-----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, UbTAI+7STmMC79lbGLg8BdfT75br+t6uxv99dQx5uEq9BOmCm7XmPa+l6EfJPWIa I1+mT6aUt8MditWP6SIHSw== 0000950123-05-002760.txt : 20050308 0000950123-05-002760.hdr.sgml : 20050308 20050308160312 ACCESSION NUMBER: 0000950123-05-002760 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 17 CONFORMED PERIOD OF REPORT: 20041231 FILED AS OF DATE: 20050308 DATE AS OF CHANGE: 20050308 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ALLEGHANY CORP /DE CENTRAL INDEX KEY: 0000775368 STANDARD INDUSTRIAL CLASSIFICATION: TITLE INSURANCE [6361] IRS NUMBER: 510283071 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-09371 FILM NUMBER: 05666939 BUSINESS ADDRESS: STREET 1: 375 PARK AVENUE STREET 2: SUITE 3201 CITY: NEW YORK STATE: NY ZIP: 10152 BUSINESS PHONE: 2127521356 MAIL ADDRESS: STREET 1: 375 PARK AVENUE STREET 2: SUITE 3201 CITY: NEW YORK STATE: NY ZIP: 10152 FORMER COMPANY: FORMER CONFORMED NAME: ALLEGHANY FINANCIAL CORP DATE OF NAME CHANGE: 19870115 10-K 1 y06166e10vk.txt ALLEGHANY CORPORATION 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, 2004 [ ] 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 1-9371 ALLEGHANY CORPORATION (Exact name of registrant as specified in its charter) Delaware 51-0283071 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number)
375 Park Avenue, New York, New York 10152 (Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 212/752-1356 Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered ------------------- ----------------------------------------- Common Stock, $1.00 par value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: Not applicable Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes X No ----- ----- As of June 30, 2004, 7,675,313 shares of Common Stock were outstanding, and the aggregate market value (based upon the closing price of these shares on the New York Stock Exchange) of the shares of Common Stock of Alleghany Corporation held by non-affiliates was $1,724,584,435. DOCUMENTS INCORPORATED BY REFERENCE Portions of the following documents are incorporated by reference into the indicated part(s) of this Report:
Part -------- Annual Report to Stockholders of Alleghany Corporation for the year 2004 I and II Proxy Statement relating to Annual Meeting of Stockholders of Alleghany Corporation to be held on April 22, 2005 III
ALLEGHANY CORPORATION Annual Report on Form 10-K for the year ended December 31, 2004 Table of Contents
Description Page ----------- ---- PART I Item 1. Business 5 Item 2. Properties 35 Item 3. Legal Proceedings 39 Item 4. Submission of Matters to a Vote of Security Holders 39 Supplemental Item Executive Officers of Registrant 39 PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Company Purchases of Equity Securities 41 Item 6. Selected Financial Data 41 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 41 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 41 Item 8. Financial Statements and Supplementary Data 41 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 41 Item 9A. Controls and Procedures 42
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Description Page ----------- ---- PART III Item 10. Directors and Executive Officers of Registrant 42 Item 11. Executive Compensation 43 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 43 Item 13. Certain Relationships and Related Transactions 46 Item 14. Principal Accountant Fees and Services 46 PART IV Item 15. Exhibits and Financial Statement Schedules 47 Signatures 69 Index to Financial Statement Schedules 71
FINANCIAL STATEMENT SCHEDULES INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULES Index to Exhibits EXHIBITS 4 PART I Item 1. Business. Alleghany Corporation ("Alleghany") was incorporated in 1984 under the laws of the State of Delaware. In December 1986, Alleghany succeeded to the business of its parent company, Alleghany Corporation, a Maryland corporation incorporated in 1929, upon the parent company's liquidation. Alleghany's principal executive offices are located at 375 Park Avenue, New York, New York 10152 and its telephone number is (212) 752-1356. Alleghany is engaged, through its subsidiary Alleghany Insurance Holdings LLC ("AIHL") and AIHL's subsidiaries RSUI Group, Inc. ("RSUI"), Capitol Transamerica Corporation ("Capitol Transamerica"), Darwin Professional Underwriters, Inc. ("Darwin") and Platte River Insurance Company ("Platte River"), in the property and casualty and fidelity and surety insurance businesses. Through its direct and indirect subsidiaries Mineral Holdings Inc. and World Minerals Inc. ("World Minerals") and World Minerals' subsidiaries Celite Corporation ("Celite"), Harborlite Corporation ("Harborlite") and World Minerals International and their subsidiaries, Alleghany is engaged in the industrial minerals business. Through its subsidiary Alleghany Properties LLC ("Alleghany Properties"), Alleghany owns and manages properties in California. Until December 31, 2004, Alleghany was also engaged, through its subsidiary Heads & Threads International LLC ("Heads & Threads"), in the steel fastener importing and distribution business. On that date, Heads & Threads was merged with an acquisition vehicle formed by a private investor group led by Heads & Threads management and Capital Partners, Inc. Alleghany received cash proceeds of $53.8 million and recorded a pre-tax loss of approximately $1.9 million as a result of the disposition. Heads & Threads has been classified as a discontinued operation. On May 3, 2004, AIHL acquired Darwin National Assurance Company ("DNA") (formerly known as U.S. AEGIS Energy Insurance Company), an admitted insurance company domiciled in Delaware, for cash consideration of approximately $20.4 million, $17.1 million of which represented consideration for DNA's investment portfolio and the balance of which represented consideration for licenses. On July 1, 2003, AIHL completed the acquisition of Resurgens Specialty Underwriting, Inc. ("Resurgens Specialty"), a specialty wholesale underwriting agency, from Royal Group, Inc., a subsidiary of Royal & SunAlliance Insurance Group plc ("R&SA"), for cash consideration, including capitalized expenditures, of approximately $116.0 million. Resurgens Specialty became a subsidiary of RSUI. In connection with the acquisition of Resurgens Specialty, on June 30, 2003, RSUI acquired RSUI Indemnity Company ("RIC") to write admitted business underwritten by Resurgens 5 Specialty, from Swiss Re America Holding Corporation for consideration of approximately $19.7 million, $13.2 million of which represented consideration for RIC's investment portfolio and the balance of which represented consideration for licenses. On September 2, 2003, RIC purchased Landmark American Insurance Company ("Landmark") to write non-admitted business underwritten by Resurgens Specialty, from R&SA for cash consideration of $33.9 million, $30.4 million of which represented consideration for Landmark's investment portfolio and the balance of which represented consideration for licenses. R&SA provided loss reserve guarantees for all of the loss and loss adjustment expense liabilities of Landmark that existed at the time of the sale. RIC and Landmark were further capitalized by Alleghany in an aggregate amount of approximately $520.0 million. On January 4, 2002, Alleghany completed the acquisition of Capitol Transamerica. The total purchase price paid by Alleghany was approximately $182.0 million. Contemporaneous with the acquisition of Capitol Transamerica, Alleghany purchased Platte River for approximately $40.0 million, $31.0 million of which represented consideration for Platte River's investment portfolio and the balance of which represented consideration for licenses. The seller provided loss reserve guarantees for all of the loss and loss adjustment expense liabilities of Platte River that existed at the time of the sale. Until November 5, 2001, Alleghany was also engaged, through its subsidiary Alleghany Underwriting Holdings Ltd. ("Alleghany Underwriting") and Alleghany Underwriting's subsidiaries, in the global property and casualty insurance and reinsurance business at Lloyd's of London. On that date, AIHL completed the disposition of Alleghany Underwriting to Talbot Holdings Ltd., a new Bermuda holding company formed by certain principals of the Black Diamond Group and the senior management of Alleghany Underwriting. AIHL recorded an after-tax loss of $50.5 million on the disposition of this Lloyd's of London insurance operation. Consideration for the sale included a warrant which entitled AIHL to recover a portion of any residual capital in Alleghany Underwriting as determined upon the closure of the 2001 Lloyd's year of account. A nominal value was ascribed to the warrant in computing the loss on the sale of Alleghany Underwriting. In 2004, it was determined that there was no reasonable prospect of any residual capital in Alleghany Underwriting and the warrant was cancelled. In connection with the sale, AIHL provided a $25.0 million letter of credit to support business written by a new Talbot syndicate for the 2002 Lloyd's year of account while Talbot sought new capital. AIHL subsequently agreed that the capital provided by its letter of credit would also support business written by the syndicate for the 2003 and 2004 Lloyd's years of account, in exchange for reductions in the amount of the letter of credit to $15.0 million in January 2003 and $10.0 million in December 2003 as a result of the infusion of new capital into the syndicate. In November 2004, AIHL agreed to the use of its $10.0 million letter of credit by the Talbot syndicate for the 2005 6 Lloyd's year of account, in exchange for the syndicate's agreement to extinguish AIHL's commitment under the reduced letter of credit no later than June 30, 2006. As a result of its disposition, Alleghany Underwriting has been classified as a discontinued operation. Until February 1, 2001, Alleghany was also engaged, through its subsidiary Alleghany Asset Management, Inc. ("Alleghany Asset Management") and Alleghany Asset Management's subsidiaries, in the financial services business. On that date, Alleghany Asset Management merged into a wholly owned subsidiary of ABN AMRO North America Holding Company. Alleghany received cash proceeds of $825.0 million and recorded an after-tax gain of approximately $474.8 million, or approximately $63.14 per share, excluding certain expenses relating to the closing of the sale. As a result of its disposition, Alleghany Asset Management has been classified as a discontinued operation. Until May 10, 2000, Alleghany was also engaged, through its subsidiary Underwriters Re Group, Inc. ("Underwriters Re Group") and Underwriters Re Group's subsidiaries, in the global property and casualty reinsurance and insurance businesses. On that date, Underwriters Re Group was sold to Swiss Re America Holding Corporation. Alleghany recorded pre-tax proceeds of approximately $649.0 million in cash. In connection with the sale, Alleghany paid approximately $187.9 million in cash (or $25.3125 per share) for the purchase from Underwriters Re Group of 7.425 million shares of Burlington Northern Santa Fe Corporation. Alleghany's pre-tax gain on the sale was approximately $136.7 million, reflecting additional adjustments from previously reported figures for the settlement of certain outstanding obligations of Underwriters Re Group that were assumed by Alleghany and the final resolution of post-closing purchase price adjustments. The tax on the gain was approximately $7.1 million, resulting in an after-tax gain on the sale of $129.6 million. The tax rate on the gain differs from the expected statutory rate principally due to a difference between the tax and book bases of Underwriters Re Group. Alleghany retained Underwriters Re Group's London-based Lloyd's operations conducted through Alleghany Underwriting, which was subsequently sold on November 5, 2001, as described above. During 1994 and early 1995, Alleghany and its subsidiaries acquired a substantial number of shares of common stock of Santa Fe Pacific Corporation ("Santa Fe"). On September 22, 1995, Santa Fe and Burlington Northern, Inc. merged under a new holding company named Burlington Northern Santa Fe Corporation ("BNSF"). As a result of the merger, the shares of Santa Fe beneficially owned by Alleghany were converted into shares of BNSF. As of March 1, 2005, Alleghany owned 8.0 million shares of BNSF, or approximately 2.1 percent of BNSF's currently outstanding common stock. BNSF owns one of the largest railroad networks in North America, with 32,000 route miles covering 28 states and two Canadian provinces. 7 In 2004, Alleghany studied a number of potential acquisitions. Alleghany intends to continue to expand its operations through internal growth at its subsidiaries as well as through possible operating company acquisitions and investments. Reference is made to Items 7 and 8 of this Report for further information about the business of Alleghany in 2004. The consolidated financial statements of Alleghany, incorporated by reference in Item 8 of this Report, include the accounts of Alleghany and its subsidiaries for all periods presented. Alleghany makes available on its website at www.alleghany.com its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after electronically filing or furnishing such material to the Securities and Exchange Commission. Alleghany's Financial Personnel Code of Ethics, Code of Business Conduct and Ethics, Corporate Governance Guidelines and the charters for its Audit, Compensation and Nominating and Governance Committees are also available on its website. In addition, stockholders may obtain, free of charge, copies of any of the above reports or documents upon request to the Secretary of Alleghany. PROPERTY AND CASUALTY/FIDELITY AND SURETY INSURANCE BUSINESSES General Description of Business AIHL is a holding company for Alleghany's property and casualty and fidelity and surety insurance operations which are conducted through RSUI, headquartered in Atlanta, Georgia, Capitol Transamerica and Platte River, headquartered in Madison, Wisconsin and Darwin, headquartered in Farmington, Connecticut. Unless noted, references to AIHL include the operations of RSUI, Capitol Transamerica, Platte River and Darwin. RSUI, which includes the operations of Resurgens Specialty, RIC and Landmark, underwrites specialty insurance coverages in the property, umbrella/excess, general liability, directors and officers liability and professional liability lines of business. RSUI writes business on an admitted basis primarily through RIC in 47 states where RIC is licensed and subject to the applicable state's form and rate regulations. RSUI writes business on an approved, non-admitted basis primarily through Landmark, which, as a non-admitted company, is not subject to state form and rate regulations and thus has more flexibility in its rates and coverages for specialized or hard-to-place risks. As of December 31, 2004, Landmark was approved to write business on a non-admitted basis in 49 states and on an admitted basis in Oklahoma. 8 RIC and Landmark entered into a quota share arrangement, effective as of September 1, 2003, whereby Landmark cedes 90.0 percent of all premiums and losses, net of third party reinsurance, to RIC. As of December 31, 2004, the statutory surplus of RIC and Landmark was approximately $647.3 million and $56.6 million, respectively. RIC is rated A (Excellent) by A.M. Best Company, Inc. ("A.M. Best"), an independent organization that analyzes the insurance industry, and Landmark is rated A (Excellent) on a reinsured basis by A.M. Best. Capitol Transamerica, primarily through its wholly-owned subsidiaries Capitol Indemnity Corporation ("Capitol Indemnity") and Capitol Specialty Insurance Corporation ("CSIC"), operates in 49 states and the District of Columbia, with a geographic concentration in the Midwestern and Plains states. Capitol Indemnity conducts its business on an admitted basis, and CSIC conducts its business on an approved, non-admitted basis, through independent and general insurance agents that write primarily specialty lines of property and casualty insurance for certain types of businesses or activities, including barber and beauty shops, bowling alleys, contractors, restaurants and taverns. Capitol Indemnity also writes fidelity and surety bonds, including contractors' performance and payment bonds, license/permit bonds, fiduciary bonds, judicial bonds and commercial fidelity bonds. Capitol Transamerica continuously evaluates its lines of business and adjusts its products as appropriate. In January 2005, Capitol Transamerica decided to exit the construction segment of the contract surety line of business upon completion of a strategic review. Therefore, commencing in the 2005 first quarter, Capitol Transamerica will not be issuing additional contract surety bonds in the construction segment, except to the extent required under applicable law or in certain other limited circumstances. Capitol Transamerica will continue to manage the run-off from this business line and is still obligated to pay losses incurred on the construction segment of the contract surety business written by it prior to exit. Platte River is licensed in 50 states and the District of Columbia and operates in conjunction with Capitol Indemnity by providing commercial surety products. Platte River also offers pricing flexibility in those jurisdictions where both Capitol Indemnity and Platte River are licensed. The property and casualty business of Capitol Transamerica accounted for approximately 74.0 percent of gross premiums written in 2004, while the fidelity and surety business accounted for the remainder. Capitol Indemnity and Platte River entered into a pooling agreement, effective as of January 1, 2002, whereby Capitol Indemnity and Platte River agreed to share their aggregate insurance risks. Under this agreement, Capitol Indemnity is liable for 90.0 percent of the shared risks and Platte River is liable for 10.0 percent. As of December 31, 2004, the statutory surplus of Capitol Indemnity and Platte River was $138.5 million and $29.7 million, respectively. Capitol Indemnity and Platte River are rated A (Excellent) on a pooled basis by A.M. Best. CSIC, which is 9 party to a quota share arrangement with its parent Capitol Indemnity, is rated A (Excellent) on a reinsured basis by A.M. Best. Darwin, which commenced operations in May 2003, is 80.0 percent owned by AIHL and 20.0 percent owned by certain members of Darwin's management through participation in a restricted stock plan. Darwin underwrites specialty liability insurance coverages in the directors and officers liability, errors and omissions liability and medical malpractice liability lines of business as an underwriting manager for Platte River and certain subsidiaries of Capitol Transamerica. In April 2004, AIHL acquired DNA, and as of December 31, 2004, DNA was licensed to write business in 43 states. DNA and Capitol Indemnity entered into a quota share arrangement, effective as of July 1, 2004, whereby DNA cedes 90.0 percent of all premiums and losses, net of third party reinsurance, to Capitol Indemnity. DNA is rated A (Excellent) on a reinsured basis by A.M. Best. In general, property insurance protects an insured against financial loss arising out of loss of property or its use caused by an insured peril. Casualty insurance protects the insured against financial loss arising out of the insured's obligation to others for loss or damage to persons or property. Although both property and casualty insurance may involve a high degree of loss volatility, property losses are generally reported within a relatively short time period after the event; in contrast, there tends to be a significant time lag in the reporting and payment of casualty claims. In 2004, property insurance accounted for approximately 45.3 percent and casualty insurance accounted for approximately 51.7 percent of AIHL's gross premiums written. Surety bonds are three-party agreements in which the issuer of the bond (the surety) joins with a second party (the principal) in guaranteeing to a third party (the owner/obligee) the fulfillment of some obligation on the part of the principal to the owner/obligee. A surety is generally entitled to recover from the principal any losses and expenses paid to an owner/obligee. Surety bond premiums primarily reflect the type and class of risk and related costs associated with both processing the bond application, evaluating the risks involved and investigating the principal, including, if necessary, an analysis of the principal's creditworthiness and ability to perform. There are three broad types of fidelity and surety products--contract surety bonds, commercial surety bonds and fidelity bonds. Contract surety bonds secure a contractor's performance and/or payment obligation with respect to a construction project and are generally required by federal, state and local governments for public works projects. Commercial surety bonds include all surety bonds other than contract surety bonds and cover obligations typically required by law or regulation, such as license and permit coverage. Fidelity bonds cover losses arising from employee dishonesty. In 2004, commercial surety bonds, contract surety bonds and fidelity bonds accounted for 10 approximately 70.0 percent, 26.0 percent and 4.0 percent, respectively, of AIHL's surety and fidelity gross premiums written. Marketing At December 31, 2004, RSUI conducted its insurance business through approximately 147 independent wholesale insurance brokers located throughout the United States and two managing general agents. RSUI's wholesale brokers are appointed on an individual basis based on management's appraisal of expertise and experience, and only specific locations of a wholesale broker's operations may be appointed to distribute RSUI's products. Producer agreements which stipulate premium collection, payment terms and commission arrangements are in place with each wholesale broker. No wholesale broker holds underwriting, claims or reinsurance authority, with the exception of binding authority arrangements with two wholesale brokers for small, specialized coverages. RSUI's top five producing wholesale brokers accounted for approximately 47.0 percent of gross premiums written by RSUI in 2004. RSUI's top two producing wholesale brokers, Swett & Crawford Group and CRC Insurance Services, accounted for, in the aggregate, approximately 30.0 percent of AIHL's gross premiums written in 2004, with Swett & Crawford accounting for 18.0 percent and CRC accounting for 12.0 percent. Capitol Transamerica conducts its insurance business through independent and general insurance agents located throughout the United States, with a concentration in the Midwestern and Plains states. At December 31, 2004, Capitol Transamerica had approximately 750 independent agents and 32 general agents licensed to write property and casualty and fidelity and surety coverages, as well as approximately 355 independent agents licensed only to write surety coverages. The general agents write very little fidelity and surety business and have full quoting and binding authority within the parameters of their agency contracts with respect to the property and casualty business that they write. Local agents have binding authority for certain business owner policy products, including workers compensation, and non-contract surety products. No agent had writings in excess of 10.0 percent of AIHL's gross premiums written in 2004. During 2004, Darwin conducted its insurance business primarily through a selective distribution network of approximately 117 independent wholesale and specialty retail insurance brokers who bound business with Darwin. No brokers had writings in excess of 10.0 percent of AIHL's gross premiums written in 2004. Underwriting Operations RSUI's underwriting philosophy is based on handling only product lines in which its underwriters have strong underwriting expertise. RSUI generally focuses on higher severity, lower frequency specialty risks that can be effectively "desk underwritten" 11 without the need for inspection or engineering reviews. RSUI tracks underwriting results for each of its underwriters and believes that the underwriting systems and applications it has in place facilitate efficient underwriting and high productivity levels. Underwriting authority is delegated on a "top-down" basis ultimately to individual underwriters based on experience and expertise. Such authority is in writing and addresses maximum limits, excluded classes and coverages and premium size referral. Referral to a product line manager is required for risks exceeding an underwriter's authority. RSUI applies extensive risk control techniques to ensure that catastrophe exposures remain within specified parameters. On a monthly basis, RSUI models estimated losses from a 250-year event and sets its maximum risk level exposures based on this estimate. Underwriting guidelines are implemented and adjusted to maintain the estimated maximum exposure within the pre-established limits. The modeled exposure estimates are also used to structure various quota share reinsurance and catastrophe excess of loss reinsurance covers to protect RSUI's surplus from unexpected catastrophic events. Capitol Transamerica's underwriting strategy emphasizes underwriting profitability. Key elements of this strategy are prudent risk selection, appropriate pricing and coverage customization. All accounts are reviewed on an individual basis to determine underwriting acceptability. Capitol Transamerica and Platte River are subscribers to the Insurance Service Organization ("ISO"), an insurance reference resource recognized by the insurance industry. All underwriting procedures, rates and contractual coverage obligations are based on procedures and data developed by the ISO. Capitol Transamerica determines underwriting acceptability by type of business, claims experience, length of time in business and business experience, age and condition of premises occupied and financial stability. Information is obtained from, among other sources, agent applications, financial reports and on-site loss control surveys. If an account does not meet predetermined acceptability parameters, coverage is declined. If an in-force policy becomes unprofitable due to extraordinary claims activity or inadequate premium levels, a non-renewal notice is issued in accordance with individual state statutes and rules. Darwin's underwriting strategy focuses on long-term consistent underwriting profitability. The key elements of this strategy are an underwriting approach focused on disciplined analysis, appropriate pricing based on the actual risk and attachment level and the granting of appropriate coverage, accompanied by multi-level underwriting and actuarial reviews of accounts. Formal rating strategies and plans have been adopted for each line of business based upon filed rating plans and industry results. Darwin determines underwriting acceptability by type of business, company experience, claims experience, experience of the insured's management team, financial stability and other relevant factors. Information is obtained from, among other sources, application forms, underlying insurance coverage, company policies and procedures, loss experience, financial condition, public disclosures and interviews with the insured's management 12 team. If an account does not meet acceptability parameters, coverage is declined. Prior to renewal, claims activity is reviewed to ensure that profitability assumptions were correct and the information obtained during the initial underwriting of the insured is updated. Terrorism Risk Insurance Act of 2002 The Terrorism Risk Insurance Act of 2002 (the "Terrorism Act") established a program under which the federal government will reimburse insurers for losses arising from certain acts of foreign terrorism. The Terrorism Act requires that all licensed insurers must offer terrorism coverage on most commercial lines of business. Under the program, an act must be certified by the U.S. Secretary of the Treasury for it to constitute an act of terrorism. The definition of terrorism excludes domestic acts of terrorism or acts of terrorism committed in the course of a war declared by Congress. Losses arising out of the act of terrorism must exceed $5.0 million. If an event is certified as an act of terrorism, the federal government will reimburse the industry for losses up to an aggregate limit of $100.0 billion in any year. Each insurer is responsible for a deductible based on a percentage of direct premiums earned in the previous calendar year. For losses in excess of the deductible, the federal government will reimburse 90.0 percent of the insurer's loss, up to the insurer's proportionate share of the $100.0 billion. In 2005, AIHL's deductible will be 15.0 percent of its direct premiums earned in 2004, or approximately $193.7 million. AIHL's terrorism exposure is substantially attributable to RSUI. In general, RSUI's casualty reinsurance programs provide coverage for domestic and foreign acts of terrorism, while RSUI's property reinsurance programs do not provide coverage for foreign acts of terrorism. The cost of property reinsurance in the marketplace has increased significantly in recent years and reinsurance capacity for terrorism exposures is limited and expensive. As a result, RSUI retains such exposures on a net basis, subject to the Terrorism Act coverage, for property policies containing terrorism coverage. Approximately 10.0 percent of all policies, and approximately 17.0 percent of all property policies, written by RSUI in 2004 contained coverage for domestic and foreign acts of terrorism. RSUI uses various underwriting strategies to mitigate its exposure to terrorism losses. Outstanding Losses and Loss Adjustment Expenses ("LAE") Alleghany's insurance operations establish reserves on their balance sheets for unpaid losses and LAE related to their property and casualty insurance and fidelity and surety contracts. As of any balance sheet date, historically there have been claims that have not yet been reported, and some claims are not reported for many years after the date a loss occurs. As a result of this historical pattern, the liability for unpaid losses and 13 LAE includes significant estimates for claims incurred but not yet reported, known as "IBNR." Additionally, reported claims are in various stages of the settlement process. Each claim is settled individually based upon its merits, and certain claims may take years to settle, especially if legal action is involved. As a result, the liabilities for unpaid losses and LAE include significant judgments, assumptions and estimates made by management relating to the ultimate losses that will arise from the claims. Due to the inherent uncertainties in the process of establishing these liabilities, the actual ultimate loss from a claim is likely to differ, perhaps materially, from the liability initially recorded and could be material to the results of Alleghany's operations. Alleghany's insurance operations use a variety of techniques that employ significant judgments and assumptions to establish the liabilities for unpaid losses and LAE recorded at the balance sheet date. These techniques include detailed statistical analyses of past claim reporting, settlement activity, claim frequency, internal loss experience, changes in pricing or coverages and severity data when sufficient information exists to lend statistical credibility to the analysis. More subjective techniques are used when statistical data is insufficient or unavailable. These liabilities also reflect implicit or explicit assumptions regarding the potential effects of future inflation, judicial decisions, changes in laws and recent trends in such factors as well as a number of actuarial assumptions that vary across Alleghany's insurance operations and across lines of business. This data is analyzed by line of business, coverage and accident year, as appropriate. As noted above, as of any balance sheet date, all claims that have occurred have not yet been reported to Alleghany's insurance operations, and if reported may not have been settled. The time period between the occurrence of a loss and the time it is settled by the insurer is referred to as the "claim tail." Property claims usually have a fairly short claim tail and, absent claim litigation, are reported and settled within no more than a few years of the balance sheet date. For short tail lines, the process of recording quarterly and annual liabilities for unpaid losses and LAE is primarily focused on maintaining an appropriate reserve level for reported claims and IBNR, rather than determining an expected loss ratio for the current business. In conformity with generally accepted accounting principles ("GAAP"), Alleghany's insurance operations are not permitted to establish IBNR reserves for catastrophe losses that have not occurred. Therefore, losses related to a significant catastrophe or accumulation of catastrophes in any reporting period could have a material, negative impact on Alleghany's results during such period. Casualty claims can have a very long claim tail, occasionally extending for decades. In addition, casualty claims are more susceptible to litigation and the legal environment and can be significantly affected by changing contract interpretations, all of which contribute to extending the claim tail. For long tail casualty lines of business, estimation of ultimate liabilities for unpaid losses and LAE is a more complex process and depends on a number of factors, including the line and volume of the business involved. 14 The loss reserve review processes of Alleghany's insurance operations use actuarial methods and underlying assumptions that vary by company and line of business and produce ranges from which the operations select the carried reserve for each class of business. The actuarial methods used by Alleghany's insurance operations include the Incurred Development method, Paid Development method, Bornhuetter-Ferguson method for both paid and incurred, Balanced Incurred method and Ultimate Incurred times Ultimate Claims method. Each of AIHL's insurance operations establish their best estimate for liabilities for unpaid losses and LAE. Because of the high level of uncertainty regarding the setting of liabilities for unpaid losses and LAE, it is the practice of each of Alleghany's insurance operations to engage, at least annually, an outside actuary to evaluate, and opine on, the reasonableness of these liabilities. Although Alleghany is unable at this time to determine whether additional reserves, which could have a material impact upon its financial condition, results of operations and cash flows, may be necessary in the future, Alleghany believes that the reserves for unpaid losses and LAE established by its insurance operations are adequate as of December 31, 2004. Alleghany's insurance operations continually evaluate the potential for changes, both positive and negative, in their estimates of such liabilities and use the results of these evaluations to adjust both recorded liabilities and underwriting criteria. With respect to liabilities for unpaid losses and LAE established in prior years, such liabilities are periodically analyzed and their expected ultimate cost adjusted, where necessary, to reflect positive or negative development in loss experience and new information, including, for certain catastrophic events, revised industry estimates of the magnitude of a catastrophe. Adjustments to previously recorded liabilities for unpaid losses and LAE, both positive and negative, are reflected in Alleghany's financial results in the periods in which such adjustments are made and are referred to as prior year reserve development. Changes in Historical Net Loss and LAE Reserves The following table shows changes in historical net loss and LAE reserves for AIHL for each year since 2002. Reported reserve development is derived primarily from information included in statutory financial statements of RSUI, Capitol Transamerica, Platte River and Darwin. The first line of the upper portion of the table shows the net reserves at December 31 of each of the indicated years, representing the estimated amounts of net outstanding losses and LAE for claims arising during that year and in all prior years that are unpaid, including losses that have been incurred but not yet reported to AIHL's insurance operations. The upper (paid) portion of the table shows the cumulative net amounts paid as of December 31 of successive years with respect to the net reserve liability for each year. The lower portion of the table shows the re-estimated amount of the previously recorded net reserves for each year based on experience as of the end of each succeeding year. The estimate changes as more information becomes 15 known about claims for individual years. In evaluating the information in the table, it should be noted that a reserve amount reported in any period includes the effect of any subsequent change in such reserve amount. For example, if a loss was first reserved in 2002 at $100,000 and was determined in 2004 to be $150,000, the $50,000 deficiency would be included in the Cumulative Redundancy (Deficiency) row shown below for each of the years 2002 through 2004. Conditions and trends that have affected the development of the net reserve liability in the past may not necessarily occur in the future. Accordingly, it is not appropriate to extrapolate future redundancies or deficiencies based on this table. Changes in Historical Net Reserves for Losses and LAE
Years Ended December 31, -------------------------------- 2002 2003 2004 -------- -------- ---------- (in thousands) Net liability as of the end of year ............. $113,705 $275,962 $ 640,920 Cumulative amount of net liability paid as of: One year later ............................... 47,396 72,604 -- Two years later .............................. 80,557 -- -- Net liability re-estimated as of: One year later ............................... 133,962 268,663 -- Two years later .............................. 147,964 -- -- Cumulative Redundancy (Deficiency) ........... (33,989) 7,300 -- Gross Liability-End of Year ..................... $258,471 $437,994 $1,232,337 Less: Reinsurance Recoverable ................... 144,766 162,032 591,417 -------- -------- ---------- Net Liability-End of Year ....................... $113,705 $275,962 $ 640,920 ======== ======== ========== Gross Re-estimated Liability-Latest ............. $220,360 $387,544 -- Re-estimated Recoverable-Latest ................. 72,666 142,422 -- -------- -------- Net Re-estimated Liability-Latest ............... $147,694 $245,122 -- ======== ======== Gross Cumulative Redundancy (Deficiency) ........ $ 38,111 $ 50,450 --
16 Net Loss and LAE Reserves The reconciliation between the aggregate net loss and LAE reserves of AIHL reported in the annual statements filed with state insurance departments prepared in accordance with statutory accounting practices ("SAP") and those reported in AIHL's consolidated financial statements prepared in accordance with GAAP for the last three years is shown below (in thousands): Reconciliation of Reserves for Losses and LAE from SAP Basis to GAAP Basis
2004 2003 2002 ---------- -------- -------- Statutory reserves ............... $ 642,017 $277,281 $114,925 Reinsurance recoverables ......... 591,417 162,032 144,766 Purchase accounting adjustment ... (1,097) (1,319) (1,220) ---------- -------- -------- GAAP reserves .................... $1,232,337 $437,994 $258,471 ========== ======== ========
The reserves for unpaid losses and LAE related to asbestos and environmental impairment claims reported in the annual statements filed with state insurance departments prepared in accordance with SAP and those reported in AIHL's consolidated financial statements prepared in accordance with GAAP for the year ended December 31, 2004 were identical. The reconciliation of beginning and ending aggregate reserves for unpaid losses and LAE of AIHL for the last three years is shown below (in thousands): 17 Reconciliation of Reserves for Losses and LAE
2004 2003 2002 ---------- -------- -------- Reserves as of January 1 ......................................... $ 437,994 $258,471 $ -- Reserves acquired ................................................ -- 14,573 266,688 Less: reinsurance recoverables ................................... 162,032 159,766 179,512 ---------- -------- -------- Net reserves ..................................................... 275,962 113,278 87,176 ---------- -------- -------- Incurred loss, net of reinsurance, related to: Current year .................................................. 547,868 229,519 82,639 Prior years ................................................... (7,299) 20,683 17,869 ---------- -------- -------- Total incurred loss, net of reinsurance .......................... 540,569 250,202 100,508 ---------- -------- -------- Paid loss, net of reinsurance, related to: Current year .................................................. 103,033 40,122 28,562 Prior years ................................................... 72,578 47,396 45,417 ---------- -------- -------- Total paid loss, net of reinsurance .............................. 175,611 87,518 73,979 ---------- -------- -------- Reserves, net of reinsurance recoverables, as of December 31 ..... 640,920 275,962 113,705 Reinsurance recoverables, as of December 31(1) ................... 591,417 162,032 144,766 ---------- -------- -------- Reserves, gross of reinsurance recoverables, as of December 31 ... $1,232,337 $437,994 $258,471 ========== ======== ========
- ---------- (1) Balance of reinsurance recoverables excludes:
2004 2003 2002 ------- ------- ------ (in thousands) Current reinsurance recoverables $31,908 $12,067 $2,713
and includes:
2004 2003 2002 ------- ------- -------- Reinsurance recoverables from: Seller of Platte River $71,956 $91,950 $142,501 Seller of Landmark $23,718 $37,261 $ --
18 Asbestos, Environmental Impairment and Mold Claims Reserves AIHL's reserves for losses and LAE include amounts for various liability coverages related to asbestos and environmental impairment claims that arose from reinsurance of certain general liability and commercial multiple peril coverages assumed by Capitol Indemnity between 1969 and 1976. Capitol Indemnity exited this business in 1976. Reserves for asbestos and environmental impairment claims cannot be estimated with traditional loss reserving techniques because of uncertainties that are greater than those associated with other types of claims. Factors contributing to those uncertainties include a lack of historical data, the significant periods of time that often elapse between the occurrence of an insured loss and the reporting of that loss to the ceding company and the reinsurer, uncertainty as to the number and identity of insureds with potential exposure to such risks, unresolved legal issues regarding policy coverage, and the extent and timing of any such contractual liability. Loss reserve estimates for such environmental and asbestos exposures include case reserves, which also reflect reserves for legal and other LAE and IBNR reserves. IBNR reserves are determined based upon Capitol Transamerica's historic general liability exposure base and policy language, previous environmental and loss experience and the assessment of current trends of environmental law, environmental clean up costs, asbestos liability law and judgmental settlements of asbestos liabilities. For both asbestos and environmental excess of loss reinsurance claims, Capitol Transamerica establishes case reserves by applying reinsurance contract terms to losses reported by ceding companies, analyzing from the first dollar of loss incurred by the primary insurer. In establishing the liability for claims for asbestos related liability and for environmental impairment claims, management considers facts currently known and the current state of the law and coverage litigation. Additionally, ceding companies often report potential losses on a precautionary basis to protect their rights under the reinsurance arrangement, which generally calls for prompt notice to the reinsurer. Ceding companies, at the time they report such potential losses, advise Capitol Transamerica of the ceding companies' current estimate of the extent of such loss. Capitol Transamerica's claims department reviews each of the precautionary claims notices and, based upon current information, assesses the likelihood of loss to Capitol Transamerica. Such assessment is one of the factors used in determining the adequacy of the recorded asbestos and environmental reserves. Promptly after its acquisition by Alleghany in January 2002, Capitol Transamerica's management commenced a program to settle, or position for commutation, Capitol Indemnity's assumed reinsurance treaties and make appropriate payments on a timely basis when deemed necessary. Since January 2002, Capitol Indemnity has experienced an increase in paid losses on its assumed reinsurance runoff related to such treaties, which was initially attributed to this change in Capitol Transamerica's settlement philosophy. Upon completion in 2003 of an actuarial study 19 undertaken by management, it was determined that the increase in paid losses related to the treaties reflected developments in the underlying claims environment, particularly with respect to asbestos related claims, and, accordingly, Capitol Transamerica strengthened its reserves related to such assumed reinsurance coverages in the amount of $20.7 million. For the year ended December 31, 2004, the aggregate net loss and LAE payments for asbestos and environmental impairment claims of Capitol Transamerica were $1.7 million, compared with $3.6 million in 2003. As of December 31, 2004, reserves of Capitol Transamerica totaled approximately $19.4 million for asbestos liabilities and approximately $7.1 million for environmental liabilities, resulting in aggregate asbestos and environmental reserves of $26.5 million. Such aggregate reserves are approximately 13.3 times the average paid claims for the prior three-year period. Although Alleghany is unable at this time to determine whether additional reserves, which could have a material impact upon its results of operations, may be necessary in the future, Alleghany believes that Capitol Transamerica's asbestos and environmental reserves are adequate as of December 31, 2004. The reconciliation of the beginning and ending aggregate reserves for unpaid losses and LAE related to asbestos and environmental impairment claims of AIHL for the years 2002 through 2004 is shown below (in thousands): Reconciliation of Asbestos-Related Claims Reserves for Losses and LAE
2004 2003 2002 ------- ------- ------ Reserves as of January 1 ..... $24,781 $ 2,944 $ -- Losses and LAE incurred ...... (4,227) 24,985 3,244 Paid losses .................. (1,212) (3,148) (300) ------- ------- ------ Reserves as of December 31 ... $19,342 $24,781 $2,944 ======= ======= ====== Type of reserves Case ...................... $ 4,548 $ 4,039 $1,243 IBNR ...................... 14,794 20,742 1,701 ------- ------- ------ Total ........................ $19,342 $24,781 $2,944 ======= ======= ======
20 Reconciliation of Environmental Impairment Claims Reserves for Losses and LAE
2004 2003 2002 ------ ------ ------ Reserves as of January 1 .... $3,335 $4,416 $ -- Losses and LAE incurred ...... 4,227 (658) 4,867 Paid losses .................. (444) (423) (451) ------ ------ ------ Reserves as of December 31 ... $7,118 $3,335 $4,416 ====== ====== ====== Type of reserves Case ...................... $1,674 $ 552 $1,865 IBNR ...................... 5,444 2,783 2,551 ------ ------ ------ Total ........................ $7,118 $3,335 $4,416 ====== ====== ======
In 2004, management performed a review of various assumed reinsurance treaties and concluded that a re-allocation of reserves totaling $4,227,000 should be made from the asbestos loss reserve to the environmental claims loss reserve. AIHL's subsidiaries have experienced limited mold claims to date and have exclusions for mold claims in their policies. As of December 31, 2004, AIHL's operating units had no reserves for mold exposure. Competition The property and casualty businesses of RSUI and Darwin compete on a national basis, as does the fidelity and surety business of Capitol Transamerica. Capitol Transamerica's property and casualty business competes on a regional basis with a primary focus on the Midwestern and Plains states. Competitors of each of AIHL's subsidiaries include other primary insurers and new forms of insurance such as alternative self-insurance mechanisms. Many such competitors have considerably greater financial resources and greater experience in the insurance industry and offer a broader line of insurance products than do AIHL's subsidiaries. Except for regulatory considerations, there are virtually no barriers to entry into the insurance industry. Competition may be domestic or foreign, and competitors are not necessarily required to be licensed by various state insurance departments. The number of competitors within the industry is not known. The commercial property and casualty 21 insurance and fidelity and surety insurance industries are highly competitive, competing on the basis of reliability, financial strength and stability, ratings, underwriting consistency, service, business ethics, price, performance, capacity, policy terms and coverage conditions. Competition in the property and casualty insurance business has historically been cyclical in nature. Typically, a cycle operates as follows. The ability of primary insurers to conduct business is dependent generally upon their ability to purchase reinsurance. A surplus of reinsurers allows primary insurers to obtain reinsurance more cheaply, thereby enhancing profits. Enhanced profits increase the number of primary insurers, which increases competition for business and consequently reduces premium rates. As premium rates fall, the primary insurance business becomes less profitable and insurers profit only at the expense of their reinsurers. As reinsurance becomes less profitable, the reinsurance market contracts, consequently increasing reinsurance rates. Reduced insurance rates and increased reinsurance rates cause the primary insurance market to contract. Competition decreases in a contracted primary insurance market, allowing insurance rates to increase again, thereby enhancing profits of primary insurers. The enhanced profitability of primary insurers can be shared with reinsurers depending on the terms of the individual reinsurance agreements. A profitable reinsurance market generally will again lead to a surplus of reinsurers. The dynamics of the surety industry are also cyclical, partly for the same reasons as the property and casualty business described above. Typically, the cycles of surety business and property and casualty business run independent of each other. Currently, the surety industry is experiencing a flattening of price increases for primary coverages after two years of rising prices. The price increases have been driven by catastrophic losses for both primary writers and reinsurers, with the reinsurers sustaining the bulk of the losses. These losses have caused several large primary writers and reinsurers to exit the surety marketplace, creating opportunity for primary writers that can continue to obtain reinsurance at reasonable rates from the remaining reinsurers as a result of favorable loss histories. The Gramm-Leach-Bliley Act of 1999 removed many federal and state law barriers to affiliations between insurers, banks, securities firms and other financial services providers. This legislation and similar initiatives may lead to increased consolidation and competition in the insurance industry. Regulation AIHL is subject to the insurance holding company laws of several states. Certain dividends and distributions by an insurance subsidiary are subject to approval by the insurance regulators of the domiciliary state of such subsidiary. Other significant transactions between an insurance subsidiary and its holding company or other 22 subsidiaries of the holding company may require approval by insurance regulators in the domiciliary state of each of the insurance subsidiaries participating in such transactions. AIHL's subsidiaries are subject to regulation in their domiciliary states as well as in the other states in which they do business. Such regulation pertains to matters such as approving policy forms and various premium rates, licensing agents, granting and revoking licenses to transact business and regulating trade practices. The majority of AIHL's insurance operations are in states requiring prior approval by regulators before proposed rates for property or casualty or fidelity or surety insurance policies may be implemented. Insurance regulatory authorities perform periodic examinations of an insurer's market conduct and other affairs. Insurance companies are required to report their financial condition and results of operation in accordance with statutory accounting principles prescribed or permitted by state insurance regulators in conjunction with the National Association of Insurance Commissioners (the "NAIC"). State insurance regulators also prescribe the form and content of statutory financial statements, perform periodic financial examinations of insurers, set minimum reserve and loss ratio requirements, establish standards for the types and amounts of investments, and require minimum capital and surplus levels. Such statutory capital and surplus requirements include risk-based capital ("RBC") rules promulgated by the NAIC. These RBC standards are intended to assess the level of risk inherent in an insurance company's business and consider items such as asset risk, credit risk, underwriting risk and other business risks relevant to its operations. In accordance with RBC formulas, a company's RBC requirements are calculated and compared to its total adjusted capital to determine whether regulatory intervention is warranted. At December 31, 2004, the total adjusted capital of each of AIHL's insurance subsidiaries exceeded the minimum levels required under RBC rules and each had excess capacity to write additional premiums in relation to these requirements. The NAIC annually calculates certain statutory financial ratios for most insurance companies in the United States. These calculations are known as the Insurance Regulatory Information System ("IRIS") ratios. There presently are twelve IRIS ratios, with each ratio having an established "usual range" of results. The IRIS ratios assist state insurance departments in executing their statutory mandate to oversee the financial condition of insurance companies. A ratio falling outside the usual range is not considered a failing result; rather, unusual values are viewed as part of the regulatory early monitoring system. Furthermore, in some years, it may not be unusual for financially sound companies to have several ratios with results outside the usual ranges. The NAIC reports the ratios to state insurance departments who may then contact a company if four or more its ratios fall outside the NAIC's usual ranges. Based upon calculations as of December 31, 2004, Landmark and Capitol Indemnity had four or more of their ratios falling outside the usual ranges. 23 AIHL's subsidiaries are required under the guaranty fund laws of most states in which they transact business to pay assessments up to prescribed limits to fund policyholder losses or liabilities of insolvent insurance companies. AIHL's subsidiaries also are required to participate in various involuntary pools, principally involving workers compensation and windstorms. In most states, the involuntary pool participation of AIHL's subsidiaries is in proportion to their voluntary writings of related lines of business in such states. In addition to the regulatory requirements described above, a number of current and pending legislative and regulatory measures may significantly affect the insurance business in a variety of ways. These measures include, among other things, tort reform, consumer privacy requirements and financial services deregulation initiatives. Employees AIHL's subsidiaries employed 634 persons as of December 31, 2004, 336 of whom were at RSUI and its subsidiaries, 243 of whom were at Capitol Transamerica and its subsidiaries and 55 of whom were at Darwin. 24 INDUSTRIAL MINERALS BUSINESS On July 31, 1991, a holding company subsidiary of Alleghany acquired all of Manville Corporation's worldwide industrial minerals business, now conducted principally through World Minerals. World Minerals, headquartered in Santa Barbara, California, is principally engaged in the mining, production and sale of two industrial minerals, diatomite and perlite. Diatomite World Minerals conducts its domestic diatomite business (as well as a portion of its overseas diatomite business) through its Celite Corporation subsidiary. World Minerals is in the process of transferring most of Celite Corporation's overseas diatomite business to a separate wholly owned subsidiary of World Minerals. Celite Corporation, its diatomite subsidiaries, and the other overseas diatomite subsidiaries of World Minerals (collectively, "Celite") are believed to be collectively the world's largest producer of filter-aid grade diatomite, which is marketed worldwide under the Celite(R), Diafil(R) and Kenite(R) brand names. Celite also markets filter-aid grade diatomite in Europe under the Primisil(R) brand name and in Latin America and other areas under the Diactiv(R) brand name. Diatomite is a silica-based mineral consisting of the fossilized remains of microscopic freshwater or marine plants. Diatomite's primary applications are in filtration and as a functional filler. Filtration accounts for the majority of the worldwide diatomite market and for over 50.0 percent of Celite's diatomite sales. Diatomite is used as a filter aid in the production of beer, food, juice, wine, water, sweeteners, fats and oils, pharmaceuticals, chemicals, lubricants and petroleum. Diatomite is used as a filler, mainly in paints, and as an anti-block agent in plastic film. In addition to diatomite, Celite also produces calcium silicate products and magnesium silicate products, which are sold worldwide under the MicroCel(R) and Celkate(R) brand names (except in portions of Europe where calcium silicate products are sold under the Calflo(R) brand name). These products, which have high surface area and adsorption and absorption capabilities, are used to convert liquid, semi-solid and sticky ingredients into dry, free-flowing powders in the production of rubber, sweeteners, flavorings and pesticides. Celite has its world headquarters in Santa Barbara, California and owns diatomite mines and/or processing plants in Lompoc, California; Quincy, Washington; Fernley, Nevada; Murat, France; Alicante, Spain; Arica, Chile; Arequipa, Peru; Ayacucho, Peru; Tuxpan, Mexico; and Guadalajara, Mexico. In addition, World Minerals, through various subsidiaries of Celite, owns controlling interests in three joint ventures of which two are 25 active and engaged in the mining and processing of diatomite in Jilin Province, People's Republic of China ("PRC"). In 2001, Celite sold its 48.6 percent of Kisilidjan, h.f., a joint venture with the Government of Iceland, which mines and processes diatomite from Lake Myvatn in Iceland, to Allied EFA. Following the sale, Celite retained the exclusive right to sell the diatomite products produced from the Icelandic mine as long as such products continue to be produced. Production ceased at this mine in 2004. Also in 2001, Celite acquired the diatomite business, including a plant and mining properties, in and around Fernley, Nevada from CR Minerals, LLC. Celite's largest diatomite plant and mine is located near Lompoc, California. Celite currently obtains all additional diatomite supplies from its mines in the states of Washington and Nevada and in France, Spain, Mexico, Chile and Peru, and from its joint ventures in China. Celite believes that its diatomite reserves in California, Washington, Nevada, Mexico, Chile, Peru, Spain and China are generally sufficient to last for at least 20 more years at current rates of production. In 2004 broadened crude specifications, improved plant processes and exploration programs improved mineral assets at Lompoc and Spain to 20 years. France has ten to fifteen years mine life, and access to a new deposit requiring permitting. China is securing mine permits on adjacent land for an additional 20 year supply. Celite has substantial ore reserves at several of its mines and sufficient plant capacities that enable it, if necessary, to supply customers from different locations. Celite's silicate products are produced from purchased magnesium and calcium compounds and internally supplied diatomite. Perlite World Minerals conducts its domestic perlite business (as well as a portion of its overseas perlite business) through its Harborlite Corporation subsidiary. World Minerals is in the process of transferring most of Harborlite Corporation's overseas perlite business to a separate wholly owned subsidiary of World Minerals. World Minerals believes that Harborlite Corporation and the other overseas perlite subsidiaries of World Minerals (collectively, "Harborlite") are the world's largest producers of perlite filter aids and that Harborlite, which is also engaged in the business of selling perlite ore, is one of the world's largest merchant producers of perlite ore. These products are marketed worldwide under the Harborlite(R) and Europerl(R) brand names. Perlite is a volcanic rock which contains between two percent and five percent natural combined water. When heated rapidly, the natural combined water turns explosively into steam, and the perlite ore "pops" in a manner similar to popcorn, 26 expanding up to twenty times its original volume and creating a soft material with large surface area and correspondingly low density. Harborlite has its world headquarters in Santa Barbara, California and owns or operates a perlite mine and mill in No Agua, New Mexico; a perlite loading facility in Antonito, Colorado; a perlite mine and a mill in Superior, Arizona; a perlite deposit in Utah; a perlite mine and mill in Dikili, Turkey; perlite deposits in Central Mexico and Central Turkey; and perlite expansion facilities in Escondido, California; Green River, Wyoming; LaPorte, Texas; Youngsville, North Carolina; Vicksburg, Michigan; Quincy, Florida; Wissembourg, France; Barcelona, Spain; Milan, Italy; Santiago, Chile; and Paulinia, Brazil. The Perlite ore mined at Harborlite's No Agua, New Mexico mine is sold primarily to companies that expand it in their own expansion plants and use it in the manufacture of roofing board, formed pipe insulation and acoustical ceiling tile. Perlite ore for filter aid and certain filler applications is mined at Harborlite's Superior, Arizona mine and is expanded at Harborlite's six expansion plants located in the United States. Expanded perlite is also produced at Harborlite's European expansion plants at Wissembourg, France; Barcelona, Spain and Milan, Italy from perlite ore obtained from Harborlite's perlite mines at Dikili, Turkey and in Central Turkey; and from merchant ore producers in Europe. In the 2003 fourth quarter, Harborlite announced the closing of its Hessle, United Kingdom expansion plant, which had been acquired in 2000, and the plant was sold during 2004. Harborlite's Chilean plant expands perlite obtained from its own deposits in Chile and its Brazil plant expands perlite ore obtained from Harborlite's Turkish mines. Most of the expanded perlite is used as a filter aid in the brewing, food, wine, sweetener, pharmaceutical, chemical and lubricant industries, or as a filler and insulating medium in various construction applications. In 2000, a Harborlite subsidiary completed the acquisition of a small perlite expansion business in Spain, which has been merged into the existing Harborlite business in that country. In 2001, Harborlite acquired a small perlite expansion business in Spain, which was merged into Harborlite's existing operations in Spain, and acquired additional perlite ore reserves in Central Turkey. In 2002, Harborlite acquired the perlite mining and expansion business in Chile and the perlite expansion business in Brazil. Harborlite obtains perlite ore in the United States from its No Agua and Superior mines, and believes that its perlite ore reserves at each of these sites are sufficient to last at least 20 more years at the current rates of production. The perlite used by Harborlite for expansion in Europe and Brazil is obtained from Harborlite's two mines in Turkey and from third parties in Europe. Ore reserves at the Turkish mines are believed to be sufficient to last at least 20 more years at the current rates of production. Ore reserves at 27 Harborlite's Chilean mine are facing urban pressures. Additional reserves are being tested at other locations in Chile to ensure a 20 year supply. World Minerals conducts its business on a worldwide basis, with mining and processing operations in ten countries. In 2004, approximately 49.0 percent of World Minerals' revenues (equal to 11.3 percent of Alleghany's consolidated revenues) were generated by foreign operations, and an additional 12.0 percent of World Minerals' revenues were generated by export sales from the United States. While World Minerals believes that the international scope of its operations gives it unique competitive advantages, international operations can be subject to additional risks, such as currency fluctuations, changes in foreign legal requirements and political instability. World Minerals closely monitors its methods of operating in each country and adopts strategies responsive to changing economic and political environments. World Minerals minimizes its exposure to the risk of foreign currency fluctuation by, among other things, requiring its non-European foreign subsidiaries to invoice their export customers in United States dollars and causing all of its subsidiaries to declare and pay dividends whenever feasible. As a result, World Minerals' foreign operations do not subject Alleghany to a material risk from foreign currency fluctuation. World Minerals' operating subsidiaries experienced no interruptions in raw materials availability in 2004. Barring unforeseen circumstances, World Minerals anticipates no such interruptions in 2005. Celite and Harborlite believe that they have taken reasonable precautions for the continuous supply of their critical raw materials. Many of Celite's and Harborlite's operations use substantial amounts of energy, including electricity, fuel oil, natural gas and propane. In 2001, Celite and Harborlite experienced the effects of unprecedented increases in the costs of electricity (particularly in California) and natural gas, and temporary shutdowns in California as a result of electricity shortages. The electricity shortages did not extend beyond 2001, but higher electricity and natural gas prices are expected to continue for the foreseeable future. Celite and Harborlite have supply contracts for most of their energy requirements, most of which extend for one year or less. Celite and Harborlite have not experienced any energy shortages outside of California and they believe that they have taken reasonable precautions to ensure that their energy needs will be met, barring any unusual or unpredictable developments. From the time World Minerals began operations in 1991, none of its customers accounted for 10.0 percent or more of World Minerals' annual sales. World Minerals presently owns, controls or holds licenses either directly or through its subsidiaries to approximately 22 United States and 112 foreign patents and patent applications. Although World Minerals considers all of its patents and licenses to be valuable, World Minerals believes that none of its patents or licenses is by itself material to its business. 28 World Minerals normally maintains approximately a one- to four-week supply of inventory on certain products due to production lead times. Although diatomite mining activities at Celite's principal mine in Lompoc, California may be suspended during periods of heavy rainfall, World Minerals believes that, because of the stockpiling of ore during dry periods, such suspensions do not materially affect the supply of inventory. Barring unusual circumstances, World Minerals does not experience backlogs of orders. World Minerals' business is not seasonal to any material degree. In order to bring more focused attention to the unique business needs of various areas of the world, World Minerals reorganized the management of its business in 2000 into three regional sectors. Sales, operations and finance functions are now managed on a regional basis. Administrative, technical and support services are provided to the regional sectors by World Minerals. World Minerals has research and development, environmental control and quality control laboratories at its Lompoc production facilities and quality control laboratories at each of its other production facilities. In 2004, World Minerals spent approximately $2.4 million on company-sponsored research and technical services (in addition to amounts spent on engineering and exploration) related to the development and improvement of its products and services, compared with approximately $2.3 million in 2003 and approximately $3.0 million in 2002. World Minerals embarked on a major project to upgrade its information technology capabilities in 2000. During 2004, World Minerals began the implementation of a worldwide enterprise resource planning software system. It is expected that the implementation process will continue into 2006. Competition World Minerals believes that Celite is the world's largest producer of filter-aid grade diatomite. The remainder of the market is shared by Celite's four major competitors: Eagle-Picher Minerals (United States), CECA (France), Showa (Japan) and Grefco (United States), and a number of smaller competitors. World Minerals believes that Harborlite is the world's largest producer of perlite filter aids and is one of the world's largest merchant producers of perlite ore. Harborlite has two large competitors in the expanded perlite market, Grefco and CECA, and many smaller competitors. Harborlite also has two large competitors in the merchant perlite ore market, Silver & Baryte (Greece) and Grefco, and numerous smaller competitors. The filter aid products of Celite and Harborlite compete with other filter aids, such as cellulose, and other filtration technologies, such as crossflow and centrifugal separation. Celite's silicates compete with a wide variety of other synthetic mineral products. 29 In all of World Minerals' businesses, competition is principally on the basis of service, product quality and performance, warranty terms, speed and reliability of delivery, product availability and price. Regulation All of Celite's and Harborlite's domestic operations are subject to a variety of federal, state and local environmental laws and regulations. These laws and regulations establish potential liability for costs incurred in cleaning up waste sites and impose limitations on atmospheric emissions, discharges to domestic waters, and disposal of hazardous materials. Certain state and local jurisdictions have adopted regulations that may be more stringent than corresponding federal regulations. Celite and Harborlite believe that the impact of environmental regulations on their respective operating results has been minimal due to their environmental compliance programs; however, Celite and Harborlite cannot predict the potential future impact of such regulations, given the increasing number and complexity, and changing character, of such regulations. Moreover, federal and state laws governing disposal of wastes impact customers who must dispose of used filter-aid materials. World Minerals works with its customers to implement disposal strategies to minimize the impact of these disposal regulations. The domestic mining operations of Celite and Harborlite are subject to regulation by the Mine Safety and Health Administration ("MSHA"). This agency establishes health and safety standards relating to noise, respiratory protection and dust for employee work environments in the mining industry. Celite's and Harborlite's domestic production facilities which are not under the jurisdiction of MSHA are subject to regulation by the Occupational Safety and Health Administration ("OSHA"), which establishes regulations regarding, among other things, workplace conditions and exposure to dust and noise. In addition, certain state agencies exercise concurrent jurisdiction in these areas. During 1997, both MSHA and OSHA announced special emphasis programs to reduce the incidence of silicosis in the workplace. Due to Celite's industrial hygiene and monitoring programs, Celite does not expect these special emphasis programs to impact its business in any material way. World Minerals maintains a staff of experienced environmental, safety and industrial hygiene professionals who assist plant personnel in complying with environmental, health and safety regulations. Its environmental, safety and industrial hygiene audit group also performs routine internal audits and reviews of World Minerals' plant facilities worldwide. Due to these programs and responsible management at the local plant level, compliance with such regulations has been facilitated and the financial impact of such regulations on operating results has been minimal. 30 Certain products of Celite and Harborlite are subject to the Hazard Communication Standard promulgated by OSHA, which requires Celite and Harborlite to disclose the hazards of those products to employees and customers. Celite's diatomite products and certain of Harborlite's products contain varying amounts of crystalline silica, a mineral which is among the most common found on earth. In 1997, the International Agency for Research on Cancer ("IARC") reclassified the inhalation of crystalline silica from occupational sources from "probably carcinogenic to humans" to a category reflecting "sufficient evidence of human carcinogenicity." Celite and Harborlite provide required warning labels on their products containing in excess of 0.1 percent respirable crystalline silica, advising customers of the IARC designation and providing recommended safety precautions. Such requirements also mandate that industrial customers who purchase diatomite or perlite for use as a filler in their products label such products to disclose hazards which may result from the inclusion of crystalline silica-based fillers, if such products contain in excess of 0.1 percent of crystalline silica by volume, except in the case of non-calcined diatomaceous earth where labeling is only required in cases where the crystalline silica level exceeds 1 percent. Due to labeling concerns, some manufacturers of paint may be considering the use of other fillers in place of Celite's products. In such cases, Celite has actively worked with the customers to switch to alternative products. Celite believes that the loss of these customers would not have a material adverse effect on its operating results. Several states have also enacted or adopted "right to know" laws or regulations, which seek to expand the federal Hazard Communication Standard to include providing notice of hazards to the general public, as well as to employees and customers. Celite, through the industry-sponsored International Diatomite Producers Association ("IDPA"), has participated in funding several studies to examine in more detail the cancer risk to humans from occupational exposure to crystalline silica. One such study, conducted by the University of Washington on diatomite workers in Lompoc, California (the "Washington Study"), found a modest increase in lung cancer deaths in the cohort compared with national rates (indicated by a standardized mortality ratio ("SMR") equal to 1.43). The SMR compares the number of expected cancer deaths in the cohort with 1, which represents the number of cancer deaths in the population at large. The study also found an increase in non-malignant respiratory disease ("NMRD") (SMR equal to 2.59); this finding was expected because the NMRD category included silicosis resulting from exposures in past decades. After the publication of the Washington Study, Celite conducted its own review of the portion of the cohort representing the Lompoc plant and found that more workers in this portion of the cohort may have been exposed to asbestos prior to World Minerals' purchase of the Lompoc plant than originally thought. Since exposure to asbestos has been found to cause lung cancer and respiratory disease, this finding has raised concern that the Washington Study may have overstated the adverse health effects of exposure to 31 crystalline silica. IDPA engaged an epidemiologist and an industrial hygienist to examine the cohort to determine whether asbestos exposure was properly accounted for in the Washington Study's results. The final IDPA report (the "Asbestos Study") was issued in December 1994 and found: "Although asbestos operations were small relative to the diatomaceous earth operations, analyses in this report showed that exposure to asbestos by workers was relatively common. For example, the number of cohort members who were ever definitely, probably or possibly exposed to asbestos was shown to involve approximately 60 percent of the cohort. Even when only men employed in jobs definitely exposed to asbestos for more than [one] year in the period 1950-1977 were considered, more than 8 percent of the cohort had held such jobs." The Asbestos Study's authors called for further analyses which fully take into account the results of their study stating "[t]he interpretation of the silica-lung cancer risk relationships based on the [Lompoc] cohort should await the outcome of such analyses." The results of the Asbestos Study were analyzed by the authors of the Washington Study. They did not agree that asbestos was a likely confounder of the results of the initial study. In 1996, the Washington Study's authors, in association with researchers from Tulane University, conducted a seven-year follow-up study of the Lompoc cohort. The follow-up study, funded by a grant from the National Institute for Occupational Safety and Health, reported a lower SMR for the cohort (1.29 vs. 1.43), a weakened dose response relationship (which may suggest a less conclusive indication of a causative relationship between occupational exposure to crystalline silica and cancer deaths), and a continued absence of excess lung cancer in workers hired after 1960. Data errors later discovered in the follow-up study reduced the final SMR to 1.22 and further weakened the dose response relationship. An additional aspect of the study, which sought to compare results of the cohort study to radiographic readings of the workers, confirmed that the risk of silicosis to workers hired since 1950 and exposed to a cumulative crystalline silica exposure equal to or less than 3 mg/m3 over the working lifetime of the workers has not been appreciably different than in non-exposed populations. The various agreements covering the purchase of the business of Celite in 1991 provide for the indemnification of the holding company subsidiary of Alleghany which acquired Celite by the various selling Manville entities in respect of any environmental and health claims arising from the operations of the business of Celite prior to its acquisition by the holding company subsidiary. Such commitments of the selling Manville entities will terminate on July 31, 2006 with respect to claims first asserted thereafter. 32 Employees As of December 31, 2004, World Minerals and its consolidated subsidiaries had approximately 1,591 employees worldwide, including 1,129 at Celite and 267 at Harborlite. Approximately 342 of Celite's employees and 40 of Harborlite's employees in the United States are covered by collective bargaining agreements. All of the collective bargaining agreements covering workers at Celite and Harborlite are in full force and effect. 33 REAL ESTATE BUSINESS Headquartered in Sacramento, California, Alleghany Properties owns and manages properties in the Sacramento region of California. Such properties include improved and unimproved commercial land and commercial and residential lots. The majority of these properties are located in the City of Sacramento in the planned community of North Natomas. A considerable amount of activity from developers has occurred in the North Natomas area since 1998, including the construction of more than 10,000 single family homes, 3,100 apartment units, office buildings and several fully-leased regional retail shopping centers. Participating in this growth, Alleghany Properties has sold over 372 acres of residential land and 55 acres of commercial property. At December 31, 2004, Alleghany Properties had four employees. 34 Item 2. Properties. Alleghany's headquarters is located in leased office space of approximately 16,000 square feet at 375 Park Avenue in New York City. RSUI leases approximately 115,000 square feet of office space in Atlanta, Georgia for its headquarters and approximately 34,000 square feet of office space in Sherman Oaks, California. Capitol Transamerica leases approximately 50,000 square feet of office space in Madison, Wisconsin for its and Platte River's headquarters. Darwin leases approximately 12,500 square feet of office space in Farmington, Connecticut for its headquarters. World Minerals' headquarters is located in leased premises of approximately 13,000 square feet in Santa Barbara, California. On July 31, 1991, a holding company subsidiary of Alleghany acquired all of Manville Corporation's worldwide non-asbestos industrial minerals business (including the Lompoc, Guadalajara and No Agua mining operations discussed below) for a total purchase price of approximately $144.0 million. The acquired industrial minerals business is now conducted principally through World Minerals. The significant mining operations of Celite (constituting an aggregate of 77.0 percent of the annual diatomite produced) and Harborlite (constituting an aggregate of 89.0 percent of the annual perlite produced) are described below. Lompoc, CA. Celite's largest mine in terms of tonnage produced is located at 2500 Miguelito Road, Lompoc, California on property immediately adjacent to the City of Lompoc, California, and accessed via public roads and highways. The mine, which is an open-pit mine, celebrated its 100th anniversary of production in 1993 and has been in continuous operation for more than 60 years. The Lompoc property consists of approximately 8,700 acres, of which 5,000 acres are owned and 3,700 acres consist of property on which Celite has leased mineral rights from non-governmental third parties. All of the mining and mining operations are currently conducted on 2,500 acres of the owned property, with 2,500 acres of such property undeveloped. With respect to the mineral rights leases, such leases are long-term (in excess of ten years) provided that Celite pays annual minimum holding royalties and are not material to the current mining operations of Celite. Celite extracted, through surface mining, a total of approximately 297,000 tons of diatomaceous earth from the Lompoc property in 2004 and, on average, has extracted a total of approximately 300,000 tons of diatomaceous earth from the Lompoc property each year for the past three years, or approximately 46.0 percent of World Minerals' total diatomaceous earth production. This diatomaceous earth is processed at the Lompoc production facility which has approximately 1.0 million square feet of space, has a rated capacity in excess of 200,000 tons annually and currently supplies more than 25 different grades of diatomite products to the filtration and filler markets. The facility also houses World Minerals' research and development, and health, safety and environmental 35 departments and Celite's quality control laboratories. The plant and equipment are maintained by a full-time maintenance department and operate on regular replacement and repair cycles. The power sources used by the mining operations are natural gas and electricity. Celite believes that its proven and probable recoverable ore reserves of diatomaceous earth at the Lompoc property are approximately 8.6 million tons, of which approximately 72.0 percent consists of bright diatomite and approximately 28.0 percent consists of organically dark diatomite, which contains higher sulfur content than bright diatomite, based on estimates by the mining and exploration personnel employed by Celite. The Lompoc property's annual utilization of dark ore diatomite is capped at approximately 20.0 percent using current plant equipment due to air emission standards. Exploration programs have identified a potential 6.0 million tons of bright reserves in addition to the 8.6 million of proven and probable reserves of diatomaceous earth, at the Lompoc property. Quincy, Washington. Celite's second largest mine in terms of tonnage produced is located at 16419 Road 10.5 Northwest in Quincy, Washington and is accessed via public roads and highways. The mine, plant and equipment were acquired in 1991 from Witco Corporation for a purchase price of $10.0 million. The mine, which is an open-pit mine, has been in continuous operation for more than 50 years. The Quincy property consists of approximately 3,500 acres, 500 acres of which are owned and 3,000 acres of which consist of six separate parcels with respect to which Celite has leased mineral rights from non-governmental third parties. Approximately 85.0 percent of the current mining operations occur on the leased parcels. The remaining terms of the active mineral rights leases vary from two to fifteen years provided that Celite pays annual minimum holding royalties and production royalties, where applicable. Celite has no reason to believe that such leases will not be renewed on commercially reasonable terms. Celite extracted, through surface mining, a total of approximately 136,000 tons of diatomaceous earth from the Quincy property in 2004 and, on average, has extracted a total of approximately 100,000 tons of diatomaceous earth from this property each year for the past three years, or approximately 15.0 percent of its total diatomaceous earth production. This diatomaceous earth is processed at the Quincy production facility which has approximately 60,941 square feet of space and has a rated capacity in excess of 85,000 tons annually. The plant and equipment are maintained by a full-time maintenance department and operate on regular replacement and repair cycles. The power sources of the mining operations are natural gas and electricity. Celite believes that its proven and probable recoverable reserves of diatomaceous earth at the Quincy property are approximately 3.1 million tons, based on estimates by the mining and exploration personnel employed by Celite. 36 Guadalajara, Mexico. Celite's third largest mine in terms of tonnage produced is located at Almeria, S.A. de C.V., Jose A. Torres 400, General Andres Figueroa, KM 55 Carretera Guadalajara-CD Guzman, Jalisco, Mexico C.P. 44910 approximately 45 kilometers south of Guadalajara, Mexico and is accessed via public roads and highways. The mine, which is an open-pit mine, has been in continuous operation for more than 40 years. The Guadalajara mining activity is conducted on approximately 12,500 acres of government granted mineral concessions. The active concessions continue for a period of at least 20 years, provided Celite continues mining above minimum required production amounts, makes annual payments of concession taxes, meets certain environmental conditions and provides required extraction reports. The processing facility is located on approximately 110 acres of company owned property. Celite extracted, through surface mining, a total of approximately 105,000 tons of diatomaceous earth from the Guadalajara property in 2004 and, on average, has extracted a total of approximately 88,000 tons of diatomaceous earth from this property each year for the past three years, or approximately 16.0 percent of its total diatomaceous earth production. This diatomaceous earth is processed at the Guadalajara production facility which has approximately 116,000 square feet of space and has a rated capacity in excess of 60,000 tons annually. The plant and equipment are maintained by a full-time maintenance department and operate on regular replacement and repair cycles. The power sources of the mining operations are diesel oil and electricity. Celite believes that its proven and probable recoverable reserves of diatomaceous earth at the Guadalajara property are approximately 5.7 million tons, based on estimates by the mining and exploration personnel employed by Celite. Perlite No Agua, New Mexico. Harborlite's largest mine in terms of tonnage produced is located on U.S. Highway 285 in No Agua, New Mexico and is accessed via public roads and highways. The mine, which is an open-pit mine, has been in continuous operation for more than 40 years. The No Agua property consists of approximately 1,579 acres of property owned by Harborlite, of which approximately 350 acres are developed. Harborlite extracted, through surface mining, a total of approximately 302,000 tons of perlite from the No Agua property in 2004 and, on average, has extracted a total of approximately 250,000 tons of perlite from this property each year for the past three years, or approximately 54.0 percent of its total perlite production. This perlite is crushed and screened at the No Agua facility which has approximately 41,000 square feet of space and has a rated capacity in excess of 250,000 tons annually. The plant and equipment are fully maintained by a full-time maintenance department and operate on regular replacement and repair cycles. The power sources are diesel fuel and electricity. 37 Harborlite believes that its proven and probable recoverable reserves of perlite at the No Agua property are approximately 31.6 million tons, based on estimates by the mining and exploration personnel employed by Harborlite. Dikili, Turkey. Harborlite's second largest mine in terms of tonnage produced is located at Izmir-Cannakkale Karayolli 110 km. Kaynarca Mevkii, 35880 Dikili-Izmir, near Dikili, Turkey and is accessed via public roads and highways. The Dikili property and mine were acquired in 1995 for a purchase price of $4.0 million from EGE Endustri Mineralleri Sanayi A.S. The mine, which is an open-pit mine developed by Harborlite, has been in continuous operation for more than nine years. The Dikili property consists of approximately 20 square kilometers, of which approximately 10 acres is owned and the remainder is utilized pursuant to government granted mineral concessions. The mine site is located on the leased portion and the plant on the owned portion. The terms of the government granted concessions range from ten to thirty years and are renewable provided that Harborlite makes annual concession fee payments or production royalty payments where applicable and provides required production reports to the mining agency of the Turkish government. Harborlite extracted, through surface mining, a total of approximately 95,000 tons of perlite from the Dikili property in 2004 and, on average, has extracted a total of approximately 100,000 tons of perlite from this property each year for the past three years, or approximately 23.0 percent of its total perlite production. This perlite is crushed and screened at the Dikili facility which has approximately 63,000 square feet of space and has a rated capacity in excess of 115,000 tons annually. The plant and equipment are maintained by a full-time maintenance department and operate on regular replacement and repair cycles. The power sources are diesel, olive seeds and electricity. Harborlite believes that its proven and probable reserves of perlite at the Dikili property are approximately 4.5 million tons. Recoverable reserve estimates are 25.0 percent lower due to loss of product during mining and plant operations, based on estimates by the mining and exploration personnel employed by Harborlite. Superior, Arizona. Harborlite's third largest mine in terms of tonnage produced is located at 45156 Silver King Road in Superior, Arizona and is accessed via public roads and highways. This open-pit mine, along with the perlite expansion plants located in the United States, was acquired in 1992 for a purchase price of $15.8 million from a private, individual landowner and has been in continuous operation for more than 40 years. The Superior property consists of approximately 2,000 acres, of which approximately 200 acres are owned. The remaining 1,800 acres consists of U.S. Forest Service property on which Harborlite holds unpatented mining claims. Of the total acreage of the property, the active mine consists of approximately 100 acres, plant and equipment is on approximately 20 acres and approximately 1,880 acres are undeveloped. 38 Harborlite extracted, through surface mining, a total of approximately 59,000 tons of perlite from the Superior property in 2004 and, on average, has extracted a total of approximately 55,000 tons of perlite from this property each year for the past three years, or approximately 12.0 percent of its total perlite production. This perlite is crushed and screened at the Superior facility which has approximately 7,000 square feet of space and has a rated capacity in excess of 70,000 tons annually. The plant and equipment are fully maintained by a full-time maintenance department and operate on regular replacement and repair cycles. The power sources are natural gas and electricity. Harborlite believes that its proven and probable recoverable reserves of perlite at the Superior property are approximately 3.1 million tons, based on estimates by the mining and exploration personnel employed by Harborlite. Item 3. Legal Proceedings. Alleghany's subsidiaries are parties to pending litigation and claims in connection with the ordinary course of their businesses. Each such subsidiary makes provision on its books, in accordance with GAAP, for estimated losses to be incurred in such litigation and claims, including legal costs. In the opinion of management, such provision is adequate under GAAP as of December 31, 2004. Item 4. Submission of Matters to a Vote of Security Holders. No matter was submitted to a vote of security holders during the fourth quarter of 2004. Supplemental Item. Executive Officers of Registrant. The name, age, current position, date elected and five-year business history of each executive officer of Alleghany are as follows: 39
Current Position Business Experience Name Age (date elected) During Last 5 Years ---- --- ---------------- ------------------- F.M. Kirby 85 Chairman of the Board (since Chairman of the Board, Alleghany. 1967) Weston M. Hicks 48 President, chief executive Executive Vice President, Alleghany (from October officer (since December 2004) 2002 to December 2004); Executive Vice President and Chief Financial Officer, The Chubb Corporation (from June 2001 to October 2002); Chief Financial Officer, The Chubb Corporation (from May 2001 to October 2002); Senior Vice President and Financial Assistant to the Chairman, The Chubb Corporation (March 2001 to May 2001); Senior Research Analyst and Managing Director, J.P. Morgan Securities (from February 1999 to March 2001); Senior Research Analyst, Sanford C. Bernstein & Co., Inc. (from March 1991 to February 1999). David B. Cuming 72 Senior Vice President and Senior Vice President and chief financial officer, chief financial officer (since Alleghany. 1989) Robert M. Hart 60 Senior Vice President, General Senior Vice President, General Counsel and Counsel (since 1994) and Secretary, Alleghany. Secretary (since 1995) James P. Slattery 53 Senior Vice President - Senior Vice President - Insurance, Alleghany; Insurance (since 2002) President, JPS & Co., LLC (from April 2001); Chief Operating Officer and Deputy Chief Executive Officer, Swiss Reinsurance America Corporation (from November 1999 to April 2001); Senior Vice President - Swiss Re (from 1983 to 1999).
40 Peter R. Sismondo 49 Vice President, Controller, Vice President, Controller, Treasurer, Assistant Secretary, principal Assistant Secretary and principal accounting officer (since accounting officer, Alleghany. 1989) and Treasurer (since 1995)
PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. The information required by this Item with respect to the market price of and dividends on Alleghany's common stock and related stockholder matters is incorporated by reference from page 46 of Alleghany's Annual Report to Stockholders for the year 2004, filed as Exhibit 13 hereto. Item 6. Selected Financial Data. The information required by this Item 6 is incorporated by reference from page 46 of Alleghany's Annual Report to Stockholders for the year 2004, filed as Exhibit 13 hereto. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The information required by this Item 7 is incorporated by reference from pages 10 through 20, 22 through 44, 48 through 51 and 54 of Alleghany's Annual Report to Stockholders for the year 2004, filed as Exhibit 13 hereto. Item 7A. Quantitative and Qualitative Disclosures About Market Risk. The information required by this Item 7A is incorporated by reference from pages 52 through 54 of Alleghany's Annual Report to Stockholders for the year 2004, filed as Exhibit 13 hereto. Item 8. Financial Statements and Supplementary Data. The information required by this Item 8 is incorporated by reference from pages 56 through 78 of Alleghany's Annual Report to Stockholders for the year 2004, filed as Exhibit 13 hereto. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. Not applicable. 41 Item 9A. Controls and Procedures. Disclosure Controls and Procedures Alleghany carried out an evaluation, under the supervision and with the participation of its management, including the Chief Executive Officer (the "CEO") and the Chief Financial Officer (the "CFO"), of the effectiveness of the design and operation of Alleghany's disclosure controls and procedures as of the end of the period covered by this Form 10-K Report pursuant to Rule 13a-15 promulgated under the Securities Exchange Act of 1934. Based on that evaluation, Alleghany's management, including the CEO and CFO, concluded that Alleghany's disclosure controls and procedures were effective as of such date in timely alerting them to material information required to be included in Alleghany's periodic reports required to be filed with the Securities and Exchange Commission. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. Management's Report on Internal Control over Financial Reporting Management's report on internal control over financial reporting required by this Item 9A is incorporated by reference from pages 55 and 79 of Alleghany's Annual Report to Stockholders for the year 2004, filed as Exhibit 13 hereto. Changes in Internal Control over Financial Reporting There were no changes in internal control over financial reporting during the quarter ended December 31, 2004 that materially affected, or are reasonably likely to materially affect, Alleghany's internal control over financial reporting. PART III Item 10. Directors and Executive Officers of Registrant. As permitted by General Instruction G(3), information concerning the executive officers of Alleghany is set forth as a supplemental item included in Part I of this Form 10-K Report under the caption "Executive Officers of Registrant." Information concerning the directors of Alleghany is incorporated by reference from pages 4 through 11 of Alleghany's Proxy Statement, filed or to be filed in connection with its Annual Meeting of Stockholders to be held on April 22, 2005. Information concerning compliance with the reporting requirements under Section 16 of the Securities Exchange Act of 1934, as amended, is incorporated by reference from page 13 of Alleghany's Proxy Statement, filed or to be filed in connection with its Annual Meeting of Stockholders to be held on April 22, 2005. 42 In September 2003, the Board of Directors of Alleghany adopted a Financial Personnel Code of Ethics (the "Financial Personnel Code of Ethics") applicable to its chief executive officer, chief financial officer, chief accounting officer and vice president for tax matters that complies with the requirements of Item 406 of Regulation S-K under the Securities Exchange Act of 1934, as amended. The Financial Personnel Code of Ethics supplements Alleghany's Code of Business Conduct and Ethics, adopted by the Board of Directors of Alleghany in September 2003, which is applicable to all employees of Alleghany and its directors. A copy of the Financial Personnel Code of Ethics was filed as an Exhibit to Alleghany's annual report on Form 10-K for the year ended December 31, 2003. The Financial Personnel Code of Ethics and the Code of Business Conduct and Ethics are available on Alleghany's website at www.alleghany.com or may be obtained, free of charge, upon request to the Secretary of Alleghany. Item 11. Executive Compensation. The information required by this Item 11 is incorporated by reference from pages 13 through 25 of Alleghany's Proxy Statement, filed or to be filed in connection with its Annual Meeting of Stockholders to be held on April 22, 2005. The information set forth beginning on the bottom of page 25 through page 33 of Alleghany's Proxy Statement, filed or to be filed in connection with its Annual Meeting of Stockholders to be held on April 22, 2005, is not "filed" as a part hereof. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. Equity Compensation Plan Information The following table summarizes information, as of December 31, 2004, relating to the equity compensation plans of Alleghany under which equity securities of Alleghany are authorized for issuance: 43
(C) NUMBER OF (A) SECURITIES REMAINING NUMBER OF (B) AVAILABLE FOR FUTURE SECURITIES TO BE WEIGHTED- ISSUANCE UNDER ISSUED UPON AVERAGE EXERCISE EQUITY EXERCISE OF PRICE OF COMPENSATION PLANS OUTSTANDING OUTSTANDING (EXCLUDING OPTIONS, WARRANTS OPTIONS, WARRANTS SECURITIES REFLECTED PLAN CATEGORY AND RIGHTS AND RIGHTS IN COLUMN(A)) - ----------------------------- ----------------- ----------------- -------------------- Equity compensation plans approved by security holders(1) ............... 86,469(2) $148.78 796,255 Equity compensation plans not approved by security holders(3) ............... 23,459 $138.71 10,440 ------- ------- ------- Total ....................... 109,928 806,695 ======= =======
- ---------- (1) These plans consist of: (i) the Amended and Restated Directors' Stock Option Plan, (ii) the 2000 Directors' Stock Option Plan, (iii) the Directors' Equity Compensation Plan, (iv) the 1993 Long-Term Incentive Plan (the "1993 Plan")and (v) the 2002 Long-Term Incentive Plan (the "2002 Plan"). The 2000 Directors' Stock Option Plan, which provided for the annual grant of an option to purchase 1,000 shares of Common Stock (subject to antidilution adjustments) to each director who was not an employee of the Company or any of its subsidiaries, expired on December 31, 2004 and therefore no shares of Common Stock remain available for future grants. As of December 31, 2004, options to purchase 86,469 shares of Common Stock (subject to antidilution adjustments) were outstanding. The Directors' Equity Plan, which provides for the payment of a non-employee director's annual retainer for service as a director one-half in shares of Common Stock (which are not subject to any forfeiture or transfer restrictions) and one-half in cash, is due to expire on December 31, 2005. In December 2004, the Board of Directors adopted the 2005 Directors' Stock Plan (the "2005 Directors' Plan"), effective upon stockholder approval. Upon such stockholder approval, the Directors' Equity Plan will be terminated and no more grants of Common Stock will be made. Under the 2005 Directors' Plan, a maximum of 50,000 shares of Common Stock, which are not included in the above table, may be issued to non- 44 employee directors and/or purchased pursuant to stock options granted thereunder, subject to antidilution and other adjustments in certain events specified in the 2005 Directors' Plan. Such shares of Common Stock may be original issue shares of Common Stock, treasury stock, shares of Common Stock purchased in the open market or otherwise. (2) This amount does not include 49,783 performance shares outstanding under the 1993 Plan and 98,333 performance shares outstanding under the 2002 Plan. Performance shares do not have an exercise price because their value is dependent upon the achievement of certain performance goals over a period of time. Performance shares are typically paid one-half in cash and one-half in Common Stock. (3) These plans consist of: (i) the Subsidiary Directors' Stock Option Plan (the "Subsidiary Option Plan") and (ii) the Underwriters Re Group, Inc. 1997 Stock Option Plan (the "URG 1997 Plan"). Under the Subsidiary Option Plan, which was adopted on July 21, 1998, the Compensation Committee of Alleghany's Board of Directors selected non-employee directors of Alleghany's subsidiaries to receive grants of nonqualified stock options. Not more than 25,000 shares of Common Stock (subject to adjustment by reason of any stock split, stock dividend or other similar event) will be issued pursuant to options granted under the Subsidiary Option Plan. As of December 31, 2004, options to purchase 7,752 shares of Alleghany's Common Stock (subject to adjustment by reason of any stock split, stock dividend or other similar event) were outstanding. The Subsidiary Option Plan expired on July 31, 2003 and therefore no shares of Alleghany's Common Stock remain available for future grants. Each option has a term of 10 years from the date it is granted. One-third of the total number of shares of Common Stock covered by each option becomes exercisable each year beginning with the first anniversary of the date it is granted; however, an option automatically becomes exercisable in full when the non-employee subsidiary director ceases to be a non-employee subsidiary director for any reason other than death. If an optionholder dies while holding options that have not been fully exercised, his or her executors, administrators, heirs or distributees, as the case may be, may exercise those options which the decedent could have exercised at the time of death within one year after the date of such death. Under the URG 1997 Plan, which was adopted on September 17, 1997, options were granted to certain members of URG management in exchange for options to purchase shares of URG. As of December 31, 2004, options to purchase 20,728 shares of Alleghany's Common Stock (subject to adjustment by reason of any stock split, stock dividend or other similar event) were outstanding, and no shares of Alleghany's Common Stock remained available for future option grants under the URG 1997 Plan. Under the URG 1997 Plan, options expire if they are not 45 exercised prior to the earliest of (i) the tenth anniversary of the date of grant of the original warrant or option, (ii) three months after termination of the optionee's employment for any reason except death or a permanent disability, or (iii) one year after termination of the optionee's employment by reason of death or permanent disability. The additional information required by this Item 12 is incorporated by reference from pages 1 through 4, and from pages 11 through 13, of Alleghany's Proxy Statement, filed or to be filed in connection with its Annual Meeting of Stockholders to be held on April 22, 2005. Item 13. Certain Relationships and Related Transactions. The information required by this Item 13 is incorporated by reference from page 8 of Alleghany's Proxy Statement, filed or to be filed in connection with its Annual Meeting of Stockholders to be held on April 22, 2005. Item 14. Principal Accountant Fees and Services The information required by this Item 14 is incorporated by reference from pages 43 and 44 of Alleghany's Proxy Statement, filed or to be filed in connection with its Annual Meeting of Stockholders to be held on April 22, 2005. 46 PART IV Item 15. Exhibits and Financial Statement Schedules. (a) 1. Financial Statements. The consolidated financial statements of Alleghany and its subsidiaries, together with the report thereon of KPMG LLP, independent registered public accounting firm, are incorporated by reference from the Annual Report to Stockholders for the year 2004 into Item 8 of this Report. 2. Financial Statement Schedules. The schedules relating to the consolidated financial statements of Alleghany and its subsidiaries, together with the report thereon of KPMG LLP, independent registered public accounting firm, are detailed in a separate index herein. 3. Exhibits. The following are filed as exhibits to this Report:
Exhibit Number Description - -------------- ----------- 3.01 Restated Certificate of Incorporation of Alleghany, as amended by Amendment accepted and received for filing by the Secretary of State of the State of Delaware on June 23, 1988, filed as Exhibit 20 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1988, is incorporated herein by reference. 3.02 By-laws of Alleghany, as amended September 21, 2004, filed as Exhibit 3.2 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, is incorporated herein by reference. *10.01 Description of Alleghany Management Incentive Plan, filed as Exhibit 10.01 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.
- ---------- * Compensatory plan or arrangement. 47 *10.02 Alleghany Deferred Compensation Plan, as amended and restated as of December 15, 1992, filed as Exhibit 10.03 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1992, is incorporated herein by reference. *10.03(a) Alleghany 1993 Long-Term Incentive Plan, as amended and restated effective as of January 1, 1994, filed as Exhibit 10.06(b) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1994, is incorporated herein by reference. *10.03(b) Alleghany 2002 Long-Term Incentive Plan, adopted and effective April 26, 2002, filed as Exhibit A to Alleghany's Proxy Statement, filed in connection with its Annual Meeting of Stockholders held on April 26, 2002, is incorporated herein by reference. *10.04 Alleghany Supplemental Death Benefit Plan dated as of May 15, 1985 and effective as of January 1, 1985, filed as Exhibit 10.08 to Old Alleghany's Annual Report on Form 10-K for the year ended December 31, 1985, is incorporated herein by reference. *10.05 Alleghany Retirement Plan, amended and restated as of July 1, 2004. *10.06 Alleghany Retirement COLA Plan dated and effective as of January 1, 1992, as adopted on March 17, 1992, filed as Exhibit 10.7 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1991, are incorporated herein by reference. *10.07 Description of Alleghany Group Long Term Disability Plan effective as of July 1, 1995, filed as Exhibit 10.10 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1995, is incorporated herein by reference.
- ---------- * Compensatory plan or arrangement. 48 *10.08(a) Alleghany Amended and Restated Directors' Stock Option Plan effective as of April 20, 1993, filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993, is incorporated herein by reference. *10.08(b) Alleghany 2000 Directors' Stock Option Plan effective April 28, 2000, filed as Exhibit A to Alleghany's Proxy Statement, filed in connection with its Annual Meeting of Stockholders held on April 28, 2000, is incorporated herein by reference. *10.09 Alleghany Directors' Equity Compensation Plan, effective as of January 16, 1995, filed as Exhibit 10.11 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1994, is incorporated herein by reference. *10.10 Alleghany Non-Employee Directors' Retirement Plan, as amended, effective January 1, 2005. *10.11(a) Employment Agreement, dated October 7, 2002, between Alleghany and Weston M. Hicks, filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, is incorporated herein by reference. *10.11(b) Restricted Stock Award Agreement, dated October 7, 2002, between Alleghany and Weston M. Hicks, filed as Exhibit 10.2 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, is incorporated herein by reference. *10.11(c) Restricted Stock Unit Matching Grant Agreement, dated October 7, 2002, between Alleghany and Weston M. Hicks, filed as Exhibit 10.3 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, is incorporated herein by reference.
- ---------- * Compensatory plan or arrangement. 49 *10.11(d) Restricted Stock Award Agreement, dated December 31, 2004, between Alleghany and Weston M. Hicks. *10.12 Description of compensatory arrangements between Alleghany and John J. Burns, Jr., filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, is incorporated herein by reference. *10.13 Description of compensatory arrangements between Alleghany and its directors. *10.14 Description of compensatory arrangements between Alleghany and its named executive officers, as defined by Item 402(a)(3) of Regulation S-K. 10.15(a) Credit Agreement, dated as of July 28, 2004, among Alleghany, the banks which are signatories thereto, Wachovia Bank, National Association as administrative agent for the banks, U.S. Bank National Association as syndication agent for the banks, and LaSalle Bank National Association and HSBC Bank USA, National Association, as documentation agents for the banks (the "Credit Agreement"), filed as Exhibit 10.4 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, is incorporated herein by reference. 10.15(b) List of Contents of Exhibits and Schedules to the Credit Agreement. The Company agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.16(a) Installment Sales Agreement dated December 8, 1986 by and among Alleghany, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch & Co., Inc., filed as Exhibit 10.10 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1986, is incorporated herein by reference.
- ---------- * Compensatory plan or arrangement. 50 10.16(b) Intercreditor and Collateral Agency Agreement dated as of October 20, 1997 among The Chase Manhattan Bank, Barclays Bank PLC and Alleghany Funding Corporation, filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997, is incorporated herein by reference. 10.16(c) Master Agreement dated as of October 20, 1997 between Barclays Bank PLC and Alleghany Funding Corporation, and related Amended Confirmation dated October 24, 1997 between Barclays Bank PLC and Alleghany Funding Corporation, filed as Exhibit 10.2 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997, are incorporated herein by reference. 10.16(d) Indenture dated as of October 20, 1997 between Alleghany Funding Corporation and The Chase Manhattan Bank, filed as Exhibit 10.3 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997, is incorporated herein by reference. 10.17(a) Stock Purchase Agreement dated as of July 1, 1991 among Celite Holdings Corporation, Celite Corporation and Manville International, B.V. (the "Celite Stock Purchase Agreement"), filed as Exhibit 10.2(a) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference. 10.17(b) List of Contents of Exhibits and Schedules to the Celite Stock Purchase Agreement, filed as Exhibit 10.2(b) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.18(a) Joint Venture Stock Purchase Agreement dated as of July 1, 1991 among Celite Holdings Corporation, Celite Corporation and Manville Corporation (the "Celite Joint Venture Stock Purchase Agreement"), filed as Exhibit 10.3(a) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference.
51 10.18(b) List of Contents of Exhibits and Schedules to the Celite Joint Venture Stock Purchase Agreement, filed as Exhibit 10.3(b) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.19(a) Asset Purchase Agreement dated as of July 1, 1991 among Celite Holdings Corporation, Celite Corporation and Manville Sales Corporation (the "Celite Asset Purchase Agreement"), filed as Exhibit 10.4(a) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference. 10.19(b) List of Contents of Exhibits and Schedules to the Celite Asset Purchase Agreement, filed as Exhibit 10.4(b) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.19(c) Amendment No. 1 dated as of July 31, 1991 to the Celite Asset Purchase Agreement, filed as Exhibit 10.32(c) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1991, is incorporated herein by reference. 10.20(a) Acquisition Related Agreement dated as of July 1, 1991, by and between Celite Holdings Corporation, Celite Corporation and Manville Corporation (the "Celite Acquisition Related Agreement"), filed as Exhibit 10.5(a) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference. 10.20(b) List of Contents of Exhibits to the Celite Acquisition Related Agreement, filed as Exhibit 10.5(b) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request.
52 10.20(c) Amendment dated as of July 31, 1991 to Celite Acquisition Related Agreement, filed as Exhibit 10.33(c) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1991, is incorporated herein by reference. 10.21(a) Credit Agreement dated as of March 12, 2003 among Mineral Holdings, Inc., World Minerals, designated subsidiary borrowers, the Banks named therein and Union Bank of California, N.A., as Sole Lead Arranger, Administrative Agent and Collateral Agent (the "World Minerals Credit Agreement"), filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended March 31, 2003, is incorporated herein by reference. 10.21(b) List of Contents of Exhibits, Annexes and Schedules to the World Minerals Credit Agreement, filed as Exhibit 10.2 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended March 31, 2003, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.21(c) Subordination Agreement dated as of March 12, 2003 between Alleghany and Union Bank of California, N.A., as Administrative Agent and Collateral Agent, filed as Exhibit 10.3 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended March 31, 2003, is incorporated herein by reference. 10.22(a) Stock Purchase Agreement dated as of December 30, 1999 by and between Alleghany and Swiss Re America Holding Corporation, filed as Exhibit 99.1 to Alleghany's Current Report on Form 8-K dated December 30, 1999, is incorporated herein by reference. 10.22(b) Closing Agreement, dated May 10, 2000, by and between Swiss Re America Holding Corporation and Alleghany, filed as Exhibit 99.2 to Alleghany's Current Report on Form 8-K dated May 25, 2000, is incorporated herein by reference.
53 10.23 Agreement, effective as of December 20, 2000, by and among Alleghany, Underwriters Reinsurance Company and London Life and Casualty Reinsurance Corporation, filed as Exhibit 10.23 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 2000, is incorporated herein by reference. 10.24(a) Agreement and Plan of Amalgamation dated as of July 30, 1998 by and among Underwriters Reinsurance Company, Underwriters Acquisition Company Ltd. and Venton Holdings Ltd. (the "Amalgamation Agreement"), filed as Exhibit 10.28(a) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1998, is incorporated herein by reference. 10.24(b) List of Contents of Exhibits to the Amalgamation Agreement, filed as Exhibit 10.28(b) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1998, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.24(c) Amendment No. 1 dated as of September 24, 1998 to the Amalgamation Agreement (the "Amalgamation Amendment No. 1"), filed as Exhibit 10.28(c) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1998, is incorporated herein by reference. 10.24(d) List of Contents of Exhibits to the Amalgamation Amendment No. 1, filed as Exhibit 10.28(d) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1998, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request.
54 10.25(a) Credit Agreement dated as of August 14, 2000, by and among Alleghany Underwriting Ltd, Alleghany Underwriting Capital Ltd, Talbot Underwriting Limited, and Alleghany Underwriting Capital (Bermuda) Ltd, as Borrowers and Account Parties; Alleghany, as Guarantor; the Banks parties thereto from time to time; Mellon Bank, N.A., as Issuing Bank, as Administrative Agent and as Arranger; National Westminster Bank plc, as Syndication Agent and ING Bank, N.V., as Managing Agent (the "Alleghany Underwriting Credit Agreement"), filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 2000, is incorporated herein by reference. 10.25(b) List of Contents of Exhibits and Schedules to the Alleghany Underwriting Credit Agreement, filed as Exhibit 10.2 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 2000, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.25(c) First Amendment to Credit Agreement dated as of February 1, 2001, by and among Alleghany Underwriting Ltd, Alleghany Underwriting Capital Ltd, Talbot Underwriting Limited, Alleghany Underwriting Capital (Bermuda) Ltd, Alleghany, Alleghany Insurance Holdings LLC, the Banks and Agents which have signed the signature pages thereto, and Mellon Bank, N.A., as Bank, as Issuing Bank and as Administrative Agent for the Banks and the Issuing Bank, filed as Exhibit 10.25(c) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 2000, is incorporated herein by reference. 10.25(d) Purchase Agreement dated as of October 31, 2001 by and between Alleghany Insurance Holdings LLC and Talbot Holdings Ltd, filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 2001, is incorporated herein by reference.
55 10.26(a) Agreement and Plan of Merger, dated as of October 18, 2000, by and among ABN AMRO North America Holding Company, Alleghany Asset Management, Inc. and Alleghany, filed as Exhibit 2.1 to Alleghany's Current Report on Form 8-K dated October 23, 2000, is incorporated herein by reference. 10.26(b) Amendment to the Agreement and Plan of Merger dated as of January 17, 2001, by and among ABN AMRO North America Holding Company, Alleghany Asset Management, Inc. and Alleghany, filed as Exhibit 2.2 to Alleghany's Current Report on Form 8-K dated February 14, 2001, is incorporated herein by reference. 10.26(c) Closing Agreement dated as of February 1, 2001, by and among ABN AMRO North America Holding Company, Alleghany Asset Management, Inc. and Alleghany, filed as Exhibit 2.3 to Alleghany's Current Report on Form 8-K dated February 14, 2001, is incorporated herein by reference. 10.27(a) Agreement and Plan of Merger dated as of July 20, 2001 by and among Capitol Transamerica, ABC Acquisition Corp. and Alleghany (the "Capitol Transamerica Merger Agreement"), filed as Exhibit 10.1(a) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2001, is incorporated herein by reference. 10.27(b) List of Contents of Exhibits and Schedules to the Capitol Transamerica Merger Agreement, filed as Exhibit 10.1(b) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2001, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.28(a) Acquisition Agreement, dated as of June 6, 2003, by and between Royal Group, Inc. and AIHL (the "Resurgens Specialty Acquisition Agreement"), filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference.
56 10.28(b) List of Contents of Exhibits and Schedules to the Resurgens Specialty Acquisition Agreement, filed as Exhibit 10.2 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.29 Assignment and Assumption Agreement, dated as of June 30, 2003, by and between AIHL and RSUI (regarding the transfer of rights under the Resurgens Specialty Acquisition Agreement), filed as Exhibit 10.3 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.30(a) Quota Share Reinsurance Agreement, dated as of July 1, 2003, by and between Royal Indemnity Company and RIC (the "Royal Indemnity Company Quota Share Reinsurance Agreement"), filed as Exhibit 10.4 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.30(b) List of Contents of Exhibits and Schedules to the Royal Indemnity Company Quota Share Reinsurance Agreement, filed as Exhibit 10.5 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.31(a) Quota Share Reinsurance Agreement, dated as of July 1, 2003, by and between Royal Surplus Lines Insurance Company and RIC (the "Royal Surplus Lines Insurance Company Quota Share Reinsurance Agreement"), filed as Exhibit 10.6 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference.
57 10.31(b) List of Contents of Exhibits and Schedules to the Royal Surplus Lines Insurance Company Quota Share Reinsurance Agreement, filed as Exhibit 10.7 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.32(a) Quota Share Reinsurance Agreement, dated as of July 1, 2003, by and between Landmark and RIC (the "Landmark Quota Share Reinsurance Agreement"), filed as Exhibit 10.8 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.32(b) List of Contents of Exhibits and Schedules to the Landmark Quota Share Reinsurance Agreement, filed as Exhibit 10.9 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.33(a) Administrative Services Agreement, dated as of July 1, 2003, by and among Royal Indemnity Company, Resurgens Specialty and RIC (the "Royal Indemnity Company Administrative Services Agreement"), filed as Exhibit 10.10 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.33(b) List of Contents of Exhibits and Schedules to the Royal Indemnity Company Administrative Services Agreement, filed as Exhibit 10.11 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request.
58 10.34(a) Administrative Services Agreement, dated as of July 1, 2003, by and among Royal Surplus Lines Insurance Company, Resurgens Specialty and RIC (the "Royal Surplus Lines Insurance Company Administrative Services Agreement"), filed as Exhibit 10.12 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.34(b) List of Contents of Exhibits and Schedules to the Royal Surplus Lines Insurance Company Administrative Services Agreement, filed as Exhibit 10.13 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.35(a) Administrative Services Agreement, dated as of July 1, 2003, by and among Royal Insurance Company of America, Resurgens Specialty and RIC (the "Royal Insurance Company of America Administrative Services Agreement"), filed as Exhibit 10.14 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.35(b) List of Contents of Exhibits and Schedules to the Royal Insurance Company of America Administrative Services Agreement, filed as Exhibit 10.15 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.36(a) Administrative Services Agreement, dated as of July 1, 2003, by and among Landmark, Resurgens Specialty and RIC (the "Landmark Administrative Services Agreement"), filed as Exhibit 10.16 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference.
59 10.36(b) List of Contents of Exhibits and Schedules to the Landmark Administrative Services Agreement, filed as Exhibit 10.17 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.37(a) Trust Agreement, dated as of July 1, 2003, by and among Royal Indemnity Company, Royal Surplus Lines Insurance Company, Landmark, RIC and LaSalle Bank National Association, as Trustee (the "Trust Agreement"), filed as Exhibit 10.18 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.37(b) Amendment, dated as of September 2, 2003, amending the Trust Agreement, filed as Exhibit 10.7 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, is incorporated herein by reference. 10.38(a) Assignment of Net Premium Receivables, dated as of July 1, 2003, by and between LaSalle Bank National Association and Royal Indemnity Company, Royal Surplus Lines Insurance Company and Landmark ("Assignment of Receivables"), filed as Exhibit 10.19 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.38(b) Amendment, dated as of September 2, 2003, amending the Assignment of Receivables, filed as Exhibit 10.8 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, is incorporated herein by reference. 10.39(a) Assignment of Reinsurance Recoverables, dated as of July 1, 2003, by and among RIC, LaSalle Bank National Association and Royal Indemnity Company, Royal Surplus Lines Insurance Company and Landmark ("Assignment of Recoverables"), filed as Exhibit 10.20 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.39(a) Assignment of Reinsurance Recoverables, dated as of July 1, 2003, by and among RIC, LaSalle Bank National Association and Royal Indemnity Company, Royal Surplus Lines Insurance Company and Landmark ("Assignment of Recoverables"), filed as Exhibit 10.20 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference.
60 10.39(b) Amendment, dated as of September 2, 2003, amending the Assignment of Recoverables, filed as Exhibit 10.9 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, is incorporated herein by reference. 10.40 Administrative Services Intellectual Property License Agreement, dated as of July 1, 2003, by and between Royal Indemnity Company and Resurgens Specialty (entered into pursuant to the Royal Indemnity Company Administrative Services Agreement), filed as Exhibit 10.21 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.41 Administrative Services Intellectual Property License Agreement, dated as of July 1, 2003, by and between Royal Indemnity Company and Resurgens Specialty (entered into pursuant to the Royal Surplus Lines Insurance Company Administrative Services Agreement), filed as Exhibit 10.22 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.42 Administrative Services Intellectual Property License Agreement, dated as of July 1, 2003, by and between Royal Indemnity Company and Resurgens Specialty (entered into pursuant to the Royal Insurance Company of America Administrative Services Agreement), filed as Exhibit 10.23 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.43 Administrative Services Intellectual Property License Agreement, dated as of July 1, 2003, by and between Royal Indemnity Company and Resurgens Specialty (entered into pursuant to the Landmark Administrative Services Agreement), filed as Exhibit 10.24 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference.
61 10.44(a) Claims Servicing Agreement, dated as of July 1, 2003, by and among RIC, Royal Indemnity Company, Royal Surplus Lines Insurance Company, Landmark, Royal Insurance Company of America, American and Foreign Insurance Company, Globe Indemnity Company, Safeguard Insurance Company and Phoenix Assurance Company of New York (the "Claims Servicing Agreement"), filed as Exhibit 10.25 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.44(b) List of Contents of Exhibits and Schedules to the Claims Servicing Agreement, filed as Exhibit 10.26 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.45 Claims Servicing Information Technology License Agreement, dated as of July 1, 2003, by and between Royal Indemnity Company and RIC, filed as Exhibit 10.27 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.46(a) Renewal Rights Agreement, dated as of July 1, 2003, by and among Landmark, Royal Indemnity Company, Royal Surplus Lines Insurance Company, Royal Insurance Company of America and AIHL (the "Renewal Rights Agreement"), filed as Exhibit 10.28 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.46(b) List of Contents of Exhibits to the Renewal Rights Agreement, filed as Exhibit 10.29 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request.
62 10.47(a) Transition Services Agreement, dated as of July 1, 2003, by and among Royal Group, Inc., RSUI and Resurgens Specialty (the "Transition Services Agreement"), filed as Exhibit 10.30 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.47(b) List of Contents of Schedules to the Transition Services Agreement, filed as Exhibit 10.31 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.48 Transitional Trademark License Agreement, dated as of July 1, 2003, by and among R&SA, Resurgens Specialty and RSA Surplus Lines Insurance Services, Inc, filed as Exhibit 10.32 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.49 Employee Leasing Agreement, dated as of July 1, 2003, by and between Royal Indemnity Company and RIC, filed as Exhibit 10.33 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.50(a) Managing General Agency Agreement, dated as of July 1, 2003, by and among Resurgens Specialty, as Managing General Agent, Royal Indemnity Company, Royal Surplus Lines Insurance Company, Royal Insurance Company of America and Landmark (the "Managing General Agency Agreement"), filed as Exhibit 10.34 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.50(b) List of Contents of Exhibits to the Managing General Agency Agreement, filed as Exhibit 10.35 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request.
63 10.51(a) Stock Purchase Agreement, dated as of July 1, 2003, by and between AIHL and Royal Group, Inc. (the "RSA Surplus Lines Insurance Services, Inc. Stock Purchase Agreement"), filed as Exhibit 10.36 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.51(b) List of Contents of Exhibits and Schedules to the RSA Surplus Lines Insurance Services, Inc. Stock Purchase Agreement, filed as Exhibit 10.37 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.52 Assignment and Assumption of Liabilities Agreement, dated as of July 1, 2003, by and between RSA Surplus Lines Insurance Services, Inc. and Royal Indemnity Company, filed as Exhibit 10.38 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.53 Assignment and Assumption Agreement, dated as of July 1, 2003, by and between AIHL and RSUI, filed as Exhibit 10.39 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.54 Assignment and Assumption Agreement, dated as of July 1, 2003, by and between AIHL and RSUI, filed as Exhibit 10.40 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.55 Assignment and Assumption Agreement, dated as of July 1, 2003, by and between AIHL and RSUI, filed as Exhibit 10.41 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference.
64 10.56(a) Stock Purchase Agreement, dated as of June 6, 2003, by and between AIHL and Guaranty National Insurance Company (the "Landmark Stock Purchase Agreement"), filed as Exhibit 10.42 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.56(b) List of Contents of Exhibits and Schedules to the Landmark Stock Purchase Agreement, filed as Exhibit 10.43 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.57(a) Stock Purchase Agreement, dated as of June 12, 2003, by and between Swiss Re America Holding Corporation and RSUI (the "RIC Stock Purchase Agreement"), filed as Exhibit 10.44 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.57(b) List of Contents of Exhibits and Schedules to the RIC Stock Purchase Agreement, filed as Exhibit 10.45 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.58 Assignment and Assumption Agreement, dated as of July 1, 2003, by and between AIHL and RIC (regarding the transfer of rights under the Landmark Stock Purchase Agreement), filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, is incorporated herein by reference. 10.59(a) RIC (Landmark) Quota Share Reinsurance Agreement, dated as of September 2, 2003, by and between Landmark and Royal Indemnity Company (the "Royal Indemnity Company (Landmark) Quota Share Reinsurance Agreement"), filed as Exhibit 10.2 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, is incorporated herein by reference.
65 10.59(b) List of Contents of Exhibits and Schedules to the Royal Indemnity Company (Landmark) Quota Share Reinsurance Agreement, filed as Exhibit 10.3 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.60(a) RIC (Landmark) Administrative Services Agreement, dated as of September 2, 2003, by and between Royal Indemnity Company and Landmark (the "Royal Indemnity Company (Landmark) Administrative Services Agreement"), filed as Exhibit 10.4 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, is incorporated herein by reference. 10.60(b) List of Contents of Exhibits and Schedules to the Royal Indemnity Company (Landmark) Administrative Services Agreement, filed as Exhibit 10.5 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, is incorporated herein by reference. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.61 Assumption of Liabilities Agreement, dated as of September 2, 2003, by and between Landmark and Royal Indemnity Company, filed as Exhibit 10.6 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 2003, is incorporated herein by reference. 10.62(a) Stock Purchase Agreement, dated as of January 30, 2004, by and among AIHL, Aegis Holding Inc. and Associated Electric & Gas Insurance Services Limited Landmark and Royal Indemnity Company ("Aegis Stock Purchase Agreement"), filed as Exhibit 10.65 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 2003, is incorporated herein by reference. 10.62(b) List of Contents of Exhibits and Schedules to the Aegis Stock Purchase Agreement. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request, filed as Exhibit 10.66 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 2003, is incorporated herein by reference.
66 10.63 Closing Agreement, dated May 3, 2004, by and among Darwin Group, Inc., Aegis Holding Inc. and Associated Electric & Gas Insurance Services Limited, filed as Exhibit 10.2 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended March 31, 2004, is incorporated herein by reference. 10.64 Trust Agreement, dated as of June 10, 2004, by and among Royal Indemnity Company, Royal Surplus Lines Insurance Company, RSUI Indemnity Company and The Bank of New York, as Trustee, filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, is incorporated herein by reference. 10.65 Assignment of Net Premium Receivables, dated as of June 10, 2004, by and among The Bank of New York, Royal Indemnity Company and Royal Surplus Lines Insurance Company, filed as Exhibit 10.2 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, is incorporated herein by reference. 10.66 Assignment of Reinsurance Recoverables, dated as of June 10, 2004, by and among RSUI Indemnity Company, The Bank of New York, Royal Indemnity Company and Royal Surplus Lines Insurance Company, filed as Exhibit 10.3 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, is incorporated herein by reference. 10.67(a) Agreement and Plan of Merger, dated as of December 23, 2004, among HTI Acquisition LLC, Heads & Threads and Alleghany (the "Heads & Threads Merger Agreement"). 10.67(b) List of Contents of Exhibits and Schedules to the Heads & Threads Merger Agreement. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.68(a) Stock Purchase Agreement, dated as of January 31, 2005, by and among Darwin National Assurance Company and Ulico Casualty Company ("Ulico Stock Purchase Agreement"). 10.68(b) List of Contents of Exhibits and Schedules to the Ulico Stock Purchase Agreement. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request.
67 13 Pages 10 through 20, 22 through 44, 46 and 48 through 79, of the Annual Report to Stockholders of Alleghany for the year 2004. 21 List of subsidiaries of Alleghany. 23 Consent of KPMG LLP, independent registered public accounting firm, to the incorporation by reference of its reports relating to the financial statements the related schedules of Alleghany and subsidiaries and its attestation report in Alleghany's Registration Statements on Form S-8 (Registration No. 333-37237), Form S-8 (Registration No. 333-76159), Form S-8 (Registration No. 333-76996), Form S-3 (Registration No. 33-55707), Form S-3 (Registration No. 33-62477), Form S-3 (Registration No. 333-09881), and Form S-3 (Registration No. 333-13971). 31.1 Certification of the Chief Executive Officer of Alleghany pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of the Chief Financial Officer of Alleghany pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of the Chief Executive Officer of Alleghany pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This exhibit shall not be deemed "filed" as a part of this Annual Report on Form 10-K. 32.2 Certification of the Chief Financial Officer of Alleghany pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This exhibit shall not be deemed "filed" as a part of this Annual Report on Form 10-K.
68 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ALLEGHANY CORPORATION (Registrant) Date: March 8, 2005 By /s/ Weston M. Hicks ------------------------------------- Weston M. Hicks President 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. Date: March 8, 2005 By /s/ Rex D. Adams ------------------------------------- Rex D. Adams Director Date: March 8, 2005 By /s/ John J. Burns, Jr. ------------------------------------- John J. Burns, Jr. Vice Chairman of the Board and Director Date: March 8, 2005 By ------------------------------------- Dan R. Carmichael Director Date: March 8, 2005 By /s/ David B. Cuming ------------------------------------- David B. Cuming Senior Vice President (principal financial officer) Date: March 8, 2005 By /s/ Weston M. Hicks ------------------------------------- Weston M. Hicks President and Director (principal executive officer) 69 Date: March 8, 2005 By /s/ Thomas S. Johnson ------------------------------------- Thomas S. Johnson Director Date: March 8, 2005 By /s/ Allan P. Kirby, Jr. ------------------------------------- Allan P. Kirby, Jr. Director Date: March 8, 2005 By /s/ F.M. Kirby ------------------------------------- F.M. Kirby Chairman of the Board and Director Date: March 8, 2005 By /s/ William K. Lavin ------------------------------------- William K. Lavin Director Date: March 8, 2005 By /s/ Roger Noall ------------------------------------- Roger Noall Director Date: March 8, 2005 By /s/ Peter R. Sismondo ------------------------------------- Peter R. Sismondo Vice President, Controller, Treasurer and Assistant Secretary (principal accounting officer) Date: March 8, 2005 By /s/ James F. Will ------------------------------------- James F. Will Director 70 ALLEGHANY CORPORATION AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENT SCHEDULES I SUMMARY OF INVESTMENTS - OTHER THAN IN RELATED PARTIES II CONDENSED FINANCIAL INFORMATION OF REGISTRANT III SUPPLEMENTARY INSURANCE INFORMATION IV REINSURANCE V VALUATION AND QUALIFYING ACCOUNTS VI SUPPLEMENTAL INFORMATION CONCERNING INSURANCE OPERATIONS REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
SCHEDULE I ALLEGHANY CORPORATION AND SUBSIDIARIES SUMMARY OF INVESTMENTS -- OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 2004 (in thousands)
AMOUNT AT WHICH SHOWN IN THE FAIR BALANCE TYPE OF INVESTMENT COST VALUE SHEET - ------------------ ---------- ---------- ----------- Fixed maturities: Bonds: United States Government and government agencies and authorities $ 93,469 $ 92,760 $ 92,760 States, municipalities and political subdivisions 573,779 575,236 575,236 Foreign governments 0 0 0 Mortgage backed securities 237,883 237,799 237,799 All other bonds 273,851 273,415 273,415 Redeemable preferred stock 0 0 0 ---------- ---------- ---------- Fixed maturities $1,178,982 $1,179,210 $1,179,210 ---------- ---------- ---------- Equity securities: Common stocks: Banks, trust, and insurance companies $ 63,692 $ 104,558 $ 104,558 Public utilities 6,960 8,199 8,199 Industrial, miscellaneous, and all other 219,945 532,427 532,427 ---------- ---------- ---------- Equity securities $ 290,597 $ 645,184 $ 645,184 ---------- ---------- ---------- Short-term investments 378,452 378,452 378,452 ---------- ---------- ---------- Total investments $1,848,031 $2,202,846 $2,202,846 ========== ========== ==========
SCHEDULE II ALLEGHANY CORPORATION CONDENSED BALANCE SHEETS DECEMBER 31, 2004 AND 2003 (in thousands)
2004 2003 ---------- ---------- Assets Equity securities (cost: 2004 $140,345; 2003 $123,846) $ 446,355 $ 293,053 Debt securities (cost: 2004 $11,096; 2003 $15,322) 11,096 15,309 Short-term investments 80,948 81,880 Cash 2,069 1,950 Notes receivable -- 140 Accounts receivable 3,206 1,415 Property and equipment - at cost, net of accumulated depreciation 189 155 Other assets 6,854 4,598 Deferred tax assets 18,047 11,487 Investment in subsidiary classified as discontinued operation -- 51,736 Current tax receivable 1,881 -- Investment in subsidiaries 1,407,176 1,277,537 ---------- ---------- $1,977,821 $1,739,260 ========== ========== Liabilities and common stockholders' equity Current taxes payable $ -- $ 17,978 Other liabilities 51,920 35,928 Deferred tax liabilities 150,678 103,409 Long-term debt 19,123 19,123 ---------- ---------- Total liabilities 221,721 176,438 Stockholders' equity 1,756,100 1,562,822 ---------- ---------- $1,977,821 $1,739,260 ========== ==========
See accompanying Notes to Condensed Financial Statements. SCHEDULE II ALLEGHANY CORPORATION CONDENSED STATEMENTS OF EARNINGS THREE YEARS ENDED DECEMBER 31, 2004 (in thousands)
2004 2003 2002 -------- -------- ------- Revenues: Interest, dividend and other income $ 7,661 $ 11,894 $21,490 Net gain on investment transactions 2,392 96,748 48,132 -------- -------- ------- Total revenues 10,053 108,642 69,622 -------- -------- ------- Costs and Expenses: Interest expense 2,618 2,660 2,556 General and administrative 40,215 34,770 25,593 -------- -------- ------- Total costs and expenses 42,833 37,430 28,149 -------- -------- ------- Operating (loss) profit (32,780) 71,212 41,473 Equity in earnings of consolidated subsidiaries 202,907 174,088 13,495 -------- -------- ------- Earnings from continuing operations, before income taxes 170,127 245,300 54,968 Income taxes 52,179 79,112 1,583 -------- -------- ------- Earnings from continuing operations 117,948 166,188 53,385 (Loss) earnings from discontinued operations (including loss on disposal of $1,950 in 2004) (1,033) (4,933) 2,436 Income taxes (benefit) (781) (1,123) 1,008 -------- -------- ------- (Loss) earnings from discontinued operations (252) (3,810) 1,428 -------- -------- ------- Net earnings $117,696 $162,378 $54,813 ======== ======== =======
See accompanying Notes to Condensed Financial Statements. SCHEDULE II ALLEGHANY CORPORATION CONDENSED STATEMENTS OF CASH FLOWS THREE YEARS ENDED DECEMBER 31, 2004 (in thousands)
2004 2003 2002 --------- --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES Earnings from continuing operations $ 117,948 $ 166,188 $ 53,385 Adjustments to reconcile earnings to cash provided by (used in) operations: Equity in undistributed net (earnings) losses of consolidated subsidiaries (134,129) (114,077) 9,717 Capital contributions to consolidated subsidiaries (20,547) (366,747) (17,776) Distributions from consolidated subsidiaries 8,459 58,217 248,220 Depreciation and amortization 1,165 743 47 Net gain on investment transactions and sales of subsidiaries (2,392) (96,748) (48,132) Tax benefit on stock options exercised 1,317 4,267 1,188 Decrease in accounts receivable (205) 389 64 Increase in notes receivable -- -- (140) Decrease (increase) in other assets (1,589) (133) 2,094 Increase (decrease) in other liabilities and taxes payable (11,136) 21,352 (253,020) --------- --------- --------- Net adjustments (159,057) (492,737) (57,738) --------- --------- --------- Net cash (used in) provided by operations (41,109) (326,549) (4,353) --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of investments (16,499) (55,930) (712,771) Sales of investments 5,008 334,061 375,396 Purchases of property and equipment (76) (36) (100) Net change in short-term investments 932 (11,803) 585,427 Proceeds from the sale of subsidiaries,net of cash disposed 53,403 -- -- Acquisition of subsidiaries, net of cash acquired -- -- (221,056) Other, net (677) 66,016 -- --------- --------- --------- Net cash provided by investing activities 42,091 332,308 26,896 --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Treasury stock acquisitions -- (287) (28,731) Net cash provided to discontinued operations (2,230) -- -- Other, net 1,367 (6,235) 8,175 --------- --------- --------- Net cash used in financing activities (863) (6,522) (20,556) --------- --------- --------- Net (decrease) increase in cash 119 (763) 1,987 Cash at beginning of year 1,950 2,713 726 --------- --------- --------- Cash at end of year $ 2,069 $ 1,950 $ 2,713 ========= ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the year for: Interest $ -- $ 1,967 $ 1,912 Income taxes $ 105,001 $ 10,244 $ 45,504
See accompanying Notes to Condensed Financial Statements. SCHEDULE II ALLEGHANY CORPORATION NOTES TO CONDENSED FINANCIAL STATEMENTS (in thousands) 1. Investment in Consolidated Subsidiaries. Reference is made to Note 1 of the Notes to Consolidated Financial Statements incorporated herein by reference. 2. Long-Term Debt. Reference is made to Note 8 of the Notes to Consolidated Financial Statements incorporated herein by reference for information regarding the significant provisions of the revolving credit loan agreement of Alleghany. Included in long-term debt in the accompanying condensed balance sheets is $19,123 in 2004 and 2003 of inter-company notes payable to Alleghany Funding. 3. Income taxes. Reference is made to Note 9 of the Notes to Consolidated Financial Statements incorporated herein by reference. 4. Commitments and Contingencies. Reference is made to Note 15 of the Notes to Consolidated Financial Statements incorporated herein by reference. 5. Stockholders' Equity. Reference is made to Note 10 of the Notes to Consolidated Financial Statements incorporated herein by reference with respect to stockholders' equity and surplus available for dividend payments to Alleghany from its subsidiaries. SCHEDULE III ALLEGHANY CORPORATION AND SUBSIDIARIES SUPPLEMENTARY INSURANCE INFORMATION (IN THOUSANDS)
AT DECEMBER 31, FOR THE YEAR ENDED DECEMBER 31, ---------------------------------------------- ---------------------------------- FUTURE POLICY OTHER BENEFITS, BENEFITS, POLICY CLAIMS, DEFERRED LOSSES, CLAIMS LOSSES POLICY CLAIMS GROSS AND NET NET AND ACQUISITION AND LOSS UNEARNED BENEFITS EARNED INVESTMENT SETTLEMENT YEAR LINE OF BUSINESS COSTS EXPENSES PREMIUMS PAYABLE PREMIUMS INCOME* EXPENSES - ---- ---------------- ----------- ---------- -------- -------- -------- ---------- ---------- 2004 Property and Casualty Insurance $56,165 $1,232,337 $751,131 $0 $805,417 $127,678 $540,569 ------- ---------- -------- --- -------- -------- -------- 2003 Property and Casualty Insurance $47,282 $ 437,994 $644,068 $0 $430,914 $ 80,617 $250,202 ------- ---------- -------- --- -------- -------- -------- 2002 Property and Casualty Insurance $22,547 $ 258,471 $ 64,115 $0 $125,649 $ 2,442 $100,508 ------- ---------- -------- --- -------- -------- -------- FOR THE YEAR ENDED DECEMBER 31, ------------------------------------------------- AMORTIZATION OF DEFERRED COMMISSIONS POLICY OTHER AND NET ACQUISITION OPERATING BROKERAGE PREMIUMS YEAR LINE OF BUSINESS COSTS EXPENSES EXPENSES WRITTEN - ---- ---------------- ------------ --------- ----------- -------- 2004 Property and Casualty Insurance $62,190 $79,308 $77,238 $857,195 ------- ------- ------- -------- 2003 Property and Casualty InsurancE $43,035 $14,346 $69,154 $782,475 ------- ------- ------- -------- 2002 Property and Casualty Insurance $ 6,229 $12,377 $29,100 $131,524 ------- ------- ------- --------
* Includes net gain on investment transactions. SCHEDULE IV ALLEGHANY CORPORATION AND SUBSIDIARIES REINSURANCE THREE YEARS ENDED DECEMBER 31, 2004 (in thousands)
PERCENTAGE CEDED TO ASSUMED OF AMOUNT GROSS OTHER FROM OTHER NET ASSUMED LINE OF BUSINESS AMOUNT COMPANIES COMPANIES AMOUNT TO NET - ---------------- ---------- --------- ---------- -------- ---------- Property and casualty $1,291,242 $585,818 $ 99,993 $805,417 12.4% ---------- -------- -------- -------- ---- Property and casualty $ 262,045 $ 95,299 $264,168 $430,914 61.3% ---------- -------- -------- -------- ---- Property and casualty $ 140,340 $ 16,716 $ 2,025 $125,649 1.6% ---------- -------- -------- -------- ----
SCHEDULE V ALLEGHANY CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS (in thousands)
Charged to Charged to Balance at costs and other Deductions Balance at YEAR Description January 1, expenses accounts describe December 31, - ---- --------------------------- ---------- ---------- ---------- ---------- ------------ 2004 Allowance for uncollectible reinsurance recoverables $ -- -- -- -- $ -- --- --- --- --- --- Allowance for uncollectible premiums receivable $659 (81) -- -- $578 --- --- --- --- --- 2003 Allowance for uncollectible reinsurance recoverables $ -- -- -- -- $ -- --- --- --- --- --- Allowance for uncollectible premiums receivable $618 41 -- -- $659 --- --- --- --- --- 2002 Allowance for uncollectible reinsurance recoverables $ -- -- -- -- $ -- --- --- --- --- --- Allowance for uncollectible premiums receivable $ -- 618 -- -- $618 --- --- --- --- ---
SCHEDULE VI ALLEGHANY CORPORATION AND SUBSIDIARIES SUPPLEMENTAL INFORMATION CONCERNING INSURANCE OPERATIONS (in thousands)
AT DECEMBER 31, ------------------------------------------------- DISCOUNT, IF ANY, RESERVES DEDUCTED FOR IN RESERVES UNPAID FOR UNPAID FOR THE YEAR ENDED DECEMBER 31, DEFERRED CLAIMS CLAIMS ------------------------------- POLICY AND CLAIM AND CLAIM GROSS NET NET ACQUISITION ADJUSTMENT ADJUSTMENT UNEARNED EARNED INVESTMENT YEAR LINE OF BUSINESS COSTS EXPENSES EXPENSES PREMIUMS PREMIUMS INCOME * - ---- ---------------- ----------- ---------- ----------- -------- -------- ---------- 2004 Property and Casualty $56,165 $1,232,337 $0 $751,131 $805,417 $127,678 ------- ---------- --- -------- -------- -------- 2003 Property and Casualty $47,282 $ 437,994 $0 $644,068 $430,914 $ 80,617 ------- ---------- --- -------- -------- -------- 2002 Property and Casualty $22,547 $ 258,471 $0 $ 64,115 $125,649 $ 2,442 ------- ---------- --- -------- -------- -------- FOR THE YEAR ENDED DECEMBER 31, ----------------------------------------------------------- CLAIMS AND CLAIM ADJUSTMENT EXPENSES INCURRED RELATED TO AMORTIZATION ------------------- OF DEFERRED PAID CLAIMS (1) (2) POLICY AND CLAIM NET CURRENT PRIOR ACQUISITION ADJUSTMENT PREMIUMS YEAR LINE OF BUSINESS YEAR YEAR COSTS EXPENSES WRITTEN - ---- ---------------- -------- -------- ------------ ----------- -------- 2004 Property and Casualty $547,868 ($7,299) $62,190 $175,611 $857,195 -------- -------- ------- -------- -------- 2003 Property and Casualty $229,519 $ 20,683 $43,035 $ 87,518 $782,475 -------- -------- ------- -------- -------- 2002 Property and Casualty $ 82,639 $ 17,869 $ 6,229 $ 73,979 $131,524 -------- -------- ------- -------- --------
* Includes net gain on Investment transactions. EX-10.05 2 y06166exv10w05.txt AMENDED AND RESTATED RETIREMENT PLAN Exhibit 10.05 ALLEGHANY CORPORATION RETIREMENT PLAN (As Amended and Restated as of July 1, 2004) This document sets forth the Alleghany Corporation Retirement Plan, as amended and restated as of July 1, 2004. The Plan, as so amended and restated, is intended to be a plan which is unfunded and is maintained by Alleghany Corporation primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees both within the meaning, and for the purposes of, Sections 201(2), 301(a)(3) and 401(a)(1) of the Employee Retirement Income Security Act of 1974, as amended. The rights under the Plan of any person who retired or otherwise terminated employment with Alleghany Corporation before the effective date of a particular amendment shall be determined solely under the terms of the Plan as in effect on the date of such retirement or other termination of employment, without regard to such amendment, except that such person's benefit under the Plan may be paid at such time, and in such form, as may be permitted under the terms of the Plan as in effect on the date as of which the payment of such person's benefit commences. ARTICLE I DEFINITIONS 1.01 "Actuarial Equivalent" means with respect to a benefit, an equivalent amount or amounts computed on the basis of the factors or rates contained in Exhibit I attached hereto. 1.02 "Applicable Exclusion Ratio" means the exclusion ratio provided for in Section 72 of the Code and the Treasury Regulations thereunder which is applicable to the annual retirement benefit payable to a Participant as an annuity for his life at the Participant's Early, Normal or Late Retirement Date, as the case may be. 1.03 "Average Salary" means, with respect to any Participant, the sum of (i) the annual average of his Base Compensation for the three consecutive calendar years, in the period of ten calendar years that ends with the calendar year in which he has a Termination of Employment, which results in the highest such average, and (ii) one-half (1/2) of the average of his Incentive Compensation for the five consecutive calendar years, in the period of ten calendar years that ends with the calendar year in which he has Termination of Employment, which results in the highest such average. If the Participant was not employed by the Company for three consecutive calendar years or five consecutive calendar years, as the case may be, then his Average Salary shall be computed by using the annual average of his Base Compensation or one-half of the average of his Incentive Compensation, as applicable, for all full calendar years during which he was so employed, or if none, then for his entire period of such employment. 1.04 "Base Compensation" means the base salary earned by an Employee for the relevant period (whether or not such compensation is currently payable or deferred) for his services as such, which base salary shall not include (by way of illustration and not limitation) any non-cash compensation, annual incentive bonuses, long term incentive bonuses, restricted stock or other extraordinary compensation, payments, allowances or reimbursements. An Employee shall be treated as earning Base Compensation, for the period which begins on the date on which he becomes is Totally Disabled, and which ends on the date of his Termination of Employment, in an amount which is equal to his annual rate of base salary immediately prior to the date on which he becomes Totally Disabled. Such amount shall be adjusted on the first day of each Plan Year included in such period to take into account the percentage increase, if any, in the CPIU over the previous Plan Year. The "CPIU" is the U.S. City Average All Items Consumer Price Index for all Urban Consumers, published by the U.S. Department of Labor, Bureau of Labor Statistics, or any successor index designated by the Department of Labor. 1.05 "Beneficiary" means the person or persons last designated by a Participant to receive benefits under Article VI following the Participant's death. If all the persons so designated are individuals and if there is no such individual living at the death of the Participant, or if no such person has been designated, then the Participant's Beneficiary shall be his estate. 1.06 "Benefit Accrual Service" means the number of years determined under Section 4.02. In general, Benefit Accrual Service is used to determine the amount of the annual retirement benefit to which a Participant is entitled pursuant to Article V. 1.07 "Board" means the Board of Directors of the Company or the Executive Committee thereof. 1.08 "Code" means the Internal Revenue Code of 1986, as amended. 1.09 "Company" means Alleghany Corporation excluding any operating divisions of Alleghany Corporation. 1.10 "Component Members" means (a) the Company; (b) any corporation which is a member of a controlled group of corporations (within the meaning of Section 1563(a) of the Code, determined without regard to Sections 1563(a)(4) and (e)(3)(C), provided such group includes the Company; (c) any trade or business (whether or not incorporated) which is controlled by, or under common control with, the Company under the regulations promulgated pursuant to Section 210(b) or (c) of ERISA; and (d) any other entity (whether or not incorporated) designated as a Component Member by the Board. 1.11 "Early Retirement Date" means, with respect to any Participant, the first day of the calendar month coinciding with or next following the latest of (a) the date on which he incurs a Termination of Employment, (b) the date on which he attains age 55, or (c) the date (not later than his Normal Retirement Date) elected by him (where such election is made in accordance with the rules in Section 6.09). 1.12 "Effective Date" means January 1, 1989. 2 1.13 "Employee" means any individual in the employ of the Company. 1.14 "Employment Commencement Date" means the first day on which an Employee performs an Hour of Service with the Company. 1.15 "ERISA" means the Employee Retirement Income Security Act of 1974 and regulations thereunder, as from time to time amended and in effect. 1.16 "Gross-Up Payment" means a distribution pursuant to Article VII in respect of the Income Taxes which may be imposed upon a Participant by reason of an Income Amount. 1.17 "Hour of Service" (a) An "Hour of Service" means each hour for which either: (i) An Employee is directly or indirectly paid or entitled to payment by a Component Member for the performance of duties; (ii) Back pay, irrespective of mitigation of damages, has been awarded to him or agreed to be paid to him by a Component Member; or (iii) Each hour (but not in excess of 501 hours in any continuous period) for which he is directly or indirectly paid or entitled to payment by a Component Member for reasons (such as vacation, sickness or disability) other than the performance of duties. (b) Hours of Service shall be credited whether occurring before or after the Effective Date, except that such hours shall not be credited if the employer in question was not a Component Member at the time they would otherwise be counted. Hours of Service shall be determined pursuant to the rules promulgated by the Plan Administrator, and in the absence of any inconsistent rules, shall be determined in accordance with Department of Labor Regulations 2530.200b-2 and -3. (c) An Employee who becomes Totally Disabled shall be credited, for the period which begins on the date on which he becomes Totally Disabled, and which ends on the date of his Termination of Employment, with Hours of Service at the rate with which he was being credited with Hours of Service immediately before such period began. 1.18 "Incentive Compensation" means the amount of the cash bonus payable to an Employee in respect of the relevant period (whether or not such amount is currently paid or deferred) under the Company's Management Incentive Plan (or any plan adopted by the Board in replacement of such plan). An Employee shall be treated as earning Incentive Compensation, for the period which begins with the calendar year during which he becomes Totally Disabled, and which ends with 3 the calendar year in which his Termination of Employment occurs (the "Disability Period"), in an amount which is equal to his average annual rate of Incentive Compensation. For this purpose, an Employee's average annual rate of Incentive Compensation shall mean the average of the Employee's Incentive Compensation for (a) the five consecutive calendar years in the period of the ten calendar years which immediately precedes the start of the Disability Period and which results in the highest such average, or (b) for the calendar years during which he was employed by the Company, if he had not been employed by the Company for at least 5 consecutive calendar years. Such average annual rate of Incentive Compensation shall be adjusted, for each calendar year in the Disability Period, to take into account the percentage increase, if any, in the CPIU (as defined in Section 1.04) over the previous calendar year. 1.19 "Income Taxes" means all Federal, state and local income or employment taxes which may be imposed upon a Participant by reason of participation in the Plan, including by reason of any distribution of retirement benefits or Gross-Up Payments provided under the Plan. 1.20 "Income Amount" means that amount which is currently includable under the Code (or applicable State or local tax law) in gross income during any Plan Year by reason of the participation of the Participant in the Plan or any distributions of retirement benefits under the Plan (not including any Gross-Up Payments). 1.21 "Late Retirement Date" means the first day of the calendar month coinciding with or next following the date on which a Participant incurs a Termination of Employment after his Normal Retirement Date. 1.22 "Normal Retirement Date" means the first day of the calendar month coinciding with or next following the date on which a Participant attains age 65. 1.23 "Participant" means an Employee who has been selected to participate in the Plan as provided in Article II and who has any accrued retirement benefits under the Plan which have not been distributed in full to him (or his Beneficiary). 1.24 "Plan" means the plan set forth herein as modified or amended from time to time. 1.25 "Plan Administrator" means the person serving from time to time as the Treasurer of the Company, or if no person is so serving at the time of reference, then the Company. 1.26 "Plan Year" means a calendar year. 1.27 "Prior Plan" means the Retirement Plan of Alleghany Corporation in effect on December 31, 1988 and any plan designated therein as a "Prior Plan." 1.28 "Prior Plan Accrued Benefit" means that benefit payable annually in the form of a straight life annuity, commencing at age 65, to a Participant by reason of an accrued benefit under the Prior Plan in an amount set forth opposite his name on Exhibit II attached hereto. 4 1.29 "Termination of Employment" means, and an Employee shall be treated as having incurred, a termination of employment as of the first date on which he is no longer in the employ of the Company or any other Component Member or on the date he ceases for any reason to be an officer of the Company, as provided in the By-Laws of the Company. A Participant who becomes Totally Disabled shall be treated as having incurred a Termination of Employment on the earliest of the date on which he ceases to be Totally Disabled, his Normal Retirement Date or the date of his death. 1.30 "Totally Disabled" means a physical and/or mental incapacity of such condition that it qualifies an individual (after the waiting period required thereunder) for benefits under the Alleghany Corporation Group Long-Term Disability Plan, as in effect from time to time. ARTICLE II PARTICIPATION 2.01 Participation. Each Employee who has been elected by the Board to the position of an officer of the Company, as provided in the By-Laws of the Company and who is designated by the Board to participate in the Plan shall become a Participant effective on the later of the date he completes his first Hour of Service or the date specified by the Board. 2.02 Re-Employment of Former Participant. If a Participant who incurred a Termination of Employment shall again become an Employee and he is again designated by the Board to participate in the Plan, such Employee shall again become a Participant, effective on the later of the date he completes his first Hour of Service following his re-employment or the date specified by the Board. A former Participant who again becomes an Employee, but is not designated by the Board to participate in the Plan, shall not again become a Participant and his Benefit Accrual Service and Compensation during his subsequent period of employment shall be disregarded in calculating his benefits under this Plan. ARTICLE III VESTING 3.01 Vesting at Age 55. A Participant's right to his retirement benefit as determined pursuant to Article V shall be nonforfeitable upon his attainment of age 55 while he is employed by a Component Member. 3.02 Vesting before Age 55. A Participant who has not attained age 55 has a nonforfeitable right to 100 percent of his retirement benefit as determined pursuant to Article V when he has completed 5 Years of Vesting Service, provided, however, that: (a) Such benefit shall be forfeited (except as provided in Article VI) in the event of his death; and 5 (b) Payment of such benefit may be suspended for such period as the Employee is employed, subsequent to commencement of payment thereof, by a Component Member. 3.03 Year of Vesting Service. For purposes of this Article III, a Year of Vesting Service means each Plan Year (whether before or after the Effective Date) during which the Employee has completed 1,000 Hours of Service. Years of Vesting Service shall be based only upon an Employee's most recent period of continuous employment with Component Members. 3.04 Termination before Vesting. A Participant who terminates his employment with a Component Member prior to age 55 and before he has completed 5 Years of Vesting Service shall not be entitled to any benefits under this Plan unless he is thereafter re-employed by a Component Member. 3.05 Special Grants of Vesting Service. The Board by resolution may grant Vesting Service to a Participant for such period prior to the Employee's current employment with a Component Member as the Board shall determine, which grant for such period shall be set forth opposite his name on Exhibit III attached hereto. ARTICLE IV ACCRUAL OF BENEFITS 4.01 Service Required for Benefits. The amount of any retirement benefit payable to a Participant or former Participant following his Termination of Employment shall be based on his Benefit Accrual Service and his Average Salary. 4.02 Benefit Accrual Service. Benefit Accrual Service shall be determined as follows: (a) For Plan Years beginning prior to the Effective Date, a Participant shall be credited with that period of Benefit Accrual Service which is opposite his name as set forth on Exhibit II attached hereto; (b) For any Plan Year beginning on or after the Effective Date, a Participant shall be credited with one year of Benefit Accrual Service if he has 1,000 Hours of Service with the Company for that year, including any such hours occurring after his Normal Retirement Date. If a Participant was not vested in any of his retirement benefits under the Plan at the time of his Termination of Employment, then if he again becomes an Employee, his Benefit Accrual Service shall be based only upon his most recent period of continuous employment with the Company. 4.03 Special Grants of Benefit Accrual Service. The Board by resolution may grant Benefit Accrual Service to a Participant for such period prior to the Participant's current employment with a Component Member as the Board shall determine, which grant for such period shall be set forth opposite his name on Exhibit III attached hereto. 6 ARTICLE V RETIREMENT BENEFITS 5.01 Retirement Benefit at Normal Retirement Date. The annual retirement benefit of a Participant, in the form of an annuity for his life payable monthly beginning on his Normal Retirement Date, shall equal the difference between: (a) the product of (i) 52.7625% of the Participant's Average Salary reduced by 33.5% of the amount the Participant would receive as a primary benefit under the Social Security Act as in effect on the date of calculation if he continued to work until his Normal Retirement Date with wages, for purposes of that Act, equal to his most recent rate of Base Compensation; times (ii) a fraction, not greater than one, the numerator of which is the number of his years of Benefit Accrual Service and the denominator of which is 15; and (b) 67% of his Prior Plan Accrued Benefit. 5.02 Retirement Benefit at Late Retirement Date. The annual retirement benefit of a Participant who terminates employment with a Component Member after his Normal Retirement Date, in the form of an annuity for his life payable monthly beginning on his Late Retirement Date, shall be equal to the annual benefit determined in accordance with the formula in Section 5.01 based on the Participant's Prior Plan Accrued Benefit calculated at his Normal Retirement Date and his years of Benefit Accrual Service, Social Security benefit and Average Salary calculated as of his Late Retirement Date, then increased by the percentage which the annuity factor derived from the actuarial assumptions set forth in Section 1 in Exhibit I at age 65 is of the annuity factor derived from such actuarial assumptions at his age at his Late Retirement Date; provided, however, that for any Participant who had attained his Normal Retirement Date on or before March 31, 1995, his retirement benefit as of his Late Retirement Date shall equal the product of: (a) the Actuarial Equivalent, determined at the earlier of (i) March 31, 1995 or (ii) his Late Retirement Date, of the benefit determined in accordance with the formula in Section 5.01 (a) on the Effective Date, minus 67% of the Actuarial Equivalent of his Prior Plan Accrued Benefit payable at the earlier of (i) March 31, 1995 or (ii) his Late Retirement Date, times (b) the percentage which the annuity factor derived from the actuarial assumptions set forth in Section 1 in Exhibit I based upon his age on March 31, 1995, bears to the annuity factor so derived at his age at his Late Retirement Date. 5.03 Retirement Benefit before Normal Retirement Date. The annual retirement benefit of a Participant who terminated his employment with a right to a nonforfeitable retirement benefit and who has attained age 55, in the form of an annuity for his life payable monthly beginning on his Early Retirement Date, shall be the Actuarial Equivalent of the annual benefit determined under Section 5.01. 5.04 Social Security Calculations and Reduction. With respect to a Participant (or Beneficiary) who is receiving a benefit under the Plan or a Participant who has a Termination of Employment with a vested right to such a benefit, such benefit shall not be reduced by any 7 increase in the level of benefits payable under Title II of the Social Security Act or in the wage base under Title 11 of the Social Security Act which occurs subsequent to the commencement of benefit payments or Termination of Employment. For purposes of all calculations of Social Security benefits under the Plan, all earnings with Component Members shall be included and the Participant's earnings in calendar years preceding the earliest complete calendar year of employment with Component Members shall be deemed to reflect a progression equivalent to that used for indexing earnings under the provisions of the Social Security Act. 5.05 Reduction for Prior Distributions. In the case of any Participant identified on Exhibit IV who received a prior distribution on account of all or any part of the Participant's then accrued retirement benefits under the Plan pursuant to Section 6.14, the retirement benefits calculated under Section 5.01, 5.02 or 5.03, as the case maybe, and subsequently payable to such Participant shall be reduced. In the case of a Participant identified on Exhibit IV as having received a lump sum distribution, the annual retirement benefit determined under Section 5.01, 5.02 or 5.03, as the case maybe, of the Participant shall be reduced (but not below zero) by the Actuarial Equivalent of the annual annuity which would be payable monthly for the Participant's life beginning on his Early, Normal or Late Retirement Date, as the case may be, based upon (i) the lump sum amount identified in Exhibit IV increased by (ii) the Interest Accumulation Factor in Exhibit I from September 15, 2004 until the Participant's Early, Normal or Late Retirement Date, as the case may be. In the case of a Participant identified on Exhibit IV as having received a distribution of an annuity contract, the annual retirement benefit determined under Section 5.01, 5.02 or 5.03, as the case may be, of the Participant shall be reduced (but not below zero) by (i) the amount of the annual annuity that would be payable monthly to the Participant for his life only identified in Exhibit IV plus (ii) the Actuarial Equivalent of the annual amount of the annuity that would be payable monthly to the Participant for his life beginning on his Early, Normal or Late Retirement Date, as the case may be, based upon the sum of the monthly life annuity payments received by the Participant under the annuity contract from October 1, 2004 until the Participant's Early, Normal or Late Retirement Date, as the case may be. ARTICLE VI FORMS OF RETIREMENT BENEFITS 6.01 Calculation of Amount of Benefit Payments. All forms of retirement benefit distribution under this Article VI shall be the Actuarial Equivalent of the actual retirement benefit payable, in the form of an annuity for the Participant's life. 6.02 Automatic Forms of Benefit. (a) Unless he shall elect to the contrary, a Participant who is married on the first day on which an amount is payable in accordance with Section 6.11 (the "Annuity Starting Date") shall receive a retirement benefit for his life payable monthly with a survivor annuity payable for the life of his spouse to whom he was married on the 8 Annuity Starting Date which is equal to 50% of the benefit payable during the Participant's life. (b) Unless he shall elect to the contrary, a Participant who is not married on the Annuity Starting Date shall receive for his life the retirement benefit as provided in Section 5.01, 5.02, or 5.03, as the case may be. 6.03 Retirement Death Benefit for Spouse. (a) Prior to Normal Retirement Date. If a Participant (i) has a nonforfeitable retirement benefit under Article III, (ii) dies before the earlier of (x) his Annuity Starting Date and (y) his Normal Retirement Date, and (iii) has a surviving spouse, then his surviving spouse shall receive a Pre-Normal Retirement Survivor Annuity (as defined below). For purposes of this Article, a Pre-Normal Retirement Survivor Annuity shall mean an annuity for the life of the surviving spouse of the Participant where the amount of the retirement benefit to the surviving spouse shall be the same as the amount of the retirement benefit that would have been paid to the spouse under Section 6.02(a) if (i) in the case of a Participant who dies after attaining age 55, the Participant had retired with an immediate joint and 50% survivor annuity on the day before his or her death; or (ii) in the case of a Participant who dies on or before attaining age 55, the Participant had separated from service on the date of his or her death, survived until age 55, and retired at that time with a joint and 50% survivor annuity as determined under Section 6.02(a). (b) After Normal Retirement Date. If a Participant (i) dies after attaining his Normal Retirement Date and (ii) has a surviving spouse, then his surviving spouse shall receive a Post-Normal Retirement Survivor Annuity (as defined below). For purposes of this Article, a Post-Normal Retirement Survivor Annuity shall mean an annuity for the life of the surviving spouse of the Participant where the amount of the retirement benefit to the surviving spouse shall be the same as the amount of the retirement benefit that would have been paid to the spouse under Section 6.06 if the Participant had retired with an immediate joint and 100% survivor annuity on the day before his or her death. 6.04 Single Life Option. In lieu of the form of benefit provided for by Section 6.02(a), a married Participant may elect to receive the single life option, under which the Participant's retirement benefit shall consist of monthly payments which shall continue for as long as the Participant lives after retirement. 6.05 Period Certain Option. In lieu of the form of benefit provided for by Section 6.02, a Participant may elect to receive the period certain option, under which the Participant shall 9 receive a retirement benefit payable in equal monthly installments during his lifetime and ending with the payment due on the first day of the month in which the Participant's death occurs, but with the provision that not less than 120 monthly installments shall be made to him or to his Beneficiary or alternate Beneficiary. If such Participant and Beneficiaries all die before the 120 monthly payments have been made, the commuted value of the balance shall be paid in a lump sum to the estate of the last to survive of the Participant and his Beneficiaries. 6.06 Joint and Survivor Option. In lieu of the form of benefit provided for by Section 6.02, a Participant who so elects shall receive a monthly retirement benefit for his life with a survivor annuity for the life of his Beneficiary which is equal to 50% or 100% of the monthly benefit for the Participant's life. 6.07 Lump Sum Option. In lieu of the form of benefit provided for by Section 6.02, a Participant who so elects shall receive a lump sum distribution of the retirement benefit to which he would be entitled. 6.08 Cash-out of Benefits. (a) If a Participant ceases to be an Employee prior to his Early Retirement Date and has a nonforfeitable right to his retirement benefit under Article III, such Participant may elect under this Section 6.08 to receive, in lieu of the periodic benefit payments as provided in this Article VI commencing at his Early or Normal Retirement Date, a lump sum which is the Actuarial Equivalent of the retirement benefit to which he would become entitled at age 65. (b) A former Participant who has received a lump sum payment under Section 6.08 or Section 6.12 (but not Section 6.14) and later becomes re-employed by the Company and becomes a Participant again, upon his subsequent retirement shall be entitled to a benefit based on the total amount of his Benefit Accrual Service and his Average Salary at the time he again terminates his employment with Component Members but reduced by the then Actuarial Equivalent of the lump sum previously distributed to him. 6.09 Elections. All elections under this Article VI (other than an election made pursuant to Section 6.14), including but not limited to, any election made under Section 6.08, must be made by the later of (i) September 30, 2004 or (ii) the date that is thirty (30) days after the date the individual is designated by the Board to participate in the Plan or becomes a Participant, whichever is later. A Participant may make a new election (which shall revoke all prior elections), but no such new election shall be given effect (and, instead such prior election shall be given effect) unless such new election is filed with the Plan Administrator more than one (1) year prior to the earlier to occur of (i) the commencement date of the payment of the Participant's retirement benefit under the prior election or (ii) the commencement date of the payment of the Participant's retirement benefit under the new election. Each election shall be in writing on a form provided by the Plan Administrator, and shall specify the form of benefit the 10 Participant elects and the commencement date of the payment of such benefit. There shall be no limit on the number of times a Participant may make or revoke an election. 6.10 Death Benefits. No benefits shall be payable under the Plan after death unless specifically provided for in the Plan. 6.11 Commencement of Benefits. Payment of a Participant's retirement benefit shall commence on the date that the Participant elects, but in no event may such date precede the date of the Participant's Termination of Employment . In the absence of a Participant's effective election, payment of a Participant's retirement benefit shall commence on the later of (x) the first day of the calendar month coinciding with or next following the date the Participant has a Termination of Employment or (y) the date the Participant attains his Normal Retirement Date. In the case of a Participant who dies before his Annuity Starting Date and who has a surviving spouse who is entitled to receive a Pre- or Post-Normal Retirement Survivor Annuity, such Pre- or Post-Normal Retirement Survivor Annuity shall commence (unless the Participant had elected prior to his death or his surviving spouse elects otherwise after his death pursuant to Section 6.09, applied as if the surviving spouse were the Participant), in the case of a Participant who dies after attaining age 55, as of the first day of the month coinciding with or next following the Participant's death, or, in the case of a Participant who dies on or before attaining age 55, the first day of the month coinciding with or next following the date the Participant would have attained age 55. 6.12 Small Benefits. If any monthly payment that would otherwise be made to any person under the Plan is less than $1,000, then, if the Plan Administrator shall so direct, the aggregate of the amounts which shall be paid to such person in any year shall be paid in quarterly, semiannual or annual installments. If the present value of the nonforfeitable retirement benefit of any Participant on the date of his Termination of Employment or the Survivor Annuity payable to the surviving spouse of a Participant on the date of his death, in either case, does not exceed $50,000, then an amount equal to such present value shall be paid to him in a lump sum in lieu of any benefits to which he may be entitled to under Article V. 6.13 Termination of Benefit. If the period of any retirement benefit is measured by the life of an individual, the last payment shall be the last payment due prior to the death of the individual. 6.14 Special In-Service Distributions. Each Participant identified on Exhibit IV shall have the right to elect to receive in respect of all or part of such Participant's then accrued benefit under the Plan the lump sum amount identified in Exhibit IV identified opposite such Participant's name or an annuity contract issued by an insurance company based upon the amount of the immediate pay annual annuity that would be payable monthly to the Participant for his life only identified in Exhibit IV opposite such Participant's name; provided, that if such Participant is married, his spouse consents to the form and time of such payment. A Participant's election to receive such distribution shall be in such form, and contain such provisions, as the Plan Administrator shall prescribe. 11 6.15 Method of Payment. The Plan Administrator shall, in its sole discretion, decide whether retirement benefits payable other than as a lump sum are to be paid directly by the Company or by means of annuity contracts purchased from one or more insurance companies. Such decision may be different as between different Participants. ARTICLE VII GROSS-UP PAYMENTS 7.01 Gross-Up Payment. The retirement benefits payable under the Plan are intended to represent a net-after tax amount. Therefore, at the time of each distribution to a Participant of retirement benefits under the Plan, there shall also be distributed to such Participant an amount equal to the sum necessary to reimburse the Participant for the entire amount of Income Taxes incurred in respect of the inclusion in the Participant's gross income for such Plan Year of (i) the Income Amount and (ii) the Gross-Up Payment. In addition, if a Participant receives his benefits in the form of an annuity contract issued by an insurance company and if the number of annuity payments received by the Participant exceeds the number of payments taken into account in calculating his Applicable Exclusion Ratio, then thereafter there shall also be distributed each Plan Year to such Participant an amount equal to the sum necessary to reimburse the Participant for the entire amount of Income Taxes incurred in respect of the inclusion in the Participant's gross income of (i) the amount of the annuity payments thereafter received in such Plan Year times such Applicable Exclusion Ratio plus (ii) the Gross-Up Payment. 7.02 Calculation of Gross-Up Payment. In calculating the amount of any Gross-Up Payments to a Participant, the Plan Administrator shall assume that the Federal income tax rate applicable to such Participant is the highest marginal rate specified in Section 1(a) of the Code that would apply to such Participant if his compensation income from the Company (without giving regard to any deferred compensation arrangement) and any distribution of retirement benefits from the Plan ("Alleghany Income") were his only source of income. The Plan Administrator shall further assume that any Participant who is subject to state or local income tax in respect of his Alleghany Income is taxable at the highest marginal rate that would apply if his Alleghany Income were his only source of income in each such state or local jurisdiction in which he is taxable for such year on his Alleghany Income; provided that the Plan Administrator shall give effect to any Federal income tax deductions available with respect to such state and local income taxes. In determining the amount of any employment taxes, the Plan Administrator shall take into account the actual state of facts which exists with respect to such Participant's Alleghany Income. The sum of the federal tax rate, the tax-effected state and local income tax rates and the appropriate rate of employment taxes shall be known as the "Blended Tax Rate". Notwithstanding the foregoing provisions of this Section 7.02, if a Participant demonstrates to the satisfaction of the Plan Administrator (by providing a copy of such Participant's income tax return or otherwise) that his actual Blended Tax Rate differs from the Blended Tax Rate determined by the Plan Administrator, the Plan Administrator shall base the computation of the Gross-Up Payment on the actual Blended Tax Rate established by the Participant. 12 7.03 Form and Payment. Gross-Up Payments pursuant to this Article VII shall be made by depositing the same for the benefit of the Participant with the appropriate tax authorities. 7.04 Gross-Up Payments to Surviving Spouses and Beneficiaries. If any Income Amount shall be includable in the gross income of any surviving spouse or Beneficiary following the death of a Participant, then such surviving spouse or Beneficiary also shall be entitled to receive Gross-Up Payments in accordance with the provisions of Section 7.01 to the same extent that Gross-Up Payments would have been made to the Participant. ARTICLE VIII PAYMENTS 8.01 Company Payments. The Company agrees as a contractual obligation with the Participants to pay the retirement and other benefits specified in the Plan, including without limitation, the Gross-Up Payments provided in Article VII. ARTICLE IX PLAN ADMINISTRATION 9.01 Plan Administrator Records. The Plan Administrator shall keep or cause to be kept all data, records and documents relating to the administration of the Plan. 9.02 Employment of Experts. The Plan Administrator may employ or engage such independent actuary, accountant, counsel, other experts or persons as either may deem necessary in connection with discharging their duties under the Plan. 9.03 Payment of Expenses. All expenses incurred in connection with the administration of the Plan, including, but not limited to, the compensation of any actuary, accountant, counsel, other experts or persons who shall be employed by the Plan Administrator in connection with the administration of the Plan shall be paid by the Company. 9.04 Indemnification of Plan Administrator. The Company shall indemnify and hold harmless to the fullest extent permitted by law the Plan Administrator and any Employee of the Company to whom Plan responsibilities are delegated by the Plan Administrator from and against any liabilities, damages, costs and expenses (including attorneys' fees and amounts paid in settlement of any claims approved by the Company) incurred by or asserted against him by reason of his occupying or having occupied positions in connection with the Plan, except that no indemnification shall be provided if the Plan Administrator or any Employee personally profited from any act or transaction in respect of which indemnification is sought. 9.05 Binding Action. To the fullest extent permitted by law, all actions taken and decisions made by the Plan Administrator shall be final, conclusive and binding on all persons having any interest in the Plan or in any benefits payable thereunder. 13 ARTICLE X POWERS AND DUTIES OF PLAN ADMINISTRATOR 10.01 Administration Powers. The Plan Administrator shall have the power to take all action and to make all decisions necessary or proper in order to carry out his duties and responsibilities under the provisions of the Plan, including without limitation, the following: (a) To make and enforce such rules and regulations as he shall deem necessary or proper for the efficient administration of the Plan; (b) To interpret the Plan and its regulations; and (c) To delegate to one or more persons the authority to administer the Plan, with such duties, powers and authority relative to the administration of the Plan as the Plan Administrator shall determine, and in so doing to limit his own duties and responsibilities to the extent specified in such appointment. The Plan Administrator shall report to the Compensation Committee of the Board each year concerning the administration and operation of the Plan. 10.02 Plan Administrator-Claims Review Authority and Procedures. Any claim for benefits or other payments under the Plan shall be determined in accordance with the procedure set forth below. A claim for benefits or other payments may be filed by a Participant, the surviving spouse of a Participant, a Beneficiary of a Participant or the authorized representative of such Participant, surviving spouse or Beneficiary (the "claimant"). (a) Initial Claim Determination. Any claim for benefits or other payments under the Plan shall be made by filing a written statement of such claim with the person or persons designated by the Plan Administrator to process and make initial determinations as to such claims. In the event such claim is denied in whole or in part, such person or persons shall notify the claimant of the denial within 90 days after the date on which the claim was filed. However, if the Plan Administrator determines that special circumstances require an extension of time for deciding the claim, the Plan Administrator shall furnish written notice of the extension to the claimant prior to the expiration of such 90-day period. This notice shall indicate the special circumstances requiring the extension, and the date by which the Plan expects to render the determination on the claim. If an extension is taken, and if the claim is denied in whole or in part, the person or persons who processed and denied the claim shall notify the claimant of the denial within 180 days after the date on which the claim was filed. (b) Initial Notification of Claim Denial. Any notification of a whole or partial denial of a claim shall be in writing. Such notification shall set forth, in a manner calculated to be understood by the claimant: (i) the specific reason or reasons for the denial; 14 (ii) reference to the specific provisions of the Plan on which the denial was based; (iii) a description of any additional material or information necessary for the claimant to perfect the claim, and an explanation of why such material or information is necessary; and (iv) an explanation of the review procedure under subsection (c), including a description of the time limits applicable to such procedure and a statement of the claimant's right to bring a civil action under Section 502(a) of ERISA following an adverse determination of the claim on review. (c) Review Procedure. A claimant whose claim is denied in whole or in part under subsection (a) shall be entitled to have such denial reviewed by the Plan Administrator, by filing a written request for such review with the Plan Administrator within 60 days after his receipt of the notification of the claim denial under subsection (b). The claimant may request and shall be provided, free of charge, reasonable access to, and copies of, all documents, records and other information which is relevant to the claim, and which is in the possession of the Plan Administrator or the Company. The claimant may provide comments, documents, records and other information relating to the claim to the Plan Administrator to consider when reviewing the claim. Upon receipt of a request for a review of a denied claim, the Plan Administrator shall make a full and fair review of the claim. Such review shall take into account all comments, documents, records and other information submitted by the claimant relating to the claim, without regard to whether the same was submitted or considered in the initial claim determination. (d) Decision on Review. The Plan Administrator shall make a decision with respect to such claim, and shall notify the claimant of its decision, within 60 days after its receipt of the claimant's written request for review. However, if the Plan Administrator determines that special circumstances, such as the need to hold a hearing, require an extension of time for deciding the claim, the Plan Administrator shall provide a written notice of the extension to the claimant prior to the expiration of such 60-day period. This notice shall indicate the special circumstances requiring the extension, and the date by which the Plan expects to render the determination on review. If an extension is taken, the Plan Administrator shall notify the claimant of its decision on the claim within 120 days after the date on which the request to review the denial of the claim was filed. However, if the Plan Administrator determines that an extension is needed because the claimant must submit additional information in order for the Plan Administrator to make its determination on the claim, and the Plan Administrator requests such additional information from the claimant in the notification of extension, then the 120-day period for making the determination on review shall be tolled for the period which starts on the date on which such notification is sent to the claimant, and which ends on the date on which the claimant provides such additional information to the Plan Administrator. 15 (e) Notification of Decision on Review. The notification of the Plan Administrator's decision on review shall be in writing. If the claim is denied, the notification shall set forth, in a manner calculated to be understood by the claimant: (i) the specific reason or reasons for the claim denial; (ii) reference to the specific Plan provisions on which the claim denial was based; (iii) a statement that the claimant is entitled to receive, upon request and free of charge, reasonable access to, and copies of, all documents, records and other information which is relevant to the claim, and which is in the possession of the Plan Administrator or the Company; and (iv) a statement of the claimant's right to bring an action with respect to the matter raised in the claim under Section 502(a) of ERISA. The Plan Administrator shall provide the claimant with reasonable access to, and copies of, any documents, records and other information which the claimant is entitled to receive, as indicated in the notification. 10.03 Conflicts of Interest. No person who is an Employee of the Company and who is the Plan Administrator shall participate in the resolution of any question which relates directly or indirectly to him and which, if applied to him, would significantly vary his eligibility for, or the amount of, any benefit payable to him. In cases involving the disqualification under this Section 9.03 of the Plan Administrator, the questions at issue shall be certified to the Board for resolution. ARTICLE XI LIMITATION OF RIGHTS AND OBLIGATIONS 11.01 Plan is Voluntary. Although it is the intention of the Company that the Plan shall be continued, the Plan is entirely voluntary on the part of the Company and the Plan's continuance is not a contractual obligation of the Company. Notwithstanding any termination of the Plan by the Company, the Company agrees as a contractual obligation with the Participants to pay all amounts as shall be necessary to provide the retirement benefits payable and the Gross-Up Payments payable in respect of such retirement benefits under the Plan as of the date of any such termination of the Plan. 11.02 Creation of Certain Employment Rights. The Plan shall be deemed to constitute a contract between the Company and each Participant and is consideration or inducement for the employment of the Participant by the Company. Notwithstanding the foregoing, nothing contained in the Plan shall be deemed (a) to give any person the right to be retained in the service of the Company or (b) to interfere with the right of the Company to discharge any person at any time without regard to the effect which such discharge shall have upon his rights or potential rights, if any, under the Plan. 16 11.03 Distributions Only from the Company. Each Participant and any other person who shall claim any rights under the Plan shall be entitled to look only to the Company for any payment or benefit, and no member of the Board, officer or employee of the Company shall be liable in any manner if the Company shall fail to meet its obligations hereunder. ARTICLE XII AMENDMENT AND TERMINATION 12.01 Amendment. The Board may, at any time, or from time to time, whether upon termination or otherwise, modify or amend the Plan in any manner, whether prospectively or retroactively, in whole or in part, provided, however, that no amendment may reduce the accrued benefit of any Participant or other person or eliminate or modify the obligations of the Company under Section 11.01 hereof. 12.02 Termination. The Board may at any time terminate the Plan, in whole or part, except that the Company's obligation under Section 11.01 hereof shall survive such termination. 12.03 Payment of Benefits upon Termination. Upon termination of the Plan, benefits may be paid directly by the Company or by means of insurance and/or annuity contracts purchased from one or more insurance companies either (a) by payment of the benefits when and as called for under the Plan until such time as all benefits are paid, or (b) by distribution of the Actuarial Equivalent (calculated in accordance with Article VI) of the accrued retirement benefits of each Participant, in cash in one lump sum or (c) by the purchase of annuity contracts of such type as the Plan Administrator shall determine. ARTICLE XIII LIMITATION OF ASSIGNMENT 13.01 Spendthrift Provision. In order that the benefits hereunder shall be fully protected against claims of all sorts, direct or otherwise, none of the benefits provided hereunder to any person shall be assignable or transferable voluntarily, nor shall they be subject to the claims of any creditor whatsoever, nor subject to attachment, garnishment or other legal process by any creditor or to the jurisdiction of any bankruptcy court or any insolvency proceedings by operation of law, or otherwise, and no person shall have any right to alienate, anticipate, pledge, commute, or encumber any of such benefits voluntarily or involuntarily. 13.02 Incompetence of Participant or Beneficiary. If the Plan Administrator receives evidence satisfactory to him that a person entitled to receive any payment under the Plan is legally incompetent to receive such payment and to give valid release therefor, such payment may be made to the guardian, committee, or other representative of such person duly appointed by a court of competent jurisdiction. If a person or institution other than a guardian, committee, or other representative of such person who has been duly appointed by a court of competent jurisdiction is then maintaining or has custody of such incompetent person, the payment may be made to such other person or institution and the release of such other person or institution shall be valid and complete discharge for the payment. 17 ARTICLE XIV MISCELLANEOUS 14.01 Governing Laws. This Plan and all provisions thereof shall be construed and administered according to the laws of the State of New York without giving effect to the principle of conflicts of law thereof. 14.02 Necessary Parties. The Company, the Plan and the Plan Administrator shall be the only necessary parties in any litigation involving the Plan, unless otherwise required by law. 14.03 Name. The name of this Plan is the "Alleghany Corporation Retirement Plan." 14.04 Titles and Heading not to Control. The titles to the Articles and the headings of Sections in the Plan are placed herein for convenience of reference only, and in case of any conflict, the text of this instrument, rather that such titles or headings, shall control. 14.05 Gender and Person. The masculine pronoun shall include the feminine, the feminine pronoun shall include the masculine and the singular shall include the plural wherever the context so requires. 14.06 Elections and Payment. All payments of benefits under the Plan shall commence as of the dates herein set forth; provided, however, that if any payment shall be conditioned upon an election of a Participant as to time, or the amount of such payment is dependent upon the election of a Participant as to the form of his benefit or cannot be determined until the receipt of information or additional information from the Participant, his surviving spouse or Beneficiary, the Plan Administrator may defer commencement of the payment of such benefit for 90 days from the receipt of such election or information. Notwithstanding any such delay in the commencement of the payment of benefits, such Participant, surviving spouse or Beneficiary shall receive all such amounts to which he is entitled, including any amounts the payment of which is permitted to be delayed hereunder. 18 ALLEGHANY CORPORATION RETIREMENT PLAN EXHIBIT I Actuarial Equivalents and Interest Accumulation Factor 1. For all purposes of Section 5.02: UP --1984 Mortality Table 7.75% Interest Rate 2. For purposes of Section 5.03 (early retirement reduction factors): 0.25% per month for each month that the date as of which benefit payments commence precedes age 65. 3. For all purposes of Article VI: Based on the unisex annuity purchase rates from a qualified insurance company, in effect on the date of determination. In no event shall any lump sum calculated in accordance with the preceding sentence be less than the lump sum determined by using (i) the mortality table prescribed in Section 417(e)(3)(A)(ii)(I) of the Code and (ii) the interest rate prescribed by the Internal Revenue Service under Section 417(e)(3)(A)(ii)(II) of the Code for the month of December immediately preceding the Plan Year in which such determination is being made. The Plan Administrator may employ, in his sole discretion, reasonable approximations in lieu of obtaining actual unisex annuity purchase rates. Such approximations shall be based on the recommendations provided to the Plan Administrator by a qualified third party such as an insurance broker or pension actuary. 4. Interest Accumulation Factors If the period from September 15, 2004, to the date of the Participant's Normal Retirement Date is 12 years or less, then 3.55%. If the period from September 15, 2004, to the date of the Participant's Normal Retirement Date is more than 12 years, then 4.14%. I-1 ALLEGHANY CORPORATION RETIREMENT PLAN EXHIBIT II Benefit Actual Service and Prior Plan Accrued Benefit
Benefit Accrual Prior Plan Accrued Benefit Monthly Name Service at 12/31/88 Life Annuity Benefit Payable At Age 65 ---- ------------------- -------------------------------------- Burns, John 20.75 $7,835.25 Cuming, David 12.0 4,512.70 Sismondo, Peter 1.0 175.41
I-2 ALLEGHANY CORPORATION RETIREMENT PLAN EXHIBIT III Special Grants of Vesting Service and Benefit Accrual Service
Years of Additional Name Vesting Service Benefit Accrual Service ---- ------------------- ----------------------- Hart, Robert M. 5 5
I-3 ALLEGHANY CORPORATION RETIREMENT PLAN EXHIBIT IV Accrued Benefits Paid As A Lump Sum
Name - ---- Chapman, Benson $1,045,685 Hart, Robert 3,270,903
Accrued Benefits Paid As Annuity Contracts
Amount of Annual Annuity Payable Monthly for Participant's Life Only (amount is payable as of the first day of the month following the date the participant attains Name age 55) - ---- ------------------------ Sismondo, Peter $86,636
I-4 Table of Contents
Page ---- ARTICLE I DEFINITIONS.................................................... 1 1.01 "Actuarial Equivalent"........................................... 1 1.02 "Applicable Exclusion Ratio"..................................... 1 1.03 "Average Salary"................................................. 1 1.04 "Base Compensation".............................................. 1 1.05 "Beneficiary".................................................... 2 1.06 "Benefit Accrual Service"........................................ 2 1.07 "Board".......................................................... 2 1.08 "Code"........................................................... 2 1.09 "Company"........................................................ 2 1.10 "Component Members".............................................. 2 1.11 "Early Retirement Date".......................................... 2 1.12 "Effective Date"................................................. 2 1.13 "Employee"....................................................... 3 1.14 "Employment Commencement Date"................................... 3 1.15 "ERISA".......................................................... 3 1.16 "Gross-Up Payment"............................................... 3 1.17 "Hour of Service"................................................ 3 1.18 "Incentive Compensation"......................................... 3 1.19 "Income Taxes"................................................... 4 1.20 "Income Amount".................................................. 4 1.21 "Late Retirement Date"........................................... 4 1.22 "Normal Retirement Date"......................................... 4 1.23 "Participant".................................................... 4 1.24 "Plan"........................................................... 4 1.25 "Plan Administrator"............................................. 4 1.26 "Plan Year"...................................................... 4 1.27 "Prior Plan"..................................................... 4 1.28 "Prior Plan Accrued Benefit"..................................... 4 1.29 "Termination of Employment"...................................... 5 1.30 "Totally Disabled"............................................... 5 ARTICLE II PARTICIPATION................................................. 5 2.01 Participation.................................................... 5 2.02 Re-Employment of Former Participant.............................. 5 ARTICLE III VESTING...................................................... 5 3.01 Vesting at Age 55................................................ 5 3.02 Vesting before Age 55............................................ 5 3.03 Year of Vesting Service.......................................... 6 3.04 Termination before Vesting....................................... 6
i Table of Contents (continued)
Page ---- 3.05 Special Grants of Vesting Service................................ 6 ARTICLE IV ACCRUAL OF BENEFITS........................................... 6 4.01 Service Required for Benefits.................................... 6 4.02 Benefit Accrual Service.......................................... 6 4.03 Special Grants of Benefit Accrual Service........................ 6 ARTICLE V RETIREMENT BENEFITS............................................ 7 5.01 Retirement Benefit at Normal Retirement Date..................... 7 5.02 Retirement Benefit at Late Retirement Date....................... 7 5.03 Retirement Benefit before Normal Retirement Date................. 7 5.04 Social Security Calculations and Reduction....................... 7 5.05 Reduction for Prior Distributions................................ 8 ARTICLE VI FORMS OF RETIREMENT BENEFITS.................................. 8 6.01 Calculation of Amount of Benefit Payments........................ 8 6.02 Automatic Forms of Benefit....................................... 8 6.03 Retirement Death Benefit for Spouse.............................. 9 6.04 Single Life Option............................................... 9 6.05 Period Certain Option............................................ 9 6.06 Joint and Survivor Option........................................ 10 6.07 Lump Sum Option.................................................. 10 6.08 Cash-out of Benefits............................................. 10 6.09 Elections........................................................ 10 6.10 Death Benefits................................................... 11 6.11 Commencement of Benefits......................................... 11 6.12 Small Benefits................................................... 11 6.13 Termination of Benefit........................................... 11 6.14 Special In-Service Distributions................................. 11 6.15 Method of Payment................................................ 12 ARTICLE VII GROSS-UP PAYMENTS............................................ 12 7.01 Gross-Up Payment................................................. 12 7.02 Calculation of Gross-Up Payment.................................. 12 7.03 Form and Payment................................................. 13 7.04 Gross-Up Payments to Surviving Spouses and Beneficiaries......... 13 ARTICLE VIII PAYMENTS.................................................... 13 8.01 Company Payments................................................. 13 ARTICLE IX PLAN ADMINISTRATION........................................... 13 9.01 Plan Administrator Records....................................... 13 9.02 Employment of Experts............................................ 13 9.03 Payment of Expenses.............................................. 13 9.04 Indemnification of Plan Administrator............................ 13 9.05 Binding Action................................................... 13
ii Table of Contents (continued)
Page ---- ARTICLE X POWERS AND DUTIES OF PLAN ADMINISTRATOR........................ 14 10.01 Administration Powers........................................... 14 10.02 Plan Administrator-Claims Review Authority and Procedures....... 14 10.03 Conflicts of Interest........................................... 16 ARTICLE XI LIMITATION OF RIGHTS AND OBLIGATIONS.......................... 16 11.01 Plan is Voluntary............................................... 16 11.02 Creation of Certain Employment Rights........................... 16 11.03 Distributions Only from the Company............................. 17 ARTICLE XII AMENDMENT AND TERMINATION.................................... 17 12.01 Amendment....................................................... 17 12.02 Termination..................................................... 17 12.03 Payment of Benefits upon Termination............................ 17 ARTICLE XIII LIMITATION OF ASSIGNMENT.................................... 17 13.01 Spendthrift Provision........................................... 17 13.02 Incompetence of Participant or Beneficiary...................... 17 ARTICLE XIV MISCELLANEOUS................................................ 18 14.01 Governing Laws.................................................. 18 14.02 Necessary Parties............................................... 18 14.03 Name............................................................ 18 14.04 Titles and Heading not to Control............................... 18 14.05 Gender and Person............................................... 18 14.06 Elections and Payment........................................... 18
iii EX-10.10 3 y06166exv10w10.txt NON-EMPLOYEE DIRECTORS'S RETIREMENT PLAN Exhibit 10.10 ALLEGHANY CORPORATION NON-EMPLOYEE DIRECTORS' RETIREMENT PLAN 1. Purpose of the Plan. This plan, known as the Alleghany Corporation Non-Employee Directors' Retirement Plan (the "Plan"), is maintained by Alleghany Corporation, a Delaware corporation ("Alleghany"), for the purpose of providing additional compensation in the form of retirement benefits for members of its board of directors (the "Board") who were not employees of Alleghany or any of its subsidiaries and who served as members of the Board prior to January 1, 2005. 2. Participants. Every person who served as a non-employee director of Alleghany at any time after the Effective Date and prior to January 1, 2005, shall be a participant (a "Participant") under the Plan. 3. Vesting. In order to be entitled to a benefit under the Plan, a Participant must: (a) have at least five years of Credited Service; and (b) have ceased to serve as a director of Alleghany either (i) at the time required by Alleghany's retirement policy for directors as then in effect or (ii) upon or after attaining age 70. Credited Service shall mean all years and fractions of a year, whether before or after the Effective Date, during which the Participant served as a director of Alleghany or of Alleghany Corporation, a Maryland corporation, while not an employee of either such corporation or any of their subsidiaries; provided that no period of service as a director after December 31, 2004, shall be recognized as Credited Service for purposes of measuring the duration of a Participant's benefit under the Plan. 4. Benefit. The benefit payable to a Participant who is entitled to a benefit under the Plan shall be an annual amount equal to (a) the basic annual retainer payable to non-employee directors of Alleghany at the time such Participant ceased to be a director of Alleghany, exclusive of additional fees and expenses paid for attendance at or participation in meetings of the Board of Directors and service on committees of the Board, and exclusive of benefits under the Alleghany Corporation Directors' Stock Option Plan or the like, or (b), in the case of a Participant who ceases to be a director of Alleghany after December 31, 2004, the basic annual retainer for 2004 of $30,000. 5. Duration of Benefit. A Participant who is entitled to receive a benefit under the Plan shall receive such benefit commencing upon the termination for any reason of his service as a director of Alleghany and continuing until the end of a period equal to his Credited Service, or until his death, whichever occurs sooner. -2- 6. Payment or Benefit. One-fourth of the annual benefit payable to a Participant hereunder shall be paid at the end of each calendar quarter, beginning with the calendar quarter following that in which his service as a director of Alleghany terminated. If the Credited Service of a Participant includes a fraction of a calendar quarter, his final payment shall consist of the same fraction of the amount otherwise payable per calendar quarter. In the event of a Participant's death prior to termination of his benefit payments, the final such payment shall be made at the end of the calendar quarter in which his death has occurred. 7. General Provisions. (a) Nothing in the Plan shall create, or be construed to create, a trust or fiduciary relationship of any kind between Alleghany and a Participant or any other person. All amounts payable under the Plan shall be paid from the general funds of Alleghany, and the right to receive payments from Alleghany under the Plan shall be no greater than the right of any unsecured general creditor. Alleghany may, but need not, purchase securities or instruments as a means of hedging its obligations to any participant under the Plan, but if it does, neither the Participant nor any other person shall have any interest therein or other right to any such property. All payments hereunder shall be made in cash. (b) The right of any Participant to receive benefits under the Plan shall not be assigned, transferred, pledged or encumbered in my manner, nor shall it be subject to -3- attachment or to interference or control, by the creditors or beneficiaries of any Participant. (c) Participation in the Plan shall not be construed as conferring upon any Participant the right to continue as a director of Alleghany or in any other capacity. 8. Administration of the Plan. The Plan shall be administered by an officer or Alleghany (the "Plan Administrator'") appointed by the Board to serve as administrator under the direction of the Board. The Board shall have full power and authority at my time to interpret, construe, administer, amend and terminate the Plan, and the Board's interpretation and construction thereof and actions taken thereunder shall be binding on all persons for all purposes; provided, that no amendment or termination of the Plan shall reduce the benefits to which any Participant has previously become entitled under the Plan. 9. Governing Law. The Plan shall be governed by and construed under the laws of the State of New York. 10. Effective Date. The effective date of the Plan (the "Effective Date") is July 1, 1990. -4- EX-10.11.D 4 y06166exv10w11wd.txt RESTRICTED STOCK AWARD AGREEMENT Exhibit 10.11(d) ALLEGHANY CORPORATION Restricted Stock Award Agreement Restricted Stock Award Agreement (this "Agreement"), dated as of December 31, 2004, between Alleghany Corporation, a Delaware corporation ("Alleghany"), and Weston M. Hicks (the "Participant"). Section 1. Restricted Stock Award. Alleghany hereby grants to the Participant, on the terms and conditions hereinafter set forth, a restricted stock award of 26,010 shares of the common stock, par value $1.00 per share (the "Common Stock") of Alleghany (the "Restricted Shares"). This grant has been made by the Compensation Committee of the Board of Directors of Alleghany (the "Committee") pursuant to the terms of the Alleghany Corporation 2002 Long-Term Incentive Plan (the "Plan") and is intended to qualify as "performance-based compensation" for purposes of Section 162(m) of the Internal Revenue Code of 1986, as amended. The applicable terms of the Plan are incorporated herein by reference. Any terms used but not defined herein shall have the meanings ascribed thereto in the Plan. Any ambiguity between any term used in this Agreement and a term used in the Plan shall be resolved in favor of and in accordance with the term used in the Plan. Any interpretation, determination or decision made or taken by the Committee regarding the Plan or this Agreement shall be final and binding upon Alleghany and the Participant. Section 2. Vesting of Restricted Shares. Subject to Section 3 hereof, the Restricted Shares shall vest and become nonforfeitable as follows: (a) If Alleghany achieves average annual compound growth in Stockholders' Equity Per Share equal to 10% or more as measured over a calendar year period commencing January 1, 2005 and ending on December 31, 2008, 2009, 2010 or 2011, the Restricted Shares will vest and become nonforfeitable upon the certification by the Committee that such performance goal has been met. (b) If the performance goal set forth in (a) above has not been achieved as of December 31, 2011, the Restricted Shares will vest and become nonforfeitable when Alleghany achieves average annual compound growth in Stockholders' Equity Per Share equal to 7% or more as measured over a calendar year period commencing January 1, 2005 and ending on December 31, 2012, 2013 or 2014 and upon the certification by the Committee that such performance goal has been met. (c) If the performance goals provided above are not achieved as of December 31, 2014, the Participant will forfeit all of the Restricted Shares. (d) "Stockholders' Equity Per Share" shall mean the stockholders' equity per share of Common Stock of Alleghany, determined, except as otherwise herein provided, on the basis of the same accounting principles used in the preparation of Alleghany's consolidated balance sheet for the calendar year in question which is included in Alleghany's Annual Report to Stockholders for such calendar year. Stockholders' Equity Per Share shall be determined and certified in writing by the Committee, with such adjustments as the Committee shall deem to be required to take account of the effects on Stockholders' Equity Per Share of any stock dividend, unusual cash distributions, spin-off, stock split, recapitalization, merger, consolidation or other similar event and will also be automatically adjusted to reflect reinvestment of the value of dividends and distributions other than stock dividends. The Committee's determination with respect to any such adjustments shall be final and binding. Section 3. Custody and Delivery of Shares. Alleghany shall hold the certificate or certificates representing the Restricted Shares subject to this Award until such Restricted Shares have vested pursuant to Section 2 hereof. Contemporaneous with the execution of this Agreement, the Participant shall execute and deliver to Alleghany one or more irrevocable stock powers related thereto to facilitate the transfer of the Restricted Shares subject to this Award to Alleghany (or its assignee or nominee) if such Restricted Shares are forfeited pursuant hereto. Upon the vesting of the Restricted Shares subject to this Award pursuant to Section 2 hereof, Alleghany shall deliver or cause to be delivered the certificate or certificates representing such Restricted Shares to the Participant, shall destroy the related stock power or powers, and shall pay all original issue or transfer taxes and all fees and expenses incident to such delivery. Section 4. Termination of Employment. If the Participant's employment with Alleghany is terminated for any reason prior to the occurrence of any otherwise applicable vesting date provided in Section 2 hereof, the Participant shall (i) forfeit his interest in any Restricted Shares that have not yet become vested, (ii) assign, transfer, and deliver any certificates evidencing ownership of such Restricted Shares to Alleghany, and (iii) cease for all purposes to be a stockholder with respect to such Restricted Shares; provided, however, that if, subsequent to December 31, 2006, Alleghany terminates the Participant's employment other than for Cause or other than in the case of Total Disability, and, as of the calendar year end immediately preceding such termination, the performance goal set forth in Section 2(b) has been satisfied in all respects except for the passage of the required period of time, the following number of Restricted Shares shall vest and become nonforfeitable upon written certification by the Committee that such pro rated performance goal has been achieved: 26,010 multiplied by a fraction the numerator of which is the number of full calendar years beginning January 1, 2005 and ending on or before the date of such termination, and the denominator of which is ten. For purposes hereof, "Cause" shall mean conviction of a felony; willful failure to implement reasonable directives of the President, Chairman or the Board of Directors of Alleghany after written notice, which failure is not corrected within ten days following notice thereof; or gross misconduct in connection with the performance of any of Participant's duties; and "Total Disability" shall mean Participant's inability to discharge his duties due to physical or -2- mental illness or accident for one or more periods totaling six months during any consecutive twelve-month period. Section 5. Rights as a Stockholder. Subject to the otherwise applicable provisions of the Plan and this Agreement, the Participant will have all rights of a stockholder of the shares of Common Stock in respect of which the Restricted Shares are granted to the Participant hereunder, including the right to vote the shares and receive all dividends and other distributions paid in respect thereof; provided, however, that Alleghany shall retain all cash dividends or other cash distributions on the Restricted Shares until they vest, using such cash to purchase shares of Common Stock at the Fair Market Value thereof on the date paid, and the Participant shall deliver any stock dividends or other non-cash distributions on the Restricted Shares until they vest (including, without limitation, shares of any corporation distributed in a spin-off), together with appropriate stock transfer or other assignment documents, to Alleghany. The Common Stock acquired with the cash dividends or other cash distributions on the Restricted Shares or distributed as a stock dividend and any other non-cash distributions on the Restricted Shares (the "Distribution Amounts") shall be held by Alleghany until the Restricted Shares in respect of which such Distribution Amounts were paid vest and become nonforfeitable, at which time such Distribution Amounts shall also vest and become nonforfeitable, and the certificates or other evidence of the Distribution Amounts shall be delivered, or caused to be delivered, by Alleghany. Alleghany shall also destroy the related stock power or powers, and shall pay all original issue or transfer taxes and all fees and expenses incident to such delivery. To the extent that any Restricted Shares are forfeited pursuant to the terms of this Agreement, the Distribution Amounts paid in respect thereof shall also be forfeited. Section 6. Restrictions on Transfer. Neither this Agreement nor any Restricted Shares covered hereby or dividends or other distributions paid in respect thereof may be sold, assigned, transferred, encumbered, hypothecated or pledged by the Participant, other than to Alleghany as a result of forfeiture of the Restricted Shares and dividends or other distributions as provided herein, or unless such Restricted Shares and dividends or other distributions have vested and become nonforfeitable in accordance herewith. Any such disposition by the Participant shall be made in compliance with all applicable securities laws. The Participant hereby represents and warrants to Alleghany that the Restricted Shares are being acquired for investment and not with a view to the distribution thereof, and not with any present intention of distributing the same. Section 7. Tax Withholding. Alleghany's obligation to deliver the Restricted Shares to the Participant pursuant to Section 3 hereof and any Distribution Amount is subject to the Participant's making provision for the payment or withholding of any taxes required to be paid or withheld pursuant to any applicable law in respect of the receipt of, or lapse of forfeiture restrictions with respect to, such Restricted Shares and the payment or delivery of any Distribution Amounts. At the written election of Participant, and upon the approval of the Committee, any such required withholding payments may be made in Restricted Shares or Distribution Amounts, in each case valued at Fair Market Value on the date of payment. -3- Section 8. No Right of Employment. Nothing in this Agreement shall confer upon the Participant any right to continue as an employee of Alleghany or to interfere in any way with the right of Alleghany to terminate the Participant's employment at any time. Section 9. Entire Agreement. This Agreement, the letter agreement dated as of October 7, 2002, the Restricted Stock Award Agreement dated as of October 7, 2002, and the Restricted Stock Unit Matching Grant Agreement dated as of October 7, 2002 contain the entire understanding of Alleghany and the Participant with respect to the subject matter hereof and thereof and, except as specifically provided herein or therein, cancel and supersede any and all other agreements between Alleghany and the Participant with respect to the subject matter hereof and thereof. Any amendment or modification of this Agreement shall not be binding unless in writing and signed by Alleghany and the Participant. Section 10. Governing Law. This Agreement shall be governed by and enforceable in accordance with the laws of the State of New York, without giving effect to the principles of conflict of laws thereof. IN WITNESS WHEREOF, the Participant has duly executed this Agreement and Alleghany has duly caused this Agreement to be executed in its name and on its behalf, all as of December 31, 2004. ALLEGHANY CORPORATION By: /s/ Dan R. Carmichael -------------------------------------- Dan R. Carmichael Chairman of the Compensation Committee PARTICIPANT /s/ Weston M. Hicks -------------------------------------- Weston M. Hicks -4- EX-10.13 5 y06166exv10w13.txt DESCRIPTION OF COMPENSATORY ARRANGEMENTS EXHIBIT 10.13 COMPENSATION OF DIRECTORS OF ALLEGHANY CORPORATION (THE "COMPANY") Each director of the Company who is not an officer thereof receives an annual retainer of $30,000, payable one-half in cash and one-half in shares of Common Stock as more fully explained below, as well as $1,000 for each board meeting attended in person and $500 for each conference telephone meeting attended. In addition, the Chairman of the Executive Committee receives an annual fee of $25,000, and each other member thereof who is not an officer of the Company receives an annual fee of $7,500. The Chairman of the Audit Committee receives an annual fee of $15,000, and each other member thereof receives an annual fee of $11,000. The Chairman of the Audit Committee also receives a fee of $1,000 for each audit committee meeting of a Company operating unit which he attends. The Chairman of the Compensation Committee receives an annual fee of $8,000, and each other member thereof receives an annual fee of $6,000. The Chairman of the Nominating and Governance Committee receives an annual fee of $6,500, and each other member thereof receives an annual fee of $5,000. Pursuant to the Directors' Equity Compensation Plan (the "Directors' Equity Plan"), each director of the Company who is not an employee of the Company or any of its subsidiaries receives his retainer in the beginning of each year of his term for the following twelve-months' service as a director, exclusive of any per meeting fees, committee fees or expense reimbursements, payable one-half in shares of Common Stock, based on the market value (as defined in the plan) of such shares on the date of payment, and one-half in cash. Each eligible director received 57 shares of Common Stock on May 19, 2004. Pursuant to the 2000 Directors' Stock Option Plan (the "2000 Directors' Plan"), each director of the Company who is not an employee of the Company or any of its subsidiaries receives annually, as of the first business day after the conclusion of each Annual Meeting of Stockholders of the Company, an option to purchase 1,000 shares of Common Stock (subject to antidilution adjustments) at a price equal to the fair market value (as defined in the plan) of such shares on the date of grant. On April 26, 2004, each eligible director received an option to purchase 1,000 shares of Common Stock at a price of $265.00 per share. The 2000 Directors' Plan expired on December 31, 2004. In December 2004, the Board of Directors adopted the 2005 Directors' Stock Plan, which is being submitted to the stockholders of the Company for their approval at the 2005 Annual Meeting. Upon such stockholder approval, the Directors' Equity Plan will be terminated. Pursuant to the Non-Employee Directors' Retirement Plan, each person who has served as a non-employee director of the Company after July 1, 1990 is entitled to receive, after his retirement from the Board of Directors, an annual retirement benefit payable in cash equal to the annual retainer payable to directors of the Company at the time of his retirement. The benefit is paid from the date of the director's retirement from the Board of Directors until the end of a period equal to his length of service thereon or until his death, whichever occurs sooner. To be entitled to this benefit, the director must have served as such for at least five years and must have continued so to serve either until the time he is required to retire by the Company's retirement policy for directors or until he has attained age 70. In January 2005, the Directors' Retirement Plan was amended to "freeze" the Plan at December 31, 2004. Under the Directors' Retirement Plan as amended, no new non-employee director will be eligible to participate in the Directors' Retirement Plan, a director's service after December 31, 2004 is no longer included in measuring how long the director's annual retirement benefit will be payable, and the annual retirement benefit for directors who retire after December 31, 2004 is limited to $30,000, which is the current annual retainer. As Chairman of the Board of the Company, Mr. F.M. Kirby received in respect of 2004 $342,121 in salary, $21,721 representing payments for reimbursement of taxes and the reimbursement itself, and $81,760 representing (i) a savings benefit of $51,318 credited pursuant to the Alleghany Corporation Officers, Highly Compensated Employees and Directors' Deferred Compensation Plan; and (ii) a benefit, valued at $30,442 pursuant to Securities and Exchange Commission rules, of life insurance maintained by the Company on his behalf. Such life insurance policy provides a death benefit to Mr. F.M. Kirby if he is an employee at the time of his death equal to four times the amount of his annual salary at January 1 of the year of his death. After his retirement as President and chief executive officer of the Company effective December 30, 2004 and pursuant to action taken by the Board of Directors, Mr. Burns is continuing as a director, serving as Vice Chairman of the Board, and as a non-executive employee of the Company. As an employee, Mr. Burns is not entitled to receive any director or committee fees and does not participate in any non-employee directors' equity or retirement plans. As non-executive Chairman of the board of directors of World Minerals, Mr. Will was entitled to receive an annual retainer of $40,000 as well as $600 for each board meeting or conference telephone meeting attended. As a member of the Audit Committee of the World Minerals board, Mr. Will was entitled to receive $500 for each committee meeting attended. In 2004, Mr. Will was paid fees of $44,900 for services in these capacities. EX-10.14 6 y06166exv10w14.txt DESCRIPTION OF COMPENSATORY ARRANGEMENTS EXHIBIT 10.14 COMPENSATION OF NAMED EXECUTIVE OFFICERS OF ALLEGHANY CORPORATION (THE "COMPANY") The following information relates to the compensation of the chief executive officer and the four other most highly compensated executive officers of the Company serving as executive officers at the end of 2004, and John J. Burns, Jr., who served as President and chief executive officer of the Company during 2004 until his retirement from these positions effective December 30, 2004. SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION ------------------------------------ LONG-TERM OTHER ANNUAL INCENTIVE ALL OTHER NAME AND PRINCIPAL BONUS COMPENSATION PLAN PAYOUTS COMPENSATION POSITION YEAR SALARY (1) (2) (3) (4) - ------------------ ---- ---------- -------- ------------ ------------ ------------ John J. Burns, Jr.,................ 2004 $1,009,284 $617,147 $24,175 $1,709,807 $183,850 Vice Chairman 2003 970,465 741,763 22,356 1,115,924 175,810 of the Board 2002 970,465 593,410 23,112 1,442,639 173,116 Weston M. Hicks,................... 2004 $ 700,000 $518,007 $ 5,104 $ -- $111,430 President and chief 2003 624,000 468,000 4,743 -- 99,866 executive officer(5) 2002 115,000 450,000 520 -- 625 David B. Cuming,................... 2004 $ 472,593 $273,984 $11,945 $ 706,485 $ 85,142 Senior Vice President 2003 454,416 259,356 12,566 460,788 83,179 2002 436,938 251,151 15,124 595,807 82,048 Robert M. Hart,.................... 2004 $ 472,593 $282,703 $ 6,787 $ 706,485 $ 79,956 Senior Vice President, 2003 454,416 268,149 6,304 460,788 76,581 General Counsel 2002 436,938 260,589 6,421 595,807 73,152 and Secretary James P. Slattery,................. 2004 $ 416,000 $227,136 $ 4,756 $ 293,781 $ 68,733 Senior Vice President -- 2003 400,000 229,200 4,569 -- 66,024 Insurance 2002 250,000 127,125 2,212 -- 40,160 Peter R. Sismondo,................. 2004 $ 230,245 $103,749 $ 3,030 $ 363,114 $ 38,579 Vice President, Controller, 2003 221,389 101,485 2,867 236,940 37,034 Treasurer and Assistant 2002 212,874 95,666 2,894 306,221 35,358 Secretary
- --------------- (1) These amounts represent bonuses earned in respect of the relevant year under the Company's management incentive plan, which is a short-term incentive plan designed to reward officers for achieving specified net earnings per share and/or individual objectives. (2) These amounts represent payments for reimbursement of taxes. (3) These amounts represent payouts in settlement of performance shares awarded under the 1993 Long-Term Incentive Plan (the "1993 Plan"), which entitled the holder thereof to payouts of cash and/or Common Stock (in such proportion as is determined by the Compensation Committee) up to a maximum amount equal to the value of one share of Common Stock on the payout date for each performance share, depending upon the average annual compound growth in the Company's Earnings Per Share (as defined by the Compensation Committee pursuant to the 1993 Plan) in a four-year award period commencing with the year following that in which the performance shares were awarded; payouts have generally been made one-half in cash and one-half in Common Stock. (4) The 2004 amounts listed for Messrs. Burns, Hicks, Cuming, Hart, Slattery and Sismondo include (i) savings benefits of $151,150, $104,526, $70,775, $70,775, $62,300 and $34,481, respectively, credited pursuant to the Alleghany Corporation Officers, Highly Compensated Employees and Directors' Deferred Compensation Plan; and (ii) benefits valued at $28,680, $2,884, $10,347, $5,161, $2,413 and $1,013, respectively, pursuant to the Securities and Exchange Commission rules, of life insurance maintained by the Company on their behalf. Such life insurance policies provide a death benefit to an executive officer who is an employee at the time of his death equal to four times the amount of such executive officer's annual salary at January 1 of the year of his death. The 2004 amounts listed for each of Messrs. Burns, Hicks, Cuming, Hart and Slattery also include compensation of $4,020, and the 2004 amount listed for Mr. Sismondo also includes compensation of $3,085, in respect of other insurance coverage. (5) Mr. Hicks was appointed President and chief executive officer of the Company effective December 31, 2004, and was Executive Vice President of the Company prior thereto. EX-10.67.A 7 y06166exv10w67wa.txt AGREEMENT AND PLAN OF MERGER EXHIBIT 10.67(a) AGREEMENT AND PLAN OF MERGER DATED AS OF DECEMBER 23, 2004 AMONG HTI ACQUISITION LLC HEADS & THREADS INTERNATIONAL LLC AND ALLEGHANY CORPORATION TABLE OF CONTENTS
PAGE ---- 1. Definitions.............................................................. 1 2. Merger................................................................... 1 2.1 The Merger........................................................ 1 2.2 Closing........................................................... 1 2.3 Effective Time of the Merger...................................... 1 2.4 Certificate of formation; Limited Liability Company Agreement..... 2 2.5 Directors and Officers............................................ 2 2.6 Employment Agreements............................................. 2 2.7 Effect of the Merger.............................................. 2 3. Treatment of Membership Interests........................................ 2 3.1 Effect of the Merger on Membership Interests...................... 2 3.2 Post-Closing Adjustment of Unadjusted Merger Consideration........ 3 3.3 Tax Treatment and Allocation...................................... 5 4. Representations and Warranties by the Company and Alleghany.............. 6 4.1 Organization...................................................... 6 4.2 Membership Interests Ownership.................................... 6 4.3 Company Subsidiaries.............................................. 7 4.4 Authority......................................................... 8 4.5 No Violation...................................................... 8 4.6 Financial Statements.............................................. 9 4.7 No Undisclosed Liabilities........................................ 10 4.8 Absence of Certain Changes........................................ 11 4.9 Title to and Condition of Properties and Assets................... 12 4.10 Certain Properties................................................ 13 4.11 Taxes............................................................. 13 4.12 Contracts......................................................... 15 4.13 Litigation........................................................ 16 4.14 Intellectual Property............................................. 17 4.15 Compliance with Laws.............................................. 17 4.16 Environmental Matters............................................. 17 4.17 Governmental Authorizations and Regulations....................... 18 4.18 Employee Benefit Plans............................................ 19 4.19 Related Party Transactions........................................ 20 4.20 Certain Practices................................................. 20 4.21 Minute Books...................................................... 21
-i- 4.22 Insurance......................................................... 21 4.23 Bank Accounts; Powers of Attorney................................. 21 4.24 Product Warranties................................................ 21 4.25 Customers and Suppliers........................................... 21 4.26 Certain Disclosures............................................... 22 4.27 Employees......................................................... 22 4.28 Brokers........................................................... 22 5. Representations and Warranties by HTI Acquisition........................ 22 5.1 Organization...................................................... 22 5.2 Authority......................................................... 22 5.3 No Violation...................................................... 23 5.4 Litigation........................................................ 23 5.5 HSR Act........................................................... 23 5.6 Financing......................................................... 23 5.7 Interim Operations of HTI Acquisition............................. 24 5.8 Solvency.......................................................... 24 5.9 Delivery of New Employment Agreements............................. 24 5.10 Brokers........................................................... 24 6. Covenants of the Company and Alleghany................................... 25 6.1 Access, Information and Documents................................. 25 6.2 Conduct of Business Pending Closing............................... 25 6.3 Cooperation with Respect to Financing............................. 27 6.4 Consents and Approvals............................................ 27 6.5 Transferred Assets and Transferred Liabilities.................... 27 6.6 Use of Name....................................................... 27 6.7 No Solicitation of Offers......................................... 27 6.8 Confidential Information.......................................... 28 6.9 The Company's Obligations......................................... 28 6.10 Commercially Reasonable Efforts................................... 28 7. Covenants of HTI Acquisition............................................. 28 7.1 Confidential Information.......................................... 28 7.2 Consents and Approvals............................................ 28 7.3 Financing Obligation.............................................. 28 7.4 Acquisition Financing............................................. 29 7.5 Annual Incentive Plan............................................. 29 7.6 Payment of Certain Debt........................................... 29 7.7 Certain Post-Closing Matters...................................... 29 7.8 Commercially Reasonable Efforts................................... 31 8. Conditions Precedent to the Company's and Alleghany's Obligations to Effect the Merger........................................................ 31 8.1 Representations and Warranties; Performance....................... 31 8.2 Consents and Approvals............................................ 31 8.3 No Injunction..................................................... 31
-ii- 8.4 Solvency Opinion................................................. 32 8.5 Certificates..................................................... 32 9. Conditions Precedent to HTI Acquisition's Obligation to Effect the Merger............................................................... 32 9.1 Representations and Warranties; Performance...................... 32 9.2 Consents and Approvals........................................... 32 9.3 Availability of Financing........................................ 33 9.4 No Injunction.................................................... 33 9.5 Certificates..................................................... 33 10. Tax Matters.............................................................. 33 10.1 Tax Returns...................................................... 33 10.2 Post-Closing Tax Matters......................................... 35 10.3 Alleghany Indemnity for Taxes.................................... 36 10.4 Matters Involving Income Tax Claims.............................. 36 10.5 Transfer Taxes................................................... 37 10.6 FIRPTA........................................................... 37 10.7 Survival......................................................... 37 11. Termination.............................................................. 37 11.1 Termination by HTI Acquisition................................... 37 11.2 Termination by Alleghany......................................... 37 11.3 Termination by Alleghany or by HTI Acquisition................... 37 11.4 Effect of Termination............................................ 38 12. Survival of Representations and Warranties; Indemnification.............. 38 12.1 Survival of Representations and Warranties....................... 38 12.2 Alleghany's Indemnification Obligations.......................... 38 12.3 Limitation on Alleghany's Indemnification Obligations............ 39 12.4 HTI Acquisition's Indemnification Obligations.................... 40 12.5 Limitation on HTI Acquisition's Indemnification Obligations...... 40 12.6 Other Limitations on Indemnification............................. 41 12.7 Notice........................................................... 42 12.8 Right to Contest Claims of Third Parties......................... 42 12.9 Indemnification Payments......................................... 43 12.10 Treatment of Indemnification Payments............................ 43 12.11 Exclusive Remedy................................................. 44 13. Non-Competition.......................................................... 44 14. Miscellaneous............................................................ 44 14.1 Fees and Expenses................................................ 44 14.2 Waiver........................................................... 45 14.3 Notices.......................................................... 45 14.4 Entire Agreement; Amendment...................................... 45 14.5 Rights Under this Agreement; Nonassignability.................... 45 14.6 Governing Law.................................................... 45
-iii- 14.7 Waiver of Jury Trial............................................. 46 14.8 Specific Performance............................................. 46 14.9 Publicity........................................................ 46 14.10 Headings; References to Sections, Exhibits and Schedules......... 46 14.11 Counterparts..................................................... 46 Acknowledgement and Signatures................................................ 46
Exhibits A Definitions B-1 Form of New Employment Agreement B-2 Form of New Employment Agreement B-3 Form of New Employment Agreement C Form of Solvency Opinion Schedules 4.1 Organization 4.3 Company Subsidiaries 4.5 No Violation 4.6 Financial Statements 4.7 Undisclosed Liabilities, Etc. 4.8 Certain Changes 4.9 Encumbrances 4.10 Certain Properties 4.11 Taxes 4.12 Contracts 4.13 Litigation 4.14 Intellectual Property 4.15 Compliance with Laws 4.16 Environmental Matters 4.17 Governmental Authorizations 4.18 Employee Benefit Plans 4.19 Related Party Transactions 4.22 Insurance 4.23 Bank Accounts; Powers of Attorney 4.24 Product Warranties 4.26 Certain Disclosures 4.27 Employees 6.2 Conduct of Business Prior to Closing 8.2 Consents and Approvals
-iv- AGREEMENT AND PLAN OF MERGER AGREEMENT AND PLAN OF MERGER ("Agreement") dated as of December 23, 2004 among HTI ACQUISITION LLC, a Delaware limited liability company ("HTI Acquisition"), HEADS & THREADS INTERNATIONAL LLC, a Delaware limited liability company (the "Company"), and ALLEGHANY CORPORATION, a Delaware corporation and the owner of all of the issued and outstanding membership interests in the Company ("Alleghany"). WHEREAS, each of the Board of Managers and the sole member of HTI Acquisition and the Board of Directors and the sole member of the Company have approved this Agreement and the merger of the Company with and into HTI Acquisition (the "Merger"), upon the terms and subject to the conditions set forth in this Agreement; and WHEREAS, the Board of Directors of Alleghany has approved this Agreement and the Merger, upon the terms and subject to the conditions set forth in this Agreement. NOW, THEREFORE, in consideration of the foregoing and the mutual covenants and agreements contained herein, the parties hereto, intending to be legally bound hereby, agree as follows: 1. Definitions. As used herein, defined terms have the meanings set forth in Exhibit A. 2. Merger. Upon the terms and subject to the conditions of this Agreement: 2.1 The Merger. In accordance with the Limited Liability Company Act of the State of Delaware ("DLLCA"), at the Effective Time, the Company shall be merged with and into HTI Acquisition. As a result of the Merger, the separate existence of the Company shall cease and HTI Acquisition shall continue as the surviving entity in the Merger (sometimes hereinafter referred to as the "Surviving Entity"). 2.2 Closing. Subject to the terms and conditions of this Agreement, the closing of the Merger (the "Closing") will take place at the offices of Morgan Lewis & Bockius LLP, 101 Park Avenue, New York, New York 10178 (or such other place upon which the parties shall mutually agree), at 10:00 a.m. on December 31, 2004 or on such later date upon which the parties shall mutually agree (the "Closing Date"). 2.3 Effective Time of the Merger. Subject to the terms and conditions of this Agreement, at the Closing, the parties shall cause the Merger to be consummated by filing a certificate of merger (the "Certificate of Merger") with the Secretary of State of the State of Delaware (the "Delaware Secretary of State") pursuant to the DLLCA, in such form as required by and executed in accordance with the relevant provisions of the DLLCA (the date and time of the filing of the Certificate of Merger with the Delaware Secretary of State (or such later date and time as may be specified in the Certificate of Merger in accordance with the DLLCA with the written consent of HTI Acquisition and Alleghany) being the "Effective Time"). 2.4 Certificate of formation; Limited Liability Company Agreement. At the Effective Time and without any further action on the part of HTI Acquisition, the Company, Alleghany or the Surviving Entity: (A) The certificate of formation of HTI Acquisition, as in effect immediately prior to the Effective Time, shall be amended as a result of the Merger to change the name of the Surviving Entity to "Heads & Threads International LLC". The certificate of formation of HTI Acquisition as so amended shall be the certificate of formation of the Surviving Entity following the Merger, until thereafter further amended or repealed in accordance with its terms and as provided under the DLLCA. (B) The limited liability company agreement of HTI Acquisition, as in effect immediately prior to the Effective Time, shall be the limited liability company agreement of the Surviving Entity following the Merger, until thereafter amended or repealed in accordance with its terms, the terms of the certificate of formation of the Surviving Entity and as provided under the DLLCA. 2.5 Directors and Officers. The directors of HTI Acquisition immediately prior to the Effective Time shall be the initial directors of the Surviving Entity following the Merger, and the officers of HTI Acquisition immediately prior to the Effective Time shall be the initial officers of the Surviving Entity following the Merger, in each case until their respective successors are duly elected or appointed or until their earlier death, resignation or removal in accordance with the certificate of formation and limited liability company agreement of the Surviving Entity and as provided under the DLLCA. 2.6 Employment Agreements. Simultaneously with the execution and delivery of this Agreement, HTI Acquisition and each of the parties thereto are entering into employment agreements in the forms of Exhibit B-1, B-2 and B-3 (the "New Employment Agreements"). Each of the New Employment Agreements by its terms will take effect at the Effective Time. 2.7 Effect of the Merger. The Merger shall have the effects set forth in this Agreement and in the DLLCA. Without limiting the generality of the foregoing, and subject thereto, at the Effective Time, all properties, rights, privileges, powers and franchises of HTI Acquisition and the Company shall be vested in the Surviving Entity, and all debts, liabilities and duties of HTI Acquisition and the Company shall attach to the Surviving Entity, and the Surviving Entity shall continue its existence under the DLLCA. 3. Treatment of Membership Interests. The Membership Interests of HTI Acquisition and the Company shall be treated as follows: 3.1 Effect of the Merger on Membership Interests. As of the Effective Time, by virtue of the Merger and without any action on the part of HTI Acquisition, the Company, Alleghany, the Surviving Entity or any holder of any membership interests in HTI Acquisition or any membership interests in the Company: -2- (A) Membership Interests in HTI Acquisition. All of the membership interests in HTI Acquisition outstanding immediately prior to the Effective Time shall remain outstanding. (B) Conversion of Membership Interests in the Company into Right to Receive Merger Consideration. All of the membership interests in the Company outstanding immediately prior to the Effective Time shall by virtue of the Merger and without any action on the part of the holder thereof be converted into the right to receive $54,656,000 in cash (the "Unadjusted Merger Consideration"), which amount is equal to the Member's Equity in the Company as set forth on the unaudited consolidated balance sheet of the Company and the Company Subsidiaries as at November 30, 2004 referred to in Section 4.6, subject to adjustment as set forth in Section 3.2. At the Closing, HTI Acquisition shall pay the Unadjusted Merger Consideration to Alleghany by wire transfer of immediately available funds. In addition, at the Closing, HTI Acquisition shall cause the Alleghany Debt and the LaSalle Debt to be repaid in full. As of the Effective Time, all membership interests in the Company shall automatically be canceled and retired and shall cease to be outstanding and exist. 3.2 Post-Closing Adjustment of Unadjusted Merger Consideration. (A) Within sixty (60) days after the Effective Date, Alleghany shall prepare a consolidated balance sheet of the Company and its consolidated Company Subsidiaries as of the time immediately preceding the Effective Time (as it may be audited or changed below, the "Closing Date Balance Sheet") in accordance with generally accepted accounting principles applied in a manner consistent with the application of such principles in the preparation of the December 31, 2003 Balance Sheet, except for the absence of footnote disclosures and other financial statements required thereby. Alleghany and HTI Acquisition agree that except as explicitly set forth in this Agreement, the Closing Date Balance Sheet will not give effect to the transactions contemplated hereby. (B) The parties agree that the Closing Date Balance Sheet shall give effect to (i) the deferred Tax assets, without giving effect to any valuation allowance therefor, (ii) any Taxes to be refunded or recovered, (iii) completion bonuses paid to officers or employees of the Company at or prior to the Closing ("Completion Bonuses") to the extent that such Completion Bonuses are paid by the Company, (iv) accruals made for periods prior to the Closing in respect of the Company's 2004 annual incentive plans, (v) the transfer and assignment of the Transferred Assets from the Company to Alleghany and (vi) the transfer from the Company to Alleghany and the acceptance and assumption by Alleghany of the Transferred Liabilities. The parties agree that the Closing Date Balance Sheet shall not give effect to (i) any current Income Tax expense, (ii) the termination of the Tax Sharing Agreement, (iii) any Completion Bonuses paid by Alleghany, (iv) the repayment by HTI Acquisition of the Alleghany Debt and the LaSalle Debt, (v) the New Employment Agreements, or (vi) the termination of the Existing Employment Agreements. (C) Alleghany shall cause the Closing Date Balance Sheet to be audited by KPMG LLP or such other firm of certified independent public accountants of national reputation mutually agreed to by all of the parties (the "Designated Accountants") and shall cause the Designated Accountants to issue and deliver the Closing Date Balance Sheet, as so -3- audited, to Alleghany and to HTI Acquisition within sixty (60) days after the Effective Date. Total assets less total liabilities as shown on the Closing Date Balance Sheet is hereinafter referred to as the "Closing Date Book Value." The parties agree that the fees and expenses of the Designated Accountants in connection with the preparation of the audited Closing Date Balance Sheet shall be paid by Alleghany, and that, in the event HTI Acquisition engages the Designated Accountants to assist in its review of the audited Closing Date Balance Sheet, the fees and expenses of the Designated Accountants in connection with such review shall be paid by HTI Acquisition. (D) During the preparation of the Closing Date Balance Sheet by Alleghany as provided in Section 3.2(A) hereof, HTI Acquisition shall (i) provide Alleghany and its representatives with reasonable access to all relevant books, records and work papers in the possession of HTI Acquisition and all former employees of the Company employed by HTI Acquisition, (ii) cooperate with Alleghany and its representatives, including providing all information in the possession of HTI Acquisition necessary or useful in the preparation of the Closing Date Balance Sheet, and (iii) be entitled to observe and review the preparation of the Closing Date Balance Sheet and the audit, including the Designated Accountants' work papers, and shall have full access to the Designated Accountants during such audit, which review shall not constitute any approval of or acquiescence in the Closing Date Balance Sheet on the part of HTI Acquisition. In order to prepare the Closing Date Balance Sheet, Alleghany shall cause the Company to conduct a physical count of the inventory (including raw materials, finished goods and work-in-progress) of the Company and its consolidated Company Subsidiaries during the period from December 28, 2004 through December 31, 2004, or at such other time prior to the Closing as may be mutually agreed to by all of the parties. Alleghany will roll forward the value of such inventory, based on the purchases and use of such inventory from the date of such physical count through the time immediately preceding the Effective Time, to value the inventory of the Company and its consolidated Company Subsidiaries as at the time immediately preceding the Effective Time. HTI Acquisition and its representatives shall be entitled to participate in such physical count. (E) In the event that the Closing Date Book Value is greater than the Unadjusted Merger Consideration, then HTI Acquisition shall pay to Alleghany an amount equal to the difference. In the event that the Closing Date Book Value is less than the Unadjusted Merger Consideration, then Alleghany shall pay to HTI Acquisition an amount equal to the difference. (F) In the event that HTI Acquisition does not disagree with the Closing Date Balance Sheet pursuant to Section 3.2(G), then the payment to be made pursuant to Section 3.2(E) shall be made in cash by wire transfer of immediately available funds on or prior to the forty-fifth (45th) day after the delivery of the Closing Date Balance Sheet as provided in Section 3.2(A). (G) In the event that HTI Acquisition disagrees with the Closing Date Balance Sheet, HTI Acquisition shall in writing advise Alleghany within forty-five (45) days after the delivery of the Closing Balance Sheet as provided in Section 3.2(A), specifying the nature of all such disagreements, the reason therefor and its calculation of the amount of the payment it believes is required by Section 3.2(E). HTI Acquisition may object to the Closing -4- Date Balance Sheet only to the extent that such Closing Date Balance Sheet was not prepared in accordance with generally accepted accounting principles applied in a manner consistent with the application of such principles in the preparation of the December 31, 2003 Balance Sheet. HTI Acquisition specifically agrees that it will not object to the inclusion of the deferred Tax asset on the Closing Date Balance Sheet as a result of the utilization of net operating losses generated by the Company in the federal Consolidated Income Tax Return of the affiliated group of which Alleghany is the common parent. HTI Acquisition and Alleghany shall attempt to resolve all such disagreements. If HTI Acquisition and Alleghany are unable to resolve all such disagreements within fifteen (15) days after HTI Acquisition shall have advised Alleghany of such disagreements, HTI Acquisition and Alleghany shall then select a mutually acceptable firm of certified independent public accountants of national reputation (the "Independent Accountants") to resolve the disagreements and to determine the amount of the payment required by Section 3.2(E) (the "Revised Amount"). The Independent Accountants shall deliver their determination of the Revised Amount to HTI Acquisition and Alleghany as soon as practicable and such determination shall be final and binding upon HTI Acquisition and Alleghany. Payment of the Revised Amount shall be made in cash by wire transfer of immediately available funds within five (5) Business Days of the receipt of the determination of the Revised Amount as provided in this Section 3.2(G). (H) The fees and expenses of the Independent Accountants shall be shared equally by HTI Acquisition and Alleghany. 3.3 Tax Treatment and Allocation. Alleghany and HTI Acquisition agree to treat the Merger as a sale of the assets of the Company and Heads & Threads (PA) (other than the Transferred Assets) for all Tax purposes, Alleghany intends to treat such sale as followed by the deemed distribution to Alleghany of the Transferred Assets and the assumption by Alleghany of the Transferred Liabilities in a completed liquidation of the Company pursuant to Section 332 of the Code, and Alleghany and HTI Acquisition agree not to take any contrary position (whether in audits, Tax Returns, or otherwise) unless required to do so pursuant to a final determination within the meaning of Section 1313 of the Code. HTI Acquisition shall prepare and deliver to Alleghany an allocation of the Unadjusted Merger Consideration, as adjusted pursuant to Section 3.2(E) (the "Merger Consideration"), any assumed liabilities of the Company, and all other capitalized costs, among the assets of the Company and the Company Subsidiaries in accordance with their respective fair market values pursuant to Section 1060 of the Code and the Regulations promulgated thereunder, no later than ninety (90) days after the determination of the Revised Amount pursuant to Section 3.2(G), or, if HTI Acquisition does not disagree with the Closing Date Balance Sheet pursuant to Section 3.2(G), no later than ninety (90) days after the delivery of the Closing Date Balance Sheet as provided in Section 3.2(A) (the "Allocation"). The parties hereto agree to consult in good faith regarding the Allocation, and HTI Acquisition shall make such changes to the Allocation as are reasonably requested by Alleghany; provided that Alleghany will accept HTI Acquisition's determination of the Allocation provided such determination is reasonable and consistent with applicable law. The parties shall report the sale and purchase of the assets of the Company and Heads & Threads (PA) (other than the Transferred Assets) on all Tax Returns (including, without limitation, Internal Revenue Service Form 8594) in a manner consistent with the Allocation as finally determined, unless required to do otherwise pursuant to a final determination within the -5- meaning of Section 1313 of the Code. The parties agree to consult with one another with respect to any Tax audit, controversy or litigation relating to the Allocation. 4. Representations and Warranties by the Company and Alleghany. The Company and Alleghany represent and warrant to HTI Acquisition as follows: 4.1 Organization. The Company is a limited liability company duly organized, validly existing, and in good standing under the laws of the State of Delaware and has the power and authority to carry on its business as now being conducted and to own and operate the properties and assets now owned and being operated by it. The Company has delivered to HTI Acquisition complete and correct copies of the Certificate of formation and limited liability company agreement of the Company as in effect on the date hereof. The Company is duly qualified or licensed to do business and is in good standing as a foreign entity in each of the jurisdictions set forth in Schedule 4.1. The Company is not required to be qualified or licensed to do business as a foreign entity in any other jurisdiction except for such jurisdictions, if any, in which the failure to be so qualified or licensed, individually or in the aggregate, has not had and would not reasonably be expected to have a Company Material Adverse Effect. The term "Company Material Adverse Effect" as used in this Agreement shall mean any material adverse effect on the business, operations, financial condition or results of operations of the Company and the Company Subsidiaries, taken as a whole, other than effects caused by or resulting from (i) economic or financial conditions affecting the U.S. economy, any non-U.S. economy or the global economy generally, (ii) changes in interest rate levels, (iii) changes generally affecting the industry in which the Company and the Company Subsidiaries operate, (iv) the identity of HTI Acquisition as the acquirer of the Company, (v) the announcement of the acquisition of the Company by HTI Acquisition, (vi) the conduct of HTI Acquisition (including activities related to due diligence) prior to the Closing, including the impact of the conduct of HTI Acquisition on the relationships of the Company or any of the Company Subsidiaries with suppliers, distributors, customers, employees and others having business relationships with the Company, or (vii) any breach of any provision of this Agreement by HTI Acquisition. Alleghany is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware and has the corporate power and authority to carry on its business as now being conducted and to own and operate the properties and assets now owned and being operated by it. Alleghany has made available to HTI Acquisition complete and correct copies of the Certificates of Incorporation and By-Laws of Alleghany as in effect on the date hereof. 4.2 Membership Interests Ownership. Alleghany owns all of the outstanding membership interests in the Company, free and clear of all Liens, and has full corporate power and authority to vote or give consents with respect to such membership interests. Neither the Company nor Alleghany is a party to or bound by any contract, agreement or arrangement to issue, sell or otherwise dispose of or redeem, purchase or otherwise acquire any membership interest or other security of the Company or any other security of the Company exercisable or exchangeable for or convertible into any membership interest or any other security of the Company, and, except for this Agreement, there is no outstanding option, warrant or other right to subscribe for or purchase, or contract, agreement or arrangement with -6- respect to, any membership interest or any other security of the Company or any other security exercisable or exchangeable for or convertible into any membership interest or any other security of the Company. 4.3 Company Subsidiaries. Schedule 4.3 lists each of the Company's directly and indirectly owned Subsidiaries (individually a "Company Subsidiary" and, collectively, the "Company Subsidiaries"). Except as set forth in Schedule 4.3, the Company does not own, directly or indirectly, any material interest in any Person. Schedule 4.3 sets forth, with regard to each of the Company Subsidiaries, a true and complete list of (i) its name and jurisdiction of incorporation, formation or organization, as the case may be, (ii) its authorized capital stock, membership interests or other equity interests, as the case may be, (iii) the number of shares of capital stock, membership interests or other equity interests, as the case may be, of each class thereof outstanding, (iv) the number of shares of capital stock, membership interests or other equity interests, as the case may be, of each class owned by the Company or a Company Subsidiary and (v) the names and titles of its managers, directors and executive officers. Except as set forth in Schedule 4.3, no shares of capital stock, membership interests or other equity interests, as the case may be, or any other security (including any debt security) of any Company Subsidiary is held by any Person or entity other than the Company or one or more of the Company Subsidiaries. Each Company Subsidiary is a corporation, limited liability company or other business entity validly existing under the laws of the jurisdiction of its incorporation, formation or organization, as the case may be, and has the power and authority to carry on its business as now being conducted and to own and operate the properties and assets now owned and being operated by it. The Company has made available to HTI Acquisition complete and correct copies of each of the Company Subsidiary's certificate of incorporation and bylaws, certificate of formation and limited liability company agreement or other organizational documents, as the case may be, as in effect on the date hereof. Each Company Subsidiary is duly qualified or licensed to do business and in good standing in each of the respective jurisdictions listed in Schedule 4.3. No Company Subsidiary is required to be qualified or licensed to do business as a foreign corporation, limited liability company or other business entity in any other jurisdiction except such jurisdictions, if any, in which the failure to be so qualified or licensed would not, individually or in the aggregate, reasonably be expected to have a Company Material Adverse Effect. All outstanding membership interests of each Company Subsidiary owned by the Company or a Company Subsidiary have been duly authorized and validly issued, and are fully paid and non-assessable. Except as set forth in Schedule 4.3 and except for the LaSalle Lien, all outstanding equity interests in each of the Company Subsidiaries is owned by the Company or one or more of the Company Subsidiaries free and clear of all Liens, other than restrictions on transfer pursuant to applicable law and, subject to compliance with such laws, are freely transferable. Except as set forth in Schedule 4.3, neither the Company nor any Company Subsidiary nor Alleghany is a party to or bound by any contract, agreement or arrangement with any Person (other than the Company or another Company Subsidiary) to issue, sell or otherwise dispose of or redeem, purchase or otherwise acquire any equity interest in or any other security (including any debt security) of any Company Subsidiary or any other security exercisable or exchangeable for or convertible into any equity interest in or any other security (including any debt security) of any Company Subsidiary. Except as set forth in Schedule 4.3, there is no outstanding option, warrant or other right to subscribe for or to purchase, or contract, agreement or arrangement with any Person -7- (other than the Company or another Company Subsidiary) with respect to, any equity interest in or any other security (including any debt security) of any Company Subsidiary, or any other security exercisable or exchangeable for or convertible into any equity interest in or any other security (including any debt security) of any Company Subsidiary. 4.4 Authority. The Company has the power to enter into this Agreement and to perform its obligations hereunder. The execution, delivery and performance of this Agreement and the consummation of the Merger and the other transactions contemplated hereby have been duly authorized by the Board of Directors of the Company and by its sole member and no other proceeding on the part of the Company is necessary to authorize the execution, delivery and performance of this Agreement and the consummation of the Merger and the other transactions contemplated hereby. This Agreement has been duly executed and delivered on behalf of the Company and, assuming the due authorization, execution and delivery of this Agreement by HTI Acquisition, constitutes a legal, valid and binding obligation of the Company enforceable against the Company in accordance with its terms, except as enforceability may be limited by bankruptcy, fraudulent conveyance, insolvency, reorganization, moratorium and other similar laws relating to or affecting creditors' rights generally or by general equitable principles (regardless of whether such enforceability is considered in a proceeding in equity or at law). Alleghany has the power to enter into this Agreement and to perform its obligations hereunder. The execution, delivery and performance of this Agreement and the consummation of the Merger and the other transactions contemplated hereby have been duly authorized by the Board of Directors of Alleghany and no other corporate proceeding on the part of Alleghany is necessary to authorize the execution, delivery and performance of this Agreement and the consummation of the Merger and the other transactions contemplated hereby. This Agreement has been duly executed and delivered on behalf of Alleghany and, assuming the due authorization, execution and delivery of this Agreement by HTI Acquisition, constitutes a legal, valid and binding obligation of Alleghany enforceable against Alleghany in accordance with its terms, except as enforceability may be limited by bankruptcy, fraudulent conveyance, insolvency, reorganization, moratorium and other similar laws relating to or affecting creditors' rights generally or by general equitable principles (regardless of whether such enforceability is considered in a proceeding in equity or at law). 4.5 No Violation. Except as set forth in Schedule 4.5, neither the execution, delivery nor performance of this Agreement by the Company nor the consummation of the Merger or any of the other transactions contemplated hereby (i) will violate or conflict with the Certificate of formation or limited liability company agreement of the Company, (ii) will result in any breach of or default under any provision of any loan agreement, real property lease or Material Business Contract to which the Company is a party or by which the Company is bound or to which any property or asset of the Company is subject, (iii) is prohibited by or requires the Company to obtain or make any consent, authorization, approval, registration or filing under any Applicable Law to which the Company is subject, or to which any property or asset of the Company is subject, (iv) will cause any acceleration of maturity of any note, instrument or other obligation with respect to which the Company is an obligor or guarantor or (v) will result in the creation or imposition of any Lien upon any property or asset of the -8- Company or give rise to any right on the part of any other Person to terminate, cancel or revoke any agreement or instrument referred to above, other than, in the case of clauses (ii), (iii), (iv) and (v), any such conflicts, violations, breaches, defaults, revocations, Liens, rights or losses which, would not, individually or in the aggregate, reasonably be expected to have a Company Material Adverse Effect. Except as set forth in Schedule 4.5, neither the execution, delivery nor performance of this Agreement by Alleghany nor the consummation of the Merger and the other transactions contemplated hereby (i) will violate or conflict with the Certificate of Incorporation or By-Laws of Alleghany, (ii) will result in any breach of or default under any provision of any loan agreement, real property lease or other material agreement to which Alleghany is a party or by which Alleghany is bound or to which any property or asset of Alleghany is subject, (iii) is prohibited by or requires Alleghany to obtain or make any consent, authorization, approval, registration or filing under any Applicable Law to which Alleghany is subject or to which any property or asset of Alleghany is subject, (iv) will cause any acceleration of maturity of any note, instrument or other obligation with respect to which Alleghany is an obligor or guarantor or (v) will result in the creation or imposition of any Lien upon any property or asset of Alleghany or give rise to any right on the part of any other Person to terminate, cancel or revoke any agreement or instrument referred to above, other than, in the case of clauses (ii), (iii), (iv) and (v), any such conflicts, violations, breaches, defaults, revocations, Liens, rights or losses which would not, individually or in the aggregate, reasonably be expected to have a material adverse effect on the ability of Alleghany to perform its obligations hereunder or to consummate the transactions contemplated hereby. 4.6 Financial Statements. (A) Schedule 4.6 contains copies of the following financial statements: (i) the audited consolidated balance sheets of the Company and the Company Subsidiaries as at December 31, 2001, 2002 and 2003 and related audited consolidated statements of income and changes in financial position for each of the fiscal years ended on those dates, together with the reports thereon of KPMG LLP, certified independent public accountants (such audited financial statements being hereinafter referred to as the "Audited Financial Statements" and the audited consolidated balance sheet of the Company and the Company Subsidiaries as at December 31, 2003 being hereinafter referred to as the "December 31, 2003 Balance Sheet"); (ii) the unaudited consolidated balance sheets of the Company and the Company Subsidiaries as at September 30, 2003 and 2004 and related unaudited consolidated statements of income and changes in financial position for the nine-month periods ended on those dates (such unaudited financial statements being hereinafter referred to as the "Interim Financial Statements" and such unaudited consolidated balance sheet of the Company and the Company Subsidiaries as at September 30, 2004 being hereinafter referred to as the "September 30, 2004 Balance Sheet"); -9- (iii) the unaudited consolidated balance sheet of the Company and the Company Subsidiaries as at October 31, 2004 and related unaudited consolidated statement of income (the "October 2004 Financial Statements"); and (iv) the unaudited consolidated balance sheet of the Company and the Company Subsidiaries as at November 30, 2004 and related unaudited consolidated statement of income (the "November 2004 Financial Statements"). (B) The Audited Financial Statements were prepared in accordance with generally accepted accounting principles ("GAAP") consistently applied throughout the periods involved (except as may be indicated in the notes thereto). The Audited Financial Statements have been audited by KPMG LLP, and present fairly in all material respects the consolidated financial position of the Company and the Company Subsidiaries at the respective dates thereof and the consolidated results of operations of the Company and the Company Subsidiaries for the respective periods then ended. (C) The Interim Financial Statements were prepared in accordance with GAAP consistently applied throughout the periods involved and in a manner consistent with the application of such principles applied in the preparation of the Audited Financial Statements. The Interim Financial Statements do not contain any footnote disclosures and are subject to normal recurring year-end adjustments, but otherwise present fairly in all material respects the consolidated financial condition and consolidated results of operations of the Company and the Company Subsidiaries as of the dates and for the periods indicated therein except as otherwise set forth therein. (D) The October 2004 Financial Statements and the November 2004 Financial Statements were prepared in accordance with GAAP consistently applied throughout the periods involved and in a manner consistent with the application of such principles applied in the preparation of the Audited Financial Statements. The October 2004 Financial Statements and the November 2004 Financial Statements accurately reflect the consolidated financial position and the consolidated results of operations of the Company and the Company Subsidiaries for the respective periods covered thereby. 4.7 No Undisclosed Liabilities. Except for liabilities and obligations provided for in this Agreement and pursuant to the transactions contemplated hereby, neither the Company nor any Company Subsidiary has any liability or obligation (absolute, accrued, contingent or otherwise) of any nature, except (i) to the extent reflected or reserved against on the September 30, 2004 Balance Sheet, (ii) as set forth on Schedule 4.7 or on the other Schedules hereto, or (iii) which, individually or in the aggregate, has not had and would not reasonably be expected to have a Company Material Adverse Effect. -10- 4.8 Absence of Certain Changes. (A) Since December 31, 2003, except (i) for the execution and delivery of this Agreement and (ii) as set forth in Schedule 4.8 or on the other Schedules hereto: (i) the Company and the Company Subsidiaries have conducted the Business only in the usual and ordinary course consistent with past practice; and (ii) there has not been any change, effect or circumstance which, individually or in the aggregate, has had or would reasonably be expected to have a Company Material Adverse Effect. (B) Since September 30, 2004, except for the execution and delivery of this Agreement and as set forth in Schedule 4.8 or on the other Schedules hereto, or as otherwise contemplated by this Agreement, neither the Company nor any Company Subsidiary has: (i) suffered any damage, destruction or loss of physical property (whether or not covered by insurance) which, individually or in the aggregate, has had or would reasonably be expected to have a Company Material Adverse Effect; (ii) issued, sold or otherwise disposed of, or agreed to issue, sell or otherwise dispose of, any shares of capital stock, membership interests or any other security of the Company or any Company Subsidiary and has not granted or agreed to grant any option, warrant or other right to subscribe for or to purchase any shares of capital stock, membership interests or any other security of the Company or any Company Subsidiary; (iii) incurred or agreed to incur any indebtedness for borrowed money other than the LaSalle Debt; (iv) paid or obligated itself to pay in excess of $100,000 in the aggregate for fixed assets; (v) except for the LaSalle Lien, mortgaged, pledged or subjected to any Lien, or agreed to mortgage, pledge or subject to any Lien, any of its properties or assets; (vi) declared, set aside or paid any dividend (whether in cash, property, capital stock or membership interest) with respect to any of its shares of capital stock, membership interests or other equity interests, as the case may be, or redeemed, purchased or otherwise acquired, or agreed to redeem, purchase or otherwise acquire, any of its shares of capital stock, membership interests or other equity interests, as the case may be; (vii) except for the Completion Bonuses, increased, or agreed to increase, the compensation or bonuses or special compensation of any kind of any of its officers, employees or agents over the rate being paid to them on September 30, 2004, other -11- than normal merit and/or cost-of-living increases pursuant to customary arrangements consistently followed, or adopted or increased any benefit under any insurance, Benefit Plan (as defined in Section 4.18(A)) or other arrangement made to, for or with any such officer, employee or agent; (viii) made or permitted, or agreed to make or permit, any material amendment or termination of any Material Business Contract other than in the ordinary course of business; (ix) received notice of the resignation or termination of employment of any of its officers or key employees or otherwise knows of any impending or threatened resignation or resignations or termination or terminations of employment of any of its officers or key employees that has had or would reasonably be expected to have a Company Material Adverse Effect; (x) had any labor strike or work stoppage, nor are there any pending proceedings relating to the certification or decertification of any labor union; (xi) made any material change in its accounting methods or practices with respect to its condition, operations, business, properties, assets or liabilities; (xii) made any material change in its Tax methods or practices, made any election with respect to Taxes (but, for the avoidance of doubt, the foregoing shall not be applicable to any change in Income Tax methods or practices or any election with respect to Income Taxes of Alleghany, even if the Company or any Company Subsidiary is required to conform to, or is bound by, such change or election) or entered into any agreement or arrangement with respect to Taxes; or (xiii) entered into any material transaction not in the ordinary course of its business. 4.9 Title to and Condition of Properties and Assets. (A) Except for the LaSalle Lien and except as set forth on Schedule 4.9 hereto, and except for sales of inventory and other assets made in the ordinary course of business since September 30, 2004, the Company and the Company Subsidiaries have good and legal title, free and clear of all Liens, to all of the properties and assets reflected as properties and assets owned by the Company or any Company Subsidiary in the September 30, 2004 Balance Sheet. (B) Except as set forth on Schedule 4.9 and except for sales of inventory and other assets made in the ordinary course of business since September 30, 2004, neither the Company nor any Company Subsidiary has sold, transferred or disposed of any assets or properties, individually or in the aggregate, having a book value or fair market value as of the date of sale, transfer or disposal in excess of $ 100,000. -12- (C) The facilities, machinery, furniture, office and other equipment used in the operation of the Business, taken as a whole, are in commercially reasonable operating condition and repair, taking into account their current use, age and ordinary wear and tear. EXCEPT FOR THE REPRESENTATIONS AND WARRANTIES SPECIFICALLY PROVIDED FOR HEREIN, ALL OF THE TANGIBLE ASSETS OF THE COMPANY ARE SOLD TO PURCHASER "WHEREAS" AND "AS IS" WITHOUT IMPLIED WARRANTY OF MERCHANTABILITY, FITNESS FOR INTENDED USE OR OTHERWISE. 4.10 Certain Properties. Neither the Company nor any Company Subsidiary owns any real estate. Schedule 4.10 sets forth all of the real property leased to the Company or any Company Subsidiary and specifies the location of each property, the use of the facility thereon, the name of the owner or the names of the lessor and the lessee, and the approximate square footage of improvements which are leased, as specified in each lease. The Company and Alleghany have delivered to HTI Acquisition (i) a copy of each lease by which the Company or any Company Subsidiary acquired its interest in the real estate described in Schedule 4.10 and (ii) to the extent in the possession of the Company, any of the Company Subsidiaries or Alleghany, a copy of all certificates of occupancy for the improvements on the real estate described in Schedule 4.10 and a copy of any variance granted with respect to any of such real estate described in Schedule 4.10, all of which documents are true and complete copies thereof as in effect on the date hereof, except as may otherwise be set forth in Schedule 4.10. Neither the Company nor any Company Subsidiary nor Alleghany has received any written notice from any Governmental Authority, with respect to any of the real estate described in Schedule 4.10 alleging a violation of Applicable Law which is the responsibility of the Company or any of the Company Subsidiaries to cure under a lease and which has not been cured. Except as set forth in Schedule 4.10 there is no sublease, occupancy agreement or like instrument to which the Company or any Company Subsidiary is a party with respect to any of the real estate described in Schedule 4.10. Each lease pursuant to which the Company or any Company Subsidiary leases any real property is in full force and effect and, to the Company's knowledge, is valid and enforceable in accordance with its terms. There is not under any such lease any default by the Company or any Company Subsidiary with regard to the payment of rent or any other material default including, without limitation, any default that could be a basis for termination of the lease. To the Company's Knowledge, there is no other default under any such lease by the Company or any Company Subsidiary, nor has there occurred any event that with notice or lapse of time or both would constitute such a default by the Company or any Company Subsidiary. To the Company's Knowledge, there is not under any such lease any default by any other party thereto or any event that with notice or lapse of time or both would constitute such a default thereunder by such party. 4.11 Taxes. Except as set forth on Schedule 4.11: (A) For all periods of its ownership of the Company during which the Company was treated as a corporation for Income Tax purposes, Alleghany has included (or, with respect to the taxable year including the Closing Date, will include) the Company and any of its corporate Company Subsidiaries in its federal Consolidated Income Tax Return as a member of the affiliated group of which Alleghany is the common parent. -13- (B) All material Tax Returns required to have been filed on or before the Closing Date by or with respect to the Company or any Company Subsidiary have been duly and timely filed (or, if due between the date hereof and the Closing Date, will be duly and timely filed), and all Taxes shown as due on any such Tax Return have been duly and timely paid (or, if due between the date hereof and the Closing Date, will be duly and timely paid). Each state Income Tax Return and each Non-Income Tax Return filed by or with respect to the Company or any Company Subsidiary was true, correct and complete in all material respects as of the time of its filing or after taking into account any changes reflected on any amended Tax Returns. (C) The accrued but unpaid Non-Income Taxes of the Company and the Company Subsidiaries did not, as of September 30, 2004, exceed the provision for Non-Income Tax liability set forth on the face of the September 30, 2004 Balance Sheet (rather than any notes thereto). Notwithstanding any statement on Schedule 4.11 or any other Schedule hereto, the Non-Income Taxes of the Company and the Company Subsidiaries that will have accrued (in accordance with GAAP applied in a manner consistent with the preparation of the Audited Financial Statements) but not been paid for taxable periods and portions thereof up to and including the Closing Date will not exceed the provision for Non-Income Taxes of the Company and the Company Subsidiaries on the Closing Date Balance Sheet. The Company and the Company Subsidiaries have withheld and paid all Taxes required to have been withheld and paid in connection with amounts paid or owing to any employee, former employee, creditor, independent contractor, shareholder, Affiliate, customer, supplier or other third party. (D) There is no dispute or claim concerning any Tax liability of the Company or any Company Subsidiary claimed or raised in writing by any Taxing Authority. No issues have been raised in writing in any examination by any Taxing Authority with respect to the Company or any Company Subsidiary which by application of similar principles reasonably could be expected to result in a proposed deficiency for any period not so examined. The Company has delivered to HTI Acquisition complete and correct copies of (i) all of the relevant Income Tax schedules, forms and information relating to the Company and the Company Subsidiaries, complete in all respects, to permit their inclusion in the Consolidated Income Tax Returns of Alleghany (but not the Consolidated Income Tax Returns of Alleghany) and (ii) all state, local and foreign Income Tax Returns filed by, and all Tax examination reports and statements of deficiencies assessed against or agreed to by, the Company or any Company Subsidiary since January 1, 2001. (E) There are no outstanding written requests, agreements, consents or waivers to extend the statutory period of limitations applicable to the assessment of any Taxes against the Company or any Company Subsidiary. None of the assets or properties of the Company or any Company Subsidiary constitute tax-exempt bond financed property or tax-exempt use property, within the meaning of Section 168 of the Code. None of the Company or any Company Subsidiary is a party to any "safe harbor lease" that is subject to the provisions of Section 168(f)(8) of the Internal Revenue Code as in effect prior to the Tax Reform Act of 1986. None of the Company or any Company Subsidiary is a party to any joint venture, partnership or other arrangement that is treated as a partnership for federal income tax purposes. (F) Except as shall be terminated pursuant to Section 10.2(B), none of the Company or any Company Subsidiary is a party to any agreement providing for the -14- allocation or sharing of Taxes. None of the Company or any Company Subsidiary has received or is subject to any written ruling of a Taxing Authority related to Taxes or has entered into any written and legally binding agreement with a Taxing Authority relating to Taxes. None of the Company or any Company Subsidiary has any liability for Taxes of any Person or entity (i) under Treasury Regulations Section 1.1502-6 or any similar provision of state, local or foreign law, other than in respect of Alleghany and the Company Subsidiaries, (ii) as a transferee or successor, (iii) by contract or (iv) otherwise. (G) Except as set forth in Schedule 4.11, there are no liens for Taxes upon the assets of the Company or any Company Subsidiary, except for liens for Taxes not yet due and payable and liens for Taxes that are being contested in good faith that are adequately reserved for on the Financial Statements. (H) The Company has been a properly treated as a corporation for federal income tax purposes since January 1, 2000. Heads & Threads (PA) has been disregarded as an entity separate from the Company for U.S. federal income tax purposes, within the meaning of Section 301.7701-3(b)(ii) of the Treasury regulations throughout the entire period of its existence. Heads & Threads (Mexico) (LLC) and the Mexican Company Subsidiaries are corporations for U.S. federal income tax purposes. 4.12 Contracts. (A) Schedule 4.12 sets forth a true and complete list of all of the following contracts (other than Benefit Plans) in effect as of the date hereof to which the Company or any of the Company Subsidiaries is a party or by which any of the assets or properties of the Company or any of the Company Subsidiaries is bound (collectively, the "Material Business Contracts"): (i) any contract with any labor union; (ii) any employment or consulting contract or other contract for services involving a payment of more than $75,000 annually; (iii) any lease, whether as lessor or lessee, with respect to Personal property providing for annual rental payments in excess of $25,000; (iv) other than the LaSalle Credit Agreement, any loan agreement or other instrument relating to any debt for money borrowed; (v) any contract of purchase or sale involving more than $100,000, except for contracts relating to the purchase or sale of inventory; (vi) any written contract with any agent, dealer or distributor providing for the marketing, sale and/or distribution of the products sold or distributed by the Company or any of the Company Subsidiaries; (vii) any stand-by letter of credit, guarantee or performance bond involving an amount in excess of $100,000; -15- (viii) any contract or agreement restricting the freedom or ability of the Company or any Company Subsidiary to engage in any line of business or to engage in business in any geographical area anywhere in the world; and (ix) any other contract involving payment of more than $50,000 per year, except for contracts entered into in the ordinary course of business relating to the purchase of supplies or services or to the sale of inventory. (B) All of the stand-by letters of credit guarantees and performance bonds to which the Company or any of the Company Subsidiaries is a party or by which any of the assets or properties of the Company or any of the Company Subsidiaries are bound involve in the aggregate an amount not in excess of $100,000. (C) Except for the consents identified on Schedule 4.5, no Material Business Contract requires any consent, approval, waiver or authorization by any third party for the consummation of the Merger and the other transactions contemplated by this Agreement. (D) Each of the Material Business Contracts is a valid and binding obligation of the Company and/or the Company Subsidiaries party thereto. To the Company's Knowledge, each of the Material Business Contracts is a valid and binding obligation of each other Person party thereto and is in full force and effect enforceable against the parties thereto in accordance with its terms. Except as specified in Schedule 4.12(c), neither the Company nor any of the Company Subsidiaries is in default under any of the Material Business Contracts, except for such defaults which would not, individually or in the aggregate, reasonably be expected to have a Company Material Adverse Effect. Except as specified in Schedule 4.12(c), to the knowledge of the Company, no party (other than the Company or any of the Company Subsidiaries) to a Material Business Contract is in default under such Material Business Contract, except for such defaults which would not, individually or in the aggregate, reasonably be expected to have a Company Material Adverse Effect. (E) The Company has made available to HTI Acquisition true and complete copies of all of the Material Business Contracts. 4.13 Litigation. Except as set forth in Schedule 4.13, since January 1, 2004, there has been no action, suit, proceeding or investigation, either at law or in equity, by or before any commission or other administrative authority in the United States or any foreign jurisdiction, or before any arbitration panel, of any kind pending or, to the Knowledge of the Company, threatened against the Company or any Company Subsidiary or any of their respective properties or assets that, if asserted and decided adversely to the Company or such Company Subsidiary, individually or in the aggregate, has had or would reasonably be expected to have a Company Material Adverse Effect. Except as set forth in Schedule 4.13, there is no outstanding judicial or administrative judgment, order, decree or restraint against the Company or any of the Company Subsidiaries or any of their respective properties or assets that, individually or in the aggregate, has had or would reasonably be expected to have a Company Material Adverse Effect. -16- 4.14 Intellectual Property. Except as set forth in Schedule 4.14, neither the Company nor any Company Subsidiary owns any patent relating to any product which it sells or any process used in the manufacture of any such product, nor has any license under any patent been granted to the Company or any Company Subsidiary relating to any such product or any such process, and to the Knowledge of the Company there is no patent which would cover any such product or any such process, and neither the Company nor any Company Subsidiary owns any registered copyright, trademark or trade name, nor has any license to use any registered copyright, trademark or trade name been granted to the Company or any Company Subsidiary. Each of the patents, registered copyrights, trademarks and trade names listed on Schedule 4.14 has been validly issued and is owned by the Company or a Company Subsidiary, and the Company and the Company Subsidiaries have the exclusive rights to use all such patents, copyrights, registered trademarks and trade names (if any) in the Business. Except as set forth in Schedule 4.14, the Company and the Company Subsidiaries own or have the right to use all patents, copyrights, trademarks, trade names, know-how, trade secrets and other proprietary rights (collectively, the "Proprietary Rights") necessary to conduct the Business in the manner in which it has heretofore been conducted, except where the failure to have such Proprietary Rights, individually or in the aggregate, has not had and would not reasonably be expected to have a Company Material Adverse Effect. To the Knowledge of the Company, there is no claim, nor is there a basis for any claim, that the Company or any Company Subsidiary has infringed any Proprietary Right of any other Person, except for those claims which, whether or not asserted, individually or in the aggregate, have not had and would not reasonably be expected to have a Company Material Adverse Effect. 4.15 Compliance with Laws. Except as set forth on Schedule 4.15, the Company and each of the Company Subsidiaries have complied and are in compliance with all Applicable Laws (including, without limitation, Applicable Laws relating to the importation of any inventory, labor union activities, civil rights, and equal employment opportunity or other similar laws), except where the failure to be in compliance with Applicable Laws, individually or in the aggregate, have not had and would not reasonably be expected to have a Company Material Adverse Effect. 4.16 Environmental Matters. Except as set forth in Schedule 4.16: (A) The Company and the Company Subsidiaries have obtained and hold all required Environmental Permits which are identified on Schedule 4.16 except where the failure to have such Permits, individually or in the aggregate, have not had and would not reasonably be expected to have a Company Material Adverse Effect and, to the Knowledge of the Company, each such Environmental Permit will remain valid and effective after the Closing, without any notice to or consent of any Governmental Authority. (B) The Company and the Company Subsidiaries are in compliance with all provisions of all applicable (i) Environmental Permits, and (ii) Environmental Laws, except for such failures to be in compliance which, individually or in the aggregate, have not had and would not reasonably be expected to have a Company Material Adverse Effect. (C) There are no pending, or to the Company's Knowledge, threatened Environmental Claims against the Company or any Company Subsidiary, except for such -17- pending or threatened Environmental Claims which, individually or in the aggreate, have not had and would not reasonably be expected to have a Company Material Adverse Effect. (D) To the Knowledge of the Company, no Releases of Hazardous Materials have occurred at, from, in, to, on, or under any Site which, under an applicable lease, is the responsibility of the Company or any of the Company Subsidiaries to remediate and which has not been remediated, and no Hazardous Materials are present in, on, about or migrating to or from any Site that have given rise or would reasonably be expected to give rise to an Environmental Claim against the Company or any Company Subsidiary. (E) To the Company's Knowledge, neither the Company nor any Company Subsidiary nor any predecessor of the Company or any Company Subsidiary, nor any entity previously owned by the Company or any Company Subsidiary, has transported or arranged for the treatment, storage, handling, disposal, or transportation of any Hazardous Material to any location at, from, in, to, on or under which a Release of Hazardous Materials has occurred that has resulted in or would reasonably be expected to result in an Environmental Claim against the Company or any Company Subsidiary, and which is not in compliance with any Environmental Permit or Environmental Law. (F) To the Knowledge of the Company, no Site currently, or at any time during the three year period ending on the date of this Agreement, leased by the Company or any Company Subsidiary is a current or proposed Environmental Clean-up Site. (G) To the Knowledge of the Company, there are no (i) underground storage tanks, active or abandoned, (ii) polychlorinated biphenyl containing equipment, or (iii) asbestos containing material which is friable at any Site which, under any applicable lease, is the responsibility of the Company or any of the Company Subsidiaries, and which is not in compliance with any Environmental Permit or Environmental Law. Except for liabilities and obligations assumed pursuant to the terms of the real property leases set forth on Schedule 4.10, neither the Company nor any Company Subsidiary has expressly assumed or undertaken, or agreed to assume or undertake, responsibility for any liability or obligation of any other Person, arising under or relating to Environmental Laws, including, but not limited to, any obligation for investigation, corrective or remedial action, nor, to the Company's Knowledge, has the Company or any of the Company Subsidiaries assumed or undertaken any such liability or obligation by operation of law, except, in each case, for such liabilities and obligations the performance of which, individually or in the aggregate, have not had, and would not reasonably be expected to have, a Company Material Adverse Effect. (H) There have been no environmental investigations, studies, audits, tests, reviews or other analyses conducted by, on behalf of, or which are in the possession of the Company or any Company Subsidiary (or, to the Company's Knowledge, any representative of either thereof) with respect to any Site currently, or at any time during the three year period ending on the date of this Agreement, leased by the Company or any Company Subsidiary which have not been delivered to HTI Acquisition prior to execution of this Agreement. 4.17 Governmental Authorizations and Regulations. Schedule 4.17 lists all licenses, franchises, permits and other governmental authorizations (collectively, "Permits") -18- held by the Company or any Company Subsidiary which are material to the conduct of the Business. All such Permits are valid and in full force and effect, and, except as set forth on Schedule 4.17, neither the Company nor any Company Subsidiary nor Alleghany has received any notice that any Governmental Authority intends to cancel, terminate or not renew any such Permit. The Company and the Company Subsidiaries hold all Permits which are necessary for the lawful operation of the Business, as conducted on the date hereof, except where the failure to have such Permits, individually or in the aggregate, have not had and would not reasonably be expected to have a Company Material Adverse Effect. 4.18 Employee Benefit Plans. (A) Each bonus, incentive compensation, deferred compensation, pension, profit sharing, retirement, stock purchase, stock option, stock ownership, stock appreciation rights, phantom stock, leave of absence, layoff, vacation, day or dependent care, legal services, cafeteria, life, health, accident, disability, workmen's compensation or other insurance, severance, separation or other employee benefit plan, practice, policy or arrangement of any kind, whether written or oral, or whether for the benefit of a single individual or more than one individual including, but not limited to, any "employee benefit plan" within the meaning of Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), (whether or not subject thereto), contributed to, maintained or sponsored by the Company or any Company Subsidiary or with respect to which the Company or any Company Subsidiary could have any liability to make contributions (collectively, the "Benefit Plans"), that is material alone or in combination with Benefit Plans of similar type, is listed on Schedule 4.18. (B) With respect to each Benefit Plan, the Company has made available to the HTI Acquisition a true and correct copy of (i) the most recent annual report (e.g., Form 5500), if any, for such Benefit Plan, (ii) any written plan document constituting or containing such Benefit Plan, (iii) each trust agreement, if any, relating to such Benefit Plan, (iv) the summary plan description, if any, for such Benefit Plan, (v) the most recent actuarial report or valuation, if any, relating to such Benefit Plan and (vi) the most recent determination letter or opinion letter, if any, from the IRS which covers such Benefit Plan, if such Benefit Plan is intended to be qualified under Section 401(a) of the Internal Revenue Code of 1986, as amended (the "Code"). (C) No Benefit Plan (i) is a "defined benefit plan" within the meaning of Section 3(35) of ERISA (whether or not subject thereto), (ii) is a "multiemployer plan" within the meaning of Section 3(37) of ERISA (whether or not subject thereto), (iii) is sponsored or maintained by Alleghany or any of its Affiliates (other than the Company or any of the Company Subsidiaries), or (iv) except as set forth on Schedule 4.18, provides post-retirement health or death benefit coverage (other than as required under Part 6 of Subtitle B of Title I of ERISA or Section 4980B of the Code). (D) Except as set forth on Schedule 4.18, to the Knowledge of the Company, each Benefit Plan has at all times been maintained and administered in all material respects in accordance with its terms and with the material requirements of all Applicable Law, including ERISA and the Code. To the Knowledge of the Company, each Benefit Plan intended to qualify under Section 401(a) of the Code has at all times since its adoption been so qualified, -19- and each trust which forms a part of any such plan has at all times since its adoption been Tax-exempt under Section 501(a) of the Code. There is no commitment or agreement (whether written or oral) that would prevent the termination or modification of any Benefit Plan that provides for post-retirement welfare benefits without the Company incurring any obligation or liability with respect to such termination or modification. (E) To the Knowledge of the Company, neither the Company nor any Company Subsidiary has incurred any liability (either directly, secondarily, jointly or contingently) under Title IV of ERISA or Sections 4971 through 4980G of the Code or under Section 502(i) or (1) of ERISA that has had or would have a Company Material Adverse Effect. (F) The consummation of the Merger and the other transactions contemplated by this Agreement, will not either alone or in conjunction with any other event, require any payment or benefit under any Benefit Plan that, in the absence of the transactions contemplated by this Agreement, would not be required, or accelerate the timing thereof. The Tax deductibility of any amount payable under any Benefit Plan will not be limited by operation of Section 280G of the Code. (G) No suit, action or other litigation (excluding claims for benefits incurred in the ordinary course of plan activities) which has had or could reasonably be expected to result in a Company Material Adverse Effect has been brought or, to the Knowledge of the Company, threatened with respect to any Benefit Plan and, to the Knowledge of the Company, there are no facts or circumstances known to the Company that could reasonably be expected to give rise to any such suit, action or other litigation. 4.19 Related Party Transactions. Except as set forth in Schedule 4.19, neither the Company nor any of the Company Subsidiaries is a party to any transaction (other than employee compensation and other agreements related to employment) and none is now proposed with any Person who is a director or officer of the Company or any of the Company Subsidiaries, or with Alleghany or any Company Subsidiary of Alleghany (other than the Company or a Company Subsidiary of the Company). 4.20 Certain Practices. (A) Accounting Practices. The books and records of the Company are complete and accurate in all material respects, and are maintained in accordance with customary business practices. (B) Certain Other Practices. Neither the Company nor any Company Subsidiary nor, to the Knowledge of the Company, any director, officer, agent, or employee of the Company or any Company Subsidiary has used any funds (corporate or otherwise) for any unlawful contribution, gift, entertainment or other expense relating to political activity or made any direct or indirect unlawful payment to any United States or foreign government official or employee from corporate funds or violated or is in violation of any provision of the Foreign Corrupt Practices Act of 1977. -20- 4.21 Minute Books. The Company's minute books which record the minutes of the meetings of its members, Board of Directors and committees thereof are complete and accurate in all material respects. 4.22 Insurance. Schedule 4.22 lists all policies of insurance maintained by the Company or by any of the Company Subsidiaries as of the date hereof, and each such insurance policy is a valid and binding obligation of the parties thereto and is in full force and effect enforceable in accordance with the terms. The Company and Alleghany have made available to HTI Acquisition prior to the date hereof true and complete copies of all such policies. 4.23 Bank Accounts; Powers of Attorney. Schedule 4.23 sets forth (i) the name of each bank, trust company or other financial institution in which the Company or any Company Subsidiary maintains an account or safe deposit box and the names of all Persons authorized to draw thereon or to have access thereto, and (ii) the names of all Persons, if any, holding powers of attorney from the Company or any Company Subsidiary and a summary statement of the terms thereof. 4.24 Product Warranties. Schedule 4.24 sets forth the Company's standard printed warranty used at all times since January 1, 2004 in connection with the sale or distribution of its products. To the Company's Knowledge, the Company has not used any other form of warranty which remains in effect with respect to any product that it has previously sold or distributed. There are no claims pending nor, to the Company's Knowledge, are there any claims threatened against the Company based upon any product warranty. Neither the Company nor any Company Subsidiary has manufactured any product during the period January 1, 1999 through the date hereof. 4.25 Customers and Suppliers. (A) The Company has heretofore delivered to HTI Acquisition lists of the ten largest customers of and the ten largest suppliers to the Company for the fiscal year of the Company ended December 31, 2003 and for the ten-month period ended October 31, 2004, including in each case for such period the approximate dollar amount of the sales to such customer or purchases from such supplier. As of the date of this Agreement, none of the ten largest customers of or suppliers to the Company identified for the ten-month period ended October 31, 2004 has given the Company written notice that it intends to terminate its business relationship with the Company. (B) The Company has heretofore delivered to HTI Acquisition (i) a list as of November 30, 2004 by scheduled month of delivery of all of the outstanding purchase orders of the Company exceeding $100,000 and (ii) a statement as to the approximate aggregate amount of all of the outstanding sales orders of the Company as of November 30, 2004. -21- 4.26 Certain Disclosures. Schedule 4.26 contains: (i) a list of all categories of products sold and/or distributed by the Company or any Company Subsidiary during the ten-month period ended October 31, 2004 through the date hereof; and (ii) a list by location of all machinery and equipment owned by the Company on the date hereof. 4.27 Employees. Schedule 4.27 sets forth a list of the names of all of the employees of the Company and of each of the Company Subsidiaries who were paid by the Company or any of the Company Subsidiaries salary and bonuses during the year ended December 31, 2003 (or whom the Company anticipates will be paid by the Company or any of the Company Subsidiaries salary and bonuses during the year ending December 31, 2004) aggregating $50,000 or more (excluding from such list (i) all Persons employed by the Atlas division of the Company (which was sold in November 2004) and (ii) any Person whose employment with the Company or any Company Subsidiary terminated on or before June 30, 2004), and their respective ages and positions with the Company or such Company Subsidiary, as the case may be, and such other information relating to such employees as is readily available to the Company or such Company Subsidiary. The Company agrees to provide periodic updates to the list prior to the Closing as may be reasonably requested by HTI Acquisition to reflect new hires and terminations. 4.28 Brokers. Except for HAAS Capital, the fees and expenses of which will be paid by Alleghany, no broker, finder or investment banker is entitled to any fee or commission in connection with the transactions contemplated hereby based upon arrangements made by or on behalf of the Company or Alleghany. 5. Representations and Warranties by HTI Acquisition. HTI Acquisition represents and warrants to the Company and Alleghany as follows: 5.1 Organization. HTI Acquisition is a limited liability company duly organized, validly existing and in good standing under the laws of the State of Delaware and has the power and authority to carry on the business now being conducted by the Company and to acquire and own and operate the properties, assets and business of the Company. HTI Acquisition has delivered to Alleghany complete and correct copies of the Certificate of formation and limited liability agreement of HTI Acquisition as in effect on the date hereof. 5.2 Authority. HTI Acquisition has the power to enter into this Agreement and to perform its obligations hereunder. The execution, delivery and performance of this Agreement and the consummation of the Merger and the other transactions contemplated hereby have been duly authorized by the Board of Managers of HTI Acquisition and by its members and no other proceeding on the part of HTI Acquisition is necessary to authorize the execution, delivery and performance of this Agreement and the consummation of the Merger and the other transactions contemplated hereby. This Agreement has been duly executed and delivered on behalf of HTI Acquisition, and, assuming the due authorization, execution and delivery of this Agreement by each of the other parties hereto, constitutes a legal, valid and -22- binding obligation of HTI Acquisition enforceable against HTI Acquisition in accordance with its terms, except as enforceability may be limited by bankruptcy, fraudulent conveyance, insolvency, reorganization, moratorium and other similar laws relating to or affecting creditors' rights generally or by general equitable principles (regardless of whether such enforceability is considered in a proceeding in equity or at law). 5.3 No Violation. Neither the execution, delivery and performance of this Agreement nor the consummation of the Merger or any of the other transactions contemplated hereby (i) will violate or conflict with the certificate of formation or limited liability company agreement of HTI Acquisition, (ii) will result in any breach of or default under any provision of any loan agreement, real property lease or other material agreement of any kind to which HTI Acquisition is a party or by which HTI Acquisition is bound or to which any property or asset of HTI Acquisition is subject and (iii) except for the filing of the Certificate of Merger with the Delaware Secretary of State, is prohibited by or requires HTI Acquisition to obtain or make any consent, authorization, approval, registration or filing under any Applicable Law to which HTI Acquisition is subject, or to which any property or asset of HTI Acquisition is subject, other than, in the case of clauses (ii) and (iii), any such conflicts, violations, breaches or defaults which would not, individually or in the aggregate, reasonably be expected to have a material adverse effect on the ability of HTI Acquisition to perform its obligations hereunder or to consummate the Merger and the other transactions contemplated hereby. 5.4 Litigation. There are no actions, suits, proceedings or investigations, either at law or in equity, by or before any commission or other administrative authority in the United States or any foreign jurisdiction, or before any arbitration panel, of any kind pending or, to the Knowledge of HTI Acquisition, threatened against HTI Acquisition or any of its properties or assets that, if asserted and decided adversely to HTI Acquisition, would reasonably be expected to, individually or in the aggregate, have a material adverse effect on the ability of HTI Acquisition to perform its obligations hereunder or to consummate the Merger and the other transactions contemplated hereby. 5.5 HSR Act. No Person "controls" HTI Acquisition within the meaning of the HSR Act. For purposes of the "size-of-the-parties" test under the HSR Act, HTI Acquisition has less than $10,000,000 in total assets and less than $10,000,000 in annual sales, and no requirements of the HSR Act apply to the acquisition of the Company by HTI Acquisition provided for hereunder. 5.6 Financing. HTI Acquisition has delivered to Alleghany (i) true, correct and complete signed counterpart(s) of commitment letters (the "Equity Commitment Letters"), dated on or prior to the date hereof, whereby the parties thereto (the "Equity Investors") have agreed, subject to the terms and conditions set forth therein, to make or cause to be made in HTI Holding equity investments in cash in the aggregate amount of not less than $25,000,000 (the "Equity Commitment"); (ii) a true, correct and complete signed counterpart of a letter agreement by and between HTI Holding and HTI Acquisition, dated on or prior to the date hereof, whereby HTI Holding has agreed to contribute the entire Equity Commitment to HTI Acquisition (the "Contribution Letter"); and (iii) true, correct and complete signed counterpart(s) of commitment letter(s), dated on or prior to the date hereof, pursuant to which -23- the lenders party thereto have agreed, subject to the terms and conditions set forth therein, to provided or cause to be provided debt financing in connection with the transactions provided for herein and revolving credit to HTI Acquisition (the "Commitment Letters" and, together with the Equity Commitment Letters and the Contribution Letter, the "Commitments"). The Commitments have not been amended in a manner that would be prohibited by the last sentence of this Section 5.6 and are, to the Knowledge of HTI Acquisition, in full force and effect. The Commitments are subject to no contingencies or conditions other than those set forth in the copies of the Commitments delivered to Alleghany. Subject to the terms and conditions of the Commitments, and subject to the terms and conditions of this Agreement, the Commitments would provide HTI Acquisition with acquisition financing at the Effective Time sufficient to consummate the Merger upon the terms contemplated by this Agreement (the "Acquisition Financing"). Nothing contained in this Agreement shall prohibit HTI Acquisition or the Equity Investors from entering into agreements relating to the financing or the operation of HTI Acquisition or the Surviving Equity, including adding other equity providers or operating partners; provided that (i) the aggregate amount of the Equity Commitment shall not be reduced in any way to less than $25,000,000 and (ii) HTI Acquisition shall have obtained any and all required consents of the lenders under the Commitment Letters. 5.7 Interim Operations of HTI Acquisition. HTI Acquisition was formed solely for the purpose of engaging in the transactions contemplated by this Agreement. HTI Acquisition has not owned, operated or conducted and, prior to the Effective Time, will not own, operate or conduct any businesses or activities other than in connection with its organization, the negotiation and execution of this Agreement, obtaining the Acquisition Financing (and any Substitute Financing) and the consummation of the transactions contemplated hereby. 5.8 Solvency. At the Effective Time, the Surviving Entity, after taking into account consummation of the Merger, the transactions contemplated by the Commitments (and any Substitute Financing) and the way HTI Acquisition intends that the businesses of the Company be operated after the Effective Time (including any agreements or arrangements by and among HTI Acquisition and the parties to the Commitments), (i) will be able to pay its debts, including its stated and contingent liabilities as they mature, (ii) will not have unreasonably small capital for the business in which it is and will be engaged and (iii) will be solvent. 5.9 Delivery of New Employment Agreements. HTI Acquisition has delivered to Alleghany true, correct and complete and signed counterparts of the New Employment Agreements. 5.10 Brokers. Except for Craig R. Stapleton, the fees and expenses of which will be paid by HTI Acquisition, no broker, finder or investment banker is entitled to any fee or commission in connection with the transactions contemplated hereby based upon arrangements made by or on behalf of HTI Acquisition. -24- 6. Covenants of the Company and Alleghany. The Company and Alleghany covenant and agree with HTI Acquisition as follows: 6.1 Access, Information and Documents. From the date hereof until the Closing, the Company will give to HTI Acquisition and to HTI Acquisition's authorized representatives (including, but not limited to, accountants, lawyers and appraisers) (collectively, "Representatives") full and complete access to any and all of the properties, assets, books, records and other documents of the Company and each Company Subsidiary to enable HTI Acquisition to make such examination of the business, properties, assets, books, records and other documents of the Company and each Company Subsidiary as HTI Acquisition may determine, such access to be provided at all reasonable times, upon reasonable notice and in a manner so as not to interfere with the normal operation of the Business. The Company will furnish, and will cause each Company Subsidiary to furnish, to HTI Acquisition such information and copies of such documents and records as HTI Acquisition shall reasonably request. 6.2 Conduct of Business Pending Closing. (A) From the date hereof until the Closing, except as set forth on Schedule 6.2 or any of the other Schedules hereto, as contemplated by this Agreement, or as consented to in writing by HTI Acquisition, the Company and the Company Subsidiaries will continue to conduct the Business in the ordinary course consistent with past practice. (B) Except as set forth on Schedule 6.2 or any of the other Schedules hereto, or as otherwise contemplated by this Agreement, from the date hereof until the Closing, except with the prior written consent of HTI Acquisition (which will not be unreasonably withheld or denied): (i) The Company will maintain its existence as a limited liability company duly organized, validly existing and in good standing under the laws of the State of Delaware; (ii) Neither the Company nor any of the Company Subsidiaries will make any commitment or commitments to purchase or spend involving $100,000 or more in any one instance or $500,000 or more in the aggregate, except for purchases of inventory in the ordinary course of its business; (iii) The Company will not declare, authorize or pay, and will not permit any of the Company Subsidiaries to declare, authorize or pay, any distribution or dividend to any of its members (but the foregoing shall not preclude the payment or distribution by the Company of an amount in respect of the provision for current Income Taxes), and the Company will not redeem, purchase or otherwise acquire or agree to redeem, purchase or otherwise acquire, and will not permit any of the Company Subsidiaries to redeem, purchase or otherwise acquire or to agree to redeem, purchase or otherwise acquire, any of its membership interests; -25- (iv) Except for the Completion Bonuses, the Company will not, and will not permit any of the Company Subsidiaries to, increase the compensation or employee benefits in effect on the date of this Agreement of any of the directors, officers or employees of the Company or any of the Company Subsidiaries, amend the current terms of any Benefit Plan or adopt any new plan or arrangement providing compensation or employee benefits for any of the directors, officers or employees of the Company or any of the Company Subsidiaries; (v) The Company will continue to carry, and will cause each of the Company Subsidiaries to continue to carry, all of its existing insurance policies (except that any such policy may be replaced, prior to the Closing, by a policy providing substantially similar coverage, and Schedule 4.22 may be updated prior to the Closing to reflect any such replacements); (vi) The Company will use, and will cause each of the Company Subsidiaries to use, reasonable efforts to preserve the Company's and each of the Company Subsidiaries' relationships with suppliers, distributors and customers and others having business relationships with the Company or any of the Company Subsidiaries; (vii) The Company will not, and will not obligate itself to, and will not permit any of the Company Subsidiaries to, or obligate itself to, sell or otherwise dispose of or pledge or otherwise encumber any of its properties or assets except for sales of inventory and except for other sales of its properties or assets in the ordinary course of business; (viii) The Company will continue to maintain, and will cause each of the Company Subsidiaries to continue to maintain, its facilities, machinery and equipment in the ordinary couse of busienss consistent with past practice; (ix) The Company will not amend its certificate of formation or limited liability company agreement, and the Company will not permit any of the Company Subsidiaries to amend its organizational documents; (x) The Company will not make, and will not permit any of the Company Subsidiaries to make, any material change in its accounting methods or practices; (xi) The Company will not make, and will not permit any of the Company Subsidiaries to make, any change in its Tax methods or practices, make any election with respect to Taxes or enter into any agreement or arrangement with respect to Taxes (but, for the avoidance of doubt, the foregoing shall not restrict Alleghany from making any change in its Income Tax methods or practices or making any election with respect to Income Taxes, even if the Company or any Company Subsidiary is required to conform to, or is bound by, -26- such change or election), if any such change, election, agreement or arrangement would have the effect of increasing the Tax liability of the Company and the Company Subsidiaries for any taxable period following the Closing Date; and (xii) Without limiting the foregoing, the Company and Alleghany will consult with HTI Acquisition regarding all significant developments, transactions and proposals relating to the Companies or any of the Company's Subsidiaries' business or operations. 6.3 Cooperation with Respect to Financing. Alleghany will cause the Company to provide reasonable assistance to HTI Acquisition in obtaining the Acquisition Financing (and any Substitute Financing), including by participating in meetings and due diligence sessions. 6.4 Consents and Approvals. The Company shall use commercially reasonable efforts to obtain, and to cause each of the Company Subsidiaries to obtain, prior to the Closing all consents, authorizations and approvals under all Applicable Laws of any Governmental Authority or of any other Person required to be obtained by the Company or any of the Company Subsidiaries in connection with the execution, delivery and performance of this Agreement and the consummation of the Merger and the other transactions contemplated hereby; provided, that the Company shall not be required to pay any landlord or other Person any money or other consideration in order to obtain any such consent, authorization or approval; provided, further, that the Company shall not otherwise be required to incur any unreasonable expenses in order to obtain any such consent, authorization or approval. 6.5 Transferred Assets and Transferred Liabilities. On or prior to the Closing Date, (i) the Company will transfer and assign to Alleghany, and Alleghany will accept and assume, the Transferred Liabilities and (ii) in consideration of the acceptance and assumption by Alleghany of the Transferred Liabilities, HTI will transfer and assign to Alleghany all of Alleghany's right, title and interest in and to the Transferred Assets. 6.6 Use of Name. Alleghany will not use, and will not permit any of its Affiliates to use, the name "Heads & Threads" or any derivative thereof in any way whatsoever at any time after the Closing. 6.7 No Solicitation of Offers. From the date of this Agreement until the Closing Date, other than in connection with the transactions contemplated hereby, Alleghany shall not, and shall cause the Company and its and their officers, directors, employees, representatives and agents not to, solicit, propose or facilitate (including by way of providing information regarding the Company to any third party), directly or indirectly, any inquiries, discussions or proposals for, continue or enter into negotiations looking toward, or enter into or consummate any agreement or understanding in connection with any proposal regarding any purchase or other acquisition of all or any portion of the assets or membership interests (whether newly issued or currently outstanding) of the Company (other than the sale of services or inventory or replacement of assets or other routine activities in the ordinary course of business) or any merger, business combination or recapitalization involving the Company. -27- 6.8 Confidential Information. Each of the Company and Alleghany agrees to use reasonable efforts, consistent with those employed by it prior to the date of this Agreement, to preserve and maintain the proprietary information and trade secrets used in the Business, and neither the Company nor Alleghany shall disclose to any third Person (other than HTI Acquisition and its Representatives) any proprietary information or trade secrets used in the Business other than such proprietary information or trade secrets which are a matter of public knowledge. The covenants on the part of Alleghany contained in this Section 6.9 shall survive the Closing, but the covenants of the Company contained in this Section 6.9 shall terminate at the Closing. 6.9 The Company's Obligations. Alleghany agrees to cause the Company to fully perform in all material respects each and every obligation of the Company under this Agreement to be performed by the Company prior to the Effective Time. 6.10 Commercially Reasonable Efforts. Subject to the terms and conditions of this Agreement, and specifically subject to the limitations on the obligations of the Company and Alleghany set forth in Section 6.4 hereof with regard to consents and approvals, each of the Company and Alleghany agrees to use all commercially reasonable efforts to take, or cause to be taken, all actions, and to do, or cause to be done, all things necessary, proper or advisable under all Applicable Laws to consummate the transactions contemplated hereby, including, without limitation, satisfaction of the conditions set forth in Section 9. 7. Covenants of HTI Acquisition. 7.1 Confidential Information. Prior to the Closing, HTI Acquisition and its Representatives shall keep confidential all information and documents provided to HTI Acquisition or its Representatives prior to the date of this Agreement or pursuant to Section 6.1 hereof in accordance with the terms set forth in the Confidentiality Agreement by and between Alleghany and Capital Partners dated as of August 27, 2004 (the "Confidentiality Agreement"), and HTI Acquisition agrees, on behalf of itself and each of its Representatives, to be bound by all of the terms of the Confidentiality Agreement as if it were a party thereto. The covenants of HTI Acquisition contained in this Section 7.1 shall terminate at the Closing. 7.2 Consents and Approvals. HTI Acquisition shall use its best efforts to obtain prior to the Closing all consents, authorizations and approvals under all Applicable Laws of any Governmental Authority or of any other Person required to be obtained by HTI Acquisition in connection with the execution, delivery and performance of this Agreement and the consummation of the Merger and the other transactions contemplated hereby; provided, that HTI Acquisition shall not be required to pay any landlord or other Person any money or other consideration in order to obtain any such consent; provided, further, that HTI Acquisition shall not otherwise be required to incur any unreasonable expenses in order to obtain any such consent, authorization or approval. 7.3 Financing Obligation. HTI Acquisition will use its best efforts to do or cause to be done all things necessary to consummate the Acquisition Financing. HTI Acquisition shall use commercially reasonable efforts to cause the Equity Investors to comply with the terms of their respective Equity Commitment Letters and to cause HTI Holding to -28- comply with the terms of the Commitment Letter. HTI Acquisition shall not, and shall use commercially reasonable efforts to cause the Equity Investors not to, amend or modify the terms of (i) the Commitment Letters (including all exhibits, annexes, schedules, fee letters and other ancillary documents) in a manner that would increase the conditionality of the Commitment Letters or in a manner that would adversely affect the ability of HTI Acquisition to consummate the transactions provided for herein or the likelihood of the Merger or (ii) the Equity Commitment Letters, in each case without the prior written consent of Alleghany. If funds in the amounts set forth in the Commitment Letters, or any portion thereof, become unavailable to HTI Acquisition on the terms and conditions set forth therein, HTI Acquisition shall use commercially reasonable efforts to obtain substitute financing ("Substitute Financing"). Prior to the Effective Time, HTI Acquisition will not amend or modify, or agree to amend or modify, any agreement or other document or plan, which, pursuant to the terms of the Commitment Letters, requires the lenders' prior consent to amend or is a condition to the lenders' obligations thereunder, without the prior written consent of the lenders party to the Commitment Letters and any other Person whose consent is required pursuant to the Commitment Letters, which consent(s) shall acknowledge that such amendment or modification does not relieve such lender or other Person of its obligations pursuant to the Commitment Letters. For the avoidance of doubt, nothing contained in this Agreement shall obligate any Equity Investor to provide any credit support, guarantee or other payment to the lenders in addition to those currently contained in the Commitment Letters (other than making their equity contributions pursuant to the Equity Commitment Letters) in connection with HTI Acquisition obtaining the Acquisition Financing or any Substitute Financing. 7.4 Acquisition Financing. The indebtedness contemplated by the Commitment Letters (or any Substitute Financing) shall be incurred by HTI Acquisition at or prior to the Effective Time. 7.5 Annual Incentive Plan. HTI Acquisition shall continue the existing annual incentive plans of the Company in accordance with their terms at least through December 31, 2004, and the Surviving Entity shall make all incentive payments in respect of calendar year 2004 provided for thereunder in accordance with the terms of such plans. 7.6 Payment of Certain Debt. At the Closing, HTI Acquisition will repay in full (i) the Alleghany Debt and (ii) the LaSalle Debt. 7.7 Certain Post-Closing Matters. (A) On and after the Closing Date, HTI Acquisition (or any successor company) shall have all liability and responsibility for meeting all requirements under "COBRA," as hereinafter defined, with respect to each Person who becomes an "M&A qualified beneficiary," within the meaning of Treasury Regulation Section 54.4980B-9, Q/A-4(b), because of the transactions contemplated by this Agreement. For these purposes, "COBRA" shall mean the health care continuation coverage described in Section 4980B of the Code, Section 601 through 608 of ERISA and any applicable state law which requires the continuation of health care coverage to a terminated employee. (B) For policy periods commencing on and after April 1, 1996, -29- Alleghany has mainted certain umbrella insurance policies for the benefit of Alleghany and its subsidiaries on a group-wide basis (the "Alleghany Umbrella Policies"). Coverage under some or all of such Alleghany Umbrella Policies may be available to HTI Acquisition, as the Surviving Entity in the Merger, from and after the Closing. HTI Acquisition agrees that, from and after the Closing, (i) HTI Acquisition will assert any claim which it seeks to make under an Alleghany Umbrella Policy only through Alleghany (and Alleghany agrees to use all commercially reasonable efforts to assert any such claim on behalf of HTI Acquisition), and (ii) HTI Acquisition will not seek to assert any claim which, together with all other claims asserted by HTI Acquisition, would cause the aggregate amount of claims asserted under an Alleghany Umbrella Policy to exceed $5 million in any policy period. For the avoidance of doubt, Alleghany makes no representation or warranty as to the availability of coverage under any Alleghany Umbrella Policy to HTI Acquisition after the Effective Time. (C) Following the Closing, HTI Acquisition shall allow Alleghany, at Alleghany's expense and with counsel of its choice, to assume complete control of the prosecution and collection of the Customs Refund. HTI Acquisition shall fully cooperate with and assist Alleghany in the prosecution and collection of the Customs Refund to the same extent as if it were an Income Tax Claim described in Section 10.4, except that Alleghany shall have sole control over the prosecution and collection of the Customs Refund and shall be entitled to settle or dispose of the Customs Refund without HTI Acquisition's consent. If, as, and to the extent any of the Customs Refund is received by HTI Acquisition, HTI Acquisition shall promptly (and in any event within 5 business days) pay the amount of the Customs Refund received by it to Alleghany. To the extent that all or any part of the Customs Refund may be assigned or transferred, upon the request of Alleghany, HTI Acquisition will assign or transfer the Customs Refund in accordance with that request. HTI Acquisition's sole obligation with respect to the Customs Refund shall be to cooperate with Alleghany in the prosecution and collection of such Customs Refund and to promptly pay over to Alleghany all or any part of the Customs Refund collected (or to transfer and assign the Customs Refund as requested). (D) Alleghany agrees to reimburse HTI Acquisition (or any successor thereto) for the reasonable costs (including, without limitation, administrative costs and any insurance premiums directly attributable to) of providing retiree medical benefits to Leon Bookman and his spouse. HTI Acquisition agrees that it will use a reasonable basis to determine such costs and to submit to Alleghany not more frequently than each calendar quarter a statement of such costs (in reasonable detail). Alleghany agrees to reimburse such costs to HTI Acquisition promptly (and, in any event, within 30 days of submission to Alleghany). HTI Acquisition agrees to continue to provide post-retirement medical benefits to Lee Bookman and his spouse pursuant to the Heads & Threads Health Care Benefits Plan, as the same may be amended or modified from time to time by HTI Acquisition (but no such amendment and modification shall discriminate as between the medical benefits provided to Bookman and his spouse and the comparable medical benefits provided to other senior executives of HTI Acquisition, if applicable) as long as Alleghany reimburses HTI Acquisition for such costs; provided that nothing herein shall limit HTI Acquisition's right or ability to terminate or modify retiree medical coverage provided to any other employee or retiree of HTI Acquisition. Alleghany shall use its commercially reasonable best efforts to establish or provide comparable or equivalent replacement retiree medical benefits for Lee Bookman and his spouse, which -30- Alleghany shall reasonably pursue, and when Alleghany has established or provided comparable or equivalent replacement retiree medical benefits for Lee Bookman and his spouse, the obligations of the parties under this Section 7.7(D) (including, without limitation, the obligation of HTI Acquisition to provide such post-retirement medical benefits) shall cease. 7.8 Commercially Reasonable Efforts. Subject to the terms and conditions of this Agreement, and specifically subject to the limitations on the obligations of HTI Acquisition set forth in Section 7.2 hereof with regard to consents and approvals, HTI Acquisition agrees to use all commercially reasonable efforts to take, or cause to be taken, all actions, and to do, or cause to be done, all things necessary, proper or advisable under all Applicable Laws to consummate the transactions contemplated hereby, including, without limitation, satisfaction of the conditions set forth in Section 8. 8. Conditions Precedent to the Company's and Alleghany's Obligations to Effect the Merger. The obligations of the Company and Alleghany to effect the Merger is subject to the fulfillment prior to or at the Closing of each of the following conditions (unless waived by the Company and Alleghany): 8.1 Representations and Warranties; Performance. (A) All representations and warranties made by HTI Acquisition contained in this Agreement shall be true and correct in all material respects (except that materiality qualifiers contained in such representations and warranties shall be disregarded for purposes of this Section 8.1(A)) as of the date hereof and, except for any representations and warranties which are made as of a particular date (which shall be true and correct as of such date), as of the Closing Date, except for any changes permitted by the terms hereof or consented to in writing by the Company and Alleghany. (B) HTI Acquisition shall have performed and complied in all material respects with all of the terms, provisions and conditions of this Agreement to be performed and complied with by HTI Acquisition at or before the Closing. 8.2 Consents and Approvals. All consents, authorizations and approvals required to be obtained by Alleghany, the Company or HTI Acquisition in connection with the execution, delivery and performance of this Agreement and the consummation of the Merger and the other transactions contemplated hereby from any Governmental Authority, including, without limitation, the expiration or termination of the waiting period under the HSR Act, if applicable, shall have been obtained. All consents, authorizations and approvals required to be obtained by Alleghany, the Company or HTI Acquisition in connection with the execution, delivery and performance of this Agreement and the consummation of the Merger and the other transactions contemplated hereby from any Persons which are not Governmental Authorities and which are set forth on Schedule 8.2 hereof shall have been obtained. 8.3 No Injunction. No Governmental Authority of competent jurisdiction shall have issued any order, injunction or decree that is in effect and restrains, enjoins or otherwise prohibits the consummation of the Merger. -31- 8.4 Solvency Opinion. Houlihan Lokey Howard & Zukin shall have delivered an opinion addressed to Alleghany in the form attached as Exhibit C hereto. 8.5 Certificates. Alleghany shall have received a certificate of a senior executive officer of HTI Acquisition, dated the Closing Date, to the effect set forth in Section 8.1(A) and Section 8.1(B). In addition, Alleghany shall have received certificates, dated the Closing Date, executed by each of Greg Brown, Fred J. Weber and Michael Wrenn, respectively, certifying that, to the best of such individual's knowledge, the representations and warranties made by or on behalf of the Company in this Agreement are true and correct in all material respects (except that materiality qualifiers shall be disregarded for purposes of such certificates) as of the date hereof and, except for any representations and warranties which are made as of a specified date (which shall be true and correct as of such date), as of the Closing Date, except for any changes permitted by the terms hereof or consented to in writing by HTI Acquisition. 9. Conditions Precedent to HTI Acquisition's Obligation to Effect the Merger. The obligation of HTI Acquisition to effect the Merger is subject to the fulfillment prior to or at the Closing of each of the following conditions (unless waived by HTI Acquisition): 9.1 Representations and Warranties; Performance. (A) All representations and warranties made by the Company and Alleghany contained in this Agreement shall be true and correct in all material respects (except that materiality qualifiers contained in such representations and warranties shall be disregarded for purposes of this Section 9.1(A)) as of the date hereof and, except for any representations and warranties which are made as of a particular date (which shall be true and correct as of such date), as of the Closing Date, except for any changes permitted by the terms hereof or consented to in writing by HTI Acquisition. (B) Each of Alleghany and the Company shall have performed and complied in all material respects with all of the terms, provisions and conditions of this Agreement to be performed and complied with by it at or before the Closing. 9.2 Consents and Approvals. All consents, authorizations and approvals required to be obtained by Alleghany, the Company or HTI Acquisition in connection with the execution, delivery and performance of this Agreement and the consummation of the Merger and the other transactions contemplated hereby from any Governmental Authority, including, without limitation, the expiration or termination of the waiting period under the HSR Act, if applicable, shall have been obtained. All consents, authorizations and approvals required to be obtained by the Company or HTI Acquisition in connection with the execution, delivery and performance of this Agreement and the consummation of the Merger and the other transactions contemplated hereby from any third Persons which are not Governmental Authorities shall have been obtained except for those consents, authorizations and approvals which, if not obtained, would not, individually or in the aggregate, (i) materially impair the ability of the Surviving Entity to conduct the Business substantially as the Business is now being conducted or (ii) have or reasonably be expected to have a Company Material Adverse Effect. -32- 9.3 Availability of Financing. The Acquisition Financing shall have been consummated on the terms set forth in the Commitments, or HTI Acquisition shall have received the proceeds of a Substitute Financing. 9.4 No Injunction. No Governmental Authority of competent jurisdiction shall have issued any order, injunction or decree that is in effect and restrains, enjoins or otherwise prohibits the consummation of the Merger. 9.5 Certificates. HTI Acquisition shall have received a certificate of a senior executive officer of each of the Company and Alleghany, dated the Closing Date, to the effect set forth in Section 9.1(A) and Section 9.1(B). 10. Tax Matters. 10.1 Tax Returns. (A) Alleghany shall, or shall cause the Company and the Company Subsidiaries to, prepare and timely file all Tax Returns of or including the Company and/or the Company Subsidiaries that are required to be filed (with extensions) on or before the Closing Date and shall timely pay all Taxes shown as due on such Tax Returns. All such Tax Returns will be prepared and filed by Alleghany, the Company or the Company Subsidiaries in a manner consistent with the prior practice of Alleghany, the Company or the Company Subsidiaries, as applicable. HTI Acquisition shall, or shall cause the Company and the Company Subsidiaries to, prepare and file all Tax Returns of or including the Company or any of the Company Subsidiaries (other than any federal Income Tax Returns) that are required to be filed (with extensions) following the Closing Date for all taxable periods ending prior to, or that include, the Closing Date and (subject to Section 10.1(C) in respect of Income Tax Returns) shall pay any Taxes shown as due on such Tax Returns. All such Tax Returns that are Income Tax Returns will be prepared and filed by HTI Acquisition in a manner consistent with the prior practice of Alleghany, the Company or the Company Subsidiaries, as applicable. (B) For each taxable year of Alleghany for which the Company and any of the Company Subsidiaries are included for all or any part of such taxable year on any Consolidated Income Tax Return of Alleghany that is due (with extensions) to be filed after the Closing Date, HTI Acquisition shall prepare, or shall cause the Company Subsidiaries to prepare, in a manner consistent with the prior practice of the Company, and deliver to Alleghany no later than June 15th of the immediately following calendar year, all relevant Tax schedules, forms and information relating to the Company and the Company Subsidiaries, complete in all material respects, to permit their inclusion in the Consolidated Income Tax Returns of Alleghany for each such taxable year. (C) In the case of any Income Tax Return of the Company or any of the Company Subsidiaries that is not a federal Income Tax Return and that is required to be filed with respect to any taxable period that ends before or includes the Closing Date (each, a "Pre-Closing Income Tax Return"), HTI Acquisition shall provide Alleghany with a copy of such completed Pre-Closing Income Tax Return, together with the related work papers and such other documents as Alleghany shall reasonably request, no later than 30 days before the due date for -33- the filing of such Pre-Closing Income Tax Return. Alleghany and its authorized representatives shall have the right to review the Pre-Closing Income Tax Returns received from HTI Acquisition pursuant to this Section 10.1(C). If the Pre-Closing Income Tax Return is not in a Straddle Period, HTI Acquisition shall make such changes to any Pre-Closing Income Tax Return as requested by Alleghany for which there is a reasonable basis in fact and law, and if the Pre-Closing Income Tax Return is for a Straddle Period and Alleghany disputes the treatment of any items on the Income Tax Returns prepared by HTI Acquisition, Alleghany and HTI Acquisition agree to consult with each other and attempt to resolve in good faith any such dispute. If the parties are unable to resolve any dispute with respect to a Pre-Closing Income Tax Return for a Straddle Period within 60 days after the receipt of any such Pre-Closing Income Tax Return, the parties shall submit such dispute to a mutually acceptable national accounting firm (which shall not be the accountants who regularly audit the financial statements of Alleghany or HTI Acquisition), whose decision shall be conclusive and binding on the parties. Alleghany and HTI Acquisition shall each pay one-half of the fees and expenses of such accounting firm. No fewer than 5 days before the due date for the filing of such Pre-Closing Income Tax Return, Alleghany shall pay to HTI Acquisition an amount equal to the Income Tax shown on such Pre-Closing Income Tax Return, or if the Pre-Closing Income Tax Return is for a Straddle Period, the amount of such Income Tax that is attributable to Alleghany pursuant to Section 10.1(D). However, if any dispute relating to a Pre-Closing Income Tax Return for a Straddle Period has not been resolved prior to the due date for the filing of such Pre-Closing Income Tax Return, the Tax Return in question, to the extent any issues thereon remain unresolved, shall be filed (and Alleghany shall make payments pursuant to this Section 10.1(C)) in accordance with the positions taken by HTI Acquisition; provided that the fact that such Tax Return will have been filed in accordance with HTI Acquisition's position shall not be taken into account for purposes of any dispute resolution under this Section 10.1(C). If a determination is made through the dispute resolution process after a Pre-Closing Income Tax Return is filed that HTI Acquisition's position was inappropriate, HTI Acquisition shall promptly file an amended Income Tax Return in respect of such taxable period (to the extent permitted by Applicable Law) reflecting the final decision of the accounting firm and an adjusting payment will be made by Alleghany to HTI Acquisition or HTI Acquisition to Alleghany, as the case may be, to reflect any difference between the Income Tax due with respect to the amended Income Tax Return and the Income Tax due with respect to the Income Tax Return as originally filed. (D) Alleghany and HTI Acquisition agree that for all Income Tax purposes, the taxable period of the Company and the Company Subsidiaries which began on January 1st of the calendar year in which the Closing Date occurs shall be terminated as of the close of business on the Closing Date and items of income, gain, loss, deduction or credit shall be apportioned for all Income Tax purposes on a basis consistent with, or the principles applicable in the preparation of, the Closing Date Balance Sheet. Alleghany and HTI Acquisition further agree to file all Income Tax Returns, handle the contest of any audit and otherwise act for all Tax purposes consistent with the provisions of this paragraph 10.1(D). If any taxable period for a non-federal Income Tax begins before but ends after the Closing Date (a "Straddle Period"), then the portion of any Income Tax in such Straddle Period for which Alleghany shall be responsible for all purposes of this Section 10 shall be calculated as if the portion of the Straddle Period ending on the Closing Date was a separate taxable period, except -34- that exemptions, allowances, deductions or credits that are calculated on an annual basis (such as the deduction for depreciation or capital allowances) shall be apportioned on a per diem basis. 10.2 Post-Closing Tax Matters. (A) To the extent relevant for a taxable period for which the requesting party is charged with payment responsibility for Taxes under this Section 10, each of Alleghany and HTI Acquisition will provide the other (and the other's attorneys, accountants and agents) with, and the Surviving Entity, after the Closing Date, shall provide, and shall cause the Company Subsidiaries to provide, Alleghany (and Alleghany's attorneys, accountants and agents) with, the right, at reasonable times and upon reasonable notice, to have access to, and to copy and use, any records or information and personnel which may be relevant for the preparation of any Tax Returns, the determination of amounts due under Section 10.3, any audit or other examination by any Taxing Authority, the filing of any claim for a refund of Tax or for the allowance of any Tax credit, or any judicial or administrative proceedings relating to liability for Taxes. The party requesting assistance hereunder shall reimburse the other party for reasonable out-of-pocket expenses incurred in providing such assistance. Any information obtained pursuant to this Section 10.2(A) shall be held in strict confidence and shall be used solely in connection with the reason for which it was requested. (B) Alleghany shall cause the Tax Sharing Agreement and/or any similar arrangement with respect to Taxes involving the Company or the Company Subsidiaries to be terminated effective as of the Closing Date. To the extent any such agreement or arrangement obligates the Company or the Company Subsidiaries to make any payments with respect to Taxes after the Closing Date, none of the Company, the Company Subsidiaries or Alleghany shall have any obligation under any such agreement or arrangement for any past, present or future period. Except as agreed to by HTI Acquisition, all powers of attorney granted by the Company and any of the Company Subsidiaries with respect to Taxes shall be revoked as of the Closing Date. (C) Except as otherwise provided in this Agreement, any refund of Income Taxes (other than any refund of Income Tax shown as an asset on the Closing Date Balance Sheet) with respect to the Company or any of the Company Subsidiaries that is received with respect to any Pre-Closing Tax Period or the portion of any Straddle Period for which Alleghany is responsible pursuant to Section 10.1(D) shall be for the account of Alleghany, and to the extent that HTI Acquisition or any of the Company Subsidiaries receives any such refund (or such refund is applied against any Tax for which Alleghany is not responsible) after the Closing Date, the amount of such refund and interest thereon or fairly attributable thereto (net of any Taxes imposed with respect to the receipt or accrual of such refund and interest and any reasonable expenses incurred in connection with obtaining the refund) shall be promptly paid to Alleghany. -35- 10.3 Alleghany Indemnity for Taxes. Alleghany shall pay and shall indemnify and hold harmless HTI Acquisition, the Company, the Company Subsidiaries and all Affiliates of HTI Acquisition against any and all Losses resulting from or relating to: (i) Income Taxes of the Company and the Company Subsidiaries for all Pre-Closing Tax Periods and the portion of any Straddle Period for which Alleghany is responsible (including, for the avoidance of doubt, all Income Taxes resulting from the Merger); (ii) the several liability of the Company and the Company Subsidiaries in respect of Income Taxes pursuant to Treasury Regulations Section 1.1502-6 or any analogous state, local or foreign law or regulation or by reason of the Company and the Company Subsidiaries having been a member of any consolidated, combined or unitary group on or prior to the Closing Date; and (iii) Income Taxes of any Person or entity other than the Company or any of the Company Subsidiaries pursuant to any agreement or contract, whether written or unwritten, entered into by the Company or any of the Company Subsidiaries on or before the Closing Date, or as a transferor or successor, by contract or otherwise. and any and all actions, suits, demands, assessments or judgments with respect to any claim arising out of or relating to the subject matter of the indemnification. 10.4 Matters Involving Income Tax Claims. If a claim is made or threatened by any Taxing Authority that, if successful, may result in an indemnity payment under Section 10.3 (an "Income Tax Claim"), HTI Acquisition shall notify Alleghany stating the nature and basis of such claim, and the amount thereof, to the extent known. Failure to give such notice shall not relieve Alleghany from any liability that it may have on account of this indemnification or otherwise, except to the extent that Alleghany is precluded from, or materially prejudiced in, the defense of such claim thereby. Alleghany will have the right, at its option, upon timely notice to HTI Acquisition, to assume at its own expense control of any audit or other defense of any Income Tax Claim with its own counsel. Alleghany's right to control an Income Tax Claim will be limited to issues in respect of which amounts in dispute would be paid by Alleghany or for which Alleghany would be liable pursuant to Section 10.3. Costs of such Income Tax Claims are to be borne by Alleghany unless the Income Tax Claim relates to a Straddle Period, in which event such costs shall be fairly apportioned. HTI Acquisition, the Company and the Company Subsidiaries at their own expense shall cooperate with Alleghany in contesting any Income Tax Claim, which cooperation shall include the retention and, upon Alleghany's request, providing of records and information that are reasonably relevant to such Income Tax Claim and making employees available on a mutually convenient basis to provide additional information or explanation of any material provided hereunder. Notwithstanding the foregoing, (i) Alleghany shall not have the right to solely control any Income Tax Claim unless it first acknowledges in writing its obligation to fully indemnify HTI Acquisition for the Income Taxes at issue in the proceeding, (ii) no settlement or disposition of any Income Tax Claim shall be made without HTI Acquisition's consent (which consent shall not be unreasonably withheld, -36- conditioned or delayed) if the same could reasonably be expected to adversely affect HTI Acquisition's, the Company's or any of the Company Subsidiary's Income Tax Liability for Taxes in a taxable year or period beginning after the Closing Date, and (iii) HTI Acquisition and Alleghany shall jointly control all proceedings taken in connection with any claims for Income Taxes relating solely to a Straddle Period of any of the Company or the Company Subsidiaries, and each party shall bear its own out-of-pocket costs and expenses of the contest and all joint costs and expenses of the contest shall be borne in the same ratio as the applicable proposed Income Tax would be allocated. 10.5 Transfer Taxes. Alleghany and HTI Acquisition shall each pay one-half of all Transfer Taxes, if any, that result from the Merger. Alleghany and HTI Acquisition shall cooperate in the preparation and filing of all Tax Returns and other documentation relating to any such Transfer Taxes including any that relate to any applicable exemption therefrom. 10.6 FIRPTA. On the Closing Date, Alleghany shall cause the Company to provide HTI Acquisition with a certificate in the form required by Treasury Regulation Section 1.1445-2(b)(2) of the Code and the regulations promulgated thereunder to the effect that the Company is not a "foreign person" within the meaning of Section 1445(f) of the Code. 10.7 Survival. All rights and obligations under this Section 10 shall survive the Merger and continue indefinitely, except that the survival of the representations and warranties in Section 4.11 shall be governed by Section 12.1. 11. Termination. This Agreement may be terminated at any time prior to the Closing by the mutual agreement in writing of HTI Acquisition and Alleghany. In addition, this Agreement may be terminated at any time prior to the Closing as follows: 11.1 Termination by HTI Acquisition. HTI Acquisition may, without liability to the Company or Alleghany, terminate this Agreement by written notice to Alleghany if an event occurs that makes it impossible to satisfy any condition to Closing set forth in Section 9 of this Agreement; provided, that the right to terminate this Agreement pursuant to this Section 11.1 shall not be available to HTI Acquisition if any breach on the part of HTI Acquisition of any provision of this Agreement has been the cause of, or resulted in, such impossibility. 11.2 Termination by Alleghany. Alleghany may, without liability to HTI Acquisition, terminate this Agreement by written notice to HTI Acquisition if an event occurs that makes it impossible to satisfy any condition to Closing set forth in Section 8 of this Agreement; provided, that the right to terminate this Agreement pursuant to this Section 11.2 shall not be available to Alleghany if any breach on the part of Alleghany or the Company of any provision of this Agreement has been the cause of, or resulted in, such impossibility. 11.3 Termination by Alleghany or by HTI Acquisition. Either Alleghany, on the one hand, or HTI Acquisition, on the other hand, may terminate this Agreement upon written notice to the other if the Closing shall not have occurred on or before -37- February 28, 2005 (the "Termination Date"); notwithstanding the foregoing, (i) the right to terminate this Agreement pursuant to this Section 11.3 shall not be available to HTI Acquisition (x) if any breach on the part of HTI Acquisition of any provision of this Agreement has been the cause of, or resulted in, the failure of the Closing to occur on or before the Termination Date, or (y) if HTI Acquisition has failed to comply in all material respects with its obligations set forth in Section 7.3 and Section 7.8 of this Agreement; and (ii) the right to terminate this Agreement pursuant to this Section 11.3 shall not be available to Alleghany (x) if any breach on the part of Alleghany or the Company of any provision of this Agreement has been the cause of, or resulted in, the failure of the Closing to occur on or before the Termination Date, or (y) if either Alleghany or the Company has failed to comply in all material respects with its obligations set forth in Section 6.12 of this Agreement. 11.4 Effect of Termination. If this Agreement is terminated, this Agreement shall no longer be of any force or effect and there shall be no liability on the part of any party or its respective directors, officers or shareholders other than for damages to the extent arising from a prior breach of this Agreement which is a willful and material breach; provided, however, that the Confidentiality Agreement, including the obligations of HTI Acquisition and its Representatives thereunder as set forth in this Agreement, shall continue in full force and effect in accordance with its terms. 12. Survival of Representations and Warranties; Indemnification. 12.1 Survival of Representations and Warranties. All representations and warranties contained in this Agreement shall survive the Closing and remain operative and in full force and effect, regardless of any investigation heretofore made or hereafter made by any of the parties hereto, for a period of 18 months; provided, however, (i) all representations and warranties made pursuant to Sections 4.11 (Taxes) and Section 5.8 (Solvency) shall survive the Closing for a period continuing until 60 days from and after the expiration of all applicable statutes of limitations (including extensions) and (ii) all representations and warranties made pursuant to Sections 4.2 (Membership Interests Ownership), Section 4.4 (Authority) and Section 5.2 (Authority) shall survive indefinitely. 12.2 Alleghany's Indemnification Obligations. Subject to the terms and conditions of this Section 12, and other than in respect of matters with respect to which Alleghany is obligated to provide indemnification pursuant to Section 10.3, which are governed solely by Section 10 hereof, Alleghany agrees to indemnify and hold HTI Acquisition harmless against any and all Losses, except as expressly limited by the terms of Section 12.3, resulting from or relating to: (A) any breach of any representation or warranty of the Company or Alleghany contained in this Agreement or in any certificate delivered by the Company or Alleghany at the Closing; provided that any claim for indemnification made by HTI Acquisition for indemnification from Alleghany under this paragraph (A) may be made no later than a date 18 months from and after the Closing Date, excepting only that (i) any claim for breach of any representation or warranty under Section 4.11 (Taxes) may be made no later than a date 60 days from and after the expiration of all applicable statutes of limitation (including extensions) and (ii) -38- any claim for breach of any representation or warranty under Section 4.2 (Membership Interests Ownership), or Section 4.4 (Authority) may be made at any time; (B) any breach of any covenant of the Company or Alleghany contained in this Agreement; provided that any claim made by HTI Acquisition for indemnification from Alleghany under this paragraph (B) for the breach of any covenant of the Company or Alleghany contained in this Agreement may be made no later than a date one year from and after the last day of the period during which such covenant was to be performed; and (C) for any obligation, liability (including any liability under Section 4062, 4063 or 4064 of ERISA), lien, fine, penalty or Tax with respect to, or by reason of, any employee benefit plan (within the meaning of Section 3(3) of ERISA) of any entity (other than the Company or any of the Company Subsidiaries) which has ever been considered a single employer with Alleghany under Section 4001(b) of ERISA or Section 414(b), (c), (m) or (o) of the Code prior to the Closing Date. For purposes of the indemnification provided in Section 12.2(A), in determining whether the representations and warranties of the Company or Alleghany have been breached, no effect will be given to any materiality qualifier set forth in such representations and warranties or related definitions. For purposes of determining the extent to which Alleghany has breached any representation contained in Section 4.11 of this Agreement, in the case of any Straddle Period, (i) in the case of any Non-Income Tax of the Company or any of the Company Subsidiaries that is based on specific receipts, transactions, events or occurrences, the portion of such Non-Income Tax that is attributable to the portion of the Straddle Period ending on the Closing Date shall be determined by reference to the date of the receipt, transaction, event or occurrence giving rise to the liability for such Non-Income Tax, and (ii) in the case of any Non-Income Taxes of the Company or any of the Company Subsidiaries that are imposed on a periodic, annual or other basis not related to specific receipts, transactions, events or occurrences, the portion of such Non-Income Taxes of the Company or any of the Company Subsidiaries attributable to the portion of the Straddle Period ending on the Closing Date shall equal the total amount of such Non-Income Taxes for the period in question, multiplied by a fraction, the numerator of which is the number of days in such period in the Straddle Period through and including the Closing Date, and the denominator of which is the total number of days in such period with respect to which such Non-Income Tax accrues or is imposed in the Straddle Period. 12.3 Limitation on Alleghany's Indemnification Obligations. Except as hereinafter provided in this Section 12.3, Alleghany shall have no obligation to provide indemnification pursuant to Section 12.2(A) except to the extent that the aggregate amount of indemnification to which HTI Acquisition, but for this Section 12.3, otherwise shall have become entitled hereunder would exceed $375,000 ("Alleghany's Basket"), in which event Alleghany shall be obligated, subject to the next succeeding sentence, to provide indemnification with respect to all amounts in excess of Alleghany's Basket. Notwithstanding anything contained in this Agreement to the contrary, in no event shall Alleghany have any -39- liability for indemnification pursuant to Section 12.2(A) in an aggregate amount in excess of $10,000,000 ("Alleghany's Cap"). Notwithstanding anything to the contrary in this Agreement, Alleghany shall be obligated to provide indemnification pursuant to Section 12.2(A) for any and all amounts owing by Alleghany to HTI Acquisition pursuant to Section 12.2(A) as a result of any fraud involving a Knowing breach of a representation or warranty of the Company or Alleghany made in this Agreement, and Alleghany's Basket and Alleghany's Cap referred to in the immediately preceding paragraph shall be calculated without taking into account any such amounts. Notwithstanding anything to the contrary in this Agreement, Alleghany shall be obligated to provide indemnification pursuant to Section 12.2 (B) and Section 12.2(C) without limitation and without regard to Alleghany's Basket or Alleghany's Cap referred to in the immediately preceding paragraph. 12.4 HTI Acquisition's Indemnification Obligations. Subject to the terms and conditions of this Section 12, and other than in respect of Income Taxes, which are governed solely by Section 10 hereof, HTI Acquisition agrees to indemnify and hold Alleghany harmless against any and all Losses, except as expressly limited by the terms of Section 12.5, resulting from or relating to: (A) any breach of any representation or warranty of HTI Acquisition contained in this Agreement or in any certificate delivered by HTI Acquisition to the Company or Alleghany at the Closing; provided that any claim made by Alleghany for indemnification from HTI Acquisition under this paragraph (A) may be made no later than a date 18 months from and after the Closing Date, excepting only that (i) any claim for breach of any representation or warranty under Section 5.8 (Solvency) may be made no later than a date 60 days from and after the expiration of all applicable statutes of limitation (including extensions) and (ii) any claim for breach of any representation or warranty under Section 5.2 (Authority) may be made at any time; and (B) any breach of any covenant of HTI Acquisition contained in this Agreement; provided that any claim made by Alleghany for indemnification from HTI Acquisition under this paragraph (B) for the breach of any covenant of HTI Acquisition contained in this Agreement may be made no later than a date one year from and after the last day of the period during which such covenant was to be performed. For purposes of the indemnification provided in Section 12.4(A), in determining whether the representations and warranties of HTI Acquisition have been breached, no effect will be given to any materiality qualifier set forth in such representations and warranties or related definitions. 12.5 Limitation on HTI Acquisition's Indemnification Obligations. Except as hereinafter provided in this Section 12.5, HTI Acquisition shall have no obligation to provide indemnification pursuant to Section 12.4(A) except to the extent that the aggregate amount of indemnification to which Alleghany, but for this Section 12.5, otherwise shall have become entitled hereunder would exceed $375,000 ("HTI Acquisition's Basket"), in which -40- event HTI Acquisition shall be obligated, subject to the next succeeding sentence, to provide indemnification with respect to all amounts in excess of HTI Acquisition's Basket. Notwithstanding anything contained in this Agreement to the contrary, in no event shall HTI Acquisition have any liability for indemnification pursuant to Section 12.4(A) in an aggregate amount in excess of $1,000,000 ("HTI Acquisition's Cap"); provided, however, that HIT Acquisition's Cap shall not apply, and no other limitation shall apply, to the indemnification obligation of HTI Acquisition in respect of the breach of any representation or warranty set forth in Section 5.8 (Solvency). Notwithstanding anything to the contrary in this Agreement, HTI Acquisition shall be obligated to provide indemnification pursuant to Section 12.4(A) for any and all amounts owing by HTI Acquisition to Alleghany pursuant to this Section 12.4(A) as a result of any fraud involving a Knowing breach of a representation or warranty of HTI Acquisition made in this Agreement, and HTI Acquisition's Basket and HTI Acquisition's Cap referred to in the immediately preceding paragraph shall be calculated without taking into account any such amounts. Notwithstanding anything to the contrary in this Agreement, HTI Acquisition shall be obligated to provide indemnification pursuant to Section 12.4(B) without limitation and without regard to HTI Acquisition's Basket or HTI Acquisition's Cap referred to in the immediately preceding paragraph. 12.6 Other Limitations on Indemnification. (A) The amount of any Losses sustained by an indemnified party shall be reduced (i) by any amount received by such indemnified party with respect thereto under any insurance coverage relating thereto (other than insurance coverage provided by an Affiliate of such indemnified party) or from any third party (not a party to this Agreement) alleged to be responsible therefor, and (ii) by the amount of any Tax benefit actually realized with respect to the Loss. Each of Alleghany and HTI Acquisition agrees to use commercially reasonable efforts to collect any amounts available under such insurance coverage and from any such third party alleged to have responsibility and to realize any Tax benefit with respect to the Loss. If an indemnified party realizes a Tax benefit or receives an amount under insurance coverage or from any such third party with respect to Losses sustained at any time subsequent to any indemnification provided pursuant to this Section 12, then such indemnified party shall promptly reimburse the indemnifying party for any payment made by such indemnifying party in connection with providing such indemnification up to such amount realized or received by such indemnified party. Nothing in this Section 12.6(A) shall limit in any way the ability of Alleghany or HTI Acquisition to (i) take (or refrain from taking, as the case may be) any reasonable position for Tax purposes that it determines to take (or refrain from taking) in its sole discretion, or (ii) refrain from pursuing any third party insurance recovery that Alleghany or HTI Acquisition, as the case may be, determines would be commercially inadvisable to pursue. (B) Each indemnified party shall be obligated to use its reasonable best efforts to mitigate to the fullest extent practicable the amount of any Loss for which its it entitled to seek indemnification hereunder, and the indemnifying party shall not be required to make any -41- payment to an indemnified party in respect of such Loss to the extent such indemnified party has failed to comply with the foregoing obligation. (C) Upon making any indemnification payment, the indemnifying party will, to the extent of such payment, be subrogated to all rights of the indemnified party against any third party in respect of the Loss to which the payment relates; provided, however, that until the indemnified party recovers full payment of its Loss, any and all claims of the indemnifying party against any such third party on account of said payment are hereby made expressly subordinated and subjected in right of payment to the indemnified party's rights against such third party. Without limiting the generality of any other provision hereof, each such indemnified party and indemnifying party will duly execute upon request all instruments reasonably necessary to evidence and perfect the above described subrogation and subordination rights. (D) Neither Alleghany nor HTI Acquisition shall have any right to set off any Losses against any payments to be made by such party pursuant to this Agreement. 12.7 Notice. In the event that either Alleghany or HTI Acquisition wishes to assert a claim for indemnification under this Section 12, the party seeking indemnification (the "Indemnified Party") shall deliver written notice (a "Claims Notice") to the other party (the "Indemnifying Party") no later than twenty (20) Business Days after such claim becomes known to the Indemnified Party, specifying the facts constituting the basis for, and the amount (if known) of the claim asserted. Failure to deliver a Claims Notice with respect to a claim in a timely manner as specified in the preceding sentence shall not release the Indemnifying Party from any of its obligations under this Section 12, except to the extent the Indemnifying Party is materially prejudiced by such failure. 12.8 Right to Contest Claims of Third Parties. (A) If an Indemnified Party asserts, or may in the future seek to assert, a claim for indemnification hereunder because of an Action instituted by any Person not a party to this Agreement (a "Third-Party Claimant") that may result in a Loss with respect to which the Indemnified Party would be entitled to indemnification pursuant to this Section 12 (an "Asserted Liability"), the Indemnified Party shall deliver to the Indemnifying Party a Claims Notice with respect thereto, which Claims Notice shall, in accordance with the provisions of Section 12.7 hereof, be delivered as promptly as practicable and in any event no later than twenty (20) Business Days after such Asserted Liability is actually known to the Indemnified Party. The failure to deliver a Claims Notice with respect to an Asserted Liability within twenty (20) Business Days of the Indemnified Party's receipt of written notice of such Asserted Liability shall not release the Indemnifying Party from any of its obligations under this Section 12, except to the extent the Indemnifying Party is materially prejudiced by such failure. (B) (i) The Indemnifying Party shall, upon receipt of such notice and upon its notifying the Indemnified Party in writing that it shall, either unconditionally or subject to a reservation of rights, indemnify the Indemnified Party in respect of such matter, be entitled to participate in or, at the Indemnifying Party's option, assume at its own expense the defense, appeal or settlement of such Asserted Liability with respect to which such indemnity -42- has been invoked with counsel of its own choosing (who shall be reasonably satisfactory to the Indemnified Party), and the Indemnified Party shall fully cooperate with the Indemnifying Party in connection therewith including contesting such Asserted Liability or making any counterclaim against the Third Party Claimant; provided, however, that if the Indemnifying Party assumes the defense, appeal or settlement of such Asserted Liability, (i) the Indemnifying Party shall reimburse the Indemnified Party for out of pocket expenses incurred by the Indemnified Party (such as travel costs, but not internal time charges) and (ii) if, in the reasonable opinion of counsel to the Indemnified Party, an actual conflict of interest exists between the Indemnifying Party and the Indemnified Party in respect of such Asserted Liability, the Indemnified Party shall be entitled to employ one counsel to represent itself, and in that event the reasonable fees and expenses of such counsel shall be paid by the Indemnifying Party. An Indemnified Party is hereby authorized prior to the date on which its receives written notice from the Indemnifying Party that it intends to assume the defense, appeal or settlement of such Asserted Liability, to file any motion, answer or other pleading and take such other action which it shall reasonably deem necessary to protect its interest or that of the Indemnifying Party until the date on which the Indemnified Party receives such notice from the Indemnifying Party; provided that, prior to filing such motion, answer or other pleading or taking such other action, the Indemnified Party shall have made reasonable efforts to consult with the Indemnifying Party. In the event that the Indemnifying Party fails to assume the defense, appeal or settlement of such Asserted Liability within twenty (20) days after receipt of notice thereof from the Indemnified Party, such Indemnified Party shall have the right to undertake the defense or appeal of or settle or compromise such Asserted Liability on behalf of and for the account and risk of the Indemnifying Party, unless and until the Indemnifying Party notifies the Indemnified Party that it has elected to assume such defense, appeal or settlement. If the Indemnifying Party fails to assume the defense, appeal or settlement of such Asserted Liability and the Indemnified Party undertakes such defense, appeal or settlement, the Indemnified Party shall, upon the request of the Indemnifying Party, keep the Indemnifying Party advised of relevant developments on a timely basis. (ii) Except as set forth in Section 12.8(B)(i), no claim or demand may be settled by the Indemnified Party without the consent of the Indemnifying Party, which consent shall not be unreasonably delayed or withheld. Unless the claim or demand seeks only dollar damages (all of which are to be paid by the Indemnifying Party), no such claim or demand may be settled by the Indemnifying Party without the consent of the Indemnified Party, which consent shall not be unreasonably delayed or withheld. (iii) Alleghany and HTI Acquisition shall make mutually available to each other all relevant information in their possession relating to any Asserted Liability and shall cooperate with each other in the defense thereof. 12.9 Indemnification Payments. Any indemnification payment hereunder shall be made by wire transfer of immediately available funds to such account or accounts as the Indemnified Party shall designate to the Indemnifying Party in writing. 12.10 Treatment of Indemnification Payments. Alleghany and HTI Acquisition agree to treat, to the maximum extent permitted by Applicable Law, any payments -43- under this Section 12 or under Section 10 hereof as an adjustment to the Merger Consideration for all Tax purposes. 12.11 Exclusive Remedy. If the Closing occurs, absent any fraud, the indemnification provided for in this Section 12 and in Section 10 hereof shall be the sole and exclusive remedy in any action seeking money damages or any other form of monetary relief brought by any party to this Agreement. The terms of this Section 12.11 shall not be construed as limiting in any way whatsoever any remedy (i) in the event of any fraud or (ii) other than for the recovery of money damages or another form of monetary relief. 13. Non-Competition. For a period of three years commencing on the Closing Date (the "Non-Compete Period"), Alleghany will not, and Alleghany will not permit any Company Subsidiary of Alleghany to, directly or indirectly, market, sell or distribute, anywhere in the world (within or without North America), any product which, at the time of Closing, is marketed, sold or distributed, or which, to the Knowledge of Alleghany at the time of Closing, is proposed to be marketed, sold or distributed, by the Company (any such marketing, sale or distribution, a "Competing Activity"); provided, however, that the foregoing restrictions shall not prevent Alleghany or any of the Company Subsidiaries, during the Non-Compete Period, from (i) holding or acquiring for investment purposes only any interest in securities of a Person which are listed or quoted or traded on any generally recognized market; provided that such securities amount to less than ten percent (10%) of the outstanding securities of such Person and carry less than ten percent (10%) of the voting rights attaching to the outstanding securities of that Person, or (ii) purchasing an entity or group of entities (an "Acquired Entity") that engages in a Competing Activity, so long as the gross revenues of the Competing Activity do not exceed 15% of the gross revenues of the Acquired Entity during the most recent fiscal year of the Acquired Entity ended before the date of acquisition of the Acquired Entity. If, at the time of enforcement of this Section 13, a court shall hold that the duration, scope or area restrictions stated herein are unreasonable under circumstances then existing, the parties agree that the maximum duration, scope or area reasonable under such circumstances shall be substituted for the stated duration, scope or area and that the court shall be allowed to revise the restrictions contained herein to cover the maximum period, scope and area permitted by law. 14. Miscellaneous. 14.1 Fees and Expenses. Whether or not the Merger is consummated, each of the parties will pay all of its own fees and expenses (including, without limitation, the fees and expenses of attorneys, accountants, investment bankers and other representatives and agents) incurred in connection with this Agreement and the transactions contemplated hereby. Without limiting the foregoing, all such fees and expenses of the Company incurred prior to the Merger in connection with the performance of the obligations of the Company pursuant to this Agreement and the transactions contemplated hereby shall be paid by the Company and, except as specifically provided otherwise in Section 3.2 hereof, shall be fully accrued on the Closing Date Balance Sheet. The fees and expenses of Houlihan Lokey Howard & Zukin shall be shared equally by Alleghany and HTI Acquisition. For the avoidance of doubt, no fees and expenses described in this Agreement as payable by HTI Acquisition (including without limitation fees and expenses of the Designated Accountants payable by HTI Acquisition pursuant to Section 3.2(C), fees and expenses of the Independent Accountants payable by HTI -44- Acquisition pursuant to Section 3.2(H), fees and expenses of Craig Stapleton payable by HTI Acquisition pursuant to Section 5.10, and fees and expenses of Houlihan Lokey Howard & Zukin payable by HTI Acquisition pursuant to this Section 14.1) shall be reflected on the Closing Date Balance Sheet. 14.2 Waiver. The parties hereto may by written agreement (i) extend the time for or waive or modify the performance of any of the obligations or other acts of the parties hereto or (ii) waive any inaccuracies in the representations and warranties contained in this Agreement or in any document delivered pursuant to this Agreement. 14.3 Notices. All notices, requests or other communications hereunder shall be in writing and shall be deemed to have been duly given if delivered or mailed first class certified mail postage prepaid addressed as follows: if to HTI Acquisition, to HTI Acquisition LLC, c/o Capital Partners, Inc. Eight Greenwich Office Park, Third Floor, Greenwich, CT 06831, attention Brian D. Fitzgerald, Chairman (with a copy to Samuel B. Fortenbaugh III, Esq., 1211 Avenue of the Americas, 27th Floor, New York, New York 10036); if to the Company or Alleghany, to Alleghany Corporation, 375 Park Avenue, New York, NY 10152, attention Robert M. Hart, Esq., Senior Vice President and General Counsel (with a copy to Aileen C. Meehan, Esq., Dewey Ballantine LLP, 1301 Avenue of the Americas, New York, NY 10019-6092), or to such other address as may have been furnished in writing to the party giving the notice by the party to whom notice is to be given. 14.4 Entire Agreement; Amendment. This Agreement, together with the Confidentiality Agreement, which shall continue in full force and effect until Closing, embodies the entire agreement among the parties and there have been and are no agreements, representations or warranties, oral or written among the parties other than those set forth or provided for in this Agreement. No party hereto has relied upon any oral or written statement, representation, warranty, covenant, condition, understanding or agreement made by any other party or any representative, agent or employee thereof, except for those expressly set forth in this Agreement or in the Exhibits, Schedules or certificates delivered pursuant hereto. Disclosure on any one of the Schedules hereto constitutes disclosure on each other Schedule as applicable (to the extent that the relevance of such disclosure for each such other schedule is reasonably evident from the text thereof). This Agreement may be amended, modified, superseded or supplemented only by an instrument in writing executed and delivered by the parties hereto. 14.5 Rights Under this Agreement; Nonassignability. This Agreement shall bind and inure to the benefit of the parties hereto and their respective successors and assigns, but shall not be assignable by any party without the prior written consent of the other parties, which consent shall not be unreasonably withheld or delayed. Nothing contained in this Agreement is intended to confer upon any Person, other than the parties to this Agreement and their respective successors and assigns, any rights, remedies, obligations or liabilities under or by reason of this Agreement. 14.6 Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New York, without regard to any -45- applicable conflicts of law provisions thereof that may require the application of the laws of another jurisdiction. The parties hereby irrevocably submit to the exclusive jurisdiction of the courts of the State of New York and the federal courts of the United States of America located in the State of New York in respect of all matters that arise out of or are related to this Agreement or the documents referred to in or contemplated by this Agreement and the transactions contemplated hereby and thereby and hereby waive, and agree not to assert, as a defense in any action for the interpretation or enforcement hereof or of any such document, that is not subject thereto or that such action may not be brought or is not maintainable in said courts or that the venue thereof may not be appropriate or that this Agreement or any such document may not be enforced in or by such courts, and the parties irrevocably agree that all claims with respect to such action shall be heard and determined in such a New York State or federal court. The parties hereby consent to and grant any such court jurisdiction over the Person of such parties and over the subject matter of such dispute and agree that mailing of process or other papers in connection with any such action in the manner provided in this Section 14.6 or in such other matter as may be permitted by law shall be valid and sufficient service thereof. 14.7 Waiver of Jury Trial. EACH PARTY HEREBY IRREVOCABLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY LAW, ALL RIGHTS TO TRIAL BY JURY IN ANY ACTION, PROCEEDING OR COUNTERCLAIM (WHETHER BASED UPON CONTRACT, TORT OR OTHERWISE) ARISING OUT OF OR RELATING TO THIS AGREEMENT OR ANY OF THE TRANSACTIONS CONTEMPLATED HEREBY. 14.8 Specific Performance. Without intending to limit the remedies available to any party hereto, each party (i) acknowledges that breach of this Agreement will result in irreparable harm for which there is no adequate remedy at law, and (ii) agrees that any party seeking to enforce this Agreement shall be entitled to injunctive relief, including specific performance, or other equitable remedies upon any such breach. 14.9 Publicity. No party to this Agreement shall, without the prior written consent of the other parties hereto, issue any press release or otherwise make any public statement with respect to this Agreement or the transactions contemplated hereby, except for such press releases or other statements as the disclosing party may reasonably determine are required by applicable law. 14.10 Headings; References to Sections, Exhibits and Schedules. The headings of the Sections, paragraphs and subparagraphs of this Agreement are solely for convenience and reference and shall not limit or otherwise affect the meaning of any of the terms or provisions of this Agreement. The references herein to Sections, Exhibits and Schedules, unless otherwise indicated, are references to Sections of and exhibits and schedules to this Agreement. 14.11 Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be an original, but which together constitute one and the same instrument. REMAINDER OF PAGE INTENTIONALLY LEFT BLANK - -46- IN WITNESS WHEREOF, the parties have duly executed this Agreement as of the date first above written. HTI ACQUISITION LLC By: /s/ Brian D. Fitzgerald ------------------------------------ Brian D. Fitzgerald Chairman HEADS & THREADS INTERNATIONAL LLC By: /s/ Fred J. Weber ------------------------------------ Fred J. Weber Vice President - Finance and Chief Financial Officer ALLEGHANY CORPORATION By: /s/ David B. Cuming ------------------------------------ David B. Cuming Senior Vice President -47- EXHIBIT A The following terms have the following meanings and such meanings are equally applicable to both the singular and the plural forms of the terms defined: "Acquired Entity" has the meaning set forth in Section 13. "Acquisition Financing" has the meaning set forth in Section 5.6. "Affiliate" means, in respect of any Person, a Person that, directly or indirectly, through one or more intermediaries, controls, is controlled by or is under common control with such Person. "Alleghany Debt" means all of the outstanding indebtedness of the Company to Alleghany, which amount as of the date hereof is and at the Closing will be $3,081,000. "Alleghany Umbrella Policies" has the meaning set forth in Section 7.7(B). "Alleghany's Basket" has the meaning set forth in Section 12.3. "Alleghany's Cap" has the meaning set forth in Section 12.3. "Allocation" has the meaning set forth in Section 3.3. "Applicable Law" means any applicable order, law, statute, regulation, rule, ordinance, writ, injunction, directive, judgment, decree, principle of common law, constitution or treaty enacted, promulgated, issued, enforced or entered by any Governmental Authority, including any amendments thereto that may be adopted from time to time. "Asserted Liability" has the meaning set forth in Section 12.8(A). "Audited Financial Statements" has the meaning set forth in Section 4.6(A). "Benefit Plans" has the meaning set forth in Section 4.18(A). "Business" means the business of the Company and the Company Subsidiaries, taken as a whole. "Business Day" means any day, other than a Saturday, Sunday and any day which is a legal holiday in the State of New York, or is a day on which banking institutions located in the State of New York are authorized or required by Applicable Law or other governmental action to close. "Claim" means any claim (including any cross-claim or counterclaim), demand, investigation, chose in or cause of action, suit, default, assessment, litigation, third party action, arbitral proceeding or proceeding by or before any Governmental Authority or any other Person. "Claims Notice" has the meaning set forth in Section 12.7. "Closing" has the meaning set forth in Section 2.2. "Closing Date" has the meaning set forth in Section 2.2. "Closing Date Balance Sheet" has the meaning set forth in Section 3.2(A). "Closing Date Book Value" has the meaning set forth in Section 3.2(C). "COBRA" has the meaning set forth in Section 6.5. "Code" has the meaning set forth in Section 4.18(B). "Commitments" has the meaning set forth in Section 5.6. "Commitment Letters" has the meaning set forth in Section 5.6. "Company" has the meaning set forth in the Recitals. "Company Subsidiary" or "Company Subsidiaries" has the meaning set forth in Section 4.3. "Company Material Adverse Effect" has the meaning set forth in Section 4.1. "Competing Activity" has the meaning set forth in Section 13. "Completion Bonuses" has the meaning set forth in Section 3.2(B). "Confidentiality Agreement" has the meaning set forth in Section 7.1. "Consolidated Income Tax Return" means any consolidated, combined, unitary or Affiliated Income Tax Return of Alleghany that the Company is required or eligible to join. "Contribution Letter" has the meaning set forth in Section 5.6. "Customs Refund" means the right to receive the refund (plus any interest thereon or credited with respect thereto) of the antidumping duties in the approximate amount of $419,302 paid to the Bureau of Customs and Border Protection, U.S. Department of Homeland Security, for excessive antidumping duties on entries of helical lockwashers from October 1, 1997 through September 30, 1998. "DLLCA" has the meaning set forth in Section 2.1 "December 31, 2003 Balance Sheet" has the meaning set forth in Section 4.6(A). "Delaware Secretary of State" has the meaning set forth in Section 2.3. "Designated Accountants" has the meaning set forth in Section 3.2(C). 2 "Effective Time" has the meaning set forth in Section 2.3. "Environment" means all air, surface water, groundwater, or land, including land surface or subsurface, including all fish, wildlife, biota and all other natural resources. "Environmental Claim" means any and all Claims, pursuant to or relating to any applicable Environmental Law by any Person based upon, alleging, asserting, or claiming any actual or potential (i) violation of or liability under any Environmental Law, (ii) violation of any Environmental Permit, or (iii) liability for investigatory costs, cleanup costs, removal costs, remedial costs, response costs, natural resource damages, property damage, personal injury, fines, or penalties arising out of, based on, resulting from, or related to the presence, Release, or threatened Release into the Environment, of any Hazardous Materials at any location, including, but not limited to any location to which Hazardous Materials or materials containing Hazardous Materials were sent for handling, storage, treatment, or disposal. "Environmental Clean-up Site" means any location which is listed or proposed for listing on the National Priorities List, the Comprehensive Environmental Response, Compensation, and Liability Information System, or on any similar state list of sites requiring investigation or cleanup. "Environmental Law" means any and all federal, state, local, provincial and foreign, civil and criminal laws, statutes, ordinances, orders, common law, codes, rules, regulations, Environmental Permits, judgments, decrees or injunctions with any Governmental Authority, relating to the protection of health and the Environment, worker health and safety, and/or governing the handling, use, generation, treatment, storage, transportation, disposal, manufacture, distribution, formulation, packaging, labeling, or Release of Hazardous Materials, whether now existing or subsequently amended or enacted, including, but not limited to: the Clean Air Act, 42 U.S.C. Section 7401 et seq.; the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, 42 U.S.C. Section 9601 et seq.; the Federal Water Pollution Control Act, 33 U.S.C. Section 1251 et seq.; the Hazardous Material Transportation Act 49 U.S.C. Section 1801 et seq.; the Federal Insecticide, Fungicide and Rodenticide Act 7 U.S.C. Section 136 et seq.; the Resource Conservation and Recovery Act of 1976 ("RCRA"), 42 U.S.C. Section 6901 et seq.; the Toxic Substances Control Act, 15 U.S.C. Section 2601 et seq.; the Occupational Safety & Health Act of 1970, 29 U.S.C. Section 651 et seq.; the Oil Pollution Act of 1990, 33 U.S.C. Section 2701 et seq.; and the state analogies thereto, all as amended or superseded from time to time; and any common law doctrine, including, but not limited to, negligence, nuisance, trespass, personal injury, or property damage related to or arising out of the presence, Release, or exposure to a Hazardous Material. "Environmental Permit" means any federal, state, local, provincial, or foreign permit, license, approval, consent or authorization required by any Governmental Authority under or in connection with any Environmental Law. "ERISA" has the meaning set forth in Section 4.18(A). "Equity Commitment" has the meaning set forth in Section 5.6. 3 "Existing Employment Agreements" means the Employment Agreements in effect as of the date hereof between the Company and each of Gregory R. Brown, Fred J. Weber and Michael T. Wrenn. "GAAP" has the meaning set forth in Section 4.6(B). "Governmental Authority" means any government or political subdivision thereof, whether foreign or domestic, federal, state, provincial, county, local, municipal or regional, or any other governmental entity, agency, authority, department, division or instrumentality of any such government, political subdivision or other governmental entity, any court, and any government self-regulatory organization or other quasi-governmental authority. "Hazardous Material" means petroleum, petroleum hydrocarbons or petroleum products, petroleum by-products, radioactive materials, asbestos or asbestos-containing materials, gasoline, diesel fuel, pesticides, radon, urea formaldehyde, lead or lead-containing materials, polychlorinated biphenyls; and any other chemicals, materials, substances or wastes in any amount or concentration which are now or hereafter become defined as or included in the definition of "hazardous substances," "hazardous materials," "hazardous wastes," "extremely hazardous wastes," "restricted hazardous wastes," "toxic substances," "toxic pollutants," "pollutants," "regulated substances," "solid wastes," or "contaminants" or words of similar import, under any Environmental Law. "Heads & Threads (Mexico)" means Heads & Threads (Mexico) LLC, a Delaware limited liability company, all of the outstanding membership interests of which are owned by the Company. "Heads & Threads (PA)" means Heads & Threads (PA) LLC, a Delaware limited liability company, all of the outstanding membership interests of which are owned by the Company. "HSR Act" means the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the rules and regulations promulgated thereunder. "HTI Acquisition" has the meaning set forth in the recitals. "HTI Acquisition's Basket" has the meaning set forth in Section 12.5. "HTI Acquisition's Cap" has the meaning set forth in Section 12.5. "HTI Holding" means HTI Holding LLC, a Delaware limited liability company, which owns all of the outstanding membership interests in HTI Acquisition. "Income Tax" or "Income Taxes" means all Taxes (x) based upon, measured by, or calculated with respect to, net income or net receipts, proceeds or profits, or (y) based upon, measured by, or calculated with respect to multiple bases (including, but not limited to, corporate franchise and occupation Taxes) if such Tax may be based upon, measured by, or calculated with respect to one or more bases described in clause (x) above. 4 "Income Tax Claim" has the meaning set forth in Section 10.4. "Income Tax Return" means a Tax Return in respect of an Income Tax. "Indemnifying Party" has the meaning set forth in Section 12.7. "Independent Accountants" has the meaning set forth in Section 3.2(G). "Interim Financial Statements" has the meaning set forth in Section 4.6(A). "Knowledge," "Knowing" and other correlative terms mean (i) with respect to the Company, any fact or matter actually known to Greg Brown, Fred J. Weber or Michael Wrenn, in each case, without independent investigation, and (ii) with respect to Alleghany, any fact or matter actually known to David B. Cuming, Robert M. Hart, Christopher K. Dalrymple or Peter R. Sismondo, in each case, without independent investigation. "Knowledge," "Knowing" and other correlative terms mean, with respect to HTI Acquisition, any fact or matter actually known to Brian D. Fitzgerald or William R. Schlueter, in each case, without independent investigation. "LaSalle Credit Agreement" means the Credit Agreement, dated as of April 30, 2003, as amended from time to time, between the Company and LaSalle Bank National Association which provides for aggregate borrowings in a principal amount not to exceed $30,000,000. "LaSalle Debt" means all of the outstanding indebtedness of the Company under the LaSalle Credit Agreement, the principal amount of which, as of December 17, 2004 is $21,387,467. "LaSalle Lien" means the Lien on substantially all of the assets of the Company under the LaSalle Security Agreement. "LaSalle Security Agreement" means the Security Agreement and Financing Statement, dated as of April 30, 2003, as amended from time to time, between the Company and LaSalle Bank, National Association, pursuant to which substantially all of the assets of the Company secure the LaSalle Debt. "Lien" means any mortgage, pledge, lien, encumbrance, charge, adverse claim (whether pending or, to the Knowledge of the Person against whom the adverse claim is being asserted, threatened) or restriction of any kind affecting title or resulting in an encumbrance against any property, real or personal, tangible or intangible, or a security interest of any kind, including, without limitation, any conditional sale or other title retention agreement, any lease in the nature thereof, and any filing of or agreement to give any financing statement under the Uniform Commercial Code (or equivalent statute) of any jurisdiction (other than a financing statement which is filed or given solely to protect the interest of a lessor), other than Permitted Liens. "Losses" means any and all obligations, liabilities, losses, expenses and fees, including court costs and reasonable attorneys' fees and expenses. 5 "Material Business Contract" has the meaning set forth in Section 4.12(A). "Member's Equity" means total assets of the Company less total liabilities of the Company. "Merger" has the meaning set forth in the recitals. "Merger Consideration" has the meaning set forth in Section 3.3. "Mexican Company Subsidiaries" means Grupo Heads & Threads, S. de R.L. de C.V., Operadora Heads & Threads, S. de R.L. de C.V., and Servicios Heads & Threads, S. de R.L. de C.V. "New Employment Agreements" has the meaning set forth in Section 2.6. "Non-Compete Period" has the meaning set forth in Section 13. "Non-Income Tax" means any Tax that is not an Income Tax. "Non-Income Tax Return" means a Tax Return in respect of a Non-Income Tax. "November 2004 Financial Statements" has the meaning set forth in Section 4.26. "October 2004 Financial Statements" has the meaning set forth in Section 4.26. "Permits" has the meaning set forth in Section 4.17. "Permitted Liens" means (i) liens for water and sewer charges and Taxes not yet due and payable or being contested in good faith (and, in each case, for which adequate accruals or reserves have been established) and (ii) mechanics', carriers', workers', repairers', materialmen's, warehousemen's and other similar liens arising or incurred in the ordinary course of business with respect to a liability or obligation that is not yet due or delinquent and that is not material in amount. "Person" means any individual, firm, group, corporation, company, joint stock company, limited liability company, partnership, joint venture, trust, association, Governmental Authority, labor union or other organization, entity or enterprise. "Pre-Closing Tax Period" means a taxable period (or portion thereof) ending on or prior to the Closing Date. "Pre-Closing Income Tax Return" has the meaning set forth in Section 10.1(C). "Proprietary Rights" has the meaning set forth in Section 4.17. "Release" means any spilling, leaking, pumping, pouring, emitting, emptying, discharging, injecting, escaping, leaching, dumping, or disposing of a Hazardous Material into the Environment. 6 "Representatives" has the meaning set forth in Section 6.1. "Revised Amount" has the meaning set forth in Section 3.2(G). "September 30, 2004 Balance Sheet" has the meaning set forth in Section 4.6(B). "Site" means any of the real properties currently or previously owned, leased or operated by: (i) the Company or any Company Subsidiary; or (ii) any entities previously owned by the Company or any Company Subsidiary, in each case, including all soil, subsoil, surface waters and groundwater thereat. "Straddle Period" has the meaning set forth in Section 10.1(D). "Subsidiary" and "Subsidiaries" means, with respect to any Person, any corporation, partnership, limited liability company, joint venture or other entity in which such Person (i) owns, directly or indirectly, 50% or more of the outstanding voting securities, equity interests, profits interest or capital interest, (ii) is entitled to elect at least a majority of the board of directors or similar governing body, or (iii) in the case of a limited partnership or limited liability company, is a general partner or managing member, respectively. "Substitute Financing" has the meaning set forth in Section 7.3. "Surviving Entity" has the meaning set forth in Section 2.1. "Tax Return" means any report, return, document, declaration or other information or filing, including any amendments thereto and related or supporting information, required to be supplied to any Taxing Authority with respect to Taxes. "Tax Sharing Agreement" means the Tax Sharing Agreement, dated as of January 1, 1999, by and between Alleghany and the Company. "Taxes" means any and all taxes, charges, fees, levies or other assessments, including, without limitation, income, gross receipts, excise, real or personal property, sales, withholding, social security, occupation, use, service, service use, value added, license, net worth, payroll, franchise, transfer and recording taxes, fees and charges, imposed by any Taxing Authority, whether computed on a separate, consolidated, unitary, combined or any other basis; and such term shall include any interest, penalties or additional amounts attributable to, or imposed upon, or with respect to, any such taxes, charges, fees, levies or other assessments. "Taxing Authority" means the Internal Revenue Service or any other authority (whether domestic or foreign, including, without limitation, any state, local or foreign government or any subdivision or taxing agency thereof (including a United States possession)) responsible for the administration of any Tax. "Termination Date" has the meaning set forth in Section 11.3. "Third Party Claimant" has the meaning set forth in Section 12.8(A). 7 "Transfer Taxes" means all transfer, documentary, sales, use, stamp, registration, value added and other similar such Taxes and fees (including any penalties and interest) including any real property transfer tax and any similar Tax. "Transferred Assets" means the General American Life Insurance Company policies numbered 1917746 and 1901611 and the Northwestern Mutual Life Insurance Company policy numbered 9946381, all insuring the life of Leon Bookman. "Transferred Liabilities" means all liabilities and obligations of the Company relating to (i) deferred compensation and post-termination welfare benefits to Leon Bookman, and (ii) deferred compensation to Fred J. Weber, in each case pursuant to the Benefit Plans identified in Schedule 4.18, subject to the obligations set forth in Section 7.7(D). "Unadjusted Merger Consideration" has the meaning set forth in Section 3.1(B). 8 EX-10.67.B 8 y06166exv10w67wb.txt LIST OF CONTENTS OF EXHIBITS TO THE MERGER AGREEMENT . . . Exhibit 10.67(b) List of Contents of Exhibit and Schedules to the Heads & Threads Merger Agreement Exhibits A Definitions B-1 Form of New Employment Agreement B-2 Form of New Employment Agreement B-3 Form of New Employment Agreement C Form of Solvency Opinion Schedules 4.1 Organization 4.3 Company Subsidiaries 4.5 No Violation 4.6 Financial Statements 4.7 Undisclosed Liabilities, Etc. 4.8 Certain Changes 4.9 Encumbrances 4.10 Certain Properties 4.11 Taxes 4.12 Contracts 4.13 Litigation 4.14 Intellectual Property 4.15 Compliance with Laws 4.16 Environmental Matters 4.17 Governmental Authorizations 4.18 Employee Benefit Plans 4.19 Related Party Transactions 4.22 Insurance 4.23 Bank Accounts; Powers of Attorney 4.24 Product Warranties 4.26 Certain Disclosures 4.27 Employees 6.2 Conduct of Business Prior to Closing 8.2 Consents and Approvals
EX-10.68.A 9 y06166exv10w68wa.txt STOCK PURCHASE AGREEMENT Exhibit 10.68(a) STOCK PURCHASE AGREEMENT by and between DARWIN NATIONAL ASSURANCE COMPANY and ULICO CASUALTY COMPANY Dated as of January 31, 2005 TABLE OF CONTENTS ARTICLE I DEFINITIONS....................................................... 2 1.1. "2005 Filing Fees"............................................... 2 1.2. "Acquisition Proposals".......................................... 2 1.3. "Actions"........................................................ 2 1.4. "Administrative Services Agreement".............................. 2 1.5. "Affiliate" or "Affiliated"...................................... 2 1.6. "Agreement"...................................................... 2 1.7. "Allocation"..................................................... 2 1.8. "Amended Termination of Pooling Agreement"....................... 2 1.9. "Applicable Law"................................................. 2 1.10. "Arkansas Commissioner".......................................... 2 1.11. "Assumption Agreement"........................................... 2 1.12. "Bankruptcy Exception"........................................... 3 1.13. "Benefit-Related Liability"...................................... 3 1.14. "Business Day"................................................... 3 1.15. "Closing" and "Closing Date"..................................... 3 1.16. "Closing Assets"................................................. 3 1.17. "COBRA".......................................................... 3 1.18. "Code"........................................................... 3 1.19. "Company"........................................................ 3 1.20. "Confidential Information"....................................... 3 1.21. "Documents"...................................................... 3 1.22. "Employees"...................................................... 3 1.23. "Employee Benefit Plan".......................................... 3 1.24. "Employee-Related Liability"..................................... 4 1.25. "ERISA".......................................................... 4 1.26. "ERISA Affiliate"................................................ 4 1.27. "Exhibit"........................................................ 4 1.28. "Filing Fees".................................................... 4 1.29. "Final Purchase Price"........................................... 4 1.30. "GAAP"........................................................... 4 1.31. "Governmental Entity"............................................ 4 1.32. "Guarantee"...................................................... 4 1.33. "Indemnification Event".......................................... 4 1.34. "Indemnitee"..................................................... 4 1.35. "Indemnitor"..................................................... 4 1.36. "Insurance Permit"............................................... 4 1.37. "Intercompany Marketing Agreement"............................... 4 1.38. "Interim Balance Sheets"......................................... 5 1.39. "Joint Marketing Agreements"..................................... 5 1.40. "Latest Balance Sheet"........................................... 5 1.41. "Liability" and "Liabilities".................................... 5 1.42. "Liens or Restrictions".......................................... 5 1.43. "Loss"........................................................... 5
i 1.44. "Material Adverse Effect"........................................ 5 1.45. "Negative Tax Adjustment"........................................ 5 1.46. "Parent"......................................................... 5 1.47. "Parent Group"................................................... 5 1.48. "Permit"......................................................... 5 1.49. "Person"......................................................... 6 1.50. "Positive Tax Adjustment"........................................ 6 1.51. "Post-Closing Period"............................................ 6 1.52. "Pre-Closing NOL"................................................ 6 1.53. "Pre-Closing Period"............................................. 6 1.54. "Property"....................................................... 6 1.55. "Purchase Price"................................................. 6 1.56. "Purchaser"...................................................... 6 1.57. "Purchaser's Basket"............................................. 6 1.58. "Purchaser's Knowledge".......................................... 6 1.59. "Quota Share Agreement".......................................... 6 1.60. "Reinsured Liabilities".......................................... 6 1.61. "Related Agreements"............................................. 6 1.62. "Schedule"....................................................... 6 1.63. "Section 2(b) Liabilities"....................................... 7 1.64. "Section 338 Elections".......................................... 7 1.65. "Section 338 Forms".............................................. 7 1.66. "Securities"..................................................... 7 1.67. "Seller"......................................................... 7 1.68. "Seller's Approvals"............................................. 7 1.69. "Seller's Basket"................................................ 7 1.70. "Seller's Knowledge" or "Known to Seller"........................ 7 1.71. "Seller's 338 Payment"........................................... 7 1.72. "Statutory Financial Statements"................................. 7 1.73. "Stock".......................................................... 7 1.74. "Straddle Period"................................................ 7 1.75. "Subsidiary"..................................................... 7 1.76. "Surplus Lines Brokers".......................................... 7 1.77. "Tax" or "Taxes"................................................. 8 1.78. "Tax Adjustment"................................................. 8 1.79. "Tax Claim"...................................................... 8 1.80. "Tax Return"..................................................... 8 1.81. "Tax Savings".................................................... 8 1.82. "Taxing Authority"............................................... 8 1.83. "Termination and Commutation of LPT Agreement"................... 8 1.84. "Third-Party Reinsurance Agreements"............................. 8 1.85. "Transfer Taxes"................................................. 8 1.86. "Transferee"..................................................... 8 1.87. "Trust Agreement"................................................ 8 1.88. "Unauthorized States"............................................ 8 1.89. "Undisclosed Liabilities"........................................ 8 1.90. "USACC".......................................................... 8
ii 1.91. "Valuation Date"................................................ 9 1.92. "Year End Balance Sheets"....................................... 9 ARTICLE II PURCHASE OF STOCK............................................... 9 2.1. Purchase and Sale............................................... 9 2.2. The Purchase Price.............................................. 9 2.3. Closing......................................................... 10 2.4. Transfer of Stock............................................... 11 ARTICLE III REPRESENTATIONS AND WARRANTIES OF SELLER....................... 11 3.1. Organization and Standing....................................... 11 3.2. Insurance Permits............................................... 12 3.3. Authorization of Agreements..................................... 13 3.4. Capital Stock of the Company.................................... 14 3.5. Interests in Securities of the Company.......................... 14 3.6. Financial Statements............................................ 14 3.7. Subsidiaries.................................................... 15 3.8. Tax Returns and Reports......................................... 15 3.9. Required Filings................................................ 16 3.10. No Breach of Statute or Contract; Consents and Authorizations... 16 3.11. Legal Proceedings............................................... 18 3.12. Bank Accounts................................................... 18 3.13. Form of Capital and Surplus..................................... 18 3.14. Undisclosed Liabilities......................................... 18 3.15. Contracts....................................................... 19 3.16. Employee Matters................................................ 19 3.17. Powers of Attorney.............................................. 20 3.18. Accuracy of Documents........................................... 20 3.19. Brokers and Finders............................................. 20 3.20. Excess and Surplus Lines Brokers................................ 20 3.21. Assets and Properties........................................... 21 3.22. No Restrictions on Business..................................... 21 3.23. Marketing Agreements............................................ 22 3.24. Policyholder Complaints......................................... 22 3.25. Absence of Certain Changes...................................... 22 3.26. Real Property; Environmental Matters............................ 23 3.27. Insurance Business.............................................. 24 ARTICLE IV REPRESENTATIONS AND WARRANTIES OF PURCHASER..................... 24 4.1. Organization and Standing....................................... 24 4.2. Authorization of Agreement...................................... 24 4.3. No Breach of Statute or Contract; Consents and Authorizations... 25 4.4. Investment Intent............................................... 25 4.5. No Litigation................................................... 25 4.6. Brokers and Finders............................................. 25
iii ARTICLE V CONDUCT AND TRANSACTIONS PRIOR TO CLOSING; COVENANTS; INDEMNITIES.......................................... 26 5.1. Investigations; Operation of the Business of the Company........ 26 5.2. Pending or Threatened Action.................................... 27 5.3. Tax Audits; Tax Returns......................................... 28 5.4. Section 338(h)(10) Elections.................................... 31 5.5. Transfer Taxes.................................................. 32 5.6. Conduct of Business by Purchaser................................ 32 5.7. Change of Name.................................................. 33 5.8. Disclosure of Confidential Information.......................... 33 5.9. Compliance with Arkansas Insurance Laws......................... 33 5.10. Notification of Changes......................................... 33 5.11. Acquisition Proposals........................................... 33 5.12. Related Agreements.............................................. 34 5.13. Payment of Brokers' or Finders' Fees............................ 34 5.14. Preparation of Financial Statements............................. 34 5.15. Filing Fees..................................................... 34 5.16. Certain Litigation.............................................. 35 5.17. Third-Party Reinsurance Agreements.............................. 35 ARTICLE VI CONDITIONS TO CLOSING; ABANDONMENT OF THE TRANSACTION........... 35 6.1. Conditions to the Obligations of Purchaser...................... 35 6.2. Conditions to the Obligations of Seller......................... 38 6.3. Termination of Agreement and Abandonment of Transactions........ 39 ARTICLE VII TERMINATION OF OBLIGATIONS AND WAIVER OF CONDITIONS; PAYMENT OF EXPENSES......................................... 40 ARTICLE VIII INDEMNIFICATION............................................... 41 8.1. Indemnification of Purchaser.................................... 41 8.2. Indemnification of Seller....................................... 42 8.3. Notice.......................................................... 42 8.4. Determination of Right to Indemnification....................... 42 8.5. Determination of Amount of Indemnification...................... 42 8.6. Adjustments to Indemnification Amounts.......................... 43 8.7. Indemnification Limits.......................................... 44 8.8. Single Recovery................................................. 45 8.9. Third Party Beneficiaries....................................... 45 8.10. Deemed Adjustment to Purchase Price............................. 45 8.11. Exclusive Remedy................................................ 45 ARTICLE IX GENERAL...................................................... 46 9.1. Amendment and Waiver............................................ 46 9.2. Integrated Contract............................................. 46
iv 9.3. Publicity....................................................... 46 9.4. Governing Law................................................... 46 9.5. Jurisdiction.................................................... 46 9.6. Notices......................................................... 47 9.7. No Assignment................................................... 48 9.8. Headings........................................................ 48 9.9. Counterparts.................................................... 48 9.10. Severability.................................................... 48 9.11. Third Parties................................................... 49 9.12. Further Assurances.............................................. 49
Schedule 2.2(d) - Authorized States Schedule 3.1(b) - Officers and Directors/Certificate of Incorporation and Bylaws Schedule 3.2(b) - Notices of Suspension, Cancellations, or Terminations of Insurance Permits Schedule 3.8 - Tax Matters Schedule 3.9(b) - Filing Fees Schedule 3.10(b) - Consents and Approvals Schedule 3.11(a) - Legal Proceedings Schedule 3.11(b) - Legal Proceedings Brought by the Company Schedule 3.12 - Bank Accounts Schedule 3.13 - Capital and Surplus Schedule 3.14 - Liabilities Schedule 3.15(a) - Contracts and Commitments to be Terminated or Amended at Closing Schedule 3.15(b) - Third-Party Reinsurance Agreements Schedule 3.17 - Power of Attorney Schedule 3.20(b) - Certain Fee Arrangements Schedule 4.3(b) - Purchasers' Governmental Approvals Exhibit A - Administrative Services Agreement Exhibit B - Amended Termination of Pooling Agreement Exhibit C - Assumption Agreement Exhibit D - Guarantee Exhibit E - 100% Quota Share Reinsurance Agreement Exhibit F - Termination and Commutation of LPT Agreement Exhibit G - Trust Agreement
v STOCK PURCHASE AGREEMENT This Stock Purchase Agreement, dated as of January 31, 2005, is by and between Darwin National Assurance Company, a Delaware property and casualty insurance company ("Purchaser"), and Ulico Casualty Company, a Delaware property and casualty insurance company ("Seller"). RECITALS: WHEREAS, Seller owns 10,000 shares, constituting all of the issued and outstanding shares, of common stock, par value $420.00 per share (the "Stock"), of Ulico Indemnity Company, a stock property and casualty insurance company organized under the laws of the State of Arkansas (the "Company"); and WHEREAS, prior to the Closing (as defined below), Seller, the Company and Ulico Standard of America Casualty Company, a California property and casualty insurance company ("USACC"), shall enter into the Amended Termination of Pooling Agreement (as defined below) pursuant to which the parties thereto shall clarify their mutual understanding and agreement concerning the commutation, settlement and discharge of the intercompany reinsurance pool referred to therein; and WHEREAS, on or prior to the Closing, Seller and the Company shall enter into (i) the Termination and Commutation of LPT Agreement pursuant to which Seller and the Company shall terminate and commute the Union Liability and Trustee and Fiduciary Liability Loss Portfolio Reinsurance Agreement dated November 3, 2004 by and between Seller and the Company, (ii) the Quota Share Agreement pursuant to which the Company shall cede to Seller, and Seller shall assume, 100% of all insurance liabilities and obligations of the Company; (iii) the Trust Agreement pursuant to which funds are to be held in trust to ensure the payment of amounts due to the Company under the Quota Share Agreement; (iv) the Administrative Services Agreement pursuant to which Seller shall provide the Company with those administrative services described therein in respect of the liabilities ceded pursuant to the Quota Share Agreement; and (v) the Assumption Agreement pursuant to which Seller shall assume from the Company certain liabilities of the Company as provided therein; and WHEREAS, prior to the Closing, the Company and ULLICO Inc., a Maryland corporation and sole stockholder of Seller ("Parent"), shall enter into the Guarantee pursuant to which Parent shall guarantee Seller's obligations under this Agreement, the Quota Share Agreement, Administrative Services Agreement, Trust Agreement and Assumption Agreement; and WHEREAS, Purchaser desires to purchase and Seller desires to sell the Stock upon the terms and conditions set forth herein. NOW, THEREFORE, in consideration of the foregoing premises and the mutual agreements contained herein, intending to be legally bound hereby, the parties hereto agree as follows: ARTICLE I DEFINITIONS As used herein, the terms below shall have the following meanings, except as otherwise expressly provided or unless the context otherwise requires: 1.1. "2005 Filing Fees" shall have the meaning set forth in Section 5.15(b). 1.2. "Acquisition Proposals" shall have the meaning set forth in Section 5.11. 1.3. "Actions" shall have the meaning set forth in Section 3.11 (a). 1.4. "Administrative Services Agreement" shall refer to the Administrative Services Agreement to be entered into by and between Seller and the Company on or prior to the Closing, in the form attached hereto as Exhibit A (with such changes thereto as may be approved by Purchaser). 1.5. "Affiliate" or "Affiliated" shall mean with respect to any Person, any Person directly or indirectly controlling, controlled by, or under direct or indirect common control with, such Person. A Person will be deemed to control a Person if such Person possesses, directly or indirectly, the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities, by contract or otherwise. 1.6. "Agreement" shall refer to this Stock Purchase Agreement together with all Exhibits and Schedules hereto, as the same may be amended from time to time. 1.7. "Allocation" shall have the meaning set forth in Section 5.4(b). 1.8. "Amended Termination of Pooling Agreement" shall refer to the Amended and Restated Termination of Restated Reinsurance Pooling Agreement to be entered into by and among the Company, Seller and USACC at or prior to the Closing, in the form attached hereto as Exhibit B (with such changes thereto as may be approved by Purchaser). 1.9. "Applicable Law" shall mean any law, statute, ordinance, regulation, writ, injunction, rule, established principle of common law, directive, decree or administrative ruling of any Governmental Entity or applicable court decision applicable to a Person or any such Person's subsidiaries, properties, assets, or to such Person's officers, directors, managing directors, employees or agents in their capacity as such. 1.10. "Arkansas Commissioner" shall mean the Insurance Commissioner of the Arkansas Department of Insurance. 1.11. "Assumption Agreement" shall refer to the Assumption Agreement to be entered into by and between the Company and Seller on or prior to the Closing and shall be in the form attached hereto as Exhibit C (with such changes thereto as may be approved by Purchaser). 2 1.12. "Bankruptcy Exception" shall refer, in respect of any agreement, contract or commitment, to any limitation thereon imposed by any bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium or similar law affecting creditors' rights and remedies generally (including the rights and remedies of creditors of insurance companies generally) and, with respect to the enforceability thereof, by general principles of equity, including principles of commercial reasonableness, good faith and fair dealing (regardless of whether enforcement is sought in a proceeding at law or in equity). 1.13. "Benefit-Related Liability" shall have the meaning set forth in Section 3.16(c). 1.14. "Business Day" shall mean a Monday, Tuesday, Wednesday, Thursday or Friday on which banking institutions in the State of Delaware are not authorized or obligated by applicable law to close. 1.15. "Closing" and "Closing Date" shall have the respective meanings set forth in Section 2.3. 1.16. "Closing Assets" shall have the meaning set forth in Section 2.2(b). 1.17. "COBRA" shall mean the Consolidated Omnibus Budget Reconciliation Act of 1985, as amended. 1.18. "Code" shall mean the Internal Revenue Code of 1986, as amended, and the Treasury Regulations promulgated thereunder. 1.19. "Company" shall have the meaning set forth in the recitals hereto. 1.20. "Confidential Information" shall mean all Documents and information concerning Parent, Seller or the Company furnished to Purchaser in connection with this Agreement and any Documents or compilations prepared by or for Purchaser which contain, reflect or are based upon such information. 1.21. "Documents" shall refer to any books, records, files, papers, tapes, microfilms and any other documents. 1.22. "Employees" shall have the meaning set forth in Section 3.16(a). 1.23. "Employee Benefit Plan" shall mean any "employee benefit plan" (as such term is defined in section 3(3) of ERISA), and any other retirement, pension, profit-sharing, thrift, savings, target benefit, employee stock ownership, cash or deferred, deferred or incentive compensation, bonus, stay bonus, stock option, employee stock purchase, phantom stock, stock appreciation, change in control, retention compensation, medical, dental, vision, psychiatric or other counseling, employee assistance, tuition reimbursement, vacation, holiday, sick pay, disability, salary continuation, termination allowance, severance, employee relocation, death benefit, survivor income, dependent care assistance, legal assistance or fringe benefit (cash or noncash) plan, program, policy, practice or arrangement, or any cafeteria plan under Section 125 of the Code, in which any current or former officer, director, independent contractor or employee 3 of the Company or any ERISA Affiliate has ever participated, or as to which the Company or any ERISA Affiliate has ever had any present or contingent obligation, including any obligation to make contributions. 1.24. "Employee-Related Liability" shall have the meaning set forth in Section 3.16(b). 1.25. "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended, and the regulations promulgated thereunder. 1.26. "ERISA Affiliate" shall mean any entity that is, or ever has been, required to be aggregated with the Company as a single employer under Sections 414(b), (c), (m) or (o) of the Code. 1.27. "Exhibit" shall refer to each of several written Exhibits to this Agreement, each of which is incorporated into and made a part of this Agreement for all purposes. 1.28. "Filing Fees" shall have the meaning set forth in Section 3.9(b). 1.29. "Final Purchase Price" shall have the meaning set forth in Section 2.2(a). 1.30. "GAAP" shall have the meaning set forth in Section 3.6(b). 1.31. "Governmental Entity" shall mean any federal, state, local or foreign government, political subdivision, legislature, court, agency, department, bureau, commission or other governmental or regulatory authority, body or instrumentality, including any insurance or securities regulatory authority. 1.32. "Guarantee" shall refer to the Guarantee Agreement to be entered into by and between Parent and the Company on or prior to the Closing, in the form attached hereto as Exhibit D (with such changes thereto as may be approved by Purchaser). 1.33. "Indemnification Event" shall refer to any action, proceeding or claim for which a Person is entitled to indemnification under this Agreement. 1.34. "Indemnitee" shall have the meaning set forth in Section 8.3. 1.35. "Indemnitor" shall have the meaning set forth in Section 8.3. 1.36. "Insurance Permit" shall mean any Permit in any jurisdiction to issue, underwrite, assume, place, sell or otherwise transact the business of insurance, including the issuance of insurance policies on an excess or surplus lines basis. 1.37. "Intercompany Marketing Agreement" shall mean the Intercompany Marketing and Underwriting Agreement, dated September 1, 2004, by and between Ulico Insurance Group, the Company and Seller, and any agreements relating thereto, as such agreements may be amended from time to time. 4 1.38. "Interim Balance Sheets" shall have the meaning set forth in Section 3.6(b). 1.39. "Joint Marketing Agreements" shall mean (i) the Memorandum of Understanding by and between Zurich U.S. Construction and Ulico Insurance Group, Inc. entered into in May 2001 and (ii) the Strategic Alliance Agreement, dated May 8, 2001, by and among Farmers Group, Inc., Seller, the Company and Ulico Insurance Group, Inc., and any agreements related thereto, including without limitation the Agreement of Reinsurance, dated May 8, 2001, by and among Fire Insurance Exchange, Truck Insurance Exchange, Farmers Insurance Exchange, Farmers Texas County Mutual, Seller and the Company, and the Service Mark and Trademark License Agreement, dated May 8, 2001, by and among Seller, the Company, Ulico Insurance Group, Inc. and Farmers Group, Inc., as any such agreement may be amended from time to time. 1.40. "Latest Balance Sheet" shall have the meaning set forth in Section 3.6(b). 1.41. "Liability" and "Liabilities" shall have the meanings set forth in Section 3.14. 1.42. "Liens or Restrictions" shall refer to any lien (including but not limited to liens for unpaid taxes), pledge, mortgage, security interest, charge, adverse claim, attachment, automatic or other stay in bankruptcy or insolvency proceeding, or other encumbrance of any kind. 1.43. "Loss" shall have the meaning set forth in Section 8.1. 1.44. "Material Adverse Effect" shall mean any material adverse effect on the business, operations, financial condition or results of operations of the Company, other than any such effect to the extent arising or resulting from (a) changes in general business or economic conditions, (b) national or international political or social conditions, including the engagement by the United States in military hostilities, whether or not pursuant to the declaration of a national emergency or war, (c) changes in financial, banking, or securities markets (including any disruption thereof and any decline in the price of any security or any market index), (d) changes in United States generally accepted accounting principles or (e) changes in law, rules or regulations of general applicability. 1.45. "Negative Tax Adjustment" shall have the meaning set forth in Section 5.3(k). 1.46. "Parent" shall have the meaning set forth in the recitals hereto. 1.47. "Parent Group" shall have the meaning set forth in Section 3.8(a). 1.48. "Permit" shall refer to any federal, state, local or other governmental consent, license, permit, grant, eligibility, qualification or authorization which is held by the Company in a particular jurisdiction immediately prior to the Closing Date. 5 1.49. "Person" shall mean any individual, corporation, partnership, limited liability company, joint venture, association, joint stock company, mutual company, trust, unincorporated organization or Governmental Entity or agency thereof. 1.50. "Positive Tax Adjustment" shall have the meaning set forth in Section 5.4(f). 1.51. "Post-Closing Period" shall refer to a taxable period of the Company beginning after the Closing Date. 1.52. "Pre-Closing NOL" shall have the meaning set forth in Section 5.3(k). 1.53. "Pre-Closing Period" shall refer to a taxable period of the Company ending on or prior to the Closing Date. 1.54. "Property" shall mean any real, personal or mixed property, whether tangible or intangible. 1.55. "Purchase Price" shall have the meaning set forth in Section 2.2. 1.56. "Purchaser" shall have the meaning set forth in the preamble. 1.57. "Purchaser's Basket" shall have the meaning set forth in Section 8.7(e). 1.58. "Purchaser's Knowledge" shall refer to the actual knowledge of (i) individuals who, at the time of execution of this Agreement, perform such functions or hold such positions with Purchaser as would reasonably be expected to require them to be aware of the information in question and (ii) officers of Purchaser holding the position of Vice President or higher. 1.59. "Quota Share Agreement" shall refer to the 100% Quota Share Reinsurance Agreement to be entered into by and between Seller and the Company on or prior to the Closing, in the form attached hereto as Exhibit E (with such changes thereto as may be approved by Purchaser). 1.60. "Reinsured Liabilities" shall have the meaning set forth in Quota Share Agreement. 1.61. "Related Agreements" shall refer collectively to the Quota Share Agreement, Trust Agreement, Administrative Services Agreement, Assumption Agreement, Amended Termination of Pooling Agreement, Termination and Commutation of LPT Agreement and Guarantee Agreement. 1.62. "Schedule" shall refer to each of several written Schedules to this Agreement, each of which is incorporated into and made a part of this Agreement for all purposes. 6 1.63. "Section 2(b) Liabilities" shall have the meaning set forth in the Assumption Agreement. 1.64. "Section 338 Elections" shall have the meaning set forth in Section 5.4(a). 1.65. "Section 338 Forms" shall have the meaning set forth in Section 5.4(b). 1.66. "Securities" shall have the meaning set forth in Section 3.13. 1.67. "Seller" shall have the meaning set forth in the preamble. 1.68. "Seller's Approvals" shall have the meaning set forth in Section 3.10(b). 1.69. "Seller's Basket" shall have the meaning set forth in Section 8.7(d). 1.70. "Seller's Knowledge" or "Known to Seller" shall refer to the actual knowledge of (i) individuals who, at the time of execution of this Agreement, perform such functions or hold such positions with Parent, Seller or the Company (prior to the Closing) as would reasonably be expected to require them to be aware of the information in question and (ii) officers of Parent, Seller or the Company (prior to the Closing) holding the position of Vice President or higher. 1.71. "Seller's 338 Payment" shall mean the payment in the amount of two hundred thousand dollars ($200,000) to Seller pursuant to Section 5.4 to compensate Seller for making the Section 338 Elections. 1.72. "Statutory Financial Statements" shall mean the Annual Statements and the Quarterly Statements of the Condition and Affairs of the Company filed with the Arkansas Insurance Department, in each case including all exhibits, interrogatories, notes and schedules thereto and any actuarial opinion, affirmation or certification or other supporting documentation filed in connection therewith. 1.73. "Stock" shall have the meaning set forth in the first recital of this Agreement. 1.74. "Straddle Period" shall refer to a taxable period of the Company beginning before and ending after the Closing Date. 1.75. "Subsidiary" shall mean, with respect to any Person, any corporation, partnership, limited liability company, joint venture or other entity in which such Person (i) owns, directly or indirectly, 50% or more of the outstanding voting securities, equity interests, profits interest or capital interest, (ii) is entitled to elect at least a majority of the board of directors or similar governing body, or (iii) in the case of a limited partnership or limited liability company, is a general partner or managing member, respectively. 1.76. "Surplus Lines Brokers" shall mean all brokers and producers that have solicited, negotiated, sold or produced the Company's insurance business. 7 1.77. "Tax" or "Taxes" shall mean all federal, state, county, municipal, foreign and other income, profits, windfall profits, gains, gross receipts, net worth, premium, value added, ad valorem, sales, use, excise, stamp, transfer, franchise, withholding, payroll, employment, occupation, workers' compensation, disability, severance, unemployment insurance, social security and property taxes, and all other taxes, levies, fees, imposts, duties and charges of any kind whatsoever, together with any interest, penalties and additions thereto imposed by any Taxing Authority, including all amounts imposed as a result of being a member of an affiliated or combined or unitary group. 1.78. "Tax Adjustment" shall have the meaning set forth in Section 2.2(c)(iii). 1.79. "Tax Claim" shall have the meaning set forth in Section 5.3(i). 1.80. "Tax Return" shall mean all returns, reports, elections, estimates, declarations, information statements and other forms and documents (including all schedules, exhibits, and other attachments thereto and any supplements or amendments thereof) relating to, and required to be filed or maintained in connection with the calculation, determination, assessment or collection of, any Taxes (including estimated Taxes). 1.81. "Tax Savings" shall have the meaning set forth in Section 5.3(k). 1.82. "Taxing Authority" shall refer to any Governmental Entity responsible for the administration or collection of Taxes. 1.83. "Termination and Commutation of LPT Agreement" shall refer to the Termination and Commutation of Union Liability and Trustee and Fiduciary Liability Loss Portfolio Reinsurance Agreement to be entered into by and between the Company and Seller at or prior to the Closing, in the form attached hereto as Exhibit F (with such changes thereto as may be approved by Purchaser). 1.84. "Third-Party Reinsurance Agreements" shall mean the agreements between the Company and one or more third-party reinsurers set forth on Schedule 3.15(b). 1.85. "Transfer Taxes" shall have the meaning set forth in Section 5.5. 1.86. "Transferee" shall have the meaning set forth in Section 2.4. 1.87. "Trust Agreement" shall refer to the Trust Agreement by and among the Company, Seller and Mellon Trust of Delaware, National Association, a national banking association, as Trustee (or with such other trustee as may be acceptable to Purchaser and Seller), to be entered into at or prior to Closing, in substantially the form attached hereto as Exhibit G. 1.88. "Unauthorized States" shall have the meaning set forth in Section 2.2(d). 1.89. "Undisclosed Liabilities" shall have the meaning set forth in Section 3.14. 1.90. "USACC" shall have the meaning set forth the recitals hereto. 8 1.91. "Valuation Date" shall have the meaning set forth in Section 2.2(b). 1.92. "Year End Balance Sheets" shall have the meaning set forth in Section 3.6(b). ARTICLE II PURCHASE OF STOCK 2.1. Purchase and Sale. Upon the terms and subject to the conditions of this Agreement, at the Closing, Purchaser shall purchase from Seller, and Seller shall sell to Purchaser, all of the Stock. 2.2. The Purchase Price. (a) Purchaser agrees to pay to Seller, and Seller agrees to accept from Purchaser, as consideration for the sale of the Stock, an amount payable at the Closing, such amount, subject to adjustment, if any, pursuant to Section 2.2(d), to be determined as follows: the sum of (1) Three Million Dollars ($3,000,000) and (2) the fair market value of the Closing Assets as determined pursuant to this Section 2.2. For purposes of this Agreement, the amount equal to the sum of (1) Three Million Dollars ($3,000,000) and (2) the fair market value of the Closing Assets as determined pursuant to this Section 2.2, shall be referred to as the "Purchase Price," and the Purchase Price as adjusted for any decrease pursuant to Section 2.2(d) shall be referred to as the "Final Purchase Price". (b) Not later than 6 p.m. EDT on the Business Day immediately preceding the Closing Date (the "Valuation Date"), Seller shall provide Purchaser with a complete list and specific description of the following assets which shall be held by the Company upon the Closing: cash and cash equivalents, fixed income securities traded in a public market and bonds or deposits with certain states as required to obtain Insurance Permits in those states (collectively, the "Closing Assets"); provided; however, that the Closing Assets, other than cash and cash equivalents, shall be U.S. Government and Government Agency fixed income securities or fixed income securities having a rating by Moody's Investors Services, Inc. of at least Aa or by the Securities Valuation Office of the National Association of Insurance Commissioners of at least Category 2. Such description shall include a valuation as of the close of business on the Valuation Date of the net fair market value of the Closing Assets. Purchaser shall have an opportunity at its own expense to verify such valuation and all information related thereto, concerning such Closing Assets. Without the prior written consent of Purchaser, Seller shall not, nor shall Seller permit the Company to, take any action which would cause or require any changes to the valuation of Closing Assets as of the Valuation Date, or which would cause the sale or disposition of any Closing Assets. (c) The net fair market value of the Closing Assets shall be determined as follows: (i) (x) cash and cash equivalents shall be valued at face value, (y) investment securities traded in a recognized public market shall be valued at their closing composite price 9 on the Valuation Date as reported by Bloomberg LP or, if such values are not reported by Bloomberg LP, for the business day preceding the Valuation Date as reported by the Wall Street Journal (if there is no closing price, then the average bid and asked prices shall be used); provided, however, that if the investment security is quoted only on a yield or discount rate basis, then such security shall be valued at the price calculated in accordance with generally accepted financial practice for the mean of the quoted bid and asked yield or rate, and (z) interests in money market funds shall have a fair market value equal to their face or par value plus (ii) interest accrued and dividends attributable to such Closing Assets accrued as of the close of business on the Valuation Date, increased or decreased by (iii) the sum of (A) the amount of Taxes reasonably estimated to be imposed on the Company for any Post-Closing Period (or for any Straddle Period to the extent that such Taxes are allocable to the Purchaser pursuant to Section 8.5(c)) with respect to interest and dividends accrued with respect to the Closing Assets as of the Valuation Date, and (B) the amount of Taxes reasonably estimated to be imposed on the Company for any Post-Closing Period (or for any Straddle Period to the extent that such Taxes are allocable to the Purchaser pursuant to Section 8.5(c)) that would be incurred if the Closing Assets were sold for their gross fair market value as of the Valuation Date and no Section 338 Elections were made, less (C) the amount of Taxes reasonably estimated to be saved by the Company in any Post-Closing Period (or for any Straddle Period to the extent of the reduction in the Taxes allocable to the Purchaser pursuant to Section 8.5(c)) that would be incurred if the Closing Assets were sold for their gross fair market value as of the Valuation Date and no Section 338 Elections were made (the positive or negative amount in this clause (iii) being referred to herein as the "Tax Adjustment") (it being intended that the Tax Adjustment shall as nearly as possible equal the amount of the deferred tax asset or deferred tax liability, as the case may be, in respect of the Closing Assets that would appear on the balance sheet of the Company prepared on the Valuation Date and in accordance with generally accepted accounting principles (applied without regard to any valuation allowance for such deferred tax assets)). (d) In the event that the Company is not eligible to issue insurance policies on an excess or surplus lines basis in one or more of the states listed on Schedule 2.2(d) hereto (the "Unauthorized States"), on the Closing Date, the Purchase Price for the Stock payable at the Closing shall be decreased by the amount listed in the column titled "Purchase Allocation" on Schedule 2.2(d) for each Unauthorized State. At Closing, Seller shall provide Purchaser with evidence of each of the surplus lines eligibilities of the Company. 2.3. Closing. The closing of the purchase and sale of the Stock pursuant to this Agreement (the "Closing") shall take place at the offices of Dewey Ballantine LLP, 1301 Avenue of the Americas, New York, New York at 10:00 a.m. New York time on the third Business Day following the satisfaction or waiver of all conditions to the obligations of the parties to consummate the transaction contemplated hereby (other than conditions with respect to actions the parties will take at the Closing itself) (the "Closing Date"), or such other place, times or dates as the parties hereto agree in writing. At the Closing: (a) Seller shall deliver to Purchaser a certificate or certificates representing the Stock duly endorsed to Purchaser or accompanied by duly executed stock powers so as to transfer and assign to Purchaser good and valid title to the Stock free and clear of all Liens or 10 Restrictions and to constitute Purchaser the sole beneficial owner and record stockholder of the Company; (b) Purchaser shall pay to Seller the Final Purchase Price by wire transfer of immediately available funds to an account designated in writing by Seller on or before the Closing; and (c) Seller shall deliver to Purchaser fully executed originals of (i) the Quota Share Agreement, (ii) the Trust Agreement, (iii) the Administrative Services Agreement, (iv) the Assumption Agreement, (v) the Amended Termination of Pooling Agreement, (vi) the Termination and Commutation of LPT Agreement and (vii) the Guarantee. 2.4. Transfer of Stock. Seller hereby acknowledges and agrees that, subsequent to the Closing, Purchaser shall have the right to transfer, exchange or contribute the Stock to any direct or indirect majority owned or wholly owned Subsidiary of the Purchaser ("Transferee"); provided, however that, notwithstanding any such transaction, Purchaser shall be considered as the purchaser of the Stock for federal income tax purposes within the meaning of Treas. Reg. Section 1.338-3(c). ARTICLE III REPRESENTATIONS AND WARRANTIES OF SELLER Seller hereby represents and warrants to Purchaser, as of the date of this Agreement (except if another date is specified in the representation or warranty) and as of the Closing Date, as follows: 3.1. Organization and Standing. (a) Each of Seller and the Company is duly organized, validly existing and in good standing under the laws of its respective jurisdiction, and each of Seller and the Company has all requisite power and authority to own, lease and operate its assets and Properties (including, without limitation, the Stock) and to conduct its business as currently being conducted. Seller is duly qualified or licensed to conduct business and is in good standing as a foreign corporation in each jurisdiction in which the nature of its business or the ownership, leasing or operation of its Properties makes such qualification or licensing necessary, except for those jurisdictions where the failure to be so qualified or licensed or to be in good standing has not had, and would not reasonably be expected to have, individually or in the aggregate, (i) a Material Adverse Effect, (ii) a material adverse effect on the ability of Seller to execute and deliver this Agreement, to perform its obligations hereunder or to consummate the transactions contemplated hereby, or (iii) a material adverse effect on the ability of Seller or the Company to execute and deliver the Related Agreements to which they are a party, to perform their respective obligations therein or to consummate the transactions contemplated thereby. (b) Schedule 3.1(b) identifies each director and executive officer of the Company as currently in effect and contains true and correct copies of the Company's 11 Certificate of Incorporation and the Bylaws, including all amendments thereto through, and as in effect on, the date hereof. (c) Seller has delivered to Purchaser true, accurate and complete copies of the stock and minute books of the Company. To Seller's Knowledge, such stock and minute books are true, accurate and complete and contain minutes of all meetings, proceedings and other actions of the shareholders and the board of directors of the Company, and any committees thereof from the date of the formation of the Company to the date hereof. 3.2. Insurance Permits. (a) The Company's Arkansas insurance license is in full force and effect and will be in full force and effect as of the Closing Date, and the Company has not received any notice of default or termination with respect to such license or any threatened cancellation or termination in connection therewith. (b) Schedule 2.2(d) contains a true and correct list of each state in which the Company is eligible, authorized or qualified to issue insurance policies on an excess or surplus lines basis together with satisfactory evidence (as of a recent date) of such eligibility, authorization or qualification in each such state. The eligibilities, authorizations and qualifications set forth on Schedule 2.2(d), together with the Company's Arkansas insurance license, constitute all Insurance Permits required for the conduct of the Company's business as now conducted. The Company shall be so eligible, authorized or qualified, as the case may be, in each such state listed on Schedule 2.2(d) as of the Closing Date. Other than as set forth in Schedule 3.2(b), the Company has not received from any Governmental Entity any notice of suspension or termination with respect to any such Insurance Permits or any threatened suspension, cancellation or termination in connection therewith, or any subpoena or other notice of investigation of any current or prior business practice of the Company. (c) The Company is in good standing with all applicable insurance regulatory authorities with respect to the conduct of the business by the Company. (d) Since its formation, the Company has been engaged solely and exclusively in the insurance business and has conducted no insurance business or other business in any jurisdiction other than the jurisdictions listed in Schedule 2.2(d) and Schedule 3.2(b) with respect to which it would be required to have an Insurance Permit. (e) The Company has (i) timely paid all guaranty fund assessments that are due, or claimed or asserted by any insurance regulatory authority to be due from the Company, or (ii) provided for all such assessments in its Statutory Financial Statements. (f) Except as disclosed on Schedule 3.2(b), no proceeding is pending nor, to Seller's Knowledge, is any proceeding threatened in which any Person is seeking to revoke or deny the renewal of any Insurance Permit. (g) Except as limited by state statute generally applicable to all companies of a similar type as the Company or as set forth in Schedule 3.2(b), the Company's authority to write the lines and classes of insurance set forth on Schedule 2.2(d) is unrestricted and the 12 Company is not a party to any agreement or arrangement with any regulatory official or agency limiting or restricting the Company's ability to make full use of the Insurance Permits. Except as set forth in Schedule 3.2(b), each such Insurance Permit is currently in good standing, and, other than as set forth in Schedule 3.2(b), no Insurance Permit has been withdrawn, modified, restricted or conditioned in any respect by a state insurance regulatory authority, and no application for an Insurance Permit filed by the Company within the last 12 months has been denied or withdrawn. No event has occurred that, with or without notice or lapse of time or both, would reasonably be expected to result in the revocation, suspension, lapse or limitation of any Insurance Permit. 3.3. Authorization of Agreements. Seller has all requisite power to execute and deliver this Agreement and perform its obligations under this Agreement, and the execution, delivery and performance of this Agreement and the consummation of the transactions contemplated by this Agreement have been duly authorized and approved by all necessary action on the part of Seller. Each of Seller and the Company has the requisite power to execute and deliver the Quota Share Agreement, the Trust Agreement, the Administrative Services Agreement, the Assumption Agreement and Termination and Commutation of LPT Agreement and to perform its obligations thereunder, and the execution, delivery and performance of each of the Quota Share Agreement, the Trust Agreement, the Administrative Services Agreement, the Assumption Agreement and the Termination and Commutation of LPT Agreement and the consummation of the transactions contemplated thereby have been duly authorized by all necessary requisite action on the part of each of Seller and the Company. Each of Seller, the Company and USACC has the requisite power to execute and deliver the Amended Termination of Pooling Agreement and to perform its obligations thereunder, and the execution, delivery and performance of the Amended Termination of Pooling Agreement and the consummation of the transactions contemplated thereby have been duly authorized by all necessary requisite action on the part of each of Seller, the Company and USACC. The Company has all requisite power to execute and deliver the Guarantee and perform its obligations thereunder, and the execution, delivery and performance of the Guarantee and the consummation of the transactions contemplated thereby have been duly authorized by all necessary requisite action on the part of the Company. This Agreement has been duly executed and delivered by Seller and is the valid and binding obligation of Seller enforceable against Seller in accordance with its terms, subject to the Bankruptcy Exception. Prior to the Closing Date, the Quota Share Agreement, Trust Agreement, Administrative Services Agreement, Assumption Agreement and Termination and Commutation of LPT Agreement will have been duly authorized, executed and delivered by each of Seller and the Company, and, on the Closing Date, each of the Quota Share Agreement, Trust Agreement, Administrative Services Agreement, Assumption Agreement and Termination and Commutation of LPT Agreement will be the valid and binding obligations of each of Seller and the Company enforceable against each of them in accordance with its terms, subject to the Bankruptcy Exception. Prior to the Closing Date, the Amended Termination of Pooling Agreement will have been duly authorized, executed and delivered by each of Seller, the Company and USACC, and, on the Closing Date, the Amended Termination of Pooling Agreement will be the valid and binding obligation of each of Seller, the Company and USACC enforceable against each of them in accordance with its terms, subject to the Bankruptcy Exception. Prior to the Closing Date, the Guarantee will have been duly authorized, executed and delivered by the Company, and, on the Closing Date, the Guarantee will be the valid and binding obligation of the Company. 13 3.4. Capital Stock of the Company. The authorized capital stock of the Company consists of 10,000 shares of common stock, $420.00 par value per share, all of which shares have been and are now validly issued and outstanding, fully paid and nonassessable. The Stock constitutes all of the issued and outstanding capital stock of the Company. Seller is the lawful owner, beneficially and of record, of all of the Stock and has good and valid title to the Stock, free and clear of all Liens or Restrictions, voting trusts or other voting agreements, contracts, calls, commitments of any kind, including any such agreement, arrangement, commitment or understanding restricting or otherwise relating to the voting, dividend rights or dispositions of the Stock. Upon consummation of the transactions contemplated by this Agreement, Purchaser will acquire record and beneficial ownership of the Stock, free and clear of any Liens or Restrictions, voting trusts or other voting agreements, contracts, calls, commitments of any kind, including any such agreement, arrangement, commitment or understanding restricting or otherwise relating to the voting, dividend rights or dispositions of the Stock. 3.5. Interests in Securities of the Company. There are no outstanding options, convertible securities, warrants or other rights to subscribe for or purchase from Seller or the Company, and there are no plans, contracts or commitments for the granting by Seller or the Company of rights to acquire or redeem: (i) any capital stock or other ownership interests in the Company including the Stock; or (ii) any securities convertible into or exchangeable for any such capital stock or ownership interests in the Company. 3.6. Financial Statements. (a) Seller has delivered to Purchaser true, correct and complete copies of the Statutory Financial Statements of the Company for the year ended December 31, 2003 (with the accompanying independent auditors' report of PricewaterhouseCoopers LLP), and for the quarterly periods ended March 31, June 30 and September 30, 2004. Subject, in the case of the quarterly statutory financial statements, to normal recurring year-end adjustments, the Statutory Financial Statements fairly represent in all material respects the financial position and the results of operations of the Company as of and for the respective dates and for periods indicated therein, in accordance with accounting practices prescribed or permitted by the Arkansas Insurance Department, applied on a consistent basis. All books of account of the Company fully and fairly disclose in all material respects all of the transactions, properties, assets, liabilities and obligations of the Company and are true, correct and complete in all material respects. The information contained in the Statutory Financial Statements was prepared in accordance with accounting practices prescribed or permitted by the Arkansas Insurance Department applied on a consistent basis and is not inaccurate in any material respect. Except as disclosed on such Statutory Financial Statements or in the notes thereto, there has not been any change in the business, financial condition or results of operations of the Company during the last 12 months that has had, or would reasonably be expected to have, a Material Adverse Effect. Seller has heretofore delivered to Purchaser true, correct and complete copies of the Statutory Financial Statements of the Company for each of the years ended December 31, 1999, 2000, 2001 and 2002 (with the accompanying independent auditors' report of PricewaterhouseCoopers LLP). (b) Seller has delivered to Purchaser true, correct and complete copies of balance sheets of the Company as of December 31, 1999, 2000, 2001, 2002 and 2003 (collectively, the "Year End Balance Sheets") and as of March 31, June 30, and September 30, 14 2004 (collectively, the "Interim Balance Sheets," and the September 30, 2004 balance sheet, the "Latest Balance Sheet"), all prepared in accordance with generally accepted accounting principles ("GAAP") consistently applied throughout the periods involved (except as may be indicated in the notes thereto). The Year End Balance Sheets are as included in the audited financial statements of Parent and fairly present in all material respects the financial position of the Company at the respective dates thereof. The Interim Balance Sheets were prepared in accordance with GAAP consistently applied and in a manner consistent with that employed in the Year End Balance Sheet dated December 31, 2003 and fairly present in all material respects the financial position of the Company at the respective dates thereof. 3.7. Subsidiaries. The Company does not own, either of record or beneficially, any direct or indirect equity interest or any right (contingent or otherwise) to acquire the same in any other Person. 3.8. Tax Returns and Reports. (a) Parent is the common parent of an affiliated group of corporations (within the meaning of section 1504(a) of the Code) (such group, the "Parent Group") that files a consolidated federal income Tax Return. For all periods during which it has owned the Company, Parent has properly included (or, with respect to the taxable year ending on the Closing Date, will properly include) the Company in its consolidated federal income Tax Return as a member of the Parent Group. (b) Other than as set forth on Schedule 3.8, (i) the Company has filed (or joined in the filing of) when due all material Tax Returns required to be filed by or with respect to the Company, including Tax Returns of the Parent Group and of any other consolidated, combined, unitary or other affiliated group of which the Parent is a member, and all Taxes shown to be due on such Tax Returns have been timely paid; (ii) all such Tax Returns were true, correct and complete in all material respects; (iii) to Seller's Knowledge, there is no action, suit, proceeding, investigation, audit or claim now pending against, or with respect to, the Company in respect of any Tax or assessment, nor is any claim for additional Tax or assessment being asserted or, threatened by any Taxing Authority with respect to the Company; (iv) no claim has been asserted in writing by any Taxing Authority in a jurisdiction in which the Company does not currently file a Tax Return that it is or may be subject to Tax by such jurisdiction; (v) the Company is not a party to any agreement, whether written or unwritten, providing for the payment of Taxes, payment for Tax losses, entitlement to refunds or similar Tax matters; (vi) the Company has withheld and remitted to its applicable Taxing Authorities all Taxes required to be withheld in connection with any material amounts paid or owing to any employee, creditor, attorney, independent contractor or other Person; (vii) except as set forth in its previously filed Tax Returns, neither Parent, Seller nor the Company has made, changed or revoked, or permitted to be made, changed or revoked, any material election or method of accounting with respect to material Taxes affecting or relating to the Company; (viii) none of Parent, Seller or the Company has entered into, or permitted to be entered into, any closing or other agreement or settlement with respect to Taxes affecting or relating to the Company; (ix) no ruling with respect to Taxes has been requested by or on behalf of the Company or by Parent or Seller with respect to any transaction involving the Company that could affect the liability of the Company for Taxes for any period after the Closing; (x) the 15 Company has no liability for the Taxes of any Person (other than pursuant to Treasury Regulation Section 1.1502-6, or any analogous state, local or foreign law or regulation) as a transferee or successor, by contract or otherwise; (xi) the statutes of limitations for Tax years of the Company have closed for all years ending prior to January 1, 1999; (xii) Seller is not a "foreign person" within the meaning of Section 1445(f)(3) of the Code; and (xiii) neither Parent, Seller nor the Company has ever engaged in any transaction that is the same as, or substantially similar to, a transaction that would be a "reportable transaction" for purposes of Section 1.6011-4(b) of the Code (including without limitation any transaction which the Internal Revenue Service has determined to be a "listed transaction" for purposes of Section 1.6011-4(b)(2) of the Code). 3.9. Required Filings. (a) All statements, reports, forms or other information required to be filed with respect to the Company have been or will be timely filed, and all required regulatory approvals in respect thereof are in full force and effect, except for any such statements, reports, forms, other information or regulatory approvals that if not made or obtained would not reasonably be expected, individually or in the aggregate, to have a Material Adverse Effect. All such regulatory filings were true and correct in all material respects when filed and were in compliance with Applicable Laws, and no deficiencies have been asserted by any such Governmental Entity with respect to such regulatory filings that have not been satisfied. (b) Schedule 3.9(b) sets forth all amounts which, as of December 31, 2004, have been paid by the Company as annual statement filing fees, license renewal fees, excess and surplus lines eligibility fees, examination fees, membership fees or dues to state guaranty associations and joint underwriting associations, minimum required state insurance premium taxes (i.e. those imposed without regard to the amount of premiums written) and other taxes, fees or assessments paid by the Company in order to maintain its Insurance Permits in good standing (all such fees and amounts, collectively, the "Filing Fees") for the year ending December 31, 2004 and the dates of payments of each of such amounts. Schedule 3.9(b) also sets forth an estimate of the amount of Filing Fees which will be due for calendar year 2004 which have not been paid as of December 31, 2004. 3.10. No Breach of Statute or Contract; Consents and Authorizations. (a) Neither the execution and delivery of this Agreement by Seller, nor the execution and delivery of the Quota Share Agreement, Trust Agreement, Administrative Services Agreement, Assumption Agreement or Termination and Commutation of LPT Agreement by Seller and the Company, nor the execution and delivery of the Amended Termination of Pooling Agreement by Seller, the Company and USACC, nor the execution and delivery of the Guarantee by the Company, nor performance by any of them of any of their obligations hereunder or thereunder will (x) conflict with, or result in a breach of, any of the terms, conditions or provisions of: (i) the certificate of incorporation or bylaws (or comparable organizational documents) of Seller, the Company or USACC; (ii) subject to receipt of approvals referred to in Section 3.10(b), any judgment, order, injunction, decree or ruling of any court or Governmental Entity or any Applicable Law to which Seller, the Company or USACC is subject; or (iii) any agreement, contract or commitment to which 16 Seller, the Company or USACC is a party or is subject, except, in the case of clauses (ii) and (iii) only, for such conflicts or breaches that (A) would not be reasonably expected to have a Material Adverse Effect, (B) would not materially impair the ability of Seller to execute, deliver and perform its obligations under this Agreement, (C) would not materially impair the ability of either Seller or the Company to execute, deliver and perform its obligations under the Quota Share Agreement, the Trust Agreement, the Administrative Services Agreement, the Assumption Agreement and the Termination and Commutation of LPT Agreement, (D) would not materially impair the ability of any of Seller, the Company or USACC to execute, deliver and perform its obligations under the Amended Termination of Pooling Agreement, (E) would not materially impair the ability of the Company to execute, deliver and perform its obligations under the Guarantee and (F) would not impair the validity of any Insurance Permit, or (y) result in the creation or imposition of any Lien or Restriction on any of the Properties or assets of the Company. (b) Except for approval by the Arkansas Commissioner with respect to the change in control of the Company and except as set forth in Schedule 3.10(b), none of Seller, the Company or USACC is required to obtain any consent, approval or authorization from or to make any filings with any Governmental Entity or any other Person with regard to execution, delivery and performance of this Agreement (including the transfer of the Stock pursuant hereto), the Related Agreements or such other agreements or documents as are to be executed by Seller, the Company or USACC pursuant hereto and thereto, or the consummation of the transactions contemplated herein or therein ("Seller's Approvals"). With regard to this Agreement and the Related Agreements and the consummation of the transactions contemplated hereby and thereby, so called "bulk reinsurance" statutes, which generally require a ceding company to provide notification to or obtain the approval of the insurance department of the applicable jurisdiction prior to or in connection with the transfer by reinsurance of all or substantially all of the ceding company's business or a given line of business, either (x) do not apply or (y) no notification or approval is required thereunder. (c) The Company is in compliance with all Applicable Laws relating to the operation, conduct or ownership of the Property or business of the Company, except for any such failure to comply that would not reasonably be expected, individually or in the aggregate, to have a Material Adverse Effect. (d) Neither the Company nor, to Seller's Knowledge, any officer, director, employee or authorized agent on behalf of the Company, has made any unlawful payment to, or entered into any written or oral understanding or agreement to make any unlawful payment to, any governmental or quasi-governmental official, or to any other Person or entity. Neither Seller nor the Company has received any notice of, nor to Seller's Knowledge is there, any violation of any Applicable Law relating to the operation, conduct or ownership of the business of the Company other than a violation which has been resolved and for which no sanction is pending. Without limitation of the foregoing, the Company has not been subject of any allegation made by any Governmental Entity or by any other Person that the Company has unlawfully shared fees or made any unlawful rebates or engaged in any other unlawful reciprocal practice, nor has the Company entered into any written or oral understanding or agreement to do any of the foregoing and, to Seller's Knowledge, the Company has not 17 engaged in any business practice which could reasonably be expected to give rise to any such allegation. 3.11. Legal Proceedings. (a) Except as set forth in Schedule 3.11(a), there are no unresolved complaints (consumer or otherwise), claims, actions, suits, arbitrations, hearings, proceedings or investigations, whether at law or in equity, and whether or not before any Governmental Entity (collectively, "Actions"), pending or, to Seller's Knowledge, threatened against or affecting or which pertain to or involve the Company or any Property of the Company or any individual in his or her capacity as a director, officer or employee of the Company, or any aspect of the business or operation of the Company, or the ability of the Company to conduct or transact any insurance business or to consummate the transactions contemplated by this Agreement or the Related Agreements. Except as set forth in Schedule 3.11(a), there are no judgments, orders, decrees or injunctions of any Governmental Entity issued or outstanding against or which affect the Company or any property of the Company or any aspect of the business or operation of the Company, or the ability of the Company to conduct or transact any insurance business or to consummate the transactions contemplated by this Agreement or the Related Agreements that remain unsatisfied or require continuing compliance. (b) Except as set forth in Schedule 3.11(b), there are no Actions pending or, to Seller's Knowledge, threatened in which the Company is either a plaintiff or (if not a formal proceeding) an aggrieved party or claimant and there are no orders, decrees or injunctions issued in favor of the Company. 3.12. Bank Accounts. Schedule 3.12 sets forth a list of all bank accounts maintained by the Company together with the addresses of the banks at which such accounts are maintained and the contact persons for the Company thereat. 3.13. Form of Capital and Surplus. The Company's capital and surplus consist only of (i) cash and cash equivalents, (ii) fixed income securities traded in a recognized public market and (iii) bonds on deposit with certain states as required to obtain Insurance Permits in those states. Schedule 3.13 sets forth a description of the items constituting the Company's capital and surplus (collectively, the "Securities"), including the values thereof, valued as of December 31, 2004 in accordance with the valuation methods set forth in Section 2.2 of this Agreement. The Securities comply with the requirements of the insurance laws and regulations of the State of Arkansas as well as the insurance laws and regulations of any other applicable jurisdiction. 3.14. Undisclosed Liabilities. (i) The Company does not have any direct or indirect indebtedness, liability, or other obligation, whether fixed or unfixed, secured or unsecured, accrued, absolute, contingent or otherwise (individually, a "Liability," and collectively, "Liabilities") that would be required by GAAP to be and were not reflected or reserved against in the Latest Balance Sheet, and no such Liabilities have arisen since the date of the Latest Balance Sheet except as set forth on Schedule 3.14 hereto and (ii) to Seller's Knowledge, the Company does not have any Liabilities, whether or not required by GAAP to be included on a balance sheet prepared in accordance with GAAP, which are not either reflected or 18 reserved against in the Latest Balance Sheet or set forth on Schedule 3.14 hereto, other than in the case of clauses (i) and (ii), Liabilities arising under or resulting from this Agreement or the Related Agreements. All Liabilities which, in the case of clause (i), were required by GAAP to be and were not reflected or reserved against in the Latest Balance Sheet, or which have arisen since the date of the Latest Balance Sheet and would be required by GAAP to be included on a balance sheet prepared in accordance with GAAP and are not set forth on Schedule 3.14, and, in the case of clause (ii), are Known to Seller, whether or not such Liabilities would be required by GAAP to be included on a balance sheet prepared in accordance with GAAP, and which are not either reflected or reserved against in the Latest Balance Sheet or set forth on Schedule 3.14 hereto, shall collectively be referred to herein as "Undisclosed Liabilities". 3.15. Contracts. (a) To Seller's Knowledge, the Related Agreements constitute all of the contracts and commitments by which the Company is bound or to which the Company is subject, and there are no other contracts or commitments to which the Company is now a party or by which the Company or its assets are or may be bound or to which the Company or its assets are or may be subject, other than (i) contracts and commitments identified on Schedule 3.15(a), all of which, except as indicated on such Schedule, shall be either terminated or amended effective on or prior to the Closing Date to remove the Company as a party thereto, and to discharge the Company from any and all obligations, liabilities or commitments thereunder, (ii) the Third-Party Reinsurance Agreements and (iii) this Agreement. On the Closing Date, the Related Agreements and the Third-Party Reinsurance Agreements will constitute all of the contracts and commitments by which the Company or its assets are or may be bound or to which the Company or its assets are or may be subject, and there will be no other contracts or commitments to which the Company is a party or by which the Company or its assets are or may be bound or to which the Company or its assets are or may be subject, other than this Agreement. (b) The Company is not a party to any reinsurance contract other than the Third-Party Reinsurance Agreements set forth on Schedule 3.15(b). True and complete copies of all of the Third-Party Reinsurance Agreements, including all amendments, endorsements and addenda thereto, have been delivered to the Purchaser prior to the date of this Agreement. The Company is a cedent, and is not a reinsurer, under each of the Third-Party Reinsurance Agreements. All Third-Party Reinsurance Agreements providing reinsurance cover for errors and omissions, medical malpractice, personal injury or employment practices lines of business (none of which the Company ever wrote), directors and officers liability, or other similar lines, have expired or been terminated prior to the date hereof as to new and renewal business written by the Company. 3.16. Employee Matters. (a) The Company (i) does not have, and has not at any time since its formation had, any full-time or part-time employees, independent contractors, consultants, distributors, salespersons, insurance agents or persons performing similar functions (other than Surplus Lines Brokers) (collectively, "Employees") and (ii) is not a party to or obligated 19 under, and does not have any liabilities or obligations with respect to, any employment, consulting or agency contract or agreement (written or oral) with any Person. (b) The Company does not have any liabilities or obligations of any nature whatsoever to any Employee or to any current or former officers or directors of the Company or any Affiliate of the Company, including, without limitation, pursuant to (i) any indemnification agreements (written or oral), (ii) the Company's Certificate of Incorporation or Bylaws, as currently in effect or as in effect at any time since the Company's formation, or (iii) any other agreement, understanding or obligation (any such obligation or liability referred to herein as an "Employee-Related Liability"). (c) The Company has not maintained, contributed to, been obligated to contribute to or have liability (including, without limitation, potential or contingent liability under Title IV of ERISA or any liability incurred by an ERISA Affiliate) with respect to any Employee Benefit Plan (any such obligation or liability referred to herein as a "Benefit-Related Liability"). (d) The Company is not a party to or otherwise obligated under any collective bargaining agreement. (e) Seller acknowledges that Purchaser is assuming no liability or responsibility with respect to any Employee-Related Liability or Benefit-Related Liability, or with respect to any agreement or arrangement with any Surplus Lines Brokers (including any commissions or fees owed in connection therewith). 3.17. Powers of Attorney. Except as set forth in Schedule 3.17, other than any powers of attorney granted to insurance commissioners in connection with state licensing matters, all powers of attorney granted by the Company have expired or been revoked prior to the date hereof. 3.18. Accuracy of Documents. All minute books and stock records of the Company and all other Documents delivered by Seller or the Company to Purchaser in connection with the transactions contemplated hereby are complete and accurate in all material respects. All corporate books and records of the Company are maintained in compliance in all material respects with all applicable statutes, including requirements as to their location. 3.19. Brokers and Finders. Except for Merger and Acquisition Services, Inc., the fees and expenses of which shall be paid by Seller, no broker, finder or investment banker is entitled to any fee or commission in connection with the transactions contemplated hereby or the Related Agreements based upon arrangements made by or on behalf of Seller or the Company. 3.20. Excess and Surplus Lines Brokers. (a) Each Surplus Lines Broker, at the time such Surplus Line Broker solicited, negotiated, sold or produced any insurance business of the Company, to the extent required by Applicable Law, was duly and appropriately licensed as a Surplus Line Broker (for the type of business solicited, negotiated, sold or produced by such excess and surplus lines broker), in 20 each case, in the particular jurisdiction in which such Surplus Line Broker solicited, negotiated, sold or produced such insurance business. (b) Except as set forth on Schedule 3.20(b), the Company is not and has never been a party to any profit sharing, contingent fee, placement service, market service or similar agreement with any insurance producer, agent or broker, including any Surplus Lines Broker. The Company does not pay and has at no time paid any insurance producer, agent or broker, including any Surplus Lines Broker, any fees, commissions, overrides, production bonuses or other payments based upon (i) the amount of business placed with the Company by clients of such producer, (ii) such producer's clients rate of renewal of policies with the Company or (iii) the profitability of the business placed by such producer. The Company has never provided or submitted a false, sham, phony or otherwise artificial bid or quote with respect to prospective insurance business. To Seller's Knowledge, no insurance producer, agent or broker, including any Surplus Lines Broker, has violated any term or provision of any Applicable Law applicable to any aspect (including, but not limited to, the soliciting, negotiating, marketing, sale or production) of the Company's insurance business. (c) Schedule 3.20(c) contains a true and complete list of (i) all agreements with Surplus Lines Brokers or other brokers, agents or producers and (ii) all marketing agreements (true and complete copies of all such written agreements and a written description of all such oral agreements having been made available to Purchaser), which are or were in force or effective at any time during the period from January 1, 2000 through the date hereof, to which the Company is or was a party or by which any Properties of the Company is, was, may be or may have been bound, as such agreements may have been amended to the date hereof. 3.21. Assets and Properties. (a) The Company owns and has good and marketable title to all of its assets and Properties, free from any Liens or Restrictions (other than any escrowed amounts or other deposits made with state insurance commissioners). (b) On the Closing Date, the Company will not own any assets or Properties, except (i) its corporate charter and the Insurance Permits set forth on Schedule 3.2(b), (ii) the Closing Assets, and (iii) the contractual rights of the Company pursuant to this Agreement and the Related Agreements. 3.22. No Restrictions on Business. Other than pursuant to the restrictions of Applicable Law and as set forth on Schedule 3.2(b), the Company is not subject to any contract, agreement, commitment or other contractual obligation with any Person including, but not limited to, any Governmental Entity, containing any provision or covenant (i) limiting the ability of the Company to engage in any line of business, to compete with any Person, to do business with any Person or in any location or to employ any Person or (ii) limiting the ability of any Person to compete with or obtain products or services from the Company. For the avoidance of doubt, the parties hereto acknowledge that the failure of the Company to have an Insurance Permit (other than those permits listed on Schedule 2.2(d) hereto) shall not be deemed to breach this Section 3.22. 21 3.23. Marketing Agreements. (a) No business was ever written by or on behalf of the Company pursuant to or in connection with the Joint Marketing Agreements. Pursuant to termination agreements or amendments reasonably satisfactory to Purchaser, on or prior to the Closing Date each of the Joint Marketing Agreements and the Intercompany Marketing Agreement shall be either terminated or amended effective on or prior to the Closing Date to remove the Company as a party thereto, and to discharge the Company from any and all obligations, liabilities or commitments thereunder (other than obligations, liabilities and commitments arising under business written by the Company pursuant to the Intercompany Marketing Agreement and ceded to Seller pursuant to the Quota Share Agreement). From and after the Closing Date, the Company shall have no obligations, liabilities or commitments under the Joint Marketing Agreements or Intercompany Marketing Agreement. (b) Seller, the Company and their respective Affiliates have complied with all of the covenants, agreements and other obligations of Seller, the Company and their Affiliates, respectively, arising out of or related to the Joint Marketing Agreements. (c) The Company is not subject to any contract, agreement, commitment or other obligation with any Person including, but not limited to, any Governmental Entity, concerning the marketing or underwriting of business, or which are otherwise similar to the Joint Marketing Agreements or Intercompany Marketing Agreement. 3.24. Policyholder Complaints. Neither the Company or any of its Affiliates nor, to Seller's Knowledge, any Governmental Entity (including the Arkansas Commissioner) has received any complaints by policyholders of the Company of the nature which would customarily be recorded by insurance companies on a policyholder complaint log. 3.25. Absence of Certain Changes. Except as contemplated by this Agreement, the Related Agreements or as set forth on Schedule 3.25, and except for events occurring in the ordinary course of the Company's business, since December 31, 2003, the Company has not: (a) been engaged in or conducted any business other than an insurance business; (b) incurred any obligation or liability (absolute or contingent); (c) mortgaged, pledged or subjected to any Lien or Restriction any of its assets or Properties; (d) sold or transferred any assets or Property or cancelled any debts or claims, except for sales of investment assets, followed by reinvestment of the net proceeds thereof; (e) made any loan or advance to, or guaranteed the obligations of, any individuals, firms, corporations or other entities; (f) entered into any transaction or agreement, insurance or otherwise; 22 (g) declared, made, set aside or paid any dividend, distribution or payment on, or any purchase or redemption of, any shares of any class of its capital stock or made any commitments therefor; (h) incurred any indebtedness, absolute or contingent; (i) made any change in its accounting methods or practices, or made any change in depreciation or amortization policies or rates adopted by it; (j) except as set forth in its consolidated federal income tax return for its 2003 taxable year and other previously filed Tax Returns, changed any method of accounting with respect to Taxes, revoked, changed or made any Tax elections, or compromised or entered into any settlements in respect of Taxes; (k) made any payment or commitment to pay any person; (l) entered into or amended any contract or other agreement pursuant to which it agrees to indemnify any party or to refrain from competing with any party; (m) except for investment assets acquired in the ordinary course of business, made any acquisition of any of the assets, properties, capital stock or business of any other person or entity; (n) suffered or had any adverse change, event or condition in its business, results of operations, assets, financial condition, or the manner of conducting its business; (o) issued, granted, sold or otherwise disposed of any of its capital stock or other securities, or options or rights to acquire its capital stock or securities; (p) amended its Certificate of Incorporation or Bylaws; (q) formed, acquired or disposed of any interest in any corporation, partnership, joint venture or other entity; (r) written up, written down or written off the value of any material amount of assets; or (s) entered into any oral or written agreement or understanding to do any of the acts or things described in this Section 3.25. 3.26. Real Property; Environmental Matters. (a) The Company does not own and since its formation has never owned any real property. The Company is not a party to, and neither the Company nor the business of the Company is in any way subject to, any lease (as lessee or lessor) or sublease (as sublessee or sublessor) of real property. 23 (b) Except for claims in the normal course of its insurance business, all of which will be reinsured pursuant to the Quota Share Agreement, no litigation, suits, claims, proceedings or investigations or private or governmental enforcement actions or orders are pending or, to Seller's Knowledge, threatened against the Company with respect to any Hazardous Material or applicable Environmental Law (each as defined below). (c) Neither Seller nor the Company has received any notice from any Governmental Entity or other Person of any claims or potential violations by the Company of, or liability under, any Environmental Law. (d) To Seller's Knowledge, there is not (i) any activity on any properties presently or formerly owned or operated by the Company which was conducted, or is being conducted, in violation of any Environmental Law, or (ii) any actual or threatened release (including, without limitation, any spill, discharge, leak, emission, ejection, escape or dumping) or improper or inadequate storage of, or contamination caused by, any Hazardous Material on or under any properties of the Company, which in any of such cases has or would reasonably be expected to have a Material Adverse Effect. (e) For purposes of this Section 3.26, "Environmental Law" means any Applicable Law relating to pollution or protection of the environment, health, safety, or natural resources or to the use, handling, transportation, treatment, storage, disposal, release or discharge of Hazardous Materials; and "Hazardous Material" means any material, substance, waste, pollutant, contaminant, chemical or other matter that is defined as a hazardous material, hazardous substance, hazardous waste, toxic material, toxic substance or other term having a similar meaning under Applicable Law or is otherwise subject to elimination, abatement, removal, remediation or cleanup under Applicable Law. 3.27. Insurance Business. No insurance policy or contract issued by or on behalf of the Company is in-force as of the date hereof. The Company is not required pursuant to Applicable Law or the terms of any insurance policy or contract issued by or on behalf of the Company to issue or renew any insurance policy or contract. ARTICLE IV REPRESENTATIONS AND WARRANTIES OF PURCHASER Purchaser represents and warrants to Seller, as of the date of this Agreement (except if another date is specified in the representation or warranty) and as of the Closing Date, as follows: 4.1. Organization and Standing. Purchaser is a property and casualty insurance company duly organized, validly existing and in good standing under the laws of the State of Delaware. 4.2. Authorization of Agreement. Purchaser has all requisite power to execute and deliver this Agreement and perform its obligations under this Agreement, and the execution, delivery and performance of this Agreement and the consummation of the transactions 24 contemplated by this Agreement have been duly authorized and approved by all necessary corporate action on the part of Purchaser. This Agreement has been duly executed and delivered by Purchaser and is the valid and binding obligation of Purchaser enforceable against it in accordance with its terms, subject to the Bankruptcy Exception. 4.3. No Breach of Statute or Contract; Consents and Authorizations. (a) Neither the execution and delivery by Purchaser of this Agreement nor performance by Purchaser of its obligations hereunder will conflict with, or result in a breach of, any of the terms, conditions or provisions of: (i) the Certificate of Incorporation or Bylaws of Purchaser; (ii) subject to receipt of approvals referred to in Section 4.3(b), any judgment, order, injunction, decree or ruling of any court or Governmental Entity, or any Applicable Law, to which Purchaser is subject; or (iii) any agreement, contract or commitment to which Purchaser is a party or is subject, except, in the case of clauses (ii) and (iii) only, for such conflicts or breaches which would not materially impair the ability of Purchaser to execute, deliver and perform its obligations under this Agreement. (b) To Purchaser's Knowledge, except for (i) the approval by the Arkansas Commissioner with respect to the change in control of the Company and (ii) any approvals by the insurance department of any other jurisdiction asserting regulatory authority over the transactions contemplated by this Agreement which are required by applicable law, regulation or rule to be obtained by Seller, there are no governmental approvals required to permit the consummation of the transactions contemplated by this Agreement. 4.4. Investment Intent. Purchaser represents and warrants that (i) subject to the provisions of Section 2.4 hereof, Purchaser is acquiring the Stock for its own account, for investment purposes only and not with a view to the resale, distribution or other disposition thereof or any part thereof or any interest therein, and (ii) Purchaser has such knowledge of and experience in financial and business matters as to be capable of evaluating the merits and risks of its prospective investment in the Company as contemplated by this Agreement. Purchaser acknowledges that the Stock will not be registered under the Securities Act of 1933, as amended, or under any state securities law and, therefore, may not be sold by Purchaser except pursuant to an effective registration statement under such Securities Act or an exemption from registration thereunder and pursuant to registration or qualification under any applicable state securities law or exemption therefrom. 4.5. No Litigation. There are no actions, suits or administrative, arbitration or other proceedings or governmental investigations (including counterclaims) pending or, to Purchaser's Knowledge, threatened in writing to restrain, prohibit or otherwise challenge the performance by Purchaser of the transactions contemplated by this Agreement. 4.6. Brokers and Finders. Except for Merger and Acquisition Services, Inc., the fees and expenses of which shall be paid by Seller, no broker, finder or investment banker is entitled to any fee or commission in connection with the transactions contemplated hereby based upon arrangements made by or on behalf of Purchaser. 25 ARTICLE V CONDUCT AND TRANSACTIONS PRIOR TO CLOSING; COVENANTS; INDEMNITIES 5.1. Investigations; Operation of the Business of the Company. Between the date of this Agreement and the Closing: (a)(i) Upon receipt of reasonable notice, Seller will give, or cause to be given, to Purchaser or Purchaser's representatives and agents, reasonable access to the books, records and officers of the Company and, to the extent that the same pertain to the Company, the books and records of Seller, and Seller will cause the officers and employees of Seller and of the Company to furnish to Purchaser upon reasonable prior notice such financial data and other information with respect to the assets and the conduct of the business of the Company as Purchaser shall from time to time reasonably request; provided, however, that any such investigation shall be conducted during normal business hours and in such manner so as not to interfere unreasonably with the operation of the business of Seller or the Company. (ii) Until the Closing Date and thereafter at all times if the transactions contemplated by this Agreement are not consummated, Purchaser shall hold any Confidential Information in confidence unless and until such time as such information otherwise becomes publicly available, and, in the event of the termination of this Agreement, upon request by Seller, shall deliver to Seller all such Confidential Information so obtained by Purchaser. (iii) It is acknowledged and agreed that unauthorized use of any Confidential Information would cause irreparable injury constituting the proper subject of injunctive relief and specific performance, in addition to providing Purchaser an action for damages. Notwithstanding any other provision of this Agreement, the covenants of Purchaser set forth in this Section 5.1(a) shall survive the cancellation, abandonment or termination of this Agreement. (b) Each of Seller and Purchaser agrees that it will promptly make or cause to be made any filing or submission required to be made by it or on its behalf or on behalf of the Company with the Arkansas Commissioner and with the insurance department or similar regulatory authority of any other jurisdiction asserting regulatory authority over the transactions contemplated by this Agreement. (c) Seller and Purchaser shall cooperate in using all reasonable efforts to cause the conditions to the Closing hereunder to be satisfied as soon as practicable including, without limitation, obtaining the consents, approvals and authorizations necessary for the Closing. For purposes of this Agreement, the covenant of the parties to use their "reasonable efforts" shall not require any party to incur any unreasonable expenses. (d) Except as otherwise provided for by the terms of this Agreement, without the prior written consent of Purchaser, Seller will not permit the Company to: (i) issue or sell, or commit to issue or sell, any shares of its capital stock; (ii) grant or commit to grant any 26 options, warrants or rights to subscribe for, purchase, or otherwise acquire any shares of its capital stock; (iii) issue or commit to issue any securities convertible into or exchangeable for shares of its capital stock; (iv) either declare, set aside, pay or commit to pay any dividend or other distribution with respect to its capital stock or transfer any asset for any other purpose; (v) directly or indirectly redeem, purchase or otherwise acquire or dispose of, or commit to acquire or dispose of, any shares of its capital stock; (vi) effect a split, modification or reclassification of its capital stock or a recapitalization of the Company; (vii) change the Certificate of Incorporation or Bylaws of the Company; (viii) make, or agree to make, any borrowings or any guarantee, or agree to guarantee, the borrowings of any other Person; (ix) enter into or become party to any contract or commitment other than the Related Agreements; (x) write any insurance or reinsurance business, on a surplus lines basis or otherwise, or engage in any business except as may be specifically contemplated in this Agreement; (xi) take any action that would cause the Company to incur any Employee-Related Liability, Benefit Related Liability, Undisclosed Liability or liability of the nature described in Section 3.20(b), (xii) take any action that would cause the Company to incur any other liability whatsoever not fully indemnified hereby or that would have the effect of impairing the value of the assets or the validity of any Insurance Permit; (xiii) enter into any new employment, severance or consulting contracts or otherwise hire any employees, contract with any independent contractors or appoint any insurance agents; (xiv) subject any of its Properties or assets to any Liens or Restrictions; or (xv) except as set forth herein, take any action not in the ordinary course of the Company's business or which would be inconsistent with delivering to Purchaser a corporation as otherwise contemplated in this Agreement. (e) Except as specifically consented to in writing by Purchaser, Seller shall not, and shall not permit the Company to, take any action or omit to take action that would result in a breach of any representation or warranty of Seller contained in this Agreement. (f) Except as otherwise contemplated by this Agreement or specifically consented to in writing by Purchaser, from the date of this Agreement through the Closing Date, Seller shall cause the Company to (i) conduct its business only in the ordinary course consistent with past and current practices, (ii) comply in all material respects with all Applicable Laws, (iii) preserve and maintain in full force and effect the Insurance Permits and (iv) perform in all material respects its obligations under all contracts and commitments to which it is a party or by which it is bound. (g) Purchaser covenants to use reasonable efforts to file as promptly as practicable the Statement Regarding the Acquisition of Control of or Merger with a Domestic Insurer (Form A) with the Arkansas Commissioner. 5.2. Pending or Threatened Action. Between the date of this Agreement and the Closing Date, Seller and Purchaser shall each inform the other, promptly upon any party's obtaining knowledge thereof, of any pending or threatened Action by any Governmental Entity which could reasonably be anticipated (i) to prohibit or restrain or impair the consummation of the transactions contemplated by this Agreement or the Related Agreements, or the performance by Parent, Seller, the Company, USACC or Purchaser of their respective obligations under this Agreement or the Related Agreements, as applicable, (ii) to have a Material Adverse Effect or 27 (iii) to have the effect of impairing the value of the Closing Assets or other Property of the Company or the validity of any Insurance Permit. 5.3. Tax Audits; Tax Returns. (a) Seller, at its sole cost and expense, shall, or shall cause Parent or the Company to, file or cause to be filed when due all Tax Returns of or including the Company that are required to be filed by or with respect to the Company for any Pre-Closing Period and Seller shall, or shall cause Parent (or the Company prior to the Valuation Date) to, remit (or cause to be remitted) any Taxes due in respect of such Tax Returns. All Tax Returns described in this Section 5.3(a) will be prepared in a manner consistent with the past practice of Parent, Seller and the Company. Purchaser shall cause the Company to sign (or cause the Company to grant Seller power of attorney to sign) any Tax Returns that are prepared in accordance with Applicable Law, are required to be filed by or with respect to the Company for any Pre-Closing Period and that are filed after the Closing Date. (b) Purchaser, at its sole cost and expense, shall file or cause to be filed when due all Tax Returns that are required to be filed for any Post-Closing Period or any Straddle Period by or with respect to the Company and, subject to Section 8.5(c) hereof, Purchaser shall remit (or cause to be remitted) any Taxes due in respect of such Tax Returns. (c) Purchaser shall not amend, or allow the Company to amend, any Tax Return of the Company for any Pre-Closing Period. Purchaser shall, or shall cause the Company to, pay to Seller the net amount of any refunds for Taxes received by the Company or Purchaser after the Closing Date, and attributable to Taxes paid by Seller under this Agreement or with respect to any Pre-Closing Period, less any Taxes or other costs imposed on the Company, Purchaser or any of their Affiliates as a result of receiving or claiming such refund, and subject to repayment by Seller in the event that Purchaser, the Company or any of their Affiliates is subsequently required to return such refund. All such Tax refunds shall be paid within five (5) days of receipt by the Company or Purchaser (or within five (5) days of request therefor by the Purchaser in the case of a refund required to be returned). (d) Purchaser shall cause the Company to prepare in a manner consistent with past practice of the Company and to deliver to Parent or Seller all relevant Tax information relating to the Company reasonably required to permit Parent or Seller to file or cause to be filed when due all Tax Returns pursuant to Section 5.3(a) of this Agreement. (e) Purchaser and the Company will provide Seller (and its attorneys, accountants and agents) with the right, at reasonable times, upon reasonable notice, to have access to, copy and use, any records or information that are reasonably available to the Company and that Seller deems in its reasonable discretion relevant for the preparation of any Tax Returns, any audit or other examination by any Taxing Authority, the filing of any claim for a refund of Tax or for the allowance of any Tax credit, or any judicial or administrative proceedings relating to liability for Taxes of the Company for taxable periods ending on or prior to the Closing Date. Purchaser shall retain all books and records provided to it with respect to any Tax matters pertinent to the Company, Seller or Parent relating to any Pre-Closing Period until the expiration of the applicable statute of limitations (and, to the extent 28 notified by Seller, any extensions thereof) of the respective tax periods. Seller shall, or shall cause Parent to, reimburse Purchaser for all reasonable out-of-pocket expenses incurred by Purchaser in connection with providing such information. Any information obtained pursuant to this Section 5.3(e) shall be held in strict confidence and shall be used solely in connection with the reason for which it was requested. (f) In the case of any income or premium Tax Return for any Straddle Period, Purchaser shall provide Seller with copies of the completed Tax Return for such taxable period and a schedule apportioning the Tax shown on such Tax Return as between Seller and Purchaser and specifying the amount due to or from Seller (all computed in accordance with Section 8.5(c) hereof), together with such related work papers and other documents as Seller shall reasonably request, no later than forty-five (45) days before the due date for the filing of such Tax Return. Seller and its authorized representatives shall have the right to review the Tax Return and schedule received from Purchaser pursuant to the terms of this Section 5.3(f). Seller and Purchaser shall consult with one another and resolve reasonably and in good faith and in accordance with Applicable Law any issues concerning the apportionment required by this Section 5.3(f) as a result of the review of any such Tax Return and schedule received from Purchaser. Seller shall, or shall cause Parent to, pay the amount of Tax, if any, due and owing from Seller to Purchaser no later than five (5) days prior to the date of filing of such Tax Return. (g) Seller shall cause any Tax sharing agreement or similar arrangement with respect to Taxes involving the Company, on the one hand, and Parent or Seller, or any Affiliates of Seller, on the other hand, to be either terminated or amended effective as of the Closing Date, so that to the extent any such agreement or arrangement relates to the Company after the Closing Date, none of Parent, the Company, Seller nor any of their respective Affiliates shall have any obligation thereunder to the other, whether to make payment or otherwise, under any such agreement or arrangement for any past, present or future period. (h) Except as otherwise expressly contemplated by this Agreement, from the date hereof to and including the Closing Date, Seller shall not permit the Company to, and shall cause Parent not to permit the Company to, without the prior written consent of Purchaser, which shall not be unreasonably withheld, conditioned or delayed, directly or indirectly (i) make, change or revoke, or permit to be made, changed or revoked, any election or method of accounting, with respect to Taxes affecting the Company for Post-Closing Tax Periods, except elections made on the consolidated federal income tax return of the Parent for periods ending on December 31, 2004 and on the Closing Date that are consistent with similar elections made for prior tax periods or are as disclosed on Schedule 3.8, (ii) enter into, or permit to be entered into, any closing or other agreement or settlement with respect to Taxes of the Company affecting or relating to Post-Closing Tax Periods, or (iii) enter into any transaction or series of transactions other than in the ordinary course of business, or take any position on any Tax Return for any taxable period (or portion thereof) ending on or prior to the Closing Date that would have the effect of increasing the Company's tax liability for any taxable period (or portion thereof) beginning after the Closing Date. (i) If (i) Purchaser or the Company receives a written notice from any Taxing Authority proposing an audit or other examination of a Tax Return of the Company for any 29 Pre-Closing Period or (ii) a claim is made or threatened in writing by any Taxing Authority that, if successful, may result in an indemnity payment under Section 8.1 hereof (each a "Tax Claim"), Purchaser shall promptly notify Seller in writing stating the nature and basis of such Tax Claim, and the amount thereof, to the extent known. Failure to give such notice shall not relieve Seller from any liability that it may have on account of this indemnification or otherwise, unless and to the extent that Seller is materially adversely prejudiced thereby. Seller will have the right, upon notification to Purchaser within thirty (30) days of the date Purchaser notified Seller of such Tax Claim, to assume at its own expense the control of any audit or other defense of any Tax Claim with its own counsel. If Seller elects not to control any audit or other defense of a Tax Claim, Purchaser shall have the authority to settle such Tax Claim subject to Seller's consent which shall not be unreasonably withheld, conditioned or delayed. Seller's right to control a Tax Claim will be limited to issues in respect of which amounts in dispute would be paid by Seller or for which Seller would be liable pursuant to Section 8.1 hereof. Purchaser shall cooperate in good faith with Seller in contesting any Tax Claim, which cooperation shall include providing records and information that are reasonably available to the Company and relevant to such Tax Claim. All reasonable out-of-pocket expenses of Purchaser related to such cooperation shall be borne by Seller. Notwithstanding the foregoing: (i) Seller shall not have the right to control any issue involved in a Tax Claim unless Seller first acknowledges in writing its obligation to fully indemnify Purchaser for the Taxes asserted in connection with such issue; (ii) no settlement or disposition of any Tax Claim shall be made without Purchaser's prior written consent (which consent shall not be unreasonably withheld, delayed or conditioned); and (iii) Purchaser and Seller shall jointly control all proceedings involving any claims for Taxes assessed in respect of a Straddle Period, and each party shall bear its own out-of-pocket costs and expenses relating to such claims. (j) Seller, Purchaser and the Company agree that for all income Tax purposes, the taxable period of the Company shall be terminated as of the close of business on the date of the Closing in accordance with Treasury Regulations Section 1.1502-76(b)(1) and items of income, gain, loss, deduction or credit shall be apportioned based upon a closing of the books for Tax purposes in accordance with Treasury Regulation Section 1.1502-76(b) (other than transactions properly allocable thereunder to the portion of the day after the Closing shall occur, which shall be treated for all federal income tax purposes as occurring at the beginning of the following day). No elections shall be made under either Treasury Regulation Section 1.1502-76(b)(2)(ii) (relating to ratable allocation of a year's items) or Treasury Regulation Section 1.1502-76(b)(2)(iii) (to ratably allocate the items for the month which includes the Closing Date). Seller, Purchaser and the Company further agree to, and Seller shall cause Parent to, file all Tax Returns, handle the contest of any audit and otherwise act for all Tax purposes consistent with the provisions of this Section 5.3(j). (k) If the Seller and Purchaser do not make the Section 338 Elections and in a Post-Closing Period the liability of the Company for any income Tax is actually reduced (determined by assuming that all other current or prior period (but not including any carryback) losses, deductions or credits of the Company or any consolidated, combined, or unitary group that includes the Company as a member are used first, regardless of any ordering rule in Applicable Law) (the "Tax Savings") by reason of any net operating loss carryover of the Company from any Pre-Closing Period (a "Pre-Closing NOL"), then, (i) to 30 the extent that the Tax Savings equals all or any part of the Tax Adjustment that decreased the amount of the Purchase Price payable to Seller (the "Negative Tax Adjustment"), Purchaser shall pay the Seller an amount equal to the lesser of the Tax Savings or the Negative Tax Adjustment, and (ii) to the extent that the Tax Savings exceeds the Negative Tax Adjustment, then for purposes of determining the amount of Tax incurred by the Company that reduces a refund due to Seller pursuant to Section 5.3(c), or increases an Indemnification Payment by Seller pursuant to Section 8.6(ii), the amount of such Tax Savings in excess of the Negative Tax Adjustment shall be deemed to offset any Tax described in such Sections. Nothing contained herein shall be construed as creating any obligation on the part of the Company (or any consolidated, combined, or unitary group that includes the Company as a member) to claim or deduct any Pre-Closing NOL in any Straddle Period or Post-Closing Period, and if any Pre-Closing NOL shall be reduced, disallowed or adjusted and such reduction, disallowance or adjustment results in any loss or repayment of any Tax Savings, the amount of such lost or repaid Tax Savings (plus any interest thereon or penalties related thereto) up to the amount of the Negative Tax Adjustment paid to the Seller or applied to offset any Tax shall be treated and indemnified (pursuant to Section 8.1(c)(ii)(A)) as Liabilities of the Company for Taxes assessed in respect of a Pre-Closing Period. 5.4. Section 338(h)(10) Elections. (a) At the request of Purchaser, and subject to the receipt of Seller's 338 Payment, Seller agrees to (and agrees to cause Parent to, if applicable) join with Purchaser in making a timely and irrevocable election pursuant to Section 338(h)(10) of the Code, and, at Purchaser's request, any corresponding or analogous election under applicable state, local or foreign law (collectively, the "Section 338 Elections"). (b) Purchaser shall be solely responsible for preparing drafts of all forms, attachments and schedules necessary to effectuate the Section 338 Elections, including, without limitation, IRS Form 8023 or applicable successor form, any similar forms or applicable successor forms under applicable state or local income tax laws, and the determination of the ADSP (as defined in applicable Treasury Regulations under Section 338 of the Code) and the allocation of ADSP among the assets of the Company and other relevant items (the "Allocation"), valuing the Closing Assets using the methodology set forth in Section 2.2 hereof (the "Section 338 Forms"). Purchaser shall furnish a copy of the draft Section 338 Forms to Seller for Seller's review and comment, which Seller agrees to do promptly. Seller shall, and if required, Seller shall cause Parent to, cooperate in good faith with Purchaser's preparation of the Section 338 Forms, and Seller agrees to (and agrees to cause Parent to) promptly provide to Purchaser true, correct and complete information regarding Seller (or Parent or Parent Group, if applicable) reasonably requested by Purchaser and necessary to complete the Section 338 Forms. (c) Thereafter, Purchaser shall deliver to Seller for execution by Seller (or Parent, if applicable) the final Section 338 Forms. Within five (5) days of delivering the final Section 338 Forms to Seller, Purchaser shall pay to Seller (by wire transfer in U.S. dollars of immediately available funds to the bank account specified in writing by Seller to Purchaser) an amount equal to Seller's 338 Payment, and Seller agrees to (and agrees to cause Parent to, if applicable) simultaneously execute and deliver to Purchaser the final Section 338 Forms. 31 (d) If Purchaser has paid Seller's 338 Payment to Seller, then Seller agrees that Seller (i) shall (or shall cause Parent to, if applicable) report the acquisition of the Company by Purchaser in a manner consistent with the making of the Section 338 Elections (ii) shall not, and shall cause Parent and each member of Parent Group not to, take a position in any Tax Return or audit or any proceeding before any Taxing Authority or otherwise inconsistent with the Section 338 Elections, including the determination of the ADSP and the Allocation shown thereon, unless and to the extent required to do so pursuant to a determination (as defined in Section 1313(a) of the Code or any similar state or local law). (e) Purchaser shall bear the costs and expenses of preparing the Section 338 Forms and the Allocation (f) If Purchaser and Seller make Section 338 Elections with respect to Purchaser's acquisition of the Stock, then the Seller's 338 Payment shall be increased by the amount of the Negative Tax Adjustment or, if the Tax Adjustment increased the amount of the Purchase Price payable to Seller (the "Positive Tax Adjustment"), the Seller's 338 Payment shall be reduced by the amount of the Positive Tax Adjustment. (g) The amount of the Seller's 338 Payment, as increased or decreased, as the case may be, by the Negative Tax Adjustment or the Positive Tax Adjustment paid to the Seller, if any, shall be treated for all tax purposes as the payment to Seller of additional purchase price for the Stock. 5.5. Transfer Taxes. Seller shall cause all appropriate stock transfer Tax stamps required by New York to be affixed to the certificate or certificates representing the Stock, and Seller or Purchaser, as required by Applicable Law, shall cause all other appropriate stock transfer Tax stamps to be affixed to the certificate or certificates representing the Stock. Seller, the Company and Purchaser shall cooperate in the preparation, execution and filing of all returns, applications or other documents regarding any real property transfer, transfer gains, sales or other similar transfer Taxes that become payable in connection with the sale of the Stock (other than the stock transfer taxes mentioned above) pursuant to this Agreement (collectively, "Transfer Taxes"). Any Transfer Taxes shown as due on such returns shall be borne by Purchaser or Seller as required by Applicable Law. 5.6. Conduct of Business by Purchaser. Purchaser covenants that it shall not, and it shall not permit the Company to, take any action that would cause the Company to incur any liability whatsoever until the day following the Closing Date including, without limitation, the commencement of operations by the Company, the hiring of employees or insurance agents for the Company, the writing of any insurance business by the Company or engaging in any reinsurance or other business by the Company, amending or modifying any governing document of the Company or the taking of any other action whatsoever which obligates the Company to act or omit to act and if Purchaser elects to make the Section 338 Elections, Purchaser shall not, and it shall not permit the Company to, take any action after the Closing that would cause the purchase of the Stock hereunder to fail to constitute a "qualified stock purchase" as defined in Section 338(d)(3) of the Code. 32 5.7. Change of Name. As promptly as practicable after the Closing, the Company shall change its name so that the Company does not have the word "Ulico" in its name, and the Company shall cease using the word "Ulico" in any of its business dealings. Purchaser shall promptly provide Seller with copies of all documentation effecting such name change, as filed with each applicable jurisdiction. Further, Purchaser hereby covenants that it will not use the words "Ulico", "ULLICO", or any derivatives thereof in any of its business dealings, and that it will not present itself or any of its Affiliates to the public as being related in any way to Seller or Parent. For the avoidance of doubt, statements by Purchaser and its Affiliates in regulatory documents, public filings or otherwise that it has purchased the Company from Seller and disclosures related thereto shall not be deemed to breach the covenant set forth in this Section 5.7. 5.8. Disclosure of Confidential Information. Seller shall not, and shall cause its Affiliates and its and their respective officers and directors not to, disclose any confidential information of the Company after the date hereof to any third party, unless compelled to disclose by judicial or administrative process or, in the written opinion of its counsel, by other requirements of law. It is acknowledged and agreed that unauthorized use of any confidential information of the Company would cause irreparable injury constituting the proper subject of injunctive relief and specific performance, in addition to providing Purchaser an action for damages. 5.9. Compliance with Arkansas Insurance Laws. During the period from the date hereof to the Closing Date, Seller shall, and shall cause the Company to, comply with all of the requirements of Arkansas insurance laws. 5.10. Notification of Changes. (a) Seller shall, after the first notice or occurrence thereof but not later than the Closing Date, promptly notify Purchaser in writing of any event or the existence of any state of facts that would (i) make any of its representations and warranties in this Agreement untrue, (ii) reasonably be likely to constitute a Material Adverse Effect, (iii) materially impair the ability of Seller to execute, deliver and perform its obligations under this Agreement, including, without limitation, the provisions of Article VIII hereof or (iv) materially impair the ability of Parent, Seller, the Company and/or USACC to execute, deliver or perform their respective obligations under any of the Related Agreements. (b) Purchaser shall, after the first notice or occurrence thereof but not later than the Closing Date, promptly notify Seller in writing of any event or the existence of any state of facts that would (i) make any of its representations and warranties in this Agreement untrue or (ii) materially impair the ability of Purchaser to execute, deliver and perform its obligations under this Agreement. 5.11. Acquisition Proposals. From the date hereof through the Closing Date, Seller shall not, nor shall Seller permit any of its Affiliates or any of the officers, directors, employees, representative or agents of Seller or any of such Affiliates to, directly or indirectly, solicit, initiate or participate in any way in discussions or negotiations with, or provide any information or assistance to, or enter into any agreement with, any person or group of persons 33 (other than Purchaser) concerning any acquisition of an equity interest in, or in a merger, consolidation, liquidation, dissolution, or disposition of assets of the Company, or any disposition of any of the securities of the Company (other than sales of investment securities in its investment portfolio with the prior written consent of Purchaser) (each, an "Acquisition Proposal"), or assist or participate in, facilitate or encourage any effort or attempt by any other person to do or seek to do any of the foregoing. Seller shall promptly communicate to Purchaser the terms of any Acquisition Proposal which it or any such other person may receive. 5.12. Related Agreements. On or prior to the Closing Date, (i) Seller shall, and shall cause the Company to, execute and deliver each of the Quota Share Agreement, Trust Agreement and Assumption Agreement, (ii) Seller shall, and shall cause the Company and USACC to, execute and deliver the Amended Termination of Reinsurance Pooling Agreement and (iii) Seller shall cause the Company to execute the Guarantee. 5.13. Payment of Brokers' or Finders' Fees. At or prior to the Closing, Seller will pay the finder's fee due to Merger and Acquisition Services, Inc. 5.14. Preparation of Financial Statements. With respect to any period ending on or prior to the Closing Date for which Statutory Financial Statements are required to be filed (including without limitation the year ended December 31, 2004), Seller shall prepare, on a basis consistent with past practices, all Statutory Financial Statements of the Company, and Seller shall promptly provide to Purchaser, at least fifteen (15) business days prior to the due date, including any extensions, for the filing thereof, such Statutory Financial Statements together with such other information reasonably relevant to such Statutory Financial Statements, including schedules and work papers. Following receipt of any Statutory Financial Statements prepared by Seller, Purchaser shall promptly notify Seller if it disputes any of the information contained in such Statutory Financial Statements. The parties shall cooperate to promptly resolve any such dispute. Subsequent to the Closing, Seller shall provide Purchaser with such assistance in the preparation of Statutory Financial Statements of the Company as may reasonably be requested by Purchaser or the Company. Subsequent to the Closing, Seller shall also provide to Purchaser such information as may reasonably be required by Purchaser in connection with Purchaser's preparation of GAAP financial statements for the financial reporting period in which the Closing occurs and for subsequent reporting periods. 5.15. Filing Fees. (a) On or prior to the Closing Date, the Company shall have paid all remaining Filing Fees due for calendar year 2004. At or prior to the Closing Date, the Company shall deliver to Purchaser an updated Schedule 3.9(b) indicating the amounts and dates (whether before or after the date hereof) on which all such Filing Fees for calendar year 2004 were paid and shall deliver to Purchaser satisfactory evidence thereof. (b) The parties agree that the filing fees which will be due for the calendar year 2005 (the "2005 Filing Fees") shall be allocated between the Seller and Purchaser in accordance with this Section 5.15(b) and that such allocation shall be binding on the parties regardless of the actual amount of the 2005 Filing Fees and regardless of when such 2005 Filing Fees are actually paid. First, the parties hereto stipulate and agree that the total amount used to calculate 2005 Filing Fees for purposes of this Section 5.15(b) shall be the aggregate amount of Filing Fees for calendar year 2004 as shown on Schedule 3.9(b) (i.e., as of the date of this Agreement, 34 $19,825.95). Next, it is agreed that one-fourth of such aggregate amount of Filing Fees (i.e., as of the date of this Agreement, $4,956.48) shall be chargeable to the Seller and three-fourths of such Filing Fees shall be chargeable to the Purchaser as follows: From the amount equal to one-fourth of the 2005 Filing Fees shall be deducted all amounts actually paid by the Company prior to the Closing Date. If the resulting balance is less than zero, such negative balance shall considered a prepaid expense and shall be reimbursed by Purchaser to Seller on the Closing Date. If the resulting balance is positive, such amount shall be considered an unpaid expense as of the Closing Date and shall be offset against the Purchase Price. The foregoing adjustments shall constitute complete settlement between the parties with respect to the 2005 Filing Fees, provided, nothing in this Section 5.15(b) shall relieve Seller from any obligation as otherwise set forth in this Agreement resulting from a breach of the representations and warranties set forth in Section 3.9(b). 5.16. Certain Litigation With regard to each of the Actions set forth on Schedule 3.11(b) in which, as of the date of this Agreement, the Company is a plaintiff, Seller agrees to take, or cause the Company to take, prior to the Closing, appropriate action such that, at the Closing, the Company shall have been removed as a plaintiff in each such Action or, if removal is not feasible, then all of the rights and obligations of the Company in respect of each such Action shall have been assigned to Seller or an affiliate of Seller, with the effect that, from and after the Closing, the Company shall have no further involvement in any of such Actions. Seller further agrees that, from the date of this Agreement through the Closing Date, Seller shall not permit the Company to commence, or to be named as a plaintiff in, any Action other than an Action set forth on Schedule 3.11(b). 5.17. Third-Party Reinsurance Agreements .. Seller agrees to use commercially reasonable efforts to terminate or take any other action with respect to any Third-Party Reinsurance Agreement which is reasonably requested by Purchaser or the Company subsequent to the Closing, and to provide regular periodic updates as to Seller's efforts to comply with any such request. ARTICLE VI CONDITIONS TO CLOSING; ABANDONMENT OF THE TRANSACTION 6.1. Conditions to the Obligations of Purchaser. Except to the extent waived by Purchaser in writing, the obligations of Purchaser to consummate the transactions contemplated herein and to purchase the Stock shall be subject to the satisfaction of each of the following conditions: (a) The representations and warranties made by Seller contained in this Agreement shall be true and correct in all material respects at and as of the Closing, as if and to the same effect as though made at and as of the Closing Date. Seller shall have performed all of its obligations and complied in all material respects with all covenants and conditions required by this Agreement to be performed or complied with by it at or prior to the Closing. Seller shall have delivered to Purchaser a certificate, in form and substance satisfactory to Purchaser, dated the Closing Date and signed on its behalf by its President, any Vice President 35 or Chief Financial Officer, in his or her respective representative capacity, and not individually, to all such effects and certifying to the satisfaction of the conditions to be performed by Seller or the Company (prior to the Closing) set forth in this Section 6.1. (b) No Action shall have been instituted and remain pending before a court or other Governmental Entity to restrain, prohibit or otherwise challenge the transactions contemplated by this Agreement or the Related Agreements, the sale of the Stock to Purchaser or the performance of the material obligations of the parties to this Agreement or the Related Agreements; nor shall any Governmental Entity have notified any party to this Agreement or the Company that the consummation of the transactions contemplated by this Agreement or the Related Agreements would constitute a violation of Applicable Law and that it intends to commence proceedings to restrain consummation of such transactions, to force divestiture if such transactions are consummated or to materially modify the terms or the results of such transactions, unless such Government Entity shall have withdrawn such notice prior to the Closing Date. (c) Seller's Approvals shall have been obtained and shall be in full force and effect without conditions reasonably found objectionable by Purchaser. (d) Seller and the Company shall have entered into the Quota Share Agreement, the Trust Agreement, the Administrative Services Agreement, the Assumption Agreement and the Termination and Commutation of LPT Agreement, fully executed originals of which shall have been delivered to Purchaser. (e) Parent and Company shall have entered into the Guarantee, a fully executed original of which shall have been delivered to Purchaser. (f) Seller, the Company and USACC shall have entered into the Amended Termination of Pooling Agreement, a fully executed original of which shall have been delivered to Purchaser. (g) Purchaser shall have received from counsel to Seller, Parent and the Company, which counsel shall be reasonably satisfactory to Purchaser, one or more opinions, dated the Closing Date and addressed to Purchaser, in form and substance reasonably satisfactory to Purchaser, which opinions shall be to the effect that: (i) Each of Seller and the Company is duly organized, validly existing and in good standing under the laws of its respective jurisdiction; (ii) (A) Seller has all requisite corporate power and authority to execute, deliver and perform its obligations under each of this Agreement, the Quota Share Agreement, the Trust Agreement, the Administrative Services Agreement, the Assumption Agreement, the Amended Termination of Pooling Agreement and the Termination and Commutation of LPT Agreement and (B) all action required on the part of Seller to authorize the execution, delivery and performance of each of this Agreement, the Quota Share Agreement, the Trust Agreement, the Administrative Services Agreement, Assumption Agreement, the Amended Termination of Pooling Agreement and the Termination and Commutation of LPT Agreement has been taken; 36 (iii) (A) the Company has all requisite corporate power and authority to execute, deliver and perform its obligations under each of the Quota Share Agreement, the Trust Agreement, the Administrative Services Agreement, the Assumption Agreement, the Amended Termination of Pooling Agreement, the Guarantee and the Termination and Commutation of LPT Agreement and (B) all action required on the part of the Company to authorize the execution, delivery, and performance of each of the Quota Share Agreement, the Trust Agreement, the Administrative Services Agreement, the Assumption Agreement, the Amended Termination of Pooling Agreement, the Guarantee and the Termination and Commutation of LPT Agreement has been taken; (iv) (A) USACC has all requisite corporate power and authority to execute, deliver and perform its obligations under the Amended Termination of Pooling Agreement, (B) all actions required on the part of USACC to authorize the execution, delivery, and performance of the Amended Termination of Pooling Agreement have been taken, and (C) USACC has the power to perform its obligations thereunder; (v) (A) Parent has all requisite corporate power and authority to execute, deliver and perform its obligations under the Guarantee and (B) all actions required on the part of Parent to authorize the execution, delivery, and performance of the Guarantee have been taken; (vi) each of this Agreement, the Quota Share Agreement, the Trust Agreement, the Administrative Services Agreement, the Assumption Agreement, the Amended Termination of Pooling Agreement and the Termination and Commutation of LPT Agreement has been duly executed and delivered by Seller and constitutes the valid and binding obligation of Seller, enforceable against Seller in accordance with its terms, subject to the Bankruptcy Exception; (vii) each of the Quota Share Agreement, the Trust Agreement, the Administrative Services Agreement, the Assumption Agreement, the Amended Termination of Pooling Agreement, the Guarantee and the Termination and Commutation of LPT Agreement has been duly executed and delivered by the Company and constitutes the valid and binding obligation of the Company, enforceable against the Company in accordance with its terms, subject to the Bankruptcy Exception; (viii) the Amended Termination of Pooling Agreement has been duly executed and delivered by USACC and constitutes the valid and binding obligation of USACC, enforceable against USACC in accordance with its terms, subject to the Bankruptcy Exception; (ix) the Guarantee has been duly executed and delivered by Parent and constitutes the valid and binding obligation of Parent, enforceable against Parent in accordance with its terms, subject to the Bankruptcy Exception; and 37 (x) neither the execution and delivery by Seller of this Agreement, nor the execution and delivery of the Related Agreements by Parent, Seller, Company or USACC, as applicable, nor the compliance by any of them with the terms and provisions hereof and thereof will conflict with, or result in a breach of, any of the terms, conditions or provisions of: (A) the certificate of incorporation or bylaws (or comparable organizational documents) of Parent, Seller, the Company or USACC or (B) any material agreement to which Parent, Seller, the Company or USACC is a party. In rendering such opinion, such counsel may rely, to the extent such counsel deems such reliance necessary or appropriate: (A) upon opinions of local counsel as to matters of law other than that of the federal laws of the United States (provided such local counsel's opinions are received from counsel reasonably satisfactory to Purchaser and its counsel and are addressed to Purchaser) and (B) as to matters of fact, upon certificates of state officials and of any officer or officers of Seller, the Company or USACC provided in all such cases that the extent of any such reliance is specified in such opinion. For purposes of the opinion described in paragraph (x)(B) above, it is understood and agreed that such counsel shall opine only to those agreements which are identified by Parent, Seller, the Company or USACC, as the case may be, to such counsel as material agreements. (h) Purchaser shall have received the evidence of the surplus lines eligibilities of the Company described in Section 2.2(d) hereof, certified by Seller as being in full force and effect. (i) At the Closing, Seller shall deliver to Purchaser resignations of all officers and directors of the Company, effective upon the Closing. (j) All contracts listed on Schedule 3.15(a), including the Joint Marketing Agreements and the Intercompany Agreement, shall have been terminated or amended as provided in Section 3.15(a) hereof. (k) Purchaser shall have received a certificate of Seller satisfying the requirements of Treasury Regulation Section 1.1445-2(b)(2). (l) The Company shall continue to be authorized to issue insurance policies on a surplus lines basis in the State of California. 6.2. Conditions to the Obligations of Seller. Except to the extent waived by Seller in writing, the obligations of Seller to consummate the transactions contemplated herein and to sell the Stock shall be subject to the satisfaction of each of the following conditions: (a) The representations and warranties of Purchaser contained in this Agreement shall be true and correct in all material respects at and as of the Closing, as if and to the same effect as though made at and as of the Closing Date. Purchaser shall have performed all of its obligations and complied in all material respects with all covenants and conditions required by this Agreement to be performed or complied with by it at or prior to the Closing. Purchaser shall have delivered to Seller certificates of Purchaser, in form and substance satisfactory to Seller, dated the Closing Date and signed on behalf of Purchaser by 38 its President or a Vice President in his or her respective representative capacity, and not individually, to all such effects and certifying to the satisfaction of the conditions to be performed by Purchaser set forth in this Section 6.2. (b) No Action shall have been instituted and remain pending before a court or other Governmental Entity to restrain, prohibit or otherwise challenge the transactions contemplated by this Agreement or the Related Agreements, the sale of the Stock by Seller or the performance of the material obligations of the parties to this Agreement or the Related Agreements; nor shall any Governmental Entity have notified either party to this Agreement or the Company that the consummation of the transactions contemplated by this Agreement or the Related Agreements would constitute a violation of Applicable Law and that it intends to commence proceedings to restrain the consummation of such transactions, to force divestiture if such transactions are consummated, or to materially modify the terms or the results of such transactions, unless such Government Entity shall have withdrawn such notice prior to the Closing Date. (c) Seller's Approvals and Purchaser's Approvals shall have been obtained and shall be in full force and effect without conditions reasonably found objectionable by Seller. (d) Seller shall have received from Dewey Ballantine LLP, counsel to Purchaser, one or more opinions, dated the Closing Date and addressed to Seller, in form and substance reasonably satisfactory to Seller, which opinions shall be to the effect that: (i) Purchaser is a corporation duly organized, validly existing and in good standing under the laws of the state of Delaware; (ii) all action required on the part of Purchaser to authorize the execution, delivery and performance of this Agreement by Purchaser has been taken, and Purchaser has the power to perform its obligations hereunder; and (iii) this Agreement has been duly executed and delivered by Purchaser and constitutes the valid and binding obligation of Purchaser, enforceable against Purchaser in accordance with its terms, subject to the Bankruptcy Exception. In rendering such opinions such counsel may rely, to the extent such counsel deems such reliance necessary or appropriate: (A) upon opinions of local counsel as to matters of law other than that of the federal laws of the United States (provided such local counsel's opinions are received from counsel reasonably satisfactory to Seller and its counsel and are addressed to Seller); and (B) as to matters of fact, upon certificates of state officials and of any officer or officers of Purchaser, provided in all such cases the extent of any such reliance is specified in such opinion. (e) At the Closing, Purchaser shall elect successor directors for resigning directors of the Company, and such successor directors shall elect successor officers of the Company. 6.3. Termination of Agreement and Abandonment of Transactions. Notwithstanding anything in this Agreement to the contrary, this Agreement and the transactions 39 contemplated hereby may be terminated in any of the following ways at any time before the Closing and in no other manner: (a) By mutual written consent of Seller and Purchaser; (b) By Purchaser, if the conditions set forth in Section 6.1 shall not have been met on or before May 2, 2005; or (c) By Seller, if the conditions set forth in Section 6.2 shall not have been met on or before May 2, 2005. In the event of termination of this Agreement pursuant hereto, no party hereto shall have any liability or obligation to any other party hereto in respect of this Agreement, except that the provisions of Section 5.1(a)(ii), Article VII and Section 9.3 shall survive any such termination, and except that nothing herein shall relieve any party from liability for any breach of any of its covenants or agreements or willful breach of its representations and warranties contained in this Agreement prior to termination of this Agreement or any obligations hereunder. ARTICLE VII TERMINATION OF OBLIGATIONS AND WAIVER OF CONDITIONS; PAYMENT OF EXPENSES In the event that this Agreement shall be terminated pursuant to Section 6.3(a) of this Agreement, all further obligations of the parties under this Agreement shall terminate without further liability of Seller, on the one hand, or Purchaser, on the other hand, to the other, and each party will pay all of its own costs and expenses incident to the negotiation and preparation of this Agreement and to its performance of, and compliance with, all agreements and conditions contained in this Agreement on its part to be performed or complied with, including the fees, expenses and disbursements of counsel, provided that the obligations of the parties under Section 9.3 and the obligations of Purchaser under Section 5.1(a)(ii) shall survive any such termination. Termination of this Agreement pursuant to Section 6.3(b) or Section 6.3(c) shall be without prejudice to the rights and remedies available to Seller, on the one hand, or Purchaser, on the other hand, under Applicable Law, including the right to recover all expenses, costs and other damages, but no party shall be entitled to incidental or consequential damages including loss of anticipated profits. If any of the conditions specified in Section 6.1 have not been satisfied, Purchaser may, nevertheless, at its election waive such conditions in writing and proceed with the transactions contemplated by this Agreement. If any of the conditions specified in Section 6.2 have not been satisfied, Seller may, nevertheless, at its election waive such conditions in writing and proceed with the transactions contemplated by this Agreement. In the event that the transactions contemplated by this Agreement are consummated, each party will pay all of its own costs and expenses in connection therewith. 40 ARTICLE VIII INDEMNIFICATION 8.1. Indemnification of Purchaser. Seller shall indemnify and hold harmless Purchaser and its shareholders, Affiliates, subsidiaries, officers, directors, employees, agents and assigns from and against any and all liabilities, claims, liens, obligations, damages, losses, costs and expenses (including fines, assessments (including guaranty fund assessments), penalties and reasonable investigatory and attorney's fees and disbursements) ("Loss") actually suffered or incurred by any of them or the Company by reason of or arising out of or related to: (a)(i) the breach, failure or inaccuracy of any representation or warranty made by Seller in this Agreement or any Schedule to this Agreement; (ii) any pending or threatened Action set forth on Schedule 3.11(a) hereto; (iii) any Action based upon the conduct of the Company's business at any time during the period from the formation of the Company through the Closing or any actions taken or omissions made at any time during the period from the formation of the Company through the Closing; or (iv) any violation or alleged violation of Applicable Law based upon the conduct of the Company's business at any time during the period from the formation of the Company through the Closing; (b) the failure by Seller to perform any of the covenants or agreements contained in this Agreement; or (c) any of the following: (i) all Reinsured Liabilities; (ii) (A) all Liabilities of the Company for Taxes assessed in respect of, and all costs and expenses of Tax audits or the preparation of Tax Returns for, all Pre-Closing Periods, and the Parent's portion of any Straddle Period; (B) all Liabilities resulting by reason of the several liability of the Company pursuant to Treasury Regulation Section 1.1502-6 or any analogous state, local or foreign law or regulation or by reason of the Company having been a member of an affiliated, consolidated, combined or unitary group of which the Company was a member on or prior to the Closing Date; (C) all Liabilities of the Company in respect of Taxes of any other Person or entity pursuant to any agreement or contract, whether written or unwritten, entered into on or before the Closing Date, or as a transferor or successor, by contract or otherwise; and (D) all Liabilities arising as a result of a breach of the representations provided in Section 3.8 hereof, or the failure of Seller or Parent to perform their respective obligations pursuant to Section 5.3 or Section 5.4; 41 (iii) all Liabilities of the Company arising out of or relating to activities of the nature described in Section 3.20(b), including those set forth on Schedule 3.20(b); (iv) all Liabilities of the Company arising out of or relating to any arrangement or agreement with any Surplus Lines Broker (including any commissions or fees owed in connection therewith); and (v) all Liabilities of the Company arising out of or relating to any of the Third-Party Reinsurance Agreements or any other reinsurance contract to which the Company is a party. 8.2. Indemnification of Seller. Purchaser shall indemnify and hold harmless Seller and its shareholders, Affiliates, subsidiaries, officers, directors, employees, agents and assigns from and against any Loss actually suffered or incurred by any of them by reason of or arising out of or related to: (a) the breach, failure or inaccuracy of any representation or warranty made by Purchaser in the Agreement or any Schedule to this Agreement; (b) the failure by Purchaser to perform any of the covenants or agreements of Purchaser contained in this Agreement; or (c) all Liabilities of the Company for Taxes assessed in respect of, and all costs and expenses of Tax audits or the preparation of Tax Returns for, all taxable periods beginning after the Closing Date, and the portion of any Straddle Period beginning after the Closing Date. 8.3. Notice. The party seeking indemnification (the "Indemnitee") shall promptly notify the indemnifying party (the "Indemnitor") if the Indemnitee believes that it has incurred a Loss for which indemnification may be asserted under this Article VIII. Such notice shall specify the circumstances of such asserted Loss and must be given prior to the date recovery of such Loss is time barred due to the expiration of any period of limitation set forth in Section 8.7. Failure to provide notice in accordance with this Section 8.3 shall not be deemed a waiver of the right of the Indemnitee to indemnification other than to the extent that such failure prejudices the defense of the claim by the Indemnitor. 8.4. Determination of Right to Indemnification. The determination of the right of an Indemnitee to indemnification under this Agreement with respect to any Loss shall be finally determined by Purchaser and Seller jointly; provided, however, if Purchaser and Seller cannot make such a joint determination within thirty (30) days from the date on which the notice provided in Section 8.3 is delivered, either party may commence litigation with respect to such disagreement in a court in the State of Delaware. 8.5. Determination of Amount of Indemnification. The amount of any asserted Loss for which an Indemnitee seeks indemnification pursuant to this Article VIII shall be finally determined as follows: 42 (a) Subject to paragraphs (b) and (c) below, such determination shall be made jointly by Purchaser and Seller; provided, however, if Purchaser and Seller cannot make such a joint determination within thirty (30) days from the date on which the notice provided in Section 8.3 is given, either party may commence litigation with respect to such disagreement in a court in the State of Delaware. (b) In the case of any Loss arising out of or resulting from a liability or obligation to, or claim, action or suit by, any party seeking monetary relief other than the Indemnitee, the Indemnitor shall give written notice to the Indemnitee within thirty (30) days after its receipt of the notice given pursuant to Section 8.3, that the Indemnitor disputes and intends to defend the liability, obligation, claim, action or suit giving rise to such Loss or potential Loss. In such event the Indemnitor shall have the right to litigate or otherwise contest (at the expense of the Indemnitor) such liability, obligation, claim, action or suit with counsel selected by the Indemnitor. The Indemnitor and Indemnitee shall, in any case, cooperate in such litigation or other contest and shall keep each other advised of the progress and disposition thereof. The Indemnitor may not settle any such Loss without Indemnitee's written consent (which consent shall not be unreasonably withheld) unless such settlement (A) includes only the payment of money and the execution and delivery of appropriate releases including a complete release of the Indemnitee and (B) with respect to Taxes, has no adverse or binding effect on the Company for any taxable period (or portion thereof) beginning after the Closing Date. Upon the final adjudication of any such liability, obligation, claim, action or suit, the amount of the Loss attributable thereto shall be then determined pursuant to (a) above. (c) In the case of any Straddle Period, Seller shall be solely responsible for all Taxes of the Company (and that portion of the Company's costs for the preparation of each such Tax Return and Tax Audits) attributable to the portion of the period ending on, and that includes, the Closing Date (other than transactions properly allocable to the portion of the day after the Closing), and Purchaser shall be solely responsible and shall indemnify Seller for all Taxes imposed on the income or operations of the Company and attributable to the portion of the period beginning after the Closing Date (including transactions properly allocable to the portion of the day after the Closing). For purposes of this Agreement, the portion of any Tax that is attributable to the portion of a Straddle Period up to and including the Closing Date shall be (i) in the case of a Tax that is not based on gross or net income, premiums, sales or gross receipts (including real property taxes), the total amount of such Tax for the period in question multiplied by a fraction, the numerator of which is the number of days in the Straddle Period through and including the Closing Date, and the denominator of which is the total number of days in such Straddle Period, and (ii) in the case of any Tax that is based on any of gross income, premiums, sales or gross receipts, the Tax that would be due with respect to the portion of the Straddle Period through and including the Closing Date, if such portion of the Straddle Period were a separate taxable period, except that exemptions, allowances, deductions, credits or graduated rates that are calculated or applied on an annual basis (such as the deduction for depreciation or capital allowances) shall be apportioned on the basis of the gross income, premiums, sales or gross receipts for each such period, or if not based upon such gross income, premiums, sales or gross receipts, then on a per diem basis. 8.6. Adjustments to Indemnification Amounts. The amount of any Loss subject to indemnification under Section 8.1 or Section 8.2 shall be (i) reduced by any insurance 43 or other recoveries or Tax benefits that the Indemnitee actually receives as a result of or in connection with such Loss, and (ii) increased by any Taxes such Indemnitee actually incurs with respect to the indemnification for such Loss under Section 8.1 or Section 8.2, as the case may be. 8.7. Indemnification Limits. (a) Time Limits. No Indemnitor shall have any obligation to indemnify an Indemnitee for any Loss pursuant to Section 8.1(a) or Section 8.2(a) unless, on a date not later than the fifth anniversary of the Closing Date, the Indemnitee provides notice to the Indemnitor in accordance with the provisions of Section 8.3. The foregoing limit shall not apply, expressly or by implication, (i) to claims based on the breach, failure or inaccuracy of any representation or warranty made in Sections 3.1 (Organization and Standing), 3.2 (Insurance Permits), 3.3 (Authorization of Agreements), 3.4 (Capital Stock of the Company), 3.5 (Interests in Securities of the Company), 3.8 (Tax Returns and Reports), 3.16 (Employee Matters), 3.19 (Brokers and Finders), 3.20 (Excess and Surplus Lines Brokers), 3.22 (No Restrictions on Business) and 3.23 (Marketing Agreements), each of which shall survive indefinitely, (ii) to claims based on Sections 4.1 (Organization and Standing), 4.2 (Authorization of Agreement) and 4.6 (Brokers and Finders), each of which shall survive indefinitely, (iii) to claims arising under Section 8.1(b) or 8.1(c), each of which shall survive indefinitely, and (iv) to claims arising under Section 8.2(b) or 8.2(c), each of which shall survive indefinitely. Each covenant or agreement contained in this Agreement shall survive indefinitely. (b) Seller's Maximum Obligation for Certain Claims. Seller shall have no obligation to make payment to an Indemnitee in respect of indemnifiable claims made pursuant to Section 8.1(a)(i) in an amount which, when added to the sum of (A) the aggregate amount of payments previously paid by Seller in respect of indemnifiable claims made pursuant to Section 8.1(a)(i) (other than pursuant to the Sections identified in clause (i) of Section 8.7(a)) plus (B) the aggregate amount of payments previously paid by Seller in respect of Section 2(b)(i) Liabilities, would exceed the amount of the Final Purchase Price; provided, however, that such limitation on amount of payment set forth in this Section 8.7(b) shall not apply, and no limitation shall apply, to limit recovery by an Indemnitee for indemnification under Section 3.14 (Undisclosed Liabilities) or under the sections of this Agreement referenced in clauses (ii), (iii) or (iv) of Section 8.1(a) or clauses (i) or (iii) of Section 8.7(a). (c) Purchaser's Maximum Obligation for Certain Claims. Purchaser shall have no obligation to make payment to an Indemnitee in respect of indemnifiable claims made pursuant to Section 8.2(a) in an amount which, when added to the aggregate amount of payments previously paid by Purchaser in respect of such indemnifiable claims made pursuant to Section 8.2(a) (other than pursuant to the Sections identified in clause (ii) of Section 8.7(a)), would exceed the amount of the Final Purchase Price; provided, however, that such limitation on amount of payment set forth in this Section 8.7(c) shall not apply, and no limitation shall apply, to limit recovery by an Indemnitee for indemnification under the sections of this Agreement referenced in clauses (ii) or (iv) of Section 8.7(a). (d) Indemnification Basket. Except as hereinafter provided in this Section 8.7(d), Seller shall have no obligation to provide indemnification pursuant to Section 8.1(a)(i) 44 except to the extent that the aggregate amount of indemnification to which Purchaser, but for this Section 8.7(d), otherwise shall have become entitled hereunder would exceed $50,000 ("Seller's Basket"), in which event, subject to the limitation set forth in Section 8.7(b) above, Seller shall be obligated to provide indemnification with respect to all amounts in excess of Seller's Basket. Notwithstanding anything to the contrary in this Agreement, Seller shall be obligated to provide indemnification pursuant to Section 8.1(a)(i) without regard to Seller's Basket referred to in the immediately preceding sentence in respect of representations and warranties made under the sections of this Agreement referenced in Section 8.7(a)(i). (e) Purchaser's Indemnification Basket. Except as hereinafter provided in this Section 8.7(e), Purchaser shall have no obligation to provide indemnification pursuant to Section 8.2(a) except to the extent that the aggregate amount of indemnification to which Seller, but for this Section 8.7(e), otherwise shall have become entitled hereunder would exceed $50,000 ("Purchaser's Basket"), in which event, subject to the limitation set forth in Section 8.7(c) above, Purchaser shall be obligated to provide indemnification with respect to all amounts in excess of Purchaser's Basket. Notwithstanding anything to the contrary in this Agreement, Purchaser shall be obligated to provide indemnification pursuant to Section 8.2(a) without regard to Purchaser's Basket referred to in the immediately preceding sentence in respect of representations and warranties made under the sections of this Agreement referenced in Section 8.7(a)(ii). (f) No Application to Related Agreements. For the avoidance of doubt, none of the limitations set forth in this Section 8.7 shall in any way apply to the liabilities and obligations of the parties under the Related Agreements, except as explicitly provided in the Assumption Agreement. 8.8. Single Recovery. It is the intention of the parties to this Agreement and the Related Agreements that no party shall make any demand for payment, indemnification or reinsurance payment with respect to any Loss, Reinsured Liability or other Liability hereunder or thereunder to the extent that such payment, indemnification or reinsurance payment would result in the duplication of recovery to any party (or any Affiliate thereof) to this Agreement or any Related Agreement in respect of any Loss, Reinsured Liability or other Liability under this Agreement and/or any Related Agreement. 8.9. Third Party Beneficiaries. The Company and all indemnified parties are intended to be third party beneficiaries of this Article VIII. 8.10. Deemed Adjustment to Purchase Price. Purchaser and Seller agree to treat, to the maximum extent permitted under Applicable Law, any payments under this Article VIII as an adjustment to the Purchase Price for Tax purposes. 8.11. Exclusive Remedy. Except as expressly set forth in this Agreement, the parties hereto acknowledge and agree that the indemnification provisions in this Article VIII shall be the exclusive remedy of the Purchaser and the Seller with respect to the transactions contemplated by, and any claims arising under, this Agreement; provided, however, that the foregoing shall not, in any way, be deemed to limit any remedies under any Related Agreement, including the remedies against Parent under the Guarantee. 45 ARTICLE IX GENERAL 9.1. Amendment and Waiver. This Agreement may not be amended, modified or supplemented except upon execution and delivery of a written agreement executed by the parties hereto. Any of the terms, covenants, representations, warranties or conditions hereof may be waived in writing at any time by or on behalf of the party which is entitled to the benefits thereof. Any waiver of any of the provisions of this Agreement by any party hereto shall be binding only if set forth in an instrument in writing signed on behalf of such party. No failure to enforce any provision of this Agreement shall be deemed to or shall constitute a waiver of such provision, and no waiver of any of the provisions of this Agreement shall be deemed to or shall constitute a waiver of any other provision hereof (whether or not similar) nor shall such waiver constitute a continuing waiver. 9.2. Integrated Contract. This Agreement and the Schedules and Exhibits to this Agreement (which constitute part of this Agreement) and the other documents and writings referred to herein or delivered pursuant hereto (including, without limitation, the Related Agreements) contain the entire understanding of the parties with respect to the subject matter hereof and thereof and supersede all prior agreements and understandings, both written and oral, between the parties with respect to the subject matter hereof and thereof. This Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and permitted assigns. 9.3. Publicity. From the date hereof until the Closing Date, the parties will consult with each other and will mutually agree by written consent upon any publication or press release of any nature with respect to this Agreement or the transactions contemplated hereby (such agreement not to be unreasonably withheld) and shall not issue any such publication or press release prior to such consultation and agreement, except as may be required by Applicable Law or by obligations pursuant to any listing agreement with any securities exchange or any securities exchange regulation, in which case the party proposing to issue such publication or press release shall use reasonable efforts to consult in good faith with the other party before issuing any such publication or press release. 9.4. Governing Law. This Agreement and the legal relations between the parties shall be governed by and construed in accordance with the laws of the State of Delaware, without regard to the principles regarding the choice of law. 9.5. Jurisdiction. (a) The parties hereto hereby consent and agree that they shall commence any action with respect to any claims or disputes between or among the parties hereto pertaining to this Agreement or the Related Agreements or to any matter arising out of or related to such agreements in the United States District Court for the District of Delaware, so long as the action falls within the subject matter jurisdiction of such court; in the event any such action shall be determined by the court to be outside its subject matter jurisdiction, then the parties agree to commence any such action in the state courts of Delaware located in New Castle 46 County. The parties hereto expressly submit and consent in advance to such jurisdiction in any action or suit commenced in any such court, and hereby waive any objection which it may have based upon lack of personal jurisdiction, improper venue or forum non conveniens and hereby consent to the granting for such legal or equitable relief as is deemed appropriate by such court. Each party hereto irrevocably consents to the service of process by registered or certified mail, postage prepaid, to it at its address given pursuant to Section 9.6 hereof. Subject to the foregoing, nothing in this Agreement shall be deemed or operate to affect the right of Purchaser or Seller to serve legal process in any other manner permitted by law, or to preclude the enforcement by Purchaser or Seller of any judgment or order obtained in the forum specified in this subsection or the taking of any action under this Agreement and the Related Agreements to enforce the same in any other appropriate forum or jurisdiction. (b) To the extent that Purchaser or Seller has or may hereafter acquire any immunity from the jurisdiction of any court or from any legal process (whether through service or notice, attachment prior to judgment, attachment in aid of execution, execution or otherwise) with respect to such party or such party's property, Purchaser and Seller hereby irrevocably waive such immunity in respect of their respective obligations under this Agreement and the Related Agreements. 9.6. Notices. All notices, requests, claims, demands and other communications required or permitted under this Agreement shall be in writing and sufficiently given, upon receipt or three days after deposit in the United States mail (registered or certified, postage prepaid, return receipt requested) or by telex, facsimile or other written form of electronic communication, to the respective parties as follows: If to Seller, to: Ulico Casualty Company 1625 Eye Street, NW Washington, DC 20006 Attention: Chief Financial Officer Telephone: (202) 682-6705 Facsimile: (202) 962-2989 with a copy to: ULLICO Inc. 1625 Eye Street, N.W. Washington, DC 20006 Attention: General Counsel Telephone: (202) 962-8466 Facsimile: (202) 682-6784 47 Wiley Rein & Fielding, LLP 1776 K Street, N.W. Washington, DC 20006 Attention: Cynthia T. Andreason, Esq. Telephone: (202) 719-7364 Facsimile: (202) 719-7049 If to Purchaser, to: Darwin National Assurance Company 76 Batterson Park Road Farmington, Connecticut 06032 Attention: Mr. John L. Sennott Telephone: (860) 507-1077 Facsimile: (860) 507-1177 with a copy to: Dewey Ballantine LLP 1301 Avenue of the Americas New York, New York 10019 Attention: Aileen C. Meehan, Esq. Facsimile: (212) 259-6333 or to such other address or person as either party hereto may, from time to time, designate in a written notice given in like manner (except that a notice of change of address shall not be deemed to have been given until received by the addressee). 9.7. No Assignment. Neither this Agreement nor any rights, interests or obligations hereunder may be assigned by any party hereto without the prior written consent of all other parties party hereto; provided, however, that Purchaser may assign its rights, interests and obligations hereunder to a wholly or majority owned subsidiary of Purchaser without the prior written consent of Seller, provided that Purchaser shall promptly give Seller written notice of such assignment after it is completed. Any permitted assignment by Purchaser (including any assignment permitted by the proviso to the preceding sentence) shall not release Purchaser from its obligations and responsibilities hereunder. 9.8. Headings. The headings contained in this Agreement are for reference only and shall not affect in any way the meaning or interpretation of this Agreement. 9.9. Counterparts. This Agreement may be executed in one or more counterparts, all of which shall be considered one and the same agreement and each of which shall be deemed an original. 9.10. Severability. Any provision of this Agreement which is invalid, illegal or unenforceable in any jurisdiction shall, as to that jurisdiction, be ineffective to the extent of such invalidity, illegality or unenforceability, without affecting in any way the remaining provisions 48 hereof in such jurisdiction or rendering that or any other provision of this Agreement invalid, illegal or unenforceable in any other jurisdiction. 9.11. Third Parties. Nothing herein expressed or implied is intended or shall be construed to confer upon or give to any Person, other than the parties hereto, any rights or remedies under or by reason of this Agreement, except as provided in Article VIII hereof. 9.12. Further Assurances. Seller and Purchaser will, whenever and as often as reasonably requested to do so by the other party or its successors, do any and all such other and further acts, and execute, acknowledge and deliver any and all such other and further assignments, transfers and instruments of further assurances, approvals and consents as are necessary or proper in order to complete, ensure and perfect the transactions contemplated by this Agreement. [SIGNATURE PAGE FOLLOWS] 49 IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to be executed on its behalf by its officers or representatives thereunto duly authorized, all as of the day and year first above written. (Purchaser) DARWIN NATIONAL ASSURANCE COMPANY By: /s/ John L. Sennott ------------------------------------- Name: John L. Sennott Title: Chief Financial Officer and Treasurer (Seller) ULICO CASUALTY COMPANY By: /s/ Mark E. Singleton ------------------------------------- Name: Mark E. Singleton Title: Senior Vice President, Chief Financial Officer and Treasurer 1 EX-10.68.B 10 y06166exv10w68wb.txt LIST OF CONTENTS OF EXHIBITS AND SCHEDULES TOTHE ULICO STOCK PURCHASE AGREEMENT . . . Exhibit 10.68(b) List of Contents of Exhibit and Schedules to the Ulico Stock Purchase Agreement Schedule 2.2(d) - Authorized States Schedule 3.1(b) - Officers and Directors/Certificate of Incorporation and Bylaws Schedule 3.2(b) - Notices of Suspension, Cancellations, or Terminations of Insurance Permits Schedule 3.8 - Tax Matters Schedule 3.9(b) - Filing Fees Schedule 3.10(b) - Consents and Approvals Schedule 3.11(a) - Legal Proceedings Schedule 3.11(b) - Legal Proceedings Brought by the Company Schedule 3.12 - Bank Accounts Schedule 3.13 - Capital and Surplus Schedule 3.14 - Liabilities Schedule 3.15(a) - Contracts and Commitments to be Terminated or Amended at Closing Schedule 3.15(b) - Third-Party Reinsurance Agreements Schedule 3.17 - Power of Attorney Schedule 3.20(b) - Certain Fee Arrangements Schedule 4.3(b) - Purchasers' Governmental Approvals Exhibit A - Administrative Services Agreement Exhibit B - Amended Termination of Pooling Agreement Exhibit C - Assumption Agreement Exhibit D - Guarantee Exhibit E - 100% Quota Share Reinsurance Agreement Exhibit F - Termination and Commutation of LPT Agreement Exhibit G - Trust Agreement
EX-13 11 y06166exv13.txt SELECTED PAGES OR THE ANNUAL REPORT TO STOCKHOLDERS Exhibit 13 CONSOLIDATED RESULTS OF OPERATIONS Alleghany is primarily engaged in the property and casualty and fidelity and surety insurance businesses through its subsidiary Alleghany Insurance Holdings LLC ("AIHL") and its principal subsidiaries RSUI Group, Inc. ("RSUI"), Capitol Transamerica Corporation ("CATA") and Darwin Professional Underwriters, Inc. ("Darwin"), and in the industrial minerals business through its subsidiary World Minerals Inc. ("World Minerals"). The following table summarizes the significant sources of Alleghany's consolidated revenues and costs and expenses (in millions):
Years Ended December 31, -------------------------- 2004 2003 2002 -------- ------ ------ Revenues Net premiums earned $ 805.4 $430.9 $125.6 Net mineral and filtration sales 285.6 266.1 251.4 Interest, dividend and other income 63.0 56.1 53.1 Net gain on investment transactions 86.9 151.8 36.4 -------------------------- Total revenues $1,240.9 $904.9 $466.5 ========================== Costs and expenses Loss and loss adjustment expenses $ 540.6 $250.2 $100.5 Commissions and brokerage expenses 190.7 113.7 29.1 Cost of mineral and filtration sales 217.5 199.1 184.7 Salaries, administrative and other operating expenses 75.9 57.2 65.7 Corporate administration 41.3 34.7 25.7 Interest expense 4.8 4.7 5.8 -------------------------- Total costs and expenses $1,070.8 $659.6 $411.5 ==========================
The substantial increase in Alleghany's revenues for the three-year period ended December 31, 2004 was primarily due to the growth in net premiums earned resulting from the expansion of its insurance operations at AIHL, most notably the acquisition of RSUI in July 2003. RSUI's operations accounted for $293.8 million of the $430.9 million in net premiums earned in 2003 and $609.3 million of the $805.4 million in net premiums earned in 2004. Net mineral and filtration sales of World Minerals reflected a steady, if modest, increase over the period primarily due to the favorable impact of the strengthening of the euro against the U.S. dollar in 2003 (had foreign exchange rates remained constant with those of 2002, World Minerals' revenues would have been approximately flat) and in 2004, primarily due to increased demand, particularly with respect to the diatomite business, as well as the favorable impact of the continued strengthening of the euro against the U.S. dollar. Net gain on investment transactions in 2004 primarily reflected the sale of 2.6 million shares of common stock of CIGNA Corporation, which generated $58.6 million of the $86.9 million gain recorded in that year. Net gain on investment transactions in 2003 primarily reflected the sale of 8.0 million shares of common stock of Burlington Northern Santa Fe Corporation ("Burlington Northern"), which generated $137.7 million of the $151.8 million gain recorded in that year. Net gain on investment transactions in 2002 primarily reflected the sale of 1.9 million shares of common stock of Burlington Northern, which generated $23.3 million of the $23.6 million gain recorded in that year. The increase in costs and expenses over the three-year period ended December 31, 2004 primarily reflected the growth of business, with commissions and brokerage expenses keeping pace with the increases in net premiums earned, as well as the costs incurred in building Darwin's organization and transitioning RSUI from a managing agency to an integrated insurance company. The significant increase in loss and loss adjustment expenses in 2004 is attributable to the $157.2 million of pre-tax catastrophe losses (including reinsurance reinstatement premiums of $10.5 million), net of reinsurance, incurred at RSUI as a result of 2004 third quarter hurricane activity. In addition, during each of the three year periods ended December 31, 2004, adverse development at CATA was responsible for an aggregate $49.5 million increase in loss and loss adjustment expenses. Corporate administration expenses increased 34.9 percent from 2002 to 2003, and another 20.0 percent from 2003 to 2004, which was primarily attributable to increased expense for stock-based incentive compensation due to a significant increase in the market price of Alleghany's common stock from $170.60 at December 31, 2002 to $285.25 at December 31, 2004 and a restricted stock award granted in connection with the employment of a senior officer. The comparative contributions to earnings from continuing operations before income taxes made by AIHL, World Minerals, "corporate activities" and discontinued operations of Heads & Threads International LLC ("Heads & Threads," Alleghany's steel fastener importing business sold in December 2004), were as follows (in millions):
Years Ended December 31, ------------------------ 2004 2003 2002 ------ ------ ------ AIHL $173.4 $134.8 $(20.1) World Minerals 21.2 25.7 23.5 Corporate activities* (24.5) 84.8 51.6 ------------------------ Earnings from continuing operations, before income taxes 170.1 245.3 55.0 Income taxes 52.2 79.1 1.6 ------ ------ ------ Earnings from continuing operations 117.9 166.2 53.4 (Loss) earnings from operations of discontinued operations (including loss on disposal of $2.0 million in 2004) (1.0) (4.9) 2.4 Income taxes (benefit) (0.8) (1.1) 1.0 ------ ------ ------ (Loss) earnings on discontinued operations (0.2) (3.8) 1.4 ------ ------ ------ Net earnings 117.7 162.4 54.8 ====== ====== ====== Basic earnings (loss) per share of common stock** Continuing operations $15.38 $21.87 $ 7.03 Discontinued operations (0.03) (0.50) 0.19 ------ ------ ------ Basic net earnings per share** $15.35 $21.37 $ 7.22 ====== ====== ====== Diluted earnings (loss) per share of common stock** Continuing operations $15.34 $21.79 $ 6.97 Discontinued operations (0.03) (0.50) 0.19 ------ ------ ------ Diluted net earnings per share** $15.31 $21.29 $ 7.16 ====== ====== ======
* Corporate activities consists of Alleghany Properties LLC, which owns and manages properties in California, and corporate activities at the parent level, including strategic equity investments which 2 are available to support the internal growth of subsidiaries and for acquisitions of, or substantial investments in, operating companies. ** Amounts reflect subsequent common stock dividends. Earnings from continuing operations before income taxes declined to $170.1 million in 2004 from $245.3 million in 2003 due to a number of factors. The 2004 results reflect a significant increase in the contribution made by AIHL, which benefited from RSUI's first full year of operations as part of the AIHL group of companies. RSUI posted strong underwriting results and a substantial increase in net gains on investment transactions in 2004. These benefits were partially offset by the catastrophe losses incurred at RSUI caused by the 2004 third quarter hurricane activity. The contributions of AIHL's insurance operations, however, were not sufficient to make up for the loss from the continuing operations before income taxes of corporate activities, caused by the near absence of net gains on investment transactions at the parent company level in 2004. By comparison, 3.7 million shares of common stock of Burlington Northern were sold by the parent company in 2003 which, along with other investment transactions, generated $62.3 million of pre-tax net gains on investment transactions at the parent company in that year. World Minerals' contribution to earnings from continuing operations declined in 2004 compared with 2003 due to competitive pricing pressures and increased energy and operational costs, which resulted in lower margins in the more recent year. Earnings from continuing operations before income taxes of $245.3 million in 2003 reflects a more than four-fold increase from the $55.0 million recorded in 2002, with the insurance operations of AIHL accounting for a substantial portion of this significant improvement. In late 2001, Alleghany began assembling the group of companies that currently comprise the AIHL insurance segment. CATA and Platte River Insurance Company ("Platte River") were acquired in early 2002, and upon completion of such acquisitions, a number of initiatives were undertaken to strengthen operations, resulting in a loss from continuing operations before income taxes for AIHL of $20.1 million in 2002. This loss reflects a $17.9 million strengthening of CATA's loss reserves for 2001 and prior years and a $10.0 million realized investment loss recognized as part of the restructuring of the investment portfolio acquired in connection with CATA. The addition of RSUI in mid-2003 accounted for a substantial increase in AIHL's earnings for that year, partially offset by additional loss reserve strengthening at CATA. More detail regarding the reserve strengthenings at CATA can be found on pages 33 through 35 of this Report. Corporate activities also showed a significant increase in 2003 from 2002. The sale of 3.7 million shares of common stock of Burlington Northern in 2003 discussed above compares with the sale of 1.9 million shares of common stock of Burlington Northern in 2002, which resulted in pre-tax net gains on investment transactions at the parent company of $35.8 million. World Minerals posted an increase in earnings from continuing operations before income taxes in 2003 from 2002 due to the favorable impact of changes in foreign currency rates. With the strengthening of the euro against the U.S. dollar in 2003, the results of World Minerals' European operations were stronger when translated into U.S. dollars for financial statement purposes. The effective tax rate on earnings from continuing operations before income taxes was 30.7 percent in 2004 and 32.1 percent in 2003. The effective tax rate in 2002 was 2.9 percent, reflecting a net credit of $18.1 million in the provision for income taxes as a result of an adjustment of Alleghany's estimated state and federal tax liabilities. 3 On December 31, 2004, Alleghany completed the disposition of Heads & Threads. Prior to its disposition, Heads & Threads was included in corporate activities; it is now recorded as discontinued operations for all periods presented herein. Alleghany had previously announced that it may purchase shares of its common stock in open market transactions from time to time. In 2004, Alleghany did not purchase any shares of its common stock. As of December 31, 2004, Alleghany had 7,676,197 shares of its common stock outstanding. The foregoing summary constitutes only a part of management's discussion and analysis of our results of operations. The results of operations of AIHL and World Minerals are discussed in detail beginning on page 21 of this Report. CRITICAL ACCOUNTING POLICIES Loss and Loss Adjustment Expenses. Alleghany's insurance operations establish reserves on their balance sheets for unpaid losses and loss adjustment expenses related to their property and casualty insurance and fidelity and surety contracts. As of any balance sheet date, historically there have been claims that have not yet been reported, and some claims may not be reported for many years after the date a loss occurs. As a result of this historical pattern, the liability for unpaid losses and loss adjustment expenses includes significant estimates for claims incurred but not yet reported, known as "IBNR." Additionally, reported claims are in various stages of the settlement process. Each claim is settled individually based upon its merits, and certain claims may take years to settle, especially if legal action is involved. As a result, the liabilities for unpaid losses and loss adjustment expenses include significant judgments, assumptions and estimates made by management relating to the ultimate losses that will arise from the claims. Due to the inherent uncertainties in the process of establishing these liabilities, the actual ultimate loss from a claim is likely to differ, perhaps materially, from the liability initially recorded and could be material to the results of Alleghany's operations. The accounting policies used in connection with the establishment of these liabilities are considered to be critical accounting policies. Alleghany's insurance operations use a variety of techniques that employ significant judgments and assumptions to establish the liabilities for unpaid losses and loss adjustment expenses recorded at the balance sheet date. These techniques include detailed statistical analyses of past claim reporting, settlement activity, claim frequency, internal loss experience, changes in pricing or coverages and severity data when sufficient information exists to lend statistical credibility to the analysis. More subjective techniques are used when statistical data is insufficient or unavailable. These liabilities also reflect implicit or explicit assumptions regarding the potential effects of future inflation, judicial decisions, changes in laws and recent trends in such factors as well as a number of actuarial assumptions that vary across Alleghany's insurance operations and across lines of business. This data is analyzed by line of business, coverage and accident year, as appropriate. As noted above, as of any balance sheet date, all claims that have occurred have not yet been reported to Alleghany's insurance operations, and if reported may not have been settled. The time period between the occurrence of a loss and the time it is settled by the insurer is referred to as the "claim tail." Property claims usually have a fairly short claim tail and, absent claim litigation, are reported and settled within no more than a few years of the balance sheet date. For short tail lines, the process of recording quarterly and 4 annual liabilities for unpaid losses and loss adjustment expenses is primarily focused on maintaining an appropriate reserve level for reported claims and IBNR, rather than determining an expected loss ratio for the current business. In conformity with generally accepted accounting principles ("GAAP"), Alleghany's insurance operations are not permitted to establish IBNR reserves for catastrophe losses that have not occurred. Therefore, losses related to a significant catastrophe or accumulation of catastrophes in any reporting period could have a material, negative impact on Alleghany's results during such period. Casualty claims can have a very long claim tail, occasionally extending for decades. In addition, casualty claims are more susceptible to litigation and the legal environment and can be significantly affected by changing contract interpretations, all of which contribute to extending the claim tail. For long tail casualty lines of business, estimation of ultimate liabilities for unpaid losses and loss adjustment expenses is a more complex process and depends on a number of factors, including the line and volume of the business involved. The loss reserve review processes of Alleghany's insurance operations use actuarial methods and underlying assumptions that vary by company and line of business and produce ranges from which the operations select the carried reserve for each class of business. The actuarial methods used by Alleghany's insurance operations include the Incurred Development method, Paid Development method, Bornhuetter-Ferguson method for both paid and incurred, Balanced Incurred method and Ultimate Incurred times Ultimate Claims method. Each of Alleghany's insurance operations establish their best estimates for liabilities for unpaid losses and loss adjustment expenses. Because of the high level of uncertainty regarding the setting of liabilities for unpaid losses and loss adjustment expenses, it is the practice of each of Alleghany's insurance operations to engage, at least annually, an outside actuary to evaluate, and opine on, the reasonableness of these liabilities. Although Alleghany is unable at this time to determine whether additional reserves, which could have a material impact upon its financial condition, results of operations and cash flows, may be necessary in the future, Alleghany believes that the reserves for unpaid losses and loss adjustment expenses established by its insurance operations are adequate as of December 31, 2004. Alleghany's reserve for unpaid losses and loss adjustment expenses includes $26.5 million and $28.1 million of gross and net reserves at December 31, 2004 and 2003, respectively, for various liability coverages related to asbestos and environmental impairment claims that arose from reinsurance assumed by a subsidiary of CATA between 1969 and 1976. The subsidiary exited this business in 1976. Reserves for asbestos and environmental impairment claims cannot be estimated with traditional loss reserving techniques because of uncertainties that are greater than those associated with other types of claims. Factors contributing to those uncertainties include a lack of historical data, the significant periods of time that often elapse between the occurrence of an insured loss and the reporting of that loss to the ceding company and the reinsurer, uncertainty as to the number and identity of insureds with potential exposure to such risks, unresolved legal issues regarding policy coverage, and the extent and timing of any such contractual liability. Loss reserve estimates for such environmental and asbestos exposures include case reserves, which also reflect reserves for legal and other loss adjustment expenses and IBNR reserves. IBNR reserves are determined based upon CATA's historic general liability exposure base and policy language, previous environmental loss experience and the assessment of current trends of environmental law, 5 environmental cleanup costs, asbestos liability law and judgmental settlements of asbestos liabilities. For both asbestos and environmental excess of loss reinsurance claims, CATA establishes case reserves by applying reinsurance contract terms to losses reported by ceding companies, analyzing from the first dollar of loss incurred by the primary insurer. In establishing the liability for claims for asbestos related liability and for environmental impairment claims, management considers facts currently known and the current state of the law and coverage litigation. Additionally, ceding companies often report potential losses on a precautionary basis to protect their rights under the reinsurance arrangement, which generally calls for prompt notice to the reinsurer. Ceding companies, at the time they report such potential losses, advise CATA of the ceding companies' current estimate of the extent of such loss. CATA's claims department reviews each of the precautionary claims notices and, based upon current information, assesses the likelihood of loss to CATA. Such assessment is one of the factors used in determining the adequacy of the recorded asbestos and environmental reserves. Although Alleghany is unable at this time to determine whether additional reserves, which could have a material impact upon its results of operations, may be necessary in the future, Alleghany believes that CATA's asbestos and environmental reserves are adequate as of December 31, 2004. Alleghany's insurance operations continually evaluate the potential for changes, both positive and negative, in their estimates of such liabilities and use the results of these evaluations to adjust both recorded liabilities and underwriting criteria. With respect to liabilities for unpaid losses and loss adjustment expenses established in prior years, such liabilities are periodically analyzed and their expected ultimate cost adjusted, where necessary, to reflect positive or negative development in loss experience and new information, including, for certain catastrophic events, revised industry estimates of the magnitude of a catastrophe. Adjustments to previously recorded liabilities for unpaid losses and loss adjustment expenses, both positive and negative, are reflected in Alleghany's financial results in the periods in which such adjustments are made and are referred to as prior year reserve development. Additional information regarding prior year loss reserve development during the three-year period ended December 31, 2004 is included on pages 24 through 27 of this Report. Receivables recorded with respect to claims ceded by Alleghany's insurance operations to reinsurers under reinsurance contracts are estimated in a manner similar to liabilities for unpaid losses and, therefore, are also subject to a significant degree of uncertainty. In addition to the factors cited above, reinsurance receivables may prove uncollectible if the reinsurer is unable to perform under the contract. Reinsurance contracts purchased by Alleghany's insurance operations do not relieve them of their obligations to their own policyholders. Investments. Alleghany holds it equity and debt securities as available for sale, and as such, these securities are recorded at fair value based on quoted market prices or dealer quotes. Alleghany completes a detailed analysis each quarter to assess whether the decline in the fair value of any investment below cost is other than temporary. All securities with an unrealized loss are reviewed. Considerations of the detailed analysis include the persistence and magnitude of the decline of the issuer, issuer specific financial conditions rather than general market or industry conditions and extraordinary events including negative news releases and rating agency downgrades. A decline in value that is considered to be other than temporary is charged to earnings based on the 6 fair value of the security at the time of assessment, resulting in a new cost basis for the security. Risks and uncertainties are inherent in Alleghany's other than temporary decline in value assessment methodology. Risks and uncertainties could include, but are not limited to, incorrect or overly optimistic assumptions about financial condition or liquidity, incorrect or overly optimistic assumptions about future prospects, inadequacy of any underlying collateral, unfavorable changes in economic or social conditions and unfavorable changes in interest rates or credit ratings. Goodwill and other Intangible Assets. Alleghany's consolidated balance sheet as of December 31, 2004 includes goodwill and other intangible assets, net of amortization, of approximately $223.7 million. This amount has been recorded as a result of prior business acquisitions accounted for under the purchase method of accounting. Prior to 2002, goodwill from each acquisition was generally amortized as a charge to earnings. Under Financial Accounting Standards Board Statement (Statement) No. 142, "Goodwill and Other Intangible Assets," which was adopted by Alleghany as of January 1, 2002, goodwill is tested for impairment at least annually in lieu of amortization. Alleghany completed the annual test for impairment during the fourth quarter of 2004 based upon results of operations through September 30, 2004 and determined that there was no indication of impairment. A significant amount of judgment is required in performing goodwill impairment tests. Such tests include estimating the fair value of Alleghany's operating units. As required by Statement No. 142, Alleghany compares the estimated fair value of its operating units with their respective carrying amounts including goodwill. Under Statement No. 142, fair value refers to the amount for which the entire operating unit may be bought or sold. Alleghany's methods for estimating operating unit values include asset and liability fair values and other valuation techniques, such as discounted cash flows and multiples of earnings or revenues. All of these methods involve significant estimates and assumptions. Deferred Taxes. Alleghany files a consolidated federal income tax return with its domestic subsidiaries. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. 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. At December 31, 2004 a net deferred tax asset of $104.6 million was recorded, including a valuation allowance of $11.4 million for certain foreign tax credits and deferred state tax assets which Alleghany believes may not be realized. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. Deferred tax liabilities at December 31, 2004 were $224.8 million. In addition to the critical accounting policies described above, Alleghany's other accounting policies are described in Note 1 to the Consolidated Financial Statements. The accounting policies described in Note 1 require Alleghany to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities but do not meet the level of materiality required for a determination that the accounting policy is a critical accounting 7 policy. On an ongoing basis, Alleghany evaluates its estimates, including those related to the value of long-lived assets, inventories, bad debts, pension benefits, and contingencies and litigation. Alleghany's estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. 8 AIHL Operating Unit Pre-Tax Results
RSUI(1) CATA(2) Darwin(3) AIHL -------- ------- --------- -------- (in millions, except for ratios) 2004 Gross premiums written (4) $1,223.8 $174.0 $100.5 $1,498.3 Net premiums written (4) 630.6 156.1 70.5 857.2 Net premiums earned 609.3 150.0 46.1 805.4 Loss and loss adjustment expenses 423.6 87.6 29.4 540.6 Underwriting expenses 102.5 71.3 16.8 190.6 -------- ------ ------ -------- Underwriting profit(loss) (5) $ 83.2 $ (8.9) $ (0.1) $ 74.2 ======== ====== ====== -------- Interest, dividend and other income 43.2 Net gain on investment transactions 84.5 Other expenses 28.5 -------- Earnings before income taxes $ 173.4 ======== Loss ratio (6) 69.5% 58.4% 63.6% 67.1% Expense ratio (7) 16.8% 47.5% 36.5% 23.7% Combined ratio (8) 86.3% 105.9% 100.1% 90.8% 2003 Gross premiums written (4) $ 931.3(9) $162.7 $ 24.2 $1,118.2 Net premiums written (4) 622.9 141.4 18.2 782.5 Net premiums earned 293.8 133.0 4.1 430.9 Loss and loss adjustment expenses 150.1 97.6 2.5 250.2 Underwriting expenses 52.0 56.8 4.9 113.7 -------- ------ ------ -------- Underwriting profit (loss) (5) $ 91.8 $(21.4) $ (3.3) $ 67.0 ======== ====== ====== -------- Interest, dividend and other income 25.7 Net gain on investment transactions 54.9 Other expenses 12.8 -------- Earnings before income taxes $ 134.8 ======== Loss ratio (6) 51.1% 73.4% 60.8% 58.1% Expense ratio (7) 17.7% 42.7% 120.1% 26.4% Combined ratio (8) 68.8% 116.1% 180.9% 84.5% 2002 Gross premiums written (4) -- $148.5 -- $ 148.5 Net premiums written (4) -- 131.5 -- 131.5 Net premiums earned -- 125.6 -- 125.6 Loss and loss adjustment expenses -- 100.5 -- 100.5 Underwriting expenses -- 45.3 -- 45.3 -------- Underwriting loss (5) -- $(20.2) -- $ (20.2) -------- Interest, dividend and other income 13.4 Net gain on investment transactions (11.0) Other expenses 2.3 -------- Loss before income taxes $ (20.1) ======== Loss ratio (6) -- 80.0% -- 80.0% Expense ratio (7) -- 36.1% -- 36.1% Combined ratio (8) -- 116.1% -- 116.1%
9 (1) Since July 1, 2003. (2) Includes the results of Platte River, which was acquired contemporaneously with CATA in January 2002 and operates in conjunction with CATA. (3) Although Darwin is an underwriting manager for Platte River and certain subsidiaries of CATA, Darwin is managed on an operating unit basis and therefore, the results of business generated by Darwin have been separated from CATA's results for purposes of this table. (4) Amounts do not reflect the impact of an inter-company pooling agreement. (5) Represents net premiums earned less loss and loss adjustment expenses and underwriting expenses, all as determined in accordance with GAAP, and does not include interest, dividend and other income or net gains on investment transactions. Underwriting profit (loss) does not replace net income (loss) determined in accordance with GAAP as a measure of profitability; rather, Alleghany believes that underwriting profit (loss), which does not include interest, dividend and other income or net gains on investments transactions, enhances the understanding of AIHL's insurance operating units' operating results by highlighting net income attributable to their underwriting performance. With the addition of interest, dividend and other income and net gains on investment transactions, reported pre-tax net income (a GAAP measure) may show a profit despite an underlying underwriting loss. Where such underwriting losses persist over extended periods, an insurance company's ability to continue as an ongoing concern may be at risk. Therefore, Alleghany views underwriting (loss) profit as an important measure in the overall evaluation of performance. (6) Loss and loss adjustment expenses divided by net premiums earned, all as determined in accordance with GAAP. (7) Underwriting expenses divided by net premiums earned, all as determined in accordance with GAAP. (8) The sum of the Loss Ratio and Expense Ratio, all as determined in accordance with GAAP, representing the percentage of each premium dollar an insurance company has to spend on losses (including loss adjustment expenses) and underwriting expenses. (9) Includes $320.8 million of unearned premiums which were acquired with RSUI in July 2003 and $169. 9 million of premiums assumed on a net basis. ALLEGHANY INSURANCE HOLDINGS LLC OVERVIEW. AIHL is a holding company for Alleghany's insurance operations, which are conducted primarily through its subsidiaries RSUI, headquartered in Atlanta, Georgia, CATA, headquartered in Madison, Wisconsin and Darwin, headquartered in Farmington, Connecticut. AIHL completed the acquisition of Resurgens Specialty Underwriting, Inc. ("Resurgens Specialty") from Royal Group, Inc., a subsidiary of Royal & SunAlliance Insurance Group plc ("R&SA") on July 1, 2003 for cash consideration of approximately $116.0 million. Resurgens Specialty became a subsidiary of RSUI. In connection with the acquisition of Resurgens Specialty, on June 30, 2003, RSUI acquired RSUI Indemnity Company ("RIC") to write admitted business underwritten by Resurgens Specialty, from Swiss Re America Holding Corporation for cash consideration of approximately $19.7 million, $13.2 million of which represented consideration for RIC's investment portfolio and the balance of which represented consideration for licenses. On September 2, 2003, RIC purchased Landmark American Insurance Company ("Landmark") to write non-admitted business underwritten by Resurgens Specialty, from R&SA for cash consideration of $33.9 million, $30.4 million of which represented consideration for Landmark's investment portfolio and the balance of which represented consideration for licenses. R&SA provided loss reserve guarantees for all of the loss and loss adjustment expenses liabilities of Landmark that existed at the time of the sale. Such guarantees are described in more detail in Note 6 to the Consolidated Financial Statements included in this Report. RIC and Landmark were further capitalized by Alleghany in an aggregate amount of approximately $520.0 million. 10 On January 4, 2002, Alleghany completed the acquisition of CATA. The total purchase price paid by Alleghany was approximately $182.0 million. Contemporaneous with the acquisition of CATA, Alleghany purchased Platte River for approximately $40.0 million, $31.0 million of which represented consideration for Platte River's investment portfolio and the balance of which represented consideration for licenses. The seller provided loss reserve guarantees for all of the loss and loss adjustment expenses liabilities of Platte River that existed at the time of the sale. Such guarantees are described in more detail in Note 6 to the Consolidated Financial Statements included in this Report. During 2003, Alleghany also established Darwin. Darwin is 80.0 percent owned by AIHL and 20.0 percent owned by certain members of Darwin's management. In 2004, AIHL acquired Darwin National Assurance Company (formerly U.S. AEGIS Energy Insurance Company), an admitted insurance company domiciled in Delaware, for cash consideration of approximately $20.4 million, $17.1 million of which represented consideration for AEGIS's investment portfolio and the balance of which represented consideration for licenses. RESERVE REVIEW PROCESS. AIHL's operating units continually evaluate the potential for changes, both positive and negative, in their estimates of such liabilities and use the results of these evaluations to adjust both recorded liabilities and underwriting criteria. With respect to liabilities for unpaid losses and loss adjustment expenses established in prior years, such liabilities are periodically analyzed and their expected ultimate cost adjusted, where necessary, to reflect positive or negative development in loss experience and new information, including, for certain catastrophic events, revised industry estimates of the magnitude of a catastrophe. Adjustments to previously recorded liabilities for unpaid losses and loss adjustment expenses, both positive and negative, are reflected in Alleghany's financial results in the periods in which such adjustments are made and are referred to as prior year reserve development. The following table presents the components of reserves established in connection with the loss and loss adjustment expense liabilities of Alleghany's insurance operating units for each of the three years ended December 31, 2004. Such loss reserve amounts represent the accumulation of estimates of ultimate losses (including IBNR) and loss adjustment expenses, before reinsurance protection.
LOSSES AND LAE LOSSES AND LAE LOSSES AND LAE RESERVES AT RESERVES AT RESERVES AT DEC. 31, 2004 DEC. 31, 2003 DEC. 31, 2002 -------------- -------------- -------------- (in millions) Property $ 449.7 $ 58.0 $ 0.3 Casualty 563.2 136.3 23.3 CMP* 82.6 70.1 69.6 Surety 15.8 17.6 14.2 All Other 121.0 156.0 151.1 -------- ------ ------ Total $1,232.3 $438.0 $258.5 ======== ====== ======
11 The increase in total loss and loss adjustment expense reserves at December 31, 2004 from the year ended December 31, 2003 primarily reflects an increase in business generated by AIHL's operating units and losses incurred in connection with the 2004 third quarter hurricanes. The increase in total losses and loss adjustment expense reserves at December 31, 2003 from the year ended December 31, 2002 primarily reflects increased business generated from RSUI, acquired in July 2003 and Darwin, which commenced operations in May 2003. With respect to property lines of business, the increase in loss and loss adjustment expense reserves in 2004 primarily reflects unpaid losses of $341.8 million on AIHL's gross property catastrophe losses of $401.8 million from the 2004 third quarter hurricanes. The increase in loss and loss adjustment expense reserves for casualty lines of business (which include, among others, excess and umbrella liability, directors and officers liability, professional liability, general liability and workers compensation) in 2004 primarily reflects increased business generated by RSUI, acquired in July 2003 and Darwin, which commenced operations in May 2003. With respect to the CMP line of business, the increase in loss and loss adjustment expense reserves in 2004 primarily reflects strengthening of prior year loss reserves related to higher than expected CMP claims settlements. With respect to property and casualty lines of business, the increase in loss and loss adjustment expense reserves in 2003 primarily reflects increased business generated by RSUI, acquired in July 2003, and Darwin, which commenced operations in May 2003. With respect to the CMP line of business, the increase in loss and loss adjustment expense reserves in 2003 primarily reflects adverse development on prior year loss reserves related to higher than expected CMP claims settlements. With respect to surety lines of business, the increase in loss and loss adjustment expense reserves in 2003 primarily reflects growth in CATA's commercial surety lines. The "All Other" lines primarily consist of loss reserves from lines of business discontinued in 2004 and prior years and loss reserves acquired in connection with the acquisition of companies in which the seller provided loss reserve guarantees. Loss reserves acquired in connection with the acquisition of companies include $181.3 million of liabilities of Platte River which existed at the time of its acquisition by AIHL on January 4, 2002 and $16.0 million of liabilities of Landmark which existed at the time of its acquisition by RIC on September 2, 2003. Additional details regarding such loss reserve guarantees can be found in Note 6 to Consolidated Financial Statements included in this Report. The decrease in loss and loss adjustment expense reserve in connection with "All Other" lines of business in 2004 reflects a $1.7 million decrease in reserves related to assumed reinsurance written by CATA during the years 1969-1976 as a result of settlement of losses, a $13.5 million decrease in liabilities for which the seller of Landmark provided loss reserve guarantees and a $20.0 million decrease in the liabilities for which the seller of Platte River provided loss reserve guarantees. In 2003, the increase in loss and loss adjustment expense reserve in connection with such lines of business reflects a $18.3 million increase in reserves related to assumed reinsurance written by CATA during the years 1969-1976 and a $37.3 million increase in liabilities for which the seller of Landmark provided loss reserve guarantees, partially offset by a $50.5 million decrease in the liabilities for which the seller of Platte River provided loss reserve guarantees. 12 During 2002, after Alleghany completed the acquisition of CATA and Platte River in January of that year, CATA's loss reserves for 2001 and prior years were strengthened in the amount of $17.9 million following independent actuarial reviews. Alleghany had no loss and loss adjustment expenses at December 31, 2001. Additional information regarding CATA's reserve strengthening can be found on page 33 through 35 of this Report. CATASTROPHE RISK MANAGEMENT. AIHL's operating units, particularly RSUI, expose AIHL to losses on claims arising out of natural or man-made catastrophes. Catastrophes can be caused by various events, but losses are principally driven by hurricanes, earthquakes, windstorms and floods. The incidence and severity of catastrophes are inherently unpredictable and may materially reduce AIHL's profitability or produce losses in a given period. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the affected area and the severity of the event. Most catastrophes are restricted to small geographic areas; however, hurricanes, earthquakes, windstorms and floods may produce significant damage, especially in areas that are heavily populated. The geographic distribution of AIHL's insurance operations subjects them to catastrophe exposure principally from hurricanes in Florida and the Mid-Atlantic, Northeast, and Gulf coast regions, earthquakes in California, the Pacific Northwest region and along the New Madrid fault line in the Midwest region, and windstorms in the Midwest and Southern regions. AIHL's operating units use underwriting controls and systems, including catastrophe modeling, in an effort to attempt to ensure that the aggregate amount of catastrophe exposures conform to established risk tolerances and fit within the existing exposure portfolio. In addition, RSUI relies on reinsurance to limit its exposure to catastrophes. Actual results may vary from the expectations developed in catastrophe modeling, and such variances could negatively impact Alleghany's results of operations. Information regarding RSUI's 2004 catastrophe losses can be found on page 31 of this Report. REINSURANCE. AIHL's operating units reinsure a portion of the risks they underwrite in order to mitigate their exposure to losses, manage capacity, stabilize earnings and protect capital resources. In general, the operating units obtain reinsurance on a treaty and facultative basis. Treaty reinsurance is based on a contract between a primary insurer or "cedent" and a reinsurer and covers certain class of risk specified in such treaty. Under most treaties, the cedent is obligated to offer, and the reinsurer is obligated to accept, a specified portion of a class of risk underwritten by the cedent. Alternatively, facultative reinsurance is the reinsurance of individual risks, whereby a reinsurer separately rates and underwrites each risk and is free to accept or reject each risk offered by the cedent. Facultative reinsurance is normally purchased for risks not otherwise covered or covered only in part by reinsurance treaties, and for unusual risks. Treaty and facultative insurance can be written on both a quota share or excess of loss basis. Under a quota share reinsurance treaty, the cedent and reinsurer share the premiums as well as the losses and expenses of any single risk, or an entire group of risks. Under excess of loss reinsurance contracts, a reinsurer agrees to reimburse the cedent for all or part of any losses in excess of a predetermined amount (commonly referred to as the cedent's "retention"), generally up to a predetermined limit, at which point the risk of loss is assumed by another reinsurer or reverts to the cedent. 13 RSUI uses reinsurance on an extensive basis in order to build stable capacity and to provide protection against the accumulation of catastrophe risk. In 2004, RSUI ceded 48.5 percent of its gross premiums written to reinsurers. While the net amount of loss exposure retained by RSUI varies by line of business, as of December 31, 2004, RSUI retained a maximum net exposure for any single property or casualty risk of $7.5 million, with the exception of losses arising from acts of foreign terrorism. To protect against multiple losses due to catastrophes, RSUI maintains excess of loss reinsurance coverage in an amount estimated to be its loss exposure from a one-in-250 year catastrophic event. RSUI applies extensive risk control techniques to ensure that catastrophe exposures remain within specified parameters. On a monthly basis, RSUI models estimated losses from a 250-year event and sets its maximum risk level exposures based on this estimate. Underwriting guidelines are implemented and adjusted to maintain the estimated maximum exposure within the pre-established limits. The modeled exposure estimates are also used to structure various quota share reinsurance and catastrophe excess of loss reinsurance covers to protect RSUI's surplus from unexpected catastrophic events. In addition, RSUI uses facultative reinsurance in instances when RSUI wants greater coverage than provided by its treaties. With respect to potential losses at RSUI arising from acts of foreign terrorism, the Terrorism Risk Insurance Act of 2002 (the "Terrorism Act") established a program under which the federal government will reimburse insurers for losses arising from certain acts of foreign terrorism. The Terrorism Act requires that all licensed insurers must offer terrorism coverage on most commercial lines of business. Under the program, an act must be certified by the U.S. Secretary of the Treasury for it to constitute an act of terrorism. The definition of terrorism excludes domestic acts of terrorism or acts of terrorism committed in the course of a war declared by Congress. Losses arising out of the act of terrorism must exceed $5.0 million. If an event is certified as an act of terrorism, the federal government will reimburse the industry for losses up to an aggregate limit of $100.0 billion in any year. Each insurer is responsible for a deductible based on a percentage of direct earned premiums in the previous calendar year. For losses in excess of the deductible, the federal government will reimburse 90.0 percent of the insurer's loss, up to the insurer's proportionate share of the $100.0 billion. In 2005, AIHL's deductible will be 15.0 percent of its direct earned premiums in 2004, or approximately $193.7 million. AIHL's terrorism exposure is substantially attributable to RSUI. In general, RSUI's casualty reinsurance programs provide coverage for domestic and foreign acts of terrorism, while RSUI's property reinsurance programs do not provide coverage for foreign acts of terrorism. The cost of property reinsurance in the marketplace has increased significantly in recent years and reinsurance capacity for terrorism exposures is limited and expensive. As a result, RSUI retains such exposures on a net basis, subject to the Terrorism Act coverage, for property policies containing foreign terrorism coverage. Approximately 10.0 percent of all policies, and approximately 17.0 percent of all property policies, written by RSUI in 2004 contained coverage for domestic and foreign acts of terrorism. RSUI uses various underwriting strategies to mitigate its exposure to terrorism losses. CATA uses reinsurance to protect against severity losses. In the first eleven months of 2004, CATA reinsured individual property and casualty and contract surety risks in excess of $1.25 million with various reinsurers. The commercial surety line was reinsured for individual losses above $1.0 million with a 16.0 percent quota share 14 reinsurance agreement. The quota share reinsurance agreement had a sliding scale ceded commission based upon the loss ratio of the commercial surety business. In addition, CATA purchases facultative reinsurance coverage for risks in excess of $6.0 million on property and casualty, $7.0 million on contract surety and $10.0 million on commercial surety. On December1, 2004, CATA renegotiated its reinsurance treaties, lowering the overall cost for such treaties by increasing CATA's retention. For the property and casualty and contract surety treaties, the net retention was raised to $1.5 million and on the commercial surety treaty, the retention was raised to $1.25 million. The commercial surety quota share treaty was also eliminated. Through December 31, 2004, business underwritten by Darwin was generally reinsured on a treaty basis for individual losses in excess of $3.0 million for directors and officers liability and managed care errors and omissions liability. Darwin reinsures on a treaty basis for individual losses in excess of $0.5 million for medical professional liability insurance for physicians, and in excess of $1.0 million (with a 15.0 percent participation on losses in excess of $2.0 million) for medical professional liability for medical facilities. The medical professional liability program also provides $2.0 million of "clash" protection reinsurance (offering protection in the event that multiple policies written by Darwin are involved in the same loss occurrence) for losses in excess of $1.0 million. In addition, Darwin reinsures on a 50 percent quota share basis for individual psychiatrists professional liability. Certain of the above reinsurance treaties contain swing-rated premiums that will vary, within a range, depending upon the profitability of the underlying premium subject to the treaty. In addition, Darwin obtains facultative reinsurance for certain business. At December 31, 2004, Alleghany had reinsurance recoverables of $591.4 million on gross unpaid loss and loss adjustment expenses of $1,232.3 million. The reinsurance purchased by AIHL's operating units does not relieve them from their obligations to their policyholders, and therefore, the financial strength of their reinsurers is important. Approximately 96.0 percent of AIHL's reinsurance recoverables balance at December 31, 2004 was due from reinsurance companies having financial strength ratings of A or higher by A.M. Best Company, Inc. ("A.M. Best") an independent organization that analyzes the insurance industry. AIHL had no allowance for uncollectible reinsurance as of December 31, 2004. AIHL's Reinsurance Security Committee, which includes certain Alleghany officers and the chief financial officers of each of AIHL's operating units, meets to track, analyze and manage the use of reinsurance by AIHL's operating units. The Reinsurance Security Committee considers the limits on the maximum amount of unsecured reinsurance recoverables that can be outstanding from any particular reinsurer, the lines of business that can be ceded to a particular reinsurer and, where applicable, the types of collateral that should be posted by reinsurers. Information related to concentration of reinsurance recoverables can be found in Note 6 to the Consolidated Financial Statements. RSUI GROUP, INC. RSUI, which includes the operations of Resurgens Specialty, RIC and Landmark, underwrites specialty insurance coverages in the property, umbrella/excess, general liability, directors and officers liability and professional liability lines. RSUI reported an underwriting profit of $83.2 million in 2004, despite recording $157.2 million of pre-tax catastrophe losses (including reinsurance reinstatement premiums of $10.5 million), net 15 of reinsurance, related to 2004 third quarter hurricane activity. Of RSUI's $401.8 million of estimated gross losses from the third quarter hurricanes, $255.1 million were ceded to RSUI's reinsurers under all of RSUI's reinsurance programs. Ceded losses as a result of the 2004 third quarter hurricanes represented 43.3 percent of RSUI's reinsurance receivables as of December 31, 2004. RSUI's reported 2004 hurricane losses represent management's current best estimate and are based on management's assessment of information from actual claim reports, catastrophe computer modeling and industry loss estimates. Due to the unusual frequency and strength of the third quarter hurricanes, the ultimate, actual amount of RSUI losses attributable to 2004 third quarter hurricane activity could vary from current estimated losses. At December 31, 2004, RSUI had gross paid losses of $63.2 million related to the 2004 third quarter hurricanes. RSUI's underwriting profit of $91.8 million for the period July 1, 2003 through year-end 2003 reflected strong markets in its lines of business and aggregate pre-tax catastrophe losses of $18.7 million. RSUI reported $1,223.8 million of gross premiums written in 2004, reflecting strong markets in all lines of business except property, with the increase in underwriting expenses in 2004 primarily reflecting costs incurred in transitioning from a managing agency to an integrated insurance company and the increase in the growth of the business. The $931.3 million of gross premiums written by RSUI during the last half of 2003 include $320.8 million of unearned premiums which were acquired with RSUI in July 2003, $115.7 million of net premiums assumed pursuant to arrangements entered into in connection with the acquisition of RSUI, as well as $494.8 million of direct premiums written. Alleghany acquired RIC to write business underwritten by RSUI on an admitted basis. As RIC did not possess all necessary licenses to be able to write business on an admitted basis in most states at the time of acquisition, R&SA agreed to provide policy issuing services to RIC through June 2004. Under this arrangement and in respect of the unearned premiums acquired with RSUI, RIC assumed the policies and the related premiums (net of reinsurance paid by R&SA), from R&SA by reinsuring the obligations of the R&SA carrier under the policy. RSUI's underwriting expense is reduced by commissions that it receives under its reinsurance treaties for ceding premiums to the reinsurers. Such payments recognize and offset expenses incurred by RSUI in underwriting and administering the ceded business. RSUI's property surplus share treaties provide for profit sharing payments by the reinsurers based upon underwriting results of the ceded business. In 2004 and 2003, such profit sharing accruals reduced underwriting expense by $10.2 million and $19.0 million, respectively. In view of the 2004 catastrophe losses, RSUI does not expect to have the benefit in 2005 of any profit sharing under the property surplus share treaties. Underwriting expense in 2004 and 2003 also reflects amortization of the cost of the unearned premium acquired with RSUI in the amount of $2.7 million and $12.3 million, respectively.The significant increase in loss and loss adjustment expenses in 2004 reflects gross property catastrophe losses of $401.8 million from the 2004 third quarter hurricanes as well as a full year of operations in 2004. This increase was partially offset by an $18.1 million decrease in property loss reserves due to better than expected loss emergence in the 2003 accident year. Rates at RSUI in 2004 as compared with the second half of 2003 continued to reflect overall industry trends, with flat or marginally increased rates in RSUI's casualty lines of business (except for professional liability which experienced more significant increases in rates) and decreased rates in its property lines of business primarily due to 16 increased competition. The continuation of the rate trends discussed above may result in lower levels of gross premiums written by RSUI during 2005, since RSUI is expected to write less business when it considers prices inadequate to support acceptable profit margins. Starting in the 2004 second quarter, RSUI increased the amount of net premiums and losses retained in its property, general liability, directors and officers and professional liability lines. Such increase in retentions will allow RSUI to retain larger amounts of net written premiums which may partially offset the effect of potentially lower volume of gross written premiums during 2005. RIC is rated A (Excellent) by A.M. Best. Landmark is rated A (Excellent) on a reinsured basis by A.M. Best. CAPITOL TRANSAMERICA CORPORATION CATA, primarily through its wholly owned subsidiaries Capitol Indemnity Corporation ("Capitol Indemnity") and Capitol Specialty Insurance Corporation ("CSIC"), operates in 49 states and the District of Columbia with a geographic concentration in the Midwestern and Plains states. Platte River is licensed in 50 states and the District of Columbia and operates in conjunction with Capitol Indemnity. Capital Indemnity and CSIC write primarily property and casualty insurance for certain types of businesses or activities, including barber and beauty shops, bowling alleys, contractors, restaurants and taverns. Capitol Indemnity conducts its business on an admitted basis, and CSIC conducts its business on an approved, non-admitted basis, through independent and general insurance agents. As a non-admitted company, CSIC is not subject to state form and rate regulations and thus has more flexibility in its rates and coverages for specialized or hard-to-place property and casualty risks than Capitol Indemnity. Capitol Indemnity also writes fidelity and surety bonds and specialty insurance coverage, including contractors' performance and payment bonds, license/permit bonds, fiduciary bonds, judicial bonds and commercial fidelity bonds. CATA's 2004 underwriting loss of $8.9 million primarily reflects $10.9 million of prior year reserve strengthening upon completion of a reserve analysis during the 2004 fourth quarter which showed higher than expected emergence for construction defect claims, as well as higher underwriting expenses, partially offset by better underwriting margins on the current accident year. With respect to the prior year reserve strengthening, $9.7 million related to commercial multiple peril lines, principally construction defect claims. CATA's 2003 underwriting loss of $21.4 million reflects $21.9 million of loss reserve strengthening related to assumed reinsurance treaties written by Capitol Indemnity between 1969 and 1976. Such assumed reinsurance treaties primarily relate to asbestos and environmental exposures. Promptly after its acquisition by Alleghany in January 2002, CATA's management commenced a program to settle, or position for commutation, Capitol Indemnity's assumed reinsurance treaties and make appropriate payments on a timely basis when deemed necessary. Since January 2002, Capitol Indemnity has experienced an increase in paid losses on its assumed reinsurance, which was initially attributed to a change in CATA's settlement philosophy. Upon completion in 2003 of an actuarial study undertaken by management, it was determined that the increase in paid losses related to the treaties reflected developments in the underlying claims environment, particularly with respect to asbestos related claims, and, accordingly, 17 CATA strengthened its reserves related to such assumed reinsurance coverages in the amount of $21.9 million. CATA's 2002 underwriting loss of $20.2 million reflects a $17.9 million strengthening of CATA's loss reserves for 2001 and prior years following independent actuarial reviews, and $10.0 million in realized investment loss recognized as part of CATA's restructuring of its investment portfolio. The prior year reserve strengthening primarily reflects $13.6 million due to the results of the 2002 claims review project and $3.7 million due to adverse development on fidelity and surety lines of business for 2001 and prior years. With respect to the claims review project, upon acquisition by Alleghany, CATA revised its claim file reserving methodology and implemented the practice of establishing case reserves for newly reported claims on the basis of its estimate of such costs through the expected resolution of the claim. CATA commenced a review of each claim file that was open as of December 31, 2001 to adjust, where appropriate, the case reserves for such claim to the claim's estimated ultimate cost of resolution. With respect to initiatives related to its investment portfolio and policies, CATA undertook, and substantially completed, a restructuring of its investment portfolio in 2002, reallocating its portfolio to higher quality and more liquid securities. The increase in gross premiums written during the three-year period ended December 31, 2004 primarily reflects the expansion of CATA's business into the excess and surplus markets. Underwriting expenses have increased during the same three-year period, primarily reflecting the growth of the business, information technology initiatives and personnel costs. Rates at CATA for 2004 as compared with 2003 reflect lower levels of rate increases in its casualty lines of business and rate decreases in its property lines of business, primarily due to increased competition. Rates in 2003 were generally in line with the prior year's rate increases except for a notable reduction in rate increases in CATA's property lines of business. In both 2004 and 2003, the most significant rate reductions and lowest levels of rate increases were on CATA's largest accounts due to increased competition. CATA continuously evaluates its lines of business and adjusts its products as appropriate. In January 2005, CATA decided to exit the construction segment of the contract surety line of business upon completion of a strategic review. Therefore, commencing in the 2005 first quarter, CATA will not be issuing additional contract surety bonds in the construction segment, except to the extent required under applicable law or in certain other limited circumstances. CATA will continue to manage the run-off from this business line and is still obligated to pay losses incurred on the construction segment of the contract surety business written by it prior to exit. Capitol Indemnity and Platte River are rated A (Excellent) on a pooled basis by A.M. Best, and CSIC is rated A (Excellent) on a reinsured basis by A.M. Best. DARWIN PROFESSIONAL UNDERWRITERS, INC. Darwin underwrites specialty liability insurance coverages in the directors and officers liability, errors and omissions liability and medical professional liability areas as an underwriting manager for Platte River and certain subsidiaries of CATA. In May 2004, AIHL acquired U.S. AEGIS Energy Insurance Company (subsequently renamed Darwin National Assurance Company), an admitted insurance company domiciled in Delaware, for cash consideration of approximately $20.4 million, $17.1 million of which 18 represented consideration for AEGIS's investment portfolio and the balance of which represented consideration for licenses. Darwin's underwriting loss of $36,000 in 2004 and $3.3 million in 2003 reflects organizational build-up expenses incurred to support premium levels, as well as increased competition across all of its lines of business. Darwin generated approximately $100.5 million of gross premiums written in 2004, its first full year of operations, compared with $24.2 million during the period from May 2003 to 2003 year-end. Of such $100.5 million of gross premiums written, approximately $39.0 million was attributable to errors and omissions liability business, $39.0 million was attributable to medical professional liability business and $22.0 million was attributable to directors and officers liability business. As Darwin commenced operations in May 2003, it does not have any meaningful claims experience on which to base its reserves. In the absence of such history, Darwin's management and outside actuaries have used industry data related to the lines of business underwritten by Darwin to establish reserves until sufficient claims experience exists. On October 14, 2004, the New York State Attorney General brought a lawsuit against Marsh & McLennan Companies, Inc. and Marsh Inc. challenging certain insurance broker contingent commission compensation practices, and containing allegations of bid-rigging and price-fixing. Currently, neither Alleghany nor any of its subsidiaries has been subpoenaed by the New York State Attorney General regarding any matters related to insurance broker contingent commission compensation practices, bid-rigging or price-fixing. Darwin has in place two broker contingent commission agreements of the type covered the New York State Attorney General's lawsuit. After a review, Alleghany does not believe that Darwin has participated in any activities involving bid-rigging or price-fixing. In 2004, Darwin paid approximately $1.0 million in contingent commissions and accrued an additional $0.3 million under such contingent commission agreements. Such contingent commission agreements have been suspended. Darwin National Assurance is rated A (Excellent) on a reinsured basis by A.M. Best. AIHL INVESTMENTS GENERAL. AIHL and its operating units invest in debt and equity securities to support their operations. Following is information relating to AIHL's investments.
Years Ended December 31, ---------------------------- 2004 2003 2002 ------- ------- -------- (in thousands) Interest, dividend and other income $43,200 $25,672 $ 13,395 Net gain (loss) on investment transactions $84,478 $54,945 $(10,953)
The increase in interest, dividend and other income at AIHL during the three-year period ended December 31, 2004 primarily reflects a larger invested asset base principally due to capital contributions by Alleghany and the acquisition of RSUI in 2003. AIHL's 2004 net gain on investment transactions primarily reflects the sale of 2.6 million shares of common stock of CIGNA Corporation, for aggregate cash proceeds of 19 $169.9 million, while its 2003 pre-tax net gain on investment transactions primarily reflects the disposition of 4.3 million shares of common stock of Burlington Northern for aggregate cash proceeds of $118.6 million for the purpose of diversifying the investment portfolios of its operating units. AIHL's 2002 pre-tax net loss on investment transactions primarily reflects $10.0 million in realized investment loss recognized as part of CATA's restructuring of its investment portfolio. INVESTMENT STRATEGY. AIHL's investment strategy seeks to preserve principal and maintain liquidity while trying to maximize its risk-adjusted, after-tax rate of return. Investment decisions are guided mainly by the nature and timing of expected liability payouts, management's forecast of cash flows and the possibility of unexpected cash demands, for example, to satisfy claims due to catastrophic losses. AIHL's investment portfolio currently consists mainly of highly rated and liquid debt securities and equity securities listed on national securities exchanges. AIHL's debt securities portfolio has been designed to enable management to react to investment opportunities created by changing interest rates, prepayments, tax and credit considerations or other factors, or to circumstances that could result in a mismatch between the duration of such portfolio assets and the duration of liabilities, and, as such, is classified as available for sale. Despite significant catastrophe losses in 2004, AIHL produced positive cash flow from continuing operations each quarter during the year ended December 31, 2004. AIHL's positive cash flow from continuing operations decreases any need to liquidate portions of its debt securities portfolio to pay for current claims. Such positive cash flow also permits AIHL, as attractive investment opportunities arise, to make investments in debt securities that have a longer duration than AIHL liabilities. Such a strategy, when used, is designed to grow AIHL's capital resources. When attractive investment opportunities do not arise, AIHL may maintain higher proportions of shorter duration securities to preserve its capital resources. In this regard, as of December 31, 2004 AIHL held approximately $479.6 million, or 41.0 percent, of its debt securities portfolio in securities with maturities of five years or less and approximately $287.8 million of short-term investments. Approximately $152.7 million of AIHL's debt securities with maturities over ten years, however, are redeemable at par in less than one year, providing additional liquidity to AIHL. In the event the current investment environment improves, AIHL anticipates modestly increasing the proportion of its debt securities portfolio held in securities with maturities of more than five years. AIHL does not believe that such a strategy would reduce AIHL's ability to meet ongoing claim payments or respond to further significant catastrophe losses. In the event paid losses accelerate beyond the ability of AIHL's insurance operating units to fund such paid losses from current cash balances, current operating cash flow, coupon receipts and security maturities, AIHL would need to liquidate a portion of its investment portfolio, receive capital contributions from Alleghany at the parent level and/or arrange for financing. Potential events causing such a liquidity strain could be the result of several significant catastrophic events occurring in a relatively short period of time. Additional strain on liquidity could occur if the investments sold to fund such paid losses were sold into a depressed marketplace and/or reinsurance recoverable on such paid losses became uncollectible or collateral supporting such reinsurance recoverable significantly decreased. While the majority of AIHL's investment holdings are denominated in U.S. dollars, investments may be made in other currency denominations depending upon investment opportunities in those currencies, or the 20 currencies in which loss reserves are maintained, or as may be required by regulation or law. AIHL's investment guidelines require compliance with applicable local regulations and laws. INVESTMENT POSITION SUMMARY. The following table summarizes the investments of AIHL and its subsidiaries on a consolidated basis, excluding cash, as of December 31, 2004, with all investments carried at fair value (in thousands, except for percentages):
Amortized Cost or Cost Fair Value ----------------------- ----------------------- Amount Percentage Amount Percentage ---------- ---------- ---------- ---------- Investments Short-term investments .................... $ 287,841 17.9% $ 287,841 17.4% Corporate bonds ........................... 257,532 16.1 257,076 15.5 United States government and government agency bonds ........................... 93,469 5.8 92,760 5.6 Mortgage- and asset-backed securities ..... 237,883 14.8 237,799 14.4 Municipal bonds ........................... 573,779 35.8 575,236 34.8 Foreign bonds ............................. 3,689 0.2 3,709 0.2 Equity securities ......................... 150,252 9.4 198,829 12.0 ---------- ----- ---------- ----- Total .................................. $1,604,445 100.0% $1,653,250 100.0% ========== ===== ========== =====
AIHL continually monitors the difference between cost and the estimated fair value of its investments, which involves uncertainty as to whether declines in value are temporary in nature. If AIHL believes a decline in the value of a particular investment is temporary, it records the decline as an unrealized loss in common stockholders' equity. If the decline is believed to be other than temporary, it is written down to the carrying value of the investment and a realized loss is recorded on AIHL's statement of operations. Management's assessment of a decline in value includes, among other things, its current judgment as to the financial position and future prospects of the entity that issued the investment security. If that judgment changes in the future, AIHL may ultimately record a realized loss after having originally concluded that the decline in value was temporary. The following table summarizes, for all securities in an unrealized loss position at December 31, 2004, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position (in thousands): 21 Securities in an Unrealized Loss Position
Gross Unrealized Fair Value Loss ---------- ---------------- Debt securities: 0 - 6 months ......... $212,918 $1,262 Over 6 months ........ 387,086 5,198 -------- ------ Total ............. $600,004 $6,460 ======== ====== Equity Securities: 0 - 6 months ......... $ 1,180 $ 45 Over 6 months ........ 9,221 618 -------- ------ Total ............. $ 10,401 $ 663 ======== ======
DEBT SECURITIES PORTFOLIO. The following table reflects investment results for the debt securities portfolio of AIHL and its subsidiaries, on a consolidated basis, for the years ended December 31, 2004, 2003 and 2002 (in thousands, except for percentages): Investment Results for the Debt Securities Portfolio
Net Net Pre-Tax Pre-Tax After-Tax Realized Average Investment Investment Gains Effective After-Tax Year Ended: Investments (1) Income (2) Income (3) (Losses) Yield (4) Yield (5) - ----------------- --------------- ----------- ---------- -------- --------- --------- Dec. 31, 2004 $1,043,396 $33,837 $25,701 $ 49 3.24% 2.46% December 31, 2003 $ 486,894 $13,609 $ 9,877 $ (28) 2.80% 2.03% December 31, 2002 $ 155,857 $ 7,619 $ 5,905 $(470) 4.89% 3.79%
(1) Average of amortized cost of fixed maturity portfolio at beginning and end of period. (2) After investment expenses, excluding realized gains or losses from sale of investments. (3) Net pre-tax investment income less appropriate income taxes. (4) Net pre-tax investment income for the period divided by average investments for the same period. (5) Net after-tax investment income for the period divided by average investments for the same period. The following table indicates the composition of the long-term debt securities portfolio by rating as of December 31, 2004 (in thousands, except for percentages): Debt Securities Portfolio by Rating*
Fair Value Percentage ---------- ---------- Aaa/AAA ...................... $ 738,372 63.3% Aa/AA ........................ 192,233 16.5 A/A .......................... 120,303 10.3 Baa/BBB ...................... 100,825 8.6 Non-rated or below Baa/BBB ... 14,847 1.3 ---------- ----- Total ..................... $1,166,580 100.0% ========== =====
* Rating category used is the lower of Moody's or Standard & Poors rating. 22 The following table indicates the composition of the long-term debt securities portfolio by years until contractual maturity as of December 31, 2004 (in thousands, except for percentages): Debt Securities Portfolio by Years Until Maturity
Amortized Cost Fair Value Percentage -------------- ---------- ---------- One year or less ........................ $ 99,003 98,787 8.5% Over one through five years ............. 382,340 380,848 32.6 Over five through ten years ............. 214,680 215,615 18.5 Over ten years* ......................... 232,446 233,531 20.0 Mortgage- and asset-backed securities ... 237,883 237,799 20.4 ---------- ---------- ----- Total ................................ $1,166,352 $1,166,580 100.0% ========== ========== =====
* Includes $152.7 million of securities that are redeemable within one year at par. EQUITY SECURITIES PORTFOLIO. As of December 31, 2004, the equity securities portfolio of AIHL and its subsidiaries, on a consolidated basis, was carried at a fair value of approximately $198.8 million with an original cost of approximately $150.3 million. In 2004, AIHL had dividend income on its portfolio of $5.3 million, compared with $7.8 million in 2003 and $4.4 million in 2002. AIHL and its subsidiaries may, from time to time, make significant investments in the common stock of a public company, subject to limitations imposed by applicable regulations. REGULATION. Investments of AIHL's subsidiaries must comply with the insurance laws of the states in which they are domiciled which include Wisconsin, Delaware, New Hampshire, Oklahoma and Nebraska, as well as the insurance laws of other states in which they are licensed. These laws prescribe the kind, quality and concentration of investments which may be made by insurance companies. In general, these laws permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common stocks, and real estate mortgages. 23 WORLD MINERALS INC. World Minerals, headquartered in Santa Barbara, California, conducts a worldwide industrial minerals business through its own operations and those of its various subsidiaries, including Celite Corporation and Harborlite Corporation. World Minerals, through its Celite subsidiaries, is believed to be the world's largest producer of filter-aid grade diatomite, a silica-based mineral consisting of the fossilized remains of microscopic freshwater or marine plants. Diatomite is used as a filter aid in the production of beer, fruit juice, wine, water, sweeteners, fats and oils, pharmaceuticals, chemicals, lubricants and petroleum; it is also used as a filler, mainly in paints, and as an anti-block agent in plastic film. The company is also a producer of calcium and magnesium silicate products, which are used to convert liquid, semi-solid and sticky ingredients into dry, free-flowing powders in the production of rubber, sweeteners, flavorings and pesticides. World Minerals, through its Harborlite and Europerlite subsidiaries, is believed to be the world's largest producer of perlite filter aids and, as a seller of perlite ore, is one of the world's largest merchant producers of perlite ore. Perlite ore is a volcanic rock containing a small amount of water that causes the ore to "pop" when heated, expanding it up to twenty times its original volume. Harborlite and Europerlite sell perlite ore to companies that expand it for use primarily in the manufacture of roofing board, formed pipe insulation, acoustical ceiling tile and filter aids. Harborlite and Europerlite also expand perlite in their own expansion plants in the United States, Europe and Latin America. Most of this expanded perlite is sold as a filter aid to companies in the brewing, food, wine, sweetener, pharmaceutical, chemical and lubricant industries or as a filler and insulating medium to companies in the construction industry. World Minerals recorded pre-tax earnings of $21.2 million on revenues of $285.4 million in 2004, compared with pre-tax earnings of $25.7 million on revenues of $266.3 million in 2003 and $23.5 million on revenues of $251.2 million in 2002. Revenues in 2004 reflect a 7.3 percent increase in net sales over 2003, primarily due to increased demand, particularly with respect to the diatomite business, as well as the favorable impact of the strengthening of the euro against the dollar (had the euro to dollar exchange rate remained constant with that of 2003, World Minerals' revenues would have increased by approximately four percent). The 17.5 percent decrease in pre-tax earnings in 2004 from 2003 primarily reflects lower operating margins due to competitive pricing pressures, and rising energy and operational costs, increased selling, general and administrative expenses, a $1.5 million write-down of certain assets in World Minerals' Quincy, Florida plant, higher interest expense and foreign exchange translation losses with respect to World Minerals' Latin American operations. The 2003 results primarily reflect the favorable impact of the strengthening of the euro against the dollar (had foreign exchange rates remained constant with those of 2002, World Minerals' revenues would have been approximately flat) and a modest increase in net sales offset by lower margins due to competitive pricing pressures and increased labor and benefit costs. An impairment charge in connection with an announced closing of a plant in the United Kingdom and expenses related to staff reductions negatively impacted results by approximately $2.0 million in 2003. World Minerals' 2002 results reflect the impact of businesses acquired in 2001 and 2002, increases in net sales from World Minerals' operations in Europe, Latin America and Asia, including China, higher profit margins due to net reductions of 24 approximately $5.0 million in energy costs, primarily natural gas, at U.S. and Latin American plants, cost control efforts, and net reductions of $1.7 million in interest expense and $1.7 million in amortization expense. Such positive factors more than offset a decline in net sales in the United States and in the European and Asian export markets for World Minerals' U.S.-produced products due to sluggish demand and competitive pressures, and charges of approximately $2.6 million, primarily reflecting impairment charges taken with respect to United Kingdom operations, a write-off of certain product development costs and expenses incurred in connection with staff reductions. World Minerals conducts its business on a worldwide basis, with mining or processing operations in ten countries. Although World Minerals believes that the international scope of its operations gives it some competitive advantages, international operations can be subject to additional risks, such as currency fluctuations, changes in foreign legal requirements and political instability. World Minerals seeks to minimize its exposure to these risks by closely monitoring its methods of operating in each country and by adopting strategies responsive to changing economic and political environments. World Minerals attempts to minimize its exposure to the risk of foreign currency fluctuations by, among other things, requiring its non-European subsidiaries to invoice their export customers in U.S. dollars and causing all of its subsidiaries to declare and pay dividends whenever feasible. The strengthening of the euro against the U.S. dollar in 2004 and 2003 has had a positive impact on World Minerals' results as revenues from its European operations are higher when converted into U.S. dollars and exports of World Minerals' U.S.-produced products to Europe are more price competitive with products produced in Europe. Currency fluctuations in 2004, particularly in Latin America, resulted in foreign exchange transaction losses of $246,000 in 2004 compared with gains of $204,000 in 2003 and gains of $416,000 in 2002. Transaction gains and losses, which are reflected in pre-tax earnings, arise from the settlement or translation of monetary assets and liabilities that are denominated in a currency other than the functional currency when the exchange rates between those currencies change. ALLEGHANY PROPERTIES LLC Headquartered in Sacramento, California, Alleghany Properties owns and manages properties in the Sacramento region of California. Such properties include improved and unimproved commercial land and commercial and residential lots. The majority of these properties are located in the City of Sacramento in the planned community of North Natomas. A considerable amount of activity from developers has occurred in the North Natomas area since 1998, including the construction of more than 10,000 single family homes, 3,100 apartment units, office buildings and several fully-leased regional retail shopping centers. Participating in this growth, Alleghany Properties has sold over 372 acres of residential land and 55 acres of commercial property. 25 SELECTED FINANCIAL DATA ALLEGHANY CORPORATION AND SUBSIDIARIES SELECTED FINANCIAL DATA Alleghany Corporation and Subsidiaries (in thousands, except for share and per share amounts)
Years Ended December 31, -------------------------------------------------------------- 2004 2003 2002 2001 ** 2000 ---------- ---------- ---------- ---------- ---------- OPERATING DATA Revenues from continuing operations $1,240,927 $ 904,956 $ 466,449 $ 317,033 $ 429,602 ========== ========== ========== ========== ========== Earnings from continuing operations $ 117,948 $ 166,188 $ 53,385 $ 18,208 $ 143,735 (Losses) earnings from discontinued operations (252) (3,810) 1,428 206,022 (74,878) ---------- ---------- ---------- ---------- ---------- Net earnings $ 117,696 $ 162,378 $ 54,813 $ 224,230 $ 68,857 ========== ========== ========== ========== ========== Basic earnings (losses) per share of common stock:* Continuing operations $ 15.38 $ 21.87 $ 7.03 $ 2.37 $ 18.16 Discontinued operations (0.03) (0.50) 0.19 26.87 (9.46) ---------- ---------- ---------- ---------- ---------- Net earnings $ 15.35 $ 21.37 $ 7.22 $ 29.24 $ 8.70 ========== ========== ========== ========== ========== Average number of shares of common stock* 7,667,811 7,599,638 7,597,019 7,669,413 7,912,747 ========== ========== ========== ========== ==========
Years Ended December 31, -------------------------------------------------------------- 2004 2003 2002 2001 2000 ---------- ---------- ---------- ---------- ---------- BALANCE SHEET Total assets $4,427,725 $3,518,498 $2,216,035 $1,953,916 $1,694,113 ========== ========== ========== ========== ========== Debt $ 138,258 $ 148,998 $ 140,246 $ 157,236 $ 166,943 ========== ========== ========== ========== ========== Common stockholders' Equity $1,756,100 $1,562,822 $1,379,342 $1,390,582 $1,165,074 ========== ========== ========== ========== ========== Common stockholders' equity per share of common stock* $ 228.77 $ 204.44 $ 182.51 $ 181.85 $ 152.24 ========== ========== ========== ========== ==========
Alleghany sold Underwriters Re Group in May 2000. Underwriters Re Group has been classified as discontinued operations for the year ended 2000. Alleghany sold Alleghany Asset Management in February 2001 and Alleghany Underwriting in November 2001. Both Alleghany Asset Management and Alleghany Underwriting have been classified as discontinued operations for each of the two years ended in 2001. AIHL purchased CATA and Platte River in January 2002. In March 2003, AIHL established Darwin and acquired RSUI in July 2003. On July 1, 2003, AIHL completed the acquisition of Resurgens Specialty which became a subsidiary of RSUI. In connection with the acquisition of Resurgens Specialty, on June 30, 2003, RSUI acquired RIC. On September 2, 2003, RIC purchased Landmark. In 2004, AIHL acquired Darwin National Assurance Company. Alleghany sold Heads & Threads in December 2004. Heads & Threads has been classified as discontinued operations for all five years presented. * Amounts have been adjusted for subsequent common stock dividends. ** Operating results for 2001 have been restated to correctly classify the net gain on sale of subsidiaries as part of discontinued operations. The 2001 financial statements included in Alleghany's 2003 Annual Report to Stockholders incorrectly classified the net gain on sale of subsidiaries as part of revenues from continuing operations. Previously the Company reported revenues from continuing operations of $958,851, earnings from continuing operations of $430,563 and losses from discontinued operations of $206,333. The error in classification of the net gain on sale of subsidiaries in 2001 had no impact on net earnings or any balance sheet item. Dividends, Market Prices and Related Security Holder Matters As of December 31, 2004, there were 1,296 holders of record of Alleghany common stock. The following table indicates quarterly high and low prices of the common stock in 2004 and 2003 on the New York Stock Exchange. Alleghany's ticker symbol is Y. 26
2004 2003 ----------------- ----------------- Quarter Ended High Low High Low - ------------- ------- ------- ------- ------- March 31 $249.75 $215.43 $172.05 $149.94 June 30 292.50 246.81 202.21 160.29 September 30 300.77 251.01 197.90 185.97 December 31 $291.90 $268.00 $219.85 $191.91
In 2005, 2004, and 2003, Alleghany's Board of Directors declared, as Alleghany's dividend on its common stock for that year, a stock dividend consisting of one share of Alleghany common stock for every fifty shares outstanding. Alleghany's ability to pay cash dividends is restricted by the terms of its loan agreements. At December 31, 2004, these agreements permitted the payment of cash dividends aggregating approximately $169.5 million. 27 FINANCIAL CONDITION In recent years, Alleghany has followed a policy of maintaining a relatively liquid financial condition at the parent company in the form of cash, marketable securities, available credit lines and minimal amounts of debt. This has permitted Alleghany to expand its operations through internal growth at its subsidiaries and through acquisitions of, or substantial investments in, operating companies. At December 31, 2004 Alleghany held approximately $540.5 million of marketable securities and cash at the parent company and had no debt outstanding under its credit facilities. On May 3, 2004, AIHL acquired U.S. AEGIS Energy Insurance Company (subsequently renamed Darwin National Assurance Company), an admitted insurance company domiciled in Delaware, for cash consideration of approximately $20.4 million, $17.1 million of which represented consideration for AEGIS's investment portfolio and the balance of which represented consideration for licenses. On July 1, 2003, AIHL completed the acquisition of Resurgens Specialty, a wholesale specialty underwriting agency, from Royal Group, Inc., a subsidiary of R&SA, for cash consideration, including capitalized expenditures, of approximately $116.0 million. Resurgens Specialty became a subsidiary of RSUI. In connection with the acquisition of Resurgens Specialty, on June 30, 2003, RSUI acquired RIC, to write admitted business underwritten by Resurgens Specialty, from Swiss Re America Holding Corporation for consideration of approximately $19.7 million, $13.2 million of which represented consideration for RIC's investment portfolio and the balance of which represented consideration for licenses. On September 2, 2003, RIC purchased Landmark, a non-admitted insurance company, to write non-admitted business underwritten by Resurgens Specialty, from R&SA for cash consideration of $33.9 million, $30.4 million of which represented consideration for Landmark's investment portfolio and the balance of which represented consideration for licenses. The seller of Landmark provided loss reserve guarantees for all of the loss and loss adjustment expenses liabilities of Landmark that existed at the time of the sale. RIC and Landmark were capitalized by Alleghany in an aggregate amount of approximately $520.0 million. On January 4, 2002, AIHL completed the acquisition of Capitol Transamerica. The total purchase price was approximately $182.0 million. Contemporaneous with the acquisition of Capitol Transamerica, AIHL purchased Platte River, a Nebraska-domiciled insurance company, for approximately $40.0 million, $31.0 million of which represented consideration for Platte River's investment portfolio and the balance of which represented consideration for licenses. The seller provided loss reserve guarantees for all of the loss and loss adjustment expenses liabilities of Platte River that existed at the time of the sale. The above acquisitions were funded from internal cash resources. Alleghany has declared stock dividends in lieu of cash dividends every year since 1987 except 1998 when Chicago Title Corporation was spun off to Alleghany stockholders. These stock dividends have helped to conserve Alleghany's financial strength and, in particular, the liquid assets available to finance internal growth and operating company acquisitions and investments. On April 22, 2005, as its dividend on its common stock for 2005, Alleghany will pay to stockholders of record on April 1, 2005 a dividend of one share of Alleghany common stock for every 50 shares outstanding. 28 In addition to its liquid assets, in July 2004, Alleghany entered into a three-year unsecured credit agreement with a bank syndicate (the "Credit Agreement"). The Credit Agreement provides commitments for revolving credit loans in an aggregate principal amount of up to $200.0 million. The Credit Agreement replaced a prior 364-day credit agreement which expired on June 14, 2004 and a three-year credit agreement which was scheduled to expire on June 14, 2005, each of which provided for revolving credit loans in an aggregate principal amount of up to $100.0 million. Wachovia Bank, National Association, serves as administrative agent for the banks under the Credit Agreement. At Alleghany's option, borrowings under the Credit Agreement will bear interest at either (x) the higher of (i) the administrative agent's prime commercial lending rate or (ii) the federal funds rate plus 0.5 percent or (y) the London Interbank Overnight Rate plus a margin (currently 80 basis points) based on Alleghany's Standard & Poors and/or Moody's rating. Borrowings under the Credit Agreement will be available for working capital and general corporate purposes. Alleghany's practice is to repay borrowings under its credit agreements promptly in order to keep the facilities available for future acquisitions. No borrowings under the Credit Agreement were made during the year ended December 31, 2004. From time to time, Alleghany makes capital contributions to its subsidiaries when third-party financing may not be attractive or available. In 2004, Alleghany made capital contributions of $20.0 million to AIHL for Darwin's acquisition of Darwin National Assurance Company and to fund business expansion. In 2003, Alleghany made capital contributions of approximately $636.0 million to AIHL to acquire and capitalize Resurgens Specialty, RIC and Landmark, to allow Capitol Transamerica to strengthen reserves and to provide for acquisitions. In 2002, Alleghany made capital contributions of approximately $232.7 million to AIHL for, among other things, acquisition purposes, business expansion and reserve strengthening. Alleghany expects that it will continue to make such capital contributions to its subsidiaries in the future for similar or other purposes. Alleghany has announced that it may purchase shares of its common stock in open market transactions from time to time. In 2004, Alleghany did not purchase any shares of its common stock. In 2003, Alleghany purchased an aggregate of 1,326 shares of its common stock for approximately $0.3 million, at an average cost of $222.24 per share. In 2002, Allegany purchased an aggregate of 155,613 shares of its common stock for approximately $28.7 million, at an average cost of approximately $184.64 per share. At December 31, 2004, about $193.8 million of the equity of Alleghany's subsidiaries was available for dividends or advances to Alleghany. At that date, approximately $1.6 billion of $1.8 billion of Alleghany's equity was unavailable for dividends or advances to Alleghany from its subsidiaries, due to limitations imposed by statutes and agreements with lenders to which those subsidiaries are subject. In particular, Alleghany's insurance subsidiaries are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid to their parent without prior approval of insurance regulatory authorities. A maximum of $67.9 million was available for dividends without prior approval of the applicable insurance regulatory authorities at 2004 year-end. These limitations have not affected Alleghany's ability to meet its obligations. Alleghany and its subsidiaries have certain obligations to make future payments under contracts and credit-related financial instruments and commitments. At December 29 31, 2004, certain long-term aggregate contractual obligations and credit-related financial commitments were as follows (in thousands):
MORE THAN MORE THAN MORE WITHIN 1 YEAR BUT 3 YEARS BUT THAN 5 CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR WITHIN 3 WITHIN 5 YEARS ----------------------- ---------- -------- ---------- ----------- -------- Long-Term Debt Obligations $ 138,258 $ 5,232 $132,354 $ 398 $ 274 Operating Lease Obligations 53,981 9,665 17,500 14,543 12,273 Other Long-Term Liabilities Reflected on Alleghany Consolidated Balance Sheet under GAAP* 31,518 2,981 7,342 7,212 13,983 Losses and loss adjustment expenses 1,232,337 266,806 459,073 273,870 232,588 ---------- -------- -------- -------- -------- Total $1,456,094 $284,684 $616,269 $296,023 $259,118 ========== ======== ======== ======== ========
* Other long-term liabilities primarily reflect pension and long-term incentive obligations. Alleghany's insurance operations have obligations to make certain payments for losses and loss adjustment expenses pursuant to insurance policies they issue. These future payments are reflected as reserves on Alleghany's financial statements. With respect to loss and loss adjustment expenses, there is typically no minimum contractual commitment associated with insurance contracts and the timing and ultimate amount of actual claims related to these reserves is uncertain. Additional information regarding reserves for loss and loss adjustment expenses, including information regarding the timing of payments of such expenses, can be found on pages 14 through 18 and pages 24 through 27 of this Report. Financial strength is also a high priority of Alleghany's subsidiaries, whose assets stand behind their financial commitments to their customers and vendors. Alleghany management believes that Alleghany and its subsidiaries have and will have adequate internally generated funds, cash resources and unused credit facilities to provide for the currently foreseeable needs of its and their businesses. Alleghany and its subsidiaries have no material commitments for capital expenditures. ALLEGHANY INSURANCE HOLDINGS LLC The obligations and cash outflow of AIHL's operating units include claim settlements, administrative expenses and purchases of investments. In addition to premium collections, cash inflow is obtained from interest and dividend income and maturities and sales of investments. Because cash inflow from premiums is received in advance of cash outflow required to settle claims, AIHL's operating units accumulate funds which they invest pending the need for liquidity. As an insurance company's cash needs can be unpredictable due to the uncertainty of the claims settlement process, AIHL's portfolio (which includes those of its operating units) is composed primarily of short-term investments and debt securities to ensure the availability of funds and maintain a sufficient amount of liquid securities. As of December 31, 2004, investments represented 49.0 percent of the assets of AIHL and its operating units. AIHL's investment strategy seeks to preserve principal and maintain liquidity while trying to maximize its risk-adjusted, after-tax rate of return. Investment decisions are guided mainly by the nature and timing of expected liability payouts, management's forecast of cash flows and the possibility of unexpected cash demands, for example, to 30 satisfy claims due to catastrophic losses. AIHL's investment portfolio currently consists mainly of highly rated and liquid debt securities and equity securities listed on national securities exchanges. AIHL's debt securities portfolio has been designed to enable management to react to investment opportunities created by changing interest rates, prepayments, tax and credit considerations or other factors, or to circumstances that could result in a mismatch between the duration of such portfolio assets and the duration of liabilities, and, as such, is classified as available for sale. At December 31, 2004, Alleghany's had total unpaid losses and adjustment expenses of $1,232.3 million, which included unpaid losses of $341.8 million on AIHL's gross property catastrophe losses from 2004 third quarter hurricane activity, and reinsurance recoverables on such total unpaid losses and loss adjustment expenses of $591.4 million. As of December 31, 2004, AIHL's investment portfolio had a fair market value of $1.65 billion and consisted primarily of high quality debt securities with an average life of 3.7 years and an effective duration of 2.7 years. Effective duration measures a portfolio's sensitivity to change in interest rates; a change within a range of plus or minus 1 percent in interest rates would be expected to result in an inverse change of approximately 2.7 percent in the fair market value of the portfolio of AIHL. The overall debt securities portfolio credit quality is measured using the lower of either Standard & Poors or Moody's rating. The weighted average rating at December 31, 2004 was AA/Aa, with over 98.7 percent of all securities rated investment grade. AIHL's investment portfolio also included 404,300 shares of CIGNA common stock with a fair market value of $33.0 million as of December 31, 2004. AIHL's investment portfolio contains no investments of a derivative nature. Although Alleghany believes that AIHL's liquid assets and its net cash provided by operations will enable it to meet any foreseeable cash requirements, if losses to be paid accelerated beyond the ability of AIHL's operating units to fund such losses from current operating cash flows, AIHL would need to liquidate a portion of its investment portfolio and/or arrange for financing. Potential events causing such a liquidity strain could be the result of several significant catastrophic events occurring in a relatively short period of time. Additional strain on liquidity could occur if the investments sold to fund such paid losses were sold into a depressed marketplace and/or reinsurance recoverables on such paid losses became uncollectible or collateral supporting such reinsurance recoverables significantly decreased. Additional detail regarding AIHL's investment portfolio and investment strategy can be found on pages 37 through 41 of this Report. WORLD MINERALS INC. The obligations and cash outflow of World Minerals include payments for supplies used in making products for sale to customers, capital expenditures, labor and other costs related to production, transportation expenses, administrative expenses and dividends. Cash inflow is obtained from profits made on the sale of products and collection of receivables, and proceeds from borrowings. In March 2003, World Minerals entered into a credit agreement with several banks providing for a commitment for revolving credit loans and/or letters of credit in an aggregate principal amount of $100.0 million which expires in 2007. World Minerals used amounts available to it under such credit agreement to pay all outstanding indebtedness under its former credit agreement. As of December 31, 2004, $52.0 million 31 of indebtedness and no letters of credit were outstanding under the credit agreement, leaving $48.0 million unused and available for borrowing and/or letters of credit. An additional $5.1 million of short-term debt and $1.2 million of long-term debt from local foreign loans and $0.5 million of letters of credit which are permitted under World Minerals' credit agreement were outstanding as of December 31, 2004. World Minerals paid cash dividends to Alleghany of $6.8 million in 2004, $35.4 million in 2003 and $2.6 million in 2002. ALLEGHANY PROPERTIES LLC As part of Alleghany's sale of Sacramento Savings Bank in 1994, Alleghany, through its wholly owned subsidiary Alleghany Properties, purchased the real estate and real estate-related assets of Sacramento Savings. Alleghany Properties is Alleghany's only subsidiary holding substantial real estate investments. As of December 31, 2004, Alleghany Properties held properties having a total book value of approximately $30.1 million, as compared with approximately $32.7 million as of December 31, 2003 and approximately $36.3 million as of December 31, 2002. Such properties and loans had a total book value of approximately $90.1 million as of October 31, 1994 (the date the assets were purchased by Alleghany Properties). On December 11, 1998, Alleghany Properties issued $40.0 million aggregate principal amount of 6.83 percent senior notes due 2004, the proceeds from which were used to pay a dividend of $39.5 million to Alleghany in 1998 and to cover the expenses of the issuance. On December 11, 2004, Alleghany Properties made its final principal payment on the notes, including accrued interest thereon, in the amount of $8.3 million. The capital needs of Alleghany Properties consist primarily of various development costs relating to its owned properties and corporate administration. Adequate funds to provide for the currently foreseeable needs of its business are expected to be generated by sales and, if needed, capital contributions by Alleghany. Alleghany Properties paid an aggregate of $10.0 million of cash dividends to Alleghany in 2003. MATERIAL OFF-BALANCE SHEET ARRANGEMENTS Alleghany did not enter into any material off-balance sheet arrangements during 2004, 2003 or 2002, nor did it have any material off-balance sheet arrangements outstanding at December 31, 2004, 2003 or 2002. QUANTITATIVE AND QUALITATIVE MARKET RISK DISCLOSURE Market risk is the risk of loss from adverse changes in market prices and rates, such as interest rates, foreign currency exchange rates and commodity prices. The primary market risk related to Alleghany's non-trading financial instruments is the risk of loss associated with adverse changes in interest rates. Alleghany and its subsidiaries invest in equity securities. Equity securities are subject to fluctuations in market value. Alleghany and its subsidiaries also purchase debt securities with fixed maturities that exposes them to risk related to adverse changes in interest rates. 32 Alleghany holds its equity securities and debt securities as available for sale. Any changes in the fair value in these securities, net of tax, would be reflected in Alleghany's accumulated other comprehensive income as a component of stockholders' equity. The table below summarizes Alleghany's equity price risk and shows the effect of a hypothetical increase or decrease in market prices as of December 31, 2004 and 2003 on the estimated fair value of Alleghany's consolidated equity portfolio. The selected hypothetical changes do not indicate what could be the potential best or worst case scenarios (dollars in millions):
Estimated Fair Value Hypothetical Percentage AS OF Estimated Fair Hypothetical after Hypothetical Increase (Decrease) in DECEMBER 31, Value Price Change Change in Prices Stockholders' Equity - ------------ -------------- ------------ -------------------- ----------------------- 2004 $645.2 20% Increase $774.2 4.8% 20% Decrease $516.1 (4.8)% 2003 $620.8 20% Increase $744.9 5.1% 20% Decrease $496.6 (5.1)%
The primary market risk for the long-term debt of Alleghany and its subsidiaries is interest rate risk at the time of refinancing. Alleghany and its subsidiaries monitor the interest rate environment to evaluate refinancing opportunities. For additional information regarding the long-term debt of Alleghany and its subsidiaries, see "Financial Condition." Other than one interest rate swap, Alleghany currently does not use derivatives to manage market and interest rate risks. In respect of the interest rate swap, Alleghany is exposed to a credit risk in the unlikely event of nonperformance by the swap counterparty. Alleghany, through World Minerals, conducts certain business activities in foreign countries. World Minerals minimizes its exposure to the risk of foreign currency fluctuation by, among other things, requiring its non-European subsidiaries to invoice their export customers in U.S. dollars and causing its subsidiaries, whenever feasible, to declare and pay dividends to repatriate profits back to the U.S. in U.S. dollars. Alleghany does not believe that the operations of World Minerals subject Alleghany to a material risk from foreign currency fluctuation. The tables below present a sensitivity analysis of Alleghany's consolidated debt securities and subsidiaries' debt, as of December 31, 2004 and 2003, that are sensitive to changes in interest rates. Sensitivity analysis is defined as the measurement of potential change in future earnings, fair values or cash flows of market sensitive instruments resulting from one or more selected hypothetical changes in interest rates over a selected time. In this sensitivity analysis model, Alleghany uses fair values to measure its potential change, and a +/- 200 basis point range of change in interest rates to measure the hypothetical change in fair value of the financial instruments included in the analysis. The change in fair value is determined by calculating hypothetical December 31, 2004 and 2003 ending prices based on yields adjusted to reflect a +/- 200 basis point range of change in interest rates, comparing such hypothetical ending prices to actual ending prices, and multiplying the difference by the par outstanding. 33 At December 31, 2004 (dollars in millions)
INTEREST RATE SHIFTS -200 -100 0 100 200 - -------------------- -------- -------- -------- -------- -------- ASSETS Debt securities, fair value $1,242.4 $1,211.1 $1,179.2 $1,146.8 $1,114.4 Estimated change in fair value $ 63.2 $ 31.9 $ 0 $ (32.4) $ (64.8) LIABILITIES Subsidiaries' debt, fair value $ 140.4 $ 141.5 $ 142.6 $ 143.7 $ 144.9 Estimated change in fair value $ (2.2) $ (1.1) $ 0 $ 1.1 $ 2.3
At December 31, 2003 (dollars in millions)
INTEREST RATE SHIFTS -200 -100 0 100 200 - -------------------- ------ ------ ------ ------ ------ ASSETS Debt securities, fair value $979.2 $948.0 $917.3 $887.1 $857.9 Estimated change in fair value $ 61.9 $ 30.7 $ 0 $(30.2) $(59.4) LIABILITIES Subsidiaries' debt, fair value $149.9 $151.2 $152.6 $153.9 $152.2 Estimated change in fair value $ (2.6) $ (1.3) $ 0 $ 1.3 $ 2.6
These sensitivity analyses provide only a limited, point-in-time view of the market risk of the financial instruments discussed above. The actual impact of changes in equity prices and market interest rates on the financial instruments may differ significantly from those shown in the above sensitivity analyses. The sensitivity analyses are further limited because they do not consider any actions Alleghany could take in response to actual and/or anticipated changes in equity prices and in interest rates. 34 FORWARD-LOOKING STATEMENTS "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Quantitative and Qualitative Disclosures About Market Risk" contain disclosures which are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements include all statements that do not relate solely to historical or current facts, and can be identified by the use of words such as "may," "will," "expect," "project," "estimate," "anticipate," "plan," "believe," "potential," "should," "continue" or the negative versions of those words or other comparable words. These forward-looking statements are based upon the Company's current plans or expectations and are subject to a number of uncertainties and risks that could significantly affect current plans, anticipated actions and Alleghany's future financial condition and results. These statements are not guarantees of future performance, and Alleghany has no specific intention to update these statements. The uncertainties and risks include, but are not limited to: risks relating to Alleghany's insurance subsidiaries such as - the cyclical nature of the property casualty industry; - the long-tail and potentially volatile nature of certain casualty lines of business written by such subsidiaries; - the availability of reinsurance; - exposure to terrorist acts; - the willingness and ability of such subsidiaries' reinsurers to pay reinsurance recoverables owed to such subsidiaries; - changes in the ratings assigned to such subsidiaries; - claims development and the process of estimating reserves; - legal and regulatory changes; - the uncertain nature of damage theories and loss amounts; - increases in the levels of risk retention by such subsidiaries; - adverse loss development for events insured by such subsidiaries in either the current year or prior years; and - significant weather-related or other natural or human-made catastrophes and disasters. Additional risks and uncertainties include general economic and political conditions, including the effects of a prolonged U.S. or global economic downturn or recession, changes in costs, including changes in labor costs, energy costs and raw material prices, variations in political, economic or other factors such as currency exchange rates, risks relating to conducting operations in a competitive environment and conducting operations in foreign countries, effects of acquisition and disposition activities, inflation rates or recessionary or expansive trends, changes in market prices of Alleghany's significant equity investments, tax, extended labor disruptions, civil unrest or other external factors over which Alleghany has no control, and changes in Alleghany's plans, strategies, objectives, expectations or intentions, which may happen at any time at its discretion. As a consequence, current plans, anticipated actions and future financial condition and results may differ from those expressed in any forward-looking statements made by or on behalf of Alleghany. 35 REPORTS AND CERTIFICATIONS Management's Report on Internal Control Over Financial Reporting Alleghany's management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Alleghany's internal control system was designed to provide reasonable assurance to its management and Board of Directors regarding the preparation and fair presentation of financial statements for external purposes. Alleghany carried out an evaluation, under the supervision and with the participation of its management, including the chief executive officer and chief financial officer, of the effectiveness of its internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, Alleghany management, including the chief executive officer and chief financial officer, concluded that, as of December 31, 2004, Alleghany's internal control over financial reporting was effective. Alleghany's independent registered public accounting firm, KPMG LLP, has issued an attestation report on the effectiveness of Alleghany's internal control over financial reporting and Alleghany management's assessment of such effectiveness which appears on page 79 of this Report. It should be noted that all internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Certifications The certifications of Alleghany's President and chief executive officer and its chief financial officer required by Section 302 of the Sarbanes-Oxley Act of 2002 were included as exhibits to Alleghany's Annual Report on Form 10-K for the year ended December 31, 2004, which was filed with the Securities and Exchange Commission in March 2005. On May 21, 2004, the annual certification of Alleghany's President and chief executive officer, certifying that, other than non-compliance resulting from Alleghany not yet having a website, he was not aware of any violation by Alleghany of the New York Stock Exchange's corporate governance listing standards, was filed with the New York Stock Exchange. Alleghany established its website, www.alleghany.com, in June 2004. 36 CONSOLIDATED BALANCE SHEETS Alleghany Corporation and Subsidiaries December 31,
2004 2003 ---------- ---------- (in thousands, except share amounts) ASSETS Available for sale securities at fair value: Equity securities (cost: 2004, $290,597;2003, $370,982) $ 645,184 $ 620,754 Debt securities (cost: 2004, $1,178,982; 2003, $910,307) 1,179,210 917,270 Short-term investments 378,452 135,079 ---------- ---------- 2,202,846 1,673,103 ---------- ---------- Cash 288,436 230,929 Notes receivable 91,665 92,082 Accounts receivable, net 70,547 99,697 Premium balances receivable 203,141 279,682 Reinsurance recoverables 623,325 174,099 Ceded unearned premium reserves 286,451 231,166 Deferred acquisition costs 56,165 47,282 Property and equipment at cost, net of accumulated depreciation and amortization 168,316 174,097 Inventory 41,521 35,164 Goodwill and other intangibles, net of amortization 223,706 227,595 Deferred tax assets 104,563 77,640 Other assets 67,043 90,809 Assets of discontinued operations -- 85,153 ---------- ---------- $4,427,725 $3,518,498 ========== ========== LIABILITIES AND COMMON STOCKHOLDERS' EQUITY Losses and loss adjustment expenses $1,232,337 $ 437,994 Unearned premiums 751,131 644,068 Reinsurance payable 112,479 255,117 Deferred tax liabilities 224,847 190,402 Subsidiaries' debt 138,258 148,998 Current taxes payable 17,433 49,605 Other liabilities 195,140 193,204 Liabilities of discontinued operations -- 36,288 ---------- ---------- Total liabilities 2,671,625 1,955,676 Preferred stock (preferred shares authorized: 2004 and 2003 - 8,000,000; preferred shares issued and outstanding: none) -- -- Common stockholders' equity: (common shares authorized: 2004 and 2003 - 22,000,000; common shares issued and outstanding 2004 - 7,676,197; 2003 - 7,644,232) 1,756,100 1,562,822 ---------- ---------- $4,427,725 $3,518,498 ========== ==========
See accompanying Notes to Consolidated Financial Statements. 37 CONSOLIDATED STATEMENTS OF EARNINGS Alleghany Corporation and Subsidiaries Years ended December 31,
2004 2003 2002 ---------- -------- -------- (in thousands, except per share amounts) REVENUES Net premiums earned $ 805,417 $430,914 $125,649 Net mineral and filtration sales 285,587 266,136 251,361 Interest, dividend and other income 63,053 56,064 53,064 Net gain on investment transactions 86,870 151,842 36,375 ---------- -------- -------- Total revenues 1,240,927 904,956 466,449 ---------- -------- -------- COSTS AND EXPENSES Loss and loss adjustment expenses 540,569 250,202 100,508 Commissions and brokerage expenses 190,657 113,688 29,100 Cost of mineral and filtration sales 217,546 199,148 184,685 Salaries, administrative and other operating expenses 75,950 57,214 65,702 Corporate administration 41,278 34,678 25,700 Interest expense 4,800 4,726 5,786 ---------- -------- -------- Total costs and expenses 1,070,800 659,656 411,481 ---------- -------- -------- Earnings from continuing operations, before income taxes 170,127 245,300 54,968 Income taxes 52,179 79,112 1,583 ---------- -------- -------- Earnings from continuing operations 117,948 166,188 53,385 DISCONTINUED OPERATIONS (Loss) earnings from operations of discontinued operations, (including loss on disposal of $1,950 in 2004) (1,033) (4,933) 2,436 Income taxes (benefit) (781) (1,123) 1,008 ---------- -------- -------- Losses from discontinued operations, net of tax benefit (252) (3,810) 1,428 ---------- -------- -------- Net earnings $ 117,696 $162,378 $ 54,813 ========== ======== ======== BASIC EARNINGS (LOSS) PER SHARE OF COMMON STOCK: * Continuing operations $ 15.38 $ 21.87 $ 7.03 Discontinued operations (0.03) (0.50) 0.19 ---------- -------- -------- Basic net earnings per share $ 15.35 $ 21.37 $ 7.22 ========== ======== ======== DILUTED EARNINGS (LOSS) PER SHARE OF COMMON STOCK:* Continuing operations $ 15.34 $ 21.79 $ 6.97 Discontinued operations (0.03) (0.50) 0.19 ---------- -------- -------- Diluted net earnings per share $ 15.31 $ 21.29 $ 7.16 ========== ======== ========
* Amounts reflect subsequent common stock dividends. See accompanying Notes to Consolidated Financial Statements. 38 CONSOLIDATED STATEMENTS OF CHANGES IN COMMON STOCKHOLDERS' EQUITY Alleghany Corporation and Subsidiaries Three Years Ended December 31, 2004
Accumulated Other Total Common Contributed Comprehensive Treasury Retained Stockholders' Stock Capital Income Stock Earnings Equity ------- ----------- ------------- -------- ---------- ------------- (in thousands, except share amounts) BALANCE AT DECEMBER 31, 2001 $7,514 $495,204 $183,849 $(57,356) $ 761,371 $1,390,582 (7,973,543 shares of common stock issued; 326,597 in treasury)* ADD (DEDUCT): Net earnings -- -- -- -- 54,813 54,813 Other comprehensive income, net of tax: Translation loss -- -- 5,790 -- -- 5,790 Minimum pension liability -- -- (3,888) -- -- (3,888) Change in unrealized appreciation of investments, net -- -- (44,384) -- -- (44,384) ------ -------- -------- -------- ---------- ---------- Comprehensive income -- -- (42,482) -- 54,813 12,331 ------ -------- -------- -------- ---------- ---------- Common stock dividend -- 238 -- 26,355 (26,685) (92) Other, net -- (1,520) -- (21,959) -- (23,479) ------ -------- -------- -------- ---------- ---------- BALANCE AT DECEMBER 31, 2002 7,514 493,922 141,367 (52,960) 789,499 1,379,342 (7,817,199 shares of common stock issued; 259,732 in treasury) ADD (DEDUCT): Net earnings -- -- -- -- 162,378 162,378 Other comprehensive loss, net of tax: Translation gain -- -- 12,679 -- -- 12,679 Minimum pension liability -- -- (108) -- -- (108) Change in unrealized appreciation of investments, net -- -- (628) -- -- (628) ------ -------- -------- -------- ---------- ---------- Comprehensive income -- -- 11,943 -- 162,378 174,321 ------ -------- -------- -------- ---------- ---------- Common stock dividend -- (2,125) -- 26,685 (24,639) (79) Other, net -- (6,366) -- 15,604 -- 9,238 ------ -------- -------- -------- ---------- ---------- BALANCE AT DECEMBER 31, 2003 7,514 485,431 153,310 (10,671) 927,238 1,562,822 (7,663,921 shares of common stock issued; 19,689 in treasury) ADD (DEDUCT): Net earnings -- -- -- -- 117,948 117,948 Loss from discontinued operations -- -- -- -- (252) (252) Other comprehensive income, net of tax: Translation gain -- -- 6,088 -- -- 6,088 Minimum pension liability -- -- (697) -- -- (697) Change in unrealized appreciation of investments, net -- -- 65,188 -- -- 65,188 ------ -------- -------- -------- ---------- ---------- Comprehensive income 70,579 117,696 188,275 ------ -------- -------- -------- ---------- ---------- Common stock dividend 150 39,779 -- (40,046) (117) Other, net 13 1,683 -- 3,424 5,120 ------ -------- -------- -------- ---------- ---------- BALANCE AT DECEMBER 31, 2004 $7,677 $526,893 $223,889 $ (7,247) $1,004,888 $1,756,100 (7,677,137 shares of common stock issued; 940 in treasury) ====== ======== ======== ======== ========== ==========
* Amounts reflect subsequent common stock dividends. See accompanying Notes to Consolidated Financial Statements. 39 CONSOLIDATED STATEMENTS OF CASH FLOWS Alleghany Corporation and Subsidiaries Years Ended December 31
2004 2003 2002 ----------- ----------- ---------- (in thousands) CASH FLOWS FROM OPERATING ACTIVITIES Net earnings from continuing operations $ 117,948 $ 166,188 $ 53,385 Adjustments to reconcile net earnings to cash provided by operations: Depreciation and amortization 45,801 28,755 17,401 Net gain on investment transactions and sales of subsidiary (86,870) (151,842) (36,375) Tax benefit on stock options exercised 1,317 4,267 1,188 Decrease (increase) in other assets 23,107 (46,068) 15,898 (Increase) decrease in accounts and notes receivable 31,485 2,626 (31,346) (Increase) decrease in inventory (6,113) (2,659) 19,779 (Increase) decrease in reinsurance receivable, net of reinsurance payable (591,864) 76,264 34,727 (Increase) decrease in premium balances receivable 76,541 (271,008) -- (Increase) decrease in ceded unearned premium reserves (55,285) (305,843) 266 Increase in deferred acquisition costs (8,883) (30,601) -- Increase (decrease) in other liabilities and current taxes (38,355) 104,144 (41,486) Increase in unearned premiums 107,063 657,406 6,141 Increase (decrease)in losses and loss adjustment expenses 794,343 199,987 (8,215) ----------- ----------- --------- Net adjustments 292,287 265,428 (22,022) ----------- ----------- --------- Net cash provided by operating activities 410,235 431,616 31,363 ----------- ----------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of investments (1,039,690) (1,451,746) (885,410) Sales of investments 940,419 756,517 503,652 Sale of subsidiary 53,403 -- -- Purchases of property and equipment (16,489) (13,313) (13,173) Net change in short-term investments (242,845) 493,321 581,315 Other, net (19,988) 94,189 65,811 Acquisition of insurance companies, net of cash acquired (17,918) (109,244) (221,056) ----------- ----------- --------- Net cash provided by (used in) investing activities (343,108) (230,276) 31,139 ----------- ----------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Principal payments on long-term debt (26,382) (49,104) (30,647) Proceeds of long-term debt 15,642 58,152 13,775 Treasury stock acquisitions -- (287) (28,731) Net cash used in discontinued operations (2,230) -- (1,548) Other, net 3,350 (5,623) 450 ----------- ----------- --------- Net cash provided by (used in) financing activities (9,620) 3,138 (46,701) ----------- ----------- --------- Net increase in cash 57,507 204,478 15,801 Cash at beginning of year 230,929 26,451 10,650 ----------- ----------- --------- Cash at end of year $ 288,436 $ 230,929 $ 26,451 =========== =========== ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the year for: Interest $ 3,613 $ 3,599 $ 13,158 Income taxes $ 117,410 $ 41,569 $ 5,307 =========== =========== =========
See accompanying Notes to Consolidated Financial Statements. 40 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ALLEGHANY CORPORATION AND SUBSIDIARIES 1. Summary of Significant Accounting Principles a. Principles of Financial Statement Presentation. Alleghany Corporation, a Delaware corporation ("Alleghany," or together with its subsidiaries, the "Company"), owns Alleghany Funding Corporation ("Alleghany Funding"); World Minerals Inc. ("World Minerals"); Alleghany Properties LLC ("API"); and Alleghany Insurance Holdings LLC ("AIHL"). The Company owns 100% of these subsidiaries, except for World Minerals in which its ownership interest is 99.9%. Alleghany also owned Heads & Threads International LLC ("H&T") until December 31, 2004. Accordingly, the operations of H&T have been reclassified as discontinued operations for all periods presented. See Note 2. On January 4, 2002, Alleghany completed the acquisition of Capitol Transamerica Corporation ("Capitol Transamerica") for a total purchase price of approximately $182.0 million, of which $23.3 million was allocated to goodwill and $26.3 million was allocated to intangibles. Contemporaneous with the acquisition of Capitol Transamerica, Alleghany purchased Platte River Insurance Company ("Platte River") for a total purchase price of approximately $40.0 million, of which $8.3 million was allocated to intangibles. On July 1, 2003, AIHL completed the acquisition of Resurgens Specialty Underwriting, Inc. ("Resurgens Specialty"), a specialty wholesale underwriting agency, from Royal Group, Inc., a subsidiary of Royal & Sun Alliance Insurance Group plc ("R&SA"), for cash consideration, including capitalized expenditures, of approximately $116.0 million. Resurgens Specialty became a subsidiary of RSUI Group, Inc. ("RSUI"). In connection with the acquisition of Resurgens Specialty, on June 30, 2003, RSUI Group, Inc. acquired RSUI Indemnity Company ("RIC") to write admitted business underwritten by Resurgens Specialty, from Swiss Re America Holding Corporation for cash consideration of approximately $19.7 million. On September 2, 2003, RIC purchased Landmark American Insurance Company ("Landmark") to write non-admitted business underwritten by Resurgens Specialty, for cash consideration of $33.9 million. As a result of these acquisitions, AIHL allocated $21.9 million to goodwill and $102.9 million to intangible assets. AIHL's results of operations include Resurgens Specialty's results from July 1, 2003. In March 2003, AIHL established a new specialty liability insurance underwriting company, Darwin Professional Underwriters, Inc. ("Darwin"). AIHL owns 80 percent of the currently outstanding shares of common stock of Darwin. The remaining 20 percent of the shares of common stock of Darwin were awarded to members of Darwin's management under a restricted stock plan. In 2004 and 2003, certain conditions were not achieved and as a result, no minority interest was recorded in 2004 or 2003. The accompanying consolidated financial statements include the results of Alleghany and its majority-owned subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States of America. All significant inter-company balances and transactions have been eliminated in consolidation. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts 41 of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those reported results to the extent that those estimates and assumptions prove to be inaccurate. b. Investments. Investment securities consist of equity securities, debt securities and short-term investments. The Company classifies its marketable equity securities and debt securities as available for sale. Debt securities consist of securities with an initial maturity of more than one year. Such securities include U.S. Treasury, Federal National Mortgage and Federal Home Loan Mortgage notes. Short-term investments include commercial paper, certificates of deposit, money market instruments and any fixed maturity with an initial maturity of one year or less. At December 31, 2004 and 2003, available for sale securities are recorded at fair value based on quoted market prices or dealer quotes. Unrealized gains and losses during the year, net of the related tax effect applicable to available-for-sale securities, are excluded from earnings and reflected in comprehensive income and the cumulative effect is reported as a separate component of common stockholders' equity until realized. A decline in the fair value of an available-for-sale security below its cost that is deemed other than temporary is charged to earnings. Realized gains and losses on investments are determined on the specific identification method. At December 31, 2004 and 2003, the Company had a concentration of market risk in its holdings of the equity securities of Burlington Northern Santa Fe Corporation of $378.5 million and $258.8 million, respectively. The cost of these securities is $96.6 million. c. Derivative Financial Instruments. The Company has only limited involvement with derivative financial instruments and does not use them for trading purposes. The Company enters into interest rate swaps for purposes of converting variable interest rate exposure to a fixed rate and to match interest expense with interest income. Interest rate swaps are accounted for as a hedge of the obligation. Interest expense is recorded using the revised interest rate. d. Cash. For purposes of the consolidated statements of cash flows, cash includes only funds which are available for immediate withdrawal. e. Accounts Receivable. Accounts receivable consist of receivables, net of allowances. f. Premiums and Unearned Premiums. Premiums are recognized as revenue on a pro-rata basis over the term of an insurance policy. This recognition is based on the short term (twelve months or less) nature of the lines of business written by AIHL's operating units, which consist of property and casualty and fidelity and surety lines. Unearned premiums represent the portion of premiums written which are applicable to the unexpired terms of insurance policies in force. 42 Premium balances receivable are reported net of an allowance for estimated uncollectible premium amounts. Ceded premiums are charged to income over the applicable terms of the various reinsurance contracts with third party reinsurers. g. Reinsurance Recoverables. AIHL follows the customary practice of reinsuring with other companies the loss exposures on business its insurance operations have written. This practice allows AIHL's insurance operations to diversify their business and write larger policies, while limiting the extent of their primary maximum net loss. Reinsuring loss exposures does not relieve AIHL's insurance operations from their obligations to policyholders. AIHL's insurance operations remains liable to their policyholders for the portion reinsured to the extent that any reinsurer does not meet the obligations assumed under the reinsurance agreements. To minimize their exposure to losses from a reinsurer's inability to pay, AIHL's insurance operations periodically evaluate the financial condition of their reinsurers. Reinsurance recoverables (including amounts related to claims incurred but not reported) and prepaid reinsurance premiums are reported as assets. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured business. Ceded premiums are charged to income over the applicable terms of the various reinsurance contracts with third party reinsurers. Reinsurance contracts that do not result in a reasonable possibility that the reinsurer may realize a significant loss from the insurance risk assumed and that do not provide for the transfer of significant insurance risk generally do not meet the conditions for reinsurance accounting and are accounted for as deposits. h. Deferred Acquisition Costs. Acquisition costs related to unearned premiums that vary with, and are directly related to, the production of such premiums (principally commissions, premium taxes, compensation and certain underwriting expenses) are deferred. Deferred acquisition costs are amortized to expense as the related premiums are earned. Deferred acquisition costs are periodically reviewed to determine their recoverability from future income, including investment income, and if any such costs are determined to be not recoverable they are charged to expense. Deferred acquisition costs amortized to expense in 2004 and 2003 were $62.2 and $43.0 million, respectively. i. Property and Equipment. Depreciation of buildings and equipment and amortization of leasehold improvements are principally calculated using the straight-line method over the estimated useful life of the respective assets or the life of the lease, whichever is less. j. Inventory. Inventories are stated at the lower of cost or market. Cost is computed using either the last in, first out (LIFO) method, the first in, first out (FIFO) method or the average cost. k. Goodwill and Other Intangible Assets. Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 141 (SFAS 141), "Business Combinations," and No. 142 (SFAS 142), "Goodwill and Other Intangible Assets." Upon adoption, the Company 43 stopped amortizing goodwill and certain intangible assets with an indefinite useful life created by business combinations accounted for using the purchase method of accounting. Instead, goodwill and certain intangible assets deemed to have an indefinite useful life are subject to an annual review for impairment. Other intangible assets that are not deemed to have an indefinite useful life will continue to be amortized over their useful lives. l. Income Taxes. The Company files a consolidated federal income tax return with its domestic subsidiaries. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. 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. m. Loss Reserves. The reserves for losses and loss adjustment expenses represent management's best estimate of the ultimate cost of all reported and unreported losses incurred through the balance sheet date and include but are not limited to: (i) the accumulation of individual estimates for claims reported on direct business prior to the close of an accounting period; (ii) estimates received from reinsurers with respect to reported claims which have been reinsured; (iii) estimates for incurred but not reported claims based on past experience modified for current trends; and (iv) estimates of expenses for investigating and settling claims based on past experience. The reserves recorded are based on estimates resulting from the review process, and differences between estimates and ultimate payments are reflected as an expense in the statement of earnings in the period in which the estimates are revised. n. Revenue Recognition for Non-Insurance Operations. The Company recognizes revenue when products are shipped or delivered and the customer takes ownership and assumes risk of loss, collection of the relevant receivable is probable, persuasive evidence of an arrangement exists, and the sales price is fixed and determinable. Allowances for estimated returns and discounts are provided when the related revenue is recognized. Revenue and profits from land sales are recognized using the full accrual method when title has passed to the buyer, the collectibility of the sales price is reasonably assured, the required minimum cash down payment has been received, and the Company has no continuing involvement with the property. The Company has recorded sales under the full accrual method as all requirements have been met. o. Net Earnings Per Share of Common Stock. Net earnings per share of common stock are based on the average number of shares of Alleghany common stock outstanding during the years ended December 31, 2004, 2003, and 2002, respectively, as adjusted for stock dividends. The average number 44 of shares of common stock outstanding, as adjusted for stock dividends, was 7,667,811 in 2004, 7,599,638 in 2003, and 7,597,019 in 2002. p. Stock Option Plans. The Company follows Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation Transition and Disclosure." SFAS 123 establishes accounting and reporting standards for stock-based employee compensation plan, and allows companies to choose between the "fair value based method of accounting" as defined in SFAS 123 and the "intrinsic value based method of accounting" as prescribed by Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees." The Company has elected to continue to follow the "intrinsic value based method of accounting" for awards granted prior to 2003 and accordingly no expense is recognized on stock option grants. Effective January 1, 2003, the Company adopted the "fair value based method of accounting" of SFAS 123, using the prospective transition method for awards granted after January 1, 2003. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: no cash dividend yield for all years; expected volatility of 18 percent for all years; risk-free interest rates ranging from 3.56 to 4.13 percent; and expected lives of eight years. The compensation cost that has been charged against income for the Company's stock-based plans was $16.7 million, $7.7 million, and $0.2 million in 2004, 2003, and 2002, respectively. Had compensation cost for the Company's two stock-based compensation plans been determined based on the fair value at the grant date for awards under those plans consistent with the method of SFAS 123, the Company's net earnings and earnings per share would have changed to the pro forma amounts indicated as follows:
2004 2003 2002 -------- -------- ------- Net earnings As reported $117,696 $162,378 $54,813 Pro forma $118,934 $161,905 $53,109 Basic earnings per share As reported $ 15.35 $ 21.37 $ 7.22 Pro forma $ 15.51 $ 21.30 $ 6.99
q. Reclassification. Certain prior year amounts have been reclassified to conform to the 2004 presentation. r. Reclamation Costs. On January 1, 2003, the Company adopted Statement of Financial Accounting Standards No. 143 (SFAS 143), "Accounting for Asset Retirement Obligations." SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset and amortized over its useful life. In addition, the retirement obligation is discounted and accretion expense is recognized. In this regard, a provision has been established with respect to the Company's World Minerals subsidiary for the present value of estimated future costs of site reclamation relating to final reclamation at each site. The provision is based on engineering estimates of the 45 anticipated method and extent of site reclamation required to meet regulatory requirements. The provision for reclamation costs is subject to review by management on a regular basis and is revised periodically to reflect changes in future estimated costs and/or regulatory requirements. The adoption of SFAS 143 did not have a material impact on the Company's consolidated financial condition or results of operations. s. Recently Adopted Accounting Standards. Effective December 31, 2003, the Company adopted EITF Issue 03-01 (EITF 03-01), "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." EITF 03-01 requires that certain quantitative and qualitative disclosures be made for debt and marketable equity securities classified as available for sale that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. The Company has added the applicable disclosure information in Note 3. During 2004, the Company performed the impairment tests using the fair value approach required by SFAS 142. Based on these tests, there was no impairment to goodwill or intangible asset values during 2004. In November 2004 FASB Statement 151, "Inventory Costs," was issued. The Statement clarifies that abnormal amounts of idle facility expense, freight, handling costs and spoilage should be recognized as current period charges. The Statement requires that the allocation of fixed production overheads to the cost of conversion be based on the normal capacity of the production facilities. Adoption of the Statement is required for inventory costs incurred during fiscal periods beginning after June 15, 2005. The Company's financial statements for all years presented reflect the adoption of the Statement's provisions. In December 2004 FASB Statement 123 (revised), "Share-Based Payment," was issued. The Statement requires that the cost resulting from all share-based payment transactions be recognized in the financial statements, establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires the application of a fair value based measurement method in accounting for share-based payment transactions with employees. The Statement is effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. The Company's present method of accounting for share-based payments is described in Note 1.p. Stock Option Plans. The proforma effects of adoption of the Statement are also described in Note 1.p. The Company plans to adopt the Statement in the third quarter of 2005. t. Statutory Accounting Practices. The Company's insurance subsidiaries, domiciled principally in the States of New Hampshire, Delaware, Wisconsin, Nebraska and Oklahoma, prepare statutory financial statements in accordance with the accounting practices prescribed or permitted by the insurance departments of the states of domicile. Prescribed statutory accounting practices are those practices that are incorporated directly or by reference in state laws, regulations, and general administrative rules applicable to all insurance enterprises domiciled in a particular state. Permitted statutory accounting practices include practices not prescribed by the domiciliary state, but allowed by the domiciliary state regulatory authority. The impact of any permitted accounting practices on statutory surplus of the Company is not material. 46 u. Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of. Statement of Financial Accounting Standards No. 144 (SFAS 144), "Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of," provides a single accounting model for long-lived assets to be disposed of. SFAS 144 also changes the criteria for classifying an asset as held for sale, broadens the scope of businesses to be disposed of that qualify for reporting as discontinued operations and changes the timing of recognizing losses on such operations. The Company adopted SFAS 144 on January 1, 2002. As a result of the Company's analysis, certain assets were written down by $0.9 million in 2004, $0.9 million in 2003 and $1.2 million in 2002 to their fair value. v. Correction of Error. The Consolidated Balance Sheet at December 31, 2003 has been restated to reflect the correction of an accounting error made at one of the Company's insurance operations. The asset and liability accounts affected by the correction, the amount previously reported, the amount of the correction and the restated amount are as follows:
Amount Previously Amount of December 31, 2003 Reported Correction Restated Amount ----------------- ---------- ----------------- (in millions) Assets Reinsurance recoverables $ 190.8 $(16.7) $ 174.1 Ceded unearned premium reserves $ 264.0 (32.8) $ 231.2 ------ Total assets $3,568.0 $(49.5) $3,518.5 -------- ------ -------- Liabilities Losses and loss adjustment expenses $ 454.7 $(16.7) $ 438.0 Unearned premiums $ 676.9 (32.8) $ 644.1 ------ Total liabilities $2,005.2 $(49.5) $1,955.7 -------- ====== --------
The correction recorded in the 2004 third quarter was identified by management during a financial statement review and relates to certain inter-company reinsurance balances that had not been eliminated on the Consolidated Balance Sheet. The correction had no impact on the Consolidated Statements of Earnings or stockholders' equity. The Consolidated Statements of Cash Flow have been adjusted for the correction. There was no impact on cash flows from operating activities, investing activities or financing activities. 2. Sale of H&T In December 2004, the Company entered into an agreement to sell H&T. The sale closed on December 31, 2004. The Company has classified the operation as a "discontinued operation" in its financial statements for all periods presented. Under the terms of the transaction, Alleghany received consideration of approximately $54 million in cash, subject to adjustment based upon net book value at closing. The sale generated a pre-tax loss on disposal of $1.95 million and a $1.2 million loss after taxes. The loss on sale is included in discontinued operations in 2004. Historical information relating to the discontinued operation is as follows (in thousands): 47
2003 ------- Assets Cash $ 654 Accounts receivable, net 13,111 Inventory 49,448 Property and equipment at cost, net 3,611 Goodwill 6,144 Deferred tax assets 10,967 Other assets 4,089 ------- $88,024 ======= Liabilities and Stockholder's Equity Bank debt $18,052 Other liabilities 17,796 Deferred tax liabilities 440 ------- 36,288 Common stockholder's equity 51,736 ------- $88,024 =======
The balance sheet accounts shown above are before an inter-company elimination of $2,871 for deferred taxes made in the preparation of the Company's 2003 Consolidated Balance Sheet. The results of operations for each of the three years ending in 2004 are shown below:
2004 2003 2002 -------- -------- -------- Revenues Net fastener sales $158,244 $113,277 $110,408 -------- -------- -------- Costs and Expenses Salaries, administration and other expenses 35,711 29,259 25,051 Cost of goods sold-- fasteners 120,920 88,163 82,162 Interest expense 696 788 759 -------- -------- -------- Total costs and expenses 157,327 118,210 107,972 -------- -------- -------- Earnings (loss) 917 (4,933) 2,436 Income taxes (benefit) (34) 1,123 1,008 -------- -------- -------- Net earnings (loss) from discontinued operations $ 951 $ (3,810) $ 1,428 ======== ======== ========
3. Investments Available for sale securities at December 31, 2004 and 2003 are summarized as follows (in thousands): 48 2004
Amortized Gross Gross Cost Unrealized Unrealized Fair Consolidated or Cost Gains Losses Value - ---------------------- ---------- ---------- ---------- ---------- Equity securities $ 290,057 $355,250 $ (663) $ 645,184 Debt securities 1,178,982 6,688 (6,460) 1,179,210 Short-term investments 378,452 -- -- 378,452 ---------- -------- ------- ---------- $1,848,031 $361,938 $(7,123) $2,202,846 ========== ======== ======= ========== INDUSTRY SEGMENT AIHL insurance group $1,604,445 $ 55,928 $(7,123) $1,653,250 World Minerals 4,061 -- -- 4,061 Corporate activities 239,525 306,010 -- 545,535 ---------- -------- ------- ---------- $1,848,031 $361,938 $(7,123) $2,202,846 ========== ======== ======= ==========
2003
Amortized Gross Gross Cost Unrealized Unrealized Fair CONSOLIDATED or Cost Gains Losses Value - ---------------------- ---------- ---------- ---------- ---------- Equity securities $ 370,982 $249,785 $ (13) $ 620,754 Debt securities 910,307 9,808 (2,845) 917,270 Short-term investments 135,079 -- -- 135,079 ---------- -------- ------- ---------- $1,416,368 $259,593 $(2,858) $1,673,103 ========== ======== ======= ========== INDUSTRY SEGMENT AIHL insurance group $1,186,052 $ 87,983 $(2,845) $1,271,190 Mining and filtration 1,234 -- -- 1,234 Corporate activities 229,082 171,610 (13) 400,679 ---------- -------- ------- ---------- $1,416,368 $259,593 $(2,858) $1,673,103 ========== ======== ======= ==========
The amortized cost and estimated fair value of debt securities at December 31, 2004 by contractual maturity are shown below (in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Debt securities due after ten years include $152.7 million of securities, at amortized cost and fair value, that are redeemable at par within one year.
Amortized Cost Fair Value -------------- ---------- Short-term investments due in one year or less $ 378,452 $ 378,452 ---------- ---------- Mortgage-backed securities 237,883 237,799 ---------- ---------- Debt securities due within one year 99,003 98,787 due one through five years 394,970 393,478 due five through ten years 214,680 215,615 due after ten years 232,446 233,531 ---------- ---------- Equity securities 290,597 645,184 ---------- ---------- $1,848,031 $2,202,846 ========== ==========
The proceeds from sales of available-for-sale securities were $940.4 million, $756.5 million, and $503.7 million in 2004, 2003, and 2002, respectively. Gross realized gains and gross realized losses of available-for-sale securities were $ 90.8 million and 49 $3.9 million, $159.4 million and $7.5 million, and $48.1 million and $11.7 million in 2004, 2003, and 2002, respectively. Interest, dividend and other income is comprised as follows (in thousands):
2004 2003 2002 ------- ------- ------- Interest income $41,462 $22,549 $24,691 Dividend income 10,387 14,522 10,944 Other income 11,204 18,993 17,429 ------- ------- ------- $63,053 $56,064 $53,064 ======= ======= =======
During 2004, 2003, and 2002, Alleghany had available-for-sale securities that were trading below cost. The Company determined that these declines were other-than-temporary and, accordingly, recorded a loss provision of approximately $0.3 million, $0.4 million, and $1.5 million, respectively, for these investments. An investment in a debt or equity security is impaired if its fair value falls below its book value and the decline is considered to be other than temporary. Factors considered in determining whether a decline is other-than-temporary include the duration of time and the magnitude to which fair value has been below cost; the financial condition and near-term prospects of the issuer; extraordinary events including negative news releases and rating agency downgrades; and the Company's ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery. A debt security is impaired if it is probable that the Company will not be able to collect all amounts due under the security's contractual terms. Equity investments are impaired when it becomes apparent that the Company will not recover its cost over the expected holding period. Further, for securities expected to be sold, an other-than-temporary impairment charge is recognized if the Company does not expect the fair value of a security to recover the cost prior to the expected date of sale. The gross unrealized investment losses and related fair value for fixed maturities and equity securities at December 31, 2004 were as follows:
Gross Fair unrealized value loss -------- ---------- Fixed maturities US GOVERNMENT OBLIGATIONS Less than 6 months $ 37,556 $ 319 More than 6 months $ 41,088 $ 598 MORTGAGE-BACKED SECURITIES Less than 6 months $ 21,729 $ 78 More than 6 months $ 84,806 $1,093 STATE, MUNICIPALS AND POLITICAL SUBDIVISIONS Less than 6 months $ 50,964 $ 158 More than 6 months $197,942 $2,456 CORPORATE BONDS AND OTHER Less than 6 months $102,669 $ 707 More than 6 months $ 63,250 $1,051 -------- ------ TOTAL DEBT SECURITIES Less than 6 months $212,918 $1,262 More than 6 months $387,086 $5,198 -------- ------
50 EQUITY SECURITIES Less than 6 months $ 1,180 $ 45 More than 6 months $ 9,221 $ 618 -------- ------ TOTAL TEMPORARILY IMPAIRED SECURITIES Less than 6 months $214,098 $1,307 More than 6 months $396,307 $5,816 -------- ------ Total $610,405 $7,123 ======== ======
4. Notes Receivable Notes receivable are primarily comprised of a $91.5 million note due January 2007 bearing interest at a rate equal to the 30-day commercial paper rate plus 0.0625 percent. At December 31, 2004 such rate was 2.32 percent. 5. Inventory Inventories at December 31, 2004 and 2003 are summarized as follows (in thousands):
2004 2003 ------- ------- Finished goods $20,580 $16,489 Work in process 5,941 5,509 Raw material 15,000 13,166 ------- ------- $41,521 $35,164 ======= =======
6. Reinsurance In the ordinary course of business, AIHL cedes reinsurance for purposes of risk diversification and limiting maximum loss exposure to catastrophic events. If the assuming reinsurers are unable to meet the obligations assumed under these agreements, AIHL would remain liable. Reinsurance recoverables at December 31, 2004, 2003 and 2002 consist of the following (in thousands):
2004 2003 2002 -------- -------- -------- Reinsurance recoverables on paid losses $ 31,908 $ 12,067 $ 2,713 Ceded outstanding losses and loss adjustment expenses 591,417 162,032 144,766 -------- -------- -------- Reinsurance recoverables $623,325 $174,099 $147,479 ======== ======== ========
The largest concentration of reinsurance recoverables at December 31, 2004 was due from Swiss Re for $86.1 million, or 13.8% of the total. A.M. Best rates Swiss Re A+ for its financial strength. In addition, AIHL has a recoverable from Employers Re of $74.6 million, or 12% of the total. A.M. Best rates Employers Re A for its financial strength. Approximately 96.0% of AIHL's reinsurance recoverables are with reinsurers with an A.M. Best rating of A or higher for their financial strength. AIHL had no allowance for uncollectible reinsurance as of December 31, 2004. In connection with the acquisitions of Platte River and Landmark, the sellers contractually retained all of the loss and loss adjustment expense liabilities. These contractual provisions constituted loss reserve guarantees as contemplated under Emerging Issues Task Force ("EITF") D-54. "Accounting by the Purchasers for a 51 Seller's Guaranty of the Adequacy of Liabilities for Losses and Loss Adjustment Expenses of an Insurance Enterprise Acquired in a Purchase Business Combination." The relevant terms of these conditions are described below. On January 3, 2002, Alleghany acquired Platte River from Swiss Reinsurance American Corporation ("Swiss Re") pursuant to a Stock Purchase Agreement dated as of December 5, 2001, and transferred Platte River to AIHL pursuant to a Contribution Agreement dated January 3, 2002. The Stock Purchase Agreement provides that Swiss Re shall indemnify and hold harmless Alleghany, AIHL and Platte River and their respective directors, officers and employees from and against any and all liabilities arising out of binders, policies and contracts of insurance issued by Platte River to the date of closing under the Stock Purchase Agreement. AIHL recorded a reinsurance recoverables and a corresponding loss reserve liability in the amount of $181.3 million at the time it acquired Platte River. Such reinsurance recoverables and loss reserve liability may change as losses are reported. Such amounts were $72.0 million, $92.0 million, and $142.5 million for Platte River at December 31, 2004, 2003, and 2002, respectively. On September 2, 2003, RIC acquired Landmark from Guaranty National Insurance Company ("Guaranty National") pursuant to a Stock Purchase Agreement dated as of June 6, 2003. In contemplation of the sale of Landmark to RIC, Landmark and Royal Indemnity Company, an affiliate of Guaranty National ("Royal Indemnity"), entered into a 100% Quota Share Reinsurance Agreement and an Assumption of Liabilities Agreement, each dated as of September 2, 2003. Pursuant to these two agreements Royal Indemnity assumed all of Landmark's liabilities of any nature arising out of or relating to all policies, binders, and contracts of insurance issued in Landmark's name prior to the closing under the Stock Purchase Agreement, and all other liabilities of Landmark. The reinsurance recoverable and loss reserve liability recorded was $37.3 million at December 31, 2003. Such amount has decreased to $23.7 million at December 31, 2004. The following table indicates property and casualty premiums written and earned for the years ended December 31, 2004, 2003 and 2002 (in thousands):
2004 Written Earned - ---- ---------- ---------- Premiums direct $1,506,161 $1,291,242 Premiums assumed $ (7,863) $ 99,993 Premiums ceded $ 641,103 $ 585,818 ========== ==========
2003 Written Earned - ---- -------- -------- Premiums direct $742,436 $262,045 Premiums assumed $375,768 $264,168 Premiums ceded $335,729 $ 95,299 ======== ========
2002 Written Earned - ---- -------- -------- Premiums direct $145,497 $140,340 Premiums assumed $ 3,009 $ 2,025 Premiums ceded $ 16,982 $ 16,716 ======== ========
The 2003 premiums attributable to reinsurance assumed are due to arrangements established in connection with two acquisitions made by AIHL, where the sellers issued policies at the request of the acquired company and the acquired company reinsured the risk of the seller under those policies net of certain reinsurance. 52 Written premiums assumed were $375.8 million in 2003. Of this amount, about $374.7 arose in connection with AIHL's acquisition on July 1, 2003 of Resurgens Specialty, a wholesale underwriting agency, from a subsidiary of R&SA. Resurgens Specialty became a subsidiary of RSUI, and on June 30, 2003, RSUI acquired RIC to issue the insurance policies underwritten by Resurgens Specialty. At the time of its acquisition by RSUI, RIC was licensed in several states but was not licensed in all states in which Resurgens Specialty operated, and it was anticipated that it would take several months for RIC to obtain licenses in all of such states. Consequently, and in connection with the acquisition of Resurgens Specialty, RSA agreed to provide policy issuing services to RIC through June 2004 to cover this regulatory transition period. Thus, in a typical transaction in a state in which RIC was not yet licensed, Resurgens Specialty, as the underwriting agency, would underwrite the coverage, and one of R&SA's carriers would issue the policy to the insured. RIC then assumed the obligations of the R&SA carrier under the policy. RIC ceased using this R&SA policy issuing arrangement in the fourth quarter of 2003. AIHL's operating units reinsure a portion of the risks they underwrite in order to control their exposure to losses, manage capacity, stabilize earnings and protect capital resources. RSUI uses reinsurance on an extensive basis in order to build stable capacity and to provide protection against the accumulation of catastrophe risk. In 2004, RSUI ceded 48.5 percent of its gross premiums written to reinsurers. While the net amount of loss exposure retained by RSUI varies by line of business, as of December 31, 2004, RSUI retained a maximum net exposure for any single property or casualty risk of $7.5 million, with the exception of losses arising from acts of foreign terrorism. To protect against multiple losses due to catastrophes, RSUI maintains excess of loss reinsurance coverage in an amount estimated to be its loss exposure from a one-in-250 year catastrophic event. On a monthly basis, RSUI models estimated losses from a 250-year event and the modeled exposure estimates are used to structure various quota share reinsurance and catastrophe excess of loss reinsurance covers to protect RSUI's surplus from unexpected catastrophic events. In addition, RSUI uses facultative reinsurance in instances when RSUI wants greater coverage than provided by its treaties. Capitol Transamerica uses reinsurance to protect against severity losses. In the first eleven months of 2004, Capitol Transamerica reinsured individual property and casualty and contract surety risks in excess of $1.25 million with various reinsurers. The commercial surety line was reinsured for individual losses above $1.0 million with a 16.0 percent quota share reinsurance agreement. The quota share reinsurance agreement had a sliding scale ceded commission based upon the loss ratio of the commercial surety business. On December 1, 2004, Capitol Transamerica renegotiated its reinsurance treaties, lowering the overall cost for such treaties by increasing Capitol Transamerica's retention. For the property and casualty and contract surety treaties, the net retention was raised to $1.5 million and on the commercial surety treaty, the retention was raised to $1.25 million. The commercial surety quota share treaty was also eliminated. Through December, 31, 2004, business underwritten by Darwin was generally reinsured on a treaty basis for individual losses in excess of $3.0 million for directors and officers liability and managed care errors and omissions liability. Darwin reinsures on a treaty basis for individual losses in excess of $0.5 million for medical professional liability insurance for physicians, and in excess of $1.0 million (with a 15.0 percent participation on losses in excess of $2.0 million) for medical professional liability for medical facilities. The medical professional liability program also provides $2.0 million 53 of "clash" protection (offering protection in the event that multiple policies written by Darwin are involved in the same loss occurrence) for losses in excess of $1.0 million. In addition, Darwin reinsures on a 50 percent quota share basis for individual psychiatrists professional liability. Certain of these reinsurance treaties contain swing-rated premiums that will vary, within a range, depending upon the profitability of the underlying premium subject to the treaty. In addition, Darwin obtains facultative reinsurance for certain business. Ceded loss recoveries for AIHL included in the Consolidated Statement of Earnings are approximately $567.1 million, $107.2 million and $8.6 million for the three years ended December 31, 2004. 7. Liability for Loss and Loss Adjustment Expenses Activity in liability for losses and loss adjustment expenses in 2004, 2003 and 2002 is summarized as follows (in thousands):
2004 2003 2002 ---------- -------- -------- Balance at January 1 $ 437,994 $258,471 $ -- Reserves acquired -- 14,573 266,688 Less reinsurance recoverables 162,032 159,766 179,512 ---------- -------- -------- Net balance 275,962 113,278 87,176 Incurred related to: Current year 547,868 229,519 82,639 Prior years (7,299) 20,683 17,869 ========== ======== ======== Total incurred 540,569 250,202 100,508 ---------- -------- -------- Paid related to: Current year 103,033 40,122 28,562 Prior years 72,578 47,396 45,417 ---------- -------- -------- Total paid 175,611 87,518 73,979 ---------- -------- -------- Net balance at December 31 640,920 275,962 113,705 Plus reinsurance recoverables 591,417 162,032 144,766 ---------- -------- -------- Balance at December 31 $1,232,337 $437,994 $258,471 ========== ======== ========
The increase in liability for loss and loss adjustment expenses in 2004 from 2003 reflects the first full year of operations of Resurgens Specialty, RIC, Landmark and Darwin and the losses incurred in connection with the 2004 third quarter hurricanes. Of the $1,232.3 million in liability for loss and loss adjustment expenses as of December 31, 2004, losses in property lines accounted for $449.7 million, or 36.5% (of which $341.8 million, or 27.7%, resulted from the 2004 third quarter hurricane activity); losses in casualty lines (including primarily excess and umbrella liability, directors and officers liability, professional liability and general liability) accounted for $563.2 million, or 45.7%; and losses from discontinued lines of business and losses contractually retained by the sellers of Platte River and Landmark pursuant to loss reserve guarantees accounted for $121.0 million, or 9.8%. During 2004, the losses covered by loss reserve guarantees decreased by $33.5 million as a result of claims settlements. The approximate $7.3 million of net favorable loss development during 2004 reflects a decrease of approximately $18.1 million in RSUI property loss reserves due to better than expected loss emergence in the 2003 accident year offset by $10.9 million of prior year loss reserve strengthening by Capitol Transamerica primarily due to higher than expected 54 claims emergence related to commercial multiple peril lines, principally construction defect claims. The increase in liability for losses and loss adjustment expenses in 2003 from 2002 is primarily due to the expansion of the insurance operations of AIHL during the year through the acquisition of Resurgens Specialty, RIC and Landmark and the formation of Darwin. Of the $438.0 million in liability for losses and loss adjustment expenses as of December 31, 2003, losses in property lines accounted for $58.0 million, or 13.2%; losses in casualty lines accounted for $136.3 million, or 31.1%; and losses from discontinued lines of business and losses contractually retained by the sellers of Platte River and Landmark pursuant to loss guarantees accounted for $156.0 million, or 35.6%. During 2003, there was a net adverse loss reserve development of $20.7 million primarily due to the strengthening of Capitol Transamerica's reserves in respect of assumed reinsurance treaty business written by one of its subsidiaries between 1969 and 1976. Such reserves primarily related to asbestos and environmental exposures. During 2002 and 2003, Capitol Transamerica experienced an increase in paid losses on this assumed reinsurance, which was initially attributed to the implementation of a more aggressive settlement policy. Upon completion in December 2003 of an actuarial study, management determined that the increase in paid losses reflected developments in the underlying claims environment, particularly with respect to asbestos related claims and, accordingly, Capitol Transamerica strengthened its reserves related to such assumed reinsurance coverages in the amount of $18.3 million. The liability for loss and loss adjustment expenses at 2002 year-end reflects the business of Capitol Transamerica and Platte River, both of which were acquired in January of that year. This liability includes losses contractually retained by the seller of Platte River pursuant to loss reserve guarantees of $142.5 million, or 55.1% of the total liability of $258.5 million as of December 31, 2002. During 2002, there was a net adverse loss reserve development of $17.9 million due to the strengthening of Capitol Transamerica's reserves as a result of the implementation of a change in reserving methodology after the acquisition of Capitol Transamerica and to cover adverse development in fidelity and surety lines of business for 2001 and prior years. 8. Debt Total debt at December 31, 2004 and 2003 is summarized as follows (in thousands):
2004 2003 ------ ------- SHORT-TERM DEBT API Senior notes at 6.83%, due through 2004 $ -- $ 8,000 World Minerals Bank of China term loan at 5.84% due 2005 2,355 2,356 Other loans due through 2005 1,579 93 Industrial & Commercial Bank of China term loan at 6.58% due 2005 1,136 1,262 ------ ------- 5,070 11,711 ====== =======
55
2004 2003 -------- -------- LONG-TERM DEBT Alleghany Funding Notes payable at 2.1% to 2.8% due 2007 80,000 80,000 World Minerals Revolving credit line at LIBOR + 1.5% to 2.0% due through 2007 52,000 56,000 Other loans at 3.0% to 7.0%, due through 2011 1,188 1,287 -------- -------- 133,188 137,287 -------- -------- $138,258 $148,998 ======== ========
On December 11, 1998, API issued $40 million of 6.83 percent senior notes due through 2004. The notes were repaid in five equal annual principal amortization payments. In March 1999, World Minerals entered into a credit agreement with several banks which, as amended, provided for a commitment for revolving credit loans and/or letters of credit in an aggregate principal amount of $120 million. Such credit agreement matured in March 2003 and was replaced by a new credit agreement providing $100 million of credit. As of December 31, 2004, $52.0 million of long-term indebtedness was outstanding under World Minerals' credit facility. World Minerals also had $0.5 million of letters of credit outstanding at December 31, 2004. The aggregate available long-term borrowing and letter of credit amount was $47.5 million as of December 31, 2004. Alleghany Funding's notes of $80 million are primarily secured by a $91.5 million installment note receivable. Alleghany Funding has entered into a related interest rate swap agreement with a notional amount of $86.2 million for the purpose of matching interest expense with interest income. This swap is pay variable, receive variable. Alleghany Funding pays a variable rate equal to the one month commercial paper rate plus 0.0625 percent and receives a variable rate equal to the three month LIBOR rate plus 0.375 percent. The swap matures on January 22, 2007. Alleghany Funding is exposed to credit risk in the unlikely event of nonperformance by the swap counter-party. The Company monitors the credit rating of the swap counter-party. Upon cancellation in June 2002 of its five-year and 364-day revolving credit agreements with a bank, Alleghany entered into three-year and 364-day revolving credit agreements with a bank syndicate which provided commitments for revolving credit loans in an aggregate principal amount of $200.0 million. In June 2003, the 364-day revolving credit agreement was amended and renewed and the three-year credit agreement was renewed. In June 2004, the 364-day revolving credit facility expired and was not renewed. In July 2004, the three-year revolving credit facility was cancelled and replaced by a new three-year revolving credit facility in the amount of $200.0 million. At Alleghany's option, borrowings under the revolving credit agreement bear interest at a rate based on the prevailing rates for dollar deposits in the London interbank market or the greater of the federal funds rate and the administrative agent bank's prime rate plus applicable margins. No amounts were outstanding at 2004 and 2003 year end. A commitment fee of 1/4 of 1 percent per annum of the unused commitment is charged. The revolving credit agreement requires Alleghany, among other things, to maintain tangible net worth of not less than $1.13 billion, limit the amount of certain other indebtedness, and maintain certain levels of unrestricted liquid assets. Such agreement also contains restrictions with respect to mortgaging or pledging any of Alleghany's assets and the consolidation or merger with any other corporation. At 56 December 31, 2004, the Company was in full compliance with these requirements and restrictions. Regarding the Company's interest rate swaps, the impact of Alleghany's hedging activities has been to increase (decrease) its weighted average borrowing rates by 0.05 percent, (0.7) percent, and (4.3) percent, and to increase (decrease) reported interest expense by $0.1 million, $(0.5) million, and $(2.1) million for the years ended 2004, 2003 and 2002, respectively. Scheduled aggregate annual maturities of debt for each of the next five years and thereafter are as follows (in thousands): 2005 $ 5,232 2006 172 2007 132,182 2008 193 2009 205 Thereafter 274 -------- $138,258 ========
9. Income Taxes Income tax expense (benefit) from continuing operations consists of the following (in thousands):
Federal State Foreign Total -------- ------- ------- -------- 2004 Current $ 59,819 $ 4,879 $ 8,828 $ 73,527 Deferred (20,978) 447 (817) (21,348) -------- ------- ------- -------- $ 38,841 $ 5,326 $ 8,012 $ 52,179 ======== ======= ======= ======== 2003 Current $ 78,983 $(3,047) $10,730 $ 86,666 Deferred (5,711) (1,542) (301) (7,554) -------- ------- ------- -------- $ 73,272 $(4,589) $10,429 $ 79,112 ======== ======= ======= ======== 2002 Current $(18,079) $(3,573) $ 9,259 $(12,393) Deferred 12,647 1,594 (263) 13,978 -------- ------- ------- -------- $ (5,432) $(1,979) $ 8,996 $ 1,585 ======== ======= ======= ========
Earnings from continuing operations, before income taxes, include $23.5 million, $25.6 million, and $23.0 million from foreign operations in 2004, 2003 and 2002, respectively. The difference between the federal income tax rate and the effective income tax rate on continuing operations is as follows:
2004 2003 2002 ---- ---- ----- Federal income tax rate 35.0% 35.0% 35.0% Income subject to dividends-received deduction (1.4) (1.2) (4.5) Tax-exempt interest (2.4) -- -- State taxes, net of federal tax benefit 2.0 (1.3) (2.0) Adjustment of estimated tax liabilities -- -- (28.6) Other, net (2.5) (0.4) 3.0 ---- ---- ----- 30.7% 32.1% 2.9% ==== ==== =====
57 The 2002 adjustment of estimated tax liabilities reduced the effective tax rate by 28.6%. The components were approximately $15 million due to adjustment of the estimated tax basis of Underwriters Re Group to actual tax basis and $3 million due to adjustment of state income taxes on the sale of Alleghany Asset Management. The adjustments were identified following a reconciliation of the 2000 and 2001 tax returns to Alleghany's tax accounts in September 2002 and reported in that quarter. The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2004 and 2003 are as follows (in thousands):
2004 2003 --------- --------- DEFERRED TAX ASSETS Net operating loss carry forward and foreign tax credit $ 11,771 $ 6,028 Reserves for impaired assets 1,347 2,183 Expenses deducted for tax purposes when paid 354 3,113 Securities valuation 441 507 Property and casualty loss reserves 25,160 12,539 Unearned premium reserves 33,670 29,250 Performance shares 9,069 5,817 Compensation accruals 24,433 13,116 Other 9,755 6,581 --------- --------- Deferred tax assets 116,000 79,134 --------- --------- Valuation allowance (11,437) (1,494) --------- --------- Total deferred tax asset $ 104,563 $ 77,640 ========= ========= DEFERRED TAX LIABILITIES Unrealized gain on investments $ 126,128 $ 90,215 Tax over book depreciation 21,239 26,207 Deferred income on installment note 31,974 31,974 Burlington Northern redemption 11,311 11,311 Deferred acquisition costs 27,530 19,095 Purchase accounting adjustments 6,958 7,490 Other (293) 4,110 --------- --------- Total deferred tax liabilities 224,847 190,402 --------- --------- Net deferred tax liability $(120,284) $(112,762) ========= =========
A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. In the opinion of the Company's management, realization of the recognized deferred tax asset of $104,563 is more likely than not based on expectations as to the Company's future taxable income. The American Jobs Creation Act of 2004 introduced a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer provided that certain criteria are met. These provisions apply to World Minerals which has the only foreign subsidiaries in the Company group. Management has begun its 58 evaluation of the potential effects of the repatriation provision and expects to complete this evaluation in the fourth quarter of 2005. Since no decisions have yet been made, there have been no effects on income tax expense or benefit. The range of reasonably possible amounts of unremitted earnings that is being considered for repatriation as a result of the repatriation provision is $13.2 million to $40.8 million, and the related potential range of income tax effects of such repatriation is from $0.7 million to $2.1 million. Pro forma financial data for any effect of the repatriation provision is not available since the Company did not decide on a plan for reinvestment or repatriation prior to the issuance of its financial statements. 10. Stockholders' Equity The total number of shares of all classes of capital stock which Alleghany has authority to issue is 30,000,000, of which 8,000,000 shares are preferred stock, par value of $1.00, and 22,000,000 shares are common stock, par value of $1.00. At December 31, 2004, $192.5 million of World Minerals stockholders' equity was restricted as to dividend payments to Alleghany by a borrowing agreement. AIHL's insurance subsidiaries are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid without prior approval of insurance regulatory authorities. In 2004, a maximum amount of $64.7 million and $1.0 million will be available without prior approval of the New Hampshire and Wisconsin insurance departments, respectively. Additionally, payments of dividends (other than stock dividends) by Alleghany to its stockholders are limited by the terms of its revolving credit facility which provide that Alleghany can pay dividends up to the sum of cumulative net earnings after December 31, 2003, proceeds from the issuance of stock after December 31, 2003, and $50.0 million, provided that Alleghany maintains certain financial ratios as defined in the agreement. At December 31, 2004, approximately $169.5 million of common stockholders' equity was available for dividends by Alleghany to its stockholders. Alleghany provides, through its 1993 Long-Term Incentive Plan (under which awards were granted through 2001 year-end) and its 2002 Long-Term Incentive Plan, incentive compensation of the types commonly known as restricted stock, stock options, stock appreciation rights, performance shares, performance units and phantom stock, as well as other types of incentive compensation. Awards may include, but are not limited to, cash and/or shares of Alleghany's common stock, rights to receive cash and/or shares of common stock and options to purchase shares of common stock including options intended to qualify as incentive stock options under the Internal Revenue Code and options not intended to so qualify. The number of performance shares awarded under the incentive plans to current employees of the Company were 28,994, 30,766, 26,906 and for the four-year award periods beginning in 2004, 2003 and 2002, respectively (as adjusted for stock dividends). Under the incentive plans, participants are entitled, at the end of a four-year award period, to a maximum amount equal to the value of one and one-half shares of Alleghany's common stock for each performance share issued to them based on market value on the payment date and normally payable half in cash and half in common stock, provided defined levels of performance are achieved. As of December 31, 2004 (for all award periods through the award period ending December 31, 2004), 133,155 performance shares were outstanding. Expense is recognized over the performance period on a pro rata basis. 59 Alleghany also provided, through its Amended and Restated Directors' Stock Option Plan (under which options were granted through May 1999) and its 2000 Directors' Stock Option Plan (which terminated on December 31, 2004), for the automatic grant of non-qualified stock options to purchase 1,000 shares of common stock in each year after 1987 to each non-employee director. Options to purchase 7,000 shares at the then fair market value of $265.00 were granted in 2004. At December 31, 2004, 86,469 options were outstanding, of which 72,281 options were vested at an average option price of $148.78. No options were granted to subsidiary directors in 2004. At December 31, 2004, 7,752 options issued to subsidiary directors were outstanding and fully vested at an average option price of $189.28. Compensation cost that has been charged against income for the Company's incentive and stock-based plans was $16.7 million, $7.7 million, and $0.2 million in 2004, 2003 and 2002, respectively. In October 1997, options outstanding under the 1993 Stock Option Plan of Underwriters Re Group were exchanged for Alleghany options under the Underwriters Re Group 1997 Stock Option Plan, which is still in effect. No options were issued in 2004. At December 31, 2004, options to purchase 15,707 shares were outstanding and vested at an average option price of $113.75. The Board of Directors has authorized the purchase from time to time of shares of common stock for the treasury. During 2004 no shares were repurchased by Alleghany. In 2003 and 2002, Alleghany repurchased 1,326 and 155,613 shares of its common stock at a cost of $0.3 million and $28.7 million, respectively. Statutory net income of the Company's insurance subsidiaries was $99.5 million and $9.8 million for the years ended December 31, 2004 and 2003, respectively. Statutory capital and surplus of the Company's insurance subsidiaries was $854.0 million and $737.0 million at December 31, 2004 and 2003, respectively. 11. Fixed Option Plans A summary of the status of the Company's fixed option plans as of December 31, 2004, 2003 and 2002 and changes during the years ending on those dates is presented as follows: 60
2004 2003 2002 WEIGHTED Weighted Weighted AVERAGE Average Average SHARES GRANT Shares Grant Shares Grant (000) PRICE (000) Price (000) Price ------ -------- ------ -------- ------ -------- FIXED OPTIONS Outstanding, beginning 126 $ 138 214 $ 105 245 $ 100 Granted 7 265 7 167 7 180 Exercised (23) (86) (95) (67) (37) 90 Forfeited -- -- -- -- (1) 210 --- ------ --- ------ --- ------ Outstanding, ending 110 $ 156 126 $ 138 214 $ 105 === ====== === ====== === ====== Options exercisable at year end 96 -- 111 -- 197 -- --- ------ --- ----- --- ------ Weighted-average fair value of options granted during the year -- $92.59 -- $57.40 -- $60.03 === ====== === ====== === ======
OPTIONS OUTSTANDING
WEIGHTED AVERAGE NUMBER OUTSTANDING Remaining Weighted AT 12/31/04 Contractual Average (000) Life(years) Exercise Price ----------- ----------- -------------- Range of Exercise Prices $80 to $265 110 4.2 $156 === === ====
OPTIONS EXERCISABLE
NUMBER (000) Exercise Price ------ -------------- Range of Exercise Prices $80 to $265 96 $146 == ====
12. Employee Benefit Plans The Company has several noncontributory defined benefit pension plans including plans in place at World Minerals. The defined benefits are based on years of service and the employee's average annual base salary over a consecutive three-year period during the last ten years of employment plus one half of the highest average annual bonus over a consecutive five-year period during the last ten years of employment. The Company's funding policy is to contribute annually the amount necessary to satisfy the Internal Revenue Service's funding requirements. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. During 2004, the parent company executive plan was amended and changed from a funded to an unfunded plan. Such amendment resulted in the distribution of all accrued benefits to vested participants. 61 The following tables set forth the defined benefit plans' funded status at December 31, 2004 and 2003 and total cost for each of the three years ended December 31, 2004 (in millions, except percentages):
2004 2003 ------ ------ CHANGE IN PROJECTED BENEFIT OBLIGATIONS Projected benefit obligation at beginning of year $ 73.7 $ 60.9 Additional projected benefit obligation for non-U.S. plans $ 4.0 $ -- Service cost 3.5 3.3 Interest cost 4.6 4.1 Plan amendments 0.6 1.8 Actuarial loss 6.8 6.9 Benefits paid (9.2) (3.3) Curtailments (0.6) -- Currency adjustment 0.3 -- ------ ------ Projected benefit obligation at end of year $ 83.7 $ 73.7 ------ ------ Accumulated benefit obligation at end of year $ 70.8 $ 63.8 ====== ====== CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of year $ 51.2 $ 40.7 Additional assets for non-U.S. plans 3.0 -- Actual return on plan assets, net of expenses 4.1 6.9 Company contributions 5.6 6.9 Benefits paid (9.2) (3.3) Currency adjustment 0.1 -- ------ ------ Fair value of plan assets at end of year $ 54.8 $ 51.2 ====== ====== Funded status $(28.8) $(22.5) Unrecognized net actuarial loss 16.6 12.6 Unrecognized prior service cost 4.1 5.4 ------ ------ Net amount recognized (8.1) $ (4.5) ====== ====== AMOUNTS RECOGNIZED IN STATEMENT OF FINANCIAL POSITION CONSISTS OF: Prepaid benefit cost $ 1.1 $ 1.2 Accrued benefit liability $(18.7) $(14.3) Intangible asset 2.3 2.5 Accumulated other comprehensive income 7.2 6.1 ------ ------ Net amount recognized $ (8.1) $ (4.5) ====== ====== Increase in minimum liability included in other comprehensive income $ 1.1 $ (0.4) ====== ====== WEIGHTED AVERAGE ASSET ALLOCATIONS Equity securities 51% 47% Debt securities 46% 53% Cash accumulation policy 3% -- ------ ------ Total 100% 100% ====== ======
2004 2003 2002 ----- ----- ----- NET PENSION COST INCLUDED THE FOLLOWING EXPENSE (INCOME) COMPONENTS Service cost-- benefits earned during the year $ 3.5 $ 3.3 $ 2.4 Interest cost on projected benefit obligation 4.6 4.1 3.6 Expected return on plan assets (3.9) (3.1) (3.1) ----- ----- ----- Net amortization and deferral 2.5 2.6 1.7 Net periodic pension cost included in salaries, administration and other operating expenses $ 6.7 $ 6.9 $ 4.6 SFAS .88 settlement charge 1.1 -- -- Other charges 0.9 -- -- ----- ----- ----- Total cost $ 8.7 $ 6.9 $ 4.6 ===== ===== =====
62
2004 2003 2002 -------- ---- --------- ASSUMPTIONS USED IN COMPUTING THE FUNDED STATUS OF THE PLANS ARE AS FOLLOWS Rates for increases in compensation levels 3.5-6% 4-5% 4-5% Range of weighted average discount rates 5.3-8.68% 6.00% 6.50-6.75% Range of expected long-term rates of return 4-9% 4-8% 4-8%
The Company's investment policy with respect to its defined benefit plans is to provide long-term growth combined with a steady income stream. The target allocation of 51 percent in equity security includes 37 percent in a low-cost S&P index fund, 5 percent in an aggressive growth fund of funds and 9 percent in an international fund of funds. The 46 percent for debt securities includes 28 percent in an intermediate bond fund and 18 percent in a stable value, mortgage-backed securities fund. Three percent is invested in a cash accumulation policy with an insurance company. All funds are rebalanced periodically. This mix of investments is intended to provide stability and an income stream sufficient to meet current obligations without the need to sell longer-term investments. The overall long-term, rate-of-return-on-assets assumptions are based on historical investments. Contributions of $4.7 million are expected to be made to the plans during 2005. Estimated Future Benefit Payments The following benefit payments, which reflect expected future service, as appropriate, are expected to be made: 2005 $ 3.8 2006 3.5 2007 4.1 2008 3.8 2009 4.1 2010-2014 26.1 -----
The measurement date used to determine pension and other postretirement benefit plans is December 31, 2004. The Company provides supplemental retirement benefits through deferred compensation programs and profit sharing plans for certain of its officers and employees for which earnings were charged $8.6 million in 2004, $4.6 million in 2003, and $4.1 million in 2002. The Company also provides certain healthcare and life insurance benefits for retired employees. The cost of these benefits is accrued during the period that employees render service. The accrued postretirement benefit obligation was $0.2 million both at December 31, 2004 and 2003. The postretirement healthcare and life insurance costs recognized were $30 thousand, $70 thousand, and $80 thousand for 2004, 2003 and 2002, respectively. 13. Comprehensive Income Comprehensive income requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the 63 accumulated balance of other comprehensive income separately in the equity section of the balance sheet. Accumulated other comprehensive income of the Company consists of unrealized gains on investment securities, foreign exchange translation adjustments and minimum pension liability (in thousands):
Before Tax Net of Tax Tax Expense Amount --------- -------- ---------- 2004 Unrealized gains (losses) arising during year $ 187,159 $(65,506) $ 121,653 Less: reclassification adjustments for gains realized in net income 86,870 (30,405) 56,465 --------- -------- --------- Change in unrealized gain on investments $ 100,289 $(35,101) $ (65,188) ========= ======== ========= 2003 Unrealized gains (losses) arising during year $(152,808) $ 53,483 $ (99,325) Less: reclassification adjustments for gains realized in net income 151,842 (53,145) 98,697 --------- -------- --------- Change in unrealized gain on investments $ (966) $ 338 $ (628) ========= ======== ========= 2002 Unrealized gains (losses) arising during year $(104,658) $ 36,630 $ (68,028) Less: reclassification adjustments for gains realized in net income 36,375 (12,731) 23,644 --------- -------- --------- Change in unrealized gain on investments $ (68,283) $ 23,899 $ (44,384) ========= ======== =========
The components of accumulated other comprehensive income at December 31 are as follows (in thousands):
2004 2003 2002 --------- --------- --------- Unrealized appreciation on investments $ 231,446 $ 166,258 $ 166,886 --------- --------- --------- Minimum pension liability (4,380) (3,683) (3,575) --------- --------- --------- Translation adjustment (3,177) (9,265) (21,944) --------- --------- --------- $ 223,889 $ 153,310 $ 141,367 ========= ========= =========
14. Earnings per share The following is a reconciliation of the income and share data used in the basic and diluted earnings per share computations for the years ended December 31
2004 2003 2002 ---------- ---------- ---------- (in thousands, except share amounts): Income from continuing operations $ 117,948 $ 166,188 $ 53,385 Discontinued operations (252) (3,810) 1,428 ---------- ---------- ---------- Income available to common stockholders for basic earnings per share 117,696 162,378 54,813
64 Effect of dilutive securities 182 245 -- ---------- ---------- ---------- Income available to common stockholders for diluted earnings per share $ 117,878 $ 162,623 $ 54,813 ========== ========== ========== Weighted average shares outstanding applicable to basic earnings per share 7,667,811 7,599,638 7,597,019 Effect of dilutive securities: Options 32,170 39,821 57,558 ---------- ---------- ---------- Adjusted weighted average shares outstanding applicable to diluted earnings per share 7,699,981 7,639,459 7,654,577 ========== ========== ==========
Contingently issuable shares of 51,761, 28,112, and 25,723 were potentially available during 2004, 2003 and 2002, respectively, but were not included in the computations of diluted earnings per share because the impact was anti-dilutive to the earnings per share calculation. 15. Commitments and Contingencies The Company leases certain facilities, furniture and equipment under long-term lease agreements. In addition, certain land, office space and equipment are leased under noncancelable operating leases which expire at various dates through 2016. Rent expense was $9.7 million, $6.6 million and $4.3 million, in 2004, 2003 and 2002, respectively. The aggregate minimum payments under operating leases with initial or remaining terms of more than one year as of December 31, 2004 are $9.7 million, $9.3 million, $8.2 million, $7.4 million, $7.1 million and $12.2 million in 2005, 2006, 2007, 2008, 2009 and thereafter, respectively. Alleghany's subsidiaries are parties to pending litigation and claims in connection with the ordinary course of their businesses. Each such subsidiary makes provisions for estimated losses to be incurred in such litigation and claims, including legal costs. In the opinion of management, based in part on advice of counsel, such provisions are adequate. Talbot Holdings Ltd., the new owners of Alleghany Underwriting, raised new capital in the Lloyd's insurance market. In January 2003, Alleghany agreed to provide a $15.0 million letter of credit to support the business written by a new syndicate of Talbot Holdings Ltd. during 2003 and 2004. Such letter of credit was reduced to $10.0 million in December 2003. The letter of credit was $10.0 million at December 31, 2004. AIHL's reserve for unpaid losses and loss adjustment expenses includes $26.5 million and $28.1 million of gross and net reserves at December 31, 2004 and 2003, respectively, for various liability coverages related to asbestos and environmental impairment claims that arose from reinsurance of certain general liability and commercial multiple-peril coverages assumed by a subsidiary of Capitol Transamerica between 1969 and 1976. This subsidiary exited this business in 1976. Restrictive asbestos and environmental impairment exclusions were introduced in late 1986 on both insurance and reinsurance contracts, significantly reducing these exposures for incidents occurring after 1986. Reserves for asbestos and environmental impairment claims cannot be estimated with traditional loss reserving techniques because of uncertainties that are greater than those associated with other types of claims. Factors contributing to those uncertainties include a lack of historical data, the significant periods of time that often elapse between 65 the occurrence of an insured loss and the reporting of that loss to the ceding company and the reinsurer, uncertainty as to the number and identity of insureds with potential exposure to such risks, unresolved legal issues regarding policy coverage, and the extent and timing of any such contractual liability. Loss reserve estimates for such environmental and asbestos exposures include case reserves, which also reflect reserves for legal and other loss adjustment expenses and IBNR reserves. IBNR reserves are determined based upon historic general liability exposure base and policy language, previous environmental loss experience and the assessment of current trends of environmental law, environmental cleanup costs, asbestos liability law and judgmental settlements of asbestos liabilities. For both asbestos and environmental excess of loss reinsurance claims, Capitol Transamerica establishes case reserves by applying reinsurance contract terms to losses reported by ceding companies, analyzing from the first dollar of loss incurred by the primary insurer. In establishing the liability for claims for asbestos related liability and for environmental impairment claims, management considers facts currently known and the current state of the law and coverage litigation. Additionally, ceding companies often report potential losses on a precautionary basis to protect their rights under the reinsurance arrangement, which generally calls for prompt notice to the reinsurer. Ceding companies, at the time they report such potential losses, advise Capitol Transamerica of the ceding companies' current estimate of the extent of such loss. Capitol Transamerica's claims department reviews each of the precautionary claims notices and, based upon current information, assesses the likelihood of loss to Capitol Transamerica. Such assessment is one of the factors used in determining the adequacy of the recorded asbestos and environmental reserves. Although Alleghany is unable at this time to determine whether additional reserves, which could have a material impact upon its results of operations, may be necessary in the future, Alleghany believes that Capitol Transamerica's asbestos and environmental reserves are adequate at December 31, 2004. 16. Fair Value of Financial Instruments The estimated carrying values and fair values of the Company's financial instruments are as follows (in thousands):
2004 2004 2003 2003 CARRYING FAIR Carrying Fair AMOUNT VALUE Amount Value ---------- ---------- ---------- ---------- ASSETS Investments $2,202,846 $2,202,846 $1,673,103 $1,673,103 Notes receivable $ 91,665 $ 91,665 $ 92,082 $ 92,082 Accounts receivable $ 70,547 $ 70,547 $ 99,697 $ 99,697 Premium balances receivable $ 203,141 $ 203,141 $ 279,682 $ 279,682 Swap-hedging purposes $ 510 $ 510 $ 771 $ 771 LIABILITIES Other liabilities $ 195,140 $ 195,140 $ 193,204 $ 193,204 Reinsurance payable $ 112,479 $ 112,479 $ 255,117 $ 255,117 Subsidiaries' debt $ 138,258 $ 142,579 $ 148,998 $ 152,564 ========== ========== ========== ==========
The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate fair value: 66 Investments: The fair value of equity securities and debt securities is based upon quoted market prices. The fair value of short-term investments approximates amortized cost. Notes receivable: The carrying amount approximates fair value because interest rates approximate market rates. Accounts receivable, premium balances receivable and reinsurance payable: The carrying amount approximates fair value. Swap: The fair value of the swap is based on a valuation model. Other liabilities: The carrying amount approximates fair value. Subsidiaries' debt: The fair value of the subsidiaries' debt is estimated based on the quoted market prices for the same or similar issues or on current rates offered for debt with the same remaining maturities. 17. Segments of Business Information related to Alleghany's reportable business operating segments is shown in the tables below (in thousands). Alleghany's reportable segments are reported in a manner consistent with the way management evaluates the businesses. As such, insurance underwriting activities are evaluated separately from investment activities. Realized investment gains are not considered relevant in evaluating investment performance on an annual basis.
2004 2003 2002 ---------- ---------- ---------- REVENUES FROM CONTINUING OPERATIONS AIHL insurance group Net premiums earned RSUI $ 609,360 $ 293,380 $ -- CATA 149,964 132,960 125,649 Darwin 46,093 4,115 -- ---------- --------- -------- 805,417 430,914 139,044 Interest, dividend and other income 43,200 25,672 13,395 ---------- --------- -------- Total insurance group 848,617 456,586 125,649 ---------- --------- -------- World Minerals 285,352 266,270 251,173 ---------- --------- -------- Corporate activities 20,088 30,258 39,857 Net gain (loss) on investments 86,870 151,842 36,375 ---------- --------- -------- Total $1,240,927 $ 904,956 $446,449 ========== ========= ======== EARNINGS FROM CONTINUING OPERATIONS, BEFORE INCOME TAXES AIHL insurance group Underwriting profit (loss) RSUI $ 83,198 $ 91,778 $ -- CATA (8,971) (21,424) (20,208) Darwin (36) (3,330) -- ---------- --------- -------- 74,191 67,024 (20,208) ---------- --------- -------- Interest, dividend and other income 43,200 25,672 13,395 Net gain (loss) on investments 84,478 54,945 (10,953) Other expenses 28,492 12,847 2,357 ---------- --------- -------- 173,377 134,794 (20,123) ---------- --------- -------- World Minerals 23,612 27,494 25,428 Corporate activities 19,216 122,416 81,149 ---------- --------- -------- 216,205 284,704 86,454
67 Interest expense 4,800 4,726 5,786 Corporate administration 41,278 34,678 25,700 ---------- ---------- ---------- Total $ 170,127 $ 245,300 $ 54,968 ========== ========== ========== IDENTIFIABLE ASSETS AT DECEMBER 31 AIHL insurance group $3,388,709 $2,557,413 $ 682,693 World Minerals 336,584 331,305 327,887 Corporate activities 702,432 629,780 1,205,455 ---------- ---------- ---------- Total $4,427,725 $3,518,498 $2,216,035 ========== ========== ========== CAPITAL EXPENDITURES AIHL insurance group $ 6,675 $ 5,310 $ 3,252 World Minerals 9,728 7,953 9,797 Corporate activities 86 43 113 ---------- ---------- ---------- Total $ 16,489 $ 13,306 $ 13,162 ========== ========== ========== DEPRECIATION AND AMORTIZATION AIHL insurance group $ 27,840 $ 11,819 $ 1,680 World Minerals 16,701 16,067 15,627 Corporate activities 1,260 869 56 ---------- ---------- ---------- Total $ 45,801 $ 28,755 $ 17,365 ========== ========== ==========
18. Other Information a. The amount of goodwill included in the Consolidated Balance Sheets at December 31, 2004 and 2003 is as follows (in thousands):
2004 2003 ------- ------- AIHL insurance group $45,161 $45,161 World Minerals 43,513 42,134 ------- ------- $88,674 $87,295 ======= =======
b. The amount of other intangible assets, net of amortization, included in the Consolidated Balance Sheets at December 31, 2004 and 2003 is as follows (in thousands):
2004 2003 -------- -------- AIHL insurance group Agency relationships $ 13,288 $ 13,892 State insurance licenses 28,827 25,121 Trade name 35,500 35,500 Brokerage and reinsurance relationships 30,420 32,674 Renewals rights 17,382 21,727 Other 2,129 3,614 -------- -------- $127,546 $132,528 -------- -------- World Minerals 7,486 7,772 -------- -------- $135,032 $140,300 ======== ========
The economical useful lives of intangible assets are as follows: agency relationships (15 years) state insurance licenses (indefinite), trade name (indefinite), broker and reinsurance relationships (15 years) and renewal rights (5.5 years). 68 c. Other assets shown in the Consolidated Balance Sheets include the following amounts at December 31, 2004 and 2003 (in thousands):
2004 2003 ------- ------- Real estate properties $29,879 $32,243 Prepaid expenses 5,757 4,927 Reinsurance deposit premiums 2,899 15,046 Interest receivable 9,393 8,379 Other 19,115 30,214 ------- ------- $67,043 $90,809 ======= =======
d. Property and equipment, net of accumulated depreciation and amortization, at December 31, 2004 and 2003 are as follows (in thousands):
Depreciation 2004 2003 Period --------- --------- ------------ Land $ 16,428 $ 16,665 -- Buildings and improvements 43,428 43,513 30-40 years Furniture and equipment 167,327 161,348 3-20 years Ore reserves 41,882 41,093 30 years Leasehold improvements 2,269 2,075 Various Mining equipment 29,468 28,992 5-7 years Other 29,327 20,150 -- --------- --------- 330,129 313,836 --------- --------- Less: accumulated depreciation and amortization (161,813) (139,739) --------- --------- $ 168,316 $ 174,097 ========= =========
e. Other liabilities shown in the Consolidated Balance Sheets include the following amounts at December 31, 2004 and 2003 (in thousands):
2004 2003 -------- -------- Accounts payable $ 21,425 $ 62,402 Performance shares 25,913 17,501 Pension, retirement and incentive plans 71,033 41,285 Minority interest ownership in World Minerals 7 1,841 Accrued salaries and wages 15,578 11,050 Deferred compensation 5,435 4,544 Accrued expenses 6,396 8,366 Deferred revenue 1,421 9,810 Other 47,932 36,405 -------- -------- $195,140 $193,204 ======== ========
19. Quarterly Results of Operations (unaudited) Selected quarterly financial data for 2004 and 2003 are presented below (in thousands, except per share amounts): 69
Quarters ended ------------------------------------------------ March 31 June 30 September 30 December 31 -------- -------- ------------ ----------- 2004 Revenues $306,284 $290,480 $296,726 $347,437 ======== ======== ======== ======== Earnings (loss) from: Continuing operations $ 60,696 $ 47,085 $(47,448) $ 57,615 Discontinued operations 1,368 1,638 444 (3,702) -------- -------- -------- -------- Net earnings $ 62,064 $ 48,723 $(47,004) $ 53,913 ======== ======== ======== ======== Basic earnings (loss) per share of common stock: * Continuing operations $ 7.93 $ 6.14 $ (6.18) $ 7.50 Discontinued operations 0.18 0.21 0.06 (0.48) -------- -------- -------- -------- Total $ 8.11 $ 6.35 $ (6.12) $ 7.02 ======== ======== ======== ======== 2003 Revenues $110,707 $117,074 $324,291 $352,884 ======== ======== ======== ======== Earnings (loss) from: Continuing operations $ 7,652 $ 7,099 $ 74,728 $ 76,709 Discontinued operations 72 (1,103) 142 (2,921) -------- -------- -------- -------- Net earnings $ 7,724 $ 5,996 $ 74,870 $ 73,788 Basic earnings per share of common stock: * Continuing operations $ 1.01 $ 0.94 $ 9.81 $ 10.04 Discontinued operations 0.01 (0.15) 0.02 (0.38) -------- -------- -------- -------- Total $ 1.02 $ 0.79 $ 9.83 $ 9.66 ======== ======== ======== ========
* Adjusted to reflect subsequent stock dividends. Earnings per share by quarter may not equal the amount for the year due to the timing of share transactions and rounding. 20. Related Party Transactions During 2003, the Company made an investment of $10.0 million in Broadfield Capital, L.P., an investment fund formed and managed by a limited liability company owned by Jefferson W. Kirby. This fund invests in small and mid-cap public equities, private equities and distressed debt. Such investment was valued at $11.1 million at December 31, 2004 and $10.3 million at December 31, 2003. Mr. Kirby was a Vice President of Alleghany until June 30, 2003, and is a son of F.M. Kirby, Chairman of the Board of Alleghany. 70 Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Alleghany Corporation: We have audited the accompanying consolidated balance sheets of Alleghany Corporation and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of earnings, changes in common stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Alleghany Corporation and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Alleghany Corporation's internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 8, 2005 expressed an unqualified opinion on management's assessment of, and the effective operation of, internal control over financial reporting. /s/ KPMG LLP - --------------------------- New York, New York March 8, 2005 71 Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Alleghany Corporation: We have audited management's assessment, included in the accompanying Managements Report on Internal Control over Financial Reporting, that Alleghany Corporation maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Alleghany Corporation's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that Alleghany Corporation maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Alleghany Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control--Integrated 72 Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Alleghany Corporation and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of earnings, changes in common stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2004, and our report dated March 8, 2005 expressed an unqualified opinion on those consolidated financial statements. /s/ KPMG LLP - --------------------------- New York, New York March 8, 2005 73 EX-21 12 y06166exv21.txt LIST OF SUBSIDIARIES Exhibit 21 SUBSIDIARIES OF ALLEGHANY Alleghany Capital Corporation (Delaware) Alleghany Consulting, Inc. (Delaware) Alleghany Funding Corporation (Delaware) Alleghany Properties Holdings LLC (Delaware) Alleghany Properties LLC (California) Mineral Holdings Inc. (Delaware--99.95%) World Minerals Inc. (Delaware) Advanced Minerals Corporation (Delaware) World Minerals International, Inc. (Delaware) World Minerals Americas LLC BV (Delaware/Netherlands) World Minerals Luxembourg (Luxembourg) Celite B.V. (Luxembourg) Europerlite B.V. (Luxembourg) Harborlite Aegean Endustri Mineralleri Sanayi a.s. (Turkey) Anadolu Perlit (Turkey) World Minerals Espana S.L. (Spain) Celite Hispanica, S.A. (Spain) Europerlita Espanola, S.A. (Spain) Harborlite (U.K.) Limited (United Kingdom) World Minerals (U.K.) Limited (United Kingdom) World Minerals Europe, S.A. (France) Harborlite France, S.A. (France) Celite Europe LLC (Delaware) Celite France, S.A. (France) World Minerals Italia, S.r.L. (Italy) Europerlite Italiana, S.p.A. (Italy) WM Canada Inc. (Canada) World Minerals do Brasil Ltda. (Brazil) World Minerals FSC, Inc. (Barbados) World Minerals Island, h.f. (Iceland) Celite Corporation (Delaware) Celite Mexico S.A. de C.V. (Mexico) Almeria, S.A. de C.V. (Mexico) Diatomita San Nicolas, S.A. de C.V. (Mexico) Celite Pacific Limited (Hong Kong) Celite China Inc. (Delaware) Linjiang Celite Diatomite Company Ltd. (China--77.33%) Celite Shanghai International Trading Co., Ltd. (China) Celite Jilin, Inc. (Delaware) Changbai Celite Diatomite Company Ltd. (China--71.76%) Celite Minerals China Corporation (Delaware) Linjiang Lin-Lin Celite Diatomite Company Limited (China--73.48%) Celite Chile S.A. (Chile) Sociedad Minera Celite del Peru, S.A. (Peru) Peruco, Inc. (Delaware) Peru Minerals Corporation (Delaware) Celite Korea Ltd. (South Korea) Harborlite Corporation (Delaware) Harborlite Chile, S.A. (Chile) Perlite, Inc. (Delaware) Substancias y Mineralas Navajas S.A. de C.V. (Mexico) Bibb Steel and Supply Company (Delaware) MSL Property Holdings, Inc. (Delaware) MSL Capital Recovery Corp. (Delaware) J & E Corporation (Tennessee) Alleghany Insurance Holdings LLC (Delaware) Capitol Transamerica Corporation (Wisconsin) Capitol Facilities Corporation (Wisconsin) Capitol Indemnity Corporation (Wisconsin) Capitol Specialty Insurance Corporation (Wisconsin) Darwin Group, Inc. (Delaware) Darwin National Assurance Company (Delaware) Darwin Professional Underwriters, Inc. (Delaware--80%) Platte River Insurance Company (Nebraska) RSUI Group, Inc. (Delaware) Resurgens Specialty Underwriting, Inc. (Georgia) RSA Surplus Lines Insurance Services, Inc. (Delaware) RSUI Indemnity Company (New Hampshire) Landmark American Insurance Company (Oklahoma) 2 EX-23 13 y06166exv23.txt CONSENT OF KPMG LLP Exhibit 23 Consent of Independent Registered Public Accounting Firm The Board of Directors Alleghany Corporation: We consent to the incorporation by reference in the registration statements Nos. 333-37237, 333-76159 and 333-76996 on Forms S-8 and Nos. 33-55707, 33-62477, 333-09881 and 333-13971 on Forms S-3 of Alleghany Corporation of our reports dated March 8, 2005, with respect to the consolidated balance sheets of Alleghany Corporation as of December 31, 2004 and 2003, and the related consolidated statements of earnings, changes in common stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2004, and all related financial statement schedules, management's assessment of the effectiveness of internal control over financial reporting as of December 31, 2004 and the effectiveness of internal control over financial reporting as of December 31, 2004, which reports appear in the December 31, 2004 annual report on Form 10-K of Alleghany Corporation. New York, New York March 8, 2005 EX-31.1 14 y06166exv31w1.txt CERTIFICATION Exhibit 31.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Weston M. Hicks, certify that: 1. I have reviewed this annual report on Form 10-K of Alleghany Corporation (the "Registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report; 4. The Registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the Registrant and we have: a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. evaluated the effectiveness of the Registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. disclosed in this report any change in the Registrant's internal control over financial reporting that occurred during the Registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Registrant's internal control over financial reporting; and 5. The Registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant's auditors and the audit committee of Registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant's ability to record, process, summarize and report financial information; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. Date: March 8, 2005 /s/ Weston M. Hicks ----------------------------------------- Weston M. Hicks President and chief executive officer EX-31.2 15 y06166exv31w2.txt CERTIFICATION Exhibit 31.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, David B. Cuming, certify that: 1. I have reviewed this annual report on Form 10-K of Alleghany Corporation (the "Registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report; 4. The Registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the Registrant and we have: a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. evaluated the effectiveness of the Registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. disclosed in this report any change in the Registrant's internal control over financial reporting that occurred during the Registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Registrant's internal control over financial reporting; and 5. The Registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant's auditors and the audit committee of Registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant's ability to record, process, summarize and report financial information; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. Date: March 8, 2005 /s/ David B. Cuming ----------------------------------------- David B. Cuming Chief Financial Officer EX-32.1 16 y06166exv32w1.txt CERTIFICATION Exhibit 32.1 ALLEGHANY CORPORATION CERTIFICATION In connection with the annual report of Alleghany Corporation (the "Company") on Form 10-K for the year ended December 31, 2004, as filed with the Securities and Exchange Commission (the "Report"), I, Weston M. Hicks, President and chief executive officer of the Company, hereby certify as of the date hereof, solely for purposes of Title 18, Chapter 63, Section 1350 of the United States Code, that: (1) the Report fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934, and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company at the dates and for the periods indicated. This Certification, which accompanies the Report, has not been, and shall not be deemed, "filed" with the Securities and Exchange Commission. Date: March 8, 2005 By: /s/ Weston M. Hicks ------------------------------------- Weston M. Hicks President and chief executive officer EX-32.2 17 y06166exv32w2.txt CERTIFICATION Exhibit 32.2 ALLEGHANY CORPORATION CERTIFICATION In connection with the annual report of Alleghany Corporation (the "Company") on Form 10-K for the period ended December 31, 2004, as filed with the Securities and Exchange Commission (the "Report"), I, David B. Cuming, Senior Vice President and chief financial officer of the Company, hereby certify as of the date hereof, solely for purposes of Title 18, Chapter 63, Section 1350 of the United States Code, that: (1) the Report fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934, and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company at the dates and for the periods indicated. This Certification, which accompanies the Report, has not been, and shall not be deemed, "filed" with the Securities and Exchange Commission. Date: March 8, 2005 By: /s/ David B. Cuming ------------------------------------- David B. Cuming Senior Vice President and chief financial officer -----END PRIVACY-ENHANCED MESSAGE-----