-----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, SnGVEdjzUIa46XQjL0HnYfD+u91PbIdQ9FZoVQgt67OYDY8oBDlv1sglBfme52Ti yIKXCi93SyRReXLoSiEH3w== 0000916641-99-000056.txt : 19990201 0000916641-99-000056.hdr.sgml : 19990201 ACCESSION NUMBER: 0000916641-99-000056 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990115 ITEM INFORMATION: ITEM INFORMATION: FILED AS OF DATE: 19990129 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MARKEL CORP CENTRAL INDEX KEY: 0000803509 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 540292420 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 8-K SEC ACT: SEC FILE NUMBER: 001-13051 FILM NUMBER: 99517402 BUSINESS ADDRESS: STREET 1: 4551 COX RD CITY: GLEN ALLEN STATE: VA ZIP: 23060-3382 BUSINESS PHONE: 8047470136 MAIL ADDRESS: STREET 1: P O BOX 2009 CITY: GLEN ALLEN STATE: VA ZIP: 23058-2009 8-K 1 MARKEL CORPORATION FORM 8-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 8-K CURRENT REPORT Pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 Date of Report (Date of earliest event reported) January 15, 1999 MARKEL CORPORATION (Exact name of registrant as specified in its charter) Virginia (State or other jurisdiction of incorporation or organization) 1-13051 54-0292420 (Commission (I.R.S. employer file number) identification number) 4551 Cox Road, Glen Allen, Virginia 23060-3382 (Address of principal executive offices) (Zip code) (804) 747-0136 (Registrant's telephone number, including area code) NONE (Former name, former address and former fiscal year, if changed since last report) Item 2. Acquisition or Disposition of Assets On January 15, 1999 Markel Corporation (the Registrant) acquired Gryphon Holdings Inc. and its subsidiaries (Gryphon) as a result of the completion of a public tender offer. As of the termination of the offer, based on a preliminary count from the depositary for the offer, approximately 5.9 million shares of Gryphon common stock had been tendered and accepted for payment. These shares together with the shares that the Registrant already owned, represent approximately 98 percent of Gryphon's total issued and outstanding shares of common stock. The Registrant intends to cause a wholly owned subsidiary of the Registrant to effect a merger with Gryphon pursuant to which the remaining shares of Gryphon common stock will be converted into the right to receive $19.00 per share in cash. Markel currently expects the merger to be consummated by the end of February 1999. The timing of the merger will depend upon, among other things, whether the outstanding shares of Gryphon preferred stock are redeemed, converted into shares of Gryphon common stock or purchased by Markel in a negotiated transaction. Total consideration paid for Gryphon was approximately $150.7 million. The Registrant funded the transaction with available cash on hand of approximately $100.7 million and borrowings under existing lines of credit. In addition, the Registrant subsequently refinanced $55.0 million of Gryphon's debt. Gryphon, which operates through its main subsidiary, Gryphon Insurance Group, is a specialty property and casualty underwriting organization. Gryphon's wholly-owned insurance subsidiaries are Associated International Insurance Company, Calvert Insurance Company and The First Reinsurance Company of Hartford (FRH). Gryphon acquired FRH on July 13, 1998. Following the acquisition, the Registrant expects to significantly reorganize Gryphon. The Registrant anticipates that certain unprofitable lines of business will be discontinued which may materially reduce the amount of business written by Gryphon. "Safe Harbor" Statement This is a "Safe Harbor" statement under the Private Securities Litigation Reform Act of 1995. Certain statements that are contained herein are forward-looking statements that involve risks and uncertainties. Future actual results may materially differ from those in these statements because of many factors. For instance, the registrant will be significantly reorganizing Gryphon's operations and the scope and impact of these changes cannot be determined at this time. Insurance industry price competition has made it more difficult to attract and retain adequately priced business. State regulatory actions can impede the Company's ability to charge adequate rates and efficiently allocate capital. Also the frequency and severity of natural catastrophes are highly variable. Economic conditions and interest rate volatility can have significant impacts on the market value of fixed maturity and equity investments. The business community's state of readiness for the Year 2000 and the Company's potential underwriting exposure to Year 2000 claims are difficult to predict with any certainty. Accordingly, the Company's premium growth, underwriting and investing results have been and will continue to be potentially materially affected by these factors. Item 7. Financial Statements, Pro Forma Financial Information and Exhibits (a) Financial Statements of Business Acquired The following financial statements of Gryphon Holdings, Inc. are filed as part of this report: Independent Auditors' Report Consolidated Balance Sheets as of December 31, 1997 and 1996 Consolidated Statements of Income for the Years Ended December 31, 1997, 1996 and 1995 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1997, 1996 and 1995 Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995 Notes to Consolidated Financial Statements Consolidated Balance Sheets as of September 30, 1998 and December 31, 1997(Unaudited) Consolidated Statements of Income for the Nine Months Ended September 30, 1998 and 1997 (Unaudited) Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 1998 and 1997 (Unaudited) Notes to Consolidated Financial Statements (Unaudited) (b) Pro Forma Financial Information (Unaudited) The following pro forma financial information is included as part of this report: Introduction Pro Forma Consolidated Balance Sheet as of September 30, 1998 Pro Forma Consolidated Statement of Income and Comprehensive Income for the Nine Months Ended September 30, 1998 Pro Forma Consolidated Statement of Income and Comprehensive Income for the Year Ended December 31, 1997. Notes to Pro Forma Consolidated Financial Statements (c) Exhibits The Exhibits listed on the Exhibit Index are filed as part of this report. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. MARKEL CORPORATION Date: January 29, 1999 By: Darrell D. Martin --------------------- Executive Vice President And Chief Financial Officer EXHIBIT INDEX 4 Agreement and Plan of Merger among Markel Corporation, MG Acquisition Corp. and Gryphon Holdings, Inc.* 23 Consent of KPMG LLP to the inclusion of their report as part of this report on Form 8-K. * Incorporated by reference from Exhibit (g)(6) to Amendment No. 7 to Schedule 14D-1 filed by the Registrant on November 25, 1998. Item 7a. FINANCIAL STATEMENTS OF BUSINESS ACQUIRED INDEPENDENT AUDITORS' REPORT Board of Directors and Shareholders Gryphon Holdings Inc. We have audited the accompanying consolidated balance sheets of Gryphon Holdings Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Gryphon Holdings Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. KPMG LLP New York, New York February 24, 1998
Consolidated Balance Sheets December 31, 1997 1996 (Dollars in thousands) Assets Investments: Fixed maturities, available for sale, at fair value (amortized cost: 1997 - $274,506; 1996 - $274,515) $ 280,553 $ 280,164 Short-term investments, at cost, which approximates market 257 307 Total investments 280,810 280,471 Cash and cash equivalents 32,272 23,398 Accrued investment income 4,071 3,919 Premiums receivable 16,151 18,509 Reinsurance recoverable on paid losses 18,261 14,326 Reinsurance recoverable on unpaid losses 140,810 137,952 Prepaid reinsurance premiums 16,573 18,965 Deferred policy acquisition costs 11,849 12,415 Deferred income taxes 10,569 10,282 Other assets 7,619 6,747 Total assets $ 538,985 $ 526,984 Liabilities and Stockholders' Equity Policy liabilities: Unpaid losses and loss adjustment expenses $ 328,911 $ 309,259 Unearned premiums 62,351 68,683 Total policy liabilities 391,262 377,942 Reinsurance balances payable 12,179 16,207 Income taxes payable 389 55 Long-term debt 21,125 24,625 Other liabilities 9,521 13,019 Total liabilities 434,476 431,848 Commitments and contingencies Stockholders' equity: Preferred stock, $.01 par value; 1,000,000 shares authorized; none issued or outstanding Common stock, $.01 par value; 15,000,000 shares authorized; 8,148,050 shares issued 81 81 Additional paid-in capital 30,742 30,847 Foreign currency translation adjustment, net of tax (346) (219) Net unrealized investment gains, net of tax 3,931 3,672 Deferred compensation (151) (257) Retained earnings 95,065 86,271 Treasury stock, at cost; shares 1997: 1,461,169: 1996:1,487,075 (24,813) (25,259) Total stockholders' equity 104,509 95,136 Total liabilities and stockholders' equity $ 538,985 $ 526,984
See accompanying notes to consolidated financial statements. Consolidated Statements of Income
Year ended December 31, 1997 1996 1995 ---------------------------------- (Dollars and shares in thousands, except per-share data) Revenues Net premiums earned $ 104,246 $ 87,929 $ 83,399 Net investment income 17,061 16,453 15,839 Realized gains on investments 6,188 1,203 3,647 Other income 979 1,059 Total revenues 128,474 106,644 102,885 Expenses Losses and loss adjustment expenses 71,015 57,700 50,816 Underwriting, acquisition, and insurance expenses 45,089 40,967 34,590 Interest expense 1,607 1,761 595 Total expenses 117,711 100,428 86,001 Income before income taxes 10,763 6,216 16,884 Provision for income taxes (benefit): Current 2,395 1,389 2,969 Deferred (426) (1,336) 990 Total income taxes 1,969 53 3,959 Net income $ 8,794 $ 6,163 $ 12,925 Basic earnings per share $ 1.32 $ 0.93 $ 1.69 Weighted average shares outstanding 6,680 6,656 7,648
See accompanying notes to consolidated financial statements. Consolidated Statements of Stockholders' Equity
Foreign Unrealized Additional Currency Investment Common Paid-in Translation Gains Deferred Retained Treasury Stock Capital Adjustment (Losses) Compensation Earnings Stock Total --------- ---------- ------------- ---------- ----------- -------- --------- ----- (Dollars in thousands) Balances at January 1, 1995 $ 81 $ 30,850 $ (259) $ (3,840) $ (242) $ 67,183 $ 93,773 Add (deduct): Net income 12,925 12,925 Translation adjustment 50 50 Stock award plans 49 49 Net unrealized investment gains, net of tax 11,903 11,903 Purchase of common stock for treasury (25,478) (25,478) Balances at December 31, 1995 81 30,850 (209) 8,063 (193) 80,108 (25,478) 93,222 Add (deduct): Net income 6,163 6,163 Translation adjustment (10) (10) Stock award plans (3) (64) 219 152 Net unrealized investment losses, net of tax (4,391) (4,391) Balances at December 31, 1996 81 30,847 (219) 3,672 (257) 86,271 (25,259) 95,136 Add (deduct): Net income 8,794 8,794 Translation adjustment (127) (127) Stock award plans (105) 106 446 447 Net unrealized investment gains, net of tax 259 259 Balances at December 31, 1997 $ 81 $ 30,742 $ (346) $ 3,931 $ (151) $ 95,065 $ (24,813) $104,509
See accompanying notes to consolidated financial statements. Consolidated Statements of Cash Flows
Year ended December 31, 1997 1996 1995 ------------------------------------------ (Dollars in thousands) Operating activities Net income $ 8,794 $ 6,163 $ 12,925 Adjustments to reconcile net income to net cash provided by operating activities: Increase in net policy liabilities 8,919 32,239 4,958 Decrease (increase) in premiums receivable 2,358 (1,034) (3,196) Decrease (increase) in deferred policy acquisition costs 566 (233) (2,388) Deferred income tax provision (426) (1,336) 990 Decrease (increase) in other assets and liabilities (3,009) 1,543 (539) Amortization and depreciation 781 595 402 Amortization of bond discount, net 498 944 370 Realized gains on investments (6,188) (1,203) (3,647) Increase (decrease) in reinsurance balances payable (4,028) (13,166) 12,341 Decrease (increase) in accrued investment income (152) 161 (175) Net cash provided by operating activities 8,113 24,673 22,041 Investing activities Sales of fixed maturities 438,021 281,728 221,026 Purchases of fixed maturities (434,292) (310,660) (249,119) Maturities or calls of fixed maturities 1,800 3,000 4,775 Net sales of Short-term investments 50 230 Capital expenditures (1,568) (2,111) (366) Net cash provided by (used in) investing activities 4,011 (27,813) (23,684) Financing activities Proceeds from long-term debt 25,500 Common stock acquired for treasury (25,478) Principal payment on long-term debt (3,500) (875) Issuance of common stock 340 217 Deferred compensation 37 (131) Net cash provided by (used in) financing activities (3,123) (789) 22 Effect of exchange rate changes on cash (127) (10) 50 Increase (decrease) in cash and cash equivalents 8,874 (3,939) (1,571) Cash and cash equivalents at beginning of year 23,398 27,337 28,908 Cash and cash equivalents at end of year $ 32,272 $ 23,398 $ 27,337 Supplemental disclosure of cash flow information Income taxes paid $ 1,855 $ 1,701 $ 2,783 Interest paid 1,607 1,761 586
See accompanying notes to consolidated financial statements. 1. Summary of Significant Accounting Policies The significant accounting policies followed by the Company are summarized below. Basis of Presentation and Principles of Consolidation Gryphon Holdings Inc. operates through its main subsidiary, Gryphon Insurance Group Inc., as a specialty property and casualty underwriting organization. The Company's wholly owned insurance company subsidiaries are Associated International Insurance Company ("Associated") and Calvert Insurance Company ("Calvert"), which operate in the property and casualty insurance industry. Associated writes the majority of its property and casualty insurance policies in the State of California. Calvert writes property and casualty insurance policies throughout the United States and Canada. The accompanying consolidated financial statements have been prepared on the basis of generally accepted accounting principles ("GAAP"), which as to the two insurance subsidiaries differ from the statutory accounting practices ("SAP") prescribed or permitted by regulatory authorities, and include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The preparation of the consolidated financial statements in conformity with GAAP requires the use of estimates and assumptions that affect amounts reported in the consolidated financial statements and the accompanying notes. Actual results could differ from such estimates. Premium Revenues Direct, assumed and ceded property and liability insurance premiums written are recognized as earned on a pro rata basis over the terms of the policies. Unearned premiums are calculated principally by the application of pro rata fractions and represent the portion of premiums written that is applicable to unexpired terms of policies in force. Recoverable policy acquisition costs that vary with and are directly related to the production of business, consisting of commissions, premium taxes and other underwriting expenses incurred, net of ceding allowances, are deferred and amortized to income as the related premiums are earned. The Company does not consider anticipated investment income when determining the recoverability of amounts deferred. Amortization of deferred policy acquisition costs amounted to $34.0 million, $30.1 million, and $26.7 million for the years ended December 31, 1997, 1996 and 1995, respectively. Reinsurance Assumed reinsurance premiums written, commissions and unpaid losses and loss adjustment expenses are accounted for based principally on the reports received from the ceding insurance companies and in a manner consistent with the terms of the related reinsurance agreements. To limit its risks, the Company acquires reinsurance coverage with retentions and limits that management believes are appropriate for the circumstances. Reinsurance arrangements effected under quota-share reinsurance contracts and excess-of- loss reinsurance contracts provide for greater diversification of business, allow management to control exposure to potential losses arising from large risks, and provide additional capacity for growth. The accompanying consolidated financial statements reflect premiums earned, losses and loss adjustment expenses ("LAE") and underwriting, acquisition and insurance expenses, net of reinsurance ceded. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policies. Contingent commissions and retrospectively-rated premiums are accounted for on an earned basis and are accrued, in accordance with the terms of the applicable reinsurance agreement, based on the estimated ultimate level of profitability relating to such reinsured business. Accordingly, the profitability of the reinsured business is continually reviewed and as adjustments become necessary, such adjustments are reflected in current operations. Cash and Cash Equivalents The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Investments The Company's securities are classified as available for sale and reported at fair value, with unrealized gains and losses, net of deferred income taxes, included in stockholders' equity. Fair values are based on quoted market prices, when available, or estimates based on market prices for similar securities, when quotes are not available. Short-term investments are carried at cost, which approximates their fair value. Realized gains and losses from sales or liquidations of investments are determined on the basis of the specific identification method and are included in net income. Investment income is recognized when earned. The amortization of premium and accretion of discount for fixed maturity securities are computed utilizing the interest method. Losses and Loss Adjustment Expenses The liabilities for unpaid losses and LAE are based on the Company's estimates of the ultimate cost of unpaid losses reported prior to the close of the accounting period, IBNR losses, and the related LAE. These liabilities are estimated by management utilizing methods and procedures which it believes are reasonable and necessarily are subject to the impact of future changes in claim severity and frequency, as well as numerous other factors. Although management believes that the estimated liabilities for losses and LAE are reasonable, because of the extended period of time over which such losses are reported and settled, the subsequent development of these liabilities may not conform to the assumptions inherent in their determination and, accordingly, may vary from the estimated amounts included in the accompanying consolidated financial statements. To the extent that the actual emerging loss experience varies from the assumptions used in the determination of these liabilities, they are adjusted to reflect actual experience. Such adjustments, to the extent they occur, are reported in the period recognized. The Company's liabilities for unpaid losses and LAE include estimates for certain types of latent exposures, such as environmental impairment and asbestos-related claims, relating to business written prior to 1985 and which are generally difficult to establish with traditional reserving techniques. The Company wrote policies with environmental impairment and asbestos-related exposures at high attachment levels and obtained reinsurance coverage reducing its net retention to $50,000 per occurrence. Among the complications of reserving for this type of business are a lack of sufficient historical data, long reporting delays, uncertainty as to the number and identity of insureds with potential exposure, and complex, unresolved legal issues regarding policy coverage and the extent and timing of any such contractual liability. Courts have reached different and sometimes inconsistent conclusions as to when a loss occurred and which policies provide coverage, which claims are covered, whether there is an insured obligation to defend, how policy limits are determined, how policy exclusions are applied and interpreted, and whether clean-up costs are includible as insured property damage. These legal issues are not likely to be resolved in the near future. The establishment of appropriate reserves is an inherently uncertain process, and there can be no assurance that the ultimate liability, particularly with respect to latent exposures such as environmental impairment and asbestos, will not materially exceed the Company's current liability for unpaid loss and loss adjustment expense reserve estimates and have a material adverse effect on its future results of operations and financial condition. Furthermore, due to the inherent uncertainty of estimating such liabilities, particularly with respect to such latent exposures, it has been, and may over time continue to be, necessary to revise such estimated liabilities. However, on the basis of the Company's internal procedures, which analyze, among other things, its experience with similar cases and historical trends such as reserving patterns, loss payments, pending levels of unpaid claims, and product mix, as well as court decisions, economic conditions and public attitudes, management believes that adequate provision has been made for the Company's liabilities for unpaid losses and LAE as of December 31, 1997. Foreign Currency Transactions denominated in foreign currencies are translated at the rate of exchange at the transaction date. Revenues and expenses are translated at average exchange rates. Assets and liabilities are translated at the exchange rates in effect at the balance sheet date. Earnings per Share In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share", which the Company implemented in 1997. SFAS No. 128 establishes standards for computing and presenting earnings per share. Primary earnings per share have been replaced by basic earnings per share and calculated by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period. Fully diluted earnings per share have been replaced by diluted earnings per share and calculated by including additional common shares that would have been outstanding if potentially dilutive shares had been issued during the period. Prior period earnings per share were not affected by the adoption of SFAS No. 128. New Accounting Standards In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income", which requires enterprises to disclose comprehensive income and its components in a prominent position on the face of the financial statement. The Company will implement this statement in 1998. This statement relates to presentation of information and will have no impact on results of operations or financial condition. In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information", which will be effective for the Company beginning January 1, 1998. SFAS No. 131 redefines how operating segments are determined and requires disclosure of certain financial and descriptive information about a company's operating segments. This statement relates to presentation of information and will have no impact on results of operations or financial condition. Interim financial information will be required beginning in 1999 (with comparative 1998 information). The Company is currently evaluating the segment information disclosures required by SFAS No. 131. In December of 1997, the American Institute of Certified Public Accountants issued Statement of Position No. 97-3 "Accounting by Insurance and Other Enterprises for Insurance- related Assessments" ("SOP 97-3"). SOP 97-3 establishes standards for accounting for guaranty-fund and certain other insurance related assessments. SOP 97-3 is effective for fiscal years beginning after December 15, 1998 and requires any impact of adoption to be reported as a change in accounting principle. The adoption of this statement is not expected to have a material effect on the Company's results of operations or financial condition. 2. Investments The major categories of net investment income are summarized as follows: Year ended December 31 1997 1996 1995 -------------------------------- (Dollars in thousands) Fixed maturities $16,384 $ 16,256 $ 15,245 Cash, cash equivalents and short-term investments 1,684 1,117 1,610 Total investment income 18,068 17,373 16,855 Less related expenses (1,007) (920) (1,016) Net investment income $17,061 $ 16,453 $ 15,839 The gross realized gains and losses from sales of fixed maturity securities are as follows: Year ended December 31 1997 1996 1995 --------------------------------- (Dollars in thousands) Gross realized gains $ 7,530 $ 3,074 $ 4,306 Gross realized losses (1,342) (1,871) (659) Net realized gains on sales $ 6,188 $ 1,203 $ 3,647 At December 31, 1997 and 1996, the amortized cost and estimated fair values of investments in fixed maturities, by categories of securities, and short-term investments were as follows:
Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------- ---------- ------------ ---------- (Dollars in thousands) December 31, 1997 U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 78,623 $ 667 $ (22) $ 79,268 Debt securities issued by foreign governments 5,857 130 (6) 5,981 Tax-exempt obligations of states and political subdivisions 108,194 4,322 112,516 Mortgage-backed securities 47,488 501 (47) 47,942 Corporate securities 34,344 617 (115) 34,846 274,506 6,237 (190) 280,553 Short-term investments 257 257 $ 274,763 $ 6,237 $ (190) $ 280,810
Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- ---------- (Dollars in thousands) December 31, 1996 U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 55,845 $ 826 $ (87) $ 56,584 Debt securities issued by foreign governments 5,747 186 (10) 5,923 Tax-exempt obligations of states and political subdivisions 141,686 4,718 (69) 146,335 Mortgage-backed securities 43,381 294 (214) 43,461 Corporate securities 27,856 345 (340) 27,861 274,515 6,369 (720) 280,164 Short-term investments 307 307 $ 274,822 $ 6,369 $ (720) $ 280,471
At December 31, 1997, the amortized cost and estimated fair value of fixed maturities, by contractual maturity, are shown below. Expected maturities, which are best estimates, will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.
December 31, 1997 Amortized Fair Cost Value --------- ------ (Dollars in thousands) Due in one year or less $ 279 $ 286 Due after one year through five years 65,562 66,567 Due after five years through ten years 95,153 97,677 Due after ten years 66,024 68,081 227,018 232,611 Mortgage-backed securities 47,488 47,942 Total $274,506 $280,553
At December 31, 1997, investments in Federal National Mortgage Association securities aggregating $11.8 million represented the only investments in any entity in excess of 10.0% of stockholders' equity other than those investments issued or guaranteed by the U.S. government. Securities on Deposit At December 31, 1997 and 1996, securities with a fair value of approximately $19.3 million and $18.6 million, respectively were on deposit with various state or governmental insurance departments in order to comply with statutory insurance laws. 3. Losses and Loss Adjustment Expenses The following table provides a reconciliation of beginning and ending loss and LAE reserve balances of the Company for each of the years in the three-year period ended December 31, 1997 as computed in accordance with GAAP.
1997 1996 1995 ---- ---- ---- Gross reserves for losses and LAE at the beginning of the year $ 309,259 $ 308,886 $ 315,691 Ceded reserves for losses and LAE at the beginning of the year 137,952 152,975 169,889 Net reserves for losses and LAE at the beginning of the year 171,307 155,911 145,802 Add: Provision for losses and LAE for claims occurring in: The current year 64,222 53,402 50,424 Prior years 6,793 4,298 392 Total net incurred losses and LAE 71,015 57,700 50,816 Less: Losses and LAE payments for claims occurring in: The current year 13,932 11,520 11,796 Prior years 40,289 30,784 28,911 Total net paid losses and LAE 54,221 42,304 40,707 Reserves for net losses and LAE at end of year 188,101 171,307 155,911 Reinsurance recoverable on unpaid losses 140,810 137,952 152,975 Reserves for gross losses and LAE at end of year $ 328,911 $ 309,259 $ 308,886
The provision for losses and LAE for claims occurring in prior years shows an unfavorable development of $6.8 million in 1997. The unfavorable development resulted principally from a pre-1985 book of Casualty business and certain pre-1987 reinsurance-assumed business, both previously discontinued. The following table provides a reconciliation of beginning and ending loss and LAE reserve balances of the Company for each of the years in the three-year period ended December 31, 1997 for environmental impairment and asbestos-related liabilities. Reconciliation of Environmental Impairment and Asbestos-related Liability for Loss and Loss Adjustment Expenses (Dollars in thousands)
Year ended December 31, Environmental Impairment Liability 1997 1996 1995 ---- ---- ----- Gross reserves for losses and LAE at the beginning of the year $ 12,981 $ 11,938 $ 14,200 Ceded reserves for losses and LAE at the beginning of the year 4,177 3,958 5,100 Net reserves for losses and LAE at the beginning of the year 8,804 7,980 9,100 Add: Provision for losses and LAE for claims occurring in prior years (845) 1,598 3 Less: Losses and LAE payments for claims occurring in prior years 1,159 774 1,123 Reserves for net losses and LAE at end of year 6,800 8,804 7,980 Reinsurance recoverable on unpaid losses 5,200 4,177 3,958 Reserves for gross losses and LAE at end of year $ 12,000 $ 12,981 $ 11,938
Year ended December 31, Asbestos-related Liability 1997 1996 1995 ---- ---- ----- Gross reserves for losses and LAE at the beginning of the year $ 4,121 $ 1,700 $ 4,050 Ceded reserves for losses and LAE at the beginning of the year 3,110 1,060 3,350 Net reserves for losses and LAE at the beginning of the year 1,011 640 700 Add: Provision for losses and LAE for claims occurring in prior years 847 583 612 Less: Losses and LAE payments for claims occurring in prior years 143 212 672 Reserves for net losses and LAE at end of year 1,715 1,011 640 Reinsurance recoverable on unpaid losses 2,500 3,110 1,060 Reserves for gross losses and LAE at end of year $ 4,215 $ 4,121 $ 1,700
At December 31, 1997, the reserve for unpaid environmental impairment losses and related LAE was approximately $6.8 million, net of reinsurance recoverables deemed probable of collection by the Company of approximately $5.2 million. The range of gross reserves for unpaid environmental impairment losses and LAE is estimated to be $12.0 million to $20.0 million and the range of reserves, net of reinsurance recoverable, for unpaid environmental impairment losses and LAE is estimated to be approximately $6.8 million to $9.5 million. At December 31, 1997, the reserve for unpaid asbestos- related losses and related LAE was $1.7 million, net of reinsurance recoverables deemed probable of collection by the Company of approximately $2.5 million. The range of gross reserves for unpaid asbestos-related losses and LAE is estimated to be $4.2 million to $9.4 million and the range of reserves, net of reinsurance recoverable, for unpaid asbestos-related losses and LAE is estimated to be approximately $1.7 million to $3.3 million. There are significant uncertainties in estimating the amount of the Company's environmental impairment and asbestos- related liabilities resulting from a lack of historical data, long reporting delays, uncertainty as to the number and identity of insureds with potential exposure, and complex, unresolved legal issues regarding policy coverage and the extent and timing of any such contractual liability. Courts have reached different and sometimes inconsistent conclusions as to when a loss occurred and what policies provide coverage, what claims are covered, whether there is an insured obligation to defend, how policy limits are determined, how policy exclusions are applied and interpreted, and whether cleanup costs are includible as insured property damage. These issues are not likely to be resolved in the near future. As a result of these issues, the ultimate number and cost of these claims may generate losses that vary materially from the amounts currently recorded and could have a material adverse effect on the Company's results of operations and financial condition. While management believes the Company's reserves for these coverages are appropriately established, because of the uncertainty of circumstances surrounding many critical factors that affect environmental impairment and asbestos-related liabilities, there can be no assurance that the Company's reserves for and losses from these claims will not increase in the future. 4. Reinsurance Certain premiums and losses are assumed from and ceded to other insurance companies under various reinsurance agreements. The Company cedes a portion of its business through quota share treaties, excess of loss treaties and facultative placements, and generally retains net amounts of risk ranging from $100,000 to $500,000 per risk. The following table sets forth the significant reinsurance receivables due from reinsurers as of December 31, 1997.
Year ended December 31, 1997 (Dollars in thousands) Reinsurance A.M. Best's Reinsurer Receivables Rating ----------- ----------- American Re-Insurance Company $ 19,684 A+ Signet Star Reinsurance Corporation 10,853 A Odyssey Reinsurance Corporation 10,507 A - St. Paul Fire and Marine Insurance Company 10,224 A+ First Excess & Reinsurance Corporation 9,430 A Lloyd's Underwriters 9,310 * Great Lakes American Reinsurance Company 8,884 A - Swiss Reinsurance America Corp. 7,589 A
* A.M. Best does not assign ratings to Lloyd's syndicates. The amount and cost of reinsurance available to companies specializing in property and casualty insurance are subject, in large part, to prevailing market conditions beyond the control of the Company. The Company's ability to provide insurance at competitive premium rates and coverage limits on a continuing basis depends to a significant extent upon its ability to obtain adequate reinsurance in amounts and at rates that will not adversely affect its competitive position. For the years ended December 31, 1997, 1996 and 1995, amounts relating to assumed and ceded reinsurance premiums written and earned and losses and LAE incurred reflected in the accompanying consolidated statements of income approximated the following:
Year ended December 31, 1997 1996 1995 ---- ---- ---- (Dollars in thousands) Premiums Written: Assumed $ 3,315 $ 2,390 $ 2,076 Ceded 45,792 62,330 66,805 Premiums Earned: Assumed $ 3,715 $ 2,209 $ 1,715 Ceded 48,179 63,824 66,064 Losses & LAE Incurred: Assumed $ 14,617 $ 4,455 $ 2,585 Ceded 46,569 42,052 52,089
At December 31, 1997 the Company held letters of credit of approximately $7.7 million securing amounts due from reinsurers. During 1997, Associated maintained a six-layer property catastrophe reinsurance program which covered 95% of the annual aggregate amount of property claims up to $138.0 million per occurrence, subject to a retention of $2.5 million per occurrence. Associated limits its net retention to $100,000 per risk for difference in conditions ("DIC"). Until October 1, 1996, Associated retained $250,000 per risk for casualty, architects' and engineers' professional liability, specialty lines, and commercial auto and up to $500,000 per risk for non-DIC property policies. Calvert reinsured various lines of business through quota share treaties, excess of loss treaties and facultative placements which limited Calvert's net retention per risk to a maximum of $200,000 for property and casualty. Effective October 1, 1996, the Company's reinsurance program was restructured to provide protection for loss events covering property and casualty classes of business, excluding DIC and certain other property business. The program provides for $24.5 million of coverage in excess of a new retention of $500,000 for each and every event. Certain business is covered by a quota share treaty that limits the Company's net retention per risk to a maximum of $250,000. Reinsurance ceded contracts do not relieve the Company of its obligations to policyholders. The Company remains liable to its policyholders for the portion reinsured to the extent that any reinsurer does not meet its obligations for reinsurance ceded to it under the reinsurance agreements. Failure of reinsurers to honor their obligations could result in losses to the Company. In addition, as is often the case in the normal course of business, the Company is involved in disputes with reinsurers regarding certain loss recoverables. Although the Company believes that such issues will be resolved in the Company's favor, there can be no assurance that the Company will prevail; an unfavorable resolution could have a material effect on the Company's financial statements. 5. Federal Income Taxes The Company uses an asset and liability approach for financial accounting and reporting for income taxes. Under the asset and liability method, deferred tax assets and liabilities are recorded based on the difference between the financial statement and tax bases of assets and liabilities and the tax rates in effect when these temporary differences are expected to reverse. The principal assets and liabilities giving rise to such differences are loss and LAE reserves, unearned premiums, deferred policy acquisition costs, and net unrealized investment gains (losses). The components of the net deferred income tax asset are as follows:
Year ended December 31, 1997 1996 ---- ---- (Dollars in thousands) Discount on loss reserves $ 12,769 $ 12,270 Unearned premium reserve 3,204 3,477 Alternative minimum tax credit 1,099 1,099 Other, net 130 129 Deferred income tax asset 17,202 16,975 Deferred policy acquisitions costs (4,147) (4,345) Unrealized gains on investments (2,117) (1,977) Other, net (369) (371) Deferred income tax liability (6,633) (6,693) Net deferred income tax asset $ 10,569 $ 10,282
The Company has not established a valuation reserve because it believes, based on its tax-planning strategies and projected future earnings, that it is likely that the net deferred tax asset will be fully realized. A reconciliation of income taxes computed at the statutory federal income tax rate to the income tax provision is presented below:
1997 1996 1995 % of Pre-Tax % of Pre-Tax % of Pre-Tax Amount Income Amount Income Amount Income --------------- --------------- --------------- (Dollars in thousands) Taxes based on statutory federal income tax rate $ 3,767 35.0% $ 2,176 35.0% $ 5,909 35.0% Add (deduct): Tax exempt interest (1,994) (18.5) (2,338) (37.6) (2,131) (12.6) Other, net 196 1.8 215 3.5 181 1.1 Total income taxes $ 1,969 18.3% $ 53 0.9% $ 3,959 23.5%
6. Long-Term Debt In September 1995, the Company purchased 1.5 million shares of its common stock beneficially owned by Willis Corroon Group plc for a purchase price of $25.5 million, including related expenses. The Company financed its purchase through an unsecured term loan from commercial lending institutions. This loan matures in varying amounts through 2002 with interest payable at least quarterly. The term loan interest rate is equivalent to either the bank's prime rate or the London Interbank Offered Rate ("LIBOR") plus 1%, at the discretion of the Company. The term loan agreement contains certain restrictive covenants, including restrictions on the Company's ability to declare or pay any cash dividends to its shareholders. As of December 31, 1997, the weighted average interest rate was 6.89%, and the fair value of the loan approximated the carrying value. Principal payments due on the term loan are as follows: Year ending December 31, Principal Amount (Dollars in thousands) 1998 $ 3,625 1999 4,125 2000 4,625 2001 5,000 2002 3,750 Total $21,125 In October 1995, the Company entered into an interest rate swap agreement with a commercial lending institution in order to reduce the impact of interest rate fluctuations on the Company's term loan. The interest rate swap was effected with respect to the first $15.5 million of scheduled principal amortizations of the $25.5 million loan. The impact of the swap was to create an effective fixed rate of 6.97% on the $15.5 million principal amount. As of December 31, 1997, the fair value of the interest rate swap approximated the carrying value. 7. Fair Value of Financial Instruments The Company follows SFAS No. 119, "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments." SFAS No. 119 requires disclosure of an estimate of the fair value of financial instruments. The Statement defines the fair value of financial instruments as the amount at which the instruments could be exchanged in a current transaction between willing parties. The following table summarizes the carrying amount and estimated fair value of the Company's financial instruments at December 31, 1997 and 1996.
Year ended December 31 1997 1996 (Dollars in thousands) Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value -------- ---------- -------- ---------- Financial assets: Investments and cash $313,082 $313,082 $303,869 $303,869 Financial liabilities: Long-term debt 21,125 21,129 24,625 24,651
The following methods and assumptions were used to estimate the fair value of each class of financial instrument: Investments and cash The fair values of fixed maturities are based on quoted market prices. The fair value of short-term instruments approximates amortized cost. The fair value of cash and cash equivalents approximates amortized cost. Long-term debt The fair value of the Company's long-term debt is estimated based on the quoted market prices for the same or similar issues or on current rates offered to the Company for debt of the same maturities. The fair value includes the effect of the interest rate swap. 8. Commitments and Contingencies Leases The Company and its subsidiaries lease certain office facilities and computer equipment. Minimum rental commitments for these leases, exclusive of escalations due to real estate taxes and operating expenses, are as follows: Year ending December 31, (Dollars in thousands) 1998 $1,163 1999 1,130 2000 964 2001 755 2002 784 Thereafter 4,728 $9,524 Total rent expense for all leases was $1,469,000, $1,310,000 and $959,000 in 1997, 1996 and 1995, respectively. 9. Dividends and Stockholders' Equity Dividends Associated, a California domiciled company, and Calvert, a Pennsylvania domiciled company, are required to file with the Department of Insurance of various states an annual convention statement, which is prepared in conformity with accounting practices prescribed or permitted by the respective states. These practices vary from GAAP principally in that policy acquisition costs are charged to expense when incurred, deferred federal income taxes are not recognized, investments are reflected at amortized cost, and nonadmitted assets are excluded from the balance sheet. Under state insurance laws of Pennsylvania, the maximum amount of dividends which can be paid by Pennsylvania-domiciled insurance companies without prior approval of the Insurance Commissioner is limited to the greater of 10% of surplus as regards policyholders as of the preceding year end or the insurance company's net income for the previous year. Under state insurance laws of California, Associated is permitted to pay as dividends to the Company, after advance notice to the California Insurance Department, an amount equal to the greater of 10% of Associated's policyholders surplus at the end of the preceding year or its statutory net income for the preceding year. Dividends in excess of these amounts require the prior approval of the California Insurance Department. Dividends may be paid only out of earned surplus. As such, at December 31, 1997, the maximum amount of dividends that Associated could pay in 1998 without California Insurance Department approval amounted to approximately $9.0 million and the maximum amount of dividends that Calvert could pay in 1998 without Pennsylvania Insurance Department approval amounted to approximately $2.0 million. Stockholders' Equity A reconciliation of the two insurance subsidiaries' net income and stockholders' equity for each of the years in the three years ended December 31, 1997 and as of December 31, 1997 and 1996, as reported to the various regulatory authorities in accordance with SAP, to the related GAAP amounts included in the accompanying consolidated financial statements is as follows:
Stockholders' Net Income Equity 1997 1996 1995 1997 1996 ---- ---- ---- ---- ---- (Dollars in thousands) Associated's and Calvert's statutory basis amounts $ 11,013 $ 7,298 $ 13,876 $ 87,705 $ 82,566 Add (deduct): Deferred policy acquisition costs (566) 233 2,388 11,849 12,415 Deferred income taxes 426 341 (728) 11,602 11,175 Nonadmitted assets 2,781 3,090 Unauthorized reinsurance 3,862 3,980 Foreign currency translation adjustment 7 (68) (110) Unrealized investment gains 3,931 3,672 Net income - non insurance subsidiaries 794 816 Other, net (197) (67) 25 98 (33) Associated's and Calvert's GAAP amounts 11,477 8,553 15,451 121,828 116,865 Holding Company: Non-insurance company expenses (2,683) (2,390) (2,526) GAAP equity (17,319) (21,729) Consolidated amounts -- GAAP basis $ 8,794 $ 6,163 $ 12,925 $ 104,509 $ 95,136
10. Shareholder Rights Plan In June 1995, the Board of Directors declared a dividend of one right for each outstanding share of Common Stock. Each right entitles the holder to purchase from the Company a unit consisting of 1/100 of a share of Junior Participating Cumulative Preferred Stock at a price of $50 per unit. Initially, the rights will not be exercisable and will trade with the Common Stock. In the event a person or group acquires 20% or more of the Common Stock, or commences a tender offer for the outstanding shares, the rights become exercisable. If a person or group acquires 20% or more of the Common Stock, the rights will entitle a holder (other than the acquiring person or group of acquiring persons) to buy shares of Common Stock having a market value of twice the exercise price of the right. If the Company is subsequently involved in a merger or other business combination with a holder of 20% or more of the stock of the Company, the rights will entitle a holder to buy shares of common stock of the acquiring corporation having a market value of twice the exercise price of the right. The rights may be redeemed by the Company at $.001 per right at any time prior to the acquisition by any person or group of 20% or more of the Company's shares. The rights have no voting power and will expire in June 2005, if not previously redeemed. 11. Property and Equipment Property and equipment is classified with other assets in the accompanying consolidated balance sheets and is stated at cost, net of accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the related property and equipment and ranges principally from three to seven years. Property and equipment, included in Other assets in the balance sheet, is comprised of the following:
Year ended December 31, 1997 1996 ---- ---- (Dollars in thousands) Furniture, fixtures and leasehold improvements $ 2,539 $ 2,475 Computers 2,074 1,011 Office equipment 416 354 5,029 3,840 Less: Accumulated depreciation and amortization 1,715 1,116 $ 3,314 $ 2,724
12. Stock Option and Restricted Stock Plans The Company's stock option plans provide for granting of stock options to key employees and non-employee directors. Options are granted at a price not less than the market price on the date of grant. Options that have been granted under the plans will become exercisable in four annual installments of 25% each commencing on the second anniversary of the date of grant and will expire ten years from the date of grant. The Company's restricted stock award plan provides for the granting of up to 100,000 shares of common stock to key employees, subject to restrictions as to continuous employment except in the case of death or normal retirement. Restrictions generally expire over a five-year period from date of grant. Compensation expense is recognized over the restriction period. As of December 31, 1997, 76,500 shares are available for issuance under the plan. The Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123 provides an option either to continue the Company's current method of accounting for stock-based compensation, or to adopt the fair value method of accounting for stock-based employee compensation plans, which would require the Company to expense the fair value of its stock options at the date of grant over the vesting period. The Company has continued to elect to follow Accounting Principle Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations in accounting for its stock option and restricted stock plans. Accordingly, no compensation expense has been recognized for its stock-based compensation plans other than for restricted stock awards. Although the Company elected to continue to follow APB No. 25, it is required to provide additional disclosures including pro forma net income and earnings per share as if the Company adopted the fair value method for recognition purposes in 1995. A summary of stock option activity as of December 31, 1997, follows:
Weighted Average of Available Exercise Price of for Option Outstanding Outstanding Options ---------- ----------- ------------------ Balance, December 31, 1994 34,000 366,000 $ 13.18 Authorized 100,000 Granted (114,000) 114,000 14.89 Cancelled 21,000 (21,000) 13.07 Balance, December 31, 1995 41,000 459,000 13.61 Authorized 250,000 Granted (162,500) 162,500 17.44 Exercised (3,925) 13.00 Cancelled 59,250 (59,250) 15.03 Balance, December 31, 1996 187,750 558,325 14.58 Granted (46,500) 46,500 16.02 Exercised -- (32,500) 13.00 Cancelled 41,250 (41,250) 15.18 Balance, December 31, 1997 182,500 531,075 14.76
The following table summarizes outstanding and exercisable options as of December 31, 1997.
Options Outstanding Options Exercisable Weighted Range of Average Weighted Weighted Year of Exercise Number Remaining Average Number Average of Grant Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price - ------- -------- ---------- ---------------- -------------- ----------- -------------- 1993 $13 209,825 6.00 $13.00 148,263 $13.00 1994 $13 - $15 57,500 6.45 14.11 28,750 14.11 1995 $13 - $16 100,250 7.48 14.88 50,125 14.88 1996 $14 - $20 122,000 8.36 17.44 30,500 17.44 1997 $13 - $17 41,500 9.85 16.31 - 16.31 531,075 257,638
The pro forma net income and basic earnings per share determined consistent with SFAS No. 123 is as follows: Pro forma (1) 1997 1996 1995 Net income $8,583 $5,974 $12,880 Basic earnings per share $1.28 $.90 $1.68 (1) During the initial phase-in period of SFAS No. 123, the effects of applying the standard for either recognizing compensation cost or providing pro forma disclosures are not likely to be representative of the effects on reported net income for future years, based on the fact that options vest over several years and additional awards generally are made each year. The weighted average fair value of options granted during 1997, 1996 and 1995 were $6.62, $7.64 and $6.29, respectively. The Black-Scholes option-pricing model was used with the following weighted average assumptions: volatility of 22.8%, and risk-free interest rate of 5.99% in 1997; volatility of 24.3%, and risk-free interest rate of 6.81% in 1996; volatility of 24.3%, and risk-free interest rate of 6.18% in 1995. For all periods, a seven-year life is assumed. 13. Employee Benefits and Incentive Bonus Plans The Company maintains a defined contribution retirement 401(k) & Profit Sharing Plan. Participation in the plan is available to all employees upon their satisfaction of specified eligibility requirements. Under the 401(k) component of the plan, the Company matches, on a dollar-for-dollar basis, each employee's contribution up to 3% of eligible compensation. Under the profit sharing component of the plan, annual contributions may be authorized by the Board of Directors based upon the Company's performance for the relevant year. The Company's costs are charged to income and amounted to $0.5 million in 1997, $0.5 million in 1996 and $0.4 million in 1995. The Company maintains an annual incentive bonus plan for officers and other key employees. Bonuses are based upon predetermined objectives established by the Compensation Committee. The Company's total incentive bonus plan expense for the years ended December 31, 1997, 1996 and 1995 was $0.4 million, $0.6 million and $1.6 million, respectively. 14. Concentrations of Business Gross premiums written in the State of California amounted to approximately $59,696,000, $68,663,000 and $76,396,000 in 1997, 1996 and 1995, respectively. In the State of New York, the Company's gross premiums written were $11,190,000, $11,975,000 and $20,141,000 for the years ended December 31, 1997, 1996 and 1995, respectively. Gross premiums written in any other state do not exceed 10% of gross premiums written. The Company's architects' and engineers' professional liability insurance business is produced by Risk Administration and Management Company ("RAMCO"), an unaffiliated managing general agent. For the years ended December 31, 1997, 1996 and 1995, direct premiums written by RAMCO for the Company amounted to approximately $17,704,000, $17,843,000 and $14,452,000, respectively. 15. Quarterly Financial Information (unaudited) Quarterly financial information (unaudited) for the year ended December 31, 1997 is presented below:
Three months ended March 31, June 30, Sept. 30, Dec. 31, 1997 1997 1997 1997 -------- -------- --------- -------- (Dollars and shares in thousands, except per share amounts) Gross premiums written $35,651 $40,747 $37,290 $32,438 Net premiums written 24,423 27,209 28,223 20,479 Net premiums earned 23,101 25,917 27,783 27,445 Net investment income 4,170 4,315 4,344 4,232 Realized gains on investments 17 12 2,601 3,558 Other income 242 256 296 185 Total revenues 27,530 30,500 35,024 35,420 Income before income taxes 2,740 2,475 5,019 529 Net income 2,171 2,167 3,697 759 Basic earnings per share $ 0.33 $ 0.32 $ 0.55 $ 0.11 Weighted average shares outstanding 6,663 6,688 6,688 6,686
Quarterly financial information (unaudited) for the year ended December 31, 1996 is presented below:
Three months ended March 31, June 30, Sept. 30, Dec. 31, 1996 1996 1996 1996 --------- -------- -------- --------- (Dollars and shares in thousands, except per share amounts) Gross premiums written $ 34,919 $ 39,017 $ 44,807 $ 38,194 Net premiums written 21,213 22,585 28,165 22,644 Net premiums earned 21,951 21,180 22,292 22,506 Net investment income 4,159 3,921 4,065 4,308 Realized gains (losses) on investments 802 (190) 4 587 Other income 270 285 389 115 Total revenues 27,182 25,196 26,750 27,516 Income (loss) before income taxes 4,658 (294) 2,249 (397) Net income 3,505 337 1,986 335 Basic earnings per share (1) $ 0.53 $ 0.05 $ 0.30 $ 0.05 Weighted average shares outstanding 6,648 6,656 6,660 6,661
(1) As a result of the Company's purchase of its Common Stock, the average number of shares outstanding varies from quarter to quarter, and the sum of the quarterly earnings per common share may not equal the total for the year. 16. Subsequent Event In February 1998, the Company agreed to acquire The First Reinsurance Company of Hartford ("FRH") and certain affiliated entities from Dearborn Risk Management, Inc. for a combination of cash and preferred stock valued at $43.6 million, plus certain other performance-driven contingent consideration. The purchase consideration of $43.6 million consists of $31.9 million of cash and $11.7 million fair value of a new issue of Gryphon perpetual convertible preferred stock. The preferred stock, which will have a face amount of $14.4 million, will be convertible into 643,672 shares of the Company's common stock, reflecting a conversion price of $22.44 per share. No cash dividends will be paid or owed during the first four and one-half years; a cash dividend at the rate of 4.0% of the face amount will be paid thereafter. The preferred shares, which are non- callable for three years, have no sinking fund or mandatory redemption features. In connection with the transaction, Gryphon intends to enter into a $55 million credit facility with a group of financial institutions, the proceeds of which will be used to pay the cash portion of the purchase price and to repay existing bank borrowings. The acquisition will be accounted for by the purchase method of accounting under Opinion No. 16, "Business Combinations," of the Accounting Principles Board of the American Institute of Certified Public Accountants. Under this accounting method, any excess of purchase price over the fair market value of identifiable assets acquired less liabilities assumed will be recorded as goodwill. The transaction, which is subject only to regulatory approvals and other customary conditions, is expected to close during the second quarter of 1998.
PART 1-FINANCIAL INFORMATION Gryphon Holdings Inc. and Subsidiaries Consolidated Balance Sheet September 30, December 31, Assets 1998 1997 ---- ---- Investments: (Dollars in thousands) Fixed maturities, available for sale, at fair value (amortized cost: 9/30/98 - $371,714; 12/31/97 - $274,506) $ 385,403 $ 280,553 Short-term investments, at cost, which approximates market 233 257 Equity securities, available for sale, at fair value (cost: 9/30/98 - $882) 901 -- Total investments 386,537 280,810 Cash and cash equivalents 16,733 32,272 Accrued investment income 5,340 4,071 Premiums receivable 36,242 16,151 Reinsurance recoverable on paid losses 17,068 18,261 Reinsurance recoverable on unpaid losses 201,051 140,810 Prepaid reinsurance premiums 34,794 16,573 Deferred policy acquisition costs 12,746 11,849 Deferred income taxes 15,216 10,569 Income taxes receivable 1,030 -- Goodwill 11,368 1,409 Other assets 9,872 6,210 Total assets $ 747,997 $ 538,985 Liabilities and Stockholders' Equity Policy liabilities: Unpaid losses and loss adjustment expenses $ 448,636 $ 328,911 Unearned premiums 91,555 62,351 Total policy liabilities 540,191 391,262 Reinsurance balances payable 23,212 12,179 Income taxes payable -- 389 Long-term debt 55,000 21,125 Other liabilities 13,918 9,521 Total liabilities 632,321 434,476 Commitments and contingencies Stockholders' equity: Preferred stock, $.01 par value; 1,000,000 shares authorized;14,444 issued and outstanding 11,741 -- Common stock, $.01 par value; 15,000,000 shares authorized; 8,148,050 shares issued 81 81 Additional paid-in capital 30,581 30,742 Accumulated other comprehensive income, net of tax 8,342 3,585 Deferred compensation (234) (151) Retained earnings 89,080 95,065 Treasury stock, at cost; shares 1998: 1,407,821; 1997: 1,461,169 (23,915) (24,813) Total stockholders' equity 115,676 104,509 Total liabilities and stockholders' equity $ 747,997 $ 538,985
See accompanying notes to consolidated financial statements. The interim financial statements are unaudited.
Gryphon Holdings Inc. and Subsidiaries Consolidated Statements of Income Three months ended Nine months ended September 30, September 30, 1998 1997 1998 1997 ---- ---- ---- ---- (Dollars and shares in thousand, except per-share data) Revenues Gross premiums written $ 48,629 $ 37,290 $ 127,137 $ 113,688 Net premiums written 29,123 28,223 76,089 79,855 Net premiums earned 28,418 27,783 72,849 76,801 Net investment income 5,407 4,344 13,809 12,829 Realized gains on investments 648 2,601 1,945 2,630 Other income -- 296 -- 794 Total revenues 34,473 35,024 88,603 93,054 Expenses Losses and loss adjustment expenses 21,225 17,895 63,946 47,862 Underwriting, acquisition, and insurance expenses 12,089 11,712 34,265 33,730 Interest expense 819 398 1,508 1,228 Total expenses 34,133 30,005 99,719 82,820 Income (loss) before income taxes 340 5,019 (11,116) 10,234 Provision for income taxes (benefit): Current 486 872 (1,226) 2,070 Deferred (970) 450 (4,136) 129 Total income taxes (benefit) (484) 1,322 (5,362) 2,199 Net income (loss) before accretion of preferred stock $ 824 $ 3,697 ($ 5,754) $ 8,035 Accretion of preferred stock 111 111 Net income (loss) attributable to common stockholders 713 3,697 (5,865) 8,035 Other comprehensive income, net of tax: Unrealized investment gains (losses), net of reclassification adjustments 4,879 1,284 4,872 698 Foreign currency translation adjustments (162) 3 (237) (9) Comprehensive income (loss) $ 5,430 $ 4,984 ($ 1,230) $ 8,724 Basic net earnings (loss) per share $ 0.11 $ 0.55 ($ 0.87) $ 1.20 Diluted net earnings (loss) per share $ 0.11 $ 0.55 ($ 0.87) $ 1.20 Basic comprehensive income (loss) per share $ 0.81 $ 0.75 ($ 0.18) $ 1.31 Diluted comprehensive income (loss) per share $ 0.75 $ 0.75 ($ 0.18) $ 1.31 Weighted average shares outstanding 6,740 6,688 6,726 6,680
See accompanying notes to consolidated financial statements. These statements are unaudited. Gryphon Holdings Inc. and Subsidiaries Consolidated Statements of Cash Flows
Nine months ended September 30, 1998 1997 ---- ---- (Dollars in thousands) Operating activities Net (loss) income ($ 5,865) $ 8,035 Adjustments to reconcile net income to net cash provided by operating activities: Deferred income tax provision (4,136) 129 Amortization and depreciation 696 573 Amortization of bond discount, net 747 352 Realized gains on investments (1,945) (2,630) Change in assets and liabilities, net of effect of purchase acquisition Increase in net policy liabilities 24,678 2,811 Increase in premiums receivable (11,129) 1,263 Decrease (increase) in deferred acquisition costs 739 (1,231) Change in other assets and liabilities (2,005) (4,160) Increase (decrease) in reinsurance balances payable 4,589 (3,940) Decrease (increase) in accrued investment income (267) 272 Net cash provided by operating activities 6,102 1,474 Investing activities Sales of fixed maturities 215,046 304,542 Purchases of fixed maturities (241,373) (298,471) Maturities or calls of fixed maturities -- 1,800 Payment for the purchase acquisition, net of cash acquired (39,924) -- Capital expenditures (562) (959) Net cash (used in) provided by investing activities (66,813) 6,912 Financing activities Proceeds from long-term debt 55,000 -- Debt issue costs (686) -- Repayment of long-term debt (21,125) (2,625) Issuance of common stock 738 342 Issuance of preferred stock 11,630 -- Deferred compensation (148) 60 Net cash used in financing activities 45,409 (2,223) Effect of exchange rate changes on cash (237) (9) Decrease in cash and cash equivalents (15,539) 6,154 Cash and cash equivalents at beginning of period 32,272 23,398 Cash and cash equivalents at end of period $ 16,733 $ 29,552 Supplemental disclosure of cash flow information Income taxes paid $ 75 $ 530 Interest paid $ 1,508 $ 1,228
See accompanying notes to consolidated financial statements. These statements are unaudited. Gryphon Holdings Inc. and Subsidiaries Notes to Consolidated Financial Statements 1. Basis of Presentation Gryphon Holdings Inc. (the "Company") operates through its main subsidiary, Gryphon Insurance Group Inc., as a specialty property and casualty underwriting organization. The Company's wholly owned insurance company subsidiaries are Associated International Insurance Company ("Associated"), Calvert Insurance Company ("Calvert") and, since July 13, 1998, The First Reinsurance Company of Hartford ("First Re"). The accompanying consolidated financial statements include the accounts and operations of Gryphon Holdings Inc. and its subsidiaries. 2. Principles of Consolidation The accompanying consolidated financial statements have been prepared on the basis of generally accepted accounting principles, which as to the three wholly owned insurance company subsidiaries differ from the statutory accounting practices prescribed or permitted by regulatory authorities, and include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. 3. Acquisition On July 13, 1998, the Company acquired all of the capital stock of The First Reinsurance Company of Hartford, Oakley Underwriting Agency, Inc. and F/I Insurance Agency, Incorporated (collectively, "First Re") from Dearborn Risk Management, Inc. for a combination of cash and preferred stock with an estimated value of $43.6 million, plus certain other performance-driven contingent consideration. First Re, a Connecticut corporation with headquarters in Chicago, is a specialty insurer of professional liability and program risks. Through its affiliate, Oakley Underwriting Agency, First Re provides Directors & Officers and Errors & Omissions coverages for corporations, professional firms, not-for-profit entities, and public entities. The total estimated purchase consideration of $43.6 million consisted of $31.9 million of cash and $11.7 million fair value of a new issue of Gryphon perpetual convertible preferred stock. The preferred stock, which has a face amount of $14.4 million, is convertible into 643,672 shares of the Company's common stock, reflecting a conversion price of $22.44 per share. No cash dividends will be paid or owed during the first four and one-half years; a cash dividend at a rate of 4.0% of the face amount will be paid thereafter. The discount on the preferred shares attributable to the period in which no cash dividends are paid is accreted over that four and one-half years. The preferred shares, which are non-callable for three years, have no sinking fund or mandatory redemption features. In connection with the transaction, Gryphon entered into a $55.0 million credit facility with a group of financial institutions, the proceeds of which were used to pay the cash portion of the purchase price, including related expenses of the acquisition, and to repay existing bank borrowings. The acquisition was accounted for by the purchase method of accounting under Opinion No. 16, "Business Combinations," of the Accounting Principles Board of the American Institute of Certified Public Accountants. Under this accounting method, the results of First Re are included in the Financial Statements from the date of the acquisition and any excess of purchase price and direct costs of acquisition over management's preliminary estimates of the fair market value of identifiable assets acquired less liabilities assumed have been recorded as goodwill (approximately $10.0 million) and amortized over 40 years. As part of the Stock Purchase Agreement the final determination of the purchase price is subject to adjustment due to contingencies. The contingencies include final determination and agreement as to the closing balance sheet amounts. The allocation of the purchase price of the acquisition is subject to revision when additional information concerning asset and liability valuations are obtained. In addition, the seller may earn additional consideration over the next three years at an amount equal to a multiple of net underwriting income, net of tax, on certain program business. Since any amounts that may become due to the seller under this agreement are entirely contingent upon future performance, no provision for such amounts has been included in the financial statements. The pro forma financial data, which give effect to the acquisition of First Re as though it had been completed January 1, 1997, for the nine months ended September 30, 1998 and 1997 include revenues of $102.4 million and $103.0 million, net income (loss) attributable to common stockholders of $(6.8) million and $8.1 million, basic net earnings (loss) per share of $(1.01) and $1.21, and diluted net earnings (loss) per share of $(1.01) and $1.16, respectively. The results of operations in the proforma financial data reflect adjustments to give effect to the acquisition as if it had occurred on January 1, 1997, for the amortization of goodwill, interest expense related to the debt incurred to finance the acquisition and their tax effect. In addition, the accretion of preferred stock has been reflected as if it had occurred from January 1, 1997. The pro forma financial information does not purport to represent what Gryphon's results of operations or financial position would actually have been had the acquisition in fact occurred on January 1, 1997 or to project the company's results of operations or financial position for or at any future period or date. 4. Investments The Company's securities are classified as available for sale and reported at fair value, with unrealized gains and losses, net of deferred income taxes, included in stockholders' equity. Fair values are based on quoted market prices, when available, or estimates based on market prices for similar securities, when quotes are not available. Short-term investments are carried at cost, which approximates their fair value. Realized gains and losses from the sales or liquidation of investments are determined on the basis of the specific identification method and are included in net income. Investment income is recognized when earned. The amortization of premium and accretion of discount for fixed maturity securities are computed utilizing the interest method. The major categories of net investment income are summarized as follows:
For the three months For the nine months ended September 30, ended September 30, 1998 1997 1998 1997 ---- ---- ---- ---- (Dollars in thousands) Fixed maturities $ 5,365 $ 4,151 $13,641 $12,212 Cash, cash equivalents and short-term investments 340 441 975 1,353 Total investment income 5,705 4,592 14,616 13,565 Less related expenses 298 248 807 736 Net investment income $ 5,407 $ 4,344 $13,809 $12,829
The gross realized gains and losses from sales of fixed maturity securities are as follows:
For the three months For the nine months ended September 30, ended September 30, 1998 1997 1998 1997 ---- ---- ---- ---- (Dollars in thousands) Gross realized gains $ 1,703 $ 2,711 $ 3,332 $ 3,879 Gross realized losses (1,055) (110) (1,387) (1,249) Net realized gain on sales $ 648 $ 2,601 $ 1,945 $ 2,630
At September 30, 1998 and December 31, 1997, the amortized cost and estimated fair values of investments in fixed maturities and equity securities, by categories of securities, and short-term investments were as follows:
Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---- ----- ------ ----- (Dollars in thousands) September 30, 1998 Fixed maturities U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 69,770 $ 3,334 ($ 17) $ 73,087 Debt securities issued by foreign governments 6,399 233 -- 6,632 Tax-exempt obligations of states and political subdivisions 148,990 6,699 (3) 155,686 Mortgage-backed securities 81,459 1,968 (131) 83,296 Corporate securities 65,096 2,091 (485) 66,702 Total fixed maturities 371,714 14,325 (636) 385,403 Equity securities Preferred stock 882 19 -- 901 Short-term investments 233 -- -- 233 $ 372,829 $ 14,344 ($ 636) $ 386,537 December 31, 1997 U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 78,623 $ 667 ($ 22) $ 79,268 Debt securities issued by foreign governments 5,857 130 (6) 5,981 Tax-exempt obligations of states and political subdivisions 108,194 4,322 -- 112,516 Mortgage-backed securities 47,488 501 (47) 47,942 Corporate securities 34,344 617 (115) 34,846 274,506 6,237 (190) 280,553 Short-term investments 257 -- -- 257 $ 274,763 $ 6,237 ($ 190) $ 280,810
5. Long-Term Debt In July 1998, the Company borrowed $55.0 million from a group of commercial lending institutions to finance the cash portion of the purchase price, including related expenses, of its acquisition of The First Reinsurance Company of Hartford and its affiliates and repay previously existing bank debt. The loan matures in varying amounts through 2004 with interest payable quarterly. The initial term loan interest rate is equivalent to either the bank's prime rate plus 62.5 basis points or the London Interbank Offered Rate ("LIBOR") plus 162.5 basis points, at the discretion of the Company. The term loan agreement contains certain restrictive covenants, including restrictions on the Company's ability to declare or pay any cash dividends to its shareholders. As of September 30, 1998, the fair value of the loan approximated the carrying value. Principal payments due on the term loan are as follows: Principal Amount Year ending December 31, (Dollars in thousands) ------------------------ ---------------------- 1998 $ 0 1999 0 2000 4,000 2001 6,000 2002 7,500 Thereafter 37,500 Total $ 55,000 The Company has entered into interest rate swap agreements with commercial lending institutions in order to reduce the impact of interest rate fluctuations on the Company's term loan. The interest rate swaps were effected with respect to the first $43.5 million of scheduled principal amortizations of the $55.0 million loan. The impact of the swap was to create an effective fixed rate of approximately 7.65% on the $43.5 million principal amount. 6. Earnings Per Share In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share," which the Company implemented in 1997. SFAS No. 128 establishes standards for computing and presenting earnings per share. Primary earnings per share have been replaced by basic earnings per share and calculated by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period. Fully diluted earnings per share have been replaced by diluted earnings per share and calculated by including additional common shares that would have been outstanding if potentially dilutive shares had been issued during the period. Prior period earnings per share were not affected by the adoption of SFAS No. 128. 7. Comprehensive Income As of January 1, 1998, the Company adopted SFAS No. 130, "Reporting comprehensive Income." This statement establishes standards for the reporting and presentation of comprehensive income and its components in a full set of financial statements. Comprehensive income encompasses all changes in shareholders' equity (except those arising from transactions with shareholders) and includes net income, net unrealized capital gains or losses on available- for-sale securities and foreign currency translation adjustments, net of taxes. This new standard changes only the presentation of certain information in the financial statements and does not affect the Company's financial position or results of operations. The summary of the Accumulated other comprehensive income, net of tax, as reported in the Consolidated Balance Sheets are as follows:
As at September 30, As at December 31, 1998 1997 ---- ---- (Dollars in thousands) (Dollars in thousands) Unrealized investment gains, net of tax $8,925 $3,931 Foreign currency translation adjustments, net of tax (583) (346) Accumulated other comprehensive income, net of tax $8,342 $3,585
The following table provides a summary of the components of net unrealized investment gains (losses), as reported in the Consolidated Statements of Income:
For the three months For the nine months ended September 30, ended September 30, 1998 1997 1998 1997 ---- ---- ---- ---- (Dollars in thousands) Unrealized gains arising during the period (net taxes of $2,784 and $2,758 in 1998, respectively and $567 and $187 in 1997, respectively) $ 5,172 $ 1,053 $ 5,122 $ 348 Less: reclassification adjustments for realized gains (losses) included in net income (net of taxes of $158 and $134 in 1998, respectively and $(124) and $(188) in 1997, respectively) 293 (231) 250 (350) Net unrealized investment gains on securities $ 4,879 $ 1,284 $ 4,872 $ 698
8. New Accounting Standards In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information". SFAS No. 131 redefines how operating segments are determined and requires disclosure of certain financial and descriptive information about a company's operating segments. This statement relates to presentation of information and will have no impact on results of operations or financial condition. An annual presentation is required for the year ending December 31, 1998 and interim financial information will be required beginning in 1999 (with comparative 1998 information). The Company is currently evaluating the segment information disclosures required by SFAS No. 131. In December 1997, the American Institute of Certified Public Accountants issued Statement of Position No. 97-3 "Accounting by Insurance and Other Enterprises for Insurance-related Assessments" ("SOP 97-3"). SOP 97-3 establishes standards for accounting for guaranty-fund and certain other insurance related assessments. SOP 97-3 is effective for fiscal years beginning after December 15, 1998 and requires any impact of adoption to be reported as a change in accounting principle. The adoption of this statement is not expected to have a material effect on the Company's results of operations or financial condition. In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which requires companies to record all derivatives on the balance sheet as either assets or liabilities and measure those instruments at fair value. The manner in which companies are to record gains or losses resulting from changes in the values of those derivatives depends on the use of the derivative and whether it qualifies for hedge accounting. This standard is effective January 1, 2000, with early adoption permitted. The Company is currently evaluating the impact of the adoption of this statement and the potential effect on its financial position and results of operations. 9. Unaudited Consolidated Financial Statements In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly the results of operations and financial position of the Company for the periods ended September 30, 1998 and 1997. The unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes to financial statements as contained in the Company's 1997 Annual Report on Form 10-K. The results of operations for the period presented are not necessarily indicative of the results to be expected for the entire year. Item 7b. PRO FORMA FINANCIAL INFORMATION Introduction The following Pro Forma Financial Information is based on the historical financial statements of Markel Corporation adjusted to give effect to the acquisition of Gryphon Holdings, Inc. (Gryphon). The Consolidated Statements of Income and Comprehensive Income for the nine months ended September 30, 1998 and the year ended December 31, 1997 for Gryphon include the effect of Gryphon's July 13, 1998 acquisition of First Reinsurance Company of Hartford as if that acquisition had occurred on January 1, 1997. The Pro Forma Consolidated Statements of Income and Comprehensive Income give effect to the Registrant's acquisition of Gryphon as if it had occurred on January 1, 1997. The Pro Forma Consolidated Balance Sheet gives effect to the acquisition as if it had occurred on September 30, 1998. In the opinion of management, the historical consolidated financial statements of Markel Corporation reflect all adjustments, which are of a normal recurring nature, to present fairly Markel's financial position at September 30, 1998 and results of operations for the nine months ended September 30, 1998 and the year ended December 31, 1997. The pro forma adjustments are based upon available information and certain assumptions that management believes are reasonable. The acquisition of Gryphon was accounted for using the purchase method of accounting. The purchase price for the acquisition has been allocated to tangible and identifiable intangible assets and liabilities based upon management's estimates of their fair value with the excess of purchase price over fair value of net assets acquired allocated to goodwill and amortized over 20 years. For purposes of presenting pro forma results, no changes in revenues and expenses have been made to reflect the results of any modification to operations that might have been made had the acquisition been consummated on the assumed effective date of the acquisition. The pro forma expenses include the recurring costs, which are directly attributable to the acquisition, such as net investment income forgone on cash and investments liquidated to complete the acquisition, amortization of goodwill and interest expense. The Pro Forma Financial Information does not purport to represent what Markel's results of operations or financial position would actually have been had the acquisition in fact occurred on January 1, 1997 or September 30, 1998 or to project Markel's results of operations or financial position for or at any future period or date. MARKEL CORPORATION Pro Forma Consolidated Balance Sheet As of September 30, 1998 (dollars in thousands) (Unaudited)
Markel and Markel Gryphon Pro Forma Gryphon (historical) (historical) Adjustments Pro Forma - ---------------------------------------------------------------------------------------------------------------------------- ASSETS Investments Fixed maturities $ 1,115,280 $ 385,403 (60,305)(A) $ 1,440,378 Equity securities 281,981 901 (12,278)(A) 270,604 Short-term 65,599 233 (28,123)(A) 37,709 - ---------------------------------------------------------------------------------------------------------------------------- Total investments 1,462,860 386,537 (100,706) 1,748,691 - ---------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents 1,367 16,733 18,100 Receivables 73,691 36,242 109,933 Reinsurance recoverable on unpaid losses 199,957 201,051 401,008 Reinsurance recoverable on paid losses 17,844 17,068 34,912 Deferred policy acquisition costs 42,338 12,746 (3,000)(C) 52,084 Prepaid reinsurance premiums 41,997 34,794 76,791 Property and equipment 9,167 3,283 12,450 Intangible assets 35,806 11,368 42,635 (B) 89,809 Other assets 24,373 28,175 4,095 (E) 56,643 - ---------------------------------------------------------------------------------------------------------------------------- Total assets $ 1,909,400 $ 747,997 (56,976) $ 2,600,421 ============================================================================================================================ LIABILITIES AND SHAREHOLDERS' EQUITY Unpaid losses and loss adjustment expenses $ 943,738 $ 448,636 $ 1,392,374 Unearned premiums 211,076 91,555 302,631 Payables to insurance companies 26,689 23,212 49,901 Long-term debt 93,205 55,000 50,000 (A) 198,205 Other liabilities 80,546 13,918 8,700 (D) 103,164 Company-Obligated Mandatorily Redeemable Preferred Capital Securities of the Subsidiary Trust Holding Solely Junior Subordinated Deferrable Interest Debentures of Markel Corporation 150,000 -- 150,000 - ---------------------------------------------------------------------------------------------------------------------------- Total liabilities 1,505,254 632,321 58,700 2,196,275 - ---------------------------------------------------------------------------------------------------------------------------- Shareholders' equity Common stock 25,213 30,662 (30,662)(G) 25,213 Preferred Stock -- 11,741 (11,741)(F)(G) -- Retained earnings 286,757 88,846 (88,846)(G) 286,757 Accumulated other comprehensive income 92,176 8,342 (8,342)(G) 92,176 Treasury stock and other -- (23,915) 23,915 (G) -- - ---------------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 404,146 115,676 (115,676) 404,146 - ---------------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 1,909,400 $ 747,997 (56,976) $ 2,600,421 ============================================================================================================================
See accompanying Notes to Pro Forma Consolidated Financial Statements. MARKEL CORPORATION Pro Forma Consolidated Statement of Income and Comprehensive Income Nine Months Ended September 30, 1998 (dollars in thousands, except per share data) (Unaudited)
Markel and Markel Gryphon Pro Forma Gryphon (historical) (pro forma) Adjustments Pro Forma - ---------------------------------------------------------------------------------------------------------------------- OPERATING REVENUES Earned premiums $ 248,089 $ 83,230 $ 331,319 Net investment income 53,137 16,201 (4,068)(H) 65,270 Net realized gains from investment sales 11,434 2,916 14,350 Other 665 -- 665 - ---------------------------------------------------------------------------------------------------------------------- Total operating revenues 313,325 102,347 (4,068) 411,604 - ---------------------------------------------------------------------------------------------------------------------- OPERATING EXPENSES Losses and loss adjustment expenses 157,293 70,575 227,868 Underwriting, acquisition and insurance expenses 86,754 40,447 127,201 Amortization of intangible assets 1,525 243 1,782 (I) 3,550 - ---------------------------------------------------------------------------------------------------------------------- Total operating expenses 245,572 111,265 1,782 358,619 - ---------------------------------------------------------------------------------------------------------------------- Operating income 67,753 (8,918) (5,850) 52,985 Interest expense 15,290 2,809 4,331 (J) 22,430 - ---------------------------------------------------------------------------------------------------------------------- Income before income taxes 52,463 (11,727) (10,181) 30,555 Income taxes 12,591 (5,265) (2,940)(K) 4,386 Accretion of preferred stock -- 365 (365)(L) -- - ---------------------------------------------------------------------------------------------------------------------- Net income $ 39,872 $ (6,827) (6,876) $ 26,169 ====================================================================================================================== OTHER COMPREHENSIVE INCOME Unrealized gains on securities, net of taxes Unrealized gains arising during the period 14,349 6,258 20,607 Less reclassification adjustments for gains included in net income (7,432) (1,776) (9,208) Foreign currency translation adjustments (237) (237) - ---------------------------------------------------------------------------------------------------------------------- Total Other Comprehensive Income 6,917 4,245 -- 11,162 - ---------------------------------------------------------------------------------------------------------------------- Comprehensive Income $ 46,789 $ (2,582) (6,876) $ 37,331 ====================================================================================================================== Net income per share - ---------------------------------------------------------------------------------------------------------------------- Basic $ 7.25 -- $ 4.76 ====================================================================================================================== Diluted $ 7.07 -- $ 4.64 ======================================================================================================================
See accompanying Notes to Pro Forma Consolidated Financial Statements. MARKEL CORPORATION Pro Forma Consolidated Statement of Income and Comprehensive Income Year Ended December 31, 1997 (dollars in thousands, except per share data) (Unaudited)
Markel and Markel Gryphon Pro Forma Gryphon (historical) (pro forma) Adjustments Pro Forma - ---------------------------------------------------------------------------------------------------------------------- OPERATING REVENUES Earned premiums $ 332,878 $ 119,773 $ 452,651 Net investment income 68,653 20,977 (6,042)(H) 83,588 Net realized gains from investment sales 15,834 7,859 23,693 Other 1,682 979 2,661 - ---------------------------------------------------------------------------------------------------------------------- Total operating revenues 419,047 149,588 (6,042) 562,593 - ---------------------------------------------------------------------------------------------------------------------- OPERATING EXPENSES Losses and loss adjustment expenses 210,061 79,483 289,544 Underwriting, acquisition and insurance expenses 120,076 53,462 173,538 Amortization of intangible assets 2,435 324 2,376 (I) 5,135 - ---------------------------------------------------------------------------------------------------------------------- Total operating expenses 332,572 133,269 2,376 468,217 - ---------------------------------------------------------------------------------------------------------------------- Operating income 86,475 16,319 (8,418) 94,376 Interest 20,124 4,208 5,775 (J) 30,107 - ---------------------------------------------------------------------------------------------------------------------- Income before income taxes 66,351 12,111 (14,193) 64,269 Income taxes 15,924 2,785 (4,136)(K) 14,573 Accretion of preferred stock -- 485 (485)(L) -- - ---------------------------------------------------------------------------------------------------------------------- Net income $ 50,427 $ 8,841 (9,572) $ 49,696 ====================================================================================================================== OTHER COMPREHENSIVE INCOME Unrealized gains on securities, net of taxes Unrealized gains arising during the period 51,800 5,598 57,398 Less reclassification adjustments for gains included in net income (10,292) (5,108) (15,400) Foreign currency translation adjustments -- (127) (127) - ---------------------------------------------------------------------------------------------------------------------- Total Other Comprehensive Income 41,508 363 -- 41,871 - ---------------------------------------------------------------------------------------------------------------------- Comprehensive Income $ 91,935 $ 9,204 (9,572) $ 91,567 ====================================================================================================================== Net income per share - ---------------------------------------------------------------------------------------------------------------------- Basic $ 9.20 -- $ 9.06 ====================================================================================================================== Diluted $ 8.92 -- $ 8.79 ======================================================================================================================
See accompanying Notes to Pro Forma Consolidated Financial Statements. Notes to Pro Forma Consolidated Financial Statements (Unaudited) 1. Basis of presentation On January 15, 1999 Markel (the Registrant) acquired Gryphon through the completion of a public tender offer. The purchase price was funded as follows (in thousands): Cash $ 100,706 Borrowings under existing lines of credit 50,000 ---------- $ 150,706 ========== In addition, the Registrant subsequently refinanced $55.0 million of Gryphon's debt. The accompanying unaudited Pro Forma Consolidated Balance Sheet and Statements of Income and Comprehensive Income are provided to illustrate the effect of the acquisition on the Registrant and have been prepared using the purchase method of accounting. The unaudited Pro Forma Consolidated Financial Statements reflect how the balance sheet might have appeared at September 30, 1998 if the acquisition had been consummated at that date and how the statements of income and comprehensive income for the nine months ended September 30, 1998 and for the year ended December 31, 1997 might have appeared if the acquisition had been consummated on January 1, 1997. Certain reclassifications of Gryphon's historical financial statements have been made to conform with the Registrant's historical presentation. Adjustments to Unaudited Pro Forma Consolidated Balance Sheet The accompanying unaudited Pro Forma Consolidated Balance Sheet as of September 30, 1998 reflects certain adjustments which are explained below and are based on assumptions made by management. These adjustments are required to give effect to matters directly attributable to the acquisition. The explanations of these adjustments are as follows: (A) To record the cash paid and debt incurred to finance the acquisition. (B) To adjust the intangible assets to reflect the excess of cost over the fair value of net assets acquired resulting from the acquisition (in thousands). Fair value of net assets acquired $ 96,703 Excess of cost over fair value of net assets acquired 54,003 -------- Total purchase price $150,706 ======== (C) To bring Gryphon's deferred policy acquisition cost accounting practices into compliance with the Registrant's practices. (D) To accrue severance as specified in various employment contracts, investment banking expenses and legal fees. (E) To record current and deferred tax assets relating to severance and other acquisition costs and the adjustment of the deferred acquisition costs at an assumed 35% statutory rate. (F) To record the retirement or repurchase of Gryphon's convertible preferred stock. (G) To record consolidating and eliminating entries. Adjustments to Unaudited Pro Forma Consolidated Statements of Income and Comprehensive Income The accompanying unaudited Pro Forma Consolidated Statements of Income and Comprehensive Income for the nine months ended September 30, 1998 and for the year ended December 31, 1997 reflect certain adjustments which are explained below and are based on assumptions made by management. These adjustments are required to give effect to matters directly attributable to the purchase. The explanations of these adjustments are as follows: (H) Reduction in net investment income due to net cash used in funding the transactions; the rate of return is calculated at 6%. (I) Excess of cost over fair value of net assets acquired is amortized on a straight line basis over 20 years. (J) Interest on borrowed funds under existing lines of credit is assumed to be 5.5%. (K) Taxes are calculated at an assumed 35% statutory rate. (L) To record the retirement or repurchase of Gryphon's convertible preferred stock. Other Adjustments to unaudited statements Other Matters In the fourth quarter of 1998, Gryphon recorded a charge to earnings by increasing losses and loss adjustment expenses reserves (loss reserves) for environmental, asbestos and construction defect claims by $15.0 million. An actuarial analysis completed in the fourth quarter indicated that additional loss reserves were required. EX-23.1 2 CONSENT OF INDEPENDENT AUDITORS Exhibit 23 Consent of Independent Auditors The Board of Directors Gryphon Holdings Inc. We consent to the inclusion of our report dated February 24, 1998, with respect to the consolidated balance sheets of Gryphon Holdings, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997, which report appears in the Form 8-K of Markel Corporation dated January 29, 1999. KPMG LLP New York, New York January 29, 1999 -----END PRIVACY-ENHANCED MESSAGE-----