-----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, A+Z+pQpDVIJ6jVHC1PBOHAloTh/k6AwgfdGzzN7MNj0n3rHElkmEbOILQZoYcyQh IkQfRv1ypwcWnPmHPIL/qg== 0000780118-97-000007.txt : 19970401 0000780118-97-000007.hdr.sgml : 19970401 ACCESSION NUMBER: 0000780118-97-000007 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: AMEX FILER: COMPANY DATA: COMPANY CONFORMED NAME: AMWEST INSURANCE GROUP INC CENTRAL INDEX KEY: 0000780118 STANDARD INDUSTRIAL CLASSIFICATION: SURETY INSURANCE [6351] IRS NUMBER: 952672141 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-09580 FILM NUMBER: 97571685 BUSINESS ADDRESS: STREET 1: 6320 CANOGA AVE STE 300 CITY: WOODLAND HILLS STATE: CA ZIP: 91367 BUSINESS PHONE: 8187041111 MAIL ADDRESS: STREET 1: 6320 CANOGA AVENUE SUITE 300 STREET 2: PO BOX 4500 CITY: WOODLAND HILLS STATE: CA ZIP: 91367 EX-27 1 FDS -- I
7 1,000 U.S. Dollars 12-Mos DEC-31-1996 JAN-01-1996 DEC-31-1996 1 102,494 0 0 14,032 0 0 120,265 6,434 9,192 16,101 181,418 42,009 33,939 0 0 12,500 0 0 33 49,899 181,418 87,883 6,807 2,201 2 46,647 38,367 12,698 (5,046) (2,360) (2,686) 0 0 0 (2,686) (.80) (.80) 24,246 45,853 794 (21,638) (13,379) 35,876 794
10-K 2 FORM 10-K 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 [FEE REQUIRED] FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE TRANSITION PERIOD FROM _____ TO _____ Commission file number: 1-9580 AMWEST INSURANCE GROUP, INC. (Exact name of registrant as specified in its charter) Delaware 95-2672141 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 6320 Canoga Avenue, Suite 300 Woodland Hills, California 91367 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (818) 704-1111 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered Common Stock, $.01 par value American Stock Exchange, Inc. Stock Purchase Rights Pacific Stock Exchange, Inc. Securities registered pursuant to Section 12(g) of the Act: None 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. ( X ) As of March 27, 1997, 3,351,752 shares of common stock, $.01 par value, were outstanding. As of March 27, 1997, the market value of the voting stock held by non-affiliates of the registrant, based on the closing sales price of the registrant's common stock as reported by the American Stock Exchange, Inc. on such date, was $23,563,604. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive proxy statement for the 1996 Annual Meeting of stockholders (incorporated by reference under Part III). TABLE OF CONTENTS Item PART I Page 1. Business 1 General 1 Products 2 Underwriting and Collateral 4 Statutory Net Premiums Written to Statutory Policyholders' Surplus Ratio 5 Combined Ratios 5 Reinsurance 6 Reserves 7 Investments 11 Marketing and Growth 14 The Safety Association 14 Competition 15 Employees 15 Government Regulation 15 2. Properties 16 3. Legal Proceedings 17 4. Submission of Matters to a Vote of Security Holders 17 PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters 18 Market Information 18 Holders 18 Dividends 18 6. Selected Financial Data 19 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 21 Results of Operations 21 Liquidity and Capital Resources 24 8. Financial Statements and Supplementary Data 25 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 26 PART III 10. Directors and Executive Officers of the Registrant 27 11. Executive Compensation 27 12. Security Ownership of Certain Beneficial Owners and Management 27 13. Certain Relationships and Related Transactions 27 PART IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 28 i PART I ITEM 1. BUSINESS GENERAL Amwest Insurance Group, Inc., a Delaware corporation ("the Company"), is an insurance holding company engaged, through its wholly-owned subsidiaries, Amwest Surety Insurance Company ("Amwest Surety"), Far West Insurance Company ("Far West"), Far West Bond Services, Condor Insurance Company ("Condor"), Raven Claims Services, Inc. and Southern California Bonding Services, Inc., in underwriting surety bonds nationwide, commercial automobile insurance in the State of California and , to a lesser extent, other property and casualty coverages in several western states. The surety bonds are underwritten through 30 branch offices, 5 of which are located in California and the balance of which are located in 20 other states. On March 14, 1996, the Company completed its previously announced merger with Condor Services, Inc. ("CSI"), an insurance holding company. In the merger, each outstanding share of Condor Services' common stock (other than shares owned by Condor Services as treasury stock or by the Company) were converted into the right to receive 0.5 of a share of the Company's common stock. In connection with the merger, the Company issued 992,000 shares of common stock. The merger has been accounted for under the pooling of interests method. Accordingly, all financial information presented herein for all periods includes CSI on a historical cost basis. On March 1, 1996, the Company purchased Southern California Bonding Services, Inc., a California corporation. The purchase price was immaterial. Amwest Surety and Far West underwrite a wide variety of surety bonds, for small to mid-sized surety accounts through independent agents and brokers. This type of underwriting involves smaller companies and smaller bond amounts than typically written by the larger multi-line insurance companies. Bonds are underwritten using a variety of factors to help mitigate risk, including the acceptance of full or partial collateral based on the characteristics of the account. See "Business -Underwriting and Collateral." According to A.M. Best Company ("Best"), an insurance company rating and statistical service, property and casualty insurance companies wrote approximately $2.5 billion in surety net premiums in 1995. The Company ranked 11th nationally when measured by net premiums written for all companies writing surety. In California, which currently is the largest market for surety business and where the Company has historically generated a significant portion of its business, the Company ranked 7th when measured by gross premiums written for all companies writing surety in 1995. As the Company's branches outside California have matured, the percentage of surety business generated in California has declined. In 1996, 20.8% of the Company's surety business was generated in California as compared to 22.4% in 1995. Condor primarily writes insurance packages which consist principally of commercial automobile liability and physical damage coverage and, to a lesser extent, general liability and other related coverages (excluding hazardous waste and environmental impairment except with respect to policies written for the intermodal trucking industry) for insureds involved in general trucking including solid waste disposal, sand and gravel, transit mix, logging, farm to market, intermodal trucking, less than total load (LTL), newspaper distribution, tow truck and limousine services industries. In order to accept coverage written on commercial policies by Condor Insurance, an applicant must become a member of the Waste Industry Loss Prevention and Safety Association (d.b.a. "The Safety Association"). From 1993 to mid-1995, Condor Insurance offered ocean marine coverage to small boat owners in California and Arizona. Since 1993, Condor Insurance has also offered automobile private passenger coverage in Arizona. The Company was incorporated in California on August 19, 1970 and reincorporated in Delaware on September 11, 1987. During the year ended December 31, 1995 two of the Company's wholly owned subsidiaries, Amwest Surety Insurance Company and Far West Insurance Company, reincorporated from California to Nebraska. Condor remains a California domiciled company. Accordingly, the Company is now registered with the Nebraska Department of Insurance as an insurance holding company. Amwest Surety is licensed in all 50 states, the District of Columbia, Guam and Puerto Rico, Far West is licensed in 43 states and the District of Columbia and Condor is licensed in California and Arizona. Amwest Surety and Far West hold certificates of authority from the United States Department of the Treasury, which qualifies them as acceptable sureties on Federal bonds. Amwest Surety and Far West are rated (a group rating) "A" (Excellent) by Best and Condor is rated a "B" (Adequate) . The term "the Company" unless the context otherwise requires, refers to Amwest Insurance Group, Inc. and its insurance subsidiaries. The principal executive offices of the Company are located at 6320 Canoga Avenue, Suite 300, Woodland Hills, California 91367. The Company's telephone number is (818) 704-1111 and its facsimile number is (818) 592-3660. PRODUCTS The Company's major products are: Contract performance bonds, which guarantee the performance of specific contractual obligations between the principal and the obligee and/or payments to labor and material suppliers. Included within this product are contract performance bonds which are partially guaranteed by the Small Business Administration ("SBA"). Court bonds, which guarantee that the principal will adequately discharge the obligations set by a court. These bonds principally consist of bail and immigration bonds for which the agent is generally primarily liable. Commercial Surety bonds, which includes all non-contract surety bonds including numerous types of license and permit, miscellaneous and judicial bonds for which the Company is primarily liable. Specialty Property and Casualty, which includes commercial auto liability and physical damage, general liability, homeowners and other property and casualty coverages. The following tables show, for the periods indicated, the premiums written, net premiums earned, losses and loss adjustment expenses and loss ratios for the Company's three major types of bonds:
PREMIUMS WRITTEN Years ended December 31, 1996 1995 1994 (Dollars in thousands) ------------------------------------------------------------------------------------ Type of Insurance Contract performance bonds $ 49,782 51.1% $ 54,039 57.4% $ 51,362 54.5% Specialty Property & Casualty insurance 25,072 25.9 24,101 25.6 23,737 25.2 Court bonds 13,221 13.6 7,669 8.1 8,677 9.2 Commercial Surety bonds 9,167 9.4 8,375 8.9 10,446 11.1 ------------- ------------- ------------- ------------- -------------- ------------- Total $ 97,242 100.0% $ 94,184 100.0% $ 94,222 100.0% ============= ============= ============= ============= ============== =============
NET PREMIUMS EARNED Years ended December 31, 1996 1995 1994 (Dollars in thousands) ------------------------------------------------------------------------------------ Type of Insurance Contract performance bonds $ 46,158 52.5% $ 49,737 58.4% $ 43,353 53.3% Specialty Property & Casualty insurance 22,421 25.5 17,872 21.0 19,460 24.0 Court bonds 12,209 13.9 7,816 9.2 8,373 10.3 Commercial Surety bonds 7,095 8.1 9,745 11.4 10,103 12.4 ------------- ------------- ------------- ------------- -------------- ------------- Total $ 87,883 100.0% $ 85,170 100.0% $ 81,289 100.0% ============= ============= ============= ============= ============== =============
LOSSES & LOSS ADJUSTMENT EXPENSES AND LOSS RATIOS Years ended December 31, 1996 1995 1994 (Dollars in thousands) ------------------------------------------------------------------------------------ Type of Insurance Contract performance bonds $ 24,430 52.9% $ 20,044 40.3% $ 11,250 26.0% Specialty Property & Casualty insurance 18,829 83.4 13,131 73.5 14,633 75.2 Court bonds 1,092 9.0 323 4.1 1,058 12.6 Commercial Surety bonds 2,296 32.4 1,767 18.1 1,796 17.8 ------------- ------------- ------------- ------------- -------------- ------------- Total $ 46,647 53.1% $ 35,265 41.4% $ 28,737 35.4% ============= ============= ============= ============= ============== =============
The loss ratio can be substantially affected by the size and timing of losses, as well as by underwriting standards and procedures. UNDERWRITING AND COLLATERAL For the surety line of business, the Company individually analyzes the risk associated with each application it receives, except for selected categories of miscellaneous bonds. This underwriting evaluation includes verifying the credit history and financial resources of the applicant. The Company maintains control of the underwriting process through the use of authority limits for each underwriter, through committee underwriting of larger risks and through a system of limited delegation. The Company may require collateral on contract bonds and, occasionally, other types of bonds based upon an assessment of the risk characteristics. The risk assessment includes evaluation of the financial strength of the contractor, the credit history of the contractor, work in progress and successful work experience. Collateral can consist of irrevocable letters of credit, certificates of deposit, cash, savings accounts, publicly traded securities and trust deeds or mortgages on real property. The principal form of collateral accepted by the Company currently consists of irrevocable letters of credit and certificates of deposit. Total collateral held as of December 31, 1996 had a value of approximately $245,243,000. Trust deeds and mortgages on real property held as collateral are not reflected in this figure due to the inexact nature of their disposition values. The Company reflects in its consolidated financial statements only funds received as collateral on which net earnings inure to the benefit of the Company. This amounted to $29,928,000 at December 31, 1996. Recent reductions in total collateral reflect competitive market conditions and, further in 1996, a decrease in contract payment and performance bond writings. For the specialty property and casualty lines of business, the Company sets insurance premium rates for various risk classifications based upon its historical loss experience and industry averages. The Company's rates and classifications are established using actuarial computations prepared by its actuarial consultant and are reviewed on a semi-annual basis and adjusted periodically. The information used by the Company in its actuarial evaluations includes complete historical claim information related to its experience as an insurance company and industry data. The Company's insurance premium rates are subject to rate regulation, which varies by state. Insurance applications are evaluated and a decision to write a particular risk at a specific premium is made by the Company's underwriting department. The Company's policy is to have its underwriting personnel or third party administrator for the assigned risk business individually review each risk. The underwriting department or third party administrator determines whether to write a particular risk after evaluating a number of factors based upon detailed objective underwriting standards contained in the underwriting standards manual. These factors include the type and value of the property to be insured, the location and management of operations conducted by the insured, the experience and claim history of the insured and, with respect to vehicle coverage, the driving records of the vehicle operators. When a determination has been made that an applicant represents an appropriate risk, the Company offers coverage on a monthly or annual basis. Many of the Company's specialty property and casualty coverages are offered in Group Business Package policies. Package policies include fire and allied lines, commercial inland marine, general liability, commercial automobile liability, physical damage and surety. The commercial automobile liability portion of the package policy provides bodily injury and property damage liability. Property damage liability has a mandatory deductible which applies to property damage liability coverage. Also, uninsured/underinsured motorist coverage, medical payments coverage, and comprehensive and collision coverages are offered. The general liability portion of the Group Business Package covers bodily injury and property damage liability written on an occurrence basis. The policy contains customary extensions of coverage. All Group Business Package policies contain an absolute pollution liability exclusion. Limited pollution coverage is provided only to the extent required by the U.S. Department of Transportation ("DOT") regulatory requirements, which generally require minimum liability policy limits of $750,000 to cover environmental restoration on claims for insureds who travel interstate or on federal property. Policies covering garbage dumps and landfills contain exclusions for products and completed operations and the hazards of explosion, collapse and underground. STATUTORY NET PREMIUMS WRITTEN TO STATUTORY POLICYHOLDERS' SURPLUS RATIO This ratio reflects the leverage of the Company's current volume of net business in relation to its policyholders' surplus. There are no legal requirements governing this ratio, but guidelines established by the National Association of Insurance Commissioners ("NAIC") have historically provided that the ratio should not exceed 3.0 to 1. In addition, the guidelines can vary according to the lines of business written. The following table shows, for the years indicated, the insurance subsidiaries' consolidated ratios:
Years ended December 31, 1996 1995 1994 1993 1992 (Dollars in thousands) --------------------------------------------------------------------- Statutory net premiums written $87,396 $82,814 $84,093 $79,194 $62,024 Statutory policyholders' surplus 40,298 45,361 40,467 39,661 38,432 Ratio 2.17 1.83 2.08 2.00 1.61
In December 1993, the NAIC adopted a Risk-Based Capital ("RBC") Model Law for property and casualty companies. The RBC Model Law is intended to provide standards for calculating a variable regulatory capital requirement related to a company's current operations and its risk exposures (asset risk, underwriting risk, credit risk and off-balance sheet risk). These standards are intended to serve as a diagnostic solvency tool for regulators that establishes uniform capital levels and specific authority levels for regulatory intervention when an insurer falls below minimum capital levels. The Model Law specifies four distinct action levels at which a regulator can intervene with increasing degrees of authority over a domestic insurer as its financial condition deteriorates. These RBC levels are based on the percentage of an insurer's surplus to its calculated RBC. A company's RBC is required to be disclosed in its statutory annual statement, however, the detailed RBC calculation as well as a company's corrective action plan will remain confidential. The RBC is not intended to be used as a rating or ranking tool nor is it to be used in premium rate making or approval. The Company has calculated it's RBC requirements as of December 31, 1996 and found that it exceeded the highest level of recommended capital requirement. COMBINED RATIOS The combined ratio is the sum of (1) the ratio of losses and loss adjustment expenses incurred (including a provision for incurred but not reported losses) to net premiums earned (the "loss ratio") and (2) the ratio of policy acquisition and general operating costs to net premiums earned (the "expense ratio"). The following table shows the loss ratios, expense ratios and combined ratios of the Company as derived from data prepared in accordance with generally accepted accounting principles. Generally, if the combined ratio is below 100% an insurance company has an underwriting profit; if it is above 100% the company has an underwriting loss.
Years ended December 31, 1996 1995 1994 1993 1992 ------------- ------------- ------------- ------------- ------------- Loss Ratio 53.1% 41.4% 35.4% 39.5% 32.9% Expense Ratio 58.1 63.9 64.2 62.7 65.7 ------------- ------------- ------------- ------------- ------------- Combined Ratio 111.2% 105.3% 99.6% 102.2% 98.6% ============= ============= ============= ============= =============
The increase in the Company's loss ratio is primarily attributable to a number of large contract bond losses on claims initially reported during 1996 and which adversely developed in the fourth quarter of 1996. Management believes that it has addressed the problems associated with these large contract bond losses by making significant changes in 1996. These changes include a strengthening of underwriting expertise in a number of branches, a required higher level of contractor visits by underwriting personnel, an adjustment to the Company's underwriting guidelines for certain specialty construction programs and a change in the reinsurance arrangements to include an aggregate stop-loss treaty for the Company's surety bond business. REINSURANCE A reinsurance transaction occurs when an insurance company remits or "cedes" a portion of the premium to a reinsurer as payment for the reinsurer's assumption of a portion of the risk. Reinsurance does not legally discharge the insurer from its primary liability for the full amount of the policies, and the ceding company must pay the loss if the assuming company fails to meet its obligations under the reinsurance agreement. The Company evaluates and monitors the financial condition of its reinsurers in order to minimize its exposure to significant losses from reinsurer insolvencies. The Company purchases reinsurance for protection against liabilities in excess of certain limits. The Company imposes stricter underwriting standards with respect to bonds with penal amounts in excess of reinsured limits. On the surety lines of business, the Company's subsidiaries maintain an excess of loss reinsurance treaty with a group of reinsurers lead by Kemper Reinsurance Company, (the "Kemper Treaty"). Kemper Reinsurance Company is a 50% participant, Scor Reinsurance Company has a 40% participation and Gerling Global Reinsurance Corp., USB has a 10% participation in the treaty. The Kemper Treaty, which was amended on October 1, 1996, may be canceled at the election of either party by providing notice of cancellation 90 days prior to any anniversary, however, the reinsurers would remain liable for covered losses incurred up to the cancellation date. The amended Kemper Treaty limits the Company's exposure on any one principal (the person or entity for whose account the surety contract is made, and whose debt or obligation is the subject of the surety contract) to the first $2,000,000 of loss and to losses in excess of $6,000,000. Coverage is provided for most types of bonds which the Company writes except SBA guaranteed bonds, which are not covered by the treaty. The reinsurers' maximum exposure under the Kemper Treaty is $8,000,000 of losses discovered during any one contract period (October 1 to October 1). Prior to the amendment on October 1, 1996, the coverage was $5,500,000 excess $500,000 and the Company received a percentage of the profit, if any, on the treaty in the form of contingent commission. Contingent commissions in the amount of $3,287,000, $2,226,000 and $366,000 were recognized under the profit sharing provisions of the treaty for the years ended December 31, 1996, 1995 and 1994, respectively. In conjunction with the change in reinsured limits effective October 1, 1996 the Company, effective January 1, 1997, entered into an aggregate stop-loss treaty with Underwriters Reinsurance Company (Barbados), Inc. This contract covers approximately $5,000,000 of losses and allocated loss adjustment expenses on the surety lines of business in excess of 25.86% of net earned premiums, with an option to increase the coverage by up to $5,000,000 by payment of $1,000,000 prior to the incurrance of $2,500,000 in ceded losses under the original treaty. The Company also maintains a semiautomatic bond facultative reinsurance contract for surety bonds. The contract also applies to most types of bonds the Company writes with single bond penalty limits up to $10,000,000 or multiple bonds under a specific aggregate work program per principal with limits up to $20,000,000 for contract surety bonds and $25,000,000 for commercial surety bonds. The Company's retention under the contract is $6,000,000 plus 12% of the reinsured amount. The Company's aggregate retention is additionally reinsured by the aforementioned excess of loss reinsurance treaty, further limiting the Company's net exposure. The Company's insurance subsidiaries also issue contract bonds under the SBA Surety Guarantee Program. Industry practice is to account for SBA guarantees as reinsurance transactions. The purpose of the SBA Surety Guarantee Program is to assist small contractors, who have not established credit or who fail to meet a surety's normal underwriting standards, in obtaining bonds. An SBA guarantee covers between 80% and 90% of the surety's liability up to $1,250,000 per bond. For its liability lines of business, the Company has reduced its exposure on any one risk with the purchase of excess of loss reinsurance. The net retained amount has varied by year, primarily based on the Company's surplus position. Currently, the Company retains the first $400,000 on any one risk with the next $600,000 ceded to a consortium of reinsurers led by Gerling Global Reinsurance Corporation. The Company participates in this treaty with a 10% share. The Company further reinsures $1,000,000 in excess of $1,000,000 for its liability coverages including extra contractual obligations and excess of policy limits exposures. For its property coverages, the Company generally retains the first $200,000 on any one exposure and purchases excess of loss reinsurance for $4,800,000 in excess of $200,000. Limits relating to its Hawaiian homeowners program differ from the above with the Company retaining $500,000 ultimate on each net loss with the Company reinsuring $1,250,000 in excess of $500,000. The Company participates in the Hawaii Hurricane Relief Fund, and accordingly, its Hawaiian policies exclude wind coverage over 75 miles per hour. RESERVES The Company maintains reserves for losses and loss adjustment expenses with respect to both reported and unreported claims. The amount of loss reserves for reported claims, including related loss adjustment expense reserves, is generally based upon a case-by-case evaluation of the type of loss. In evaluating reserves for surety losses and loss adjustment expenses, the Company considers a number of factors including an estimate of the costs to complete the project, outstanding obligations to subcontractors, suppliers and the like and prevailing case law and regulations pertaining to the underlying exposures. The Company also considers the financial strength of the principal, possible offsets to the claimed amount and defenses available to the principal and the Company. The Company may use outside attorneys and construction consultants throughout the reserving process. All reserves for reported claims are net of anticipated collateral and other non-reinsurance recoveries. Reserves for incurred but not reported claims are based on Company experience. An amount is included in the reserves for unallocated loss adjustment expenses consisting of the costs for the Company's claims, legal and subrogation departments to settle claims incurred prior to year end. The loss settlement period on most of the Company's insurance claims is relatively short. Nevertheless, it is often necessary to adjust estimates of liability on a claim either upward or downward between the time a claim is reported and the time of payment. There are inherent uncertainties in estimating reserves, therefore, actual losses and loss adjusting expenses may deviate, perhaps substantially, from reserves on the accompanying consolidated financial statements, which could have a material adverse effect on the Company's financial condition and results of operations. The Company does not discount its claim reserves for financial reporting purposes. While the Company may make implicit provisions for inflation or increasing costs in establishing reserves for known claims, the relatively short claim to payment period and the nature of the insured losses makes provisions for inflation or increasing costs generally unnecessary. The following table sets forth a reconciliation of the statutory liability for losses and loss adjustment expenses (1) for the periods shown:
December 31, 1996 1995 1994 (Dollars in thousands) ------------------------------------------ Statutory liability for losses and loss adjustment expenses at beginning of year $24,246 $26,584 $28,502 Provision for losses and loss adjustment expenses occurring in current year 45,853 35,508 30,400 Increase (decrease) in estimated losses and loss adjustment expenses for claims occurring in prior years 794 (243) (1,663) Losses and loss adjustment expense payments for claims occurring during: Current year (21,638) (19,283) (14,795) Prior years (13,379) (18,320) (15,860) ------------- -------------- ------------- Statutory liability for losses and loss adjustment expenses at end of year $35,876 $24,246 $26,584 ============= ============== ============= (1) Amounts reflect the liability for losses and loss adjustment expenses net of reinsurance recoverable on unpaid loss and loss adjustment expenses.
The table on page 10 discloses the cumulative development of unpaid losses and loss adjustment expenses of the Company from 1986 through 1996. The top line of this table depicts the estimated net liability for unpaid losses and loss adjustment expenses recorded at the balance sheet date for each of the indicated years. This liability represents the estimated net amount of losses and loss adjustment expenses for claims arising in all prior years that are unpaid at the balance sheet date, including losses that had been incurred but not reported to the Company. The lower portion of the table shows the re-estimated amount of the previously recorded net liability based on experience as of the end of each succeeding year. Estimated gross liability and the re-estimated amount of previously recorded gross liability for the four years ended December 31, 1995 are shown below the table. The increase or decrease in estimated losses and loss adjustment expenses for losses occurring in prior years reflects the net effect of the resolution of losses for other than full reserve value and subsequent readjustment of loss values as of December 31st of the applicable years. The difference between the reserves reported in the Company's consolidated financial statements prepared in accordance with generally accepted accounting principles ("GAAP") and those reported in the annual statements filed with the State Departments of Insurance in accordance with statutory accounting principles ("SAP") is as follows:
December 31, 1996 1995 1994 (Dollars in thousands) ------------------------------------------ Reserves reported on a SAP basis $35,876 $24,246 $26,584 Net reinsurance recoverable on unpaid loss and loss adjustment expenses 6,133 7,669 8,069 ------------- -------------- ------------- Reserves reported on a GAAP basis $42,009 $31,915 $34,653 ============= ============== =============
In accordance with Financial Accounting Standards Board Statement No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts, reinsurance recoverable on unpaid losses and loss adjustment expenses are reported for generally accepted accounting practices as assets rather than netted against the corresponding liability for such items on the balance sheet. Since these recoverable balances are netted against the losses and loss adjustment expense liability for statutory purposes, a SAP/GAAP difference results. The Company attempts to estimate reserves that are adequate and neither deficient nor redundant. Therefore, no meaningful evaluation of estimated future redundancies or deficiencies can be developed from the Company's prior experience. The cumulative "redundancy/(deficiency)" shown in the table on page 10 represents the aggregate change in the estimates over prior years. For example, the 1991 liability has developed a $6,485,000 redundancy over five years. That amount has been reflected in income over the five years. The effect on income for the past three years of changes in estimates of the liabilities for losses and loss adjustment expenses is shown in the reconciliation table on page 8. The cumulative redundancy or (deficiency) as of the end of any year is due to a re-evaluation of reserves established in prior years at less than or more than the reserved values as of that date.
CUMULATIVE LOSS DEVELOPMENT December 31, (Dollars in thousands) 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 ------------------------------------------------------------------------------------------------------------ Net liability for losses & loss adjustment $2,292 $3,072 $3,528 $13,169 $23,199 $23,269 $24,860 $28,641 $26,584 $24,246 $35,876 expenses Net paid (cumulative) as of: One year later 1,769 2,108 4,000 5,426 9,892 9,826 11,224 15,862 18,318 13,379 - Two years later 2,017 3,461 4,021 8,146 14,386 14,473 16,896 23,547 24,579 Three years later 2,088 3,394 3,915 9,301 17,057 16,464 18,576 26,659 Four years later 2,065 3,436 3,693 10,996 18,261 16,654 18,902 Five years later 1,903 3,352 3,723 11,642 17,976 16,795 Six years later 1,801 3,419 4,519 11,646 18,074 Seven years later 1,868 3,348 4,425 11,583 Eight years later 1,830 3,325 4,318 Nine years later 1,819 3,221 Ten years later 1,793 Net liability re-estimated as of: One year later 2,462 2,886 5,513 12,247 20,580 20,560 21,937 26,860 26,343 25,040 - Two years later 2,114 3,618 4,650 10,463 18,890 18,401 19,565 25,943 28,540 Three years later 2,198 3,955 3,809 11,071 18,871 17,810 18,695 27,699 Four years later 2,207 3,485 4,020 11,622 18,654 16,664 19,048 Five years later 1,845 3,375 4,050 11,706 17,982 16,784 Six years later 1,811 3,431 4,483 11,628 17,943 Seven years later 1,868 3,341 4,429 11,542 Eight years later 1,830 3,325 4,319 Nine years later 1,819 3,221 Ten years later 1,793 Net Reserve Redundancy (Deficiency): $499 ($149) ($791) $1,627 $5,256 $6,485 $5,812 $942 ($1,956) ($794) - ========================================================================================================== Net redundancy (deficiency) as a percent of original 22% (5%) (22%) 12% 23% 28% 23% 3% (7%) (3%) - net liability: ========================================================================================================== Gross liability for losses & loss adjustment 35,150 46,614 34,653 31,915 42,009 expenses Ceded liability for losses & loss adjustment (10,290) (17,973) (8,069) (7,669) (6,133) expenses ---------------------------------------------------- Net liability for losses & loss adjustment 24,860 28,641 26,584 24,246 35,876 expenses ==================================================== Gross liability re-estimated 30,128 41,084 39,591 31,358 Ceded liability re-estimated (11,080) (13,385) (11,051) (6,318) ------------------------------------------ Net liability re-estimated 19,048 27,699 28,540 25,040 ========================================== Gross Reserve Redundancy (Deficiency) 5,022 5,530 (4,938) 557 ========================================== Note 1: The Company allocates salvage and subrogation recoverable balances by calendar year based on its best estimate of the years for which the accrued salvage and subrogation relates.
INVESTMENTS The Company's primary investment objectives are the protection and long-term enhancement of surplus, flexibility to respond to changing business conditions and the maximization of after-tax total return consistent with the Company's business objectives. The Company has investment management agreements with two firms to manage a significant part of the Company's investment portfolio. The Company pays each investment manager a quarterly fee based on the market value of the portfolio managed. The Company's arrangement with each investment manager is terminable by either party on 60 days prior notice. With respect to each of the investment mangers, investment guidelines have been established. These guidelines establish limits for maturity risk, quality risk and diversification risk. Guidelines are also established for investment grades, issue size and effective portfolio duration. Certain states or territories require the Company to deposit securities issued by such states or territories as a condition of licenser. These securities are managed in-house in accordance with guidelines established by the various states and territories. At December 31, 1996, the market value of all state deposits was approximately $12,561,000. The following table sets forth the composition of the Company's investment portfolio at the dates indicated:
December 31, 1996 1995 1994 1993 1992 (Dollars in thousands) ---------------------------------------------------- Fixed maturities, held-to-maturity, at amortized cost: Bonds: U.S. Government $ -- $ -- $ 10,850 $ 9,903 $ 12,859 Mortgage backed securities -- -- 696 -- -- States, municipalities and political subdivisions -- -- 3,524 2,921 21,262 Certificates of deposit, at cost -- -- 50 50 2,178 -------- -------- -------- -------- -------- Total -- -- 15,120 12,874 36,299 -------- -------- -------- -------- -------- Fixed maturities, available-for-sale, at market (1): Bonds: U.S. Government 13,739 32,101 14,292 19,931 47,467 Asset backed securities 4,004 5,636 -- -- -- Mortgage backed securities 24,245 17,723 27,904 7,845 -- States, municipalities and political subdivisions 26,608 34,952 34,374 54,141 20,760 Other 27,848 20,284 22,080 18,193 3,189 Redeemable preferred stock, at market (1) 6,050 6,495 8,280 7,641 3,305 -------- -------- -------- -------- -------- Total 102,494 117,191 106,930 107,751 74,721 -------- -------- -------- -------- -------- Total fixed maturities 102,494 117,191 122,050 120,625 111,020 Common equity securities, at market (1) 9,779 8,689 7,386 5,737 3,150 Preferred equity securities, at market (1) 4,253 3,592 2,321 2,998 1,195 Other invested assets 2,849 797 -- -- -- Short-term investments, at cost 890 745 2,289 1,849 1,174 -------- -------- -------- -------- -------- Total investments 120,265 131,014 134,046 131,209 116,539 Interest bearing cash equivalents (2) 6,434 5,232 4,032 7,103 11,088 -------- -------- -------- -------- -------- Total investments and cash equivalents $126,699 $136,246 $138,078 $138,312 $127,627 ======== ======== ======== ======== ======== (1) Market value is principally determined by quotations on national securities exchanges. When national securities exchange quotes are not available, quotations are determined by the Company's investment advisors. (2) These amounts represent gross invested bank balances.
During 1993, the Company adopted Financial Accounting Standards Board Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, which requires investments to be classified in one of three categories: held-to-maturity securities, available-for-sale securities and trading securities. Because such securities had already been appropriately classified as discussed above, there was no affect to the consolidated financial statements in 1993. During the fourth quarter of 1995 the Company concluded that it would no longer commit to holding any security to maturity, as this limited management from responding to changes in circumstances and perceived economic trends and it would no longer participate in the active trading of any portion of its portfolio. Accordingly, all invested amounts have been classified at December 31, 1996 and 1995 as available for sale. The Company's investment results, pre-tax investment yields and effective yields for the periods indicated were as follows:
Years ended December 31, 1996 1995 1994 1993 1992 Investment Results: (Dollars in thousands) --------------------------------------------------------------------- Average invested assets (includes short-term investments) $131,473 $137,162 $138,195 $132,970 $118,986 Net investment income 6,807 7,863 7,337 6,430 7,063 Average annual return on investments 6.14% 14.01% (0.72%) 8.91% 7.21% Average annual yield on investments: Fixed maturities 5.83% 6.15% 5.93% 5.51% 6.17% Equity securities 3.11 4.53 2.32 3.73 26.94 Short-term investments 41.35 33.55 19.38 24.21 3.62 ------------- ------------- ------------- ------------- ------------- Effective yield total investments 5.44 6.10 5.65 5.26 6.22 Less investment expense (0.26) (0.37) (0.34) (0.42) (0.28) ============= ============= ============= ============= ============= Total investment yield 5.18% 5.73% 5.31% 4.84% 5.94% ============= ============= ============= ============= ============= (1) The effective tax rates for the periods shown above are only those effective tax rates applicable to investment income for the corresponding periods (2) Average annual return is net investment income, realized gains (losses) and the change in unrealized gains (losses) divided by average invested assets. The effective tax rates used for average annual return are the effective tax rates applicable to net investment income, realized gains (losses) and the change in unrealized gains (losses) for the corresponding periods.
The maturity distribution of the Company's fixed maturity investments at December 31, 1996 was as follows: Amortized Cost Estimated Market Value Fixed maturities due: (Dollars in thousands) ----------------------------------- Within 1 year $ 4,235 $ 4,217 Beyond 1 year but within 5 years 47,667 48,023 Beyond 5 years but within 10 years 28,440 28,561 Beyond 10 years but within 20 years 13,905 14,010 Beyond 20 years 7,552 7,683 ----------------- ----------------- $ 101,799 $ 102,494 ================= ================= MARKETING AND GROWTH The Company markets its surety bond products in 50 states, the District of Columbia, Guam and Puerto Rico through approximately 9,000 independent agents and brokers. California constituted 20.8% and 22.4% of surety premiums written for the years ended December 31, 1996 and 1995, respectively. The Company also accepts surety business on a direct basis (i.e., without the assistance of an agent). For the years ended December 31, 1996 and 1995, direct business accounted for 4.3% and 4.6%, respectively, of surety premiums written. The Company directs its specialty property and casualty marketing efforts primarily at independent insurance producers. At December 31, 1996, the total number of producers placing coverage with Condor was 123, of which 82 represent California business and 41 represent Arizona business. Such producers are made aware of the coverages offered by Condor primarily through direct mailing and advertisements in trade publications and trade shows. THE SAFETY ASSOCIATION The Company's subsidiary, Condor, offers its monthly commercial automobile insurance policies to members of the Waste Industry Loss Prevention and Safety Association (d.b.a. "The Safety Association"). The Safety Association was formed in 1981 to enhance the availability of insurance for and provide services aimed at improving operational safety to the industries to which Condor provides insurance. One of the directors and executive officers of the Company is an officer, director and shareholder of The Safety Association. The Safety Association employs five field safety specialists who are responsible for inspecting members' fleets and facilities and providing safety engineering and loss prevention advice and aids to members, including videos and bi-monthly newsletters. The Company believes that the activities of the field safety specialists enhance loss prevention and risk experience. COMPETITION The insurance industry is a highly competitive industry. There are numerous firms, particularly in the specialty markets, which compete for a limited volume of business. Competition is based upon price, service, products offered and financial strength of the insurance company. There are a number of companies in the industry which offer packages and policies similar to the Company's. The largest surety company in the country has less than six percent of the total surety market. The top ten companies collectively have less than half of the total market. The industry is growing at an annual rate of only about three percent which has intensified the competition within the industry. The Company primarily competes for surety business in the specialty market which is dominated by small, regional companies. However, some of the national, standard market companies have begun to pursue specialty market business. Pricing, service and agent commissions are the primary competitive tools. The Company has positioned itself to be competitive in pricing and agent commissions, but strives to exceed its major competitors in the quality of its service. The Company believes that its branch service network and expertise in the specialty surety niche will enable it to compete effectively, even when challenged by the larger, better capitalized, standard market companies. The Company's strategy for its specialty property and casualty business generally is to position itself within a limited regional geographic location as a consistent and reliable provider of commercial insurance packages for insureds involved in specialized industries. The Company believes that its monthly direct-bill commercial policies create a competitive advantage because the insured is not required to finance an annual premium. Additionally, the Company believes that its ability to provide a consistent insurance package for specialized industries and to continue to provide quality service in the handling of claims through staff who are particularly experienced in the areas of the Company's specialization permit it to compete successfully in its targeted customer base. The Company's direct billing also enables insurance producers to enjoy the benefits of a monthly commission without incurring the cost of billing and the attendant problems relating to premium collection. EMPLOYEES At December 31, 1996, the Company employed 479 people. GOVERNMENT REGULATION During 1995, two of the Company's wholly owned insurance subsidiaries, Amwest Surety and Far West redomesticated from California to the State of Nebraska, in part to reduce the Company's premium tax expenses. The Company's other insurance subsidiary, Condor, remains a California domiciled company. The redomestication had no impact on the Company's physical location, but does affect the ongoing regulation of the insurance subsidiaries and the Company. Subsequent to the redomestication, the Company became regulated by the Nebraska Department of Insurance as an insurance holding company because it controls two Nebraska domiciled insurance companies. Any person who acquires or agrees to acquire an amount of the Company's Common Stock which would cause him to own beneficially more than 10% of such stock must obtain the prior approval of the Nebraska Insurance Commissioner. The Company's insurance subsidiaries are required to file with the Department of Insurance in their state of domicile information concerning ownership, financial condition, capital structure and general business operations. The Company's insurance subsidiaries can only conduct business in states in which they are licensed. Each of the insurance subsidiaries are subject to varying degrees of regulation and supervision in the states in which they conduct business. This regulation relates to such matters as the adequacy of reserves, the type and quality of investments, minimum capital and surplus requirements, risk-based capital requirements, deposit of securities with state insurance authorities for the benefit of policyholders, restrictions on dividends, periodic examination of the insurers' affairs, claims handling procedures, and annual and other reports required to be filed with the state insurance commissioners on the financial and other condition of these companies. The subsidiaries must also file rates with most of the states in which they are licensed to underwrite insurance. The Company's insurance subsidiaries are also subject to triennial examinations of their financial condition by their state of domicile. Condor is currently under examination by the State of California and a report is expected in early 1997. Management does not believe any findings in the examiners report will be material to the financial position of Condor at December 31, 1996. Amwest Surety and Far West were last examined in 1993. Amwest Surety and Far West are also regulated by the United States Department of the Treasury as acceptable sureties for Federal bonds. During 1994, the Department of the Treasury changed its minimum requirement for bonding Federal obligations from $25,000 to $100,000. This change could reduce the number of Federal bonds written, however, the Company believes that it has not and will not have a material affect on the Company's business. Condor is a participant in California's "assigned risk" program as it relates to commercial automobile liability insurance. Automobile liability insurers in California are required to sell bodily injury liability to a proportionate number (based on the insurer's share of the California automobile casualty insurance market) of those drivers applying to the California Department of Insurance for placement as assigned risks. Drivers seek placement as assigned risks because their driving records or other relevant characteristics make them difficult to insure in the open market. See discussion regarding Proposition 103 at Item 3 - "Legal Proceedings." ITEM 2. PROPERTIES The Company leases all of its office space which, as of December 31, 1996, totaled approximately 156,000 square feet. The home office aggregates approximately 53,000 square feet. In addition, the Company leases and subleases approximately 18,000 square feet of office space in the same building as home office. Branch locations range from 270 to 4,600 square feet. See Note 12 of Notes to Consolidated Financial Statements. On January 26, 1996, the Company entered into a lease agreement for new home office space in the City of Calabasas, located approximately 7 miles from its current home office. The expected occupancy date for this office space is June 1997. The lease term is for a period of 15 years and covers approximately 63,000 square feet. The Company also has the option to purchase this new home office building and land three years into the lease period at a predetermined rate for the building, with the value of land based on then existing market rates. ITEM 3. LEGAL PROCEEDINGS The Company is from time to time named as a defendant in various lawsuits incidental to its business. Listed below are recent developments in certain legal proceedings involving the Company or its insurance subsidiaries: Proposition 103 - California voters passed Proposition 103, an insurance initiative which required a rollback in insurance rates for policies (and bonds) written or renewed during the twelve month period beginning November 8, 1988 and provided that changes in insurance premiums after November 8, 1988 must be submitted for approval of the California Insurance Commissioner prior to implementation. While the Proposition has the most significant impact on automobile insurance, its provisions, as written, also apply to other property and casualty insurers including surety insurers. On August 26, 1990, the State of California enacted Insurance Code Section 1861.135 ("Section 1861.135") exempting surety insurance from the rate rollback and prior approval provisions of Proposition 103. Section 1861.135 does not affect Proposition 103's prohibition against excessive, inadequate or discriminatory rates. Due to the enactment of Section 1861.135, the Company terminated a previously established reserve for potential premium rebates. Subsequently, the Department of Insurance ("Department") and Voter Revolt brought a motion for writ of mandate challenging the validity of Section 1861.135. On March 21, 1991, the Los Angeles Superior Court concluded that Section 1861.135 did not violate the California Constitution or provisions of Proposition 103. The Department and Voter Revolt appealed. On December 7, 1993, the Second District Court of Appeal overturned Section 1861.135 by a 2-1 vote. On February 24, 1994, the California Supreme Court agreed to hear the Company's petition for review, thereby staying the Court of Appeals opinion. On December 14, 1995, the Supreme Court of the State of California affirmed the decision of the Second District Court of Appeal, overturning Insurance Code Section 1861.135, which exempted the surety insurance industry from major provisions of Proposition 103. Accordingly, the Company is no longer exempted from the rate rollback and prior approval provisions contained in Proposition 103. The Company accrued $2,000,000 during the quarter ended December 31, 1995 representing the Company's best estimate of its rollback obligations pursuant to Proposition 103. On August 15, 1996, the Company entered into a Stipulation and Consent Order with the Insurance Commissioner of the State of California which requires the Company's insurance subsidiaries to pay $1,928,370 in full payment of their Proposition 103 liabilities. The Proposition 103 refund checks were issued by the subsidiaries in January 1997. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION The Company's Common Stock has been traded on the American Stock Exchange under the symbol AMW since June 25, 1987 and on the Pacific Stock Exchange under the symbol AMW since April 21, 1988. The following table sets forth, for the periods indicated, the high and low sale prices per share as reported on the American Stock Exchange. This table also sets forth the amount per share of cash dividends paid by the Company with respect to its Common Stock for each of the indicated periods. Period High Low Dividends - ------ ---- --- --------- 1994 First Quarter $14 1/2 $12 $.09 Second Quarter 14 1/4 12 1/2 .09 Third Quarter 13 7/8 12 1/8 .09 Fourth Quarter 12 3/8 11 1/8 .09 1995 First Quarter 15 1/4 11 3/4 .10 Second Quarter 15 14 1/8 .10 Third Quarter 15 1/8 14 1/4 .10 Fourth Quarter 18 1/4 14 7/8 .10 1996 First Quarter 15 3/8 13 3/8 .11 Second Quarter 13 7/8 11 3/4 .11 Third Quarter 12 1/2 11 1/2 .11 Fourth Quarter 13 3/4 11 1/4 .11 On March 27, 1997, the closing price of the Company's Common Stock on the American Stock Exchange was $12.125 per share. HOLDERS As of March 27, 1997, there were 341 holders of record of the Company's Common Stock. However, based on available information, the Company believes that the total number of stockholders, including beneficial stockholders, exceeds 1,000. DIVIDENDS The Company began paying cash dividends in 1986. The Company's ability to pay cash dividends is subject to certain regulatory and contractual restrictions. See Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" and Notes 8 and 10 of Notes to Consolidated Financial Statements. In addition to regulatory and contractual restrictions, the payment, amount and timing of future dividends by the Company will depend upon the Company's operating results, overall financial condition, capital requirements and general business condition, as well as other factors deemed relevant by the Board of Directors. ITEM 6. SELECTED FINANCIAL DATA The selected data presented on page 20 under the captions "Summary of Earnings," "Year End Financial Position" and "Operating Ratios" for, and as of the end of, each of the years in the five year period ended December 31, 1996, are derived from the consolidated financial statements of Amwest Insurance Group, Inc. and subsidiaries, which financial statements have been audited by KPMG Peat Marwick LLP, independent certified public accountants. The consolidated financial statements as of December 31, 1996 and 1995 and for each of the years in the three year period ended December 31, 1996 and the report thereon, are included elsewhere in this Annual Report on Form 10-K.
SELECTED FINANCIAL DATA (In thousands, except per share amounts) Year ended December 31, 1996 1995 1994 1993 1992 ------------------------------------------------------------------------------- Summary of Earnings: Net premiums earned $ 87,883 $ 85,170 $ 81,289 $ 72,085 $ 63,543 Underwriting expenses 97,712 89,644 80,960 73,663 62,666 Underwriting income (loss) (9,829) (4,474) 329 (1,578) 877 Net investment income 6,807 7,863 7,337 6,430 7,063 Realized gains (losses) 2,201 2,176 65 2,331 950 Income (loss) before income taxes and extraordinary item (5,046) 4,498 6,393 4,948 6,322 Provision for income taxes (2,360) 829 1,352 1,001 1,297 Income before extraordinary item (2,686) 3,669 5,041 3,947 5,025 Extraordinary item - - - (249) - Net income $ (2,686) $ 3,669 $ 5,041 $ 3,698 $ 5,025 =============================================================================== Per share: Income before extraordinary item $ (.80) $ 1.10 $ 1.50 $ 1.20 $ 1.55 Extraordinary item - - - (.08) - Net income $ (.80) $ 1.10 $ 1.50 $ 1.12 $ 1.55 =============================================================================== Dividends $ 0.44 $ 0.40 $ 0.36 $ 0.28 $ 0.28 =============================================================================== Weighted average number of shares outstanding 3,350 3,341 3,350 3,299 3,251 =============================================================================== Year End Financial Position: Total investments $ 120,265 $ 131,014 134,047 131,209 116,539 Total assets 181,418 183,833 186,863 195,856 161,005 Bank indebtedness 12,500 12,500 12,500 12,500 12,264 Total stockholders' equity 49,932 55,075 46,157 48,347 42,184 Average stockholders' equity 52,504 50,616 47,252 45,266 39,973 Return on stockholders' equity (5.12%) 7.25% 10.67% 8.17% 12.57% Operating Ratios: Loss & loss adjustment expenses 53.08% 41.41% 35.35% 39.49% 32.86% Policy acquisition costs 43.66% 44.70% 45.03% 40.13% 43.92% General operating expenses 14.45% 16.80% 19.21% 19.98% 21.85% Other operating expenses - 2.35% - 2.59% - Combined ratios 111.18% 105.25% 99.60% 102.19% 98.62%
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS On March 14, 1996, the Company merged with Condor Services, Inc. in a transaction accounted for as a pooling of interests (the "Merger").The following analysis has been prepared as if Condor Services, Inc. ("CSI") were wholly owned for all periods presented herein. RESULTS OF OPERATIONS Year ended December 31, 1996 compared to year ended December 31, 1995 Premiums written increased 3.3% from $94,184,000 in 1995 to $97,242,000 in 1996. The increase in premiums written is attributable primarily to court probate bonds subsequent to the Company's acquisition of Southern California Bonding, Inc. in March of 1996. Net premiums earned increased 3.2% from $85,170,000 in 1995 to $87,883,000 in 1996. The increase in net premiums earned reflects the increased premium writings. Net losses and loss adjustment expenses increased 32.3% from $35,265,000 in 1995 to $46,647,000 in 1996. This resulted in an increase in the loss and loss adjustment expense ratio from 41.4% in 1995 to 53.1% in 1996. The increased loss ratio is primarily attributable to an increase in the loss and loss adjustment expense ratio for contract performance and payment bonds from 40.3% in 1995 to 52.9% in 1996 as well as adverse loss experience on the Company's private passenger automobile program in the State of Arizona. The loss ratio on contract performance and payment bonds was negatively impacted by increased severity caused by a number of large losses reported in 1996. Such losses were not limited to any one geographic area. The adverse loss development on private passenger business in Arizona is due to general rate inadequacy for that program. Policy acquisition costs as a percentage of net premiums earned decreased from a ratio of 44.7% or $38,070,000 in 1995 to 43.7% or $38,367,000 in 1996. The relatively constant ratio reflects the costs associated with producing contract and commercial surety business through the Company's network of 30 branch offices, as well as commissions and premium taxes on the Company's other product lines. General operating costs also decreased as a percentage of net premiums earned from 16.8% or $14,309,000 in 1995 to 14.5% or $12,698,000 in 1996. The decrease in the actual amount of general operating costs is primarily attributable to significantly reduced bonus accruals in 1996 due to the Company's 1996 results as well as efficiencies related to the merger between the Company and Condor Services, Inc. which occurred in March of 1996. On December 14, 1995 the Supreme Court of the State of California affirmed the decision of the Second District Court of Appeal overturning Insurance Code Section 1861.135 which exempted the surety insurance industry from major provisions of proposition 103. Accordingly the Company is no longer exempted from the rate rollback and prior approval provisions contained in Proposition 103. The Company accrued $2,000,000 during the quarter ended December 31, 1995. On August 15, 1996, the Company entered into a Stipulation and Consent Order with the Insurance Commissioner of the State of California which required the Company's insurance subsidiaries to pay $1,928,370. The Proposition 103 refund checks were issued in January 1997. The Company's underwriting loss increased from $4,474,000 for the year ended December 31, 1995 to $9,829,000 for the year ended December 31, 1996. The combined ratio increased from 105.3% in 1995 to 111.2% in 1996. The increase in the underwriting loss is primarily attributable to increased losses on the contract performance and payment bond and Arizona private passenger automobile lines of business as discussed above. Interest expense decreased 5.4% from $1,056,000 in 1995 to $999,000 in 1996 due to an decrease in the average interest rate on the bank indebtedness. The $12,500,000 in outstanding indebtedness has a variable rate which averaged 7.8% during 1995 but decreased to an average rate of 7.4 % during 1996 due to fluctuations during 1996 in the London Interbank Offered Rate (LIBOR) which is used as the benchmark for the Company's rate on bank indebtedness. The interest rate on the Company's bank indebtedness at December 31, 1996 was 6.88 %. Collateral interest expense decreased 28.3% from $1,698,000 in 1995 to $1,218,000 in 1996. This decrease is attributed to an overall reduction in funds held as collateral during 1996. At December 31, 1995 and 1996, the collateral balances accrued interest daily at an average rate of 3.5% and 3.8% per annum, respectively. Net investment income and realized investment gains decreased 10.3% from $10,039,000 in 1995 to $9,008,000 in 1996. This decrease is primarily due to a decrease in the amount of invested assets from $131,014,000 at December 31, 1995 to $120,265,000 at December 31, 1996. Average annual yield on investments decreased from 5.7% in 1995 to 5.2% in 1996. Realized investment gains amounted to $2,176,000 during 1995 compared to $2,201,000 during 1996. Other revenue decreased 99.8% from $797,000 in 1995 to $2,000 in 1996. Included in this number for 1995 is revenue earned from independent third parties by the Company's subsidiary, Raven Claims Services. During 1996, the Company performed minimal loss adjusting activities for outside sources. Merger expenses of $710,000 was incurred in 1996 in connection with the Merger of CSI with and into Amwest Insurance Group, Inc. Subsequent to the Merger, the separate existence of CSI ceased. The Merger has been accounted for as a pooling of interests. Lease termination costs of $1,300,000 were incurred in 1996 in connection with the signing of a definitive agreement to terminate the Company's lease at its Corporate headquarters prior to its scheduled termination in August 1998. The Company's lease at its current headquarters will now terminate on June 30, 1997 at which time the Company intends to occupy a new facility in Calabasas, California at significantly reduced rental rates. Income (loss) before income taxes decreased from income of $4,498,000 in 1995 to a loss of $5,046,000 in 1996 due to the factors outlined above. The effective tax rate was 18.4% for the year ended December 31, 1995. The effective rate of the tax benefit for 1996 is 46.8%. The primary reason for the variance from the corporate income tax rate of 34% is tax advantage income received on a portion of the Company's investment portfolio. Net income (loss) decreased from income of $3,669,000 in 1995 to a loss of $2,686,000 in 1996 due to the factors outlined above. Year ended December 31, 1995 compared to year ended December 31, 1994 Premiums written remained relatively flat at $94,222,000 in 1994 as compared to $94,184,000 in 1995. No product line had significant changes in written premium from 1994 to 1995. Net premiums earned increased 4.8% from $81,289,000 in 1994 to $85,170,000 in 1995. The increase in net premiums earned reflects the increased premium writings in the latter half of 1994 which were earned during 1995. The Company earns premiums ratably over the estimated bond and/or policy terms. Net losses and loss adjustment expenses increased 22.7% from $28,737,000 in 1994 to $35,265,000 in 1995. This resulted in an increase in the loss and loss adjustment expense ratio from 35.5% in 1994 to 41.4% in 1995. The increased loss ratio is primarily attributable to an increase in the loss and loss adjustment expense ratio on the contract performance and payment bond product line from 26.0% in 1994 to 40.3% in 1995. The loss ratio on contract performance and payment bonds was negatively impacted by increased severity caused by a number of large losses reported in 1995. Such losses were not limited to any one geographic area. Policy acquisition costs as a percentage of net premiums earned remained relatively constant at a ratio of 45.0% or $36,607,000 in 1994 as compared to 44.7% or $38,070,000 in 1995. General operating costs also decreased as a percentage of net premiums earned from 19.2% or $15,616,000 in 1994 to 16.8% or $14,309,000 in 1995. The decrease in the actual amount of general operating costs is primarily attributable to earthquake related charges and a loss on subleasing a portion of the Company's headquarters during 1994. No such charges were incurred during 1995. Underwriting income (loss) decreased from income of $329,000 for the year ended December 31, 1994 to an underwriting loss of $4,474,000 for the year ended December 31, 1995. Excluding the Proposition 103 accrual, the Company would have had an underwriting loss of $2,474,000 for the year ended December 31,1995. The reason for the underwriting loss is a combination of the facts previously discussed. The combined ratio increased from 99.6% in 1994 to 105.3% in 1995. Interest expense increased 25.7% from $840,000 in 1994 to $1,056,000 in 1995 due to an increase in the interest rate on the bank indebtedness. The $12,500,000 in outstanding indebtedness has a variable rate which averaged 6.7% during 1994 but increased to an average rate of 7.8% during 1995 due to higher average short term interest rates in 1995 versus 1994. The interest rate on the Company's bank indebtedness at December 31, 1995 was 7.9375%. Collateral interest expense decreased 11.6% from $1,921,000 in 1994 to $1,698,000 in 1995. This decrease is attributed to an overall reduction in funds held as collateral during 1995. At December 31, 1994 and 1995, the collateral balances accrued interest daily at an average rate of 3.9% and 3.5% per annum, respectively. Net investment income and realized investment gains (losses) increased 35.6% from $7,402,000 in 1994 to $10,039,000 in 1995. This increase is primarily due to an increase in realized gains on sales of investments from $65,000 in 1994 to $2,176,000 in 1995. This change of $2,111,000 was augmented by slightly higher yields on larger invested balances during 1995. Such higher yields were predominately attributable to investments made prior to the general decline in interest rates during 1995. Income before income taxes decreased 29.6% from $6,393,000 in 1994 to $4,498,000 in 1995 due to the factors outlined above. Excluding the Proposition 103 accrual income before income taxes increased to $6,498,000 in 1995. The Company's net income for 1995 includes a one time recovery of $890,000 related to previously misappropriated funds from Condor Insurance Company which was acquired in March of 1996 in a transaction accounted for as a pooling of interests. The effective tax rate was 21.2% for the year ended December 31, 1994 as compared to 18.4% for the year ended December 31,1995 . The lower effective tax rate in 1995 is attributed to a greater amount of income before income taxes derived from tax-advantaged securities in 1995. Net income decreased 27.2% from $5,041,000 in 1994 to $3,669,000 in 1995 due to the factors outlined above. Excluding the accrual of the Proposition 103 premium refund net income decreased by 1.0% to $4,989,000. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 1996, the Company had total cash and cash equivalents and investments of $126,699,000. Included in these amounts is an aggregate of $29,928,000 in funds held as collateral which are shown as a liability on the Company's consolidated balance sheet. As of December 31, 1996, the Company's investment balances were comprised of $102,494,000 in fixed maturities held at market, $9,779,000 in common equity securities, $4,253,000 in preferred equity securities, $2,849,000 in other invested assets and $890,000 in short-term investments. The Company's off balance sheet collateral which primarily consists of irrevocable letters of credit and certificates of deposit declined from $228,428,000 at December 31, 1995 to $215,315,000 at December 31, 1996. This decrease is primarily attributable to competitive market conditions and a decrease in contract performance and payment bond writings in 1996. In addition, cash collateral declined from $37,650,000 at December 31, 1995 to $29,928,000 at December 31, 1996. The Company reflects in its consolidated financial statements only funds received as collateral on which net earnings inure to the benefit of the Company. The decline in this amount is primarily attributed to decreased writings in those lines of business for which cash collateral is generally accepted. These include contractor's license bonds and sales tax bonds. The amount of cash collateral can also be impacted by the timing and payment of claims activity related to draws on irrevocable letters of credit and certificates of deposit. Because the Company depends primarily on dividends from its insurance subsidiaries for its net cash flow requirements, absent other sources of cash flow, the Company cannot pay dividends materially in excess of the amount of dividends that could be paid by the insurance subsidiaries to the Company. See Note 8 of Notes to Consolidated Financial Statements. On December 30, 1988, the Company borrowed $12,300,000 (the "1988 Loan") pursuant to a credit agreement with Security Pacific National Bank of which $10,000,000 was contributed on that date to the surplus of Amwest Surety. See Note 10 of Notes to Consolidated Financial Statements. On August 6, 1993, the Company entered into a revolving credit agreement with Union Bank for $12,500,000 which refinanced the 1988 Loan. This loan was amended on April 24,1995 and again on July 10, 1996 to increase the amount available under the revolving line of credit from $12,500,000 to $15,000,000. The loan has a variable rate based upon fluctuations in the London Interbank Offered Rate (LIBOR) with amortizing principal payments beginning September 30, 1996 and maturing September 30, 2001. The interest rate at December 31, 1996 was 6.88%. The credit agreement contains certain financial covenants with respect to capital expenditures, business acquisitions, liquidity ratio, leverage ratio, tangible net worth, net profit and dividend payments. The Company is a party to a lease with Trillium/Woodland Hills regarding its corporate headquarters. During 1996, the Company signed of a definitive agreement to terminate the Company's lease at its Corporate headquarters prior to its scheduled termination in August 1998. The Company's lease at its current headquarters will now terminate on June 30, 1997. On January 26, 1996, the Company entered into a lease agreement for new home office space in the City of Calabasas, California. The expected occupancy date for this office space is June 1997. The lease term is for a period of 15 years and contains provisions for scheduled lease charges. The Company's minimum commitment with respect to this lease in 1997 is approximately $515,000. The Company also has the option to purchase this new home office building and land three years into the lease period at a predetermined rate for the building, with the value of land based on then existing market rates. See Note 12 of Notes to Consolidated Financial Statements. Other than the Company's obligations with respect to funds held as collateral, the Company's obligations to pay claims as they arise, the Company's commitments to pay principal and interest on the bank debt, the Company's obligation under Proposition 103 and lease expenses as noted above, the Company has no significant cash commitments. The Company believes that its cash flows from operations and other present sources of capital are sufficient to sustain its needs for the remainder of 1997. The Company generated $8,534,000, used $1,252,000 and generated $1,346,000 in cash from operating activities in the fiscal years ended December 31, 1994, 1995 and 1996, respectively. The Company used $12,394,000 and generated $10,363,000 and $8,741,000 in cash for investing activities for the fiscal years ended December 31, 1994, 1995 and 1996, respectively. The Company generated $1,327,000, and used $10,143,000 and $8,885,000 in cash from financing activities for the fiscal years ended December 31, 1994, 1995 and 1996, respectively. The cash used for investing activities in 1994 was funded principally by operating activities. The effect of inflation on the revenues and net income of the Company during all three periods discussed above was not significant. Certain statements contained in this Form 10-K regard matters which are not historical facts and are forward looking statements. Because such forward looking statements include risks and uncertainties, actual results may differ materially from those expressed in or implied by such forward looking statements. Factors that could cause actual results to differ materially include, but are not limited to: A decline in demand for surety bonds or specialty property and casualty insurance, the ineffectiveness of changes made by management, a deterioration in results of any of the Company's product lines, or a general economic decline. The Company undertakes no obligation to release publicly the results of any revisions to these forward looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements required in response to this section are submitted as part of Item 14(a) of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT For information regarding Directors and Executive Officers of the Registrant, reference is made to the Registrant's definitive proxy statement for its Annual Meeting of Stockholders to be held on May 30, 1997, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1996, and which is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION For information regarding executive compensation, reference is made to the Registrant's definitive proxy statement for its Annual Meeting of Stockholders to be held on May 30, 1997, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1996, and which is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT For information regarding security ownership of certain beneficial owners and management, reference is made to the Registrant's definitive proxy statement for its Annual Meeting of Stockholders to be held on May 30, 1997, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1996, and which is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS For information regarding certain relationships and related transactions, reference is made to the Registrant's definitive proxy statement for its Annual Meeting of Stockholders to be held on May 30, 1997, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1996, and which is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Financial Statements The index to the consolidated financial statements appears on page 38. (b) Reports on Form 8-K None. (c) Exhibits 3.1 Restated Certificate of Incorporation of the Company as amended to date. (Incorporated by reference to Exhibit 3(3)(a) to the Company's Form 8-B Registration Statement No. 1-9580.) 3.2 Bylaws of the Company. (Incorporated by reference to Exhibit 3.2 of the Company's 1990 Form 10-K.) 4.1 Specimen Common Stock Certificate. (Incorporated by reference to Exhibit 3(4) to the Company's Form 8-B Registration Statement No. 1-9580.) 10.1 Lease Agreement dated April 1, 1986, by and between Amwest Insurance Group, Inc. and Trillium/Woodland Hills. (Incorporated by reference to Exhibit 10.9 to the Company's 1986 Form 10-K.) 10.2 First amendment to Lease Agreement dated January 30, 1987, by and between Amwest Insurance Group, Inc. and Trillium/Woodland Hills. (Incorporated by reference to Exhibit 10.13 to the Company's 1987 Form 10-K.) 10.3 Second amendment to Lease Agreement dated June 11, 1987, by and between Amwest Insurance Group, Inc. and Trillium/Woodland Hills. (Incorporated by reference to 10.14 to the Company's 1987 Form 10-K.) 10.4 Third amendment to Lease Agreement dated September 1, 1988, by and between Amwest Insurance Group, Inc. and Trillium/Woodland Hills. (Incorporated by reference to Exhibit 10.15 to the Company's 1988 Form 10-K.) 10.5 Reinsurance Binder dated October 13, 1988 by and between Condor Services, Inc. and Transamerica Reinsurance Company (Incorporated by reference to Exhibit 10.8 to the Condor Services, Inc. Registration Statement). 10.6 Agreement for Semi-Automatic Facultative Reinsurance Agreement by and between Condor Insurance Company and General Reinsurance Corporation (Incorporated by reference to Exhibit 10.11 to the Condor Services, Inc. Registration Statement). 10.7 Memorandum of Reinsurance dated October 23, 1989, as amended by Addendum Number 1 dated December 21, 1989 and Addendum Number 2 dated February 1, 1990, regarding Property Catastrophe Excess of Loss Reinsurance Agreement between Transamerica Reinsurance Company and Condor Insurance Company (Incorporated by reference to Exhibit 10.15 to Condor Services, Inc.'s 1989 Form' 10-K). 10.8 Memorandum of Reinsurance dated October 23, 1989, as amended by Addendum Number 1 dated November 22, 1989, Addendum Number 2 dated December 21, 1989 and Addendum Number 3 dated February 1, 1990, regarding Casualty Excess of Loss Reinsurance Agreement between Transamerica Reinsurance Company and Condor Insurance Company (Incorporated by reference to Exhibit 10.16 to Condor Services, Inc.'s 1989 Form 10-K). 10.9 Memorandum of Reinsurance dated October 23, 1989, as amended by Addendum Number 1 dated December 15, 1989, Addendum Number 2 dated December 21, 1989 and Addendum Number 3 dated February 1, 1990, regarding the Property Quota Share Reinsurance Agreement between Transamerica Reinsurance Company and Condor Insurance Company Incorporated by reference to Exhibit 10.17 to Condor Services, Inc.'s 1989 Form 10-K). 10.10 Memorandum of Reinsurance dated October 23, 1989, as amended by Addendum Number 1 dated November 22, 1989, Addendum Number 2 dated December 21, 1989, Addendum Number 3 dated January 15, 1990, Addendum Number 4 dated January 15, 1990, and Addendum Number 5 dated February 1, 1990, regarding the Casualty Quota Share Reinsurance Agreement between Transamerica Reinsurance Company and Condor Insurance Company (Incorporated by reference to Exhibit 10.18 to Condor Services, Inc.'s 1989 Form 10-K). 10.11 Fourth amendment to Lease Agreement dated November 20, 1989, by and between Amwest Insurance Group, Inc. and Trillium/Woodland Hills. (Incorporated by reference to 10.15 to the Company's 1989 Form 10-K.) 10.12 Fifth amendment to Lease Agreement dated December 20, 1989, by and between Amwest Insurance Group, Inc. and Trillium/Woodland Hills. (Incorporated by reference to 10.16 to the Company's 1989 Form 10-K.) 10.13 Sixth amendment to Lease Agreement dated December 31, 1989, by and between Amwest Insurance Group, Inc. and Trillium/Woodland Hills. (Incorporated by reference to 10.17 to the Company's 1989 Form 10-K.) 10.14 Memorandum of Reinsurance dated June 6, 1990 regarding modification of Excess Open Lot Automatic Agreement between Condor Insurance Company and General Reinsurance (Incorporated by reference to Exhibit 10.25 to Condor Services, Inc.'s 1990 Form 10-K). 10.15 Third-party administrative support service agreement for California Non-CAIP Assigned Risk Automobile (Incorporated by reference to Exhibit 10.28 to Condor Services, Inc.'s 1991 Form 10-K). 10.16 Memorandum of Reinsurance dated December 1, 1990 regarding the Property Quota Share Reinsurance Agreement Between Prudential Reinsurance Company, The General Security Assurance Corporation of New York, Insurance Corporation of Hanover and Republic Western Insurance Company (Incorporated by reference to Exhibit 10.24 to Condor Services, Inc.'s 1990 Form 10-K). 10.17 Reinsurance Treaty dated May 1, 1991 for Semi-automatic Property Catastrophic cover with General Reinsurance (Incorporated by reference to Exhibit 10.30 to Condor Services, Inc.'s 1991 Form 10-K). 10.18 Reinsurance Treaty dated May 1, 1991 for Property Quota Share with Republic Western, Insurance Corporation of Hanover, Prudential Reinsurance and General Security Assurance Corporation of New York (Incorporated by reference to Exhibit 10.31 to Condor Services, Inc.'s 1991 Form 10-K). 10.19 Reinsurance Treaty dated May 1, 1991 for Property Catastrophic Excess of Loss with various underwriting members of Lloyd's (Incorporated by reference to Exhibit 10.32 to Condor Services, Inc.'s 1991 Form 10-K). 10.20 Reinsurance Treaty dated May 1, 1991 for Excess of Loss with Gerling Global Reinsurance Corporation and Republic Western Insurance Company (Incorporated by reference to Exhibit 10.33 to Condor Services, Inc.'s 1991 Form 10-K). 10.21 Reinsurance Treaty dated May 1, 1991 for Second Casualty Excess with Lloyd's and various London company markets (Incorporated by reference to Exhibit 10.34 to Condor Services, Inc.'s 1991 Form 10-K). 10.22 Reinsurance Treaty dated May 1, 1991 for First Casualty Excess of Loss domestic placement with Gerling Global Reinsurance Corporation and Republic Western Insurance Company (Incorporated by reference to Exhibit 10.35 to Condor Services, Inc.'s 1991 Form 10-K). 10.23 Reinsurance Treaty dated May 1, 1991 for First Casualty Excess of Loss, foreign placement with Lloyds and various London company markets (Incorporated by reference to Exhibit 10.36 to Condor Services, Inc.'s 1991 Form 10-K). 10.24 Contract between the Company and Hewlett-Packard Company, dated September 16, 1991. (Incorporated by reference to Exhibit 10.22 to the Company's 1991 Form 10-K.) 10.25 Memorandum of Reinsurance dated October 1, 1991 for Facultative Casualty with Transatlantic Reinsurance and USF Reinsurance (Incorporated by reference to Exhibit 10.29 to Condor Services, Inc.'s 1991 Form 10-K). 10.26 Memorandum of Reinsurance dated March 16, 1992, effective October 1, 1991; Third Casualty Excess of Loss Reinsurance with 91.67% Transatlantic Reinsurance Company and 8.33% USF Re Insurance Company (Incorporated by reference to Exhibit 10.39 to Condor Services, Inc.'s 1992 Form 10-K). 10.27 Lease Agreement dated June 16, 1992 by and between Amwest Insurance Group, Inc. and Hewlett-Packard Company. (Incorporated by reference to Exhibit 10.18 to the Company's 1992 Form 10-K.) 10.28 Investment Management Agreement between the Company and AAM Advisors, Inc., dated August 11, 1992. (Incorporated by reference to Exhibit 10.21 to the Company's 1992 Form 10-K.) 10.29 Contract between the Company and Scudder, Stevens & Clark, Inc., dated August 13, 1992. (Incorporated by reference to Exhibit 10.22 to the Company's 1992 Form 10-K.) 10.30 First Excess of Loss Reinsurance Contract effective October 1, 1992 issued to Amwest Surety Insurance Company and Far West Insurance Company by a group of reinsurers lead by Kemper Reinsurance Company. (Incorporated by reference to Exhibit 10.19 to the Company's 1992 Form 10-K.) 10.31 Notice of Commencement Date dated December 9, 1992 regarding Lease dated December 1, 1991 between Condor Services, Inc. and Continental Development (Incorporated by reference to Exhibit 10.37 to Condor Services, Inc.'s 1992 Form 10-K). 10.32 Memorandum of Reinsurance dated July 23, 1993 regarding First Casualty Excess of Loss Reinsurance Agreement between Condor Insurance Company and Gerling Global Reinsurance Corporation, U.S. Branch, The Reinsurance Corporation of New York, Republic Western Insurance Company, and USF Re Insurance Company (Incorporated by reference to Exhibit 10.40 to Condor Services, Inc.'s 1993 Form 10-K). 10.33 Memorandum of Reinsurance dated July 23, 1993 regarding Second Casualty Excess of Loss Reinsurance Agreement between Condor Insurance Company and Gerling Global Reinsurance Corporation, U.S. Branch, The Reinsurance Corporation of New York, Republic Western Insurance Company, Insurance Corporation of Hanover, and USF Re Insurance Company (Incorporated by reference to Exhibit 10.41 to Condor Services, Inc.'s 1993 Form 10-K). 10.34 Memorandum of Reinsurance dated July 23, 1993 regarding Property Auto Physical Damage First Funded Catastrophe Excess of Loss Reinsurance Agreement between Condor Insurance Company and Gerling Global Reinsurance Corporation, U.S. Branch, AXA Reinsurance Company, Employers Mutual Casualty Company, and USF Re Insurance Company (Incorporated by reference to Exhibit 10.42 to the Condor Services, Inc.'s 1993 Form 10-K). 10.35 Memorandum of Reinsurance dated August 3, 1993 regarding Addendum No. 2 to the Property Package/Marine 60% Quota Share of $500,000 Agreement between Condor Insurance Company and Republic Western Insurance Company (Incorporated by reference to Exhibit 10.43 to Condor Services, Inc.'s 1993 Form 10-K). 10.36 Revolving Credit Agreement dated August 6, 1993 between Amwest Insurance Group, Inc. and Union Bank. (Incorporated by reference to Exhibit 10.13 to the Company's 1993 Form 10-K.) 10.37 First Amendment to the First Excess of Loss Reinsurance Contract effective October 1, 1993. (Incorporated by reference to Exhibit 10.14 to the Company's 1993 Form 10-K.) 10.38 Semiautomatic Bond Quota Share Reinsurance Contract effective October 1, 1993 issued to Amwest Surety Insurance Company by Kemper Reinsurance Company and Underwriters Reinsurance Company. (Incorporated by reference to Exhibit 10.15 to the Company's 1993 Form 10-K.) 10.39 Semiautomatic Contract Surety Reinsurance Agreement effective March 1, 1994 issued to Amwest Surety Insurance Company and Far West Insurance Company by a group of reinsurers lead by Kemper Reinsurance Company. (Incorporated by reference to Exhibit 10.17 to the Company's 1994 Form 10-K.) 10.40 Memorandum of Reinsurance dated June 17, 1994 regarding First Casualty Excess of Loss Reinsurance Agreement between Condor Insurance Company and Gerling Global Reinsurance Corporation, U.S. Branch, The Reinsurance Corporation of New York, Republic Western Insurance Company and USF Re Insurance Company (Incorporated by reference to Exhibit 10.48 to Condor Services, Inc.'s 1994 Form 10-K). 10.41 Memorandum of Reinsurance dated June 17, 1994 regarding Second Casualty Excess of Loss Reinsurance Agreement between Condor Insurance Company and Gerling Global Reinsurance, The Reinsurance Corporation of New York, Republic Western Insurance Company and USF Re Insurance Company (Incorporated by reference to Exhibit 10.49 to Condor Services, Inc.'s 1994 Form 10-K). 10.42 First Excess of Loss Reinsurance Contract effective October 1, 1994 issued to Amwest Surety Insurance Company and Far West Insurance Company by a group of reinsurers lead by Kemper Reinsurance Company. (Incorporated by reference to Exhibit 10.16 to the Company's 1994 Form 10-K.) 10.43 Memorandum of Reinsurance dated October 21, 1994 regarding Excess of Loss Reinsurance of Commercial Property Business Agreement between Condor Insurance Company and General Reinsurance Corporation (Incorporated by reference to Exhibit 10.50 to Condor Services, Inc.'s 1994 Form 10-K). 10.44 First amendment to the Revolving Credit Agreement (Incorporated by reference to Exhibit 19.1 to the Company's March 31, 1995 Form 10-Q.) 10.45 Memorandum of Reinsurance dated May 1, 1995 regarding First Excess of Loss Reinsurance Agreement between Condor Insurance Company and Christiania General Insurance Corporation of New York, Gerling Global Reinsurance Corporation, U.S. Branch, Republic Western Insurance Company and USF Re Insurance Company. (Incorporated by reference to Exhibit 10.54 to Condor Services, Inc.'s 1995 Form 10-K.) 10.46 Memorandum of Reinsurance dated May 1, 1995 regarding Second Excess Casualty of Loss Reinsurance between Condor Insurance Company and Christiania General Insurance Corporation of New York, Gerling Global Reinsurance Corporation, U.S. Branch, Republic Western Insurance Company and USF Re Insurance Company. (Incorporated by reference to Exhibit 10.55 to Condor Services, Inc.'s 1995 Form 10-K.) 10.47 Memorandum of Reinsurance dated May 1, 1995 regarding Contingent Excess of Loss Reinsurance between Condor Insurance Company and Christiania General Insurance Corporation of New York, Folksamerica Reinsurance Company, Gerling Global Reinsurance Corporation, U.S. Branch, The Mercantile and General Reinsurance Company of America, Republic Western Insurance Company, SOREMA North America Reinsurance Company, TOA-RE Insurance Company of America, USF RE Insurance Company. (Incorporated by reference to Exhibit 10.56 to Condor Services, Inc.'s 1995 Form 10-K.) 10.48 Agreement and Plan of Merger dated November 30, 1995 by and between the Amwest Insurance Group, Inc. and Condor Services, Inc., a Delaware corporation (Incorporated by reference to Annex A to the Company's Form S-4 Registration Statement No. 333-00119.) 10.49 Stockholder Agreement dated November 30, 1995 by and between the Amwest Insurance Group, Inc. and Guy A. Main, stockholder of Condor Services, Inc. (Incorporated by reference to Annex B to the Company's Form S-4 Registration Statement No. 333-00119.) 10.50 First Amendment to office lease dated January 10, 1996 between Condor Services, Inc. and Continental Development Corporation, amending office lease filed as Exhibit 10.27 hereto (Incorporated by reference to Exhibit 10.53 to Condor Services, Inc.'s 1995 Form 10-K.) 10.51 Lease Agreement dated January 24, 1996 by and between Amwest Insurance Group, Inc. and ACD2, a California corporation (Incorporated by reference to 10.24 to the Company's Form S-4 Registration Statement No. 333-00119) 10.52 Option Agreement dated January 24, 1996 by and between Amwest Insurance Group, Inc. and ACD2, a California corporation (Incorporated by reference to 10.25 to the Company's Form S-4 Registration Statement No. 333-00119) 10.53 Casualty Excess of Loss Reinsurance Contract effective July 1, 1996 issued to Condor Insurance Company, Amwest Surety Insurance Company and Far West Insurance Company by a group of reinsurers led by Gerling Global Reinsurance Corporation. 10.54 Contingent Excess of Loss Reinsurance Contract effective July 1, 1996 issued to Co Condor Insurance Company, Amwest Surety Insurance Company and Far West Insurance Company by a group of reinsurers led by SOREMA North America Reinsurance Company. 10.55 Restated Revolving Credit Agreement dated July 10, 1996 between Amwest Insurance Group, Inc. and Union Bank of California, N.A. 10.56 Excess of Loss Reinsurance Contract effective October 1, 1996 issued to Amwest Surety Insurance Company by a group of reinsurers lead by Kemper Reinsurance Company. 10.57 Aggregate Excess of Loss Reinsurance Contract effective January 1, 1997 issued to Amwest Surety Insurance Company and Far West Insurance Company by Underwriters Reinsurance Company (Barbados) Inc. Management Contracts and Compensatory Plans: (10.23 through 10.27) 10.58 Stock Option Plan of the Company, as amended. (Incorporated by reference to Exhibit 4.1 to the Company's Form S-8 Registration Statement No. 33-82178.) 10.59 Form of Indemnity Agreement between the Company and Individual Directors and Certain Officers Designated by the Company's Board of Directors. (Incorporated by reference to Exhibit 3(10) to the Company's Form 8-B Registration Statement No. 1-9580.) 10.60 Form of Senior Executive Severance Agreement entered into by the Company and certain officers. (Incorporated by reference to 10.20 to the Company's 1989 Form 10-K.) 10.61 Rights Agreement dated as of May 10, 1989 executed by the Company and Bankers Trust Company of California, N.A., as rights agent. (Incorporated by reference to Exhibit 10.1 to the Company's Registration Statement on Form 8-A dated May 11, 1989.) 10.62 Non-Employee Director Stock Option Plan of the Company. (Incorporated by reference to Exhibit 4.2 to the Company's Form S-8 Registration Statement No. 33-82178.) 10.63 Separation Agreement and General and Special Release of Claims by and between Arthur F. Melton and Amwest Insurance Group, Inc. Amwest Surety Insurance Company and Far West Insurance Company. 11.1 Statement regarding computation of per share earnings. (See Note 1 of Notes to Consolidated Financial Statements.) 21.1 List of Subsidiaries of Registrant. (Incorporated by reference to Exhibit 3(22) to the Company's Form 8-B Registration Statement No. 1-9580.) 23.1 Consent of KPMG Peat Marwick LLP for incorporation by reference of their opinion to the Registration Statements Nos. 33-11020, 33-24243, 33-38128 and 33-82178 on Form S-8 and in Registration Statements Nos. 33-28645 and 33-37984 on Form S-3 of Amwest Insurance Group, Inc. (See page 71 of the Consolidated Financial Statements.) (d) Schedules Independent Auditors' Report. Index to financial statement schedules. Schedule Caption I Summary of Investments-Other Than Investments in Related Parties at December 31, 1996. II Condensed Financial Information of the Registrant. Items omitted are not applicable or not required for Form 10-K. 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. AMWEST INSURANCE GROUP, INC. Date: March 28, 1997 By: /s/ JOHN E. SAVAGE ------------------- John E. Savage President, Chief Operating Officer, Co-Chief Executive Officer and Director 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 date indicated. Signature Title Date Chairman of the Board and Co- Chief Executive Officer /s/ RICHARD H. SAVAGE (Principal Executive Officer) March 28,1997 - ------------------------ Richard H. Savage President, Chief Operating Officer, Co- Chief Executive Officer and Director /s/ JOHN E. SAVAGE March 28,1997 - ------------------------ John E. Savage Senior Vice President, Chief Financial Officer, Treasurer and Director (Principal Financial and Principal /s/ STEVEN R. KAY Accounting Officer) March 28,1997 - ------------------------ Steven R. Kay /s/ ARTHUR F. MELTON Director March 28,1997 - ------------------------ Arthur F. Melton /s/ THOMAS R. BENNETT Director March 28,1997 - ------------------------ Thomas R. Bennett /s/ BRUCE A. BUNNER Director March 28,1997 - ------------------------ Bruce A. Bunner /s/ EDGAR L. FRASER Director March 28,1997 - ------------------------ Edgar L. Fraser /s/ JONATHAN K. LAYNE Director March 28,1997 - ------------------------ Jonathan K. Layne /s/ CHARLES L. SCHULTZ Director March 28, 1997 - ------------------------ Charles L. Schultz INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Independent Auditors' Report 39 Consolidated Financial Statements: Consolidated Statements of Operations for the Years Ended December 31, 1995, 1994 and 1993 40 Consolidated Balance Sheets as of December 31, 1995 and 1994 41 Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 43 Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 1995, 1994 and 1993 45 Notes to Consolidated Financial Statements 46 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders Amwest Insurance Group, Inc.: We have audited the accompanying consolidated balance sheets of Amwest Insurance Group, Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, cash flows and changes in stockholders' equity for each of the years in the three year period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Amwest Insurance Group, Inc. and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 1996, in conformity with generally accepted accounting principles. Los Angeles, California February 21, 1997 KPMG PEAT MARWICK LLP
AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except share and per share data) Years ended December 31, 1996 1995 1994 ----------------- ---------------- ----------------- Underwriting Revenues: Net premiums written $ 89,325 $ 82,814 $ 84,093 Net change in unearned premiums (1,442) 2,356 (2,804) ----------------- ---------------- ----------------- Net premiums earned 87,883 85,170 81,289 ----------------- ---------------- ----------------- Underwriting Expenses: Net losses and loss adjustment expenses 46,647 35,265 28,737 Policy acquisition costs 38,367 38,070 36,607 General operating costs and expenses 12,698 14,309 15,616 Proposition 103 expense - 2,000 - ----------------- ---------------- ----------------- Total underwriting expenses 97,712 89,644 80,960 ----------------- ---------------- ----------------- Underwriting income (loss) (9,829) (4,474) 329 Interest expense (999) (1,056) (840) Collateral interest expense (1,218) (1,698) (1,921) Merger expense (710) - - Lease termination cost (1,300) - - Recovery on misappropriation of funds - 890 - Net investment income 6,807 7,863 7,337 Net realized gains 2,201 2,176 65 Other revenue 2 797 1,423 ----------------- ---------------- ----------------- Income (loss) before income taxes and extraordinary item (5,046) 4,498 6,393 ----------------- ---------------- ----------------- Provision for income taxes (benefit): Current (1,947) 2,044 975 Deferred (413) (1,215) 377 ----------------- ---------------- ----------------- Total provision for income taxes (benefit) (2,360) 829 1,352 ----------------- ---------------- ----------------- Net income (loss) $ (2,686) $ 3,669 $ 5,041 ================= ================ ================= Earnings Per Common Share: Net income (loss) $ (.80) $ 1.10 $ 1.50 ================= ================ ================= Weighted average number of common shares outstanding 3,349,458 3,340,851 3,350,118
See accompanying notes to consolidated financial statements.
AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands) December 31, 1996 1995 ----------------- ---------------- ASSETS Investments: Fixed maturities, available-for-sale (amortized cost of $101,799 and $114,792 at December 31, 1996 and 1995, respectively) $ 102,494 $ 117,191 Common equity securities, available-for-sale (cost of $7,217 and $6,630 at December 31, 1996 and 1995, respectively) 9,779 8,689 Preferred equity securities, available-for-sale (cost of $3,971 and $3,485 at December 31, 1996 and 1995, respectively) 4,253 3,592 Other invested assets (cost of $2,667 and $703 at December 31, 1996 and 1995, respectively) 2,849 797 Short-term investments 890 745 ----------------- ---------------- Total investments 120,265 131,014 Cash and cash equivalents 6,434 5,232 Accrued investment income 1,399 1,573 Agents' balances and premiums receivable (less allowance for doubtful accounts of $446 and $436 at December 31, 1996 and 1995, respectively) 10,882 9,356 Reinsurance recoverable: Paid loss and loss adjustment expenses 2,749 865 Unpaid loss and loss adjustment expenses 6,443 7,669 Ceded unearned premiums 1,849 2,941 Deferred policy acquisition costs 16,101 13,885 Furniture, equipment and improvements, net 4,747 3,311 Current Federal income taxes receivable 2,802 7 Other assets 7,747 7,980 ----------------- ---------------- Total assets $ 181,418 $ 183,833 ================= ================
AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Continued) (Dollars in thousands, except share and per share data) December 31, 1996 1995 ----------------- ---------------- LIABILITIES Unpaid losses and loss adjustment expenses $ 42,009 $ 31,915 Unearned premiums 33,939 33,589 Funds held as collateral 29,928 37,650 Deferred Federal income taxes 1,842 2,497 Bank indebtedness 12,500 12,500 Amounts due to reinsurers 345 2,188 Other liabilities 10,923 8,419 ----------------- ---------------- Total liabilities 131,486 128,758 ----------------- ---------------- STOCKHOLDERS' EQUITY Preferred stock, $.01 par value, 1,000,000 shares authorized: issued and outstanding; none - - Common stock, $.01 par value, 10,000,000 shares authorized: issued and outstanding; 3,326,002 at December 31, 1996 and 3,335,607 at December 31, 1995 33 33 Additional paid-in capital 16,827 17,204 Net unrealized appreciation of investments carried at market, net of income taxes 2,456 3,074 Retained earnings 30,616 34,764 ----------------- ---------------- Total stockholders' equity 49,932 55,075 ----------------- ---------------- Total liabilities and stockholders' equity $ 181,418 $ 183,833 ================= ================
See accompanying notes to consolidated financial statements.
AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Increase (Decrease) in Cash and Cash Equivalents (Dollars in thousands) Years ended December 31, 1996 1995 1994 ---------------- ----------------- ---------------- Cash flows from operating activities: Net income (loss) $ (2,686) $ 3,669 $ 5,041 Adjustments to reconcile net income to cash provided by operating activities: Change in agents' balances, premiums receivable and unearned premiums (1,176) (2,580) 2,841 Change in accrued investment income 174 326 190 Change in unpaid losses and loss adjustment expenses 10,094 (2,738) (11,830) Change in reinsurance recoverables and ceded unearned premiums 434 (446) 10,630 Change in amounts due to reinsurers (1,843) 917 429 Change in reinsurance funds held, net - 115 (230) Change in other assets and other liabilities 2,737 (652) 407 Change in income taxes, net (3,132) (1,160) 681 Change in deferred policy acquisition costs (2,216) 1,630 (1,592) Net realized (gain) loss on sale of investments (2,295) (2,078) 269 Net realized loss on sale of fixed assets 44 7 1 Equity securities, trading Purchases - (26,644) (13,895) Sales - 26,959 13,703 Provision for depreciation and amortization 1,261 1,423 1,889 ---------------- ----------------- ---------------- Net cash provided (used) by operating activities 1,396 (1,252) 8,534 ---------------- ----------------- ---------------- Cash flows from investing activities: Cash received from investments sold, matured, called or repaid: Investments held-to-maturity - - 1,604 Investments available-for-sale 66,561 106,250 67,033 Cash paid for investments acquired: Investments held-to-maturity - - (2,027) Investments available-for-sale (55,197) (93,703) (78,492) Accretion of premium on bonds 68 (779) 1,028 Capital expenditures, net (2,741) (1,405) (1,540) ---------------- ----------------- ---------------- Net cash provided (used) by investing activities 8,691 10,363 (12,394) ---------------- ----------------- ---------------- Cash flows from financing activities: Proceeds from issuance of common stock 299 448 110 Repurchase of common stock - (375) (467) Change in funds held as collateral (7,722) (9,276) 2,536 Dividends paid (1,462) (940) (852) ---------------- ----------------- ---------------- Net cash provided (used) by financing activities (8,885) (10,143) 1,327 ---------------- ----------------- ---------------- Net increase (decrease) in cash and cash equivalents 1,202 (1,032) (2,533) Cash and cash equivalents at beginning of year 5,232 6,264 8,797 ---------------- ----------------- ---------------- Cash and cash equivalents at end of year $ 6,434 $ 5,232 $ 6,264 ================ ================= ================ Supplemental disclosure of cash flow information: Cash paid during the year for: Interest $ 2,217 $ 2,754 $ 2,761 Income taxes 848 2,133 1,004 Cash received during the year on: Investments sold $ 59,093 $ 81,362 $ 63,391 Investments held to maturity 7,468 24,888 5,246
See accompanying notes to consolidated financial statements.
AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Dollars in thousands, except share data) Years ended December 31, 1996, 1995, and 1994 Net unrealized appreciation Common stock (depreciation) ----------------------- $.01 Additional of Total Shares issued par paid-in investments Retained stockholders' value capital carried at earnings equity market -------------- -------- -------------- --------------- -------------- -------------- Balance at December 31, 1993 3,349,964 33 17,489 2,981 27,845 48,348 Repurchase of common stock (43,622) (1) (467) - - (468) Issuance of common stock pursuant to the exercise of options 12,650 1 110 - - 111 Change in net unrealized depreciation of investments carried at market - - - (6,023) - (6,023) Cash dividends - - - - (852) (852) Net income - - - - 5,041 5,041 -------------- -------- -------------- --------------- -------------- -------------- Balance at December 31, 1994 3,318,992 33 17,132 (3,042) 32,034 46,157 Repurchase of common stock (32,260) - (376) - - (376) Issuance of common stock pursuant to the exercise of options 48,875 - 448 - - 448 Change in net unrealized appreciation of investments carried at market - - - 6,116 - 6,116 Cash dividends - - - - (939) (939) Net income - - - - 3,669 3,669 -------------- -------- -------------- --------------- -------------- -------------- Balance at December 31, 1995 3,335,607 33 17,204 3,074 34,764 55,075 Retirement of shares pursuant to completion of merger (48,680) - (676) - - (676) Issuance of common stock pursuant to the exercise of options 39,075 - 299 - - 299 Change in net unrealized depreciation of investments carried at market - - - (618) - (618) Cash dividends - - - - (1,462) (1,462) Net loss - - - - (2,686) (2,686) -------------- -------- -------------- --------------- -------------- -------------- Balance at December 31, 1996 3,326,002 33 16,827 2,456 30,616 49,932 ============== ======== ============== =============== ============== ==============
See accompanying notes to consolidated financial statements. AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1996, 1995, and 1994 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Amwest Insurance Group, Inc., (the "Company") through its wholly-owned insurance subsidiaries, is primarily engaged in underwriting surety bonds nationwide, commercial automobile insurance in the State of California and, to a lesser extent, other property and casualty coverages in several western states. The surety bonds are underwritten through the Company's 30 branch offices, 5 of which are located in California and the balance of which are located in 20 other states. In 1996 and 1995, respectively, the Company's business generated in California was 38.3% and 40.1%. On March 14, 1996, the Company completed its previously announced merger with Condor Services, Inc. ("Condor Services"), an insurance holding company. In the merger, each outstanding share of Condor Services' common stock (other than shares owned by Condor Services as treasury stock or by the Company) were converted into the right to receive 0.5 of share of the Company's common stock. In connection with the merger, the Company issued 992,000 shares of common stock. The merger has been accounted for under the pooling of interests method. Accordingly, all financial information presented herein for all periods includes Condor Services on a historical cost basis. Additionally, share and per share data presented in these financial statements reflect the retroactive effects of the merger with Condor Services. On March 1, 1996, the Company purchased Southern California Bonding Services, Inc., a California corporation. The purchase price was immaterial. Principles of Consolidation The accompanying consolidated financial statements include the accounts of Amwest Insurance Group, Inc. and its wholly-owned subsidiaries, Amwest Surety Insurance Company ("Amwest Surety"), Far West Insurance Company ("Far West"), Far West Bond Services ("FWBS"), Condor Insurance Company ("Condor"), Raven Claims Services ("Raven") and Southern California Bonding Services, Inc. The consolidated financial statements have been prepared in conformity with generally accepted accounting principals ("GAAP") which differ in some respects from those followed in reports to insurance regulatory authorities. All material intercompany transactions and balances have been eliminated. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Deferred Policy Acquisition Costs Acquisition costs related to unearned premiums, consisting of commissions, premium taxes, salaries and other acquisition costs, are deferred and amortized to income ratably over the estimated term of the bond or the effective period of the policy. These costs vary with and are related to the production of business. Deferred acquisition costs are limited to the estimated future profit, based on the anticipated losses and loss adjustment expenses, maintenance costs and investment income. Policy acquisition costs incurred and amortized to income are as follows:
Years ended December 31, 1996 1995 1994 (Dollars in thousands) --------------------------------------------------- Balance at beginning of year $ 13,885 $ 15,515 $ 13,923 Costs deferred during the year 40,583 36,440 38,199 Amortization charged to expense (38,367) (38,070) (36,607) ---------------- ----------------- ---------------- Balance at end of year $ 16,101 $ 13,885 $ 15,515 ================ ================= ================
Earnings Per Share Earnings per share is calculated based on the weighted average number of common shares outstanding, adjusted for stock options which are considered common stock equivalents. Weighted average number of common shares outstanding for the years ended December 31, 1995 and 1994 are based upon Amwest Insurance Group, Inc. and Condor Services, Inc.'s combined historical weighted average shares, after adjustment of Condor Services, Inc.'s historical number of shares as converted and excluding any Condor Services, Inc.'s shares held in treasury or owned by the Company. Federal Income Taxes Deferred income taxes are recognized for the tax consequences of "temporary differences" by applying the applicable tax rate to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Cash and Cash Equivalents The cash and cash equivalents shown on the statements of cash flows include cash and short-term, highly liquid investments (those with original maturities when purchased of ninety days or less). Funds Held as Collateral The Company accepts various forms of collateral for issuance of its surety bonds, including cash, trust deeds or mortgages on real property, irrevocable letters of credit, certificates of deposit, savings accounts and publicly traded securities. The Company's policy is to record in the accompanying consolidated financial statements only funds received as collateral on which earnings inure to the benefit of the Company. These funds are not restricted as to withdrawal or usage, are not segregated by the Company and are invested on an ongoing basis. At December 31, 1996, the related collateral balances accrue interest daily at an average rate of 3.8% per annum and are due and payable (together with accrued interest) to the collateral owner upon exoneration of the underlying liability. Investments Fixed maturities include bonds, notes and redeemable preferred stock. In connection with establishing its investment objectives, the Company determined that it needed to maintain flexibility to respond to changes in interest rates, tax planning considerations or other aspects of asset/liability management. Since the Company does not purchase fixed maturity investments with a view towards resale, the fixed maturities have been classified as "available-for-sale" and are carried at market value. This "available-for-sale" classification does not denote a trading account. Market values for fixed maturities are obtained from a national quotation service. Temporary unrealized investment gains and losses on fixed maturities, available-for-sale are credited or charged directly to stockholders' equity, net of applicable tax affect. When a decline in the value of fixed maturities is considered to be other than temporary, a loss is recognized in the consolidated statement of operations. Equity securities are carried at market value. Net unrealized appreciation (depreciation) on equity securities "available for sale", to the extent that there is no other than temporary impairment of value, is credited or charged directly to stockholders' equity, net of the related deferred Federal income tax affect. Net unrealized holding gains or losses on trading securities were included in income in the year of the trade. Transfers of securities between categories are recorded at market value at the date of transfer. Market values for equity securities are principally determined by quotations on national securities exchanges. When a decline in value is considered other than temporary, a loss is recognized in the consolidated statement of operations. Realized gains and losses are determined using the specific identification method. Short-term investments consist primarily of certificates of deposit with original maturities of less than one year and greater than 90 days and are stated at cost which approximates market value. Losses and Loss Adjustment Expenses The liability for unpaid losses and loss adjustment expenses is based upon the accumulation of individual case estimates for losses reported prior to the close of the accounting period plus estimates of unreported claims. The liability is stated net of anticipated salvage and subrogation recoverable and other non-reinsurance recoveries. In evaluating reserves for surety losses and loss adjustment expenses, the Company considers a number of factors including an estimate of the costs to complete the project, outstanding obligations to subcontractors, supplies and the like and prevailing case law and regulations pertaining to the underlying exposures. The Company also considers the financial strength of the principal, possible offsets to the claimed amount and defenses available to the principal and the Company. The Company may use outside attorneys and construction consultants throughout the reserving process. All reserves for reported claims are net of anticipated collateral and other non-reinsurance recoveries. Reserves for incurred but not reported claims are based on Company experience. An amount is included in the reserves for unallocated loss adjustment expenses consisting of the costs for the Company's claims, legal and subrogation departments to settle claims incurred prior to year end. The loss settlement period on most of the Company's insurance claims is relatively short. Nevertheless, it is often necessary to adjust estimates of liability on a claim either upward or downward between the time a claim is reported and the time of payment. There are inherent uncertainties in estimating reserves, therefore, actual losses and loss adjusting expenses may deviate, perhaps substantially, from reserves on the accompanying consolidated financial statements, which could have a material adverse effect on the Company's financial condition and results of operations. The Company does not discount its claim reserves for financial reporting purposes. While the Company may make implicit provisions for inflation or increasing costs in establishing reserves for known claims, the relatively short claim to payment period and the nature of the insured losses makes provisions for inflation or increasing costs generally unnecessary. Any differences between estimates and ultimate payments are reflected in the Consolidated Statements of Operations in the period in which such estimates are changed and could have a material adverse effect on the Company's financial condition and results of operations at that time. Premium Income Recognition Premium income on surety bonds are recognized as follows: bonds with a known term (such as contractor's license, sales tax and most miscellaneous bonds), are recognized as income ratably over the term of the bond. Bonds on which the Company has significant experience in and information available for estimating the term (such as most court bonds and customs bonds), are recognized as income over the estimated term of the bond. For other bonds with indefinite terms (generally contract performance bonds), the Company estimates a term of twelve months, and premiums are recognized ratably over such period, unless information comes to the Company's attention that the obligation guaranteed has already been discharged, in which case all remaining unearned premiums are immediately recognized as earned. Premium income on non-surety property and casualty policies are recognized ratably over the effective period of the policy. Reinsurance In the normal course of business, the Company seeks to reduce the loss that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. Amounts recoverable from reinsurers are estimated in a manner consistent with the premium and claim liability associated with the reinsured bond or policy. Fair Value of Financial Instruments Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments", and Statement of Financial Accounting Standards No. 119, "Disclosures about Derivative Financial Instruments and Fair Value of Financial Instruments", require disclosure of estimated fair value information about financial instruments, for which it is practicable to estimate that value. Under Statement of Financial Accounting Standards No. 115, the Company categorizes all of its investments in debt and equity securities as available for sale. Accordingly, all investments, including cash and short term investment, are carried on the balance sheet at their fair value. The carrying amounts and fair values for investment securities are disclosed in Note 3 and were drawn from standard trade data sources such as market and broker quotes. The estimated fair value of bank indebtedness equals its carrying value, which was based on the bank loan's variable interest rate which approximates the rates currently available today. The carry amounts and fair values for the bank indebtedness are disclosed in Note 10. Risk-Based Capital In December 1993, the NAIC adopted a risk-based capital formula for property casualty insurance companies which establishes recommended minimum capital requirements. The formula has been designed to capture the widely varying elements of risks undertaken by writers of different lines of insurance having differing risk characteristics, as well as writers of similar lines where differences in risk may be related to corporate structure, investment policies, reinsurance arrangements and a number of other factors. The Company has calculated its risk-based capital requirement as of December 31, 1996 and found that its subsidiaries exceeded the highest level of recommended capital requirement. Stock-Based Compensation During October, 1995, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"). The disclosure provisions are effective for fiscal years beginning after December 15, 1995. The Company has continued to use the accounting methods presented by Accounting Principles Board Opinion No. 25 and has expanded its disclosure of stock-based compensation as permitted by FAS 123 (see Note 17). Accordingly, adoption of this pronouncement did not have a material effect on the consolidated financial statements of the Company. Reclassifications Certain amounts in the accompanying consolidated financial statements for 1994 and 1995 have been reclassified to conform with the 1996 financial statement presentation. (2) FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND FINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF CREDIT RISK The vast majority of the collateral held by the Company does not qualify for inclusion in the accompanying consolidated financial statements. The Company's policy is to record in the accompanying consolidated financial statements only those funds received as collateral on which earnings inure to the benefit of the Company. Most of the off-balance sheet collateral is in the form of irrevocable letters of credit and certificates of deposit. On a case-by-case basis, loss reserves are reduced for that portion that can be recovered through liquidation of collateral. To the extent that these collateral items prove to be worth less than the face or notional value, the Company may incur additional losses. However, the Company believes that since the quality of collateral funds are evaluated prior to the setting of loss reserves on a case-by-case basis, any differences between face or notional value and ultimate disposition value will generally be minor. A summary of off-balance sheet collateral held by the Company as of December 31 is as follows: December 31, 1996 1995 (Dollars in thousands) ---------------------------------- Off-Balance Sheet Collateral: Irrevocable letters of credit $ 140,004 $ 138,463 Certificates of Deposit 27,624 35,249 Other Collateral 47,687 54,716 ---------------- ----------------- Total Off-Balance Sheet Collateral $ 215,315 $ 228,428 ================ ================= Trust deeds and mortgages on real property held as collateral are not reflected in the above figures due to the inexact nature of their disposition values. During 1996 and 1995, the Company received approximately 9%, of its total collateral recoveries from trust deeds and mortgages on real property. The Company's off-balance-sheet collateral, most notably irrevocable letters of credit, is taken on behalf of principals located in every geographical region of the country. The Company does not believe there to be noteworthy concentration of credit risk in any single area. (3) INVESTMENTS A summary of net investment income is as follows:
Years ended December 31, 1996 1995 1994 (Dollars in thousands) --------------------------------------------------- Gross investment income: Fixed maturities $ 6,405 $ 7,357 $ 7,191 Equity securities 409 498 214 Cash and short-term investments 338 509 401 Investment expense (345) (501) (469) ---------------- ----------------- ---------------- Net investment income $ 6,807 $ 7,863 $7,337 ================ ================= ================ Gross realized gains: Fixed maturities $ 1,343 $ 1,780 $ 533 Equity securities 1,528 1,710 697 Other assets 53 - - Gross realized losses: Fixed maturities (218) (519) (649) Equity securities (358) (645) (465) Other assets (147) (150) (51) ---------------- ----------------- ---------------- Net realized gains $ 2,201 $ 2,176 $ 65 ================ ================= ================
A summary of the accumulated net unrealized appreciation (depreciation) on investments carried at market and the applicable deferred Federal income taxes is shown below: December 31, 1996 1995 (Dollars in thousands) ----------------------------------- Gross unrealized appreciation: Fixed maturities $ 1,648 $ 2,944 Equity securities 3,190 2,524 Other invested assets 182 94 Gross unrealized (depreciation): Fixed maturities (953) (545) Equity securities (346) (358) ----------------- ----------------- Gross unrealized appreciation on investments carried at market 3,721 4,659 Deferred Federal income taxes (1,265) (1,585) ----------------- ----------------- Net unrealized appreciation (depreciation), net of deferred Federal income taxes $ 2,456 $ 3,074 ================= ================= (3) INVESTMENTS (CONTINUED) A summary of the net increase (decrease) in unrealized investment gains (losses) less applicable deferred Federal income taxes is as follows:
Years ended December 31, 1996 1995 1994 (Dollars in thousands) --------------------------------------------------- Fixed maturities, available-for-sale $ (1,704) $ 7,230 $ (7,750) Common equity securities, available-for-sale 503 1,613 (866) Preferred equity securities, available-for-sale 175 330 (509) Other invested assets 88 94 - ---------------- ----------------- ---------------- Total (938) 9,267 (9,125) Deferred Federal income taxes 320 (3,151) 3,102 ---------------- ----------------- ---------------- Net increase (decrease) in unrealized investment gains (losses), net of deferred Federal income taxes $ (618) $ 6,116 $ (6,023) ================ ================= ================
The Company's insurance subsidiaries are required to deposit securities in several of the states in which it conducts business as a condition of licensure. These investments are included in the "Fixed maturities" and "Short-term investments" captions within the accompanying consolidated balance sheets. As of December 31, 1996 and 1995, the market value of these deposits was approximately $12,561,000 and $11,562,000, respectively. The amortized cost and estimated market values of investments in fixed maturities are as follows:
December 31, 1996 (Dollars in thousands) --------------------------------------------------------------------- ----------------- ---------------- ----------------- ---------------- Gross Gross Amortized Cost Unrealized Unrealized Estimated Fixed maturities, available-for-sale Gains Losses Market Value ----------------- ---------------- ----------------- ---------------- Bonds: U.S. Government $ 13,582 $ 287 $ (130) $ 13,739 Asset backed securities 3,997 20 (13) 4,004 Mortgage backed securities 24,352 89 (196) 24,245 States, municipalities and political subdivisions 26,034 602 (28) 26,608 Industrial and miscellaneous 27,658 517 (502) 27,673 ----------------- ---------------- ----------------- ---------------- Total 95,623 1,515 (869) 96,269 Redeemable preferred stock 6,001 133 (84) 6,050 Certificates of Deposit 175 - - 175 ----------------- ---------------- ----------------- ---------------- Total $ 101,799 $ 1,648 $ (953) $ 102,494 ================= ================ ================= ================
(3) INVESTMENTS (CONTINUED)
December 31, 1995 (Dollars in thousands) --------------------------------------------------------------------- ----------------- ---------------- ----------------- ---------------- Gross Gross Amortized Cost Unrealized Unrealized Estimated Fixed maturities, available-for-sale Gains Losses Market Value ----------------- ---------------- ----------------- ---------------- Bonds: U.S. Government $ 31,376 $ 740 $ (15) $ 32,101 Asset backed securities 5,542 94 - 5,636 Mortgage backed securities 17,547 307 (131) 17,723 States, municipalities and political subdivisions 34,202 756 (6) 34,952 Industrial and miscellaneous 19,653 921 (315) 20,259 ----------------- ---------------- ----------------- ---------------- Total 108,320 2,818 (467) 110,671 Redeemable preferred stock 6,447 126 (78) 6,495 Certificates of Deposit 25 - - 25 ----------------- ---------------- ----------------- ---------------- Total $ 114,792 $ 2,944 $ (545) $ 117,191 ================= ================ ================= ================
The amortized cost and estimated market value of fixed maturities at December 31, 1996, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Prepayment assumptions for asset backed and mortgage backed securities are obtained from broker dealer survey values or internal estimates. These assumptions are consistent with the current interest rate and economic environment. Maturity distribution of fixed maturities, Amortized Cost Estimated available-for-sale: Market Value (dollars in thousands) ----------------------------------- Due in 1 year or less $ 4,235 $ 4,217 Due after 1 year through 5 years 47,667 48,023 Due after 5 years through 10 years 28,440 28,561 Due after 10 years through 20 years 13,905 14,010 Due after 20 years 7,552 7,683 ----------------- ----------------- Total bonds and sinking fund preferred stock $ 101,799 $ 102,494 ================= ================= Proceeds from the sale of available-for-sale securities during 1996 and 1995 were $59,093,000 and $81,362,000, respectively. Gross gains of $2,871,000 and $2,990,000 and gross losses of $576,000 and $779,000 were realized on those sales in 1996 and 1995, respectively. Gross gains of $500,000 and gross losses of $385,000 were realized on the sale of trading securities during 1995. Securities with an amortized cost of $11,285,000 were transferred from held-to-maturity to available-for-sale during 1995. An unrealized gain of $532,000 related to these securities is included in the net unrealized appreciation (depreciation) of investments carried at market component of stockholders' equity. This transfer was made at December 31, 1995 because the Company concluded that it would no longer commit to holding any security to maturity, as this limited management from responding to changes in circumstances and perceived economic trends. (4) FURNITURE, EQUIPMENT AND IMPROVEMENTS Furniture, equipment and improvements are recorded at historical cost. Depreciation and amortization of automobiles, furniture and equipment is calculated using the straight-line method over estimated useful lives from 3 to 5 years. Amortization of leasehold improvements is calculated using the straight-line method over the estimated useful lives of the assets or the term of the lease, whichever is shorter. December 31, 1996 1995 Summary of Furniture, Equipment (Dollars in thousands) and Improvements: ----------------------------------- Automobiles $ 145 $ 60 Furniture 2,664 2,482 Equipment 8,965 7,092 Improvements 3,019 2,774 ----------------- ----------------- Total fixed assets 14,793 12,408 Less accumulated depreciation (10,046) (9,097) ----------------- ----------------- Furniture, equipment and improvements, net $ 4,747 $ 3,311 ================= ================= (5) INCOME TAXES Amwest Insurance Group, Inc. and subsidiaries file a consolidated income tax return. A reconciliation of the corporate federal tax with the financial statement effective tax for the years ended December 31, 1996, 1995 and 1994 are as follows:
Years ended December 31, 1996 1995 1994 (Dollars in thousands) --------------------------------------------------- Computed tax expense at statutory rate $ (1,715) $ 1,529 $ 2,173 Tax-advantaged interest income (616) (556) (737) Change in valuation allowance - (94) (168) State taxes 47 97 99 Other, net (76) (147) (15) ---------------- ----------------- ---------------- Total provision for income taxes (benefit) $ (2,360) $ 829 $ 1,352 ================ ================= ================
(5) INCOME TAXES (CONTINUED) The tax effects of temporary differences that give rise to significant portions of the deferred tax liability and the deferred tax asset at December 31, 1996 and 1995 are presented below.
Years ended December 31, 1996 1995 (Dollars in thousands) ----------------------------------- Deferred tax liabilities: Deferred policy acquisition costs $ (5,474) $ (4,721) Unrealized investment gains (1,314) (1,603) Unearned contingent commission (215) (332) Fixed assets (40) (11) Bad debt reserve - (30) Discount on salvage & subrogation reserves (62) (113) Deductible receivables (50) (82) Other (39) (12) ----------------- ----------------- Total gross deferred tax liabilities (7,194) (6,904) ----------------- ----------------- Deferred tax assets: Unearned premiums 2,182 2,084 Accrued loss on lease termination and sub-lease 421 - Discount on loss reserves 1,289 1,060 Proposition 103 reserve - 680 Accrued vacation 196 204 Deferred compensation/ Accrued severance 216 115 Alternative minimum tax credit 667 586 Bad debt reserve 328 - Net operating loss 622 159 Other 82 170 ----------------- ----------------- Total gross deferred tax assets 6,003 5,058 Less: valuation allowance (651) (651) ----------------- ----------------- Net deferred tax assets 5,352 4,407 ----------------- ----------------- Total net deferred tax liability $ (1,842) $ (2,497) ================= =================
Financial Accounting Standard No. 109 requires the establishment of a valuation allowance when management has determined that it is more likely than not that a portion of the deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the reversal of deferred credits and the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers primarily the scheduled reversal of deferred tax liabilities and tax planning strategies in making this assessment. A valuation allowance has been established based on this criteria. At December 31, 1996, the Company has $1,809,000 of net operating loss carryforwards ("NOLs") which will expire, if unused, in the year 2011. A portion of this NOL was attributable to Condor Services prior to the merger with the Company and is limited to the taxable earnings of the Company's subsidiary, Condor. (6) RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES The following table sets forth a reconciliation of the liability for losses and loss adjustment expenses for the periods shown:
December 31, 1996 1995 1994 (Dollars in thousands) ------------------------------------------ Balance at beginning of year $ 31,915 $ 34,653 $ 46,483 Less: net reinsurance recoverable on unpaid loss and loss adjustment expenses (7,669) (8,069) (17,981) ------------- -------------- ------------- Net balance at beginning of year 24,246 26,584 28,502 Provision for losses and loss adjustment expenses occurring in current year 45,853 35,508 30,400 (Decrease) increase in estimated losses and loss adjustment expenses for claims occurring in prior years 794 (243) (1,663) Losses and loss adjustment expense payments for claims occurring during: Current year (21,638) (19,283) (14,795) Prior years (13,379) (18,320) (15,860) ------------- -------------- ------------- Net balance at end of year 35,876 24,246 26,584 Plus: net reinsurance recoverable on unpaid loss and loss adjustment expenses 6,133 7,669 8,069 ------------- -------------- ------------- Balance at end of year $ 42,009 $ 31,915 $ 34,653 ============= ============== =============
The increase or decrease in estimated losses and loss adjustment expenses for losses occurring in prior years reflects the net effect of the resolution of losses for other than full reserve value and subsequent readjustment of loss values as of December 31st of the applicable years. (7) REINSURANCE The Company cedes insurance to reinsurers and the Small Business Administration ("SBA") under reinsurance treaties that cover individual risks or entire classes of business. Although the ceding of insurance does not discharge the Company from its primary liability to its bondholder, the insurance company that assumes the coverage assumes the related liability, and it is the practice of insurers for accounting purposes to treat reinsured risks, to the extent of the reinsurance ceded, as though they were risks for which the original insurer is not liable. The Company evaluates and monitors the financial condition of its reinsurers in order to minimize its exposure to significant losses from reinsurer insolvencies. The reinsurance recoverables and ceded unearned premium reported on the accompanying balance sheet would represent a liability of the Company if all reinsurers were unable to meet existing obligations under reinsurance agreements. (7) REINSURANCE (CONTINUED) The following amounts represent premiums assumed and the deductions for reinsurance ceded for the years ended December 31, 1996, 1995 and 1994.
Years ended December 31, 1996 1995 1994 (Dollars in thousands) --------------------------------------------------- Net premiums written: Premiums written $ 94,935 $ 93,604 $ 94,018 Premiums assumed 2,307 580 204 Premiums ceded (7,917) (11,370) (10,129) ---------------- ----------------- ---------------- Net premiums written $ 89,325 $ 82,814 $ 84,093 ================ ================= ================ Net change in unearned premiums: Direct $ (330) $ 1,080 $ (2,731) Ceded (1,112) 1,276 (73) ---------------- ----------------- ---------------- Net change in unearned premiums $ (1,442) $ 2,356 $ (2,804) ================ ================= ================ Net loss and loss adjustment expenses: Losses and loss adjustment expenses $ 50,836 $ 42,197 $ 36,345 Reinsurance recoveries (4,189) (6,932) (7,608) ---------------- ----------------- ---------------- Net losses and loss adjustment expenses $ 46,647 $ 35,265 $ 28,737 ================ ================= ================
On the surety lines of business, the Company's subsidiaries maintain an excess of loss reinsurance treaty with a group of reinsurers lead by Kemper Reinsurance Company, (the "Kemper Treaty"). Kemper Reinsurance Company is a 50% participant, Scor Reinsurance Company has a 40% participation and Gerling Global Reinsurance Corp., USB has a 10% participation in the treaty. The Kemper Treaty, which was amended on October 1, 1996, may be canceled at the election of either party by providing notice of cancellation 90 days prior to any anniversary, however, the reinsurers would remain liable for covered losses incurred up to the cancellation date. The amended Kemper Treaty limits the Company's exposure on any one principal (the person or entity for whose account the surety contract is made, and whose debt or obligation is the subject of the surety contract) to the first $2,000,000 of loss and to losses in excess of $6,000,000. Coverage is provided for most types of bonds which the Company writes except SBA guaranteed bonds, which are not covered by the treaty. The reinsurers' maximum exposure under the Kemper Treaty is $8,000,000 of losses discovered during any one contract period (October 1 to October 1). Prior to the amendment on October 1, 1996, the coverage was $5,500,000 excess $500,000 and the Company received a percentage of the profit, if any, on the treaty in the form of contingent commission. Contingent commissions in the amount of $3,287,000, $2,226,000 and $366,000 were recognized under the profit sharing provisions of the treaty for the years ended December 31, 1996, 1995 and 1994, respectively. In conjunction with the change in reinsured limits effective October 1, 1996 the Company, effective January 1, 1997, entered into an aggregate stop-loss treaty with Underwriters Reinsurance Company (Barbados), Inc. This contract covers approximately $5,000,000 of losses and allocated loss adjustment expenses on the surety lines of business in excess of 25.86% of net earned premiums, with an option to increase the coverage by up to $5,000,000 by payment of $1,000,000 prior to the incurrance of $2,500,000 in ceded losses under the original treaty. (7) REINSURANCE (CONTINUED) The Company also maintains a semiautomatic bond facultative reinsurance contract for surety bonds. The contract also applies to most types of bonds the Company writes with single bond penalty limits up to $10,000,000 or multiple bonds under a specific aggregate work program per principal with limits up to $20,000,000 for contract surety bonds and $25,000,000 for commercial surety bonds. The Company's retention under the contract is $6,000,000 plus 12% of the reinsured amount. The Company's aggregate retention is additionally reinsured by the aforementioned excess of loss reinsurance treaty, further limiting the Company's net exposure. The Company's insurance subsidiaries also issue contract bonds under the SBA Surety Guarantee Program. Industry practice is to account for SBA guarantees as reinsurance transactions. The purpose of the SBA Surety Guarantee Program is to assist small contractors, who have not established credit or who fail to meet a surety's normal underwriting standards, in obtaining bonds. An SBA guarantee covers between 80% and 90% of the surety's liability up to $1,250,000 per bond. For its liability lines of business, the Company has reduced its exposure on any one risk with the purchase of excess of loss reinsurance. The net retained amount has varied by year, primarily based on the Company's surplus position. Currently, the Company retains the first $400,000 on any one risk with the next $600,000 ceded to a consortium of reinsurers led by Gerling Global Reinsurance Corporation. The Company participates in this treaty with a 10% share. The Company further reinsures $1,000,000 in excess of $1,000,000 for its liability coverages including extra contractual obligations and excess of policy limits exposures. For its property coverages, the Company generally retains the first $200,000 on any one exposure and purchases excess of loss reinsurance for $4,800,000 in excess of $200,000. Limits relating to its Hawaiian homeowners program differ from the above with the Company retaining $500,000 ultimate on each net loss with the Company reinsuring $1,250,000 in excess of $500,000. The Company participates in the Hawaii Hurricane Relief Fund, and accordingly, its Hawaiian policies exclude wind coverage over 75 miles per hour. (8) RESTRICTIONS ON DIVIDENDS As a holding company, the Company depends primarily on dividends from its insurance subsidiaries for its cash flow requirements. The Company's insurance subsidiaries are subject to state regulations which restrict their ability to pay dividends. These regulations restrict the amount of stockholder dividends which may be paid within any one year without the approval of the Department of Insurance in their state of domicile. In 1994 and 1995 Amwest Surety and Far West were domiciled in California. The California Insurance Code provides that amounts may be paid as dividends on an annual noncumulative basis without prior approval up to a maximum of the greater of (1) statutory net income for the preceding year or (2) 10% of statutory policyholders' surplus as of the preceding December 31. In 1995, Amwest Surety and Far West redomesticated to the state of Nebraska. The Nebraska Insurance Code provides that amounts may be paid as dividends on an annual basis without prior approval up to a maximum of the greater of (1) statutory net income, excluding realized capital gains, for the preceding year plus any carryforward net income from the previous two calendar years that have not already been paid out as dividends or (2) 10% of statutory policyholders' surplus as of the preceding December 31. Amwest Surety and Condor can pay $3,108,000 and $922,000, respectively, in dividends to the Company during 1997 without prior approval. For the years ended December 31, 1996, 1995 and 1994, Amwest Surety paid dividends of $500,000, $2,000,000 and $1,000,000, respectively, to Amwest Insurance Group, Inc. The Company's credit agreements also contain restrictions on the payment of dividends (see Note 10). (9) STATUTORY ACCOUNTING PRINCIPLES FINANCIAL INFORMATION The Company's insurance subsidiaries are required to file annual statements with insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities ("statutory"). For such subsidiaries, generally accepted accounting principles differ in certain respects from statutory accounting practices. The more significant of these differences for statutory accounting are (a) premium income is taken into earnings over the periods covered by the policies, whereas the related acquisition and commission costs are expensed when incurred; (b) all bonds and sinking fund preferred stock are recorded at amortized cost, regardless of trading activity; (c) non-admitted assets are charged directly against surplus; (d)loss reserves and unearned premium reserves are stated net of reinsurance; (e) Federal income taxes are recorded when payable; and (f) the outstanding contribution certificate is included as a component of surplus, and the interest on the outstanding contribution certificate is a direct charge to surplus. Additionally, the cash flow presentation is not consistent with generally accepted accounting principles and a reconciliation from net income to funds provided by operations is not presented. Policyholders surplus and net income on a statutory basis is as follows:
December 31, 1996 1995 1994 Statutory Statutory Statutory Statutory Policyholders Net Income Statutory Net Income Statutory Net Income Surplus (Loss) Surplus (Loss) Surplus (Loss) (Dollars in thousands) -------------------------------------------------------------------------------------------------------- Amwest Surety 31,081 (3,803) 36,813 5,204 34,004 3,061 Far West 7,042 1,176 5,866 555 5,311 266 Condor 9,217 (1,707) 8,548 48 6,463 297
(10) BANK INDEBTEDNESS On August 6, 1993, the Company entered into a revolving credit agreement with Union Bank for $12,500,000. The debt agreement was amended on April 24, 1995 and again on July 10, 1996 to increase the amount available under the revolving line of credit from $12,500,000 to $15,000,000. The amounts available are reduced by $3,000,000 each year beginning on September 30, 1997 and ending on September 30, 2001. Accordingly at December 31, 1996, $15,000,000 is available under the revolving line of credit, $12,500,000 of which is currently utilized. The bank loan has a variable rate based upon fluctuations in the London Interbank Offered Rate (LIBOR) and amortizing principal payments. The interest rate at December 31, 1996 was 6.88%. The credit agreement contains certain financial covenants with respect to capital expenditures, business acquisitions, liquidity ratio, leverage ratio, tangible net worth, net profit and dividend payments. Balance (Dollars in thousands) ------------------------- Summary of debt maturity schedule: September 30, 1997 $ 3,000 September 30, 1998 3,000 September 30, 1999 3,000 September 30, 2000 3,000 September 30, 2001 3,000 (10) BANK INDEBTEDNESS (CONTINUED) At December 31, 1996, the Company was in violation with respect to a covenant requiring a net profit for the fiscal year and a covenant requiring a certain level of statutory policyholders' surplus. The Company has received a letter from Union Bank stating that they intend to issue a waiver regarding compliance with these two covenants. The bank loan has a variable interest rate which approximates the rates currently available today. Accordingly, estimated fair value of the debt is equal to the statement value of $12,500,000. (11) OTHER LIABILITIES The following table is a summary of other liabilities at December 31, 1996 and 1995:
December 31, 1996 1995 (Dollars in thousands) ----------------------------------- Accrued salaries, fringe benefits and other compensation $ 2,271 $ 2,067 Premium taxes payable 878 314 Accrued rent payable 654 932 General accounts payable 141 27 Accrued payable - SBA 36 102 Dividends payable 365 237 Loss on early lease termination and sub-lease 1,696 459 Proposition 103 reserve 1,928 2,000 Litigation reserve 175 180 Other 2,779 2,101 ----------------- ----------------- Total other liabilities $ 10,923 $ 8,419 ================= =================
(12) COMMITMENTS AND CONTINGENCIES The Company is subject to certain claims arising in the ordinary course of its operations. The Company believes that the ultimate resolution of such matters will not materially affect its consolidated financial condition. At December 31, 1996, the Company occupied office space under various operating leases in addition to a leased mini-computer that have remaining noncancellable lease terms in excess of one year. Rental expenses of approximately $5,647,000, $4,033,000 and $3,972,000 for the years ended December 31, 1996, 1995 and 1994, respectively, have been charged to operations in the accompanying consolidated statements of operations. (12) COMMITMENTS AND CONTINGENCIES (CONTINUED) Balance (Dollars in thousands) -------------------------- Summary of minimum future annual rental commitments: 1997 $ 3,174 1998 1,831 1999 1,582 2000 1,380 2001 and thereafter 12,108 -------------------------- Total minimum payments 20,075 Sublease income (191) -------------------------- Total $ 19,884 ========================== (13) PROPOSITION 103 On November 8, 1988, California voters passed Proposition 103, an insurance initiative which required a rollback in insurance rates for policies (and bonds) written or renewed during the twelve month period beginning November 8, 1988 and provided that changes in insurance premiums after November 8, 1988 must be submitted for approval of the California Insurance Commissioner prior to implementation. While the Proposition has the most significant impact on automobile insurance, its provisions, as written, also apply to other property and casualty insurers including surety insurers. On August 26, 1990, the State of California enacted Insurance Code Section 1861.135 ("Section 1861.135") exempting surety insurance from the rate rollback and prior approval provisions of Proposition 103. Section 1861.135 does not effect Proposition 103's prohibition against excessive, inadequate or discriminatory rates. Due to the enactment of Section 1861.135, the Company terminated a previously established reserve for potential premium rebates. Subsequently, the Department of Insurance ("Department") and Voter Revolt brought a motion for writ of mandate challenging the validity of Section 1861.135. On March 21, 1991, the Los Angeles Superior Court concluded that Section 1861.135 did not violate the California Constitution or provisions of Proposition 103. The Department and Voter Revolt appealed. On December 7, 1993, the Second District Court of Appeal overturned Section 1861.135 by a 2-1 vote. On February 24, 1994, the California Supreme Court agreed to hear the Company's petition for review, thereby staying the Court of Appeals opinion. On December 14, 1995, the Supreme Court of the State of California affirmed the decision of the Second District Court of Appeal, overturning Insurance Code Section 1861.135, which exempted the surety insurance industry from major provisions of Proposition 103. Accordingly, the Company is no longer exempted from the rate rollback and prior approval provisions contained in Proposition 103. The Company accrued $2,000,000 during the quarter ended December 31, 1995 representing the Company's best estimate of its rollback obligations pursuant to Proposition 103. On August 15, 1996, the Company entered into a Stipulation and Consent Order with the Insurance Commissioner of the State of California which requires the Company's insurance subsidiaries to pay $1,928,370. The Proposition 103 refund checks were issued in January 1997. (14) RELATED PARTY TRANSACTIONS Condor, since the commencement of insurance company operations in 1989, has offered its monthly commercial automobile insurance policies to members of the Waste Industry Loss Prevention and Safety Association (d.b.a. "The Safety Association"). One of the directors and executive officers of the Company is an officer, director and shareholder of The Safety Association. In order to accept monthly commercial automobile coverage written by Condor, an applicant must become a member of The Safety Association. This business constituted approximately 88%, 90% and 94% for 1996, 1995 and 1994, respectively, of total premiums written by Condor. Since 1981, the Company has had the exclusive right to provide insurance programs to The Safety Association pursuant to an agreement which may be terminated as of April 1 of any year by either party by giving 15 months notice of cancellation. (15) STOCKHOLDER RIGHTS PLAN On May 10, 1989, the Board of Directors adopted a Stockholder Rights Plan and declared a dividend of one Stock Purchase Right (a "Right") for each share of common stock outstanding on May 22, 1989. Each Right becomes exercisable on the tenth business day after a person or group (other than the Company and certain related parties) has acquired or commenced a tender or exchange offer to acquire 20% or more of the Company's common stock, or upon consummation of certain mergers, business combinations or sales of the Company's assets. If the Rights become exercisable, a holder will be entitled to purchase in certain cases (i) one one-hundredth of a share of Series A Junior Participating Preferred Stock, $.01 par value, at the then current exercise price (initially $50), (ii) shares of common stock, $.01 par value, having a market price equal to two times the then current exercise price, or (iii) in case of a merger, common stock of the acquiring corporation having a market value equal to two times the then current exercise price. The Company is entitled to redeem the Rights at $.01 per Right under certain circumstances. The rights do not have voting or dividend rights, and cannot be traded independently from the Company's common stock until such time as they become exercisable. (16) RETIREMENT PLAN In January, 1992, the Company adopted a 401(k) savings plan entitled the Amwest Surety Insurance Company 401(k) Plan (the "Plan"). Employees eligible for participation in the Plan must have attained one year of service and be at least 21 years of age. The Plan provides for employer matching contributions at 50%, up to a maximum of the first 6% of the employee contribution and become fully vested at the end of 5 years of employment. Total expense to the Company during 1996, 1995 and 1994 amounted to $344,000, $275,000 and $263,000, respectively. (17) STOCK OPTIONS The Company has a Stock Option Plan and a Non-Employee Director Stock Option Plan ("the Plans") pursuant to which it has reserved an aggregate of 751,000 shares of its Common Stock, subject to adjustment for reorganizations, recapitalizations, stock splits or similar events. Shares of Common Stock subject to the unexercised portions of any options granted under the Plans which expire, terminate or are canceled may again be subject to options under the Plans. The per share exercise price of options under the Plans may not be less than 100% of the fair market value of the underlying Common Stock on the date of the grant of the option (110% of such fair market value with respect to Incentive Options granted to an individual who owns more than 10% of the total combined voting power of all classes of stock of the Company or any subsidiary or parent corporation). The Plans were approved by the Company's stockholders.
Non-Employee Director Stock Option Plan Stock Option Plan Total ------------------------- ------------------------- -------------------------- Shares reserved for issuance 676,000 75,000 751,000 Granted (994,121) (40,000) (1,034,121) Canceled / Expired 403,287 - 403,287 ========================= ========================= ========================== Total available for grant 85,166 35,000 120,166 ========================= ========================= ==========================
A summary of the status of the Plans as of December 31, 1996, 1995 and 1994, and changes during the years ending on those dates is presented below:
1996 1995 1994 ---------------------------------- --------------------------------- --------------------------------- Weighted Average Weighted Average Weighted Average Shares Exercise Price Shares Exercise Price Shares Exercise Price -------------- ------------------- -------------- ------------------ --------------- ----------------- Outstanding at beginning of year 328,950 $12.70 276,950 $11.44 209,875 $10.31 Granted 149,430 12.54 106,000 14.29 86,700 13.94 Exercised (6,950) 8.75 (48,875) 9.17 (11,000) 9.51 Canceled / Expired (29,425) 14.46 (5,125) 11.56 (8,625) 11.52 -------------- ------------------- -------------- ------------------ --------------- ----------------- Outstanding at end of year 442,005 $12.59 328,950 $12.70 276,950 $11.44 ============== =================== ============== ================== =============== ================= Options exercisable at end of year 225,174 $11.63 154,488 $11.88 139,781 $10.73 ============== =================== ============== ================== =============== =================
(17) STOCK OPTIONS (CONTINUED) The following table summarizes information about options outstanding under the Plans at December 31, 1996:
Options Outstanding Options Exercisable Weighted Average Range of Number Remaining Weighted Number Weighted Exercise Prices Outstanding Contractual Life Average Outstanding Average Exercise Price Exercise Price - --------------------------- ---------------- ----------------- ---------------- ----------------- ---------------- $6.14 - $9.213 53,580 2.5 $8.51 53,580 $8.51 $9.875 - $11.825 81,750 2.1 10.79 71,750 10.76 $12.50 - $14.875 306,675 7.9 13.78 99,844 13.93 ================ ================= ================ ================= ================ $6.14 - $14.875 442,005 6.2 $12.59 225,174 $11.63 ================ ================= ================ ================= ================
Pro forma net income (loss) and earnings (loss) per share information, as required by SFAS No. 123, has been calculated as if the Company had accounted for options granted under the Plans under the fair value method. The fair value of options granted was estimated as of the date of grant based on the Black-Scholes option pricing model given the following weighted average assumptions: risk-free interest rates of 6.39% for 1996 and 6.36% for 1995, a dividend yield of 3.48% for 1996 and 2.72% for 1995, volatility of the Company's Common Stock of 7.18%, and an expected life of the stock options of 10 years. The weighted average grant date fair values of stock options granted during 1996 and 1995 were $5.09 and $5.07, respectively. For purposes of pro forma disclosures, the estimated fair value is amortized on a straight-line basis over the vested period.
Dollars in thousands, Year ended Year ended except per share data December 31, 1996 December 31, 1995 - --------------------------- ------------------------- ------------------------- -------------------------- Net income (loss) As reported ($ 2,686) $ 3,669 Pro forma (2,797) 3,624 Earnings per share As reported ($ .80) $ 1.10 Pro forma (.83) 1.09
AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES SUPPLEMENTARY INFORMATION (UNAUDITED) QUARTERLY FINANCIAL INFORMATION The quarterly results for the years ended December 31, 1996, 1995 and 1994 are set forth in the following table:
(Dollars in thousands, except per share data) ---------------- ----------------- ----------------- ---------------- First Second Quarter Third Fourth Quarter Quarter Quarter ---------------- ----------------- ----------------- ---------------- 1996 Premiums written $23,208 $25,749 $24,719 $23,566 Net premiums earned 21,835 21,535 22,239 22,274 Net investment income 1,807 1,678 1,581 1,741 Net realized gains 1,025 517 325 334 Other revenue 143 81 - (222) Total revenues 24,810 23,811 24,145 24,129 Net income (loss) 86 (1,311) 1,191 (2,652) Earnings (loss) per share .03 (.39) .36 (.80) ---------------- ----------------- ----------------- ---------------- First Second Quarter Third Fourth Quarter Quarter Quarter ---------------- ----------------- ----------------- ---------------- 1995 Premiums written $21,799 $25,333 $24,722 $22,330 Net premiums earned 21,233 21,153 21,322 21,462 Net investment income 1,997 1,985 2,016 1,782 Net realized gains (losses) 20 589 634 933 Net unrealized gains (losses) on trading securities 32 43 (1) 9 Other revenue 181 131 142 343 Total revenues 23,463 23,901 24,113 24,529 Net income (loss) 1,259 1,682 785 (57) Earnings (loss) per share .38 .50 .23 (.01) ---------------- ----------------- ----------------- ---------------- First Second Quarter Third Fourth Quarter Quarter Quarter ---------------- ----------------- ----------------- ---------------- 1994 Premiums written $21,056 $24,359 $26,722 $22,085 Net premiums earned 19,455 19,482 21,003 21,349 Net investment income 1,649 1,754 1,909 2,105 Net realized gains 181 (159) 128 (85) Net unrealized gains (losses) on trading securities (14) (25) 9 (50) Other revenues 179 248 298 698 Total revenues 21,450 21,300 23,347 24,017 Net income (loss) 1,550 (138) 401 3,228 Earnings (loss) per share .46 (.04) .12 .96
SCHEDULE I AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES SUMMARY OF INVESTMENTS- OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 1996 (Dollars in thousands) Column A Column B Column C Column D Amount as shown on Type of investment Cost Value balance sheet Fixed Maturities: Bonds: United States Government and government agencies and authorities $ 37,723 $ 37,774 $ 37,774 States, municipalities and political subdivisions 26,034 26,608 26,608 Foreign governments - - - Public utilities 324 335 335 Convertibles and bonds with warrants attached - - - All other corporate bonds 31,542 31,552 31,552 --------------- --------------- ---------------- Total bonds 95,623 96,269 96,269 Certificates of deposit 175 175 175 Redeemable preferred stock 6,001 6,050 6,050 --------------- --------------- ---------------- Total fixed maturities 101,799 102,494 102,494 Equity securities: Common stocks: Public utilities 121 141 141 Banks, trust and insurance companies 1,583 2,418 2,418 Industrial, miscellaneous and all other 5,513 7,220 7,220 Non-redeemable preferred stocks 3,971 4,253 4,253 --------------- --------------- ---------------- Total equity securities 11,188 14,032 14,032 Mortgage loans on real estate - XXXXXXX - Real estate - XXXXXXX - Policy loans - XXXXXXX - Other long-term investments 2,667 XXXXXXX 2,849 Short-term money-market investments 890 XXXXXXX 890 --------------- --------------- ---------------- Total investments $ 116,544 XXXXXXX $ 120,265 =============== =============== ================
SCHEDULE II
AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION (Parent Company Only) STATEMENT OF OPERATIONS (Dollars in thousands) Year ended December 31, 1996 1995 1994 REVENUES: Management fee income, net $ - $ 734 $ 1,469 Equity in income (loss) of subsidiaries (969) 3,307 4,756 Commissions & fees 2 1,176 1,257 Net investment income 65 201 6 Net realized gains (losses) (5) - - ------------ ------------ ------------- Total revenues (907) 5,418 7,488 EXPENSES: General and administrative - 1,489 2,217 Merger expenses 710 - - Lease termination cost 1,300 - - Interest expense 107 - - ------------ ------------ ------------- Total expenses 2,117 1,489 2,217 Income before income taxes (3,024) 3,929 5,271 Provision for income taxes (benefit) (338) 260 230 ------------ ------------ ------------- Net income (loss) $ (2,686) $ 3,669 5,041 ============ ============ =============
See accompanying notes to financial statements.
SCHEDULE II (continued) AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION (Parent Company Only) BALANCE SHEETS (Dollars in thousands) December 31, 1996 1995 ASSETS: Total investments $ 61,083 $ 62,225 Cash and cash equivalents 1,059 2,088 Accrued investment income - 10 Income taxes receivable 21 269 Deferred Federal income tax asset 533 1,235 Due from affiliates - - Furniture, equipment and improvements 1,078 1,531 Other assets 2,046 2,334 -------------- -------------- Total assets $ 65,820 $ 69,692 ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY: Liabilities: Bank indebtedness $ 12,500 $ 12,500 Due to affiliates 1,166 1,436 Other liabilities 2,222 681 -------------- -------------- Total liabilities 15,888 14,617 -------------- -------------- Stockholders' Equity: Common stock and additional paid in capital 16,860 17,238 Net unrealized appreciation (depreciation) on equity securities, net of taxes 2,456 3,074 Retained earnings 30,616 34,763 -------------- -------------- Total stockholders' equity 49,932 55,075 -------------- -------------- Total liabilities and stockholders' equity $ 65,820 $ 69,692 ============== ==============
See accompanying notes to financial statements.
SCHEDULE II (continued) AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION (Parent Company Only) STATEMENT OF CASH FLOWS (Dollars in thousands) Year ended December 31, 1996 1995 1994 CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ (2,686) $ 3,669 $ 5,041 Less equity in income of subsidiary 969 (3,307) (4,756) ------------ ------------- -------------- Net income from operations (1,717) 362 285 Adjustments: Change in income taxes, net 1,268 97 242 Change in accrued investment income 10 - - Change in due (to) from affiliates (270) 597 (932) Change in other assets / liabilities 1,829 (1,539) 299 Dividend received from affiliate 500 2,160 1,480 Provision for depreciation and amortization 431 822 958 Realized loss 4 - - on sale of investments Purchases of trading securities - (26,644) (13,895) Sales of trading securities - 26,959 13,703 Realized loss on sale of fixed assets 36 6 - ------------ ------------- -------------- Net cash provided (used) 2,091 2,820 2,140 ------------ ------------- -------------- CASH FLOWS FROM INVESTING ACTIVITIES: Cash received from investments sold, matured, called or repaid 995 - - Cash paid for investments acquired (2,262) - - Amortization of premium on bonds - (632) 632 Capital expenditures, net (14) (256) (871) ------------ ------------- -------------- Net cash provided (used) (1,281) (888) (239) ------------ ------------- -------------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of surplus note from subsidiary 1,000 - - Proceeds from common stock issuance 299 448 110 Repurchase of common stock (676) (375) (467) Capital contribution to subsidiaries (1,000) (938) - Dividends paid (1,462) (940) (852) ------------ ------------- -------------- Net cash from financing activities (1,839) (1,805) (1,209) ------------ ------------- -------------- Net increase (decrease) (1,029) 127 692 Cash and cash equivalents, beginning 2,088 1,961 1,269 ------------ ------------- -------------- Cash and cash equivalents, ending $ 1,059 $ 2,088 $ 1,961 ============ ============= ==============
See accompanying notes to financial statements. SCHEDULE II (continued) AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION (Parent Company Only) NOTES TO FINANCIAL STATEMENTS 1. Basis of Presentation The accompanying condensed financial statements include the accounts of Amwest Insurance Group, Inc. (the "Parent Company"). The Parent Company's wholly-owned subsidiaries, Amwest Surety Insurance Company, Far West Insurance Company, Far West Bond Services, Condor Insurance Company and Raven Claims Services, Inc. are not presented as consolidated entities on these condensed financial statements. On March 14, 1996, the Parent Company completed its previously announced merger with Condor Services, Inc. ("Condor Services"), an unaffiliated insurance holding company. In the merger, each outstanding share of Condor Services' common stock (other than shares owned by Condor Services as treasury stock or by the Company) were converted into the right to receive 0.5 of a share of the Company's common stock. In connection with the merger, the Parent Company issued 992,000 shares of common stock. The merger has been accounted for under the pooling of interests method. Accordingly, all financial information presented herein for all periods includes Condor Services. Additionally, share and per share data presented in these financial statements reflect the retroactive effects of the merger with Condor Services. 2. Material Contingencies The Parent Company is the subject of certain claims arising in the ordinary course of its operations. The Parent Company believes that the ultimate resolution of such matters will not materially affect its financial condition. 3. Long-Term Obligations and Guarantees On August 6, 1993, the Parent Company entered into a revolving credit agreement with Union Bank for $12,500,000. The debt agreement was amended on April 24, 1995 and again on July 10, 1996 to increase the amount available under the revolving line of credit from $12,500,000 to $15,000,000. The amounts available are reduced by $3,000,000 each year beginning on September 30, 1997 and ending on September 30, 2001. Accordingly at December 31, 1996, $15,000,000 is available under the revolving line of credit, $12,500,000 of which is currently utilized. The bank loan has a variable rate based upon fluctuations in the London Interbank Offered Rate (LIBOR) and amortizing principal payments. The Board of Directors Amwest Insurance Group, Inc.: We consent to incorporation by reference in registration statements Nos. 33-11020, 33-24243 and 33-38128 on Form S-8 and in registration statements Nos. 33-28645 and 33-37984 on Form S-3 of Amwest Insurance Group, Inc. of our reports dated February 21, 1997, relating to the consolidated balance sheets of Amwest Insurance Group, Inc. and subsidiaries as of December 31, 1996 and 1995 and the related consolidated statements of operations, changes in stockholders' equity and cash flows and related schedules for each of the years in the three-year period ended December 31, 1996, which reports appear in the December 31, 1996 annual report on Form 10-K of Amwest Insurance Group, Inc. KPMG PEAT MARWICK LLP Los Angeles, California March 28, 1997 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Amwest Insurance Group, Inc.: Under date of February 21, 1997, we reported on the consolidated balance sheets of Amwest Insurance Group, Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1996, as contained in the annual report on Form 10-K for the year 1996. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related consolidated financial statement schedules as listed in the accompanying index. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits. In our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. KPMG PEAT MARWICK LLP Los Angeles, California February 21, 1997 EX-10.55 3 RESTATED REVOLVING CREDIT AGREEMENT RESTATED REVOLVING CREDIT AGREEMENT dated as of July 10, 1996 between AMWEST INSURANCE GROUP, INC. ("Borrower") and UNION BANK OF CALIFORNIA, N.A. ( "Bank" ) $17,500,000 TABLE OF CONTENTS ARTICLE I DEFINITIONS AND INTERPRETATIONS Page(s) SECTION 1.1 Definitions 1 SECTION 1.2 Accounting Terms and Determinations 12 SECTION 1.3 Computation of Time Periods 13 SECTION 1.4 Construction 13 SECTION 1.5 Exhibits and Schedules 13 SECTION 1.6 No Presumption Against Any Party 13 SECTION 1.7 Independence of Provisions 13 ARTICLE II THE CREDIT SECTION 2.1 The Revolving Commitment 14 SECTION 2.2 Payment of Excess Obligations 14 SECTION 2.3 Interest Rates 14 SECTION 2.4 Notice of Borrowing Requirements 15 SECTION 2.5 Conversion or Continuation Requirements 16 SECTION 2.6 Eurodollar Costs 17 SECTION 2.7 Special Eurodollar Circumstances 18 SECTION 2.8 Revolving Note; Statements of Obligations 18 SECTION 2.9 Holidays 19 SECTION 2.10 Time and Place of Payments 19 SECTION 2.11 Fees 19 SECTION 2.12 Mandatory Commitment Reductions 20 ARTICLE III REPRESENTATIONS AND WARRANTIES OF BORROWER SECTION 3.1 Due Organization 20 SECTION 3.2 Requisite Power 21 SECTION 3.3 Binding Agreements 21 SECTION 3.4 No Conflict 21 SECTION 3.5 Litigation 21 SECTION 3.6 Consents 22 SECTION 3.7 Financial Statements and Condition 22 SECTION 3.8 Use of Loans Proceeds 22 SECTION 3.9 Regulation U 22 SECTION 3.10 Tax Returns 22 SECTION 3.11 Trademarks, Licenses, etc 23 SECTION 3.12 Burdensome Agreements, etc 23 SECTION 3.13 Title and Liens 23 SECTION 3.14 Other Information 23 SECTION 3.15 Existing Defaults 23 SECTION 3.16 Leases 24 SECTION 3.17 Casualty 24 SECTION 3.18 Investment Company Act 24 SECTION 3.19 Public Utility Holding Company Act 24 SECTION 3.20 Disclosure 24 SECTION 3.21 Location of Chief Executive Office 24 SECTION 3.22 No Default 25 SECTION 3.23 No Pension Fund Irregularities 25 SECTION 3.24 Compliance With Law 25 ARTICLE IV CONDITIONS TO LOANS SECTION 4.1 Conditions Precedent to the Loans 26 ARTICLE V AFFIRMATIVE COVENANTS SECTION 5.1 Accounting Records 27 SECTION 5.2 Financial Statements and Reports 27 SECTION 5.3 Corporate Existence 30 SECTION 5.4 Compliance With Law 30 SECTION 5.5 Insurance 31 SECTION 5.6 Properties 31 SECTION 5.7 Taxes and Other Liabilities 31 SECTION 5.8 Tax Returns 31 SECTION 5.9 Fixed Charge Coverage Ratio 31 SECTION 5.10 (Intentionally Deleted) 32 SECTION 5.11 Tangible Net Worth 32 SECTION 5.12 Net Profit 32 SECTION 5.13 Policyholders' Surplus 32 SECTION 5.14 Operating Leverage Ratio 32 SECTION 5.15 A.M. Best Rating 32 SECTION 5.16 Investment Portfolio Quality 32 SECTION 5.17 Pension Plan Funding 32 SECTION 5.18 Reinsurance Contract 33 SECTION 5.19 Storage and Protection of Data 33 ARTICLE VI NEGATIVE COVENANTS SECTION 6.1 Mergers, Consolidations 34 SECTION 6.2 Sale of Assets 34 SECTION 6.3 Liens 34 SECTION 6.4 Contingent Obligations 35 SECTION 6.5 Conduct of Business 35 SECTION 6.6 Transactions with Shareholders 36 SECTION 6.7 Restrictive Agreements 36 SECTION 6.8 Debt 36 SECTION 6.9 Dividends 36 SECTION 6.10 Leases 37 SECTION 6.11 Stock 37 SECTION 6.12 Prepayment and Repayment of Debt 37 SECTION 6.13 Sale-Leasebacks 37 SECTION 6.14 Misrepresentations 37 SECTION 6.15 Partnerships 37 SECTION 6.16 Subsidiaries Debt and Liens 37 SECTION 6.17 Changes in Location of Chief Executive Office 38 SECTION 6.18 Loss Reserves 38 SECTION 6.19 Surplus Note 38 SECTION 6.20 Capitalized Expenditures 38 SECTION 6.21 Acquisitions 38 ARTICLE VII EVENTS OF DEFAULT SECTION 7.1 Events of Default 39 SECTION 7.2 Remedies 41 ARTICLE VIII MISCELLANEOUS SECTION 8.1 Waivers, Modifications in Writing 41 SECTION 8.2 Failure or Delay 42 SECTION 8.3 Notices, etc 42 SECTION 8.4 Costs and Expenses 42 SECTION 8.5 Sale of Participation 43 SECTION 8.6 Headings 43 SECTION 8.7 Execution in Counterparts 43 SECTION 8.8 Binding Effect; Assignment 43 SECTION 8.9 Severability of Provisions 43 SECTION 8.10 Publicity 44 SECTION 8.11 Complete Agreement 44 SECTION 8.12 Governing Law and Venue 44 SECTION 8.13 Dispute Resolution 44 EXHIBITS AND SCHEDULES Schedule 1 Reserved Schedule 2 Permitted Liens Schedule 3 Contingent Obligations Schedule 4 Permitted Debt Schedule 5 Permitted Partnerships Schedule 6 Litigation Exhibit 1 Surplus Note Exhibit 2 Notice of Borrowing Exhibit 3 Notice of Continuation or Conversion Exhibit 4 Compliance Certificate RESTATED REVOLVING CREDIT AGREEMENT This RESTATED REVOLVING CREDIT AGREEMENT, dated as of July 10, 1996, is entered into between Borrower and Bank. The parties hereto agree as follows: ARTICLE I DEFINITIONS AND INTERPRETATIONS SECTION 1.1 Definitions. The following terms, as used herein, shall have the following meanings: "Affiliate" means, with respect to any designated Person, any Person that, directly or indirectly, controls, is controlled by or is under common control with such designated Person; and, for purposes of the foregoing "control" (including "controlled by" and "under common control with") with respect to any Person shall mean the possession, directly or indirectly, of 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. An "Affiliate" of Borrower shall not include Richard or John Savage. "Agreement" means this Revolving Credit Agreement, together with any concurrent or subsequent rider, amendment, schedule or exhibit to this Revolving Credit Agreement. "Applicable Base Rate Margin" and "Applicable Eurodollar Rate Margin" means the percentage per annum set forth in the table below opposite the Interest Coverage for the most recently ended four fiscal quarters for which Financial Statements have been delivered to Bank pursuant to Sections 5.2(a) or 5.2(b) and the Interest Rate Leverage Ratio as of the end of such the last quarter or, if the respective percentages per annum set forth opposite such Interest Coverage and such Interest Rate Leverage Ratio are different, the higher of such percentages per annum. Interest Rate Applicable Applicable Applicable Leverage Ratio Base Lending Rate Eurodollar Lending Margin Margin .30 less than x .50% 2.00% .25 less than x less than .30 .25% 1.75% .20 less than x less than .25 .00% 1.50% .15 less than x less than .20 .00% 1.25% x less than .15 .00% 1.00% "ASIC" means Amwest Surety Insurance Company, a Subsidiary of the Borrower. "Asset" means any interest of a Person in any kind of property or asset, whether real, personal, or mixed real and personal, and whether tangible or intangible. "Bank" means Union Bank of California, N.A., successor in interest to Union Bank, a California banking corporation. "Bank" or "Union Bank" when referred to in this agreement shall mean Union Bank of California, N. A. "Bank Expenses" means all costs or expenses paid or advanced by Bank which are required to be paid by Borrower under this Agreement and all other documents executed in connection herewith; taxes and insurance premiums of every nature and kind of Borrower paid by Bank; appraisal, filing, recording, documentation, publication and search fees paid or incurred by Bank to correct any default or enforce any provision of this Agreement and all other documents executed in connection herewith; to the extent reimbursable under Section 8.4, costs and expenses of suit or arbitration proceeding incurred by Bank in enforcing or defending this Agreement, or any portion hereof, and reasonable attorneys' fees and expenses incurred by Bank in structuring, drafting, reviewing, amending, terminating, enforcing, defending or concerning this Agreement and all other documents executed in connection herewith, whether or not suit is brought, such attorneys' fees to include the reasonable estimate of the allocated costs and expense of Bank's legal counsel and professional staff. All Bank Expenses paid or incurred by Bank shall be considered to be, and shall become a part of the Obligations, are payable, except as otherwise provided herein, within 10 days after demand, and if not reimbursed, shall immediately thereafter bear interest, together with all other amounts to be paid by Borrower pursuant hereto at the Base Rate. "Bank's Fees" means the Revolving Commitment Fee. "Bankruptcy Code" means The Bankruptcy Reform Act of 1978 (Pub. L. No. 95-598; 11 U.S.C. Section 101-1330), as amended or supplemented from time to time, or any successor statute, and any and all rules and regulations issued or promulgated in connection therewith. "Base Rate" means the sum of the Reference Rate Plus the Applicable Base Rate Margin. "Base Rate Borrowing" means any Borrowing designated by Borrower as bearing the Base Rate pursuant to Section 2.3(a) or 2.5(a) . "Base LIBOR" means the offered quotation, if any, to first-class banks in the Eurodollar market by Bank for U.S. Dollar deposits of amounts in funds comparable to the principal amount of the Eurodollar Rate Borrowing for which the Eurodollar Rate is being determined with maturities comparable to the Interest Period for which such Eurodollar Rate will apply as of approximately 10:00 a.m., California time, two (2) Eurodollar Business Days prior to the commencement of such Interest Period. "Borrower" means AMWEST INSURANCE GROUP, INC. "Business Day" means a borrowing pursuant to the terms of Section 2.1 consisting of Revolving Loans made by Bank to Borrower. "Business Day" means any day other than a Saturday, a Sunday, or a day on which commercial banks in the City of Los Angeles, California are authorized or required by law or executive order or decree to close. "Cash Equivalents" means, when used in connection with any Person, that Person's Investment in: (a) Government Securities due within one year after the date of determination; (b) Readily marketable direct obligations of any State of the United States of America or any political subdivision of any such State given on the date of such investment a credit rating of at least A by Moody's Investments Service, Inc. or A by Standard & Poor's Corporation, in each case due within one year from the date of determination; (c) Certificates of deposit issued by, bank deposits in, eurodollar deposits through, bankers' acceptances of, and reverse repurchase agreements covering Government Securities ("Qualified Bank Deposits") executed by, the Bank or any other bank, savings and loan or savings bank doing business in and incorporated under the Laws of the United States of America or any State thereof and having on the date of such Investment combined capital, surplus and undivided profits of at least $250,000,000 ("Qualified Domestic Institutions"), in each case due within one year after the date of determination; (d) Qualified Bank Deposits executed by, any branch or office located in the United States of America of a bank incorporated under the Laws of any jurisdiction outside the United States of America having on the date of such Investment combined capital, surplus and undivided profits of at least $500,000,000 ("Qualified Foreign Institution"), in each case due within one year after the date of determination; (e) Readily marketable commercial paper of corporations doing business in and incorporated under the Laws of the United States of America or any State thereof given on the date of such Investment the highest or second highest credit rating by Moody's Investors Service, Inc. and Standard & Poor's Corporation, in each case due within 270 days after the date of the determination; (f) Money Market Funds investing in securities otherwise constituting Cash Equivalents; Provided that, the portion of Qualified Bank Deposits not executed by a Qualified Domestic Institution, or Qualified Foreign Institution, which are insured by the Federal Deposit Insurance Corporation, the Federal Savings and Loan Insurance Corporation or the Securities Investor Protection Corporation shall be considered Cash Equivalents. "Capitalized Expenditures" means, when used in connection with any Person, any expenditure by such Person that, in conformity with GAAP, has been or should be included in the furniture equipment and improvements reflected in the Person's balance sheet, excluding, however, any Investment. "Capital Surplus" means the "surplus as regards policyholders" of ASIC and its Subsidiaries as set forth in the consolidated statements of ASIC and its Subsidiaries as filed with the California Department of Insurance. "Closing Date" means July 10, 1996. "Commitment Reduction" means, for each applicable Revolving Commitment Reduction Date, that amount expressed in Dollars indicated in the table in Section 2.12 opposite the applicable Revolving Commitment Reduction Date. "Contingent Obligation" means, as to any Person, any (a) direct or indirect guarantee of Indebtedness of, or other obligation performable by, any other Person, including any endorsement (other than for collection or deposit in the ordinary course of business), co-making or sale with recourse of the obligations of any other Person or (b) assurance given to an obligee with respect to the performance of an obligation by, or the financial condition of, any other Person, whether direct, indirect or contingent, including any purchase or repurchase agreement covering such obligation or any collateral security therefor, any agreement to provide funds (by means of loans, capital contributions or otherwise) to such other Person, any agreement to support the solvency or level of any balance sheet item to such other Person, or any "keep-well", "take-or-pay" or "through put" or any other arrangement of whatever nature having the effect of assuring or holding harmless any obligee against loss with respect to any obligation of such other Person. The amount of any Contingent Obligation shall be deemed to be an amount equal to the stated or determinable amount of the related primary obligation (unless the Contingent Obligation is limited by its terms to a lesser amount, in which case to the extent of such amount) or, if not stated or determinable, the maximum reasonably anticipated liability in respect thereof as determined by the Person in good faith, provided however, Contingent Obligation shall not include surety bonds and other insurance products issued by the Borrower or any of its subsidiaries in the ordinary course of Borrower or its Subsidiaries business. "Credit Document(s)" means each of the following documents, instruments, and agreements individually or collectively, as the context requires: (i) the Revolving Note; and (ii) such other documents, instruments,and agreements as Bank may reasonably request in connection with the transactions contemplated hereunder. "Daily Balances" means the amount determined by taking the amount of the obligations owed under the Revolving Loans at the beginning of a given day, adding any new obligations advanced or incurred on such date, and subtracting any payments or collections which are deemed to be paid on that date under the provisions of this Agreement. "Debt" means the outstanding aggregate principal balance of the Revolving Loans plus all of Borrower's consolidated Capitalized Lease Obligations and any indebtedness heretofore or hereafter created, issued, guaranteed, incurred or assumed by Borrower (directly or indirectly) for or in respect of money borrowed or for or in respect of the deferred purchase price of property or services purchased (other than trade accounts payable arising in the ordinary course of business). "Default" means any condition or event which constitutes an Event of Default or which with the giving of notice or lapse of time or both would, unless cured or waived, become an Event of Default. "Dollars" or "$" means lawful currency of the United States of America. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended from time to time, and unless the context otherwise requires, the regulations thereunder. "ERISA Affiliate" means the Borrower and all members of a controlled group of corporations and all trades or businesses (irrespective of whether incorporated) under common control that, together with the Borrower, are treated as a single employer under subsection (b), (c), (m) or (o) of Section 414 of the Internal Revenue Code or the regulations promulgated thereunder. "ERISA Group" means Borrower and all members of a controlled group of corporations and all trades or businesses (whether or not incorporated) under common control which, together with such Borrower are treated as a single employer under Section 414 of the Internal Revenue Code. "Eurodollar Business Day" means any Business Day on which major commercial banks are open for international business (including dealings in Dollar deposits) in Los Angeles, California and London, England. "Eurodollar Rate" means, with respect to a Eurodollar Rate Borrowing, the rate per annum (rounded upwards if necessary to the nearest whole one-hundredth of one percent (.01%)), determined as the sum of: (a) the quotient of: (i) Base LIBOR for the relevant Interest Period; divided by (ii) the number (expressed as a decimal) equal to one hundred percent (100%) in the LIBOR Reserve Percentage; plus (b) the Applicable Eurodollar Rate Margin. The Eurodollar Rate shall be adjusted automatically on the effective date of any change in the LIBOR Reserve Percentage, such adjustment to affect any Eurodollar Rate Borrowings outstanding on such effective date to the extent such change is applied retroactively to eurocurrency funding of a member bank in the Federal Reserve System. Each determination of a eurodollar Rate by Bank, including, but not limited to, any determination as to the applicability or allocability of reserves to eurocurrency liabilities or as to the amount of such reserves, shall be conclusive and final in the absence of manifest error. "Eurodollar Rate Borrowing" means any Borrowing designated by Borrower as bearing the Eurodollar Rate pursuant to Sections 2.3(a) or 2.5(a). "Event of Default" has the meaning set forth in Section7.1. "Financial Statement(s)" means, with respect to any accounting period of any Person, statements of operations and of cash flows of such Person for such period, and balance sheets of such Person as of the end of such period, setting forth in each case in comparative form figures for the corresponding period in the preceding fiscal year or, if such period is a full fiscal year, corresponding figures from the preceding annual audit, all prepared in reasonable detail and in accordance with GAAP. "Financial Statement(s)" shall include the notes and schedules thereto. "Fiscal Year" shall mean the calendar year. "Funds Held as Collateral" means, as of any date of determination, the amount that should, in accordance with GAAP, be reflected in a consolidated balance sheet of Borrower and its Subsidiaries on that date, prepared consistently with the consolidated balance sheet of Borrower and its Subsidiaries for the Fiscal Year of Borrower and identified as "funds held as collateral." "GAAP" means generally accepted accounting principles in the United States of America, consistently applied, which are in effect as of the date of their application. "Government Securities" means readily marketable direct full faith and credit obligations of the United States of America or obligations unconditionally guaranteed or backed by the full faith and credit of the United States of America. "Insolvency Proceeding" means any proceeding commenced by or against any Person, under any provision of the Bankruptcy Code, or under any other bankruptcy or insolvency law, including, but not limited to, assignments for the benefit of creditors, formal or informal moratoriums, compositions, or extensions with some or all creditors. "Interest Coverage" means Cash Operating Income divided by interest expense for the Borrower and its Subsidiaries on a consolidated basis. Cash Operating Income equals pre-tax income plus interest expense, plus amortization of bond premiums, less accretion of bond discounts, less gain on sale of investments, plus loss on sale of investments, plus depreciation and amortization expense. "Interest Rate Leverage Ratio" means (as it pertains to the interest rate determination) total liabilities divided by total assets for the Borrower and its Subsidiaries on a consolidated basis. "Interest Payment Date" means July 31, 1996 and the last day of every month thereafter or, with respect to Eurodollar Rate Borrowings, the last day of the Interest Period applicable to each outstanding Eurodollar Rate Borrowing unless the Interest Period is greater than three months in which case interest is payable at the end of each three month period during such period and at the end of the Interest Period. "Interest Period" means, with respect to each Eurodollar Rate Borrowing, the period commencing on the date of such Eurodollar Rate Borrowing and ending one (1), two (2), three (3), six (6) or more (with Bank's prior written consent) months thereafter, as Borrower may elect pursuant to the applicable Notice of Borrowing or Notice of Conversion or Continuation; provided, however, that: (a) any Interest Period which would otherwise end on a day which is not a Eurodollar Business Day shall be extended to the next succeeding Eurodollar Business Day unless such Eurodollar Business Day falls in another calendar month in which case such Interest Period shall end on the next preceding Eurodollar Business Day; and (b) any Interest Period which begins on the last Eurodollar Business Day of the calendar month (or on a day for which there is no numerically corresponding day in the calendar month at the end of such Interest Period) shall end on the last Eurodollar Business Day of the calendar month in which it would have ended if there were a numerically corresponding day in such calendar month. "Internal Revenue Code" means the Internal Revenue Code of 1986, as supplemented and amended from time to time, or any successor statute, and any and all regulations and . rules promulgated thereunder. "Invested Assets" means, as of any date of determination, the amount that should, in accordance with GAAP be reflected in a consolidated balance sheet of Borrower and its Subsidiaries on that date, prepared consistently with the consolidated balance sheet of Borrower and its Subsidiaries for the Fiscal Year of Borrower and identified as "investments." "Investment" means, as applied to any Person, any direct or indirect purchase or other acquisition by that Person of, or beneficial interest in, stock or other securities of any other Person, or any direct or indirect loan, advance (other than advances to employees for moving, travel, and payroll expenses, drawing accounts and similar expenditures in the ordinary and usual course of business) or capital contribution by that Person to any other Person, including all indebtedness and accounts receivable due from that other Person which are not current assets or did not arise from sales to that other Person in the ordinary and usual course of business. The amount of any Investment shall be the original cost of such Investment plus the cost of all additions thereto, without any adjustments, except as permitted by generally accepted accounting principles, for increases or decreases in value, or write-ups, write-downs or write-offs with respect to such Investment. "Investment Income" means the "investment income," determined in accordance with GAAP, for the twelve (12) month period immediately preceding the applicable fiscal quarter end. "Lending Office" means Bank's office located at its address set forth on the signature pages hereof, or such other office of Bank as it may hereafter designate as its Lending Office by notice to Borrower. "Leverage Ratio" means the ratio of (a) funded Debt to Union Bank to (b) Tangible Net Worth, measured as of the last day of each fiscal quarter. "LIBOR Reserve Percentage" means, as of the date of determination thereof, the percentage (rounded upward to the nearest one-hundredth of one percent (.01%)), as determined by Bank in accordance with its usual procedures (which determination shall be conclusive in the absence of manifest error), representing the actual, aggregate incremental reserve requirement of the Bank as prescribed by the Board of Governors of the Federal Reserve System with respect to new nonpersonal time deposits in the form of eurocurrency (currently referred to as "eurocurrency liabilities") in an amount equal to the particular Loan and for a time period comparable to the number of days in the applicable Interest Period. "Lien" means any mortgage, deed of trust, pledge, security interest, assignment, conditional sale or other title retention agreement, lien, charge or encumbrance of any kind. "Liquidity Ratio" means the ratio of (a) Cash plus Cash Equivalents plus Invested Assets plus accrued Investment Income to (b) Total Liabilities less the long term portion of Debt to the Bank hereunder and other long term liabilities of the Borrower and its Subsidiaries determined as of the last day of each fiscal quarter. "Mandatory Commitment Reductions" means, as of the date of determination, the aggregate amount of the Commitment Reduction required. "Material Adverse Change" means a material adverse change in (i) the business, Assets, condition (financial or otherwise) or results of operations of Borrower and its Subsidiaries taken as a whole, (ii) the ability of Borrower to perform its obligations under this Agreement (including, without limitation, repayment of the Obligations as they come due) or (iii) the validity or enforceability of this Agreement, the Credit Documents, or the rights or remedies of Bank hereunder and thereunder. "Maturity Date" means September 30, 2001. "Multiemployer Plan" means a "multiemployer plan" as defined in ss. 4001(a) (3) of ERISA, Section 414 of the Code, or Section 3(37) of ERISA to which any member of the ERISA Group is then making or accruing an obligation to make contributions or has within the preceding five plan years made contributions, including for these purposes any Person which ceased to be a member of the ERISA Group during such five year period. "Net Profit" means a net profit of Borrower, pursuant to GAAP, on a consolidated basis, for each fiscal year excluding any gains or (losses) related to "accounting changes". "Net Written Premiums" means the net premiums written by ASIC and its Subsidiaries as set forth in the annual consolidated statement of ASIC and its Subsidiaries filed with the California Department of Insurance. "Notice of Borrowing" means an irrevocable notice from Borrower to Bank of Borrower's request for a Borrowing pursuant to the terms of Section 2.4(b), substantially in the form of Exhibit 3. "Notice of Conversion or Continuation" means a written notice given pursuant to the terms of Section 2.5(b), substantially in the form of Exhibit 4. "Obligations" mean any and all indebtedness, liabilities, and obligations of Borrower owing to Bank and to its successors and assigns, previously, now, or hereafter incurred, and howsoever evidenced, whether direct or indirect, absolute or contingent, joint or several, liquidated or unliquidated, voluntary or involuntary, due or not due, legal or equitable, whether incurred before, during, or after any Insolvency Proceeding, and whether recovery thereof is or becomes barred by a statute of limitations or is or becomes otherwise unenforceable or unallowable as claims in any Insolvency Proceeding, together with all interest thereupon (including all interest accruing during the pendency of an Insolvency Proceeding), and all Bank Expenses. The Obligations shall include, without limiting the generality of the foregoing, all principal and interest owing under the Revolving Loans, all Bank's Fees, all Bank Expenses, any other fees and expenses due hereunder, and all other indebtedness evidenced by this Agreement and the Revolving Note. "Operating Leverage Ratio" means Net Written Premiums over the most recent four quarters divided by Capital Surplus as of the most recent quarterly ending date. "PBGC" means the Pension Benefit Guaranty Corporation or any entity succeeding to any or all of its functions under ERISA. "Permitted Liens" is defined in Section 6.3. "Person" means and includes natural persons, corporations, limited partnerships, general partnerships, joint stock companies, joint ventures, associations, companies, trusts, banks, trust companies, land trusts, business trusts, or other organizations, irrespective of whether they are legal entities, and governments and agencies and political subdivisions thereof. "Plan" means an "employee benefit plan" as defined in Section 3(3) of ERISA in which any personnel of either Borrower or an ERISA Affiliate participate or from which any such personnel may derive a benefit, excluding any Multiemployer Plan, but including any plan either established or maintained by such Borrower or any ERISA Affiliate or to which such Person contributes under the laws of any foreign country. "Prohibited Transaction" means a transaction that is prohibited under Section 4975 of the Internal Revenue Code or Section 406 or 407 of ERISA and not exempt under Section 4975 of the Internal Revenue Code or Section 408 of ERISA. "Reference Rate" means the rate of interest announced by Bank at its corporate headquarters as its reference rate and which serves as the basis upon which effective rates of interest are calculated for those loans making reference thereto. The Reference Rate is determined by Bank from time to time as a means of pricing credit extensions to some customers and is neither directly tied to some external rate of interest or index nor necessarily the lowest rate of interest charged by Bank at any given time for any particular class of customers or credit extensions. "Reportable Event" means a reportable event described in Section 4043 of ERISA, a withdrawal from a Plan described in Section 4063 of ERISA, or a substantial cessation of operations described in Section 4062(e) or ERISA. "Responsible Officer" means the president or chief financial officer, or any other Person designated by the president or chief financial officer in a writing delivered to Bank. "Revolving Commitment" means subject to Section 2.12, Seventeen Million Five Hundred Thousand Dollars ($17,500,000); provided that on each Revolving Commitment Reduction Date, the Revolving Commitment in effect immediately prior to such date shall be reduced by the Commitment Reduction for that date. "Revolving Commitment Fee" has the meaning set forth in Section 2.11. "Revolving Commitment Reduction Date" means each of the dates set forth in the table in Section 2.12. "Revolving Commitment Reduction Payment" means a payment in an amount which is necessary in order to reduce the aggregate outstanding principal balance of the Revolving Loans to the amount of the Revolving Commitment as reduced on the applicable Revolving Commitment Reduction Date by the Commitment Reduction in effect on such date, plus all accrued interest on such amount. "Revolving Loans" means the revolving loans made by Bank to Borrower pursuant to the terms of Section 2.1. "Revolving Note" means that certain Revolving Note, dated as of even date herewith, executed by Borrower to the order of Bank, in the principal amount of Seventeen Million Five Hundred Thousand Dollars ($17,500,000), and any replacements, substitution, renewals, refinancings or restatements thereof. "Subsidiary" means any corporation (whether now existing or hereafter organized or acquired) of which a Person or one or more Subsidiaries of such Person at the time owns or controls directly or indirectly more than 50% of the shares of stock having general voting power under ordinary circumstances to elect a majority of the board of directors, managers or trustees of such corporation (irrespective of whether at the time stock of any other class or classes shall have or might have voting power by reason of the happening of any contingency). "Surplus Note" means that certain $10,000,000 Certificate of Contribution issued by Amwest Surety Insurance Company to Borrower, a copy of which is attached hereto as Exhibit 1, either as originally executed or as the same may from time to time be supplemented, modified, amended, renewed, extended or supplanted. "Tangible Net Worth" means stockholders' equity of Borrower and its Subsidiaries as determined in accordance with GAAP consistently applied but excluding the effect of FASB 115, increased by debt subordinated to Bank and decreased by the following: licenses, trademarks, trade names, goodwill, subscription lists, organization expenses and other intangible assets (but "intangible assets" shall exclude deferred policy acquisition costs), as determined in accordance with GAAP. "Total Liabilities"means total liabilities as defined by GAAP. "Unfunded Liabilities" means, with respect to any Plan at any time, the amount (if any) by which (i) the present value of all benefits under such Plan exceeds (ii) the fair market value of all Plan assets allocable to such benefits (excluding any accrued but unpaid contributions), all determined as of the then most recent valuation date for such Plan, but only to the extent that such excess represents a potential liability of a member of the ERISA Group to the PBGC or an appointed trustee under Title IV of ERISA. SECTION 1.2 Accounting Terms and Determinations. Unless otherwise specified herein, all accounting terms used herein shall be interpreted, all accounting determinations hereunder shall be made, and all financial statements required to be delivered hereunder shall be prepared in accordance with GAAP; provided, however, that if the Borrower notifies the Bank that the Borrower wishes to amend any covenant in Article V or VI to eliminate the effect of any change in GAAP or an adverse ruling with respect to Prop 103 on the operation of such covenant, then the Borrower's compliance with such covenant shall be determined on the basis of GAAP in effect immediately before the relevant change in GAAP became effective or without giving effect to such ruling as the case may be until either such notice is withdrawn or such covenant is amended in a manner satisfactory to the Borrower and the Bank. SECTION 1.3 Computation of Time Periods. In this Agreement, with respect to the computation of periods of time from a specified date to a later specified date, the word "from" means "from and including" and the words "to" and "until" each mean "to but excluding." Periods of days referred to in this Agreement shall be counted in calendar days unless otherwise stated. SECTION 1.4 Construction. Unless the context of this Agreement clearly requires otherwise, references to the plural include the singular and to the singular include the plural, references to any gender include any other gender, the part includes the whole, the term: "including" is not limiting, and the term "or" has, except where otherwise indicated, the inclusive meaning represented by the phrase "and/or." References in this Agreement to "determination" by Bank include good faith estimates by Bank (in the case of quantitative determinations), and good faith beliefs by Bank (in the case of qualitative determinations). The words "hereof," "herein," "hereby," "hereunder," and similar terms in this Agreement refer to this Agreement as a whole and not to any particular provision of this Agreement. Article, section, subsection, clause, exhibit and schedule references are to this Agreement, unless otherwise specified. Any reference in this Agreement or any of the Credit Documents to this Agreement or any of the Credit Documents includes any and all permitted alterations, amendments, changes, extensions, modifications, renewals, or supplements thereto or thereof, as applicable. SECTION 1.5 Exhibits and Schedules. All of the exhibits and schedules attached hereto shall be deemed incorporated herein by reference. SECTION 1.6 No Presumption Against Any Party. Neither this Agreement, any of the Credit Documents, any other document, agreement, or instrument entered into in connection herewith, nor any uncertainty or ambiguity herein or therein shall be construed or resolved using any presumption against any party hereto, whether under any rule of construction or otherwise. On the contrary, this Agreement, the Credit Documents, and the other documents, instruments, and agreements entered into in connection herewith have been reviewed by each of the parties and their counsel and shall be construed and interpreted according to the ordinary meanings of the words used so as to accomplish fairly the purposes and intentions of all parties hereto. SECTION 1.7 Independence of Provisions. All agreements and covenants hereunder, under the Credit Documents, and the other documents, instruments, and agreements entered into in connection herewith shall be given independent effect such that if a particular action or condition is prohibited by the terms of any such agreement or covenant, the fact that such action or condition would be permitted within the limitations of another agreement or covenant shall not be construed as allowing such action to be taken or condition to exist. ARTICLE II THE CREDIT SECTION 2.1 The Revolving Commitment. (a) Revolving Loans. Subject to the terms and conditions hereof, Bank agrees to make Revolving Loans to Borrower, pursuant to this Section 2.1, from the Closing Date to but not including the Maturity Date, in an aggregate principal amount not to exceed the amount of the Revolving Commitment then in effect. Provided that no Default or Event of Default has occurred and is continuing, Borrower may borrow, and reborrow such sum in increments of One Hundred Thousand Dollars ($100,000) upon notice in accordance with the provisions of Section 2.4. (b) Payments of Principal and Interest. All interest on all Revolving Loans, as calculated in accordance with Section 2.3, shall be payable, in arrears, on each and every Interest Payment Date. All outstanding principal of and all accrued but unpaid interest on all Revolving Loans shall be due and payable on the Maturity Date. (c) Prepayments. The Revolving Loans may be prepaid at any time without penalty or premium (except as provided in Section 2.6) upon three (3) Eurodollar Business Days' prior written notice, in the case of Eurodollar Rate Borrowings, and upon one (1) Business Day's prior written notice, in the case of Base Rate Borrowings, to Bank. All prepayments shall be in increments of One Hundred Thousand Dollars ($100,000). SECTION 2.2 Payment of Excess Obligations. Any and all Revolving Loans and financial accommodations made, extended, or arranged by Bank to or for the benefit of Borrower pursuant to this Agreement shall be added to and be deemed part of the Obligations when made or extended. If, at any time and for any reason, the amount of the Obligations exceeds the Revolving Commitment then in effect, then Borrower, upon Bank's election and demand, shall immediately pay to Bank in immediately available funds, the amount of such excess. SECTION 2.3 Interest Rates. The unpaid principal balance of the Revolving Loans shall bear interest at the applicable rate per annum provided below: (a) Revolving Loan. Borrower shall from time to time designate one or both of the following two options to apply to all or any portion of the unpaid principal balance of the Revolving Loans: (1) the Base Rate; or (2) the Eurodollar Rate. (b) Post Maturity Rate. If all or any portion of the principal amount of any Revolving Loan made under this Agreement shall not be paid when due (whether at the stated maturity, by acceleration, or otherwise), such overdue principal amount, and to the extent permitted by law overdue interest thereon, shall bear interest at a rate of two percent (2%) (200 basis points) greater than the interest rate with respect to such Revolving Loan, effective on the day following the date of nonpayment and continuing until such amounts are paid in full. (c) Computation of Interest. All computations of interest with respect to Eurodollar Rate Borrowings, shall be calculated on the basis of a year of three hundred sixty (360) days for the actual days elapsed in such period. All computations of interest with respect to Base Rate Borrowings shall be calculated on the basis of a year of three hundred sixty (360). In the event that the Reference Rate announced is, from time to time, changed, adjustment in the rate of interest payable hereunder on all outstanding Base Rate Borrowings shall be made as of 12:01 a.m. (California time) on the effective date of the change in the Reference Rate. Interest shall accrue from the first day of the making of a Revolving Loan to the date of repayment of such Revolving Loan in accordance with the provisions of this Agreement; provided, however, if a Revolving Loan is repaid on the same day on which it is made, then one (1) day's interest shall be paid on that Revolving Loan. Any and all interest not paid when due shall thereafter be deemed to be a Revolving Loan made under Section 2.1 and shall bear interest thereafter as provided for in Sections 2.3(a) and (b). SECTION 2.4 Notice of Borrowing Requirements. (a) Each Base Rate Borrowing shall be made on a Business Day and each Eurodollar Rate Borrowing shall be made on a Eurodollar Business Day. (b) Each Borrowing shall be made upon telephonic notice given by a Responsible Officer of Borrower, followed by a Notice of Borrowing in the form of Exhibit 3, given by telex, telecopy, facsimile, or personal service, delivered to Bank at both of the addresses set forth in the Notice of Borrowing. If for a Base Rate Borrowing, Bank shall be given such telephonic notice no later than 11:00 a.m., California time, one (1) Business Day prior to the day on which such Borrowing is to be made, and, if for a Eurodollar Rate Borrowing, Bank shall be given such telephonic notice no later than 11:00 a.m., California time, three (3) Eurodollar Business Days prior to the day on which such Borrowing is to be made, and such notice shall state the amount thereof (subject to the provisions of Section 2.1(a) plus the appropriate Interest Period thereof. (c) Bank shall not incur any liability to Borrower in acting upon any telephonic notice which Bank believes in good faith to have been given by a Responsible Officer of Borrower, or for otherwise acting in good faith under this Section 2.4, and in making any Revolving Loans pursuant to telephonic notice. SECTION 2.5 Conversion or Continuation Requirements. (a) Borrower shall have the option to: (i) convert, at any time, all or any part of the outstanding Revolving Loans, in integral multiples of One Hundred Thousand Dollars ($100,000), from a Revolving Loan bearing interest at one of the interest rate options available pursuant to Section 2.3(a) to another; or (ii) upon the expiration of any Interest Period applicable to a Eurodollar Rate Borrowing, to continue all or any portion of a Eurodollar Rate Borrowing as a Eurodollar Rate Borrowing, with the succeeding Interest Period(s) of such continued Eurodollar Rate Borrowing commencing on the expiration date of the Interest Period previously applicable thereto; provided, however, that a Eurodollar Rate Borrowing may only become a Base Rate Borrowing or be continued as a Eurodollar Rate Borrowing on the expiration date of the Interest Period applicable thereto; provided further, however, that no outstanding Revolving Loan may be continued as, or be converted into, a Eurodollar Rate Borrowing in the event that, on the earlier of the date of the delivery of the Notice of Conversion or Continuation or the telephonic notice in respect thereof, any Default or Event of Default has occurred and is continuing; provided further, however, that if Borrower fails to deliver the appropriate Notice of Conversion or Continuation or the telephonic notice in respect thereof pursuant to the required notice period before the expiration of the Interest Period of a Eurodollar Rate Borrowing, such Eurodollar Rate Borrowing shall automatically be converted to a Base Rate Borrowing, upon the expiration of the applicable Interest Period. (b) Borrower shall give telephonic notice of any proposed continuation or conversion pursuant to this Section 2.5 followed by a Notice of Conversion or Continuation, given by telex, telecopy, facsimile, or personal service, delivered to Bank at both of the addresses set forth in the Notice of Conversion or Continuation, in the form of Exhibit 4. Such telephonic notice shall be given no later than 11:00 a.m., California time, on the Business Day which is the proposed conversion date (in the case of a conversion to a Base Rate Borrowing) and no later than 11:00 a.m. California time, one (1) Business Day in advance of the proposed conversion date (in the case of a conversion of a Eurodollar Rate Borrowing to a Base Rate Borrowing), three (3) Eurodollar Business Days in advance of the proposed conversion or continuation date (in the case of a conversion to, or a continuation of, a Eurodollar Rate Borrowing). If such Notice of Conversion or Continuation is received by Bank not later than 11:00 a.m., California time, on a Eurodollar Business Day, such day shall be treated as the first Eurodollar Business Day of the required notice period. In any other event, such notice will be treated as having been received at the opening of business of the next Eurodollar Business Day. A Notice of Conversion or Continuation shall specify: (1) the proposed conversion or continuation date (which shall be a Business Day or a Eurodollar Business Day, as applicable); (2) the amount of the Revolving Loan to be converted or continued; (3) the nature of the proposed conversion or continuation; and (4) in the case of a conversion to or continuation of a Eurodollar Rate Borrowing, the requested Interest Period. (c) Bank shall incur no liability to Borrower in acting upon any telephonic notice referred to above which Bank believes in good faith to have been given by a Responsible Officer on behalf of Borrower or for otherwise acting in good faith under this Section 2.5 and in conversion or continuation by Bank in accordance with this Agreement pursuant to any telephonic notice. Any Notice of Conversion or Continuation (or telephonic notice in respect thereof) shall be irrevocable and Borrower shall be bound to convert or continue in accordance therewith. SECTION 2.6 Eurodollar Costs. Borrower shall reimburse Bank for any increase in Bank's costs (which shall include, but not be limited to, taxes, other than taxes imposed on or measured by the overall net income of Bank (including franchise taxes) fees or charges), or any loss or expense (including, without limitation, any loss or expense incurred by reason of the liquidation or re-employment of deposits or other funds acquired by Bank to fund or maintain outstanding the principal amount of the Revolving Loans) incurred by it directly or indirectly resulting from the making of any Eurodollar Rate Borrowing due to: (a) the modification, adoption, or enactment of any law, regulation or treaty or the interpretation thereof by any governmental or other authority (whether or not having the force of law) which becomes effective after the date hereof; (b) the modification or new application of any law, regulation or treaty or the interpretation thereof by any governmental or other authority (whether or not having the force of law) which becomes effective after the date hereof; (c) compliance by Bank with any request or directive (whether or not having the force of law) of any monetary or fiscal agency or authority which becomes effective after the date hereof; (d) violations by Borrower of the terms of this Agreement; or (e) any prepayment of a Eurodollar Rate Borrowing at any time prior to the end of the applicable Interest Period. The amount of such costs, losses, or expenses shall be determined solely by Bank based upon the assumption that Bank funded one hundred percent (100%) of each Eurodollar Rate Borrowing in the Eurodollar market. In attributing Bank's general costs relating to its eurocurrency operations to any transaction under this Agreement or averaging any costs over a period of time, Bank may use any reasonable attribution or averaging methods which it deems appropriate and practical. Bank shall notify Borrower of the amount due Bank pursuant to this Section 2.6 in respect of any Eurodollar Rate Borrowing as soon as practicable but in any event within forty-five (45) days after the last day of the Interest Period of such Eurodollar Rate Borrowing, and Borrower shall pay to Bank the amount due within fifteen (15) days of its receipt of such notice. A certificate as to the amounts payable and calculations made pursuant to the foregoing sentence together with whatever detail is reasonably available to Bank shall be submitted by Bank to Borrower. Such determination shall if not objected to within ten (10) days be conclusive and binding upon Borrower in the absence of manifest error. If Bank claims increased costs, loss, or expenses pursuant to this Section 2.6, then Bank, if requested by Borrower, shall use reasonable efforts to take such steps that Borrower reasonably request, as wculd eliminate or reduce the amount of such increased costs, losses, or expenses, so long as taking such steps would not, in the judgment of Bank, otherwise be disadvantageous to Bank. Any recovery by Bank or its Lending Office of amounts previously borne by Borrower pursuant to this Section 2.6 shall be promptly remitted, without interest (unless Bank received interest on such recovered amounts), to Borrower by Bank. SECTION 2.7 Special Eurodollar Circumstances. In the event that after the date hereof any change in circumstances or any law, regulation, treaty or directive, or any change therein or in the interpretation or application thereof, shall at any time in the reasonable opinion of Bank make it unlawful or impractical for Bank to fund or maintain a Eurodollar Rate Borrowing in the eurodollar market or to continue such funding or maintaining, or to determine or charge interest rates based upon any appropriate Eurodollar Rate, Bank shall give notice of such circumstances to Borrower and (i) in the case of any Eurodollar Rate Borrowing which is outstanding, Borrower shall, if requested by Bank, prepay such Eurodollar Rate Borrowing on or before the date specified in such request, together with interest accrued thereon, and the date so specified shall be deemed to be the last day of the Interest Period of that Eurodollar Rate Borrowing, and concurrent with any such prepayment, Bank shall make a Base Rate Borrowing to Borrower in the principal amount equal to the principal amount of the Eurodollar Rate Borrowings so prepaid, and (ii) Bank shall not be obligated to make any further Eurodollar Rate Borrowings until Bank determines that it would no longer be unlawful or impractical to do so. SECTION 2.8 Revolving Note; Statements of Obligations. The Revolving Loans and Borrower's obligation to repay the same shall be evidenced by the Revolving Note, this Agreement and the books and records of Bank and all advances on and payments of principal or interest with respect to the Revolving Loans shall be evidenced by notations made by Bank on such books and records showing the date and amount of each such payment of principal or interest. Bank shall render monthly statements of the Obligations to Borrower, including statements of all principal and interest owing on the Revolving Loans, and all Bank's Fees and Bank Expenses owing, and such statements shall be presumed to be correct and accurate and constitute an account stated between Borrower and Bank unless, within thirty (30) days after receipt thereof by Borrower, Borrower delivers to Bank, by registered or certified mail, at Bank's Lending Office, written objection thereof specifying the error or errors, if any, contained in any such statement. SECTION 2.9 Holidays. Any principal or interest in respect of the Revolving Loans (other than in respect of a Eurodollar Rate Borrowing) which would otherwise become due on a day other than a Business Day, shall instead become due on the next succeeding Business Day and such adjustment shall be reflected in the computation of interest; provided, however, that in the event that such due date shall, subsequent to the specification thereof by Bank, for any reason no longer constitute a Business Day, Bank may change such specified due date in accordance with this Section 2.9. SECTION 2.10 Time and Place of Payments. (a) All payments due hereunder shall be made available to Bank in immediately available Dollars, not later than 12:00 p.m., Los Angeles time, on the day of payment, to the following address: UNION BANK OF CALIFORNIA, N.A. Investment Banking Note Center #192 1980 Saturn Street Monterey Park, California 91754 Attention: Maria Suncin Telefacsimile: (213) 724-6198 Telephone: (213) 720-2672 (b) Without limitation of Bank's rights of setoff granted and acknowledged hereby by Borrower, Bank shall have the right to charge any account maintained by Borrower with Bank for the amount of any payment due or past due hereunder. SECTION 2.11 Fees. Borrower shall pay to Bank a commitment fee (the "Revolving Commitment Fee") in an amount equal to 0.375% per annum on the unused commitment amount payable quarterly. The Revolving Commitment Fee shall begin to accrue on the Closing Date and shall be due and payable on the last day of each calendar quarter and shall be computed in the same manner as interest on a Base Rate Borrowing pursuant to Section 2.3(c). Borrower shall also pay a closing fee of $37,500. SECTION 2.12 Mandatory Commitment Reductions. The RevolvingCommitment shall be reduced annually, commencing September 30, 1996 in accordance with this Section 2.12. On each Revolving Commitment Reduction Date, the Revolving Commitment shall be reduced by the amount of the applicable Commitment Reduction. The reduction shall be accomplished to the extent necessary, by the payment of a Revolving Commitment Reduction Payment. Revolving Commitment Commitment Reduction Date Reduction September 30, 1996 $2,500,000 September 30, 1997 3,000,000 September 30, 1998 3,000,000 September 30, 1999 3,000,000 September 30, 2000 3,000,000 September 30, 2001 3,000,000 (the Revolving Commitment shall be reduced to Zero Dollars ($0) on September 30, 2001) Borrower shall have the right to voluntarily reduce the Revolving Commitment at any time in minimum reductions of no less than $500,000. Any-Voluntary reduction of the Commitment or Revolving Commitment Reduction Payment shall permanently reduce the Revolving Commitment. ARTICLE III REPRESENTATIONS AND WARRANTIES OF BORROWER In order to induce Bank to enter into this Agreement, Borrower makes the following representations and warranties which shall be true and correct in all material respects as of the Closing Date, and each time a Revolving Loan is made hereunder, such representations and warranties to survive the execution and delivery of this Agreement and the making of the Revolving Loans. SECTION 3.1 Due Organization. Borrower is a duly organized and validly existing corporation in good standing under the laws of the State of Delaware and is duly qualified or licensed and in good standing as a foreign corporation authorized to do business in all jurisdictions where its failure to do so would have a material adverse effect on its business. Each of Borrower's Subsidiaries is a duly organized and validly existing corporation in good standing under the laws of the state of its incorporation and is duly qualified or licensed and in good standing as a foreign corporation authorized to do business in all jurisdictions where its failure to do so would have a material adverse effect on the business of Borrower and its Subsidiaries taken as a whole. SECTION 3.2 Requisite Power. Each of Borrower and its Subsidiaries has all requisite corporate power and all domestic governmental licenses, authorizations, consents, and approvals necessary to own and operate its properties and to carry on its business as now conducted and as proposed to be conducted. Borrower has all requisite corporate power to borrow the sums provided for in this Agreement, to execute and deliver this Agreement, and to carry out the transactions contemplated hereby and thereby. The execution, delivery, and performance of this Agreement have been duly authorized by Borrower's Board of Directors and do not require any consent or approval of the shareholders of Borrower. SECTION 3.3 Binding Agreements. This Agreement has been duly executed and delivered by Borrower, and constitutes the legal, valid, and binding obligation of Borrower enforceable against Borrower in accordance with its terms, except as the enforceability thereof may be affected by: (a) bankruptcy, insolvency, moratorium, or similar laws affecting the enforcement of creditors' rights generally; and (b) the limitation of certain remedies by equitable principles of general applicability. SECTION 3.4 No Conflict. The execution or delivery of and performance of this Agreement do not and will not violate the articles of incorporation or by-laws of, or any provision of law or regulation (including, without limitation, Regulations U and X of the Federal Reserve Board), or any order, writ, judgment, or decree of any domestic governmental authority, court, arbitration board or tribunal binding on Borrower, or any of its Subsidiaries or result in the breach of, constitute a default under, contravene any provisions of, or result in the creation of any Lien (other than Permitted Liens) upon any of the property or assets owned by Borrower or any of its Subsidiaries pursuant to any contractual obligation to which Borrower or any of its Subsidiaries or any of the properties owned by them are bound. SECTION 3.5 Litigation. Other than as set forth on Schedule 6, attached hereto and incorporated herein by this reference, as of the Closing Date, there is no litigation, investigation, or proceeding in any court or before any arbitrator or regulatory commission, board, administrative agency, or other governmental authority pending, or threatened, against or affecting Borrower or any of Borrower's Subsidiaries or any of their properties (other than proceedings in the ordinary course of business to the extent they concern the coverage under surety bonds or other products issued by the Borrower or any Subsidiary of Borrower) which: (a) may adversely affect the ability of Borrower or its Subsidiaries to perform their respective obligations under this Agreement; (b) involves the application for issuance of an injunction, writ, restraining order, or other order (other than for the payment of money) of any re materially adverse to Borrower and its Subsidiaries taken as a whole, which such injunction, writ, restraining, or other order (other than for the payment of money) been issued and remains in force and effect; or involves litigation or proceedings as to which there is a reasonable possibility of an adverse determination that would a material adverse effect upon the business, operations, condition, financial or otherwise, of Borrower and its subsidiaries taken as a whole. SECTION 3.6 Consents. Other than such as may previously been obtained, no consent, license, permit, oval, or authorization of, exemption by, notice to, report or registration, filing or declaration with, any domestic, governmental authority, or agency is required in section with the execution, delivery of or performance of payment obligations by Borrower under this Agreement. SECTION 3.7 Financial Statements and Condition. The audited consolidated balance sheet of Borrower dated as of December 31, 1995, and the related statements of operations, in stockholders' equity and cash flows for the fiscal ended on such date, certified by KPMG Peat Marwick, a of which has been delivered to Bank, does fairly present consolidated financial condition of Borrower and its subsidiaries as of such date and the results of their operations for the period then ended. All of the aforementioned financial statements have been prepared in accordance with generally accepted accounting principles provided on a consistent basis (unless specifically disclosed otherwise in the notes to such financial statements) of the Closing Date, there has been no material adverse generally in the financial condition of Borrower and its subsidiaries taken as a whole, since the preparation of the aforementioned financial statements. SECTION 3.8 Use of Loans Proceeds. The proceeds on the Revolving Loan provided for hereunder shall be used by Borrower to provide working capital for Borrower, including the making acquisitions except as limited hereunder. SECTION 3.9 Regulation U. Borrower, its Subsidiaries are not engaged principally, in the business of extending, or arranging for the extension of, credit for the purpose of "purchasing" or "carrying" any margin stock or securities (within the meaning of Regulations G, T, U or X of the Federal Reserve Board) as now or from time to time in effect. SECTION 3.10 Tax Returns. All tax returns required to have been filed by Borrower and Borrower's Subsidiaries in any jurisdiction have been filed; all material taxes, assessments, fees and other governmental charges upon Borrower and Borrower's Subsidiaries or upon any of their respective properties, incomes, or franchises, which are due and payable have been paid, or are being contested in good faith or adequate reserves have been provided for payment thereof. SECTION 3.11 Trademarks, Licenses, etc. Borrower and each of its Subsidiaries that has commenced operations is possessed of all licenses, trademarks, trademark rights, trade names, trade name rights, copyrights, permits, franchises and agreements material to the Borrower and its Subsidiaries taken as whole which are required in order for them to conduct their business and to operate their properties as now conducted without known conflict with the rights of others. SECTION 3.12 Burdensome Aqreements, etc. Borrower and its Subsidiaries are not, individually or in combination, party to any unusual or unduly burdensome agreement or undertaking which materially and adversely affects Borrower's and/or its Subsidiaries' businesses or properties, assets, operations or condition, financial or otherwise, taken as a whole. SECTION 3.13 Title and Liens. Except for Permitted Liens, all of the properties and assets of Borrower and each of its Subsidiaries are free from all Liens, of any nature whatsoever. Borrower and its Subsidiaries have good and marketable title to all of the properties and assets reflected in Borrower's or such Subsidiaries' books and records as being owned by them. SECTION 3.14 Other Information. Borrower has furnished and/or may furnish to Bank certain written financial information concerning Borrower and its Subsidiaries, including written estimates and projections of Borrower's results of operations and financial position for and as at the end of certain future periods. There are no statements or conclusions therein which, at the time provided, are based upon or include misleading information or fail to take into account material information regarding the matters covered therein. Borrower has no reason to believe that any of the statements or conclusions included therein are not true and correct in all material respects at the time provided. Notwithstanding the foregoing, as to estimates, projections and other materials relating to future results of operations or financial condition, Borrower is only representing that such materials have been prepared in good faith based upon reasonable assumptions and using historical financial information prepared in accordance with GAAP. SECTION 3.15 Existing Defaults. As of the Closing Date, neither Borrower nor any of its Subsidiaries is in material default under any term of any mortgage, deed of trust, indenture, or any other agreement to which it is a party or by which it or any of its properties may be bound that is material to the Borrower and its Subsidiaries taken as a whole. Neither Borrower nor any of its Subsidiaries is in violation of any law, ordinance, rule or regulation to which it or any of its properties is subject, the failure to comply with which would have a material adverse effect on the business or properties of Borrower and its Subsidiaries taken as a whole. SECTION 3.16 Leases. Borrower and each of its Subsidiaries enjoys peaceful and undisturbed possession under all the leases which are material to the business of Borrower and its Subsidiaries taken as a whole, to which it is or they are a party or under which it is or they are operating and all such leases are valid and subsisting with no material default by Borrower or its Subsidiaries existing under any of them. SECTION 3.17 Casualty. As of the Closing Date, neither the business nor the properties or operations of Borrower or any of its Subsidiaries are presently affected by any fire, explosion, strike, lockout or other labor dispute, act of God or other casualty (whether or not covered by insurance), which materially and adversely affects the businesses, properties or operations of Borrower and its Subsidiaries taken as a whole. SECTION 3.18 Investment Company Act. Borrower is not, nor is any of its Subsidiaries, and immediately after the application by Borrower of the proceeds of the Loan none of such Persons will be, an "investment company" required to register under the Investment Company Act of 1940, as amended. SECTION 3.19 Public Utility Holding Company Act. Borrower is not, nor is any of its Subsidiaries: (i) a "holding company" nor a "subsidiary company" or "affiliate" of a "holding company" or of a "subsidiary company" of a "holding company" within the meaning of the Public Utility Holding Company Act of 1935, as amended; or (ii) subject to any state law or regulation regulating public utilities or similar entities. SECTION 3.20 Disclosure. At the time provided, no representation or warranty of Borrower contained in this Agreement and no representation of Borrower or any of its Subsidiaries contained in any other written document, certificate, or statement furnished to Bank by or on behalf of Borrower for use in connection with the transactions contemplated by this Agreement contains any untrue statement of a material fact or omits to state a material fact necessary in order to make the statements contained herein or therein not misleading. There is no fact known to Borrower which materially adversely affects or is reasonably likely to materially adversely affect, the business (present or prospective), operations, property, assets or condition (financial or otherwise) of Borrower and its Subsidiaries, taken as a whole, which has not been disclosed herein or in such other documents, certificates, and statements furnished to Bank on or before the Closing Date hereof for use in connection with the transactions contemplated hereby. SECTION 3.21 Location of Chief Executive Office. The chief executive office of Borrower and its Subsidiaries is located at 6320 Canoga Avenue, Woodland Hills, California 91365-4500. SECTION 3.22 No Default. No Event of Default has occurred. SECTION 3.23 No Pension Fund Irregularities. With respect to each Plan, Borrower represents and warrants that, except to the extent that such is not material to the Borrower and its Subsidiaries taken as a whole: (a) As of the Closing Date, each Plan is either a valid, existing and qualified Plan under Sections 401(a) and 501(a) of the IRC or the Borrower has taken or will promptly take all necessary actions in order to ensure that each Plan will be valid, existing and qualified under Sections 401(a) and 501(a) of the IRC as soon as is reasonably possible. (b) Neither Borrower nor any Subsidiary of Borrower nor any Plan is in violation of or will violate any of the provisions of ERISA or any of the qualification requirements of Section 401(a) or 501(a) of the IRC. (c) No Prohibited Transaction or Reportable Event has occurred or will occur with respect to any Plan, nor has any Plan been the subject of or will be the subject of a waiver of the minimum funding standard under Section 412 of the IRC. (d) No notice of intent to terminate a Plan has been filed under Section 4041 of ERISA, nor has any Plan been terminated under Section 4041 of ERISA. (e) The PBGC has not instituted proceedings to terminate, or appoint a trustee to administer, a Plan and no event has occurred or condition exists which might constitute grounds under Section 4042 of ERISA for the termination of, or the appointment of, a trustee to administer any Plan. (f) Neither Borrower nor any Subsidiary would be liable for any amount pursuant to Section 4062, 4063 or 4064 of ERISA if all Plans terminated as of the most recent valuation dates of such Plans. SECTION 3.24 Compliance With Law. Borrower and its Subsidiaries are materially in compliance with all applicable laws, rules, regulations, including, without limitation, those promulgated by the California Department of Corporations and the California Department of Insurance. ARTICLE IV CONDITIONS TO LOANS SECTION 4.1 Conditions Precedent to the Loans. The obligation of Bank to make the Loans hereunder is subject to the fulfillment, to the satisfaction of Bank and its counsel, of each of the following conditions on or before the Closing Date: (a) Borrower shall have executed and delivered to Bank this Agreement and the Revolving Note; (b) Bank shall have received a good standing certificate for Borrower dated within thirty (30) days of the Closing Date, issued by the Secretary of State of California and the Secretary of State of Delaware; (c) Bank shall have received certificates of good standing as a foreign corporation for Borrower, dated within thirty (30) days of the Closing Date, issued by the Secretary of State or Department of Insurance, as appropriate, of the states in which Borrower's failure to be duly qualified or licensed would have a material adverse effect on the business of Borrower taken as a whole; (d) Bank shall have received certified copies of Borrower's articles of incorporation; (e) Bank shall have received copies of the by-laws of Borrower certified by its Secretary or Assistant Secretary; (f) Bank shall have received signature and incumbency certificates respecting the officers executing this Agreement; (g) Bank shall have received an officers' certificate from Borrower, dated as of the Closing Date, duly executed by the President or a Vice President and a Secretary or an Assistant Secretary of Borrower, certifying that no Event of Default has occurred and is continuing; (h) Bank shall have received a certificate from the Secretary or an Assistant Secretary of Borrower attesting to the resolution of Borrower's Board of Directors authorizing the execution and delivery of this Agreement and authorizing specific officers to execute same; (i) Bank shall have received full payment of any fees agreed to, as well as full payment of Bank's reasonable costs and expenses (including the fees and expenses of Bank's counsel) incurred in connection with the preparation, negotiation, execution, and delivery of this Agreement; (j) the representations and warranties of Borrower set forth in Article III of this Agreement shall be true and correct; (k) no Material Adverse Change shall have occurred since March 31, 1996 in the business, operations or financial condition of Borrower and its Subsidiaries, taken as a whole; (1) Bank shall have received such other instruments, agreements and documents as Bank may reasonably request; and (m) all other documents and legal matters in connection with the transactions contemplated by this Agreement shall be in form and substance reasonably satisfactory to Bank and its counsel. ARTICLE V AFFIRMATIVE COVENANTS Borrower covenants that so long as the Loans shall remain unpaid Borrower shall comply with and fulfill each and all of the following covenants: SECTION 5.1 Accounting Records. Borrower shall, and shall cause each of its Subsidiaries to, maintain adequate books and records in accordance with generally accepted accounting principles consistently applied, and permit any representative of Bank, at any time during usual business hours that do not unreasonably interfere with the conduct of such business, to inspect, audit and examine such books and inspect any of their properties and shall furnish Bank with all reasonable information regarding their business or finances promptly upon Bank's request. SECTION 5.2 Financial Statements and Reports. Borrower will furnish or cause to be furnished to Bank: (a) within sixty (60) days after the close of each of the first three (3) quarterly accounting periods of Borrower in each fiscal year: (i) consolidated statements of changes in stockholders' equity and consolidated statement of cash flows of Borrower and its Subsidiaries for such quarterly period, each setting forth in comparative form, if applicable, the corresponding figures for the corresponding periods of the previous fiscal year; (ii) consolidated statements of operations of Borrower and its Subsidiaries for such quarterly period, each setting forth in comparative form, if applicable, the corresponding figures for the corresponding periods of the previous fiscal year; and (iii) consolidated balance sheets of Borrower and its Subsidiaries as of the end of such quarterly period, each setting forth in comparative form, if applicable, the corresponding figures for the most recent fiscal year end, all in reasonable detail, subject to year-end audit adjustments and certified by the chief financial officer of Borrower to have been prepared in accordance with generally accepted accounting principles consistently applied; (b) within ninety (90) days after the close of each fiscal year of Borrower a copy of the annual audit report for such year for Borrower and its Subsidiaries including therein: (i) consolidated statements of changes in stockholders' equity and consolidated statements of cash flows of Borrower and its Subsidiaries for such fiscal year; (ii) consolidated statements of operations of Borrower and its Subsidiaries for such fiscal year; and (iii) consolidated balance sheets of Borrower and its Subsidiaries as of the end of such fiscal year, each setting forth in comparative form, if applicable, the corresponding figures for the previous year, all in reasonable detail; the consolidated income statements and balance sheet to be audited by independent, nationally recognized, certified public accountants, and certified, without a "going concern" qualification or other qualification or exception or any qualification arising out of the scope of the audit, by such accountants to have been prepared in accordance with generally accepted accounting principles, consistently applied, together with certificates of such accounting firm to Bank, stating that, in the ordinary and usual course of the regular audit(s) of the businesses of Borrower and its Subsidiaries which audit(s) was (were) conducted by such accounting firm in accordance with generally accepted auditing standards, and, if requested by Bank within 150 days after the close of each fiscal year of Borrower, Borrower shall, at Borrower's expense, cause such accounting firm to provide to Bank in a timely manner a certificate of such accounting firm stating that such accounting firm has obtained no knowledge that an Event of Default has occurred and is continuing, or if, in the opinion of such accounting firm, an Event of Default has occurred and is continuing, a statement as to the nature thereof; (c) contemporaneously with each quarterly and year-end financial report required by the foregoing clauses (a) and (b), a certificate in the form of Exhibit 5 of the chief financial officer of Borrower stating that he has individually reviewed the provisions of this Agreement, and that a review of the activities of Borrower and its Subsidiaries during such year or quarterly period, as the case may be, has been made by or under such individual's supervision, with a view to determining whether Borrower and its Subsidiaries have fulfilled all of their obligations under this Agreement, and that Borrower and its Subsidiaries have observed and performed each undertaking contained in this Agreement and that no Event of Default has occurred and is continuing, or if any Event of Default has occurred and is continuing, specifying the nature thereof; (d) promptly after sending or making available or filing of the same, copies of all reports regarding financial condition, proxy statements, notices, and financial statements that Borrower, and its Subsidiaries sends or makes available to stockholders and all regular and periodic reports and all filings and registration statements, including, without limitation, all reports on Forms 8-K, 10-Q, and 10-K, under the Exchange Act and all final prospectuses filed pursuant to Rule 424(b) under the Securities Act of 1933, that Borrower or its Subsidiaries files with the Securities and Exchange Commission or any successor thereto, or any other securities exchange; (e) notice, as soon as possible and in any event within five (5) days after Borrower has knowledge of (i) the occurrence of an Event of Default, or (ii) any event of default as defined in any evidence of Debt of Borrower or its Subsidiaries for borrowed money or under any agreement, indenture or other instrument under which such Debt has been issued, irrespective of whether such Debt is accelerated or such default waived. In either event, Borrower shall also supply Bank with a statement from Borrower's chief financial officer setting forth the details of such Event of Default or event of default with respect to other Debt, and the action which Borrower proposes to take with respect thereto; (f) within sixty (60) days after the end of each of the first three (3) quarterly accounting periods of Borrower in each fiscal year and within ninety (90) days after the end of each of Borrower's fiscal years, a report in the form of Exhibit 5 in form satisfactory to Bank, indicating Borrower's financial status as measured by and Borrower's compliance with the quantitative financial covenants set forth in Sections 5.9, 5.10, 5.11, 5.12, 5.13, 5.14, 5.15 and 5.16 hereof and containing sufficient detail as to explain the calculation of such financial covenants, which report shall be certified as true and correct by the chief financial officer of Borrower; (g) as soon as available, any final written report or letter to management pertaining to material items in respect of Borrower's or any of its Subsidiaries' internal control matters submitted to any such Person by its independent accountants in connection with each annual or interim special audit of the financial condition of Borrower and its Subsidiaries; (h) prompt written notice of any condition or event which has resulted or might reasonably result in (i) a Material Adverse Change in the financial condition of Borrower or any of its Subsidiaries taken as a whole; or (ii) a breach of or noncompliance with any term, condition or covenant contained in this Agreement; (i) prompt written notice of any claims, proceedings or disputes against Borrower and/or any of its Subsidiaries (other than proceedings in the ordinary course of business to the extent they concern the coverage under surety bonds or other insurance products issued by the Borrower or any Subsidiary of Borrower) which, if adversely determined, would have a material adverse effect on the business, properties or condition (financial or otherwise) of Borrower and its Subsidiaries taken as a whole or any material labor controversy which could result in a strike against Borrower or any of its Subsidiaries, or any proposal by any public authority to acquire any of the material part of the assets or business of Borrower or any of its Subsidiaries; (j) as soon as the same is available, copies of all quarterly and annual statutory statements filed by Borrower or any of its Subsidiaries with the California Department of Corporations, the California Department of Insurance or any other state or federal agency, instrumentality or governmental body; (k) As soon as practicable, and in any event within 30 days after the commencement of each fiscal year, a projection for that fiscal year and the two subsequent fiscal years, including projected consolidated and consolidating balance sheets and statements of income and cash flow of Borrower and its Subsidiaries, all in reasonable detail; (1) within sixty (60) days after the close of each of the first three (3) quarterly accounting periods of Borrower in each fiscal year and within ninety (90) days after the close of each fiscal year of Borrower: (i) unconsolidated statement of cash flows of Borrower for such period (statement of cash flows to be supplied annually only); (ii) unconsolidated statements of operations of Borrower for such period; and (iii) unconsolidated balance sheets as of the end of such period, all in reasonable detail, subject to yearly audit adjustments and certified by the chief financial officer of Borrower to have been prepared in accordance with generally accepted accounting principles consistently applied; and (m) promptly, such other information in such form as the Bank may reasonably request concerning the business or condition (financial or otherwise) of Borrower or its Subsidiaries. SECTION 5.3 Corporate Existence. Borrower shall, and shall cause each of its Subsidiaries to preserve and maintain its corporate existence unless all material and all of its rights, privileges, licenses, permits and franchises necessary or desirable in the ordinary and usual course of its business including, without limitation, all materially necessary permits, authorizations and licenses required by the California Department of Corporations and California Department of Insurance. SECTION 5.4 Compliance With Law. Borrower shall, and shall cause all of its Subsidiaries to in all material respects comply with the requirements of all applicable laws, rules, regulations and orders of any governmental agency, including, without limitation, those of the California Department of Corporations and the California Department of Insurance. SECTION 5.5 Insurance. Borrower shall, and shall cause each of its Subsidiaries to, maintain and keep in force self insurance and insurance of the types, with such deductibles, including but not limited to fire, public liability, property damage, and workmen's compensation insurance in amounts similar to the amounts carried by others in like industries, and Borrower shall, from time to time, deliver to Bank, as Bank may request, schedules and certificates setting forth all insurance then in effect. SECTION 5.6 Properties. Borrower shall, and shall cause each of its Subsidiaries to, keep in reasonably good repair and condition those material properties and assets useful or necessary to its business and, from time to time, to make necessary repairs, renewals, and replacements thereto and thereof so that such properties and assets shall be fully and efficiently preserved and maintained. SECTION 5.7 Taxes and Other Liabilities. Borrower shall, and shall cause each of its Subsidiaries to, pay and discharge prior to delinquency all material taxes, assessments, and governmental charges or levies against any material properties owned by it, and all material claims which if unpaid might become a Lien, except such as it may in good faith and by appropriate proceedings diligently contest or as to which a bona fide dispute may arise if Borrower or the Subsidiary is diligently attempting to resolve such dispute by appropriate actions; provided, however, that provision must be made by Borrower or the Subsidiary to the satisfaction of Bank, for prompt payment thereof in the event that a final and non-appealable determination is made in such proceeding by the judge or similar official that Borrower or the Subsidiary must satisfy such obligation. SECTION 5.8 Tax Returns. At the request of Bank, Borrower shall furnish Bank with copies of all federal income tax returns which are filed after the Closing Date by Borrower. SECTION 5.9 Fixed-Charge Coverage Ratio. The term" Fixed Charge Coverage Ratio" shall mean, "the ratio of (a) the sum of (i) the amount of cash, cash equivalents and investments of the borrower, on a non-consolidated basis, as of the end of such fiscal quarter plus (ii) the estimated interest expense related to the $10 million Capital Surplus Note over the subsequent four (4) consecutive quarters plus (iii) the maximum dividends allowable for Amwest (domicilied in Nebraska) and Condor (domiciled in California), determined on a combined statutory basis for the four (4) consecutive fiscal quarters ending on such day, or (2) 10% of the statutory surplus of the most recently ended fiscal quarter, plus (iv) cash received from stock options exercised for the four (4) previous consecutive fiscal quarters, plus (v) unused amounts available to be drawn under this Agreement, to (b) the sum of (i) aggregate payments of principal and interest on all Debt of the Borrower and its Subsidiaries required to be paid during the following four (4) consecutive fiscal quarters, plus (ii) the total amount of common stock dividends to be paid over the next four (4) consecutive fiscal quarters, plus (iii) the total amount of common share repurchases over the next four (4) consecutive fiscal quarters, plus (iv) total capital expenditures incurred by Borrower (inclusive of permitted acquisition payments made) over the next four (4) consecutive fiscal quarters." Borrower shall maintain minimum Fixed Charge Coverage Ratio of 1.1:1.0. SECTION 5.10 Section 5.10 is intentionally deleted in this Restated Revolving Credit Agreement. SECTION 5.11 Tangible Net Worth. Borrower shall maintain a minimum of 90% of the Tangible Net Worth as reported in its March 31, 1996 financial statement. The minimum Tangible Net Worth shall increase each fiscal year thereafter by 50% of Borrower's net income. Minimum Tangible Net Worth shall also be increased each fiscal year by the dollar amount of any initial public offering of securities. SECTION 5.12 Net Profit. On a consolidated GAAP basis, Borrower and its Subsidiaries shall earn a Net Profit for each fiscal year during the term of this Agreement. SECTION 5.13 Policyholders' Surplus. On a consolidated statutory basis, ASIC and its Subsidiaries shall maintain Capital Surplus of at least 90% of the Capital Surplus as reported as of March 31, 1996. SECTION 5.14 Operating Leverage Ratio. On a consolidated statutory basis, ASIC and its Subsidiaries shall not permit the Operating Leverage Ratio to exceed 3.0:1.0 as of the last day of each fiscal quarter during the term of this Agreement. SECTION 5.15 A.M. Best Rating. ASIC shall at all times d uring the term of this Agreement maintain an A.M. Best rating of A- or better. Should A.M. Best cease to exist then any other acknowledged rating agency shall be substituted with an equivalent rating being required. SECTION 5.16 Investment Portfolio Ouality. On a consolidated basis, ASIC and its Subsidiaries, shall at all times during the term of this Agreement maintain an average fixed income portfolio rating of A as determined by the Borrower's investment advisors who shall use in their calculation the individual bond ratings supplied by reputable rating agencies. SECTION 5.17 Pension Plan Funding. Borrower shall furnish to Bank: (a) Promptly and in any event within thirty (30) days after the occurrence of a Reportable Event with respect to a Plan, a copy of any materials required to be filed with the PBGC with respect to such Reportable Event (whether or not Borrower or a Subsidiary of Borrower is required to provide the PBGC with notice of such Reportable Event within thirty (30) days of its occurrence or at some later time) and a statement of the chief financial officer of Borrower setting forth the details concerning such Reportable Event and the action which Borrower or the Subsidiary of Borrower proposes to take with respect thereto; (b) At least ten (10) days prior to the filing of a notice of intent to terminate by an administrator of a Plan, a copy of such notice; (c) Promptly and in no event more than ten (10) days after receipt thereof by Borrower or any Subsidiary of Borrower, a copy of a notice received by Borrower or any Subsidiary of Borrower or any administrator of any Plan that the PBGC has instituted proceedings to terminate any Plan or to appoint a trustee to administer the Plan; (d) Promptly and in no event more than ten (10) days after the filing thereof with the Internal Revenue Service, copies of each annual report for each Plan and the actuarial statements and certified financing statements for the Plan filed therewith; (e) Promptly and in any event within three (3) days after Borrower knows or has reason to know of any event or condition which might constitute grounds under Section 4042 of ERISA for the termination of, or the appointment of, a trustee to administer, any Plan, a statement of the chief financial officer of Borrower describing such event or condition; and (f) Promptly and in no event more than ten (10) days after receipt thereof by Borrower or any Subsidiary of Borrower, each notice received by.Borrower or any Subsidiary of Borrower concerning the imposition of any withdrawal liability under Section 4202 of ERISA. SECTION 5.18 Reinsurance Contract. Borrower shall maintain in full force and effect participation reinsurance contracts with major reinsurers, similar in substance to those reinsurance contracts in place on the date of this Agreement. SECTION 5.19 Storage and Protection of Data. Borrower shall, and shall cause each of its Subsidiaries to, take all actions customary in the insurance business (including, but not limited to, data dumps and off-site data records and storage periodically updated) to adequately maintain, store, secure and protect all data, records and files, the loss of which would materially adversely affect the operations and business of Borrower and/or any of its Subsidiaries. ARTICLE VI NEGATIVE COVENANTS Borrower covenants that so long as any of the Loans shall remain unpaid Borrower shall comply with and fulfill each and all of the following covenants: SECTION 6.1 Mergers, Consolidations. Borrower shall not, nor shall it permit any of its Subsidiaries, to change its or their name without notification to Bank, materially change the nature of its or their business, sell (whether in any one transaction or a series of transactions) all or substantially all of the assets of the Borrower and its Subsidiaries on a consolidated basis, enter into any merger, consolidation, reorganization or recapitalization, or reclassify its capital stock. Notwithstanding the first sentence of this Section 6.1, nothing contained in this Agreement shall be construed to prevent any merger or consolidation which occurs solely between Subsidiaries of Borrower or any reorganization, recapitalization or reclassification of the capital stock of any Subsidiary which occurs in connection therewith. SECTION 6.2 Sale of Assets. Notwithstanding anything to the contrary contained in this Agreement, except in the ordinary course of business, Borrower will not, and will not permit any of its Subsidiaries to sell, assign, transfer, convey or otherwise dispose of their assets, whether now owned or hereafter acquired, including the stock of either Subsidiary of Borrower. SECTION 6.3 Liens. Borrower shall not, nor shall it permit any Subsidiary to, mortgage, pledge, grant, or permit to exist any Lien upon or with respect to any of its properties or assets of any kind, including, without limitation, the stock of any of its Subsidiaries, now owned or hereafter acquired, or any income or profits therefrom, except: (i) the Liens reflected on Schedule 2, attached hereto and incorporated herein by this reference; (ii) warehouseman's, mechanic's, landlord's, tax, assessments, other governmental charges and other like liens arising in the ordinary course of business securing obligations that are not incurred in connection with the obtaining of any advance or credit and which are either not overdue or are being contested and provided for in accordance with Section 5.7 hereof; (iii) Liens (other than any Lien imposed by ERISA) incurred or deposits made in the ordinary course of business in connection with surety and appeal bonds, leases, government contracts, performance and return-of-money bonds and other similar obligations (exclusive of obligations for the payment of borrowed money); (iv) first trust deed mortgages securing conforming real estate loans requiring substantially equal monthly payments amortizing over a period of no less than fifteen (15) years; (v) purchase money security interests in personal property; (vi) easements, rights of way, restrictions, and other similar charges or encumbrances on real property not interfering with the ordinary conduct of the business of Borrower or any of its Subsidiaries; (vii) judgment liens in existence less than thirty (30) days after the entry thereof or with respect to which execution has been stayed or the payment of which is covered in full by insurance (subject to customary deductibles); and (viii) banker's liens arising in the ordinary and usual course of Borrower's or its Subsidiaries' business (ix) Liens existing on property of any Person at the time such Person becomes a Subsidiary and not incurred in contemplation thereof; (x) Liens existing on property at the time of the acquisition thereof and not incurred in contemplation thereof, including without limitation Liens on property acquired by foreclosure on junior mortgages or deeds of trust; (xi) renewals, extensions or other modifications of the liens under clauses (i), (ix) and (x), provided the principal amount of the obligations secured thereby does not exceed the amount set forth on Schedule 2 (in the case of clause (i)) or the amount outstanding at the time such Person becomes a Subsidiary or of such acquisition (in the case of clauses (ix) and (x), respectively, as applicable; (xii) Liens securing Debt in an amount not to exceed $500,000 at any time outstanding and permitted by Section 6.8; and (xiii) Liens incidental to the conduct of the business of the Borrower and its Subsidiaries or the ownership of their property that were not incurred in connection with borrowed money and that, in the aggregate, do not materially detract from the value of the property or impair the use thereof and that, in any event, do not secure obligations aggregating in excess of $500,000 (the items described in clauses (i) through (xiii) of this Section 6.3 are collectively referred to herein as the "Permitted Liens"). SECTION 6.4 Contingent Obiigations. Borrower will not, and will not permit any of its Subsidiaries to, directly or indirectly, create or become or be liable with respect to any material Contingent Obligation except that Borrower and its Subsidiaries may remain liable for any preexisting Contingent Obligation set forth on Schedule 3, attached hereto and incorporated herein by this reference and any amendments, renewals, extensions or other modifications thereof provided that the amount thereof does not exceed the amount set forth on such Schedule. Notwithstanding anything contained in this Section 6.4, Borrower and its Subsidiaries may amend and/or replace reinsurance agreements in the ordinary course of business. SECTION 6.5 Conduct of Business. Borrower will not, and Borrower will not permit its Subsidiaries to, engage in any business other than the businesses in which Borrower and its Subsidiaries are engaged as of the date hereof and businesses reasonably related thereto. SECTION 6.6 Transactions with Shareholders. Borrower will not, and will not permit any of its Subsidiaries to, directly or indirectly, enter into or permit to exist any transaction (including, without limitation, the purchase, sale, lease or exchange of any property or the rendering of any service) with any holder of five percent (5%) or more of any class of equity securities of Borrower or with any Subsidiaries or of any such holder, on terms that are materially less favorable to Borrower or such Subsidiary than those which might be obtained at the time from Persons who are not such a holder or Subsidiary or, if such transaction is not one in which terms could be obtained from such other Person, on terms that are not negotiated in good faith on an arm's length basis. The foregoing shall not prohibit (i) any transaction between the Borrower and its Subsidiaries or between its Subsidiaries, (ii) the payment of directors' fees, and (iii) subject to Section 6.8, Investments by the Borrower or any Subsidiary thereof in a Subsidiary of the Borrower or another such Subsidiary. SECTION 6.7 Restrictive Agreements. Borrower will not, and will not permit any of its Subsidiaries to, enter into any agreement which restricts the ability of such Subsidiary to make payments to Borrower by way of dividends, advances, or reimbursements or otherwise, other than as specifically authorized, permitted or required pursuant to this Agreement or as required by applicable insurance laws, insurance regulators or other governmental authority. SECTION 6.8 Debt. Borrower shall not, nor shall it permit any of its Subsidiaries to, incur, create, assume, or permit to exist any Debt, excluding only the following: the Revolving Loans; loans or advances made to its Subsidiaries; travel, relocation and entertainment advances to employees; loans to employees not exceeding Twenty Thousand Dollars ($20,000) each or One Hundred Thousand Dollars ($100,000) in the aggregate; conforming real estate loans secured by real property, provided such real estate loans are secured by a first trust deed mortgage requiring substantially equal monthly payments amortizing over a period no less than fifteen (15) years; purchase money Debt; and the Debt described on Schedule 4, attached hereto and incorporated herein by this reference and renewals, refinancings, extensions or other modifications thereof provided the principal amount thereof does not exceed the amount set forth on such Schedule; Debt of any Person existing at the time such Person becomes a Subsidiary and not incurred in contemplation thereof; Debt assumed in connection with the acquisition of property, including without limitation Debt secured by property acquired by foreclosure on junior mortgages or deeds of trust; Contingent Obligations not prohibited by Section 6.4; performance, surety and other bonds issued by the Borrower and its Subsidiaries in the ordinary course of their business; and secured or unsecured Debt in an amount not to exceed $500,000 at any time outstanding. SECTION 6.9 Dividends. Dividends shall be permitted during any given fiscal year in an amount set forth below opposite the applicable Tangible Net Worth of Borrower as of the end of the immediately preceding fiscal year, as reported in the financial statements for such fiscal year delivered to the Bank, if at the time of the payment of the dividend there has not occurred or is not continuing an Event of Default. Maximum Annual Consolidated Dividend _____ Tangible Net Worth_______ $1,700,000 x greater than or = 48,700,000 1,820,000 x greater than or = 54,500,000 1,975,000 x greater than or = 61,400,000 2,125,000 x greater than or = 69,500,000 2,250,000 x greater than or = 71,500,000 SECTION 6.10 Leases. Borrower shall not, nor shall it permit any of its Subsidiaries to incur obligations under leases other than in the ordinary and usual course of their business consistent with past practices. SECTION 6.11 Stock. Borrower may redeem, purchase, retire or otherwise acquire any shares of any class of capital stock of Borrower, but any such acquisitions shall reduce the annual payment limitation in Section 6.21, except that transactions under Borrowers employee stock option plans shall not be counted towards the annual limitation. SECTION 6.12 Prepayment and Repayment of Debt. Borrower shall not, nor shall it permit any of its Subsidiaries to, make any optional prepayment with respect to any Debt for borrowed money, or any Debt secured by any Permitted Lien, or enter into or modify any Debt agreement in a way which would be materially adverse to the interests of Bank or as a result of which the terms of payment of any of the foregoing Debt are accelerated except, that: (a) Borrower shall be entitled to the benefit of its rights respecting the Revolving Loans provided for in this Agreement; and (b) Subsidiaries of Borrower may prepay Debt owed to Borrower. SECTION 6.13 Sale-Leaseback$. Borrower shall not, nor shall it permit any of its Subsidiaries to, enter into any sale-leaseback transaction. SECTION 6.14 Misrepresentations. Borrower shall not, nor shall it permit any of its Subsidiaries to, furnish Bank any certificate or other document that contains any untrue statement of material fact or that fails to state a material fact necessary to make it not misleading in light of the circumstances under which it was furnished. SECTION 6.15 Partnerships. Borrower and its Subsidiaries may become a general or limited partner in any partnership or a joint venturer in any joint venture, but if a monetary investment, other than an investment in the ordinary course of business, is required then such investment shall reduce the annual limitation in Section 6.21. Investments must be in full compliance with Borrower's internal investment guideline parameters as authorized by Borrower's Board of Directors. Set forth on Schedule 5, attached hereto and incorporated herein by this reference are current partnership or joint venture investments. SECTION 6.16 Subsidiaries Debt and Liens. Borrower shall not, except for Permitted Liens, directly or indirectly, sell, assign, pledge or otherwise transfer any Debt of or claim against a Subsidiary and will not permit a Subsidiary to sell, assign, pledge or otherwise transfer any Debt or claim against Borrower or any other Subsidiary. SECTION 6.17 Changes in Location of Chief Executive Office. Borrower shall not, nor shall it permit any of its Subsidiaries to, relocate their respective chief executive offices without first giving Bank thirty (30) days prior written notice of any proposed relocation. SECTION 6.18 Loss Reserves. Borrower shall not sell any of its loss reserves without prior written approval of Bank. SECTION 6.19 Surplus Note. Borrower shall not during the term of this Agreement, directly or indirectly sell, assign, transfer, discount, pledge, encumber, convey, grant an option on or otherwise dispose of that certain Surplus Note held by Borrower. SECTION 6.20 Capitalized Expenditures. Borrower, on a consolidated basis, shall not expend more than One Million Dollars ($1,000,000) per fiscal year on Capitalized Expenditures (other than expenditures subject to Section 6.21). To the extent that less than One Million Dollars ($1,000,000) is used, the unused portion may be added to the limitation applicable to the immediately following fiscal year but may not be added to any year thereafter. The amount carried over shall be applied first. SECTION 6.21 Acquisitions. Borrower, on a consolidated basis, shall not make any acquisitions of stock representing a controlling interest or all or substantially all assets of (or a division of) any entities that are not in the same or similar kind of business as Borrower, nor shall any acquisitions in any fiscal year require annual payments of more than Two Million Dollars ($2,000,000) in any such fiscal year; provided however that aggregate annual amount of permitted acquistions hereunder shall be reduced by the Capital Expenditures used by Borrower under Section 6.20 above. To the extent that less than the aggregate annual amount of permitted acquisitions less Capital Expenditures is used, the unused portion may be added to the limitation applicable to the immediately following fiscal year but may not be added to any year thereafter. The amount carried over shall be applied first. ARTICLE VII EVENTS OF DEFAULT SECTION 7.1 Events of Default. The occurrence of any of the following events, acts, or occurrences shall constitute an event of default (an "Event of Default") hereunder: (a) Borrower shall fail to pay within ten (10) days of the date when due any amount owing hereunder in respect of principal, and/or interest on the Loans or any other amounts payable in connection herewith; (b) Borrower shall default in any respect in the performance or observance of any term, covenant, condition or agreement on its part to be performed or observed under Sections 5.9, 5.10, 5.11, 5.12, 5.13, 5.14, 5.15 and/or 5.16 hereof; or (c) Borrower or any of its Subsidiaries shall fail to observe or perform any other term, covenant, condition, agreement, or obligation to be observed or performed by it under this Agreement and such failure shall not be cured or remedied within thirty (30) days following notice by Bank to Borrower of such occurrence; or (d) Borrower or any of its Subsidiaries shall default (as principal or guarantor or other surety) in the payment when due (subject to any applicable notice or grace period), whether at stated maturity or otherwise in an amount in excess of $1,500,000, of any monetary obligation (howsoever designated) on any Debt, whether such indebtedness now exists or shall hereafter be created and such default shall not be cured and remedied within thirty (30) days of the date of occurrence of such default; or (e) An event of default (with respect to the Borrower or any of its Subsidiaries) as defined in any mortgage, indenture or instrument under which there may be issued, or by which there may be secured or evidenced, any Debt of, or guaranteed by, Borrower or any of its Subsidiaries, whether such Debt now exists or shall hereafter be created, shall occur and shall permit such Debt to become due and payable prior to its stated maturity or due date, and such event of default shall not be cured and remedied within thirty (30) days of the date of occurrence of such event of default; or (f) Any financial statement, representation, warranty or certification made or furnished by Borrower or any of its Subsidiaries in any statement, document, letter or other writing or instrument furnished or delivered to Bank pursuant to or in connection with this Agreement, or as an inducement to Bank to enter into this Agreement, shall at any time prove to have been materially false, incorrect, or incomplete when made or effective or reaffirmed, as the case may be; or (g) Borrower or any of its Subsidiaries shall suffer a final judgment or judgments for payment of money aggregating in excess of Two Hundred Fifty Thousand Dollars ($250,000) (net of insurance) and shall not discharge the same within a period of thirty (30) days unless, pending further proceedings, execution has not been commenced or if commenced, has been effectively stayed or bonded against; (h) A judgment creditor of Borrower or any of its Subsidiaries shall obtain possession of any material portion of the properties or assets of Borrower or any of its Subsidiaries by any means, including, without limitation, levy, distraint, replevin or self-help; or (i) Borrower or any of its Subsidiaries shall institute a voluntary case seeking liquidation or reorganization under Chapter 7 or Chapter 11, respectively, of the Bankruptcy Code; or Borrower, or any of its Subsidiaries shall file a petition, answer or complaint or shall otherwise institute any similar proceeding under any other applicable federal or state law, or shall consent thereto; or Borrower, or any of its Subsidiaries shall apply for, or by consent or acquiescence there shall be an appointment of, a receiver, liquidator, sequestrator, trustee or other officer with similar powers, of Borrower or any such Subsidiary; or any conservatorship or similar proceeding is commenced by or brought on behalf of the California Department of Insurance with respect to any insurance Subsidiary of Borrower; or Borrower or any of its Subsidiaries shall make a general assignment for the benefit of creditors; or if an involuntary case shall be commenced seeking the liquidation or reorganization of Borrower or any of its Subsidiaries under Chapter 7 or Chapter 11, respectively, of the United States Bankruptcy Code or any similar proceeding shall be commenced against Borrower or any such Subsidiary under any other applicable federal or state law and (a) Borrower or any of its Subsidiaries consents to the institution of the involuntary case, (b) the petition commencing the involuntary case is not timely controverted, (c) the petition commencing the involuntary case is not dismissed within sixty (60) days of its filing, (d) an interim trustee is appointed to take possession of all or a portion of the property, and/or to operate all or any portion of the business of Borrower or any of its Subsidiaries, or (e) an order for relief shall have been issued or entered therein; or a decree or order of a court having jurisdiction in the premises for the appointment of a receiver, liquidator, sequestrator, trustee or other officer having similar powers of Borrower or any of its Subsidiaries or of all or a portion of its property, shall have been entered and, within forty-five (45) days from the date of entry, is not vacated, discharged, or bonded against; or any other similar relief shall be granted against Borrower, or any of its Subsidiaries under any applicable federal or state law and, within forty-five (45) days from the date of entry, is not vacated, discharged, or bonded against; or (j) Borrower or any of its Subsidiaries shall generally fail to pay, or admit in writing its inability to pay, its debts as they become due. SECTION 7.2 Remedies. Upon the occurrence of an Event of Default: (a) If such Event of Default arises under clause (i) of Section 7.1 hereof, then all principal, accrued interest, and any other sums then owing by Borrower under and in connection herewith shall become and be immediately due and payable and Bank's obligation to make advances on the Revolving Loan (and Bank's obligation to continue/convert any Loan pursuant to Section 2.5 hereinabove) shall cease, without presentment, demand, protest or notice of any kind all of which are hereby expressly waived by the Borrower; and (b) In the case of any other Event of Default, Bank's obligation to make advances on the Revolving Loan (and Bank's obligation to continue/convert any Loan pursuant to Section 2.5 hereinabove) shall cease and Bank may declare all principal, interest, and other sums then owing by Borrower under and in connection herewith to be forthwith due and payable, whereupon all such sums shall become and be immediately due and payable without presentment, demand, protest or notice of any kind, all of which are hereby expressly waived by Borrower. Promptly following the making of any such declaration, Bank shall give notice thereof to Borrower but failure to do so or any delay in so doing shall not impair the effect of such declaration; and (c) In addition to any acceleration of the Debt owing to Bank by Borrower hereunder as provided for in clauses (a) and (b) above, Bank shall have all rights and remedies available at law, in equity, and otherwise. ARTICLE VIII MISCELLANEOUS SECTION 8.1 Waivers, Modifications in Writing. The remedies provided for herein are cumulative and are not exclusive of any remedies that may be available to Bank at law, in equity, or otherwise. No amendment, modification, supplement, termination, or waiver of or to any provision of this Agreement, nor consent to any departure by Borrower therefrom, shall be effective unless the same shall be in writing and signed by Bank. Any waiver of any provision of this Agreement, and any consent to any departure by Borrower from the terms of any provisions therefrom, shall be effective only in the specific instance and for the specific purpose for which given. No notice to or demand on Borrower in any case shall entitle Borrower to any other or further notice or demand in similar or other circumstances. SECTION 8.2 Failure or Delay. No failure or delay on the part of Bank in the exercise of any power, right, remedy or privilege under this Agreement shall operate as a waiver thereof, nor shall any single or partial exercise of any such power, right, remedy, or privilege preclude other or further exercise of any other power, right, remedy, or privilege. SECTION 8.3 Notices, etc. All notices, demands, instructions, and other communications required or permitted to be given to or made upon any party hereto shall be in writing and (except for financial statements and other related informational documents to be furnished pursuant hereto which may be sent by first-class mail, postage prepaid) shall be personally delivered or sent by registered or certified mail, postage prepaid, return receipt requested, or by prepaid telex, TWX, telecopy or telegram (with messenger delivery specified) and shall be deemed to be given for purposes of this Agreement on the day that such writing is received by the intended recipient thereof. Unless otherwise specified in a notice sent or delivered in accordance with the foregoing provisions of this Section 8.3, notices, demands, instructions and other communications in writing shall be given to or made upon the respective parties hereto at their respective addresses (or to their respective telex, TWX or telecopier numbers) as follows: If to Bank: Union Bank of California, N.A. 550 South Hope Street, 3rd Floor Los Angeles, California 90071 Attn: James R. Fothergill, V.P. With a Copy to: Union Bank of California, N.A. 445 South Figueroa Street, 8th Floor Los Angeles, California 90071 Attn: Legal Department If to Borrower: Amwest Insurance Group, Inc. 6320 Canoga Ave. Woodland Hills, California 91365-4500 Attn: Steven R. Kay, Sr. V.P. SECTION 8.4 Costs and Expenses. Borrower agrees to pay: (a) all reasonable out-of-pocket costs and expenses of Bank incurred or expended in connection with the negotiation, preparation, printing, reproduction, execution, and delivery of this Agreement, any amendments or modifications of (or supplements to) any of the foregoing and any and all other agreements or documents furnished in connection with the execution and delivery of this Agreement, including the reasonable fees and out-of-pocket expenses of Buchalter, Nemer, Fields & Younger, a Professional Corporation, special counsel to Bank, or any other counsel to Bank; (b) all costs and expenses (including, without limitation, all attorneys' fees and expenses), if any, incurred or expended by Bank after an Event of Default in connection with the enforcement of this Agreement or any other agreements or documents furnished pursuant hereto or in connection herewith or therewith, whether or not suit is brought with respect thereto; and (c) all stamp, transfer, and other taxes payable or determined to be payable in connection with the execution and delivery of this Agreement. SECTION 8.5 Sale of Participation. Bank shall be entitled to sell participation interests in the Loans to Persons not party to this Agreement without being required to so advise Borrower so long as Bank is entitled to represent the interests of such Persons. Except as otherwise expressly agreed in writing by Borrower, Bank shall not, by reason of the sale of any participation interest, be relieved of any of its obligations hereunder. SECTION 8.6 Headings. Article and Section headings used in this Agreement are for convenience of reference only and shall not affect the construction of this Agreement. SECTION 8.7 Execution in Counterparts. This Agreement may be executed in any number of counterparts and by different parties on separate counterparts, each of which counterparts, when so executed and delivered, shall be deemed to be an original and all of which counterparts, taken together, shall constitute but one and the same Agreement. SECTION 8.8 Binding Effect; Assignment. This Agreement shall be binding upon, and inure to the benefit of, Borrower and Bank, and their respective successors and assigns; provided, however, that Borrower may not assign its rights hereunder or in connection herewith or any interest herein (voluntarily, by operation of law, or otherwise) without the prior written consent of Bank. This Agreement shall not be construed so as to confer any right or benefit upon any Person other than the parties to this Agreement and each of their respective successors and assigns. SECTION 8.9 Severability of Provisions. Any provision of this Agreement which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof or affecting the validity or enforceability of such provision in any other jurisdiction. SECTION 8.10 Publicity. Except for filings with regulatory bodies in the ordinary course of business, any publicity release, advertisement, filing, public statement, or announcement made by or at the behest of Borrower or any Subsidiary of Borrower regarding this Agreement or the financing provided hereunder which makes reference to Bank or describes the financing provided by Bank, shall be first reviewed by Bank and must be reasonably satisfactory to Bank. SECTION 8.11 Complete Agreement. This Agreement, together with the exhibits to this Agreement, is intended by the parties as a final expression of their agreement and is intended as a complete statement of the terms and conditions of their agreement. SECTION 8.12 Governing Law and Venue. This Agreement shall be deemed to have been made in the State of California and the validity of this Agreement, the construction, interpretation, and enforcement thereof, and the rights of the parties thereto shall be determined under, governed by, and construed in accordance with the internal laws of the State of California, without regard to principles of conflicts of law. The parties agree that all arbitrations brought pursuant to Section 8.13 hereof shall be held only in the County of Los Angeles, State of California or, at the sole option of Bank, in any other venue in which Bank, shall initiate such arbitration. SECTION 8.13 Dispute Resolution. (a) Mandatory Arbitration. Any controversy or claim between or among the parties arising out of or relating to (i) this Agreement, any Credit Documents, or any other document, instrument, or agreement executed in conjunction herewith (collectively, the "Subject Documents"), (ii) any negotiations, correspondence, or communications, whether or not incorporated or integrated into the Subject Documents, relating to the Subject Documents or any indebtedness evidenced thereby or (iii) the administration or management of the Revolving Note and the other Subject Documents evidenced thereby, and with respect to (i), (ii) and (iii) also including any such controversy or claim based on or arising out of an alleged tort, shall be determined by arbitration in accordance with Title 9 of the U.S. Code and the Commercial Arbitration Rules of the American Arbitration Association (the "AAA"); provided, however, that unless Bank and all parties to the Subject Documents consent to such submission, this Section shall not apply to the extent that (i) such claims or controversy involves enforcement of any Subject Documents with respect to obligations which are incurred primarily for personal, family, or household use or (ii) any Subject Documents or any other obligations to Bank described in or covered by any of the Subject Documents are secured by real property. All statutes of limitations and waivers which would otherwise be applicable shall apply to any arbitration proceeding under this subsection (a). Judgment upon the award rendered may be entered in any court having jurisdiction. (b) Judicial Reference. If any such claim or controversy is not determined by arbitration as provided and limited in subsection (a) but becomes the subject of a judicial action, then all matters of fact and law in such judicial action shall at the election of any party hereto be referred to a referee in accordance with California Code of civil Procedure Sections 638 et seq. for determination in accordance with applicable law. If such an election is made, then the parties shall designate to the court a referee or referees selected under the auspices of the AAA in the same manner as arbitrators are selected in AAA sponsored proceedings. The presiding referee of the panel, or the referee if there is a single referee, shall be an experienced attorney actively engaged in the practice of commercial finance law or a retired judge. Judgment upon the award rendered by such referee or referees shall be entered in the court in which such proceeding was commenced in accordance with California Code of Civil Procedure Sections 644 and 645. IN CONNECTION WITH ANY SUCH JUDICIAL REFERENCE, THE PARTIES HERETO HEREBY EXPRESSLY, DELIBERATELY, AND INTENTIONALLY WAIVE ANY RIGHT THEY MAY OTHERWISE HAVE TO TRIAL BY JURY OF SUCH CLAIM OR CONTROVERSY, WHETHER SOUNDING IN CONTRACT, TORT, OR OTHERWISE, UNLESS SUCH CLAIM OR CONTROVERSY INVOLVES THE ENFORCEMENT OF ANY SUBJECT DOCUMENT WITH RESPECT TO OBLIGATIONS WHICH ARE INCURRED PRIMARILY FOR PERSONAL, FAMILY, OR HOUSEHOLD USE. (c) Provisional Remedies, Self Help and Foreclosure. No provision of, or the exercise of any rights under, subsection (a) shall limit the right of any party to exercise self-help remedies such as setoff, to foreclose against any real or personal property collateral, or to obtain provisional or ancillary remedies, including but not limited to, injunctive relief or the appointment of a receiver from a court having jurisdiction before, during, or after the pendency of any arbitration. At Bank's option, foreclosure under a deed of trust or mortgage may be accomplished either by exercise of power of sale under the deed of trust or mortgage or by judicial foreclosure. The institution and maintenance of an action for judicial relief or pursuit of provisional or ancillary remedies or exercise of self-help remedies shall not constitute a waiver of the right of any party, including the plaintiff, to submit the controversy or claim to arbitration. The parties agree that the submission of any controversy or claim to arbitration under subsection (a), or to a referee under subsection (b); the granting or entry of any award in connection with such submission; or, the exercise of any provisional or self-help remedy, including foreclosure of collateral, under this subparagraph 3 shall not be deemed to be an "action" under Section 726 of the California Code of Civil Procedure or any other similar law or regulation. (d) Miscellaneous. In connection with any claim or controversy governed by this Section, the party whom the arbitrator or referee determines is the prevailing party shall be entitled to have the other party or parties pay the expenses of the prevailing party, but subject to the award of the arbitrator or referee, each party shall pay an equal share of the arbitrator's or referee's fees. In this regard the arbitrator or referee shall have the power to award recovery to such prevailing party of all costs and fees (including attorneys' fees and a reasonable allocation for the costs of in-house counsel and staff), administrative fees, arbitrator's or referee's fees, and court costs, all as determined by the arbitrator or referee, as the case may be. Any decision or award by the arbitrator shall be in writing and include a brief summary of the supporting evidence and applicable law. Any arbitration hereunder shall be conducted in Los Angeles, California. The provisions of this Section shall survive any termination, amendment or expiration of the Subject Documents, or any of them, unless Bank and all other parties thereto otherwise expressly agree in writing. In any arbitration or other proceeding held pursuant to this Section, all oral and written communications between or among the parties hereto [remainder of this page intentionally left blank] shall be deemed privileged for all purposes as if the parties had proceeded judicially. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed by their respective authorized officers as of the day and year first above written. UNION BANK OF CALIFORNIA, N.A. By: Title: AMWEST INSURANCE GROUP, INC. a Delaware corporation By: Title: REVOLVING NOTE $17,500,000 Los Angeles, California July 10, 1996 FOR VALUE RECEIVED, AMWEST INSURANCE GROUP, INC., a Delaware corporation ("Borrower") hereby promises to pay to the order of UNION BANK OF CALIFORNIA, N. A., a California banking corporation ("Bank"), the principal sum of Seventeen Million Five Hundred Thousand Dollars ($17,500,000), or such lesser sum as shall equal the aggregate outstanding principal amount of the Revolving Loans made by Bank to Borrower pursuant to the Restated Revolving Credit Agreement referred to below, on or before the Maturity Date specified in the Restated Revolving Credit Agreement. Borrower further promises to pay interest on the aggregate outstanding principal amount of the Revolving Loans at the rates provided in the Restated Revolving Credit Agreement. All computations of interest shall be in accordance with the provisions of the Restated Revolving Credit Agreement. If the Revolving Loans remain unpaid after maturity (whether by acceleration or otherwise), Borrower shall pay interest on the aggregate outstanding balance of the Revolving Loans at a per annum rate equal to two percent (2%) greater than the interest rate otherwise in effect with respect thereto. Borrower shall make all payments hereunder in lawful money of the United States of America and in immediately available funds to Bank's office located at 192 Commercial Loan Center, 1980 Saturn Street, Monterey Park, California 91754, attention: Department 77723 Supervisor, telefacsimile number: 213-724-6198. Borrower hereby authorizes Bank to record in its books and records or on the back of this Revolving Note the date, amount and interest rate of each Revolving Loan (and, in the case of each Eurodollar Lending Rate Borrowing, the Interest Period applicable thereto) and of each payment or prepayment of principal made by Borrower, and agrees that all such notations shall constitute prima facie evidence of the matters noted. This Revolving Note is the Revolving Note referred to in that certain Restated Revolving Credit Agreement dated as of July 10, 1996 by and between Borrower and Bank (as at any time amended, supplemented, or otherwise modified or restated, the "Agreement"), and is governed by the terms thereof. Initially capitalized terms used herein which are not otherwise defined have the meanings assigned to such terms in the Agreement. [SIGNATURE BLOCK ON NEXT PAGE] This Revolving Note shall be governed by and construed in accordance with the internal laws of the State of California without regard to principles of conflicts of laws. AMWEST INSURANCE GROUP, INC. By: Name: Title: NOTICE OF BORROWING (Revolving Loan) To: UNION BANK OF CALIFORNIA, N.A. Investment Banking Note Center #192 1980 Saturn Street Monterey Park, California 91754 Attn: Pursuant to that certain Restated Revolving Credit Agreement, as of July 10, 1996 ( the "Agreement"), between Amwest Insurance Group, Inc., a Delaware corporation ("Borrower"), on the one hand, and Union Bank of California, N.A. on the other hand, this Notice of Borrowing represents Borrower's request for a borrowing pursuant to Section 2.4 of the Agreement: $__________ Reference Rate Borrowing; and $__________ Eurodollar Rate Borrowing with an interest Period of months and expiring on , 19 Total: $__________ Borrower requests that the above extension of credit be made available on , 19 . The undersigned officer certifies that, as of the date of the requested borrowing; (i) the representations and warranties of Borrower contained in the Agreement are true and correct in all material respects on and as of such date, except to the extent such representations and warranties expressly relate solely to an earlier date; (ii) no Event of Default or Default has occurred and is continuing under the Agreement or will result from the proposed borrowing; (iii) Borrower has satisfied all conditions under the Agreement to be performed or satisfied by it on or before such date. Exhibit 2 Each capitalized term contained in this Notice of Borrowing and not separately defined herein shall have the meaning ascribed thereto in the Agreement. Dated: 19 . AMWEST INSURANCE GROUP, INC. a California corporation By: Title: By: Title: Exhibit 2 NOTICE OF CONVERSION/CONTINUATION (Revolving Loan) To: UNION BANK OF CALIFORNIA, N.A. Investment Banking Note Center #192 1980 Saturn Street Monterey Park, California 91754 Attn: Pursuant to that certain Restated Revolving Credit Agreement, dated as of July 10, 1996 (the "Agreement"), between Amwest Insurance Group, Inc., a Delaware corporation ("Borrower"), on the one hand, and Union Bank of California, N.A., on the other hand, this Notice of Conversion/Continuation represents Borrower's request pursuant to Section 2.5 of the Agreement to: (a) Convert $_________ in principal amount of Reference Rate Borrowings on , 19 to a Eurodollar Rate Borrowing with an Interest Period of [months] and expiring on 19 ; (b) Convert $ in principal amount Eurodollar Rate Borrowings on , 19 , to a Reference Rate Borrowing; (c)Continue as Eurodollar Rate Borrowings $_______________ in principal amount of presently outstanding Eurodollar Rate Borrowings, commencing on , 19 , with an Interest Period of [months] and expiring on , 19 . Exhibit 3 Each capitalized term contained in this Request for Conversion/Continuation and not separately defined herein shall have the meaning ascribed thereto in the Agreement. Dated: , 19-- AMWEST INSURANCE GROUP, INC. a California corporation By: Title: By: Title: EXHIBIT 3 COMPLIANCE CERTIFICATE To: Union Bank of California, N.A. Reference is made to the Restated Revolving Credit Agreement dated as of July 10, 1996, between AMWEST INSURANCE GROUP, INC., a Delaware corporation ("Borrower"), and UNION BANK OF CALIFORNIA, N.A. (the "Restated Revolving Credit Agreement"). Terms defined in the Restated Revolving Credit Agreement and not otherwise defined in this Compliance Certificate ("Certificate") shall have the meanings defined for them in the Restated Revolving Credit Agreement. This Certificate is delivered in accordance with Sections 5.2(c) and 5.2(f) of the Restated Revolving Credit Agreement. I. COMPLIANCE WITH FINANCIAL COVENANTS. Through the fiscal quarter ending . Computations showing compliance with Sections 5.9, 5.11, 5.12, 5.13, 5.14, 5.15, and 5.16 of the Loan Agreement are as follows: A. 5.9; Fixed-Charqe Coveraqe Ratio. The Fixed-Charge Coverage Ratio, as computed in accordance with Section 5.9 of the Restated Revolving Credit Agreement, is : 1.0. COVENANT REQUIREMENT - Cannot be less than 1.1:1.0. B. 5.11; Tanqible Net Worth. Tangible Net Worth as computed in accordance with Section 1.1 and 5.11 of the Restated Revolving Credit Agreement is . COVENANT REQUIREMENT - Minimum Tangible Net Worth must be greater than 90% of consolidated Tangible Net Worth at March 31, 1996, plus 50% of Borrower's net income. Minimum Tangible Net Worth shall also be increased each fiscal year by the dollar amount of any initial public offering of securities. C. 5.12; Net Profit. Net Profit as computed in accordance with Section 1.1 and 5.12 of the Restated Revolving Credit Agreement is . EXHIBIT 4 COVENANT REQUIREMENT - Must be > 0 on an annual basis. D. 5.13; Policyholders' Surplus. Policyholders Surplus as computed in accordance with Section 1.1 and 5.13 of the Restated Revolving Credit Agreement is : COVENANT REQUIREMENT - must be > 90% of Capital Surplus as of March 31, 1996. E. 5.14; Operating Leverage Ratio. Operating Leverage Ratio as computed in accordance with Sections 1.1 and 5.14 of the Restated Revolving Credit Agreement is : 1.0. COVENANT REQUIREMENT -Cannot exceed 3.0:1.0. In the above computation, the Operating Leverage Ratio is computed as follows: Net Written Premiums (over the most recent four quarters) Capital Surplus (as of the most recent quarterly ending date) F. 5.15; A.M. Best Rating. A.M. Best Rating as discussed in Section 5.15 of the Restated Revolving Credit Agreement is COVENANT REQUIREMENT - Must maintain an A.M. Best rating of A- or better. G. 5.16; Investment Portfolio Quality. Investment Portfolio Quality as discussed in Section 5.16 of the Restated Revolving Credit Agreement is COVENANT REQUIREMENT - Must maintain an average fixed income portfolio rating of A. II.PERFORMANCE OF OBLIGATIONS. A review of the activities of Borrower and its Subsidiaries during the fiscal period covered by the attached financial statements has been made under my supervision with a view to determining whether during such fiscal period Borrower an dits Subsidiaries performed and observed all their respective obligations under the Restated Resolving Credit Agreement. Except as described in an attached document or in an earlier Certificate, Borrower and its Subsidiaries performed and observed each covenant contained in the Restated Revolving Credit Agreement applicable to it, and no Default or Event of Default has occurred during such EXHIBIT 4 fiscal period which had not been previously waived by Bank nor is such a Default or Event of Default continuing. IN WITNESS WHEREOF, as a Senior Officer of Borrower, I have signed this Certificate as of the day of , 19-- BY: Printed Name and Title EXHIBIT 4 EX-10.56 4 EXCESS OF LOSS REINSURANCE CONTRACT Excess of Loss Bond Confirmation Slip Terms' Effective: October 1, 1996 issued to Amwest Surety Insurance Company Woodland Hills, California (hereinafter referred to collectively as the "Company") by Various Reinsurers (hereinafter referred to as the "Reinsurer") Reinsurance Confirmation Slip Article I - Classes of Business Reinsured By this Contract the Reinsurer agrees to reinsure the excess liability which may accrue to the Company under Surety Bonds (hereinafter called "bonds") whether in force or expired at the effective date hereof or issued by the Company on or after that date (including bonds with premium anniversary dates on or after that date), and classified by the Company as Contract Bonds, Subdivision Bonds or Commercial Bonds subject to the terms, conditions and limitations hereinafter set forth. Article H - Term A. This Contract shall become effective on October 1, 1995, with respect to losses discovered by the Company on or after that date and shall remain in force until December 31, 1997, both days inclusive. B. Upon termination of this Contract, the following provisions shall apply: 1. The Reinsurer shall remain liable hereunder with respect to business in force on the date of termination until: a. As respects bonds written for an indefinite period and containing a valid cancellation clause, the date of cancellation or the date of the next premium anniversary, whichever first occurs, after the date of termination of this Contract, but in no event beyond 60 months following the date of termination of this Contract; b. As respects all other bonds, the date of expiration or final settlement of the Company's liability, but in no event beyond 60 months following the date of termination of this Contract; it being understood that any portion of the Reinsurer's share of unearned premium in force 60 months following the date of termination shall be promptly reallocated to the Company. 2. Unless the Company elects to reassume the Reinsurer's portion of the outstanding losses as of the date of termination of this Contract, and so notifies the Reinsurer no later than 15 days after the date of termination, the Reinsurer shall remain liable for its portion of the Reinsurer's share of outstanding losses until final settlement or commutation of all such losses. D. Notwithstanding the provisions of paragraph C above, if the Company elects to reassume the Reinsurer's portion of the unearned premium in force on the effective date of termination of this Contract, and so notifies the Reinsurer no later than 15 days after the date of termination, the Reinsurer shall have no liability hereunder with respect to losses discovered after the date of termination. E. Notwithstanding paragraph A above, it is understood and agreed that should at any time a subscribing reinsurer lose the whole or part of its paid up capital, become insolvent, or be placed in conservation, rehabilitation or liquidation, or be acquired or controlled by any other company or lose its accreditation by the U.S. Treasury Department, become a non-admitted reinsurer in the State of California or be downgraded by A.M. Best Company to "B+" or less, the Company shall have the right to terminate this Contract by giving such subscribing reinsurer 15 days prior notice by certified mail. Article III - Territory The liability of the Reinsurer shall be limited to losses discovered under bonds issued to principals domiciled within the territorial limits of the United States of America, its territories or possessions, Puerto Rico, the District of Columbia and Canada, inclusive of principals domiciled in the United States of America which are performing obligations in Mexico; but this limitation shall not apply to losses if the Company's bonds provide coverage outside the aforesaid territorial limits. Article IV - Exclusions A. This Contract does not apply to and specifically excludes the following: 1. Business accepted by the Company as reinsurance from other insurance companies or associations, except business originally written or reunderwritten by the Company. 2. Any loss or liability accruing to the Company directly or indirectly) from any business written by or through any pool or association, not including pools or associations under which membership by the Company is required under statutes or regulations or voluntary membership in pools and associations that are approved by Kemper Reinsurance Company, acting for and on behalf of the Reinsurer. 3. Co-surety bonds not controlled in their entirety by the Company (except as provided for under Article VII). 4. Reclamation bonds negotiated prior to or during the mining phase of a parcel of property, except commercial bonds when part of an account. 5. Workers' Compensation self-insurance bonds or any other self-insurance bonds, except commercial bonds when part of an account. 6. Asbestos Abatement/Removal contracting, except incidental exposures (i.e., the lesser of 25% of the total! job contract or $500,000 for that portion of the total job contract). 7. Completion bonds. 8. Hazardous Waste Closure bonds and Post Closure bonds, except commercial bonds when part of an account. 9. Fidelity and Commercial Crime bonds. 10. Lease bonds, except commercial bonds when part of an account. 11. Financial Guarantee, Credit Insurance or any miscellaneous bond(s) classified as SAA #580, #581 and #597. 12. ERISA bonds. 13. Mortgage Impairment, Deficiency or Guarantee bonds. 14. Rate Guarantee bonds. 15. Money Market Guarantee or Guarantee of Installment Paper bonds. 16. Bank Depository bonds. 17. Note Guarantee bonds or bonds guaranteeing letters of credit. 18. Casualty insurance or any third party tort liability. 19. All Contract bonds issued by the Company with estimated completion terms greater than three years in length (not including the time involved in start-up delays), other than service business contracts. 20. Bonds to principals in claim for amounts greater than $500,000 except commercial bonds when part of an account and pre-approved by Kemper Reinsurance Company. B. However, any reinsurance that is specially accepted from the Company by Kemper Reinsurance Company and Scor Reinsurance Company, acting for and on behalf of the Reinsurer, shall be covered under this Contract and subject to the terms hereof, except to the extent such terms are modified by the special acceptance. Article V - Retention and Limit A. The Company shall retain and be liable for the first $2,000,000 of ultimate net loss (whether involving any one or any combination of the classes of business covered hereunder) as respects losses discovered during the contract year under all bonds issued to any one principal. The Reinsurer shall then be liable for the amount by which such ultimate net loss exceeds the Company's retention, but the liability of the Reinsurer shall not exceed $4,000,000 of ultimate net loss as respects losses discovered during the contract year under all bonds issued to any one principal, nor shall it exceed $8,000,000 in the aggregate as respects losses discovered during the contract year. B. "Ultimate net loss" as used herein is defined as the sum or sums (including extra contractual obligations, interest on judgments, litigation expenses and all other loss adjustment expenses, except office expenses and salaries of the Company's regular employees) paid or payable by the Company in settlement of claims and in satisfaction of judgments rendered on account of such claims, after deduction of all salvage, all recoveries and all claims on inuring insurance or reinsurance, whether collectible or not Ultimate net loss shall also be reduced by collateral (as perfected) associated with bonds subject to this Contract (or a pro rata portion thereof, where the collateral is also associated with bonds not subject hereto). As respects co-surety bonds controlled by the Company, only losses attributable to the Company's participation on such bonds shall be considered ultimate net loss hereunder. Nothing herein shall be construed to mean that losses under this Contract are not recoverable until the Company's ultimate net loss has been ascertained. It is understood that the Company is not responsible for the reduction in value or collapse of collateral due to unforeseen events after the original collateral assessment has been made. Moreover, the value of collateral shall be subsequently re-evaluated by the Company in the event adjustments are being made to the collective performance or completion penalty amounts issued to one principal. C. "Extra contractual obligations" as used herein shall be defined as 80.0% of those liabilities not covered under any other provision of this Contract an which arise from the handling of any claim on business covered hereunder, such liabilities arising because of, but not limited to, the following: failure by the Company to settle within the bond limit, or by reason of alleged or actual negligence, fraud or bad faith in rejecting an offer of settlement or in the preparation of the defense or in the trial of any action against its insured or reinsured or in the preparation or prosecution of any appeal consequent upon such action or unintentional violation of any Unfair Claim or Trade Practice Act or any similar act or any related law or statute. This Coverage shall not apply where the loss has been incurred due to the fraud of a member of the Board of Directors or a corporate officer of the Company acting individually or collectively or in collusion with any individual or corporation or any other organization or party involved in the presentation, defense or settlement of any claim covered hereunder. Recoveries from any form of insurance or reinsurance which protects the Company against extra contractual obligations claims shall inure to the benefit of this Contract. If any provision set forth in this paragraph is held to be invalid under the law of any state, that provision shall be deemed to comply with the minimum requirements of such law, giving due consideration to the original intentions of the parties. But this shall not affect the validity or enforceability of the original provisions in any other jurisdiction. D. "Contract year" as used in this Contract shall mean the period from October 1, 1996 to December 31, 1997, both days inclusive. In the event this Contract is terminated on a "runoff" basis, the contract year shall be from the beginning of the contract year through the end of the runoff period. E. A loss shall be deemed "discovered" on the date when the Company has incurred an ultimate net loss of $500,000 or more (net of surplus or quota share reinsurance) for any one principal through the establishment of reserves, payments, assumption or guarantee of liabilities to prevent a default, or any combination thereof. The date on which an extra contractual obligation is discovered by the Company shall be deemed, in all circumstances, to be the date the original loss is discovered. The discovery date shall determine the contract year to which such loss is assigned, and shall not be subject to change regardless of fluctuation in the amount of the incurred loss. F. The Company may maintain in force pro rata reinsurance, recoveries under which shall inure to the benefit of this Contract. G. The term "principal" as used herein shall mean one or more principals under the same management and control, or one or more principals for which bonds were executed in reliance upon the indemnity of the same person, fu-m or corporation, or in reliance upon the indemnity of a related group of persons, firm or corporations. However, when the Company receives bonding opportunities from separate principals that operate under individual financial statements but may have corporate affiliations and are engaged in different types of contracting projects, the Company may be able to classify each principal as a separate entity, when approved by Kemper Reinsurance Company. Article VI - Reinstatement A. In the event all or any portion of the reinsurance provided under this Contract is exhausted by loss, the amount so exhausted shall be reinstated immediately from the time the loss is discovered by the Company. B. Notwithstanding paragraph A above the liability of the Reinsurer for reinsurance coverage provided shall not exceed either of the following: 1. $4,000,000 as respects loss or losses discovered under any one principal; nor 2. $8,000,000 in all during the contract year. Article VII - Co-Surety Bonds It is agreed that with respect to co-surety bonds, the Company's cession to the Reinsurer shall be the same percentage of the applicable reinsurance limit that the amount of the bond controlled by the Company bears to the full amount of the bond. Article VIII - Losses A. Whenever a loss discovered by the Company exceeds the Company's retention hereunder and/or appears likely (in the Company's opinion) to result in a claim hereunder, the Company shall notify the Reinsurer, and the Reinsurer shall have the right to participate in the adjustment of such loss at its own expense. B. All loss settlements made by the Company, provided they are within the terms of this Contract, shall be unconditionally binding upon the Reinsurer. Except as provided in paragraph C below, the Reinsurer agrees to pay all amounts for which it may be liable immediately upon receipt of reasonable evidence of the amount paid (or scheduled to be paid) by the Company. C. Within 45 days after the end of each calendar quarter, the Company shall provide the Reinsurer a loss bordereau which lists all losses by principal for losses exceeding $500,000 in the aggregate that were reported to the Company from the inception of this Contract through the calendar quarter under consideration and will contain the following information, listed by principal: 1. Name of principal; 2. Bond number; 3. Date of loss; 4. Amount of loss; 5. Obligee; 6. Status update on each loss; 7. Whether any salvage, subrogation or collateral proceedings are in progress. Article IX - Salvage and Subrogation The Reinsurer shall be credited with salvage and subrogation (i.e., reimbursement obtained or recovery made by the Company, less the actual cost, excluding salaries of officials and employees of the Company and sums paid to attorneys as retainer, of obtaining such reimbursement or making such recovery) on account of claims and settlements involving reinsurance hereunder. Salvage thereon shall always be used to reimburse the excess carriers in the reverse order of their priority according to their participation before being used in any way to reimburse the Company for its primary loss. The Company hereby agrees to enforce its rights to salvage or subrogation relating to any loss, a part of which loss was sustained by the Reinsurer, and to prosecute all claims arising out of such rights. Article X - Premium 1. As premium for the reinsurance provided during the contract year, the Company shall pay the Reinsurer the greater of $1,200,000 or 1.90% of the Company's earned premium for the contract year. In the event this contract is terminated on a run off basis, the Company shall pay the Reinsurer 1.90% of the Company's earned premium during the run off period. 2. The Company shall pay the Reinsurer a deposit premium of $1,500,000 in five equal installments of $300,000 payable at October 1, 1996, January 1, April 1, July 1 and October 1, 1997. 3. Within 60 days after the end of the contract year, the Company shall provide a report to the Reinsurer setting forth the premium due hereunder for the contract year, computed in accordance with paragraph 1 above, and any additional premium due the Reinsurer or return premium due the Company shall be remitted promptly. 4. "Earned premium" as used herein shall mean unearned premiums at the beginning of the contract year, plus written premiums during the contract year, less unearned premiums at the end of the contract year. Article XI - Commutation Not later than 15 days after the close of any one contract year, the Company at its sole option may require commutation of all claims deemed discovered for said contract year which have not been finally settled and are likely to result in a claim under this Contract. The Company shall determine the commuted value of the Reinsurer's share of outstanding loss and loss adjustment expense as of the date of any such commutation, based on the known losses as of that date, and payment thereof by the Reinsurer of its proportion of such amount or amounts shall constitute a complete and final release of any further liability hereunder on the part of the Reinsurer as respects all outstanding loss and loss adjustment expense, whether known or unknown. The Reinsurer shall forego the fight to any unearned premium and outstanding loss reserves as of the effective date of commutation. Article XII - Offset (BRMA 36C) The Company and the Reinsurer shall have the right to offset any balance or amounts due from one party to the other under the terms of this Contract. The party asserting the fight of offset may exercise such fight any time whether the balances due are on account of premiums or losses or otherwise. Article XIII - Access to Records (BRMA 1D) The Reinsurer or its designated representatives shall have the access at any reasonable time to all records of the Company which pertain in any way to this reinsurance. Article XIV - Liability of the Reinsurer A. The liability of the Reinsurer shall follow that of the Company in every case, and be subject in all respects to all the general and special stipulations, clauses, waivers and modifications of the Company's bonds, and any endorsements thereon. However, in no event shall this be construed in any way to provide coverage outside the terms and conditions set forth in this Contract. B. Nothing herein shall in any manner create any obligations or establish any fights against the Reinsurer in favor of any third party or any persons not parties to this Contract. Article XV - Net Retained Lines (BRMA 32B) A. This Contract applies only to that portion of any bond which the Company retains net for its own account, and in calculating the amount of any loss hereunder and also in computing the amount or amounts in excess of which this Contract attaches, only loss or losses in respect of that portion of any bond which the Company retains net for its own account shall be included. B. The amount of the Reinsurer's liability hereunder in respect of any loss or losses shall not be increased by reason of the inability of the Company to collect from any other reinsurer(s), whether specific or general, any amounts which may have become due from such reinsurer(s), whether such inability arises from the insolvency of such other reinsurer(s) or otherwise. Article XVI - Errors and Omissions (BRMA 14F) Inadvertent delays, errors or omissions made in connection with this Contract or any transaction hereunder shall not relieve either party from any liability which would have attached had such delay, error or omission not occurred, provided always that such error or omission is rectified as soon as possible after discovery. Article XVII - Currency (BRMA 12A) A. Whenever the word "Dollars" or the "$" sign appears in this Contract, they shall be construed to mean United States Dollars and all transactions under this Contract shall be in United States Dollars. B. Amounts paid or received by the Company in any other currency shall be converted to United States Dollars at the rate of exchange at the date such transaction is entered on the records of the Company. Article XVIII - Taxes (BRMA 50C) In consideration of the terms under which this Contract is issued, the Company will not claim a deduction in respect of the premium hereon when making tax returns, other than income or profits tax returns, to any state or territory of the United States of America, the District of Columbia or Canada. Article XIX - Federal Excise Tax (BRMA 17A) (Applicable to those reinsurers, excepting Underwriters at Lloyd's London and other reinsurers exempt from Federal Excise Tax, who are domiciled outside the United States of America.) A. The Reinsurer has agreed to allow for the purpose of paying the Federal Excise Tax the applicable percentage of the premium payable hereon as imposed under Section 4371 of the Internal Revenue Code to the extent such premium is subject to the Federal Excise Tax. B. In the event of any return premium becoming dale hereunder the Reinsurer will deduct the applicable percentage from the return premium payable hereon and the Company or its agent should take steps to recover the tax from the United States Government. Article XX - Unauthorized Reinsurers A. If the Reinsurer is unauthorized in any state of the United States of America or the District of Columbia, the Reinsurer agrees to fund its share of the Company's ceded United States unearned premium and outstanding loss and loss adjustment expense reserves (including incurred but not reported loss reserves, hereinafter referred to as "IBNR") by: 1. Clean, irrevocable and unconditional letters of credit issued and confirmed, if confirmation is required by the insurance regulatory authorities involved, by a bank or banks meeting the NAIC Securities Valuation Office credit standards for issuers of letters of credit and acceptable to said insurance regulatory authorities; and/or 2. Escrow accounts for the benefit of the Company; and/or 3. Cash advances; if, without such funding, a penalty would accrue to the Company on any financial statement it is required to file with the insurance regulatory authorities involved. The Reinsurer, at its sole option, may fund in other than cash if its method and form of funding are acceptable to the insurance regulatory authorities involved. B. If the Reinsurer is unauthorized in any province or jurisdiction of Canada, the Reinsurer agrees to fund 115% of its share of the Company's ceded Canadian unearned premium and outstanding loss and loss adjustment expense reserves (excluding IBNR) by: 1. A clean, irrevocable and unconditional letter of credit issued and confirmed, if confirmation is required by the insurance regulatory authorities involved, by a Canadian bank or banks meeting the NAIC Securities Valuation Office credit standards for issuers of letters of credit and acceptable to said insurance regulatory authorities, for no more than 15/115ths of the total funding required; and/or 2. Cash advances for the remaining balance of the funding required; if, without such funding, a penalty would accrue to the Company on any financial statement it is required to file with the insurance regulatory authorities involved. C. With regard to funding in whole or in part by letters of credit, it is agreed that each letter of credit will be in a form acceptable to insurance regulatory authorities involved, will be issued for a term of at least one year and will include an "evergreen clause," which automatically extends the term for at least one additional year at each expiration date unless written notice of non-renewal is given to the Company not less than 30 days prior to said expiration date. The Company and the Reinsurer further agree, notwithstanding anything to the contrary in this Contract, that said letters of credit may be drawn upon by the Company or its successors in interest at any time, without diminution because of the insolvency of the Company or the Reinsurer, but only for one or more of the following purposes: 1. To reimburse itself for the Reinsurer's share of unearned premiums returned to insureds on account of bond cancellations, unless paid in cash by the Reinsurer; 2. To reimburse itself for the Reinsurer's share of losses and/or loss adjustment expenses paid under the terms of bonds reinsured hereunder, unless paid in cash by the Reinsurer; 3. To reimburse itself for the Reinsurer's share of any other amounts claimed to be due hereunder, unless paid in cash by the Reinsurer; 4. To fund a cash account in an amount equal to the Reinsurer's share of any ceded unearned premium and/or outstanding loss and loss adjustment expense reserves (including IBNR) funded by means of a letter of credit which is under non-renewal notice, if said letter of credit has not been renewed or replaced by the Reinsurer 10 days prior to its expiration date; 5. To refund to the Reinsurer any sum in excess of the actual amount required to fund the Reinsurer's share of the Company's ceded unearned premium and/or outstanding loss and loss adjustment expense reserves (including IBNR), if so requested by the Reinsurer. In the event the amount drawn by the Company on any letter of credit is in excess of the actual amount required for C(1), C(2) or C(4), or in the case of C(3), the actual amount determined to be due, the Company shall promptly return to the Reinsurer the excess amount so drawn. D. For purposes of determining the amount to be funded under this Article, IBNR shall be calculated on a per principal basis, and shall not exceed 10.0% of total known subject losses discovered per principal in excess of the Company's retention hereunder (outstanding loss and loss adjustment expense reserves only), subject to a maximum of $450,000 per principal. Article XXI - Insolvency A. In the event of the insolvency of one or both of the reinsured companies, this reinsurance shall be payable directly to the company or to its liquidator, receiver, conservator or statutory successor immediately upon demand, with reasonable provision for verification, on the basis of the liability of the company without diminution because of the insolvency of the company or because the liquidator, receiver, conservator or statutory successor of the company has failed to pay all or a portion of any claim. It is agreed, however, that the liquidator, receiver, conservator or statutory successor of the company shall give written notice to the Reinsurer of the pendency of a claim against the company indicating the bond reinsured which claim would involve a possible liability on the part of the Reinsurer within a reasonable time after such claim is filed in the conservation or liquidation proceeding or in the receivership, and that during the pendency of such claim, the Reinsurer may investigate such claim and interpose, at its own expense, in the proceeding where such claim is to be adjudicated, any defense or defenses that it may deem available to the company or its liquidator, receiver, conservator or statutory successor. The expense thus incurred by the Reinsurer shall be chargeable, subject to the approval of the Court, against the company as part of the expense of conservation or liquidation to the extent of a pro rata share of the benefit which may accrue to the Company solely as a result of the defense undertaken by the Reinsurer. B. Where two or more reinsurers are involved in the same claim and a majority in interest elect to interpose defense to such claim, the expense shall be apportioned in accordance with the terms of this Contract as though such expense had been incurred by the company. C. It is further understood and agreed that, in the event of the insolvency of one or both of the reinsured companies, the reinsurance under this Contract shall be payable directly by the Reinsurer to the company or to its liquidator, receiver, conservator or statutory successor, except as provided by Section 4118(a) of the New York Insurance Law or except: 1. Where this Contract specifically provides another payee of such reinsurance in the event of the insolvency of the company; or 2. Where the Reinsurer with the consent of the direct insured or insureds has assumed such bond obligations of the company as direct obligations of the Reinsurer to the payees under such bonds and in substitution for the obligations of the company to such payees. Prior to implementation of a novation mentioned in this subparagraph, the certificate of assumption on New York risks shall be approved by the Superintendent of the State of New York. Article XXII - Arbitration (BRMA 6J) A. As a condition precedent to any right of action hereunder, in the event of any dispute or difference of opinion hereafter arising with respect to this Contract, it is hereby mutually agreed that such dispute or difference of opinion shall be submitted to arbitration. One Arbiter shall be chosen by the Company, the other by the Reinsurer, and an Umpire shall be chosen by the two Arbiters before they enter upon arbitration, all of whom shall be active or retired disinterested executive officers of insurance or reinsurance companies. In the event that either party should fail to choose an Arbiter within thirty (30) days following a written request by the other party to do so, the requesting party may choose two Arbiters who shall in turn choose an Umpire before entering upon arbitration. If the two Arbiters fail to agree upon the selection of an Umpire within thirty (30) days following their appointment, each Arbiter shall nominate three candidates within ten (10) days thereafter, two of whom the other shall decline, and the decision shall be made by drawing lots. B. Each party shall present its case to the Arbiters within thirty (30) days following the date of appointment of the Umpire. The Arbiters shall consider this Contract as an honorable engagement rather than merely as a legal obligation and they are relieved of all judicial formalities and may abstain from following the strict rules of law. The decision of the Arbiters shall be final and binding on both parties; but failing to agree, they shall call in the Umpire and the decision of the majority shall be final and binding upon both parties. Judgment upon the final decision of the Arbiters may be entered in any court of competent jurisdiction. C. If more than one reinsurer is involved in the same dispute, all such reinsurers shall constitute and act as one party for purposes of this Article and communications shall be made by the Company to each of the reinsurers constituting one party, provided, however, that nothing herein shall impair the rights of such reinsurers to assert several, rather than joint, defenses or claims, nor be construed as changing the liability of the reinsurers participating under the terms of this Contract from several to joint. D. Each party shall bear the expense of its own Arbiter, and shall jointly and equally bear with the other the expense of the Umpire and of the arbitration. In the event that the two Arbiters are chosen by one party, as above provided, the expense of the Arbiters, the Umpire and the arbitration shall be equally divided between the two parties. E. Any arbitration proceedings shall take place in Woodland Hills, California, but notwithstanding the location of the arbitration, all proceedings pursuant hereto shall be governed by the law of the State of California. Article XXIII - Service of Suit (BRMA 49C) (Applicable if the Reinsurer is not domiciled in the United States of America, and/or is not authorized in any State, Territory or District of the United States where authorization is required by insurance regulatory authorities) A. It is agreed that in the event the Reinsurer fails to pay any amount claimed to be due hereunder, the Reinsurer, at the request of the Company, will submit to the jurisdiction of any court of competent jurisdiction within the United States. Nothing in this Article constitutes or should be understood to constitute a waiver of the Reinsurer's rights to commence an action in any court of competent jurisdiction in the United States, to remove an action to a United States District Court, or to seek a transfer of a case to another court as permitted by the laws of the United States or of any state in the United States. B. Further, pursuant to any statute of any state, territory or district of the United States which makes provision therefor, the Reinsurer hereby designates the party named in its Interests and Liabilities Agreement, or if no party is named therein, the Superintendent, Commissioner or Director of Insurance or other officer specified for that purpose in the statute, or his successor or successors in office, as its true and lawful attorney upon whom may be served any lawful process in any action, suit or proceeding instituted by or on behalf of the Company or any beneficiary hereunder arising out of this Contract. Article XXIV - Assignment The Company may not assign the Contract, or its rights under this Contract, except with the express written agreement of the Reinsurer. Article XXV - Agency Agreement A. Amwest Surety Insurance Company shall be deemed the agent of Far West Insurance Company for purposes of sending or receiving notices required by the terms and conditions of this Contract, and for purposes of remitting or receiving any monies due any party. B. Notwithstanding the provisions of paragraph A above, each party to this Contract agrees to honor the terms set forth herein as if this Contract were a separate agreement between the Reinsurer and each individually named reinsured company. Balances payable or recoverable by any subscribing reinsurer or each individual named reinsured company shall not serve to offset any balances payable or recoverable to or from any other named reinsured company. C. Reports and remittances made to the Reinsurer in accordance with the provisions of this Contract are to be in sufficient detail to identify both the Reinsurer's loss obligations due each reinsured company and each reinsured company's premium remittance under the report. Article XXVI - Intermediary (BRMA 23A) E. W. Blanch Co. is hereby recognized as the Intermediary negotiating this Contract for all business hereunder. All communications (including but not limited to notices, statements, premium, return premium, commissions, taxes, losses, loss adjustment expense, salvages and loss settlements) relating thereto shall be transmitted to the Company or the Reinsurer through E. W. Blanch Co., Reinsurance Services, 3500 West 80th Street, Minneapolis, Minnesota 55431. Payments by the Company to the Intermediary shall be deemed to constitute payment to the Reinsurer. Payments by the Reinsurer to the Intermediary shall be deemed to constitute payment to the Company only to the extent that such payments are actually received by the Company. EX-10.57 5 AGGREGATE EXCESS OF LOSS REINSURANCE CONTRACT Aggregate Excess of Loss Reinsurance Placement Slip Effective: January 1, 1997 issued to Amwest Surety Insurance Company and Far West Insurance Company both of Woodland Hills, California (hereinafter referred to collectively as the "Company") by Underwriters Reinsurance Company (Barbados) Inc. Barbados, West Indies Article I - Business Reinsured By this Contract the Reinsurer agrees to reinsure and/or indemnify the Company for the net excess liability which may accrue to the Company during the term of this contract under its bonds, policies, contracts and binders of insurance or reinsurance (hereinafter called "bonds") whether in force or expired on the effective date hereof, issued or renewed on or after that date (including bonds with premium anniversary dates on or after that date), for all surety business written by the Company (direct and assumed), subject to the terms, conditions and limitations hereinafter set forth. Article II -Term The term of this Contract shall be January 1, 1997 through December 31, 1997, both days inclusive, with respect to losses occurring during said period. Article III- Territory (BRMA 51A) The territorial limits of this Contract shall be identical with those of the Company's bonds. Article IV - Retention and Limit A. No claim shall be made under this Contract unless and until the Company shall have first incurred an amount of ultimate net loss on business covered during the contract term in excess of the greater of $19,000,000 or 25.86% of its net earned premium for contract term. The Reinsurer shall then be liable for the greater of $5,000,000 or 7.0% of net earned premium for the term of this agreement in excess of Company's ultimate net loss in excess of its retention for the term of this agreement. B. As respects contract surety business subject hereunder, the maximum bond limit (except statutory) any one bond shall be deemed not to exceed $2,000,000, with limits written in excess of this amount deemed reinsured elsewhere. C. The Company shall have the option to purchase additional reinsurance limit equal to the greater of $5,000,000 or 7.0% of net earned premium. This option expires on December 31, 1997 and can only be exercised if the ultimate net loss ceded under this contract is less than $2,500,000. Article V - Definitions A. "Net excess liability" as used herein shall mean those amounts payable by the Company as defined in the ultimate net loss definition set forth in paragraph B below. B. "Ultimate net loss" as used herein is defined as the sum or sums (including loss in excess of bond limits, extra contractual obligations, prejudgment interest if included as part of an award or judgment and any loss adjustment expense, as herein after defined) paid or payable by the Company in settlement of claims and in satisfaction of judgments rendered on account of such claims, after deduction of all salvage, all recoveries and all claims on inuring insurance or reinsurance, whether collectible or not. Nothing herein shall be construed to mean that losses under this Contract are not recoverable until the Company's ultimate net loss has been ascertained. C. "Loss in excess of bond limits" and "extra contractual obligations" as used herein shall mean: 1. "Loss in excess of bond limits" shall mean 90% of any amount paid or payable by the Company under a bond ceded to this Contract in excess of its bon limits, but otherwise within the terms of its bond, as a result of an action against it by its insured or its insured's assignee to recover damages the insured is legally obligated to pay to a third party claimant because of the Company's alleged or actual negligence or bad faith in rejecting a settlement within bond limits, or in discharging its duty to defend or prepare the defense in the trial of an action against its insured, or in discharging its duty to prepare or prosecute an appeal consequent upon such an action. 2. "Extra contractual obligations" shall mean 90% of any punitive, exemplary, compensatory or consequential damages, other than loss in excess of bond limits, paid or payable by the Company under a bond ceded to this Contract as a result of an action against it by its insured, its insured's assignee or a third party claimant, which action alleges negligence or bad faith on the part of the Company in handling a claim under a bond subject to this Contract. Any loss in excess of bond limits or extra contractual obligation shall be deemed to have occurred on the same date as the loss covered or alleged to be covered under the bond. Notwithstanding anything stated herein, this Contract shall not apply to any loss incurred by the Company as a result of any fraudulent and/or criminal act by any officer or director of the Company acting individually or collectively or in collusion with an individual or corporation or any other organization or party involved in the presentation, defense or settlement of any claim covered hereunder D. "Loss adjustment expense" as used herein shall mean expenses allocable to the investigation, defense and/or settlement of specific claims, including 1) prejudgment interest, unless included as part of the award or judgment; 2) post-judgment interest; and 3) legal expenses and costs incurred in connection with coverage questions and legal actions connected thereto; but not including office expenses or salaries of the Company's regular employees, except that allocated outside costs of the Company shall be included. With respect to legal expenses and costs incurred in direct connection with declaratory judgment actions brought to resolve bond language coverage disputes between the Company and its insured, such expenses shall, for purposes of this Contract, not exceed an amount equal to the applicable limit of the bond or bonds involved unless agreed to by the Reinsurer. E. "Net earned premium" as used herein is defined as gross earned premium of the Company for the classes of business reinsured hereunder, less the earned portion of premiums ceded by the Company for reinsurance which inures to the benefit of this Contract or increases the Company's available capacity. Article VI - Other Reinsurance A. Notwithstanding the provisions of paragraph B of Article IV, the Company is permitted, but not required, to purchase other facultative and/or other treaty reinsurance on business subject to this Contract. Premiums ceded by the Company for reinsurance which inures to the benefit of this Contract or increases the Company' s available capacity shall be deducted in determining subject premium hereunder as provided in Article IX. B. It is agreed by the Company that inuring reinsurance agreements in force at the inception of this Contract shall remain in force during the term of this Contract, or so deemed. Article VII - Loss Notices and Settlements A. Whenever losses sustained by the Company appear likely to result in a claim hereunder, the Company shall notify the Reinsurer, and the Reinsurer shall have the right to participate in the adjustment of such losses at its own expense. B. All loss settlements made by the Company, provided they are within the terms of this Contract, shall be binding upon the Reinsurer, and the Reinsurer agrees to pay all amounts for which it may be liable upon receipt of reasonable evidence of the amount paid (or scheduled to be paid) by the Company. Article VIII - Salvage and Subrogation The Reinsurer shall be credited with salvage (i.e., reimbursement obtained or recovery made by the Company, less the actual cost, excluding salaries of officials and employees of the Company and sums paid to attorneys as retainer, of obtaining such reimbursement or making such recovery) on account of claims and settlements involving reinsurance hereunder. Salvage thereon shall always be used to reimburse the excess carriers in the reverse order of their priority according to their participation before being used in any way to reimburse the Company for its primary loss. The Company hereby agrees to enforce its rights to salvage or subrogation relating to any loss, a part of which loss was sustained by the Reinsurer, and to prosecute all claims arising out of such rights. Article IX - Reinsurance Premium A. As premium for the reinsurance provided hereunder, the Company shall pay the Reinsurer 2.0% of its net earned premium. B. The Company shall pay the Reinsurer an annual minimum and deposit premium of $1,500,000, payable in equal semi-annual installments of $750,000 at January 1 and July 1, 1997. C. Within 60 days after the end of each accident year, the Company shall provide a report to the Reinsurer setting forth the premium due hereunder, computed in accordance with paragraph A, and any additional premium due the Reinsurer or return premium due the Company shall be remitted promptly. D. As respects the reinsurance limit available under paragraph C of Article IV, the premium payable shall be adjusted at a rate of 1.33% of net earned premium subject to a minimum and deposit premium of $1,000,000 payable at January 1, 1998. Article X - Late Payments A. It is understood and agreed that the provisions of this Article shall not be implemented unless specifically invoked, in writing, by one of the parties to this Contract. B. In the event any premium, loss or other payment due either party is not received by the intermediary named in Article XXV (hereinafter referred to as the "Intermediary") by the payment due date, the party to whom payment is due may, by notifying the Intermediary in writing, require the debtor party to pay, and the debtor party agrees to pay, an interest penalty on the amount past due calculated for each such payment on the last business day of each month as follows: 1. The number of full days which have expired since the due date or the last monthly calculation, whichever the lesser; times 2. 1/365th of the six month (or nearest thereto) U.S. Treasury Bill rate, as quoted in the Wall Street Journal on the first business day of the month for which the calculation is being made; times 3. The amount past due, including accrued interest. It is agreed that interest shall accumulate until payment of the original amount due plus interest penalties have been received by the Intermediary. C. The establishment of the due date shall, for purposes of this Article, be determined as follows: 1. As respects the payment of routine deposits and premiums due the Reinsurer, the due date shall be as provided for in the applicable section of this Contract. In the event a due date is not specifically stated for a given payment, it shall be deemed due 45 days after the date of transmittal by the Intermediary of the initial billing for each such payment. 2. Any claim or loss payment due the Company hereunder shall be deemed due five business days following receipt by the applicable Subscribing Reinsurer of written notification that payment has been received from Subscribing Reinsurers constituting at least 662/3% of the interests and liabilities of all Subscribing Reinsurers participating under the applicable layer of this Contract, who are active as of the due date; it being understood that said date shall not be later than 75 days from the date of transmittal by the Intermediary of the initial billing for each such payment. 3. As respects any payment, adjustment or return due either party not otherwise provided for in subparagraphs 1 and 2 of paragraph C above, the due date shall be deemed as five business days following receipt of written notification that the provisions of this Article have been invoked. For purposes of interest calculations only, amounts due hereunder shall be deemed paid upon receipt by the Intermediary. D. Nothing herein shall be construed as limiting or prohibiting 1) a Subscribing Reinsurer from contesting the validity of any claim, or from participating in the defense or control of any claim or suit; or 2) either party from contesting the validity of any payment, or from initiating any arbitration or other proceeding in accordance with the provisions of this Contract. If the debtor party prevails in an arbitration or other proceeding, then any interest penalties due hereunder on the amount in dispute shall be null and void. If the debtor party loses in such proceeding, then the interest penalty on the amount determined to be due hereunder shall be calculated in accordance with the provisions set forth above unless otherwise determined by such proceedings. If a debtor party advances payment of any amount it is contesting, and proves to be correct in its contestation, either in whole or in part, the other party shall reimburse the debtor party for any such excess payment made plus interest on the excess amount calculated in accordance with this Article. E. As provided under Article VIII, it is understood and agreed that the Company shall furnish the Reinsurer with usual and customary claim information and nothing herein shall be construed as limiting or prohibiting a Subscribing Reinsurer from requesting additional information that it may deem necessary. F. As respects subparagraph 2 of paragraph C above, a Subscribing Reinsurer shall be deemed not to be active when it 1) ceases assuming new or renewal reinsurance business through the Intermediary; 2) is declared insolvent, or put in liquidation, conservatorship or rehabilitation by a competent regulator authority or court; 3) is declared insolvent, or is the subject of an administrative order or enters provisional liquidation and/or liquidation; or 4) has a reduction in its statutory surplus or shareholders' funds of 50% or more from its statutory surplus or shareholders' funds as of the effective date of this Contract. G. Interest penalties arising out of the application of this Article that are $100 or less from any party shall be waived unless there is a pattern of late payments consisting of three or more items over the course of any 12-month period. Article XI - Reports and Remittances Within 60 days after the end of each calendar quarter following the end of the contract term, the Company shall report to the Reinsurer its aggregate ultimate net loss paid for the contract term as of the end of the quarter. If the aggregate ultimate net loss paid exceeds an amount equal to the Company's retention hereunder for the contract term based on an estimate of the Company's net earned premium for the contract term, the Reinsurer shall pay its portion of such estimated excess (net of any prior payments for the contract term). However, any such payment by the Reinsurer shall be provisional, subject to adjustment when the Company's actual ultimate net loss and net earned premium for the contract term have been determined. Article XII - Commutation The Company may commute this Contract with agreement by the Reinsurer. Article XIII - Offset (BRMA 36C) The Company and the Reinsurer shall have the right to offset any balance or amounts due from one party to the other under the terms of this Contract. The party asserting the right of offset may exercise such right any time whether the balances due are on account of premiums or losses or otherwise. Article XIV - Access to Records (BRMA 1D) The Reinsurer or its designated representatives shall have access at any reasonable time to all records of the Company which pertain in any way to this reinsurance. Article XV - Net Retained Lines (BRMA 32B) A. This Contract applies only to that portion of any bond which the Company retains net for its own account, and in calculating the amount of any loss hereunder and also in computing the amount or amounts in excess of which this Contract attaches, only loss or losses in respect of that portion of any bond which the Company retains net for its own account shall be included. B. The amount of the Reinsurer's liability hereunder in respect of any loss or losses shall not be increased by reason of the inability of the Company to collect from any other reinsurer(s), whether specific or general, any amounts which may have become due from such reinsurer(s), whether such inability arises from the insolvency of such other reinsurer(s) or otherwise. Article XVI - Errors and Omissions (BRMA 14F) Inadvertent delays, errors or omissions made in connection with this Contract or any transaction hereunder shall not relieve either party from any liability which would have attached had such delay, error or omission not occurred, provided always that such error or omission is rectified as soon as possible after discovery. Article XVII - Currency (BRMA 12A) A. Whenever the word "Dollars" or the "$" sign appears in this Contract, they shall be construed to mean United States Dollars and all transactions under this Contract shall be in United States Dollars. B. Amounts paid or received by the Company in any other currency shall be converted to United States Dollars at the rate of exchange at the date such transaction is entered into the books of the Company. Article XVIII - Taxes (BRMA 50C) In consideration of the terms under which this Contract is issued, the Company will not claim a deduction in respect of the premium hereon when making tax returns, other than income or profits tax returns, to any state or territory of the United States of America, the District of Columbia or Canada. Article XIX - Insolvency A. In the event of the insolvency of one or more of the reinsured companies, this reinsurance shall be payable directly to the company or to its liquidator, receiver, conservator or statutory successor immediately upon demand, with reasonable provision for verification, on the basis of the liability of the company without diminution because of the insolvency of the company or because the liquidator, receiver, conservator or statutory successor of the company has failed to pay all or a portion of any claim. It is agreed, however, that the liquidator, receiver, conservator or statutory successor of the company shall give written notice to the Reinsurer of the pendency of a claim against the company indicating the bond or bond reinsured which claim would involve a possible liability on the part of the Reinsurer within a reasonable time after such claim is filed in the conservation or liquidation proceeding or in the receivership, and that during the pendency of such claim, the Reinsurer may investigate such claim and interpose, at its own expense, in the proceeding where such claim is to be adjudicated, any defense or defenses that it may deem available to the company or its liquidator, receiver, conservator or statutory successor. The expense thus incurred by the Reinsurer shall be chargeable, subject to the approval of the Court, against the company as part of the expense of conservation or liquidation to the extent of a pro rata share of the benefit which may accrue to the company solely as a result of the defense undertaken by the Reinsurer. B. Where two or more reinsurers are involved in the same claim and a majority in interest elect to interpose defense to such claim, the expense shall be apportioned in accordance with the terms of this Contract as though such expense had been incurred by the company. C. It is further understood and agreed that, in the event of the insolvency of one or more of the reinsured companies, the reinsurance under this Contract shall be payable directly by the Reinsurer to the company or to its liquidator, receiver or statutory successor, except as provided by Section 4118(a) of the New York Insurance Law or except (1) where this Contract specifically provides another payee of such reinsurance in the event of the insolvency of the company or (2) where the Reinsurer with the consent of the direct insured or insureds has assumed such bond obligations of the company as direct obligations of the Reinsurer to the payees under such policies and in substitution for the obligations of the company to such payees. Article XX - Arbitration A. As a condition precedent to any right of action hereunder, any dispute arising out of the interpretation, performance or breach of this Contract, including the formation or validity thereof, shall be submitted for decision to a panel of three arbitrators. Notice requesting arbitration will be in writing and sent certified or registered mail, return receipt requested. B. One arbitrator shall be chosen by each party and the two arbitrators shall, before instituting the hearing, choose an impartial third arbitrator who shall preside at the hearing. If either party fails to appoint its arbitrator within thirty (30) days after being requested to do so by the other party, the latter, after ten (10) days notice by certified or registered mail of its intention to do so, may appoint the second arbitrator. C. If the two arbitrators are unable to agree upon the third arbitrator within thirty (30) days of their appointment, the two arbitrators will jointly petition the American Arbitration Association to appoint the third arbitrator from the AAA's Panel of Reinsurance Arbitrators. D. All arbitrators shall be disinterested active or former executive officers of insurance or reinsurance companies, underwriters at Lloyd's of London, reinsurance intermediaries and attorneys actively or formerly engaged in practicing law in the areas of insurance or reinsurance. E. Within thirty (30) days after notice of appointment of all arbitrators, the panel shall meet and determine timely periods for briefs, discovery procedures and schedules for heatings. F. The panel shall be relieved of all judicial formality and shall not be bound by the strict rules of procedure and evidence. The arbitration shall take place in Woodland Hills, California or, if unanimously agreed by the panel, any other mutually acceptable location. G. If more than one reinsurer is involved in the same dispute, all such reinsurers shall constitute and act as one party for purposes of this article. However, nothing shall impair the rights of such reinsurers to assert several rather than joint defenses or claims, nor shall this provision be construed as changing the liability of the reinsurers under the terms of this Contract from several to joint. H. The panel shall make its decision considering custom and practice as promptly as possible following the termination of hearings. The decision of any two arbitrators, when rendered in writing shall be final and binding, and judgment upon the award may be entered in any court having jurisdiction. The panel is empowered to grant such interim relief as it may deem appropriate. I. Each party shall bear the expense of its own arbitrator and shall jointly and equally with the other party bear the cost of the third arbitrator. The remaining costs of the arbitration shall be allocated by the panel. The panel may, at its discretion, award such further costs and expenses as it considers appropriate, including but not limited to attorney's fees and interest to the extent permitted by law. Insofar as the arbitration panel chooses to look to substantive law, it shall consider the law of the State of California. Article XXI - Service of Suit (BRMA 49C) (Applicable if the Reinsurer is not domiciled in the United States of America, and/or is not authorized in any State, Territory or District of the United States where authorization is required by insurance regulatory authorities) A. It is agreed that in the event the Reinsurer fails to pay any amount claimed to be due hereunder, the Reinsurer, at the request of the Company, will submit to the jurisdiction of a court of competent jurisdiction within the United States. Nothing in this Article constitutes or should be understood to constitute a waiver of the Reinsurer's rights to commence an action in any court of competent jurisdiction in the United States, to remove an action to a United States District Court, or to seek a transfer of a case to another court as permitted by the laws of the United States or of any state in the United States. B. Further, pursuant to any statute of any state, territory or district of the United States which makes provision therefor, the Reinsurer hereby designates the party named in its Interests and Liabilities Agreement, or if no party is named therein, the Superintendent, Commissioner or Director of Insurance or other off~cer specified for that purpose in the statute, or his successor or successors in office, as its true and lawful attorney upon whom may be served any lawful process in any action, suit or proceeding instituted by or on behalf of the Company or any beneficiary hereunder arising out of this Contract. Article XXII - Agency Agreement Amwest Surety Insurance Company shall be deemed the agent of the other reinsured company for purposes of sending or receiving notices required by the terms and conditions of this Contract, and for purposes of remitting or receiving any monies due any party. Article XXIH - Intermediary (BRMA 23A) E. W. Blanch Co. is hereby recognized as the Intermediary negotiating this Contract for all business hereunder. All communications (including but not limited to notices, statements, premium, return premium, commissions, taxes, losses, loss adjustment expense, salvages and loss settlements) relating thereto shall be transmitted to the Company or the Reinsurer through E. W. Blanch Co., Reinsurance Services, 3500 West 80th Street, Minneapolis, Minnesota 55431. Payments by the Company to the Intermediary shall be deemed to constitute payment to the Reinsurer. Payments by the Reinsurer to the Intermediary shall be deemed to constitute payment to the Company only to the extent that such payments are actually received by the Company. EX-10.63 6 SEPARATION AGREEMENT SEPARATION AGREEMENT AND GENERAL AND SPECIAL RELEASE OF CLAIMS This Separation Agreement and General and Special Release of Claims (the "Agreement") is made and entered into as of December 31, 1996 by and between Arthur F. Melton ("Melton") on the one hand and Amwest Insurance Group, Inc., a Delaware corporation ("Amwest"), Amwest Surety Insurance Company, a California corporation ("Amwest Surety"), and Far West Insurance Company, a California Corporation ("Far West") (together with their affiliates sometimes collectively referred to as the "Companies"), on the other hand. WHEREAS, Melton has been for several years prior to the execution of this Agreement, an executive employee, officer and director of Amwest and of Amwest's subsidiaries, Amwest Surety and Far West; and WHEREAS, Melton desires to resign from all of his present officer and employee positions with Amwest, Amwest Surety, Far West and any of their respective affiliates; and WHEREAS, Melton and Amwest, Amwest Surety, and Far West are desirous of entering into this Agreement to resolve amicably all matters between them on the terms set forth herein. NOW, THEREFORE, in consideration of the premises and mutual covenants set forth herein, the parties hereto agree as follows: 1. Resignation as Officer & Employee - Melton hereby voluntarily resigns, effective November 22, 1996, as an officer and employee of Amwest, Amwest Surety, Far West and any and all of their respective affiliates. The Companies accept Melton's resignations. Melton understands that his resignations are final and irrevocable and that the Companies are relying on his resignations in business and employment planning. However, Melton is not resigning as a director or as a member of the Board of Directors (or any committee thereof) of Amwest, Amwest Surety, Far West or any of their respective affiliates. Melton agrees to execute appropriate letters of resignation simultaneously with the execution of this Agreement. 2. Severance Payments - For so long as Melton is in full compliance with the terms of this Agreement, Amwest Surety shall pay to Melton as severance pay an amount equal to an aggregate gross amount of $ 200,567, less payroll taxes, payable every two weeks at the same time as salary is paid to Amwest Surety executives, in twenty-six equal installments each in the gross amount of $7,714.12, less payroll taxes, commencing December 10, 1996. Except as specifically set forth in this Agreement, Melton acknowledges and agrees that there are no other monies or benefits, including without limitation, vacation pay, sick pay or bonus, payable now or in the future from Amwest, Amwest Surety, Far West or any of their affiliates. 3. Stock Options - It is acknowledged and agreed that Melton currently holds options to purchase 55,900 shares of Amwest's Common Stock (the "Stock Options"), 30,700 of which are currently vested, and 25,200 of which are unvested, at various exercise prices ranging from $8.375 to $14.25 per share. The Stock Options were granted pursuant to stock option agreements dated December 3, 1990, March 17, 1992, May 20, 1993, March 22, 1994, April 4, 1995, April 4, 1995 and April 10, 1996 (collectively the "option Agreements"). The parties intend that, notwithstanding any provisions to the contrary contained in the Option Agreements or elsewhere, none of the Stock Options shall expire, terminate or accelerate by virtue of Melton's resignations contemplated in Paragraph 1 above. Consequently, it is hereby agreed that each of the Option Agreements is hereby amended and modified to provide language to the following effect: "If Optionee both: (a) ceases to be employed by the Company or its parent or any subsidiary, and (b) ceases to be a member of the Board of Directors of the Company or its parent or any subsidiary other than as a result of Optionee's retirement or death, then this Option, subject to earlier termination pursuant to other relevant provisions of this Option Agreement, shall expire three months after the later to occur of (a) and (b) above, and during such period after Optionee ceases to be an employee and a member of the Board of Directors of the Company (or its parent or any subsidiary), this Option shall be exercisable only as to those shares, if any, with respect to which the Optionee could have exercised the Option as of the date of cessation of employment or cessation of service as a member of the Board of Directors of the Company, whichever is later." 4. Insurance - Amwest Surety agrees to ask its carriers to consent to continuance of coverage under its group health, life and disability insurance plans, as they presently exist and as they may from time to time be amended with respect to executive employees, for Melton and his presently-designated dependents at the same levels as existed at time of termination through November 30, 1997. If such consent is given Amwest Surety will pay the cost of such coverage. Provided, however, Amwest Surety shall be under no obligation to change its group insurance carrier(s), or to self-insure, or, except as provided in the 2nd-to-last sentence of this Paragraph 4, otherwise to provide or pay for medical, dental, life and/or disability coverage or expenses if such carriers refuse to consent. Provided further, should Melton become eligible for medical, dental, life, and/or disability insurance paid for in whole or in part by another employer, Melton shall immediately notify Amwest Surety, and Amwest Surety will then be entitled to discontinue Melton's (and any dependents') coverage under the particular plan in question. At that time, or in the event Amwest Surety's insurance carrier(s) refuse to consent to cover Melton under Amwest Surety's group health, disability and/or life insurance plans, Amwest Surety will pay to Melton in one lump sum, an amount equal to the premiums then paid for such medical, dental, life and/or disability insurance coverage, multiplied by the number of months then remaining during which installment payments are to be made under this Agreement. Nothing herein shall in any way affect Melton's entitlements to continuation coverage under and in accordance with COBRA. 5. Accrued But Untaken Sick and Vacation Pay; Other Employee Payments - Melton acknowledges that Amwest Surety owes Melton the gross amount of $37,064.25, less payroll taxes, in full payment of any and all accrued but untaken sick and vacation pay owed by the Companies to Melton. 6. Termination Of Senior Executive Severance Agreement; Indemnity Agreement - The parties agree that effective immediately, any Senior Executive Severance Agreement by and between Amwest and Melton is hereby terminated and shall be of no further force or effect. It is hereby agreed that all Indemnity Agreements by and between Amwest and Melton shall remain in full force and effect. 7. Covenant Not to Compete - Melton agrees with Amwest Surety that during the period of time payments are made to Melton as specified in Paragraph 2 herein, he will not, in the counties of California, or elsewhere in the United States where Amwest, Amwest Surety, Far West, or any of their respective affiliates currently conduct their businesses, directly or indirectly own an interest in, operate, join, control or participate in, or be connected as an officer, employee, director, agent, independent contractor, partner, shareholder, consultant or principal of any corporation, partnership, agency, proprietorship, firm, association, person or other entity which sells, markets, underwrites or issues surety, fidelity or bail bonds; provided, however, that Melton shall not be prohibited hereunder from being employed by a business entity whose revenues derived from surety insurance premiums were at least $10,000, but were less than 10% of such entity's total revenues for its last fiscal year. Melton agrees that nothing contained in this Paragraph 7 reduces or in any way diminishes his fiduciary or other duties or responsibilities owed to Amwest, Amwest Surety or Far West as a member of the boards of directors of such corporations. 8. Remedies For Breach of Agreement - In the event Melton breaches or in any way violates any provision of this Agreement, including specifically the Covenant Not to Compete set forth in Paragraph 7 above, in addition to all the remedies available to Amwest Surety at law and in equity, Amwest Surety shall be entitled immediately: a) to cease making any further payments set forth in Paragraph 2 above, b) to provide Melton with notice that he will forfeit any unvested Stock Options to which he would otherwise have been entitled under Paragraph 3 herein, and c) to terminate any and all coverage under the plans set forth in Paragraph 4 above, except for COBRA continuation coverage. In addition, Amwest Surety and Melton recognize and acknowledge that any breach of the Covenant Not to Compete by Melton can not reasonably or adequately compensate Amwest Surety in damages, and that Amwest Surety shall be entitled to injunctive relief, which may include, but not be limited to, restraining Melton from rendering any service that would breach the Covenant Not to Compete set forth in Paragraph 7, the arbitration agreement contained in paragraph 10 notwithstanding. No remedy conferred on Amwest Surety by any of the specific provisions in this Agreement, including this Paragraph 8, is intended to be exclusive of any other remedy, and each and every remedy shall be cumulative, and shall be in addition to every other remedy given hereunder or hereafter existing at law or in equity, or by statute or otherwise. The election of any one or more remedies by Amwest Surety shall not constitute a waiver of its right to pursue other available remedies. Amwest Surety agrees to provide to Melton notice of breaches of this Agreement by Melton (including reasonable specifics which form the basis for such breach) 15 days before it shall exercise any of the remedies set forth herein. If Melton, in the opinion of Amwest Surety, does not fully and completely cure all breaches specified in the notice within 15 days after his receipt of such notice, Amwest Surety shall be entitled to exercise any or all of its rights set forth in this paragraph in addition to every other right or remedy existing at law or in equity, by statute or otherwise. 9. Releases A. General and Special Releases By Melton. -As a material provision of this Agreement, Melton (for himself, his agents, heirs, successors, assigns, executors and/or administrators) does hereby and forever release and discharge Amwest, Amwest Surety and Far West and each of their past and present parent, subsidiary and affiliated corporations, divisions or other entities, if any, as well as the successors, shareholders, officers, directors, heirs, predecessors, assigns, agents, employees, attorneys and representatives of each of them, past or present, from any and all causes of action, actions, judgments, liens, debts, contracts, indebtedness, damages, losses, claims, liabilities, rights, interests and demands of whatsoever kind or character, known or unknown, suspected to exist or not suspected to exist, anticipated or not anticipated, whether or not heretofore brought before any state or federal court or before any state or federal agency or other governmental entity, which Melton has or may have against any released person or entity, by reason of any and all acts, omissions, events or facts occurring or existing prior to the date hereof, including, without limitation, all claims attributable to the employment of Melton, all claims attributable to the termination of that employment, and all claims arising under any federal, state or other governmental statute, regulation or ordinance or common law, such as, for example and without limitation, Title VII of the Civil Rights Act of 1964 which prohibits discrimination on the basis of sex, race, color, national origin and religion, the civil Rights Act of 1866, the Americans With Disabilities Act, the Age Discrimination in Employment Act which prohibits discrimination on the basis of age over 40, the California Fair Employment and Housing Act which prohibits discrimination on the basis of race, religious creed, color, national origin, ancestry, physical disability, mental disability, medical condition, marital status, age over 40, and sex, the California Labor Code, wrongful termination claims and claims for breach of implied or express contract, excepting only those obligations expressly recited to be performed hereunder. B. General and Special Releases By Amwest, Amwest Surety and Far West. - As a material provision of this Agreement, Amwest, Amwest Surety and Far West do hereby and forever release and discharge Melton from any and all causes of action, actions, judgments, liens, debts, contracts, indebtedness, damages, losses, claims, liabilities, rights, interests and demands of whatsoever kind or character, known or unknown, suspected to exist or not suspected to exist, anticipated or not anticipated, whether or not heretofore brought before any state or federal court or before any state or federal agency or other governmental entity, which the Companies may have against any released person or entity, by reason of any and all acts, omissions, events or facts occurring or existing prior to the date hereof, including, without limitation, all claims attributable to the employment of Melton, all claims attributable to the termination of that employment, and all claims arising under any federal, state or other governmental statute, regulation or ordinance or common law, such as, for example and without limitation, Title VII of the civil Rights Act of 1964 which prohibits discrimination on the basis of sex, race, color, national origin and religion, the civil Rights Act of 1866, the Americans With Disabilities Act, the Age Discrimination in Employment Act which prohibits discrimination on the basis of age over 40, the California Fair Employment and Housing Act which prohibits discrimination on the basis of race, religious creed, color, national origin, ancestry, physical disability, mental disability, medical condition, marital status, age over 40, and sex, the California Labor Code, wrongful termination claims and claims for breach of implied or express contract, excepting only those obligations expressly recited to be performed hereunder. C. Excepted Claims. - Notwithstanding the provisions of Paragraph 9B, nothing contained herein or in any other provision of this Agreement shall release, acquit or discharge Melton from any claim: (a) arising out of or relating to Melton gaining in fact any personal profit or advantage from or at the expense of Amwest, Amwest Surety or Far West or any of their affiliates to which Melton is not or was not legally entitled, (b) relating to an accounting of profits made from the purchase or sale by Melton of securities of Amwest in violation of Section 16(b) of the Securities Exchange Act of 1934, as amended, or similar provisions of any state law, or (c) based upon or arising out of Melton's knowingly fraudulent, deliberately dishonest or willful misconduct. D. Waiver Of Unknown Claims. It is further understood and agreed that all rights of the parties hereto under Section 1542 of the Civil Code of California and any similar law of any state or territory of the United States are hereby expressly waived. This section reads as follows: 1542. Extent of General Release by Creditor Against Unknown Claims. A general release does not extend to claims which the creditor does not know or suspect to exist in his favor at the time of executing the release, which if known by him must have materially affected his settlement with the debtor. Melton and the Companies hereby declare and represent that no promise, inducement, or agreement not set forth in this Agreement has been made to any of them, and that this Agreement contains the entire agreement between the parties hereto. 10. Arbitration - As a material part of this Agreement, Melton and the Companies expressly agree that any and all disputes,controversies or claims arising out of or concerning this Agreement,any alleged breach of this Agreement, or the matters resolved and settled by this Agreement, including but not limited to disputes, controversies or claims arising out of Melton's employment by the Companies or its termination, or this Agreement, whether arising under theories of liability or damages based on contract, tort or statute, shall be determined exclusively by final and binding arbitration before a single arbitrator in accordance with the Employment Dispute Resolution Rules of the American Arbitration Association, unless other rules are provided in this Paragraph, and that judgment upon the award rendered by the arbitrator may be rendered in any court of competent jurisdiction. Claims subject to exclusive final and binding arbitration under this Agreement include, without limitation, claims that otherwise could be tried in court to the court or to a jury in the absence of this Agreement. Such claims include, without limitation, claims for breach of contract, breach of the implied covenant of good faith and fair dealing, breach of oral or written promise, wrongful termination, constructive discharge, infliction of emotional distress, defamation, interference with contract relations or prospective economic advantage, negligence, misrepresentation, retaliation, or employment discrimination, and including without limitation any claim for punitive damages or allegedly lost compensation or recovery for personal injury on any theory of pleading or proof, claims for attorneys' fees, or alleged violations of the California Labor Code (including Section 970), the California Constitution, the California Fair Employment and Housing Act prohibiting discrimination based on sex, race, religious creed, color, national origin, ancestry, physical disability, mental disability, medical condition, marital status, or age over 40, Title VII of the 1964 civil Rights Act prohibiting discrimination based on race, color, religion, sex or national origin, and the Americans with Disabilities Act prohibiting discrimination based on disability, and the Age Discrimination in Employment Act prohibiting discrimination based on age over 40, as these statutes have been from time to time amended. MELTON AND THE COMPANIES EXPRESSLY GIVE UP AND WAIVE ALL RIGHTS TO A JURY TRIAL IN COURT ON ANY SUCH STATUTORY OR OTHER CLAIMS. Any arbitration shall be held in Los Angeles, California. The Arbitrator will make his/her award in writing and shall accompany it with an opinion discussing the evidence and setting forth the reasons for the award. The Companies and Employee shall equally share the fees and costs of the Arbitrator. 11. Entire Agreement - This Agreement constitutes a single integrated contract expressing the entire agreement of the parties with respect to the subject matter hereof and supersedes all prior and contemporaneous oral and written agreements and discussions with respect to the subject matter hereof. There are no other agreements, written or oral, express or implied, between the parties hereto, concerning the subject matter hereof, except as set forth herein. This Agreement may be amended or modified only by an agreement in writing. 12. Governing Law; Notices; Separability - (a) The formation, construction, and performance of this Agreement shall be construed in accordance with the laws of California and the promises contained in Paragraph 7 shall be construed as a separate covenant in each of the separate cities and counties of the United States in which Amwest, Amwest Surety, or Far West and their respective affiliates are presently engaged in business. (b) Any notice required or permitted under this Agreement shall be given in writing to Amwest, Amwest Surety, and Far West either by personal service or by registered or certified mail, postage prepaid, addressed to Amwest, in care of its President, at its then principal place of business. Any such notice to Melton shall be given in a like manner and, if mailed, shall be addressed to Melton at 320 Junipero Plaza, Santa Barbara, CA. 93105. For the purpose of determining compliance with any time limit in this Agreement, a notice shall be deemed to have been duly given (i) on the date of service, if served personally on the party to whom notice is to be given, or (ii) on the third business day after mailing, if mailed to the party to whom the notice is to be given in the manner provided in this subsection. (c) In the event that any provision of this Agreement is determined to be invalid, prohibited or unenforceable for any reason, this Agreement shall be construed as if such invalid, prohibited or unenforceable provision had been more narrowly drawn so as not to be invalid, prohibited or unenforceable. If, notwithstanding the foregoing, any provision of this Agreement would be held to be invalid, prohibited or unenforceable, such provision shall be ineffective to the extent of such invalidity, prohibition or unenforceability, without invalidating the remaining provisions of this Agreement or affecting the validity or enforceability of such provision in any other jurisdiction. If any provision is held invalid or unenforceable with respect to particular circumstances, it shall nevertheless remain in full force and effect in all other circumstances. 13. Nonassignability; Death or Disability of Melton - This Agreement may not be assigned by Melton. If Melton should become disabled or die while any amounts are still payable to him hereunder, all such amounts shall be paid in accordance with the terms of this Agreement to Melton in the event of his disability or to Melton's executor, administrator, conservator or estate in the event of his death. 14. Further Assurances; Melton Activities - The parties agree they will sign any and all documents, certificates, and all other instruments necessary to carry out the purposes and intent of this Agreement. In addition, Melton agrees that from and after November 22, 1996, he shall not, in any manner, represent or act for, or on behalf of, Amwest, Amwest Surety and Far West, their affiliates, or any of them, except as Amwest's Chairman of the Board of Directors or President shall direct in writing. 15. Confidential Information and Trade Secrets -Melton hereby reaffirms his continuing obligation to safeguard the confidentiality of trade secrets and confidential information known to him through his employment with Amwest, Amwest Surety and Far West, their affiliates, or any of them, affirms that nothing in this Agreement abridges such obligations, and agrees to consult at once with the President of Amwest regarding any questions he may have regarding the meaning or application of such obligations in a specific circumstance. Melton acknowledges that he is in possession of material information not generally available to the public regarding Amwest, Amwest Surety and Far West and their affiliates. Melton acknowledges that he is aware of the provisions of the securities laws prohibiting the disclosure of such material inside information to third parties, including but not limited to securities analysts, and agrees that he shall not make any such disclosures without the prior written consent of Amwest's President. Furthermore, Melton agrees from the date this Agreement is executed through December 31, 1998 he will not communicate in a derogatory manner with any person (except his counsel), including without limitation, any stock analyst or stockholder or employee of Amwest, Amwest Surety or Far West, or any of them, regarding Amwest, Amwest Surety or Far West or their affiliates, without the prior consent of the President of Amwest; provided, however, Melton shall be permitted, without the prior consent of the President of Amwest, to discuss with potential employers the responsibilities Melton had while employed by Amwest, Amwest Surety and Far West. 16. Business Reputation of Amwest, Amwest Surety and Far West - - Melton agrees that the business reputation of Amwest, Amwest Surety and Far West, their affiliates and each of them is of critical importance to such companies. Melton agrees that he shall not, for the term of this Agreement (during which time Melton acknowledges and agrees that he owes Amwest, Amwest Surety and Far West a duty of loyalty), make or disclose to any person any statement, in written or oral form, if it could be reasonably expected that the business reputation(s) of Amwest, Amwest Surety, Far West, and/or their affiliates and/or any of their respective employees, or any of them, could be injured or damaged in any fashion whatsoever as a result of such statement. 17. Waiting Period and Right Of Revocation - MELTON ACKNOWLEDGES THAT HE IS AWARE THAT AND IS HEREBY ADVISED THAT HE HAS THE RIGHT TO CONSIDER THIS AGREEMENT FOR TWENTY-ONE DAYS BEFORE SIGNING IT AND THAT IF HE SIGNS IT PRIOR TO THE EXPIRATION OF TWENTY-ONE DAYS, MELTON IS WAIVING THIS RIGHT FREELY AND VOLUNTARILY. MELTON ALSO ACKNOWLEDGES THAT HE IS AWARE OF AND IS HEREBY ADVISED OF HIS RIGHT TO REVOKE THIS AGREEMENT FOR A PERIOD OF SEVEN DAYS FOLLOWING THE SIGNING OF THIS AGREEMENT AND THAT 'IT SHALL NOT BECOME EFFECTIVE OR ENFORCEABLE UNTIL THE REVOCATION PERIOD HAS EXPIRED. TO REVOKE THIS AGREEMENT, MELTON MUST NOTIFY AMWEST SURETY WITHIN SEVEN DAYS OF SIGNING IT. 18. Attorney Advice - MELTON ACKNOWLEDGES THAT HE IS AWARE OF HIS RIGHT TO CONSULT AN ATTORNEY, THAT HE HAS BEEN ADVISED TO CONSULT WITH AN ATTORNEY, AND THAT HE HAS HAD THE OPPORTUNITY TO CONSULT WITH AN ATTORNEY, IF DESIRED, PRIOR TO SIGNING THIS AGREEMENT. 19. Understanding Of Agreement - Melton states that he has carefully read this Agreement, that he has had sufficient time and opportunity to consider its terms and get legal advice, that he understands its final and bindingffect, that the only promises made to him to sign this Agreement are those stated above and that Melton is signing this Agreement voluntarily. AMWEST INSURANCE GROUP, INC. Dated: December , 1996 By: --------------------- John E. Savage President AMWEST SURETY INSURANCE COMPANY Dated: December , 1996 By: --------------------- John E. Savage President FAR WEST INSURANCE COMPANY Dated: December , 1996 By: --------------------- John E. Savage President Dated: December , 1996 By: -------------------- Arthur F. Melton -----END PRIVACY-ENHANCED MESSAGE-----