-----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, BgUf2u+WolvVlJdChWgraMorBm9S32C3NEiifmjr+IdrIZH3GhcaYAMaCf1TJvb0 3ICd+MpN6TCp1OUQzHTqTQ== 0001130319-02-000601.txt : 20020613 0001130319-02-000601.hdr.sgml : 20020613 20020613172023 ACCESSION NUMBER: 0001130319-02-000601 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 7 FILED AS OF DATE: 20020613 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HUB INTERNATIONAL LTD CENTRAL INDEX KEY: 0001133016 STANDARD INDUSTRIAL CLASSIFICATION: INSURANCE AGENTS BROKERS & SERVICES [6411] FILING VALUES: FORM TYPE: S-1/A SEC ACT: 1933 Act SEC FILE NUMBER: 333-84734 FILM NUMBER: 02678595 BUSINESS ADDRESS: STREET 1: 214 KING STREET WEST STREET 2: SUITE 314 CITY: ONTARIO STATE: A6 ZIP: 00000 BUSINESS PHONE: 4169795866 MAIL ADDRESS: STREET 1: 214 KING STREET WEST STREET 2: SUITE 314 CITY: ONTARIO STATE: A6 ZIP: 00000 S-1/A 1 t07444a3sv1za.txt S-1 AMENDMENT NO. 3 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 13, 2002 REGISTRATION NO. 333-84734 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------------------------ Amendment No. 3 to FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------------------ HUB INTERNATIONAL LIMITED (Exact name of Registrant as specified in its Charter) ONTARIO, CANADA 6411 36-4412416 (State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employee Identification Number) incorporation or organization) Classification Code Number)
------------------------------------ HUB INTERNATIONAL LIMITED 55 EAST JACKSON BOULEVARD CHICAGO, ILLINOIS 60604 (877) 402-6601 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) ------------------------------------ W. KIRK JAMES VICE PRESIDENT AND GENERAL COUNSEL HUB INTERNATIONAL LIMITED 55 EAST JACKSON BOULEVARD CHICAGO, ILLINOIS 60604 (312) 279-4881 (Name, address, including zip code, and telephone number, including area code, of agent for service) ------------------------------------ COPIES TO: BRICE T. VORAN, ESQ. LUCIANA FATO, ESQ. SHEARMAN & STERLING DAVIS POLK & WARDWELL 199 BAY STREET 450 LEXINGTON AVENUE COMMERCE COURT WEST, SUITE 4405 NEW YORK, NY 10017 TORONTO, ONTARIO CANADA M5L 1E8 (212) 450-4000 (416) 360-8484
------------------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after this 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 this Form is a post-effective amendment filed pursuant to Rule 462(c) 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 this Form is a post-effective amendment filed pursuant to Rule 462(d) 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 delivery of the prospectus is expected to be made pursuant to Rule 434 under the Securities Act, 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 THAT SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART I INFORMATION REQUIRED TO BE DELIVERED TO OFFEREES OR PURCHASERS THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES, AND WE ARE NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED. SUBJECT TO COMPLETION, DATED JUNE 13, 2002 PROSPECTUS 5,000,000 SHARES (HUB INTERNATIONAL LOGO) COMMON SHARES Hub International Limited is selling 5,000,000 common shares. Our common shares are listed on the Toronto Stock Exchange under the symbol HBG. This is our initial public offering in the United States. We anticipate that the initial public offering price will be between $14.00 and $16.00 per share. We are not offering our shares for sale in Canada. We have been authorized to list our common shares on the New York Stock Exchange under the symbol HBG.
- ----------------------------------------------------------------------------------------------------------- PER SHARE TOTAL - ----------------------------------------------------------------------------------------------------------- Initial public offering price $ $ Underwriting commissions $ $ Proceeds to Hub, before expenses $ $ - -----------------------------------------------------------------------------------------------------------
We have granted the underwriters an option for a period of 30 days to purchase up to 750,000 additional common shares. INVESTING IN OUR COMMON SHARES INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS" BEGINNING ON PAGE 7. NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. JPMORGAN COCHRAN, CARONIA & CO. STEPHENS INC. BMO NESBITT BURNS FERRIS, BAKER WATTS Incorporated , 2002 TABLE OF CONTENTS
PAGE Exchange rate information................................... ii Prospectus summary.......................................... 1 Risk factors................................................ 7 Forward-looking statements.................................. 16 Use of proceeds............................................. 17 Capitalization.............................................. 18 Dilution.................................................... 19 Market price of our common shares........................... 20 Dividend policy............................................. 20 Unaudited pro forma consolidated statement of earnings...... 21 Selected historical consolidated financial data............. 23 Management's discussion and analysis of financial condition and results of operations................................... 28 Industry.................................................... 44 Business.................................................... 47 Management.................................................. 56 Certain relationships and related party transactions........ 66 Principal shareholders...................................... 69 Description of share capital................................ 71 Shares eligible for future sale............................. 72 Certain United States and Canadian federal income tax considerations............................................ 74 Underwriting................................................ 79 Legal matters............................................... 82 Experts..................................................... 82 Where you can find more information......................... 82 Index to consolidated financial statements.................. F-1
THE COMMON SHARES OFFERED BY THIS PROSPECTUS HAVE NOT BEEN AND WILL NOT BE QUALIFIED FOR SALE UNDER THE SECURITIES LAWS OF ANY PROVINCE OR TERRITORY OF CANADA AND ARE NOT BEING OFFERED FOR SALE IN CANADA OR TO ANY RESIDENT OF CANADA AND MAY NOT BE OFFERED OR SOLD, DIRECTLY OR INDIRECTLY, IN CANADA, OR TO OR FOR THE ACCOUNT OF ANY RESIDENT OF CANADA. i EXCHANGE RATE INFORMATION We publish our consolidated financial statements in U.S. dollars. All references in this prospectus to "dollars" or "$" are to U.S. dollars and all references to "C$" are to Canadian dollars, unless otherwise noted. The following table presents, in U.S. dollars, the exchange rates for the Canadian dollar, determined based on the inverse of the noon buying rate in New York City for cable transfers in U.S. dollars as certified for customs purposes by the Federal Reserve Bank of New York (the "noon buying rate") for the periods indicated.
- ---------------------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 2001 2000 1999 1998 1997 - ---------------------------------------------------------------------------------------------- High................................... $0.6697 $0.6969 $0.6925 $0.7105 $0.7487 Low.................................... 0.6241 0.6410 0.6535 0.6341 0.6945 End of period.......................... 0.6279 0.6669 0.6925 0.6504 0.6999 Average................................ 0.6444 0.6724 0.6744 0.6714 0.7197 - ----------------------------------------------------------------------------------------------
The average exchange rate is calculated on the last business day of each month for the applicable period. On June 12, 2002, the noon buying rate was C$1.00 = $0.6508. ------------------------------------ Unless the context requires otherwise, "Hub," "we," "our" and "us" refer to Hub International Limited and our consolidated subsidiaries. Except as otherwise indicated, all financial statements and financial data contained in this prospectus and in the documents incorporated by reference in this prospectus have been prepared in accordance with generally accepted accounting principles in Canada, or Canadian GAAP, which differs in certain significant respects from generally accepted accounting principles in the United States of America, or U.S. GAAP. Please see note 7 to our unaudited interim consolidated financial statements and note 17 to our audited consolidated financial statements for a description of the material differences between Canadian GAAP and U.S. GAAP. ii PROSPECTUS SUMMARY This summary highlights selected information contained elsewhere in this prospectus. This summary does not contain all of the information you should consider before investing in our common shares. You should read the entire prospectus carefully, including "Risk factors" beginning on page 7, our consolidated financial statements and the accompanying notes, as well as our unaudited pro forma consolidated statement of earnings and the accompanying notes, included elsewhere in this prospectus, before making an investment decision. Unless otherwise indicated, all dollar amounts are expressed in, and the term "dollars" and the symbol "$" refer to, U.S. dollars. The term "Canadian dollars" and the symbol "C$" refer to Canadian dollars. HUB INTERNATIONAL LIMITED We are a leading North American insurance brokerage providing a broad array of property and casualty, life and health, employee benefits, investment and risk management products and services. We focus primarily on middle-market commercial accounts in the United States and Canada, which we serve through our approximately 1,900 employees in 130 locations, using a variety of retail and wholesale distribution channels. We define the middle market as those companies with 20 to 499 employees, which typically generate annual commissions and fees ranging from $2,500 to $250,000. We generate commissions and other revenue from placing insurance. Since our company was formed in 1998 through the merger of 11 Canadian insurance brokerages, we have acquired an additional 78 brokerages and have established a strong presence in the northeastern and midwestern United States and in the Canadian provinces of Ontario, Quebec and British Columbia. Through a combination of organic growth and acquiring quality brokerages with proven track records, we have grown our revenue from $38.7 million in 1998 to $154.0 million in 2001, of which 93% is attributable to acquisitions, and from $28.1 million in the first quarter of 2001 to $49.5 million in the first quarter of 2002, of which 88% is attributable to acquisitions. In addition, our Adjusted EBITDA has increased from $6.2 million in 1998 to $30.7 million in 2001 and from $5.9 million in the first quarter of 2001 to $10.9 million in the first quarter of 2002. We operate through an organizational structure comprised of our head office, larger regional brokerages that we call "hub" brokerages and smaller brokerages that we call "fold-ins." We have nine hub brokerages, four operating in the United States and five in Canada. Each hub brokerage has a significant market presence in a geographic region in the United States or Canada. A hub brokerage is responsible not only for the development of its own business, but also the identification of fold-ins that can be acquired by and integrated into the operations of the hub brokerage. This process allows each hub brokerage an opportunity to strengthen its regional market presence by acquiring new or complementary products and services and management talent, while improving profit margins through the reduction or elimination of redundant administrative functions, premises and systems. Our structure enables our hub brokerages to more effectively and quickly meet the changing needs of our clients in various markets, while benefiting from the operating efficiencies and leverage of a large brokerage. We offer commercial and specialized insurance products and services to businesses, personal insurance products and services to individuals and program products to affinity groups and associations. We offer three categories of commercial products and services: property and casualty products, employee benefits and risk management services. We offer two categories of personal products and services: property and casualty products and life, health and financial products and services. Our program products involve the development, in collaboration with insurance companies, of baskets of insurance products for members of affinity groups or associations, such as 1 bar associations, medical associations and other professional groups. Our specialized risk products cover diverse exposures such as environmental, professional liability and directors' and officers' liability. We utilize retail, wholesale and call-center distribution channels, and have the ability to employ these distribution channels for specific market segments. Our primary goals are to further develop our position as a leading North American middle-market insurance broker and to generate significant sustained shareholder value. We plan to achieve these objectives by executing the following strategies: FOCUS ON MIDDLE-MARKET COMMERCIAL ACCOUNTS. We focus our sales efforts on middle-market companies because we believe the insurance needs of these companies are underserved and that middle-market commercial accounts generally generate higher profit margins than personal accounts and provide us with greater cross-selling opportunities. GROW ORGANICALLY. We intend to increase profitability per customer and attract new customers by leveraging our existing infrastructure to sell a broad range of products and services through multiple distribution channels, target profitable client segments and maximize cross-selling opportunities. GROW THROUGH SELECTED ACQUISITIONS. We acquire brokerages to grow our revenue, complement and supplement our existing products and services and add experienced management. STANDARDIZE PROCEDURES TO INCREASE OPERATING EFFICIENCY AND REDUCE COSTS. We strive to implement the best operating and sales practices of our brokerages across our company to increase operating efficiencies and reduce costs by eliminating administrative redundancies. RECRUIT, TRAIN AND RETAIN QUALIFIED PERSONNEL. We are formalizing our recruiting and training program to continue to build and sustain a sales and service team with a wide variety of experience and capabilities. We believe the following competitive advantages will enable us to achieve our objectives: DECENTRALIZED HUB APPROACH. Our decentralized hub approach allows us to react to regional market conditions while still centrally managing the growth and profitability of our business with consistent standards. BROAD ARRAY OF PRODUCTS AND SERVICES OFFERED THROUGH MULTIPLE DISTRIBUTION CHANNELS. We offer a broad array of products and services through a variety of distribution channels, which allows us to maintain and maximize existing client relationships and attract new clients. BENEFITS OF SCALE. Our scale, relative to smaller brokerages, provides insurers with greater incentives to work with us, which enables us to generate increased volume overrides and contingent commissions, based on the volume and profitability of the business we place, favorable commission rates, exclusive distribution rights for certain territories and products, and, in some cases, have expanded authority to price and approve insurance policies on behalf of insurance companies. We believe our scale also makes us attractive to smaller brokerages as a potential acquiror. COMMITTED AND EXPERIENCED MANAGEMENT. Most of the senior managers of our brokerages have over 20 years of experience in the industry and also have significant shareholdings in our company, typically with transfer restrictions for up to ten years. Our executive office is located at 55 East Jackson Boulevard, Chicago, Illinois 60604, and our telephone number is (877) 402-6601. Our web site is located at www.hubinternational.com. Information contained on our website is not part of this prospectus. You should read the entire prospectus carefully, including "Risk factors" beginning on page 7 before making an investment decision. 2 THE OFFERING Common shares offered by us: 5,000,000 shares Common shares to be outstanding after this offering: 26,655,748 shares USE OF PROCEEDS We estimate that the net proceeds from this offering will be approximately $68.6 million. We intend to use approximately $47 million of the net proceeds from this offering to repay existing indebtedness and the balance for working capital and other general corporate purposes, which may include acquisitions. See "Use of proceeds" on page 19 for more information regarding our use of the proceeds from this offering. DIVIDEND POLICY We have paid a dividend of C$0.07 per common share for each quarter commencing June 30, 2000. We have no formal dividend policy other than the board of directors considers the payment of dividends as quarterly financial information becomes available. In the future, dividends will be paid at the discretion of our board of directors depending on our financial position and capital requirements, general business conditions, contractual restrictions and other factors. New York Stock Exchange symbol: HBG Toronto Stock Exchange symbol: HBG The share information above is based on shares outstanding as of June 12, 2002. The number of common shares to be outstanding after this offering does not include (1) 1,250,000 common shares that may be issued upon the exercise of options we expect to grant prior to the completion of this offering with an exercise price equal to the higher of the initial public offering price and the closing price of our common shares on the TSX on the date the initial public offering price is determined, and (2) 254,033 restricted shares and 482,745 common shares underlying restricted share units that we have agreed to award under our equity incentive plan. Unless otherwise noted, the information in this prospectus assumes that the underwriters' over-allotment option will not be exercised. 3 SUMMARY CONSOLIDATED FINANCIAL DATA Our summary consolidated financial data has been derived from our unaudited interim consolidated financial statements as of and for each of the three month periods ended March 31, 2002 and 2001 and our audited consolidated financial statements as of and for each of the years in the three year period ended December 31, 2001, which are included elsewhere in this prospectus. Our historical consolidated financial statements are prepared in accordance with Canadian GAAP, which differs in certain significant respects from U.S. GAAP. For a discussion of the principal differences between Canadian GAAP and U.S. GAAP see note 7 to our unaudited interim consolidated financial statements and note 17 to our audited consolidated financial statements beginning on page F-1. Historical results of operations are not necessarily indicative of future results. It is important that you read this information together with "Management's discussion and analysis of financial condition and results of operations" beginning on page 28 and our consolidated financial statements and the accompanying notes, included elsewhere in this prospectus. You should also read our "Unaudited pro forma consolidated statement of earnings" for the year ended December 31, 2001 and the accompanying notes, beginning on page 23 of this prospectus. Our unaudited pro forma consolidated statement of earnings gives effect to our June 28, 2001 acquisition of Kaye Group Inc. as if it had occurred on January 1, 2001. 4
- ---------------------------------------------------------------------------------------------------------------- THREE MONTHS ENDED MARCH 31, YEAR ENDED DECEMBER 31, ------------------- ---------------------------- 2002 2001 2001 2000 1999 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)(1) (UNAUDITED) - ---------------------------------------------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF EARNINGS DATA: Revenue: Commission income......................................... $41,393 $23,211 $142,851 $86,410 $47,964 Contingent commissions and volume overrides............... 6,175 4,001 5,946 4,909 2,824 Other..................................................... 1,916 885 5,196 3,921 3,309 -------------------------------------------------- 49,484 28,097 153,993 95,240 54,097 -------------------------------------------------- Expenses: Remuneration.............................................. 27,690 16,083 88,015 54,701 29,519 Selling................................................... 2,921 1,719 8,359 4,840 3,036 Occupancy................................................. 2,725 1,569 9,061 5,756 3,393 Depreciation.............................................. 1,280 572 3,940 1,885 1,275 Administration............................................ 5,214 2,832 17,856 11,182 6,806 -------------------------------------------------- 39,830 22,775 127,231 78,364 44,029 -------------------------------------------------- Net earnings before the following........................... 9,654 5,322 26,762 16,876 10,068 Interest expense.......................................... 2,694 589 7,447 1,981 632 Goodwill and other intangible asset amortization.......... 379 771 4,940 3,260 1,626 (Gain) loss on disposal of capital assets and investments............................................. (42) 25 (173) 127 14 Other (income) -- put option liability.................... (373) -- (719) -- -- -------------------------------------------------- Net earnings before income taxes............................ 6,996 3,937 15,267 11,508 7,796 Provision for income tax expense................................................... 2,057 1,471 5,262 5,370 4,052 -------------------------------------------------- Net earnings................................................ $ 4,939 $ 2,466 $ 10,005 $ 6,138 $ 3,744 -------------------------------------------------- -------------------------------------------------- Net earnings per share: Basic..................................................... $ 0.25 $ 0.13 $ 0.53 $ 0.34 $ 0.22 Diluted................................................... $ 0.21 $ 0.13 $ 0.50 $ 0.34 $ 0.22 Weighted average shares: Basic..................................................... 19,503 18,571 19,012 18,327 16,941 Diluted................................................... 27,460 18,571 20,105 18,327 16,941 Dividends declared per share(2)............................. $ 0.04 $ 0.04 $ 0.18 $ 0.13 -- Net earnings (U.S. GAAP).................................... $ 4,787 $ 2,547 $ 9,858 $ 6,543 $ 3,977 Net earnings per share (U.S. GAAP): Basic..................................................... $ 0.25 $ 0.14 $ 0.52 $ 0.36 $ 0.23 Diluted................................................... $ 0.20 $ 0.14 $ 0.49 $ 0.36 $ 0.23 - ----------------------------------------------------------------------------------------------------------------
(1) Effective September 30, 2001, we adopted the U.S. dollar as our reporting currency. Our financial results for all periods prior to October 1, 2001 have been restated from Canadian dollars to U.S. dollars using the exchange rate in effect at September 30, 2001 of C$1.00 = $0.6338. (2) We commenced payment of dividends in the second quarter of 2000. 5
- --------------------------------------------------------------------------------------------------- THREE MONTHS ENDED YEAR ENDED DECEMBER 31, MARCH 31, 2002 --------------------------------- (IN THOUSANDS, EXCEPT PERCENTAGES)(1) (UNAUDITED) 2001 2000 1999 - --------------------------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEET DATA (AT PERIOD END): Cash and cash equivalents(2)................... $18,526 $ 26,979 $ 19,919 $ 21,371 Total assets................................... $459,531 $ 502,296 $ 206,157 $ 171,202 Total debt(3).................................. $194,350 $ 196,952 $ 34,665 $ 20,565 Total shareholders' equity..................... $141,018 $ 135,271 $ 112,212 $ 105,462 Total shareholders' equity (U.S. GAAP)......... $134,458 $ 128,611 $ 118,221 $ 115,340 OTHER FINANCIAL DATA: Adjusted EBITDA(4)............................. $10,934 $ 30,702 $ 18,761 $ 11,343 Adjusted EBITDA margin(5)...................... 22.1% 19.9% 19.6% 20.9% Net cash flow provided by (used in) operating activities................................... $(15,948) $ 46,912 $ 12,807 $ 5,103 Net cash flow provided (used in) by financing activities................................... $(2,309) $ 132,431 $ 5,613 $ 58,494 Net cash flow (used in) investing activities... $ 322 $(134,213) $ (17,983) $ (34,655) - ---------------------------------------------------------------------------------------------------
(1) Effective September 30, 2001, we adopted the U.S. dollar as our reporting currency. Our financial results for all periods prior to October 1, 2001 have been restated from Canadian dollars to U.S. dollars at the exchange rate in effect at September 30, 2001 of C$1.00 = $0.6338. (2) Excludes trust cash, which includes premiums collected (less commissions and other deductions) not yet remitted to insurance companies. (3) Long-term debt and capital leases (including current portion), bank debt and subordinated convertible notes. (4) Adjusted EBITDA is defined as earnings before interest, income taxes, depreciation and goodwill and other intangible asset amortization, but excluding gains or losses from the sale of capital assets and investments and other income - -- put option liability. We believe that Adjusted EBITDA presents a useful measure of our ability to service and incur debt based on our ongoing operations. Adjusted EBITDA is not a measure of financial performance under either U.S. or Canadian GAAP and the items excluded to arrive at Adjusted EBITDA are significant in understanding and assessing our overall financial condition. Therefore, Adjusted EBITDA should not be considered in isolation or as a substitute for net income, cash flows from operating activities or other income or cash flow statement data prepared in accordance with generally accepted accounting principles as a measure of profitability or liquidity. We believe the presentation of Adjusted EBITDA is relevant because Adjusted EBITDA and similar measures are used by industry analysts to evaluate operating performance. Investors should be aware that our presentation of Adjusted EBITDA may not be comparable with similarly titled measures presented by other companies. (5) Adjusted EBITDA margin represents Adjusted EBITDA as a percentage of total revenue. Adjusted EBITDA margin is presented because we believe that it is a useful indicator to investors of our profitability. Adjusted EBITDA margin should not be considered by investors as an alternative to operating margin as an indicator of our profitability. Investors should be aware that our presentation of Adjusted EBITDA margin may not be comparable with similarly titled measures presented by other companies. 6 RISK FACTORS You should carefully consider the risks described below and all other information contained in this prospectus before making an investment decision. If any of the following risks, as well as additional risks and uncertainties that are not yet known to us or that we currently think are immaterial, actually occur, our business, financial condition and results of operations could be materially adversely affected. In that event, the trading price of our shares could decline, and you may lose part or all of your investment. RISKS RELATED TO OUR BUSINESS WE MAY BE UNSUCCESSFUL IN IDENTIFYING AND ACQUIRING SUITABLE ACQUISITION CANDIDATES, WHICH COULD IMPEDE OUR GROWTH AND ABILITY TO REMAIN COMPETITIVE IN OUR INDUSTRY. Our strategic plan includes the regular and systematic evaluation and acquisition of insurance brokerages in new and existing markets. Since our formation in 1998, approximately 93% of our revenue growth has been attributable to acquisitions. However, we may not successfully identify suitable acquisition candidates. Prospective acquisition candidates may not become available or we may not be able to complete an acquisition once negotiations have commenced. We compete for acquisition and expansion opportunities with entities that have substantially greater resources than we do and these entities may be able to outbid us for these acquisition targets. If we fail to execute our acquisition strategy, our revenue growth is likely to suffer and we may be unable to remain competitive. OUR CONTINUED GROWTH IS PARTLY BASED ON OUR ABILITY TO SUCCESSFULLY INTEGRATE ACQUIRED BROKERAGES AND OUR FAILURE TO DO SO MAY HAVE AN ADVERSE EFFECT ON OUR REVENUE AND EXPENSES. We may be unable to successfully integrate brokerages that we may acquire in the future. The integration of an acquisition involves a number of factors that may affect our operations. These factors include: - - diversion of management's attention; - - difficulties in the integration of acquired operations and retention of personnel; - - entry into unfamiliar markets; - - unanticipated problems or legal liabilities; and - - tax and accounting issues. A failure to integrate acquired brokerages may be disruptive to our operations and negatively impact our revenue or increase our expenses. INSURANCE BROKERAGES THAT WE HAVE ACQUIRED MAY HAVE LIABILITIES THAT WE ARE NOT AWARE OF AND MAY NOT BE AS PROFITABLE AS WE EXPECT THEM TO BE. Since our formation in November 1998 through the merger of 11 insurance brokerages, we have acquired an additional 78 brokerages. Although we conduct due diligence in respect of the business and operations of each of the brokerages we acquire, we may not have identified all material facts concerning these brokerages. For example, on one occasion we discovered a brokerage's liability for unaccrued corporate taxes only after we had completed the acquisition of the brokerage. Unanticipated events or liabilities relating to these brokerages could have a material adverse effect on our financial condition. Furthermore, once we have integrated an acquired brokerage, it may not achieve levels of revenue, profitability, or productivity comparable to our existing locations, or otherwise perform as expected. Our failure to integrate one or more 7 acquired brokerages so that they achieve our performance goals may have a material adverse effect on our results of operations and financial condition. IF WE FAIL TO OBTAIN ADDITIONAL FINANCING FOR ACQUISITIONS, WE MAY BE UNABLE TO EXPAND OUR BUSINESS. Our acquisition strategy may require us to seek additional financing. If we are unable to obtain sufficient financing on satisfactory terms and conditions, we may not be able to maintain or increase our market share or expand our business through acquisitions. Our ability to obtain additional financing will depend upon a number of factors, many of which are beyond our control. We may not be able to obtain additional satisfactory financing because we already have debt outstanding and because we may not have sufficient cash flow to service or repay our existing or additional debt. For example, as of March 31, 2002, we had $194 million of total debt and two of our credit facilities contain covenants that, among other things, require us to maintain certain financial ratios and restrict our ability to incur additional debt. WE CANNOT ACCURATELY FORECAST OUR COMMISSION REVENUE BECAUSE OUR COMMISSIONS DEPEND ON PREMIUM RATES CHARGED BY INSURANCE COMPANIES, WHICH HISTORICALLY HAVE VARIED AND ARE DIFFICULT TO PREDICT. ANY DECLINES IN PREMIUMS MAY ADVERSELY IMPACT OUR PROFITABILITY. In 2001, we derived approximately 93% of our revenue from commissions paid by insurance companies on the sale of their insurance products to our clients. Our revenue from commissions fluctuates with premiums charged by insurers, as commissions typically are determined as a percentage of premiums. When premiums decline, we experience downward pressure on our revenue and earnings. Historically, property and casualty premiums have been cyclical in nature and have varied widely based on market conditions. Significant reductions in premium rates occurred during the years 1988 through 2000 as a result of expanded underwriting capacity of property and casualty insurance companies and increased competition. In some cases, property and casualty insurance companies lowered commission rates. Because we cannot determine the timing and extent of premium pricing changes, we cannot accurately forecast our commission revenue, including whether it will significantly decline. If premiums decline or commission rates are reduced, our revenue, earnings and cash flow could decline. In addition, our budgets for future acquisitions, capital expenditures, dividend payments, loan repayments and other expenditures may have to be adjusted to account for unexpected changes in revenue. INSURANCE COMPANY CONTINGENT COMMISSIONS AND VOLUME OVERRIDES ARE LESS PREDICTABLE THAN NORMAL COMMISSIONS, WHICH IMPAIRS OUR ABILITY TO FORECAST THE AMOUNT OF SUCH REVENUE THAT WE WILL RECEIVE AND MAY NEGATIVELY IMPACT OUR OPERATING RESULTS. We derive a portion of our revenue from contingent commissions and volume overrides. The aggregate of these sources of revenue generally has accounted for 4% to 5% of our total revenue. Contingent commissions may be paid by an insurance company based on the profit it makes on the overall volume of business that we place with it. We generally receive these commissions in the first and second quarters of each year. Volume overrides are paid by an insurance company based on the volume of business that we place with it and are generally paid over the course of the year. As a result of recent developments in the property and casualty insurance industry, including changes in underwriting criteria due in part to the higher numbers and dollar value of claims as compared to the premiums collected by insurance companies, we cannot predict the payment of these performance-based revenues as accurately as we have been able to in the past. Further, we have no control over the process by which insurance companies estimate their own loss reserves, which affects our ability to forecast contingent commissions. Because these contingent commissions 8 affect our revenue, any decrease in their payment to us could adversely affect our results of operations. PROPOSED TORT REFORM LEGISLATION IN THE UNITED STATES, IF ENACTED, COULD DECREASE DEMAND FOR LIABILITY INSURANCE, THEREBY REDUCING OUR COMMISSION REVENUE. Legislation concerning tort reform is currently being considered in the United States Congress and in several states. Among the provisions being considered for inclusion in such legislation are limitations on damage awards, including punitive damages, and various restrictions applicable to class action lawsuits, including lawsuits asserting professional liability of the kind for which insurance is offered under certain policies we sell. Enactment of these or similar provisions by Congress, or by states or countries in which we sell insurance, could result in a reduction in the demand for liability insurance policies or a decrease in policy limits of such policies sold, thereby reducing our commission revenue. WE HAVE ENTERED INTO PUT OPTION ARRANGEMENTS WITH FORMER SHAREHOLDERS OF OUR ACQUIRED BROKERAGES, J.P. FLANAGAN CORPORATION AND BURNHAM INSURANCE GROUP, INC., WHICH MAY REQUIRE US TO PAY SUBSTANTIAL AMOUNTS TO REPURCHASE OUR COMMON SHARES FROM THESE SHAREHOLDERS. THOSE PAYMENTS WOULD REDUCE OUR CASH FLOW AND THE FUNDS AVAILABLE TO GROW OUR BUSINESS. In connection with our acquisitions of Flanagan and Burnham, we entered into put option arrangements with the former shareholders of those companies whereby we gave them the right to require us to repurchase their shares of Hub that were issued in consideration of the acquisitions. The rights under the put arrangements may be exercised between 2006 and 2011, and if exercised, we could be required to buy back our common shares at C$17.00 per share at specific exercise dates set out under the heading "Certain relationships and related party transactions--Put options." We may not have sufficient cash on hand on the exercise dates to satisfy our obligations under these put arrangements and as a consequence we may have to obtain additional financing. However, we may not be able to incur additional debt at such time. Our inability to satisfy our obligations under the put options may adversely affect our relationship with the management team at Flanagan and Burnham and may result in the loss of key management personnel from these subsidiaries and, in turn, the loss of customers, which would adversely affect our business and financial condition. In addition, our failure to satisfy our obligations under the put options may cause us to breach our agreements with those shareholders. A SUBSTANTIAL PORTION OF OUR TOTAL ASSETS ARE REPRESENTED BY GOODWILL AS A RESULT OF OUR ACQUISITIONS AND UNDER NEW ACCOUNTING STANDARDS, WE MAY BE REQUIRED TO WRITE DOWN THE VALUE OF OUR GOODWILL. When we acquire a brokerage, virtually the entire purchase price for the acquisition is allocated to goodwill and other identifiable intangible assets. The amount of purchase price allocated to goodwill is determined by the excess of the purchase price over the net identifiable assets paid by us to acquire the brokerage. On July 1, 2001, we adopted the Canadian Institute of Chartered Accountants (CICA) Accounting Standards Board Handbook Section 1581, "Business Combinations". These new rules require that all business combinations after June 30, 2001 be accounted for in accordance with the purchase method of accounting and expand the definition of other identifiable intangible assets acquired in a business combination using the purchase method. On January 1, 2002, we adopted CICA's Section 3062, "Goodwill and Other Intangible Assets". For all business combinations accounted for using the purchase method prior to June 30, 2001, Section 3062 eliminates the amortization of goodwill, requires annual impairment testing of goodwill and introduces the concept of definite life and indefinite life intangible assets. Indefinite 9 life intangible assets, similar to goodwill, will no longer be amortized and will be tested at least annually for impairment. The carrying value of our goodwill and other indefinite life intangible assets may be adversely affected by this new accounting standard. THE LOSS OF MEMBERS OF OUR SENIOR MANAGEMENT OR A SIGNIFICANT NUMBER OF OUR BROKERS COULD NEGATIVELY AFFECT OUR FINANCIAL PLANS, MARKETING AND OTHER OBJECTIVES. The loss of or failure to attract key personnel could significantly impede our financial plans, growth, marketing and other objectives. Our success depends to a substantial extent not only on the ability and experience of our senior management but also on the individual brokers and teams that service our clients and maintain client relationships. In the past, we have experienced short-term disruptions to certain brokerage operations due to the early retirement of senior members of management at those brokerages. Our operations are not generally dependent on any one individual; however, the loss of Martin Hughes, our Chairman and Chief Executive Officer, or Bruce Guthart, our President, U.S. Operations, could negatively impact our acquisition strategy in the United States due to their significant relationships and expertise in the insurance industry. The insurance brokerage industry has in the past experienced intense competition for the services of leading individual brokers and brokerage teams. We believe that our future success will depend in large part on our ability to attract and retain additional highly skilled and qualified personnel and to expand, train and manage our employee base. We may not be successful in doing so because the competition for qualified personnel in our industry is intense. If we fail to recruit and retain top producers, our organic growth may be adversely affected. COMPETITION IN OUR INDUSTRY IS INTENSE, AND IF WE ARE UNABLE TO COMPETE EFFECTIVELY, WE MAY LOSE MARKET SHARE AND OUR BUSINESS MAY BE MATERIALLY ADVERSELY AFFECTED. The insurance brokerage business is highly competitive and we actively compete with other insurance brokerages for customers and insurance company markets, many of which have existing relationships with insurance companies or have a significant presence in niche insurance markets that may give them an advantage over us. Because relationships between insurance brokers and insurance companies or clients are often local or regional in nature, this potential competitive disadvantage is particularly pronounced. See "Business--Competition" for a further discussion of the level of competition in our industry. We face competition in all markets in which we operate, based on product breadth, innovation, quality of service and price. We compete with a number of brokerages, such as Arthur J. Gallagher & Co., Hilb, Rogal and Hamilton Company and Brown & Brown, Inc. in the United States, who may have greater resources than we do, as well as with numerous Internet-based, specialist and regional firms in the United States and Canada. If we are unable to compete effectively against our competitors, we will suffer a loss of market share, decreased revenue and reduced operating margins. In addition, regulatory changes in the financial services industry in the United States and Canada have permitted banks, securities firms and insurance companies to affiliate, causing rapid consolidation in the insurance industry. Some insurance companies are engaged in the direct sale of insurance, primarily to individuals, and do not pay commissions to agents and brokers on policies they sell directly. Increasing competition from insurance companies and from within the financial services industry, generally, could have a negative effect on our operations. 10 WE DO BUSINESS WITH CERTAIN SUBSIDIARIES OF OUR LARGEST SHAREHOLDER AND IF A CONFLICT OF INTEREST WERE TO ARISE IT MAY NOT BE RESOLVED IN OUR FAVOR AND COULD ADVERSELY AFFECT OUR REVENUE. Fairfax Financial Holdings Limited owns 37% of our common shares. We do business with certain subsidiaries of Fairfax which represented approximately 4.9% of our revenue in 2001. We expect that this percentage will increase as a result of our sale of Old Lyme Insurance Company of Rhode Island, Inc. and Old Lyme Insurance Company Ltd., which together we call Old Lyme, to Fairfax, as we will continue to do a significant amount of business with Old Lyme as described under "Certain relationships and related party transactions." The sale of Old Lyme was completed on May 30, 2002. If a conflict of interest were to arise between us and Fairfax or one of its subsidiaries, we cannot assure you that this conflict would be resolved in a manner that would favor us. In addition, if Fairfax were to sell our common shares that it owns, it may no longer be as interested in continuing to do business with us which could have a material adverse effect on our revenue and expenses. WE DEPEND ON OUR INFORMATION PROCESSING SYSTEMS. INTERRUPTION OR LOSS OF OUR INFORMATION PROCESSING SYSTEMS COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS. Our ability to provide administrative services depends on our capacity to store, retrieve, process and manage significant databases and expand and upgrade periodically our information processing capabilities. Interruption or loss of our information processing capabilities through loss of stored data, breakdown or malfunctioning of computer equipment and software systems, telecommunications failure, or damage caused by fire, tornadoes, lightning, electrical power outage or other disruption could have a material adverse effect on our business, financial condition and results of operations. Although we have disaster recovery procedures in place for all our hub brokerages and insurance to protect against such contingencies, such procedures may not be effective and any insurance or recovery procedures may not continue to be available at reasonable prices and may not address all such losses or compensate us for the possible loss of clients occurring during any period that we are unable to provide services. PRIVACY LEGISLATION MAY IMPEDE OUR ABILITY TO UTILIZE OUR CUSTOMER DATABASE AS A MEANS TO GENERATE NEW SALES. We intend to utilize our extensive customer databases for marketing and sales purposes, which we believe will enhance our ability to meet our organic growth targets. However, new privacy legislation, such as the Gramm-Leach-Bliley Act and the Health Insurance Portability and Accountability Act of 1996 in the United States and the Personal Information Protection and Electronic Documents Act in Canada, as well as other regulatory changes, may restrict our ability to utilize personal information that we have collected in our normal course of operations to generate new sales. If we become subject to new restrictions, or other regulatory restrictions which we are not aware of, our ability to grow our business may be adversely affected. THE SECURITY OF THE DATABASES THAT CONTAIN OUR CUSTOMERS' PERSONAL INFORMATION MAY BE BREACHED WHICH COULD SUBJECT US TO LITIGATION OR ADVERSE PUBLICITY. We depend on computer systems to store information about our customers, some of which is private. Database privacy, identity theft and related computer and internet issues are matters of growing public concern. We have installed privacy protection systems and devices on our network in an attempt to prevent unauthorized access to information in our database. However, our technology may fail to adequately secure the private information we maintain in our databases and protect it from theft or inadvertent leakage. In such circumstances, we may be held liable to our customers, which could result in litigation or adverse publicity that could have a material adverse effect on our business. 11 OUR CORPORATE STRUCTURE AND STRATEGY OF OPERATING THROUGH DECENTRALIZED BROKERAGES MAY MAKE IT MORE DIFFICULT FOR US TO BECOME AWARE OF AND RESPOND TO ADVERSE OPERATING OR FINANCIAL DEVELOPMENTS AT OUR BROKERAGES. We depend on timely and accurate reporting of business conditions and financial results from our brokerages to affect our business plan and determine and report our operating results. We receive end of month reports from each of our brokerages regarding their financial condition and operating results. If an adverse business or financial development occurs at one or more of our brokerages near the beginning of a month, we may not become aware of the occurrence for several weeks which could make it more difficult for us to effectively respond to that development. In addition, if one of our brokerages was to report inaccurate financial information, we might not learn of these inaccuracies for several weeks, if at all, which could adversely affect our ability to determine and report our financial results. For example, on occasion, inconsistent accounting treatment at a brokerage has not been detected until preparation of our quarterly financial statements. We are investigating the purchase of enterprise reporting software that would enable us to extract financial and operating data from our brokerages electronically and on a real time basis. We anticipate that such a system will be implemented in 2003. However, such system may not be implemented within this time frame and it may not be effective. OUR PROFITABILITY AND LIQUIDITY MAY BE MATERIALLY ADVERSELY AFFECTED BY ERRORS AND OMISSIONS. We have extensive operations and are subject to claims and litigation in the ordinary course of business resulting from alleged errors and omissions. Errors and omissions claims can involve significant defense costs and may result in large damage awards against us. Errors and omissions could include, for example, our employees or sub-agents failing, whether negligently or intentionally, to place coverage or to notify insurance companies of claims on behalf of clients, to provide insurance companies with complete and accurate information relating to the risks being insured or to appropriately apply funds that we hold for our clients on a fiduciary basis. It is not always possible to prevent and detect errors and omissions and the precautions we take may not be effective in all cases. Each of our U.S. brokerages has its own errors and omissions policy, providing limits, depending on the brokerage, from $5 million to $10 million per claim and $6 million to $10 million annual aggregate coverage. The deductible on these policies ranges from $15,000 to $225,000 per claim. Our primary errors and omissions policy covering our Canadian brokerages provides limits of C$5 million per claim and C$10 million annual aggregate coverage, with sublimits for our life and mutual fund agents of C$1 million per claim and C$2 million annual aggregate coverage. This policy has a tiered deductible based on the amount of the annualized revenue of the respective brokerage, to a maximum deductible of C$25,000 per claim. We also carry a C$10 million aggregate excess policy with no deductible. In addition, we are eligible for coverage for errors and omissions losses under an insurance policy purchased by Fairfax. See "Certain relationships and related party transactions--Fairfax Insurance Coverage." The amount of coverage limits and related deductible amounts of our errors and omissions insurance policies are established annually based upon our assessment of our errors and omissions exposure, loss experience and the availability and pricing of coverage within the marketplace. We are investigating purchasing errors and omissions policies in 2002 that will provide increased coverage for all of our brokerages and we anticipate that the deductible portion of claims and premiums related to such policies will be higher than is presently the case. While we endeavor to purchase coverage that is appropriate to our assessment of our risk, we are unable to predict with certainty the frequency, nature or magnitude of claims for direct or consequential damages. 12 Our profitability and liquidity may be adversely affected if in the future our insurance coverage proves to be inadequate or unavailable or there is an increase in liabilities for which we self-insure. In addition, errors and omissions claims may harm our reputation or divert management resources away from operating our business. IF WE FAIL TO COMPLY WITH REGULATORY REQUIREMENTS FOR INSURANCE BROKERAGES, WE MAY NOT BE ABLE TO CONDUCT OUR BUSINESS. Our business is subject to legal requirements and governmental regulatory supervision in the jurisdictions in which we operate. These requirements are designed to protect our clients by establishing minimum standards of conduct and practice, particularly regarding the provision of advice and product information as well as financial criteria. Our activities in the United States and Canada are subject to regulation and supervision by state and provincial authorities. Although the scope of regulation and form of supervision by state and provincial authorities may vary from jurisdiction to jurisdiction, insurance laws in the United States and Canada are often complex and generally grant broad discretion to supervisory authorities in adopting regulations and supervising regulated activities. This supervision generally includes the licensing of insurance brokers and agents and the regulation of the handling and investment of client funds held in a fiduciary capacity. Our ability to conduct our business in the jurisdictions in which we currently operate depends on our compliance with the rules and regulations promulgated from time to time by the regulatory authorities in each of these jurisdictions. Our clients have the right to file complaints with the regulators about our services, and the regulators may investigate and require us to address these complaints. Our failure to satisfy the regulators that we are in compliance with their requirements or the legal requirements governing our activities can result in disciplinary action, fines, reputational damage and financial harm. In addition, changes in legislation or regulations and actions by regulators, including changes in administration and enforcement policies, could from time to time require operational improvements or modifications at various locations which could result in higher costs or hinder our ability to operate our business. See "Business--Government regulation." OUR SIGNIFICANT CANADIAN OPERATIONS EXPOSE US TO EXCHANGE RATE FLUCTUATIONS, AND OUR NET INCOME MAY SUFFER IF THE CANADIAN DOLLAR DECLINES IN VALUE. We report our results in U.S. dollars. However, our Canadian Operations, which accounted for 51% of our revenue in 2001 and 39.2% of our revenue for the first quarter of 2002, earn revenue and incur expenses in Canadian dollars. The Canadian dollar has suffered a decline in value compared to the U.S. dollar in recent years. For example, at December 31, 1999, C$1.00 was equivalent to $0.6925 and at December 31, 2001, C$1.00 was equivalent to only $0.6279, a decline of more than 9%. A decline in the value of the Canadian dollar compared to the U.S. dollar would reduce our reported revenue, which could have a material adverse effect on our reported earnings. RISKS RELATED TO OUR COMMON SHARES OUR COMMON SHARES HAVE NO PRIOR TRADING HISTORY IN THE UNITED STATES AND AN ACTIVE TRADING MARKET MAY NOT DEVELOP. We are a reporting issuer in Ontario, Canada under the Securities Act (Ontario) and in the other provinces and territories of Canada under similar legislation. Our common shares are currently listed on the TSX but are not listed on any U.S. stock exchange or quoted on any U.S. quotation system. Accordingly, prior to this offering, there has been no public market for our common shares in the United States and we cannot assure you that an active trading market will develop or be sustained in the United States after this offering. Furthermore, there can be no assurance that an 13 active trading market will be sustained in Canada. The public offering price negotiated among us and the underwriters may not be indicative of prices that will prevail in any trading market. THE PRICE OF OUR COMMON SHARES MAY FLUCTUATE SUBSTANTIALLY, WHICH COULD NEGATIVELY AFFECT THE HOLDERS OF OUR COMMON SHARES. The price of our common shares may fluctuate substantially due to the following factors: (1) fluctuations in the price of the shares of the small number of public companies in the insurance brokerage business, (2) announcements of acquisitions as part of our growth strategy, (3) additions or departures of key personnel, (4) announcements of legal proceedings or regulatory matters and (5) the general volatility in the stock market. The market price of our common shares could also fluctuate substantially if we fail to meet or exceed securities analysts' expectations of our financial results or if there is a change in financial estimates or securities analysts' recommendations. From the beginning of 2000 to the end of the first quarter of 2002, the price of our common shares on the TSX has ranged from a low of C$9.50 to a high of C$24.00. In addition, the stock market has experienced volatility that has affected the market prices of equity securities of many companies, and that has often been unrelated to the operating performance of these companies. A number of other factors, many of which are beyond our control, could also cause the market price of our common shares to fluctuate substantially. As a result, you may not be able to resell your shares at or above the offering price, or at all. SIGNIFICANT FLUCTUATION IN THE MARKET PRICE OF OUR COMMON SHARES COULD RESULT IN SECURITIES CLASS ACTION CLAIMS AGAINST US. Significant price and value fluctuations have occurred with respect to the securities of insurance and insurance-related companies. Our common share price is likely to be volatile in the future. In the past, following periods of downward volatility in the market price of a company's securities, class action litigation has often been pursued against the respective company. If similar litigation was pursued against us, it could result in substantial costs and a diversion of our management's attention and resources. OUR CONTROLLING SHAREHOLDER MAY SUBSTANTIALLY INFLUENCE CERTAIN ACTIONS REQUIRING SHAREHOLDERS APPROVAL. As of March 31, 2002, Fairfax owned 37% of our common shares. After giving effect to the sales of our common shares contemplated in this offering, Fairfax will own 30% of our common shares. Fairfax also holds $35 million of subordinated convertible notes which it can convert at any time into our common shares at C$17.00 per share. If Fairfax converts the notes, after giving effect to this offering, it would hold 38% of our common shares. Under our by-laws and articles of incorporation, Fairfax has the ability to substantially influence certain actions requiring shareholder approval, including: - - electing members of our board of directors; - - adopting amendments to our articles and by-laws; and - - approving a merger or consolidation, liquidation or sale of all or substantially all of our assets. Fairfax may have different interests than you have and therefore may make decisions that are adverse to your interests. 14 FUTURE SALES OR THE POSSIBILITY OF FUTURE SALES OF A SUBSTANTIAL AMOUNT OF OUR COMMON SHARES MAY DEPRESS THE PRICE OF YOUR COMMON SHARES. Future sales of a substantial number of our common shares by us from treasury or by one of our shareholders in the public market could adversely affect prevailing market prices and the price of your common shares. It may also impair our ability to raise capital through future sales of, or pay for acquisitions using, our equity securities. Upon completion of this offering, we will have 26.7 million common shares issued and outstanding of which 14.3 million common shares will be freely tradeable without restrictions under the Securities Act. These numbers do not include (1) 1,250,000 common shares that may be issued upon the exercise of options we expect to grant prior to the completion of this offering at an exercise price equal to the higher of the initial public offering price and the closing price of our common shares on the TSX on the date the initial public offering price is determined, and (2) 254,033 restricted shares and 482,745 restricted share units that we have agreed to award under our equity incentive plan. All of the shares offered pursuant to this offering, plus any shares sold pursuant to the exercise of the underwriters' option to purchase additional common shares, will be freely tradeable without restriction under the Securities Act, unless purchased by our affiliates. Upon completion of this offering, 12.4 million shares will be restricted securities within the meaning of Rule 144. The rules affecting the sale of these securities are summarized under "Shares eligible for future sale." We expect we will continue to acquire brokerages to grow our business. We intend to pay for acquisitions using, at least in part, our common shares. In the event any such acquisition is significant, the number of shares that we may issue may in turn be significant. In addition, we may also grant registration rights covering shares issued in connection with any acquisition. Any significant share issuance by us will dilute your equity interest in our company. INVESTORS WILL INCUR IMMEDIATE DILUTION AND MAY EXPERIENCE FURTHER DILUTION. The initial public offering price of our common shares will be substantially higher than the net tangible book value per share of the outstanding common shares immediately after this offering. If you purchase common shares in this offering, based upon the issuance and sale of 5.0 million common shares at the initial public offering price of $15.00 per share, which is the midpoint of the range on the cover of this prospectus, you will incur immediate dilution of approximately $16.33 in the net tangible book value per common share. WE ARE INCORPORATED IN ONTARIO, CANADA, AND, AS A RESULT, IT MAY NOT BE POSSIBLE FOR SHAREHOLDERS TO ENFORCE CIVIL LIABILITY PROVISIONS OF THE SECURITIES LAWS OF THE UNITED STATES. We are organized under the laws of Ontario, Canada and some of our assets are located outside the United States. As a result, it may not be possible for the holders of our common shares to enforce against us in United States courts judgments based on the civil liability provisions of the securities laws of the United States. In addition, there is doubt as to whether the courts of Canada would recognize or enforce judgments of United States courts obtained against us or our directors or officers based on the civil liability provisions of the securities laws of the United States or any state or hear actions brought in Canada against us or those persons based on those laws. 15 FORWARD-LOOKING STATEMENTS Any written or oral statements made by us or on our behalf may include forward-looking statements which reflect our current views with respect to future events and financial performance. These forward-looking statements relate, among other things, to our plans and objectives for future operations. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. These uncertainties and other factors (which we describe in more detail elsewhere in this prospectus) include, but are not limited to: - - risks associated with implementing our business strategies; - - failure to identify or consummate acquisitions; - - failure to successfully integrate acquired businesses; - - decrease in the level of demand for insurance products; - - decrease in the premiums charged by insurance companies (which may result in a corresponding decrease in our revenue); - - loss of services of key executive officers; - - failure to successfully recruit and retain qualified employees; - - actions of our competitors, including industry consolidation and increased competition in the industry; - - inability to develop and implement effective information technology systems; and - - the passage of legislation subjecting our business to supervision or regulation in the jurisdictions in which we operate. The words "believe," "anticipate," "project," "expect," "intend," "will likely result" or "will continue" and similar expressions identify forward-looking statements. We caution readers not to place undue reliance on these forward-looking statements, which speak only as of their dates. We have described some important factors that could cause our actual results to differ materially from our expectations in this prospectus, including in the section titled "Risk factors." We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. 16 USE OF PROCEEDS We estimate that we will receive net proceeds from this offering of approximately $68.6 million, or $79.1 million if the underwriters' over-allotment option is exercised in full, assuming an initial public offering price of $15.00 per share, the midpoint of the range set forth on the cover of this prospectus, and after deducting the estimated underwriting commissions and estimated offering expenses payable by us. We expect to use the net proceeds from this offering to repay (1) the C$42.5 million, or approximately $26.6 million, of 8.5% convertible subordinated notes due June 28, 2006, issued to Zurich Insurance Company in connection with our acquisition of Kaye, and (2) $20 million outstanding under one of our credit facilities incurred on July 19, 2001 in connection with our acquisition of Kaye, which expires on July 17, 2002 and bears interest at LIBOR plus 150 basis points. See "Management's discussion and analysis of financial condition and operating results--Liquidity and capital resources" for a more detailed description of our outstanding debt. The remaining proceeds will be used for working capital and general corporate purposes, which may include acquisitions. We have no commitments or agreements concerning any acquisitions as of the date of this prospectus. Pending the use of the net proceeds, we intend to invest these funds in short-term, interest-bearing, investment grade securities. 17 CAPITALIZATION The following table sets forth our capitalization as of March 31, 2002: - - on an actual basis; and - - on an as adjusted basis to give effect to (1) the application of proceeds of $43.5 million from the sale of Old Lyme on May 30, 2002, (2) the sale by us of 5.0 million common shares at an assumed initial public offering price of $15.00 per share, the midpoint of the range set forth on the cover of this prospectus, after deducting underwriting commissions and estimated offering expenses, and (3) the application of the proceeds therefrom. See "Use of proceeds" on page 17 for more information regarding our use of the net proceeds from this offering. This table should be read in conjunction with "Management's discussion and analysis of financial condition and results of operations," our consolidated financial statements and our unaudited pro forma consolidated statement of earnings and the accompanying notes, appearing elsewhere in this prospectus.
- -------------------------------------------------------------------------------------------- AT MARCH 31, 2002 (IN THOUSANDS, EXCEPT SHARE AMOUNTS) ACTUAL AS ADJUSTED - -------------------------------------------------------------------------------------------- Cash and cash equivalents(1)................................ $ 18,526 $ 42,051(2) ---------------------------- ---------------------------- Short-term debt(3).......................................... 58,436 1,436(4) ---------------------------- Long-term debt and capital leases........................... 135,914 104,314(5) ---------------------------- Shareholders' equity: Preferred shares, unlimited authorized, none issued and outstanding at December 31, 2001 (actual and as adjusted).............................................. -- -- Common shares, unlimited authorized, 21,605,748 issued and outstanding at March 31, 2002, (actual) and 26,605,748 shares issued and outstanding (as adjusted)(6)......... 125,506 194,131 Cumulative translation account............................ 3,578 3,578 Retained earnings......................................... 11,934 15,318(7) ---------------------------- Total shareholders' equity............................. 141,018 210,443 ---------------------------- Total capitalization.............................. $335,368 $360,828 ---------------------------- - --------------------------------------------------------------------------------------------
(1) Excludes trust cash, which includes premiums collected (less commissions and other deductions) not yet remitted to insurance companies. (2) Includes $0.8 million of proceeds from the sale of Old Lyme. (3) Includes bank debt and current portion of long-term debt and capital leases. (4) Includes the application of $37.0 million of proceeds from the sale of Old Lyme. (5) Includes the application of $5.0 million of proceeds from the sale of Old Lyme. (6) Does not include (1) 1,275,000 common shares that may be issued upon the exercise of options we expect to grant prior to the completion of this offering at an exercise price equal to the higher of the initial public offering price and the closing price of our common shares on the TSX on the date the initial public offering price is determined, and (2) 254,033 restricted shares and 482,745 restricted share units that we have agreed to award under our equity incentive plan. (7) Includes an estimated after tax gain of $2.6 million related to the sale of Old Lyme. 18 DILUTION At March 31, 2002, our net tangible book value was $(104.1) million, or $(4.82) per common share. Net tangible book value represents the amount of our total tangible assets less our total liabilities. After giving effect to the sale of 5.0 million shares at an assumed initial public offering price of $15.00 per share, the midpoint of the range set forth on the cover of this prospectus, our net tangible book value after this offering as of March 31, 2002, not including a $2.6 million increase in retained earnings as a result of the sale of Old Lyme on May 30, 2002, would have been $(35.5) million, or $(1.33) per share. The net tangible book value after this offering assumes that the proceeds to us, net of underwriting commissions and offering expenses, will be approximately $68.6 million. Based on the foregoing, there would be as of March 31, 2002 an immediate increase in net tangible book value of $3.49 per share to existing stockholders and an immediate dilution of $16.33 per share to new investors. The following table illustrates this per share dilution: - -------------------------------------------------------------------------------------- Assumed initial public offering price per share............. $15.00 Net tangible book value per share at March 31, 2002....... $(4.82) Increase per share attributable to new investors.......... 3.49 --------- Net tangible book value per share after this offering....... (1.33) --------- Dilution per share to new investors......................... $16.33 - --------------------------------------------------------------------------------------
The following table summarizes, as of March 31, 2002, the differences between our officers, directors and affiliates and new investors with respect to: - - the number of common shares purchased from us; - - the total consideration paid to us; and - - the average price paid per share. The table below is based on an assumed initial public offering price of $15.00 per share and is calculated before deducting estimated underwriting commissions and estimated offering expenses payable by us.
- ------------------------------------------------------------------------------------------------- SHARES PURCHASED TOTAL CONSIDERATION AVERAGE --------------------- ---------------------- PRICE PER NUMBER PERCENT AMOUNT PERCENT SHARE - ------------------------------------------------------------------------------------------------- Affiliated shareholders............. 11,982,195 70.6% $ 96,555,940 58.5% $8.06 New investors....................... 5,000,000 29.4% 68,625,000 41.5% $13.73 ----------------------------------------------------------- Total.......................... 16,982,195 100.0% $165,180,940 100.0% $9.73 - -------------------------------------------------------------------------------------------------
If the underwriters' over-allotment option is exercised in full: - - the number of common shares held by affiliated shareholders would be reduced to 31.8% of the total number of common shares to be outstanding after this offering; and - - the number of common shares held by new investors would be increased to 5,750,000 or 21% of the total number of common shares to be outstanding after this offering. The discussion and tables above do not include (1) 1,275,000 common shares that may be issued upon the exercise of options we expect to grant prior to the completion of this offering at an exercise price equal to the higher of the initial public offering price and the closing price of our common shares on the TSX on the date the initial public offering price is determined, and (2) 254,033 restricted shares and 482,745 restricted share units that we have agreed to award under our equity incentive plan. 19 MARKET PRICE OF OUR COMMON SHARES Our common shares are listed and posted for trading on the TSX under the symbol HBG. The following table sets forth the high and low closing prices for our common shares on the TSX and the quarterly dividends paid for the periods indicated:
- ----------------------------------------------------------------------------------------------- HIGH LOW VOLUME DIVIDENDS - ----------------------------------------------------------------------------------------------- 2000 First Quarter.................................. C$18.00 C$13.50 614,565 C$ -- Second Quarter................................. 16.00 13.00 110,183 0.07 Third Quarter.................................. 14.50 10.00 122,091 0.07 Fourth Quarter................................. 13.00 9.50 32,768 0.07 2001 First Quarter.................................. C$16.75 C$12.00 345,968 C$0.07 Second Quarter................................. 17.50 15.80 441,006 0.07 Third Quarter.................................. 17.25 14.00 247,485 0.07 Fourth Quarter................................. 15.50 13.00 400,802 0.07 2002 First Quarter.................................. C$20.50 C$15.50 799,033 C$0.07 Second Quarter (through June 12)............... 24.25 20.25 904,138 - -----------------------------------------------------------------------------------------------
Source: Dow Jones & Company, Inc. and the TSX. On June 12, 2002 the closing price of our common shares on the TSX was C$23.75 and the inverse of the noon buying rate quoted by the Federal Reserve Bank of New York was C$1.00 per $0.6508. As of June 12, 2002, there were 21,655,748 of our common shares issued and outstanding. As of the close of business June 12, 2002, we had approximately 1,040 holders of record of our common shares. DIVIDEND POLICY We have paid a dividend of C$0.07 per common share for each quarter commencing June 30, 2000. We have no formal dividend policy other than the board of directors considers the payment of dividends as quarterly financial information becomes available. In the future, dividends will be paid at the discretion of our board of directors depending on our financial position and capital requirements, general business conditions, contractual restrictions and other factors. 20 UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF EARNINGS We have set forth below our unaudited pro forma consolidated statement of earnings for the year ended December 31, 2001, which is prepared in accordance with U.S. GAAP. Our unaudited pro forma consolidated statement of earnings gives effect to the acquisition of Kaye as if it had occurred on January 1, 2001. We acquired Kaye on June 28, 2001, for cash consideration of $125.1 million. We accounted for the acquisition under the purchase method. Accordingly, $59.8 million of the purchase price was allocated to goodwill. For information as to the basis on which the unaudited pro forma consolidated statement of earnings are presented, see the accompanying notes to the unaudited pro forma consolidated statement of earnings. The unaudited pro forma consolidated statement of earnings is presented for illustrative purposes only and does not purport to represent what our actual performance or financial position would have been if the acquisition of Kaye had occurred at an earlier date. The pro forma adjustments are based upon currently available information and our estimates and assumptions. Actual adjustments may differ from the pro forma adjustments. Our future operating results may differ materially from the unaudited pro forma consolidated statement of earnings presented below due to various factors, including those described under "Risk factors" included elsewhere in this prospectus. You should read the unaudited pro forma consolidated statement of earnings including the accompanying notes, in conjunction with our historical consolidated financial statements and the accompanying notes, the audited financial statements of Kaye and "Management's discussion and analysis of financial condition and results of operations" included elsewhere in this prospectus. 21
- ------------------------------------------------------------------------------------------------------ YEAR ENDED DECEMBER 31, 2001 HUB (IN THOUSANDS, EXCEPT INTERNATIONAL KAYE PRO FORMA PER SHARE AMOUNTS) LIMITED GROUP INC. ADJUSTMENTS PRO FORMA - ------------------------------------------------------------------------------------------------------ UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF EARNINGS(1): Revenue: Commission income............................ $144,685 $20,174 $ -- $164,859 Net premiums earned.......................... -- 16,792 (16,792)(2) -- Contingent commissions and volume overrides.. 6,116 448 -- 6,564 Investment and other income.................. 5,278 8,264 (1,301)(2) 12,241 ----------------------------------------------------- 156,079 45,678 (18,093) 183,664 ----------------------------------------------------- Expenses: Remuneration................................. 89,322 12,089 -- 101,411 Losses and loss expenses..................... -- 7,258 (7,258)(2) -- Underwriting expenses........................ -- 6,701 (4,903)(2) 1,798 Other operating expenses..................... 39,721 8,042 -- 47,763 Interest expense............................. 7,007 452 4,200(3) 11,659 Goodwill and intangible asset amortization... 4,999 676 505(4) 6,180 (Gain) loss on disposal of capital assets and investments................................ (183) 1,077 (713)(2) 181 Non-recurring expenses....................... -- 13,263(5) (13,263)(6) -- ----------------------------------------------------- 140,866 49,558 (21,432) 168,992 ----------------------------------------------------- Earnings (loss) before income taxes and cumulative effect of change in accounting principle.................................... 15,213 (3,880) 3,339 14,672 Provision for income tax (expense) benefit..... (5,355) 2,032 (1,130)(7) (4,453) ----------------------------------------------------- Earnings (loss) from continuing operations..... $ 9,858 $(1,848) $ 2,209 $ 10,219 ----------------------------------------------------- ----------------------------------------------------- Net earnings from continuing operations per share: Basic........................................ $ 0.52 $ 0.53 Diluted...................................... $ 0.49 $ 0.50 Average shares outstanding: Basic........................................ 19,012 19,232 Diluted...................................... 20,105 20,325 - ------------------------------------------------------------------------------------------------------
(1) Amounts presented in our unaudited pro forma consolidated statement of earnings are in accordance with U.S. GAAP. (2) Represents the results of Kaye's property and casualty companies that relate to Old Lyme, an investment held for sale. Consequently, the results of Old Lyme are excluded from our results. The remaining portion of the results of Kaye's property and casualty companies relates to Claims Administration Corporation, which we have retained as part of our ongoing operations. Consequently, the results of Claims Administration Corporation are included in our results. (3) Represents interest on convertible subordinated notes and short-term bank debt issued in connection with the acquisition of Kaye. The convertible subordinated notes issued in aggregate principal amounts of $35.0 million and $26.6 million bear interest at 8.6% for the six month period ended June 30, 2001. In addition, bank debt of $48.0 million accrued interest at an average rate of 6.7% for the six month period ended June 30, 2001. (4) Represents amortization of goodwill and other identifiable intangible assets resulting from the acquisition of Kaye in the amount of $1.2 million, net of goodwill amortization previously recorded by Kaye of $676,000. Goodwill in the amount of $59.8 million is amortized over 40 years. Definite-lived intangible assets in the amount of $13.0 million are amortized over 15 years. (5) Includes non-recurring costs incurred by Kaye in connection with our acquisition of Kaye in the amount of $13.2 million, including payments of approximately $10.6 million to retire Kaye's obligation under stock-based compensation plans. (6) Represents a reversal of non-recurring costs incurred by Kaye, directly attributable to our acquisition of Kaye. (7) Current tax benefit of 40.0% of the above adjustments excluding amortization of goodwill. 22 SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA The following selected historical consolidated financial data should be read with "Management's discussion and analysis of financial condition and results of operations" and our historical consolidated financial statements and the accompanying notes included elsewhere in this prospectus. The consolidated statement of earnings data for each of three months ended March 31, 2002 and 2001 and the balance sheet data as of March 31, 2002 are derived from our unaudited interim consolidated financial statements for the three month periods ended March 31, 2002 and 2001 and as of March 31, 2002 beginning on page F-1. The consolidated statement of earnings data relating to each of the years in the three year period ended December 31, 2001 and the balance sheet data as of December 31, 2001 and 2000 are derived from our audited consolidated financial statements for the three year period ended December 31, 2001 and as of December 31, 2001 and 2000 audited by PricewaterhouseCoopers LLP, our independent auditors, beginning on page F-1. The financial data relating to the year ended December 31, 1999 is derived from our audited consolidated financial statements for that year. The financial data for the years ended December 31, 1998 and 1997 is derived from our audited combined financial statements for those years. Historical results of operations are not necessarily indicative of future results. We were formed in November 1998 through the merger of 11 independent insurance brokerages into a new company. The merger was accounted for using the pooling-of-interests method. Accordingly, our results for the years ended December 31, 1998 and 1997 include the assets, liabilities, shareholders' equity, revenue and expenses of the combined companies, without adjustments. Our results for the year ended December 31, 1999 reflect the results of TOS Insurance Services Ltd. and Mack and Parker, Inc. from September 1, 1999 and October 28, 1999, respectively, the dates on which we acquired each brokerage. Our results for the year ended December 31, 2000 reflect the results of C.J. McCarthy Insurance Agency, Inc. from July 1, 2000, the dates on which we acquired it. Our results for the year ended December 31, 2001 reflect the results of Flanagan, Kaye and Burnham from June 1, 2001, June 29, 2001 and July 2, 2001, respectively, the dates on which we acquired each brokerage. In addition to the acquisition of these larger brokerages, our results also reflect the acquisition of smaller brokerages that occurred in each respective period. As a result of our acquisitions, the results in each period are not directly comparable. Our historical consolidated financial statements are prepared in accordance with Canadian GAAP, which differs in certain significant respects from U.S. GAAP. For a discussion of the principal differences between Canadian GAAP and U.S. GAAP see note 7 to our unaudited interim consolidated financial statements and note 17 to our audited consolidated financial statements included elsewhere in this prospectus. 23
- ---------------------------------------------------------------------------------------------------------------------------- THREE MONTHS ENDED MARCH 31, YEAR ENDED DECEMBER 31, ----------------- ------------------------------------------------ (IN THOUSANDS, EXCEPT 2002 2001 2001 2000 1999 1998 1997 PER SHARE AMOUNTS)(1) (UNAUDITED) - ---------------------------------------------------------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF EARNINGS DATA: Revenue: Commission income................................... $41,393 $23,211 $142,851 $86,410 $47,964 $34,952 $27,390 Contingent commissions and volume overrides......... 6,175 4,001 5,946 4,909 2,824 2,604 1,528 Other............................................... 1,916 885 5,196 3,921 3,309 1,170 882 -------------------------------------------------------------------- 49,484 28,097 153,993 95,240 54,097 38,726 29,800 -------------------------------------------------------------------- Expenses: Remuneration........................................ 27,690 16,083 88,015 54,701 29,519 21,849 16,099 Selling............................................. 2,921 1,719 8,359 4,840 3,036 2,810 2,622 Occupancy........................................... 2,725 1,569 9,061 5,756 3,393 2,364 1,596 Depreciation........................................ 1,280 572 3,940 1,885 1,275 897 658 Administration...................................... 5,214 2,832 17,856 11,182 6,806 5,461 4,151 -------------------------------------------------------------------- 39,830 22,775 127,231 78,364 44,029 33,381 25,126 -------------------------------------------------------------------- Net earnings before the following..................... 9,654 5,322 26,762 16,876 10,068 5,345 4,674 Interest expense.................................... 2,694 589 7,447 1,981 632 806 567 Goodwill and other intangible asset amortization.... 379 771 4,940 3,260 1,626 1,087 807 (Gain) loss on disposal of capital assets and investments....................................... (42) 25 (173) 127 14 (84) -- Other (income) -- put option liability.............. (373) -- (719) -- -- -- -- -------------------------------------------------------------------- Net earnings before income taxes...................... 6,996 3,937 15,267 11,508 7,796 3,536 3,300 Provision for income tax expense...................... 2,057 1,471 5,262 5,370 4,052 1,848 1,319 -------------------------------------------------------------------- Net earnings(2)....................................... $ 4,939 $ 2,466 $ 10,005 $ 6,138 $ 3,744 $ 1,688 $ 1,981 -------------------------------------------------------------------- -------------------------------------------------------------------- Net earnings per share:(2) Basic............................................... $ 0.25 $ 0.13 $ 0.53 $ 0.34 $ 0.22 $ 0.26 $ 0.37 Diluted............................................. $ 0.21 $ 0.13 $ 0.50 $ 0.34 $ 0.22 $ 0.26 $ 0.37 Weighted average shares: Basic............................................... 19,503 18,571 19,012 18,327 16,941 6,448 5,380 Diluted............................................. 27,460 18,571 20,105 18,327 16,941 6,448 5,380 Dividends declared per share(3)....................... $ 0.04 $ 0.04 $ 0.18 $ 0.13 -- -- Reconciliation to U.S. GAAP: Net earnings (Canadian GAAP)(2)..................... $ 4,939 $ 2,466 $ 10,005 $ 6,138 $ 3,744 $ 1,688 $ 1,981 Adjustment to investment held for sale(4)......... 245 -- 520 -- -- -- -- Change in reporting currency(5)................... -- 81 144 405 233 109 279 Adjustment to put option liability(6)............. (397) -- (811) -- -- -- -- -------------------------------------------------------------------- Net earnings (U.S. GAAP)(7)......................... $ 4,787 $ 2,547 $ 9,858 $ 6,543 $ 3,977 $ 1,797 $ 2,260 -------------------------------------------------------------------- Net earnings per share (U.S. GAAP):(7) Basic............................................... $ 0.25 $ 0.14 $ 0.52 $ 0.36 $ 0.23 $ 0.28 0.42 Diluted............................................. $ 0.20 $ 0.14 $ 0.49 $ 0.36 $ 0.23 $ 0.28 0.42 - ----------------------------------------------------------------------------------------------------------------------------
(1) Effective September 30, 2001, we adopted the U.S. dollar as our reporting currency. Our financial results for all periods prior to October 1, 2001 have been restated from Canadian dollars to U.S. dollars at the exchange rate in effect at September 30, 2001 of C$1.00 = $0.6338. 24 (2) As discussed in footnote 2, "Summary of significant accounting policies," of the notes to the unaudited interim consolidated financial statements, we adopted CICA Section 3062 on January 1, 2002. Upon adoption of CICA Section 3062, goodwill is no longer amortized. The following table illustrates the effect that CICA Section 3062 would have had on net earnings and per share information under Canadian GAAP for three months ended March 31, 2002 and 2001 and the years ended December 31, 2001, 2000, 1999, 1998 and 1997 had goodwill not been amortized:
- --------------------------------------------------------------------------------------------------------------------------- THREE MONTHS ENDED (IN THOUSANDS, EXCEPT MARCH 31, DECEMBER 31, PER SHARE AMOUNTS) --------------- ------------------------------------------- (UNAUDITED) 2002 2001 2001 2000 1999 1998 1997 - --------------------------------------------------------------------------------------------------------------------------- Reported net earnings -- Canadian GAAP...................... $4,939 $2,466 $10,005 $6,138 $3,744 $1,688 $1,982 Add back: Goodwill amortization............................. -- 673 4,630 2,820 1,490 1,010 801 ------------------------------------------------------------- Net earnings adjusted for goodwill.......................... $4,939 $3,139 $14,635 $8,958 $5,234 $2,698 $2,783 Basic EPS -- Reported....................................... $ 0.25 $ 0.13 $ 0.53 $ 0.34 $ 0.22 $ 0.26 $ 0.37 Basic EPS -- Adjusted for goodwill.......................... $ 0.25 $ 0.17 $ 0.77 $ 0.49 $ 0.31 $ 0.42 $ 0.52 Diluted EPS -- Reported..................................... $ 0.21 $ 0.13 $ 0.50 $ 0.34 $ 0.22 $ 0.26 $ 0.37 Diluted EPS -- Adjusted for goodwill........................ $ 0.21 $ 0.17 $ 0.73 $ 0.49 $ 0.31 $ 0.42 $ 0.52 - ---------------------------------------------------------------------------------------------------------------------------
(3) We commenced payment of dividends in the second quarter of 2000. (4) As part of our acquisition of Kaye, we acquired Old Lyme, which we have sold to a subsidiary of Fairfax, as described under "Certain relationships and related party transactions." Under U.S. GAAP, interest expense on debt we incurred to finance the purchase of Old Lyme is not charged to earnings. See note 7 to our unaudited interim consolidated financial statements and note 17 to our audited consolidated financial statements for more information. (5) Under U.S. GAAP, financial statements are translated using a current exchange rate. See note 7 to our unaudited interim consolidated financial statements and note 17 to our audited consolidated financial statements for more information. (6) Under U.S. GAAP, the fair value of put options is recorded as a debit to shareholders' equity, representing an unearned compensation expense which is amortized to earnings using the straight-line method over the period from the issue date to the put date. See note 7 to our unaudited interim consolidated financial statements and note 17 to our audited consolidated financial statements for more information. (7) As discussed in the section "Effects of New U.S. GAAP Accounting Pronouncements" included in note 17, "Reconciliation to U.S. GAAP" of the notes to the audited consolidated financial statements, we adopted SFAS No. 142 on January 1, 2002. Upon adoption of SFAS No. 142 goodwill is no longer amortized. The following table illustrates the effect that SFAS No. 142 would have had on net earnings and per share information under US GAAP for the years ended December 31, 2001, 2000, 1999, 1998 and 1997, and for the three months interim period ended March 31, 2002 had goodwill not been amortized:
- --------------------------------------------------------------------------------------------------------------------------- THREE MONTHS ENDED (IN THOUSANDS, EXCEPT MARCH 31, DECEMBER 31, PER SHARE AMOUNTS) --------------- ------------------------------------------- (UNAUDITED) 2002 2001 2001 2000 1999 1998 1997 - --------------------------------------------------------------------------------------------------------------------------- Reported net earnings -- U.S. GAAP.......................... $4,787 $2,547 $ 9,858 $6,543 $3,977 $1,797 $2,260 Add back: Goodwill amortization............................. -- 673 4,698 2,988 1,583 1,076 913 ------------------------------------------------------------- Net earnings adjusted for goodwill.......................... $4,787 $3,220 $14,556 $9,531 $5,560 $2,873 $3,173 Basic EPS -- Reported....................................... $ 0.25 $ 0.14 $ 0.52 $ 0.36 $ 0.23 $ 0.28 $ 0.42 Basic EPS -- Adjusted for goodwill.......................... $ 0.25 $ 0.17 $ 0.77 $ 0.52 $ 0.33 $ 0.45 $ 0.59 Diluted EPS -- Reported..................................... $ 0.20 $ 0.14 $ 0.49 $ 0.36 $ 0.23 $ 0.28 $ 0.42 Diluted EPS -- Adjusted for goodwill........................ $ 0.20 $ 0.17 $ 0.72 $ 0.52 $ 0.33 $ 0.45 $ 0.59 - ---------------------------------------------------------------------------------------------------------------------------
25
YEAR ENDED DECEMBER 31, --------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------------- THREE MONTHS ENDED MARCH 31, 2002 (IN THOUSANDS, EXCEPT PERCENTAGES)(1) (UNAUDITED) 2001 2000 1999 1998 1997 - -------------------------------------------------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEET DATA (AT PERIOD END): Cash and cash equivalents(2)......................... $ 18,526 $ 26,979 $ 19,919 $ 21,371 $ 308 $ 563 Total assets......................................... 459,531 $ 502,296 $206,157 $171,202 $49,133 $39,741 Total debt(3)........................................ 194,350 $ 196,952 $ 34,665 $ 20,565 $14,388 $15,724 Total shareholders' equity........................... $141,018 $ 135,271 $112,212 $105,462 $13,463 $ 6,297 RECONCILIATION TO U.S. GAAP: Total shareholders' equity (Canadian GAAP).................................... $141,018 $ 135,271 $112,212 $105,462 $13,463 $ 6,297 Adjustment to investment held for sale(4)............................. $ 765 $ 520 -- -- -- -- Accumulated other comprehensive income: Unrealized gains (losses), net of tax of $61 -- 2002, $85 -- 2001, $(122) -- 2000, $(26) -- 1999......................................... $ (101) $ (140) $ 198 $ 42 -- -- Cumulative translation account(5).............. $ 50 -- $ 5,811 $ 9,836 $ 370 $(1,290) Adjustment to put option liability(6).......... $ (5,128) $ (4,898) -- -- -- -- Executive share purchase plan loan(7).......... $ (2,146) $ (2,142) -- -- -- -- ------------------------------------------------------------------- Total shareholders' equity (U.S. GAAP)............... $134,458 $ 128,611 $118,221 $115,340 $13,833 $ 5,007 ------------------------------------------------------------------- OTHER FINANCIAL DATA: Adjusted EBITDA(8)................................... $ 10,934 $ 30,702 $ 18,761 $ 11,343 $ 6,241 $ 5,332 Adjusted EBITDA margin(9)............................ 22.1% 19.9% 19.6% 20.9% 16.1% 17.8% Net cash flow provided by (used in) operating activities......................................... $(15,948) $ 46,912 $ 12,807 $ 5,103 $ 3,545 $ 1,214 Net cash flow provided by financing activities....... $ (2,309) $ 132,431 $ 5,613 $ 58,494 $ 4,075 $ 3,250 Net cash flow (used in) investing activities......... $ 322 $(134,213) $(17,983) $(34,655) $(8,931) $(4,100) - --------------------------------------------------------------------------------------------------------------------------
(1) Effective September 30, 2001, we adopted the U.S. dollar as our reporting currency. Our financial results for all periods prior to October 1, 2001 have been restated from Canadian dollars to U.S. dollars using the exchange rate in effect at September 30, 2001 of C$1.00 = $0.6338. (2) Excludes trust cash, which includes premiums collected (less commissions and other deductions) not yet remitted to insurance companies. (3) Includes long-term debt and capital leases (including current portion), bank debt and subordinated convertible notes. (4) As part of our acquisition of Kaye, we acquired Old Lyme, which we have sold to a subsidiary of Fairfax, as described under "Certain relationships and related party transactions". Under U.S. GAAP, interest expense on debt we incurred to finance the purchase of Old Lyme is not charged to earnings. See note 7 to our unaudited interim consolidated financial statements and note 17 to our audited consolidated financial statements for more information. (5) Under U.S. GAAP, financial statements are translated using a current exchange rate. See note 7 to our unaudited interim consolidated financial statements and note 17 to our audited consolidated financial statements for more information. (6) Under U.S. GAAP, the fair value of put options is recorded as a debit to shareholders' equity, representing an unearned compensation expense which is amortized to earnings using the straight-line method over the period from the issue date to the put date. Further, the redemption value of the common shares to which the put options is attached has been reclassified as mezzanine equity outside of shareholders' equity. See note 7 to our unaudited interim consolidated financial statements and note 17 to our audited consolidated financial statements for more information. (7) Under U.S. GAAP, loans granted to employees under the executive share purchase plan must be included as a reduction to shareholders' equity. See note 7 to our unaudited interim consolidated financial statements and note 17 to our audited consolidated financial statements for more information. (8) Adjusted EBITDA is defined as earnings before interest, income taxes, depreciation and goodwill and other intangible asset amortization, but excluding gains or losses from the sale of capital assets and investments and other income - -- put option liability. We believe that Adjusted EBITDA presents a useful measure of our ability to service and incur debt based on our ongoing operations. Adjusted EBITDA is not a measure of financial performance under either U.S. or Canadian GAAP and the items excluded to arrive at Adjusted EBITDA are significant in understanding and assessing our financial condition. Therefore, Adjusted EBITDA should not be considered in isolation or as a substitute for net income, cash flows from operating activities or other income or cash flow statement data prepared in accordance with generally accepted accounting principles as a measure of profitability or liquidity. 26 We believe the presentation of Adjusted EBITDA is relevant because Adjusted EBITDA and similar measures are used by industry analysts to evaluate operating performance. Investors should be aware that our presentation of Adjusted EBITDA may not be comparable with similarly titled measures presented by other companies. (9) Adjusted EBITDA margin represents Adjusted EBITDA as a percentage of total revenue. Adjusted EBITDA margin is presented because we believe that it is a useful indicator to investors of our profitability. Adjusted EBITDA margin should not be considered by investors as an alternative to operating margin as an indicator of our profitability. Investors should be aware that our presentation of Adjusted EBITDA margin may not be comparable with similarly titled measures presented by other companies. 27 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with our consolidated financial statements and accompanying notes. Certain information contained in "Management's discussion and analysis of financial condition and results of operations" are forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements because of various factors, including those discussed below and elsewhere in this prospectus, particularly under the heading "Risk factors." We adopted the U.S. dollar as our reporting currency in the fourth quarter of 2001 as a result of the increasing significance of our U.S. operations. Unless otherwise indicated, all dollar amounts are expressed in, and the term "dollars" and the symbol "$" refer to, U.S. dollars. The term "Canadian dollars" and the symbol "C$" refer to Canadian dollars. OVERVIEW We are a leading North American insurance brokerage providing a wide variety of property and casualty, life and health, employee benefits, investment and risk management products and services from 130 locations across North America. We were formed in November 1998 through the merger of 11 Canadian independent, privately-held insurance brokers. In 1999, we acquired 44 brokerages, including Mack and Parker, Inc., our first acquisition in the United States. In 2000, we acquired 18 brokerages in the United States and Canada, including C.J. McCarthy Insurance Agency, Inc. In 2001, we acquired 16 brokerages, including Kaye Group Inc. on June 28, Burnham Stewart Group Inc. on July 1 and Flanagan Corporation on May 31. We apply the purchase method of accounting to our acquisitions and, as a result, the acquired brokerages' financial results are included only from the date of purchase. Revenue generated by Kaye, which was previously listed on NASDAQ, represented 16% of our revenue for the year ended December 31, 2001 on an actual basis, and 29% on a pro forma basis. As part of our acquisition of Kaye, we acquired Old Lyme Insurance Company of Rhode Island, Inc. and Old Lyme Insurance Company Ltd., primary insurance companies, which together we call Old Lyme. We acquired Kaye with the intent to sell Old Lyme and have since sold Old Lyme to a subsidiary of Fairfax Financial Holdings Limited at a purchase price equivalent to its U.S. GAAP book value as of December 31, 2001 of approximately $43.5 million. The sale of Old Lyme was completed on May 30, 2002. As of December 31, 2001, Fairfax owned 37% of our common shares. As of June 28, 2001, we recorded Old Lyme as an investment available for sale. Accordingly, Old Lyme is shown separately on our balance sheet at cost, which is at or below market value, and its results of operations are not included in our consolidated earnings. We generate our revenue in the United States and Canada. As the table below shows, historically we derived a large percentage of our revenue from our Canadian Operations. However, after our acquisitions of Kaye, Burnham and Flanagan, and our other acquisitions in 2001, revenue from our U.S. Operations increased to almost half of our total revenue for 2001. For the three months ended March 31, 2002 revenue from our U.S. operations was 61% of our total revenue. We expect that in the future, a greater percentage of our revenue will be derived from our U.S. Operations and generated in U.S. dollars. 28
- ----------------------------------------------------------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, MARCH 31, % OF MARCH 31, % OF % OF % OF % OF (IN THOUSANDS, EXCEPT PERCENTAGES) 2002 TOTAL 2001 TOTAL 2001 TOTAL 2000 TOTAL 1999 TOTAL - ----------------------------------------------------------------------------------------------------------------------------------- Revenue U.S. Operations.................. $30,104 60.8% $ 9,556 34.0% $ 75,429 49.0% $20,004 21.0% $ 1,535 2.8% Canadian Operations.............. 19,380 39.2% 18,541 66.0% 78,564 51.0% 75,236 79.0% 52,562 97.2% ----------------------------------------------------------------------------------------------- Total............................ $49,484 100.0% $28,097 100.0% $153,993 100.0% $95,240 100.0% $54,097 100.0% - -----------------------------------------------------------------------------------------------------------------------------------
We have demonstrated growth in revenue and Adjusted EBITDA (which we define as earnings before interest, income taxes, depreciation and goodwill and other intangible asset amortization, but excluding gains or losses from the sale of capital assets and investments and other income--put option liability) over the past three years. We believe that Adjusted EBITDA presents a useful measure of our ability to service and incur debt based on our ongoing operations. From December 31, 1998 to December 31, 2001, our revenue increased from $38.7 million to $154.0 million and from $28.1 million in the first quarter of 2001 to $49.5 million in the first quarter of 2002. This growth in revenue is primarily attributable to the additional 78 brokerages we have acquired since our formation in 1998 and has been supplemented by our consistent organic growth in commission income, which has ranged from 5% to 7% per year. We define organic growth as an increase in revenue for one period as compared to a prior period, including net new business and net increases in commissions from existing business. Revenue from a brokerage we acquire is excluded from the calculation of organic growth for the first 12 months subsequent to the acquisition of the brokerage. From December 31, 1998 to December 31, 2001, Adjusted EBITDA improved from $6.2 million to $30.7 million and from $5.9 in the first quarter of 2001 to $10.9 in the first quarter of 2002. Adjusted EBITDA is not a measure of financial performance under either U.S. or Canadian GAAP and the items excluded to arrive at Adjusted EBITDA are significant in understanding and assessing our financial condition. Therefore, Adjusted EBITDA should not be considered in isolation or as a substitute for net income, cash flows from operating activities or other income or cash flow statement data prepared in accordance with generally accepted accounting principles as a measure of profitability or liquidity. We believe the presentation of Adjusted EBITDA is relevant because Adjusted EBITDA and similar measures are used by industry analysts to evaluate operating performance. Investors should be aware that our presentation of Adjusted EBITDA may not be comparable with similarly titled measures presented by other companies. Though the insurance brokerage industry is highly sensitive to changes in the property and casualty insurance industry, it is relatively less sensitive to economic cycles than other industries. Insurance coverage, products and services are essential to businesses, governmental agencies and consumers, and are typically a fixed cost that is difficult to eliminate even in periods of economic weakness. The commissions that we receive from primary insurers, however, fluctuate with premium levels within the insurance market. During the 1990's and into 2000, the property and casualty insurance industry experienced excess capacity which resulted in highly competitive market conditions, declining premium levels and a corresponding reduction in commissions paid to brokers. However, market participants, particularly in the United States, have recently reported significant increases in property and casualty premium levels. This change is the result of several years of reduced profitability for property and casualty insurance companies and a subsequent contraction of capacity. In the United States, premium levels for property and casualty insurance policy renewals generally increased throughout 2001, while in Canada prices did not begin to increase until the fourth quarter of 2001. We believe that the events of September 11, 2001 have caused property and casualty insurance companies to increase premium levels even further. We also believe that the publicity surrounding these events has led to widespread acceptance of rate increases by middle-market companies. While we cannot 29 predict the timing or extent of premium pricing changes or their effect on our operations in the future, we believe that premium rates will continue to increase at least through 2003. REVENUE We derive our revenue primarily from commissions on the sale of insurance products and services to our clients. Commissions, which represented approximately 93% of our revenue for 2001, are calculated as a percentage of and paid from premiums. The insurance companies determine insurance premium rates based upon their underwriting analyses, while the percentage of commission is negotiated between us and the insurers. Typically commission rates fall within a range of industry norms based on lines of business. For example, basic commissions for property and casualty insurance typically average approximately 15% of premiums. For the year ended December 31, 2001, approximately 65% of our revenue was derived from commercial accounts and approximately 28% from personal accounts, in both cases, excluding related contingent commissions and volume overrides. In addition to revenue from commissions on premiums, we derive a portion of our revenue from volume overrides, contingent commissions and fees. Volume overrides are additional compensation paid by insurance companies based upon the overall volume of business that an insurance broker places with an insurance company. Contingent commissions are based on the profit an insurance company makes on the overall volume of business we place with it. Contingent commissions are typically received in the first or second quarter. In 2001, 3.9% of our total revenue was derived from contingent commissions and volume overrides. We are not dependent on any single client or on a few clients for our revenue, nor are we dependent on a single industry or client type for a substantial amount of our business. We place insurance policies with more than 150 different insurance companies in the United States and Canada and do not depend on any single insurance company or group of related insurance companies for the products we market to our clients or for any substantial amount of our revenue. As of March 31, 2002, we placed insurance policies with six insurance companies owned by Fairfax, each of which offers competitively-priced products. All of our transactions with the Fairfax companies are in the normal course of business, at fair market value and, in the aggregate, generated approximately 4.9% of our total revenue in 2001. This percentage will increase in 2002 as a result of the sale of Old Lyme. See "Certain relationships and related party transactions" for a more detailed description of these transactions. EXPENSES The majority of expenses we incur are remuneration expenses related to compensation and employee benefits, which typically account for approximately 70% of our total operating expenses. In addition to salaries, we also pay bonuses pursuant to our performance bonus program whereby each brokerage has an opportunity to achieve an annual bonus ranging from 50% to 65% of its brokerage pre-bonus operating profit in excess of 20% of the brokerage's prior year revenue. The bonus percentage earned is based upon the respective brokerage's operating profit margin. In 2001, salary, bonuses and benefits equaled approximately 57% of our total revenue. Other expenses include selling (which includes marketing and advertising, but not commissions paid to our sales producers), occupancy (which includes rent and related operating costs), administration (which includes office supplies, postage, telephone, training, technology and bad debts) and depreciation. 30 RESULTS OF OPERATIONS THREE MONTHS ENDED MARCH 31, 2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2001 Revenue. Total revenue for the three months ended March 31, 2002 increased by $21.4 million or 76% to $49.5 million from $28.1 million for the three months ended March 31, 2001. Of this increase, $18.8 million was attributable to acquisitions. For the three months ended March 31, 2002, commission income increased by $18.2 million or 78% to $41.4 million from $23.2 million for the three months ended March 31, 2001. Excluding the effects of acquisitions, commission income increased by $2.6 million or 11%. This increase was mainly due to organic growth, including the continued firming of insurance premium rates. For the three months ended March 31, 2002 revenue from contingent commissions and volume overrides increased by $2.2 million or 54% to $6.2 million from $4.0 million for the three months ended March 31, 2001. This increase was primarily attributable to acquisitions. For the three months ended March 31, 2002 other income, which includes fees and interest income, increased by $1.0 million or 116% to $1.9 million from $0.9 million for the three months ended March 31, 2001. This increase was primarily attributable to acquisitions. For the three months ended March 31, 2002, total revenue from U.S. Operations increased by $20.5 million or 215% to $30.1 million from $9.6 million for the three months ended March 31, 2001. Excluding the effect of acquisitions, total revenue increased $1.6 million or 17% primarily due to organic growth and the continued firming of insurance premium rates. For the three months ended March 31, 2002, total revenue from Canadian Operations increased by $0.9 million or 5% to $19.4 million from $18.5 million for the three months ended March 31, 2001. This increase was primarily due to organic growth and the continued firming of insurance premium rates. Remuneration. Remuneration costs for the three months ended March 31, 2002 increased by $11.6 million or 72% to $27.7 million from $16.1 million for the three months ended March 31, 2001. Remuneration costs as a percentage of total revenue decreased to 56% from 57% in 2001. This decrease was primarily the result of a combination of strong organic growth and certain fixed remuneration costs. Selling. Selling expenses for the three months ended March 31, 2002 increased by $1.2 million or 70% to $2.9 million from $1.7 million for the three months ended March 31, 2001. Selling expenses as a percentage of total revenue of 6% remained unchanged for 2002 as compared to 2001. Occupancy. Occupancy expenses for the three months ended March 31, 2002 increased by $1.1 million or 74% to $2.7 million from $1.6 million for the three months ended March 31, 2001. Occupancy expenses as a percentage of total revenue of 6% remained unchanged for 2002 as compared to 2001. Depreciation. Depreciation expenses for the three months ended March 31, 2002 increased by $0.7 million or 124% to $1.3 million from $0.6 million for the three months ended March 31, 2001. Depreciation expenses as a percentage of total revenue increased to 3% in 2002 from 2% in 2001. This increase was primarily due to capital assets acquired in conjunction with brokerage acquisitions in 2001. Administration. Administration expenses for the three months ended March 31, 2002 increased by $2.4 million or 84% to $5.2 million from $2.8 million for the year ended March 31, 2001. Administration expenses as a percentage of total revenue increased to 11% in 2002 from 10% in 2001. We expect administration expenses for 2002 to be approximately 10% of total revenue on an annual basis. 31 Interest expense. Interest expense for the three months ended March 31, 2002 increased by $2.1 million or 357% to $2.7 million from $0.6 million for the three months ended March 31, 2001. The increase is largely attributable to our issuance of 8.5% convertible subordinated notes to Fairfax and a third-party as well as short-term bank loans incurred to fund the acquisitions of Kaye Group Inc. and other brokerages we acquired in 2001. Goodwill and other intangible asset amortization. Goodwill and other intangible asset amortization for the three months ended March 31, 2002 decreased by $0.4 million or 51% to $0.4 million from $0.8 million for the three months ended March 31, 2001. This decrease is attributable to the elimination of goodwill amortization effective January 1, 2002 under The Canadian Institute of Chartered Accountants Accounting Standards Board Handbook Section 3062, "Goodwill and Other Intangible Assets." Other income--put option liability. Other income--put option liability of $0.4 million for the three months ended March 31, 2002 reflects a change in the fair value of the put options. We used put options as consideration for certain businesses acquired in the second and third quarters of 2001. The put option liability is classified as long-term debt at fair value until such time as the option is exercised or expires. Accordingly, these put options did not exist at March 31, 2001. Provision for income tax expense. Income taxes for the three months ended March 31, 2002 and 2001 amounted to $2.1 million and $1.5 million, respectively, resulting in an effective tax rate of 29% and 37% for 2002 and 2001, respectively. The decrease in our effective income tax rate was the result of a greater proportion or our revenues earned outside of Canada, where income is taxed at lower rates. Net earnings. Net earnings for the three months ended March 31, 2002 increased by $2.4 million or 100% to $4.9 million compared to $2.5 million in 2001. Basic earnings per share were $0.25 compared to $0.13 per share for 2001, a 92% increase. Diluted earnings per share increased 62% to $0.21 for 2002 from $0.13 for 2001. YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000 Revenue. Total revenue for the year ended December 31, 2001 increased by $58.8 million or 62% to $154.0 million from $95.2 million for the year ended December 31, 2000. Of this increase, $55.6 million or 95% was attributable to acquisitions and reflects the inclusion of the results of each brokerage we acquired during the year from the respective date of each acquisition. For the year ended December 31, 2001, commission income increased by $56.5 million or 65% to $142.9 million from $86.4 million for the year ended December 31, 2000. Excluding the effects of acquisitions, commission income increased $4.3 million or 5%. This increase was mainly due to organic growth including premium rate increases. For the year ended December 31, 2001, revenue from contingent commissions and volume overrides increased by $1.0 million or 20% to $5.9 million from $4.9 million for the year ended December 31, 2000. This increase was primarily attributable to acquisitions. For the year ended December 31, 2001 other income, which includes fees and interest income, increased by $1.3 million or 33% to $5.2 million from $3.9 million for the year ended December 31, 2000. This increase was primarily attributable to acquisitions. For the year ended December 31, 2001, total revenue from U.S. Operations increased by $55.4 million or 277% to $75.4 million from $20.0 million for the year ended December 31, 2000. This increase was primarily due to acquisitions. Excluding the effect of acquisitions, total revenue increased $2.1 million or 10% primarily due to organic growth. For the year ended December 31, 2001, total revenue from Canadian Operations increased by $3.4 million or 5% to $78.6 million from $75.2 million for the year ended December 31, 2000. Excluding the effect of acquisitions, total revenue increased $1.1 million or 1%. 32 Remuneration. Remuneration costs for the year ended December 31, 2001 increased by $33.3 million or 61% to $88.0 million from $54.7 million for the year ended December 31, 2000. Remuneration costs as a percentage of total revenue remained unchanged at 57% for 2001 as compared to 2000. Selling. Selling expenses for the year ended December 31, 2001 increased by $3.6 million or 75% to $8.4 million from $4.8 million for the year ended December 31, 2000. Selling expenses as a percentage of total revenue of 5% remained unchanged for 2001 as compared to 2000. Occupancy. Occupancy expenses for the year ended December 31, 2001 increased by $3.3 million or 57% to $9.1 million from $5.8 million for the year ended December 31, 2000. Occupancy expenses as a percentage of total revenue of 6% remained unchanged for 2001 as compared to 2000. Depreciation. Depreciation expenses for the year ended December 31, 2001 increased by $2.0 million or 105% to $3.9 million from $1.9 million for the year ended December 31, 2000. Depreciation expenses as a percentage of total revenue increased to 3% in 2001 from 2% in 2000. This increase was primarily due to capital assets that we acquired with our brokerage acquisitions. Administration. Administration expenses for the year ended December 31, 2001 increased by $6.7 million or 60% to $17.9 million from $11.2 million for the year ended December 31, 2000. Administration expenses as a percentage of total revenue of 12%, remained unchanged for 2001 as compared to 2000. Interest expense. Interest expense for the year ended December 31, 2001 increased by $5.4 million or 270% to $7.4 million from $2.0 million for the year ended December 31, 2000. This increase was largely attributable to our issuance of 8.5% convertible subordinated notes to Fairfax and Zurich Insurance Company and new short-term bank loans incurred to fund the acquisitions of Kaye and other brokerages we acquired in 2001. Goodwill and other intangible asset amortization. Goodwill and other intangible asset amortization for the year ended December 31, 2001 increased by $1.6 million or 48% to $4.9 million from $3.3 million for the year ended December 31, 2000. This increase is attributable to acquisitions in 2001 and 2000. For more information, see "--Goodwill and other intangible assets" below. Provision for income tax expense. Income taxes for the year ended December 31, 2001 and 2000 amounted to $5.3 million and $5.4 million, respectively, resulting in an effective tax rate of 34% and 47% for 2001 and 2000, respectively. The decrease in our effective income tax rate was the result of a greater proportion of our revenue earned outside of Canada, where income is taxed at lower rates. Net earnings. Net earnings for the year ended December 31, 2001 increased by $3.9 million or 63% to $10.0 million compared to $6.1 million in 2000. Basic earnings per share increased to $0.53 per share for 2001 from $0.34 per share for 2000. Diluted earnings per share increased to $0.50 per share for 2001 from $0.34 per share for 2000. YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999 Revenue. Total revenue for the year ended December 31, 2000 increased by $41.1 million or 76% to $95.2 million from $54.1 million for the year ended December 31, 1999. Of this increase, $39.5 million or 96% was attributable to acquisitions. For the year ended December 31, 2000, commission income increased by $38.4 million or 80% to $86.4 million from $48.0 million for the year ended December 31, 1999. Excluding the effects of acquisitions, commission income increased $2.8 million or 6%. This increase was mainly due to organic growth. For the year ended December 31, 2000, revenue from contingent commissions and volume overrides increased by $2.1 million or 75% to $4.9 million from $2.8 million for the year ended December 31, 1999. This 33 increase was primarily attributable to acquisitions. For the year ended December 31, 2000, other income, which includes fees and interest income, increased by $0.6 million or 18% to $3.9 million from $3.3 million for the year ended December 31, 1999. This increase was primarily attributable to acquisitions. For the year ended December 31, 2000, total revenue from U.S. Operations increased by $18.5 million or 1,233% to $20.0 million from $1.5 million for the year ended December 31, 1999. This increase was primarily due to acquisitions. Total revenue from our U.S. Operations increased to 21% of our consolidated total revenue in 2000 from 3% in 1999. For the year ended December 31, 2000, total revenue from Canadian Operations increased $22.6 million or 43% to $75.2 million from $52.6 million for the year ended December 31, 1999 primarily due to acquisitions. Total revenue from our Canadian Operations decreased to 79% of consolidated total revenue in 2000 from 97% in 1999. Remuneration. Remuneration costs for the year ended December 31, 2000 increased by $25.2 million or 85% to $54.7 million from $29.5 million for the year ended December 31, 1999. Remuneration costs as a percentage of total revenue increased to 57% in 2000 from 55% in 1999. This increase was primarily a result of increases in brokerage performance bonuses. Brokerage performance bonuses were 4% of total revenue in 2000 compared to 1% in 1999. Due to the timing of our acquisitions, many of the brokerages did not qualify for an operating bonus in 1999. In 2000 however, all but three brokerages achieved a pre-bonus operating profit in excess of 20%. Selling. Selling expenses for the year ended December 31, 2000 increased by $1.8 million or 60% to $4.8 million from $3.0 million for the year ended December 31, 1999. Selling expenses as a percentage of total revenue decreased to 5% in 2000 from 6% in 1999. This decrease was mainly due to increased cost reductions. Occupancy. Occupancy expenses for the year ended December 31, 2000 increased by $2.4 million or 71% to $5.8 million from $3.4 million for the year ended December 31, 1999. Occupancy expenses as a percentage of total revenue of 6% remained unchanged for 2000 as compared with 1999. Depreciation. Depreciation expenses for the year ended December 31, 2000 increased by $0.6 million or 46% to $1.9 million from $1.3 million for the year ended December 31, 1999. Depreciation expenses as a percentage of total revenue of 2% remained unchanged for 2000 as compared to 1999. Administration. Administration expenses for the year ended December 31, 2000 increased by $4.4 million or 65% to $11.2 million from $6.8 million for the year ended December 31, 1999. Administration expenses as a percentage of total revenue decreased to 12% in 2000 from 13% in 1999. This decrease was primarily due to our continuous effort to reduce overhead costs. Interest expense. Interest expense for the year ended December 31, 2000 increased by $1.4 million or 233% to $2.0 million from $0.6 million for the year ended December 31, 1999. This increase is attributable to the increase in long-term debt incurred to fund our acquisitions. Goodwill and other intangible asset amortization. Goodwill and other intangible asset amortization for the year ended December 31, 2000 increased by $1.7 million or 106% to $3.3 million from $1.6 million for the year ended December 31, 1999. This increase is attributable to the 62 acquisitions we completed during 2000 and 1999. Provision for income tax expense. Income taxes for the year ended December 31, 2000 and 1999 amounted to $5.4 million and $4.1 million, respectively, resulting in an effective tax rate of 47% and 52% for 2000 and 1999, respectively. The decrease in our effective income tax rate is the result 34 of more efficient tax planning, including the manner in which we have structured certain of our acquisitions in the United States. Net earnings. Net earnings for the year ended December 31, 2000 increased by $2.4 million or 65% to $6.1 million compared to $3.7 million for 1999. Basic and diluted earnings per share increased to $0.34 per share for 2000 from $0.22 per share for 1999. CASH FLOW, LIQUIDITY AND CAPITAL RESOURCES We act as an intermediary between insurance companies and their insured customers. As such, we collect and hold premiums paid by customers on behalf of the insurers. We deduct commissions and other expenses from these payments and hold the remainder in trust for the insurers. We earn interest on those funds during the time between receipt of the cash and the time the cash is paid out to the insurers. However, we may not use the funds for any purpose and we must remit the funds within a specified period after the effective date of the respective policy. The cash we hold in trust is shown separately on our balance sheet. As of March 31, 2002, we had cash and cash equivalents of $59.5 million, of which $40.9 million was trust cash, a decrease of $17.9 million from $77.4 million as of December 31, 2001. For the three months ended March 31, 2002, $15.9 million of cash was used by operating activities, of which $9.5 million was trust cash, primarily as a result of timing differences between the payment of accounts payable and the collection of accounts receivable, partially offset by net earnings adjusted for items not affecting working capital. Long-term debt and capital lease repayments used $2.3 million of cash. Sales of subsidiaries generated cash of $1.2 million and $0.9 million was used for additions to capital assets and other assets. There have been no other changes to our debt and subordinated convertible debentures from December 31, 2001. As of December 31, 2001, we had cash and cash equivalents of $77.4 million, of which $50.4 million was trust cash, an increase of $45.1 million from $32.3 million as of December 31, 2000. During 2001, $46.9 million of cash was provided by operating activities, primarily as a result of timing differences between the payment of accounts payable and the collection of accounts receivable. The remainder was the result of increased net earnings adjusted for items affecting working capital. Long-term debt financing and bank debt financing generated $137.8 million of cash. Share capital issued generated cash of $3.3 million, net of repurchases. From these amounts and existing cash balances, $148.8 million (including gross of $25.4 million cash received) was used to acquire businesses and $5.2 million was used to repay long-term debt and capital leases, $3.6 million was used to pay dividends, and $10.9 million was used for additions to capital assets and other assets. As of December 31, 2000, we had cash and cash equivalents of $32.3 million, of which $12.4 million was trust cash, an increase of $0.5 million from $31.8 million as of December 31, 1999. During 2000, $12.8 million of cash was provided from operating activities primarily as a result of timing differences between the payment of accounts payable and the collection of accounts receivable. The remainder was the result of increased net earnings adjusted for items affecting working capital. Long-term debt financing generated $29.8 million of cash. In addition, the executive share purchase plan and the sale of other assets generated $2.8 million of cash. From these amounts and existing cash balances, $18.9 million was used to acquire brokerages, $2.8 million was used to repurchase our common shares, $18.9 million was used to repay long-term debt, capital leases, and bank debt, $2.5 million was used to pay dividends, and $2.1 million was used for additions to capital assets. As of March 31, 2002, we had client premiums receivable outstanding of $54.2 million, of which 3.2% were over 90 days old. We monitor these receivables on a regular and timely basis and have controls in place to manage aging accounts. In addition, we can mitigate the risk of loss related to 35 client premiums receivable by requesting that the insurance company cancel the contract for insurance where payment is overdue, thereby reducing the related premiums payable to insurance companies and the related amounts to be collected from the client. Therefore, we do not believe that the aging of our accounts receivable presents a material liquidity risk. As of March 31, 2002, we had related premiums payable to insurance companies of $88.9 million. We require that our brokerages submit to head office on a monthly basis all excess cash on hand in excess of a working capital ratio of 1:1. All brokerages with trust reporting requirements are required to submit to head office on a quarterly basis trust reconciliation calculations stating whether or not they are in compliance with applicable insurance broker regulations. We maintain four separate credit facilities: - - $50 million facility. Borrowings under this facility are accessed at a floating rate of 112.5 basis points above LIBOR, which was 1.90% as of March 31, 2002. This facility expires on June 20, 2002 and requires us to maintain certain financial ratios. We intend to extend this facility for a further period of one year, but if the revolving period is not extended, any amounts outstanding will automatically convert into a three-year term loan at a fixed interest rate equal to the Canadian dollar interest swap rate quoted by the lender plus 1.375%. As of March 31, 2002, $49.2 million had been drawn on this facility. We intend to pay down approximately $5 million of this facility with the proceeds from the sale of Old Lyme. - - $25 million facility. Borrowings under this facility are accessed at a floating rate of 135 basis points above LIBOR. This facility is guaranteed by certain of our subsidiaries and by Fairfax. It expires on July 18, 2002 and contains covenants that, among other things, require us to maintain certain financial ratios, restrict our ability to incur additional debt and limit our quarterly dividend payments to C$0.07 per share. As of March 31, 2002, $25.0 million was drawn on this facility. We intend to fully repay and terminate this facility with proceeds from the sale of Old Lyme. - - $25 million facility. Borrowings under this facility are accessed either at a floating rate of 150 basis points above LIBOR or at a fixed interest rate of 9%. This facility is guaranteed by certain of our subsidiaries. The floating rate portion of this facility expires on July 17, 2002 and contains covenants that, among other things, require us to maintain certain financial ratios, restrict our ability to incur additional debt and limit our quarterly dividend payments to C$0.07 per share. As of March 31, 2002, $24.4 million was drawn on this facility, of which $23.0 million was drawn at a floating interest rate, and $1.4 million was drawn at a fixed interest rate, which is included in long-term debt and is due October 31, 2005. We intend to repay $4.5 million of this facility with proceeds from the sale of Old Lyme and to repay $20.0 million and terminate both the fixed and floating portions of this facility with proceeds from this offering. - - $7.5 million facility. Borrowings under this facility are at an interest rate of prime, which was 4.75% as of March 31, 2002, plus 1%. Payment is due on demand. As of March 31, 2002, $7.0 million had been drawn on this facility. We intend to fully repay and terminate this facility with the proceeds from the sale of Old Lyme. As of September 30, 2001, we were not in compliance with certain financial covenants relating to the maintenance of our financial ratios under both of our $25 million credit facilities. Our non-compliance was the direct result of a delay in reaching a final agreement for the sale of Old Lyme, the proceeds of which would have been used to repay debt. Our lenders have granted us waivers with respect to our non-compliance with these covenants. In addition, we have negotiated amended agreements with these lenders as of December 31, 2001. Under the amended agreements, we are in compliance with all of the financial covenants governing the respective credit facilities as of March 31, 2002. 36 As of March 31, 2002, we had $11.5 million of subsidiary debt comprised of various notes payable, term loans and capital leases. We intend to repay these liabilities from internally generated cash flow, existing cash balances and/or borrowings under our credit facilities as the subsidiary debt becomes due during 2002 through 2010. Of the outstanding subsidiary debt, $7.0 million is secured by liens on certain assets of our subsidiaries. In connection with our acquisition of Kaye on June 28, 2001, we issued: (1) $26.6 million aggregate principal amount of 8.5% convertible subordinated notes due June 28, 2006 to Zurich Insurance Company, the Zurich notes; and (2) $35 million aggregate principal amount of 8.5% convertible subordinated notes due June 28, 2007 to certain subsidiaries of Fairfax, the Fairfax notes. These convertible notes were anti-dilutive to earnings per share as of March 31, 2002. The Zurich notes are convertible by Zurich at any time into our common shares at C$17.00 per share, subject to mandatory conversion on June 30, 2006. Zurich has agreed not to convert the Zurich notes into common shares before June 30, 2002 and also has agreed to allow us to repay the Zurich notes, in whole or in part, on or before June 30, 2002, without penalty. We intend to repay the Zurich notes using proceeds from this offering. The Fairfax notes are convertible by the holders at any time into our common shares at C$17.00 per share. Beginning June 28, 2006, we may require Fairfax to convert the Fairfax notes into our common shares at C$17.00 per share if, at any time, the weighted average closing price of our common shares for 20 consecutive trading days equals or exceeds C$19.00 per share. If Fairfax converted all of the Fairfax notes, Fairfax would own approximately 45.1% of our total outstanding common shares as of March 31, 2002 or 37.8% after giving effect to this offering. Net debt, defined as, long-term debt, including the current portion, bank debt and subordinated convertible notes, less non-trust cash and the investment held for sale, as of March 31, 2002, was $134.9 million compared to $129.2 million as of December 31, 2001 and $14.7 million as of December 31, 2000. The increase in debt in the first quarter of 2002 is due to the decrease in non-trust cash exceeding debt repayments. The increase from 2000 to 2001 is largely associated with debt incurred to finance acquisitions we made in 2001. In connection with our acquisition of Kaye for $125.1 million, we issued $61.6 million in convertible subordinated notes to Fairfax and Zurich, as described above, as well, $54.0 million was financed with bank debt and $9.5 million was paid with cash. Similarly, the cash portion of our purchase of Burnham was financed with a short-term bank loan of $11.5 million. As a result of financing of these acquisitions with debt, our net debt-to-equity ratio has increased. As of March 31, 2002, our net debt-to-equity ratio remained 0.96:1 from December 31, 2001, up from 0.13:1 as of December 31, 2000. We may incur additional debt to pay for future acquisitions. However, we intend to continue our practice of using our common shares to pay for acquisitions. To the extent we issue additional common shares to pay for future acquisitions, your equity interest in us will be diluted. The table below summarizes our contractual obligations and commercial commitments as of March 31, 2002:
- -------------------------------------------------------------------------------------------------- PAYMENTS DUE BY PERIOD ON LESS THAN 1 - 3 4 - 5 AFTER (IN THOUSANDS) TOTAL DEMAND 1 YEAR YEARS YEARS 5 YEARS - -------------------------------------------------------------------------------------------------- Bank borrowings...................... $ 55,000 $7,000 $48,000 $ -- $ -- $ -- Long-term debt and capital lease obligations........................ 77,679 -- 3,436 4,290 61,717 8,236 Operating lease obligations.......... 62,166 -- 6,314 11,439 41,665 2,748 ----------------------------------------------------------- Total.............................. $194,845 $7,000 $57,750 $15,729 $103,382 $10,984 - --------------------------------------------------------------------------------------------------
37 We intend to repay approximately $41.5 million of bank borrowings with the proceeds from the sale of Old Lyme. We intend to repay $20 million of our remaining bank borrowings and the Zurich notes with the net proceeds from this offering. It is our intention to pay for operating lease obligations with cash flows generated from our operating activities. We believe that our existing cash, funds generated from operations and borrowings available under our credit facilities, together with the proceeds from the sale of Old Lyme and the net proceeds from this offering, will be sufficient to satisfy our financial requirements, including strategic acquisitions, during the next twelve months. We may also raise debt or equity capital in the public or private markets in the future. If we issue additional common shares, your equity interest in us will be diluted. CONTINGENT OBLIGATIONS As part of our executive share purchase plan, we guaranteed loans made by a Canadian chartered bank to executives and employees to acquire our common shares. We may be required under certain circumstances to repay up to $5.5 million in loans incurred under the plan. The loans are secured by 663,000 of our common shares, which had a market value of $8.5 million as of March 31, 2002. See "Management--Indebtedness of directors, executive officers and senior officers" for a more detailed discussion of the loans outstanding. Additionally, in conjunction with our acquisitions of Flanagan and Burnham in 2001, we issued our common shares to the former owners of each brokerage in consideration of the purchase price paid and granted to them the option to require us to repurchase our shares, approximately 2.1 million common shares in total, upon certain triggering events. The estimated financial liability associated with these put options totaled $16.9 million as of March 31, 2002 and is included in long-term debt. See note 8 to our consolidated financial statements and the section entitled "Certain relationships and related party transactions--Put options" for more detail regarding the put options. We paid for the acquisition of Burnham and Flanagan with a combination of cash and our common shares. The former shareholders of Burnham and Flanagan are also entitled to receive contingent consideration if their respective brokerages meet specified performance targets, based on revenue and operating profit. FLANAGAN The following table summarizes the contingent consideration that will be issued to the former shareholders of Flanagan if Flanagan meets certain performance criteria:
- -------------------------------------------------------------------------------------------------- CONTINGENT CONTINGENT CONSIDERATION YEAR CONSIDERATION TARGET CRITERIA - -------------------------------------------------------------------------------------------------- 2002............................................. 38,000 shares Revenue 2002............................................. 38,000 shares Profitability 2003............................................. 88,000 shares Revenue 2003............................................. 37,000 shares Profitability - --------------------------------------------------------------------------------------------------
Flanagan met its contingent consideration criteria for 2001. Accordingly, as of December 31, 2001, we had an obligation to issue 50,000 shares in the amount of $478,000. The additional purchase consideration has been recorded in goodwill and share capital as of December 31, 2001. BURNHAM The former shareholders of Burnham are entitled to contingent consideration in the event that the acquired Burnham operations meet certain profitability targets for the twelve-month period ended 38 June 30, 2002. The contingent consideration to be issued, if the profitability criteria are met, will be a portion of actual profitability in excess of the target. Any contingent consideration issued by us will be paid 38% in cash, 51% in our restricted shares, and 11% in our unrestricted shares. OTHERS An additional $400,000 of contingent consideration, based primarily on revenue targets, may also be issued in connection with acquisitions we made in 2001. SHAREHOLDERS' EQUITY Share repurchases. In the first quarter of 2002 and in 2001, no common shares were purchased and cancelled. As of March 31, 2002, 7,757 common shares were reserved in respect of our executive stock purchase plan. In 2000, we purchased and cancelled 225,960 of our common shares for an aggregate cost of $2.0 million of which $0.6 million was charged to retained earnings. In addition, we reserved 61,898 common shares in respect of our executive stock purchase plan. Of the aggregate cost of $0.8 million, retained earnings was charged with $0.4 million. Shareholders' equity increased by $5.7 million or 4% to $141.0 million as of March 31, 2002 from $135.3 million as of December 31, 2001. This increase resulted from net earnings of $4.9 million and an increase of the cumulative translation account of $0.8 million. Shareholders' equity increased by $23.1 million or 21% to $135.3 million as of December 31, 2001 from $112.2 million as of December 31, 2000. This increase resulted from net earnings of $10.0 million, an increase in the cumulative translation account of $2.6 million and an increase in share capital of $14.1 million primarily related to issuance of our common shares in connection with acquisitions. The increase in shareholders' equity was offset by the payment of dividends of $3.6 million. Shareholders' equity increased by $6.7 million or 6% to $112.2 million as of December 31, 2000 from $105.5 million as of December 31, 1999. This increase resulted from net earnings of $6.1 million, an increase in the cumulative translation account of $1.0 million and an increase in share capital of $3.1 million, which was offset by the payment of dividends of $2.5 million and excess over stated value of shares purchased of $1.0 million. MARKET RISK INTEREST RATE RISK We are exposed to interest rate risk in connection with our credit facilities. We have approximately $104.5 million of floating rate bank debt. However, we intend to pay down approximately $41.5 million of such debt with proceeds from the sale of Old Lyme and $20 million of such debt with proceeds from this offering. Accordingly, upon completion of this offering and the application of the proceeds, we will be subject to interest rate risk on $43 million. Each 100 basis point increase in the interest rates charged on the balance of our outstanding floating rate debt after the offering will result in a $0.3 million decrease in our net earnings. We currently do not engage in any derivatives or hedging transactions. However, we are investigating and may enter into an interest rate swap for our outstanding foreign currency debentures. EXCHANGE RATE SENSITIVITY We report our revenue in U.S. dollars. Our Canadian Operations earn revenue and incur expenses in Canadian dollars. Given our significant Canadian dollar revenue, we are sensitive to the fluctuations in the value of the Canadian dollar and are therefore exposed to foreign currency exchange risk. Foreign currency exchange risk is the potential for loss in revenue and net income as 39 a result of a decline in the U.S. dollar value of our Canadian dollar revenue due to a decline in the value of the Canadian dollar compared to the U.S. dollar. The Canadian dollar is subject to volatility and has experienced significant decline in its value compared to the U.S. dollar in recent years. As shown in the table under "Exchange rate information," the value of the Canadian dollar as of December 31, 1999 was $0.6925 compared to $0.6279 as of December 31, 2001, a decline of more than 9%. The table below summarizes the effect that a $0.01 decline or increase in the value of the Canadian dollar would have had on our revenue, debt, cumulative translation account and net earnings in prior years.
- ------------------------------------------------------------------------------------------------- YEAR ENDED THREE MONTHS ENDED DECEMBER 31, MARCH 31, --------------------------- (IN THOUSANDS, EXCEPT PERCENTAGES) 2002 2001 2000 1999 - ------------------------------------------------------------------------------------------------- Canadian Operations revenue..................... $19,380 $78,564 $75,236 $52,562 Percentage of total........................... 39.2% 51.0% 79.0% 97.2% Canadian Operations net earnings................ $ 3,096 $ 9,163 $ 6,446 $ 3,969 Percentage of total........................... 62.7% 91.6% 100.0% 100.0% Canadian dollar denominated debt................ $45,083 $45,672 $ 2,121 $ 3,925 $0.01 change in value of C$ results in change in: Revenue....................................... +/-$194 +/-$785 +/-$752 +/-$ 525 Net earnings.................................. +/-$ 31 +/- 92 +/- 64 +/- 40 Cumulative translation account.................. +/-$451 +/- 456 +/- 21 +/- 39 - -------------------------------------------------------------------------------------------------
The increasing proportion of our revenue derived from our U.S. Operations and earned in U.S. dollars has, in part, offset the potential risk of a decline in the Canadian dollar. We expect that the proportion of revenue earned in U.S. dollars will continue to increase, further mitigating our foreign currency exchange sensitivity. We have not entered into, and do not intend to enter into, foreign currency forward exchange agreements. GOODWILL AND OTHER INTANGIBLE ASSETS Intangible assets arising from acquisitions consist of the following:
- ----------------------------------------------------------------------------------------------- YEAR ENDED THREE MONTHS ENDED DECEMBER 31, MARCH 31, -------------------- (IN THOUSANDS) 2002 2001 2000 - ----------------------------------------------------------------------------------------------- Customer relationships............................. $21,519 $ 21,720 $ -- Non-competition covenants.......................... 1,839 1,839 -- Trademarks......................................... 2,587 2,587 -- Goodwill........................................... 235,176 235,670 128,226 Accumulated amortization........................... (16,043) (15,637) (10,482) ---------- -------------------- Total............................................ $245,078 $246,179 $117,744 - -----------------------------------------------------------------------------------------------
The amounts allocated to customer relationships, non-competition covenants and trademarks are determined by discounting the net cash flow of future commissions adjusted for expected persistency, mortality and associated costs. The balance of the excess purchase price is allocated to goodwill. 40 Customer relationships are amortized on a straight-line basis over their periods of duration, normally fifteen years. Many factors outside our control determine the persistency of our customer relationships and we cannot be sure that the value we have allocated will ultimately be realized. Non-competition covenants and trademarks are intangible assets that have an indefinite life and accordingly, are not amortized but are evaluated for impairment under the new accounting standards as discussed under "--Effects of new accounting pronouncements." We have historically amortized goodwill primarily over a period of forty years. Under the new accounting standards, goodwill is not amortized and is evaluated annually for impairment. For the three months ended March 31, 2002 and the past three years ended December 31, 2001, our amortization has been comprised of the following:
- ----------------------------------------------------------------------------------------------- YEAR ENDED THREE MONTHS ENDED DECEMBER 31, MARCH 31, ------------------------ (IN THOUSANDS) 2002 2001 2000 1999 - ----------------------------------------------------------------------------------------------- Customer relationships.......................... $369 $ 759 $ -- $ -- Non-competition covenants....................... 10 56 -- -- Goodwill........................................ -- 4,125 3,260 1,626 ----- ------------------------ Total......................................... $379 $4,940 $3,260 $1,626 - -----------------------------------------------------------------------------------------------
We estimate that our amortization charges for 2002 through 2006 for all acquisitions consummated to date will be:
- ----------------------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, (IN THOUSANDS) 2002 2003 2004 2005 2006 - ----------------------------------------------------------------------------------------------- Customer relationships............................ $1,487 $1,487 $1,487 $1,487 $1,487 Non-competition covenants......................... 80 24 -- -- -- ------------------------------------------ Total........................................... $1,567 $1,511 $1,487 $1,487 $1,487 - -----------------------------------------------------------------------------------------------
EFFECTS OF NEW ACCOUNTING PRONOUNCEMENTS BUSINESS COMBINATIONS, GOODWILL AND OTHER INTANGIBLE ASSETS In July 2001, we adopted the Canadian Institute of Chartered Accountants (CICA) Accounting Standards Board Handbook Sections 1581, "Business Combinations" and Section 3062, "Goodwill and Other Intangible Assets" (Section 1581 and Section 3062, respectively) for all business combinations accounted for using the purchase method consummated after that date. These sections harmonize Canadian standards with Financial Accounting Standards Boards Statement of Financial Accounting Standards No. 141 and No. 142 (SFAS No. 141 and SFAS No. 142, respectively). Section 1581 and SFAS No. 141 require that all business combinations be accounted for in accordance with the purchase method of accounting. We have historically used the purchase method to record acquisitions, with the exception of the initial 11 acquisitions in 1998, which was accounted for as a pooling-of-interests. Section 1581 and SFAS No. 141 also expand the definition of intangible assets acquired in a business combination accounted for using the purchase method. As a result, the purchase price allocation of future business combinations may be different than the allocation that would have resulted under the old rules. Business combinations must be accounted for using Section 1581 and SFAS No. 141 beginning on July 1, 2001. Our acquisition of the Burnham, effective July 1, 2001, was accounted for under the provisions of Section 1581 and SFAS No. 141. 41 In accordance with the above, we completed valuations of our 2001 acquisitions and separately identified definite and indefinite life intangible assets apart from goodwill acquired as a result of our business combinations accounted for using the purchase method. Prior to 2001, we allocated the entire excess of the purchase price over net assets acquired to goodwill and primarily amortized that amount over a period of 40 years. Accordingly, there were no attempts to value and separately identify other intangible assets apart from goodwill associated with business combinations accounted for using the purchase method prior to 2001. For business combinations with a date of acquisition before July 1, 2001, accounted for by the purchase method, the transitional guidance of CICA Section 1581 and SFAS No. 141 require that the carrying amount of any recognized intangible assets, that meet the recognition criteria in paragraph 1581.48 (SFAS No. 141 paragraph 61), and has been included in an amount reported as goodwill (or as goodwill and intangible assets) should be reclassified and accounted for as an asset, apart from goodwill, upon initial application of CICA Section 3062 and SFAS No. 142 to the entire financial statements. For acquisitions prior to 2001, we did not separately identify and recognize intangible assets apart from goodwill in our accounting records. Therefore, we intend to continue to report the carrying value of the excess of purchase price over net assets acquired as goodwill for purchase business combinations prior to 2001. We believe that this treatment is in accordance with the transitional provisions of CICA Section 1581 and SFAS No. 141. In January 2002, we adopted CICA Section 3062 and SFAS No. 142 "Goodwill and Other Intangible Assets" for all business combinations accounted for using the purchase method prior to June 30, 2001. CICA Section 3062 and SFAS No. 142 eliminate the amortization of goodwill, require annual impairment testing of goodwill, and introduces the concept of definite and indefinite life intangible assets. Indefinite life intangible assets, similar to goodwill, will no longer be amortized and will be tested at least annually for impairment. Definite life intangible assets will be amortized over the estimated useful life of the asset. CICA Section 3062 and SFAS No. 142 must be adopted on January 1, 2002. These new requirements will increase our future net earnings by an amount equal to the amount of goodwill amortization that has been discontinued, offset by any goodwill impairment charges and additional amortization as a result of reclassification of other intangible assets as goodwill. An initial impairment test must be performed as of January 1, 2002. Any resulting impairment charge from this initial test will be reported as a change in accounting principle, and charged to opening retained earnings, net of tax. Although we have not completed our assessment of the impact of the new impairment testing rules or the reclassification rules, based on current conditions, we do not expect to incur a material transition goodwill impairment charge as of January 1, 2002. We do, however, expect that because goodwill will no longer be amortized and charged to earnings that there will be a significant impact on our consolidated earnings in 2002 when compared to consolidated earnings for prior years. Amortization expense related to goodwill and other intangible assets for the years ended December 31, 2001 was $4.9 million compared to $3.3 million and $1.6 million in 2000 and 1999, respectively. ACCOUNTING FOR THE DISPOSAL OF LONG-LIVED ASSETS In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS No. 144). SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This Statement supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and the accounting and reporting provisions of Accounting 42 Principal Board Opinion No. 30 "Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" (APB No. 30). SFAS No. 144 generally retains the basic accounting model for the identification and measurement of impairments to long-lived assets to be held, and long-lived assets to be disposed. SFAS No. 144 broadens the definition of "discontinued operations," as previously defined by APB No. 30, but does not allow for the accrual of future operating losses, as was previously permitted under that standard. SFAS No. 144 also addresses several implementation and financial statement presentation issues not previously addressed under U.S. GAAP. SFAS No. 144 excludes from its scope financial accounting and reporting for the impairment of goodwill and other intangible assets. The transitional guidance of SFAS No. 144 generally permits long-lived assets classified as held for disposal as a result of disposal activities that were initiated prior to SFAS No. 144's initial application to continue to be accounted for in accordance with the prior pronouncement applicable for that disposal. As such, our investment in Old Lyme, which is classified as held for disposal at December 31, 2001, will continue to be accounted for in accordance with generally accepted accounting principles applicable at the date that the disposal activities were initiated. As of the time of this filing, the CICA has not harmonized Canadian GAAP with the provisions of SFAS No. 144. Accordingly, any impact related to the adoption of the provisions of SFAS No. 144 will be treated as a reconciling item between U.S. and Canadian GAAP. However, we do not anticipate that the provisions of SFAS No. 144 will have a material impact on our financial position or results of operations as reported under U.S. GAAP. 43 INDUSTRY OVERVIEW An insurance broker is an intermediary that places and negotiates insurance contracts for an insured. The broker works with the insured to assess its risk, determine the amount and type of coverage it needs, and select insurance providers. An insurance broker does not typically assume underwriting risk. There are three main sub-sectors of the insurance brokerage industry: (a) retail brokering, (b) wholesale brokering and (c) reinsurance brokering. Retail brokering involves placing insurance on behalf of the insured. The retail broker handles the majority of traditional risk placement services. Wholesale brokering involves placing insurance on behalf of another insurance broker. Reinsurance brokering involves placing reinsurance on behalf of an insurance company or reinsurance company. Typically, a broker is compensated for its services through commissions, which are calculated and paid as a percentage of the total insurance premium, and through fees for management and consulting services. The insured submits the premium to the broker who then deducts its commission and remits the remaining premium to the insurance company. The broker has the opportunity to earn investment income on premiums held in trust, pending remittance to the insurance company. Premiums are typically held in trust for less than 60 days and are invested in short-term securities. Insurance brokers may also earn fees for other risk management and consulting services that they perform for clients. Volume overrides and contingent commissions can also be negotiated with an insurance company based on the volume, type and profitability of the coverage placed with that insurance company. Payments for volume overrides are received from insurance companies throughout the year while payments for contingent commissions are typically received in the first or second quarter of the subsequent year. TRENDS AFFECTING THE INSURANCE BROKERAGE INDUSTRY Correlation with the property and casualty insurance underwriting industry. The insurance brokerage industry is highly sensitive to changes in the property and casualty insurance industry. The property and casualty insurance industry has undergone a substantial restructuring in recent years, including significant consolidation of insurers and until recently significant downward pressure on premiums. In an effort to improve profitability, insurance companies began to take steps to reduce their costs, including their distribution costs. As a result, insurance companies have demanded increased service and efficiency from insurance brokers. For example, brokers are expected to be fully automated in order to provide additional administrative services and to gain efficiencies in processing insurance applications. In addition, many insurers have redesigned the insurer/broker relationship by replacing loyalty with demands for minimum volume levels and requiring that the ratio between the claims paid and the premiums collected be reduced on policies being sold by brokerages. Beginning in 2001, and accelerated by the events of September 11, 2001, insurance premiums have risen. Increased premiums are now pervasive in the marketplace. Insurers have also become more selective in underwriting risks, causing brokers to expend greater resources to place coverages. In some cases, higher premium levels and more selective underwriting have caused brokers to lose clients due to unavailable or non-competitively priced products. Consolidation. The soft pricing conditions that, until recently, characterized the insurance market for more than a decade resulted in downward pressure on margins in the insurance brokerage industry. Moreover, insurance brokers were only able to achieve a relatively low level of organic growth, typically tracking overall economic growth, because of the maturity of this industry. These 44 two factors resulted in increasing consolidation within the insurance brokerage industry during the 1990s as insurance brokers sought to supplement their organic growth with growth from acquisitions. Some of the larger acquisitions in the 1990s included Marsh & McLennan Companies, Inc.'s purchases of Johnson & Higgins and Sedgwick and Aon Corporation's purchases of Alexander & Alexander and Frank B. Hall. In addition, a number of smaller insurance brokers have employed acquisition strategies, such as Arthur J. Gallagher, Hilb, Rogal and Hamilton, Brown & Brown, Acordia and USI, to develop a regional or national presence. This period of rapid consolidation has led to the emergence of two dominant participants in the North American insurance brokerage market: Marsh & McLennan and Aon Corporation, each of which primarily serve Fortune 1000 companies and other large companies. In the middle-market, the insurance brokerage industry tends to be fragmented and continues to be dominated by regional insurance brokerages. Despite consolidation, the insurance brokerage industry still features a large number of small, independent brokers, that often lack sophisticated succession plans. As the principals of small brokerages approach retirement, there is often an opportunity for larger, better capitalized brokers to acquire the smaller brokerages, providing the principals with liquidity for their ownership stake and providing the consolidators with attractive acquisition targets. Consolidators attempt to improve the efficiency of acquired brokerages by providing new technology, centralizing certain key management and administrative functions and providing a greater depth of products and services. Non-traditional sources of competition. Additional competitive pressures have arisen in the insurance brokerage industry from the entry of new market participants, such as banks, mid-sized accounting firms and insurance companies. In the United States certain banks have implemented aggressive insurance brokerage acquisition strategies in an attempt to augment their non-interest income and to capitalize on existing lending relationships with middle-market customers. Some mid-sized accounting firms have also sought to expand their existing relationships with middle-market customers by acquiring insurance brokerages, although the success of this strategy has generally been limited. Insurance companies also compete with brokers by directly soliciting insureds without the assistance of an independent broker or agent. In addition, both insurers and brokers have turned to the Internet as a direct marketing strategy. Despite these trends we believe that traditional insurance brokers will continue to have a significant role in the placement of larger, more complicated policies and to function as risk managers on behalf of many small to medium-sized clients. Diversification. Another trend in the insurance brokerage industry is the increasing diversification of products and services offered by larger regional and national brokers. Brokers specializing in commercial lines traditionally have focused on offering one or two niche products targeted to a particular industry. In recent years, larger brokers have added a variety of new products and services in order to meet the increasingly complex risk management needs of their clients and to address the decision by clients to retain more of the risk themselves to better manage premium levels. Client demands. Clients generally have an increasing level of awareness of their risk management options and are demanding improved coverage and services without commensurate increases in price. Brokers no longer can adopt a uniform strategy to attract and satisfy clients. Clients are more segmented, with certain groups emphasizing price and others emphasizing personal service and efficiencies in the insurance purchasing process. In this new environment, brokers must employ different strategies and offer a broader range of products, services and distribution channels to attract and satisfy different client segments. 45 RESULTING EFFECTS ON INSURANCE BROKERS Property and casualty insurers are becoming more selective about the brokers that distribute their products. Brokers must demonstrate to insurers productivity (by meeting minimum volume levels and not exceeding specified loss ratios), efficiency (by having the capability to process insurance applications on behalf of the insurer) and sophistication (by having information technology, aggressive marketing strategies and client retention systems). To meet these high standards, brokers are changing the way they traditionally have operated their businesses by making greater investments in technology, preparing comprehensive business, marketing and succession plans and generally transforming themselves into more sophisticated operations. Many large brokers have established multiple distribution channels to attract different market segments and to compete on a cost-effective basis with new entrants into the market. In addition, many brokers now offer multiple types of insurance products and services in an effort to provide one-stop shopping. We believe that smaller brokers may be unable to invest in improving technology or to further broaden their products and services. We also believe that consolidation of the brokerage industry will continue as smaller brokers seek access to the resources of larger partners and their economies of scale. DIFFERENCES BETWEEN THE U.S. AND CANADIAN MARKETS The trends in the insurance brokerage industry tend to be similar in the United States and Canada. However, there are a few distinctions. For example: - - premiums generally began to increase in the United States in the early part of 2001, but did not generally begin to increase in Canada until the latter part of 2001; - - provincial governments in Canada provide publicly funded, government-managed health insurance to all residents and some provincial governments have assumed the role of the exclusive provider of primary liability automobile insurance, which they sell through designated independent brokers; and - - the Canadian market for insurance brokerage products and services is much smaller than the U.S. market. 46 BUSINESS OVERVIEW We are a leading North American insurance brokerage providing a broad array of property and casualty, life and health, employee benefits, investment and risk management products and services. We focus primarily on middle-market commercial accounts in the United States and Canada, which we serve through our approximately 1,900 employees in 130 locations, using a variety of retail and wholesale distribution channels. We define the middle market as those clients with 20 to 499 employees, which typically generate annual commissions and fees ranging from $2,500 to $250,000. Since our company was formed in 1998 through the merger of 11 Canadian insurance brokerages, we have acquired an additional 78 brokerages and have established a strong presence in the northeastern and midwestern United States and in the Canadian provinces of Ontario, Quebec and British Columbia. Through a combination of acquiring quality brokerages with proven track records and organic growth, we have grown our revenue from $38.7 million in 1998 to $154.0 million in 2001, of which 93% is attributable to acquisitions, and from $28.1 million in the first quarter of 2001 to $49.5 million in the first quarter of 2002, of which 88% is attributable to acquisitions. In addition, our Adjusted EBITDA has increased from $6.2 million in 1998 to $30.7 million in 2001 and from $5.9 million in the first quarter of 2001 to $10.9 million in the first quarter of 2002. We operate through an organizational structure comprised of our head office, larger regional brokerages that we call "hub" brokerages and smaller brokerages that we call "fold-ins." Our head office coordinates selling and marketing efforts, identifies cross-selling opportunities among our brokerages, negotiates significant contracts with insurers and handles general administrative functions. We have nine hub brokerages, four operating in the United States and five in Canada. Each hub brokerage has a significant market presence in a geographic region of the United States or Canada. We operate our hub brokerages in a decentralized manner so they may more effectively address their local market conditions. A hub brokerage is responsible not only for the development of its own business, but also the identification of fold-ins that can be acquired by and integrated into the operations of the hub brokerage. This process allows each hub brokerage an opportunity to strengthen its regional market presence by acquiring new or complementary products and services and management talent and improve profit margins through the reduction or elimination of redundant administrative functions, premises and systems. Our structure enables our hub brokerages to more effectively and quickly meet the changing needs of our clients in various markets, while benefiting from the operating efficiencies and leverage of a large brokerage. OUR PRODUCTS AND SERVICES We offer commercial and specialized insurance products and services to businesses, personal insurance products and services to individuals and program products to affinity groups and associations. We offer three categories of commercial products and services: property and casualty products, employee benefits and risk management services. We offer two categories of personal products and services: property and casualty products and life, health and financial products and services. Our program products involve the development, in collaboration with insurance companies, of baskets of insurance products for members of affinity groups or associations, such as bar associations, medical associations and other professional groups. Our specialized risk products cover diverse exposures such as environmental, professional liability and directors' and officers' liability. 47 The chart below lists a selection of our commercial and personal insurance products and services. COMMERCIAL INSURANCE
- ----------------------------------------------------------------------------------- PROPERTY AND CASUALTY EMPLOYEE BENEFITS RISK MANAGEMENT SERVICES - ----------------------------------------------------------------------------------- - - Business property - Group life and health - Claims management - - Auto and trucking fleets - Employment issues - Risk finance structuring - - Technology - Human resources - Exposure evaluation - - Intellectual property - Retirement plans - Coverage analysis - - Natural disaster - Contract review - Contract review - - Workers' compensation - - Liability - - Surety bonds - - Business income - - Accounts receivable - - Environmental risks - -----------------------------------------------------------------------------------
PERSONAL INSURANCE
- -------------------------------------------------------------------------------------------- PROPERTY AND CASUALTY LIFE, HEALTH AND FINANCIAL - -------------------------------------------------------------------------------------------- - - Home - Disability - - Personal property - Life - - Auto and recreational vehicles - Investments - - Travel accident and trip cancellation - Financial planning - --------------------------------------------------------------------------------------------
The mix of products and services we offer in the United States differs from those we offer in Canada. Our product mix in the United States is comprised of more commercial products and services as compared to more personal products and services in Canada. In the United States in 2001, 83.6% of our commission income was generated from the sale of commercial lines and 10.0% from personal lines. In Canada in 2001, 47.1% of our commission income was generated from the sale of commercial lines and 44.5% from personal lines. STRATEGY Our primary goals are to further develop our position as a leading North American middle-market insurance brokerage and to generate significant sustained shareholder value. We plan to achieve these objectives by executing the following strategies: Focus on middle-market commercial accounts. We focus our sales efforts on middle-market companies. We estimate that there are more than 1.1 million middle-market companies in the United States and more than 130,000 middle-market companies in Canada. We believe that the insurance and risk management needs of these companies are underserved because many of the brokers that target them have limited capital resources and lack the breadth of products and services that we are able to offer due to our scale and strong insurer relationships. We primarily target commercial accounts because they generally generate higher profit margins than personal accounts. Commercial accounts also provide us with the opportunity to sell personal insurance products and employee benefits to the employees of those businesses. 48 Grow organically. We intend to increase profitability per customer and attract new customers by leveraging our existing infrastructure to: - - sell a broad range of products and services through the efficient use of a variety of distribution channels; - - effectively and efficiently identify and target profitable client segments by employing technology to capitalize on our extensive customer databases; and - - maximize cross-selling opportunities among our brokerages. Grow through selected acquisitions. The introduction of new brokerages through acquisitions is a fundamental component of our strategy. We have acquired an additional 78 brokerages since our formation in 1998. We acquire brokerages to grow our revenue, complement and supplement our existing products and services and add experienced management. In addition, acquisitions of larger brokerages allow us to further expand our hub platform and geographic reach. We believe that we are well positioned to compete for quality brokerages and that our proven success in consolidating brokerages in the past will make us attractive to regional brokerages seeking to join with and share in the resources of a larger North American brokerage. Standardize procedures to increase operating efficiency and reduce costs. We strive to implement the best operating and sales practices of our brokerages across our company. We provide centralized marketing support to our brokers for many specialized risk programs and group home and auto plans and we are integrating promotional programs across our brokerage offices. Our brokerages share certain systems, such as accounting and payroll, which reduce redundancies and increase operating efficiencies. In addition, we are developing a comprehensive quality control program and a standardized approach to our sales and marketing efforts across our brokerages. Recruit, train and retain qualified personnel. We are formalizing our recruiting and training program to continue to build and sustain a sales and service team with a wide variety of experience and capabilities. We intend to recruit directly from college campuses and provide graduates with effective training and attractive compensation packages. In addition, we are making a concerted effort to develop a company-wide sales culture by promoting the techniques and results of our most successful producers through regular newsletters, sales meetings, sales tracking, awards, recognition programs and training. We are implementing a formal internship program designed to groom selected candidates to be successful producers within our company. We anticipate commencing the program in the second half of 2002. Candidates will be selected by our hub brokerages and typically will have a university education or relevant work experience. Participants will spend several weeks learning about the insurance industry, our company, quality standards, products and services and leading sales techniques from our leading producers, members of management, representatives of insurance companies and other members of the industry. Upon completion of the curriculum, successful trainees will be designated for an area of specialization. COMPETITIVE ADVANTAGES We believe the following competitive advantages will enable us to achieve our objectives: Decentralized hub approach. Our decentralized hub approach allows us to react to regional market conditions while still centrally managing the growth and profitability of our business with consistent standards. Our geographic diversity allows us to balance our revenue stream across markets and better insulate us from regional adverse developments. Our hub structure provides us with strong local name recognition and a ready platform, capable of reacting quickly to smaller brokerage acquisition opportunities, and to assimilate fold-ins once acquired. 49 Broad array of products and services offered through multiple distribution channels. We offer a broad array of products and services, which allows us to maintain and maximize existing client relationships and attract new clients. We offer these insurance products and services through four distribution channels: retail, wholesale property and casualty, wholesale life and financial and call- centers. Our diversity provides us with the flexibility to determine the most appropriate product and service and which distribution channel to employ for particular market segments. We are exploring the implementation of Internet strategies to reach a growing on-line market segment and to reduce costs in processing insurance quotes and applications. See "--Distribution channels" for a more detailed discussion about distribution. Benefits of scale. Our scale, relative to smaller brokerages, provides insurers with greater incentives to work with us. Enhanced insurer relationships often result in mutual cost savings, increased volume overrides and contingent commissions, favorable commission rates, collaborative marketing arrangements and product design, exclusive distribution rights for certain territories and products, and, in some cases, expanded authority to price and approve insurance policies on behalf of insurance companies, thus eliminating the time and expense required for the broker to solicit numerous price quotes. Our scale also makes us attractive to smaller brokerages as a potential acquiror. Committed and experienced management. Most of the senior managers of our brokerages have over 20 years of experience in the industry and also have significant shareholdings in our company, typically with transfer restrictions for up to ten years. In addition, designated key employees in each brokerage are rewarded for their contribution to their brokerage's success through a bonus program that recognizes brokerage performance in excess of specified targets. We believe that these strategies encourage loyalty and align the interests of management of our brokerages with our corporate goals and the interests of our shareholders, combining to create a powerful incentive to maximize financial results. Most of our senior managers have extensive contacts in the insurance brokerage industry, including participation in prominent industry associations, brokerage networks and insurance company broker councils. OUR OPERATIONS We were created in November 1998 when 11 Canadian brokerages merged to form Hub. Significant events that have occurred since our formation in the last four years include: - - January 1999--Fairfax purchased 5.4 million common shares of Hub for $34.2 million cash. - - January 1999--We completed a financing whereby we issued a total of 2,838,080 common shares, on a private placement basis at a price of $8.60 per common share or approximately $24.4 million in the aggregate. Fairfax purchased, through certain of its wholly-owned subsidiaries, 1,185,184 of the common shares. - - February 1999--We completed a public offering in Canada of 865,624 common shares at a price of $8.60 per share for total proceeds of approximately $7.4 million and listed our common shares on the TSX. - - During 1999--We acquired 44 brokerages in Canada and completed our first acquisition in the United States (Mack and Parker, Chicago, Illinois). - - During 2000--We acquired 18 brokerages in Canada and the United States (including McCarthy). - - During 2001--We acquired 16 brokerages in Canada and the United States (including Flanagan, Kaye and Burnham). 50 Our activities are currently conducted from principal offices located in Chicago, New York, Boston, Toronto, Vancouver and Montreal. The following table lists our nine hub brokerages.
- ----------------------------------------------------------------------------------------------------- NAME LOCATIONS DATE ACQUIRED - ----------------------------------------------------------------------------------------------------- Burnham Battle Creek, Michigan, and other July 2001 locations in Michigan, Chicago, Cleveland, Dallas Kaye New York, Rhode Island, Connecticut, June 2001 California C.J. McCarthy Boston June 2000 Mack and Parker Chicago, New York, Baltimore, October 1999 (includes Flanagan Cleveland, Denver acquired in June 2001) TOS Insurance Services Ltd. Vancouver, British Columbia August 1999 Barton Insurance Brokers Ltd. British Columbia November 1998 The Hub Group (Ontario) Inc. Southern and central Ontario November 1998 Martin Assurance & Gestion de Risques Inc. Montreal, Quebec November 1998 Hub Financial Inc. Toronto, Calgary, Vancouver, Edmonton November 1998 - -----------------------------------------------------------------------------------------------------
ACQUISITION PROCESS Our senior management is responsible for identifying and negotiating the acquisition of hub brokerages that are strategically suited to our growth strategy. Typically we are familiar with the owners and management of the acquisition target well before we initiate discussions. Most of the hub brokerages we acquire are owner operated. We perform extensive diligence on potential targets and we determine what the budget of the acquired brokerage will be, including payroll and other adjustments, prior to completing the acquisition. We anticipate that we will selectively acquire more hub brokerages in geographic regions where we currently have a limited presence, most notably the southeastern, southwestern and western United States. There are many more brokerages in the United States that we would consider suitable hub brokerage acquisition candidates than in Canada due to the market size of the United States. Each new hub will be characterized by the following attributes: - - an experienced and talented management team prepared to make a long-term commitment to executing our strategic business plan; - - the ability to identify, acquire and seamlessly integrate smaller brokerages (fold-ins) in its region; - - specialization in certain products or services that may be beneficial to or complement our other brokerages; and - - a demonstrated record of organic growth and profitability, operating at, or capable of achieving in the near term, minimum financial performance targets. The retention of existing management at the hub brokerages we acquire is important to the successful integration and subsequent operation of acquired brokerages. We encourage existing management to stay with the acquired hub brokerage by using our common shares to pay a large majority of the acquisition price. The shares the owner/management receive are subject to transfer restrictions for up to ten years, with 10% being released from these restrictions on the third, fourth and fifth anniversaries of the acquisition. 51 DISTRIBUTION CHANNELS We utilize retail, wholesale and call-center distribution channels, and have the ability to employ these distribution channels for specific market segments. Each brokerage uses a combination of different distribution channels: - - Retail sales and service centers that target middle-market companies provide a broad range of property and casualty insurance, life and health insurance, risk management and financial services from traditional office locations leased by our brokerages in local communities. All of our brokerages utilize this distribution channel; - - Retail call-centers provide sales and services by telephone to individuals or members of employee groups, associations, affinity groups and specific communities. We operate call-centers in Chicago, Toronto, Saint John, New Brunswick and Chilliwack, British Columbia; - - Wholesale life and financial services centers, known as managing general agents, provide life and financial products and expertise to independent agents on a wholesale basis from our locations in Vancouver, Calgary and Toronto; and - - Wholesale property and casualty insurance centers provide products, international risk solutions, captive management programs and specialty lines to independent brokers and corporations in North America and internationally from our locations in New York, Toronto and Vancouver. In addition, we are a member of the Worldwide Broker Network, a consortium of international brokerages which we can access to service clients resident in the United States and Canada who require insurance internationally. DECISION-MAKING PROCESS We have established an executive committee that consists of our senior executive officers and the heads of each of our hub brokerages. The executive committee is comprised of two subcommittees that meet independently of each other, one comprised of U.S. representatives (chaired by Bruce Guthart, our President, U.S. Operations), and the other comprised of Canadian representatives (chaired by Craig Barton, our President, Canadian Operations). The mandate of the sub-committees is to discuss topics of common concern and opportunity for the brokerages of each respective country and to make recommendations to the executive committee and to implement and report to the executive committee regarding initiatives that are undertaken. The executive committee convenes monthly to discuss company-wide strategies and developments. COMPETITION The insurance brokerage industry is highly competitive. We face several sources of competition including other brokerages, insurance companies, banks and other financial services companies. Brokerage consolidators have been active in the market over several years. Consolidators, often publicly traded corporations, consolidate small to medium size independent brokerages with a view to strengthening their competitive position and increasing their market share. In addition to direct competition from the insurance companies, new sources of competition are emerging as banks in the United States accelerate their efforts to diversify their financial services to include insurance brokerage services (often through the acquisition of established insurance brokerages) and as the Canadian chartered banks lobby for greater flexibility to create and market insurance products. Our position in the United States and Canada relative to our competition in each country, and in the countries combined, in terms of revenue, premiums sold and status as a publicly traded company on the TSX and, upon completion of this offering, the NYSE, places us as a leading 52 insurance brokerage in North America. Our status as a leader is supported by a combination of facts and information, including a survey published in the July 16, 2001 edition of Business Insurance of revenue generated by insurance brokerages in the United States in which we, including Kaye and Burnham, would have been the fourteenth largest, a survey published in the April 2002 edition of The Insurance Journal of Canadian property and casualty insurance brokerages which ranked us first by premiums sold, public information indicating that only three other major U.S. brokerages have significant operations in Canada and the fact that our revenue for 2001 was more than 10 times greater than the next largest insurance brokerage publicly traded in Canada. We compete for clients in both the United States and in Canada on the basis of reputation, client service, program and product offerings and the ability to tailor our products and risk management services to the specific needs of a client. We believe that we are in a favorable competitive position in most of the meaningful aspects of our business, because of our broad array of products and services, diversity of distribution channels, industry focus and expertise, and management experience. Like some of our competitors, we focus our sales efforts primarily on middle-market commercial accounts. However, the use of the term of "middle market" differs among insurance brokerages. Companies that we consider to be middle market may not be considered middle market by the other brokerages. Similarly, middle market is not a term that is used to define a segment of the brokerage industry, and we do not use the term middle market to define ourselves or our competitors. Rather, middle market is a term we use to define the companies that we target as customers and direct our sales efforts toward. We believe that our most serious competitive threat in the United States will likely come from brokerages such as Arthur J. Gallagher, Brown & Brown and Hilb, Rogal and Hamilton, who pursue an acquisition or consolidation strategy similar to ours. We believe that our primary competitors in Canada are local retail brokers. GOVERNMENT REGULATION LICENSES In every state, province and territory in which we do business, the relevant brokerage is required to be licensed or to have received regulatory approval to conduct business. In addition to licensing requirements, most jurisdictions require individuals who engage in brokerage and certain insurance service activities to be licensed personally. Our operations depend on the validity of and continued good standing under the licenses and approvals pursuant to which we operate. Licensing laws and regulations vary from jurisdiction to jurisdiction and are always subject to amendment or interpretation by regulatory authorities. Such authorities are generally vested with general discretion as to the grant, renewal and revocation of licenses and approvals. PRIVACY The management and dissemination of information is critical to our business. We gather information from our customers to assess and address their insurance needs. We share information both internally, among our employees, and, where appropriate and permitted, between our brokerages, as well as externally, with insurers. We believe we have taken appropriate steps to safeguard our customers' information. A recent trend in both the United States and Canada has been the introduction of more comprehensive privacy laws designed to protect the privacy of individuals from the undisclosed or non-consensual sharing of sensitive information for commercial purposes. As the gathering and use 53 of information is such an integral component of our business, we must always be alert for changes in the information regulatory environment. For example, in response to the recent effectiveness of the privacy provisions of the Gramm-Leach-Bliley Act, our U.S.-based brokerages have developed or refined written privacy policies that, together with appropriate opt-out elections, have been sent to all of our customers who are resident in the United States. In Canada, the federal Personal Information Protection and Electronic Documents Act and similar proposed provincial legislation will affect our operations as of January 1, 2004, and possibly sooner. This new legislation will require us to obtain the consent of our customers before their personal information can be collected, used or disclosed. Furthermore, to the extent we share information with federally regulated Canadian organizations or disclose personal information between provinces or internationally for consideration, we are already subject to the federal legislation. We do not believe that these regulatory changes will have any significant effect on our operations. EMPLOYEES As of March 31, 2002, we employed 1,932 persons on a full-time basis, 1,544 of whom were employed in sales and customer service and 388 of whom were employed in corporate finance and administration. None of our employees are represented by a labor union and we have never experienced a work stoppage. We believe our relationship with our employees is good. FACILITIES We maintain our corporate headquarters at premises that we sublet from Mack and Parker in Chicago, Illinois. This facility, totaling approximately 3,500 square feet, contains corporate, finance, administration, sales and customer support functions. The lease on the premises expires on October 1, 2011. We also lease the following premises:
- ------------------------------------------------------------------------------------------------ SPACE NUMBER OF LEASE EXPIRATION OF FACILITY (SQUARE FEET) LOCATIONS REGIONAL HEAD OFFICE - ------------------------------------------------------------------------------------------------ California.................................. 7,200 1 September 30, 2007 Connecticut................................. 10,400 1 November 30, 2002 Illinois.................................... 50,200 4 October 1, 2011 Massachusetts............................... 32,800 6 July 1, 2002 Michigan.................................... 25,000 8 June 30, 2011 New York.................................... 82,600 3 August 31, 2010 Rhode Island................................ 7,500 1 April 30, 2007 Texas....................................... 15,000 2 September 30, 2006 Alberta..................................... 21,800 5 December 31, 2006 British Columbia............................ 175,300 68 December 31, 2010 New Brunswick............................... 2,200 1 May 31, 2004 Ontario..................................... 106,400 24 August 31, 2010 Quebec...................................... 62,300 4 August 31, 2010 - ------------------------------------------------------------------------------------------------
Total annual base rent for all of these locations is approximately $7.4 million. We believe that our facilities are well maintained and in good condition and are adequate for our current needs. We expect that suitable additional space will be available as required. 54 LEGAL PROCEEDINGS In the normal course of business, we are involved in various claims and legal proceedings relating to insurance placed by us and other contractual matters. Our management does not believe that any such pending or threatened proceedings will have a material adverse effect on our consolidated financial position or future results of operations. 55 MANAGEMENT EXECUTIVE OFFICERS AND DIRECTORS The following persons are our executive officers and directors as of December 31, 2001:
- ------------------------------------------------------------------------------------------------------- NAME AGE POSITION - ------------------------------------------------------------------------------------------------------- Martin P. Hughes 53 Chairman, Chief Executive Officer and Director Richard A. Gulliver 47 President, Chief Operating Officer and Director Bruce D. Guthart 46 President, U.S. Operations and Director R. Craig Barton 48 President, Canadian Operations and Director W. Kirk James 47 Vice President, Secretary and General Counsel Dennis J. Pauls 41 Vice President and Chief Financial Officer Peter L. Scavetta 41 Vice President, Finance Jean Martin 55 Vice President and Director Anthony F. Griffiths(1) 71 Director Paul Murray(1) 70 Director Bradley P. Martin(1) 42 Director - -------------------------------------------------------------------------------------------------------
(1) Member of audit committee and compensation committee. Martin P. Hughes has served as our Chairman, Chief Executive Officer and a director since December 1999. Mr. Hughes has 28 years of experience in the insurance brokerage industry. In 1973, Mr. Hughes joined Mack and Parker for which he served as Chairman from 1999 to 2001 and as President from 1990 to 1999. Mr. Hughes previously served as Chairman of Assurex International, a worldwide insurance service organization, as director of the Assurex Marketing Group and as a director of the Council of Insurance Agents and Brokers. Richard A. Gulliver has served as our President and a director since November 1998, and as our Chief Operating Officer from December 1999 to the present and as our Chief Executive Officer from January 1999 to December 1999. Mr. Gulliver has 25 years of marketing, sales and management experience in the insurance brokerage industry. Prior to joining us, Mr. Gulliver served as President of The Hub Group (Ontario) from 1997 to 1998 and of its subsidiary, Gulliver Insurance Brokers Ltd., from 1986 to 1998. In 1995, Mr. Gulliver and others collaborated to form Insurance Network Solutions Inc., a company for which Mr. Gulliver served as President from 1995 to 1997. Mr. Gulliver holds his designation from the Insurance Institute of Canada and is a Canadian Certified Insurance Broker. Bruce D. Guthart has served as our President, U.S. Operations and a director since August 2001. Prior to joining us, Mr. Guthart held the position of President of Kaye since its formation in 1993. He was appointed Chief Executive Officer of Kaye in 1996 and its Chairman in 1997. Mr. Guthart is a Director of the Council of Insurance Agents and Brokers. R. Craig Barton has served as our President, Canadian Operations since November 2001, and as a director since November 1998. Mr. Barton has been involved in the insurance brokerage industry for approximately 29 years. He has been the President and Chief Executive Officer of Barton Insurance since 1988. W. Kirk James has served as our Vice President, Secretary and General Counsel since December 1999. Mr. James has practiced law for 20 years and is a member of the Law Society of Upper Canada (Ontario). Prior to joining us, Mr. James was a corporate lawyer and partner with the law firm McKenzie, Lake, in London, Ontario from 1991 to 1999. 56 Dennis J. Pauls has served as our Chief Financial Officer and as Vice President since February 1999 and December 1999, respectively. Mr. Pauls served as Chief Financial Officer of The Hub Group (Ontario) and its subsidiary, Gulliver Insurance, from 1991 to 1999, where he participated in planning the initial organization and structure of our company. Mr. Pauls is a chartered accountant. Peter L. Scavetta, has served as our Vice President, Finance, since December 1, 2001. Prior to that, since September 1992, Mr. Scavetta was Vice President, Finance of Kaye. Mr. Scavetta has been a certified public accountant since 1985 and is a member of the American Institute of Certified Public Accountants. Prior to joining Kaye, Mr. Scavetta held positions in both the audit and tax departments at Coopers & Lybrand, Certified Public Accountants. Jean Martin has been our Vice President and a director since November 1998. Mr. Martin has been involved in the insurance brokerage industry for approximately 30 years. He has served as President of Martin Assurance (and its predecessor companies) for the past 20 years. Anthony F. Griffiths has served as a director since December 1998. He is currently an independent business consultant and corporate director. Mr. Griffiths became the Chairman of Mitel Corporation, a telecommunications company, in 1987 and also assumed the positions of President and Chief Executive Officer in addition to that of Chairman from 1991 to 1993. He is currently a director of various operating subsidiaries of Fairfax and of Alliance Atlantis Communications Inc., Leitch Technology Corporation, QLT Inc. and Russel Metals Inc. Paul Murray has served as a director since January 1999. He has been President of Pinesmoke Investments Ltd. of Toronto, Ontario, since 1985. From 1990 to 1998 Mr. Murray served as President, Secretary and Treasurer of Lockwood Manufacturing Inc. of Brantford, Ontario. Mr. Murray is a chartered accountant. Bradley P. Martin was elected to our board of directors in May 2002. He has served as a Vice President of Fairfax since June 1998. Prior to that, Mr. Martin was a partner at the law firm of Torys LLP in Toronto, Ontario since 1995. BOARD COMMITTEES Our board of directors has an audit committee, a compensation committee and an executive committee. AUDIT COMMITTEE Our board of directors has established an audit committee to be comprised of three directors. The audit committee's primary responsibilities include: - - engaging independent accountants; - - approving independent audit fees; - - reviewing quarterly and annual financial statements, audit results and reports, including management comments and recommendations thereto; - - reviewing our system of controls and policies, including those covering conflicts of interest and business ethics; - - evaluating reports of actual or threatened litigation; - - considering significant changes in accounting practices; and - - examining improprieties or suspected improprieties, with the authority to retain outside counsel or experts. 57 Our audit committee is currently comprised of Anthony F. Griffiths, Paul Murray and Bradley P. Martin. COMPENSATION COMMITTEE Our board of directors has established a compensation committee to be comprised of three directors. The compensation committee's primary responsibilities include reviewing and making recommendations to our board of directors regarding our restricted share plan, share purchase plans and compensation to our officers. The compensation committee also establishes and reviews general policies relating to compensation and benefits of our employees. Our compensation committee is currently comprised of Anthony F. Griffiths, Paul Murray and Bradley P. Martin. EXECUTIVE COMMITTEE We also have an executive committee, appointed by our board of directors, comprised of certain of our senior executive officers identified in the table under the heading "--Executive officers and directors" as well as the following, each of whom are the heads of hub brokerages: Charles C. Burnham (Burnham), Nelson Tilander (Hub Ontario), Edward Mack (Mack and Parker), Joseph P. Flanagan (Mack and Parker), Cornelius J. McCarthy (McCarthy) and Larry Lineker (TOS). The executive committee meets on a monthly basis and assists management in assessing, developing and exploiting company-wide brokerage opportunities and initiatives. See "Business--Our operations--Decision making process" for a more detailed description of the executive committee. DIRECTOR COMPENSATION Directors other than directors who are officers of Hub or of any of Hub's subsidiaries ("outside directors") are paid an annual retainer of approximately $3,100 for their services. Additional amounts may be paid to outside directors for special assignments. In 2001 three outside directors were entitled to receive an aggregate of $9,300 pursuant to these arrangements. Directors other than outside directors are not compensated for their services. Directors are reimbursed for travel and other out-of-pocket expenses incurred in attending board or committee meetings or in otherwise being engaged on Hub's business. EXECUTIVE COMPENSATION The following table sets forth compensation information for our Chief Executive Officer and our five other most highly compensated executive officers, referred to as our named executive officers, during the year ended December 31, 2001.
- ---------------------------------------------------------------------------------------------------------------------- ANNUAL COMPENSATION ------------------------------------- LONG-TERM OTHER ANNUAL ALL OTHER COMPENSATION NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION(1) COMPENSATION(2) AWARDS - ---------------------------------------------------------------------------------------------------------------------- Martin P. Hughes........................ 2001 $350,000 $350,000 $45,989 $ -- -- Chairman and Chief Executive Officer Richard A. Gulliver..................... 2001 250,000 250,000 42,635 -- -- President and Chief Operating Officer Bruce D. Guthart(3)..................... 2001 250,000 296,000 13,700 2,550 -- President, U.S. Operations R. Craig Barton(4)...................... 2001 258,715 538,452 39,097 4,366 -- President, Canadian Operations Dennis J. Pauls......................... 2001 200,000 100,000 14,272 -- -- Vice President and Chief Financial Officer W. Kirk James........................... 2001 200,000 100,000 67,764 -- -- Vice President, Secretary and General Counsel - ----------------------------------------------------------------------------------------------------------------------
58 (1) The amounts quoted in this column include the taxable benefits represented by automobile allowances, memberships, participation in group medical and life insurance plans, relocation expenses, an interest free loan to R.C. Barton Ltd. (now repaid in full) and interest or deemed interest with respect to 10 year interest free loans granted in connection with our executive share purchase plan described under "Executive share purchase plan" and "Indebtedness of directors, executive officers and senior officers." The shares issued under the plan vest at 10% per year while the participant remains employed by us. Until the principal of the loan has been repaid, these shares continue to be held as collateral for the outstanding loan. We have agreed to forgive the $0.5 million and $0.4 million loans made by us to each of Mr. Hughes and Mr. Gulliver, respectively, after each has been continuously employed by us for ten years from the original date of the respective loan. When we implement our restricted share plan, Mr. Hughes and Mr. James will no longer participate in our executive share purchase plan. (2) The amounts quoted in this column include our contribution to Mr. Guthart's 401(k) plan and a contribution to the Barton Insurance retirement plans on behalf of Mr. Barton. (3) Employed and paid by Hub's subsidiary, Kaye (which was acquired by us effective June 2001) for six months in 2001. (4) Salary and Bonus until December 31, 2001 were paid in the form of fees to Librico Properties Ltd., a corporation controlled by R. Craig Barton, by Hub's subsidiary, Barton Insurance. Pursuant to the employment agreement we entered into with Mr. Barton on January 1, 2002, salary and bonus will now be paid by Barton Insurance directly to Mr. Barton. MANAGEMENT AND EMPLOYMENT CONTRACTS We have entered into employment agreements with Martin Hughes, our Chairman and Chief Executive Officer, Richard Gulliver, our President and Chief Operating Officer, Dennis J. Pauls, our Vice President and Chief Financial Officer, and W. Kirk James, our Vice President, Secretary and General Counsel. The agreements provide Mr. Hughes, Mr. Gulliver, Mr. Pauls and Mr. James with an annual salary of $350,000, $300,000, $200,000 and $200,000, respectively, participation in our 401(k) plan, in which we provide a matching contribution of 60% of the participant's contribution, up to a maximum of three percent of the participant's salary, and an annual bonus of up to $350,000, $200,000, $100,000 and $100,000, respectively, to be declared at the discretion of our compensation committee. Our compensation committee determines the amount of the annual bonuses of Mr. Hughes, Mr. Gulliver, Mr. Pauls and Mr. James taking into consideration not only individual performance, but also our performance as a company relative to our growth and profitability targets for the applicable year. Under our agreement with Mr. Hughes, he is provided with use of a company car. Under our respective agreements with Mr. Gulliver, Mr. Pauls and Mr. James, each is provided with a car allowance. In the event of termination of Mr. Hughes, Mr. Gulliver, Mr. Pauls or Mr. James by us without cause, or by Mr. Hughes, Mr. Gulliver, Mr. Pauls or Mr. James for good reason (including any significant alteration in the nature of his duties), each is entitled to payment of an amount equal to one year's salary plus a ratable portion of an amount equal to his bonus for the prior year. Each of Mr. Hughes, Mr. Gulliver, Mr. Pauls and Mr. James is obligated not to compete with us through employment or other arrangements with any insurance brokerage in the United States or Canada (except in the case of termination by us without cause or by him for good reason) or to solicit any of our clients or employees for a period of two years following the cessation of his employment. Our agreements with Mr. Hughes, Mr. Gulliver, Mr. Pauls and Mr. James provide that once we implement our restricted share plan each will be awarded 44,130 shares, 35,817 shares, 25,000 shares and 30,000 shares, respectively, under the plan. The shares will be awarded without payment of any cash consideration and to be free from transfer restrictions, other than securities laws restrictions, as to 50% after five years and the balance after 10 years of employment. Our hub brokerage, Kaye, has entered into an employment agreement with Bruce Guthart, our President, U.S. Operations, as President and Chief Executive Officer of Kaye. Under the agreement, Mr. Guthart is entitled to an annual salary of $500,000, a car allowance, participation in our 401(k) plan and an annual bonus representing 50% of the aggregate of any bonuses earned by senior management under Kaye's management bonus agreement. In the event of termination by us without cause, or by Mr. Guthart for good reason (including significant alteration in the nature of his duties), Mr. Guthart is entitled to payment of an amount equal to one year's salary plus a ratable portion of his share of Kaye's management bonus for the year. Mr. Guthart is obligated not to compete with us through employment or other arrangements with any insurance brokerage 59 in the United States (except in the case of termination by us without cause or by him for good reason) or to solicit any of our clients or employees for a period of two years following the cessation of his employment. In connection with the acquisition of Kaye, we agreed to award Mr. Guthart 88,261 restricted shares when we implement our restricted share plan, to be issued without payment of any cash consideration and to be free from transfer restrictions, other than securities laws restrictions, as to 50% after five years and the balance after 10 years of employment. Our hub brokerage, Barton Insurance, has entered into an employment contract with Craig Barton, our President, Canadian Operations, as President and Chief Executive Officer of Barton. Under the agreement, Mr. Barton is entitled to an annual salary of C$400,000, and an annual bonus representing his share, as determined by him, of the aggregate of any bonuses earned by senior management under Barton's management bonus agreement. In the event of termination by us without cause, Mr. Barton is entitled to payment of an amount equal to one year's salary plus a ratable portion of his share of Barton's management bonus for the year. Mr. Barton is obligated not to compete in any insurance brokerage in the Province of British Columbia (except in the case of termination by us without cause) or to solicit any of our clients or employees for a period of two years following the cessation of his employment. Each member of senior management of our brokerages is subject to an employment agreement that sets out the terms of his or her employment. These agreements typically include non-competition covenants, which continue for two years following the cessation of employment, except in the case of termination by us without cause, and generally provide for a payment equal to one year's salary in the event they are terminated without cause. Members of senior management of our brokerages also may be entitled to bonuses pursuant to the management bonus agreement for the respective brokerage if operating targets are achieved. We believe that the compensation we provide to our senior management is commensurate with that provided to senior management of similar sized insurance brokerages. MANAGEMENT BONUS AGREEMENTS Since our formation, the senior managers of our brokerages have participated in our management bonus plans. The payment of bonuses under these plans is based on the respective brokerage's operating profit and the overall financial performance of our Company, which is computed on the basis of Adjusted EBITDA as a percentage of total revenue, which we call Adjusted EBITDA Margin. The purpose of the plan is to align the interests of our senior managers with that of our shareholders by providing rewards for excellent performance. In the past, management bonuses have been paid in cash. However, to further integrate the interests of our senior managers with those of our shareholders, we have recently amended our management bonus agreements to provide that a portion of the brokerage management bonus will be paid in options to purchase our common shares. We believe this provides two benefits: it creates an additional incentive for our managers to enhance shareholder value and will lower our cash remuneration expense. EXECUTIVE SHARE PURCHASE PLAN We have an executive share purchase plan under which we may from time to time grant or guarantee loans to our designated employees, officers and service providers to purchase common shares. Our board of directors determines who may participate in the plan. Participation in the plan is entirely voluntary. A loan advanced or arranged under the plan is repayable by the participant ten years from the date of the loan. We pay interest on behalf of the employee. A participant's entitlement to shares allocated under the plan vests at the rate of 10% per year while employed. All shares purchased pursuant to the plan are held as security for the outstanding loans 60 of the participant. Common shares purchased under the plan may be purchased from treasury at market values or in the open market without any discount from fair market value. The maximum number of shares authorized for issuance from treasury under such plan is 1,000,000. There is no limit on the number of shares, which may be purchased in the open market under the plan. The plan is administered by Computershare Trust Company of Canada. We have arranged and made loans under the plan. See "--Indebtedness of directors, executive officers and senior officers." EMPLOYEE SHARE PURCHASE PLAN We have an employee share purchase plan under which our employees and service providers who have completed three months of continuous service may purchase our common shares by contributing to the plan up to a maximum of 10% of his or her annual compensation. We do not make any loan or other contribution in respect of such purchase. Participation in the plan is entirely voluntary and transfers of shares acquired under this plan are not restricted by the terms of the plan. Common shares purchased under the plan are to be made by the trustee of the plan either from treasury at market values or in the open market without any discount from fair market value. The maximum number of shares authorized for issuance from treasury under such plan is 1,000,000. There is no limit on the number of shares which may be purchased in the open market under the plan. The plan is administered by Computershare Trust Company of Canada. 401(K) PLAN We have established a 401(k) retirement savings plan that is intended to qualify as a profit-sharing plan under Internal Revenue Code Section 401(a), and includes a cash or deferred arrangement that is intended to qualify under Code Section 401(k). The plan was established and is maintained for the exclusive benefit of our eligible employees and their beneficiaries. The plan was effective as of January 1, 2002 and merged the 401(k) plan and related assets previously administered by each of Mack and Parker, McCarthy, Kaye and Flanagan. We make matching contributions for active participants equal to 60% of their permitted contributions, up to a maximum of three percent of the participant's salary. One-third of our contribution is used by the trustee that administers the plan to fund the purchase of our common shares on the open market. EQUITY INCENTIVE PLAN We have established an equity incentive plan administered by our compensation committee. The compensation committee may, subject to stock exchange requirements: - - select participants; - - make awards; - - determine the number of common shares subject to each award; - - determine the terms and conditions of each award (including those related to transferability, vesting, forfeiture and exercisability and the effect of a participant's termination of employment); - - adjust the terms of an award to comply with the laws, regulations or rules of any applicable jurisdiction or stock exchange; - - amend the terms and conditions of an award; - - specify and approve the provisions of award documents; - - construe and interpret any award document; - - prescribe, amend and rescind rules and procedures relating to the equity incentive plan; 61 - - delegate to one or more of our officers some or all of its authority under the equity incentive plan; - - adopt, on our behalf, one or more sub-plans applicable to separate classes of participants; - - employ legal counsel, independent auditors and consultants for the administration of the equity incentive plan; and - - make all other determinations necessary or advisable for the administration of the equity incentive plan. We are authorized to issue awards representing up to 2,100,000 common shares, which represents 9.7% of our issued and outstanding common shares. Subject to compliance with applicable laws, regulations and rules of any applicable jurisdiction or stock exchange, common shares utilized in connection with the equity incentive plan may be purchased on the open market or otherwise acquired, newly issued, treasury shares or any combination thereof. Currently, the maximum aggregate number of awards under the equity incentive plan that may be newly issued common shares is limited to 500,000 and the maximum number of common shares that may be subject to an award granted to participants in any calendar year will not exceed 1,000,000 common shares. However, subject to shareholder ratification, our board of directors has approved removing the 500,000 and 1,000,000 share limitations currently in the plan. For purposes of determining the number of common shares that remain available for issuance under the equity incentive plan, there will be added back to the 2,100,000 authorized shares, and again be available for future awards, the number of common shares withheld to satisfy a participant's tax withholding obligations and the number of common shares underlying any award that are surrendered and cancelled without being exercised. INITIAL AWARDS We will make previously agreed upon awards of approximately 736,778 common shares to our management and management of our subsidiaries in the United States. Certain of theses initial awards contemplate that 254,033 of the underlying common shares will be in the form of restricted shares, as described below, that will be paid for by the participants with loans either from us or from a bank and guaranteed by us, and that will vest as to 10% per year while the participant continues to be employed by us. Until repayment of the loan, the related shares will be held by a trustee subject to the terms of the equity incentive plan and the respective award. In connection with certain of the loans for those shares, we will pay interest at commercially reasonable rates on behalf of the participants. The aggregate principal indebtedness under such loans will be approximately $2,777,000. The aggregate principal indebtedness under loans in respect of which we have no ongoing obligation to pay interest will be approximately $2,009,000. The balance of the initial awards contemplate that 482,745 of the underlying common shares will be awarded in the form of restricted share units, as described below, without payment of cash consideration by the participants, but will be subject to transfer restrictions that will cease to apply and, subject to applicable securities laws, be freely tradable as to 50% after five years and the balance after ten years of continuous employment. OPTIONS The compensation committee may grant options under the equity incentive plan that entitle a participant to purchase a specified number of common shares during a specified time at a price fixed by the compensation committee on the date of grant or to be determined by a specified method, provided that such price will not be less than fair market value of a common share on the date of the grant. An option will become exercisable after or at the time such option becomes vested as determined by the compensation committee. An option will be exercisable during such 62 period(s) and on such terms as will be determined by the compensation committee and the compensation committee may, subject to regulatory approval, extend the term of an option after the date of grant provided that options must expire not later than ten years after the date of grant. An option that is not exercised will expire without any payment to the participant. Upon a participant's death, disability or retirement, the participant will, unless otherwise provided in the terms of a particular award, retain the right to exercise the vested portion of any option held by the participant for the applicable term of the option. Subject to the terms of the award, the exercise price of an option may be paid in cash, certified check or bank check, or a combination thereof, and, if the applicable award so provides, in whole or in part through the withholding of common shares subject to the option with a value equal to the exercise price. The compensation committee may also establish procedures pursuant to which an option may be exercised through a "cashless exercise" procedure involving a broker or dealer approved by the compensation committee, that affords participants the opportunity to sell immediately some or all of the common shares underlying the exercised portion of the option in order to generate sufficient cash to pay the option exercise price and/or to satisfy the minimum required withholding tax obligations related to the option. Prior to the completion of this offering we expect to grant options exercisable for 1,275,000 common shares at a price equal to the higher of the initial public offering price and the closing price of our common shares on the TSX on the date the initial public offering price is determined. RESTRICTED SHARES Subject to applicable law relating to payment for common shares, the compensation committee may grant restricted common shares that will be held in escrow rather than delivered to the participant pending the release of the applicable restrictions. The participant will generally have the right to vote the restricted shares and to receive dividends. At the discretion of the compensation committee, cash dividends and stock dividends with respect to the restricted shares may be either currently paid to the participant or withheld by us for the participant's account, subject to such terms as determined by the compensation committee. Cash dividends and stock dividends may be subject to the same restrictions as the underlying restricted shares. The duration of the restricted period and the other restrictions, if any, that will be imposed upon the restricted shares will be determined by the compensation committee at the time each grant of restricted shares is made. The compensation committee may, in any particular case and in its sole discretion, reduce any restricted period or any other restrictions regarding the transferability or forfeiture of all or a portion of any award. Upon the death or disability of a participant, the restricted period applicable to restricted shares will end as to a pro rata portion of the restricted shares and the remainder of the restricted shares comprising the grant will be forfeited and cancelled without any payment to such participant. Upon the participant's retirement at an agreed upon age or the termination of the participant's employment by us without cause or by the participant for good reason, the restricted period applicable to any restricted shares granted to such participant will terminate. The compensation committee may, however, in any particular case suspend or vary the forfeiture provisions, but only in a manner that is not adverse to the participant and complies with applicable laws and stock exchange rules. RESTRICTED SHARE UNITS The compensation committee may grant units which represent the right to receive an award of our restricted common shares on a deferred basis, subject to such vesting, forfeiture and other restrictions as the compensation committee may determine, including allowing the participant to defer settlement of the restricted share units until termination of employment or death. Each restricted share unit represents the right of the participant to receive one of our common shares. 63 Upon the grant of a restricted share unit, a participant's account will be credited with the number of restricted share units. The compensation committee has the discretion to pay cash equal to any cash dividends declared on our common shares to a participant holding restricted share units, or, alternatively, to credit the participant with further restricted share units of like value. The crediting of restricted share units to a participant's account will not confer any rights as a shareholder on the participant. INDEBTEDNESS OF DIRECTORS, EXECUTIVE OFFICERS AND SENIOR OFFICERS The aggregate outstanding indebtedness represented by loans made under our executive share purchase plan to our current and former officers, directors and employees as of December 31, 2001 was $5,542,341 and $2,141,823 to a Canadian chartered bank and our company, respectively. We pay the interest on the loans provided by the bank, calculated at rates ranging from prime plus one-half percent to prime plus one-and-a-half percent per annum. We have guaranteed the loans provided by the bank and may, under certain circumstances, be obligated to purchase the loans from the bank. The following table summarizes indebtedness of certain officers and directors represented by loans made under our executive share purchase plan:
- ----------------------------------------------------------------------------------------------------- LARGEST AMOUNT FINANCIALLY OUTSTANDING AMOUNT ASSISTED SECURITIES DURING FISCAL OUTSTANDING PURCHASED DURING SHARES YEAR ENDED AS OF FISCAL YEAR ENDED HELD AS DECEMBER 31, DECEMBER 31, DECEMBER 31, SECURITY FOR NAME AND PRINCIPAL POSITION 2001 2001 2001 INDEBTEDNESS - ----------------------------------------------------------------------------------------------------- Martin P. Hughes(1).............. $463,177 $463,177 -- 36,883 Chairman and Chief Executive Officer Richard A. Gulliver.............. 397,147 397,147 -- 52,444 President and Chief Operating Officer R. Craig Barton.................. 545,877 545,877 -- 86,937 President, Canadian Operations W. Kirk James(1)................. 125,580 125,580 -- 11,765 Vice President, Secretary and General Counsel Jean Martin...................... 52,445 52,445 -- 6,187 Vice President - -----------------------------------------------------------------------------------------------------
(1) When we implement our restricted share plan, Mr. Hughes and Mr. James will no longer participate in our executive share purchase plan. 64 The aggregate indebtedness of our directors, executive officers and senior officers, other than under our executive share purchase plan is $50,801 as at December 31, 2001, and is summarized in the following table:
- --------------------------------------------------------------------------------------------------- LARGEST AMOUNT AMOUNT OUTSTANDING DURING AMOUNT OUTSTANDING AS FISCAL YEAR ENDED OUTSTANDING AS OF OF NAME AND PRINCIPAL POSITION DECEMBER 31, 2001 DECEMBER 31, 2001 MARCH 31, 2002 - --------------------------------------------------------------------------------------------------- R. Craig Barton(1)..................... $ 22,187 $18,684 -- President, Canadian Operations W. Kirk James(2)....................... 105,546 60,197 -- Vice President, Secretary and General Counsel - ---------------------------------------------------------------------------------------------------
(1) A non-interest bearing loan made by our subsidiary Barton Insurance to R.C. Barton Ltd., a corporation controlled by Mr. Barton, to facilitate the acquisition of shares in the capital of Barton Insurance. (2) A non-interest bearing loan made by us to Mr. James to facilitate the relocation of his principal residence from London, Ontario to Toronto, Ontario and from Toronto, Ontario to Chicago, Illinois. 65 CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS BUSINESS RELATIONSHIPS RELATIONSHIPS WITH INSURANCE COMPANIES OWNED BY FAIRFAX Most of the founding 11 brokerages have generated a significant portion of their revenue from the sale of insurance policies issued by Lombard Canada Ltd., a property and casualty insurer which is a wholly-owned subsidiary of Fairfax. Certain of the founding 11 brokerages and their principals have in the past received financial support from Lombard in accordance with standard practice between insurance companies and their significant brokers. Such financial support was primarily in the form of loans and equity investments negotiated at arms length between the parties. Certain of the former shareholders of the founding 11 brokerages who are officers or employees of the founding 11 brokerages or Hub or associates of such individuals remain indebted to Lombard in an aggregate amount of approximately C$5.2 million. We also had transactions with and recorded commission income from the following Fairfax insurance companies which represented approximately 4.9%, 8.6% and 12.1% of our total revenue in 2001, 2000 and 1999, respectively.
- ---------------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, (IN THOUSANDS) 2001 2000 1999 - ---------------------------------------------------------------------------------------- Lombard General Insurance Company of Canada................. $6,123 $7,527 $6,077 Commonwealth Insurance Company.............................. 374 351 353 Federated Insurance Company of Canada....................... 28 10 1 Markel Insurance Company of Canada.......................... 88 72 61 Crum & Forster Insurance.................................... 745 291 67 TIG Specialty Insurance..................................... 150 -- -- -------------------------- Total................................................... $7,508 $8,251 $6,559 - ----------------------------------------------------------------------------------------
As of December 31, 2001, we had accounts receivable and accounts payable balances with the Fairfax insurance companies in the amounts of $0.3 million and $6.8 million, respectively. All revenue and related accounts receivable and accounts payable are the result of transactions in the normal course of business and were transacted at fair market value. As part of our acquisition of Kaye, we acquired Old Lyme but have since sold Old Lyme to a subsidiary of Fairfax, at a purchase price equivalent to its U.S. GAAP book value as of December 31, 2001 of approximately $43.5 million. The sale of Old Lyme was completed on May 30, 2002. In connection with the sale of Old Lyme, we entered into four agreements with Old Lyme under which some of our subsidiaries will continue to provide services that they had previously provided to Old Lyme. As a result of our sale of Old Lyme the amount of our revenue generated from transactions with insurance companies owned by Fairfax will increase in 2002. Claims services agreement. We will provide claims settlement and administration services to Old Lyme. Such services will include analysis, investigation, adjustment, settlement and denial of claims. Compensation will be based on a schedule. Underwriting services agreement. We will provide underwriting-related services to Old Lyme, including, but not limited to, receiving and reviewing applications submitted by producing brokers and determining the premium to be charged. We will be compensated on a commission basis. Administrative services and cost allocation agreement. We will provide certain administrative 66 services to Old Lyme, including actuarial, audit, executive, legal, personnel, accounting and other financial services. In addition, we will provide office space and office equipment. Compensation will be based on the actual cost we incur to provide the services. Contingent compensation agreement. We have entered into an agreement with Fairfax pursuant to which Fairfax will compensate us for business we produce, which is underwritten directly or assumed by Old Lyme. We will be compensated on a commission basis equal to a percentage of Old Lyme's underwriting profit generated from business we place. Although we will not incur underwriting risk, under the agreement Fairfax will be entitled to offset a percentage of underwriting losses resulting from new business we place against our future contingent commissions. FAIRFAX INSURANCE COVERAGE Fairfax has purchased an insurance policy from Lloyd's of London and various other insurance companies covering comprehensive crime insurance, insurance companies professional liability insurance, directors' and officers' liability and company reimbursement insurance, employment practices liability insurance and fiduciary liability insurance. Fairfax's coverage under the policy is subject to an overall aggregate limit of $250 million combined during the policy period which runs from May 31, 2000 to May 31, 2003, subject to various single loss limits, deductibles, retentions, and other exclusions, adjustments and limitations. The comprehensive crime insurance portion of the policy covers specified losses sustained by Fairfax and certain entities in which more than 50% of the outstanding voting shares are owned directly or indirectly by Fairfax, and other entities in which Fairfax maintains an ownership interest, including us. The professional liability insurance, directors' and officers' liability and company reimbursement insurance, employment practices liability insurance and fiduciary liability insurance portion of the policy cover specified losses sustained by the companies and their officers and directors in respect of claims made during the policy period. Coverage includes directors and officers and company liability coverage, employment practices coverage, fiduciary liability coverage, and errors and omissions coverage. Our share of the premiums for this policy for the year ended December 31, 2001 was $350,000. RELATIONSHIPS WITH SENIOR OFFICERS AND DIRECTORS When we acquire a brokerage we only purchase the brokerage operations and not other assets such as a building from which a brokerage operates. In circumstances where the former principal of an acquired brokerage owns the office space, we frequently enter into an agreement to lease the premises from the former principal at fair market value. R. Craig Barton, President of our Canadian Operations and President of Barton Insurance, leases four premises to us through a company he controls. The following table lists the annual base rent and expiry date of each lease.
- --------------------------------------------------------------------------------- ANNUAL BASE RENT EXPIRY DATE - --------------------------------------------------------------------------------- C$138,000................................................... December 31, 2010 C$59,400.................................................... November 30, 2008 C$21,450.................................................... November 30, 2008 C$285,524................................................... December 31, 2007 - ---------------------------------------------------------------------------------
In addition, we lease one of our locations from Mr. Barton's brother, at an annual rent of C$45,320. This lease expires on November 30, 2008. Under the terms of the leases, after five years the annual base rent will increase by 20%. We believe that each of these leases represents the fair market value of the associated premises. 67 PUT OPTIONS In conjunction with our acquisition of Flanagan and Burnham in 2001, we granted to the former owners of the brokerages the right to require us to repurchase our shares issued in consideration of the purchase price of the respective brokerage, in accordance with the schedule set out below, if the trading price of our shares is below C$17.00 per share at these specified exercise dates. FLANAGAN
- -------------------------------------------------------------------------------- EXERCISE DATE NUMBER OF SHARES - -------------------------------------------------------------------------------- June 18, 2006............................................... 340,000 (50.0%) June 18, 2007............................................... 68,000 (10.0%) June 18, 2011............................................... 272,000 (40.0%) ------------------ Total..................................................... 680,000 (100.0%) - --------------------------------------------------------------------------------
BURNHAM
- ---------------------------------------------------------------------------------- EXERCISE DATE NUMBER OF SHARES - ---------------------------------------------------------------------------------- July 1, 2006................................................ 873,062 (61.4%) July 1, 2011................................................ 549,772 (38.6%) -------------------- Total..................................................... 1,422,834 (100.0%) - ----------------------------------------------------------------------------------
In the event of special circumstances, such as attaining age 60, death, disability or dismissal without cause, the put options are exercisable relative to all of the shares held by the respective individuals. In addition, the put options are effective with respect to any shares that such individuals may receive as contingent consideration in connection with the Flanagan acquisition and the Burnham acquisition (estimated at about an aggregate maximum of 420,000 shares). See "Management's discussion and analysis of financial conditions and results of operations--Contingent obligations." In the event that any put options are exercised, we have the option to require the Flanagan and Burnham shareholders to sell their shares on the open market. We would then be required to make a payment to the selling shareholders equal to the difference between the sale price of the shares being sold and C$17.00 per share. 68 PRINCIPAL SHAREHOLDERS The following tables sets forth information with respect to the beneficial ownership of our issued share capital, comprised solely of common shares, as of June 12, 2002 and as adjusted to reflect our sale of common shares in this offering by: - - all those known by us to be beneficial owners of more than five percent of the outstanding common shares; - - our top five most highly compensated named executive officers; - - each of our directors; and - - all executive officers and directors as a group. Beneficial ownership is determined in accordance with the rules of the SEC that deem shares to be beneficially owned by any person or group who has or shares voting or investment power with respect to such shares. Unless otherwise indicated, the persons names on this table have sole voting and investment control with respect to all shares beneficially owned.
- ------------------------------------------------------------------------------------------------- COMMON SHARES COMMON SHARES BENEFICIALLY OWNED BENEFICIALLY OWNED PRIOR TO THE OFFERING AFTER THE OFFERING --------------------- --------------------- NAME OF BENEFICIAL OWNER AMOUNT PERCENT AMOUNT PERCENT - ------------------------------------------------------------------------------------------------- Fairfax Financial Holdings Limited(1)............ 11,232,870 45.1% 11,232,870 37.6% Zurich Insurance Company(2)...................... 2,500,000 10.4% 2,500,000 8.6% R. Craig Barton(3)............................... 598,666 2.8% 598,666 2.3% Martin P. Hughes(4).............................. 489,048 2.3% 489,048 1.8% Bruce D. Guthart(5).............................. 439,526 2.0% 439,526 1.7% Richard A. Gulliver(6)........................... 321,844 1.5% 321,844 1.2% Jean Martin(7)................................... 226,345 1.0% 226,345 0.9% Dennis J. Pauls(8)............................... 29,323 * 29,323 * W. Kirk James(9)................................. 12,015 * 12,015 * Paul Murray...................................... 2,000 * 2,000 * Anthony F. Griffiths............................. -- -- -- -- Bradley P. Martin................................ -- -- -- -- ---------------------------------------------- Executive officers and directors as a group...... 2,118,767 9.8% 2,118,767 7.9% - -------------------------------------------------------------------------------------------------
* Indicates less than 1%. (1) Includes 3,278,904 shares issuable upon the conversion of the Fairfax notes and 638,273 shares subject to escrow releasable as to 70,920 shares on each of November 30, 2002 and 2003 and 496,433 shares on November 30, 2008. The Sixty Two Investment Company Limited, a company controlled by V. Prem Watsa, owns subordinate and multiple voting shares representing 55.8% of the total votes attached to all classes of shares of Fairfax. Mr. Watsa himself beneficially owns and controls additional subordinate voting shares which, together with the shares owned by Sixty Two, represent 56.3% of the total votes attached to all classes of Fairfax's shares. (2) Represents the shares that are issuable upon the conversion of the Zurich notes. Zurich is a wholly owned subsidiary of Zurich Financial Services Group, a Swiss Company whose shares trade on the SWX Swiss Exchange and the London Stock Exchange. Zurich has agreed to allow us to redeem the Zurich notes at our option and without penalty until June 30, 2002. Zurich has also agreed not to convert the Zurich notes until after June 30, 2002. (3) Includes 86,937 shares allocated under our executive share purchase plan of which 69,550 are not vested and which vest as to 10% of the allocated amount per year while employed and includes 356,183 shares subject to escrow restrictions, which release 62,854 shares on each of November 30, 2002 and 2004, 46,096 shares on each of November 30, 2003, 2005, 2006 and 2007 and 46,091 shares on November 30, 2008. (4) Includes 36,883 shares allocated under our executive share purchase plan of which 33,195 are not vested and which vest as to 10% of the allocated amount per year while employed and includes 452,165 shares subject to escrow restrictions, which release 45,217 shares on each of October 27, 2002, 2003 and 2004 and 316,514 shares on September 8, 2008. 69 (5) Represents 439,526 shares subject to escrow restrictions, which release 43,953 shares on each of June 30, 2004, 2005 and 2006 and 307,667 shares on June 30, 2011. (6) Includes 52,444 shares allocated under our executive share purchase plan of which 41,955 are not vested and which vest as to 10% of the allocated amount per year while employed and includes 242,460 shares subject to escrow restrictions, which release 26,940 shares on each of November 30, 2002 and 2003 and 188,580 shares on November 30, 2008. (7) Includes 6,187 shares allocated under our executive share purchase plan of which 4,950 are not vested and which vest as to 10% of the allocated amount per year while employed and includes 198,142 shares subject to escrow restrictions, which release 22,016 shares on each of November 30, 2002 and 2003 and 154,110 shares on December 6, 2006. (8) Includes 26,091 shares subject to escrow restrictions, which release 3,232 shares on November 30, 2002, 2,804 shares on November 30, 2003, 428 shares on November 30, 2004 and 19,627 shares on November 30, 2008. (9) Represents shares allocated under our executive share purchase plan of which 10,588 are not vested and which vest as to 10% of the allocated amount per year while employed. 70 DESCRIPTION OF SHARE CAPITAL Our authorized capital consists of an unlimited number of preference shares, issuable in series, and an unlimited number of common shares. After giving effect to the offering, no preference shares and 26,655,748 common shares will be issued and outstanding. The following is a summary of the material provisions of the share capital of Hub. COMMON SHARES The holders of our common shares are entitled to one vote per share at meetings of our shareholders other than those meetings where only the holders of the preference shares as a class or the holders of one or more series of the preference shares are entitled to vote. The holders of common shares will be entitled to such dividends as may be declared by the directors out of funds legally available therefore, subject to the preferential rights of the preference shares. In the event of our liquidation, dissolution or winding-up, the holders of our common shares will be entitled to receive all of the our assets remaining after the payment of all of our liabilities, subject to the preferential right of the preference shares or any other shares which may rank prior to the common shares. PREFERENCE SHARES Preference shares may be issued at any time and from time to time in one or more series, each series comprising the number of shares, and having the designation, rights, privileges, restrictions and conditions, which our board of directors determines by resolution. Our preference shares rank prior to our common shares with respect to the payment of dividends and distribution of assets in the event of our liquidation, dissolution or winding-up. Except as required by law or where the rights privileges, restrictions and conditions attaching to a series of preference shares provide for voting rights for the holders of that series of preference shares, the holders of the preference shares as a class are not entitled as such to receive notice of, to attend or to vote at any meeting of our shareholders. INDEMNIFICATION OF OFFICERS AND DIRECTORS Our by-laws provide that we will indemnify our current and former directors and officers to the fullest extent permitted by Ontario law. The by-laws also provide that we will purchase and maintain insurance for the benefit of our directors and officers to the extent permitted by Ontario law. We believe that the provisions in our by-laws are necessary to attract and retain qualified persons as directors and officers. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for our common shares is CIBC Mellon Trust Company. The co-transfer agent and co-registrar for our common shares is Mellon Investor Services LLC. 71 SHARES ELIGIBLE FOR FUTURE SALE If our shareholders sell substantial amounts of common shares in the public market following this offering, the market price of our common shares could fall. These sales also might make it more difficult for us to sell equity or equity-related securities in the future and at a time and price that we consider appropriate. Upon completion of this offering, we will have outstanding an aggregate of 26.7 million common shares. All of the common shares sold in this offering will be freely tradeable without restriction or further registration under the Securities Act, unless these common shares are purchased by our affiliates, or persons who directly or indirectly control, are controlled by or are under common control with us. Common shares held by affiliates generally may be sold only in compliance with the limitations of Rule 144 of the Securities Act described below. Upon completion of this offering, 12.4 million of our outstanding shares will be restricted securities and 9.9 million shares will be eligible for sale in the public market 180 days from the date of this prospectus. LOCK-UP AGREEMENTS All of our officers, directors and certain of our shareholders have signed lock-up agreements with the underwriters under which they agreed, subject to certain limitations, not to offer, pledge, announce the intention to sell, 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, (or enter into any swap or other agreement that transfers, in whole or part, any of the economic consequences of ownership of), any shares of our common shares, or any securities convertible into or exercisable or exchangeable for our common shares (including, common shares which may be deemed to beneficially owned by them in accordance with the rules, of the SEC) for a period of 180 days after the date of this prospectus, without the prior written consent of J.P. Morgan Securities Inc. RULE 144 In general, under Rule 144 as currently in effect, beginning 90 days after the date of this prospectus, a person who has beneficially owned restricted securities for at least one year would be entitled to sell within any three-month period a number of shares that does not exceed the greater of: - - 1% of the number of our common shares then outstanding, which will equal approximately 26,656 shares immediately after this offering; or - - the average weekly trading volume of our common shares on the NYSE during the four calendar weeks preceding the filing of a notice on Form 144 concerning that sale. Sales under Rule 144 are also subject to manner of sale provisions and notice requirements and to the availability of current public information about us. RULE 144(K) Under Rule 144(k) as currently in effect, a person who has not been one of our affiliates at any time during the 90 days preceding a sale, and who has beneficially owned restricted securities proposed to be sold for at least two years, including the holding period of any prior owner other than an affiliate, is entitled to sell those shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144. Therefore, unless otherwise restricted, Rule 144(k) shares may be sold immediately upon the completion of this offering. 72 RULE 701 In general, under Rule 701 of the Securities Act as currently in effect, any of our employees, consultants or advisors who purchases our common shares from us in connection with a compensatory stock plan or other written agreement is eligible to resell those shares 90 days after the effective date of this prospectus in reliance on Rule 144. EQUITY INCENTIVE PLAN Shortly after this offering, we intend to file a registration statement on Form S-8 covering the common shares reserved for issuance under our plans that will provide for the issuance of our restricted shares, awards of units representing our restricted shares and options to purchase our common shares. The common shares covered by the Form S-8 registration statement will be freely tradeable, subject to volume restrictions applicable to affiliates and other restrictions applicable under the equity incentive plan. Prior to the completion of this offering we expect to grant options exercisable for 1,275,000 common shares at a price equal to the higher of the initial public offering price and the closing price of our common shares on the TSX on the date the initial public offering price is determined. In addition, we have agreed to award 254,033 restricted shares and 482,745 restricted share units under our equity incentive plan. 73 CERTAIN UNITED STATES AND CANADIAN FEDERAL INCOME TAX CONSIDERATIONS CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS This section describes the material United States federal income tax consequences of the purchase, ownership and disposition of the common shares, subject to the limitations provided herein. This section assumes that you will hold your common shares as capital assets for United States federal income tax purposes. This section does not discuss special rules that may apply to you if you are a member of a class of holders subject to special rules, including if you are: - - a bank; - - a dealer in securities or currencies; - - a trader in securities that elects to use a mark-to-market method of accounting for your securities holdings; - - a tax-exempt organization; - - a life insurance company; - - a person liable for alternative minimum tax; - - a person that actually or constructively owns 10% or more of our voting shares; - - a person that holds common shares as part of a straddle, hedging or conversion transaction; or - - a person whose functional currency is not the U.S. dollar. This section is based on the Internal Revenue Code of 1986, as amended, its legislative history, existing and proposed regulations, published rulings and court decisions, all as currently in effect. These laws are subject to change, possibly on a retroactive basis. For purposes of this discussion, you are a U.S. holder if you are a beneficial owner of common shares and you are: - - a citizen or resident of the United States; - - a corporation, partnership or other entity organized under the laws of the United States or any state thereof; - - an estate whose income is subject to United States federal income tax regardless of its source; or - - a trust (a) if a United States court can exercise primary supervision over the trust's administration and one or more United States persons are authorized to control all substantial decisions of the trust or (b) that has elected to be treated as a United States person under applicable Treasury regulations. You should consult your own tax advisor regarding the United States federal, state and local and other tax consequences of owning and disposing of common shares in your particular circumstances. TAXATION OF DIVIDENDS U.S. holders. Subject to the passive foreign investment company rules discussed below, if you are a U.S. holder, you must include in your gross income as ordinary income the gross amount of any dividend paid by us out of our current or accumulated earnings and profits (as determined for United States federal income tax purposes). You must include the dividend in income when you receive the dividend, actually or constructively. The dividend will not be eligible for the dividends- 74 received deduction generally allowed to United States corporations in respect of dividends received from other United States corporations. The amount of the dividend distribution that you must include in your income will be the U.S. dollar value of the Canadian dollar payments made, determined at the Canadian dollar to U.S. dollar "spot rate" on the date the dividend distribution is includible in your income, regardless of whether the payment is in fact converted into U.S. dollars. Generally, any gain or loss resulting from currency exchange fluctuations during the period from the date you include the dividend payment in income to the date you convert the payment into U.S. dollars will be treated as ordinary income or loss. This income or loss generally will be income or loss from sources within the United States for foreign tax credit limitation purposes. Distributions in excess of our current and accumulated earnings and profits (as determined for United States federal income tax purposes) will be treated as a non-taxable return of capital to the extent of your basis in the common shares and thereafter as capital gain. We do not maintain calculations of earnings and profits (as determined for United States federal income tax purposes). For purposes of this discussion, the "spot rate" generally means a rate that reflects a fair market rate of exchange available to the public for currency under a "spot contract" in a free market and involving representative amounts. A "spot contract" is a contract to buy or sell a currency on or before two business days following the date of the execution of the contract. If such a spot rate cannot be demonstrated, the Internal Revenue Service has the authority to determine the "spot rate." A portion of dividends paid by us, as a foreign corporation which is engaged in a U.S. trade or business, will be treated as domestic source income because 25% or more of our worldwide gross income over a three-year testing period (ending with the close of the our taxable year immediately preceding the declaration of a dividend) is effectively connected with our U.S. business or is treated as effectively connected. The dividends will be U.S. source income to the extent our gross income for the testing period is effectively connected income, or treated as such, in relation to our gross income from all sources for such period. The remainder of the dividends from the common shares will be classified as foreign source income. The foreign source income generally will be "passive income" or "financial services income" which will be treated separately from other types of income for purposes of computing the foreign tax credit allowable to you. The rules relating to foreign tax credits are extremely complex and the availability of a foreign tax credit depends on numerous factors. You should consult your own tax advisors concerning the application of the U.S. foreign tax credit rules to your particular situation. TAXATION OF CAPITAL GAINS U.S. holders. Subject to the passive foreign investment company rules discussed below, if you are a U.S. holder and you sell or otherwise dispose of your common shares, you will recognize capital gain or loss for United States federal income tax purposes equal to the difference between the U.S. dollar value of the amount that you realize and your tax basis, determined in U.S. dollars, in your common shares. Capital gain of a non-corporate U.S. holder is generally taxed at a maximum rate of 20% if the property has been held more than one year and 18% if the property has been held for more than five years. The deductibility of capital losses is subject to limitations. The gain or loss will generally be gain or loss from sources within the United States for foreign tax credit limitation purposes. PASSIVE FOREIGN INVESTMENT COMPANY RULES We do not expect to be considered a passive foreign investment company, but this conclusion is a factual determination that is made annually and this may be subject to change. In general, if you 75 are a United States holder, we will be a passive foreign investment company with respect to you if, for any taxable year in which you held our common shares: - - 75% or more of our gross income for the taxable year is "passive income"; or - - 50% or more of the average quarterly value of our assets consists of assets that produce, or are held for the production of, passive income. Passive income generally includes dividends, interest, royalties, rents (other than certain rents and royalties derived in the active conduct of a trade or business) and net gains from the disposition of assets that produce passive income. For purposes of determining whether we will be treated as a passive foreign investment company, we will be treated as holding our proportionate share of the assets of any corporation in which we owned, directly or indirectly, 25%, by value, of the corporation's stock and we will be treated as receiving directly our proportionate share of the corporation's income. If we are treated as a passive foreign investment company, and you are a U.S. holder that does not make a mark-to-market election, as described below, you will be subject to special rules with respect to: - - any gain you realize on the sale or other disposition of your common shares; and - - any excess distribution that we make to you (generally, any distributions to you during a single taxable year that are greater than 125% of the average annual distributions received by you in respect of the ordinary shares during the three preceding taxable years or, if shorter, your holding period for the common shares). Under these rules: - - the gain or excess distribution will be allocated ratably over your holding period for the common shares; - - the amount allocated to the taxable year in which you realized the gain or excess distribution or to any years prior to our being treated as a passive foreign investment company will be taxed as ordinary income; - - the amount allocated to each prior year other than a year prior to the first year in which we were a passive foreign investment company, with certain exceptions, will be taxed at the highest federal income tax rate in effect for that year with respect to ordinary income; and - - the interest charge generally applicable to underpayments of tax will be imposed in respect of the tax attributable to each such year. These rules apply even if we would not be considered a passive foreign investment company in a subsequent year, unless you make an election to be taxed under these rules on any gain that would be recognized if you sold your common shares on the last day of the last taxable year in which we were a passive foreign investment company. Special rules apply for calculating the amount of the foreign tax credit with respect to excess distributions by a passive foreign investment company. The foregoing rules with respect to distribution and dispositions may be avoided if you are eligible for and timely make either a valid "qualifying electing fund" election, in which case you would be required to include in income on a current basis your pro rata share of our ordinary income and net capital gains. We do not currently intend to complete the actions necessary for U.S. holders to make a qualifying electing fund election in the event that we are considered a passive foreign investment company for any taxable year. 76 If we are a passive foreign investment company and the common shares are treated as "marketable stock" under applicable Treasury regulations, you may make a mark-to-market election. With respect to your common shares, if you make this election, you will not be subject to the passive foreign investment company rules described above. Instead, in general, you will include as ordinary income each year the excess, if any, of the fair market value of your common shares at the end of the taxable year over your adjusted basis in your common shares. You will also be allowed to take an ordinary loss in respect of the excess, if any, of the adjusted basis of your common shares over their fair market value at the end of the taxable year (but only to the extent of the net amount of previously included income as a result of the mark-to-market election). Your basis in the common shares will be adjusted to reflect any such income or loss amounts. The mark-to-market election is made on a shareholder-by-shareholder basis and, once made, can only be revoked with the consent of the Internal Revenue Service. Under applicable Treasury regulations, the term "marketable stock" includes stock of a passive foreign investment company that is "regularly traded" on a qualified exchange or other market. For these purposes, a class of stock is regularly traded on a qualified exchange or other market for any calendar year during which such class of stock is traded (other than in de minimis quantities) on at least 15 days during each calendar quarter. The New York Stock Exchange is a qualified exchange and it is expected that there will be sufficient trading in the shares so that any will be treated as "regularly traded", but no assurances can be given. If you own common shares during any year that we are a passive foreign investment company, you must file Internal Revenue Service Form 8621 with your annual United States federal income tax return for each year in which you own common shares even if we subsequently would not be considered a passive foreign investment company. If we are a passive foreign investment company, U.S. holders who acquire common shares from decedents could be denied the step-up of the income tax basis for such common shares, which would otherwise have been available. INFORMATION REPORTING AND BACK-UP WITHHOLDING You may be subject to information reporting on dividends or sales proceeds on the common shares unless you establish that you are an "exempt recipient" for purposes of the information reporting rules. If you do not establish that you are an exempt recipient, you may be subject to backup withholding on these amounts if you do not provide a correct taxpayer identification number. You generally may obtain a credit against your United States federal income tax liability for any amounts withheld under the backup withholding rules and a refund for amounts that exceed your income tax liability by filing the required information with the United States Internal Revenue Service. CERTAIN CANADIAN FEDERAL INCOME TAX CONSIDERATIONS The following is a summary of the principal Canadian federal income tax considerations generally applicable to the holders described below. This summary is based on the current provisions of the Income Tax Act, the regulations thereunder, all specific proposals to amend the Income Tax Act or the regulations publicly announced by the Minister of Finance (Canada) prior to the date hereof, and counsel's understanding of the current administrative practices of the Canada Customs and Revenue Agency. This summary is not exhaustive of all possible Canadian federal income tax considerations and, except as mentioned above, does not take into account or anticipate any changes in law, whether by legislative, administrative or judicial decision or action, nor does it take into account provincial, territorial or foreign tax legislation or considerations, which may differ from the federal income tax considerations described herein. 77 THIS SUMMARY IS OF A GENERAL NATURE ONLY AND IS NOT INTENDED TO BE, NOR SHOULD IT BE CONSTRUED TO BE, LEGAL OR TAX ADVICE TO ANY PARTICULAR HOLDER, AND NO REPRESENTATION WITH RESPECT TO THE INCOME TAX CONSEQUENCES TO ANY PARTICULAR HOLDER IS MADE. CONSEQUENTLY, PROSPECTIVE PURCHASERS SHOULD CONSULT THEIR OWN TAX ADVISORS WITH RESPECT TO THEIR PARTICULAR CIRCUMSTANCES. The following summary is generally applicable to a person (a "Non-Resident Holder"): (1) who acquires common shares under this offering, (2) who holds such common shares as capital property, (3) who, at all relevant times, for purposes of the Income Tax Act and any applicable tax treaty or convention, is not a resident of Canada, (4) who does not use or hold (and will not use or hold) and is not deemed to use or hold the common shares in, or in the course of, carrying on a business in Canada and does not carry on an insurance business in Canada and elsewhere, and (5) whose shares do not constitute "taxable Canadian property" for purposes of the Income Tax Act. Provided that the common shares are listed on a prescribed stock exchange (which includes the TSX and the NYSE) at a particular time, the common shares will generally not constitute taxable Canadian property to a Non-Resident Holder at that time. This rule applies unless, at any time during the five-year period immediately preceding that time, 25% or more of the issued shares of any class or series of a class of Hub capital stock was owned by the Non-Resident Holder, persons with whom the Non-Resident Holder did not deal at arm's length or any combination thereof. For this purpose, the Non-Resident Holder and persons with whom the Non-Resident Holder did not deal at arm's length are considered to own any shares which such Non-Resident Holder or such persons have an interest in or an option in respect of. A Non-Resident Holder's common shares can be deemed to be taxable Canadian property in certain circumstances set out in the Income Tax Act. Dividends on common shares paid or credited or deemed under the Income Tax Act to be paid or credited to a Non-Resident Holder generally will be subject to Canadian withholding tax at the rate of 25%, subject to any applicable reduction in the rate of withholding in an applicable tax treaty where the Non-Resident Holder is a resident of a country with which Canada has an income tax treaty. Where the Non-Resident Holder is a U.S. resident entitled to benefits under the Canada--U.S. Income Tax Convention, dividends on common shares generally will be subject to Canadian withholding tax at the rate of 15%. A Non-Resident Holder will not be subject to tax under the Income Tax Act in respect of any capital gain realized on the disposition of common shares. THE ABOVE SUMMARY IS NOT INTENDED TO CONSTITUTE A COMPLETE ANALYSIS OF ALL TAX CONSEQUENCES RELATING TO ACQUISITION, OWNERSHIP AND DISPOSITION OF COMMON SHARES. PROSPECTIVE PURCHASERS OF COMMON SHARES SHOULD CONSULT THEIR OWN TAX ADVISORS CONCERNING THE TAX CONSEQUENCES OF THEIR PARTICULAR SITUATIONS. 78 UNDERWRITING Subject to the terms and conditions of an underwriting agreement, dated the date of this prospectus, the underwriters named below, who are represented by J.P. Morgan Securities Inc., have severally agreed to purchase from us the respective number of common shares shown opposite their names below.
- ------------------------------------------------------------------------------ NAME NUMBER OF SHARES - ------------------------------------------------------------------------------ J.P. Morgan Securities Inc. ................................ Cochran, Caronia Securities LLC ............................ Stephens Inc. .............................................. BMO Nesbitt Burns Corp. .................................... Ferris, Baker Watts, Incorporated........................... ----------- Total....................................................... 5,000,000 - ------------------------------------------------------------------------------
The underwriting agreement provides that the obligations of the underwriters are subject to certain conditions precedent, including the absence of any material adverse change in our business and the receipt of certain certificates, opinions and letters from us, our counsel and our independent auditors. The underwriters are committed to purchase all of our common shares if they purchase any shares. The following table shows the underwriting fees to be paid to the underwriters by us in connection with this offering. These amounts are shown assuming both no exercise and full exercise of the underwriters' option to purchase additional common shares. UNDERWRITING COMMISSIONS
- ---------------------------------------------------------------------------------------------------- WITHOUT OVER- WITH OVER- ALLOTMENT EXERCISE ALLOTMENT EXERCISE - ---------------------------------------------------------------------------------------------------- Per share $ $ Total $ $ - ----------------------------------------------------------------------------------------------------
We will pay the offering expenses, estimated to be $1.5 million, excluding underwriting commissions. The underwriters propose to initially offer some of the common shares directly to the public at the public offering price on the cover page of this prospectus and some of the shares to dealers at the public offering price less a concession not in excess of $ per share. The underwriters may allow, and these dealers may re-allow, a concession not in excess of $ per share on sales to other dealers. After the initial offering of the shares to the public, the representative of the underwriters may change the public offering price and such concessions. The underwriters do not intend to confirm sales to any accounts over which they exercise discretionary authority. We have granted to the underwriters an option, exercisable for 30 days after the date of the underwriting agreement, to purchase up to 750,000 additional common shares at the initial public offering price less the underwriting fees. The underwriters may exercise this option solely to cover over-allotments, if any, made in connection with this offering. To the extent that the underwriters exercise this option, each of the underwriters will have a firm commitment to purchase approximately the same percentage thereof which the number of common shares to be purchased by it shown in the above table bears to the total number of common shares offered hereby. We 79 will be obligated, pursuant to the option, to sell shares to the underwriters to the extent the option is exercised. The underwriters may exercise this option only to cover over-allotments made in connection with the sale of common shares offered hereby. The offering of our common shares is made for delivery when, as and if accepted by the underwriters and subject to prior sale and to withdrawal, cancellation, or modification of the offering without notice. The underwriters reserve the right to reject an order for the purchase of common shares in whole or in part. We have agreed to indemnify the underwriters against certain liabilities, including liabilities under the Securities Act, or to contribute the payments that the underwriters may be required to make in respect of these liabilities. We, our executive officers and directors and certain of our shareholders have agreed, subject to limited exceptions, for a period of 180 days after the date of this prospectus, not to, without the prior written consent of J.P. Morgan Securities Inc.: - - 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 common shares or any securities convertible into or exercisable or exchangeable for common shares; or - - enter into any swap or other arrangement that transfers all or a portion of the economic consequences associated with the ownership of any common shares. Either of the foregoing transfer restrictions will apply regardless of whether a covered transaction is to be settled by the delivery of common shares or such other securities, in cash or otherwise. In addition, during this 180-day period, we have also agreed not to file any registration statement for, and each of our executive officers, directors and several shareholders have agreed not to make any demand for, or exercise any right of, the registration of any shares of common shares or any securities convertible into or exercisable or exchangeable for common shares without the prior written consent of J.P. Morgan Securities Inc. We have been authorized to list our common shares on the NYSE under the symbol HBG. The common shares to be sold in the offering have not been and will not be qualified for sale under the securities laws of any province or territory of Canada. The common shares to be sold in the offering may not be offered or sold, directly or indirectly, in Canada, or to or for the benefit of any resident thereof. Each underwriter has agreed that it will: a) not, directly or indirectly, offer, sell or deliver common shares in Canada or to persons who are residents of Canada or acting on the behalf of residents of Canada or to any person whom it believes intends to reoffer, resell or deliver the shares in Canada or to any persons who are residents of Canada or acting on the behalf of residents of Canada; and b) cause any dealer to whom it may sell such shares to agree to observe a similar restriction. Confirmations of the acceptance of offers to purchase any common shares will be sent to purchasers who have not withdrawn their offers to purchase prior to the issuance of such confirmations. Each purchaser of common shares who receives a purchase confirmation is, by the purchaser's receipt thereof, deemed to represent to us, the underwriters and the dealers from whom such purchase confirmation is received, that such purchaser is not a resident of Canada or acting on behalf of any resident of Canada and does not have a current intention to reoffer, resell or deliver the common shares in Canada or to a resident of Canada or a person acting on behalf of a resident of Canada. We have been advised by the representative that, pursuant to Regulation M under the Securities Act, some persons participating in the offering may engage in transactions, including syndicate covering transactions, stabilizing bids or the imposition of penalty bids, that may have the effect of 80 stabilizing or maintaining the market price of our common shares at a level above that which might otherwise prevail in the open market. A "syndicate covering transaction" is a bid for or the purchase of common shares on behalf of the underwriters to reduce a syndicate short position incurred by the underwriters in connection with the offering. The underwriters may create a syndicate short position by making short sales of our common shares and may purchase our common shares in the open market to cover syndicate short positions created by short sales. Short sales involve the sale by the underwriters of a greater number of common shares than they are required to purchase in the offering. Short sales can be either "covered" or "naked." "Covered" short sales are sales made in an amount not greater than the underwriters' over-allotment option to purchase additional shares from us in the offering. "Naked" short sales are sales in excess of the over-allotment option. A naked short position is more likely to be created if the underwriters are concerned that there may be downward pressure on the price of our common shares in the open market after pricing that could adversely affect investors who purchase in the offering. If the underwriters create a syndicate short portion, they may choose to reduce or "cover" this position by either exercising all or part of the over-allotment option to purchase additional shares from us or by engaging in "syndicate covering transactions." The underwriters may close out any covered short position by either exercising their over-allotment option or purchasing shares in the open market. The underwriters must close out any naked short position by purchasing shares in the open market. In determining the source of shares to close out the covered short position, the underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which they may purchase shares through the over-allotment option. A "stabilizing bid" is a bid for, or the purchase of, common shares on behalf of the underwriters for the purpose of fixing or maintaining the price of our common shares. A "penalty bid" is an arrangement that permits the representative to reclaim the selling concession from an underwriter or a syndicate member when our common shares sold by such underwriter or syndicate member are purchased by the representative in the syndicate covering transaction and therefore have not been effectively placed by the underwriter or syndicate member. We have been advised by the representative that these transactions may be effected on the NYSE or otherwise, but not on the TSX, and, if commenced, may be discontinued at any time. Similar to other purchase activities, these activities may have the effect of raising or maintaining the market price of our common shares or preventing or retarding the decline in the market price of our common shares. As a result, the price of our common shares may be higher than the price that might otherwise exist in the open market. One or more members of the underwriting selling group may make copies of the preliminary prospectus available over the Internet to customers or through its or their websites. The underwriters may agree to allocate a number of shares to members of the underwriting selling group for sale to their respective online brokerage account holders. Internet distributions will be allocated by the underwriters and selling group members that will make Internet distributions on the same basis as other allocations. 81 LEGAL MATTERS Legal matters relating United States law will be passed upon for us by Shearman & Sterling, Toronto, Canada. The validity of the issuance of the common shares to be sold in the offering and other legal matters relating to Canadian law will be passed upon for us by Torys LLP, Toronto, Canada. Legal matters relating to United States law will be passed upon for the underwriters by Davis Polk & Wardwell, New York, New York and certain matters relating to Canadian law will be passed upon for the underwriters by Osler Hoskin & Harcourt LLP, New York, New York. EXPERTS The consolidated financial statements of Hub International Limited as of December 31, 2001 and 2000 and for each of the three years in the period ended December 31, 2001 included in this prospectus have been so included in reliance on the report of PricewaterhouseCoopers LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting. The consolidated financial statements of Kaye Group Inc. as of June 28, 2001, and December 31, 2000 and 1999, and for the period January 1, 2001 through June 28, 2001, and for each of the three years in the period ended December 31, 2000 included in this prospectus have been so included in reliance on the reports of PricewaterhouseCoopers LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting. WHERE YOU CAN FIND MORE INFORMATION We have filed with the SEC a registration statement on Form S-1 under the Securities Act, and the rules and regulations promulgated thereunder, with respect to our common shares offered by this prospectus. This prospectus, which constitutes a part of the registration statement, does not contain all of the information set forth in the registration statement and the exhibits filed as part of the registration statement. For further information about the common shares offered by this prospectus, we refer you to the registration statement. Statements contained in this prospectus as to the contents of any contract or other document that is filed as an exhibit to the registration statement are not necessarily complete. If a contract or document has been filed as an exhibit to the registration statement, we refer you to the copy of the contract or document that has been filed, which qualifies each statement about such contract or document contained in this prospectus. You may read and copy all or any portion of the registration statement and the exhibits at the SEC's public reference room at 450 Fifth Street N.W., Washington, D.C. 20549, and at the regional offices of the SEC located at 233 Broadway Avenue, New York, New York 10279 and Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. You can request copies of these documents, upon payment of a duplication fee, by writing to the SEC. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the SEC's public reference rooms. Also, the SEC maintains a World Wide Web site on the Internet at http://www.sec.gov that contains reports, proxy and information statements and other information regarding registrants that file electronically with the SEC. As a result of this offering, we will become subject to the information and periodic reporting requirements of the Exchange Act and, in accordance therewith, will file periodic reports, proxy and information statements and other information with the SEC. These periodic reports, proxy, and information statements and other information will be available for inspection and copying at the public reference facilities, regional offices and SEC's Web site referred to above. 82 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
HUB INTERNATIONAL LIMITED PAGE Consolidated Balance Sheets as of March 31, 2002 and December 31, 2001......................................... F-3 Consolidated Statements of Earnings for the three months ended March 31, 2002 and 2001............................. F-4 Consolidated Statements of Retained Earnings for the three months ended March 31, 2002 and 2001...................... F-5 Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and 2001............................. F-6 Notes to Interim Consolidated Financial Statements.......... F-7 HUB INTERNATIONAL LIMITED Auditors' Report to the Board of Directors and Shareholders of Hub International Limited.............................. F-15 Consolidated Balance Sheets as of December 31, 2001 and 2000...................................................... F-16 Consolidated Statements of Earnings for the Years Ended December 31, 2001, 2000 and 1999.......................... F-17 Consolidated Statements of Retained Earnings (Deficit) for the Years Ended December 31, 2001, 2000 and 1999.......................... F-18 Consolidated Statements of Cash Flows for the Years Ended December 31, 2001, 2000 and 1999.......................... F-19 Notes to Consolidated Financial Statements.................. F-20 KAYE GROUP INC. Report of Independent Accountants to the Board of Directors of Kaye Group Inc......................................... F-45 Consolidated Balance Sheet as of June 28, 2001.............. F-46 Consolidated Statement of Operations for the period January 1, 2001 through June 28, 2001............................. F-48 Consolidated Statement of Stockholders' Equity for the period January 1, 2001 through June 28, 2001.............. F-49 Consolidated Statements of Comprehensive Loss for the period January 1, 2001 through June 28, 2001..................... F-50 Consolidated Statements of Cash Flows for the period January 1, 2001 through June 28, 2001............................. F-51 Notes to Consolidated Financial Statements.................. F-52 KAYE GROUP INC. Report of Independent Accountants to the Board of Directors and Stockholders of Kaye Group Inc........................ F-68 Consolidated Balance Sheets as of December 31, 2000 and 1999...................................................... F-69 Consolidated Statements of Income for the years ended December 31, 2000, 1999 and 1998.......................... F-71 Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998.......................... F-72 Consolidated Statements of Stockholders' Equity for the years ended December 31, 2000, 1999 and 1998.............. F-73 Consolidated Statements of Comprehensive Income for the years ended December 31, 2000, 1999 and 1998.............. F-74 Notes to Consolidated Financial Statements.................. F-75
F-1
KAYE GROUP INC. PAGE Financial Statement Schedules: Schedule II--Condensed Financial Information of Registrant: Balance Sheets as of December 31, 2000 and 1999........... F-94 Statements of Income for the years ended December 31, 2000, 1999 and 1998.................................... F-95 Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998.................................... F-96 Notes to Condensed Financial Statements................... F-97 Schedule IV--Reinsurance for the years ended December 31, 2000, 1999 and 1998....................................... F-98 Schedule VI--Supplemental Information Concerning Property-Casualty Insurance Operations for the years ended December 31, 2000, 1999 and 1998.......................... F-99
The information for Schedule I is contained in the Notes to the Consolidated Financial Statements. The information for Schedule III is included in Schedule VI. The information required for Schedule V is not applicable. F-2 HUB INTERNATIONAL LIMITED CONSOLIDATED BALANCE SHEETS As of March 31, 2002 and December 31, 2001 (in thousands of U.S. dollars)
2002 2001 ----------- -------- (UNAUDITED) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 18,526 $ 26,979 Trust cash 40,944 50,426 Accounts and other receivables 77,228 101,313 Investment held for sale 40,938 40,772 Income taxes receivable 1,167 1,460 Future income taxes 2,238 1,999 Prepaid expenses 3,265 2,471 -------- -------- TOTAL CURRENT ASSETS 184,306 225,420 Capital assets 20,373 20,935 Other intangible assets 24,764 25,331 Goodwill 220,314 220,848 Future income taxes 2,810 2,671 Other assets 6,964 7,091 -------- -------- TOTAL ASSETS $459,531 $502,296 --------- -------- LIABILITIES CURRENT LIABILITIES: Bank debt $ 55,000 $ 55,000 Accounts payable and accrued liabilities 118,451 164,094 Future income taxes 758 1,387 Current portion long-term debt and capital leases 3,436 4,169 -------- -------- TOTAL CURRENT LIABILITIES 177,645 224,650 Long-term debt and capital leases 74,243 76,159 Subordinated convertible debentures 61,671 61,624 Future income taxes 4,954 4,592 -------- -------- TOTAL LIABILITIES 318,513 367,025 -------- -------- COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY Share capital 125,506 125,506 Cumulative translation account 3,578 2,770 Retained earnings 11,934 6,995 -------- -------- TOTAL SHAREHOLDERS' EQUITY 141,018 135,271 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $459,531 $502,296 --------- --------
(the accompanying notes form an integral part of the interim financial statements) F-3 HUB INTERNATIONAL LIMITED CONSOLIDATED STATEMENTS OF EARNINGS For the three months ended March 31, 2002 and 2001 (in thousands of U.S. dollars, except per share amounts) (Unaudited)
2002 2001 ------- ------------ (AS RESTATED SEE NOTE 1) REVENUE Commission income $41,393 $23,211 Contingent commissions and volume overrides 6,175 4,001 Other 1,916 885 ------- ------- 49,484 28,097 ------- ------- EXPENSES Remuneration 27,690 16,083 Selling 2,921 1,719 Occupancy 2,725 1,569 Depreciation 1,280 572 Administration 5,214 2,832 ------- ------- 39,830 22,775 ------- ------- NET EARNINGS BEFORE THE FOLLOWING 9,654 5,322 Interest expense 2,694 589 Goodwill and other intangible asset amortization 379 771 (Gain) loss on disposal of capital assets and investments (42) 25 Other income -- put option liability (373) -- ------- ------- NET EARNINGS BEFORE INCOME TAXES 6,996 3,937 ------- ------- PROVISION FOR INCOME TAX EXPENSE (BENEFIT) Current 2,781 1,295 Future (724) 176 ------- ------- 2,057 1,471 ------- ------- NET EARNINGS $ 4,939 $ 2,466 ------- ------------ EARNINGS PER SHARE BASIC $ 0.25 $ 0.13 DILUTED $ 0.21 $ 0.13 WEIGHTED AVERAGE SHARES OUTSTANDING -- BASIC (000'S) 19,503 18,571 WEIGHTED AVERAGE SHARES OUTSTANDING -- DILUTED (000'S) 27,460 18,571
(the accompanying notes form an integral part of the interim financial statements) F-4 HUB INTERNATIONAL LIMITED CONSOLIDATED STATEMENTS OF RETAINED EARNINGS For the three months ended March 31, 2002 and 2001 (in thousands of U.S. dollars) (Unaudited)
2002 2001 ------- ------------ (AS RESTATED SEE NOTE 1) RETAINED EARNINGS -- BEGINNING OF PERIOD $ 6,995 $ 587 Net earnings for the period 4,939 2,466 ------- ------- RETAINED EARNINGS -- END OF PERIOD $11,934 $ 3,053 ------- ------------
(the accompanying notes form an integral part of the interim financial statements) F-5 HUB INTERNATIONAL LIMITED CONSOLIDATED STATEMENTS OF CASH FLOWS For the three months ended March 31, 2002 and 2001 (in thousands of U.S. dollars) (Unaudited)
2002 2001 -------- ------------ (AS RESTATED SEE NOTE 1) OPERATING ACTIVITIES Net earnings $ 4,939 $ 2,466 Items not affecting working capital Amortization and depreciation 1,659 1,343 (Gain) loss on disposal of capital assets and investments (42) 25 Other income -- put option liability (373) -- Future income taxes (724) 176 -------- -------- 5,459 4,010 Non-cash working capital items Accounts and other receivables 23,830 6,861 Prepaid expenses (437) 150 Accounts payable and accrued liabilities (45,022) (10,944) Income taxes 222 (519) -------- -------- (15,948) (442) -------- -------- FINANCING ACTIVITIES Long-term debt and capital leases -- repayments (2,309) (1,740) Share capital -- repurchases -- (84) -------- -------- (2,309) (1,824) -------- -------- INVESTING ACTIVITIES Capital assets -- purchases (756) (531) Sale of subsidiaries 1,242 -- Purchase of subsidiaries, net of cash received -- (1,557) Other assets (164) 64 -------- -------- 322 (2,024) -------- -------- CHANGE IN CASH AND CASH EQUIVALENTS AND TRUST CASH (17,935) (4,290) CASH AND CASH EQUIVALENTS AND TRUST CASH -- BEGINNING OF PERIOD 77,405 32,275 -------- -------- CASH AND CASH EQUIVALENTS AND TRUST CASH -- END OF PERIOD $ 59,470 $ 27,985 -------- ----------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION AMOUNT OF INTEREST PAID IN THE PERIOD $ 2,501 $ 663 AMOUNT OF INCOME TAXES PAID IN THE PERIOD $ 2,566 $ 1,983
(the accompanying notes form an integral part of the interim financial statements) F-6 NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS for the three months ended March 31, 2002 and 2001 (in thousands of U.S. dollars, except per share amounts or as otherwise indicated) 1. NATURE OF OPERATIONS Business operations Hub International Limited (the "Company") is an international insurance brokerage which provides a variety of property and casualty, life and health, employee benefits, investment and risk management products and services. Change in reporting currency The Company's consolidated financial statements have historically been expressed in Canadian dollars. Effective September 30, 2001, the Company adopted the U.S. dollar as its reporting currency. Comparative financial information has been restated in U.S. dollars using the translation of convenience method. At September 30, 2001, all historical financial statements including financial results for the quarter ending March 31, 2001, were converted from Canadian to U.S. dollars at the exchange rate in effect at September 30, 2001 of one Canadian dollar to 0.6338 U.S. dollar. Business combinations Acquisitions of subsidiaries have been accounted for using the purchase method, whereby the results of acquired companies are included only from the date of acquisition. Effective June 28, 2001, the Company acquired Kaye Group Inc. (Kaye). Kaye, primarily an insurance broker, also underwrote insurance risks through its subsidiaries, Old Lyme Insurance Company of Rhode Island Inc. and Old Lyme Insurance Company, Ltd. (collectively Old Lyme). The Company did not want to retain the underwriting risk associated with Old Lyme, and indicated prior to the effective date of the acquisition that it intended to find a purchaser for the Old Lyme operations as soon as possible after closing. At March 31, 2002 and December 31, 2001, the net assets and liabilities of Old Lyme are recorded at their original cost as an investment held for sale in the Company's consolidated balance sheets. The net earnings of the Old Lyme operations from the date of acquisition to March 31, 2002 have been excluded from the Company's consolidated statements of earnings for the three months ended March 31, 2002 and for the year ended December 31, 2001 and accordingly, transactions with Old Lyme have not been eliminated on consolidation. The amount of Old Lyme net earnings excluded from consolidated net earnings for the three months ended March 31, 2002 was approximately $1,100. On December 31, 2001, Kaye entered into a stock purchase agreement with Fairfax Inc. to sell all of the issued and outstanding shares of Old Lyme, pending regulatory approval. Fairfax Inc. is a subsidiary of Fairfax Financial Holdings Limited (Fairfax), which currently owns approximately 37% of the Company's outstanding shares. The agreed upon purchase price (which is considered to be fair market value) is Old Lyme's December 31, 2001 shareholder's equity of approximately $42,800 determined in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). The purchase price will be increased by four percent, compounded annually, from January 1, 2002, until the closing date. Any difference between the actual purchase price at the closing date and the carrying amount of the investment held for sale in the Company's consolidated balance sheet will be recorded as a gain or loss on the sale of investment at the closing date. F-7 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The interim consolidated financial statements do not include all disclosures required by Canadian generally accepted accounting principles (Canadian GAAP) for annual financial statements and accordingly, should be read in conjunction with the Company's consolidated financial statements for the year ended December 31, 2001 as set out on pages 12 to 45 of the Company's 2001 Annual Report. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the accompanying statements have been reflected therein. These interim consolidated financial statements of the Company are expressed in United States (U.S.) dollars and have been prepared in accordance with Canadian GAAP using the same accounting principles as were used for the Company's consolidated financial statements for the year ended December 31, 2001, except as noted below. Canadian GAAP differs in certain respects from U.S. GAAP and to the extent that they affect the Company, the differences are described in note 7 "Reconciliation to U.S. GAAP." Goodwill Effective January 1, 2002, the Company adopted the Canadian Institute of Chartered Accountants Accounting Standards Board Handbook Section 3062, "Goodwill and Other Intangible Assets" (Section 3062) without restatement of prior periods. Goodwill and intangible assets with indefinite useful lives are no longer amortized but are subject to impairment tests on at least an annual basis. Goodwill is allocated to reporting units and any potential goodwill impairment is identified by comparing the carrying value of a reporting unit with its fair value. If any potential impairment is indicated, it is quantified by comparing the carrying value of goodwill to its fair value, based on the fair value of the assets and liabilities of the reporting unit. Intangible assets, other than goodwill, which do not have indefinite lives are amortized over their useful lives. These intangible assets are subject to an annual impairment test comparing carrying values to net recoverable amounts. The Company is required to complete the transitional impairment test within six months of adoption of Section 3062 and to record impairment, if any, by the end of the fiscal year. Any loss resulting from the transitional impairment test will be recorded as a cumulative effect of a change in accounting principle and charged to opening retained earnings. The Company has substantially completed its impairment testing on the balance of goodwill and intangible assets with an indefinite life as of January 1, 2002. Based on the testing completed at the time of preparation of these interim consolidated financial statements, no impairment losses are expected. As required under Section 3062, no goodwill amortization expense was incurred for the three months ended March 31, 2002. For the three months ended March 31, 2001, the Company incurred goodwill amortization expense of $771 before tax and approximately $673 after tax ($0.04 per share). F-8 The effect of the adoption of Section 3062 on net earnings and earnings per share for the three months ended March 31, 2002 and 2001 was as follows:
2002 2001 ------ ------ Reported net earnings $4,939 $2,466 Add back: Goodwill amortization -- 673 ------ ------ Net earnings adjusted for goodwill $4,939 $3,139 ------ ------ Basic EPS -- Reported $0.25 $0.13 Basic EPS -- Adjusted for goodwill $0.25 $0.17 Diluted EPS -- Reported $0.21 $0.13 Diluted EPS -- Adjusted for goodwill $0.21 $0.17
3. EARNINGS PER SHARE Basic earnings per share, excluding the dilutive effect of common share equivalents, is calculated by dividing net earnings by the weighted average number of common shares outstanding for the year. Diluted earnings per share is calculated using the treasury stock method and includes the effects of all potentially dilutive securities. Earnings per common share has been compiled below:
2002 2001 ------- ------- Net earnings (numerator) $ 4,939 $ 2,466 Plus income effect of assumed conversions: Interest on 8.5% subordinated convertibles debentures 804 -- ------- ------- Net earnings plus assumed conversions (numerator) $ 5,743 $ 2,466 ------- ------- Weighted average shares outstanding -- basic (denominator) 19,503 18,571 Plus incremental shares from assumed conversions: Put options 2,176 -- 8.5% subordinated convertible debentures 5,781 -- ------- ------- Weighted average shares outstanding -- Diluted (denominator) 27,460 18,571 ------- ------- Earnings per common share: Basic $ 0.25 $ 0.13 Diluted $ 0.21 $ 0.13
4. COMMITMENTS AND CONTINGENCIES (a) The Company may, under certain circumstances, be obligated to purchase loans for officers, directors and employees from a Canadian chartered bank totaling $5,493 (2001 -- $5,838) to assist in purchasing common shares of the Company. As collateral, the employees have pledged 663 (2001 -- 699) common shares which have a quarter-end market value of $8,531 (2001 -- $7,450). Interest in the amount of $61 (2001 -- $117) on the loans was paid by the Company. (b) In the ordinary course of business, the Company and its subsidiaries are subject to various claims and lawsuits consisting primarily of alleged errors and omissions in connection with the placement of insurance. In the opinion of management, the ultimate resolution of all asserted and potential claims and lawsuits will not have a material effect on the consolidated financial position or results of operations of the Company. F-9 5. OTHER INTANGIBLE ASSETS AND GOODWILL As of March 31, 2002 and December 31, 2001 the gross carrying amount and accumulated amortization of intangible assets were as follows:
AS OF MARCH 31, 2002 AS OF DECEMBER 31, 2001 --------------------------------- --------------------------------- GROSS GROSS CARRYING ACCUMULATED CARRYING ACCUMULATED AMOUNT AMORTIZATION TOTAL AMOUNT AMORTIZATION TOTAL -------- ------------ ------- -------- ------------ ------- Definite life intangible assets: Customer relationships $21,519 $1,115 $20,404 $21,720 $759 $20,961 Indefinite life intangible assets: Non-competition covenants 1,839 66 1,773 1,839 56 1,783 Trademarks 2,587 -- 2,587 2,587 -- 2,587 ------- ------ ------- ------- ---- ------- Total $25,945 $1,181 $24,764 $26,146 $815 $25,331 ------- --------- ------- ------- --------- -------
The Company is unable to estimate the useful life of non-competition covenants and trademarks. These indefinite life intangible assets will be reviewed annually for impairment. Once a non-competition covenant is triggered, the Company's policy is to amortize the related intangible asset over the period of the remaining contractual obligation. The changes in the carrying amount of goodwill for the three months ended March 31, 2002, are as follows:
OPERATIONS OPERATIONS IN CANADA IN U.S. TOTAL ---------- ---------- -------- Balance as of January 1, 2002 $74,282 $146,566 $220,848 Goodwill disposed of during 2002 (681) (166) (847) Cumulative translation adjustment 313 -- 313 ------- -------- -------- Balance as of March 31, 2002 $73,914 $146,400 $220,314 -------- --------- --------
For the three months ended March 31, 2002 and 2001, amortization has been comprised of the following:
2002 2001 ---- ---- Customer relationships $369 $ -- Non-competition covenants 10 -- Goodwill -- 771 ---- ---- Total $379 $771 ---- ----
We estimate that our amortization charges for 2002 through 2006 for all acquisitions consummated to date will be:
2002 2003 2004 2005 2006 YEAR ENDED DECEMBER 31, ------ ------ ------ ------ ------ Customer relationships $1,487 $1,487 $1,487 $1,487 $1,487 Non-competition covenants 80 24 -- -- -- ------ ------ ------ ------ ------ Total $1,567 $1,511 $1,487 $1,487 $1,487 ------ ------ ------ ------ ------
F-10 6. SEGMENTED INFORMATION The Company is an international insurance brokerage which provides a variety of property and casualty, life and health, employee benefits, investment and risk management products and services. In addition to its Corporate Operations, the Company has two operating segments within its insurance brokerage business; Canadian Operations and U.S. Operations. Corporate Operations consist primarily of investment income, unallocated administrative costs, interest expense and the income tax expense or benefit which is not allocated to the Company's operating segments. The elimination of intra-segment revenue relates to intra-company interest charges and management fees. Geographic revenue is determined based upon the functional currency of the various subsidiaries. Financial information by operating and geographic segment for the three months ended March 31, 2002 and 2001 is as follows:
2002 2001 ---------------------------------- --------------------------------- CANADA U.S. CONSOLIDATED CANADA U.S. CONSOLIDATED -------- -------- ------------ -------- ------- ------------ REVENUE Brokerage $ 19,323 $ 30,094 $ 49,417 $ 18,441 $ 9,553 $ 27,994 Corporate and other 5,088 267 5,355 2,199 24 2,223 Elimination of intra-segment revenue (5,031) (257) (5,288) (2,099) (21) (2,120) -------- -------- -------- -------- ------- -------- $ 19,380 $ 30,104 $ 49,484 $ 18,541 $ 9,556 $ 28,097 -------- -------- ---------- -------- ------- ---------- NET EARNINGS BEFORE INCOME TAXES Brokerage $ 1,223 $ 5,726 $ 6,949 $ 1,866 $ 2,461 $ 4,327 Corporate and other 2,322 (2,275) 47 1,136 (1,526) (390) -------- -------- -------- -------- ------- -------- $ 3,545 $ 3,451 $ 6,996 $ 3,002 $ 935 $ 3,937 -------- -------- ---------- -------- ------- ---------- INCOME TAXES Brokerage $ 494 $ 2,494 $ 2,988 $ 967 $ 1,015 $ 1,982 Corporate and other (45) (886) (931) 87 (598) (511) -------- -------- -------- -------- ------- -------- $ 449 $ 1,608 $ 2,057 $ 1,054 $ 417 $ 1,471 -------- -------- ---------- -------- ------- ---------- NET EARNINGS Brokerage $ 729 $ 3,232 $ 3,961 $ 899 $ 1,446 $ 2,345 Corporate and other 2,367 (1,389) 978 1,049 (928) 121 -------- -------- -------- -------- ------- -------- $ 3,096 $ 1,843 $ 4,939 $ 1,948 $ 518 $ 2,466 -------- -------- ---------- -------- ------- ---------- IDENTIFIABLE ASSETS Brokerage $112,525 $278,273 $390,798 $125,225 $62,698 $187,923 Investment held for sale -- 40,938 40,938 -- -- -- Corporate and other 25,377 2,418 27,795 6,091 4,612 10,703 -------- -------- -------- -------- ------- -------- $137,902 $321,629 $459,531 $131,316 $67,310 $198,626 -------- -------- ---------- -------- ------- ---------- AMORTIZATION $ 5 $ 374 $ 379 $ 497 $ 274 $ 771 ADDITIONS TO CAPITAL ASSETS $ 539 $ 232 $ 771 $ 453 $ 99 $ 552 DEPRECIATION $ 426 $ 854 $ 1,280 $ 449 $ 123 $ 572 INTEREST INCOME $ 126 $ 212 $ 338 $ 271 $ 217 $ 488 INTEREST EXPENSE $ 2,387 $ 307 $ 2,694 $ 553 $ 36 $ 589
7. RECONCILIATION TO U.S. GAAP The interim consolidated financial statements have been prepared in accordance with Canadian GAAP which differs in certain respects from United States GAAP. F-11 Net earnings and other comprehensive income The table below represents the differences between Canadian and U.S. GAAP affecting net earnings at March 31, 2002 and 2001:
2002 2001 ------- ------- Net earnings for the period based on Canadian GAAP $ 4,939 $ 2,466 Adjustment to investment held for sale(1) 245 -- Change in reporting currency(2) -- 81 Adjustment to put option liability(3) (397) -- ------- ------- Net earnings for the year based on U.S. GAAP(4) 4,787 2,547 Other comprehensive income Unrealized gains (losses), net of tax of $(24) -- 2002, $67 -- 2001 39 (109) Foreign currency translation adjustment, net of tax of $(525) -- 2002, $2,540 -- 2001 856 (4,145) ------- ------- Comprehensive income (loss) based on U.S. GAAP(5) $ 5,682 $(1,707) ------- ------- Basic earnings per share based on U.S. GAAP $ 0.25 $ 0.14 Diluted earnings per share based on U.S. GAAP $ 0.20 $ 0.14
Shareholders' equity The table below sets out the differences between Canadian GAAP and U.S. GAAP that affect shareholders' equity at March 31, 2002 and December 31, 2001:
MARCH 31, DECEMBER 31, 2002 2001 --------- ------------ Shareholders' equity based on Canadian GAAP $141,018 $135,271 Adjustment to investment held for sale(1) 765 520 Accumulated other comprehensive income: Unrealized gains (losses), net of tax of $61 -- 2002, $85 -- 2001 (101) (140) Cumulative translation account(2) 50 -- Adjustment to put option liability(3) (5,128) (4,898) Executive share purchase plan loans(6) (2,146) (2,142) -------- -------- Shareholders' equity based on U.S. GAAP(4) $134,458 $128,611 -------- ------------
- --------------- Notes: (1) Under Canadian GAAP, Old Lyme is treated as an investment held for sale at its cost of $40,938. Under U.S. GAAP, Old Lyme is reflected at its fair market value, which is equal to its U.S. GAAP shareholder's equity at December 31, 2001, increased by an amount of 4% compounded annually for the three month period ended March 31, 2002, pursuant to the agreement providing for the pending sale of Old Lyme. Accordingly, under U.S. GAAP, the investment in Old Lyme has been increased to reflect the net increase in its shareholder's equity from the date of acquisition through December 31, 2001, as well as the 4% since January 1, 2002 in the amount of $423. This adjustment is treated as a purchase price adjustment to the Kaye acquisition and results in an increase of $2,498 in the investment in Old Lyme and a corresponding decrease in goodwill, with no effect on net earnings or shareholders' equity. Under Canadian GAAP, interest on debt used to finance the Old Lyme acquisition in the amount of $520 and $245 (in each case, net of tax) for the six months ended December 31, 2001 and for the three months ended March 31, 2002, respectively, is charged to earnings. Under U.S. GAAP, the interest expense on the debt incurred to finance the purchase F-12 of Old Lyme is applied to the carrying value of the investment and does not affect the net earnings of the Company. (2) The Company's consolidated financial statements have historically been expressed in Canadian dollars. Effective September 30, 2001, the Company adopted the U.S. dollar as its reporting currency. In accordance with Canadian GAAP, comparative financial information has been restated in U.S. dollars using the translation of convenience method. At September 30, 2001, all historical financial statements were converted from Canadian to U.S. dollars at the exchange rate in effect at September 30, 2001 of one Canadian dollar to 0.6338 U.S. dollar. Revenue and expenses subsequent to September 30, 2001 were translated to U.S. dollars at the average exchange rate for the period. In accordance with U.S. GAAP, historical financial statements are translated using a current exchange rate; which for assets and liabilities is the exchange rate at the balance sheet date; for the income statement is the average exchange rate for the period; and for the share capital accounts is the historical exchange rate. In addition, foreign exchange differences are included in the cumulative translation account net of tax. The aggregate impact of these differences has been presented in the reconciliation of shareholders' equity for Canadian to U.S. GAAP under the caption "cumulative translation account." (3) Under Canadian GAAP, the fair value of the put options (determined using the Black-Scholes model) issued in connection with the Burnham and Flanagan acquisitions was allocated to equity instruments on the balance sheet. The balance of the purchase price was allocated to debt. Changes in the value of the put options in periods subsequent to the acquisition dates are included in earnings. Under U.S. GAAP, the fair value of the share consideration and the attached put options is initially recorded in equity. The redemption value of the shares to which the put options are attached has been reclassified as mezzanine equity outside of shareholders' equity as a result of the put options granted on those shares to certain of the selling shareholders. The fair value of the put options at the date of issuance is also recorded as a debit to shareholders' equity, representing an unearned compensation expense, as these options require the selling shareholders to remain employed by the Company in order to be able to exercise the put options. Compensation expense is being recognized using the straight-line method over the period from the issue date to the put date. (4) The condensed consolidated statements of earnings and cash flows for the three months ended March 31, 2002 and 2001 and the condensed consolidated balance sheets as at March 31, 2002 and December 31, 2001 under U.S. GAAP are as follows:
MARCH 31, MARCH 31, 2002 2001 --------- ------------ Revenue $ 49,484 $ 29,009 Net earnings before income taxes $ 6,863 $ 4,065 Net earnings $ 4,787 $ 2,547 Cash provided (used) by operating activities(7) $ (6,056) $ 482 Cash provided (used) by investing activities $ 288 $ (3,815) Cash used by financing activities $ (2,686) $ (1,824)
8. SUBSEQUENT EVENT On May 30, 2002, the Company completed the sale of its investment in Old Lyme to Fairfax Financial Holdings Limited, a related party, in consideration for approximately $43,500. F-13
MARCH 31, DECEMBER 31, 2002 2001 --------- ------------ Total current assets $185,932 $226,191 Total assets $458,487 $500,852 Total current liabilities $178,154 $224,968 Total liabilities $301,642 $350,070 Mezzanine equity $ 22,387 $ 22,171 Total shareholders' equity $134,458 $128,611
(5) Comprehensive income is measured in accordance with Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income" (SFAS 130). This standard defines comprehensive income as all changes in equity other than those resulting from investments by owners and distributions to owners and includes the change in unrealized gains (losses) on debt and equity securities and foreign currency translation adjustments, which under Canadian GAAP are not recognized and recorded as a separate component of shareholders' equity, respectively. Certain disclosures required by SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities", have not been included as such disclosures related to the Company's investments in debt and equity securities are immaterial to the overall financial statement presentation. (6) Under Canadian GAAP, loans granted by the Company to employees under the executive share purchase plan are treated as a receivable and included in the balance sheet caption "Accounts and other receivables." Under U.S. GAAP, those loans must be included as a reduction to shareholders' equity. (7) Under Canadian GAAP, the statement of cash flows reconciles changes in cash and cash equivalents and trust cash for each of the periods presented. The statement of cash flows includes changes in trust cash as it is available to settle accounts payable to insurance companies which are included as part of current liabilities. Under U.S. GAAP, the statement of cash flows reconciles changes in cash and cash equivalents only. Under U.S. GAAP, changes in trust cash are included as part of the change in non-cash working capital in the determination of cash provided from operating activities. Effective January 1, 2002, the Company adopted the Canadian Institute of Chartered Accountants Accounting Standards Board Handbook Section 3062, "Goodwill and Other Intangible Assets". This section harmonizes Canadian standards with the Financial Accounting Standards Board's Statement of Financial Accounting Standard No. 142. See note 2. The following table illustrates the effect that SFAS No. 142 would have had on net earnings and per share information under U.S. GAAP for each of the three month periods ended March 31, 2002 and 2001 if goodwill had not been amortized:
MARCH 31, --------------- 2002 2001 ------ ------ Reported net earnings -- U.S. GAAP $4,787 $2,547 Add back: Goodwill amortization -- 673 ------ ------ Net earnings adjusted for goodwill $4,787 $3,220 Basic EPS -- Reported $ 0.25 $ 0.14 Basic EPS -- Adjusted for goodwill $ 0.25 $ 0.17 Diluted EPS -- Reported $ 0.20 $ 0.14 Diluted EPS -- Adjusted for goodwill $ 0.20 $ 0.17
F-14 AUDITORS' REPORT TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF HUB INTERNATIONAL LIMITED: We have audited the accompanying consolidated balance sheets of Hub International Limited and its subsidiaries as of December 31, 2001 and 2000 and the related consolidated statements of earnings, retained earnings (deficit) and cash flows for each of the years in the three year period ended December 31, 2001, all expressed in United States of America dollars. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in Canada and in the United States of America. Those standards require that we plan and perform an audit to obtain reasonable assurance 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, these consolidated financial statements referred to above present fairly, in all material respects, the financial position of Hub International Limited and its subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 2001, in accordance with accounting principles generally accepted in Canada. LOGO Chartered Accountants Toronto, Ontario, Canada March 18, 2002, except for note 19 which is as of May 30, 2002 F-15 HUB INTERNATIONAL LIMITED CONSOLIDATED BALANCE SHEETS As of December 31, 2001 and 2000 (in thousands of U.S. dollars)
2001 2000 -------- ------------ (AS RESTATED SEE NOTE 2) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 26,979 $ 19,919 Trust cash 50,426 12,356 Accounts and other receivables 101,313 41,975 Investment held for sale 40,772 -- Income taxes receivable 1,460 2,382 Future income taxes 1,999 -- Prepaid expenses 2,471 872 -------- -------- TOTAL CURRENT ASSETS 225,420 77,504 Capital assets 20,935 7,208 Other intangible assets 25,331 -- Goodwill 220,848 117,744 Future income taxes 2,671 368 Other assets 7,091 3,333 -------- -------- TOTAL ASSETS $502,296 $206,157 -------- ------------ LIABILITIES CURRENT LIABILITIES: Bank debt $ 55,000 $ -- Accounts payable and accrued liabilities 164,094 57,601 Income taxes payable -- 927 Future income taxes 1,387 -- Current portion long-term debt and capital leases 4,169 2,167 -------- -------- TOTAL CURRENT LIABILITIES 224,650 60,695 Long-term debt and capital leases 76,159 32,498 Subordinated convertible debentures 61,624 -- Future income taxes 4,592 752 -------- -------- TOTAL LIABILITIES 367,025 93,945 -------- -------- COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY Share capital 125,506 111,430 Cumulative translation account 2,770 195 Retained earnings 6,995 587 -------- -------- TOTAL SHAREHOLDERS' EQUITY 135,271 112,212 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $502,296 $206,157 -------- ------------
(the accompanying notes form an integral part of the financial statements) F-16 HUB INTERNATIONAL LIMITED CONSOLIDATED STATEMENTS OF EARNINGS For the years ended December 31, 2001, 2000 and 1999 (in thousands of U.S. dollars, except per share amounts)
2001 2000 1999 -------- ------------ ------------ (AS RESTATED (AS RESTATED SEE NOTE 2) SEE NOTE 2) REVENUE Commission income $142,851 $86,410 $47,964 Contingent commissions and volume overrides 5,946 4,909 2,824 Other 5,196 3,921 3,309 -------- ------- ------- 153,993 95,240 54,097 -------- ------- ------- EXPENSES Remuneration 88,015 54,701 29,519 Selling 8,359 4,840 3,036 Occupancy 9,061 5,756 3,393 Depreciation 3,940 1,885 1,275 Administration 17,856 11,182 6,806 -------- ------- ------- 127,231 78,364 44,029 -------- ------- ------- NET EARNINGS BEFORE THE FOLLOWING 26,762 16,876 10,068 Interest expense 7,447 1,981 632 Goodwill and other intangible asset amortization 4,940 3,260 1,626 (Gain) loss on disposal of capital assets and investments (173) 127 14 Other income -- put option liability (719) -- -- -------- ------- ------- NET EARNINGS BEFORE INCOME TAXES 15,267 11,508 7,796 -------- ------- ------- PROVISION FOR INCOME TAX EXPENSE (BENEFIT) Current 4,967 4,907 4,260 Future 295 463 (208) -------- ------- ------- 5,262 5,370 4,052 -------- ------- ------- NET EARNINGS $ 10,005 $ 6,138 $ 3,744 -------- ------------ ------------ EARNINGS PER SHARE BASIC $ 0.53 $ 0.34 $ 0.22 DILUTED $ 0.50 $ 0.34 $ 0.22 WEIGHTED AVERAGE SHARES OUTSTANDING -- BASIC (000'S) 19,012 18,327 16,941 WEIGHTED AVERAGE SHARES OUTSTANDING -- DILUTED (000'S) 20,105 18,327 16,941
(the accompanying notes form an integral part of the financial statements) F-17 HUB INTERNATIONAL LIMITED CONSOLIDATED STATEMENTS OF RETAINED EARNINGS (DEFICIT) For the years ended December 31, 2001, 2000 and 1999 (in thousands of U.S. dollars)
2001 2000 1999 ------- ------------ ------------ (AS RESTATED (AS RESTATED SEE NOTE 2) SEE NOTE 2) RETAINED EARNINGS (DEFICIT) -- BEGINNING OF YEAR $ 587 $(2,049) $(3,159) Net earnings 10,005 6,138 3,744 Excess over stated value of shares purchased -- (1,046) (2,634) Dividends (3,597) (2,456) -- ------- ------- ------- RETAINED EARNINGS (DEFICIT) -- END OF YEAR $ 6,995 $ 587 $(2,049) ------- ------------ ------------
(the accompanying notes form an integral part of the financial statements) F-18 HUB INTERNATIONAL LIMITED CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended December 31, 2001, 2000 and 1999 (in thousands of U.S. dollars)
2001 2000 1999 --------- ------------ ------------ (AS RESTATED (AS RESTATED SEE NOTE 2) SEE NOTE 2) OPERATING ACTIVITIES Net earnings $ 10,005 $ 6,138 $ 3,744 Items not affecting working capital Amortization and depreciation 8,880 5,145 2,901 (Gain) loss on disposal of capital assets and investments (173) 127 14 Other income -- put option liability (719) -- -- Future income taxes 295 463 (208) --------- -------- -------- 18,288 11,873 6,451 Non-cash working capital items Accounts and other receivables (5,511) (2,330) (3,331) Prepaid expenses (299) (283) 128 Accounts payable and accrued liabilities 32,571 6,122 1,953 Income taxes 1,863 (2,575) (98) --------- -------- -------- 46,912 12,807 5,103 --------- -------- -------- FINANCING ACTIVITIES Bank debt 55,122 (16,425) 14,178 Long-term debt -- advances 21,096 29,835 92 Subordinated convertible debentures 61,624 -- -- Long-term debt and capital leases -- repayments (5,154) (2,501) (14,529) Share capital -- issued for cash, net of issue costs 3,621 -- 65,534 Share capital -- repurchases (281) (2,840) (6,781) Dividends (3,597) (2,456) -- --------- -------- -------- 132,431 5,613 58,494 --------- -------- -------- INVESTING ACTIVITIES Capital assets -- purchases (10,298) (2,050) (1,243) Capital assets -- proceeds on sale 96 222 76 Purchase of subsidiaries, net of cash received (123,365) (18,932) (29,203) Other assets (646) 2,777 (4,285) --------- -------- -------- (134,213) (17,983) (34,655) --------- -------- -------- CHANGE IN CASH AND CASH EQUIVALENTS AND TRUST CASH 45,130 437 28,942 CASH AND CASH EQUIVALENTS AND TRUST CASH -- BEGINNING OF YEAR 32,275 31,838 2,896 --------- -------- -------- CASH AND CASH EQUIVALENTS AND TRUST CASH -- END OF YEAR $ 77,405 $ 32,275 $ 31,838 --------- ----------- -----------
(the accompanying notes form an integral part of the financial statements) F-19 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS for the years ended December 31, 2001, 2000 and 1999 (in thousands, except per share amounts or as otherwise indicated) 1. NATURE OF OPERATIONS Business operations Hub International Limited (the "Company") is an international insurance brokerage which provides a variety of property, casualty, life and health, employee benefits, investment and risk management products and services. Business combinations Acquisitions of subsidiaries have been accounted for using the purchase method, whereby the results of acquired companies are included only from the date of acquisition. Effective June 28, 2001, the Company acquired Kaye Group Inc. (Kaye). Kaye, primarily an insurance broker, also underwrote insurance risks through its subsidiaries, Old Lyme Insurance Company of Rhode Island Inc. and Old Lyme Insurance Company, Ltd. (collectively Old Lyme). The Company did not want to retain the underwriting risk associated with Old Lyme, and indicated prior to the effective date of the acquisition that it intended to find a purchaser for the Old Lyme operations as soon as possible after closing. At December 31, 2001, the net assets and liabilities of Old Lyme are recorded at their original cost as an investment held for sale in the Company's consolidated balance sheet. The net earnings of the Old Lyme operations from the date of acquisition to December 31, 2001 have been excluded from the Company's 2001 consolidated statement of earnings and, accordingly, transactions with Old Lyme have not been eliminated on consolidation. The amount of Old Lyme net earnings excluded from consolidated net earnings for the period ended December 31, 2001 was approximately $1,833. On December 31, 2001, Kaye entered into a stock purchase agreement with Fairfax Inc. to sell all of the issued and outstanding shares of Old Lyme, pending regulatory approval. Fairfax Inc. is a subsidiary of Fairfax Financial Holdings Limited (Fairfax), which currently owns approximately 37% of the Company's outstanding shares. The agreed-upon purchase price (which is considered to be fair market value) is Old Lyme's December 31, 2001 stockholder's equity of approximately $42,800 determined in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). The purchase price will be increased by four percent, compounded annually, from January 1, 2002, until the closing date. Any difference between the actual purchase price at the closing date and the carrying amount of the investment held for sale in the Company's consolidated balance sheet will be recorded as a gain or loss on the sale of investment at the closing date. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES These consolidated financial statements of the Company are expressed in United States (U.S.) dollars and have been prepared in accordance with Canadian generally accepted accounting principles (Canadian GAAP). These principles differ in certain respects from U.S. GAAP and to the extent that they affect the Company, the differences are described in note 17 "Reconciliation to U.S. GAAP." The more significant of the accounting policies are as follows: Basis of presentation The consolidated financial statements include the accounts of the Company and all of its subsidiaries. All material inter-company accounts and transactions have been eliminated. Certain F-20 reclassifications have been made to prior years' financial statements to conform to the current year presentation. Change in reporting currency The Company's consolidated financial statements have historically been expressed in Canadian dollars. Effective October 1, 2001, the Company adopted the U.S. dollar as its reporting currency as the result of increasing significance of its U.S. operations. Comparative financial information has been restated in U.S. dollars using the translation of convenience method. At September 30, 2001, all historical financial statements were converted from Canadian to U.S. dollars at the exchange rate in effect at September 30, 2001 of one Canadian dollar to 0.6338 U.S. dollar. Foreign currency translation The assets and liabilities of these subsidiaries as at December 31, 2001 were translated to U.S. dollars at the year end exchange rate. Revenue and expenses subsequent to September 30, 2001 were translated to U.S. dollars at the average exchange rate for the period. The operations of the Company's subsidiaries outside of the U.S. are self-sustaining. Accordingly, the unrealized gains and losses which result from this translation are deferred and included in shareholders' equity under the caption "Cumulative translation account." Revenue Recognition Commission income and fees, (including commission income related to installment billing arrangements) are recognized as of the effective date of the policy unless information is not available relating to the determination of the client's policy premiums, in which case commission income and fees related to that policy are recognized when that information becomes available and the revenue can be reasonably determined. Commission income is reported net of sub-broker commission expense. Commission and other adjustments are recorded when they occur and the Company maintains an allowance for estimated policy cancellations and commission returns based upon applying historical policy cancellation and commission return rates to the current year revenue, adjusted for any known deviations. The Company is entitled to contingent commissions and volume overrides from insurance companies which are recorded in the earlier of the period in which amounts can be reasonably estimated or the period in which the amounts are received. Amounts related to contingent commissions and volume overrides can be reasonably estimated when information pertaining to the calculation, such as premium volumes, loss ratios and expenses, can be obtained from the insurance carriers. Other revenue primarily includes investment income and policy service fees. The Company is entitled to retain interest income on trust cash as a result of state and provincial laws and regulations as opposed to contractual arrangements with insurance carriers. Accordingly this entitlement to retain interest income on trust cash does not have any effect on the commission rates the Company negotiates with insurance carriers. Investment income is recorded when earned. Policy service fees are recorded on the effective date of the policy, at which time the service has been provided. Cash and cash equivalents and trust cash Cash and cash equivalents consist of cash, highly-liquid investments having maturities of three months or less and trust cash. The carrying amounts on the balance sheet approximate fair value. Premiums collected (less commissions and other deductions) but not yet remitted to insurance carriers are included in trust cash. Trust cash is restricted as to use by contractual obligations and by laws in certain states and provinces in which the Company operates. Capital assets Capital assets are stated at cost less accumulated depreciation and amortization. Depreciation is recorded based on useful economic lives, using principally the declining balance method at a rate F-21 which ranges between 20% and 30%. Leasehold improvements are amortized on the straight-line method over the term of the related lease. Upon sale or retirement, the cost and related accumulated depreciation or amortization are removed from the accounts and any gain or loss is reflected in earnings. Goodwill Goodwill, equal to the excess of the purchase price over the fair value of net identifiable assets acquired, relating to acquisitions which took place before July 1, 2001, is amortized to earnings on a straight-line basis over 40 years. Goodwill relating to acquisitions which took place on or after July 1, 2001 is carried at cost and reviewed annually for impairment. In June 2001, the Canadian Institute of Chartered Accountants approved a new Handbook Section 3062, Goodwill and Other Intangible Assets. From January 1, 2002, goodwill will no longer be amortized but will be subject to regular review for impairment. The impact of ceasing the amortization of goodwill on the year ended December 31, 2002 will likely be to increase net earnings before income taxes by approximately $3,400. The Company does not anticipate any other material impact on the financial statements as a result of implementation of this new accounting standard. The new rule harmonizes Canadian GAAP with U.S. GAAP. Other intangible assets Intangible assets arising from purchase acquisitions principally represent the fair value of customer relationships, company trademarks and non-competition covenants. Definite life intangible assets are amortized to earnings on a straight-line basis over the estimated useful life of the asset, averaging 15 years. Indefinite life intangible assets are carried at cost and reviewed annually for impairment. Investment held for sale The investment held for sale (Old Lyme) is recorded at cost, which is at or below market value. Future income taxes Income taxes reflect the expected future tax consequences of temporary differences between the carrying amounts of assets or liabilities and their tax bases. Future income tax assets and liabilities are determined for each temporary difference based on the tax rates which are expected to be in effect when the asset or liability is settled. The benefit of loss carryforwards is recognized as an asset to the extent that it is more likely than not to be recoverable from future profitable operations. The principal temporary differences are related to loss carryforwards, goodwill and other intangible asset amortization and reserves. Estimates and assumptions Preparation of the financial statements in conformity with Canadian GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and the reported amount of revenue and expense during the reporting period. Actual results could differ from those estimated. F-22 Earnings per share Basic earnings per share, excluding the dilutive effect of common share equivalents, is calculated by dividing net earnings by the weighted average number of common shares outstanding for the year. Diluted earnings per share are calculated using the treasury stock method and include the effects of all potentially dilutive securities. Earnings per common share has been compiled below:
2001 2000 1999 ------- ------ ------ Net income (numerator) $10,005 $6,138 $3,744 ------- ------ ------ Weighted average common shares and effect of dilutive shares used in the computation of earnings per share: Average shares outstanding -- basic (denominator) 19,012 18,327 16,941 Effect of dilutive shares* 1,093 -- -- ------- ------ ------ Average shares outstanding -- diluted (denominator) 20,105 18,327 16,941 ------- ------ ------ Earnings per common share: Basic $ 0.53 $ 0.34 $ 0.22 Diluted $ 0.50 $ 0.34 $ 0.22
* Reflects dilutive effect of all put options issued in connection with certain 2001 acquisitions. The subordinated convertible debentures are anti-dilutive. Written put options The fair value of put options issued by the Company as consideration for businesses acquired is classified as long-term debt until such time as the option is exercised or expires. Changes in the fair value of these options are recorded in earnings. 3. ACQUISITIONS The Company's strategic business plan includes the regular and systematic evaluation and acquisition of insurance brokerages in new and existing markets. Insurance brokerages, due to their nature, typically maintain a very low capital to earnings ratio. As a result, the Company recorded a substantial amount of goodwill and other intangible assets in connection with these acquisitions. The Company typically pays a portion of the consideration for an acquired brokerage in cash. Consideration for the remainder of the purchase price is normally in the form of the Company's common shares. The Company's common shares issued in consideration for acquired brokerages are valued based on the quoted market price, on the Toronto Stock Exchange, for a short period before and after the closing date of the business combination. a) During 2001, the Company purchased all of the issued and outstanding shares of Kaye, Burnham Stewart Group, Inc. (Burnham) and J.P. Flanagan Corporation (Flanagan), as well as the outstanding shares or net assets of 13 other brokerages, all of which were acquired using the purchase method of accounting. Accordingly, the results of operations and cash flows of the acquired companies have been included in the Company's consolidated results from their respective acquisition dates. F-23 The allocation of the purchase price, including goodwill and other identifiable intangible assets, and the cost of the acquired brokerages are summarized as follows:
KAYE BURNHAM FLANAGAN OTHERS TOTAL ------------- ------------ ------------ ------- -------- Acquisition Date June 28, 2001 July 1, 2001 May 31, 2001 Various Working capital $ 43,141 $ 3,002 $ (703) $ (216) $ 45,224 Capital and other assets 7,413 1,580 79 (244) 8,828 Long-term debt and capital leases assumed (1,449) (8,200) (1,339) (70) (11,058) -------- ------- ------- ------- -------- Net assets (liabilities), at fair value $ 49,105 $(3,618) $(1,963) $ (530) $ 42,994 ------------- ------------ ------------ ------- -------- Consideration Cash $125,131 $11,533 $ 776 $ 3,950 $141,390 Debt -- 12,435 7,210 1,760 21,405 Shares -- 6,191 1,821 557 8,569 -------- ------- ------- ------- -------- $125,131 $30,159 $ 9,807 $ 6,267 $171,364 ------------- ------------ ------------ ------- -------- Goodwill $ 59,816 $27,269 $ 8,838 $ 6,001 $101,924 Customer relationships 12,992 5,690 2,242 796 21,720 Trademarks 1,714 623 250 -- 2,587 Non-competition covenants 1,204 195 440 -- 1,839 -------- ------- ------- ------- -------- $ 75,726 $33,777 $11,770 $ 6,797 $128,070 ------------- ------------ ------------ ------- -------- Number of shares issued as consideration (000's) -- 1,743 730 51 2,524 ------------- ------------ ------------ ------- --------
Contingent Consideration In addition to the consideration shown above, the previous owners of Burnham, Flanagan and other subsidiaries are entitled to contingent consideration if certain revenue and profitability targets are met. Purchase price allocations for Flanagan and Burnham are subject to adjustment for future consideration issued. Flanagan The following table summarizes the contingent consideration that may be issued in connection with the acquisition of Flanagan:
CONTINGENT CONSIDERATION CONTINGENT CONSIDERATION YEAR (000'S) TARGET CRITERIA - ---- ------------- ------------------------- 2001 50 shares Revenue and Profitability 2002 38 shares Revenue 2002 38 shares Profitability 2003 88 shares Revenue 2003 37 shares Profitability
As of December 31, 2001, the contingent consideration criteria for 2001 were met. Accordingly, the Company has an obligation to issue 50 shares in the amount of $478. The additional purchase consideration has been recorded in goodwill and share capital as of December 31, 2001. F-24 Burnham The owners of Burnham shall be entitled to contingent consideration in the event that the acquired Burnham operations meet certain profitability targets for the twelve-month period ended June 30, 2002. The contingent consideration to be issued, if the profitability criteria are met, shall be a portion of actual profitability in excess of the target. Any contingent consideration issued by the Company shall be paid 38% in cash, 51% in restricted shares of the Company's common stock, and 11% in unrestricted shares of the Company's common shares. If the additional consideration is issued, the shares and related put options on those shares will be recorded as an increase to goodwill and a corresponding increase in long-term debt and share capital. Others An additional $400 of contingent consideration, based primarily on revenue targets, may also be issued in connection with other acquisitions made by the Company in 2001. If the additional consideration is issued, it will be issued in cash and recorded as an increase to goodwill. F-25 b) During 2000, the Company purchased all of the issued and outstanding shares of C.J. McCarthy Insurance Agency Inc. (McCarthy), as well as the outstanding shares or net assets of 17 other brokerages, all of which were acquired using the purchase method of accounting. Accordingly, the results of operations and cash flows of the acquired companies have been included in the Company's consolidated results from their respective acquisition dates. The allocation of the purchase price, including goodwill, and the cost of the acquired brokerages are summarized as follows:
MCCARTHY OTHERS TOTAL ------------- ------- ------- Acquisition date June 30, 2000 Various Working capital $ 3,033 $(1,600) $ 1,433 Capital and other assets 487 363 850 Long-term debt and capital leases assumed (899) (24) (923) ------- ------- ------- Net assets (liabilities), at fair value $ 2,621 $(1,261) $ 1,360 ------------ ------- ------- Consideration Cash $18,236 $ 6,710 $24,946 Debt -- 1,951 1,951 Shares 4,415 466 4,881 ------- ------- ------- $22,651 $ 9,127 $31,778 ------------ ------- ------- Goodwill $20,030 $10,388 $30,418 ------------ ------- ------- Number of shares issued as consideration (000's) 465 43 508 ------------ ------- -------
F-26 c) During 1999, the Company purchased all of the issued and outstanding shares of 44 brokerages, all of which were acquired using the purchase method of accounting. Accordingly, the results of operations and cash flows of the acquired companies have been included in the Company's consolidated results from their respective acquisition dates. The allocation of the purchase price, including goodwill, and the cost of the acquired brokerages are summarized as follows:
TOS MACK AND INSURANCE PARKER, INC. SERVICES LTD. OTHERS TOTAL ---------------- --------------- ------- ------- Acquisition date October 27, 1999 August 31, 1999 Various Working capital $ 3,283 $ 441 $ (632) $ 3,092 Capital and other assets 793 1,296 1,246 3,335 Long-term debt and capital leases assumed (251) (2,219) (3,825) (6,295) ------- ------- ------- ------- Net assets (liabilities), at fair value $ 3,825 $ (482) $(3,211) $ 132 -------------- ------------- ------- ------- Consideration Cash $10,082 $ 4,376 $22,097 $36,555 Shares 13,249 4,496 12,586 30,331 ------- ------- ------- ------- $23,331 $ 8,872 $34,683 $66,886 -------------- ------------- ------- ------- Goodwill $19,506 $ 9,354 $37,894 $66,754 -------------- ------------- ------- ------- Number of shares issued as consideration (000's) 1,103 417 1,185 2,705 -------------- ------------- ------- -------
F-27 4. ACCOUNTS AND OTHER RECEIVABLES Accounts and other receivables consist of the following:
DECEMBER 31, ------------------ 2001 2000 -------- ------- Client premiums receivable $ 80,488 $33,430 Commissions receivable 18,214 5,870 Less: Allowance for doubtful accounts and policy cancellations (1,427) (502) -------- ------- 97,275 38,798 Other receivables 4,038 3,177 -------- ------- $101,313 $41,975 -------- -------
Allowance for doubtful accounts and policy cancellations:
2001 2000 1999 ------ ---- ---- Balance, January 1 $ 502 $309 $110 Charged to net earnings before income taxes 340 26 188 Acquired through acquisitions 585 167 11 ------ ---- ---- Balance, December 31 $1,427 $502 $309 ------ ---- ----
5. CAPITAL ASSETS
DECEMBER 31, ------------------- 2001 2000 -------- -------- Leasehold improvements $ 10,043 $ 1,929 Office equipment 11,140 6,570 Computer equipment 13,620 8,900 -------- -------- 34,803 17,399 Accumulated depreciation and amortization (13,868) (10,191) -------- -------- Net book value $ 20,935 $ 7,208 -------- --------
During 2001 and 2000, capital assets were acquired at an aggregate cost of $11,534 and $2,395, respectively, of which $1,236 and $345, respectively, were acquired by means of capital leases. The cost above reflects certain capital assets held under capital leases of which the remaining liability at December 31, 2001 and 2000 was $1,470 and $667, respectively. 6. OTHER INTANGIBLE ASSETS AND GOODWILL As of December 31, 2001, the gross carrying amount and accumulated amortization of intangible assets were as follows:
GROSS CARRYING ACCUMULATED AMOUNT AMORTIZATION TOTAL -------- ------------ ------- Definite life intangible assets: Customer relationships $21,720 $759 $20,961 Indefinite life intangible assets: Non-competition covenants 1,839 56 1,783 Trademarks 2,587 -- 2,587 ------- ---- ------- Total $26,146 $815 $25,331 ------- --------- -------
F-28 The Company is unable to estimate the useful life of non-competition covenants and trademarks. These indefinite life intangible assets will be reviewed annually for impairment. Once a non-competition covenant is triggered, the Company's policy is to amortize the related intangible asset over the period of the remaining contractual obligation. The changes in the carrying amount of goodwill for the years ended December 31, 2001 and 2000, are as follows:
OPERATIONS OPERATIONS IN CANADA IN U.S. TOTAL ---------- ---------- -------- Balance as of January 1, 2000 $67,760 $ 22,051 $ 89,811 Goodwill acquired during 2000 10,388 20,030 30,418 Amortization of goodwill during 2000 (2,501) (759) (3,260) Cumulative translation adjustment -- 775 775 ------- -------- -------- Balance as of December 31, 2000 $75,647 $ 42,097 $117,744 Goodwill acquired during the period January 1, 2001 to June 30, 2001 1,255 67,848 69,103 Goodwill acquired during the period July 1, 2001 to December 31, 2001 556 32,265 32,821 Amortization of goodwill during 2001 (2,292) (1,833) (4,125) Cumulative translation adjustment (884) 6,189 5,305 ------- -------- -------- Balance as of December 31, 2001 $74,282 $146,566 $220,848 -------- --------- --------
Goodwill acquired prior to July 1, 2001 is amortized on a straight-line basis over a period of 40 years. Accumulated amortization was $14,822 and $10,482 at December 31, 2001 and 2000, respectively. Prior to the change in reporting currency on October 1, 2001, the Company regarded its operations in the U.S. as self-sustaining. Accordingly, exchange gains and losses arising on translation of the financial statements of these operations in periods ending on or before September 30, 2001 were recorded in the cumulative translation account. For the years ended December 31, 2001, 2000 and 1999, amortization has been comprised of the following:
2001 2000 1999 ------ ------ ------ Customer relationships $ 759 $ -- $ -- Non-competition covenants 56 -- -- Goodwill 4,125 3,260 1,626 ------ ------ ------ Total $4,940 $3,260 $1,626 ------ ------ ------
7. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES Accounts payable and accrued liabilities consist of the following:
DECEMBER 31, DECEMBER 31, 2001 2000 ------------- ------------- Insurance premiums payable $122,668 $42,472 Accrued liabilities 41,426 15,129 -------- ------- $164,094 $57,601 ------------- ------------
F-29 8. DEBT Bank debt At December 31, 2001, the Company had bank debt consisting of three separate credit facilities: - $25 million facility. Borrowings under this facility are accessed at a floating rate of 135 basis points above LIBOR, which was 2.09% as of December 31, 2001. This facility is guaranteed by certain of the Company's subsidiaries and by Fairfax. It expires on July 18, 2002 and contains covenants that, among other things, require the Company to maintain certain financial ratios, restrict its ability to incur additional debt, and limit quarterly dividends to C$.07 per share. As of December 31, 2001, $25 million was drawn on this facility. The Company intends to fully repay and terminate this facility with proceeds from the sale of Old Lyme. - $25 million facility. Borrowings under this facility are accessed either at a floating rate of 150 basis points above LIBOR, which was 2.09% as of December 31, 2001, or at a fixed interest rate of 9%. This facility is guaranteed by certain of the Company's subsidiaries. It expires on July 17, 2002 and contains covenants that, among other things, require the Company to maintain certain financial ratios, restrict its ability to incur additional debt and limit quarterly dividend payments to C$0.07 per share. As of December 31, 2001, $24.5 million was drawn on this facility, $23 million at a floating interest rate and $1.5 million at a fixed interest rate, which is included in long-term debt and is due October 31, 2005. We intend to repay approximately $4.5 million of this facility with the proceeds from the sale of Old Lyme. - $7.5 million facility. Borrowings under this facility are at an interest rate of prime, which was 4.75% as of December 31, 2001, plus 1%. Payment is due on demand. As of December 31, 2001, $7.0 million had been drawn on this facility. The Company intends to fully repay and terminate this facility with the proceeds from the sale of Old Lyme. The Company has agreed to sell Old Lyme to a subsidiary of Fairfax for approximately $42.8 million, subject to obtaining regulatory approval. The Company intends to use the proceeds from the sale of Old Lyme to repay debt. As of September 30, 2001, the Company was not in compliance with certain financial covenants relating to the maintenance of certain ratios under both of the $25 million credit facilities. The non-compliance was the direct result of a delay in reaching a final agreement for the sale of Old Lyme, the proceeds of which would have been used to repay debt. The Company's lenders have granted waivers with respect to the non-compliance with these covenants. In addition, the Company has negotiated amended agreements, with respect to these covenants, with these lenders as of December 31, 2001. The amendments are for the remaining life of the loans. Under the amended agreements, the Company is in compliance with all the financial covenants governing the respective credit facilities as of December 31, 2001. F-30 Long-term debt and capital leases
2001 2000 ------- ------- Revolving U.S. Dollar LIBOR loans at 3.2% $49,454 $29,835 Put options (see below) 17,274 -- Term loan with interest at prime plus 3/4%, repayable at $22 monthly, due August, 2005* 849 1,130 Term loan with interest at 9%, repayable at $46 monthly, due October, 2005* 1,533 -- Term loan with interest at 7.8%, repayable at $367 quarterly, due June 2002* 728 -- Term loan with interest at 7.75% repayable at $13 monthly, due March 2002* 38 -- Note payable with interest at 5.92%, repayable at $272 annually, due November 2005 953 1,103 Term loan with interest at 8.25%, repayable at $364 semi-annually, due June 2007* 4,007 -- Term loan with interest at 8%, repayable at $18 monthly, due July 2010 1,353 -- Various other unsecured notes payable and debt 2,669 1,702 Capital leases* 1,470 667 Term loans repaid during the year -- 228 ------- ------- Long-term debt and capital leases 80,328 34,665 Less current portion (4,169) (2,167) ------- ------- $76,159 $32,498 ------- -------
- --------------- * Certain capital assets have been pledged as collateral in amounts not less than the outstanding balance at December 31, 2001. Revolving U.S. dollar LIBOR loans Borrowings under this facility total $50 million and are accessed at a floating rate of 112.5 basis points above LIBOR, which was 2.09% as of December 31, 2001. This facility expires on June 20, 2002 and requires the Company to maintain certain financial ratios. The Company intends to extend the facility for a further period of one year; however, if the revolving period is not extended, any amounts outstanding will automatically convert into a three-year term loan at a fixed interest rate equal to the Canadian dollar interest swap rate quoted by the lender plus 1.375%. As of December 31, 2001 $49.5 million had been drawn on this facility. The Company intends to pay down approximately $5 million of this facility with the proceeds from the sale of Old Lyme. Put options Long-term debt includes the estimated value of the financial liability of $17,274 relating to written put option agreements on 2,103 common shares, exercisable at a price of C$17.00 per share, issued to former owners of brokerages acquired who are officers and employees of the Company. The put options are exercisable as follows:
NUMBER OF SHARES DATE (000'S) - ---- --------- June 18, 2006 340 July 1, 2006 873 June 18, 2007 68 June 18, 2011 272 July 1, 2011 550
F-31 The Company will not be required to settle the liabilities in cash if the common share price exceeds C$17.00 on each of the above mentioned exercise dates. Any options not exercised on the exercise date immediately expire. Subordinated convertible debentures In connection with the acquisition of Kaye on June 28, 2001, we issued: (1) $26.6 million aggregate principal amount of 8.5% convertible subordinated notes due June 28, 2006 to a third-party, the third-party notes; and (2) $35 million aggregate principal amount of 8.5% convertible subordinated notes due June 28, 2007 to certain subsidiaries of Fairfax, the Fairfax notes. These convertible notes were anti-dilutive to earnings per share as of December 31, 2001. The third-party notes are convertible at any time into the Company's common shares at C$17.00 per share, subject to mandatory conversion at June 28, 2006. The Company subsequently entered into an agreement whereby the third-party agreed not to convert the notes into common shares before June 30, 2002 and also agreed to allow the Company to repay the notes, in whole or in part, on or before June 30, 2002 without penalty. The Fairfax notes are convertible by the holders at any time into the Company's common shares at C$17.00 per share. Beginning June 28, 2006, the Company may require conversion of the Fairfax notes into common shares at C$17.00 per share if, at any time, the weighted average closing price of the Company's common shares for twenty consecutive trading days equals or exceeds C$19.00 per share. If converted, Fairfax would own approximately 45% of the total outstanding common shares as of December 31, 2001. Future repayment of long-term debt and capital leases is as follows: Year ending December 31, 2002 $ 4,169 2003 2,794 2004 2,478 2005 51,365 2006 11,016 2007 and thereafter 8,506 ------- $80,328 -------
9. COMMITMENTS AND CONTINGENCIES a) The Company is committed under lease agreements for office premises and computer equipment. At December 31, 2001, aggregate minimum rental commitments (net of expected sub-lease receipts) under operating leases of $53,766 are summarized as follows: 2002 $ 9,061 2003 $ 7,909 2004 $ 6,968 2005 $ 6,311 2006 $ 5,680 2007 and thereafter $17,837
b) The Company may, under certain circumstances be obligated to purchase loans for officers, directors and employees from a Canadian chartered bank totaling $5,542 (2000 -- $5,896) to assist in purchasing common shares of the Company. As collateral, the employees have pledged 669 (2000 -- 690) common shares which have a year-end market value of $6,389 (2000 -- $5,683). Interest in the amount of $377 (2000 -- $397) on the loans was paid by the Company. F-32 c) In the ordinary course of business, the Company and its subsidiaries are subject to various claims and lawsuits consisting primarily of alleged errors and omissions in connection with the placement of insurance. In the opinion of management, the ultimate resolution of all asserted and potential claims and lawsuits will not have a material effect on the consolidated financial position or results of operations of the Company. 10. SHAREHOLDERS' EQUITY At December 31, 2001 and 2000, there were an unlimited number of non-voting, preferred shares authorized, issuable in series on such terms and conditions as set by the Board of Directors, of which no shares were issued. At December 31, 2001 and 2000, there were an unlimited number of common shares authorized, of which 21,656 in 2001 and 18,528 in 2000 were issued and outstanding.
COMMON SHARES ---------------------- OUTSTANDING (000'S) AMOUNT ----------- -------- Balance, January 1, 1999 7,077 $ 16,624 Repurchase (577) (4,147) Issued for cash 9,104 65,534 Purchase of subsidiaries 2,704 30,331 ------ -------- Balance, December 31, 1999 18,308 108,342 Repurchase (288) (1,794) Purchase of subsidiaries 508 4,882 ------ -------- Balance, December 31, 2000 18,528 111,430 Issued for cash 440 3,621 Issued for executive stock purchase plan (net of repurchases) 164 1,886 Purchase of subsidiaries 2,474 8,091 Issuable for contingent consideration 50 478 ------ -------- Balance, December 31, 2001 21,656 $125,506 ----------- --------
During 2000, under terms of normal course issuer bids approved by the Toronto Stock Exchange, the Company purchased and cancelled 226 common shares for an aggregate cost of $1,996, of which $649 was charged to retained earnings. On January 22, 1999, the Company issued 2,838 Special Warrants for cash of $24,282. Holders of Special Warrants were entitled to receive, upon exercise and without payment of any further consideration, one common share of the Company for each Special Warrant held. These warrants were exercised on February 10, 1999. On January 29, 1999, the Company filed a prospectus with applicable regulatory authorities in each of the provinces of Canada for the offering and issuance of 866 common shares of the Company for cash of $7,406. The offering closed on February 10, 1999. Shares issued for cash of $65,534 is net of issue costs of $376. F-33 Cumulative translation account
2001 2000 ------- ------ Balance at January 1 $ 195 $ (831) Translation of self-sustaining foreign operations 9,479 1,335 Translation of debt financing self-sustaining foreign operations (6,904) (309) ------- ------ Balance at December 31 $ 2,770 $ 195 ------- ------
11. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts of the Company's financial assets and liabilities, including cash and cash equivalents, accounts and other receivables, accounts payable and accrued liabilities at December 31, 2001 and 2000, approximate fair value because of the short maturity of these instruments. The carrying value of the Company's variable rate debt of $105,300 approximates fair market value. In connection with the acquisition of Kaye, the Company issued the following subordinated convertible debentures: -- 8.5% subordinated convertible debentures due June 28, 2006 with a carrying amount and aggregate principal of $26.6 million; -- 8.5% subordinated convertible debentures due June 28, 2007 with a carrying amount and aggregate principal of $35.0 million. The Company believes it is not practicable to estimate the fair value of the subordinated convertible debentures due to the conversion features. The carrying values of put options and other long-term debt approximate fair values. 12. INCOME TAXES The provision for income tax expense differs from the result that would have been obtained by applying the combined Canadian statutory federal and provincial income tax rate of 41.7% for 2001, 44.0% for 2000 and 44.5% for 1999, as follows:
2001 2000 1999 ------- ------- ------ Provision for tax at statutory rates $ 6,366 $ 5,058 $3,467 Non-deductible amortization of goodwill 1,579 994 588 Income earned outside Canada (3,170) (1,148) (44) Other 487 466 41 ------- ------- ------ Provision for tax $ 5,262 $ 5,370 $4,052 ------- ------- ------
F-34 The components of the future tax assets and liabilities at December 31, 2001 and 2000, were as follows:
2001 2000 ------- ----- Future income tax assets Loss carryforwards $ 1,886 $ 166 Non-deductible book reserves 1,602 -- Deferred compensation 879 -- Other 303 202 ------- ----- Total future income tax assets 4,670 368 Less: current portion future income tax assets (1,999) -- ------- ----- Future income tax assets $ 2,671 $ 368 ------- ----- Future income tax liabilities Goodwill and other intangible asset amortization $ 3,663 $ 712 Other accrual adjustments 1,309 -- Capital asset depreciation 169 181 Other 838 (141) ------- ----- Total future income tax liabilities 5,979 752 Less: current portion future income tax liabilities (1,387) -- ------- ----- Future income tax liabilities $(4,592) $ 752 ------- -----
The Company has Canadian net operating loss carryforwards of $2,425 at December 31, 2001 that expire 2007 through 2008. In addition, the Company has various state and local net operating loss carryforwards in the U.S. of approximately $9,100, which expire 2016 through 2021. Such net operating losses are currently available to offset certain future state and local taxable income. As a result of an ownership change, there are annual limitations imposed upon the utilization of these losses and, accordingly, a valuation allowance in the amount of approximately $1,400 has been established where we do not believe the net operating losses will be realized. Valuation allowance January 1, 2001 $ -- Acquired through acquisitions 1,461 Valuation allowance December 31, 2001 1,400 ------ Change in the period $ 61 Average state and local tax rate 10% ------ Charged to provision for income tax expense for the year ended December 31, 2001 $ 6 ------
13. INTEREST AND INCOME TAXES PAID Interest and income taxes paid were for the years ending December 31 were:
2001 2000 1999 ------ ------ ------ Interest paid $6,818 $2,606 $ 632 Income taxes paid $3,444 $7,528 $4,264
F-35 14. PRO FORMA RESULTS OF ACQUISITIONS (UNAUDITED) The following table reflects the results of our operations, on a pro forma basis, as if the 2001 acquisitions of Burnham, Flanagan and Kaye had been completed on January 1, 2000, and the 2000 acquisition of McCarthy had been completed on January 1, 1999. The 1999 acquisitions have not been presented due to the significant number of individually immaterial acquisitions.
2001 2000 -------- -------- Total revenue $197,786 $172,541 Net earnings (loss) before income taxes $ 16,321 $ (2,287) Net earnings (loss) from operations $ 11,440 $ (3,388) Net earnings (loss) from operations per share Basic $ 0.56 $ (0.18) Diluted $ 0.53 $ (0.16) Weighted average shares outstanding Basic (000's) 20,387 19,231 Diluted (000's) 21,480 21,654
The pro forma adjustments for 2001 and 2000 include adjustments to remove non-recurring expenses incurred by the brokerages acquired in connection with the purchase transactions by the Company, adjustments to amortization of goodwill and other identifiable intangible assets, as well as adjustments to reflect the Company's cost of borrowings as if the 2001 acquisitions of Burnham, Flanagan and Kaye had been completed on January 1, 2000, and the 2000 acquisition of McCarthy had been completed on January 1, 2000. 15. SEGMENTED INFORMATION The Company is an international insurance brokerage which provides a variety of property, casualty, life and health, employee benefits, investment and risk management products and services. In addition to its Corporate Operations, the Company has identified two operating segments within its insurance brokerage business; Canadian Operations and U.S. Operations. Corporate Operations consist primarily of investment income, unallocated administrative costs, interest expense and the income tax expense or benefit which is not allocated to the Company's operating segments. The elimination of intra-segment revenue relates to intra-company interest charges and management fees. Geographic revenue is determined based upon the functional currency of the various subsidiaries. Financial information by operating and geographic segment for 2001, 2000 and 1999 is as follows:
2001 2000 ---------------------------------- --------------------------------- CANADA U.S. CONSOLIDATED CANADA U.S. CONSOLIDATED -------- -------- ------------ -------- ------- ------------ REVENUE Brokerage $ 78,488 $ 75,458 $153,946 $ 74,710 $19,864 $ 94,574 Corporate and other 16,960 237 17,197 7,953 5,142 13,095 Elimination of intra-segment revenue (16,884) (266) (17,150) (7,427) (5,002) (12,429) -------- -------- -------- -------- ------- -------- $ 78,564 $ 75,429 $153,993 $ 75,236 $20,004 $ 95,240 -------- -------- ---------- -------- ------- ---------- NET EARNINGS BEFORE INCOME TAXES Brokerage $ 6,625 $ 13,200 $ 19,825 $ 8,017 $ 3,242 $ 11,259 Corporate and other 6,126 (10,684) (4,558) 3,771 (3,522) 249 -------- -------- -------- -------- ------- -------- $ 12,751 $ 2,516 $ 15,267 $ 11,788 ($280) $ 11,508 -------- -------- ---------- -------- ------- ----------
F-36
2001 2000 ---------------------------------- --------------------------------- CANADA U.S. CONSOLIDATED CANADA U.S. CONSOLIDATED -------- -------- ------------ -------- ------- ------------ INCOME TAXES Brokerage $ 3,910 $ 5,793 $ 9,703 $ 4,930 $ 1,339 $ 6,269 Corporate and other (322) (4,119) (4,441) 412 (1,311) (899) -------- -------- -------- -------- ------- -------- $ 3,588 $ 1,674 $ 5,262 $ 5,342 $ 28 $ 5,370 -------- -------- ---------- -------- ------- ---------- NET EARNINGS Brokerage $ 2,715 $ 7,407 $ 10,122 $ 3,087 $ 1,903 $ 4,990 Corporate and other 6,448 (6,565) (117) 3,359 (2,211) 1,148 -------- -------- -------- -------- ------- -------- $ 9,163 $ 842 $ 10,005 $ 6,446 ($308) $ 6,138 -------- -------- ---------- -------- ------- ---------- IDENTIFIABLE ASSETS Brokerage $109,896 $319,989 $429,885 $129,899 $63,116 $193,015 Investment held for sale -- 40,772 40,772 -- -- -- Corporate and other 28,212 3,427 31,639 8,309 4,833 13,142 -------- -------- -------- -------- ------- -------- $138,108 $364,188 $502,296 $138,208 $67,949 $206,157 -------- -------- ---------- -------- ------- ---------- AMORTIZATION $ 2,316 $ 2,624 $ 4,940 $ 2,482 $ 778 $ 3,260 ADDITIONS TO CAPITAL ASSETS $ 1,624 $ 9,910 $ 11,534 $ 2,190 $ 205 $ 2,395 DEPRECIATION $ 1,755 $ 2,185 $ 3,940 $ 1,619 $ 266 $ 1,885 INTEREST REVENUE $ 805 $ 1,188 $ 1,993 $ 977 $ 704 $ 1,681 INTEREST EXPENSE $ 6,337 $ 1,110 $ 7,447 $ 1,920 $ 61 $ 1,981
F-37
1999 --------------------------------- CANADA U.S. CONSOLIDATED -------- ------- ------------ REVENUE Brokerage $ 50,944 $ 1,535 $ 52,479 Corporate and other 4,029 -- 4,029 Elimination of intra-segment revenue (2,411) -- (2,411) -------- ------- -------- $ 52,562 $ 1,535 $ 54,097 -------- ------- ----------- NET EARNINGS BEFORE INCOME TAXES Brokerage $ 5,727 $ (236) $ 5,491 Corporate and other 2,510 (205) 2,305 -------- ------- -------- $ 8,237 $ (441) $ 7,796 -------- ------- ----------- INCOME TAXES Brokerage $ 3,274 $ (65) $ 3,209 Corporate and other 994 (151) 843 -------- ------- -------- $ 4,268 $ (216) $ 4,052 -------- ------- ----------- NET EARNINGS Brokerage $ 2,453 $ (171) $ 2,282 Corporate and other 1,516 (54) 1,462 -------- ------- -------- $ 3,969 $ (255) $ 3,744 -------- ------- ----------- IDENTIFIABLE ASSETS Brokerage $117,038 $32,070 $149,108 Corporate and other 20,247 1,847 22,094 -------- ------- -------- $137,285 $33,917 $171,202 -------- ------- ----------- AMORTIZATION $ 1,547 $ 79 $ 1,626 ADDITIONS TO CAPITAL ASSETS $ 1,225 $ 83 $ 1,308 DEPRECIATION $ 1,211 $ 64 $ 1,275 INTEREST REVENUE $ 724 $ 83 $ 807 INTEREST EXPENSE $ 425 $ 207 $ 632
16. RELATED PARTY TRANSACTIONS The Company had transactions with and recorded commission income from the following related parties:
2001 2000 1999 ------ ------ ------ Lombard General Insurance Company of Canada $6,123 $7,527 $6,077 Commonwealth Insurance Company 374 351 353 Federated Insurance Company of Canada 28 10 1 Markel Insurance Company of Canada 88 72 61 Crum & Forster Insurance 745 291 67 TIG Specialty Insurance 150 -- -- ------ ------ ------ $7,508 $8,251 $6,559 ------ ------ ------
As of December 31, 2001, the Company had accounts receivable and accounts payable balances with the above related parties in the amounts of $271 and $6,839 (2000 -- $269 and $3,605), respectively. All revenue and related accounts receivable and accounts payable are the result of F-38 transactions in the normal course of business. The companies above are related through common ownership by Fairfax, which owns approximately 37% of the Company's common shares. As of December 31, 2001, long-term debt related to put options and certain subordinated convertible debentures are due to related parties. During 2001 and 2000, the Company incurred expenses related to rental of premises from related parties in the amount of $1,373 and $993, respectively. At December 31, 2001 and 2000, the Company also had accounts receivable due from related parties in the amount of $4,586 (2000 -- $2,320), of which the majority were loans to employees to enable them to purchase shares of the Company. 17. RECONCILIATION TO U.S. GAAP The consolidated financial statements have been prepared in accordance with Canadian GAAP, which differs in certain respects from U.S. GAAP. NET EARNINGS AND OTHER COMPREHENSIVE INCOME The table below represents the differences between Canadian and U.S. GAAP affecting net earnings.
2001 2000 1999 ------------ ------------ ------------ Net earnings for the year based on Canadian GAAP $10,005 $6,138 $ 3,744 Adjustment to investment held for sale(1) 520 -- -- Change in reporting currency(2) 144 405 233 Adjustment to put option liability(3) (811) -- -- ------- ------ ------- NET EARNINGS FOR THE YEAR BASED ON U.S. GAAP(4) 9,858 6,543 3,977 Other comprehensive income: Unrealized gains (losses), net of tax of $120 -- 2001, ($102) -- 2000, ($26) -- 1999 (195) 166 42 Less: reclassification adjustment, net of tax of ($88) -- 2001, ($6) -- 2000 (143) (10) -- Foreign currency translation adjustment, net of tax of $2,324 -- 2001, $2,498 -- 2000, ($615) -- 1999(2) (3,792) (4,076) 1,004 ------- ------ ------- Comprehensive income based on U.S. GAAP(5) $ 5,728 $2,623 $ 5,023 ------------ ------------ ------------ Basic earnings per share based on U.S. GAAP $ 0.52 $ 0.36 $ 0.23 Diluted earnings per share based on U.S. GAAP $ 0.49 $ 0.36 $ 0.23
F-39 SHAREHOLDERS' EQUITY The table below sets out the differences between Canadian GAAP and U.S. GAAP that affect shareholders' equity:
2001 2000 ------------ ------------ Shareholders' equity based on Canadian GAAP $135,271 $112,212 Adjustment to investment held for sale(1) 520 -- Accumulated other comprehensive income: Unrealized gains (losses), net of tax of $85 -- 2001, $(122) -- 2000 (140) 198 Cumulative translation account(2) -- 5,811 Adjustment to put option liability(3) (4,898) -- Executive share purchase plan loan(6) (2,142) -- -------- -------- SHAREHOLDERS' EQUITY BASED ON U.S. GAAP(4) $128,611 $118,221 ------------ ------------
- --------------- Notes: (1) Under Canadian GAAP, Old Lyme is treated as an investment held for sale at its June 28, 2001 cost of $40,772. Under U.S. GAAP, Old Lyme is reflected at its fair market value, which is equal to its U.S. GAAP shareholder's equity at December 31, 2001 pursuant to the pending sale of Old Lyme, which is expected to close in the second quarter of 2002. Accordingly, under U.S. GAAP, the investment in Old Lyme has been increased to reflect the net increase in its shareholder's equity from the date of acquisition. This adjustment is treated as a purchase price adjustment to the Kaye acquisition and results in an increase of $2,075 in the investment in Old Lyme and a corresponding decrease in goodwill, with no effect on net earnings or shareholders' equity. Under Canadian GAAP, interest on debt used to finance the Old Lyme acquisition in the amount of $520 (net of tax) is charged to earnings. Under U.S. GAAP, the interest expense on the debt incurred to finance the purchase of Old Lyme is applied to the carrying value of the investment and does not affect the net earnings of the Company. The following reconciles the change in the investment held for sale under U.S. GAAP from the date of acquisition to December 31, 2001, including the net earnings of Old Lyme during the period which have been excluded from the consolidated statement of earnings of the Company: Investment held for sale carrying value at date of acquisition $40,772 Net earnings of Old Lyme from date of acquisition through December 31, 2001 1,833 Other equity changes 242 ------ Total increases in shareholder's equity of Old Lyme 2,075 Interest expense incurred to finance the purchase of Old Lyme 520 Tax liability related to foreign subsidiary operations 318 ------- Investment held for sale carrying value at December 31, 2001 43,685 -------
(2) Under Canadian GAAP, the Company's consolidated financial statements have historically been expressed in Canadian dollars. Effective September 30, 2001, the Company adopted the U.S. dollar as its reporting currency. Comparative financial information has been restated in U.S. dollars using the translation of convenience method. At September 30, 2001, all historical F-40 financial statements were converted from Canadian to U.S. dollars at the exchange rate in effect at September 30, 2001 of one Canadian dollar to 0.6338 U.S. dollar. Revenue and expenses subsequent to September 30, 2001 were translated to U.S. dollars at the average exchange rate for the period. Under U.S. GAAP, historical financial statements are translated using a current exchange rate; which for assets and liabilities is the exchange rate at the balance sheet date; for the income statement is the average exchange rate for the period; and for share capital accounts is the historical exchange rate. In addition, foreign exchange differences under U.S. GAAP are included in the cumulative translation account net of tax. The aggregate impact of these differences has been presented in the reconciliation of shareholders' equity for Canadian to U.S. GAAP under the caption "cumulative translation account". (3) Under Canadian GAAP, the fair value of the put options (determined using the Black-Scholes model) issued in connection with the Burnham and Flanagan acquisitions was allocated to equity instruments on the balance sheet. The balance of the purchase price was allocated to debt. Changes in the value of the put options in periods subsequent to the acquisition dates are included in earnings. Under U.S. GAAP, the fair value of the share consideration and the attached put options is initially recorded in equity. The redemption value of the shares to which the put options are attached has been reclassified as mezzanine equity outside of shareholders' equity as a result of the put options granted on those shares to certain of the selling shareholders. The fair value of the put options is also recorded as a debit to shareholders' equity, representing an unearned compensation expense, as these options require the selling shareholders to remain employed by the Company in order to be able to exercise the put options. Compensation expense in being recognized using the straight-line method over the period from the issue date to the put date. (4) The condensed consolidated statements of earnings and cash flows for the years ended December 31, 2001, 2000 and 1999 and the condensed balance sheets as at December 31, 2001 and 2000, under U.S. GAAP are as follows:
2001 2000 1999 ------------ ------------ ------------ Revenue $ 156,079 $100,917 $ 57,426 Net earnings before income taxes $ 15,213 $ 12,269 $ 8,286 Net earnings $ 9,858 $ 6,543 $ 3,977 Cash provided by (used in) operating activities(7) $ 29,060 $ 12,004 $ (3,121) Cash (used in) provided by investing activities $(130,687) $ 18,914 $ 37,886 Cash provided by financing activities $ 130,881 $ 5,904 $ 63,949 Total current assets $ 226,191 $ 81,518 Total assets $ 500,852 $217,153 Total current liabilities $ 224,968 $ 63,839 Total liabilities $ 350,070 $ 98,932 Mezzanine equity $ 22,171 $ -- Total shareholders' equity $ 128,611 $118,221
(5) Comprehensive income is measured in accordance with Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income" (SFAS 130). This standard defines comprehensive income as all changes in equity other than those resulting from investments by owners and distributions to owners and includes the change in unrealized gains (losses) and F-41 foreign currency translation adjustments, under which Canadian GAAP are not recognized and recorded as a separate component of shareholders' equity, respectively. Certain disclosures required by SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities", have not been included as such disclosures related to the Company's investments in debt and equity securities are immaterial to the overall financial statement presentation. (6) Under Canadian GAAP, loans granted by the Company to employees under the executive share purchase plan are treated as a receivable and included in the balance sheet caption "Accounts and other receivables". Under U.S. GAAP, those loan receivables must be included as a reduction to shareholders' equity. (7) Under Canadian GAAP, the statement of cash flows reconciles changes in cash and cash equivalents and trust cash for each of the years presented. The statement of cash flows includes changes in trust cash as it is available to settle accounts payable to insurance companies which are included as part of current liabilities. Under U.S. GAAP, the statement of cash flows reconciles changes in cash and cash equivalents only. Under U.S. GAAP, changes in trust cash are included as part of the change in non-cash working capital in the determination of cash provided from operating activities. EFFECTS OF NEW U.S. GAAP ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that all business combinations subsequent to June 30, 2001 be accounted for in accordance with the purchase method of accounting, as well as specifies criteria for recognizing intangible assets acquired in a purchase business combination. SFAS No. 142 eliminates the amortization of goodwill, requires annual impairment testing of goodwill, and introduces the concept of definite and indefinite life intangible assets. Indefinite life intangible assets, similar to goodwill, will no longer be amortized and will be tested at least annually for impairment. Definite life intangible assets will be amortized over the estimated useful life of the asset. SFAS No. 142 must be adopted on January 1, 2002. Effective January 1, 2002, the Company adopted SFAS No. 142. The Company is required to complete the transitional impairment test within six months of adoption of SFAS No. 142 and to record impairment, if any, by the end of the fiscal year. Any loss resulting from the transitional impairment test will be recorded as a cumulative effect of a change in accounting principle and charged to opening retained earnings. The Company has substantially completed its impairment testing on the balance of goodwill and intangible assets with an indefinite life as of January 1, 2002. Based on the testing completed at the time of the preparation of the March 31, 2002 interim consolidated financial statements, no impairment losses are expected. As required under SFAS No. 142 no goodwill amortization expense was incurred for the three months ended March 31, 2002. The following table illustrates the effect that SFAS No. 142 would have had on net earnings and per share information under U.S. GAAP for the years ended December 31, 2001, 2000 and 1999 if goodwill had not been amortized: F-42
DECEMBER 31, ------------------------- 2001 2000 1999 ------- ------ ------ Reported net earnings -- U.S. GAAP $ 9,858 $6,543 $3,977 Add back: Goodwill amortization 4,698 2,988 1,583 ------- ------ ------ Net earnings adjusted for goodwill $14,556 $9,531 $5,560 Basic EPS -- Reported $ 0.52 $ 0.36 $ 0.23 Basic EPS -- Adjusted for goodwill $ 0.77 $ 0.52 $ 0.33 Diluted EPS -- Reported $ 0.49 $ 0.36 $ 0.23 Diluted EPS -- Adjusted for goodwill $ 0.72 $ 0.52 $ 0.33
In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", effective for fiscal years beginning after December 15, 2001. This Statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30 "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" (APB No. 30). SFAS No. 144 generally retains the basic accounting model for the identification and measurement of impairments to long-lived assets to be held, and long-lived assets to be disposed. SFAS No. 144 broadens the definition of "discontinued operations," as previously defined by APB No. 30, but does not allow for the accrual of future operating losses, as was previously permitted under that standard. SFAS No. 144 also addresses several implementation and financial statement presentation issues not previously addressed under U.S. GAAP. SFAS No. 144 excludes from its scope financial accounting and reporting for the impairment of goodwill and other intangible assets. The transitional guidance of SFAS No. 144 generally permits long-lived assets classified as held for disposal as a result of disposal activities that were initiated prior to SFAS No. 144's initial application to continue to be accounted for in accordance with the prior pronouncement applicable for that disposal. As such, our investment in Old Lyme, which is classified as held for disposal at December 31, 2001, will continue to be accounted for in accordance with Canadian and U.S. generally accepted accounting principles applicable at the date that the disposal activities were initiated. In the event that the sale of Old Lyme is not completed by December 31, 2002, the investment will be reclassified as held for use in operations, in accordance with the provisions of SFAS No. 144. Canadian GAAP has not been harmonized with U.S. GAAP related to the provisions of SFAS No. 144. Accordingly, any impact related to the adoption of the provisions of SFAS No. 144 will be treated as a reconciling item between U.S. and Canadian GAAP. However, we do not anticipate that the provisions of SFAS No. 144 will have a material impact on our financial position or results of operations as reported under U.S. GAAP. F-43 18. QUARTERLY DATA (UNAUDITED)
FIRST SECOND THIRD FOURTH FULL QUARTER QUARTER QUARTER QUARTER YEAR ------- ------- ------- ------- -------- YEAR ENDED DECEMBER 31, 2001 Revenue $28,096 $29,342 $43,601 $52,954 $153,993 Net earnings $2,467 $2,558 $2,029 $2,951 $10,005 Net earnings per share -- Basic $0.13 $0.14 $0.11 $0.15 $0.53 Net earnings per share -- Diluted $0.13 $0.14 $0.09 $0.14 $0.50 YEAR ENDED DECEMBER 31, 2000 Revenue $23,205 $23,080 $24,504 $24,451 $95,240 Net earnings $2,302 $2,093 $1,184 $559 $6,138 Net earnings per share -- Basic $0.13 $0.12 $0.06 $0.03 $0.34 Net earnings per share -- Diluted $0.13 $0.12 $0.06 $0.03 $0.34
19. SUBSEQUENT EVENT On May 30, 2002, the Company completed the sale of its investment in Old Lyme to Fairfax Financial Holdings Limited, a related party, in consideration for approximately $43,500. F-44 REPORT OF INDEPENDENT ACCOUNTANTS TO THE BOARD OF DIRECTORS OF KAYE GROUP INC.: In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, of cash flows, of stockholders' equity and comprehensive loss present fairly, in all material respects, the financial position of Kaye Group Inc. and its subsidiaries at June 28, 2001, and the results of their operations and their cash flows for the period from January 1, 2001 through June 28, 2001 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. LOGO PricewaterhouseCoopers LLP New York, New York March 12, 2002 F-45 KAYE GROUP INC. CONSOLIDATED BALANCE SHEET As of June 28, 2001 (in thousands, except par value per share) ASSETS INSURANCE BROKERAGE COMPANIES: CURRENT ASSETS Cash and cash equivalents $ 1,435 Restricted cash 16,618 Premiums and other receivables 36,857 Prepaid expenses and other assets 1,251 Deferred income taxes 1,363 -------- TOTAL CURRENT ASSETS 57,524 -------- Fixed assets (net of accumulated depreciation of $7,950) 5,256 Intangible assets (net of accumulated amortization of $5,485) 12,128 Deferred income taxes 1,287 Other assets 518 -------- TOTAL ASSETS -- INSURANCE BROKERAGE COMPANIES 76,713 -------- PROPERTY AND CASUALTY COMPANIES: Investments available-for-sale Fixed maturities, at market value (amortized cost $50,038) 50,261 Equity securities, at market value (cost $350) 350 -------- TOTAL INVESTMENTS 50,611 -------- Cash and cash equivalents 8,998 Accrued interest and dividends 1,107 Premiums receivable 3,429 Reinsurance recoverable on paid and unpaid losses 7,430 Prepaid reinsurance premiums 1,248 Deferred acquisition costs 3,376 Deferred income taxes 3,120 Other assets 5,092 -------- TOTAL ASSETS -- PROPERTY AND CASUALTY COMPANIES 84,411 -------- CORPORATE: Cash and cash equivalents 107 Restricted cash 2,445 Prepaid income taxes 1,176 Prepaid expenses and other assets 10 Investment -- Equity securities, at market value (cost $308) 359 Deferred income taxes 71 -------- TOTAL ASSETS -- CORPORATE 4,168 -------- TOTAL ASSETS $165,292 --------
See notes to consolidated financial statements. F-46 KAYE GROUP INC. CONSOLIDATED BALANCE SHEET As of June 28, 2001 (in thousands, except par value per share) LIABILITIES INSURANCE BROKERAGE COMPANIES: Current liabilities Premiums payable and unearned commissions $ 42,657 Accounts payable and accrued liabilities 6,625 Notes payable 488 Advance from Hub International Limited 10,585 Deferred income taxes 1,069 -------- TOTAL CURRENT LIABILITIES 61,424 Notes payable 94 Deferred income taxes 288 -------- TOTAL LIABILITIES -- INSURANCE BROKERAGE COMPANIES 61,806 -------- PROPERTY AND CASUALTY COMPANIES: Liabilities Unpaid losses and loss expenses 30,366 Unearned premium reserves 11,875 Accounts payable and accrued liabilities 375 Deferred income taxes 1,442 Other liabilities 954 -------- TOTAL LIABILITIES -- PROPERTY AND CASUALTY COMPANIES 45,012 -------- CORPORATE: Current liabilities Accounts payable and accrued liabilities 2,482 Loan payable 1,412 Deferred income taxes 17 -------- TOTAL CURRENT LIABILITIES -- CORPORATE 3,911 -------- TOTAL LIABILITIES 110,729 -------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY Preferred stock, $1.00 par value; 1,000 shares authorized; none issued or outstanding Common stock, $.01 par value; 20,000 shares authorized; 8,507 shares issued and outstanding 85 Paid-in capital 17,995 Accumulated other comprehensive income, net of deferred income tax liability of $93 181 Retained earnings 36,302 -------- TOTAL STOCKHOLDERS' EQUITY 54,563 -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $165,292 --------
See notes to consolidated financial statements. F-47 KAYE GROUP INC. CONSOLIDATED STATEMENT OF OPERATIONS For the period January 1, 2001 through June 28, 2001 (in thousands) INSURANCE BROKERAGE COMPANIES: Revenues Commissions and fees -- net $20,174 Net investment income 448 Net realized loss on investments (364) ------- TOTAL REVENUES 20,258 ------- Expenses Compensation and benefits 12,089 Amortization of intangibles 676 Other operating expenses 7,795 ------- TOTAL OPERATING EXPENSES 20,560 ------- Interest expense 377 ------- LOSS BEFORE MERGER EXPENSES -- INSURANCE BROKERAGE COMPANIES (679) ------- PROPERTY AND CASUALTY COMPANIES Revenues Net premiums written 14,671 Change in unearned premiums 2,121 ------- Net premiums earned 16,792 Net investment income 1,768 Net realized loss on investments (713) Other income 6,480 ------- TOTAL REVENUES 24,327 ------- Expenses Losses and loss expenses 7,258 Acquisition costs and general and administrative expenses 6,701 ------- TOTAL EXPENSES 13,959 ------- INCOME BEFORE MERGER EXPENSES -- PROPERTY AND CASUALTY COMPANIES 10,368 ------- CORPORATE: Revenues -- Net investment income 16 Expenses Other operating expenses 247 Interest expense 75 ------- LOSS BEFORE MERGER EXPENSES -- CORPORATE (306) ------- Income before merger expenses 9,383 Merger expenses 13,263 ------- LOSS BEFORE INCOME TAXES (3,880) ------- (Benefit) provision for income taxes Current 703 Deferred (2,735) ------- TOTAL BENEFIT FOR INCOME TAXES (2,032) ------- Loss before cumulative effect of change in accounting principle (1,848) Cumulative effect of change in accounting principle (net of tax effect) 158 ------- NET LOSS $(1,690) -------
See notes to consolidated financial statements. F-48 KAYE GROUP INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY For the period January 1, 2001 through June 28, 2001 (in thousands)
COMMON STOCK ACCUMULATED ------------------- COMMON UNEARNED OTHER TOTAL OUTSTANDING PAR STOCK STOCK GRANT PAID-IN COMPREHENSIVE RETAINED STOCKHOLDERS' SHARES VALUE IN TREASURY COMPENSATION CAPITAL INCOME EARNINGS EQUITY ----------- ----- ----------- ------------ ------- ------------- -------- ------------- Balance, January 1, 2001 8,481 $85 $(37) $(235) $18,019 $(207) $38,417 $56,042 Change in unrealized appreciation, net of deferred income tax of $200 388 388 Amortization of unearned restricted stock 9 9 Net loss (1,690) (1,690) Shares issued -- SRW acquisition 21 171 171 Shares issued -- employee stock option plan 4 31 31 Dividends declared (per share -- $0.05) (425) (425) Write off balance of unearned restricted stock 226 (226) -- Shares forfeited -- stock performance plan (3) -- Reissuance of treasury stock 4 37 37 ----- --- ---- ----- ------- ----- ------- ------- Balance, June 28, 2001 8,507 $85 $ -- $ -- $17,995 $ 181 $36,302 $54,563 ------- --- ------- -------- ------ -------- ------- ---------
See notes to consolidated financial statements. F-49 KAYE GROUP INC. CONSOLIDATED STATEMENT OF COMPREHENSIVE LOSS For the period January 1, 2001 through June 28, 2001 (in thousands) Net loss $(1,690) Other comprehensive income Unrealized investment holding losses arising during the period, net of deferred income tax benefit of $22 (42) Reclassification adjustment for realized investment loss included in net income, net of deferred income tax benefit of $222 430 ------- TOTAL OTHER COMPREHENSIVE INCOME 388 ------- Comprehensive loss $(1,302) -------
See notes to consolidated financial statements. F-50 KAYE GROUP INC. CONSOLIDATED STATEMENT OF CASH FLOWS For the period January 1, 2001 through June 28, 2001 (in thousands) CASH FLOWS FROM OPERATING ACTIVITIES Net loss $ (1,690) Adjustments to reconcile net loss to net cash used in operating activities Deferred acquisition costs 677 Amortization of bond premium -- net 344 Deferred income taxes (2,735) Net realized loss on investments 1,077 Depreciation and amortization 1,816 Change in assets and liabilities Restricted cash 6,311 Accrued interest and dividends (245) Premiums and other receivables 234 Prepaid expenses and other assets 1,414 Premiums payable and unearned commissions (10,158) Accounts payable and accrued liabilities (7,752) Unpaid losses and loss expenses 2,382 Unearned premium reserves (1,822) Income taxes payable (1,363) -------- NET CASH USED IN OPERATING ACTIVITIES (11,510) -------- CASH FLOWS FROM INVESTING ACTIVITIES Investments available - for - sale Purchase of fixed maturities (22,844) Purchase of equity securities (477) Maturities of fixed securities 2,320 Sales of fixed securities 13,553 Sales of equity securities 7,929 Purchase of fixed assets (615) Acquisition payments (1,124) -------- NET CASH USED IN INVESTING ACTIVITIES (1,258) -------- CASH FLOWS FROM FINANCING ACTIVITIES Acquisition debt-repayment (187) Notes and loan payable-repayment (731) Payment of dividends (636) Proceeds from issuance of common stock 31 Advanced proceeds from Hub International Limited 10,585 Receipts under deposit contracts 107 -------- NET CASH PROVIDED BY FINANCING ACTIVITIES 9,169 -------- Net change in cash and cash equivalents (3,599) Cash and cash equivalents at beginning of period 14,139 -------- Cash and cash equivalents at end of period $ 10,540 --------
See notes to consolidated financial statements. F-51 KAYE GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BUSINESS Kaye Group Inc. (the "Company"), a Delaware corporation, is a holding company which, through its subsidiaries, is engaged in a broad range of insurance brokerage, underwriting and related activities. The Company operates in two insurance business segments -- the Insurance Brokerage Companies Operations ("Brokerage Operations"), comprised of the Retail Brokerage Business and the Program Brokerage Business, and the Property and Casualty Companies Operations. In addition, Corporate Operations includes those activities that benefit the Company in its entirety and cannot be specifically identified to either the Brokerage Operations or the Property and Casualty Companies Operations. Such activities include debt servicing and public company expenses, including investor relations' costs. The Company's activities are conducted from offices in New York, New York, Arcadia, California, Westport, Connecticut, Woodbury, New York and Warwick, Rhode Island. Sale of the company On January 20, 2001, the Company reported that Hub International Limited ("HUB") had entered into a definitive agreement (the "Agreement") to acquire the Company through a merger transaction. Under the terms of the Agreement, shares of Kaye's common stock not held by affiliates or shareholders perfecting appraisal rights were converted to a right to receive $14 in cash. On June 28, 2001, the Company and HUB completed the merger, which has not been given effect in the accompanying consolidated financial statements. Prior to June 28, 2001 HUB had, however, transferred cash of $10,585,000 to the Company to settle payments for vested stock options and restricted stock held by employees; the cash is reflected in the accompanying financial statements as restricted cash and an advance from HUB, as well as recorded as a merger expense and as a payable to the employees. On June 27, 2001, all stock options issued by the Company became vested and were purchased with the payment of $8,140,000 in restricted cash advanced by HUB. Restricted stock was converted to the right to receive $14 in cash per share, totaling $2,445,000, which will be paid to stockholders upon the first anniversary of the merger. Additionally, with the merger the advances by HUB were contributed to the paid-in capital of the Company. Proposed sale of property and casualty companies On December 31, 2001, HUB, on behalf of the Company, announced that it had agreed to sell the Company's underwriting subsidiaries Old Lyme Insurance Company of Rhode Island, Inc. ("OLRI") and Old Lyme Insurance Ltd. ("OLB") to Fairfax Inc. ("Fairfax"), effective January 1, 2002. Completion of the transaction is subject to receipt of approval from and compliance with the requirements of applicable regulatory authorities. Fairfax is a subsidiary of Fairfax Financial Holdings Limited, and is HUB's largest shareholder with a 37% interest in HUB's common stock. Insurance brokerage companies operations The Retail Brokerage Business operates insurance brokerage businesses through four subsidiaries of the Company, the "Retail Brokerage Companies". The Retail Brokerage Companies offer commercial clients a full range of insurance brokerage services including procurement of property/ casualty insurance, risk management consulting, bonding, loss prevention engineering, and group employee benefit consulting services. In addition, personal lines and life and health insurance coverage are placed on behalf of individual clients. F-52 The Retail Brokerage Business' primary strategy is to service middle market companies and organizations just below the Fortune 500 level for which other national brokers intensely compete. Within this middle market, the Retail Brokerage Business has developed particular expertise and knowledge of the risks facing a number of industry sectors including health care, real estate, retail, manufacturing, houses of worship, law firms, homes for the aged and fine arts. The Retail Brokerage Business services approximately 14,000 insureds. The Retail Brokerage Business is compensated for its services primarily in the form of commissions paid by insurance companies. The commission is usually a percentage of the premium paid by the insured. Commission rates depend upon the type of insurance, the particular insurance company, and the role in which the Retail Brokerage Business acts. In some cases a commission is shared with other agents or brokers who have acted jointly with the Retail Brokerage Business in connection with the transaction. The Retail Brokerage Business may also receive from an insurance company a contingent commission that is generally based on the profitability and volume of business placed with it by the Retail Brokerage Business over a given period of time. The Retail Brokerage Business may also receive fees from insureds in connection with consulting services relating to the marketing of insurance. Program Brokerage Corporation ("PBC" or the "Program Brokerage Business") is a subsidiary of the Company and operates a wholesale insurance brokerage business which offers retail insurance agents and brokers innovative solutions to the twin insurance problems of price and availability of coverage. It accomplishes this by organizing pools of similar risks into specially designed alternative distribution programs through which it places insurance for affinity groups (the "Programs"). The Program Brokerage Business is one of the leaders in the application of purchasing groups in the commercial insurance market. Approximately 82% of PBC's premium volume was generated by its own producers and approximately 1,000 unrelated retail insurance agent and broker producers serving approximately 14,000 insureds. The remaining 18% was derived from the Retail Brokerage Business. Approximately 35% of PBC's premium volume is directly or indirectly placed with two affiliates, OLRI and Old Lyme Insurance Company, Ltd. (Bermuda) ("OLB"). Property and casualty companies operations The Company conducts its property and casualty underwriting business through two insurance company subsidiaries (the "Insurance Companies"), OLRI and OLB. OLRI is a property and casualty insurance company licensed in Rhode Island and eligible as a surplus lines insurer in New York and New Jersey. OLB is a property and casualty insurance company organized and licensed under the laws of Bermuda. In states where the Insurance Companies are not admitted insurers or surplus lines insurers, the Insurance Companies underwrite risks through various reinsurance agreements. The Insurance Companies underwrite property risks (loss or physical damage to property) and OLRI underwrites casualty risks (legal liability for personal injury or damaged property of others) for insureds in the United States. Insurance is sold principally through the Programs marketed by PBC which insure various types of businesses and properties that have similar risk characteristics, such as apartments, condominiums, cooperatives, restaurants, building maintenance companies, automobile service stations, retail stores, funeral homes and pharmacies, among others. The Insurance Companies' strategy is to underwrite only the first "layer" of the property and casualty insurance provided under the Programs. Exposure to individual insureds on individual losses is thereby generally limited to between $10,000 and $25,000 per claim, depending on the Program. Under the Programs, the Insurance Companies' policies are sold in conjunction with policies issued by unaffiliated Program insurers that provide coverage for losses above the first layer of risk underwritten by the Insurance Companies. In addition, OLRI has issued policies on a selected basis with limits up to $1,000,000, with net retention of $50,000 of exposure and has F-53 reinsured the remaining limits with unaffiliated reinsurers rated A or better by A.M. Best Company ("A.M. Best"), a major rating agency for insurers. The Property and Casualty Companies Operations includes Claims Administration Corporation ("CAC"), a subsidiary of the Company which is responsible for the administration of a large majority of the claims submitted to the Insurance Companies. The administration of claims includes investigation, engagement of legal counsel, approval of settlements and the making of payments to, or on behalf of insureds. The Insurance Companies pay CAC for its services. CAC also provides claims administration service to certain unaffiliated Program insurers for a fee. In both instances, fees are recorded based upon time incurred to provide claims administration services. 2. SIGNIFICANT ACCOUNTING POLICIES a. Basis of presentation The accompanying Consolidated Balance Sheet, Statement of Operations, Cash Flows, Stockholders' Equity and Comprehensive Loss (the "financial statements") have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and predominant industry practice. The Consolidated Balance Sheet is presented on a segmented basis with inter-company balances eliminated. Identifiable assets by segment are those assets used in the Company's operations in each business segment. Corporate assets are principally cash and cash equivalents and an equity security investment. The Statement of Operations is segmented and presents the consolidated results of the Insurance Brokerage Companies segment, the Property and Casualty Companies segment and the Corporate segment. Intersegment transactions have not been eliminated. However, transactions within each segment are eliminated. Income or loss before income taxes of the two operating segments includes expenses incurred by Corporate on behalf of the segments, which are allocated to operations of the segments. The allocation is based upon total revenues of each segment except for the allocation of incentive compensation which is allocated based on the percentage of profits contributed to the Company. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. b. Segment Reporting The accompanying consolidated financial statements have been prepared on a segmented basis. See Note 1 for segments and their respective operations. Income before income taxes of the two operating segments includes expenses incurred by Corporate on behalf of the segments, which are allocated to operations of the segments. The allocation is based upon total revenues of each segment except for the allocation of incentive compensation which is allocated based on the percentage of profits contributed to the Company. Identifiable assets by segment are those assets used in the Company's operations in each business segment. Corporate assets are principally cash and cash equivalents and an equity security investment. c. Commission income Commission income and fees are recognized as of the effective date of the policy. The Company maintains an allowance for estimated policy cancellations and commission returns based upon applying historical policy cancellation and commission return rates to the current year revenue, F-54 adjusted for any known deviations. The Company is entitled to contingent commissions and volume overrides from insurance companies which are recorded in the earlier of the period in which amounts can be reasonably estimated or the period in which the amounts are received. Amounts related to contingent commissions and volume overrides can be reasonably estimated when information pertaining to the calculation, such as premium volumes, loss ratios and expenses, can be obtained from the insurance carriers. Effective May 31, 2001, the Company changed its method of accounting for commission income. Prior to that date, commission income was recorded when earned which was principally as of the billing date. Under the new method of accounting, adopted retroactive to January 1, 2001, the Company now records commission income on the effective date of insurance policies. The cumulative effect of the change on prior years resulted in additional income of $158,000 (net of income taxes of $82,000). For each of the three years ended December 31, 2000 the effect of this change on net income (loss) was not significant. This change was effected due to the pending merger with HUB (see Note 1) and the Company's desire to move to a methodology consistent with HUB's policy, which is considered preferable by management. As a result of the change, the Company's commission and fees-net was reduced by $1,196,000 during the period January 1, 2001 through June 28, 2001. d. Fixed assets Furniture, equipment, computer hardware and software, and leasehold improvements are carried at cost, less accumulated depreciation and amortization computed using the straight-line method. Fixed assets are depreciated over periods ranging from three to ten years, and leasehold improvements are amortized over the remaining terms of the leases which expire through 2010 or useful life, whichever is shorter. e. Intangible assets Acquired expiration lists, covenants not to compete and goodwill are carried at cost, less accumulated amortization which is computed using the straight-line method over the estimated useful life of the asset not to exceed twenty years. f. Investments Investments are stated at fair value. The difference between the cost and fair value is reflected as unrealized appreciation or depreciation, net of applicable deferred income taxes, as a separate component of stockholders' equity. Realized gains or losses from the sale of investments are determined on the basis of specific identification and are reflected as a component of revenues. Investment income is recognized when earned. The fair value of fixed maturities and equity securities is based on the closing price of the investments on June 28, 2001. If a decline in fair value of an investment is considered to be other than temporary, the investment is reduced to its net realizable value and the reduction is accounted for as a realized investment loss. In evaluating whether a decline is other than temporary, management considers the duration and extent to which the market value has been less than cost, the financial condition and near-term prospects of the issuer, including events that may impact the issuer's operations and impair the earnings potential of the investment, and management's ability and intent to hold an investment for a sufficient period to allow for an anticipated recovery in fair value. Investments in equity securities in which the Company does not exert significant influence and there is no readily determinable fair value are carried at the lower of cost or market. F-55 g. Insurance premiums earned Insurance premiums are recognized as revenues ratably over the terms of the related policies in force. Unearned premiums are established to cover the unexpired portion of premiums written and are calculated using the daily pro rata method. Premiums earned are net of reinsurance ceded. h. Deferred acquisition costs Deferred acquisition costs include commissions incurred by the Insurance Companies that vary with and are attributed to new and renewal insurance policies or contracts. These costs are deferred and amortized over the applicable premium recognition period, generally one year. These deferred costs have been limited to the amount expected to be recovered from future earned premiums. Acquisition costs of $5,118,000, were amortized to expense for the period January 1, 2001 through June 28, 2001. i. Unpaid losses and loss expenses The estimated liability for unpaid losses and loss expenses is based on an evaluation of claims reported by policyholders. A provision which is based on historical experience and modified for current trends, is also included for losses and loss expenses which have been incurred but not reported. The methods of determining such estimates and establishing the resulting reserves are continually reviewed and modified to reflect current conditions, and any adjustments are reflected currently in results of operations. j. Reinsurance Assumed reinsurance premiums written, commission, and unpaid losses are accounted for based principally on the reports received from the ceding insurance companies and in a manner consistent with the terms of the related reinsurance agreements. Liabilities for unpaid losses, loss expenses and unearned premiums are stated gross of ceded reinsurance recoverables. Deferred acquisition costs are stated net of the amounts of reinsurance ceded, as are premiums written and earned, losses and loss expenses incurred, and amortized acquisition costs. k. Income taxes The Company recognizes deferred tax assets or liabilities for temporary differences between the financial reporting and tax basis of assets and liabilities based on enacted tax rates. The principal temporary differences relate to deferred acquisition costs, unearned premiums, discount for tax purposes of the unpaid losses and loss expense reserves, amortization of expiration lists, accrual adjustment for commission income and unrealized gains or losses on investments (see Note 9). l. Cash and cash equivalents Cash and cash equivalents include money market funds and certificates of deposit, with a maturity of three months or less. The Company maintains cash with banks in excess of federally insured limits and is exposed to the credit risk from this concentration of cash. m. Restricted cash In its capacity as an insurance broker the company collects premiums from insureds and, after deducting its commission and/or fees, remits these premiums to insurance carriers. Unremitted insurance premiums are held in a fiduciary capacity until disbursed by the company. Various state agencies that regulate insurance brokers provide specific requirements that limit the type of investments that may be made with such funds. Accordingly, the company invests these funds in cash, money market accounts, commercial paper and certificates of deposit. The company earns interest income on these unremitted funds, which is reported as net investment income in the accompanying Consolidated Statement of Operations. The Corporate restricted cash balance represents cash advanced from HUB and maintained in an escrow account for the purpose of F-56 paying compensation to participants of the terminated stock performance plan on the first anniversary of the Company's merger with HUB (see Note 1). n. Other income Property and Casualty Companies' other income includes non-recurring revenue from the discontinuation of agreements for claims administration relating to warranty contracts issued by a third party for which cash has already been received. o. Capitalized software policy Capitalized computer software costs (included in fixed assets on the Consolidated Balance Sheet) consist of costs to purchase software. All capitalized software costs are amortized on a straight line method over a period of three or five years. Amortization expense charged to operations was $307,000 for the period January 1, 2001 through June 28, 2001. p. Fair value of financial instruments The carrying amounts reported in the Consolidated Balance Sheet for cash and cash equivalents, receivables and premiums payable approximate those assets and liabilities fair values due to the short-term nature of the instruments. 3. CHANGES IN ACCOUNTING POLICIES a. Newly adopted accounting standards In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133 (as amended), Accounting for Derivative Instruments and Hedging Activities. This statement requires all derivatives to be recognized as either assets or liabilities in the statement of financial position and to be measured at fair value. This statement is effective for all fiscal quarters and fiscal years beginning after December 31, 2000. The Company does not have any derivative instruments and therefore SFAS No. 133 has no impact on the Company's financial statements. b. Accounting standards not yet adopted In June 2001, the FASB issued SFAS No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets". Statement 141 requires that the purchase method of accounting be used for all business combinations subsequent to June 30, 2001 and specifies criteria for recognizing intangible assets acquired in a business combination. Statement 142 requires that goodwill and certain intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually. Intangible assets with definite useful lives will continue to be amortized over their respective estimated useful lives. Statement No. 142 is effective for fiscal years beginning after December 15, 2001. The Company does not expect the adoption of SFAS No. 141 and 142 to have a material impact on the Company's consolidated financial statements. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Disposal or Impairment of Long-Lived Assets". This statement requires a single accounting model for long-lived assets to be disposed of by sale, whether previously held or newly acquired. The statement provides guidance related to the disposal of long-lived assets and broadens the presentation of discontinued operations to include a component of an entity where the operations and cash flows are clearly distinguishable. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Company does not expect the adoption of SFAS No. 144 to have a material impact on the Company's consolidated financial statements. F-57 4. ACQUISITIONS Effective January 1, 1999, the Company, through one of its insurance brokerage subsidiaries, Kaye Insurance Associates, Inc. ("KIA"), purchased the assets, including customer lists, and certain liabilities of Woodbury, N.Y. -- based broker Seaman, Ross & Wiener, Inc. and related entities for an initial purchase price of $2,422,000 in cash and $500,000 in stock of the Company. During the period January 1, 2001 through June 28, 2001, earn out payments totaling $1,124,000 in cash and $208,000 in stock of the Company were recorded as customer lists of $993,000 and goodwill of $340,000. 5. FUNDS HELD IN FIDUCIARY CAPACITY Premiums collected by the Insurance Brokerage Companies but not yet remitted to insurance carriers were approximately $16,618,000 at June 28, 2001, some of which are restricted as to use by law in certain states in which the Insurance Brokerage Companies operate. These balances are included in restricted cash. The offsetting obligation is recorded in premiums payable. 6. INVESTMENTS Net investment income for the period January 1, 2001 through June 28, 2001 was derived from the following sources (in thousands): Insurance Brokerage Companies Cash and cash equivalents $ 448 ------ Property and Casualty Companies Fixed maturities 1,256 Equity securities 2 Cash and cash equivalents 337 Other 210 ------ Total investment income 1,805 Investment expenses (37) ------ 1,768 Corporate Cash and cash equivalents 16 ------ NET INVESTMENT INCOME $2,232 ------
F-58 Net realized gains or losses and the change in unrealized appreciation or depreciation on investments included in the Statement of Operations and the Statement of Stockholders Equity, respectively, are summarized below (in thousands): Net realized gains (losses) Fixed maturities Gross realized gains $ 259 Gross realized losses (4) Equity securities Gross realized gains 157 Gross realized losses (1,043) Other investments Gross realized losses (446) ------- NET REALIZED LOSS ON INVESTMENTS $(1,077) ------- Changes in unrealized appreciation Fixed maturities $ 148 Equity securities 440 ------- NET CHANGE IN UNREALIZED APPRECIATION $ 588 -------
Included in net realized loss on investments are write downs related to other than temporary impairments in equity securities of $530,000 and limited partnership investments of $446,000. The composition cost (amortized cost for fixed maturities) and estimated fair value of the Company's investments at June 28, 2001 are presented below (in thousands):
GROSS UNREALIZED HOLDING AGGREGATE AMORTIZED -------------- FAIR COST/COST GAINS LOSSES VALUE --------- ----- ------ --------- Fixed Maturities U.S. Government agencies and authorities $23,157 $135 $ (61) $23,231 States municipalities and subdivisions 26,781 317 (103) 26,995 Corporate 100 -- (65) 35 ------- ---- ----- ------- TOTAL FIXED MATURITIES $50,038 $452 $(229) $50,261 -------- ---- ----- -------- Equity Securities Common Stock $ 608 $ 51 $ -- $ 659 Preferred Stock 50 -- -- 50 ------- ---- ----- ------- TOTAL EQUITY SECURITIES $ 658 $ 51 $ -- $ 709 -------- ---- ----- --------
F-59 The amortized cost and estimated fair value of fixed maturities at June 28, 2001, by contractual maturity date, are listed below (in thousands). Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
AGGREGATE AMORTIZED FAIR COST VALUE --------- --------- Due in one year or less $ 3,208 $ 3,163 Due after one year through five years 27,761 28,058 Due after five years through ten years 17,241 17,212 Due after ten years 1,828 1,828 ------- ------- TOTAL $50,038 $50,261 -------- --------
Fixed maturities and cash and cash equivalents carried at fair value of $3,404,000 were on deposit for governmental authorities, as required by law. Fixed maturities and cash equivalents carried at fair value of $30,163,000 have been deposited in trust funds or pledged to collateralize the obligations of OLRI to ceding companies under reinsurance agreements. In addition, OLB maintained bank letters of credit in the amount of $3,200,000. The Company's short-term investment of cash is maintained principally with seven banks and three institutional money market funds. To control this risk, the Company utilizes only high credit quality financial institutions. Additionally, under the insurance laws of the State of Rhode Island, where OLRI is domiciled, insurers and reinsurers are restricted as to the types of investments they may purchase and the concentration of risk they may accept in any one issuer or group of issuers. The Company complies with such laws which insure that the concentration of risk in its investment portfolio is at an acceptable and authorized level. 7. NOTES PAYABLE Notes payable consist of the following at June 28, 2001 (in thousands): Insurance Brokerage Note payable, due through 7/1/2002, interest at prime $ 469 Finance company note, due through 3/24/2002, interest at 7.75% 113 Current portion (488) ------- NOTES PAYABLE -- LONG TERM $ 94 ------- Corporate Term loan, due through 6/24/2002, interest at 7.8% $ 1,412 Current portion (1,412) ------- NOTES PAYABLE -- LONG TERM $ -- -------
The note payable, at prime, due through July 1, 2002, represents debt incurred related to a 1998 acquisition. The 7.8% Term Loan due through June 24, 2002 is secured by the stock of OLRI. Certain covenants exist on this loan, the most significant being the requirement to maintain a minimum GAAP net worth, minimum statutory surplus in the Insurance Companies, a fixed ratio of net premiums to surplus and a minimum debt service coverage. At June 28, 2001, the Company was in compliance with the covenants under the loan agreement. F-60 Based on the borrowing rates currently available to the Company for bank loans with similar terms and average maturities, the fair value of the notes payable at June 28, 2001 approximates their carrying value. Interest expense in the accompanying consolidated statement of operations, was $452,000. 8. INTANGIBLE ASSETS Intangible assets at June 28, 2001 consisted of the following (in thousands): Customer lists $14,760 Goodwill 2,453 Covenant not to compete 400 ------- 17,613 Less accumulated amortization (5,485) ------- INTANGIBLE ASSETS $12,128 -------
9. INCOME TAXES The Company and its wholly owned domestic subsidiaries are party to a Tax Allocation Agreement (the "Agreement"). The Agreement requires these companies to file a U.S. consolidated income tax return. The Agreement also provides that each member of the group will compute its separate tax liability or benefit on a separate return basis and pay or receive such amounts to or from the Company. The Company's effective income tax rate included in the Statement of Operations differs from the statutory rate on ordinary income before income taxes as follows (in thousands, except percentages):
% OF PRETAX AMOUNT INCOME ------- ----------- Income tax benefit computed at the statutory rate $(1,319) (34.0)% Increase (decrease) in taxes resulting from Tax-exempt investment income (318) (8.2)% Merger expenses 599 15.4 % State and local income taxes (652) (16.8)% Other (342) (8.8)% ------- ------- INCOME TAX BENEFIT $(2,032) (52.4)% ------ -----------
The source of the significant temporary differences and the related deferred tax effects are as follows (in thousands): Expiration lists $ 172 Unearned premium reserves 145 Accrual adjustment 82 Accrued incentive compensation (1,251) State and local income taxes (900) Non-deductible reserves (532) Deferred acquisition costs (230) Loss reserve discount (67) Other (154) ------- DEFERRED TAX BENEFIT $(2,735) -------
F-61 The components of the net deferred tax assets and liabilities, in the accompanying consolidated balance sheet at June 28, 2001, are as follows (in thousands): Deferred tax assets: Loss and loss expense reserves $ 1,936 Accrued incentive compensation 1,251 State and local income taxes 1,002 Non-deductible reserves 878 Unearned premium reserves 722 Other 154 ------- DEFERRED TAX ASSET BEFORE VALUATION ALLOWANCE 5,943 Valuation allowance 102 ------- TOTAL DEFERRED TAX ASSET 5,841 ------- Deferred tax liabilities: Deferred acquisition costs 1,148 Other accrual adjustments 1,288 Expiration lists 288 Unrealized gains on investments 92 ------- TOTAL DEFERRED TAX LIABILITY 2,816 ------- NET DEFERRED TAX ASSET $ 3,025 -------
The Company has state net operating loss carryforwards totaling $9,401,000 at June 28, 2001. Such net operating losses are currently available to offset our future state taxable income and begin to expire in 2016. A valuation allowance in the amount of $1,461,000 has been established for net operating losses in states where management does not believe the net operating losses will be realized. Management believes it is more likely than not that all remaining deferred tax assets are realizable based upon the past earnings history of the Company. OLB, as a Bermuda domiciled company, is not subject to federal income taxes but, rather, the Company is subject to federal income taxes based on OLB's taxable income for the entire year. Accordingly, the Company includes the taxable income of OLB in its separate company income for tax purposes, but for segment reporting the income is included with the Property and Casualty Companies. OLB has received an undertaking from the Bermuda Government exempting it from all taxes computed on profit or income, or computed on any capital asset gain or appreciation until 2016. F-62 10. LEASE COMMITMENTS AND RENTALS Minimum annual rental commitments under various non-cancelable operating leases for office space and equipment are as follows (in thousands) for years ending June 28, 2002 $1,308 2003 982 2004 974 2005 959 2006 918 Thereafter 3,850 ------ 8,991 Sub-lease rental income (156) ------ NET RENTAL COMMITMENTS $8,835 ------
Effective August 1, 2001, the Company entered into a lease for office space for its main office in Manhattan, New York. The lease expires on August 31, 2010. The minimum rental commitment for the period August 1, 2001 to June 28, 2002 is $1,228,000, and thereafter is $12,565,000. Leases for office space include various escalation clauses, none of which individually or in the aggregate are material. Escalation clauses are accounted for on a straight-line basis over the remaining life of the lease. The leases also contain provisions for the payment of certain operating expenses and real estate taxes. Rent expense included in the Statement of Operations amounted to $2,219,000, net of sublease rental income of $204,000. 11. DEFINED CONTRIBUTION PLAN Substantially all officers and employees of the Company are entitled to participate in a qualified retirement savings plan (defined contribution plan). The cost to the Company was $281,000 for 2001. 12. COMMITMENTS AND CONTINGENCIES In the ordinary course of business, the Company and its subsidiaries are subject to various claims and lawsuits consisting primarily of alleged errors and omissions in connection with the placement of insurance. In the opinion of management, the ultimate resolution of all asserted and potential claims and lawsuits will not have a material effect on the consolidated financial position and results of operations of the Company. F-63 13. REINSURANCE The components of net written and net earned insurance premiums included in the Statement of Operations were as follows (in thousands): Written premiums Direct $ 3,212 Assumed 13,112 Ceded (1,653) ------- NET WRITTEN PREMIUMS $14,671 ------- Earned premiums Direct 4,831 Assumed 13,315 Ceded (1,354) ------- NET EARNED PREMIUMS $16,792 -------
OLRI assumes reinsurance under arrangements with unaffiliated insurance companies. The Insurance Brokerage Companies produce the business assumed under these arrangements. The business has limits varying from $25,000 to $100,000 per occurrence. Claim liabilities under these agreements are secured with fixed maturity securities and cash and cash equivalents, which are deposited in trust funds. Approximately $30,163,000 as of June 28, 2001 is held in these trust funds. In addition, OLB maintained bank letters of credit in the amount of $3,200,000 at June 28, 2001 to satisfy the reinsurance collateral requirement. OLRI underwrites a small book of business with limits up to $1,000,000 retaining the first $50,000 of exposure and reinsuring the balance on an excess of loss basis to other insurers or re-insurers. Under the terms of the reinsurance agreements, loss and loss adjustment expenses recovered (incurred) during the period January 1, 2001 through June 28, 2001 was $3,360,000. Commissions earned on reinsurance ceded for the period January 1, 2001 through June 28, 2001 was $337,000. Reinsurance has been placed with PXRE Reinsurance Company and The Hartford Steam Boiler Inspection and Insurance Co. which are rated A or better by A.M. Best. A contingent liability exists with respect to reinsurance ceded, which would become an ultimate liability of OLRI in the event that the assuming companies were unable to meet their obligations under the reinsurance agreements in force at June 28, 2001. On September 25, 2001, PXRE Reinsurance Company, a primary re-insurer of OLRI, has sent a notice of termination on all of the reinsurance contacts between Old Lyme Insurance Company of Rhode Island, Inc. and PXRE Reinsurance Corporation, effective on December 31, 2001 and March 31, 2002. The Company estimates the loss exposure due to cancellation of these contracts could vary from $500,000 to $800,000 for the calendar year 2002. The exposure is primarily related to certain reinsurance liability business. F-64 14. UNPAID LOSSES AND LOSS EXPENSES The following table sets forth a reconciliation of the changes in the reserves for losses and loss expenses for the period January 1, 2001 through June 28, 2001 (in thousands): Balance at January 1, 2001 $27,984 Less reinsurance recoverables (4,600) ------- Net balance 23,384 ------- Incurred related to Current year 7,298 Prior years (40) ------- TOTAL INCURRED 7,258 ------- Paid related to Current year 1,624 Prior years 6,082 ------- TOTAL PAID 7,706 ------- Net balance at June 28, 2001 22,936 Add reinsurance recoverables 7,430 ------- BALANCE $30,366 -------
Increased provision reductions relating to prior years were due to redundant property reserves. 15. STATUTORY FINANCIAL INFORMATION AND DIVIDEND RESTRICTIONS The Insurance Companies file separate financial statements in accordance with accounting practices prescribed or permitted by the insurance regulatory authorities where they are domiciled. These statutory accounting practices ("SAP") differ in certain respects from GAAP. These differences are primarily comprised of the accounting for prepaid acquisition costs, deferred income taxes, and fixed maturity and equity investments. The following is a reconciliation of statutory surplus and net income (loss) in accordance with SAP as of June 30, 2001 as reported to the Rhode Island and Bermuda insurance regulatory authorities to stockholder's equity and net income (loss) as determined in conformity with GAAP.
NET INCOME (LOSS) STOCKHOLDER'S EQUITY/ FOR THE STATUTORY SURPLUS SIX MONTHS AS OF ENDED JUNE 30, 2001 JUNE 30, 2001 --------------------- ----------------- Consolidated amount in accordance with GAAP $ 64,950 $(1,690) (Equity) in net assets and net loss of non-insurance companies (24,012) 4,676 -------- ------- Combined insurance companies amount in accordance with GAAP 40,938 2,986 Deferred acquisition costs (3,376) 677 Non-admitted assets, deferred income taxes and other (952) (237) -------- ------- Combined amount in accordance with SAP $ 36,610 $ 3,426 ---------------- -------------
The Insurance Companies are currently subject to various regulations that limit the maximum amount of dividends ultimately available to the Company without prior approval of insurance regulatory authorities. F-65 Accounting changes adopted to conform with the provisions of the NAIC Accounting Practices and Procedures manual -- version effective January 1, 2001 are reported as changes in SAP. The cumulative effect of changes in SAP is reported as an adjustment to unassigned funds in the period of the change in SAP. The cumulative effect is the difference between the amount of capital and surplus at the beginning of the year and the amount of capital and surplus that would have been reported at the date if the new SAP had been applied retrospectively for all prior periods. As a result of these changes, OLRI reported a change in SAP from the adoption of codification that increased unassigned funds (surplus) by $986,457 as of January 1, 2001. This surplus increase adjustment was related to deferred tax assets. 16. RELATED PARTY TRANSACTIONS The administrative support for OLB is provided by International Advisory Services, Ltd. ("IAS"), an insurance management company located in Bermuda. A director of IAS is an officer of OLB and is a director of the Company. Management fees paid to IAS under a service contract for the period January 1, 2001 through June 28, 2001 was $15,000. 17. STOCK PERFORMANCE AND STOCK OPTION PLANS In 1997, the Company adopted a stock Performance Plan, under which up to 350,000 shares of the Company's common stock could have been granted and awarded to key employees. In addition, the Company had a stock option plan. In connection with the Company's merger with HUB, all outstanding options and restricted stock became vested and the plans were terminated. On June 27, 2001, restricted cash advanced from HUB totaling $8,140,000 was paid to the stock option holders at an amount equal to the purchase price of $14 per share less the grant price of the related options. Additionally, HUB advanced restricted cash of $2,445,000 for amounts payable to the holders of restricted stock on the first anniversary of the acquisition date. Total compensation expense related to these plans of $10,585,000 has been included in merger expenses in the accompanying Consolidated Statement of Operations. 18. BUSINESS SEGMENTS The Company operates in two insurance business segments, the Insurance Brokerage Companies and the Property and Casualty Companies. In addition, Corporate Operations include those activities that benefit the Company in its entirety and cannot be specifically identified to either the Insurance Brokerage companies or the Property and Casualty Companies. Such activities include debt servicing and public company expenses, including investor relations costs. The identifiable segment assets, operating profits and income before income taxes are shown on the accompanying consolidated balance sheets and statements of income. The following table is a summary of certain other segment information for the period January 1, 2001 through June 28, 2001 (in thousands):
INSURANCE PROPERTY BROKERAGE & CASUALTY --------- ---------- Revenue from external sources $19,041 $16,792 Revenue from other segments 1,133 39 Depreciation and amortization expense 1,800 5,126 Interest income from other segments 165 Capital expenditures 615
F-66 The foreign operations set forth below, relate solely to the operations of OLB, and its wholly owned subsidiary Park Brokerage, and business assumed from third party insurance companies. All such risks assumed originate in the United States.
JUNE 28, 2001 ----------------------------- FOREIGN DOMESTIC TOTAL ------- -------- -------- (in thousands) Consolidated revenues $ 947 $43,654 $ 44,601 Income (loss) before income taxes 605 (4,485) (3,880) Identifiable Assets 3,386 161,906 165,292
There were no material inter-company revenue transactions between OLB and OLRI. 19. SUPPLEMENTAL CASH FLOW DISCLOSURES Supplemental cash flow disclosures for the period January 1, 2001 through June 28, 2001 are as follows (in thousands): Cash paid during the period for Interest expense $ 509 Income taxes 2,148 Non cash financing activity Reissuance of treasury stock 208
F-67 REPORT OF INDEPENDENT ACCOUNTANTS TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF KAYE GROUP INC.: In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Kaye Group Inc. and its subsidiaries at December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. LOGO PricewaterhouseCoopers LLP New York, New York February 26, 2001 F-68 KAYE GROUP INC. CONSOLIDATED BALANCE SHEETS As of December 31, 2000 and December 31, 1999 (in thousands, except par value per share) 2000 1999 -------- -------- ASSETS INSURANCE BROKERAGE COMPANIES: Current assets: Cash and cash equivalents $ 1,217 $ 2,068 Restricted cash 25,374 25,610 Premiums and other receivables 41,744 27,265 Prepaid expenses and other assets 2,025 1,717 -------- -------- Total current assets 70,360 56,660 Fixed assets (net of accumulated depreciation of $6,827 and $6,922) 5,816 3,770 Intangible assets (net of accumulated amortization of $4,808 and $3,845) 11,472 10,228 Other assets 665 195 -------- -------- Total assets 88,313 70,853 -------- -------- PROPERTY AND CASUALTY COMPANIES: Investments available-for-sale: Fixed maturities, at market value (amortized cost: 2000, $43,157; 1999, $42,273) 43,232 41,304 Equity securities, at market value (cost: 2000, $8,610; 1999, $3,873) 8,209 4,496 -------- -------- Total investments 51,441 45,800 Cash and cash equivalents 12,784 14,327 Accrued interest and dividends 862 873 Premiums receivable 1,985 2,333 Reinsurance recoverable on paid and unpaid losses 4,600 2,747 Prepaid reinsurance premiums 949 488 Deferred acquisition costs 4,053 4,313 Deferred income taxes 1,505 1,236 Other assets 5,935 4,520 -------- -------- Total assets 84,114 76,637 -------- -------- CORPORATE: Cash and cash equivalents 138 1,233 Prepaid expenses and other assets 59 153 Investments: Equity securities, at market value (cost: 2000, $308, and 1999, $243) 320 243 Deferred income taxes 67 93 -------- -------- Total assets 584 1,722 -------- -------- Total assets $173,011 $149,212 -------- --------
See notes to consolidated financial statements. F-69 KAYE GROUP INC. CONSOLIDATED BALANCE SHEETS As of December 31, 2000 and December 31, 1999 (in thousands, except par value per share)
2000 1999 -------- -------- LIABILITIES INSURANCE BROKERAGE COMPANIES: Current liabilities: Premiums payable and unearned commissions $ 53,095 $ 42,161 Accounts payable and accrued liabilities 9,658 8,103 Notes payable 521 527 -------- -------- Total current liabilities 63,274 50,791 Notes payable 320 841 Deferred income taxes 1,083 491 -------- -------- Total liabilities 64,677 52,123 -------- -------- PROPERTY AND CASUALTY COMPANIES: Liabilities: Unpaid losses and loss expenses 27,984 23,969 Unearned premium reserves 13,697 13,694 Accounts payable and accrued liabilities 7,532 7,953 Other liabilities 567 245 -------- -------- Total liabilities 49,780 45,861 -------- -------- CORPORATE: Current liabilities: Accounts payable and accrued liabilities 254 300 Loan payable 1,343 1,241 Income taxes payable 187 366 -------- -------- Total current liabilities 1,784 1,907 Loan payable-long-term 728 2,070 -------- -------- Total liabilities 2,512 3,977 -------- -------- Total liabilities 116,969 101,961 -------- -------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY Preferred stock, $1.00 par value; 1,000 shares authorized; none issued or outstanding Common stock, $.01 par value; 20,000 shares authorized; shares issued and outstanding (2000, 8,481; 1999, 8,458) 85 85 Paid -- in capital 18,019 18,019 Accumulated other comprehensive loss, net of deferred income tax benefit (2000, $107; 1999, $118) (207) (228) Unearned stock grant compensation (235) (254) Retained earnings 38,417 29,858 Common stock in Treasury, shares at cost (2000, 4; 1999, 28) (37) (229) -------- -------- Total stockholders' equity 56,042 47,251 -------- -------- Total liabilities and stockholders' equity $173,011 $149,212 -------- --------
See notes to consolidated financial statements. F-70 KAYE GROUP INC. CONSOLIDATED STATEMENTS OF INCOME For the years ended December 31, 2000, 1999 and 1998 (in thousands, except per share amounts)
2000 1999 1998 ------- ------- ------- INSURANCE BROKERAGE COMPANIES: Revenues: Commissions and fees -- net $42,066 $37,379 $35,356 Investment income 1,339 1,374 1,846 ------- ------- ------- Total revenues 43,405 38,753 37,202 ------- ------- ------- Expenses: Compensation and benefits 23,676 22,346 21,323 Amortization of intangibles 1,161 1,095 679 Other operating expenses 13,463 12,215 13,446 ------- ------- ------- Total operating expenses 38,300 35,656 35,448 ------- ------- ------- Interest expense 870 775 49 ------- ------- ------- Income before income taxes 4,235 2,322 1,705 ------- ------- ------- PROPERTY AND CASUALTY COMPANIES: Revenues: Net premiums written 30,028 27,821 24,538 Change in unearned premiums 458 (1,041) 151 ------- ------- ------- Net premiums earned 30,486 26,780 24,689 Net investment income 3,127 2,949 2,920 Net realized gain (loss) on investments 804 (16) 85 Other income 469 72 146 ------- ------- ------- Total revenues 34,886 29,785 27,840 ------- ------- ------- Expenses: Losses and loss expenses 12,270 9,754 8,496 Acquisition costs and general and administrative expenses 12,615 11,205 9,707 Total expenses 24,885 20,959 18,203 ------- ------- ------- Income before income taxes 10,001 8,826 9,637 ------- ------- ------- CORPORATE: Revenues -- Net investment income (loss) 107 206 (31) Expenses: Other operating expenses 480 309 314 Interest expense 234 316 443 ------- ------- ------- Net expenses before income taxes (607) (419) (788) ------- ------- ------- INCOME BEFORE INCOME TAXES 13,629 10,729 10,554 ------- ------- ------- Provision (benefit) for income taxes Current 3,887 3,261 3,422 Deferred 338 (36) (150) ------- ------- ------- Total provision for income taxes 4,225 3,225 3,272 ------- ------- ------- NET INCOME $ 9,404 $ 7,504 $ 7,282 ------- ------- ------- EARNINGS PER SHARE Basic $ 1.11 $ 0.89 $ 0.86 Diluted $ 1.09 $ 0.87 $ 0.85 Weighted average of shares outstanding -- basic 8,470 8,460 8,474 Weighted average shares outstanding and share equivalents outstanding -- diluted 8,613 8,630 8,593
See notes to consolidated financial statements. F-71 KAYE GROUP INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended December 31, 2000, 1999 and 1998 (in thousands)
2000 1999 1998 -------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 9,404 $ 7,504 $ 7,282 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Deferred acquisition costs 260 (392) 18 Amortization of bond premium -- net 685 695 599 Deferred income taxes 338 (36) (150) Net realized loss (gains) on investments (868) 290 (85) Depreciation and amortization expense 2,892 2,381 1,813 Change in assets and liabilities: Restricted cash 236 7,608 (10,896) Accrued interest and dividends 11 88 (79) Premiums and other receivables (16,077) 14,071 (8,125) Prepaid expenses and other assets (1,646) (2,263) (1,253) Premiums payable and unearned commissions 10,952 (17,235) 18,371 Accounts payable and accrued liabilities 1,633 (311) 2,055 Unpaid losses and loss expenses 4,015 2,402 2,441 Unearned premium reserves 3 1,367 (251) Income taxes payable (179) (202) 552 -------- -------- -------- Net cash provided by operating activities 11,659 15,967 12,292 -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Investments available -- for -- sale : Purchase of fixed maturities (10,270) (11,560) (15,012) Purchase of equity securities (7,589) (4,049) (200) Maturities of fixed securities 5,109 5,474 4,861 Sales of fixed securities 3,498 6,094 8,158 Sales of equity securities 3,280 832 425 Purchase of fixed assets (3,866) (1,347) (2,089) Acquisition payments (3,002) (5,203) (1,239) Funds held under deposit contracts: Sales of short-term investments 173 -------- -------- -------- Net cash used in investing activities (12,840) (9,759) (4,923) -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Acquisition debt-repayment (375) (375) (657) Notes and loan payable-repayment (1,392) (1,489) (7,981) Proceeds from issuance of common stock 35 Acquisition of treasury stock (1,079) Payment of dividends (845) (847) (849) Proceeds from borrowings 5,000 Receipts (payments) under deposit contracts 304 (122) -------- -------- -------- Net cash used in financing activities (2,308) (3,755) (4,609) -------- -------- -------- NET CHANGE IN CASH AND CASH EQUIVALENTS (3,489) 2,453 2,760 Cash and cash equivalents at beginning of period 17,628 15,175 12,415 -------- -------- -------- Cash and cash equivalents at end of period $ 14,139 $ 17,628 $ 15,175 -------- -------- --------
See notes to consolidated financial statements. F-72 KAYE GROUP INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the years ended December 31, 2000, 1999 and 1998 (in thousands, except per share amounts)
COMMON STOCK ACCUMULATED ------------------- COMMON UNEARNED OTHER TOTAL OUTSTANDING PAR STOCK STOCK GRANT PAID-IN COMPREHENSIVE RETAINED STOCKHOLDERS' SHARES VALUE IN TREASURY COMPENSATION CAPITAL (LOSS) EARNINGS EQUITY ----------- ----- ----------- ------------ ------- ------------- -------- ------------- Balance, January 1, 1998 8,474 $85 $17,942 $ 373 $16,768 $35,168 Change in unrealized appreciation, net of deferred income tax of ($88) 168 168 Net income 7,282 7,282 Dividends declared (per share -- $0.10) (849) (849) ----- --- ----- ----- ------- ----- ------- ------- Balance, December 31, 1998 8,474 85 17,942 541 23,201 41,769 Change in unrealized depreciation, net of deferred income tax of $398 (769) (769) Shares issued -- employee stock option plan 7 35 35 Shares issued -- stock performance plan 5 $(264) 42 (222) Amortization of unearned restricted stock 10 10 Net income 7,504 7,504 Dividends declared (per share -- $0.10) (847) (847) Acquisition of treasury stock net of reissuances (28) $(229) (229) ----- --- ----- ----- ------- ----- ------- ------- Balance, December 31, 1999 8,458 85 (229) (254) 18,019 (228) 29,858 47,251 Change in unrealized appreciation, net of deferred income tax of ($11) 21 21 Amortization of unearned restricted stock 19 19 Net income 9,404 9,404 Dividends declared (per share -- $0.10) (845) (845) Reissuance of treasury stock 23 192 192 ----- --- ----- ----- ------- ----- ------- ------- Balance, December 31, 2000 8,481 $85 $ (37) $(235) $18,019 $(207) $38,417 $56,042 ------- --- ------- -------- ------ -------- ------- ---------
F-73 KAYE GROUP INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME For the years ended December 31, 2000, 1999 and 1998 (in thousands)
2000 1999 1998 ------ ------ ------ NET INCOME $9,404 $7,504 $7,282 ------ ------ ------ Other comprehensive income: Unrealized holding gains (losses) arising during the period, net of deferred income tax (benefit) liability (2000, $255; 1999, ($482); 1998, $116) 496 (932) 221 Less: reclassification adjustment for loss (gains) included in net income, net of deferred income tax (benefit) liability (2000, $244; 1999, ($84); 1998, $28) (475) 163 (53) ------ ------ ------ Total other comprehensive income 21 (769) 168 ------ ------ ------ COMPREHENSIVE INCOME $9,425 $6,735 $7,450 ------ ------ ------
See notes to consolidated financial statements. F-74 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2000, 1999 and 1998 1) BUSINESS Kaye Group Inc. (the "Company"), a Delaware corporation, is a holding company which, through its subsidiaries, is engaged in a broad range of insurance brokerage, underwriting and related activities. The Company operates in two insurance business segments -- the Insurance Brokerage Companies Operations ("Brokerage Operations"), comprised of the Retail Brokerage Business and the Program Brokerage Business, and the Property and Casualty Companies Operations. In addition, Corporate Operations includes those activities that benefit the Company in its entirety and cannot be specifically identified to either the Brokerage Operations or the Property and Casualty Companies Operations. Such activities include debt servicing and public company expenses, including investor relations costs. The Company's activities are conducted from offices in New York, New York, Arcadia, California, Westport, Connecticut, Woodbury, New York and Warwick, Rhode Island. Insurance Brokerage Companies Operations The Retail Brokerage Business operates insurance brokerage businesses through four subsidiaries of the Company, the "Retail Brokerage Companies". The Retail Brokerage Companies offers commercial clients a full range of insurance brokerage services including procurement of property/casualty insurance, risk management consulting, bonding, loss prevention engineering, and group employee benefit consulting services. In addition, personal lines and life and health insurance coverage are placed on behalf of individual clients. The Retail Brokerage Business' primary strategy is to service middle market companies and organizations just below the Fortune 500 level for which other national brokers intensely compete. Within this middle market, the Retail Brokerage Business has developed particular expertise and knowledge of the risks facing a number of industry sectors including health care, real estate, retail, manufacturing, houses of worship, law firms, homes for the aged and fine arts. During 2000, the Retail Brokerage Business serviced approximately 15,000 insureds. The Retail Brokerage Business is compensated for its services primarily in the form of commissions paid by insurance companies. The commission is usually a percentage of the premium paid by the insured. Commission rates depend upon the type of insurance, the particular insurance company, and the role in which the Retail Brokerage Business acts. In some cases a commission is shared with other agents or brokers who have acted jointly with the Retail Brokerage Business in connection with the transaction. The Retail Brokerage Business may also receive from an insurance company a contingent commission that is generally based on the profitability and volume of business placed with it by the Retail Brokerage Business over a given period of time. The Retail Brokerage Business may also receive fees from insureds in connection with consulting services relating to the marketing of insurance. Program Brokerage Corporation ("PBC" or the "Program Brokerage Business") is a subsidiary of the Company and operates a wholesale insurance brokerage business which offers retail insurance agents and brokers innovative solutions to the twin insurance problems of price and availability of coverage. It accomplishes this by organizing pools of similar risks into specially designed alternative distribution programs through which it places insurance for affinity groups (the "Programs"). The Program Brokerage Business is one of the leaders in the application of purchasing groups in the commercial insurance market. Approximately 73% of PBC's premium volume was generated by its own producers and approximately 800 unrelated retail insurance agent and broker producers serving approximately 10,500 insureds during 2000. The remaining 27% was derived from the F-75 Retail Brokerage Business. Approximately 35% of PBC's premium volume is directly or indirectly placed with two affiliates, Old Lyme Insurance Company of Rhode Island, Inc. ("OLRI") and Old Lyme Insurance Company, Ltd. (Bermuda) ("OLB"). Property and Casualty Companies Operations The Company conducts its property and casualty underwriting business through two insurance company subsidiaries (the "Insurance Companies"), OLRI and OLB. OLRI is a property and casualty insurance company licensed in Rhode Island and eligible as a surplus lines insurer in New York and New Jersey. OLB is a property and casualty insurance company organized and licensed under the laws of Bermuda. In states where the Insurance Companies are not admitted insurers or surplus lines insurers, the Insurance Companies underwrite risks through various reinsurance agreements. The Insurance Companies underwrite property risks (loss or physical damage to property) and OLRI underwrites casualty risks (legal liability for personal injury or damaged property of others) for insureds in the United States. Insurance is sold principally through the Programs marketed by PBC which insure various types of businesses and properties that have similar risk characteristics, such as apartments, condominiums, cooperatives, restaurants, building maintenance companies, automobile service stations, retail stores, funeral homes and pharmacies, among others. The Insurance Companies' strategy is to underwrite only the first "layer" of the property and casualty insurance provided under the Programs. Exposure to individual insureds on individual losses is thereby generally limited to between $10,000 and $25,000 per claim, depending on the Program. Under the Programs, the Insurance Companies' policies are sold in conjunction with policies issued by unaffiliated Program insurers that provide coverage for losses above the first layer of risk underwritten by the Insurance Companies. In addition, OLRI has issued policies on a selected basis with limits up to $3,500,000, with net retention on one policy of $100,000 of exposure and reinsuring the remaining limits with unaffiliated reinsurers rated A or better by A.M. Best Company ("A.M. Best"), a major rating agency for insurers. The Property and Casualty Companies Operations includes Claims Administration Corporation ("CAC"), a subsidiary of the Company which is responsible for the administration of a large majority of the claims submitted to the Insurance Companies. The administration of claims includes investigation, engagement of legal counsel, approval of settlements and the making of payments to, or on behalf of insureds. The Insurance Companies pay CAC for its services. CAC also provides claims administration service to certain of the unaffiliated Program insurers for a fee. In both instances, fees are recorded based upon time incurred to provide claims administration services. 2) SIGNIFICANT ACCOUNTING POLICIES (a) Basis of Presentation The accompanying Consolidated Balance Sheets, Statements of Income, Cash Flows, Stockholders' Equity and Comprehensive Income (the "financial statements") have been prepared in accordance with generally accepted accounting principles ("GAAP") and predominant industry practice. The Consolidated Balance Sheets are presented on a segmented basis with inter-company balances eliminated. The Statements of Income are segmented and present the consolidated results of the Insurance Brokerage Companies segment, the Property and Casualty Companies segment and the Corporate segment. Intersegment transactions have not been eliminated. However, transactions within each segment are eliminated. For details on segment activity refer to Note 19. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported F-76 amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Certain prior year information has been reclassified to conform with the 2000 presentation. (b) Segment Reporting The accompanying consolidated financial statements have been prepared on a segmented basis. See Note 1 for segments and their respective operations. Income before income taxes of the two operating segments includes expenses incurred by Corporate on behalf of the segments, which are allocated to operations of the segments. The allocation is based upon total revenues of each segment except for the allocation of incentive compensation which is allocated based on the percentage of profits contributed to the Company. Identifiable assets by segment are those assets used in the Company's operations in each business segment. Corporate assets are principally cash and cash equivalents and an equity security investment. (c) Commission Income Commission income, together with the related accounts receivable from clients and premiums payable to insurance carriers, is recorded when earned which is principally as of the billing date. Commission income related to installment billing arrangements is recorded at the date of the initial billing. Unearned commissions represent commission income that is earned in installments on multiyear policies. The Company maintains an allowance for estimated policy cancellations and commission returns based upon applying historical policy cancellation and commission return rates to the current year revenue, adjusted for any known deviations. The Company is entitled to contingent commissions and volume overrides from insurance companies which are recorded in the earlier of the period in which amounts can be reasonably estimated or the period in which the amounts are received. Amounts related to contingent commissions and volume overrides can be reasonably estimated when information pertaining to the calculation, such as premium volumes, loss ratios and expenses, can be obtained from the insurance carriers. (d) Fixed Assets Furniture, equipment, computer hardware and software, and leasehold improvements are carried at cost, less accumulated depreciation and amortization computed using the straight-line method. Fixed assets are depreciated over periods ranging from three to ten years, and leasehold improvements are amortized over the remaining terms of the leases which expire through 2010 or useful life which ever is shorter. (e) Intangible Assets Acquired expiration lists, covenants not to compete and goodwill are carried at cost, less accumulated amortization which is computed using the straight-line method over the estimated useful life of the asset not to exceed twenty years. (f) Investments Investments are stated at fair value. The difference between the cost and fair value is reflected as unrealized appreciation or depreciation, net of applicable deferred income taxes, as a separate component of stockholders' equity. Realized gains or losses from the sale of investments are determined on the basis of specific identification and are reflected as a component of revenues. Investment income is recognized when earned. The fair value of fixed maturities and equity securities is based on the closing price of the investments on December 31. If a decline in fair value of an investment is considered to be other than temporary, the investment is reduced to its net realizable value and the reduction is accounted for as a realized investment loss. In evaluating whether a decline is other than temporary, management considers the duration F-77 and extent to which the market value has been less than cost, the financial condition and near-term prospects of the issuer, including events that may impact the issuer's operations and impair the earnings potential of the investment, and management's ability and intent to hold an investment for a sufficient period to allow for an anticipated recovery in fair value. Investments in equity securities in which the Company does not exert significant influence and there is no readily determinable fair value are carried at the lower of cost or market. (g) Insurance Premiums Earned Insurance premiums are recognized as revenues ratably over the terms of the related policies in force. Unearned premiums are established to cover the unexpired portion of premiums written and are calculated using the daily pro rata method. Premiums earned are net of reinsurance ceded. (h) Deferred Acquisition Costs Deferred acquisition costs include commissions incurred by the Insurance Companies that vary with and are attributed to new and renewal insurance policies or contracts. These costs are deferred and amortized over the applicable premium recognition period, generally one year. These deferred costs have been limited to the amount expected to be recovered from future earned premiums. Acquisition costs of $9,450,000, $8,292,000, and $7,630,000 were amortized to expense in 2000, 1999 and 1998, respectively. (i) Unpaid Losses and Loss Expenses The estimated liability for unpaid losses and loss expenses is based on an evaluation of claims reported by policyholders. A provision which is based on historical experience and modified for current trends, is also included for losses and loss expenses which have been incurred but not reported. The methods of determining such estimates and establishing the resulting reserves are continually reviewed and modified to reflect current conditions, and any adjustments are reflected currently in results of operations. (j) Reinsurance Assumed reinsurance premiums written, commission, and unpaid losses are accounted for based principally on the reports received from the ceding insurance companies and in a manner consistent with the terms of the related reinsurance agreements. Liabilities for unpaid losses, loss expenses and unearned premiums are stated gross of ceded reinsurance recoverables. Deferred acquisition costs are stated net of the amounts of reinsurance ceded, as are premiums written and earned, losses and loss expenses incurred, and amortized acquisition costs. (k) Income Taxes The Company recognizes deferred tax assets or liabilities for temporary differences between the financial reporting and tax basis of assets and liabilities based on enacted tax rates. The principal temporary differences relate to deferred acquisition costs, unearned premiums, discount for tax purposes of the unpaid losses and loss expense reserves, amortization of expiration lists, accrual adjustment for commission income and unrealized gains or losses on investments (see Note 8). (l) Cash and Cash Equivalents Cash and cash equivalents include money market funds and certificates of deposit, with a maturity of three months or less. The Company maintains cash with banks in excess of federally insured limits and is exposed to the credit risk from this concentration of cash. (m) Restricted Cash In its capacity as an insurance broker the company collects premiums from insureds and, after deducting its commission and/or fees, remits these premiums to insurance carriers. Unremitted F-78 insurance premiums are held in a fiduciary capacity until disbursed by the company. Various state agencies that regulate insurance brokers provide specific requirements that limit the type of investments that may be made with such funds. Accordingly, the company invests these funds in cash, money market, commercial paper and certificates of deposit. The company earns interest income on these unremitted funds, which is reported as investment income in the accompanying Consolidated Statements of Income. (n) Earnings Per Share Basic earnings per share are calculated by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per share include the effect of all potentially dilutive securities. Earnings per common share has been compiled below (in thousands, except per share amounts):
2000 1999 1998 ------ ------ ------ Net income (numerator) $9,404 $7,504 $7,282 ------ ------ ------ Weighted average common shares and effect of dilutive shares used in the computation of earnings per share: Average shares outstanding -- basic 8,470 8,460 8,474 Effect of dilutive shares 143 170 119 ------ ------ ------ Average shares outstanding -- diluted (denominator) 8,613 8,630 8,593 ------ ------ ------ Earnings per common share: Basic $ 1.11 $ 0.89 $ 0.86 Diluted $ 1.09 $ 0.87 $ 0.85
Options to purchase 594,250, 219,250 and 161,450, common shares at prices from $7.50 to $11.63, $7.88 to $11.63 and $7.06 to $11.63 per share were outstanding at December 31, 2000, 1999 and 1998, respectively, but were not included in the computation of earnings per diluted share for the respective years, because their exercise price was greater than the average market price of the common shares. These options expire through November 16, 2009, December 10, 2008 and December 31, 2007, respectively. (o) Capitalized Software Policy Capitalized computer software costs (included in fixed assets on the Consolidated Balance Sheets) consist of costs to purchase software. All capitalized software costs are amortized on a straight line method over a period of three or five years. Amortization expense charged to operations was $547,630 in 2000, $425,265 in 1999 and $199,272 in 1998. (p) Accounting Policy for Stock Compensation Plans The Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations in accounting for its stock based compensation plans. Accordingly, no compensation expense has been recognized for its Stock Option Plan as the exercise price of the options equaled the market price of the stock at the date of grant. Compensation expense has been recognized for the Stock Performance Plan based on the market price at the date of the award. (q) Fair Value of Financial Instruments The carrying amounts reported in the Consolidated Balance Sheets for cash and cash equivalents, receivables and premiums payable approximate those assets and liabilities fair values due to the short-term nature of the instruments. F-79 3) CHANGES IN ACCOUNTING POLICIES (a) Newly Adopted Accounting Standards In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 101 which provides guidance for applying generally accepted accounting principles relating to the timing of revenue recognition in financial statements filed with the SEC. The Company is recognizing revenue in accordance with SAB No. 101 and maintains an allowance for policy cancellations and commission returns. (b) Accounting Standards Not Yet Adopted In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133 (as amended), Accounting for Derivative Instruments and Hedging Activities. This statement requires all derivatives to be recognized as either assets or liabilities in the statement of financial position and to be measured at fair value. This statement is effective for all fiscal quarters and fiscal years beginning after December 31, 2000. The statement is not expected to have a material impact on the financial position of the Company. 4) ACQUISITIONS Effective January 1, 1999, the Company, through one of its insurance brokerage subsidiaries, Kaye Insurance Associates, Inc. ("KIA"), purchased the assets, including customer lists, and certain liabilities of Woodbury, N.Y.-based broker Seaman, Ross & Wiener, Inc. ("SRW") and related entities for an initial purchase price of $2,422,000 in cash and $500,000 in stock of the Company. Additional payments of $4,458,000 in cash and $292,000 in stock of the Company have been made through December 31, 2000. The total purchase price is contingent on future billings related to the acquired customer lists and will increase significantly from the initial purchase price. This acquisition is being accounted for using the purchase method of accounting. Accordingly, intangible assets (including customer lists) of approximately $7,700,000 resulting from the allocation of the preliminary purchase price and payments made through December 31, 2000, are being amortized by using the straight-line method over a period of not more than twenty years. During 1998, the Company acquired certain assets and liabilities of Florida Insurance Associates, Inc. ("FIA"), Daniel V. Keane Agency, Inc. ("DVK"), and Laub Group of Florida, Inc. ("LGF") for cash of $275,000, $1,452,0000 and $201,000, respectively, paid through December 31, 2000 and estimated amounts payable in future periods of $656,000 (DVK). The total acquired intangible assets (including expiration lists) was $2,108,000 for DVK. These acquisitions were accounted for under the purchase method. During the first half of 2000, the Brokerage Operations sold the majority of the operations of LGF at no gain or loss, as well as certain assets and liabilities of FIA. 5) FUNDS HELD IN FIDUCIARY CAPACITY Premiums collected by the Insurance Brokerage Companies but not yet remitted to insurance carriers are approximately $25,374,000 and $25,610,000 at December 31, 2000 and 1999, respectively, some of which are restricted as to use by law in certain states in which the Insurance Brokerage Companies operate. These balances are included in restricted cash. The offsetting obligation is recorded in premiums payable. F-80 6) INVESTMENTS Net investment income for the years ended December 31, 2000, 1999 and 1998 is derived from the following sources (in thousands):
2000 1999 1998 ------ ------ ------ INSURANCE BROKERAGE COMPANIES Cash and cash equivalents $1,339 $1,374 $1,846 ------ ------ ------ PROPERTY AND CASUALTY COMPANIES Fixed maturities 2,089 2,176 2,031 Equity securities 34 45 67 Cash and cash equivalents 729 532 791 Other 340 259 98 ------ ------ ------ Total investment income 3,192 3,012 2,987 Investment expenses (65) (63) (67) ------ ------ ------ 3,127 2,949 2,920 ------ ------ ------ CORPORATE Cash and cash equivalents 107 206 (31) ------ ------ ------ NET INVESTMENT INCOME $4,573 $4,529 $4,735 ------ ------ ------
Net realized gains or losses and the change in unrealized appreciation or depreciation on investments for the years ended December 31, 2000, 1999 and 1998 are summarized below (in thousands):
2000 1999 1998 ------- ------- ------- Net realized gains (losses): Fixed maturities: Gross realized gains $ 14 $ 37 $ 85 Gross realized losses (108) (13) Equity securities: Gross realized gains 1,142 4 Gross realized losses (244) (44) ------- ------- ------- NET REALIZED GAIN (LOSS) ON INVESTMENTS $ 804 $ (16) $ 85 ------- ------- ------- Change in unrealized appreciation (depreciation): Fixed maturities $ 1,044 $(1,586) $ 47 Equity securities (1,012) 419 209 ------- ------- ------- NET CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) $ 32 $(1,167) $ 256 ------- ------- -------
F-81 The composition, cost (amortized cost for fixed maturities) and estimated market values of the Company's investments at December 31, 2000 and 1999 are presented below.
GROSS UNREALIZED HOLDING AGGREGATE -------------- FAIR COST GAINS LOSSES VALUE ------- ----- ------ --------- (in thousands) 2000 Fixed Maturities: U.S. Government(a) $ 3,792 $ 48 $ (6) $ 3,834 States(b) 35,804 287 (263) 35,828 Corporate 3,561 39 (30) 3,570 ------- ---- ----- ------- Total fixed maturities $43,157 $374 $(299) $43,232 ------- ---- ----- -------- Equity Securities: Common Stock $ 8,648 $ 12 $(594) $ 8,066 Preferred Stock 270 193 463 ------- ---- ----- ------- Total equity securities $ 8,918 $205 $(594) $ 8,529 ------- ---- ----- --------
GROSS UNREALIZED HOLDING AGGREGATE --------------- FAIR COST GAINS LOSSES VALUE ------- ----- ------- --------- (in thousands) 1999 Fixed Maturities: U.S. Government(a) $ 3,351 $ 6 $ (132) $ 3,225 States(b) 35,247 53 (836) 34,464 Corporate 3,675 7 (67) 3,615 ------- ---- ------- ------- Total fixed maturities $42,273 $ 66 $(1,035) $41,304 ------- ---- ------- -------- Equity Securities: Common Stock $ 4,066 $838 $ (215) $ 4,689 Preferred Stock 50 50 ------- ---- ------- ------- Total equity securities $ 4,116 $838 $ (215) $ 4,739 ------- ---- ------- --------
- --------------- (a) Includes U.S. Government agencies and authorities (b) Includes municipalities and subdivisions The amortized cost and estimated market value of fixed maturities at December 31, 2000, by contractual maturity date, are listed below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
AMORTIZED AGGREGATE COST FAIR VALUE --------- ---------- (in thousands) Due in one year or less $ 3,030 $ 3,035 Due after one year through five years 19,497 19,683 Due after five years through ten years 18,898 18,790 Due after ten years 1,732 1,724 ------- ------- TOTAL $43,157 $43,232 -------- --------
F-82 Fixed maturities and cash and cash equivalents carried at market value of $3,510,000 and $3,422,000, in 2000 and 1999, respectively, were on deposit for governmental authorities, as required by law. Fixed maturities and cash equivalents carried at market value of $27,328,000 and $22,270,000 in 2000 and 1999, respectively, have been deposited in trust funds or pledged to collateralize the obligations of OLRI to ceding companies under reinsurance agreements. In addition, OLB maintained a bank letter of credit in the amount of $700,000 at December 31, 2000 and 1999. The Company's short term investment of cash is maintained principally with seven banks and three institutional money market funds. To control this risk, the Company utilizes only high credit quality financial institutions. Additionally, under the insurance laws of the State of Rhode Island, where OLRI is domiciled, insurers and reinsurers are restricted as to the types of investments they may purchase and the concentration of risk they may accept in any one issuer or group of issuers. The Company complies with such laws which insure that the concentration of risk in its investment portfolio is at an acceptable and authorized level. 7) NOTES PAYABLE Notes payable consist of the following in thousands at December 31:
2000 1999 ------- ------- INSURANCE BROKERAGE: Note payable, due through 7/1/2002, interest at prime $ 656 $ 1,031 Finance company note, due through 6/24/02, interest at 7.75% 185 320 Finance company note, due through 2000, interest at Prime rate plus 1/2% -- 17 Current portion (521) (527) ------- ------- NOTES PAYABLE -- LONG TERM $ 320 $ 841 ------- ------- CORPORATE: Term loan, due through 6/24/2002, interest at 7.8% $ 2,071 $ 3,311 Current portion (1,343) (1,241) ------- ------- NOTES PAYABLE -- LONG TERM $ 728 $ 2,070 ------- -------
The note payable, at 9%, due through July 1, 2002, represents debt incurred related to the DVK acquisition. The 7.8% Term Loan due through June 24, 2002 is secured by the stock of the Property and Casualty Companies. Certain covenants exist on this loan, the most significant being the requirement to maintain a minimum GAAP net worth, minimum statutory surplus in the Insurance Companies, a fixed ratio of net premiums to surplus and a minimum debt service coverage. At December 31, 2000, the Company was in compliance with the convenants under the loan agreement. In addition, the Company has available a $4,500,000 revolving line of credit through April 30, 2001 at LIBOR plus 175 basis points or the bank's base rate. The line is also secured by the stock of the Property and Casualty Companies. The proceeds are available for general operating needs and acquisitions. At December 31, 2000, no amount was outstanding on the revolving line of credit. A quarterly fee is assessed in the amount of .05% on the unused balance. The Company maintains a $700,000 letter of credit and has established trust funds in order to satisfy the collateral requirements of certain reinsurance agreements as of December 31, 2000 and 1999. The letter of credit is secured by certain cash deposits. Based on the borrowing rates currently available to the Company for bank loans with similar terms and average maturities, the fair value of the notes payable at December 31, 2000 and 1999 approximates their carrying value. F-83 Interest expense in the accompanying consolidated statements of income for the years ended December 31, 2000, 1999 and 1998 was $1,104,000, $1,091,000 and $492,000, respectively. 8) INCOME TAXES The Company and its wholly owned domestic subsidiaries are party to a Tax Allocation Agreement (the "Agreement"). The Agreement requires these companies to file a U.S. consolidated income tax return. The Agreement also provides that each member of the group will compute its separate tax liability or benefit on a separate return basis and pay or receive such amounts to or from the Company. The Company's effective income tax rate for the years ended December 31, 2000, 1999 and 1998 differs from the statutory rate on ordinary income before income taxes as follows (in thousands, except percentages):
2000 1999 1998 --------------- --------------- --------------- % OF % OF % OF PRETAX PRETAX PRETAX AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME ------ ------ ------ ------ ------ ------ Income taxes computed at the statutory rate $4,634 34.0% $3,648 34.0% $3,588 34.0% Increase (decrease) in taxes resulting from: Tax-exempt investment income (519) (3.8) (507) (4.7) (456) (4.3) State and local income taxes and other 110 0.8 84 0.8 140 1.3 ------ ----- ------ ----- ------ ----- PROVISION FOR INCOME TAXES $4,225 31.0% $3,225 30.1% $3,272 31.0% ----- ------ ----- ------ ----- ------
The source of the significant temporary differences and the related deferred tax effects are as follows:
2000 1999 1998 ----- ----- ----- (in thousands) Expiration lists $ 268 $ 395 $ 394 Accrual adjustment 167 60 (85) Unearned premium reserves 31 (71) 10 Deferred acquisition costs (88) 133 (6) Loss reserve discount (220) (353) (246) Other 180 (200) (217) ----- ----- ----- DEFERRED TAX EXPENSE (BENEFIT) $ 338 $ (36) $(150) ----- ----- -----
F-84 The components of the net deferred tax assets and liabilities, in the accompanying consolidated balance sheets at December 31, 2000 and 1999, are as follows:
2000 1999 ------ ------ (in thousands) Deferred tax assets: Loss and loss expense reserves $1,869 $1,649 Unearned premium reserves 867 898 Other 346 525 Unrealized losses on investments 107 118 Expiration lists (116) 152 ------ ------ Total deferred tax asset 3,073 3,342 ------ ------ Deferred tax liabilities: Deferred acquisition costs 1,378 1,466 Other accrual adjustments 1,206 1,038 ------ ------ Total deferred tax liability 2,584 2,504 ------ ------ NET DEFERRED TAX ASSET $ 489 $ 838 ------ ------
Management believes it is more likely than not that all deferred tax assets are realizable based upon the past earnings history of the Company. OLB, as a Bermuda domiciled company, is not subject to federal income taxes but, rather, the Company is subject to federal income taxes based on OLB's taxable income for the entire year. Accordingly, the Company includes the taxable income of OLB in its separate company income for tax purposes, but for segment reporting the income is included with the Property and Casualty Companies. OLB has received an undertaking from the Bermuda Government exempting it from all taxes computed on profit or income, or computed on any capital asset gain or appreciation until 2016. 9) LEASE COMMITMENTS AND RENTALS Minimum annual rental commitments under various non-cancelable operating leases for office space and equipment are as follows (in thousands):
YEARS ENDING DECEMBER 31, - ------------------------- 2001 $ 3,329 2002 1,324 2003 982 2004 949 2005 923 Thereafter 4,311 ------- 11,818 Sub-lease rental income (491) ------- NET RENTAL COMMITMENTS $11,327 -------
Leases for office space include various escalation clauses, none of which individually or in the aggregate are material. Escalation clauses are accounted for on a straight-line basis over the remaining life of the lease. The leases also contain provisions for the payment of certain operating expenses and real estate taxes. Rent expense for the years ended December 31, 2000, 1999 and 1998 amounted to $3,324,000, $3,242,000 and $2,928,000, respectively, net of sublease rental income of $174,000, $48,000 and $48,000, respectively. F-85 10) DEFINED CONTRIBUTION PLAN Substantially all officers and employees of the Company are entitled to participate in a qualified retirement savings plan (defined contribution plan). The cost to the Company was $434,000 $406,000 and $255,000 for 2000, 1999 and 1998, respectively. 11) COMMITMENTS AND CONTINGENCIES In the ordinary course of business, the Company and its subsidiaries are subject to various claims and lawsuits consisting primarily of alleged errors and omissions in connection with the placement of insurance. In the opinion of management, the ultimate resolution of all asserted and potential claims and lawsuits will not have a material effect on the consolidated financial position and results of operations of the Company. As licensed brokers, the Insurance Brokerage Companies are or may become party to administrative inquiries and at times to administrative proceedings commenced by state insurance regulatory bodies. Certain subsidiaries were involved in an administrative investigation commenced in 1992 by the New York Insurance Department ("Department") relating to how property insurance policies were issued for the Residential Real Estate Program. As a result, the manner in which policies are structured for certain clients in this Program was altered, which has not had a material adverse effect on this Program. While the Company had discussions with the Department regarding settlement of such investigation, this matter has not been pursued for several years. If the matter is not closed or settled, the Department could institute formal proceedings against the subsidiaries seeking fines or license revocation. Management does not believe the resolution of this issue will have a material adverse effect on the Company. 12) REINSURANCE The components of net written and net earned insurance premiums were as follows for the years ended December 31, 2000, 1999 and 1998:
2000 1999 1998 ------- ------- ------- (in thousands) WRITTEN PREMIUMS: Direct $ 8,988 $12,120 $11,586 Assumed 23,139 16,668 13,207 Ceded (2,099) (967) (255) ------- ------- ------- Net written premiums $30,028 $27,821 $24,538 ------- ------- ------- EARNED PREMIUMS: Direct $11,070 $11,576 $11,652 Assumed 21,054 15,846 13,392 Ceded (1,638) (642) (355) ------- ------- ------- Net earned premiums $30,486 $26,780 $24,689 ------- ------- -------
OLRI assumes reinsurance under arrangements with unaffiliated insurance companies. The Insurance Brokerage Companies produce the business assumed under these arrangements. The business has limits varying from $25,000 to $100,000 per occurrence. Claim liabilities under these agreements are secured with fixed maturity securities and cash and cash equivalents, which are deposited in trust funds. Approximately $27,328,000 and $22,270,000 as of December 31, 2000 and 1999, respectively, are held in these trust funds. In addition, OLB maintained a bank letter of credit in the amount of $700,000 at December 31, 2000 and 1999 to satisfy the reinsurance collateral requirement. OLRI underwrites a small book of business with limits up to $3,500,000 with net retention on one policy of $100,000 and reinsures the balance on an excess of loss basis to other insurers or reinsurers. F-86 Under the terms of the reinsurance agreements, loss and loss adjustment expenses recovered (incurred) in 2000, 1999 and 1998 were $2,174,857, $(451,000), and $409,000, respectively. Commissions earned on reinsurance ceded in 2000, 1999 and 1998 were $347,000, $148,000 and $45,000, respectively. Reinsurance has been placed with PXRE Reinsurance Company and The Hartford Stream and Boiler Inspection and Insurance Co. which are rated A or better by A.M. Best. A contingent liability exists with respect to reinsurance ceded, which would become an ultimate liability of OLRI in the event that the assuming companies were unable to meet their obligations under the reinsurance agreements in force at December 31, 2000. 13) UNPAID LOSSES AND LOSS EXPENSES The following table sets forth a reconciliation of the changes in the reserves for losses and loss expenses, including paid losses and loss expenses:
YEARS ENDED DECEMBER 31, ----------------------------- 2000 1999 1998 ------- ------- ------- (in thousands) Balance at January 1, $23,969 $21,567 $19,126 Less: reinsurance recoverables (2,678) (3,220) (2,811) ------- ------- ------- Net balance 21,291 18,347 16,315 ------- ------- ------- Incurred related to: Current year 13,340 10,410 8,461 Prior years (1,070) (656) 35 ------- ------- ------- Total incurred 12,270 9,754 8,496 ------- ------- ------- Paid related to: Current year 2,809 2,188 1,877 Prior years 7,368 4,622 4,587 ------- ------- ------- Total paid 10,177 6,810 6,464 ------- ------- ------- Net balance at December 31, 23,384 21,291 18,347 Add: reinsurance recoverables 4,600 2,678 3,220 ------- ------- ------- BALANCE $27,984 $23,969 $21,567 ------- ------- -------
2000 and 1999 incurred provisions increased over prior year's amounts due to the growth of liability business. Incurred provision reductions in 2000 and 1999 relating to prior years were due to redundant property and liability reserves established in those years. Paid losses in 2000 and 1999 for both current and prior years increased over the prior year's amount due to the overall growth in business. 14) STATUTORY FINANCIAL INFORMATION AND DIVIDEND RESTRICTIONS The Insurance Companies file separate financial statements in accordance with accounting practices prescribed or permitted by the insurance regulatory authorities where they are domiciled. These statutory accounting practices ("SAP") differ in certain respects from GAAP. These differences are primarily comprised of the accounting for prepaid acquisition costs, deferred income taxes, and fixed maturity and equity investments. F-87 The following is a reconciliation of net income and surplus regarding policyholders in accordance with SAP as reported to the Rhode Island and Bermuda insurance regulatory authorities to net income and capital as determined in conformity with GAAP.
STATUTORY SURPLUS/ NET INCOME FOR YEARS STOCKHOLDERS' EQUITY ENDED AS OF DECEMBER 31, DECEMBER 31, --------------------- ------------------------- 2000 1999 2000 1999 1998 --------- --------- ------- ------ ------ (in thousands) Consolidated amount in accordance with GAAP $ 56,042 $ 47,251 $ 9,404 $7,504 $7,282 Deficit (equity) in net assets and net loss (income) of non-insurance companies (14,782) (10,083) (1,658) (226) (141) -------- -------- ------- ------ ------ Combined amount in accordance with GAAP 41,260 37,168 7,746 7,278 7,141 Deferred acquisition costs (4,053) (4,313) 260 (392) 18 Non-admitted assets, deferred income taxes and other (1,898) (341) (278) (292) (241) -------- -------- ------- ------ ------ COMBINED AMOUNT IN ACCORDANCE WITH SAP $ 35,309 $ 32,514 $ 7,728 $6,594 $6,918 -------- -------- ------- ------ ------
The Insurance Companies are currently subject to various regulations that limit the maximum amount of dividends ultimately available to the Company without prior approval of insurance regulatory authorities. Under SAP, approximately $3,811,000 of statutory surplus is available for distribution in 2001 without prior regulatory approval. In 1998, the National Association of Insurance Commissioners ("NAIC") adopted the Codification of Statutory Accounting Principles guidance, which will replace the current Accounting Practices and Procedures manual as the NAIC's primary guidance on statutory accounting. The new accounting guidance becomes effective January 1, 2001 and has been adopted by the State of Rhode Island. 15) RELATED PARTY TRANSACTIONS The administrative support for OLB is provided by International Advisory Services, Ltd. ("IAS"), an insurance management company located in Bermuda. A director of IAS is an officer of OLB and is a director of the Company. Management fees paid to IAS under a service contract for the years ended December 31, 2000, 1999 and 1998 were $20,000, $20,000 and $30,000, respectively. A director of the Company is also a director of, and had shared beneficial ownership of more than ten percent of the outstanding common stock of Sun Television and Appliances, Inc. ("Sun TV"). In 1994, Sun TV and a subsidiary of the Company entered into two agreements whereby the Company's subsidiary agreed to assume certain service contracts that were sold by Sun TV to its retail customers (the "Agreement") and contracted with Sun TV to have Sun TV provide repair services under certain service contracts. The Board of Directors believes that the agreements were commercially reasonable. On September 11, 1998, Sun TV filed bankruptcy petitions under Chapter 11 of the Bankruptcy Code. The Company's subsidiary filed a proof of claim on March 11, 1999 for any and all amounts that are due and owing under the Agreement. 16) DIVIDENDS AND TREASURY STOCK The Board of Directors of the Company declared annual dividends of $845,000 and $847,000 for the years ended December 2000 and 1999, respectively, of which $212,000 was unpaid at December 31, 2000 and 1999. In December 1998, the Board of Directors authorized for a two year period the repurchase, at management's discretion, of up to 300,000 shares of the Company's Common Stock. The Company's repurchases of shares of Common Stock are recorded as treasury stock and result in a reduction of stockholders' equity. When treasury shares are reissued the Company uses a first-in, first-out F-88 method and the excess of re-issuance price over repurchase cost is treated as an increase of paid-in capital. Net issuances/(purchases) of treasury stock for the years ended December 31, 2000 and 1999 amounted to 23,176 shares and (27,657) shares, respectively. Treasury shares at December 31, 2000 and 1999 amounted to 4,481 and 27,657 shares, respectively at a cost of approximately $37,000 and $229,000. 17) STOCK PERFORMANCE AND STOCK OPTION PLANS On December 30, 1997, the Company adopted a Stock Performance Plan, under which up to 350,000 shares of the Company's common stock may be granted and awarded to key employees. The grant of stock under this plan is contingent upon criteria established by the Compensation Committee of the Company's Board of Directors. Awards are based on performance targets of the Company's stock based on increases in the market value of the Company's common stock from the price on the date the stock is initially granted by the Company. Shares must be granted, awarded, and vested before participants take full title to the performance stock. Awards vest on the occurrence of any of the following events, (i) fifteen years of continuous service with the Company from the date shares are granted to the participant, (ii) death or disability of the participant, (iii) immediately before a change of control (as defined under the plan), (iv) attaining the age of 65, or (v) immediately before a sale or merger (as defined under the plan). During 2000 and 1999, $0 and 26,016 shares of performance stock were granted under this plan, respectively. During July 1999, the Company awarded 33,844 shares of restricted stock from shares previously granted under the Stock Performance Plan to certain key employees. The market value of these shares awarded totaled approximately $264,000 and has been recorded as unearned stock grant compensation (net of amortization) as a separate component of stockholders' equity. Unearned compensation is being amortized to expense on a straight-line basis over the remaining vesting period. At December 31, 2000 and 1999, no performance stock under this plan was vested. In addition to the Stock Performance Plan, the Company has a stock option plan. Under the option plan a total of 1,350,000 shares of common stock are reserved for issuance. The option plan provides for the granting to directors, executives or other key employees (including officers) of the Company non-qualified stock options (NQO's) or incentive stock options (ISO's) within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended. The Compensation Committee determines the terms of the options including the exercise price, number of shares subject to option and exercisability. The exercise price of all ISO's and NQO's under the plan is generally at least the fair market value of the common stock of the Company on the date of grant. A summary of the stock option activity and related information consists of the following:
2000 1999 1998 ---------------------- -------------------- -------------------- WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE ---------- --------- -------- --------- -------- --------- Outstanding at beginning of year 993,000 $6.70 659,200 $6.15 624,850 $6.12 Granted 144,250 7.41 361,800 7.63 54,500 6.46 Exercised (6,900) 5.06 Forfeited (7,540) 5.94 (21,100) 5.93 (20,150) 7.88 ---------- -------- -------- Outstanding at end of year 1,129,710 $7.55 993,000 $6.70 659,200 $6.15 ---------- -------- -------- Options exercisable at year-end 544,060 341,300 232,900 ---------- -------- -------- Weighted-average fair value of options granted during the year $ 3.09 $ 2.34 $ 2.17 ---------- -------- --------
F-89 The following table summarizes information about the stock options outstanding at December 31, 2000:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------------------- ---------------------------- NUMBER WEIGHTED-AVERAGE WEIGHTED- NUMBER WEIGHTED- OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE EXERCISE PRICES AT 12/31/00 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/00 EXERCISE PRICE - --------------- ----------- ---------------- -------------- ----------- -------------- $11.63 500 3.09 years $11.63 500 $11.63 $10.91 5,000 3.06 $10.91 5,000 $10.91 $10.00 75,500 2.62 $10.00 75,500 $10.00 $8.43 39,750 4.81 $ 8.43 39,750 $ 8.43 $8.24 20,000 8.82 $ 8.24 4,000 $ 8.24 $8.24 48,500 8.83 $ 8.24 9,700 $ 8.24 $8.03 15,000 6.83 $ 8.03 9,000 $ 8.03 $7.88 15,000 4.70 $ 7.88 15,000 $ 7.88 $7.50 252,500 8.95 $ 7.50 50,500 $ 7.50 $7.50 122,500 9.37 $ 7.50 24,500 $ 7.50 $7.50 750 9.88 $ 7.50 $7.41 160 8.12 $ 7.41 160 $ 7.41 $7.38 40,000 8.15 $ 7.38 8,000 $ 7.38 $7.07 1,000 9.78 $ 7.07 $7.06 10,000 5.37 $ 7.06 8,000 $ 7.06 $6.90 20,000 9.83 $ 6.90 $6.64 5,000 7.00 $ 6.64 3,000 $ 6.64 $6.60 21,800 7.94 $ 6.60 8,900 $ 6.60 $6.17 20,000 7.83 $ 6.17 8,000 $ 6.17 $5.06 156,750 6.15 $ 5.06 95,550 $ 5.06 $5.00 250,000 6.12 $ 5.00 173,000 $ 5.00 $4.97 10,000 6.50 $ 4.97 6,000 $ 4.97 --------- ------- 1,129,710 6.99 years $ 7.55 544,060 $ 6.58 ---------- -----------
Unless otherwise specified, the options vest and are exercisable at the rate of 20% per year and terminate ten years from date of grant. At December 31, 2000, 1999 and 1998, 544,060, 341,300 and 232,900 options were exercisable and there were 220,290, 0, and 40,800 options available for future grants, respectively. Had the compensation cost for the Company's stock based compensation plans been determined based on the fair value at the grant date for awards under those plans consistent with the method of SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below (in thousands, except per share amounts):
2000 1999 1998 ------ ------ ------ Net Income As reported $9,404 $7,504 $7,282 Pro forma 9,159 7,361 7,167 Earnings per share -- basic As reported 1.11 .89 .86 Pro forma 1.08 .87 .85 Earnings per share -- diluted As reported 1.09 .87 .85 Pro forma 1.06 .85 .84
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: (i) dividend yield of 1.3%, (ii) expected volatility range of 45%, (iii) risk-free interest rate of 6.63%, and (iv) expected life of 5 years. F-90 18) QUARTERLY FINANCIAL INFORMATION (UNAUDITED) The following quarterly financial information for each of the three months ended March 31, June 30, September 30 and December 31, 2000 and 1999 is unaudited. However, in the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the results of operations for such periods, have been made.
FOR THE THREE MONTHS ENDED ----------------------------------------------------------------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, ----------------- ----------------- ----------------- ----------------- 2000 1999 2000 1999 2000 1999 2000 1999 ------- ------- ------- ------- ------- ------- ------- ------- (in thousands, except for per share) Revenues $17,375 $16,083 $20,644 $17,739 $18,937 $16,599 $21,442 $18,323 ------- ------- ------- ------- ------- ------- ------- ------- Net income $ 1,622 $ 1,359 $ 2,917 $ 2,123 $ 2,349 $ 1,723 $ 2,516 $ 2,299 ------- ------- ------- ------- ------- ------- ------- ------- Earnings per share: Basic $ 0.19 $ 0.16 $ 0.34 $ 0.25 $ 0.28 $ 0.20 $ 0.30 $ 0.27 Diluted 0.19 0.16 0.34 0.25 0.27 0.20 0.29 0.27 ------- ------- ------- ------- ------- ------- ------- ------- Weighted average shares outstanding: Basic 8,461 8,460 8,466 8,448 8,473 8,460 8,479 8,464 Diluted 8,669 8,605 8,570 8,590 8,610 8,655 8,625 8,667 ------- ------- ------- ------- ------- ------- ------- -------
19) BUSINESS SEGMENTS The Company operates in two insurance business segments, the Insurance Brokerage Companies and the Property and Casualty Companies. In addition, Corporate Operations include those activities that benefit the Company in its entirety and cannot be specifically identified to either the Insurance Brokerage Companies or the Property and Casualty Companies. Such activities include debt servicing and public company expenses, including investor relations costs. The identifiable segment assets, operating profits and income before income taxes and minority interests are shown on the accompanying consolidated balance sheets and statements of income. The following table is a summary of certain other segment information for the years ended December 31, 2000, 1999 and 1998:
BUSINESS SEGMENTS -- 2000 ------------------------- INSURANCE PROPERTY & BROKERAGE CASUALTY --------- ---------- (in thousands) Revenue from external sources $38,935 $30,486 Revenue from other segments 3,131 76 Depreciation and amortization expense 2,857 9,466 Interest income from other segments 275 Capital expenditures 3,866
BUSINESS SEGMENTS -- 1999 ------------------------- INSURANCE PROPERTY & BROKERAGE CASUALTY --------- ---------- (in thousands) Revenue from external sources $33,158 $26,780 Revenue from other segments 4,221 72 Depreciation and amortization expense 2,355 8,309 Interest income from other segments 192 Capital expenditures 1,347
F-91
BUSINESS SEGMENTS -- 1998 ------------------------- INSURANCE PROPERTY & BROKERAGE CASUALTY --------- ---------- (in thousands) Revenue from external sources $31,324 $24,689 Revenue from other segments 4,032 69 Depreciation and amortization expense 1,792 7,651 Capital expenditures 2,089
The foreign operations set forth below, relate solely to the operations of OLB, and its wholly owned subsidiary Park Brokerage, and business assumed from third party insurance companies. All such risks assumed originate in the United States.
2000 ------------------------------- FOREIGN DOMESTIC TOTAL ------- -------- -------- (in thousands) Consolidated Revenues $1,589 $76,809 $ 78,398 Income before income taxes 805 12,824 13,629 Identifiable assets 3,063 169,948 173,011
1999 1998 ----------------------------- ----------------------------- FOREIGN DOMESTIC TOTAL FOREIGN DOMESTIC TOTAL ------- -------- -------- ------- -------- -------- (in thousands) Consolidated Revenues $1,717 $67,027 $ 68,744 $2,092 $62,919 $ 65,011 Income before income taxes 1,055 9,674 10,729 1,169 9,385 10,554 Identifiable assets 2,648 146,564 149,212 2,936 157,647 160,583
There were no material inter-company revenue transactions between OLB and OLRI. 20) SUPPLEMENTAL CASH FLOW DISCLOSURES
2000 1999 1998 ------ ------- ------- (in thousands) CASH PAID DURING THE PERIOD FOR: Interest expense $1,097 $ 968 $ 501 Income taxes $4,066 $ 3,463 $ 2,870 NON-CASH INVESTING AND FINANCING ACTIVITIES: Stock issued under Stock Performance Plan $ 222 DETAILS OF ACQUISITIONS: Purchase payments including outstanding payable $4,225 $ 7,784 $ 5,196 Amounts contingently payable (656) (1,578) (3,300) Reissuance of treasury stock (192) (628) Acquisition debt repayment (375) (375) (657) ------ ------- ------- Cash paid for acquisitions $3,002 $ 5,203 $ 1,239 ------ ------- -------
21) SUBSEQUENT EVENT On January 20, 2001, the Company reported that Hub International Limited ("Hub") had entered into a definitive agreement to acquire the Company through a merger transaction. Upon the merger, each holder of the Company's shares will receive $14.00 per share consisting of cash of $9.33 and $4.67 principal amount of 5 year 8.50% subordinate convertible debentures of Hub. Hub has the right to amend the merger consideration by replacing any or all of the convertible debentures with an equal amount of cash. F-92 Completion of this transaction, anticipated to occur in the second quarter of 2001, is subject to the receipt of satisfactory applicable regulatory approvals, approval of the merger by the shareholders of the Company, compliance with applicable legal and regulatory requirements and standard closing conditions. The holders of approximately 55% of the shares of the Company, under individual agreements, have agreed to vote in favor of the merger, and have granted Hub an irrevocable option to purchase their shares of the Company in the event that the merger is not completed. Immediately prior to the transaction all outstanding stock options shall become vested, and in return for their cancellation, the holders of options will receive a cash payment; and in return for the cancellation of all outstanding and awarded Performance Stock Shares, the holders will receive a cash payment at a later date. On completion of the transaction, the Company will record an expense of approximately $2,400,000 related to the cancellation of the awarded shares of the Stock Performance Plan. In addition, as a result of the transaction, the Company will incur related expenses of approximately $2.5 million during the period January 1, 2001 through completion of the transaction. F-93 SCHEDULE II KAYE GROUP INC. (PARENT COMPANY ONLY) CONDENSED BALANCE SHEETS As of December 31, 2000 and 1999 (in thousands, except par value per share)
2000 1999 ------- ------- ASSETS Cash and cash equivalents $ 138 $ 1,233 Prepaid expenses and other assets 59 153 Investments: Equity securities, at market (cost: 2000, $308, and 1999, $243) 320 243 Deferred income taxes 67 93 Due from subsidiaries 2,427 890 Investment in subsidiaries 55,543 48,616 ------- ------- Total assets $58,554 $51,228 ------- ------- LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Accounts payable and other liabilities $ 254 $ 300 Note payable 1,343 1,241 Income taxes payable 187 366 ------- ------- Total current liabilities 1,784 1,907 Note payable -- long term 728 2,070 ------- ------- Total liabilities 2,512 3,977 ------- ------- STOCKHOLDERS' EQUITY Preferred stock, $1.00 par value; 1,000 shares authorized; none issued or outstanding Common stock, $.01 par value; 20,000 shares authorized; (2000, 8,481; 1999, 8,458 shares issued and outstanding) 85 85 Paid-in capital 18,019 18,019 Unearned stock grant compensation (235) (254) Common stock in Treasury, shares at cost (2000, 4; 1999, 28) (37) (229) Unrealized appreciation (depreciation) of investments, net of deferred income tax provision (benefit), (2000, ($107); 1999, ($118)) (207) (228) Retained earnings 38,417 29,858 ------- ------- Total stockholders' equity 56,042 47,251 ------- ------- Total liabilities and stockholders' equity $58,554 $51,228 ------- -------
The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto and the accompanying notes. F-94 SCHEDULE II KAYE GROUP INC. (PARENT COMPANY ONLY) CONDENSED STATEMENTS OF INCOME For the years ended December 31, 2000, 1999 and 1998 (in thousands)
2000 1999 1998 ------- ------- ------- REVENUES: Net investment income (loss) $ 107 $ 206 $ (31) Equity in income of subsidiaries 14,236 11,148 11,342 EXPENSES: Other operating expenses 480 309 314 Interest expense 234 316 443 ------- ------- ------- Income before income taxes 13,629 10,729 10,554 Provision for income taxes 4,225 3,225 3,272 ------- ------- ------- NET INCOME $ 9,404 $ 7,504 $ 7,282 ------- ------- -------
The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto and the accompanying notes. F-95 SCHEDULE II KAYE GROUP INC. (PARENT COMPANY ONLY) CONDENSED STATEMENTS OF CASH FLOWS For the years ended December 31, 2000, 1999 and 1998 (in thousands)
2000 1999 1998 -------- ------- ------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 9,404 $ 7,504 $ 7,282 Adjustment to reconcile net income to net cash provided by (used in) operating activities: Deferred income tax benefit 21 (93) (150) Restricted stock compensation 19 10 Equity in net income of subsidiaries (10,214) (8,115) (7,826) Dividends received from subsidiaries 3,900 3,886 4,060 Realized (gain) loss on investment (64) 274 Change in assets and liabilities: Prepaid expenses and other assets 94 95 (20) Due from subsidiaries (1,537) 1,228 1,294 Accounts payable and other liabilities (46) (211) (263) Income taxes payable (179) (202) 552 -------- ------- ------- Net cash provided by operating activities 1,398 4,376 4,929 -------- ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Payment of dividends (845) (847) (849) Notes payable-repayment (1,240) (1,145) (7,575) Reissuance (acquisition) of treasury stock 192 (571) Proceeds from borrowing 5,000 Capital contribution to subsidiary (600) (950) (1,200) -------- ------- ------- Net cash used in financing activities (2,493) (3,513) (4,624) -------- ------- ------- NET CHANGE IN CASH AND CASH EQUIVALENTS (1,095) 863 305 Cash and cash equivalents at beginning of period 1,233 370 65 -------- ------- ------- Cash and cash equivalents at end of period $ 138 $ 1,233 $ 370 -------- ------- ------- SUPPLEMENTAL CASH FLOW DISCLOSURES Cash paid during the period for: Interest expense $ 234 $ 316 $ 480 Income taxes $ 4,066 $ 3,463 $ 2,870
The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto and the accompanying notes. F-96 SCHEDULE II KAYE GROUP INC. (PARENT COMPANY ONLY) NOTES TO CONDENSED FINANCIAL STATEMENTS 1. CONDENSED FINANCIAL STATEMENTS Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. It is suggested that these condensed financial statements be read in conjunction with the Company's consolidated financial statements and the notes thereto. 2. SIGNIFICANT ACCOUNTING POLICIES The Company carries its investment in subsidiaries under the equity method. All other accounting policies are consistent with those of the Company on a consolidated basis. F-97 SCHEDULE IV KAYE GROUP INC. REINSURANCE For The Years Ended December 31, 2000, 1999 and 1998 (in thousands)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F - --------------- -------- -------------- --------------- ---------- -------------- PERCENTAGE INSURANCE GROSS CEDED TO OTHER ASSUMED FROM OF AMOUNT PREMIUMS EARNED AMOUNT COMPANIES OTHER COMPANIES NET AMOUNT ASSUMED TO NET - --------------- -------- -------------- --------------- ---------- -------------- 2000 $11,070 $1,638 $21,054 $30,486 69% 1999 $11,576 $ 642 $15,846 $26,780 59% 1998 $11,652 $ 355 $13,392 $24,689 54%
F-98 SCHEDULE VI KAYE GROUP INC. SUPPLEMENTAL INFORMATION CONCERNING INSURANCE COMPANIES OPERATIONS For the years ended December 31, 2000, 1999 and 1998 (in thousands)
COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G COLUMN H COLUMN I COLUMN A ----------- ------------- -------- -------- -------- ---------- ----------------- ------------ - --------------- CLAIMS AND CLAIM ADJUSTMENT EXPENSES INCURRED RESERVES FOR DISCOUNT RELATED TO UNPAID CLAIMS IF ANY ----------------- AMORTIZATION DEFERRED AND CLAIM DEDUCTED NET (1) (2) OF DEFERRED AFFILIATION WITH ACQUISITION ADJUSTMENT IN UNEARNED EARNED INVESTMENT CURRENT PRIOR ACQUISITION REGISTRANT COSTS EXPENSES COLUMN C PREMIUMS PREMIUMS INCOME YEAR YEARS COSTS - ---------------- ----------- ------------- -------- -------- -------- ---------- ------- ------- ------------ Foreign $ 149 $ 246 N/A $ 709 $ 1,459 $ 130 $ 348 $ (88) $ 307 Domestic 3,904 27,738 N/A 12,988 29,027 2,924 12,992 (982) 9,143 ------ ------- --- ------- ------- ------ ------- ------- ------ 2000 $4,053 $27,984 N/A $13,697 $30,486 $3,054 $13,340 $(1,070) $9,450 -------- --------- ----- ------- ------- ------- ------ ------ -------- Foreign $ 152 $ 260 N/A $ 725 $ 1,598 $ 119 $ 375 $ (144) $ 335 Domestic 4,161 23,709 N/A 12,969 25,182 2,678 10,035 (542) 7,957 ------ ------- --- ------- ------- ------ ------- ------- ------ 1999 $4,313 $23,969 N/A $13,694 $26,780 $2,797 $10,410 $ (656) $8,292 -------- --------- ----- ------- ------- ------- ------ ------ -------- Foreign $ 193 $ 295 N/A $ 916 $ 1,957 $ 135 $ 313 $ 95 $ 414 Domestic 3,728 21,272 N/A 11,411 22,732 2,453 8,148 (60) 7,216 ------ ------- --- ------- ------- ------ ------- ------- ------ 1998 $3,921 $21,567 N/A $12,327 $24,689 $2,588 $ 8,461 $ 35 $7,630 -------- --------- ----- ------- ------- ------- ------ ------ -------- COLUMN J COLUMN K COLUMN L COLUMN A ----------- -------- --------- - --------------- PAID CLAIMS AND CLAIM OTHER AFFILIATION WITH ADJUSTMENT PREMIUMS OPERATING REGISTRANT EXPENSES WRITTEN EXPENSES - ---------------- ----------- -------- --------- Foreign $ 272 $ 1,443 $ 218 Domestic 9,905 28,584 2,947 ------- ------- ------ 2000 $10,177 $30,027 $3,165 -------- ------- ------- Foreign $ 296 $ 1,408 $ 66 Domestic 6,514 26,414 2,847 ------- ------- ------ 1999 $ 6,810 $27,822 $2,913 -------- ------- ------- Foreign $ 317 $ 1,742 $ 102 Domestic 6,147 22,796 2,178 ------- ------- ------ 1998 $ 6,464 $24,538 $2,280 -------- ------- -------
F-99 5,000,000 SHARES (HUB LOGO) COMMON SHARES PROSPECTUS JPMORGAN COCHRAN, CARONIA & CO. STEPHENS INC. BMO NESBITT BURNS FERRIS, BAKER WATTS Incorporated , 2002 YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION DIFFERENT FROM THAT CONTAINED IN THIS PROSPECTUS. WE ARE OFFERING TO SELL, AND SEEKING OFFERS TO BUY, COMMON SHARES ONLY IN JURISDICTIONS WHERE OFFERS AND SALES ARE PERMITTED. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS ACCURATE ONLY AS OF THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF DELIVERY OF THIS PROSPECTUS OR OF ANY SALE OF OUR COMMON SHARES. NO ACTION IS BEING TAKEN IN ANY JURISDICTION OUTSIDE THE UNITED STATES TO PERMIT A PUBLIC OFFERING OF THE COMMON SHARES OR POSSESSION OR DISTRIBUTION OF THIS PROSPECTUS IN THAT JURISDICTION. PERSONS WHO COME INTO POSSESSION OF THIS PROSPECTUS IN JURISDICTION OUTSIDE THE UNITED STATES ARE REQUIRED TO INFORM THEMSELVES ABOUT AND TO OBSERVE ANY RESTRICTIONS AS TO THIS OFFERING AND THE DISTRIBUTION OF THIS PROSPECTUS APPLICABLE TO THAT JURISDICTION. UNTIL , ALL DEALERS THAT BUY, SELL OR TRADE IN OUR COMMON SHARES, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE DEALER'S OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. - --------------------------------------------------------------------------- SEC registration fee........................................ $ 9,487.50 NASD filing fee............................................. 9,987.50 NYSE listing fee............................................ 40,425.00 Blue Sky fees and expenses.................................. 5,000.00 Printing and engraving expenses............................. 200,000.00 Attorneys' fees and expenses................................ 650,000.00 Accountants' fees and expenses.............................. 400,000.00 Transfer agent's and registrar's fees and expenses.......... 15,000.00 Miscellaneous............................................... 170,100.00 Total....................................................... $1,500,000.00 - ---------------------------------------------------------------------------
The amounts set forth above are estimates except for the SEC registration fee, the NASD filing fee and the NYSE listing fee. ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS. Under the Business Corporations Act (Ontario), the Corporation may indemnify a present or former director or officer or a person who acts or acted at the Corporation's request as a director or officer of another corporation of which the Corporation is or was a shareholder or creditor, and his or her heirs and legal representatives, against all costs, charges and expenses, including an amount paid to settle an action or satisfy a judgment, reasonably incurred by him or her in respect of any civil, criminal or administrative action or proceeding to which he or she is made a party by reason of being or having been a director or officer of the Corporation of such other corporation and provided that the director or officer acted honestly and in good faith with a view to the best interests of the Corporation, and, in the case of a criminal or administrative action or proceeding that is enforced by a monetary penalty, such director or officer had reasonable grounds for believing that his or her conduct was lawful. Such indemnification may be made in connection with an action by or on behalf of the Corporation or such other corporation to procure a judgment in its favor only with court approval. A director or officer is entitled to indemnification from the Corporation as a matter of right if he or she was substantially successful on the merits in his or her defense of the action or proceeding and fulfilled the conditions set forth above. The by-laws of the Corporation provide that the Corporation shall indemnify a director or officer, a former director or officer or a person who acts or acted at the Corporation's request as a director or officer of a body corporate of which the Corporation is or was a shareholder or creditor, and the heirs and legal representatives of such a person to the extent permitted by the Business Corporations Act (Ontario). The by-laws of the Corporation further provide that the Corporation may, to the extent permitted by the Business Corporations Act (Ontario), purchase and maintain insurance for the benefit of any director or officer, a former director or officer or a person who acts or acted at the Corporation's request as a director or officer of a body corporate of which the Corporation is or was a shareholder or creditor. II-1 A policy of directors' and officers' liability insurance is maintained by the Corporation which insures, subject to certain exclusions, directors and officers for losses as a result of claims against the directors and officers of the Corporation in their capacity as directors and officers and also reimburses the Corporation for payments made pursuant to the indemnity provided by the Corporation pursuant to the Business Corporations Act (Ontario) and the by-laws of the Corporation. Insofar as indemnification for liabilities under the Securities Act may be permitted to directors, officers or persons controlling the Registrant pursuant to the foregoing provisions, the Registrant has been advised that in the opinion of the SEC such indemnification is against public policy as expressed in the Securities Act and is, therefore unenforceable. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES. The following information reflects sales by the registrant of unregistered securities within the past three years:
- ------------------------------------------------------------------------------------------------------- NUMBER OF PRICE PER DATE ISSUED TO (NUMBER OF HOLDERS) SHARES SOLD SHARE - ------------------------------------------------------------------------------------------------------- 1/20/99................ Fairfax and wholly-owned subsidiaries for cash(1) 5,400,000 C$10.00 1/20/99................ Fairfax in exchange for 2,838,080 special 2,838,080 13.50 warrants(1) 2/10/99................ Initial Public Offering in Canada(2) 865,624 13.50 4/30/99................ Group Five Planned Insurance Services Inc. and The 247,857 14.00 Independent Brokerage Group Inc.(3) 5/31/99................ P. Moauro & Associates Inc.(3) 11,765 17.00 5/31/99................ Paul Ayotte Insurance Broker Ltd.(3) 52,941 17.00 5/31/99................ Paul Ayotte Insurance Brokers (Kapuskasing) Ltd.(3) 61,441 17.00 6/30/99................ Page Insurance Ltd.(3) 11,764 17.00 6/30/99................ Pro-Form Insurance Services Inc.(3) 24,264 17.00 6/30/99................ Evans-Bastion Insurance Agencies Ltd.(3) 63,000 17.00 6/30/99................ Mointra Services Inc. and Cambridge Insurance 82,353 17.00 Brokers Ltd.(3) 7/8/99................. Assurance Murdoch Crevier Inc.(3) 57,584 17.00 7/31/99................ Affinity Brokerage Network Inc., Segger & Associates 130,853 17.00 Ltd., APS Financial Corporation and APS Financial Brokerage Inc.(3) 7/31/99................ Revelstoke Agencies Ltd. and Ken Magnes Agencies 9,189 18.50 Ltd.(3) 7/31/99................ KMS Insurance Services Ltd. and Underwriting 55,985 17.00 Alliance Group Inc.(3) 7/31/99................ Allan Tolsma Agencies Ltd. and Allan Tolsma Agencies 41,000 17.00 (Colwood) Ltd.(3) 7/31/99................ Feder & Associates Insurance Brokers Ltd. and 20,000 17.00 Canadian Block Managers Inc.(3) 8/3/99................. Assurances Cloutier & Cloutier Inc.(3) 13,889 18.00 8/3/99................. Gestion S. Lamanque Inc.(3) 2,673 17.00 8/31/99................ Parson Brown & Company Limited(3) 126,555 17.00 8/31/99................ TOS Insurance Services Ltd.(3) 417,358 17.00 9/30/99................ Tenax Employee Benefits and Consulting Inc.(3) 26,176 17.00
II-2
- ------------------------------------------------------------------------------------------------------- NUMBER OF PRICE PER DATE ISSUED TO (NUMBER OF HOLDERS) SHARES SOLD SHARE - ------------------------------------------------------------------------------------------------------- 10/27/99............... Mack & Parker, Inc.(5) 1,102,593 C$19.00 10/31/99............... Salmon Arm Insurance Agency Ltd.(3) 74,510 20.00 11/1/99................ NILA Financial & Insurance Services Inc.(3) 42,500 20.00 11/20/99............... S & P Agencies (1980) Ltd. and G. B. Ventures 8,700 20.00 Ltd.(3) 11/30/99............... Bytown Insurance Brokers Inc.(3) 15,000 20.00 12/31/99............... McIntosh Insurance Services Inc.(3) 4,620 20.00 12/31/99............... Executive Share Purchase Plan(4) 45,250 20.00 1/14/00................ Executive Share Purchase Plan(4) 5,882 17.00 2/2/00................. Executive Share Purchase Plan(4) 5,000 20.00 4/1/00................. Blais, Chalifour, Couillard, McCarthy, Thabet inc. 18,640 18.00 and Les Placements Stefrasco Inc.(3) 4/3/00................. Executive Share Purchase Plan(4) 5,000 20.00 6/30/00................ C. J. McCarthy Insurance Agency, Inc.(5) 464,470 15.00 7/1/00................. NILA Financial Group Inc.(3) 20,000 20.00 7/12/00................ Executive Share Purchase Plan(4) 25,982 20.00 7/12/00................ Executive Share Purchase Plan(6) 73,766 20.00 7/12/00................ Executive Share Purchase Plan(4) 1,851 13.50 7/27/00................ Executive Share Purchase Plan(4) 1,750 20.00 11/6/00................ Price adjustment pursuant to November 30, 1998 4,564 10.00 Merger Agreement(3) 1/1/01................. Assurances Dumas & Associes Inc.(3) 50,879 17.00 6/18/01................ J. P. Flanagan Corporation(5) 680,000 17.00 6/26/01................ Executive Share Purchase Plan(6) 186,999 17.00 7/19/01................ Bruce Guthart for cash(1) 439,526 13.00 7/20/01................ Burnham Stewart Group, Inc.(5) 1,422,834 17.00 320,266 16.28 7/26/01................ Executive Share Purchase Plan(6) 500 10.00 7/30/01................ Executive Share Purchase Plan(6) 150 10.00 8/15/01................ Executive Share Purchase Plan(6) 600 10.00 9/27/01................ Executive Share Purchase Plan(6) 2,353 17.00 9/28/01................ Executive Share Purchase Plan(6) 800 10.00 10/9/01................ Executive Share Purchase Plan(6) 258 13.50 10/30/01............... Executive Share Purchase Plan(6) 289 13.50 12/28/01............... Executive Share Purchase Plan(6) 11,765 17.00 - -------------------------------------------------------------------------------------------------------
1. The sale of the securities was made in reliance upon an exemption from the registration provisions of the Securities Act set forth in Section 4(2) thereof with respect to transactions by an issuer not involving a public offering. No underwriter was involved in the sale and the purchaser represented himself to be an accredited investor as defined by Rule 501 of Regulation D under the Securities Act and represented his intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution of the securities. Appropriate legends were affixed to the certificates representing the securities issued in these transactions. 2. The sale of securities was made in connection with a public offering in Canada in reliance upon an exemption from the registration provisions of the Securities Act set forth in Regulation S II-3 thereof with respect to offers and sales made outside the United States. The sale of the securities constituted an offshore transaction as defined by Rule 902 of Regulation S because at the time the offer and sale of the securities was made, the Registrant had a reasonable belief that each purchaser was resident in Canada. At the time of the offer and sale, the Registrant was a foreign private issuer and reasonably believed that there was no substantial U.S. market interest ("SUSMI") in its common shares. No directed selling efforts were made in the United States by the Registrant or any of its affiliates, or any person acting on their behalf and the securities were sold in an overseas directed offering. 3. The sale of securities was made in reliance upon an exemption from the registration provisions of the Securities Act set forth in Regulation S thereof with respect to offers and sales made outside the United States. The offer and sale was made in connection with the acquisition of an insurance brokerage located in Canada to the shareholders of the Canadian brokerage. The sale of the securities constituted an offshore transaction as defined by Rule 902 of Regulation S because at the time the offer and sale of the securities was made, the Registrant had a reasonable belief that each purchaser was resident in Canada. At the time of the offer and sale, the Registrant was a foreign private issuer and reasonably believed that there was no SUSMI in its common shares. No directed selling efforts were made in the United States by the Registrant or any of its affiliates, or any person acting on their behalf. 4. The sale of securities was made in reliance upon an exemption from the registration provisions of the Securities Act set forth in Regulation S thereof with respect to offers and sales made outside the United States. The offer and sale was made to employees of the Registrant resident in Canada, pursuant to an executive share purchase plan established and administered in accordance with Canadian laws and practices. At the time of the offer and sale, the Registrant was a foreign private issuer and reasonably believed that there was no SUSMI in its common shares. No directed selling efforts were made in the United States by the Registrant or any of its affiliates, or any person acting on their behalf in connection with the offer and sale of the securities. 5. The sale of the securities was made in reliance upon an exemption from the registration provisions of the Securities Act set forth in Rule 506 under the Securities Act and therefore deemed to be a transaction not involving any public offering within the meaning of Section 4(2) of the Securities Act. No underwriter was involved in the sale. There were no more than 35 purchasers of securities in the offering and each purchaser who was not an accredited investor as defined by Rule 501 of Regulation D, had such knowledge and experience in financial and business matters that he was capable of evaluating the merits and risks of the investment in the Registrant. Further, each purchaser represented his intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution of the securities. Appropriate legends were affixed to the certificates representing the securities issued in these transactions. 6. The sale of the securities was made in reliance upon an exemption from the registration provisions of the Securities Act set forth in Rule 701 thereof with respect to offers and sales of securities pursuant to certain compensatory benefit plans and contracts relating to compensation. The offer and sale of securities was made pursuant to a written executive share purchase plan established by the Registrant to a person who at that time was an employee of the Registrant and the Registrant was not then subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act. The employee was provided with a copy of the executive share purchase plan as well as all other information that the Registrant was required to provide the employee with under Rule 701. II-4 ITEM 1. EXHIBITS.
- --------------------------------------------------------------------------- EXHIBIT NUMBER DESCRIPTION OF EXHIBIT - --------------------------------------------------------------------------- 1.1+ -- Form of Underwriting Agreement. 3.1+ -- Articles of Incorporation of the Registrant. 3.2+ -- By-laws of the Registrant. 4.1+ -- Specimen Certificate representing Common Shares. 5.1+ -- Opinion of Torys LLP as to the legality of the Common Shares. 10.1+ -- Agreement and Plan of Merger between Hub International Limited, 416 Acquisition Inc. and Kaye Group Inc. dated January 19, 2001. 10.2+ -- Executive Share Purchase Plan. 10.3+ -- Employee Share Purchase Plan. 10.4+ -- Employment Agreement dated as of March 19, 2002 between Hub International Limited and Martin P. Hughes. 10.5+ -- Executive confidentiality, non-solicitation and insider agreement dated as of March 19, 2001 between Hub International Limited and its subsidiaries and Martin P. Hughes. 10.6+ -- Employment Agreement dated as of March 19, 2002 between Hub International Limited and Richard A. Gulliver. 10.7+ -- Executive confidentiality, non-solicitation and insider agreement dated as of March 19, 2001 between Hub International Limited and its subsidiaries and Richard A. Gulliver. 10.8+ -- Employment Agreement dated as of March 19, 2002 between Hub International Limited and Dennis J. Pauls. 10.9+ -- Executive confidentiality, non-solicitation and insider agreement dated as of March 19, 2001 between Hub International Limited and its subsidiaries and Dennis J. Pauls. 10.10+ -- Employment Agreement dated as of March 19, 2002 between Hub International Limited and W. Kirk James. 10.11+ -- Executive confidentiality, non-solicitation and insider agreement dated as of March 19, 2001 between Hub International Limited and its subsidiaries and W. Kirk James. 10.12+ -- Employment Agreement dated as of June 28, 2001 among Kaye Group Inc., Hub International Limited and Bruce D. Guthart. 10.13+ -- Employment Agreement dated as of January 1, 2002 among Barton Insurance Brokers Ltd., Hub International Limited and R. Craig Barton. 10.14+ -- Hub International Limited Equity Incentive Plan. 10.15+ -- Amended and Restated Credit Agreement dated as of June 21, 2001 between Hub International Limited and Bank of Montreal. 10.16+ -- Debenture dated as of June 28, 2001 between Hub International Limited and Royal Trust Corporation of Canada as Trustee for Zurich Insurance Company, as amended. 10.17+ -- Debenture dated as of June 28, 2001 between Hub International Limited and Odyssey Reinsurance Corporation. 10.18+ -- Debenture dated as of June 28, 2001 between Hub International Limited and United States Fire Insurance Company. 10.19+ -- Credit Agreement dated as of July 19, 2001, as amended, between Hub International Limited and Bank of America, N.A.
II-5
- --------------------------------------------------------------------------- EXHIBIT NUMBER DESCRIPTION OF EXHIBIT - --------------------------------------------------------------------------- 10.20+ -- Credit Agreement dated as of July 19, 2001, as amended, between Hub International Limited and LaSalle Bank National Association. 10.21 -- Stock Purchase Agreement dated as of December 31, 2001, as amended, between Kaye Group Inc. and Fairfax Inc. 10.22 -- Contingent Compensation Agreement dated as of May 30, 2002 between Fairfax Inc. and Program Brokerage Corporation. 10.23 -- Underwriting Services Agreement dated as of January 1, 2002 between Old Lyme Insurance Company of Rhode Island, Inc. and Program Brokerage Corporation. 10.24 -- Claims Services Agreement dated as of May 30, 2002 between Old Lyme Insurance Company of Rhode Island, Inc. and Claims Administration Corporation. 10.25 -- Administrative Services and Cost Allocation Agreement dated as of January 1, 2002 between Old Lyme Insurance Company of Rhode Island, Inc. and Kaye Group Inc. 21.1+ -- List of Registrant's subsidiaries. 23.1 -- Consent of PricewaterhouseCoopers LLP. 23.2+ -- Consent of PricewaterhouseCoopers LLP. 23.3+ -- Consent of Torys LLP (included in its opinion in Exhibit 5.1). 24.1+ -- Powers of Attorney. - ---------------------------------------------------------------------------
+ Previously filed. ITEM 2. UNDERTAKINGS. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions or otherwise, the Registrant has been advised that in the opinion of the SEC such indemnification is against public policy as expressed in the Securities Act of 1933 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, 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 whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. The undersigned 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 registration 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 registration statement as of the time it was declared effective. (2) For the purposes 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. The undersigned Registrant hereby undertakes to provide to the Underwriters at the closing specified in the Underwriting Agreement certificates in such denominations and registered in such name as required by the Underwriters to permit prompt delivery to each purchaser. II-6 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant certifies that it has duly caused this Amendment No. 3 to the Registration Statement on Form S-1 to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Chicago in the State of Illinois on June 13, 2002. Hub International Limited By: /s/ RICHARD D. GULLIVER -------------------------------------- Name: Richard D. Gulliver Title: President and Chief Operating Officer II-7 POWER OF ATTORNEY Pursuant to the requirements of the Securities Act of 1933, this Amendment No. 3 to the Registration Statement has been signed by the following persons in the capacities and on the date indicated.
SIGNATURE TITLE DATE --------- ----- ---- * Director and Principal Executive June 13, 2002 - ----------------------------------------------------- Officer Martin P. Hughes /s/ DENNIS J. PAULS Principal Financial and Accounting June 13, 2002 - ----------------------------------------------------- Officer Dennis J. Pauls /s/ RICHARD A. GULLIVER Director June 13, 2002 - ----------------------------------------------------- Richard A. Gulliver * Director June 13, 2002 - ----------------------------------------------------- R. Craig Barton * Director June 13, 2002 - ----------------------------------------------------- Anthony F. Griffiths * Director June 13, 2002 - ----------------------------------------------------- Bruce D. Guthart * Director June 13, 2002 - ----------------------------------------------------- Jean Martin * Director June 13, 2002 - ----------------------------------------------------- Paul Murray /s/ BRADLEY P. MARTIN Director June 13, 2002 - ----------------------------------------------------- Bradley P. Martin *By: /s/ RICHARD D. GULLIVER ----------------------------------------- Attorney-in-fact
II-8 AUTHORIZED REPRESENTATIVE Pursuant to the requirements of Section 6(a) of the Securities Act of 1933, the Authorized Representative has duly signed this Amendment No. 3 to the Registration Statement below on June 13, 2002. HUB U.S. HOLDINGS, INC. By: /s/ W. KIRK JAMES -------------------------------------- Name: W. Kirk James Title: Secretary II-9 INDEX OF EXHIBITS
- ------------------------------------------------------------------------------------------- EXHIBIT SEQUENTIALLY NUMBER DESCRIPTION OF EXHIBIT NUMBERED PAGES - ------------------------------------------------------------------------------------------- 1.1+ -- Form of Underwriting Agreement. 3.1+ -- Articles of Incorporation of the Registrant. 3.2+ -- By-laws of the Registrant. 4.1+ -- Specimen Certificate representing Common Shares. 5.1+ -- Opinion of Torys LLP as to the legality of the Common Shares. 10.1+ -- Agreement and Plan of Merger between Hub International Limited, 416 Acquisition Inc. and Kaye Group Inc. dated January 19, 2001. 10.2+ -- Executive Share Purchase Plan. 10.3+ -- Employee Share Purchase Plan. 10.4+ -- Employment Agreement dated as of March 19, 2002 between Hub International Limited and Martin P. Hughes. 10.5+ -- Executive confidentiality, non-solicitation and insider agreement dated as of March 19, 2001 between Hub International Limited and its subsidiaries and Martin P. Hughes. 10.6+ -- Employment Agreement dated as of March 19, 2002 between Hub International Limited and Richard A. Gulliver. 10.7+ -- Executive confidentiality, non-solicitation and insider agreement dated as of March 19, 2001 between Hub International Limited and its subsidiaries and Richard A. Gulliver. 10.8+ -- Employment Agreement dated as of March 19, 2002 between Hub International Limited and Dennis J. Pauls. 10.9+ -- Executive confidentiality, non-solicitation and insider agreement dated as of March 19, 2001 between Hub International Limited and its subsidiaries and Dennis J. Pauls. 10.10+ -- Employment Agreement dated as of March 19, 2002 between Hub International Limited and W. Kirk James. 10.11+ -- Executive confidentiality, non-solicitation and insider agreement dated as of March 19, 2001 between Hub International Limited and its subsidiaries and W. Kirk James. 10.12+ -- Employment Agreement dated as of June 28, 2001 among Kaye Group Inc., Hub International Limited and Bruce D. Guthart. 10.13+ -- Employment Agreement dated as of January 1, 2002 among Barton Insurance Brokers Ltd., Hub International Limited and R. Craig Barton. 10.14+ -- Hub International Limited Equity Incentive Plan. 10.15+ -- Amended and Restated Credit Agreement dated as of June 21, 2001 between Hub International Limited and Bank of Montreal. 10.16+ -- Debenture dated as of June 28, 2001 between Hub International Limited and Royal Trust Corporation of Canada as Trustee for Zurich Insurance Company, as amended.
II-10
- ------------------------------------------------------------------------------------------- EXHIBIT SEQUENTIALLY NUMBER DESCRIPTION OF EXHIBIT NUMBERED PAGES - ------------------------------------------------------------------------------------------- 10.17+ -- Debenture dated as of June 28, 2001 between Hub International Limited and Odyssey Reinsurance Corporation. 10.18+ -- Debenture dated as of June 28, 2001 between Hub International Limited and United States Fire Insurance Company. 10.19+ -- Credit Agreement dated as of July 19, 2001, as amended, between Hub International Limited and Bank of America, N.A. 10.20+ -- Credit Agreement dated as of July 19, 2001, as amended, between Hub International Limited and LaSalle Bank National Association. 10.21 -- Stock Purchase Agreement dated as of December 31, 2001, as amended, between Kaye Group Inc. and Fairfax Inc. 10.22 -- Contingent Compensation Agreement dated as of May 30, 2002 between Fairfax Inc. and Program Brokerage Corporation. 10.23 -- Underwriting Services Agreement dated as of January 1, 2002 between Old Lyme Insurance Company of Rhode Island, Inc. and Program Brokerage Corporation. 10.24 -- Claims Services Agreement dated as of May 30, 2002 between Old Lyme Insurance Company of Rhode Island, Inc. and Claims Administration Corporation. 10.25 -- Administrative Services and Cost Allocation Agreement dated as of January 1, 2002 between Old Lyme Insurance Company of Rhode Island, Inc. and Kaye Group Inc. 21.1+ -- List of Registrant's subsidiaries. 23.1 -- Consent of PricewaterhouseCoopers LLP. 23.2+ -- Consent of PricewaterhouseCoopers LLP. 23.3+ -- Consent of Torys LLP (included in its opinion in Exhibit 5.1). 24.1+ -- Powers of Attorney. - -------------------------------------------------------------------------------------------
+ Previously filed. II-11 EX-10.21 3 t07444a3exv10w21.txt STOCK PURCHASE AGREEMENT EXHIBIT 10.21 STOCK PURCHASE AGREEMENT By and Between Kaye Group Inc. and Fairfax Inc. Dated as of December 31, 2001 ================================================================================ TABLE OF CONTENTS
Page ---- ARTICLE I PURCHASE AND SALE......................................................................................1 SECTION 1.01. Purchase and Sale of the Shares.......................................................1 SECTION 1.02. Purchase Price........................................................................1 SECTION 1.03. Closing...............................................................................2 SECTION 1.04. Closing Deliveries by Seller..........................................................2 SECTION 1.05. Closing Deliveries by Purchaser.......................................................2 SECTION 1.06. Purchase Price Adjustment.............................................................2 SECTION 1.07 Reserve Analysis....................................................................... ARTICLE II REPRESENTATIONS AND WARRANTIES OF SELLER..............................................................3 SECTION 2.01. Organization, Authority and Qualification of Seller...................................3 SECTION 2.02. No Conflict; Required Filings and Consents............................................4 SECTION 2.03. Governmental Consents and Approvals...................................................4 SECTION 2.04. Brokers...............................................................................5 SECTION 2.05. Organization and Qualification........................................................5 SECTION 2.06. Company Certificate of Incorporation and By-Laws......................................5 SECTION 2.07. Company Capitalization................................................................5 SECTION 2.08. Company Permits; Compliance; Regulatory Matters.......................................6 SECTION 2.09. Company Financial Statements..........................................................7 SECTION 2.10. Reserves..............................................................................7 SECTION 2.11. Undisclosed Liabilities of the Companies..............................................8 SECTION 2.12. Absence of Certain Changes or Events With Respect to the Companies....................8 SECTION 2.13. Absence of Company Litigation.........................................................8 SECTION 2.14. Company Material Contracts............................................................9 SECTION 2.15. Taxes................................................................................11 SECTION 2.16. Business ............................................................................12 SECTION 2.17. Title to Insurance Business..........................................................13 SECTION 2.18. Absence of Restrictions on Conduct of Company Business...............................13 SECTION 2.19. Company Computer Systems.............................................................13 SECTION 2.20. No Downgrading of Rating of Companies................................................14 SECTION 2.21. Environmental Matters................................................................14 SECTION 2.22. Service Marks, Trademarks, Intellectual Property, etc................................15 SECTION 2.23. Assets...............................................................................16 SECTION 2.24. Tangible Property....................................................................16 SECTION 2.25. Real Property........................................................................17 SECTION 2.26 Leased Real Property.................................................................17 SECTION 2.27 Reinsurance and Retrocessions........................................................18 SECTION 2.28 Investments..........................................................................19 SECTION 2.29. Insurance............................................................................19 SECTION 2.30. Benefit Plans........................................................................20
Page ---- ARTICLE III REPRESENTATIONS AND WARRANTIES OF PURCHASER.........................................................22 SECTION 3.01. Organization and Qualification.......................................................22 SECTION 3.02. Authority Relative to This Agreement.................................................22 SECTION 3.03. No Conflict..........................................................................22 SECTION 3.04. Governmental Consents and Approvals..................................................23 SECTION 3.05. No Registration of Shares............................................................23 SECTION 3.06. Investment Knowledge and Experience..................................................23 SECTION 3.07. Investment Purpose...................................................................23 SECTION 3.08. No General Solicitation..............................................................23 SECTION 3.09. Brokers..............................................................................23 SECTION 3.10. Availability of Funds................................................................24 ARTICLE IV COVENANTS .....................................................................................24 SECTION 4.01. Conduct of Business..................................................................24 SECTION 4.02. Access to Information; Confidentiality...............................................26 SECTION 4.03. Commercially Reasonable Efforts......................................................26 SECTION 4.04. Consents, Approvals and Filings......................................................27 SECTION 4.05. Certain Notices......................................................................27 SECTION 4.06. Public Announcements.................................................................27 SECTION 4.07. Certain Intercompany Agreements and Accounts.........................................27 SECTION 4.08. Termination of Existing Security Interests...........................................28 SECTION 4.09. Post-Closing Cooperation.............................................................28 SECTION 4.10. Further Assurances...................................................................28 SECTION 4.11. Due Diligence........................................................................28 ARTICLE V ADDITIONAL AGREEMENTS.................................................................................29 SECTION 5.01. Confidentiality......................................................................29 SECTION 5.02. Expenses.............................................................................29 ARTICLE VI CONDITIONS TO CLOSING................................................................................29 SECTION 6.01. Conditions to the Obligations of Each Party..........................................29 SECTION 6.02. Conditions to the Obligations of Purchaser...........................................30 SECTION 6.03. Conditions to the Obligations of Seller..............................................31 ARTICLE VII TERMINATION, AMENDMENT AND WAIVER...................................................................31 SECTION 7.01. Termination..........................................................................31 SECTION 7.02. Effect of Termination; Non-Survival of Representations and Warranties................32 SECTION 7.03. Amendment............................................................................33 SECTION 7.04. Waiver...............................................................................33 ARTICLE VIII SURVIVAL OF REPRESENTATIONS AND WARRANTIES; TAX INDEMNIFICATION....................................33 SECTION 8.01. Survival of Representations and Warranties Generally.................................33 SECTION 8.02. Indemnity............................................................................33 SECTION 8.03. Returns and Payments.................................................................34 SECTION 8.04. Refunds..............................................................................35 SECTION 8.05. Contests.............................................................................35 SECTION 8.06. Time of Payment......................................................................36 SECTION 8.07. Cooperation and Exchange of Information..............................................37 SECTION 8.08. Conveyance Taxes.....................................................................37 SECTION 8.09. Miscellaneous........................................................................37
iii
Page ---- ARTICLE IX GENERAL PROVISIONS...................................................................................38 SECTION 9.01. Notices..............................................................................38 SECTION 9.02. Certain Definitions..................................................................38 SECTION 9.03. Severability.........................................................................43 SECTION 9.04. Assignment; Binding Effect; Benefit..................................................43 SECTION 9.05. Incorporation of Exhibits............................................................43 SECTION 9.06. Specific Performance.................................................................43 SECTION 9.07. Governing Law; Consent to Jurisdiction...............................................43 SECTION 9.08. Headings.............................................................................44 SECTION 9.09. Counterparts.........................................................................44 SECTION 9.10. No Third Party Beneficiaries.........................................................44 SECTION 9.11. Entire Agreement.....................................................................44
iv STOCK PURCHASE AGREEMENT (this "Agreement"), dated as of December 31, 2001, by and between Kaye Group Inc., a corporation organized under the laws of Delaware ("Seller"), and Fairfax Inc., a corporation organized under the laws of Wyoming ("Purchaser"). W I T N E S S E T H: WHEREAS, pursuant to and in accordance with the Agreement and Plan of Merger, dated as of January 19, 2001, by and among Seller, 416 Acquisition Inc., a Delaware corporation ("Merger Sub"), and Hub International Limited, an Ontario corporation, Merger Sub merged with and into Seller (the "Merger"); and WHEREAS, as a result of the Merger, Seller and Purchaser are affiliated companies that are each indirect subsidiaries of Fairfax Financial Holdings Limited; WHEREAS, Seller owns all of the issued and outstanding capital stock (the "Shares") of Old Lyme Insurance Company of Rhode Island, Inc., a Rhode Island-domiciled insurance company ("OLRI"), and of Old Lyme Insurance Company Ltd., a Bermuda-domiciled insurance company ("OLB"), and together with OLRI, referred to herein as the "Companies"); WHEREAS, Seller wishes to sell to Purchaser, and Purchaser wishes to purchase from Seller, the Shares, upon the terms and subject to the conditions set forth herein; and WHEREAS, certain capitalized terms used in this Agreement are defined in Section 9.02 of this Agreement. NOW, THEREFORE, in consideration of the foregoing and the mutual covenants and agreements herein contained, and intending to be legally bound hereby, Seller and Purchaser hereby agree as follows: ARTICLE I PURCHASE AND SALE SECTION 1.01. Purchase and Sale of the Shares. Upon the terms and subject to the conditions of this Agreement, at the Closing, Seller shall sell, assign, transfer, convey and deliver, or cause to be sold, assigned, transferred, conveyed and delivered, to Purchaser, the Shares, and Purchaser shall purchase the Shares free and clear of any Encumbrances. SECTION 1.02. Purchase Price. The purchase price for the Shares shall be an amount in cash equal to the combined GAAP shareholder's equity of OLRI and OLB as reflected on the audited GAAP financial statements of Seller as of December 31, 2001 (the "Purchase Price Balance Sheet") (such amount being the "Purchase Price"). The Seller shall deliver to Purchaser the Purchase Price Balance Sheet as soon as commercially reasonable after the completion of the Purchase Price Balance Sheet but in no event later than February 28, 2002. The Purchase Price will be increased by four per cent (4%) compounded annually from January 1, 2002 until the Closing Date, as such term is defined below. SECTION 1.03. Closing 1 . Upon the terms and subject to the conditions of this Agreement, the sale and purchase of the Shares contemplated by this Agreement shall take place at a closing (the "Closing") to be held at the offices of LeBoeuf, Lamb, Greene & MacRae, L.L.P., 125 West 55th Street, New York, New York 10019, or at such other location as the parties may agree, on a date specified by the parties hereto (the "Closing Date"), which shall be no later than the fifth business day after satisfaction or waiver of the conditions set forth in Article VI. SECTION 1.04. Closing Deliveries by Seller. At the Closing, Seller shall deliver or cause to be delivered to Purchaser: (i) stock certificates evidencing the Shares duly endorsed in blank, or accompanied by stock powers duly executed in blank, in form satisfactory to Purchaser and with all required stock transfer tax stamps affixed; (ii) a receipt for the Purchase Price; (iii) the certificates and other documents required to be delivered pursuant to Section 6.02; and (iv) resignations of the officers and directors of OLRI and OLB as requested by Purchaser. (v) the Purchase Price Balance Sheet. SECTION 1.05. Closing Deliveries by Purchaser. At the Closing, Purchaser shall deliver to Seller: (i) the Purchase Price by wire transfer in immediately available funds to the Purchase Price Bank Account; and (ii) the certificates and other documents required to be delivered pursuant to Section 6.02. SECTION 1.06. Purchase Price Adjustment. Following the Closing, the Purchase Price shall be adjusted as follows: (a) If Purchaser disagrees with the Purchase Price or any other line item set forth on the Purchase Price Balance Sheet, Purchaser shall notify Seller (the "Notice of Objection") on or before the date which is fifteen (15) days after the date on which Seller delivers to Purchaser the Purchase Price Balance Sheet, which shall be the audited balance sheet prepared as of December 31, 2001. Such Notice of Objection shall be in writing and shall state in reasonable detail the line item(s) disputed, the amount which is disputed and the basis for such dispute. Any line item, calculation or amount set forth in the Purchase Price Balance Sheet not objected to by Purchaser in writing within such fifteen (15) day period shall be conclusively deemed to have been accepted and agreed to by the party against whom enforcement will be sought. (b) Seller and Purchaser shall attempt to resolve any disagreements. If Purchaser and Seller are unable to resolve all such disagreements on or before the date which is 2 fifteen (15) days after the date a Notice of Objection is delivered, all (but not less than all) of such disputes and disagreements may be submitted by either party upon notice to the other party to a nationally recognized independent accounting firm (the "Independent Accounting Firm") for resolution by such firm. The Independent Accounting Firm shall resolve such disputes or disagreements and, based on such resolution, shall render a final and binding calculation or calculations. The Independent Accounting Firm shall be instructed to use every reasonable effort to perform its services within 10 business days of submission to it of any such dispute or disagreement and, in any case, as soon as practicable after such submission. The Independent Accounting Firm also shall be instructed to resolve all disputes consistent with the provisions of Section 1.06(a) above. SECTION 1.07. Reserve Analysis. The Purchase Price Balance Sheet shall specifically reflect liabilities associated with the events of September 11, 2001. Buyer shall cause a reserve analysis ("Reserve Analysis") to be completed as of year-end 2002 regarding the events of September 11, 2001, and the Purchase Price shall be adjusted to reflect any adverse development or redundancies as evidenced by the Reserve Analysis. If the Reserve Analysis reflects adverse development, the Seller shall pay to Purchaser such amount as equals such adverse development. If the Reserve Analysis reflects redundant reserves, the Purchaser shall pay to Seller such amount as equals the redundant reserves. ARTICLE II REPRESENTATIONS AND WARRANTIES OF SELLER Except as set forth in the disclosure schedule delivered by Seller to Purchaser concurrently with the execution of this Agreement (the "Seller Disclosure Schedule"), which provides an exception to, or otherwise qualifies in reasonable detail with specific Section references, the representations or warranties of Seller specifically referred to therein, Seller hereby represents and warrants to Purchaser that: SECTION 2.01. Organization, Authority and Qualification of Seller. Seller is a corporation duly organized and validly existing under the laws of Delaware and has all necessary power and authority to enter into this Agreement, to carry out its obligations hereunder and to consummate the transactions contemplated hereby. Seller is duly licensed or qualified to do business and is in good standing in each jurisdiction in which the properties owned or leased by it or the operation of its business makes such licensing or qualification necessary, except to the extent that the failure to be so licensed or qualified would not adversely affect (i) the ability of Seller to carry out its obligations under, and to consummate the transactions contemplated by, this Agreement and (ii) the ability of the Companies to conduct the Business. The execution and delivery of this Agreement by Seller, the performance by Seller of its obligations hereunder and the consummation by Seller of the transactions contemplated hereby have been duly authorized by all requisite action on the part of Seller. This Agreement has been duly executed and delivered by Seller, and (assuming due authorization, execution and delivery by Purchaser) this Agreement constitutes a legal, valid and binding obligation of Seller enforceable against Seller in accordance with its terms, subject to the effect of any applicable bankruptcy, reorganization, 3 insolvency, moratorium or similar laws affecting creditors' rights generally and subject, as to enforceability, to the effect of general principles of equity. SECTION 2.02. No Conflict; Required Filings and Consents. Assuming that all consents, approvals, authorizations and other actions described in Section 2.03 have been obtained and all filings and notifications listed in Section 2.03 of Seller Disclosure Schedule have been made, the execution, delivery and performance of this Agreement by Seller do not and will not (a) violate, conflict with or result in the breach of any provision of the charter or by-laws (or similar organizational documents) of Seller, (b) conflict with or violate any federal, national, state, provincial, municipal, local or any other law, statute, ordinance, rule, regulation, order, injunction, judgment or decree ("Law") or Order applicable to Seller or by which any property or asset of Seller is bound or affected, (c) except as set forth in Section 2.02(c) of Seller Disclosure Schedule, result in the creation of any Encumbrance on any of the Shares, or (d) result in any conflict with, breach or violation of, or default (or an event that, with notice or lapse of time or both, would constitute a default) under, require any consent or approval which has not been obtained with respect to, give rise to any right of termination, cancellation or acceleration of any obligations or loss of any benefit under, or result in the imposition of any liens on any of the properties or assets of the Companies or the creation or enforcement of any lien on any of the properties or assets of the Companies under any note, bond, mortgage, indenture, deed of trust, license, lease, contract, agreement or other instrument or obligation, permit, concession, franchise or license to which either of the Companies is a party or by which it or any of its properties or assets is bound, which conflict, breach, violation or default, or failure to obtain consent or approval, or right of termination, cancellation or acceleration or loss of benefit or imposition of any lien would reasonably be expected to have a Material Adverse Effect or which would interfere in any material way with the ability of Seller to consummate the transactions contemplated by this Agreement. SECTION 2.03. Governmental Consents and Approvals. Except (a) as described in Section 2.03 of Seller Disclosure Schedule and (b) the Insurance Filings, the execution, delivery and performance of this Agreement by Seller do not and will not require any consent, approval, authorization or other order of, action by, filing with or notification to any Governmental Entity. SECTION 2.04. Brokers. No broker, finder or investment banker is entitled to any brokerage, finder's or other fee or commission in connection with the transactions contemplated by this Agreement based upon arrangements made by or on behalf of Seller. SECTION 2.05. Organization and Qualification. (a) Each of the Companies is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation and has all requisite corporate power and authority and all necessary governmental approvals to own, lease and operate its properties and to carry on its Business as it is now being conducted. Each of the Companies is duly qualified or licensed as a foreign corporation or organization to do business, and is in good standing, in each jurisdiction where the character of the properties owned, leased or operated by it or the nature of its business makes such qualification or licensing necessary. (b) Except as set forth in Section 2.05(b) of Seller Disclosure Schedule, neither of the Companies directly or indirectly owns, or has outstanding contractual obligations to acquire, any equity or similar interest in, or any interest convertible into or exchangeable or 4 exercisable for any equity or similar interest in, any corporation, partnership, joint venture or other business association or entity. (c) Each of the Companies is an authorized insurer or is eligible as a surplus or excess lines insurer in each jurisdiction in which it presently writes insurance for the type of insurance it presently writes in such jurisdictions and meets in all material respects all statutory and regulatory requirements of all Governmental Entities which have jurisdiction over it to be an authorized or eligible surplus lines insurer. Section 2.05(c) of Seller Disclosure Schedule sets forth each jurisdiction in which the Companies are either an authorized or eligible surplus lines insurer. To Seller's knowledge or the knowledge of the Companies, there are no material adverse events that may adversely impact the ability of either of the Companies to continue to operate in any of the jurisdictions identified on Section 2.05(c) of Seller Disclosure Schedule. SECTION 2.06. Company Certificate of Incorporation and By-Laws. Seller has heretofore made available to Purchaser a complete and correct copy of the certificate of incorporation and the by-laws (or other comparable organizational documents), each as amended to date, of each of the Companies. Such certificates of incorporation and by-laws (or other comparable organizational documents) are in full force and effect. Neither of the Companies is in violation of any of the provisions of its certificate of incorporation or by-laws (or other comparable organizational documents). True and complete copies of all minute books of each of the Companies have been made available by Seller to Purchaser. SECTION 2.07. Company Capitalization. (a) The authorized capital stock of OLRI consists of (i) 10,000,000 shares of common stock, par value $14.50 per share ("OLRI Common Stock") and (ii) 100,000 shares of Preferred Stock, par value $1.00 per share ("OLRI Preferred Stock"). As of the date hereof, 200,000 shares of OLRI Common Stock were issued and outstanding and 100,000 shares of OLRI Preferred Stock were issued and outstanding. All of the issued and outstanding shares of OLRI Common Stock and OLRI Preferred Stock are validly issued, fully paid and nonassessable and are held by Seller, free and clear of all security interests, liens, claims, pledges, options, rights of first refusal, agreements, limitations on OLRI's voting rights, charges and other encumbrances of any nature whatsoever. (b) The authorized capital stock of OLB consists of 100,000 shares of common stock, par value $1.20 per share ("OLB Common Stock"). As of the date hereof, 100,000 shares of OLB Common Stock were issued and outstanding. All of the issued and outstanding shares of OLB Common Stock are validly issued, fully paid and nonassessable and are owned beneficially and of record by Seller, free and clear of all security interests, liens, claims, pledges, options, rights of first refusal, agreements, limitations OLB's voting rights, charges and other encumbrances of any nature whatsoever. (c) As of the Closing, there are no issued or outstanding bonds, debentures, notes, convertible notes or other indebtedness of either Company having the right to vote on any matters on which stockholders of such Company may vote. There are no options, warrants or other rights, agreements, arrangements or commitments of any character relating to the issued or unissued stock of either of the Companies or conditionally or absolutely obligating either of the Companies to issue or sell any shares of stock of, or other equity interests in, the Companies. Neither of the Companies have outstanding obligations (whether conditional or absolute) to repurchase, redeem or otherwise acquire any shares of capital stock or other equity interests of the Companies. 5 SECTION 2.08. Company Permits; Compliance; Regulatory Matters.(a) Except as disclosed in Section 2.08(a) of Seller Disclosure Schedule, each of the Companies is in possession of all franchises, grants, authorizations, licenses, permits, easements, variances, exceptions, consents, certificates, approvals and orders of any Governmental Entity necessary for each of the Companies to own, lease and operate its properties or to carry on its Business as it is now being conducted (the "Company Permits") except where the failure to obtain any such Company Permits, would not, individually or in the aggregate, have a Material Adverse Effect. As of the date hereof, no suspension or cancellation of any of the Company Permits is pending or, to the knowledge of Seller, threatened. (b) Except as disclosed in Section 2.08(b) of Seller Disclosure Schedule, neither of the Companies is in conflict with, or in default or violation of, (i) any Law applicable to the Companies or by which any property or asset of the Companies is bound or affected, (ii) any note, bond, mortgage, indenture, contract, agreement, lease, license, permit, franchise or other instrument or obligation to which the Companies is a party or by which the Companies or any property or asset of the Companies is bound or affected or (iii) any Company Permit. (c) All insurance policies issued by the Companies, which are required to be filed with or approved by insurance regulatory authorities have been so filed or approved, or have been filed and not objected to (or such objection has been withdrawn or resolved) by such authorities within the period provided for objection, and all policies have been issued in the forms approved. All premium rates established by the Companies that are required to be filed with or approved by insurance regulatory authorities have been so filed or approved, the premiums charged conform to the premiums so filed or approved and comply (or complied at the relevant time) with the insurance laws applicable thereto. Except as disclosed in Section 2.08(C) of the Seller Disclosure Schedule, all material reports, statements, documents, registrations, filings and submissions to insurance regulatory authorities have been made and complied in all material respects with applicable law in effect when filed. No material deficiencies have been asserted by any such regulatory authority with respect to such reports, statements, documents, registrations, filings or submissions that have not been satisfied. (d) Section 2.08(d) of the Seller Disclosure Schedule provides a complete and accurate list of any and all pending complaints, deficiency or delinquency notices or other similar documents, notices or correspondence of any kind provided to Seller, either of the Companies or any of their respective affiliates by any regulatory authority. SECTION 2.09. Company Financial Statements. (a) True and complete copies of the audited statutory financial statements of each of the Companies as of December 31, 2001 and for the year ended December 31, 2000, together with all related notes and schedules thereto, and the unaudited statutory financial statements of the Companies as of September 30, 2001 and for the period then ended (the "Company Financial Statements") are attached as Section 2.09(a) of Seller Disclosure Schedule. The Company Financial Statements were prepared in conformity with the statutory accounting practices prescribed or permitted by the state or jurisdiction of domicile for each the Companies applied on a consistent basis throughout the periods indicated, and each presents fairly, in all material respects, the financial position of the Company to which it relates as at the respective dates thereof and for the respective periods indicated therein, except as otherwise noted therein. 6 (b) Except as disclosed in Section 2.09(b) of Seller Disclosure Schedule, the Companies have good and marketable title to all real and personal property reported on the Company Financial Statements, free and clear of all liens, other than liens or defects in title that do not materially detract from the values of such property or materially interfere with the present uses thereof. (c) Except as disclosed on Section 2.09(d) of Seller Disclosure Schedule, the Companies have not issued a notice of non-renewal for any Program since January 1, 2001. (d) Except as disclosed on Section 2.09(e) of the Seller Disclosure Schedule, the Companies have no knowledge of any actual or threatened cancellation by a third party of any fronting or reinsurance arrangement in which either of the Companies participate. SECTION 2.10. Reserves. Except as set forth in Section 2.10 of Seller Disclosure Schedule, Seller has delivered to Purchaser true and complete copies of all actuarial reports prepared by an unaffiliated third party since December 31, 1998 on behalf and at the request of either Seller or the Companies relating to the loss and loss adjustment expense reserves of the Companies. The reserves for losses and loss adjustment expenses of the Companies are adequate or sufficient, and such reserves were determined in accordance with the appropriate actuarial, statutory or other applicable standards. All reinsurance recoverables of the Companies as reported in the Company Financial Statements are fully collectible. SECTION 2.11. Undisclosed Liabilities of the Companies. Except for those liabilities that are disclosed in Section 2.11 of Seller Disclosure Schedule or are fully reflected or reserved against on the Company Balance Sheets, neither of the Companies has outstanding any liability or obligation of any nature whatsoever (whether absolute, accrued, contingent or otherwise and whether due or to become due), except for liabilities and obligations that have been incurred since the date of the Company Balance Sheets in the ordinary course of business and that could not, individually or in the aggregate, have a Material Adverse Effect. SECTION 2.12. Absence of Certain Changes or Events With Respect to the Companies. From June 30, 2001 through the date hereof, except as set forth in Section 2.12 of Seller Disclosure Schedule, (a) each of the Companies has conducted its Business only in the ordinary course, (b) there has not been any circumstance, event, occurrence, change or effect that could reasonably be expected, individually or in the aggregate, to have a Material Adverse Effect and (c) neither of the Companies has taken or permitted any action that if taken or permitted after the date hereof would constitute a breach of any of the covenants set forth in Article IV. SECTION 2.13. Absence of Company Litigation. Except as specifically disclosed in Section 2.13 of Seller Disclosure Schedule and except for claims under policies in the ordinary course, there is no litigation, suit, claim, action, proceeding or investigation (an "Action") pending, or to the knowledge of Seller or the Companies, threatened, against the Companies, or against any property or asset of the Companies, before any court, arbitrator or Governmental Entity, domestic or foreign which Seller reasonably believes, individually or in the aggregate, would be reasonably likely to result in liability of either of the Companies in amounts in excess of $50,000 or since January 1, 2000, which have been settled for an amount in excess of $5,000 and with respect to which the Companies have not been reimbursed or otherwise indemnified. Except as specifically disclosed in Section 2.13 of Seller Disclosure Schedule, neither of the Companies nor any property or asset of either of the Companies is 7 subject to any continuing order of, consent decree, settlement agreement or similar written agreement with, or, to the knowledge of Seller, continuing investigation by, any Governmental Entity, or any order, writ, judgment, injunction, decree, determination or award of any Governmental Entity. Except as specifically disclosed in Section 2.13 of Seller Disclosure Schedule, neither of the Companies has paid or settled any policy claim in excess of policy limits for the period of time from January 1, 1996 through the date hereof. SECTION 2.14. Company Material Contracts. (a) Subsections (i) through (xvi) of Section 2.14 of Seller Disclosure Schedule contain a list of the following types of contracts and agreements, including contracts of insurance or reinsurance, to which either of the Companies is a party (such contracts, agreements and arrangements as are required to be set forth in Section 2.14 of Seller Disclosure Schedule being the "Company Material Contracts"): (i) each contract and agreement which (A) has or is likely to involve consideration of more than $50,000, in the aggregate, during one or more of the calendar years ending December 31, 2001 or 2002 or (B) is likely to involve consideration of more than $50,000, in the aggregate, over the remaining term of such contract, and which, in either case, cannot be canceled by either of the Companies without penalty or further payment and without more than 90 days' notice; (ii) all broker, distributor, dealer, manufacturer's representative, franchise, agency, sales promotion, market research, marketing consulting and advertising contracts and agreements to which either of the Companies is a party; (iii) all management contracts (excluding contracts for employment) and contracts with other consultants which has or is likely to involve consideration of more than $50,000, including any contracts involving the payment of royalties or other amounts calculated based upon the revenues or income of each of the Companies or income or revenues related to any product of either of the Companies to which either of the Companies is a party; (iv) all contracts and agreements evidencing indebtedness for borrowed money; (v) all contracts and agreements with any Governmental Entity to which either of the Companies is a party; (vi) all contracts and agreements that limit, or purport to limit, the ability of either of the Companies to compete in any line of business or with any person or entity or in any geographic area or during any period of time; (vii) all contracts, agreements, commitments and instruments that obligate either of the Companies to make any payments or issue or pay in excess of $50,000 to any employee or consultant or make any payments or issue or pay anything of value to any affiliate, director or officer; (viii) all material contracts or arrangements that result in any person or entity holding a power of attorney from either of the Companies that relates to either of the Companies or their respective Business; 8 (ix) all contracts, agreements, commitments and instruments relating to any obligation to engage in a merger, consolidation, business combination, share exchange or business acquisition, or for the purchase or sale of any assets of either of the Companies other than in the ordinary course of business consistent with past practice; (x) all contracts, agreements, commitments and instruments that include any indemnification, contribution or support obligations in an amount which would reasonably be expected to exceed $50,000 or which in the aggregate would reasonably be expected to exceed $50,000; (xi) all contracts, agreements, commitments and instruments that obligate capital expenditures involving total payments of more than $50,000; (xii) all contracts, agreements, commitments and instruments that obligate either of the Companies to issue or sell any capital stock; (xiii) all contracts that contain a change of control provision; (xiv) all employment agreements and agreements providing for the payment of any type of a bonus to a current employee of either of the Companies; (xv) all contracts, agreements, commitments and instruments between any of the Seller, the Companies or any Company Subsidiary, on the one hand, and any officer, director or employee, or, to the best of the Seller's knowledge, immediate family member of any such officer, director or employee, on the other, including, without limitation, such contracts, agreements, commitments and instruments (i) providing for the furnishing of material services by, (ii) providing for the rental of material real or personal property from; or (iii) otherwise requiring material payments to (other than for services as officers, directors or employees of the Seller, Company or Company Subsidiary) any such Person; and (xvi) all other contracts and agreements, whether or not made in the ordinary course of business, which are material to either of the Companies or the conduct of their respective Businesses, or the absence of which would, individually or in the aggregate, have a Material Adverse Effect. (b) Except as would not, individually or in the aggregate, have a Material Adverse Effect and except as set forth in Section 2.14(b) of the Disclosure Schedule, (i) each Company Material Contract is a legal, valid and binding agreement in full force and effect, and none of the Company Material Contracts is in default by its terms or has been canceled by the other party and no event has occurred that with notice or lapse of time or both would constitute a default, (ii) to Seller's knowledge or the knowledge of either of the Companies, no other party is in breach or violation of, or default (where applicable) under, any Company Material Contract; (iii) neither of the Companies is in receipt of any claim of default (where applicable) under any such agreement; and (iv) neither the execution of this Agreement nor the consummation of the acquisition of the Shares pursuant hereto or any other transaction contemplated herein shall constitute default, give rise to cancellation rights or change of control rights or otherwise adversely affect any of either of the Companies" rights under any Company Material Contract. 9 Seller has furnished or made available to Purchaser true and complete copies of all Company Material Contracts, including any amendments thereto. SECTION 2.15. Taxes. (a) The Companies and each Company Subsidiary have: (i) timely filed true and correct versions of all United States federal, state, local and non-United States Tax returns and reports due and/or required to be filed by them (including any consolidated or unitary return filed by Seller that includes the Companies and/or each Company Subsidiary on a consolidated or combined basis); (ii) timely paid or accurately accrued all Taxes due and/or required to be paid, other than such Taxes, returns or reports as are being contested in good faith by appropriate proceedings; (iii) not been formally or informally contacted by United States (federal, state or local) or non-United States Governmental Entity which have asserted in writing or threatened to assert in writing against either of the Companies, any Company Subsidiary, or any other corporation included in the filing of a consolidated or combined Tax return which included the Companies or Company Subsidiary (together or individually), any deficiencies or claim for any Taxes or interest thereon or penalties in connection therewith; (iv) not granted any waiver of any statute of limitations with respect to, or any extension of a period for the assessment of any Tax; (v) provided for accruals and reserves for Taxes, as reflected in the Pre-Closing Balance Sheet and Closing Date Balance Sheet, that are adequate to cover all Taxes accruable through such date (including interest and penalties, if any, thereon) in accordance with GAAP; (vi) no Tax liens upon any property or assets except liens for current Taxes not yet due; and (vii) not been required to include in income any adjustment pursuant to Section 481 of the Code by reason of a voluntary change in accounting method initiated by either of the Companies, and the Internal Revenue Service (the "IRS") has not initiated or proposed any such adjustment or change in accounting method, in either case which adjustment or change would have a Material Adverse Effect. In addition, (i) neither Seller nor any Company Subsidiary or affiliate of Seller is a party to any agreement or arrangement that would result, separately or in the aggregate, in the payment of any "excess parachute payments" within the meaning of Section 280G of the Code; (ii) no acceleration of the vesting schedule for any property that is substantially unvested within the meaning of the Regulations under Section 83 of the Code will occur in connection with the transactions contemplated by this Agreement; (iii) from and after June 28, 2001, OLRI has been and other than being part of the consolidated return of Kaye Group Inc. until June 28, 2001, continues to be a member of an affiliated group (within the meaning of Section 1504(a)(1) of the Code) for which Seller joins in a consolidated return with Hub US Holdings Inc. as the common parent, and has not been includible in any other consolidated return for any taxable period for which the statute of limitations has not expired; (iv) neither of the Companies nor Company Subsidiary has been at any time a member of any partnership or joint venture or the holder of a beneficial interest in any trust for any period for which the statute of limitations for any Tax has not expired; (v) OLRI has not been a United States real property holding corporation within the meaning of Section 897(c)(2) of the Code during the applicable period specified in Section 897(c)(1)(A)(ii) of the Code; (vi) neither of the Companies nor the Company Subsidiary is subject to any accumulated earnings tax penalty or personal holding company tax, including the foreign personal holding company tax; (vii) any tax sharing or tax allocation agreement between the Companies (individually or collectively) and/or each Company Subsidiary and any other Person shall terminate or be terminated prior to the Closing Date; and (viii) all transactions between and among Seller, the Companies and each Company Subsidiary, or with any other affiliated Persons have satisfied the arm's length transaction standard for all United States and non-United States Tax purposes. 10 (b) Except as disclosed with reasonable specificity in Section 2.15(b) of Seller Disclosure Schedule: (i) neither of the Companies nor the Company Subsidiary, has when applicable (A) had to have an amount includible in its income for the current taxable year under Section 951 of the Code, (B) been a passive foreign investment company within the meaning of Section 1296 of the Code, (C) an unrecaptured overall foreign loss within the meaning of Section 904(f) of the Code or (D) participated in or cooperated with an international boycott within the meaning of Section 999 of the Code; (ii) neither of the Companies or the Company Subsidiary has any income reportable for a period ending after the Closing Date but attributable to a transaction (e.g., an installment sale) occurring in or a change in accounting method made for a period ending on or prior to the Closing Date which resulted in a deferred reporting of income from such transaction or from such change in accounting method (other than a deferred intercompany transaction), and (iii) no power of attorney that is currently in force has been granted with respect to any matter relating to Taxes that could affect the Company or a Company Subsidiary. SECTION 2.16. Business. (a) Section 2.16(a) of the Seller Disclosure Schedule sets forth a complete and accurate list, as of the date hereof, of all programs with respect to which either of the Companies issued at any time a policy of insurance or reinsurance or otherwise assumed any risk (the "Program Business"), in each case setting forth the inception date of such program, the coverage provided by the Company and, with respect to any Program Business that is in force or with respect to which program all or any portion of the risk under such program remains unliquidated or undischarged, the next renewal date. Except as disclosed on Section 2.16(a) of the Seller Disclosure Schedule as of the date hereof, other than in respect of the Program Business, neither Company has issued any policy of insurance or reinsurance or otherwise assumed any risk, whether on a direct or assumed basis, including, but not limited to, any environmental, asbestos, lead or other long tail casualty risks. (b) Section 2.16(b) of the Seller Disclosure Schedule sets forth a complete and accurate list of all contracts, agreements, commitments or instruments (copies of which have been provided to Purchaser prior to the date hereof) which relate to the Program Business to which either of the Companies is or was a party or to which Seller or any of its affiliates is or was a party which relate to the Program Business, including without limitation, (i) managing general agent or similar agreements; (ii) profit sharing agreements; (iii) commission agreements; (iv) business sharing agreements or other similar agreements between Seller and its affiliates and any other broker or wholesaler who produces business in connection with the Program Business; (v) reinsurance agreements; (vi) fronting agreements; (vii) claims management agreements; and (viii) any other material agreements, commitments or instruments relating to the Program Business. (c) Section 2.16(c) of the Seller Disclosure Schedule contains a complete and accurate list of all policy forms for the Program Business, copies of which have been provided to Purchaser prior to the date hereof. (d) Section 2.16(d) of the Seller Disclosure Schedule contains a complete and accurate list of all documents (copies of which have been provided to Purchaser prior to the date hereof) relating to such groups as risk purchasing groups, risk retention groups and other similar groups with respect to which either of the Companies underwrote risks, including, without limitation, all filings, contracts, manuals, policy forms, master policies and other similar documents. 11 (e) Section 2.16(e) of the Seller Disclosure Schedule contains a complete and accurate list of (i) all changes in the terms and conditions of the Program Business and (ii) all arrangements between Seller and/or its affiliates, on the one hand, and the Companies or any other parties involved in the Program Business or servicing the Program Business, on the other hand, in each case since December 31, 2000. (f) Section 2.16(f) of the Seller Disclosure Schedule contains a complete and accurate list of all correspondence or communication (copies or, if such communication was delivered orally, written summaries, of which have been provided to Purchaser prior to the date hereof) from insureds, insurers, reinsurers and intermediaries with respect to renewals of existing, in-force Program Business, including without limitation, communications relating to cancellations of programs or policies issued thereunder or changes in material terms and conditions of any such programs or policies. (g) With respect to any services provided by Seller or any of its affiliates or Ivy S. Fischer, Esq. and Fischer Fiden & Norris, LLP, except as disclosed on Schedule 2.16(g) of the Seller Disclosure Schedule, no (i) fronting or issuing insurance company, (ii) reinsurer of any such company, (iii) reinsurer of either of the Companies, (iv) other risk bearing entity, or (v) representative of any of the above, has raised any issue or dispute or made any complaint or criticism of Seller or any such affiliate, orally or in writing, relating to (A) disclosure with respect to a program, (B) claims handling or reserving practices, late notice or other claims practices, (C) any charges or billing practices, (D) any underwriting practices or violation of underwriting guidelines or pricing or binding rules or requirements. Seller has provided Purchaser with copies of any such written complaint, criticism, issue or dispute (including litigation documents arising therefrom or relating thereto) and has provided Purchaser with written descriptions of any such complaints, criticisms, issues or disputes that were made orally or other than in written form. SECTION 2.17. Title to Insurance Business. Except as set forth on Section 2.17 of Seller Disclosure Schedule, no employee or producer of the Companies nor any other person, has any claim, right, title or interest in or to the book of insurance business serviced by the Companies. SECTION 2.18. Absence of Restrictions on Conduct of Company Business. Other than ordinary course regulatory restrictions, no oral or written contract, license or permit restricts the ability of the Companies to own, possess or use its assets or conduct its Business or operations in any geographic area or restricts in any way the full participation of any employees, producers or agents of the Companies in the operation of such Business. SECTION 2.19. Company Computer Systems. Other than in respect of ordinary course maintenance and repairs, the Computer Systems owned or used by or on behalf of each of the Companies are operational and Seller, the Companies and/or its affiliates maintain valid licenses to continue to process the Business as contemplated by the Services Agreements. SECTION 2.20. No Downgrading of Rating of Companies. As of the date hereof, there has not occurred any downgrading, nor to either of the Companies does there exist any pending or overtly threatened downgrading, of either of the Companies' rating by A.M. Best Company or Standard & Poor's Corporation. 12 SECTION 2.21. Environmental Matters. (a) There are not any past or present conditions or circumstances that could reasonably be expected to limit, interfere with or prevent the conduct of the Business of the Companies in compliance with: (i) law (including common law principles) , ordinance, governmental rule, regulation, order, consent decree, or binding administrative or judicial interpretation thereof, related to human health or the environment ("Environmental Law"), or (ii) the terms or conditions of any permits, approvals, licenses, authorizations, registrations or consents required to be issued by any Governmental Entity pursuant to any applicable Environmental Law; (b) There are not any past or present conditions or circumstances at, arising out of, or related to, any current or former Business, assets or properties of the Companies, including but not limited to on-site or off-site storage, treatment, disposal or the release or threatened release of any hazardous toxic materials, wastes or substances, pollutants or contaminants, which could, individually or in the aggregate, reasonably be expected to give rise to: (i) liabilities or obligations for any investigation, removal or cleanup, remediation, disposal or corrective action or any long-term monitoring requirements under any Environmental Law, or (ii) claims arising for personal injury, property damage, or damage to natural resources; (c) Neither of the Companies has (i) received any notice of noncompliance with, violation of, or liability or potential liability under any Environmental Law or (ii) entered into any consent decree, settlement or order or is subject to any order of any court or Governmental Entity or tribunal under any Environmental Law or relating to the cleanup of any hazardous or toxic materials, wastes, substances or any pollutants or contamination; (d) There are no persons or entities whose liability, for any environmental matters or under any applicable Environmental Law, the Companies have retained or assumed contractually or have retained or assumed by operation of law; (e) Neither of the Companies has handled or directed the management of or participated in any decisions with respect to or exercised any influence or control over the use, generation, storage, treatment or disposal of any hazardous or toxic materials, wastes or substances at or related to any of their Business, assets or properties; and (f) Seller has made available to Purchaser copies of all environmental inspections, audits, studies, plans, records, data analyses or reports conducted or prepared by or on behalf of the Companies and which are in their possession or control. SECTION 2.22. Service Marks, Trademarks, Intellectual Property, etc. (a) Section 2.22 of Seller Disclosure Schedule sets forth true, complete and correct lists (including the current status of any registrations) of all foreign and domestic: patents, trademarks, service marks, trade names, corporate and assumed names, design rights, copyrights and applications therefor, trade secrets, rights in know-how and other intangible and intellectual property rights of any kind that are material to the Business or operation of the Companies, in each case whether registered or unregistered and including applications for the grant of any of the foregoing and all rights or forms of protection having equivalent or similar effect to any of the foregoing which may subsist anywhere in the world (each, an "Intellectual Property Right"), in each case stating: (i) any geographical limitations that may be applicable to the same; (ii) any the term for which such Intellectual Property Right is so owned or licensed; and (iii) for all software and other tangible property listed, the location of each such Intellectual Property Right. 13 (b) Except as set forth on Section 2.22 of Seller Disclosure Schedule, (i) either of the Companies is the sole legal and beneficial owner, or has a valid and effective license or otherwise has the right to use, all of the Intellectual Property Rights, free and clear of any encumbrances or restrictions thereon; (ii) either of the Companies has the right to use, free and clear of any royalty or other payment obligations, claims of infringement or liens, all Intellectual Property Rights that are material to the conduct of its ongoing Businesses; (iii) either of the Companies has taken all reasonable measures to protect and preserve the security, confidentiality and value of its Intellectual Property Rights, including trade secrets and other confidential information. (c) With respect to trade secrets and other confidential information set forth on Schedule 2.22 of Seller Disclosure Schedule, and except as otherwise set forth on such Schedule, all such trade secrets and other confidential information of the Companies are presently valuable and protectable and are not part of the public domain or knowledge, nor have they been used, divulged or appropriated for the benefit of any person or entity other than the Companies or otherwise to the detriment of the Companies and no employee or consultant of the Companies has used any trade secrets or other confidential information of any other third party or entity in the course of his work for the Companies, and all employees or consultants of the Companies with knowledge of trade secrets or confidential information of the Companies have signed confidentiality agreements with the Companies and have signed employment agreements preserving the trade secret or confidential information as exclusive property of the Companies. (d) With respect to the software set forth on Schedule 2.22 of Seller Disclosure Schedule, and except as otherwise set forth on such Schedule, the Companies have a valid and effective copyright or license or otherwise have the right to use (free and clear of any royalty or other payment obligations, claims of infringement or liens), all of such software and the Companies hold valid maintenance agreements with those that are the licensors of such software. The Companies have made all material payments and performed all of their other material obligations and covenants in connection therewith and the representations and warranties of the Companies to the licensors and sublicensors thereof were materially true and correct when made. With respect to all Intellectual Property Rights marketed or sold by the Companies that use third party products for their operation, the Companies are fully capable of using, selling, or otherwise transferring such Intellectual Property Rights that make use of such third party rights and have the right to license customers such ability to use that third party product. No patent, invention, devise, principle or any statute, law, rule, regulation, standard or code is pending or proposed that would restrict the Companies' ability to use any of the Intellectual Property Rights. (e) Except as set forth on Schedule 2.22 of Seller Disclosure Schedule, (i) the Companies have not been charged and have not received any claim or charge (written or oral), and the Companies are not aware of any facts that would lead to a claim or charge being made, with respect to the infringement (whether in the past or as an ongoing matter) of any Intellectual Property Rights owned or used by the Companies,; and (ii) the Companies have not made improper use of third-party confidential information. No act has been done or omitted to be done, and no event has occurred or is reasonably likely to occur, that may render any of the Intellectual Property Rights subject to revocation, compulsory license, cancellation or amendment or may prevent the grant or registration of a valid intellectual property right pursuant to a pending application or impair its value to the buyer. No person other than the Companies 14 use any of the service marks listed on Schedule 2.22 of Seller Disclosure Schedule and no person has disputed the right of the Companies to use without restriction any such service marks. No Intellectual Property Rights owned or used by the Companies and no use by or license for use granted to the Companies will be lost, or rendered liable to any right of termination by any persons, by reason of the transactions contemplated by this Agreement and these rights will not be affected by transfer of ownership of rights by this buyer. (f) All the records and systems (including computer systems) and all data and information of the Companies are recorded, stored, maintained or operated or otherwise held by the Companies free from any liens or encumbrances, and all data and information of the Companies recorded, stored, maintained or processed by them is recorded, stored, maintained or processed in accordance with all applicable laws relating thereto. SECTION 2.23. Assets. Except as set forth on Section 2.23 of the Seller Disclosure Schedule, each of the Companies and each Company Subsidiary owns (or leases in the case of leased assets), and has good and marketable title to (or, in the case of leased assets, valid leasehold interests in), all of the material assets necessary for the operation of its business as now operated. None of such assets is subject to any Encumbrance, except for Encumbrances which in the aggregate do not materially detract from the value of the asset subject thereto or interfere with the present use of such asset. SECTION 2.24. Tangible Property. Section 2.24 of Seller Disclosure Schedule sets forth all interests owned or claimed by the Companies and each Company Subsidiary (including, without limitation, options) as of December 31, 2001 in or to the equipment, furniture, leasehold improvements, fixtures, vehicles, structures, any related capitalized items and other tangible property which are treated by either of the Companies or any Company Subsidiary as depreciable or amortizable property and are ascribed a value on the books of the applicable Company or Company Subsidiary in excess of $5,000 (collectively, the "Tangible Property"). The Tangible Property is in good operating condition and repair, ordinary wear and tear excepted, and none of the Companies or any Company Subsidiary has received written notice that any of the Tangible Property is in violation of any existing statute, law, or any health, safety or other ordinance, code or regulation. The Tangible Property is owned by the Companies and each Company Subsidiary free and clear of any Encumbrance. SECTION 2.25. Real Property. Except as set forth in Section 2.25 of Seller Disclosure Schedule, neither of the Companies or any Company Subsidiary owns any land, buildings or other interests of any kind in any real property (regardless of where located). Section 2.25 of Seller Disclosure Schedule includes a list and description of all such real property owned by the Companies and each Company Subsidiary. Such real property is owned by the applicable Company or Company Subsidiary free and clear of any Encumbrance, except for liens for current taxes not yet due and payable or which do not materially detract from the value thereof or the use to which such property is presently subject. Section 2.25 of Seller Disclosure Schedule also includes a list of all leases of equipment to which either of the Companies or any Company Subsidiary is a party that obligate the such Company or Company Subsidiary to expend more than $25,000 during any fiscal year. Neither of the Companies nor Company Subsidiary nor, to the knowledge of Seller, any other party, is in default of a material provision under such leases, nor has any notice of default with respect to such leases been received. 15 SECTION 2.26. Leased Real Property. (a) Section 2.26(a) of Seller Disclosure Schedule includes a list of all real property leased by either of the Companies or any Company Subsidiary (the "Leased Real Property"). All leases currently in effect relating to the Leased Real Property, together with all amendments and modifications thereto (the "Leases"), are listed on Section 2.26 of Seller Disclosure Schedule. (b) Except as described on Section 2.26(b) of Seller Disclosure Schedule, neither of the Companies nor any Company Subsidiary is in default under any of the material terms and provisions of any of the Leases or has received any written notice of any default. (c) To the knowledge of Seller, there are no outstanding defaults on the part of the landlord or lessor of a material provision under any Lease. (d) Except as set forth on Section 2.26(d) of Seller Disclosure Schedule, neither of the Companies nor any Company Subsidiary has exercised any option to extend the term of any Lease or to terminate any Lease, except to the extent that such extension or termination has already come into effect. (e) Except as described on Section 2.26(e) of Seller Disclosure Schedule, neither of the Companies nor any Company Subsidiary has entered into any subleases relating to the Leased Real Property or granted any licenses or occupancy rights with respect to the Leased Real Property. (f) Neither of the Companies nor any Company Subsidiary has granted or created any Encumbrances on the Leased Real Property, including, without limitation, leasehold mortgages of the Leased Real Property. (g) The use and occupancy of the Leased Real Property by either of the Companies or any Company Subsidiary is in compliance with all Laws, including, without limitation, those governing zoning, subdivision, land development access, erosion and drainage control, sewage collection and disposal, use, occupancy, building, fire, safety, access and environmental matters. None of Seller, any Company or any Company Subsidiary has received any written notice from any Governmental Entity advising of a violation of any applicable building code, zoning, subdivision, land development or land use laws, regulations or ordinances or any other applicable local, state or federal laws, regulations or ordinances. (h) Seller has neither knowledge of nor received any notice of any existing or proposed assessments for public improvements imposed or to be imposed upon the Leased Real Property which will remain unpaid at Closing, except for escalation adjustments in relation to any prior assessments, which escalation adjustments are listed on Section 2.26(h) of Seller Disclosure Schedule. (i) The Permits listed on Section 2.26(i) of Seller Disclosure Schedule include all Permits which are required for the present use and occupancy of the Leased Real Property by the Companies and each Company Subsidiary, and each, to the knowledge of Seller, has been duly issued. SECTION 2.27. Reinsurance and Retrocessions. Section 2.27 of Seller Disclosure Schedule sets forth an accurate and complete list of (a) all reinsurance and 16 retrocession treaties and agreements in force as of the date of this Agreement to which the Companies or any Company Subsidiary is a party and (b) any terminated or expired treaty or agreement under which there remains any outstanding liability from one reinsurer with respect to paid or unpaid case reserves in excess of $50,000, and, for each such treaty or agreement, the effective date of such treaty or agreement and the termination date if such treaty or agreement has a definite termination date. All such treaties or agreements set forth in Section 2.27 of Seller Disclosure Schedule are in full force and effect to the respective dates noted on Section 2.27 of Seller Disclosure Schedule, and neither of the Companies nor any Company Subsidiary is in default in any respect as to any provision of any reinsurance or retrocession treaty or agreement or has failed to meet the underwriting standards required for any business reinsurance thereunder. No such agreement contains any provision providing that the other party thereto may terminate such agreement by reason of the transactions contemplated by this Agreement; and, to the knowledge of Seller, the financial condition of any other party to any such agreement is not so impaired that a default thereunder may reasonably be anticipated. SECTION 2.28. Investments. (a) Section 2.28 of Seller Disclosure Schedule sets forth a true and complete list of all bonds, stocks (other than the capital stock of the Companies), mortgages and other investments of any type owned by either of the Companies or any Company Subsidiary as of the date hereof (collectively, the "Scheduled Investments"). Each Company and each Company Subsidiary has good and marketable title to each of the Scheduled Investments. (b) Except as set forth on Section 2.28 of Seller Disclosure Schedule, none of the Scheduled Investments is currently in default in the payment of principal or interest, and, to the knowledge of Seller, no event has occurred which reasonably would be expected to result in a diminution of the value of any nonpublicly traded security owned by either of the Companies or any Company Subsidiary. (c) There are no Encumbrances on any of the Scheduled Investments, except for (i) those Scheduled Investments deposited with Governmental Authorities, as indicated on Section 2.28 of Seller Disclosure Schedule, (ii) Encumbrances which do not materially detract from the value of the Scheduled Investments subject thereto and (iii) assets pledged to secure assumed reinsurance contract obligations which assets are listed on Section 2.28 of Seller Disclosure Schedule. (d) None of Seller, either Company or any Company Subsidiary has taken, or omitted to take, any action which would result in either Company or any Company Subsidiary being unable to enforce the terms of any Scheduled Investment or which would cause any Scheduled Investment to be subject to any valid offset, defense or counterclaim against the right of such Company or such Company Subsidiary to enforce the terms of such Scheduled Investment. (e) Since June 30, 2001, neither of the Companies or any Company Subsidiary has (i) purchased or otherwise invested in, or committed to purchase or otherwise invested in, any interest in real property (including without limitation any extension of credit secured by a mortgage or deed of trust), (ii) purchased or otherwise invested in, or committed to purchase or otherwise invest in, bonds, notes, debentures or other evidences of indebtedness rated lower than "Baa-" by Moody's Investors Service Inc. or "BBB-" by Standard & Poor's Corporation at the time of purchase, (iii) entered into any contract with any affiliate with respect 17 to the purchase or other acquisition, sale or other disposition or allocation of any Scheduled Investment or (iv) entered into any contract with respect to any foreign investments. SECTION 2.29. Insurance. (a) Section 2.29 of the Disclosure Schedule sets forth, as of the date hereof, an accurate and complete list of all policies of insurance relating to the assets, properties, business, operations, employees, officers or directors of the Companies and each Company Subsidiary. Section 2.29 of Seller Disclosure Schedule also describes each pending claim involving a Company under any of such policies of more than $10,000 and sets forth the aggregate amounts paid out on behalf of a Company under each such policy through the date hereof. Such policies are valid and binding in accordance with their terms and are in full force and effect and insure against risks and liabilities customary for the Businesses in which the Companies and each Company Subsidiary are engaged. Neither Seller nor either of the Companies or any Company Subsidiary has received a notice of cancellation or nonrenewal of any such policy and, to the knowledge of Seller, no state of facts exists which might form the basis for termination of any such policy. Each of the Companies and each Company Subsidiary has, or has made or will make provision for, insurance coverage consistent with current practices through the Closing Date. None of the insurance policies for the benefit of the Companies or any Company Subsidiary is in default, and neither Seller nor either of the Companies nor any Company Subsidiary has failed to give any notice or present any claim thereunder in due or timely fashion or as required by such insurance policies so as to jeopardize full recovery under such policies. Seller or the Companies and the each Company Subsidiary paid or will pay all premiums payable for periods through the Closing Date with respect to such insurance policies. (b) Each of Seller, Claims Administration Corporation, Program Brokerage Corporation, Kaye Insurance Associates, Inc. except Fischer Fiden & Norris, LLP has in place and has at all times maintained in place on a continuous basis (i) errors and omissions insurance policies with a policy limit of not less than $5,000,000 and (ii) employment practices liability insurance policies with a policy limit of not less than $5,000,000. Fischer Fiden & Norris, LLP has in place and has at all times maintained in place on a continuous basis (i) errors and omissions insurance policies with a policy limit of not less than $2,000,000 and (ii) employment practices liability insurance policies with a policy limit of not less than $2,000,000. Section 2.29(b) of the Seller Disclosure Schedule contains a complete and accurate list of all outstanding or threatened claims against any such policies and the remaining limits under such policies taking into account claims paid to date and assuming that any such outstanding or threatened claims may ultimately result in payments made by the insurer under such policies that would reduce such limits. SECTION 2.30. Benefit Plans. (a) Each material written Company Employee Benefit Plan is listed in Section 2.30(a) of Seller Disclosure Schedule. Each Company Employee Benefit Plan is in substantial compliance with all applicable laws and has been administered and operated in all material respects in accordance with its terms, except where the failure to do so would not reasonably be expected to result in a Material Adverse Effect on Seller or the Companies. (b) Each Company Employee Benefit Plan which is intended to be "qualified" within the meaning of Section 401(a) of the Code is so qualified and, to the knowledge of Seller, no event has occurred and no condition exists which could reasonably be expected to result in the revocation of such qualified status. 18 (c) Full payment has been made of all amounts so required under the terms of the Company Employee Benefit Plans on or prior to the date hereof (excluding any amounts not yet due) and any amounts which have accrued but are not yet payable are reflected on the Company Financial Statements. (d) No Company Employee Benefit Plan which is subject to Part 3 of Subtitle B of Title I of ERISA has incurred any "accumulated funding deficiency" (within the meaning of Section 302 of ERISA or Section 412 of the Code), whether or not waived. (e) Except as disclosed in Section 2.30(e) of Seller Disclosure Schedule, neither of the Companies or any other "disqualified person" or "party in interest" (as defined in Section 4975(e)(2) of the Code or Section 3(14) of ERISA, respectively), has engaged in any transaction in connection with any Company Employee Benefit Plan that could reasonably be expected to result in the imposition of a penalty pursuant to Section 502(i) of ERISA, damages pursuant to Section 409 of ERISA or a tax pursuant to Sections 4971 through 4980E of the Code. (f) Except as disclosed in Section 2.30(f) of Seller Disclosure Schedule, the Companies have not maintained any Company Employee Benefit Plan (other than a Company Employee Benefit Plan which is intended to be "qualified" within the meaning of Section 401(a) of the Code) which provides benefits with respect to employees or former employees following their termination of service with the Companies (other than as required pursuant to COBRA). Each Company Employee Benefit Plan subject to the requirements of COBRA has been operated in substantial compliance with the provisions of COBRA and the applicable regulations thereunder. (g) During the three (3) years ending on the date of this Agreement, except as disclosed in Section 2.30(g) of Seller Disclosure Schedule, no Company Employee Benefit Plan that is subject to Title IV of ERISA has been terminated or is or has been the subject of termination proceedings pursuant to Title IV of ERISA. (h) The "amount of unfunded benefit liabilities" within the meaning of Section 4001(a)(18) of ERISA does not exceed zero with respect to any Company Employee Benefit Plan subject to Title IV of ERISA. (i) No notice of "reportable event" (within the meaning of Section 4043 of ERISA) for which the 30-day reporting requirement has not been waived or extended has occurred with respect to any Company Employee Benefit Plan within the twelve months ending on the date of this Agreement. (j) With respect to each "multiemployer plan" (as defined in Section 3(37) of ERISA), (i) no withdrawal liability has been incurred by the Companies, and neither of the Companies has reason to believe that any such liability will be incurred, prior to the Closing Date, (ii) no such plan is in "reorganization" (within the meaning of Section 4241 of ERISA), (iii) no notice has been received that increased contributions may be required to avoid a reduction in plan benefits or the imposition of an excise tax, or the plan is or may become "insolvent" (within the meaning of Section 4245 of ERISA), (iv) no proceedings have been instituted by the Pension Benefit Guaranty Corporation against the plan, (v) there is no contingent liability for withdrawal liability by reason of a sale of assets pursuant to Section 4204 of ERISA, and (vi) except as disclosed in Section 2.30(j) of the Disclosure Schedule, if either of the Companies were 19 to have a complete or partial withdrawal under Sections 4203 or 4205 of ERISA as of the Closing, no obligation to pay withdrawal liability would exist on the part of the Companies. (k) Except as disclosed in Section 2.30(k) of Seller Disclosure Schedule or as previously disclosed to Purchaser, no benefit under any Company Employee Benefit Plan, including any severance or parachute or similar or other plan or agreement, will be established, be increased, or become accelerated, vested or payable, by reason of the execution and delivery of this Agreement or any transactions contemplated under this Agreement, and no amount payable or benefit provided under any Company Employee Benefit Plan will fail to be deductible by reason of Section 162(m) or Section 280G of the Code. (l) No tax has been incurred under Section 511 of the Code with respect to any Company Employee Benefit Plan (or trust or other funding vehicle pursuant thereto). ARTICLE III REPRESENTATIONS AND WARRANTIES OF PURCHASER Except as set forth in the disclosure schedule delivered by Purchaser to Seller concurrently with the execution of this Agreement (the "Purchaser Disclosure Schedule") which provides an exception to, or otherwise qualifies in reasonable detail with specific Section references, the representations or warranties of Purchaser specifically referred to therein, Purchaser hereby represents and warrants to Seller that: SECTION 3.01. Organization and Qualification. Purchaser is a stock company incorporated, validly existing and in good standing under the laws of the State of Wyoming. SECTION 3.02. Authority Relative to This Agreement. Purchaser has all necessary corporate power and authority to execute and deliver this Agreement, and to perform its obligations hereunder and to consummate the transactions contemplated hereby. The execution and delivery of this Agreement by Purchaser, the performance by Purchaser of its obligations hereunder and the consummation by Purchaser of the transactions contemplated hereby have been duly authorized by all requisite action on the part of Purchaser. This Agreement has been duly executed and delivered by Purchaser, and (assuming due authorization, execution and delivery by Seller) this Agreement constitutes a legal, valid and binding obligation of Purchaser enforceable against Purchaser in accordance with its terms, subject to the effect of any applicable bankruptcy, reorganization, insolvency, moratorium or similar laws affecting creditors' rights generally and subject, as to enforceability, to the effect of general principles of equity. SECTION 3.03. No Conflict. Assuming the making and obtaining of all filings, notifications, consents, approvals, authorizations and other actions referred to in Section 3.04, except as may result from any facts or circumstances relating solely to Seller, the execution, delivery and performance of this Agreement by Purchaser do not and will not (a) violate, conflict with or result in the breach of any provision of the certificate of incorporation or by-laws of Purchaser, (b) conflict with or violate any Law or Governmental Order applicable to Purchaser or (c) conflict with, or result in any breach of, constitute a default (or event which with the giving of notice or lapse or time, or both, would become a default) under, require any consent under, or 20 give to others any rights of termination, amendment, acceleration, suspension, revocation, or cancellation of, or result in the creation of any Encumbrance on any of the assets or properties of Purchaser pursuant to, any note, bond, mortgage or indenture, contract, agreement, lease, sublease, license, permit, franchise or other instrument or arrangement to which Purchaser is a party or by which any of such assets or properties are bound or affected which would have a material adverse effect on the ability of Purchaser to consummate the transactions contemplated by this Agreement. SECTION 3.04. Governmental Consents and Approvals. The execution, delivery and performance of this Agreement by Purchaser do not and will not require any consent, approval, authorization or other order of, action by, filing with, or notification to, any Governmental Entity, except the notification requirements of the Insurance Filings. SECTION 3.05. No Registration of Shares. Purchaser understands that the Shares have not been and will not be registered under the Securities Act and that the sale contemplated hereby is being made in reliance on an exemption from registration available under the Securities Act. SECTION 3.06. Investment Knowledge and Experience. Purchaser (i) has had access to such information, if any, concerning Seller as it has considered necessary in connection with its investment decision to invest in the Shares, (ii) has such knowledge and experience in financial and business matters as to be capable of evaluating the merits and risks of its investment in the Shares and is able to bear the economic risks of such investment and (iii) is an Institutional Accredited Investor. SECTION 3.07. Investment Purpose. Purchaser is purchasing the Shares for its own account for investment, and not with a view to, or for offer or sale in connection with, any distribution thereof in violation of the Securities Act or other applicable securities laws. SECTION 3.08. No General Solicitation. Purchaser acknowledges that it has not purchased the Shares as a result of any general solicitation or general advertising, including advertisements, articles, notices or other communications published in any newspaper, magazine or similar media or broadcast over radio or television, or any seminar or meeting whose attendees have been invited by general solicitation or general advertising. SECTION 3.09. Brokers. No broker, finder or investment banker is entitled to any brokerage, finder's or other fee or commission in connection with the transactions contemplated by this Agreement based upon arrangements made by or on behalf of Purchaser. SECTION 3.10. Availability of Funds. Purchaser has available and will have available on the Closing Date sufficient funds to enable it to consummate the transactions contemplated by this Agreement, including the payment of the Purchase Price pursuant to Article I hereof. 21 ARTICLE IV COVENANTS SECTION 4.01. Conduct of Business. (a) Except as expressly contemplated or permitted by this Agreement, from the date of this Agreement to the Closing Date, Seller shall cause the Companies and each Company Subsidiary to carry on their respective Businesses only in the ordinary course of business consistent with past practice and use commercially reasonable efforts to preserve intact their current business organizations and their material relationships with agents, insureds and others having business dealings with them, keep available the services of their current employees and maintain their material rights and franchises. Without limiting the generality of the foregoing, from the date of this Agreement to the Closing Date, except as set forth in Section 4.01 of Seller Disclosure Schedule or as expressly contemplated or permitted by this Agreement, Seller shall not permit the Companies to, without the prior consent of Purchaser: (i) (A) declare, set aside or pay any dividends on, or make any other distributions (whether in cash, stock or property) in respect of, any of the Companies' outstanding capital stock, (B) split, combine or reclassify any of the outstanding capital stock of the Companies or issue or authorize the issuance of any other securities in respect of, in lieu of or in substitution for shares of outstanding capital stock of the Companies, or (C) purchase, redeem or otherwise acquire any shares of outstanding capital stock of the Companies or any rights, warrants or options to acquire, or securities convertible into or redeemable for, any such shares; (ii) issue, sell, grant, pledge or otherwise encumber any shares of its capital stock, any other voting securities or any securities convertible into or redeemable for, or any rights, warrants or options to acquire, any such shares, voting securities or convertible securities; (iii) amend its certificate of incorporation, by-laws or other comparable organizational documents; (iv) acquire any corporation, partnership, joint venture, association or other business organization or division thereof, or a substantial portion of the assets of any of the foregoing (including by way of reinsurance); (v) (A) incur any indebtedness for borrowed money or guarantee or otherwise become responsible for any such indebtedness of another person, except in the ordinary course of business consistent with past practice or (B) make any loans, advances or capital contributions to, or investments in, any other person, and loans and advances to agents and employees in the ordinary course of business consistent with past practice and other than as to such matters related to the investment portfolio of the Companies in the ordinary course of business consistent with past practice; (vi) make any tax election or settle or compromise any income tax liability unless such election, settlement or compromise (x) is required by law and is supported by an opinion of counsel or (y) is in the ordinary course of business consistent with past practice; 22 (vii) make any change in accounting methods, principles or practices used by the Companies, except insofar as may be required by law or regulation or by a change in applicable accounting principles; (viii) other than as previously disclosed to Purchaser in writing, adopt or amend any Company Employee Benefit Plan (or any plan that would be a Company Employee Benefit Plan if adopted) or enter into, adopt, extend, renew or amend any collective bargaining agreement or other agreement with any labor organization, union or association, except in each case as required by applicable law; (ix) grant to any officer or employee any increase in compensation or benefits, except in the ordinary course of business consistent with past practice; (x) increase the current workforce of the Companies; (xi) cancel any indebtedness for borrowed money owed to the Companies or, other than in the ordinary course of business consistent with past practice, waive any claims or rights of substantial value; (xii) sell, lease, license or otherwise dispose of (including by way of reinsurance) any of its assets (other than investments), except in the ordinary course of business consistent with past practice at fair value; (xiii) enter into any contract or agreement, except insurance and reinsurance contracts entered into the ordinary course of business consistent with past practice; (xiv) settle any claim, action or proceeding (other than any claim under any insurance or reinsurance policy or contract) for an amount in excess of $50,000 individually or $100,000 in the aggregate and, in the case of any claim, action or proceeding under any insurance or reinsurance policy or contract, for an amount in excess of $50,000 individually, or otherwise settle any claim, action or proceeding; (xv) make any capital expenditures in excess of $5,000 in the aggregate; (xvi) transfer (other than to the Companies) any right or interest of the Companies in any trade name, trademark, service mark or logo; (xvii) sell, lease or otherwise transfer any property or assets to, or purchase, lease or otherwise acquire any property or assets from, or otherwise engage in any transactions with, any of its affiliates, except (A) transactions that are at prices and on terms and conditions not less favorable to the Companies than could be obtained on an arm's-length basis from unrelated third parties, or (B) transactions between the Companies not involving any other affiliate; or (xviii) make any change in the policies and procedures related to the administration of the Business of the Companies; (xix) enter into any contract or otherwise agree to take any of the foregoing actions. 23 (b) Prior to the Closing, Seller shall cause the Companies to consult with Purchaser about asset allocation guidelines in their investment portfolios, and will give consideration to the views of Purchaser with respect thereto. Further, prior to the Closing, Seller shall cause the Companies to consult with, and give consideration to the views of, Purchaser with respect to any material actions affecting their financial position or operations or any change in accounting or reserving methods, principles or practices which in either case the Companies may from time to time consider taking. (c) Neither Purchaser nor Seller shall, nor shall they permit any of their respective subsidiaries to, voluntarily take any action intended to result in any of the conditions set forth in Article VI not being satisfied. SECTION 4.02. Access to Information; Confidentiality. Seller shall cause the Companies to afford to Purchaser and to the officers, employees and other representatives of Purchaser reasonable access upon reasonable notice during normal business hours during the period prior to the Closing Date to all of its properties, books, contracts, commitments and records and, during such period, Seller shall cause the Companies to furnish to Purchaser such information concerning its Business, properties, financial condition, operations and personnel as Purchaser may from time to time reasonably request, other than any such properties, books, contracts, commitments, records and information that (i) are subject to an attorney-client or other legal privilege which might be impaired by such disclosure or (ii) are subject to an obligation of confidentiality. All requests for access or information pursuant to this Section 4.02 shall be directed to one or more employees of Seller. SECTION 4.03. Commercially Reasonable Efforts. Upon the terms and subject to the conditions and other agreements set forth in this Agreement, each of the parties agrees to use its commercially reasonable efforts to cause the Closing to occur and to take, or cause to be taken, all actions, and to do, or cause to be done, and to assist and cooperate with the other parties in doing, all things necessary, proper or advisable to consummate and make effective, in the most expeditious manner practicable, the transactions contemplated by this Agreement. SECTION 4.04. Consents, Approvals and Filings. (a) Seller and Purchaser will each use, and Seller will cause the Companies to use, their commercially reasonable efforts, and will, and Seller will cause the Companies to, cooperate fully with each other (i) to comply as promptly as practicable with all governmental requirements applicable to the transactions contemplated by this Agreement, and (ii) to obtain as promptly as practicable all necessary permits, orders or other consents, approvals or authorizations of Governmental Entities and consents or waivers of all third parties necessary in connection with the consummation of the transactions contemplated by this Agreement. In connection therewith, Seller and Purchaser will make and cause their respective affiliates to make all legally required filings, including filings with applicable Governmental Entities, as promptly as practicable in order to facilitate prompt consummation of the transactions contemplated by this Agreement, and will provide and will cause their respective affiliates to provide such information and communications to Governmental Entities as such Governmental Entities may request. (b) Purchaser shall cooperate and use all reasonable efforts to assist Seller in giving such notices and obtaining such consents; provided, however, that Purchaser shall have no obligation to give any guarantee or other consideration of any nature in connection with any such notice or consent or to consent to any change in the terms of any agreement or arrangement 24 which Purchaser may reasonably deem adverse to the interest of Purchaser, the Companies or the Business of such entities. (c) Seller and Purchaser agree that in the event any consent, approval or authorization necessary or desirable to preserve for the Companies, or any right or benefit under any lease, license, contract, commitment or other agreement or arrangement to which Seller or the Companies is a party, is not obtained prior to the Closing, Seller will, subsequent to the Closing, cooperate with Purchaser and the Companies in attempting to obtain such consent, approval or authorization as promptly thereafter as practicable. SECTION 4.05. Certain Notices. Seller shall give notice to Purchaser, and Purchaser shall give notice to Seller, of any representation or warranty made by it contained in this Agreement becoming untrue or inaccurate in any material respect or the failure by it to comply with or satisfy in any material respect any covenant, condition or agreement to be complied with or satisfied by it under this Agreement. SECTION 4.06. Public Announcements. Purchaser and Seller will consult with each other before issuing, and will provide each other the opportunity to review and comment upon, any press release or other public statement with respect to the transactions contemplated by this Agreement and shall not issue any such press release or make any such public statement without the advance approval of the other party following such consultation (such approval not to be unreasonably withheld or delayed), except as may be required by applicable law or regulation, court process or by the requirements of any securities exchange. Fairfax Financial Holdings Limited, however, may issue a press release or other public statement with respect to the transactions contemplated by this Agreement without the consent of Seller and Purchaser. SECTION 4.07. Certain Intercompany Agreements and Accounts. The actions described in Section 4.07 of Seller Disclosure Schedule shall be taken with respect to the intercompany agreements and accounts set forth therein. SECTION 4.08. Termination of Existing Security Interests. Section 4.08 of Seller Disclosure Schedule contains a list of all loans or lines of credit of the Companies, Seller and all affiliates of Seller that are secured by the assets or capital stock of any of the Companies. As of the Closing Date, all such security interests shall be terminated. SECTION 4.09. Post-Closing Cooperation. Following the Closing Date, upon reasonable written notice, Purchaser and Seller shall furnish, and will cause their respective subsidiaries to furnish, to each other and any of their respective affiliates, and their respective counsel and accountants, during normal business hours, reasonable access to such information (including the books and records of the Companies) to the extent that such access may be reasonably necessary for financial reporting and accounting matters or to prepare documents required to be filed with Governmental Entities. Purchaser will not, and will cause their respective affiliates not to, dispose of, alter or destroy any such books and records until the later of (i) seven years after the Closing Date and (ii) 30 days after giving notice to Seller to permit it, at its expense, to examine, duplicate or repossess such books and records. Notwithstanding the foregoing, this Section 4.09 shall not apply to tax returns. SECTION 4.10. Further Assurances. From time to time, as and when requested by any party, each party shall execute and deliver, or cause to be executed and delivered, all such 25 documents and instruments and shall take, or cause to be taken, all such further or other actions (in each case, subject to Section 4.03, as may be reasonably necessary or desirable to consummate the transactions contemplated by this Agreement. SECTION 4.11. Due Diligence. For a period of twenty one (21) days following the date of execution of this Agreement, Seller shall provide to Purchaser and its representatives access pursuant to Section 4.02 in order for Purchaser to complete its due diligence investigation of Seller and the Companies. ARTICLE V ADDITIONAL AGREEMENTS SECTION 5.01. Confidentiality. Seller and Purchaser agree to hold in confidence and not to disclose or reveal to any person or entity not affiliated with Fairfax Financial Holdings Limited the terms of this Agreement, information received from the other party hereunder and, with respect to Seller, any confidential information relating to the Companies, without the express written consent of such other party, which consent shall not be unreasonably withheld. SECTION 5.02. Expenses. Except as otherwise specified in this Agreement, all costs and expenses, including, without limitation, fees and disbursements of counsel, financial advisors and accountants, incurred in connection with this Agreement and the transactions contemplated hereby shall be paid by the party incurring such costs and expenses, whether or not the Closing shall have occurred. ARTICLE VI CONDITIONS TO CLOSING SECTION 6.01. Conditions to the Obligations of Each Party. The obligations of Seller and Purchaser to consummate the transactions contemplated by this Agreement are subject to the satisfaction or waiver (where permissible), at or prior to Closing, of each of the following conditions: (a) No Order. No Governmental Entity or court of competent jurisdiction located or having jurisdiction in the United States or Bermuda shall have enacted, issued, promulgated, enforced or entered any law, rule, regulation, judgment, decree, executive order or award (an "Order") which is then in effect and has the effect of making the transactions contemplated by this Agreement illegal or otherwise prohibiting their consummation; (b) Consents. All material permits, orders, approvals, consents, non-disapprovals or non-objections relating to the Insurance Filings and of any other governmental or insurance regulatory authority which are required in connection with the consummation of the transaction contemplated by this Agreement including, but not limited to, the approval by the states in which the Insurance Filings are required and such other regulatory authorities as require a permit, order, approval, consent, non-disapproval or non-objection (in the case of any non-disapprovals or non-objections as evidenced by the time period prescribed by applicable 26 insurance law having elapsed without Purchaser having received any objection), shall have been obtained upon such terms and conditions as would not, in the sole discretion of Purchaser, interfere with the strategic advantages and benefits to Purchaser of the acquisition of the Shares, or would otherwise not have a Material Adverse Effect on Purchaser or the Companies and such permits, orders, approvals, consents, non-disapprovals and/or non-objections shall be effective and shall not have been suspended, revoked or stayed; (c) Other Agreements. Pending appropriate regulatory approvals, OLRI shall have entered into (i) an Underwriting Services Agreement with Program Brokerage Corporation and Kaye Insurance Associates, Inc.; (ii) a Claims Services Agreement with Claims Administration Corporation; and (iii) an Administrative Services and Cost Allocation Agreement with Seller, each substantially in the form of the agreements attached as Exhibit A, Exhibit B and Exhibit C, respectively, to this Agreement and such agreements shall be in full force and effect as of the Closing Date. Following the Closing, Seller and its affiliates will not have the authority to negotiate and purchase reinsurance on behalf of the Companies except as may be provided in the Underwriting Services Agreement. SECTION 6.02. Conditions to the Obligations of Purchaser. The obligations of Purchaser to consummate the transactions contemplated by this Agreement are subject to the satisfaction or waiver (where permissible), at or prior to Closing, of each of the following conditions: (a) Representations and Warranties. Each of the representations and warranties of Seller contained in this Agreement shall have been true and correct as of the date of this Agreement (or as to representations and warranties made as of a particular date shall have been true and correct as of such date), and each of the representations and warranties of Seller contained in this Agreement which is not made as of a specific date shall continue to be true and correct as of the Closing, with the same force and effect as if made as of the Closing, except, in each case, where such failure to be true and correct would not prevent or materially delay consummation of the transactions contemplated by this Agreement and would not, individually or in the aggregate, have a material effect on Purchaser, and Purchaser shall have received a certificate (as to which there shall be no individual, as opposed to corporate liability) of a duly authorized officer of Seller to that effect, or otherwise prevent or materially delay Seller from performing its obligations under this Agreement; and Purchaser shall have received a certificate (as to which there shall be no individual, as opposed to corporate, liability) of a duly authorized officer of Seller to such effect; (b) Agreements and Covenants. Seller shall have performed or complied in all material respects with all agreements and covenants required by this Agreement to be performed or complied with by it on or prior to the Closing Date and Purchaser shall have received a certificate (as to which there shall be no individual, as opposed to corporate, liability) of a duly authorized officer of the each of Seller to that effect; (c) Resolutions of Seller. Purchaser shall have received a true and complete copy, certified by the Secretary or an Assistant Secretary of Seller, of the resolutions duly and validly adopted by the Board of Directors of Seller evidencing its authorization of the execution and delivery of this Agreement and the consummation of the transactions contemplated hereby; and 27 (d) Incumbency Certificate of Seller. Purchaser shall have received a certificate of the Secretary or an Assistant Secretary of Seller certifying the names and signatures of the officers of Seller authorized to sign this Agreement and the other documents to be delivered hereunder. SECTION 6.03. Conditions to the Obligations of Seller. The obligations of Seller to consummate the transactions contemplated by this Agreement are subject to the satisfaction or waiver (where permissible), at or prior to Closing, of each of the following conditions: (a) Representations and Warranties. Each of the representations and warranties of Purchaser contained in this Agreement shall have been true and correct in all material respects as of the date of this Agreement (or as to representations and warranties made as of a particular date shall have been true and correct in all material respects as of such date), and each of the representations and warranties of Purchaser which is as of a particular date shall continue to be true and correct in all material respects as of Closing with the same force and effect as if made as of Closing, except, in each case, where such failure to be true and correct would not prevent or materially delay consummation of the transactions contemplated by this Agreement or otherwise prevent or materially delay Purchaser from performing its obligations under this Agreement and would not, individually or in the aggregate, have a Material Adverse Effect on Purchaser; and Seller shall have received a certificate (as to which there shall be no individual, as opposed to corporate, liability) of a duly authorized officer of Purchaser to such effect; (b) Agreements and Covenants. Purchaser shall have performed or complied in all material respects with all agreements and covenants required by this Agreement to be performed or complied with by it on or prior to the Closing Date, and Seller shall have received a certificate (as to which there shall be no individual, as opposed to corporate, liability) of a duly authorized officer of Purchaser to that effect; (c) Resolutions. Seller shall have received a true and complete copy, certified by the Secretary or an Assistant Secretary of Purchaser, of the resolutions duly and validly adopted by the Board of Directors of Purchaser evidencing its authorization of the execution and delivery of this Agreement and the consummation of the transactions contemplated hereby; and (d) Incumbency Certificate. Seller shall have received a certificate of the Secretary or an Assistant Secretary of Purchaser certifying the names and signatures of the officers of Purchaser authorized to sign this Agreement and the other documents to be delivered hereunder. ARTICLE VII TERMINATION, AMENDMENT AND WAIVER SECTION 7.01. Termination. This Agreement may be terminated and the transactions contemplated by this Agreement may be abandoned at any time prior to the Closing as follows: 28 (a) by mutual written consent duly authorized by the Boards of Directors of each of Purchaser and Seller; (b) by either Seller or Purchaser if the Closing shall not have occurred by the first anniversary hereof; provided, however, that the right to terminate this Agreement under this Section 7.01(b) shall not be available to any party whose failure to fulfill any obligation under this Agreement shall have been the cause of, or shall have resulted in, the failure of the Closing to occur on or prior to such date; (c) by either Purchaser or Seller if there shall be any Order restraining, enjoining or otherwise prohibiting the transactions contemplated by this Agreement and such Order shall have become final and nonappealable; (d) by Purchaser upon a breach of any material representation, warranty, covenant or agreement on the part of Seller set forth in this Agreement, or if any representation or warranty of Seller shall have become untrue, in either case such that the conditions set forth in Sections 6.02(a) and 6.02(b) would not be satisfied ("Terminating Seller Breach"); provided, however, that, if such Terminating Seller Breach is curable by Seller through the exercise of its commercially reasonable best efforts and for so long as Seller continues to exercise such best efforts, Purchaser may not terminate this Agreement under this Section 7.01(d) unless such breach is not cured within thirty (30) days after notice thereof is provided by Purchaser to Seller; or (e) by Seller upon a breach of any material representation, warranty, covenant or agreement on the part of Purchaser set forth in this Agreement, or if any representation or warranty of Purchaser shall have become untrue, in either case such that the conditions set forth in Sections 6.03(a) and 6.03(b) would not be satisfied ("Terminating Purchaser Breach"); provided, however, that, if such Terminating Purchaser Breach is curable by Purchaser through the exercise of their respective commercially reasonable best efforts and for so long as Purchaser continues to exercise such best efforts, Seller may not terminate this Agreement under this Section 7.01(e) unless such breach is not cured within thirty (30) days after notice thereof is provided by Seller to Purchaser; or (f) by Purchaser by written notice (which notice shall specify Purchaser's reasons in reasonable detail) delivered to Seller on or before April 31, 2002 if (i) Purchaser in the due diligence investigation contemplated by Section 4.11 shall uncover information that, as of the date of this Agreement, has not been previously disclosed by Seller to Purchaser and (ii) such information in the aggregate (A) reflects, in the reasonable judgment of Purchaser, a Material Adverse Effect on the Companies, or (B) would, in the reasonable judgment of Purchaser, interfere with the strategic advantages and benefits anticipated by Purchaser from the acquisition of the Shares, in each case, as compared to the information that was disclosed by Seller to Purchaser prior to the date of this Agreement. SECTION 7.02. Effect of Termination; Non-Survival of Representations and Warranties(a) If this Agreement is terminated pursuant to the provisions of Section 7.01 hereof, such termination shall be without liability of or to any party to this Agreement or any affiliate, shareholder, partner, director, officer, employee, agent, consultant or representative of such party, except that termination of this Agreement shall not relieve any party from liability for breach prior to the date of termination of any agreement or covenant contained in this Agreement (but 29 not of any of the representations or warranties contained in this Agreement other than those set forth in Section 2.01 or Section 3.02 hereof). (b) Except for any breach for which notice has been given, none of the representations or warranties contained in this Agreement or in Seller Disclosure Schedule or Purchaser Disclosure Schedule shall survive any termination of this Agreement. SECTION 7.03. Amendment. This Agreement may be amended by the parties hereto by action taken by or on behalf of their respective Boards of Directors at any time prior to the Closing Date. This Agreement may not be amended except by an instrument in writing signed by the parties hereto. SECTION 7.04. Waiver. At any time prior to the Closing Date, any party hereto may (a) extend the time for the performance of any obligation or other act of any other party hereto, (b) waive any inaccuracy in the representations and warranties contained herein or in any document delivered pursuant hereto, and (c) waive compliance with any agreement or condition contained herein. Any such extension or waiver shall be valid if set forth in an instrument in writing signed by the party or parties to be bound thereby. ARTICLE VIII SURVIVAL OF REPRESENTATIONS AND WARRANTIES; TAX INDEMNIFICATION SECTION 8.01. Survival of Representations and Warranties Generally All representations and warranties contained herein shall terminate upon the Closing with the exception of the representations and warranties contained in Section 2.15 (Taxes) which shall survive the Closing until the expiration of the applicable statutes of limitation and shall be subject to the indemnification rights, obligations and procedures set forth in this Article VIII. SECTION 8.02. Indemnity. (a) Seller agrees to indemnify and hold harmless Purchaser, the Companies and each Company Subsidiary against the following Taxes (except to the extent current Taxes on the Closing Date Balance Sheet have been specifically reserved for such specific Taxes) and, except as otherwise provided in Section 8.05, against any loss, damage, liability or expense, including reasonable fees for attorneys and other outside consultants, incurred in contesting or otherwise in connection with any such Taxes: (i) Taxes imposed on the Companies or any Company Subsidiary with respect to taxable periods ending on or before the Closing Date; (ii) with respect to taxable periods beginning before the Closing Date and ending after the Closing Date, Taxes imposed on the Companies or any Company Subsidiary which are allocable, pursuant to Section 8.02(b) to the portion of such period ending on the Closing Date; (iii) Taxes imposed on any member of any affiliated group with which any of the Companies and any Company Subsidiary file or have filed a Return on a consolidated or combined basis for a taxable period ending on or before the Closing Date; and (iv) Taxes imposed on Purchaser or the Companies or any Subsidiaries as a result of any breach of warranty or misrepresentation under Section 2.15. Purchaser shall be responsible for all Taxes and associated expenses not allocated to Seller pursuant to the first sentence hereof. (b) In the case of Taxes that are payable with respect to a taxable period that begins before the Closing Date and ends after the Closing Date, the portion of any such Tax that is allocable to the portion of the period ending on the Closing Date shall be: 30 (i) in the case of Taxes that are either (x) based upon or related to income or receipts, or (y) imposed in connection with any sale or other transfer or assignment of property (real or personal, tangible or intangible) (other than conveyances pursuant to this Agreement, as provided under Section 8.08), deemed equal to the amount which would be payable if the taxable year ended with the Closing Date; and (ii) in the case of Taxes imposed on a periodic basis with respect to the assets of the Companies or any Company Subsidiary, or otherwise measured by the level of any item, deemed to be the amount of such Taxes for the entire period (or, in the case of such Taxes determined on an arrears basis, the amount of such Taxes for the immediately preceding period), multiplied by a fraction the numerator of which is the number of calendar days in the period ending on the Closing Date and the denominator of which is the number of calendar days in the entire period. SECTION 8.03. Returns and Payments. (a) From the date of this Agreement through and after the Closing Date, Seller shall prepare and file or otherwise furnish in proper form to the appropriate United States and non-United States Governmental Entity (or cause to be prepared and filed or so furnished) in a timely manner all Tax returns, reports and forms ("Returns") relating to the Companies and each Company Subsidiary that are due on or before or relate to any taxable period ending on or before the Closing Date (and Purchaser shall do the same with respect to any taxable period ending after the Closing Date). Returns of the Companies and each Company Subsidiary not yet filed for any taxable period that begins before the Closing Date shall be prepared in a manner consistent with past practices employed with respect to the Companies and each Company Subsidiary (except to the extent counsel for Seller or the Company renders a legal opinion that there is no reasonable basis in law therefor or determines that a Return cannot be so prepared and filed without being subject to penalties). With respect to any Return required to be filed by Purchaser or Seller with respect to the Companies and each Company Subsidiary and as to which an amount of Tax is allocable to the other party, the filing party shall provide the other party and its authorized representatives with a copy of such completed Return and a statement certifying the amount of Tax shown on such Return that is allocable to such other party, together with appropriate supporting information and schedules at least thirty (30)business days prior to the due date (including any extension thereof) for the filing of such Return, and such other party and its authorized representatives shall have the right to review and comment on such Return and statement prior the filing of such Return. (b) Seller shall pay or cause to be paid when due and payable all Taxes with respect to the Companies and each Company Subsidiary for any taxable period ending on or before the Closing Date to the extent such Taxes exceed the amount, if any, accrued for such Taxes as current Taxes payable on the Closing Date Balance Sheet, and Purchaser shall pay or cause to be paid Taxes for (i) any taxable period after the Closing Date, and (ii) periods prior to the Closing Date to the extent the Taxes were accrued in the Closing Date Balance Sheet. Purchaser's obligation to pay Taxes will be subject to its right of indemnification from Seller for Taxes attributable to the portion of any Tax period that includes the Closing Date. SECTION 8.04. Refunds. Any Tax refund (including any interest with respect thereto) relating to the Companies or any Company Subsidiary for any taxable period prior to the Closing Date (except for any refund included on the Closing Date Balance Sheet, which shall be the property of Purchaser, and if paid to Seller, shall be paid over promptly to Purchaser) shall be the property of Seller, and if received by Purchaser or the Companies or any Company Subsidiary shall be paid over promptly to Seller. Notwithstanding the foregoing sentence: (a) any Tax refund (or equivalent benefit to Seller through a reduction in Tax liability) for a period before the Closing Date arising out of the carryback of a loss or credit incurred by the Companies or any Company 31 Subsidiary in a taxable year ending after the Closing Date shall be the property of Purchaser and, if received by Seller, shall be paid over promptly to Purchaser; and )b) if, and to the extent that, as of such time, if any, as Purchaser shall receive a refund that would be the property of Seller and payable to Seller under the immediately preceding sentence, Taxes have been asserted in writing that would be required to be indemnified by Seller hereunder, all or part of such refund up to an amount equal to 120% of such asserted Taxes shall, at the option of Purchaser, be deposited by Purchaser into an account for the satisfaction of any amounts indemnifiable under this Article which have been asserted or subsequently are asserted, until the time set forth in clause (ii) of Section 8.06 of this Agreement with respect to any such asserted amounts (or, if earlier, expiration of the applicable statute of limitations). SECTION 8.05. Contests. (a) After the Closing, Purchaser shall promptly notify Seller in writing of any written notice of a proposed assessment or claim in an audit or administrative or judicial proceeding of Purchaser or of any of the Companies and each Company Subsidiary which, if determined adversely to the taxpayer, would be grounds for indemnification under this Article VIII; provided, however, that a failure to give such notice will not affect Purchaser's right to indemnification under this Article except to the extent, if any, that, but for such failure, Seller could have avoided all or a portion of the Tax liability in question. (b) In the case of an audit or administrative or judicial proceeding that relates to periods ending on or before the Closing Date, provided that Seller acknowledges in writing its liability under this Agreement to hold Purchaser, the Companies and each Company Subsidiary harmless against the full amount of any adjustment which may be made as a result of such audit or proceeding that relates to periods ending on or before the Closing Date (or, in the case of any taxable year that includes the Closing Date, against an adjustment allocable under Section 8.02(b) to the portion of such year ending on or before the Closing Date), Seller shall have the right at its expense to participate in and control the conduct of such audit or proceeding but only to the extent that such audit or proceeding relates solely to a potential adjustment for which Seller has acknowledged its liability; Purchaser also may participate in any such audit or proceeding and, if Seller does not assume the defense of any such audit or proceeding, Purchaser may defend the same in such manner as it may deem appropriate, including, but not limited to, settling such audit or proceeding after giving five days prior written notice to Seller setting forth the terms and conditions of settlement. In the event that issues relating to a potential adjustment for which Seller has acknowledged its liability are required to be dealt with in the same proceeding as separate issues relating to a potential adjustment for which Purchaser would be liable, Purchaser shall have the right, at its expense, to control the audit or proceeding with respect to the latter issues. (c) (i) With respect to issues relating to a potential adjustment for which both Seller (as evidenced by its acknowledgment under this Section) and Purchaser or the Companies or any Company Subsidiary could be liable, (a) each party may participate in the audit or proceeding, and (b) the audit or proceeding shall be controlled by that party which would bear the burden of the greater portion of the sum of the adjustment and any corresponding adjustments that may reasonably be anticipated for future Tax periods. The principle set forth in the immediately preceding sentence shall govern also for purposes of deciding any issue that must be 32 decided jointly (including, without limitation, choice of judicial forum) in situations in which separate issues are otherwise controlled under this Article VIII by Purchaser and Seller. (ii) Neither Purchaser, the Companies, any Company Subsidiary, nor Seller shall enter into any compromise or agree to settle any claim pursuant to any Tax audit or proceeding which would adversely affect the other party for such year or a subsequent year without the written consent of the other party, which consent may not be unreasonably withheld. Purchaser and Seller agree to cooperate, and Purchaser agrees to cause the Company and the Subsidiaries to cooperate, in the defense against or compromise of any claim in any audit or proceeding. SECTION 8.06. Time of Payment. Payment by Seller of any amounts due under this Article VIII in respect of Taxes shall be made (i) at least thirty (30)business days before the due date of the applicable estimated or final Return required to be filed by Purchaser on which is required to be reported income for a period ending after the Closing Date for which Seller is responsible under Sections 8.02(a) and 8.02(b) without regard to whether the Return shows overall net income or loss for such period, and (ii) within fifteen (15) business following an agreement between Seller and Purchaser that an indemnity amount is payable, an assessment of a Tax by a United States or non-United States Governmental Entity, or a "determination" as defined in Section 1313(a) of the Code. If liability under this Article VIII is in respect of costs or expenses other than Taxes, payment by Seller of any amounts due under this Article shall be made within fifteen (15) business days after the date when Seller has been notified by Purchaser that Seller has a liability for a determinable amount under this Article and is provided with calculations or other materials supporting such liability. SECTION 8.07. Cooperation and Exchange of Information. Seller and Purchaser will provide each other with such cooperation and information as either of them reasonably may request of the other in filing any Return, amended Return or claim for refund, determining a liability for Taxes or a right to a refund of Taxes, participating in or conducting any audit or other proceeding in respect of Taxes or making representations to or furnishing information to parties subsequently desiring to purchase any of the Companies or any of the Subsidiaries or any part of the Business from Purchaser. Such cooperation and information shall include providing copies of relevant Returns or portions thereof, together with accompanying schedules, related work papers and documents relating to rulings or other determinations by Tax authorities. Seller shall make its employees available on a basis mutually convenient to both parties to provide explanations of any documents or information provided hereunder. Each of Seller and Purchaser shall retain all Returns, schedules and work papers, records and other documents in its possession relating to Tax matters of the Companies and each Company Subsidiary for each taxable period first ending after the Closing Date and for all prior taxable periods until the later of (a) the expiration of the statute of limitations of the taxable periods to which such Returns and other documents relate, without regard to extensions except to the extent notified by the other party in writing of such extensions for the respective Tax periods, or (b) six years following the due date (without extension) for such Returns. Any information obtained under this Section shall be kept confidential, except as may be otherwise necessary in connection with the filing of Returns or claims for refund or in conducting an audit or other proceeding. SECTION 8.08. Conveyance Taxes. Seller shall be liable for and shall hold Purchaser harmless against any transfer, gains, sales, use, value added, stock transfer, and stamp taxes, any transfer, recording, registration, and other fees, and any similar Taxes which become 33 payable in connection with the transactions contemplated by this Agreement, and shall file such applications and documents as shall permit any such Tax to be assessed and paid on or prior to the Closing Date in accordance with any available pre-sale filing procedure. Purchaser shall execute and deliver all instruments and certificates necessary to enable Seller to comply with the foregoing. SECTION 8.09. Miscellaneous. (a) Seller and Purchaser agree to treat all payments made by either of them to or for the benefit of the other (including any payments to the Companies or any Company Subsidiary) under this Article VIII, as adjustments to the Purchase Price or as capital contributions for Tax purposes and that such treatment shall govern for purposes hereof except to the extent that the Laws of a particular jurisdiction provide otherwise, in which case such payments shall be made in an amount sufficient to indemnify the relevant party on an after-tax basis, calculated at highest Tax rate applicable to taxpayers like the relevant party. (b) From and after the date of this Agreement, Seller shall not without the prior written consent of Purchaser (which may, in its sole and absolute discretion, withhold such consent) make, or cause or permit to be made, any Tax election that would affect the Company or any Company Subsidiary. (c) Purchaser shall be entitled to recover professional fees and related costs that it may reasonably incur to enforce the provisions of this Article VIII. (d) Purchaser and Seller shall for all tax purposes respect the form of the transactions described in Section 1.01 as a sale by Seller of the Shares. ARTICLE IX GENERAL PROVISIONS SECTION 9.01. Notices. All notices, requests, claims, demands and other communications hereunder shall be in writing and shall be given (and shall be deemed to have been duly given upon receipt) by delivery in person, by cable, telecopy, facsimile, telegram or telex or by registered or certified mail (postage prepaid, return receipt requested) to the respective parties at the following addresses (or at such other address for a party as shall be specified in a notice given in accordance with this Section 9.01): if to Purchaser: Fairfax Inc. 305 Madison Avenue Morristown, New Jersey 07960 Facsimile No.: (973) 490-6849 Attention: Valerie J. Gasparik 34 with a copy to: LeBoeuf, Lamb, Greene & MacRae, L.L.P. 125 West 55th Street New York, New York 10019 Facsimile No.: (212) 424-8500 Attention: Jane Boisseau if to Seller: Kaye Group Inc. 122 East 42nd Street New York, New York 10168 Facsimile No.: (212) 986-2278 Attention: President with a copy to: Ivy S. Fischer, Esq. General Counsel Kaye Insurance Associates, Inc. 1065 Avenue of the Americas New York, New York 10018 SECTION 9.02. Certain Definitions. (a) As used in this Agreement, the following terms shall have the following meanings: (i) "affiliate" of a specified person means a person who directly or indirectly through one or more intermediaries controls, is controlled by, or is under common control with such specified person. (ii) "beneficial owner" with respect to any shares means a person who shall be deemed to be the beneficial owner of such shares (i) which such person or any of its affiliates or associates (as such term is defined in Rule 12b-2 promulgated under the Exchange Act (as defined herein)) beneficially owns, directly or indirectly, (ii) which such person or any of its affiliates or associates has, directly or indirectly, (A) the right to acquire (whether such right is exercisable immediately or subject only to the passage of time), pursuant to any agreement, arrangement or understanding or upon the exercise of consideration rights, exchange rights, warrants or options, or otherwise, or (B) the right to vote pursuant to any agreement, arrangement or understanding, or (iii) which are beneficially owned, directly or indirectly, by any other persons with whom such person or any of its affiliates or associates or person with whom such person or any of its affiliates or associates has any agreement, arrangement or understanding for the purpose of acquiring, holding, voting or disposing of any shares. 35 (iii) "Business" means the property and casualty insurance business of the Companies and all other business which prior to the date hereof has been conducted by the Companies. (iv) "business day" means any day on which banks are not required or authorized to close in New York, New York. (v) "COBRA" means Part 6 of Subtitle I of ERISA and Section 4980B of the Code. (vi) "Code" means the Internal Revenue Code of 1986, as amended. (vii) "Company Subsidiary" means a subsidiary of either of the Companies. (viii) "Company Employee Benefit Plan" means each "employee benefit plan" (as defined in Section 3(3) of ERISA), bonus, deferred compensation, equity- or non-equity based, severance or other plan, program, arrangement or agreement relating to employment, compensation or benefits as to which the Companies or any Company subsidiary has any liability. (ix) "Computer Systems" shall mean all computer, hardware, software, systems, and equipment (including embedded microcontrollers in non-computer equipment) embedded within or required to operate the current products of the Companies, and/or material to or necessary for the Companies to carry on their Businesses as currently conducted. (x) "control" (including the terms "controlled by" and "under common control with") means the possession, directly or indirectly or as trustee or executor, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, as trustee or executor, by contract or credit arrangement or otherwise. (xi) "Encumbrance" means any security interest, pledge, mortgage, lien (including, without limitation, environmental and tax liens), charge, encumbrance, adverse claim, preferential arrangement or restriction of any kind, including, without limitation, any restriction on the use, voting, transfer, receipt of income or other exercise of any attributes of ownership. (xii) "ERISA" means the Employment Retirement Income Security Act of 1974, as amended. (xiii) "Exchange Act" means the Securities Exchange Act of 1934, as amended. (xiv) "GAAP" means generally accepted accounting principles. (xv) "general solicitation" and "general advertising", respectively, shall each have the meaning specified in Rule 502(c) under the Securities Act, including advertisements, articles, notices or other communications published in any newspaper, magazine or similar media or broadcast over radio or television, or any seminar or 36 meeting whose attendees had been invited by general solicitation or general advertising or in any other manner involving a public offering within the meaning of Section 4(2) of the Securities Act (xvi) "Governmental Entity" means any federal, national, state, provincial, municipal or local government, any instrumentality, subdivision, court, administrative agency or commission or other authority thereof, or any quasi-governmental or private body exercising any regulatory, taxing, importing or any other governmental or quasi-governmental authority. (xvii) "Institutional Accredited Investor" means those institutional "accredited investors" specified in Rule 501(a)(1), (2), (3) and (7) of Regulation D. (xviii) "Insurance Filings" shall mean such filings as may be necessary with applicable insurance regulatory authorities having jurisdiction over the Companies, Seller, Purchaser or any of their respective subsidiaries. (xix) "Material Adverse Effect" means when used in connection with the Companies any circumstance, event, occurrence, change or effect that is or is likely to be materially adverse to the Business, operations, properties, condition (financial or otherwise), assets (tangible or intangible), liabilities (including contingent liabilities) or results of operations or prospects of the Companies taken as a whole and when used in connection with Purchaser or Seller means any circumstance, event, occurrence, change or effect that is or is likely to be materially adverse to the Business, operations, properties, condition (financial or otherwise), assets (tangible or intangible), liabilities (including contingent liabilities) or results of operations or prospects of Purchaser or Seller, as applicable, and its subsidiaries taken as an whole. (xx) "Program" means a type or structure of coverage(s) offered to policyholders of the Companies. (xxi) "person" means an individual, corporation, partnership, limited partnership, syndicate, person (including, without limitation, a "person" as defined in Section 13(d)(3) of the Exchange Act), trust, association or entity or government, political subdivision, agency or instrumentality of a government. (xxii) "Purchase Price Bank Account" means a bank account in the United States to be designated by Seller in a written notice to Purchaser at least two business days before the Closing. (xxiii) "Regulation D" means Regulation D adopted by the SEC under the U.S. Securities Act. (xxiv) "SEC" means the United States Securities and Exchange Commission. (xxv) "subsidiary" or "subsidiaries" of any person means any corporation, partnership, joint venture or other legal entity of which such person (either alone or through or together with any other subsidiary) owns, directly or indirectly, more than 50% of the stock or other equity interests, the holders of which are generally entitled to 37 vote for the election of the board of directors or other governing body of such corporation or other legal entity. (xxvi) "Securities Act" means the United States Securities Act of 1933, as amended. (xxvii) "Tax" or "Taxes" shall mean any and all taxes, fees, levies, duties, tariffs, imposts and other charges of any kind (together with any and all interest, penalties, additions to tax and additional amounts imposed with respect thereto) imposed by any Governmental Entity or taxing authority, including, without limitation: taxes or other charges on or with respect to income, franchise, windfall or other profits, gross receipts, property, sales, use, capital stock, payroll, employment, social security, workers' compensation, unemployment compensation or net worth; taxes or other charges in the nature of excise, withholding, ad valorem, stamp, transfer, value-added or gains taxes; license, registration and documentation fees; and customers' duties, tariffs and similar charges. (xxviii) "$" or "dollar" means a United States dollar. (b) In addition to those terms set forth in Section 9.02(a), the following terms shall have the meanings defined for such terms in the Sections of this Agreement set forth below:
Term Section ---- -------- Action................................................................................... 2.13 Agreement................................................................................. Preamble Closing................................................................................... 1.03 Closing Date.............................................................................. 1.03 Purchase Price Balance Sheet.............................................................. 1.06(a) Companies................................................................................. Recitals Company Balance Sheets................................................................... 2.09(a) Company Financial Statements............................................................. 2.09(a) Company Material Contracts................................................................ 2.14(a) Company Permits........................................................................... 2.08(a) Environmental Law......................................................................... 2.21 Independent Accounting Firm............................................................... 1.06(b) Intellectual Property Right............................................................... 2.22 IRS....................................................................................... 2.15(a) Law....................................................................................... 2.02 Leased Real Property...................................................................... 2.26(a) Leases ................................................................................... 2.26(a) Merger.................................................................................... Recitals Merger Sub................................................................................ Recitals Notice of Objection....................................................................... 1.06(a) OLB....................................................................................... Recitals OLB Common Stock......................................................................... 2.07(b) OLRI...................................................................................... Recitals OLRI Common Stock......................................................................... 2.07(a) OLRI Preferred Stock...................................................................... 2.07(a)
38
Term Section ---- -------- Order..................................................................................... 6.01(a) Purchase Price............................................................................ 1.02 Purchaser Disclosure Schedule............................................................. Article III Purchaser................................................................................. Preamble Returns................................................................................... 8.03 Scheduled Investments..................................................................... 2.28(a) Seller.................................................................................... Preamble Seller Disclosure Schedule................................................................ Article II Shares.................................................................................... Recitals Tangible Property......................................................................... 2.24 Terminating Seller Breach................................................................. 7.01(d) Terminating Purchaser Breach.............................................................. 7.01(e)
(c) Interpretation. When reference is made in this Agreement to any Section, Exhibit or Schedule, such reference is to a Section, Exhibit or Schedule of this Agreement unless otherwise indicated. The table of contents and headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. Whenever the words "include," "includes" or "including" are used in this Agreement, they shall be deemed to be followed by the words "without limitation." As used herein, terms appearing in the singular shall include the plural and terms appearing in the plural shall include the singular, where appropriate. SECTION 9.03. Severability. If any term or other provision of this Agreement is invalid, illegal or incapable of being enforced by any rule of Law or public policy, all other conditions and provisions of this Agreement shall nevertheless remain in full force and effect so long as the economic or legal substance of the transactions contemplated by this Agreement is not affected in any manner materially adverse to any party. Upon such determination that any term or other provision is invalid, illegal or incapable of being enforced, the parties hereto shall negotiate in good faith to modify this Agreement so as to effect the original intent of the parties as closely as possible in a mutually acceptable manner in order that the transactions contemplated by this Agreement be consummated as originally contemplated to the fullest extent possible. SECTION 9.04. Assignment; Binding Effect; Benefit. Neither this Agreement nor any of the rights, interests or obligations hereunder shall be assigned by any of the parties hereto (whether by operation of law or otherwise) without the prior written consent of the other parties except that Purchaser may, without such consent, assign its rights and obligations to a direct or indirect wholly-owned subsidiary of Purchaser provided that Purchaser shall continue to be liable for its obligations hereunder if any such assignee shall fail to fulfill such obligations. Subject to the preceding sentence, this Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and assigns. Notwithstanding anything contained in this Agreement to the contrary, nothing in this Agreement, expressed or implied, is intended to confer on any person other than the parties hereto or their respective successors and assigns any rights, remedies, obligations or liabilities under or by reason of this Agreement. SECTION 9.05. Incorporation of Exhibits. Seller Disclosure Schedule, Purchaser Disclosure Schedule and all Exhibits attached hereto and referred to herein are hereby incorporated herein and made a part hereof for all purposes as if fully set forth herein. 39 SECTION 9.06. Specific Performance. The parties hereto agree that irreparable damage would occur in the event any provision of this Agreement was not performed in accordance with the terms hereof and that the parties shall be entitled to specific performance of the terms hereof, in addition to any other remedy at law or in equity. SECTION 9.07. Governing Law; Consent to Jurisdiction. This Agreement shall be governed by, and construed in accordance with, the laws of the State of New York. To the extent that any legal action, suit or proceeding arises out of or relates to this Agreement or the transactions contemplated hereby, such action, suit or proceeding may be instituted in any federal court or state court located in New York County, State of New York, U.S.A., and each party agrees not to assert, as a defense in any such action, suit or proceeding, any claim that it is not subject personally to the jurisdiction of such court, that its property is exempt or immune from attachment or execution, that the action, suit or proceeding is brought in an inconvenient forum, that the venue of the action, suit or proceeding is improper or that this Agreement or the subject matter hereof may not be enforced in or by such court. Each party further irrevocably submits to the jurisdiction of any such court in any such action, suit or proceeding. Any and all service of process and any other notice in any such action, suit or proceeding shall be effective against any party if given personally or by registered or certified mail return receipt requested, or by any other means of mail that requires a signed receipt, postage prepaid. Nothing contained herein shall be deemed to affect the right of any party to serve process in any manner permitted by law. SECTION 9.08. Headings. The descriptive headings contained in this Agreement are included for convenience of reference only and shall not affect in any way the meaning or interpretation of this Agreement. SECTION 9.09. Counterparts. This Agreement may be executed and delivered (including by facsimile transmission) in one or more counterparts, and by the different parties hereto in separate counterparts, each of which when executed and delivered shall be deemed to be an original but all of which taken together shall constitute one and the same agreement. SECTION 9.10. No Third Party Beneficiaries. This Agreement shall be binding upon and inure solely to the benefit of the parties hereto and their permitted assigns and nothing herein, express or implied, is intended to or shall confer upon any other person, including, without limitation, any union or any employee or former employee of Seller, any legal or equitable right, benefit or remedy of any nature whatsoever, including, without limitation, any rights of employment for any specified period, under or by reason of this Agreement. SECTION 9.11. Entire Agreement. This Agreement (including the Exhibits, Seller Disclosure Schedule and Purchaser Disclosure Schedule) constitute the entire agreement among the parties with respect to the subject matter hereof and supersede all prior agreements and understandings among the parties with respect thereto. No addition to or modification of any provision of this Agreement shall be binding upon any party hereto unless made in writing and signed by all parties hereto. Neither Seller nor any shareholder, officer or director of Seller have made or shall be deemed to have made to Purchaser or any affiliate of Purchaser any representations or warranty with respect to the Companies, their financial condition, assets, liabilities or results of operations or any other matter, event or condition except as expressly set forth in Articles II and IV of this Agreement. Without limiting the generality of the foregoing, and except as otherwise expressly represented or warranted by Seller in Article II and IV of this Agreement, neither Seller nor any shareholder, officer or director of Seller have made or shall be 40 deemed to have made any representations or warranty with respect to any projections, estimates or budgets of future revenues, expenses or expenditures or any future results of operations to which Purchaser or any affiliate of Purchaser may have had or been provided access or may have reviewed during the due diligence activities. 41 IN WITNESS WHEREOF, Seller and Purchaser have caused this Agreement to be executed by its respective officers thereunto duly authorized as of the date first written above. KAYE GROUP INC. By: /s/ Bruce Guthart -------------------------------------------- Name: Title: FAIRFAX INC. By: /s/ Bradley P. Martin -------------------------------------------- Name: Title: By: -------------------------------------------- Name: Title: 42 AMENDMENT TO STOCK PURCHASE AGREEMENT This Amendment to the Stock Purchase Agreement (this "Amendment") is entered into as of May 30, 2002 between Kaye Group Inc., a corporation organized under the laws of Delaware (the "Seller"), and Fairfax Inc., a corporation organized under the laws of Wyoming (the "Purchaser"). RECITALS WHEREAS, Seller and Purchaser are parties to a Stock Purchase Agreement entered into as of December 31, 2001 (the "Stock Purchase Agreement") providing for the purchase by Purchaser from Seller of all of the Shares of OLRI and OLB for consideration and on the terms as set forth in the Stock Purchase Agreement; and WHEREAS, Seller and Purchaser desire to amend the Stock Purchase Agreement as provided in this Amendment. NOW, THEREFORE, in consideration of the mutual premises and covenants contained in this Amendment, and for other valuable consideration, receipt of which is hereby acknowledged, the parties hereby agree that the Stock Purchase Agreement shall be amended as follows: AMENDMENT Defined Terms. (a) All capitalized terms not otherwise defined in this Amendment shall have the same meaning as in the Stock Purchase Agreement. 2. Section 6.01(c) of the Stock Purchase Agreement. Section 6.01(c) of the Stock Purchase Agreement is amended to read in full as follows: "Other Agreements. Pending appropriate regulatory approvals, (i) OLRI shall have entered into (a) an Underwriting Services Agreement with Program Brokerage Corporation; (b) a Claims Services Agreement with Claims Administration Corporation; and (c) an Administrative Services and Cost Allocation Agreement with Seller; and (ii) Purchaser and Program Brokerage Corporation shall have entered into the Contingent Compensation Agreement, each substantially in the form of the agreements attached as Exhibit A, Exhibit B, Exhibit C and Exhibit D, respectively, to this Amendment, and such agreements shall be in full force and effect as of the Closing Date. Following the Closing, Seller and its affiliates will not have the authority to negotiate and purchase reinsurance on behalf of the Companies except as may be provided in the Underwriting Services Agreement." 3. Continued Effect of the Stock Purchase Agreement. Except as amended hereby, the Stock Purchase Agreement shall remain in full force and effect. 4. Severability. If, at any time, any provision of this Amendment is or becomes illegal, invalid, void or unenforceable in any respect under the law of any jurisdiction, neither the legality, validity, nor enforceability of the remaining provisions hereof, nor the legality, validity or enforceability of such provision under the law of any other jurisdiction, shall in any way be affected or impaired thereby, and the remainder of the provisions of this Amendment shall remain in full force and effect. The parties shall endeavor to negotiate in good faith to replace any invalid, illegal, void or unenforceable provision with a valid, legal and enforceable provision, the economic effect of which comes as close as possible to the invalid, illegal, void or unenforceable provision. 5. Governing Law. THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED AND ENFORCED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK WITHOUT REGARD TO THE PRINCIPLES OF CONFLICT OF LAWS. 6. Counterparts. This Amendment may be executed by the parties hereto in separate counterparts, each of which when so executed and delivered shall be an original, but all such counterparts shall together constitute one and the same instrument. Each counterpart may consist of a number of copies hereof each signed by less than all, but together signed by all of the parties hereto. 2 IN WITNESS WHEREOF, the parties have duly executed and delivered this Amendment as of the date first above written. SELLER: PURCHASER: KAYE GROUP INC. FAIRFAX INC. By: /s/ Michael P. Sabanos By: /s/ Bradley P. Martin ---------------------- --------------------- Name: Bradley P. Martin Title: Vice President EX-10.22 4 t07444a3exv10w22.txt CONTINGENT COMPENSATION AGREEMENT EXHIBIT 10.22 CONTINGENT COMPENSATION AGREEMENT This Contingent Compensation Agreement (this "Agreement") is made and entered into on the 30th day of May, 2002 by and between Fairfax Inc., a Wyoming corporation ("Fairfax Inc."), and Program Brokerage Corporation, a Delaware corporation ("PBC"). WHEREAS, upon the closing (the "Closing") of the transactions contemplated by the Stock Purchase Agreement dated as of December 31, 2001, entered into by and between Fairfax Inc. and Kaye Group Inc., a Delaware Corporation (the "Stock Purchase Agreement"), Old Lyme Insurance Company of Rhode Island, Inc., a Rhode Island-domiciled insurance company ("Old Lyme"), will be a direct, wholly owned subsidiary of Fairfax Inc.; WHEREAS, Old Lyme and PBC have entered into an Underwriting Services Agreement effective as of January 1, 2002 (the "Underwriting Agreement"), pursuant to which, inter alia, PBC agrees to offer New Programs and Existing Programs (each, as defined in the Underwriting Agreement) to Old Lyme; WHEREAS, Fairfax Inc. desires to compensate PBC, for the business produced by PBC and written directly, or assumed, by Old Lyme pursuant to the Underwriting Agreement if, and for so long as, such business is profitable, subject to the terms and conditions hereof; and WHEREAS, the execution of this Agreement is a condition precedent to the Closing. NOW, THEREFORE, in consideration of the premises and of the mutual promises set forth herein, and intending to be legally bound hereby, Fairfax Inc. and PBC agree as follows: ARTICLE I DEFINITIONS A. Capitalized terms used herein shall have the meanings set forth below: "Accident Year" means the period from January 1 to December 31 each year. The presentation of underwriting results for an Accident Year represents Earned Premiums and Incurred Losses on all claims arising from occurrences during such period. "Acquisition Costs" means commission expenses, fronting fees or other such charges paid or payable by Old Lyme to PBC in connection with direct business placed by PBC with Old Lyme or to any insurers from which Old Lyme is assuming business in connection with a Program managed by PBC pursuant to the Underwriting Agreement, including the Commission (as defined therein). "Contingent Compensation" means sixty five percent (65%) of the Underwriting Profit or Underwriting Loss for each Accident Year. "Contingent Compensation Statement" means the written report to be prepared by Old Lyme reporting the Underwriting Profit or Underwriting Loss and the Contingent Compensation: (i) with respect to property and Umbrella SIR insurance, as of the end of each calendar quarter and Accident Year; and (ii) with respect to casualty insurance (other than Umbrella SIR insurance), as of the end of each Accident Year. The Contingent Compensation Statement shall be substantially in the form attached hereto as Exhibit A. "Earned Premiums" means gross earned premium net of return premium, less ceded reinsurance premiums earned by Old Lyme on all direct and assumed business placed by PBC during the Accident Years subject to the Underwriting Agreement. "General and Administrative Expenses" means all expenses incurred by Old Lyme including, but not limited to, premium taxes, salaries, rent, utilities, furniture, fixtures, inspection fees, information technology, telecommunications, postage, boards and bureaus, licenses, legal and auditing expenses, administrative services fees, provisions for or write-offs of uncollectible premiums and reinsurance recoverables to the extent not recorded as a reduction of Earned Premiums or increase in Incurred Losses, and all other overhead. Without limiting the generality of the foregoing, "General and Administrative Expenses" shall include any costs, fees, expenses, judgments, settlements or other charges to Old Lyme arising from claims by any third parties in connection with the Program business produced by PBC and written directly, or assumed, by Old Lyme pursuant to the Underwriting Agreement. "Incurred Losses" means all losses and allocated and unallocated loss adjustment expenses paid and incurred, including IBNR (net of reinsurance), relating to business placed by PBC and written directly, or assumed, by Old Lyme pursuant to the Underwriting Agreement. The IBNR included in the Incurred Losses shall be calculated by Old Lyme and reviewed by an independent third-party actuary on an annual basis. "Umbrella SIR" means the Policies issued or assumed by Old Lyme under Existing Programs and New Programs pursuant to which Old Lyme "buys back" an insured's deductible or self-insured retention under an umbrella policy. "Underwriting Loss" has the meaning set forth in Article II(B)(1) hereof. "Underwriting Profit" has the meaning set forth in Article II(B)(1) hereof. B. Capitalized terms used but not defined herein shall have the meaning ascribed thereto in the Underwriting Agreement. 2 ARTICLE II CONTINGENT COMPENSATION A. Contingent Compensation Payments. Fairfax Inc. shall pay to PBC an amount equal to the Contingent Compensation as calculated by or on behalf of Old Lyme in accordance with Section B of this Article II. The parties hereby expressly agree that, if, at any time, the total amount of all dividends declared and paid by Old Lyme to Fairfax Inc. in accordance with the insurance laws of Old Lyme's state of domicile (which dividends, for greater certainty, may be ordinary or extraordinary or both) is less than the amount of Contingent Compensation due to be paid to PBC at such time, Fairfax Inc. may elect to defer payment of any amount of Contingent Compensation (the amount so deferred being the "Deferred Compensation Amount"); provided, however, that the Deferred Compensation Amount (i) shall not exceed the amount of the dividend shortfall; and (ii) until so paid, shall accrue interest beginning on the business day immediately following the day on which such Contingent Compensation payment is due at the rate of interest as publicly announced from time to time by Old Lyme's principal bank as its "prime rate" in effect for such business day. B. Contingent Compensation Calculations; Timing of Payments. 1. The Underwriting Profit of Old Lyme relating to the business produced by PBC shall be determined on an Accident Year basis, separately for each of (a) property and Umbrella SIR lines, and (b) casualty lines, each on a GAAP basis, and shall be an amount equal to: Earned Premiums less the sum of (i) Incurred Losses; (ii) Acquisition Costs; and (iii) General and Administrative Expenses. In the event that such calculation results in a value less than zero, such amount shall be referred to as the "Underwriting Loss." 2. Fairfax Inc. shall pay to PBC the Contingent Compensation calculated in accordance with paragraph 3 of this Section B attributable to business produced by PBC having an inception date on or after January 1, 2002 (or, in the case of business having an inception date prior to January 1, 2002, in respect of the portion of such business for which premium is earned on or after January 1, 2002) and written directly, or assumed, by Old Lyme pursuant to the Underwriting Agreement. If the sum of the Underwriting Profits or Underwriting Losses of all open Accident Years for all lines is a net Underwriting Loss as of the end of the applicable calculation period, there shall be no payment due to PBC by Fairfax Inc., and the amount of any such net Underwriting Loss shall be carried forward and applied against any Underwriting Profit reported on the Contingent Compensation Statement of succeeding periods until offset in full by a subsequent Underwriting Profit. 3 3. The Contingent Compensation shall be calculated and payable as set forth below: (a) Property Insurance and Umbrella SIR Business. With respect to property insurance and Umbrella SIR business, the Contingent Compensation shall be payable at such time, and in such amount, as set forth below: (i) Within forty-five (45) days following the end of each of the first three calendar quarters and within ninety (90) days following the end of the first calendar year in respect of each Accident Year: seventy-five percent (75%) of the Contingent Compensation reported on the Contingent Compensation Statement for such period. The calculation of the Contingent Compensation shall be performed on a year-to-date basis, with payment by Fairfax Inc. for the most recent quarter equal to: the product of (x) the most recent Contingent Compensation calculation, and (y) 0.75, less (z) the sum of all previous payments of Contingent Compensation amounts for the current Accident Year. (ii) Within ninety (90) days following the end of the second calendar year in respect of each Accident Year: the product of (x) the most recent Contingent Compensation calculation, and (y) 0.90, less (z) the sum of all payments made pursuant to Item (i) above; provided, however, that, after reduction for net Underwriting Losses carried forward as provided herein, such calculation produces an Underwriting Profit. (iii) Within ninety (90) days following the end of the third calendar year in respect of each Accident Year: the sum of (x) the most recent Contingent Compensation calculation, less (y) the sum of all payments made pursuant to Items (i) and (ii) above, subject to the application of any Underwriting Losses carried forward. (iv) The Contingent Compensation for each Accident Year shall be recalculated as of each subsequent calendar year-end until such time as all claims have been settled and, in each instance, shall be payable within ninety (90) days following the end such calendar year-end. (b) Casualty Insurance. With respect to casualty insurance (including, but not limited to, commercial multi-peril and business owner policies), the Contingent Compensation shall be payable at such time, and in such amount, as set forth below: (i) Twenty five percent (25%) of the Contingent Compensation shall be calculated and payable no later than seventy five (75) days following the end of each of the following periods: (i) the subject Accident Year; (ii) the first year following the end of the subject 4 Accident Year; (iii) the second year following the end of the subject Accident Year; and (iv) the third year following the end of the subject Accident Year. Each payment after the initial calculation shall be based upon the Accident Year results as subsequently calculated. (ii) The Contingent Compensation for each Accident Year shall be recalculated as of each subsequent year-end until such time as all claims have been settled. (c) Further Adjustments. If, at any time, the net payment due for all lines and Accident Years combined (with respect to both property insurance and Umbrella SIR business and casualty insurance), valued at any December 31, is greater than the aggregate amount of the Contingent Compensation payments previously paid by Fairfax Inc. in connection with all subject Accident Years, Fairfax Inc. shall pay to PBC the additional amount, subject to Fairfax Inc.'s election to defer any amount of each payment in the event of a dividend shortfall as provided in Section A of this Article II. If the net payment due for all lines and Accident Years combined (with respect to both property insurance and Umbrella SIR business and casualty insurance), valued at December 31, is less than the payments previously paid by Fairfax Inc. in connection with all Accident Years, PBC shall pay the difference to Fairfax Inc. (d) Exclusion of Certain Expenses. In calculating the Contingent Compensation, Old Lyme shall not include as an expense (either as part of an administrative expense or otherwise) any charges incurred by Old Lyme, either directly or indirectly, for outside legal fees of Old Lyme that Old Lyme has incurred in negotiating, drafting or otherwise working on this Agreement or any of the following agreements prior to the Effective Date: (1) Claims Services Agreement by and between Old Lyme and Claims Administration Corporation, made and entered into as of January 1, 2002; (2) Administrative Services Agreement by and between United States Fire Insurance Company and Old Lyme, made and entered into as of January 1, 2002; (3) Administrative Services and Cost Allocation Agreement by and between Old Lyme and Kaye Group, made and entered into as of January 1, 2002; (4) Stock Purchase Agreement; and (5) the Underwriting Agreement. (e) Delivery of Information. The information necessary to prepare the Contingent Compensation Statement in respect of each Accident Year (with respect to both property insurance and Umbrella SIR business and casualty insurance) shall be delivered to Old Lyme, or to such affiliate of Old Lyme as Fairfax Inc. may direct, no less than 15 days prior the date on which the Contingent Compensation to which such Statement relates is due to be paid. (f) Review of Contingent Compensation Calculations. PBC shall have the right to review each Contingent Compensation calculated by or on behalf of 5 Old Lyme pursuant to this Article II.B and set forth in a Contingent Compensation Statement. C. Form and Method of Payments. All payments due hereunder shall be disbursed to PBC or Fairfax Inc., as the case may be, by wire transfer in immediately available funds to an account to be designated in writing by the party receiving such payment. ARTICLE III TERM AND TERMINATION The term of this Agreement shall be continuous unless terminated as provided in the following sentence. This Agreement shall terminate automatically and immediately upon termination of the Underwriting Agreement for any reason; provided, however, that all payments that would otherwise be required to be made pursuant to this Agreement shall continue to be made in such amounts, and at such times, as provided herein. ARTICLE IV MISCELLANEOUS PROVISIONS A. Cooperation. The parties shall cooperate in a commercially reasonable manner in order that the obligations of the parties hereunder will be effectively, efficiently and promptly discharged. Fairfax Inc. shall, and shall cause Old Lyme to, at all reasonable times, during their respective normal business hours, make available to PBC properly authorized personnel of Fairfax Inc. or Old Lyme for the purpose of consultation and decision and information as may be reasonably required by PBC. PBC shall: (i) promptly respond to any question from Old Lyme and persons authorized by it or by any regulator with respect to the accounts and records maintained in accordance with the terms of this Agreement; and (ii) assist and cooperate with Old Lyme's auditors and regulators in the conduct of any audit or examination of Old Lyme's financial condition and results of operations; and (iii) at all reasonable times, during its normal business hours, make available to Fairfax Inc. or Old Lyme properly authorized personnel of PBC for the purpose of consultation and decision and information as may be reasonably required by Fairfax Inc. or Old Lyme. B. Reasonableness. The parties will act reasonably and in good faith on all matters within the terms of this Agreement. C. Assignment. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns and legal representatives. This Agreement is not assignable except by operation of law or by written consent of the parties hereto. D. Amendments and Waivers. This Agreement may be amended at any time by an agreement in writing between the parties. The terms of this Agreement may be waived only by a written instrument signed by the party waiving compliance. No delay on the part of any party in exercising any right, power or privilege hereunder shall operate as a waiver 6 thereof. Nor shall any waiver on the part of any party of any right, power or privilege, nor any single or partial exercise of any such right, power or privilege, preclude any further exercise thereof or the exercise of any other such right, power or privilege. E. Entire Agreement. This Agreement constitutes the entire contract between the parties with respect to the subject matter hereof and there are no understandings between the parties as to the Services to be provided other than as expressed in this Agreement. Any amendment or modification hereto shall be null and void unless made by amendment to this Agreement and signed by all parties. F. No Third-Party Beneficiaries. Nothing in this Agreement is intended or shall be construed to give any person, other than the parties hereto, any legal or equitable right, remedy or claim under or in respect of this Agreement or any provision contained herein. G. Governing Law. This Agreement shall be interpreted and governed by the laws of the State of New York, without giving effect to the conflict of laws provisions of such jurisdiction. H. Invalidity. Unless the invalidity or unenforceability of any provision or portion hereof frustrates the intent of the parties or the purpose of this Agreement, such invalidity or unenforceability shall not affect the validity or enforceability of the other provisions or portions hereof. In the event that such provision shall be declared unenforceable by a court of competent jurisdiction, such provision, to the extent declared unenforceable, shall be stricken. However, in the event any such provision shall be declared unenforceable due to its scope, breadth or duration, then it shall be modified to the scope, breadth or duration permitted by law and shall continue to be fully enforceable as so modified. I. Dispute Resolution. In the event of an alleged breach of this Agreement or any dispute or difference arising with reference to the applicable interpretation or effect of this Agreement, or any part thereof (each, a "Dispute"), the parties agree to work together in good faith to resolve the matter internally by escalating to higher levels of management of the parties and to senior management of Fairfax Financial Holdings Limited and then, if necessary, to submit the matter to arbitration in the manner described below. No Dispute will be submitted to arbitration during such internal dispute process. The duration of such process will not exceed sixty (60) days starting upon the written notification of a Dispute from one party to the other. In any event, any party may stop the internal dispute resolution procedure whenever it, in good faith, determines that the procedure is no longer appropriate to resolve the Dispute. Notwithstanding the foregoing, PBC hereby acknowledges that nothing set forth in this Section (I) shall be construed as limiting the ability of Old Lyme to suspend, withdraw or terminate all or any part of the authority of PBC pursuant to the Underwriting Agreement. In the event a Dispute is not resolved pursuant to the preceding paragraph, such Dispute shall be referred to a Board of Arbitration (the "Board") of two (2) arbitrators and an umpire. The members of the Board shall be U.S. citizens and shall be active or retired disinterested officers of insurance or reinsurance companies. 7 1. One arbitrator shall be chosen by the party initiating the arbitration and designated in the letter requesting arbitration. The other party shall respond, within thirty (30) days, advising of its arbitrator. The umpire shall thereafter be chosen by the two (2) arbitrators. In the event either party fails to designate its arbitrator as indicated above, the other party is hereby authorized and empowered to name the second arbitrator, and the party which failed to designate its arbitrator shall be deemed to have waived its right to designate an arbitrator and shall not be aggrieved thereby. The two (2) arbitrators shall then have thirty (30) days within which to choose an umpire. If they are unable to do so, the umpire shall be chosen by the manager of the American Arbitration Association who shall be a person meeting the qualifications set forth above. Each party shall submit its case to the Board within thirty (30) days from the date of the appointment of the umpire, but this period of time may be extended by unanimous written consent of the Board. 2. The sittings of the Board shall take place in New York, New York, unless otherwise agreed by the parties hereto. The Board shall make its decision with regard to the custom and usage of the insurance and reinsurance business. The Board is released from all judicial formalities and may abstain from the strict rules of evidence. The written decision of a majority of the Board shall be rendered within sixty (60) days following the termination of the Board's hearings, unless the parties consent to an extension. Such majority decision of the Board shall be final and binding upon the parties both as to law and fact, and may not be appealed to any court of any jurisdiction. Judgment may be entered upon the final decision of the Board in any court of proper jurisdiction. 3. Each party shall bear the fees and expenses of the arbitrator elected by or on its behalf, and the parties shall bear the fees and expenses of the umpire as determined by the Board. J. Notices. Any notice or other communication required or permitted hereunder shall be in writing and shall be delivered personally, telegraphed, telexed, sent by facsimile transmission or sent by certified, registered or express mail, postage prepaid. Any such notice shall be deemed given when so delivered personally, telegraphed or telexed or sent by facsimile transmission to the appropriate facsimile number on Appendix A or, if mailed, three days after the date of deposit in the United States mails, to the appropriate address on Appendix A. Any party may, by notice given in accordance with this Agreement to the other parties, designate another address or person for receipt of notices hereunder. K. Headings. The headings in this Agreement are for convenience of reference only and shall not affect its interpretation. L. Non-exclusivity. Nothing herein shall be deemed to grant PBC an exclusive right to provide services to Old Lyme, and Old Lyme retains the right to contract with any third party, affiliated or unaffiliated, for the performance of services as have been requested by Old Lyme pursuant to this Agreement; provided, however, that, during the Term of this Agreement, Producers shall be the exclusive providers of Services to Old Lyme with respect to Existing Programs. 8 M. Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 9 IN WITNESS WHEREOF, the parties have caused this Agreement to be executed in triplicate by their respective officers duly authorized to do so, as of the date and year first above written. FAIRFAX INC. By: /s/ Bradley P. Martin ---------------------------------- Bradley P. Martin Vice President PROGRAM BROKERAGE CORPORATION By: /s/ Michael P. Sabanos ---------------------------------- Name: Title: EX-10.23 5 t07444a3exv10w23.txt UNDERWRITING SERVICES AGREEMENT EXHIBIT 10.23 UNDERWRITING SERVICES AGREEMENT This Underwriting Services Agreement (this "Agreement") is made and entered into on the 1st day of January, 2002 by and between Old Lyme Insurance Company of Rhode Island, Inc., a Rhode Island-domiciled insurance company ("Old Lyme"), and Program Brokerage Corporation, a Delaware corporation ("PBC"). WHEREAS, Old Lyme specializes in underwriting certain property and casualty risks; and WHEREAS, PBC is an insurance brokerage company that has extensive experience in providing underwriting support of such business; and WHEREAS, Old Lyme desires for PBC to provide underwriting support services to Old Lyme. NOW, THEREFORE, in consideration of the premises and of the mutual promises set forth herein, and intending to be legally bound hereby, Old Lyme and PBC agree as follows: ARTICLE I DEFINITIONS Capitalized terms used herein shall have the meanings set forth below: "CAC" means Claims Administration Corporation, a Delaware corporation. "Commission" has the meaning set forth in Article VII hereof. "Effective Date" means January 1, 2002. "Existing Program" means a Program produced by PBC and written directly, or assumed, by Old Lyme prior to the Effective Date. "Fairfax" means Fairfax Financial Holdings Limited. "Kaye Group" means Kaye Group Inc., a Delaware corporation. "Net Premiums" has the meaning set forth in Article V.A hereof. "New Program" means a Program presented to Old Lyme by PBC after the Effective Date. A Program that is a New Program shall be treated as an Existing Program for all purposes hereunder on and after the first anniversary of the effective date of such New Program. "Policy" and "Policies" means a policy or policies underwritten by Old Lyme and issued by PBC pursuant to this Agreement. "Premium Trust Account" has the meaning set forth in Article V.B hereof. "Premium Trust Account Guidelines" means the guidelines in respect of the Premium Trust Account set forth at Exhibit B hereof. "Premium Trust Funds" has the meaning set forth in Article V.B hereof. "PBC" has the meaning set forth in the preamble hereof. "Producer Systems" has the meaning set forth in Article VIII.D(iv) hereof. "Program" means a type or structure of coverage(s) offered to a number of like policyholders. "Services" has the meaning set forth in Article II.A hereof. "Statement" has the meaning set forth in Article V.C hereof. "Sub-Producers" has the meaning set forth in Article V.B hereof. "Term" has the meaning set forth in Article VIII hereof. "Underwriting Guidelines" has the meaning set forth in Article II(A) hereof. ARTICLE II UNDERWRITING AND RELATED SERVICES A. Subject to the limitations set forth in this Agreement, PBC shall provide underwriting and related services to Old Lyme set forth in Section B of this Article II (collectively, the "Services") in accordance with the Binding Authority Agreement, attached hereto as Exhibit A, and in accordance with Old Lyme's written underwriting guidelines, manuals, procedures, instructions, authority limits, and any memoranda (collectively, the "Underwriting Guidelines") in respect of the Policies and the Programs provided to PBC. Exhibit A and the Underwriting Guidelines are incorporated herein by reference. Exhibit A and the Underwriting Guidelines may be modified by Old Lyme from time to time without the need to amend this Agreement and shall be effective upon thirty (30) days' prior written notice to PBC. Additionally, Old Lyme may provide PBC with memoranda setting forth certain policies of Old Lyme with regard to the coverage or Policies written by PBC which shall govern PBC's conduct, including, but not limited to, permitted coverage, character and quality of risk, reporting, policies issued, renewals, cancellations, collections or remittance of premiums and premium refunds, accounting, and record keeping. PBC agrees to comply with and be bound by such memoranda without the need for amendment of this Agreement. B. Subject to the limitations set forth in this Agreement, the Services to be performed hereunder shall include, but not be limited to: 1. receipt of applications of insurance from producing subproducers; 2 2. review of applications of insurance to evaluate whether the insurance falls within the Underwriting Guidelines; 3. determination of the premium to be charged (within a range established as appropriate by Old Lyme and provided to PBC) and quote such premium to the producing broker; 4. collection, receipt of, and accounting for, premiums on Policies; 5. issuance, countersignature, and delivery of policies executed by authorized officers of Old Lyme within the authorized limits specified in the Underwriting Guidelines; 6. execution of endorsements, changes, modifications to, and cancellations and non-renewals of, Policies as authorized by Old Lyme; 7. when appropriate, ordering an inspection of the insured premises and communication with the producing broker regarding compliance with the inspector's recommendations; 8. negotiation of ceded and assumed reinsurance for specific Programs; 9. submission of necessary filings except rate, rule or form filings to applicable regulatory and quasi-regulatory bodies, including, but not limited to, the Excess Lines Association of New York and other applicable stamping offices; and 10. establishment and maintenance of a complaint log relating to the Policies and the Programs, which log shall include, at a minimum, the following information: Policy number; name(s) of insured(s); date and time claim received; name of complainant; location where complaint was received; description of complaint; whether complaint involves any communication with any regulatory or quasi-regulatory authority; action taken to date; and final resolution of complaint, including date of resolution. 11. Provision of any other related activities or services incidental or necessary to the complete servicing of Policies issued hereunder. On the Effective Date, and at least annually thereafter, the parties shall mutually agree upon the specific details of the Services to be provided hereunder. In no event shall the Services hereunder duplicate services provided to Old Lyme by any other affiliated corporation of Old Lyme. C. Notwithstanding Section B.9 of this Article II, unless PBC shall have received prior written approval of Old Lyme to communicate directly with an insurance department, communication and correspondence with the various insurance departments will be solely through Old Lyme. The parties will work together to promptly and adequately respond to any such correspondence. Nothing contained herein shall limit Old Lyme's final authority to establish rates and forms in its sole discretion. 3 ARTICLE III GENERAL OBLIGATIONS OF THE PRODUCERS A. PBC represents and warrants that it is, and will continue to be during the Term of this Agreement and thereafter while providing any continuing Services hereunder, authorized and licensed to perform all acts set forth in this Agreement and is further licensed as a surplus lines agent or broker, if applicable. PBC warrants that a managing general agency license is not required in any state in which PBC provides Services hereunder. In the event that PBC becomes subject to such law or there is a change in the law requiring such a license, PBC agrees and hereby warrants that it will obtain such a license. B. PBC shall maintain a listing and current copies of the insurance licenses of any sub-agent, producer, or broker (collectively, "Sub-Producers") from which PBC accepts a submission. PBC shall not appoint any Sub-Producer without first assuring that such Sub-Producer is lawfully licensed to transact the type of insurance for which such Sub-Producer is appointed. PBC shall be responsible to Old Lyme for all such Sub-Producers and for all funds related to business placed by PBC, whether or not collected, for business solicited by such Sub-Producers. At Old Lyme's request, PBC shall allow Old Lyme to review, or provide copies to Old Lyme of, the listing of and any agreements with such Sub-Producers. C. PBC shall be responsible for full compliance with all applicable laws, regulations, rules, and requirements relating to the performance of its obligations hereunder, including, but not limited to, maintaining all necessary licenses in jurisdictions in which Old Lyme writes insurance on an admitted or excess or surplus lines basis; the general standards, rules, and regulations of the insurance industry; and all written instructions provided to PBC from time to time by Old Lyme. D. Upon request, PBC shall forward to Old Lyme no later than five (5) days from such request (or such longer period as may be reasonably necessary for PBC to produce such information) exact copies of all Policies or other appropriate evidences of insurance written, modified, or cancelled pursuant to this Agreement; underwriting and financial documents or other reports written, produced, or received hereunder; policyholder data; or any other information in PBC's possession requested by Old Lyme relating to the Policies. E. PBC shall keep true and complete records of all transactions and correspondence with policyholders, producers, sub-producers, brokers, state insurance departments, reinsurers, and Old Lyme. F. All records and documents required to be maintained by PBC referred to herein, including, but not limited to, policyholder information, underwriting files, financial documents, and records relating to PBC's Premium Trust Account, shall be maintained during the Term and thereafter while providing any continuing services hereunder, in a manner and form as mutually agreed upon or as required by Old Lyme to be compatible with Old Lyme's internal systems and in accordance with generally accepted accounting principles and insurance regulatory practices. Promptly upon termination of this Agreement, PBC shall return to Old Lyme all records and documents and any copies thereof maintained by it 4 pursuant to this Agreement; provided, however, that with to any continuing services provided hereunder, PBC shall continue to maintain such records and documents and any copies thereof and shall return them to Old Lyme upon conclusion of the continuing services that may be required as to any Policy. G. During the Term hereof, and notwithstanding termination hereof, such records and documents may be inspected, audited, examined, and copied by representatives of Old Lyme at any time during normal business hours and shall be made available for examination by Old Lyme, its reinsurers, or any state insurance department or regulatory body which so requires. H. PBC shall provide Old Lyme with a monthly written report in the format prescribed by Old Lyme of all declaration(s) or policy(ies) issued, spoiled, voided, or mutilated inadvertently hereunder. Such written report shall list all such declaration(s) and policy(ies) in continuous numerical sequence and shall set forth an explanation of gaps, if any, in such sequence. PBC further agrees to return any such issued, spoiled, voided, or mutilated declaration(s) or policy(ies) to Old Lyme with such report. I. With regard to the Policies written, PBC shall provide, at its expense and within a reasonable time, sufficient information to satisfy reasonable reporting requirements imposed on Old Lyme by boards, bureaus, and associations, and to enable Old Lyme and reinsurers to file required financial statements and reports with state insurance departments and regulatory bodies. Old Lyme shall provide PBC with such written reporting requirements. J. Except as specifically provided herein, PBC shall have no authority to delegate any authority contained herein to sub-agents, brokers, producers, sub-producers, or to any other person or entity, or to enter into any joint ventures or other arrangements with wholesalers or other entities with respect to the Services, without the prior written authorization from Old Lyme. Notwithstanding the foregoing, PBC shall not delegate the binding authority received by them pursuant to this Agreement. K. PBC acknowledges that it and its employees are independent contractors and not employees of Old Lyme and, accordingly, all agency expenses including, but not limited to, PBC's office rent; transportation; salaries; utilities; furniture; fixtures; equipment; telephone; attorney or other legal fees; postage; promotional advertising and public relations expenses; printing costs of proposals, premium notices, records, and reports; inspection fees; retail credit reports and any other documents required to fulfill the obligations of PBC under this Agreement; commissions, fees, or countersignature fees due to agents, sub-agents, producers, or brokers; and PBC's license fees and occupational taxes, whether billed to PBC or Old Lyme, shall be the sole liability of PBC, unless assumption of such expense by Old Lyme is agreed to in writing by Old Lyme. PBC will remit promptly to Old Lyme the amount of any such item billed to Old Lyme upon notice by Old Lyme to PBC of the charge therefor. 5 L. PBC shall not charge or commit Old Lyme to any expense, agreement, payment, debt, settlement, or obligation other than as expressly provided for herein. M. PBC may not use the name, logo, or service mark of Old Lyme or any of its affiliates in any advertising, promotional material, or in any material disseminated by PBC without the prior written consent of Old Lyme . Any such materials in use at the Effective Date shall be deemed consented to by Old Lyme. PBC shall maintain copies and provide an original to Old Lyme of any advertisement or other materials approved by Old Lyme along with full details concerning where, when, and how it was used. PBC shall be liable for any liability of or cost incurred by Old Lyme as a result of any such materials. N. All supplies (which shall not include any real property or furnishings) provided to a party or authorized for use by such party shall remain the property of the party that provided such supplies or authorized their use. Upon termination of this Agreement or PBC's authority hereunder, (i) at Old Lyme's request, PBC shall return all, or such supplies as Old Lyme may request, to Old Lyme or to its designated representative and (ii) at PBC's request, Old Lyme shall return all, or such supplies, as PBC may request, to PBC or its designated representative. O. PBC shall promptly report all claims, suits, or losses to Old Lyme or an adjuster or claim representative who has been designated by Old Lyme. PBC shall cooperate with Old Lyme or the assigned adjuster or claim representative in the investigation, adjustment, settlement, and payment of claims arising out of the Policies. All records, files, correspondence, or other materials pertaining to claims shall be the sole property of Old Lyme. Retention of a commission under the terms of this Agreement shall constitute a representation by PBC that all claims known to PBC have been accurately, promptly, and completely reported to Old Lyme or to an authorized claims representative of Old Lyme. P. 1. PBC shall notify Old Lyme in writing: (a) fifteen (15) days prior to any change of ownership of ten percent (10%) or more of the outstanding stock of PBC; (b) fifteen (15) days prior to any change in control of PBC or the owner of a controlling interest in PBC not related to the transfer of shares of either of PBC; and (c) within thirty (30) days of any change of any principal officer of PBC. 2. Old Lyme shall notify PBC in writing: (a) fifteen (15) days prior to any change of ownership of ten percent (10%) or more of the outstanding stock of Old Lyme; 6 (b) fifteen days (15) prior to any change in control of Old Lyme or the owner of a controlling interest in Old Lyme not related to the transfer of shares to Fairfax Inc.; (c) within thirty (30) days of any change of any principal officer of Old Lyme; (d) within five (5) days after any change to its Best's rating. Q. Subject to the terms, conditions and limitations of this Agreement, PBC agrees to perform the Services requested by Old Lyme pursuant to the terms of this Agreement diligently and in a professional manner. R. PBC agrees to furnish Old Lyme with a balance sheet and profit and loss statement each year, which statements shall accurately reflect the financial condition of PBC and will include an auditor's statement and report if PBC obtains audited statements. If PBC does not obtain audited statements, the financial information furnished may be unaudited, unless submission of an audited statement is required by the law of any state having jurisdiction over this Agreement. Such financial information shall be furnished to Old Lyme within ninety (90) days following the close of the fiscal year of PBC. S. PBC shall not charge to its subproducers or to Old Lyme's insureds any policy fees, membership fees or other compensation of any kind in connection with the business placed by PBC with Old Lyme without the prior written approval of Old Lyme. ARTICLE IV LIMITATIONS OF AUTHORITY A. With respect to the Policies which PBC is now or may in the future be authorized to solicit, transact, quote, underwrite, rate, or bind under this Agreement, PBC shall not solicit, transact, quote, underwrite, rate, bind or issue Policies on the following: 1. risks which are unacceptable in accordance with this Agreement, or the Underwriting Guidelines, procedures, instructions, or memoranda provided to PBC by Old Lyme from time to time, or in excess of the authority limits, or in violation of any other limitations set forth in Exhibit A or the Underwriting Guidelines; or 2. risks which are not in compliance with the applicable forms, rules, rates, or filings of Old Lyme according to their exact terms and to the laws and regulations in effect in the jurisdiction in which the risk is located; or 3. risks, coverages, or classes of business on which Old Lyme grants exclusive authority to any other person or entity; provided, however, that Old Lyme may not grant exclusive authority to any other person or entity for risks, coverages or classes of business written by PBC for Old Lyme under an Existing Program or a New Program and during the Term of this Agreement, PBC shall be the exclusive 7 provider of Services to Old Lyme with respect to Existing Programs and New Programs.. B. In the event that PBC solicits, transacts, quotes, underwrites, rates, binds or issues Policies as prohibited by Section A of this Article IV without the prior written approval of Old Lyme, whether intentional or not, PBC will immediately do such things and take such actions as are necessary to remove or to minimize Old Lyme's exposure as an insurer on such unacceptable risks or such excess policy limits. C. PBC shall have no authority to purchase reinsurance of any type on behalf of Old Lyme with respect to any Policy or Program written by or through PBC, shall have no authority to bind retrocessions on behalf of Old Lyme, and shall have no authority to commit Old Lyme to participate in insurance or reinsurance syndicates. For avoidance of doubt, without the prior written approval of Old Lyme, PBC shall have no authority to bind or otherwise commit Old Lyme to underwrite or otherwise participate in any ceded or assumed reinsurance risk in connection with any Policy or Program. D. PBC shall not act as an insurer for any insureds, and this Agreement shall not be construed as an insurance policy or any contract or agreement of indemnity of insureds. E. PBC has no authority to adjust or settle any claims arising out of or in connection with the Policies. PBC shall not collect payment from a reinsurer or commit Old Lyme to a claim settlement with a reinsurer. ARTICLE V PREMIUMS AND ACCOUNTING A. PBC shall be liable for and shall pay to Old Lyme all Net Premiums attributable to the Policies, whether or not such premiums have been collected by PBC, less Commissions. "Net Premiums" shall mean gross premiums written on Policies less return premiums due to cancellations and endorsements. B. All premiums collected by PBC on business issued by Old Lyme are the property of Old Lyme and shall be held in trust on behalf of Old Lyme in a fiduciary capacity ("Premium Trust Funds") and shall be deposited and maintained in an account separate and segregated from PBC's own funds or funds held by PBC on behalf of any other company or person and shall not be commingled with any other funds or accounts of PBC or any other company or person (the "Premium Trust Account"). The Premium Trust Account shall be maintained in an amount at least equal to the premiums (unpaid to Old Lyme), and return premiums (unpaid to policyholders or insureds) received by PBC. After premiums have been deposited into the Premium Trust Account, PBC may deduct from such account the appropriate Commission. The privilege of retaining such Commission shall not be construed as altering or diminishing PBC's fiduciary duties in respect of the Premium Trust Funds. For avoidance of doubt, PBC shall not deduct any amounts from the Premium Trust Account or the Premium Trust Funds other than deductions from the Premium Trust Account for Commission. The Premium Trust Account and the Premium Trust Funds 8 shall be solely for the purposes set forth herein and shall not be used for any other purpose, including without limitation, for payment by or reimbursement to PBC for any of their operating or other expenses. C. Old Lyme authorizes PBC to (i) maintain the Premium Trust Account in an interest-bearing trust account in a non-affiliated bank approved by Old Lyme in writing which meets the "Premium Trust Account Guidelines," a copy of which is set forth in Exhibit B attached hereto and incorporated herein by this reference and as modified from time to time by Old Lyme without the need for amending this Agreement, with interest payable to PBC until such amounts due to Old Lyme are paid as set forth below, and (ii) to deduct Commissions from the Premium Trust Account. PBC shall be responsible for full compliance with all applicable laws, regulations, rules, fiduciary obligations and requirements regarding the Premium Trust Funds and the Premium Trust Account. D. PBC shall provide Old Lyme with an itemized statement (the "Statement(s)") of money due to Old Lyme on an account-current basis and remit such amounts to Old Lyme within forty-five (45) days from the last day of the month from which coverage is effective. The Statements and the money due to Old Lyme as reflected thereon shall be delivered to Old Lyme on a monthly basis. Any dispute respecting such Statement(s) shall be resolved based on Old Lyme's records. Such Statement shall include the names of all insureds, the applicable policy effective date, the applicable policy expiration date, the transaction effective date for each policy or endorsement issued, the type of policy, the state or states in which the risk(s) is located, gross premium amount, net written premium amount, premiums collected, commission amount, and net premium amount, or such other information and in such format as Old Lyme may request from time to time. PBC shall properly report the location of the risks in order that Old Lyme may properly allocate premium taxes. E. PBC shall use diligence in collecting premiums from insureds. PBC is responsible for (i) earned premium whether or not collected from the insured; (ii) return commissions on cancellation credits; and (iii) commissions to subagents. PBC must process cancellations for non-payment of premiums and must forward copy of such cancellation notice to Old Lyme on the same date that the cancellation notice is sent to the insured. PBC may only process a flat cancellation within thirty (30) days of the policy effective date and such cancellation must be accompanied a lost policy release or the declaration page of the replacement policy. In no event shall backdating of flat cancels other than within the above thirty (30) day period be permitted. Any cancellation occurring more than thirty (30) days after the effective date of the policy must be on an earned premium basis and PBC is responsible for such earned premium. F. Notwithstanding termination of this Agreement, PBC shall refund to the policyholder or insured, as appropriate, or to Old Lyme if so directed by Old Lyme in writing, return premiums at the same rate as provided in the applicable Policy. Additionally, PBC shall refund to Old Lyme from PBC's own funds, Commissions (or other fees or amounts 9 retained by PBC) on return premiums at the same rate paid to PBC. PBC shall not be required to return, as commission or return commission, monies greater than the total Commission paid or otherwise payable to PBC. G. Should PBC default in any payment of any installment on any Policy, the installment option on such Policy shall be revoked and all premiums on such Policy shall be due and payable immediately. H. Notwithstanding Section F of this Article VI, if PBC fails to pay Old Lyme any premiums or monies when due, Old Lyme shall be entitled to the issuance of an injunction to obtain such premiums or monies, to prohibit PBC's use of such funds in violation of this Agreement, or to require PBC to deposit such funds in accordance with this Agreement; and the cost and expense thereof, including attorneys' fees, shall be borne by PBC. I. PBC agrees to be responsible for the collection from the insureds and payment to the appropriate governmental authority of any applicable excess or surplus lines taxes and the filing of all affidavits as required by the appropriate surplus lines governmental entities and jurisdictions and shall provide Old Lyme with written evidence of such payment and compliance on a quarterly basis. J. PBC shall be responsible for charging Old Lyme any sales or other similar tax, if any, due from Old Lyme in the Statement. Any penalties, fines, interest, etc., that may be imposed upon any taxes due by Old Lyme arising out of the failure of Producer to timely notify Old Lyme of such tax and unknown to Old Lyme shall be paid by PBC at PBC's own expense. ARTICLE VI EXISTING PROGRAMS AND RIGHT OF FIRST REFUSAL A. PBC and Old Lyme shall maintain all Existing Programs with Old Lyme; provided, however, that Old Lyme may terminate any Program which, in Old Lyme's sole, reasonable judgement, has been or is projected to be materially unprofitable or injurious to Old Lyme. Old Lyme shall notify PBC in writing ninety (90) days prior to the effective date of termination of any Program. In the event that Old Lyme terminates one or more Programs over a 24 month period and such Programs, in the aggregate, generated at least 25% of the net premiums written by Old Lyme during the preceding 12 month period, then PBC (i) is not required to maintain all Existing Programs with Old Lyme; or (ii) may terminate this Agreement, the Claims Agreement and the Administrative Services Agreement. PBC shall provide notice of termination of each agreement that it determines to terminate at least 30 days prior to the effective date of termination of such Agreement(s). In the event that PBC terminates this Agreement pursuant to this paragraph, Old Lyme shall raise no objection to PBC replacing Old Lyme (or carriers for whom Old Lyme is assuming the risk) as the carrier on all policies placed by Producer with Old Lyme. B. PBC shall present each New Program to Old Lyme prior to offering such New Program to any other carrier and Old Lyme shall have the right of first refusal with respect thereto 10 unless such New Program is not substantially similar to one or more Existing Programs or is otherwise not substantially similar to the kinds of insurance underwritten by Old Lyme at such time. C. Subject to the applicable laws and regulations of the jurisdiction in which the risk is located, and notwithstanding Article II.B hereof, Old Lyme shall have the right to reject any application or business submitted by PBC or to modify, cancel, or refuse to renew any business written hereunder and Old Lyme may at its option request that PBC modify any policy/certificate, or give notice of cancellation or non-renewal to the policyholder/certificate holder to effect the foregoing. Alternatively, or should PBC not act within a reasonable time, Old Lyme may send such notice directly to the policyholder/certificate holder. ARTICLE VII COMPENSATION As compensation for PBC's services hereunder, Old Lyme shall pay to PBC a Commission to be calculated as follows: A. Existing Programs: The rate of the Commission for Existing Programs to be paid by Old Lyme to PBC shall be the same rate paid by Old Lyme to PBC with respect to each Existing Program as of the Effective Date, not to exceed thirty-five percent (35%); and B. New Programs: The rate of the Commission for New Programs to be paid by Old Lyme to PBC shall be an amount to be mutually agreed upon by Old Lyme and PBC at the time PBC presents such New Program to Old Lyme. The Commission for a New Program shall not exceed thirty-five percent (35%) of gross written premium collected, less return premium, attributable to each such Program. ARTICLE VIII TERM AND TERMINATION A. Term and Termination Generally. Except as provided below, the term (the "Term") of this Agreement shall be continuous unless (1) terminated by mutual agreement among the parties; or (2) terminated by either party upon twelve (12) months prior written notice to the other party; or (3) terminated by either party for cause pursuant to Sections B and C of this Article VIII; or (4) terminated by PBC pursuant to Article VI.A. B. Termination by Old Lyme. Notwithstanding Section A. of this Article VIII, Old Lyme may immediately, unless otherwise indicated, upon written notice to PBC, terminate this Agreement in whole or in part, for cause, which cause shall include, but shall not be limited to, the following: 1. PBC, Kaye Group or any subsidiary of Kaye Group becomes insolvent, institutes or acquiesces in the institution of any bankruptcy, financial reorganization, or liquidation proceeding or any such proceeding is instituted against PBC, Kaye 11 Group or any subsidiary of Kaye Group and remains undismissed for thirty (30) days (PBC shall immediately notify Old Lyme of the foregoing); or 2. PBC, or the owner of a controlling interest in PBC, sells, exchanges, transfers, assigns, consolidates, pledges or causes to be sold, exchanged, transferred, assigned, consolidated, or pledged, all or substantially all of the stock or assets of PBC, or any entity controlling PBC, to a third party other than (a) Hub International Limited or its subsidiaries or (b) any other entity controlled directly or indirectly by Fairfax, without the prior written consent of Old Lyme. PBC shall immediately notify Old Lyme of any such sale, exchange, transfer, assignment, consolidation or pledge. For purposes of this Agreement, "control" and "controlled" shall have the meanings set forth in section 27-35-1(c) of the General Laws of the State of Rhode Island, as amended; or 3. PBC fails to maintain a staff qualified to service the Policies or to maintain the quality of services and obligations necessary to operate within this Agreement including, but not limited to, in the event that both Bruce Guthart and Marc Cohen are no longer employed by PBC; or 4. PBC fails to render timely and proper reports or premium accounting as required, or remit premiums when due, after ten (10) days written notice from Old Lyme; or 5. PBC fails to maintain premium funds in the amount and manner required in this Agreement; provided, however, that PBC shall have one (1) opportunity to correct such failure within ten (10) days notice by Old Lyme during any rolling twelve (12) month period; or 6. PBC engages in acts or omissions constituting abandonment, fraud, insolvency, misappropriation of funds, material misrepresentation, or gross and willful misconduct; or 7. PBC's licenses or certificates of authority are cancelled, suspended, or are declined renewal by any regulatory body in a jurisdiction in which PBC provides the Services if, after ninety (90) days, PBC fails to remedy such loss of license. PBC shall immediately notify Old Lyme of any such cancellation, suspension or declination of renewal; or 8. PBC binds risks (i) that are unacceptable in accordance with the underwriting guidelines, procedures, instructions, or memoranda provided for herein, or (ii) with limits in excess of those specified in the underwriting authority limits provided for herein, or (iii) with rates or policy forms or filings in a jurisdiction where PBC has knowledge that required regulatory approvals have not been met; or 9. PBC fails to permit Old Lyme to inspect, audit, examine and copy any records or files relating to the Policies in accordance with Article III.G hereof and PBC has 12 not, within ten (10) days following a written request by Old Lyme, permitted such inspection, audit, examination and copying; or 10. Old Lyme determines, in good faith, that PBC has otherwise materially breached any of its obligations hereunder, including, but not be limited to, a breach of PBC's obligations set forth in Articles II and III hereof. C. Termination by PBC. Notwithstanding Section A of this Article VIII, upon written notice, PBC may immediately, unless otherwise indicated, terminate this Agreement in whole or in part, for cause, which cause shall include, but not be limited to, the following: 1. Old Lyme or Fairfax Inc. institutes or acquiesces in the institution of any bankruptcy, financial reorganization, supervision, rehabilitation, conservationship or liquidation proceeding, or any such proceeding is instituted against Old Lyme or Fairfax Inc. and remains undismissed for thirty (30) days; or 2. Old Lyme's license, certificate of authority or surplus or excess lines eligibility is cancelled or declined renewal by any regulatory or quasi-regulatory body within the jurisdiction in which Old Lyme is issuing Policies hereunder, if after ninety (90) days Old Lyme fails to remedy such loss of license. 3. Old Lyme is downgraded by A.M. Best Company to a rating less than "A-"; or 4. Old Lyme terminates all Programs; or 5. Old Lyme terminates the Claims Services Agreement entered into with CAC and/or the Administrative Services and Cost Allocation Agreement with Kaye Group. Moreover, PBC may terminate this Agreement, for cause, if (i) Fairfax Inc. sells or otherwise transfers the stock of Old Lyme to another entity and such entity's A.M. Best Company rating is less than A- or becomes less than A-, and (ii) Fairfax does not provide PBC with notice that within 45 days thereafter, it shall assign all PBC-generated business of Old Lyme to an insurer which has a Best's rating of A- or better, and that such insurer has agreed to and has the ability to (pursuant to law and otherwise) assume all of Old Lyme's obligations under this Agreement, the Claims Services Agreement, the Administrative Services Agreement and the Administrative Services and Cost Allocation Agreement. The option to terminate this Agreement pursuant to this paragraph shall have no effect if the business produced by PBC is responsible for the downgrade of the shareholder's Best rating. D. Continued Servicing: PBC agrees that, in the event this Agreement is terminated for whatever reason, PBC shall continue to perform all customary and necessary Services regarding all Policies previously issued by PBC on behalf of Old Lyme in accordance with the provisions of this Agreement until all such Policies have been completely cancelled, non-renewed, or otherwise terminated; provided, however, that Old Lyme may, in its sole discretion, immediately suspend or terminate PBC's continuing service obligation 13 hereunder. PBC's continuing service obligations after termination of the Agreement shall include, but not be limited to: 1. the issuance and countersignature of appropriate endorsements to Policies when so authorized in writing by Old Lyme, provided that such endorsements shall not increase Old Lyme's liability or extend the term of any Policy without prior written approval of Old Lyme; 2. the issuance of all applicable cancellation and/or non-renewal notices in full and complete compliance with the applicable insurance code(s) or regulations and in accordance with any written instructions that may be issued by Old Lyme; 3. the collection and remittance of all premiums due on the Policies hereunder; 4. providing to Old Lyme a final accounting of all financial matters in connection with the Services provided hereunder; and 5. providing to Old Lyme for a reasonable period of time following the effective date of termination and at Old Lyme's own expense, reasonable access to all software, procedures, processes and systems generated, developed, or licensed by PBC and used in connection with the provision of the Services (collectively, the "Producer Systems"). Except in respect of clause (5) of this Section D, if PBC fails in any respect to fulfill the foregoing continuing service obligations, PBC shall reimburse Old Lyme any expense incurred by Old Lyme to service or arrange for the servicing of the Policies issued by or through PBC hereunder or such amounts may be offset by Old Lyme. This Section D shall survive termination of this Agreement. E. Upon Old Lyme providing written notice of termination to PBC hereunder, Old Lyme is hereby authorized to deal directly with all other licensed persons or entities with respect to the Policies hereunder with respect solely to the right to collect from and to return premiums directly to all sub-agents, producers, brokers, or insureds. F. During the Term and following termination of the Agreement, if PBC has made full payments of all amounts due Old Lyme and continue to do so in a timely manner, then PBC's expirations, renewals, and related records shall be the property of PBC. Notwithstanding the foregoing, all financial, claims, policy, and underwriting records shall continue to be maintained by PBC in accordance with Sections E and F of Article III, provided to Old Lyme in accordance with Section D of Article III, and available to Old Lyme as provided in Section G of Article III. If, during the Term and following termination of this Agreement, PBC has not made full payment to Old Lyme or PBC fails to make the payment within twenty (20) days after the resolution of a dispute and no dispute is pending in respect of any payment claimed to be due to PBC, then PBC's insurance Policy records, expirations, renewals, and related records may not be the exclusive property of PBC, and Old Lyme may be entitled to PBC's insurance Policy 14 records, and the use and control of expirations, renewals, and related records shall be vested in Old Lyme for sale, use, or disposal as Old Lyme deems fit. If and only if any dispute in respect of any payment claimed to be due to Old Lyme is resolved in favor of Old Lyme, and PBC does not then make payment of amounts due to Old Lyme within twenty (20) days after the resolution of the dispute, then PBC's insurance Policy records, expirations, renewals, and related records shall not be the exclusive property of PBC and Old Lyme shall be entitled to PBC's insurance Policy records, and the use and control of expirations, renewals, and related records shall be vested in Old Lyme for sale, use or disposal as Old Lyme deems fit. This Section F shall survive termination of this Agreement. ARTICLE IX ACCOUNTING RECORDS AND REPORTS A. All business records, reports, studies, documents, financial statements and other information generated by PBC pursuant to or relating to the Services provided to Old Lyme hereunder are the property of Old Lyme. All Producer Systems shall be the property of PBC; provided, however, that any such items developed by PBC pursuant to a formal written specification request from Old Lyme and paid for by Old Lyme, shall be the property of Old Lyme. B. If Old Lyme provides access to its information or networks through computer access, PBC shall be responsible for maintaining the security and integrity of such information and of Old Lyme's systems. Additionally, PBC shall be responsible to ensure that PBC's employees, agents, and representatives are aware of the sensitive and proprietary nature of the information obtained, of the importance of confidentiality, and of the conditions described in this Section B. C. In connection with the Services provided hereunder, PBC agrees to furnish Old Lyme financial, accounting, data processing and budgeting reports on a monthly basis, and actuarial reports on a quarterly basis, in each case in such manner and at such time as shall be reasonably required by Old Lyme. D. PBC shall be responsible for maintaining full and accurate accounts and records of all Services provided hereunder in accordance with applicable laws and regulations, and such additional information as Old Lyme may reasonably request for purposes of its internal bookkeeping and accounting operations, including, without limitation, the preparation of GAAP and SAP annual and quarterly financial statements, or to evaluate the profitability of any Policy or Program. PBC shall keep copies of such accounts and records available at their principal offices for audit, inspection and copying by Old Lyme and persons authorized by it or any governmental agency having jurisdiction over Old Lyme (a "Regulator") upon reasonable notice during all reasonable business hours and Old Lyme shall maintain copies of such accounts and records at its home office in Rhode Island. E. PBC shall promptly respond to any question from Old Lyme and persons authorized by it or any Regulator with respect to the accounts and records maintained in accordance with 15 the terms of this Agreement. PBC shall also assist and cooperate with Old Lyme's auditors and Regulators in the conduct of any audit or examination of Old Lyme's financial condition and results of operations. ARTICLE X INSURANCE AND INDEMNIFICATION A. PBC is required to maintain in full force and effect the following policies of insurance issued by an insurer rated no less than "A-" by A. M. Best Company during the Term of this Agreement and thereafter while PBC has any obligations hereunder: 1. errors and omissions insurance covering PBC and its employees in the minimum amount of Ten Million Dollars ($10,000,000) with a deductible not to exceed five hundred thousand dollars (500,000); 2. fidelity insurance covering PBC and its employees in the minimum amount of Five Million Dollars ($5,000,000); 3. commercial general liability insurance (including personal injury) covering PBC and its employees in the minimum amount of One Million Dollars ($1,000,000) single limit per occurrence covering PBC and its employees and a Five Million Dollars ($5,000,000) umbrella policy covering PBC and its employees; 4. non-owned automobile liability insurance covering PBC's employees in the minimum amount of One Million Dollars ($1,000,000) single limit per occurrence and a Five Million Dollars ($5,000,000) umbrella policy covering PBC and its employees; and 5. workers compensation insurance in at least the minimum amounts required to be maintained by PBC by any applicable statute or regulation. Such insurance shall be maintained by PBC at its sole cost and expense and shall be primary and noncontributing coverage with regard to any valid and collectible insurance available to Old Lyme. PBC shall request its insurers to provide thirty (30) days prior notification to Old Lyme, and PBC agrees to immediately notify Old Lyme when it receives notice of lapse, increased deductibles, decreased coverage, or upon receipt of a notice terminating coverage. Prior to the Effective Date and on or before January 30 of each year thereafter, PBC shall furnish proof of such insurance. PBC further agrees to notify Old Lyme of any claim brought under any such policy which arises out of or is connected with the Services performed hereunder. B. Indemnification by Old Lyme. Old Lyme shall indemnify, defend and hold harmless each of PBC and its affiliates and directors, officers, employees and agents from and against any and all claims, liabilities, demands, actions, proceedings, damages, including punitive, consequential or extracontractual obligations and obligations in excess of original policy limits, losses, deficiencies, fines, penalties, costs or expenses, including reasonable attorneys' fees ("Demands") to the extent relating to or arising out of any act or omission of 16 Old Lyme, its affiliates and directors, officers, employees and agents, in performing their obligations under this Agreement except to the extent such act or omission occurred at the direction of or request of PBC or in conformity with guidelines or instructions provided by PBC. Old Lyme shall further indemnify and hold PBC and its affiliates and directors, officers, employees and agents harmless from and against any and all Demands to the extent relating to or arising in any way as a result of the Old Lyme's breach of this Agreement or the failure of Old Lyme to make available to PBC any information or to provide any services required to be made available to or provided to PBC under this Agreement. Notwithstanding the foregoing, Old Lyme shall not indemnify for any Demands to the extent arising from the willful misconduct, bad faith or gross negligence on the part of PBC and its affiliates and directors, officers, employees and agents, other than Old Lyme. C. Indemnification by PBC. PBC shall indemnify, defend and hold harmless Old Lyme and its affiliates and directors, officers, employees and agents from and against any and all Demands to the extent relating to or arising out of any act or omission of PBC, its affiliates and directors, officers, employees and agents in performing its obligations under this Agreement except to the extent such act or omission occurred at the direction of or request of Old Lyme or in conformity with guidelines or instructions provided by Old Lyme. PBC shall further indemnify and hold Old Lyme and its affiliates and directors, officers, employees and agents harmless from and against any and all Demands to the extent relating to or arising in any way as a result of PBC's breach of this Agreement or the failure of PBC to make available to Old Lyme any information or to provide any services required to be made available to or provided to Old Lyme under this Agreement. Notwithstanding the foregoing, PBC shall not indemnify for any Demands to the extent arising from the willful misconduct, bad faith or gross negligence on the part of Old Lyme and its affiliates and directors, officers, employees and agents other than PBC. D. The provisions of Sections B. and C. of this Article X shall survive termination of this Agreement. E. Indemnification Procedure. If a party hereto (the "Indemnified Party") asserts that another party (the "Indemnifying Party") has become obligated to indemnify pursuant to this Article X, or if any suit, action, investigation, claim or proceeding is begun, made or instituted as a result of which the Indemnifying Party may become obligated to the Indemnified Party hereunder, the Indemnified Party shall give written notice to the Indemnifying Party within a sufficiently prompt time to avoid prejudice to the Indemnifying Party, specifying in reasonable detail the facts upon which the claimed right to indemnification is based. The Indemnifying Party shall, at its own cost, be entitled to contest or defend any action against the Indemnified Party. The Indemnified Party and the Indemnifying Party shall each be entitled to choose counsel of their choice and each party shall bear the cost of counsel it so chooses. In the event of the settlement of an action for which indemnification is required, the Indemnifying Party shall not be required to indemnify the Indemnified Party unless the Indemnifying Party shall have agreed to the terms of such settlement, which agreement shall not be unreasonably withheld. Any payment to be made by an Indemnifying Party shall be made within thirty (30) days of the 17 delivery of notice of an uncontested claim to indemnification or final determination of the amount to be indemnified. ARTICLE XI MISCELLANEOUS PROVISIONS A. Cooperation. The parties shall cooperate in a commercially reasonable manner in order that the duties assumed by PBC will be effectively, efficiently and promptly discharged. Old Lyme shall, at all reasonable times, during its normal business hours, make available to PBC properly authorized personnel of Old Lyme for the purpose of consultation and decision and information as may be reasonably required by PBC. B. Reasonableness. The parties will act reasonably and in good faith on all matters within the terms of this Agreement. C. Assignment. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns and legal representatives. This Agreement is not assignable except by operation of law or by written consent of all of the parties hereto. D. Amendments and Waivers. This Agreement may be amended at any time by an agreement in writing between the parties. The terms of this Agreement may be waived only by a written instrument signed by the party waiving compliance. No delay on the part of any party in exercising any right, power or privilege hereunder shall operate as a waiver thereof. Nor shall any waiver on the part of any party of any right, power or privilege, nor any single or partial exercise of any such right, power or privilege, preclude any further exercise thereof or the exercise of any other such right, power or privilege. E. Entire Agreement. This Agreement constitutes the entire contract between the parties with respect to the subject matter hereof and there are no understandings between the parties as to the Services to be provided other than as expressed in this Agreement. Any amendment or modification hereto shall be null and void unless made by amendment to this Agreement and signed by all parties. F. No Third-Party Beneficiaries. Nothing in this Agreement is intended or shall be construed to give any person, other than the parties hereto, any legal or equitable right, remedy or claim under or in respect of this Agreement or any provision contained herein. G. Governing Law. This Agreement shall be interpreted and governed by the laws of the State of New York, without giving effect to the conflict of laws provisions of such jurisdiction. H. Invalidity. Unless the invalidity or unenforceability of any provision or portion hereof frustrates the intent of the parties or the purpose of this Agreement, such invalidity or unenforceability shall not affect the validity or enforceability of the other provisions or portions hereof. In the event that such provision shall be declared unenforceable by a court 18 of competent jurisdiction, such provision, to the extent declared unenforceable, shall be stricken. However, in the event any such provision shall be declared unenforceable due to its scope, breadth or duration, then it shall be modified to the scope, breadth or duration permitted by law and shall continue to be fully enforceable as so modified. I. Dispute Resolution. In the event of an alleged breach of this Agreement or any dispute or difference arising with reference to the applicable interpretation or effect of this Agreement, or any part thereof (each, a "Dispute"), the parties agree to work together in good faith to resolve the matter internally by escalating to higher levels of management of the parties and to senior management of Fairfax and then, if necessary, to submit the matter to arbitration in the manner described below. No Dispute will be submitted to arbitration during such internal dispute process. The duration of such process will not exceed sixty (60) days starting upon the written notification of a Dispute from one party to the other. In any event, any party may stop the internal dispute resolution procedure whenever it, in good faith, determines that the procedure is no longer appropriate to resolve the Dispute. Notwithstanding the foregoing, nothing set forth in this Section (I) shall be construed as limiting the ability of Old Lyme to suspend, withdraw or terminate all or any part of the authority of PBC pursuant to this Agreement. In the event a Dispute is not resolved pursuant to the preceding paragraph, such Dispute shall be referred to a Board of Arbitration (the "Board") of two (2) arbitrators and an umpire. The members of the Board shall be U.S. citizens and shall be active or retired disinterested officers of insurance or reinsurance companies. 1. One arbitrator shall be chosen by the party initiating the arbitration and designated in the letter requesting arbitration. The other party shall respond, within thirty (30) days, advising of its arbitrator. The umpire shall thereafter be chosen by the two (2) arbitrators. In the event either party fails to designate its arbitrator as indicated above, the other party is hereby authorized and empowered to name the second arbitrator, and the party which failed to designate its arbitrator shall be deemed to have waived its right to designate an arbitrator and shall not be aggrieved thereby. The two (2) arbitrators shall then have thirty (30) days within which to choose an umpire. If they are unable to do so, the umpire shall be chosen by the manager of the American Arbitration Association who shall be a person meeting the qualifications set forth above. Each party shall submit its case to the Board within thirty (30) days from the date of the appointment of the umpire, but this period of time may be extended by unanimous written consent of the Board. 2. The sittings of the Board shall take place in New York, New York, unless otherwise agreed by the parties hereto. The Board shall make its decision with regard to the custom and usage of the insurance and reinsurance business. The Board is released from all judicial formalities and may abstain from the strict rules of evidence. The written decision of a majority of the Board shall be rendered within sixty (60) days following the termination of the Board's hearings, unless the parties consent to an extension. Such majority decision of the Board shall be final and binding upon the parties both as to law and fact, and may not be appealed to 19 any court of any jurisdiction. Judgment may be entered upon the final decision of the Board in any court of proper jurisdiction. 3. Each party shall bear the fees and expenses of the arbitrator elected by or on its behalf, and the parties shall bear the fees and expenses of the umpire as determined by the Board. J. Equitable Relief Available. Notwithstanding anything to the contrary in Section I of this Article XI, Old Lyme and PBC acknowledge that it will be impossible to measure in money the damages if any of them fails to comply with certain obligations imposed by this Agreement, that every obligation is material, and that in the event of any failure to comply the injured party will not have an adequate remedy at law or in damages. Old Lyme and PBC further acknowledge that money damages would be insufficient to obtain the duplicate or substantial equivalent of the promised performance of the other as provided in this Agreement due to the unique character of this Agreement. Old Lyme and PBC further acknowledge that substantially equivalent performance could not be obtained by the other due to the difficulty, delay, and inconvenience involved. Therefore, Old Lyme and PBC agree that the obligations set forth in Article II.C, Article III, Article IV, Article VIII.D(v) and Article IX under this Agreement may be enforced by temporary and permanent injunctive relief or other available equitable remedies against each of them at the suit of the other without bond or other security to compel performance of the terms of this Agreement. Old Lyme and PBC waive and covenant not to raise as a defense in any action seeking injunctive relief (i) failure of consideration and (ii) availability of relief in damages. Without in any way limiting the foregoing, upon Old Lyme's termination of the authority of PBC to perform the Services, upon the refusal of PBC to deliver such files to Old Lyme within a reasonable time, PBC agrees to consent to the entry of an injunction requiring PBC to deliver all policy underwriting and claims files required to be maintained by PBC hereunder to permit Old Lyme to properly discharge its obligations in respect of the Policies and to adequately protect its interests in connection therewith. In addition, Old Lyme and PBC agree that any award of injunctive relief will include recovery of associated costs and expenses (including reasonable attorneys' fees). K. Government Action. PBC and Old Lyme shall notify the other within ten (10) days of notice or receipt (or such shorter period as necessary to adequately respond) of any inquiry, investigation, cease and desist order, audit, complaint or other similar matter from any state or federal regulatory or law enforcement body or any similar organization relating to the Policies, any Program or any Service hereunder, whether against Old Lyme, PBC, producers, sub-agent, or brokers. PBC shall provide Old Lyme with a proposed written response to a complaint and a copy of all documentation relating to such complaint including, but not limited to, a written summary of all facts relevant to such complaint. Old Lyme will then respond, or authorize PBC to respond, to such complaint in such form as Old Lyme determines, in Old Lyme's sole discretion, necessary. The parties will work together to promptly and adequately respond to any such complaint. L. Privacy. Neither party shall disclose any non-public personal, medical or financial information gathered in the course of performing any Services hereunder to any third party 20 and shall in all respects comply with the Gramm-Leach-Bliley Act, Pub. L. No. 106-102, 113 Stat. 1338 (1999) as implemented by any and all state insurance regulatory bodies. Further, both parties shall comply with any and all privacy regulations and statutes applicable to any information obtained by either party as a result of the Services and shall be solely responsible for any fines, penalties or damages associated with its own improper disclosure of protected information and shall fully defend, indemnify, and hold harmless the other party for any such improper disclosure in accordance with Article VII hereof. M. Notices. Any notice or other communication required or permitted hereunder shall be in writing and shall be delivered personally, telegraphed, telexed, sent by facsimile transmission or sent by certified, registered or express mail, postage prepaid. Any such notice shall be deemed given when so delivered personally, telegraphed or telexed or sent by facsimile transmission to the appropriate facsimile number on Appendix A or, if mailed, three days after the date of deposit in the United States mails, to the appropriate address on Appendix A. Any party may, by notice given in accordance with this Agreement to the other parties, designate another address or person for receipt of notices hereunder. N. Headings. The headings in this Agreement are for convenience of reference only and shall not affect its interpretation. O. Non-exclusivity. Nothing herein shall be deemed to grant PBC an exclusive right to provide services to Old Lyme, and Old Lyme retains the right to contract with any third party, affiliated or unaffiliated, for the performance of services as have been requested by Old Lyme pursuant to this Agreement; provided, however, that, during the Term of this Agreement, PBC shall be the exclusive providers of Services to Old Lyme with respect to Existing Programs. P. Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 21 IN WITNESS WHEREOF, the parties have caused this Agreement to be executed in triplicate by their respective officers duly authorized to do so, as of the date and year first above written. OLD LYME INSURANCE COMPANY OF RHODE ISLAND, INC. By: /s/ Michael P. Sabanos ----------------------------------- Name: Title: PROGRAM BROKERAGE CORPORATION By: /s/ Michael P. Sabanos ----------------------------------- Name: Title: EX-10.24 6 t07444a3exv10w24.txt CLAIMS SERVICES AGREEMENT EXHIBIT 10.24 CLAIMS SERVICES AGREEMENT This Claims Services Agreement (this "Agreement") is made and entered into on the ___ day of May, 2002 (the "Effective Date") by and between Old Lyme Insurance Company of Rhode Island, Inc., a Rhode Island-domiciled insurance company ("Old Lyme"), and Claims Administration Corporation, a Delaware corporation ("CAC"). WHEREAS, Old Lyme from time to time issues certain policies of insurance; and WHEREAS, Old Lyme is seeking the assistance of a claims administrator and adjuster; and WHEREAS, CAC is in the business of providing claims adjusting and claims administration services and is willing to perform the services hereinafter set forth. NOW, THEREFORE, in consideration of the covenants, promises and obligations contained herein and for other good and valuable consideration, receipt of which is acknowledged, the parties hereto agree as follows: ARTICLE I CLAIMS SUPPORT A. CAC, when requested by Old Lyme and at the sole discretion of Old Lyme, shall, subject to the terms, conditions and limitations set forth in this Agreement, provide to Old Lyme claims support functions and services as set forth at Exhibit A, Claims Service Standards and Performance Definitions (collectively, the "Services"). On the Effective Date, and at least annually thereafter, CAC and Old Lyme shall mutually agree upon the specific details of the Services to be provided hereunder and the costs therefor. In no event shall the Services provided hereunder duplicate services provided to Old Lyme by any other affiliated corporation of Old Lyme. B. With respect to any Service provided to Old Lyme hereunder, it is understood that: (i) CAC shall provide such Service in accordance with Old Lyme's claims handling standards, policies and procedures, including claims authority levels applicable to all lines of business as such may be amended from time to time as defined in Exhibit A; and (ii) Old Lyme shall retain final claims settlement authority for all claims settlements in excess of $100,000. For avoidance of doubt, CAC shall have no authority to commit to settle any insurance claim in an amount in excess of $100,000. Old Lyme shall at all times maintain authority to retain or assume control of any claim and to increase or decrease such settlement authority limit. C. Subject to the terms, conditions and limitations of this Agreement, CAC agrees to perform all Services diligently and in a manner consistent with the claims standards and sound claims handling practice recognized by the insurance industry and professional claims adjustment services. CAC shall be familiar with the claims standards set forth in Exhibit A and will familiarize itself and comply with any written revisions or supplements thereto issued by Old Lyme following execution of this Agreement. CAC 2 Claims Services Agreement shall provide the Services in accordance with all applicable federal and state laws, rules and regulations, or any regulations imposed by any competent regulatory body. Personnel assigned to handle claims shall maintain all required licenses and shall complete all required training in connection therewith. CAC will promptly notify Old Lyme in writing of any conflicts between the claims standards set forth in Exhibit A and any law or regulation applicable to any claim CAC is handling. D. CAC will respond on behalf of Old Lyme to all inquiries and complaints from applicants, insureds and claimants. With regard to insurance regulatory body complaints, CAC shall provide a response to such complaints within ten (10) from the date CAC receives each such complaint and in no event later than the due date for such response as contained in such complaint. In addition, CAC shall answer all inquires and complaints from any state or federal agency and provide to Old Lyme a copy of such complaint or inquiry and the response thereto. All complaints and inquiries and responses thereto shall be kept in the files of CAC. E. CAC shall be solely responsible for all licensing and training and for ensuring that all such licenses remain current and at all times comply with all applicable continuing education and other requirements imposed thereon. 3 ARTICLE II COMPENSATION A. The charges for the Services rendered by CAC to Old Lyme will be in accordance with the schedule attached hereto as Appendix A. It is intended that the charges for the Services will be fair and equitable and will, as nearly practicable, be commercially reasonable rates. Old Lyme shall be entitled to evaluate the charges for the Services provided hereunder no less frequently than once per calendar year. B. CAC shall submit to Old Lyme monthly invoices for the charges for the Services as set forth in Section 2(A). Old Lyme shall thereafter remit payment to CAC within ten (10) days after receipt of said invoice. ARTICLE III INDIVIDUAL CLAIMS FUNDING ACCOUNT A. Losses on claims handled by CAC will be paid with funds provided by Old Lyme to CAC for those purposes. CAC acknowledges and agrees that all such funds shall remain the property of Old Lyme. CAC will receive and hold such funds as a fiduciary in trust for Old Lyme for the sole purpose of paying covered losses and Allocated Loss Adjustment Expenses. CAC shall establish an interest-bearing fiduciary account designated as the Old Lyme Individual Claims Funding Account (the "Claims Funding Account"), which account shall be established in the name of Old Lyme Insurance Company of Rhode Island, Inc. Interest earned on the assets of the Claims Funding Account shall be immediately deposited into the Claims Funding Account and shall be separately reported, 4 net of bank fees, to Old Lyme as at June 30 and December 31 within sixty (60) days following each such date. The bank at which the Claims Funding Account is established shall be a member of the FDIC and shall not be a parent, subsidiary or affiliate of CAC. CAC agrees not to commingle any other moneys with such Claims Fund Account and at all times shall maintain sufficient books and records to evidence the establishment and maintenance of the Individual Claims Finding Account. B. The initial balance of the Claims Funding Account shall be five hundred thousand dollars ($500,000.00), which amount shall be reviewed periodically by Old Lyme and CAC and increased or decreased as necessary to approximate ninety (90) days of losses as projected by Old Lyme. In no event shall CAC retain in the Claims Fund Account or otherwise an amount in excess of three (3) months estimated claims payments and Allocated Loss Adjustment Expenses. Individual payments in excess of fifty thousand dollars ($50,000) shall be separately funded, prior to payment, by wire transfer on the basis of a special invoice issued by CAC to Old Lyme. The wire transfer shall take place within five (5) business days following receipt by Old Lyme of the invoice. CAC shall acknowledge receipt of such funds in writing. In the event that CAC advances claims payments, which in no event may be in excess of fifty thousand dollars ($50,000), such claim payment will be reimbursed by Old Lyme to CAC. C. CAC will deposit into the Claims Funding Account all recoveries, including, but not limited to, subrogation, salvage, reimbursements of third party deductibles and adjustments to previous payments for claims expenses. 5 D. All dividends, interest and other income resulting from the investment of the assets in the Claims Funding Account shall be the property of Old Lyme and shall be payable to Old Lyme. CAC acknowledges its obligation to return the balance of the Claims Funding Account within five (5) days after termination of this Agreement or the closing of the last claim submitted to CAC by Old Lyme. E. In addition to charges paid in accordance with Article II(B) hereof, Old Lyme shall reimburse CAC for (i) loss payments made on behalf of Old Lyme, and (ii) Allocated Loss Adjustment Expenses (as defined in Exhibit B). CAC expressly acknowledges and agrees that Allocated Loss Adjustment Expenses do not include any part of the salaries of employees of CAC, its overhead, ordinary travel expenses or other normal and ordinary costs of a similar nature or any fees and expenses relating to claim services charged by CAC or a subcontractor of CAC. ARTICLE IV TERMINATION A. Except as provided below, this Agreement shall be continuous unless: (i) terminated by mutual agreement between the parties; or (ii) terminated by either party upon twelve (12) months prior written notice to the other party. In the event of termination pursuant to this Section A, in Old Lyme's sole discretion, CAC shall continue to handle all claims reported prior to the effective date of termination at such rates of compensation as may be 6 in effect as of such date, unless such continued handling shall be commercially unreasonable due to the voluntary termination of CAC's employees. B. Old Lyme may terminate this Agreement in the event that CAC has materially breached any of its obligations hereunder (a "Material Breach"), provided that (i) Old Lyme shall have first notified CAC in writing of such Material Breach (a "Notice of Material Breach) and (ii) CAC shall not have cured the Material Breach within sixty (60) days following delivery to CAC of the Notice of Material Breach (the "Cure Period"). Termination pursuant to this Section B shall become effective upon the expiration of the Cure Period. For purposes of this Section B, a Material Breach shall include, but not be limited to, a breach of CAC's obligations set forth in Article I(B) hereof. C. Old Lyme may, in its sole discretion, terminate this Agreement in the event of a transfer of ownership or change in control of CAC, other than a Permitted Change of Control. A "Permitted Change of Control" means a sale or other transfer of all, or any portion of, the voting securities of CAC as a result of which Hub International Limited directly indirectly controls a majority of the voting securities of CAC. Termination pursuant to this Section C shall become effective immediately upon the effectiveness of the transfer of ownership or change in control. For purposes of this Agreement, "control" and "controlled" shall have the meanings set forth in section 27-35-1(c) of the General Laws of the State of Rhode Island, as amended. 7 D. In the event this Agreement is terminated, the parties shall cooperate in a commercially reasonable manner to ensure that such termination does not unduly disrupt the business operations of Old Lyme. For greater certainty, Old Lyme shall, for a reasonable period of time following the effective date of termination and at its own expense, continue to have reasonable access to all software, procedures, processes and systems generated, developed, or licensed by CAC and used in connection with the provision of the Services (collectively, the "CAC Systems"). E. Notwithstanding any other provision of this Agreement, Old Lyme may, because of profitability or regulatory concerns, in its sole discretion, terminate CAC's handling of certain Programs. In the event that Old Lyme terminates CAC's handling of certain Programs over a 24 month period and such Programs, in the aggregate, generated at least 25% of the net premiums written by Old Lyme during the preceding 12 month period, then CAC and/or the relevant Kaye Group Inc. subsidiaries may terminate the Underwriting Services Agreement, this Agreement and the Administrative Services Agreement. CAC and/or the Kaye subsidiaries shall provide notice of termination of each agreement that it determines to terminate at least 30 days prior to the effective date of termination of such agreement(s). ARTICLE V ACCOUNTING RECORDS AND REPORTS AND AUDITS A. CAC acknowledges and agrees that all business records, reports, studies, documents, financial statements, claims files and related records, regardless of the medium or media in which they are kept (collectively, "Claims Files"), relating to this Agreement and the 8 Services provided hereunder, whether generated by Old Lyme or CAC, are the property of Old Lyme and shall be surrendered to Old Lyme upon its demand. CAC acknowledges that its failure to surrender Claims Files would subject Old Lyme to irreparable harm and is grounds for Old Lyme to seek legal redress including, but not limited to, obtaining a court order directing CAC to surrender such Claims Files. At all times, CAC will maintain files on its claims administration system until such files are surrendered to Old Lyme. All CAC Systems shall be the property of CAC; provided, however, that any such items developed by CAC pursuant to a formal written specification request from Old Lyme and paid for by Old Lyme, shall be the property of Old Lyme. A. In connection with the Services provided hereunder, CAC agrees to furnish Old Lyme all financial, accounting, data processing and budgeting reports on a monthly basis, and all actuarial reports on a quarterly basis, in each case in such manner and at such time as shall be reasonably required by Old Lyme. B. CAC shall be responsible for maintaining full and accurate accounts and records of all Services provided hereunder in accordance with applicable laws and regulations, and such additional information as Old Lyme may reasonably request for purposes of its internal bookkeeping and accounting operations, including, without limitation, the preparation of GAAP and SAP annual and quarterly financial statements. CAC shall keep copies of such accounts and records available at their principal offices for audit, inspection and copying by Old Lyme and persons authorized by it or any governmental 9 agency having jurisdiction over Old Lyme (a "Regulator") at any time and for any reason during all reasonable business hours. Old Lyme shall maintain copies of such accounts and records at its home office in Rhode Island. C. CAC shall promptly respond to any inquiry from Old Lyme and persons authorized by it or any Regulator with respect to the accounts and records maintained in accordance with the terms of this Agreement. CAC shall also assist and cooperate with Old Lyme's auditors and Regulators in the conduct of any audit or examination of Old Lyme's financial condition and results of operations. Old Lyme, its agents or its representatives may audit the Claims Files and books and records relating to this Agreement and the Services provided hereunder in CAC's possession at any time during normal business hours and for any reason. ARTICLE VI INDEMNIFICATION A. Indemnification by Old Lyme. Old Lyme shall indemnify, defend and hold harmless CAC and its affiliates and directors, officers, employees and agents from and against any and all claims, liabilities, demands, actions, proceedings, damages, including punitive, consequential or extracontractual obligations and obligations in excess of original policy limits, losses, deficiencies, fines, penalties, costs or expenses, including reasonable attorneys' fees ("Demands") to the extent relating to or arising out of any act or omission of Old Lyme, its affiliates and directors, officers, employees and agents, in performing their obligations under this Agreement except to the extent such act or omission occurred 10 at the direction or request of CAC or in conformity with guidelines provided by CAC. Old Lyme shall further indemnify and hold CAC and its affiliates and directors, officers, employees and agents harmless from and against any and all Demands to the extent relating to or arising in any way as a result of the Old Lyme's breach of this Agreement or the failure of Old Lyme to make available to CAC any information or to provide any services required to be made available to or provided to CAC under this Agreement. Notwithstanding the foregoing, Old Lyme shall not indemnify for any Demands to the extent arising from the willful misconduct, bad faith or gross negligence on the part of CAC and its affiliates and directors, officers, employees and agents, other than Old Lyme. B. Indemnification by CAC. CAC shall indemnify, defend and hold harmless Old Lyme and its affiliates and directors, officers, employees and agents from and against any and all Demands to the extent relating to or arising out of any act or omission of CAC, its affiliates and directors, officers, employees and agents in performing their obligations under this Agreement except to the extent such act or omission occurred at the written direction or request of Old Lyme. It is understood and agreed that CAC shall be responsible for its discretionary decisions in the handling of claims. CAC shall further indemnify and hold Old Lyme and its affiliates and directors, officers, employees and agents harmless from and against any and all Demands to the extent relating to or arising in any way as a result of CAC's breach of this Agreement or the failure of CAC to make available to Old Lyme any information or to provide any services required to be made available to or provided to Old Lyme under this Agreement. Notwithstanding the 11 foregoing, CAC shall not indemnify for any Demands to the extent arising from the willful misconduct, bad faith or gross negligence on the part of Old Lyme and its affiliates and directors, officers, employees and agents other than CAC. C. Indemnification Procedure. If a party hereto (the "Indemnified Party") asserts that another party (the "Indemnifying Party") has become obligated to indemnify pursuant to this Article VI, or if any suit, action, investigation, claim or proceeding is begun, made or instituted as a result of which the Indemnifying Party may become obligated to the Indemnified Party hereunder, the Indemnified Party shall give written notice to the Indemnifying Party within a sufficiently prompt time to avoid prejudice to the Indemnifying Party, specifying in reasonable detail the facts upon which the claimed right to indemnification is based. The Indemnifying Party shall, at its own cost, be entitled to contest or defend any action against the Indemnified Party. The Indemnified Party and the Indemnifying Party shall each be entitled to choose counsel of their choice and each party shall bear the cost of the counsel it so chooses. In the event of the settlement of an action for which indemnification is required, the Indemnifying Party shall not be required to indemnify the Indemnified Party unless the Indemnifying Party shall have agreed to the terms of such settlement, which agreement shall not be unreasonably withheld. Any payment to be made by an Indemnifying Party shall be made within thirty (30) days of the delivery of notice of an uncontested claim to indemnification or final determination of the amount to be indemnified. 12 ARTICLE VII MAINTENANCE OF INSURANCE A. CAC is required to maintain in full force and effect the following policies of insurance issued by an insurer rated no less than "A-" by A. M. Best Company during the Term of this Agreement and thereafter while CAC has any obligations hereunder: (1) errors and omissions insurance covering CAC and its employees in the minimum amount of ten million dollars ($10,000,000) with a deductible not to exceed five hundred thousand dollars ($500,000); (2) fidelity insurance covering CAC and its employees in the minimum amount of five million dollars ($5,000,000); (3) commercial general liability insurance (including personal injury) covering CAC and its employees in the minimum amount of one million dollars ($1,000,000) single limit per occurrence covering CAC and its employees and a five million dollar ($5,000,000) umbrella policy covering CAC and its employees; (4) non-owned automobile liability insurance covering CAC's employees in the minimum amount of one million dollars ($1,000,000) single limit per occurrence and a five million dollar ($5,000,000) umbrella policy covering CAC and its employees; and 13 (5) workers compensation insurance in at least the minimum amounts required to be maintained by CAC by any applicable statute or regulation. Such insurance shall be maintained by CAC at its sole cost and expense and shall be primary and noncontributing coverage with regard to any valid and collectible insurance available to Old Lyme. CAC shall request its insurers to provide thirty (30) days prior notification to Old Lyme, and CAC agrees to immediately notify Old Lyme when it receives notice of lapse, increased deductibles, decreased coverage, or upon receipt of a notice terminating coverage. Prior to the Effective Date and on or before January 30 of each year thereafter, CAC shall furnish proof of such insurance. CAC further agrees to notify Old Lyme of any claim brought under any such policy which arises out of or is connected with the Services performed hereunder. Old Lyme must be identified as a joint payee or joint insured as Old Lyme's interests may appear. ARTICLE VIII MISCELLANEOUS PROVISIONS A. Cooperation. The parties shall cooperate in a commercially reasonable manner in order that the duties assumed by CAC will be effectively, efficiently and promptly discharged. Old Lyme shall, at all reasonable times, during its normal business hours, make available to CAC properly authorized personnel of Old Lyme for the purpose of consultation and decision and information as may be reasonably required by CAC. B. Reasonableness. The parties will act reasonably and in good faith on all matters within the terms of this Agreement. 14 C. Errors and Omissions. Any delays, errors or omissions on the part of a party occurring in connection with this Agreement or any transaction hereunder shall not relieve any other party from any liability which would have otherwise attached, had such delay, error or omission not occurred, provided that such error or omission is rectified as soon as reasonably practicable after discovery thereof. D. Assignment. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns and legal representatives. This Agreement is not assignable except by operation of law or by written consent of all of the parties hereto. E. Amendments and Waivers. This Agreement may be amended at any time by an agreement in writing between the parties. The terms of this Agreement may be waived only by a written instrument signed by the party waiving compliance. No delay on the part of any party in exercising any right, power or privilege hereunder shall operate as a waiver thereof. Nor shall any waiver on the part of any party of any right, power or privilege, nor any single or partial exercise of any such right, power or privilege, preclude any further exercise thereof or the exercise of any other such right, power or privilege. F. Entire Agreement. This Agreement constitutes the entire contract between the parties with respect to the subject matter hereof and there are no understandings between the parties as to the Services to be provided other than as expressed in this Agreement. Any 15 amendment or modification hereto shall be null and void unless made by amendment to this Agreement and signed by both parties. G. No Third-Party Beneficiaries. Nothing in this Agreement is intended or shall be construed to give any person, other than the parties hereto, any legal or equitable right, remedy or claim under or in respect of this Agreement or any provision contained herein. H. Governing Law. This Agreement shall be interpreted and governed by the laws of the State of New York, without giving effect to the conflict of laws provisions of such jurisdiction. I. Invalidity. Unless the invalidity or unenforceability of any provision or portion hereof frustrates the intent of the parties or the purpose of this Agreement, such invalidity or unenforceability shall not affect the validity or enforceability of the other provisions or portions hereof. In the event that such provision shall be declared unenforceable by a court of competent jurisdiction, such provision, to the extent declared unenforceable, shall be stricken. However, in the event any such provision shall be declared unenforceable due to its scope, breadth or duration, then it shall be modified to the scope, breadth or duration permitted by law and shall continue to be fully enforceable as so modified. J. Dispute Resolution. In the event of an alleged breach of this Agreement or any dispute or difference arising with reference to the applicable interpretation or effect of this 16 Agreement, or any part thereof (each, a "Dispute"), the parties agree to work together in good faith to resolve the matter internally by escalating to higher levels of management of the parties and to senior management of Fairfax and then, if necessary, to submit the matter to arbitration in the manner described below. No Dispute will be submitted to arbitration during such internal dispute process. The duration of such process will not exceed sixty (60) days starting upon the written notification of a Dispute from one party to the other. In any event, either party may stop the internal dispute resolution procedure whenever it, in good faith, determines that the procedure is no longer appropriate to resolve the Dispute. Notwithstanding the foregoing, nothing set forth in this Section J shall be construed as limiting the ability of Old Lyme to suspend, withdraw or terminate all or any part of CAC's authority pursuant to this Agreement. In the event a Dispute is not resolved pursuant to the preceding paragraph, such Dispute shall be referred to a Board of Arbitration (the "Board") of two (2) arbitrators and an umpire. The members of the Board shall be U.S. citizens and shall be active or retired disinterested officers of insurance or reinsurance companies. 1. One arbitrator shall be chosen by the party initiating the arbitration and designated in the letter requesting arbitration. The other party shall respond, within thirty (30) days, advising of its arbitrator. The umpire shall thereafter be chosen by the two (2) arbitrators. In the event either party fails to designate its arbitrator as indicated above, the other party is hereby authorized and empowered to name the second arbitrator, and the party which failed to designate its arbitrator shall be 17 deemed to have waived its right to designate an arbitrator and shall not be aggrieved thereby. The two (2) arbitrators shall then have thirty (30) days within which to choose an umpire. If they are unable to do so, the umpire shall be chosen by the manager of the American Arbitration Association who shall be a person meeting the qualifications set forth above. Each party shall submit its case to the Board within thirty (30) days from the date of the appointment of the umpire, but this period of time may be extended by unanimous written consent of the Board. 2. The sittings of the Board shall take place in New York, New York, unless otherwise agreed by the parties hereto. The Board shall make its decision with regard to the custom and usage of the insurance and reinsurance business. The Board is released from all judicial formalities and may abstain from the strict rules of evidence. The written decision of a majority of the Board shall be rendered within sixty (60) days following the termination of the Board's hearings, unless the parties consent to an extension. Such majority decision of the Board shall be final and binding upon the parties both as to law and fact, and may not be appealed to any court of any jurisdiction. Judgment may be entered upon the final decision of the Board in any court of proper jurisdiction. 3. Each party shall bear the fees and expenses of the arbitrator elected by or on its behalf, and the parties shall bear the fees and expenses of the umpire as determined by the Board. 18 K. Equitable Relief Available. Notwithstanding anything to the contrary in Section J of this Article VIII, Old Lyme and CAC acknowledge that it will be impossible to measure in money the damages if either of them fails to comply with certain obligations imposed by this Agreement, that every obligation is material, and that in the event of any failure to comply the injured party will not have an adequate remedy at law or in damages. Old Lyme and CAC further acknowledge that money damages would be insufficient to obtain the duplicate or substantial equivalent of the promised performance of the other as provided in this Agreement due to the unique character of this Agreement. Old Lyme and CAC further acknowledge that substantially equivalent performance could not be obtained by the other due to the difficulty, delay, and inconvenience involved. Therefore, Old Lyme and CAC agree that the obligations set forth in Article I and Article V under this Agreement may be enforced by temporary and permanent injunctive relief or other available equitable remedies against them at the suit of the other without bond or other security to compel performance of the terms of this Agreement. Old Lyme and CAC waive and covenant not to raise as a defense in any action seeking injunctive relief (i) failure of consideration and (ii) availability of relief in damages. Without in any way limiting the foregoing, upon Old Lyme's termination of the authority of CAC to perform the Services, upon the refusal of CAC to deliver such files to Old Lyme within a reasonable time, CAC agrees to consent to the entry of an injunction requiring CAC to deliver all policy claims and other files required to be maintained by CAC hereunder to permit Old Lyme to properly discharge its obligations in respect of the policies underwritten by Old Lyme and to adequately protect its interests in connection therewith. 19 In addition, Old Lyme and CAC agree that any award of injunctive relief will include recovery of associated costs and expenses (including reasonable attorneys' fees). L. Government Action. Each party shall promptly notify the other party of any inquiry, investigation, cease and desist order, audit, complaint or other similar matter from any state or federal regulatory or law enforcement body or any similar organization having authority to regulate surplus lines insurance received by such party and to which such other party may be subject (each, an "Inquiry"), within three days following receipt or otherwise becoming aware of such Inquiry. CAC shall notify Old Lyme no later than three days after becoming aware that CAC is the subject of any Inquiry that relates to a policy written by Old Lyme or may otherwise impact the business of Old Lyme. M. Privacy. Neither party shall disclose any non-public personal, medical or financial information gathered in the course of performing any Services hereunder to any third party and shall in all respects comply with the Gramm-Leach-Bliley Act, Pub. L. No. 106-102, 113 Stat. 1338 (1999) as implemented by any and all state insurance regulatory bodies. Further, both parties shall comply with any and all privacy regulations and statutes applicable to any information obtained by CAC or Old Lyme as a result of the Services and each shall be solely responsible for any fines, penalties or damages associated with its own improper disclosure of protected information and shall fully defend, indemnify, and hold harmless the other party for any such improper disclosure in accordance with Article V hereof. 20 N. Notices. Any notice or other communication required or permitted hereunder shall be in writing and shall be delivered personally, telegraphed, telexed, sent by facsimile transmission or sent by certified, registered or express mail, postage prepaid. Any such notice shall be deemed given when so delivered personally, telegraphed or telexed or sent by facsimile transmission to the appropriate facsimile number on Appendix B or, if mailed, three days after the date of deposit in the United States mails, to the appropriate address on Appendix B. Any party may, by notice given in accordance with this Agreement to the other parties, designate another address or person for receipt of notices hereunder. O. Headings. The headings in this Agreement are for convenience of reference only and shall not affect its interpretation. P. Non-exclusivity. Nothing herein shall be deemed to grant CAC an exclusive right to provide services to Old Lyme, and Old Lyme retains the right to contract with any third party, affiliated or unaffiliated, for the performance of services as have been requested by Old Lyme pursuant to this Agreement. Notwithstanding the above, Old Lyme shall utilize CAC to perform claims services for all accounts produced by Program Brokerage Corporation and Kaye Insurance Associates, Inc. to Old Lyme until such time as Old Lyme or CAC terminate this Agreement in accordance with Article III with the exception of any Programs that Old Lyme terminates pursuant to Article IV, Section E. 21 Q. Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 22 IN WITNESS WHEREOF, the parties have caused this Agreement to be executed in triplicate by their respective officers duly authorized to do so, as of the date and year first above written. OLD LYME INSURANCE COMPANY OF RHODE ISLAND, INC. By: /s/ Michael P. Sabanos -------------------------------------------- Name: Title: CLAIMS ADMINISTRATION CORPORATION By: /s/ Michael P. Sabanos -------------------------------------------- Name: Title: EXHIBIT A CLAIM SERVICE STANDARDS AND PERFORMANCE DEFINITIONS A. FILE MANAGEMENT CAC agrees to perform the following in the management of claims under the policy: o Receive directly from the policyholder or its agent/broker all notices of claim. Establish a file with respect to each claim that presents a likelihood of incurring loss and/or expense costs. Provide each claim file with a written chronology of all action taken. The claim file must be available at all reasonable times during normal business hours for inspection by Old Lyme or regulatory authorities. o In accordance with the Performance Definitions, verify, analyze and address coverage for each claim and advise Old Lyme immediately of any coverage questions including those relating to policy term, exclusions, definitions, etc. Proceed with the handling of coverage issues only at the request of Old Lyme. o In accordance with the Performance Definitions, investigate, adjust, settle, issue reservation of rights letters or deny all claims within the authority limit as contained in Article I(B) hereof. Adjust, settle or deny all claims in excess of the authority limit with the prior approval of Old Lyme. o Provide trained, competent, and, where required, licensed claim adjusters to perform the services in a manner commensurate with the highest professional standards of good faith and in accordance with all applicable laws and regulations. Provide all necessary administrative and clerical support including all necessary forms and supplies. o Subscribe and report appropriate cases to the Index Bureau, NICB, and PILR. Report all claims involving potential fraud to the local or state law enforcement agencies. Report all required vendor and professional payments to the Internal Revenue Service in accordance with Section 6041 of the Internal Revenue Code. o Upon prior approval of Old Lyme, engage the services of outside persons or firms to provide services for litigation, medical bill review, vocational rehabilitation, medical case management, hospital bill audit, utilization review, property and automobile damage appraisal, fraud investigation, salvage disposal, structured settlements, etc. Both the selection and compensation of these persons or firms, including attorneys, shall be approved by Old Lyme and Old Lyme shall have the right to terminate their employment or engagement at any time. Outside persons or firms engaged by CAC at the effective date of this Agreement will be deemed to have been approved by Old Lyme. o Protect the subrogation and contribution rights of Old Lyme and notify Old Lyme of any rights which may be available. At the direction of Old Lyme, pursue those rights. Evaluate and pursue potential Second Injury Fund recoveries. Issue stop payments and clarify status A-1 of abandoned property. Dispose of salvage in an economical and lawful manner. o Provide Old Lyme with a monthly reconciliation package from the Claims Funding Account that reflects all debits and credits, paid and outstanding items, stop pays, and opening and closing balances. o Coordinate notices to insurance companies providing coverage for claims or losses in excess of Old Lyme's limit, as appropriate, and in conjunction therewith: (a) provide appropriate notice to such other insurance companies; (b) track policy aggregates, where applicable, and (c) make recommendations to Old Lyme regarding tender to such other insurance companies of the limits of Old Lyme's policy with respect to claims, the disposition of which may exceed Old Lyme's policy limit. CAC acknowledges and agrees that it shall be liable for any damages or liabilities of any nature whatsoever arising out of a late notice to any insurer or reinsurer of any claim or loss, unless Old Lyme caused the late notice. o Forward closed files to Old Lyme. o Provide to Old Lyme all information with respect to claims required/requested by Old Lyme. CLAIM REPORTING CAC will immediately report any claim when the reserve is in excess of the claims settlement authority as contained in Article I, Section B, hereof, as such claims handling authority may be amended from time to time. If Old Lyme has issued a policy to an insured other than a ceding insurer (i.e., Old Lyme is not the reinsurer) CAC will immediately report the following claims regardless of reserve: Claims where coverage is questionable including claims that are denied or coverage reservations exist. Claims alleging fatality, brain injury, severe spinal injuries, amputations or permanent loss of use of an arm, leg or eye, regardless of perceived liability/compensability. Claims alleging burns over 10% or more of the body Claims alleging civil rights violations, sexual harassment or assault, environmental damage or impairment, personal or advertising injury, rape, class action suits, AIDS exposure. Claims alleging latent injury. Claims alleging punitive damages. Employer's Liability claims or any claim filed by a former, present or prospective employee. The following must be reported immediately: A-2 Any conflict of interest between Old Lyme, CAC or the Insured. All lawsuits naming Old Lyme as a defendant except when named in a direct action state. Any allegations of bad faith, error and omission, or punitive damages against CAC, Old Lyme or the Insured. CAC will provide access to all claim files and quarterly loss runs that include the following on all open and/or active claims: o claim number o claimant's name o date, time and location of the loss o loss and expense payments and outstanding reserves. o subrogation and salvage recoveries o type of injury or damage o description of loss current status CAC shall maintain a complaint log, which log shall include, at a minimum, the following information: Definitions Consumer Complaint - A consumer complaint is any verbal or written communication directed to the company from a consumer, state insurance department, or other source acting on behalf of the consumer, which expresses a grievance or dissatisfaction concerning any of our products, services, operation or policies. It is not the intent of this procedure to handle consumer inquiries as complaints. However, it may sometimes be difficult to distinguish between the two. Judgment and careful attention and sensitivity to the tone and content of the communication will usually determine whether it should be treated as a complaint. Whenever in doubt, it should be referred to Old Lyme to determine proper handling. However, all complaints received from the state insurance department must be treated as a complaint and is subject to handling according to this procedure. The Consumer - By nature of our business, Old Lyme has a variety of consumers, but for the purpose of this procedure, "consumer" shall be defined as any policy holder, applicant, third party complainant or producer, i.e., anyone who is or was, or could be, using any of Old Lyme's products and/or services. The Source - The source of complaint will originate from any of a variety of persons or organizations including, but not limited to, the following: A-3 - - Insureds and/or Policyholders - - Producers - - State Insurance Departments - - Third Parties - - Media - - Public Officials - - Consumer Groups Nature of Complaint - Complaints generally will fall into one of the following categories. ss. Claims - It is not the intention of the procedure to include the normal interchange that takes place between policyholder and company with respect to a loss or a claim. Negotiations between the company's and plaintiffs' attorneys are also not considered as complaints. CAC will, however, include any evidence of policyholders' or other complainants' dissatisfactions with respect to settlements or the treatment received in the course of settlements as complaints. ss. Coverage - Complaints in this category will usually involve the terminology employed in Old Lyme contracts. Exceptions and modifications found in endorsements may cause policyholders to feel that coverage provided in the main policy is taken away in the "fine print." Any misrepresentation of the policy coverage may lead to complaints. ss. Public Relations - This is a broad category consisting of complaints brought about by employee attitudes such as lack of promptness, courtesy and good letter writing techniques. Policyholder service will generate a number of complaints due to delays in issuing policies, endorsements and premium refunds. ss. Credit reporting, Inspections, Safety - These complaints generally reflect the conduct of individuals who represent CAC either as employees or through fee services rendered. A-4 PROCEDURE The following outlines the required procedures for handling consumer complaints. Complaint handling should be prompt, courteous, fair and informative. The most important factor to remember in handling complaints is the use of sound judgment. THE RESPONDENT INDIVIDUALS IN RESPONSIBLE MANAGEMENT POSITIONS OF CAC MUST MAKE REPLIES ON BEHALF OF OLD LYME. THE VICE PRESIDENT OF CLAIMS OF UNITED STATES FIRE INSURANCE COMPANY ("U.S. FIRE") OR HIS/HER DESIGNEE MUST SIGN ALL RESPONSE LETTERS. LEGAL DEPARTMENT UPON RECEIPT OF EACH COMPLAINT, MANAGEMENT OF CAC MUST CONSIDER WHETHER OR NOT THE LEGAL DEPARTMENT OF U.S. FIRE SHOULD REVIEW THE COMPLAINT. ANY DOUBTS SHOULD BE RESOLVED IN FAVOR OF CONSULTING THE LEGAL DEPARTMENT. ANY PERSON RECEIVING A CONSUMER COMPLAINT EITHER BY PHONE OR LETTER WILL IMMEDIATELY FORWARD IT TO THE APPLICABLE VICE PRESIDENT OF CLAIMS OF U.S. FIRE. WHEN CAC RECEIVES A CONSUMER COMPLAINT FROM AN OFFICE, INDIVIDUAL OR OTHER SOURCE, HE/SHE WILL IMMEDIATELY: - RESPOND BY LETTER TO THE COMPLAINANT, IF THIS ACTION HAS NOT ALREADY BEEN TAKEN, ADVISING COMPLAINANT THAT THE COMPLAINT HAS BEEN RECEIVED AND IS BEING INVESTIGATED. - IMMEDIATELY GIVE THE FILE TO THE APPROPRIATE CAC FUNCTIONAL MANAGER FOR DISPOSITION. - WHEN DISPOSITION OF THE COMPLAINT IS COMPLETED, A LETTER OF EXPLANATION SHALL BE WRITTEN TO THE COMPLAINANT BY OLD LYME OR AN APPROPRIATE CAC FUNCTIONAL MANAGER TO CLOSE THE FILE. - A COMPLETE COPY OF THE COMPLAINT FILE WILL BE MAINTAINED ON FILE WITH CAC IN SUCH A WAY THAT ALL COMPLAINTS CAN BE EASILY ACCESSED UPON REQUEST. A-5 Procedure for Responding to Complaints Replies should be given to all complaints within three working days of receipt of the complaint. If a delay is unavoidable, a letter should be sent to the complainant explaining the reason for the delay, and follow-up should be made promptly. Standard CAC and/or Old Lyme letterheads should be used for response to the complainant and should include the name, telephone number, and address of the individual assigned the complaint. A full letter of explanation must be given the complainant of the position taken by CAC and/or Old Lyme and should be fully documented to support the position. Responses to complaints received from any media source, e.g. Action Lines, consumer reporters, must be referred to the attention of the Senior Vice President of Claims of U.S. Fire for review, before mailing. Responses to complaints of this nature may result in widespread public attention and this will serve to assure that replies are appropriate and effective. Personal opinions and comments should not be included in any response or the complaint files. All complaints originating from one of our insureds or producers and directed to the company from the state insurance department or any source will require a company response to the insured and/or producer as well as to the insurance department. (We should note in our response to the insurance department that the company has also responded directly to the insured.) The producer should be notified of all complaints directed to CAC and/or Old Lyme by an insured and advised of the final disposition of the complaint prior to mailing to the insured. This is an integral part of our customer service philosophy. Records All correspondence received must be date stamped and initialed by the receiver. A-6 Claims Services Agreement Individual files must be suspended and followed to conclusion in a timely manner. Copies of all complaints must be maintained by CAC and filed in one central location. Records must be retained for a period of four years from date of disposition. These records must be available for review by Old Lyme or by authorized representatives of any insurance department. PERFORMANCE DEFINITIONS COVERAGE Coverage must be analyzed promptly. Performance by CAC must include: o Documentation of the policy, effective dates and applicable endorsements. o Clear written communication of a reservation of rights or denial of coverage within 30 days of assignment. o Prompt follow up to resolve pending coverage issues. Promptly advising the policyholder of their excess exposure. INVESTIGATION: FACTUAL/MEDICAL o Twenty-four hour contact with the claimant and insured. o Field investigation when needed. Examples include claims requiring inspection of accident location, photographs, review of scars or disfigurements, assessment of witness credibility, serious injuries or damages, occupational disease or repetitive trauma, and extended temporary total disability. o Statements from insureds, claimants, and witnesses unless unimportant to the investigation. o Inspection of damaged property within five business days of notice on building and personal property loss exceeding $2500 and on all auto damage losses exceeding $1500. o Collection of relevant contracts, police reports, leases, medical reports, bills, lost wage confirmation, repair estimates, accountants evaluations of loss of earnings, etc. o Indexing of the injured claimant. A-7 o Appropriate use of experts to clarify damages or liability, i.e., independent medical exams, accident reconstruction, engineer reports for property damage, etc. o Activity checks and legal collateral sources of information must be pursued. INVESTIGATION: SUBROGATION; CONTRIBUTION; OTHER INSURANCE The investigation must include inquiries regarding possible third party involvement and the potential for other insurance. This should include developing documentation to support: o Transfer of risk under a hold harmless agreement or insurance clause in a business contract, additional insured endorsement, vendor's endorsement or legal theory or law. o Contribution based on comparative negligence. Theories for subrogation recovery. A-8 EVALUATION AND RESERVING Reserves must be established within five (5) days of receipt of a claim. Reserves should always reflect the ultimate expected payout of each claim. Ongoing evaluation should take place as facts are developed that will impact the ultimate expected claim payout. PROCEDURAL FILE MANAGEMENT All claims activities must be documented in the claim file. This is most easily accomplished through running notes that document day to day activity. Summary reports must be used on larger or more complicated files. The file must include all correspondence and pleadings as well as the investigation documents noted above. A reviewer should be able to determine the present status of the claim, what activity has taken place to date, what the reserve is and why, and what the offers have been and why. Appropriate files must be reported to Old Lyme. Files must demonstrate regular activity and diary control must be must be present and effective. Authority must be obtained appropriately. File set up and payments must be timely. All notes be done in a professional manner. LITIGATION MANAGEMENT Effective litigation management begins well before suit is filed. Quality investigation, thorough evaluation and timely negotiation of non-litigated cases will help to achieve settlements and avoid suits. Once suit is filed, extensions of time to answer can avoid needless discovery and allow negotiations that may resolve the claim. Extensions of time to answer must be confirmed in writing with the plaintiff attorney and should be for no more than 60 days. An integrated defense plan must be developed between the claim handler and defense attorney. The purpose is to promptly decide if the claim should be settled or defended, agree on value, outline strategy and determine appropriate things to do to achieve these ends. Activities for the attorney must be clearly outlined. The following additional actions are recommended: Promptly acknowledge the suit to insured. Prepare and revise the integrated defense plan as indicated. Interim legal bills must be reviewed in light of the agreed upon actions. Trial notices must be given to insured and Old Lyme. A-9 EXHIBIT B ALLOCATED LOSS ADJUSTMENT EXPENSES Allocated Loss Adjustment Expenses are defined as follows: o Fees to attorneys for claims in suit and for representation at hearings or pretrial conferences; o Fees to court reporters; o Printing costs related to trials and appeals; o Credit bureau reports: o All court costs, court fees and court expenses; o Pre- and post-judgment interest paid as a result of litigation; o Fees for service of process; o Costs of undercover operatives and detective services; o Costs of employing experts for the preparation of maps, professional photographs, accountings, chemical or physical analysis and diagrams; o Costs of employing experts for their advice, opinions or testimony concerning claims under investigation or in litigation; o Costs of independent medical examinations and/or evaluation for rehabilitation and/or to determine liability, including the reasonable and necessary transportation expenses of claimants; o Appeal bonds; o Costs of legal transcripts of testimony taken at a coroner's inquest, criminal or civil proceeding; o Costs of copies of any public records and/or medical records; o Costs of depositions and court transcripts; o Costs and expenses of subrogation when referred to outside attorneys; o Fees of appraisers used to establish the amount of damage to vehicles and other property; o Any other similar cost, fee or expense reasonably chargeable to the investigation, evaluation, negotiation, settlement or defense of a claim or loss or to the protection or perfection of the subrogation rights of Old Lyme and/or the insured provided CAC obtains prior approval of Old Lyme. o CAC Services Fees Allocated Loss Adjustment Expenses do not include any part of the salaries of employees of CAC, its overhead, ordinary travel expenses or other normal and ordinary costs of a similar nature or any fees or expenses relating to claim services charged by [CAC or] a subcontractor of B-1 CAC. Workers Compensation Allocated Loss Adjustment Expenses is based upon individual state unit statistical plans. B-2 APPENDIX A Claims Handling Fee Schedule 1. Liability Claims: $81.00 per hour 2. Property Claims: $690.00 per claim 3. Subrogation recoveries: 25% of recovery B-3 EX-10.25 7 t07444a3exv10w25.txt ADMINISTRATIVE SERVICES & COST ALLOCATION EXHIBIT 10.25 ADMINISTRATIVE SERVICES AND COST ALLOCATION AGREEMENT This Administrative Services and Cost Allocation Agreement ("Agreement") is made and entered into on the 1st day of January, 2002 (the "Effective Date") by and between Old Lyme Insurance Company of Rhode Island, Inc., a Rhode Island-domiciled insurance company ("Old Lyme"), and Kaye Group Inc., a Delaware corporation (together with certain of its wholly owned subsidiaries, "Kaye Group"). WITNESSETH: WHEREAS, Old Lyme and Kaye Group are controlled by Fairfax Financial Holdings Limited ("Fairfax"); and WHEREAS, Kaye Group has the expertise to provide certain administrative services to Old Lyme; and WHEREAS, Old Lyme and Kaye Group acknowledge that it is desirable that certain administrative services required by Old Lyme be performed Kaye Group. NOW, THEREFORE, in consideration of the covenants, promises and obligations contained herein and for other good and valuable consideration, receipt of which is acknowledged, the parties hereto agree as follows: ARTICLE I ADMINISTRATIVE SERVICES TO BE PERFORMED A. Kaye Group shall provide or arrange for the provision of administrative services requested by Old Lyme (collectively, the "Services"), including, but not limited to: actuarial, audit, executive, legal, personnel, accounting and other financial services, insurance coverages, computer and related expenses, telephone, the provision of necessary office accommodation and rent. On the Effective Date and at the beginning of each calendar year thereafter, the parties shall mutually agree upon the specific details of the Services to be provided hereunder and the costs to be charged therefor, which costs shall be at cost. In no event shall the Services provided hereunder duplicate services provided to Old Lyme by any other affiliated corporation of Old Lyme. B. With respect to any Service provided to Old Lyme hereunder, it is understood that Kaye Group shall provide or arrange for the provision of such services in accordance with Old Lyme's standards, policies and procedures. Kaye Group shall provide the Services in accordance with all applicable federal and state laws, rules and regulations, including, but not limited to, maintaining all necessary licenses in jurisdictions in which Old Lyme writes insurance on an admitted or surplus lines basis. Notwithstanding any other provision of this Agreement, it is understood that Old Lyme's business affairs shall be managed by its Board of Directors, and, to the extent delegated by such board, by its appropriately designated officers. C. Subject to the terms, conditions and limitations of this Agreement, Kaye Group shall perform or arrange for the provision of all Services requested by Old Lyme pursuant to this Agreement diligently and in a professional manner. 2 ARTICLE II COMPENSATION The charges for the Services rendered by Kaye Group to Old Lyme will be the actual cost Kaye Group incurs in providing the Services. It is intended that the charges for the Services rendered hereunder will be fair and equitable and will, as nearly as practicable, approximate Kaye Group's cost therefor. Such costs and expenses shall be paid by Old Lyme on a quarterly basis. No later than sixty (60) days following the end of each calendar year, the parties hereto shall review the costs and expenses incurred by Kaye Group during such calendar year (the "True-up Amount"). Within thirty (30) days of the completion of such review, Old Lyme shall pay to Kaye Group the amount, if any, by which the True-up Amount exceeds the total amount of costs and expenses paid by Old Lyme to Kaye Group during the prior calendar year, or Kaye Group shall reimburse Old Lyme for the amount, if any, by which the total amount of costs and expenses paid by Old Lyme to Kaye Group during the prior calendar year that exceeds the True-up Amount. ARTICLE III TERMINATION A. Except as provided below, this Agreement shall be continuous unless: (i) terminated by mutual agreement between the parties; or (ii) terminated by either party upon twelve (12) months prior written notice to the other party. B. Old Lyme may terminate this Agreement in the event that Kaye Group has materially breached any of its obligations hereunder (a "Material Breach"), provided that (i) Old Lyme shall have first notified Kaye Group in writing of such Material Breach (a "Notice of Material Breach) and (ii) Kaye Group shall not have cured the Material Breach within 3 sixty (60) days following delivery to Kaye Group of the Notice of Material Breach (the "Cure Period"). Termination pursuant to this Section B shall become effective upon the expiration of the Cure Period. For purposes of this Section B, a Material Breach shall include, but not be limited to, a breach of Kaye Group's obligations set forth in Article I(B) hereof. C. Old Lyme may, in its sole discretion, terminate this Agreement in the event of a transfer of ownership or change in control of Kaye Group, other than a Permitted Change of Control. A "Permitted Change of Control" means a sale or other transfer of all, or any portion of, the voting securities of Kaye Group (i) as a result of which Hub International Limited directly or indirectly controls a majority of the voting securities of Kaye Group; or (ii) to an entity controlled directly or indirectly by Fairfax. Termination pursuant to this Section C shall become effective immediately upon the effectiveness of the transfer of ownership or change in control. For purposes of this Section C, "control" and "controlled" shall have the meanings set forth in section 27-35-1(c) of the General Laws of the State of Rhode Island, as amended. D. Old Lyme may terminate Kaye Group's right to perform certain Services hereunder in the event that Old Lyme chooses to perform such Services itself or in the event that Fairfax shall perform such Services. Termination pursuant to this subsection shall be effective upon 120 days prior written notice to Kaye Group. In the event that Old Lyme elects to terminate Kaye Group's right to perform certain Services, then Old Lyme shall provide Kaye Group with reports and other information that Kaye Group had provided to Old Lyme prior to such termination. Such reports and information shall be provided as frequently as Kaye Group had provided them to Old Lyme. 4 E. In the event this Agreement is terminated, the parties shall cooperate in a commercially reasonable manner to ensure that such termination does not unduly disrupt the business operations of Old Lyme. For greater certainty, Old Lyme shall, for a reasonable period of time following the effective date of termination and at its own expense, continue to have reasonable access to all software, procedures, processes and systems generated, developed, or licensed by Kaye Group and used in connection with the provision of the Services (collectively, the "Kaye Group Systems"). ARTICLE IV ACCOUNTING RECORDS AND REPORTS A. All business records, reports, studies, documents, financial statements and other information generated by Kaye Group pursuant to or relating to the Services provided to Old Lyme hereunder are the property of Old Lyme. All Kaye Group Systems shall be the property of the Kaye Group; provided, however, that any such items developed by Kaye Group pursuant to a formal written specification request from Old Lyme and paid for by Old Lyme shall be the property of Old Lyme. B. In connection with the Services provided hereunder, Kaye Group agrees to furnish Old Lyme financial, accounting, data processing and budgeting reports on a monthly basis, and actuarial reports on a quarterly basis, in each case in such manner and at such time as shall be reasonably required by Old Lyme. C. Kaye Group shall be responsible for maintaining full and accurate accounts and records of all Services provided hereunder in accordance with applicable laws and regulations, and such additional information as Old Lyme may reasonably request for purposes of its 5 internal bookkeeping and accounting operations, including, without limitation, the preparation of GAAP and SAP annual and quarterly financial statements. Kaye Group shall keep copies of such accounts and records available at their principal offices for audit, inspection and copying by Old Lyme and persons authorized by it or any governmental agency having jurisdiction over Old Lyme (a "Regulator") upon reasonable notice during all reasonable business hours and Old Lyme shall maintain copies of such accounts and records at its home office in Rhode Island. D. Kaye Group shall promptly respond to any inquiry from Old Lyme and persons authorized by it or any Regulator with respect to the accounts and records maintained in accordance with the terms of this Agreement. Kaye Group shall also assist and cooperate with Old Lyme's auditors and Regulators in the conduct of any audit or examination of Old Lyme's financial condition and results of operations. ARTICLE V INDEMNIFICATION A. Indemnification by Old Lyme. Old Lyme shall indemnify, defend and hold harmless Kaye Group and its affiliates and directors, officers, employees and agents from and against any and all claims, liabilities, demands, actions, proceedings, damages, including punitive, consequential or extracontractual obligations and obligations in excess of original policy limits, losses, deficiencies, fines, penalties, costs or expenses, including reasonable attorneys' fees ("Demands") to the extent relating to or arising out of any act or omission of Old Lyme, its affiliates and directors, officers, employees and agents, in performing their obligations under this Agreement except to the extent such act or omission occurred at the direction or request of Kaye Group or in conformity with 6 guidelines provided by Kaye Group. Old Lyme shall further indemnify and hold Kaye Group and its affiliates and directors, officers, employees and agents harmless from and against any and all Demands to the extent relating to or arising in any way as a result of the Old Lyme's breach of this Agreement or the failure of Old Lyme to make available to Kaye Group any information or to provide any services required to be made available to or provided to Kaye Group under this Agreement. Notwithstanding the foregoing, Old Lyme shall not indemnify for any Demands to the extent arising from the willful misconduct, bad faith or gross negligence on the part of Kaye Group and its affiliates and directors, officers, employees and agents, other than Old Lyme. B. Indemnification by Kaye Group. Kaye Group shall indemnify, defend and hold harmless Old Lyme and its affiliates and directors, officers, employees and agents from and against any and all Demands to the extent relating to or arising out of any act or omission of Kaye Group, its affiliates and directors, officers, employees and agents in performing their obligations under this Agreement except to the extent such act or omission occurred at the direction or request of Old Lyme or in conformity with guidelines provided by Old Lyme. Kaye Group shall further indemnify and hold Old Lyme and its affiliates and directors, officers, employees and agents harmless from and against any and all Demands to the extent relating to or arising in any way as a result of Kaye Group's breach of this Agreement or the failure of Kaye Group to make available to Old Lyme any information or to provide any services required to be made available to or provided to Old Lyme under this Agreement. Notwithstanding the foregoing, Kaye Group shall not indemnify for any Demands to the extent arising from the willful misconduct, bad faith or gross 7 negligence on the part of Old Lyme and its affiliates and directors, officers, employees and agents other than Kaye Group. C. Indemnification Procedure. If a party hereto (the "Indemnified Party") asserts that another party (the "Indemnifying Party") has become obligated to indemnify pursuant to this Article V, or if any suit, action, investigation, claim or proceeding is begun, made or instituted as a result of which the Indemnifying Party may become obligated to the Indemnified Party hereunder, the Indemnified Party shall give written notice to the Indemnifying Party within a sufficiently prompt time to avoid prejudice to the Indemnifying Party, specifying in reasonable detail the facts upon which the claimed right to indemnification is based. The Indemnifying Party shall, at its own cost, be entitled to contest or defend any action against the Indemnified Party. The Indemnified Party and the Indemnifying Party shall each be entitled to choose counsel of their choice and each party shall bear the cost of counsel it so chooses. In the event of the settlement of an action for which indemnification is required, the Indemnifying Party shall not be required to indemnify the Indemnified Party unless the Indemnifying Party shall have agreed to the terms of such settlement, which agreement shall not be unreasonably withheld. Any payment to be made by an Indemnifying Party shall be made within thirty (30) days of the delivery of notice of an uncontested claim to indemnification or final determination of the amount to be indemnified. 8 ARTICLE VI MAINTENANCE OF INSURANCE A. Kaye Group is required to maintain in full force and effect the following policies of insurance issued by an insurer rated no less than "A-" by A. M. Best Company during the Term of this Agreement and thereafter while Kaye Group has any obligations hereunder: (1) errors and omissions insurance covering Kaye Group and its employees in the minimum amount of ten million dollars ($10,000,000) with a deductible not to exceed five hundred thousand dollars ($500,000); (2) fidelity insurance covering Kaye Group and its employees in the minimum amount of five million dollars ($5,000,000); (3) commercial general liability insurance (including personal injury) covering Kaye Group and its employees in the minimum amount of one million dollars ($1,000,000) single limit per occurrence covering Kaye Group and its employees and a five million dollar ($5,000,000) umbrella policy covering Kaye Group and its employees; (4) non-owned automobile liability insurance covering Kaye Group employees in the minimum amount of one million dollars ($1,000,000) single limit per occurrence and a five million dollar ($5,000,000) umbrella policy covering Kaye Group and its employees; and 9 (5) workers compensation insurance in at least the minimum amounts required to be maintained by Kaye Group by any applicable statute or regulation. Such insurance shall be maintained by Kaye Group at its sole cost and expense and shall be primary and noncontributing coverage with regard to any valid and collectible insurance available to Old Lyme. Kaye Group shall request their insurers to provide thirty (30) days prior notification to Old Lyme, and Kaye Group agrees to immediately notify Old Lyme when it receives notice of lapse, increased deductibles, decreased coverage, or upon receipt of a notice terminating coverage. Prior to the Effective Date and on or before January 30 of each year thereafter, Kaye Group shall furnish proof of such insurance. Kaye Group further agrees to notify Old Lyme of any claim brought under any such policy which arises out of or is connected with the Services performed hereunder. Old Lyme must be identified as a joint payee or joint insured as Old Lyme's interests may appear. ARTICLE VII MISCELLANEOUS PROVISIONS A. Cooperation. The parties shall cooperate in a commercially reasonable manner in order that the duties assumed by Kaye Group will be effectively, efficiently and promptly discharged. Old Lyme shall, at all reasonable times, during its normal business hours, make available to Kaye Group properly authorized personnel of Old Lyme for the purpose of consultation and decision and information as may be reasonably required by Kaye Group. 10 B. Reasonableness. The parties will act reasonably and in good faith on all matters within the terms of this Agreement. C. Errors and Omissions. Any delays, errors or omissions on the part of a party occurring in connection with this Agreement or any transaction hereunder shall not relieve any other party from any liability which would have otherwise attached, had such delay, error or omission not occurred, provided that such error or omission is rectified as soon as reasonably practicable after discovery thereof. D. Assignment. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns and legal representatives. This Agreement is not assignable except by operation of law or by written consent of all of the parties hereto. E. Amendments and Waivers. This Agreement may be amended at any time by an agreement in writing between the parties. The terms of this Agreement may be waived only by a written instrument signed by the party waiving compliance. No delay on the part of any party in exercising any right, power or privilege hereunder shall operate as a waiver thereof. Nor shall any waiver on the part of any party of any right, power or privilege, nor any single or partial exercise of any such right, power or privilege, preclude any further exercise thereof or the exercise of any other such right, power or privilege. F. Entire Agreement. This Agreement constitutes the entire contract between the parties with respect to the subject matter hereof and there are no understandings between the parties as to the Services to be provided other than as expressed in this Agreement. Any 11 amendment or modification hereto shall be null and void unless made by amendment to this Agreement and signed by both parties. G. No Third-Party Beneficiaries. Nothing in this Agreement is intended or shall be construed to give any person, other than the parties hereto, any legal or equitable right, remedy or claim under or in respect of this Agreement or any provision contained herein. H. Governing Law. This Agreement shall be interpreted and governed by the laws of the State of New York, without giving effect to the conflict of laws provisions of such jurisdiction. I. Invalidity. Unless the invalidity or unenforceability of any provision or portion hereof frustrates the intent of the parties or the purpose of this Agreement, such invalidity or unenforceability shall not affect the validity or enforceability of the other provisions or portions hereof. In the event that such provision shall be declared unenforceable by a court of competent jurisdiction, such provision, to the extent declared unenforceable, shall be stricken. However, in the event any such provision shall be declared unenforceable due to its scope, breadth or duration, then it shall be modified to the scope, breadth or duration permitted by law and shall continue to be fully enforceable as so modified. J. Dispute Resolution. In the event of an alleged breach of this Agreement or any dispute or difference arising with reference to the applicable interpretation or effect of this Agreement, or any part thereof (each, a "Dispute"), the parties agree to work together in good faith to resolve the matter internally by escalating to higher levels of management of the parties and to senior management of Fairfax and then, if necessary, to submit the 12 matter to arbitration in the manner described below. No Dispute will be submitted to arbitration during such internal dispute process. The duration of such process will not exceed sixty (60) days starting upon the written notification of a Dispute from one party to the other. In any event, either party may stop the internal dispute resolution procedure whenever it, in good faith, determines that the procedure is no longer appropriate to resolve the Dispute. In the event a Dispute is not resolved pursuant to the preceding paragraph, such Dispute shall be referred to a Board of Arbitration (the "Board") of two (2) arbitrators and an umpire. The members of the Board shall be U.S. citizens and shall be active or retired disinterested officers of insurance or reinsurance companies. 1. One arbitrator shall be chosen by the party initiating the arbitration and designated in the letter requesting arbitration. The other party shall respond, within thirty (30) days, advising of its arbitrator. The umpire shall thereafter be chosen by the two (2) arbitrators. In the event either party fails to designate its arbitrator as indicated above, the other party is hereby authorized and empowered to name the second arbitrator, and the party which failed to designate its arbitrator shall be deemed to have waived its right to designate an arbitrator and shall not be aggrieved thereby. The two (2) arbitrators shall then have thirty (30) days within which to choose an umpire. If they are unable to do so, the umpire shall be chosen by the manager of the American Arbitration Association who shall be a person meeting the qualifications set forth above. Each party shall submit its case to the Board within thirty (30) days from the date of the appointment of the 13 umpire, but this period of time may be extended by unanimous written consent of the Board. 2. The sittings of the Board shall take place in New York, New York, unless otherwise agreed by the parties hereto. The Board shall make its decision with regard to the custom and usage of the insurance and reinsurance business. The Board is released from all judicial formalities and may abstain from the strict rules of evidence. The written decision of a majority of the Board shall be rendered within sixty (60) days following the termination of the Board's hearings, unless the parties consent to an extension. Such majority decision of the Board shall be final and binding upon the parties both as to law and fact, and may not be appealed to any court of any jurisdiction. Judgment may be entered upon the final decision of the Board in any court of proper jurisdiction. 3. Each party shall bear the fees and expenses of the arbitrator elected by or on its behalf, and the parties shall bear the fees and expenses of the umpire as determined by the Board. K. Government Action. Each party shall promptly notify the other party of any inquiry, investigation, cease and desist order, audit, complaint or other similar matter from any state or federal regulatory or law enforcement body or any similar organization having authority to regulate surplus lines insurance to which such other party may be subject, within three days following receipt or otherwise becoming aware thereof. 14 L. Privacy. Neither party shall disclose any non-public personal, medical or financial information gathered in the course of performing any Services hereunder to any third party and shall in all respects comply with the Gramm-Leach-Bliley Act, Pub. L. No. 106-102, 113 Stat. 1338 (1999) as implemented by any and all state insurance regulatory bodies. Further, both parties shall comply with any and all privacy regulations and statutes applicable to any information obtained by either party as a result of the Services and shall be solely responsible for any fines, penalties or damages associated with its own improper disclosure of protected information and shall fully defend, indemnify, and hold harmless the other party for any such improper disclosure in accordance with Article VII hereof. M. Notices. Any notice or other communication required or permitted hereunder shall be in writing and shall be delivered personally, telegraphed, telexed, sent by facsimile transmission or sent by certified, registered or express mail, postage prepaid. Any such notice shall be deemed given when so delivered personally, telegraphed or telexed or sent by facsimile transmission to the appropriate facsimile number on Appendix A or, if mailed, three days after the date of deposit in the United States mails, to the appropriate address on Appendix A. Any party may, by notice given in accordance with this Agreement to the other parties, designate another address or person for receipt of notices hereunder. N. Headings. The headings in this Agreement are for convenience of reference only and shall not affect its interpretation. 15 O. Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 16 IN WITNESS WHEREOF, the parties have caused this Agreement to be executed in triplicate by their respective officers duly authorized to do so, as of the date and year first above written. OLD LYME INSURANCE COMPANY OF RHODE ISLAND, INC. By: /s/ Michael P. Sabanos ----------------------------------- Name: Title: KAYE GROUP INC. TOGETHER WITH CERTAIN OF ITS WHOLLY OWNED SUBSIDIARIES By: /s/ Michael P. Sabanos ----------------------------------- Name: Title: EX-23.01 8 t07444a3exv23w01.txt CONSENT OF PRICEWATERHOUSECOOPERS LLP. Exhibit 23.1 - -------------------------------------------------------------------------------- PricewaterhouseCoopers LLP Chartered Accountants PO Box 82 Royal Trust Tower, Suite 3000 Toronto Dominion Centre Toronto, Ontario Canada M5K 1G8 Telephone +1 416 863 1133 Facsimile +1 416 365 8215 The Board of Directors Hub International Limited 55 East Jackson Blvd. Chicago, IL 60604 U.S.A. May 29, 2002 Dear Sirs: We hereby consent to the use in this Registration Statement on Form S-1 of our report dated March 18, 2002, except for note 19 which is dated as of May 29, 2002, relating to the financial statements and financial statement schedules of Hub International Limited, which appear in such Registration Statement. We also consent to the references to us under the headings "Selected historical consolidated financial data" and "Experts" in such Registration Statement. Yours truly, /s/ PricewaterhouseCoopers LLP - ------------------------------ PricewaterhouseCoopers LLP Chartered Accountants PricewaterhouseCoopers refers to the Canadian firm of PricewaterhouseCoopers LLP and other members of the worldwide PricewaterhouseCoopers organization. -----END PRIVACY-ENHANCED MESSAGE-----