-----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, J6UD8uwqHTJZYl4ufEJmMziaIZdfUAlwxkdQLsmFy6KweUD1b0j6uhT8SyYcogyl okvDspltvZoIY5SROeT+0Q== 0000780118-98-000001.txt : 19980330 0000780118-98-000001.hdr.sgml : 19980330 ACCESSION NUMBER: 0000780118-98-000001 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980327 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: SEC FILE NUMBER: 001-09580 FILM NUMBER: 98576401 BUSINESS ADDRESS: STREET 1: 5230 LAS VIRGENES RD CITY: CALABASAS STATE: CA ZIP: 91302 BUSINESS PHONE: 8188712000 MAIL ADDRESS: STREET 1: 5230 LAS VIRGENES RD CITY: CALABASAS STATE: CA ZIP: 91302 EX-27 1 FDS -- I
7 1,000 U.S. Dollars 12-Mos DEC-31-1997 JAN-01-1997 DEC-31-1997 1 98,746 0 0 13,191 0 0 120,673 3,807 8,709 21,299 190,519 39,523 42,013 0 0 14,500 0 0 34 57,145 190,519 92,150 6,396 3,473 24 34,657 45,379 12,606 7,435 1,937 5,498 0 0 0 5,498 1.62 1.60 35,876 35,212 (555) (15,095) (22,100) 33,338 555
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, 1997 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) 5230 Las Virgenes Road Calabasas, California 91302 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (818) 871-2000 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 26, 1998, 3,471,477 shares of common stock, $.01 par value, were outstanding. As of March 26, 1998, 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 $33,135,924. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive proxy statement for the 1997 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 6 Reinsurance 7 Reserves 9 Investments 12 Marketing and Growth 15 The Safety Association 16 Competition 16 Employees 16 Government Regulation 17 2. Properties 18 3. Legal Proceedings 18 4. Submission of Matters to a Vote of Security Holders 18 PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters 19 Market Information 19 Holders 19 Dividends 19 6. Selected Financial Data 20 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 22 Results of Operations 22 Liquidity and Capital Resources 25 Other Matters 26 8. Financial Statements and Supplementary Data 27 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 27 PART III 10. Directors and Executive Officers of the Registrant 28 11. Executive Compensation 28 12. Security Ownership of Certain Beneficial Owners and Management 28 13. Certain Relationships and Related Transactions 28 PART IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 29 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"), Condor Insurance Company ("Condor") and Far West Insurance Company ("Far West") in underwriting surety bonds nationwide, commercial automobile insurance in the State of California and, to a lesser extent, other property and casualty coverages in various parts of the United States. Surety bonds are predominately written through 26 branch offices located throughout the United States. Both the surety and property and casualty products are marketed through independent agents with a small percentage of the Company's business written directly to the insured. Amwest Surety and Far West underwrite a wide variety of surety bonds for small to mid-sized surety accounts through independent agents and brokers. Currently, the Company has the capacity to write accounts up to $25 million and individual bonds up to $20 million. In order to protect the Company from major losses on the larger accounts, the Company purchases reinsurance from a consortium of Treasury listed reinsurers. Bonds are underwritten using a variety of factors to help mitigate risk, including the acceptance of full or partial collateral and the usage of funds control where appropriate. See "Reinsurance" and "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 $2.7 billion in surety net premiums in 1996. The Company ranked 12th nationally when measured by gross premiums written for all companies writing surety in 1996. 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 1996. The Company currently writes most of its non-surety property and casualty products through Condor. Condor primarily writes insurance packages which consist principally of commercial automobile liability and physical damage and, to a lesser extent, general liability and other related coverages 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, an applicant must become a member of the Waste Industry Loss Prevention and Safety Association d.b.a. "The Safety Association". In addition to its commercial policies, Condor offers non-standard private passenger automobile insurance in the states of Arizona and California and homeowners coverage in the state of California. The Company offers motorcycle insurance in the state of New York through Amwest and homeowners insurance in the state of Hawaii through Far West. The Company was incorporated in California on August 19, 1970 and redomesticated in Delaware on September 11, 1987. During the year ended December 31, 1995, two of the Company's wholly owned subsidiaries, Amwest Surety and Far West, reincorporated from California to Nebraska. Condor was reincorporated from California to Nebraska in December 1997. Accordingly, the Company is 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 44 states and the District of Columbia and Condor is licensed in California, Arizona and Oregon. 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 "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 5230 Las Virgenes Road, Calabasas, California 91302. The Company's telephone number is (818) 871-2000 and its facsimile number is (818)871-2019. 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, non-standard personal auto, homeowners and other related 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 four major product lines:
PREMIUMS WRITTEN Years ended December 31, 1997 1996 1995 (Dollars in thousands) ------------------------------------------------------------------------------------ Type of Insurance Contract performance bonds $ 54,808 50.7% $ 49,782 51.1% $ 54,039 57.4% Specialty Property & Casualty insurance 25,480 23.6 25,072 25.9 24,101 25.6 Court bonds 11,109 10.3 11,196 11.5 7,669 8.1 Commercial Surety bonds 16,694 15.4 11,192 11.5 8,375 8.9 ------------- ------------- ------------- ------------- -------------- ------------- Total $ 108,091 100.0% $ 97,242 100.0% $ 94,184 100.0% ============= ============= ============= ============= ============== ============= NET PREMIUMS EARNED Years ended December 31, 1997 1996 1995 (Dollars in thousands) ------------------------------------------------------------------------------------ Type of Insurance Contract performance bonds $ 46,741 50.7% $ 46,158 52.5% $ 49,737 58.4% Specialty Property & Casualty insurance 21,585 23.4 22,382 25.5 17,872 21.0 Court bonds 11,038 12.0 10,897 12.4 7,816 9.2 Commercial Surety bonds 12,786 13.9 8,446 9.6 9,745 11.4 ------------- ------------- ------------- ------------- -------------- ------------- Total $ 92,150 100.0% $ 87,883 100.0% $ 85,170 100.0% ============= ============= ============= ============= ============== ============= LOSSES & LOSS ADJUSTMENT EXPENSES AND LOSS RATIOS Years ended December 31, 1997 1996 1995 (Dollars in thousands) ------------------------------------------------------------------------------------ Type of Insurance Contract performance bonds $ 15,738 33.7% $ 24,430 52.9% $ 20,044 40.3% Specialty Property & Casualty insurance 14,644 67.8 18,811 84.1 13,131 73.5 Court bonds 1,402 12.7 835 7.7 323 4.1 Commercial Surety bonds 2,873 22.5 2,571 30.4 1,767 18.1 ------------- ------------- ------------- ------------- -------------- ------------- Total $ 34,657 37.6% $ 46,647 53.1% $ 35,265 41.4% ============= ============= ============= ============= ============== =============
UNDERWRITING AND COLLATERAL For the contract and commercial surety lines 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 contract and commercial surety 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, 1997 had a value of approximately $235,097,000. 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 $23,116,000 at December 31, 1997. Recent reductions in total collateral reflect competitive market conditions. The underwriting process for the court line of business consists of two separate approaches, one for the wholesale agent written business and another for the retail direct business. The underwriting procedures are as follows: Wholesale Underwriting Procedures - The Company contracts with retail agents and, through this contract, the agents are provided with underwriting authority levels ranging from a low of about $20,000 to a maximum of $125,000 together with powers of attorney. Underwriting authority levels are agreed to by the agents in writing. Court division regional managers and home office management set the underwriting levels based upon a number of factors. These factors include the agent's experience, track record, and most importantly, the amount of agent collateral that the Company holds pursuant to the indemnification provisions of the agent contract. Should an agent wish to write a bond that is in excess of his underwriting authority level, he is required to contact the Company for approval. The Company then reviews the collateral with the agent to determine whether or not the collateral is sufficient. Each of the court divisions underwriting staff have been assigned underwriting authority levels. Bonds in excess of staff underwriting authority levels must be approved by management. Generally, the Company requires the agent to obtain full collateral, except in those cases where the agent has a very large amount of contract collateral on deposit with the Company and/or the agent has been in the business for a long period of time. The Company maintains an underwriting approval record in the bond files for each approval. The Company periodically reviews an agent's adherence to these policies through on-site agent reviews or audits. Once an agent executes a bond, he reports the execution to the Company along with payment. Powers are replaced in an amount equal to those which have been reported in order to assure a complete reporting of all bonds executed. Retail Underwriting Procedures - The Company's retail office in the state of Washington is staffed with court bond underwriters. The retail branch manager has set underwriting authority levels for each of the underwriters. The retail branch managers underwriting authority level is established by court division home office management. Any bond over the underwriter's underwriting authority level must be approved by the branch manager. Any bond over the branch manager's underwriting authority level must be approved by court division home office management, in writing. Full collateral is generally required, however, on smaller bonds ($2,500 or less), underwriters may approve a bond with little collateral if the indemnitors appear to be strong. This evaluation is based upon a TRW credit report and/or employment stability. The retail offices are supplied with powers of attorney from the home office. These powers are in turn supplied to non-liable agents who post the bonds. Agents are re-supplied with powers on an as needed basis. Powers for the retail offices are replaced in an amount equal to those which have been reported in order to assure a complete reporting of all bonds executed. 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. 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, 1997 1996 1995 1994 1993 (Dollars in thousands) --------------------------------------------------------------------- Statutory net premiums written $100,034 $87,396 $82,814 $84,093 $79,194 Statutory policyholders' surplus 44,312 40,298 45,361 40,467 39,661 Ratio 2.26 2.17 1.83 2.08 2.00
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. 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, 1997 and found that it exceeded the highest level of recommended capital requirement. The Companies insurance subsidiaries currently prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by the various state insurance departments. Prescribed statutory accounting practices include a variety of publications of the NAIC, as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. The NAIC is working on a project to codify statutory accounting practices, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. When complete, that project will most likely change the definition of prescribed versus permitted statutory accounting practices and may result in changes to the accounting policies that insurance enterprises use to prepare their statutory financial statements. COMBINED RATIOS The GAAP 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, 1997 1996 1995 1994 1993 ------------- ------------- ------------- ------------- ------------- Loss Ratio 37.6% 53.1% 41.4% 35.4% 39.5% Expense Ratio 62.9 58.1 63.9 64.2 62.7 ------------- ------------- ------------- ------------- ------------- Combined Ratio 100.5% 111.2% 105.3% 99.6% 102.2% ============= ============= ============= ============= =============
The decrease 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 issues associated with these large contract bond losses by making significant changes in 1997. These changes included regionalization of contract surety underwriting, 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 27.5% participant, Scor Reinsurance Company has a 20% participation, Swiss Reinsurance Company has a 20% participation, Hartford Fire Insurance Company has a 15% participation, Underwriters Reinsurance Company has a 10% participation and General Accident Insurance Company of America has a 7.5% participation in the treaty. The Kemper Treaty, which was prospectively amended on October 1, 1997, 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 $20,000,000. Coverage is provided for most types of bonds which the Company writes except SBA guaranteed bonds and bail bonds, which are not covered by the treaty. The reinsurers' maximum exposure under the Kemper Treaty is $26,000,000 of losses discovered during any one contract period (October 1 to October 1). Effective October 1, 1996 to September 30, 1997, the coverage was $4,000,000 excess $2,000,000. Prior to 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 and $2,226,000 were recognized under the profit sharing provisions of the treaty for the years ended December 31, 1996 and 1995, 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 incurred for the 1997 accident year 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. At December 31, 1997, the Company has not yet pierced this reinsurance treaty. Through September 30, 1997, the Company also maintained a semiautomatic bond facultative reinsurance contract for surety bonds. The contract applied 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 was $6,000,000 plus 12% of the reinsured amount. The Company's aggregate retention was 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. From July 1, 1996 to June 30, 1997 the Company participated 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. The Company is also a party to a quota share agreement with regards to its non-standard private passenger automobile business. Under this agreement, the Company cedes 50% of its net liability on all non-standard private passenger automobile coverages. 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 and California homeowners programs differ from the above. For Hawaiian homeowners, the Company retains $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. For California homeowners, the Company is party to a quota share agreement in which the Company cedes 75% of its net liability with a limit of $7,500,000 per occurrence. 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. The Company establishes expense reserves to cover the anticipated expenses incurred by its outside consultants and attorneys. 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, 1997 1996 1995 (Dollars in thousands) ------------------------------------------ Statutory liability for losses and loss adjustment expenses at beginning of year $35,876 $24,246 $26,584 Provision for losses and loss adjustment expenses occurring in current year 35,212 45,853 35,508 Increase (decrease) in estimated losses and loss adjustment expenses for claims occurring in prior years (555) 794 (243) ------------- -------------- ------------- 34,657 46,647 35,265 ------------- -------------- ------------- Losses and loss adjustment expense payments for claims occurring during: Current year (15,095) (21,638) (19,283) Prior years (22,100) (13,379) (18,320) ------------- -------------- ------------- (37,195) (35,017) (37,603) ------------- -------------- ------------- Statutory liability for losses and loss adjustment expenses at end of year $33,338 $35,876 $24,246 ============= ============== ============= (1) Amounts reflect the liability for losses and loss adjustment expenses net of reinsurance recoverable on unpaid loss and loss adjustment expenses.
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, 1997 1996 1995 (Dollars in thousands) ------------------------------------------ Reserves reported on a SAP basis $33,338 $35,876 $24,246 Net reinsurance recoverable on unpaid loss and loss adjustment expenses 6,185 6,133 7,669 ------------- -------------- ------------- Reserves reported on a GAAP basis $39,523 $42,009 $31,915 ============= ============== =============
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 table on page 11 discloses the cumulative development of unpaid losses and loss adjustment expenses of the Company from 1987 through 1997. 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 five years ended December 31, 1997 are shown below the table. 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 11 represents the aggregate change in the estimates over prior years. For example, the 1992 liability has developed a $6,140,000 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 9. The cumulative redundancy (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) 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 ---------------------------------------------------------------------------------------------------------- Net liability for losses & loss adjustment $3,072 $3,528 $13,169 $23,199 $23,269 $24,860 $28,641 $26,584 $24,246 $35,876 $33,338 expenses Net paid (cumulative) as of: One year later 2,108 4,000 5,426 9,892 9,826 11,224 15,862 18,318 13,379 22,100 - Two years later 3,461 4,021 8,146 14,386 14,473 16,896 23,547 24,579 22,934 Three years later 3,394 3,915 9,301 17,057 16,464 18,576 26,659 28,010 Four years later 3,436 3,693 10,996 18,261 16,654 18,902 27,303 Five years later 3,352 3,723 11,642 17,976 16,795 18,962 Six years later 3,419 4,519 11,646 18,074 16,838 Seven years later 3,348 4,425 11,583 18,227 Eight years later 3,325 4,318 11,434 Nine years later 3,221 4,291 Ten years later 3,192 Net liability re-estimated as of: One year later 2,886 5,513 12,247 20,580 20,560 21,937 26,860 26,343 25,040 35,322 - Two years later 3,618 4,650 10,463 18,890 18,401 19,565 25,943 28,540 26,237 Three years later 3,955 3,809 11,071 18,871 17,810 18,695 27,699 28,415 Four years later 3,485 4,020 11,622 18,654 16,664 19,048 26,914 Five years later 3,375 4,050 11,706 17,982 16,784 18,720 Six years later 3,431 4,483 11,628 17,943 16,589 Seven years later 3,341 4,429 11,542 17,994 Eight years later 3,325 4,319 11,204 Nine years later 3,221 4,301 Ten years later 3,200 Net Reserve Redundancy (Deficiency): ($128) ($773) $1,965 $5,205 $6,680 $6,140 $1,727 ($1,825) ($1,987) $555 - ========================================================================================================== Net redundancy (deficiency) as a percent of original (4%) (22%) 15% 22% 29% 25% 6% (7%) (8%) 2% - net liability: ========================================================================================================== Gross liability for losses & loss adjustment 35,150 46,614 34,653 31,915 42,009 39,523 expenses Ceded liability for losses & loss adjustment (10,290) (17,973) (8,069) (7,669) (6,133) (6,185) expenses -------------------------------------------------------- Net liability for losses & loss adjustment 24,860 28,641 26,584 24,246 35,876 33,338 expenses ======================================================== Gross liability re-estimated 29,044 39,505 37,975 31,430 40,897 Ceded liability re-estimated (10,324) (12,591) (9,560) (5,193) (5,575) ------------------------------------------------ Net liability re-estimated 18,720 26,914 28,415 26,237 35,322 ================================================ Gross Reserve Redundancy (Deficiency) 6,106 7,109 (3,322) 485 1,112 ================================================ 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, 1997, the market value of all state deposits was approximately $13,935,000. The following table sets forth the composition of the Company's investment portfolio at the dates indicated:
December 31, 1997 1996 1995 1994 1993 (Dollars in thousands) ---------------------------------------------------------------------- Fixed maturities, held-to-maturity, at amortized cost: Bonds: - $ $ $ 10,850 $ 9,903 U.S. Government - - Mortgage backed securities - - - 696 - States, municipalities and political subdivisions - - - 3,524 2,921 Certificates of deposit, at cost - - - 50 50 -------------- ------------- ------------- ------------- ------------- Total - - - 15,120 12,874 -------------- ------------- ------------- ------------- ------------- Fixed maturities, available-for-sale, at market (1): Bonds: U.S. Government 11,289 13,739 32,101 14,292 19,931 Asset backed securities 3,342 4,004 5,636 - - Mortgage backed securities 17,754 24,245 17,723 27,904 7,845 States, municipalities and political subdivisions 27,845 26,608 34,952 34,374 54,141 Other 34,612 27,848 20,284 22,080 18,193 Redeemable preferred stock, at market (1) 3,904 6,050 6,495 8,280 7,641 -------------- ------------- ------------- ------------- ------------- Total 98,746 102,494 117,191 106,930 107,751 -------------- ------------- ------------- ------------- ------------- Total fixed maturities 98,746 102,494 117,191 122,050 120,625 Common equity securities, at market (1) 10,297 9,779 8,689 7,386 5,737 Preferred equity securities, at market (1) 2,894 4,253 3,592 2,321 2,998 Other invested assets 6,455 2,849 797 - - Short-term investments, at cost 2,281 890 745 2,289 1,849 -------------- ------------- ------------- ------------- ------------- Total investments 120,673 120,265 131,014 134,046 131,209 Interest bearing cash equivalents (2) 3,807 6,434 5,232 4,032 7,103 -------------- ------------- ------------- ------------- ------------- Total investments and cash equivalents $124,480 $126,699 $136,246 $138,078 $138,312 ============== ============= ============= ============= ============= (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 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, 1997, 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, 1997 1996 1995 1994 1993 Investment Results: (Dollars in thousands) ----------------------------------------------------------------- Average invested assets (includes short-term investments) $125,590 $131,473 $137,162 $138,195 $132,970 Net investment income 6,396 6,807 7,863 7,337 6,430 Average annual yield on investments: Fixed maturities 5.88% 5.83% 6.15% 5.93% 5.51% Equity securities 3.95 3.11 4.53 2.32 3.73 Short-term investments 4.92 5.08 8.28 5.25 3.45 ------------ ------------ ------------- ------------ ------------ Effective yield total investments 5.40 5.44 6.10 5.65 5.26 Less investment expense (0.31) (0.26) (0.37) (0.34) (0.42) ============ ============ ============= ============ ============ Total investment yield 5.09% 5.18% 5.73% 5.31% 4.84% ============ ============ ============= ============ ============ Average annual return on investments (1) 10.10% 6.14% 14.01% (0.72%) 8.91% ============ ============ ============= ============ ============ (1) Average annual return is net investment income, realized gains (losses) and the change in unrealized gains (losses) divided by average invested assets.
The maturity distribution of the Company's fixed maturity investments at December 31, 1997 was as follows: Amortized Estimated Cost Market Value Fixed maturities due: (Dollars in thousands) ----------------------------------- Within 1 year $ 4,140 $ 4,157 Beyond 1 year but within 5 years 35,606 36,305 Beyond 5 years but within 10 years 30,740 31,219 Beyond 10 years but within 20 years 13,481 14,086 Beyond 20 years 12,549 12,979 ----------------- ----------------- $ 96,516 $ 98,746 ================= ================= MARKETING AND GROWTH The Company markets its surety bond products in 50 states, the District of Columbia, Guam, Puerto Rico, the U.S. Virgin Islands, Argentina and the Marshall Islands through approximately 9,000 independent agents and brokers. California constituted 23.4% and 20.8% of surety premiums written for the years ended December 31, 1997 and 1996, respectively. The Company's contract performance and commercial surety bonds are distributed through a network of 26 branch offices located in major metropolitan areas throughout the United States. Each branch office has a defined territory which it serves, primarily working with those independent agents specializing in writing surety bonds. While the branch offices occasionally write business directly with the customer, the Company does not actively seek such business. The Company's distribution methodology results in a relatively high distribution cost system inasmuch as the Company must maintain a cadre of professionals in each branch location as well as pay competitive commissions to the agents it serves. The Company believes, however that the higher costs of maintaining a local presence in each market it serves are essential to produce acceptable loss characteristics for the surety bonds it underwrites. The Company's experience has shown that it is important to have experienced underwriting professionals in the markets is serves. This results in more construction site, contractor and agent direct contact that would be possible if the business were underwritten from a remote location. The Company believes that this direct interface is essential to consistently produce profitable underwriting results. The higher distribution cost system does present opportunities for the Company as well. While commission costs vary directly with the amount of premiums written, costs of maintaining branch and regional underwriting centers vary indirectly with premiums written. Generally, branches become more efficient in servicing the business it underwrites at larger premium volumes. Accordingly, for the Company to achieve maximum profitability from its branch network, each branch must write a certain minimum amount of premium. This amount varies by market primarily based on cost characteristics of the geographic area. Further any increases to the minimum premium generally result in increased efficiency. The Company has therefor geared its strategy to grow the surety business to take advantage of the cost dynamics of its branch system. Wholesale court bonds are produced by contracting directly with retail agents. The court division also contracts with general agents who in turn contract with retail agents. In both scenarios, the agents are fully liable for all losses generated on bonds they underwrite. Amwest Surety markets for contracted agents by advertising in trade publications and by personally marketing to agents in their offices. Personal marketing efforts are primarily handled by the regional managers. The Company markets its retail court bonds in the states of Washington, Idaho, New Mexico, Utah and Hawaii under the name "Allwest General Bail Bond Agency". The business is developed primarily through yellow page advertising. The Company utilizes a large number of independent contractor non-liable agents to post the bonds it writes. The Company directs its specialty property and casualty marketing efforts primarily at independent insurance producers. At December 31, 1997, the total number of producers placing specialty property and casualty coverage was 253. 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 competes for surety business as a middle market. The Company's capacity enables the Company to underwrite specialty surety credit which is dominated by small, regional companies as well as business marketed by professional surety agents who are generally sought after by standard market companies. Local service, pricing and, to some extent, agent commissions are the primary competitive tools. The Company, while competitive in pricing and commissions, believes that service is the difference. To this end, the Company believes its branch network and its decentralized approach to doing business will enable it to continue to compete effectively, even when challenged by the larger 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, 1997, the Company employed 502 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, was redomesticated from California to Nebraska in 1997. 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. 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 was last examined by the State of California as of December 31, 1995. The California examiners decreased policyholder surplus of Condor as of December 31, 1995 by $1,600,000 for reserve development that occurred during 1996. Amwest Surety and Far West were examined by the State of Nebraska as of December 31, 1996. Amwest Surety and Far West are also regulated by the United States Department of the Treasury as acceptable sureties for Federal bonds. The Company participates in the Hawaii Hurricane Relief Fund (the "Fund"), and accordingly, its Hawaiian policies exclude wind coverage over 75 miles per hour. As a participant, the Company could be assessed in the event the Fund sustains hurricane losses. 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, 1997, totaled approximately 154,000 square feet. The home office aggregates approximately 63,000 square feet. Branch locations range from 1,400 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. The Company moved to this location in 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. While the outcome of lawsuits and other proceedings cannot be predicted with certainty, management expects these matters will not have a materially adverse effect on the consolidated financial position or results of operations of the Company. Proposition 103 - On August 26, 1990, the California legislature enacted A.B. 3798 exempting surety insurance from certain provisions of Proposition 103, which later became operative as Insurance Code Section 1861.135 ("Section 1861.135") on January 1, 1991. In April of 1991, a Los Angeles Superior Court Judge upheld the constitutionality of Section 1861.135. 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. On December 14, 1995, the California Supreme Court affirmed the decision of the Second District Court of Appeal. Accordingly, the surety insurance industry is no longer exempted from the rate rollback and prior approval provisions contained in 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 required 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 - ------ ---- --- --------- 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 1997 First Quarter 13 5/8 11 3/4 .11 Second Quarter 15 11 5/8 .11 Third Quarter 16 7/8 14 7/8 .11 Fourth Quarter 16 1/4 13 3/4 .11 On March 26, 1998, the closing price of the Company's Common Stock on the American Stock Exchange was $16.125 per share. HOLDERS As of March 26, 1998, there were 319 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, 1997, 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, 1997 and 1996 and for each of the years in the three year period ended December 31, 1997 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, 1997 1996 1995 1994 1993 ------------------------------------------------------------------------------- Summary of Earnings: Net premiums earned $ 92,150 $ 87,883 $ 85,170 $ 81,289 $ 72,085 Underwriting expenses 92,642 97,712 89,644 80,960 73,663 Underwriting income (loss) (492) (9,829) (4,474) 329 (1,578) Net investment income 6,396 6,807 7,863 7,337 6,430 Realized gains (losses) 3,473 2,201 2,176 65 2,331 Income (loss) before income taxes and extraordinary item 7,435 (5,046) 4,498 6,393 4,948 Provision (benefit) for income taxes 1,937 (2,360) 829 1,352 1,001 Income before extraordinary item 5,498 (2,686) 3,669 5,041 3,947 Extraordinary item - - - - (249) Net income (loss) $ 5,498 $ (2,686) $ 3,669 $ 5,041 $ 3,698 =============================================================================== Per share: Basic: Income before extraordinary item $ 1.62 $ (.81) $ 1.12 $ 1.53 $ 1.21 Extraordinary item - - - - (.08) Net income $ 1.62 $ (.81) $ 1.12 $ 1.53 $ 1.13 =============================================================================== Diluted: Income before extraordinary item $ 1.60 $ (.81) $ 1.09 $ 1.50 $ 1.20 Extraordinary item - - - - (.08) Net income $ 1.60 $ (.81) $ 1.09 $ 1.50 $ 1.12 =============================================================================== Dividends $ 0.44 $ 0.44 $ 0.40 $ 0.36 $ 0.28 =============================================================================== Year End Financial Position: Total investments $ 120,673 $ 120,265 $ 131,014 134,047 131,209 Total assets 190,519 181,418 183,833 186,863 195,856 Bank indebtedness 14,500 12,500 12,500 12,500 12,500 Total stockholders' equity 57,179 49,932 55,075 46,157 48,347 Average stockholders' equity 53,558 52,504 50,616 47,252 45,266 Return on stockholders' equity 10.27% (5.12%) 7.25% 10.67% 8.17% Operating Ratios: Loss & loss adjustment expenses 37.61% 53.08% 41.41% 35.35% 39.49% Policy acquisition costs 49.24% 43.66% 44.70% 45.03% 40.13% General operating expenses 13.68% 14.45% 16.80% 19.21% 19.98% Other operating expenses - - 2.35% - 2.59% Combined ratios 100.53% 111.18% 105.25% 99.60% 102.19%
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, 1997 compared to year ended December 31, 1996 Gross premiums written increased 11% from $97,242,000 in 1996 to $108,091,000 in 1997. Substantially all of this premium growth was due to written premium increases in the surety product lines. Management believes that the increase in premiums written is attributable to the impact of regionalization of contract surety underwriting function thereby allowing the Company to respond on a more timely basis to bond requests coupled with continued strong growth in commercial surety and the purchase of two surety agencies during 1997. The latter contributed approximately $1,800,000 of the increase in written premiums during 1997. Net premiums earned increased 5% from $87,883,000 in 1996 to $92,150,000 in 1997. The increase in net premiums earned reflects the increased premium writings. Net losses and loss adjustment expenses decreased 26% from $46,647,000 in 1996 to $34,657,000 in 1997. This resulted in a decrease in the loss and loss adjustment expense ratio from 53.1% in 1996 to 37.6% in 1997. The decreased loss ratio is primarily attributable to a decrease in the loss and loss adjustment expense ratio for contract performance and payment bonds from 52.9% in 1996 to 33.7% in 1997 as well as a decrease in 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 in 1996 was negatively impacted by increased severity caused by a number of large losses reported in that year. Such losses were not experienced in 1997. The 1996 adverse loss experience on private passenger business in Arizona was due to general rate inadequacy for that program which the Company believes was corrected in 1997. Policy acquisition costs as a percentage of net premiums earned increased from a ratio of 43.7% or $38,367,000 in 1996 to 49.2% or $45,379,000 in 1997. The increase is primarily attributable to a decline in contingent commissions earned by the Company due to changes in its reinsurance treaties coupled with higher commission rates paid on surety products due to intensified competitive pressures during 1997. General operating costs decreased as a percentage of net premiums earned from 14.5% or $12,698,000 in 1996 to 13.7% or $12,606,000 in 1997. The decrease in the actual amount of general operating costs is primarily attributable to decreased home office occupancy costs due to the consolidation of the El Segundo and Woodland Hills home office locations in Calabasas, California during May and June of 1997. The Company's underwriting loss decreased from $9,829,000 for the year ended December 31, 1996 to $492,000 for the year ended December 31, 1997. The combined ratio decreased from 111.2% in 1996 to 100.5% in 1997. The decrease in the underwriting loss is primarily attributable to decreased losses on the contract performance and payment bond product line and Arizona private passenger automobile lines of business as discussed above. Interest expense decreased 11% from $2,217,000 in 1996 to $1,966,000 in 1997 primarily due to a decrease in funds held as collateral during 1997. At December 31, 1996 and 1997, the collateral balances accrued interest daily at an average rate of 3.8% and 3.7% per annum, respectively. Additionally, the average interest rate on the bank indebtedness decreased from an average rate of 7.8% during 1996 to an average rate of 7.3% during 1997 due to fluctuations during 1997 in the London Interbank Offered Rate (LIBOR) which is used as the benchmark for the Company's rate on bank indebtedness. This decrease was partially offset by an increase in the outstanding debt of $2,000,000 in June 1997. The interest rate on the Company's bank indebtedness at December 31, 1997 was 7.52%. Net investment income and realized investment gains increased 10% from $9,008,000 in 1996 to $9,869,000 in 1997. This increase is primarily due to an increase in realized investment gains from $2,201,000 during 1996 to $3,473,000 during 1997. This increase was partially offset by a slight decrease in average annual yield on investments from 5.2% in 1996 to 5.1% in 1997. Merger expenses of $710,000 were incurred in 1996 in connection with the Merger of Condor Services, Inc. with and into Amwest Insurance Group, Inc. No such costs were incurred during 1997. 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 moved to a new facility in Calabasas, California at significantly reduced rental rates in June of 1997. Income (loss) before income taxes changed from a loss of $5,046,000 in 1996 to income of $7,435,000 in 1997 due to the factors outlined above. The effective rate of the tax benefit was 46.8% for the year ended December 31, 1996. The effective tax rate for 1997 is 26.1%. The primary reason for the variance from the corporate income tax rate of 34% is tax advantaged income received on a portion of the Company's investment portfolio. Additionally, due to various factors arising during 1997, the Company eliminated its valuation allowance on its deferred tax assets. Net income (loss) changed from a loss of $2,686,000 in 1996 to income of $5,498,000 in 1997 due to the factors outlined above. 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 written 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. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 1997, the Company had total cash and cash equivalents and investments of $124,480,000. Included in these amounts is an aggregate of $23,116,000 in funds held as collateral which are shown as a liability on the Company's consolidated balance sheet. As of December 31, 1997, the Company's investment balances were comprised of $98,746,000 in fixed maturities held at market, $10,297,000 in common equity securities, $2,894,000 in preferred equity securities, $6,455,000 in other invested assets and $2,281,000 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 $215,315,000 at December 31, 1996 to $211,981,000 at December 31, 1997. This decrease is primarily attributable to competitive market conditions. In addition, cash collateral declined from $29,928,000 at December 31, 1996 to $23,116,000 at December 31, 1997. 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 August 6, 1994, the Company entered into a revolving credit agreement with Union Bank for $12,500,000 which refinanced a previous loan. The debt agreement was amended on April 24, 1996, July 10, 1996 and again on September 30, 1997 to increase the amount available under the revolving line of credit from $12,500,000 to $15,000,000 and to change certain covenants and payment requirements. The bank loan has a variable rate of interest based upon fluctuations in the London Interbank Offered Rate (LIBOR) and has amortizing principal payments. The interest rate at December 31, 1997 was 7.52 %. 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. See Note 10 of Notes to Consolidated Financial Statements. The Company is a party to a lease with ACD2 regarding its corporate headquarters. 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 1998 is approximately $932,000. The Company has the option to purchase this 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 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 1998. The Company used $1,252,000, generated $1,396,000 and used $1,539,000 in cash from operating activities in the fiscal years ended December 31, 1995, 1996 and 1997, respectively. The Company generated $10,363,000, $8,691,000 and $3,835,000 in cash for investing activities for the fiscal years ended December 31, 1995, 1996 and 1997, respectively. The Company used $10,143,000, $8,885,000, and $4,923,000 in cash from financing activities for the fiscal years ended December 31, 1995, 1996 and 1997, respectively. The cash used for financing activities in 1995, 1996 and 1997 were funded principally by investing activities. The effect of inflation on the revenues and net income of the Company during all three periods discussed above was not significant. OTHER MATTERS Since 1996, the Company has been in the process of implementing a new surety production computer system. Implementation is scheduled in phases with project completion scheduled for the fourth quarter of 1998. This new surety production system is year 2000 compliant. The property and casualty operating computer systems are currently running in a version that is not year 2000 compliant. The company is working to install and test the year 2000 compliant version by October 1998. Additionally, the Company has tested and/or received certification from its vendors that the financial and corporate computer and communication systems are year 2000 compliant. The cost of achieving year 2000 compliance is not expected to have a materially adverse effect on the consolidated financial position of the Company. 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. The Company will adopt Statement of Financial Accounting Standards ("SFAS") No. 130, "Comprehensive Income" and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" for the year ending December 31, 1998. These SFAS's require that additional information be included in a complete set of financial statements, but will have no effect on the Company's operations, cash flows or stockholders' equity. 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 22, 1998, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1997, 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 22, 1998, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1997, 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 22, 1998, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1997, 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 22, 1998, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1997, 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 34. (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 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). 10.2 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.) 10.3 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.) 10.4 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) 10.5 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) 10.6 Restated Revolving Credit Agreement dated July 10, 1996 between Amwest Insurance Group, Inc. and Union Bank of California, N.A. (Incorporated by reference to Exhibit 10.55 to the Company's 1996 Form 10-K.) 10.7 Waiver and Amendment No. 1 dated as of September 30, 1997 to the Restated Revolving Credit Agreement dated July 10, 1996. (Incorporated by reference to Exhibit 19.1 to the Company's September 30, 1997 Form 10-Q.) 10.8 Casualty Excess of Loss Reinsurance Contract effective July 1, 1997 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. (Incorporated by reference to Exhibit 10.53 to the Company's 1996 Form 10-K.) 10.9 Contingent Excess of Loss Reinsurance Contract effective July 1, 1997 issued to Condor Insurance Company, Amwest Surety Insurance Company and Far West Insurance Company by a group of reinsurers led by Kemper Reinsurance Company. (Incorporated by reference to Exhibit 10.54 to the Company's 1996 Form 10-K.) 10.10 Excess of Loss Reinsurance Contract effective October 1, 1997 issued to Amwest Surety Insurance Company by a group of reinsurers lead by Kemper Reinsurance Company. 10.11 Aggregate Excess of Loss Reinsurance Contract effective January 1, 1998 issued to Amwest Surety Insurance Company and Far West Insurance Company by Underwriters Reinsurance Company (Barbados) Inc. 10.12 50% Private Passenger Automobile Quota Share Reinsurance Contract effective July 1, 1997 issued to Condor Insurance Company, Amwest Surety Insurance Company and Far West Insurance Company by Gerling Global Reinsurance Corporation and USF RE Insurance Company. 10.13 75% California Homeowners Multiple Line Quota Share Reinsurance Contract effective July 1, 1997 issued to Condor Insurance Company, Amwest Surety Insurance Company and Far West Insurance Company by Constitution Reinsurance Corporation and Vesta Fire Insurance Company. 10.14 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.) 10.15 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.) 10.16 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.) 10.17 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.) 10.18 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.) 10.19 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. (Incorporated by reference to Exhibit 10.63 to the Company's 1996 Form 10-K.) 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, 1997. 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 27, 1998 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 27,1998 - ------------------------ Richard H. Savage President, Chief O perating Officer, Co- Chief Executive Officer and Director /s/ JOHN E. SAVAGE March 27,1998 - ------------------------ John E. Savage /s/ GUY A. MAIN Executive Vice President - ------------------------ and Director March 27,1998 Guy A. Main Senior Vice President, Chief Financial Officer, Treasurer and Director Principal Financial and Principal /s/ STEVEN R. KAY Accounting Officer) March 27,1998 - ------------------------ Steven R. Kay /s/ NEIL F. PONT Senior Vice President - ------------------------ and Director March 27,1998 Neil F. Pont /s/ ARTHUR F. MELTON Director March 27,1998 - ------------------------ Arthur F. Melton /s/ THOMAS R. BENNETT Director March 27,1998 - ------------------------ Thomas R. Bennett /s/ BRUCE A. BUNNER Director March 27,1998 - ------------------------ Bruce A. Bunner /s/ EDGAR L. FRASER Director March 27,1998 - ------------------------ Edgar L. Fraser /s/ JONATHAN K. LAYNE Director March 27,1998 - ------------------------ Jonathan K. Layne /s/ CHARLES L. SCHULTZ Director March 27, 1998 - ------------------------ Charles L. Schultz INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Independent Auditors' Report 35 Consolidated Financial Statements: Consolidated Statements of Operations for the Years Ended December 31, 1995, 1994 and 1993 36 Consolidated Balance Sheets as of December 31, 1995 and 1994 37 Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993 39 Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 1995, 1994 and 1993 41 Notes to Consolidated Financial Statements 42 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, 1997 and 1996, and the related consolidated statements of operations, and changes in stockholders' equity for each of the years in the three year period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Amwest Insurance Group, Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. Los Angeles, California February 5, 1998 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, 1997 1996 1995 ----------------- ---------------- ----------------- Underwriting Revenues: Net premiums written $ 100,034 $ 89,325 $ 82,814 Net change in unearned premiums (7,884) (1,442) 2,356 ----------------- ---------------- ----------------- Net premiums earned 92,150 87,883 85,170 ----------------- ---------------- ----------------- Underwriting Expenses: Net losses and loss adjustment expenses 34,657 46,647 35,265 Policy acquisition costs 45,379 38,367 38,070 General operating costs and expenses 12,606 12,698 14,309 Proposition 103 expense - - 2,000 ----------------- ---------------- ----------------- Total underwriting expenses 92,642 97,712 89,644 ----------------- ---------------- ----------------- Underwriting loss (492) (9,829) (4,474) Interest expense (1,966) (2,217) (2,754) Merger expense - (710) - Lease termination cost - (1,300) - Recovery on misappropriation of funds - - 890 Net investment income 6,396 6,807 7,863 Net realized gains 3,473 2,201 2,176 Commissions and fees 24 2 797 ----------------- ---------------- ----------------- Income (loss) before income taxes 7,435 (5,046) 4,498 ----------------- ---------------- ----------------- Provision (benefit) for income taxes: Current 761 (1,947) 2,044 Deferred 1,176 (413) (1,215) ----------------- ---------------- ----------------- Total provision (benefit) for income taxes 1,937 (2,360) 829 ----------------- ---------------- ----------------- Net income (loss) $ 5,498 $ (2,686) $ 3,669 ================= ================ ================= Earnings (loss) per common share: Basic $ 1.62 $ (.81) $ 1.12 ================= ================ ================= Diluted $ 1.60 $ (.81) $ 1.09 ================= ================ =================
See accompanying notes to consolidated financial statements. AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands)
December 31, 1997 1996 ----------------- ---------------- ASSETS Investments: Fixed maturities, available-for-sale (amortized cost of $96,516 and $101,799 at December 31, 1997 and 1996, respectively) $ 98,746 $ 102,494 Common equity securities, available-for-sale (cost of $6,856 and $7,217 at December 31, 1997 and 1996, respectively) 10,297 9,779 Preferred equity securities, available-for-sale (cost of $2,664 and $3,971 at December 31, 1997 and 1996, respectively) 2,894 4,253 Other invested assets (cost of $5,816 and $2,667 at December 31, 1997 and 1996, respectively) 6,455 2,849 Short-term investments 2,281 890 ----------------- ---------------- Total investments 120,673 120,265 Cash and cash equivalents 3,807 6,434 Accrued investment income 1,366 1,399 Agents' balances and premiums receivable (less allowance for doubtful accounts of $467 and $446 at December 31, 1997 and 1996, respectively) 12,511 10,882 Reinsurance recoverable: Paid loss and loss adjustment expenses 2,524 2,749 Unpaid loss and loss adjustment expenses 6,185 6,443 Ceded unearned premiums 2,039 1,849 Deferred policy acquisition costs 21,299 16,101 Furniture, equipment and improvements, net 5,355 4,747 Income taxes recoverable 1,581 2,802 Other assets 13,179 7,747 ----------------- ---------------- Total assets $ 190,519 $ 181,418 ================= ================
AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Continued) (Dollars in thousands, except share and per share data)
December 31, 1997 1996 ----------------- ---------------- LIABILITIES Unpaid losses and loss adjustment expenses $ 39,523 $ 42,009 Unearned premiums 42,013 33,939 Funds held as collateral 23,116 29,928 Deferred Federal income taxes 3,925 1,842 Bank indebtedness 14,500 12,500 Amounts due to reinsurers 455 345 Other liabilities 9,808 10,923 ----------------- ---------------- Total liabilities 133,340 131,486 ----------------- ---------------- 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; 3,452,856 at December 31, 1997 and 3,326,002 at December 31, 1996 34 33 Additional paid-in capital 18,209 16,827 Net unrealized appreciation of investments carried at market, net of income taxes 4,316 2,456 Retained earnings 34,620 30,616 ----------------- ---------------- Total stockholders' equity 57,179 49,932 ----------------- ---------------- Total liabilities and stockholders' equity $ 190,519 $ 181,418 ================= ================
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, 1997 1996 1995 ---------------- ----------------- ---------------- Cash flows from operating activities: Net income (loss) $ 5,498 $ (2,686) $ 3,669 Adjustments to reconcile net income to cash provided by operating activities: Change in agents' balances, premiums receivable and unearned premiums 6,445 (1,176) (2,580) Change in accrued investment income 33 174 326 Change in unpaid losses and loss adjustment expenses (2,486) 10,094 (2,738) Change in reinsurance recoverables and ceded unearned premiums 293 434 (446) Change in amounts due to/from reinsurers 110 (1,843) 917 Change in reinsurance funds held, net - - 115 Change in other assets and other liabilities (6,547) 2,737 (652) Change in income taxes, net 2,346 (3,132) (1,160) Change in deferred policy acquisition costs (5,198) (2,216) 1,630 Net realized gain on sale of investments (3,478) (2,295) (2,078) Net realized loss on sale of fixed assets 48 44 7 Equity securities, trading Purchases - - (26,644) Sales - - 26,959 Provision for depreciation and amortization 1,398 1,261 1,423 ---------------- ----------------- ---------------- Net cash provided by operating activities (1,538) 1,396 (1,252) ---------------- ----------------- ---------------- Cash flows from investing activities: Cash received from investments sold 52,441 59,093 81,362 Cash received from investments matured or called 8,545 7,468 24,888 Cash paid for investments acquired (55,214) (55,197) (93,703) Amortization/accretion of bonds 116 68 (779) Capital expenditures, net (2,053) (2,741) (1,405) ---------------- ----------------- ---------------- Net cash provided (used) by investing activities 3,835 8,691 10,363 ---------------- ----------------- ---------------- Cash flows from financing activities: Proceeds from issuance of long term debt 2,000 - - Proceeds from issuance of common stock 1,382 299 448 Repurchase of common stock - - (375) Change in funds held as collateral (6,812) (7,722) (9,276) Dividends paid (1,494) (1,462) (940) ---------------- ----------------- ---------------- Net cash used by financing activities (4,924) (8,885) (10,143) ---------------- ----------------- ---------------- Net increase (decrease) in cash and cash equivalents (2,627) 1,202 (1,032) Cash and cash equivalents at beginning of year 6,434 5,232 6,264 ---------------- ----------------- ---------------- Cash and cash equivalents at end of year $ 3,807 $ 6,434 $ 5,232 ================ ================= ================ Supplemental disclosure of cash flow information: Cash paid during the year for: Interest $ 1,966 $ 2,217 $ 2,754 Income taxes 460 848 2,133
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, 1997, 1996, and 1995
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, 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 the completion of the merger (48,680) - (676) - - (676) Issuance of common stock pursuant to the exercise of options 39,075 - 299 - - 299 Change in net unrealized appreciation 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 Issuance of common stock pursuant to the exercise of options 71,100 1 681 - - 682 Issuance of common stock pursuant to the employee stock purchase plan 8,473 - 132 - - 132 Issuance of common stock for agency purchases 47,281 - 569 - - 569 Change in net unrealized appreciation of investments carried at market - - - 1,860 - 1,860 Cash dividends - - - - (1,494) (1,494) Net income - - - - 5,498 5,498 -------------- -------- -------------- --------------- -------------- -------------- Balance at December 31, 1997 3,452,856 $ 34 $ 18,209 $ 4,316 $ 34,620 $ 57,179 ============== ======== ============== =============== ============== ==============
See accompanying notes to consolidated financial statements. AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1997, 1996, and 1995 (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 various parts of the United States. The surety bonds are predominantly written through the Company's 26 branch offices located throughout the United States. In 1997 and 1996, respectively, the Company's business generated in California was 38.1% and 38.3%. 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. 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"), Condor Insurance Company ("Condor") and Far West Insurance Company ("Far West"). 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, 1997 1996 1995 (Dollars in thousands) --------------------------------------------------- Balance at beginning of year $ 16,101 $ 13,885 $ 15,515 Costs deferred during the year 50,577 40,583 36,440 Amortization charged to expense (45,379) (38,367) (38,070) ---------------- ----------------- ---------------- Balance at end of year $ 21,299 $ 16,101 $ 13,885 ================ ================= ================
Earnings Per Share In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 128 ("FAS 128"), "Earnings Per Share", which requires the presentation of "basic" and "diluted" earnings per share ("EPS") and is effective for periods ending after December 15, 1997. Basic EPS is calculated based on the weighted average number of common shares outstanding and diluted EPS includes the effects of dilutive potential common shares. The weighted average number of common shares outstanding for the year ended December 31, 1995 is 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. The effect of this change on reported EPS data is as follows:
Years ended December 31, Income Shares Per-Share (Numerator) (Denominator) Amount ($ in thousands) (Dollars) ------------------- ------------------- ------------------- Basic EPS: 1997 $ 5,498 3,384,774 $ 1.62 1996 $ (2,686) 3,315,831 $ (.81) 1995 $ 3,669 3,284,899 $ 1.12 Effect of Dilutive Securities: 1997 42,906 1996 33,627 1995 78,741 Diluted EPS: 1997 $ 5,498 3,426,680 $ 1.60 1996 $ (2,686) 3,349,458 $ (.81) 1995 $ 3,669 3,363,640 $ 1.09
Diluted earnings per common share for 1996 is the same as basic earnings per share because the result of the calculation is antidilutive due to the net operating loss reported for the year. 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, 1997, the related collateral balances accrue interest daily at an average rate of 3.7% 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 market 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 applicable 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 market value is considered to be 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 adjustment 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 carrying amounts and fair values for the bank indebtedness are disclosed in Note 10. Risk-Based Capital In December 1992, the NAIC adopted a risk-based capital formula for property and 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, 1997 and found that its subsidiaries exceeded the highest level of recommended capital requirement. Impact of New Accounting Pronouncements The Company will adopt Statement of Financial Accounting Standards ("SFAS") No. 130, "Comprehensive Income" and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" for the year ending December 31, 1998. These SFAS's require that additional information be included in a complete set of financial statements, but will have no effect on the Company's operations, cash flows or stockholders' equity. Reclassifications Certain amounts in the accompanying consolidated financial statements for 1995 and 1996 have been reclassified to conform with the 1997 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, 1997 1996 (Dollars in thousands) ---------------------------------- Off-Balance Sheet Collateral: Irrevocable letters of credit $ 160,845 $ 140,004 Certificates of Deposit 25,480 27,624 Other Collateral 25,656 47,687 ---------------- ----------------- Total Off-Balance Sheet Collateral $ 211,981 $ 215,315 ================ ================= 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 1997 and 1996, 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, 1997 1996 1995 (Dollars in thousands) --------------------------------------------------- Gross investment income: Fixed maturities $ 5,918 $ 6,405 $ 7,357 Equity securities 538 409 498 Cash and short-term investments 330 338 509 Investment expense (390) (345) (501) ---------------- ----------------- ---------------- Net investment income $ 6,396 $ 6,807 $ 7,863 ================ ================= ================ Gross realized gains: Fixed maturities $ 1,542 $ 1,343 $ 1,780 Equity securities 2,686 1,528 1,710 Other assets - 53 - Gross realized losses: Fixed maturities (403) (218) (519) Equity securities (347) (358) (645) Other assets (5) (147) (150) ---------------- ----------------- ---------------- Net realized gains $ 3,473 $ 2,201 $ 2,176 ================ ================= ================
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, 1997 1996 (Dollars in thousands) ----------------------------------- Gross unrealized appreciation: Fixed maturities $ 2,636 $ 1,648 Equity securities 4,068 3,190 Other invested assets 639 182 Gross unrealized depreciation: Fixed maturities (406) (953) Equity securities (398) (346) ----------------- ----------------- Gross unrealized appreciation on investments carried at market 6,539 3,721 Deferred Federal income taxes (2,223) (1,265) ----------------- ----------------- Net unrealized appreciation, net of deferred Federal income taxes $ 4,316 $ 2,456 ================= =================
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, 1997 1996 1995 (Dollars in thousands) --------------------------------------------------- Fixed maturities, available-for-sale $ 1,535 $ (1,704) $ 7,230 Common equity securities, available-for-sale 879 503 1,613 Preferred equity securities, available-for-sale (52) 175 330 Other invested assets 457 88 94 ---------------- ----------------- ---------------- Total 2,819 (938) 9,267 Deferred Federal income taxes (959) 320 (3,151) ---------------- ----------------- ---------------- Net increase (decrease) in unrealized investment gains (losses), net of deferred Federal income taxes $ 1,860 $ (618) $ 6,116 ================ ================= ================
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, 1997 and 1996, the market value of these deposits was approximately $13,935,000 and $12,561,000, respectively. The amortized cost and estimated market values of investments in fixed maturities are as follows:
December 31, 1997 (Dollars in thousands) --------------------------------------------------------------------- ----------------- ---------------- ----------------- ---------------- Gross Gross Amortized Cost Unrealized Unrealized Estimated Fixed maturities, available-for-sale Gains Losses Market Value ----------------- ---------------- ----------------- ---------------- Bonds: U.S. Government $ 11,008 $ 309 $ (28) $ 11,289 Asset backed securities 3,287 56 (1) 3,342 Mortgage backed securities 17,647 131 (24) 17,754 States, municipalities and political subdivisions 26,980 873 (8) 27,845 Industrial and miscellaneous 33,708 1,141 (332) 34,517 ----------------- ---------------- ----------------- ---------------- Total 92,630 2,510 (393) 94,747 Redeemable preferred stock 3,791 126 (13) 3,904 Certificates of Deposit 95 - - 95 ----------------- ---------------- ----------------- ---------------- Total $ 96,516 $ 2,636 $ (406) $ 98,746 ================= ================ ================= ================ 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 ================= ================ ================= ================
The amortized cost and estimated market value of fixed maturities at December 31, 1997, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. 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 $ 4,140 $ 4,157 Due after 1 year through 5 years 35,606 36,305 Due after 5 years through 10 years 30,740 31,219 Due after 10 years through 20 years 13,481 14,086 Due after 20 years 12,549 12,979 ----------------- ----------------- Total bonds and sinking fund preferred stock $ 96,516 $ 98,746 ================= =================
Proceeds from the sale of available-for-sale securities during 1997 and 1996 were $52,441,000 and $59,093,000, respectively. Gross gains of $4,228,000 and $2,871,000 and gross losses of $750,000 and $576,000 were realized on those sales in 1997 and 1996, respectively. (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, 1997 1996 Summary of Furniture, Equipment and Improvements: (Dollars in thousands) ----------------------------------- Automobiles $ 149 $ 145 Furniture 3,002 2,664 Equipment 9,605 8,965 Improvements 2,343 3,019 ----------------- ----------------- Total fixed assets 15,099 14,793 Less accumulated depreciation (9,744) (10,046) ----------------- ----------------- Furniture, equipment and improvements, net $ 5,355 $ 4,747 ================= =================
(5) INCOME TAXES Amwest Insurance Group, Inc. and subsidiaries file a consolidated Federal income tax return. A reconciliation of the corporate federal tax with the financial statement effective tax for the years ended December 31, 1997, 1996 and 1995 are as follows:
Years ended December 31, 1997 1996 1995 (Dollars in thousands) --------------------------------------------------- Computed tax expense at statutory rate $ 2,528 $ (1,715) $ 1,529 Tax-advantaged interest income (506) (616) (556) Change in valuation allowance (652) - (94) State taxes 15 47 97 Bad debt expense 291 (463) - Other, net 261 387 (147) ---------------- ----------------- ---------------- Total provision for income taxes (benefit) $ 1,937 $ (2,360) $ 829 ================ ================= ================
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, 1997 and 1996 are presented below.
Years ended December 31, 1997 1996 (Dollars in thousands) ----------------------------------- Deferred tax assets: Unearned premiums 2,718 2,182 Accrued loss on lease termination and sub-lease - 421 Discount on loss reserves 1,202 1,289 Accrued vacation 266 196 Deferred compensation/ Accrued severance 173 216 Alternative minimum tax credit 1,268 667 Bad debt reserve 74 328 Net operating loss - 622 Other 92 82 ----------------- ----------------- Total gross deferred tax assets 5,793 6,003 Less: valuation allowance - (651) ----------------- ----------------- Net deferred tax assets 5,793 5,352 ----------------- ----------------- Deferred tax liabilities: Deferred policy acquisition costs $ (7,242) $ (5,474) Unrealized investment gains (2,220) (1,314) Unearned contingent commission - (215) Fixed assets (86) (40) Discount on salvage & subrogation reserves (67) (62) Deductible receivables (55) (50) Other (48) (39) ----------------- ----------------- Total gross deferred tax liabilities (9,718) (7,194) ----------------- ----------------- Total net deferred tax liability $ (3,925) $ (1,842) ================= =================
Statement of 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. Since 1992 the Company has maintained a valuation allowance for the fresh start benefit taken as a result of the Omnibus Budget Reconciliation Act of 1990. The amount of the valuation allowance has been reduced each year as the fresh start benefit has been realized through the collection of salvage and subrogation. During 1997, the Internal Revenue Service completed its audit of the Company's 1991, 1992 and 1993 tax years. The audit resulted in additional taxes of $301,804 related to the fresh start benefit. Accordingly, the remaining valuation allowance of $300,000 was eliminated during 1997. Prior to the 1996 merger with Condor Services, Condor Services had established a $351,000 valuation allowance based on a history of net operating losses. During 1997, due to various factors including the filing of a Federal consolidated return, management determined that the Company would realize full benefit from Condor's deferred tax asset. Accordingly, the valuation allowance of $351,000 was eliminated. At December 31, 1997, the Company has no net operating loss carryforwards available. (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, 1997 1996 1995 (Dollars in thousands) ------------------------------------------ Balance at beginning of year $ 42,009 $ 31,915 $ 34,653 Less: net reinsurance recoverable on unpaid loss and loss adjustment expenses (6,133) (7,669) (8,069) ------------- -------------- ------------- Net balance at beginning of year $35,876 $24,246 $26,584 Provision for losses and loss adjustment expenses occurring in current year 35,212 45,853 35,508 Increase (decrease) in estimated losses and loss adjustment expenses for claims occurring in prior years (555) 794 (243) ------------- -------------- ------------- 34,657 46,647 35,265 ------------- -------------- ------------- Losses and loss adjustment expense payments for claims occurring during: Current year (15,095) (21,638) (19,283) Prior years (22,100) (13,379) (18,320) ------------- -------------- ------------- (37,195) (35,017) (37,603) ------------- -------------- ------------- Net balance at end of year 33,338 35,876 24,246 Plus: net reinsurance recoverable on unpaid loss and loss adjustment expenses 6,185 6,133 7,669 ------------- -------------- ------------- Balance at end of year $ 39,523 $ 42,009 $ 31,915 ============= ============== =============
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. The following amounts represent premiums assumed and the deductions for reinsurance ceded for the years ended December 31, 1997, 1996 and 1995.
Years ended December 31, 1997 1996 1995 (Dollars in thousands) --------------------------------------------------- Net premiums written: Direct $ 107,015 $ 94,935 $ 93,604 Assumed 1,076 2,307 580 Ceded (8,057) (7,917) (11,370) ---------------- ----------------- ---------------- Net premiums written $ 100,034 $ 89,325 $ 82,814 ================ ================= ================ Net change in unearned premiums: Direct $ (8,706) $ 480 $ 1,222 Assumed 632 (810) (142) Ceded 190 (1,112) 1,276 ---------------- ----------------- ---------------- Net change in unearned premiums $ (7,884) $ (1,442) $ 2,356 ================ ================= ================ Net loss and loss adjustment expenses: Direct $ 36,038 $ 50,391 $ 42,032 Assumed 995 445 165 Ceded (2,376) (4,189) (6,932) ---------------- ----------------- ---------------- Net losses and loss adjustment expenses $ 34,657 $ 46,647 $ 35,265 ================ ================= ================
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 27.5% participant, Scor Reinsurance Company has a 20% participation, Swiss Reinsurance Company has a 20% participation, Hartford Fire Insurance Company has a 15% participation, Underwriters Reinsurance Company has a 10% participation and General Accident Insurance Company of America has a 7.5% participation in the treaty. The Kemper Treaty, which was prospectively amended on October 1, 1997, 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 $20,000,000. 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 $26,000,000 of losses discovered during any one contract period (October 1 to October 1). Effective October 1, 1996 to September 30, 1997, the coverage was $4,000,000 excess $2,000,000. Prior to 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 and $2,226,000 were recognized under the profit sharing provisions of the treaty for the years ended December 31, 1996 and 1995, 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 incurred for the 1997 accident year 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. Through September 30, 1997, the Company also maintained a semiautomatic bond facultative reinsurance contract for surety bonds. The contract applied 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 was $6,000,000 plus 12% of the reinsured amount. The Company's aggregate retention was 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. From July 1, 1996 to June 30, 1997 the Company participated 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. The Company is also a party to a quota share agreement with regards to its non-standard private passenger automobile business. Under this agreement, the Company cedes 50% of its net liability on all non-standard private passenger automobile coverages. 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 and California homeowners programs differ from the above. For Hawaiian homeowners, the Company retains $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. For California homeowners, the Company is party to a quota share agreement in which the Company cedes 75% of its net liability with a limit of $7,500,000 per occurrence. (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. Amwest Surety and Far West are domiciled in the state of Nebraska. During 1997, Condor was 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. The amount is further restricted to the amount of earned surplus as of December 31, 1997. Amwest Surety and Condor can pay $3,382,000 and $75,000, respectively, in dividends to the Company during 1998 without prior approval. For the years ended December 31, 1997, 1996 and 1995, Amwest Surety paid dividends of $0, $500,000 and $2,000,000, 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"). Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners ("NAIC"), as well as state laws, regulations and general administrative rules. Generally accepted accounting principles differ in certain respects from these prescribed statutory accounting practices. The more significant of these differences 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. Permitted statutory accounting practices encompass all accounting practices not so prescribed. As of December 31, 1997, there were no material permitted statutory accounting practices utilized by the insurance companies. The NAIC is working on a project to codify statutory accounting practices, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. When complete, that project will most likely change the definition of prescribed versus permitted statutory accounting practices and may result in changes to the accounting policies that insurance enterprises use to prepare their statutory financial statements. Policyholders surplus and net income on a statutory basis is as follows:
December 31, 1997 1996 1995 Statutory Statutory Statutory Statutory Policyholders Net Income Statutory Net Income Statutory Net Income Surplus (Loss) Surplus (Loss) Surplus (Loss) (Dollars in thousands) -------------------------------------------------------------------------------------------------------- Amwest Surety $ 33,823 $ 3,528 $ 31,081 $ (3,803) $ 36,813 $ 5,204 Far West 6,501 (461) 7,042 1,176 5,866 555 Condor 10,489 1,362 9,217 (1,707) 6,948 48
(10) BANK INDEBTEDNESS On August 6, 1994, the Company entered into a revolving credit agreement with Union Bank for $12,500,000. The debt agreement was amended on April 24, 1996, July 10, 1996 and again on September 30, 1997 to increase the amount available under the revolving line of credit from $12,500,000 to $15,000,000 and to change certain covenants and payment requirements. At December 31, 1997, $15,000,000 is available under the revolving line of credit, $14,500,000 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, 1997 was 7.52 %. 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, 1998 $ 3,000 September 30, 1999 3,500 September 30, 2000 4,000 September 30, 2001 4,500 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 $14,500,000. (11) OTHER LIABILITIES The following table is a summary of other liabilities at December 31, 1997 and 1996:
December 31, 1997 1996 (Dollars in thousands) ----------------------------------- Accrued salaries, fringe benefits and other compensation $ 3,072 $ 2,271 Premium taxes payable 986 878 Accrued rent payable 93 654 General accounts payable 73 141 Accrued payable - SBA 183 36 Dividends payable 379 365 Loss on early lease termination and sub-lease 56 1,696 Proposition 103 reserve 982 1,928 Litigation reserve - 175 Other 3,984 2,779 ----------------- ----------------- Total other liabilities $ 9,808 $ 10,923 ================= =================
(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, 1997, 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 $3,648,000, $5,647,000 and $4,033,000 for the years ended December 31, 1997, 1996 and 1995, respectively, have been charged to operations in the accompanying consolidated statements of operations. Balance (Dollars in thousands) ----------------------- Summary of minimum future annual rental commitments: 1998 $ 2,421 1999 2,182 2000 1,984 2001 1,615 2002 and thereafter 10,706 ----------------------- Total $ 18,908 ======================= (13) PROPOSITION 103 On August 26, 1990, the California legislature enacted A.B. 3798 exempting surety insurance from certain provisions of Proposition 103, which later became operative as Insurance Code Section 1861.135 ("Section 1861.135") on January 1, 1991. In April of 1991, a Los Angeles Superior Court Judge upheld the constitutionality of Section 1861.135. On December 7, 1992, 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. On December 14, 1995, the California Supreme Court affirmed the decision of the Second District Court of Appeal. Accordingly, the surety insurance industry is no longer exempted from the rate rollback and prior approval provisions contained in 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 required 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. (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 87%, 88% and 90% for 1997, 1996 and 1995, 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 1997, 1996 and 1995 amounted to $365,000, $344,000 and $275,000, 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. In October, 1995, the FASB issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"). As permitted by FAS 123, the Company continued to use accounting methods presented by Accounting Principles Board Opinion No. 25 and has expanded its disclosure of stock-based compensation in the tables below. The additional compensation costs that would have been recorded if the Company had adopted FAS 123 are not material to the consolidated financial statements of the Company.
Non-Employee Director Stock Option Plan Stock Option Plan Total ------------------------- ------------------------- -------------------------- Shares reserved for issuance 676,000 75,000 751,000 Granted (1,069,621) (57,500) (1,127,121) Canceled / Expired 419,007 - 419,007 ========================= ========================= ========================== Total available for grant 25,386 17,500 42,886 ========================= ========================= ==========================
A summary of the status of the Plans as of December 31, 1997, 1996 and 1995, and changes during the years ending on those dates is presented below:
1997 1996 1995 ---------------------------------- --------------------------------- --------------------------------- Weighted Average Weighted Average Weighted Average Shares Exercise Price Shares Exercise Price Shares Exercise Price -------------- ------------------- -------------- ------------------ --------------- ----------------- Outstanding at beginning of year 442,005 $12.59 328,950 $12.70 276,950 $11.44 Granted 93,000 12.50 149,430 12.54 106,000 14.29 Exercised (71,000) 9.59 (6,950) 8.75 (48,875) 9.17 Canceled / Expired (15,820) 13.24 (29,425) 14.46 (5,125) 11.56 -------------- ------------------- -------------- ------------------ --------------- ----------------- Outstanding at end of year 448,185 $13.03 442,005 $12.59 328,950 $12.70 ============== =================== ============== ================== =============== ================= Options exercisable at end of year 237,766 $12.93 225,174 $11.63 154,488 $11.88 ============== =================== ============== ================== =============== =================
The following table summarizes information about options outstanding under the Plans at December 31, 1997:
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 12,860 4.7 $8.36 12,860 $8.36 $9.875 - $11.825 53,300 1.1 10.96 53,300 10.96 $12.50 - $14.875 382,025 5.2 13.47 171,606 13.89 ================ ================= ================ ================= ================ $6.14 - $14.875 448,185 4.7 $13.03 237,766 $12.93 ================ ================= ================ ================= ================
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 using 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 6.34% and 6.67% for 1997, 6.39% for 1996 and 6.36% for 1995, a dividend yield of 3.12% for 1997, 3.48% for 1996 and 2.72% for 1995, volatility of the Company's Common Stock of 7.15% for 1997, 7.18% for 1996 and 7.44% for 1995, and an expected life of the stock options of 10 years. The weighted average grant date fair values of stock options granted during 1997, 1996 and 1995 were $4.92, $5.09 and $5.07, respectively. AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES SUPPLEMENTARY INFORMATION (UNAUDITED) QUARTERLY FINANCIAL INFORMATION The quarterly results for the years ended December 31, 1997, 1996 and 1995 are set forth in the following table:
(Dollars in thousands, except per share data) ---------------- ----------------- ----------------- ---------------- First Second Quarter Third Fourth Quarter Quarter Quarter ---------------- ----------------- ----------------- ---------------- 1997 Premiums written $ 21,609 $ 28,175 $ 30,083 $ 28,224 Net premiums earned 21,446 21,781 23,736 25,187 Net investment income 1,681 1,605 1,594 1,516 Net realized gains 637 348 1,044 1,444 Commissions and fees - 5 17 2 Total revenues 23,764 23,739 26,391 28,149 Net income 1,785 1,314 685 1,714 Earnings per share - basic .54 .39 .20 .50 Earnings per share - diluted .53 .39 .20 .49 ---------------- ----------------- ----------------- ---------------- 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 Commissions and fees 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 - basic .03 (.39) .36 (.80) Earnings (loss) per share - diluted .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 Commissions and fees 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 - basic .38 .51 .24 (.02) Earnings (loss) per share - diluted .38 .50 .23 (.02)
SCHEDULE I AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES SUMMARY OF INVESTMENTS- OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 1997 (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 $ 20,093 $ 20,422 $ 20,422 States, municipalities and political subdivisions 32,468 33,362 33,362 Foreign governments - - - Public utilities - - - Convertibles and bonds with warrants attached - - - All other corporate bonds 40,069 40,963 40,963 --------------- --------------- ---------------- Total bonds 92,630 94,747 94,747 Certificates of deposit 95 95 95 Redeemable preferred stock 3,791 3,904 3,904 --------------- --------------- ---------------- Total fixed maturities 96,516 98,746 98,746 Equity securities: Common stocks: Public utilities 120 214 214 Banks, trust and insurance companies 1,713 3,048 3,048 Industrial, miscellaneous and all other 5,023 7,035 7,035 Non-redeemable preferred stocks 2,664 2,894 2,894 --------------- --------------- ---------------- Total equity securities 9,520 13,191 13,191 Mortgage loans on real estate - XXXXXXX - Real estate - XXXXXXX - Policy loans - XXXXXXX - Other long-term investments 5,816 XXXXXXX 6,455 Short-term money-market investments 2,281 XXXXXXX 2,281 --------------- --------------- ---------------- Total investments $ 114,133 XXXXXXX $ 120,673 =============== =============== ================
SCHEDULE II AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION (Parent Company Only) STATEMENT OF OPERATIONS (Dollars in thousands)
Year ended December 31, 1997 1996 1995 REVENUES: Management fee income, net $ - $ - $ 734 Equity in income (loss) of subsidiaries 5,208 (969) 3,307 Commissions & fees 572 2 1,176 Net investment income 32 65 201 Net realized gains (losses) 8 (5) - ------------ ------------ ------------- Total revenues 5,820 (907) 5,418 EXPENSES: General and administrative - - 1,489 Merger expenses - 710 - Lease termination cost - 1,300 - Interest expense 306 107 - ------------ ------------ ------------- Total expenses 306 2,117 1,489 Income before income taxes 5,514 (3,024) 3,929 Provision for income taxes (benefit) 16 (338) 260 ------------ ------------ ------------- Net income (loss) $ 5,498 $ (2,686) 3,669 ============ ============ =============
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, 1997 1996 ASSETS: Total investments $ 66,989 $ 61,083 Cash and cash equivalents 176 1,059 Income taxes receivable 123 21 Deferred Federal income tax asset 523 533 Due from affiliates 76 - Furniture, equipment and improvements 3,648 1,078 Other assets 1,071 2,046 -------------- -------------- Total assets $ 72,606 $ 65,820 ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY: Liabilities: Bank indebtedness $ 14,500 $ 12,500 Due to affiliates - 1,166 Other liabilities 927 2,222 -------------- -------------- Total liabilities 15,427 15,888 -------------- -------------- Stockholders' Equity: Common stock and additional paid in capital 18,243 16,860 Net unrealized appreciation (depreciation) of investments, net of taxes 4,316 2,456 Retained earnings 34,620 30,616 -------------- -------------- Total stockholders' equity 57,179 49,932 -------------- -------------- Total liabilities and stockholders' equity $ 72,606 $ 65,820 ============== ==============
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, 1997 1996 1995 CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 5,498 $ (2,686) $ 3,669 Less equity in income of subsidiary (5,208) 969 (3,307) ------------ ------------- -------------- Net income from operations 290 (1,717) 362 Adjustments: Change in income taxes, net (92) 1,268 97 Change in accrued investment income - 10 - Change in due (to) from affiliates (1,242) (270) 597 Change in other assets / liabilities (320) 1,829 (1,539) Dividend received from affiliate - 500 2,160 Provision for depreciation and amortization 372 431 822 Realized (gains) losses on sale of investments (8) 4 - Purchases of trading securities - - (26,644) Sales of trading securities - - 26,959 Realized loss on sale of fixed assets 46 36 6 ------------ ------------- -------------- Net cash provided (used) (954) 2,091 2,820 ------------ ------------- -------------- CASH FLOWS FROM INVESTING ACTIVITIES: Cash received from investments sold, matured, called or repaid 187 995 - Cash paid for investments acquired (17) (2,262) - Amortization of premium on bonds - - (632) Capital expenditures, net (2,988) (14) (256) ------------ ------------- -------------- Net cash provided (used) (2,818) (1,281) (888) ------------ ------------- -------------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of surplus note from subsidiary 1,000 1,000 - Proceeds from issuance of long term debt 2,000 - - Proceeds from common stock issuance 1,382 299 448 Repurchase of common stock - (676) (375) Capital contribution to subsidiaries - (1,000) (938) Dividends paid (1,493) (1,462) (940) ------------ ------------- -------------- Net cash from financing activities 2,889 (1,839) (1,805) ------------ ------------- -------------- Net increase (decrease) (883) (1,029) 127 Cash and cash equivalents, beginning 1,059 2,088 1,961 ------------ ------------- -------------- Cash and cash equivalents, ending $ 176 $ 1,059 $ 2,088 ============ ============= ==============
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, 1994, the Parent Company entered into a revolving credit agreement with Union Bank for $12,500,000. The debt agreement was amended on April 24, 1996, July 10, 1996 and again on September 30, 1997 to increase the amount available under the revolving line of credit from $12,500,000 to $15,000,000 and to change certain covenants and payment requirements. At December 31, 1997, $15,000,000 is available under the revolving line of credit, $14,500,000 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, 1997 and 1996 and the related consolidated statements of operations, cash flows and changes in stockholders' equity and related schedules for each of the years in the three-year period ended December 31, 1997, which reports appear in the December 31, 1997 annual report on Form 10-K of Amwest Insurance Group, Inc. KPMG PEAT MARWICK LLP Los Angeles, California March 26, 1998 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Amwest Insurance Group, Inc.: Under date of February 4, 1998, we reported on the consolidated balance sheets of Amwest Insurance Group, Inc. and subsidiaries as of December 31, 1997 and 1996, 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, 1997, as contained in the annual report on Form 10-K for the year 1997. 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 4, 1998 EX-10.10 3 EXCESS OF LOSS REINSURANCE CONTRACT Excess of Loss Bond Reinsurance Contract Effective: October 1, 1997 issued to Amwest Surety Insurance Company and Far West Insurance Company both of Omaha, Nebraska (hereinafter referred to collectively as the "Company") by The Subscribing Reinsurer(s) Executing the Interests and Liabilities Agreement(s) Attached Hereto (hereinafter referred to as the "Reinsurer") 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: 1. Coverage A: Contract Bonds, Subdivision Bonds or Commercial Bonds; 2. Coverage B: Film Completion Bonds; subject to the terms, conditions and limitations hereinafter set forth. Article II - Term A. This Contract shall become effective on October 1, 1997, with respect to losses discovered by the Company on or after that date, and shall remain in force until September 30, 1998, both days inclusive. B. 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. C. Unless the Company elects that the Reinsurer have no liability for losses discovered by the Company after the effective date of termination or expiration, and so notifies the Reinsurer prior to or as promptly as possible after the effective date of termination or expiration, reinsurance hereunder on business in force on the effective date of termination or expiration shall remain in full force and effect until: 1. 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 expiration of this Contract, but in no event beyond 60 months following the date of termination or expiration of this Contract; 2. 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 or expiration of this Contract. 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 the Reinsurer. 3. Reclamation bonds negotiated prior to or during the mining phase of a parcel of property, except commercial bonds when part of an account. 4. Workers' Compensation self-insurance bonds or any other self-insurance bonds, except commercial bonds when part of an account. 5. Completion bonds, except film completion guaranties subject to Coverage B of this Contract. 6. Hazardous Waste Closure bonds and Post Closure bonds, except commercial bonds when part of an account. 7. Fidelity and Commercial Crime bonds. 8. Lease bonds, except commercial bonds when part of an account. 9. Financial Guarantee, Credit Insurance or any miscellaneous bond(s) classified as SAA #580, #581 and #597. 10. ERISA bonds. 11. Mortgage Impairment, Deficiency or Guarantee bonds. 12. Rate Guarantee bonds. 13. Money Market Guarantee or Guarantee of Installment Paper bonds. 14. Bank Depository bonds. 15. Note Guarantee bonds or bonds guaranteeing letters of credit. 16. Casualty insurance or any third party tort liability. 17. Bonds to principals in claim for amounts greater than $500,000, except commercial bonds when part of an account and are pre-approved by the Reinsurer. B. However, any reinsurance that is specially accepted from the Company by 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. As respects each excess layer of reinsurance coverage provided by this Contract, the Company shall retain and be liable for the first amount of ultimate net loss, shown as "Company's Retention" for that excess layer in Schedule A attached hereto, as respects each loss. The Reinsurer shall then be liable, as respects each excess layer, for the amount by which such ultimate net loss exceeds the Company's applicable retention, but the liability of the Reinsurer under each excess layer shall not exceed the amount, shown as "Reinsurer's Per Principal Limit" for that excess layer in Schedule A attached hereto, as respects each loss, nor shall it exceed the amount shown as "Reinsurer's Aggregate Limit" for that excess layer in Schedule A attached hereto, as respects all losses for the term of this Contract. 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). 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 and 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. A loss shall be deemed "discovered" on the date when the Company has incurred an ultimate net loss of $1,000,000 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. E. The Company may maintain in force pro rata reinsurance, recoveries under which shall inure to the benefit of this Contract. F. 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, firm or corporation, or in reliance upon the indemnity of a related group of persons, firms 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 the Reinsurer. Article VI - 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 during the calendar quarter under consideration. The bordereau shall also include any losses that were reported during an earlier calendar quarter and have an increase of $500,000 or more in the outstanding loss reserves during the calendar quarter under consideration. The loss bordereau 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 VII - 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 VIII - Premium A. As premium for each excess layer of reinsurance coverage provided by this Contract, the Company shall pay the Reinsurer the greater of the following: 1. The amount, shown as "Annual Minimum Premium" for that excess layer in Schedule A attached hereto; or 2. The percentage, shown as "Premium Rate" for that excess layer in Schedule A attached hereto, of the Company's net earned premium for the term of this Contract. B. The Company shall pay the Reinsurer an annual deposit premium for each excess layer of the amount, shown as "Annual Deposit Premium" for that excess layer in Schedule A attached hereto, in four equal installments of the amount, shown as "Quarterly Deposit Premium" for that excess layer in Schedule A attached hereto, on October 1, 1997, January 1, 1998, April 1, 1998 and July 1, 1998. C. Within 60 days after the termination or expiration of this Contract, the Company shall provide a report to the Reinsurer setting forth the premium due hereunder, computed in accordance with paragraph A above, and any additional premium due the Reinsurer or return premium due the Company shall be remitted promptly. D. In the event this Contract is terminated or expires on a runoff basis, premium for the runoff period for each excess layer will be a percentage, shown as "Premium Rate" for that excess layer in Schedule A attached hereto, of the Company's net earned premium for the runoff period. As promptly as possible after the end of each calendar quarter during the runoff period, the Company shall pay the Reinsurer an amount equal to a percentage, shown as "Premium Rate" for that excess layer in Schedule A attached hereto, of the Company's net earned premium during the calendar quarter. E. "Net earned premium" as used herein is defined as the Company's gross earned premium on the classes of business subject to this Contract, less only the earned portion of premiums, if any, ceded by the Company for reinsurance which inures to the benefit of this Contract. Article IX - Commutation A. Not later than two years after the expiration of this Contract, the Company shall advise the Reinsurer of all claims, both reported and unreported, for the term of this Contract not finally settled which are likely to result in a claim under this Contract. If both parties desire to commute all claims, then within 60 days after such agreement, the Company and the Reinsurer or their respective representatives shall, by mutual agreement, determine and capitalize such claims. Payment by the Reinsurer of its proportion of the amount or amounts, so mutually agreed, shall constitute a complete and final release of the Reinsurer of all claims, both reported and unreported, under this Contract, and the Reinsurer shall have no further liability for any claims under this Contract. B. If agreement cannot be reached, the Company and the Reinsurer shall mutually appoint an actuary or appraiser to investigate, determine and capitalize such claims. If both parties then agree, the Reinsurer shall pay its proportion of the amount so determined to be the capitalized value of such claims. C. If the parties fail to agree, then any difference shall be settled by a panel of three actuaries, one to be chosen by each party and the third by the two so chosen. If either party refuses or neglects to appoint an actuary within 60 days, the other party may appoint two actuaries. If the two actuaries fail to agree on the selection of a third actuary within 60 days of their appointment, each of them shall name two, of whom the other shall decline one and the decision shall be made by drawing lots. All the actuaries shall be regularly engaged in the valuation of Surety reinsurance claims and shall be Fellows of the Casualty Actuarial Society or of the American Academy of Actuaries. None of the actuaries shall be under the control of either party to this Contract. D. Each party shall submit its case to its actuary within 60 days of the appointment of the third actuary. The decision in writing of any two actuaries, when filed with the parties hereto, shall be final and binding on both parties. The expense of the actuaries and of the commutation shall be equally divided between the two parties. Said commutation shall take place in Los Angeles, California, unless some other place is mutually agreed upon by the Company and the Reinsurer. E. This Commutation Clause shall survive the termination of this Contract. Article X - 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 XI - 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 XII - 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. Except as provided in Article XXI, nothing herein shall in any manner create any obligations or establish any rights against the Reinsurer in favor of any third party or any persons not parties to this Contract. Article XIII - 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 XIV - 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 XV - 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 XVI - 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 XVII - 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 expense paid under the terms of policies 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). Article XVIII - 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 XIX - 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 XX - 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 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 XXI - Alternate Payee A. It is understood that in order to make the Company's policies generally acceptable, one or more Subscribing Reinsurers (hereinafter referred to as "such Designated Co-Sureties") have agreed to issue co-surety and/or Miller Act Endorsements which guarantee that such Designated Co-Sureties will pay valid claims under any of the Company's policies to which said co-surety and/or Miller Act Endorsements are attached. B. Notwithstanding the provisions of Article XXII, it is agreed that if any such Designated Co-Sureties under the provisions of a co-surety and/or Miller Act Endorsement, pays or becomes liable to pay any claim or claims under any policy or policies subject to this Contract, such Designated Co-Sureties shall be substituted for the Company as payee of any reinsurance recoverable hereunder in respect of such claim or claims, and the Reinsurer, upon notice from such Designated Co-Sureties, shall make payment directly to such Designated Co-Sureties. C. In the event the foregoing provisions apply, all the other provisions of this Contract shall apply to such Designated Co-Sureties in the same manner as if such Designated Co-Sureties were substituted for the Company as the reinsured party hereunder, and to the extent this Contract reinsures such Designated Co-Sureties, coverage hereunder shall be excluded as respects the Company. Article XXII - 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, except with regard to retentions and limits set forth herein, 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 XXIII - 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 XXIV - 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. In Witness Whereof, the Company by its duly authorized representative has executed this Contract as of the dates undermentioned at: Calabasas, California this ________ day of _____________________ 199___. -------------------------------------------------- Amwest Surety Insurance Company Far West Insurance Company Schedule A Excess of Loss Bond Reinsurance Contract Effective: October 1, 1997 issued to Amwest Surety Insurance Company Far West Insurance Company both of Omaha, Nebraska
First* Second Second Third Third Excess Excess Excess Excess Excess (Coverage A) (Coverage A) (Coverage B) (Coverage A) (Coverage B) Company's Retention $2,000,000 $6,000,000 $6,000,000 $10,000,000 $10,000,000 Reinsurer's Per Principal Limit $4,000,000 $4,000,000 $4,000,000 $10,000,000 $10,000,000 Reinsurer's Aggregate Limit $8,000,000 $8,000,000 $8,000,000 $10,000,000 $10,000,000 Annual Minimum Premium $1,099,800 $361,800 N/A $225,600 N/A Premium Rate 1.95% .65% .65% .40% .40% Annual Deposit Premium $1,374,750 $458,250 N/A $282,000 N/A Quarterly Deposit Premium $343,687.50 $114,562.50 N/A $70,500 N/A * It is understood that Coverage B shall not apply under the First Excess Layer.
Table of Contents Article Page I Classes of Business Reinsured 1 II Term 1 III Territory 2 IV Exclusions 2 V Retention and Limit 4 VI Losses 5 VII Salvage and Subrogation 6 VIII Premium 6 IX Commutation 7 X Offset (BRMA 36C) 8 XI Access to Records (BRMA 1D) 8 XII Liability of the Reinsurer 8 XIII Net Retained Lines (BRMA 32B) 9 XIV Errors and Omissions (BRMA 14F) 9 XV Currency (BRMA 12A) 9 XVI Taxes (BRMA 50C) 9 XVII Unauthorized Reinsurers 10 XVIII Insolvency 11 XIX Arbitration (BRMA 6J) 12 XX Service of Suit (BRMA 49C) 13 XXI Alternate Payee 14 XXII Agency Agreement 14 XXIII Co-Surety Bonds 15 XXIV Intermediary (BRMA 23A) 15 Schedule A EX-10.11 4 AGGREGATE STOP LOSS REINSURANCE CONTRACT Aggregate Stop Loss Reinsurance Contract Effective: January 1, 1998 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 (hereinafter referred to as the "Reinsurer") 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 This Contract shall become effective on January 1, 1998, with respect to losses occurring on or after that date and shall remain in force until December 31, 1998, both days inclusive. Article III - Territory 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 term of this Contract in excess of 32.80% of its net earned premium for the term of this Contract. 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 Contract in excess of Company's ultimate net loss in excess of its retention for the term of this Contract. B. The Company shall have the option to purchase additional reinsurance limit equal to the greater of $5,000,000 or 7.0% of the net earned premium for the term of this Contract. This option expires on December 31, 1998 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 all loss adjustment expense as hereinafter 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 bond 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 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. It is agreed that for purposes of this Contract, loss adjustment expense shall be no greater than 8.4% of net earned premium. 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 for the term of this Contract. B. The Company shall pay the Reinsurer an annual minimum and deposit premium of $1,500,000 in equal semi-annual installments of $750,000 on January 1 and July 1 of 1998. C. Within 60 days after the expiration of this Contract, the Company shall provide a report to the Reinsurer setting forth the premium due hereunder, computed in accordance with paragraph A and if the premium so computed is greater that the previously paid minimum and deposit premium, the balance shall be remitted by the Company with its report. 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 its net earned premium, subject to a minimum and deposit premium of $1,000,000 payable on January 1, 1999. 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 regulatory 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 expiration of this Contract, 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 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 50B) 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 or the District of Columbia. 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 due 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 unearned premium and outstanding loss and loss adjustment expense reserves (including incurred but not reported loss reserves) 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. 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 expense 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 incurred but not reported loss reserves) 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 incurred but not reported loss reserves), 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 B(1), B(2) or B(4), or in the case of B(3), the actual amount determined to be due, the Company shall promptly return to the Reinsurer the excess amount so drawn. Article XXI - 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 bonds and in substitution for the obligations of the company to such payees. Article XXII - 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 30 days after being requested to do so by the other party, the latter, after 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 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 30 days after notice of appointment of all arbitrators, the panel shall meet and determine timely periods for briefs, discovery procedures and schedules for hearings. 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 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 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 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 - 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 XXV - 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. In Witness Whereof, the parties hereto by their duly authorized representatives have executed this Contract as of the dates undermentioned at: Woodland Hills, California, this _______ day of ______________________ 199___. ------------------------------------------------- Amwest Surety Insurance Company Far West Insurance Company Barbados, West Indies, this _______ day of ______________________ 199___. ------------------------------------------------- Underwriters Reinsurance Company (Barbados), Inc. Table of Contents Article Page I Business Reinsured 1 II Term 1 III Territory 1 IV Retention and Limit 2 V Definitions 2 VI Other Reinsurance 3 VII Loss Notices and Settlements 4 VIII Salvage and Subrogation 4 IX Reinsurance Premium 4 X Late Payments 5 XI Reports and Remittances 6 XII Commutation 7 XIII Offset (BRMA 36C) 7 XIV Access to Records (BRMA 1D) 7 XV Net Retained Lines 7 XVI Errors and Omissions (BRMA 14F) 7 XVII Currency (BRMA 12A) 8 XVIII Taxes (BRMA 50B) 8 XIX Federal Excise Tax (BRMA 17A) 8 XX Unauthorized Reinsurers 8 XXI Insolvency 10 XXII Arbitration 11 XXIII Service of Suit (BRMA 49C) 12 XXIV Agency Agreement 12 XXV Intermediary (BRMA 23A) 12 EX-10.12 5 50% PRIVATE PASSENGER AUTO QUOTA SHARE REINSURANCE 50% Private Passenger Automobile Quota Share Reinsurance Contract Effective: July 1, 1997 issued to Condor Insurance Company Calabasas, California Amwest Surety Insurance Company Omaha, Nebraska and Far West Insurance Company Omaha, Nebraska (hereinafter referred to collectively as the "Company") by The Subscribing Reinsurer(s) Executing the Interests and Liabilities Agreement(s) Attached Hereto (hereinafter referred to as the "Reinsurer") Article I - Classes of Business Reinsured A. By this Contract, the Company obligates itself to cede to the Reinsurer and the Reinsurer obligates itself to accept quota share reinsurance of the Company's net liability under policies, contracts and binders of insurance or reinsurance (hereinafter called "policies") issued or renewed on or after the effective date hereof, and classified by the Company as Non-Standard Private Passenger Automobile business. B. It is understood that the classes of business reinsured under this Contract are deemed to include: 1. Coverages required for non-resident drivers under the motor vehicle financial responsibility law or the motor vehicle compulsory insurance law or any similar law of any state or province, following the provisions of the Company's policies when they include or are deemed to include so-called "Out of State Insurance" provisions; 2. Coverages required under Section 30 of the Motor Carrier Act of 1980 and/or any amendments thereto. C. "Net liability" as used herein is defined as the Company's gross liability remaining after cessions, if any, to reinsurance which inures to the benefit of this Contract. D. The liability of the Reinsurer with respect to each cession hereunder shall commence obligatorily and simultaneously with that of the Company, subject to the terms, conditions and limitations hereinafter set forth. Article II - Commencement and Termination A. This Contract shall become effective on July 1,1997 with respect to losses arising out of occurrences commencing on or after that date, and shall continue in force thereafter until terminated. B. Either party may terminate this Contract at the end of any contract year by giving the other party not less than 90 days prior notice by certified mail. C. Unless the Company elects to reassume the ceded unearned premium in force on the effective date of termination, and so notifies the Reinsurer prior to or as promptly as possible after the effective date of termination, reinsurance hereunder on business in force on the effective date of termination shall remain in full force and effect until expiration, cancellation or next premium anniversary of such business, whichever first occurs, but in no event beyond 12 months following the effective date of termination. D. Notwithstanding the provisions of paragraph C above, in the event the Company is prohibited or precluded by the appropriate regulatory authorities, or by law (in those states where applicable and enforced), from arranging mid-term cancellation or non-renewal of any policies subject to this Contract beyond their natural expiry, the Reinsurer agrees to extend reinsurance coverage until such policies may be terminated by the Company, but in no event beyond 36 months after the effective date of termination. E. "Contract year" as used herein shall mean the period from July 1, 1997, through June 30, 1998, both days inclusive, and each respective 12-month period thereafter that this Contract continues in force. However, if this Contract is terminated, the final contract year shall be from the beginning of the then current contract year through the date of termination if this Contract is terminated on a "cutoff" basis, or the end of the runoff period if this Contract is terminated on a "runoff" basis. Article III - Assignments A. The provisions of Article VI shall apply to risks assigned to the Company under any Assigned Risk Plan if, in the opinion of the Company, such risks were assigned to the Company because of the business written and reinsured hereunder. Any assignments shall be allocated to the contract year upon which the basis of assignments were calculated. B. In the event this Contract is terminated, notwithstanding the provisions of paragraph C of Article II, the provisions of this Article shall continue to apply for as long as the Company is required to accept assignments because of the business reinsured hereunder. Article IV - Territory The liability of the Reinsurer shall be limited to policies issued to insureds domiciled in the State of Arizona; but this limitation shall not apply to losses if the Company's policies provide coverage outside the aforesaid territorial limits. Article V - Exclusions A. This Contract does not apply to and specifically excludes the following: 1. All classifications of business not included in Article I. 2. All excess of loss reinsurance assumed by the Company. 3. Reinsurance assumed by the Company under obligatory reinsurance agreements, except agency reinsurance where the policies involved are to be reunderwritten in accordance with the underwriting standards of the Company and reissued as Company policies at the next anniversary or expiration date. 4. Nuclear risks as defined in the "Nuclear Incident Exclusion Clause - Physical Damage - Reinsurance" and the "Nuclear Incident Exclusion Clause - Liability - Reinsurance" attached to and forming part of this Contract. 5. Automobile Liability coverage with respect to all commercial vehicles and any vehicle used principally as: a. An ambulance, fire department or law enforcement vehicle; b. A racing or exhibition vehicle; c. A long-haul public freight carrier operating regularly and frequently beyond a 300-mile radius from its terminal location; d. A transporter of explosives, munitions, ammonium nitrate, gasoline or liquefied petroleum gas, including butane and propane. 6. Taxi or livery vehicles; vehicles weighing more than 20,000 pounds; newspaper or mail carriers. B. Notwithstanding the foregoing, any reinsurance falling within the scope of one or more of the exclusions set forth in subparagraphs 5 and/or 6 of paragraph A that is specially accepted by the Reinsurer from the Company shall be covered under this Contract and be subject to the terms hereof, except as such terms shall be modified by the special acceptance. Furthermore, any exclusion set forth in subparagraph 5 or 6 of paragraph A shall be waived automatically when in the opinion of the Company, the exposure excluded therein is incidental to the principal exposure on the risk in question. C. If the Company is bound, without the knowledge and contrary to the instructions of the Company's supervisory underwriting personnel, on any business falling within the scope of one or more of the exclusions set forth in subparagraphs 5 and/or 6 of paragraph A, the exclusion shall be suspended with respect to such business until 30 days after an underwriting supervisor of the Company acquires knowledge thereof. D. If the Company is required to accept an assigned risk which conflicts with one or more of the exclusions set forth in subparagraphs 5 and/or 6 of paragraph A, reinsurance shall apply, but in no event shall the Reinsurer's liability exceed the applicable limits set forth in Article VI. Article VI - Retention and Limit A. As respects business subject to this Contract, the Company shall retain and be liable for 50% of its net liability. The Company shall cede to the Reinsurer and the Reinsurer agrees to accept 50% of the Company's net liability. B. Notwithstanding the provisions of paragraph A above, in the event that the Company's net written premium during the first contract year exceeds $4,500,000, the percentage of the Company's net liability ceded hereunder, as respects business issued or renewed during that period, may, at the option of the Reinsurer, be reduced to not less than the proportion that $4,500,000 bears to the Company's total net written premium for the first contract year. In the event this Contract is terminated before the end of the first contract year, the "premium cap" amount above shall be reduced proportionately before applying the provisions of this paragraph. In the event of a reduction of the cession percentage under this paragraph, the premiums and losses paid hereunder for the first contract year, and the ceding commission allowed on said premium, shall be adjusted retroactively to the inception of this Contract. C. The Company shall purchase or be deemed to have purchased inuring reinsurance to limit its loss from loss in excess of policy limits or extra contractual obligations to $250,000 per occurrence. D. The Company shall purchase or be deemed to have purchased inuring excess facultative reinsurance to limit its loss subject hereto from any one coverage, any one policy (exclusive of loss in excess of policy limits or extra contractual obligations) to the following amounts: 1. Automobile Bodily Injury Liability, $15,000 each person, $30,000 each occurrence; 2. Automobile Property Damage Liability, $10,000 each occurrence; 3. Uninsured Motorists, $15,000 each person, $30,000 each occurrence; 4. Automobile No-Fault, statutory required or required to be offered limits; 5. Automobile Physical Damage, $30,000 each risk, each occurrence; E. The Automobile Liability amounts shown in paragraph E shall be extended to follow the Company's policy if the Company's loss is greater than one or more of said amounts because its policy includes or is deemed to include: 1. So-called "Out of State Insurance" provisions; 2. Limits of liability required under Section 30 of the Motor Carrier Act of 1980 and/or any amendments thereto. F. "Net written premium" as used herein is defined as gross written premium of the Company for the classes of business subject hereto (excluding policy fees), less cancellations and return premiums, and less premiums ceded by the Company for reinsurance which inures to the benefit of this Contract. Article VII - Loss in Excess of Policy Limits/ECO A. In the event the Company pays or is held liable to pay an amount of loss in excess of its policy limit, but otherwise within the terms of its policy (hereinafter called "loss in excess of policy limits") or any punitive, exemplary, compensatory or consequential damages, other than loss in excess of policy limits (hereinafter called "extra contractual obligations") because of alleged or actual bad faith or negligence on its part in rejecting a settlement within policy limits, or in discharging its duty to defend or prepare the defense in the trial of an action against its policyholder, or in discharging its duty to prepare or prosecute an appeal consequent upon such an action, or in otherwise handling a claim under a policy subject to this Contract, the loss in excess of policy limits and/or the extra contractual obligations, if any, under the policy involved, shall be subject to the provisions of paragraph C of Article VI. B. An extra contractual obligation shall be deemed to have occurred on the same date as the loss covered or alleged to be covered under the policy. C. Notwithstanding anything stated herein, this Contract shall not apply to any loss in excess of policy limits or any extra contractual obligation 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 any individual or corporation or any other organization or party involved in the presentation, defense or settlement of any claim covered hereunder. D. Recoveries from any form of insurance or reinsurance which protects the Company against claims the subject matter of this Article shall inure to the benefit of this Contract. Article VIII - Losses and Loss Adjustment Expenses A. Losses shall be reported by the Company in summary form as hereinafter provided. The Reinsurer shall have the right to participate in the adjustment of losses subject to this Contract at its own expense. B. All loss settlements made by the Company, whether under strict policy conditions or by way of compromise (excluding ex gratia payments made by the Company), shall be binding upon the Reinsurer, and the Reinsurer agrees to pay or allow, as the case may be, its proportion of each such settlement in accordance with the provisions of Article XII. C. In the event of a claim under a policy subject hereto, the Reinsurer shall be liable for its proportionate share of loss adjustment expenses incurred by the Company in connection therewith (including litigation expenses, prejudgment interest and postjudgment interest, but not including office expenses or salaries of the Company's regular employees), and shall be credited with its proportionate share of any recoveries of such expense. Article IX - Salvage and Subrogation The Reinsurer shall be credited with its proportionate share of salvage (i.e., reimbursement obtained or recovery made by or on behalf of 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. 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 - Original Conditions A. All reinsurance under this Contract shall be subject to the same rates, terms, conditions, waivers and interpretations and to the same modifications and alterations as the respective policies of the Company. However, in no event shall this be construed in any way to provide coverage outside the terms and conditions set forth in this Contract. The Reinsurer shall be credited with its exact proportion of the original premiums received by the Company (net of policy fees or equivalent charges and other service fees or brokerage fees), prior to disbursement of any dividends, but after deduction of premiums, if any, ceded by the Company for inuring reinsurance, and taking into account additional and return premiums. B. Nothing herein shall in any manner create any obligations or establish any rights against the Reinsurer in favor of any third party or any persons not parties to this Contract. Article XI - Sliding Scale Commission A. The Reinsurer shall allow the Company a 25.0% provisional commission on all premiums ceded to the Reinsurer hereunder. The Company shall allow the Reinsurer return commission on return premiums at the same rate. B. The provisional commission allowed the Company shall be adjusted periodically in accordance with the provisions set forth herein. The first adjustment period shall be from the effective date of this Contract through June 30, 1998, and each subsequent contract period shall be a separate adjustment period. However, if this Contract is terminated, the final adjustment period shall be from the beginning of the then current adjustment period through the date of termination if this Contract is terminated on a "cutoff" basis, or the end of the runoff period if this Contract is terminated on a "runoff" basis. C. The adjusted commission rate shall be calculated as follows and be applied to premiums earned for the period under consideration: 1. If the ratio of losses incurred to premiums earned is 74.0% or greater, the adjusted commission rate for the period under consideration shall be 20.0%; 2. If the ratio of losses incurred to premiums earned is less than 74.0%, but not less than 69.0%, the adjusted commission rate for the period under consideration shall be 20.0%, plus the difference in percentage points between 74.0% and the actual ratio of losses incurred to premiums earned; 3. If the ratio of losses incurred to premiums earned is less than 69.0%, but not less than 49.0%, the adjusted commission rate for the period under consideration shall be 25.0%, plus one-half of the difference in percentage points between 69.0% and the actual ratio of losses incurred to premiums earned; 4. If the ratio of losses incurred to premiums earned is 49.0% or less, the adjusted commission rate for the period under consideration shall be 35.0%. D. If the ratio of losses incurred to premiums earned for any period is greater than 74.0%, the difference in percentage points between the actual ratio of losses incurred to premiums earned and 74.0% shall be multiplied by premiums earned for the period and the product shall be carried forward to the next adjustment period as a debit to losses incurred. If the ratio of losses incurred to premiums earned for any period is less than 49.0%, the difference in percentage points between 49.0% and the actual ratio of losses incurred to premiums earned shall be multiplied by premiums earned for the period and the product shall be carried forward to the next adjustment period as a credit to losses incurred. E. Except as provided in the next paragraph, the Company shall calculate and report the adjusted commission on premiums earned within 45 days after the end of each adjustment period, and within 45 days after the end of each 12-month period thereafter until all losses subject hereto have been finally settled. Each such calculation shall be based on cumulative transactions hereunder from the beginning of the adjustment period through the date of adjustment, including, as respects losses incurred, any debit or credit from the preceding adjustment period. If the adjusted commission on premiums earned for the adjustment period as of the date of adjustment is less than commissions previously allowed by the Reinsurer on premiums earned for the same period, the Company shall remit the difference to the Reinsurer with its report. If the adjusted commission on premiums earned for the adjustment period as of the date of adjustment is greater than commissions previously allowed by the Reinsurer on premiums earned for the same period, the Reinsurer shall remit the difference to the Company as promptly as possible after receipt and verification of the Company's report. F. As respects the final adjustment period, the Company shall calculate and report the adjusted commission on premiums earned within 45 days after the date of termination, and within 45 days after the end of each 12-month period thereafter until all losses subject hereto have been finally settled. Each such calculation shall be based on cumulative transactions hereunder from the beginning of the final adjustment period through the date of adjustment, including, as respects losses incurred, any debit or credit from the preceding adjustment period. If the adjusted commission on premiums earned for the final adjustment period as of the date of adjustment is less than commissions previously allowed by the Reinsurer on premiums earned for the same period, the Company shall remit the difference to the Reinsurer with its report. If the adjusted commission on premiums earned for the final adjustment period as of the date of adjustment is greater than commissions previously allowed by the Reinsurer on premiums earned for the same period, the Reinsurer shall remit the difference to the Company as promptly as possible after receipt and verification of the Company's report. G. "Losses incurred" as used herein shall mean ceded losses and loss adjustment expense paid as of the effective date of calculation, plus the ceded reserves for losses and loss adjustment expense outstanding as of the same date, all as respects losses occurring during the adjustment period under consideration, plus the debit or minus the credit from the preceding adjustment period. H. "Premiums earned" as used herein shall mean ceded unearned premiums at the beginning of the adjustment period under consideration, plus ceded net written premiums during the period, less ceded unearned premiums at the end of the period. I. It is expressly agreed that the ceding commission allowed the Company includes provision for all dividends, commissions, taxes, assessments, and all other expenses of whatever nature, except loss adjustment expense. Article XII - Reports and Remittances A. Within 45 days after the end of each month, the Company shall report to the Reinsurer: 1. Ceded net written premium for the month; 2. Ceding commission on (1) above; 3. Ceded losses paid during the month; 4. Ceded loss adjustment expenses paid during the month. The positive balance of (1) less (2) less (3) less (4) shall be remitted by the Company within 45 days after the end of the month of account. Any balance shown to be due the Company shall be remitted by the Reinsurer within 60 days after the end of the month of account. B. Within 45 days after the end of each month, the Company shall report to the Reinsurer the ceded unearned premiums and ceded outstanding loss reserves as of the end of the month. C. Annually, the Company shall furnish the Reinsurer with such information as the Reinsurer may require to complete its Annual Convention Statement. Article XIII - Late Payments A. 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 XXIII (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. 1/365ths of the 6-month United States Treasury Bill rate, as quoted in the Wall Street Journal on the first business day of the month for which the calculation is 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 30 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 5 business days after the proof of loss or demand for payment is transmitted to the Reinsurer. If such loss or claim payment is not received within the 5 days, interest will accrue on the payment or amount overdue in accordance with paragraph B above, from the date the proof of loss or demand for payment was transmitted to the Reinsurer. 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 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 10 business days following transmittal 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 a Subscribing Reinsurer from contesting the validity of any claim, or from participating in the defense or control of any claim or suit, or prohibiting 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. Interest penalties arising out of the application of this Article that are $100.00 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 XIV - Offset The Company or the Reinsurer shall have, and may exercise at any time and from time to time, the right to offset any balance or balances, whether on account of premiums or on account of losses or otherwise, due from one party to the other under the terms of this Contract or any other contract heretofore or hereafter entered into by and between them, whether as ceding company or assuming reinsurer. However, in the event of the insolvency of any party hereto, offset shall only be allowed in accordance with the statutes and/or regulations of the state having jurisdiction over the insolvency. Article XV - Access to Records The Reinsurer, by its duly appointed representatives, shall have the right at any reasonable time to examine all papers in the possession of the Company referring to business effected hereunder. Article XVI - Errors and Omissions 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 will be rectified as soon as possible after discovered and brought to the attention of the Company's management. Article XVII - Taxes (BRMA 50B) 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 or the District of Columbia. Article XVIII - Unearned Premium and Loss Reserves A. If the Reinsurer is unauthorized in any state of the United States of America or the District of Columbia or rated B+ or less by A.M. Best, the Reinsurer agrees to fund its share of the Company's ceded unearned premium and outstanding loss and loss adjustment expense reserves (including incurred but not reported loss reserves) 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. 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 policy 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 policies 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 incurred but not reported loss reserves) 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 incurred but not reported loss reserves), 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 B(1), B(2) or B(4), or in the case of B(3), the actual amount determined to be due, the Company shall promptly return to the Reinsurer the excess amount so drawn. 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 policy 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 policy 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, 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 or Lloyd's London Underwriters. In the event that either party should fail to choose an Arbiter within 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 30 days following their appointment, each Arbiter shall nominate three candidates within 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 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 at El Segundo, California unless otherwise mutually agreed upon by the parties to this Contract, but notwithstanding the location of the arbitration, all proceedings pursuant hereto shall be governed by the law of the state in which the Company has its principal office. 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 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 XXII - Agency Agreement If more than one reinsured company is named as a party to this Contract, the first named company shall be deemed the agent of the other reinsured companies 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 XXIII - 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. In Witness Whereof, the Company by its duly authorized representative has executed this Contract as of the date undermentioned at: El Segundo, California, this _______ day of _______________________199___. -------------------------------------------------- Condor Insurance Company Table of Contents Article Page I Classes of Business Reinsured 1 II Commencement and Termination 2 III Assignments 2 IV Territory 3 V Exclusions 3 VI Retention and Limit 4 VII Loss in Excess of Policy Limits/ECO 5 VIII Losses and Loss Adjustment Expenses 6 IX Salvage and Subrogation 6 X Original Conditions 7 XI Sliding Scale Commission 7 XII Reports and Remittances 9 XIII Late Payments 9 XIV Offset 11 XV Access to Records 11 XVI Errors and Omissions 11 XVII Taxes (BRMA 50B) 12 XVIII Unearned Premium and Loss Reserves 12 XIX Insolvency 13 XX Arbitration 14 XXI Service of Suit (BRMA 49C) 15 XXII Agency Agreement 15 XXIII Intermediary (BRMA 23A) 16 EX-10.13 6 75% CALIFORNIA HOMEOWNERS QUOTA SHARE REINSURANCE 75% California Homeowners Multiple Line Quota Share Reinsurance Contract Effective: July 1, 1997 issued to Condor Insurance Company Calabasas, California Amwest Surety Insurance Company Omaha, Nebraska and Far West Insurance Company Omaha, Nebraska (hereinafter referred to collectively as the "Company") by The Subscribing Reinsurer(s) Executing the Interests and Liabilities Agreement(s) Attached Hereto (hereinafter referred to as the "Reinsurer") Article I - Classes of Business Reinsured A. By this Contract the Company obligates itself to cede to the Reinsurer and the Reinsurer obligates itself to accept quota share reinsurance of the Company's net liability under policies, contracts and binders of insurance or reinsurance (hereinafter called "policies") in force at the effective date, or issued or renewed on or after the effective date hereof, and classified by the Company as Homeowners Multiple Peril (Sections I and II), Inland Marine and Earthquake business written in conjunction with the California homeowners program. B. "Net liability" as used herein is defined as the Company's gross liability remaining after cessions, if any, to other pro rata reinsurers. C. The liability of the Reinsurer with respect to each cession hereunder shall commence obligatorily and simultaneously with that of the Company, subject to the terms, conditions and limitations hereinafter set forth. Article II - Commencement and Termination A. This Contract shall become effective on July 1, 1997, with respect to losses under policies allocated to underwriting years commencing on or after that date, and shall continue in force thereafter until terminated. B. Either party may terminate this Contract on June 30, 1999, or any June 30 or December 31 thereafter by giving the other party not less than 90 days prior notice by certified mail. C. Notwithstanding the foregoing, in the event that the ratio of the Reinsurer's losses incurred (as defined in Article XI) to premiums earned (as defined in Article XI) for the then current underwriting year or immediately preceding underwriting year is equal to or exceeds 75.0%, it is agreed that the Reinsurer may terminate this Contract at any time after July 1, 1998, by giving the Company not less than 60 days prior notice by certified mail. D. Unless the Company elects to reassume the ceded unearned premium in force on the effective date of termination, and so notifies the Reinsurer prior to or as promptly as possible after the effective date of termination, reinsurance hereunder on business in force on the effective date of termination shall remain in full force and effect until expiration, cancellation or next premium anniversary of such business, whichever first occurs, but in no event beyond 12 months plus odd time (not exceeding 15 months in all) following the effective date of termination. E. Notwithstanding the provisions of paragraph C above, in the event the Company is prohibited or precluded by the appropriate regulatory authorities, or by law, from arranging mid-term cancellation or non-renewal of any policies subject to this Contract beyond their natural expiry, the Reinsurer agrees to extend coverage hereunder with respect to such policies until such policies may be terminated by the Company, but in no event beyond 24 months after the effective date of termination. F. "Underwriting year" as used herein shall mean the period from July 1, 1997 through June 30, 1998, and each subsequent 12-month period shall be a separate underwriting year. All premiums and losses from policies allocated to an underwriting year shall be credited or charged, respectively, to such underwriting year, regardless of the date said premiums earn or such losses occur. It is understood that a policy will be allocated to the underwriting year which is in effect as of: 1. As respects all new policies, the effective date of such policies; 2. As respects renewals of one year or less term policies, the renewal date of such policies; 3. As respects continuous or greater than one year term policies, the premium anniversary date of such policies. Notwithstanding the foregoing, it is understood that policies in force on July 1, 1997, shall be allocated to the first underwriting year hereunder. Policies shall remain in the same underwriting year, as originally allocated, until the next renewal date or premium anniversary date, at which time such policies shall be reallocated to the underwriting year in effect of such date as provided in subparagraphs 2 and 3 above. Article III - Territory This Contract shall only apply to policies issued to insureds domiciled in the State of California, but this limitation shall not apply to losses if the Company's policies provide coverage outside the aforesaid territorial limits. Article IV - Exclusions This Contract does not apply to and specifically excludes the following: 1. All business not included in Article I. 2. All excess of loss reinsurance assumed by the Company. 3. Reinsurance assumed by the Company under obligatory reinsurance agreements, except agency reinsurance where the policies involved are to be reunderwritten in accordance with the underwriting standards of the Company and reissued as Company policies at the next anniversary or expiration date. 4. Financial guarantee and insolvency. 5. Flood and/or earthquake when written on a stand-alone basis. 6. Mortgage Impairment insurances and similar kinds of insurances, however styled. 7. Workers' Compensation except as respects domestic employees. 8. Nuclear risks as defined in the "Nuclear Incident Exclusion Clause - Physical Damage - Reinsurance" and the "Nuclear Incident Exclusion Clause - Liability - Reinsurance" attached to and forming part of this Contract. 9. Loss or damage caused by or resulting from war, invasion, hostilities, acts of foreign enemies, civil war, rebellion, insurrection, military or usurped power, or martial law or confiscation by order of any government or public authority, but this exclusion shall not apply to loss or damage covered under a standard policy with a standard War Exclusion Clause. 10. This Contract excludes loss and/or damage and/or costs and/or expenses arising from asbestos presence and/or seepage and/or pollution and/or contamination, other than contamination from smoke. Nevertheless, this exclusion does not preclude payment of the cost of removing debris of property damaged by a loss otherwise covered hereunder, subject always to a limit of not more than $10,000 plus 25% of the Company's property loss under the applicable original policy. However, this exclusion will not apply where there has been a final court ruling that the Company's asbestos and/or seepage and/or pollution and/or contamination exclusion is invalid or unenforceable. Article V - Retention and Limit A. As respects business subject to this Contract, the Company shall retain and be liable for 25.0% of its net liability.The Company shall cede to the Reinsurer and the Reinsurer agrees to accept 75.0% of the Company's net liability. B. As respects policies allocated to any one underwriting year, in no event shall the Reinsurer's liability under this Contract exceed $7,500,000 in all with respect to any one occurrence. C. The Company shall purchase or be deemed to have purchased inuring reinsurance to limit its loss to the following amounts: 1. Homeowners Multiple Peril (Section I), $200,000 each risk; 2. Homeowners Multiple Peril (Section II), $300,000 each risk; 3. Inland Marine and Earthquake, $406,500 each risk. D. The Company shall be the sole judge of what constitutes "one risk". E. The Company shall purchase or be deemed to have purchased inuring reinsurance to limit its loss from loss in excess of policy limits or extra contractual obligations to $250,000 any one occurrence. Article VI - Assessments A. The provisions of Article V shall apply to a proportion of any assessments made against the Company pursuant to those laws and regulations creating obligatory funds (including insurance guaranty and insolvency funds to the extent that such costs are transferable to the policyholder), pools, joint underwriting associations, FAIR plans and similar plans, said proportion to be the proportion of the Company's total premiums causing the assessment which were or are subject to this Contract, subject to a maximum of 20.0% of the premiums earned hereunder for each underwriting year. 80.0% of any FAIR plan disbursements received by the Company will be counted as subject premium hereunder. Any assessments shall be allocated to the underwriting year upon which the basis of assessments were calculated. B. In the event this Contract is terminated, the provisions of this Article shall continue to apply for as long as the Company is required to accept assignments and/or assessments because of the business reinsured hereunder. Article VII - Loss in Excess of Policy Limits/ECO A. In the event the Company pays or is held liable to pay an amount of loss in excess of its policy limit, but otherwise within the terms of its policy (hereinafter called "loss in excess of policy limits") or any punitive, exemplary, compensatory or consequential damages, other than loss in excess of policy limits (hereinafter called "extra contractual obligations") because of alleged or actual bad faith or negligence on its part in rejecting a settlement within policy limits, or in discharging its duty to defend or prepare the defense in the trial of an action against its policyholder, or in discharging its duty to prepare or prosecute an appeal consequent upon such an action, or in otherwise handling a claim under a policy subject to this Contract, the loss in excess of policy limits and/or the extra contractual obligations shall be added to the Company's loss (including loss adjustment expense), if any, under the policy involved, and the sum thereof shall be subject to the provisions of Article V. B. An extra contractual obligation shall be deemed to have occurred on the same date as the loss covered or alleged to be covered under the policy. C. Notwithstanding anything stated herein, this Contract shall not apply to any loss in excess of policy limits or any extra contractual obligation 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 any individual or corporation or any other organization or party involved in the presentation, defense or settlement of any claim covered hereunder. D. Recoveries from any form of insurance or reinsurance which protects the Company against claims the subject matter of this Article shall inure to the benefit of this Contract. Article VIII - Claims and Loss Adjustment Expense A. Losses shall be reported by the Company in summary form as hereinafter provided, but the Company shall notify the Reinsurer immediately when a specific case involves unusual circumstances or large loss possibilities. The Reinsurer shall have the right to participate, at its own expense, in the defense or control of any claim or suit or proceeding involving this reinsurance. B. All loss settlements made by the Company, whether under strict policy conditions or by way of compromise, shall be binding upon the Reinsurer, and the Reinsurer agrees to pay or allow, as the case may be, its proportion of each such settlement in accordance with Article XII. C. In the event of a claim under a policy subject hereto, the Reinsurer shall be liable for its proportionate share of loss adjustment expense incurred by the Company in connection therewith, and shall be credited with its proportionate share of any recoveries of such expense. Loss adjustment expense shall include litigation expenses, both prejudgment and postjudgment interest, and legal expenses incurred in direct connection with legal actions, including but not limited to declaratory judgment actions. "Declaratory judgment actions" are defined as those actions brought to determine the Company's defense and/or indemnification obligations that are allocable only to specific policies and claims covered under this Contract. Any declaratory judgment expense shall be deemed to have been fully incurred on the same date as the original loss (if any) giving rise to the action. Loss adjustment expense shall not include office expenses or salaries of the Company's regular employees. Article IX - Salvage and Subrogation The Reinsurer shall be credited with its proportionate share of 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. 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 - Original Conditions A. All reinsurance under this Contract shall be subject to the same rates, terms, conditions, waivers and interpretations and to the same modifications and alterations as the respective policies of the Company. However, in no event shall this be construed in any way to provide coverage outside the terms and conditions set forth in this Contract. The Reinsurer shall be credited with its exact proportion of the original premiums received by the Company (net of rebates, policy fees or equivalent charges, other service fees or brokerage fees), prior to disbursement of any dividends, but after deduction of premiums, if any, ceded by the Company for inuring reinsurance. B. Nothing herein shall in any manner create any obligations or establish any rights against the Reinsurer in favor of any third party or any persons not parties to this Contract. Article XI - Sliding Scale Commission A. The Reinsurer shall allow the Company a 27.5% provisional commission on all premiums ceded to the Reinsurer hereunder. The Company shall allow the Reinsurer return commission on return premiums at the same rate. The provisional commission allowed the Company shall be adjusted periodically in accordance with the provisions set forth herein. B. The adjusted commission rate shall be calculated as follows and be applied to premiums earned for the underwriting year under consideration: 1. If the ratio of losses incurred to premiums earned is 64.0% or greater, the adjusted commission rate for the underwriting year under consideration shall be 23.5% 2. If the ratio of losses incurred to premiums earned is less than 64.0%, but not less than 60.0%, the adjusted commission rate for the underwriting year under consideration shall be 23.5%, plus the difference in percentage points between 64.0% and the actual ratio of losses incurred to premiums earned; 3. If the ratio of losses incurred to premiums earned is less than 60.0%, but not less than 47.5%, the adjusted commission rate for the underwriting year under consideration shall be 27.5% plus 60.0% of the difference in percentage points between 60.0% and the actual ratio of losses incurred to premiums earned; 4. If the ratio of losses incurred to premiums earned is 47.5% or less, the adjusted commission rate for the underwriting year under consideration shall be 35.0%. D. If the ratio of losses incurred to premiums earned for any underwriting year is greater than 64.0%, the difference in percentage points between the actual ratio of losses incurred to premiums earned and 64.0% shall be multiplied by premiums earned for the underwriting year and the product shall be carried forward to the next underwriting year as a debit to losses incurred. If the ratio of losses incurred to premiums earned for any period is less than 47.5%, the difference in percentage points between 47.5% and the actual ratio of losses incurred to premiums earned shall be multiplied by premiums earned for the underwriting year and the product shall be carried forward to the next underwriting year as a credit to losses incurred. E. Within 30 days after the end of each underwriting year the Company shall calculate and report the adjusted commission on premiums earned for the underwriting year. If the adjusted commission on premiums earned is less than commissions previously allowed by the Reinsurer on premiums earned for the underwriting year, the Company shall remit the difference to the Reinsurer with its report. If the adjusted commission on premiums earned is greater than commissions previously allowed by the Reinsurer on premiums earned for the underwriting year, the Reinsurer shall remit the difference to the Company as promptly as possible after receipt and verification of the Company's report. F. In the event the adjusted commission calculation for any underwriting year is based partly on ceded reserves for losses and/or loss adjustment expense, the adjusted commission shall be recalculated within 30 days after the end of each subsequent underwriting year until all losses under policies with effective or renewal dates during the underwriting year have been settled. Any balance shown to be due either party as a result of any such recalculation shall be remitted promptly by the other party. G. "Losses incurred" as used herein shall mean ceded losses and loss adjustment expense paid as of the effective date of calculation, plus the ceded reserves for losses and loss adjustment expense outstanding as of the same date, plus the debit or minus the credit from the preceding underwriting year, it being understood and agreed that all losses and related loss adjustment expense under policies with effective or renewal dates during an underwriting year shall be charged to that underwriting year, regardless of the date said losses actually occur, unless this Contract is terminated on a "cutoff" basis, in which event the Reinsurer shall have no liability for losses occurring after the effective date of termination. H. "Premiums earned" as used herein shall mean ceded net written premiums for policies with effective or renewal dates during the underwriting year, less the unearned portion thereof as of the effective date of calculation, it being understood and agreed that all premiums for policies with effective or renewal dates during an underwriting year shall be credited to that underwriting year, unless this Contract is terminated on a "cutoff" basis, in which event the unearned reinsurance premium (less previously allowed ceding commission) as of the effective date of termination shall be returned by the Reinsurer to the Company. I. It is expressly agreed that the ceding commission allowed the Company includes provision for all dividends, commissions, taxes, assessments, and all other expenses of whatever nature, except loss adjustment expense. Article XII - Reports and Remittances A. As promptly as possible after the effective date of this Contract, the Company shall remit the Reinsurer's share of the unearned premium (less provisional commission thereon) applicable to subject business in force at the effective date of this Contract. B. Within 30 days after the end of each month, the Company shall report to the Reinsurer: 1. Ceded net written premium for the month; 2. Ceded net collected premium for the month; 3. Provisional commission on (2) above; 4. Ceded losses and loss adjustment expense paid during the month; 5. Ceded unearned premiums and ceded outstanding loss reserves as of the end of the month. Within 45 days after the end of each month, the positive balance of (2) less (3) less (4) shall be remitted by the Company. Any balance shown to be due the Company shall be remitted by the Reinsurer within 45 days after the end of the month of account. B. Annually, the Company shall furnish the Reinsurer with such information as the Reinsurer may require to complete its Annual Convention Statement. Article XIII - Late Payments A. 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 XXIII (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. 1/365ths of the 6-month United States Treasury Bill rate as quoted in The Wall Street Journal on the first business day of the month for which the calculation is 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 30 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 5 business days after the proof of loss or demand for payment is transmitted to the Reinsurer. If such loss or claim payment is not received within the 5 days, interest will accrue on the payment or amount overdue in accordance with paragraph B above, from the date the proof of loss or demand for payment was transmitted to the Reinsurer. 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 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 10 business days following transmittal 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 a Subscribing Reinsurer from contesting the validity of any claim, or from participating in the defense or control of any claim or suit, or prohibiting 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. 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 XIV - 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 XV - 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 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 - Taxes (BRMA 50B) 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 or the District of Columbia. Article XVIII - Unauthorized Reinsurers A. If the Reinsurer is unauthorized in any state of the United States of America or the District of Columbia or rated B+ or less by A.M. Best, the Reinsurer agrees to fund its share of the Company's ceded unearned premium and outstanding loss and loss adjustment expense reserves (including incurred but not reported loss reserves) 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. 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 policy cancellations, unless paid in cash by the Reinsurer; 2. To reimburse itself for the Reinsurer's share of losses and/or loss adjustment expense paid under the terms of policies 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 incurred but not reported loss reserves) 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 incurred but not reported loss reserves), 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 B(1), B(2) or B(4), or in the case of B(3), the actual amount determined to be due, the Company shall promptly return to the Reinsurer the excess amount so drawn. 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 policy 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 policy 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, 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 or Lloyd's London Underwriters. In the event that either party should fail to choose an Arbiter within 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 30 days following their appointment, each Arbiter shall nominate three candidates within 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 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 at El Segundo, California unless otherwise mutually agreed upon by the parties to this Contract, but notwithstanding the location of the arbitration, all proceedings pursuant hereto shall be governed by the law of the state in which the Company has its principal office. 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 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 XXII - Agency Agreement If more than one reinsured company is named as a party to this Contract, the first named company shall be deemed the agent of the other reinsured companies 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 XXIII - 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. In Witness Whereof, the Company by its duly authorized representative has executed this Contract as of the date undermentioned at: El Segundo, California, this _______ day of _______________________199___. ------------------------------------------------- Condor Insurance Company Table of Contents Article Page I Classes of Business Reinsured 1 II Commencement and Termination 1 III Territory 3 IV Exclusions 3 V Retention and Limit 4 VI Assessments 4 VII Loss in Excess of Policy Limits/ECO 5 VIII Claims and Loss Adjustment Expense 5 IX Salvage and Subrogation 6 X Original Conditions 6 XI Sliding Scale Commission 6 XII Reports and Remittances 8 XIII Late Payments 9 XIV Offset (BRMA 36C) 10 XV Access to Records (BRMA 1D) 10 XVI Errors and Omissions (BRMA 14F) 11 XVII Taxes (BRMA 50B) 11 XVIII Unearned Premium and Loss Reserves 11 XIX Insolvency 12 XX Arbitration 13 XXI Service of Suit (BRMA 49C) 14 XXII Agency Agreement 14 XXIII Intermediary (BRMA 23A) 15 -----END PRIVACY-ENHANCED MESSAGE-----