-----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, E0fQl/qK6CtJFxnx946DV4leLoJowaLbRgbp1h4iLOkIVqR+guMuxTuaiOUt5xlZ 9JNZxYMvLDI3Q5e9fC5MIw== 0000780118-99-000007.txt : 19990402 0000780118-99-000007.hdr.sgml : 19990402 ACCESSION NUMBER: 0000780118-99-000007 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 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: 99581852 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 --
7 1,000 U.S. Dollars 12-mos Dec-31-1998 jan-01-1998 Dec-31-1998 1 107,227 0 0 14,837 0 0 128,640 2,431 16,073 20,209 216,291 42,244 51,627 0 0 14,500 0 0 39 61,863 216,291 105,971 6,651 4,400 0 40,831 51,090 14,172 9,012 2,743 6,269 0 0 0 6,269 1.62 1.59 33,338 43,420 (2,589) (24,992) (16,770) 32,407 0
10-K 2 AMWEST INSURANCE GROUP, INC. 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, 1998 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, 1999, 3,922,886 shares of common stock, $.01 par value, were outstanding. As of March 26, 1999, 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 $25,192,134. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive proxy statement for the 1998 Annual Meeting of stockholders (incorporated by reference under Part III). TABLE OF CONTENTS PART I Item Page 1. Business 1 General 1 Products 2 Underwriting and Collateral 4 Statutory Net Premiums Written to Statutory Policyholders' Surplus Ratio 6 Combined Ratios 7 Reinsurance 7 Reserves 8 Investments 13 Marketing and Growth 16 The Safety Association 17 Competition 17 Employees 17 Government Regulation 18 2. Properties 18 3. Legal Proceedings 19 4. Submission of Matters to a Vote of Security Holders 19 PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters 20 Market Information 20 Holders 20 Dividends 20 6. Selected Financial Data 21 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 23 Results of Operations 23 Liquidity and Capital Resources 26 Market Risk 27 Other Matters 28 8. Financial Statements and Supplementary Data 31 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 31 PART III 10. Directors and Executive Officers of the Registrant 32 11. Executive Compensation 32 12. Security Ownership of Certain Beneficial Owners and Management 32 13. Certain Relationships and Related Transactions 32 PART IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 33 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 30 branch and field 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. The Company's surety division underwrites 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 bonds up to $25 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 $2.9 billion in surety net premiums in 1997. The Company ranked 10th nationally when measured by gross premiums written for all companies writing surety in 1997. 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 3rd when measured by gross premiums written for all companies writing surety in 1997. The Company's property and casualty division 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 addition to its commercial policies, the Company offers non-standard private passenger automobile insurance in the states of California and Arizona and homeowners coverage in the states of California, Florida and Hawaii and motorcycle insurance in the state of New York. The Company was incorporated in California on August 19, 1970 and redomesticated in Delaware on September 11, 1987. The Company's insurance subsidiaries, Amwest Surety, Condor and Far West, are domiciled in Nebraska. 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 45 states and the District of Columbia and Condor is licensed in California, Arizona, Idaho, Montana, Nebraska, Nevada 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"). 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. 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. 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, 1998 1997 1996 (Dollars in thousands) ----------------------------------------------------------------------------------- Type of Insurance Contract performance bonds $ 62,293 46.9% $ 54,808 50.7% $49,782 51.2% Commercial Surety bonds 27,662 20.8 16,694 15.4 11,192 11.5 Court bonds 12,315 9.3 11,109 10.3 11,196 11.5 ------------- ------------- ------------- ------------- ------------- ------------- Total Surety 102,270 77.0 82,611 76.4 72,170 74.2 Specialty Property & Casualty insurance 30,549 23.0 25,480 23.6 25,072 25.8 ------------- ------------- ------------- ------------- ------------- ------------- Total $132,819 100.0% $ 108,091 100.0% $ 97,242 100.0% ============= ============= ============= ============= ============= =============
NET PREMIUMS EARNED Years ended December 31, 1998 1997 1996 (Dollars in thousands) ----------------------------------------------------------------------------------- Type of Insurance Contract performance bonds $ 52,491 49.5% $ 46,741 50.7% $46,158 52.5% Commercial Surety bonds 20,233 19.1 12,786 13.9 8,446 9.6 Court bonds 11,442 10.8 11,038 12.0 10,897 12.4 ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- Total Surety 84,166 79.4 70,565 76.6 65,501 74.5 Specialty Property & Casualty insurance 21,805 20.6 21,585 23.4 22,382 25.5 ------------- ------------- ------------- ------------- ------------- ------------- Total $105,971 100.0% $ 92,150 100.0% $87,883 100.0% ============= ============= ============= ============= ============= =============
LOSSES & LOSS ADJUSTMENT EXPENSES AND LOSS RATIOS Years ended December 31, 1998 1997 1996 (Dollars in thousands) ----------------------------------------------------------------------------------- Type of Insurance Contract performance bonds $ 17,447 33.2% $ 15,738 33.7% $24,430 52.9% Commercial Surety bonds 5,485 27.1 2,873 22.5 2,571 30.4 Court bonds 330 2.9 1,402 12.7 835 7.7 ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- Total Surety 23,262 27.6 20,013 28.4 27,836 42.5 Specialty Property & Casualty insurance 17,569 80.6 14,644 67.8 18,811 84.1 ------------- ------------- ------------- ------------- ------------- ------------- Total $ 40,831 38.5% $ 34,657 37.6% $46,647 53.1% ============= ============= ============= ============= ============= =============
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. Substantially all risks are underwritten utilizing indemnity agreements which may be personal, corporate or both. Such agreements indemnify the Company from losses on surety bonds and are an integral part of the underwriting process. Additionally, 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, 1998 had a value of approximately $240,452,000. 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 $22,092,000 at December 31, 1998. 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 division's 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 offices are 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 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, 1998 1997 1996 1995 1994 (Dollars in thousands) ---------------------------------------------------------------------- Statutory net premiums written $107,961 $100,034 $89,325 $82,814 $84,093 Statutory policyholders' surplus 48,600 44,312 40,298 45,361 40,467 Ratio 2.22 2.26 2.22 1.83 2.08
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, 1998 and found that it exceeded the highest level of recommended capital requirement. The Company's 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 membership adopted in March 1998, the Codification of Statutory Accounting Principles Project as the NAIC supported basis of accounting, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. The Codification Project, which will become effective on January 1, 1999, was approved with the provision for commissioner discretion in the determination of appropriate statutory accounting for insurers. Such discretion will continue to allow prescribed or permitted accounting practices that may differ from state to state. Accordingly, this project will change the definition of what comprises 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. The Company has not determined how implementation will affect its statutory financial statements and is unable to predict how insurance rating agencies will interpret or react to such changes. No assurance can be given that future legislative or regulatory changes from such activities will not adversely affect the Company. 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, 1998 1997 1996 1995 1994 ------------- ------------- -------------- ------------- ------------- Loss Ratio 38.5% 37.6% 53.1% 41.4% 35.4% Expense Ratio 61.6 62.9 58.1 62.9 62.4 ------------- ------------- -------------- ------------- ------------- Combined Ratio 100.1% 100.5% 111.2% 104.3% 97.8% ============= ============= ============== ============= =============
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 (the "Excess Treaty"). The Excess Treaty may be canceled at the election of either party by providing notice of cancellation 90 days prior to any anniversary (currently October 1), however, the reinsurers would remain liable for covered losses incurred up to the cancellation date. The amended Excess 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 for losses incurred prior to October 1, 1998 and $25,000,000 for losses incurred thereafter. 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 Excess Treaty is $26,000,000 of losses discovered during any one contract period (October 1 to October 1) for the 1997-1998 contract year and $35,000,000 for the 1998-1999 contract year. The Excess treaty also contains profit sharing provisions for the $4,000,000 excess of $2,000,000 layer of the treaty, of which no amounts are currently accrued based on experience of the treaty through December 31, 1998. The Company, effective January 1, 1997, entered into an aggregate stop-loss treaty with Underwriters Reinsurance Company (Barbados), Inc. which treaty was renewed for the 1998 accident year. This contract has a limit of approximately $7,000,000 of losses and loss adjustment expenses incurred for the 1998 accident year. On the surety lines of business when losses and loss adjustment expenses exceed 32.8% of net earned premiums and for all other lines when losses and loss adjustment expenses exceed 67% of net earned premiums the reinsurer becomes liable for losses. The Company has 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, 1998 and 1997, the Company ceded $2,533,000 and $0, respectively, in losses to the stop-loss treaty. 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. The Company also purchased a quota share reinsurance treaty with Underwriters Reinsurance Company, a New Hampshire domiciled reinsurer which was effective July 1, 1998. This treaty cedes 15% of net surety written premium for all surety written through Amwest Surety Insurance Company on a pro rata basis. 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, 1997 to June 30, 1998 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 commercial automobile 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, California homeowners and Florida homeowners programs differ from the above. For Hawaiian homeowners, 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 75% quota share reinsurance agreement with a limit of $7,500,000 per occurrence. For Florida homeowners, the Company is a party to a 75% quota share reinsurance agreement with a limit of 200% of the actual gross premiums written in any policy year. Additionally, the Company participates in the Florida Hurricane Catastrophe Fund as a 90% participant. Recoveries from this Fund are limited to hurricanes and are based on a formula which utilizes, among other factors, premiums written, industry premiums written, industry losses and amounts available in the fund. 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, estimated offsets to the claimed amount, such as collateral, contract funds and indemnity agreements, 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, 1998 1997 1996 (Dollars in thousands) ----------------------------------------- Statutory liability for losses and loss adjustment expenses at beginning of year $33,338 $35,876 $24,246 Provision for losses and loss adjustment expenses occurring in current year 43,420 35,212 45,853 Increase (decrease) in estimated losses and loss adjustment expenses for claims occurring in prior years (2,589) (555) 794 ------------- ------------- ------------- 40,831 34,657 46,647 ------------- ------------- ------------- Losses and loss adjustment expense payments for claims occurring during: Current year (24,992) (15,095) (21,638) Prior years (16,770) (22,100) (13,379) ------------- ------------- ------------- (41,762) (37,195) (35,017) ------------- ------------- ------------- Statutory liability for losses and loss adjustment expenses at end of year $32,407 $33,338 $35,876 ============= ============= ============= (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 surety loss and loss adjustment expense ratios remained constant at 28% for 1997 and 1998. The 1998 ratio includes the impact of the excess of loss and the aggregate stop loss reinsurance treaties. During 1998 $4,168,000 was ceded in premiums on these treaties with $4,100,000 ceded in losses. In 1997 $2,987,000 was ceded in premiums with no losses ceded to the reinsurers. Competitive market conditions and the Company's ability to write surety bonds for larger contractors has resulted, on many bonds, in the substitution of indemnity agreements for liquid and non-liquid collateral. The Company, through its ongoing reserve analysis, has estimated the benefit to be derived from such agreements and reduced estimates of ultimate losses incurred accordingly. In the fourth quarter of 1998, the Company increased its estimate of such "salvage and subrogation" recoveries by approximately $5.4 million which is partially attributable to salvage and subrogation on losses incurred during the fourth quarter. The increase relates primarily to the 1998 and 1997 years and reflects the Company's belief that the underlying data is maturing. Further, subsequent collection efforts have proven prior estimates to be conservative. Since the Company had also pierced it's aggregate excess contract in the fourth quarter, the net benefit attributable to the increased "salvage and subrogation" estimate was approximately $1,025,000. 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, 1998 1997 1996 (Dollars in thousands) -------------------------------------- Reserves reported on a SAP basis $32,407 $33,338 $35,876 Net reinsurance recoverable on unpaid loss and loss adjustment expenses 9,837 6,185 6,133 ------------- ------------ ----------- Reserves reported on a GAAP basis $42,244 $39,523 $42,009 ============= ============ =========== 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 12 discloses the cumulative development of unpaid losses and loss adjustment expenses of the Company from 1988 through 1998. 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, 1998 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 12 represents the aggregate change in the estimates over prior years. For example, the 1992 liability has developed a $6,086,000 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) 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 ----------------------------------------------------------------------------------------------------------- Net liability for losses & loss adjustment expenses $3,528 $13,169 $23,199 $23,269 $24,860 $28,641 $26,584 $24,246 $35,876 $33,338 $32,407 Net paid (cumulative) as of: One year later 4,000 5,426 9,892 9,826 11,224 15,862 18,318 13,379 22,100 16,770 - Two years later 4,021 8,146 14,386 14,473 16,896 23,547 24,579 22,934 28,301 Three years later 3,915 9,301 17,057 16,464 18,576 26,659 28,010 24,256 Four years later 3,693 10,996 18,261 16,654 18,902 27,303 27,446 Five years later 3,723 11,642 17,976 16,795 18,962 27,089 Six years later 4,519 11,646 18,074 16,838 18,618 Seven years later 4,425 11,583 18,227 16,463 Eight years later 4,318 11,434 17,965 Nine years later 4,291 11,455 Ten years later 4,314 Net liability re-estimated as of: One year later 5,513 12,247 20,580 20,560 21,937 26,860 26,343 25,040 35,322 30,749 - Two years later 4,650 10,463 18,890 18,401 19,565 25,943 28,540 26,237 33,998 Three years later 3,809 11,071 18,871 17,810 18,695 27,699 28,415 26,141 Four years later 4,020 11,622 18,654 16,664 19,048 26,914 28,675 Five years later 4,050 11,706 17,982 16,784 18,720 27,273 Six years later 4,483 11,628 17,943 16,589 18,774 Seven years later 4,429 11,542 17,994 16,565 Eight years later 4,319 11,204 18,005 Nine years later 4,301 11,483 Ten years later 4,330 Net Reserve Redundancy (Deficiency): ($802) $1,686 $5,194 $6,704 $6,086 $1,368 ($2,091) ($1,895) $1,878 $2,589 - =========================================================================================================== Net redundancy (deficiency) as a percent of original (23%) 13% 22% 29% 24% 5% (8%) (8%) 5% 8% - net liability: =========================================================================================================== Gross liability for losses and loss adjustment expenses 46,614 34,653 31,915 42,009 39,523 43,004 Ceded liability for losses and loss adjustment expenses (17,973) (8,069) (7,669) (6,133) (6,185) (10,597) ------------------------------------------------------------- Net liability for losses and loss adjustment expenses 28,641 26,584 24,246 35,876 33,338 32,407 ============================================================= Gross liability re-estimated 39,878 38,492 31,861 39,870 37,278 Ceded liability re-estimated (12,605) (9,817) (5,720) (6,492) (6,529) ---------------------------------------------------- Net liability re-estimated 27,273 28,675 26,141 33,998 30,749 ==================================================== Gross Reserve Redundancy (Deficiency) 6,736 (3,839) 54 2,139 2,245 ==================================================== 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, 1998, the market value of all state deposits was approximately $14,170,000. The following table sets forth the composition of the Company's investment portfolio at the dates indicated:
December 31, 1998 1997 1996 1995 1994 (Dollars in thousands) --------------------------------------------------------------------- Fixed maturities, held-to-maturity, at amortized cost: Bonds: U.S. Government $ - $ - $ - $ - $ 10,850 Mortgage backed securities - - - - 696 States, municipalities and political subdivisions - - - - 3,524 Certificates of deposit, at cost - - - - 50 ------------- ------------- ------------- ------------- ------------- Total - - - - 15,120 ------------- ------------- ------------- ------------- ------------- Fixed maturities, available-for-sale, at market (1): Bonds: U.S. Government 12,411 11,289 13,739 32,101 14,292 Asset backed securities 2,349 3,342 4,004 5,636 - Mortgage backed securities 23,070 17,754 24,245 17,723 27,904 States, municipalities and political subdivisions 37,329 27,845 26,608 34,952 34,374 Other 29,413 34,612 27,848 20,284 22,080 Redeemable preferred stock, at market (1) 2,655 3,904 6,050 6,495 8,280 ------------- ------------- ------------- ------------- ------------- Total 107,227 98,746 102,494 117,191 106,930 ------------- ------------- ------------- ------------- ------------- Total fixed maturities 107,227 98,746 102,494 117,191 122,050 Common equity securities, at market (1) 10,572 10,297 9,779 8,689 7,386 Preferred equity securities, at market (1) 4,265 2,894 4,253 3,592 2,321 Other invested assets 4,375 6,455 2,849 797 - Short-term investments, at cost 2,201 2,281 890 745 2,289 ------------- ------------- ------------- ------------- ------------- Total investments 128,640 120,673 120,265 131,014 134,047 Interest bearing cash equivalents (2) 2,431 3,807 6,434 5,232 4,032 ------------- ------------- ------------- ------------- ------------- Total investments and cash equivalents $131,071 $124,480 $126,699 $136,246 $138,079 ============= ============= ============= ============= ============= (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, 1998, 1997 and 1996 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, 1998 1997 1996 1995 1994 Investment Results: (Dollars in thousands) ------------------------------------------------------------------ Average invested assets (includes short-term investments) $127,776 $125,590 $131,473 $137,162 $138,195 Net investment income 6,651 6,396 6,807 7,863 7,337 Average annual yield on investments: Fixed maturities 5.86% 5.88% 5.83% 6.15% 5.93% Equity securities 4.90 3.95 3.11 4.53 2.32 Short-term investments 4.31 3.49 4.93 8.21 4.78 ------------ ------------- ------------ ------------ ------------- Effective yield total investments 5.51 5.40 5.44 6.10 5.65 Less investment expense (0.31) (0.31) (0.26) (0.37) (0.34) ============ ============= ============ ============ ============= Total investment yield 5.21% 5.09% 5.18% 5.73% 5.31% ============ ============= ============ ============ ============= Average annual return on investments (1) 7.5% 10.10% 6.14% 14.01% (0.72%) ============ ============= ============ ============ ============= (1) Average annual return is net investment income, realized gains (losses) and the change in unrealized gains (losses) divided by average invested assets.
The amortized cost and estimated market value of fixed maturities at December 31, 1998, 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. Amortized Cost Estimated Market Value Fixed maturities due: (Dollars in thousands) ---------------------------------- Within 1 year $ 6,492 $ 6,519 Beyond 1 year but within 5 years 35,139 35,882 Beyond 5 years but within 10 years 35,064 35,234 Beyond 10 years but within 20 years 14,416 14,896 Beyond 20 years 14,244 14,696 ---------------- ----------------- $105,355 $107,227 ================ ================= 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 23.3% and 23.4% of surety premiums written for the years ended December 31, 1998 and 1997, respectively. The Company's contract performance and commercial surety bonds are distributed through a network of 30 branch and field 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 it 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. 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 therefore 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, 1998, the total number of producers placing specialty property and casualty coverage was approximately 250. 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 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. Effective June 30, 1998, the Company purchased the Safety Association and merged its operations into Condor. 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. The acquisition of The Safety Association was not material to the consolidated financial statements of the Company. 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 competition. The Company competes for surety business in the 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 enable 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, 1998, the Company employed 518 people. GOVERNMENT REGULATION The Company's insurance subsidiaries are domesticated in the state of Nebraska. Accordingly, the Company is 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 and other transfers, 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, and accordingly, its Hawaiian policies exclude wind coverage over 75 miles per hour. Additionally, the Company participates in the Florida Hurricane Catastrophe Fund as a 90% participant. Recoveries from this Fund are limited to hurricanes and are based on a formula which utilizes, among other factors, premiums written, industry premiums written, industry losses and amounts available in the fund. As a participant, the Company could be assessed in the event the above Funds sustain hurricane losses. The Company 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. ITEM 2. PROPERTIES The Company leases all of its office space which, as of December 31, 1998, totaled approximately 166,000 square feet. The home office aggregates approximately 63,000 square feet. Branch locations range from 1,000 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 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 home office building and land commencing on April 27, 2000 and extending for a six month 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. 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 1996 (1) First Quarter 14 12 1/4 .10 Second Quarter 12 5/8 10 5/8 .10 Third Quarter 11 3/8 10 1/2 .10 Fourth Quarter 12 1/2 10 1/4 .10 1997 (1) First Quarter 12 3/8 10 5/8 .10 Second Quarter 13 5/8 10 5/8 .10 Third Quarter 15 3/8 13 1/2 .10 Fourth Quarter 14 3/4 12 1/2 .10 1998 First Quarter 15 13 1/4 .10 Second Quarter 16 7/8 14 5/8 .10 Third Quarter 14 1/2 13 1/4 .10 Fourth Quarter 14 1/2 13 .10 (1) Amounts reflect a 10% stock dividend effective March 31, 1998. On March 26, 1999, the closing price of the Company's Common Stock on the American Stock Exchange was $11.00 per share. HOLDERS As of March 26, 1999, there were 321 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, 1998, are derived from the consolidated financial statements of Amwest Insurance Group, Inc. and subsidiaries, which financial statements have been audited by KPMG LLP, independent certified public accountants. The consolidated financial statements as of December 31, 1998 and 1997 and for each of the years in the three year period ended December 31, 1998 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, 1998 1997 1996 1995 1994 ------------------------------------------------------------------------------- Summary of Earnings: Net premiums earned $ 105,971 $ 92,150 $ 87,883 $ 85,170 $ 81,289 Underwriting expenses 106,093 92,618 97,710 88,847 79,537 Underwriting income (loss) (122) (468) (9,827) (3,677) 1,752 Net investment income 6,651 6,396 6,807 7,863 7,337 Realized gains 4,400 3,473 2,201 2,176 65 Income (loss) before income taxes 9,012 7,435 (5,046) 4,498 6,393 Provision (benefit) for income taxes 2,743 1,937 (2,360) 829 1,352 Net income (loss) $ 6,269 $ 5,498 $ (2,686) $ 3,669 $ 5,041 =============================================================================== Per share (1): Basic $ 1.62 $ 1.48 $ (.74) $ 1.01 $ 1.39 =============================================================================== Diluted $ 1.59 $ 1.46 $ (.74) $ .99 $ 1.37 =============================================================================== Cash dividends $ 0.40 $ 0.44 $ 0.44 $ 0.40 $ 0.36 =============================================================================== Year End Financial Position: Total investments $128,640 $ 120,673 $120,265 $131,014 134,047 Total assets 216,291 190,519 181,418 183,833 186,863 Bank indebtedness 14,500 14,500 12,500 12,500 12,500 Total stockholders' equity 61,902 57,179 49,932 55,075 46,157 Average stockholders' equity 59,541 53,558 52,504 50,616 47,252 Return on stockholders' equity 10.53% 10.27% (5.12%) 7.25% 10.67% Operating Ratios: Loss & loss adjustment expenses 38.53% 37.61% 53.08% 41.41% 35.35% Policy acquisition costs 48.21% 49.22% 43.66% 44.70% 45.03% General operating expenses 13.37% 13.68% 14.45% 16.80% 19.21% Other operating expenses - - - 2.35% - Combined ratios 100.11% 100.53% 111.18% 105.25% 99.60% (1) Amounts reflect a 10% stock dividend effective March 31, 1998.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS Year ended December 31, 1998 compared to year ended December 31, 1997 Gross premiums written increased 23% from $108,091,000 in 1997 to $132,819,000 in 1998. Premium growth for the surety division was 24%, with the commercial surety product showing the largest growth, up 66% from $16,694,000 in 1997 to $27,662,000 in 1998. Management believes that this growth is attributable to continued emphasis on this product and a strengthening of our servicing and underwriting capabilities for commercial surety during 1998. In addition, the Company's bail product grew 11% from $11,109,000 in 1997 to $12,315,000 in 1998 due primarily to increased penetration of this product in Missouri, Oklahoma and Texas. Contract surety premiums grew 14% from $54,808,000 in 1997 to $62,293,000 in 1998. Of this amount, 8% was the product of acquisitions completed during late 1997 and 6% was internally generated. Property and Casualty Division premiums grew 20% primarily due to the implementation of the Division's California non-standard automobile program and specialty motorcycle program in New York State. Net premiums earned increased 15% from $92,150,000 in 1997 to $105,971,000 in 1998. The increase in net premiums earned reflects the increased premium writings partially offset by increased premiums ceded as a result of changes in the Company's reinsurance program during 1998. Net losses and loss adjustment expenses increased 18% from $34,657,000 in 1997 to $40,831,000 in 1998. This resulted in a slight increase in the loss and loss adjustment expense ratio from 37.6% in 1997 to 38.5% in 1998. The increased loss ratio is primarily attributable to an increase in the loss and loss adjustment expense ratio for the property and casualty division whose loss and loss adjustment expense ratio was 80.6% for the year ended December 31, 1998, compared to 67.8% for the year ended December 31, 1997. Substantially all of this increase is attributable to adverse development of prior year commercial auto and general liability reserves as a result of ongoing reserve analysis performed by the Company. During 1998, the Company completed several organizational changes within the P&C claims and legal departments, partially in response to the noted adverse development of prior year reserved amounts and also to both strengthen the Company's in-house capabilities and streamline the expense structure of settling P&C claims. Management believes that these changes will strengthen the Company's reserving and claims settlement practices. The surety loss and loss adjustment expense ratios remained constant at 28% for 1997 and 1998. The 1998 ratio includes the impact of the excess of loss and the aggregate stop loss reinsurance treaties. During 1998 $4,168,000 was ceded in premiums on these treaties with $4,100,000 ceded in losses. In 1997 $2,987,000 was ceded in premiums with no losses ceded to the reinsurers. Competitive market conditions and the Company's ability to write surety bonds for larger contractors has resulted, on many bonds, in the substitution of indemnity agreements for liquid and non-liquid collateral. The Company, through its ongoing reserve analysis, has estimated the benefit to be derived from such agreements and reduced estimates of ultimate losses incurred accordingly. In the fourth quarter of 1998, the Company increased its estimate of such "salvage and subrogation" recoveries by approximately $5.4 million which is partially attributable to salvage and subrogation on losses incurred during the fourth quarter. The increase relates primarily to the 1998 and 1997 years and reflects the Company's belief that the underlying data is maturing. Further, subsequent collection efforts have proven prior estimates to be conservative. Since the Company had also pierced it's aggregate excess contract in the fourth quarter, the net benefit attributable to the increased "salvage and subrogation" estimate was approximately $1,025,000. Policy acquisition costs as a percentage of net premiums earned decreased from a ratio of 49% or $45,355,000 in 1997 to 48% or $51,090,000 in 1998. The decrease is primarily attributable to an increase in commissions earned by the Company on its quota share reinsurance treaties. General operating costs decreased as a percentage of net premiums earned from 14% or $12,606,000 in 1997 to 13% or $14,172,000 in 1998. The decrease in the ratio is due to increased efficiency in servicing an increased premium base. The 1998 amounts include a non-recurring $319,000 charge in connection with the disposition and write-off of the Company's New York probate operation. The Company's underwriting loss decreased from $468,000 for the year ended December 31, 1997 to $122,000 for the year ended December 31, 1998. The combined ratio decreased from 100.5% in 1997 to 100.1% in 1998. The decrease in the underwriting loss is primarily attributable to improved performance in the Company's surety product lines offset by increased losses in the Property & Casualty Division as previously discussed. Interest expense remained relatively flat at $1,966,000 in 1997 compared with $1,917,000 in 1998. At December 31, 1997 and 1998, the collateral balances accrued interest daily at an average rate of 3.7% per annum for both years. Additionally, the average interest rate on the bank indebtedness increased from an average rate of 7.3% during 1997 to an average rate of 7.4% during 1998 due to fluctuations during 1998 in the London Interbank Offered (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, 1998 was 7.1%. Net investment income and realized investment gains increased 12% from $9,869,000 in 1997 to $11,051,000 in 1998. This increase is primarily due to an increase in realized investment gains from $3,473,000 during 1997 to $4,400,000 during 1998. In addition, net investment income before realized investment gains increased 4% from $6,396,000 to $6,651,000 due to higher average invested balances during 1998. Income before income taxes increased from $7,435,000 in 1997 to $9,012,000 in 1998 due to the factors outlined above. The effective tax rate was 26% for 1997 and 30% for 1998. 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 offset by certain non-deductible expenses. Additionally, due to various factors arising during 1997, the Company eliminated its valuation allowance on its deferred tax assets, which further lowered the 1997 effective tax rate. Net income was $5,498,000 in 1997 and $6,269,000 in 1998 due to the factors outlined above. 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% of $38,367,000 in 1996 to 49.2% or $45,355,000 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 offices 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 in 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. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 1998, the Company had total cash and cash equivalents and investments of $131,071,000. Included in these amounts is an aggregate of $30,542,000 in funds held which are shown as a liability on the Company's consolidated balance sheet. As of December 31, 1998, the Company's investment balances were comprised of $107,227,000 in fixed maturities held at market, $10,572,000 in common equity securities, $4,265,000 in preferred equity securities, $4,375,000 in other invested assets and $2,201,000 in short-term investments. The Company's off balance sheet collateral which primarily consists of irrevocable letters of credit and certificates of deposit increased from $211,981,000 at December 31, 1997 to $218,360,000 at December 31, 1998. This increase is primarily attributable to market conditions. In addition, funds held increased from $23,116,000 at December 31, 1997 to $30,542,000 at December 31, 1998. 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 increase in this amount is primarily attributed to deposits attributable to the "Safety Association" which the Company acquired during 1998. 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 waived and amended as of September 30, 1997 and 1998 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, 1998 was 7.1 %. 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 1999 is approximately $932,000. The Company has the option to purchase this home office building and land commencing on April 27, 2000 and extending for a six month 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, 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 1999. The Company generated $1,396,000, used $1,539,000 and used $697,000 in cash from operating activities in the fiscal years ended December 31, 1996, 1997 and 1998, respectively. The Company generated $8,691,000, generated $3,835,000 and used $7,526,000 in cash for investing activities for the fiscal years ended December 31, 1996, 1997 and 1998, respectively. The Company used $8,885,000, used $4,924,000 and generated $6,847,000 in cash from financing activities for the fiscal years ended December 31, 1996, 1997 and 1998, respectively. The cash used for investing activities in 1998 was funded principally by financing activities. The effect of inflation on the revenues and net income of the Company during all three periods discussed above was not significant. MARKET RISK The main objective in managing the investment portfolios of the Company is to maximize total investment returns while minimizing credit risks, in order to provide maximum support to the insurance underwriting operations. Investment strategies are developed based on many factors including expected underwriting results, tax position, regulatory requirements, fluctuations in interest rates and consideration of other market risks. Investment decisions are primarily managed by the Company's investment advisors based on guidelines established by management and approved by the board of directors. Market risk represents the potential for loss due to adverse changes in the fair value of financial instruments. The market risks related to financial instruments of the Company primarily relate to the investment portfolio, which exposes the Company to risks related to interest rates and, to a lesser extent, credit quality, prepayment and equity prices. Interest rate risk is the price sensitivity of a fixed income security to changes in interest rates. Since most of the Company's property and casualty business is short-tailed in nature, the Company has established duration guidelines to be commensurate with our liabilities. Our guidelines have established duration of the portfolio to be between 2-5 years. The following table provides information about all our fixed maturity investments which are sensitive to changes in interest rates. The table presents cash flows of principal amounts and related weighted average interest rates by expected maturity dates at December 31, 1998. The cash flows are based on the earlier of the call date or the maturity date or, for mortgage-backed securities, expected payment patterns. Actual cash flows could differ from the expected amounts.
December 31, December 31, 1998 Estimated There-After Amortized Market 1999 2000 2001 2002 2003 Cost Value ----------- ------------ ----------- ----------- ----------- ------------- -------------- ------------- (Dollars in thousands) Tax-exempt $1,500 $2,750 $4,995 $1,000 $2,400 $22,625 $36,376 $37,329 Average interest rate 3.74% 3.59% 3.77% 4.22% 3.97% 4.79% -- -- Taxable - other than mortgage-backed securities $3,340 $2,167 $ 4,700 $4,584 $4,432 $28,517 $45,821 $46,828 Average interest rate 4.49% 5.86% 5.23% 5.18% 5.52% 6.25% -- -- Mortgage-backed securities $1,595 $3,371 $ 963 $ 708 $2,900 $13,294 $23,158 $23,070 Average interest rate 5.13% 5.85% 5.32% 5.84% 5.03% 6.86% -- -- =========== ============ =========== =========== =========== ============= ============== ============= Total $6,435 $8,288 $10,658 $6,292 $9,732 $64,436 $105,355 $107,227 =========== ============ =========== =========== =========== ============= ============== =============
Prepayment risk refers to the changes in prepayment patterns related to decreases and increases in interest rates than can either shorten or lengthen the expected timing of the principal repayments and thus the average life and the effective yield of a security. Such risk exists primarily within the portfolio of mortgage-backed securities. Equity market risk is defined as the chance that market influences will affect the expected returns of all equities. Returns are influenced not only by the fundamental attributes of investment securities, but by the price movements of the general marketplace. Much of this depends on the sensitivity to the overall market of the individual issue. The Company attempts to reduce this risk through diversification and a focus on high quality, blue chip investments. OTHER MATTERS Year 2000 Issues: The Company and its third party vendors are highly reliant on the use of computers and embedded technology for the conduct of its business. Accordingly the Company has, for several years, been in the process of analyzing, and to the extent necessary either replacing non-year 2000 (Y2K) compliant systems or fixing non-compliant Y2K systems in order to make them Y2K compliant. The following is a summary of the Company's efforts to date with respect to Y2K issues: The Company's State of Readiness: The Company has summarized its exposure to Y2k issues by four general categories which are: 1. Corporate Systems 2. Surety Specific Systems 3. Property and Casualty Systems 4. Third Party (Vendor) Systems The Company's state of readiness with respect to each of these categories is as follows: Corporate Systems: The Company has five significant corporate wide applications which include Oracle financials, the system providing electronic interface between Oracle financials and the Company's bank, fixed asset accounting, payroll, reinsurance and corporate e-mail. The Company has completed its assessment of these systems and believes that all of these systems other than the reinsurance system are Y2K compliant. This conclusion is based on either certifications received from the third party vendor(s) supplying the system or testing performed by the Company for internally developed or modified systems. As stated the only currently deployed corporate system which the Company believes to be non-Y2K compliant is the reinsurance system. The Company is currently analyzing whether to replace the system with a different Y2K compliant product or modify the current system to make it Y2K compliant. Currently the Company estimates that the current version would require one person month to make this system compliant. Surety Specific Systems: The Company has fourteen surety specific systems which vary in their significance from critical (such as the surety production system commonly known as ABS) to non-critical applications which only affect a small portion of the surety business (such as several retail bail production systems). The Company has completed its assessment of its fourteen surety specific systems and believes that all of the mission critical surety specific systems are Y2K compliant other than the Company's probate production system, cash collateral system and one bail system. This conclusion is based on either certifications received from the third party vendor(s) supplying the system or testing performed by the Company for internally developed or modified systems. The Company is currently in the process of modifying its ABS system in order for it to be used for probate production and is proceeding with completing system changes for the cash collateral and bail systems. The Company expects that these modifications will be completed during the second quarter of 1999, and will be implemented immediately thereafter. Property and Casualty Systems: The Company has 4 mission critical systems for its property and casualty operations. These include a personal lines system supplied by an outside vendor, a commercial lines system also supplied by an outside vendor, a system for electronic transmission for the Company's program business and data replicating software supplied by an outside vendor. The Company has completed its assessment of these four systems and believes that the personal lines system, the internally developed system for electronic transmission of program business and the data replicating system are Y2K compliant while the commercial lines system is not Y2K compliant. This conclusion is based on either certifications received from the third party vendor(s) supplying the system or testing performed by the Company for internally developed or modified systems. The Company is currently in the process of developing a new commercial lines system to replace the non-Y2K compliant system supplied by an outside vendor. The Company currently estimates that this system will be completed and installed during the third quarter of 1999. Third Party (Vendor) Systems: In addition to the above systems where the Company is primarily responsible for assessing, analyzing and implementing Y2K compliant systems, the Company may also be affected by any of the agents, brokers, suppliers, financial institutions or others with whom the Company does business who may be materially affected by Y2K problems and thus indirectly affect the Company. Where appropriate, the Company has inquired as to the state of readiness with respect to these third parties, but the Company has not performed any independent Y2K testing of these systems as the Company does not believe that such independent testing would be cost justified. Costs to Address the Year 2000 Issues: The majority of the costs associated with system development of year 2000 compliant systems have been associated with the development of the ABS surety production system and the property and casualty personal and commercial lines systems. In all three of these cases, the underlying previously utilized systems had significant business related flaws, such that they needed to be replaced without regard to year 2000 compliance issues. The Company does not believe that the incremental costs of making the replacement systems Y2K compliant were or will be significant. Further, for those systems which have been modified solely to assure Y2K compliance, the Company does not believe that these costs are material. Risks of the Company's Year 2000 Issues: The Company has analyzed the risks associated with the year 2000 issues and concluded that the biggest risk which the Company can have a reasonable influence toward preventing is the lack of Y2K compliance by the commercial lines property and casualty production system. The commercial lines represent approximately $20,000,000 of written premiums for the Company and the lack of a Y2K compliant system for this business could have a significant adverse impact on the Company's results. The Company has also reviewed the underwriting risks associated with its insureds for both the property and casualty and surety products and believes that the major risk with respect to Y2K non-compliance relates to the surety product. Should Y2K problems affect the ability of the Company's principals to complete projects and pay subcontractors on a timely basis it could have a material adverse affect on the Company's surety loss ratio. Further, should Y2K problems affect the ability of obligees to pay for work performed on bonded projects, liquidity issues for principals could also impact the Company's surety loss ratio. The Company is unable to estimate the affect such risks will have on the Company's financial results. Contingency Plans: Due to the potential for sweeping problems associated with the Y2K issue, the Company believes that any contingency plan for addressing Y2K must be flexible and part of a broad based disaster recovery plan. The Company's experience with disaster recovery (the Northridge earthquake) has led it to believe that a rigid disaster recovery plan will be less effective than a flexible plan which analyzes the specific problems associated with each unique disaster and proposes solutions based on the problems encountered. Other than for the specific internal systems which are not currently Y2K compliant and for which the Company is developing contingency plans (substantially based on temporary manual intervention), the Company believes that a broad based disaster recovery plan will be more effective in addressing the multitude of potential Y2K problems. The Company has developed a disaster recovery plan and will use this plan in responding to scenarios created by the Y2K problem. Other Issues: 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 programs initiated and changes made by management, a deterioration in results of any of the Company's product lines, or a general economic decline. The Company undertakes no obligation to release publicly the results of any revisions to these forward looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements required in response to this section are submitted as part of Item 14(a) of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT For information regarding Directors and Executive Officers of the Registrant, reference is made to the Registrant's definitive proxy statement for its Annual Meeting of Stockholders to be held on May 21, 1999, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1998, 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 21, 1999, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1998, 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 21, 1999, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1998, 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 21, 1999, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1998, and which is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Financial Statements The index to the consolidated financial statements appears on page 38. (b) Reports on Form 8-K None. (c) Exhibits 3.1 Restated Certificate of Incorporation of the Company as amended to date. (Incorporated by reference to Exhibit 3(3)(a) to the Company's Form 8-B Registration Statement No. 1-9580.) 3.2 Bylaws of the Company. (Incorporated by reference to Exhibit 3.2 of the Company's 1990 Form 10-K.) 4.1 Specimen Common Stock Certificate. (Incorporated by reference to Exhibit 3(4) to the Company's Form 8-B Registration Statement No. 1-9580.) 10.1 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 Waiver and Amendment No. 2 dated as of February 9, 1999 to the Restated Revolving Credit Agreement dated July 10, 1996. 10.9 Casualty Excess of Loss Reinsurance Contract effective July 1, 1996 issued to Condor Insurance Company, Amwest Surety Insurance Company and Far West Insurance Company by a group of reinsurers led by Gerling Global Reinsurance Corporation. (Incorporated by reference to Exhibit 10.53 to the Company's 1996 Form 10-K.) 10.10 Contingent Excess of Loss Reinsurance Contract effective July 1, 1998 issued to Condor Insurance Company, Amwest Surety Insurance Company and Far West Insurance Company by a group of reinsurers led by Kemper Reinsurance Company. 10.11 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. (Incorporated by reference to Exhibit 10.10 to the Company's 1997 Form 10-K.) 10.12 Aggregate Stop Loss Reinsurance Contract effective January 1, 1998 issued to Amwest Surety Insurance Company, Far West Insurance Company and Condor Insurance Company by Underwriters Reinsurance Company (Barbados) Inc. 10.13 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. (Incorporated by reference to Exhibit 10.12 to the Company's 1997 Form 10-K.) 10.14 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. (Incorporated by reference to Exhibit 10.13 to the Company's 1997 Form 10-K.) 10.15 75% Florida Multiple Line Quota Share Reinsurance Contract effective July 1,1998 issued to Condor Insurance Company, Amwest Surety Insurance Company and Far West Insurance Company by a group of reinsurers led by Vesta Fire Insurance Corporation. 10.16 Quota Share Reinsurance Agreement effective July 1, 1998 issued to Amwest Surety Insurance Company by Underwriters Reinsurance Company. 10.17 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.) 10.18 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.) 10.19 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.) 10.20 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.) 10.21 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.) 10.22 Amwest Insurance Group, Inc. 1998 Stock Incentive Plan (Incorporated by reference to Exhibit 4.1 to the Company's Form S-8 Registration Statement No. 333-61819.) 10.23 Amwest Insurance Group, Inc. Employee Stock Purchase Plan (Incorporated by reference to Exhibit 99.1 to the Company's Form S-8 Registration Statement No. 333-17109.) 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 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, 1998. II Condensed Financial Information of the Registrant. III Supplementary Insurance Information 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 26, 1999 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 26,1999 - ------------------------ Richard H. Savage President, Chief Operating Officer, Co- Chief Executive Officer /s/ JOHN E. SAVAGE and Director March 26,1999 - ------------------------ John E. Savage /s/ GUY A. MAIN Executive Vice President and Direct March 26,1999 - ------------------------ Guy A. Main Senior Vice President, Chief Financial Officer, Treasurer and Director (Principal Financial and Principal /s/ STEVEN R. KAY Accounting Officer) March 26,1999 - ----------------------- Steven R. Kay /s/ NEIL F. PONT Senior Vice President and Director March 26,1999 - ------------------------ Neil F. Pont /s/ ARTHUR F. MELTON Director March 26,1999 - ------------------------ Arthur F. Melton /s/ THOMAS R. BENNETT Director March 26,1999 - ------------------------ Thomas R. Bennett /s/ BRUCE A. BUNNER Director March 26,1999 - ------------------------ Bruce A. Bunner /s/ ROBERT W. KLEINSCHMIDT Director March 26,1999 - ----------------------------- Robert W. Kleinschmidt /s/ JONATHAN K. LAYNE Director March 26,1999 - ------------------------ Jonathan K. Layne /s/ ROLAND D. MILLER Director March 26,1999 - ------------------------ Roland D. Miller /s/ CHARLES L. SCHULTZ Director March 26,1999 - ------------------------ Charles L. Schultz INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Independent Auditors' Report 39 Consolidated Financial Statements: Consolidated Statements of Operations and Comprehensive Income for the Years Ended December 31, 1998, 1997 and 1996 40 Consolidated Balance Sheets as of December 31, 1998 and 1997 41 Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996 43 Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 1998, 1997 and 1996 44 Notes to Consolidated Financial Statements 45 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, 1998 and 1997, and the related consolidated statements of operations and comprehensive income, cash flows and changes in stockholders' equity for each of the years in the three year period ended December 31, 1998. 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, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 1998, in conformity with generally accepted accounting principles. Los Angeles, California February 3, 1999 KPMG LLP
AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (Dollars in thousands, except share and per share data) Years ended December 31, OPERATIONS 1998 1997 1996 ----------------- ---------------- ----------------- Underwriting Revenues: Net premiums written $ 107,961 $100,034 $89,325 Net change in unearned premiums (1,990) (7,884) (1,442) ----------------- ---------------- ----------------- Net premiums earned 105,971 92,150 87,883 ----------------- ---------------- ----------------- Underwriting Expenses: Net losses and loss adjustment expenses 40,831 34,657 46,647 Policy acquisition costs 51,090 45,355 38,365 General operating costs and expenses 14,172 12,606 12,698 ----------------- ---------------- ----------------- Total underwriting expenses 106,093 92,618 97,710 ----------------- ---------------- ----------------- Underwriting loss (122) (468) (9,827) Interest expense (1,917) (1,966) (2,217) Merger expense - - (710) Lease termination cost - - (1,300) Net investment income 6,651 6,396 6,807 Net realized gains 4,400 3,473 2,201 ----------------- ---------------- ----------------- Income (loss) before income taxes 9,012 7,435 (5,046) ----------------- ---------------- ----------------- Provision (benefit) for income taxes: Current 2,985 761 (1,947) Deferred (242) 1,176 (413) ----------------- ---------------- ----------------- Total provision (benefit) for income taxes 2,743 1,937 (2,360) ----------------- ---------------- ----------------- Net income (loss) $ 6,269 $ 5,498 $ (2,686) ================= ================ ================= Earnings (loss) per common share: Basic $ 1.62 $ 1.48 $ (.74) ================= ================ ================= Diluted $ 1.59 $ 1.46 $ (.74) ================= ================ ================= COMPREHENSIVE INCOME (LOSS) Net income (loss) $ 6,269 $ 5,498 $ (2,686) Other comprehensive income, net of tax: Unrealized gains (losses) on securities, net of income taxes of $498, $(959) and $320, respectively 1,258 3,608 490 Reclassification adjustment for gains included in net income (2,225) (1,748) (1,108) ----------------- ---------------- ----------------- Comprehensive income (loss) $ 5,302 $ 7,358 $ (3,304) ================= ================ ================= See accompanying notes to consolidated financial statements.
AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands) December 31, 1998 1997 ---------------- ----------------- ASSETS Investments: Fixed maturities, available-for-sale (amortized cost of $105,355 and $96,516 at December 31, 1998 and 1997, respectively) $ 107,227 $ 98,746 Common equity securities, available-for-sale (cost of $7,692 and $6,856 at December 31, 1998 and 1997, respectively) 10,572 10,297 Preferred equity securities, available-for-sale (cost of $4,258 and $2,664 at December 31, 1998 and 1997, respectively) 4,265 2,894 Other invested assets (cost of $4,058 and $5,816 at December 31, 1998 and 1997, respectively) 4,375 6,455 Short-term investments 2,201 2,281 ---------------- ----------------- Total investments 128,640 120,673 Cash and cash equivalents 2,431 3,807 Accrued investment income 1,470 1,366 Agents' balances and premiums receivable (less allowance for doubtful accounts of $1,015 and $467 at December 31, 1998 and 1997, respectively) 17,309 12,511 Reinsurance recoverable: Paid loss and loss adjustment expenses 6,236 2,524 Unpaid loss and loss adjustment expenses 9,837 6,185 Ceded unearned premiums 8,584 2,039 Deferred policy acquisition costs 20,209 21,299 Furniture, equipment and improvements, net 6,267 5,355 Income taxes recoverable 951 1,581 Other assets 14,357 13,179 ---------------- ----------------- Total assets $ 216,291 $190,519 ================ =================
AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Continued) (Dollars in thousands, except share and per share data) December 31, 1998 1997 ---------------- ----------------- LIABILITIES Unpaid losses and loss adjustment expenses $ 42,244 $ 39,523 Unearned premiums 51,627 42,013 Funds held 30,542 24,434 Deferred Federal income taxes 3,185 3,925 Bank indebtedness 14,500 14,500 Amounts due to reinsurers 4,393 455 Other liabilities 7,898 8,490 ---------------- ----------------- Total liabilities 154,389 133,340 ---------------- ----------------- 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; 3,919,618 at December 31, 1998 and 3,798,141 at December 31, 1997 39 38 Additional paid-in capital 19,183 18,209 Net unrealized gains on investments carried at market, net of income taxes 3,349 4,316 Retained earnings 39,331 34,616 ---------------- ----------------- Total stockholders' equity 61,902 57,179 ---------------- ----------------- Total liabilities and stockholders' equity $ 216,291 $190,519 ================ ================= 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, 1998 1997 1996 ----------------- ---------------- ----------------- Cash flows from operating activities: Net income (loss) $ 6,269 $5,498 $ (2,686) Adjustments to reconcile net income to cash provided by operating activities: Change in agents' balances, premiums receivable and unearned premiums 4,816 6,445 (1,176) Change in accrued investment income (104) 33 174 Change in unpaid losses and loss adjustment expenses 2,721 (2,486) 10,094 Change in reinsurance recoverables and ceded unearned premiums (13,909) 293 434 Change in amounts due to/from reinsurers 3,938 110 (1,843) Change in other assets and other liabilities (3,088) (6,547) 2,737 Change in income taxes, net 388 2,346 (3,132) Change in deferred policy acquisition costs 1,090 (5,198) (2,216) Net realized gain on sale of investments (4,400) (3,478) (2,295) Net realized loss on sale of fixed assets 6 48 44 Provision for depreciation and amortization 1,576 1,398 1,261 ----------------- ---------------- ----------------- Net cash provided (used) by operating activities (697) (1,538) 1,396 ----------------- ---------------- ----------------- Cash flows from investing activities: Cash received from investments sold 74,642 52,441 59,093 Cash received from investments matured or called 18,475 8,545 7,468 Cash paid for investments acquired (98,331) (55,214) (55,197) Amortization/accretion of bonds 181 116 68 Capital expenditures, net (2,493) (2,053) (2,741) ----------------- ---------------- ----------------- Net cash provided (used) by investing activities (7,526) 3,835 8,691 ----------------- ---------------- ----------------- Cash flows from financing activities: Proceeds from issuance of long term debt - 2,000 - Proceeds from issuance of common stock 975 1,382 299 Change in funds held 7,426 (6,812) (7,722) Dividends paid (1,554) (1,494) (1,462) ----------------- ---------------- ----------------- Net cash provided (used) by financing activities 6,847 (4,924) (8,885) ----------------- ---------------- ----------------- Net increase (decrease) in cash and cash equivalents (1,376) (2,627) 1,202 Cash and cash equivalents at beginning of year 3,807 6,434 5,232 ----------------- ---------------- ----------------- Cash and cash equivalents at end of year $ 2,431 $ 3,807 $ 6,434 ================= ================ ================= Supplemental disclosure of cash flow information: Cash paid during the year for interest $ 1,917 $ 1,966 $ 2,217 Cash paid during the year for income taxes 4,023 460 848 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, 1998, 1997, and 1996 Net unrealized Common stock appreciation ----------------------- (depreciation) $.01 Additional of investments Total Shares issued par paid-in carried at Retained stockholders' value capital market earnings equity -------------- -------- -------------- ---------------- -------------- -------------- Balance at December 31, 1995 3,669,168 $ 37 $ 17,204 $ 3,074 $ 34,760 $ 55,075 Retirement of shares pursuant to the completion of the merger (53,548) - (676) - - (676) Issuance of common stock pursuant to the exercise of options 42,982 - 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 3,658,602 37 16,827 2,456 30,612 49,932 Issuance of common stock pursuant to the exercise of options 78,210 1 681 - - 682 Issuance of common stock pursuant to the employee stock purchase plan 9,320 - 132 - - 132 Issuance of common stock for agency purchases 52,009 - 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 3,798,141 38 18,209 4,316 34,616 57,179 Issuance of common stock pursuant to the exercise of options 73,788 1 439 - - 440 Issuance of common stock pursuant to the employee stock purchase plan 16,315 - 215 - - 215 Issuance of common stock for agency purchases 31,374 - 320 - - 320 Change in net unrealized appreciation of investments carried at market - - - (967) - (967) Cash dividends - - - - (1,554) (1,554) Net income - - - - 6,269 6,269 -------------- -------- -------------- ---------------- -------------- -------------- Balance at December 31, 1998 3,919,618 $ 39 $ 19,183 $ 3,349 $ 39,331 $ 61,902 ============== ======== ============== ================ ============== ============== See accompanying notes to consolidated financial statements.
AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1998, 1997, and 1996 (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 30 branch and field offices located throughout the United States. In 1998 and 1997, respectively, the Company's direct premiums written in California was 36.9% and 38.1%. On March 14, 1996, the Company completed a 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. 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 principles ("GAAP") which differ in some respects from those followed in reports to insurance regulatory authorities. 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. Earnings Per Share 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, 1996 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 on reported EPS data is as follows:
Years ended December 31, Income Shares Per-Share (Numerator) (Denominator) (1) Amount (1) ($ in thousands) (Dollars) --------------------- ----------------------- -------------------- Basic EPS: 1998 $ 6,269 3,871,531 $ 1.62 1997 $ 5,498 3,723,251 $ 1.48 1996 $ (2,686) 3,647,414 $ (.74) Effect of Dilutive Securities: 1998 69,340 1997 47,197 1996 36,990 Diluted EPS: 1998 $ 6,269 3,940,871 $ 1.59 1997 $ 5,498 3,770,448 $ 1.46 1996 $ (2,686) 3,684,404 $ (.74) (1) Amounts reflect a 10% stock dividend effective March 31, 1998.
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. Dilutive securities are the Company's stock options. See Note 18 for further discussion on stock options. 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, 1998 1997 1996 (Dollars in thousands) ----------------------------------------------- Balance at beginning of year $ 21,299 $ 16,101 $ 13,885 Costs deferred during the year 50,000 50,553 40,581 Amortization charged to expense (51,090) (45,355) (38,365) -------------- --------------- ---------------- Balance at end of year $ 20,209 $ 21,299 $ 16,101 ============== =============== ================ 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 basis 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 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, 1998, 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. The Company also holds deposits for contractors for whom the Company is controlling disbursements from obligees ("funds control") and deposits for commercial transportation insureds on which the earnings inure to the benefit of the Company. 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. 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. Mortgage backed securities are valued at amortized cost using the pro-rata method of amortization including anticipated prepayments calculated at the date of purchase using the average life method. Adjustments are made as necessary to the value of the bonds for changes in the average life calculation. These changes are based upon current and past experience for the underlying collateral. 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. 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, estimated offsets to the claimed amount, such as collateral, contract funds and indemnity agreements, 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 investments, 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 The NAIC has 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, 1998 and found that its subsidiaries exceeded the highest level of recommended capital requirement. Segment Information In 1998, the Company adopted Financial Accounting Standards No. 131 ("FAS 131"), "Disclosures about Segments of an Enterprise and Related Information," which requires reporting certain financial information according to the "management approach." This approach requires reporting information regarding operating segments on the basis used internally by management to evaluate segment performance. FAS 131 also requires disclosures about products and services, geographic areas and major customers. The statement was effective December 31, 1998 and has been adopted for all periods presented. Reclassifications Certain amounts in the accompanying consolidated financial statements for 1996 and 1997 have been reclassified to conform with the 1998 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, 1998 1997 (Dollars in thousands) ---------------------------------- Off-Balance Sheet Collateral: Irrevocable letters of credit $ 152,814 $ 160,845 Certificates of Deposit 22,352 25,480 Other Collateral 43,194 25,656 ----------------- ---------------- Total Off-Balance Sheet Collateral $ 218,360 $ 211,981 ================= ================ 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 1998 and 1997, the Company received approximately 5.8% and 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, 1998 1997 1996 (Dollars in thousands) ---------------------------------------------------- Gross investment income: Fixed maturities $ 6,038 $ 5,918 $ 6,405 Equity securities 686 538 409 Cash and short-term investments 319 330 338 Investment expense (392) (390) (345) ----------------- ---------------- ----------------- Net investment income $ 6,651 $ 6,396 $ 6,807 ================= ================ ================= Gross realized gains: Fixed maturities $ 2,172 $ 1,542 $ 1,343 Equity securities 2,391 2,686 1,528 Other assets 980 - 53 Gross realized losses: Fixed maturities (588) (403) (218) Equity securities (555) (347) (358) Other assets - (5) (147) ----------------- ---------------- ----------------- Net realized gains $ 4,400 $ 3,473 $ 2,201 ================= ================ =================
A summary of the accumulated net unrealized gains (losses) on investments carried at market and the applicable deferred Federal income taxes is shown below: December 31, 1998 1997 (Dollars in thousands) ---------------------------------- Gross unrealized gains: Fixed maturities $ 3,019 $ 2,636 Equity securities 3,844 4,068 Other invested assets 389 639 Gross unrealized losses: Fixed maturities (1,147) (406) Equity securities (958) (398) Other invested assets (72) - ---------------- ----------------- Gross unrealized gains on investments carried at market 5,075 6,539 Deferred Federal income taxes (1,726) (2,223) ---------------- ----------------- Net unrealized gains, net of deferred Federal income taxes $ 3,349 $ 4,316 ================ ================= 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, 1998 1997 1996 (Dollars in thousands) ---------------------------------------------------- Fixed maturities, available-for-sale $ (358) $ 1,535 $ (1,704) Common equity securities, available-for-sale (561) 879 503 Preferred equity securities, available-for-sale (223) (52) 175 Other invested assets (323) 457 88 ----------------- ---------------- ----------------- Total (1,465) 2,819 (938) Deferred Federal income taxes 498 (959) 320 ----------------- ---------------- ----------------- Net increase (decrease) in unrealized investment gains (losses), net of deferred Federal income taxes $ (967) $ 1,860 $ (618) ================= ================ =================
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, 1998 and 1997, the market value of these deposits was approximately $14,170,000 and $13,935,000, respectively. The amortized cost and estimated market values of investments in fixed maturities are as follows:
December 31, 1998 (Dollars in thousands) ---------------------------------------------------------------------- ----------------- ----------------- ---------------- ----------------- Gross Gross Amortized Cost Unrealized Gains Unrealized Estimated Fixed maturities, available-for-sale Losses Market Value ----------------- ----------------- ---------------- ----------------- Bonds: U.S. Government $ 11,837 $ 574 $ - $ 12,411 Asset backed securities 2,289 65 (5) 2,349 Mortgage backed securities 23,158 170 (258) 23,070 States, municipalities and political subdivisions 36,376 975 (22) 37,329 Industrial and miscellaneous 28,877 1,148 (817) 29,208 ----------------- ----------------- ---------------- ----------------- Total 102,537 2,932 (1,102) 104,367 Redeemable preferred stock 2,613 87 (45) 2,655 Certificates of Deposit 205 - - 205 ----------------- ----------------- ---------------- ----------------- Total $ 105,355 $ 3,019 $(1,147) $107,227 ================= ================= ================ =================
December 31, 1997 (Dollars in thousands) ---------------------------------------------------------------------- ----------------- ----------------- ---------------- ----------------- Gross Gross Amortized Cost Unrealized Gains Unrealized Estimated Fixed maturities, available-for-sale 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 ================= ================= ================ =================
The amortized cost and estimated market value of fixed maturities at December 31, 1998, 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 $ 6,492 $ 6,519 Due after 1 year through 5 years 35,139 35,882 Due after 5 years through 10 years 35,064 35,234 Due after 10 years through 20 years 14,416 14,896 Due after 20 years 14,244 14,696 ---------------- ----------------- Total bonds and sinking fund preferred stock $105,355 $107,227 ================ ================= Proceeds from the sale of available-for-sale securities during 1998 and 1997 were $74,642,000 and $52,441,000, respectively. Gross gains of $4,563,000 and $4,228,000 and gross losses of $1,143,000 and $750,000 were realized on those sales in 1998 and 1997, 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. Summary of Furniture, Equipment and Improvements: December 31, 1998 1997 (Dollars in thousands) ---------------------------------- Automobiles $ 149 $ 149 Furniture 3,215 3,002 Equipment 11,522 9,605 Improvements 1,723 2,343 ---------------- ----------------- Total fixed assets 16,609 15,099 Less accumulated depreciation (10,342) (9,744) ---------------- ----------------- Furniture, equipment and improvements, net $ 6,267 $ 5,355 ================ ================= (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, 1998, 1997 and 1996 are as follows:
Years ended December 31, 1998 1997 1996 (Dollars in thousands) ---------------------------------------------------- Computed tax expense at statutory rate $ 3,064 $ 2,528 $ (1,715) Tax-advantaged interest income (595) (506) (616) Change in valuation allowance - (652) - State taxes 65 15 47 Bad debt expense - 291 (463) Other, net 209 261 387 ----------------- ---------------- ----------------- Total provision for income taxes (benefit) $ 2,743 $ 1,937 $ (2,360) ================= ================ =================
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, 1998 and 1997 are presented below. Years ended December 31, 1998 1997 (Dollars in thousands) ------------------------------- Deferred tax assets: Unearned premiums $ 2,927 $ 2,718 Discount on loss reserves 1,068 1,202 Accrued vacation 309 266 Deferred compensation/ Accrued severance 224 173 Alternative minimum tax credit 667 1,268 Bad debt reserve 232 74 Other 191 92 ------------- ----------------- Total gross deferred tax assets 5,618 5,793 ------------- ----------------- Deferred tax liabilities: Deferred policy acquisition costs (6,871) (7,242) Unrealized investment gains (1,722) (2,220) Fixed assets (75) (86) Discount on salvage & subrogation reserves (74) (67) Deductible receivables (44) (55) Other (17) (48) --------------- ----------------- Total gross deferred tax liabilities (8,803) (9,718) --------------- ----------------- Total net deferred tax liability $ (3,185) $ (3,925) =============== ================= At December 31, 1998, 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, 1998 1997 1996 (Dollars in thousands) ----------------------------------------- Balance at beginning of year $ 39,523 $ 42,009 $ 31,915 Less: net reinsurance recoverable on unpaid loss and loss adjustment expenses (6,185) (6,133) (7,669) ------------- ------------- ------------- Net balance at beginning of year 33,338 35,876 24,246 Provision for losses and loss adjustment expenses occurring in current year 43,420 35,212 45,853 Increase (decrease) in estimated losses and loss adjustment expenses for claims occurring in prior years (2,589) (555) 794 ------------- ------------- ------------- 40,831 34,657 46,647 ------------- ------------- ------------- Losses and loss adjustment expense payments for claims occurring during: Current year (24,992) (15,095) (21,638) Prior years (16,770) (22,100) (13,379) ------------- ------------- ------------- (41,762) (37,195) (35,017) ------------- ------------- ------------- Net balance at end of year 32,407 33,338 35,876 Plus: net reinsurance recoverable on unpaid loss and loss adjustment expenses 9,837 6,185 6,133 ------------- ------------- ------------- Balance at end of year $42,244 $ 39,523 $ 42,009 ============= ============= =============
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 31 of the applicable years. The surety loss and loss adjustment expense ratios remained constant at approximately 28% for 1997 and 1998. The 1998 ratio includes the impact of the excess of loss and the aggregate stop loss reinsurance treaties. During 1998, $4,168,000 was ceded in premiums on these treaties with $4,100,000 ceded in losses. In 1997, $2,987,000 was ceded in premiums with no losses ceded to the reinsurers. Competitive market conditions and the Company's ability to write surety bonds for larger contractors has resulted, on many bonds, in the substitution of indemnity agreements for liquid and non-liquid collateral. The Company, through its ongoing reserve analysis, has estimated the benefit to be derived from such agreements and reduced estimates of ultimate losses incurred accordingly. In the fourth quarter of 1998, the Company increased its estimate of such "salvage and subrogation" recoveries by approximately $5.4 million which is partially attributable to salvage and subrogation on losses incurred during the fourth quarter. The increase relates primarily to the 1998 and 1997 years and reflects the Company's belief that the underlying data is maturing. Further, subsequent collection efforts have proven prior estimates to be conservative. Since the Company had also pierced it's aggregate excess contract in the fourth quarter, the net benefit attributable to the increased "salvage and subrogation" estimate was approximately $1,025,000. (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, 1998, 1997 and 1996.
Years ended December 31, 1998 1997 1996 (Dollars in thousands) --------------------------------------------------- Net premiums written: Direct $ 129,614 $ 107,015 $ 94,935 Assumed 3,205 1,076 2,307 Ceded (24,858) (8,057) (7,917) ---------------- ---------------- ----------------- Net premiums written $ 107,961 $ 100,034 $ 89,325 ================ ================ ================= Net change in unearned premiums: Direct $ (8,961) $ (8,706) $ 480 Assumed 484 632 (810) Ceded 6,487 190 (1,112) ---------------- ---------------- ----------------- Net change in unearned premiums $ (1,990) $ (7,884) $ (1,442) ================ ================ ================= Net loss and loss adjustment expenses: Direct $ 50,364 $ 36,038 $ 50,391 Assumed 2,058 995 445 Ceded (11,591) (2,376) (4,189) ---------------- ---------------- ----------------- Net losses and loss adjustment expenses $ 40,831 $ 34,657 $ 46,647 ================ ================ =================
On the surety lines of business, the Company's subsidiaries maintain an excess of loss reinsurance treaty with a group of reinsurers (the "Excess Treaty"). The Excess Treaty may be canceled at the election of either party by providing notice of cancellation 90 days prior to any anniversary (currently October 1), however, the reinsurers would remain liable for covered losses incurred up to the cancellation date. The amended Excess 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 for losses incurred prior to October 1, 1998 and $25,000,000 for losses incurred thereafter. 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 Excess Treaty is $26,000,000 of losses discovered during any one contract period (October 1 to October 1) for the 1997-1998 contract year and $35,000,000 for the 1998-1999 contract year. The Excess treaty also contains profit sharing provisions for the $4,000,000 excess of $2,000,000 layer of the treaty, of which no amounts are currently accrued based on experience of the treaty through December 31, 1998. The Company, effective January 1, 1997, entered into an aggregate stop-loss treaty with Underwriters Reinsurance Company (Barbados), Inc. which treaty was renewed for the 1998 accident year. This contract has a limit of approximately $7,000,000 of losses and loss adjustment expenses incurred for the 1998 accident year. On the surety lines of business when losses and loss adjustment expenses exceed 32.8% of net earned premiums and for all other lines when losses and loss adjustment expenses exceed 67% of net earned premiums the reinsurer becomes liable for losses. The Company has 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, 1998 and 1997, the Company ceded $2,533,000 and $0, respectively, in losses to the stop-loss treaty. 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. The Company also purchased a quota share reinsurance treaty with Underwriters Reinsurance Company, a New Hampshire domiciled reinsurer which was effective July 1, 1998. This treaty cedes 15% of net surety written premium for all surety written through Amwest Surety Insurance Company on a pro rata basis. 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 commercial automobile 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, California homeowners and Florida homeowners programs differ from the above. For Hawaiian homeowners, 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 75% quota share reinsurance agreement with a limit of $7,500,000 per occurrence. For Florida homeowners, the Company is a party to a 75% quota share reinsurance with a limit of 200% of the actual gross premiums written in any policy year. Additionally, the Company participates in the Florida Hurricane Catastrophe Fund as a 90% participant. Recoveries from this Fund are limited to hurricanes and are based on a formula which utilizes, among other factors, premiums written, industry premiums written, industry losses and amounts available in the fund. (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. The Company's insurance subsidiaries are domiciled in 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, 1998. Amwest Surety and Condor can pay $7,987,000 and $0, respectively, in dividends to the Company during 1998 without prior approval. For the years ended December 31, 1998, 1997 and 1996, Amwest Surety paid dividends of $0, $0 and $500,000, 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, 1998, there were no material permitted statutory accounting practices utilized by the insurance companies. The NAIC membership adopted in March 1998, the Codification of Statutory Accounting Principles Project as the NAIC supported basis of accounting, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. The Codification Project, which will become effective on January 1, 1999, was approved with the provision for commissioner discretion in the determination of appropriate statutory accounting for insurers. Such discretion will continue to allow prescribed or permitted accounting practices that may differ from state to state. Accordingly, this project will change the definition of what comprises 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. The Company has not determined how implementation will affect its statutory financial statements and is unable to predict how insurance rating agencies will interpret or react to such changes. No assurance can be given that future legislative or regulatory changes from such activities will not adversely affect the Company. Policyholders surplus and net income on a statutory basis is as follows:
December 31, 1998 1997 1996 Statutory Statutory Statutory Statutory Statutory Statutory Policyholders Net Income Policyholders Net Income Policyholders Net Income Surplus (Loss) Surplus (Loss) Surplus (Loss) (Dollars in thousands) ------------------------------------------------------------------------------------------------------ Amwest Surety $ 39,526 $ 7,624 $ 33,823 $ 3,528 $ 31,081 $ (3,803) Far West 7,562 835 6,501 (461) 7,042 1,176 Condor 9,074 (767) 10,489 1,362 9,217 (1,707)
(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 waived and amended as of September 30, 1997 and 1998 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, 1998, $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, 1998 was 7.1%. 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. As of December 31, 1998, the Company was in compliance with its debt covenants. Balance (Dollars in thousands) ------------------------- Summary of debt maturity schedule: September 30, 2000 $ 5,000 September 30, 2001 5,000 September 30, 2002 5,000 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, 1998 and 1997: December 31, 1998 1997 (Dollars in thousands) ---------------------------------- Accrued salaries, fringe benefits and other compensation $ 3,098 $ 3,072 Premium taxes payable 898 986 General accounts payable 320 340 Notes payable 600 - Dividends payable 391 379 Deferred compensation payable 660 510 Proposition 103 reserve 228 982 Commission payable 430 574 Other 1,273 1,647 ---------------- ----------------- Total other liabilities $ 7,898 $ 8,490 ================ ================= (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, 1998, 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 $3,369,000, $3,648,000 and $5,647,000 for the years ended December 31, 1998, 1997 and 1996, respectively, have been charged to operations in the accompanying consolidated statements of operations. Balance (Dollars in thousands) ------------------------- Summary of minimum future annual rental commitments: 1999 $ 2,554 2000 2,362 2001 1,950 2002 1,693 2003 and thereafter 9,004 ------------------------- Total $ 17,563 ========================= (13) 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"), a related party. In order to accept monthly commercial automobile coverage written by Condor, an applicant must become a member of The Safety Association. Since 1981, the Company has had the exclusive right to provide insurance programs to The Safety Association members. Effective June 30, 1998, the Company purchased the Safety Association and merged its operations into Condor. This acquisition was not material to the consolidated financial statements. (14) STOCK DIVIDEND The Company paid a 10% stock dividend to stockholders of record as of March 31, 1998. All share and per share amounts included in the accompanying consolidated financial statements and notes are based on the increased number of shares giving retroactive effect to the stock dividend. (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) EMPLOYEE STOCK PURCHASE PLAN The Company provides an employee stock purchase plan under Section 423 of the Internal Revenue Code of 1986, as amended, to any employee who has a customary working schedule of more than 20 hours per week and whose customary employment is for more than five months in any calendar year. It excludes any employee who own stock possessing 5% or more of the total combined voting power or value of all classes of stock of the Company. Eligible employees are entitled to purchase shares of the Company's common stock on a calendar month basis at 92% of the fair market value of the Company's common stock on the last business day of a calendar month. (17) RETIREMENT PLAN The Company has 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 1998, 1997 and 1996 amounted to $423,000, $365,000 and $344,000, respectively. (18) STOCK OPTIONS In May 1998, the stockholders approved the 1998 Stock Incentive Plan ("the Plan") which replaced the existing Stock Option Plan and a Non-Employee Director Stock Option Plan. The new Stock Incentive Plan reserved 250,000 shares of its Common Stock, subject to adjustment for reorganizations, recapitalizations, stock splits or similar events. As of December 31, 1998, 5,500 options had been granted under this plan. Shares of Common Stock subject to the unexercised portions of any options granted under the Plan which expire, terminate or are canceled may again be subject to options under the Plan. The per share exercise price of options under the Plan 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 479,855 outstanding options from the Stock Option Plan and the Non-Employee Director Stock Option Plan will remain in effect until exercised, canceled or expired. The Company accounts for its options under 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. Transactions involving stock options during the years ended December 31, 1998, 1997 and 1996 are presented below:
1998 1997 1996 ---------------------------------- --------------------------------- --------------------------------- Weighted Average Weighted Average Weighted Average Shares Exercise Price Shares Exercise Price Shares Exercise Price --------------- ------------------ --------------- ----------------- --------------- ------------------ Outstanding at beginning of year 493,003 $11.84 486,205 $11.45 361,845 $11.54 Granted 82,750 16.32 102,300 11.36 164,373 11.40 Exercised (73,788) 10.60 (78,210) 8.72 (7,645) 7.96 Canceled / Expired (16,610) 11.93 (17,292) 12.04 (32,368) 13.14 --------------- ------------------ --------------- ----------------- --------------- ------------------ Outstanding at end of year 485,355 12.79 493,003 $11.84 486,205 $11.45 =============== ================== =============== ================= =============== ================== Options exercisable at end of year 293,217 12.43 261,543 $11.76 247,691 $10.58 =============== ================== =============== ================= =============== ==================
The following table summarizes information about options outstanding under the Plans at December 31, 1998:
Options Outstanding Options Exercisable Weighted Average Range of Number Remaining Weighted Average Number Weighted Average Exercise Prices Outstanding Contractual Life Exercise Price Outstanding Exercise Price - ---------------------------- ---------------- ----------------- ----------------- ---------------- ----------------- $5.582 - $8.977 8,937 3.7 $ 7.42 8,937 $ 7.42 $9.432 - $12.745 254,693 7.2 11.75 152,899 11.91 $12.841 - $16.375 221,725 6.8 14.21 131,381 13.37 ================ ================= ================= ================ ================= $5.582- $16.375 485,355 6.9 $ 12.79 293,217 $ 12.43 ================ ================= ================= ================ =================
Pro forma net income (loss) and earnings (loss) per share information, as required by SFAS No. 123, has been calculated as if the Company had accounted for options granted under the Plans under the fair value method. The fair value of options granted was estimated as of the date of grant based on the Black-Scholes option pricing model given the following weighted average assumptions: risk-free interest rates of 5.64% for 1998, 6.34% and 6.67% for 1997 and 6.39% for 1996, a dividend yield of 2.76% for 1998, 3.12% for 1997 and 3.48% for 1996, volatility of the Company's Common Stock of 6.91% for 1998, 7.15% for 1997 and 7.18% for 1996, and an expected life of the stock options of 10 years. The weighted average grant date fair values of stock options granted during 1998, 1997 and 1996 were $5.88, $4.92 and $5.09, respectively. For purposes of pro forma disclosures, the estimated fair value is amortized on a straight-line basis over the vested period.
Year ended December 31, 1998 1997 1996 Net income (loss) As reported $6,269 $ 5,498 $ (2,686) Pro forma 6,210 5,449 (2,720) Diluted Earnings per share (1) As reported $ 1.59 $ 1.46 $ (.74) Pro forma 1.58 1.45 (.75) (1) Amounts reflect 10% stock dividend effective March 31, 1998.
(19) SEGMENT INFORMATION The accounting policies of the segments are the same as those described in Note 1, "Summary of Significant Accounting Policies". Segments are determined based on product categories. The Company evaluates performance based on underwriting income or loss. Reportable segments include Surety and Specialty Property & Casualty. The Company's surety division underwrites 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 bonds up to $25 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. The Company's property and casualty division 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 addition to its commercial policies, the Company offers non-standard private passenger automobile insurance in the states of Arizona and California and homeowners coverage in the states of California, Florida and Hawaii and motorcycle insurance in the state of New York. Reportable segment data is as follows:
Net Earned Premium Underwriting Income (Loss) Segment Assets (2) (Dollars in thousands) 1998 1997 1996 1998 1997 1996 1998 1997 1996 Surety $84,166 $70,565 $65,501 $ 3,689 $ 1,395 $ (6,357) $47,634 $35,766 $30,939 Specialty Property & Casualty 21,805 21,585 22,382 (3,811) (1,863) (3,470) 14,541 8,792 7,085 ------------ ----------- ------------ ----------- ------------ ------------ ----------- ------------ ----------- Total Segments 105,971 92,150 87,883 (122) (468) (9,827) 62,175 44,558 38,024 Corporate (1) - - - - - - 154,116 145,961 143,394 ------------ ----------- ------------ ----------- ------------ ------------ ----------- ------------ ----------- Consolidated Total $105,971 $92,150 $87,883 $ (122) $ (468) $ (9,827) $216,291 $190,519 $181,418 ============ =========== ============ =========== ============ ============ =========== ============ =========== (1) Corporate assets include investments, cash and cash equivalents, accrued investment income, furniture, equipment and improvements, income taxes recoverable and other assets. (2) Segment assets include agents' balances and premiums receivable, reinsurance recoverable, ceded unearned premiums and deferred policy acquisition expenses.
AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES SUPPLEMENTARY INFORMATION (UNAUDITED) QUARTERLY FINANCIAL INFORMATION The quarterly results for the years ended December 31, 1998, 1997 and 1996 are set forth in the following table:
(Dollars in thousands, except per share data) ----------------- ---------------- ----------------- ---------------- First Second Quarter Third Fourth Quarter Quarter Quarter ----------------- ---------------- ----------------- ---------------- 1998 Premiums written $29,342 $35,044 $34,687 $33,746 Net premiums earned 27,124 27,248 25,633 25,966 Net investment income 1,577 1,560 1,733 1,781 Net realized gains 820 1,065 1,901 614 Total revenues 29,521 29,873 29,267 28,361 Net income 2,056 975 2,098 1,140 Earnings per share - basic (1) .54 .25 .54 .29 Earnings per share - diluted (1) .53 .25 .53 .29 ----------------- ---------------- ----------------- ---------------- 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 Total revenues 23,764 23,734 26,374 28,147 Net income 1,785 1,314 685 1,714 Earnings per share - basic (1) .49 .36 .18 .45 Earnings per share - diluted (1) .48 .35 .18 .45 ----------------- ---------------- ----------------- ---------------- 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 Total revenues 24,667 23,730 24,145 24,349 Net income (loss) 86 (1,311) 1,191 (2,652) Earnings (loss) per share - basic (1) .02 (.36) .33 (.73) Earnings (loss) per share - diluted (1) .02 (.36) .32 (.73) (1) Amounts reflect a 10% stock dividend effective March 31, 1998.
SCHEDULE I AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES SUMMARY OF INVESTMENTS- OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 1998 (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 $ 23,955 24,543 24,543 States, municipalities and political subdivisions 39,239 40,246 40,246 Foreign governments - - - Public utilities 765 803 803 Convertibles and bonds with warrants attached - - - All other corporate bonds 38,578 38,775 38,775 --------------- --------------- --------------- Total bonds 102,537 104,367 104,367 Certificates of deposit 205 205 205 Redeemable preferred stock 2,613 2,655 2,655 --------------- --------------- --------------- Total fixed maturities 105,355 107,227 107,227 Equity securities: Common stocks: Public utilities - - - Banks, trust and insurance companies 1,754 3,256 3,256 Industrial, miscellaneous and all other 5,938 7,316 7,316 Non-redeemable preferred stocks 4,258 4,265 4,265 --------------- --------------- --------------- Total equity securities 11,950 14,837 14,837 Mortgage loans on real estate - XXXXXXX - Real estate - XXXXXXX - Policy loans - XXXXXXX - Other long-term investments 4,058 XXXXXXX 4,375 Short-term money-market investments 2,201 XXXXXXX 2,201 --------------- --------------- --------------- Total investments $ 123,564 XXXXXXX $ 128,640 =============== =============== ===============
SCHEDULE II AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION (Parent Company Only) STATEMENT OF OPERATIONS (Dollars in thousands) Year ended December 31, 1998 1997 1996 REVENUES: Equity in income (loss) of subsidiaries $ 6,083 $ 5,208 $ (969) Commissions & fees 697 572 2 Net investment income - 32 65 Net realized gains (losses) 1,001 8 (5) ------------- ------------- ------------- Total revenues 7,781 5,820 (907) EXPENSES: Merger expenses - - 710 Lease termination cost - - 1,300 Interest expense 533 306 107 ------------- ------------- ------------- Total expenses 533 306 2,117 Income before income taxes 7,248 5,514 (3,024) Provision for income taxes (benefit) 979 16 (338) ------------- ------------- ------------- Net income (loss) $ 6,269 $ 5,498 $ (2,686) ============= ============= ============= 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, 1998 1997 ASSETS: Total investments $ 71,229 $ 66,989 Cash and cash equivalents 184 176 Income taxes receivable - 123 Deferred Federal income tax asset 84 523 Due from affiliates 642 76 Furniture, equipment and improvements 4,701 3,648 Other assets 976 1,071 ------------- -------------- Total assets $ 77,816 $ 72,606 ============= ============== LIABILITIES AND STOCKHOLDERS' EQUITY: Liabilities: Bank indebtedness $ 14,500 $ 14,500 Income tax payable 301 - Other liabilities 1,113 927 ------------- -------------- Total liabilities 15,914 15,427 ------------- -------------- Stockholders' Equity: Common stock and additional paid in capital 19,222 18,247 Net unrealized appreciation (depreciation) of investments, net of taxes 3,349 4,316 Retained earnings 39,331 34,616 ------------- -------------- Total stockholders' equity 61,902 57,179 ------------- -------------- Total liabilities and stockholders' equity $ 77,816 $ 72,606 ============= ============== 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, 1998 1997 1996 CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 6,269 $ 5,498 $ (2,686) Less equity in income of subsidiary (6,083) (5,208) 969 ------------ -------------- ------------- Net income from operations 186 290 (1,717) Adjustments: Change in income taxes, net 879 (92) 1,268 Change in accrued investment income - - 10 Change in due (to) from affiliates (566) (1,242) (270) Change in other assets / liabilities 281 (320) 1,829 Dividend received from affiliate - - 500 Provision for depreciation and amortization 557 372 431 Realized (gains) losses on sale of investments (1,002) (8) 4 Realized loss on sale of fixed assets 5 46 36 ------------ -------------- ------------- Net cash provided (used) 340 (954) 2,091 ------------ -------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Cash received from investments sold, matured, called or repaid 2,025 187 995 Cash paid for investments acquired (162) (17) (2,262) Capital expenditures, net (1,616) (2,988) (14) ------------ -------------- ------------- Net cash provided (used) 247 (2,818) (1,281) ------------ -------------- ------------- 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 975 1,382 299 Repurchase of common stock - - (676) Capital contribution to subsidiaries - - (1,000) Dividends paid (1,554) (1,493) (1,462) ------------ -------------- ------------- Net cash from financing activities (579) 2,889 (1,839) ------------ -------------- ------------- Net increase (decrease) 8 (883) (1,029) Cash and cash equivalents, beginning 176 1,059 2,088 ------------ -------------- ------------- Cash and cash equivalents, ending $ 184 $ 176 $ 1,059 ============ ============== ============= 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. 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, September 30, 1997 and again on February 9, 1999 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, 1998, $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. 4. Stock Dividend The Company paid a 10% stock dividend to stockholders of record as of March 31, 1998. The dividend was charged to retained earnings in the amount of $5,424,000, which was based on the closing price of $15.625 per share of Common Stock on the declaration date. All share and per share amounts included in the accompanying consolidated financial statements and notes are based on the increased number of shares giving retroactive effect to the stock dividend.
SCHEDULE III AMWEST INSURANCE GROUP, INC. AND SUBSIDIARIES SUPPLEMENTARY INSURANCE INFORMATION December 31, (Dollars in thousands) Column A Column B Column C Column D Column E Column F Column G Column H Column I Column J Column K Future policy Other Benefits, Amortization Deferred benefits, policy claims, of policy losses, claims Net losses and deferred Other acquis claims and Unearned and Premium investment settlement policy operating Premiums Segment costs loss premiums benefits revenue income (1) expenses acquisition expenses written expenses payable costs As of and for the year ended December 31, 1998 Surety $ 19,636 $20,295 $ 47,650 - $ 84,166 $ 5,121 $ 23,262 $ 44,374 $ 12,841 $ 102,270 Specialty Property & 573 21,949 3,977 - 21,805 1,530 17,569 6,716 1,331 30,549 Casualty --------------------------------------------------------------------------------------------------------------- Total $ 20,209 $ 42,244 $ 51,627 - $ 105,971 $ 6,651 $ 40,831 $ 51,090 $ 14,172 $ 132,819 --------------------------------------------------------------------------------------------------------------- As of and for the year ended December 31, 1997 Surety $ 21,042 $ 18,862 $ 40,249 - $ 70,565 $ 4,861 $ 20,013 $ 39,158 $ 9,999 $ 82,611 Specialty Property & 257 20,661 1,764 - 21,585 1,535 14,644 6,197 2,607 25,480 Casualty --------------------------------------------------------------------------------------------------------------- Total $ 21,299 $ 39,523 $ 42,013 - $ 92,150 $ 6,396 $ 34,657 $ 45,355 $ 12,606 $ 108,091 --------------------------------------------------------------------------------------------------------------- As of and for the year ended December 31, 1996 Surety $ 16,099 $ 20,607 $ 32,878 - $ 65,501 $ 5,037 $ 27,836 $ 33,373 $ 10,346 $ 72,170 Specialty Property & 2 21,402 1,061 - 22,382 1,770 18,811 4,992 2,352 25,072 Casualty --------------------------------------------------------------------------------------------------------------- Total $ 16,101 $ 42,009 $ 33,939 - $ 87,883 $ 6,807 $ 46,647 $ 38,365 $ 12,698 $ 97,242 --------------------------------------------------------------------------------------------------------------- (1) Allocation based upon net premiums written
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, 33-37984, 333-61819 and 333-17109 on Form S-3 of Amwest Insurance Group, Inc. of our reports dated February 3, 1998, relating to the consolidated balance sheets of Amwest Insurance Group, Inc. and subsidiaries as of December 31, 1998 and 1997 and the related consolidated statements of operations and comprehensive income, cash flows and changes in stockholders' equity and related schedules for each of the years in the three-year period ended December 31, 1998, which reports appear in the December 31, 1998 annual report on Form 10-K of Amwest Insurance Group, Inc. KPMG LLP Los Angeles, California March 29, 1999 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Amwest Insurance Group, Inc.: Under date of February 3, 1998, we reported on the consolidated balance sheets of Amwest Insurance Group, Inc. and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations and comprehensive income, cash flows and changes in stockholders' equity for each of the years in the three-year period ended December 31, 1998, as contained in the annual report on Form 10-K for the year 1998. 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 LLP Los Angeles, California February 3, 1999 EX-10.8 3 WAIVER AND AMEND NO. 2 TO RESTATED CREDIT AGREE. WAIVER AND SECOND AMENDMENT This Waiver and Second Amendment dated as of February 9, 1999 (the "Waiver and Amendment") to the Restated Revolving Credit Agreement dated as of July 10, 1996, as amended by that certain Waiver and Amendment No. 1 dated as of September 30, 1997, (the "Credit Agreement") between Amwest Insurance Group, Inc. (the "Borrower") and Union Bank of California, N.A. (the "Bank") is entered into between Borrower and Bank. WHEREAS, the Borrower desires, and the Bank is willing upon the terms and conditions hereinafter set forth, to (a) waive compliance with Section 2.12 Mandatory Commitment Reductions, as amended, for the September 30, 1998 Revolving Commitment Reduction Date, and (b) amend the Credit Agreement to: (i) modify Section 2.12 Mandatory Commitment Reductions, and (ii) reset Section 5.13 Policyholders' Surplus. In consideration of the premises and the agreements, provisions and covenants herein contained, the parties hereto hereby agree, on the terms and subject to the conditions set forth herein, as follows. Section 1. Waiver of Section 2.12 of the Credit Agreement. The Bank hereby waives compliance with Section 2.12 Mandatory Commitment Reductions for the September 30, 1998 Revolving Commitment Reduction Date provided that the provisions of Section 2 following remain in full force and effect. Section 2. Amendment to Section 2.12 of the Credit Agreement. Delete the table contained in Section 2.12 Mandatory Commitment Reductions as amended in its entirety and replace it with the following table: Revolving Commitment Commitment Reduction Date Reduction September 30, 1998 $0 September 30, 1999 $0 September 30, 2000 $5,000,000 September 30, 2001 $5,000,000 September 30, 2002 $5,000,000 Section 3. Amendment to Section 5.13 of the Credit Agreement. Delete $30,000,000 from the third line of Section 5.13 Policyholders' Surplus and replace it with "$32,500,000". Section 4. Representations and Warranties. The Borrower represents and warrants to the Borrower that: (a) before and after giving effect to this Amendment, the representations and warranties set forth in Article III of the Credit Agreement are true and correct in all material respects with the same effect as if made on the date hereof, except to the extent such representations and warranties expressly relate to an earlier date. (b) before and after giving effect to this Amendment, no Event of Default or Default has occurred and is continuing. Section 5. Conditions to Effectiveness. This Amendment shall become effective as of the date first written above when the Bank shall have received executed originals of the following-. (a) the counterpart of this Amendment that bears the signature of the Borrower, (b) an Authorization to Obtain Credit, Grant Security, Guarantee or Subordinate duly completed by the Borrower, (c) an Alternative Dispute Resolution Agreement duly completed by the Borrower, (d) an Authorization to Obtain Credit, Grant Security, Guarantee or Subordinate duly completed by Amwest Surety Insurance Company, (e) an Addendum to Authorization Letter of Credit Services duly completed by Amwest Surety Insurance Company, an Alternative Dispute Resolution Agreement duly completed by Amwest Surety Insurance Company, (g) an Authorization to Obtain Credit, Grant Security, Guarantee or Subordinate duly completed by Far West Insurance Company, (h) an Addendum to Authorization Letter of Credit Services duly completed by Far West Insurance Company, (i) an Alternative Dispute Resolution Agreement duly completed by Far West Insurance Company, and (j) such other documents, certificates, opinions and instruments in connection with this Amendment No. 2 as it shall be reasonably requested by the Bank. Section 6. Expenses. The Borrower agrees to reimburse the Bank for its out-of-pocket expenses in connection with the Amendment. Section 7. Applicable Law. This Amendment shall be governed by, and construed in accordance with, the laws of the State of California. Section 8. Counterparts. This Amendment may be executed in two or more counterparts, each of which shall constitute an original, but all of which when taken together shall constitute but one contract. Section 9. Credit Agreement. Except as specifically stated herein, the provisions of the Credit Agreement are and shall remain in full force and effect. In witness whereof, the parties hereto have caused this Amendment to be duly executed by their respective authorized officers as of the day and year first written above. AMWEST INSURANCE GROUP, INC. by: Name: Steven R. Kay Title: Senior Vice President and Chief Financial Officer UNION BANK OF CALIFORNIA, N.A. by: Name: James R. Fothergill Title: Vice President EX-10.10 4 CONTINGENT EXCESS OF LOSS REINSURANCE CONTRACT Contingent Excess of Loss Reinsurance Contract Effective: July 1, 1998 issued to Condor Insurance Company Amwest Surety Insurance Company and Far West Insurance Company all 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 A. By this Contract the Reinsurer agrees to reinsure the excess liability which may accrue to the Company under its 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 the following: 1. Casualty business, including but not limited to Commercial Automobile Liability and General Liability; 2. Extra contractual obligations and/or loss in excess of policy limits arising under events from Private Passenger Auto, Homeowners, Mobile Homeowners and Motorcycle business; subject to the terms, conditions and limitations hereinafter set forth. 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. Article II - Term A. This Contract shall become effective on July 1, 1998, with respect to losses under policies allocated to this Contract in accordance with the provisions of paragraph C below, and shall continue in force until June 30, 1999, both days inclusive. B. Unless the Company elects to reassume the ceded unearned premium in force on the effective date of expiration, and so notifies the Reinsurer prior to or as promptly as possible after the effective date of expiration, reinsurance hereunder on business in force on the effective date of expiration shall remain in full force and effect until expiration, cancellation or next premium anniversary date of such business, whichever first occurs, but in no event beyond 12 months following the effective date of expiration. This limitation, however, shall not apply to any extended reporting period provisions. It is understood and agreed that the term "premium anniversary date" shall mean the month and day of the year on which the Company issued the original policy. C. Notwithstanding the provisions of paragraph B above, policies shall be allocated to this Contract if this Contract is in effect as of: 1. As respects all new policies, the effective date of such policies; 2. As respects monthly continuous policies, the monthly renewal date of such policies; 3. As respects all other term policies not greater than 12 months, the premium anniversary date of such policies; 4. As respects all term policies greater than 12 months, the premium anniversary date of such policies. All premiums and losses (and related loss adjustment expenses) from policies allocated to this Contract shall be credited or charged, respectively, to this Contract, regardless of the date said premiums earn or such losses occur (or the date said claims are made or reported, as respects claims made policies). Premiums, losses and related loss adjustment expenses for any extended reporting period provisions shall be allocated to this Contract if the original policy was allocated to this Contract. Article III - Territory This Contract shall only apply to policies issued to insureds domiciled in the United States of America, its territories and possessions, Puerto Rico and the District of Columbia; but this limitation shall not apply to losses if the Company's policies provide coverage outside the aforesaid territorial limits. Article IV - Exclusions A. This Contract does not apply to and specifically excludes the following: 1. All reinsurance assumed other than reinsurance which covers business underwritten by the Company. 2. Business written by the Company on a co-indemnity basis where the Company is not the controlling carrier. 3. All liability of the Company arising by contract, operation of law, or otherwise, from its participation or membership, whether voluntary or involuntary, in any insolvency fund. "Insolvency fund" includes any guaranty fund, insolvency fund, plan, pool, association, fund or other arrangement, however denominated, established or governed, which provides for any assessment of or payment or assumption by the Company of part or all of any claim, debt, charge, fee or other obligation of an insurer, or its successors or assigns, which has been declared by any competent authority to be insolvent, or which is otherwise deemed unable to meet any claim, debt, charge, fee or other obligation in whole or in part. 4. Pollution as excluded by the underlying Policy - "Pollution Exclusion - Absolute"; if not present, then deemed to be. However, this exclusion shall not apply to Environmental Restoration Coverages provided under MCS 90 Endorsement, which is required for those insureds maintaining ICC filings, or to the Company endorsement CA 99 48 as respects business classified by the Company as residential trash haulers. 5. Hazardous Waste Operations (except when exposure is unknown or unintended). 6. Liability as a member, subscriber or reinsurer of any Pool, Syndicate or Association, but this exclusion shall not apply to Assigned Risk Plans or similar plans. 7. Nuclear risks as defined in the "Nuclear Incident Exclusion Clause - Liability - Reinsurance" attached to and forming part of this Contract. 8. Automobile Liability Insurance relating to the ownership, maintenance, or use of trucks used for transporting commodities such as explosives, munitions, gasoline, or liquefied petroleum gas (LPG), including butane and propane. It is understood and agreed that this exclusion shall not apply to those insureds involved in the removal of soils saturated with gasoline or petroleum products. B. 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 paragraph A above, the exclusion shall be suspended with respect to such business until 30 days after an underwriting supervisor of the Company acquires knowledge thereof. C. If the Company is required to accept an assigned risk which conflicts with one or more of the exclusions set forth in paragraph A above, reinsurance shall apply, but only for the difference between the Company's retention and the minimum limit required by the applicable state statute, and in no event shall the Reinsurer's liability exceed the limits set forth in Article V. Article V - Retention and Limit A. Coverage A: As respects Casualty business, including but not limited to Commercial Automobile Liability and General Liability business subject to this Contract, the Company shall retain and be liable for the first $1,000,000 of ultimate net loss (whether involving any one or any combination of the classes of business covered hereunder) arising out of any one occurrence. The Reinsurer shall then be liable for the amount by which such ultimate net loss exceeds the Company's retention, but the liability of the Reinsurer shall not exceed $1,000,000 as respects any one occurrence, nor shall it exceed $3,000,000 as respects all losses arising out of occurrences commencing during the term of this Contract. B. Coverage B: As respects extra contractual obligations and/or loss in excess of policy limits arising under events from Private Passenger Auto, Homeowners, Mobile Homeowners and Motorcycle business subject to this Contract, the Company shall retain and be liable for the first $250,000 of ultimate net loss (whether involving any one or any combination of the classes of business covered hereunder) arising out of any one occurrence. The Reinsurer shall then be liable for the amount by which such ultimate net loss exceeds the Company's retention, but the liability of the Reinsurer shall not exceed $750,000 as respects any one occurrence, nor shall it exceed $2,250,000 as respects all extra contractual obligations and/or loss in excess of policy limits arising during the term of this Contract. It is understood that the ultimate net loss referred to in this paragraph B shall be made up only of extra contractual obligations and loss in excess of policy limits. C. The Company shall purchase or be deemed to have purchased inuring reinsurance to limit its ultimate net loss under any one policy subject to Coverage A (exclusive of loss in excess of policy limits or extra contractual obligations) to $1,000,000 each occurrence, Combined Single Limit. D. The amount shown in paragraph C above shall be extended to follow the Company's policy if the Company's ultimate net loss is greater than said amount 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. Article VI - Definitions A. "Ultimate net loss" as used herein is defined as the sum or sums (including loss in excess of policy limits, extra contractual obligations and any loss adjustment expense, as hereinafter defined, which reduces the Company's limit of liability under the policy involved) 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. B. "Loss in excess of policy limits" and "extra contractual obligations" as used herein shall be defined as follows: 1. "Loss in excess of policy limits" shall mean 90.0% of any amount paid or payable by the Company in excess of its policy limits, but otherwise within the terms of its policy, 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 policy 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 90.0% of any punitive, exemplary, compensatory or consequential damages, other than loss in excess of policy limits, paid or payable by the Company 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 policy subject to this Contract. 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. 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. C. "Loss adjustment expense" as used herein shall mean expenses allocable to the investigation, defense and/or settlement of specific claims, including litigation expenses, interest on judgments, and legal expenses incurred in connection with coverage questions and legal actions connected thereto, but not including office expenses or salaries of the Company's regular employees. D. "Occurrence" as used herein shall follow the definition of "loss" or "occurrence," as elected by the Company, under the applicable original policy. Article VII - Claims and Loss Adjustment Expense A. Whenever a claim is reserved by the Company for an amount greater than its retention hereunder and/or whenever a claim appears likely to result in a claim under this Contract, the Company shall notify the Reinsurer. Further, the Company shall notify the Reinsurer whenever a claim involves a fatality, amputations or permanent loss of use of upper or lower extremities, spinal injuries resulting in partial or total paralysis of upper or lower extremities, brain injuries resulting in impairment of physical functions, severe burn cases, or any other injuries likely to result in a permanent disability rating of 50.0% or more, regardless of liability, if the policy limits or statutory benefits applicable to the claim are greater than the Company's retention hereunder. 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 claim 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 by the Company. C. In the event of loss hereunder, loss adjustment expense incurred by the Company in connection therewith which does not reduce the Company's limit of liability under the policy involved shall be shared by the Company and the Reinsurer in the proportion the ultimate net loss paid or payable by the Reinsurer bears to the total loss paid or payable by the Company, prior to any reinsurance recoveries, but after deduction of all salvage, subrogation and other recoveries. However, if a verdict or judgment is reduced by any process other than by the trial court, resulting in an ultimate saving to the Reinsurer, or a judgment is reversed outright, the expenses incurred in securing such reduction or reversal shall be shared by the Company and the Reinsurer in the proportion that each benefits from such reduction or reversal, and the expenses incurred up to the time of the original verdict or judgment which do not reduce the Company's limit of liability under the policy involved shall be shared in proportion to each party's interest in such original verdict or judgment. The Reinsurer's liability for such loss adjustment expense shall be in addition to its liability for ultimate net loss. Article VIII - Other Reinsurance A. The Company shall be permitted to carry underlying reinsurance, recoveries under which shall inure solely to the benefit of the Company and be entirely disregarded in applying all of the provisions of this Contract. B. The Company shall maintain in force excess of loss reinsurance for $600,000 in excess of $400,000 any one occurrence, any one policy, recoveries under which shall inure to the benefit of this Contract only with respect to claims which do not involve extra contractual obligations or loss in excess of policy limits. Article IX - Premium A. As premium for the reinsurance provided hereunder, the Company shall pay the Reinsurer .54% of its net written premium for the term of this Contract, subject to a minimum premium of $126,000. B. The Company shall pay the Reinsurer a deposit premium of $140,000 in four equal installments of $35,000 on the first day of each calendar quarter during the term of this Contract. C. Within 45 days after the expiration of this Contract, the Company shall report the premium due hereunder determined in accordance with paragraph A above. Any additional premium due the Reinsurer or return premium due the Company shall be promptly remitted. D. "Net written premium" as used herein is defined as gross written premium of the Company for the classes of business reinsured hereunder, less cancellations and return premiums, and less premiums ceded by the Company for reinsurance which inures to the benefit of this Contract or for reinsurance which increases the Company's available capacity. E. Within 45 days after the end of each calendar quarter, the Company shall report to the Reinsurer the unearned reinsurance premium as of the end of the calendar quarter. F. The Company shall furnish the Reinsurer with such information as the Reinsurer may require to complete its Annual Convention Statement. 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 - 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 XII - 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 XIII - 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 specific stipulations, clauses, waivers and modifications of the Company's policies and any endorsements thereon. However, in no event shall this be construed in any way to provide coverage outside the terms and conditions set forth in this Contract. B. Nothing herein shall in any manner create any obligations or establish any rights against the Reinsurer in favor of any third party or any persons not parties to this Contract. Article XIV - Net Retained Lines (BRMA 32E) A. This Contract applies only to that portion of any policy which the Company retains net for its own account (prior to deduction of any underlying reinsurance specifically permitted in this Contract), 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 policy 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 XV - 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 XVI - 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 books of the Company. 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 - 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 of 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 XIX - 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 the Reinsurer has an A. M. Best rating equal to or below B++, 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 XX - 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 XXI - 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 XXII - 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 XXIII - 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 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 date undermentioned at: Calabasas, California, this _______ day of ________________________199___. -------------------------------------------------- Condor Insurance Company Table of Contents Article Page I Classes of Business Reinsured 1 II Term 2 III Territory 3 IV Exclusions 3 V Retention and Limit 4 VI Definitions 5 VII Claims and Loss Adjustment Expense 6 VIII Other Reinsurance 7 IX Premium 7 X Offset (BRMA 36C) 7 XI Salvage and Subrogation 8 XII Access to Records (BRMA 1D) 8 XIII Liability of the Reinsurer 8 XIV Net Retained Lines (BRMA 32E) 8 XV Errors and Omissions (BRMA 14F) 9 XVI Currency (BRMA 12A) 9 XVII Taxes (BRMA 50B) 9 XVIII Federal Excise Tax (BRMA 17A) 9 XIX Unearned Premium and Loss Reserves 9 XX Insolvency 11 XXI Arbitration 11 XXII Service of Suit (BRMA 49C) 12 XXIII Agency Agreement 13 XXIV Intermediary (BRMA 23A) 13 EX-10.12 5 AGGREGATE STOP LOSS REINSURANCE CONTRACT Aggregate Stop Loss Reinsurance Contract Effective: January 1, 1998 issued to Amwest Surety Insurance Company Far West Insurance Company and Condor Insurance Company all of Omaha, Nebraska (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," as respects surety business, and "policies," as respects property and casualty business) whether in force or expired on the effective date hereof, issued or renewed on or after that date (including bonds or policies with premium anniversary dates on or after that date), for all surety business and property and casualty 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 or policies. Article IV - Retention and Limit A. Coverage A: As respects surety business, 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 surety business during the term of this Contract. The Reinsurer shall then be liable for an amount equal to 7.0% of net earned premium for surety business during the term of this Contract in excess of the Company's ultimate net loss in excess of its retention for the term of this Contract. B. Coverage B: As respects property and casualty business, 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 67.0% of its net earned premium for property and casualty business during the term of this Contract. The Reinsurer shall then be liable for an amount equal to 7.0% of net earned premium for surety business during the term of this Contract in excess of the Company's ultimate net loss in excess of its retention for the term of this Contract. C. As respects losses under Coverage A or Coverage B or any combination thereof, the Reinsurer's liability as respects all losses occurring during the term of this Contract shall not exceed an amount equal to 7.0% of the net earned premium for surety business during the term of this Contract. D. As respects Coverage A and/or Coverage B, the Company shall have the option to purchase additional reinsurance limit equal to 7.0% of the net earned premium for surety business during 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 3.5% of net earned premium for the term of this Contract. 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 or policy 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 or policy limits" and "extra contractual obligations" as used herein shall mean: 1. "Loss in excess of bond or policy limits" shall mean 90% of any amount paid or payable by the Company under a bond or policy ceded to this Contract in excess of its bond or policy limits, but otherwise within the terms of its bond or policy, 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 or policy 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 or policy limits, paid or payable by the Company under a bond or policy 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 or policy subject to this Contract. Any loss in excess of bond or policy 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 or policy. 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. As respects surety business, "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 for surety business during the term of this Contract. 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. As respects property and casualty business, "loss adjustment expense" as used herein shall mean expenses allocable to the investigation, defense and/or settlement of specific claims, including 1) prejudgment interest, unless included as part of the award or judgment; 2) post-judgment interest; and 3) legal expenses and costs incurred in connection with coverage questions and legal actions connected thereto; but not including office expenses or salaries of the Company's regular employees, except that allocated outside costs of the Company shall be included. With respect to legal expenses and costs incurred in direct connection with declaratory judgment actions brought to resolve policy 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 policy or policies involved unless agreed to by the Reinsurer. F. "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 $1,900,000 in equal semi-annual installments of $950,000 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 B of Article IV, the premium payable shall be adjusted at a rate of 1.33% of its net earned premium for surety business, 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 66 2/3% 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 or policy 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 or policy 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 or 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 bonds or 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 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 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 bond or policy obligations of the company as direct obligations of the Reinsurer to the payees under such bonds or policies 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: Calabasas, California, this _______ day of _______________________ 199___. -------------------------------------------------- Amwest Surety Insurance Company Far West Insurance Company Condor Insurance Company Barbados, West Indies, this _______ day of _______________________ 199___. -------------------------------------------------- Underwriters Reinsurance Company (Barbados), Inc. E. W. BLANCH CO. 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 4 VII Loss Notices and Settlements 4 VIII Salvage and Subrogation 5 IX Reinsurance Premium 5 X Late Payments 5 XI Reports and Remittances 7 XII Commutation 7 XIII Offset (BRMA 36C) 7 XIV Access to Records (BRMA 1D) 8 XV Net Retained Lines 8 XVI Errors and Omissions (BRMA 14F) 8 XVII Currency (BRMA 12A) 8 XVIII Taxes (BRMA 50B) 8 XIX Federal Excise Tax (BRMA 17A) 9 XX Unauthorized Reinsurers 9 XXI Insolvency 10 XXII Arbitration 11 XXIII Service of Suit (BRMA 49C) 12 XXIV Agency Agreement 13 XXV Intermediary (BRMA 23A) 13 EX-10.15 6 75% FLORIDA MULTIPLE LINE QUOTA SHARE REINSURANCE 75% Florida Multiple Line Quota Share Reinsurance Contract Effective: July 1, 1998 issued to Condor Insurance Company Amwest Surety Insurance Company and Far West Insurance Company All 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 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 hereof, or issued or renewed on or after that date, and classified by the Company as Homeowners Multiple Peril (Sections I and II), Mobile homeowners Multiple Peril (Sections I and II) and Inland Marine business. B. "Net liability" as used herein is defined as the Company's gross liability remaining after cessions, if any, to other 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 - Term A. This Contract shall become effective at 12:01 a.m., Local Standard Time at the location of the risk, July 1, 1998, with respect to losses arising out of occurrences commencing on or after that time and date, and shall remain in force until 12:01 a.m., Local Standard Time at the location of the risk, July 1, 1999 (i.e., providing coverage on a "risks attaching/ underwriting year" basis during the term of this Contract). B. Unless the Company elects to reassume the ceded unearned premium in force on the effective date of expiration, and so notifies the Reinsurer prior to or as promptly as possible after the effective date of expiration, reinsurance hereunder on business in force on the effective date of expiration 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 expiration. C. Notwithstanding the provisions of paragraph B 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 expiration. D. All premiums and losses from policies allocated to this Contract shall be credited or charged, respectively, to this Contract, regardless of the date said premiums earn or such losses occur. It is understood that a policy will be allocated to this Contract if the term of this Contract 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, 1998, shall be allocated to this Contract. Policies shall remain allocated to this Contract until the next renewal date or premium anniversary date. Article III - Territory This Contract shall only apply to policies issued to insureds domiciled in the State of Florida, 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. 11. Liability as a member, subscriber or reinsurer of any Pool, Syndicate or Association; and any combination of insurers or reinsurers formed for the purpose of covering specific perils, specific classes of business or for the purpose of insuring risks located in specific geographical areas. However, this exclusion shall not apply to residual market mechanisms, including but not limited to FAIR Plans, Joint Underwriting Associations, or to Coastal Pools, Beach Plans or similar plans, however styled. It is understood and agreed, however, that this reinsurance does not include any increase in liability to the Company resulting from (a) the inability of any other participant in a residual market mechanism, including but not limited to a FAIR Plan, Joint Underwriting Association, Coastal Pool, Beach Plan or similar plan, to meet its liability, or (b) any claim against such a residual market mechanism, including but not limited to a FAIR Plan, Joint Underwriting Association, Coastal Pool, Beach Plan or similar plan, or any participant therein, including the Company, whether by way of subrogation or otherwise, brought by or on behalf of any insolvency fund. 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. 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, Coverage A), $500,000 each risk; 2. Homeowners Multiple Peril (Section II), $500,000 each risk. C. The Company shall be the sole judge of what constitutes "one risk". D. As respects the interim period, the Reinsurer's provisional limit of liability for property losses arising out of any one loss occurrence shall be $5,000,000 (exclusive of loss in excess of policy limits, extra contractual obligations, loss adjustment expense or any assessments from any FAIR plans, Joint Underwriting Associations, Coastal Pools, Beach Plans or similar plans or any insolvency fund or guaranty fund). After expiration of the interim period, the Reinsurer's provisional limit of liability for property losses arising out of any one loss occurrence shall be 200% of the actual gross ceded property premium hereunder (exclusive of loss in excess of policy limits, extra contractual obligations, loss adjustment expense or any assessments from any FAIR plans, Joint Underwriting Associations, Coastal Pools, Beach Plans or similar plans or any insolvency fund or guaranty fund). However, it is understood that the Reinsurer's final limit of liability for losses (including those losses occurring during the interim period), not including any loss adjustment expense, incurred from any one loss occurrence shall ultimately be calculated in accordance with paragraph A above, subject to the maximum limits of liability specified in paragraph F. E. "Interim period" as used herein shall mean the period from the effective date of this Contract through the date that the Company's gross ceded property premium hereunder exceeds $2,500,000. F. Notwithstanding the provisions of paragraph D above, in no event shall the Reinsurer's liability for property losses arising out of any one loss occurrence exceed 200% of the gross ceded property premium hereunder, after deduction for inuring reinsurance, subject to a maximum of $25,000,000 (exclusive of loss in excess of policy limits, extra contractual obligations, loss adjustment expense or any assessments from any FAIR plans, Joint Underwriting Associations, Coastal Pools, Beach Plans or similar plans or any insolvency fund or guaranty fund). G. Notwithstanding the provisions of paragraph A above, in no event shall the Reinsurer's liability for losses from any assessments from any FAIR plans, Joint Underwriting Associations or to Coastal Pools, Beach Plans or similar plans or any insolvency fund or guaranty fund exceed $25,000,000 during the term of this Contract. H. In the event the Company suffers losses arising out of the same loss occurrence involving two or more separate policies allocated to this Contract and to any prior or replacement contract, if any, the loss occurrence limitation specified in paragraphs D and E above shall be reduced to the percentage that the loss under policies allocated to this Contract bears to the Company's total losses arising out of that loss 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. B. Upon expiration of this Contract, 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 XIII. 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, regardless of how such expenses are classified for statutory reporting purposes. "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 - Florida Hurricane Catastrophe Fund A. Any loss reimbursement the Company receives under the Florida Hurricane Catastrophe Fund (FHCF) as a result of loss occurrences commencing during the term of this Contract shall be deemed to be salvage received by the Company in determining ultimate net loss under this Contract. If the salvage amount is based on the Company's losses in more than one loss occurrence and the FHCF does not designate the amount allocable to each loss occurrence, the salvage amount shall be prorated in the proportion that the Company's losses in each loss occurrence bear to the Company's total losses arising out of all loss occurrences to which the salvage applies. If, as a result of such salvage, the loss to the Reinsurer under this Contract in any one loss occurrence is less than the amount previously paid by the Reinsurer, the Company shall promptly remit the difference to the Reinsurer. B. Any return premium due the Company under this Contract as a result of a salvage payment made to the Reinsurer in accordance with paragraph A shall be payable by the Reinsurer concurrently with payment by the Company of the salvage amount. C. Any reimbursement premiums, equalization charge or emergency assessment paid by the Company under the FHCF shall be deemed to be premiums paid for inuring reinsurance. Article XI - 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 XII - Sliding Scale Commission A. The Reinsurer shall allow the Company a 32.0% 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. 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 term of this Contract: 1. If the ratio of losses incurred to premiums earned is 59.0% or greater, the adjusted commission rate for the term of this Contract shall be 26.0% 2. If the ratio of losses incurred to premiums earned is less than 59.0%, but not less than 50.0%, the adjusted commission rate for the term of this Contract shall be 26.0%, plus 67.0% of the difference in percentage points between 59.0% and the actual ratio of losses incurred to premiums earned; 3. If the ratio of losses incurred to premiums earned is less than 50.0%, but not less than 40.0%, the adjusted commission rate for the term of this Contract shall be 32.0% plus 60.0% of the difference in percentage points between 50.0% and the actual ratio of losses incurred to premiums earned; 4. If the ratio of losses incurred to premiums earned is 40.0% or less, the adjusted commission rate for the term of this Contract shall be 38.0%. C. Within 30 days after 12 months following the expiration of this Contract, the Company shall calculate and report the adjusted commission on premiums earned for the term of this Contract. If the adjusted commission on premiums earned is less than commissions previously allowed by the Reinsurer on premiums earned for the term of this Contract, 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 term of this Contract, the Reinsurer shall remit the difference to the Company as promptly as possible after receipt and verification of the Company's report. D. In the event the adjusted commission calculation for the term of this Contract 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 12-month period until all losses under policies with effective or renewal dates during the term of this Contract 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. E. "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, it being understood and agreed that all losses and related loss adjustment expense under policies with effective or renewal dates during the term of this Contract shall be charged to this Contract, regardless of the date said losses actually occur, unless this Contract expires on a "cutoff" basis, in which event the Reinsurer shall have no liability for losses occurring after the effective date of expiration. F. "Premiums earned" as used herein shall mean ceded net written premiums for policies with effective or renewal dates during the term of this Contract, 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 the term of this Contract shall be credited to this Contract, unless this Contract expires on a "cutoff" basis, in which event the unearned reinsurance premium (less previously allowed ceding commission) as of the effective date of expiration shall be returned by the Reinsurer to the Company. G. 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 XIII - 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 XIV - Loss Occurrence (NMA 2244/BRMA 27A) A. The term "loss occurrence" shall mean the sum of all individual losses directly occasioned by any one disaster, accident or loss or series of disasters, accidents or losses arising out of one event which occurs within the area of one state of the United States or province of Canada and states or provinces contiguous thereto and to one another. However, the duration and extent of any one "loss occurrence" shall be limited to all individual losses sustained by the Company occurring during any period of 168 consecutive hours arising out of and directly occasioned by the same event, except that the term "loss occurrence" shall be further defined as follows: 1. As regards windstorm, hail, tornado, hurricane, cyclone, including ensuing collapse and water damage, all individual losses sustained by the Company occurring during any period of 72 consecutive hours arising out of and directly occasioned by the same event. However, the event need not be limited to one state or province or states or provinces contiguous thereto. 2. As regards riot, riot attending a strike, civil commotion, vandalism and malicious mischief, all individual losses sustained by the Company occurring during any period of 72 consecutive hours within the area of one municipality or county and the municipalities or counties contiguous thereto arising out of and directly occasioned by the same event. The maximum duration of 72 consecutive hours may be extended in respect of individual losses which occur beyond such 72 consecutive hours during the continued occupation of an assured's premises by strikers, provided such occupation commenced during the aforesaid period. 3. As regards earthquake (the epicentre of which need not necessarily be within the territorial confines referred to in paragraph A of this Article) and fire following directly occasioned by the earthquake, only those individual fire losses which commence during the period of 168 consecutive hours may be included in the Company's "loss occurrence." 4. As regards "freeze," only individual losses directly occasioned by collapse, breakage of glass and water damage (caused by bursting frozen pipes and tanks) may be included in the Company's "loss occurrence." B. Except for those "loss occurrences" referred to in subparagraphs 2 of paragraph A above, the Company may choose the date and time when any such period of consecutive hours commences, provided that it is not earlier than the date and time of the occurrence of the first recorded individual loss sustained by the Company arising out of that disaster, accident or loss, and provided that only one such period of 168 consecutive hours shall apply with respect to one event, except for any "loss occurrences" referred to in subparagraph 1 of paragraph A above where only one such period of 72 consecutive hours shall apply with respect to one event, regardless of the duration of the event. C. However, as respects those "loss occurrences" referred to in subparagraph 2 of paragraph A above, if the disaster, accident or loss occasioned by the event is of greater duration than 72 consecutive hours, then the Company may divide that disaster, accident or loss into two or more "loss occurrences," provided that no two periods overlap and no individual loss is included in more than one such period, and provided that no period commences earlier than the date and time of the occurrence of the first recorded individual loss sustained by the Company arising out of that disaster, accident or loss. D. No individual losses occasioned by an event that would be covered by 72 hours clauses may be included in any "loss occurrence" claimed under the 168 hours provision. Article XV - 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 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. 1/365ths 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 XVI - 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 XVII - 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 XVIII - 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 XIX - 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 XX - 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 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 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 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 XXII - 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 Calabasas, 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 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 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 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 Company by its duly authorized representative has executed this Contract as of the date undermentioned at: Calabasas, California, this _______ day of ________________________199___. -------------------------------------------------- Condor Insurance Company Table of Contents Article Page I Classes of Business Reinsured 1 II Term 1 III Territory 2 IV Exclusions 3 V Retention and Limit 4 VI Assessments 5 VII Loss in Excess of Policy Limits/ECO 5 VIII Claims and Loss Adjustment Expense 6 IX Salvage and Subrogation 7 X Florida Hurricane Catastrophe Fund 7 XI Original Conditions 7 XII Sliding Scale Commission 8 XIII Reports and Remittances 9 XIV Loss Occurrence (NMA 2244/BRMA 27A) 10 XV Late Payments 11 XVI Offset (BRMA 36C) 13 XVII Access to Records (BRMA 1D) 13 XVIII Errors and Omissions (BRMA 14F) 13 XIX Taxes (BRMA 50B) 13 XX Unearned Premium and Loss Reserves 13 XXI Insolvency 15 XXII Arbitration 15 XXIII Service of Suit (BRMA 49C) 16 XXIV Agency Agreement 17 XXV Intermediary (BRMA 23A) 17 EX-10.16 7 QUOTA SHARE REINSURANCE AGREEMENT Quota Share Reinsurance Agreement REINSURED: Amwest Surety Insurance Company Calabasas, California REINSURER: Underwriters Reinsurance Company Calabasas, California SUBJECT BUSINESS: Business classified as Surety by Reinsured. SUBJECT LOSS: Subject Loss shall be defined as Loss, ALAE and ULAE for losses with a discovery date during the term of this agreement. "Losses Discovered" shall be deemed to mean new losses reported on or after the effective date and specifically excludes any development of losses discovered by the Company prior to inception relating to business inforce as of July 1, 1998. SUBJECT PREMIUM: Unearned Premium as of June 30, 1998, PLUS Written Premium during the Term for Subject Business, TERM: July 1, 1998 to June 30, 1999. LIMIT: 15.0% Quota ,hare of Subject Premium. CEDING COMMISSION: Provisional: 75.09"0 at 25,0% Loss and I AE Ratio. Sliding- 1 for 1 to Minimum: 67.0% at 33.0% Loss and LAE Ratio. FUNDS WITHHELD ACCOUNT: The Funds Withheld Account (FWA) shall be established and maintained by the Reinsured. The balance 'in the FWA shall be calculated at follows: 100% of Ceded Subject Premium, Less Ceding Commission, Less Reinsurer Expense, Less Ceded Paid Loss, Plus Interest Credit Interest shall be credited quarterly to the FWA by the Reinsured at a rate of 1.5% multiplied by the average daily balance in the FWA over the quarter. REINSURER EXPENSE: Flat $400,000, payable in four installments at October 1, 1998; December 31, 1998; March 31, 1999; and June 30, 1999. Reinsurer Expense is payable in addition to the 15.0% of Subject Premium. EXCLUSIONS: 1. Inuring reinsurance which is uncollectable. 2. Others to conform to Excess Treaty. ACCOUNTS& RIEMITTANCES: Quarterly within 45 days, the Reinsured shall furnish the following: 1. GNWPI on Subject Business. 2. Net Earned Premiums on Subject Business. 3. Ceded Subject Loss Outstanding. 4. Ceded Subject Loss Paid. 5. FWA balance. Balances due either party will be payable quarterly within 45 days. Ceded Subject Loss shall first be paid from the FWA, and then from the Reinsurer's own funds. COMMUTATION: The Company may commute this agreement at any time on or after December 31, 1998. As consideration for commutation, the Reinsurer shall release 100%, of the FWA back to the Company. Commutation shall fully and finally release the Reinsurer from all liability under this agreement. INSOLVENCY: In the event of the insolvency of the REINSURED, this reinsurance shall be payable directly to the REINSURED or to its liquidator. receiver, conservator, or statutory successor on the basis of the liability of the REINSURED without diminution because of the insolvency of the REINSURED or because the liquidator, receiver, conservator, or statutory successor of the REINSURED has failed to pay all or a portion of a claim. It is agreed, however, that the liquidator, receiver, conservator, or statutory successor of the REINSURED shall give written notice to the REINSURER of the pendency of a claim against the REINSURED indicating the policy insured 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 the receivership, and that during the pendency of such a claim, the REINSURER may investigate such claim and interpose, at their own expense, in the proceeding where such claim is to be adjudicated, any defense or defenses that they may deem available to the REINSURED 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 REINSURED as part of the expense of conservation or liquidation to the extent of a pro rata share of the defense undertaken by the REINSURER. URC SHARE: 100% of 15.0% Quota Share. Agreed to Cede: Accepted by: Steven P,. Kay Date Anthony L. Manzitto Date Amwest Surety Insurance Company Underwriters Reinsurance Company -----END PRIVACY-ENHANCED MESSAGE-----