-----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, NTMHKZB35Urie2JPpZOBgt0i+p0ItP/yJrzz8w2IVoCMG7MQfI6qFF8xFtkrP2yP ta5qrHAuTW+vSdGecsXZ0Q== 0000891554-99-000605.txt : 19990331 0000891554-99-000605.hdr.sgml : 19990331 ACCESSION NUMBER: 0000891554-99-000605 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 15 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CAPITAL RE CORP CENTRAL INDEX KEY: 0000829277 STANDARD INDUSTRIAL CLASSIFICATION: SURETY INSURANCE [6351] IRS NUMBER: 521567009 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-10995 FILM NUMBER: 99577662 BUSINESS ADDRESS: STREET 1: 1325 AVE OF THE AMERICAS STREET 2: 18TH FLR CITY: NEW YORK STATE: NY ZIP: 10019 BUSINESS PHONE: 2129740100 MAIL ADDRESS: STREET 1: 1325 AVENUE OF THE AMERICAS STREET 2: 18TH FL CITY: NEW YORK STATE: NY ZIP: 10019 10-K 1 ANNUAL REPORT SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 1998 Commission file number 1-10995 Capital Re Corporation (Exact name of registrant as specified in its charter) Delaware 52-1567009 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 1325 Avenue of the Americas, New York, N.Y. 10019 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 212-974-0100 Securities registered pursuant to Section 12(b) of the Act: Common Stock, $.01 par value, and Capital Re LLC 7.65% Cumulative Monthly Income Preferred Shares, Series A (guaranteed by Capital Re Corporation) New York Stock Exchange, Inc. (Title of Class) (Name of each exchange on which registered) Securities registered pursuant to Section 12(g) of the Act: None (Title of Class) Indicate by check mark whether registrant (1) has filled all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __X__ No_____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. [ ] The approximate aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of February 26, 1999 was $338,229,048. The number of shares of Common Stock outstanding as of February 26, 1999 was 32,045,119. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's 1999 definitive Proxy Statement for the annual shareholders meeting to be held May 20, 1999 (which is expected to be filed with the Commission within 120 days after the end of the Registrant's 1998 fiscal year) are incorporated by reference into Part III of this Report. PART I Item 1. Business. A. GENERAL: (1) Company Overview and Business Strategy - Capital Re Corporation (the "Company" or "Capital Re") is an insurance holding company for a group of reinsurance companies that provide value-added reinsurance products in several specialty insurance markets. The Company has two principal divisions: financial guaranty and financial risks. The financial guaranty division is composed of municipal and non-municipal financial guaranty reinsurance and credit default swaps. The financial risks division is composed of mortgage guaranty reinsurance, trade credit reinsurance, title reinsurance and financial solutions. The Company's financial guaranty and financial risks divisions contributed 43.7% and 56.3%, respectively, of 1998 net premiums written. In both of its principal areas of business, the Company seeks to provide innovative reinsurance solutions to satisfy the diverse risk and financial management demands of its primary clients. Theses solutions often take the form of complex reinsurance arrangements that provide value other than pure risk management (i.e., financial statement benefit, regulatory relief and rating agency qualified capital). The Company believes that its future growth will be generated through application of its core credit expertise to new products and markets in its two existing divisions. The Company participates in its business lines through five wholly-owned insurance subsidiaries and two joint venture vehicles. Its wholly-owned subsidiaries are: Capital Reinsurance Company ("Capital Reinsurance"), Capital Credit Reinsurance Company Ltd. ("Capital Credit"), Capital Mortgage Reinsurance Company ("Capital Mortgage"), KRE Reinsurance Ltd. ("KRE"), and Capital Title Reinsurance Company ("Capital Title"). The Company owns a fifty percent economic interest in ACE Capital Re Ltd. ("ACRE"), a non-consolidated, Bermuda based joint venture vehicle. The Company's joint venture partner in ACRE is Bermuda based ACE Bermuda Insurance, Ltd. ("ACE Bermuda"). The Company also owns a fifty percent interest in Lenders Residential Asset Company LLC (formerly, Lenders Mortgage Alliance Company LLC) ("LRAC"), a non-consolidated Delaware limited liability company. Capital Reinsurance's financial strength is rated AAA by Standard and Poor's, a division of The McGraw Hill Companies, Inc. ("S&P"), and Aa2 by Moody's Investors Service, Inc. ("Moody's"), and its claims-paying ability is rated triple-A by Fitch IBCA ("Fitch"). KRE's financial strength is rated AA by S&P, and its claims-paying ability is rated AA+ by Duff & Phelps Credit Rating Co. ("Duff & Phelps"). The financial strength of Capital Credit is rated A+ by S&P. The financial strength of Capital Mortgage is rated AA by S&P. Capital Title's financial strength is rated AA- by S&P, and its claims paying ability is rated AA- by Duff & Phelps. On December 16, 1998, the financial strength ratings by S&P of KRE, Capital Credit, Capital Mortgage and Capital Title were placed on "CreditWatch" with negative implications. See "Business of Capital Re--Ratings." The Company's financial guaranty division conducts its business primarily through Capital Reinsurance and KRE. Capital Reinsurance is a professional reinsurance company dedicated to serving the U.S. domestic and international financial guaranty insurance markets and has established itself as a leading specialty reinsurer (by market share) of financial guaranties of investment grade debt obligations, principally municipal debt obligations. Capital Reinsurance's focus on the municipal bond reinsurance business recognizes the fact that historically municipal bond insurance has been a proven revenue source in the financial guaranty insurance market which, when managed properly, can provide predictable revenues from (i) an associated deferred premium revenue account, (ii) installment premiums from business already originated and (iii) interest income on the Company's investment portfolio. Capital Reinsurance applies a "zero loss" standard to its underwriting process, which is premised on a general policy of reinsuring only those obligations that are investment grade on the date reinsured and where there is no expectation of loss on the risk reinsured. Nevertheless, losses can be expected to occur in Capital Reinsurance's existing and future 2 reinsurance and credit default swap portfolios. At the same time, consistent with its "zero loss" underwriting policies, Capital Reinsurance has pursued the reinsurance of investment grade non-municipal debt obligations and directed its capacity to the reinsurance of financial guaranties of asset-backed securities. In the case of both municipal bond reinsurance and the reinsurance of non-municipal debt obligations, Capital Reinsurance has emphasized facultative reinsurance, which Capital Reinsurance believes better permits it to maintain portfolio diversification, pricing discipline and conformity to its underwriting policies, because through facultative reinsurance the reinsurer may exercise control over risks assumed as they are accepted only on a risk-by-risk basis. In addition, Capital Reinsurance sells municipal and non-municipal credit risk protection on a facultative basis to a wide variety of counterparties through credit default swap transactions. Credit default swaps are underwritten in accordance with the same "zero loss" standard that applies to Capital Reinsurance's municipal and non-municipal financial guaranty business. KRE, a Bermuda based insurer, also assumes financial guaranty risk, both as a retrocessionaire of Capital Reinsurance and directly from certain primary financial guaranty insurers. The Company's financial risks division conducts its business primarily through Capital Mortgage, Capital Credit, Capital Title, KRE, ACRE and LRAC. Capital Mortgage is a leading reinsurer of mortgage guaranty insurance. Capital Mortgage's strategy is based on the development of creative reinsurance programs targeted to the individual capital, risk and portfolio management demands of the primary mortgage guaranty insurers. Mortgage guaranty reinsurance is underwritten with the expectation that losses will occur regularly. In order to optimize capital utilization, the business plan of Capital Mortgage includes the reinsurance of mortgage guaranty insurance business by KRE, both as a retrocessionaire of Capital Mortgage and directly from primary mortgage guaranty insurers. The Company writes trade credit reinsurance in the U.S. and Europe through Capital Credit. Trade credit insurance protects those who sell goods and services on credit terms against default by the purchaser on its payment obligations. Trade credit reinsurance is a logical extension of the Company's underwriting focus, relying on credit analysis and portfolio diversification techniques similar to those employed in financial guaranty and mortgage guaranty reinsurance. Capital Credit's strategy is to build a limited portfolio of trade credit reinsurance business from the leading European and U.S. primary trade credit insurers, which outperforms the overall market by combining quota share and structured excess of loss participations. Portfolio losses will also occur regularly in the Company's trade credit reinsurance business. Capital Title is a New York domiciled, monoline insurance company formed in 1996 to provide title reinsurance. Prior to the formation of Capital Title, there were no dedicated title reinsurers, and only intra-industry facultative reinsurance was available to support large commercial title insurance policies. Capital Title provides coverages designed to aid title insurers in meeting capital adequacy concerns and to achieve desired claims-paying ability ratings from nationally recognized rating agencies. Capital Title derives business from relationships with primary title insurers, financial institutions active in commercial real estate lending and professionals involved in the real estate industry. Capital Title offers excess of loss and quota share reinsurance products on both a treaty and facultative basis. Title reinsurance is underwritten without the expectation of any significant loss; however, losses can be expected to occur in Capital Title's existing and future reinsured portfolio. KRE provides retrocessional support to Capital Title. The Company's financial solutions business is written through KRE and ACRE. The financial solutions business is focused on providing highly structured solutions to problems of financial and risk management through reinsurance, including credit enhancement, excess of loss and surplus management covers. The principle target market is life, accident and health insurers and reinsurers, although specialty property and casualty markets also provide opportunities. The underwriting process places significant emphasis on actuarial analysis. Transactions are underwritten to be risk remote or finite, standards that are compatible with the Company's "zero loss" financial guaranty underwriting standard. Losses can be expected to occur in the Company's existing and future financial solutions portfolio. 3 LRAC provides marketing and consulting services to mortgage lenders with regard to the origination and closing of residential mortgages and the sale of such mortgages into the capital markets. In addition, by providing direct access to lenders, it generates markets for the sale of the Company's other products. The Company also owns RGB Underwriting Agencies Ltd. ("RGB"), a Lloyd's of London ("Lloyd's") managing agency which presently manages four syndicates operating in the Lloyd's insurance market, and CRC Capital Ltd. ("CRC Capital"), a corporate name at Lloyd's, which provides underwriting capacity to the syndicates managed by RGB. The Company has commenced a plan of divestiture of its Lloyd's operations. Accordingly, commencing in 1998, the Company began reflecting its participation in Lloyd's as a discontinued operation. All 1998 and prior year figures presented herein reflect Lloyd's as a discontinued operation. See "Discontinued Operations." The Capital Re corporate group also includes Capital Re Solutions Incorporated (formerly, Capital Re Management Corporation), a New York reinsurance intermediary, ACE Capital Re Managers Ltd., a Bermuda based management company, and Capital Re LLC, a Turks & Caicos Islands finance subsidiary organized in 1993 to issue $75 million of Company guaranteed mandatorily redeemable preferred stock, the proceeds of which were loaned to Capital Re. Capital Re Financial Products Corporation, a newly formed Delaware business corporation, and Capital Risk Assurance Company ("Capital Risk"), a newly formed Maryland surety insurer, intend to commence business in 1999. Set forth below is a chart showing the subsidiaries and affiliates of Capital Re: [GRAPHIC OF CHART OF SUBSIDIARIES AND AFFILIATES OF CAPITAL RE] In managing its investment portfolio, the Company places a high priority on credit and liquidity. At December 31, 1998, 79.5% of the Company's investment portfolio consisted exclusively of fixed income securities rated AAA or A-1+ by S&P or Aaa or P-1 by Moody's, or issued by the U.S. Government or its agencies or instrumentalities. Overall portfolio weighted average quality is AA+. The Company employs a modified total return investment strategy, and investment guidelines are established and approved by the Investment Committee of the Company's Board of Directors. The investment guidelines permit investments in investment grade and limited amounts of non-investment grade fixed income securities, including non-dollar denominated bonds, emerging market debt and other financial instruments. See "Business of Capital Re--Investments." The Company has a common and preferred equity investment in CGA Group, Ltd. ("CGA Group"), a Bermuda holding company which owns Commercial Guaranty Assurance, Ltd. ("CGA Ltd."), a Bermuda insurance company, and CGA Investment Management, Inc. ("CGAIM"), a Delaware corporation. CGA Ltd. provides financial guaranty 4 insurance of commercial real estate securities, including commercial mortgage backed securities. CGA Ltd. also provides financial guaranty insurance of other financial obligations, primarily asset-backed securities, by targeting market segments and originating structures which are outside of the traditional markets of the major AAA/Aaa rated financial guaranty insurers. For a discussion of the Company's investment in CGA Group, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II hereof. (2) Recent Developments - On February 19, 1999, the Company and ACE Bermuda entered into a Stock Purchase Agreement (the "Stock Purchase Agreement") pursuant to which ACE Bermuda agreed to purchase $75 million of the Company's Common Stock at a per share price equal to the lesser of (i) the fully diluted book value per share of the Common Stock at December 31, 1998 and (ii) 1.15 multiplied by the average of the five highest closing prices of the Common Stock between February 19, 1999 and April 15, 1999, as reported on the New York Stock Exchange composite tape. The closing of the sale was subject to the satisfaction of certain conditions, including the affirmation by Moody's of the Aaa financial strength rating of Capital Reinsurance. On March 10, 1999, Moody's downgraded Capital Reinsurance's financial strength rating to Aa2. The Company and ACE Bermuda executed an amendment to the Stock Purchase Agreement on March 16, 1999, which modified the per share price to equal the lesser of (i) the fully diluted book value per share of the Common Stock at December 31, 1998 and (ii) the average of the five highest closing prices of the Common Stock between March 12, 1999 and April 15, 1999. As of the date of this Annual Report, the Company estimates that ACE Bermuda will own between 11% and 12.6% of the outstanding Common Stock upon consummation of the issuance. Closing remains subject to the satisfaction of certain customary conditions, including the receipt of all required regulatory approvals; accordingly, it is not certain when or if the closing will take place. Under the Stock Purchase Agreement, as amended, for so long as ACE Bermuda continues to hold at least 8% of the voting capital stock of the Company, it will have the right to nominate two members to the Company's board of directors. In addition, the Company has agreed to file a shelf registration statement covering the shares of Common Stock owned by ACE Bermuda and maintain the effectiveness of such registration statement for a period of no greater than three years from the closing date. (3) Financial Guaranty Division - (a) Overview of Financial Guaranty Insurance Market - Financial guaranty insurance is a type of credit enhancement in the form of a surety or insurance which is regulated under the insurance laws of various jurisdictions. The insurance provides an unconditional and irrevocable guaranty which indemnifies the insured against nonpayment of principal and interest when due by an obligor on an insured debt obligation. The two largest nationally recognized rating agencies, S&P and Moody's, assign the financial strength rating of a financial guaranty insurance company to the obligations insured by that company. Because all of the major U.S. primary financial guaranty insurance companies have triple-A financial strength ratings from these rating agencies, bonds insured by those companies are rated triple-A. Both issuers of and investors in financial instruments may benefit from financial guaranty insurance. Issuers benefit because the insurance may have the effect of lowering an issuer's cost of borrowing in the public and private debt markets. The borrowing costs are lowered to the extent that the insurance premium is less than the value of the difference between the yield on the AAA/Aaa insured obligation and the yield on the obligation if sold on the basis of its uninsured credit rating. Financial guaranty insurance also increases the marketability of obligations issued by infrequent or unknown issuers. Investors benefit from increased liquidity in the secondary market, reduced exposure to price volatility caused by changes in the credit quality of the underlying insured issue, and added protection against loss in the event of the obligor's default on its obligation. Upon nonpayment by an obligor, the financial guaranty insurance company is obligated to pay the principal of and interest on the insured obligation in accordance with the original payment schedule as if no default had occurred. 5 The majority of financial guaranty insurance premiums are paid in full at policy inception, although on certain financial guaranties, such as guaranties of most non-municipal obligations, premiums are paid on an installment basis and typically earned in the period paid. Financial guaranty premiums are non-refundable and those paid in full are earned over the term of the related insured obligation. Because most obligations insured by the financial guaranty insurers have long maturities, the portion of premiums earned on a policy in any year represents a relatively small percentage of initial premium received. This methodology generates a predictable contribution to revenues over time that is relatively independent of new business written in any given year. Premium rates are generally calculated as a percentage of the principal amount of the insured obligation or the principal and interest scheduled to come due during the stated term of the insured obligation. A number of factors are considered in the setting of premium rates including the type of credit obligation, collateral security, maturity and rating agency capital charge. The financial guaranty insurance market consists of two main product sectors: municipal bond insurance and insurance of non-municipal debt obligations. Municipal bond insurance provides credit enhancement of debt obligations issued by or on behalf of states or their political subdivisions (counties, cities, towns and villages, utility districts, public universities and hospitals, public housing and transportation authorities) and other public and quasi-public entities (including non-U.S. sovereigns and subdivisions thereof). Insurance provided to the municipal bond market has been and continues to be the major source of revenue for the financial guaranty insurance industry. The volume of long-term municipal debt issuances and municipal bond insurance has increased significantly since 1983. In 1985, pending federal tax legislation relating to municipal bonds prompted an unusual rise in total long-term new issue municipal bond volume. The market for new issues returned to more normal volumes in 1987 and grew steadily through 1991. In 1992 and 1993, historically low interest rates prompted a dramatic increase in new issue volume, in part arising from the refinancing of refunding activity. This increase ended in 1994 as rising interest rates and other market uncertainties developed throughout the year. Growth in new issue volume regained momentum in 1995 through 1998 as market conditions improved in a lower interest rate environment. Furthermore, insurance penetration again reached an historic high in 1998, exceeding 50% of issuances. The table below sets forth the volume of long-term municipal bonds and the volume of insured long-term municipal bonds issued over the period from 1989 through 1998. New Total New Insured New Insured Volume Year Volume Volume as a Percent of New (in billions) (in billions) Total Volume -------------------------------------------------------------------------- 1989 125.0 31.1 24.9 -------------------------------------------------------------------------- 1990 127.8 33.5 26.2 -------------------------------------------------------------------------- 1991 172.4 51.9 30.1 -------------------------------------------------------------------------- 1992 234.6 80.8 34.4 -------------------------------------------------------------------------- 1993 292.3 107.9 36.9 -------------------------------------------------------------------------- 1994 165.0 61.5 37.3 -------------------------------------------------------------------------- 1995 160.0 68.5 42.8 -------------------------------------------------------------------------- 1996 185.0 85.7 46.3 -------------------------------------------------------------------------- 1997 220.7 107.5 48.7 -------------------------------------------------------------------------- 1998 285.9 145.3 50.8 -------------------------------------------------------------------------- Source: Figures for 1989 are based upon data provided by The Bond Buyer, February 6, 1998, and figures for 1990-1998 are based upon data provided by The Bond Buyer, February 9, 1999. Amounts under the New Insured Volume column include only the insured portion of an issue. Amounts under the New Total Volume and New Insured Volume columns represent gross principal amounts issued or insured, as the case may be, during such year. 6 The primary financial guaranty insurers also insure municipal bond investment vehicles, such as unit investment trusts and mutual funds, and outstanding municipal bonds trading in the secondary market. The non-municipal financial guaranty insurance market is newer and more diverse than the municipal bond insurance market. The types of securities supported by guaranties of non-municipal debt obligations include various asset-backed securities, including consumer and trade receivable-backed securities and commercial and residential mortgage-backed securities, corporate bonds and mutual funds. Although this market has been slower to develop than the municipal market, demand for this type of insurance is being stimulated by innovations in both domestic and foreign capital markets coupled with increasing investor and issuer awareness of the value provided by financial guaranties. As of December 31, 1998 there were four triple-A rated primary U.S. financial guaranty insurance companies active in the business: MBIA Insurance Corporation ("MBIA"), AMBAC Indemnity Company ("AMBAC"), Financial Guaranty Insurance Company ("FGIC") and Financial Security Assurance Inc. ("FSA"). In 1997, ACA Financial Guaranty Corporation ("ACA") commenced operations. ACA is a single-A rated financial guaranty insurer focusing on the insurance of marginally investment grade and non-investment grade municipal and non-municipal securities. Further, CGA Ltd., a Bermuda based financial guaranty insurer which commenced operations in June 1997, provides financial guaranty insurance of structured securities, including commercial real estate and asset-backed securities. (b) Financial Guaranty Reinsurance Market - Reinsurance is a transaction whereby the reinsurer agrees to indemnify the primary insurance company against part or all of the loss which the latter may sustain under a policy which it has issued. The reinsurer may also assume reinsurance from other reinsurers ("retrocessions"). In the event of loss, the reinsured generally remains liable on its obligation to indemnify the insured. The two major kinds of reinsurance are treaty and facultative. Treaty reinsurance requires the reinsured to cede and the reinsurer to assume specific classes of risk underwritten by the ceding company over a period of time, typically one year. Facultative reinsurance is the reinsurance of part or all of one or more reinsurance policies which is subject to separate negotiation for each cession. It offers the option of accepting or rejecting individual submissions by a ceding company as distinguished from the obligation to accept specified classes of risk as a treaty reinsurer. Ceding companies generally will seek facultative agreements when treaty terms preclude the cession or inclusion of a particular risk, when the capacity of the treaty program is insufficient for a given risk (for instance, when policy limits are in excess of the treaty limits) or when special coverage is needed to comply with regulatory or other capacity restrictions. Reinsurance is written on a proportional or non-proportional basis. Proportional reinsurance includes: (i) quota share reinsurance, whereby the assumed risk is a fixed percentage of the reinsured's risk, (ii) surplus share reinsurance, whereby the percentage of risk assumed is a multiple of the reinsured's net retention up to a stated maximum, and (iii) variable quota share reinsurance, whereby the percentage of assumed risk increases with the risk size to a stated maximum. There are many possible variations of these three types of proportional reinsurance. Non-proportional reinsurance includes: (i) risk assumption per risk and per occurrence in excess of a reinsured's retention, subject to a specified limit, and (ii) stop loss or aggregate excess of loss reinsurance, whereby the reinsurer assumes an aggregate loss incurred over a specific time period (for specific risks) above the reinsured's retention of loss incurred, up to a stated maximum. The purposes of reinsurance in the financial guaranty industry are to (i) increase the insurance capacity of the reinsured, (ii) assist the reinsured in meeting applicable regulatory and rating agency requirements, (iii) augment the reinsured's financial strength, and (iv) manage the reinsured's risk exposure. State insurance laws and regulations, as well as the rating agencies, impose minimum capital requirements on financial guaranty companies, limiting the aggregate amount of insurance which may be written and the maximum size of any single risk which may be insured. 7 Reinsurance allows the reinsured to increase its capacity to write new business by effectively reducing the reinsured's gross liability on an aggregate and single risk basis. Furthermore, primary insurers manage the risk of their insured portfolios based on internal underwriting criteria and portfolio management guidelines. Reinsurance is instrumental in achieving those portfolio risk management goals. There are currently two domestic reinsurance companies, Capital Reinsurance and Enhance Reinsurance Company, specializing in the reinsurance of financial guaranties. Several non-U.S. multiline insurers and a small number of domestic multiline insurers also participate in this reinsurance market. Based upon the 1998 annual statutory statements filed by each of the U.S. primary financial guaranty insurers, the Company believes that the Company and its principal competitor assumed most of the reinsurance ceded by the U.S. primary financial guaranty insurers in 1998. The size and growth of the financial guaranty reinsurance market is dependent on (i) the size of the primary insurance market, (ii) the percentage of aggregate risk that the primary insurers cede to the reinsurers, (iii) regulatory, rating agency and other external risk retention limitations imposed on the primary insurers and (iv) the price and availability of substitute highly rated capital facilities. (c) Credit Default Swap Market - Credit default swaps are transactions whereby one party, in consideration of a fixed payment, agrees to make a specified payment to another party upon the occurrence of one or more specified credit events with respect to a reference entity. The Company, through Capital Reinsurance, entered the credit default swap business in early 1996. Although structured as financial derivatives, credit default swaps are functionally equivalent to financial guaranty insurance, and Capital Reinsurance underwrites and manages this business in tandem with, and in accordance with the same policies and procedures as, its financial guaranty business. Capital Reinsurance engages in credit default swap with numerous counterparties, including U.S. and European money center banks and investment banks. (4) Financial Risks Division - (a) Mortgage Guaranty Reinsurance Market - The purposes of reinsurance in the mortgage guaranty insurance industry are to (i) increase the insurance capacity of the reinsured, (ii) assist the reinsured in meeting applicable regulatory and rating agency requirements, (iii) augment the reinsured's financial strength and (iv) manage the reinsured's risk exposure. Mortgage guaranty insurance is a specialized class of credit insurance, providing protection to mortgage lending institutions against the default of borrowers on mortgage loans which at the time of the advance had a loan-to-value ("LTV") ratio in excess of 80%. The market for mortgage guaranty insurance is competitively shared by three sectors: governmental agencies, principally the Federal Housing Administration ("FHA") and the Veterans Administration ("VA"), private mortgage guaranty insurers, and the lending institutions which choose to self-insure against the risk of loss on high LTV mortgage loans. The private mortgage insurance industry, composed of only monoline insurance companies, as required by law, provides two basic types of coverage: primary insurance, which protects lenders against default on individual residential mortgage loans by covering losses on such loans to a stated coverage percentage; and pool insurance, which protects lenders against aggregate default levels in an underlying pool of individual mortgages by covering the full amount of loss (less the proceeds from any primary insurance coverage that may be in place) on individual residential mortgage loans in such pool of loans, with an aggregate limit usually expressed as a percentage of the initial loan balances of the pool of loans. Primary insurance and pool insurance are used to facilitate the sale of mortgage loans in the secondary mortgage market, principally to the Federal Home Loan Mortgage Corporation ("Freddie Mac") and Federal National Mortgage Association ("Fannie Mae"). Freddie Mac and Fannie Mae provide indirect funding for approximately half of all mortgage loans originated in the U.S. In addition, pool insurance is often used to provide credit support for mortgage-backed securities and other secondary mortgage market 8 transactions. There are seven private mortgage guaranty insurers writing new business: General Electric Mortgage Insurance Company ("GEMICO"); Mortgage Guaranty Insurance Company; PMI Mortgage Insurance Co. ("PMI"); United Guaranty Residential Insurance Company; Commonwealth Mortgage Assurance Company ("CMAC"); Republic Mortgage Insurance Company; and Triad Mortgage Insurance Company. In 1998 CMAC entered into an agreement to acquire Amerin Guaranty Corporation, which had been the fifth largest mortgage guaranty insurer. CMAC's acquisition of Amerin is expected to be completed in the spring of 1999. Mortgage guaranty insurers do not underwrite risk to a "zero loss" underwriting standard as in the financial guaranty insurance industry; rather, they underwrite with a view to target loss ratios ranging from 45% to 60%. A critical factor to successfully underwriting this class of business is the ability to consistently control the quality and diversity of insurance in force, avoiding catastrophic losses from regional depressions and declines in residential real estate prices, by effective geographic and product dispersion. Except for the Company, the third-party reinsurance capacity for the industry is provided almost exclusively by European multiline insurers and reinsurers, who offer modest amounts of traditional reinsurance products. The primary mortgage insurers also utilize various internal risk sharing arrangements with their own affiliates. In recent years, the primary mortgage insurers have established numerous risk and profit sharing mechanisms with lenders. As a result of a ruling by the Comptroller of the Currency in 1997, federal banks are now permitted to establish operating subsidiaries, known as lender-owned captives, to reinsure a portion of the mortgage insurance issued on loans originated or purchased by the bank or its lending affiliates. The growing use of lender-owned captives that assume risk from the primary mortgage insurers has materially altered mortgage guaranty insurance industry in that the primary insurers now cede a significant percentage of premium to lender-owned captives leaving less premiums available to purchase reinsurance from third parties. In general, lender-owned captive reinsurance transactions are structured as non-proportional arrangements with the lender-owned captive assuming risk on an excess of loss basis, although some lender-owned captive transactions are structured as proportional reinsurance. The growing popularity of lender-owned captive arrangements has reduced the mortgage guaranty insurers use of third party reinsurance for their risk management needs. Both Fannie Mae and Freddie Mac have recently taken positions that place increased pressure on the mortgage guaranty insurance industry. In early 1999, Fannie Mae reduced the amount of insurance coverage required for loans it purchases. Fannie Mae has also introduced certain products that may further decrease the need for mortgage guaranty insurance. The reduced risk and revenue opportunities for the mortgage guaranty insurance industry caused by the recent actions of Fannie Mae and Freddie Mac further lessen the industry's need for third-party reinsurance. Low loss ratios, higher premiums and streamlined operations have allowed mortgage insurers to bolster capital thereby diminishing the need for reinsurance support. The mortgage insurers, however, continue to utilize non-captive reinsurance to optimize financial results and/or meet rating agency capitalization requirements. The Company, which through Capital Mortgage is the only dedicated mortgage guaranty reinsurer, has been able to capitalize on these factors by providing sophisticated mortgage reinsurance products in addition to the quota share reinsurance products historically offered. Moreover, the Company has begun to develop new reinsurance products specifically for lender-owned captives that will enable such captives to have greater financial flexibility while providing risk management and other financial benefits. Rating agencies currently impose more stringent requirements on risk-to-capital ratios for mortgage guaranty insurers than the 25:1 ratio imposed by applicable law. Generally, S&P and Moody's require that AA rated mortgage guaranty insurers operate at a risk-to-capital ratio of less than 20:1. The maintenance or improvement of high quality (AA or better) financial strength ratings directly influences an insurer's ability to compete in the market and access capital resources to support its book of business. One new product offered by mortgage insurers, known as GSE pool insurance, is extremely capital consumptive and, in an effort to operate at a ratio below 20:1, some mortgage insurers have approached the third-party reinsurance market. The Company has begun to develop sophisticated 9 reinsurance products designed to provide capital relief and solve rating agency concerns arising from the GSE pool insurance product. (b) Trade Credit Reinsurance Market- Trade credit insurance protects sellers of goods and services from the risk of non-payment of trade receivables and is a large, well-established specialty insurance product, particularly in Western Europe. Policyholders are generally covered for short-term exposures (generally less than 180 days and averaging 60-90 days) to insolvency or payment defaults by domestic and/or foreign buyers. Some export credit policies also cover political events which can disrupt either the flow of goods and services or payment for goods and services. Specialist underwriters dominate the market, using sophisticated information management systems to provide rapid approval of policy requests while maintaining underwriting controls. Trade credit insurance relies on credit analysis and portfolio diversification techniques similar to those employed in financial guaranty and mortgage guaranty insurance. Results are heavily dependent upon macroeconomic conditions, with typical loss ratios of 30-50% during healthy economies and rising to 80-100% during recessions. The trade credit reinsurance market is led by traditional international multiline reinsurers, principally Munich Re and Swiss Re, who have been able to maintain their dominant market position in part through their ownership interests in many of the leading primary companies. Capital Credit has attempted to identify areas of opportunity where its specialty focus provides some advantage over the traditional players. Revenue targets have been set conservatively with the intention of selectively choosing participations. The product mix combines quota share and structured excess participations that are geared to produce results that outperform the overall credit insurance market. Although trade credit reinsurance represents the bulk of its portfolio, Capital Credit has written reinsurance in several related specialty areas, including international bonding and political risk reinsurance. Capital Credit ceased writing specialty reinsurance in early 1999. (c) Title Reinsurance Market- Title insurance is currently written by seven national and dozens of regional companies throughout the United States, all of which are required by statute to be monoline insurers. Title insurance essentially provides the acquirer or the mortgagee of real property with two forms of coverage. The first assures that the search and examination of the real estate records upon which the acquirer or mortgagee is relying for good and clean title was properly performed. In insuring that a process was in fact properly done and recorded, the title insurer is providing risk exclusion. The second form of coverage assures that all previously existing mortgages and liens will be paid off from the proceeds of the sale or refinancing of the property. In insuring that the existing mortgages and liens are extinguished, the title insurer is providing risk assumption. Capital Title was formed to take advantage of the strategic opportunities presented by the recent trends in the title insurance business discussed above. Specifically, reinsurance needs are becoming more complex as primary insurers strive to react to the trends detailed above by diversifying reinsurance recoverable risk, optimizing financial results and maintaining high quality claims-paying ability or financial strength ratings. Risk syndication and access to larger, independent pools of capital to support ever increasing industry exposure is an important issue as the industry begins to compete in a rated environment. To address the concerns of rating agencies and the resulting capital adequacy and profitability issues, title insurers are adjusting their business practices, especially with regard to commercial transactions. Rating agencies, lenders, and regulators are increasingly concerned with the level of risk being taken by insurers on large commercial transactions. Single-risk limits on the order of 20% to 30% of policyholders surplus have been, and are likely to continue to be, imposed on insurers. Accordingly, third party reinsurance, such as that provided by Capital Title, to build single risk capacity and as an overall capital substitute, has become important. 10 Capital Title applies its financial, reinsurance, rating agency, underwriting and legal expertise to provide reinsurance solutions tailored to the particular rating agency, financial, regulatory and risk management needs of each primary title insurer. Capital Title represents an independent source of capacity in an industry which has historically relied on a closed system of reinsurance capacity provided by the industry's primary insurers. Capital Title offers several specific products to the title insurance industry, all of which are derived from two basic reinsurance product types, excess of loss and quota share. 11 B. BUSINESS OF CAPITAL RE: (1) Insurance in Force - The information below is presented on a consolidated basis for Capital Reinsurance, Capital Mortgage, KRE, Capital Credit and Capital Title, unless expressly indicated otherwise. The information includes estimates derived from the accounting and statistical records of Capital Reinsurance, Capital Mortgage, KRE, Capital Credit and Capital Title. The Company did not write any financial solutions business prior to 1997; accordingly, no information relating to the financial solutions line is presented for 1996. Capital Reinsurance's credit default swap income and exposure is included as part of financial guaranty premium and exposure. The table below sets forth gross and net premiums written and net premiums earned by line of business. Premiums by Line of Business (dollars in thousands) Year Ended December 31, ==================================== 1998 1997 1996 ================================================================================ Gross Premiums Written: - -------------------------------------------------------------------------------- Financial Guaranty Division: - -------------------------------------------------------------------------------- Municipal $55,280 $52,778 $48,411 - -------------------------------------------------------------------------------- Non-Municipal 39,872 16,674 10,902 - -------------------------------------------------------------------------------- Financial Risks Division: - -------------------------------------------------------------------------------- Mortgage 66,802 70,752 53,683 - -------------------------------------------------------------------------------- Credit 35,298 23,025 15,070 - -------------------------------------------------------------------------------- Title 5,713 4,024 1,752 - -------------------------------------------------------------------------------- Financial Solutions 10,976 2,689 0 - -------------------------------------------------------------------------------- Total Gross Premiums Written $213,941 $169,942 $129,818 ================================================================================ ================================================================================ Net Premiums Written: - -------------------------------------------------------------------------------- Financial Guaranty Division: - -------------------------------------------------------------------------------- Municipal $52,269 $50,157 $36,707 - -------------------------------------------------------------------------------- Non-Municipal 39,772 16,599 10,902 - -------------------------------------------------------------------------------- Financial Risks Division: - -------------------------------------------------------------------------------- Mortgage 66,725 70,480 40,936 - -------------------------------------------------------------------------------- Credit 35,142 22,955 14,891 - -------------------------------------------------------------------------------- Title 5,713 4,024 1,752 - -------------------------------------------------------------------------------- Financial Solutions 10,976 60 0 - -------------------------------------------------------------------------------- Total Net Premiums Written $210,593 $164,275 $105,188 ================================================================================ ================================================================================ Net Premiums Earned: - -------------------------------------------------------------------------------- Financial Guaranty Division: - -------------------------------------------------------------------------------- Municipal $42,956 $29,748 $27,540 - -------------------------------------------------------------------------------- Non-Municipal 20,705 11,402 7,199 - -------------------------------------------------------------------------------- Financial Risks Division: - -------------------------------------------------------------------------------- Mortgage 59,347 53,246 43,882 - -------------------------------------------------------------------------------- Credit 28,688 17,207 12,239 - -------------------------------------------------------------------------------- Title 5,713 3,628 1,576 - -------------------------------------------------------------------------------- Financial Solutions 10,976 60 0 - -------------------------------------------------------------------------------- Total Net Premiums Earned $168,385 $115,291 $92,436 ================================================================================ 12 The following charts set forth certain information regarding gross premiums written on insurance ceded to the Company by its largest ceding company clients in each material line of business in 1998, 1997, and 1996. Gross Premiums Written by Primary Financial Guaranty Insurer (dollars in thousands) Year Ended December 31, ============================================================== 1998 1997 1996 ================================================================================ Primary Gross Percent Gross Percent Gross Percent Insurer Premiums of Total Premiums of Total Premiums of Total Written Written Written Written - -------------------------------------------------------------------------------- AMBAC $9,458 10% $4,797 7% $8,766 15% - -------------------------------------------------------------------------------- CGA 12,763 13 108 0 0 0% - -------------------------------------------------------------------------------- FGIC 4,683 5 15,559 22 15,388 26 - -------------------------------------------------------------------------------- FSA 25,567 27 19,518 28 8,590 14 - -------------------------------------------------------------------------------- MBIA(1) 33,538 35 28,063 40 25,681 43 - -------------------------------------------------------------------------------- Other 9,143 10 1,047 2 888 1 - -------------------------------------------------------------------------------- ================================================================================ Total $95,152 100 $69,452 100% $59,313 100% ================================================================================ (1) 1996 and 1997 premiums for MBIA include business ceded by Capital Markets Assurance Company, which was acquired by MBIA in 1998. Gross Premiums Written by Primary Mortgage Guaranty Insurer (dollars in thousands) Year Ended December 31, ============================================================== 1998 1997 1996 ================================================================================ Primary Gross Percent Gross Percent Gross Percent Insurer Premiums of Total Premiums of Total Premiums of Total Written Written Written - -------------------------------------------------------------------------------- PMI 13,427 20% $15,176 21% $13,897 26% - -------------------------------------------------------------------------------- CMAC 31,217 47 26,879 38 20,553 38 - -------------------------------------------------------------------------------- GEMICO 8,829 13 9,908 14 7,686 14 - -------------------------------------------------------------------------------- Commercial 952 1 4,173 6 4,490 8 General Union - -------------------------------------------------------------------------------- Other 12,377 19 14,616 21 7,057 14 - -------------------------------------------------------------------------------- ================================================================================ Total $66,802 100% $70,752 100% $53,683 100% ================================================================================ 13 Gross Premiums Written by Primary Title Insurer (dollars in thousands) Year Ended December 31, ============================================================== 1998 1997 1996 ================================================================================ Primary Gross Percent Gross Percent Gross Percent Insurer Premiums of Total Premiums of Total Premiums of Total Written Written Written - -------------------------------------------------------------------------------- Commonwealth $1,536 27% $1,243 31% $536 31% - -------------------------------------------------------------------------------- United General 2,503 44 1,600 40 1,061 61 - -------------------------------------------------------------------------------- Other 1,674 29 1,181 29 155 8 - -------------------------------------------------------------------------------- ================================================================================ Total $5,713 100% $4,024 100% $1,752 100% ================================================================================ Gross Premiums Written by Primary Credit Insurer (dollars in thousands) Year Ended December 31, ============================================================== 1998 1997 1996 ================================================================================ Primary Gross Percent Gross Percent Gross Percent Insurer Premiums of Total Premiums of Total Premiums of Total Written Written Written - -------------------------------------------------------------------------------- AIU $8,697 25% $5,903 23% $4,176 28% - -------------------------------------------------------------------------------- HERMES 2,775 8 2,989 12 3,513 23 - -------------------------------------------------------------------------------- HSB 4,663 13 120 0 0 0 - -------------------------------------------------------------------------------- NCM 4,557 13 4,358 17 3,838 25 - -------------------------------------------------------------------------------- Trade Indemnity 2,327 7 2,667 10 501 3 - -------------------------------------------------------------------------------- Other 12,279 35 6,988 38 3,042 20 - -------------------------------------------------------------------------------- ================================================================================ Total 35,298 100% $23,025 100 $15,070 100 ================================================================================ The following table sets forth the Company's gross premiums written, net premiums written and net premiums earned relating to its reinsured U.S. and non-U.S. risks for each of the three years ended December 31, 1998, 1997 and 1996. 14 U.S. and Non-U.S. Premiums Written and Earned (dollars in thousands) U.S.% Non-U.S.% U.S. Non-U.S. Total Total Total ================================================================================ Year Ended December 31, 1998 - -------------------------------------------------------------------------------- Gross Premiums Written $169,620 $43,321 $213,941 79.3% 20.7% - -------------------------------------------------------------------------------- Net Premiums Written 166,420 44,174 210,594 79.0 21.0 - -------------------------------------------------------------------------------- Net Premiums Earned 135,395 33,005 168,400 80.4 19.6 ================================================================================ ================================================================================ Year Ended December 31, 1997 - -------------------------------------------------------------------------------- Gross Premiums Written $130,396 $39,561 $169,957 76.7% 23.3% - -------------------------------------------------------------------------------- Net Premiums Written 125,016 39,273 164,289 76.1 23.9 - -------------------------------------------------------------------------------- Net Premiums Earned 93,770 21,535 115,305 81.3 18.7 ================================================================================ ================================================================================ Year Ended December 31, 1996 - -------------------------------------------------------------------------------- Gross Premiums Written $104,605 $25,214 $129,818 80.6% 19.4% - -------------------------------------------------------------------------------- Net Premiums Written 80,298 24,890 105,188 76.3 23.7 - -------------------------------------------------------------------------------- Net Premiums Earned 76,803 15,634 92,437 83.1 16.9 ================================================================================ (2) Detail on Financial Guaranty Insurance in Force - The following table shows the Company's ten largest municipal financial guaranty single risk exposures by consolidated net par in force as of December 31, 1998. Collectively, these ten exposures accounted for 13.21% (consolidated net par) of the Company's reinsured financial guaranty portfolio. Ten Largest Municipal Financial Guaranty Single Risk Exposures Net Par in Force (dollars in thousands) - -------------------------------------------------------------------------------- Credit (1) As of December 31, 1998 - -------------------------------------------------------------------------------- California General Obligation Bonds $993,505 - ------------------------------------------------------------------------- Massachusetts State GO & Bay Transportation Bonds 919,338 - ------------------------------------------------------------------------- New York City General Obligation Bonds 910,339 - ------------------------------------------------------------------------- New Jersey Transportation Trust Fund Authority 862,191 - ------------------------------------------------------------------------- Washington Public Power Supply System 681,683 - ------------------------------------------------------------------------- Long Island Power 679,236 - ------------------------------------------------------------------------- Los Angeles County California Metro Transportation 668,644 - ------------------------------------------------------------------------- New York City Municipal Water Finance Authority 661,353 - ------------------------------------------------------------------------- New York State General Obligation Bonds 604,942 - ------------------------------------------------------------------------- Denver Colorado Airport System Revenue Bonds 560,163 - ------------------------------------------------------------------------- (1) All subject to non proportional Excess of Loss ("EOL") retrocessional program and/or Annual Debt Service ("ADS") retrocessional program. See "Business of Capital Re--Retrocessional Arrangements, Soft Capital Facilities and Intercompany Capital Supports." 15 The following table shows the Company's ten largest non-municipal financial guaranty exposures by consolidated net par in force as of December 31, 1998. The top nine exposures are asset backed securities, each of which may represent risk to one or more asset securitizations. In addition, asset backed securities serviced by a single seller/servicer have been listed as a single exposure, regardless of whether such securities belong to the same or different asset classes. Collectively, these ten exposures accounted for 6.87% (consolidated net par) of the Company's reinsured financial guaranty portfolio. Ten Largest Non-Municipal Financial Guaranty Exposures Net Par in Force (dollars in thousands) - -------------------------------------------------------------------------------- Net Par Seller/Servicer or Issuer, Asset Class/Credit in Force as of as applicable December 31, 1998 - -------------------------------------------------------------------------------- The Money Store Residential Mortgages/Automobile $680,509 Loans - -------------------------------------------------------------------------------- Arcadia Financial Ltd. Automobile Loans 593,531 - -------------------------------------------------------------------------------- Takefuji Corporation Consumer Receivables 401,000 - -------------------------------------------------------------------------------- United Companies Financial Corporation Residential Mortgages 399,471(1) - -------------------------------------------------------------------------------- ContiMortgage Residential Mortgages 399,341 - -------------------------------------------------------------------------------- IMC Mortgage Residential Mortgages 321,075 - -------------------------------------------------------------------------------- Commerzbank Collateralized Loan Obligations 300,000 - -------------------------------------------------------------------------------- Chevy Chase Bank Residential Mortgages/Automobile 287,304 Loans - -------------------------------------------------------------------------------- Advanta Residential Mortgages/Automobile 270,664 Loans - -------------------------------------------------------------------------------- Government Development Bank for Bank 267,000 Puerto Rico(2) - -------------------------------------------------------------------------------- (1) Of this amount, $276 million in net par is reinsured on an excess of loss basis. (2) Pursuant to this transaction, the Company has guaranteed a triple-A rated financial guaranty insurer's financial guaranty obligations with respect to certain bonds issued by the Government Development Bank for Puerto Rico. The execution for this transaction is a credit default swap. Although the Company generally does not write financial guaranty reinsurance on obligations that are non-investment grade at the time reinsured, the credit ratings of certain obligations may be reduced after the date such obligations are reinsured. The Company monitors its exposure to non-investment grade obligations and in this regard relies in part on information provided by its ceding companies, particularly with respect to certain municipal treaty business. The Company is familiar on an ongoing basis with the criteria used by S&P and Moody's for determining the investment grade status of the various credit sectors reinsured by the Company. These criteria are specific to, and vary considerably depending on, the line of business and type of credit reinsured. In certain cases, the Company and/or its cedants may obtain access to information on individual credits indicating that those credits no longer conform to the rating agencies' investment grade criteria, even through the rating agencies may not have yet reviewed those credits to determine their investment grade status. In such cases, the Company and/or its cedants may determine that certain individual credits are below investment grade quality. Based upon these procedures, the Company believes that approximately 1.25% of the reinsured financial guaranty portfolio (based on net par amount), or approximately $0.7 million, was rated below investment grade (i.e., not rated at least BBB- or Baa3 by either S&P or Moody's, or, if not rated, determined to be below investment grade in the opinion of the ceding company or the Company) at December 31, 1998. The following table sets forth the distribution of consolidated net book of business by rating as of December 31, 1998. 16 [THE FOLLOWING TABLE WAS REPRESENTED BY A PIE CHART IN THE PRINTED MATERIAL.] Distribution of Financial Guaranty Net Book of Business by Rating(1) As of December 31, 1998 (dollars in thousands) NIG 1.2% AAA 9.9% BBB 18.2% AA 19.4% A 51.3% Capital Reinsurance has developed several non-proportional retrocessional programs which supplement its financial guaranty single risk capacity for a number of selected large volume issuers of municipal bonds. In some cases, these arrangements are effected on an excess of loss basis and involve the retention by Capital Reinsurance of a first loss exposure (liability for all losses related to a particular risk up to a stated dollar amount). Under these arrangements, Capital Reinsurance's potential annual payment liability (the annual amount of claims payments which Capital Reinsurance is obligated to pay) related to an issue default during the period of such first loss exposure may be several times Capital Reinsurance's net average annual debt service exposure to such reinsured issue. _____________________________________ (1) Non-rated securities are allocated among investment grade securities on a pro rata basis. 17 The financial guaranty reinsured portfolio of the Company contained exposures in each of the fifty states, the District of Columbia, Puerto Rico and several foreign countries. The following table sets forth the distribution of consolidated net book of business by state as of December 31, 1998. [THE FOLLOWING TABLE WAS REPRESENTED BY A PIE CHART IN THE PRINTED MATERIAL.] Distribution of Financial Guaranty Net Book of Business by State As of December 31, 1998 (dollars in thousands) Total: $57,093,361 State Distribution ----- ------------ Washington 2.45% Ohio 2.51% Puerto Rico 2.73% Mass. 3.20% Ill. 3.31% N.J. 3.52% Penn. 3.92% Florida 5.16% Texas 5.16% New York 9.72% California 10.74% Others 47.57% (3) Exposure under Credit Default Swaps - As of December 31, 1998, the Company had approximately $6.8 billion of nominal exposure as a counterparty to credit default swap agreements. This exposure is included in the information provided in "Business of Capital Re - Insurance In Force." (4) Marketing - The majority of the Company's business is derived from relationships it has established and maintains with the major U.S. primary financial guaranty, mortgage guaranty and title insurers. European trade credit insurers, U.S. title insurers, United Kingdom mortgage guaranty insurers and Australian mortgage guaranty insurers also provide a significant portion of the Company's business. These relationships provide business opportunities for the Company on both a treaty and facultative basis. The Company's international retrocessional relationships enable it to access international sources of reinsurance. These relationships link the Company's technical expertise in financial guaranty and related reinsurance risk underwriting with the market knowledge and capital strength of the Company's international retrocessionaires. See "Business of Capital Re -- Retrocessional Arrangements, Soft Capital Facilities and Intercompany Capital Supports." For the year ended December 31, 1998, intermediaries and brokers had accounted for 27.3% of U.S. gross premiums written and 77.3% of non-U.S. gross premiums written. The Company's relationships with these brokers do not 18 commit or obligate the Company to accept business submitted by them. All applications for reinsurance from both new and existing ceding companies are subject to review and acceptance by the Company in accordance with the Company's underwriting guidelines. Brokers are compensated based on a percentage of premium, which varies from transaction to transaction. Certain U.S. domestic mortgage guaranty, non-municipal and other special risk reinsurance opportunities may also be produced by reinsurance intermediaries and brokers. Capital Mortgage and KRE derive their mortgage guaranty reinsurance business principally through direct relationships with primary mortgage guaranty insurance companies. Reinsurance intermediaries and brokers are used in accessing reinsurance opportunities in the United Kingdom and the international market. Capital Credit has developed credit reinsurance business opportunities principally through reinsurance brokers and intermediaries. Capital Title has developed substantially all of its business opportunities through direct contacts with primary title insurers. The financial solutions line of business has developed its opportunities through both direct contact with life and health and property-casualty insurers and through reinsurance intermediaries. (5) Underwriting Guidelines, Policies and Procedures - (a) Financial Guaranty Reinsurance - The underwriting process for the Company's financial guaranty insurance business is premised on the Company's policy of reinsuring investment grade obligations. Capital Reinsurance underwrites risks on a "zero loss" basis, meaning that each reinsured policy obligation has been evaluated by Capital Reinsurance under a standard of no loss expectation. However, losses in Capital Reinsurance's reinsured portfolio can be expected to occur, and there can be no assurance that these losses will not have a material adverse effect on financial condition and results of operations. See "Business of Capital Re--Losses and Reserves." In addition, Capital Reinsurance's ongoing review of its portfolio does not involve any commitment by rating agencies or ceding companies to provide credit rating information on each assumed obligation. Capital Reinsurance has organized its underwriting procedures to provide for multiple levels of credit review and analysis. Facultative submissions, which form the majority of Capital Reinsurance's business, are initially reviewed by one of Capital Reinsurance's underwriting analysts who performs a detailed evaluation of each individual submission to assure compliance with Capital Reinsurance's underwriting guidelines and rating agency and regulatory criteria. The analyst's recommendation is presented to one of Capital Reinsurance's Underwriting Committees for consideration. There are separate committees for municipal, non-municipal and non-U.S. financial guaranty risks. The Company's Chief Underwriting Officer must approve the decision of the Underwriting Committee before the risk is written by Capital Reinsurance. The Board of Directors of the Company also reviews underwriting policy and trends on a quarterly basis. Capital Reinsurance has established treaty reinsurance relationships with most of the U.S. primary financial guaranty insurance companies. Ceding insurers must be financially strong. Generally, each ceding company must also adhere to the underwriting standard of no loss expectation on financial guaranty insurance. Prior to initiating any treaty relationship, and on an annual basis thereafter, Capital Reinsurance conducts a review of the ceding company. Capital Reinsurance evaluates the ceding company's capital position, in-force book of business, reserves, cash flow, profitability and financial strength. The ceding company's underwriting process is analyzed to determine compliance with established credit guidelines and legal documentation requirements. Management of each ceding company is reviewed in the areas of credit control, monitoring and surveillance practices, claims administration and remedial management. After Capital Reinsurance completes its ceding company review, a report is prepared and presented to Capital Reinsurance's senior management. All new treaty relationships must be approved by the appropriate Underwriting Committee and the Chief Underwriting Officer before the treaty is accepted by Capital Reinsurance. Treaty results and compliance are reviewed by Capital Reinsurance on quarterly and annual bases. 19 Capital Reinsurance also conducts its own due diligence and credit surveillance of underlying credits in accordance with internally developed and maintained standards. Capital Reinsurance's Chief Underwriting Officer formulates Capital Reinsurance's underwriting policy and is responsible for its administration. The Board of Directors of Capital Reinsurance regularly reviews Capital Reinsurance's underwriting policy. The underwriting staff is also responsible for the ongoing monitoring and review of ceding company underwriting practices and financial results. The annual underwriting reviews of the ceding companies described above measure adherence to the ceding company's own underwriting standards and monitor the relationship of pricing to risk on business being reinsured by Capital Reinsurance. The reviews are also used to monitor pricing by product line, bond type and risk classification in an effort to allocate capital effectively to specific portfolios and product areas that are considered to have a greater potential for profitability. Capital Reinsurance's ongoing credit management of its reinsured portfolio is overseen by the Chief Underwriting Officer and the underwriting staff. The underwriting analysts recommend appropriate bond and credit sector representations and distributions. Capital Reinsurance's single and aggregate risk underwriting policies, while complying with regulatory and rating agency requirements, reflect Capital Reinsurance's capital resources, liquidity capabilities and retrocessional programs. Portfolio diversification is monitored regularly to improve the balance of geographic distribution, credit quality, bond type and maturity. (b) Mortgage Guaranty Reinsurance - Unlike the "zero loss" standard applied in financial guaranty insurance underwriting, mortgage guaranty insurance is underwritten with the expectation of loss. Under normal economic conditions and in a stable interest rate environment, loss ratios in this line of business are generally in the 15% to 40% range and are associated with frictional unemployment, divorce and other social factors. By avoiding geographic concentrations and employing prudent underwriting, mortgage insurers are better able to manage their risk. Capital Mortgage has established underwriting standards, procedures and closely monitored controls. A senior Mortgage Underwriting Committee, comprised of three voting members, including the Chief Underwriting Officer, must approve each underwriting submission. Submissions are made through preparation of a comprehensive underwriting report, which is derived from (i) extensive meetings with senior management and staff of the ceding company, (ii) underwriting, actuarial and financial analysis of detailed information including historic mortgage performance, portfolio composition, origination procedures, quality control, loss mitigation and claims management, and (iii) reinsurance structure and profitability analysis. Generally, ceding companies must demonstrate their capability to monitor economic trends in markets in which they are providing insurance and to exercise underwriting discipline. Capital Mortgage seeks to identify insurers having the capability to prospectively analyze economic trends in various markets based on local and regional market factors, political developments and global resource factors, such as energy prices. The ceding company is required to maintain analytical personnel dedicated to reviewing trends in local residential property markets. Capital Mortgage closely examines analytical methods by which the ceding company follows pricing adequacy and loss development patterns of its insurance in force. Ceding company loss mitigation and claims management procedures are evaluated and analyzed. The ceding company must demonstrate an adequate investigative capability, engaging in a systematic review of early payment defaults to detect fraud or potential defects in underwriting systems. Capital Mortgage's underwriting staff reviews all reinsurance in force and recommends portfolio balancing targets (e.g., amount of risk in force by region, underwriting year, ceding company, loan type). On-site reviews of all ceding companies are conducted on at least an annual basis, encompassing a review of overall company organization, financial performance, developments in sales and marketing, underwriting systems and operations, actuarial services and claims management. Underwriting department analysts are charged with following rating agency reviews 20 and industry developments, including a detailed review of semi-annual portfolio reports submitted by each ceding company to the rating agencies. (c) Trade Credit Reinsurance - Credit sales expose the seller to numerous risks ranging from the ability and willingness of the buyer to make payments according to agreed terms to political events which could disrupt the relationship between the seller and the buyer. Credit insurance is available in a variety of forms, and in varying degrees of comprehensiveness, to cover many of the potential risks encountered by the seller of goods and services. There are two broad areas of risk assumed in credit insurance and, consequently, reinsurance: commercial risks, including bankruptcy of the buyer and political risks, which can interfere with the fulfillment of an otherwise valid contract. Credit insurance underwriters manage risk by modifying the terms of coverage, by diversifying exposures to control aggregations of risks to particular buyers, industries, or territories, and by developing sophisticated databases of credit and political information. Up until early 1999, the Company also wrote a limited portfolio of other specialty lines related to trade credit reinsurance. All risks reinsured by the Company must be approved by an International Underwriting Committee composed of senior underwriting staff, including the Chief Underwriting Officer. The Company performs extensive diligence of prospective ceding companies to identify those expected to produce superior underwriting results, structures its reinsurance participation to eliminate unacceptable risks and actively monitors exposures to identify any deterioration in risk profile and control aggregation across participations. (d) Title Reinsurance - Similar to the "zero loss" standard applied in financial guaranty insurance underwriting, title reinsurance is underwritten without the expectation of any significant loss. Capital Title's underwriting decisions are, in major part, based on the underwriting audits of its ceding companies, focusing on (i) underwriting policies, guidelines and procedures and the experience and quality of underwriting personnel, including knowledge of localized issues and quality control, (ii) financial performance and stability, reserve adequacy and liquidity, (iii) claims handling procedures and personnel and loss management techniques and procedures, with particular emphasis on salvage, (iv) record keeping and title plant to ensure that all are well maintained and up to date, (v) agent and branch office review procedures, and (vi) trust fund and escrow account procedures. Preference is given to those companies whose overall policies, procedures and personnel exhibit a strong commitment to quality underwriting and loss management. Capital Title automatically accepts for reinsurance all policies which fall within the parameters of its various treaties. However, policies which contain certain enumerated types of extraordinary risks will have to be submitted on a special acceptance basis and separately underwritten by Capital Title's underwriting staff. Such extraordinary risks may include insured interests created by, under or concerning bankruptcy or state insolvency laws, federal or state securities laws, mineral interests, Indian lands, wet lands, tide lands, and mechanic's lien issues. In designing and recommending various excess of loss reinsurance strategies, Capital Title pays particular attention to each ceding company's loss experience, including frequency, severity and type of loss, at various policy sizes and levels of business. In conjunction therewith, salvage practices and procedures are considered. Capital Title is also called upon to provide facultative reinsurance capacity to the industry, particularly on larger commercial transactions and securitized pools of real estate. Capital Title maintains an underwriting staff experienced in handling these types of transactions and familiar with the particular risks attendant thereto. (e) Financial Solutions - The underwriting process used in the financial solutions line places significant emphasis on actuarial analysis. Transactions are either underwritten on a risk remote basis or are subject to an aggregate limit of liability for the reinsurer, standards that are compatible with the Company's "zero loss" financial guaranty underwriting standard. 21 Moreover, many financial solutions transactions provide for the payment of additional premium to the reinsurer in the event of poor loss experience on the reinsured business and for the payment of a profit commission to the reinsured in the event of favorable loss experience. Losses can be expected to occur in the Company's existing and future financial solutions portfolio. (6) Retrocessional Arrangements, Soft Capital Facilities and Intercompany Capital Supports - The Company's business strategy places emphasis on the development of retrocessional relationships which provide the Company with a higher level of reinsurance risk capacity and serve as a means of accessing additional reinsurance opportunities. The Company's retrocessional strategy emphasizes building single-risk capacity and risk management. The Company retroceded 1.6% or $3.3 million of its gross premiums written in 1998, 1.7% or $3.5 million of its gross premiums written in 1997 and 19.0% or $24.6 million of its gross premiums written in 1996. In 1992, Capital Reinsurance entered into a portfolio first loss and excess of loss reinsurance agreement with Centre Reinsurance Company of New York, a AA rated reinsurer. The agreement, which covered the entire reinsured portfolio of Capital Reinsurance, provided protection against currently unforeseen losses which, should they occur, would, in the absence of the reinsurance cover, require a significantly greater loss reserve in the year of occurrence. The cover also provided Capital Reinsurance with catastrophic loss protection. Capital Credit entered into a similar cover in 1992 with AXA Re Finance S.A. Under these arrangements, as of December 31, 1998, Capital Reinsurance has ceded $19.5 million in premium and Capital Credit has ceded $4.25 million in premium. On January 31, 1994, Capital Reinsurance entered into an agreement with Deutsche Bank AG for a credit facility of up to $75 million specifically designed to provide rating agency qualified capital to further support the claims-paying resources of Capital Reinsurance. On March 22, 1999, the amount of the facility was increased to $100 million. The agreement expires on January 27, 2006. As part of its original capital structure, in 1994 Capital Mortgage purchased $30 million of portfolio excess of loss reinsurance. Additionally, in 1994 Capital Reinsurance established a $100 million portfolio excess of loss reinsurance arrangement. The Company creates specialized retrocessional structures for establishing large financial guaranty single risk capacity, which the Company believes improve its competitive position with the primary financial guaranty insurance market. The Company believes that its ability to offer the primary financial guaranty market reinsurance capacity for the largest insurable debt issues is a significant marketing benefit, which allows it to access additional reinsurance opportunities. The Company's retrocessional treaty programs are its EOL Program and ADS Program. The EOL Program was a structured, non-proportional retrocessional treaty which (i) produced single risk capacity for the largest issuers of insurable municipal bonds, (ii) allowed international retrocessionaires to participate at a variety of risk levels, (iii) improved transactional profitability for the Company and (iv) complied with the Company's external risk limitations. The EOL Program was active through the end of 1991, and currently no new business is being ceded to it. The ADS Program is a proportional treaty covering annual payment obligations of the Company on certain of its large financial guaranty exposures.The ADS Program was effective as of January 1, 1992. Capital Credit acts as a captive retrocessionaire for Capital Reinsurance in connection with reinsurance opportunities that might otherwise be constrained in the context of Capital Reinsurance's regulatory limitations. Capital Reinsurance ceded to Capital Credit $1.8 million, $3.1 million and $0 million in premiums, and $.3 billion, $.7 billion and $.8 billion in par amounts, for the years ended December 31, 1998, 1997 and 1996, respectively. KRE provides retrocessional capacity to Capital Reinsurance, Capital Mortgage, Capital Credit and Capital Title. Capital Reinsurance ceded to KRE $1.8 million, $2.0 million and $1.1 million in premiums, and $0 billion, $0 billion and $.3 billion in par amounts, for the years ended December 31, 1998, 1997 and 1996, respectively. 22 Capital Credit and Capital Reinsurance have terminated, as of December 31, 1998, on a cut-off basis, a reinsurance arrangement whereby Capital Reinsurance supported Capital Credit's business by providing $25 million in aggregate excess coverage to it. In addition, Capital Credit and Capital Reinsurance have terminated, as of December 31, 1998, on a cut-off basis, an aggregate excess of loss reinsurance agreement pursuant to which Capital Reinsurance covered 100% of Capital Credit's losses on its trade credit and specialty book in excess of a 40% loss ratio, up to a $3.5 million annual limit. Capital Re supports Capital Credit's A+ rating via a $50 million guaranty of Capital Credit's liabilities. Approximately $85 million of per policy coverage is provided to Capital Title by KRE pursuant to a Per Policy Excess of Loss Retrocession Agreement. Under this agreement, KRE covers an amount of loss paid by Capital Title arising from each of its policies equal to $90 million minus Capital Title's retention under the agreement. Capital Title's retention under the agreement is equal to the greater of: (i) $5 million, and (ii) 20% of Capital Title's policyholder's surplus. $25 million of additional coverage is provided by KRE to Capital Title pursuant to an Excess of Loss Retrocession Agreement. Under this agreement, KRE covers up to $25 million of loss paid by Capital Title arising from its policies in excess of the lesser of: (i) 100% of Capital Title's net written premium and (ii) the amount by which Capital Title's statutory capital exceeds $25 million. In addition, Capital Reinsurance and KRE are parties to a Guaranty Agreement pursuant to which Capital Reinsurance has guaranteed all of KRE's obligations arising under all reinsurance contracts issued or assumed by KRE covering business other than business classified by KRE as mortgage guaranty reinsurance, credit reinsurance and financial guaranty reinsurance, to the extent such obligations are associated with the first $18 million of premium per calendar year written by KRE with respect to such business. As of December 31, 1998, Capital Reinsurance ceased to guaranty any KRE obligations assumed after such date other than treaty title obligations reinsured by KRE. On December 31, 1999, the guaranty will terminate in its entirety with regard to obligations of KRE assumed after such date. However, KRE has purchased $100 million of excess of loss protection from ACE Bermuda Insurance, Ltd. with respect to its liabilities under the Per Policy Excess of Loss Retrocession Agreement described above. Capital Mortgage and KRE are parties to a Capital Support Agreement pursuant to which Capital Mortgage has agreed, subject to certain limitations, to maintain the net worth of KRE at $15 million and KRE has agreed to maintain the net worth of Capital Mortgage at $25 million. (7) Competition - (a) Financial Guaranty Reinsurance - Capital Reinsurance competes directly with one U.S. financial guaranty reinsurer, Enhance Reinsurance Company, and indirectly with various international multiline reinsurers and insurers. Based upon the 1998 annual statutory statements filed by each of the primary U.S. financial guaranty insurers, the Company believes that the Company and its principal competitor assumed most of the reinsurance ceded by the primary U.S. financial guaranty insurers in 1998. U.S. multiline insurance companies generally do not provide reinsurance to the financial guaranty insurance industry. Although applicable state insurance regulations have mandated a specialized form for the transaction of primary financial guaranty insurance, multiline insurers may participate as reinsurers. However, the Company believes, based upon its own experience, that almost all U.S. multiline insurers have declined to participate in this market primarily because of their lack of the special expertise and underwriting skills necessary for this line of reinsurance. Numerous non-U.S. insurers participate in financial guaranty reinsurance treaties. Competition from international multiline reinsurance companies is best understood in the context of the financial guaranty reinsurance market in general. Cooperative channels of reinsurance capacity have developed throughout the reinsurance market in order to spread financial guaranty risk across a broad spectrum of insurers. As a result, international companies which may 23 compete with Capital Reinsurance are frequently Capital Reinsurance's retrocessionaires and ceding companies. As the global market evolves, this interaction may become more pronounced. Competition in the financial guaranty reinsurance business is based upon many factors, including overall financial strength, pricing, service and evaluation of claims-paying ability by the major rating agencies, including S&P. S&P will grant credit against a primary company's capital requirements and single risk limits for reinsurance ceded, provided the reinsurer meets S&P claims-paying ability standards. The primary company receives a 100% credit for reinsurance ceded subject to the reinsurer's maintenance of a AAA financial strength rating from S&P. A 70% credit is assigned if the reinsurer is rated AA and 30% if the reinsurer is rated A. Capital Reinsurance also faces competition indirectly from other triple-A rated financial institutions which provide capital substitutes to the primary financial guaranty insurance companies. Several international commercial banks have developed credit facilities and letter of credit products that qualify as rating agency capital and therefore provide primary insurers with increased insurance capacity for rating agency purposes. However, these banking facilities cannot provide regulatory capital or credit against liabilities. Further, the current lack of substantial triple-A bank credit has reduced banks as a competitive force in the reinsurance market. Competition is also a function of the ease with which primary insurers can raise capital in the private or public equity markets. Increased primary capital increases the ability of insurers to retain risk and the need for reinsurance in general is diminished. The Company believes that primary insurers have recently increased their primary capital base and that increased competition from foreign insurers is occurring. AXA Group Cie., one of France's largest insurers, established a subsidiary in 1995, AXA Re Finance S.A., in an effort to compete more effectively with triple-A rated U.S. financial guaranty reinsurers. In 1998, RAM Re, a Bermuda domiciled financial guaranty reinsurance company, commenced operations. RAM Re is rated AAA by S&P and Aa3 by Moody's. In addition, several multiline reinsurers have begun assuming certain forms of financial guaranty reinsurance over the past year. (b) Mortgage Guaranty Reinsurance - Capital Mortgage is not aware of any other U.S. professional reinsurer which specializes in mortgage guaranty reinsurance. Several U.S. multiline reinsurers offer capacity to the mortgage guaranty market but their participation has been limited. Substantially all of the external reinsurance capacity for the mortgage guaranty insurance industry is provided by European multiline insurers and reinsurers, who offer modest amounts of traditional reinsurance products. Capital Mortgage believes that those reinsurance providers typically lack the orientation and flexibility to address the current risk management, capital and financial problems of the mortgage guaranty insurance industry. In recent years, the primary mortgage insurers have established numerous risk and profit sharing mechanisms with lenders. As a result of a ruling by the Comptroller of the Currency in 1997, federal banks are now permitted to establish operating subsidiaries, known as lender-owned captives, to reinsure a portion of the mortgage insurance issued on loans originated or purchased by the bank or its lending affiliates. The growing use of lender-owned captives that assume risk from the primary mortgage insurers has materially altered mortgage guaranty insurance industry in that the primary insurers now cede a significant percentage of premium to lender-owned captives leaving less premiums available to purchase reinsurance from third parties. Like financial guaranty reinsurance, competition is also a function of the ease with which primary insurers can raise capital in the private or public equity markets. Increased primary capital increases the ability of insurers to retain risk and reduces the need for reinsurance in general. (c) Trade Credit Reinsurance - The trade credit reinsurance market is led by traditional multiline insurers and reinsurers, principally Munich Re and Swiss Re, which have been able to maintain their dominant market position in part through their ownership interests in many of the leading primary companies. In addition to the market leaders, there are a large number of mainly 24 European and U.S. reinsurers that compete for the business. Reciprocal reinsurance arrangements between primary companies are widespread, thus adding to the degree of competition in the industry. (d) Title Reinsurance - Capital Title is the only U.S. professional reinsurer which specializes in third-party title reinsurance. To date, substantially all title reinsurance has been provided by the large title insurance companies, except for some minor excess coverage. The global reinsurance market has not been tapped to any significant extent by title insurers. (e) Financial Solutions - The financial solutions line of business is generally highly competitive, with many life and health and property-casualty reinsurers offering products similar to, or in direct competition with, those offered by KRE and ACRE. Nevertheless, KRE and ACRE have focused (i) in certain sub-markets having little or no direct competition and (ii) on bespoke transactions. KRE and ACRE typically avoid commodity-type products and "bidding" situations. (8) Ratings - (a) Financial Guaranty Reinsurance - The financial strength of Capital Reinsurance is rated AAA by S&P and Aa2 by Moody's. In addition, Capital Reinsurance's claims paying ability is rated AAA by Fitch. Prior to March 10, 1999, the financial strength of Capital Reinsurance had been rated Aaa by Moody's; however, on March 10, 1999, Moody's downgraded the financial strength rating of Capital Reinsurance to Aa2. The financial strength rating of a reinsurer is particularly important in the area of financial guaranty reinsurance, because that rating affects the amount of capital credit the rating agencies will allow to a ceding company in connection with a cession to that reinsurer. S&P will permit a AAA rated ceding company 100% credit for a cession only if the reinsurer is also triple A rated. Moody's does not have published standards for determining the amount of credit a Aaa rated ceding company will be permitted for a cession to an Aa2 rated reinsurer; however, the rating of the reinsurer is an important element in Moody's determination of the amount of permitted credit. The ceding commission payable by Capital Reinsurance under certain of Capital Reinsurance's reinsurance agreements with two of its financial guaranty ceding companies will increase as a result of the recent rating action by Moody's. The increase will apply to in-force and future business ceded by those companies. The financial impact of the increased ceding commission with respect to the in-force business at December 31, 1998 is not expected to exceed $2.0 million in 1999. Generally, Capital Reinsurance's reinsurance agreements with its ceding companies give the ceding companies an option to reassume business previously ceded to Capital Reinsurance upon certain adverse rating actions; however, those options to fully reassume were not triggered by Capital Reinsurance's March 10th downgrade. Additionally, one of the two ceding companies referred to above may reassume a minor portion of its previously ceded business based on the recent rating action alone; however, that company has not indicated that it will exercise the option. The Company does not believe that the recent downgrade of its financial strength rating by Moody's will have a material adverse affect on its long-term business prospects. The major rating agencies have developed and published rating guidelines for rating financial guaranty reinsurers. These criteria follow the standards used to evaluate the financial strength of primary monoline financial guaranty insurers. The financial strength ratings assigned by S&P and Moody's are based upon factors relevant to policyholders and are not directed towards the protection of investors in Capital Re. The financial strength rating criteria used by S&P and Moody's focus on the following factors: capital resources, financial strength; demonstrated management expertise in financial guaranty and traditional reinsurance, credit analysis, systems development, marketing, capital markets and investment operations; and a minimum policyholders' surplus comparable to primary 25 company requirements, with capital sufficient to meet projected growth as well as access to such additional capital as may be necessary to continue to meet standards for capital adequacy. S&P has published standards as to capital charges and single risk categories to which Capital Reinsurance and other triple-A rated financial guaranty insurers and reinsurers must adhere in order to maintain their highest ratings. These standards weight numerous factors to types of obligations which are significantly more complex than an insurance-in-force-to-capital ratio. In addition, capital adequacy is tested against an economic model that simulates a growth period followed by an economic depression which assumes no new business is written. (b) Mortgage Guaranty Reinsurance - A reinsurer's financial ability to pay claims is the standard of value to its primary insurance market. Certain national mortgage lenders and a large segment of the mortgage securitization market, including Fannie Mae and Freddie Mac, generally will not purchase mortgages or mortgage-backed securities unless the private mortgage insurance on such mortgages has been issued by an insurer with a financial strength rating of at least AA- from S&P or at least Aa3 from Moody's or a claims-paying ability rating of at least AA-from Duff & Phelps or Fitch. As a result, each of the seven U.S. primary mortgage guaranty insurers has a financial strength or claims-paying ability rating of at least AA and generally seeks similarly rated reinsurance security. Capital Mortgage and KRE each have a AA financial strength rating from S&P, and KRE also has a AA+ claims-paying ability rating from Duff and Phelps. On December 16, 1998, the S&P ratings for both Capital Mortgage and KRE were placed on "CreditWatch" with negative implications. To The extent the S&P ratings were downgraded below the AA category, the credit received by the ceding companies for the reinsurance provided by Capital Mortgage and KRE would be discounted under S&P's capital adequacy models. In addition, certain of Capital Mortgage's and KRE's reinsurance contracts provide that the ceding company may recapture business previously ceded to the reinsurer if the reinsurer fails to either maintain an S&P rating of at least AA- or provide the ceding company with comparable security. In the event of a downgrade below AA-, the companies would be subject to additional costs incurred in providing AA- security. Both Capital Mortgage and KRE have identified potential new sources of reinsurance premium which would not be as dependent on AA ratings as the traditional sources of business. Both companies will seek to develop these opportunities in 1999. (c) Title Reinsurance - Capital Title is rated AA- by S&P and Duff & Phelps. The S&P rating for Capital Title is currently on "CreditWatch" with negative implications. Although the rating agencies have not published explicit rules regarding rating agency credit for reinsurance in the title insurance area, in practice, the primary title insurers receive 100% credit for cessions to Capital Title. Title insurers are only beginning to obtain claims- paying ability ratings; the general standard of creditworthiness that seems to be developing in the title insurance industry is A. (d) Other Ratings - In 1997, Capital Credit received an A+ financial strength rating from S&P. The S&P rating for Capital Credit is currently on "CreditWatch" with negative implications. The Company's senior debt is rated A by S&P and A1 by Moody's, and the MIPS issued by the Company's finance subsidiary, Capital Re LLC, are rated BBB+ by S&P and a2 by Moody's. Capital Reinsurance, Capital Mortgage, KRE and Capital Title have not received ratings from A.M. Best Company, Inc. ("A.M. Best"), a major rating agency covering the insurance industry. A.M. Best rates insurance companies 26 annually and provides statistical reports on their financial condition and history. However, A.M. Best has not rated financial guaranty insurers and reinsurers. Because the financial strength ratings discussed above from S&P and Moody's and the claims-paying ability ratings discussed above from Duff & Phelps and Fitch are generally considered far more important than A.M. Best ratings in the markets in which those companies compete, the Company believes the absence of an A.M. Best rating has no impact on the Company's business or on its competitive position. (9) NAIC-IRIS Ratios - The National Association of Insurance Commissioners' Insurance Regulatory Information System ("IRIS") was developed by a committee of state insurance regulators and is primarily intended to assist state insurance departments in executing their statutory mandates to oversee the financial condition of insurance companies operating in their respective states. IRIS identifies eleven industry ratios and specifies "usual values" for each ratio. Departure from the usual values on four or more of the ratios could lead to inquiries from individual state insurance commissioners as to certain aspects of a company's business. For the year ended December 31, 1998, Capital Reinsurance had one unusual value, which was an increase in net writings, and Capital Mortgage had two unusual values, both of which were related to the establishment of a reserve by Capital Mortgage's subsidiary, KRE, in connection with KRE's reinsurance of three issues of asset backed securities serviced by Commercial Financial Services, Inc. (10) Losses and Reserves - In the financial guaranty reinsurance business, case basis loss reserves are required to be established under generally accepted accounting principles ("GAAP") and statutory accounting practices ("SAP") when a payment default on an insured obligation is probable and the amount of the probable loss can be reasonably estimated. Moreover, under its various reinsurance treaties and facultative agreements, Capital Reinsurance is obligated to establish and maintain SAP case basis loss reserves. Under GAAP, the amount of the case basis loss reserve is calculated as the present value of the losses expected to be incurred through the full term of the obligation, including loss adjustment expenses, net of anticipated salvage and subrogation. Under current Maryland insurance law, case basis loss reserves may not be discounted under SAP. In the mortgage guaranty reinsurance business, the Company's reserves are a function of the reserving methodologies of the primary insurance companies from which mortgage guaranty risk is assumed. A significant period of time may elapse between the occurrence of the borrower's default on mortgage payments (the event a potential future claim), the reporting of such default to the primary insurance company, the primary company's notification of loss to the reinsurer and the eventual payment of the claim related to the default. To recognize the liability for unpaid mortgage guaranty losses related to defaulted mortgages, primary mortgage guaranty insurers establish loss reserves in respect of such defaults based upon the claim rate and estimated average claim amount. Included in these loss reserves are loss adjustment expense ("LAE") and Incurred But Not Reported Reserves. These reserves are estimates and there can be no assurance that they will prove adequate to cover ultimate loss developments on the reported defaults. The reserving process is premised on the assumption that historical experience relating to mortgage defaults, adjusted for the anticipated effect of current economic conditions and projected future economic trends, provides a reasonable basis for estimating future events. However, estimation of loss reserves is a difficult process, especially in light of the rapidly changing economic conditions that have affected certain regions of the United States. Additionally, economic conditions that have affected the development of the loss reserves in the past may not necessarily affect development patterns in the future. For the trade credit reinsurance business, loss reserves are established according to management's loss expectations which are based on historical loss development patterns experienced by the ceding companies on similar business as well as management's view of current macroeconomic conditions in the countries in which the policies apply. 27 For the specialty reinsurance business, loss reserves are established according to management's loss expectations which are based on historical loss development patterns experienced by the ceding companies on similar business. For the title reinsurance business, case basis loss reserves are required to be established under GAAP and SAP when a loss under a reinsured title policy is probable and the amount of the probable loss can be reasonably estimated. For the financial solutions business, reserves are set according to the type of product reinsured. Generally, for quota share reinsurance transactions, reserves equal the present value of future policy benefits less the present value of future policy premiums. For other transactions, reserves are set according to the expectation of future payments to be made under the agreement. The Chief Financial Officer of the Company is responsible for determining the appropriate timing and amount of loss reserves after consultation with the Company's Chief Executive Officer and Chief Underwriting Officer. In making his determination, the Chief Financial Officer will also confer with the ceding company which originally insured the obligation. The Company may, in its discretion, establish a loss reserve independent of the originating ceding company. As of December 31, 1998, the Company had established a net $84.6 million in GAAP case basis loss and LAE reserves (of which $18.2 million is classified as incurred but not reported reserves in the Company's statutory financial statements). The Company believes its loss and LAE reserves are adequate. The following table sets forth for the periods indicated certain information regarding the Company's loss experience.
Year Ended December 31 (dollars in thousands) ========================================== 1998 1997 1996 ================================================================================================ GAAP Net Premiums Earned 168,385 115,291 92,436 - ----------------------------------------------------------------------------------------------- Net Reserve for Unpaid Losses and LAE at Beginning of Period (including foreign currency revaluation) 22,459 18,068 10,259 - ----------------------------------------------------------------------------------------------- Incurred Losses and LAE 75,182 15,633 9,483 - ----------------------------------------------------------------------------------------------- Paid (Recovered) Losses and LAE 13,184 10,836 1,969 - ----------------------------------------------------------------------------------------------- Unrealized Foreign Currency Loss on Reserve Revaluation 210 (406) 296 - ----------------------------------------------------------------------------------------------- Net Reserve for Unpaid Losses and LAE at End of Period (including foreign currency revaluation)(1) 84,667 22,459 18,069 - ----------------------------------------------------------------------------------------------- Ratio of Losses Incurred and LAE to GAAP Net Premiums Earned 44.64% 13.56% 10.26% ================================================================================================
(1) Net of reinsurance recoverable on ceded losses of (in thousands) $3,292, $5,527 and $1,833 for the years ended December 31, 1998, 1997 and 1996, respectively. In addition, as of December 31, 1998, the Company had established a net $17.8 million in accident and health reserves and a net zero dollars in annuity benefit reserves. The Company believes its annuity benefit and accident and health reserves are adequate. (11) Investments - 28 In managing its investment portfolio, the Company places a high priority on credit quality and liquidity. Investment policy is set by the Board of Directors and specific investments are managed by two outside advisers: Lazard Freres Asset Management, Inc. and Goldman Sachs Asset Management (the "Advisers"). The Advisers act as investment managers of the Company's portfolio under contracts terminable on 30 days' notice. Performance of the Advisers and the fees associated with these arrangements have been and will continue to be periodically reviewed by the Board of Directors of the Company. All investments made by the Advisers for the Company are in accordance with the general requirements and guidelines for investments established by the Board of Directors and Investment Committee thereof, including guidelines relating to average maturities, duration and quality, in accordance with applicable law. All investments in municipal bonds and certain asset backed securities are subject to prior approval by the Capital Reinsurance underwriting department. The Company's current investment policy permits the purchase of both investment grade and non-investment grade fixed income securities, provided that non-investment grade fixed income securities may be rated no lower than "B" at the time of purchase. Further, total investment in non-investment grade fixed income securities may not exceed 3% of the aggregate portfolio. At December 31, 1998, 79.5% of the Company's investment portfolio consisted exclusively of fixed income securities rated AAA or A-1+ by S&P or Aaa or P-1 by Moody's, or issues by the U.S. Government or its agencies or instrumentalities. Overall weighted average credit quality is AA+. The Company's investment guidelines allow tactical purchases of high yield/emerging market debt securities at the discretion of the Advisers and within the constraints established by the Board of Directors. The overall portfolio performance, however, remains benchmarked to composite domestic benchmarks. No assurance can be given that the Company's strategy of diversification will prove successful, or that losses will not be incurred in excess of those realized under the prior investment strategy.
Aggregate Investment Portfolio by Maturity as of December 31 (dollars in thousands) ========================================================================================= 1998 1997 1996 ==================================================================================================================== Carrying Percentage Carrying Percentage Carrying Percentage Value of Total Value of Total Value of Total Maturity of Investment Investment Investment Investments Portfolio Portfolio Portfolio - -------------------------------------------------------------------------------------------------------------------- Due in One Year or $104,982 8.9% $87,757 8.7% $76,606 8.5% Less - -------------------------------------------------------------------------------------------------------------------- Due After One Year 127,040 10.8% 112,001 11.1% 117,503 13.0% Through Five Years - -------------------------------------------------------------------------------------------------------------------- Due After Five Years 151,639 12.9% 128,094 12.6% 74,723 8.3% Through Ten Years - -------------------------------------------------------------------------------------------------------------------- Due After Ten Years 791,377 67.4% 683,239 67.6% 632,270 70.2% - -------------------------------------------------------------------------------------------------------------------- Total Investment $1,175,038 100% $1,011,091 100% $901,102 100% Portfolio ====================================================================================================================
29 Aggregate Investment Portfolio and Yield by Type of Security as of December 31, 1998 (dollars in thousands)
Carrying Estimated Weighted Average Value Fair Yield Investment Category Value to Maturity(1) =========================================================================================================== Long-Term Investments: - ----------------------------------------------------------------------------------------------------------- Municipal Obligations $526,685 $526,685 5.96% - ----------------------------------------------------------------------------------------------------------- Corporate Securities 162,142 162,142 6.84% - ----------------------------------------------------------------------------------------------------------- U.S. Government and Agency Obligations 115,675 115,675 5.62% - ----------------------------------------------------------------------------------------------------------- Mortgage-Backed Securities 193,620 193,620 6.62% - ----------------------------------------------------------------------------------------------------------- Emerging Markets 11,661 11,661 7.50% - ----------------------------------------------------------------------------------------------------------- Other Asset-Backed Securities 67,549 67,549 6.46% - ----------------------------------------------------------------------------------------------------------- Other 9,559 9,559 10.80% - ----------------------------------------------------------------------------------------------------------- Total Long-Term Investments 1,086,891 1,086,891 6.26% - ----------------------------------------------------------------------------------------------------------- Short-Term Investments 88,147 88,147 5.03% =========================================================================================================== =========================================================================================================== Total Investment Portfolio $1,175,038 $1,175,038 6.17% ===========================================================================================================
(1) Represents yield to maturity on long-term investments and current yield on short-term investments. All percentages are stated on a pre-tax basis, based on contractual maturity periods. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. At December 31, 1998, approximately $193.6 million or 16.5% of the Company's investment portfolio was comprised of mortgage-backed securities ("MBS"). Of the MBS portfolio, approximately $167.5 million or 86.5% was backed by agencies or entities sponsored by the U.S. government as to the full amount of principal and interest. As of December 31, 1998, the entire MBS portfolio was invested in triple A rated securities. Prepayment risk is an inherent risk of holding MBS. However, the degree of prepayment risk is particular to the type of MBS held. The Company limits its exposure to prepayments by purchasing less volatile types of MBS. As of December 31, 1998, $3.6 million or approximately 1.9% of the MBS portfolio was invested in collateralized mortgage obligations ("CMOs") which are characterized as planned amortization class CMOs ("PACs"). PACs are securities whose cash flows are designed to remain constant over a variety of mortgage prepayment environments. Other classes in the CMO security are structured to accept the volatility of mortgage prepayment changes, thereby insulating the PAC class. Of the remaining MBS portfolio, $190.0 million, or 98.1%, was invested in mortgage-backed pass-throughs or sequential CMOs. Pass-throughs are securities in which the monthly cash flows of principal and interest (both scheduled and prepayments) generated by the underlying mortgages are distributed on a pro-rata basis to the holders of securities. A sequential MBS is structured to divide the CMO security into sequentially ordered classes. Receipt of principal payments within classes is contingent on the retirement of all previously paying classes. Generally, interest payments are made currently on all classes. While these securities are more sensitive to prepayment risk than PACs, they are not considered highly volatile securities. While the Company may consider investing in any tranche of a sequential MBS, the individual security's characteristics (duration, relative value, underlying collateral, etc.) along with aggregate portfolio risk management determine which tranche of sequential MBS will be purchased. At December 31, 1998, the Company had no securities such as interest only securities, principal only securities, or MBS purchased at a substantial premium to par that have the potential for loss of a significant portion of the original investment due to changes in the prepayment rate of the underlying loans supporting the security. 30 (12) Data Processing - The Company believes that its data processing system is adequate to support its current needs and that such system has the capacity to support a greater volume of reinsurance business. The Company uses microcomputers on a Novell, Windows NT and UNIX network. The network has six fileservers which provide for disk duplexing and complete data and application redundancy. System applications files and databases are backed up to tape daily. Backup tapes are shipped to an off-site storage facility weekly and on-site backup is stored in a fire-proof safe outside the data center. For a discussion of Year 2000 issues, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II hereof. (13) Employees - As of December 31, 1998, the Company employed 67 persons, of whom 44 were in administration, legal, finance and management, 12 were in underwriting and technical support and 11 were in management information services. None of these employees is covered by collective bargaining agreements. The Company believes that its employee relations are excellent. (14) Executive Officers - The executive officers of the Company and their present ages and positions with the Company are set forth below.
Name Age Position and Term of Office ---- --- --------------------------- Jerome F. Jurschak 51 Chairman of the Board and Chief Executive Officer (effective December 1998, officer since 1988) Joseph W. Swain III 46 President and Chief Operating Officer (effective December 1998, officer since 1988) David A. Buzen 39 Executive Vice President and Chief Financial Officer (officer since 1988) Alan S. Roseman 42 Executive Vice President, General Counsel and Secretary (officer since 1989) Laurence C.D. Donnelly 40 Executive Vice President (officer since 1988) Susan L. Hooker 49 Executive Vice President (officer since 1990)
31 (15) Regulatory Status of Insurance Subsidiaries - Capital Reinsurance is licensed as a surety, property and casualty insurer (including mortgage guaranty insurance) in the State of Maryland and is licensed or authorized to transact insurance business in the States of New York, Michigan, Florida and California and is an approved or accredited reinsurer in the States of Alaska, Colorado, Illinois, North Carolina, Pennsylvania, Texas and Wisconsin and in the Islands of Bermuda. Under its New York license, Capital Reinsurance is authorized to write surety insurance and to reinsure risks of every kind or description permitted by its charter (including financial guaranty risks). Notwithstanding the breadth of its New York license, Capital Reinsurance has committed to the New York Insurance Department that it will act in the United States only as a reinsurer and intends to reinsure only financial guaranty and related special risks consistent with its business strategy as a financial guaranty reinsurer. On May 7, 1998, Capital Risk was incorporated under the laws of the State of Maryland. On October 29, 1998, it was authorized by the Maryland Insurance Administration, the same regulatory authority that oversees Capital Reinsurance in Maryland, to write surety business under the laws of Maryland. Capital Risk has received no authorizations to transact insurance business in any other state and it has not been accredited or qualified as a reinsurer by any other state's insurance regulatory authority. Under its license to write surety business in Maryland, Capital Risk may write primary financial guaranty insurance in Maryland consistent with its business plan to support the objectives of Capital Reinsurance and its affiliates. Capital Mortgage is licensed as a mortgage guaranty insurer in the State of New York and is thereby authorized to transact solely the business of mortgage guaranty insurance. Capital Mortgage is an approved or accredited reinsurer in the States of Arizona, Illinois, North Carolina, Pennsylvania and Wisconsin. Capital Title is licensed as a title insurer in the State of New York and is thereby authorized to transact solely the business of title insurance. Capital Title is also licensed or authorized to transact title insurance business in the States of Michigan and Texas. Capital Title is an approved or accredited reinsurer in the States of Connecticut, Florida, Louisiana, Maryland, North Carolina, South Carolina and Virginia. Capital Reinsurance and Capital Risk are subject to the insurance laws and regulations of the State of Maryland and Capital Mortgage and Capital Title are subject to the insurance laws of the State of New York. Additionally, Capital Reinsurance, Capital Mortgage and Capital Title are subject to the laws of the other jurisdictions in which they are licensed to transact business. In general, such insurance laws and regulations are primarily for the protection of the policyholders of these companies, i.e., their ceding insurers, and ultimately the policyholders of those ceding insurers. These laws and regulations, as well as the level of supervisory authority that may be exercised by the various state insurance departments, vary by jurisdiction, but generally require reinsurance companies to maintain minimum standards of business conduct and solvency, including the satisfaction of minimum capital requirements, and certain financial tests, the maintenance of deposits of securities with state insurance departments for the benefit of ceding insurers and the filing of certain reports with regulatory authorities. Capital Reinsurance, Capital Mortgage and Capital Title are required to file quarterly and annual SAP financial statements in each jurisdiction where they are licensed and with the National Association of Insurance Commissioners, and are subject to certain risk limits and other statutory restrictions concerning the types and quality of, and limitations on, investments. Capital Risk is similarly required to file quarterly annual SAP financial statements, but only in Maryland and with the National Association of Insurance Commissioners. The operations and accounts of Capital Reinsurance, Capital Risk, Capital Mortgage and Capital Title are subject to periodic examination by the insurance departments of the jurisdictions in which they are licensed, authorized or accredited. The Maryland Insurance Administration, the regulatory authority of the domiciliary jurisdiction of Capital Reinsurance, conducts a triennial examination of insurance companies domiciled in Maryland. During 1997, the Maryland Insurance Administration completed its field work in connection with a triennial examination of 32 Capital Reinsurance for the period from January 1, 1994 though December 31, 1996. The Report on Financial Examination, which was issued by the Maryland Insurance Administration on May 29, 1998 in connection with such examination, did not contain any materially adverse findings. The Maryland Insurance Administration has completed its field work on its Organization Examination, as of September 24, 1998, on Capital Risk. The final report has not been issued by the Maryland Insurance Administration. The New York Insurance Department, the regulatory authority of the domiciliary jurisdiction of Capital Mortgage, conducts a triennial examination of insurance companies domiciled in New York. During 1997, the New York Insurance Department completed its field work in connection with a triennial examination of Capital Mortgage for the period from January 1, 1994 though December 31, 1996. The report on the examination has not yet been issued. During the latter half of 1998, the New York Insurance Department, the regulatory authority of the domiciliary jurisdiction of Capital Title, completed its field work in connection with a triennial examination of Capital Title for the period form March 6, 1996 to December 31, 1997. The report on the examination has not yet been issued. Although the rates and policy terms of primary insurance agreements are generally closely regulated by state insurance departments, the terms and conditions of reinsurance agreements generally are not subject to regulation by any regulatory authority with respect to rates or policy terms. However, as a practical matter, the rates charged by the primary insurers have an effect on the rates that can be charged by reinsurers and, with respect to reinsurance of financial guaranty, mortgage guaranty and title primary insurers licensed in the States of California, Florida and New York, certain terms must often be included in the reinsurance agreement in order for such primary insurers to receive credit for the reinsurance on their statutory financial statements. Capital Credit and KRE are insurance companies registered and licensed as general insurers under the laws of the Islands of Bermuda. Each is subject to the Insurance Act of 1978, as amended, of the Islands of Bermuda. It is the policy of the government of Bermuda that the insurance industry be essentially self-regulating and the Insurance Act is drawn to require certification by the appropriate officers and professionals of each company of compliance with the applicable statutory standards. Capital Credit and KRE are required under the Act to prepare annual statutory financial statements and file a statutory financial return, including a declaration of compliance with the statutory ratios (premium to statutory surplus ratio, five-year operating ratio and change in statutory surplus ratio) and a general business solvency certificate demonstrating compliance with the Insurance Act's minimum solvency ratio. (16) Insurance Holding Company Regulations - The Company, Capital Reinsurance, Capital Risk, Capital Mortgage and Capital Title are subject to regulation under the insurance holding company statutes of Maryland, the domiciliary state of Capital Reinsurance and Capital Risk, New York, the domiciliary state of Capital Mortgage and Capital Title, and of other jurisdictions in which they are licensed. The insurance holding company laws and regulations vary from jurisdiction to jurisdiction, but generally require an insurance holding company, such as the Company, and insurers and reinsurers that are subsidiaries of insurance holding companies, to register with the applicable state regulatory authorities and to file with those authorities certain reports describing, among other information, their capital structure, ownership, financial condition, certain inter-company transactions and general business operations. The insurance holding company statutes also require prior regulatory agency approval or, in certain circumstances, prior notice of certain material inter-company transfers of assets and certain transactions between insurance companies, their parent companies and affiliates. The insurance holding company statutes impose standards on certain transactions between affiliated companies within the holding company structure, which include, among other requirements, that all transactions be fair and reasonable and have terms no less favorable than terms that would result from transactions between parties negotiating at arm's length and that those exceeding specified limits receive prior regulatory approval. 33 (17) Maryland and New York Insurance Acquisitions Disclosure and Control Acts - Under the Maryland Insurance Code and New York Insurance Laws, unless certain filings are made with the Insurance Commissioner, no person may acquire any voting security, or security convertible into a voting security, of an insurance holding company, such as the Company, which controls a Maryland or New York insurance company, as applicable, such as Capital Reinsurance, Capital Risk, Capital Mortgage or Capital Title, or merge with such holding company, if, as a result of such transaction, such person would "control" such insurance holding company. Under current law, the transaction may not proceed without prior approval or exemption by the Insurance Commissioner unless following the required provision of certain information to the Insurance Commissioner, the Insurance Commissioner affirmatively approves the acquisition within a specified time period. "Control" is presumed to exist if a person, directly or indirectly, owns or controls 10% or more of the voting securities of another person. This presumption may be rebutted by establishing by a preponderance of evidence that control does not exist in fact. (18) Restrictions on Dividends - (a) Maryland Law: The principal source of cash for the payment of debt service and dividends by the Company is the receipt of dividends from Capital Reinsurance. Under current Maryland insurance law, as it applies to Capital Reinsurance, any proposed payment of a dividend or distribution in excess of certain amounts is called an "extraordinary dividend." "Extraordinary dividends" must be reported to, and approved by, the Maryland Commissioner prior to payment. An "extraordinary dividend" is defined to be any dividend or distribution to stockholders, such as the Company, which together with dividends paid during the preceding twelve months exceeds 10% of an insurance company's policyholders' surplus at the preceding December 31. Further, an insurer may not pay any dividend or make any distribution to its shareholders, such as the Company, unless the insurer notifies the Commissioner of the proposed payment within five business days following declaration and at least ten days before payment. The Commissioner may declare that such dividend not be paid if he finds that the insurer's policyholders surplus would be inadequate after payment of the dividend or could lead the insurer to a hazardous financial condition. Based on the Maryland restrictions, at December 31, 1998, the maximum amount available during 1999, with notice to, but without prior approval of the Maryland Insurance Administration, for payment of dividends by Capital Reinsurance to the Company which would not be characterized as "extraordinary dividends" is approximately $32.3 million. (b) New York Law: Capital Mortgage is subject to the dividend restrictions imposed under sections 4105 and 6502(b)(2) of the New York Insurance Law. Those sections provide that dividends may only be declared and distributed out of earned surplus. Additionally, no dividend may be declared or distributed in an amount which, together with all dividends declared or distributed by the company during the preceding twelve months, exceeds the lesser of 10% of the company's surplus to policyholders as shown by its last Annual Statutory Statement on file with the New York Department, or 100% of adjusted net investment income during such period, unless, upon prior application therefor, the superintendent approves a greater dividend distribution based upon his finding that the company will retain sufficient surplus to support its obligations and writings. "Earned surplus" is defined as the portion of the company's surplus that represents the net earnings, gains or profits, after deduction of all losses, that have not been distributed to shareholders as dividends or transferred to stated capital or capital surplus or contingency reserves or applied to other purposes permitted by law but does not include unrealized appreciation of assets. "Adjusted net investment income" is defined as net investment income for the twelve months immediately preceding the declaration of the dividend increased by the excess, if any, of net investment income over dividends declared or distributed during the period commencing thirty-six months before the declaration of the current dividend and ending twelve months prior thereto. 34 Capital Title is subject to the dividend restrictions imposed under sections 4105 and 6407 of the New York Insurance Law. Those sections provide that dividends may only be declared and distributed out of earned surplus and only if such dividends do not reduce the company's surplus to less than 50% of its outstanding capital shares, i.e., the value of its outstanding common equity. Additionally, no dividend may be declared or distributed in an amount which, together with all dividends declared or distributed by the company during the preceding twelve months, exceeds 10% of the company's outstanding capital shares, unless, after deducting such dividends, it has a surplus at least equal to 50% of its statutory reinsurance reserve or a surplus at least equal to $250,000, whichever is greater. "Earned surplus" is defined as the portion of the company's surplus that is not attributable to contributions to surplus made in the preceding five years or to appreciation in the value of the company's investments not sold or otherwise disposed of. (c) Bermuda Law: Capital Credit paid its first dividend to the Company in October 1998 in the amount of $4.0 million. KRE has never declared nor paid dividends. Under Bermuda Law and the Bye-Laws of Capital Credit and KRE, dividends may be paid out of their profits (defined as accumulated realized profits less accumulated realized losses). Distributions to shareholders may also be paid out of their surplus limited by the requirements that they must at all times (i) maintain the minimum share capital required under Bermuda Law, and (ii) have relevant assets in an amount equal to or greater than 75% of relevant liabilities, all as defined under Bermuda Law. (19) Credit for Reinsurance - Through the "credit for reinsurance" mechanism, Capital Re's insurance subsidiaries are indirectly subject to the effects of regulatory requirements imposed by jurisdictions in which ceding primary insurers are licensed. In general, a ceding insurer will ordinarily enter into reinsurance agreements only if the ceding insurer can obtain credit for reinsurance on its statutory financial statements. Credit is allowed when the reinsurer is licensed, authorized or accredited in a jurisdiction where the ceding company is domiciled or, in some cases, licensed. In addition, many jurisdictions allow credit for reinsurance ceded to a reinsurer that is licensed in another jurisdiction and which meets certain financial requirements, provided, in some instances, that the jurisdiction has substantially similar reinsurance credit law requirements. Alternatively, most jurisdictions permit a ceding insurer to take credit for reinsurance on its statutory financial statements if the reinsurer is not licensed, accredited or authorized if the reinsurer provides security against the reserves ceded in the form of a letter of credit, funds withheld or through a trust fund mechanism. Capital Reinsurance is licensed or meets the financial requirements in each of the jurisdictions in which the primary U.S. financial guaranty insurers are domiciled. Capital Mortgage is licensed or meets the financial requirements in each of the jurisdictions in which the primary private U.S. mortgage guaranty insurers are domiciled. Capital Title is licensed or meets the financial requirements in each of the jurisdictions in which it has ceding companies and that impose such requirements. Capital Risk is licensed in Maryland. (20) SAP Reserves - (a) Financial Guaranty Contingency Reserve - Capital Reinsurance maintains the contingency reserves which the Company believes are required by the New York, California and Florida insurance laws to provide credit for reinsurance to ceding financial guaranty insurers licensed in New York, California and Florida. Under those laws, all financial guaranty insurers, or their reinsurers, are required to maintain a contingency reserve to protect policyholders against the impact of excessive losses occurring during adverse economic cycles. Under the New York Insurance Law, for financial guaranty policies written on and after July 1, 1989, contributions are required to be made to the contingency reserve equal to the greater of 50% of premiums written for the relevant category of insurance or a percentage of the principal guaranteed, varying from 0.55% to 2.50%, depending upon the 35 type of obligation. Contributions to the contingency reserve are required to be made as follows: (a) for municipal bonds, special revenue bonds and substantially equivalent obligations, by quarterly payments equal to one-eightieth of the total reserve required over a 20 year period; (b) for all other obligations, by quarterly payments equal to one-sixtieth of the total reserve required over a 15 year period. Contributions may be discontinued if the required total contingency reserve for all categories of obligations has been reached. The contingency reserves must be maintained for the period specified above, except that withdrawals by the insurer may be permitted, with the prior written approval of or written notice to the Superintendent of Insurance, under specified circumstances in the event that the actual incurred loss experience exceeds certain thresholds or if the reserve accumulated is deemed excessive in relation to the insurer's outstanding insured obligations. As of December 31, 1998, 1997 and 1996, the contingency reserve (as required by Maryland (Capital Reinsurance's domiciliary state) and New York) recorded on Capital Reinsurance's statutory financial statements was $129.7 million, $103.9 million and $87.4 million, respectively. (b) Mortgage Guaranty Contingency Reserve: Under the New York Insurance Law, Capital Mortgage is required to establish a contingency reserve in an amount equal to 50% of earned premiums. Contributions to the contingency reserve made during each calendar year must be maintained for a period of one hundred and twenty months, except that withdrawals may be made by the insurer with the prior approval of the Superintendent of Insurance in any year in which the actual incurred losses exceed 35% of corresponding earned premiums. (c) Title Reinsurance Reserve: Under the New York Insurance Law, Capital Title is required to establish a reinsurance reserve in an amount equal to one-eightieth of one percent of the exposure assumed by it. Capital Title may release from the reinsurance reserve five percent of the amount added to the reinsurance reserve during each year following the year in which the sum was added. (21) Single and Aggregate Risk Limitations - (a) Financial Guaranty Business - The New York Insurance Law limits the single and aggregate risks that a financial guaranty insurer may insure on a net basis. Capital Reinsurance complies with the single and aggregate risk limits of the New York Insurance Law for financial guaranty insurers. For example, the New York Insurance Law limits the insured average annual debt service on insured municipal bonds, special revenue bonds and substantially equivalent obligations with respect to a single entity and backed by a single revenue source (net of qualifying collateral and reinsurance) to not more than 10% of the sum of the insurer's policyholders' surplus and contingency reserves. In addition, insured principal of municipal bonds attributable to any single risk, net of qualifying collateral and reinsurance, is limited to not more than 75% of the sum of the insurer's policyholders' surplus and contingency reserves. Single risk limits, which generally are more restrictive than the municipal bond single risk limit, are also specified for several other categories of insured obligations. The New York Insurance Law also limits the aggregate insured outstanding principal and interest of guaranteed obligations, net of qualifying collateral and reinsurance, to certain multiples of the insurer's policyholders' surplus and contingency reserve. Aggregate risk limits vary for different categories of insured obligations. 36 (b) Mortgage Guaranty Business: Capital Mortgage is subject to the various limitations and requirements of the New York Insurance Law governing mortgage guaranty insurance. For example, the aggregate risk (i.e., total liability under its aggregate insurance and reinsurance policies) that a mortgage guaranty insurer may insure on a net basis cannot exceed twenty-five times its policyholders' surplus. The regulations promulgated under the New York Insurance Laws also contain detailed limitations on the conduct of mortgage pool insurance business by a New York licensed mortgage guaranty insurer. (c) Title Business: Capital Title is subject to the various limitations and requirements of the New York Insurance Law governing title insurance. For example, Capital Title may not assume any single risk in excess of the sum of its capital, policyholders' surplus, statutory premium reserves and voluntary reserves. C. DISCONTINUED OPERATIONS The Company has commenced a plan of divestiture of its Lloyd's operations. Accordingly, commencing in 1998, the Company began reflecting its participation in Lloyd's as a discontinued operation. Following is a description of the Company's Lloyd's operations. (1) Overview of Lloyd's of London Insurance Market - Lloyd's is a long established insurance marketplace where many varied forms of insurance are sold by syndicates, which, until 1994, were annual joint ventures of participating capital providers known as "Names." Participation as a Name on a syndicate carries with it unlimited liability for the Name's share of any insurance losses incurred by the syndicate (each Name participating severally). In 1994, the rules relating to membership in Lloyd's were changed to allow limited liability corporate capital vehicles to enter the Lloyd's marketplace as capital providers. Typically, Lloyd's syndicates now comprise a mixture of limited and unlimited liability capital combining in the annual joint venture. Several of the underwriting years of the late 1980's and early 1990's were particularly unprofitable for many of the syndicates operating at Lloyd's. This proved to be financially disastrous for some of the Names on the affected syndicates due to the unlimited liability of their participation. In August 1996, Lloyd's implemented its "Reconstruction and Renewal" proposals which involved a new company, Equitas, being authorized to reinsure the liabilities of the 1992 and prior years of account of most of the syndicates at Lloyd's. The funding to give effect to these proposals came from a variety of sources including the premiums on the liabilities assumed by Equitas as well as a series of levies charged to entities that had historically provided services to the Lloyd's insurance market (including managing agencies and insurance brokers). The Company participates in life, marine and non-marine syndicates through a dedicated corporate capital vehicle, CRC Capital, thereby limiting the liability of the Company. RGB provides accounting, reporting and ancillary insurance services to the syndicates managed by it and on which the Company participates. For the 1998 year of account, the Company committed approximately (pound)44 million of capital, in the form of a letter of credit, to five syndicates managed by RGB, which supported approximately (pound)88 million of underwriting capacity, and, for the 1999 year of account, the Company committed approximately (pound)47.5 million of capital, in the form of a letter of credit, to four syndicates managed by RGB, which supports approximately (pound)95 million of underwriting capacity. 37 (2) Competition - There is significant competition in all classes of business transacted by the syndicates managed by RGB emanating from a number of different markets worldwide. Depending upon the class of business, competition comes from the London market, other Lloyd's syndicates, Institute of London Underwriters companies, and major international insurers and reinsurers. With respect to international risks, competition also comes from domestic insurers in the country of origin of the insured. (3) Losses and Reserves - In the Lloyd's business, case basis loss reserves are established for all known losses. Notice of a claim is given by the cedant to its broker who in turn provides notice to the lead underwriter and, once the claim has been agreed by the lead underwriter, it in turn provides notice of such claim to the Lloyd's claims notification system, which is common to all syndicates operating at Lloyd's. For developed underwriting years, a provision for ultimate losses is made by applying statistical projection techniques to incurred losses. For undeveloped years, Bornhuetter-Ferguson techniques are applied based on a weighting of incurred and expected loss ratios to estimate ultimate losses. Ultimate premiums are also estimated by the same methods. Reserves for incurred but not reported ("IBNR") losses are calculated as the earned portion of ultimate premiums applied to ultimate losses less paid losses and case reserves. For paid losses and case reserves, the reinsurance recoverables are calculated by applying reinsurance to those specific losses. Reinsurance recoverables are provided against IBNR losses based on techniques similar to those used to calculate ultimate losses for undeveloped years. (4) Regulatory Status - The Company and certain of its UK subsidiaries are subject to the regulatory jurisdiction of the Council of Lloyd's (the "Council") as a result of the acquisition by the Company of RGB and the establishment of CRC Capital. Unlike other financial markets in the UK, Lloyd's is not currently subject to direct UK government regulation through the UK Financial Services Act 1986 but, instead, is self regulating by virtue of the Lloyd's Act 1971-1982 through bye-laws, regulations and codes of conduct made by the Council, which governs the market. Under the Council there are two boards, the Market Board and the Regulatory Board. The former is led by working members of the Council and is responsible for strategy and the provision of services such as premium and claims handling, accounting and policy signing. The Regulatory Board is responsible for the regulation of the market, compliance and the protection of policyholders. There are no provisions in the Lloyd's Acts, the bye-laws or the regulations which provide for any liabilities of CRC Capital or RGB to be met by the Company. In addition, a managing agency is required to comply with various capital and solvency requirements and to submit to regular monitoring and compliance procedures. CRC Capital, as a corporate member of Lloyd's, is required to commit an amount broadly equal to 50 percent of its underwriting capacity on the syndicates to support its underwriting on those syndicates. In 1997, the UK Government announced reforms for the regulation of the domestic financial services industry by proposing amendments to the Financial Services Act 1986. The proposed changes involve the consolidation of all self-regulating investment organizations and the Securities and Investments Board into a single statutory regulator, the Financial Services Authority (the "FSA"). The UK Government has declared that Lloyd's will be brought into a similar regulatory scheme to that applying to insurance companies and proposed to give the FSA wide powers over the Lloyd's market. The FSA is currently seeking comments on its proposed approach. 38 (5) Lloyd's "Controller" Regulations - Under the Lloyd's regulations, the approval of the Council must be obtained before any person can be a "controller" of a Lloyd's corporate member or of a managing agency. The Company has been approved as a "controller." Lloyd's imposes an absolute prohibition on any company being a 10% controller of a corporate member without first notifying Lloyd's and receiving their consent. This prohibition is qualified in respect of becoming a 20%, 33%, 50% or majority controller in that the corporate member must do all that lies within its powers to comply with Lloyd's requirements. In these latter circumstances, this essentially means that notice must have been given to the Council that the relevant threshold will be exceeded and the Council has not objected. Persons seeking to become controllers may be required to deliver a declaration and undertaking to Lloyd's, in the form prescribed by Lloyd's, unless Lloyd's exempts such person from this requirement. As a "controller," the company is required to give certain undertakings, directed principally towards ensuring that there is no direct interference in the conduct of the business of the managing agency. Under English law, if any person that holds or subsequently becomes the holder of more than 5 percent of the Company's stock also owns any interest in a Lloyd's broker or is a partner or a director of a Lloyd's broker, that Lloyd's broker risks losing its Lloyd's license. For these purposes "Lloyd's broker" includes the holding company of a corporate Lloyd's broker, any company which controls (a test based on one-third voting rights or control of the board) such a Lloyd's broker or its holding company or, if the Lloyd's broker is a partnership, any person who controls (on a similar test) such a Lloyd's broker or one of its partners. 39 Item 2. Properties. Capital Re Corporation, Capital Reinsurance, Capital Mortgage, Capital Title and Capital Re Solutions Incorporated maintain offices at 1325 Avenue of the Americas, New York, New York 10019. The office comprises the entire 18th floor of the building, approximately 23,000 square feet of space. The companies began occupying these offices in April 1993. Prior to that, Capital Re and Capital Reinsurance maintained offices at 787 Seventh Avenue, New York, New York. The offices at 787 Seventh Avenue were sublet to a third party upon the move to 1325 Avenue of the Americas. The Company has exercised an option to lease an additional 9,000 square feet of space on the 17th floor at 1325 Avenue of the Americas commencing on March 5, 1999. The Company also rents approximately 2,000 square feet of office space at Hasilwood House, 60 Bishopgate, London, England. Item 3. Legal Proceedings. There are no material lawsuits pending, or to the knowledge of the Company threatened, to which the Company or any of its subsidiaries is a party or of which any of their properties is the subject. Item 4. Submission of Matters to a Vote of Security Holders. Not applicable. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. The Registrant's common stock trades on the New York Stock Exchange under the symbol "KRE." The high and low sales prices for, and the cash dividends declared on, the Registrant's common stock for each quarter within the two most recent fiscal years are as follows: (1) - --------------------------------------------- Quarter Dividends Paid Per Share - --------------------------------------------- - -------------------------------------------------------------------------------- High Low - -------------------------------------------------------------------------------- 1998 1st Quarter $0.04 $33.22 $28.97 2nd Quarter $0.04 $38.69 $31.34 3rd Quarter $0.04 $37.75 $24.50 4th Quarter $0.04 $25.94 $15.50 - -------------------------------------------------------------------------------- 1997 1st Quarter $0.04 $23.69 $20.63 2nd Quarter $0.04 $27.13 $19.50 3rd Quarter $0.04 $30.50 $25.03 4th Quarter $0.04 $31.44 $27.97 - -------------------------------------------------------------------------------- (1) High and low sale prices and dividends have been adjusted to reflect a two-for-one stock split of the Company's common stock effected on June 30, 1998. Information concerning restrictions on the payment of dividends is set forth in Item 1 above, under the caption "Business of Capital Re - Restrictions on Dividends." As of March 24, 1999, there were 44 stockholders of record of the Company's Common Stock. 40 Item 6. Selected Financial Data. Capital Re Corporation and Subsidiaries Selected Financial Data
Year Ended December 31, -------------------------------------------------------------------------------- (Dollars in thousands except per 1998 1997 1996 1995 1994 share amounts) - --------------------------------------------------------------------------------------------------------------------- Summary of Operations Gross Premiums Written $ 213,941 $ 169,943 $ 129,818 $ 107,599 $ 94,851 Net Premiums Written 210,594 164,275 105,188 89,508 82,795 Net Premiums Earned 168,385 115,291 92,436 60,097 58,850 Net Investment Income 64,854 56,498 51,558 46,654 40,113 Net Realized Gains (1,506) 8,037 1,471 53 1,780 Total Revenues 234,945 181,461 146,278 107,085 101,462 Net Income from Continuing Operations 44,187 70,818 57,014 45,527 39,806 Net Income 41,542 70,052 56,524 45,527 39,806 - --------------------------------------------------------------------------------------------------------------------- Balance Sheet Investment Portfolio 1,175,038 1,007,923 901,102 771,767 638,751 Total Assets 1,508,893 1,345,842 1,157,061 981,885 810,040 Net Deferred Premium Revenue 356,263 314,054 265,070 252,318 222,907 Long-term Debt 74,856 74,819 74,782 74,744 90,706 Company Obligated Mandatorily Redeemable Preferred Securities of Capital Re LLC 75,000 75,000 75,000 75,000 75,000 Stockholders' Equity 610,826 568,943 489,346 411,943 325,514 - --------------------------------------------------------------------------------------------------------------------- Per Share Data Basic Earnings Per Share from Continuing Operations 1.39 2.23 1.82 1.54 1.35 Diluted Earnings Per Share from Continuing Operations 1.35 2.18 1.79 1.53 1.34 Basic Earnings Per Share 1.30 2.21 1.81 1.54 1.35 Diluted Earnings Per Share 1.27 2.16 1.77 1.53 1.34 Cash Dividends Per Share 0.16 0.15 0.13 0.11 0.10 Book Value Per Share 19.13 17.88 15.43 13.91 11.01 - --------------------------------------------------------------------------------------------------------------------- Statutory Surplus and Reserves Unearned Premium Reserve 417,114 358,399 307,236 278,980 242,574 Contingency Reserve 211,455 162,250 123,363 89,685 63,591 Policyholders' Surplus 395,771 435,118 443,451 412,884 401,743 Total Policyholders' Surplus and Reserves 1,024,340 955,767 874,050 781,549 707,908 =====================================================================================================================
41 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. General Capital Re Corporation (the "Corporation") was incorporated in the State of Delaware in December 1991, and is the successor by merger to a Maryland corporation incorporated in 1986. The Corporation is an insurance holding company and has five wholly owned operating subsidiaries. Capital Reinsurance Company ("Capital Reinsurance"), domiciled in the State of Maryland, commenced operations in January 1988. Capital Reinsurance is engaged in the business of financial guaranty reinsurance, primarily the reinsurance of municipal and non-municipal bond insurance obligations. Capital Reinsurance also sells municipal and non-municipal credit risk protection through credit default swap transactions. Capital Mortgage Reinsurance Company ("Capital Mortgage"), a New York domiciled company, commenced operations in February 1994. Capital Mortgage reinsures only residential mortgage guaranty insurance obligations, which are originated principally in the United States and the United Kingdom. KRE Reinsurance Ltd. ("KRE"), a Bermuda domiciled company, commenced operations in March 1994. KRE is engaged in the business of reinsuring financial guaranty, mortgage guaranty and trade credit insurance, both as a direct reinsurer of third party primary insurers and as a retrocessionaire of Capital Reinsurance, Capital Mortgage, Capital Credit Reinsurance Company Ltd. ("Capital Credit") and Capital Title Reinsurance Company ("Capital Title"). KRE also provides integrated financial solutions, in the form of structured reinsurance products, to accident and health insurers and specialty property and casualty insurers. Capital Credit, also a Bermuda domiciled insurance company, commenced operations in February 1990. Capital Credit reinsures trade credit and political risk insurance concentrated in Western Europe and the United States and is a retrocessionaire of Capital Reinsurance and Capital Mortgage. Capital Title, a New York domiciled insurance company, commenced operations in March 1996. Capital Title is engaged in the business of reinsuring title insurance policies. For marketing purposes, the Corporation aggregates its reinsurance lines of business into two divisions: financial guaranty and financial risks. The financial guaranty division is composed of municipal and non-municipal financial guaranty reinsurance and credit default swaps. The financial risks division is composed of mortgage guaranty reinsurance, trade credit reinsurance, title reinsurance and financial solutions. In November 1996, the Corporation acquired 100% of the issued shares of Tower Street Holdings Limited (now known as RGB Holdings, Ltd.), the holding company for RGB Underwriting Agencies Ltd. ("RGB"). RGB is a managing agency and presently manages four syndicates operating in the Lloyd's of London ("Lloyd's") insurance market. In connection with its acquisition of RGB, the Corporation established a corporate name at Lloyd's. In 1998, the Corporation commenced a plan of divestiture of its Lloyd's operations, and those operations are presented as a discontinued operation. Pending divestiture, the Corporation will continue to support its commitments to Lloyd's. For comparative purposes, all prior period financial statements have been restated. In December 1996, the Corporation entered into a joint venture with GCR Holdings Ltd. ("GCR") to form a Bermuda based insurer, Capital Global Underwriters Limited ("CGUL"), which specializes in financial lines reinsurance. In April 1997, EXEL Limited ("EXEL") acquired GCR. In March 1998, EXEL sold its share of CGUL to Bermuda based ACE Bermuda Insurance, Ltd., and CGUL was renamed ACE Capital Re Ltd. The Corporation, through KRE, owns a fifty-percent economic interest in ACE Capital Re Ltd. and controls 9.9% of its voting stock. The Corporation accounts for its investment in ACE Capital Re Ltd. under the equity method. Results of Operations Year Ended December 31, 1998 versus Year Ended December 31, 1997 On June 30, 1998, the Corporation completed a two for one stock split of its outstanding common shares. Prior period financial results have been restated to reflect the stock split. Additionally, as mentioned above, the Corporation's investment in Lloyd's, which was previously consolidated, is reflected as a discontinued operation 42 since in 1998 the Corporation commenced a plan of divestiture of its Lloyd's operations. All prior period results have been restated for comparative purposes. Net income from continuing operations for the year ended December 31, 1998 decreased 37.6% to $44.2 million from $70.8 million for the same period of 1997. On a per share basis, basic and diluted net income from continuing operations decreased to $1.39 and $1.35, respectively, for the year ended December 31, 1998 from $2.23 and $2.18, respectively, for the same period of 1997, or 37.7% and 38.1%, respectively. Net income including income or loss from discontinued operations for the year ended December 31, 1998 decreased to $41.5 million from $70.1 million for the same period of the prior year. On a per share basis, basic and diluted net income including income or loss from discontinued operations decreased to $1.30 and $1.27, respectively, for the year ended December 31, 1998 from $2.21 and $2.16, respectively, for the same period of 1997, or, in each case, 41.2%. Net operating income from continuing operations (net income from continuing operations excluding realized gains and losses and foreign exchange gains and losses) decreased 31.5% to $45.1 million for the year ended December 31, 1998 from $65.9 million for the same period in 1997. On a per share basis, basic and diluted net operating income from continuing operations decreased to $1.42 and $1.38, respectively, for the year ended December 31, 1998 from $2.07 and $2.03, respectively, for the same period of 1997, or 31.4% and 32.0%, respectively. The decrease in the year end 1998 financial results was primarily due to two separate financial guaranty losses. First, the Corporation established a $10.0 million pre-tax case basis loss reserve for losses arising from the bankruptcy of the Delaware Valley Obligated Group, a unit of Pittsburgh based Allegheny Health, Education and Research Foundation ("Allegheny"). Under the reinsurance treaty with its ceding company, the Corporation has reinsured Allegheny bonds with an outstanding principal amount of $14.6 million. In November, the Corporation made loss and loss adjustment payments of $1.0 million in respect of the Allegheny bonds. As a result, the aggregate case basis loss and loss adjustment expense reserve for Allegheny as of December 31, 1998 decreased to $9.0 million. The Corporation expects that the reserve will cover all anticipated present value losses arising from its exposure to Allegheny. The second loss was a $44.1 million pre-tax increase in Capital Re's case basis loss reserve for losses arising from the reinsurance of three issues of asset-backed securities serviced by Commercial Financial Services, Inc. ("CFS"). As of December 31, 1998, the Corporation had $153.3 million in reinsured principal outstanding to the CFS securities. The $44.1 million reserve represents the Corporation's best estimate of all currently anticipated and probable losses. Notwithstanding the Allegheny and CFS losses, the Corporation's total revenues increased to $234.9 million for the year ended December 31, 1998 from $181.5 million in 1997, or 29.4%, principally due to growth in net premiums earned and net investment income. Gross premiums written increased 25.9% to $213.9 million for the year ended December 31, 1998 from $169.9 million for the same period of 1997. This increase was primarily due to growth in non-municipal bond reinsurance business. This growth was due to a significant increase in premiums written in the credit default swaps sector of that business. The Corporation has expanded its traditional municipal and non-municipal financial guaranty bond reinsurance lines of business to include credit default swaps. A credit default swap is a transaction whereby one counterparty pays a periodic fee in fixed basis points on a notional amount in return for a contingent payment by the other counterparty in the event one or more defined credit events occurs with respect to one or more third party reference securities or loans. A credit event is defined as failure to pay, bankruptcy, cross acceleration (generally accompanied by a failure to pay), repudiation, restructuring, or similar nonpayment event. Credit default swap premium grew to $6.8 million for the year ended December 31, 1998 from $0.7 million in the prior year. In addition, growth in the non-municipal bond reinsurance line was attributable to a large reinsurance transaction the Corporation entered into in the fourth quarter of 1998 which provided credit enhancement of $74.6 million of investment grade asset backed securities. The Corporation received upfront premium of $10.4 million for this transaction. Mortgage guaranty reinsurance premium decreased in 1998 from 1997 due to an increase in mortgage prepayments caused by lower interest rates as well as the Corporation's shift away from assuming quota share 43 mortgage guaranty reinsurance business to assuming structured excess of loss mortgage guaranty reinsurance business. In 1997, the Corporation added a financial solutions line of business. The financial solutions business is focused on providing highly structured solutions to problems of financial and risk management through reinsurance, including credit enhancement, excess of loss and surplus management covers. Gross premiums written attributable to the financial solutions line increased to $11.0 million for the year ended December 31, 1998 from $2.7 million for the same period of 1997. The following table shows gross premiums written by line of business for the years ended December 31, 1998 and December 31, 1997. Gross Premiums Written Year Ended December 31, 1998 1997 ---- ---- (dollars in millions) Financial Guaranty Division: Municipal $55.2 $52.7 Non-Municipal 39.9 16.7 Financial Risks Division: Mortgage 66.8 70.8 Credit 35.3 23.0 Financial Solutions 11.0 2.7 Title 5.7 4.0 ------ ------ Total Gross Premiums Written $213.9 $169.9 Net premiums written increased by 28.2% to $210.6 million for the year ended December 31, 1998 from $164.3 million for the same period in 1997. This increase is commensurate with the increase in gross premiums written explained above. The following table shows net premiums written by line of business for the years ended December 31, 1998 and December 31, 1997. Net Premiums Written Year Ended December 31, 1998 1997 ---- ---- (dollars in millions) Financial Guaranty Division: Municipal $52.3 $50.2 Non-Municipal 39.8 16.6 Financial Risks Division: Mortgage 66.7 70.5 Credit 35.1 23.0 Financial Solutions 11.0 0.1 Title 5.7 4.0 ------ ------ Total Net Premiums Written $210.6 $164.3 44 For the year ended December 31, 1998, net premiums earned increased 46.1% to $168.4 million from $115.3 million for the comparable 1997 period. This increase was primarily due to growth in net premiums earned in the municipal, non-municipal (including credit default swaps), credit, and financial solutions lines of business. For the year ended December 31, 1998, net refunded earned premium increased to $16.5 from $4.8 million for the comparable period in 1997. Excluding the effects of net refunded municipal earned premium, net premiums earned increased 37.5% to $151.9 million for the year ended December 31, 1998 from $110.5 million for the year ended December 31, 1997. A refunding extinguishes the Corporation's reinsurance liability for the refunded obligation and the Corporation then recognizes revenue equal to the remaining related deferred premium revenue. Net premiums earned from credit default swaps, which are earned as written, increased to $6.8 million for the year ended December 31, 1998 from $0.7 million in the prior year. For the years ended December 31, 1998 and 1997, ceded earned premium was $13.7 million and $17.7 million, respectively. The following table shows net premiums earned by line of business for the years ended December 31, 1998 and December 31, 1997. Net Premiums Earned Year Ended December 31, 1998 1997 ---- ---- (dollars in millions) Financial Guaranty Division: Municipal $43.0 $29.8 Non-Municipal 20.7 11.4 Financial Risks Division: Mortgage 59.3 53.2 Credit 28.7 17.2 Financial Solutions 11.0 0.1 Title 5.7 3.6 ------ ------ Total Net Premiums Earned $168.4 $115.3 For the year ended December 31, 1998, net investment income increased 14.9% to $64.9 million from $56.5 million for the comparable period in 1997. Growth in investment income was primarily attributable to a larger investment portfolio caused by an increase in invested assets from positive operating cash flows during the twelve months ended December 31, 1998. In addition, the Corporation recognized net realized losses of $1.5 million for the year ended December 31, 1998 compared to net realized gains of $8.0 million for the same period in 1997. The net realized losses recorded in 1998 were a result of a $7.5 million write-down of the Corporation's investment in CGA Group, Ltd. ("CGA") based on the Corporation's estimate of a permanent impairment in the carrying value of that investment. Loss and loss adjustment expenses increased to $86.6 million from $15.6 million for the years ended December 31, 1998 and 1997, respectively. The increase in losses recorded for the year ended December 31, 1998 was primarily attributable to the $10.0 million Allegheny loss and the $44.1 million CFS loss explained above, as well as expected loss development commensurate with the growth in net premiums earned. Ceded losses for the years ended December 31, 1998 and 1997 were $4.8 million and $6.6 million, respectively. The loss ratio was 51.4% for the year ended December 31, 1998 compared to 13.6 % for the prior year. Excluding the Allegheny and CFS losses, the loss ratio for the year ended December 31, 1998 was 19.3%. Total expenses, including loss and loss adjustment expenses, increased 114.4% to $180.1 million for the year ended December 31, 1998 from $84.0 million for the same period of 1997. This increase was primarily attributable to the Allegheny and CFS losses as well as the amortization of acquisition expenses associated with the increased level of 45 premiums earned and normal expected loss development from the credit, mortgage and financial lines businesses. The expense ratios for the years ended December 31, 1998 and 1997 were 47.8% and 47.6%, respectively. The combined ratio, excluding expenses associated with non-insurance operations, increased to 99.2% for the year ended December 31, 1998 from 61.2% for the comparable 1997 period. This increase is a result of the Allegheny and CFS losses as well as the Corporation's mix of business, which is producing more business from lines with relatively higher combined ratios than that of the financial guaranty reinsurance business. For the year ended December 31, 1998, the combined ratio excluding the Allegheny and CFS losses was 67.1%. For the year ended December 31, 1998, the total federal tax provision decreased to $10.7 million from $26.6 million for the same period in 1997. In addition, the effective tax rate decreased to 19.4% for the year ended December 31, 1998 from 27.3% for the same period of 1997. Year Ended December 31, 1997 versus Year Ended December 31, 1996 Net income from continuing operations for the year ended December 31, 1997 increased 24.1% to $70.8 million from $57.0 million for the same period of 1996. The Corporation adopted Statement of Financial Standards No. 128, "Earnings per Share" ("FAS 128"), as of December 31, 1997. FAS 128 requires the calculation and presentation on the face of the income statement of basic earnings per share and, if applicable, diluted earnings per share. Basic earnings per share is calculated based on the weighted average common shares outstanding. All potentially dilutive securities such as stock options and convertible securities are excluded from the basic earnings per share calculation. In calculating diluted earnings per share, the number of shares is increased to include all potentially dilutive securities, including stock options and convertible securities. On a per share basis, basic and diluted net income from continuing operations increased to $2.23 and $2.18, respectively, for the year ended December 31, 1997 from $1.82 and $1.79, respectively, for the same period of 1996, or 22.5% and 21.8%, respectively. Net income including income or loss from discontinued operations for the year ended December 31, 1997 increased to $70.1 million from $56.5 million for the same period of the prior year. On a per share basis, basic and diluted net income including income or loss from discontinued operations increased to $2.21 and $2.16, respectively, for the year ended December 31, 1997 from $1.81 and $1.77, respectively, for the same period of 1996, or 22.1% and 22.0%, respectively. In addition, net operating income from continuing operations (net income from continuing operations excluding realized gains and losses) increased 18.1% to $65.9 million for the year ended December 31, 1997 from $55.8 million for the same period in 1996. On a per share basis, basic and diluted net operating income increased to $2.07 and $2.03, respectively, for the year ended December 31, 1997 from $1.78 and $1.75, respectively, for the same period of 1996, or 16.3% and 16.0%, respectively. Growth in net premiums earned to $115.3 million from $92.4 million, or 24.8%, was the principal cause of the increase in net income. Growth in net premiums earned was a result of growth in the financial guaranty, mortgage, trade credit and other specialty reinsurance lines of business. Gross premiums written increased 30.9% to $169.9 million for the year ended December 31, 1997 from $129.8 million for the same period in 1996. Gross premiums written increased across all product lines. In addition, in 1997 the Corporation added a financial solutions line of business. The financial solutions business is focused on providing highly structured solutions to problems of financial and risk management through reinsurance, including credit enhancement, excess of loss and surplus management covers. The following table shows gross premiums written by line of business for the years ended December 31, 1997 and December 31, 1996. 46 Gross Premiums Written Year Ended December 31, 1997 1996 ---- ---- (dollars in millions) Financial Guaranty Division: Municipal $52.7 $48.3 Non-Municipal 16.7 10.9 Financial Risks Division: Mortgage 70.8 53.7 Credit 23.0 15.1 Financial Solutions 2.7 0.0 Title 4.0 1.8 ------ ------ Total Gross Premiums Written $169.9 $129.8 Net premiums written increased by 56.3% to $164.3 million for the year ended December 31, 1997 from $105.2 million for the same period in 1996. This increase is commensurate with the increase in gross premiums written explained above as well as the recording of a large ceded premium installment on a municipal portfolio paid in the fourth quarter of 1996. The following table shows net premiums written by line of business for the years ended December 31, 1997 and December 31, 1996. Net Premiums Written Year Ended December 31, 1997 1996 ---- ---- (dollars in millions) Financial Guaranty Division: Municipal $50.2 $36.7 Non-Municipal 16.6 10.9 Financial Risks Division: Mortgage 70.5 40.9 Credit 22.9 14.9 Financial Solutions 0.1 0.0 Title 4.0 1.8 --- --- Total Net Premiums Written $164.3 $105.2 For the year ended December 31, 1997, net premiums earned increased 24.8% to $115.3 million from $92.4 million for the comparable 1996 period. This increase was primarily due to growth in net premiums earned across all product lines of business. For the year ended December 31, 1997, net refunded earned premium decreased to $4.8 from $5.8 million for the comparable period in 1996. Excluding the effects of net refunded earned premium, net premiums earned increased 27.6% to $110.5 million for the year ended December 31, 1997 from $86.6 million for the year ended December 31, 1996. A refunding extinguishes the Corporation's reinsurance liability for the refunded obligation and the Corporation then recognizes revenue equal to the remaining related deferred premium revenue. For the years ended December 31, 1997 and 1996, ceded earned premium was $17.7 million and $14.7 47 million, respectively. The following table shows net premiums earned by line of business for the years ended December 31, 1997 and December 31, 1996. Net Premiums Earned Year Ended December 31, 1997 1996 ---- ---- (dollars in millions) Financial Guaranty Division: Municipal $29.8 $27.5 Non-Municipal 11.4 7.2 Financial Risks Division: Mortgage 53.2 43.9 Credit 17.2 12.2 Financial Solutions 0.1 0.0 Title 3.6 1.6 ------ ----- Total Net Premiums Earned $115.3 $92.4 For the year ended December 31, 1997, net investment income increased 9.5% to $56.5 million from $51.6 million for the comparable period in 1996. Growth in investment income was primarily attributable to a larger investment portfolio caused by an increase in invested assets from positive operating cash flows during the twelve months ended December 31, 1997. In addition, the Corporation recognized net realized gains of $8.0 million for the year ended December 31, 1997 compared to $1.5 million for the same period in 1996. Loss and loss adjustment expenses increased to $15.6 million from $9.5 million for the years ended December 31, 1997 and 1996, respectively. Losses recorded for the year ended December 31, 1997 were primarily attributable to the normal loss development in the mortgage guaranty and credit reinsurance lines of business. Ceded losses for the years ended December 31, 1997 and 1996 were $6.6 million and $6.5 million, respectively. Total expenses, including loss and loss adjustment expenses, increased 22.8% to $84.0 million for the year ended December 31, 1997 from $68.4 million in the same period of 1996. This increase was primarily attributable to commissions associated with the increased level of premiums written and normal loss development from the mortgage and credit lines of business. Furthermore, the combined ratio, excluding expenses associated with non-insurance operations, increased to 61.2% for the year ended December 31, 1997 from 60.7% for the comparable 1996 period. This increase is an expected result of the Corporation's mix of business, which is producing more business from lines with relatively higher combined ratios than that of the financial guaranty reinsurance business. For the year ended December 31, 1997, the total federal tax provision increased to $26.6 million from $20.9 million for the same period in 1996. In addition, the effective tax rate increased slightly to 27.3% for the year ended December 31, 1997 from 26.8% in the same period of 1996. Liquidity and Capital Resources The Corporation relies on dividends from Capital Reinsurance and Capital Credit to fund its payment of dividends on its capital stock and interest on its outstanding debt. The major sources of liquidity for Capital Reinsurance are funds generated from reinsurance premiums, net investment income and maturing investments. Capital Reinsurance is domiciled in the State of Maryland, and, under Maryland 48 insurance law, the amount of the surplus of Capital Reinsurance available for distribution as dividends is subject to certain statutory restrictions. The amount available for distribution from Capital Reinsurance during 1999 with notice to, but without prior approval of, the Maryland Insurance Commissioner is limited to 10% of Capital Reinsurance's policyholders' surplus as of December 31, 1998, or approximately $32.3 million. For the year ended December 31, 1998, Capital Reinsurance paid $8.0 million in dividends to the Corporation. Capital Credit's major sources of liquidity are funds generated from reinsurance premiums, net investment income and maturing investments. Capital Credit is a Bermuda domiciled insurer whose distributions are governed by Bermuda law. Under Bermuda law and the by-laws of Capital Credit, dividends may be paid out of the profits of the company (defined as accumulated realized profits less accumulated realized losses). Distributions to shareholders may also be paid out of Capital Credit's surplus limited by requirements that such company must at all times (i) maintain the minimum share capital required under Bermuda law and (ii) have relevant assets in an amount equal to or greater than 75% of relevant liabilities, all as defined under Bermuda law. Capital Credit paid its first dividend to the Corporation in October 1998 in the amount of $4.0 million. Capital Mortgage is subject to the dividend restrictions imposed under New York insurance law. Accordingly, dividends may only be declared and distributed out of earned surplus (as defined under New York insurance law). Additionally, no dividend may be declared or distributed by Capital Mortgage in an amount which, together with all dividends declared or distributed by Capital Mortgage during the preceding twelve months, exceeds the lesser of 10% of such company's surplus to policyholders as shown by its last Annual Statutory Statement on file with the New York insurance department, or 100% of adjusted net investment income (as defined under New York insurance law) during such period, unless, upon prior application, the New York Superintendent of Insurance approves a greater dividend distribution based upon his finding that Capital Mortgage will retain sufficient surplus to support its obligations and writings. KRE's dividends and distributions to its sole shareholder, Capital Mortgage, are governed by Bermuda law and are subject to the same restrictions as those for Capital Credit described in the preceding paragraph. To date, Capital Mortgage and KRE have not declared nor paid any dividends. The maximum dividend payable by Capital Mortgage during 1999 is $0 since its earned surplus was ($9.2) million as of December 31, 1998. Capital Title is subject to the New York insurance laws and regulations governing title insurers. Accordingly, dividends may only be declared and distributed out of earned surplus as defined under New York insurance law and only if such dividends do not reduce the company's surplus to less than 50% of its outstanding capital shares, i.e., the value of its outstanding common equity. Additionally, no dividend may be declared or distributed in an amount which, together with all dividends declared or distributed by the company during the preceding twelve months, exceeds 10% of the company's outstanding capital shares, unless, after deducting such dividends, it has a surplus at least equal to 50% of its statutory reinsurance reserve or a surplus at least equal to $250,000, whichever is greater. Capital Title did not pay a dividend in 1998. As of December 31, 1998, Capital Title's maximum amount payable as a dividend during 1999 is approximately $3.6 million. In January 1994, the Corporation formed and capitalized, through the purchase of common shares, Capital Re LLC. Capital Re LLC exists solely for the purpose of issuing preferred and common shares and lending the proceeds of such issuance to the Corporation to fund its business operations. In January 1994, Capital Re LLC issued $75.0 million of company obligated mandatorily redeemable preferred securities, the proceeds of which were loaned to the Corporation. The Corporation has, among other undertakings, unconditionally guaranteed all legally declared and unpaid dividends of Capital Re LLC. The company obligated mandatorily redeemable preferred securities were issued at $25 par value per share and pay monthly dividends at a rate of 7.65% per annum. In June 1997, Capital Reinsurance invested approximately $10.9 million for a minority ownership interest in CGA. CGA was formed to provide financial guaranty insurance ("Policies") of structured securities, including commercial real estate and asset backed transactions. CGA's initial capitalization consisted of $150.5 million of paid-in capital and $60 million of committed capital. The Corporation's investment consists of an aggregate of $10.0 million in B Preferred Stock and Common Stock of CGA and $1.0 million in A Preferred Stock. In connection with its investment in the B Preferred Stock, Capital Reinsurance has a commitment to invest an additional $7.5 million (the 49 "Capital Commitments") in CGA to the extent that such investment would be necessary in order for CGA's operating subsidiary, Commercial Guaranty Assurance, Ltd. ("CG Assurance") to maintain its triple-A rating from Duff & Phelps Credit Rating Company ("D&P"). Additionally, KRE has a $20 million outstanding excess of loss reinsurance agreement with CG Assurance which responds when CG Assurance's credit losses under Policies reach certain catastrophic levels (including Policies issued in favor of the funding banks described below). Also in June 1997, Capital Reinsurance invested $0.1 million in St. George Holdings Ltd. ("St. George"). In response to market value declines in the insured portfolios of CGA and the resulting potential stress on its triple A rating from Duff & Phelps, the Corporation performed an analysis to determine the appropriate valuation of its investment in CGA for the 1998 year-end reporting period. The Corporation determined the investment in CGA had suffered a permanent impairment as defined under the guidelines of Generally Accepted Accounting Principles ("GAAP"). Based on its analysis the Corporation recorded a $7.5 million write-down. As part of its business plan, through its operating subsidiaries (the "St. George Investment Subsidiaries"), St. George purchases investment grade, asset-backed securities to be held to maturity, selectively resold, or repackaged with CG Assurance Policies and then resold (the "Managed Portfolios"). The securities purchases are funded by bank loans advanced to the St. George Investment Subsidiaries. CG Assurance issues Policies to secure repayment to the funding banks. Under certain of the bank loan agreements, the St. George Investment Subsidiaries are required to provide additional collateral to the extent the market values of the Managed Portfolios fall below certain thresholds. Failure to satisfy the collateral requirements may result in the liquidation of the Managed Portfolios and, to the extent that proceeds from liquidation are insufficient to repay the bank loans, the St. George Investment Subsidiaries must pay any shortfall. If the St. George Investment Subsidiaries cannot pay the amount then due, CG Assurance is obligated to pay such amounts under its Policies issued in favor of the funding banks. Due to unprecedented market conditions relating to credit spreads during the third and fourth quarters of 1998, the market values of the Managed Portfolios declined. As of September 30, 1998, the market values of the Managed Portfolios with collateral threshold triggers were not then below the collateral threshold triggers. Subsequent to September 30, market values further declined through mid-October and, as of October 18, 1998, CG Assurance's management prepared an estimate of market values of the Managed Portfolios, which indicated that if such market values were validated at the October 30, 1998 valuation date provided for in the bank loan agreements, substantial collateral would be required in the case of the Managed Portfolios subject to the collateral threshold triggers. As a result, certain institutional investors in CGA provided credit enhancements on various securities in the Managed Portfolios in the aggregate principal amount of $382 million. Of that aggregate amount, Capital Reinsurance credit enhanced $74.6 million of investment-grade asset-backed securities. Capital Reinsurance also credit enhanced the two other institutional investors that provided credit enhancement on the securities in the Managed Portfolios. Capital Reinsurance was paid a market rate premium for providing the reinsurance support. Market values of the Managed Portfolios have improved since October and, currently, the market values of the Managed Portfolios are above the relevant collateral threshold triggers. Throughout this period, CG Assurance was, and continues to be, rated triple-A by D&P. The Corporation's Board of Directors authorized a quarterly common stock dividend rate of $0.04 per share, or $0.16 annually. For the year ended December 31, 1998, common stock dividends were declared and paid in the amount of $5.1 million or $0.16 per share. Cash flows from operations for the years ended December 31, 1998 and 1997, consisting of reinsurance premiums collected net of expenses, investment income and income taxes, were $161.9 million and $143.4 million, respectively. The Corporation believes that current levels of cash flow from operations provide the Corporation with sufficient liquidity to meet its operating needs. The Corporation's non-operating cash outflows are primarily dedicated to (i) fixed-income investment activity, (ii) the payment of dividends on its common shares, (iii) payments of interest on long-term debt and (iv) the payment of its loan obligations to Capital Re LLC. 50 At December 31, 1998, cash and investments were approximately $1.18 billion, an increase of $162.9 million, or 15.9%, from $1.02 billion at December 31, 1997. In managing its investment portfolio, the Corporation places a high priority on quality and liquidity. As of December 31, 1998, the entire investment portfolio was invested in highly rated fixed income securities. At December 31, 1998, approximately $193.6 million, or 16.5%, of the Corporation's investment portfolio was composed of mortgage-backed securities ("MBS"). Of the MBS portfolio, approximately $167.5 million, or 86.5%, is backed by agencies or entities sponsored by the U.S. government as to the full amount of principal and interest. As of December 31, 1998, the entire MBS portfolio was invested in triple A rated securities. Prepayment risk is an inherent risk of holding MBS. However, the degree of prepayment risk is particular to the type of MBS held. The Corporation limits its exposure to prepayments by purchasing less volatile types of MBS. As of December 31, 1998, $3.6 million, or approximately 1.9%, of the MBS portfolio was invested in collateralized mortgage obligations ("CMOs") which are characterized as planned amortization class CMOs ("PACs"). PACs are securities whose cash flows are designed to remain constant over a variety of mortgage prepayment environments. Other classes in the CMO security are structured to accept the volatility of mortgage prepayment changes, thereby insulating the PAC class. Of the remaining MBS portfolio, $190.0 million, or 98.1%, was invested in mortgage-backed pass-throughs or sequential CMOs. Pass-throughs are securities in which the monthly cash flows of principal and interest (both scheduled and prepayments) generated by the underlying mortgages are distributed on a pro-rata basis to the holders of securities. A sequential MBS is structured to divide the CMO security into sequentially ordered classes. Receipt of principal payments within classes is contingent on the retirement of all previously paying classes. Generally, interest payments are made currently on all classes. While these securities are more sensitive to prepayment risk than PACs, they are not considered highly volatile securities. While the Corporation may consider investing in any tranche of a sequential MBS, the individual security's characteristics (duration, relative value, underlying collateral, etc.) along with aggregate portfolio risk management determine which tranche of sequential MBS will be purchased. At December 31, 1998, the Corporation had no securities such as interest only securities, principal only securities, or MBS purchased at a substantial premium to par that have the potential for loss of a significant portion of the original investment due to changes in the prepayment rate of the underlying loans supporting the security. Capital Reinsurance is party to a credit facility with Deutsche Bank AG (the "DB Credit Facility") pursuant to which Deutsche Bank AG provides up to $100.0 million specifically designed to provide rating agency qualified capital to further support Capital Reinsurance's claims-paying resources. This agreement expires January 27, 2006. The Corporation has not borrowed under the DB Credit Facility. In addition, on August 20, 1996, the Corporation entered into a credit agreement with Chase Manhattan Bank for the provision of a $25.0 million credit facility (the "Chase Facility") which is available for general corporate purposes. Furthermore, on August 26, 1996, the Corporation utilized $16 million of the Chase Facility for purposes of paying subordinated notes that came due. Interest on the bank note issued under the Chase Facility is payable quarterly based upon the Corporation's chosen interest rate option under the terms of the Chase Facility. In November 1996, the Corporation utilized the remaining $9 million of the Chase Facility for purposes of acquiring RGB. On March 10, 1999, Moody's Investors Service, Inc. ("Moody's") announced that it had downgraded the financial strength rating of Capital Reinsurance to Aa2 from Aaa. This action ended a review process that began on November 5, 1998. Moody's cited increased competition in the monoline financial guaranty reinsurance industry, an increased risk profile in business assumed and rising operating leverage as reasons for the downgrade. Under certain of its reinsurance agreements with two of its financial guaranty ceding companies, Capital Reinsurance has agreed to increase the ceding commission payable under such agreements as a result of the rating action by Moody's. The increase will apply to in-force and future business ceded by those companies. The financial impact of the increased ceding commission with respect to the in-force business at December 31, 1998 is not expected to exceed $2.0 million in 1999. The reinsurance agreements with the two ceding companies also give those companies an 51 option to reassume business previously ceded to Capital Reinsurance upon certain adverse rating actions; however, those options to fully reassume will not be triggered by Capital Reinsurance's March 10th downgrade. Additionally, one of the ceding companies may reassume a minor portion of its previously ceded business based on this rating action alone; however, that company has not indicated that it will exercise the option. On December 16, 1998, Standard & Poor's ("S&P") affirmed the triple A financial strength rating of Capital Reinsurance. In addition, S&P placed on Credit Watch, with negative implications, the financial strength ratings of Capital Mortgage (double "A"), KRE (double "A"), Capital Title (double "A" minus) and Capital Credit (single "A" plus). S&P took this action as a result of its perceived uncertainty resulting from changes in management that occurred in December 1998. Should S&P ultimately decide to downgrade the subsidiaries' financial strength ratings, certain reinsurance contracts could become subject to cancellation. However, the Corporation does not believe that a downgrade, if any, would be of the magnitude that would result in such cancellations. In February 1999, ACE Bermuda Insurance, Ltd., a subsidiary of ACE Limited, agreed to invest $75 million in the Corporation through a purchase of common stock. The proceeds will be used to augment the surplus of the Corporation's operating subsidiaries. Under the stock purchase agreement, as amended, the purchase price is determined as the lower of (i) fully diluted GAAP book value per share at December 31, 1998 (or $18.87 per share) and (ii) the average of the highest five consecutive market closing prices of the Corporation's common stock from March 12, 1999 through April 15, 1999. Closing is contingent on customary conditions and the affirmation of the S&P's financial strength ratings of the Corporation's major subsidiaries. Market Risk The main objectives in managing the investment portfolios of the Corporation and its operating subsidiaries are to maximize after-tax investment income and total investment returns while minimizing credit risks in order to provide maximum support to the reinsurance underwriting operations. Investment strategies are developed based on many factors including underwriting results and the Corporation's resulting tax position, regulatory requirements, fluctuations in interest rates and consideration of other market risks. Investment decisions are managed by outside investment professionals under discretionary investment management agreements and based on guidelines established by management and approved by the board of directors. Market risk represents the potential for loss due to adverse changes in the fair value of financial instruments. The market risks related to financial instruments of the Corporation and its operating subsidiaries primarily relate to the investment portfolio, which exposes the Corporation to risks related to interest rates and, to a lesser extent, credit quality and prepayment. Analytical tools and monitoring systems are in place to assess each of these elements of market risk. Interest rate risk is the price sensitivity of a fixed income security to changes in interest rates. Management views these potential changes in price within the overall context of asset and liability management. Wherever possible, the duration of asset and liability portfolios are matched. However, the duration of most of the asset portfolio is managed according to the level of expected return and volatility deemed tolerable by management. The duration of the liability portfolio does not lend itself to active duration management due to the low frequency, high severity losses in a majority of the Corporation's reinsured businesses. Other factors are considered in determining the duration of the asset portfolio, which the Corporation believes mitigates the overall effect of interest risk for the Corporation. The following table provides information about the Corporation's fixed maturity investments at December 31, 1998 that are sensitive to changes in interest rates. The table presents cash flows of principal amounts and related weighted average interest rates by expected maturity dates. The cash flows are based on the earlier of the call date or the maturity date or, for mortgage-backed securities, expected payment patterns. Actual cash flows could differ from the expected amounts. 52 Long-term Fixed Maturities Expected Cash Flows of Principal Amounts (Dollars in millions)
Amortized Market 1999 2000 2001 2002 2003 Thereafter Cost Value -------- -------- -------- -------- -------- ---------- -------- -------- Tax-exempt $1.6 $1.8 $15.0 $9.6 $30.9 $431.0 $489.9 $526.7 Average Interest Rate 7.3% 5.7% 7.2% 7.3% 6.5% 5.7% -- -- Taxable-other than mortgage-backed 17.4 28.7 46.8 37.1 24.6 202.1 356.7 366.6 securities Average Interest Rate 7.1% 7.0% 7.7% 6.7% 6.5% 5.8% -- -- Mortgage-backed securities 31.8 25.6 21.3 18.0 17.3 76.3 190.3 193.6 Average Interest Rate 7.0% 7.0% 7.0% 6.9% 6.9% 6.9% -- -- -------- -------- -------- -------- -------- -------- -------- -------- Total $50.8 $56.1 $83.1 $64.7 $72.8 $709.4 $1,036.9 $1,086.9 -------- -------- -------- -------- -------- -------- -------- --------
The Corporation and its operating subsidiaries have consistently invested in high quality marketable securities. As a result, the Corporation believes that it has minimal credit quality risk. Taxable bonds in the Corporation's domestic portfolio consist of U.S. Treasury, government agency, mortgage-backed and corporate securities. At December 31, 1998, approximately 20.7% of taxable bonds were issued by the U.S. Treasury or U.S. government agencies and approximately 83.6% were rated AA or better by Moody's or S&P. Of the tax exempt bonds, approximately 99.0% were rated AA or better with more than 90.1% rated AAA. Less than 1.5% of the Corporation's bond portfolio was below investment grade at December 31, 1998. At December 31, 1998, both taxable and tax exempt bonds had a weighted average maturity of approximately 8.9 years. The Corporation's taxable bond portfolio includes mortgage-backed securities, which comprised 17.8% of the portfolio at year-end 1998. Prepayment risk refers to the changes in prepayment patterns that can either shorten or lengthen the expected timing of the principal repayments and thus the average life and the effective yield of a security. Such risk exists primarily within the Corporation's portfolio of mortgage-backed securities. The Corporation invests primarily in those classes of mortgage-backed securities that are less subject to prepayment risk. All of the above risks are monitored on an ongoing basis. A combination of in-house systems and proprietary models and externally licensed software are used to analyze individual securities as well as each portfolio. These tools provide management with information to assist them in the evaluation of the market risks of the portfolio. 53 The Year 2000 The Corporation is actively pursuing its Year 2000 analysis and preparation. The Year 2000 issue involves potential complications related to computer systems, machinery and electronics that contain computer code, whether in software or embedded within microchips, that recognize years in two digit code, e.g. "98" for the year 1998. Software or microchips that recognize the Year 2000 as "00" or any year thereafter in its two digit equivalent, threatens date sensitive calculations by potentially misapplying the date (e.g. "00" could be applied as 1900 rather than 2000). Any coding that causes a date recognition error of this sort is commonly referred to as a Year 2000 bug. State of Readiness The Corporation has assembled a team consisting of officers and employees of the finance and information systems departments to oversee the Corporation's readiness for the Year 2000. The group has already completed the first phase of its analysis in which a comprehensive list of all the Corporation's own information technology systems and general technology was prepared. Additionally, the Corporation's clients and vendors were reviewed and a listing was prepared of those with information systems or other technology upon which the Corporation may rely and those which may be affected by the Year 2000 bug. The Corporation has made inquiries as to Year 2000 readiness with these clients and vendors and has received responses from a majority of them. It is currently evaluating these responses. However, all of the Corporation's ceding companies that have thus far responded report that they expected to be Year 2000 compliant by year-end 1998. The Corporation is now performing testing and remediation, as necessary, on its information technology systems, its general systems and any other technology that may be affected by the Year 2000 bug. This process is not yet complete, but is expected to be completed by mid-1999. The following is a summary of the Corporation's internal readiness status: o In-house Applications: All key in-house applications have been tested and are Year 2000 compliant. o Accounting Software: Vendors for the major accounting software packages used by the Corporation have stated that the software versions the Corporation uses are Year 2000 compliant. o Administration/Human Resources; Operating System Software; Network/Lan Utilities; Desktop Hardware: Ninety-five percent of these applications will be Year 2000 compliant. o General Office Services:. These systems will all be upgraded by mid-1999. The Corporation has not had to defer any of its expected information technology or other technology installations, updates or enhancements in order to accommodate its Year 2000 review and remediation work. Costs Due to the youthfulness of the Corporation's information technology and other systems, testing and remediation have been fairly uncomplicated. Moreover, none of the Corporation's technology is mainframe computer based. Mainframes traditionally use older coding methodologies and, thus, are more likely to be double digit dated coded. No external consultants have been retained. Internal information technology personnel have overseen and implemented the testing and remediation of the systems and technology. The amount of additional time allocable to employees' efforts has been nominal. All system upgrade costs incurred would have been incurred by the Corporation as part of routine software upgrades and all patches have been provided without any material cost to the Corporation. The Corporation does not expect any material additional costs and expects that, including the cost 54 allocation of internal personnel, the overall testing and remediation will be less than $50,000 as originally anticipated. The costs are being funded through operating cash flows and will be expensed as incurred. The Risk of the Corporation's Year 2000 Issues A Year 2000 bug issue may manifest itself as (i) a failure of the Corporation's software, systems and general technology, (ii) a failure of a client's or vendor's software or systems which would impact the Corporation, and (iii) insurance claims against the Corporation due to Year 2000 issues. Management believes that the likelihood that a failure of the Corporation's software and systems would have a material effect on the business of the Corporation is minimal. The information technology and other systems are not critical to the carrying-on of the Corporation's business. Additionally, all critical accounting, financial reporting and human resources functions can be maintained on a manual basis for a period of time without materially impeding the operations of the Corporation. Similarly, a failure of clients and vendors to properly provide data or services will also not materially affect the Corporation's ability to continue its operations. Such a failure would likely be temporary and could be compensated for in the short-term by using manual alternatives to tracking business with our clients or vendors. Reinsurance losses pose the most reasonably likely worst case scenario for the Corporation arising out of Year 2000 bugs. The issue would originate with a default on debt service obligations of bond issuers due to the issuer's own Year 2000 bug difficulties. In the event of such a default, the Corporation's clients, the ceding companies, will be required to make debt service payments on behalf of the defaulting issuers. The Corporation will have to make prompt payment to its clients for its agreed upon portion of such losses. Such defaults by bond issuers would generally be of a technical nature, arising out of temporary inabilities to process payments or calculate payment amounts. Additionally, the defaulted debt service obligations would generally not require our clients, the ceding insurers, to make debt service payments on behalf of the issuers for a prolonged period. Once issuers or payment agents have cured any errors, they would resume debt service payment and reimburse the insurers for all payments made. Hence, the reasonable worst case scenario for the Corporation under such circumstances would involve liquidity pressure which should ease quickly. There is no way to quantify the potential exposure under this scenario as there has never been any event similar to the Year 2000. Consequently, it is difficult to make assumptions based on the Corporation's business. However, as the Corporation's operating units affected by such an occurrence already meet the rating agency stress test requirements designed to simulate depression-era conditions, the Corporation believes it can withstand temporary defaults of that magnitude based on the Year 2000 bug. Contingency Plans The Corporation does not have a prescribed contingency plan relative to Year 2000 bug issues. The Corporation does not predict that a failure of its information technology systems will materially affect daily operations or have an immediate impact on the Corporation's ability to conduct business. All internal financial reporting of the Corporation may be conducted by hand. As for any failure of a bond issuer that has been reinsured by the Corporation, the Corporation expects to handle such matters in the ordinary course of business. As the Corporation is a reinsurer, payments are requested in bulk by the Corporation's ceding insurers, and payment of reinsurance proceeds would be made in bulk. The Corporation is not required to make payment to individual bond obligees. Ultimately, all recovery efforts in the event of any Year 2000 bug related event can either be handled internally, or would require the intervention of hardware, software or other technology vendors. The Corporation maintains a list of the appropriate contacts at such vendors in the event such a need arises. Item 7A. Quantitative and Qualitative Disclosures About Market Risk. The information concerning quantitative and qualitative disclosures about market risk is set forth in Item 7 hereof. Item 8. Financial Statements and Supplementary Data. 55 Capital Re Corporation and Subsidiaries Audited Consolidated Financial Statements Year ended December 31, 1998 Contents Report of Independent Auditors............................................. 57 Consolidated Balance Sheets................................................ 58 Consolidated Statements of Income.......................................... 60 Consolidated Statements of Comprehensive Income............................ 61 Consolidated Statements of Stockholders' Equity............................ 62 Consolidated Statements of Cash Flows...................................... 63 Notes to Consolidated Financial Statements................................. 64 56 Report of Independent Auditors Board of Directors and Stockholders Capital Re Corporation We have audited the accompanying consolidated balance sheets of Capital Re Corporation and Subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Capital Re Corporation and Subsidiaries at December 31, 1998 and 1997 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP February 22, 1999 except for Note 7, as to which the date is March 10, 1999 57 Capital Re Corporation and Subsidiaries Consolidated Balance Sheets
December 31, 1998 1997 ------------------------------- (Dollars in Thousands Except Share Amounts) Assets Fixed maturity securities available for sale, at market (amortized cost: $1,036,862 in 1998 and $887,205 in 1997) $1,086,891 $ 932,423 Short-term investments, at cost, which approximates market 88,147 75,500 ------------------------------- Total investments 1,175,038 1,007,923 Cash 9,893 14,103 Accrued investment income 15,371 13,761 Deferred acquisition costs 135,029 127,637 Prepaid reinsurance premiums 49,603 59,942 Reinsurance recoverable on ceded losses 3,292 5,527 Funds held under reinsurance contracts 5,033 3,926 Premiums receivable 17,117 8,116 Amounts receivable on ceded annuity reserves 53,869 58,635 Property and equipment, at cost (net of accumulated depreciation and amortization of $1,286 in 1998 and $1,525 in 1997) 1,937 1,939 Investment in affiliates 15,080 21,858 Net assets of discontinued operations 11,695 17,046 Other assets 15,936 5,429 ------------------------------- Total assets $1,508,893 $1,345,842 ===============================
See accompanying notes to consolidated financial statements. 58
December 31, 1998 1997 ------------------------------- (Dollars in Thousands Except Share Amounts) Liabilities Deferred premium revenue $ 405,866 $ 373,996 Reserve for losses and loss adjustment expenses 87,960 27,986 Profit commission liability 57,389 35,670 Ceded balances payable 120 92 Annuity benefit reserves 53,869 58,635 Accident and health reserves 17,843 16,367 Bank note payable 25,000 25,000 Long-term debt 74,856 74,819 Deferred federal income taxes payable 79,237 72,879 Other liabilities 20,927 16,455 ------------------------------- Total liabilities 823,067 701,899 ------------------------------- Company obligated mandatorily redeemable preferred securities of Capital Re LLC 75,000 75,000 Stockholders' equity: Preferred stock--$.01 par value per share: 25,000,000 shares authorized; no shares issued or outstanding -- -- Common stock--$.01 par value per share: 75,000,000 shares authorized; and 31,929,119 and 31,826,874 shares issued and outstanding in 1998 and 1997 324 322 Additional paid-in capital 227,280 224,999 Retained earnings 355,693 319,253 Treasury stock; 428,000 shares in 1998 and 1997 (4,891) (4,891) Other comprehensive income Net unrealized gain on fixed maturity securities available for 32,520 29,392 sale Net unrealized loss on foreign currency translation (100) (132) ------------------------------- Accumulated other comprehensive income 32,420 29,260 ------------------------------- Total stockholders' equity 610,826 568,943 ------------------------------- Total liabilities, preferred securities of Capital Re LLC and stockholders' equity $1,508,893 $1,345,842 ===============================
59 Capital Re Corporation and Subsidiaries Consolidated Statements of Income
Year ended December 31, 1998 1997 1996 ------------------------------------------------- (Dollars in Thousands Except Per Share Amounts) Revenues Gross written premiums $ 213,941 $ 169,943 $ 129,818 Ceded premiums (3,347) (5,668) (24,630) ------------------------------------------------- Net written premiums 210,594 164,275 105,188 Increase in deferred premium revenue (42,209) (48,984) (12,752) ------------------------------------------------- Earned premiums 168,385 115,291 92,436 Net investment income 64,854 56,498 51,558 Net realized (losses)/gains (1,506) 8,037 1,471 Other income 2,394 777 813 Equity income in affiliates 818 858 -- ------------------------------------------------- Total revenues 234,945 181,461 146,278 ------------------------------------------------- Expenses Losses and loss adjustment expenses 86,564 15,633 9,483 Acquisition costs 56,825 54,788 39,725 Increase in deferred acquisition costs (7,392) (16,273) (9,011) Profit commission expense 19,225 5,111 6,008 Other operating expenses 11,764 11,206 9,898 Foreign exchange (gains)/losses (45) 408 (385) Interest expense 7,412 7,399 6,895 Minority interest in Capital Re LLC 5,738 5,738 5,738 ------------------------------------------------- Total expenses 180,091 84,010 68,351 ------------------------------------------------- Income before provision for federal income taxes from continuing operations 54,854 97,451 77,927 Provision for federal income taxes: Current 5,939 18,173 9,424 Deferred 4,728 8,460 11,489 ------------------------------------------------- Total provision for federal income taxes 10,667 26,633 20,913 ------------------------------------------------- Net income from continuing operations 44,187 70,818 57,014 Loss from discontinued operations (2,645) (766) (490) ------------------------------------------------- Net Income $ 41,542 $ 70,052 $ 56,524 ------------------------------------------------- Per share data Net income from continuing operations per share: Basic $ 1.39 $ 2.23 $ 1.82 Diluted $ 1.35 $ 2.18 $ 1.79 Net income per common share: Basic $ 1.30 $ 2.21 $ 1.81 Diluted $ 1.27 $ 2.16 $ 1.77 Weighted average number of shares outstanding: Basic 31,885 31,746 31,312 Diluted 32,645 32,505 31,892 Cash dividend per common share $ 0.16 $ 0.15 $ 0.13
See accompanying notes to consolidated financial statements. 60 Capital Re Corporation and Subsidiaries Consolidated Statements of Comprehensive Income
Year Ended December 31, 1998 1997 1996 ------------------------------------------- (Dollars in Thousands) Net Income $ 41,542 $ 70,052 $ 56,524 Other comprehensive income, net of tax: Change in net unrealized gain on fixed maturity securities available for sale 3,128 12,790 (5,947) Change in foreign exchange translation 32 (254) 122 ------------------------------------------- Other Comprehensive Income/(Loss) 3,160 12,536 (5,825) ------------------------------------------- Comprehensive Income $ 44,702 $ 82,588 $ 50,699 ===========================================
See accompanying notes to consolidated financial statements 61 Capital Re Corporation and Subsidiaries Consolidated Statements of Stockholders' Equity
Net Unrealized Gain (Loss) on Fixed Maturity Additional Securities Preferred Common Paid-in Retained Treasury Available Stock Stock Capital Earnings Stock for Sale ----------------------------------------------------------------- (Dollars in Thousands Except Per Share Amounts) Balance, December 31, 1995 $ $300 $191,504 $201,228 $(3,638) $ 22,549 Net income 56,524 Issuance of common stock (1,706,240 shares) 16 25,477 Exercise of stock options, including tax benefit (397,174 shares) 4 5,384 Purchase of treasury stock, at cost (14,000 (232) shares) Fixed maturity securities available for sale, net of tax ($3,202) (5,947) Foreign currency translation adjustments Dividend ($.13 per common share) (3,945) ----------------------------------------------------------------- Balance, December 31, 1996 320 222,365 253,807 (3,870) 16,602 ----------------------------------------------------------------- Net income 70,052 Exercise of stock options, including tax benefit (161,950 shares) 2 2,634 Purchase of treasury stock, at cost (48,600 (1,021) shares) Fixed maturity securities available for sale, net of tax ($6,887) 12,790 Foreign currency translation adjustments Dividend ($.15 per common share) (4,606) ----------------------------------------------------------------- Balance December 31, 1997 322 224,999 319,253 (4,891) 29,392 ----------------------------------------------------------------- Net income 41,542 Exercise of stock options, including tax benefit (102,245 shares) 2 2,281 Fixed maturity securities available for sale, 3,128 net of tax ($1,684) Foreign currency translation adjustments Dividend ($.16 per common share) (5,102) ----------------------------------------------------------------- Balance December 31, 1998 $ $324 $227,280 $355,693 $ (4,891) $ 32,520 =================================================================
Net Unrealized (Loss) Gain on Foreign Total Currency Stockholders' Translation Equity ----------------------------------- (Dollars in Thousands Except Per Share Amounts) Balance, December 31, 1995 $411,943 Net income 56,524 Issuance of common stock (1,706,240 shares) 25,493 Exercise of stock options, including tax benefit (397,174 shares) 5,388 Purchase of treasury stock, at cost (14,000 (232) shares) Fixed maturity securities available for sale, net of tax ($3,202) (5,947) Foreign currency translation adjustments 122 122 Dividend ($.13 per common share) (3,945) ----------------------------------- Balance, December 31, 1996 122 489,346 ----------------------------------- Net income 70,052 Exercise of stock options, including tax benefit (161,950 shares) 2,636 Purchase of treasury stock, at cost (48,600 (1,021) shares) Fixed maturity securities available for sale, net of tax ($6,887) 12,790 Foreign currency translation adjustments (254) (254) Dividend ($.15 per common share) (4,606) ----------------------------------- Balance December 31, 1997 (132) 568,943 ----------------------------------- Net income 41,542 Exercise of stock options, including tax benefit (102,245 shares) 2,283 Fixed maturity securities available for sale, 3,128 net of tax ($1,684) Foreign currency translation adjustments 32 32 Dividend ($.16 per common share) (5,102) ----------------------------------- Balance December 31, 1998 $(100) $610,826 ===================================
See accompanying notes to consolidated financial statements. 62 Capital Re Corporation and Subsidiaries Consolidated Statements of Cash Flows
Year ended December 31, 1998 1997 1996 ----------------------------------------------------- (Dollars in Thousands) Operating activities Net income $ 41,542 $ 70,052 $ 56,524 Adjustments to reconcile net income to net cash provided by operating activities: Net amortization of investment security discounts (1,012) 348 293 Provision for deferred federal income taxes 4,674 7,518 11,489 Acquisition costs deferred (56,825) (54,788) (39,725) Amortization of deferred acquisition costs 49,433 38,516 30,714 Equity income in affiliates (818) (858) -- Change in accrued investment income (1,610) (1,474) (2,806) Change in premiums receivable (9,001) (2,322) 12,113 Change in deferred premium revenue, net 42,209 48,984 12,752 Change in reserve for losses and loss adjustment expenses, net 62,209 4,390 7,810 Net realized losses/(gains) on investments 1,506 (8,037) (1,471) Change in ceded balances payable 8,098 2,103 (9,594) Change in accident and health reserves 1,476 16,367 -- Other 7,209 15,908 18,186 Discontinued operations, net 12,846 6,730 (2,162) ----------------------------------------------------- Net cash provided by operating activities 161,936 143,438 94,122 ----------------------------------------------------- Investing activities Fixed maturity securities available-for-sale: Purchases (775,087) (1,868,917) (741,415) Sales 622,897 1,789,418 589,143 Maturities 9,635 -- 6,280 Purchases of short-term investments, net (12,647) (76) 8,686 Investment in affiliates -- (11,000) (10,000) Other investing activities (615) (43,500) 42,211 Discontinued operations, net (7,320) (5,553) (24,354) ----------------------------------------------------- Net cash used in investing activities (163,137) (139,627) (129,451) ----------------------------------------------------- Financing activities Net proceeds from sale of stock -- -- 25,493 Net proceeds from exercise of stock options 2,283 2,636 5,388 Net proceeds from issuance of notes payable -- -- 9,000 Purchase of treasury stock, at cost -- (1,021) (232) Dividends paid (5,102) (4,606) (3,945) Discontinued operations, net (190) (23) 8,395 ----------------------------------------------------- Net cash (used in) provided by financing activities (3,009) (3,014) 44,099 ----------------------------------------------------- (Decrease)/increase in cash (4,210) 797 8,769 Cash at beginning of year 14,103 13,306 4,537 ----------------------------------------------------- Cash at end of year $ 9,893 $ 14,103 $ 13,306 =====================================================
See accompanying notes to consolidated financial statements. 63 1. Business and Organization Capital Re Corporation (the "Corporation") was incorporated in the State of Delaware in December 1991, and is the successor by merger to a Maryland corporation incorporated in 1986. The Corporation is an insurance holding company and has five wholly-owned operating subsidiaries. Capital Reinsurance Company ("Capital Reinsurance"), domiciled in the state of Maryland, commenced operations in January 1988. Capital Reinsurance is engaged in the business of financial guaranty reinsurance, primarily the reinsurance of municipal and nonmunicipal bond obligations. Capital Reinsurance also sells municipal and nonmunicipal credit risk protection through credit default swap transactions. Capital Mortgage Reinsurance Company ("Capital Mortgage"), a New York domiciled company, commenced operations in February 1994. Capital Mortgage reinsures only residential mortgage guaranty insurance obligations which are originated principally in the United States and the United Kingdom. KRE Reinsurance, Ltd. ("KRE"), a Bermuda domiciled company, commenced operations in March 1994. KRE is engaged in the business of reinsuring financial guaranty, mortgage guaranty, and trade credit insurance both as a direct reinsurer of third party primary insurers and as a retrocessionaire of Capital Reinsurance, Capital Mortgage, Capital Credit Reinsurance Company, Ltd. ("Capital Credit") and Capital Title Reinsurance Company ("Capital Title"). KRE also provides integrated financial solutions in the form of structured reinsurance products to accident and health insurers and specialty property and casualty insurers. Capital Credit, also a Bermuda domiciled insurance company, commenced operations in February 1990. Capital Credit reinsures trade credit and political risk insurance concentrated in Western Europe and the United States, and is also a retrocessionaire of Capital Reinsurance and Capital Mortgage. Capital Title, a New York domiciled insurance company, commenced operations in March 1996. Capital Title is engaged in the business of reinsuring title insurance policies. In November 1996, the Corporation acquired 100% of the issued shares of Tower Street Holdings Limited (now known as RGB Holdings, Ltd.), the holding company for RGB Underwriting Agencies Ltd. ("RGB"). RGB is a Lloyd's managing agency and presently manages four syndicates operating in the Lloyd's of London insurance market. In connection with its acquisition of RGB, the Corporation established a corporate name at Lloyd's. In 1998 the Corporation commenced a plan of divestiture of its Lloyd's operations and those operations are presented as a discontinued operation. See Note 3. Pending divestiture, the Corporation will continue to support its commitments to Lloyd's. See Note 16. For comparative purposes, all prior period financial statements have been restated. In June 1997, the Corporation invested approximately $10.9 million in CGA Group Ltd ("CGA"), a Bermuda domiciled insurance company formed to provide financial guaranty insurance of structured securities, including commercial real estate and asset-backed transactions. The Corporation's investment was in the form of common and preferred shares. In December 1996, the Corporation entered into a joint venture with Global Capital Reinsurance Limited, ("GCR") to form a Bermuda based insurer, Capital Global Underwriters Limited ("CGUL"), which specializes in financial lines reinsurance. In April 1997, GCR was acquired by EXEL Limited. In March 1998, EXEL sold its share of CGUL to Bermuda based ACE Bermuda Insurance, Ltd. and CGUL was renamed ACE Capital Re Ltd. The Corporation, through KRE, owns a 50% economic interest in ACE Capital Re Ltd. and controls 9.9% of its voting stock. The Corporation accounts for its investment in ACE Capital Re Ltd. under the equity method. 64 2. Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements include the accounts and operations of the Corporation and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The 1997 and 1996 financial statements have been reclassified to conform with the 1998 presentation. Significant accounting policies are as follows: Discontinued Operations: During 1998, the Corporation commenced a plan of divestiture of it Lloyd's operations. As a result, the related subsidiaries of the Corporation have been classified as discontinued operations and prior period results have been restated for comparative purposes. Unless otherwise noted, all footnote disclosures reflect continuing operations only. Investments in Securities: The Corporation accounts for its investments in fixed maturity securities in accordance with FASB Statement No. 115 ("SFAS 115"), "Accounting for Certain Investments in Debt and Equity Securities". Management determines the appropriate classification of securities at the time of purchase. At December 31, 1998 and 1997 investments in fixed maturity securities were designated as available-for-sale. The Corporation invests in mortgage-backed securities, including collateralized mortgage obligations. The Corporation recognizes income for these securities using a constant effective yield based on anticipated prepayments and the estimated economic life of the securities. When actual prepayments differ significantly from anticipated prepayments, the effective yield is recalculated to reflect actual payments to date and anticipated future payments. The net investment in the security is adjusted to the amount that would have existed had the new effective yield been applied since the acquisition of the security. That adjustment is included in net investment income. Short-term investments are carried at cost, which approximates market value. Realized gains and losses on sale or maturity of investments and declines in value judged to be other-than-temporary are determined by specific identification and included in net realized gains. The amortized cost of fixed maturity securities is adjusted for amortization of premiums and accretion of discounts. That amortization or accretion is included in net investment income. 65 2. Significant Accounting Policies (continued) Premium Revenue Recognition: All premiums are earned over the terms of the risks covered under the Corporation's reinsurance contracts. Generally, premiums are received either in full at contract inception or in installments over the life of the covered risk. Financial guaranty premiums are typically received entirely at contract inception. For purposes of earnings recognition, premiums are allocated to each year in the term of the guaranty and are earned pro-rata over the period of risk. Receipts of installment premiums for financial guaranty and all other lines of business are generally earned on monthly pro-rata basis over the installment period. Deferred Acquisition Costs: Acquisition costs include only those expenses that relate to, and vary with, premium production, including commissions, brokerage and costs of underwriting and marketing personnel. Acquisition costs are deferred and amortized over the period in which the related premiums are earned. Ceding commission income on premiums ceded to other reinsurers reduces acquisition costs. Anticipated losses, loss adjustment expenses and the remaining costs of servicing the reinsured issues are considered in determining the recoverability of acquisition costs. Losses and Loss Adjustment Expenses: The liability for loss and loss adjustment expenses is determined according to management's loss expectations which are based on historical loss development patterns as well as reports and individual case estimates received from ceding companies where applicable. An estimate is also provided for losses and loss adjustment expenses for incurred but not reported losses for the mortgage guaranty and trade credit lines of business. Incurred but not reported losses are not estimated for the financial guaranty and title reinsurance lines of business since they are underwritten to a zero loss standard. Financial guaranty loss and loss adjustment expenses were discounted using an average rate of 5.5% in 1998 and 6.4% in 1997. Contingent Commissions: Under the terms of certain of the Corporation's reinsurance contracts, the Corporation is obligated to pay the ceding company a contingent commission based upon a specified percentage of the net underwriting profits. As of December 31, 1998 and 1997, the Corporation's liability for the present value of expected future payments is shown on the balance sheet under the caption "Profit commission liability." Stock Based Compensation: The Corporation grants stock options to certain employees for a fixed number of shares with an exercise price equal to the fair value of the shares at the date of grant. The Corporation accounts for stock option grants in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees," and, accordingly, recognizes no compensation expense for the stock option grants. 66 2. Significant Accounting Policies (continued) Income Taxes: In accordance with FASB Statement No. 109, "Accounting for Income Taxes," deferred federal income taxes are provided on the temporary difference between the tax basis of an asset or liability and its reported amount in the financial statements that will result in deductible or taxable amounts in future years when the reported amount of the asset or liability is recovered or settled. Such temporary differences relate principally to premium revenue recognition, deferred acquisition costs, and contingency reserve. The Internal Revenue Code permits companies writing financial guaranty insurance and mortgage guaranty insurance to deduct from taxable income amounts added to the statutory contingency reserve, subject to certain limitations. The amounts deducted must be included in taxable income in the tenth or twentieth year following the year of deduction dependent on the type of business, or in the event that incurred losses exceed certain statutorily established levels and the contingency reserve is released to cover such excess losses. However, the tax benefits obtained from such deductions must be invested in noninterest-bearing U.S. Government tax and loss bonds. The Corporation records purchases of tax and loss bonds as payments of federal income taxes. Earnings Per Share: Basic earnings per share is calculated based on the weighted average common shares outstanding. All potentially dilutive securities such as stock options are excluded from the basic earnings per share calculation. In calculating diluted earnings per share, the number of shares outstanding is increased to include all potentially dilutive securities. Basic and diluted net income per share of common stock are computed by dividing net income by the applicable weighted average number of shares of common stock outstanding during each year. For the years ended 1998, 1997 and 1996, and in order to arrive at the number of weighted average diluted shares outstanding of 32,645, 32,505, and 31,892, employee stock option awards in the amount of 760, 759 and 580 were added to weighted average common shares outstanding for basic earnings per share of 31,885, 31,746, and 31,312, respectively. All figures are reported in thousands. 67 3. Discontinued Operations As mentioned in Note 1, the Corporation has commenced a plan of divestiture of its Lloyd's operations. The sale is expected to be completed during 1999. The Corporation's commitments to Lloyd's are described in Note 16. The results were as follows: Years Ending December 31, 1998 1997 1996 -------------------------------------- (Dollars in Thousands) Total Revenues $ 56,437 $ 20,263 $ 138 Total Losses and Expenses 59,089 21,063 628 -------------------------------------- Loss Before Taxes (2,652) (800) (490) Income Taxes (7) (34) 0 -------------------------------------- Loss from Discontinued Operations $ (2,645) $ (766) $ (490) The assets and liabilities of the discontinued operations at December 31, 1998 were: Cash and Investments $ 20,689 Deferred Acquisition Costs 19,727 Reinsurance Balances 50,052 Other Assets 40,768 ---------- Total Assets $131,236 Deferred Premium Revenue $54,990 Loss and LAE Reserves 55,664 Other Liabilities 14,727 ---------- Total Liabilities $125,381 Net Assets $5,855 Payable to Capital Re Corp 5,840 ---------- Net Assets of Discontinued Operation $ 11,695 68 4. Accounting Developments In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income," which is effective for fiscal years beginning after December 15, 1997. SFAS No. 130 establishes standards for the reporting item, termed comprehensive income, which will combine net income and certain items that directly affect stockholders' equity, such as net unrealized gain/loss on fixed maturity securities available for sale and foreign currency translation adjustments. The Corporation has elected to report comprehensive income in a separate statement. SFAS No. 130 will have no impact on the financial condition or results of operations of the Corporation. In June 1997, the FASB also issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information", which is effective for fiscal years beginning after December 15, 1997, and supersedes SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise." SFAS No. 131 establishes new standards for defining how operating segments are determined and requires more comprehensive disclosures about the Corporation's reportable operating segments. The Corporation's segment information is reported in Note 10. In June 1998, The FASB issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities," which is required to be adopted in years beginning after June 15, 1999. The Statement will require the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in the fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehenstive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. Management has determined that it is likely that its credit default swap business will be subject to the requirements of SFAS 133. The Corporation is in the process of determining what the effect of Statement 133 will be on its earnings and financial position. 5. Statutory Accounting Practices The financial statements are prepared on the basis of GAAP, which differs in certain respects from accounting practices prescribed or permitted by the Maryland Insurance Administration and the Insurance Department of the State of New York (the insurance departments in the states of domicile of Capital Reinsurance and Capital Mortgage and Capital Title, respectively), as well as the statutory requirements of the Minister of Finance of the Island of Bermuda (place of domicile of Capital Credit and KRE). Statutory accounting practices for the Corporation's insurance subsidiaries differ from GAAP as follows: Acquisition costs are charged to current operations as incurred rather than as related premiums are earned; A contingency reserve is computed on the basis of statutory requirements regardless of when loss contingencies actually exist; A title statutory premium reserve is established based upon assumed exposure regardless of when loss contingencies actually exist; 69 5. Statutory Accounting Practices (continued) Federal income taxes are only provided on taxable income for which income taxes are currently payable, while under GAAP, deferred income taxes are provided with respect to temporary differences; Purchases of tax and loss bonds are reflected as admitted assets, while under GAAP they are recorded as federal income tax payments; Financial guaranty premiums are earned in direct proportion to the payment of debt service rather than pro-rata over the period of risk; Investments in fixed maturity securities are reported at amortized cost or market value based on the National Association of Insurance Commissioners ("NAIC") rating; under GAAP, these fixed maturity investments are carried in accordance with SFAS 115 (see Note 2); Certain assets designated as "nonadmitted assets" are charged directly to statutory capital and surplus, but are reflected as assets under GAAP. The following is a reconciliation of the Corporation's consolidated GAAP net income and stockholders' equity to the corresponding consolidated statutory amounts for its insurance subsidiaries: Year ended December 31, 1998 1997 1996 --------------------------------- (Dollars in Thousands) Consolidated GAAP net income $ 41,542 $ 70,052 $ 56,524 Premium revenue recognition (14,168) (899) (14,851) Deferred acquisition costs (7,392) (16,273) (9,011) Deferral of income taxes 4,728 8,460 11,489 Tax and loss bonds 1,581 4,848 Interest expense and minority interest in Capital Re LLC 13,150 13,137 12,633 Other, including noninsurance subsidiaries (5,219) (5,876) (4,091) ================================= Consolidated statutory net income $ 32,641 $ 70,182 $ 57,541 ================================= 70 5. Statutory Accounting Practices (continued) December 31, 1998 1997 ---------------------- (Dollars in Thousands) GAAP stockholders' equity $ 610,826 $ 568,943 Premium revenue recognition (60,851) (44,345) Deferred acquisition costs (135,029) (127,637) Unrealized gain on fixed maturity securities available-for-sale (50,029) (45,218) Deferral of income taxes 79,237 72,879 Tax and loss bonds 18,737 Contingency reserve (211,455) (162,250) Long-term debt and Company obligated mandatorily redeemable preferred securities of Capital Re LLC 174,856 174,819 Net assets of discontinued operations (11,695) (17,046) Other, including noninsurance subsidiaries (89) (3,764) ---------------------- Consolidated statutory policyholders' surplus $ 395,771 $ 435,118 ====================== 6. Insurance in Force--Financial Guaranty and Mortgage Guaranty Financial Guaranty: At December 31, 1998, the Corporation's reinsured financial guaranty portfolio included the reinsured portfolios of Capital Reinsurance, Capital Credit and KRE, net of eliminations and was broadly diversified by bond type, geographic location and maturity schedule, with no single risk representing more than 1.72% of the Corporation's net par in force. The Corporation limits its exposure to losses from reinsured financial guarantees by underwriting primarily investment grade obligations and retroceding a portion of its risks to other insurance companies. Net financial guaranty par in force was approximately $57.0 billion at December 31, 1998. The composition at December 31, 1998, by type of issue and the range of final maturities, was as follows: Range of Final Type of Issue Net Par in Force Maturities ------------------------------------------------------------------------- (Dollars in Billions) Tax-backed $15.8 1-40 years Utility 15.0 1-40 years Nonmunicipal 13.0 1-35 years Special revenue 6.4 1-40 years Health care 6.1 1-40 years Housing .7 1-40 years ----- $57.0 ===== 71 6. Insurance in Force--Financial Guaranty and Mortgage Guaranty (continued) The reinsured portfolio contained exposures in each of the 50 states. Net par in force at December 31, 1998, by state, was as follows: State Net Par in Force --------------------------------------------------------- (Dollars in Billions) California $ 6.1 New York 5.6 Florida 2.9 Texas 2.9 Pennsylvania 2.2 New Jersey 2.0 Illinois 1.9 Massachusetts 1.8 Puerto Rico 1.6 Ohio 1.4 Washington 1.4 Others (each less than 2%) 27.2 ----- $57.0 ===== As part of its financial guaranty business, the Corporation participates in credit default swap transactions whereby one counterparty pays a periodic fee in fixed basis points on a notional amount in return for a contingent payment by the other counterparty in the event one or more defined credit events occurs with respect to one or more third party reference secuirities or loans. A credit event is defined as failure to pay, bankruptcy, cross acceleration (generally accompanied by a failure to pay), repudiation, restructuring or similar nonpayment event. The total notional amount of credit default swaps outstanding at December 31, 1998 and included in the Corporation's financial guaranty exposure above was $6.8 billion. Mortgage Guaranty: At December 31, 1998, the Corporation's net mortgage guaranty insurance in force (representing the current principal balance of all mortgage loans that are currently reinsured) and direct primary net risk in force was approximately $7.6 billion and $2.4 billion, respectively. California represents the Corporation's largest U.S. risk concentration at approximately 23%, however, its total U.S. distribution of mortgage guaranty risk in force parallels that of the U.S. primary mortgage insurance industry. 72 7. Financial Strength Ratings On March 10, 1999, Moody's Investors Service, Inc. ("Moody's") announced that it had downgraded the financial strength rating of Capital Reinsurance to Aa2 from Aaa. This action ended a review process that began on November 5, 1998. Moody's cited increased competition in the monoline financial guaranty reinsurance industry, an increased risk profile in business assumed and rising operating leverage as the reasons for the downgrade. Under certain of its reinsurance agreements with two of its financial guaranty ceding companies, Capital Reinsurance has agreed to increase the ceding commission payable under such agreements as a result of the rating action by Moody's. The increase will apply to in-force and future business ceded by those companies. The financial impact of the increased ceding commission with respect to the in-force business at December 31, 1998 is not expected to exceed $2.0 million in 1999. The reinsurance agreements with the two ceding companies also give those companies an option to reassume business previously ceded to Capital Reinsurance upon certain adverse rating actions; however, those options to fully reassume will not be triggered by Capital Reinsurance's March 10th downgrade. Additionally, one of the ceding companies may reassume a minor portion of its previously ceded business based on this rating action alone; however, that company has not indicated that it will exercise the option. On December 16, 1998, Standard & Poor's ("S&P") affirmed the triple A financial strength rating of Capital Reinsurance. In addition, S&P placed on Credit Watch with negative implications, the financial strength ratings of Capital Mortgage (double `A'), KRE (double `A'), Capital Title (double `A'minus) and Capital Credit (single `A' plus). S&P took this action as a result of its perceived uncertainty resulting from changes in management that occurred in December 1998. Should S&P ultimately decide to downgrade the subsidiaries' financial strength ratings, certain reinsurance contracts could become subject to cancellation. However, the Corporation does not believe that a downgrade, if any, would be of the magnitude that would result in such cancellations. 73 8. Investments in Securities The following summarizes the Corporation's aggregate investment portfolio at December 31, 1998:
Gross Gross Amortized Unrealized Unrealized Estimated Cost Gains Losses Fair Value ------------------------------------------------------------ (Dollars in Thousands) Fixed maturity securities available-for-sale: U.S. Treasury securities and obligations of U.S. government agencies $ 109,323 $ 6,646 $ (294) $ 115,675 Obligations of states and political subdivisions 489,932 37,091 (338) 526,685 Corporate securities 158,739 3,972 (569) 162,142 Mortgage-backed securities 190,284 3,362 (26) 193,620 Asset-backed 66,159 1,466 (76) 67,549 Emerging markets 12,247 103 (689) 11,661 Other 10,178 3 (620) 9559 ------------------------------------------------------------ Total available-for-sale 1,036,862 52,643 (2,612) 1,086,891 Short-term investments 88,147 88,147 ------------------------------------------------------------ Total investments $1,125,007 $ 52,643 $ (2,612) $1,175,038 ============================================================
The following summarizes the Corporation's aggregate investment portfolio at December 31, 1997:
Gross Gross Amortized Unrealized Unrealized Estimated Cost Gains Losses Fair Value ------------------------------------------------------------ (Dollars in Thousands) Fixed maturity securities available-for-sale: U.S. Treasury securities and obligations of U.S. government agencies $ 85,977 $ 4,089 $ (13) $ 90,053 Obligations of states and political subdivisions 453,326 34,370 - 487,696 Corporate securities 112,595 2,759 (142) 115,212 Mortgage-backed securities 152,720 2,758 (35) 155,443 Asset-backed 64,050 1,477 (9) 65,518 Emerging markets 18,537 160 (196) 18,501 ------------------------------------------------------------ Total available-for-sale 887,205 45,613 (395) 932,423 Short-term investments ------------------------------------------------------------ Total investments 75,500 - - 75,500 ------------------------------------------------------------ $ 962,705 $ 45,613 $ (395) $1,007,923 ============================================================
8. Investments in Securities (continued) The amortized cost and estimated fair value of fixed maturity securities available-for-sale at December 31, 1998, by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Amortized Cost Fair Value ------------------------------- (Dollars in Thousands) Maturity: Due in 1999-2003 $ 138,517 $ 139,476 Due in 2004-2008 131,149 135,588 Due after 2008 576,912 618,207 Mortgage-backed securities 190,284 193,620 =============================== Total $1,036,862 $1,086,891 =============================== In 1998, the Corporation realized gross gains and losses of $8.8 million and ($10.3) million, respectively. Included in realized losses was a $7.5 million write-down in the Corporation's investment in common and preferred shares of CGA, based on management's belief that its investment in CGA had suffered a permanent impairment. After the write-down, the carrying value of the CGA investment was $3.4 million. In 1997, the Corporation realized gross gains and losses of $12.4 million and ($4.4) million, respectively. In 1996, the Corporation realized gross gains and losses of $8.5 million and ($7.0) million, respectively. Approximately 16.4% of the Corporation's total investment portfolio of $1.2 billion at December 31, 1998 is comprised of mortgage-backed securities ("MBS"), including collateralized mortgage obligations. Of the securities in the MBS portfolio, approximately 86.5% are backed by agencies or entities sponsored by the U.S. government. As of December 31, 1998, the weighted average credit quality of the Corporation's entire investment portfolio was AA+. Net investment income is derived from the following sources: Year ended December 31, 1998 1997 1996 -------------------------------- (Dollars in Thousands) Income from fixed maturity securities $ 61,678 $ 51,187 $ 46,207 Income from short-term investments 4,699 6,834 6,351 -------------------------------- Total investment income 66,377 58,139 52,558 Less investment expenses (1,523) (1,523) (1,000) -------------------------------- Net investment income $ 64,854 $ 56,498 $ 51,558 ================================ Under agreements with its cedants and in accordance with statutory requirements, certain of the Corporation's subsidiaries maintain fixed maturity securities in trust accounts for the benefit of 74 8. Investments in Securities (continued) reinsured companies and for the protection of policyholders in states in which they are not licensed. The carrying amount of such restricted balances amounted to approximately $109.2 million and $87.3 million at December 31, 1998 and 1997, respectively. Additionally, at December 31, 1998 and 1997, $4.5 million and $4.1 million, respectively, was on deposit with state insurance departments to satisfy regulatory requirements. 9. Reserves for Unpaid Losses and Loss Adjustment Expenses The following table provides a reconciliation of the beginning and ending reserve balances for unpaid losses and loss adjustment expenses ("LAE").
Year ended December 31, 1998 1997 1996 ------------------------------------- (Dollars in Thousands) Reserve for losses and LAE, net of related reinsurance recoverables, at beginning of year $ 22,555 $ 17,759 $ 10,245 Add: Provision for unpaid losses and LAE for claims occurring in the current year, net of 68,350 13,784 8,370 reinsurance Increase in estimated losses and LAE for claims occurring in prior years, net of reinsurance 6,832 1,849 1,113 ------------------------------------- Incurred losses during the current year, net of reinsurance 75,182 15,633 9,483 ------------------------------------- Deduct: Losses and LAE payments (net of recoverables) for claims occurring in the current year 2,507 985 10 Losses and LAE payments (net of recoverables) for claims occurring in the prior year 10,676 9,852 1,959 ------------------------------------- Total 13,183 10,837 1,969 ------------------------------------- Reserve for unpaid losses and LAE, net of related reinsurance recoverables, at end of year 84,554 22,555 17,759 Unrealized foreign exchange loss (gain) on reserve revaluation 114 (96) 310 Reinsurance recoverables on unpaid losses and LAE, at end of year 3,292 5,527 1,833 ------------------------------------- Reserve for unpaid losses and LAE, gross of reinsurance recoverables on unpaid losses at end of year $ 87,960 $ 27,986 $ 19,902 =====================================
The increase in incurred losses in 1998 were principally from two financial guaranty losses in the amounts of $10.0 million and $44.1 million, as well as expected losses in the mortgage guaranty, trade credit and financial solutions reinsurance lines of business. The financial guaranty losses incurred in 1998 related to two discrete reinsured bond issuances. The $10 million loss was for bonds issued by a now bankrupt hospital system while the $44.1 million was for losses expected on securities backed by charged off credit cards. During 1997, incurred losses were principally 75 9. Reserves for Unpaid Losses and Loss Adjustment Expenses (continued) from the mortgage guaranty and trade credit reinsurance lines of business. Incurred losses in 1996 were caused primarily by increases in reserves estimated for mortgage guaranty losses. The increases for 1997 and 1996 are consistent with the expected loss development patterns for the respective lines of business. 10. Segment Reporting The Corporation provides reinsurance to primary insurers in various specialty insurance markets. For segment reporting purposes, the Corporation's reinsurance lines of business are organized into four discrete segments municipal financial guaranty, nonmunicipal financial guaranty, each of which include credit default swap transactions, mortgage guaranty and trade credit. Two additional lines, financial solutions and title reinsurance are combined into "Other" for segment reporting purposes. Operating procedures and corporate resources are tailored to the business and regulatory needs of each line of business or segment as necessary. In cases where practical, the same procedures and or resources may be utilized for more than one line of business. Financial guaranty insurance of municipal and nonmunicipal debt obligations, is a form of credit enhancement which, as a specialized class of surety, provides for the unconditional and irrevocable guarantee of the obligor's scheduled payment of principal and interest on investment grade municipal and non-municipal debt obligations. The premiums related to municipal bond reinsurance are generally paid in full at the time of policy issuance, credited to a deferred premium account and then recognized as revenues over the life of the reinsured obligation. As a result, only a small portion of annual premium revenue is derived from premiums written in any one year. Given the zero loss underwriting standard, this multi-year revenue translates into an annuity of earned premiums, which is itself supplemented by the investment income derived from the deferred premiums account. Non-municipal financial guaranty premiums are generally paid in installments over the life of the underlying obligation, also providing an annuity of earned premiums. Mortgage guaranty insurance is a specialized class of credit insurance, providing protection to mortgage lenders against default by borrowers on low down-payment residential mortgage loans. For the Corporation's proportional mortgage guaranty business, reinsurance premiums are paid on a monthly basis and fully recognized when written. A certain level of losses is expected in this business. For the non-proportional mortgage guaranty business, premiums are generally paid in full at contract inception and earned over the life, usually ten years. Generally, losses are not expected in this non-proportional mortgage guaranty business. Credit insurance protects suppliers of goods and services from the risk of non-payment by their customers. Some level of losses are also expected in this business. This business is centered on blending participation in excess of loss reinsurance programs with traditional 76 10. Segment Reporting (continued) proportional treaty lines. These contracts are generally of a one year duration and premiums are typically received in installments throughout the coverage period. For purposes of financial planning, resource allocation and performance evaluation, segments are measured based on net underwriting profits and other income directly attributable to the segments. For segment reporting purposes, investment income, net realized gains/losses, operating expenses (i.e., salaries, rent, etc.), interest expense and income taxes are allocated to the segments. The mortgage segment includes equity income from an investment in a subsidiary engaged in mortgage related products. Management does not allocate assets to the Corporation's segments. Rather, assets are managed as a consolidated pool. For marketing purposes, the Corporation aggregates its reinsurance lines of business into two divisions, Financial Guaranty and Financial Risks. The municipal and non-municipal lines including credit default swaps, are combined to represent Financial Guaranty while the Financial Risks division includes mortgage, credit, title and financial solutions. The following tables summarize the operating results of the Corporation's segments:
Year Ended December 31, 1998 Reportable Segments ------------------------------------------------------------------------------- Non Municipal Municipal Mortgage Credit Other Consolidated ------------------------------------------------------------------------------- Gross Written Premiums $ 55,280 $ 39,872 $ 66,802 $ 35,298 $ 16,689 $ 213,941 Ceded Premiums (3,015) (100) (76) (156) 0 (3,347) ------------------------------------------------------------------------------- Written Premiums 52,265 39,772 66,726 35,142 16,689 210,594 Increase in Deferred Premium Revenue (9,310) (19,067) (7,378) (6,454) 0 (42,209) ------------------------------------------------------------------------------- Premiums 42,955 20,705 59,348 28,688 16,689 168,385 ------------------------------------------------------------------------------- Income 0 258 (154) 0 2,967 3,071 ------------------------------------------------------------------------------- Underwriting Revenue and Other Segment Related Income 42,955 20,963 59,194 28,688 19,656 171,456 Losses Incurred 9,966 45,249 3,187 16,780 11,382 86,564 Commissions (Net of DAC) 13,333 3,950 14,131 7,804 (232) 38,986 Profit Commissions 800 (99) 17,101 153 1,270 19,225 ------------------------------------------------------------------------------- Net Underwriting Expense 24,099 49,100 34,419 24,737 12,420 144,775 Net Underwriting Profit (Loss) and Segment Related Income $ 18,856 $ (28,137) $ 24,774 $ 3,951 $ 7,236 $ 26,681
77 10. Segment Reporting (continued)
Year Ended December 31, 1997 Reportable Segments ------------------------------------------------------------------------------- Non Municipal Municipal Mortgage Credit Other Consolidated ------------------------------------------------------------------------------- Gross Written Premiums $ 52,778 $ 16,674 $ 70,752 $ 23,025 $ 6,714 $ 169,943 Ceded Premiums (2,621) (75) (272) (71) (2,629) (5,668) ------------------------------------------------------------------------------- Net Written Premiums 50,157 16,599 70,480 22,954 4,085 164,275 Increase in Deferred Premium Revenue (20,409) (5,197) (17,234) (5,747) (397) (48,984) ------------------------------------------------------------------------------- Earned Premiums 29,748 11,402 53,246 17,207 3,688 115,291 ------------------------------------------------------------------------------- Other Income 115 83 260 0 1,078 1,536 ------------------------------------------------------------------------------- Total Underwriting Revenue and Other Segment Related Income 29,863 11,485 53,506 17,207 4,766 116,827 Losses Incurred (33) 0 7,540 8,126 0 15,633 Commissions (Net of DAC) 9,562 3,112 13,399 3,967 86 30,126 Profit Commissions 210 (119) 4,115 (115) 1,020 5,111 ------------------------------------------------------------------------------- Net Underwriting Expense 9,739 2,993 25,054 11,978 1,106 50,870 Net Underwriting Profit and Other Segment Related Income $ 20,124 $ 8,492 $ 28,452 $ 5,229 $ 3,660 $ 65,957
78 10. Segment Reporting (continued)
Year Ended December 31, 1996 Reportable Segments ------------------------------------------------------------------------------- Non Municipal Municipal Mortgage Credit Other Consolidated Reportable Segments ------------------------------------------------------------------------------- Gross Written Pemiums $ 48,411 $ 10,903 $ 53,682 $ 15,070 $ 1,752 $ 129,818 Ceded Premiums (11,704) 0 (12,746) (180) 0 (24,630) ------------------------------------------------------------------------------- Net Written Premiums 36,707 10,903 40,936 14,890 1,752 105,188 (Increase) Decrease in Deferred Premium Revenue (9,167) (3,704) 2,947 (176) (12,752) ------------------------------------------------------------------------------- Earned Premiums 27,540 7,199 43,883 12,238 1,576 92,436 ------------------------------------------------------------------------------- Other Income 0 0 523 0 0 523 ------------------------------------------------------------------------------- Total Underwriting Revenue and Other Segment Related Income 27,540 7,199 44,406 12,238 1,576 92,959 Losses Incurred (9) 0 3,396 6,096 0 9,483 Commissions (Net of DAC) 6,538 1,266 11,405 3,339 0 22,548 Profit Commissions (146) (135) 5,439 310 540 6,008 ------------------------------------------------------------------------------- Net Underwriting Expense 6,383 1,131 20,240 9,745 540 38,039 Net Underwriting Profit and Other Segment Related Income $ 21,157 $ 6,068 $ 24,166 $ 2,493 $ 1,036 $ 54,920
79 10. Segment Reporting (continued) Year Ended December 31, Reconciliation to Consolidated Results 1998 1997 1996 -------------------------------- (Dollars in Thousands) Net Segment Income $ 26,681 $ 65,957 $ 54,920 Investment Income and Net Realized Gains 63,348 64,535 53,029 Other Income 142 98 290 Operating Expense, net (22,167) (20,002) (17,709) Interest Expense & Minority Int in Subs (13,150) (13,137) (12,603) -------------------------------- Consolidated Income Before Taxes $ 54,854 $ 97,451 $ 77,927 -------------------------------- The majority of the Corporation's gross premiums are for reinsurance risks located in the United States. Remaining gross written premiums are for other worldwide risks with a concentration in western Europe. The following table summarizes the Corporation's gross written premiums on a geographic basis: Geographic Information Gross Written Premium Year Ended December 31, 1998 1997 1996 ------------------------------------------------------------ (Dollars in Thousands) United States $169,699 79.3% $130,842 77.0% $104,727 80.7% Non U.S. 44,242 20.7% 39,101 23.0% 25,091 19.3% ------------------------------------------------------------ $213,941 100.0% $169,943 100.0% $129,818 100.0% 80 10. Segment Reporting (continued) The Corporation derives the majority of its gross written premiums from a small number of primary insurers. The primary insurers which accounted for 10% or more of gross written premiums are as follows: Year Ended December 31, 1998 1997 1996 ------------------------------- Primary insurer MBIA 15.7 12.4 14.9% CMAC 14.6 15.8 15.9 FSA 12.0 11.5 * PMI * * 10.7 FGIC * * 11.9 *Less than 10% Customer concentration occurs as a result of the fact that a large portion of the Corporation's total gross written premiums comes from the financial guaranty and mortgage guaranty reinsurance lines of business. These industries are composed of a small number of primary insurance companies writing primary financial guaranty and mortgage guaranty insurance. 11. Debt and Liquidity Facility Debt consists of: December 31, 1998 1997 -------------------- (Dollars in Thousands) 7.75% debentures due 2002, net of unamortized discount of $0.2 million in 1998 and 1997 ("Debentures") $74,856 $74,819 Bank note payable 25,000 25,000 -------------------- Total $99,856 $99,819 ==================== The Debentures include certain covenants, none of which significantly restrict the Corporation's operating activities or dividend paying ability. During 1996, the Corporation entered into a $25 million credit facility with Chase Manhattan Bank, expiring August 20, 1999. The facility is renewable each year at the option of the Corporation. Interest on the facility is payable semi-annually at a rate equal to the then London Interbank offered rate plus 40 basis points. 81 11. Debt and Liquidity Facility (continued) Capital Reinsurance is party to a credit facility with Deutsche Bank AG pursuant to which Deutsche Bank AG provides up to $100 million specifically designed to provide rating agency qualified capital to further support Capital Reinsurance's claims-paying resources. This agreement expires January 27, 2006. During 1998, 1997 and 1996, the Corporation paid total interest of approximately $7.4 million, $7.4 million and $6.9 million, respectively. 12. Income Taxes The Corporation and its subsidiaries file a consolidated federal income tax return. The Corporation's effective federal corporate tax rate for 1998, 1997 and 1996 was 19.4%, 27.3% and 26.7%, respectively. A reconciliation from the tax provision calculated at the federal statutory rate of 35% in 1998, 1997 and 1996, to the total tax is as follows: Year ended December 31, 1998 1997 1996 ---------------------------------- (Dollars in Thousands) Tax provision at statutory rate $ 19,199 $ 34,107 $ 27,274 Tax-exempt interest (8,436) (7,751) (6,710) Other (96) 277 349 ---------------------------------- Total federal income tax provision $ 10,667 $ 26,633 $ 20,913 ================================== The liability for deferred federal income taxes reflects the tax effect of the following temporary differences: December 31, 1998 1997 ----------------------- (Dollars in Thousands) Deferral of acquisition costs $ 47,260 $ 44,673 Contingency reserve 33,437 33,437 Deferred premium revenue 4,834 1,517 Unrealized gain on fixed maturity securities available-for-sale 17,511 15,826 Investment writedown (2,663) Deferred compensation 0 (1,397) Other (107) (1,223) ----------------------- Effects of temporary differences 100,272 92,833 Credit for alternative minimum tax carryforwards (2,298) (1,217) Tax and loss bonds (18,737) (18,737) ----------------------- Liability for deferred federal income taxes $ 79,237 $ 72,879 ======================= 82 12. Income Taxes (continued) Income taxes paid during 1998, 1997 and 1996 were approximately $16.1 million, $18.9 million and $7.9 million, respectively. 13. Reinsurance Ceded To limit its exposure on assumed risks, the Corporation enters into certain proportional and nonproportional retrocessional agreements that cede a portion of risks underwritten to other insurance companies. In the event that any or all of the reinsurers were unable to meet their obligations, the Corporation would be liable for such defaulted amounts. For the years ended December 31, 1998, 1997 and 1996, ceded earned premiums were $13.7 million, $17.8 million and $14.7 million, respectively. Ceded losses for the same periods were $4.8 million, $6.6 million and $6.5 million, respectively. During 1993, Capital Reinsurance entered into a multi-year nonproportional reinsurance contract which provides for aggregate loss protection of $80.0 million in exchange for $19.5 million of premium. Additional premiums may become payable dependent upon the level of losses incurred. During 1993, Capital Credit entered into similar multi-year reinsurance contracts which provide for aggregate loss protection of $34.0 million in exchange for $4.25 million in premiums. Additional premiums may also become payable dependent upon the level of losses incurred. During 1994, Capital Reinsurance entered into a portfolio excess of loss reinsurance contract which provides $100.0 million aggregate loss protection on specified municipal obligations in excess of $82.0 million of losses. Capital Mortgage entered into a similar portfolio excess of loss reinsurance contract which provides $30.0 million aggregate loss protection in excess of a specified loss ratio covering all reinsured obligations. Premiums due on both contracts are not dependent upon the level of losses incurred. During 1995, Capital Mortgage entered into an assumption agreement whereby it provides excess of loss reinsurance on an existing portfolio of mortgage pool insurance. In connection with this assumed transaction, Capital Mortgage is required to cede a portion of the risks, thereby reducing its total net retention. Total ceded premiums under the contract were approximately $21.0 million. Total expected assumed premiums of $56.0 million are payable in seven annual installments of $8.0 million. As of December 31, 1998, the Corporation has received four of the seven installments. Contingent commissions will be payable on the assumed reinsurance and receivable on the ceded reinsurance, dependent upon the level of losses incurred under the contract. 14. Fair Values of Financial Instruments The following methods and assumptions were used by the Corporation in estimating its fair value disclosure for financial instruments. These determinations were made based on available market information and appropriate valuation methodologies. Considerable judgment is required to interpret market data to develop the estimates and therefore, they may not necessarily be indicative of the amount the Corporation could realize in a current market exchange. 83 14. Fair Values of Financial Instruments (continued) Cash and Short-term Investments The carrying amount reported in the balance sheet for these instruments approximates fair value. Fixed Maturity Securities The fair value for fixed maturity securities shown in Note 8 is based on quoted market prices. Deferred Premium Revenue The fair value of the Corporation's deferred premium revenue is based on entering into a cession of the entire portfolio with third party reinsurers under market conditions. This figure was determined by using the statutory basis unearned premium reserve, net of commissions, and the present value of the estimated future cash flow stream from installment premiums. At December 31, 1998, the fair value of the Corporation's net deferred premium revenue was estimated to be $361.5 million. Reserve for Losses and Loss Adjustment Expenses, Net of Reinsurance Recoverable on Ceded Losses For financial guaranty losses, the carrying amount is composed of the present value of the expected cash flows for case basis claims and therefore represents the best estimate of fair value. The short-term nature of losses from the remaining lines of business indicate that the carrying value represents the best estimate of fair value. Accordingly, for all lines, the carrying amount is deemed the best estimate of fair value as of December 31, 1998. Debt The fair value of the Corporation's $75.0 million of outstanding Debentures is determined based on the projected cash flows discounted by the sum of the seven-year U.S. treasury yield at December 31, 1998 and the appropriate credit spread for similar debt instruments. At December 31, 1998, the fair value of the Corporation's Debentures was estimated to be $80.2 million. The carrying amount of the Corporation's bank note payable of $25 million approximates fair value due to its floating interest rate provision. Preferred Securities of Capital Re LLC The fair value of the Corporation's $75.0 million Company obligated mandatorily redeemable preferred securities of Capital Re LLC at December 31, 1998 was $74.6 million based on the closing price per share on the New York Stock Exchange at that date. 15. Dividends Under Maryland's insurance law, the amount of surplus available for distribution as dividends is subject to certain statutory provisions, which generally prohibit the payment of dividends in any 84 15. Dividends (continued) twelve-month period without prior approval of the Maryland Commissioner of Insurance in an amount exceeding 10% of policyholder's surplus at the preceding December 31. The amount available for distribution from Capital Reinsurance during 1998 with notice to, but without prior approval of, the Maryland Commissioner of Insurance under the Maryland insurance law is approximately $32.3 million. During 1998, Capital Reinsurance paid dividends in the amount of $8.0 million to the Corporation. Capital Credit's and KRE's dividend distributions are governed by Bermuda law. Under Bermuda law and the By-Laws of Capital Credit and KRE, dividends may be paid out of the profits of Capital Credit and KRE (defined as accumulated realized profits less accumulated realized losses). Distributions to shareholders may also be paid out of Capital Credit's and KRE's surplus limited by requirements that Capital Credit and KRE must at all times (i) maintain the minimum share capital required under Bermuda law and (ii) have relevant assets in an amount equal to or greater than 75% of relevant liabilities, all as defined under Bermuda law. Since its organization, KRE has not declared or paid any dividends. During 1998 Capital Credit paid $4.0 million to the Corporation. Under New York Insurance Law, as a mortgage guaranty insurance corporation, Capital Mortgage may not pay dividends except from earned surplus as defined by New York Insurance Law. Capital Mortgage is further restricted from paying dividends to the extent that any dividend paid to shareholders which, together with all dividends declared or distributed by it during the preceding twelve months, exceeds the lesser of 10% of its surplus to policyholders as shown by its last statement on file with the superintendent, or 100% of adjusted net investment income during such period unless specifically allowed by the superintendent. To date, Capital Mortgage has not declared or paid any dividends. The maximum dividend payable by Capital Mortgage during 1998 is $0 since its earned surplus was ($9.2) million as of December 31, 1998. Capital Title is subject to the New York Insurance Law laws and regulations governing title insurers. Accordingly, dividends may only be declared and distributed out of earned surplus as defined under New York Insurance Law and only if such dividends do not reduce the company's surplus to less than 50% of its outstanding capital shares, i.e., the value of its outstanding common equity. Additionally, no dividend may be declared or distributed in an amount which, together with all dividends declared or distributed by the company during the preceding twelve months, exceeds 10% of the company's outstanding capital shares, unless, after deducting such dividends, it has a surplus at least equal to 50% of its statutory reinsurance reserve or a surplus at least equal to $250,000, whichever is greater. As of December 31, 1998, Capital Title's maximum amount payable as a dividend during 1998 is approximately $3.6 million. 85 16. Commitments At December 31, 1998, future minimum rental payments under the terms of the Corporation's noncancellable operating leases for office space are $1.2 million for the year 1999, $1.4 million for each of the years 2000, 2001, 2002, and 2003, and $8.0 million in the aggregate thereafter. These future minimum rental payments total $14.8 million. These payments are subject to escalations in building operating costs and real estate taxes. Total rent expense amounted to approximately $1.0 million in 1998 and 1997 and $0.9 million in 1996. As part of the Corporation's agreement to invest in CGA, it has also committed to invest an additional $7.5 million in the form of the purchase of common shares in the event that maintenance of Commercial Guaranty Assurance Ltd.'s triple A rating from Duff & Phelps make such action necessary. The Corporation participates in the Lloyd's of London insurance market through its corporate name, CRC Capital Ltd. At the Corporation's direction, a letter of credit has been provided to Lloyd's in satisfaction of CRC Capital's capital requirement. All corporate capital providers are required by Lloyd's to post funds at Lloyd's equal to a fixed percentage of the amount of committed insurance capacity. For the year ended December 31, 1998, the total amount of insurance capacity committed by CRC Capital was British Pound Sterling 88.2 million, and CRC Capital's Funds at Lloyd's requirement was 50% of that amount and was supported by a letter of credit for British Pound Sterling 44.1 million. For the 1999 year, the Corporation increased its insurance capacity commitment to British Pound Sterling 95.0 million which is supported by a letter of credit of British Pound Sterling 47.5 million. 17. Capital Re LLC In January 1994, the Corporation formed and capitalized Capital Re LLC, a limited liability company organized under the laws of the Turks and Caicos Islands. Additionally, in January 1994, Capital Re LLC issued $75,000,000, 7.65% of cumulative monthly income preferred shares, the proceeds of which were loaned to the Corporation. The preferred shares were issued at $25 par value per share and are shown on the balance sheet under the caption "Company obligated mandatorily redeemable preferred securities of Capital Re LLC." The Corporation guarantees the payment of the monthly dividend as well as any amounts upon liquidation or redemption which cannot occur prior to January 31, 1999, at the Corporation's discretion. The Corporation has no plans to exercise its redemption option in the near or midterm. Capital Re LLC exists solely for the purpose of issuing preferred and common shares and lending the proceeds to the Corporation to fund its business operations. The total amount paid to preferred shareholders for each of the years ended 1998, 1997 and 1996 was approximately $5.7 million and is shown on the income statement under the caption "Minority interest in Capital Re LLC." 18. Compensation Plans Prior to its initial public offering, the Corporation had a stock incentive plan wherein eligible employees were granted shares of restricted common stock. Shares awarded under the Plan amounted to 696,000 at December 31, 1991. For these awards, the difference between the price paid by the employees and the market value of the award at the date of grant, if any, was recorded 86 18. Compensation Plans (continued) as deferred compensation and was amortized ratably over the four-year vesting period. Upon completion of the initial public offering in 1992, these shares became vested and all restrictions lapsed. To enable recipients of awards under the stock incentive plan to meet tax obligations which may have resulted from such awards, the Corporation agreed to make loans to recipients, payable upon ultimate disposition of their shares or three years after their termination of employment. As of December 31, 1998 and 1997, total loans outstanding under all officer loan programs were approximately $0.9 million and $1.64 million, respectively, and are included under the caption "Other assets." On April 15, 1992, the Corporation adopted the 1992 Stock Option Plan (the "1992 Option Plan"). The 1992 Option Plan enables key employees to benefit from appreciation in the price of the common stock of the Corporation. The 1992 Option Plan provides for grants of incentive stock options ("ISO"), which are intended to qualify under Section 422 of the Internal Revenue Code and of options which are intended not to so qualify ("NQSO"). Under the 1992 Option Plan, options may be granted at a price not less than 100% of the fair market value as determined on the date granted. ISO's and NQSO's awarded, vest in four equal yearly installments commencing one year after the date of grant. Once vested, options may be exercised at any time and expire ten years from the date of grant. According to the terms of the 1992 Option Plan, the aggregate number of shares subject to option awards may not exceed 1,450,000. During 1997, the Corporation adopted the 1997 Stock Option Plan ("1997 Plan"). The terms of the 1997 Plan are similar to those of the 1992 Option Plan, however, the number of shares subject to option award shall not exceed 1,000,000. In 1993, the Corporation also adopted a stock option plan (the "Director's Plan") for the benefit of its outside directors. The terms of the plan are similar to those of the employee plan except that options become fully vested at the time of grant. According to the terms of the Director's Plan, the aggregate number of shares subject to option award shall not exceed 30,000. The Corporation has elected to follow Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" (APB 25) and related interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation," requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Corporation's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Pro forma information regarding net income and earnings per share is required by Statement 123, and has been determined as if the Corporation had accounted for its employee stock options under the fair value method of that statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1998, 1997 and 1996, respectively: risk-free interest rates of 5.5%, 6.3% and 5.4%; dividend yields of .53%,.67% and .80%; volatility factors of the expected market price of 87 18. Compensation Plans (continued) the Corporation's common stock of 21.35, 23.37 and 19.10; and an expected life of the options of 7 years. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Corporation's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' expected lives. The Corporation's pro forma information follows (in thousands, except for per share information): Year Ended December 31, ------------------------------ 1998 1997 1996 ------------------------------ Pro forma net income $ 40,080 $ 69,052 $ 56,030 Pro forma basic earnings per common share $ 1.26 $ 2.18 $ 1.79 Pro forma diluted earnings per common share $ 1.23 $ 2.12 $ 1.76 A summary of the Corporation's stock option activity, and related information for the years ended December 31 follows:
1998 1997 1996 ---------------------- ----------------------- --------------------- Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price ---------------------------------------------------------------------- Outstanding, beginning of year 2,363,150 $14.54 1,937,200 $12.00 1,816,000 $10.39 Granted 457,800 30.05 605,000 21.70 555,000 15.75 Exercised (102,245) 16.54 (161,950) 10.99 (411,174) 9.85 Forfeited (171,250) 20.67 (17,100) 14.52 (22,626) 13.25 ---------------------------------------------------------------------- Outstanding, end of year 2,547,455 $16.83 2,363,150 $14.54 1,937,200 $12.01 ====================================================================== Exercisable, end of year 1,436,676 $12.19 1,041,950 $10.98 844,894 $10.13 ======================================================================
1998 1997 1996 ----------------------------- Weighted-average fair value of options granted during the year $10.89 $8.50 $5.21 - -------------------------------------------------------------------------- 88 18. Compensation Plans (continued) Exercise prices for options outstanding as of December 31, 1998 ranged from $9.75 to $37.81. The weighted-average remaining contractual life of those options is approximately 6.0 years. In 1996, the Corporation adopted a performance share plan for the benefit of senior executives of the Corporation. The plan is intended to align senior management with the interest of the shareholders. To achieve this objective, the plan ties awards granted under the plan with earning per share growth and with total shareholder return and share price. Awards under the plan are payable on December 31, 1999 and December 31, 2001. The Corporation recognized $3.0 million and $1.0 million in deferred compensation expense for the years ended December 31, 1997 and 1996. As of December 31, 1998, because the relevant targets had not been met, no accrued expense was recognized and expenses recognized in 1997 and 1996 were reversed. The Corporation maintains a savings incentive plan which is qualified under Section 401 of the Internal Revenue Code. The savings incentive plan is available to all full-time employees with a minimum of six months of service. Eligible participants may contribute 9% of their base salary subject to a maximum of $10,000 for 1998. Contributions are matched by the Corporation at a rate of 100%, up to 7% of the participants' contribution subject to certain limitations and vest at a rate of 25% per year starting with the second year of service. The Corporation contributed approximately $0.4 million in 1998 and $0.3 million in 1997 and 1996. The Corporation also maintains a profit sharing plan which is available to all full-time employees with a minimum of six months of service. Annual contributions to the plan are at the discretion of the Board of Directors. The plan contains a qualified portion and a nonqualified portion. Total expense incurred under the plan amounted to approximately $0.3 million in 1998, 1997 and 1996. The Corporation does not provide health care or life insurance benefits to retirees. 89 19. Quarterly Financial Summary (Unaudited)*
1st 2nd 3rd 4th Quarter Quarter Quarter Quarter Year ----------------------------------------------------------------- (Dollars in Thousands Except Per Share Amounts) 1998 Gross written premiums $ 62,127 $ 55,804 $ 41,435 $ 54,575 $213,941 Net written premiums 61,046 55,365 40,625 53,558 210,594 Earned premiums 43,731 39,225 46,215 39,214 168,385 Net investment income and net realized gains 17,045 17,468 18,261 10,574 63,348 Income (loss) before provision for federal income tax 27,828 27,536 18,583 (19,092) 54,855 Net income (loss) from continuing operations 20,274 19,681 14,335 (10,102) 44,187 Net income (loss) 19,795 20,184 14,470 (12,906) 41,542 - ------------------------------------------------------------------------------------------------------------------------------------ Basic net income (loss) from continuing operations per common share $0.64 $0.62 $0.45 ($0.32) $1.39 Diluted net income (loss) from continuing operations per share $0.53 $0.49 $0.44 ($0.31) $1.35 - ------------------------------------------------------------------------------------------------------------------------------------ Basic net income (loss) per common share $0.62 $0.63 $0.45 ($0.40) $1.30 Diluted net income (loss) per share $0.61 $0.62 $0.44 ($0.40) $1.27 - ------------------------------------------------------------------------------------------------------------------------------------ 1997 Gross written premiums $ 44,110 $ 45,586 $ 42,843 $ 37,404 $169,943 Net written premiums 41,783 45,172 40,035 37,285 164,275 Earned premiums 28,806 27,922 31,513 27,050 115,291 Net investment income and net realized gains 16,586 13,773 16,880 17,296 64,535 Income before provision for federal income tax 24,320 22,472 25,153 25,503 97,451 Net income from continuing operations 17,320 15,849 18,463 19,185 70,818 Net income 17,136 16,109 18,256 18,550 70,052 - ------------------------------------------------------------------------------------------------------------------------------------ Basic net income from continuing operations per common share $0.55 $0.50 $0.58 $0.60 $2.23 Diluted net income from continuing operations per share $0.53 $0.49 $0.57 $0.59 $2.18 - ------------------------------------------------------------------------------------------------------------------------------------ Basic net income per common share $0.54 $0.51 $0.58 $0.58 $2.21 Diluted net income per share $0.53 $0.50 $0.56 $0.57 $2.16 1996 Gross written premiums $ 34,255 $ 30,957 $ 43,220 $ 21,386 $129,818 Net written premiums 18,060 26,902 40,500 19,726 105,188 Earned premiums 20,104 22,322 22,005 28,005 92,436 Net investment income and net realized gains 12,191 11,781 12,781 16,276 53,029 Income before provision for federal income tax 17,193 18,207 18,808 23,778 77,927 Net income from continuing operations 12,767 13,285 13,955 17,008 57,014 Net income 12,767 13,285 13,955 16,517 56,524 - ------------------------------------------------------------------------------------------------------------------------------------ Basic net income from continuing operations per common share $0.42 $0.43 $0.44 $0.53 $1.82 Diluted net income from continuing operations per common share $0.42 $0.42 $0.44 $0.53 $1.79 - ------------------------------------------------------------------------------------------------------------------------------------ Basic net income per common share $0.42 $0.43 $0.44 $0.52 $1.81 Diluted net income per share $0.42 $0.42 $0.44 $0.51 $1.77
* Numbers may not add due to rounding. 90 20. Subsequent Event In February 1999, ACE Bermuda Insurance Ltd., a subsidiary of ACE Limited, agreed to invest $75 million in the Corporation through a purchase of common stock. The proceeds will be used to augment the surplus of the Corporation's operating subsidiaries. Under the stock purchase agreement, as amended, the purchase price is determined as the lower of (i) fully diluted GAAP book value per share at December 31, 1998 (or $18.87 per share) and (ii) the average of the highest five consecutive market closing prices of the Corporation's common stock from March 12, 1999 through April 15, 1999. Closing is contingent on customary conditions and the affirmation of S&P's financial strength ratings of the Corporation's major subsidiaries. 91 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None. PART III Item 10. Directors and Executive Officers of the Registrant. The information concerning directors set forth under "Election of Directors" in the Company's 1999 Proxy Statement is incorporated herein by reference. Information concerning executive officers is set forth under PART I, Item 1 "BUSINESS OF CAPITAL RE: Executive Officers" in this report. Item 11. Executive Compensation. The information concerning compensation of the Company's executive officers set forth in the Company's 1999 Proxy Statement is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management. The information concerning security ownership of certain beneficial owners and management set forth in the Company's 1999 Proxy Statement is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions. The information concerning certain relationships and related transactions set forth in the Company's 1999 Proxy Statement is incorporated herein by reference. 92 PART IV Item 14. (a) Financial Statements, Financial Statement Schedules and Exhibits. 1. Financial Statements The following consolidated financial statements of the Company are filed as part of this Report in Item 8: CAPITAL RE CORPORATION AND SUBSIDIARIES Report of Independent Auditors Consolidated Balance Sheets at December 31, 1998 and 1997 Consolidated Statements of Income For the Years Ended December 31, 1998, 1997 and 1996 Consolidated Statements of Comprehensive Income for the Years Ended December 31, 1998, 1997 and 1996 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1998, 1997 and 1996 Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996 Notes to Consolidated Financial Statements 2. Financial Statement Schedules The following Financial Statement Schedules are filed as part of this Report: Schedule Title -------- ----- II Condensed Financial Information of Registrant IV Reinsurance The report of the Registrant's independent auditors with respect to the above listed financial statement schedules is set forth in Exhibit 23.01 of this Report. All other schedules are omitted because they are either inapplicable or the required information is presented in the consolidated financial statements of the Company or the notes thereto. 3. Exhibits The following are annexed as exhibits to this Report: Exhibit No. Exhibit ----------- ------- 3.01 Certificate of Incorporation of the Company, dated December 3, 1991, 1992 (Filed as exhibit 3.01 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference) 3.02 By-laws of the Company (Filed as exhibit 3.02 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference) 93 3.03 Certificate of Ownership and Merger of Capital Re Delaware Corporation and Capital Re Corporation (Filed as exhibit 3.03 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference) 4.01 Specimen Stock Certificate representing shares of Common Stock (Filed as exhibit 4.01 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference) 4.02 Form of Indenture between the Company and Morgan Guaranty Trust Company of New York, as Trustee including form of specimen Debenture (Filed as exhibit 4.01 to the Company's Registration Statement on Form S-1 (Reg. No. 33-53618) and incorporated herein by reference) 4.03 Form of Subordinated Promissory Notes (Filed as Exhibits 10.01 - 10.03 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 (Comm. File No. 1-10995) and incorporated herein by reference) 4.04 Form of Payment and Guarantee Agreement between Capital Re LLC and the Company (Filed as exhibit 4.1 to the Company's Registration Statement on Form S-3 (Reg. No. 33-72090) and incorporated herein by reference) 4.05 Form of the Declaration of Terms of Capital Re LLC 7.65% Cumulative Monthly Income Preferred Shares, Series A (Filed as exhibit 4.2 to the Company's Registration Statement on Form S-3 (Reg. No. 33-72090) and incorporated herein by reference) 4.06 Form of Liability Assumption Agreement between Capital Re LLC and Capital Re Corporation (Filed as exhibit 99.2 to the Company's Registration Statement on Form S-3 (Reg. No. 33-72090) and incorporated herein by reference) 4.07 Form of Loan Agreement between Capital Re LLC and Capital Re Corporation (Filed as exhibit 99.1 to the Company's Registration Statement on Form S-3 (Reg. No. 33-72090) and incorporated herein by reference) 4.08 $25 Million Credit Facility between the Company, Various Banks and Deutsche Bank AG, as Agent (Filed as Exhibit 4.08 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (Comm. File No. 1-10995) and incorporated herein by reference) 4.09 $75 Million Credit Facility between Capital Reinsurance, Various Banks and Deutsche Bank AG, as Agent (Filed as Exhibit 4.09 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (Comm. File No. 1-10995) and incorporated herein by reference) 4.10 $25 Million Credit Facility between the Company, Various Banks and The Chase Manhattan Bank, as Agent, dated August 20, 1996 (Filed as Exhibit 4.10 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (Comm. File No. 1-10995) and incorporated herein by reference). 94 4.11 Amendment dated as of March 22, 1999 to $100 Million Credit Facility between Capital Reinsurance, Various Banks and Deutsche Bank AG, as Agent. 9.01 Stockholders' Agreement dated as of January 17, 1992 by and among the Company, its institutional stockholders and certain of its management stockholders (Filed as exhibit 9.01 to the Company's Registration Statement on Form S-1 (Reg. No. 33-53618) and incorporated herein by reference) 9.02 First Amendment to Capital Re Corporation 1992 Stockholders Agreement dated December 28, 1992 (Filed as exhibit 9.03 to the Company's Annual Report on From 10-K for the fiscal year ended December 31, 1992 and incorporated herein by reference) 9.03 Modification of Credit Re Corporation Stockholders Agreement dated August 20, 1993 (Filed as Exhibit 10.31 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (Comm. File No. 1-10995) and incorporated herein by reference) * 10.01 Capital Re Corporation 1988 Stock Incentive Plan, as amended (the "1988 Plan") (Filed as exhibit 10.04 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference) 10.02 Form of 1988 Stock Incentive Plan Agreement (Filed as exhibit 10.05 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference) 10.03 Forms of Tax Equalization Loan Agreements related to 1988 Plan (Filed as exhibit 10.06 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference) 10.04 Form of Indemnity Agreement related to 1988 Plan (Filed as exhibit 10.07 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference) 10.05 1992 Stock Option Plan and related form of Non-Qualified Stock Option Agreement (Filed as exhibit 10.11 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45286) and incorporated herein by reference) 10.06 Lease Agreement for the Company's principal office between Capital Reinsurance Company and 1325 Limited Partnership (Filed as Exhibit 10.29 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992 (Comm. File No. 1-10995) and incorporated herein by reference) * 10.07 Capital Re Corporation Directors' Stock Option Plan (Filed as Exhibit 10.26 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (Comm. File No. 1-10995) and incorporated herein by reference) * 95 10.08 Capital Re Corporation Deferred Compensation Plan. (Filed as Exhibit 10.37 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995 (Comm. File No. 1-10995) and incorporated herein by reference) 10.09 Capital Re Corporation Non-Qualified Profit Sharing Plan. (Filed as Exhibit 10.38 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995 (Comm. File No. 1-10995) and incorporated herein by reference) 10.10 Capital Re Corporation Performance Share Plan (Filed as Exhibit 10.39 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (Comm. File No. 1-10995) and incorporated herein by reference). 10.11 1997 Employee Stock Option Plan (Filed as Appendix A to the Company's definitive proxy statement for the 1997 annual meeting of the Company's shareholders and incorporated herein by reference) 10.12 Annual Incentive Plan for Covered Executive Officers (Filed as Appendix C to the Company's definitive proxy statement for the 1997 annual meeting of the Company's shareholders and incorporated herein by reference) 10.13 Employment Agreement between the Company and Jerome F. Jurschak dated February 2, 1999. 10.14 Employment Agreement between the Company and Joseph W. Swain III dated February 2, 1999. 10.15 Employment Agreement between the Company and David A. Buzen dated February 2, 1999. 10.16 Employment Agreement between the Company and Laurence C.D. Donnelly dated February 2, 1999. 10.17 Employment Agreement between the Company and Alan S. Roseman dated February 2, 1999. 10.18 Amendment Number 1 to 1997 Employee Stock Option Plan 10.19 Stock Purchase Agreement dated as of February 19, 1999 by and between the Company and Ace Bermuda Insurance, Ltd. 10.20 First Amendment, dated as of March 16, 1999, to the Stock Purchase Agreement dated as of February 19, 1999 by and between the Company and Ace Bermuda Insurance, Ltd. 11.01 Statement Re: Computation of Per Share Earnings 21.01 Subsidiaries of Registrant 23.01 Consent of Ernst & Young LLP, Independent Auditors 96 24.01 Power of Attorney of the Board of Directors 27.01 Financial Data Schedule as of December 31, 1998 ---------- * Confidential treatment was afforded, or has been requested, for certain portions of these agreements (b) Reports on Form 8-K None. 97 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: March 30, 1999 CAPITAL RE CORPORATION (Registrant) By: /s/ Alan S. Roseman -------------------------------- Name: Alan S. Roseman Title: Executive Vice President, General Counsel and Secretary Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Name Title Date - ---- ----- ---- Jerome F. Jurschak* Chairman of the Board and March 30, 1999 Chief Executive Officer (Principal Executive Officer) David A. Buzen* Executive Vice President and March 30, 1999 Chief Financial Officer (Principal Financial and Accounting Officer) Harrison Conrad* Director March 30, 1999 Richard L. Huber* Director March 30, 1999 Jerome F. Jurschak* Director March 30, 1999 Steven D. Kesler* Director March 30, 1999 Philip Robinson* Director March 30, 1999 Edwin Russell* Director March 30, 1999 Dan R. Skowronski* Director March 30, 1999 Barbara Stewart* Director March 30, 1999 Jeffrey F. Stuermer* Director March 30, 1999 Joseph W. Swain III* Director March 30, 1999 - ---------- *Alan S. Roseman, by signing his name hereto, does hereby sign this Annual Report on Form 10-K on behalf of each of the Directors and Officers of the Company named above pursuant to powers of attorney duly executed by such Directors and Officers and filed with the Securities and Exchange Commission as an exhibit to this report. By: /s/ Alan S. Roseman --------------------------------- Alan S. Roseman, Attorney-in-fact 98 Schedule II - Condensed Financial Information of Registrant Capital Re Corporation December 31, 1998 (Dollars in thousands) Condensed Balance Sheets As of As of December 31, December 31, 1998 1997 ------------ ------------ Assets Investment in affiliates $794,494 $748,465 Net Assets of Discontinued Operations 11,695 17,046 -------- -------- Total Assets $806,189 $765,511 ======== ======== Liabilities and Stockholders' Equity Long-term debt $74,856 $74,819 Bank note payable 25,000 25,000 Intercompany balance with affiliates 95,315 94,946 Other Liabilities 192 1,803 Stockholders' Equity 610,826 568,943 -------- -------- Total Liabilities and Stockholders' Equity $806,189 $765,511 ======== ========
Year Ended Year Ended Year Ended December 31, December 31, December 31, 1998 1997 1996 ------------ ------------ ------------ Condensed Statements of Income Revenues $315 $241 $183 Expenses 15,462 16,376 13,564 -------- -------- -------- Total Operating (Loss) (15,147) (16,135) (13,381) Equity in net income of affiliates 54,376 81,578 66,062 -------- -------- -------- Income before income tax (benefit) 39,229 65,443 52,681 Income tax (benefit) (4,958) (5,375) (4,333) -------- -------- -------- Net Income from Continuing Operations $44,187 $70,818 $57,014 ======== ======== ======== Income from Discontinued Operations ($2,645) ($766) ($490) -------- -------- -------- Net Income $41,542 $70,052 $56,524 ======== ======== ========
See accompanying notes to Condensed Financial Statements
Year Ended Year Ended Year Ended December 31, December 31, December 31, 1998 1997 1996 ------------ ------------ ------------ Condensed Statements of Cash Flows Operating Activities Net Income $41,542 $70,052 $56,524 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Equity in net income of affiliates (54,376) (81,578) (66,062) Dividends received from subsidiary 12,000 8,000 17,500 Other 1,940 6,925 645 Discontinued operations, net 12,846 6,730 (2,162) -------- -------- -------- Net cash provided by/(used in) operating activities 13,952 10,129 6,445 Investing Activities Investment in affiliates 0 0 (25,402) Maturities (purchases) of short-term investments, net 0 0 0 Discontinued operations, net (7,320) (5,553) (24,354) -------- -------- -------- Net cash used in investing activities (7,320) (5,553) (49,756) Financing Activities Proceeds from issuance of stock 2,283 2,636 30,881 Net proceeds from issuance of bank note payable 0 0 9,000 Dividends paid to stockholders' (5,102) (4,606) (3,945) Purchase of treasury stock, at cost 0 (1,021) (232) Discontinued operations, net (190) (23) 8,395 -------- -------- -------- Net cash provided by/(used in) financing activities (3,009) (3,014) 44,009 (Decrease)/Increase in cash 3,623 1,562 787 Cash at beginning of year 2,512 950 162 -------- -------- -------- Cash at end year $6,135 $2,512 $950 ======== ======== ========
See accompanying notes to Condensed Financial Statements Schedule II - Condensed Financial Information of Registrant - continued Capital Re Corporation December 31, 1998 Notes to Condensed Financial Statements The accompanying condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto of Capital Re Corporation and Subsidiaries. The long-term debt of $74.9 million is senior unsecured debentures. See Note 11 to the consolidated financial statements of Capital Re Corporation and Subsidiaries for a description of Capital Re Corporation's debt. Of the $95.3 million intercompany balance with subsidiary, $94.9 million is a loan between the Corporation and its subsidiary, Capital Re LLC, a limited life company organized under the laws of Turks and Caicos Islands. The $94.9 million loan consists of $75.0 million of proceeds received from the issuance of Company obligated mandatorily redeemable preferred securities of Capital Re LLC as well as the Corporation's $19.9 million common stock investment in Capital Re LLC. See Note 17 to the consolidated financial statements of Capital Re Corporation and Subsidiaries for an explanation of the loan. The Corporation reflects its investment in its Lloyd's operations as a discontinued operation, since in 1998 it commenced a plan divestiture. For comparative purposes, all prior periods have been restated. CAPITAL RE CORPORATION Schedule IV - Reinsurance (dollars in thousands)
Premiums Percentage Property Ceded to Assumed of Amount and Gross Other from Other Net Assumed to Liability Amount Companies Companies Amount Net --------- ------ --------- --------- ------ --- 1998 $0 $3,347 $213,941 $210,594 101.6% 1997 $0 $5,668 $169,943 $164,275 103.5% 1996 $0 $24,630 $129,818 $105,188 123.5%
EX-4.11 2 AMENDMENT TO THE CREDIT AGREEMENT MARCH 1999 AMENDMENT TO THE CREDIT AGREEMENT MARCH 1999 AMENDMENT TO THE CREDIT AGREEMENT (this "Amendment"), dated as of March 22, 1999, among Capital Reinsurance Company (the "Borrower"), various banks (the "Banks") and Deutsche Bank AG, New York Branch, as agent (the "Agent"). All capitalized terms defined in the hereinafter defined Credit Agreement shall have the same meaning when used herein unless otherwise defined herein. W I T N E S S E T H: WHEREAS, the Borrower, the Banks and the Agent entered into a Credit Agreement, dated as of January 27, 1994 (as amended to date, the "Credit Agreement"); WHEREAS, the parties hereto wish to amend the Credit Agreement as herein provided; NOW, THEREFORE, in consideration of the premises and the mutual covenants herein contained, the parties hereto hereby agree as follows: 1. Amendments to the Credit Agreement. (a) The first sentence of Section 3.04 of the Credit Agreement is hereby amended in its entirety to read as follows: The expiration of the Commitments of the Banks shall be January 27, 2006 (the "Expiry Date"); provided, however, that before (but not earlier than 120 days nor later than 45 days before) each anniversary of the Effective Date, the Borrower may make a written request (an "Extension Request") to the Agent at its Notice Office and each of the Banks that the Expiry Date be extended by one calendar year. (b) Schedule I of the Credit Agreement is hereby amended in its entirety to the form attached hereto as Annex A. 2. Representations and Warranties. In order to induce the Banks and the Agent to enter into this Amendment, the Borrower hereby represents and warrants that: (a) no Default or Event of Default exists or will exist as of the date hereof and after giving effect to this Amendment; and (b) as of the date hereof, after giving effect to this Amendment, all representations, warranties and agreements of the Borrower contained in the Credit Agreement will be true and correct in all material respects. 3. GOVERNING LAW. THIS AMENDMENT AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES HEREUNDER SHALL BE CONSTRUED IN ACCORDANCE WITH AND BE GOVERNED BY THE LAW OF THE STATE OF NEW YORK, WITHOUT REGARD TO THE CHOICE OF LAW PROVISIONS THEREOF. 4. Agreement Not Otherwise Amended. This Amendment is limited precisely as written and shall not be deemed to be an amendment, consent, waiver or modification of any other term or condition of the Credit Agreement or any of the instruments or agreements referred to therein, or prejudice any right or rights which the Banks, the Agent or any of them now have or may have in the future under or in connection with the Credit Agreement or any of the instruments or agreements referred to therein. Except as expressly modified hereby, the terms and provisions of the Credit Agreement shall continue in full force and effect. Whenever the Credit Agreement is referred to in the Credit Agreement or any of the instruments, agreements or other documents or papers executed and delivered in connection therewith, it shall be deemed to be a reference to the Credit Agreement as modified hereby. 5. Counterparts. This Amendment may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed and delivered by their respective duly authorized officers as of the date first above written. CAPITAL REINSURANCE COMPANY By_______________________________ Title: DEUTSCHE BANK AG, NEW YORK BRANCH, Individually and as Agent By_______________________________ Title: By_______________________________ Title: The participant named below hereby acknowledges and consents to the execution, delivery and effectiveness of this Amendment. THE CHASE MANHATTAN BANK By_______________________________ Title: -2- ANNEX A SCHEDULE I COMMITMENTS Bank Commitment Deutsche Bank AG, New York Branch $100,000,000 EX-10.13 3 EMPLOYER AGREEMENT/JEROME F. JURSCHAK EMPLOYMENT AGREEMENT EMPLOYMENT AGREEMENT made this 2nd day of February, 1999, between Capital Re Corporation, a Delaware corporation with offices at 1325 Avenue of the Americas, New York, New York 10019 (the "Company"), and Jerome F. Jurschak (the "Executive"). The Executive is presently employed as Chief Executive Officer of the Company. The Board of Directors of the Company (the "Board") recognizes that the Executive's contribution to the growth and success of the Company has been substantial. The Board desires to provide for the continued employment of the Executive and to make certain changes in the Executive's employment arrangements with the Company which the Board has determined will reinforce and encourage the continued attention and dedication to the Company of the Executive as a member of the Company's management, in the best interest of the Company and its shareholders. The Executive is willing to commit himself to continue to serve the Company, on the terms and conditions herein provided. In order to effect the foregoing, the Company and the Executive wish to enter into an employment agreement on the terms and conditions set forth below. Accordingly, in consideration of the premises and the respective covenants and agreements of the parties herein contained, and intending to be legally bound hereby, the parties hereto agree as follows: 1. Employment. The Company hereby agrees to continue to employ the Executive, and the Executive hereby agrees to continue to serve the Company, on the terms and conditions set forth herein. 2. Term. The employment of the Executive by the Company as provided in Section 1 will commence on the date hereof and end at the close of business on January 31, 2001, unless further extended or sooner terminated as hereinafter provided. Commencing on January 31, 2001, the term of the Executive's employment shall automatically be extended for one additional year to January 31, 2002, unless, not later than the November 30 immediately preceding such January 31, the Executive shall have given written notice to the Company that it does not wish to extend this Agreement. Commencing on January 31, 2002, and on each January 31 thereafter, the term of the Executive's employment shall automatically be extended for one additional year to January 31, 2003, and each January 31 thereafter, unless, not later than the November 30 preceding such January 31, the Company or the Executive shall have given written notice to the other that it does not wish to extend this Agreement. 3. Position and Duties. The Executive shall serve as Chief Executive Officer of the Company and shall have such responsibilities, duties and authority as he may have as of the date hereof (or any position to which he may be promoted after the date hereof) and as may from time to time be assigned to the Executive by the Board that are consistent with such responsibilities, duties and authority. The Executive shall devote substantially all his working time and efforts to the business and affairs of the Company. 4. Place of Performance. In connection with the Executive's employment by the Company, the Executive shall be based at the principal executive offices of the Company in New York City, except for required travel on the Company's business to an extent substantially consistent with present business travel obligations. 5. Compensation and Related Matters. (a) Salary and Annual Bonus. During the period of the Executive's employment hereunder, the Company shall pay to the Executive an annual base salary at a rate not less than the rate in effect as of the date hereof or such higher rate as may from time to time be determined by the Board. This salary may be increased from time to time in accordance with normal business practices of the Company and, if so increased, shall not thereafter during the term of this Agreement be decreased. The Executive will participate in the Company's Annual Incentive Plan. In the event the Company amends or terminates the Annual Incentive Plan, the Company shall provide the Executive with an annual bonus program that will provide him with an opportunity to realize an annual bonus which is not less than the proportion of base salary which his target percentage under the Annual Incentive Plan represents at the time the Annual Incentive Plan is amended or terminated, which opportunity shall be reasonably comparable to the Executive's opportunity under the Annual Incentive Plan as of the date hereof. Compensation of the Executive by salary or bonus payments shall not be deemed exclusive and shall not prevent the Executive from participating in any other compensation or benefit plan of the Company. The salary and bonus payments (including any increased payments) hereunder shall not in any way limit or reduce any other obligation of the Company hereunder, and no other compensation, benefit or payment hereunder shall in any way limit or reduce the obligation of the Company to pay the Executive's salary or bonus hereunder. (b) Special Signing Bonus; Retention Bonuses. The Company will pay the Executive $75,000 on the date of execution of this Agreement as a Special Signing Bonus. In addition, the Executive will receive additional payments of (i) $250,000 on January 1, 2000 if, in the good faith judgment of the Compensation Committee of the Board of Directors of the Company (a) the Company has maintained key Capital Re group ratings in categories that do not result in a material impairment of the business and (b) the 1999 Capital Plan approved by the Board of Directors has been successfully executed; and (ii) $225,000 on January 31, 2001, provided, however, that, in the case of both of the 2 bonuses referred to in clauses (i) and (ii), except as otherwise provided in Section 8(d)(ii), the Executive remains employed by the Company on the date designated for payment above. (c) Expenses. During the term of the Executive's employment hereunder, the Executive shall be entitled to receive prompt reimbursement for all reasonable and customary expenses incurred by the Executive in performing services hereunder, including all expenses of travel and living expenses while away from home on business or at the request of and in the service of the Company, provided that such expenses are incurred and accounted for in accordance with the policies and procedures established by the Company. (d) Other Benefits. The Company shall maintain in full force and effect, and the Executive shall be entitled to continue to participate in, all of the employee benefit plans and arrangements and enjoy all of the perquisites in effect on the date hereof in which the Executive participates, provided that the Company may make any changes in such plans, arranges or perquisites that are permitted under the terms thereof or that would not adversely affect the Executive's rights or benefits thereunder. The Executive shall be entitled to participate in or receive benefits under any employee benefit plan, arrangement or perquisite made available by the Company in the future to its executives and key management employees, subject to and on a basis consistent with the terms, conditions and overall administration of such plans, arrangements and perquisites. Nothing paid to the Executive under any plan, arrangement or perquisite presently in effect or made available in the future shall be deemed to be in lieu of the salary and bonus payable to the Executive pursuant to paragraph (a) of this Section. Any payments or benefits payable to the Executive hereunder in respect of any year during which the Executive is employed by the Company for less than the entire such year shall, unless otherwise provided in the applicable plan or arrangement or otherwise hereunder, be prorated in accordance with the number of days in such year during which he is so employed. (e) Vacations. The executive shall be entitled to the number of weeks of vacation each year as may be determined in accordance with the Company's vacation policy as in effect on the date hereof, or such greater amount as may be established by Company policy from time to time. The Executive shall also be entitled to all paid holidays and personal days given by the Company to its executives. (f) Stock Option Grants. The Executive will be entitled to participate as an executive level employee in the Company's 1997 Employee Stock Option Plan. Specifically, the Executive has received a grant on January 15, 1999 of options to purchase 140,000 shares under that Plan, and acknowledges that such grant will be in lieu of any grant that the Board would otherwise ordinarily consider in the Year 2000. 3 (g) Services Furnished. The Company shall furnish the Executive with office space, stenographic assistance and such other facilities and services as shall be suitable to the Executive's position adequate for the performance of his duties as set forth in Section 3 hereof. 6. Service as an Officer and Director of Subsidiary. Subject to Sections 3 and 4, the Executive agrees to serve without additional compensation, if elected or appointed thereto as an officer or a director of any subsidiary of the Company, provided that the Executive is indemnified for serving in such capacity on a basis no less favorable than is currently provided by the Company to any other person serving in such capacity. 7. Termination. The Executive's employment hereunder may be terminated without any breach of this Agreement only under the following circumstances: (a) Death. The Executive's employment hereunder shall terminate upon his death. (b) Disability. If, under any applicable Company Disability Plans (as defined below) the Executive is deemed permanently disabled or, if no such plan is in effect, in the written opinion of a qualified physician selected by the Company, the Executive is unable to perform his duties hereunder due to physical or mental illness for a period of at least 180 days, the Company may terminate the Executive's employment hereunder. (c) Cause. The Company may terminate the Executive's employment hereunder for Cause. For purposes of this Agreement, the Company shall have "Cause" to terminate the Executive's employment hereunder for the Executive's (i) gross negligence or willful misconduct in connection with the performance of his duties, (ii) conviction of a criminal offense (other than minor traffic offenses); or (iii) material breach of this Agreement or any other material agreement between the Executive and the Company. For purposes of this paragraph, no act, or failure to act, on the Executive's part shall be considered "willful" unless done, or omitted to be done, by him not in good faith and without reasonable belief that his action or omission was in the best interest of the Company. (d) Termination by the Executive. The Executive may terminate his employment hereunder only for Good Reason. For purposes of this Agreement, "Good Reason" shall mean (A) the Company's material breach of this Agreement or any other material agreement between the Executive and the Company, or (B) the assignment to the Executive of any duties substantially inconsistent with the Executive's status as Chief Executive Officer of the Company or a substantial adverse alteration in the nature or status of the Executive's responsibilities. 4 (e) Any termination of the Executive's employment by the Company or by the Executive (other than termination pursuant to subsection (a) or (b) hereof) shall be communicated by written Notice of Termination to the other party hereto in accordance with Section 12. For purposes of this Agreement, a "Notice of Termination" shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated. (f) "Date of Termination" shall mean (i) if the Executive's employment is terminated by his death, the date of his death, (ii) if the Executive's employment is terminated pursuant to subsection (b) above, the date as of which the physician's written opinion is received by the Company, (iii) if the Executive's employment is terminated for any other reason, the date specified in the Notice of Termination. It is understood that in no event will such Date of Termination be deemed to occur solely for purposes of the Company's 1992 Stock Option Plan until the Executive has had a reasonable opportunity (no greater than one business day) to exercise any vested options held by the Executive on that date. 8. Compensation Upon Termination, Death or During Disability. (a) During any period that the Executive fails to perform his duties hereunder as a result of incapacity due to physical or mental illness ("disability period"). the Executive shall continue to receive his full salary at the rate then in effect for such period (and shall not be eligible for payments under the disability plans, programs and policies maintained by the Company or in connection with employment by the Company ("Disability Plans")) until his employment is terminated pursuant to Section 7(b) hereof, and upon such termination, the Executive shall, within ten (10) days of such termination, be entitled to all amounts to which the Executive is entitled pursuant to short-term Disability Plans. The Executive's rights under any long-term Disability Plan shall be determined in accordance with the provisions of such plan. (b) If the Executive's employment is terminated by his death, the Company shall within ten (10) days following the date of the Executive's death, pay any amounts due to the Executive under Section 5 through the date of his death, together with any other amounts to which the Executive is entitled pursuant to death benefit plans, programs and policies. (c) If the Executive's employment shall be terminated by the Company for Cause pursuant to Section 7(c) or by the Executive for other than Good Reason, the Company shall pay the Executive his full salary through the Date of Termination at the rate in effect at the time Notice of Termination is given and the Company shall have no further obligations to the Executive under this Agreement. 5 (d) If (A) in breach of this Agreement, the Company shall terminate the Executive's employment (it being understood that a purported termination for disability pursuant to Section 7(b) or for Cause which is disputed and finally determined not to have been proper shall be a termination by the Company in breach of this Agreement) or (B) the Executive shall terminate his employment for Good Reason, then (i) the Company shall pay the Executive any earned and accrued but unpaid installment of base salary through the Date of Termination at the rate in effect at the time Notice of Termination is given and all other unpaid and pro rata amounts to which the Executive is entitled under any compensation plan or program of the Company in effect on the Date of Termination, and all accrued vacation time; such payments to be made in a lump sum on or before the tenth day following the Date of Termination; (ii) in lieu of any further salary or bonus payments to the Executive for periods subsequent to the Date of Termination, the Company shall pay as liquidated damages to the Executive an amount equal to the sum of (A) Executive's annual salary in effect as of the Date of Termination for a period equal to the remaining term of this Agreement (but not less than one year) and any bonus amounts that would have been payable to the Executive under the Company's Annual Incentive Plan for the year in which termination occurs (assuming for purposes of that Plan that target performance levels are reached) and (B) any unpaid amounts of the Retention Bonuses specified in Section 5(b), such payment to be made in a lump sum on or before the fifth day following the Date of Termination; and (iii) if termination of the Executive's employment arises out of a breach by the Company of this Agreement, the Company shall pay all other damages to which the Executive may be entitled as a result of such breach, including damages for any and all loss of benefits to the Executive under the Company's employee welfare benefit plans and perquisite programs which the Executive would have received if the Company had not breached this Agreement and had the Executive's employment continued for the balance of the employment term hereunder. 9. "Gross-Up Payment." In the event that it shall be determined at any time that the payment provided under paragraph 8(d) above (the "Contract Payment") or any other payment or distribution by the Company to the Executive (including deemed payments arising from accelerated vesting of stock options) is subject to the tax (the "Excise Tax") imposed by section 4999 of the Internal Revenue Code of 1986, as amended, Section 11.5 of the Company's 1997 Employee Stock Option Plan or similar "parachute payment" limitations under any other agreement between the Company and the Executive that are in effect shall not apply, and the Company shall pay the Executive an additional amount (the "Gross- 6 Up Payment") such that the net amount retained by the Executive, after deduction of any Excise Tax on the Contract Payment and such other Total Payments (as defined below) and any federal and state and local income tax and Excise Tax upon the payment provided for by this paragraph, shall be equal to the Contract Payment and such other Total Payments. For purposes of determining whether any of the payments will be subject to the Excise Tax and the amount of such Excise Tax, (i) any other payments or benefits received or to be received by the Executive in connection with a change in control of the Company or the Executive's termination of employment, whether payable pursuant to the terms of this Agreement or any other plan, arrangement or agreement with the Company, its successors, any person whose actions result in a change in control of the Company or any corporation affiliated (or which, as a result of the completion of a transaction causing a change in control, will become affiliated) with the Company within the meaning of Section 1504 of the Code (together with the Contract Payment, the "Total Payments") shall be treated as "parachute payments" within the meaning of section 280G(b)(2) of the Code, and all "excess parachute payments" within the meaning of section 280G(b)(1) shall be treated as subject to the Excise Tax, unless in the opinion of tax counsel selected by the Company's independent auditors and acceptable to the Executive the Total Payments (in whole or in part) do not constitute parachute payments, or such excess parachute payments (in whole or in part) represent reasonable compensation for services actually rendered within the meaning of section 280G(b)(4) of the Code either in their entirety or in excess of the base amount within the meaning of section 280G(b)(3) of the Code, or are otherwise not subject to the Excise Tax, (ii) the amount of the Total Payments that shall be treated as subject to the Excise Tax shall be equal to the lesser of (A) the total amount of the Total Payments or (B) the amount of excess parachute payments within the meaning of section 280G(b)(1) (after applying clause (i), above), and (iii) the value of any non-cash benefits or any deferred payment or benefit shall be determined by the Company's independent auditors in accordance with the principles of sections 280G(b)(3) and (4) of the Code. For purposes of determining the amount of the Gross-Up Payment, the Executive shall be deemed to pay federal income taxes at the highest marginal rate of federal income taxation in the calendar year in which the Gross-Up Payment is to be made and state and local income taxes at the highest marginal rate of taxation in the state and locality of the Executive's residence on the date of determination, net of the maximum reduction in federal income taxes which could be obtained from deduction of such state and local taxes. In the event that the Excise Tax is subsequently determined to be less than the amount taken into account hereunder at the time of payment of the Gross-Up Payment, the Executive shall repay to the Company at the time that the amount of such reduction in Excise Tax is finally determined the portion of the Gross-Up Payment attributable to such reduction (plus the portion of the Gross-Up Payment attributable to the Excise Tax and federal and state and local income tax imposed on the Gross-Up Payment being repaid by the Executive if such repayment results in a reduction in Excise Tax and/or a federal state and local income tax deduction) plus interest on the amount of 7 such repayment at the rate provided in section 1274(d) of the Code. In the event that the Excise Tax is determined to exceed the amount taken into account hereunder at the time of the payment of the Gross-Up Payment (including by reason of any payment the existence or amount of which cannot be determined at the time of the Gross-Up Payment), the Company shall make an additional Gross-Up Payment in respect of such excess (plus any interest payable with respect to such excess) at the time that the amount of such excess is finally determined. 10. Non-Competition and Non-Solicitation Covenants. (a) Covenants of the Executive. The Executive acknowledges that (i) the principal current businesses of the Company are the insurance and reinsurance of financial guarantees, the provision of mortgage guaranty insurance and reinsurance and ancillary businesses (the "Present Business"); (ii) the Company constitutes one of a limited number of firms that have developed and carry on the Present Business; (iii) the Executive's work for the Company has given and shall continue to give him access to the confidential affairs and proprietary information of the Company not readily available to the public; and (iv) the agreements and covenants of the Executive contained in this Section 10 are essential to the business and goodwill of the Company. Accordingly, in consideration of the benefits being provided by the this Agreement, the Executive is subject to the agreements and covenants set forth in this Section 10. (b) Covenant Against Competition. While the Executive is employed by the Company and for a period of two years after the Date of Termination (whether or not termination constitutes a breach of this Agreement) or from the entry by a court of competent jurisdiction of a final judgment enforcing these restrictions, whichever is later (such period commencing on the date hereof is hereinafter referred to as the "Restricted Period"), the Executive shall not, directly or indirectly, own, manage, operate, join or control, or participate in the ownership, management, operation or control of, or be a proprietor, director, officer, stockholder, member, partner or an employee or agent of, or a consultant to, any business, firm, corporation, partnership or other entity now or hereafter which engages in (A) the Present Business, or (B) any other principal line of business developed by the Company after the date hereof but prior to the Date of Termination (a "New Business") in any state or country in which the Company has conducted business during the term of this Agreement. For purposes of the foregoing, entities that currently engage in the Present Business and therefore fall within the covenants contained herein include, but are not limited to, Enhance Re, RamRe, AXA Re, AMBAC, FGIC, ACA, CGA, FSA, MBIA, PMI, CMAC, GE Mortgage, MGIC, Triad Republic and United Guaranty, as well as any other business, firm, corporation, partnership or other entity for which any present or former chief executive officer of the Company serves in an executive officer, partner, manager or similar senior position. Notwithstanding the foregoing, however, the Executive may own, directly or indirectly, solely as an investment, securities of any business, firm, corporation, partnership or other entity which are traded on any 8 national securities exchange or the Nasdaq National Market if the Executive (A) is not a controlling person of, or a member of a group which controls, such entity and (B) does not, directly or indirectly, own 1% or more of any class of securities of such entity. (c) Solicitations of Customers. During the Restricted Period, the Executive shall not, directly or indirectly, for his own account or as proprietor, stockholder, member, partner, director, officer, employee, agent or otherwise for or on behalf of any person, business, firm, corporation, partnership or other entity other than the Company, sell, offer to sell, or contact or solicit any business from any person, corporation or other entity which was a customer or prospective customer of the Company at any time during the term of this Agreement. For purposes of this Agreement, "customers of the Company" means and includes (i) any and all persons, businesses, corporations, partnerships or other entities which (A) have done business with the Company as a customer during the relevant time period, (B) have been contacted by the Company for the purpose of doing business with the Company or (C) have preexisting business relationships and/or dealings with the Executive when his employment with the Company terminates and (ii) all persons, businesses, corporations, partnerships or other entities which control, or are controlled by, the same person, business, corporation, partnership or other entity which controls, any such customer of the Company. For purposes of this Agreement, "customers" includes prospective customers and referral sources of customers. (d) Agreement Not to Hire Employees and Former Employees. During the Restricted Period, the Executive shall not, directly or indirectly, for his own account or as proprietor, stockholder, partner, director, officer, employee, agent or otherwise for or on behalf of any person, business, firm, corporation, partnership or other entity other than the Company, solicit any person (i) who is an employee of the Company or (ii) who has left the employment of the Company for a period of one year following the termination of such employee's employment, for employment with any person, business, firm, corporation, partnership or other entity other than the Company, or hire any officer or other professional employee of the Company either directly or for or on behalf of any person, business, firm, corporation, partnership or other entity other than the Company. (e) Confidential Information. From and after the date of this Agreement, the Executive shall not at any time, directly or indirectly, disclose to any person, business, firm, corporation, partnership or other entity any confidential or proprietary information concerning the Company, its business or its customers. All information, whether written or otherwise, that is not otherwise in the public domain and is regarding the Company's business, including but not limited to, information regarding customers, customer lists, costs, prices, earnings, systems, operating procedures, prospective and executed contracts and other business arrangements, is presumed to be confidential information of the Company for purposes of this Agreement. The Executive shall return to the Company all books, records, lists and other written, typed, printed or electronically stored materials, whether furnished by 9 the Company or prepared by the Executive, which contain any information relating to the Company, its business or its customers, promptly upon termination of the Executive's employment, and the Executive shall neither make nor retain any copies of such material without the prior written consent of the Company. (f) Cumulative Provisions. The covenants and agreements contained in this Section 10 are independent of each other and are cumulative. (g) Acknowledgments. The Executive acknowledges the broad scope of the covenants contained in this Section 10, but agrees that such covenants are reasonable in light of the scope of the Executive's duties and knowledge of the Company. The Executive further acknowledges and agrees that the covenants contained in this Section 10 do not unreasonably restrict his employment opportunities or unduly burden or deprive him of a means of earning a livelihood. (h) Remedies for Breach. The Executive acknowledges and agrees that his obligations to the Company are unique and that any breach or threatened breach of such obligations may result in irreparable harm and substantial damages to the Company. Accordingly, in the event of a breach or threatened breach by the Executive of any of the provisions of this Section 10, the Company shall have the right, in addition to exercising any other remedies at law or equity which may be available to it under this Agreement or otherwise, to obtain ex parte, preliminary, interlocutory, temporary or permanent injunctive relief, specific performance and other equitable remedies in any court of competent jurisdiction, to prevent the Executive from violating such provision or provisions or to prevent the continuance of any violation thereof, together with an award or judgment for any and all damages, losses, liabilities, expenses and costs incurred by the Company as a result of such breach or threatened breach including, but not limited to, attorneys' fees incurred by the Company in connection with, or as a result of, the enforcement of these covenants. The Executive expressly waives any requirement based on any statute, rule or procedure or other source that the Company post a bond as a condition of obtaining any of the above-described remedies. (i) Divisibility. The Executive agrees that the provisions of this Section 10 are divisible and separable so that if any provision or provisions hereof shall be held to be unreasonable, unlawful or unenforceable, such holding shall not impair the remaining provisions hereof. If any provision hereof is held to be unreasonable, unlawful or unenforceable in duration, geographical scope or character of restriction by any court of competent jurisdiction, such provision shall be modified to the extent necessary in order that any such provision or portion thereof shall be legally enforceable to the fullest extent permitted by law, and the parties hereto do hereby expressly authorize any court of competent jurisdiction to enforce any such provision or portion thereof or to modify any such provision or portion thereof in order that any such provision or portion thereof shall be enforced by such court to the fullest extent permitted by applicable law. 10 11. Successors; Binding Agreement. (a) The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. Failure of the Company to obtain such assumption and agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle the Executive to compensation from the Company in the same amount and on the same terms as he would be entitled to hereunder if he terminated his employment for Good Reasons, except that for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the Date of Termination. As used in this Agreement, "Company" shall mean the Company as herein before defined and any successor to its business and/or assets as aforesaid which executes and delivers the agreement provided for in this Section 11 or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. (b) This Agreement and all rights of the Executive hereunder shall inure to the benefit of and be enforceable by the Executive's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive should die while any amounts would still be payable to him hereunder if he had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Executive's devisee, legatee, or other designee or, if there be no such designee, to the Executive's estate. 12. Notice. For the purposes of this Agreement, notices, demands and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered or (unless otherwise specified) sent by United States certified or registered mail or overnight delivery service, addressed as follows: If to the Executive: Jerome F. Jurschak Chief Executive Officer c/o Capital Re Corporation 1325 Avenue of the Americas New York, New York 10019 If to the Company: 11 Capital Re Corporation 1325 Avenue of the Americas New York, New York 10019 Attention: General Counsel or to such other address as any party may have furnished to the others in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. 13. Miscellaneous. No provisions of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing signed by the Executive and the Company. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of New York without regard to its conflicts of law principles. 14. Validity. The invalidity or unenforceability of any provision or provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 15. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall deemed to be in an original but all of which together will constitute one and the same instrument. 16. No Mitigation. In the event of a termination of the Executive's employment arising out of a breach by the Company of this Agreement or if the Executive shall terminate this Agreement for Good Reason, the Executive shall be under no obligation to seek other employment or otherwise mitigate the obligations of the Company under this Agreement. 17. Resolution of Disputes. Any claim arising out of or relating to this Agreement or the Executive's employment with the Company or the termination thereof shall be resolved by binding confidential arbitration, to be held in New York, New York, in accordance with the Commercial Arbitration Rules of the American Arbitration Association. Judgment upon the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof. 18. Entire Agreement. This Agreement sets forth the entire agreement of the parties hereto in respect of the subject matter contained herein 12 and supersedes all prior agreements, promises, covenants, arrangements, communications, representations or warranties, whether oral or written, by any officer, employee or representative of any party hereto; and any prior agreement of the parties hereto in respect of the subject matter contained herein shall, with respect to the Executive, be of no further force and effect. IN WITNESS WHEREOF, the parties have executed this Agreement on the date and year first above written. CAPITAL RE CORPORATION Attest: By: /s/ Alan S. Roseman By: /s/ Joseph W. Swain ------------------------------- ----------------------------------- Name: J.W. Swain Title: President EXECUTIVE: Attest: By: /s/ Alan S. Roseman /s/ Jerome F. Jurschak ------------------------------- -------------------------------------- Jerome F. Jurschak Chief Executive Officer EX-10.14 4 EMPLOYMENT AGREEMENT/JOSEPH SWAIN EMPLOYMENT AGREEMENT EMPLOYMENT AGREEMENT made this 2nd day of February, 1999, between Capital Re Corporation, a Delaware corporation with offices at 1325 Avenue of the Americas, New York, New York 10019 (the "Company"), and Joseph W. Swain (the "Executive"). The Executive is presently employed as President of the Company. The Board of Directors of the Company (the "Board") recognizes that the Executive's contribution to the growth and success of the Company has been substantial. The Board desires to provide for the continued employment of the Executive and to make certain changes in the Executive's employment arrangements with the Company which the Board has determined will reinforce and encourage the continued attention and dedication to the Company of the Executive as a member of the Company's management, in the best interest of the Company and its shareholders. The Executive is willing to commit himself to continue to serve the Company, on the terms and conditions herein provided. In order to effect the foregoing, the Company and the Executive wish to enter into an employment agreement on the terms and conditions set forth below. Accordingly, in consideration of the premises and the respective covenants and agreements of the parties herein contained, and intending to be legally bound hereby, the parties hereto agree as follows: 1. Employment. The Company hereby agrees to continue to employ the Executive, and the Executive hereby agrees to continue to serve the Company, on the terms and conditions set forth herein. 2. Term. The employment of the Executive by the Company as provided in Section 1 will commence on the date hereof and end at the close of business on January 31, 2001, unless further extended or sooner terminated as hereinafter provided. Commencing on January 31, 2001, the term of the Executive's employment shall automatically be extended for one additional year to January 31, 2002, unless, not later than the November 30 immediately preceding such January 31, the Executive shall have given written notice to the Company that it does not wish to extend this Agreement. Commencing on January 31, 2002, and on each January 31 thereafter, the term of the Executive's employment shall automatically be extended for one additional year to January 31, 2003, and each January 31 thereafter, unless, not later than the November 30 preceding such January 31, the Company or the Executive shall have given written notice to the other that it does not wish to extend this Agreement. 3. Position and Duties. The Executive shall serve as President of the Company and shall have such responsibilities, duties and authority as he may have as of the date hereof (or any position to which he may be promoted after the date hereof) and as may from time to time be assigned to the Executive by the Board that are consistent with such responsibilities, duties and authority. The Executive shall devote substantially all his working time and efforts to the business and affairs of the Company. 4. Place of Performance. In connection with the Executive's employment by the Company, the Executive shall be based at the principal executive offices of the Company in New York City, except for required travel on the Company's business to an extent substantially consistent with present business travel obligations. 5. Compensation and Related Matters. (a) Salary and Annual Bonus. During the period of the Executive's employment hereunder, the Company shall pay to the Executive an annual base salary at a rate not less than the rate in effect as of the date hereof or such higher rate as may from time to time be determined by the Board. This salary may be increased from time to time in accordance with normal business practices of the Company and, if so increased, shall not thereafter during the term of this Agreement be decreased. The Executive will participate in the Company's Annual Incentive Plan. In the event the Company amends or terminates the Annual Incentive Plan, the Company shall provide the Executive with an annual bonus program that will provide him with an opportunity to realize an annual bonus which is not less than the proportion of base salary which his target percentage under the Annual Incentive Plan represents at the time the Annual Incentive Plan is amended or terminated, which opportunity shall be reasonably comparable to the Executive's opportunity under the Annual Incentive Plan as of the date hereof. Compensation of the Executive by salary or bonus payments shall not be deemed exclusive and shall not prevent the Executive from participating in any other compensation or benefit plan of the Company. The salary and bonus payments (including any increased payments) hereunder shall not in any way limit or reduce any other obligation of the Company hereunder, and no other compensation, benefit or payment hereunder shall in any way limit or reduce the obligation of the Company to pay the Executive's salary or bonus hereunder. (b) Special Signing Bonus; Retention Bonuses. The Company will pay the Executive $75,000 on the date of execution of this Agreement as a Special Signing Bonus. In addition, the Executive will receive additional payments of (i) $250,000 on January 1, 2000 if, in the good faith judgment of the Compensation Committee of the Board of Directors of the Company (a) the Company has maintained key Capital Re group ratings in categories that do not result in a material impairment of the business and (b) the 1999 Capital Plan approved by the Board of Directors has been successfully executed; and (ii) $225,000 on January 31, 2001, provided, however, that, in the case of both of the bonuses referred to in clauses (i) and (ii), except as otherwise provided in Section 2 8(d)(ii), the Executive remains employed by the Company on the date designated for payment above. (c) Expenses. During the term of the Executive's employment hereunder, the Executive shall be entitled to receive prompt reimbursement for all reasonable and customary expenses incurred by the Executive in performing services hereunder, including all expenses of travel and living expenses while away from home on business or at the request of and in the service of the Company, provided that such expenses are incurred and accounted for in accordance with the policies and procedures established by the Company. (d) Other Benefits. The Company shall maintain in full force and effect, and the Executive shall be entitled to continue to participate in, all of the employee benefit plans and arrangements and enjoy all of the perquisites in effect on the date hereof in which the Executive participates, provided that the Company may make any changes in such plans, arranges or perquisites that are permitted under the terms thereof or that would not adversely affect the Executive's rights or benefits thereunder. The Executive shall be entitled to participate in or receive benefits under any employee benefit plan, arrangement or perquisite made available by the Company in the future to its executives and key management employees, subject to and on a basis consistent with the terms, conditions and overall administration of such plans, arrangements and perquisites. Nothing paid to the Executive under any plan, arrangement or perquisite presently in effect or made available in the future shall be deemed to be in lieu of the salary and bonus payable to the Executive pursuant to paragraph (a) of this Section. Any payments or benefits payable to the Executive hereunder in respect of any year during which the Executive is employed by the Company for less than the entire such year shall, unless otherwise provided in the applicable plan or arrangement or otherwise hereunder, be prorated in accordance with the number of days in such year during which he is so employed. (e) Vacations. The executive shall be entitled to the number of weeks of vacation each year as may be determined in accordance with the Company's vacation policy as in effect on the date hereof, or such greater amount as may be established by Company policy from time to time. The Executive shall also be entitled to all paid holidays and personal days given by the Company to its executives. (f) Stock Option Grants. The Executive will be entitled to participate as an executive level employee in the Company's 1997 Employee Stock Option Plan. Specifically, the Executive has received a grant on January 15, 1999 of options to purchase 140,000 shares under that Plan, and acknowledges that such grant will be in lieu of any grant that the Board would otherwise ordinarily consider in the Year 2000. 3 (g) Services Furnished. The Company shall furnish the Executive with office space, stenographic assistance and such other facilities and services as shall be suitable to the Executive's position adequate for the performance of his duties as set forth in Section 3 hereof. 6. Service as an Officer and Director of Subsidiary. Subject to Sections 3 and 4, the Executive agrees to serve without additional compensation, if elected or appointed thereto as an officer or a director of any subsidiary of the Company, provided that the Executive is indemnified for serving in such capacity on a basis no less favorable than is currently provided by the Company to any other person serving in such capacity. 7. Termination. The Executive's employment hereunder may be terminated without any breach of this Agreement only under the following circumstances: (a) Death. The Executive's employment hereunder shall terminate upon his death. (b) Disability. If, under any applicable Company Disability Plans (as defined below) the Executive is deemed permanently disabled or, if no such plan is in effect, in the written opinion of a qualified physician selected by the Company, the Executive is unable to perform his duties hereunder due to physical or mental illness for a period of at least 180 days, the Company may terminate the Executive's employment hereunder. (c) Cause. The Company may terminate the Executive's employment hereunder for Cause. For purposes of this Agreement, the Company shall have "Cause" to terminate the Executive's employment hereunder for the Executive's (i) gross negligence or willful misconduct in connection with the performance of his duties, (ii) conviction of a criminal offense (other than minor traffic offenses); or (iii) material breach of this Agreement or any other material agreement between the Executive and the Company. For purposes of this paragraph, no act, or failure to act, on the Executive's part shall be considered "willful" unless done, or omitted to be done, by him not in good faith and without reasonable belief that his action or omission was in the best interest of the Company. (d) Termination by the Executive. The Executive may terminate his employment hereunder only for Good Reason. For purposes of this Agreement, "Good Reason" shall mean (A) the Company's material breach of this Agreement or any other material agreement between the Executive and the Company, or (B) the assignment to the Executive of any duties substantially inconsistent with the Executive's status as President of the Company or a substantial adverse alteration in the nature or status of the Executive's responsibilities. 4 (e) Any termination of the Executive's employment by the Company or by the Executive (other than termination pursuant to subsection (a) or (b) hereof) shall be communicated by written Notice of Termination to the other party hereto in accordance with Section 12. For purposes of this Agreement, a "Notice of Termination" shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated. (f) "Date of Termination" shall mean (i) if the Executive's employment is terminated by his death, the date of his death, (ii) if the Executive's employment is terminated pursuant to subsection (b) above, the date as of which the physician's written opinion is received by the Company, (iii) if the Executive's employment is terminated for any other reason, the date specified in the Notice of Termination. It is understood that in no event will such Date of Termination be deemed to occur solely for purposes of the Company's 1992 Stock Option Plan until the Executive has had a reasonable opportunity (no greater than one business day) to exercise any vested options held by the Executive on that date. 8. Compensation Upon Termination, Death or During Disability. (a) During any period that the Executive fails to perform his duties hereunder as a result of incapacity due to physical or mental illness ("disability period"). the Executive shall continue to receive his full salary at the rate then in effect for such period (and shall not be eligible for payments under the disability plans, programs and policies maintained by the Company or in connection with employment by the Company ("Disability Plans")) until his employment is terminated pursuant to Section 7(b) hereof, and upon such termination, the Executive shall, within ten (10) days of such termination, be entitled to all amounts to which the Executive is entitled pursuant to short-term Disability Plans. The Executive's rights under any long-term Disability Plan shall be determined in accordance with the provisions of such plan. (b) If the Executive's employment is terminated by his death, the Company shall within ten (10) days following the date of the Executive's death, pay any amounts due to the Executive under Section 5 through the date of his death, together with any other amounts to which the Executive is entitled pursuant to death benefit plans, programs and policies. (c) If the Executive's employment shall be terminated by the Company for Cause pursuant to Section 7(c) or by the Executive for other than Good Reason, the Company shall pay the Executive his full salary through the Date of Termination at the rate in effect at the time Notice of Termination is given and the Company shall have no further obligations to the Executive under this Agreement. 5 (d) If (A) in breach of this Agreement, the Company shall terminate the Executive's employment (it being understood that a purported termination for disability pursuant to Section 7(b) or for Cause which is disputed and finally determined not to have been proper shall be a termination by the Company in breach of this Agreement) or (B) the Executive shall terminate his employment for Good Reason, then (i) the Company shall pay the Executive any earned and accrued but unpaid installment of base salary through the Date of Termination at the rate in effect at the time Notice of Termination is given and all other unpaid and pro rata amounts to which the Executive is entitled under any compensation plan or program of the Company in effect on the Date of Termination, and all accrued vacation time; such payments to be made in a lump sum on or before the tenth day following the Date of Termination; (ii) in lieu of any further salary or bonus payments to the Executive for periods subsequent to the Date of Termination, the Company shall pay as liquidated damages to the Executive an amount equal to the sum of (A) Executive's annual salary in effect as of the Date of Termination for a period equal to the remaining term of this Agreement (but not less than one year) and any bonus amounts that would have been payable to the Executive under the Company's Annual Incentive Plan for the year in which termination occurs (assuming for purposes of that Plan that target performance levels are reached) and (B) any unpaid amounts of the Retention Bonuses specified in Section 5(b), such payment to be made in a lump sum on or before the fifth day following the Date of Termination; and (iii) if termination of the Executive's employment arises out of a breach by the Company of this Agreement, the Company shall pay all other damages to which the Executive may be entitled as a result of such breach, including damages for any and all loss of benefits to the Executive under the Company's employee welfare benefit plans and perquisite programs which the Executive would have received if the Company had not breached this Agreement and had the Executive's employment continued for the balance of the employment term hereunder. 9. "Gross-Up Payment." In the event that it shall be determined at any time that the payment provided under paragraph 8(d) above (the "Contract Payment") or any other payment or distribution by the Company to the Executive (including deemed payments arising from accelerated vesting of stock options) is subject to the tax (the "Excise Tax") imposed by section 4999 of the Internal Revenue Code of 1986, as amended, Section 11.5 of the Company's 1997 Employee Stock Option Plan or similar "parachute payment" limitations under any other agreement between the Company and the Executive that are in effect shall not apply, and the Company shall pay the Executive an additional amount (the "Gross- 6 Up Payment") such that the net amount retained by the Executive, after deduction of any Excise Tax on the Contract Payment and such other Total Payments (as defined below) and any federal and state and local income tax and Excise Tax upon the payment provided for by this paragraph, shall be equal to the Contract Payment and such other Total Payments. For purposes of determining whether any of the payments will be subject to the Excise Tax and the amount of such Excise Tax, (i) any other payments or benefits received or to be received by the Executive in connection with a change in control of the Company or the Executive's termination of employment, whether payable pursuant to the terms of this Agreement or any other plan, arrangement or agreement with the Company, its successors, any person whose actions result in a change in control of the Company or any corporation affiliated (or which, as a result of the completion of a transaction causing a change in control, will become affiliated) with the Company within the meaning of Section 1504 of the Code (together with the Contract Payment, the "Total Payments") shall be treated as "parachute payments" within the meaning of section 280G(b)(2) of the Code, and all "excess parachute payments" within the meaning of section 280G(b)(1) shall be treated as subject to the Excise Tax, unless in the opinion of tax counsel selected by the Company's independent auditors and acceptable to the Executive the Total Payments (in whole or in part) do not constitute parachute payments, or such excess parachute payments (in whole or in part) represent reasonable compensation for services actually rendered within the meaning of section 280G(b)(4) of the Code either in their entirety or in excess of the base amount within the meaning of section 280G(b)(3) of the Code, or are otherwise not subject to the Excise Tax, (ii) the amount of the Total Payments that shall be treated as subject to the Excise Tax shall be equal to the lesser of (A) the total amount of the Total Payments or (B) the amount of excess parachute payments within the meaning of section 280G(b)(1) (after applying clause (i), above), and (iii) the value of any non-cash benefits or any deferred payment or benefit shall be determined by the Company's independent auditors in accordance with the principles of sections 280G(b)(3) and (4) of the Code. For purposes of determining the amount of the Gross-Up Payment, the Executive shall be deemed to pay federal income taxes at the highest marginal rate of federal income taxation in the calendar year in which the Gross-Up Payment is to be made and state and local income taxes at the highest marginal rate of taxation in the state and locality of the Executive's residence on the date of determination, net of the maximum reduction in federal income taxes which could be obtained from deduction of such state and local taxes. In the event that the Excise Tax is subsequently determined to be less than the amount taken into account hereunder at the time of payment of the Gross-Up Payment, the Executive shall repay to the Company at the time that the amount of such reduction in Excise Tax is finally determined the portion of the Gross-Up Payment attributable to such reduction (plus the portion of the Gross-Up Payment attributable to the Excise Tax and federal and state and local income tax imposed on the Gross-Up Payment being repaid by the Executive if such repayment results in a reduction in Excise Tax and/or a federal state and local income tax deduction) plus interest on the amount of such repayment at the rate provided in section 7 1274(d) of the Code. In the event that the Excise Tax is determined to exceed the amount taken into account hereunder at the time of the payment of the Gross-Up Payment (including by reason of any payment the existence or amount of which cannot be determined at the time of the Gross-Up Payment), the Company shall make an additional Gross-Up Payment in respect of such excess (plus any interest payable with respect to such excess) at the time that the amount of such excess is finally determined. 10. Non-Competition and Non-Solicitation Covenants. (a) Covenants of the Executive. The Executive acknowledges that (i) the principal current businesses of the Company are the insurance and reinsurance of financial guarantees, the provision of mortgage guaranty insurance and reinsurance and ancillary businesses (the "Present Business"); (ii) the Company constitutes one of a limited number of firms that have developed and carry on the Present Business; (iii) the Executive's work for the Company has given and shall continue to give him access to the confidential affairs and proprietary information of the Company not readily available to the public; and (iv) the agreements and covenants of the Executive contained in this Section 10 are essential to the business and goodwill of the Company. Accordingly, in consideration of the benefits being provided by the this Agreement, the Executive is subject to the agreements and covenants set forth in this Section 10. (b) Covenant Against Competition. While the Executive is employed by the Company and for a period of two years after the Date of Termination (whether or not termination constitutes a breach of this Agreement) or from the entry by a court of competent jurisdiction of a final judgment enforcing these restrictions, whichever is later (such period commencing on the date hereof is hereinafter referred to as the "Restricted Period"), the Executive shall not, directly or indirectly, own, manage, operate, join or control, or participate in the ownership, management, operation or control of, or be a proprietor, director, officer, stockholder, member, partner or an employee or agent of, or a consultant to, any business, firm, corporation, partnership or other entity now or hereafter which engages in (A) the Present Business, or (B) any other principal line of business developed by the Company after the date hereof but prior to the Date of Termination (a "New Business") in any state or country in which the Company has conducted business during the term of this Agreement. For purposes of the foregoing, entities that currently engage in the Present Business and therefore fall within the covenants contained herein include, but are not limited to, Enhance Re, RamRe, AXA Re, AMBAC, FGIC, ACA, CGA, FSA, MBIA, PMI, CMAC, GE Mortgage, MGIC, Triad Republic and United Guaranty, as well as any other business, firm, corporation, partnership or other entity for which any present or former chief executive officer of the Company serves in an executive officer, partner, manager or similar senior position. Notwithstanding the foregoing, however, the Executive may own, directly or indirectly, solely as an investment, securities of any business, firm, corporation, partnership or other entity which are traded on any 8 national securities exchange or the Nasdaq National Market if the Executive (A) is not a controlling person of, or a member of a group which controls, such entity and (B) does not, directly or indirectly, own 1% or more of any class of securities of such entity. (c) Solicitations of Customers. During the Restricted Period, the Executive shall not, directly or indirectly, for his own account or as proprietor, stockholder, member, partner, director, officer, employee, agent or otherwise for or on behalf of any person, business, firm, corporation, partnership or other entity other than the Company, sell, offer to sell, or contact or solicit any business from any person, corporation or other entity which was a customer or prospective customer of the Company at any time during the term of this Agreement. For purposes of this Agreement, "customers of the Company" means and includes (i) any and all persons, businesses, corporations, partnerships or other entities which (A) have done business with the Company as a customer during the relevant time period, (B) have been contacted by the Company for the purpose of doing business with the Company or (C) have preexisting business relationships and/or dealings with the Executive when his employment with the Company terminates and (ii) all persons, businesses, corporations, partnerships or other entities which control, or are controlled by, the same person, business, corporation, partnership or other entity which controls, any such customer of the Company. For purposes of this Agreement, "customers" includes prospective customers and referral sources of customers. (d) Agreement Not to Hire Employees and Former Employees. During the Restricted Period, the Executive shall not, directly or indirectly, for his own account or as proprietor, stockholder, partner, director, officer, employee, agent or otherwise for or on behalf of any person, business, firm, corporation, partnership or other entity other than the Company, solicit any person (i) who is an employee of the Company or (ii) who has left the employment of the Company for a period of one year following the termination of such employee's employment, for employment with any person, business, firm, corporation, partnership or other entity other than the Company, or hire any officer or other professional employee of the Company either directly or for or on behalf of any person, business, firm, corporation, partnership or other entity other than the Company. (e) Confidential Information. From and after the date of this Agreement, the Executive shall not at any time, directly or indirectly, disclose to any person, business, firm, corporation, partnership or other entity any confidential or proprietary information concerning the Company, its business or its customers. All information, whether written or otherwise, that is not otherwise in the public domain and is regarding the Company's business, including but not limited to, information regarding customers, customer lists, costs, prices, earnings, systems, operating procedures, prospective and executed contracts and other business arrangements, is presumed to be confidential information of the Company for purposes of this Agreement. The Executive shall return to the Company all books, records, lists and other written, typed, printed or electronically stored materials, whether furnished by 9 the Company or prepared by the Executive, which contain any information relating to the Company, its business or its customers, promptly upon termination of the Executive's employment, and the Executive shall neither make nor retain any copies of such material without the prior written consent of the Company. (f) Cumulative Provisions. The covenants and agreements contained in this Section 10 are independent of each other and are cumulative. (g) Acknowledgments. The Executive acknowledges the broad scope of the covenants contained in this Section 10, but agrees that such covenants are reasonable in light of the scope of the Executive's duties and knowledge of the Company. The Executive further acknowledges and agrees that the covenants contained in this Section 10 do not unreasonably restrict his employment opportunities or unduly burden or deprive him of a means of earning a livelihood. (h) Remedies for Breach. The Executive acknowledges and agrees that his obligations to the Company are unique and that any breach or threatened breach of such obligations may result in irreparable harm and substantial damages to the Company. Accordingly, in the event of a breach or threatened breach by the Executive of any of the provisions of this Section 10, the Company shall have the right, in addition to exercising any other remedies at law or equity which may be available to it under this Agreement or otherwise, to obtain ex parte, preliminary, interlocutory, temporary or permanent injunctive relief, specific performance and other equitable remedies in any court of competent jurisdiction, to prevent the Executive from violating such provision or provisions or to prevent the continuance of any violation thereof, together with an award or judgment for any and all damages, losses, liabilities, expenses and costs incurred by the Company as a result of such breach or threatened breach including, but not limited to, attorneys' fees incurred by the Company in connection with, or as a result of, the enforcement of these covenants. The Executive expressly waives any requirement based on any statute, rule or procedure or other source that the Company post a bond as a condition of obtaining any of the above-described remedies. (i) Divisibility. The Executive agrees that the provisions of this Section 10 are divisible and separable so that if any provision or provisions hereof shall be held to be unreasonable, unlawful or unenforceable, such holding shall not impair the remaining provisions hereof. If any provision hereof is held to be unreasonable, unlawful or unenforceable in duration, geographical scope or character of restriction by any court of competent jurisdiction, such provision shall be modified to the extent necessary in order that any such provision or portion thereof shall be legally enforceable to the fullest extent permitted by law, and the parties hereto do hereby expressly authorize any court of competent jurisdiction to enforce any such provision or portion thereof or to modify any such provision or portion thereof in order that any such provision or portion thereof shall be enforced by such court to the fullest extent permitted by applicable law. 10 11. Successors; Binding Agreement. (a) The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. Failure of the Company to obtain such assumption and agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle the Executive to compensation from the Company in the same amount and on the same terms as he would be entitled to hereunder if he terminated his employment for Good Reasons, except that for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the Date of Termination. As used in this Agreement, "Company" shall mean the Company as herein before defined and any successor to its business and/or assets as aforesaid which executes and delivers the agreement provided for in this Section 11 or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. (b) This Agreement and all rights of the Executive hereunder shall inure to the benefit of and be enforceable by the Executive's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive should die while any amounts would still be payable to him hereunder if he had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Executive's devisee, legatee, or other designee or, if there be no such designee, to the Executive's estate. 12. Notice. For the purposes of this Agreement, notices, demands and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered or (unless otherwise specified) sent by United States certified or registered mail or overnight delivery service, addressed as follows: If to the Executive: Joseph W. Swain President c/o Capital Re Corporation 1325 Avenue of the Americas New York, New York 10019 If to the Company: 11 Capital Re Corporation 1325 Avenue of the Americas New York, New York 10019 Attention: Chief Executive Officer or to such other address as any party may have furnished to the others in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. 13. Miscellaneous. No provisions of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing signed by the Executive and the Company. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of New York without regard to its conflicts of law principles. 14. Validity. The invalidity or unenforceability of any provision or provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 15. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall deemed to be in an original but all of which together will constitute one and the same instrument. 16. No Mitigation. In the event of a termination of the Executive's employment arising out of a breach by the Company of this Agreement or if the Executive shall terminate this Agreement for Good Reason, the Executive shall be under no obligation to seek other employment or otherwise mitigate the obligations of the Company under this Agreement. 17. Resolution of Disputes. Any claim arising out of or relating to this Agreement or the Executive's employment with the Company or the termination thereof shall be resolved by binding confidential arbitration, to be held in New York, New York, in accordance with the Commercial Arbitration Rules of the American Arbitration Association. Judgment upon the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof. 18. Entire Agreement. This Agreement sets forth the entire agreement of the parties hereto in respect of the subject matter contained herein 12 and supersedes all prior agreements, promises, covenants, arrangements, communications, representations or warranties, whether oral or written, by any officer, employee or representative of any party hereto; and any prior agreement of the parties hereto in respect of the subject matter contained herein shall, with respect to the Executive, be of no further force and effect. IN WITNESS WHEREOF, the parties have executed this Agreement on the date and year first above written. CAPITAL RE CORPORATION Attest: By: /s/ Alan S. Roseman By: /s/ Jerome F. Jurschak ------------------------------- -------------------------------------- Name: Jerome F. Jurschak Title: CEO, Chairman EXECUTIVE Attest: By: /s/ Alan S. Roseman /s/ Joseph W. Swain ------------------------------- -------------------------------------- Joseph W. Swain President 13 EX-10.15 5 EMPLOYMENT AGREEMENT/DAVID A. BUZEN EMPLOYMENT AGREEMENT EMPLOYMENT AGREEMENT made this 2nd day of February, 1999, between Capital Re Corporation, a Delaware corporation with offices at 1325 Avenue of the Americas, New York, New York 10019 (the "Company"), and David A. Buzen (the "Executive"). The Executive is presently employed as Executive Vice President and Chief Financial Officer of the Company. The Board of Directors of the Company (the "Board") recognizes that the Executive's contribution to the growth and success of the Company has been substantial. The Board desires to provide for the continued employment of the Executive and to make certain changes in the Executive's employment arrangements with the Company which the Board has determined will reinforce and encourage the continued attention and dedication to the Company of the Executive as a member of the Company's management, in the best interest of the Company and its shareholders. The Executive is willing to commit himself to continue to serve the Company, on the terms and conditions herein provided. In order to effect the foregoing, the Company and the Executive wish to enter into an employment agreement on the terms and conditions set forth below. Accordingly, in consideration of the premises and the respective covenants and agreements of the parties herein contained, and intending to be legally bound hereby, the parties hereto agree as follows: 1. Employment. The Company hereby agrees to continue to employ the Executive, and the Executive hereby agrees to continue to serve the Company, on the terms and conditions set forth herein. 2. Term. The employment of the Executive by the Company as provided in Section 1 will commence on the date hereof and end at the close of business on January 31, 2001, unless further extended or sooner terminated as hereinafter provided. Commencing on January 31, 2001, the term of the Executive's employment shall automatically be extended for one additional year to January 31, 2002, unless, not later than the November 30 immediately preceding such January 31, the Executive shall have given written notice to the Company that it does not wish to extend this Agreement. Commencing on January 31, 2002, and on each January 31 thereafter, the term of the Executive's employment shall automatically be extended for one additional year to January 31, 2003, and each January 31 thereafter, unless, not later than the November 30 preceding such January 31, the Company or the Executive shall have given written notice to the other that it does not wish to extend this Agreement. 3. Position and Duties. The Executive shall serve as Executive Vice President and Chief Financial Officer of the Company and shall have such responsibilities, duties and authority as he may have as of the date hereof (or any position to which he may be promoted after the date hereof) and as may from time to time be assigned to the Executive by the Board that are consistent with such responsibilities, duties and authority. The Executive shall devote substantially all his working time and efforts to the business and affairs of the Company. 4. Place of Performance. In connection with the Executive's employment by the Company, the Executive shall be based at the principal executive offices of the Company in New York City, except for required travel on the Company's business to an extent substantially consistent with present business travel obligations. 5. Compensation and Related Matters. (a) Salary and Annual Bonus. During the period of the Executive's employment hereunder, the Company shall pay to the Executive an annual base salary at a rate not less than the rate in effect as of the date hereof or such higher rate as may from time to time be determined by the Board. This salary may be increased from time to time in accordance with normal business practices of the Company and, if so increased, shall not thereafter during the term of this Agreement be decreased. The Executive will participate in the Company's Annual Incentive Plan. In the event the Company amends or terminates the Annual Incentive Plan, the Company shall provide the Executive with an annual bonus program that will provide him with an opportunity to realize an annual bonus which is not less than the proportion of base salary which his target percentage under the Annual Incentive Plan represents at the time the Annual Incentive Plan is amended or terminated, which opportunity shall be reasonably comparable to the Executive's opportunity under the Annual Incentive Plan as of the date hereof. Compensation of the Executive by salary or bonus payments shall not be deemed exclusive and shall not prevent the Executive from participating in any other compensation or benefit plan of the Company. The salary and bonus payments (including any increased payments) hereunder shall not in any way limit or reduce any other obligation of the Company hereunder, and no other compensation, benefit or payment hereunder shall in any way limit or reduce the obligation of the Company to pay the Executive's salary or bonus hereunder. (b) Special Signing Bonus; Retention Bonuses. The Company will pay the Executive $75,000 on the date of execution of this Agreement as a Special Signing Bonus. In addition, the Executive will receive additional payments of (i) $250,000 on January 1, 2000 if, in the good faith judgment of the Compensation Committee of the Board of Directors of the Company (a) the Company has maintained key Capital Re group ratings in categories that do not result in a material impairment of the business and (b) the 1999 Capital Plan approved by the Board of Directors has been successfully executed; and (ii) $225,000 on January 31, 2001, provided, however, that, in the case of both of the 2 bonuses referred to in clauses (i) and (ii), except as otherwise provided in Section 8(d)(ii), the Executive remains employed by the Company on the date designated for payment above. (c) Expenses. During the term of the Executive's employment hereunder, the Executive shall be entitled to receive prompt reimbursement for all reasonable and customary expenses incurred by the Executive in performing services hereunder, including all expenses of travel and living expenses while away from home on business or at the request of and in the service of the Company, provided that such expenses are incurred and accounted for in accordance with the policies and procedures established by the Company. (d) Other Benefits. The Company shall maintain in full force and effect, and the Executive shall be entitled to continue to participate in, all of the employee benefit plans and arrangements and enjoy all of the perquisites in effect on the date hereof in which the Executive participates, provided that the Company may make any changes in such plans, arranges or perquisites that are permitted under the terms thereof or that would not adversely affect the Executive's rights or benefits thereunder. The Executive shall be entitled to participate in or receive benefits under any employee benefit plan, arrangement or perquisite made available by the Company in the future to its executives and key management employees, subject to and on a basis consistent with the terms, conditions and overall administration of such plans, arrangements and perquisites. Nothing paid to the Executive under any plan, arrangement or perquisite presently in effect or made available in the future shall be deemed to be in lieu of the salary and bonus payable to the Executive pursuant to paragraph (a) of this Section. Any payments or benefits payable to the Executive hereunder in respect of any year during which the Executive is employed by the Company for less than the entire such year shall, unless otherwise provided in the applicable plan or arrangement or otherwise hereunder, be prorated in accordance with the number of days in such year during which he is so employed. (e) Vacations. The executive shall be entitled to the number of weeks of vacation each year as may be determined in accordance with the Company's vacation policy as in effect on the date hereof, or such greater amount as may be established by Company policy from time to time. The Executive shall also be entitled to all paid holidays and personal days given by the Company to its executives. (f) Stock Option Grants. The Executive will be entitled to participate as an executive level employee in the Company's 1997 Employee Stock Option Plan. Specifically, the Executive has received a grant on January 15, 1999 of options to purchase 140,000 shares under that Plan, and acknowledges that such grant will be in lieu of any grant that the Board would otherwise ordinarily consider in the Year 2000. 3 (g) Services Furnished. The Company shall furnish the Executive with office space, stenographic assistance and such other facilities and services as shall be suitable to the Executive's position adequate for the performance of his duties as set forth in Section 3 hereof. 6. Service as an Officer and Director of Subsidiary. Subject to Sections 3 and 4, the Executive agrees to serve without additional compensation, if elected or appointed thereto as an officer or a director of any subsidiary of the Company, provided that the Executive is indemnified for serving in such capacity on a basis no less favorable than is currently provided by the Company to any other person serving in such capacity. 7. Termination. The Executive's employment hereunder may be terminated without any breach of this Agreement only under the following circumstances: (a) Death. The Executive's employment hereunder shall terminate upon his death. (b) Disability. If, under any applicable Company Disability Plans (as defined below) the Executive is deemed permanently disabled or, if no such plan is in effect, in the written opinion of a qualified physician selected by the Company, the Executive is unable to perform his duties hereunder due to physical or mental illness for a period of at least 180 days, the Company may terminate the Executive's employment hereunder. (c) Cause. The Company may terminate the Executive's employment hereunder for Cause. For purposes of this Agreement, the Company shall have "Cause" to terminate the Executive's employment hereunder for the Executive's (i) gross negligence or willful misconduct in connection with the performance of his duties, (ii) conviction of a criminal offense (other than minor traffic offenses); or (iii) material breach of this Agreement or any other material agreement between the Executive and the Company. For purposes of this paragraph, no act, or failure to act, on the Executive's part shall be considered "willful" unless done, or omitted to be done, by him not in good faith and without reasonable belief that his action or omission was in the best interest of the Company. (d) Termination by the Executive. The Executive may terminate his employment hereunder only for Good Reason. For purposes of this Agreement, "Good Reason" shall mean (A) the Company's material breach of this Agreement or any other material agreement between the Executive and the Company, or (B) the assignment to the Executive of any duties substantially inconsistent with the Executive's status as Executive Vice President and Chief Financial Officer of the Company or a substantial adverse alteration in the nature or status of the Executive's responsibilities. 4 (e) Any termination of the Executive's employment by the Company or by the Executive (other than termination pursuant to subsection (a) or (b) hereof) shall be communicated by written Notice of Termination to the other party hereto in accordance with Section 12. For purposes of this Agreement, a "Notice of Termination" shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated. (f) "Date of Termination" shall mean (i) if the Executive's employment is terminated by his death, the date of his death, (ii) if the Executive's employment is terminated pursuant to subsection (b) above, the date as of which the physician's written opinion is received by the Company, (iii) if the Executive's employment is terminated for any other reason, the date specified in the Notice of Termination. It is understood that in no event will such Date of Termination be deemed to occur solely for purposes of the Company's 1992 Stock Option Plan until the Executive has had a reasonable opportunity (no greater than one business day) to exercise any vested options held by the Executive on that date. 8. Compensation Upon Termination, Death or During Disability. (a) During any period that the Executive fails to perform his duties hereunder as a result of incapacity due to physical or mental illness ("disability period"). the Executive shall continue to receive his full salary at the rate then in effect for such period (and shall not be eligible for payments under the disability plans, programs and policies maintained by the Company or in connection with employment by the Company ("Disability Plans")) until his employment is terminated pursuant to Section 7(b) hereof, and upon such termination, the Executive shall, within ten (10) days of such termination, be entitled to all amounts to which the Executive is entitled pursuant to short-term Disability Plans. The Executive's rights under any long-term Disability Plan shall be determined in accordance with the provisions of such plan. (b) If the Executive's employment is terminated by his death, the Company shall within ten (10) days following the date of the Executive's death, pay any amounts due to the Executive under Section 5 through the date of his death, together with any other amounts to which the Executive is entitled pursuant to death benefit plans, programs and policies. (c) If the Executive's employment shall be terminated by the Company for Cause pursuant to Section 7(c) or by the Executive for other than Good Reason, the Company shall pay the Executive his full salary through the Date of Termination at the rate in effect at the time Notice of Termination is given and the Company shall have no further obligations to the Executive under this Agreement. 5 (d) If (A) in breach of this Agreement, the Company shall terminate the Executive's employment (it being understood that a purported termination for disability pursuant to Section 7(b) or for Cause which is disputed and finally determined not to have been proper shall be a termination by the Company in breach of this Agreement) or (B) the Executive shall terminate his employment for Good Reason, then (i) the Company shall pay the Executive any earned and accrued but unpaid installment of base salary through the Date of Termination at the rate in effect at the time Notice of Termination is given and all other unpaid and pro rata amounts to which the Executive is entitled under any compensation plan or program of the Company in effect on the Date of Termination, and all accrued vacation time; such payments to be made in a lump sum on or before the tenth day following the Date of Termination; (ii) in lieu of any further salary or bonus payments to the Executive for periods subsequent to the Date of Termination, the Company shall pay as liquidated damages to the Executive an amount equal to the sum of (A) Executive's annual salary in effect as of the Date of Termination for a period equal to the remaining term of this Agreement (but not less than one year) and any bonus amounts that would have been payable to the Executive under the Company's Annual Incentive Plan for the year in which termination occurs (assuming for purposes of that Plan that target performance levels are reached) and (B) any unpaid amounts of the Retention Bonuses specified in Section 5(b), such payment to be made in a lump sum on or before the fifth day following the Date of Termination; and (iii) if termination of the Executive's employment arises out of a breach by the Company of this Agreement, the Company shall pay all other damages to which the Executive may be entitled as a result of such breach, including damages for any and all loss of benefits to the Executive under the Company's employee welfare benefit plans and perquisite programs which the Executive would have received if the Company had not breached this Agreement and had the Executive's employment continued for the balance of the employment term hereunder. 9. "Gross-Up Payment." In the event that it shall be determined at any time that the payment provided under paragraph 8(d) above (the "Contract Payment") or any other payment or distribution by the Company to the Executive (including deemed payments arising from accelerated vesting of stock options) is subject to the tax (the "Excise Tax") imposed by section 4999 of the Internal Revenue Code of 1986, as amended, Section 11.5 of the Company's 1997 Employee Stock Option Plan or similar "parachute payment" limitations under any other agreement between the Company and the Executive that are in effect shall not apply, and the Company shall pay the Executive an additional amount (the "Gross- 6 Up Payment") such that the net amount retained by the Executive, after deduction of any Excise Tax on the Contract Payment and such other Total Payments (as defined below) and any federal and state and local income tax and Excise Tax upon the payment provided for by this paragraph, shall be equal to the Contract Payment and such other Total Payments. For purposes of determining whether any of the payments will be subject to the Excise Tax and the amount of such Excise Tax, (i) any other payments or benefits received or to be received by the Executive in connection with a change in control of the Company or the Executive's termination of employment, whether payable pursuant to the terms of this Agreement or any other plan, arrangement or agreement with the Company, its successors, any person whose actions result in a change in control of the Company or any corporation affiliated (or which, as a result of the completion of a transaction causing a change in control, will become affiliated) with the Company within the meaning of Section 1504 of the Code (together with the Contract Payment, the "Total Payments") shall be treated as "parachute payments" within the meaning of section 280G(b)(2) of the Code, and all "excess parachute payments" within the meaning of section 280G(b)(1) shall be treated as subject to the Excise Tax, unless in the opinion of tax counsel selected by the Company's independent auditors and acceptable to the Executive the Total Payments (in whole or in part) do not constitute parachute payments, or such excess parachute payments (in whole or in part) represent reasonable compensation for services actually rendered within the meaning of section 280G(b)(4) of the Code either in their entirety or in excess of the base amount within the meaning of section 280G(b)(3) of the Code, or are otherwise not subject to the Excise Tax, (ii) the amount of the Total Payments that shall be treated as subject to the Excise Tax shall be equal to the lesser of (A) the total amount of the Total Payments or (B) the amount of excess parachute payments within the meaning of section 280G(b)(1) (after applying clause (i), above), and (iii) the value of any non-cash benefits or any deferred payment or benefit shall be determined by the Company's independent auditors in accordance with the principles of sections 280G(b)(3) and (4) of the Code. For purposes of determining the amount of the Gross-Up Payment, the Executive shall be deemed to pay federal income taxes at the highest marginal rate of federal income taxation in the calendar year in which the Gross-Up Payment is to be made and state and local income taxes at the highest marginal rate of taxation in the state and locality of the Executive's residence on the date of determination, net of the maximum reduction in federal income taxes which could be obtained from deduction of such state and local taxes. In the event that the Excise Tax is subsequently determined to be less than the amount taken into account hereunder at the time of payment of the Gross-Up Payment, the Executive shall repay to the Company at the time that the amount of such reduction in Excise Tax is finally determined the portion of the Gross-Up Payment attributable to such reduction (plus the portion of the Gross-Up Payment attributable to the Excise Tax and federal and state and local income tax imposed on the Gross-Up Payment being repaid by the Executive if such repayment results in a reduction in Excise Tax and/or a federal state and local income tax deduction) plus interest on the amount of such repayment at the rate provided in section 7 1274(d) of the Code. In the event that the Excise Tax is determined to exceed the amount taken into account hereunder at the time of the payment of the Gross-Up Payment (including by reason of any payment the existence or amount of which cannot be determined at the time of the Gross-Up Payment), the Company shall make an additional Gross-Up Payment in respect of such excess (plus any interest payable with respect to such excess) at the time that the amount of such excess is finally determined. 10. Non-Competition and Non-Solicitation Covenants. (a) Covenants of the Executive. The Executive acknowledges that (i) the principal current businesses of the Company are the insurance and reinsurance of financial guarantees, the provision of mortgage guaranty insurance and reinsurance and ancillary businesses (the "Present Business"); (ii) the Company constitutes one of a limited number of firms that have developed and carry on the Present Business; (iii) the Executive's work for the Company has given and shall continue to give him access to the confidential affairs and proprietary information of the Company not readily available to the public; and (iv) the agreements and covenants of the Executive contained in this Section 10 are essential to the business and goodwill of the Company. Accordingly, in consideration of the benefits being provided by the this Agreement, the Executive is subject to the agreements and covenants set forth in this Section 10. (b) Covenant Against Competition. While the Executive is employed by the Company and for a period of two years after the Date of Termination (whether or not termination constitutes a breach of this Agreement) or from the entry by a court of competent jurisdiction of a final judgment enforcing these restrictions, whichever is later (such period commencing on the date hereof is hereinafter referred to as the "Restricted Period"), the Executive shall not, directly or indirectly, own, manage, operate, join or control, or participate in the ownership, management, operation or control of, or be a proprietor, director, officer, stockholder, member, partner or an employee or agent of, or a consultant to, any business, firm, corporation, partnership or other entity now or hereafter which engages in (A) the Present Business, or (B) any other principal line of business developed by the Company after the date hereof but prior to the Date of Termination (a "New Business") in any state or country in which the Company has conducted business during the term of this Agreement. For purposes of the foregoing, entities that currently engage in the Present Business and therefore fall within the covenants contained herein include, but are not limited to, Enhance Re, RamRe, AXA Re, AMBAC, FGIC, ACA, CGA, FSA, MBIA, PMI, CMAC, GE Mortgage, MGIC, Triad Republic and United Guaranty, as well as any other business, firm, corporation, partnership or other entity for which any present or former chief executive officer of the Company serves in an executive officer, partner, manager or similar senior position. Notwithstanding the foregoing, however, the Executive may own, directly or indirectly, solely as an investment, securities of any business, firm, corporation, partnership or other entity which are traded on any 8 national securities exchange or the Nasdaq National Market if the Executive (A) is not a controlling person of, or a member of a group which controls, such entity and (B) does not, directly or indirectly, own 1% or more of any class of securities of such entity. (c) Solicitations of Customers. During the Restricted Period, the Executive shall not, directly or indirectly, for his own account or as proprietor, stockholder, member, partner, director, officer, employee, agent or otherwise for or on behalf of any person, business, firm, corporation, partnership or other entity other than the Company, sell, offer to sell, or contact or solicit any business from any person, corporation or other entity which was a customer or prospective customer of the Company at any time during the term of this Agreement. For purposes of this Agreement, "customers of the Company" means and includes (i) any and all persons, businesses, corporations, partnerships or other entities which (A) have done business with the Company as a customer during the relevant time period, (B) have been contacted by the Company for the purpose of doing business with the Company or (C) have preexisting business relationships and/or dealings with the Executive when his employment with the Company terminates and (ii) all persons, businesses, corporations, partnerships or other entities which control, or are controlled by, the same person, business, corporation, partnership or other entity which controls, any such customer of the Company. For purposes of this Agreement, "customers" includes prospective customers and referral sources of customers. (d) Agreement Not to Hire Employees and Former Employees. During the Restricted Period, the Executive shall not, directly or indirectly, for his own account or as proprietor, stockholder, partner, director, officer, employee, agent or otherwise for or on behalf of any person, business, firm, corporation, partnership or other entity other than the Company, solicit any person (i) who is an employee of the Company or (ii) who has left the employment of the Company for a period of one year following the termination of such employee's employment, for employment with any person, business, firm, corporation, partnership or other entity other than the Company, or hire any officer or other professional employee of the Company either directly or for or on behalf of any person, business, firm, corporation, partnership or other entity other than the Company. (e) Confidential Information. From and after the date of this Agreement, the Executive shall not at any time, directly or indirectly, disclose to any person, business, firm, corporation, partnership or other entity any confidential or proprietary information concerning the Company, its business or its customers. All information, whether written or otherwise, that is not otherwise in the public domain and is regarding the Company's business, including but not limited to, information regarding customers, customer lists, costs, prices, earnings, systems, operating procedures, prospective and executed contracts and other business arrangements, is presumed to be confidential information of the Company for purposes of this Agreement. The Executive shall return to the Company all books, records, lists and other written, typed, printed or electronically stored materials, whether furnished by 9 the Company or prepared by the Executive, which contain any information relating to the Company, its business or its customers, promptly upon termination of the Executive's employment, and the Executive shall neither make nor retain any copies of such material without the prior written consent of the Company. (f) Cumulative Provisions. The covenants and agreements contained in this Section 10 are independent of each other and are cumulative. (g) Acknowledgments. The Executive acknowledges the broad scope of the covenants contained in this Section 10, but agrees that such covenants are reasonable in light of the scope of the Executive's duties and knowledge of the Company. The Executive further acknowledges and agrees that the covenants contained in this Section 10 do not unreasonably restrict his employment opportunities or unduly burden or deprive him of a means of earning a livelihood. (h) Remedies for Breach. The Executive acknowledges and agrees that his obligations to the Company are unique and that any breach or threatened breach of such obligations may result in irreparable harm and substantial damages to the Company. Accordingly, in the event of a breach or threatened breach by the Executive of any of the provisions of this Section 10, the Company shall have the right, in addition to exercising any other remedies at law or equity which may be available to it under this Agreement or otherwise, to obtain ex parte, preliminary, interlocutory, temporary or permanent injunctive relief, specific performance and other equitable remedies in any court of competent jurisdiction, to prevent the Executive from violating such provision or provisions or to prevent the continuance of any violation thereof, together with an award or judgment for any and all damages, losses, liabilities, expenses and costs incurred by the Company as a result of such breach or threatened breach including, but not limited to, attorneys' fees incurred by the Company in connection with, or as a result of, the enforcement of these covenants. The Executive expressly waives any requirement based on any statute, rule or procedure or other source that the Company post a bond as a condition of obtaining any of the above-described remedies. (i) Divisibility. The Executive agrees that the provisions of this Section 10 are divisible and separable so that if any provision or provisions hereof shall be held to be unreasonable, unlawful or unenforceable, such holding shall not impair the remaining provisions hereof. If any provision hereof is held to be unreasonable, unlawful or unenforceable in duration, geographical scope or character of restriction by any court of competent jurisdiction, such provision shall be modified to the extent necessary in order that any such provision or portion thereof shall be legally enforceable to the fullest extent permitted by law, and the parties hereto do hereby expressly authorize any court of competent jurisdiction to enforce any such provision or portion thereof or to modify any such provision or portion thereof in order that any such provision or portion thereof shall be enforced by such court to the fullest extent permitted by applicable law. 10 11. Successors; Binding Agreement. (a) The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. Failure of the Company to obtain such assumption and agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle the Executive to compensation from the Company in the same amount and on the same terms as he would be entitled to hereunder if he terminated his employment for Good Reasons, except that for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the Date of Termination. As used in this Agreement, "Company" shall mean the Company as herein before defined and any successor to its business and/or assets as aforesaid which executes and delivers the agreement provided for in this Section 11 or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. (b) This Agreement and all rights of the Executive hereunder shall inure to the benefit of and be enforceable by the Executive's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive should die while any amounts would still be payable to him hereunder if he had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Executive's devisee, legatee, or other designee or, if there be no such designee, to the Executive's estate. 12. Notice. For the purposes of this Agreement, notices, demands and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered or (unless otherwise specified) sent by United States certified or registered mail or overnight delivery service, addressed as follows: If to the Executive: David A. Buzen Executive Vice President and Chief Financial Officer c/o Capital Re Corporation 1325 Avenue of the Americas New York, New York 10019 If to the Company: 11 Capital Re Corporation 1325 Avenue of the Americas New York, New York 10019 Attention: Chief Executive Officer or to such other address as any party may have furnished to the others in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. 13. Miscellaneous. No provisions of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing signed by the Executive and the Company. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of New York without regard to its conflicts of law principles. 14. Validity. The invalidity or unenforceability of any provision or provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 15. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall deemed to be in an original but all of which together will constitute one and the same instrument. 16. No Mitigation. In the event of a termination of the Executive's employment arising out of a breach by the Company of this Agreement or if the Executive shall terminate this Agreement for Good Reason, the Executive shall be under no obligation to seek other employment or otherwise mitigate the obligations of the Company under this Agreement. 17. Resolution of Disputes. Any claim arising out of or relating to this Agreement or the Executive's employment with the Company or the termination thereof shall be resolved by binding confidential arbitration, to be held in New York, New York, in accordance with the Commercial Arbitration Rules of the American Arbitration Association. Judgment upon the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof. 18. Entire Agreement. This Agreement sets forth the entire agreement of the parties hereto in respect of the subject matter contained herein 12 and supersedes all prior agreements, promises, covenants, arrangements, communications, representations or warranties, whether oral or written, by any officer, employee or representative of any party hereto; and any prior agreement of the parties hereto in respect of the subject matter contained herein shall, with respect to the Executive, be of no further force and effect. IN WITNESS WHEREOF, the parties have executed this Agreement on the date and year first above written. CAPITAL RE CORPORATION Attest: By: /s/ Alan S. Roseman By: /s/ Jerome F. Jurschak ------------------------------- -------------------------------------- Name: Jerome F. Jurschak Title: CEO, Chairman EXECUTIVE Attest: By: /s/ Alan S. Roseman /s/ David A. Buzen ------------------------------- -------------------------------------- David A. Buzen Executive Vice President and Chief Financial Officer 13 EX-10.16 6 EMPLOYMENT AGREEMENT/LAURENCE C.D. DONNELLY EMPLOYMENT AGREEMENT EMPLOYMENT AGREEMENT made this 2nd day of February, 1999, between Capital Re Corporation, a Delaware corporation with offices at 1325 Avenue of the Americas, New York, New York 10019 (the "Company"), and Laurence C.D. Donnelly (the "Executive"). The Executive is presently employed as Executive Vice President of the Company. The Board of Directors of the Company (the "Board") recognizes that the Executive's contribution to the growth and success of the Company has been substantial. The Board desires to provide for the continued employment of the Executive and to make certain changes in the Executive's employment arrangements with the Company which the Board has determined will reinforce and encourage the continued attention and dedication to the Company of the Executive as a member of the Company's management, in the best interest of the Company and its shareholders. The Executive is willing to commit himself to continue to serve the Company, on the terms and conditions herein provided. In order to effect the foregoing, the Company and the Executive wish to enter into an employment agreement on the terms and conditions set forth below. Accordingly, in consideration of the premises and the respective covenants and agreements of the parties herein contained, and intending to be legally bound hereby, the parties hereto agree as follows: 1. Employment. The Company hereby agrees to continue to employ the Executive, and the Executive hereby agrees to continue to serve the Company, on the terms and conditions set forth herein. 2. Term. The employment of the Executive by the Company as provided in Section 1 will commence on the date hereof and end at the close of business on January 31, 2001, unless further extended or sooner terminated as hereinafter provided. Commencing on January 31, 2001, the term of the Executive's employment shall automatically be extended for one additional year to January 31, 2002, unless, not later than the November 30 immediately preceding such January 31, the Executive shall have given written notice to the Company that it does not wish to extend this Agreement. Commencing on January 31, 2002, and on each January 31 thereafter, the term of the Executive's employment shall automatically be extended for one additional year to January 31, 2003, and each January 31 thereafter, unless, not later than the November 30 preceding such January 31, the Company or the Executive shall have given written notice to the other that it does not wish to extend this Agreement. 3. Position and Duties. The Executive shall serve as Executive Vice President of the Company and shall have such responsibilities, duties and authority as he may have as of the date hereof (or any position to which he may be promoted after the date hereof) and as may from time to time be assigned to the Executive by the Board that are consistent with such responsibilities, duties and authority. The Executive shall devote substantially all his working time and efforts to the business and affairs of the Company. 4. Place of Performance. In connection with the Executive's employment by the Company, the Executive shall be based at the principal executive offices of the Company in New York City, except for required travel on the Company's business to an extent substantially consistent with present business travel obligations. 5. Compensation and Related Matters. (a) Salary and Annual Bonus. During the period of the Executive's employment hereunder, the Company shall pay to the Executive an annual base salary at a rate not less than the rate in effect as of the date hereof or such higher rate as may from time to time be determined by the Board. This salary may be increased from time to time in accordance with normal business practices of the Company and, if so increased, shall not thereafter during the term of this Agreement be decreased. The Executive will participate in the Company's Annual Incentive Plan. In the event the Company amends or terminates the Annual Incentive Plan, the Company shall provide the Executive with an annual bonus program that will provide him with an opportunity to realize an annual bonus which is not less than the proportion of base salary which his target percentage under the Annual Incentive Plan represents at the time the Annual Incentive Plan is amended or terminated, which opportunity shall be reasonably comparable to the Executive's opportunity under the Annual Incentive Plan as of the date hereof. Compensation of the Executive by salary or bonus payments shall not be deemed exclusive and shall not prevent the Executive from participating in any other compensation or benefit plan of the Company. The salary and bonus payments (including any increased payments) hereunder shall not in any way limit or reduce any other obligation of the Company hereunder, and no other compensation, benefit or payment hereunder shall in any way limit or reduce the obligation of the Company to pay the Executive's salary or bonus hereunder. (b) Special Signing Bonus; Retention Bonuses. The Company will pay the Executive $75,000 on the date of execution of this Agreement as a Special Signing Bonus. In addition, the Executive will receive additional payments of (i) $250,000 on January 1, 2000 if, in the good faith judgment of the Compensation Committee of the Board of Directors of the Company (a) the Company has maintained key Capital Re group ratings in categories that do not result in a material impairment of the business and (b) the 1999 Capital Plan approved by the Board of Directors has been successfully executed; and (ii) $225,000 on January 31, 2001, provided, however, that, in the case of both of the 2 bonuses referred to in clauses (i) and (ii), except as otherwise provided in Section 8(d)(ii), the Executive remains employed by the Company on the date designated for payment above. (c) Expenses. During the term of the Executive's employment hereunder, the Executive shall be entitled to receive prompt reimbursement for all reasonable and customary expenses incurred by the Executive in performing services hereunder, including all expenses of travel and living expenses while away from home on business or at the request of and in the service of the Company, provided that such expenses are incurred and accounted for in accordance with the policies and procedures established by the Company. (d) Other Benefits. The Company shall maintain in full force and effect, and the Executive shall be entitled to continue to participate in, all of the employee benefit plans and arrangements and enjoy all of the perquisites in effect on the date hereof in which the Executive participates, provided that the Company may make any changes in such plans, arranges or perquisites that are permitted under the terms thereof or that would not adversely affect the Executive's rights or benefits thereunder. The Executive shall be entitled to participate in or receive benefits under any employee benefit plan, arrangement or perquisite made available by the Company in the future to its executives and key management employees, subject to and on a basis consistent with the terms, conditions and overall administration of such plans, arrangements and perquisites. Nothing paid to the Executive under any plan, arrangement or perquisite presently in effect or made available in the future shall be deemed to be in lieu of the salary and bonus payable to the Executive pursuant to paragraph (a) of this Section. Any payments or benefits payable to the Executive hereunder in respect of any year during which the Executive is employed by the Company for less than the entire such year shall, unless otherwise provided in the applicable plan or arrangement or otherwise hereunder, be prorated in accordance with the number of days in such year during which he is so employed. (e) Vacations. The executive shall be entitled to the number of weeks of vacation each year as may be determined in accordance with the Company's vacation policy as in effect on the date hereof, or such greater amount as may be established by Company policy from time to time. The Executive shall also be entitled to all paid holidays and personal days given by the Company to its executives. (f) Stock Option Grants. The Executive will be entitled to participate as an executive level employee in the Company's 1997 Employee Stock Option Plan. Specifically, the Executive has received a grant on January 15, 1999 of options to purchase 140,000 shares under that Plan, and acknowledges that such grant will be in lieu of any grant that the Board would otherwise ordinarily consider in the Year 2000. 3 (g) Services Furnished. The Company shall furnish the Executive with office space, stenographic assistance and such other facilities and services as shall be suitable to the Executive's position adequate for the performance of his duties as set forth in Section 3 hereof. 6. Service as an Officer and Director of Subsidiary. Subject to Sections 3 and 4, the Executive agrees to serve without additional compensation, if elected or appointed thereto as an officer or a director of any subsidiary of the Company, provided that the Executive is indemnified for serving in such capacity on a basis no less favorable than is currently provided by the Company to any other person serving in such capacity. 7. Termination. The Executive's employment hereunder may be terminated without any breach of this Agreement only under the following circumstances: (a) Death. The Executive's employment hereunder shall terminate upon his death. (b) Disability. If, under any applicable Company Disability Plans (as defined below) the Executive is deemed permanently disabled or, if no such plan is in effect, in the written opinion of a qualified physician selected by the Company, the Executive is unable to perform his duties hereunder due to physical or mental illness for a period of at least 180 days, the Company may terminate the Executive's employment hereunder. (c) Cause. The Company may terminate the Executive's employment hereunder for Cause. For purposes of this Agreement, the Company shall have "Cause" to terminate the Executive's employment hereunder for the Executive's (i) gross negligence or willful misconduct in connection with the performance of his duties, (ii) conviction of a criminal offense (other than minor traffic offenses); or (iii) material breach of this Agreement or any other material agreement between the Executive and the Company. For purposes of this paragraph, no act, or failure to act, on the Executive's part shall be considered "willful" unless done, or omitted to be done, by him not in good faith and without reasonable belief that his action or omission was in the best interest of the Company. (d) Termination by the Executive. The Executive may terminate his employment hereunder only for Good Reason. For purposes of this Agreement, "Good Reason" shall mean (A) the Company's material breach of this Agreement or any other material agreement between the Executive and the Company, or (B) the assignment to the Executive of any duties substantially inconsistent with the Executive's status as Executive Vice President of the Company or a substantial adverse alteration in the nature or status of the Executive's responsibilities. 4 (e) Any termination of the Executive's employment by the Company or by the Executive (other than termination pursuant to subsection (a) or (b) hereof) shall be communicated by written Notice of Termination to the other party hereto in accordance with Section 12. For purposes of this Agreement, a "Notice of Termination" shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated. (f) "Date of Termination" shall mean (i) if the Executive's employment is terminated by his death, the date of his death, (ii) if the Executive's employment is terminated pursuant to subsection (b) above, the date as of which the physician's written opinion is received by the Company, (iii) if the Executive's employment is terminated for any other reason, the date specified in the Notice of Termination. It is understood that in no event will such Date of Termination be deemed to occur solely for purposes of the Company's 1992 Stock Option Plan until the Executive has had a reasonable opportunity (no greater than one business day) to exercise any vested options held by the Executive on that date. 8. Compensation Upon Termination, Death or During Disability. (a) During any period that the Executive fails to perform his duties hereunder as a result of incapacity due to physical or mental illness ("disability period"). the Executive shall continue to receive his full salary at the rate then in effect for such period (and shall not be eligible for payments under the disability plans, programs and policies maintained by the Company or in connection with employment by the Company ("Disability Plans")) until his employment is terminated pursuant to Section 7(b) hereof, and upon such termination, the Executive shall, within ten (10) days of such termination, be entitled to all amounts to which the Executive is entitled pursuant to short-term Disability Plans. The Executive's rights under any long-term Disability Plan shall be determined in accordance with the provisions of such plan. (b) If the Executive's employment is terminated by his death, the Company shall within ten (10) days following the date of the Executive's death, pay any amounts due to the Executive under Section 5 through the date of his death, together with any other amounts to which the Executive is entitled pursuant to death benefit plans, programs and policies. (c) If the Executive's employment shall be terminated by the Company for Cause pursuant to Section 7(c) or by the Executive for other than Good Reason, the Company shall pay the Executive his full salary through the Date of Termination at the rate in effect at the time Notice of Termination is given and the Company shall have no further obligations to the Executive under this Agreement. 5 (d) If (A) in breach of this Agreement, the Company shall terminate the Executive's employment (it being understood that a purported termination for disability pursuant to Section 7(b) or for Cause which is disputed and finally determined not to have been proper shall be a termination by the Company in breach of this Agreement) or (B) the Executive shall terminate his employment for Good Reason, then (i) the Company shall pay the Executive any earned and accrued but unpaid installment of base salary through the Date of Termination at the rate in effect at the time Notice of Termination is given and all other unpaid and pro rata amounts to which the Executive is entitled under any compensation plan or program of the Company in effect on the Date of Termination, and all accrued vacation time; such payments to be made in a lump sum on or before the tenth day following the Date of Termination; (ii) in lieu of any further salary or bonus payments to the Executive for periods subsequent to the Date of Termination, the Company shall pay as liquidated damages to the Executive an amount equal to the sum of (A) Executive's annual salary in effect as of the Date of Termination for a period equal to the remaining term of this Agreement (but not less than one year) and any bonus amounts that would have been payable to the Executive under the Company's Annual Incentive Plan for the year in which termination occurs (assuming for purposes of that Plan that target performance levels are reached) and (B) any unpaid amounts of the Retention Bonuses specified in Section 5(b), such payment to be made in a lump sum on or before the fifth day following the Date of Termination; and (iii) if termination of the Executive's employment arises out of a breach by the Company of this Agreement, the Company shall pay all other damages to which the Executive may be entitled as a result of such breach, including damages for any and all loss of benefits to the Executive under the Company's employee welfare benefit plans and perquisite programs which the Executive would have received if the Company had not breached this Agreement and had the Executive's employment continued for the balance of the employment term hereunder. 9. "Gross-Up Payment." In the event that it shall be determined at any time that the payment provided under paragraph 8(d) above (the "Contract Payment") or any other payment or distribution by the Company to the Executive (including deemed payments arising from accelerated vesting of stock options) is subject to the tax (the "Excise Tax") imposed by section 4999 of the Internal Revenue Code of 1986, as amended, Section 11.5 of the Company's 1997 Employee Stock Option Plan or similar "parachute payment" limitations under any other agreement between the Company and the Executive that are in effect shall not apply, and the Company shall pay the Executive an additional amount (the "Gross- 6 Up Payment") such that the net amount retained by the Executive, after deduction of any Excise Tax on the Contract Payment and such other Total Payments (as defined below) and any federal and state and local income tax and Excise Tax upon the payment provided for by this paragraph, shall be equal to the Contract Payment and such other Total Payments. For purposes of determining whether any of the payments will be subject to the Excise Tax and the amount of such Excise Tax, (i) any other payments or benefits received or to be received by the Executive in connection with a change in control of the Company or the Executive's termination of employment, whether payable pursuant to the terms of this Agreement or any other plan, arrangement or agreement with the Company, its successors, any person whose actions result in a change in control of the Company or any corporation affiliated (or which, as a result of the completion of a transaction causing a change in control, will become affiliated) with the Company within the meaning of Section 1504 of the Code (together with the Contract Payment, the "Total Payments") shall be treated as "parachute payments" within the meaning of section 280G(b)(2) of the Code, and all "excess parachute payments" within the meaning of section 280G(b)(1) shall be treated as subject to the Excise Tax, unless in the opinion of tax counsel selected by the Company's independent auditors and acceptable to the Executive the Total Payments (in whole or in part) do not constitute parachute payments, or such excess parachute payments (in whole or in part) represent reasonable compensation for services actually rendered within the meaning of section 280G(b)(4) of the Code either in their entirety or in excess of the base amount within the meaning of section 280G(b)(3) of the Code, or are otherwise not subject to the Excise Tax, (ii) the amount of the Total Payments that shall be treated as subject to the Excise Tax shall be equal to the lesser of (A) the total amount of the Total Payments or (B) the amount of excess parachute payments within the meaning of section 280G(b)(1) (after applying clause (i), above), and (iii) the value of any non-cash benefits or any deferred payment or benefit shall be determined by the Company's independent auditors in accordance with the principles of sections 280G(b)(3) and (4) of the Code. For purposes of determining the amount of the Gross-Up Payment, the Executive shall be deemed to pay federal income taxes at the highest marginal rate of federal income taxation in the calendar year in which the Gross-Up Payment is to be made and state and local income taxes at the highest marginal rate of taxation in the state and locality of the Executive's residence on the date of determination, net of the maximum reduction in federal income taxes which could be obtained from deduction of such state and local taxes. In the event that the Excise Tax is subsequently determined to be less than the amount taken into account hereunder at the time of payment of the Gross-Up Payment, the Executive shall repay to the Company at the time that the amount of such reduction in Excise Tax is finally determined the portion of the Gross-Up Payment attributable to such reduction (plus the portion of the Gross-Up Payment attributable to the Excise Tax and federal and state and local income tax imposed on the Gross-Up Payment being repaid by the Executive if such repayment results in a reduction in Excise Tax and/or a federal state and local income tax deduction) plus interest on the amount of such repayment at the rate provided in section 7 1274(d) of the Code. In the event that the Excise Tax is determined to exceed the amount taken into account hereunder at the time of the payment of the Gross-Up Payment (including by reason of any payment the existence or amount of which cannot be determined at the time of the Gross-Up Payment), the Company shall make an additional Gross-Up Payment in respect of such excess (plus any interest payable with respect to such excess) at the time that the amount of such excess is finally determined. 10. Non-Competition and Non-Solicitation Covenants. (a) Covenants of the Executive. The Executive acknowledges that (i) the principal current businesses of the Company are the insurance and reinsurance of financial guarantees, the provision of mortgage guaranty insurance and reinsurance and ancillary businesses (the "Present Business"); (ii) the Company constitutes one of a limited number of firms that have developed and carry on the Present Business; (iii) the Executive's work for the Company has given and shall continue to give him access to the confidential affairs and proprietary information of the Company not readily available to the public; and (iv) the agreements and covenants of the Executive contained in this Section 10 are essential to the business and goodwill of the Company. Accordingly, in consideration of the benefits being provided by the this Agreement, the Executive is subject to the agreements and covenants set forth in this Section 10. (b) Covenant Against Competition. While the Executive is employed by the Company and for a period of two years after the Date of Termination (whether or not termination constitutes a breach of this Agreement) or from the entry by a court of competent jurisdiction of a final judgment enforcing these restrictions, whichever is later (such period commencing on the date hereof is hereinafter referred to as the "Restricted Period"), the Executive shall not, directly or indirectly, own, manage, operate, join or control, or participate in the ownership, management, operation or control of, or be a proprietor, director, officer, stockholder, member, partner or an employee or agent of, or a consultant to, any business, firm, corporation, partnership or other entity now or hereafter which engages in (A) the Present Business, or (B) any other principal line of business developed by the Company after the date hereof but prior to the Date of Termination (a "New Business") in any state or country in which the Company has conducted business during the term of this Agreement. For purposes of the foregoing, entities that currently engage in the Present Business and therefore fall within the covenants contained herein include, but are not limited to, Enhance Re, RamRe, AXA Re, AMBAC, FGIC, ACA, CGA, FSA, MBIA, PMI, CMAC, GE Mortgage, MGIC, Triad Republic and United Guaranty, as well as any other business, firm, corporation, partnership or other entity for which any present or former chief executive officer of the Company serves in an executive officer, partner, manager or similar senior position. Notwithstanding the foregoing, however, the Executive may own, directly or indirectly, solely as an investment, securities of any business, firm, corporation, partnership or other entity which are traded on any 8 national securities exchange or the Nasdaq National Market if the Executive (A) is not a controlling person of, or a member of a group which controls, such entity and (B) does not, directly or indirectly, own 1% or more of any class of securities of such entity. (c) Solicitations of Customers. During the Restricted Period, the Executive shall not, directly or indirectly, for his own account or as proprietor, stockholder, member, partner, director, officer, employee, agent or otherwise for or on behalf of any person, business, firm, corporation, partnership or other entity other than the Company, sell, offer to sell, or contact or solicit any business from any person, corporation or other entity which was a customer or prospective customer of the Company at any time during the term of this Agreement. For purposes of this Agreement, "customers of the Company" means and includes (i) any and all persons, businesses, corporations, partnerships or other entities which (A) have done business with the Company as a customer during the relevant time period, (B) have been contacted by the Company for the purpose of doing business with the Company or (C) have preexisting business relationships and/or dealings with the Executive when his employment with the Company terminates and (ii) all persons, businesses, corporations, partnerships or other entities which control, or are controlled by, the same person, business, corporation, partnership or other entity which controls, any such customer of the Company. For purposes of this Agreement, "customers" includes prospective customers and referral sources of customers. (d) Agreement Not to Hire Employees and Former Employees. During the Restricted Period, the Executive shall not, directly or indirectly, for his own account or as proprietor, stockholder, partner, director, officer, employee, agent or otherwise for or on behalf of any person, business, firm, corporation, partnership or other entity other than the Company, solicit any person (i) who is an employee of the Company or (ii) who has left the employment of the Company for a period of one year following the termination of such employee's employment, for employment with any person, business, firm, corporation, partnership or other entity other than the Company, or hire any officer or other professional employee of the Company either directly or for or on behalf of any person, business, firm, corporation, partnership or other entity other than the Company. (e) Confidential Information. From and after the date of this Agreement, the Executive shall not at any time, directly or indirectly, disclose to any person, business, firm, corporation, partnership or other entity any confidential or proprietary information concerning the Company, its business or its customers. All information, whether written or otherwise, that is not otherwise in the public domain and is regarding the Company's business, including but not limited to, information regarding customers, customer lists, costs, prices, earnings, systems, operating procedures, prospective and executed contracts and other business arrangements, is presumed to be confidential information of the Company for purposes of this Agreement. The Executive shall return to the Company all books, records, lists and other written, typed, printed or electronically stored materials, whether furnished by 9 the Company or prepared by the Executive, which contain any information relating to the Company, its business or its customers, promptly upon termination of the Executive's employment, and the Executive shall neither make nor retain any copies of such material without the prior written consent of the Company. (f) Cumulative Provisions. The covenants and agreements contained in this Section 10 are independent of each other and are cumulative. (g) Acknowledgments. The Executive acknowledges the broad scope of the covenants contained in this Section 10, but agrees that such covenants are reasonable in light of the scope of the Executive's duties and knowledge of the Company. The Executive further acknowledges and agrees that the covenants contained in this Section 10 do not unreasonably restrict his employment opportunities or unduly burden or deprive him of a means of earning a livelihood. (h) Remedies for Breach. The Executive acknowledges and agrees that his obligations to the Company are unique and that any breach or threatened breach of such obligations may result in irreparable harm and substantial damages to the Company. Accordingly, in the event of a breach or threatened breach by the Executive of any of the provisions of this Section 10, the Company shall have the right, in addition to exercising any other remedies at law or equity which may be available to it under this Agreement or otherwise, to obtain ex parte, preliminary, interlocutory, temporary or permanent injunctive relief, specific performance and other equitable remedies in any court of competent jurisdiction, to prevent the Executive from violating such provision or provisions or to prevent the continuance of any violation thereof, together with an award or judgment for any and all damages, losses, liabilities, expenses and costs incurred by the Company as a result of such breach or threatened breach including, but not limited to, attorneys' fees incurred by the Company in connection with, or as a result of, the enforcement of these covenants. The Executive expressly waives any requirement based on any statute, rule or procedure or other source that the Company post a bond as a condition of obtaining any of the above-described remedies. (i) Divisibility. The Executive agrees that the provisions of this Section 10 are divisible and separable so that if any provision or provisions hereof shall be held to be unreasonable, unlawful or unenforceable, such holding shall not impair the remaining provisions hereof. If any provision hereof is held to be unreasonable, unlawful or unenforceable in duration, geographical scope or character of restriction by any court of competent jurisdiction, such provision shall be modified to the extent necessary in order that any such provision or portion thereof shall be legally enforceable to the fullest extent permitted by law, and the parties hereto do hereby expressly authorize any court of competent jurisdiction to enforce any such provision or portion thereof or to modify any such provision or portion thereof in order that any such provision or portion thereof shall be enforced by such court to the fullest extent permitted by applicable law. 10 11. Successors; Binding Agreement. (a) The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. Failure of the Company to obtain such assumption and agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle the Executive to compensation from the Company in the same amount and on the same terms as he would be entitled to hereunder if he terminated his employment for Good Reasons, except that for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the Date of Termination. As used in this Agreement, "Company" shall mean the Company as herein before defined and any successor to its business and/or assets as aforesaid which executes and delivers the agreement provided for in this Section 11 or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. (b) This Agreement and all rights of the Executive hereunder shall inure to the benefit of and be enforceable by the Executive's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive should die while any amounts would still be payable to him hereunder if he had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Executive's devisee, legatee, or other designee or, if there be no such designee, to the Executive's estate. 12. Notice. For the purposes of this Agreement, notices, demands and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered or (unless otherwise specified) sent by United States certified or registered mail or overnight delivery service, addressed as follows: If to the Executive: Laurence C.D. Donnelly Executive Vice President c/o Capital Re Corporation 1325 Avenue of the Americas New York, New York 10019 11 If to the Company: Capital Re Corporation 1325 Avenue of the Americas New York, New York 10019 Attention: Chief Executive Officer or to such other address as any party may have furnished to the others in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. 13. Miscellaneous. No provisions of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing signed by the Executive and the Company. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of New York without regard to its conflicts of law principles. 14. Validity. The invalidity or unenforceability of any provision or provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 15. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall deemed to be in an original but all of which together will constitute one and the same instrument. 16. No Mitigation. In the event of a termination of the Executive's employment arising out of a breach by the Company of this Agreement or if the Executive shall terminate this Agreement for Good Reason, the Executive shall be under no obligation to seek other employment or otherwise mitigate the obligations of the Company under this Agreement. 17. Resolution of Disputes. Any claim arising out of or relating to this Agreement or the Executive's employment with the Company or the termination thereof shall be resolved by binding confidential arbitration, to be held in New York, New York, in accordance with the Commercial Arbitration Rules of the American Arbitration Association. Judgment upon the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof. 12 18. Entire Agreement. This Agreement sets forth the entire agreement of the parties hereto in respect of the subject matter contained herein and supersedes all prior agreements, promises, covenants, arrangements, communications, representations or warranties, whether oral or written, by any officer, employee or representative of any party hereto; and any prior agreement of the parties hereto in respect of the subject matter contained herein shall, with respect to the Executive, be of no further force and effect. IN WITNESS WHEREOF, the parties have executed this Agreement on the date and year first above written. CAPITAL RE CORPORATION Attest: By: /s/ Alan S. Roseman By: /s/ Jerome F. Jurschak ------------------------------- -------------------------------------- Name: Jerome F. Jurschak Title: CEO, Chairman EXECUTIVE Attest: By: /s/ Alan S. Roseman /s/ Laurence C.D. Donnelly ------------------------------- -------------------------------------- Laurence C.D. Donnelly Executive Vice President 13 EX-10.17 7 EMPLOYMENT AGREEMENT/ALAN S. ROSEMAN EMPLOYMENT AGREEMENT EMPLOYMENT AGREEMENT made this 2nd day of February, 1999, between Capital Re Corporation, a Delaware corporation with offices at 1325 Avenue of the Americas, New York, New York 10019 (the "Company"), and Alan S. Roseman (the "Executive"). The Executive is presently employed as Senior Vice President and General Counsel of the Company. The Board of Directors of the Company (the "Board") recognizes that the Executive's contribution to the growth and success of the Company has been substantial. The Board desires to provide for the continued employment of the Executive and to make certain changes in the Executive's employment arrangements with the Company which the Board has determined will reinforce and encourage the continued attention and dedication to the Company of the Executive as a member of the Company's management, in the best interest of the Company and its shareholders. The Executive is willing to commit himself to continue to serve the Company, on the terms and conditions herein provided. In order to effect the foregoing, the Company and the Executive wish to enter into an employment agreement on the terms and conditions set forth below. Accordingly, in consideration of the premises and the respective covenants and agreements of the parties herein contained, and intending to be legally bound hereby, the parties hereto agree as follows: 1. Employment. The Company hereby agrees to continue to employ the Executive, and the Executive hereby agrees to continue to serve the Company, on the terms and conditions set forth herein. 2. Term. The employment of the Executive by the Company as provided in Section 1 will commence on the date hereof and end at the close of business on January 31, 2001, unless further extended or sooner terminated as hereinafter provided. Commencing on January 31, 2001, the term of the Executive's employment shall automatically be extended for one additional year to January 31, 2002, unless, not later than the November 30 immediately preceding such January 31, the Executive shall have given written notice to the Company that it does not wish to extend this Agreement. Commencing on January 31, 2002, and on each January 31 thereafter, the term of the Executive's employment shall automatically be extended for one additional year to January 31, 2003, and each January 31 thereafter, unless, not later than the November 30 preceding such January 31, the Company or the Executive shall have given written notice to the other that it does not wish to extend this Agreement. 3. Position and Duties. The Executive shall serve as Senior Vice President and General Counsel of the Company and shall have such responsibilities, duties and authority as he may have as of the date hereof (or any position to which he may be promoted after the date hereof) and as may from time to time be assigned to the Executive by the Board that are consistent with such responsibilities, duties and authority. The Executive shall devote substantially all his working time and efforts to the business and affairs of the Company. 4. Place of Performance. In connection with the Executive's employment by the Company, the Executive shall be based at the principal executive offices of the Company in New York City, except for required travel on the Company's business to an extent substantially consistent with present business travel obligations. 5. Compensation and Related Matters. (a) Salary and Annual Bonus. During the period of the Executive's employment hereunder, the Company shall pay to the Executive an annual base salary at a rate not less than the rate in effect as of the date hereof or such higher rate as may from time to time be determined by the Board. This salary may be increased from time to time in accordance with normal business practices of the Company and, if so increased, shall not thereafter during the term of this Agreement be decreased. The Executive will participate in the Company's Annual Incentive Plan. In the event the Company amends or terminates the Annual Incentive Plan, the Company shall provide the Executive with an annual bonus program that will provide him with an opportunity to realize an annual bonus which is not less than the proportion of base salary which his target percentage under the Annual Incentive Plan represents at the time the Annual Incentive Plan is amended or terminated, which opportunity shall be reasonably comparable to the Executive's opportunity under the Annual Incentive Plan as of the date hereof. Compensation of the Executive by salary or bonus payments shall not be deemed exclusive and shall not prevent the Executive from participating in any other compensation or benefit plan of the Company. The salary and bonus payments (including any increased payments) hereunder shall not in any way limit or reduce any other obligation of the Company hereunder, and no other compensation, benefit or payment hereunder shall in any way limit or reduce the obligation of the Company to pay the Executive's salary or bonus hereunder. (b) Special Signing Bonus; Retention Bonuses. The Company will pay the Executive $75,000 on the date of execution of this Agreement as a Special Signing Bonus. In addition, the Executive will receive additional payments of (i) $250,000 on January 1, 2000 if, in the good faith judgment of the Compensation Committee of the Board of Directors of the Company (a) the Company has maintained key Capital Re group ratings in categories that do not result in a material impairment of the business and (b) the 1999 Capital Plan approved by the Board of Directors has been successfully executed; and (ii) $225,000 on January 31, 2001, provided, however, that, in the case of both of the 2 bonuses referred to in clauses (i) and (ii), except as otherwise provided in Section 8(d)(ii), the Executive remains employed by the Company on the date designated for payment above. (c) Expenses. During the term of the Executive's employment hereunder, the Executive shall be entitled to receive prompt reimbursement for all reasonable and customary expenses incurred by the Executive in performing services hereunder, including all expenses of travel and living expenses while away from home on business or at the request of and in the service of the Company, provided that such expenses are incurred and accounted for in accordance with the policies and procedures established by the Company. (d) Other Benefits. The Company shall maintain in full force and effect, and the Executive shall be entitled to continue to participate in, all of the employee benefit plans and arrangements and enjoy all of the perquisites in effect on the date hereof in which the Executive participates, provided that the Company may make any changes in such plans, arranges or perquisites that are permitted under the terms thereof or that would not adversely affect the Executive's rights or benefits thereunder. The Executive shall be entitled to participate in or receive benefits under any employee benefit plan, arrangement or perquisite made available by the Company in the future to its executives and key management employees, subject to and on a basis consistent with the terms, conditions and overall administration of such plans, arrangements and perquisites. Nothing paid to the Executive under any plan, arrangement or perquisite presently in effect or made available in the future shall be deemed to be in lieu of the salary and bonus payable to the Executive pursuant to paragraph (a) of this Section. Any payments or benefits payable to the Executive hereunder in respect of any year during which the Executive is employed by the Company for less than the entire such year shall, unless otherwise provided in the applicable plan or arrangement or otherwise hereunder, be prorated in accordance with the number of days in such year during which he is so employed. (e) Vacations. The executive shall be entitled to the number of weeks of vacation each year as may be determined in accordance with the Company's vacation policy as in effect on the date hereof, or such greater amount as may be established by Company policy from time to time. The Executive shall also be entitled to all paid holidays and personal days given by the Company to its executives. (f) Stock Option Grants. The Executive will be entitled to participate as an executive level employee in the Company's 1997 Employee Stock Option Plan. Specifically, the Executive has received a grant on January 15, 1999 of options to purchase 140,000 shares under that Plan, and acknowledges that such grant will be in lieu of any grant that the Board would otherwise ordinarily consider in the Year 2000. 3 (g) Services Furnished. The Company shall furnish the Executive with office space, stenographic assistance and such other facilities and services as shall be suitable to the Executive's position adequate for the performance of his duties as set forth in Section 3 hereof. 6. Service as an Officer and Director of Subsidiary. Subject to Sections 3 and 4, the Executive agrees to serve without additional compensation, if elected or appointed thereto as an officer or a director of any subsidiary of the Company, provided that the Executive is indemnified for serving in such capacity on a basis no less favorable than is currently provided by the Company to any other person serving in such capacity. 7. Termination. The Executive's employment hereunder may be terminated without any breach of this Agreement only under the following circumstances: (a) Death. The Executive's employment hereunder shall terminate upon his death. (b) Disability. If, under any applicable Company Disability Plans (as defined below) the Executive is deemed permanently disabled or, if no such plan is in effect, in the written opinion of a qualified physician selected by the Company, the Executive is unable to perform his duties hereunder due to physical or mental illness for a period of at least 180 days, the Company may terminate the Executive's employment hereunder. (c) Cause. The Company may terminate the Executive's employment hereunder for Cause. For purposes of this Agreement, the Company shall have "Cause" to terminate the Executive's employment hereunder for the Executive's (i) gross negligence or willful misconduct in connection with the performance of his duties, (ii) conviction of a criminal offense (other than minor traffic offenses); or (iii) material breach of this Agreement or any other material agreement between the Executive and the Company. For purposes of this paragraph, no act, or failure to act, on the Executive's part shall be considered "willful" unless done, or omitted to be done, by him not in good faith and without reasonable belief that his action or omission was in the best interest of the Company. (d) Termination by the Executive. The Executive may terminate his employment hereunder only for Good Reason. For purposes of this Agreement, "Good Reason" shall mean (A) the Company's material breach of this Agreement or any other material agreement between the Executive and the Company, or (B) the assignment to the Executive of any duties substantially inconsistent with the Executive's status as Senior Vice President and General Counsel of the Company or a substantial adverse alteration in the nature or status of the Executive's responsibilities. 4 (e) Any termination of the Executive's employment by the Company or by the Executive (other than termination pursuant to subsection (a) or (b) hereof) shall be communicated by written Notice of Termination to the other party hereto in accordance with Section 12. For purposes of this Agreement, a "Notice of Termination" shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated. (f) "Date of Termination" shall mean (i) if the Executive's employment is terminated by his death, the date of his death, (ii) if the Executive's employment is terminated pursuant to subsection (b) above, the date as of which the physician's written opinion is received by the Company, (iii) if the Executive's employment is terminated for any other reason, the date specified in the Notice of Termination. It is understood that in no event will such Date of Termination be deemed to occur solely for purposes of the Company's 1992 Stock Option Plan until the Executive has had a reasonable opportunity (no greater than one business day) to exercise any vested options held by the Executive on that date. 8. Compensation Upon Termination, Death or During Disability. (a) During any period that the Executive fails to perform his duties hereunder as a result of incapacity due to physical or mental illness ("disability period"). the Executive shall continue to receive his full salary at the rate then in effect for such period (and shall not be eligible for payments under the disability plans, programs and policies maintained by the Company or in connection with employment by the Company ("Disability Plans")) until his employment is terminated pursuant to Section 7(b) hereof, and upon such termination, the Executive shall, within ten (10) days of such termination, be entitled to all amounts to which the Executive is entitled pursuant to short-term Disability Plans. The Executive's rights under any long-term Disability Plan shall be determined in accordance with the provisions of such plan. (b) If the Executive's employment is terminated by his death, the Company shall within ten (10) days following the date of the Executive's death, pay any amounts due to the Executive under Section 5 through the date of his death, together with any other amounts to which the Executive is entitled pursuant to death benefit plans, programs and policies. (c) If the Executive's employment shall be terminated by the Company for Cause pursuant to Section 7(c) or by the Executive for other than Good Reason, the Company shall pay the Executive his full salary through the Date of Termination at the rate in effect at the time Notice of Termination is given and the Company shall have no further obligations to the Executive under this Agreement. 5 (d) If (A) in breach of this Agreement, the Company shall terminate the Executive's employment (it being understood that a purported termination for disability pursuant to Section 7(b) or for Cause which is disputed and finally determined not to have been proper shall be a termination by the Company in breach of this Agreement) or (B) the Executive shall terminate his employment for Good Reason, then (i) the Company shall pay the Executive any earned and accrued but unpaid installment of base salary through the Date of Termination at the rate in effect at the time Notice of Termination is given and all other unpaid and pro rata amounts to which the Executive is entitled under any compensation plan or program of the Company in effect on the Date of Termination, and all accrued vacation time; such payments to be made in a lump sum on or before the tenth day following the Date of Termination; (ii) in lieu of any further salary or bonus payments to the Executive for periods subsequent to the Date of Termination, the Company shall pay as liquidated damages to the Executive an amount equal to the sum of (A) Executive's annual salary in effect as of the Date of Termination for a period equal to the remaining term of this Agreement (but not less than one year) and any bonus amounts that would have been payable to the Executive under the Company's Annual Incentive Plan for the year in which termination occurs (assuming for purposes of that Plan that target performance levels are reached) and (B) any unpaid amounts of the Retention Bonuses specified in Section 5(b), such payment to be made in a lump sum on or before the fifth day following the Date of Termination; and (iii) if termination of the Executive's employment arises out of a breach by the Company of this Agreement, the Company shall pay all other damages to which the Executive may be entitled as a result of such breach, including damages for any and all loss of benefits to the Executive under the Company's employee welfare benefit plans and perquisite programs which the Executive would have received if the Company had not breached this Agreement and had the Executive's employment continued for the balance of the employment term hereunder. 9. "Gross-Up Payment." In the event that it shall be determined at any time that the payment provided under paragraph 8(d) above (the "Contract Payment") or any other payment or distribution by the Company to the Executive (including deemed payments arising from accelerated vesting of stock options) is subject to the tax (the "Excise Tax") imposed by section 4999 of the Internal Revenue Code of 1986, as amended, Section 11.5 of the Company's 1997 Employee Stock Option Plan or similar "parachute payment" limitations under any other agreement between the Company and the Executive that are in effect shall not apply, and the Company shall pay the Executive an additional amount (the "Gross- 6 Up Payment") such that the net amount retained by the Executive, after deduction of any Excise Tax on the Contract Payment and such other Total Payments (as defined below) and any federal and state and local income tax and Excise Tax upon the payment provided for by this paragraph, shall be equal to the Contract Payment and such other Total Payments. For purposes of determining whether any of the payments will be subject to the Excise Tax and the amount of such Excise Tax, (i) any other payments or benefits received or to be received by the Executive in connection with a change in control of the Company or the Executive's termination of employment, whether payable pursuant to the terms of this Agreement or any other plan, arrangement or agreement with the Company, its successors, any person whose actions result in a change in control of the Company or any corporation affiliated (or which, as a result of the completion of a transaction causing a change in control, will become affiliated) with the Company within the meaning of Section 1504 of the Code (together with the Contract Payment, the "Total Payments") shall be treated as "parachute payments" within the meaning of section 280G(b)(2) of the Code, and all "excess parachute payments" within the meaning of section 280G(b)(1) shall be treated as subject to the Excise Tax, unless in the opinion of tax counsel selected by the Company's independent auditors and acceptable to the Executive the Total Payments (in whole or in part) do not constitute parachute payments, or such excess parachute payments (in whole or in part) represent reasonable compensation for services actually rendered within the meaning of section 280G(b)(4) of the Code either in their entirety or in excess of the base amount within the meaning of section 280G(b)(3) of the Code, or are otherwise not subject to the Excise Tax, (ii) the amount of the Total Payments that shall be treated as subject to the Excise Tax shall be equal to the lesser of (A) the total amount of the Total Payments or (B) the amount of excess parachute payments within the meaning of section 280G(b)(1) (after applying clause (i), above), and (iii) the value of any non-cash benefits or any deferred payment or benefit shall be determined by the Company's independent auditors in accordance with the principles of sections 280G(b)(3) and (4) of the Code. For purposes of determining the amount of the Gross-Up Payment, the Executive shall be deemed to pay federal income taxes at the highest marginal rate of federal income taxation in the calendar year in which the Gross-Up Payment is to be made and state and local income taxes at the highest marginal rate of taxation in the state and locality of the Executive's residence on the date of determination, net of the maximum reduction in federal income taxes which could be obtained from deduction of such state and local taxes. In the event that the Excise Tax is subsequently determined to be less than the amount taken into account hereunder at the time of payment of the Gross-Up Payment, the Executive shall repay to the Company at the time that the amount of such reduction in Excise Tax is finally determined the portion of the Gross-Up Payment attributable to such reduction (plus the portion of the Gross-Up Payment attributable to the Excise Tax and federal and state and local income tax imposed on the Gross-Up Payment being repaid by the Executive if such repayment results in a reduction in Excise Tax and/or a federal state and local income tax deduction) plus interest on the amount of such repayment at the rate provided in section 7 1274(d) of the Code. In the event that the Excise Tax is determined to exceed the amount taken into account hereunder at the time of the payment of the Gross-Up Payment (including by reason of any payment the existence or amount of which cannot be determined at the time of the Gross-Up Payment), the Company shall make an additional Gross-Up Payment in respect of such excess (plus any interest payable with respect to such excess) at the time that the amount of such excess is finally determined. 10. Non-Competition and Non-Solicitation Covenants. (a) Covenants of the Executive. The Executive acknowledges that (i) the principal current businesses of the Company are the insurance and reinsurance of financial guarantees, the provision of mortgage guaranty insurance and reinsurance and ancillary businesses (the "Present Business"); (ii) the Company constitutes one of a limited number of firms that have developed and carry on the Present Business; (iii) the Executive's work for the Company has given and shall continue to give him access to the confidential affairs and proprietary information of the Company not readily available to the public; and (iv) the agreements and covenants of the Executive contained in this Section 10 are essential to the business and goodwill of the Company. Accordingly, in consideration of the benefits being provided by the this Agreement, the Executive is subject to the agreements and covenants set forth in this Section 10. (b) Covenant Against Competition. While the Executive is employed by the Company and for a period of two years after the Date of Termination (whether or not termination constitutes a breach of this Agreement) or from the entry by a court of competent jurisdiction of a final judgment enforcing these restrictions, whichever is later (such period commencing on the date hereof is hereinafter referred to as the "Restricted Period"), the Executive shall not, directly or indirectly, own, manage, operate, join or control, or participate in the ownership, management, operation or control of, or be a proprietor, director, officer, stockholder, member, partner or an employee or agent of, or a consultant to, any business, firm, corporation, partnership or other entity now or hereafter which engages in (A) the Present Business, or (B) any other principal line of business developed by the Company after the date hereof but prior to the Date of Termination (a "New Business") in any state or country in which the Company has conducted business during the term of this Agreement. For purposes of the foregoing, entities that currently engage in the Present Business and therefore fall within the covenants contained herein include, but are not limited to, Enhance Re, RamRe, AXA Re, AMBAC, FGIC, ACA, CGA, FSA, MBIA, PMI, CMAC, GE Mortgage, MGIC, Triad Republic and United Guaranty, as well as any other business, firm, corporation, partnership or other entity for which any present or former chief executive officer of the Company serves in an executive officer, partner, manager or similar senior position. Notwithstanding the foregoing, however, the Executive may own, directly or indirectly, solely as an investment, securities of any business, firm, corporation, partnership or other entity which are traded on any 8 national securities exchange or the Nasdaq National Market if the Executive (A) is not a controlling person of, or a member of a group which controls, such entity and (B) does not, directly or indirectly, own 1% or more of any class of securities of such entity. (c) Solicitations of Customers. During the Restricted Period, the Executive shall not, directly or indirectly, for his own account or as proprietor, stockholder, member, partner, director, officer, employee, agent or otherwise for or on behalf of any person, business, firm, corporation, partnership or other entity other than the Company, sell, offer to sell, or contact or solicit any business from any person, corporation or other entity which was a customer or prospective customer of the Company at any time during the term of this Agreement. For purposes of this Agreement, "customers of the Company" means and includes (i) any and all persons, businesses, corporations, partnerships or other entities which (A) have done business with the Company as a customer during the relevant time period, (B) have been contacted by the Company for the purpose of doing business with the Company or (C) have preexisting business relationships and/or dealings with the Executive when his employment with the Company terminates and (ii) all persons, businesses, corporations, partnerships or other entities which control, or are controlled by, the same person, business, corporation, partnership or other entity which controls, any such customer of the Company. For purposes of this Agreement, "customers" includes prospective customers and referral sources of customers. (d) Agreement Not to Hire Employees and Former Employees. During the Restricted Period, the Executive shall not, directly or indirectly, for his own account or as proprietor, stockholder, partner, director, officer, employee, agent or otherwise for or on behalf of any person, business, firm, corporation, partnership or other entity other than the Company, solicit any person (i) who is an employee of the Company or (ii) who has left the employment of the Company for a period of one year following the termination of such employee's employment, for employment with any person, business, firm, corporation, partnership or other entity other than the Company, or hire any officer or other professional employee of the Company either directly or for or on behalf of any person, business, firm, corporation, partnership or other entity other than the Company. (e) Confidential Information. From and after the date of this Agreement, the Executive shall not at any time, directly or indirectly, disclose to any person, business, firm, corporation, partnership or other entity any confidential or proprietary information concerning the Company, its business or its customers. All information, whether written or otherwise, that is not otherwise in the public domain and is regarding the Company's business, including but not limited to, information regarding customers, customer lists, costs, prices, earnings, systems, operating procedures, prospective and executed contracts and other business arrangements, is presumed to be confidential information of the Company for purposes of this Agreement. The Executive shall return to the Company all books, records, lists and other written, typed, printed or electronically stored materials, whether furnished by 9 the Company or prepared by the Executive, which contain any information relating to the Company, its business or its customers, promptly upon termination of the Executive's employment, and the Executive shall neither make nor retain any copies of such material without the prior written consent of the Company. (f) Cumulative Provisions. The covenants and agreements contained in this Section 10 are independent of each other and are cumulative. (g) Acknowledgments. The Executive acknowledges the broad scope of the covenants contained in this Section 10, but agrees that such covenants are reasonable in light of the scope of the Executive's duties and knowledge of the Company. The Executive further acknowledges and agrees that the covenants contained in this Section 10 do not unreasonably restrict his employment opportunities or unduly burden or deprive him of a means of earning a livelihood. (h) Remedies for Breach. The Executive acknowledges and agrees that his obligations to the Company are unique and that any breach or threatened breach of such obligations may result in irreparable harm and substantial damages to the Company. Accordingly, in the event of a breach or threatened breach by the Executive of any of the provisions of this Section 10, the Company shall have the right, in addition to exercising any other remedies at law or equity which may be available to it under this Agreement or otherwise, to obtain ex parte, preliminary, interlocutory, temporary or permanent injunctive relief, specific performance and other equitable remedies in any court of competent jurisdiction, to prevent the Executive from violating such provision or provisions or to prevent the continuance of any violation thereof, together with an award or judgment for any and all damages, losses, liabilities, expenses and costs incurred by the Company as a result of such breach or threatened breach including, but not limited to, attorneys' fees incurred by the Company in connection with, or as a result of, the enforcement of these covenants. The Executive expressly waives any requirement based on any statute, rule or procedure or other source that the Company post a bond as a condition of obtaining any of the above-described remedies. (i) Divisibility. The Executive agrees that the provisions of this Section 10 are divisible and separable so that if any provision or provisions hereof shall be held to be unreasonable, unlawful or unenforceable, such holding shall not impair the remaining provisions hereof. If any provision hereof is held to be unreasonable, unlawful or unenforceable in duration, geographical scope or character of restriction by any court of competent jurisdiction, such provision shall be modified to the extent necessary in order that any such provision or portion thereof shall be legally enforceable to the fullest extent permitted by law, and the parties hereto do hereby expressly authorize any court of competent jurisdiction to enforce any such provision or portion thereof or to modify any such provision or portion thereof in order that any such provision or portion thereof shall be enforced by such court to the fullest extent permitted by applicable law. 10 11. Successors; Binding Agreement. (a) The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. Failure of the Company to obtain such assumption and agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle the Executive to compensation from the Company in the same amount and on the same terms as he would be entitled to hereunder if he terminated his employment for Good Reasons, except that for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the Date of Termination. As used in this Agreement, "Company" shall mean the Company as herein before defined and any successor to its business and/or assets as aforesaid which executes and delivers the agreement provided for in this Section 11 or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. (b) This Agreement and all rights of the Executive hereunder shall inure to the benefit of and be enforceable by the Executive's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive should die while any amounts would still be payable to him hereunder if he had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Executive's devisee, legatee, or other designee or, if there be no such designee, to the Executive's estate. 12. Notice. For the purposes of this Agreement, notices, demands and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered or (unless otherwise specified) sent by United States certified or registered mail or overnight delivery service, addressed as follows: If to the Executive: Alan S. Roseman Senior Vice President and General Counsel c/o Capital Re Corporation 1325 Avenue of the Americas New York, New York 10019 If to the Company: 11 Capital Re Corporation 1325 Avenue of the Americas New York, New York 10019 Attention: Chief Executive Officer or to such other address as any party may have furnished to the others in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. 13. Miscellaneous. No provisions of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing signed by the Executive and the Company. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not set forth expressly in this Agreement. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of New York without regard to its conflicts of law principles. 14. Validity. The invalidity or unenforceability of any provision or provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 15. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall deemed to be in an original but all of which together will constitute one and the same instrument. 16. No Mitigation. In the event of a termination of the Executive's employment arising out of a breach by the Company of this Agreement or if the Executive shall terminate this Agreement for Good Reason, the Executive shall be under no obligation to seek other employment or otherwise mitigate the obligations of the Company under this Agreement. 17. Resolution of Disputes. Any claim arising out of or relating to this Agreement or the Executive's employment with the Company or the termination thereof shall be resolved by binding confidential arbitration, to be held in New York, New York, in accordance with the Commercial Arbitration Rules of the American Arbitration Association. Judgment upon the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof. 18. Entire Agreement. This Agreement sets forth the entire agreement of the parties hereto in respect of the subject matter contained herein 12 and supersedes all prior agreements, promises, covenants, arrangements, communications, representations or warranties, whether oral or written, by any officer, employee or representative of any party hereto; and any prior agreement of the parties hereto in respect of the subject matter contained herein shall, with respect to the Executive, be of no further force and effect. IN WITNESS WHEREOF, the parties have executed this Agreement on the date and year first above written. CAPITAL RE CORPORATION Attest: By: /s/ Joseph W. Swain By: /s/ Jerome F. Jurschak ------------------------------- -------------------------------------- Name: Jerome F. Jurschak Title: CEO, Chairman EXECUTIVE Attest: By: /s/ David A. Buzen /s/ Alan S. Roseman ----------------------------- -------------------------------------------- Alan S. Roseman Senior Vice President and General Counsel 13 EX-10.18 8 AMEND. NO. 1 TO 1997 EMPLOYEE STOCK OPTION PLAN AMENDMENT NUMBER 1 TO THE CAPITAL RE CORPORATION 1997 EMPLOYEE STOCK OPTION PLAN WHEREAS, Capital Re Corporation (the "Corporation") maintains the Capital Re Corporation 1997 Employee Stock Option Plan (the "Plan"), originally effective as of February 26, 1997; WHEREAS, the Corporation desires to amend the Plan to allow the grant of awards relating to shares available for grant under the 1992 Stock Option Plan; NOW, THEREFORE, the Plan is hereby amended as follows: I. The Section 4 is amended in its entirety to read as follows, effective as of March 10, 1999: The stock that may be issued pursuant to Options granted under the Plan shall be Stock, which shares may be treasury shares or authorized but unissued shares. The number of shares of Stock that may be issued pursuant to Options granted under the Plan shall not exceed in the aggregate (i) 2,000,000 shares of Stock, which number of shares is subject to adjustment as provided in Section 19 hereof, (ii) any shares of Stock available for future awards under the 1992 Stock Option Plan as of the Effective Date, and (iii) any shares of Stock that are represented by awards granted under the 1992 Stock Plan, or other option plan of the Corporation, which are forfeited, expire or are canceled without delivery of shares of Stock or which result in the forfeiture of shares of Stock back to the Company. If any Option expires, terminates or is terminated for any reason prior to exercise in full, the shares of Stock that were subject to the unexercised portion of such Option shall be available for future Options granted under the Plan. * * * * In all respects not amended, the Plan is confirmed and ratified. In Witness Whereof, Whereof the Corporation has caused this Amendment to be executed and delivered by its duly authorized officer on this 10th day of March 1999. CAPITAL RE CORPORATION By: /s/ Alan S. Roseman ---------------------------------- Title: EVP General Counsel & Secretary EX-10.19 9 STOCK PURCHASE AGREEMENT EXHIBIT NO. 10.19 STOCK PURCHASE AGREEMENT BETWEEN CAPITAL RE CORPORATION AND ACE BERMUDA INSURANCE, LTD. DATED AS OF FEBRUARY 19, 1999 STOCK PURCHASE AGREEMENT THIS STOCK PURCHASE AGREEMENT is entered into as of February 19, 1999 between ACE Bermuda Insurance, Ltd., an insurance company licensed and registered under the laws of the Islands of Bermuda (the "Purchaser"), and Capital Re Corporation, a Delaware corporation (the "Company"). WHEREAS, the Purchaser wishes to purchase from the Company, and the Company wishes to sell to the Purchaser that number of shares of the Company's common stock, $.01 par value per share (the "Common Stock") equal to $75 million divided by the Purchase Price (as defined in Section 2) but not to exceed the Maximum Amount (as defined in Section 2); and WHEREAS, the Purchaser and the Company are entering into this Agreement to provide for such purchase and sale and to establish various rights and obligations in connection therewith. NOW, THEREFORE, in consideration of the foregoing and of the mutual covenants and agreements hereinafter set forth, the parties hereto hereby agree as follows: 1. DEFINITIONS For all purposes of this Purchase Agreement, certain capitalized terms specified in Exhibit A shall have the meanings set forth in that Exhibit A, except as otherwise expressly provided. 2. SALE AND PURCHASE OF SHARES On the basis of the representations, warranties and agreements contained herein, and subject to the terms and conditions hereof, the Company hereby agrees to issue and sell to the Purchaser, and the Purchaser agrees to purchase from the Company, that number of shares of Common Stock (the "Shares") equal to $75,000,000 (the "Purchase Price") divided by the lesser per share price of: (a) the fully diluted book value per share of the Common Stock at December 31, 1998, determined from the Company's 1998 audited financial statements as described in Section 2 of the Disclosure Schedule and (b) the average of the five highest closing prices of the Common Stock between the date of this Agreement and April 15, 1999 inclusive, as reported on the New York Stock Exchange composite tape, and multiplied by 1.15. At the Closing, the Purchaser shall deliver to the Company the amount of $75,000,000 by wire transfer of immediately available funds, and the Company will deliver to the Purchaser one or more stock certificates, as the Purchaser may request, registered in the name of the Purchaser or otherwise as the Purchaser may direct, evidencing the Shares. Notwithstanding the foregoing, in no event will the number of Shares exceed 19.9% of the total number of shares of Common Stock outstanding immediately prior to the Closing (the "Maximum Amount"). In the event the number of Shares to be issued on the date selected for Closing would exceed the Maximum Amount, the Closing will not occur, this Agreement shall be immediately terminated and no party shall be under any further obligation to the other. 3. CLOSING 3.1. Closing of Sale and Purchase Subject to the terms and conditions of this Agreement, the Closing shall take place at the offices of Hogan & Hartson L.L.P., 885 Third Avenue, New York, New York 10022, on the Closing Date. 3.2. Conditions Precedent to the Purchaser's Obligations The Purchaser's obligation to purchase and pay for the Shares on the Closing Date is subject to the satisfaction, on or before the Closing Date, of the following conditions: (a) The Purchaser shall have received (i) from Hogan & Hartson L.L.P., counsel for the Company, a legal opinion dated as of the Closing Date, substantially to the effect attached as Exhibit B hereto; and (ii) an opinion of other counsel to the Company, who may be the Company's General Counsel, to the effect that execution, delivery and performance of this Agreement by the Company do not require any approvals under the insurance laws of any state applicable to an Insurance Subsidiary (except as have been obtained), and with respect to the absence of pending or threatened litigation against or affecting the Company and its Subsidiaries. (b) Each of the representations and warranties of the Company contained in Article 5 of this Agreement shall be true and correct at the date hereof and as of the Closing Date as if made at and as of the Closing Date, except to the extent they expressly refer to another time or period, in which case they shall be true and correct as of such time or period; provided, however, that the conditions set forth in this Section 3.2(b) shall be deemed satisfied if the respects in which such representations and warranties are not true and correct on the date hereof and, as applicable, at and as of the Closing Date (without giving effect to any materiality qualifications contained therein) would not constitute a Material Adverse Effect; - 2 - (c) The Company and the Purchaser each shall have received all consents, authorizations and approvals of governmental authorities which are required to be obtained in order to consummate the transactions contemplated hereby, including, without limitation, any affirmative approvals required under state insurance laws and the expiration or termination of any applicable waiting periods under Hart-Scott-Rodino or state insurance laws. (d) The Shares shall have been authorized for listing on the NYSE upon official notice of issuance. (e) The Aaa financial strength rating of Capital Reinsurance Company shall have been affirmed by Moody's Investor Services, Inc., the AAA financial strength rating of Capital Reinsurance Company issued by the Standard & Poor's Corporation shall remain in effect and the current financial strength ratings of each of Capital Mortgage Reinsurance Company and KRE Reinsurance Ltd. shall have been affirmed in the double A category by Standard & Poor's Corporation. Each such rating affirmation shall not require fulfillment by the Company of any material conditions subsequent thereto, other than sale of the Shares pursuant to this Agreement. (f) No order, injunction or decree issued by any court or governmental authority of competent jurisdiction or other legal restraint or prohibition preventing the consummation of the Closing or any of the transactions contemplated thereby shall be in effect. (g) There shall not be any suit, action, investigation, inquiry or other proceeding instituted by any governmental authority which seeks to enjoin or otherwise prevent consummation of the Closing or the transactions contemplated thereby or which would individually, or in the aggregate with each other failure to satisfy such condition, or in the aggregate with all other unsatisfied conditions that have not been waived result in a Material Adverse Effect. (h) The Company shall have duly performed and complied in all material respects with each obligation, covenant, agreement and condition required by this Agreement to be performed or complied with by the Company at or prior to the Closing. (i) The board of directors of the Company shall have taken all necessary action to elect that number of Purchaser nominees to the board as required by Section 4.6, subject only to Closing; (j) The Company shall have delivered to Purchaser a true, complete and correct copy of its audited annual financial statements for the period ended December 31, 1998, and the fully diluted book value per share of the Common Stock determined from such financial statements using the methodology described in - 3 - Section 2 of the Disclosure Schedule shall be within the range shown in Section 2 of the Disclosure Schedule. (k) The Company shall have delivered to Purchaser copies of all NAIC Loss Reserve Opinions issued by independent actuarial or accounting firms in respect of December 31, 1998 loss reserves of any Insurance Subsidiary, and such opinions shall be issued without material qualification. (l) Since the date of this Agreement, there shall not have occurred any event, change or effect having, or that would reasonably be likely to have, individually or in the aggregate, a Material Adverse Effect, except for events, changes or effects arising out of any differences in the amounts shown on the Company's audited 1998 financial statements from the amounts disclosed to Purchaser by the Company as good faith estimates on or prior to the date hereof. 3.3. Conditions Precedent to the Company's Obligations The Company's obligation to sell and issue the Shares on the Closing Date is subject to the satisfaction, on or before the Closing Date, of the following conditions: (a) Each of the representations and warranties of the Purchaser contained in Article 6 of this Agreement shall be true and correct at the date hereof and as of the Closing Date as if made at and as of the Closing Date, except to the extent they expressly refer to another time or period, in which case they shall be true and correct as of such time or period; provided, however, that the conditions set forth in this Section 3.3(a) shall be deemed satisfied if the respects in which such representations and warranties are not true and correct on the date hereof and, as applicable, at and as of the Closing Date (without giving effect to any materiality qualifications contained therein) would not prevent, materially delay or materially impair the ability of Purchaser to consummate the transactions contemplated hereby. (b) The Company and the Purchaser each shall have received all consents, authorizations and approvals of governmental authorities which are required to be obtained in order to consummate the transactions contemplated hereby, including, without limitation, any affirmative approvals required under state insurance laws and the expiration or termination of any applicable waiting periods under Hart-Scott-Rodino or state insurance laws. (c) No order, injunction or decree issued by any court or governmental authority of competent jurisdiction or other legal restraint or prohibition preventing the consummation of the Closing or any of the transactions contemplated thereby shall be in effect. - 4 - (d) There shall not be any suit, action, investigation, inquiry or other proceeding instituted by any governmental authority which seeks to enjoin or otherwise prevent consummation of the Closing or the transactions contemplated thereby or which would individually, or in the aggregate with each other failure to satisfy such condition, or in the aggregate with all other unsatisfied conditions that have not been waived, prevent, materially delay or materially impair the ability of Purchaser to consummate the transactions contemplated hereby. (e) The Purchaser shall have duly performed and complied in all material respects with each obligation, covenant, agreement and condition required by this Agreement to be performed or complied with by the Purchaser at or prior to the Closing. 4. ADDITIONAL UNDERTAKINGS AND COVENANTS The Purchaser and the Company hereby covenant and agree with each other as follows: 4.1. Consents and Approvals (a) The Company and the Purchaser shall take all measures reasonably necessary or advisable to secure such consents, authorizations and approvals of governmental and supragovernmental authorities and of private persons or entities with respect to the transactions contemplated by this Agreement, and to the performance of all other obligations of such parties hereunder, as may be required by any applicable statute or regulation of the United States or any country, state or other jurisdiction or by any Agreement of any kind whatsoever to which the Purchaser, the Company or any Subsidiary is a party or by which the Purchaser, the Company or any Subsidiary is bound. (b) The Purchaser and the Company shall (i) cooperate in the filing of all forms, notifications, reports and information, if any, required or reasonably deemed advisable pursuant to applicable statutes, rules, regulations or orders of any governmental or supragovernmental authority in connection with the transactions contemplated by this Agreement and (ii) use their respective good faith efforts to cause any applicable waiting periods thereunder to expire and any objections to the transactions contemplated hereby to be withdrawn before the Closing. (c) In addition to the obligations set forth in Section 4.1(b), as promptly as practicable, and in any event no later than 15 days following the execution of this Agreement, the Company and the Purchaser shall complete any filing that may be required pursuant to Hart-Scott-Rodino, or shall mutually agree that no such filing is required. The Company and the Purchaser shall diligently - 5 - take (or fully cooperate in the taking of) all actions, and provide any additional information, required or reasonably requested in order to comply with the requirements of Hart-Scott-Rodino. 4.2. Operation of Business of Company and the Subsidiaries Except as contemplated by this Agreement or as reasonably required to carry out their obligations hereunder, the Company and the Subsidiaries shall, through the Closing Date, conduct their respective businesses only in the Ordinary Course of Business and, in addition, not: (i) issue any capital stock or any options, warrants or other rights to subscribe for or purchase any of their capital stock or any securities convertible into or exchangeable for their capital stock (other than pursuant to Stock Plans or otherwise in the Ordinary Course of Business); (ii) directly or indirectly redeem, purchase or otherwise acquire any of their capital stock; (iii) effect a split, reclassification or other change in or of any of their capital stock; (iv) amend their certificate or articles of incorporation, bylaws or equivalent organizational documents (except as may be necessary to comply with applicable statutes, rules, regulations or orders of any governmental or regulatory authority); (v) merge or consolidate with any Person or enter into any agreement providing for the merger or consolidation with any Person; or (vi) enter into any new material line of business or exit any current material line of business of the Company (other than the Lloyd's business). 4.3. Stock Exchange Listing The Company shall use commercially reasonable efforts to cause the shares of Common Stock to be issued to the Purchaser hereunder to be approved for listing on the NYSE, subject to official notice of issuance, prior to the Closing Date. 4.4. Publicity The Company and the Purchaser shall consult with each other prior to issuing, and will provide each other with a meaningful opportunity to review, comment upon and concur with, any press releases or public announcements with respect to the issuance of the Shares and the other transactions contemplated by this Agreement, and prior to making any filings with any third party and/or any governmental entity with respect thereto, except as may be required by law (including federal securities laws), court process or by obligations pursuant to any listing agreement with or rules of any national securities exchange or interdealer quotation service. - 6 - 4.5. Confidentiality (a) Without the prior written consent of the Company, any information relating to the Company provided to the Purchaser or generated by the Purchaser in connection with the transactions contemplated hereby which is confidential, proprietary, or otherwise not generally available to the public (but excluding (i) information the Purchaser has obtained independently from third-party sources without the Purchaser's knowledge that the source has violated any fiduciary or other duty not to disclose such information and (ii) other information that is in the public domain or otherwise publicly available) (the "Confidential Information") will be kept confidential by the Purchaser and its directors, officers, employees and representatives (collectively, "Representatives"), using the same standard of care in safeguarding the Confidential Information as the Purchaser employs in protecting its own proprietary information which the Purchaser desires not to disseminate or publish. It is understood (i) that such Representatives shall be informed by the Purchaser of the confidential nature of the Confidential Information, (ii) that such Representatives shall be bound by the provisions of this Section 4.5 as a condition of receiving the Confidential Information and (iii) that, in any event, the Purchaser shall be responsible for any breach of this Agreement by any of its Representatives. (b) Without the prior written consent of the Company, other than as required by applicable law, the Purchaser will not, and will direct its Representatives not to, disclose to any Person either the fact that the Confidential Information has been made available to the Purchaser or that the Purchaser has inspected any portion of the Confidential Information. (c) If the Purchaser or its Representatives are requested or required (by oral question, interrogatories, requests for information or documents, subpoena, civil investigative demand or similar process) to disclose any Confidential Information, the Purchaser will, as soon as practicable, notify the Company of such request or requirement so that the Company may seek an appropriate protective order. If, in the absence of a protective order or the receipt of a waiver hereunder, the Purchaser or its Representatives are, in the opinion of the Purchaser's counsel, compelled to disclose the Confidential Information or else stand liable for contempt or suffer other censure or significant penalty, the Purchaser may disclose only such of the Confidential Information to the party compelling disclosure as is required by law. The Purchaser shall not be liable for the disclosure of Confidential Information pursuant to the preceding sentence. The Purchaser will exercise all reasonable efforts to assist the Company in obtaining a protective order or other reliable assurance that confidential treatment will be accorded the Confidential Information. - 7 - 4.6. Board Nominee (a) The Company covenants that the Company will nominate and recommend as a candidate for election to the Board of Directors, so long as the Purchaser (and/or its Affiliates) holds (i) at least 8% but less than 13% of the Total Voting Power, one individual and (ii) 13% or more of the Total Voting Power, two individuals, in each case such individuals to be reasonably acceptable to the then current Board of Directors of the Company and to be designated in writing by an executive officer of the Purchaser, provided that any executive officer of Purchaser shall be presumed to be acceptable. In the event Purchaser is entitled to designate one or more nominees between regular annual stockholder meetings, the Company will take such action as is required (including, if necessary, increasing the size of its Board of Directors) to appoint such nominee(s) to the Board of Directors to serve until the next annual stockholders meeting. (b) In addition, at least one Purchaser nominee will serve, if qualified under applicable law and the rules of the New York Stock Exchange, as a member of the Audit Committee and Executive Committee of the Board of Directors, if any. (c) If at any time the Purchaser is entitled to designate any individual under the preceding sections but such individual is not a member of the Board of Directors of the Company, the Company will notify such individual, concurrently with notice given to members of the Board of Directors of the Company, of all meetings of the Board of Directors and, as soon as available, will provide to such individual all reports, financial statements or other information distributed to the Board of Directors of the Company. The Company will permit such individual to attend all such meetings of the Board of Directors as an observer and to participate in advising and consulting with the Board, without voting. 5. REPRESENTATIONS AND WARRANTIES OF THE COMPANY Except as otherwise set forth in the applicable section of the Disclosure Schedule, the Company represents and warrants (which representation and warranty shall be deemed to include the disclosure with respect thereto so specified in the Disclosure Schedule) to the Purchaser as follows: 5.1. Organization and Standing The Company and each Subsidiary is duly organized, validly existing and in good standing under the laws of its jurisdiction of organization, and has the corporate or equivalent power and authority to own, operate and lease its Assets and to carry on its business as currently conducted. Each of the Company and its Subsidiaries is duly qualified to conduct business and is in good standing in every - 8 - jurisdiction in which the nature of the respective business conducted or Assets owned by it makes such qualification necessary and where the failure so to qualify would have a Material Adverse Effect, and has all governmental licenses, authorizations, consents and approvals required to carry on its business as currently conducted except where the failure to hold such licenses, authorizations, consents or approvals would not have a Material Adverse Effect. 5.2. Authorization The execution, delivery and performance by the Company of this Agreement and the issuance and sale of the Shares by the Company and compliance with all the provisions of this Agreement: (a) are within the corporate power and authority of the Company; (b) do not require any consent or approval of any stockholders of the Company; and (c) have been authorized by all required corporate proceedings on the part of the Company. The Company has furnished to the Purchaser true and correct copies of the Company's Certificate of Incorporation and By-Laws as in effect on the date of this Agreement. This Agreement constitutes a valid and binding obligation of the Company, enforceable in accordance with its terms. 5.3. Subsidiaries The Subsidiaries of the Company, together with their jurisdiction of organization, are set forth on Section 5.3 of the Disclosure Schedule. Each of the Subsidiaries designated as an Insurance Subsidiary on Section 5.3 of the Disclosure Schedule is (i) duly licensed or authorized as an insurance company or reinsurer in its jurisdiction of organization, (ii) duly licensed or authorized as an insurance company or reinsurer in each other jurisdiction where it is required to be so licensed or authorized, and (iii) duly authorized in its jurisdiction of organization and each other applicable jurisdiction to write each line of business reported as being written in the SAP Statements, except, in any such case, where the failure to be so licensed or authorized would not have a Material Adverse Effect. The Company has made all required filings under applicable holding company statutes except where the failure to file would not be reasonably expected to have a Material Adverse Effect. 5.4. Capitalization The authorized capital stock of the Company consists of 75,000,000 shares of Common Stock, of which 32,045,119 shares were outstanding as of the close of business on February 10, 1999, and 25,000,000 shares of Preferred Stock, par value $.01 per share (the "Preferred Stock"), of which no shares were outstanding as of the close of business on the date hereof. All of the outstanding shares of Common Stock, and the Shares, have been duly authorized, and the - 9 - outstanding shares of Common Stock are, and the Shares upon issuance and payment therefor as provided herein will be, validly issued, fully paid and nonassessable. The Company has no commitments to issue or deliver any shares of capital stock, except that, as of February 18, 1999, there were 6,460,000 shares subject to issuance pursuant to the Company's 1992 Employee Stock Option Plan, 1997 Employee Stock Option Plan, 1993 Director's Stock Option Plan and the Performance Share Plan (the "Stock Plans"). Except as described in Section 5.4 of the Disclosure Schedule, there are no preemptive or other outstanding rights, options, warrants, conversion rights, stock appreciation rights, redemption rights, repurchase rights, agreements, arrangements or commitments to issue or sell any shares of capital stock or other securities of the Company or any securities or obligations convertible or exchangeable into or exercisable for, or giving any Person a right to subscribe for or acquire, any securities of the Company, and no securities or obligations evidencing such rights are authorized, issued or outstanding. The Company does not have outstanding any bonds, debentures, notes or other obligations the holders of which have the right to vote (or, except as disclosed in Section 5.4 of the Disclosure Schedule, convertible into or exercisable for securities having the right to vote) on any matter. 5.5. Company Reports; Financial Statements (a) The Company has delivered or made available to the Purchaser true and complete copies of each registration statement, report, proxy statement or information statement prepared by it since December 31, 1997, including (a) the Company's Annual Report on Form 10-K for the year ended December 31, 1997, (b) the Company's definitive Proxy Statement for its 1998 Annual Meeting of Stockholders, and (c) the Company's Quarterly Report on Form 10-Q for the quarterly periods ended March 31, 1998, June 30, 1998 and September 30, 1998, each in the form (including exhibits, annexes and any amendments thereto) filed with the Commission (collectively, including any such reports filed subsequent to the date hereof, the "Company Reports"). As of their respective dates the Company Reports complied as to form in all material respects with the requirements of the Securities Act or the Exchange Act, as applicable, and the rules and regulations of the Commission. As of their respective dates, the Company Reports did not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements made therein, in light of the circumstances under which they were made, not misleading. Each of the consolidated balance sheets included in or incorporated by reference into the Company Reports (including the related notes and schedules) fairly presents the consolidated financial position of the Company and its Subsidiaries as of its date and each of the consolidated statements of income and of cash flow included in or incorporated by reference into the Company Reports (including any related notes and schedules) fairly presents the consolidated results of operations and cash flows, as the case may be, of the Company and its - 10 - Subsidiaries for the periods set forth therein (subject, in the case of unaudited statements, to notes and normal year-end audit adjustments that will not be material in amount or effect), in each case in accordance with generally accepted accounting principles consistently applied during the periods involved, except as may be noted therein. (b) The Company has delivered or made available to the Purchaser true and complete copies of the annual and quarterly statements of each of the Insurance Subsidiaries as filed with the applicable insurance regulatory authorities for the year ended December 31, 1997 and the quarterly periods ended March 31, 1998, June 30, 1998 and September 30, 1998, including all exhibits, interrogatories, notes, schedules and any actuarial opinions, affirmations or certifications or other supporting documents filed in connection therewith (collectively, the "SAP Statements"). The SAP Statements were prepared in conformity with statutory accounting practices prescribed or permitted by the applicable insurance regulatory authority consistently applied for the periods covered thereby and present fairly the statutory financial position of such Insurance Subsidiaries for the respective periods then ended. The SAP Statements complied in all material respects with all applicable laws, rules and regulations when filed, and no material deficiency has been asserted with respect to any SAP Statements by the applicable insurance regulatory body or any other governmental agency or body. The annual statutory balance sheets and income statements included in the SAP Statements have been audited by Ernst & Young LLP and the Company has delivered or made available to the Purchaser true and complete copies of all audit opinions related thereto. The Company has delivered or made available to the Purchaser true and complete copies of all examination reports of insurance departments and any insurance regulatory agencies since January 1, 1996 relating to the Insurance Subsidiaries. 5.6. Taxes United States Federal income tax returns of the Company and its Subsidiaries have been examined and closed through the fiscal year ended December 31, 1992 and no material issue has been raised in any examination of any other tax return of the Company or any of its Subsidiaries. The Company and each of its Subsidiaries have filed all United States Federal income tax returns and all other material tax returns which are required to be filed by them and have paid all taxes due pursuant to such returns or pursuant to any assessment received by the Company or any Subsidiary. Such returns are true and accurate in all material respects. The charges, accruals and reserves on the books of the Company and its Subsidiaries in respect of taxes or other governmental charges are, in the opinion of the Company, adequate. - 11 - 5.7. Governmental Filings; No Violations (a) Other than the filings, permits, authorizations, consents, approvals and/or notices pursuant to or required by (i) Hart-Scott-Rodino, (ii)the Exchange Act, (iii)the Securities Act, (iv)state securities or "blue-sky" laws, (v)the insurance laws and regulations of the state of New York and Maryland, and (vi) the NYSE, and except as may result from any facts or circumstances relating solely to the Purchaser or its affiliates, in connection with the execution and delivery of this Agreement by the Company and the consummation by the Company of the issuance of the Shares, there are no filings, authorizations, consents, approvals or notices required with or by any Court, administrative agency, commission, government or regulatory authority, domestic or foreign, except those that the failure to make or obtain will not, individually or in the aggregate, have a Material Adverse Effect. (b) Subject to compliance with the filings described in Section 5.7(a), the execution, delivery and performance of this Agreement by the Company do not, and the consummation by the Company of the issuance of the Shares will not, constitute or result in (i) a breach or violation of, or a default under, the certificate of incorporation or by-laws of the Company or the comparable governing instruments of any of its Subsidiaries, (ii) a breach or violation of, or a default under, or the acceleration of any obligations or the creation of a lien, pledge, security interest or other encumbrance on the assets of the Company or any of its Subsidiaries (with or without notice, lapse of time or both) pursuant to, any agreement, lease, contract, note, mortgage, indenture, arrangement or other obligation ("Contracts") binding upon the Company or any of its Subsidiaries, (iii) any change in the rights or obligations of any party under any of those Contracts, (iv) the impairment of the Company's or any of the Company's Subsidiaries' business or adversely affect any licenses or approvals necessary to enable the Company and its Subsidiaries to carry on their business as presently conducted, except for any conflict, breach, violation, default, acceleration, declaration, imposition or impairment that would not have a Material Adverse Effect. 5.8. Insurance Matters (a) Except as would not, individually or in the aggregate, have a Material Adverse Effect, all policies, binders, slips, certificates, and participation agreements and other agreements of insurance, whether individual or group, in effect as of the date hereof (including all applications, supplements, endorsements, riders and ancillary agreements in connection therewith) that are issued by the Insurance Subsidiaries (the "Insurance Contracts"), are, to the extent required under applicable law, on forms approved by applicable insurance regulatory authorities or which have been filed and not objected to by such authorities within the period provided for objection, and such forms comply in all respects with the insurance statutes, regulations and rules applicable thereto and, as to premium rates established by the Company or any Insurance Subsidiary which are required - 12 - to be filed with or approved by insurance regulatory authorities, the rates have been so filed or approved, the premiums charged conform thereto in all respects, and such premiums comply in all respects with the insurance statutes, regulations and rules applicable thereto. (b) All reinsurance and coinsurance treaties or agreements, including retrocessional agreements, to which the Company or any Insurance Subsidiary is a party or under which the Company or any Insurance Subsidiary has any existing rights, obligations or liabilities are in full force and effect except for such treaties or agreements for which the failure to be in full force and effect, individually or in the aggregate, would not have a Material Adverse Effect. Neither the Company nor any Insurance Subsidiary, nor, to the knowledge of the Company, any other party to a reinsurance or coinsurance treaty or agreement to which the Company or any Insurance Subsidiary is a party, is in default in any material respect as to any provision thereof. (c) The reserves carried on the financial statements of the Company and each Insurance Subsidiary for future insurance policy benefits, losses, claims and similar purposes were, as of the respective dates of such financial statements, in compliance in all material respects with the requirements for reserves established by the insurance departments of the state of domicile of such entity, were determined in all material respects in accordance with generally accepted actuarial standards and principles consistently applied, and were fairly stated in all material respects in accordance with sound actuarial and statutory accounting principles. The admitted assets of the Company and each Insurance Subsidiary as determined under applicable laws are in an amount at least equal to the minimum amounts required by applicable laws. (d) Except for regular periodic assessments in the ordinary course of business or assessments based on developments that are publicly known within the insurance industry, no claim or assessment is pending or, to the knowledge of the Company, threatened against the Company or any Insurance Subsidiary that is peculiar or unique to such entity by any state insurance guaranty associations in connection with such association's fund relating to insolvent insurers. 5.9. Litigation and Liabilities (a) Except as disclosed in the Company Reports filed prior to the date hereof, there are no actions, suits, claims, proceedings or investigations (or, to the knowledge of the Company, any basis for any person to assert any claim reasonably likely to result in liability or any other adverse determination) pending against, or to the knowledge of the Company, threatened against or affecting, the Company or any of its Subsidiaries or any of their respective properties before any governmental entity or otherwise that (i) individually or in the aggregate would be - 13 - expected to have a Material Adverse Effect, (ii) in any manner challenges or seeks to prevent, enjoin, alter or delay the transactions contemplated hereby or (iii) alleges criminal action or inaction. As of the date hereof, neither the Company, its Subsidiaries nor any of their respective properties is subject to any order, writ, judgment, injunction, decree, determination or award having, or that would reasonably be expected to have, a Material Adverse Effect or that would prevent or delay the consummation of the transactions contemplated hereby. Except as disclosed in the Company Reports, there are no pending or, to the knowledge of the Company, threatened claims for indemnification by the Company or any of its Subsidiaries in favor of directors, officers, employees and agents of the Company or any of its Subsidiaries. (b) Except as set forth in the Company Reports, the Company and its Subsidiaries have no liabilities, debts, claims or obligations of any nature, whether accrued, absolute, direct or indirect, contingent or otherwise, whether due or to become due, that would be required to be included on a balance sheet prepared in accordance with generally accepted accounting principles, and there is no existing condition or set of circumstances that would reasonably be expected to result in such a liability ("Company Liabilities"), except (i) Company Liabilities incurred in connection with or as a result of the transactions contemplated by this Agreement, (ii) contingent liabilities and reserves to be provided for as of December 31, 1998 in amounts that have been disclosed to Purchaser in Section 5.9 of the Disclosure Schedule and (iii) Company Liabilities that would not reasonably be expected to have a Material Adverse Effect. 5.10. Compliance with Laws; Permits Except as set forth in the Company Reports filed prior to the date hereof or as set forth on Section 5.10 of the Disclosure Schedule, the businesses of each of the Company and its Subsidiaries have been, and are being, conducted in compliance with all applicable Laws, and all notices, reports, documents and other information required to be filed thereunder within the last three years were properly filed and were in compliance with such Laws, except in any such case for noncompliance that, individually or in the aggregate, would not have a Material Adverse Effect. Except as set forth in the Company Reports filed prior to the date hereof or as set forth on Section 5.10 of the Disclosure Schedule and except for routine examinations by state governmental entities charged with supervision of insurance companies, no investigation or review by any governmental entity with respect to the Company or any of its Subsidiaries is pending or, to the knowledge of the Company, threatened, nor has any governmental entity indicated an intention to conduct the same, except for those the outcome of which would not, individually or in the aggregate, have a Material Adverse Effect. The Company and its Subsidiaries each has all permits, licenses, trademarks, patents, trade names, copyrights, service marks, franchises, variances, exemptions, orders and other governmental authorizations, consents and approvals necessary to conduct its - 14 - business as presently conducted except those the absence of which would not, individually or in the aggregate, have a Material Adverse Effect. 5.11. Material Contracts All of the material contracts of the Company and its Subsidiaries that are required to be described in the Company Reports or to be filed as exhibits thereto pursuant to Item 601 of Regulation S-K promulgated by the Commission are described in the Company Reports or filed as exhibits thereto. Neither the Company nor any of its Subsidiaries nor, to the knowledge of the Company, any other party is in breach of or in default under any such contract, except for such breaches and defaults as individually or in the aggregate have not had and will not have a Material Adverse Effect. Neither the Company nor any of its Subsidiaries is party to any agreement containing any provision or covenant limiting (in any respect that would have a Material Adverse Effect) the ability of the Company or any of its Subsidiaries to (a) sell any products or services of or to any other person, (b) engage in any line of business or (c) compete with or to obtain products or services from any person or limiting the ability of any person to provide products or services to the Company or any of its Subsidiaries. 5.12. Pension and Benefit Plans There are no Plans maintained by the Company, or under which the Company has any liability, other than those set forth on the Disclosure Schedule. No Plan or trust forming a part thereof has been terminated since September 1, 1974. All Plans and the trusts forming a part thereof have been administered and enforced in accordance with their terms, and no disputes are pending or threatened with respect thereto. All Plans and any trusts forming parts thereof which are subject to ERISA are and have been administered in compliance with ERISA and all applicable rules and regulations issued thereunder, and no Reportable Event has heretofore occurred with respect thereto. No Person has participated in any "prohibited transaction" (as defined in Section 406 of ERISA or Section 4975 of the Code) that could subject the Company to any tax, penalty or liability. No accumulated funding deficiency (as defined in Section 302 of ERISA) and no liability to the PBGC has been or is expected to be incurred with respect to any Plan. All Plans which are "employee pension benefit plans" as defined in Section 312 of ERISA since their adoption have qualified and do qualify under Section 401 of the Code. All trusts established under any Plans are exempt from taxation pursuant to Section 501(a) of the Code. 5.13. Brokers and Finders Neither the Company nor any of its executive officers, directors or employees has employed any broker or finder or incurred any liability for any - 15 - brokerage fees, commissions or finders fees in connection with the issuance of the Shares or the other transactions contemplated in this Agreement, except that the Company has employed Goldman, Sachs & Co., and Cochran, Coronia & Co. as its financial advisors, the arrangements with respect to which have been disclosed to the Purchaser prior to the date hereof. 5.14. Offering of Shares Neither the Company nor any Person acting on its behalf has offered the Shares or any similar securities of the Company for sale to, solicited any offers to buy the Shares or any similar securities of the Company from or otherwise approached or negotiated with respect to the Company with any Person other than the Purchaser and a limited number of other "accredited investors" or "qualified institutional buyers" (as defined under the Securities Act). Neither the Company nor any Person acting on its behalf has taken or will take any action (including, without limitation, any offering of any securities of the Company under circumstances which would require the integration of such offering with the offering of the Shares under the Securities Act and the rules and regulations of the Commission thereunder) which would subject the offering, issuance or sale of the Shares to the registration requirements of Section 5 of the Securities Act. Assuming the accuracy of the Purchaser's representations contained herein, the offering of the Shares and the purchase and sale of the Shares contemplated by this Agreement comply in all respects with the Securities Act, including Section 4(2) thereof. 5.15. Year 2000 Compliance The Company has established an implementation plan and budgeted a reasonably sufficient amount of capital and resources to institute software systems which include design, performance and functionality and which are intended to ensure (it being acknowledged and agreed by the parties hereto that such intention may never be realized) that such software systems do not cause the Company to experience invalid or incorrect results or abnormal software operation related to calendar year 2000 except where such invalid or incorrect results or abnormal software operation would not, individually or in the aggregate, have a Material Adverse Effect. Such plan and budget envision the creation of software systems which include calendar year 2000 date conversion and compatibility capabilities. As of the date of this Agreement, such plan, in respect of the business of the Company, is generally proceeding on schedule. 6. REPRESENTATIONS AND WARRANTIES OF THE PURCHASER The Purchaser represents and warrants to the Company as follows: - 16 - 6.1. Organization and Standing The Purchaser is an insurance company duly organized, validly existing and in good standing under the laws of the Islands of Bermuda and has the power and authority to carry on its business as currently conducted. 6.2. Authorization The execution, delivery and performance by the Purchaser of this Agreement: (a) are within the power and authority of the Purchaser; (b) do not require any consent or approval of any stockholders of the Purchaser; and (c) have been authorized by all required proceedings on the part of the Purchaser. This Agreement constitutes a valid and binding obligation of the Purchaser, enforceable in accordance with its terms. 6.3. No Registration Under the Securities Act The Purchaser understands that the Shares to be purchased by it under this Agreement have not been registered under the Securities Act, in reliance upon exemptions contained in the Securities Act or interpretations thereof, and cannot be offered for sale, sold or otherwise transferred unless such Common Stock being acquired hereunder subsequently is so registered or qualifies for exemption from registration under the Securities Act. The Purchaser acknowledges that, except as provided in Section 8 hereof, the Purchaser has no right to require the Company to register the Shares. The Purchaser understands and agrees that each certificate representing Shares shall bear the following legend: "THE TRANSFER OF THE SECURITIES REPRESENTED BY THIS CERTIFICATE IS RESTRICTED BY AN AGREEMENT ON FILE AT THE OFFICES OF THE CORPORATION. THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR THE SECURITIES LAWS OF ANY STATE AND MAY NOT BE SOLD OR OTHERWISE DISPOSED OF EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER SUCH ACT AND APPLICABLE STATE SECURITIES LAWS OR AN APPLICABLE EXEMPTION TO THE REGISTRATION REQUIREMENTS OF SUCH ACT OR SUCH LAWS." 6.4. Acquisition for Investment The Shares are being acquired under this Agreement by the Purchaser in good faith solely for its own account, for investment and not with a view toward resale or other distribution within the meaning of the Securities Act. The Shares will not be offered for sale, sold or otherwise transferred by the Purchaser without - 17 - either registration or exemption from registration under the Securities Act it being understood that any sale or disposition of the Shares is in Purchaser's control. 6.5. Evaluation of Merits and Risks of Investment The Purchaser is an "accredited investor" within the meaning of Rule 501(a) promulgated under the Securities Act. The Purchaser has such knowledge and experience in financial and business matters that the Purchaser is capable of evaluating the merits and risks of the Purchaser's investment in the Shares being acquired hereunder. The Purchaser understands and is able to bear any economic risks associated with such investment (including, without limitation, the necessity of holding such Shares for an indefinite period of time, inasmuch as such Shares have not been registered under the Securities Act). The Purchaser has had an opportunity to request, and has received or had access to, all information as the Purchaser has considered necessary to make a determination to purchase the Shares, and has had all questions which have been asked by the Purchaser satisfactorily answered by the Company. The Purchaser has not been offered the Shares by any form of general solicitations or general advertising. 7. STANDSTILL PROVISIONS; RESTRICTIONS ON TRANSFER 7.1. Acquisition of Voting Securities and Other Matters Until the earlier of (a) two years from the date hereof, and (b) the date on which the Purchaser no longer Beneficially Owns any Shares (the earliest of such dates being referred to as the "Standstill Termination Date") and subject to the further provisions hereof, the Purchaser covenants and agrees that, without the prior approval of at least a majority of the Board of Directors of the Company: (i) The Purchaser will not, directly or indirectly, acquire any Voting Securities except for (A) the Shares, additional Voting Securities of the Company if the voting power in the general election of directors of all such additional Voting Securities Beneficially Owned by the Purchaser, together with the voting power in the general election of directors of the Shares then Beneficially Owned by the Purchaser, does not exceed 19.9% of the Total Voting Power; provided, however, any action by the Company with respect to its Capital Stock (including redemptions and reverse stock splits) shall not be deemed to be a violation of this Subsection without further action by Purchaser. (ii) Neither the Purchaser nor any of its Affiliates shall deposit any Voting Securities in a voting trust or subject any Voting Securities to any arrangement or agreement with respect to the voting of such Voting Securities. - 18 - (iii) Neither the Purchaser nor any of its Affiliates shall solicit proxies or initiate, propose or become a "participant" in a "solicitation" of proxies (as such terms are defined in Regulation 14A under the Exchange Act) or seek to advise, encourage or influence any person or entity with respect to the voting of Voting Securities, or induce or attempt to induce any person to initiate any stockholder proposal, if the purpose of any of the foregoing actions is to seek to encourage or effect a change in control of the Company. (iv) Neither the Purchaser nor any of its Affiliates shall join a partnership, limited partnership, syndicate or other group, or otherwise act in concert with any other person (except as specifically contemplated hereby), for the purpose of acquiring, holding, voting or disposing of voting securities of the Company, or otherwise become a "person" or a member of a "group" within the meaning of Section 13(d)(3) of the Exchange Act which Beneficially Owns or seeks to Beneficially Own Voting Securities. (v) Neither the Purchaser nor any of its Affiliates will otherwise act, alone or in concert with others, to seek to encourage or effect a change in control of the Company, or make any proposal, whether written or oral, to the Board of Directors of the Company with respect to a tender offer for Voting Securities, a merger or similar business combination transaction or the sale of substantially all of the assets of the Company, or make any public statements with respect thereto. (vi) Neither the Purchaser nor any of its Affiliates will, directly or indirectly, participate in, aid and abet or otherwise induce any Person to take any of the actions enumerated in (i) through (v) above or any other actions inconsistent therewith, including the accumulation of Voting Securities with any intent or objective inconsistent therewith. The restrictions in (i) through (vi) above shall not apply to (A) Affiliates of the Purchaser which are engaged generally in the purchase and sale of securities or similar activities, provided that any such Affiliate shall have acquired Voting Securities of the Company solely for investment purposes, (B) the right of the Purchaser to cast its votes in its discretion with respect to any matter presented to the stockholders of the Company at any meeting of the stockholders of the Company or (C) the right of Purchaser to request, in writing or orally, a waiver of any of these restrictions for any purpose. The designation of an individual by the Purchaser to be a nominee to the Board of Directors of the Company and actions taken by the individual serving as the Purchaser's designee for nomination to the Board of Directors of the Company shall not be deemed a violation of the provisions of this Section 7.1. - 19 - 7.2. Restrictions on Transfer Until the date that is 270 days after the Closing Date, the Purchaser will not, directly or indirectly, sell, transfer, pledge, encumber or otherwise dispose of (collectively, "Transfers") any Shares except for: (a) Transfers of Shares with the approval of a majority of the Board of Directors; (b) Transfers of Shares to any Affiliate of the Purchaser, provided that such Affiliate shall, upon such transfer, become a party to this Agreement and agree to be bound by all the provisions hereof; or (c) Transfers of Shares pursuant to any bona fide tender or exchange offer to acquire Shares which is not opposed by a majority of the Board of Directors of the Company. 8. SHELF REGISTRATION 8.1. Definitions As used in this Article 8: (a) The terms "register," "registered" and "registration" refer to a registration effected by preparing and filing a registration statement in compliance with the Securities Act and the declaration or ordering of the effectiveness of such registration statement. (b) For the purposes hereof the term "Registrable Securities" means (i) the Shares and any other shares of Common Stock acquired by Holders subsequent to the date hereof, (ii) stock issued in lieu of such shares in any corporate reorganization and (iii) stock issued in respect of the stock referred to in (i) or (ii) above as a result of a stock split, stock dividend, reorganization or combination, in each case to the extent held by Holders. (c) The terms "Holder" or "Holders" means the Purchaser or any Affiliate thereof holding Registrable Securities. (d) The term "Managing Underwriters" means the investment banker or investment bankers and manager or managers that shall administer an underwritten offering, if any, as set forth in Section 8.6 hereof. (e) The term "Prospectus" means the prospectus included in any Shelf Registration Statement (including, without limitation, a prospectus that discloses information previously omitted from a prospectus filed as part of an effective registration statement in reliance upon Rule 430A under the Act), as amended or supplemented by any prospectus supplement, with respect to the terms of the offering of any portion of the Registrable Securities. - 20 - (f) The term "Shelf Registration Statement" means a "shelf" registration statement of the Company pursuant to the provisions of Section 8.2 hereof filed with the Commission which covers some or all of the Registrable Securities, as applicable, on an appropriate form under Rule 415 under the Act, or any similar rule that may be adopted by the Commission, amendments and supplements to such registration statement, including post-effective amendments, in each case including the Prospectus contained therein, all exhibits thereto and all material incorporated by reference therein. 8.2. Shelf Registration (a) The Company shall, within 90 days following the Closing Date, file with the Commission a Shelf Registration Statement relating to the offer and sale of the Registrable Securities by the Holders from time to time in accordance with the methods of distribution elected by such Holders and set forth in such Shelf Registration Statement and, thereafter, shall use its best efforts to cause such Shelf Registration Statement to be declared effective under the Act within 270 days following the Closing Date, provided, however, that no Holder shall be entitled to have the Registrable Securities held by it covered by such Shelf Registration Statement unless such Holder is in compliance with Section 8.3(i) hereof. (b) The Company shall use its reasonable best efforts to keep the Shelf Registration Statement continuously effective in order to permit the Prospectus forming part thereof to be usable by Holders for a period of three years from the Closing Date or such shorter period that will terminate upon the earlier of the following: (A) when all the Registrable Securities covered by the Shelf Registration Statement have been sold pursuant to the Shelf Registration Statement or (B) when, in the written opinion of counsel to the Company, all outstanding Registrable Securities held by Holders may be resold without registration under the Act pursuant to Rule 144(k) under the Act or any successor provision thereto (in any such case, such period being called the "Effectiveness Period"). (c) The Company may suspend sales under the Shelf Registration Statement or defer the updating of the Shelf Registration Statement and suspend sales thereunder for a reasonable period of time (not exceeding 75 days) if the Company furnishes the Holders with a notice signed by an executive officer of the Company (a "Suspension Notice") stating that, in its good faith judgment, the Company has determined that maintaining the effectiveness of the Shelf Registration Statement and permitting offers and sales thereunder would require the Company to make public disclosure of information not otherwise required to be publicly disclosed at such time, the public disclosure of which would have a Material Adverse Effect upon the Company or would adversely affect the ability of the Company to consummate a material financing, acquisition, disposition of assets or stock, merger or other comparable transaction. Upon receipt of any such notice - 21 - from the Company, each Holder agrees to discontinue disposition of Registrable Securities pursuant to the Shelf Registration Statement (a "Black Out") until the earlier of (i) such time as such Holder receives copies of a supplemental or amended prospectus, (ii) such time as such Holder receives notification from the Company that such suspension is no longer required or (iii) 75 days; provided, that the Company may not suspend sales for more than an aggregate of 105 days in any twelve month period. (d) In the event the Company shall give a Suspension Notice, the Effectiveness Period under Section 8.2(b) will be extended by the number of days during the time period from and including the date of the giving of such Suspension Notice to and including the date when the Black Out shall have terminated in accordance with the immediately preceding paragraph. (e) Promptly after the Shelf Registration Statement is declared effective, the Company shall deliver an appropriate number of Prospectuses to the New York Stock Exchange (and any successor securities exchange on which the Company's Common Stock is listed) pursuant Rule 153 under the Securities Act and NYSE Rule 204.27. 8.3. Registration Procedures In connection with any Shelf Registration Statement, the following provisions shall apply: (a) The Company shall furnish to the Purchaser, prior to the filing thereof with the Commission, a copy of any Shelf Registration Statement, and each amendment thereof and each amendment or supplement, if any, to the Prospectus included therein and shall provide the Purchaser with a meaningful opportunity to review and comment upon such material prior to filing thereof. (b) The Company shall take such action as may be necessary so that (i) any Shelf Registration Statement and any amendment thereto and any Prospectus forming part thereof and any amendment or supplement thereto (and each report or other document incorporated therein by reference in each case) complies in all material respects with the applicable provisions of the Act and the Exchange Act and the respective rules and regulations thereunder, (ii) any Shelf Registration Statement and any amendment thereto does not, when it becomes effective, contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading and (iii) any Prospectus forming part of any Shelf Registration Statement, and any amendment or supplement to such Prospectus, does not include an untrue statement of a material fact or omit to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading. - 22 - (c) (1) The Company shall advise and provide copies, if applicable, to the Purchaser and, in the case of clause (i), the Holders and, if requested by the Purchaser or any such Holder, confirm such advice in writing: (i) when a Shelf Registration Statement and any amendment thereto has been filed with the Commission and when the Shelf Registration Statement or any post-effective amendment thereto has become effective; and (ii) of any request by the Commission for amendments or supplements to the Shelf Registration Statement or the Prospectus included therein or for additional information. (2) The Company shall advise the Purchaser and the Holders and, if requested by the Purchaser or any such Holder, confirm such advice in writing of: (i) the issuance by the Commission of any stop order suspending effectiveness of the Shelf Registration Statement or the initiation of any proceedings for that purpose; (ii) the receipt by the Company of any notification with respect to the suspension of the qualification of the securities included therein for sale in any jurisdiction or the initiation of any proceeding for such purpose; and (iii) the happening of any event that requires the making of any changes in the Shelf Registration Statement or the Prospectus so that, as of such date, the Shelf Registration Statement and the Prospectus do not contain an untrue statement of a material fact and do not omit to state a material fact required to be stated therein or necessary to make the statements therein (in the case of the Prospectus, in light of the circumstances under which they were made) not misleading (which advice shall be accompanied by an instruction to suspend the use of the Prospectus until the requisite changes have been made). (d) The Company shall use its reasonable efforts to prevent the issuance, and if issued to obtain the withdrawal, of any order suspending the effectiveness of any Shelf Registration Statement at the earliest possible time. (e) The Company shall, during the Effectiveness Period, deliver to each Holder of Registrable Securities included within the coverage of any Shelf Registration Statement, without charge, as many copies of the Prospectus (including each preliminary Prospectus) included in such Shelf Registration Statement and any amendment or supplement thereto as such Holder may reasonably request; and the Company consents (except upon and during the continuance of any event described in Section 8.3(c)(2)(iii) above) to the use of the Prospectus or any amendment or supplement thereto by each of the selling Holders of Registrable Securities in connection with the offering and sale of the Registrable Securities covered by the Prospectus or any amendment or supplement thereto during the Shelf Registration Period. (f) Prior to any offering of Registrable Securities pursuant to any Shelf Registration Statement, the Company shall register or qualify or cooperate with the Holders of Registrable Securities included therein and their respective counsel in connection with the registration or qualification of such Registrable - 23 - Securities for offer and sale under the securities or blue sky laws of such jurisdictions as any such Holders reasonably request in writing and do any and all other acts or things necessary or advisable to enable the offer and sale in such United States jurisdictions of the Registrable Securities covered by such Shelf Registration Statement; provided, however, that in no event shall the Company be obligated to (i) qualify as a foreign corporation or as a dealer in securities in any jurisdiction where it would not otherwise be required to so qualify but for this Section 8.3(f), (ii) file any general consent to service of process in any jurisdiction where it is not as of the date hereof then so subject or (iii) subject itself to taxation in any such jurisdiction if it is not so subject. (g) Upon the occurrence of any event contemplated by Section 8.3(c)(2)(iii), the Company shall promptly prepare a post-effective amendment to any Shelf Registration Statement or an amendment or supplement to the related Prospectus or file any other required document so that, as thereafter delivered to purchasers of the Registrable Securities included therein, the Prospectus will not include an untrue statement of a material fact or omit to state any material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, provided that the Company shall be under no obligation to file any such document during the pendancy of the circumstances described in clauses (i), (ii) and (iii) of the last sentence of Section 8.2(b). If the Company notifies the Holders of the occurrence of any event contemplated by Section 8.3(c)(2)(iii), the Holders shall suspend the use of the Prospectus until the requisite changes to the Prospectus have been made. (h) The Company shall use its best efforts to comply with all applicable rules and regulations of the Commission and shall make generally available to its security holders or otherwise provide in accordance with Section 11(a) of the Act as soon as practicable after the effective date of the applicable Shelf Registration Statement an earnings statement satisfying the provisions of Section 11(a) of the Act. (i) The Company may require each Holder of Registrable Securities to be sold pursuant to any Shelf Registration Statement to furnish to the Company such information regarding the Holder and the distribution of such Registrable Securities as required by the Securities Act and which the Company may from time to time reasonably request for inclusion in such Shelf Registration Statement and the Company may exclude from such registration the Registrable Securities of any Holder that fails to furnish such information within a reasonable time after receiving such request. (j) The Company shall, if requested, promptly include or incorporate in a Prospectus supplement or post-effective amendment to a Shelf Registration Statement, such information as the Managing Underwriters reasonably agree should be included therein and to which the Company do not - 24 - reasonably object and shall make all required filings of such Prospectus supplement or post-effective amendment as soon as practicable after they are notified of the matters to be included or incorporated in such Prospectus supplement or post-effective amendment. (k) The Company shall enter into such customary agreements (including underwriting agreements in customary form) to take all other appropriate actions in order to expedite or facilitate the registration or the disposition of the Registrable Securities, and in connection therewith, if an underwriting agreement is entered into, cause the same to contain indemnification provisions and procedures substantially identical to those set forth in Section 8.5 (or such other provisions and procedures reasonably acceptable to the Managing Underwriters, if any) with respect to all parties to be indemnified pursuant to Section 8.5. (l) The Company shall (i) make reasonably available for inspection by the Holders of Registrable Securities to be registered thereunder, any Underwriter participating in any disposition pursuant to such Shelf Registration Statement, and any attorney, accountant or other agent retained by such Holders or any such Underwriter all relevant financial and other records, pertinent corporate documents and properties of the Company and its Subsidiaries; (ii) cause the Company's officers, directors and employees to make reasonably available for inspection all relevant information reasonably requested by such Holders or any such Underwriter, attorney, accountant or agent in connection with any such Shelf Registration Statement, in each case as is customary for similar due diligence examinations; provided, however, that any information that is designated in writing by the Company, in good faith, as confidential at the time of delivery of such information shall be kept confidential by such Holders or any such Underwriter, attorney, accountant or agent, unless such disclosure is made in connection with a court proceeding or required by law, or such information becomes available to the public generally or through a third party without an accompanying obligation of confidentiality; and provided further that the foregoing inspection and information gathering shall, to the greatest extent possible, be coordinated on behalf of the Holders and the other parties entitled thereto by one counsel designated by and on behalf of such Holders and other parties; (iii) make such representations and warranties to the Holders of Registrable Securities registered thereunder and the Underwriters, if any, in form, substance and scope as are customarily made by the Company to Underwriters in primary underwritten offerings; (iv) obtain opinions of counsel to the Company (who may be the general counsel of the Company) and updates thereof (which counsel and opinions (in form, scope and substance) shall be reasonably satisfactory to the Managing Underwriters, if any) in customary form addressed to each selling Holder and the Underwriters, if any, covering such matters as are customarily covered in opinions requested in underwritten offerings; (v) obtain "cold comfort" letters and updates thereof from the independent public accountants of the Company, addressed to each - 25 - such Holder of Registrable Securities registered thereunder and the Underwriters, if any, in customary form and covering matters of the type customarily covered in "cold comfort" letters in connection with primary underwritten offerings; and (vi) deliver such other customary documents and certificates as may be reasonably requested by any such Holders and the Managing Underwriters, if any, including those to evidence compliance with Section 8.3(g) and with any customary conditions contained in the underwriting agreement or other agreement entered into by the Company. The foregoing actions set forth in clauses (iii), (iv), (v) and (vi) of this Section 8.3(l) shall be performed at each closing under any underwritten offering to the extent required thereunder. (m) The Company shall use its reasonable efforts to take all other steps necessary to effect the registration, offering and sale of the Registrable Securities covered by the Shelf Registration Statement contemplated hereby. 8.4. Expenses of Registration The Company shall bear all fees and expenses incurred by it in connection with the performance of its obligations under Sections 8.2 and 8.3 hereof and shall bear or reimburse the Holders for the reasonable fees and disbursements of one firm of counsel designated by the Holders of a majority of the Registrable Securities covered by the Shelf Registration Statement to act as counsel therefor in connection therewith. 8.5. Indemnification (a) To the extent permitted by law, the Company will indemnify each Holder of Registrable Securities, each of its officers, directors and partners, and each person controlling (within the meaning of the Act) such Holder, with respect to which such registration has been effected pursuant to this Article 8, and each underwriter, if any, and each person who controls (within the meaning of the Act) any underwriter of the Registrable Securities held by or issuable to such Holder, against any and all claims, losses, expenses, damages and liabilities (or actions in respect thereto) whatsoever arising out of or based on any untrue statement (or alleged untrue statement) of a material fact contained in any Shelf Registration Statement (or any amendment thereto) covering Registrable Securities, including all documents incorporated therein by reference, or based on any omission (or alleged omission) to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, or any violation or alleged violation by the Company of any rule or regulation promulgated under the Act or any state securities law applicable to the Company and relating to action or inaction required of the Company in connection with any such registration, and will reimburse each such Holder, each of its officers, directors and partners, and each person controlling such Holder, each such underwriter and each person who controls any such underwriter, for any reasonable legal and any other - 26 - expenses incurred in connection with investigating, defending or settling any such claim, loss, damage, liability or action, provided that the indemnity contained in this paragraph shall not apply to amounts paid in settlement of any such claim, loss, damage, liability or action if such settlement is effected without the consent of the Company (which consent will not be unreasonably withheld) and provided further that the Company will not be liable in any such case to the extent that any such claim, loss, damage or liability arises out of or is based on any untrue statement or omission based upon written information furnished to the Company by such Holder or underwriter specifically for use therein. (b) Each Holder will, if Registrable Securities held by or issuable to such Holder are included in the securities as to which such registration is being effected, indemnify the Company, each of its directors and officers, each underwriter, if any, of the Company's securities covered by such a registration statement, each person who controls the Company within the meaning of the Act, and each other such Holder, each of its officers, directors and partners and each person controlling such Holder, against any and all claims, losses, expenses, damages and liabilities (or actions in respect thereof) whatsoever arising out of or based on any untrue statement (or alleged untrue statement) of a material fact contained in the Shelf Registration Statement (or any amendment thereto) or any Prospectus (or any amendment or supplement thereto), or any omission (or alleged omission) to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and will reimburse the Company, such Holders, such directors, officers, partners, persons or underwriters for any reasonable legal or any other expenses incurred in connection with investigating, defending or settling any such claim, loss, damage, liability or action, in each case to the extent, but only to the extent, that such untrue statement (or alleged untrue statement) or omission (or alleged omission) is made in the Shelf Registration Statement (or any amendment thereto) or any Prospectus (or any amendment or supplement thereto) in reliance upon and in conformity with written information furnished to the Company by such Holder specifically for use therein; and provided further that the indemnity contained in this paragraph shall not apply to amounts paid in settlement of any such claim, loss, damage, liability or action if such settlement is effected without the consent of the Holder (which consent will not be unreasonably withheld). (c) Each party entitled to indemnification under this Section 8.5 (the "Indemnified Party") shall give notice to the party required to provide indemnification (the "Indemnifying Party") promptly after such Indemnified Party has actual knowledge of any claim as to which indemnity may be sought, provided further that the failure of any Indemnified Party to give notice as provided herein shall not relieve the Indemnifying Party of its obligations hereunder, unless such failure resulted in actual detriment to the Indemnifying Party. The Indemnified Party shall permit the Indemnifying Party to assume the defense of any such claim or any litigation resulting therefrom, provided that - 27 - counsel for the Indemnifying Party, who shall conduct the defense of such claim or litigation, shall be approved by the Indemnified Party (whose approval shall not be unreasonably withheld), and the Indemnified Party may participate in such defense at its own expense, but if the Indemnifying Party shall elect not to assume the defense of such claim or litigation, the Indemnifying Party will reimburse such Indemnified Party for the fees and expenses of any counsel retained by such Indemnified Party. No Indemnifying Party, in the defense of any such claim or litigation, shall, except with the consent of each Indemnified Party, consent to entry of any judgment or enter into any settlement which does not include as an unconditional term thereof the giving by the claimant or plaintiff to such Indemnified Party of a release from all liability in respect of such claim or litigation. 8.6. Underwritten Offering The Holders of Registrable Securities covered by the Shelf Registration Statement who desire to do so may sell such Registrable Securities in an underwritten offering. In any such underwritten offering, the investment banker or bankers and manager or managers that will administer the offering will be selected by, and the underwriting arrangements with respect thereto will be approved by, the Holders of a majority of the Registrable Securities to be included in such offering; provided however, that (i) such investment bankers and managers and underwriting arrangements (including indemnification agreements) must be reasonably satisfactory to the Company and (ii) the Company shall not be obligated to cooperate with the Purchaser or Holders in more than one underwritten offering during the Effectiveness Period. No Holder may participate in the underwritten offering contemplated hereby unless such Holder (a) agrees to sell such Holder's Registrable Securities in accordance with any approved underwriting arrangements, (b) completes and executes all reasonable questionnaires, powers of attorney, indemnities, underwriting agreements, lock-up letters and other documents required under the terms of such approved underwriting arrangements and (c) at least 20% of the outstanding Registrable Securities are included in such underwritten offering. The Holders participating in the underwritten offering shall be responsible for any expenses customarily borne by selling securityholders, including underwriting discounts and commissions and fees and expenses of counsel to the selling securityholders, and shall reimburse the Company for the fees and disbursements of their counsel, their independent public accountants and any printing and other out-of-pocket expenses reasonably incurred in connection with such underwritten offering. 8.7. Transfer of Registration Rights The rights to cause the Company to register Registrable Securities of a Holder granted to a Holder by the Company under this Article 8 may be assigned - 28 - by a Holder to a transferee or assignee of shares of the Registrable Securities who is an Affiliate of such Holder and is or becomes a party to this Agreement for all purposes hereof. 9. TERMINATION 9.1. Termination (a) This Agreement may be terminated at any time before the Closing Date under any one or more of the following circumstances: (i) by the mutual consent of the parties hereto; (ii) by the Purchaser, by written notice of termination delivered to the Company, if any of the conditions set forth in Section 3.2 have not been fulfilled by June 30, 1999 provided that if such failure to fulfill conditions is the result solely of the necessity of obtaining government approvals or satisfying governmental requirements, the date shall be extended 60 days; or (iii) by the Company, by written notice of termination delivered to the Purchaser, if any of the conditions set forth in Section 3.3 have not been fulfilled by June 30, 1999 provided that if such failure to fulfill conditions is the result solely of the necessity of obtaining government approvals or satisfying governmental requirements, the date shall be extended 60 days. (b) This Agreement shall terminate if the number of Shares that would be issuable at Closing would exceed the Maximum Amount. 9.2. Effect of Termination In the event this Agreement is terminated as provided in this Article 9, this Agreement shall forthwith become wholly void and of no effect, and the parties shall be released from all future obligations hereunder; provided, however, that the obligations of the Purchaser as to confidentiality provided in Section 4.5 shall not be extinguished but shall survive such termination. The parties hereto shall have any and all remedies to enforce such obligations provided at law or in equity (including, without limitation, specific performance). 10. MISCELLANEOUS 10.1. Survival This Section 10 and the agreements of the Company and the Purchaser contained in Section 4.4 (Publicity), Section 4.5 (Confidentiality), - 29 - Section 4.6 (Board Nominee), Section 7 (Standstill Provisions; Restrictions on Transfer) and Section 8 (Shelf Registration) shall survive the issuance and sale of the Shares in accordance with their terms. This Section 10 and the agreements of the Company and the Purchaser contained in Section 10.8 (Expenses), and Section 9.2 (Effect of Termination) shall survive the termination of this Agreement. All representations and warranties in Sections 5 and 6 (except Section 5.9(a)) shall survive for eighteen months from the Closing Date and the representations and warranties made in Section 5.9(a) shall survive for a period of three years from the Closing Date. All other covenants and agreements in this Agreement shall not survive the consummation of the issuance of the Shares or the termination of this Agreement. 10.2. Additional Actions and Documents Each of the parties hereto hereby agrees to take or cause to be taken such further actions, to execute, deliver and file or cause to be executed, delivered and filed such further documents, and will obtain such consents, as may be necessary or as may be reasonably requested in order to fully effectuate the purposes, terms and conditions of this Agreement. 10.3. Expenses Subject to the provisions of Article 8, each party hereto shall pay its own expenses incident to this Agreement and the transactions contemplated hereunder, including all legal and accounting fees and disbursements, except that the Company shall pay all required filing fees under Hart-Scott-Rodino. 10.4. Assignment The Purchaser shall have the right to assign its rights and obligations under this Agreement, in whole or in part, to an Affiliate or to designate any of its Affiliates (to the extent permitted by Law) to receive directly the shares of Common Stock to be purchased hereunder or to exercise any of the rights of the Purchaser, or to perform any of its obligations. Except as set forth in the previous sentence and as otherwise expressly permitted hereunder, the Company and the Purchaser shall not assign its rights and obligations under this Agreement, in whole or in part, whether by operation of law or otherwise, without the prior written consent of the other party hereto, and any such assignment contrary to the terms hereof shall be null and void and of no force and effect. In no event shall the assignment by the Company or the Purchaser of its respective rights or obligations under this Agreement, whether before or after the Closing, release the Company or the Purchaser from its respective liabilities and obligations hereunder. - 30 - 10.5. Entire Agreement; Amendment This Purchase Agreement, including the Disclosure Schedule, the Exhibits and other documents referred to herein or furnished pursuant hereto, constitutes the entire agreement among the parties hereto with respect to the transactions contemplated herein, and it supersedes all prior oral or written agreements, commitments or understandings with respect to the matters provided for herein. No amendment, modification or discharge of this Agreement shall be valid or binding unless set forth in writing and duly executed and delivered by the party against whom enforcement of the amendment, modification, or discharge is sought. 10.6. Waiver No delay or failure on the part of any party hereto in exercising any right, power or privilege under this Agreement or under any other documents furnished in connection with or pursuant to this Agreement shall impair any such right, power or privilege or be construed as a waiver of any default or any acquiescence therein. No single or partial exercise of any such right, power or privilege shall preclude the further exercise of such right, power or privilege, or the exercise of any other right, power or privilege. No waiver shall be valid against any party hereto unless made in writing and signed by the party against whom enforcement of such waiver is sought and then only to the extent expressly specified therein. 10.7. Consent to Jurisdiction (a) This Agreement and the duties and obligations of the Purchaser and the Company hereunder and under each of the documents referred to herein shall be enforceable against either of the Company or the Purchaser in the courts of the United States of America and of the State of New York. For such purpose, the Company and the Purchaser hereby irrevocably submit to the non-exclusive jurisdiction of such courts, and agrees that all claims in respect of this Agreement and such other Documents may be heard and determined in any of such courts. (b) The Purchaser and the Company hereby irrevocably agree that a final judgment of any of the courts specified above in any action or proceeding relating to this Agreement or to any of the other documents referred to herein or therein shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. 10.8. Severability If any part of any provision of this Agreement or any other agreement or document given pursuant to or in connection with this Agreement shall be invalid or unenforceable in any respect, such part shall be - 31 - ineffective to the extent of such invalidity or unenforceability only, without in any way affecting the remaining parts of such provision or the remaining provisions of this Agreement. 10.9. Governing Law This Agreement, the rights and obligations of the parties hereto, and any claims or disputes relating thereto, shall be governed by and construed in accordance with the laws of the State of New York (excluding the choice of law rules thereof). 10.10. Notices All notices, demands, requests, or other communications which may be or are required to be given, served, or sent by any party to any other party pursuant to this Purchase Agreement shall be in writing and shall be hand delivered, sent by overnight courier or mailed by first-class, registered or certified mail, return receipt requested, postage prepaid, or transmitted by telegram, telecopy or telex, addressed as follows: (i) If to the Purchaser: ACE Bermuda Insurance, Ltd. The ACE Building 30 Woodbourne Avenue Hamilton HM 08 BERMUDA Attention: General Counsel with copies (which shall not constitute notice) to: ACE Limited The ACE Building 30 Woodbourne Avenue Hamilton HM 08 BERMUDA Attention: General Counsel and Mayer, Brown & Platt 190 South LaSalle Street Chicago, Illinois 60603 Attention: Edward S. Best, Esq. (ii) If to Company: - 32 - Capital Re Corporation 1325 Avenue of the Americas New York, New York 10019 Attention: General Counsel with a copy (which shall not constitute notice) to: Hogan & Hartson L.L.P. 111 South Calvert Street Baltimore, Maryland 21202 Attention: Michael J. Silver, Esq. Each party may designate by notice in writing a new address to which any notice, demand, request or communication may thereafter be so given, served or sent. Each notice, demand, request, or communication which shall be hand delivered, sent, mailed, telecopied or telexed in the manner described above, or which shall be delivered to a telegraph company, shall be deemed sufficiently given, served, sent, received or delivered for all purposes at such time as it is delivered to the addressee (with the return receipt, the delivery receipt, or (with respect to a telecopy or telex) the answerback being deemed conclusive, but not exclusive, evidence of such delivery) or at such time as delivery is refused by the addressee upon presentation. 10.11. Headings Section headings contained in this Agreement are inserted for convenience of reference only, shall not be deemed to be a part of this Agreement for any purpose, and shall not in any way define or affect the meaning, construction or scope of any of the provisions hereof. 10.12. Execution in Counterparts To facilitate execution, this Agreement may be executed in as many counterparts as may be required. It shall not be necessary that the signatures of, or on behalf of, each party, or that the signatures of all persons required to bind any party, appear on each counterpart; but it shall be sufficient that the signature of, or on behalf of, each party, or that the signatures of the persons required to bind any party, appear on one or more of the counterparts. All counterparts shall collectively constitute a single Agreement. It shall not be necessary in making proof of this Agreement to produce or account for more than a number of counterparts containing the respective signatures of, or on behalf of, all of the parties hereto. 10.13. Limitation on Benefits The covenants, undertakings and agreements set forth in this Agreement shall be solely for the benefit of, and shall be enforceable only by, the - 33 - parties hereto and their respective successors, heirs, executors, administrators, legal representatives and permitted assigns. 10.14. Binding Effect Subject to any provisions hereof restricting assignment, this Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors, heirs, executors, administrators, legal representatives and assigns. IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement, or have caused this Agreement to be duly executed on their behalf, as of the day and year first above written. PURCHASER: ACE BERMUDA INSURANCE, LTD. /s/ Christopher Z. Marshall --------------------------------------- Christopher Z. Marshall, Director COMPANY: CAPITAL RE CORPORATION /s/ Jerome F. Jurschak --------------------------------------- Jerome F. Jurschak Chairman and Chief Executive Officer - 34 - EXHIBIT A TO STOCK PURCHASE AGREEMENT DATED AS OF FEBRUARY 19, 1999 DEFINITIONS "Affiliate" means: (a) with respect to a person, any member of such person's family; (b) with respect to an entity, any officer, director, stockholder, partner or investor of or in such entity or of or in any Affiliate of such entity; and (c) with respect to a person or entity, any person or entity which directly or indirectly, through one or more intermediaries, Controls, is Controlled by, or is under common Control with such person or entity. "Agreement" means this Stock Purchase Agreement, including the Disclosure Schedule and all Exhibits hereto. "Assets" means assets of every kind and everything that is or may be available for the payment of liabilities (whether inchoate, tangible or intangible), including, without limitation, real and personal property. "Beneficially Own" with respect to any securities means having "beneficial ownership" of such securities (as determined pursuant to Rule 13d-3 under the Exchange Act), including pursuant to any agreement, arrangement or understanding, whether or not in writing. "Closing" means the closing of the sale and purchase of shares of Common Stock pursuant to the Agreement (for purposes of determining whether the number of Shares would exceed the Maximum Amount at Closing, Closing shall be deemed to be as of five business days following the satisfaction or waiver of the latest to be satisfied of the conditions precedent described in Section 3.2). "Closing Date" means 10:00 a.m. Eastern Time on such date as is five business days following the satisfaction or waiver of the latest to occur of the conditions precedent described in Section 3.2 or such other time and date as shall be mutually agreed upon by the Purchaser and the Company. "Code" means the Internal Revenue Code of 1986, as amended, and all Laws promulgated pursuant thereto or in connection therewith. "Commission" means the Securities and Exchange Commission or any other governmental authority at the time administering the Securities Act or the Exchange Act. - i - "Commonly Controlled Entity" shall mean an entity, whether or not incorporated, which is under common control with the Company within the meaning of ss. 414(c) of the Code. "Common Stock" means the common stock, $.01 par value per share, of the Company. "Company" means Capital Re Corporation, a Delaware corporation. "Company Reports" has the meaning set forth in Section 5.5. "Confidential Information" has the meaning set forth in Section 4.5. "Contracts" has the meaning set forth in Section 5.7. "Control" means possession, directly or indirectly, of power to direct or cause the direction of management or policies (whether through ownership of voting securities, by Agreement or otherwise). "Disclosure Schedule" means the disclosure schedule identified as the Disclosure Schedule to the Agreement. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended, and all Laws promulgated pursuant thereto or in connection therewith. "Exchange Act" means the Securities Exchange Act of 1934, as amended, and all laws promulgated pursuant thereto or in connection therewith. "Exhibit" means an exhibit attached to the Agreement. "Hart-Scott-Rodino" means the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and all Laws promulgated pursuant thereto or in connection therewith. "Insurance Contracts" has the meaning set forth in Section 5.8. "Insurance Subsidiary" has the meaning set forth in Section 5.3. "Laws" means all foreign, federal, state and local statutes, laws, ordinances, regulations, rules, resolutions, orders, determinations, writs, injunctions, awards (including, without limitation, awards of any arbitrator), judgments and decrees applicable to the specified persons or entities and to the businesses and Assets thereof (including, without limitation, Laws relating to securities registration and regulation; the sale, leasing, ownership or management of real property; employment practices, terms and conditions, and wages and hours; - ii - building standards, land use and zoning; safety, health and fire prevention; and environmental protection). "Loss" and "Losses" means any and all actual out of pocket: losses, liabilities, damages, costs and expenses (including reasonable attorneys' fees), taxes, penalties, fines, expenditures, judgments and awards. "Material Adverse Effect" means (i) a material adverse effect on the business, financial condition or results of operations of the Company and its Subsidiaries taken as a whole, or (ii) any effect that would prevent, materially delay or materially impair the ability of the Company to consummate the transactions contemplated by this Agreement, other than effects caused by changes in general economic conditions or conditions generally affecting the markets for government taxable and tax-exempt securities, mortgage securities, corporate fixed income securities or the insurance or reinsurance industry generally. "Maximum Amount" has the meaning set forth in Section 2. "NYSE" means the New York Stock Exchange. "Ordinary Course of Business" means ordinary course of business consistent with past practices. "PBGC" shall mean the Pension Benefit Guaranty Corporation established pursuant to Subtitle A of Title IV of ERISA. "Person" means any individual, partnership, joint venture, corporation, trust, unincorporated organization, government or department or agency of a government. "Plan" shall be defined to mean any plan of a type described in Section 3(3) of ERISA in respect of which the Company or a Commonly Controlled Entity is an "employer" as defined in Section 3(5) of ERISA. "Preferred Stock" means the preferred stock, $.01 par value per share, of the Company. "Purchase Price" has the meaning set forth in Section 2. "Purchaser" means ACE Bermuda Insurance, Ltd., an insurance company licensed and registered under the laws of the Islands of Bermuda. "Reportable Event" shall mean any of the events set forth in Section 4043(d) of ERISA or the regulations thereunder, other than an event with respect to which the provision for thirty-day notice to the PBGC has been waived by such regulations. - iii - "Representatives" has the meaning set forth in Section 4.5. "SAP Statements" has the meaning set forth in Section 5.5. "Shares" means the shares of the Company's Common Stock being purchased by the Purchaser pursuant to the Agreement. "Section" means a Section (or a subsection) of the Agreement. "Securities Act" means the Securities Act of 1933, as amended, and all laws promulgated pursuant thereto or in connection therewith. "Standstill Termination Date" has the meaning set forth in Section 7.1. "Subsidiary" means a corporation or other entity of which at least 80% of the outstanding securities or other interests having rights to vote or otherwise exercise Control are held, directly or indirectly, by the Company or another Subsidiary. "13D Group" means any group of Persons acquiring, holding, voting or disposing of Voting Securities which would be required under Section 13(d) of the Exchange Act and the rules and regulations thereunder (as in effect, and based on legal interpretations thereof existing on the date hereof) to file a statement on Schedule 13D with the Commission as a "person" within the meaning of Section 13(d)(3) of the Exchange Act if such group Beneficially Owned Voting Securities representing more than 5% of any class of Voting Securities then outstanding. "Total Voting Power" at any time means the total combined voting power in the general election of directors of all Voting Securities then outstanding. "Transfer" has the meaning set forth in Section 7.2. "Voting Securities" at any time means shares of any class of capital stock of the Company which are then entitled to vote generally in the election of directors. - iv - TABLE OF CONTENTS Page ---- 1. DEFINITIONS...............................................................1 2. SALE AND PURCHASE OF SHARES...............................................1 3. CLOSING...................................................................2 3.1. Closing of Sale and Purchase......................................2 3.2. Conditions Precedent to the Purchaser's Obligations...............2 3.3. Conditions Precedent to the Company's Obligations.................4 4. ADDITIONAL UNDERTAKINGS AND COVENANTS.....................................5 4.1. Consents and Approvals............................................5 4.2. Operation of Business of Company and the Subsidiaries.............6 4.3. Stock Exchange Listing............................................6 4.4. Publicity.........................................................6 4.5. Confidentiality...................................................7 4.6. Board Nominee.....................................................8 5. REPRESENTATIONS AND WARRANTIES OF THE COMPANY.............................8 5.1. Organization and Standing.........................................8 5.2. Authorization.....................................................9 5.3. Subsidiaries......................................................9 5.4. Capitalization....................................................9 5.5. Company Reports; Financial Statements.............................10 5.6. Taxes.............................................................11 5.7. Governmental Filings; No Violations...............................12 5.8. Insurance Matters.................................................12 5.9. Litigation and Liabilities........................................13 5.10. Compliance with Laws; Permits....................................14 5.11. Material Contracts...............................................15 5.12. Pension and Benefit Plans........................................15 5.13. Brokers and Finders..............................................15 5.14. Offering of Shares...............................................16 5.15. Year 2000 Compliance.............................................16 6. REPRESENTATIONS AND WARRANTIES OF THE PURCHASER...........................16 6.1. Organization and Standing.........................................17 6.2. Authorization.....................................................17 6.3. No Registration Under the Securities Act..........................17 6.4. Acquisition for Investment........................................17 6.5. Evaluation of Merits and Risks of Investment......................18 7. STANDSTILL PROVISIONS; RESTRICTIONS ON TRANSFER...........................18 7.1. Acquisition of Voting Securities and Other Matters................18 7.2. Restrictions on Transfer..........................................20 8. SHELF REGISTRATION........................................................20 8.1. Definitions.......................................................20 - i - 8.2. Shelf Registration................................................21 8.3. Registration Procedures...........................................22 8.4. Expenses of Registration..........................................26 8.5. Indemnification...................................................26 8.6. Underwritten Offering.............................................28 8.7. Transfer of Registration Rights...................................28 9. TERMINATION...............................................................29 9.1. Termination.......................................................29 9.2. Effect of Termination.............................................29 10. MISCELLANEOUS............................................................29 10.1. Survival.........................................................29 10.2. Additional Actions and Documents.................................30 10.3. Expenses.........................................................30 10.4. Assignment.......................................................30 10.5. Entire Agreement; Amendment......................................31 10.6. Waiver...........................................................31 10.7. Consent to Jurisdiction..........................................31 10.8. Severability.....................................................31 10.9. Governing Law....................................................32 10.10. Notices.........................................................32 10.11. Headings........................................................33 10.12. Execution in Counterparts.......................................33 10.13. Limitation on Benefits..........................................33 10.14. Binding Effect..................................................34 - ii - EX-10.20 10 FIRST AMENDMENT TO STOCK PURCHASE AGREEMENT EXECUTION COPY FIRST AMENDMENT TO STOCK PURCHASE AGREEMENT THIS FIRST AMENDMENT TO STOCK PURCHASE AGREEMENT ("First Amendment") is entered into as of March 16, 1999 between ACE Bermuda Insurance, Ltd., an insurance company licensed and registered under the laws of the Islands of Bermuda (the "Purchaser"), and Capital Re Corporation, a Delaware corporation (the "Company"). Background and Purpose The Purchaser and the Company are parties to that certain Stock Purchase Agreement dated as of February 19, 1999 (the "Agreement") pursuant to which the Purchaser agreed to purchase and the Company agreed to issue shares of the Company's common stock, $.01 par value per share (the "Common Stock"). The parties hereto have agreed to amend certain provisions contained in the Agreement and have therefore agreed to enter into and perform this First Amendment. NOW, THEREFORE, in consideration of the continuance of the Agreement and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto, intending to be legally bound thereby, hereby agree as follows: Agreement 1. Definitions. All capitalized terms used in this First Amendment shall have the meanings given them in the Agreement. 2. Amendment to Purchase Price Determination. Section 2 of the Agreement is hereby deleted in its entirety and the following inserted in place thereof: "2. SALE AND PURCHASE OF SHARES On the basis of the representations, warranties and agreements contained herein, and subject to the terms and conditions hereof, the Company hereby agrees to issue and sell to the Purchaser, and the Purchaser agrees to purchase from the Company, that number of shares of Common Stock (the "Shares") equal to $75,000,000 (the "Purchase Price") divided by the lesser per share price of: (a) the fully diluted book value per share of the Common Stock at December 31, 1998, determined from the Company's 1998 audited financial statements as described in Section 2 of the Disclosure Schedule ($18.87) and (b) the average of the five highest consecutive closing prices of the Common Stock between March 12, 1999 and April 15, 1999 inclusive, as reported on the New York Stock Exchange composite tape. At the Closing, the Purchaser shall deliver to the Company the amount of $75,000,000 by wire transfer of immediately available funds, and the Company will deliver to the Purchaser one or more stock certificates, as the Purchaser may request, registered in the name of the Purchaser or otherwise as the Purchaser may direct, evidencing the Shares. Notwithstanding the foregoing, in no event will the number of Shares exceed 19.9% of the total number of shares of Common Stock outstanding immediately prior to the Closing (the "Maximum Amount"). In the event the number of Shares to be issued on the date selected for Closing would exceed the Maximum Amount, the Company shall, at the Purchaser's option and upon the written request of the Purchaser, issue and sell to the Purchaser, and the Purchaser shall purchase from the Company, the Maximum Amount of Shares, and the Purchase Price shall be adjusted in accordance with the applicable per share price as determined under the formula set forth in the first sentence of this Section 2. In the event that the Purchaser does not exercise the option set forth in the prior sentence, the Closing will not occur, this Agreement shall be immediately terminated and no party shall be under any further obligation to the other." 3. Amendment to Board Nominee Covenant. Section 4.6 of the Agreement is hereby retitled "Board Nominees" and paragraph (a) thereof is hereby deleted in its entirety and the following inserted in place thereof: "(a) The Company covenants that the Company will nominate and recommend as a candidate for election to the Board of Directors, so long as the Purchaser (and/or its Affiliates) holds at least 8% of the Total Voting Power, two individuals, in each case such individuals to be reasonably acceptable to the then current Board of Directors of the Company and to be designated in writing by an executive officer of the Purchaser, provided that any executive officer of Purchaser shall be presumed to be acceptable. In the event Purchaser is entitled to designate such nominees between regular annual stockholder meetings, the Company will take such action as is required (including, if necessary, increasing the size of its Board of Directors) to appoint such nominees to the Board of Directors to serve until the next annual stockholders meeting." 4. Deletion of Standstill Provision. The phrase "Standstill Provisions;" is hereby deleted from the title of Section 7 and the third line of Section 10.1 of the Agreement and Section 7.1 of the Agreement is hereby deleted in its -2- entirety. All definitions of terms in Exhibit A that relate solely to Section 7.1 of the Agreement are also hereby deleted in their entirety. 5. Waiver of Condition Precedent. Purchaser hereby waives fulfillment of the condition precedent set forth in the first clause of Section 3.2(e) of the Agreement relating to the financial strength rating affirmation by Moody's Investor Services, Inc. 6. Continuance of Agreement. Except as specifically amended hereby, the terms, conditions, provisions and agreements contained in the Agreement shall be and remain in full force and effect, unchanged, unamended and unaltered in any way or manner whatsoever. 7. Counterparts. This First Amendment may be executed by the parties hereto in one or more counterparts each of which shall be deemed an original, but all of which taken together shall constitute one and the same agreement, it being understood that all of the parties need not sign the same counterpart. IN WITNESS WHEREOF, the parties hereto have duly executed this First Amendment, or have caused this First Amendment to be duly executed on their behalf, as of the day and year first above written. PURCHASER: ACE BERMUDA INSURANCE, LTD. By: /s/ Christopher Z. Marshall --------------------------------- Christopher Z. Marshall, Director COMPANY: CAPITAL RE CORPORATION By: /s/ Jerome F. Jurschak --------------------------------- Jerome F. Jurschak Chairman and Chief Executive Officer -3- EX-11.01 11 STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
CAPITAL RE CORPORATION AND SUBSIDIARIES Exhibit 11 Statement Re: Computation of Per Share Earnings (Dollars in thousands except per share amounts) Year Ended December 31, --------------------------------------------------------------- 1998 1997 1996 --------------------------------------------------------------- Net Income from Continuing Operations 44,187 70,818 57,014 Net Income 41,542 70,052 56,524 Basic weighted average shares outstanding during the period 31,885 31,746 31,312 Potentially dilutive employee stock options 760 759 580 --------------------------------------------------------------- Diluted weighted average shares outstanding during the period 32,645 32,505 31,892 =============================================================== Basic earnings per common share from continuing operations $1.39 $2.23 $1.82 =============================================================== Diluted earnings per common share from continuing operations $1.35 $2.18 $1.79 =============================================================== Basic earnings per common share $1.30 $2.21 $1.81 =============================================================== Diluted earnings per common share $1.27 $2.16 $1.77 ===============================================================
EX-21.01 12 SUBSIDIARIES OF REGISTRANT SUBSIDIARIES OF REGISTRANT CAPITAL RE CORPORATION Capital Reinsurance Company, a Maryland domiciled insurance company; Capital Credit Reinsurance Company Ltd., a Bermuda domiciled insurance company; Capital Mortgage Reinsurance Company, a New York domiciled insurance company; Capital Title Reinsurance Company, a New York domiciled insurance company; KRE Reinsurance Ltd., a Bermuda domiciled insurance company Capital Re Management Corporation, a New York reinsurance intermediary Capital Re LLC, a Turks and Caicos limited life company; Capital Re (UK) Holdings CRC Capital, Ltd., a corporation established under the Laws of England RGB Holdings, Ltd., a corporation established under the Laws of England RGB Underwriting Services, Ltd., a corporation established under the Laws of England RGB Underwriting Agencies, Ltd., a corporation established under the Laws of England C.I. de Rougemont Group Ltd., a corporation established under the Laws of England C.I. de Rougemont & Co. Ltd., a corporation established under the Laws of England ACE Capital Re Managers Ltd., a Bermuda domiciled managing general agency ACE Capital Re Ltd., a Bermuda domiciled insurance company Lenders Residential Asset Company LLC, a Delaware Limited Liability Company Capital Risk Assurance Company, a Maryland domiciled insurance company Capital Re Financial Products, a New York business corporation EX-23.01 13 CONSENT OF INDEPENDENT AUDITORS CONSENT OF INDEPENDENT AUDITORS Our report dated February 22, 1999, except for Note 7, as to which the date is March 10, 1999, on this Annual Report (Form 10-K) of Capital Re Corporation is included in Item 8. Our audits also included the financial statement schedules of Capital Re Corporation listed in Item 14(a). These schedules are the responsibility of the Corporation's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-47723) pertaining to the Capital Re Corporation 1992 Stock Option Plan, in the Registration Statement (Form S-8 No. 33-73122) pertaining to the Capital Re Corporation Directors' Stock Option Plan and in the Registration Statement (Form S-8 No. 33-37353) pertaining to the Capital Re Corporation 1997 Employee Stock Option Plan, the Capital Re Corporation Performance Share Plan and the Capital Re Corporation Annual Incentive Plan for Covered Executive Officers of our report dated February 22, 1999, except for Note 7, as to which the date is March 10, 1999, with respect to the consolidated financial statements, and our report included in the preceding paragraph with respect to the financial statement schedules included in this Annual Report (Form 10-K) of Capital Re Corporation. /s/ Ernst & Young LLP New York, New York March 26, 1999 EX-24.01 14 POWER OF ATTORNEY CAPITAL RE CORPORATION POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each of the Officers and Directors of Capital Re Corporation, 1325 Avenue of the Americas, New York, New York 10019, whose signature appears below constitutes and appoints Jerome Jurschak and Alan S. Roseman, and each of them individually, as his true and lawful attorneys-in-fact and agents as of March 31, 1999, with full power of substitution and resubstitution, for him and his name, place and stead in any and all capacities, to sign the Annual Report on Form 10-K of Capital Re Corporation and any and all amendments to such Annual Report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, granting unto said attorney's-in-fact and agents, full power and authority to perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or their substitutes, may lawfully do or cause to be done by virtue thereof.
/s/ Jerome Jurschak Chief Executive Officer March 10, 1999 - ----------------------------- and Chairman of the Board /s/ David A. Buzen Executive Vice President March 10, 1999 - ----------------------------- and Chief Financial Officer David A. Buzen /s/ Edwin Russel Director March 10, 1999 - ----------------------------- Edwin Russell /s/ Jeffery F. Stuerme Director March 10, 1999 - ----------------------------- Jeffery F. Stuermer /s/ Dan Skowronski Director March 10, 1999 - ----------------------------- Dan Skowronski /s/ Joseph Swain President and Director March 10, 1999 - ----------------------------- Joseph Swain /s/ Steven D. Kesler Director March 10, 1999 - ----------------------------- Steven D. Kesler /s/ Richard L. Huber Director March 10, 1999 - ----------------------------- Richard L. Huber /s/ Philip Robinson Director March 10, 1999 - ----------------------------- Philip Robinson /s/ Harrison Conrad Director March 10, 1999 - ----------------------------- Harrison Conrad /s/ Barbara Stewart Director March 10, 1999 - ----------------------------- Barbara Stewart
EX-27 15 ARTICLE 7 FDS FOR 10-K
7 1,000 12-mos DEC-31-1998 DEC-31-1998 1,175,038 0 0 0 0 0 1,175,038 9,893 3,292 135,029 1,508,893 87,960 405,866 0 0 99,856 75,000 0 324 610,502 1,508,893 210,594 64,854 (1,506) 3,212 86,564 49,433 11,764 54,854 10,667 44,187 (2,645) 0 0 41,542 1.30 1.27 22,555 68,350 6,832 2,507 10,676 84,554 0
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