-----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, EM9ROpFfjwsnroy6QBhMVDfvGqIDVAzIn+anbxGmzxChD9KzqmXaQyZM8crj1ZAV 1ezUlyXb1iLjx2jyhUDvUA== 0000950144-99-003779.txt : 19990402 0000950144-99-003779.hdr.sgml : 19990402 ACCESSION NUMBER: 0000950144-99-003779 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MCM CORP CENTRAL INDEX KEY: 0000275710 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 561171691 STATE OF INCORPORATION: NC FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-08678 FILM NUMBER: 99582142 BUSINESS ADDRESS: STREET 1: 702 OBERLIN RD STREET 2: BOX 12317 CITY: RALEIGH STATE: NC ZIP: 27605 BUSINESS PHONE: 9198331600 MAIL ADDRESS: STREET 1: 702 OBERLIN ROAD STREET 2: P O BOX 12317 CITY: RALEIGH STATE: NC ZIP: 27605 10-K405 1 MCM CORPORATION FORM 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES - --- EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES - --- EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO ________. COMMISSION FILE NUMBER: 0-8678 MCM CORPORATION ----------------------------------------------------- (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) NORTH CAROLINA 56-1171691 - -------------------------------------------------------------- --------------------------------- (STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) (IRS EMPLOYER IDENTIFICATION NO.) BOX 12317, 702 OBERLIN ROAD, RALEIGH, NORTH CAROLINA 27605 - -------------------------------------------------------------- --------------------------------- (ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (919) 833-1600 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NAME OF EACH EXCHANGE TITLE OF EACH CLASS ON WHICH REGISTERED - ------------------- ------------------- NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, PAR VALUE - $1.00 ------------------------------- (TITLE OF CLASS) INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING TWELVE MONTHS, AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST NINETY (90) DAYS. YES X NO --- --- INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405 OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K. [X ] STATE THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD --------------------------------------------------------- BY NON-AFFILIATES OF THE REGISTRANT AS OF MARCH 30, 1999. --------------------------------------------------------- COMMON STOCK, $1.00 PAR VALUE -- $8,313,926 AT DECEMBER 31, 1998, 4,706,388 SHARES OF COMMON STOCK OF THE REGISTRANT WERE OUTSTANDING. DOCUMENTS INCORPORATED BY REFERENCE ----------------------------------- NOT APPLICABLE 2 PART I Item 1. Business McM Corporation ("McM" or the "Company") is an insurance holding company conducting its business through insurance and non-insurance subsidiaries. The following schedule identifies the subsidiaries of McM and the abbreviations by which they are identified in this document.
Subsidiary Abbreviation ---------- ------------ PROPERTY AND CASUALTY Occidental Fire & Casualty Company of North Carolina OF&C Wilshire Insurance Company Wilshire OTHER: Equity Holdings, Inc. Equity Holdings
In connection with and because it desires to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, McM would like to caution readers regarding certain forward- looking statements in the following discussion and elsewhere in this Form 10-K. While McM believes in the veracity of all statements made herein, forward-looking statements are necessarily based upon a number of estimates and assumptions that, while considered reasonable by McM, are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond McM's control, and many of which, with respect to future business decisions, are subject to change. These uncertainties and contingencies can affect actual results and could cause its actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of McM. The forward looking statements are especially difficult for lines of business that are longer tail in nature such as the Company's commercial automobile liability line of business which is inherently subject to considerable variability and volatility. Item 1. (a) General Development of the Business McM was organized as a North Carolina corporation on May 27, 1977, and subsequently acquired or organized a number of insurance corporations and other subsidiaries. From 1977 to 1991, McM operated as a multi-line holding company with both life and health and property and casualty insurance operations. The McMillen Trust, controlling shareholder of McM, currently owns 51.6% of the outstanding stock of McM. A petition was filed on behalf of the McMillen Trust in the Chancery Court of Delaware on December 2, 1986, seeking relief from the requirement that the Trust own at least 1 3 65% of the shares of McM. The Court, on December 10, 1987, determined that the Trust must divest itself of its ownership of the shares of McM and invest the proceeds in a diversified portfolio for the benefit of present and future beneficiaries of the Trust. In 1991, McM decided to discontinue its life and health insurance segment. On October 24, 1991, Occidental Life Insurance Company and Peninsular Life Insurance Company were sold to Pennsylvania Life Insurance Company. On June 22, 1992, Atlantic Southern Insurance Company was sold to Global Life Assurance Company Limited. The sale of Atlantic Southern Insurance Company completed the disposition of the Company's life and health segment. In January 1993, McM's Board of Directors announced that it had decided to discontinue efforts to sell the remaining companies in the McM group, including OF&C and Wilshire. The Board's decision was prompted by market and economic conditions as well as other factors which had an adverse effect on the general sale process being conducted by PaineWebber, Incorporated ("PaineWebber"). However, PaineWebber continued to serve the McM group as its financial advisor. In April 1993, the Chancery Court granted the petition of the Wilmington Trust Company, Trustee of the McMillen Trust, for a clarification of existing orders to make clear, among other things, that the timing and terms of any disposition of the Trust's shares shall be determined in the sound discretion of the Trustee. In late 1996 the Trust granted an option (the "Option") to purchase all of its McM shares to McM Acquisition Corporation ("MAC"), a company controlled by Raleigh private investor M. Roland Britt. In a separate, independent action McM agreed to provide MAC with exclusive confidential access to McM's records and information to conduct due diligence reviews and pursue financing for its proposed purchase of some or all of McM's common shares (the "Standstill Agreement"). The Standstill Agreement expired September 28, 1997. On September 22, 1997, two shareholders of McM filed suit against McM purportedly on behalf of all McM shareholders other than the Trust, complaining that the Trust controlled McM and its board, that the board should not have entered into the Standstill Agreement and that the composition of McM's board of directors was inappropriate, among other allegations. The plaintiffs requested that the court void the Option. On December 23, 1997, MAC and the Trust agreed to terminate the Option. MAC and all remaining parties to the suit executed a mutual release and dismissal of MAC as a defendant. On February 20, 1998, the suit was settled with the approval of the court. The settlement provided that the defendants would use their best efforts to elect one of the plaintiffs, Jesse Greenfield, to the board of directors of McM. The settlement also contained nominal monetary concessions by the 2 4 Plaintiffs and McM and mutual releases between all parties. Mr. Greenfield was elected to the McM Board on May 21, 1998. On June 15, 1998, IAT Reinsurance Syndicate Ltd.("IAT"), a Bermuda- based insurance and investment company, provided OF&C with a $5 million cash infusion supported by five $1 million certificates of contribution. The terms of the certificates provided, upon the approval of the Commissioner of the North Carolina Department of Insurance, for quarterly interest payments at the rate of 5% per annum with the principal balance payable no later than December 31, 2000, upon the approval of the Commissioner of the North Carolina Department of Insurance. On July 17, 1998, the Company and IAT jointly announced the signing of an agreement dated July 16, 1998, (the "Offer and Rights Agreement") pursuant to which IAT expressed its intention to acquire up to 49% of McM's outstanding common stock for $3.65 per share. Up to 35% of McM's common stock was to be acquired in a public tender offer (the "Tender Offer") with the remaining 14% to be acquired from the McMillen Trust, pursuant to an agreement between IAT and the Trust executed the same day (the "Trust Purchase Agreement"). The McMillen Trust owned approximately 65% of McM's outstanding shares at the time the agreement was signed. The Offer and Rights Agreement was unanimously approved by McM's Board of Directors and the Tender Offer commenced on July 23, 1998. The Tender Offer was made through offering documents filed with the Securities and Exchange Commission and mailed to McM Shareholders. On October 1, 1998, IAT successfully completed the Tender Offer and purchased 1,279,692 shares (or 27.2%) of McM's common stock at the Tender Offer price of $3.65 per share. On the same day, IAT also purchased 658,900 shares of McM common stock from the McMillen Trust pursuant to the Trust Purchase Agreement. In total, IAT purchased 1,938,592 shares (or 41.2%) for an aggregate price of approximately $7,075,860. On October 7, 1998, IAT provided a $10 million cash contribution to McM Corporation. IAT made an additional $1 million cash contribution to McM on October 28, 1998. In consideration of these contributions, McM issued 11,000 shares of McM Corporation Series B PIK Preferred Stock, $1,000 par value to IAT. McM also retired the five $1 million certificates of contribution issued to IAT by McM subsidiary OF&C, replacing these certificates with a permanent $5 million cash capital contribution to OF&C as additional paid-in capital. McM simultaneously issued 5,000 shares of Series B PIK Preferred Stock to IAT in exchange for the retirement of these certificates of contribution. McM issued 10,000 shares of Series B PIK Preferred Stock to IAT in consideration of an additional $10 million cash contribution to McM Corporation on December 29, 1998. On the same day, McM made a permanent 3 5 $5 million cash capital contribution to OF&C as additional paid-in capital and transferred the remaining $5 million to OF&C in exchange for the issuance of 500,000 shares of OF&C 8% Preferred Stock, $10 par value. The Series B PIK Preferred Stock accumulates dividends at a rate of 12% per annum, payable quarterly in arrears on January 7, April 7, July 7, and October 7 of each year. The dividends are cumulative from the date of issuance and will be paid in kind with additional fully paid and nonassessable shares of Series B PIK Preferred Stock. At the discretion of the Board of Directors' quarterly dividends may be paid in cash. The OF&C Preferred Stock pays dividends at a rate of 8% per annum, with the first payment payable March 31 of the first year following date of issuance and quarterly thereafter. There were 134 employees of McM and its subsidiaries at December 31, 1998, all of which are directly employed by the property and casualty subsidiaries. Item 1. (b) Financial Information About Industry Segments The Company has determined that it operates in two segments: Commercial Auto and Private Passenger Auto. Appropriate disclosures about the Company's segments are included in Note L to the Consolidated Financial Statements. Item 1. (c) Narrative Description of Business PROPERTY AND CASUALTY INSURANCE McM's property and casualty insurance business is conducted through two insurance companies, OF&C and Wilshire. The business is concentrated in commercial auto liability, physical damage and cargo coverages for the trucking transportation industry as well as non-standard private passenger automobile coverages. These insurance policies are generally marketed through general and independent agents who have no authority to alter any terms of the policies. The agents who produce business for OF&C and Wilshire are not exclusive agents of the companies and generally have affiliations with other insurance companies which may compete with McM. One agent accounts for approximately 11% of premium income of the property and casualty business of McM. OF&C is licensed in the District of Columbia and all states other than Connecticut and Hawaii. Certain states have placed restrictions on the amount of premiums that OF&C may write in those states. Wilshire is licensed in nineteen states comprised of Arizona, California, Colorado, Hawaii, Idaho, Iowa, Kansas, Minnesota, Montana, Nebraska, Nevada, New 4 6 Mexico, North Carolina, Ohio, Oregon, South Dakota, Utah, Washington and Wisconsin. Wilshire is also approved, as a non-admitted carrier, to write coverages in the states of Alabama, Alaska, Florida, Georgia, Illinois, Indiana, Kentucky, Louisiana, Maryland, North Dakota, Oklahoma, Pennsylvania, Texas and Wyoming. A non-admitted carrier may write coverages at rates in excess of the rates approved by the various states, provided that licensed carriers in those states are unwilling to provide coverages at the approved rates. Wilshire's premium writings are not restricted by any state. Also see "Geographic Distribution of Premiums Received." Competition. The property and casualty insurance business is highly competitive. In most jurisdictions in which McM's property and casualty insurance subsidiaries market their policies, there are numerous large standard lines stock and mutual companies as well as other specialty companies competing for the same business. Many of the companies have greater financial resources, larger marketing organizations and broader diversification of risks than the McM companies. However, McM believes that the policies, rates, commissions and services of its companies are competitive with other companies writing these types of business. Regulation. All insurance companies are subject to regulation and supervision by the jurisdictions in which the companies are authorized to transact business. These regulatory bodies have broad administrative powers relating to the standards of solvency which must be met and maintained by insurance companies, minimum capital and surplus requirements, limitations on the investments of capital and surplus, granting and revoking of licenses, licensing of agents, filing and approval of policy forms and rates, maintenance of required reserves, unfair discrimination, form and content of financial statements and other reporting forms, issuance and sale of stock, types of allowable investments, and numerous other matters pertaining to insurance. Insurance companies must keep assets equal to the minimum capital required by law plus the accumulated reserves invested in certain classes of investments as specified in the statutes applicable to such companies. In addition, the National Association of Insurance Commissioners ("NAIC") has adopted Risk-Based Capital ("RBC") requirements for property and casualty insurance companies. RBC was developed to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks. The RBC formula serves as an early warning tool for state insurance regulators to help identify, for the purpose of initiating regulatory action, companies which may be inadequately capitalized. At December 31, 1998, the capital and surplus levels of the Company's property and casualty subsidiaries exceeded all RBC thresholds. 5 7 The reporting practices for McM's property and casualty subsidiaries are prescribed or permitted by state regulatory authorities ("statutory accounting") and may differ from generally accepted accounting principles ("GAAP"). OF&C (which includes Wilshire on a statutory equity basis) reported to insurance regulatory authorities combined statutory capital and surplus of $27.7 million and $11.5 million at December 31, 1998 and 1997, respectively. There are several reconciling differences between the statutory accounting and consolidated GAAP capital and surplus balances of McM's property and casualty subsidiaries. In GAAP accounting, costs which vary with and are primarily related to the production of property and casualty business are deferred to the extent recoverable and are amortized over the lives of the policies in proportion to the recognition of premium earned. Statutory accounting does not permit this deferral and requires property and casualty companies to fully recognize these expenses in the period they were incurred. At December 31, 1998, McM's property and casualty subsidiaries recorded $2.4 million in deferred policy acquisition costs as an asset on the GAAP balance sheet compared to $2.8 million at December 31, 1997. Under statutory accounting certain assets of a Company may not be admissible under certain circumstances such as agents' balances and other balances receivable for a period greater than ninety days. Such balances are "nonadmitted" and shown as a reduction to statutory capital and surplus. At December 31, 1998, the capital and surplus of McM's property and casualty subsidiaries was reduced by approximately $542,000 for nonadmitted assets. Statutory accounting also requires property and casualty companies to record as a liability and restriction to capital and surplus the uncollateralized portion of balances receivable from non-admitted reinsurers ("Schedule F Penalty"). The combined Schedule F Penalty recorded by McM's property and casualty subsidiaries totalled $298,000 and $261,000 at December 31, 1998 and 1997, respectively. Finally, for GAAP accounting purposes the $26 million of outstanding Series B PIK Preferred Stock of McM is not shown as a component of shareholders' equity but as "mezzanine" debt, whereas $25 million of this amount which was contributed to the property and casualty subsidiaries of McM is shown as contributed capital and included in statutory capital and surplus. Insurance holding company laws grant additional powers to insurance regulators with respect to acquisitions and control of insurance companies by holding companies and the requirements of disclosure relating to transactions with affiliated companies. Each company files a detailed annual report with the insurance department of each state or governmental jurisdiction in which it is licensed to do business. Insurance companies are also subject to periodic examinations by these regulatory bodies. Some of the jurisdictions in which OF&C is licensed to do business have, for various reasons, instituted restrictions or limitations on the amount of 6 8 business written in that state. These restrictions were imposed years ago when the property and casualty companies were generating substantial losses and experiencing financial difficulties. Generally they involved states in which the Company was not actively writing business nor had intentions to write business. These restrictions have no current effect on liquidity, capital resources or results of operations. In the future, should the Company desire to further expand its market presence into any state with such restrictions, it will then pursue the lifting of such restrictions by providing current financial and operational information as required by individual state regulatory authorities. Reinsurance As with other property and casualty insurance companies, the McM property and casualty insurance companies reinsure a portion of the insurance they write in order to control their exposure on large individual risks or in the event of catastrophic losses. The companies remain contingently liable on that portion of the risk reinsured should the reinsurer be unable to meet its obligations under the reinsurance agreements. See Note D of the Notes to Consolidated Financial Statements. The largest liability exposure insured for any one risk is $2,000,000. Reinsurance is in place to reduce the companies' exposure on premiums earned subsequent to January 1992 to $100,000 of loss per risk. The retention per risk on premiums earned prior to January 1, 1992, generally is $100,000 with the exception of 1991 when the loss retention was $250,000. Premiums payable under certain of the companies' liability reinsurance treaties prior to January 1, 1990, are based in part on actual loss experience. Premiums for the liability treaties subsequent to 1990 are calculated on a flat rate based on policy limits. Separate physical damage (excluding theft and collision) and motor cargo catastrophe reinsurance treaties provide reinsurance on any one catastrophic occurrence. Coverages under these treaties are limited to a maximum of 95% of $4,000,000 in excess of the first $500,000 of losses paid. Quota share reinsurance coverages, by which the companies and their reinsurers share risk on a proportionate basis, are also in place for both commercial and private passenger automobile business. During 1998 the companies ceded 5% of the retained commercial auto liability coverages. The cession rates for the private passenger auto coverages has ranged from the 40% rate in 1998 to 20% since this arrangement's inception. These quota share arrangements have been established to help the companies control premium growth. The principal reinsurers of the companies for current business are Zurich Reinsurance, Ltd., Unionamerica Insurance Company, CNA International Reinsurance Company, Ltd., Lloyds of London, AXA Reassurance Company and Sphere Drake Insurance. Reinsurance agreements cover commercial and private passenger automobile liability, physical damage (excluding theft and collision), motor cargo and ancillary coverages. In addition to the reinsurers named above, principal 7 9 reinsurers of the companies for prior years' reinsurance treaties are Employers Reinsurance Corporation and National Reinsurance Company. Loss Reserves and Loss Adjustment Expenses The consolidated financial statements include the estimated liability for unpaid losses and loss adjustment expenses ("LAE") of the property and casualty insurance subsidiaries. The liabilities for losses and LAE are determined using case basis evaluations and statistical projections and represent estimates of the ultimate net cost of all unpaid losses and LAE incurred through December 31 of each year. These estimates give effect to trends in claims severity and other factors which may vary as the liabilities are ultimately settled. The estimates are continually reviewed and as adjustments to these liabilities become necessary such adjustments are reflected in current operations. THIS SPACE LEFT BLANK INTENTIONALLY 8 10 The following table provides a reconciliation of beginning and ending liability balances for 1998, 1997 and 1996. RECONCILIATION OF LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
1998 1997 1996 ------- ------- ------- (Thousands of dollars) GAAP Reserves for losses and settlement expenses, net of reinsurance recoverables, at beginning of year $29,159 $26,532 $29,997 Provision for insured events of the current year 37,399 42,243 37,651 Increase in provision for insured events of prior years 7,086 5,774 1,559 ------- ------- ------- Incurred losses and settlement expenses during current year, net of reinsurance 44,485 48,017 39,210 Payments for: Losses and settlement expenses attributable to insured events of the current year 20,905 26,123 22,853 Losses and settlement expenses attributable to insured events of prior years 19,434 19,267 19,822 ------- ------- ------- 40,339 45,390 42,675 ------- ------- ------- Reserves for losses and settlement expenses, net of reinsurance recoverables, at end of year 33,305 29,159 26,532 Reinsurance recoverable on unpaid losses and settlement expenses at end of current year 27,539 28,124 28,768 ------- ------- ------- Gross reserves for losses and settlement expenses at end of year $60,844 $57,283 $55,300 ======= ======= =======
9 11 The reconciliation shows that a deficiency of $7,086,000 in the prior year reserve emerged during 1998. The deficiency at December 31, 1998, included adverse reserve development of approximately $6,885,000 in the commercial auto liability line of business, and $1,038,000 in discontinued lines of business and participation in involuntary pools and other residual market mechanisms in which OF&C and WIC are required to participate by the various states in which the companies write insurance. Mitigating the above adverse development was $748,000 of favorable development in inland marine, commercial auto physical damage, and general liability lines of business, and favorable development of $89,000 relating to private passenger liability and physical damage lines of business. The anticipated effect of inflation is implicitly considered when estimating liabilities for losses and settlement expenses. While anticipated cost increases due to inflation are considered in estimating the ultimate claim costs, the increase in average severity of claims is caused by a number of factors that vary with the individual type of policy written. Future average severity is projected based on historical trends adjusted for anticipated changes in these trends and general economic conditions. These anticipated trends are monitored based on actual development and are modified as necessary. The liability for losses and LAE of $60,844,000 reported in the accompanying financial statements in accordance with generally accepted accounting principles (GAAP) is reported on a gross basis, i.e., without reduction for reinsurance, and differs from that reported in the annual statements filed with state insurance departments in accordance with statutory accounting practices (SAP), which are reported net of reinsurance. See Note A of the accompanying 1998 financial statements. 10 12 ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT NET OF REINSURANCE WITH SUPPLEMENTAL GROSS DATA
(Thousands of dollars) YEAR ENDED 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 - ---------------------------- ------- ------- ------- ------- ------- -------- ------- ------- ------- ------- ------- Liability for Unpaid Claims and Claim Adjustment Expense $96,308 $78,120 $64,002 $64,304 $59,580 $ 51,625 $38,415 $29,997 $26,532 $29,159 $33,305 Paid (Cumulative) as of: One year later $48,461 $42,731 $41,726 $29,635 $28,500 $ 27,034 $21,338 $19,822 $19,267 $19,434 $ 0 Two years later 72,353 63,893 47,833 44,905 44,659 39,119 31,096 28,469 28,405 Three years later 84,912 67,649 56,343 54,980 51,326 44,649 35,177 32,181 Four years later 87,368 72,305 61,006 58,364 54,561 46,668 36,891 Five years later 90,495 75,568 62,341 60,459 55,699 47,849 Six years later 93,146 76,350 63,728 61,215 56,801 Seven years later 93,769 77,562 64,459 62,144 Eight years later 94,930 78,084 65,211 Nine years later 95,451 78,862 Ten years later 96,227 Liability Reestimated as of: One year later $97,562 $77,625 $68,679 $64,175 $60,849 $ 51,643 $38,167 $31,556 $32,306 $36,245 $ 0 Two years later 95,362 78,970 66,266 64,686 59,881 50,184 38,060 34,207 36,935 Three years later 96,354 79,861 67,429 64,167 58,563 49,874 38,966 36,893 Four years later 96,874 80,345 67,540 63,204 58,713 50,131 40,528 Five years later 97,453 80,695 66,357 63,939 59,138 51,062 Six years later 97,619 79,909 67,115 64,278 59,977 Seven years later 97,251 80,698 67,465 65,195 Eight years later 98,054 81,067 68,262 Nine years later 98,428 81,907 Ten years later 99,269 ------- ------- ------- ------- ------- -------- ------- ------- ------- ------- ------- Cumulative Deficiency (Redundancy) $ 2,961 $ 3,787 $ 4,260 $ 891 $ 397 ($ 563) $ 2,113 $ 6,896 $10,403 $ 7,086 $ 0 ======= ======= ======= ======= ======= ======== ======= ======= ======= ======= ======= Gross Data at End of Year Gross Liability $57,283 $60,844 Reinsurance Recoverable 28,124 27,539 ======= ======= Net Liability $29,159 $33,305 ======= =======
11 13 The table above presents the development of balance sheet liabilities for 1988 through 1998. The top line of the table shows the estimated liability for unpaid losses and LAE recorded at the balance sheet date for each of the indicated years. This liability represents the estimated amount of losses and LAE for claims arising in all prior years that are unpaid at the balance sheet date, including losses that had been incurred but not yet reported to the Company. The lower portion of the table shows the re-estimated amount of the previously recorded liability based on experience as of the end of each succeeding year. The estimate is increased or decreased as more information becomes known about the frequency and severity of claims for individual years. The deficiency/(redundancy) totals as set forth in the table represent the aggregate change in the estimates over all prior years. For example, through 1998, the 1988 liability has developed a $2,961,000 deficiency which has been recognized in operations over the ten year period. The effects on income of the past three years of changes in estimates of the liabilities for losses and LAE is shown in the preceding table, "Reconciliation of Liability for Losses and Loss Adjustment Expenses". The upper section of the table, "Analysis of Loss and Loss Adjustment Expense Development", shows the cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year. For example, as of December 31, 1998, the Company paid $96,227,000 of the current re-estimated reserve for losses and loss adjustment expenses at December 31, 1988, of $99,269,000. Thus an estimated $3,042,000 of losses incurred through 1988 remain unpaid as of the current financial statement date. In evaluating this information, it should be noted that each amount includes the effects of all changes in amounts for prior periods. For example, the amount of the deficiency related to losses settled in 1991, but incurred in 1989, will be included in cumulative redundancy (deficiency) amount for years 1989 and 1990. This table does not present accident or policy year development data. Conditions and trends that have affected development of the liability in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future deficiencies or redundancies based on this table. The information below the table is a reconciliation of the data in the table, which is reported net of reinsurance, to the reserves in the balance sheet which are stated gross of reinsurance. 12 14 Geographic Distribution of Direct Written Premiums The following is a summary of property and casualty direct written premiums in 1998 by geographic location. States accounting for less than five percent (5%) of premiums are combined in "Other".
STATE PERCENT ----- ------- Arizona 6 California 32 Colorado 6 Florida 11 Nevada 9 New Mexico 5 Other 31 --- 100%
Item 1. (d) Financial Information About Foreign and Domestic Operations and Export Sales The information called for under this item does not apply. Item 2. Properties McM and its subsidiaries lease home office properties in various locations. The major locations are set forth in the following table:
Square Book Annual Footage Value Rent ------- ----- ---- Raleigh, North Carolina OF&C 27,298 Not Owned $462,101 Wilshire McM Lancaster, California Wilshire 10,578 Not Owned $121,924 Scottsdale, Arizona OF&C 7,193 Not Owned $131,277 Wilshire
Item 3. Legal Proceedings The information called for under this item does not apply. Item 4. Submission of Matters to a Vote of Security Holders There were no matters submitted to a vote of security holders during the fourth quarter of 1998. 13 15 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters McM Corporation Common Stock was previously traded on the over-the-counter securities market, under the NASDAQ symbol, McMc. Effective with the opening of business on October 19, 1998, McM's common stock was delisted from the NASDAQ SmallCap Market. The delisting occurred as a result of McM's no longer meeting the NASDAQ requirement to maintain a minimum of 300 shareholders who each own 100 shares or more. The number of record shareholders of McM Corporation was 450 as of December 31, 1998. The table below sets forth by quarters, for the years 1998 and 1997, the range of high and low bid prices of McM Corporation's Common Stock as reported in the Wall Street Journal. No dividends were declared or paid during 1998 or 1997. See Management's Discussion and Analysis of Financial Condition and Results of Operations and Note B to the consolidated financial statements for information regarding restrictions on the ability of McM's subsidiaries to transfer funds to McM and discussion regarding nonpayment of dividends.
1998 1997 HIGH LOW HIGH LOW First Quarter $2 7/8 $1 3/4 $4 5/8 $3 7/8 Second Quarter 2 1/4 1 7/8 3 7/8 3 1/8 Third Quarter 3 1/2 2 1/8 3 3/8 2 7/8 Fourth Quarter N/A N/A 3 1/4 2 1/8
14 16 Item 6. Selected Financial Data
1998 1997 1996 1995 1994 -------- -------- -------- -------- -------- Assets $117,135 $104,140 $112,870 $126,568 $137,665 Liabilities 89,278 91,372 91,215 103,328 117,258 Redeemable Preferred Stock 26,000 -- -- -- -- Retained (deficit) earnings (8,173) 7,013 15,553 16,623 14,413 Shareholders' equity 2,457 12,768 21,655 23,240 20,407 Net premium earned 47,008 55,707 51,854 45,701 41,126 Net investment income 2,516 2,985 3,159 3,497 3,684 Realized investment gains 274 196 40 123 122 Total revenue 50,228 59,537 55,698 49,571 45,304 Net (loss)income (15,186) (8,540) (788) 2,210 1,354 Net (loss income available to common shareholders (15,595) (8,540) (788) 2,210 1,354 Per common share data: Shareholders' equity less preferred dividends in arrears $ .44 $ 2.72 $ 4.63 $ 4.97 $ 4.37 Net (loss)income - basic (3.32) (1.82) (.17) .47 .29 Net (loss) income - assuming dilution (3.32) (1.82) (.17) .47 .29 Cash dividends -- -- .06 -- --
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The response to Item 7 is submitted under a separate section of this report beginning on page 32. Item 7A. Quantitative and Qualitative Disclosures About Market Risk The Company's invested assets consist of equity and fixed maturity securities. Fixed maturity securities represent approximately 65% of the Company's invested assets at December 31, 1998, and the fair value of these fixed rate securities generally bears an inverse relationship to changes in prevailing market interest rates. A 10% relative increase or decrease in market interest rates that affect the Company's financial instruments would not have a material impact on earnings during the next fiscal year, and would not materially affect the fair value of the Company's financial instruments. The Company is exposed to equity price risk on its equity 15 17 securities. McM holds common stock with a carrying value of approximately $22.0 million. If the market value of the S&P 500 decreased 10% from their December 31, 1998, values, it is estimated that the fair value of the Company's equity investments would decrease by approximately $2.1 million. Item 8. Financial Statements and Supplementary Data The consolidated financial statements of McM Corporation and its subsidiaries and the report of the Company's independent auditors filed in response to Item 8 is submitted under a separate section of this report beginning on page 44. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The information called for under this item does not apply. THIS SPACE LEFT BLANK INTENTIONALLY 16 18 PART III Item 10 Directors and Executive Officers of the Registrant. The following table sets forth the name and age of each director, the director's occupation, including positions and offices with the Company, the period during which he has served as a director, if applicable, together with the number of shares of common stock beneficially owned, directly or indirectly, by such director, if any, and the percentage of the outstanding shares that any such ownership represented at the close of business on March 15, 1999.
Director's Name, Principal Occupation (in Period of Amount and Percent of Addition to Director, Consecutive Nature of Class if applicable) Service Beneficial Beneficially and Address** Age From Ownership Owned - ---------------------- ---- ----------- ---------- ------------ MICHAEL A. DiGREGORIO 52 1995 0 0 Vice President/Senior Trust Counsel Wilmington Trust Company Wilmington, DE MARGUERITE R. GORMAN * 68 1998 0 0 Vice President Spear, Leeds & Kellogg New York, NY PETER R. KELLOGG * 56 1998 1,936,592 41.2% Senior Managing Director Spear, Leeds & Kellogg New York, NY EDWARD A. KERBS * 48 1998 0 0 President Oceanic Company, Inc. Fair Haven, NJ GEORGE E. KING 68 1989 0 0 Chairman/Chief Executive Officer McM Corporation Raleigh, NC STEPHEN L. STEPHANO 45 1992 0 0 President/Chief Operating Officer McM Corporation Raleigh, NC Share ownership of all Directors, Nominees and Executive Officers of McM as a Group (6 persons).......................... 1,938,592 41.2%
17 19 * In Section 5.1 of the Offer and Rights Agreement (more particularly described in Item 1(a) hereof) the Company agreed to take all actions necessary to cause IAT's designees to be elected as directors of the Company. Likewise, in Section 5(a) of the Tender Agreement (more particularly described in Item 1(a) hereof) the directors of McM as of July 16, 1998, including Messrs. DiGregorio, King and Stephano listed above, agreed to appoint IAT designees to fill vacancies on the Company's Board of Directors. IAT's designees are indicated above by an asterisk *. ** John A. Amaral and Richard D. Spurling declined to accept their October 1, 1998, appointments to the McM Board of Directors. Business Experience of the Directors Mr. DiGregorio has served as a director of McM since May 1995. He has also served for more than eight years as Vice President and Senior Trust Counsel with Wilmington Trust Company in Wilmington, Delaware, where he manages the Estate and Legal Services Division. A graduate of Temple University, Mr. DiGregorio was admitted to the Pennsylvania Bar in 1979, and was then employed as an Investigator for the United States Department of Labor. Prior to joining Wilmington Trust, Mr. DiGregorio worked as an Employee Benefits Attorney for the Fidelity Mutual Group in Radnor, Pennsylvania, and later at the law firm of Stradley, Ronon, Stevens & Young in Philadelphia, Pennsylvania. Ms. Gorman was appointed to serve as a director of McM on October 1, 1998. Ms. Gorman has worked for over forty years in the stock brokerage business at Spear, Leeds & Kellogg, a New York brokerage firm. She currently serves as a Vice President of Spear, Leeds & 18 20 Kellogg. Mr. Kellogg was appointed to serve as a director of McM on October 1, 1998. Mr. Kellogg has worked for over thirty years in the stock brokerage business and has served as Senior Managing Director of Spear, Leeds & Kellogg, a New York stock brokerage firm, for over 20 years. Mr. Kellogg also serves on the Boards of Directors of the Ziegler Companies and Interstate Johnson/Lane, both public companies. Mr. Kerbs was appointed to serve as a director of McM on October 1, 1998. Mr. Kerbs has worked for over twenty years in the stock brokerage business. From 1984 - 1996, Mr. Kerbs served as Managing Director with Spear, Leeds & Kellogg, a New York stock brokerage firm. Since 1996, Mr. Kerbs has served as President of Oceanic Company, Inc., a private financial consulting firm. Mr. King has served as a director of McM since February 1989. Mr. King has also acted as Chairman of the Board of McM and Chairman of all of its subsidiaries since February 1989 when he was named President and Chief Executive Officer. He was elected Chairman Emeritus of McM in August 1996. He served as President of McM subsidiaries Occidental Life and Peninsular Life Insurance Companies until McM sold those companies on October 24, 1991. Through December 1988, Mr. King served as Executive Vice President of McM, to which position he was named in January 1985. Prior to his affiliation with McM, Mr. King was Deputy Commissioner and Chief Examiner with the North Carolina Department of Insurance. Mr. Stephano has served as a director of McM since August 1992. In August 1996, he was elected President of McM. In March 1995, he was elected Chief Executive Officer of McM subsidiaries Occidental Fire & Casualty Company of North Carolina and Wilshire Insurance Company after having been named President of both companies in July 1994. He was named Chief Operating Officer of McM and its subsidiaries in September 1992. Previously, Mr. Stephano was named Executive Vice President of McM in January 1988. He had been named Senior Vice President/Chief Financial Officer of McM in January 1985. Mr. Stephano's various other previous positions at McM have been Vice President, Chief Financial Officer and Treasurer beginning in 1983; Vice President and Controller beginning in January 1983; Controller beginning in 1982. Prior to his employment with McM, he served on the professional staff of Ernst & Young, an international public accounting firm. Executive Officers of McM Corporation The table below sets forth the names and ages of all executive officers of McM, all positions and offices with McM presently held by 19 21 each such person, and the period of service as an officer with McM and subsidiaries.
Period of Service as Name Age Offices an Officer ---- --- ------- ---------- George E. King 68 Chairman Emeritus and 12/77 Chief Executive Officer Stephen L. Stephano 45 President and Chief 1/82 Operating Officer
Mr. King - See "Business Experience of the Directors." Mr. Stephano - See "Business Experience of the Directors." Item 11. Executive Compensation Directors' Fees Prior to October 1, 1998, directors of the Board who were not salaried officers of McM or its subsidiaries were compensated at a rate of $15,000 per year plus $1,000 per diem for each Board or Board committee meeting attended and $1,000 per diem for travel associated with such meeting. The directors were also reimbursed for other expenses incurred in attending the meetings. Similarly, directors involved in special assignments were compensated at the rate of $1,000 per diem for special assignments and $1,000 per diem for travel associated with such special assignments. As with regular Board meetings, other expenses incurred by these directors in attending such special assignments were reimbursed. In addition, prior to October 1, 1998, directors of the Board who were not salaried officers were compensated at a rate of $5,000 per year for each subsidiary company Board of Directors on which they served. Per diem allowances were the same as those for serving on the McM Board of Directors except that no per diem allowances were paid if Board meetings were held concurrently. During 1998, all subsidiary Board meetings were held concurrently with McM Board meetings. Total fees in the amount of $203,500 were expended for all regular McM and subsidiary Board meetings, Board committee meetings and special assignments during 1998. Effective October 1, 1998, there are no fees paid to directors. Directors are reimbursed for expenses incurred in attending meetings. 20 22 EXECUTIVE OFFICERS' SUMMARY COMPENSATION TABLE
Long Term Compensation --------------------------------------- Annual Compensation Awards Payouts --------------------------------------------- --------------------------------------- Other Securities Name and Annual Restricted Underlying All Other Principal Compen- Stock Options LTIP Compensa- Position Year Salary($) Bonus($) sation($)(3) Award(s)($) (#) Payouts($) tion(4) - -------- ---- --------- -------- ------------ ----------- --- ---------- ------- George E. King(1) 1998 286,004 -- -- -- -- -- 10,259 Chairman Emeritus/CEO 1997 274,992 19,350 -- -- -- -- 7,120 1996 274,992 90,320 -- -- -- 22,324 7,120 Stephen L. Stephano(2) 1998 234,000 -- -- -- -- -- 1,700 President/COO 1997 225,000 15,850 -- -- -- -- 1,219 1996 225,000 66,863(5) -- -- -- 15,921 1,126
(1) Effective February 16, 1998, the Company entered into an employment contract with Mr. King. The contract, as amended effective March 28, 1990, October 18, 1990, December 30, 1991, February 1, 1993, September 1, 1993, March 16, 1995, August 6, 1996, and March 26, 1998, provided that Mr. King be employed as an executive officer of McM and provided for base salary and such additional discretionary bonuses, stock options or other compensation or increases in compensation, if any, as may be authorized by the Company. The contract also contained special provisions regarding a change in control or a termination without cause. See contract and amendments attached hereto as Exhibit 10(c) for more specific information. This contact was terminated effective January 31, 1998. Effective February 1, 1999, the Company entered into an employment contract with Mr. King. The contract provides that Mr. King be employed by the Company and provides for payment of a base salary. In addition, should Mr. King's employment be terminated without cause, he would receive continuing installments of his base salary until such time as total payments under the contract reached $450,000. (2) Effective February 1, 1993, the Company entered into an employment contract with Mr. Stephano. The contract, as amended September 1, 1993, March 16, 1995, August 6, 1996, and March 26, 1998, provided that Mr. Stephano be employed as an executive 21 23 officer of McM and provided for base salary and such additional discretionary bonuses, stock options or other compensation or increases in compensation, if any, as may be authorized by the Company. The contract also contained special provisions regarding a termination without cause. See contract and amendments attached hereto as Exhibit 10(c) for more specific information. This contract was terminated effective January 31, 1998. Effective February 1, 1999, the Company entered into an employment contract with Mr. Stephano. The contract provides that Mr. Stephano be employed by the Company and provides for payment of a base salary. In addition, should Mr. Stephano's employment be terminated without cause, he would receive continuing installments of his base salary until such time as total payments under the contract reached $450,000. (3) Personal benefits totaled less than $50,000 or 10% of annual salary and bonus. (4) The amounts noted represent premiums paid by the Company on behalf of executive officers for supplemental term life insurance. (5) Mr. Stephano also received 50,000 shares of phantom stock in 1996. RETIREMENT PLAN Officers of McM, including the named executive officers, participate in the McM Corporation Retirement Plan. A sample retirement benefit table for the Retirement Plan is outlined below showing the anticipated annual amount of normal retirement benefits associated with final average earnings and the number of years of service for the named executive officers. RETIREMENT PLAN TABLE
Participants' Final Average Earnings 15 20 25 30 35 - ---------------- -------- -------- -------- -------- -------- $125,000 $34,277 $45,702 $57,128 $ 68,553 $ 79,979 150,000 41,777 55,702 69,628 83,553 97,479 175,000 49,277 65,702 82,128 98,553 114,979 200,000 56,777 75,702 94,628 113,553 132,479 225,000 64,277 85,702 107,128 128,553 149,979 250,000 71,777 95,702 119,628 143,553 167,479
Benefits under the Retirement Plan are determined by 22 24 multiplying a participant's final average earnings (the best five consecutive years of the last ten years) by 1.35% times the years of benefit service, multiplying a participant's final average earnings in excess of Social Security Average Wages by .65% times the years of benefit service (not in excess of 35 years) and adding the two results together. Under federal law, the amount of compensation which may be considered for purposes of calculating benefits is limited. That amount will be adjusted periodically for inflation in increments of $10,000. The 1998 limit is $160,000 and will not change for 1999 benefit calculations. Benefits paid to participants are reduced in the event of earlier retirement. The estimated credited years of service for McM's executive officers are 20 years for Mr. King and 18 years for Mr. Stephano. Benefits shown in the Retirement Plan Table are not subject to any deduction for social security or other offset amounts. AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
Number of Securities Value of Unexercised Underlying Unexercised In-the Money Options at Options at 12/31/98 ($) 12/31/98 ($) Shares Acquired Value Exercisable/ Exercisable/ Name on Exercise(#)(1) Realized ($) Unexercisable Unexercisable - ----------------------- ------------------ ----------------- ---------------------------- ---------------------------- George E. King 78,981 98,512 -0- -0- Chairman Emeritus/CEO Stephen L. Stephano 78,981 98,512 -0- -0- President/COO
(1) No shares were actually acquired by Messrs. King and Stephano, as they exchanged all of their options for the payment shown above in connection with IAT's tender offer, as required by the terms of the Tender Agreement (more particularly described in Item 1(a) hereof). 23 25 Item 12. Security Ownership of Certain Beneficial Owners and Management Set forth below is the ownership of the Company's securities by all persons or groups known to the Company to be the beneficial owner of more than five percent of any class of the Company's voting securities as of December 31, 1998:
Title Name and Address Amount and Nature Percent of Of Beneficial of Beneficial of Class Owner Ownership Class - ----- ----- --------- ----- Common McMillen Trust (1) 2,428,600 shares 51.6% Wilmington Trust Company, directly owned Trustee 1100 North Market Street Wilmington, DE 19890-0001 Common IAT Reinsurance Syndicate Ltd.(2) 1,938,592 shares 41.2% Victoria Hall directly owned 11 Victoria Street Hamilton, HM 12 Bermuda
- ---------- (1) The McMillen Trust was created in 1925 pursuant to the terms of a deed of trust from Alonzo B. and Florence O. McMillen. The Trust continues in existence until the expiration of 21 years after the last to die of Elizabeth Lee Long, Florence Lee Headley, R. Peyton Woodson III and Laurence F. Lee, Jr. The McMillen Trust has been directed by the Chancery Court of the State of Delaware to dispose of its interest in McM. In April 1993, the Court granted the petition of the Wilmington Trust Company, Trustee of the McMillen Trust, for a clarification of existing orders to make clear, among other things, that the timing and terms of any such disposition or sale shall be determined in the sound discretion of the Trustee. On October 1, 1998, pursuant to the terms of a Trust Purchase Agreement dated July 16, 1998, between the McMillen Trust and IAT Reinsurance Syndicate Ltd., IAT purchased 658,900 shares from the Trust. (See Item 1(a) for further discussion.) The Trustee of the McMillen Trust, subject to certain 24 26 limitations, is required to vote the McM shares owned by the Trust in the way that a majority in interest of the income beneficiaries may decide. At present there are six income beneficiaries of the McMillen Trust. All are lineal descendants of the Trust grantors. The figures following each name show the relative interests in the Trust of the income beneficiaries: a. Mrs. Elizabeth Lee Long (1/9), Denver, Colorado. b. Mrs. Florence Lee Headley (1/9), Denver, Colorado. c. Mr. Laurence F. Lee, Jr. (1/9), Jacksonville, Florida. d. Mrs. Lonnie McMillen Sanchez (1/6), Albuquerque, New Mexico. e. Mrs. Katherine Faust Roe (1/6), Sante Fe, New Mexico. f. Mr. R. Peyton Woodson III (1/3), Raleigh, North Carolina. (2) Amount shown represents 658,900 shares purchased from the McMillen Trust as noted above and 1,279,692 shares purchased pursuant to a tender offer completed on October 1, 1998. (See Item 1(a) for further discussion.) Note: For security ownership of management and directors, see Item 10. Item 13. Certain Relationships and Related Transactions The information called for under this item does not apply. 25 27 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) The following documents are filed as a part of this report. 1. Financial Statements- The following consolidated financial statements of McM and subsidiaries are filed in response to Item 8:
Page ---- Consolidated Balance Sheets - December 31, 1998 44 and 1997 Consolidated Statements of Operations - Years Ended December 31, 1998, 1997 and 1996 45 Consolidated Statements of Shareholders' Equity Years Ended December 31, 1998, 1997 and 1996 47 Consolidated Statements of Cash Flows 46 Years Ended December 31, 1998, 1997 and 1996 Notes to Consolidated Financial Statements 48 Report of Independent Auditors 71 2. Financial Statement Schedules--The following schedules are filed in accordance with the requirements of Article 7 of Regulation S-X: Schedule 1 - Summary of Investments - Other than 72 Investments in Related Parties (In compliance with Schedule I of Rule 7-05): Schedule 2 - Condensed Financial Information of 73 Registrant (In compliance with Schedule II of Rule 7-05): Schedule 3 - Reinsurance (In compliance with 77 Schedule IV of Rule 7-05):
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Page ---- Schedule 4 - Valuation and Qualifying Accounts 78 (In compliance with Schedule V of Rule 7-05): Schedule 5 - Supplemental Information for Property 79 & Casualty Insurance Underwriters (In compliance with Schedule VI of Rule 7-05): All other schedules to the consolidated financial statements required by Article 5 or 7 of Regulation S-X are not applicable and, therefore, have been omitted. 3 The following exhibits are included in accordance with the requirements of Item 601 of Regulation S-K. Exhibit (3): a) Articles of Incorporation as amended are attached 89 b) By-laws of McM Corporation are incorporated by reference from Form 10-K, dated December 31, 1995. Exhibit (9): McMillen Trust Agreement is incorporated by reference from Form 10, dated April 24, 1978. Exhibit (10):Material contracts: a) The 1986 Employee Incentive Stock Option Plan (as amended) is incorporated by reference from the December 31, 1994, Form 10-K. The 1996 Employee Incentive Stock Option Plan is incorporated by reference from the 1996 Proxy Statement. b) The Phantom Stock Plan is incorporated by reference from the December 31, 1994, Form 10-K. The first amendment to this plan dated August 6, 1996, is incorporated by reference from the December 31, 1996, Form 10-K. See Note J of the Consolidated Financial Statements regarding the termination of this plan.
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Page ---- c) Employment and retention bonus contracts for certain executive officers are incorporated by reference from the December 31, 1989, 1992, 1993, 1994 and 1996, Forms 10-K. March 26, 1998, amendments are attached. The employment contracts were terminated effective January 1, 1999. 81 d) The Key Executive Incentive Compensation Plan is incorporated by reference from the December 31, 1994 Form 10-K. e) The Equity Appreciation Rights Plan is incorporated by reference from the 1993 Proxy Statement. f) The 1996 Employee Stock Purchase Plan is incorporated by reference from the 1996 Proxy Statement. This plan was terminated effective July 15, 1998. g) The 1996 Non-Employee Directors' Stock Purchase Plan is incorporated by reference from to 1996 Proxy Statement. h) Contracts of Employment for McM's executive officers effective February 1, 1999, are attached. 85 i) The Offers and Rights Agreement dated July 16, 1998, between McM and IAT is incorporated by reference from the July 23, 1998, McM Form 14d-9. Exhibit (21): Subsidiaries of the Registrant. 80 Exhibit (23): Consent of Independent Auditors 97 Exhibit (27): Financial Data Schedule (for SEC use only)
(b) The Company reported on Form 8-K dated October 1, 1998, the completion of IAT Reinsurance Syndicate Ltd.'s tender offer for the purchase of up to 35% of the outstanding common stock of McM for $3.65 per share. Reference is hereby made to Part I, Item 1 (a) of this Form 10-K for more detailed information concerning this transaction. 28 30 (c) Exhibits--The response to this portion of Item 14 is submitted as a separate section of this report beginning on page 32. (d) Financial Statement Schedules--The response to this portion of Item 14 is submitted as a separate section of this report beginning on page 31. THIS SPACE LEFT BLANK INTENTIONALLY 29 31 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereto duly authorized. McM CORPORATION By: /s/STEPHEN L. STEPHANO ----------------------------------- (Registrant) Stephen L. Stephano, President and Chief Operating Officer Date: 3/30/99 ------------- Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/GEORGE E. KING 3/30/99 /s/MICHAEL DIGREGORIO 3/30/99 - ------------------------------- ------------------------------ George E. King Michael A. DiGregorio Chairman Emeritus, Director Chief Executive Officer and Director /s/STEPHANO L. STEPHANO 3/30/99 /s/PETER R. KELLOGG 3/30/99 - ------------------------------- ------------------------------ Stephen L. Stephano Peter R. Kellogg President, Director Chief Operating Officer and Director /s/KEVIN J. HAMM 3/30/99 /s/EDWARD A. KERBS 3/30/99 - ------------------------------- ------------------------------ Kevin J. Hamm Edward A. Kerbs Vice President and Director Chief Financial Officer /s/MARGUERITE R. GORMAN 3/30/99 - ------------------------------- Marguerite R. Gorman Director 30 32 ANNUAL REPORT ON FORM 10-K Item 7(b) - Management's Discussion and Analysis of Financial Condition and Result's of Operations Item 8 - Financial Statements and Supplementary Data Item 14(d) - Financial Statement Schedules Item 14 (c) - Exhibits Year Ended December 31, 1998 McM CORPORATION AND SUBSIDIARIES 31 33 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS McM Corporation and Subsidiaries This section should be read in conjunction with the financial statements, notes to the financial statements and related financial data included in this annual report. REVIEW OF OPERATIONS McM Corporation reported a consolidated net loss available for common shareholders for 1998 of $15,595,000 or a basic net loss per share of $3.32 compared to a net loss of $8,540,000 or a basic net loss per share of $1.82 for 1997 and a net loss of $788,000 or basic net loss per share of $.17 for 1996. Consolidated results for 1998 were significantly affected by the need to increase reserves of prior accident years by approximately $7.1 million. This increase in reserves was necessary as a result of the Company's comprehensive review of its actuarial loss projections which showed deterioration in the commercial auto liability line of business for the 1997, 1996 and 1995 accident years. As a result of these unfavorable loss trends, the Company also strengthened commercial auto liability loss reserves for the current accident year by approximately $5.1 million in the fourth quarter of 1998. Higher than expected claim costs were also experienced by the Company in its commercial auto property coverages for the 1998 accident year. As a result the Company strengthened current year reserves for its commercial auto physical damage and cargo lines of business by approximately $1.7 million in the fourth quarter of 1998. Consolidated revenues decreased approximately 15.6% in 1998. Consolidated revenues for 1997 and 1996 showed increases of approximately 6.9% and 12.4%, respectively. The decline in revenues for 1998 reflects a $12.5 million overall reduction in the Company's gross written premiums when compared to 1997. Private passenger auto premium writings declined approximately $5.5 million and commercial auto premium writings produced by the Company's general agency force declined approximately $6.9 million during 1998. The decline in private passenger business resulted from an overall increase in market competition and rate increases implemented by the Company in certain markets during 1998. These rate increases when implemented placed the Company at a competitive disadvantage until the remainder of the market brought its rates up to levels more in line with the Company's. Though competition remains high in this market, premium writings in 1999 are beginning to show some growth. Market conditions in the Company's commercial auto business continues to be highly competitive and price sensitive. These conditions coupled with a reduction in the Company's A.M. Best 32 34 rating to C for much of 1998 significantly impacted the ability of the Company's general agents to compete effectively in this marketplace. In addition, the Company began to remediate a particular general agent's business which was producing unusually high loss ratios. The effort to improve the profitability of this agent's business reduced commercial auto premiums by approximately $5 million. In the fourth quarter of 1998 the Company's Best rating was upgraded to B-. As of December 31, 1998, the impact on this upgrade on the marketing effectiveness of the Company remained unclear. Revenue growth in 1997 and 1996 reflected planned growth in overall property & casualty insurance premiums. Growth in private passenger automobile premium writings during this period were partially offset by a reduction in net retained commercial automobile premium writings. Net earned property and casualty insurance premiums for 1998 were $47.0 million, compared to $55.7 million in 1997 and $51.8 million in 1996. As mentioned above, the decline in net premium revenue during 1998 reflects highly competitive conditions in both the commercial and private passenger auto marketplaces. The Company's property and casualty insurance writings emphasized liability, cargo and physical damage coverages associated with the transportation market with a primary emphasis on commercial automobile insurance. To diversify its premium distribution, the Company entered the nonstandard personal automobile market in 1989. Gross written premium in the Company's commercial automobile lines of business totalled $50.7 million and $57.7 million, and comprised approximately 80.4% and 76.4% of gross written premiums in 1998 and 1997, respectively. Private passenger automobile premium writings declined 30.7% to $12.4 million in 1998, from $17.9 million in 1997, and comprised 19.6% and 23.6% of gross production in 1998, and 1997, respectively. Underwriting results for cargo (inland marine) and commercial auto physical damage coverages historically have been more profitable than commercial auto liability. These coverages are generally easier to determine and claims settled more rapidly. Accordingly, the Company sought to increase written premiums in these lines of business annually and measures progress by reviewing the ratio of these coverages to total commercial auto written premiums. The percentage of cargo and commercial auto physical damage premiums to total commercial auto premiums for 1998 continues the increasing trend of the last several years showing a slight increase to 30.3% compared to 29.7% in 1997 and 26.6% in 1996 During 1998 the Company had in place quota share reinsurance arrangements for its commercial auto liability and private passenger auto coverages to help control unexpected growth and 33 35 keep its net writings to surplus ratios within regulatory limits. In 1998 the Company was party to a 40% quota share agreement on its private passenger auto business compared to 20% and 30% in 1997 and 1996, respectively. The Company also maintained a 5% quota share arrangement on commercial auto liability coverages during 1998. The cession rate of this arrangement had remained unchanged since 1995. The declining trend in net investment income seen over the last several years continued into 1998. Net investment income excluding realized investment gains declined approximately $469,000 in 1998 when compared to 1997 and totalled $2.5 million. Net investment income was $3.0 million and $3.2 million in 1997 and 1996, respectively. The decline in both 1997 and 1996 related to decreases in invested assets which totalled $49.9 million in 1997 and $56.9 million in 1996. Invested assets at December 31, 1998, totalled $62.3 million and included approximately $22 million of new equity investments. (For more detailed information concerning these new equity investments please see the discussion under the "Liquidity and Capital Resources" caption.) The declining trend continued into 1998 and is attributed to the deteriorating loss experience discussed previously and the associated settlement of claim liabilities. In addition, net investment income for 1998 was also adversely affected by the decline in written premium mentioned above. Realized investment gains of $274,000 are included in 1998 revenues compared to $196,000 and $40,000 in 1997 and 1996, respectively. The overall ratio of net loss and settlement expenses to net premiums earned was 94.6% for 1998 compared to 86.2% for 1997 and 75.6% for 1996. As discussed previously, the increase in the loss ratio in 1998 resulted primarily from the deterioration in the commercial auto liability line of business, particularly for the 1997 and 1996 accident years and higher than expected claim costs in the current underwriting year for commercial auto physical damage and inland marine(cargo) coverages. A comprehensive actuarial analysis of loss trends and projections at year end 1998 confirmed this deterioration and the need to increase prior year loss reserves. The Company determined it was also necessary to increase loss reserves for the current accident year in the fourth quarter of 1998. In 1998 current year loss reserves were increased approximately $7.0 million from management's planned levels and prior year loss reserves were increased approximately $7.1 million, for a total of $14.1 million, net of reinsurance. Of the $7.0 million increase to current year reserves, approximately $5.1 million related to commercial auto liability coverages and $1.7 million to the physical damage and inland marine lines of business. The adverse loss development on prior accident years of $7.1 34 36 million included in net losses and settlement expenses incurred for 1998 includes adverse reserve development of approximately $6.9 million in the commercial auto liability line of business primarily in the 1997 and 1996 accident years. The commercial auto physical damage and private passenger auto coverages showed favorable reserve development of approximately $1 million. In addition, the Company experienced adverse prior year development of approximately $1 million relating to discontinued lines of business and participation in involuntary pools and other residual market mechanisms. Management believes it has taken the appropriate steps to address concerns raised about the overall adequacy of its reserve levels and that reserves are now strongly positioned in relation to the overall range of actuarial indications at year end 1998. The increase in the 1997 ratio of net loss and settlement expenses to net premiums earned also reflected deterioration in overall loss and settlement expense projections. In 1997, the Company strengthened the 1997 accident year reserves by approximately $4.5 million primarily in commercial auto coverages and showed adverse reserve development on prior accident year reserves of approximately $5.7 million. The adverse development on prior year reserves in 1997 included approximately $3.5 million related to commercial auto liability, $844,000 to private passenger auto liability and $813,000 to commercial and private passenger auto physical damage coverages. In addition, $586,000 of prior accident year development in 1997 was related to discontinued lines of business and involuntary pools. The ratio of net loss and settlement expenses to net premiums earned for 1996 reflected an unusually high level of claims severity experienced by the Company in the fourth quarter of 1996 and increased claim frequency in its other lines of business. The Company's ratio of underwriting, acquisition and administrative expenses (including the provision for bad debts on liquidated reinsurance)to net earned premium ("the expense ratio") increased 8.5 percentage points to 44.5% compared to 36.0% and 33.3% for 1997 and 1996, respectively. The increase in the expense ratio for 1998 can be attributed to the overall decline in written premiums discussed previously and a $733,000 increase in the provision for liquidated reinsurance. A $550,000 increase in the provision for liquidated reinsurance when compared to 1996 was a main factor contributing to the increase in the expense ratio for 1997. Increased production levels coupled with budgetary restraint is being emphasized by management entering 1999. The Company utilizes a reinsurance intermediary with which it has a long-term relationship to assist in the development, placement and maintenance of the Company's reinsurance program. The Company's current reinsurance program has been placed with high 35 37 quality and financially sound reinsurers specializing in personal and commercial auto business. The creditworthiness of the Company's reinsurers is continually reviewed by the Company and the intermediary. The majority of the Company's reinsurance is placed through the London reinsurance market. The reinsurers participating in the Company's reinsurance program are generally very large international reinsurers with capital and surplus in excess of $100 million and hold A.M. Best ratings of B++ or better. Participating Lloyds syndicates are well regarded syndicates which have been approved by the National Association of Insurance Commissioners ("NAIC"). The Company's U.S. reinsurers are all rated A- or higher by A.M. Best. For those reinsurers not admitted by the Company's state of domicile, collateral is secured for the exposure ceded to them in the form of letters of credit or other reinsurer funds held by the Company. This collateral would minimize the impact of a potential reinsurer insolvency on the Company's operations. A schedule of the Company's reinsurers whose balances are approximately 10% or more of McM's shareholders' equity is provided below:
Ceded Reinsurer Balances Receivable --------- ------------------- (Thousands of dollars) Lloyds of London $ 8,430 CNA International 4,542 Unionamerica 4,446 AXA Reassurance 3,321 Zurich Re 3,039 Sphere Drake Insurance, PLC 1,976 Hannover Ruckersicherungs 922 Terra Nova Insurance Co. 704 National Reinsurance Corp 692 Chartwell Reinsurance Co. 567 National Workers Comp. Pool 549 Folksamerica Reinsurance Co. 505 Great Lakes American Reinsurance Company 489 Employers Reinsurance Corp. 433 Focus Insurance Company in Liquidation 375 Trenwick America Reinsurance Co. 310 All other 2,386 ------- Total $33,686
The provision for (recovery of) bad debts of liquidated reinsurers relating to discontinued property and casualty programs was increased by $1,134,000 and $401,000 and decreased by $150,000 in 1998, 1997 and 1996, respectively. The increase in the provision for 1998 was primarily related to adverse development in the workers compensation line of business. 36 38 Amortization of deferred policy acquisition costs exceeded policy acquisition costs deferred by approximately $395,000 in 1998 compared to $1.2 million in 1997 reflecting the overall declines in written premiums discussed previously. Policy acquisition costs deferred exceeded those amortized in 1996 by $649,000 reflecting overall premium growth in that year. INCOME TAXES McM Corporation files a consolidated tax return. The Company had cumulative net operating loss tax carryforwards of approximately $103.0 million as of December 31, 1998 (See Note E to the consolidated financial statements). Subject to certain limitations and alternative minimum tax considerations, future operations can earn up to the amount of these loss carryforwards without being subject to federal income taxation. IMPACT OF YEAR 2000 ISSUE The Year 2000 Issue, also known as the Y2K problem, is a worldwide problem relating to computer programs and imbedded chips that use two digits rather than four to define the applicable year. Computer programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. Failure to address the Y2K problem could have had a material adverse effect on the Company's operations and financial condition and result in systems failures or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process premium transactions, pay claims or engage in similar normal business activities. In addition to uncertainties related to the functioning of systems subsequent to December 31, 1999, property and casualty insurance companies may have an underwriting exposure related to the Year 2000. Although McM has not received any claims for coverage from its policyholders based on losses resulting from Year 2000 issues, there can be no assurance that policyholders will not suffer losses of this type and seek compensation under insurance policies issued by its property and casualty subsidiaries. If any claims are made, coverage, if any, will depend on the facts and circumstances of the claim and the provisions of the policy. At this time, McM is unable to determine whether the adverse effect, if any, in connection with the foregoing circumstances would be material to its operations. The Company completed an assessment of its computerized information systems to determine the impact of the year 2000 on the ability of those systems to accurately process information that may be date sensitive. It was found that the system managing the Company's specialized monthly commercial automobile direct bill program would have to be modified so that it would function 37 39 properly with respect to dates in the year 2000 and thereafter. This modification was successfully completed in 1997 at an approximate cost of $96,000. Other Company computer applications, most of which are licensed from third party computer program vendors, were determined to be Year 2000 compliant or, based upon communication with these vendors, would be compliant before any anticipated impact resulting from the year 2000. The project, as it relates to all of the Company's computer platforms, was completed and fully operational on July 1, 1998. The Company continues to replace peripheral hardware and software such as personal computers, telecommunications and spreadsheet software with Year 2000 compliant products. The Company remains on target to correct all remaining year 2000 related problem products well ahead December 31, 1999. The Company will devote all resources necessary to resolve any remaining year 2000 issues in a timely manner and believes the year 2000 will pose no significant threat to its operations. NEW ACCOUNTING STANDARDS In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard No. 130, "Reporting Comprehensive Income" ("SFAS 130") for years beginning after December 15, 1997. Comprehensive Income is defined as essentially all changes in shareholders' equity exclusive of transactions with owners, such as capital investments and includes net income (loss) plus changes in certain assets and liabilities that are reported directly in equity. The unrealized gain or loss on available-for-sale securities is the Company's only component of other comprehensive income and is presented in the Consolidated Statement of Changes in Shareholders' Equity. Also in June 1997, the FASB issued the Statement of Financial Accounting Standards No. 131 "Disclosure about Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131 requires companies to use the "management approach" in disclosing segment information. The management approach requires disclosure based on the types of financial information top management uses in the decision-making process and in evaluating segment operations. Management views the Company as operating in two segments: commercial automobile and private passenger automobile. Appropriate disclosures about the Company's segments are included in Note L to the Consolidated Financial Statements. In February 1998, the FASB issued the Statement of Financial Accounting Standards No. 132 "Employers' Disclosures about Pensions and Other Postretirement Benefits" ("SFAS 132") for years beginning after December 15, 1997. The objective of SFAS 132 is to improve and standardize disclosures about pensions and other postretirement benefits and to make the required information easier to prepare and 38 40 more understandable. Information disclosed in Note F "Pension Plan" to the Company's financial statements is presented in accordance with the requirements of SFAS 132. LIQUIDITY AND CAPITAL RESOURCES On July 17, 1998, the Company and IAT Reinsurance Syndicate Ltd. ("IAT"), a Bermuda-based insurance and investment company, announced the signing of an agreement dated July 16, 1998, (the "Offer and Rights Agreement") pursuant to which IAT expressed its intention to acquire up to 49% of McM's outstanding common stock for $3.65 per share. Up to 35% of McM's common stock was to be acquired in a public tender offer (the "Tender Offer") with the remaining 14% to be acquired from the McMillen Trust pursuant to an agreement between IAT and the Trust executed the same day (the "Trust Purchase Agreement"). The McMillen Trust owned approximately 65% of McM's outstanding shares at the time the agreement was signed. Contained in the Offer and Rights Agreement is a provision whereby McM issued to IAT rights (the "Rights" or "Poison Pill") to purchase 60,000 shares of McM Series A Preferred Stock, par value $1,000, at an exercise price of $.01 per share. The Rights become exercisable in whole or in part at any time after issuance and prior to June 1, 2008, if (i) the McMillen Trust sells any of its retained McM shares to any third party other than IAT (or IAT's assignees) or (ii) if any person or entity other than IAT causes IAT's McM Board designees (see Item 10 hereof) to cease to constitute a majority of the members of the McM Board of Directors. However, death, resignation or removal by IAT of IAT's Board designees shall not trigger the Rights' exercisability unless, while IAT's designees do not constitute a majority of the McM Board, the Board takes any action opposed by a majority of the remaining IAT designees or, if no IAT designees remain, then the current chief executive officer of IAT. The Offer and Rights Agreement further describes the procedure by which the Rights are exercised should any of the above-described triggering events take place. The Series A Preferred Stock that would be obtained by IAT if the Rights were exercised has no conversion, dividend or voting rights (except those required by law), but carries a senior liquidation preference and immediate right to redemption upon 10 business days' written notice to the Company. The Offer and Rights Agreement was unanimously approved by McM's Board of Directors and the Tender Offer commenced on July 23, 1998. The Tender Offer was made through offering documents filed with the Securities and Exchange Commission and mailed to McM shareholders. 39 41 On October 1, 1998, IAT successfully completed the Tender Offer and purchased 1,279,692 shares (or 27.2%) of McM's common stock at the Tender Offer price of $3.65 per share. On the same day IAT also purchased an additional 658,900 shares of McM common stock from the McMillen Trust pursuant to the Trust Purchase Agreement. In total, IAT purchased 1,938,592 shares or (41.2%) for an aggregate price of approximately $7,075,860. On October 7, 1998, IAT provided a $10 million cash contribution to McM Corporation. IAT made an additional $1 million cash contribution to McM on October 28, 1998. In consideration of these contributions, McM issued 11,000 shares of McM Corporation Series B PIK Preferred Stock, $1000 par value to IAT. The Series B PIK Preferred Stock accumulate dividends at a rate of 12% per annum, payable quarterly in arrears on January 7, April 7, July 7, and October 7 of each year. The dividends are cumulative from the date of issuance and will be paid in kind with additional fully paid and nonassessable shares of Series B PIK Preferred Stock. At the Board of Directors' discretion quarterly dividends may be paid in cash. McM also retired five $1 million certificates of contribution issued to IAT by McM subsidiary OF&C (see later discussion under this caption), replacing these certificates with a permanent $5 million cash capital contribution to OF&C as additional paid-in capital. McM simultaneously issued 5,000 shares of Series B PIK Preferred Stock to IAT in exchange for the retirement of these certificates of contribution. On December 29, 1998, IAT made an additional $10 million cash contribution to McM for consideration of 10,000 shares of McM Series B PIK Preferred Stock. On the same day, McM made a permanent $5 million cash capital contribution to OF&C as additional paid-in capital and transferred the remaining $5 million to OF&C in exchange for the issuance of 500,000 shares of OF&C 8% Preferred Stock, $10 par value. By statute, the majority of the Company's investments are required to be held in investment grade securities which provide ample protection for both the policyholder and the shareholder. Significant amounts of short-term investments are held to meet the liquidity needs of the property and casualty insurance operations. As shown in the Consolidated Statements of Cash Flows, the Company experienced negative cash flows from operations on a consolidated basis of $12.1 million in 1998 compared to $5.5 million in 1997 and $4.4 million in 1996. The main source of the Company's cash flows is derived from its property and casualty subsidiaries. The Company's property and casualty subsidiaries experienced consolidated negative cash flows from operations of $11.1 million, $5.4 million and $4.2 million in 1998, 1997 and 1996, respectively. The negative cash flows for the 40 42 property and casualty operations can be attributed primarily to the reduction in written premiums and the increase in the settlement of claim liabilities related to the deteriorated loss experience discussed previously. Short-term investments were utilized to handle the liquidity needs of the Company during 1998. Short-term investments held at December 31, 1998, were $11.6 million compared to $21.5 million at December 31, 1997. Total cash and invested assets at December 31, 1998, were approximately $70.4 million compared to $51.6 million at December 31, 1997. The increase in cash and invested assets is directly related to the cash contributions from IAT discussed above. Approximately $18.1 million of the cash received from IAT was invested in an equity investment portfolio in the property and casualty subsidiaries. The Company maintains a mix of high-quality investments which provides adequate returns, while limiting credit risk and providing necessary levels of liquidity to meet projected expenditures. At December 31, 1998, approximately 36.4% or $25.6 million of cash and invested assets were comprised of fixed-maturity securities available-for-sale, 31.2% or $22.0 million were recorded as equity securities available-for-sale and 4.5% of fixed-maturity securities held-to-maturity. Cash and short-term investments comprised the remaining 27.9% of cash and invested assets. Of the total cash and invested assets at December 31, 1997, approximately 49.0% or $25.3 million were comprised of fixed-maturity securities available-for- sale and 6.1% or $3.1 million were classified as fixed-maturity securities held-to-maturity. Cash and short-term investments totalling $23.2 million comprised the remaining 44.9% of the investment portfolio. The fixed-maturity security portfolio has a range of expected maturities which, as mentioned previously, management believes are adequate to meet long and short-term liquidity needs. At December 31, 1998, the market value of the Company's long-term fixed-maturity securities portfolio was $645,000 greater than amortized cost and $137,000 greater than its carrying value. The unrealized gain of $137,000 relates to those investments the Company intends to hold to maturity. The par value of these securities will be realized as they mature (see Note G to the consolidated financial statements). At December 31, 1998, the market value of the Company's equity securities portfolio was approximately $3.9 million greater than its cost. As mentioned above the equity security portfolio is classified as available-for- sale. At December 31, 1997, the market value of the fixed-maturity securities portfolio was $370,000 less than its amortized cost and $100,000 greater than its carrying value. Statutory capital positions of the property and casualty insurance companies are closely monitored by the Company. In 41 43 addition, the NAIC has adopted Risk-Based Capital ("RBC") requirements. Annual statutory financial statements are filed with state insurance regulators on or before March 1 following each year end. RBC was developed to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, asset and liability matching, loss reserve adequacy and other business environmental factors. The RBC formula is used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that may be inadequately capitalized. Regulatory compliance is determined by a ratio of the enterprise's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Enterprises below specific ratios are classified within certain levels, each of which requires specific corrective action. As discussed in the Company's 1997 Annual Report, OF&C, triggered the first regulatory threshold, Company Action Level, of the Risk-Based Capital framework established by the NAIC. Breaching this threshold required the Company to submit an action plan to the North Carolina Department of Insurance ("NCDOI") explaining the Company's intended course of action to eliminate this RBC condition. The plan, submitted to the NCDOI by the Company on April 15, 1998, included a proposed capital infusion of $5 million. On June 15, 1998, IAT provided OF&C with a $5 million cash infusion supported by five $1 million certificates of contribution. The terms of the certificates provided for quarterly interest payments at the rate of 5% per annum with the principal payable no later than December 31, 2000, upon the approval of the Commissioner of the NCDOI. As discussed previously, the certificates of contribution were retired upon the completion of IAT's successful cash tender purchase of McM common stock. At December 31, 1998, the Company's property and casualty insurance subsidiaries exceeded all RBC thresholds. Combined statutory capital and surplus of the property and casualty subsidiaries increased by $16.2 million to $27.7 million at December 31, 1998, compared to $11.5 million at December 31, 1997. At December 31, 1998, the Company had consolidated shareholders' equity of $2.5 million compared to $12.8 million at December 31, 1997. The Company's main source of funds from which dividends are paid to its shareholders is its insurance subsidiaries which are subject to certain restrictions as to the amount of dividends that can be paid in a given year. These restrictions are discussed in Note B to the consolidated financial statements. No dividends were declared or paid during 1998 or 1997. The Board will continue to consider carefully the Company's earnings, capital requirements, financial condition and other 42 44 relevant factors with regard to payment of dividends. THIS SPACE LEFT BLANK INTENTIONALLY 43 45 CONSOLIDATED BALANCE SHEETS McM CORPORATION AND SUBSIDIARIES (Thousands of dollars)
December 31 ASSETS 1998 1997 ------------------------- Invested assets: Securities available-for-sale, at fair value: Fixed maturities (amortized cost: 1998 - $25,152; 1997 - $25,755) $ 25,660 $ 25,284 Equity securities (cost: 1998 - $18,093; 1997 - $0) 21,969 0 Fixed maturities held-to-maturity, at amortized cost (fair value: 1998 - $3,275; 1997 - $3,235) 3,138 3,134 Short-term investments 11,572 21,522 ------------------------ 62,339 49,940 Cash 8,120 1,698 Accrued investment income 579 531 Premiums receivable 6,660 8,552 Reinsurance balances recoverable on: Paid losses and settlement expenses 3,090 1,476 Reserves for losses and settlement expenses 27,539 28,124 Unearned premiums 2,847 6,313 Deferred policy acquisition costs 2,407 2,802 Equipment, at cost less accumulated depreciation (1998 - $2,153; 1997 - $1,954) 1,639 1,833 Other assets 2,515 2,871 ------------------------ TOTAL ASSETS $ 117,735 $ 104,140 ======================== LIABILITIES AND SHAREHOLDERS' EQUITY Reserves for losses and settlement expenses $ 60,844 $ 57,283 Unearned premiums 10,793 15,676 Other policyholder funds 5,881 6,380 Amounts payable to reinsurers 3,233 4,461 Accrued expenses 8,527 7,572 ------------------------ 89,278 91,372 Redeemable Preferred Stock - Series B PIK 26,000 0 Shareholders' equity: Common Stock, par value $1 per share - authorized: 1998 and 1997 - 10,000,000 shares; issued and outstanding: 1998 - 4,706,388 and 1997 - 4,695,621 shares 4,706 4,696 Additional paid-in capital 1,540 1,530 Accumulated other comprehensive income 4,384 (471) Retained (deficit) earnings (8,173) 7,013 ------------------------ TOTAL SHAREHOLDERS' EQUITY 2,457 12,768 ------------------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 117,735 $ 104,140 ========================
See notes to consolidated financial statements. 44 46 CONSOLIDATED STATEMENTS OF INCOME McM CORPORATION AND SUBSIDIARIES (Thousands of dollars, except per share data)
Year Ended December 31 ------------------------------------ 1998 1997 1996 ------------------------------------ REVENUES Premiums earned $ 67,135 $ 75,778 $ 73,568 Premiums ceded (20,127) (20,071) (21,714) ------------------------------------ Net premiums earned 47,008 55,707 51,854 Investment income, less investment expenses: (1998 - $362; 1997 - $413; 1996 - $457) 2,516 2,985 3,159 Realized investment gains 274 196 40 Other income 430 649 645 ------------------------------------ TOTAL REVENUES 50,228 59,537 55,698 LOSSES AND EXPENSES Losses and settlement expenses 59,834 62,882 51,781 Losses and settlement expenses ceded (15,349) (14,865) (12,571) ------------------------------------ Net losses and settlement expenses 44,485 48,017 39,210 Underwriting, acquisition and administrative expenses 19,795 19,659 17,426 Provision for bad debts on liquidated reinsurers 1,134 401 (150) ------------------------------------ TOTAL LOSSES AND EXPENSES 65,414 68,077 56,486 ------------------------------------ NET LOSS (15,186) (8,540) (788) Preferred stock dividends (409) 0 0 ------------------------------------ NET LOSS AVAILABLE TO COMMON SHAREHOLDERS ($15,595) ($8,540) ($ 788) ==================================== PER SHARE DATA: Net loss per common share - basic ($ 3.32) ($ 1.82) ($ 0.17) Net loss per common share - assuming dilution ($ 3.32) ($ 1.82) ($ 0.17) Dividends per common share declared by McM $ 0.00 $ 0.00 $ 0.06 ====================================
See notes to consolidated financial statements. 45 47 CONSOLIDATED STATEMENTS OF CASH FLOWS McM CORPORATION AND SUBSIDIARIES (Thousands of dollars)
Year Ended December 31 ---------------------------------- 1998 1997 1996 ---------------------------------- OPERATING ACTIVITIES Net loss $(15,186) $(8,540) $ (788) Adjustments to reconcile net loss to net cash used by operating activities: Policy liabilities (1,821) (466) (10,828) Premiums receivable 1,892 828 555 Accrued investment income (48) 272 37 Net receivable from reinsurers 1,209 1,971 6,128 Amortization of deferred policy acquisition costs 11,401 10,332 9,116 Policy acquisition costs deferred (11,006) (9,142) (9,765) Other 1,437 (720) 1,150 ---------------------------------- CASH USED BY OPERATING ACTIVITIES (12,122) (5,465) (4,395) INVESTING ACTIVITIES Securities available-for-sale: Purchases (31,370) (10,499) (18,447) Sales 14,286 19,506 0 Maturities 86 2,050 12,974 Securities held-to-maturity: Purchases 0 0 (1,118) Maturities 0 2,777 11,362 Purchases of property and equipment (428) (1,045) (757) Decrease/(increase) in short-term investments 9,950 (7,461) 787 ---------------------------------- CASH (USED) PROVIDED BY INVESTING ACTIVITIES (7,476) 5,328 4,801 FINANCING ACTIVITIES Employee Stock Purchases 20 59 15 Cash Dividends Paid 0 0 (282) Issuance of Series B Preferred Stock 26,000 0 0 ---------------------------------- CASH PROVIDED (USED) BY FINANCING ACTIVITIES 26,020 59 (267) ---------------------------------- NET INCREASE (DECREASE) IN CASH $ 6,422 $ (78) $ 139 ==================================
See notes to consolidated financial statements. 46 48 CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY McM CORPORATION AND SUBSIDIARIES (Thousands of dollars)
Accumulated Other Retained Common Paid-in Comprehensive (Deficit) Stock Capital Income Earnings Total -------------------------------------------------------------- BALANCES AT JANUARY 1, 1996 $ 4,675 $ 1,477 $ 465 $ 16,623 $23,240 Activity for 1996 Comprehensive Income: Net loss (788) (788) Unrealized losses on securities (530) (530) ------- Comprehensive income (1,318) Dividends declared and paid (282) (282) Employee stock purchases 3 12 15 -------------------------------------------------------------- BALANCES AT DECEMBER 31, 1996 $ 4,678 $ 1,489 $ (65) $ 15,553 $21,655 Activity for 1997 Comprehensive Income: Net loss (8,540) (8,540) Unrealized losses on securities (406) (406) ------- Comprehensive income (8,946) Employee stock purchases 18 41 59 -------------------------------------------------------------- BALANCES AT DECEMBER 31, 1997 $ 4,696 $ 1,530 $ (471) $ 7,013 $12,768 Activity for 1998 Comprehensive Income: Net loss (15,186) (15,186) Unrealized gains on securities 4,855 4,855 ------- Comprehensive income (10,331) Employee stock purchases 10 10 20 -------------------------------------------------------------- BALANCES AT DECEMBER 31, 1998 $ 4,706 $ 1,540 $ 4,384 $ (8,173) $ 2,457 ===============================================================
See notes to consolidated financial statements. 47 49 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS McM CORPORATION AND SUBSIDIARIES NOTE A Significant Accounting Policies Basis of Presentation: The consolidated financial statements have been prepared in accordance with generally accepted accounting principles (GAAP) which, as to the insurance subsidiaries, vary in some respects from statutory accounting practices which are prescribed or permitted by the various state insurance departments. The consolidated financial statements include the accounts and operations of McM and its wholly-owned subsidiaries. McM is actively engaged through certain of its subsidiaries in the property and casualty insurance business. All significant intercompany accounts and transactions have been eliminated. The Company's subsidiaries are as follows:
Subsidiary Abbreviation - ------------------------------------------------------------------------- Property and Casualty: Occidental Fire & Casualty Company of North Carolina OF&C Wilshire Insurance Company Wilshire Other: Equity Holdings, Inc. Equity - -------------------------------------------------------------------------
The property and casualty insurance subsidiaries are primarily involved in the sale of commercial automobile and private passenger automobile insurance. The commercial automobile insurance consists primarily of liability, physical damage and inland marine coverages. The commercial automobile lines of business represented between 77% and 80% of gross written premium for all periods presented. Private passenger automobile insurance, which represents the remainder of gross written premiums, consists primarily of liability and physical damage coverages. The Company's products are generally marketed through general and independent agents. In 1998, premiums were written in 28 states throughout the U.S. Direct premiums written in California, all of which were for commercial automobile insurance products, represented between 32% and 34% of direct written premiums for all periods presented. Investments: Fixed maturity securities are classified as either held-to-maturity or available-for-sale. Management determines the appropriate classification of fixed maturity securities at the time of purchase. The Company has identified and accounted for its investments as follows: 48 50 Securities held-to-maturity and available-for-sale: Securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost. Securities not classified as held-to-maturity are classified as available-for-sale. Available-for-sale securities are stated at fair value, with the unrealized gains and losses reported as a separate component of shareholders' equity. The amortized cost of securities classified as held-to-maturity or available-for-sale is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage-backed securities, over the estimated life of the security. Such amortization is included in investment income. Realized gains and losses include any declines in value judged to be other-than-temporary. The cost of securities sold is based on the specific identification method. Short-term investments are comprised of corporate master notes and United States Treasury Notes and Bills maturing in twelve months or less. These investments are carried at fair value. The Company had fixed maturity securities with a face value of approximately $12.2 million and $12.0 million on deposit with various state insurance departments at December 31, 1998, and 1997, respectively. The Company also had $3.4 million in short-term investments held in a security trust as collateral for assumed reinsurance balances at December 31, 1998 and 1997. Cash: Cash represents cash balances deposited in banking institutions. Balances invested in corporate master notes and other interest bearing cash equivalents are included in short-term investments. Equipment: Equipment is stated at cost less allowances for accumulated depreciation which are computed principally on the straight-line method. Recognition of Insurance Revenues: Premiums for property and casualty insurance policies are recognized as revenues on a monthly pro rata basis over the terms of the policies. The Company utilizes a general agency force to market its annual commercial automobile business and a portion of its private passenger automobile business. As of December 31, 1998, agents' balances receivable of approximately $850,000 were associated with one general agent. 49 51 Deferred Policy Acquisition Costs: Costs which vary with and are primarily related to the production of property and casualty policies are deferred to the extent recoverable and are amortized over the lives of the policies in proportion to the recognition of premiums earned. Anticipated investment yield is considered in the evaluation of recoverability of unamortized deferred acquisition costs. Reserves for Losses and Settlement Expenses: Reserves for estimated losses are determined on a case basis for reported claims and on estimates based on Company experience for loss settlement expenses and incurred but not reported claims. These liabilities give effect to trends in claims severity and other factors which may vary as the losses are ultimately settled. Although considerable variability is inherent in such estimates for losses and loss settlement expenses, management believes that these liabilities are adequate. The estimates are continually reviewed and, as adjustments to these liabilities become necessary, such adjustments are reflected in current operations. The reserves for losses include amounts assumed from involuntary pools and other residual market mechanisms of the various states in which the Company has written policies. The estimated liability for the assumed pools is recorded based on information provided to the Company by the pools. Reinsurance: McM assumes and cedes reinsurance and participates in various pools and associations. The reinsurance arrangements allow management to control exposure to potential losses arising from large risks, and provide additional capacity for growth. The reinsurance is effected under quota-share contracts and by excess-of-loss contracts. Amounts recoverable from reinsurers for unpaid losses and settlement expenses are estimated in a manner consistent with the related liabilities associated with reinsured policies. Income Taxes: The Company accounts for income taxes using the liability method. Deferred tax assets, net of a valuation allowance, and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Leases: The Company and its subsidiaries rent office space and equipment under various operating lease agreements. The aggregate rental expense charged to operations was approximately $865,000 in 50 52 1998, $826,000 in 1997, and $802,000 in 1996. Future minimum lease commitments require payments of approximately $735,000, $681,000 and $342,000 in 1999, 2000 and 2001, respectively. Use of Estimates: The preparation of financial statements requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Such estimates and assumptions could change in the future as more information becomes known which could impact the amounts reported and disclosed herein. Earnings per Share: Basic earnings per share are based on the weighted-average number of common shares outstanding during the year. The weighted-average number of common shares outstanding was 4,702,805, 4,688,364 and 4,675,701 at December 31, 1998, 1997 and 1996, respectively. Diluted earnings per share are computed assuming that the weighted-average number of shares increases by the conversion of fixed awards (employee stock options). The diluted per share computations reflect a change in the number of common shares outstanding (the "denominator") to include the number of additional shares that would have been outstanding if the potentially dilutive shares had been issued. The Company had no potentially dilutive employee stock options outstanding for the periods presented. Therefore, the denominator was the same for both basic and dilutive per share calculations. The numerator (net loss) was also constant for both computation methods. New Accounting Standards: In June 1997, The Financial Accounting Standards Board ("FASB") issued Financial Accounting Standard No. 130, "Reporting Comprehensive Income" ("SFAS 130") for years beginning after December 15, 1997. Comprehensive income is defined as essentially all changes in shareholders' equity exclusive of transactions with owners, such as capital investments, and includes net income (loss) plus changes in certain assets and liabilities that are reported directly in equity. The unrealized gain or loss on available-for-sale securities is the Company's only component of other comprehensive income and is presented on the Consolidated Statement of Changes in Shareholders' Equity. Also during June 1997, the FASB issued Statement of Financial Accounting Standard No. 131 "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131") for years beginning after December 15, 1997. SFAS 131 requires companies to use the "management approach" in disclosing segment information based on what type of financial information top management uses in the decision-making process. This approach is intended to allow users to better understand the Company's performance. Management has reviewed the requirements of SFAS 131 and, in accordance with the standard, has determined that the Company has two operating segments: property and casualty insurance for commercial automobile and private passenger automobile. See Note L. 51 53 In February 1998, the FASB issued Statement of Financial Accounting Standards No. 132 "Employers' Disclosures about Pensions and Other Postretirement Benefits" ("SFAS 132") for years beginning after December 15, 1997. The overall objective of SFAS 132 is to improve and standardize disclosures about pensions and other postretirement benefits and to make the required information easier to prepare and more understandable. Information disclosed in Note F regarding the Company's Pension Plan is presented in accordance with the requirements of SFAS 132. NOTE B Statutory Results and Dividend Restrictions The reporting practices for McM's insurance subsidiaries prescribed or permitted by state regulatory authorities ("statutory accounting") differ from generally accepted accounting principles. OF&C (which includes Wilshire on a statutory equity basis) reported to insurance regulatory authorities a net loss of $7.1 million and $2.8 million in 1998 and 1997 respectively, and net income of $49,000 in 1996. Combined capital and surplus reported to insurance regulatory authorities totalled $27.7 million and $11.5 million at December 31, 1998 and 1997, respectively. McM's insurance subsidiaries are subject to regulation and supervision by regulatory authorities in the states in which they operate. The regulatory bodies have broad administrative powers relating to standards of solvency, minimum capital and surplus requirements, maintenance of required reserves, payments of dividends, statutory accounting and reporting practices, and other financial and operational matters. Generally, the net assets of the insurance subsidiaries available for transfer to the parent company are limited to the amounts by which the insurance subsidiaries' net assets, as determined in accordance with statutory accounting practices, exceed the minimum statutory capital requirement of $2,250,000. Also, by statute, dividends exceeding the lesser of 10% of statutory-basis capital and surplus or the previous year's net income, excluding net realized capital gains, require the prior approval of the Commissioner of the North Carolina Department of Insurance. OF&C and Wilshire are domiciled in the State of North Carolina and prepare their statutory-basis financial statements in accordance with accounting practices and procedures prescribed or permitted by the North Carolina Department of Insurance. "Prescribed" statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners ("NAIC"). "Permitted" statutory accounting practices may differ from state to state, may differ from company to company within a state, and may change in the future. In 1998, the NAIC adopted codified statutory accounting practices, which constitutes the only source of comprehensive "prescribed" statutory accounting 52 54 practices. The codified practices and principles, which are effective January 1, 2001, will result in changes to the accounting methodology that insurance enterprises use to prepare their statutory financial statements. The full impact of the codified practices and principles on McM's insurance subsidiaries' statutory financial statements is not known at this time. The North Carolina Department of Insurance imposes minimum risk-based capital requirements on insurance enterprises that were developed by the NAIC. The formulas for determining the amount of risk-based capital ("RBC") specify various weighting factors that are applied to financial balances or various levels of activity based on the perceived degree of risk. Regulatory compliance is determined by a ratio ("the Ratio") of the enterprise's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC as defined by the NAIC. Enterprises below specific trigger points or ratios are classified within certain levels, each of which requires corrective action. The capital and surplus levels at December 31, 1998, for both insurance subsidiaries exceeded all RBC requirements. NOTE C Redeemable Preferred Stock Redeemable Series A: On October 1, 1998 McM authorized 60,000 shares of Series A Preferred Stock, $1,000 par value per share ("Series A Preferred Stock"). Series A Preferred Stock has no dividend or voting rights and are nonconvertible. Upon voluntary or involuntary liquidation, dissolution or winding up of the Company, holders of shares of Series A Preferred Stock shall be entitled to receive out of net assets of the Company before any payment or distribution shall be made or set apart for payment on the common stock or any other class or series of stock of the Company, the amount of $1,000 per share of Series A Preferred Stock. After payment to the holders of Series A Preferred Stock of $1,000 per share, the holders of shares of Series A Preferred Stock, as such, shall have no right or claim to any of the remaining net assets of the Company. The shares of Series A Preferred Stock shall at all times be redeemable at the option of the holder thereof in cash for $1,000 per share payable by the Company immediately from available funds. Holders of Series A Preferred Stock do not have any rights to convert such share into to exchange such share for shares of Common Stock of the Company or any other class or series of stock of the Corporation. Holders of Series A Preferred Stock do not have a right to vote on any matter pertaining to the Company. Series A Preferred Stock shall rank senior to any other class or series of preferred stock of the Company upon liquidation of the Company. As a condition to the Offer and Rights Agreement between the 53 55 Company and two shareholders, McM has agreed to issue all 60,000 Series A Redeemable Preferred Shares to one shareholder at an exercise price of $.01 per share upon the occurrence of certain events. The events that could cause an exercise of theses rights involve the purchase/sale of shares between the two shareholders and certain changes in the Board of Directors. As of December 31, 1998, there were no shares of Series A Preferred issued or outstanding. Cumulative, Redeemable PIK Series B: On October 28, 1998, McM authorized 50,000 shares of Series B PIK Preferred Stock, $1,000 par value per share. The Series B PIK Preferred Stock are nonconvertible and have no voting rights. Series B PIK Preferred Stock accumulate dividends at a rate of 12.0% per annum, payable quarterly in arrears to such holders of Series B PIK Preferred Stock on January 7, April 7, July 7 and October 7. Dividends are cumulative from the date of issuance and shall be paid in kind with additional fully paid and nonassessable shares of Series B PIK Preferred Stock and having an aggregate liquidation preference equal to the amount of such dividends. However, the Board of Directors of McM, at its option, may pay any dividend in cash. No dividends were declared or paid in 1998. Cumulative dividends in arrears at December 31, 1998, were $408,658. Upon the voluntary or involuntary liquidation of the Company, the holders of shares of Series B PIK Preferred Stock shall be entitled to receive out of the net assets of the Company before any payment or distribution shall be made or set apart for payment on the Common Stock or any other class or series of stock of the Company other than Series A Redeemable Preferred Stock, $1,000 per share of Series B PIK Preferred Stock. After payment to holders of shares of Series B PIK Preferred Stock, the amount of $1,000 per share, the holders of shares of Series B PIK Preferred Stock shall have no right or claim to any of the remaining assets of the Company. Effective on the date that is seven years from the date of issuance, outstanding shares of Series B PIK Preferred Stock shall be redeemed by the Company in cash for $1,000 per share plus an amount equal to all accumulated and unpaid dividends. Holders of Series B PIK Preferred Stock have no rights to convert such share into or to exchange such share for shares of Common Stock or any other class or series of stock of the Company. Holders of Series B PIK Preferred Stock do not have any right to vote on any matter of the Company. Series B PIK Preferred Stock shall rank, as to the distribution of assets upon liquidation of the Company senior to any other class or series of preferred stock of the Company except Series A Redeemable Preferred Stock. As of December 31, 1998, there were 26,000 shares of Series B PIK Preferred Stock issued and outstanding. 54 56 NOTE D Reinsurance The property and casualty insurance subsidiaries have entered into reinsurance agreements with various reinsurers in order to reduce their ultimate claim risk. Current reinsurance agreements provide for premium rates based on the amount of coverage in excess of the defined retention level. Generally, the Company's retention level for all accident years was $100,000 with the exception of the 1991 accident year which was $250,000. These retention levels are effected under the Company's casualty excess of loss reinsurance treaties. The Company is also party to quota share reinsurance arrangements on its private passenger automobile and commercial auto liability coverages. A quota share reinsurance treaty is maintained on the Company's private passenger automobile business which became effective in April 1993. The rates pertaining to this treaty have ranged between 20% and 40% since its inception. An addendum to the private passenger quota share treaty provided for the ceding of 100% of the unearned premium to the reinsurers as of December 31, 1997. A 5% quota share is also maintained for commercial auto liability coverages. These quota share treaties were placed to help control the Company's statutory net writings to surplus ratios as well as future premium growth in related markets. The effect of reinsurance on premiums written and earned in 1998, 1997 and 1996 was as follows:
For the Year Ended December 31 ---------------------------------------------------------------------- 1998 1997 1996 Premiums Premiums Premiums Written Earned Written Earned Written Earned -------- -------- -------- -------- -------- --------- (Thousands of dollars) Direct $56,494 $ 59,335 $ 63,699 $ 65,205 $ 62,698 63,163 Assumed 5,759 7,800 9,830 10,573 11,561 10,405 Ceded (16,662) (20,127) (22,315) (20,071) (20,839) (21,714) ------- -------- -------- -------- -------- -------- Net $45,591 $ 47,008 $ 51,214 $ 55,707 $ 53,420 $ 51,854 ======= ======== ======== ======== ======== ========
To minimize its exposure to losses from reinsurance insolvencies, OF&C and Wilshire evaluate the financial condition of their reinsurers and monitor concentration of credit risk arising from similar geographic regions, activities or economic characteristics of the reinsurers. A schedule of the Company's reinsurers whose balances are approximately 10% or more of McM's shareholders' equity at December 31, 1998 is provided below: 55 57
Ceded Reinsurer Balances Receivable ------------ -------------------- (Thousands of dollars) Lloyds of London $ 8,430 CNA International 4,542 Unionamerica 4,446 AXA Reassurance 3,321 Zurich Re 3,039 Sphere Drake Insurance, PLC 1,976 Hannover Ruckersicherungs 922 Terra Nova Insurance Co. 704 National Reinsurance Corp 692 Chartwell Reinsurance Co. 567 National Workers Comp. Pool 549 Folksamerica Reinsurance Co. 505 Great Lakes American Reinsurance Company 489 Employers Reinsurance Corp. 433 Focus Insurance Company in Liquidation 375 Trenwick America Reinsurance Co. 310 All other 2,386 ------- Total $33,686
OF&C and Wilshire's policy is to hold collateral under related reinsurance agreements in the form of letters of credit for all reinsurers not licensed to do business in North Carolina. To the extent that reinsuring companies may later be unable to meet obligations under the reinsurance agreements, the insurance subsidiaries would remain liable. The Companies have administrative and reinsurance agreements whereby the Companies administer the business written by a Texas county mutual insurance company and the Companies assume $100,000 of risk per policy. At December 31, 1998 and 1997, the Companies had receivable balances related to these agreements of $1,720,240 and $833,460, respectively, which are included in other assets. NOTE E Income Taxes The Revenue Reconciliation Act of 1993 increased the U.S. Federal income tax rate to 35% for taxable income in excess of $10 million. Because of the large tax return net operating loss carryforwards of the Company and Company estimates that annual taxable income in the near future, before utilization of the carryforwards, will not exceed $10 million, a U.S. Federal income tax rate of 34% has been used to compute deferred tax assets and liabilities for the Company. There was no income tax expense attributable to income from 56 58 continuing operations for the years ended December 31, 1998, 1997 and 1996. These amounts differed from the amounts computed by applying the U.S. federal income tax rate of 34 percent to pretax income from continuing operations as follows:
Year Ended December 31 1998 1997 1996 (Thousands of dollars) Pretax income (loss) from continuing operations $(15,186) $(8,540) $(788) - ------------------------------------------------------------------------------ Computed "expected" tax expense (benefit) (5,163) (2,904) (268) Increase (decrease) in taxes resulting from: Change in valuation allowance 2,323 2,356 (77) Other 29 256 191 Net operating and capital losses not utilized 2,811 292 - - ------------------------------------------------------------------------------ Income Tax Expense $ 0 $ 0 $ 0 - ------------------------------------------------------------------------------
THIS SPACE LEFT BLANK INTENTIONALLY 57 59 The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of December 31, 1998 and December 31, 1997, are presented below.
December 31 ---------------------- 1998 1997 (Thousands of dollars) Deferred tax asset: Unearned premium reserves $ 540 $ 637 Claim reserves 1,367 1,270 Tax return net operating and capital loss carryforwards 35,074 33,028 Unrealized losses on fixed maturity securities 0 160 Other 286 232 -------- -------- Total gross deferred tax assets 37,267 35,327 Less: Valuation allowance (34,789) (34,117) -------- -------- Net deferred tax assets $ 2,478 $ 1,210 Deferred tax liabilities: Deferred policy acquisition costs $ 818 $ 953 Agent balances 20 57 Unrealized gains on fixed maturity securities 1,491 - Other 149 200 -------- -------- Total liabilities $ 2,478 $ 1,210 -------- -------- Net deferred tax account $ 0 $ 0 ======== ========
The valuation allowance for deferred tax assets as of January 1, 1998, was $34,789,000. The net change in the total valuation allowance for the year ended December 31, 1998, was an increase of $671,000, which includes a $1,651,000 decrease related to unrealized gains. McM and its subsidiaries file a consolidated income tax return. The Company had cumulative tax operating loss carryforwards of approximately $103 million as of December 31, 1998, with expiration dates of 1999 through 2018. No income taxes were paid in 1998, 1997, or 1996. 58 60 NOTE F Pension Plan McM and its subsidiaries have a non-contributory defined benefit pension plan covering substantially all their employees. The plan provides for payments to qualified employees based on compensation and years of service. The Company and its subsidiaries make contributions to the plan, if necessary, equal to the amounts required by ERISA. The following table sets forth the plan's funded status and amounts recognized in the Company's balance sheets at December 31:
December 31 ---------------------- 1998 1997 - ------------------------------------------------------ (Thousands of dollars) CHANGE IN BENEFIT OBLIGATION Benefit obligation at beginning of year $ 3,356 $ 2,816 Service cost 288 255 Interest cost 248 227 Actuarial loss 120 161 Benefits paid (85) (103) ------- ------- Benefit obligation at end of year $ 3,927 $ 3,356 CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of year $ 2,476 $ 1,819 Actual return on plan assets 211 369 Company contributions 443 391 Benefits paid (86) (103) ------- ------- Fair value of plan assets at end of year $ 3,044 $ 2,476 Funded status of the plan (underfunded) (882) (880) Unrecognized net actuarial loss 297 100 Unrecognized prior service cost (91) (47) ------- ------- Accrued benefit cost $ (676) (827) ======= ======= WEIGHTED-AVERAGE ASSUMPTIONS Discount rate 6.75% 7.25% Expected return on plan assets 9.00% 9.00% Rate of compensation increase 4.75% 4.75%
59 61 Net periodic pension expense included the following components:
Year Ended December 31 1998 1997 1996 - ---------------------------------------------------------- (Thousands of dollars) Service cost $ 289 $ 255 $ 257 Interest cost 248 227 206 Expected return on plan assets (226) (171) (120) Amortization of prior service cost (20) (20) (20) Recognized net actuarial loss - - 20 - --------------------------------------------------------- Benefit cost 291 291 343 =========================================================
NOTE G Investment Operations The sources of investment income are summarized as follows:
Year Ended December 31 ----------------------------- 1998 1997 1996 ----------------------------- (Thousands of dollars) Fixed maturities $1,962 $2,694 $2,490 Equity securities 20 0 0 Other long-term investments 49 44 48 Short-term investments 847 660 1,078 ----------------------------- 2,878 3,398 3,616 Investment expenses (362) (413) (457) ----------------------------- NET INVESTMENT INCOME $2,516 $2,985 $3,159 =============================
60 62 The amortized cost and estimated market values of investments in fixed maturities at December 31, 1998 and 1997, are as follows:
Gross Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gains Losses Value ------------------------------------------- (Thousands of dollars) Securities Available-for-Sale: - ------------------------------ December 31, 1998: Fixed maturities: U.S. Treasury securities and obligations of U.S. governmental corporations and agencies $22,756 $ 512 $ - $23,268 Public utilities and other 383 4 - 387 Mortgage-backed securities 2,013 - (8) 2,005 - ---------------------------------------------------------------------------- Total fixed maturities: 25,152 516 (8) $25,660 Equity securities: Industrial, miscellaneous and other 18,093 3,963 (87) 21,969 - ---------------------------------------------------------------------------- Total equity securities: 18,093 3,963 (87) 21,969 - ---------------------------------------------------------------------------- Total $43,245 $4,479 $(95) $47,629 ============================================================================ Securities Held-to-Maturity: - ---------------------------- December 31, 1998: Fixed maturities: U.S. Treasury securities and obligations of U.S. governmental corporations and agencies $ 2,943 $ 112 $ - $ 3,055 Obligations of states and political subdivisions 195 25 - 220 - ---------------------------------------------------------------------------- Total $ 3,138 $ 137 $ (0) $ 3,275 ============================================================================
61 63
Gross Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gains Losses Value --------------------------------------------- (Thousands of dollars) Fixed Maturity Securities Available-for-Sale: - --------------------------------------------- December 31, 1997: U. S. Treasury securities and obligations of U.S. governmental corporations and agencies $22,714 $178 $ (18) $22,874 Public utilities 469 2 (6) 465 Mortgage-backed securities 2,572 3 (630) 1,945 - --------------------------------------------------------------------------------------------- Total $25,755 $183 $(654) $25,284 ============================================================================================= Fixed Maturity Securities Held-to-Maturity: - ------------------------------------------- December 31, 1997: U.S. Treasury securities and obligations of U.S. governmental corporations and agencies $ 2,940 $ 74 $ (1) $ 3,013 Obligations of states and political subdivisions 194 28 - 222 - --------------------------------------------------------------------------------------------- Total $ 3,134 $102 $ (1) $ 3,235 =============================================================================================
The amortized cost and estimated market value of fixed maturities at December 31, 1998, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities as certain borrowers have the right to call or prepay obligations without penalty. 62 64
Estimated Amortized Market Cost Value ---------------------- (Thousands of dollars) Fixed Maturity Securities Available-for-Sale: - --------------------------------------------- Due in one year or less $ 587 $ 590 Due after one year through five years 10,059 10,184 Due after five years through ten years 3,452 3,788 Due after ten years 9,041 9,093 - ----------------------------------------------------------------------- 23,139 23,655 Mortgage backed securities 2,013 2,005 - ----------------------------------------------------------------------- $25,152 $25,660 ======================================================================= Fixed Maturity Securities Held-to-Maturity: - ------------------------------------------- Due in one year or less $ 1,705 $ 1,710 Due after one year through five years 1,015 1,084 Due after five years through ten years 418 481 Due after ten years -- -- - ----------------------------------------------------------------------- $ 3,138 $ 3,275 =======================================================================
Realized gains and losses from sales of investments in fixed maturities were as follows:
Year Ended December 31 1998 1997 1996 ------------------------ (Thousands of dollars) Realized gains and losses: Securities available-for-sale: Fixed maturities: Gross realized gains $ 1 $ 367 $ 40 Gross realized losses 20 171 - Equity securities: Gross realized gains 558 - - Gross realized losses 265 - -
The carrying value of investments in persons (other than the U.S. Government or a Government Agency or Authority, State, Municipality, or Political Subdivision) exceeding 10% of total shareholders' equity is as follows: 63 65
December 31 --------------------- 1998 1997 --------------------- (Thousands of dollars) Southern Capital Corporation $ 1,117 $ 3,431 General Electric Capital Corporation 9,686 17,520 AIM Short Term 759 - American Safety Razor Company 1,200 - Bankers Trust Corporation 3,417 - Elxsi Corporation 1,856 - ESS Technology Incorporated 480 - Helmerich & Payne Incorporated 969 - Keycorp Incorporated 1,357 - Lehman Brothers Holdings Incorporated 2,423 - MFC Bancorp Limited 913 - Mercer International Incorporated 2,003 - Merrill Lynch Pierce Fenner & Smith Incorporated 334 - Stolt Comex Seaway Incorporated 550 - TRC Companies Incorporated 1,669 - Thoratec Labs Corporation 1,843 - Thousand Trails Incorporated 1,182 - Varco International Incorporated 295 - Ziegler Company Incorporated 1,125 -
NOTE H Reserves for Losses and Settlement Expenses The consolidated financial statements include the estimated reserve for losses and settlement expenses of the property and casualty insurance subsidiaries. The subsidiaries primarily write commercial auto liability, physical damage and cargo coverages and non-standard private passenger automobile coverages. The liabilities for losses and settlement expenses are determined using case basis evaluations and statistical projections and represent estimates of the ultimate net cost of all unpaid losses and settlement expenses incurred through December 31 of each year. These estimates give effect to trends in claims severity and other factors which may vary as the liabilities are ultimately settled. The estimates are continually reviewed and, as adjustments to these liabilities become necessary, such adjustments are reflected in current operations. The following table provides a reconciliation of the beginning and ending reserve balances for losses and settlement expenses, on a gross-of-reinsurance basis, for 1998, 1997 and 1996, to the gross amounts reported in McM's balance sheet. 64 66
Year Ended December 31 ------------------------------ 1998 1997 1996 - --------------------------------------------------------------- (Thousands of dollars) Reserves for losses and settlement expenses, net of reinsurance recoverables, at beginning of year $29,159 $26,532 $29,997 Provision for insured events of the current year 37,399 42,243 37,651 Increase in provision for insured events of prior years 7,086 5,774 1,559 ----------------------------- Incurred losses and settlement expenses during current year, net of reinsurance 44,485 48,017 39,210 Payments for: Losses and settlement expenses attributable to insured events of the current year 20,905 26,123 22,853 Losses and settlement expenses attributable to insured events of prior years 19,434 19,267 19,822 ----------------------------- 40,339 45,390 42,675 ----------------------------- Reserves for losses and settlement expenses, net of reinsurance recoverables, at end of year 33,305 29,159 26,532 Reinsurance recoverable on unpaid losses and settlement expenses at end of year 27,539 28,124 28,768 ----------------------------- Gross reserves for losses and settlement expenses at end of year $60,844 $57,283 $55,300 =============================
The reconciliation above shows that a deficiency of $7,086,000 in the prior year reserve emerged during 1998. The deficiency at December 31, 1998, included adverse reserve development of approximately $6,885,000 in the commercial auto liability line of business, and $1,038,000 in discontinued lines of business and participation in involuntary pools and other residual market mechanisms in which OF&C and WIC are required to participate by the various states in which the companies write insurance. Mitigating 65 67 the above adverse development was $748,000 of favorable development in inland marine, commercial auto physical damage, and general liability lines of business, and favorable development of $89,000 relating to private passenger liability and physical damage lines of business. The $5,774,000 deficiency included for 1997 included adverse reserve development of approximately $844,000 in private passenger automobile liability reserves, $813,000 in private passenger and commercial automobile physical damage and inland marine reserves and $3,531,000 relating to the commercial automobile liability line of business. In addition, approximately $586,000 of this deficiency relates to discontinued lines of business and participation in involuntary pools and other residual market mechanisms in which OF&C and Wilshire are required to participate by the various states in which the companies write insurance. The increase in overall reserves levels for 1997 resulted from prior year reserve deficiencies, particularly for the 1996 and 1995 accident years and increased claim costs in the current underwriting year for commercial and private passenger automobile physical damage coverages. The anticipated effect of inflation is implicitly considered when estimating liabilities for losses and settlement expenses. While anticipated cost increases due to inflation are considered in estimating the ultimate claim costs, the increase in average severity of claims is caused by a number of factors that vary with the individual type of policy written. Future average severity is projected based on historical trends adjusted for anticipated changes in these trends and general economic conditions. These anticipated trends are monitored based on actual development and are modified as necessary. NOTE I Contingencies Litigation: In the normal course of operations, certain subsidiaries of the Company have been named as parties to various pending and threatened litigation. While the outcome of some of these matters cannot be estimated with certainty, it is the opinion of management that the resolution of these matters will not have a material adverse affect on the Company's consolidated financial position or results of operations. Guaranty Associations: The insurance subsidiaries are required to be members of various state insurance guaranty associations in order to conduct business in those states. These associations have the authority to assess member companies in the event that an insurance company conducting business in that state is unable to meet its policyholder obligations. The Company recognizes the expense for these assessments in the year they are assessed. The Company incurred expenses of $13,000 and $25,000 in 1998 and 1997, 66 68 respectively, and received a net refund of $26,000 in 1996 related to these assessments. NOTE J Stock Option Plan and Earnings Per Share At December 31, 1996, the Company adopted Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation" ("SFAS 123"). SFAS 123 introduces a fair-value based method of accounting for stock-based compensation and encourages, but does not require, compensation expense recognition for grants of stock, stock options and other equity instruments to employees. In accordance with SFAS 123, the Company has elected to continue to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations in accounting for its employee stock options. The Company had an Employee Incentive Stock Option Plan, the 1986 Employee Incentive Stock Option Plan ("1986 Plan"), which expired by its terms, May 16, 1996. The 1986 Plan provided that options could be granted to selected key employees at exercise prices equal to market value on the date the option is granted. Options were granted for a period not exceeding ten years and were exercisable at a rate of 20% per year starting one year from the date of grant. Depending upon the circumstances of an optionee's termination of employment, the optionee's options either a) remain exercisable for three or six months after termination to the extent they were exercisable at termination unless vesting is accelerated by the Compensation Committee, b) remain exercisable until a change in control of the Company, as defined in the 1986 Plan, c) remain exercisable for five years and one day from the date of the optionee's termination or d) terminate as of the termination of the optionee's employment. In 1996 the Company adopted the 1996 Employee Incentive Stock Option Plan ("1996 Plan"). The terms of the 1996 Plan are generally the same as the 1986 plan. The Company had reserved 250,000 shares of common stock for distribution under the 1986 Plan, and 300,000 shares have been reserved for distribution under the 1996 Plan. The following options to purchase the Company's common shares were outstanding under the 1986 and 1996 Plans as of December 31, 1998 and 1997: 67 69
NUMBER OF SHARES UNDERLYING OUTSTANDING OPTIONS OPTION PRICE DATE OF GRANT 1998 1997 PER SHARE - ---------------------------------------------------------------- January 15, 1988 -0- 1,000 $ 8.50 October 6, 1988 -0- 2,000 $10.00 January 15, 1993 -0- 42,962 $ 1.38 July 25, 1994 -0- 19,000 $ 2.25 August 17, 1994 -0- 81,000 $ 2.75 March 26, 1997 20,000 35,000 $ 3.94 - ---------------------------------------------------------------- 20,000 180,962 ================================================================
At December 31, 1998, 4,000 options were exercisable. In accordance with the terms of the 1986 Plan, the options granted January 15, and October 6, 1988 expired during 1998, ten years after their date of grant. The options granted January 15, 1993, July 25, 1994, and August 17, 1994 were forfeited in 1998. The remaining contractual life for the options outstanding at December 31, 1998 is 8.24 years. The Company previously had a phantom stock plan under which shares of "phantom stock" were awarded to certain employees. A maximum of 250,000 shares of phantom stock could be awarded under the plan. Upon maturity of an award, shares of phantom stock would be settled in cash equal to the market value of common shares at the maturity date plus the amount of cash dividends paid on an equal number of common shares over the life of the award. The awards generally vested over a five year period beginning five years after the award date and matured on the two year anniversary of the termination of the employee, or upon a change in control (as defined in the plan) of the Company. There were no shares of phantom stock granted in 1998 or 1997. In 1996 and 1995, 50,000 shares of phantom stock were granted under the plan. Related expenses of $80,000, $10,000, $44,000 and $26,000 were accrued at December 31, 1998, 1997, 1996, and 1995, respectively. The phantom stock plan and all awards thereunder were terminated effective December 16, 1998. The Company paid a total of $160,000 to award recipients in exchange for an agreement to terminate the outstanding awards. Pro forma information regarding net (loss) income and earnings per share is required by SFAS 123, which also requires that the information be determined as if the Company has accounted for its employee stock options and awards granted subsequent to December 31, 1994, under the fair value method prescribed by SFAS 123. The estimated fair value of the options was calculated under the Black-Scholes valuation model using the following assumptions as of December 31, 1997 (the period of the last option grant: 68 70
1997 ----- Risk-free interest rate 6.96% Dividend yield 0.00% Volatility factor 63.5% Expected life (years) 10
The pro forma basic and diluted net(loss) income per share did not change from that which has been reported, for all periods presented, as a result of SFAS 123. Further, because SFAS 123 is applicable only to stock-based awards granted after December 31, 1994, the pro forma effect of the amortization of the estimated fair value of the Company's outstanding stock is not likely to be representative of the effects on the reported net (loss) income for future years. NOTE K Summary of Fair Values The method of determining fair values for investments in fixed maturity securities is discussed in Note F. For all other financial instruments, carrying value approximates fair value. The following table summarizes the carrying value and fair value of financial instruments:
December 31 1998 1997 ---------------------------------------- Carrying Fair Carrying Fair Value Value Value Value ----------------------------------------- (Thousands of dollars) Financial Assets: Cash $ 8,120 $ 8,120 $ 1,698 $ 1,698 Short-term investments $11,572 $11,572 $21,522 $21,522 Fixed maturity securities available-for-sale (Note G) $25,660 $25,660 $25,284 $25,284 Equity securities available-for-sale (Note G) $21,969 $21,969 - - Fixed maturity securities held-to-maturity (Note G) $ 3,138 $ 3,275 $ 3,134 $ 3,235
NOTE L Segment Information The major focus of McM Corporation and its property and casualty insurance subsidiaries is providing commercial insurance to the trucking industry including cargo, liability and physical damage coverages and to the personal automobile market providing liability and physical damage coverages. The Company, therefore, has two reportable segments: commercial automobile and private passenger automobile. 69 71 The Company's reportable segments are business units that offer insurance coverage to different market segments. The reportable segments are each managed separately because their insurance products are tailored to meet the specific needs of their respective clientele. The Company does not account for assets on a segment basis.
1998 1997 1996 -------- -------- -------- Net premiums earned: Private passenger $ 6,099 $ 14,155 $ 9,703 Commercial auto 40,909 41,552 42,151 Other - - - -------- -------- -------- Total 47,008 55,707 51,854 Net investment income (including realized investment gains): Private passenger 297 381 418 Commercial auto 2,574 2,587 3,377 Other (81) 213 (596) -------- -------- -------- Total 2,790 3,181 3,199 Net (loss) income: Private passenger (2,986) (3,862) 2,759 Commercial auto (10,715) (4,600) (2,182) Other (1,485) (78) 211 -------- -------- -------- Total $(15,186) $ (8,540) $ 788 ======== ======== ========
70 72 Report of Independent Auditors ERNST & YOUNG LLP Board of Directors and Shareholders McM Corporation We have audited the accompanying consolidated balance sheets of McM Corporation and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, shareholders equity and cash flows for each of the three years in the period ended December 31, 1998. 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 generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of McM Corporation and subsidiaries at December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. Raleigh, North Carolina ERNST & YOUNG LLP February 26, 1999 71 73 SCHEDULE 1 -- SUMMARY OF INVESTMENTS McM CORPORATION AND SUBSIDIARIES December 31, 1998
AMOUNT SHOWN ON MARKET BALANCE TYPE OF INVESTMENT COST VALUE SHEET ------------------ ------- ------- ------- (Thousands of dollars) Securities Available-for-Sale - ----------------------------- Fixed Maturities: Bonds Mortgage-backed securities $ 2,013 $ 2,005 $ 2,005 U.S. Government, government agencies and authorities 22,756 23,268 23,268 Public utilities and other bonds 383 387 387 ------- ------- ------- Total Fixed Maturities 25,152 25,660 25,660 Equity Securities: Industrial, miscellaneous and other 18,093 21,969 21,969 ------- ------- ------- Total Equity Securities 18,093 21,969 21,969 Short-term investments 11,572 11,572 11,572 ------- ------- ------- Total Securities Available-for-Sale 54,817 59,201 59,201 Held-to-Maturity - ---------------- U.S. Government, government agencies and authorities 2,943 3,055 2,943 States, municipalities and political subdivisions 195 220 195 ------- ------- ------- Total Securities Held-to-Maturity 3,138 3,275 3,138 ------- ------- ------- Total Investments $57,955 $62,476 $62,339 ======= ======= =======
72 74 SCHEDULE 2 - CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS McM CORPORATION (PARENT COMPANY) (Thousands of dollars)
December 31 1998 1997 ------- ------- ASSETS Fixed maturities available for sale $ 37 $ 0 Short term investments 10 35 Cash 125 108 Other assets 33 99 ------- ------- 205 242 Investments in wholly-owned subsidiaries at equity * 31,176 15,331 ------- ------- TOTAL ASSETS $31,381 $15,573 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Accrued expenses $ 1,623 $ 1,619 Income taxes payable to wholly-owned subsidiaries * 387 387 Payable to wholly-owned subsidiaries * 914 799 ------- ------- 2,924 2,805 Redeemable Preferred Stock - Series B PIK 26,000 0 Shareholders' Equity: Common stock 4,706 4,696 Additional paid-in capital 1,540 1,530 Unrealized gain (loss) on securities available-for-sale, including unrealized gain (loss) on securities held by subsidiaries: 1998 - $4,384 ; 1997 - ($471) 4,384 (471) Retained (deficit) earnings (8,173) 7,013 ------- ------- TOTAL SHAREHOLDERS' EQUITY 2,457 12,768 ------- ------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $31,381 $15,573 ======= =======
* Eliminated in consolidation See notes to condensed financial information. 73 75 SCHEDULE 2 - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF OPERATIONS McM CORPORATON (PARENT COMPANY) (Thousands of dollars)
Year Ended December 31 1998 1997 1996 -------- ------- ----- INCOME Administrative charges to subsidiaries * - Note B $ 500 $ 650 $ 650 Realized investment income 45 (135) 8 -------- ------- ----- 545 515 658 General and administrative expenses 1,723 932 893 -------- ------- ----- LOSS BEFORE TAXES AND EQUITY IN UNDISTRIBUTED LOSS OF SUBSIDIARIES (1,178) (416) (235) Income taxes (benefits) 0 0 (140) -------- ------- ----- LOSS BEFORE EQUITY IN UNDISTRIBUTED LOSS OF SUBSIDIARIES (1,178) (416) (95) Equity in undistributed loss of subsidiaries (14,008) (8,124) (693) -------- ------- ----- NET LOSS $(15,186) $(8,540) $(788) ======== ======= =====
* Eliminated in consolidation. See notes to condensed financial information. 74 76 SCHEDULE 2 - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS McM CORPORATON (PARENT COMPANY) (Thousands of dollars)
Year Ended December 31 1998 1997 1996 -------- ------- ----- OERATING ACTIVITIES Net Loss $(15,186) $(8,540) $(788) Adjustments to reconcile net loss to net cash (used) provided by operating activities: Depreciation 2 1 4 Equity in loss of subsidiaries 14,008 8,124 693 Other assets 66 (19) 33 Other liabilities 4 57 53 Income taxes payable to wholly-owned subsidiaries 0 0 182 Payables to wholly-owned subsidiaries 115 181 69 Adjustment to market value of fixed maturity (37) 143 0 -------- ------- ----- CASH (USED) PROVIDED BY OPERATING ACTIVITIES (1,028) (53) 246 INVESTING ACTIVITIES Disposals of fixed maturities 0 0 57 Decrease (increase) in short-term investments 25 (5) (30) -------- ------- ----- CASH PROVIDED (USED) BY INVESTING ACTIVITIES 25 (5) 27 FINANCING ACTIVITIES Employee stock purchases 20 59 15 Cash dividends paid 0 0 (282) Preferred stock issuance 26,000 0 0 Purchase of wholly-owned subsidiaries' preferred stock (5,000) 0 0 Capital contributed to wholly-owned subsidiaries (20,000) 0 0 -------- ------- ----- CASH PROVIDED (USED) BY FINANCNG ACTIVITIES 1,020 59 (267) -------- ------- ----- INCREASE IN CASH $ 17 $ 1 $ 6 ======== ======= =====
See notes to condensed financial information. 75 77 SCHEDULE 2 -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT NOTES TO CONDENSED FINANCIAL INFORMATION McM CORPORATION (PARENT COMPANY) The accompanying condensed financial information should be read in conjunction with the consolidated financial statements and notes thereto of McM Corporation and Subsidiaries. NOTE A -- Significant Accounting Policies In the parent company financial statements, the Company's investments in wholly-owned subsidiaries are stated at cost plus equity in undistributed earnings of the subsidiaries. McM is actively engaged through certain of its subsidiaries in the property and casualty insurance business. NOTE B -- Administrative Charges During 1998 McM was compensated by its subsidiaries in the form of management fees for providing management support, planning assistance, financial reporting and investment services. 76 78 SCHEDULE 3 - REINSURANCE McM CORPORATION AND SUBSIDIARIES Year Ended December 31, 1998, 1997, and 1996
Premiums Earned ---------------------------------------------- Percentage Ceded to Assumed of Amount Direct Other From Other Net Assumed (Thousands of dollars) Amount Companies Parties Amount to Net ------- --------- --------- ------- ---------- YEAR ENDED DECEMBER 31, 1998 $59,335 $20,127 $ 7,800 $47,008 16.59% ======= ======= ======= ======= YEAR ENDED DECEMBER 31, 1997 $65,205 $20,071 $10,573 $55,707 18.98% ======= ======= ======= ======= YEAR ENDED DECEMBER 31, 1996 $63,163 $21,714 $10,405 $51,854 20.07% ======= ======= ======= =======
77 79 SCHEDULE 4 - VALUATION AND QUALIFYING ACCOUNTS McM CORPORATION AND SUBSIDIARIES (Thousands of dollars)
ADDITIONS ------------------------------------------- (1) (2) Charged to Charged to Balance at (Recovery of) (Recovery of) Other DESCRIPTION Beginning of Period Costs and Expenses Accounts-Describe ------------------- ------------------ ------------------- YEAR ENDED DECEMBER 31, 1998 Deducted from asset account: Allowance for uncollectible accounts $ 345 $( 316) $ 0 Deferred tax valuation allowance 34,117 0 2,323 (2) Included as liability account: Allowance for bad debts on liquidated reinsurers (242) 1,415 0 YEAR ENDED DECEMBER 31, 1997 Deducted from asset account: Allowance for uncollectible accounts $ 345 $ 0 $ 0 Deferred tax valuation allowance 31,623 0 2,356 (2) Included as liability account: Allowance for bad debts on liquidated reinsurers 158 402 0 YEAR ENDED DECEMBER 31, 1996 Deducted from asset accounts: Allowance for uncollectible accounts $ 345 $ 0 $ 0 Deferred tax valuation allowance 31,520 0 (77)(2) Included as liability account: Allowance for bad debts on liquidated reinsurers 1,060 (150) 0 Balance at End of Period Deductions-Describe (Debit) Credit - ------------------- -------------- $ 0 $ 29 1,651 34,789 444 729 $ 0 $ 345 (138)(3) 34,117 802 (242) $ 0 $ 345 180 31,263 752 158
(1) Write-off of paid recoverable balances for insolvent/liquidated reinsurers against provision established (2) Increase (decrease) in deferred tax valuation account (3) Change in deferred tax valuation account related to net appreciation (depreciation) in securities available-for-sale 78 80 SCHEDULE 5 - SUPPLEMENTAL INSURANCE INFORMATION PROPERTY/CASUALTY INSURANCE SUBSIDIARIES YEAR ENDED DECEMBER 31, 1998, 1997 AND 1996 (Thousands of dollars)
CLAIMS AND CLAIM ADJUSTMENT EXPENSES RESERVES FOR INCURRED RELATED TO DEFERRED UNPAID CLAIMS DISCOUNT -------------------- POLICY AND CLAIM IF ANY (1) (2) ACQUISITION ADJUSTMENT DEDUCTED IN UNEARNED EARNED INVESTMENT CURRENT PRIOR COSTS EXPENSES RESERVES PREMIUMS PREMIUMS INCOME YEAR YEAR ----------- ------------- ----------- -------- -------- ---------- ------- ------- YEAR ENDED DECEMBER 31: Net of Reinsurance 1998 $2,407 $33,305 -- $ 7,946 $47,008 $2,516 $37,399 $ 7,086 1997 2,802 29,159 -- 9,363 55,707 2,985 42,243 5,774 1996 3,992 26,532 -- 13,857 51,854 3,159 37,651 1,559 Gross of Reinsurance 1998 $2,407 $60,844 -- $10,793 $67,135 $2,516 $53,187 $ 6,649 1997 2,802 57,283 -- 15,676 75,778 2,985 54,266 8,616 1996 3,992 55,300 -- 17,925 73,568 3,159 52,711 (930) AMORTIZATION OF DEFERRED PAID CLAIMS POLICY AND CLAIM ACQUISITION ADJUSTMENT PREMIUMS COSTS EXPENSES WRITTEN ------------ ----------- -------- $11,401 $40,339 $45,591 10,332 45,390 51,214 9,116 42,675 53,420 $11,401 $56,275 $62,253 10,332 60,898 73,529 9,116 62,633 74,259
79 EX-3.A 2 ARTICLES OF INCORPORATION AS AMENDED 1 RESTATED ARTICLES OF INCORPORATION OF McM CORPORATION 1. The name of the corporation is McM Corporation. 2. The period of duration of the corporation is perpetual. 3. The purposes of which the corporation is organized are to perform management and other services to insurance companies; to enter into contracts with insurance companies; to perform all activities which may be useful and helpful to insurance companies; and to engage in any other lawful act or activity for which corporations may be organized under Chapter 55 of the General Statutes of North Carolina, including, but not limited to: constructing, manufacturing or producing; repairing, servicing, processing, buying, selling, dealing, brokering, factoring, owning, leasing, distributing, lending, borrowing, investing, transporting, or advertising; performing personal services; and entering into any type of management, advisory, promotional, insurance, guarantyship, fiduciary or representative capacity or relationship with or for any persons or corporation whatsoever. 4. Shares. (a) AUTHORIZED SHARES. The aggregate number of shares which the Corporation shall have authority to issue is 11,000,000, of which 10,000,000 shares shall be designated "Common Shares," with a par value of $1.00, of which 1,000,000 shares shall be designated "Preferred Shares" with such par value as the Board of Directors may hereafter determine. (b) RELATIVE RIGHTS AND PREFERENCE. The relative rights, privileges and limitations of the Common Shares and Preferred Shares shall be as follows: 89 2 1) COMMON SHARES. The holders of Common Shares issued and outstanding, except where otherwise provided by law, these Articles of Incorporation or the Board of Directors, shall have and possess the right to notice of shareholders' meetings and voting rights and powers. Subject to any and all of the rights of the Preferred Shares, as such are determined by the Board of Directors, dividends may be paid on the Common Shares, as and when declared by the Board of Directors, out of any funds of the Corporation legally available for the payment of such dividends. In the event of dissolution of the Corporation, whether voluntary or involuntary, any distribution to holders of Common Shares shall be subject to the rights and preferences of the holders of the Preferred Shares, as such rights and preferences are determined by the Board of Directors, but all of the shares together shall be entitled to receive the net assets of the Corporation. 2) PREFERRED SHARES. Authority is expressly granted to the Board of Directors at any time and from time to time to issue the Preferred Shares in one or more series and for such consideration as may be fixed from time to time by the Board of Directors, and to fix, subject to the provisions herein, before the issuance of any shares of a particular series, the designation of such series, the number of shares to comprise such series, the dividend rate per annum payable on the shares of such series, the redemption price or prices of the shares in such series, the conversion features of such series, the voting rights of such series, the liquidation preference of such series, and any other rights, preferences and limitations pertaining to such series. Such rights, preferences and limitations shall be recorded in Articles of Amendment to the Corporation's Articles of Incorporation and filed with the Secretary of State before the issuance of any shares of such series. All shares of any one series of Preferred Shares shall be identical, except that the dates from which dividends shall be cumulative may vary. 90 3 3) The rights, preferences, limitations and characteristics of the Corporation's Series A Preferred Stock are set forth in Appendix A hereto and are incorporated herein by reference. 4) The rights, preferences, limitations and characteristics of the Corporation's Series B PIK Preferred Stock are set forth in Appendix B hereto and are incorporated herein by reference. 5. The minimum amount of consideration to be received by the corporation for its shares before it shall commence business is $100 in cash or property of equivalent value. 6. The address of the current registered office of the corporation is 702 Oberlin Road, Raleigh, North Carolina 27605, Post Office Box 12317, Raleigh, North Carolina 27605; and the name of its current registered agent at such address is George E. King. 7. The number of directors constituting the initial Board of Directors shall be one; and the name and address of the person who is to serve as director until the first meeting of shareholders, or until his successors be elected and qualified, is:
Name Address ---- ------- R. Peyton Woodson III 601 Oberlin Road Raleigh, North Carolina 27605 8. The name and address of the incorporator is: Frank R. Liggett III 333 Fayetteville Street Raleigh, North Carolina 27602
9. No person who is serving or who has served as Director of the corporation shall be personally liable in any action for monetary damages for breach of his or her duty as a Director, whether such action is brought by or in the right of the corporation or otherwise, except for breach of 91 4 duty for which personal liability cannot be limited or eliminated under the North Carolina Business Corporation Act ("NCBCA") or other applicable law. If the NCBCA or other applicable law is amended after approval by the shareholders of this Article to authorize corporate action further eliminating or limiting the personal liability of Directors, then the liability of a Director of the corporation shall be eliminated or limited to the fullest extent permitted by the NCBCA or other applicable law as so amended. Any repeal or modification of this Article by the shareholders of the corporation shall not adversely affect any right or protection of a Director of the corporation existing at the time of such repeal or modification. 92 5 APPENDIX A McM CORPORATION SERIES A PREFERRED STOCK RIGHTS, PREFERENCES, LIMITATIONS AND CHARACTERISTICS 1. Designation and Amount. The shares of this series shall be designated as "Series A Preferred Stock, $1,000 par value per share" (hereinafter called this "Series"). Each share of this Series shall be identical in all respects with the other shares of this Series. The number of shares in this Series shall initially be 60,000, which number may from time to time be increased or decreased (but not below the number then outstanding) by the Board of Directors of the Corporation. Shares of this Series purchased or otherwise acquired by the Corporation shall be cancelled and shall thereupon be restored to the status of authorized but unissued shares. 2. Dividends. The holders of shares of this Series shall not be entitled to receive any dividends. 3. Liquidation. Upon the voluntary or involuntary liquidation, dissolution or winding up of the Corporation, the holders of shares of this Series shall be entitled to receive out of the net assets of the Corporation, before any payment or distribution shall be made or set apart for payment on the Common Stock or any other class or series of stock of the Corporation, the amount of $1,000 per share of this Series. After the payment to the holders of the shares of this Series of $1,000 per share, the holders of shares of this Series, as such, shall have no right or claim to any of the remaining net assets of the Corporation. Neither the sale, lease or conveyance of all or substantially all of the property or business of the Corporation, nor the merger or consolidation of the Corporation into or with any other corporation or the merger or consolidation of any other corporation into or with the Corporation, shall be deemed to be a liquidation, dissolution or winding up, voluntary or involuntary, for purposes of this paragraph. 4. Redemption. Subject to the North Carolina Business Corporation Act and required regulatory approvals, the shares of this Series shall at all times be redeemable at the option of the holder thereof in cash for $1,000 per share payable by the Corporation by official bank or certified check or wire transfer of immediately available funds. Such redemption shall occur within ten business days after receiving a written notice of redemption from the holder of shares of this Series accompanied by a certificate or certificates for such shares duly endorsed by the holder thereof with the signature guaranteed by a financial institution. 5. Conversion and Exchange. The holders of shares of this Series shall not have any rights to convert such shares into or to exchange such shares for shares of Common Stock of the Corporation or any other class or series of stock (or any other security) of the Corporation. 93 6 6. Voting Rights. The holders of shares of this Series shall not have a vote on any matter except as provided to the contrary by the North Carolina Business Corporation Act. 7. Rank. The shares of this Series shall rank, as to distribution of assets upon liquidation, dissolution or winding up, senior ro any other class or series of preferred stock of the Corporation. 94 7 APPENDIX B McM CORPORATION SERIES B PIK PREFERRED STOCK RIGHTS, PREFERENCES, LIMITATIONS AND CHARACTERISTICS 1. Designation and Amount. The shares of this series shall be designated as "Series B PIK Preferred Stock, $1,000 par value per share: (hereinafter called this "Series"). Each share of this Series shall be identical in all respects with the other shares of this Series. The number of shares in this Series shall initially be 50,000, which number may from time to time be increased or decreased (but not below the number then outstanding) by the Board of Directors of the Corporation. Shares of this Series purchased or otherwise acquired by the Corporation shall be canceled and shall thereupon be restored to the status of authorized but unissued shares. 2. Dividends. The Corporation shall pay and the holders of shares of this Series shall receive dividends at a rate of 12.0% per annum, payable quarterly in arrears to such holders on January 7, April 7, July 7 and October 7. The dividends shall be cumulative from the date of issuance and shall be paid in kind (PIK) with additional fully paid and nonassessable shares of Series B PIK Preferred Stock having an aggregate liquidation preference equal to the amount of such dividends. However, notwithstanding anything else provided herein, the Board of Directors of the Corporation may, at its option, pay any dividend in cash. All dividends paid with respect to shares of Series B PIK Preferred Stock shall be paid pro rata to the holders entitled thereto. 3. Liquidation Preference. Upon the voluntary or involuntary liquidation, dissolution or winding up of the Corporation, the holders of shares of this Series shall be entitled to receive out of the net assets of the Corporation, before any payment or distribution shall be made or set apart for payment on the Common Stock or any other class or series of stock of the Corporation other than Series A Preferred Stock, but after any payment due and payable to holders of Series A Preferred Stock, the amount of $1,000 per share of this Series B. After the payment to the holders of the shares of this Series B of $1,000 per share, the holders of share of this Series, as such, shall have no right or claim to any of the remaining net assets of the Corporation. Neither the sale, lease or conveyance of all or substantially all of the property or business of the Corporation, nor the merger or consolidation of the Corporation into or with any other corporation or the merger or consolidation of any other corporation into or with the Corporation, shall be deemed to be a liquidation, dissolution or winding up, voluntary or involuntary, for purposes of this paragraph. 4. Mandatory Redemption. Subject to the North Carolina Business Corporation Act and required regulatory approvals, effective on the date that is seven years from the date of issuance, outstanding shares of this Series B shall be redeemed by the Corporation in cash for $1,000 per share plus an amount equal to all accumulated and unpaid dividends per share payable by the Corporation by official bank or certified check or wire transfer of immediately available funds. 95 8 5. Conversion and Exchange. The holders of shares of this Series shall not have any rights to convert such shares into or to exchange such shares for shares of Common Stock of the Corporation or any other class or series of stock (or any other security) of the Corporation. 6. Voting Rights. The holders of shares of this Series shall not have the right to vote on any matter except as provided to the contrary by the North Carolina Business Corporation Act. 7. Rank. The shares of this Series shall rank, as to distribution of assets upon liquidation, dissolution or winding up, senior to any other class or series of preferred stock of the Corporation except Series A Preferred Stock. 96 EX-10.C 3 AMENDED EMPLOYMENT & RETENTION CONTRACTS 1 EIGHTH AMENDMENT TO EMPLOYMENT AGREEMENT THIS EIGHTH AMENDMENT TO EMPLOYMENT AGREEMENT (the "Amendment") is made effective the 26th day of March, 1998, between GEORGE E. KING ("Employee"), and McM CORPORATION ("McM"), OCCIDENTAL FIRE & CASUALTY COMPANY OF NORTH CAROLINA, and WILSHIRE INSURANCE COMPANY (the three companies collectively being the "Employer" or the "McM Group"). W I T N E S S E T H: WHEREAS, the Employee and the Employer have entered an Employment Agreement dated as of February 16, 1989, and amended March 28, 1990, October 18, 1990, December 30, 1991, February 1, 1993, September 1, 1993, March 16, 1995, and August 6, 1996 (collectively, the "Agreement"); and WHEREAS, the Employee and Employer wish to amend the Agreement in certain respects and agree that the mutual promises set forth in this Amendment are full and valid consideration therefor. NOW THEREFORE, the parties hereto agree as follows: 1. Term of Employment. Paragraph 3 of the Agreement is hereby deleted in its entirety and in its place is inserted the following: 3. Term. The term of this Agreement shall automatically renew on a daily rolling basis and continue until two years from the date the Employer delivers to the Employee written notice of non-renewal. 2. Relocation of Employer. In the event Employer shall require Employee to relocate his office more than fifty (50) miles from its present location at 702 Oberlin Road, Raleigh, North Carolina, and Employee terminates his employment hereunder as a result of such required relocation, Employee shall receive the lump sum provided for in paragraph 9 hereof (Termination By Employer Without Cause), the lump sum to be calculated in the manner provided for in such paragraph. 3. Ratification. Except as modified in this Amendment, the Agreement, as amended, is ratified and confirmed in all respects. 81 2 IN WITNESS WHEREOF, Employer, by action approved and directed by its Boards of Directors and Employee, on his own behalf, have executed this Amendment as of the day and year first above written. EMPLOYEE: /s/ George E. King (Seal) -------------------------------------- George E. King EMPLOYER: Attest: McM CORPORATION, a North Carolina corporation /s/ Michael D. Blinson - ---------------------------- Corporate Secretary By: /s/ Stephen L. Stephano - --------- --------------------------------------- Its: President and CEO --------------------------------------- [Corporate Seal] OCCIDENTAL FIRE & CASUALTY COMPANY OF NORTH CAROLINA, a North Attest: Carolina corporation /s/ Michael D. Blinson By: /s/ Stephen L. Stephano - ---------------------------- --------------------------------------- Corporate Secretary Its: President and CEO - --------- --------------------------------------- [Corporate Seal] WILSHIRE INSURANCE COMPANY, a North Attest: Carolina corporation /s/ Michael D. Blinson - ---------------------------- Corporate Secretary By: /s/ Stephen L. Stephano - --------- --------------------------------------- Its: President and CEO --------------------------------------- [Corporate Seal] 82 3 FOURTH AMENDMENT TO EMPLOYMENT AGREEMENT THIS FOURTH AMENDMENT TO EMPLOYMENT AGREEMENT (the "Amendment") is made effective the 26th day of March, 1998, between STEPHEN L. STEPHANO ("Employee"), and McM CORPORATION ("McM"), OCCIDENTAL FIRE & CASUALTY COMPANY OF NORTH CAROLINA, and WILSHIRE INSURANCE COMPANY (the three companies collectively being the "Employer" or the "McM Group"). W I T N E S S E T H: WHEREAS, the Employee and the Employer have entered an Employment Agreement dated as of February 1, 1993, and amended September 1, 1993, March 16, 1995, and August 6, 1996 (collectively, the "Agreement"); and WHEREAS, the Employee and Employer wish to amend the Agreement in certain respects and agree that the mutual promises set forth in this Amendment are full and valid consideration therefor. NOW THEREFORE, the parties hereto agree as follows: 1. Term of Employment. Paragraph 2 of the Agreement is hereby deleted in its entirety and in its place is inserted the following: 2. Term. The term of this Agreement shall automatically renew on a daily rolling basis and continue until two years from the date the Employer delivers to the Employee written notice of non-renewal. 2. Relocation of Employer. In the event Employer shall require Employee to relocate his office more than fifty (50) miles from its present location at 702 Oberlin Road, Raleigh, North Carolina, and Employee terminates his employment hereunder as a result of such required relocation, Employee shall receive the lump sum provided for in paragraph 8 hereof (Termination By Employer Without Cause), the lump sum to be calculated in the manner provided for in such paragraph. 3. Ratification. Except as modified in this Amendment, the Agreement, as amended, is ratified and confirmed in all respects. 83 4 IN WITNESS WHEREOF, Employer, by action approved and directed by its Boards of Directors and Employee, on his own behalf, have executed this Amendment as of the day and year first above written. EMPLOYEE: /s/ Stephen L. Stephano (Seal) -------------------------------------- Stephen L. Stephano EMPLOYER: Attest: McM CORPORATION, a North Carolina corporation /s/ Michael D. Blinson - ---------------------------- Corporate Secretary By: /s/ George E. King - --------- --------------------------------------- Its: Chairman --------------------------------------- [Corporate Seal] OCCIDENTAL FIRE & CASUALTY COMPANY OF NORTH CAROLINA, a North Attest: Carolina corporation /s/ Michael D. Blinson By: /s/ George E. King - ---------------------------- --------------------------------------- Corporate Secretary Its: Chairman - --------- --------------------------------------- [Corporate Seal] WILSHIRE INSURANCE COMPANY, a North Attest: Carolina corporation /s/ Michael D. Blinson - ---------------------------- Corporate Secretary By: /s/ George E. King - --------- --------------------------------------- Its: Chairman --------------------------------------- [Corporate Seal] 84 EX-10.H 4 CONTRACTS OF EMPLOYMENT FOR EXECUTIVE OFFICERS 1 CONTRACT OF EMPLOYMENT THIS AGREEMENT is entered into as of the 1st day of February 1999, between George E. King (the "Employee"), and McM Corporation, Occidental Fire & Casualty Company of North Carolina, and Wilshire Insurance Company (the three companies collectively being the "Employer"). WHEREAS the Employee is currently employed by the Employer, the Employer wishes to continue to employ the Employee and the Employee wishes to remain employed. NOW THEREFORE in consideration of the covenants and agreements set forth hereinafter which are acknowledged to be good and valuable consideration, the Employer and the Employee agree as follows: 1. The Employer agrees to continue to employ the employee at will and the Employee agrees to continue to be so employed at will. 2. For all services rendered by the Employee, the Employer shall pay a salary to the Employee of $200,000 (the "Salary") per annum, such amount to be pro rated and paid in equal semi-monthly amounts. 3. The Employee's accrued vacation as established in accordance with the written policy of the Employer as of December 31, 1998, shall be fixed as of December 31, 1998, and such fixed amount shall be payable to the Employee at such time as he may cease to be employed by the Employer. The Employee agrees that further accrual of vacation shall cease at December 31, 1998. 4. The Employer may terminate the Employee at any time. Should the Employee be terminated, the Employee would be entitled to Post-Termination Payments (referred to hereinafter as "PTP's"). PTP's are defined as continuing installments of the Salary to be made subsequent to termination of the Employee if, and only if, the cumulative sum of the Salary measured from the date of this Agreement, shall be less than the sum of $450,000 (the "Cumulative Compensation Amount"). Neither the Employer nor the Board of Directors of the Employer may take any unilateral action, other than for Cause, that would preclude the Employee from receiving the Cumulative Compensation Amount. 5. Termination of the Employee for cause shall immediately terminate the Employer's obligation to pay the Salary or pay PTP's. "Cause" is defined as the Employee's commission of any act constituting a felony, willful misconduct or material non-performance of those duties bestowed upon him after 30 days written notice setting out the specific deficiencies in performance of those duties. 6. The Employee shall have the right to terminate his employment hereunder at any time by giving notice in writing to the Employer, the date of such notice to be considered the effective 85 2 date of termination. The obligation of the Employer under this Agreement to pay Salary or PTP's shall be terminated upon the Employee giving written notice that he is terminating his employment. 7. If the Employee dies prior to the Salary accumulating to the level of the Cumulative Compensation Amount, the Employer shall pay to the Employee's estate the Salary that would otherwise be payable to the Employee under the terms of this Agreement. 8. If the Employee becomes incapacitated by reason of mental or physical disability during the term of this Agreement, the Employer shall provide short term and long term disability benefits to the Employee as are in effect under the Employer's group benefits plan as they exist from time to time. 9. No waiver of any provision of this Agreement or any change to this Agreement shall be valid unless the Board of Directors of McM Corporation approves it in writing. 10. This Agreement contains the entire understanding of the parties. This Agreement supersedes in full any prior employment agreements, written or oral, that may have existed between the Employer and any of its subsidiaries and the Employee. AGREED TO AND ACCEPTED BY: /s/ GEORGE E. KING ----------------------------------------------- George E. King Employee /s/ PETER R. KELLOGG ----------------------------------------------- Peter R. Kellogg Chairman - Compensation Comm. /s/ STEPHEN L. STEPHANO ----------------------------------------------- Stephen L. Stephano, for the Employer President/COO - McM Corporation President/CEO - Occidental Fire & Casualty Co. of NC President/CEO - Wilshire Insurance Company 86 3 CONTRACT OF EMPLOYMENT THIS AGREEMENT is entered into as of the 1st day of February 1999, between Stephen L. Stephano (the "Employee"), and McM Corporation, Occidental Fire & Casualty Company of North Carolina, and Wilshire Insurance Company (the three companies collectively being the "Employer"). WHEREAS the Employee is currently employed by the Employer, the Employer wishes to continue to employ the Employee and the Employee wishes to remain employed. NOW THEREFORE in consideration of the covenants and agreements set forth hereinafter which are acknowledged to be good and valuable consideration, the Employer and the Employee agree as follows: 1. The Employer agrees to continue to employ the employee at will and the Employee agrees to continue to be so employed at will. 2. For all services rendered by the Employee, the Employer shall pay a salary to the Employee of $200,000 (the "Salary") per annum, such amount to be pro rated and paid in equal semi-monthly amounts. 3. The Employee's accrued vacation as established in accordance with the written policy of the Employer as of December 31, 1998, shall be fixed as of December 31, 1998, and such fixed amount shall be payable to the Employee at such time as he may cease to be employed by the Employer. The Employee agrees that further accrual of vacation shall cease at December 31, 1998. 4. The Employer may terminate the Employee at any time. Should the Employee be terminated, the Employee would be entitled to Post-Termination Payments (referred to hereinafter as "PTP's"). PTP's are defined as continuing installments of the Salary to be made subsequent to termination of the Employee if, and only if, the cumulative sum of the Salary measured from the date of this Agreement, shall be less than the sum of $450,000 (the "Cumulative Compensation Amount"). Neither the Employer nor the Board of Directors of the Employer may take any unilateral action, other than for Cause, that would preclude the Employee from receiving the Cumulative Compensation Amount. 5. Termination of the Employee for cause shall immediately terminate the Employer's obligation to pay the Salary or pay PTP's. "Cause" is defined as the Employee's commission of any act constituting a felony, willful misconduct or material non-performance of those duties bestowed upon him after 30 days written notice setting out the specific deficiencies in performance of those duties. 6. The Employee shall have the right to terminate his employment hereunder at any time by giving 87 4 notice in writing to the Employer, the date of such notice to be considered the effective date of termination. The obligation of the Employer under this Agreement to pay Salary or PTP's shall be terminated upon the Employee giving written notice that he is terminating his employment. 7. If the Employee dies prior to the Salary accumulating to the level of the Cumulative Compensation Amount, the Employer shall pay to the Employee's estate the Salary that would otherwise be payable to the Employee under the terms of this Agreement. 8. If the Employee becomes incapacitated by reason of mental or physical disability during the term of this Agreement, the Employer shall provide short term and long term disability benefits to the Employee as are in effect under the Employer's group benefits plan as they exist from time to time. 9. No waiver of any provision of this Agreement or any change to this Agreement shall be valid unless the Board of Directors of McM Corporation approves it in writing. 10. This Agreement contains the entire understanding of the parties. This Agreement supersedes in full any prior employment agreements, written or oral, that may have existed between the Employer and any of its subsidiaries and the Employee. AGREED TO AND ACCEPTED BY: /s/ STEPHEN L. STEPHANO ------------------------------------------ Stephen L. Stephano Employee /s/ PETER R. KELLOGG ------------------------------------------ Peter R. Kellogg Chairman - Compensation Comm. /s/ MICHAEL D. BLINSON ------------------------------------------ Michael D. Blinson, for the Employer SVP - McM Corporation SVP - Occidental Fire & Casualty Co. of NC SVP - Wilshire Insurance Company 88 EX-21 5 SUBSIDIARIES 1 CORPORATE ORGANIZATION CHART As of December 31, 1998, the organization chart of corporate structure and ownership is shown below. Percent figures show percent ownership of shares by parent. Jurisdiction of organization is shown in parentheses. McM CORPORATION (NC) 56-1171691 - - 100% - - Equity Holdings, Inc. (DE) 56-1651565 - - 100% - - Occidental Fire & Casualty Company of North Carolina (NC) 84-0513811 - - 100% - - Wilshire Insurance Company (NC) 56-1507441 Note: Two entities, Equity American Financial Service, Inc. and Equity American General Agency, Inc., have been formed as North Carolina corporations. Although neither company has been fully activated or capitalized, it is anticipated that they might be utilized in additional marketing programs in the future. 80 EX-23 6 CONSENT OF INDEPENDENT AUDITORS 1 EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements (Forms S-8 No. 333-05991 and 333-05989) pertaining to the 1996 Non-Employee Directors' Stock Purchase Plan and the 1996 Employee Incentive Stock Option Plan, respectively, of McM Corporation of our report dated February 26, 1999, with respect to the consolidated financial statements and the financial statement and schedules included in this Annual Report (Form 10-K) of McM Corporation and subsidiaries. ERNST & YOUNG LLP Raleigh, North Carolina March 29, 1999 97 EX-27 7 FINANCIAL DATA SCHEDULE (FOR SEC USE ONLY)
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS OF MCM CORPORATION FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 25,660 3,138 3,275 21,969 0 0 62,339 8,120 33,476 2,407 117,735 60,844 10,793 0 5,881 0 0 26,000 4,706 (2,249) 117,735 47,008 2,516 274 430 44,485 0 20,929 (15,186) 0 (15,186) 0 0 0 (15,186) (3.23) (3.23) 29,159 37,399 7,086 20,905 19,434 33,305 7,086
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