): Loss ratio.......................... (7.0)% 43.9% 52.4% 65.1% 55.8% 53.6% 51.9% Expense ratio....................... 56.1 52.0 36.6 23.3 36.3 38.7 41.7 ------- ------- -------- -------- --------- -------- -------- Combined ratio...................... 49.1% 95.9% 89.0% 88.4% 92.1% 92.3% 93.6% ======= ======= ======== ======== ========= ======== ======== STATUTORY RATIOS(3)(6): Loss ratio.......................... (7.0)% 43.9% 52.4% 65.1% 55.8% 53.6% 51.9% Expense ratio....................... 42.6 51.5 36.9 25.2 36.5 37.8 40.9 ------- ------- -------- -------- --------- -------- -------- Combined ratio...................... 35.6% 95.4% 89.3% 90.3% 92.3% 91.4% 92.8% ======= ======= ======== ======== ========= ======== ======== Industry combined ratio(4).......... 112.2% 110.1% 110.5% 111.0% 101.8% -- --
16 18
DECEMBER 31, MARCH 31, ------------------------------------------------ ----------------- 1993 1994 1995 1996 1997 1997 1998 -------- ------- ------- ------- ------- ------- ------- (In thousands, except per share data) BALANCE SHEET DATA: Total cash and investments..... $115,203 $13,530 $23,608 $24,543 $30,609 $27,666 $34,855 Total assets................... 24,839 31,308 47,339 54,684 65,893 58,738 72,651 Unpaid losses and loss 7,125 10,141 12,013 13,944 19,592 15,018 22,236 adjustment expenses.......... Total debt(5).................. 1,633 1,225 5,901 5,479 4,985 5,481 4,986 Stockholders' equity........... 5,410 6,908 9,142 10,615 13,398 10,792 14,088 OTHER DATA: Book value per common $ 2.81 $ 3.11 $ 4.43 $ 4.95 $ 5.94 $ 5.02 $ 6.18 share(2)..................... Surplus as regards $ 5,890 $ 5,773 $12,387 $13,788 $14,262 $12,970 $14,075 policyholders(5)(6).......... Underwriting profit(7)......... 1,312 389 1,585 1,745 1,734 366 410
- --------------- (1) Effective November 12, 1993, the Group completed the acquisition of FPIC and FPIA pursuant to the Stock Purchase Agreement dated June 2, 1993. Because management of the Group had effective control of FPIC and FPIA as of May 26, 1993, the acquisition has been accounted for as of that date. Accordingly, the 1993 consolidated financial statements include results of operations for the period of May 26, 1993 through December 31, 1993. (2) All periods adjusted to reflect a 394.375 for 1 stock split effective April 14, 1998. Book value per common share is based on stockholders' equity adjusted for anticipated proceeds from the exercise of the Senior Note Warrants and outstanding shares as of the calculation date. Outstanding shares include Common Stock issued and outstanding as of the calculation date as well as Common Stock issued in conjunction with the anticipated conversion of Series A Stock and exercise of Senior Note Warrants. (3) During 1993, in conjunction with the acquisition, management determined that the Company's IBNR reserves were redundant and recorded a reserve reduction of $2.4 million. (4) Source: "Best's Insurance Reports Property/Casualty United States, 1997 Edition." The 1997 ratio is based on A.M. Best's estimate contained in the January 1998, "Review Preview -- Property/Casualty." A comparison of a company's combined ratio with the industry combined ratio does not necessarily indicate that a company has performed well or poorly as compared with its peers. (5) Effective December 28, 1995, the Company issued $5 million in Senior Notes. The Senior Notes were issued in conjunction with the Senior Note Warrants. The proceeds from the issuance of the Senior Notes were contributed to FPIC's capital. (6) Surplus as regards policyholders is derived from financial statements prepared in accordance with SAP prescribed or permitted by the DOI, a comprehensive basis of accounting other than GAAP. Statutory financial information, and the ratios derived from such information, should not be considered an alternative to information derived from financial position, results of operations or cash flows determined in accordance with GAAP. (7) Underwriting profit represents the difference between premiums earned and underwriting expenses. Underwriting profit may not provide an accurate comparison among companies because it is not necessarily computed identically by all companies. The use of such information is intended only to supplement the conventional income statement presentation and is not to be considered as an alternative to net income, cash flows or any other indicator of the Company's operating performance which is presented in accordance with GAAP. 17 19 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Group is a Delaware holding company formed in 1993 for the purpose of acquiring 100% of the outstanding shares of M.L. Oates Insurance Company ("Oates"), a Sacramento-based property/casualty insurance company domiciled in California, and its affiliated agency. The name of the insurance company was changed to Financial Pacific Insurance Company following the acquisition in 1993. FPIC underwrites primarily CMP policies through its office in Rocklin, California, which is approximately 20 miles northeast of Sacramento. FPIC also underwrites commercial automobile insurance as a companion coverage to its CMP business, and surety bonds. The Group also owns FPIA, an insurance agency acquired in 1993 and renamed in 1995 that specializes in the direct mail distribution of license and permit surety bonds in 36 states on behalf of Markel Corporation. The Company markets commercial property/casualty insurance through 232 independent insurance agents, as of March 31, 1998, located primarily throughout northern and central California. The Company believes its relationship with these agents allows it to provide ongoing and attentive service to its targeted customer base -- small to medium-sized commercial establishments. Management believes this market has been overlooked by many of the larger insurance companies as a result of the lower premiums per policy and, in some cases, the remote locations of its clients and the agents. The following table sets forth the Company's direct premiums written, net premiums earned and losses and LAE ratios by line of business and combined ratios since 1993.
THREE MONTHS YEARS ENDED DECEMBER 31, ENDED MARCH 31, ----------------------------------------------- ---------------- 1993(1) 1994 1995 1996 1997 1997 1998 ------- ------- ------- ------- ------- ------ ------- (In thousands) DIRECT PREMIUMS WRITTEN: CMP-Property.................... $1,190 $ 1,570 $ 2,668 $ 3,728 $ 4,490 $ 969 $ 1,198 CMP-Liability................... 6,270 9,435 14,167 17,767 22,766 5,403 6,470 Commercial Auto Liability....... 1,037 2,678 4,982 6,414 6,825 1,521 1,539 Commercial Auto Physical 387 683 1,182 1,748 2,244 497 504 Damage....................... Inland Marine................... 398 645 1,142 1,536 1,884 403 465 Surety.......................... 133 47 500 589 1,129 383 162 Fidelity........................ 4 14 54 145 174 27 46 ------ ------- ------- ------- ------- ------ ------- Total................... $9,419 $15,072 $24,695 $31,927 $39,512 $9,203 $10,384 ====== ======= ======= ======= ======= ====== =======
THREE MONTHS YEARS ENDED DECEMBER 31, ENDED MARCH 31, ----------------------------------------------- ---------------- 1993(1) 1994 1995 1996 1997 1997 1998 ------- ------- ------- ------- ------- ------ ------- (In thousands) NET PREMIUMS EARNED: CMP-Property.................... $ 201 $ 298 $ 548 $ 882 $ 1,134 $ 247 $ 316 CMP-Liability................... 2,444 4,652 7,180 9,261 14,872 2,993 4,460 Commercial Auto Liability....... 453 1,037 2,973 3,126 4,919 1,041 1,371 Commercial Auto Physical 233 462 948 892 768 231 158 Damage....................... Inland Marine................... 43 136 275 379 486 110 135 Surety.......................... 128 108 115 353 517 86 99 Fidelity........................ 2 8 21 94 158 33 44 ------ ------- ------- ------- ------- ------ ------- Total................... $3,504 $ 6,701 $12,060 $14,987 $22,854 $4,741 $ 6,583 ====== ======= ======= ======= ======= ====== =======
18 20
THREE MONTHS YEARS ENDED DECEMBER 31, ENDED MARCH 31, ------------------------------------------ --------------- 1993(1)(2) 1994 1995 1996 1997 1997 1998 ---------- ---- ---- ---- ----- ----- ------ LOSS AND LAE RATIOS: CMP-Property....................... 21.4% 43.0% 70.8% 38.5% 107.1% 56.3% 102.2% CMP-Liability...................... (10.4) 46.8 45.5 59.1 50.4 53.2 48.6 Commercial Auto Liability.......... 21.0 43.8 62.1 97.2 66.2 59.8 54.7 Commercial Auto Physical Damage.... 18.5 32.3 72.0 82.1 54.7 46.8 56.3 Inland Marine...................... 48.8 33.1 50.9 25.1 53.5 40.9 50.4 Surety............................. (2.3) (7.4) 2.6 19.5 14.5 24.4 15.2 Fidelity........................... --(3) 0.0 0.0 0.0 19.0 36.4 4.5 ----- ---- ---- ---- ----- ---- ----- Total...................... (7.0%) 43.9% 52.4% 65.1% 55.8% 53.6% 51.9% ===== ==== ==== ==== ===== ==== ===== STATUTORY COMBINED RATIOS: Loss Ratio(4)........................ (7.0%) 43.9% 52.4% 65.1% 55.8% 53.6% 51.9% Expense Ratio........................ 42.6 51.5 36.9 25.2 36.5 37.8 40.9 ----- ---- ---- ---- ----- ---- ----- Combined Ratios............ 35.6% 95.4% 89.3% 90.3% 92.3% 91.4% 92.8% ===== ==== ==== ==== ===== ==== =====
- --------------- (1) Although the Group assumed control of FPIC's operations effective May 26, 1993, for comparison purposes the above table reflects underwriting results for the year ended December 31, 1993. (2) During 1993, in conjunction with the acquisition, management determined that the Company's IBNR reserves were redundant and recorded a reserve reduction of $2.4 million. (3) Not meaningful based on immateriality of fidelity earned premium of $2,000 in 1993. (4) The increase in the loss ratio from 52.4% in 1995 to 65.1% in 1996 resulted primarily from the effects of the Montrose Decision in July 1995. As a result of the Montrose Decision, the Company retroactively incurred construction defect claims for which, prior to this decision, there would have been no liability. The Company has subsequently revised its underwriting practices in response to the Montrose Decision. See "Risk Factors -- Regulation, Pending Legislation and Case Law." Because insurance companies derive revenues (and incur losses) from investing activities as well as underwriting activities, an underwriting loss in a period does not necessarily preclude profitability for that period. A combined ratio of under 100% indicates an underwriting profit. A combined ratio in excess of 100% indicates an underwriting loss. Persistent underwriting losses reduce profitability and, when coupled with investment losses in any period, result in negative earnings which reduce the insurer's capital and therefore its ability to underwrite further business. RESULTS OF OPERATIONS Three months ended March 31, 1997 versus three months ended March 31, 1998 Direct premiums written. Direct premiums written for the three months ended March 31, 1997 and 1998 were $9.2 million and $10.4 million, respectively, representing an increase of 13%. Direct premiums written increased primarily due to the attraction of a larger percentage of business from each of the Company's existing agents and the appointment of new agents. During the three months ended March 31, 1998, total production from agents appointed as of March 31, 1997 increased by approximately 10%. The number of appointed agents also increased by approximately 14% from 203 as of March 31, 1997 to 232 as of March 31, 1998. Premiums ceded. Premiums ceded for the three months ended March 31, 1997 and 1998 were $2.9 million and $3.1 million, respectively, representing an increase of 5%. Premiums ceded as a percentage of direct premiums written decreased from 32.0% in 1997 to 29.8% in 1998. The decrease in premiums ceded as a percentage of direct premiums written was due to changes in FPIC's reinsurance structure. Effective January 1, 1997, FPIC increased its retention on casualty lines of business from $100,000 to $250,000 per 19 21 occurrence in order to retain more of its underwriting income and reduce the underwriting income ceded to reinsurers. See further discussion of the reinsurance structure in "Business -- Reinsurance." Net premiums earned. Net premiums earned for the three months ended March 31, 1997 and 1998 were $4.7 million and $6.6 million, respectively, representing an increase of 39%. The increase in net premiums earned is reflective of the growth in direct premiums written and reduction in premiums ceded. Commissions. Commissions earned for the three months ended March 31, 1997 and 1998 were $170,000 and $207,000, respectively, representing an increase of 22%. The increase reflects the continued growth of FPIA premium production. Investment income. Investment income for the three months ended March 31, 1997 and 1998 was $405,000 and $510,000, respectively, representing an increase of 26%. The increase in investment income is consistent with the 27% increase in the average invested assets balance from $25.1 million for the three months ended March 31, 1997 to $31.7 million for the three months ended March 31, 1998. The growth in invested assets reflects the investment of cash flows generated by operations. The weighted average annualized investment yield decreased from 6.5% for 1997 to 6.4% for 1998. Net realized gains (losses) on sales of investments. Net realized gains (losses) on sales of investments were $0 for the three months ended March 31, 1997 and 1998, respectively, reflecting a lack of sales activity. Other income (expense). Other income (expense) for the three months ended March 31, 1997 and 1998 was $178,000 and $220,000, respectively. Other income (expense) consists primarily of policyholder service fees related to the direct bill installment payment plan. The increase in other income (expense) is due primarily to the increase in direct premiums written as approximately 80% of policies issued are on the direct bill installment pay plan. Losses and loss adjustment expenses. Losses and LAE decreased as a percentage of net premiums earned from 53.6% to 51.9% for the three months ended March 31, 1997 and 1998, respectively. The decreased loss ratio is due in part to a reduced "Montrose effect" as compared to 1997. The "Montrose effect" relates to the Montrose Decision and is discussed in detail at "Risk Factors -- Regulations, Pending Legislation and Case Law" and "Business -- Reserves." The reduced loss ratio is also attributed to the formation in 1997 of in-house legal defense capability and the subsequent assignment of new legal defense work, as well as reassignment of open files previously handled by external attorneys. Policy acquisition costs. Policy acquisition costs increased as percentage of net premiums earned from 32.1% to 36.2% for the three months ended March 31, 1997 and 1998, respectively. The increase is due primarily to the bonus commission earned by agents which increased from $140,000 in 1997 to $245,000 in 1998. Additionally, the increase in policy acquisition costs was due in part to the decrease in ceding commission as a percentage of direct premiums written from 12.1% to 11.0% for the three months ended March 31, 1997 and 1998, respectively. The decrease in ceding commission was consistent with the decrease in premiums ceded. Contingent ceding commission. Contingent ceding commission decreased from $450,000 or 15.3% of premiums ceded for the three months ended March 31, 1997 to $62,000 or 2.0% of premiums ceded for the three months ended March 31, 1998. On certain of the Company's reinsurance contracts, the reinsurers allow the Company to participate, within predetermined limits, in the profits of the ceded business. The Company records an estimate of its ultimate participation in the profits, if any, through increases or decreases to contingent ceding commission. The majority of the decrease in 1998 is attributable to loss development on prior years. General operating costs. General operating costs decreased as a percentage of net premiums earned from 16.0% to 6.6% for the three months ended March 31, 1997 and 1998, respectively. The decrease is attributed primarily to the growth in net earned premium. Additionally, during the three months ended March 31, 1997 the Company incurred approximately $160,000 in non-recurring costs primarily related to software/system recovery expenses. 20 22 Agency expenses. Agency expenses for the three months ended March 31, 1997 and 1998 were $167,000 and $202,000, respectively, representing a 21% increase. The increase is consistent with the growth in commissions over the same period. Interest expense. Interest expense decreased from $163,000 to $151,000 for the three months ended March 31, 1997 and 1998, respectively. The decrease in interest expense related to the repayment of the $500,000 bank line of credit in April 1997. Income before federal income taxes. Income before federal income tax increased by 26% from $789,000 to $994,000 for the three months ended March 31, 1997 and 1998, respectively. Net income. Net income increased from $518,000 or $0.17 per diluted share for the three months ended March 31, 1997 to $653,000, or $0.22 per diluted share, for the three months ended March 31, 1998, representing an increase of 26%. Year ended December 31, 1996 versus December 31, 1997 Direct premiums written. Direct premiums written for the years ended December 31, 1996 and 1997 were $31.9 million and $39.5 million, respectively, representing an increase of 24%. Direct premiums written increased by the attraction of a larger percentage of business from each of the Company's existing agents, appointment of new agents and continued expansion of specialty program business (i.e., bowling centers, refuse haulers, farm labor contractors and restaurants). During 1997, total production from agents appointed as of December 31, 1996 increased by approximately 20%. The number of appointed independent agents also increased by approximately 15% from 198 as of December 31, 1996 to 227 as of December 31, 1997. The specialty program business direct premiums written increased from $6.2 million in 1996 to $8.0 million in 1997. Premiums ceded. Premiums ceded for the years ended December 31, 1996 and 1997 were $13.7 million and $12.6 million, respectively, representing a decrease of 8%. Premiums ceded as a percentage of direct premiums written decreased from 42.8% in 1996 to 31.8% in 1997, as FPIC changed its reinsurance structure to increase its retention. As discussed further in "Business -- Reinsurance," effective July 1, 1996, FPIC increased its retention on property lines of business from $300,000 to $600,000 and effective January 1, 1997, FPIC increased its retention on casualty lines of business from $100,000 to $250,000. FPIC increased its retention in order to retain more of its underwriting income and reduce the underwriting income ceded to reinsurers. Net premiums earned. Net premiums earned for the years ended December 31, 1996 and 1997 were $15.0 million and $22.9 million, respectively, representing an increase of 52%. The increase in net premiums earned is reflective of the growth in direct premiums written and reduction in premiums ceded. Commissions. Commissions earned for the years ended December 31, 1996 and 1997 were $628,000 and $709,000, respectively, representing an increase of 13%. The increase reflects the continued growth of FPIA premium production. Investment income. Investment income for the years ended December 31, 1996 and 1997 was $1.4 million and $1.7 million, respectively, representing an increase of 19%. The increase in investment income is consistent with the 16% increase in the average invested assets balance from $23.4 million in 1996 to $27.0 million in 1997. The growth in invested assets reflects the investment of cash flows generated by operations. The weighted average investment yield also increased from 6.2% for 1996 to 6.4% for 1997. Net realized gains (losses) on sales of investments. Net realized gains (losses) on sales of investments were a $52,000 net realized gain and a ($46,000) net realized loss for the years ended December 31, 1996 and 1997, respectively. Other income (expense). Other income (expense) for the years ended December 31, 1996 and 1997 was $547,000 and $800,000, respectively. Other income (expense) consists primarily of policyholder service fees related to the direct bill installment payment plan. The increase in other income (expense) is due 21 23 primarily to the increase in direct premiums written as approximately 80% of the policies issued are on the direct bill installment pay plan. Losses and loss adjustment expenses. Losses and LAE decreased as a percentage of net premiums earned from 65.1% in 1996 to 55.8% in 1997. The decreased loss ratio is due in part to a reduced "Montrose effect" as compared to 1996. The net impact to the Company was the creation of a retroactive liability for construction defect claims previously denied. The "Montrose effect" relates to the Montrose Decision and is discussed in detail at "Risk Factors -- Regulations, Pending Legislation and Case Law" and "Business -- Reserves." The reduced loss ratio is also attributed in part to the formation in 1997 of in-house legal defense capability and the subsequent assignment of all new legal defense work, as well as reassignment of open files previously handled by external attorneys. Policy acquisition costs. Policy acquisition costs increased as a percentage of net premiums earned from 31.9% in 1996 to 32.6% in 1997. The increase is due primarily to the bonus commission earned by agents which increased from $431,000 in 1996 to $639,000 in 1997. Agents earn a bonus commission ranging from 1.5% to 4.0% based on their annual production volume. Contingent ceding commission. Contingent ceding commission decreased from $3.2 million, or 23.6% of premiums ceded in 1996, to $1.5 million, or 12% of premiums ceded in 1997. On certain of the Company's reinsurance contracts, the reinsurers allow the Company to participate, within predetermined limits, in the profits of the ceded business. The Company records an estimate of its ultimate participation in the profits, if any, through increases or decreases to contingent ceding commission. Approximately one-half of the decrease in 1997 is attributable to loss development on prior years. The remaining decrease is largely attributable to a decrease in the ceded premium subject to adjustment as a result of the Company increasing its retention on the first casualty excess of loss treaty from $100,000 to $250,000 effective January 1997. General operating costs. General operating costs decreased as a percentage of net premiums earned from 12.9% in 1996 to 10.7% in 1997. The decrease is attributed to the 52% increase in net premiums earned exceeding the 27% increase in general operating expenses from 1996 to 1997, respectively. During 1997 the Company incurred approximately $300,000 in non-recurring costs primarily related to software/system recovery expenses and relocation of the Company headquarters. Agency expenses. Agency expenses for the years ended December 31, 1996 and 1997 were $688,000 and $721,000, respectively, representing a 5% increase. The increase is consistent with the growth in commissions over the same period. Interest expense. Interest expense decreased from $693,000 to $617,000 for the years ended December 31, 1996 and 1997, respectively. The decrease in interest expense related to reductions in the outstanding debt due to the prepayment of the original seller financing debt in May 1996 and the payoff of the $500,000 bank line of credit in April 1997. Income before federal income taxes. Income before federal income tax increased by 18% from $3.0 million in 1996 to $3.6 million in 1997. Net income. Net income increased from $2.0 million, or $0.69 per diluted share, for the year ended December 31, 1996 to $2.3 million, or $0.79 per diluted share, for the year ended December 31, 1997, representing an increase of 17%. Year ended December 31, 1995 versus December 31, 1996 Direct premiums written. Direct premiums written for the years ended December 31, 1995 and 1996 were $24.7 million and $31.9 million, respectively, representing a 29% increase. Direct premiums written increased due to the attraction of a larger percentage of business from each of the Company's agents, appointment of new agents and expansion of the specialty program business. During 1996, the total production increased by approximately 25% for agents who were appointed as of December 31, 1995. The number of appointed agents also increased by approximately 13% from 176 as of December 31, 1995 to 198 as of December 31, 1996. Additionally, the Company continued to diversify its geographic and portfolio risk by expanding its operating territory and adding specialty program business such as refuse haulers, farm labor 22 24 contractors, bowling centers and restaurants. The specialty programs accounted for direct premiums written of $4.7 million in 1995 and $6.2 million in 1996. Premiums ceded. Premiums ceded for the years ended December 31, 1995 and 1996 were $10.7 million and $13.7 million, respectively, representing an increase of 28%. Premiums ceded as a percentage of direct premiums written decreased from 43.1% in 1995 to 42.8% in 1996 as FPIC changed its reinsurance structure to increase its retention. As discussed further in "Business -- Reinsurance," effective July 1, 1996, FPIC increased its retention on property lines of business from $300,000 to $600,000 to retain more of its underwriting income and reduce the underwriting income ceded to reinsurers. Net premiums earned. Net premiums earned for the years ended December 31, 1995 and 1996 were $12.1 million and $15.0 million, respectively, representing an increase of 24%. Commissions. Commissions earned for the years ended December 31, 1995 and 1996 were $105,000 and $628,000, respectively. The increase reflects expanded production of surety premiums by FPIA during 1996. FPIA commenced operations during 1995. Investment income. Investment income for the years ended December 31, 1995 and 1996 was $1.0 million and $1.4 million, respectively, representing a 41% increase. The increase in investment income is due primarily to the investment of the proceeds from the $5.0 million Senior Notes issuance which occurred on December 28, 1995. Additionally, invested assets increased from $22.7 million at December 31, 1995 to $24.0 million at December 31, 1996 due to the investment of cash flow generated by operations. The average investment yield decreased from 6.6% (adjusted to reflect $5 million in investments purchased on December 29, 1995) in 1995 to 6.2% in 1996 due to declining interest rates. Net realized gains on sales of investments. Net realized gains on sales of investments were $466,000 in 1995, as compared to $52,000 in 1996. The increased realized gains in 1995 resulted from a reclassification of the investment portfolio from held to maturity to available for sale and the related sale of certain securities to take advantage of favorable market conditions. Other income (expense). There was no material change in the amount of other income from 1995 to 1996. Losses and loss adjustment expenses. Losses and loss adjustment expenses increased as a percentage of net premiums earned from 52.4% in 1995 to 65.1% in 1996. The increased loss ratio is due to the "Montrose effect". The net impact to the Company was the creation of a retroactive liability for construction defect claims previously denied. The "Montrose effect" relates to the Montrose Decision which is discussed in detail at "Risk Factors -- Regulations, Pending Legislation and Case Law" and "Business -- Reserves." Policy acquisition costs. There was no material change in the relationship of policy acquisition costs to net premiums earned between 1995 and 1996. Contingent ceding commission. Contingent ceding commission increased from $1.2 million or 11.7% of premiums ceded in 1995 to $3.2 million or 23.6% of premiums ceded in 1996. On certain of the Company's reinsurance contracts, the reinsurers allow the Company to participate, within predetermined limits, in the profits of the ceded business. The Company records an estimate of its ultimate participation in the profits, if any, through increases or decreases to contingent ceding commission. The increase in contingent ceding commission is due to loss development on the reinsurance treaties. General operating costs. General operating costs decreased as a percentage of net premiums earned from 14.2% in 1995 to 12.9% in 1996. The decrease is attributed to the 24% increase in net premiums earned exceeding the 13% increase in general operating costs and expenses from 1995 to 1996. Agency expenses. Agency expenses for the years ended December 31, 1995 and 1996 were $145,000 and $688,000, respectively. The increase is consistent with the growth in commissions over the same period. Interest expense. Interest expense increased from $128,000 to $693,000 for the years ended December 31, 1995 and 1996, respectively. The increase in interest expense is due to the issuance of $5.0 million of Senior Notes effective December 28, 1995 and is offset in part by the prepayment of the original seller financing in May 1996. 23 25 Income before federal income tax. Income before federal income tax decreased by 5% from $3.2 million in 1995 to $3.0 million in 1996. Net income. Net income decreased from $2.1 million, or $0.94 per diluted share for the year ended December 31, 1995, to $2.0 million, or $0.69 per diluted share, for the year ended December 31, 1996, representing a decrease of 27%. The Senior Note Warrants issued on December 28, 1995 increased the dilution of earnings per share in 1996 but had little effect in 1995. LIQUIDITY AND CAPITAL RESOURCES Operations The Company receives substantial cash from premiums, and to a lesser extent, reinsurance recoverables, investment income and other income. The principal cash outflows are for the payment of claims, premiums paid to reinsurers, LAE, policy acquisition costs, operating costs and taxes. Substantially all of the Company's revenue is received by, and expenses are incurred on behalf of, FPIC. Net cash provided by operations was $3.8 million and $4.3 million for the three months ended March 31, 1997 and 1998, respectively, and $2.5 million and $6.6 million for the years ended December 31, 1996 and 1997, respectively. Amounts due from reinsurers increased 72% from $4.5 million to $7.7 million as of March 31, 1997 and 1998, respectively, and 54% from $4.0 million to $6.2 million as of December 31, 1996 and 1997, respectively. Such increases were primarily due to the increase in covered losses and LAE. See Notes to Consolidated Financial Statements. Because the Company collects cash now for liabilities that may not require payment for a number of years, an increase in the Company's direct premiums written will result in an increase in its cash and investment portfolio. Since acquiring the Company in 1993, the Company's investment portfolio has increased substantially. The increase was ratable with the increase in the Company's direct premiums written. Investing Net funds used in investing activities of the Company were $2.8 million and $3.6 million for the three months ended March 31, 1997 and 1998, respectively, and $2.5 million and $6.0 million for the years ended December 31, 1996 and 1997, respectively. These comparative increases were attributable to the investment of cash provided by operating activities. The Company maintains a sufficient level of cash and liquid short-term investments to meet anticipated obligations, including claim payments. As of March 31, 1998, the Company had cash and short-term investments of approximately $1.4 million. The Company's remaining investment portfolio on such date consisted of $33.5 million of fixed maturity securities, which could provide additional liquidity and cash for operations. All of the Company's investments are investment grade, short and intermediate-term fixed income securities. See "Business -- Investments." Capital Expenditures During 1996, 1997 and the three months ended March 31, 1998, the Company purchased approximately $400,000, $700,000 and $130,000, respectively, in capital equipment. The capital expenditures consisted primarily of computer and office equipment acquired in conjunction with the upgrade and standardization of the Company's computer and office equipment and the move to its new headquarters in Rocklin, California. No significant future capital expenditures are currently planned. Financing Net funds used in financing activities of the Company were $0 for the three months ended March 31, 1998 and $0.4 and $0.5 million for the years ended December 31, 1996 and 1997, respectively. The Company has a bank line of credit agreement which provides for a $530,000 credit facility bearing interest (payable monthly) on outstanding balances at an annual rate of prime plus 1.00%. As of March 31, 24 26 1998, $500,000 of this credit facility was available. The bank line of credit matures on July 1, 1998 and will most likely be renewed. The Company believes its cash resources are adequate to meet its operating requirements. Reinsurance FPIC has quota share reinsurance, excess of loss reinsurance and semi-automatic facultative reinsurance contracts, under which certain types of policies are automatically reinsured to a predetermined amount. Due to these reinsurance agreements, the maximum exposure to the Company is $600,000 on any one property claim and $250,000 on any one liability claim. The reinsurance contracts renew annually. FPIC's reinsurers are rated "A-" or better by A.M. Best. See "Business -- Reinsurance." Dividend Restrictions Dividends paid by a California domiciled insurance company are subject to limitations imposed by the Code. Under the Code, cash dividends may be paid by an insurance company only from statutory earnings. In addition, a California domiciled insurer may not pay an "extraordinary" dividend to its stockholders without prior approval of the DOI. An extraordinary dividend or distribution is defined as a dividend or distribution of cash or other property whose fair market value, together with other dividends and distributions made within the preceding 12 months, exceeds the greater of 10% of earned surplus as regards policyholders as of December 31 of the preceding year or statutory net income (excluding unrealized capital gains) for the immediately preceding calendar year. As of January 1, 1998, the maximum dividend payable by FPIC without approval of the DOI is $1,426,000. A dividend in the amount of $300,000 was declared and paid on January 1, 1998 to fund the debt service on the Senior Notes. See "Business -- Regulation -- Regulation of Dividends and Other Payments From Insurance Subsidiaries." The Company does not anticipate paying cash dividends on its Common Stock in the foreseeable future, but instead intends to retain its earnings in order to fund the continued development and growth of the Company's business. Impact of Inflation The Company's operations, like those of other property/casualty insurers, are susceptible to the effects of inflation, as premiums are established before the ultimate amounts of losses and LAE are known. Management considers the potential effects of inflation when setting premiums. Nonetheless, such premiums may not fully compensate for the effects of inflation. In addition, inflation may adversely affect the rate of return on the Company's investment portfolio, as well as its portfolio market value. New Accounting Standards Statement of Financial Accounting Standards No. 130 ("SFAS No. 130"), "Reporting Comprehensive Income," and Statement of Financial Accounting Standards No. 131 ("SFAS No. 131"), "Disclosures about Segments of an Enterprise and Related Information," were issued in June 1997 and are effective for fiscal years beginning after December 15, 1997. SFAS No. 130 establishes standards for the reporting and display of comprehensive income, which includes net income and changes in equity except those resulting from investments by, or distributions to, stockholders. SFAS No. 130 was adopted during the first quarter of 1998. SFAS No. 131 establishes standards for disclosures related to business operating segments. The Company is currently evaluating the impact that these statements will have on the consolidated financial statements. 25 27 PRIMARY DIFFERENCES BETWEEN GAAP AND SAP The financial statements contained herein have been prepared in conformity with GAAP, as opposed to SAP, which is prescribed for insurance companies by insurance regulatory authorities. SAP differs from GAAP principally in the following respects: (a) premium income is taken into operations over the periods covered by the policies, whereas the related acquisition and commission costs are expensed when incurred; (b) deferred income taxes are not recognized; (c) certain assets such as agents' balances over 90 days due and prepared expenses are nonadmitted assets; (d) policyholder dividends are accrued when declared; (e) the cash flow statement is not consistent with classifications and the presentation under GAAP; (f) bonds are recorded at amortized cost, regardless of trading activities; and (g) loss and loss adjustment expense reserves and unearned premium reserves are stated net of reinsurance. YEAR 2000 COMPLIANCE The Company's systems are compliant with Year 2000 requirements with the exception of the claims accounting system, which the Company plans to replace before the end of 1999. The Company plans to use its existing internal programming staff to effect the replacement and does not expect to incur any significant additional costs for equipment or outside programming support. 26 28 BUSINESS GENERAL The Company is a regional, custom-underwriting insurance company. The Company writes policies for small and medium-sized commercial customers within specified niche markets which are typically overlooked by large insurance companies. During 1997, the Company derived direct premiums written from artisan contractors (40%), commercial property owners (5%), light industrial businesses (5%), a variety of other businesses (25%) and special programs (25%). The special programs were designed for refuse haulers, farm labor contractors, bowling centers and restaurants. For these programs, the Company has developed underwriting expertise and focused marketing materials and applies rate deviations or coverage extensions. The Company writes the vast majority of its business in rural markets in California. FPIC is currently rated A-(excellent) by A.M. Best. Direct premiums written increased from $15.1 million in 1994, the Company's first full year of operation, to $39.5 million in 1997. Net income increased from $777,000 in 1994 to $2.3 million in 1997. The Company's combined ratio, which is a measure of underwriting profitability, was 92% in 1997, well below the industry average of 102%. Much of the Company's growth and profitability is attributable to its retention of renewal policies. Renewal retention rates were 81%, 83% and 84% in the three years ended 1995, 1996 and 1997, respectively. The Company markets insurance through 232 independent insurance agents, as of March 31, 1998, all of which are located in California. The Company believes its relationship with its agents allows it to provide ongoing and attentive service to its targeted customer base. The Company's strategy is to focus on writing policies that typically generate between $1,100 to $5,000 in annual premiums. These policies are typically written for small businesses having one to five employees and for medium-sized businesses having more than five but less than 50 employees. Management believes this market has been overlooked by many of the larger insurance companies as a result of lower annual premiums per policy, and in some cases, the remote locations of the policyholders and the agents. During 1997, FPIC wrote 100% of its business in California. In that year, approximately 58% of FPIC's direct premiums written was for CMP-Liability coverages, 17% was for Commercial Automobile Liability coverages, 11% was for Commercial Property coverages, 6% was for Commercial Automobile Physical Damage coverages, and the remainder was for Inland Marine, Surety and Fidelity. The Company is also engaged, through its wholly owned insurance agency, FPIA, in the mail order distribution of license and permit surety bonds in 36 states on behalf of Markel Corporation. These bonds are low limit surety commitments pledged to a regulatory agency as a condition of obtaining and maintaining a business license. There are two general categories of commercial property/casualty insurance: custom underwritten policies and business owner policies ("BOPs"). The Company focuses exclusively on custom underwritten accounts, typically with an annual premium less than $25,000 (the Company's average premium per account is $4,500). While price is an important part in the purchase of any insurance policy, it is not necessarily the basis of competition for custom underwritten policies. The Company believes that by carefully underwriting individual risks, it is able to select the best risks. Most national insurance companies focus on larger custom underwritten property/casualty policies or BOPs. As a result, the Company does not directly compete with most national insurers. A BOP is a low price business insurance policy that provides broad coverages. BOPs are marketed to businesses with little differentiation from location to location, such as mini-marts and dry cleaners. BOPs' key point of differentiation is price. Management believes it obtains better risk selection and pricing by avoiding BOPs and focusing on custom underwritten property/casualty policies. The Company operates primarily in the agrarian valleys and coastal regions of California which tend to be less litigious than Southern California and the San Francisco Bay area. The Company will continue to focus on the rural regions of California, and other states, as it expands. In line with this small town strategy, the Company appoints small to mid-sized agents. The Company carefully selects its agents and closely monitors their flow of business and profitability primarily through the use of its proprietary QuoteTracker(TM) software. The Company believes that, as a specialty regional company, it provides more value to small to mid-sized 27 29 insurance agents than it provides to large agents or national brokerages. Consequently, the Company believes it has an important role in most of its agents' offices. The value of its agency relations is a key advantage for the Company. The Company strives to provide competitive base pay and attractive bonus opportunities. More than two-thirds of the Company's employees participate in objectively measured bonus plans that provide bonus opportunities of up to 50% of their annual salary. This and other employee-focused benefits make for extremely low employee turnover. Low turnover is a significant advantage both in terms of cost savings and in providing consistent relationships with the independent agents. BUSINESS STRATEGY Management attributes its success to date to the following business philosophies/strategies: (i) concentrating in its niche market segments, developing specialty insurance programs, carefully selecting its geography and avoiding market segments which the Company believes would be unprofitable; (ii) maintaining strong relationships with independent insurance agents by providing prompt underwriting decisions, competitive rates and coverages and competitive commissions; (iii) controlling losses by vigorously defending claims which the Company believes to be fraudulent, overstated or without merit; (iv) maintaining control of, and emphasizing the importance, of underwriting every risk; and (v) attracting and retaining a highly talented management team and staff. GROWTH STRATEGY The Company's long term growth strategies, while continuing to emphasize small to medium-sized businesses as its primary target markets, are to: Retain More Direct Premiums Written. The Company has historically ceded a large portion of its direct premiums written to reinsurers. This was necessary due to the relatively small surplus as regards policyholders the Company had maintained. The capital infusion provided by this Offering will allow the Company to retain more of its direct premiums written. As an example, immediately following this Offering, the Company plans to convert its expensive property quota share reinsurance contract into a less costly excess of loss reinsurance program. See "-- Reinsurance." Expand Existing Business. According to A.M. Best, the Company's market share in California for CMP insurance has increased each of the last five years. Management attributes the Company's growth to its strong relations with its independent agents, its ability to identify and launch insurance programs for specialty niches of the commercial market and its underwriting expertise. The Company intends to pursue further growth in California by selectively appointing new agents and by attracting a larger percentage of business from each of its existing agents. Develop New Programs. The Company will continue to research and develop new specialty insurance programs for small to mid-sized businesses. The Company attempts to identify business segments that are not being adequately served by the insurance market. By focusing on businesses that are not directly targeted by existing insurance programs, the Company is able to avoid competing solely on price. The Company is also negotiating with other insurers to offer products they developed through the Company's agents. This will enable the Company to enhance further its value to the agency force and earn a return on the products while avoiding the cost of developing the programs. Expand Surety Business. The Company began writing surety in 1995 to complement CMP. This business provides payment or performance guarantees on construction contracts or other obligations. In 1997, the Company wrote nearly $1.2 million in profitable surety premium using one staff underwriter. The Company plans to emphasize surety as a line of business by increasing its marketing efforts and adding to its staff. Though the market is highly competitive, the Company believes it can attract profitable surety business by focusing on providing a high level of service. Expand Geographically. The Company intends to expand its specialty insurance business into other states. Beginning with the states adjoining California, the Company will select and appoint agents in rural 28 30 areas of those states to sell its products. The Company does not intend to open branch offices. Its marketing efforts will focus on the insurance programs in which the Company has developed an expertise in underwriting. The Company is licensed currently to do business in Arizona, California, Idaho, Missouri, Montana, Nebraska, Nevada, North Dakota, Oregon, South Dakota and Utah and has license applications pending in eight additional states. INDUSTRY OVERVIEW According to A.M. Best, in 1996, the property/casualty insurance industry wrote over $270 billion of insurance premiums. The industry remains fragmented with approximately 3,000 insurance companies and 400 insurance groups licensed to transact property/casualty insurance business in the U.S. Last year, the ten largest companies accounted for less than a 43% national market share. California is the largest individual state market for insurance in the U.S., and its market characteristics are similar to the national market. California insurance premiums totaled $32.8 billion in 1996, and the ten largest companies captured only a 45% market share. MARKETING One of the Company's key competitive advantages is its excellent agency relations. The Company targets independent agents in small, rural central and northern California towns with existing books of commercial property casualty business. These agents are generally ignored by the larger companies because they cannot meet stiff production goals (usually $500,000 or more per year) or rigid account minimums (typically $25,000). The Company believes that smaller agents tend to be more loyal to an insurance company and their customers tend to be more loyal to their insurance agent. While the Company is most heavily represented in Fresno, Sacramento, Bakersfield and Santa Barbara, it is represented in approximately 100 communities across the state by 232 agents, as of March 31, 1998. The Company's four field marketing representatives visit each of the Company's agents at least once per month. The purpose of these visits is to communicate to the agents the Company's preference for specific classes of business, to identify and resolve problems and to maintain awareness of the Company's activities. The marketing representatives also review pending quotes with the agents and, on occasion, conduct brief inspections of risks submitted to the Company. The field marketing representatives do not have underwriting authority. The Company actively manages its agency force by closely monitoring the quality of submissions, hit/decline ratios, renewal retention and profitability. Semi-annually, the Company reviews its agents for application count, win ratio, average premiums per account, production and subjective factors primarily through the use of its proprietary QuoteTracker(TM) software. Over the past three years, this review has resulted in the termination of approximately 5% of the agents and placement of another 10% on rehabilitation. Over time, the Company believes that this process allows it to retain the best agents. The Company provides its agents with limited binding authority. Binding authority is extended to its agents for a few artisan contractors classes for general liability only. The Company believes that underwriting is the responsibility of the Company, and it tightly controls risk selection and pricing. Most agents want binding authority, primarily because it takes companies so long to quote a risk. The Company believes its exceptional service overcomes this concern, and consequently most agents readily accept their limited binding authority. The Company pays a 15% commission on new business and 15% on renewal business. From time to time, the Company may offer a higher commission on special programs or accounts above a certain size. These promotions usually involve paying the agent an additional 5% commission for a limited period of time. During 1997, commission payments under these promotions totaled $250,000 or 4% of commission expense. The Company also pays additional commissions to its agents based on volume. To qualify for additional commission an agent must produce at least $250,000 of written premium during the preceding year. In 1997, additional commissions based on volume totaled $639,000 or 9.0% of commission expense. In 1997, the Company implemented an incentive program to reward agents for retaining their business with the Company. 29 31 At the end of each year, agents who maintain better than 90% of their renewals will receive an additional 2% commission. The Company believes its commission schedules are competitive. By providing a market for difficult risks, by rewarding agent loyalty through incentive commissions and by maintaining consistency in the marketplace, the Company's agents place a significant value on an FPIC appointment. The Company believes that these efforts lead to high renewal retention ratios and more profitable renewal business. CUSTOMERS The Company's ultimate customers are small to mid-sized businesses. The Company reaches these customers through 232 independent insurance agents, as of March 31, 1998, who are appointed to represent the Company. The average customer pays approximately $4,500 per year for its insurance policy. During 1997, the Company derived direct premiums written from artisan contractors (40%), commercial property owners (5%), light industrial businesses (5%), a variety of other businesses (25%) and special programs (25%). The special programs were designed for refuse haulers that haul standard household and industrial waste, farm labor contractors, bowling centers and restaurants. For the refuse haulers, the Company provides, as part of its automobile coverage, sudden and accidental pollution coverage with a sublimit of $100,000 per occurrence. All other pollution or environmental liability is excluded by the Company's policy forms. For the special programs, the Company has developed underwriting expertise and focused marketing materials and applies rate deviations or coverage extensions. The Company is currently developing other specialty niche programs. Most customers choose to pay for their policies over nine months following a 25% down payment. The Company developed a payment plan to respond to the cash flow needs of small businesses and to respond to competitive pressures. LINES OF BUSINESS The Company writes an insurance policy which always, except for surety bonds, includes Commercial Multiple Peril-Liability ("CMP-Liability") and generally one or more additional lines of business. The lines of business are described below: CMP-Liability -- Insures businesses against third party bodily injury and property damage claims caused by or allegedly caused by acts or omissions of the insured. This coverage part also includes a duty to defend the insured against lawsuits filed alleging bodily injury, property damage or advertising injury caused by acts or omissions of the insured. CMP-Property -- First party insurance coverage for businesses for real and personal property, as well as ancillary coverages such as loss of income and loss of use. The insurance protects insureds against economic loss for damage or loss of use of their property as a result of a specified cause of loss. Commercial Auto Liability -- Similar to a personal auto insurance policy, this third party coverage protects businesses against third party bodily injury and property damage claims caused by or allegedly caused by drivers operating an insured's vehicle. Commercial Auto Physical Damage -- First party insurance coverage for businesses against loss or damage to one of its vehicles. The coverage pays to fix or replace damaged vehicles. Inland Marine -- First party business coverage for personal property and equipment which is generally mobile in nature. The coverage pays to fix or replace the mobile property. Surety -- The Company guarantees that one party, the principal, will perform pursuant to a contract for a second party, the obligee. If the principal fails to perform, the Company is obligated to complete the contract. Fidelity -- First party coverage for businesses against loss of money, securities and property due to burglary, theft, robbery and employee dishonesty. 30 32 FINANCIAL PACIFIC INSURANCE AGENCY Prior to the acquisition of FPIC, FPIA employed agents who served as the direct sales force for Oates and also placed workers' compensation policies with other insurance companies. Immediately following the acquisition, the direct sales strategy was abandoned due to the Company's expansion of independent agency appointments. In 1995, FPIA became a general agent for Markel American Insurance Company and Markel Insurance Company (unaffiliated members of Markel Corporation, a Glen Allen, Virginia-based specialty property/casualty insurance group). As such, FPIA produces license and permit surety bonds in 36 states. A license bond is a low limit (typically $10,000 to $15,000) surety commitment pledged to an obligee (regulatory agency) as a condition of obtaining and maintaining a business license. According to the Surety Association of America, the nationwide market for license bonds is $300 million with a loss ratio of 15%. There are more than 1,000 different types of license bonds throughout the United States. The typical license bond is underwritten with an application, financial statement and credit report. In 1997 and the three months ended March 31, 1998, FPIA generated $1,256,000 and $370,000, respectively, in direct premiums written, of which $709,000 and $207,000, respectively, was commission income to the Company. FPIA's net income for the year ended December 31, 1997 and the three months ended March 31, 1998 was $5,000 and $7,000, respectively. The Company solicits customers for license and permit surety bonds through the mail. The Company believes its direct mail distribution strategy will begin to reap substantial returns as its renewal business grows and when FPIC becomes the issuing insurance company for the license and permit bonds. Once FPIC becomes licensed in all of the states in which FPIA operates, FPIC can become the issuing insurance company for FPIA. UNDERWRITING The Company places a high degree of emphasis on underwriting and pricing discipline. More than 50% of the Company's employees work in underwriting roles, and the average underwriter has 16.6 years of experience. The underwriting department has 13 underwriters, along with support staff. The Company uses Insurance Services Offices ("ISO") underwriting rates, rules and guidelines. However, most of the Company's current rates are determined utilizing 1988 ISO loss costs, which are 35% higher, on average, than loss cost assumptions utilized in current ISO rates for the classes and territories that the Company writes. While the rates have remained the same since the Company's inception, the pricing strategy has become more conservative. The use of schedule rating credits, which are used to reduce the price of insurance for individual policies, has been substantially restricted. The limits of liability for each of the types of policies written by the Company are tailored to the needs of the insured. Approximately 90% of the CMP liability policies sold by the Company are for limits of $1,000,000. Limits are available under existing treaties with reinsurance companies up to $11,000,000. Subject to the judgment of the underwriting department, property insurance is also available under certain existing treaties with reinsurance companies up to a limit of $10,000,000. Additional insurance is available for each line of insurance provided that a facultative arrangement is obtained from an appropriate reinsurer. See "-- Reinsurance." Since price is a competitive factor in the sale of property/casualty insurance, the underwriting department attempts to ensure that prices quoted by the Company are competitive or that its product is sufficiently differentiated from less expensive alternatives. Each full-time employee of the underwriting department has the opportunity to earn an incentive bonus for meeting objective standards for service, production and quality. Management believes this plan makes the Company's underwriters and underwriting technicians the highest paid in the area. Because an underwriting job with the Company is highly desirable, turnover in the underwriting department is extremely low. 31 33 The Company also writes surety bonds through its agents. In 1996, its first full year of operations, the surety department wrote $589,000 of nearly loss-free surety business. In 1997 and the three months ended March 31, 1998, the Company wrote $1,129,000 and $162,000, respectively, in surety premium. The Company's surety customers are primarily small contractors with infrequent bond needs. These accounts require a high level of attention that many other sureties are not willing to provide. For a five-year comparison of the Company's combined ratio and the average for the property/casualty industry, see "Selected Consolidated Financial Data" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Overview." REINSURANCE Due to capital constraints, the Company has historically ceded large amounts of its premium to reinsurers. In 1996 and 1997, on a direct pre-tax basis, the Company earned $4.7 million and $4.0 million, respectively, of underwriting income. After ceding the reinsurer's portion of the premium and losses, the net underwriting income for the Company was approximately $1.7 in each of 1996 and 1997. The reinsurers received $3.0 million and $2.3 million of the Company's underwriting income in 1996 and 1997, respectively. The results from the last two years are not necessarily indicative of results in the future and the ultimate development of business ceded to the reinsurers could deviate, perhaps substantially, from such results. However, the Company believes that as a result of this Offering, it will decrease amounts ceded to reinsurers and retain a greater share of the corresponding risks. As a consequence, the Company believes it will also retain some portion of the underwriting profit, if any, related to the premiums that are no longer ceded. See "Use of Proceeds." The Company maintains reinsurance on its property, casualty, and surety businesses. On its property business, the Company has a 30% quota share on the first $2 million of any risk with a syndicate of reinsurers, resulting in a maximum company exposure of $600,000 related to any one occurrence. In excess of $2 million, the Company has an $8 million per risk semi-automatic facultative reinsurance arrangement with General Reinsurance Corporation. On the casualty business, the Company maintains a $750,000 excess of $250,000 treaty with a syndicate of reinsurers led by Gerling Global Reinsurance Company. The Company's maximum exposure on any one casualty risk is $250,000. In excess of $1 million, the Company has a semi-automatic facultative agreement with American Reinsurance Company which provides $10 million of coverage in excess of $1 million. For the Company's surety bond product line, the Company maintains a variable quota share reinsurance arrangement with General Reinsurance Company which provides various levels of participation depending on the size of a bond. The Company's current reinsurance structure has been in place since January 1, 1997 with the exception of the surety reinsurance contract which incepted in July 1995 and the $10 million excess $1 million casualty semi-automatic facultative agreement which incepted on January 1, 1998. Prior to January 1, 1997, the Company maintained a $400,000 excess $100,000 and $500,000 excess $500,000 casualty treaties and a $4 million excess $1 million casualty semi-automatic facultative agreement. The Company purchases Extra Contractual Obligations and Excess Policy Limits ("ECO/XPO") coverage through the London market. This coverage reinsures the Company's exposure for any punitive, exemplary, compensatory, or consequential damages in excess of policy limits because of alleged or actual bad faith or negligence on the Company's part in rejecting a settlement within policy limits, discharging its duty to defend or prepare the defense in the trial of an action against a policyholder of the Company, or in discharging its duty to prepare or prosecute an appeal consequent upon such an action, or otherwise handling a claim under a policy subject to this reinsurance. Prior to July 1, 1996, $1 million of this coverage was included in the Company's $1 million excess of $1 million reinsurance treaty. However, when the Company restructured its reinsurance treaty effective July 1, 1996, it began purchasing this coverage separately in the London markets, as it was more cost effective to do so. The Company currently purchases $2 million of ECO/XPO coverage through this facility. The reinsurance programs renew on an annual basis. Reinsurance coverages are placed both directly by the Company and through professional intermediaries. The Company's 1997 reinsurance costs for liability 32 34 coverage were reduced from 1996 levels due to favorable results achieved and the retention by the Company of larger portions of the risk. Although reinsurance does not discharge the original insurer from its primary liability to its policyholders, under SAP, it is the practice of insurers to treat reinsured risks as risks of the reinsurer since the primary insurer is indemnified by the reinsurers for ceded losses and LAE unless the reinsurer is unable to meet the obligations it assumed under the reinsurance agreements. The collectability of reinsurance is subject to the solvency of the reinsurers. All of the Company's reinsurance is currently placed with A- or better rated reinsurers. See "-- Ratings." In accordance with customary industry practice, the Company maintains no reserves for reinsured liabilities. In 1997, FPIC ceded $12.6 million in written premium to 17 reinsurers and reinsurer syndicates. Premiums ceded to the five largest reinsurers were: $2.9 million, Gerling Global Reinsurance; $1.7 million, SOREMA North America Reinsurance; $1.3 million, St. Paul Fire and Marine; $1.3 million, Constitution Reinsurance; and $1.2 million, Winterthur Reinsurance Corporation of America. At December 31, 1997, the Company had unsecured reinsurance recoverables for paid and unpaid losses and LAE and unearned premiums in excess of 10% of stockholders' equity from the following reinsurers: Gerling Global Reinsurance.................................. $3,398,002 SOREMA North America Reinsurance............................ 2,049,891 Winterthur Reinsurance Corporation of America............... 1,567,208 St. Paul Fire and Marine.................................... 1,396,365 Constitution Reinsurance.................................... 1,348,644
The Company reviews information concerning the Company's reinsurers, including ratings published by A.M. Best and other similar organizations. The Company is not aware of any financial difficulties being experienced by any of its reinsurers. The Company is selective in its choice of reinsurers and considers numerous factors, the most important of which is the financial stability of the reinsurer. At January 1, 1998, reinsurance arrangements were in place with one foreign and 11 domestic reinsurers. Following this Offering, the Company may convert its costly property quota share reinsurance contract to an excess of loss contract. It may also convert its surety quota share contract to an excess of loss contract. See "Use of Proceeds." CLAIMS The claims department pays claims and establishes losses and LAE reserves. In connection therewith, it resolves questions concerning policy coverage and manages reinsurance recoveries with the accounting department. Claims in litigation are defended by a staff of attorneys employed by the Company under the direction of its Vice President and General Counsel. In order to reduce the cost of defending its policyholders, the Company began hiring attorneys in late 1996 to build in-house defense capabilities. The Company has hired seven experienced insurance defense attorneys, all of whom have at least seven years of experience. As of March 31, 1998, 82% of the Company's insurance defense files were being adjusted by staff attorneys. By managing the majority of the cases with staff attorneys, the Company believes it will save a substantial amount of LAE. The Company's claims department is staffed by five claims examiners with an average of 18 years of claim adjustment experience. The claims examiners' caseloads average approximately 125 claims per examiner. Due to the combination of experience and manageable caseloads, the Company's claims personnel are effective in managing claims through frequent contact with claimants. The Company believes that a distinguishing factor between its claims department and other insurance companies' claims departments is that its claims examiners are incentivized to close claim files, all of the adjusters and attorneys are seasoned professionals and they are closely supervised by the Vice President of Claims and the Vice President and General Counsel. Senior management reviews and approves all reserves in 33 35 excess of $30,000. The Company recently established a special investigation unit which is used to investigate cases which are suspected to be fraudulent. RESERVES Loss reserves are estimates at a given point in time, based on facts and circumstances then known, of the amount the insurer anticipates it will have to pay claimants plus investigation and litigation costs. The ultimate liability in each case may differ from such estimates. During the loss settlement period, additional facts regarding individual claims may become known and, consequently, it frequently becomes necessary to refine and adjust the estimates of liability. The Company's reserving process, following industry practices, is based on the assumption that past experiences, adjusted for the effect of current developments and likely trends, is appropriate for predicting future events. The process also assumes that the legal climate regarding the claims process and legal liability theories remain constant. Any other assumptions employed by the Company or its actuaries are not readily quantifiable and are subject to revision as circumstances change. Reserves are initially set to take into account both a possible payment for the loss involved and the anticipated LAE. Adjustments to initial reserves are made periodically pursuant to the continuing investigation and evaluation by the claims department. Reserves for other claims, such as property damage by fire or other causes, are established and revised on a case-by-case basis pursuant to which a reserve amount is assigned to each claim when reported, based primarily upon an investigation of the circumstances surrounding each claim, consideration of the liability and the damages, and the insurance policy provisions relating to the claim. The Company also establishes IBNR reserves utilizing its historical experience. The IBNR reserve is established to provide for future case reserves and loss payments on claims which have been incurred but not yet reported to the Company. A significant portion of the Company's total loss reserve is the IBNR reserve. However, IBNR reserves, by definition, are not established for specific cases. In calculating IBNR reserves, the Company estimates the ultimate liability for losses and LAE by using both individual estimates for reported claims and generally accepted actuarial reserving techniques. IBNR reserve adjustments also are made to take into account changes in the volume of business written, claims frequency and severity, the mix of business, claims processing and other items that can be expected to affect the Company's liability for losses over time. IBNR reserves are periodically adjusted to correct historical deficiencies or redundancies in the reserves on a case-by-case basis. On a quarterly basis, the Company's independent actuary reviews the Company's loss data and recommends IBNR reserves. Inflation is implicitly provided for in the reserving function through analysis of cost trends and reviews of historical results. Reserves are closely monitored and are recomputed periodically using new information on reported claims and a variety of statistical techniques. The Company does not discount loss reserves. The following table sets forth a reconciliation of beginning and ending losses and LAE reserves for each of the periods shown. 34 36 Activity in the liability for unpaid losses and LAE is summarized as follows:
THREE MONTHS YEARS ENDED DECEMBER 31, ENDED --------------------------------------- MARCH 31, 1995 1996 1997 1998 ----------- ----------- ----------- ------------ Balance of unpaid losses and loss adjustment expense reserves, beginning of year................. $10,140,556 $12,013,317 $13,944,397 $19,592,060 Less reinsurance recoverables..... 4,902,732 4,349,118 4,007,047 6,184,927 ----------- ----------- ----------- ----------- Net balance at beginning of year.... 5,237,824 7,664,199 9,937,350 13,407,133 ----------- ----------- ----------- ----------- Incurred losses and loss adjustment expenses: Provision for insured events of the current year............... 6,490,825 7,394,848 10,991,179 3,112,070 Increase (decrease) in provision for insured events of prior years.......................... (165,766) 2,355,565 1,756,992 302,661 ----------- ----------- ----------- ----------- Total incurred losses and loss adjustment expenses............... 6,325,059 9,750,413 12,748,171 3,414,731 ----------- ----------- ----------- ----------- Payments: Losses and loss adjustment expenses attributable to insured events of the current year........................... 1,975,694 2,413,980 3,370,671 508,924 Losses and loss adjustment expenses attributable to insured events of prior years.......................... 1,922,990 5,063,282 5,907,717 1,727,486 ----------- ----------- ----------- ----------- Total payments...................... 3,898,684 7,477,262 9,278,388 2,236,410 ----------- ----------- ----------- ----------- Net balance at December 31.......... 7,664,199 9,937,350 13,407,133 14,585,454 Plus reinsurance recoverables..... 4,349,118 4,007,047 6,184,927 7,650,187 ----------- ----------- ----------- ----------- Balance of unpaid losses and loss adjustment expense reserves, at December 31..... $12,013,317 $13,944,397 $19,592,060 $22,235,641 =========== =========== =========== ===========
35 37 The following table sets forth the development of net reserves for unpaid losses and LAE from 1989 (the first full year of operations) through 1997. In evaluating the following information, it should be noted that each amount includes the effects of all changes in amounts for prior years. For example, the amount of redundancy related to losses settled in 1997 but incurred in 1989 is included in the cumulative redundance amount of each of the years for 1989 to 1996. The table does not present injury or policy-year development data. Conditions and trends that have affected development of the reserves in the past may not necessarily occur in the future. Accordingly, the data in the table may not be indicative of future redundancies or deficiencies.
DECEMBER 31, ------------------------------------------------------------------------------------ 1989 1990 1991 1992 1993 1994 1995 1996 1997 ------ ------ ------ ------- ------- ------- ------- ------- ------- ($'s in thousands) Liability for losses and LAE(1).................. $1,243 $3,119 $7,189 $ 6,964 $ 4,533 $ 5,238 $ 7,664 $ 9,938 $13,407 Paid (cumulative) as of:(2) One year later.......... 391 1,148 1,550 1,676 1,503 1,923 5,063 5,908 -- Two years later......... 967 2,307 3,038 2,883 2,537 4,574 8,903 Three years later....... 1,351 2,728 3,734 3,366 3,243 6,648 Four years later........ 1,594 3,012 4,074 3,601 3,897 Five years later........ 1,845 3,096 4,322 3,829 Six years later......... 1,883 3,308 4,512 Seven years later....... 1,976 3,487 Eight years later....... 2,002 Liability re-estimated as of:(3) One year later.......... 1,217 3,696 4,098 2,606 2,279 3,150 5,169 5,786 -- Two years later......... 1,141 1,731 1,717 1,059 1,011 2,409 2,927 Three years later....... 774 832 723 527 795 1,747 Four years later........ 398 445 347 397 738 Five years later........ 291 280 302 738 Six years later......... 169 224 336 Seven years later....... 22 251 Eight years later....... 42 REDUNDANCY (DEFICIENCY):........... $ (801) $ (619) $2,341 $ 2,397 $ (102) $(3,157) $(4,166) $(1,756) -- Redundancy (deficiency) as % of initial reserve(4),(5),(6)...... (64.4)% (19.8)% 32.6% 34.4% (2.3)% (60.3)% (54.4)% (17.7)% -- Gross liability for losses and loss adjustment expenses................ 10,060 7,125 10,141 12,013 13,945 19,592 Ceded liability for losses and loss adjustment expenses................ (3,096) (2,592) (4,903) (4,349) (4,007) (6,185) ------- ------- ------- ------- ------- ------- Net liability for losses and loss adjustment expenses................ 6,964 4,533 5,238 7,664 9,938 13,407 Gross liability re-estimated as of December 31, 1997....... 987 987 2,580 4,089 8,480 Gross paid cumulative as of December 31, 1997.... 6,301 6,094 8,550 10,405 6,580 ------ ------ ------ ------- ------- ------- ------- ------- Gross liability re-estimated............ 7,288 7,081 11,130 14,494 15,060 Gross reserve redundancy (deficiency)............ 2,772 44 (989) (2,481) (1,115) Gross reserve redundancy (deficiency) as % of initial reserve......... 27.6% 0.6% (9.8)% (20.7)% (8.0)%
- --------------- (1) Sets forth the estimated liability for unpaid losses and LAE recorded at the balance sheet date for each of the indicated years; represents the estimated amount of losses and LAE for claims arising in the current and all prior years that are unpaid at the balance sheet date, including IBNR. (2) Cumulative losses and LAE payments made in succeeding years for losses incurred prior to the balance sheet date. 36 38 (3) Re-estimated amount of the previously recorded liability based on experience for each succeeding year, increased or decreased as payments are made and more information becomes known about the severity of remaining unpaid claims. (4) Shows the cumulative redundancy or deficiency at December 31, 1997 of the reserve estimate shown on the top line of the corresponding column. A redundancy in reserves means that reserves established in prior years exceeded actual losses and LAE or were reevaluated at less than the originally reserved amount. A deficiency in reserves means that the reserves established in prior years were less than actual losses and LAE or were reevaluated at more than the originally reserved amount. (5) Prior to 1994, fluctuation in the net reserve redundancy was attributable to a $2.4 million reserve reduction in 1993 and a $2.4 million reserve increase in 1991. In 1991, the Company posted an IBNR reserve of approximately $2.4 million. The result was a net incurred losses and LAE ratio of 165%. During 1993, in conjunction with the acquisition, management determined that the Company's IBNR reserves were redundant and recorded a reserve reduction of $2.4 million. As a result, the redundancy trend in 1992 and 1993 ended. (6) The reserve deficiency noted in 1994 to 1996 resulted primarily from the effects of the Montrose Decision in July 1995. The impact to the Company was the creation of retroactive liability for construction defect claims previously denied. The Company has subsequently revised its underwriting practices in response to the Montrose Decision. See "Risk Factors -- Regulations, Pending Legislation and Case Law." Reserve variances have been affected by continued growth in premium volume and increases in IBNR, particularly in the CMP liability line between 1993 and 1994. The reserves for IBNR losses and the LAE anticipated changes in costs related to each prior year's claims. At the same time, the insurance industry was experiencing inflation in the ultimate resolution values of personal injury claims. The inflation of personal injury claim values has been principally attributed to rapidly increasing medical treatment costs, increasing jury awards for pain and suffering and increased loss adjustment and related litigation costs. In addition to the adjusted IBNR, specific measures undertaken include monitoring the actual paid medical, vigorous defense of claims deemed to be nuisance suits, and ongoing monitoring of pain and suffering awards and related LAE and litigation expenses. Adjustments are made in IBNR reserves on a periodic basis to account for documented cost increases, and similar adjustments are made to case reserves based on individual claim reviews and audits. Actual reserve development due to IBNR claims and underreported claims is continually monitored and adjustments to reserves are made consistent with this actual experience. During the loss adjustment period, additional facts regarding individual claims may become known. As the Company becomes aware of additional facts, it may become necessary to refine and adjust liability estimates. Accordingly, the ultimate liability may be less than or greater than the revised estimates. INVESTMENTS Substantially all investments are held by FPIC and are subject to regulation by the DOI. Investments are made under the direction of the Company's Chief Executive Officer and Chief Financial Officer pursuant to written guidelines approved by the Board of Directors. The written guidelines establish specific criteria for quality, marketability, holding size and maturity for each type of investment. Furthermore, the criteria are set to meet the Company's anticipated liquidity needs and tax positions. The Company's investment portfolio is managed with the intent to provide growth and safety of surplus as regards policyholders in order to facilitate increased premium writings over the long-term while maintaining the ability to service current insurance operations. 37 39 The following table shows the composition of the Company's investment portfolio by type of security as of December 31, 1995, 1996 and 1997.
DECEMBER 31, MARCH 31, --------------------------------------------------------- ----------------- 1995 1996 1997 1998 ----------------- ----------------- ----------------- ----------------- AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT ------- ------- ------- ------- ------- ------- ------- ------- ($'s in thousands) BY TYPE OF SECURITY: United States government and agencies............ $ 6,449 28.4% $ 9,870 41.1% $15,628 52.1% $17,074 51.0% States, municipalities and political subdivisions............ 1,289 5.7% 268 1.1% 71 0.2% 70 0.2% Corporate................. 14,951 65.9% 13,708 57.0% 14,065 46.9% 16,144 48.2% Certificates of deposit... -- 0.0% 200 0.8% 213 0.8% 216 0.6% ------- ----- ------- ----- ------- ----- ------- ----- Total investments... $22,689 100.0% $24,046 100.0% $29,977 100.0% $33,504 100.0% ======= ===== ======= ===== ======= ===== ======= =====
Fixed maturity investments are valued in the above table at market value. The amortized cost of fixed maturities was $22,604,000, $24,764,000 and $30,028,000 at December 31, 1995, 1996 and 1997, respectively. Fixed maturity investments held by the Company generally have an investment quality rating of "A" or better by independent rating agencies. The following table shows the composition of the Company's fixed maturity investments (at amortized cost), by rating as of December 31, 1995, 1996 and 1997.
DECEMBER 31, MARCH 31, --------------------------------------------------------- --------------------- 1995 1996 1997 1998 ----------------- ----------------- ----------------- --------------------- AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT ------- ------- ------- ------- ------- ------- ----------- ------- ($'s in thousands) BY RATING(1): U.S. Treasury and U.S. Agency Bonds........ $ 6,449 28.4% $ 9,870 41.0% $15,628 52.1% $ 17,074 51.0% AAA to A.............. 15,023 66.2% 12,259 51.0% 11,515 38.4% 13,578 40.5% BBB................... 1,217 5.4% 1,717 7.2% 2,621 8.8% 2,636 7.9% Certificates of Deposit............. -- 0.0% 200 0.8% 213 0.7% 216 0.6% ------- ----- ------- ----- ------- ----- ----------- ----- Total Investments.. $22,689 100.0% $24,046 100.0% $29,977 100.0% $ 33,504 100.0% ======= ===== ======= ===== ======= ===== =========== =====
- --------------- (1) Represents the lower of the ratings assigned by Moody's Investor's Services, Inc. or Standard and Poor's Corporation. The amortized cost of fixed maturity investments exceeded the market value by approximately $51,000 at December 31, 1997. At the same date, the Company held callable fixed maturities with an aggregate market value of $13.2 million. The amortized cost of fixed maturities as of December 31, 1995, 1996 and 1997 is shown by contractual maturity below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Management projects the anticipated weighted average maturity of the fixed maturities to be 6.7 years. Management attempts to generally match its property/casualty assets and liabilities. The maturity of claim and benefit liabilities of property/casualty insurance companies can only be estimated by using actuarial methods. Although a single figure for weighted average maturity of liabilities is not available, the Company's actuaries continually review historical data on claims maturation. In light of the review, management structures its fixed income portfolio 38 40 accordingly. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."
DECEMBER 31, MARCH 31, --------------------------------------------------------- ----------------- 1995 1996 1997 1998 ----------------- ----------------- ----------------- ----------------- AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT ------- ------- ------- ------- ------- ------- ------- ------- ($'s in thousands) BY MATURITY: One year and under........ $ 77 0.3% $ 1,830 7.6% $ 1,152 3.8% $ 1,152 3.4% Over one year through five years................... 6,364 28.1% 8,287 34.5% 9,954 33.2% 10,916 32.6% Over five years through ten years............... 9,330 41.1% 8,662 36.0% 14,681 49.0% 17,969 53.6% Over ten years............ 6,918 30.5% 5,267 21.9% 4,190 14.0% 3,467 10.4% ------- ----- ------- ----- ------- ----- ------- ----- Total Investments... $22,689 100.0% $24,046 100.0% $29,977 100.0% $33,504 100.0% ======= ===== ======= ===== ======= ===== ======= =====
Investment results of the Company for the periods indicated are shown in the following table.
YEARS ENDED DECEMBER 31, THREE MONTHS ----------------------------- ENDED 1995 1996 1997 MARCH 31, 1998 ------- ------- ------- -------------- ($'s in thousands) Invested assets(1)..................... $17,812 $23,368 $27,012 $31,741 Investment income(2)................... $ 1,029 $ 1,449 $ 1,720 $ 510 Average yield(3)....................... 5.8% 6.2% 6.4% 6.4% Net realized gain (losses)............. $ 466 $ 52 $ (46) --
- --------------- (1) Average of the aggregate invested amounts at the beginning and end of the period. (2) Investment income is net of investment expenses and does not include realized or unrealized investment gains or losses or provision for income taxes. (3) The 1995 average yield was impacted by the $5 million capital infusion from the sale of the Senior Notes which funded the purchase of $5 million in investments on December 28, 1995. COMPETITION The property/casualty insurance industry is highly competitive. The Company competes with other property/casualty insurers both in the recruitment and retention of qualified independent agents to sell its products. Success in recruiting and retaining independent agents willing to sell the Company's products or services is dependent upon the commission rates, services and the ability of the insurer to provide products that meet the needs of the agent and the agent's customers. In selling its insurance products, the Company competes with other insurers through independent agents (including insurers represented by the independent agents who represent the Company), with insurers having their own agency organizations and with direct sellers of insurance products. There are numerous companies competing for business in the geographic areas in which the Company operates. No single company dominates the marketplace, but many of the Company's competitors have more established national reputations and substantially greater financial resources and market share than the Company. The Company pays its agents a base commission of 15% with additional commission for meeting increasing volume levels. Should other insurers begin paying higher commissions than the Company, this would present a competitive disadvantage in attracting and retaining high-quality agents. While recognizing the significance of the rate of commission, the Company believes its efforts to serve the agents and their customers by providing superior service in underwriting and claims processing will allow it to continue to compete with other insurers. Twice per year, the Company surveys its agents to understand the nature of the competitive environment. The agents indicate that the Company competes with many companies, but few consistently. According to its 39 41 agents, FPIC's most consistent competitor is Allied Group. Agents were asked which companies they viewed as FPIC's main competitors. The following table summarizes the results of the last agent survey, conducted in August 1997:
COMPETITORS % of Agents(1) - ----------- -------------- Allied Group................................................ 17% Golden Eagle Insurance Company.............................. 10% Maryland Casualty Insurance Company......................... 10% Valley Insurance Company.................................... 7% CNA......................................................... 5% Fireman's Fund Insurance Company............................ 5% 10 Other Companies.......................................... 27%
- --------------- (1) Represents the percentage of survey respondents indicating that these companies compete with FPIC. RATINGS The oldest and most widely quoted insurance financial rating firm is Best's Insurance Reports, published by the firm of A.M. Best. Based on 1993 and prior results, FPIC was assigned an initial rating in April 1994 of B++ (Very Good) by A.M. Best. An A.M. Best rating is assigned after an extensive quantitative and qualitative evaluation of a company's financial condition and operating performance. An A.M. Best rating represents the current and independent opinion of a company's financial strength and ability to meet obligations to policyholders. Such ratings do not relate to the protection of investors or indicate expected investment results, and therefore do not address the quality of the insurer's securities or the advisability of an investment in such securities. In March 1996, A.M. Best upgraded FPIC's rating to A- (excellent) and in 1997 the A- rating was re-affirmed. A.M. Best rates firms both on quality and on size. The size categories range from I, which represents surplus as regards policyholders of less than $1 million, to XV, which represents surplus as regards policyholders of greater than $2 billion. Prior to the Offering, FPIC was financial size V, representing surplus as regards policyholders between $10 million and $25 million. Following this Offering, it is expected that FPIC will be category VI, representing surplus as regards policyholders between $25 million and $50 million. When considering whether to accept an FPIC policy, customers often review both the rating and the financial category size. While many customers view an A rating as sufficient, there are others that require financial category sizes of VII and greater. There can be no assurance that customers will continue to accept FPIC's rating and financial category size regardless of the Offering. A.M. Best provides ratings based on an insurer's annual financial reports and survey information for several years of operations. A.M. Best rates over 2,300 property/casualty insurers each year. For years prior to the 1994, FPIC was not assigned a letter rating by A.M. Best due to what A.M. Best described as "insufficient experience," A.M. Best requires five full years of operating activity before assigning a rating. Ratings above B+ are B++ (Very Good), A- and A (excellent), A+ and A++ (Superior). Ratings below B+ are B, B-, C++, C+, C, C-, D, E, F and NA (not issued). REGULATION National Association of Insurance Commissioners In order to enhance the regulation of insurer solvency, the NAIC adopted a formula and model law to implement risk-based capital ("RBC") requirements for property/casualty insurance companies designed to assess the minimum capital requirements for the protection of policyholder obligations. The RBC model law provides for four levels of regulatory action. The extent of regulatory intervention and action increases as a level of surplus to RBC falls. The first level, the Company Action Level (as defined by the NAIC), requires an insurer to submit a plan of corrective actions to the regulator if surplus falls below 200% of the RBC amount. The Regulatory Action Level (as defined by the NAIC) requires an insurer to submit a plan 40 42 containing corrective actions and requires the relevant insurance commissioner to perform an examination or other analysis and issue a corrective order if surplus falls below 150% of the RBC amount. The Authorized Control Level (as defined by the NAIC) gives the relevant insurance commissioner the option either to take the aforementioned actions or to rehabilitate or liquidate the insurer if surplus falls below 100% of the RBC amount. The fourth action level is the Mandatory Control Level (as defined by the NAIC) which requires the relevant insurance commissioner to rehabilitate or liquidate the insurer if surplus falls below 70% of the RBC amount. Based on the foregoing formulae, as of December 31, 1997, FPIC's ratio of total adjusted surplus to Authorized Control Level RBC was 340%. The NAIC's Insurance Regulatory Information System ("IRIS") was developed by a committee of state insurance regulators and is primarily intended 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 12 industry ratios and specifies "usual values" for each ratio. Departure from the usual values on more than four of the ratios may lead to increased regulatory oversight. Based on its 1997 statutory financial statement, FPIC was within the usual range for eight of the 12 IRIS tests. FPIC was not within the usual range of ratios for Change in Net Writings and Surplus Aid to Surplus due to growth in net written premium and contingent ceding commission related to favorable loss experience on the swing-rated reinsurance treaties. A swing-rated reinsurance treaty allows the ceding company to share in the profitability of its reinsurance program by receiving a portion of a reinsurance contract's profits. During 1997, net written premium increased by 48% which exceeded the upper limit of the NAIC usual range of 33%. Additionally during 1997 FPIC recorded $1.5 million in contingent ceding commission related to the swing-rated reinsurance treaties. Unusual values were also noted for IRIS ratios for the Two-Year Reserve Development to Surplus and Estimated Current Reserve Deficiency to Surplus. These ratios were both impacted by the results of the Montrose Decision and the resultant retroactive liability. See "Risk Factors -- Regulations, Pending Legislation and Case Law" and "-- Reserves." General The Company is principally regulated by the DOI and the Commissioner. California and various other states have established supervisory agencies with broad authority to regulate, among other things, licenses to transact business, premium rates for certain coverages, trade practices, agent licensing, policy forms, underwriting and claims practices, reserve adequacy and insurer solvency. California, like many jurisdictions, also regulates investment activities on the basis of quality, distribution and other quantitative criteria. The Company's insurance operations and accounts are subject to examination upon request by California insurance regulators. The Company is also subject to examination by all other states in which it is licensed to do business. California has also enacted legislation which regulates insurance holding company systems, including acquisitions, dividends, the use of surplus, the terms of affiliate transactions and other related matters. The last DOI examination of the Company was for the three years ended December 31, 1994. The California insurance holding company law also requires the Group to register with the DOI and file certain reports containing information concerning its capital structure, ownership, financial conditions and general business operations. Recently, the insurance industry has been subject to increased scrutiny. A number of state legislatures have considered or enacted legislative proposals that alter and, in many cases, increase the authority of state agencies to regulate insurance companies and holding company systems. In addition, legislation has been introduced in several of the past sessions of Congress which, if enacted, could result in the federal government assuming some role in the regulation of the insurance industry. Several committees of Congress have made inquiries and conducted hearings as part of a broad study of the regulation of United States insurance companies. In partial response to Congress' initiatives, the NAIC and insurance regulators are re-examining existing laws and regulations and their application to insurance companies. In particular, this re-examination has 41 43 focused on insurance company investment and solvency issues and, in some instances, has resulted in new guidelines. The NAIC has formed groups to study and formulate regulatory proposals on such diverse issues as the use of surplus debentures, accounting for reinsurance transactions and the adoption of RBC rules. In addition, in connection with its accreditation of states and as part of its program to monitor the solvency of insurance companies, the NAIC requires states to adopt model NAIC laws and regulations on specific topics, such as holding company regulations and the definition of extraordinary dividends. California is accredited by the NAIC. Accordingly, California has followed regulatory rule-making that makes the form of its insurance regulation generally consistent with the model NAIC laws. It is not possible to predict the future impact of changing state and federal regulations on the Company's operations. California and most other states have insurance laws requiring that property/casualty rate schedules, policy or coverage forms, and other information be filed with the states' regulatory authority. In many cases, such rates and/or policy forms must be approved prior to use. There can be no assurance that state or federal regulatory requirements will not become more stringent in the future and have an adverse effect on the operations of the Company's insurance subsidiary or on stockholder values. Insurance companies are required to file detailed annual reports with the state insurance regulator in each of the states in which they do business and their business and accounts are subject to examination by such agencies at any time. The Company files these reports with the DOI, the NAIC and in all other states in which it is licensed to do business. In addition, insurance regulators occasionally examine the insurer's financial condition, adherence to statutory accounting principles, and compliance with insurance department rules and regulations. In the event of a default on FPIC's liabilities or the insolvency, liquidation or other reorganization of FPIC, the rights of the creditors and stockholders of FPIC to proceed against the assets of FPIC, would be governed by state insurance laws relating to liquidation and rehabilitation. Therefore, if FPIC were to be liquidated or the subject of rehabilitation proceedings, such liquidation or rehabilitation proceedings would be conducted by the Commissioner as the receiver with respect to all FPIC's assets and business. Under the Code, all creditors of FPIC, including policyholders, would be entitled to payment in full from such assets before the Group, as a stockholder, would be entitled to receive any distribution thereof. Insurance Regulation Concerning Change or Acquisition of Control The Code contains provisions to the effect that the acquisition or change of "control" of a domestic insurer or of any person (e.g. parent or holding company) that controls a domestic insurer cannot be consummated without the prior approval of the Commissioner. In general, a presumption of "control" arises from the ownership, control, possession with the power to vote or possession of proxies with respect to 10% or more of the voting securities of a domestic insurer or of a person that controls a domestic insurer. A person seeking to acquire control, directly or indirectly, of a domestic insurance company or of any person controlling a domestic insurance company must generally file with the Commissioner a statement relating to the acquisition of control containing certain information required by statute and published regulations and provide a copy of such statement to the domestic insurer. In addition, certain state insurance laws contain provisions that require pre-acquisition notification to state agencies of a change in control of a non-domestic insurance company admitted in the state. While such pre-acquisition notification statutes do not authorize the state agency to disapprove the change of control, such statutes do authorize certain remedies, including the issuance of a cease and desist order with respect to the non-domestic admitted insurer if certain conditions exist such as undue market concentration. Any future transactions involving the acquisition of 10% or more of the Company's Common Stock by any one person or affiliated group would also currently require approval by the Commissioner and, should the Company expand its operations to other states, would require the pre-acquisition notification in those states which have adopted pre-acquisition notification provisions. Such requirements may deter, delay or prevent certain transactions affecting the ownership of the Company's Common Stock. 42 44 Limits on Writing Business The Commissioner has extremely broad power to evaluate insurance companies on a case-by-case basis, without specific regard to published rules or standards. That is, if the Commissioner deems an insurer to be in a potentially hazardous condition detrimental to the interests of the public, the Commissioner has the authority to issue orders to a particular company, restrict a company's writings, or place it under supervision or into receivership. Management of the Company is aware that the Commissioner is always concerned with companies being overly leveraged by writing large volumes of premium even though they may possess limited surplus as regards policyholders. Regulation of Dividends and Other Payments from Insurance Subsidiaries The Company is a legal entity separate and distinct from its subsidiaries. As a holding company with no other significant business operations, its primary sources of cash to meet its obligations, including principal and interest payments with respect to indebtedness, or to be able to make stockholder distributions, are dividends and other statutory permitted payments from FPIC. The payment of dividends to the Company by FPIC is subject to limitations imposed by the Code which provides that cash dividends may be paid by FPIC only from retained earnings and surplus as regards policyholders. In addition, an insurer subject to the insurance holding company law may not pay an "extraordinary" dividend to its stockholders without the prior approval of the Commissioner of Insurance. An extraordinary dividend or distribution includes any dividend or distribution of cash or other property, the fair market value of which, together with that of other dividends or distributions made within the preceding 12 months, exceeds the greater of (i) 10% of such insurer's surplus as regards policyholders as of the preceding December 31, or (ii) 100% of the insurer's statutory net income (excluding unrealized capital gains) for the preceding year. FPIC presently pays the Company to service the interest payments on the Company's $5 million Senior Notes. For the 12 months ended December 31, 1997, these interest payments totaled $600,000. The authority of the Commissioner and government regulators in a number of other states is such that, if insurance regulators determine that payment of a dividend or any other payments to an affiliate would, because of the financial condition of the paying insurance company or otherwise, be hazardous to such insurance company's policyholders or creditors, the regulators may disapprove, prohibit, or mandate return of such payments that would otherwise be permitted without prior approval. If the ability of FPIC to pay dividends or make other payments to the Company is materially restricted by regulatory requirements, it could affect the Company's ability to pay dividends to stockholders and/or service debt. No assurance can be given that California (or other states in which the Company is licensed or may someday be licensed) will not adopt statutory provisions more restrictive than those currently applicable. The Company presently has no plans to pay dividends to its stockholders. See "Dividend Policy." Surplus as Regards Policyholders As a California admitted insurer, FPIC is subject to the primary jurisdiction of the insurance regulations of California. As the Company expands its operations, it will also be subject to the regulators of each state in which it does business. Such regulators have the authority, in connection with continued licensing (or where not yet doing business, in the granting of licensing), to limit or prohibit writing new business within their jurisdiction when, in the state's judgment, the insurance subsidiary is not maintaining adequate capital and surplus as regards policyholders. Surplus as regards policyholders is the excess of all assets over all liabilities under SAP. This amount is regarded as a measure of financial protection to policyholders in the event an insurance company suffers unexpected or catastrophic losses. At March 31, 1998, the Company's surplus as regards policyholders under SAP was $14,075,000. See "Risk Factors -- Regulations, Pending Legislation and Case Law." 43 45 Investment Regulations The Company is subject to state laws and regulations that require diversification of its investment portfolio. Such regulations could cause non-conforming investments to be treated as non-admitted assets for purposes of measuring surplus as regards policyholders and, in some instances, could require divestiture. As of March 31, 1998, the Company's investments complied with such laws and regulations in all material respects. The NAIC has proposed the development of a model investment code ("Model Code") which would provide uniform regulation of insurance company investments in those states that adopt the Model Code. Although insurance industry and regulatory groups have been working on the development of the Model Code for several years, it is unclear at this time what the final provisions will be. The Company believes that FPIC could comply with the existing proposals without adverse consequences. Membership in Solvency Funds and Associations FPIC, like other insurers, is required to participate in insolvency funds and associations in each state in which FPIC is licensed, and may be subject to assessments from time to time to cover unpaid policyholder claims of insolvent insurers participating in the same lines of business as the Company. The maximum assessment authorized by law in California in any one year has varied between 1% and 2% of annual premiums written in California. Most of these payments are recoverable through future policy surcharges and premium tax reductions. No material assessments have been made on FPIC. Shared Markets As a condition of receiving a license to do business in California and most other states, a property-casualty insurance company is required to participate in mandatory property-casualty shared market mechanisms or pooling arrangements which provide various insurance coverages to individuals and other entities that otherwise are unable to purchase such coverage voluntarily through private insurers. These shared market mechanisms are structured differently depending on the state in which they are established and the particular type of insurance provided through the mechanism. Included within the shared market mechanisms are structures generally referred to as assigned risk plans, reinsurance facilities, limited liability pools and property shared markets or "fair plans." The Company's participation in such shared market mechanisms is generally in amounts related to the amount of the Company's direct premiums written for the types of coverage. The cost of mandatory participation in such shared market mechanisms has not had a materially adverse effect on the Company's operations, liquidity and capital resources in the past. For the past three years, the Company incurred no costs to participate in these mechanism. The amount of future losses or assessments from the commercial lines shared market mechanisms and pooling arrangements cannot be predicted with certainty. Federal Legislative Proposals For the past several years, Congress and certain federal agencies have been investigating the current condition of the insurance industry (encompassing both life and property-casualty insurance) in the United States to determine whether such form of federal role in the regulation of insurance companies would be appropriate. Congress has conducted several hearings and issued reports relating in general to the solvency of insurers as well as the effectiveness of state regulation. Over the past several years Congress has investigated whether it should establish an independent federal agency to regulate the financial condition of federally-certified life and property-casualty insurers and reinsurers in the United States. Among several proposals considered in Congress, which may be introduced in the future, was a bill which would allow insurers and reinsurers to elect voluntarily to obtain a certificate of solvency from this federal agency or to conduct regulation. Additionally, such insurers and reinsurers would also remain subject to state regulation. At least one congressional initiative has been introduced in Congress to modify or repeal the McCarran-Ferguson Act (which provides a limited exemption to the "business of insurance" from federal antitrust laws, to the extent it is subject to state regulation). Additionally, judicial decisions narrowing the definition of "business of insurance" for McCarran-Ferguson Act purposes may limit the ability of insurance companies in general to share information with respect to rate setting, underwriting and claims management practices in general. It is 44 46 not possible to predict whether or in what form this proposed legislation will be enacted or the potential effects thereof on the Company and its competitors. It is not possible to predict the outcome of any of the foregoing legislative, administrative or congressional activities nor the potential effects thereof on the Company. EMPLOYEES As of March 31, 1998, the Company had 93 full-time and 26 part-time employees. The Company is not a party to any collective bargaining agreement. The Company believes relations with its employees are good. PROPERTIES The Company leases a 25,000 square foot office building as its headquarters in Rocklin, California. Currently all but three employees work at the Rocklin location. It is anticipated that the existing premises will be suitable for at least several years. The Company owns a vacant 2.91 acre lot adjacent to the Company's headquarters for future expansion. LEGAL PROCEEDINGS Except for ordinary, routine litigation incidental to the Company's business, there are no pending legal proceedings to which the Company is a party. The nature of the Company's business subjects it to claims or litigation relating to policies of insurance it has issued. Management believes that the Company is not a party to any pending legal proceedings which are likely to have a material adverse effect on its business, financial conditions or results of operations. 45 47 MANAGEMENT The following table provides information regarding the executive officers and directors of the Company. Biographical information for each of the individuals set forth in the table is presented below:
NAME AGE TITLE ---- --- ----- Robert C. Goodell..... 43 Chairman of the Board, President, Chief Executive Officer, Director Robert T. Kingsley.... 32 Executive Vice President, Chief Operating Officer, Treasurer, Secretary Artur A. Terner....... 31 Vice President and Chief Financial Officer Timothy N. Blaede..... 37 Vice President of Information Services John R. Hollingshead.. 45 Vice President and General Counsel Edward J. Paoletti.... 52 Vice President of Underwriting Wallace G. Rascher.... 67 Vice President of Sales and Marketing Charles E. Wardlaw.... 56 Vice President of Claims Stephen E. Adamson.... 41 Director Patrick C. Haden...... 45 Director Michael J. Morrissey.. 50 Director Richard G. Pfeiffer... 53 Director
Mr. Goodell has served as President and Chief Executive Officer and a Director of the Company since June 1993 when he and the current stockholders acquired the Company. From 1992 to 1993, Mr. Goodell provided management consulting services at CAST Management Consultants, Inc. From 1984 to 1992, Mr. Goodell served as Executive Vice President and Chief Financial Officer of Amwest Insurance Group, Inc. From 1983 to 1984, he served as Vice President Financial Systems at California Federal Savings and Loan. From 1980 to 1983, he served as a Manager-Management Consulting for Peat, Marwick, Mitchell & Co. Between 1977 and 1980, Mr. Goodell held positions as Controller/Treasurer of Insurance Subsidiaries of Teledyne, Inc. Mr. Kingsley, Executive Vice President and Chief Operating Officer, joined the Company in August 1993, prior to the acquisition of the Company. Mr. Kingsley worked for Xerox Corporation as a Financial Analyst from 1992 to 1993 following the completion of his MBA. From 1987 to 1991, Mr. Kingsley was Assistant Treasurer for Amwest Surety Insurance Company. From 1985 to 1987, Mr. Kingsley served as Senior Insurance Analyst with the Surety Bond Branch of the U.S. Treasury Department. Mr. Terner joined the Company in 1994 as Controller, succeeding to his current position of Vice President and Chief Financial Officer in 1997. Mr. Terner was employed from 1989 to 1994 in various positions of increasing responsibility culminating in the position of Supervising Senior Accountant at KPMG Peat Marwick concentrating primarily in the financial institution practice. Mr. Blaede joined the Company as Vice President of Information Services in January 1997. Prior to joining the Company, he was Manager of Special Projects at ISI Systems, Inc. From 1995 to 1996, he worked as Senior Project Manager for Innovative Computer Systems. During the period from 1983 to 1995, Mr. Blaede served in positions of increasing responsibility at ISI Systems, Inc. culminating in the post of Manager, Custom Development. Mr. Hollingshead joined the Company in November 1996 as its senior in-house defense counsel and was promoted to Vice President and General Council in 1997. From 1995 to 1996, he was Managing Attorney for Marlin & Saltzman, a San Francisco Bay Area insurance defense firm which provided litigation services exclusively for Atlantic Mutual Insurance Co. From 1982 to 1995, Mr. Hollingshead was an attorney with Capps, Staples et al, in Walnut Creek, California. Mr. Paoletti became Vice President of Underwriting in 1996. From 1982 to 1996 he was Vice President/ Branch Manager in the Sacramento office for CIGNA Corporation. From 1978 to 1982, Mr. Paoletti was employed by CG/Aetna Insurance as Casualty Supervisor in Orange County, California and Underwriting Manager in Portland, Oregon. Previously, he was Personal and Commercial Lines Underwriter at Ohio 46 48 Casualty Insurance from 1976 to 1978 and Casualty Underwriter for Safeco Insurance based in Fountain Valley, California from 1974 to 1976. Mr. Rascher joined Financial Pacific in 1992 as Vice President of Sales and Marketing. From 1991 to 1992, he was Field Auditor at DJ Insurance Services, where he provided workers' compensation and general liability audits to insurance company clients. From 1989 to 1991, Mr. Rascher was Branch Manager/Regional Business Manager in Fresno, California for Sequoia Insurance Company. From 1970 to 1989, Mr. Rascher served in positions of increasing responsibility with California Insurance Group, including Manager of the Sacramento Branch Office, Vice President of Marketing and Sales, and various underwriting positions. Mr. Wardlaw joined the Company in November 1997 as its Vice President of Claims. From 1985 to 1997, Mr. Wardlaw was the owner of an independent property/casualty claims adjusting firm in Sacramento, California. From 1972 to 1985, Mr. Wardlaw held various claims positions with United Pacific/Reliance Insurance Company including manager of the Sacramento service center branch. In 1971, Mr. Wardlaw began his career with Safeco Insurance Company. Mr. Adamson became a member of the Board in 1993. Mr. Adamson is a managing member of Celerity Partners, a private equity firm specializing in leveraged buyouts. Prior to forming Celerity Partners in 1995, Mr. Adamson was a managing director of W.E. Myers & Co., a merchant banking firm. Mr. Adamson serves as Chairman of the Board of Dynamic Circuits, Inc. and is a director of several private companies. Mr. Haden became a member of the Board in 1993. Since 1987, Mr. Haden has been a general partner of Riordan, Lewis & Haden ("RLH"), a Los Angeles based partnership which invests in management buy-out and venture capital transactions. Mr. Haden also serves as a director of Tetra Tech, Inc., Data Processing Resources Corporation, PIA Merchandising Services, Inc. and several private companies. Mr. Morrissey became a member of the Board in 1993. Since 1983, Mr. Morrissey has been the Chairman and Chief Executive Officer of Firemark Group, a merchant banking firm specializing in insurance related investments. Mr. Morrissey also serves as a director of Pembridge, Inc. and New Cap Re Holdings, Limited. Mr. Pfeiffer became a member of the Board in 1995. Mr. Pfeiffer has worked for St. Paul Fire and Marine Insurance Company in various capacities since 1971. He is currently a Vice President working on St. Paul's worldwide insurance operations. The directors were each elected in accordance with the Stockholders Agreement dated September 7, 1993, as amended (the "Stockholders Agreement"), which requires that each stockholder will vote for the election of directors, such that the following persons are elected to the Board: (i) one nominee designated by FinPac Partners ("FinPac"), (ii) one nominee designated by St. Paul Fire and Marine Insurance Company ("St. Paul"), (iii) one nominee designated by Firemark Global Insurance Fund, L.P. ("Firemark"), (iv) the Chief Executive Officer; and (v) one nominee designated by the above four nominees. The Stockholders Agreement will terminate upon the conclusion of this Offering. See "Principal and Selling Stockholders" and "Certain Transactions." The Audit Committee of the Board of Directors consists of Messrs. Adamson, Haden, Morrissey and Pfeiffer. The Audit Committee meets privately once per year with the Company's independent auditor and actuary. Directors of the Company who are not employed by the Company or any subsidiary receive a fee of $5,000 per quarter. Directors are also entitled to reimbursement for reasonable out-of-pocket expenses related to travel for Board meetings. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Company has formed a Compensation Committee of its Board of Directors which consists of Messrs. Haden and Adamson. Mr. Haden is the nominee of RLH, the general partner of FinPac, to the Board, and Mr. Adamson is the nominee of FinPac, St. Paul, Firemark and the Chief Executive Officer to the Board. 47 49 See "Certain Transactions" for information regarding the interests of RLH in certain transactions and arrangements involving the Company. The Compensation Committee evaluates executive performance in relationship to individual efforts and contributions to corporate earnings and makes recommendations for raises and merit bonuses. The Compensation Committee is also responsible for administration of the Company's 1993 Stock Incentive Plan. Neither Mr. Haden nor Mr. Adamson was at any time during the year ended December 31, 1997, or at any other time, an officer or employee of the Company. No member of the Compensation Committee serves as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving as a member of the Company's Board or Compensation Committee. EXECUTIVE COMPENSATION The following Summary Compensation Table sets forth the compensation earned by (i) the Company's Chief Executive Officer; (ii) the other four most highly compensated executive officers at the end of 1997; and (iii) a former executive officer who would have been one of the other four most highly compensated executive officers if he remained employed with the Company (the "Named Executive Officers") for services rendered in all capacities to the Company for each of the fiscal years in the three year period ended December 31, 1997. SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION ------------ SECURITIES ALL NAME AND FISCAL UNDERLYING OTHER PRINCIPAL POSITION YEAR SALARY BONUS OPTIONS COMPENSATION(1) ------------------ ------ -------- -------- ------------ --------------- Robert C. Goodell.................. 1997 $244,043 $ 76,795 -- $ 2,684 President, Chief Executive Officer 1996 $219,734 $ 25,000 -- $ 2,079 and Chairman of the Board 1995 $175,676 $118,148 -- $ 1,402 Robert T. Kingsley................. 1997 $135,580 $ 38,475 -- $ 2,642 Executive Vice President and 1996 $117,517 $ 39,250 15,776 $ 2,152 Chief Operating Officer 1995 $ 89,464 $ 50,000 1,972 $ 1,580 Wallace G. Rascher................. 1997 $103,778 $ 34,200 -- $ 3,379 Vice President -- Sales and 1996 $ 91,508 $ 25,000 5,916 $ 2,745 Marketing 1995 $ 84,488 $ 45,000 1,972 $ 2,203 Edward J. Paoletti................. 1997 $108,516 $ 38,475 -- $ 2,288 Vice President -- Underwriting 1996 $ 78,366 $ 55,000 9,860 $ 216 1995 -- -- -- -- Timothy N. Blaede.................. 1997 $ 87,461 $ 51,813 9,860 $ 94 Vice President -- 1996 -- -- -- -- Information Services 1995 -- -- -- -- John R. Aye........................ 1997 $112,228 $ -- -- $55,788 Vice President -- Claims(2) 1996 $100,260 $ 25,000 5,916 $ 1,788 1995 $ 87,162 $ 50,000 1,972 $ 1,122
- --------------- (1) Consists of excess premiums paid by the Company for group term life insurance, contributions by the Company to the executive's 401(k) benefit plan and, when applicable, value of personal use of automobiles and severance benefits. (2) Effective December 15, 1997, Mr. Aye no longer served as an officer of the Company. He received $53,500 in severance benefits in 1997. 48 50 The following table sets forth information concerning options granted to the Named Executive Officers of the Company during the 1997 fiscal year. OPTION GRANTS IN LAST FISCAL YEAR
POTENTIAL REALIZABLE VALUE AT ASSUMED ANNUAL NUMBER OF RATES OF STOCK SECURITIES PERCENT OF PRICE APPRECIATION UNDERLYING TOTAL OPTIONS FOR OPTION TERMS OPTIONS GRANTED TO EXERCISE ($)(2) GRANTED EMPLOYEES IN PRICE EXPIRATION -------------------- NAME (#)(1) FISCAL YEAR (%) ($/SHARE) DATE 5% 10% ---- ------------- --------------- --------- ---------- -------- --------- Timothy N. Blaede....... 9,860 100% $4.82 2/12/07 $77,401 $123,250
- --------------- (1) Option vests ratably over the succeeding five anniversary dates. (2) The potential realizable value columns of the table illustrate values that might be realized upon exercise of the option immediately prior to its expiration, assuming the Common Stock appreciates at the compounded annual rates specified over the term of the option. These numbers do not take into account provisions of the option providing termination of the option following termination of employment or nontransferability of the option and do not make any provision for tax associated with exercise. Because actual gains will depend upon, among other things, future performance of the Common Stock, there can be no assurance that the amounts reflected in this table will be achieved. The following table sets forth information concerning the number of options owned by the Named Executive Officers and the value of any in-the-money unexercised stock options as of December 31, 1997. No options were exercised by the Named Executive Officers during fiscal 1997. AGGREGATE OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES
NUMBER OF VALUE OF SECURITIES UNEXERCISED UNDERLYING IN-THE-MONEY UNEXERCISED OPTIONS OPTIONS AT AT DECEMBER 31, DECEMBER 31, 1997(#) 1997($)(1)(2) ------------------- --------------- SHARES ACQUIRED VALUE EXERCISABLE/ EXERCISABLE/ NAME ON EXERCISE(#) REALIZED($) UNEXERCISABLE UNEXERCISABLE - ---- --------------- ----------- ------------------- --------------- Robert C. Goodell............. -- -- 0/0 $0/$0 Robert T. Kingsley............ -- -- 11,832/7,888 $23,309/$12,148 Wallace G. Rascher............ -- -- 5,916/3,944 $14,198/$6,074 Edward J. Paoletti............ -- -- 1,972/7,888 $2,781/$11,122 Timothy N. Blaede............. -- -- 0/9,860 $0/$9,071 John R. Aye................... -- -- 5,916/3,944 $14,198/$6,074
- --------------- (1) Because there is no established public trading market for Common Stock, the Board of Directors of the Company must, under certain circumstances, determine the fair market value of the Common Stock. The Company believes that the fair market value of the Common Stock was $5.94 per share as of December 31, 1997. (2) Values for "in-the-money" outstanding options represent the positive spread between the respective exercise prices of the outstanding options and the fair market value of the underlying Common Stock of $5.94 per share as described in Note 1. EMPLOYMENT AGREEMENTS The Company has an employment agreement with Robert C. Goodell, pursuant to which Mr. Goodell holds the position of Chief Executive Officer and Director, for a one-year term. This agreement will renew automatically at the end of such term and each anniversary thereafter for another one-year term unless 49 51 terminated in accordance with such agreement. Mr. Goodell is paid a salary of $250,000 per annum subject to increase as agreed to by Mr. Goodell and the Board. He is also eligible to receive a bonus of up to 50% of his annual base salary, as determined by the Board of Directors. The agreement also provides for an automobile allowance not to exceed $900 per month and standard benefits under any Company employee benefits plan and any additional benefits that are approved by the Board. Upon termination of employment due to disability or by the Company (with or without cause), Mr. Goodell will receive a severance payment equal to the monthly portion of his annual base salary for the first 12 months after termination of employment regardless of any amounts earned by him from other employment during such period. During this 12 month period, Mr. Goodell will be entitled to all standard employee benefits. Also, upon such termination or upon termination due to death, Mr. Goodell will receive the unpaid portion of his annual base salary and the prorated portion of his bonus. If Mr. Goodell voluntarily terminates his employment, he is entitled only to the unpaid portion of his annual base salary. During his employment and at all times thereafter, Mr. Goodell will be subject to disclosure restrictions regarding confidential information of the Company. For 36 months after his termination, Mr. Goodell also may not solicit any employees of the Company to become employed by Mr. Goodell or his subsequent employer. In February 1997, the Company entered into an employment agreement with Robert T. Kingsley pursuant to which Mr. Kingsley became Executive Vice President and Chief Operating Officer of the Company. The agreement provides for an unspecified annual salary. Upon termination of his employment by the Company or by mutual agreement with the Company, Mr. Kingsley will receive a severance of six months his annual base salary. This severance payment will not be offset by any amounts earned by him from any other employment during such six month period. Mr. Kingsley will not receive a severance payment upon termination as a result of his death or resignation. The Company entered into employment agreements with Messrs. Rascher, Blaede, Terner, Wardlaw and Hollingshead with terms identical to those of Mr. Kingsley's contract. All of these contracts, including Mr. Kingsley's, are terminable upon 30 days written notice by the Company. In February 1996, the Company entered into an employment agreement with Edward J. Paoletti, pursuant to which Mr. Paoletti became Vice President of Underwriting. The agreement calls for an annual salary of $100,000 and a bonus equal to 50% of his base salary based on achievement targets regarding production, quality and service goals for the underwriting department. If the Company terminates Mr. Paoletti's employment for any reason, it will pay severance equal to 36 weeks of his annual salary. He will receive no other benefits other than those provided by COBRA during such severance period. RESTRICTED STOCK AGREEMENT The Company entered into a Restricted Stock Agreement dated September 7, 1993 with Mr. Goodell in which the Company has the right to repurchase for cancellation up to 268,819 shares of Common Stock (the "Initial Shares") held by Mr. Goodell upon the occurrence of certain events at a purchase price of $0.00394 per share. These events include: Mr. Goodell's termination, a change in control of the Company and December 31, 1998. A "change in control" includes a merger or consolidation of the Company into another company, the sale of all or substantially all of the assets of the Company or a sale of all or substantially all of the capital stock of the Company. From 1994 to 1998, a portion of the Initial Shares became exempt from repurchase (the "Exempt Shares") upon the Company meeting certain net income thresholds. These net income targets will be adjusted if the Company consummates a public offering in which the Series A Stock is converted into Common Stock. Further, upon a "change in control" of the Company, all Initial Shares will become Exempt Shares. As of December 31, 1997, 209,021 Initial Shares had become Exempt Shares. In addition, if Mr. Goodell terminates his employment for any reason on or before December 31, 1998, the Company may repurchase all shares of Common Stock (including Exempt Shares) held by Mr. Goodell (including shares held by trusts established for the benefit of Mr. Goodell or his spouse) except for Initial 50 52 Shares, at a price equal to "book value" per share. The "book value" per share will be the initial price paid for such shares plus the net income of the Company determined in accordance with GAAP, calculated from the date of the agreement to the end of the fiscal quarter immediately preceding the fiscal quarter in which Mr. Goodell is terminated. The Company may purchase Initial Shares at $0.00394 per share. If the Company fails to repurchase all of Mr. Goodell's shares upon such termination, the other stockholders of the Company may repurchase his shares at the same price offered to the Company. In the event of the death of Mr. Goodell, his estate has the right to cause the Company to repurchase any shares not repurchased in the manner described above at the price the shares were first offered to the Company, provided that, the estate may not the cause a repurchase to exceed the amount of proceeds from any key man life insurance covering Mr. Goodell. 1993 STOCK INCENTIVE PLAN The Company's 1993 Stock Incentive Plan (the "Incentive Plan") was adopted by the Board of Directors on September 7, 1993. The Company has reserved 109,420 shares for issuance under the Incentive Plan. As of March 31, 1998, 1,972 shares had been issued upon exercise of options granted under the Incentive Plan, options for 82,819 shares were outstanding and 24,629 shares remained available for future grant. Shares of Common Stock subject to outstanding options, which expire or terminate prior to exercise, will be available for future issuance under the Incentive Plan. Under the Incentive Plan, employees and consultants may be awarded any form of Company securities (an "Award"), including without limitation, options to purchase shares of Common Stock, shares of Common Stock, warrants, phantom stock, stock appreciation rights, restricted shares, stock units or a combination thereof. These individuals may also receive cash bonuses under the Incentive Plan. Options may be incentive stock options designed to satisfy Section 422 of the Internal Revenue Code or nonstatutory stock options not designed to meet such requirements. The Incentive Plan is administered by the Compensation Committee. The Compensation Committee has the complete discretion to determine which eligible individuals are to receive Awards; determine the Award type; determine the number of shares subject to an Award, vesting requirements and other features and conditions of such Awards; interpret the Incentive Plan; and make all other decisions relating to the operation of the Incentive Plan. Upon a change in control, the Compensation Committee may accelerate the receipt of benefits pursuant to an Award. A change in control includes a merger or consolidation of the Company, the dissolution or liquidation of the Company, a sale of all or substantially all of the assets of the Company and acquisition of a specified percentage of the combined voting power of the Company's outstanding stock. The Board may amend or terminate the Incentive Plan at any time. Amendments may be subject to stockholder approval to the extent required by applicable laws. In any event, the Incentive Plan will terminate on September 7, 2003, unless sooner terminated by the Board. 401(K) PLAN The Company sponsors a contributory 401(k) Plan. All full-time employees of the Company 21 years of age or older who have completed one year of service are eligible for participation in the Plan. Currently, the Company matches 100% of the employee's pre-tax contribution up to $2,000 and matched 100% of each employee's contribution up to $1,000 and $1,500 in 1995 and 1996, respectively, to the Plan. The total amount matched for 1995, 1996 and 1997 was $20,565, $61,435, and $87,980, respectively. 51 53 PRINCIPAL AND SELLING STOCKHOLDERS The following table sets forth certain information with respect to the beneficial ownership of the Company's Common Stock as of April 1, 1998 and as adjusted to reflect the sale of Common Stock offered hereby, by: (i) each person known by the Company to beneficially own more than 5% of the outstanding shares of Common Stock; (ii) each of the Company's directors; (iii) each of the Named Executive Officers; (iv) each Selling Stockholder; and (v) all directors and executive officers of the Company as a group. Except as otherwise indicated, the Company believes that the beneficial owners of the Common Stock listed below, based on information furnished by such owners, have sole investment and voting power with respect to such shares, subject to community property laws where applicable.
BENEFICIAL SHARES OWNERSHIP NUMBER OF BENEFICIALLY PRIOR TO SHARES TO OWNED AFTER OFFERING BE SOLD OFFERING(1) ---------------------- IN THE ---------------------- SHARES PERCENTAGE OFFERING SHARES PERCENTAGE --------- ---------- --------- --------- ---------- Robert C. Goodell(2)................... 381,265 12.7% 381,265 7.6% Robert T. Kingsley(3).................. 15,776 * 15,776 * Wallace G. Rascher(4).................. 7,888 * 7,888 * Edward J. Paoletti(5).................. 3,944 * 3,944 * Timothy N. Blaede(6)................... 1,972 * 1,972 * Riordan, Lewis & Haden(7).............. 771,712 25.7% 136,971 634,741 12.7% Patrick C. Haden(7).................... 771,712 25.7% 634,741 12.7% Firemark Advisors, Inc.(8)............. 771,712 25.7% 136,971 634,741 12.7% Michael J. Morrissey(8)................ 771,712 25.7% 634,741 12.7% St. Paul Fire & Marine Insurance Company(9)........................... 771,712 25.7% 136,972 634,740 12.7% Richard G. Pfeiffer(9)................. -- -- -- -- Celerity Partners, L.P.(10)............ 59,367 2.0% 59,367 -- -- Stephen E. Adamson(11)................. 110,542 3.7% 51,175 1.0% Robert S. Goodell(12).................. 39,438 1.3% 10,000 29,438 * W.E. Myers(13)......................... 40,940 1.4% 40,940 * Brian Sanderson(14).................... 10,235 * 10,235 * David Rogers(15)....................... 70,894 2.4% 19,719 51,175 * All Directors and Executive Officers as a Group (11 persons)................. 2,072,697 68.9% 1,739,388 34.8%
- --------------- * Less than 1% (1) Assumes no exercise of the Underwriters' over-allotment option. (2) Includes 321,211 shares held jointly by Robert C. and Suzanne M. Goodell as of April 1, 1998. The address of such persons is c/o Financial Pacific Insurance Group, Inc., 3850 Atherton Road, Rocklin, California 95765. (3) Consists of 15,776 shares issuable upon exercise of options which are exercisable as of, or will be exercisable within 60 days of, April 1, 1998. (4) Consists of 7,888 shares issuable upon exercise of options which are exercisable as of, or will be exercisable within 60 days of, April 1, 1998. (5) Consists of 3,944 shares issuable upon exercise of options which are exercisable as of, or will be exercisable within 60 days of, April 1, 1998. (6) Consists of 1,972 shares issuable upon exercise of options which are exercisable as of, or will be exercisable within 60 days of, April 1, 1998. (7) Includes 178,108 shares issuable upon exercise of warrants which are exercisable as of April 1, 1998. Shares are owned by FinPac Partners, L.P., the general partner of which is RLH. Mr. Haden, a Director 52 54 of the Company, may be deemed to share voting and investment power with respect to all such shares as a general partner of RLH. Mr. Haden does not own any shares directly. The address of such persons is 300 S. Grand Avenue, 29th Floor, Los Angeles, California 90071 (8) Includes 178,108 shares issuable upon exercise of warrants which are exercisable as of April 1, 1998. Shares are owned by Firemark. Mr. Morrissey, a Director of the Company, may be deemed to have voting and investment power with respect to all such shares as the Chairman and Chief Executive Officer of Firemark. Mr. Morrissey does not own any shares directly. The address of such persons is 67 Park Place, Morristown, New Jersey 07960. (9) Includes 178,108 shares issuable upon exercise of warrants which are exercisable as of April 1, 1998. The address of such persons is 385 Washington Street, MC 516A, St. Paul, Minnesota 55102. Mr. Pfeiffer has disclaimed beneficial ownership of the shares owned by St. Paul. (10) Consists of 59,367 shares issuable upon exercise of warrants which are exercisable as of April 1, 1998. (11) Includes 59,367 shares held by Celerity Partners, L.P. Mr. Adamson, a Director of the Company, may be deemed to have voting and investment power with respect to all such shares as the managing member of Celerity Partners. Mr. Adamson also owns 51,175 shares directly, that are issuable upon exercise of warrants which are exercisable as of April 1, 1998. (12) Mr. Goodell is the father of Robert C. Goodell. (13) Consists of 40,940 shares issuable upon exercise of warrants which are exercisable as of April 1, 1998. (14) Consists of 10,235 shares issuable upon exercise of warrants which are exercisable as of April 1, 1998. (15) Includes 51,175 shares issuable upon exercise of warrants held by UMB Bank NA as successor trustee of Latham & Watkins Thrift & Profit Sharing Retirement Plan-10A FBO D. Rogers, which are exercisable as of April 1, 1998. CERTAIN TRANSACTIONS On December 28, 1995, the Company entered into a Note and Warrant Purchase Agreement (the "Agreement") with Firemark, FinPac, St. Paul, and Celerity FinPac, LLC ("Celerity"). Pursuant to the Agreement, the Company issued and sold: (i) $5,000,000 aggregate principal amount of its 12% Senior Notes due January 1, 2001 (the "Senior Notes") and (ii) Common Stock Purchase Warrants for the purchase of up to 593,691 shares of the Company's Common Stock (the "Senior Note Warrants"), as follows: Firemark, FinPac and St. Paul each acquired a Senior Note in the principal amount of $1,500,000 and Senior Note Warrants to acquire 178,108 shares of Common Stock, and Celerity acquired a Senior Note in the principal amount of $500,000 and Senior Note Warrants to acquire 59,367 shares of Common Stock. In accordance with the terms of the Senior Notes, the Company has paid interest at the rate of 12% per annum thereon on July 1, 1996, January 1 and July 1, 1997, and January 1, 1998 to Firemark, FinPac, St. Paul and Celerity. The Company intends to prepay the Senior Notes with a portion of the proceeds from this Offering. See "Use of Proceeds." The Senior Note Warrants may be exercised at any time prior to January 1, 2004, and have an exercise price of $5.61 per share. However, such Senior Note Warrants must be exercised in connection with an underwritten public offering of the Company's Common Stock in which the gross proceeds to be received by the Company equal or exceed $10,000,000 and the public offering price of the Common Stock is not less than $12.69 per share (as adjusted for stock splits, dividends or other recapitalization transactions). Holders of the Senior Note Warrants are entitled to certain registration rights. See "Description of Capital Stock -- Registration Rights." Patrick C. Haden, a Director of the Company, is a general partner of RLH, the general partner of FinPac. Mr. Haden is also of counsel to Riordan & McKinzie, the Company's legal counsel. Michael J. Morrissey, a Director of the Company, is the Chairman and Chief Executive Officer of Firemark Advisors, Inc. ("Advisors"), the general partner of Firemark. In June 1997, the Company contracted with Advisors to render financial advisory services. Advisors was paid a fee of $50,000 plus expenses of $13,099 for its services. 53 55 Since 1995, St. Paul, through its reinsurance affiliate, has participated on the Company's property quota share and casualty excess of loss reinsurance treaties. St. Paul has a 7.5% participation on the property quota share reinsurance treaty and a 15% participation on the casualty excess of loss reinsurance treaty. St. Paul is subject to the same terms and conditions as all other reinsurance treaty participants. During 1997, the Company ceded $1,269,000 of written premium to St. Paul. At December 31, 1997, the Company had a reinsurance recoverable under its reinsurance treaties of $1,336,000 due from St. Paul which consists of paid and unpaid losses and loss adjustment expenses and unearned premiums, net of amounts payable by the Company to St. Paul. During 1997, Mr. Goodell sold 15,187 shares of Common Stock to each of FinPac, St. Paul and Firemark at a price of $9.88 per share. The total proceeds to Mr. Goodell were $450,000. The Company has entered into indemnification agreements with its directors and executive officers for the indemnification of and advancement of expenses to such persons to the full extent permitted by law. The Company also intends to execute such agreements with its future directors and executive officers. The Company believes that the foregoing transactions were in its best interest and were made on terms no less favorable to the Company than could have been obtained for unaffiliated third parties. All future transactions between the Company and any of its officers, directors or principal stockholders will be approved by a majority of the independent and disinterested members of the Board of Directors, will be on terms no less favorable to the Company than could be obtained from unaffiliated third parties and will be in connection with bona fide business purposes of the Company. DESCRIPTION OF CAPITAL STOCK The Company's authorized capital stock consists of 7,500,000 shares of Common Stock and 2,000,000 shares of Preferred Stock. The following is a description of the authorized capital stock of the Company as of April 15, 1998. At such date, there were seven holders of record of the Common Stock and three holders of record of the Series A Stock. COMMON STOCK As of April 15, 1998, there were 487,955 shares of Common Stock and 4,400 shares of Series A Stock outstanding. There will be 4,816,897 shares of Common Stock outstanding (assuming conversion of all shares of Series A Stock into 1,735,521 shares of Common Stock, the full exercise of all Senior Note Warrants into 593,691 shares of Common Stock and no exercise after April 1, 1998, of outstanding options) after giving effect to the sale of shares of Common Stock to the public offered hereby. Holders of Common Stock are entitled to one vote per share and have no cumulative voting rights. In general, action to be taken by a vote of the stockholders of the Company requires the affirmative vote of at least a majority of the votes cast by the holders of Common Stock entitled to vote, except that the election of directors requires a plurality of the votes cast at an election. Consequently, the holder or holders of record of more than 50% of the outstanding shares of Common Stock can elect all of the Company's directors. Subject to any preferences that may be applicable to subsequently issued shares of Preferred Stock, if and when issued, the holders of Common Stock are entitled to receive such dividends as may be declared from time to time by the Board of Directors in its discretion from funds legally available therefor, and upon liquidation, winding up and/or dissolution of the Company are entitled, after payment of liabilities and preferences of outstanding Preferred Stock, if any stock, to share ratably in assets available for distribution. The holders of Common Stock have no preemptive rights, cumulative voting rights, or rights to convert shares of Common Stock into any other securities and are not subject to future calls or assessments by the Company. All outstanding shares of Common Stock of the Company are fully paid and nonassessable. Prior to the date of this Registration Statement, there has been no established public trading market for the Common Stock. The Company has applied for listing of the Common Stock on the Nasdaq National Market. See "Risk Factors -- Lack of Prior Public Market for Common Stock." 54 56 PREFERRED STOCK Upon the consummation of the Offering, the Company will have no outstanding preferred stock, but the Board of Directors, without further action by the holders of the Common Stock, is authorized to fix the dividend rights and terms, conversion or exchange rights, voting rights, redemption rights and terms, liquidation preferences, sinking fund and any other designations, powers, rights, preferences, privileges, qualifications, limitations and restrictions applicable to each series of preferred stock. The issuance of preferred stock could adversely affect the voting power and other rights of the holders of Common Stock. The authority possessed by the Board of Directors to issue preferred stock could potentially be used to discourage attempts by others to obtain control of the Company through a merger, tender offer, proxy contest or otherwise by making such attempts more difficult or more costly to successfully complete. The Board of Directors may issue preferred stock with voting, dividend or liquidation and conversion right that could adversely affect the rights of the holders of Common Stock. There are no agreements or understandings for the issuance of preferred stock, and the Board of Directors has no present intention to issue any preferred stock. As of April 15, 1998, the Board of Directors has designated one series of preferred stock, Series A Stock, comprised of 5,000 shares of the Preferred Stock, 4,400 of which were outstanding. Each share of Series A Stock has a stated value of $1,000. Upon the consummation of the Offering, each share of Series A Stock will, pursuant to the terms of the Company's Restated Certificate of Incorporation, convert into 394.375 shares of Common Stock. WARRANTS As of April 1, 1998, the Company has outstanding Warrants providing for the purchase of an aggregate of 747,216 shares of Common Stock (the "Warrants"). The exercise price of the Warrants range from $2.54 to $5.61 per share, and the Warrants expire on dates ranging from September 7, 2003 to January 1, 2004. Warrants to purchase 593,691 shares of Common Stock will be exercised in connection with this Offering. Under the Warrants, the holder may elect to exercise its Warrant by payment of the exercise price or on a cashless basis. The holders of the Senior Note Warrants will exercise their Warrants by canceling indebtedness under the Senior Notes in the amount of the exercise price. SECTION 203 OF THE DELAWARE GENERAL CORPORATION LAW The Company is subject to Section 203 of the Delaware General Corporation Law ("Section 203"), which, subject to certain exceptions, prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years following the date that such stockholder became an interested stockholder, unless: (i) prior to such date, the board of directors of the corporation approved either the business combination or the transaction that resulted in the stockholder becoming an interested stockholder; (ii) upon consummation of the transaction that resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding for purposes of determining the number of shares outstanding those shares owned (x) by persons who are directors and also officers and (y) by employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer; or (iii) on or subsequent such date, the business combination is approved by the board of directors and authorized at an annual or special meeting of stockholders, and not by written consent, by the affirmative vote of at least 66 2/3% of the outstanding voting stock that is not owned by the interested stockholder. Section 203 defines business combination to include: (i) any merger or consolidation involving the corporation and the interested stockholder; (ii) any sale, transfer, pledge or other disposition of 10% or more of the assets of the corporation involving the interested stockholder; (iii) subject to certain exceptions, any transaction that results in the issuance or transfer by the corporation of any stock of the corporation to the interested stockholder; (iv) any transaction involving the corporation that has the effect of increasing the proportionate share of the stock of any class or series of the corporation beneficially owned by the interested stockholder; or (v) the receipt by the interested stockholder of the benefit of any loans, advances, guarantees, 55 57 pledges or other financial benefits provided by or through the corporation. In general, Section 203 defines an interested stockholder as any entity or person beneficially owning 15% or more of the outstanding voting stock of the corporation and any entity or person affiliated with or controlling or controlled by such entity or person. REGISTRATION RIGHTS At April 15, 1998, assuming conversion of all shares of Series A Stock into 1,725,251 shares of Common Stock and the full exercise of the Senior Note Warrants into 593,691 shares of Common Stock, holders of approximately 2,816,897 shares of Common Stock are entitled to certain rights with respect to the registration of such shares under the Securities Act. Under the terms of the Stockholders Agreement, if the Company proposes to register any of its securities under the Securities Act, either for its own account or for the account of other security holders exercising registration rights, such holders are entitled to notice of such registration and are entitled to include shares of such Common Stock therein. All of these registration rights are subject to certain conditions and limitations, among them the right of the underwriters of an offering to limit the number of shares included in such registration. These rights to cause the Company to register such shares shall terminate once such shares may be sold in accordance with Rule 144(k) under the Securities Act. TRANSFER AGENT AND REGISTRAR Registrar and Transfer Company of Cranford, New Jersey will be the transfer agent and registrar for the shares of Common Stock. INDEMNIFICATION OF DIRECTORS AND OFFICERS Section 102 of the DGCL authorizes a Delaware corporation to include a provision in its Certificate of Incorporation limiting or eliminating the personal liability of its directors to the corporation and its stockholders for monetary damages for breach of the directors' fiduciary duty of care. The duty of care requires that, when acting on behalf of the corporation, directors exercise an informed business judgment based on all material information reasonably available to them. Absent the limitations authorized by such provision, directors are accountable to corporations and their stockholders for monetary damages for conduct constituting gross negligence in the exercise of their duty of care. Although Section 102 of the DGCL does not change a director's duty of care, it enables corporations to limit available relief to equitable remedies such as injunction or rescission. The Company's Certificate of Incorporation and Bylaws include provisions which limit or eliminate the personal liability of its directors to the fullest extent permitted by Section 102 of the DGCL. Consequently, a director of officer will not be personally liable to the Company or its stockholders for monetary damages for breach of fiduciary duty as a director, except for (i) any breach of the director's duty of loyalty to the Company or its stockholders; (ii) acts or omissions not in good faith or which involved intentional misconduct or a knowing violation of law; (iii) unlawful payments of dividends or unlawful stock repurchases, redemptions or other distributions; and (iv) any transaction from which the director derived an improper personal benefit. The Company Certificate of Incorporation and Bylaws also provide, in effect, that, to the fullest extent and under the circumstances permitted by Section 145 of the DGCL, the Company will indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative, by reason of the fact that he or she is a director or officer of the Company, or is or was serving at the request of the Company as a director or officer of another corporation or enterprise. The inclusion of these indemnification provisions in the Company's Certificate of Incorporation and Bylaws is intended to enable the Company to attract qualified persons to serve as directors and officers who might otherwise be reluctant to do so. The Company may, in its discretion, similarly indemnify its employees and agents. Depending upon the character of the proceeding, the Company may indemnify its directors and officers against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred in connection with any action, suit or proceeding if the person indemnified acted in good faith and in a manner he or she reasonably believed to be in or not opposed to the best interests of the 56 58 Company, and, with respect to any criminal action or proceeding, had no cause to believe his or her conduct was unlawful. To the extent that a director or officer of the Company has been successful in the defense of any action, suit or proceeding referred to above, under the DGCL, the Company would have the obligation to indemnify him or her against expenses (including attorneys' fees) actually and reasonably incurred in connection therewith. In addition, the limited liability provisions in the Certificate of Incorporation and the indemnification provisions in the Certificate of Incorporation and Bylaws may discourage stockholders from bringing a lawsuit against directors for breach of their fiduciary duty (including breaches resulting from grossly negligent conduct) and may have the effect of reducing the likelihood of derivative litigation against directors and officers, even through such an action, if successful, might otherwise have benefited the Company and its stockholders. Furthermore, a stockholder's investment in the Company may be adversely affected to the extent the Company pays the costs of settlement and damage awards against directors and officers of the Company pursuant to the indemnification provisions in the Company's Bylaws. The limited liability provisions in the Certificate of Incorporation will not limit the liability of directors under federal securities laws. SHARES ELIGIBLE FOR FUTURE SALE Upon completion of the Offering, the Company will have 4,816,897 shares of Common Stock outstanding (assuming conversion of all shares of Series A Stock into 1,735,221 shares of Common Stock, the full exercise of all Senior Note Warrants into 593,691 shares of Common Stock and no exercise after April 1, 1998 of outstanding options). All 2,500,000 shares sold pursuant to this Offering will be freely tradable without restriction or further registration under the Securities Act, unless held by an "affiliate" of the Company (as that terms is defined below). Any such affiliate would be subject to the resale limitation of Rule 144 adopted under the Securities Act. The remaining shares of outstanding Common Stock are "restricted securities" (the "Restricted Shares") within the meaning of Rule 144 under the Securities Act and may not be sold in the absence of a registration under the Securities Act unless an exemption from registration is available, including an exemption contained in Rule 144. Of the Restricted Shares, an aggregate of 2,816,897 shares of Common Stock will be eligible for sale in the public market subject to Rule 144 and Rule 701 under the Securities Act and the expiration of a contractual lock-up ending 180 days after the date of the Prospectus, unless an earlier release is consented to, in whole or in part, by the Representative. In general, under Rule 144 as currently in effect, any person (or person who shares are aggregate for purpose for Rule 144) who has beneficially owned restricted securities, as that term is defined in Rule 144, for at least one year (including, in the case of a nonaffiliated holder, any period of ownership of preceding nonaffiliate holders) is entitled to sell, within any three-month period, a number of shares that does not exceed the greater of (i) 1% of the then outstanding shares of Common Stock of the Company, or (ii) the average weekly trading volume in Common Stock during the four calendar weeks preceding such sale, provided that certain public information about the Company, as required by Rule 144, is then available and the seller complies with the manner of sale and notification requirements of the rule. A person who is not an affiliate and has not been an affiliate within three months prior to the sale and has, together with any previous owners who were not affiliates, beneficially owned restricted securities for at least two years is entitled to sell such shares under Rule 144 (k) without regard to any of the volume limitations described above. Rule 701 permits resales of shares issued pursuant to certain compensatory benefit plans and contracts and prior to the date the issuer becomes subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), subject to certain limitations on the aggregate offering price of a transaction and certain other conditions, commencing 90 days after the issuer becomes subject to the reporting requirements of the Exchange Act, in reliance upon Rule 144, but without compliance with certain restrictions, including the holding period requirements, contained in Rule 144. In addition, the Securities and Exchange Commission has indicated that Rule 701 will apply to typical stock options granted by an issuer 57 59 before it becomes subject to the reporting requirements of the Exchange Act, along with the shares acquired upon exercise of such options (including exercises after the date of this Prospectus). No predictions can be made of the effect, if any, that future sales of shares of Common Stock, and grants of options to acquire shares of Common Stock, or the availability of shares for future sale, will have on the market price of the Common Stock prevailing from time to time. Sales of substantial amounts of Common Stock in the public market, or the perception that such sales could occur, could adversely affect the prevailing market prices of the Common Stock. See "Principal and Selling Stockholders," "Description of Capital Stock" and "Underwriting." 58 60 UNDERWRITING Subject to the terms and conditions of the Underwriting Agreement, the underwriters named below (the "Underwriters"), for whom EVEREN Securities, Inc. is acting as representative (the "Representative"), have severally agreed to purchase from the Company and the Selling Stockholders, and the Company and the Selling Stockholders have agreed to sell to the Underwriters, the respective number of shares of Common Stock set forth opposite each Underwriter's name below:
NUMBER OF UNDERWRITERS SHARES ------------ --------- EVEREN Securities, Inc...................................... Total............................................. 2,500,000 =========
The Underwriting Agreement provides that the obligations of the several Underwriters thereunder are subject to approval of certain legal matters by counsel and to various other conditions. The nature of the Underwriters' obligation is such that they are committed to purchase and pay for all the shares of Common Stock if any are purchased. The Underwriters propose to offer the shares of Common Stock directly to the public at the initial public offering price set forth on the cover page of this Prospectus and to certain securities dealers at such price less a concession not in excess of $ per share. The Underwriters may allow, and such selected dealers may reallow, a concession not in excess of $ per share to certain brokers and dealers. After this Offering, the price to the public, concession, allowance and reallowance may be changed by the representatives of the Underwriters. The Company has granted the Underwriters an option, exercisable during the 45-day period after the date of this Prospectus, to purchase up to 375,000 additional shares of Common Stock to cover over-allotments, if any, at the same price per share as the initial 2,500,000 shares purchased by the Underwriters of the Company. To the extent that the Underwriters exercise this option, each of the Underwriters will be committed, subject to certain conditions, to purchase such additional shares of Common Stock in approximately the same proportions as set forth in the above table. The Underwriters may purchase such shares only to cover over-allotments made in connection with this Offering. At the close of this Offering, the Company has agreed to pay the Representative a non-accountable expense allowance of one percent of the total offering proceeds, which will include proceeds from the Underwriters' exercise of the over-allotment option to the extent exercised. The Representative's expenses in excess of the non-accountable expense allowance will be borne by the Underwriters. The Company has agreed to issue to the Representative warrants (the "Representative's Warrants") to purchase up to 143,750 shares of Common Stock, at an exercise price per share equal to 110% of the initial public offering price per share. The Representative's Warrants are exercisable for a period of four years, commencing one year from the effective date (the "Effective Date") of the Registration Statement of which this Prospectus is a part and expire five years from the Effective Date. The Representative's Warrants will not be sold, offered for sale, transferred, assigned or hypothecated for a period of one year from the effective date of the Offering other than to officers or partners of the Underwriters and members of the selling group and their officers and partners. The holders of the Representative's Warrants will have no voting, dividend or other 59 61 shareholders' rights until the Warrants are exercised. The Company has granted the Representative certain demand and piggy-back registration rights related to the Representative's Warrants, which are applicable during the period that the Representative's Warrants are exercisable and expire five years from the Effective Date. The Representative has informed the Company that the Underwriters do not intend to confirm sales to any account over which they exercise discretionary authority. The Company has agreed not to issue, and all the Company's officers and directors, the Selling Stockholders, and all of the other stockholders, who in the aggregate hold 100% of the shares of the Common Stock of the Company outstanding immediately prior to the completion of this Offering, have agreed not to sell, or otherwise dispose of, any shares of Common Stock or other equity securities of the Company for a period of 180 days after the date of this Prospectus (other than shares sold pursuant to this Prospectus) without the prior written consent of the Representative. The Company and the Selling Stockholders have agreed to indemnify the Underwriters against certain liabilities under the Securities Act, or to contribute to payments the Underwriters may be required to make in respect thereof. Prior to this Offering, there has been no trading market for the Common Stock. Consequently, the initial public offering price was negotiated among the Company, the Selling Stockholders and the Representative. Among the factors considered in such negotiations were the history of and the prospects for the Company and the industry in which it competes; an assessment of the Company's management; the past earnings of the Company and the trend and future prospects of such earnings; the present state of the Company's development; the general conditions of the securities markets at the time of the Offering; and the market prices of publicly traded common stocks of comparable companies in recent periods. There can be no assurance that an active trading market will develop for the Common Stock or that the Common Stock will trade in the public market subsequent to this Offering at or above the initial public offering price. The initial public offering price set forth on the cover page of this Prospectus should not be considered an indication of the actual value of the Common Stock. Such price is subject to change as a result of market conditions and other factors. No assurances can be given that Common Stock can be resold at or above the initial public offering price. LEGAL MATTERS The validity of the shares offered hereby will be passed upon for the Company by Riordan & McKinzie, a Professional Corporation, Los Angeles, California and for the Underwriters by Morrison & Foerster LLP, Los Angeles, California. Certain principals and employees of Riordan & McKinzie are limited partners of a partnership which is a limited partner of FinPac Partners, a California limited partnership and one of the Company's principal stockholders. Certain insurance regulatory matters will be passed upon by LeBoeuf, Lamb, Greene & MacRae L.L.P., San Francisco, California. See "Principal and Selling Stockholders" and "Certain Transactions." EXPERTS The financial statements and schedules of Financial Pacific Insurance Group, Inc. as of December 31, 1996 and 1997, and for each of the years in the three-year period ended December 31, 1997, have been included herein and in the registration statement in reliance upon the report of KPMG Peat Marwick LLP, independent certified public accountants, appearing elsewhere herein, and upon the authority of said firm as experts in accounting and auditing. 60 62 ADDITIONAL INFORMATION The Company has filed with the Securities and Exchange Commission (the "Commission"), Washington, D.C. 20549, a Registration Statement (which term shall include all amendments, exhibits and schedules thereto) on Form S-1 under the Securities Act, with respect to the Common Stock offered hereby. This Prospectus, which constitutes a part of the Registration Statement, does not contain all of the information set forth in the Registration Statement, certain parts of which are omitted in accordance with the rules and regulations of the Commission, to which Registration Statement reference is hereby made. Statements contained in this Prospectus as to the contents of any contract, agreement or other document referred to are complete in all material respects. However, with respect to each such contract, agreement or other document filed as an exhibit to the Registration Statement, reference is made to the exhibit for a more complete description of the matter involved. The Registration Statement may be inspected and copied at the public reference facilities maintained by the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C., at the Commission's regional offices located at Seven World Trade Center, 13th Floor, New York, New York 10048 and at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of such materials may also be obtained from the Public Reference Section of the Commission, Washington, D.C. 20549, at prescribed rates. The Commission maintains a website that contains reports, proxy and information statements and other information regarding issuers who file electronically with the Commission. The Commission's address on the worldwide web is: http://www.sec.gov. 61 63 GLOSSARY OF SELECTED INSURANCE TERMS Artisan contractor......... A person who is skilled in and specializes in one particular facet of the building process, such as plumbing or electrical. An artisan contractor performs its services as a subcontractor of a general contractor. Cede....................... To transfer to another insurer by way of reinsurance all or a part of the liability or expenses of insurance written by an insurer. CMP -- Liability Insurance.................. Insurance for business operations that provides protection for a business against liability for bodily injury or property damage of a third party. CMP -- Property Insurance.................. Insurance that indemnifies a person with an insurable interest in tangible property for his/her loss related to damage to or loss of use of his/her subject property. This is intended as indemnity for the insured-owner as compared to CMP -- liability insurance which is intended to provide the insured with coverage for bodily injury and property damage to others. Combined ratio............. The sum of the expense ratio and the loss ratio, determined in accordance with SAP. A combined ratio under 100% indicates an underwriting profit and a combined ratio over 100% indicates an underwriting loss. The extent by which the combined ratio deviates from 100% indicates the relative underwriting profit or loss from the business operation of issuing policies of insurance. The combined ratio does not reflect investment income, federal income taxes or other non-underwriting income or expense, all of which are included in determining net income. Commercial lines........... Insurance policies written by the Company for business operations, as opposed to personal coverages, that provide commercial general liability insurance (protection for a business operation against general liability for bodily injury and/or property damage), CMP or property insurance (protection against business property damage from fire, lightning, windstorm and certain other perils), and crime insurance (protection purchased by businesses to insure against losses caused by crimes). Direct premiums written.... Total premiums for insurance sold to insureds, as opposed to, and not including, premiums received for reinsuring risks written by other insurance companies. Excess of loss reinsurance................ Reinsurance which indemnifies the reinsured against all or a specified portion of losses on reinsured policies in excess of a specified dollar amount or "retention." Expense ratio.............. Under SAP, the ratio (expressed as a percentage) of underwriting expenses to net premiums written. Under GAAP, the ratio (expressed as a percentage) of underwriting expenses to premiums earned. Facultative reinsurance.... Individual risks offered by an insurer for acceptance or rejection by a reinsurer. Both parties are free to act in their own best interests. The reinsurer is liable only for losses which exceed the insurer's retention level. Premiums vary with loss expectation. General agent.............. Agents granted broad authority by an insurance company it represents to underwrite, bind, cancel, and collect money on the company's behalf. Gross premiums written..... Total premiums written by an insurer during a specified period of time, before ceding any portion of such insurance risks to reinsurers. 62 64 Hard Market................ An insurance market in which the demand for insurance exceeds the readily available supply and premiums are relatively high. Incurred but Not Reported ("IBNR") Reserves...... Reserves for estimated losses which have been incurred by insureds but not yet reported to the insurer. Incurred losses............ The total losses sustained by an insurance company under a policy or policies, whether paid or unpaid. Incurred losses include a provision for claims that have occurred but have not yet been reported to the insurer. Industry combined ratio.... An average combined ratio for the property/casualty insurance industry as compiled by the A.M. Best which is a broad measure of the property/casualty insurance industry's performance for a particular period. The industry combined ratio measures the overall performance of all property/casualty insurance companies and for all lines of business. The industry combined ratio is useful only in assessing general trends within the industry and should not be used to evaluate the performance of the Company relative to other companies underwriting similar lines of business. Loss adjustment expenses ("LAE")................ The insurer's cost of investigating and settling claims, including legal fees, other fees and related expenses of administering the claims adjustment process. Loss ratio................. Under both SAP and GAAP, the ratio (expressed as a percentage) of incurred losses and LAE to premiums earned. Loss reserves.............. Liabilities established by insurers to reflect the estimated cost of claim payments that the insurer will ultimately be required to pay on all reported and unreported losses which are unpaid at the end of a fiscal period on an undiscounted basis with respect to insurance it has written. Reserves are established for losses and LAE. Net premiums earned........ The amount of net premiums written recognized as income during a given period. Net premiums written....... The amount of direct (gross) premiums written of an insurer plus assumed reinsurance premiums, less ceded reinsurance premiums. Policy acquisition costs... The direct expenses associated with the production of business including agents' or brokers' commissions, premium taxes, marketing and certain underwriting expenses. Premiums earned............ The portion of premiums written that is recognized for accounting purposes (GAAP and SAP) as income during a period. Also known as earned premiums. Quota share reinsurance.... Reinsurance in which the reinsured shares a proportion of the original premiums and losses under the reinsurance policy. Also known as pro rata reinsurance. Reinsurance................ The acceptance by one or more insurers, called reinsurers, of all or a portion of the risk underwritten by another insurer which has usually directly written the coverage. However, the legal rights of the insured generally are not affected by the reinsurance transaction and the insurance company issuing the insurance policy remains liable to the insured for payment of full policy benefits. 63 65 Semi-automatic facultative reinsurance.............. Individuals risks written within the guidelines of a reinsurance treaty are automatically ceded to and accepted by the reinsurer. The reinsurer may reject any reinsurance bound by notifying the Company within a specified notice period. The liability of the reinsurer with respect to any rejected submission shall continue until the Company is able to cancel the policy. Soft Market................ An insurance market in which the supply of insurance exceeds the current demand and premiums are relatively low. Statutory accounting principles (SAP)......... Recording transactions and preparing financial statements in accordance with the rules and procedures prescribed or permitted by insurance related statutes or regulatory authorities, generally reflecting a liquidating, rather than a going concern, concept of accounting. The principal differences between SAP and GAAP, are: (a) under SAP, certain assets are eliminated from the balance sheet; (b) under SAP, policy acquisition costs are expensed as incurred, while under GAAP, they are deferred and amortized over the term of the policies; (c) under SAP, no provision is made for deferred income taxes; and (d) under SAP, certain reserves are recognized which are not recognized under GAAP. All financial data set forth in this Prospectus is presented in accordance with GAAP unless specifically otherwise stated. Surplus as regards policyholders............ The excess of all assets over all liabilities under SAP. Underwriting............... The process whereby an insurer reviews applications submitted for insurance coverage and determines whether it will issue all or part of the coverage being requested and what the applicable premiums will be. Underwriting also includes an ongoing review of existing policies and their pricing. Underwriting expenses...... The aggregate of losses, loss adjustment expenses, policy acquisition costs, contingent ceding commissions and general operating costs. Underwriting profit (loss)..................... The difference between net premiums earned and underwriting expenses. Unearned premiums.......... The pro rata portion of a premium representing the unexpired term of policies in force as of a certain date. 64 66 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- CONSOLIDATED FINANCIAL STATEMENTS -- FINANCIAL PACIFIC INSURANCE GROUP, INC. Independent Auditors' Report -- KPMG Peat Marwick LLP..... 66 Consolidated Balance Sheets of Financial Pacific Insurance Group, Inc. and Subsidiaries -- December 31, 1996 and 1997, and March 31, 1998 (unaudited)................... 67 Consolidated Statements of Operations of Financial Pacific Insurance Group, Inc. and Subsidiaries -- Years Ended December 31, 1995, 1996 and 1997, and Three Months Ended March 31, 1997 and 1998 (unaudited).............. 68 Consolidated Statements of Comprehensive Income of Financial Pacific Insurance Group, Inc. and Subsidiaries -- Years Ended December 31, 1995, 1996 and 1997, and Three Months Ended March 31, 1997 and 1998 (unaudited)............................................ 69 Consolidated Statements of Stockholders' Equity of Financial Pacific Insurance Group, Inc. and Subsidiaries -- Years Ended December 31, 1995, 1996 and 1997, and Three Months Ended March 31, 1997 and 1998 (unaudited)............................................ 70 Consolidated Statements of Cash Flows of Financial Pacific Insurance Group, Inc. and Subsidiaries -- Years Ended December 31, 1995, 1996 and 1997, and Three Months Ended March 31, 1997 and 1998 (unaudited).............. 71 Notes to Consolidated Financial Statements of Financial Pacific Insurance Group, Inc. and Subsidiaries......... 72
65 67 INDEPENDENT AUDITORS' REPORT The Board of Directors Financial Pacific Insurance Group, Inc.: We have audited the accompanying consolidated balance sheets of Financial Pacific Insurance Group, Inc. and subsidiaries as of December 31, 1996 and 1997, and the related consolidated statements of operations, comprehensive income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Financial Pacific Insurance Group, Inc. and subsidiaries as of December 31, 1996 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the information set forth under the captions "Income Statement Data" and "Balance Sheet Data" in the selected consolidated financial data as of December 31, 1996 and 1997, and for each of the years in the three-year period ended December 31, 1997, appearing on pages 16 and 17, is fairly stated, in all material respects, in relation to the consolidated financial statements from which it has been derived. /s/ KPMG Peat Marwick LLP Sacramento, California January 30, 1998, except as to Note 16, which is as of April 14, 1998 66 68 FINANCIAL PACIFIC INSURANCE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
DECEMBER 31, -------------------------- MARCH 31, 1996 1997 1998 ----------- ----------- ----------- (UNAUDITED) ASSETS Fixed maturities available for sale, at market value (cost $24,764,235, $30,027,603 and $33,506,632 in 1996, 1997 and 1998, respectively)............. $24,045,597 $29,976,813 $33,503,811 Cash and cash equivalents........................... 497,388 632,495 1,350,776 Accrued investment income........................... 304,605 426,013 564,911 Receivables: Premiums receivable, net of allowance for doubtful accounts of $40,000 in 1996, 1997 and 1998..... 13,016,982 14,631,026 15,209,728 Income taxes receivable........................... 210,099 7,933 -- Notes receivable.................................. 47,859 6,691 5,714 ----------- ----------- ----------- Total receivables......................... 13,274,940 14,645,650 15,215,442 Prepaid reinsurance premiums........................ 7,922,096 6,828,703 6,894,189 Reinsurance recoverable on unpaid losses and loss adjustment expenses............................... 4,007,047 6,184,927 7,650,187 Deferred policy acquisition costs................... 3,778,170 5,356,697 5,603,525 Fixed assets, net................................... 525,208 885,841 942,025 Other assets........................................ 329,440 956,004 926,033 ----------- ----------- ----------- Total assets.............................. $54,684,491 $65,893,143 $72,650,899 =========== =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Unpaid losses and loss adjustment expenses........ $13,944,397 $19,592,060 $22,235,641 Unearned premiums................................. 18,979,533 21,967,648 22,738,357 Deferred income taxes............................. 1,431,342 1,619,483 1,232,772 Reinsurance payable, net.......................... 1,914,378 1,472,807 2,979,179 Income taxes payable.............................. -- -- 720,902 Notes payable, net................................ 5,479,414 4,984,561 4,985,848 Other liabilities................................. 2,320,072 2,858,446 3,670,241 ----------- ----------- ----------- Total liabilities......................... $44,069,136 $52,495,005 $58,562,940 ----------- ----------- ----------- Stockholders' equity: Series A convertible preferred stock, $.001 par value; 2,000,000 shares authorized; 4,400 shares, issued and outstanding at 1996, 1997, and 1998 respectively.......................... 5 5 5 Common stock, $.001 par value; 7,500,000 shares authorized; 485,983 shares in 1996 and 1997, and 487,955 shares in 1998, issued and outstanding.................................... 486 486 488 Additional paid-in capital........................ 4,949,510 4,949,510 4,954,508 Retained earnings................................. 6,139,655 8,481,658 9,134,820 Accumulated other comprehensive income: Net unrealized loss on available for sale securities, net of deferred income tax benefit of $244,337, $17,269 and $959 in 1996, 1997 and 1998, respectively............................. (474,301) (33,521) (1,862) ----------- ----------- ----------- Total stockholders' equity................ 10,615,355 13,398,138 14,087,959 ----------- ----------- ----------- Total liabilities and stockholders' equity.................................. $54,684,491 $65,893,143 $72,650,899 =========== =========== ===========
See accompanying notes to consolidated financial statements. 67 69 FINANCIAL PACIFIC INSURANCE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED YEARS ENDED DECEMBER 31, MARCH 31, ------------------------------------------ ------------------------- 1995 1996 1997 1997 1998 ------------ ------------ ------------ ----------- ----------- (UNAUDITED) Revenues: Direct premiums written............ $ 24,694,947 $ 31,926,872 $ 39,511,737 $ 9,202,867 $10,384,879 Premiums ceded..................... (10,653,344) (13,673,996) (12,576,059) (2,940,641) (3,096,432) ------------ ------------ ------------ ----------- ----------- Net premiums written........... 14,041,603 18,252,876 26,935,678 6,262,226 7,288,447 Increase in unearned premiums........ (1,981,731) (3,265,911) (4,081,508) (1,520,795) (705,223) ------------ ------------ ------------ ----------- ----------- Net premiums earned............ 12,059,872 14,986,965 22,854,170 4,741,431 6,583,224 Commissions.......................... 104,985 627,690 709,057 170,319 206,981 Investment income, net of expenses... 1,028,524 1,449,406 1,719,877 405,495 509,943 Net realized gains (losses) on sales of investments..................... 465,695 52,171 (46,194) (117) -- Other income, net.................... 578,292 547,117 800,697 178,045 219,579 ------------ ------------ ------------ ----------- ----------- Total revenues..................... 14,237,368 17,663,349 26,037,607 5,495,173 7,519,727 Expenses: Losses and loss adjustment expenses........................... 6,325,059 9,750,413 12,748,171 2,540,998 3,414,731 Policy acquisition costs............. 3,956,595 4,785,460 7,439,612 1,524,381 2,383,144 Contingent ceding commission......... (1,245,755) (3,222,420) (1,511,253) (450,000) (62,571) General operating costs.............. 1,711,641 1,929,348 2,443,576 760,662 437,100 Agency Expenses...................... 145,720 688,188 721,187 167,164 201,714 Interest expense..................... 128,603 691,957 617,042 163,162 151,287 ------------ ------------ ------------ ----------- ----------- Total expenses..................... 11,021,863 14,622,946 22,458,335 4,706,367 6,525,405 ------------ ------------ ------------ ----------- ----------- Income before taxes.................. 3,215,505 3,040,403 3,579,272 788,806 994,322 Income tax provision: Current............................ 428,908 22,051 1,276,196 818,247 743,950 Deferred........................... 637,093 1,015,066 (38,927) (546,957) (402,790) ------------ ------------ ------------ ----------- ----------- Total income tax provision..... 1,066,001 1,037,117 1,237,269 271,290 341,160 ------------ ------------ ------------ ----------- ----------- Net income..................... $ 2,149,504 $ 2,003,286 $ 2,342,003 $ 517,516 $ 653,162 ============ ============ ============ =========== =========== Earnings per share: Basic.............................. $ 4.42 $ 4.12 $ 4.82 $ 1.06 $ 1.34 ============ ============ ============ =========== =========== Diluted............................ $ 0.94 $ 0.69 $ 0.79 $ 0.17 $ 0.22 ============ ============ ============ =========== ===========
See accompanying notes to consolidated financial statements. 68 70 FINANCIAL PACIFIC INSURANCE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
THREE MONTHS ENDED YEARS ENDED DECEMBER 31, MARCH 31, ----------------------------------- ------------------- 1995 1996 1997 1997 1998 --------- --------- --------- -------- ------- (UNAUDITED) Net income.......................... 2,149,504 2,003,286 2,342,003 517,516 653,162 --------- --------- --------- -------- ------- Other comprehensive income, net of tax: Unrealized holding gain (loss) arising during the period, net of taxes of $201,888, $(255,453), $211,361, $(175,485) and $16,309, respectively................... 391,899 (495,876) 410,292 (340,647) 31,659 Less: Reclassification adjustment for gain (loss) included in net income, net of taxes of $158,336, $17,738, $(15,706), $(40) and $0, respectively..... 307,359 34,433 (30,488) (77) -- --------- --------- --------- -------- ------- Unrealized gain (loss) on securities, net of taxes of $43,552 $(273,191), $227,067, $(175,445) and $16,309, respectively................... 84,540 (530,309) 440,780 (340,570) 31,659 --------- --------- --------- -------- ------- Comprehensive income................ 2,234,044 1,472,977 2,782,783 176,946 684,821 ========= ========= ========= ======== =======
See accompanying notes to consolidated financial statements. 69 71 FINANCIAL PACIFIC INSURANCE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997, AND THREE MONTHS ENDED MARCH 31, 1998
UNREALIZED GAIN (LOSS) NUMBER ON OF NUMBER OF ADDITIONAL AVAILABLE PREFERRED PREFERRED COMMON COMMON PAID-IN RETAINED FOR SALE SHARES STOCK SHARES STOCK CAPITAL EARNINGS SECURITIES TOTAL --------- --------- --------- ------ ---------- ---------- ----------- ----------- Balances at December 31, 1994........................... 4,400 $5 485,983 $486 $4,949,510 $1,986,865 $ (28,532) $ 6,908,334 Net income..................... -- -- -- -- -- 2,149,504 -- 2,149,504 Change in unrealized gain (loss) on available for sale securities, net of deferred income taxes of $43,552...... -- -- -- -- -- -- 84,540 84,540 ----- -- ------- ---- ---------- ---------- --------- ----------- Balances at December 31, 1995......................... 4,400 $5 485,983 $486 $4,949,510 $4,136,369 $ 56,008 $ 9,142,378 Net income..................... -- -- -- -- -- 2,003,286 -- 2,003,286 Change in unrealized gain (loss) on available for sale securities, net of deferred income taxes of $273,191..... -- -- -- -- -- -- (530,309) (530,309) ----- -- ------- ---- ---------- ---------- --------- ----------- Balances at December 31, 1996......................... 4,400 $5 485,983 $486 $4,949,510 $6,139,655 $(474,301) $10,615,355 Net income..................... -- -- -- -- -- 2,342,003 -- 2,342,003 Change in unrealized gain (loss) on available for sale securities, net of deferred income taxes of $227,067..... -- -- -- -- -- -- 440,780 440,780 ----- -- ------- ---- ---------- ---------- --------- ----------- Balances at December 31, 1997......................... 4,400 $5 485,983 $486 $4,949,510 $8,481,658 $ (33,521) $13,398,138 Net income..................... -- -- -- 653,162 -- 653,162 Capital contribution........... 1,972 2 4,998 5,000 Change in unrealized gain (loss) on available for sale securities, net of deferred income taxes of $16,309...... -- -- -- -- -- -- 31,659 31,659 ----- -- ------- ---- ---------- ---------- --------- ----------- Balances at March 31, 1998 (unaudited).................. 4,400 $5 487,955 $488 $4,954,508 $9,134,820 $ (1,862) $14,087,959 ===== == ======= ==== ========== ========== ========= ===========
See accompanying notes to consolidated financial statements. 70 72 FINANCIAL PACIFIC INSURANCE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED YEARS ENDED DECEMBER 31, MARCH 31, ----------------------------------------- ------------------------- 1995 1996 1997 1997 1998 ------------ ----------- ------------ ----------- ----------- (UNAUDITED) CASH FLOWS FROM OPERATING ACTIVITIES: Net income............................................ $ 2,149,504 $ 2,003,286 $ 2,342,003 $ 517,516 $ 653,162 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization....................... 104,480 260,138 319,029 90,427 74,545 Net realized (gains) losses on sales of investments....................................... (465,695) (52,171) 46,194 117 -- Net realized losses on sales of fixed assets........ 2,285 6,141 15,574 2,355 1,291 Write-off of note receivable........................ -- 80,000 33,252 6,000 -- Deferred income taxes............................... 637,093 1,015,066 (38,927) (546,956) (403,020) Increase in premiums receivable, net................ (3,045,663) (3,390,280) (1,614,044) (199,557) (578,702) Increase in accrued investment income............... (38,205) (40,987) (121,408) (199,908) (138,898) (Increase) decrease in income taxes receivable...... (84,160) (228,136) 202,166 1,015,247 728,835 (Increase) decrease in prepaid reinsurance premiums.......................................... (2,579,263) (1,655,441) 1,093,393 550,332 (65,486) (Increase) decrease in reinsurance recoverable on unpaid losses and loss adjustment expenses........ 553,614 342,071 (2,177,880) (448,014) (1,465,260) Increase in deferred policy acquisition costs....... (801,026) (1,147,059) (1,578,527) (532,278) (246,828) Decrease (increase) in other assets................. 24,476 (81,437) (621,417) (264,441) 29,099 Increase in unpaid losses and loss adjustment expenses.......................................... 1,872,761 1,931,080 5,647,663 1,074,061 2,643,581 Increase in unearned premiums....................... 4,560,994 4,921,352 2,988,115 970,463 770,709 Increase (decrease) in reinsurance payable, net..... 1,458,042 (2,032,914) (441,571) 1,549,741 1,506,372 Increase in other liabilities....................... 769,277 614,541 538,378 198,131 811,795 ------------ ----------- ------------ ----------- ----------- Net cash provided by operating activities...... 5,118,514 2,545,250 6,631,993 3,783,236 4,321,195 ------------ ----------- ------------ ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of fixed maturities available for sale....... (34,281,021) (7,595,264) (15,090,116) (3,031,757) (5,493,489) Proceeds from sales of fixed maturities available for sale................................................ 25,055,423 4,868,420 5,870,015 -- -- Proceeds from maturities of fixed maturities available for sale............................................ 7,408 572,817 3,896,031 410,000 2,000,000 Purchase of equity securities available for sale...... -- -- (118,832) -- -- Proceeds from sales of equity securities available for sale................................................ 47,177 -- 56,365 -- -- Proceeds from sales of short-term investments......... 935 -- -- Proceeds from principal repayment on note receivable.......................................... 27,662 3,952 7,916 4,292 977 Purchase of fixed assets, net......................... (337,492) (372,178) (618,265) (139,841) (115,402) ------------ ----------- ------------ ----------- ----------- Net cash used in investing activities.......... (9,479,908) (2,522,253) (5,996,886) (2,757,306) (3,607,914) ------------ ----------- ------------ ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of notes payable............... 5,000,000 500,000 -- -- -- Principal repayment on notes payable.................. (315,000) (945,000) (500,000) -- -- Capital contribution.................................. -- -- -- -- 5,000 ------------ ----------- ------------ ----------- ----------- Net cash provided by (used in) financing activities................................... 4,685,000 (445,000) (500,000) -- 5,000 ------------ ----------- ------------ ----------- ----------- Net increase (decrease) in cash and cash equivalents.................................. 323,606 (422,003) 135,107 1,025,930 718,281 Cash and cash equivalents, beginning of year............ 595,785 919,391 497,388 497,388 632,495 ------------ ----------- ------------ ----------- ----------- Cash and cash equivalents, end of year.................. $ 919,391 $ 497,388 $ 632,495 $ 1,523,318 $ 1,350,776 ============ =========== ============ =========== =========== SUPPLEMENTAL DISCLOSURES: Cash paid for income taxes during the year.............. $ 513,067 $ 250,187 $ 1,074,030 $ (197,000) $ 15,346 ============ =========== ============ =========== =========== Cash paid for interest expense during the year.......... $ 116,351 $ 381,922 $ 611,583 $ 311,563 $ 300,000 ============ =========== ============ =========== ===========
See accompanying notes to consolidated financial statements 71 73 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Background Financial Pacific Insurance Group, Inc. (the "Group") was formed on May 26, 1993 to acquire all of the common stock of Financial Pacific Insurance Company ("FPIC") and Financial Pacific Insurance Agency ("FPIA"). The Group, FPIC and FPIA are collectively referred to as "the Company". The Group is primarily owned by Robert C. Goodell, the current President and Chief Executive Officer, and three other investor groups. The Company deals principally in commercial property, casualty and surety lines of insurance. The majority of the Company's business is written for small to medium sized businesses in California's Central Valley. The Company's business is primarily written with artisan contractors, commercial property owners, light industrial risks, and several special programs by a network of independent agents. Basis of Presentation The consolidated financial statements include the accounts of the Group, FPIC, and the FPIA. All significant intercompany balances and transactions have been eliminated. Cash and Cash Equivalents Cash includes currency on hand with financial institutions. Cash equivalents represent short-term, highly-liquid investments, readily convertible to known amounts of cash and near maturity such that there is insignificant risk of changes in value because of changes in interest rates. Cash equivalents are carried at cost, which approximates market. Investments The Company accounts for investments in accordance with the provisions of Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("FAS 115"). Under FAS 115, the Company classifies its fixed maturity securities as available for sale. Unrealized holding gains and losses, net of deferred income taxes, on available for sale securities are reported as a net amount in a separate component of stockholders' equity until realized. Realized investment gains and losses are reported based upon specific identification of the investments sold. Equity securities are classified as available for sale and carried at market value. Unrealized investment gains and losses, resulting from carrying equity securities at market value, are recorded net of applicable deferred income taxes directly in stockholders' equity. Declines in the value of investments, which are determined to be other than temporary, are charged to realized losses. Securities are reported at market values based principally on prices obtained from security exchanges. Deferred Policy Acquisition Costs Acquisition costs, consisting of commissions, premium taxes and certain marketing, policy issuance and underwriting costs, related to the production of new and renewal business, are deferred and amortized ratably over the terms of the policies. The method followed in computing deferred acquisition costs limits the amount of such deferred costs to their estimated realizable value. The determination of estimated realizable value, gives effect to the premium to be earned, losses and loss adjustment expenses, investment income to be earned, and certain other costs expected to be incurred as the premium is earned. Amortization of deferred policy acquisition costs amounted to $3,683,926, $4,785,460 and $7,439,613 in 1995, 1996 and 1997, respectively. 72 74 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Long-Lived Assets The Company accounts for long-lived assets, which currently consists of land held for expansion, in accordance with the provisions of Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be disposed Of " ("FAS 121"). Pursuant to FAS 121, the Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Federal Income Taxes Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. The impact on deferred taxes of changes in tax rates and laws, if any, are applied to the years during which temporary differences are expected to be settled, and reflected in the consolidated financial statements in the period of enactment. Reinsurance Reinsurance recoverables (including amounts related to losses incurred but not reported) and prepaid reinsurance premiums are reported as assets. Estimated reinsurance recoverables are recognized in a manner consistent with the liabilities relating to the underlying reinsured contracts. Reinsurance premiums and commissions are recorded based on management's best estimate of the ultimate amounts to be incurred. Losses and Loss Adjustment Expenses The liability for unpaid losses and loss adjustment expenses is based upon the accumulation of individual case estimates for losses reported prior to the close of the accounting period plus estimates, based on experience and industry data, for unreported losses and loss adjustment expenses. There is a high level of uncertainty inherent in the evaluation of the required loss and loss adjustment expense reserves for the Company. The long-tailed nature of liability claims exacerbates that uncertainty. Management has selected target losses and loss adjustment expense ratios that it believes are reasonable and reflective of anticipated ultimate experience. The ultimate costs of claims are dependent upon future events, the outcomes of which are affected by many factors. Company claim reserving procedures and settlement philosophy, current and perceived social conditions, economic inflation, current and future court rulings and jury attitudes, improvements in medical technology, and many other economic, scientific, legal, political, and social factors all can have significant effects on the ultimate costs of claims. Changes in Company operations and management philosophy also may cause actual developments to vary from the past. In addition, the Company relies on policy language, developed by the Company and by others, to exclude or limit coverage. If such language is held by a court to be invalid or unenforceable, it could materially adversely affect the Company's financial position. This possibility of expansion of insurers' liability either through new concepts of liability or a refusal to accept restrictive policy language has added to the inherent uncertainty of reserving for losses. Since the emergence and disposition of claims are subject to uncertainties, the net amounts that will ultimately be paid to settle the liability may vary significantly from the estimated amounts provided for in the accompanying consolidated financial statements. Any adjustments to reserves are reflected in the operating results of the periods in which they are made. Stock-Based Employee Compensation Effective December 31, 1996, the Company adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"). Management has elected to continue use of the accounting methods prescribed by Accounting Principles 73 75 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Board Opinion No. 25 and to expand its disclosure of stock-based compensation as permitted by FAS 123. Accordingly, no related compensation cost has been recognized. Revenue Recognition Insurance premiums are earned ratably over the terms of the policies. Unearned premiums are computed on a daily pro-rata basis. Agency commission and related fees for the direct mail surety program are recognized based on the policy issue date. Revenue related to service fees is earned as billed. Costs related to service fees are predominantly incurred and recognized when policies are issued. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles 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. New Accounting Standards Statement of Financial Accounting Standards No. 130 ("FAS 130"), "Reporting Comprehensive Income," and Statement of Financial Accounting Standards No. 131 ("FAS 131"), "Disclosures about Segments of an Enterprise and Related Information," were issued in June 1997 and are effective for fiscal years beginning after December 15, 1997. FAS 130 establishes standards for the reporting and display of comprehensive income and its components, which includes net income and changes in equity during the period except those resulting from investments by, or distributions to, stockholders. FAS 131 establishes standards for disclosures related to business operating segments. As of January 1, 1998, the Company adopted the provisions of FAS 130, which have been applied retroactively to all periods presented in these financial statements. The Company is currently evaluating the impact that FAS 131 will have on the consolidated financial statements. Earnings per Share Effective December 31, 1997, the Company adopted SFAS No. 128 "Earnings per Share." Interim Financial Statements The unaudited consolidated financial statements as of March 31, 1998 and for the three months ended March 31, 1998 and 1997, have been prepared in conformity with generally accepted accounting principles (GAAP) and include all adjustments which, in the opinion of management, are necessary for fair presentation of the results for the interim periods. All such adjustments are, in the opinion of management, of a normal and recurring nature. All significant intercompany balances and transactions have been eliminated. Reclassifications Certain reclassifications have been made from amounts reported in prior years in order to be consistent with the March 31, 1998 presentation. Results of operations for the three months ended March 31, 1998 are not necessarily indicative of results to be expected for the full year. 74 76 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 2 INVESTMENTS The amortized cost and estimated market values of fixed maturities available for sale at December 31, 1996 and 1997 are as follows:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED ESTIMATED COST GAINS LOSSES MARKET VALUE ----------- ---------- ---------- ------------ 1996: U.S. government and agencies............... $ 9,976,614 $ 6,173 $113,239 $ 9,869,548 Obligations of states and political subdivision.............................. 262,587 5,906 -- 268,493 Corporate securities....................... 14,325,034 -- 617,478 13,707,556 Certificates of deposit.................... 200,000 -- -- 200,000 ----------- ------- -------- ----------- Total fixed maturities........... $24,764,235 $12,079 $730,717 $24,045,597 =========== ======= ======== =========== 1997: U.S. government and agencies............... $15,619,552 $31,245 $ 22,234 $15,628,563 Obligations of states and political subdivisions............................. 65,524 5,093 -- 70,617 Corporate securities....................... 14,129,816 37,415 102,309 14,064,922 Certificates of deposit.................... 212,711 -- -- 212,711 ----------- ------- -------- ----------- Total fixed maturities........... $30,027,603 $73,753 $124,543 $29,976,813 =========== ======= ======== ===========
The amortized cost and estimated market value of fixed maturities at December 31, 1997 by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
AMORTIZED ESTIMATED COST MARKET VALUE ----------- ------------ Maturity distribution of fixed maturities available for sale: Due in one year or less..................................... $ 1,151,399 $ 1,151,609 Due after one year through five years....................... 9,976,255 9,953,837 Due after five years through ten years...................... 14,723,380 14,681,344 Due after ten years......................................... 4,176,569 4,190,023 ----------- ----------- Total fixed maturities............................ $30,027,603 $29,976,813 =========== ===========
Proceeds from the sale of investments in fixed maturities available for sale were $25,055,423, $4,868,420 and $5,870,015 for the years ended December 31, 1995, 1996 and 1997, respectively. 75 77 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 2 INVESTMENTS (CONTINUED) Summary of investment income, net of expenses:
YEARS ENDED DECEMBER 31, -------------------------------------- 1995 1996 1997 ---------- ---------- ---------- Investment income, net of expenses of $6,604, $13,481 and $14,944 in 1995, 1996 and 1997, respectively Fixed maturities............................. $1,000,235 $1,421,463 $1,681,025 Equity securities............................ 460 -- 42 Other investments............................ 27,829 27,943 38,810 ---------- ---------- ---------- Investment income, net of expenses........ $1,028,524 $1,449,406 $1,719,877 ========== ========== ========== Realized gains (losses) on sales of investments: Fixed maturities available for sale: Gains..................................... $ 592,097 $ 63,114 $ 22,222 Losses.................................... (125,204) (10,943) (5,949) ---------- ---------- ---------- Total................................ 466,893 52,171 16,273 ---------- ---------- ---------- Equity securities available for sale: Gains..................................... -- -- 3,684 Losses.................................... (2,133) -- (66,151) ---------- ---------- ---------- Total................................ (2,133) -- (62,467) ---------- ---------- ---------- Other investments: Gains..................................... 935 -- -- Losses.................................... -- -- -- ---------- ---------- ---------- Total..................................... 935 -- -- ---------- ---------- ---------- Net realized gains (losses) on sales of investments..................... $ 465,695 $ 52,171 ($ 46,194) ========== ========== ==========
Investments with the following issuers exceeded 10% of total stockholders equity at December 31, 1997:
ISSUER ESTIMATED MARKET VALUE ------ ---------------------- Federal Home Loan Mortgage Corporation...................... $3,507,500 ========== Federal National Mortgage Association....................... $7,494,531 ==========
The Company has securities on deposit with state regulatory agencies of approximately $1,761,000 as of December 31, 1997 and 1996. The deposits approximate market value. 76 78 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 3 INCOME TAXES The income tax expense reflected in the accompanying consolidated statements of operations varied from amounts computed at the statutory rate of 35% in 1995, 1996 and 1997 on income before income taxes for the following reasons:
YEARS ENDED DECEMBER 31, -------------------------------------- 1995 1996 1997 ---------- ---------- ---------- Computed "expected" tax expense at statutory rate...... $1,125,427 $1,064,141 $1,252,745 Adjust graduated tax rate.............................. (32,155) (30,404) (35,792) Increase (decrease) in income taxes resulting from: Tax-exempt interest income........................... (31,860) (13,635) 2,442 Other, net........................................... 4,589 17,015 17,874 ---------- ---------- ---------- Total income tax provision................... $1,066,001 $1,037,117 $1,237,269 ========== ========== ==========
The tax effect of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities at December 31, 1996 and 1997, respectively, are presented below:
DECEMBER 31, -------------------------- 1996 1997 ----------- ----------- Deferred Tax Assets: Loss and loss adjustment expense reserves................... $ 551,955 $ 709,150 Unearned premiums........................................... 548,343 769,025 Unrealized loss on securities available for sale............ 244,337 17,269 Allowance for doubtful accounts............................. 13,600 13,600 ----------- ----------- Total gross deferred tax assets................... $ 1,358,235 $ 1,509,044 =========== =========== Deferred Tax Liabilities: Policy acquisition costs.................................... ($1,284,578) ($1,821,277) Contingent ceding commission................................ (1,409,488) (1,178,787) Other....................................................... (95,511) (128,463) ----------- ----------- Total gross deferred tax liabilities.............. (2,789,577) (3,128,527) ----------- ----------- Net deferred tax liabilities...................... ($1,431,342) ($1,619,483) =========== ===========
Management believes it is more likely than not the deferred tax assets will reverse during periods in which the Company generates net taxable income or may recover taxes paid in prior years. Accordingly, a valuation allowance has not been recorded. NOTE 4 REINSURANCE The Company cedes insurance to reinsurers under various contracts that cover individual risks or entire classes of business. Although the ceding of insurance does not discharge the Company from its primary liability, the insurance company that assumes the coverage assumes the related risk, and it is the practice of insurers to treat reinsured risks, to the extent of the reinsurance ceded, as though they were risks for which the original insurer is not liable. The Company is allowed a ceding commission on each of its reinsurance contracts. Additionally, the Company's property quota share and first casualty excess of loss reinsurance treaties contain provisions that establish minimum and maximum cessions and allow limited participation in the profit of the ceded business. Generally, the Company shares, on a limited basis, in the profitability through contingent ceding commissions. The Company's exposure in the loss experience is contractually defined at minimum and maximum levels. The terms of such contracts are fixed at inception. Increases in the Company's retention under such contracts reduces the level of profit participation. Since estimating the emergence of claims to the applicable 77 79 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 4 REINSURANCE (CONTINUED) reinsurance layers in subject to significant uncertainty, the net amounts that will ultimately be realized may vary significantly from the estimated amounts recorded in the accompanying financial statements. At December 31, 1996 and 1997, all property and casualty policies written by the Company are reinsured with reinsurers rated as A or A minus by A.M. Best. The Company has both a quota share agreement and a semi-automatic facultative excess of loss agreement on property and two excess of loss agreements for casualty. On its property business, the Company has a 30% quota share on the first $2 million of any risk, resulting in a maximum company exposure of $600,000 related to any one occurrence. Excess of $2 million, the Company has a semi-automatic-facultative agreement which provides $8 million of coverage excess of $2 million. On the casualty business, the Company presently maintains a $750,000 excess of $250,000 treaty with a syndicate of reinsurers. Prior to January 1, 1997, the Company maintained $400,000 excess of $100,000 and $500,000 excess of $500,000 casualty treaties. Excess of $1 million, the Company has a semi-automatic-facultative agreement which provides $10 million of coverage excess of $1 million. For the Company's surety line of business, the Company maintains a variable quota share reinsurance arrangement which provides various levels of participation depending on the size of the bond. The Company also maintains Extra Contractual Obligation/Loss in Excess of Policy Limits (ECO/XPO) coverage through the London markets. The Company currently purchases $2 million worth of ECO/XPO coverage through this facility. The property quota share and casualty excess of loss reinsurance treaties include commission adjustment provisions. The Company records such adjustments based upon estimates of cumulative experience under the contracts at each reporting period. At December 31, 1997, the Company had unsecured reinsurance recoverables for paid and unpaid losses and loss adjustment expenses and unearned premiums in excess of 10% of stockholders' equity from the following reinsurers: Gerling Global Reinsurance.................................. $3,398,002 SOREMA North America Reinsurance............................ 2,049,891 Winterthur Reinsurance Corporation of America............... 1,567,208 St. Paul Fire and Marine.................................... 1,396,365 Constitution Reinsurance.................................... 1,348,644
78 80 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 4 REINSURANCE (CONTINUED) Reinsurance activity as reported in the accompanying consolidated financial statements is as follows:
DIRECT REINSURANCE NET ACTIVITY BUSINESS CEDED OR BALANCE ----------- ----------- ------------ 1995: Premiums written.................................... $24,694,947 $10,653,344 $14,041,603 Premiums earned..................................... 20,533,128 8,473,256 12,059,872 Losses and loss adjustment expenses incurred........ 7,977,514 1,652,455 6,325,059 =========== =========== =========== Unpaid losses and loss adjustment expenses.......... $12,013,317 $ 4,349,118 $ 7,664,199 =========== =========== =========== Unearned premiums................................... $13,659,006 $ 5,867,480 $ 7,791,526 =========== =========== =========== 1996: Premiums written.................................... $31,926,872 $13,673,996 $18,252,876 Premiums earned..................................... 26,606,345 11,619,380 14,986,965 Losses and loss adjustment expenses incurred........ 11,131,863 1,381,450 9,750,413 =========== =========== =========== Unpaid losses and loss adjustment expenses.......... $13,944,397 $ 4,007,047 $ 9,937,350 =========== =========== =========== Unearned premiums................................... $18,979,533 $ 7,922,096 $11,057,437 =========== =========== =========== 1997: Premiums written.................................... $39,511,737 $12,576,059 $26,935,678 Premiums earned..................................... 36,523,622 13,669,452 22,854,170 Losses and loss adjustment expenses incurred........ 17,844,735 5,096,564 12,748,171 =========== =========== =========== Unpaid losses and loss adjustment expenses.......... $19,592,060 $ 6,184,927 $13,407,133 =========== =========== =========== Unearned premiums................................... $21,967,648 $ 6,828,703 $15,138,945 =========== =========== ===========
NOTE 5 LIABILITY FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES Activity in the liability for unpaid losses and loss adjustment expenses is summarized as follows:
1995 1996 1997 ----------- ----------- ----------- Balance at beginning of period.............. $10,140,556 $12,013,317 $13,944,397 Less reinsurance recoverables............. 4,902,732 4,349,118 4,007,047 ----------- ----------- ----------- Net balance at beginning of period.......... 5,237,824 7,664,199 9,937,350 ----------- ----------- ----------- Incurred related to: Current year.............................. 6,490,825 7,394,848 10,991,179 Prior years............................... (165,766) 2,355,565 1,756,992 ----------- ----------- ----------- Total incurred.............................. 6,325,059 9,750,413 12,748,171 ----------- ----------- ----------- Paid related to: Current year.............................. 1,975,694 2,413,980 3,370,671 Prior years............................... 1,922,990 5,063,282 5,907,717 ----------- ----------- ----------- Total paid.................................. 3,898,684 7,477,262 9,278,388 ----------- ----------- ----------- Net balance at December 31.................. 7,664,199 9,937,350 13,407,133 Plus reinsurance recoverables............. 4,349,118 4,007,047 6,184,927 ----------- ----------- ----------- Balance at December 31................. $12,013,317 $13,944,397 $19,592,060 =========== =========== ===========
During 1996 and 1997, the provision for losses and loss adjustment expenses increased due to unfavorable reserve development primarily in the liability lines of business. The unfavorable development is attributed in part to the changes in the legal interpretation of manifestation of loss. Currently, approximately 40% of the 79 81 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 5 LIABILITY FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES (CONTINUED) Company's business is related to artisan contractors. Accordingly, the law relating to construction defect liability can substantially affect the Company's business. In July of 1995, the California Supreme Court rendered its opinion on Admiral Insurance Company vs. Montrose Chemical Corporation (the "Montrose Decision"). In that decision, the Supreme Court ruled that in the case of a continuous and progressively deteriorating loss, such as pollution liability (or construction defect liability), an insurance company has a definitive duty to defend the policyholder until all uncertainty related to the severity and cause of the loss is extinguished. As a result of the Montrose Decision, the Company experienced a significant increase in construction defect liability cases, to which it would not have been subject under the old law. The liability for unpaid losses and loss adjustment expenses is stated net of anticipated salvage and subrogation recoverable of $746,000 and $913,000 at December 31, 1996 and 1997, respectively. NOTE 6 NOTES PAYABLE, NET At December 31, 1996 and 1997, and March 31, 1998, the Group owed $5,000,000 under unsecured Senior Notes payable to certain stockholders of the Company. The Notes accrue 12% interest compounded annually. Interest payments are due semi-annually and the Notes are due on January 1, 2001. The Notes were issued with Common Stock Purchase Warrants which entitle the holders to purchase up to 593,691 shares of the Group's Common Stock. The Common Stock Warrants are discussed further at Note 8. The Group is subject to certain restrictions described in the note agreement. The Group had outstanding borrowings of $500,000, $0, and $0, under a $530,000 bank line of credit at December 31, 1996 and 1997, and March 31, 1998, respectively. The line is unsecured, matures July 1, 1998, and bears interest (payable monthly) at an annual rate of 1 percent over the bank's base rate. The effective annual interest rate was 9.25% and 8.5% during the years ended December 31, 1996 and 1997, respectively. The notes payable are presented net of deferred debt issue costs. Deferred debt issue costs are amortized over the term of the note. Unamortized debt issue costs totaled $20,586, $15,439, and $14,152, at December 31, 1996 and 1997, and March 31, 1998, respectively. NOTE 7 SERIES A CONVERTIBLE PREFERRED STOCK The Group issued Series A convertible preferred stock ("Series A Stock") pursuant to a Convertible Preferred Stock Purchase Agreement, dated September 7, 1993 (the "Series A Stock Agreement"). Each share of Series A Stock is convertible, at the option of the holder thereof, into 394.375 shares of Common Stock, subject to certain adjustments described in the Series A Stock Agreement. The holders of Series A Stock have voting rights and powers equal to the voting rights and powers of such Common Stock. Each share of Series A Stock is automatically converted into shares of Common Stock immediately upon the effective date of a registration statement filed by the Company pursuant to the Securities Act of 1933, as amended, in connection with a firm commitment, underwritten public offering with an offering price of not less than $5.00 per share and with gross proceeds equal to or exceeding $10 million. In the event of any liquidation, dissolution or winding up of the Group, the holders of the Series A Stock are entitled to receive, prior and in preference to any distribution of any assets of the Group to the holders of Common Stock, the amount of $1.00 per share plus any declared but unpaid dividends. At any time after September 7, 2000, the Group is entitled to redeem all or any portion of the outstanding shares of Series A Stock for $1.00 per share plus any declared but unpaid dividends. 80 82 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 8 COMMON STOCK WARRANTS On September 7, 1993, the Group issued Common Stock Purchase Warrants ("the Warrants"). The Warrants entitle the holders to purchase 153,525 shares of the Group's Common Stock, at any time prior to September 7, 2003, at the price of $2.54 per share, subject to certain adjustments described in the Warrants. On December 28, 1995, the Group issued Common Stock Purchase Warrants (the "Senior Note Warrants") in conjunction with the issuance of the Senior Notes payable as discussed at Note 6. The Senior Note Warrants entitle the holders to purchase 593,691 shares of the Group's Common Stock, at any time prior to January 1, 2004, at the price of $5.61 per share, subject to certain restrictions described in the Senior Note Warrants. The Company believes the Warrants and the Senior Note Warrants were issued at fair market value. NOTE 9 SALE OF DIRECT BOOK OF BUSINESS Prior to August 1994, approximately 10% of FPIC policies were sold directly to policyholders. On August 1, 1994, FPIC sold its direct book of business to an existing agent, resulting in a gain of $205,000. FPIC received a twenty percent down payment during August 1994, with the remainder payable monthly over sixty months. The monthly payments are based on the agent's retention of the book of business. During 1996 and 1997, respectively, the Company charged-off to other income $80,000 and $33,252 of the note receivable due to the agent's declining book of business. The unsecured note receivable balance is $47,859 and $6,691 at December 31, 1996 and 1997, respectively. NOTE 10 STOCK INCENTIVE PLAN During 1993, the Group adopted a Stock Incentive Plan, pursuant to which up to 109,420 shares of Common Stock of the Group may be issued at the discretion of the Board of Directors or a committee thereof. Awards may include, without limitation, stock bonuses, restricted stock, stock options, reload options, stock purchase warrants, other rights to acquire stock, securities convertible or redeemable for stock, stock appreciation rights, phantom stock, dividend equivalents, performance units or performance shares. Officers, employees, consultants, and advisors to the Company or any of its subsidiaries are eligible for awards under the plan. To date, all awards have been in the form of stock options issued with exercise prices at the estimated fair market value as of the issue date. The Company applies APB Opinion 25 and related Interpretations in accounting for the stock incentive plan. Accordingly, no compensation cost has been recognized in the accompanying consolidated financial statements. Had compensation costs been determined consistent with FAS 123, the Company's net income would have been adjusted to the pro forma amounts as follows:
YEARS ENDED DECEMBER 31, -------------------------------------- 1995 1996 1997 ---------- ---------- ---------- As reported............................ $2,149,504 $2,003,286 $2,342,003 Pro forma.............................. $2,143,485 $1,983,453 $2,327,768 Pro forma Basic Earnings per share..... $ 4.41 $ 4.08 $ 4.79 Pro forma Diluted Earnings per share... $ 0.94 $ 0.68 $ 0.79
81 83 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 10 STOCK INCENTIVE PLAN (CONTINUED) The following is a summary of the transactions under the stock incentive plan for the years ended December 31, 1995, 1996 and 1997, respectively:
1995 1996 1997 ------------------ ------------------ ------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE ------- -------- ------- -------- -------- -------- Outstanding at beginning of year...... 27,608 $2.81 25,636 $3.02 69,016 $3.02 Granted............................. 7,888 $3.15 43,380 $4.25 9,860 $4.82 Forfeited........................... (9,860) $2.54 -- -- (9,860) $3.30 ------- ------- -------- Outstanding at end of year............ 25,636 $3.02 69,016 $3.80 69,016 $4.01 ======= ======= ======== Options exercisable at year end....... 9,860 19,719 31,550 ======= ======= ======== Weighted average fair value of options granted during the year............. $ 3.15 $ 4.25 $ 4.82 ======= ======= ========
All of the stock options have a ten year term. Options issued and not yet exercisable at December 31, 1997 vest over periods ranging from one to five years. At December 31, 1997, 40,226 shares were available for future grants. The following is a summary of options outstanding at December 31, 1997.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------------- ----------------------- WEIGHTED AVERAGE REMAINING WEIGHTED NUMBER WEIGHTED NUMBER CONTRACTUAL AVERAGE EXERCISABLE AVERAGE OUTSTANDING AT LIFE EXERCISE AT EXERCISE RANGE OF EXERCISE PRICES 12/31/97 (IN YEARS) PRICE 12/31/97 PRICE - ------------------------ -------------- ----------- -------- ----------- -------- $2.54 to 3.15..................... 15,776 6.5 $2.84 15,775 $2.84 $4.20 to 4.33..................... 43,380 8.3 4.25 15,775 4.28 $4.82............................. 9,860 9.1 4.82 -- -- ------ --- ----- ------ ----- $2.54 to 4.82..................... 69,016 8.0 $4.01 31,550 $3.56 ====== === ===== ====== =====
The fair value of each option grant was estimated using the Minimum Value Method. Minimum value is determined by calculating the difference between the current stock price and the present value of the exercise price with the following assumptions for 1995, 1996 and 1997, respectively: risk free interest rates of 5.4%, 6.2% and 5.7%, expected lives of 5 years and no expected dividends. NOTE 11 401(k) PLAN The Company sponsors a contributory 401(k) plan. All employees of the Company who have completed one year of service are eligible for participation in the plan. The Company matches 100% of the employee's pre-tax contribution up to $1,000, $1,500 and $2,000 in 1995, 1996 and 1997, respectively. In 1995, 1996 and 1997, the Company contributed $20,565, $61,435 and $87,980, respectively, to the plan. NOTE 12 STATUTORY REGULATIONS AND ACCOUNTING All dividends from FPIC require prior notice to the California Department of Insurance ("DOI"). All "extraordinary" dividends must be approved in advance by the DOI. A dividend is deemed "extraordinary" if, when aggregated with all other dividends paid within the preceding 12 months, the dividend exceeds the greater of (i) FPIC's statutory net income (excluding unrealized capital gains) for the preceding calendar year or (ii) 10% of surplus as regards policyholders as of the preceding December 31st. Additionally, unless approved in advance by the DOI, no dividend may be paid by FPIC except from unassigned funds or earned 82 84 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 12 STATUTORY REGULATIONS AND ACCOUNTING (CONTINUED) surplus. The DOI may disallow the payment of any dividend if, in the DOI's opinion, the payment would in any way violate the Code or be hazardous to policyholders, creditors or the public. During 1998, the maximum dividend that may be paid by FPIC without approval of the DOI is $1,426,180. During the years ended December 31, 1995, 1996 and 1997, FPIC paid dividends of $402,000, $630,000 and $900,000, respectively, with the approval of the DOI. Statutory accounting principles vary in some respects from generally accepted accounting principles, the more significant of these differences being: (a) the cost related to policy acquisition and commission costs are expensed when incurred, rather than capitalized and amortized over the coverage period; (b) federal income taxes are recorded when payable and deferred income taxes are not provided; (c) assets must be included in the statutory statements of admitted assets, liabilities and changes in capital and surplus at "admitted asset value" and "non-admitted assets" are excluded through a charge against surplus. The minimum statutory capital and surplus required by the California Insurance Code is $2,600,000. As of December 31, 1996 and 1997, respectively, FPIC had statutory capital and surplus of $13,788,332 and $14,261,802. FPIC's statutory net income for the years ended December 31, 1995, 1996 and 1997 was $2,095,205, $2,123,815 and $1,213,293, respectively. In December 1993, the National Association of Insurance Commissioners ("NAIC") adopted a model law which establishes certain minimum Risk Based Capital ("RBC") requirements for property/casualty insurance companies. The RBC calculation serves as a benchmark for the regulation of insurance companies by state insurance regulatory authorities. The calculation specifies various formulas and rating factors that are applied to financial balances or various levels of activity based on the perceived degree of risk, and are set forth in the RBC requirements. The Company's capital as of December 31, 1996 and 1997 meets the minimum RBC requirements, and management expects capital to continue to meet the amount required. The NAIC recently approved newly codified accounting practices that will change the definition of what constitutes prescribed statutory accounting practices and may result in changes to the accounting policies that insurance enterprises use to prepare their statutory financial statements commencing in 1999. The Company has not determined how the newly codified statutory accounting practices will affect its insurance subsidiary's statutory financial statements or how insurance rating agencies will interpret or react to any such changes. No assurance can be given that future legislative or regulatory changes resulting from such activities will not adversely affect the Company. 83 85 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 13 FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107, "Disclosures About Fair Value of Financial Instruments" ("FAS 107"), requires disclosures of fair value information about financial instruments, whether or not recognized in the consolidated balance sheet, for which it is practicable to estimate that value. The following table presents the carrying amounts and estimated fair values of the Company's financial instruments as of December 31, 1996 and 1997. FAS 107 defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties.
1996 1997 -------------------------- -------------------------- CARRYING CARRYING AMOUNT FAIR VALUE AMOUNT FAIR VALUE ----------- ----------- ----------- ----------- Financial assets Cash and cash equivalents............ $ 497,388 $ 497,000 $ 632,495 $ 632,000 Premiums receivable.................. 13,016,982 13,017,000 14,631,026 14,631,000 Investment securities................ 24,045,597 24,046,000 29,976,813 29,977,000 Accrued interest receivable.......... 304,605 305,000 426,013 426,000 Financial liabilities Notes payable........................ 5,479,414 5,500,000 4,984,561 5,000,000
The following methods and assumptions were used to estimate the fair value of each class of financial instruments: Cash, premiums receivable and accrued interest receivable: The carrying amounts approximate fair value because of the short maturity of those instruments. Investment securities: The fair values of debt securities and equity investments are based on quoted market prices at the reporting date for those or similar investments. Notes payable: The fair value of the Group's notes payable is estimated based upon discounting expected cash flows at rates currently offered to the Group for debt of the same remaining maturities and security. NOTE 14 COMMITMENTS AND CONTINGENCIES At December 31, 1997, the Company occupied office space and leased equipment and vehicles under various operating leases that have remaining noncancellable lease terms in excess of one year. A summary of minimum future non-cancelable lease commitments at December 31, 1997 follows:
YEARS ENDED DECEMBER 31 - ----------------------- 1998............................................. $ 511,697 1999............................................. 454,615 2000............................................. 360,016 2001............................................. 313,594 2002............................................. 313,594 Thereafter....................................... 1,124,375 ---------- Total minimum payments................. $3,077,891 ==========
Rental expense of approximately $382,796, $494,587 and $541,736 for the years ended December 31, 1995, 1996 and 1997, respectively, has been charged to operations in the accompanying consolidated statements of operations. The Company is also the subject of certain claims arising in the ordinary course of its operations. The Company believes that the ultimate resolution of such matters will not materially impact its financial condition. 84 86 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 15 EARNINGS PER SHARE Reconciliations of the outstanding shares used in the basic and fully diluted earnings per share calculations, are presented below:
THREE MONTHS ENDED YEARS ENDED DECEMBER 31, MARCH 31, ------------------------------------ ----------------------- 1995 1996 1997 1997 1998 ---------- ---------- ---------- ---------- ---------- (UNAUDITED) Income (Numerator): Income available to Common Stockholders for Basic and Diluted earnings per share.................. $2,149,504 $2,003,286 $2,342,003 $ 517,516 $ 653,162 ---------- ---------- ---------- ---------- ---------- Weighted Average Shares (Denominator): Basic Shares.......................... 485,983 485,983 485,983 485,983 486,376 Effect of dilutive securities Stock Options....................... 7,380 13,158 37,115 42,186 42,528 Warrants............................ 63,612 666,454 703,273 708,288 708,288 Convertible Preferred stock......... 1,735,250 1,735,250 1,735,250 1,735,250 1,735,250 ---------- ---------- ---------- ---------- ---------- Diluted Shares........................ 2,292,225 2,900,845 2,961,621 2,971,707 2,972,442 ========== ========== ========== ========== ========== Per Share Amounts: Basic Earnings per Share.............. $ 4.42 $ 4.12 $ 4.82 $ 1.06 $ 1.34 Diluted Earnings per Share............ $ 0.94 $ 0.69 $ 0.79 $ 0.17 $ 0.22
For the years ended December 31, 1995 and 1996, the Company had 593,691 warrants which could potentially dilute Basic EPS in the future but were not included in Diluted EPS because their effect was antidilutive. NOTE 16 SUBSEQUENT EVENT On April 14, 1998, the Company declared a 394.375-to-1 stock split effected in the form of a dividend to stockholders of record on April 14, 1998. All data with respect to equity classification, earnings per share and share information, including price per share, where applicable, in the consolidated financial statements and notes thereto have been retroactively adjusted to reflect the split. 85 87 - ------------------------------------------------------ NO PERSON HAS BEEN AUTHORIZED IN CONNECTION WITH THE OFFERING MADE HEREBY TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY TO ANY PERSON OR BY ANYONE IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY DATES SUBSEQUENT TO THE DATE HEREOF. ------------------------------------ TABLE OF CONTENTS
PAGE ---- Prospectus Summary......................... 3 Risk Factors............................... 7 Use of Proceeds............................ 13 Dividend Policy............................ 13 Dilution................................... 14 Capitalization............................. 15 Selected Consolidated Financial Data....... 16 Management's Discussion and Analysis of Financial Condition and Results of Operations........................... 18 Business................................... 27 Management................................. 46 Principal and Selling Stockholders......... 52 Certain Transactions....................... 53 Description of Capital Stock............... 54 Shares Eligible for Future Sale............ 57 Underwriting............................... 59 Legal Matters.............................. 60 Experts.................................... 60 Additional Information..................... 61 Glossary of Selected Insurance Terms....... 62 Index to Consolidated Financial Statements........................... 65
- ------------------------------------------------------ PROSPECTUS - ------------------------------------------------------ 2,500,000 SHARES (FINANCIAL PACIFIC LOGO) Common Stock ------------------------ EVEREN SECURITIES, INC. - ------------------------------------------------------ 88 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following table sets forth the costs and expenses, other than underwriting discounts and commissions, payable by the Company in connection with the sale of Common Stock being registered. All amounts are estimates except the SEC registration fee, the NASD filing fees and the Nasdaq Stock Market listing fee. SEC Registration fee........................................ $ 9,330 NASD fee.................................................... $ 3,670 Nasdaq National Market listing fee.......................... $ 60,000 Printing and engraving expenses............................. $130,000 Legal fees and expenses..................................... $210,000 Accounting fees and expenses................................ $120,000 Blue sky fees and expenses.................................. $ 25,000 Transfer agent fees......................................... $ 15,000 Miscellaneous fees and expenses............................. $127,000 -------- Total............................................. $700,000 ========
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS Section 145 of the Delaware General Corporation Law authorizes a court to award or a corporation's Board of Directors to grant indemnification to directors and officers in terms sufficiently broad to permit such indemnification under certain circumstances for liabilities (including reimbursement for expenses incurred) arising under the Securities Act of 1933, as amended (the "Securities Act"). Article VI, Section 1, of the Registrant's Bylaws provides for mandatory indemnification of its directors and officers and permissible indemnification of employees and other agents to the maximum extent permitted by the Delaware General Corporation Law. The Registrant's Amended and Restated Certificate of Incorporation provides that, pursuant to Delaware law, its directors shall not be liable for monetary damages for breach of the directors' fiduciary duty as directors to the Company and its stockholders. This provision in the Amended and Restated Certificate of Incorporation does not eliminate the directors' fiduciary duty, and in appropriate circumstances equitable remedies such as injunctive or other forms of non-monetary relief will remain available under Delaware law. In addition, each director will continue to be subject to liability for breach of the director's duty of loyalty to the Company for acts or omissions not in good faith or involving intentional misconduct, for knowing violations of law, for actions leading to improper personal benefit to the director, and for payment of dividends or approval of stock repurchases or redemptions that are unlawful under Delaware law. The provision also does not affect a director's responsibilities under any other law, such as the federal securities laws or state or state or federal environmental laws. The Registrant has entered or will enter into Indemnification Agreements with its officers and directors that provide the Registrant's officers and directors with further indemnification to the maximum extent permitted by the Delaware General Corporation Law. Reference is made to Section of the Underwriting Agreement contained in Exhibit 1.1 hereto, indemnifying officers and directors of the Registrant against certain liabilities. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES Since April 1995, the Company has issued and sold the following unregistered securities. 1. On December 28, 1995, Registrant issued Warrants to purchase up to 593,691 shares of its Common Stock and $5,000,000 aggregate principal amount of 12% Senior Notes due January 1, 2001 to a Group of four investors for an aggregate purchase price of $5,000,000. II-1 89 2. Within the past three years, from time to time, the Registrant has granted to employees, directors and consultants options to purchase an aggregate of approximately 80,847 shares of Common Stock pursuant to stock option agreements and the Registrant's stock option plans. 3. The Company has agreed to issue to the representative of the Underwriters ("Representative") warrants (the "Representative's Warrants") to purchase up to 143,750 shares of Common Stock, at an exercise price per share equal to 110% of the initial public offering price per share. The Representative's Warrants are exercisable for a period of four years, commencing one year from the effective date (the "Effective Date") of the Registration Statement and expire five years from the Effective Date. The Representative's Warrants are not transferable prior to the expiration of one year from the Effective Date other than to officers or partners of the Underwriters and members of the selling group and their officers and partners. The holders of the Representative's Warrants will have no voting, dividend or other shareholders' rights until the Warrants are exercised. The Company has granted the Representative certain demand and piggy-back registration rights related to the Representative's Warrants, which are applicable during the period that the Representative's Warrants are exercisable and expire five years from the Effective Date. The sales and issuances described above were deemed to be exempt from registration under the Securities Act in reliance upon Section 4(2) thereof, as transactions by an issuer not involving any public offering, or in reliance upon the exemption from registration provide by Rule 701 promulgated under the Securities Act. In addition, the recipients of securities in each such transaction represented their intentions to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the share certificates issued in such transactions. All recipients had adequate access, through their relationships with the Registrant, to information about the Registrant. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (A) EXHIBITS The following Exhibits are attached hereto and incorporated herein by reference.
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT - ------- ------------------------------------------------------------ 1.1 Underwriting Agreement between EVEREN Securities, Inc. and the Registrant. 3.1* Restated Certificate of Incorporation of the Registrant. 3.2* Bylaws of the Registrant. 4.1* Specimen Common Stock certificate. 4.2+* Stockholders Agreement, dated September 7, 1993, between the Registrant and the investors named therein. 4.3* Amendment Number One to the Stockholders Agreement, dated December 28, 1995, between the Registrant and the investors named therein. 5.1 Opinion of Riordan & McKinzie, a Professional Law Corporation. 10.1* 1993 Stock Incentive Plan. 10.2* Form of Stock Option Agreement. 10.3*++ Employment Agreement between the Registrant and Robert C. Goodell dated February 6, 1996, as amended. 10.4*++ Employment Agreement between the Registrant and Robert T. Kingsley dated February 13, 1997. 10.5*++ Employment Agreement between the Registrant and Edward J. Paoletti dated November 14, 1997. 10.6*++ Employment Agreement between the Registrant and Wallace G. Rascher dated February 14, 1997. 10.7*++ Employment Agreement between the Registrant and Timothy N. Blaede dated February 14, 1997. 10.8*++ Employment Agreement between the Registrant and John R. Hollingshead dated November 14, 1997.
II-2 90
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT - ------- ------------------------------------------------------------ 10.9*++ Employment Agreement between the Registrant and Artur A. Terner dated February 14, 1997. 10.10*++ Employment Agreement between the Registrant and Charles E. Wardlaw dated January 1, 1998. 10.11+ ++ Restricted Stock Agreement between the Registrant and Robert C. Goodell dated September 7, 1993, as amended. 10.12* Note and Warrant Purchase Agreement dated December 28, 1995 among the Registrant and the purchasers listed therein. 10.13* Form of 12% Senior Note due 2001. 10.14* Form of Warrant issued by the Registrant dated December 28, 1995. 10.15* Form of Warrant issued by the Registrant dated September 7, 1993. 10.16* Financial Pacific Insurance Company Property Quota Share Reinsurance Contract originally effective July 1, 1993. 10.17* Financial Pacific Insurance Company Contingent Excess of Loss Reinsurance Contract originally effective July 1, 1996. 10.18* Financial Pacific Insurance Company Contingent Excess of Loss Reinsurance Contract originally effective January 1, 1997. 10.19* Financial Pacific Insurance Company Semi-Automatic Casualty Facultative Reinsurance Contract originally effective July 1, 1996. 10.20* Financial Pacific Insurance Company (M.L. Oates Insurance Company) Property Quota Share Reinsurance Contract originally effective July 1, 1993. 10.21* Financial Pacific Insurance Company First Excess Casualty Reinsurance Contract originally effective January 1, 1997. 10.22* Producer Agreement between American Underwriting Managers Agency, Inc. and Financial Pacific Insurance Agency, Inc. ("FPIA") effective October 1, 1995. 10.23* Claims Management Agreement between FPIA and American Underwriting Managers dated November 28, 1995 10.24* Agreement between Financial Pacific Insurance Company ("FPIC") and General Reinsurance Corporation (No. 118). 10.25* Agreement between FPIC and General Reinsurance Corporation (No. AFF-6243440) 10.26* Agreement between FPIC and General Reinsurance Corporation (No. 8090). 10.27* Quota Share Reinsurance Agreement between FPIC and American Re-insurance dated October 23, 1997. 10.28* Net Lease Agreement between FPIC and Stanford Ranch I, LLC dated June 11, 1996. 10.29* Promissory Note dated September 15, 1997 issued by the Registrant to U.S. Bank 10.30* Stock Purchase Agreement dated February 24, 1997 between Robert C. Goodell and the purchasers listed therein. 10.31* Form of Indemnification Agreement between the Registrant and each director of the Registrant. 10.32 Representatives Warrant Agreement between the Registrant and EVEREN Securities, Inc. dated June , 1998. 11.1* Computation of Net Income Per Share. 21.1* Subsidiaries of the Registrant. 23.1 Consent of KPMG Peat Marwick LLP, Independent Accountants. 23.2 Consent of Riordan & McKinzie (contained in Exhibit 5.1). 23.3 Consent of LeBoeuf, Lamb, Greene & Macrae. 24.1* Power of Attorney (see page II-5). 27.1* Financial Data Schedule.
- --------------- * Filed as an exhibit to the Company's Registration Statement on Form S-1 (Registration No. 333-50511) on April 20, 1998. ++ Confidential treatment requested. II-3 91 + The Schedules to this Exhibit have not been filed with the Commission because the Registrant believes that such Schedules do not contain information that is material to an investment decision. The Registrant hereby agrees to furnish supplementally a copy of the omitted schedules to the Commission upon request. (B) FINANCIAL STATEMENT SCHEDULES Schedules not listed above have been omitted because the information required to be set forth therein is not applicable or is shown in the financial statements or notes thereto. ITEM 17. UNDERTAKINGS Insofar as indemnification for liabilities arising under the Securities Act maybe permitted to directors, officers and controlling persons of the Registrant pursuant to the Delaware General Corporation Law, the Certificate of Incorporation or the Bylaws of the Registrant, the Underwriting Agreement, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act, and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer, or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered hereunder, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question of whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final jurisdiction of such issue. The Registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of Prospectus filed as part of this Registrant Statement in reliance upon Rule 430A and contained in a form of Prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this Registrant Statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of Prospectus shall be deemed to be a new Registration Statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-4 92 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the Registrant has duly caused this Amendment No. 1 Registration Statement on Form S-1 to be signed on its behalf by the undersigned, thereto duly authorized, in the City of Rocklin, State of California, on this 29th day of May, 1998. FINANCIAL PACIFIC INSURANCE GROUP, INC. By /s/ ROBERT C. GOODELL ------------------------------------- Robert C. Goodell President and Chief Executive Officer Pursuant to the requirements of the Securities Act of 1933, this Amendment No. 1 Registration Statement has been signed below by the following person in the capacities and on the dates indicated. /s/ ROBERT C. GOODELL President and Chief Executive May 29, 1998 - --------------------------------------------------- Officer and Director Robert C. Goodell (Principal Executive Officer) * Chief Financial Officer May 29, 1998 - --------------------------------------------------- (Principal Financial and Artur A. Terner Accounting Officer) * Director May 29, 1998 - --------------------------------------------------- Richard G. Pfeiffer * Director May 29, 1998 - --------------------------------------------------- Patrick C. Haden * Director May 29, 1998 - --------------------------------------------------- Michael J. Morrissey * Director May 29, 1998 - --------------------------------------------------- Stephen E. Adamson By: /s/ ROBERT C. GOODELL - --------------------------------------------------- Robert C. Goodell Attorney-in-Fact
II-5 93 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To The Board of Directors and Stockholders Financial Pacific Insurance Group, Inc. The audits referred to in our report dated January 30, 1998, except as to Note 16, which is as of April 14, 1998, included the related financial statement schedules as of December 31, 1997, and for each of the years in the three-year period ended December 31, 1997, included in the registration statement. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein. We consent to the use of our reports included herein and to the reference to our firm under the headings "Selected Consolidated Financial Data" and "Experts" in the Prospectus. KPMG Peat Marwick LLP Los Angeles, California April 17, 1998 S-1 94 SCHEDULE I FINANCIAL PACIFIC INSURANCE GROUP, INC. SUMMARY OF INVESTMENTS -- OTHER THAN INVESTMENTS IN RELATED PARTIES YEARS ENDED DECEMBER 31, 1997
COLUMN A COLUMN B COLUMN C COLUMN D - --------------------------------------------------- -------- ------------ ---------------- AMOUNT AS SHOWN ON BALANCE TYPE OF INVESTMENT COST VALUE SHEET - --------------------------------------------------- -------- ------------ ---------------- (Dollars in thousands) Fixed Maturities: Bonds: United States Government and Government Agencies and Authorities.................... $15,619 $ 15,628 $15,628 States, municipalities and political subdivisions................................ 66 71 71 Foreign governments........................... -- -- -- Public utilities.............................. -- -- -- Convertibles and bonds with warrants attached.................................... -- -- -- All other corporate bonds..................... 14,130 14,065 14,065 ------- ------------ ------- Total bonds.............................. 29,815 29,764 29,764 Certificates of deposit....................... 213 213 213 Redeemable preferred stock.................... -- -- -- ------- ------------ ------- Total fixed maturities................... 30,028 29,977 29,977 ------- ------------ ------- Equity Securities: Common stock: Public utilities.............................. -- -- -- Banks, trust and insurance companies.......... -- -- -- Industrial, miscellaneous and all other....... -- -- -- Non-redeemable preferred stock................... -- -- -- ------- ------------ ------- Total equity securities.................. -- -- -- ------- ------------ ------- Mortgage loans on real estate...................... -- xxxxxxxxxxxx -- Real estate........................................ -- xxxxxxxxxxxx -- Policy loans....................................... -- xxxxxxxxxxxx -- Other long-term investments........................ -- xxxxxxxxxxxx -- Short-term money-market investments................ -- xxxxxxxxxxxx -- ------- ------------ ------- Total investments........................ $30,028 xxxxxxxxxxxx $29,977 ======= ============ =======
S-2 95 SCHEDULE II.1 FINANCIAL PACIFIC INSURANCE GROUP, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION -- PARENT COMPANY ONLY BALANCE SHEETS ($'S IN THOUSANDS) ASSETS
YEARS ENDED DECEMBER 31, ------------------------ 1996 1997 -------- -------- Investment in subsidiaries.................................. $16,309 $18,655 Cash and cash equivalents................................... 3 5 Other assets................................................ 277 487 ------- ------- Total assets...................................... $16,589 $19,147 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Notes payable, net........................................ $ 5,479 $ 4,985 Interest payable.......................................... 304 300 Due to affiliates......................................... 190 464 ------- ------- Total liabilities................................. 5,973 5,749 ======= ======= Stockholders' Equity Series A convertible preferred stock, $.001 par value; 5,000 shares authorized; 4,400 shares issued and outstanding at 1996 and 1997, respectively............. -- -- Common stock, $.001 par value; 3,000,000 shares authorized; 485,983 issued and outstanding at 1996 and 1997, respectively..................................... -- -- Additional paid-in capital................................ 4,950 4,950 Retained earnings......................................... 6,140 8,482 Net unrealized loss on available for sale securities, net of deferred income tax benefit of $244,337 in 1996 and $17,269 in 1997........................................ (474) (34) ------- ------- Total stockholders' equity........................ 10,616 13,398 ------- ------- Total liabilities and stockholders' equity........ $16,589 $19,147 ======= =======
See accompanying notes to financial statements. S-3 96 SCHEDULE II.2 FINANCIAL PACIFIC INSURANCE GROUP, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION -- PARENT COMPANY ONLY STATEMENT OF OPERATIONS ($'S IN THOUSANDS)
YEARS ENDED DECEMBER 31, -------------------------- 1995 1996 1997 ------ ------ ------ Revenues: Equity in income of subsidiaries.......................... $2,204 $2,462 $2,804 Net investment income..................................... 4 2 2 ------ ------ ------ Total revenues.................................... 2,208 2,464 2,806 Expenses: General and administrative................................ 5 5 4 Interest espense.......................................... 128 692 617 Due diligence expense..................................... -- -- 81 ------ ------ ------ 133 697 702 Income before federal indome tax benefit.......... 2,075 1,767 2,104 Provision for federal income tax benefit.................... 75 236 238 ------ ------ ------ $2,150 $2,003 $2,342 ====== ====== ======
See accompanying notes to financial statements. S-4 97 SCHEDULE II.3 FINANCIAL PACIFIC INSURANCE GROUP, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION -- PARENT COMPANY ONLY STATEMENT OF CASH FLOWS ($'S IN THOUSANDS)
1995 1996 1997 ------- ------- ------- Cash flows from operating activities: Net income................................................ $ 2,150 $ 2,003 $ 2,342 Less equity in income of subsidiaries..................... (1,804) (1,832) (1,904) ------- ------- ------- Net loss from operations............................... 346 171 438 Amortization........................................... 15 32 8 Adjustments: Increase in other assets (164) (104) (214) Increase (decrease) in federal income taxes payable (3) 3 Increase (decrease) in interest payable.............. 15 289 (4) Increase in intercompany payable..................... 118 43 274 ------- ------- ------- Net cash provided (used).......................... 327 434 502 Cash flows from investing activities: Proceeds from sale of fixed maturities available for sale................................................... 5 Purchase of fixed maturities available for sale........... (55) ------- ------- ------- Net cash provided by investing activities.............. Cash flows from financing activities: Proceeds form issuance of note payable.................... 5,000 500 Capital contribution...................................... (5,000) Principal repayment on note payable....................... (315) (945) (500) ------- ------- ------- Net cash provided (used) by financing activities....... (315) (445) (500) Net increase (decrease) in cash and cash equivalents... 12 (11) 2 Cash and cash equivalents, beginning of year........... 1 14 3 ------- ------- ------- Cash and cash equivalents, end of year................. $ 13 $ 3 $ 5 ======= ======= =======
See accompanying notes to financial statements. S-5 98 SCHEDULE II.4 FINANCIAL PACIFIC INSURANCE GROUP, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION -- PARENT COMPANY ONLY NOTES TO FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The accompanying condensed financial statements include the accounts of Financial Pacific Insurance Group, Inc. (the "Parent Company"). The Parent Company's wholly-owned subsidiaries, Financial Pacific Insurance Company ("Insurance Company") and Financial Pacific Insurance Agency and Financial Pacific Technologies, Inc. are not presented as consolidated entities on these condensed financial statements. 2. MATERIAL CONTINGENCIES The Parent Company is the subject of certain claims arising in the ordinary course of its operations. The Parent Company believes that the ultimate resolution of such matters will not materially affect its financial condition. 3. NOTES PAYABLE, NET At December 31, 1995 and 1996, the Parent Company owed $5,000,000 under an unsecured senior note payable to certain stockholders and directors of the Parent Company. The note payable accrues 12% interest compounded annually and is payable semi-annually. The note is due on January 1, 2001. The note was issued with a Common Stock Warrant Purchase agreement which entitles the holders the option to purchase up to 1,505.4 shares of the Group's common stock. The Group is subject to certain restrictions described in the note agreement. At December 31, 1995, the Parent Company owed $945,000 under a secured promissory note issued in conjunction with the Acquisition of the Insurance Company and Agency. Effective February 1, 1995, the note was amended to extend the maturity to November 12, 1998 with interest to accrue at 10% compounded annually and payable quarterly. Principal payments of $315,000 are due annually on the anniversary date of the promissory note, November 12, 1993. The promissory note is secured by the common stock of the Insurance Company. The note was issued with a stock option agreement which grants the holder an option to purchase from the Parent Company common stock equal to 5% of the Insurance Company's outstanding common stock each year during the term of promissory note, on the anniversary of the promissory note, in exchange for the cancellation by the holder of the principal payment then due under the promissory note. Effective May 1, 1996, the Parent Company paid off the balance due under this note and obtained a general release from the former owner. At December 31, 1996, the Parent Company owed $500,000 under a $530,000 bank line of credit. The line of credit is unsecured, matures April 1, 1997, and bears interest (payable monthly) at an annual rate of 1 percent over the bank's base rate. The effective annual interest through December 31, 1996 was 9.25%. The bank also granted a $30,000 irrevocable letter of credit covered by this line of credit. The notes payable are presented net of deferred debt issue costs. Deferred debt issue costs are amortized over the term of the note. Unamortized debt issue costs totaled $20.586 and $44,340 at December 31, 1996 and 1995, respectively. NOTE 4. DIVIDENDS FROM SUBSIDIARIES Financial Pacific Insurance Company, a consolidated subsidiary of the Parent Company paid dividends to its parent of $402,000, $630,000, and $900,000 in 1995, 1996, and 1997 respectively. S-6 99 SCHEDULE III FINANCIAL PACIFIC INSURANCE GROUP, INC. SUPPLEMENTARY INSURANCE INFORMATION YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G - ------------------------------------------ ----------- -------------- -------- ---------- -------- ---------- FUTURE POLICY OTHER DEFERRED BENEFITS, POLICY POLICY LOSSES, CLAIMS CLAIMS AND NET NET ACQUISITION AND LOSS UNEARNED BENEFITS PREMIUM INVESTMENT SEGMENT COST EXPENSES PREMIUM PAYABLE REVENUE INCOME - ------------------------------------------ ----------- -------------- -------- ---------- -------- ---------- (Dollars in thousands) 1997 -- Property & Casualty Insurance..... $5,357 $19,592 21,968 -- $22,854 $ 1,720 ====== ======= ======= == ======= ======= 1996 -- Property & Casualty Insurance..... $3,778 $13,944 $18,980 -- $14,987 $ 1,449 ====== ======= ======= == ======= ======= 1995 -- Property & Casualty Insurance..... $2,495 $12,225 $13,659 -- $12,060 $ 1,029 ====== ======= ======= == ======= ======= COLUMN A COLUMN H COLUMN I COLUMN J COLUMN K - ------------------------------------------ -------------- ------------ --------- -------- BENEFITS, AMORTIZATION CLAIMS, LOSSES OF DEFERRED AND POLICY OTHER NET SETTLEMENT ACQUISITION OPERATING PREMIUMS SEGMENT EXPENSES COSTS EXPENSES WRITTEN - ------------------------------------------ -------------- ------------ --------- -------- (Dollars in thousands) 1997 -- Property & Casualty Insurance..... $12,748 $ 7,440 $ 1,655 $26,936 ======= ======= ======= ======= 1996 -- Property & Casualty Insurance..... $ 9,750 $ 4,785 $ 1,443 $18,253 ======= ======= ======= ======= 1995 -- Property & Casualty Insurance..... $ 6,325 $ 3,684 $ 1,447 $14,042 ======= ======= ======= =======
S-7 100 SCHEDULE IV FINANCIAL PACIFIC INSURANCE GROUP, INC. REINSURANCE YEARS ENDED DECEMBER 31, 1997
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F - ------------------------------------- -------- --------- ---------- -------- ---------- PERCENTAGE CEDED TO ASSUMED OF AMOUNT GROSS OTHER FROM OTHER NET ASSUMED TO AMOUNT COMPANIES COMPANIES AMOUNT NET -------- --------- ---------- -------- ---------- ($'s in thousands) Life insurance in force.............. $ -- $ -- $ -- $ -- --% ------- ------- ------- ------- --- Premiums: Life insurance..................... -- -- -- -- -- Accident and health insurance...... -- -- -- -- -- Property and liability insurance... 39,512 12,576 -- 26,936 0.0 Title insurance.................... -- -- -- -- -- ------- ------- ------- ------- --- Total Premiums............. $39,512 $12,576 -- $26,936 0.0% ======= ======= ======= ======= ===
S-8 101 SCHEDULE IV FINANCIAL PACIFIC INSURANCE GROUP, INC. REINSURANCE YEARS ENDED DECEMBER 31, 1996
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F - ------------------------------------- -------- --------- ---------- -------- ---------- PERCENTAGE CEDED TO ASSUMED OF AMOUNT GROSS OTHER FROM OTHER NET ASSUMED TO AMOUNT COMPANIES COMPANIES AMOUNT NET -------- --------- ---------- -------- ---------- ($'s in thousands) Life insurance in force.............. $ -- $ -- $ -- $ -- --% ------- ------- ------- ------- --- Premiums: Life insurance..................... -- -- -- -- -- Accident and health insurance...... -- -- -- -- -- Property and liability insurance... 31,927 13,674 -- 18,253 0.0 Title insurance.................... -- -- -- -- -- ------- ------- ------- ------- --- Total Premiums............. $31,927 $13,674 $ -- $18,253 0.0% ======= ======= ======= ======= ===
S-9 102 SCHEDULE IV FINANCIAL PACIFIC INSURANCE GROUP, INC. REINSURANCE YEARS ENDED DECEMBER 31, 1995
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F - ------------------------------------- -------- --------- ---------- -------- ---------- PERCENTAGE CEDED TO ASSUMED OF AMOUNT GROSS OTHER FROM OTHER NET ASSUMED TO AMOUNT COMPANIES COMPANIES AMOUNT NET -------- --------- ---------- -------- ---------- ($'s in thousands) Life insurance in force.............. $ -- $ -- $ -- $ -- --% ------- ------- ------- ------- --- Premiums: Life insurance..................... -- -- -- -- -- Accident and health insurance...... -- -- -- -- -- Property and liability insurance... 24,695 10,653 -- 14,042 0.0 Title insurance.................... -- -- -- -- -- ------- ------- ------- ------- --- Total Premiums............. $24,695 $10,653 $ -- $14,042 0.0% ======= ======= ======= ======= ===
S-10 103 SCHEDULE V FINANCIAL PACIFIC INSURANCE GROUP, INC. VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E - -------------------------------------------- ------------ ------------ ------------- ---------- DEDUCTIONS -- ADDITIONS -- FROM PREMIUM BALANCE AT CHARGED TO BALANCE TO BALANCE AT BEGINNING OF COSTS AND ALLOWANCE END OF PERIOD EXPENSES ACCOUNT PERIOD ------------ ------------ ------------- ---------- ($'s in thousands) 1997: Allowance for doubtful accounts............. $40 $30 $30 $40 === === === === 1996: Allowance for doubtful accounts............. $40 $31 $31 $40 === === === === 1995: Allowance for doubtful accounts............. $20 $56 $36 $40 === === === ===
S-11 104 SCHEDULE VI FINANCIAL PACIFIC INSURANCE GROUP, INC. SUPPLEMENTAL INFORMATION CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1997
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G COLUMN H - ------------------------- ------------ ------------ --------- -------- -------- ---------- ------------------ NET CLAIMS AND CLAIMS ADJUSTMENT RESERVES FOR EXPENSES INCURRED UNPAID DISCOUNT, RELATED TO DEFERRED CLAIMS & IF ANY, ------------------ POLICY CLAIM DEDUCTED NET NET (1) (2) AFFILIATION WITH ACQUISITIONS ADJUSTMENT IN UNEARNED EARNED INVESTMENT CURRENT PRIOR REGISTRANT COSTS EXPENSES COLUMN C PREMIUMS PREMIUM INCOME YEAR YEAR - ------------------------- ------------ ------------ --------- -------- -------- ---------- -------- ------- 1997: Financial Pacific Insurance Company...... $5,357 $19,592 $-- $21,968 $22,854 $1,720 $10,991 $1,757 ====== ======= == ======= ======= ====== ======= ====== 1996: Financial Pacific Insurance Company...... $3,778 $13,944 $-- $18,980 $14,987 $1,449 $ 7,183 $2,356 ====== ======= == ======= ======= ====== ======= ====== 1995: Financial Pacific Insurance Company...... $2,495 $12,225 $-- $13,659 $12,060 $1,029 $ 6,702 $ (166) ====== ======= == ======= ======= ====== ======= ====== COLUMN A COLUMN I COLUMN J COLUMN K - ------------------------- ------------ ---------- -------- AMORTIZATION PAID NET OF DEFERRED CLAIMS AND POLICY CLAIM NET AFFILIATION WITH ACQUISITION ADJUSTMENT PREMIUMS REGISTRANT COST EXPENSES WRITTEN - ------------------------- ------------ ---------- -------- 1997: Financial Pacific Insurance Company...... $7,440 $9,278 $26,936 ====== ====== ======= 1996: Financial Pacific Insurance Company...... $4,785 $7,477 $18,253 ====== ====== ======= 1995: Financial Pacific Insurance Company...... $3,684 $3,899 $14,042 ====== ====== =======
S-12 105 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT - ------- ----------------------- 1.1 Underwriting Agreement between EVEREN Securities, Inc. and the Registrant. ............................................ 3.1* Restated Certificate of Incorporation of the Registrant. ... 3.2* Bylaws of the Registrant. .................................. 4.1* Specimen Common Stock certificate. ......................... 4.2+* Stockholders Agreement, dated September 7, 1993, between the Registrant and the investors named therein. ................ 4.3* Amendment Number One to the Stockholders Agreement, dated December 28, 1995, between the Registrant and the investors named therein. ............................................. 5.1 Opinion of Riordan & McKinzie, a Professional Law Corporation. ............................................... 10.1* 1993 Stock Incentive Plan. ................................. 10.2* Form of Stock Option Agreement. ............................ 10.3*++ Employment Agreement between the Registrant and Robert C. Goodell dated February 6, 1996, as amended. ................ 10.4*++ Employment Agreement between the Registrant and Robert T. Kingsley dated February 13, 1997. .......................... 10.5*++ Employment Agreement between the Registrant and Edward J. Paoletti dated November 14, 1997. .......................... 10.6*++ Employment Agreement between the Registrant and Wallace G. Rascher dated February 14, 1997. ........................... 10.7*++ Employment Agreement between the Registrant and Timothy N. Blaede dated February 14, 1997. ............................ 10.8*++ Employment Agreement between the Registrant and John R. Hollingshead dated November 14, 1997. ...................... 10.9*++ Employment Agreement between the Registrant and Artur A. Terner dated February 14, 1997. ............................ 10.10*++ Employment Agreement between the Registrant and Charles E. Wardlaw dated January 1, 1998. ............................. 10.11+++ Restricted Stock Agreement between the Registrant and Robert C. Goodell dated September 7, 1993, as amended. ............ 10.12* Note and Warrant Purchase Agreement dated December 28, 1995 among the Registrant and the purchasers listed therein. .... 10.13* Form of 12% Senior Note due 2001. .......................... 10.14* Form of Warrant issued by the Registrant dated December 28, 1995. ...................................................... 10.15* Form of Warrant issued by the Registrant dated September 7, 1993. ...................................................... 10.16* Financial Pacific Insurance Company Property Quota Share Reinsurance Contract originally effective July 1, 1993. .... 10.17* Financial Pacific Insurance Company Contingent Excess of Loss Reinsurance Contract originally effective July 1, 1996. ...................................................... 10.18* Financial Pacific Insurance Company Contingent Excess of Loss Reinsurance Contract originally effective January 1, 1997. ...................................................... 10.19* Financial Pacific Insurance Company Semi-Automatic Casualty Facultative Reinsurance Contract originally effective July 1, 1996. ................................................... 10.20* Financial Pacific Insurance Company (M.L. Oates Insurance Company) Property Quota Share Reinsurance Contract originally effective July 1, 1993. ......................... 10.21* Financial Pacific Insurance Company First Excess Casualty Reinsurance Contract originally effective January 1, 1997. ...................................................... 10.22* Producer Agreement between American Underwriting Managers Agency, Inc. and Financial Pacific Insurance Agency, Inc. ("FPIA") effective October 1, 1995. ........................
106
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT - ------- ----------------------- 10.23* Claims Management Agreement between FPIA and American Underwriting Managers dated November 28, 1995. ............. 10.24* Agreement between Financial Pacific Insurance Company ("FPIC") and General Reinsurance Corporation (No. 118). .... 10.25* Agreement between FPIC and General Reinsurance Corporation (No. AFF-6243440). ......................................... 10.26* Agreement between FPIC and General Reinsurance Corporation (No. 8090). ................................................ 10.27* Quota Share Reinsurance Agreement between FPIC and American Re-insurance dated October 23, 1997. ....................... 10.28* Net Lease Agreement between FPIC and Stanford Ranch I, LLC dated June 11, 1996. ....................................... 10.29* Promissory Note dated September 15, 1997 issued by the Registrant to U.S. Bank. ................................... 10.30* Stock Purchase Agreement dated February 24, 1997 between Robert C. Goodell and the purchasers listed therein. ....... 10.31* Form of Indemnification Agreement between the Registrant and each director of the Registrant. ........................... 10.32 Warrant Agreement between the Registrant and EVEREN Securities, Inc. dated June , 1998. ...................... 11.1* Computation of Net Income Per Share. ....................... 21.1* Subsidiaries of the Registrant. ............................ 23.1 Consent of KPMG Peat Marwick LLP, Independent Accountants. ............................................... 23.2 Consent of Riordan & McKinzie (contained in Exhibit 5.1).... 23.3 Consent of LeBoeuf, Lamb, Greene & Macrae. ................. 24.1* Power of Attorney (see page II-5). ......................... 27.1* Financial Data Schedule. ...................................
- --------------- * Filed as an exhibit to the Company's Registration Statement on Form S-1 (Registration No. 333-50511) on April 20, 1998. ++ Confidential treatment requested. EX-1.1 2 UNDERWRITING AGREEMENT 1 EXHIBIT 1.1 2,500,000 Shares FINANCIAL PACIFIC INSURANCE GROUP, INC. Common Stock, Par Value $.001 June __, 1998 UNDERWRITING AGREEMENT EVEREN Securities, Inc. 2 2,500,000 Shares FINANCIAL PACIFIC INSURANCE GROUP, INC. Common Stock Par Value $.001 UNDERWRITING AGREEMENT June __, 1998 EVEREN Securities, Inc. As Representative of the Several Underwriters 77 West Wacker Drive Chicago, Illinois 60601-1994 Ladies and Gentlemen: Financial Pacific Insurance Group, Inc., a Delaware corporation (the "Company"), and Riordan, Lewis & Haden, Firemark Advisors, Inc., St. Paul Fire & Marine Insurance Company, Celerity Partners, L.P., Robert S. Goodell and David Rogers (collectively, the "Selling Stockholders") confirm their agreements with each other and the several underwriters listed in Schedule I hereto (the "Underwriters"), for whom EVEREN Securities, Inc. (the "Representative") has been duly authorized to act as representative, as follows: 1. The Shares. Subject to the terms and conditions set forth in this agreement (the "Agreement"), the Company proposes to issue and sell 2,000,000 shares of its authorized but unissued Common Stock, $.001 par value (the "Common Stock"), to the several Underwriters and the Selling Stockholders propose to sell an aggregate of 500,000 shares of the Company's authorized and outstanding Common Stock to the several Underwriters, with each of the Selling Stockholders to sell the number of shares listed beside such Selling Stockholder's name on Schedule II hereto. The 2,000,000 shares of Common Stock of the Company to be sold by the Company are hereinafter called the "Company Shares" and the 500,000 shares of Common Stock to be sold by the Selling Stockholders are hereinafter called the "Selling Stockholder Shares." The Company Shares and the Selling Stockholder Shares are hereinafter collectively referred to as the "Firm Shares." The Company also proposes to grant to the Underwriters an option to purchase up to 375,000 additional shares of Common Stock (the "Option Shares") if requested by the Underwriters as provided in Section 3 hereof. The Firm Shares and the Option Shares are herein collectively called the "Shares." The Company and the Selling Stockholders hereby confirm their respective agreements with the Underwriters as follows: 1 3 2. Registration Statement and Prospectus. The Company has prepared and filed with the Securities and Exchange Commission (the "Commission") in accordance with the provisions of the Securities Act of 1933, as amended, and the rules and regulations of the Commission thereunder (collectively, the "Act"), a registration statement on Form S-1 (File No. 333-50511) including a prospectus, relating to the Shares, which may have been amended; each such amendment was so prepared and filed. The registration statement, as amended at the time when it became or becomes effective, including all financial schedules and exhibits thereto and all of the information (if any) deemed to be part of the registration statement at the time of its effectiveness pursuant to Rule 430A under the Act ("Rule 430A"), is hereinafter referred to as the "Registration Statement"; any registration statement filed pursuant to Rule 462(b) under the Act is herein called the "462(b) Registration Statement," and after such filing the term "Registration Statement" shall include the Rule 462(b) Registration Statement; the prospectus in the form first provided to the Underwriters by the Company in connection with the offering and sale of the Shares (whether or not required to be filed pursuant to Rule 424(b) under the Act ("Rule 424(b)")) is hereinafter referred to as the "Prospectus," except that if any revised prospectus shall be provided to the Underwriters by the Company for use in connection with the offering of the Shares that differs from the Prospectus (whether or not any such revised prospectus is required to be filed by the Company pursuant to Rule 424(b) under the Act), the term "Prospectus" shall refer to the revised prospectus from and after the time it is first provided to the Underwriters for such use; and each preliminary prospectus included in the Registration Statement prior to the time it became or becomes effective is herein referred to as a "Preliminary Prospectus." 3. Agreements to Sell and Purchase. On the basis of the representations and warranties contained in this Agreement, and subject to the terms and conditions hereof, (i) the Company and the Selling Stockholders agree, severally and not jointly, to sell to the Underwriters, at a price of $ ________ per Share (the "Purchase Price"), the Company Shares and the Selling Stockholder Shares, respectively; and (ii) each Underwriter agrees, severally and not jointly, to purchase from the Company and the Selling Stockholders, at the Purchase Price, the aggregate number of Firm Shares set forth opposite the name of such Underwriter in Schedule I hereto. On the basis of the representations and warranties contained in this Agreement, and subject to the terms and conditions hereof, (i) the Company agrees to sell to the Underwriters, at the Purchase Price, up to 375,000 Option Shares; and (ii) the Underwriters shall have the right to purchase, severally and not jointly, from time to time, up to an aggregate of 375,000 Option Shares at the Purchase Price. Option Shares may be purchased as provided in Section 4 hereof solely for the purpose of covering over-allotments made in connection with the offering of the Firm Shares. If any Option Shares are to be purchased, each Underwriter, severally and not jointly, agrees to purchase the number of Option Shares (subject to such adjustments to eliminate fractional shares as the Representative may determine) that bears the same proportion to the total number of Option Shares to be purchased as the number of Firm Shares set forth opposite the name of such Underwriter in Schedule I bears to the total number of Firm Shares. For a period of 180 days from the date this Agreement becomes effective, the Company will not, without the prior written consent of EVEREN Securities, Inc. on behalf of the Underwriters (1) offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, or otherwise transfer or dispose of, directly or indirectly, any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock, or (2) enter into any swap or other agreement that transfers, in whole or in part, any of the economic consequences of ownership of the Common Stock, whether any such transaction 2 4 described in clause (1) or (2) above is to be settled by delivery of Common Stock or such other securities, in cash or otherwise; provided, however, that this clause shall not apply to the transactions expressly contemplated hereby, the issuance of the Warrants pursuant to the Warrant Agreement dated June __, 1998 between the Company and the purchasers party thereto and the granting of options for shares of Common Stock and involving the Shares the sales of shares of Common Stock to the Company's employees pursuant to the exercise of options under those employee benefit plans described in the Prospectus and provided further, however, that the Company may issue shares of Common Stock ("Acquisition Shares") during such period in connection with acquisitions of business so long as the purchaser of such Acquisition Shares agrees to be bound by a lock-up letter in form and substance satisfactory to you pursuant to which such purchaser agrees with the Company not to sell, offer to sell, solicit an offer to buy, contract to sell, grant any option to purchase, or otherwise transfer or dispose of, any such Acquisition Shares at any time before the expiration of such 180 day period and the certificates evidencing such Acquisition Shares bear a legend to such effect. For a period of 180 days from the date this Agreement becomes effective, the Company will not, without the prior written consent of EVEREN Securities, Inc. on behalf of the Underwriters, file a registration statement relating to shares of capital stock (including the Common Stock) or securities convertible into or exercisable or exchangeable for, capital stock or warrants, options or rights to purchase or acquire, capital stock, with the exception of the filing of Registration Statements on Form S-8 with respect to the Company's employee benefit plans described in the Prospectus and provided further, however, that the Company may issue shares of Common Stock ("Acquisition Shares") during such period in connection with acquisitions of business so long as the purchaser of such Acquisition Shares agrees to be bound by a lock-up letter in form and substance satisfactory to you pursuant to which such purchaser agrees with the Company not to sell, offer to sell, solicit an offer to buy, contract to sell, grant any option to purchase, or otherwise transfer or dispose of, any such Acquisition Shares at any time before the expiration of such 180 day period and the certificates evidencing such Acquisition Shares bear a legend to such effect. 4. Agreements of the Company as to Delivery and Payment. The Company agrees with each Underwriter that: (a) Delivery to the Underwriters of and payment for the Firm Shares shall be made at 9:00 A.M., Los Angeles time, on the third full business day (such time and date being referred to as the "Closing Date") following the date of the initial public offering of the Firm Shares as advised to you by the Company, at such place as you shall designate. Payment for the Firm Shares shall be made to the Company or its order upon delivery of the Company Shares, and shall be made to the Custodian for the account of the Selling Stockholders upon delivery of the Selling Stockholder Shares, in each case in Federal or other funds immediately available in Los Angeles. (b) Delivery to the Underwriters of and payment for any Option Shares to be purchased by the Underwriters shall be made at such place as the Representative shall designate, at 9:00 A.M., Los Angeles time, on such date or dates (individually, an "Option Closing Date" and collectively, the "Option Closing Dates"), which may be the same as the Closing Date but shall in no event be earlier than the Closing Date, as shall be specified in a written notice from the Representative to the Company of the Underwriters' determination to purchase a number, 3 5 specified in said notice, of Option Shares. Any such notice may be given at any time within 45 days after the date of this Agreement. Payment for any Option Shares shall be made to the Company or its order upon delivery of the Option Shares, in Federal or other funds immediately available in Los Angeles. (c) Certificates for the Shares shall be registered in such names and issued in such denominations as you shall request in writing not later than two business days prior to the Closing Date or the applicable Option Closing Date, as the case may be, and shall be made available for inspection not later than 9:00 A.M., Los Angeles time, on the business day next preceding the Closing Date or the applicable Option Closing Date, as the case may be, with any transfer taxes payable upon initial issuance or the transfer thereof duly paid by the Company for the respective accounts of the Underwriters against payment of the Purchase Price therefor. 5. Further Agreements of the Company. The Company also agrees with each Underwriter that: (a) it will, if the Registration Statement has not heretofore become effective under the Act, file an amendment to the Registration Statement or, if necessary pursuant to Rule 430A under the Act, a post-effective amendment to the Registration Statement, as soon as practicable after the execution and delivery of this Agreement, and will use its best efforts to cause the Registration Statement or such post-effective amendment to become effective at the earliest possible time; and the Company will comply fully and in a timely manner with the applicable provisions of Rule 424(b) and Rule 430A under the Act; (b) it will advise you promptly and, if requested by you, confirm such advice in writing, (i) when the Registration Statement has become effective, if and when the Prospectus is sent for filing pursuant to Rule 424 under the Act and when any post-effective amendment to the Registration Statement becomes effective, (ii) of the receipt of any comments from the Commission that relate to the Registration Statement or requests by the Commission for amendments to the Registration Statement or amendments or supplements to the Prospectus or for additional information, (iii) of the issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement, or of the suspension of qualification of the Shares for offering or sale in any jurisdiction, or the initiation or, to the best knowledge of the Company, threat of any proceedings for such purpose by the Commission or any state securities commission or other regulatory authority, and (iv) of the happening of any event or information becoming known during the period referred to in paragraph (e) below that makes any statement of a material fact made in the Registration Statement untrue or that requires the making of any additions to or changes in the Registration Statement (as amended or supplemented from time to time) in order to make the statements therein not misleading or that makes any statement of a material fact made in the Prospectus (as amended or supplemented from time to time) untrue or that requires the making of any additions to or changes in the Prospectus (as amended or supplemented from time to time) in order to make the statements therein not misleading except statements in or omissions from the Registration Statement and the Prospectus made or omitted in reliance upon, and in conformity with, information relating to the Underwriters furnished in writing to the Company by or on behalf of the Underwriters with your consent expressly for use therein; if at any time the Commission shall issue or institute 4 6 proceedings (or threaten to institute any such proceedings) to issue any stop order suspending the effectiveness of the Registration Statement, or any state securities commission or other regulatory authority shall issue or institute proceedings (or threaten to institute proceedings) to issue an order suspending the qualification or exemption of the Shares under any state securities or Blue Sky laws, the Company shall use its best efforts to obtain the withdrawal or lifting of such order at the earliest possible time; (c) it will furnish to the Representative without charge one signed copy of the Registration Statement as first filed with the Commission and of each amendment to it, including all exhibits filed therewith, and, from time to time, will furnish to you and each Underwriter designated by you a reasonable number of conformed copies of the Registration Statement as so filed and of each amendment to it, without exhibits; (d) it will not file any amendment or supplement to the Registration Statement, whether before or after the time when it becomes effective, make any filing under Rule 462(b) of the Act or make any amendment or supplement to the Prospectus of which you shall not previously have been advised and provided a copy a reasonable period of time prior to the filing thereof or to which you or your counsel shall reasonably object; and it will prepare and file with the Commission, promptly upon your reasonable request, any amendment to the Registration Statement or supplement to the Prospectus that may be necessary or advisable in connection with the distribution of the Shares by you in your or your counsel's opinion, and will use its reasonable commercial efforts to cause the same to become effective as promptly as possible; (e) promptly after the Registration Statement becomes effective, and from time to time thereafter for such period as a prospectus is required by the Act to be delivered in connection with the sales by an underwriter or a dealer (in the opinion of your counsel), it will furnish to each Underwriter and dealer without charge as many copies of the Prospectus (and any amendment or supplement of the Prospectus) as such Underwriter or dealer may reasonably request for the purposes contemplated by the Act; the Company consents to the use of the Prospectus and any amendment or supplement thereto by any Underwriter or any dealer, both in connection with the offering or sale of the Shares and for such period of time thereafter as the Prospectus is required by the Act to be delivered in connection therewith; (f) if during the period specified in paragraph (e) any event shall occur or information become known as a result of which in the opinion of your counsel or in the judgment of the Company it becomes necessary to amend or supplement the Prospectus in order to make the statements therein, in light of the circumstances existing as of the date the Prospectus is delivered to a purchaser, not misleading, or it is necessary to amend or supplement the Prospectus to comply with any law, forthwith to prepare and, subject to paragraph 5(d) above, it will file with the Commission at the sole expense of the Company an appropriate amendment or supplement to the Prospectus so that the statements of any material facts in the Prospectus, as so amended and supplemented, will not in light of the circumstances when it is so delivered, be misleading, or so that the Prospectus will comply with law, and it will furnish to the Underwriters and to such dealers as the Underwriters shall specify, at the sole expense of the Company, such number of copies thereof as such Underwriters or dealers may reasonably request; (g) prior to any public offering of the Shares, it will cooperate with you and counsel for the Underwriters in connection with the registration or qualification of the Shares for offer and sale by the several Underwriters and by dealers under the state securities or Blue Sky laws of such jurisdictions as you may reasonably request (provided, that the Company shall not be obligated to qualify as a foreign corporation in any jurisdiction in which it is not so qualified or 5 7 to take any action which would subject it to general consent to service of process in any jurisdiction in which it is not now so subject); the Company will continue such qualification in effect so long as required by law for the distribution of the Shares and will file such consents to service of process or other documents as may be necessary in order to effect such registration or qualification (provided, that the Company shall not be obligated to take any action that would subject it to general consent to service of process in any jurisdiction in which it is not now so subject); (h) it will not, prior to the exercise in full or termination or expiration of the option to purchase the Option Shares, incur any liability or obligation, direct or contingent, or enter into any material transaction, other than in the ordinary course of business, except as contemplated by the Prospectus; (i) it will not acquire any capital stock of the Company prior to the exercise in full or termination or expiration of the option to purchase the Option Shares nor will the Company declare or pay any dividend or make any other distribution upon the Common Stock payable to Stockholders of record on a date prior to the exercise in full or termination or expiration of the option to purchase the Option Shares, except in either case as contemplated by the Prospectus; (j) it will make generally available to its security holders as soon as reasonably practicable a consolidated earnings statement covering a period of at least 12 months beginning after the "effective date" (as defined in Rule 158 under the Act) of the Registration Statement (but in any event not later than the forty-fifth (45th) day following the end of the fiscal quarter first occurring after the first anniversary of the effective date of the Registration Statement) that will satisfy the provisions of Section 11(a) of the Act and Rule 158 thereunder and to advise you in writing when such statement has been made so available; (k) during the period of five years after the date of this Agreement, it will furnish to you a copy (i) as soon as practicable after the filing thereof, of each report filed by the Company with the Commission, any securities exchange or the National Association of Securities Dealers, Inc. ("NASD"); (ii) as soon as practicable after the release thereof, of each material press release in respect of the Company; (iii) as soon as available, of each report of the Company mailed to Stockholders; and (iv) as soon as available, such other publicly available information concerning the Company as you may reasonably request; (l) subject to Section 5(m), whether or not the transactions contemplated hereby are consummated or this Agreement becomes effective as to all of its provisions or is terminated, it will pay all costs, fees, expenses and taxes incident to the performance by the Company of its obligations hereunder, including (i) the preparation, printing, filing and distribution under the Act of the Registration Statement (including financial statements and exhibits), each Preliminary Prospectus and all amendments and supplements to any of them prior to or during the period specified in paragraph (e) above of this Section 5, (ii) the word processing, reproduction and distribution of this Agreement, the Blue Sky Survey and any other agreements, memoranda, correspondence and other documents prepared and delivered by the Underwriters or their counsel in connection with the offering of the Shares (including in each case any disbursements of counsel for the Underwriters relating to such preparation and delivery), (iii) the registration or qualification of the Shares for offer and sale under the securities or Blue Sky laws of the several states, including in each case the fees and disbursements of counsel for the Underwriters, 6 8 relating to such registration or qualification and memoranda relating thereto, provided that the Company shall not be required to pay more than $25,000 for legal fees of the counsel for the Underwriters relating to Blue Sky matters, (iv) the listing of the Shares on The Nasdaq National Market System ("NMS"); (v) furnishing such copies of the Registration Statement, each Preliminary Prospectus, the Prospectus and all amendments and supplements thereto as may be requested for use in connection with the offering or sale of the Shares by the Underwriters or by dealers to whom the Shares may be sold, (vi) obtaining the opinions to be provided pursuant to Section 8 of this Agreement and (vii) the performance by the Company of all of its other obligations under this Agreement; (m) in addition to the expenses set forth in Section 5(l), the Company shall, as applicable: (A) on the Closing Date, and on each of the Option Closing Dates, pay to EVEREN Securities, Inc., individually and not in its capacity as Representative, a non-accountable expense allowance equal to one percent (1%) of the initial public offering price of the Shares and Option Shares sold pursuant to this Agreement, or (B) (i) if the sale of the Shares provided for herein is not consummated because the Underwriters exercise their right to terminate this Agreement pursuant to Section 9 hereof and any of the following have occurred during the term of this Agreement: (1) there has been any material adverse change in the condition (financial or otherwise), earnings, affairs, business or prospects of the Company; (2) the discovery of any defect in the authorization, validity of issuance or fully paid status of any of the Company's outstanding securities; (3) the discovery that any of the Company's business plans, prospects, condition (financial or otherwise) or projections are materially different from information with respect thereto previously provided to you; (4) the failure or inability to qualify or register the offer and sale of the Common Stock on the NASDAQ-NMS or other appropriate exchange; or (5) the Company or the Selling Stockholders shall refuse or be unable to comply with any provision hereof (except as the result of any breach of this Agreement by the Underwriters), the Company will promptly reimburse the Underwriters upon demand for all reasonable out-of-pocket expenses (including the fees and disbursements of counsel for the Underwriters) that shall have been incurred by the Underwriters in connection with the proposed purchase and sale of Shares, or (ii) notwithstanding any provision of this Agreement to the contrary, if the sale of the Shares provided for herein is not consummated or this Agreement is terminated for any reason other than the reasons set forth set in clause (B) (i) of this Section 5(m), the Company shall not pay any out-of-pocket expenses (including the fees and disbursements of counsel for the Underwriters) that shall have been incurred by the Underwriters in connection with the proposed purchase and sale of Shares. For purposes of this Section 5(m), the reimbursable amount for fees and disbursements of counsel for the Underwriters will be limited to $100,000.00. (n) it intends to use the net proceeds received by it from the sale of the Shares being sold by it in the manner specified under the caption "Use of Proceeds" in the Prospectus, and it will file such reports with the Commission with respect to the application of the proceeds therefrom as may be required in accordance with Rule 463 under the Act; (o) if, at the time of effectiveness of the Registration Statement, any information shall have been omitted therefrom in reliance upon Rule 430A, then immediately following the execution and delivery of this Agreement, it will prepare, and file or transmit for filing with the Commission in accordance with such Rule 430A and Rule 424(b), copies of an amended prospectus, or, if required by such Rule 430A, a post-effective amendment to the Registration 7 9 Statement (including an amended prospectus), containing all information so omitted; (p) it will cause the Shares to be listed, subject to notice of issuance or sale, on the NMS; it will comply with all registration, filing and reporting requirements of the Securities Exchange Act of 1934, as amended, (the "Exchange Act") and the NMS applicable to the Company; (q) the Company shall obtain and deliver to you prior to the Closing Date an agreement from each current officer and director of the Company, and each beneficial owner of Common Stock (other than John Aye) prior to the date hereof a written agreement (the "Lock-up Agreements") that for a period of 180 days from the date this Agreement becomes effective, he or she will not, without the prior written consent of the Representative on behalf of the Underwriters (1) offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, or otherwise transfer or dispose of, directly or indirectly, any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock, or (2) enter into any swap or other agreement that transfers, in whole or in part, any of the economic consequences of ownership of the Common Stock, whether any such transaction described in clause (1) or (2) above is to be settled by delivery of Common Stock or such other securities, in cash or otherwise; provided, however, that this clause shall not apply to the transactions expressly contemplated hereby involving the Shares or the warrants to be provided under the Warrant Agreement (the "Warrants") or to transfers of Common Stock to partnerships, limited liability companies, trusts or similar entities organized for the exclusive benefit of family members of the transferor for financial and estate planning purposes so long as any transferee that receives Common Stock as a result of such transfer shall agree upon such transfer to be bound by the terms of this paragraph and shall be capable of being so bound; and (r) it will use its reasonable commercial efforts to do and perform all things required to be done and performed under this Agreement by it prior to or after the Closing Date or any Option Closing Date, as the case may be, and to satisfy all conditions precedent to the delivery of the Shares. 6. Representations and Warranties. (a) the Company represents and warrants to each Underwriter as of the date hereof, the Closing Date and each Option Closing Date that: (i) the Company has not received from the Commission any order preventing or suspending the use of any Preliminary Prospectus relating to the proposed offering of the Shares nor instituted or threatened any proceedings for that purpose. The Registration Statement, on the date it became or becomes effective, any 462(b) Registration Statement, on the date it became or becomes effective, each Preliminary Prospectus, on the date of the filing thereof with the Commission, and the Prospectus and any amendment or supplement thereto, on the date of filing thereof with the Commission (or if not filed, on the date provided by the Company to the Underwriters in connection with the offering and sale of the Shares) and at the Closing Date and each Option Closing Date conformed or will conform in all material respects with the requirements of the Act and the rules and regulations promulgated thereunder ("Rules 8 10 and Regulations"); the Registration Statement, on the date it became or becomes effective, and any 462(b) Registration Statement, on the date it became or becomes effective, did not or will not contain an untrue statement of material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading; each Preliminary Prospectus, on the date of the filing thereof with the Commission, and the Prospectus and any amendment or supplement thereto, on the date of filing thereof with the Commission (or if not filed, on the date provided by the Company to the Underwriters in connection with the offering and sale of the Shares) and at the Closing Date and each Option Closing Date did not and will not include an untrue statement of material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading; the foregoing shall not apply to statements in or omissions from the Registration Statement and the Prospectus made or omitted in reliance upon, and in conformity with, information relating to the Underwriters furnished in writing to the Company by or on behalf of the Underwriters with your consent expressly for use therein; the Company and the Selling Stockholders hereby acknowledge for all purposes under this Agreement that (A) the statements set forth under the caption "Underwriting" in the Prospectus and (B) the stabilization legend on the inside cover of the Prospectus constitute the only written information furnished to the Company by or on behalf of the Underwriters for use in the preparation of the Registration Statement or the Prospectus or any amendment or supplement thereto; (ii) the Company has been duly incorporated and is a validly existing corporation in good standing under the laws of Delaware, with full corporate power and authority to own or lease its properties and assets and to conduct its business as described in the Registration Statement and the Prospectus, is duly registered as an insurance holding company under the laws of California, and is duly qualified to do business in each jurisdiction in which it owns or leases real property or in which the conduct of its business or the ownership or leasing of property requires such qualification, except where the failure to be so qualified, either individually or in the aggregate, would not have a material adverse effect on the condition (financial or otherwise), business, assets, prospects, net worth or results of operations of the Company taken as a whole (a "Material Adverse Effect"); (iii) the Company has no subsidiaries other than Financial Pacific Insurance Agency ("FPIA"), Financial Pacific Insurance Company ("FPIC")and Financial Pacific Technology, Inc., each a corporation organized and operating under the laws of California; all issued and outstanding shares of capital stock or other equity interest of each subsidiary of the Company have been duly authorized and validly issued and are fully paid and nonassessable, and were not issued in violation of or subject to any preemptive right, or other rights to subscribe for or purchase shares or other equity interest and are owned by the Company free and clear of any pledge, lien, security interest, encumbrance, claim or equitable interest. (iv) the capitalization of the Company is, and upon consummation of the transactions contemplated hereby and by the Prospectus will be, as set forth in the Registration Statement and the Prospectus under the caption "Capitalization"; all of the outstanding shares of capital stock of the Company (including the shares to be sold by 9 11 the Selling Stockholders hereunder) have been duly authorized and are validly issued, are fully paid and non-assessable and conform to the description thereof in the Registration Statement and the Prospectus and were not issued in violation of any preemptive rights or other rights to subscribe for or purchase securities; and, except as set forth in the Registration Statement and the Prospectus with respect to 4,400 shares of Series A Preferred Stock and the warrants to purchase an aggregate of 747,216 shares of the Common Stock described under the Caption "Description of Capital Stock" and the options to purchase 82,819 shares of the Common Stock under the Company's 1993 Stock Incentive Plan, and except for the Warrants, no options, warrants or other rights to purchase from the Company, agreements or other obligations of the Company to issue or other rights to convert any obligation into, or exchange any securities for, shares of capital stock of or ownership interests in the Company are outstanding; the description of the Company's 1993 Stock Incentive Plan and the options or other rights granted and exercised thereunder, as set forth in the Registration Statement and the Prospectus, accurately and fairly presents the information required to be shown under the Act with respect to such options and rights; (v) subsequent to the respective dates as of which information is given in the Registration Statement and Prospectus, and except as described therein, (A) the Company has not incurred any material liabilities or obligations, direct or contingent, or entered into any material transactions not in the ordinary course of business, (B) the Company has not purchased any of its outstanding capital stock or declared, paid or otherwise made any dividend or distribution of any kind on its capital stock or otherwise and (C) there has not been any material adverse change in the Company's condition (financial or otherwise), business, affairs, prospects or results of operations or any material change in the Company's capital stock, short-term debt or long-term debt; (vi) the Company Shares have been duly and validly authorized and, when issued, delivered and paid for pursuant to this Agreement, will be validly issued, fully paid and nonassessable, and will conform to the description thereof contained in the Prospectus; (vii) this Agreement has been duly authorized, executed and delivered by the Company and is a legal, valid and binding agreement of the Company enforceable in accordance with its terms, except as enforceability of the same may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting creditors' rights generally and by general equity principles; (viii) the Company is not in violation of its Restated Certificate of Incorporation or By-laws; the Company is not in violation of or in breach of or in default in (nor has any event occurred that with notice or lapse of time, or both, would be a breach of or a default in) the performance of any obligation, agreement or condition contained in any agreement, lease, contract, permit, license, franchise agreement, mortgage, loan agreement, debenture, note, deed of trust, bond, indenture or other evidence of indebtedness or any other instrument or obligation (collectively, "Obligations or Instruments") to which the Company is a party or by which the Company or any of its properties or assets is bound or affected (except for such breach or default as would not have a Material Adverse Effect); the Company is not in violation 10 12 of any statute, judgment, decree, order, rule or regulation (collectively, "Laws") applicable to the Company or any of its properties or assets that, alone, or together with other violations of Laws would result in a Material Adverse Effect; and to the best knowledge of the Company, no other party under any contract or other agreement to which the Company is a party is in material default thereunder except for such defaults as would not individually or in the aggregate result in a Material Adverse Effect; (ix) the execution, delivery and performance of this Agreement, the delivery of the Shares by the Company and the Selling Stockholders pursuant to this Agreement, and the consummation of the transactions contemplated hereby and thereby will not, alone or upon notice or the passage of time or both, (A) require any consent, approval, authorization or other order of any court, regulatory body, administrative agency or other governmental body or third party, except such consents or approvals as have been obtained or waived or which would not result in a Material Adverse Effect (and except in the case of the Shares such as may be required under the Act and the securities or Blue Sky laws of the various states or by the NASD), and except those relating to the acquisition of 10% or more of the aggregate number of shares of the Common Stock to be outstanding upon the consummation of the transactions contemplated by this Agreement by any person or affiliated persons (other than the purchase and sale of the Shares by the Underwriters pursuant to this Agreement), (B) except as described in the Prospectus, result in the creation or imposition of any lien, charge or encumbrance upon any of the properties or assets of the Company pursuant to the terms and provisions of any Obligation or Instrument, (C) conflict with or constitute a breach or default under any Obligation or Instrument to which the Company is a party or by which the Company or any of its properties or assets is bound, (except for such creation, conflict, breach or default as would not have a Material Adverse Effect or would not interfere with the consummation of the transactions contemplated by this Agreement), or (D) assuming compliance with the Act and all applicable state securities or Blue Sky laws, violate or conflict with any Laws applicable to the Company or its subsidiary or any of their respective properties or assets taken as a whole (except for such violation or conflict as could not have a Material Adverse Effect or would not interfere with the consummation of the transactions contemplated by this Agreement); no action, suit or proceeding before any court or arbitrator or any governmental body, agency or official (domestic or foreign) is pending against or, to the knowledge of the Company, threatened against the Company, that, if adversely determined, could reasonably be expected to in any manner invalidate this Agreement or the Warrant Agreement; (x) except as set forth in the Prospectus, there is no action, suit, proceeding, inquiry or investigation, governmental or otherwise before any court, arbitrator or governmental agency or body (collectively, "Proceedings") pending to which the Company or its subsidiary is a party or to which any of their respective properties or assets are subject, that, if determined adversely to the Company or its subsidiary, as the case may be, would result in a Material Adverse Effect, or that would materially and adversely affect the properties or assets thereof, or that seeks to restrain, enjoin, prevent the consummation of or otherwise challenge the issuance or sale of any of the Shares to be sold hereunder or the consummation of the transactions contemplated hereunder, or under the Warrant Agreement and, to the best knowledge of the Company, no such Proceedings are threatened or contemplated; and (except for such contracts, documents 11 13 or agreements for which confidential treatment has been granted by the Commission in accordance with Rule 406 of the Rules and Regulations) there is no contract, document, agreement or transaction to which the Company or its subsidiary is a party, or that involved or involves the Company, its subsidiary or any of their properties or assets that are required to be described in or filed as exhibits to the Registration Statement or the Prospectus by the Act or the Rules and Regulations that have not been so described or filed; no action has been taken with respect to the Company, and, to the best knowledge of the Company, no statute, Rule or regulation or order has been enacted, adopted or issued by any governmental agency that suspends the effectiveness of the Registration Statement, prevents or suspends the use of any Preliminary Prospectus or the Prospectus, or suspends the sale of the Shares in any jurisdiction referred to in Section 5(g) hereof; no injunction, restraining order or order of any nature by a federal or state court of competent jurisdiction or any insurance regulatory agency has been issued with respect to the Company that might prevent the issuance of the Shares, suspend the effectiveness of the Registration Statement, prevent or suspend the use of any Preliminary Prospectus or the Prospectus or suspend the sale of the Shares in any jurisdiction referred to in Section 5(g) hereof; and every request of the Commission, or any securities authority or agency of any jurisdiction, for additional information (to be included in the Registration Statement or the Prospectus or otherwise) has been complied with in all material respects; (xi) the Company and each of its subsidiaries is duly licensed or authorized as an insurer or insurance agency or third-party administrator in each jurisdiction where it is required to be so licensed or authorized to conduct its business as described in the Prospectus, or is subject to no material liability or disability by reason of the failure to be so licensed or authorized in any such jurisdiction; the Company has made all required filings under applicable insurance holding company statutes; each subsidiary of the Company is in compliance with the requirements of the insurance laws and regulations of California and the insurance laws and regulations of other jurisdictions which are applicable to such subsidiary, and has filed all notices, reports, documents or other information required to be filed thereunder, except where the failure to so comply or file would not have a Material Adverse Effect; the Company and each of its subsidiaries have all other necessary authorizations, approvals, orders, consents, certificates, permits, registrations or qualifications of and from all insurance regulatory authorities to conduct its businesses as described in the Prospectus, or are subject to no material liability or disability by reason of the failure to have such authorizations, approvals, orders, consents, licenses, certificates, permits, registrations or qualifications; and none of the Company or any of its subsidiaries has received any notification from any insurance regulatory authority to the effect that any additional authorization, approval, order, consent, license, certificate, permit, registration or qualification from such insurance regulatory authority is needed to be obtained by any of the Company or its subsidiaries in any case where it could be reasonably expected that (x) the Company or its subsidiaries would in fact be required either to obtain any such additional authorization, approval, order, consent, license, certificate, permit, registration or qualification, or cease or otherwise limit writing certain business and (y) the failure to obtain such authorization, approval, order, consent, license, certificate, permit, registration or qualification or the limiting of such business would have a Material Adverse Effect on the business, financial position or results of operations of the Company and its subsidiaries; (xii) the Company is not aware that any of its pending applications for licenses or permits to act as an insurer or insurance agent or third-party administrator, or any such pending application of a subsidiary, is not being processed in due course; 12 14 (xiii) except as disclosed in the Prospectus, to the best knowledge of the Company, no change in any insurance laws, rules or regulations in California has been introduced that would reasonably be expected to be adopted and if adopted, would reasonably be expected to have, individually or in the aggregate with all such changes, a Material Adverse Effect; (xiv) in addition to the above, the Company and its subsidiaries believe they have such permits, licenses, franchises and authorizations of governmental or regulatory authorities or third parties ("Permits"), including, without limitation, under any applicable Environmental Laws, as are necessary to own, lease and operate its properties and assets and to conduct its businesses, except where the failure to have any such Permit would not have a Material Adverse Effect; the Company has fulfilled and performed all of its material conditions or obligations with respect to such Permits, and no event has occurred that allows, or after notice or lapse of time, or both would allow, revocation or termination thereof or result in any other material impairment of the rights of the holder of any such Permit; (xv) all reinsurance treaties and arrangements to which the Company or any of its subsidiaries is a party are in full force and effect and none of the Company or its subsidiaries is in violation of or in default in the performance, observance or fulfillment of, any material obligation, agreement, covenant or condition contained therein; neither the Company nor any of its subsidiaries has received notice from any of the other parties to such treaties, contracts or agreements that such other party intends not to perform such treaty, and the Company and its subsidiaries, to their best knowledge, have no reason to believe that any of the other parties to such treaties or arrangements will be unable to perform any such treaties or arrangements except to the extent adequately and properly reserved for in the consolidated financial statements of the Company and its subsidiaries included in the Prospectus. (xvi) the Company has not violated any foreign, federal, state or local law or regulation relating to the protection of human health and safety, the environment or hazardous or toxic substances or wastes, pollutants or contaminants ("Environmental Laws"), nor any foreign, Federal, state or local law relating to discrimination in the hiring, promotion or pay of employees nor any applicable foreign, Federal or state wages and hours laws, nor any provisions of the Employee Retirement Income Security Act of 1974, as amended or the rules and regulations promulgated thereunder or similar foreign laws, that, in each case or in the aggregate, would have in a Material Adverse Effect; none of the property leased by the Company is contaminated with any waste or hazardous substances, and, to the extent that the Company disposes in the ordinary course of its business products that may be classified as or contain "hazardous substances," the disposal of such products (A) is in material compliance with all applicable laws as of the date hereof and (B) has not and will not result in a Material 13 15 Adverse Effect; (xvii) the Company is not, and does not intend to conduct its business in a manner in which it would become, an "investment company" or a company "controlled" by an "investment company" within the meaning of the Investment Company Act of 1940, as amended (the "Investment Company Act"); (xviii) except as otherwise set forth in the Prospectus, the Company has good and marketable title, free and clear of all liens, claims, encumbrances and restrictions (except liens for taxes not yet due and payable) to all property and assets described in the Registration Statement as being owned by it; all leases to which the Company is a party are subsisting, valid and binding and no default of the Company or, to the best knowledge of the Company any other person has occurred or is continuing thereunder that might result in a Material Adverse Effect; and the Company enjoys peaceful and undisturbed possession under all such leases to which the Company is a party as lessee with such exceptions as do not materially interfere with the use made thereof by the Company; (xix) the Company believes it maintains adequate insurance for the conduct of its business with reputable third-party insurers in accordance with prudent practices in its industry, and the Company has no reason to believe that it will not be able to renew its existing coverage as and when such coverage expires or to obtain similar coverage from similar insurers as may be necessary to continue its business at a comparable cost; (xx) to the best of the Company's knowledge, KPMG Peat Marwick LLP, the accounting firm that has certified or reviewed, or shall certify or review, the financial statements and supporting schedules filed or to be filed with the Commission as part of the Registration Statement and the Prospectus, is an independent public accounting firm with respect to the Company as required by the Act; (xxi) the consolidated financial statements of the Company, together with related notes and schedules of the Company included in the Registration Statement and the Prospectus, are accurate and present fairly, in all material respects, the financial position, results of operations and cash flows of the Company at the indicated dates and for the indicated periods; such financial statements of have been prepared in accordance with generally accepted accounting principles ("GAAP") consistently applied throughout the periods involved, except where such summary and selected financial and operating data have been prepared or include data prepared in accordance with statutory accounting principles and the Registration Statement specifically indicates that this is the case, and all adjustments necessary for a fair presentation of results for such periods have been made, and any unaudited financial statements have been prepared on a basis substantially consistent with that of the audited operating financial statements included in the Registration Statement and the Prospectus; and the summary and selected financial and operating data included in the Registration Statement and the Prospectus present fairly, in all material respects, the information shown therein and have been compiled on a basis consistent with the audited and any unaudited financial statements, as the case may be, included therein; 14 16 (xxii) the statutory financial statements of the Company and its subsidiaries from which certain ratios and other statistical data filed as part of the Registration Statement or included or incorporated in the Prospectus have been derived: (i) have for each relevant period been prepared in conformity with statutory accounting practices required or permitted by the National Association of Insurance Commissioners and by the California Department of Insurance, and such statutory accounting practices have been applied on a consistent basis throughout the periods involved, except as may otherwise be indicated therein or in the notes thereto; and (ii) present fairly the statutory financial position of the Company and its subsidiaries as at the dates thereof, and the statutory basis results of operations of the Company for the periods covered thereby; (xxiii) FPIC is currently rated A- (excellent) by A.M. Best; the Company is not aware of any action by A.M. Best that could lead to a downward change in the rating of FPIC, nor is it aware of any circumstance that could be the basis for such downward change; (xxiv) except for the registration rights of the Selling Stockholders which have been exercised, all rights of security holders of the Company to require registration of shares of Common Stock (a "Registration Right") or any other security of the Company because of the filing of the Registration Statement or consummation of the transactions contemplated by this Agreement or to receive notification of such filing or consummation have been duly waived with respect to the public offering contemplated hereby. There are no preemptive rights with respect to the offering being made by the Prospectus; (xxv) except as disclosed in the Registration Statement and the Prospectus, no labor dispute with the employees of the Company exists, or to the best knowledge of the Company, is imminent, and the Company has not received notice of any existing or imminent labor disturbance by the employees of any of its principle suppliers, customers, manufacturers or contractors that could result in any Material Adverse Effect; (xxvi) to the best of the Company's knowledge, the Company has filed or caused to be filed, or has properly filed extensions for, all foreign, federal, state and local income, value added and franchise tax returns and has paid all taxes and assessments shown thereon as due, except for such taxes and assessments as are disclosed or adequately reserved against and that are being contested in good faith by appropriate proceedings, promptly instituted and diligently conducted; (xxvii) the Company does not own or require any patents in connection with the business it now operates and the Company owns or possesses the licenses, inventions, copyrights, know-how (including trade secrets and other unpatented and or unpatentable proprietary or confidential information, systems or procedures), trademarks, service marks and trade names (collectively, "Proprietary Rights") currently employed by it in connection with the business it now operates except where the failure to so own such Proprietary Rights would not have a Material Adverse Effect; and the Company has not received any notice and is not otherwise aware of any infringement of or conflict with asserted rights of others with respect to any Proprietary Rights that, if the subject of any unfavorable decision, ruling or finding, in the aggregate, would result in a Material Adverse Effect; 15 17 (xxviii) the Company is conducting and intends to conduct its business so as to comply in all material respects with applicable federal, state, local and foreign government Laws, except where the failure to comply would not have a Material Adverse Effect; and except as set forth in the Registration Statement and the Prospectus, the Company is not charged with or, to the best knowledge of the Company, under investigation with respect to, any material violation of any such Laws; (xxix) the Company has not taken and will not take, directly or indirectly, any action designed to or that might reasonably be expected to cause or result, under the Exchange Act or otherwise, in stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Shares; (xxx) neither the Company nor, to the best knowledge of the Company, any employee or agent of the Company has made any payment of funds of the Company or received or retained any funds in violation of any law, rule or regulation (including, without limitation, the Foreign Corrupt Practices Act) or of a character required to be disclosed in the Prospectus; the Company has not, at any time during the past five years, (1) made any unlawful contributions to any candidate for any political office, or failed fully to disclose any contribution in violation of law, or (2) made any unlawful payment to state, federal or foreign government officer or officers, or other person charged with similar public or quasi-public duty; (xxxi) the Company maintains a system of internal accounting controls which it believes is sufficient to provide reasonable assurance that (i) transactions are executed in accordance with management's general or specific authorizations, (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with GAAP and to maintain asset accountability, (iii) access to assets is permitted only in accordance with management's general or specific authorization, and (iv) the recorded accountability for inventory is compared with the existing inventory at reasonable intervals and appropriate action is taken with respect to any differences; (b) In addition, the Selling Stockholders, severally and not jointly, represent and warrant to and agree with each Underwriter and the Company that: (i) each such Selling Stockholder now has and on the Closing Date will have valid marketable title to the Selling Stockholder Shares to be sold by him or her, free and clear of any pledge, lien, security interest, encumbrance, claim or equitable interest other than pursuant to this Agreement; and upon delivery of such Shares hereunder and payment of the Purchase Price as herein contemplated, each of the Underwriters will obtain valid marketable title to the Shares purchased by it from such Selling Stockholder, free and clear of any pledge, lien, security interest pertaining to such Selling Stockholder or such Selling Stockholder's property, encumbrance, claim or equitable interest, including any liability for estate or inheritance taxes, or any liability to or claims of any creditor, devisee, legatee or beneficiary of such Selling Stockholders; (ii) each such Selling Stockholder has duly executed and delivered, in the form heretofore furnished to the Representative, an irrevocable Power of Attorney and Custody Agreement appointing Robert C. Goodell, Patrick C. Haden and Stephen E. 16 18 Adamson, or any of them, as attorney-in-fact (the "Attorney") with Robert C. Goodell as custodian (the "Custodian"); the Power of Attorney and Custody Agreement constitutes a valid and binding agreement on the part of each Selling Stockholder, enforceable in accordance with its terms, except as the enforcement thereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally or by general equitable principles; and the Attorney, acting alone, is authorized to execute and deliver this Agreement and the certificate referred to in Section 8(l) hereof on behalf of such Selling Stockholder, to determine the Purchase Price to be paid by the several Underwriters to such Selling Stockholder as provided in Section 3 hereof, and to duly endorse (in blank or otherwise) the certificate or certificates representing such Shares or a stock power or powers with respect thereto, to accept payment therefor, and otherwise to act on behalf of such Selling Stockholder in connection with this Agreement; (iii) all consents, approvals, authorizations and orders required for the execution and delivery by each Selling Stockholder of the Power of Attorney and Custody Agreement, the execution and delivery by or on behalf of such Selling Stockholder of this Agreement and the sale and delivery of the Selling Stockholder Shares to be sold by such Selling Stockholder under this Agreement (other than, at the time of the execution hereof (if the Registration Statement has not yet been declared effective by the Commission), the issuance of the order of the Commission declaring the Registration Statement effective and such consents, approvals, authorizations or orders as may be necessary under state or other securities or Blue Sky laws) have been obtained and are in full force and effect; and such Selling Stockholder has full legal right, power and authority to enter into and perform its obligations under this Agreement and such Power of Attorney and Custody Agreement, and to sell, assign, transfer and deliver the Shares to be sold by such Selling Stockholder under this Agreement; (iv) for a period of 180 days from the date this Agreement becomes effective, no Selling Stockholder will, without the prior written consent of EVEREN Securities, Inc. on behalf of the Underwriters (1) offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, or otherwise transfer or dispose of, directly or indirectly, any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock (except for such transactions contemplated in the Registration Statement), or (2) enter into any swap or other agreement that transfers, in whole or in part, any of the economic consequences of ownership of the Common Stock, whether any such transaction described in clause (1) or (2) above is to be settled by delivery of Common Stock or such other securities, in cash or otherwise; provided, however, that this clause shall not apply to the transactions expressly contemplated hereby involving the Shares or to transfers of Common Stock to partnerships, limited liability companies, trusts or similar entities organized for the exclusive benefit of family members of a Selling Stockholder for financial and estate planning purposes so long as any transferee that receives Common Stock as a result of such transfer shall agree upon such transfer to be bound by the terms of this paragraph and shall be capable of being so bound; (v) the performance of this Agreement and the consummation of the 17 19 transactions herein contemplated will not result in a breach or violation of any of the terms and provisions of or constitute a default under any bond, debenture, note or other evidence of indebtedness, or under any lease, contract, indenture, mortgage, deed of trust, loan agreement, joint venture or other agreement or instrument to which any Selling Stockholder is a party or by which any Selling Stockholder, may be bound or, to the best of each Selling Stockholder's knowledge, result in any violation of any law, order, rule, regulation, writ, injunction, judgment or decree of any court, government or governmental agency or body, domestic or foreign, having jurisdiction over such Selling Stockholder; (vi) no Selling Stockholder has taken or will take, directly or indirectly, any action designed to or that might reasonably be expected to cause or result in stabilization or manipulation of the price of the Common Stock to facilitate the sale or resale of the Shares; (vii) other than as permitted by the Act, no Selling Stockholder has distributed or will distribute any prospectus or other offering material in connection with the offering and sale of the Shares; (viii) each such Selling Stockholder has reviewed the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus) and the Registration Statement, and the information regarding such Selling Stockholder set forth therein under the caption "Principal and Selling Stockholders" is complete and accurate; (ix) each Selling Stockholder will review the Prospectus and will comply with all agreements and satisfy all conditions to be complied with or satisfied by the Selling Stockholders pursuant to this Agreement on or prior to the Closing Date, and will advise the Representative prior to the Closing Date if any statement to be made on behalf of such Selling Stockholder in the certificate contemplated by Section 8(l) would be inaccurate if made as of the Closing Date; (x) no Selling Stockholder has, unless waived prior to the date hereof, any preemptive right, co-sale right or right of first refusal or other similar right to purchase any of the Company Shares; such Selling Stockholder does not have, or has waived prior to the date hereof, any registration right or other similar right to participate in the offering made by the Prospectus, other than such rights of participation as have been satisfied by the participation of such Selling Stockholder in the transactions to which this Agreement relates in accordance with the terms of this Agreement; and such Selling Stockholder does not own any warrants, options or similar rights to acquire, and does not have any right or arrangement to acquire, any capital stock, rights, warrants, options or other securities from the Company, other than those described in the Registration Statement and the Prospectus. 7. Indemnification. (a) The Company agrees to indemnify and hold harmless each of the Underwriters and each person, if any, who controls each of the Underwriters within the meaning of Section 15 of the Act or Section 20 of the Exchange Act (the "indemnified parties") from and against any 18 20 and all losses, claims, damages, liabilities and judgments caused by, arising out of, related to or based upon any untrue statement or alleged untrue statement of a material fact contained in the Registration Statement (as amended or supplemented if the Company shall have furnished any amendments or supplements thereto), including the information deemed to be part of the Registration Statement at the time of effectiveness pursuant to Rule 430A, if applicable, or the Prospectus or any Preliminary Prospectus or caused by any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading; provided, however, that the Company shall not be liable in any such case to the extent that such losses, claims, damages, liabilities or judgments are caused by an untrue statement or omission made or omitted in reliance upon written information furnished to the Company by or on behalf of the Underwriters for use in the preparation of the Registration Statement or the Prospectus or any amendment or supplement thereto. In addition to its other obligations under this Section 7(a), the Company agrees that, as an interim measure during the pendency of any claim, action, investigation, inquiry or other proceeding arising out of or based upon any statement or omission, or any alleged statement or omission, described in this Section 7(a), or any inaccuracy in the representations and warranties of the Company herein or the failure to perform its obligations hereunder, the Company will pay each Underwriter on a quarterly basis for all reasonable legal or other expenses incurred in connection with investigating or defending any such claim, action, investigation, inquiry or other proceeding, notwithstanding the absence of a judicial determination as to the propriety and enforceability of the Company's obligation to indemnify hereunder or to pay each Underwriter for such expenses and the possibility that such payments might later be held to have been improper by a court of competent jurisdiction. To the extent that any such interim payment is so held to have been improper, the Underwriters shall promptly return such payment to the Company. Any such interim reimbursement payments which are not made to the Underwriters within thirty (30) days of a request for reimbursement shall bear interest at the prime rate (or other commercial lending rate for borrowers of the highest credit standing) listed from time to time in The Wall Street Journal which represents the base rate on corporate loans posted by a substantial majority of the nation's thirty (30) largest banks (the "Prime Rate"), from the date of such request. (b) The Selling Stockholders agree, severally and not jointly, to indemnify and hold harmless each of the Underwriters and each person, if any, who controls each of the Underwriters within the meaning of Section 15 of the Act or Section 20 of the Exchange Act (the "indemnified parties") from and against any and all losses, claims, damages, liabilities and judgments caused by, arising out of, related to or based upon any untrue statement or alleged untrue statement of a material fact contained in the Registration Statement (as amended or supplemented if the Company shall have furnished any amendments or supplements thereto), including the information deemed to be part of the Registration Statement at the time of effectiveness pursuant to Rule 430A, if applicable, or the Prospectus or any Preliminary Prospectus or caused by any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in reliance upon and in conformity with written information furnished to such Underwriter by a Selling Stockholder, directly or through such Selling Stockholder's representatives, specifically for use in the preparation thereof; provided, however, that the Selling Stockholders shall not be liable in any such case to the extent that such losses, claims, damages, liabilities or judgments are caused by an untrue statement or omission made or omitted in reliance 19 21 upon written information furnished to the Underwriters for use in the preparation of the Registration Statement or the Prospectus or any amendment or supplement thereto. In addition to any other obligations of the Selling Stockholders under this Section 7(b), the Selling Stockholders agree that, as an interim measure during the pendency of any claim, action, investigation, inquiry or other proceeding arising out of or based upon any statement or omission, or any alleged statement or omission, described in this Section 7(b), or any inaccuracy in the representations and warranties of the Selling Stockholders herein or the failure to perform any of their obligations hereunder, the Selling Stockholders will, severally and not jointly, pay each Underwriter on a quarterly basis for all reasonable legal or other expenses incurred in connection with investigating or defending any such claim, action, investigation, inquiry or other proceeding, notwithstanding the absence of a judicial determination as to the propriety and enforceability of the Selling Stockholders' obligation to indemnify hereunder or to pay each Underwriter for such expenses and the possibility that such payments might later be held to have been improper by a court of competent jurisdiction. To the extent that any such interim payment is so held to have been improper, the Underwriters shall promptly return such payment to the Selling Stockholders. Any such interim reimbursement payments which are not made to the Underwriters within thirty (30) days of a request for reimbursement shall bear interest at the Prime Rate from the date of such request. (c) In case any action shall be brought against any of the indemnified parties, based upon any Preliminary Prospectus, the Registration Statement or the Prospectus or any amendment or supplement thereto and with respect to which indemnity may be sought against the Company and the Selling Stockholders, such indemnified parties shall promptly notify the Company (and the Selling Stockholders, care of the Company) in writing (but the failure so to notify shall not relieve the Company or the Selling Stockholders of any liability that they may otherwise have to such indemnified parties under this Section 7 (although the Company's and the Selling Stockholder's liability to an indemnified party may be reduced on a monetary basis to the extent, but only to the extent, they have been prejudiced by such failure on the part of such indemnified party), and the Company and the Selling Stockholders shall promptly assume the defense thereof, including the employment of counsel satisfactory to such indemnified party and payment of all fees and expenses. The indemnified parties shall each have the right to employ separate counsel in any such action and participate in the defense thereof, but the fees and expenses of such counsel shall be at the expense of such indemnified parties unless (i) the employment of such counsel shall have been specifically authorized by the Company, (ii) the Company or the Selling Stockholder, as the case may be, shall have failed to assume promptly the defense or to employ counsel reasonably satisfactory to such indemnified party or (iii) the named parties to any such action (including any impleaded parties) include both the indemnified parties and the Company or the Selling Stockholders, and an indemnified party shall have been advised by counsel that there may be one or more legal defenses available to one or more of the indemnified parties that are different from or additional to those available to the Company or the Selling Stockholders (in which case the Company and the Selling Stockholders shall not have the right to assume the defense of such action on behalf of such indemnified party, it being understood, however, that the Company and the Selling Stockholders shall not, in connection with any one such action or separate but substantially similar or related actions in the same jurisdiction arising out of the same general allegations or circumstances, be liable for the fees and expenses of more than one separate firm of attorneys (in addition to any local counsel) for the indemnified parties, which firm shall be designated in writing by the Representative, and that all 20 22 such fees and expenses shall be reimbursed promptly as they are incurred). The Company and the Selling Stockholders shall not be liable for any settlement of any such action effected without their written consent, which consent shall not be unreasonably withheld, but if settled with the written consent of the Company and the Selling Stockholders, the Company and the Selling Stockholders agree to indemnify and hold harmless the indemnified parties from and against any and all loss or liability by reason of such settlement. No indemnifying party shall, without the prior written consent of the indemnified party, effect any settlement of any pending or threatened proceeding in respect of which any indemnified party is or could have been a party and indemnity could have been sought hereunder by such indemnified party, unless such settlement includes an unconditional and complete release in writing of such indemnified party from any and all liability on claims that are the subject matter of such proceeding, which such settlement shall be in form and substance satisfactory to the indemnified party. The indemnification provided in this Section 7 will be in addition to any liability which the Company and the Selling Stockholders may otherwise have. (d) The Underwriters agree, severally and not jointly, to indemnify and hold harmless each Selling Stockholder, the Company, its directors, its officers who sign the Registration Statement and any person controlling the Company within the meaning of Section 15 of the Act or Section 20 of the Exchange Act (the "indemnified parties"), to the same extent as the foregoing indemnity from the Company and the Selling Stockholder to the Underwriters but only with reference to information stated in or omitted from the Registration Statement, the Prospectus or any Preliminary Prospectus in reliance upon, and in conformity with, information relating to the Underwriters furnished in writing to the Company by or on behalf of the Underwriters with your consent expressly for use therein. In case any action shall be brought against the Company, the Selling Stockholders, any of the Company's directors, any such officers or any person controlling the Company based on the Registration Statement, the Prospectus or any Preliminary Prospectus and in respect of which indemnity may be sought against the Underwriters, the Underwriters shall have the rights and duties given to the Company and the Selling Stockholders by Section 7(c) hereof (except that if the Company and the Selling Stockholders shall have assumed the defense thereof, such Underwriter shall not be required to do so, but may employ separate counsel therein and participate in the defense thereof but the fees and expenses of such counsel shall be at the expense of such Underwriter), and each Selling Stockholder, the Company, its directors, any such officers and any person controlling the Company shall have the rights and duties given to the "indemnified parties" by Section 7(c) hereof. In addition to their other obligations under this Section 7(d), the Underwriters severally and not jointly agree that, as an interim measure during the pendency of any claim, action, investigation, inquiry or other proceeding described in Section 7(d) hereof, they will reimburse the Company and the Selling Stockholders on a quarterly basis for all reasonable legal or other expenses incurred in connection with investigating or defending any such claim, action, investigation, inquiry or other proceeding, notwithstanding the absence of a judicial determination as to the propriety and enforceability of the Underwriters' obligation to reimburse the Company and the Selling Stockholders for such expenses and the possibility that such payments might later be held to have been improper by a court of competent jurisdiction. To the extent that any such interim reimbursement payment is so held to have been improper, the Company and the Selling Stockholders shall promptly return such payment to the Underwriters together with interest, compounded daily, determined on the basis of the Prime Rate. Any such interim reimbursement payments which are not made to the Company or the Selling Stockholders 21 23 within thirty (30) days of a request for reimbursement shall bear interest at the Prime Rate from the date of such request. (e) If the indemnification provided for in this Section 7 is for any reason unavailable to an indemnified party or insufficient to hold such indemnified party harmless in respect of any losses, claims, damages, liabilities or judgments referred to therein, then each indemnifying party, in lieu of indemnifying such indemnified party, shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages, liabilities and judgments (i) in such proportion as is appropriate to reflect the relative benefits received by the Company and the Selling Stockholders on the one hand and the Underwriters on the other from the offering of the Securities or (ii) if the allocation provided in clause (i) above is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to in clause (i) above but also the relative fault of the Company and the Selling Stockholders on the one hand and the Underwriters on the other in connection with the statements or omissions or alleged statements or omissions that resulted in such losses, claims, damages, liabilities or judgments, as well as any other relevant equitable considerations. The relative benefits received by the Company and the Selling Stockholders on the one hand and the Underwriters on the other shall be deemed to be in the same proportion as the total net proceeds from the offering and sale of the Shares (before deducting expenses) received by the Company and the Selling Stockholders on the one hand, and the total underwriting discounts and commissions received by the Underwriters on the other, bears to the total price to the public of the Shares, in each case as set forth in the table on the cover page of the Prospectus. The relative fault of the Company, the Selling Stockholders and the Underwriters shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or the alleged omission to state a material fact relates to information supplied by the Company, the Selling Stockholders or the Underwriters and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company, the Selling Stockholders and the Underwriters agree that it would not be just and equitable if contribution pursuant to this Section 7(e) were determined by pro rata allocation (even if the Underwriters, the Company or the Selling Stockholders were treated as one entity for such purpose) or by any other method of allocation that does not take account of the equitable considerations referred to in the immediately preceding paragraph. The amount paid or payable by an indemnified party as a result of the losses, claims, damages, liabilities or judgments referred to in the immediately preceding paragraph shall be deemed to include, subject to the limitations set forth above, any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this Section 7, no Underwriter shall be required to contribute any amount in excess of the amount by which the total price at which the Shares underwritten by it and distributed to the public were offered to the public exceeds the amount of any damages which such Underwriter has otherwise paid or been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission, and no Selling Stockholder shall be required to contribute, more in the aggregate than the total selling price of his or her shares (net of all amounts reimbursed, for any reason, by the Company or insurance policies paid for or held by the Company). No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. The Underwriters' obligations in this Section 7(e) to contribute are several in proportion to the respective amount of Shares purchased hereunder by 22 24 each Underwriter and not joint. (f) It is agreed that any controversy arising out of the operation of the interim payment arrangements set forth in Sections 7(a), 7(b) or 7(d) hereof, including the amounts of any requested payments and method of determining such amounts, shall be settled by arbitration conducted under the provisions of the Constitution and Rules of the Board of Governors of the New York Stock Exchange, Inc. or pursuant to the Code of Arbitration Procedure of the National Association of Securities Dealers, Inc. Any such arbitration shall be commenced by service of a written demand for arbitration or written notice of intention to arbitrate, therein electing the arbitration tribunal. In the event the party demanding arbitration does not make such designation of an arbitration tribunal in such demand or notice, then the party responding to said demand or notice is authorized to do so. Such an arbitration shall be limited to the operation of the interim payment provisions contained in Sections 7(a), 7(b) and 7(d) hereof and shall not resolve the ultimate propriety or enforceability of the obligation to indemnify or pay expenses which is created by the provisions of such Sections 7(a), 7(b) and 7(d) hereof. (g) The parties to this Agreement hereby acknowledge that they are sophisticated business persons who were represented by counsel during the negotiations regarding the provisions hereof including, without limitation, the provisions of this Section 7, and are fully informed regarding said provisions. They further acknowledge that the provisions of this Section 7 fairly allocate the risks in light of the ability of the parties to investigate the Company and its business in order to assure that adequate disclosure is made in the Registration Statement and Prospectus as required by the Act and the Exchange Act. The parties are advised that federal or state public policy, as interpreted by the courts in certain jurisdictions, may be contrary to certain of the provisions of this Section 7, and the parties hereto hereby expressly waive and relinquish any right or ability to assert such public policy as a defense to a claim under this Section 7 and further agree not to attempt to assert any such defense. (h) Notwithstanding any other provision herein to the contrary, the liability of each Selling Stockholder under this Agreement, including under the representations, warranties and agreements contained herein and under the indemnity and contribution agreements contained in the provisions of this Section 7, shall be limited to an amount equal to the initial public offering price of the Shares sold by such Selling Stockholder to the Underwriters minus the amount of the underwriting discount paid thereon to the Underwriters by such Selling Stockholder. 8. Conditions to the Obligations of the Underwriters. The obligations of the several Underwriters to purchase and pay for the Firm Shares on the Closing Date and the Option Shares on any Option Closing Date are subject to the fulfillment of each of the following conditions on or prior to the Closing Date and each Option Closing Date: (a) All the representations and warranties of the Company and the Selling Stockholders contained in this Agreement and in any certificate delivered hereunder shall be true and correct on the Closing Date and each Option Closing Date with the same force and effect as if made on and as of the Closing Date or Option Closing Date, as applicable. The Company and the Selling Stockholders shall not have failed at or prior to the Closing Date or Option Closing Date, as applicable, to perform or comply in all respects with any of the agreements herein contained and required to be performed or complied with by the Company at or prior to the Closing Date. 23 25 (b) If the Registration Statement is not effective at the time of the execution and delivery of this Agreement, the Registration Statement shall have become effective (or, if a post-effective amendment is required to be filed pursuant to Rule 430A under the Act, such post-effective amendment shall have become effective) not later than 8:00 A.M., Los Angeles time, on the date of this Agreement or such later time as you may approve in writing or, if the Registration Statement has been declared effective prior to the execution and delivery hereof in reliance on Rule 430A, the Prospectus shall have been filed as required hereby, if necessary; and at the Closing Date and each applicable Option Closing Date, no stop order suspending the effectiveness of the Registration Statement shall have been issued, and no proceedings for that purpose shall have been commenced or shall be pending before or, to the best knowledge of the Underwriters, the Company or the Selling Stockholder, threatened by the Commission; every request for additional information on the part of the Commission shall have been complied with to the Underwriters' reasonable satisfaction; no stop order suspending the sale of the Shares in any jurisdiction referred to in Section 5(g) shall have been issued, and no proceeding for that purpose shall have been commenced or shall be pending or threatened. (c) The Shares shall have been qualified for sale under the Blue Sky laws of such states as shall have been specified by the Representative. (d) The legality and sufficiency of the authorization, issuance and sale or transfer and sale of the Shares hereunder, the validity and form of the certificates representing the Shares, the execution and delivery of this Agreement and all corporate proceedings and other legal matters incident thereto, and the form of the Registration Statement and the Prospectus (except financial statements) shall have been approved by counsel for the Underwriters exercising reasonable judgment, and no Underwriter shall have advised the Company that the Registration Statement or the Prospectus, or any amendment or supplement thereto, contains an untrue statement of material fact, or omits to state a fact that in your opinion is material and is required to be stated therein or is necessary to make the statements therein not misleading. (e) Subsequent to the execution and delivery of this Agreement, there shall not have occurred any material change, or any material development involving a prospective change, in or affecting particularly the business or properties of the Company, whether or not arising in the ordinary course of business, that, in the judgment of the Representative, makes it impractical or inadvisable to proceed with the public offering or purchase of the Shares as contemplated hereby. (f) You shall have received the Lock-up Agreements specified in Section 5(q) of this Agreement. (g) You shall have received an opinion (satisfactory to you and your counsel) dated the Closing Date or the Option Closing Date, as the case may be, of Riordan & McKinzie, counsel for the Company and the Selling Stockholders, to the effect set forth on Exhibit A hereto and incorporated herein. (h) You shall have received an opinion (satisfactory to you and your counsel) dated the Closing Date or the Option Closing Date, as the case may be, of LeBoeuf, Lamb, Greene, MacRae, LLP, special counsel to the Company with respect to matters involving insurance regulation to the effect set forth on Exhibit B hereto and incorporated herein. 24 26 (i) You shall have received on the Closing Date and on any later date on which Option Shares are to be purchased, as the case may be, a letter from KPMG Peat Marwick, LLP addressed to the Company and the Underwriters, dated the Closing Date or such later date on which Option Shares are to be purchased, as the case may be, confirming that they are independent certified public accountants with respect to the Company within the meaning of the Act and the applicable published Rules and Regulations and based upon the procedures described in such letter delivered to you concurrently with the execution of this Agreement (herein called the "Original Letter"), but carried out to a date not more than five (5) business days prior to the Closing Date or such later date on which Option Shares are to be purchased, as the case may be, (i) confirming, to the extent true, that the statements and conclusions set forth in the Original Letter are accurate as of the Closing Date or such later date on which Option Shares are to be purchased, as the case may be, and (ii) setting forth any revisions and additions to the statements and conclusions set forth in the Original Letter which are necessary to reflect any changes in the facts described in the Original Letter since the date of such letter, or to reflect the availability of more recent financial statements, data or information. The letter shall not disclose any change in the condition (financial or otherwise), earnings, operations, business or business prospects of the Company and its subsidiaries considered as one enterprise from that set forth in the Registration Statement or Prospectus, which, in your sole judgment, is material and adverse and that makes it, in your sole judgment, impracticable or inadvisable to proceed with the public offering of the Shares as contemplated by the Prospectus. The Original Letter from KPMG Peat Marwick, LLP shall be addressed to or for the use of the Underwriters in form and substance satisfactory to the Underwriters and shall (i) represent, to the extent true, that they are independent certified public accountants with respect to the Company within the meaning of the Act and the applicable published Rules and Regulations, (ii) set forth their opinion with respect to their examination of the balance sheets of the Company as of December 31, 1997, and related statements of operations, shareholders' equity and cash flows for the years then ended December 31, 1997, (iii) state that KPMG Peat Marwick, LLP has performed the procedure set out in Statement on Auditing Standards No. 71 ("SAS 71") for a review of financial information at March 31, 1998, and (iv) address other matters agreed upon by KPMG Peat Marwick, LLP and you. In addition, you shall have received confirmation from KPMG Peat Marwick, LLP that a letter addressed to the Company has been delivered to the Company stating that, in performing their audit of the Company's consolidated financial statements as of March 31, 1998, to the extent they deemed necessary in determining their auditing procedures, they considered the Company's system of internal accounting controls and noted no matters that they considered to be material weaknesses. (j) You shall have received from the Company a certificate, signed by Robert C. Goodell and Arthur A. Terner, in their capacities as Chief Executive Officer and Chief Financial Officer of the Company, respectively, addressed to the Underwriters and dated the Closing Date or Option Closing Date, as applicable, to the effect that: (i) such officer does not know of any Proceedings instituted, threatened or contemplated against the Company of a character required to be disclosed in the Prospectus that are not so disclosed; such officer does not know of any material contract required to be filed as an exhibit to the Registration Statement which is not so filed; (ii) such officer has carefully examined the Registration Statement and the Prospectus and all amendments or supplements thereto and, in such officer's opinion, such Registration Statement or such amendment as of its effective date and as of the Closing Date, and the Prospectus or such supplement as of its date and as of the Closing Date, did not contain an untrue statement of material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein not misleading and, in such officer's opinion, since the effective date of the Registration 25 27 Statement, no event has occurred or information become known that should have been set forth in an amendment to the Registration Statement or a supplement to the Prospectus which has not been so set forth in such amendment or supplement; (iii) the representations and warranties of the Company set forth in Section 6(a) of this Agreement are true and correct as of the date of this Agreement and as of the Closing Date or the Option Closing Date, as the case may be, and the Company has complied with all the agreements and satisfied all the conditions on its part to be performed or satisfied at or prior to such Closing Date; and (iv) the Commission has not issued an order preventing or suspending the use of the Prospectus or any preliminary prospectus filed as a part of the Registration Statement or any amendment thereto; no stop order suspending the effectiveness of the Registration Statement has been issued; and, to the best knowledge of the respective signers, no proceedings for that purpose have been instituted or are pending or contemplated under the Act. The delivery of the certificate provided for in this subparagraph shall be and constitute a representation and warranty of the Company as to the facts required in the immediately foregoing clauses (iii) and (iv) of this subparagraph to be set forth in said certificate. (k) You shall have received a certificate, dated the Closing Date, from each Selling Stockholder to the effect that, as of the Closing Date, such Selling Stockholder has not been informed that: (i) The representations and warranties made by any Selling Stockholder herein are not true or correct in any material respect on the Closing Date or on any later date on which Option Shares are to be purchased, as the case may be; or that (ii) Any Selling Stockholder has not complied with any obligation or satisfied any condition which is required to be performed or satisfied on the part of such Selling Stockholder at or prior to the Closing Date or any later date on which Option Shares are to be purchased, as the case may be. (l) You and Morrison & Foerster LLP, counsel for the Underwriters, shall have received on or before the Closing Date or the Option Closing Date, as the case may be, such further documents, opinions, certificates and schedules or instruments relating to the business, corporate, legal and financial affairs of the Company as you and they shall have reasonably requested from the Company. (m) The Company shall have executed and delivered to the Representative the Warrant Agreement, together with certificates for the Warrants in the form and under the terms specified therein, registered in such names and amounts as the Representative shall direct. 9. Effective Date of Agreement, Termination and Defaults. This Agreement shall become effective upon, and shall not be deemed delivered until, the later of (i) execution of this Agreement and (ii) when notification of the effectiveness of the Registration Statement has been released by the Commission. 26 28 This Agreement may be terminated at any time prior to the Closing Date and any exercise of the option to purchase Option Shares may be canceled at any time prior to any Option Closing Date by the Underwriters by written notice to the Company if any of the following has occurred: (i) since the respective dates as of which information is given in the Registration Statement and the Prospectus, any material adverse change or development involving a prospective material adverse change in the condition, financial or otherwise, of the Company or the earnings, affairs, management, or business of the Company, whether or not arising in the ordinary course of business, that would, in the Representative's reasonable judgment, make it impracticable to market the Shares on the terms and in the manner contemplated in the Prospectus, (ii) any outbreak or escalation of hostilities or other national or international calamity or crisis or change in economic conditions or in the financial markets of the United States that, in the Representative's reasonable judgment, is material and adverse and would, in the Representative's judgment, make it impracticable to market the Shares on the terms and in the manner contemplated in the Prospectus, (iii) the suspension or material limitation of trading in securities on the New York Stock Exchange, the American Stock Exchange or the Nasdaq Stock Market or limitation on prices for securities on either such exchange or the Nasdaq Stock Market, (iv) the enactment, publication, decree or other promulgation of any federal or state statute, regulation, Rule or order of any court or other governmental authority that in the Representative's opinion materially and adversely affects, or will materially and adversely affect, the business or operations of the Company, (v) the declaration of a banking moratorium by either federal or New York or California state authorities, (vi) the taking of any action by any Federal, state or local government or agency in respect of its monetary or fiscal affairs that in the Representative's reasonable opinion has a material adverse effect on the financial markets in the United States or (vii) there shall be any change in financial markets or in political, economic or financial conditions which, in the reasonable opinion of the Representative, either renders it impracticable or inadvisable to proceed with the offering and sale of the Shares on the terms set forth in the Prospectus or materially adversely affects the market for the Shares. If on the Closing Date or on any Option Closing Date, as the case may be, any of the Underwriters shall fail or refuse to purchase the Firm Shares or Option Shares, as the case may be, which it has agreed to purchase hereunder on such date, and the aggregate number of Firm Shares or Option Shares, as the case may be, that such defaulting Underwriter or Underwriters agreed but failed or refused to purchase does not exceed, in the aggregate, 10% of the total number of Shares that all Underwriters are obligated to purchase on such date, each non-defaulting Underwriter shall be obligated, in the proportion which the number of Firm Shares set forth opposite its name in Schedule I hereto bears to the total number of Firm Shares or Option Shares, as the case may be, which all the non-defaulting Underwriters have agreed to purchase, or in such other proportion as you may specify, to purchase the Firm Shares or Option Shares, as the case may be, that such defaulting Underwriter or Underwriters agreed but failed or refused to purchase on such date. If, on the Closing Date or on the Option Closing Date, as the case may be, any of the Underwriters shall fail or refuse to purchase the Firm Shares or Option Shares, as the case may be, in an amount that exceeds, in the aggregate, 10% of the total number of the Shares, and arrangements satisfactory to you and the Company for the purchase of such Shares are not made within 48 hours after such default, this Agreement shall terminate without liability on the part of the non-defaulting Underwriters, the Company or the Selling Stockholder, except as otherwise provided in this Section 9. In any such case that does not result in termination of this Agreement, either you or the Company may postpone the Closing Date or the Option Closing Date, as the case may be, for not longer than seven (7) days, in order that the required changes, if any, in the Registration Statement and the Prospectus or any other documents or arrangements may be effected. Any action taken under this paragraph shall not relieve a defaulting Underwriter from liability in respect of any 27 29 default of any such Underwriter under this Agreement. The indemnity and contribution provisions and other agreements, representations and warranties of the Company, the Selling Stockholders and the Company's officers and directors set forth in or made pursuant to this Agreement shall remain operative and in full force and effect, and will survive delivery of and payment for the Shares, regardless of (i) any investigation, or statement as to the results thereof, made by or on behalf of any of the Underwriters or by or on behalf of the Company or the Selling Stockholders or the officers or directors of the Company or any controlling person of the Company, (ii) acceptance of the Shares and payment therefor hereunder or (iii) termination of this Agreement. Notwithstanding any termination of this Agreement, the Company shall be liable for and shall pay all expenses it has agreed to pay pursuant to Section 5(l). Except as otherwise provided, this Agreement has been and is made solely for the benefit of, and shall be binding upon, the Company, the Selling Stockholders, the Underwriters, any indemnified person referred to herein and their respective successors and assigns, all as and to the extent provided in this Agreement, and no other person shall acquire or have any right under or by virtue of this Agreement. The terms "successors and assigns" shall not include a purchaser of any of the Shares from any of the several Underwriters merely because of such purchase. 10. Effectiveness of Registration Statement. You, the Company and the Selling Stockholders will use your, its and their best efforts to cause the Registration Statement to become effective, if it has not yet become effective, and to prevent the issuance of any stop order suspending the effectiveness of the Registration Statement and, if such stop order be issued, to obtain as soon as possible the lifting thereof. 11. Miscellaneous. All communications hereunder will be in writing and, if sent to the Underwriters will be mailed, delivered or telegraphed and confirmed to you at 77 West Wacker Drive, Chicago, Illinois 60601-1994, Attention: Syndicate Department, with a copy to EVEREN Securities, Inc., 1901 Avenue of the Stars, Suite 1460, Los Angeles, California 90067, Attention: Basil E. Horner, Senior Managing Director; if sent to the Company will be mailed, delivered or telegraphed and confirmed to the Company at 3850 Atherton Road, Rocklin, California 95765 Attention: Robert C. Goodell, President and Chief Executive Officer with a copy to Riordan & McKinzie, 300 South Grand Avenue, 29th Floor, Los Angeles, California 90071, Attention: Janis B. Salin; and if sent to the Selling Stockholders will be mailed, delivered or telegraphed to them care of the Company, with a copy to, or in any case to such other address as the person to be notified may have requested in writing. The Underwriters confirm that they will acquire the Shares only for resale to the public and do not intend to hold the Shares for investment. They further confirm that they do not intend to exercise control over the Company or FPIC. Until the initial public offering of the shares to the public has been completed (as evidenced by termination of the underwriting syndicate), the Underwriters will not knowingly sell to a single person or an affiliated group a number of shares which equals or exceeds 10% or more of the Company's outstanding voting securities, unless the purchaser or purchasers provide the Underwriters with evidence satisfactory to the Underwriters that it or they have obtained all required approvals form the California Department of Insurance or that such approvals are not required. Absent actual knowledge, the knowledge of one member of the underwriting syndicate shall not be attributed to other members of the underwriting syndicate. Until the initial public offering of the shares to the public has been completed, no Underwriter shall exercise any voting right associated with shares held for such Underwriter's account. The Company shall not in any event be liable to any of the Underwriters for loss of anticipated profits from the transactions covered by this Agreement. 28 30 THIS AGREEMENT SHALL BE GOVERNED AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF ILLINOIS WITHOUT REGARD TO THE PRINCIPLES OF CONFLICTS OF LAW THEREOF. This Agreement may be signed in various counterparts which together shall constitute one and the same instrument. Please confirm that the foregoing correctly sets forth the agreement among the Company, the Selling Stockholder and the several Underwriters, including you. Very truly yours, FINANCIAL PACIFIC INSURANCE GROUP, INC., a California corporation By: ___________________________________ Its ___________________________________ Selling Stockholders: RIORDAN, LEWIS & HADEN By: ___________________________________ Attorney-in-Fact FIREMARK ADVISORS, INC. By: ___________________________________ Attorney-in-Fact ST. PAUL FIRE & MARINE INSURANCE COMPANY By: ___________________________________ Attorney-in-Fact 29 31 The foregoing Underwriting Agreement is hereby confirmed and accepted as of the date first above written. EVEREN Securities, Inc. Acting as Representative of the several Underwriters named in Schedule I. By: ___________________________________ [Title] 30 32 SCHEDULE I
UNDERWRITER NUMBER OF SHARES ----------- ---------------- Everen Securities, Inc............................. $ $ $ $ $ $ $ $ $ $ TOTAL................................... $
31 33 SCHEDULE II
STOCKHOLDER NAME NUMBER OF SHARES ---------------- ---------------- Riordan, Lewis & Haden 136,971 Firemark Advisors, Inc. 136,971 St. Paul Fire & Marine Insurance Co. 136,972 Celerity Partners, L.P. 59,367 Robert S. Goodell 10,000 David Rogers 19,719 TOTAL................................... 500,000
32 EX-5.1 3 OPINION OF RIORDAN & MCKINZIE 1 EXHIBIT 5.1 May 28, 1998 06-158-007 Financial Pacific Insurance Group, Inc. 3850 Atherton Road Rocklin, California 95765 Ladies and Gentlemen: We have acted as counsel to Financial Pacific Insurance Group, Inc., a Delaware corporation (the "Company"), in connection with the registration under the Securities Act of 1933, as amended (the "1933 Act"), of the sale in an underwritten public offering of up to 2,375,000 authorized but unissued shares of the Common Stock, $.01 par value (the "Common Stock"), of the Company (the "Company Shares") and 500,000 authorized, issued and outstanding shares of the Company currently held by existing stockholders. This opinion is delivered to you in connection with the Registration Statement on Form S-1, Registration No. 333-50511, as amended to date (the "Registration Statement"), for the aforementioned sale, filed with the Securities and Exchange Commission (the "Commission") under the 1933 Act. In rendering the opinion set forth herein, we have made such investigations of fact and law, and examined such documents and instruments, or copies thereof established to our satisfaction to be true and correct copies thereof, as we have deemed necessary under the circumstances. Based upon the foregoing and such other examination of law and fact as we have deemed necessary, and in reliance thereon, we are of the opinion that, subject to such proceedings as are now contemplated being duly taken and completed by you prior to the issuance of the Company Shares, the issuance of an appropriate order by the Commission declaring the Registration Statement, as amended, effective, and the compliance with applicable state securities and "blue sky" laws, the Company Shares have been duly authorized and will, upon sale and 2 Financial Pacific Insurance Group, Inc. May 28, 1998 Page 2 delivery thereof and receipt by the Company of full payment therefor as set forth in the Registration Statement, be validly issued, fully paid and nonassessable. We hereby consent to the filing of this opinion as an exhibit to the Registration Statement and to the reference to this firm under the caption "Legal Matters" in the Prospectus which is a part of the Registration Statement. Very truly yours, /s/ RIORDAN & MCKINZIE EX-10.11 4 RESTRICTED STOCK AGREEMENT 1 Exhibit 10.11 ALL SECTIONS MARKED WITH TWO ASTERISKS ("**") REFLECT PORTIONS WHICH HAVE BEEN REDACTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION BY THE REGISTRANT AS PART OF A REQUEST FOR CONFIDENTIAL TREATMENT. [Execution Copy] RESTRICTED STOCK AGREEMENT This Restricted Stock Agreement is made as of September 7, 1993 by and among Financial Pacific Insurance Group, Inc., a Delaware corporation (the "Corporation"), Robert C. Goodell ("RCG") and Suzanne M. Goodell ("SMG"). RCG and SMG are collectively referred to herein as ("Goodell"). RECITALS A. On the date hereof, immediately prior to the transactions referred to below, RCG owns 100% of the outstanding shares of the common stock, $.001 par value (the "Common Stock"), of the Corporation, consisting of 682,284 shares (the "Initial Shares"). B. The parties listed on Schedule 1 attached hereto (the "Purchasers") propose to purchase from the Corporation, and the Corporation proposes to sell to the Purchasers, an aggregate of 3,650,001 shares of the Corporation's Series A Convertible Preferred Stock , $.001 par value (the "Series A Stock"), pursuant to a Series A Convertible Preferred Stock Purchase Agreement of even date herewith by and among the Corporation and the Purchasers (the "Purchase Agreement"). C. RCG, SMG and the trustees of their respective Individual Retirement Accounts propose to purchase from the Corporation, and the Corporation proposes to sell to such persons, an aggregate of 500,000 additional shares of Common Stock (the "New Shares") on the terms and conditions set forth in this Agreement. The New Shares consist of the following (and any shares issued in exchange for or in connection with the following): Number of Record Holder Shares ------------- ------ 79,000 California Central Trust Bank Corporation, as Trustee #1060000539 FBO Robert C. Goodell ("RCG Trustee") California Central Trust Bank Corporation, 20,500 as Trustee #1060000539 FBO Suzanne M. Goodell ("SMG Trustee") Robert C. Goodell 200,000 Robert C. Goodell and Suzanne M. Goodell 200,300 2 As used hereafter in this Agreement, the term "Restricted Shares" shall mean the Initial Shares and the New Shares. D. The Purchasers, the holders of the Common Stock and the Corporation are entering into a Stockholders Agreement of even date herewith (the "Stockholders Agreement"). The term "Stockholders" as used herein has the meaning as provided from time to time in the Stockholders Agreement. E. Goodell believes that the consummation of the transactions contemplated by the Purchase Agreement will be of financial benefit to the Corporation and accordingly assumes certain duties toward and confers certain benefits upon the Purchasers under this Agreement in satisfaction of one of the Purchasers' closing conditions under the Purchase Agreement. NOW, THEREFORE, in consideration of the foregoing recitals and mutual covenants and conditions contained herein, the parties agree as follows: 1. Repurchase Option Upon Failure to Satisfy Performance Standards. (a) Performance Standards. The parties hereby agree upon the performance standard for the annual consolidated net income of the Corporation and its subsidiaries, excluding any extraordinary or nonrecurring gains or losses (net of taxes) (the "Target Annual Net Income"), to be determined in accordance with generally accepted accounting principles ("GAAP") consistently applied, as set forth below:
Target Annual Cumulative Year Net Income Net Income ---- ------------- ----------- January 1, 1994 to December 31, 1994 $ 1,119,000 $1,119,000 January 1, 1995 to December 31, 1995 1,460,000 2,579,000 January 1, 1996 to December 31, 1996 2,124,000 4,703,000 January 1, 1997 to December 31, 1997 2,744,000 7,447,000 January 1, 1998 to December 31, 1998 3,698,000 11,145,000
However, in the event the Board of Directors of the Corporation (the "Board") elects to determine a more conservative investment policy for the Corporation and its insurance subsidiary than is in effect on the date hereof, then the Target Annual Net Income, as set forth above, shall be adjusted as the Board and RCG shall reasonably agree in good faith to account for the resulting change in investment income. In addition, if the Corporation conducts a public offering of its Common Stock that would require the automatic conversion of the outstanding shares of Series A Stock into Common Stock pursuant to the Certificate of Designations of Series A Convertible Preferred Stock of the Corporation, then 2. 3 the Target Annual Net Income shall be adjusted as the Board and RCG shall reasonably agree in good faith to account for the resulting change in investment income. (b) Annual Designation of Exempt Shares. The parties hereby agree that up to 20% of the original Initial Shares shall be eligible to be converted into shares exempt from the repurchase option described in subparagraph (c) below ("Exempt Shares") each calendar year; provided, however, that all of the Initial Shares shall be converted into Exempt Shares upon the consolidation or merger of the Corporation with or into another corporation, the sale or conveyance of all or substantially all of the assets of the Corporation or a sale of all or substantially all of the capital stock of the Corporation (a "Sale Transaction"). After each calendar year end, upon the receipt of the Corporation's audited consolidated financial statements, the Board shall determine the percentage of the Target Annual Net Income achieved by the Corporation for such calendar year. For each calendar year, if the Corporation achieves: (i) 100% or more of the Target Annual Net Income for such calendar year, then the entire eligible percentage of the Initial Shares shall become Exempt Shares; (ii) less than 80% of the Target Annual Net Income for such calendar year, then no Initial Shares shall become Exempt Shares; (iii) 80% of the Target Annual Net Income for such calendar year, then 80% of the Initial Shares shall become Exempt Shares; and (iv) greater than 80%, but less than 100%, of the Target Annual Net Income for such calendar year, then a pro rata portion of the eligible percentage of Initial Shares shall become Exempt Shares; provided, however, that if the Corporation's cumulative net income on a consolidated basis, excluding any extraordinary or nonrecurring gains or losses (net of taxes), determined in accordance with GAAP consistently applied, from January 1, 1994 to the end of such calendar year is equal to or greater than the amount of Cumulative Net Income set forth above, then the portion of any eligible Initial Shares which were not converted into Exempt Shares in any prior calendar year shall be converted into Exempt Shares. Those Initial Shares that have become Exempt Shares pursuant to this subparagraph (b) shall remain Exempt Shares regardless of the future performance of the Corporation. Notwithstanding the foregoing, if RCG is employed by the Corporation on December 31, 2001, then all of the Initial Shares on such date shall be converted into Exempt Shares. Upon any Date of Determination, as hereinafter defined, the performance standards set forth in this subparagraph (b) shall be applied to the most recently completed calendar quarter and in such a manner as to give RCG the benefit of any partial year's 3. 4 performance by the Corporation, and such performance standards shall be prorated accordingly. For purposes of this Section 2, the term "Determination Date" shall mean the first date as of which any of the following occurs; (a) the termination of RCG's employment with the Corporation for any reason, (b) a Sale Transaction or (c) December 31, 1998. (c) Repurchase Upon Determination Date. As of the Determination Date, the Corporation shall have the right to repurchase for cancellation all Initial Shares that have not been converted into Exempt Shares, as follows: (i) Corporation's Repurchase Option. The Corporation shall have the option (the "Corporation's Repurchase Option") to purchase for a period of 60 days after the Determination Date any or all of the Initial Shares at the Repurchase Price (as hereinafter defined). Should the Corporation fail to purchase any or all of the Initial Shares which it is entitled to purchase pursuant to the Corporation's Repurchase Option, the balance of the Initial Shares shall become Exempt Shares. The Corporation's Repurchase Option may not be assigned by the Corporation, and all Initial Shares repurchased shall be cancelled. (ii) Purchase Price. The purchase price ("Repurchase Price") for any Initial Shares to be purchased pursuant to the Corporation's Repurchase Option shall be $.01 per Incentive Share (as adjusted for Recapitalizations, as hereinafter defined). (iii) Exercise of Repurchase Option. The Corporation's Repurchase Option shall be exercised by the Corporation by delivery (a) within the 60 day period specified in clause (i) to Goodell of a written notice specifying the number of Initial Shares to be purchased and (b) within the same 60 day period, a check in the amount of the Repurchase Price, calculated as provided in clause (iii), for all Initial Shares to be purchased by the Corporation. (iv) Payment by Goodell for Exempt Shares. Goodell shall, on the Determination Date, either (i) pay the Corporation $1.00 times the number of Exempt Shares (as adjusted for Recapitalizations) on such date (the "Cash Amount") or (ii) sell to the Corporation for cancellation at a price of $.01 per share (as adjusted for Recapitalizations) the number of Exempt Shares equal in value to the Cash Amount. 2. Repurchase Option Upon Termination. (a) Corporation's Repurchase Option. In the event that RCG's employment by the Corporation terminates for any reason on or before December 31, 1998, 4. 5 the Corporation shall have the option (the "Corporation's Repurchase Option") to purchase for cancellation for a period of 60 days after the date of such termination (the "Termination Date") any or all of the Restricted Shares (including but not limited to any Exempt Shares) at the Restricted Share Repurchase Price (as hereinafter defined). Should the Corporation fail to purchase any or all of the Restricted Shares which it is entitled to purchase pursuant to the Corporation's Repurchase Option, the Corporation shall promptly give written notice (the "Repurchase Notice") to the other stockholders of the Corporation (the "Other Stockholders") specifying the number of Restricted Shares not purchased by the Corporation. (b) Other Stockholders' Repurchase Option. Within 30 days after delivery of the Repurchase Notice, the Other Stockholders may elect to purchase (the "Other Stockholders' Repurchase Option") the Restricted Shares not purchased by the Corporation pursuant to the Corporation's Repurchase Option (the "Remaining Shares"). Should the aggregate number of shares that the Other Stockholders elect to purchase exceed the number of Remaining Shares the Other Stockholders are entitled to purchase, each Other Stockholder electing to purchase shall be entitled to purchase such proportion of the Remaining Shares as the number of shares of Common Stock held by such Other Stockholder (determined on an as-converted as to the Purchasers) bears to the aggregate number of shares of Common Stock (determined on an as-converted basis) held by all Other Stockholders electing to purchase. The Secretary of the Corporation shall promptly give notice to each Other Stockholder of the number of Remaining Shares which such Other Stockholder may purchase. (c) Purchase Price. The Corporation's Repurchase Option pursuant to Section 1 shall first be applied for the repurchase of Restricted Shares. The purchase price ("Restricted Share Repurchase Price") for any remaining Restricted Shares to be purchased pursuant to the Corporation's Repurchase Option or the Other Stockholders' Repurchase Option set forth in this Section 2 shall equal (i) for New Shares and Restricted Shares that have become Exempt Shares (A) $1.00 per Restricted Share (as adjusted for Recapitalizations) if the Termination Date is on or before September 7, 1994 and (B) the book value (as hereinafter defined) per Restricted Share if the Termination Date is after September 7, 1994 but on or before December 31, 1998; and (ii) for Restricted Shares that are then Incentive Shares, $.01 per Restricted Share (as adjusted for Recapitalizations). The book value of each Restricted Share shall equal the price per share originally paid plus the net income or minus the net loss of the Corporation and its subsidiaries on a consolidated basis, determined in accordance with GAAP consistently applied, and calculated from the date hereof to the end of the fiscal quarter immediately preceding the fiscal quarter in which the Termination Date occurs. In computing net income or net loss for purposes of the preceding sentence, there shall be excluded the amortization of intangibles. (d) Exercise of Repurchase Options. The Corporation's Repurchase Option shall be exercised by the Corporation by delivery (a) within the 60 day period specified in subparagraph (a) to Goodell of a written notice specifying the number of Restricted Shares to be purchased and (b) within the same 60 day period, a check in the 5. 6 amount of the Restricted Share Repurchase Price, calculated as provided in subparagraph (c) for all Restricted Shares to be purchased by the Corporation. The Other Stockholders' Repurchase Option shall be exercised by the Other Stockholders by delivery (a) within the 30 day period specified in subparagraph (b) to Goodell of a written notice specifying the number of Remaining Shares to be purchased and (b) within the same 30 day period, a check in the amount of the Restricted Share Repurchase Price, calculated as provided in subparagraph (c), for all Remaining Shares to be purchased by the Other Stockholders. 3. Put Option. In the event of death of RCG, his estate shall have the right, at its option (the "Put Option"), to require the Corporation to purchase in the manner and on the terms set forth in this Section 3 any Restricted Shares not repurchased by the Corporation or the Other Stockholders pursuant to Section 2. The Purchase Price for the Restricted Shares which the Corporation is required to purchase upon the exercise of the Put Option ( the "Put Price") shall be the same as the Restricted Share Repurchase Price pursuant to Section 2(c) hereof, provided, however, that the Corporation shall not be obligated to repurchase Restricted Shares in a number that would cause the payment to be made for such Restricted Shares to exceed the proceeds of the key man life insurance required under the terms of Section 5.2(k) of the Purchase Agreement, less any portion thereof applied to repay Marvin L. Oates pursuant to the terms of the Note to be issued by the Corporation to Mr. Oates. Notwithstanding the foregoing, the date upon which the Corporation is required to make payment of the Put Price shall be delayed to the extent that and for so long as the Corporation lacks sufficient legally available funds to pay the Put Price or is otherwise prohibited under Delaware or California law from making such payment. 4. Escrow. As security for the faithful performance of the terms of this Agreement and to insure the availability for delivery of any Initial Shares upon exercise of the repurchase options herein provided for, Goodell agrees to deliver to and deposit with the Secretary of the Corporation, or such other person designated by the Corporation ("Escrow Agent"), as Escrow Agent in this transaction, two Stock Assignments duly endorsed (with date and number of shares blank) in the form attached hereto as Exhibit A, together with the certificate or certificates evidencing the Initial Shares. Said documents are to held by the Escrow Agent and delivered by said Escrow Agent pursuant to the Joint Escrow Instructions of the Corporation and Goodell set forth in Exhibit B attached hereto and incorporated by this reference. 5. Restrictions on Transfer of Restricted Shares. The Restricted Shares shall be subject to the restrictions on transfer set forth in that certain Stockholders Agreement dated as of September 7, 1993 among the Corporation, Goodell and the other stockholders named therein (the "Stockholders Agreement"). Each qualified transferee of Restricted Shares must, prior to the acknowledgment and acceptance of such transfer by the Corporation, agree to take and hold such Restricted Shares subject to the terms and conditions of the Stockholders Agreement. 6. 7 6. RIGHTS AS STOCKHOLDER. Subject to compliance with the provisions of this Agreement, Goodell shall exercise all rights and privileges of the registered holder of the Restricted Shares and shall be entitled to receive any dividend or other distribution thereon. 7. NO CONTRACT OF EMPLOYMENT. Goodell acknowledges and agrees that this Agreement shall not be construed to give RCG any right to be retained in the employ of the Corporation or any subsidiary thereof, and that the right and power of the Corporation or any subsidiary to dismiss or discharge RCG (with or without cause) is strictly reserved. 8. RECLASSIFICATION, REORGANIZATION, ACQUISITION OF STOCK,ETC. In the event of any reclassification, reorganization, recapitalization, stock split, stock dividend, combination of shares, or any other change in the capital structure of the Corporation (a "Recapitalization"), all shares of Common Stock obtained as the result thereof by Goodell in addition to, in exchange for or in respect of the Restricted Shares shall be deemed Restricted Shares and shall be subject to this Agreement. Goodell's ownership interest shall be appropriately adjusted in a manner consistent with the Certificate of Designations of Series A Convertible Preferred Stock of the Corporation and the Warrants. 9. SHARES HELD BY IRA TRUSTEES. The Subscription Agreements pursuant to which the shares of Common stock held by RCG Trustee and SMG Trustee were issued provide that such shares shall be subject to the terms of this Agreement. RCG shall cause RCG Trustee to comply with the provisions of this Agreement, including the obligation to sell the shares of Common Stock held by RCG Trustee as provided in this Agreement. SMG shall cause SMG Trustee to comply with the provisions of this Agreement, including the obligation to sell the shares of Common Stock held by SMG Trustee as provided in this Agreement. 10. THIRD PARTY BENEFICIARIES. The Other Stockholders shall be third party beneficiaries of this Agreement. 11. MISCELLANEOUS. (a) FURTHER ASSURANCES. Each party hereto agrees to perform any further acts and execute and deliver any document which may be reasonably necessary to carry out the intent if this Agreement. (b) BINDING AGREEMENT. This Agreement shall bind and inure to the benefit of the successors and assigns of the Corporation and the personal representatives, heirs and legatees of Goodell. (c) NOTICES. Any notice required or permitted to be given pursuant to this Agreement shall be in writing and shall be deemed given upon personal delivery or, if mailed, upon the expiration of 48 hours after mailing by any form of United States mail 7. 8 requiring a return receipt, addressed (i) to Goodell at the address set forth on the signature page hereof, (ii) to Financial Pacific Insurance Group, Inc., 8583 Elder Creek Road, Suite 100, Sacramento, California 95828, Attention: President, and (iii) if to an Other Stockholder, at the address shown on SCHEDULE 1 attached hereto. A party may change its address by giving written notice to the other parties setting forth the new address for the giving of notices pursuant to this Agreement. (d) AMENDMENTS. This Agreement may be amended at any time by the written agreement and consent of the parties hereto. (e) GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the State of California. (f) DISPUTES. In the event of any dispute among the parties arising out of this Agreement, the prevailing party shall be entitled to recover from the nonprevailing party the reasonable expenses of the prevailing party, including, without limitation, reasonable attorneys' fees. (g) ENTIRE AGREEMENT. This Agreement, including the agreements referred to herein, constitute the entire agreement and understand among the parties pertaining to the subject matter hereof and supersedes any and all prior agreements, whether written or oral, relating thereto. (h) HEADINGS. Introductory headings at the beginning of each section of this Agreement are solely for the convenience of the parties and shall not be deemed to be a limitation upon or description of the contents of any such section. 8. 9 (i) Counterparts. This Agreement may be executed in two or more counterparts, all of which, when taken together, shall constitute one and the same instrument. IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the day and year first above written. FINANCIAL PACIFIC INSURANCE GROUP, INC. By: /s/ Karen Oldenkamp --------------------------------- Karen Oldenkamp, Secretary /s/ Robert C. Goodell -------------------------------------- Robert C. Goodell Address: ** /s/ Suzanne M. Goodell -------------------------------------- Suzanne M. Goodell Address: ** 9. 10 FIRST AMENDMENT TO RESTRICTED STOCK AGREEMENT This Amendment to Restricted Stock Agreement is made as of May 7, 1998 by and among Financial Pacific Insurance Group, Inc., a Delaware corporation (the "Corporation"), Robert C. Goodell ("RCG") and Suzanne M. Goodell ("SMG"). RCG and SMG are collectively referred to herein as "Goodell." R E C I T A L S A. The parties to this First Amendment entered into that certain Restricted Stock Agreement dated as of September 7, 1993 (the "Original Agreement"). B. The parties desire to amend the Original Agreement to make the agreement consistent with the original intent of the parties with respect to the consideration to be paid by RCG for certain shares of the Corporation. NOW, THEREFORE, in consideration of the foregoing recitals and the mutual covenants and conditions contained therein, the parties agree as follows: 1. Section 1(c)(iv) of the Original Agreement is hereby deleted. 2. Section 11 of the Original Agreement is hereby incorporated into this First Amendment by reference. IN WITNESS WHEREOF, the parties hereto have duly executed this First Amendment as of the day and year first above written. FINANCIAL PACIFIC INSURANCE GROUP, INC. /s/ Robert T. Kingsley ------------------------------------- By: Robert T. Kingsley Its: Executive Vice President and Chief Operating Officer /s/ Robert C. Goodell ------------------------------------- ROBERT C. GOODELL 1800 Shelborne Dr. Granite Bay, CA 96746 /s/ Suzanne M. Goodell ------------------------------------- SUZANNE M. GOODELL 1800 Shelborne Dr. Granite Bay, CA 96746 EX-10.32 5 WARRANT AGREEMENT 1 EXHIBIT 10.32 FINANCIAL PACIFIC INSURANCE GROUP, INC. and EVEREN SECURITIES, INC. WARRANT AGREEMENT Dated as of June , 1998 THIS WARRANT AGREEMENT (the "Agreement"), dated as of June __, 1998, is made and entered into by and between FINANCIAL PACIFIC INSURANCE GROUP, INC., a Delaware corporation (the "Company"), EVEREN SECURITIES, INC. ("Everen") and the persons listed on Exhibit A attached hereto (the "Warrantholders"). The Company agrees to issue and sell to the Warrantholders and the Warrantholders severally agree to purchase, for the price of $0.01 per warrant, warrants, as hereinafter described (the "Warrants") to purchase up to an aggregate of 125,000 shares (the "Shares") of the Company's Common Stock, $.001 par value (the "Common Stock") in the amounts set forth on Exhibit A hereto, in connection with a public offering (the "Public Offering") by the Company of 2,500,000 shares of Common Stock pursuant to an underwriting agreement (the "Underwriting Agreement"), dated as of June __, 1998, by and among the Company, certain stockholders of the Company, and Everen, as the representative of the underwriters that are party to the Underwriting Agreement (the "Underwriters"). The number of Shares purchasable upon exercise of these Warrants by the Warrantholders shall be increased by an amount equal to 5% of the number of Shares issued upon exercise of the Underwriters' over-allotment option pursuant to the second paragraph of section 3 and section 4(b) of the Underwriting Agreement, (and then rounding down to the nearest whole number) at a price of $0.01 per share of Common Stock. The purchase and sale of Warrants to purchase 125,000 shares of the Common Stock shall occur on the Closing Date, as defined in the Underwriting Agreement, and be subject to the conditions to the Underwriters' obligations to purchase Common Stock thereunder (except for delivery of this Agreement) and the performance of such obligations by the Underwriters. On the Option Closing Date or Dates (if any), the Warrantholders shall purchase, and the Company shall sell, Warrants to purchase a number of shares equal to 5% of the number of Option Shares purchased on that date, at a price of $0.01 per share of Common Stock, subject to the conditions to the Underwriters' obligations to purchase Common Stock on that Option Closing Date. Everen acknowledges that receipt of the Warrants by the Warrantholders constitutes full satisfaction of the Company's obligation under Paragraph 8 of the Engagement Agreement dated March 26, 1998 between the Company and Everen. In consideration of the foregoing and for the purpose of defining the terms and provisions of the Warrants and the respective rights and obligations thereunder, the parties hereto, for value received, hereby agree as follows: 1 2 SECTION 1. Transferability and Form of Warrants. 1.1 Registration. The Warrants shall be numbered and shall be registered on the books of the Company when issued. 1.2 Transfer. The Warrants shall be transferable only on the books of the Company maintained at its principal office in Rocklin, California, or wherever its principal office may then be located, upon delivery thereof duly endorsed by the transferring Warrantholder or by its duly authorized attorney or representative, accompanied by proper evidence of succession, assignment or authority to transfer. Upon any registration of transfer, the Company shall execute and deliver new Warrants to the person entitled thereto. 1.3 Limitations on Transfer of the Warrants. Subject to the provisions of Section 11 hereof, the Warrants shall not be sold, transferred, assigned or hypothecated (a "Transfer") by any Warrantholder until _________, 1999, except to (i) an officer or partner of the transferring Warrantholder, another Underwriter or member of the selling group or officer, partner or employee of any of them; (ii) a successor to the transferring Warrantholder which is not an individual (a "Warrantholder Entity") in merger or consolidation; (iii) a purchaser of all or substantially all of the transferring Warrantholder Entity's assets; (iv) any person receiving the Warrants from one or more of the persons listed in this subsection 1.3 at such person's or persons' death pursuant to will, trust or the laws of intestate succession; or (v) an inter vivos trust for the benefit of the transferor, his spouse, family and designated heirs, successors and assigns. The Warrants may be divided or combined, upon request to the Company by any Warrantholder, into a certificate or certificates representing the right to purchase the same aggregate number of Shares. Notwithstanding the foregoing, no Warrant may be Transferred unless the transferee agrees to be bound by the terms and conditions of this Agreement. Unless the context indicates otherwise, the terms "Warrantholder" shall include any transferee or transferees of the Warrants pursuant to this subsection 1.3, and the term "Warrants" shall include any and all warrants outstanding pursuant to this Agreement, including those evidenced by a certificate or certificates issued upon division, exchange, substitution or transfer pursuant to this Agreement. 1.4 Form of Warrants. The text of the Warrants and of the form of election to purchase Shares shall be substantially as set forth in Exhibit B attached hereto. The number of Shares issuable upon exercise of the Warrants is subject to adjustment upon the occurrence of certain events, all as hereinafter provided. The Warrants shall be executed on behalf of the Company by its President or by a Vice President, attested to by its Secretary or an Assistant Secretary. A Warrant bearing the signature of an individual who was at any time the proper officer of the Company shall bind the Company, notwithstanding that such individual shall have ceased to hold such office prior to the delivery of such Warrant or did not hold such office on the date of this Agreement. The Warrants shall be dated as of the date of signature thereof by the Company either upon initial issuance or upon division, exchange, substitution or transfer. 1.5 Legend on Shares. Each certificate for Shares initially issued upon exercise of the Warrants shall bear the following legend, unless, at the time of exercise, such Shares are subject 2 3 to a currently effective Registration Statement under the Securities Act of 1933, as amended (the "Act"): "THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR ANY STATE SECURITIES LAWS AND MAY NOT BE SOLD, OFFERED FOR SALE, EXCHANGED, HYPOTHECATED OR TRANSFERRED IN ANY MANNER IN THE ABSENCE OF A REGISTRATION STATEMENT IN EFFECT WITH RESPECT TO THE SECURITIES UNDER THE SECURITIES ACT AND IN COMPLIANCE WITH APPLICABLE STATE SECURITIES LAWS OR AN OPINION OF COUNSEL THAT SUCH REGISTRATION IS NOT REQUIRED OR UNLESS SOLD PURSUANT TO RULE 144 OF THE SECURITIES ACT." Any certificate issued at any time in exchange or substitution for any certificate bearing such legend (except a new certificate issued upon completion of a public distribution pursuant to a registration statement under the Act, of the securities represented thereby) shall also bear the above legend unless, in the opinion of the Company's counsel, the securities represented thereby need no longer be subject to such restrictions. SECTION 2. Exchange of Warrant Certificate. Any Warrant certificate may be exchanged for another certificate or certificates entitling a Warrantholder to purchase a like aggregate number of Shares as the certificate or certificates surrendered then entitled such Warrantholder to purchase. Any Warrantholder desiring to exchange a Warrant certificate shall make such request in writing delivered to the Company, and shall surrender, properly endorsed, with signatures guaranteed, the certificate evidencing the Warrant to be so exchanged. Thereupon, the Company shall execute and deliver to the person entitled thereto a new Warrant certificate as so requested. SECTION 3. Term of Warrants; Exercise of Warrants. (a) Subject to the terms of this Agreement, any Warrantholder shall have the right, at any time during the period commencing at 9:00 a.m., California Time, on ___________, 1999 and ending at 5:00 p.m., California Time, on ___________, 2003 (the "Termination Date"), to purchase from the Company up to the number of fully paid and non-assessable Shares to which such Warrantholder may at the time be entitled to purchase pursuant to this Agreement, upon surrender to the Company, at its principal office, of the certificate evidencing the Warrants to be exercised, together with the purchase form on the reverse thereof duly filled in and signed, with signatures guaranteed, and upon payment to the Company of the Warrant Price (as defined in and determined in accordance with the provisions of this section 3 and sections 7 and 8 hereof), for the number of Shares in respect of which such Warrants are then exercised, but in no event for less than 100 Shares (unless less than an aggregate of 100 Shares are then purchasable under all outstanding Warrants held by a Warrantholder). (b) Payment of the aggregate Warrant Price shall be made in cash, by wire transfer, by certified or official bank check or through the use of Appreciation Currency (as defined below), or any combination thereof. Upon such surrender of the Warrants and payment of such Warrant Price as aforesaid, the Company shall issue and cause to be delivered with all reasonable 3 4 dispatch to or upon the written order of such Warrantholder and in the name or names of such Warrantholder or, subject to compliance with the provisions of Section 11(a) hereof, in such name or names as such Warrantholder may designate, a certificate or certificates for the number of full Shares so purchased upon the exercise of the Warrant, together with cash, as provided in Section 9 hereof, in respect of any fractional Shares otherwise issuable upon such surrender. Such certificate or certificates shall be deemed to have been issued and any person so designated to be named therein shall be deemed to have become a holder of record of such securities as of the date of surrender of the Warrants and payment of the Warrant Price, as aforesaid, notwithstanding that the certificate or certificates representing such securities shall not actually have been delivered or that the stock transfer books of the Company shall then be closed. The Warrants shall be exercisable, at the election of such Warrantholder, either in full or from time to time in part and, in the event that a certificate evidencing the Warrants is exercised in respect of less than all of the Shares specified therein at any time prior to the Termination Date, a new certificate evidencing the remaining portion of the Warrants will be issued by the Company. (c) As used herein, "Appreciation Currency" shall mean the consideration given by the surrender of Warrants in exchange for Shares. The number of Shares to which the holder shall be entitled upon such surrender of Warrants ("X") shall be determined by applying the following formula: X = N MULTIPLIED BY (($S - $W) DIVIDED BY $S), where "N" is the number of Shares that would be received if the Warrants surrendered were instead exercised for cash, "$S" is the Current Market Price (as defined in section 9 hereof) per share of Common Stock and "$W" is the Warrant Price defined in section 7 as adjusted and readjusted as set forth in Section 8 hereof. SECTION 4. PAYMENT OF TAXES. The Company will pay all documentary stamp taxes, if any, attributable to the initial issuance of the Warrants or the securities comprising the Shares; provided, however, the Company shall not be required to pay any tax which may be payable in respect of any secondary transfer of the Warrants or the securities comprising the Shares. SECTION 5. MUTILATED OR MISSING WARRANTS. In case the certificate or certificates evidencing the Warrants shall be mutilated, lost, stolen or destroyed, the Company shall, at the request of any Warrantholder, issue and deliver in exchange and substitution for and upon cancellation of the mutilated certificate or certificates, or in lieu of and substitution for the certificate or certificates lost, stolen or destroyed, a new Warrant certificate or certificates of like tenor and representing an equivalent right or interest, but only upon receipt of evidence reasonably satisfactory to the Company of such loss, theft or destruction of such Warrant and a bond of indemnity, if requested, also satisfactory in form and amount at the Warrantholder's cost. Applicants for such substitute Warrants certificate shall also comply with such other reasonable regulations and pay such other reasonable charges as the Company may prescribe. SECTION 6. RESERVATION OF SHARES. There has been reserved, and the Company shall at all times keep reserved so long as the Warrants remain outstanding, out of its authorized Common Stock, such number of shares of Common Stock as shall be subject to purchase under the Warrants. The Company will supply every transfer agent for the Common Stock and other securities of the Company issuable upon the exercise of the Warrants with duly executed stock 4 5 and other certificates, as appropriate, for such purpose and will provide or otherwise make available any cash which may be payable as provided in Section 9 hereof. SECTION 7. WARRANT PRICE. The price per Share at which Shares shall be purchasable upon the exercise of the Warrants (the "Warrant Price") shall be $______ [insert 110% of initial public offering price per Share] subject to further adjustment pursuant to Section 8 hereof. SECTION 8. ADJUSTMENT OF NUMBER OF SHARES. The number and kind of securities purchasable upon the exercise of the Warrants and the Warrant Price shall be subject to adjustment from time to time upon the happening of certain events, as follows: 8.1 ADJUSTMENTS. The number of Shares purchasable upon the exercise of the Warrants shall be subject to adjustment as follows: In case the Company shall (i) pay a dividend in Common Stock or make a distribution in Common Stock, (ii) subdivide its outstanding Common Stock, (iii) combine its outstanding Common Stock into a smaller number of shares of Common Stock, or (iv) issue by reclassification of its Common Stock other securities of the Company, the Warrant Price and the number of Shares purchasable upon exercise of the Warrants immediately prior thereto shall be proportionately adjusted so that the Warrantholder shall be entitled to receive the kind and number of Shares or other securities of the Company which it would have owned or would have been entitled to receive immediately after the happening of any of the events described above, had the Warrants been exercised at the Warrant Price immediately prior to the happening of such event or any record date with respect thereto. Any adjustment made pursuant to this subsection 8.1 shall become effective immediately after the effective date of such event retroactive to the record date, if any, for such event. For the purpose of this subsection 8.1, the term "Common Stock" shall mean (i) the class of stock designated as the Common Stock of the Company at the date of this Agreement, or (ii) any other class of stock resulting from successive changes or reclassifications of such Common Stock consisting solely of changes in par value, or from par value to no par value, or from no par value to par value. 8.2 NO ADJUSTMENT FOR DIVIDENDS. Except as provided in subsection 8.1, no adjustment in respect of any dividends or distributions out of earnings shall be made during the term of the Warrants or upon the exercise of the Warrants. 8.3 CERTIFICATE OF ADJUSTMENT. Whenever the number of Shares purchasable upon the exercise of the Warrants is adjusted as herein provided, the Company shall cause to be promptly mailed to the Warrantholder by first class mail, postage prepaid, notice of such adjustment and a certificate of the chief financial officer or other executive officer of the Company setting forth the number of Shares purchasable upon the exercise of the Warrants after such adjustment, a brief statement of the facts requiring such adjustment and the computation by which such adjustment was made. 8.4 PRESERVATION OF PURCHASE RIGHTS UPON RECLASSIFICATION, CONSOLIDATION, ETC. In case of any consolidation of the Company with or merger of the Company into another corporation or in case of any sale or conveyance to another corporation of 5 6 the property, assets or business of the Company as an entirety or substantially as an entirety, the Company or such successor or purchasing corporation, as the case may be, shall execute with each Warrantholder an agreement that the Warrantholder shall have the right thereafter upon payment of the Warrant Price in effect immediately prior to such action to purchase, upon exercise of the Warrants, the kind and amount of consideration which it would have owned or have been entitled to receive after the happening of such consolidation, merger, sale or conveyance had the Warrants been exercised immediately prior to such action. In the event of a merger described in Section 368(a)(2)(E) of the Internal Revenue Code of 1986, in which the Company is the surviving corporation, the right to purchase Shares under the Warrants shall terminate on the date of such merger and thereupon the Warrants shall become null and void, but only if the controlling corporation shall agree to substitute for the Warrants its warrant which entitles the holder thereof to purchase upon its exercise the kind and amount of consideration which it would have owned or been entitled to receive had the Warrants been exercised immediately prior to such merger. Any such agreements referred to in this subsection 8.4 shall provide for adjustments, which shall be as nearly equivalent as may be practicable to the adjustments provided for in Section 8 hereof. The provisions of this subsection 8.4 shall similarly apply to successive consolidations, mergers, sales or conveyances. 8.5 PAR VALUE OF SHARES OF COMMON STOCK. Before taking any action which would cause an adjustment effectively reducing the portion of the Warrant Price allocable to each Share below the then par value per share of the Common Stock issuable upon exercise of the Warrants, the Company will take any corporate action which may, in the opinion of its counsel, be necessary in order that the Company may validly and legally issue fully paid and non-assessable Common Stock upon exercise of the Warrants. 8.6 INDEPENDENT PUBLIC ACCOUNTANTS. The Company may retain a firm of independent public accountants of recognized national standing (which may be any such firm regularly employed by the Company) to make any computation required under this Section 8, and a certificate signed by such firm shall be conclusive evidence of the correctness of any computation made under this Section 8. 8.7 STATEMENT ON WARRANT CERTIFICATES. Irrespective of any adjustments in the number of securities issuable upon exercise of Warrants, Warrant certificates theretofore or thereafter issued may continue to express the same number of securities as are stated in the similar Warrant certificates initially issuable pursuant to this Agreement. However, the Company may, at any time in its sole discretion (which shall be conclusive), make any change in the form of Warrant certificate that it may deem appropriate and that does not affect the substance thereof; and any Warrant certificate thereafter issued, whether upon registration or transfer of, or in exchange or substitution for, an outstanding Warrant certificate, may be in the form so changed. SECTION 9. FRACTIONAL INTERESTS; CURRENT MARKET PRICE. The Company shall not be required to issue fractional Shares on the exercise of the Warrants. If any fraction of a Share would, except for the provisions of this Section 9, be issuable on the exercise of the Warrants (or specified portion thereof), the Company shall pay an amount in cash equal to the then Current Market Price per share of Common Stock multiplied by such fraction. 6 7 For purposes of this Agreement, the term "Current Market Price" shall mean (i) if the Common Stock is traded in the over-the-counter market and is neither quoted in The Nasdaq National Market nor traded on any national securities exchange, the average of the per share closing bid price on the 30 consecutive trading days immediately preceding the date in question, as reported by The Nasdaq SmallCap Market (or an equivalent generally accepted reporting service if quotations are not reported on The Nasdaq SmallCap Market), or (ii) if the Common Stock is quoted in The Nasdaq National Market or traded on a national securities exchange, the average for the 30 consecutive trading days immediately preceding the date in question of the daily per share closing prices in The Nasdaq National Market or on the principal stock exchange on which it is listed, as the case may be. For purposes of clause (i) above, if trading in the Common Stock is not reported by The Nasdaq SmallCap Market, the applicable bid price referred to in that clause shall be the lowest bid price as reported in The Nasdaq Electronic Bulletin Board or, if not reported thereon, as reported in the "pink sheets" published by National Quotation Bureau, Incorporated, and, if such securities are not so reported, shall be the price of a share of Common Stock determined by the Company's Board of Directors in good faith. The closing price referred to in clause (ii) above shall be the last reported sale price or, in case no such reported sale takes place on such day, the average of the reported closing bid and asked prices, in either case in The Nasdaq National Market or on the national securities exchange on which the Common Stock is then listed. SECTION 10. NO RIGHTS AS SHAREHOLDER; NOTICES TO WARRANTHOLDERS. Nothing contained in this Agreement or in the Warrants shall be construed as conferring upon any Warrantholder or its transferees any rights as a shareholder of the Company, including the right to vote, receive dividends, consent or receive notices as a shareholder in respect of any meeting of shareholders for the election of directors of the Company or any other matter. If, however, at any time prior to the expiration of the Warrants and prior to their exercise, any one or more of the following events shall occur: (a) any action which would require an adjustment pursuant to Section 8.1; or (b) a dissolution, liquidation or winding up of the Company (other than in connection with a consolidation, merger or sale of its property, assets and business as an entirety or substantially as an entirety) shall be proposed; then the Company shall give notice in writing of such event to each Warrantholder, as provided in Section 14 hereof, at least 20 days prior to the date fixed as a record date or the date of closing the transfer books for the determination of the shareholders entitled to any relevant dividend, distribution, subscription rights or other rights or for the determination of shareholders entitled to vote on such proposed dissolution, liquidation or winding up. Such notice shall specify such record date or the date of closing the transfer books, as the case may be. Failure to mail or receive such notice or any defect therein shall not affect the validity of any action taken with respect thereto. SECTION 11. RESTRICTIONS ON TRANSFER; REGISTRATION RIGHTS. (a) Each Warrantholder agrees that prior to making any disposition of the Warrants or the Shares, including without limitation, to persons or entities identified in clauses (i) through 7 8 (v), inclusive, of Section 1.3 hereof, other than pursuant to a registration statement or other notification or post-effective amendment thereto (hereinafter collectively a "Registration Statement") filed by the Company with, and declared effective, by, the Securities and Exchange Commission (the "Commission"), each Warrantholder shall give written notice to the Company describing briefly the manner in which any such proposed disposition is to be made and shall provide such other information as may reasonably be required by the Company and counsel familiar with securities matters to conclude that no Registration Statement under the Act is required with respect to such disposition. If requested by the Company, and if the transfer will result in a public sale that is not in compliance with Rule 144 of the Securities Act, the Warrantholder will provide an opinion of counsel reasonably satisfactory to the Company that a Registration Statement under the Act is not required with respect to such disposition. (b) Whenever during the four-year period beginning on _________, 1999 and ending on_______, 2003, the Company proposes to file with the Commission a Registration Statement (other than as to securities issued pursuant to an employee benefit plan or as to a transaction subject to Rule 145 promulgated under the Act (or any successor provision) or for which a Form S-4 Registration Statement (or any successor form) could be used), it shall, at least 30 days prior to each such filing, give written notice of such proposed filing to each Warrantholder and each holder of Shares, at their respective addresses as they appear on the records of the Company, and shall offer to include and shall include in such filing any proposed disposition of the Warrants and Shares upon receipt by the Company, not less than 10 days prior to the proposed filing date, of a request therefor setting forth the facts with respect to such proposed disposition and all other information with respect to such person reasonably necessary to be included in such Registration Statement. If the managing underwriter for the offering made pursuant to the Registration Statement advises the Company in writing that the inclusion of such securities in the offering would be detrimental to the offering, such securities may not be included in the Registration Statement. (c) The Company shall pay all fees, disbursements and out-of-pocket expenses (other than brokerage fees and commissions of the Warrantholders and holders of Shares, and legal fees of counsel to the Warrantholders and holders of Shares, if any) in connection with the filing of any Registration Statement under Section 11(b) hereof (or obtaining the opinion of counsel and any no-action position of the Commission with respect to sales under Rule 144) and in complying with applicable securities and Blue Sky laws. The Company at its expense will supply any Warrantholder and any holder of Shares with copies of such Registration Statement and the prospectus included therein and other related documents, opinions and no-action letters in such quantities as may be reasonably requested by a Warrantholder or holder of Shares. (d) The provisions of this Section 11 and Section 12 hereof shall apply to the extent as provided herein if the Company chooses to file an Offering Statement under Regulation A promulgated under the Act. (e) The Company agrees that until all Shares have been sold under a Registration Statement or pursuant to Rule 144 under the Act, it will use commercially reasonable efforts to keep current in filing all materials required to be filed with the Commission in order to permit the holders of such securities to sell the same under Rule 144. 8 9 SECTION 12. Indemnification. (a) In the event of the filing of any Registration Statement with respect to the Shares pursuant to Section 11 hereof, the Company agrees to indemnify and hold harmless any Warrantholder or any holder of such Shares and each person, if any, who controls any Warrantholder or any holder of such Shares within the meaning of the Act, against any losses, claims, damages or liabilities, joint or several (which shall, for all purposes of this Agreement, include, but not be limited to, all costs of defense and investigation and all reasonable attorneys' fees), to which any Warrantholder or any holder of such Shares or such controlling person may become subject, under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in any such Registration Statement, or any related preliminary prospectus, final prospectus, or amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, provided, however, that the Company will not be liable in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in such Registration Statement, preliminary prospectus, final prospectus or amendment or supplement thereto in reliance upon, and in conformity with, written information furnished to the Company by the Warrantholder or the holder of such Shares or any person who controls the Warrantholder or any holder of such Shares within the meaning of the Act specifically for use in the preparation thereof. This indemnity will be in addition to any liability which the Company may otherwise have. (b) Each Warrantholder and the holders of the Shares agree that they will indemnify and hold harmless the Company, each other person referred to in subparts (1), (2) and (3) of Section 11(a) of the Act in respect of the Registration Statement and each person, if any, who controls the Company within the meaning of the Act, against any losses, claims, damages or liabilities (which shall, for all purposes of this Agreement, include but not be limited to, all costs of defense and investigation and all attorneys' fees) to which the Company or any such director, officer or controlling person may become subject under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in such Registration Statement, or any related preliminary prospectus, final prospectus or amendment or supplement thereto, or arise out of or are based upon the omission or the alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, but in each case only to the extent that such untrue statement or alleged untrue statement or omission or alleged omission was made in such Registration Statement, preliminary prospectus, final prospectus or amendment or supplement thereto in reliance upon, and in conformity with, written information furnished to the Company by such Warrantholder or such holder of Shares specifically for use in the preparation thereof. This indemnity agreement will be in addition to any liability which such Warrantholder or such holder of Shares may otherwise have. (c) Promptly after receipt by an indemnified party under this Section 12 of notice of the commencement of any action, such indemnified party shall, if a claim in respect thereof is to be made against any indemnifying party under this Section 12, notify the indemnifying party in 9 10 writing of the commencement thereof but the omission so to notify the indemnifying party will not relieve it from any liability which it may have to any indemnified party otherwise than under this Section 12. In case any such action is brought against any indemnified party, and it notified the indemnifying party of the commencement thereof, the indemnifying party will be entitled to participate therein and, to the extent that it shall elect by written notice delivered to the indemnified party promptly after receiving the aforesaid notice from such indemnified party, to assume the defense thereof, with counsel reasonably satisfactory to such indemnified party; provided, however, that if the defendants in any such action include both the indemnified party and the indemnifying party and the indemnified party shall have reasonably concluded that there may be legal defenses available to it and/or other indemnified parties which are different from or additional to those available to the indemnifying party, the indemnified party or parties shall have the right to select separate counsel to assume such legal defenses and to otherwise participate in the defense of such action on behalf of such indemnified party or parties. Upon receipt of notice from the indemnifying party to such indemnified party of the indemnifying party's election so to assume the defense of such action and approval by the indemnified party of counsel, the indemnifying party will not be liable to such indemnified party under this Section 12 for any legal or other expenses subsequently incurred by such indemnified party in connection with the defense thereof unless (i) the indemnified party shall have employed separate counsel in accordance with the proviso to the next preceding sentence (it being understood, however, that the indemnifying party shall not be liable for the expenses of more than one separate counsel (together with appropriate local counsel) approved by the indemnifying party representing all the indemnified parties under Section 12(a) or 12(b) hereof who are parties to such action), (ii) the indemnifying party shall not have employed counsel satisfactory to the indemnified party to represent the indemnified party within a reasonable time after notice of commencement of the action or (iii) the indemnifying party has authorized the employment of counsel for the indemnified party at the expense of the indemnifying party. In no event shall any indemnifying party be liable in respect of any amounts paid in settlement of any action unless the indemnifying party shall have approved the terms of such settlement; provided that such consent shall not be unreasonably withheld. No indemnifying party shall, without the prior written consent of the indemnified party, effect any settlement of any pending or threatened proceeding in respect of which any indemnified party is or could have been a party and indemnification could have been sought hereunder by such indemnified party, unless such settlement includes an unconditional release of such indemnified party from all liability on claims that are the subject matter of such proceeding. SECTION 13. Contribution. In order to provide for just and equitable contribution under the Act in any case in which (i) a Warrantholder or any holder of the Shares or controlling person makes a claim for indemnification pursuant to Section 12 hereof but it is judicially determined (by the entry of a final judgment or decree by a court of competent jurisdiction and the expiration of time to appeal or the denial of the last right of appeal) that such indemnification may not be enforced in such case notwithstanding the fact that the express provisions of Section 12 hereof provide for indemnification in such case or (ii) contribution under the Act may be required on the part of any Warrantholder or any holder of the Shares or controlling person, then the Company and any Warrantholder or any such holder of the Shares or controlling person shall contribute to the aggregate losses, claims, damages or liabilities to which they may be subject (which shall, for all purposes of this Agreement, include, but not be limited to, all costs of defense and investigation and all attorneys' fees), in either such case (after contribution from others) on the 10 11 basis of relative fault as well as any other relevant equitable considerations. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company on the one hand or a Warrantholder or holder of Shares or controlling person on the other and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company and such holders of such securities and such controlling persons agree that it would not be just and equitable if contribution pursuant to this Section 13 were determined by pro rata allocation or by any other method which does not take account of the equitable considerations referred to in this Section 13. The amount paid or payable by an indemnified party as a result of the losses, claims, damages or liabilities (or actions in respect thereof) referred to above in this Section 13 shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. SECTION 14. Notices. Any notice pursuant to this Agreement by the Company or by a Warrantholder or a holder of Shares shall be in writing and shall be deemed to have been duly given if delivered or mailed by certified mail, return receipt requested: (a) If to a Warrantholder or a holder of Shares, addressed to EVEREN Securities, Inc., 1901 Avenue of the Stars, Suite 1460, Los Angeles, California 90067, and 77 West Wacker Drive, Chicago, Illinois 60601, Attention: Corporate Finance Department. (b) If to the Company, addressed to it at 3850 Atherton Road, Rocklin, California 95765, Attention: President and Chief Executive Officer. Each party may from time to time change the address to which notices to it are to be delivered or mailed hereunder by notice in accordance herewith to the other party. SECTION 15. Successors. All the covenants and provisions of this Agreement by or for the benefit of the Company, Everen, the Warrantholders, or the holders of Shares shall bind and inure to the benefit of their respective successors and permitted assigns hereunder. SECTION 16. Merger or Consolidation of the Company. The Company will not merge or consolidate with or into any other corporation or sell all or substantially all of its property to another corporation, unless the provisions of Section 8.4 are complied with. SECTION 17. Survival of Representations and Warranties. All statements contained in any schedule, exhibit, certificate or other instrument delivered by or on behalf of the parties hereto, or in connection with the transactions contemplated by this Agreement, shall be deemed to be representations and warranties hereunder. Notwithstanding any investigations made by or on behalf of the parties to this Agreement, all representations, warranties and agreements made by the parties to this Agreement or pursuant hereto shall survive. SECTION 18. Applicable Law. This Agreement shall be deemed to be a contract made under the laws of the State of California and for all purposes shall be construed in accordance with the laws of California. 11 12 SECTION 19. Benefits of this Agreement. Nothing in this Agreement shall be construed to give to any person or corporation other than the Company, Everen, the Warrantholders and the holders of Shares any legal or equitable right, remedy or claim under this Agreement. This Agreement shall be for the sole and exclusive benefit of the Company, Everen, the Warrantholders and the holders of Shares. IN WITNESS WHEREOF, the parties have caused this Agreement to be duly executed, all as of the day and year first above written. FINANCIAL PACIFIC INSURANCE GROUP, INC. By:_______________________________________ Title:____________________________________ EVEREN SECURITIES, INC. By:_______________________________________ Title:____________________________________ [WARRANTHOLDERS' SIGNATURES] By:_______________________________________ By:_______________________________________ By:_______________________________________ 12 13 EXHIBIT B Form of Warrant Certificate A-1 14 [FORM OF FACE OF WARRANT CERTIFICATE] "THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR ANY STATE SECURITIES LAWS AND MAY NOT BE SOLD, OFFERED FOR SALE, EXCHANGED, HYPOTHECATED OR TRANSFERRED IN ANY MANNER IN THE ABSENCE OF A REGISTRATION STATEMENT IN EFFECT WITH RESPECT TO THE SECURITIES UNDER THE SECURITIES ACT AND IN COMPLIANCE WITH APPLICABLE STATE SECURITIES LAWS OR AN OPINION OF COUNSEL THAT SUCH REGISTRATION IS NOT REQUIRED OR UNLESS SOLD PURSUANT TO RULE 144 OF THE SECURITIES ACT." No. W-1 ________ __, 1998 FINANCIAL PACIFIC INSURANCE GROUP, INC. WARRANT TO PURCHASE 125,000 SHARES OF COMMON STOCK EXPIRING ________ __, 2003 This Warrant Certificate certifies that ___________________, or registered assigns, is the registered holder of a warrant (the "Warrant") of Financial Pacific Insurance Group, Inc., a Delaware corporation (the "Company"), to purchase the number of shares (the "Shares") of Common Stock, $.001 par value (the "Common Stock"), of the Company set forth above. This Warrant expires at 5:00 p.m. California Time (the "Close of Business") on ________ __, 2003 (the "Expiration Date") and entitles the holder to purchase from the Company the number of fully paid and nonassessable Shares set forth above at $[insert offer price] per share (the "Exercise Price"), payable in lawful money of the United States of America. Subject to the terms and conditions set forth herein and in the Warrant Agreement referred to on the reverse hereof, this Warrant may be exercised upon surrender of this Warrant Certificate and payment in full of the aggregate Exercise Price at the offices of the Company in Rocklin, California (the "Company Offices"). The Exercise Price and the number of Shares purchasable upon exercise of this Warrant are subject to adjustment upon the occurrence of certain events as set forth in the Warrant Agreement. No Warrant may be exercised after the Close of Business on the Expiration Date. After the Close of Business on the Expiration Date, the Warrants will become wholly void and of no value. REFERENCE IS HEREBY MADE TO THE FURTHER PROVISIONS OF THIS A-2 15 WARRANT CERTIFICATE SET FORTH ON THE REVERSE HEREOF. SUCH FURTHER PROVISIONS SHALL FOR ALL PURPOSES HAVE THE SAME EFFECT AS THOUGH FULLY SET FORTH AT THIS PLACE. A-3 16 IN WITNESS WHEREOF, the Company has caused this Certificate to be executed by its duly authorized officers, and the corporate seal hereunto affixed. Dated:_____________ FINANCIAL PACIFIC INSURANCE GROUP, INC. By_______________________________________ ATTEST: By____________________________ A-4 17 [FORM OF REVERSE OF WARRANT CERTIFICATE] FINANCIAL PACIFIC INSURANCE GROUP, INC. The Warrant evidenced by this Warrant Certificate is a part of a duly authorized issue of Warrants to purchase a maximum of one hundred forty-three thousand seven hundred fifty (143,750) Shares of Common Stock (subject to adjustment) issued pursuant to that certain Warrant Agreement, dated as of June __, 1998 as the same may be amended from time to time (the "Warrant Agreement"), duly executed by the Company and Everen Securities, Inc. The Warrant Agreement is hereby incorporated by reference in and made a part of this instrument and is hereby referred to for a description of the rights, limitation of rights, obligations, duties and immunities thereunder of the Company and the holders (the words "holders" or "holder" meaning the registered holders or registered holder) of the Warrant. A copy of the Warrant Agreement may be inspected at the Company Offices and is available upon written request addressed to the Company. All terms used herein that are defined in the Warrant Agreement have the meanings assigned to them therein. The Warrant may be exercised to purchase Shares from the Company before the Close of Business on the Expiration Date, at the Exercise Price set forth on the face hereof, subject to adjustment as described in the Warrant Agreement. The Warrant may be exercised in whole or in part, provided that the Warrant may not be exercised to purchase fewer than 100 Shares unless the registered holder has, in aggregate, under all Warrants held, a right to receive fewer than 100 Shares. The holder of the rights to purchase Shares evidenced by this Warrant Certificate may exercise any of such rights by surrendering the Warrant Certificate, with the form of election to purchase set forth hereon properly completed and executed, together with either (a) payment of the aggregate Warrant Price for the Warrants exercised, in lawful money of the United States of America, and any applicable transfer taxes, at the Company Offices, or (b) an election to use Appreciation Currency, as defined in the Agreement, to pay the Warrant Price. After the Close of Business on the Expiration Date, the Warrant shall become wholly void and of no value. If the exercise hereof is in part only, unless this Warrant has expired, the Company shall issue a new Warrant or Warrants of like tenor calling, in the aggregate on the face or faces thereof, for the number of Warrant Shares equal (without giving effect to any adjustment herein) to the number of such shares called for on the face of this Warrant minus (a) in an exercise for cash, the number of Warrant Shares purchased, or (b) in an exercise using Appreciation Currency, the number of Shares the Warrantholder would have had a right to receive if the Warrants surrendered were exercised for cash. The Company shall not be required to issue fractions of Shares or any certificates that evidence fractional Shares. In lieu of such fractional Shares, the Company shall pay to holders of the Warrant Certificates otherwise entitled to receive such fractional Shares an amount in cash equal to the then Current Market Price (as determined pursuant to the Warrant Agreement) per share of Common Stock multiplied by such fraction. Warrant Certificates, when surrendered at the Company Offices by the registered holder thereof in person or by a legal representative or attorney duly authorized in writing, may be exchanged, in the manner and subject to the limitations provided in the Warrant Agreement, but A-5 18 without payment of any service charge, for another Warrant Certificate of like tenor evidencing Warrants to purchase in the aggregate a like number of Shares. Upon due presentment for registration of transfer of this Warrant Certificate at the Company Offices, a new Warrant Certificate of like tenor and evidencing Warrants to purchase in the aggregate a like number of Shares shall be issued to the transferee in exchange for this Warrant Certificate, subject to the limitations provided in the Warrant Agreement, without charge, except for any tax or other governmental charge imposed in connection therewith. The Company may deem and treat the registered holder hereof as the absolute owner of this Warrant Certificate (notwithstanding any notation of ownership or other writing hereon made by anyone) for the purpose of any exercise hereof and for all other purposes, and the Company shall not be affected by any notice to the contrary. A-6 19 FORM OF SUBSCRIPTION TO BE EXECUTED ONLY UPON EXERCISE OF WARRANT FOR CASH To FINANCIAL PACIFIC INSURANCE GROUP, INC. The undersigned registered holder of the within Warrant hereby irrevocably exercises such Warrant for and purchases thereunder, *shares of Common Stock of FINANCIAL PACIFIC INSURANCE GROUP, INC. and herewith makes payment of $ therefor, and requests that the certificates for such shares be issued as follows: ------------------------------------------ Name ------------------------------------------ Address ------------------------------------------ Delivery Address (if different) - ------------------------------------- ------------------------------------- Social Security or Other Taxpayer Signature Identification Number of Holder Note: The above signature must correspond with the name as written upon the face of this Warrant Certificate in every particular, without alteration or enlargement or any change whatsoever. If the certificate representing the Shares or any Warrant Certificate representing Warrants not exercised is to be registered in a name other than that in which this Warrant Certificate is registered the signature of the holder hereof must be guaranteed. * Insert here the number of shares called for on the face of this Warrant (or in the case of a partial exercise, the portion thereof as to which this Warrant is being exercised), in either case without making any adjustment for additional Common Stock or any other securities or property or cash or combination thereof which, pursuant to the adjustment provisions of the Warrant Agreement, may be delivered upon exercise. In the case of a partial exercise, a new Warrant or Warrants will be issued and delivered, representing the unexercised portion of the Warrant, to the holder surrendering the Warrant. A-7 20 FORM OF SUBSCRIPTION AND ELECTION TO USE APPRECIATION CURRENCY TO BE EXECUTED ONLY UPON EXERCISE OF WARRANT FOR APPRECIATION CURRENCY (CASHLESS EXERCISE) To FINANCIAL PACIFIC INSURANCE GROUP, INC. The undersigned registered holder of the within Warrant hereby irrevocably exercises such Warrant by surrendering the right to purchase *shares of Common Stock of FINANCIAL PACIFIC INSURANCE GROUP, INC. as Appreciation Currency for the number of Shares issuable therefor pursuant to Section 3 of the Warrant Agreement, and requests that the certificates for such shares be issued as follows: ------------------------------------------ Name ------------------------------------------ Address ------------------------------------------ Delivery Address (if different) - ------------------------------------- ------------------------------------- Social Security or Other Taxpayer Signature Identification Number of Holder Note: The above signature must correspond with the name as written upon the face of this Warrant Certificate in every particular, without alteration or enlargement or any change whatsoever. If the certificate representing the Shares or any Warrant Certificate representing Warrants not exercised is to be registered in a name other than that in which this Warrant Certificate is registered the signature of the holder hereof must be guaranteed. * Insert here the number of shares called for on the face of this Warrant (or in the case of a partial exercise, the portion thereof as to which this Warrant is being exercised), in either case without making any adjustment for additional Common Stock or any other securities or property or cash or combination thereof which, pursuant to the adjustment provisions of the Warrant Agreement, may be delivered upon exercise. In the case of a partial exercise, a new Warrant or Warrants will be issued and delivered, representing the unexercised portion of the Warrant, to the holder surrendering the Warrant. A-8 21 FORM OF ASSIGNMENT (TO BE EXECUTED BY THE REGISTERED HOLDER IF SUCH HOLDER DESIRES TO TRANSFER THE WARRANT CERTIFICATE) FOR VALUE RECEIVED, the undersigned registered holder hereby sells, assigns and transfers unto ------------------------------------------ Name of Assignee ------------------------------------------ Address of Assignee this Warrant Certificate, together with all right, title and interest therein, and does irrevocably constitute and appoint __________________________ attorney, to transfer the within Warrant Certificate on the books of the Company, with full power of substitution. - ------------------------------- -------------------------------------- Dated Signature Note: The above signature must correspond with the name as written upon the face of this Warrant Certificate in every particular, without alteration or enlargement or any change whatsoever. - ------------------------------------- Social Security or Other Taxpayer Identification Number of Assignee SIGNATURE GUARANTEED: A-9 EX-23.1 6 CONSENT OF KPMG PEAT MARWICK LLP 1 EXHIBIT 23.1 INDEPENDENT AUDITORS' REPORT AND CONSENT The Board of Directors Financial Pacific Insurance Group, Inc: The audits referred to in our report dated January 30, 1998, except as to note 16 which is as of April 14, 1998, included the related financial statement schedules as of December 31, 1996 and 1997 and for each of the years in the three-year period ended December 31, 1997 included in the registration statement. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements, taken as a whole, present fairly in all material respects the information set forth therein. We consent to the use of our reports included herein and to the reference to our firm under the heading "Experts" in the prospectus. Los Angeles, California May 29, 1998 KPMG Peat Marwick LLP EX-23.3 7 CONSENT OF LEBOEUF, LAMB, GREENE & MACRAE 1 EXHIBIT 23.3 [LeBOEUF, LAMB, GREENE & MacRAE L.L.P. LETTERHEAD] May 28, 1998 Financial Pacific Insurance Group, Inc. 3850 Atherton Road Rocklin, California 95765 Re: Registration Statement on Form S-1 ---------------------------------- Ladies and Gentlemen: In connection with the Registration Statement on Form S-1, Registration No. 333-50511, as amended to date (the "Registration Statement"), regarding the registration under the Securities Act of 1933, as amended, of the sale in an underwritten public offering of up to 2,375,000 authorized but unissued shares of the common stock ("Common Stock") of Financial Pacific Insurance Group, Inc. (the "Company") and 500,000 shares of the Common Stock currently held by existing stockholders of the Company, we hereby consent to the reference to LeBoeuf, Lamb, Greene & MacRae, L.L.P. under the caption "Legal Matters" in the Prospectus which is a part of the Registration Statement. Very truly yours, /s/ KENNETH B. SCHNOLL --------------------------- Kenneth B. 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