-----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, DOc+thQXR77rG66v3jjjC17u6o8mpMmyu4x/EgIlhtuqQI+tn8/L1CPLE8aYUH5z ugVbT4YBBaQ0BxcycFnrdA== 0000844828-01-000009.txt : 20010207 0000844828-01-000009.hdr.sgml : 20010207 ACCESSION NUMBER: 0000844828-01-000009 CONFORMED SUBMISSION TYPE: S-4/A PUBLIC DOCUMENT COUNT: 22 FILED AS OF DATE: 20010205 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CII FINANCIAL INC CENTRAL INDEX KEY: 0000844828 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 954188244 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-4/A SEC ACT: SEC FILE NUMBER: 333-52726 FILM NUMBER: 1525401 BUSINESS ADDRESS: STREET 1: 2716 N TENAYA WAY CITY: LAS VEGAS STATE: NV ZIP: 89128 BUSINESS PHONE: 7022427000 MAIL ADDRESS: STREET 1: PO BOX 15645 CITY: LAS VEGAS STATE: NV ZIP: 89114-5645 S-4/A 1 0001.txt As filed with the Securities and Exchange Commission on February 5, 2001 Registration No. 333-52726 =============================================================================== SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 AMENDMENT NO. 1 TO FORM S-4 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 CII FINANCIAL, INC. (Exact name of Registrant as specified in its charter)
California 6719 95-4188244 (State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer incorporation or organization) Classification Code Number) Identification Number) 2716 North Tenaya Way Las Vegas, Nevada 89128 (702) 242-7040
(Name and address, including zip code, and telephone number, including area code, of Registrant's principal executive offices) David Sonenstein, Esq. General Counsel 2716 North Tenaya Way Las Vegas, Nevada 89128 (702) 242-7046 (Name and address, including zip code, and telephone number, including area code, of agent for service) Copies to: Stephen P. Farrell, Esq. Howard A. Kenny, Esq. Morgan, Lewis & Bockius LLP 101 Park Avenue New York, New York 10178 (212) 309-6000 Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement is declared effective in connection with the exchange offer described in the prospectus contained in this Registration Statement. If the securities being registered on this Form are being offered in connection with the formation of a holding company and there is compliance with General Instruction G, check the following box. |_| If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. |_|__________ If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. |_| ____________ ------------------------ The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until this Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. ================================================= - ------------------------------------------------------------------------------ Subject to Completion. Dated February 5, 2001 =============== ================ =============== ================= - ------------------------------------------------------------------------------- PROSPECTUS AND EXCHANGE OFFER =============== ================ =============== ================= - ------------------------------------------------------------------------------- =============== ================ =============== ================= - ------------------------------------------------------------------------------ CII FINANCIAL, INC. =============== ================ =============== ================= - ------------ - ------------ EXCHANGE OFFER FOR ALL OUTSTANDING 7 1/2% CONVERTIBLE SUBORDINATED DEBENTURES DUE SEPTEMBER 15, 2001 OF CII FINANCIAL, INC. (CUSIP NO. 12551LAB7) - ------------ - ------------ EXCHANGE OFFER EXPIRATION: February 12, 2001 at 5:00 p.m., New York time. - ------------ - ------------ EXCHANGE OFFER - ------------ - ------------ We are offering to exchange your 7 1/2% convertible subordinated debentures due September 15, 2001 of CII Financial, Inc., under either of the following two options: - ------------ o - ------------ o o $1,000 in principal amount of new 9% senior subordinated debentures due September 15, 2006 of CII Financial for each $1,000 in principal amount of the old junior subordinated debentures that you tender; or - ------------ o o $525 in cash for each $1,000 in principal amount of the old junior subordinated debentures that you tender, up to a maximum of $19,500,000 in aggregate principal amount of old junior subordinated debentures. If the cash option is oversubscribed, holders who elect the cash option will be permitted to sell a prorated amount of their old junior subordinated debentures for cash and we will exchange the balance of old junior subordinated debentures we receive for new senior subordinated debentures. - ------------ We will pay the interest on all old junior subordinated debentures accepted in the exchange offer to, but not including, the date of acceptance. - ------------ We have applied to list the new senior subordinated debentures on the New York Stock Exchange. - ------------ The exchange offer is subject to the following material conditions: - ------------ o valid tenders of at least 90% of the aggregate principal amount of the old junior subordinated debentures; - ------------ o the receipt of the consent of the lenders under the $135 million senior secured credit facility of our parent, Sierra Health Services, Inc., which has been irrevocably and unconditionally guaranteed by us, to the issuance by us of the new senior subordinated debentures in the exchange offer; - ------------ o the receipt of the approval of the California Department of Insurance required for one or more of our subsidiaries to directly or indirectly fund all or part of the cash to be paid as exchange consideration; and - ------------ o our obtaining sufficient cash to pay any cash required to be paid as exchange consideration. - ------------ If the conditions of the exchange offer are satisfied or waived by us, we will accept for exchange any and all old junior subordinated debentures that are validly tendered and not withdrawn before 5:00 p.m., New York City time, on the expiration date of the exchange offer. If the conditions are not satisfied or waived or if we otherwise terminate the exchange offer, tendered old junior subordinated debentures will be returned, without expense to you. - ------------ Both acceptance and rejection of this exchange offer involve a high degree of risk. See "Risk Factors" beginning on page 12 of this prospectus for a discussion of some of the risks you should consider in evaluating the exchange offer and an investment in the securities offered through this prospectus. - ------------ Neither the Securities and Exchange Commission nor any state securities regulator has approved or disapproved these securities, or determined if this prospectus is adequate or accurate. Any representation to the contrary is a criminal offense. ----------------------------------------------------------------- - ------------ o The exclusive dealer manager for the exchange offer is: Banc of America Securities LLC The date of this prospectus is . - ------------ - ------- - ------- ----------------------------------------------------------------------- TABLE OF CONTENTS Page
PROSPECTUS SUMMARY............................................................................................1 RISK FACTORS....................................................................................................12 SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS...............................................................18 WHERE YOU CAN FIND ADDITIONAL INFORMATION.......................................................................18 USE OF PROCEEDS.................................................................................................19 CAPITALIZATION..................................................................................................20 THE EXCHANGE OFFER..............................................................................................21 BUSINESS 32 SELECTED FINANCIAL AND OTHER DATA...............................................................................47 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...........................49 MANAGEMENT......................................................................................................60 CERTAIN TRANSACTIONS............................................................................................66 PRINCIPAL STOCKHOLDERS..........................................................................................67 DESCRIPTION OF OTHER INDEBTEDNESS...............................................................................67 UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS...........................................................69 DESCRIPTION OF DEBENTURES.......................................................................................85 BOOK-ENTRY SYSTEM-- THE DEPOSITORY TRUST COMPANY................................................................93 MATERIAL UNITED STATES FEDERAL INCOME TAX CONSEQUENCES..........................................................94 LEGAL MATTERS...................................................................................................100 EXPERTS .......................................................................................................100 ANNEX I .......................................................................................................a-1 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS......................................................................f-1
PROSPECTUS SUMMARY This summary highlights selected information from this prospectus and may not contain all of the information that is important to you. To understand the exchange offer fully and for a more complete description of the legal terms of the exchange offer, you should read carefully this entire prospectus and the other documents to which we have referred you, including the letter of transmittal accompanying this prospectus. Unless otherwise indicated, "CII Financial," "we," "us," and "our" refer to CII Financial, Inc. and its subsidiaries. Although we refer to CII Financial in this manner, CII Financial is a holding company and conducts all of its operations through its subsidiaries. CII Financial is the sole obligor on all of the debentures discussed in this prospectus. Throughout this prospectus, we sometimes refer to our existing 7 1/2% convertible subordinated debentures due September 15, 2001 as our "old junior subordinated debentures," to our new 9% senior subordinated debentures due September 15, 2006 as our "new senior subordinated debentures" and to those new senior subordinated debentures and the cash payment offered in exchange for your old junior subordinated debentures collectively as the "exchange consideration." CII Financial, Inc. We are a holding company primarily engaged in writing workers' compensation insurance in nine western and midwestern states through our wholly owned subsidiaries, California Indemnity Insurance Company, Commercial Casualty Insurance Company, Sierra Insurance Company of Texas and CII Insurance Company. In addition, we have other smaller subsidiaries that we consider immaterial to our overall results. Our insurance subsidiaries write workers' compensation insurance in the states of California, Colorado, Nevada, Texas, Nebraska, Kansas, Missouri, New Mexico and Utah primarily through independent insurance agents and brokers. We have licenses in 33 states and the District of Columbia and have applications pending for licenses in other states. California, Colorado and Nevada represented approximately 77%, 8%, and 7%, respectively, of our direct written premiums for the nine months ending September 30, 2000. We were acquired by Sierra Health Services, Inc. on October 31, 1995 in a transaction treated as a pooling of interests. However, our old junior subordinated debentures remain solely our obligation and Sierra has not guaranteed the debentures. Sierra is a diversified health care services company that operates health maintenance organizations, indemnity and workers' compensation insurers, military health programs, preferred provider organizations and multi-specialty medical groups. When Sierra acquired us, each share of our common stock was exchanged for .37 of a share of Sierra common stock and our old junior subordinated debentures became convertible into Sierra common stock. The old junior subordinated debentures are now convertible into Sierra common stock at a conversion price of $39.398 per share. As a result, $1,000 in principal is convertible into 25.382 shares of Sierra common stock. Based on the closing price of Sierra common stock on December 29, 2000, the market value of 25.382 shares of Sierra's common stock was $96.45. In August 2000, we became a guarantor of Sierra's $185 million revolving credit facility, which was subsequently reduced in size to $135 million. At December 31, 2000 the credit facility was fully drawn and had an outstanding balance of $135 million. The old junior subordinated debentures and the new senior subordinated debentures are subordinated to this guaranty of the credit facility debt. We were incorporated in the State of California on September 15, 1988. The principal executive offices of CII Financial are located at 2716 North Tenaya Way, Las Vegas, Nevada 89128, and CII Financial's telephone number at that address is (702) 242-7040. Summary Background, Purposes and Effects of the Exchange Offer CII Financial, as a holding company, has limited sources for cash and is dependent upon dividends from its subsidiary, California Indemnity Insurance Company, to meet its debt payment obligations. California Indemnity cannot currently pay any dividends without prior approval by the California Department of Insurance. In addition, CII Financial, as a holding company and sole obligor under the old junior subordinated debentures, has no available source of cash with which to pay the old junior subordinated debentures when they mature on September 15, 2001. Due to the foregoing, we are making this exchange offer in an effort to extend the maturity date and reduce our indebtedness. Summary of the Exchange Offer The Old Junior Subordinated Debentures: We are making the exchange offer with respect to the entire $47,059,000 aggregate principal amount of our old junior subordinated debentures, CUSIP No. 12551LAB7. - --------------------------------------------- The Exchange Offer: We are offering to acquire your old junior subordinated debentures in exchange for: o $1,000 in principal amount of new senior subordinated debentures for each $1,000 in principal amount of old junior subordinated debentures that you tender; or o $525 in cash for each $1,000 in principal amount of old junior subordinated debentures that you tender, up to a maximum of $19,500,000 aggregate principal amount of old junior subordinated debentures as described below. We are only offering to purchase a maximum of $19,500,000 aggregate principal amount of old junior subordinated debentures for cash. If holders of more than $19,500,000 aggregate principal amount of old junior subordinated debentures elect the cash option, we will not have enough cash to pay for all the debentures that holders elect to sell. In that case, we will purchase a total of $19,500,000 principal amount of old junior subordinated debentures for cash and we will exchange the balance of the old junior subordinated debentures we receive for new senior subordinated debentures. All holders who elect the cash option will be permitted to sell the same fraction of their old junior subordinated debentures for cash. This fraction will equal $19,500,000, divided by the aggregate principal amount of all debentures tendered for cash by all holders. We refer to this as "oversubscription" of the cash option. We will publicly announce whether the cash option is oversubscribed and the effect of any required proration as soon as practicable after the expiration of the exchange offer. You do not have to choose the same option for all of the old junior subordinated debentures that you tender. You do not have to tender all of your old junior subordinated debentures to participate in the exchange offer. Interest: We will pay in cash accrued and unpaid interest on all old junior subordinated debentures accepted in the exchange offer to, but not including, the date of acceptance. Source of Funds: We intend to fund the cash portion of the exchange consideration from: o dividends or other transfers of funds from our operating subsidiaries, subject to approval by the California Department of Insurance; and o a loan from an affiliate, which will be represented by our demand promissory note bearing interest at a rate equal to the then current interest rate on Sierra's credit facility. This promissory note will rank senior to the new senior subordinated debentures and the old junior subordinated debentures. Purpose: We are making the exchange offer for old junior subordinated debentures to extend the maturity date of the debentures and to reduce indebtedness. Expiration of the Exchange Offer: 5:00 p.m. New York time, on February 12, 2001, unless extended. Exchange Date: The exchange of old junior subordinated debentures for the exchange consideration will be made promptly following the expiration of the exchange offer and the satisfaction or waiver of all conditions. Conditions to the Exchange Offer: The exchange offer is subject to the following material conditions: o we must receive valid tenders for at least 90% of the aggregate principal amount of the old junior subordinated debentures; o we must receive the consent of the lenders under Sierra's senior secured credit facility, which has been irrevocably and unconditionally guaranteed by us, to our issuing the new senior subordinated debentures in the exchange offer; o we must receive the approval of the California Department of Insurance required for one or more of our subsidiaries to directly or indirectly fund all or part of the cash to be paid as the exchange consideration; and o we must obtain sufficient cash to pay any cash consideration required to be paid as exchange offer consideration. Subject to satisfaction or waiver of the conditions, we will accept for exchange any and all old junior subordinated debentures that are validly tendered and not withdrawn before 5:00 p.m., New York City time, on the expiration date of the exchange offer. However, we reserve the right to: o delay the acceptance of the old junior subordinated debentures for exchange; o terminate the exchange offer; o extend the expiration date and retain all old junior subordinated debentures that have been tendered, subject to the right of owners of old junior subordinated debentures to withdraw their tendered old junior subordinated debentures; o refuse to accept the old junior subordinated debentures and return all old junior subordinated debentures that have been tendered to us; or o waive any condition or otherwise amend the terms of the exchange offer in any respect. Procedures for Tendering Debentures: If you hold your old junior subordinated debentures in book-entry form, you must request your broker, dealer, commercial bank, trust company or other nominee to effect the transaction for you. If you own old junior subordinated debentures that are registered in the name of a broker, dealer, commercial bank, trust company or other nominee, you must contact that broker, dealer, commercial bank, trust company or other nominee. We have arranged to have this exchange offer eligible for the Depository Trust Company's, or DTC's, Automated Tender Offer Program, or ATOP. DTC participants that are accepting the exchange offer must transmit their acceptance to DTC, which will verify the acceptance and execute a book-entry delivery to the exchange agent's account at DTC. DTC will then send an agent's message to the exchange agent for its acceptance. Delivery of the agent's message by DTC will satisfy the terms of the exchange offer as to the tender of old junior subordinated debentures. If you hold physical certificates evidencing your old junior subordinated debentures, complete and sign the enclosed letter of transmittal, or a manually signed facsimile thereof, in accordance with the instructions in that document, have your signature guaranteed if required by Instruction 1 of the letter of transmittal, and send or deliver your manually signed letter of transmittal, or manually signed facsimile, together with the certificates evidencing the old junior subordinated debentures being tendered and any other required documents to the exchange agent. If you desire to tender old junior subordinated debentures in the exchange offer and cannot comply with the procedures described in this prospectus for tender or delivery on a timely basis or if your old junior subordinated debentures are not immediately available, you may tender your old junior subordinated debentures using the procedures for guaranteed delivery described in this prospectus. Withdrawal of Tenders of Debentures: You may withdraw your tender of old junior subordinated debentures at any time prior to the expiration of the exchange offer, but the exchange consideration will not be payable in respect of any old junior subordinated debentures so withdrawn. We will not determine and announce whether the cash option for the exchange consideration has been oversubscribed until after the expiration of the exchange offer. You will not be able to withdraw your tender of old junior subordinated debentures once we make this determination even though it may affect the type of exchange consideration you will receive in the exchange offer. Untendered Debentures: If you do not tender your old junior subordinated debentures, they will remain outstanding. The old junior subordinated debentures will be subordinated to the new senior subordinated debentures. We will have up to $182,059,000 of indebtedness that will rank senior to any untendered debentures, consisting of the new senior subordinated debentures, the credit facility guaranty and the demand promissory note held by an affiliate. In addition, as a result of the consummation of the exchange offer, the aggregate principal amount of the old junior subordinated debentures that are outstanding will be significantly reduced, which may adversely affect their market price, if any. Old junior subordinated debentures that remain outstanding will remain convertible into shares of Sierra common stock at $39.398 per share. As of close of business on December 29, 2000, the closing price of Sierra common stock on the New York Stock Exchange was $3.80. Acceptance of Tendered Debentures and Exchange: Under the terms of the exchange offer and upon satisfaction or our waiver of the conditions to the exchange offer, we will accept for exchange old junior subordinated debentures validly tendered on or prior to the expiration of the exchange offer. You will only receive the exchange consideration if you validly tender your old junior subordinated debentures. We will make payment of the exchange consideration for old junior subordinated debentures validly tendered and accepted for payment by deposit of the appropriate amount of cash and the appropriate amount of new senior subordinated debentures with the exchange agent, who will act as agent for the tendering holders of old junior subordinated debentures. We expect the exchange will be made on the exchange date described in this prospectus. Accounting Treatment for the Exchange Offer: The new senior subordinated debentures will be recorded at the carrying amount of the old junior subordinated debentures less cash consideration given, if any, and that amount will be used to determine the effective interest rate of the new senior subordinated debentures. United States Federal Income Tax Considerations: You are referred to the discussion about the federal income tax consequences of the exchange offer in "Material United States Federal Income Tax Consequences." Tax matters are very complicated and the tax consequences of the exchange offer to you will depend on the facts of your own situation. You should consult your own tax advisor for a full understanding of the tax consequences to you of the exchange offer. No Appraisal Rights: In connection with the exchange offer, you will not have any right to dissent or to receive an appraisal of your old junior subordinated debentures. Use of Proceeds: Our new senior subordinated debentures are being issued only in exchange for your old junior subordinated debentures. All old junior subordinated debentures accepted by us in the exchange offer will be canceled. We will not receive any cash proceeds from the issuance of new senior subordinated debentures in the exchange offer. "Blue Sky" Compliance: We are not making this offer to, and we will not accept tenders from, holders of old junior subordinated debentures in any jurisdiction in which this exchange offer or the acceptance of old junior subordinated debentures would not comply with the applicable securities or "blue sky" laws of that jurisdiction. Dealer Manager: Banc of America Securities LLC is serving as exclusive dealer manager in connection with the exchange offer. Its address and telephone numbers are set forth on the back cover of this prospectus. Exchange Agent: Wells Fargo Corporate Trust is serving as exchange agent in connection with the exchange offer. Its address and telephone numbers are located on the back cover of this prospectus. Information Agent: D.F. King & Co., Inc. is serving as the information agent in connection with the exchange offer. Its address and telephone numbers are located on the back cover of this prospectus. Summary Description of New Senior Subordinated Debentures: The New Senior Subordinated Debentures: Up to $47,059,000 aggregate principal amount of 9% senior subordinated debentures due September 15, 2006. Issuer: CII Financial, Inc. Trustee: Wells Fargo Bank Minnesota, N.A. Maturity: September 15, 2006 Interest: Interest on the new senior subordinated debentures will be payable in cash at a rate of 9% per year, payable on March 15 and September 15 of each year, commencing March 15, 2001. Ranking: The new senior subordinated debentures, like the old junior subordinated debentures, will be subordinated to all our senior indebtedness, including our guaranty of Sierra's credit facility. However, the new senior subordinated debentures will rank senior to any remaining old junior subordinated debentures. Optional Redemption: Until September 15, 2001, the new senior subordinated debentures may be redeemed at our option at any time, from time to time, at a price equal to $1,007.50 per $1,000 principal amount of the new senior subordinated debentures, plus accrued and unpaid interest, if any. After September 15, 2001, the new senior subordinated debentures may be redeemed at our option at any time, from time to time, at a price equal to $1,000 per $1,000 principal amount of the new senior subordinated debentures, plus accrued and unpaid interest, if any. Repurchase at Option of Holders: In the event of a change in control of CII Financial, the holders of these new senior subordinated debentures may require that we repurchase the new senior subordinated debentures at $1,000 per $1,000 principal amount of the new senior subordinated debentures, plus accrued and unpaid interest, if any. Listing: We have applied to list the new senior subordinated debentures on the New York Stock Exchange. However, we do not expect the new senior subordinated debentures to be listed until after 30 days following the consummation of the exchange offer. Principal Differences Between Old and New Debentures: o The new senior subordinated debentures will rank senior in right of payment to any old junior subordinated debentures which are not tendered. o You will receive a higher rate of interest on the new senior subordinated debentures, which will pay 9% per annum, than on the old junior subordinated debentures, which pay 7 1/2% per annum. o The scheduled maturity date of the new senior subordinated debentures is September 15, 2006, which is five years later than September 15, 2001, the scheduled maturity date of the old junior subordinated debentures. o The new senior subordinated debentures will not be convertible into Sierra common stock. The old junior subordinated debentures are convertible into Sierra common stock at $39.398 per share. Outstanding Indebtedness: As of December 31, 2000, we had $182,059,000 of indebtedness, consisting of the old junior subordinated debentures and the credit facility guaranty. After the consummation of the exchange offer, we - will have up to $145,237,500 of indebtedness that will rank senior to the new senior subordinated debentures, consisting of the credit facility guaranty and the demand promissory note held by an affiliate. The amount of indebtedness that ranks senior to the new senior subordinated debentures will depend on the amount of old junior subordinated debentures tendered for cash and the amount of cash we borrow from an affiliate to fund the cash portion of the exchange consideration. The only indebtedness that will rank junior to the new senior subordinated debentures will be any old junior subordinated debentures that remain outstanding after the exchange offer. Summary Historical Financial and Other Data of CII Financial The table below presents our selected consolidated financial information for the periods indicated and at the end of these periods. The consolidated financial statement information as of December 31, 1999 and 1998 and for the years ended December 31, 1999, 1998 and 1997 was derived from our consolidated financial statements included elsewhere in this prospectus. These financial statements were prepared in accordance with accounting principles generally accepted in the United States of America, and were audited by Deloitte & Touche LLP. The consolidated financial statement information at and for the nine months ended September 30, 2000 and 1999 has been derived from our unaudited consolidated financial statements included elsewhere in this prospectus. The unaudited consolidated financial statements have been prepared by us on a basis consistent with the audited financial statements and include all normal recurring adjustments necessary for a fair presentation of the information set forth therein. Operating results for the nine months ended September 30, 2000 are not necessarily indicative of the results that will be achieved for future periods, including the entire year ending December 31, 2000. See the Glossary of Selected Insurance Terms annexed to this prospectus for an explanation of certain of the financial and other items included below.
Nine Months Ended September 30, Year Ended December 31, ----------------- ----------------------- (dollars in thousands) (dollars in thousands) 2000 1999 1999 1998 1997 ---- ---- ---- ---- ---- Income Statement Data: Direct written premiums $153,034 $106,291 $148,824 $153,914 $135,580 ======== ======== ======== ======== ======== Net written premiums $93,857 $60,833 $85,097 $134,147 $130,597 ======= ======= ======= ======== ======== Net earned premiums $90,951 $58,254 $82,955 $134,274 $129,197 Net investment income and net 10,757 11,901 15,395 20,229 17,361 ------- ------- ------- ------- ------- realized gains and losses Total revenues 101,708 70,155 98,350 154,503 146,558 Total costs and expenses 115,715 58,301 91,255 136,625 135,745 ------- ------ ------ ------- ------- (Loss) income before federal income taxes and (14,007) 11,854 7,095 17,878 10,813 extraordinary gain Federal income tax (benefit) (4,902) 4,815 3,602 4,166 272 --------- ------- ------- -------- ---------- expense Income before extraordinary gain (9,105) 7,039 3,493 13,712 10,541 Extraordinary gain from debt 654 0 111 48 2 ----------- ----------- --------- ------------ ------------- extinguishment, net of tax Net (Loss) Income $(8,451) $7,039 $3,604 $13,760 $10,543 ======== ====== ====== ======= ======= Combined Ratios: Loss ratio 92.38% 59.76% 74.08% 70.26% 72.24% Underwriting expense ratio (1) 28.59% 35.61% 31.45% 28.45% 29.67% -------- ------ -------- ------ -------- Combined ratio 120.97% 95.37% 105.53% 98.71% 101.91% ======= ====== ======= ====== ======= Balance Sheet Data: Total cash, cash equivalents and $231,604 $238,864 $226,572 $283,509 invested assets Total assets 492,852 380,766 404,338 379,880 Total debt 47,059 51,196 50,498 51,251 Total liabilities 434,338 309,669 338,285 305,933 Total stockholder's equity 58,514 71,097 66,053 73,947 .........
- ------------------------------------------------------------------------------- (1) Includes policyholders' dividend ratio of 1.83% for nine months ended September 30, 2000. RATIO OF EARNINGS TO FIXED CHARGES - -------------------------------------------------------------------------------- - ------------------------------------ ----------------------- ------------------
Nine Months Ended For the year Ended December 31, September 30, 2000 1999 1999 1998 1997 1996 1995 (dollars in thousands) (dollars in thousands) Pre-tax (loss) income before $(14,007) $11,854 $7,095 $17,878 $10,813 $10,630 $9,083 discontinued operations and extraordinary gains Fixed Charges: Interest expense 2,717 2,751 3,706 4,301 4,091 4,123 4,868 Capitalized interest 0 130 130 0 0 0 0 Interest relating to rental 704 632 867 438 438 542 491 ------ ------ ------ ------ ------ ------ ------ expense (1) Total fixed charges 3,421 3,513 4,703 4,739 4,524 4,665 5,359 Earnings available for fixed $(10,586) $15,367 $11,798 $22,617 $15,342 $15,295 $14,442 charges Ratio of earnings to fixed charges (3.09x) 4.37x 2.51x 4.77x 3.39x 3.28x 2.69x - ------------------------------------ ------------ ---------- ---------- ----------- ---------- ------------ ---------- - ------------------------- - ------------------------------------------------------------------------------
(1) The representative interest portion of rental expense was deemed to be one-third of all rental expense. Earnings were not sufficient to cover fixed charges during the first nine months of 2000 by $14,007,000; all other periods had sufficient income to cover charges. PRO FORMA RATIO OF EARNINGS TO FIXED CHARGES - ----------------------------------- ------------ ------------ ------------ ---
Nine Nine Year Nine Months ----------- Months Ended Months Year Ended Year Ended Ended December Ended Ended September December September 31, 1999 September December 30, 2000 31, 1999 30, 2000 30, 2000 31, 1999 Presentation One (1) Presentation Two (2) Presentation Three (3) (dollars in thousands) (dollars in thousands) (dollars in thousands) Pre-tax (loss) income before $(13,012) $6,907 $(13,747) $5,975 $(14,551) $4,962 discontinued operations and extraordinary gains Fixed Charges: Interest expense 1,382 1,840 2,116 2,772 3,176 4,126 Capitalized interest 0 130 0 130 0 130 Interest relating to rental 704 867 704 867 704 867 ------ ------ ------ ------ ------ ------ expense (4) Total fixed charges 2,086 2,837 2,820 3,769 3,880 5,123 Earnings available for fixed $(10,926) $9,744 $(10,927) $9,744 $(10,671) $10,085 charges Ratio of earnings to fixed (5.24x) 3.44x (3.87x) 2.59x (2.75x) 1.97x charges - ----------------------------------- ------------ ------------ ------------ ---------- ------------ ----------- - ------------------------- - -------------------------------------------------------------------------------
(1) Presentation One assumes the exchange of $47,059,000 in principal amount of old junior subordinated debentures for $10,237,500 in cash and $27,559,000 in principal amount of new 9% senior subordinated debentures. (2) Presentation Two assumes the exchange of $47,059,000 in principal amount of old junior subordinated debentures for $5,250,000 in cash and $37,059,000 in principal amount of new 9% senior subordinated debentures. (3) Presentation Three assumes the exchange of $47,059,000 in principal amount of old junior subordinated debentures for $47,059,000 in principal amount of new 9% senior subordinated debentures. (4) The representative interest portion of rental expense was deemed to be one-third of all rental expense. Proforma earnings were not sufficient to cover fixed charges during the first nine months of 2000 by $13,012,000 for presentation one, $13,747,000 for presentation two and $14,551,000 for presentation three; all other periods had sufficient income to cover charges. RISK FACTORS By exchanging your old junior subordinated debentures for the exchange consideration, you may be choosing to invest in the new senior subordinated debentures. If you do not participate in the exchange offer, you will continue to hold old junior subordinated debentures. An investment in our debentures involves a high degree of risk. In addition to the other information contained in or incorporated by reference into this prospectus, you should carefully consider the following risk factors in deciding whether to tender your old junior subordinated debentures in the exchange offer and what form of consideration to request. Risks relating to CII Financial We may not be able to repay the principal amount of our debentures at their maturity date. CII Financial, as a holding company and sole obligor of the old junior subordinated debentures, has no available source of cash with which to pay the old junior subordinated debentures when they mature on September 15, 2001. Our ability to service our indebtedness following the exchange offer, including our payment obligations under the new senior subordinated debentures and any old junior subordinated debentures that remain outstanding, and to meet our other financial obligations, will depend upon our future operating performance, which in turn is subject to market conditions and other factors, including factors beyond our control. CII Financial, as a holding company, does not currently generate cash flows that will be sufficient to pay the principal amount of the debentures on their stated maturity dates. Our ability to repay the debentures or to refinance our debentures will depend on the availability of new sources of funding, which will in turn depend on our operating performance, the state of the financial markets and other factors at the time that we want to repay or refinance the debentures. Accordingly, we may not have the cash resources required to meet our obligations to repay the old junior subordinated or new senior subordinated debentures when they become due. We may not be able to service our debt because of our operational structure. Substantially all our assets consist of investments in our subsidiaries, and our operations are currently conducted through our subsidiaries. Our subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay any amounts due pursuant to the debentures, whether by dividends, loans or other payments. In addition, the payment of dividends and the making of loan advances to us by our subsidiaries are and will continue to be subject to statutory and regulatory restrictions. California Indemnity Insurance Company, which is our only direct subsidiary, cannot currently pay any dividends to us without the prior approval of the California Department of Insurance. If our subsidiaries cannot or do not distribute a portion of their earnings to us or if their earnings are insufficient, we may be unable to service our debt. If we are required to perform on our guaranty of Sierra's credit facility, we may not have enough assets to pay interest on or the principal amount of your debentures. In August 2000, CII Financial, but not any of our subsidiaries, became a guarantor of Sierra's revolving credit facility. At December 31, 2000 the credit facility was fully drawn and had an outstanding balance of $135 million. On December 15, 2000, Sierra amended and restated its credit facility. Prior to this amendment, Sierra was in breach of the credit facility's financial covenants. The old junior subordinated debentures and the new senior subordinated debentures are subordinated to our guaranty of the credit facility debt. In the event of a default in payment on our old junior subordinated debentures, Sierra's senior lenders would have the right to receive payment in full by us on our guaranty of Sierra's credit facility prior to any payment being made on the old junior subordinated debentures or the new senior subordinated debentures. In addition, in the event of Sierra's liquidation or insolvency or payment default with respect to its credit facility, our assets will be available to pay obligations on the debentures only after the credit facility has been paid in full. As a result, if we are required to perform on the guaranty we may not be able to pay the interest and principal of the debentures. After the exchange offer, we will have up to $182 million of senior indebtedness that has and could continue to restrict our ability to obtain financing and pursue various business opportunities. CII Financial, as a holding company, has a significant amount of outstanding indebtedness. Upon consummation of the exchange offer, we will have up to $182,059,000 of senior indebtedness, consisting of the new senior subordinated debentures, the credit facility guaranty and the demand promissory note held by an affiliate. As a result, we will remain highly leveraged following the exchange offer. This high leverage will restrict our flexibility to obtain financing and pursue various business opportunities which could impact our ability to pay the interest and principal of the debentures. Since our business is concentrated geographically and by industry, adverse changes in these areas could significantly impact our written premiums and profitability. Our current business is concentrated geographically and by industry. For the nine months ended September 30, 2000, approximately 77% of our direct written premiums were in California, 8% were in Colorado and 7% were in Nevada. Policyholders whose primary business is construction account for approximately 32% of our premiums. Any adverse change in the economic condition of these areas or in the construction industry that significantly affects our written premiums could impair our ability to pay the interest and principal of the debentures. If we are required to increase reserves for losses for adverse loss development on prior accident years our subsidiaries will have less earnings available to pay dividends to us, which will affect our ability to pay the interest and principal of the debentures. In both 1999 and 2000 we were required to increase reserves for losses incurred in prior accident years. For the year ended December 31, 1999, we increased reserves related to losses on prior accident years by a net amount of $9.9 million. For the nine months ended September 30, 2000, we increased reserves related to losses on prior accident years by a net amount of $20.2 million. A significant portion of this adverse loss development was related to the 1996 through 1998 accident years and was primarily attributable to increased severity of claims in California. The average cost per claim under our workers' compensation policies has increased each year since 1995. Two of the factors increasing the costs of claims are medical inflation and, in California, adverse court decisions related to medical control of claims. If we are required to make additional increases in our loss reserves for prior year incurred losses or if any such losses have a material impact on our results of operations, our subsidiaries will have less earnings available to pay dividends to us which will make it more difficult for us to pay the interest and principal of the debentures. If our reinsurers do not perform their obligations, we would experience significant losses which could adversely affect our ability to pay the interest and principal of the debentures. In the ordinary course of our business we reinsure our losses with several reinsurers. Reinsurance does not, however, relieve us of our obligation to policyholders. As of September 30, 2000, we had over $211 million of reinsurance receivables from our reinsurers. A single reinsurer accounts for approximately 87.6% of this amount. If these reinsurance companies fail to reimburse us for losses paid by us under the direct policies, we would experience significant losses which could adversely affect our ability to pay the interest and principal of the debentures. We have reduced our reinsurance coverage, which will expose us to greater risk of ultimate loss. For policies issued after June 30, 2000, our reinsurance coverage has a much higher retention of liability, and covers claims in excess of $250,000 per occurrence, compared to our former retention that had a maximum of $17,000 per occurrence. As a result, we must pay a substantially higher portion of each claim before we have recourse to our reinsurers. In making this change, we expect an increase in premiums retained after reinsurance, an increase in investment income over time and an increase in our net loss ratio. If our net loss ratio increases greater than the offsetting investment income, then our subsidiaries will have less earnings available to pay dividends to us, which will affect our ability to pay the interest and principal of the debentures. If the competitive environment in California continues to adversely affect our premiums on workers' compensation insurance policies, our profitability and ability to repay the debentures will be adversely affected. For the nine months ended September 30, 2000, approximately 77% of our direct written premiums were in California. There has been intense price competition in California since that state replaced its minimum rate law with an open rating premium law in 1995. While workers' compensation rates have risen in California during 2000, the premiums charged remain lower than those charged prior to the 1995 change in law. This price competition has affected and could continue to affect our profitability. Many of our competitors are larger and have significantly greater resources than us. Continued price competition could reduce our profitability and may reduce the earnings of our subsidiaries available to pay the interest and principal of the debentures. If the open rating environment in Nevada scheduled for July 1, 2001 results in price competition that requires us to lower our premiums, our profitability may be harmed. For the nine months ended September 30, 2000, approximately 7% of our direct written premiums were in Nevada. Nevada is scheduled to change to an open rating environment from a minimum rating environment beginning July 1, 2001. After the introduction of open rating in California, premium rates were reduced. As a result, premium revenues and operating profits were adversely affected due to increased price competition and the risk of incurring losses. Although we intend to underwrite each account taking into consideration the insured's risk profile, prior loss experience, loss prevention plans and other underwriting considerations, if the open rating environment in Nevada results in reduced premiums, our profitability could be harmed and we may not have sufficient subsidiary earnings to pay the interest and principal of the debentures. A rating downgrade from insurance rating agencies could reflect negatively on our reliability and make it more difficult for us to sell our workers' compensation insurance policies. In the event we default on our debentures, our subsidiaries' insurance ratings may be downgraded. A downgrade of our insurance subsidiaries' rating by A.M. Best or Fitch could adversely affect our sales of workers' compensation insurance to customers since these customers frequently consider insurance agency ratings as a factor in selecting their insurers. If our costs are increased because of regulations and regulatory development we may not be able to operate profitably. Our insurance subsidiaries are subject to extensive regulation by the California and Texas Departments of Insurance, and are also subject to regulation in each additional jurisdiction in which they become licensed to transact business. Because insurance regulations are designed primarily for the protection of policyholders rather than stockholders or creditors, these regulations could impede our creditors' ability to fully enforce their rights. Our failure to comply with these regulations could result in various regulatory actions including oversight of our insurance subsidiaries or other actions which could adversely affect our operations and our ability to service our debt. The nature and extent of such regulations varies from jurisdiction to jurisdiction, but typically involves: o standards of solvency and minimum amounts of capital and surplus which must be maintained; o limits on types and amounts of investments; o restrictions on the size of risks which may be insured by a single company; o licensing of insurers and their agents; o required deposits of securities for the benefit of policyholders; o approval of policy forms; o establishment of statutory reporting practices and the form and content of statutory financial statements; o establishment of methods for setting statutory loss and expense reserves; o review, and in some instances, prior approval of premium rates; o limits on transactions among insurers and their affiliates; o approval of all proposed changes of control; o approval of dividends; o setting and collecting guarantee fund assessments; and o required filing of annual and other reports with respect to the financial condition and operation of insurers. In addition, state regulatory examiners perform periodic financial and underwriting examinations of insurers. Changes in regulation could further increase our costs. For example, the National Association of Insurance Commissioners, or the NAIC, which is a voluntary organization of state regulators, is currently engaged in a project to codify statutory accounting practices. This project is likely to change the definition of what constitutes prescribed versus permitted statutory accounting practices and may result in changes to the accounting policies that insurance enterprises use to prepare their statutory financial statements. If our costs are increased or if the operations of our insurance subsidiaries are otherwise adversely affected by insurance regulations, our profitability could be harmed and we may not have sufficient subsidiary earnings to pay the interest and principal of the debentures. If we are unable to maintain and improve our management information system, our operations would be adversely affected. Our management information system is critical to our current and future operations. The information gathered and processed by our management information system assists us in, among other things, pricing our product, invoicing and collecting our premiums, processing and paying our claims and vendor invoices and providing us with information to manage our business. In the past we have encountered some difficulty with replacing or enhancing our systems. In 1998 we began a two-year project to convert our policy and claims processing system from our internally developed software to software supported by a third party vendor. The conversion failed due to non-performance by the vendor. Our internally developed software, which is critical to our operations, runs on WANG hardware. Although WANG has continued to support the hardware, there is uncertainty of future availability and cost of hardware upgrades. If our systems were to fail or if we were unable to expand or enhance the capability of our systems, our business would be adversely affected. We are planning to migrate our claims and policy processing functions off the WANG platform and on to a Hewlett Packard / Unix based operating system. Power interruptions due to power shortages in California will negatively impact our operations. Our centralized WANG computer system is housed in Northern California and has recently been shut down for a short period of time due to a power outage. Our WANG system is supported by an uninterrupted power source, which provides up to ninety minutes of power during a power outage. The uninterrupted power source requires twelve hours to recharge after each use. We are currently in the process of upgrading our uninterrupted power source to allow operation of the WANG system without interruption for approximately three hours and to provide a portion of our desktop units with power during this period. In the event a power outage occurs which lasts longer,we may experience data corruption with respect to the claims and policy information being used at the time the system shuts down. In addition, our employees in all states would be prevented from accessing the claims and policy processing systems during a prolonged power outage. We are in the planning stages to move the centralized computer system outside the state of California. Approximately half of our employees are located in California. A power outage not only reduces the productivity of these employees but also impacts our ability to service our customers. Should the frequency or duration of the power outages increase, our business would be adversely impacted. Factors beyond our control may lead to reduced premium levels and investment income which could make it more difficult for us to repay the debentures. In the workers' compensation insurance business, changes in economic conditions can lead to reduced premium levels due to lower payrolls and to increased claims due to the tendency of workers who are laid off to submit workers' compensation claims. Changes in market interest rates can affect the amount of interest income that we can earn on our investment portfolio, as well as the amount of realized and unrealized gains or losses on specific holdings within our investment portfolio. Any reduction in premium levels or in the interest income we earn on our investment portfolio could adversely affect our business and ability to repay the debentures. We are controlled by Sierra and since Sierra's interests may not be the same as the interests of the holders of the debentures, Sierra's actions could adversely affect our ability to pay the interest and principal of the new debentures. All of CII Financial's common stock is owned by Sierra. Sierra thus is able to elect our board of directors and thereby indirectly control our policies and those of our subsidiaries, including mergers, sales of assets and similar transactions. Shares of our common stock and shares of common stock of our subsidiaries may from time to time be pledged, subject to certain regulatory requirements, to secure obligations of Sierra or its affiliates. CII Financial has guaranteed Sierra's obligations under its fully drawn $135 million senior secured credit facility. Since the interests of Sierra may not be the same as the interests of the holders of debentures, Sierra's actions could adversely affect our ability to pay the interest and principal of the debentures. Risks relating to our debentures We expect a limited trading market for the debentures and this will make it difficult for you to sell them. The old junior subordinated debentures are not listed on any securities exchange or quoted on The Nasdaq Stock Market. Although we have applied to list the new senior subordinated debentures on the New York Stock Exchange, we do not expect any active trading market for our debentures to exist. Accordingly, you may have difficulty selling your debentures after the expiration of the offer. To the extent that the old junior subordinated debentures are tendered and accepted in the exchange offer, the outstanding principal amount available for trading will be reduced, and consequently, any existing trading market for the remaining old junior subordinated debentures will likely become even more limited than it is now. As a result, you may have even more difficulty selling your old junior subordinated debentures after the consummation of the exchange offer. Since the old junior subordinated debentures will rank junior to the new senior subordinated debentures, in the event of a default, we will only be able to make payments to holders of old junior subordinated debentures after the guaranty of Sierra's credit facility, new senior subordinated debentures and any other senior debt has been paid in full. The old junior subordinated debentures will rank junior to the new senior subordinated debentures and to our guaranty of Sierra's credit facility and other senior debt. The risk of non-payment to holders of old junior subordinated debentures will be increased because, in the event of a payment default, we will only be able to make payments to holders of old junior subordinated debentures after the new senior subordinated debentures, the guaranty of Sierra's credit facility and any other senior debt has been paid in full. Risks Associated with the Exchange Offer If the cash option is oversubscribed, you will have to accept new senior subordinated debentures as part of your exchange consideration. If you elect to receive cash in the exchange offer, and the cash option is oversubscribed, you will receive new senior subordinated debentures as a portion of your exchange consideration. We will not determine whether the cash option for the exchange consideration has been oversubscribed until after the expiration of the exchange offer. You will not be able to withdraw your tender of old junior subordinated debentures at the time we make this determination even though it may affect the type of exchange consideration you will receive in the exchange offer. The exchange offer may not represent a fair valuation of the old junior subordinated debentures and holders who do not tender their old junior subordinated debentures may receive less than we are offering when the old junior subordinated debentures mature. Our board of directors has made no determination that the exchange offer represents a fair valuation of the old junior subordinated debentures. We have not obtained a fairness opinion from any financial advisor about the fairness of the exchange offer to you or us. We do not now have an available source of cash with which to pay the old junior subordinated debentures when they mature on September 15, 2001. If we default on the old junior subordinated debentures, up to $182 million of indebtedness that ranks senior to those debentures could come due and would then have to be paid first. In that event, our remaining cash resources may not be sufficient to pay the old junior subordinated debentures. In fact, the amount then available to pay these debentures may be less than the cash available under this exchange offer. If we are unable to fund the cash portion of the exchange consideration, we will not be able to complete the exchange offer. We intend to fund the cash portion of the exchange consideration through a combination of dividends or other transfers from our California insurance subsidiaries and a loan from an affiliate. The insurance subsidiaries may not be permitted to declare and pay dividends or make other transfers to us unless the California Department of Insurance approves. We may not receive this regulatory approval. Our affiliates are under no obligation to loan funds to us. If we are unable to obtain the cash required for this transaction, we will not be able to complete the exchange offer. If Sierra does not receive the consent of Sierra's lenders under its $135 million credit facility to the exchange offer, we will not be able to complete the exchange offer. The consent of the lenders under Sierra's credit facility is required in order for us to consummate the exchange offer. Sierra may not receive the lenders' consent if the lenders disapprove of the terms of the exchange offer. If the consent is not received, we will not be able to complete the exchange offer. If the proposed exchange offer is unsuccessful and we are required to perform on our credit facility guaranty and are forced to sell our insurance subsidiaries, the amount of cash available to pay the old junior subordinated debentures would likely be less than the cash available under this exchange offer. If the proposed exchange offer is unsuccessful and we were to default on the payment of the old junior subordinated debentures when they mature, then there will be a cross default on Sierra's credit facility debt and the banks may demand that CII Financial perform on its payment guaranty. If we then had to sell our insurance subsidiaries, our net cash proceeds would probably be substantially less than if the sale were to occur when we were not in a default situation. Under such circumstances, the California Department of Insurance could, among other things, exercise its oversight powers to preserve the assets of the insurance companies for the benefit of the policyholders and claimants and could prevent or significantly delay a possible sale of our insurance subsidiaries. If we are required to perform on the credit facility guaranty and are forced to sell our insurance subsidiaires, the amount of cash available to pay the old junior subordinated debentures would likely be less than the cash available under this exchange offer. SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS We have made forward-looking statements with respect to our financial condition, results of operations and business and on the expected impact of the exchange offer on our financial performance. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates" and similar expressions identify forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties, including those described under "Risk Factors" in this prospectus, that could cause actual results to differ materially from the results contemplated by the forward-looking statements. In evaluating the exchange offer, you should carefully consider the discussion of risks and uncertainties in the section entitled "Risk Factors" on page 12 of this prospectus. WHERE YOU CAN FIND ADDITIONAL INFORMATION We have filed a registration statement on Form S-4 under which we are registering the new senior subordinated debentures to be issued to our debenture holders in the exchange offer. This prospectus is a part of that registration statement. This prospectus does not contain all of the information in the registration statement and the exhibits and schedules to it. For further information with respect to us and our new senior subordinated debentures, we refer you to the registration statement and to the exhibits and schedules to the registration statement. Statements contained in this prospectus as to the contents of any contract or any other document referred to are not necessarily complete, and in each instance, we refer you to the copy of the contract or other document filed as an exhibit to the registration statement. Each of these statements is qualified in all respects by this reference. You may inspect copies of the registration statements without charge at the SEC's principal office in Washington, D.C., and copies of all or any part of the registration statement may be obtained from the Public Reference Section of the SEC, 450 Fifth Street, N.W., Washington, D.C. 20549, upon payment of fees prescribed by the SEC. We do not currently file reports and information with the SEC. Upon completion of this offering, we will be subject to the information reporting requirements of the Securities Exchange Act of 1934 and we will file reports, and other information with the SEC. You may read and copy any reports, statements or other information that we file with the SEC at the SEC's public reference rooms at the following locations: Public Reference Room New York Regional Office Chicago Regional Office 450 Fifth Street, N.W. 7 World Trade Center Citicorp Center Room 1024 Suite 1300 500 West Madison Street Washington, D.C. 20549 New York, NY 10048 Suite 1400 Chicago, IL 60661-2511 Please call the SEC at 1-800-SEC-0330 for further information on the public reference rooms. These SEC filings are also available to the public from commercial document retrieval services and at the Internet worldwide web site maintained by the SEC at "http://www.sec.gov". Reports, proxy statements and other information concerning Sierra may also be inspected at the offices of the New York Stock Exchange, which is located at 20 Broad Street, New York, New York 10005. The old junior subordinated debentures are convertible into shares of Sierra common stock. Sierra has filed a registration statement on Form S-3 under which it registered the shares of Sierra common stock into which the old junior subordinated debentures are convertible. In addition, Sierra files annual, quarterly and special reports and other information with the SEC. Documents filed by Sierra with the SEC can be obtained as described above. The registration statement and Sierra's periodic filings under the Exchange Act are not incorporated by reference in this prospectus. - ----------------------------------- USE OF PROCEEDS The new senior subordinated debentures issued in connection with the exchange offer are only being issued in exchange for your old junior subordinated debentures. We will not receive any cash proceeds from the issuance of new senior subordinated debentures pursuant to the exchange offer. All old junior subordinated debentures accepted by us in the exchange offer will be canceled. CAPITALIZATION The following table sets forth as of September 30, 2000: o our actual capitalization; and o our capitalization adjusted to reflect the tender of all $47,059,000 aggregate principal amount of old junior subordinated debentures in the exchange offer and full subscription of the cash option, so that owners tendering outstanding old junior subordinated debentures will receive, in the aggregate, $10,237,500 in cash and $27,559,000 principal amount of new senior subordinated debentures under the exchange offer. We intend to fund a portion of the cash consideration of the exchange offer, as well as interest and expenses, through a loan from an affiliate evidenced by a demand promissory note, which we refer to as the affiliate note. The amount of this loan will be determined prior to the expiration of the exchange offer. For purposes of this table, we have assumed that the amount of the affiliate note will be $5.0 million. To the extent that old junior subordinated debentures are not validly tendered or accepted in the exchange offer, the amount set out below in the "pro forma" column for the new senior subordinated debentures and the affiliate note, depending on the election of the debenture holder, may decrease and the amount set out below in the "pro forma" column for the old junior subordinated debentures would increase. In addition, it is possible that the cash option will not be fully subscribed. In that event, the amount set below in the "pro forma" column for the new senior subordinated debentures would increase and the amount of the affiliate note may decrease. This information should be read in conjunction with our consolidated financial statements and notes thereto which are included elsewhere in this prospectus.
September 30, 2000 Historical Adjustment Proforma (dollars in thousands, except share data) Total debt: New senior subordinated debentures (1)............. - $36,821 $36,821 Old junior subordinated debentures (2)............. $ 47,059 (47,059) - Notes payable-affiliates (3)....................... - 5,000 5,000 Other debt......................................... - _ - ------------ --------------- Total debt....................................... 47,059 (5,238) 41,821 Stockholder's equity: Common stock, no par value; 1,000 shares authorized; 100 shares issued and outstanding 3,604 3,604 - --------------------------------------------------------- 64,450 64,450 Additional paid-in capital......................... Accumulated other comprehensive loss: Unrealized holding loss on available-for-sale investments ................................... (8,651) (8,651) Accumulated deficit ................................. (889) (889) ---------- ------------ Total stockholder's equity....................... 58,514 58,514 ---------- ----------- Total capitalization............................. $105,573 $(5,238) $100,335
(1) New senior subordinated debentures will have an accounting book value of $36,821,000, which includes a deferred gain of $9,262,500. This premium will be amortized over the life of the senior subordinated debentures. - ------------------------------------------------------------------------------- (2) Retirement of old junior subordinated debentures for new senior subordinated debentures and cash. (3) New affiliate note payable. THE EXCHANGE OFFER This section of the prospectus describes the proposed exchange offer. While we believe that the description covers the material terms of the exchange offer, this summary may not contain all of the information that is important to you. You should read this entire document and the other documents we refer to carefully for a more complete understanding of the exchange offer. Terms of the Exchange Offer Upon the terms and subject to the conditions of the exchange offer set forth in this prospectus and in the accompanying letter of transmittal, you can choose to exchange your old junior subordinated debentures for: o $1,000 in principal amount of new senior subordinated debentures for each $1,000 in principal amount of old junior subordinated debentures that you tender; or o $525 in cash for each $1,000 in principal amount of the old junior subordinated debentures that you tender, up to a maximum of $19,500,000 aggregate principal amount of old junior subordinated debentures as described below. We will pay in cash accrued and unpaid interest on all old junior subordinated debentures accepted in the exchange offer to, but not including, the date of acceptance. We have structured the exchange offer based on what we believe is an attractive offer to holders based on historical trading prices for the old junior subordinated debentures, the financial condition of our business, and our ability to pay the interest and principal on the old junior subordinated debentures when due. We are only offering to purchase a maximum of $19,500,000 aggregate principal amount of old junior subordinated debentures for cash. If holders of more than $19,500,000 aggregate principal amount of old junior subordinated debentures elect the cash option, we will not have enough cash to pay for all the debentures that holders elect to sell. In that case, we will purchase a total of $19,500,000 principal amount of old junior subordinated debentures for cash and we will exchange the balance of the old junior subordinated debentures we receive for new senior subordinated debentures. All holders who elect the cash option will be permitted to sell the same fraction of their old junior subordinated debentures for cash. This fraction will equal $19,500,000, divided by the aggregate principal amount of all debentures tendered for cash by all holders. To receive the maximum amount of cash, you must tender all of your old junior subordinated debentures for the cash option. The following table illustrates how new senior subordinated debentures and cash will be distributed in the aggregate under three scenarios, all of which assume that 100% of the old junior subordinated debentures are tendered, but each of which assumes that a different percentage of holders elects the cash option. The three scenarios are: first, that no old junior subordinated debentures are tendered for cash; second, that $19,500,000 of old junior subordinated debentures are tendered for cash; and third, that $47,059,000 of old junior subordinated debentures are tendered for cash.
Principal amount of Cash paid for old Principal amount of new old junior junior subordinated senior subordinated subordinated debentures debentures issued for debentures tendered old junior subordinated for cash debentures ----------------------- ----------------------- -------------------------- $ 0 $ 0 $47,059,000 $19,500,000 $10,237,500 $27,559,000 $47,059,000 $10,237,500 $27,559,000
We will not determine whether the cash option has been oversubscribed until after the expiration of the exchange offer. You will not be able to withdraw your tender of old junior subordinated debentures once we make this determination even though it may affect the type of exchange consideration you will receive in the exchange offer. We will publicly announce whether the cash option has been oversubscribed and the effect of any required proration of exchange consideration as soon as practicable after the expiration of the exchange offer. You do not have to choose the same option for all of the old junior subordinated debentures that you tender. You do not have to tender all of your old junior subordinated debentures to participate in the exchange offer. You may withdraw your tender of old junior subordinated debentures at any time before the expiration of the exchange offer. Our board of directors makes no recommendation to owners of the old junior subordinated debentures whether or not to tender their debentures in the exchange offer or as to the form of exchange consideration to elect. In addition, we have not authorized anyone to make a recommendation on our behalf regarding the exchange offer. Owners of the old junior subordinated debentures must make their own decision whether to tender their old junior subordinated debentures in the exchange offer and as to the form of exchange consideration to elect. Principal Differences between the Old Junior Subordinated Debentures and the New Senior Subordinated Debentures The terms of our old junior subordinated debentures and our new senior subordinated debentures are described in more detail in the sections headed "Description of Debentures." The principal differences are as follows: o The new senior subordinated debentures will rank senior in right of payment to any old junior subordinated debentures which are not tendered. o You will receive a higher rate of interest on the new senior subordinated debentures, which will pay 9% per annum, than on the old junior subordinated debentures, which pay 7 1/2% per annum. o The scheduled maturity date of the new senior subordinated debentures is September 15, 2006, which is five years later than September 15, 2001, the scheduled maturity date of the old junior subordinated debentures. o The new senior subordinated debentures will not be convertible into Sierra common stock. The old junior subordinated debentures are convertible into Sierra common stock at $39.398 per share. Period For Tendering Your Debentures Subject to applicable securities laws and the terms and conditions in this prospectus, we will accept for exchange any and all old junior subordinated debentures that are validly tendered and not withdrawn before 5:00 p.m., New York City time, on the expiration date of the exchange offer. If we make a material change in the terms of the exchange offer or the information concerning the exchange offer or waive a material condition to the exchange offer, we will disseminate additional exchange offer materials and extend the exchange offer to the extent required by law. In addition, we may, if we deem appropriate, extend the exchange offer for any other reason. If the consideration to be paid in the exchange offer is increased or decreased or the principal amount of old junior subordinated debentures subject to the exchange offer is decreased, the exchange offer will remain open at least 10 business days from the date we first give notice to you, by public announcement or otherwise, of that increase or decrease. In the case of an extension of the exchange offer, the announcement will be issued no later than 9:00 a.m., New York time, on the next business day after the previously scheduled expiration of the exchange offer. Without limiting the manner in which any public announcement may be made, we will have no obligation to publish, advertise or otherwise communicate any public announcement other than by issuing a release to the Dow Jones News Service. Market and Trading Information Regarding the Old Junior Subordinated Debentures The old junior subordinated debentures currently are traded over-the-counter. There is no established reporting system or trading market for trading in the old junior subordinated debentures. Accordingly, there is no practical way to determine the trading history of the old junior subordinated debentures. We believe that trading in the old junior subordinated debentures has been limited and sporadic. We believe that the trading market for the old junior subordinated debentures that remain outstanding after the exchange offer will be very limited. Acceptance for Exchange of Debentures Upon the terms and subject to the conditions of the exchange offer and applicable law, we will exchange the applicable exchange consideration for all old junior subordinated debentures validly tendered and not withdrawn under the exchange offer on or prior to the expiration of the exchange offer. This exchange will be made by our deposit of the exchange consideration with the exchange agent as soon as practicable after the expiration of the exchange offer so that the exchange consideration may be paid to you on the exchange date. The exchange agent will act as agent for you for the purpose of issuing the exchange consideration for the old junior subordinated debentures. Under no circumstances will interest on the exchange consideration be paid by us by reason of any delay on behalf of the exchange agent in making that exchange. We expressly reserve the right, in our sole discretion and subject to Rule 14e-l(c) under the Exchange Act of 1934, to delay acceptance for exchange of, or the exchange of, old junior subordinated debentures in order to comply, in whole or in part, with any applicable law or regulation. In all cases, the exchange agent will deliver the exchange consideration for old junior subordinated debentures accepted for exchange under the exchange offer only after timely receipt by the exchange agent of: o certificates representing your old junior subordinated debentures or timely confirmation of a book-entry transfer of your old junior subordinated debentures into the exchange agent's account at DTC; o a properly completed and duly executed letter of transmittal, or a manually signed facsimile thereof or, in the case of book-entry transfer, an "agent's message"; and o any other documents required by the letter of transmittal. For purposes of the exchange offer, validly tendered old junior subordinated debentures, or defectively tendered old junior subordinated debentures for which we have waived that defect, will be deemed to have been accepted for exchange by us if, as and when we give written notice thereof to the exchange agent. If the exchange offer is terminated or withdrawn, or the old junior subordinated debentures are not accepted for exchange, no exchange consideration will be paid or payable. If any tendered old junior subordinated debentures are not exchanged under the exchange offer for any reason, or certificates are submitted evidencing more old junior subordinated debentures than are tendered, those old junior subordinated debentures not exchanged will be returned, without expense, to you, or, in the case of old junior subordinated debentures tendered by book-entry transfer, those old junior subordinated debentures will be credited to the account maintained at DTC from which those old junior subordinated debentures were delivered, unless otherwise requested by you under the heading "Special Delivery Instructions" in the letter of transmittal, promptly after the expiration of the exchange offer or termination of the exchange offer. Procedures for Exchanging Debentures In order to receive the exchange consideration you must tender your old junior subordinated debentures under the exchange offer on or before its expiration. The method of delivery of old junior subordinated debentures and letters of transmittal, any required signature guarantees and all other required documents, including delivery through DTC and any acceptance of an agent's message transmitted through ATOP, is at your election and risk. Except as otherwise provided in the letter of transmittal, delivery will be deemed made only when actually received by the exchange agent. If delivery is by mail, we suggest that you use properly insured, registered mail with return receipt requested, and that the mailing be made sufficiently in advance of the expiration of the exchange offer. It is contemplated that our new senior subordinated debentures will be delivered in book-entry form through DTC. Accordingly, if you anticipate tendering other than through DTC, you are urged to promptly contact a bank, broker or other intermediary that has the capability to hold securities custodially through DTC, to arrange for the receipt of any new senior subordinated debentures to be delivered as part of the exchange consideration, and to obtain the information necessary in the letter of transmittal. The payment of any cash to you will be paid to you by the exchange agent. If you have any questions or need help in tendering your notes, please call the information agent whose address and phone number are on the back cover of this prospectus. Tenders of debentures. Your tender of old junior subordinated debentures, and subsequent acceptance by us, by one of the procedures set out below will constitute a binding agreement between us and you in accordance with the terms and subject to the conditions set forth in this prospectus, in the letter of transmittal and, if applicable, in the notice of guaranteed delivery. Tenders of debentures held in physical form. To effectively tender old junior subordinated debentures held in physical form: o you must properly complete and duly execute a letter of transmittal, or a manually signed facsimile thereof, and any other documents required by the letter of transmittal, and those documents must be received by the exchange agent at its address set out on the back cover of this prospectus; and o you must ensure that certificates representing those old junior subordinated debentures are received by the exchange agent at that address on or prior to the expiration of the exchange offer. Letters of transmittal and old junior subordinated debentures should be sent only to the exchange agent and should not be sent to us, the information agent or the dealer manager. If your old junior subordinated debentures are registered in the name of a person other than the signatory to the letter of transmittal, then, in order to tender those old junior subordinated debentures under the exchange offer, the old junior subordinated debentures must be endorsed or accompanied by an appropriate written instrument or instruments of transfer signed exactly as that name appears on the old junior subordinated debentures, with the signature on the old junior subordinated debentures or instruments of transfer guaranteed as provided below. Tender of debentures held through a custodian. If your old junior subordinated debentures are registered in the name of a broker, dealer, commercial bank, trust company or other nominee and if you wish to tender old junior subordinated debentures and deliver a letter of transmittal, you should contact that broker, dealer, commercial bank, trust company or other nominee promptly and instruct him or her or it to tender old junior subordinated debentures and deliver a letter of transmittal on your behalf. A letter of instructions is enclosed in the materials provided along with this prospectus which may be used by you in this process to instruct the registered holder to tender old junior subordinated debentures. If you wish to tender those old junior subordinated debentures yourself, you must, prior to completing and executing the letter of transmittal and delivering those old junior subordinated debentures, either make appropriate arrangements to register ownership of the old junior subordinated debentures in your name or follow the procedures described in the immediately preceding paragraph. The transfer of record ownership may take considerable time. Tender of debentures held through DTC. We have confirmed with DTC that the old junior subordinated debentures may be tendered using ATOP. DTC participants may electronically transmit their acceptance of the exchange offer by causing DTC to transfer their old junior subordinated debentures to the exchange agent using the ATOP procedures. In connection with the transfer, DTC will send an "agent's message" to the exchange agent. The agent's message states that DTC has received instructions from the participant to tender old junior subordinated debentures and that the participant agrees to be bound by the terms of the letter of transmittal. By using the ATOP procedures to tender old junior subordinated debentures, you will not be required to deliver a letter of transmittal to the exchange agent. However, you will be bound by its terms just as if you had signed it. Book-entry delivery procedures. The exchange agent will establish accounts with respect to the old junior subordinated debentures at DTC for purposes of the exchange offer within two business days after the date of this prospectus. Although delivery of old junior subordinated debentures may be effected through book-entry transfer into the exchange agent's account at DTC, the letter of transmittal, or a manually signed facsimile thereof, with any required signature guarantees, or an agent's message, in connection with a book-entry transfer, and any other required documents, must, in any case, be transmitted, to and received by the exchange agent at one or more of its addresses set out on the back cover of this prospectus on or prior to the expiration of the exchange offer in connection with the tender of those old junior subordinated debentures. Delivery of documents to DTC does not constitute delivery to the exchange agent. The confirmation of a book-entry transfer into the exchange agent's account at DTC as described above is referred to in this prospectus as a "book-entry confirmation." The term "agent's message" means a message transmitted by DTC to, and received by, the exchange agent and forming a part of the book-entry confirmation, which states that DTC has received an express acknowledgment from a DTC participant that such participant has received the letter of transmittal and agrees to be bound by the terms of the letter of transmittal. Signature guarantees. Signatures on all letters of transmittal must be guaranteed by a recognized participant in the Securities Transfer Agents Medallion Program, unless your tender of old junior subordinated debentures tendered are tendered: o by a registered holder of old junior subordinated debentures, or by a participant in DTC whose name appears on a security position listing as the owner of those old junior subordinated debentures, who has not completed any of the boxes entitled "Special Payment Instructions" or "Special Delivery Instructions" on the letter of transmittal; or o for the account of a member firm of a registered national securities exchange, a member of the National Association of Securities Dealers, Inc. or a commercial bank or trust company having an office or correspondent in the United States, which entities we refer to as "eligible institutions". If your old junior subordinated debentures are registered in the name of a person other than the signatory to the letter of transmittal or if old junior subordinated debentures not accepted for exchange or not tendered are to be returned to a person other than the registered holder, then the signature on the letter of transmittal accompanying the tendered old junior subordinated debentures must be guaranteed. See Instructions 1 and 5 of the letter of transmittal. Mutilated, lost, stolen or destroyed certificates. If you desire to tender old junior subordinated debentures, but the certificates evidencing those old junior subordinated debentures have been mutilated, lost, stolen or destroyed, you should contact us for information about the procedures for obtaining replacement certificates for old junior subordinated debentures at the following address or telephone number: 2716 North Tenaya Way, Las Vegas, Nevada 89128 or (702) 242-7040. Guaranteed delivery. If you want to tender old junior subordinated debentures under the exchange offer prior to the expiration of the exchange offer and, o your certificates representing those old junior subordinated debentures are not immediately available; o time will not permit your letter of transmittal, the certificates representing your old junior subordinated debentures and all other required documents to reach the exchange agent on or prior to the expiration of the exchange offer; or o the procedures for book-entry transfer, including delivery of an agent's message, cannot be completed on or prior to the expiration of the exchange offer, you may nevertheless tender your old junior subordinated debentures with the effect that tender will be deemed to have been received on or prior to the expiration of the exchange offer if all the following conditions are satisfied: o the tender is made by or through an eligible institution; o a properly completed and duly executed notice of guaranteed delivery or an agent's message with respect to guaranteed delivery that is accepted by us is received by the exchange agent on or prior to the expiration of the exchange offer as provided below; and o the certificates for the tendered old junior subordinated debentures, in proper form for transfer, or a book-entry confirmation of the transfer of those old junior subordinated debentures into the exchange agent's account at DTC as described above, together with a letter of transmittal, or manually signed facsimile thereof, that is properly completed and duly executed, with any signature guarantees and any other documents required by the letter of transmittal, or a properly transmitted agent's message, are received by the exchange agent within two business days after the date of execution of the notice of guaranteed delivery. The notice of guaranteed delivery may be sent by hand delivery, facsimile transmission or mail to the exchange agent and must include a guarantee by an eligible institution in the form set out in the notice of guaranteed delivery. Under no circumstances will interest be paid by us by reason of any delay in exchanging old junior subordinated debentures for the exchange consideration to any person using the guaranteed delivery procedures that results from this guaranteed delivery. The exchange consideration for old junior subordinated debentures tendered under the guaranteed delivery procedures will be the same as for old junior subordinated debentures delivered to the exchange agent on or prior to the expiration of the exchange offer, even if the old junior subordinated debentures to be delivered subject to the guaranteed delivery procedures are not so delivered to the exchange agent, and therefore exchange by the exchange agent on account of those old junior subordinated debentures is not made, until after the exchange date. Backup United States federal income tax withholding. To prevent backup federal income tax withholding you must provide the exchange agent with your current taxpayer identification number and certify that you are not subject to backup federal income tax withholding by completing the Substitute Form W-9 included in the letter of transmittal. Determination of validity. All questions as to the validity, form, eligibility, including time of receipt, and acceptance of any tendered old junior subordinated debentures subject to any of the procedures described above will be determined by us, in our sole discretion, which determination shall be final and binding. We reserve the right to reject any or all tenders of any old junior subordinated debentures that we determine not to be in proper form or if the acceptance for tender of those old junior subordinated debentures may, in the opinion of our counsel, be unlawful. We also reserve the right to waive any of the conditions of the exchange offer or any defect or irregularity in any tender of your old junior subordinated debentures, whether or not similar defects or irregularities are waived in the case of other holders of old junior subordinated debentures. Our interpretation of the terms and conditions of the exchange offer, including the letter of transmittal and the instructions thereto, will be final and binding. Neither we, the exchange agent nor any other person will be under any duty to give notification of any defects or irregularities in tenders or will incur any liability for failure to give any such notification. If we waive our right to reject a defective tender of old junior subordinated debentures, you will be entitled to the exchange consideration. Withdrawal of Tendered Old Junior Subordinated Debentures You may withdraw tenders of debentures at any time on or prior to the expiration of the exchange offer, but the exchange consideration shall not be payable in respect of old junior subordinated debentures so withdrawn. We will not determine whether the cash option for the exchange consideration has been oversubscribed until after the expiration of the exchange offer. You will not be able to withdraw your tender of old junior subordinated debentures at the time we make this determination even though it may affect the type of exchange consideration you will receive in the exchange offer. Tenders of old junior subordinated debentures may be validly withdrawn if the exchange offer is terminated without any old junior subordinated debentures being exchanged thereunder. In this case, the old junior subordinated debentures tendered under the exchange offer will be promptly returned to you. If we make a material change in the terms of the exchange offer or waive a material condition of the exchange offer, we will disseminate additional exchange offer materials and extend the exchange offer to the extent required by law. In addition, we may, if we deem appropriate, extend the exchange offer for any other reason. If the consideration to be paid in the exchange offer is increased or decreased or the principal amount of old junior subordinated debentures subject to the exchange offer is decreased, the exchange offer will remain open at least 10 business days from the date we first give notice to you, by public announcement or otherwise, of that increase or decrease. For a withdrawal of tendered old junior subordinated debentures to be effective, a written or facsimile transmission notice of withdrawal must be received by the exchange agent on or prior to the expiration of the exchange offer at its address set out on the back cover of this prospectus. Any such notice of withdrawal must: o specify the name of the person who tendered the old junior subordinated debentures to be withdrawn; o contain the description of the old junior subordinated debentures to be withdrawn and identify the certificate number or numbers shown on the particular certificates evidencing those old junior subordinated debentures, unless those old junior subordinated debentures were tendered by book-entry transfer, and the aggregate principal amount represented by those old junior subordinated debentures; and o be signed in the same manner as the original signature on the letter of transmittal by which those old junior subordinated debentures were tendered, including any required signature guarantees, or be accompanied by evidence sufficient to the exchange agent that the person withdrawing the tender has succeeded to the beneficial ownership of the old junior subordinated debentures. If the old junior subordinated debentures to be withdrawn have been delivered or otherwise identified to the exchange agent, a signed notice of withdrawal is effective immediately upon written or facsimile notice of that withdrawal even if physical release is not yet effected. Any permitted withdrawal of old junior subordinated debentures may not be rescinded, and any old junior subordinated debentures properly withdrawn will thereafter be deemed not validly tendered for purposes of the exchange offer. Withdrawn old junior subordinated debentures may, however, be re-tendered by again following one of the appropriate procedures described in this prospectus at any time on or prior to the expiration of the exchange offer. If we extend the exchange offer or if for any reason, whether before or after any old junior subordinated debentures have been accepted for tender, the acceptance for tender of old junior subordinated debentures is delayed or if we are unable to accept the tender of old junior subordinated debentures under the exchange offer, then, without prejudice to our rights under the exchange offer, tendered old junior subordinated debentures may be retained by the exchange agent on our behalf and may not be withdrawn, subject to Rule 14e-l(c) under the Exchange Act, which requires that an offeror pay the consideration offered or return the securities deposited by or on behalf of the investor promptly after the termination or withdrawal of a tender offer, except as otherwise provided in this section. All questions as to the validity, form and eligibility, including time of receipt, of notices of withdrawal will be determined by us, in our sole discretion, which determination shall be final and binding. Neither we, the exchange agent, the dealer manager, the information agent nor any other person will be under any duty to give notification of any defects or irregularities in any notice of withdrawal, or incur any liability for failure to give any such notification. Conditions to, and Amendment of, the Exchange Offer The exchange offer is subject to the conditions that: o we must receive valid tenders for at least 90% of the aggregate principal amount of the outstanding old junior subordinated debentures; o we must receive the consent of the lenders, under Sierra's $135 million senior secured credit facility, which has been guaranteed by us to our issuing the new senior subordinated debentures in the exchange offer; o we must receive the approval of the California Department of Insurance required for one or more of our subsidiaries to directly or indirectly fund all or part of the cash to be paid as the exchange consideration; o we must obtain sufficient cash to pay any cash consideration required to be paid as exchange offer consideration; and o the exchange offer complies with applicable laws and applicable interpretations of the staff of the SEC; o the new senior subordinated debentures must be approved for listing on the New York Stock Exchange; o no litigation has been instituted or threatened or law enacted that could prohibit the exchange offer, materially adversely affect our business or materially impair the benefits of the exchange offer; o no event has occurred affecting our business that could prohibit, prevent or significantly delay consummation of the exchange offer, or materially impair our contemplated benefits of the exchange offer; and o no tender or exchange offer for our equity securities or any business combination involving us has been proposed or announced or has occurred. Subject to satisfaction or waiver of the conditions, we will accept for exchange any and all old junior subordinated debentures that are validly tendered and not withdrawn before 5:00 p.m., New York City time, on the expiration date of the exchange offer. However, we reserve the right to: o delay the acceptance of your old junior subordinated debentures for exchange; o terminate the exchange offer; o extend the expiration date and retain all old junior subordinated debentures that have been tendered, subject to the right of owners of the old junior subordinated debentures to withdraw their tendered old junior subordinated debentures; o refuse to accept the old junior subordinated debentures and return all old junior subordinated debentures that have been tendered to us; or o waive any condition or otherwise amend the terms of the exchange offer in any respect. United States Federal Income Tax Consequences of the Exchange Offer You are referred to the discussion about the federal income tax consequences of the exchange offer under "Material United States Federal Tax Consequences". Tax matters are very complicated and the tax consequences of the exchange offer to you will depend on the facts of your own situation. You should consult your own tax advisor for a full understanding of the tax consequences to you of the exchange offer. Exchange Agent We have appointed Wells Fargo Bank Minnesota, N.A. as the exchange agent for the exchange offer of the old junior subordinated debentures. We have agreed to pay Wells Fargo Corporate Trust reasonable and customary fees for its services and will reimburse Wells Fargo Corporate Trust for its reasonable out-of-pocket expenses. All executed letters of transmittal and any other required documents should be sent or delivered to the exchange agent at the address set forth below. Questions and requests for assistance, requests for additional copies of this prospectus or of the letter of transmittal and requests for notices of guaranteed delivery should be directed to the exchange agent, addressed as follows: Wells Fargo Corporate Trust: By Registered & Certified Mail: WELLS FARGO BANK MINNESOTA, N.A. Corporate Trust Operations MAC N9303-121 PO Box 1517 Minneapolis, MN 55480 By Regular Mail or Overnight Courier: WELLS FARGO BANK MINNESOTA, N.A. Corporate Trust Operations MAC N9303-121 Sixth & Marquette Avenue Minneapolis, MN 55479 In Person by Hand Only: WELLS FARGO BANK MINNESOTA, N.A. 12th Floor - Northstar East Building Corporate Trust Services 608 Second Avenue South Minneapolis, MN 55479 By Facsimile (for Eligible Institutions only): (612) 667-4927 For Information or Confirmation by Telephone: (800) 344-5128 Delivery of a letter of transmittal to an address other than that for the exchange agent as set forth above or transmission of instructions via facsimile other than as set forth above does not constitute a valid delivery of a letter of transmittal. Dealer Manager We have retained Banc of America Securities LLC as our exclusive dealer manager in connection with the exchange offer. We will pay Banc of America Securities LLC a customary fee for its services. We have also agreed to reimburse Banc of America Securities LLC for its expenses and to indemnify it against certain expenses and liabilities, including liabilities under federal securities laws. These expenses are not included in the fees set forth above. Information Agent We have appointed D.F. King & Co., Inc., the information agent for the exchange offer of the old junior subordinated debentures. We have agreed to pay D.F. King reasonable and customary fees for its services and will reimburse D.F. King for its reasonable out-of-pocket expenses. Any questions concerning the exchange offer procedures or requests for assistance or additional copies of this prospectus or the letters of transmittal may be directed to the information agent at: D.F. King & Co., Inc. 77 Water Street New York, New York 10005 Banks and Brokers, call collect: (212) 269-5500 Others, call toll free: (800) 735-3591 Fees and Expenses We will bear the expenses of soliciting tenders for the exchange offer. We are making the principal solicitation by mail. However, we may make additional solicitations by telephone, facsimile, e-mail or in person by officers and regular employees of ours and those of our affiliates. In addition, we may make payments to brokers, dealers or others soliciting acceptance of the exchange offer. We will also pay the exchange agent reasonable and customary fees for its services and will reimburse it for its reasonable out-of-pocket expenses. We will pay the cash expenses to be incurred in connection with the exchange offer and are estimated in the aggregate to be approximately $1.6 million. Such expenses include fees and expenses of the exchange agent and trustee, accounting and legal fees and printing costs, among others. Payment of Solicitation Fee We will pay to soliciting dealers a solicitation fee of $2.50 per $1,000 of old junior subordinated debentures tendered, accepted for purchase and paid pursuant to the exchange offer, provided, that the aggregate solicitation fee paid to any one soliciting dealer shall not exceed $15,000. As used herein, a "soliciting dealer" is an entity covered by a letter of transmittal which designated its name as having solicited and obtained the tender, and is: o any broker or dealer in securities, excluding the dealer manager, which is a member of any national securities exchange or of the NASD; o any foreign broker or dealer not eligible for membership in the NASD which agrees to conform to the NASD's Rules of Fair Practice in soliciting tenders outside the United States to the same extent as though it were an NASD member; or o any bank or trust company. No such fee shall be payable to a soliciting dealer with respect to the tender of old junior subordinated debentures by a holder unless the letter of transmittal accompanying such tender designates such soliciting dealer. No such fee shall be payable to a soliciting dealer in respect of old junior subordinated debentures registered in the name of such soliciting dealer unless such old junior subordinated debentures are held by such soliciting dealer as nominee and such old junior subordinated debentures are being tendered for the benefit of one or more beneficial owners identified on the letter of transmittal. No such fee shall be payable to a soliciting dealer if such soliciting dealer is required for any reason to transfer the amount of such fee to a depositing holder (other than itself). No such fee shall be paid to a soliciting dealer with respect to old junior subordinated debentures tendered for such soliciting dealer's own account. No broker, dealer, bank, trust company or fiduciary shall be deemed to be the agent of us, DTC, the dealer manager or the information agent for purposes of the exchange offer. For all purposes noted in all materials related to the exchange offer, the term "solicit" shall be deemed to mean no more than "processing old junior subordinated debentures tendered" or "forwarding to customers materials relating to the exchange offer." We will also, upon request, reimburse soliciting dealers for reasonable and customary handling and mailing expenses incurred by them in forwarding materials relating to the exchange offer to their customers. Transfer Taxes Owners who tender their old junior subordinated debentures for exchange will not be obligated to pay any transfer taxes. If, however, o new senior subordinated debentures are to be delivered to, or issued in the name of, any person other than the registered owner of the old junior subordinated debentures; or o old junior subordinated debentures are registered in the name of any person other than the person signing the letter of transmittal; or o a transfer tax is imposed for any reason other than the exchange of new senior subordinated debentures for old junior subordinated debentures in connection with the exchange offer; then the amount of any transfer taxes, whether imposed on the registered owner or any other persons, will be payable by the tendering holder. If satisfactory evidence of payment of such taxes or exemption from them is not submitted with the letter of transmittal, the amount of such transfer taxes will be billed directly to the tendering holder. No Appraisal Rights You will not have any right to dissent and receive an appraisal of your old junior subordinated debentures in connection with the exchange offer. Listing We have applied to list the new senior subordinated debentures on the New York Stock Exchange. However, we do not expect the new senior subordinated debentures to be listed until after 30 days following the consummation of the exchange offer. Accounting Treatment of the Exchange Offer The new senior subordinated debentures will be recorded at the carrying amount of the old junior subordinated debentures less cash consideration given, if any, and that amount will be used to determine the effective interest rate of the new senior subordinated debentures. Fractional Debentures We will issue new senior subordinated debentures in denominations of $1,000 and integral multiples of $1,000. Any fractional principal amount of new senior subordinated debentures which a registered holder is entitled to receive as exchange consideration will be paid in cash. "Blue Sky" Compliance We are making this exchange offer to all holders of old junior subordinated debentures. We are not aware of any jurisdiction in which the making of the exchange offer is not in compliance with applicable law. If we become aware of any jurisdiction in which the making of the exchange offer would not be in compliance with applicable law, we will make a good faith effort to comply with any such law. If, after such good faith effort, we cannot comply with any such law, the exchange offer will not be made to, nor will tenders of old junior subordinated debentures be accepted from or on behalf of, the holders of old junior subordinated debentures residing in such jurisdiction. BUSINESS General We are a holding company whose subsidiaries, California Indemnity Insurance Company, Commercial Casualty Insurance Company, Sierra Insurance Company of Texas and CII Insurance Company are primarily engaged in writing workers' compensation insurance in nine Western and Midwestern states. Substantially all of our assets and our operations are conducted through our subsidiaries. In addition, we have other smaller subsidiaries that we consider immaterial to our overall results. We were acquired by Sierra on October 31, 1995 in a transaction treated as a pooling of interests. However, our old junior subordinated debentures remain solely our obligation and Sierra has not guaranteed the payment of the debentures. Our subsidiaries write workers' compensation insurance in the states of California, Colorado, Nevada, Texas, Nebraska, Kansas, Missouri, New Mexico and Utah primarily through independent insurance agents and brokers, and have licenses in 33 states and the District of Columbia and applications pending for licenses in other states. California, Colorado and Nevada represented approximately 77%, 8% and 7%, respectively, of our direct written premiums for the nine months ended September 30, 2000. We focus on writing lower-severity classes of workers' compensation insurance for primarily small and mid-sized employers although we actively pursue accounts of all sizes. This strategy allows us to direct our managed care expertise to employers that may lack the in-house resources needed to manage costs effectively and to return injured employees to work safely and quickly. These techniques include the use of specialized preferred provider networks, utilization review by our board certified occupational medicine physician and the employment of nurse case managers, medical bill reviewers, and job developers to facilitate early return to work. In particular, our Return to Work, or RTW, Program has brought a large number of injured workers back to the job more quickly and at a lower cost than would have otherwise been possible. By focusing primarily on small and mid-sized employers, we seek to target under-served segments of the workers' compensation market and avoid the price competition associated with large accounts. As of September 30, 2000, we had 16,155 policies in force and an average policy size of approximately $11,700. The following table sets forth the percentages of our written premiums in force on September 30, 2000, December 31, 1999, and July 31, 1998 attributable to the listed risk classifications identified as the policy holders governing class:
September 30, 2000 Dec. 31, 1999 July 31, 1998 ----------------------- ---------------------- ----------------------- Construction 31.20% 28.41% 26.63% Manufacturing 15.33 15.97 14.69 Service Industry 12.58 12.82 12.27 Agriculture 11.92 11.80 11.39 Other (1) 28.97 31.00 35.02 ----- ----- ----- Total 100.00% 100.00% 100.00%
- ------------------ (1) Includes all other risk classifications insured by us, none of which accounted for more than 9.5% of our written premiums in force as of any of the above dates. Underwriting Prior to insuring a particular risk, we review, among other factors, the employer's prior loss experience and other pertinent underwriting information. Additionally, we determine whether the employer's employment classifications are among the classifications that we have elected to insure and if the amounts of the premiums for the classifications are within our guidelines. We review these classifications periodically to evaluate whether they are profitable. Of the approximately 550 employment classifications in California, we are willing to insure approximately two-thirds. The remaining classifications are either excluded by our reinsurance treaty or are believed by us to be too hazardous or not profitable. In addition, we increase our requirements for certain classifications to increase the likelihood of profitability. Once an employer has been insured by us, our loss control department may assist the insured in developing and maintaining safety programs and procedures to minimize on-the-job injuries and industrial health hazards. The safety programs and procedures vary from insured to insured. Depending upon the size, classifications and loss experience of the employer, our loss control department will periodically inspect the employer's places of business and may recommend changes that could prevent industrial accidents. In addition, severe or recurring injuries may also warrant on-site inspections. In certain instances, members of our loss control department may conduct special educational training sessions for insured employees to assist in the prevention of on-the-job injuries. For example, employers engaged in contracting may be offered a training session on general first aid and prevention of injuries from specific work exposures. Claims Our claims operation is organized into a centralized claims/managed care service office in Las Vegas, Nevada, and four regional claims service offices. Major claims, those of high severity, complex nature and/or which are expected to exceed applicable reinsurance retention levels, are handled directly, or supervised, by the reinsurance claims staff. Our approach to claims administration relies upon a high level of interaction with the injured worker and the insured to resolve claims in an efficient and cost effective manner. Claims personnel act as the contact point with the insured and refer the claim to the appropriate support services within our managed care and Return To Work, or RTW, functions. Sierra Health and Life Insurance Company. Effective December 2000, for all claims other than from our Texas operation, we have contracted our medical management, bill review, and return to work with Sierra Health and Life Insurance Company's Workers' Compensation Managed Care Division. The arrangement is at cost. The staff of the Managed Care Division, consists of 88 employees, who were previously employed by California Indemnity Insurance Company in the same capacities. Sierra Health and Life Insurance Company is a wholly-owned subsidiary of Sierra. We have sought to reduce medical and indemnity cost by minimizing litigation and litigation expense, returning workers to work safely and quickly, and having access to medical attention at competitive prices. We have sought to accomplish this by: o using statewide medical provider networks, the members of which have agreed to provide hospital and physician services at reduced fee schedules; o utilizing medical bill review services which advise us of any excess charges submitted by providers; o facilitating early return to work and managing vocational rehabilitation costs; o improving customer service to allow for faster reporting; and o outsourcing legal defense. Use of Managed Care. We use managed care techniques to manage claim costs. Except where limited by law, our managed care strategy directs injured workers to preferred provider organizations, which we refer to as PPO's, to take advantage of rates negotiated by the PPO's with participating providers and to utilize doctors who understand the procedures and communication required to allow injured workers to return to work safely and quickly. This strategy has led us to spend substantially less on medical costs than otherwise payable under state established fee schedules. From 1995 to September 30, 2000, our use of PPO's as a percentage of total medical bills where a saving was achieved, known as "PPO penetration", increased from 25% to 50%. In addition to increasing PPO penetration we also increased the savings from state established fee schedules to 33% through September 30, 2000, from 22% of such schedules for 1995. Management of the medical portion of any claim assists the employer in managing the cost of the indemnity benefit. Our staff of nurses evaluates lost-time cases and directs the injured employee to preferred providers. We utilize a board certified occupational medicine physician as medical director to provide prospective, concurrent, and retrospective review of inpatient admissions. The medical director can communicate directly with treating physicians to assist with the direction of appropriate and timely medical care. By requesting the treating provider to obtain authorization prior to the administration of medical care, we seek to receive medical justification for proposed treatments, which often leads to more accurate medical diagnoses. We have used the medical authorization process to reduce the costs associated with over-treating or under-treating by medical care providers. Medical Bill Review. We use medical bill reviewers to manage costs. By performing the bill review work, we have increased our bill review savings as a percentage of state fee schedules from 25% for 1995 to 38% for the nine months ended September 30, 2000. Return to Work, or "RTW", Program. A critical component of our claims administration approach and our accompanying efforts to reduce indemnity costs is our RTW Program. The program assigns certain claims to a RTW technician, who contacts the injured worker's physician and employer to ascertain functional capacity restrictions and determines whether the employee can perform modified or temporary work. In an unmanaged environment, the doctor typically relies upon the injured worker's description of job duties and bases the medical impairment and disability status upon that subjective description. Such reliance on the worker's description can lead to increased amounts of lost time and, therefore, much higher indemnity payments by us. The RTW technician's task is to work with the doctor and the employer to formally define job duties and to compare those against functional capacity restrictions. This process allows the RTW technician to determine the extent of job disability and the need for vocational rehabilitation as required by the state. By being directly involved with the assessment process, we not only strive to obtain an objective disability diagnosis, but also provide a valuable service to our smaller insureds, who typically do not have formalized processes for return to work. Customer Service. Early claims reporting allows us to direct the injured worker to in-network medical care providers, to enroll those workers in the RTW program, and to reduce the chance of litigation. We have instituted a 24-hour per day, seven days per week, toll free "800" telephone number that allows employers to notify us of a potential claim as quickly as possible. Our customer service call center directs policyholders and injured workers to the nearest preferred health care facility and provides assistance to claims examiners by asking specific investigative questions which allow the examiner to make prompt claim decisions. The customer service representatives additionally answer questions relating to provider bill status, pharmacy authorization, and agent/employer requests for information. California Health Care Organization. In December 2000, Sierra Health and Life Insurance Company was licensed in California as a Health Care Organization by the California Department of Managed Care. A California Health Care Organization coordinates the health care delivery system for the injured worker, including primary provider assignment, emergency and inpatient care, physician consultations, referrals and diagnostic testing. The Health Care Organization also provides quality assurance, medical management and return to work assistance. These provisions afford better cost controls for employers by allowing their injured employees access to medical providers trained in workers' compensation issues. We expect to phase in the activities of Sierra Health and Life as a California Health Care Organization beginning in the Fresno, California market for the first three months of 2001, extending to other markets in California later in the year. Legal Defense. In April 1997, we discontinued our in-house claims legal defense unit in Southern California and entered into a five-year contract with a law firm specializing in the defense of workers' compensation claims. This legal arrangement defines roles for the attorneys and claims personnel to maximize efficient handling of litigated claims. Competition Workers' compensation is a statutory system that requires an employer to provide its employees with medical care and other specified benefits for work-related injuries, even though the injuries may have resulted from the negligence or wrongs of a person, including the employee. Employers typically purchase workers' compensation insurance to provide these benefits. The benefits payable are generally established by statute. The California workers' compensation insurance industry is extremely competitive. Approximately 185 companies wrote workers' compensation insurance in California in 1999, including the State Compensation Insurance Fund, which is the largest writer in California. Many of these companies have been in business longer, have a larger volume of business, offer a more diversified line of insurance coverage, have greater financial resources and have greater distribution capability than us. We believe that the dominant competitor in the industry is the State of California Compensation Insurance Fund. We concentrate on insuring workers' compensation accounts in the small to medium-size range, where we compete primarily on the basis of service and where policyholder dividends are not a significant factor. Based on 1999 direct written premiums, we were the 13th largest writer of workers' compensation insurance in California, with a 2% market share. Our insurance subsidiaries are currently rated "B++" by A.M. Best. The following table provides an illustration of our subsidiary, California Indemnity Insurance Company, and the top 10 workers' compensation writers in the state of California for 1999: California Workers' Compensation Market For the Year Ended December 31, 1999 (dollars in millions) -------------------------------------------------- ------------------
Direct Written Insurer Premiums Market Share State Compensation Fund $ 1,244.7 21.6% Fremont Comp Insurance Group* 520.4 9.0 Superior National Insurance Group* 482.2 8.4 Liberty Mutual Insurance 463.0 8.0 Fireman's Fund/Allianz 232.6 4.0 Kemper Insurance Companies 213.7 3.8 Farmers Insurance Group 184.6 3.2 Reliance Insurance* 184.1 3.2 Great American P&C 173.3 3.0 Legion Insurance Co. 173.0 3.0 California Indemnity Insurance Company 120.5 2.0 --------------------------------------------------- ----------------- -----------------
Source: California Workers' Compensation Institute Bulletin No. 00-15 * These three companies have significantly reduced their writings in California or announced their intentions to do so. Fremont and Superior each had an "E" (under regulatory supervision) rating by A.M. Best as of December 10, 2000. Reliance had a "D" (poor) rating by A.M. Best as of December 10, 2000. Prior to 1995, California law set minimum rates. This minimum rate law was repealed by the California legislature with policies issued or renewed on or after January 1, 1995. From 1995 until the end of 1999, our pricing declined significantly as competitors sought to write more business by cutting their prices. Beginning in December 1999 we began achieving rate increases on renewing policies. This increasing rate trend has continued through September 2000. In other states in which we are currently writing business, competition for workers' compensation insurance is primarily driven by pricing, dividend plans and agents' commission. In these states, the National Council on Compensation Insurance, or NCCI, is usually the designated rating organization. The NCCI accumulates statistical information and recommends pure loss cost rates to each state's department of insurance who has final approval authority. We then add loss cost multipliers or expense loads to derive premium rates for each filed company. Rating plans in NCCI states are more "standardized" pricing models based upon plans (algorithms) developed by the NCCI and approved by departments of insurance. Both Colorado and Nevada have competitive and dominant state insurance funds who represent the major competition in their respective states. In Colorado, the state fund is Pennacol Insurance Company. In Nevada, it is Employers Insurance Company of Nevada, formerly a state fund but now a private mutual insurer. In addition to these two organizations, there are approximately 200 other companies competing for business in states outside of California. The major competitive tool in NCCI states is the use of participating policies, which grant policyholders' dividends, and policies with retrospective rated premium. We currently write participating policies in Colorado, Nevada, Missouri, Nebraska, New Mexico and Kansas. Nevada is scheduled to change to an open rating environment from a minimum rating environment beginning July 2001. Losses and Loss Adjustment Expenses Often, several years may elapse between the occurrence of a loss and the final settlement of the loss. To recognize liabilities for unpaid losses, we establish reserves, which are balance sheet liabilities representing estimates of future amounts needed to pay claims and related expenses for insured events. We also establish reserves for events that have been incurred but have not yet been reported to us, which we refer to as "incurred but not reported" or "IBNR". When a claim is reported, our claims personnel initially establish reserves on a case-by-case basis for the estimated amount of the ultimate payment. These estimates reflect the judgment of the claims personnel based on their experience and knowledge of the nature and value of the specific type of claim and the available facts at the time of reporting as to severity of injury and initial medical prognosis. Included in these reserves are estimates of the expenses of settling claims, including legal and other fees. Claims personnel adjust the amount of the case reserves as the claim develops and as the facts warrant. IBNR reserves are established for unreported claims and loss development relating to current and prior accident years. In the event that a claim that occurred during a prior accident year was not reported until the current accident year, the case reserve for such claim typically will be established out of previously established IBNR reserves for that prior accident year. The National Association of Insurance Commissioners requires that we submit a formal actuarial opinion concerning loss reserves with each statutory annual report. The annual report must be filed with each applicable state department of insurance on or before March 1 of the succeeding year. The actuarial opinion must be signed by a qualified actuary as determined by the California Insurance Commissioner. We retain the services of a qualified independent actuary to periodically review our loss reserves. The actuarial review for the year ended December 31, 1999 showed that our loss and LAE reserves were below the actuary's projected estimate by approximately $9 million and we recorded an increase to our reserves in December 1999 of $9.9 million. This reserve deficiency was primarily caused by adverse loss development on California claims in accident years 1996 to 1998. Our average cost per claim has increased each year since 1995 and the majority of our claims occur in California. The entire California workers' compensation industry has been adversely affected by higher claim severity. According to a published estimate by the California Workers' Compensation Insurance Rating Bureau in October 2000, the average ultimate loss per indemnity claim in California increased 58% from accident year 1995 to accident year 1999. Factors influencing this increase include rising average temporary disability costs, the increase in the number of major permanent disability claims, medical inflation and adverse court decisions related to medical control of claimant's treatment. According to the California Workers' Compensation Institute, an industry association, industry-wide workers' compensation medical costs in California have far outstripped medical inflation, rising 15.3% in 1997, 15.8% in 1998 and 13.6% in 1999. In the first six months of 2000 and especially in the second quarter, we continued to see adverse reserve development on prior accident years and we had our independent actuary perform a review of the June 30, 2000 reserves. As a result of this review, we increased our reserves by $19.2 million, which was in addition to a $1.5 million increase in the first quarter. The total net adverse reserve development on prior accident years through September 30, 2000 was $20.2 million. The reserve deficiency was again primarily related to adverse reserve development on California claims in accident years 1996 to 1999 and was due to continuing increases in average claim costs. We and an independent actuary test the adequacy of our reserves using generally accepted actuarial methods. Both paid loss and incurred loss methods are used to estimate the amount of the ultimate reserves. We also test our reserves by comparing our paid losses and incurred losses to similar data provided by the California Workers Compensation Insurance Rating Bureau for all California workers' compensation insurance companies. We review the adequacy of our reserves with our independent actuary periodically and consider external forces such as changes in the rate of inflation, the regulatory environment, the judicial administration of claims, medical costs and other factors that could cause actual losses and LAE to change. The actuarial projections include a range of estimates reflecting the uncertainty of projections. Management evaluates the reserves in the aggregate, based upon the actuarial indications and makes adjustments where appropriate. Our consolidated financial statements provide for reserves based on the anticipated ultimate cost of losses. The following table sets forth the number of claims reported to us for the nine month accident period ended September 30, 2000 and accident years ended December 31, 1999, 1998 and 1997, and related direct earned premiums and claims frequency, or the number of claims per million dollars of direct earned premium.
Nine ------------------- ----------------------------------------- months ended September 30, Year ended December 31, 2000 1999 1998 1997 Number of claims reported during the period ended 15,600 17,200 18,600 18,100 Direct earned premiums (in millions) 150.1 146.7 154.0 134.2 Claims frequency 103.9 117.2 120.8 134.8
- ----------------------------------------------------------------------------- The following table sets forth, for the nine months ended September 30, 2000 and the years ended December 31, 1999, 1998, and 1997, the cumulative loss ratio, net of reinsurance, for each accident year or nine-month period and also shows the loss "development" for each of these accident periods' loss ratios.
Cumulative ----------------------- Loss Ratios Nine months ended Cumulative Loss Ratios September 30, Year ended December 31, Accident Year 2000 1999 1998 1997 1995 and prior 72.32% 72.05% 73.76% 76.60% 1996 93.22 89.60 85.72 83.84 1997 96.43 90.42 84.21 79.18 1998 85.87 83.64 77.45 1999 66.11 62.13 2000 70.20
- ----------------------------------------------------------------------------- The following table sets forth, for the nine months ended September 30, 2000 and the years ended December 31, 1999, 1998, and 1997, the cumulative loss ratio, gross of reinsurance, for each accident year or nine-month period and also shows the loss "development" for each of these accident periods' loss ratios.
Cumulative ----------------------- Loss Ratios Cumulative Loss Ratios Nine months ended Year ended December 31, September 30, Accident Year 2000 1999 1998 1997 1995 and prior 72.36% 71.98% 73.54% 76.34% 1996 91.51 88.41 83.98 82.32 1997 95.91 90.08 84.42 81.32 1998 98.97 92.08 83.45 1999 110.65 96.48 2000 103.61
- ------------------------------------------------------------------------------ The liabilities for losses and loss adjustment expense, which we refer to as LAE, are determined using loss evaluations and statistical projections and represent estimates of the ultimate net cost of all unpaid losses and LAE incurred through December 31 of each year. These estimates are subject to the effect of trends in claim severity and frequency and are continually reviewed and adjusted to reflect new experience and information, as it becomes known. Such adjustments, if any, are reflected in current operations. Notwithstanding the fact that the claims for which reserves are established may not be paid for many years, the reserves for losses and LAE payments are not discounted, except to calculate the liability for federal income taxes. The anticipated price or cost increases due to inflation are considered in estimating ultimate claim costs. Historical trends, adjusted to reflect anticipated changes in underwriting standards, policy provisions and general economic trends, provide the basis for predicting the severity of future claims. Actual developments are monitored and anticipated trends are modified, if necessary. The following table provides a reconciliation of beginning and ending liability balances for the nine months ended September 30, 2000 and 1999 and years ended December 31, 1999, 1998 and 1997. Reconciliation of Liability for Loss and Loss Adjustment Expenses (in thousands)
Nine months ended September 30, -------------------------------------------- Year ended December 31, 2000 1999 1999 1998 1997 Net Beginning Loss and LAE Reserve $134,305 $174,467 $174,467 $181,643 $172,100 Net Provision for Insured Events Incurred in: Current Year 63,843 36,061 51,540 103,990 102,302 Prior Years 20,177 (1,248) 9,920 (9,643) (8,970) ------ ------- ----- ------- ------- Total Net Provision 84,020 34,813 61,460 94,347 93,332 ------ ------ ------ ------ ------ Net Payments for Loss and LAE Attributable to Insured Events Incurred - --------------------------------------------- In: Current Year 15,763 12,836 21,206 29,591 26,812 Prior Years 49,893 64,668 80,416 71,932 56,977 ------ ------ -------- -------- ------- Total Net Payments 65,656 77,504 101,622 101,523 83,789 ------ ------ ------- ------- ------- Net Ending Loss and LAE Reserve 152,669 131,776 134,305 174,467 181,643 Reinsurance Recoverable 189,233 81,367 110,089 37,797 21,056 ------- -------- ------- -------- -------- Gross Ending Loss and LAE Reserve $341,902 $213,143 $244,394 $212,264 $202,699 ======== ======== ======== ======== ========
We recognized favorable loss development as our losses were lower than projected in calendar years 1997 and 1998 of $9.0 million and $9.6 million, respectively. This favorable loss development reduced our incurred losses reported in those calendar years and was mainly attributable to lower actual paid claims than were previously reserved on accident years prior to 1995. In calendar years 1991 and 1992, we experienced significant adverse loss development on prior accident years and recorded reserve increases of $16.2 million and $28.1 million, respectively. The adverse development occurred primarily on the 1990 and 1991 accident years and was attributable to what we referred to as "stress and strain" claims, which were primarily psychological or mental claims and were usually unaccompanied by any outward display of a physical injury. The economic recession in California during this period resulted in a significant increase in workers' compensation reported claims. Benefits paid to a claimant were not subject to income taxes whereas unemployment benefits were subject to income taxes. In establishing reserves in 1992 and subsequent periods, we tried to factor in this adverse development trend. In 1993, California enacted workers' compensation reform laws, which, along with an improving economy, substantially eliminated stress and strain claims. We did not reduce our prior accident year reserves until we and our actuary were satisfied that the claims payment trend was fully substantiated. In calendar year 1999, we had adverse loss development of $9.9 million which, as discussed above, was primarily due to higher average claims in California on accident years 1996 to 1998. For the nine months ended September 30, 2000, we had additional adverse loss development of $20.2 million. This too, as discussed above, was due to continuing higher average claims on accident years 1996 to 1999. The following table discloses our development of the liability for losses and LAE for the nine months ended September 30, 2000 and the ten years ended December 31, 1999. ANALYSIS OF LOSSES AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT (in thousands)
Sept. 30, Year ended December 31, 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 Losses and LAE Reserve...$341,902 $244,394 $212,264 $202,699 $187,776 $182,318 $190,962 $200,356 $178,460 $112,749 $ 67,593 Less Reinsurance - ------------------------- Recoverables (1)..........189,233 110,089 37,797 21,056 15,676 25,871 29,342 25,841 20,207 ------- --------- --------- ------- --------- ------ ------- ------ Net Loss and LAE Reserves............ 152,669 134,305 174,467 181,643 172,100 156,447 161,620 174,515 158,253 Net Reserve Re-estimated as of (2) 1 Year Later.............. 154,482 184,386 172,000 163,130 141,163 139,741 160,562 154,388 140,815 83,841 2 Years Later............. 201,265 173,596 146,987 132,193 125,279 141,100 147,167 142,447 96,011 3 Years Later............. 187,491 140,563 113,766 117,792 126,483 134,747 143,433 97,142 4 Years Later............. 146,692 102,652 102,955 122,517 132,193 137,143 97,942 5 Years Later............. 104,400 95,997 114,443 131,112 135,249 94,852 6 Years Later............. 96,530 112,284 127,258 135,299 93,561 7 Years Later............. 112,506 125,936 133,729 93,672 8 Years Later............. 126,163 132,696 92,851 9 Years Later............. 132,906 92,104 10 Years Later............ 92,226 Cumulative Net Paid as of (2): 1 Year Later.............. 49,893 80,416 71,933 56,977 45,731 44,519 50,210 50,360 57,611 39,118 2 Years Later............. 115,256 117,794 91,765 70,854 68,619 79,788 84,465 89,177 65,165 3 Years Later............. 137,737 113,054 83,674 80,645 94,865 104,569 108,849 76,988 4 Years Later............. 122,386 91,115 86,381 102,395 114,293 120,539 83,822 5 Years Later............. 94,557 89,601 106,012 119,462 126,100 87,618 6 Years Later............. 91,074 107,850 122,000 129,060 89,607 7 Years Later............. 108,785 123,291 130,649 90,721 8 Years Later............. 123,956 131,346 91,354 9 Years Later............. 131,744 91,598 10 Years Later............ 91,745 Cumulative (Deficiency) Redundancy (2)......... (20,177) (26,799) (5,848) 25,408 52,047 65,090 62,009 32,090 (20,157) (24,633) Net Reserve...............152,669 134,305 174,467 181,643 172,100 156,447 161,620 174,515 Reins. Recoverables.......189,233 110,089 37,797 21,056 15,676 25,871 29,342 25,841 ------- --------- -- ------ -- ------ -- ------ -- ------ -- ------ -- ------ Gross Reserve.............$341,902 $244,394 $212,264 $202,699 $187,776 $182,318 $190,962 $200,356 ======== ======== ======== ======== ======== ======== ======== ======== Net Re-estimated Reserve.. 154,482 201,265 187,491 146,692 104,400 96,530 112,506 Re-estimated Reins. Recoverables........... 135,654 45,866 21,487 16,049 26,712 29,874 26,180 ------- -- ------ -- ------ -- ------ -- ------ -- ------ -- ------ Gross Re-estimated Reserve................ 290,136 247,131 208,978 162,741 131,112 126,404 138,686 -------- -------- -------- ------- ------- ------- ------- Gross Cumulative (Deficiency) Redundancy............. $(45,742) $(34,867) $ (6,279) $ 25,035 $51,206 $ 64,558 $ 61,670 ========= ========= ========= ======== ======= ======== ========
(1) Amounts reflect reinsurance recoverable under prospective reinsurance contracts and the cumulative amortization of retroactive reinsurance recoverable. Unamortized retroactive reinsurance recoverable is excluded as it does not reduce incurred losses under generally accepted accounting principles. Reinsurance recoverables on unpaid losses and LAE are shown as an asset on the balance sheets at September 30, 2000 and December 31, 1999 and 1998. (2) The last amount in each column and the cumulative (deficiency) redundancy represent development through nine months ended September 30, 2000. Our average cost per claim has increased each year since 1995. The majority of our claims occur in California. The entire California workers' compensation industry has been adversely affected by higher claim severity. The average ultimate loss per indemnity claim for California increased 58% from accident year 1995 to accident year 1999, according to a published estimate of the California Workers Compensation Insurance Rating Bureau in October 2000. Two of the factors influencing this increase are medical inflation and adverse court decisions related to medical control of claimant's treatment. - ------------------------------------------------------------------------------- Unallocated loss adjustment expense reserves are established for the estimated costs related to the general administration of the claims adjustment process. We review the adequacy of our reserves on a periodic basis and consider external forces such as changes in the rate of inflation, the regulatory environment, the judicial administration of claims, medical costs and other factors that could cause actual losses and loss adjustment expenses to change. Reserves are reviewed with our independent actuary at least annually. The actuarial projections include a range of estimates reflecting the uncertainty of projections. Management evaluates the reserves in the aggregate, based upon the actuarial indications, and makes adjustments where appropriate. Our financial statements provide for reserves based on the anticipated ultimate cost of losses. Investments As of September 30, 2000, our bond and preferred stock portfolio is invested primarily in high quality investment grade securities, which represent approximately 98% of total bond and preferred stock investments. The total bond and preferred stock portfolio is comprised of approximately 28% in U.S. Treasury securities; approximately 34% in U.S. Government-sponsored Agency securities; approximately 12% in AAA-rated corporate bonds; approximately 20% in AA-rated corporate bonds; approximately 4% in A-rated corporate bonds; and approximately 2% in BAA-rated or lower corporate bonds. As of September 30, 2000, there has been no significant change in the composition of our bond and preferred stock portfolio when compared to the portfolio at December 31, 1999. In addition to our cash and cash equivalents, preferred stocks, and fixed income bond portfolio, other investments include mortgage loans with a book value of $16.5 million and a real estate limited partnership with a book value of $7.1 million. The mortgage loan investments are comprised of approximately $10.3 million in two commercial mortgages extended to Sierra and a subsidiary of Sierra; approximately $4.6 million in relocation mortgages extended to our current and former employees prior to the 1995 merger of Sierra and us; and approximately $1.6 million in commercial mortgages extended to third parties. While mortgages and mortgage-backed securities usually have a higher rate of return than rated corporate and government bonds, we do face the potential risk associated with having to reinvest these funds if interest rates drop and the mortgages are prepaid. Since these mortgages are typically prepaid when rates are lower we would probably have to reinvest in other securities with a lower rate of return. The real estate limited partnership represents our interest in the partnership which owns our Las Vegas headquarters. As of December 31, 2000, the real estate of the limited partnership was sold to an unaffiliated third party. Approximately $22 million of our investment assets as of September 30, 2000 are booked as "assets held to maturity" according to FAS 115. Assets held to maturity are carried at amortized cost; changes in the market value of these assets do not affect their book value for reporting purposes under accounting principles generally accepted in the United States of America. We manage our investment portfolio to provide liquidity for claims and other liabilities and to maximize total return within the financial constraints of applicable regulatory guidelines and requirements. We manage liquidity by estimating the timing of claims and operating expense payments and premium revenues received as well as the timing of payments to and from our reinsurers. During 2000, we had to reduce our estimates of premiums receipts and increase our estimates of claims payments during the year This was primarily due to negative cash flow resulting from paying more ceded premiums to our reinsurers than had previously been projected. We successfully met these revised estimates by selling a portion of our investment portfolio while trying to minimize net realized capital losses. The following table reflects investments, interest earned thereon and the average annual yield on investments for the periods indicated:
Nine Months Ended September 30, Years Ended December 31, 2000 1999 1998 1997 (dollars in thousands) Total cash, cash equivalents and invested assets at end of period $231,604 $226,572 $283,509 $278,479 Net investment income including net realized gains and losses before taxes 10,757 15,395 20,229 17,361 Average annual yield on investment - ----------------------------------------------- portfolio (before realized gains and losses and taxes) 6.5% 6.2% 6.5% 6.2%
The following table sets forth information concerning the composition of our investment portfolio at December 31, 1999:
Percent of Amount Portfolio Fixed maturities, at fair value: (dollars in thousands) U.S. government and government agencies $114,358 54.7 AAA 14,380 6.9 AA 43,145 20.7 A 13,395 6.4 Less than A 4,107 2.0 ----------- --- --- Total fixed maturities, at fair value 189,325 90.7 Equity securities, at fair value 3,486 1.7 Mortgage loans receivable 9,375 4.5 Real estate partnership 6,559 3.1 ------------ ------- Total investments $208,745 100.0 ======== =====
Except for mortgage loans receivable, there were no significant changes in the composition of the investment portfolio when compared to the portfolio at September 30, 2000. Mortgage loans receivable increased by $7.2 million and were due to a new loan of $7.4 million that we made to Sierra in the first quarter of 2000. The details of this loan are discussed below in the section "Certain Transactions". The following table sets forth the contractual maturity profile of our debt and mortgage loan investments at September 30, 2000:
Fair Value Percent of Maturity Amount Portfolio - -------- ------ --------- (dollars in thousands) One year or less $14,441 7.3 More than one year, through five years 51,085 25.7 More than five years, through ten years 15,112 7.6 More than ten years, through fifteen years 18,408 9.3 More than fifteen years 99,654 50.1
Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations. There were no significant changes in the composition of maturity values when compared to the portfolio at September 30, 2000. Reinsurance Our insurance subsidiaries purchase reinsurance to reduce our liability on individual policies and claims and catastrophic losses. However, we are still responsible for the direct payment of all policy benefits and claims. We pay our reinsurers a ceded premium, which is a reduction of our revenues, and the amount is primarily calculated as a percentage of our earned premiums. Ceded incurred losses are determined in a manner that is consistent with how we determine our gross incurred losses and reduce the amount of our gross incurred losses and loss adjustment expenses. Under generally accepted accounting principles, ceded unpaid losses are recorded as a reinsurance recoverable asset. Our reinsurers do not have to pay us for ceded losses until we have made payments on a claim and our payment may have to exceed certain pre-determined levels before our reinsurers become obligated to pay us. As of September 30, 2000 we had over $211 million of reinsurance recoverables from our reinsurers. A single reinsurer, Travelers Indemnity Company of Illinois, which is rated A+ by the A.M. Best Company, accounts for approximately 87% of this amount. Substantially all of the recoverables are due from reinsurers rated A+ by the A.M. Best Company and all reinsurance recoverables are considered to be collectible. We historically and currently have excess of loss reinsurance agreements at pre-determined amounts or retention levels that have varied throughout the years depending on our statutory capital and the protection we believed to be prudent. Prior to 2000, the non-catastrophic excess of loss layer, which we define to be below $10 million per occurrence, was placed with General Reinsurance Corporation, which is rated A+ by the A.M. Best Company. At September 30, 2000, reinsurance recoverable balances due from this reinsurer represented approximately 11% of the total. Effective July 1, 1998, all claims with dates of injury occurring on or after that date are reinsured under a quota share and excess of loss agreement, which we refer to as "low level" reinsurance, with Travelers Indemnity Company of Illinois . The low level reinsurance provides quota share protection for 30% of the first $10,000 of each loss, and excess of loss protection of 75% of the next $40,000 of each loss, and 100% of the next $450,000 on a per occurrence basis. The maximum net loss retained on any one claim ceded under this treaty is $17,000. This agreement continued until June 30, 2000, when we executed an option for a twelve month extension relating to the run-off of policies in force as of June 30, 2000, which covers claims arising under such policies during the term of the extension. In addition to the low level reinsurance, effective January 1, 2000 we entered into a reinsurance contract that provides statutory (unlimited) coverage for workers' compensation claims in excess of $500,000 per occurrence. The contract is in effect for claims occurring on or after January 1, 2000 through December 31, 2003. The reinsurer, National Union Fire Insurance Company, which is rated A+ by the A.M. Best Company, has a limited ability to cancel this treaty on each anniversary of inception during that period. When the low level reinsurance agreement expired on June 30, 2000, as a result of a general tightening of the reinsurance market as well as the impact of the increased loss experience in California, a comparable type of reinsurance program was unavailable in the market and those reinsurers which were offering other forms of lower retention programs were charging premiums that we believed were not cost justified. Therefore, effective July 1, 2000, we entered into a reinsurance contract that provides $250,000 of coverage for workers' compensation claims in excess of $250,000 per occurrence. The contract is in effect for claims occurring on policies with effective dates beginning July 1, 2000 and thereafter. The reinsurer, also National Union Fire Insurance Company, has the ability to cancel the treaty if written notice is provided 90 days prior to each anniversary of inception. In total, reinsurance recoverable balances due from this reinsurer at September 30, 2000 represented approximately 2% of the total. Marketing Our insurance policies are sold primarily through independent insurance agents and brokers, who may also represent other insurance companies. We believe that independent insurance agents and brokers choose to market our insurance policies because of the quality of service that we provide, the commissions we pay and the price of the insurance product. We employ full-time employees as marketing representatives to make personal contacts with agents and brokers, to maintain regular communication with them, to advise them of our services and products, and to recruit additional agents and brokers. We currently have relationships with approximately 900 agents and brokers and pay our agents and brokers commissions based on a percentage of the gross written premium produced by such agents and brokers. In 2001, we anticipate a reduction in the number of agents resulting from more stringent volume and profitability standards we imposed. We maintain standard commission plans that vary by state for our agents and brokers. In addition to the standard commission plans, agents and brokers may be eligible to receive additional commissions in certain instances. Commissions, including additional commissions if any, are negotiated on an individual policy basis. No one agent or broker accounted for more than 1.7% of our total premiums in force on September 30, 2000, and no one policy accounted for more than 0.6% of our total premiums in force on September 30, 2000. Our top 10 agents and brokers accounted for 12.2% of our total premiums in force September 30, 2000. From time to time, we advertise and participate in insurance trade association functions to maintain existing relationships and develop new ones. Geographic Distribution of Premiums and Policy The following tables set forth information concerning the percentages of premiums and policies in force with us by geographic area as of September 30, 2000, and as of December 31, 1999, 1998 and 1997. In force premiums are the total estimated annual premiums of all policies in force at a point in time.
September 30, December 31, 2000 1999 1998 1997 ---- ---- ---- ---- Percent of premiums in force: California 77% 80% 83% 83% Nevada 8 4 0 0 Colorado 8 8 8 10 Other States 7 8 9 7 ------------------ ------------ ------------ ------------ ------------------ ------------ ------------ ------------ Total 100% 100% 100% 100% ================== ============ ============ ============ ================== ============ ============ ============ Total premiums in force (in thousands): $189,557 $154,963 $132,789 $128,840 Percent of policies in force: California 74% 79% 80% 84% Nevada 7 3 0 0 Colorado 7 6 6 6 Other States 12 12 14 10 ------------------ ------------ ------------ ------------ ------------------ ------------ ------------ ------------ Total 100% 100% 100% 100% ================== ============ ============ ============ ================== ============ ============ ============ Total policies in force 16,155 15,485 12,624 11,779
- ----------------------------------------------------------------------------- Government Regulation and Recent Legislation We are subject to extensive governmental regulation and supervision in each state in which we conduct workers' compensation business. The primary purpose of such regulation and supervision is to provide safeguards for policyholders and injured workers rather than protect the interests of shareholders or creditors. The extent and form of the regulation may vary, but generally has its source in statutes that establish regulatory agencies and delegate to the regulatory agencies broad regulatory, supervisory and administrative authority. Typically, state regulations extend to such matters as licensing companies; restricting the types or quality of investments; requiring triennial financial examinations and market conduct surveys of insurance companies; licensing agents; regulating aspects of a company's relationship with its agents; restricting use of some underwriting criteria; regulating premium rates, forms and advertising; limiting the grounds for cancellation or nonrenewal of policies; solicitation and replacement practices; and specifying what might constitute unfair practices. In the normal course of business, we and the various state agencies that regulate our activities may disagree on interpretations of laws and regulations, policy wording and disclosures or other related issues. These disagreements, if left unresolved, could result in administrative hearings and/or litigation. We attempt to resolve all issues with the regulatory agencies, but are willing to litigate issues where we believe we have a strong position. The ultimate outcome of these disagreements could result in sanctions and/or penalties and fines assessed against us. Currently, there are no litigation matters pending with any department of insurance. State holding company acts also regulate changes in control of insurance holding companies, such as the transactions and dividends between an insurance company and its parent or affiliates. Although the specific provisions vary, holding company acts generally prohibit a person from acquiring a controlling interest in an insurer unless the insurance authority has approved the proposed acquisition pursuant to applicable regulations. In many states, including California, where the insurance subsidiaries are incorporated, "control" is presumed to exist if 10% or more of the voting securities of the insurance holding company are owned or controlled by one person or entity. In addition, the insurance authority may find that "control" in fact does or does not exist where one person or entity owns or controls either a lesser or greater amount of securities. The holding company acts also impose standards on certain transactions with related companies and individuals which include, among other requirements, that all transactions are to be fair and reasonable and that transactions exceeding specified limits receive prior regulatory approval. Typically, states mandate participation in insurance guaranty associations, which assess solvent insurance companies in order to fund claims of policyholders of insolvent insurance companies. Under this arrangement, insurers can be assessed up to 1%, or 2% in certain states, of premiums written for workers' compensation insurance in that state each year to pay losses and LAE on covered claims of insolvent insurers. In California and certain other states, insurance companies are allowed to recoup such assessments from policyholders while several states allow an offset against premium taxes. The California Insurance Guarantee Association has issued an assessment as a result of the insolvency of the insurers owned by Superior National Insurance Group. The assessment is 1% of 1999 written premium to be paid in two installments on December 31, 2000 and June 30, 2001. The payments of approximately $1.2 million will be recouped during 2001 and 2002 through assessments to policyholders. It is likely that Guarantee Fund assessments related to this insolvency will continue. Besides state insurance laws, we are subject to general business and corporation laws, federal and state securities laws, consumer protection laws, fair credit reporting acts and other laws regulating the conduct and operation of our subsidiaries. Dividends Our insurance subsidiaries are restricted by state law as to the amount of dividends that can be declared and paid to us. Moreover, insurance companies domiciled in California and Texas generally may not pay extraordinary dividends without providing the state insurance commissioner with 30 days' prior notice, during which period the commissioner may disapprove the payment. An "extraordinary dividend" is generally defined as a dividend whose fair market value together with that of other dividends or distributions made within the preceding 12 months exceeds the greater of ten percent of the insurer's surplus as of the preceding December 31 or the income of such insurer for the 12-month period ending on the preceding December 31. In addition, our insurance subsidiaries may not pay a dividend without the prior approval of the state insurance commissioner to the extent the cumulative amount of dividends or distributions paid or proposed to be paid in any year exceeds the amount shown as unassigned funds (reduced by any unrealized gains included in such amount) on the insurer's statutory statement as of the previous December 31. California Indemnity, which is our only direct subsidiary, cannot currently pay any dividends to us without the prior approval of the California Department of Insurance. We are not in a position to assess the likelihood of obtaining future approval for the payment of dividends other than those specifically allowed by law in each of our subsidiaries' state of domicile. No prediction can be made as to whether any legislative proposals relating to dividend rules in the domiciliary states of our subsidiaries will be made or adopted in the future, whether the insurance departments of such states will impose either additional restrictions in the future or a prohibition on the ability of our regulated subsidiaries to declare and pay dividends or as to the effect of any such proposals or restrictions on our regulated subsidiaries. Deposits and Other Requirements Our insurance subsidiaries are required by state regulatory agencies to maintain certain deposits for the benefit of policyholders or claimants and must also meet certain net worth and reserve requirements. Our insurance subsidiaries have assets on deposit for the benefit of policyholders in various states totaling $152,356,000 at September 30, 2000. Legal Proceedings We are subject to various claims and other litigation in the ordinary course of our business. Such litigation includes workers' compensation claims by injured workers and by providers for payment for medical services rendered to injured workers. In the opinion of our management, the ultimate resolution of pending legal proceedings is not expected to have a material adverse effect on our financial condition. Employees At September 30, 2000, we had a total of 404 full-time equivalent employees, which we refer to as FTE's, grouped into underwriting, claims, marketing and administrative functions. With the completion of our 1997-1998 restructuring and the commencement of Nevada operations in 1999, 157.5 of our FTE's are located at the headquarters in Las Vegas, while 143.3 work at the Pleasanton, California office, and 63 work at the Burbank, California office. In addition, we have full-service branch offices in Denver, Colorado and Dallas, Texas, which employ 20 and 16 FTE's respectively. We have two FTE's in Reno, Nevada and two FTE's in Gladstone, Missouri. Facilities Our principal executive offices and the Las Vegas, Nevada branch office are comprised of 41,005 square feet of office space subleased from Sierra through December 31, 2001. We have an option to renew this sublease yearly for up to 14 more years. Our Northern California branch office, comprised of approximately 34,975 square feet of office space leased through October 31, 2002, is located in Pleasanton, California. Our Southern California branch office, comprised of 23,250 square feet of office space leased through September 30, 2003, is located in Burbank, California. We also lease space in other locations where we have operations and believe our facilities are adequate for our current needs. SELECTED FINANCIAL AND OTHER DATA The table below presents our selected consolidated financial information for the periods indicated and at the end of these periods. The consolidated financial statement information as of December 31, 1999 and 1998 and for the years ended December 31, 1999, 1998 and 1997 was derived from our consolidated financial statements included elsewhere in this prospectus. These financial statements were prepared in accordance with accounting principles generally accepted in the United States of America, and were audited by Deloitte & Touche LLP. The consolidated financial information at December 31, 1997 and for the year ended December 31, 1996 was derived from our unaudited consolidated financial statements for that year and the consolidated financial information for the year ended December 31, 1995 was derived from our audited consolidated financial statements for that year. The consolidated financial statement information at September 30, 2000 and for the nine months ended September 30, 2000 and 1999 has been derived from our unaudited consolidated financial statements included elsewhere in this prospectus. The unaudited consolidated financial statements have been prepared by us on a basis consistent with the audited financial statements and included all normal recurring adjustments necessary for a fair presentation of the information set forth therein. Operating results for the nine months ended September 30, 2000 are not necessarily indicative of the results that will be achieved for future periods, including the entire year ending December 31, 2000.
Nine Months Ended ---------------------------------------------------------- September 30, Year Ended December 31, (dollars in (dollars in thousands) thousands) 2000 1999 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- ---- ---- Income Statement Data: Direct written premiums $153,034 $106,291 $148,824 $153,914 $135,580 $126,724 $94,953 Net written premiums $93,857 $60,833 $85,097 $134,147 $130,597 $121,555 $90,926 Net earned premiums $90,951 $58,254 $82,955 $134,274 $129,197 $120,951 $90,584 Net investment income and net realized gains ========= 10,757 11,901 15,395 20,229 17,361 18,689 14,454 Other revenue 0 0 0 0 0 0 3,547 Total revenues 101,708 70,155 98,350 154,503 146,558 139,640 108,585 Total costs and expenses 115,715 58,301 91,255 136,625 135,745 129,010 99,502 (Loss) income from continuing operations before federal --------- income taxes, discontinued operations, and extraordinary gain (14,007) 11,854 7,095 17,878 10,813 10,630 9,083 Federal income tax (benefit) expense --------- (4,902) 4,815 3,602 4,166 272 (896) (750) (Loss) income from continuing operations before discontinued operations and extraordinary gain (9,105) 7,039 3,493 13,712 10,541 11,526 9,833 Net loss from discontinued operations 0 0 0 0 0 0 (6,600) Extraordinary gain from debt extinguishment, net of tax ---------- --------- ---------- 654 0 111 48 2 58 0 Net (loss) income $(8,451) $7,039 $3,604 $13,760 $10,543 $11,584 $3,233
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Nine Months Ended September 30, ---------------------------------------------------------- Year Ended December 31, (dollars in (dollars in thousands) thousands) 2000 1999 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- ---- ---- Combined Ratios: GAAP Combined Ratio: Loss ratio 92.38% 59.76% 74.08% 70.26% 72.24% 72.69% 59.72% Underwriting expense ratio(1) 28.59% 35.61% 31.45% 28.45% 29.67% 30.54% 44.75% Combined ratio 120.97% 95.37% 105.53% 98.71% 101.91% 103.23% 104.47% Statutory Combined Ratio: Loss ratio 96.32% 61.07% 78.73% 71.03% 72.24% 72.69% 59.72% Underwriting expense ratio 30.10% 37.53% 32.48% 28.92% 29.56% 30.48% 40.89% Combined ratio 126.42% 98.60% 111.21% 99.95% 101.80% 103.17% 100.61% Balance Sheet Data: Total cash, cash equivalents and invested assets $231,604 $238,864 $226,572 $283,509 $278,479 $261,846 $244,396 Total assets 492,852 380,766 404,338 379,880 343,022 315,895 303,151 Total debt 47,059 51,196 50,498 51,251 54,467 54,497 56,800 Total liabilities 434,338 309,669 338,285 305,933 285,452 270,975 260,977 Total stockholder's equity 58,514 71,097 66,053 73,947 57,570 44,920 42,174
- ----------------------------------- (1) Includes policyholders' dividend ratio of 1.83% for the nine months ended September 30, 2000. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------------------------------ You should read the following discussion in conjunction with the consolidated financial statements of CII Financial and the related notes, which appear elsewhere in this prospectus and Annex 1 to this prospectus which contains a glossary of terms. Any forward-looking statements contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations and any other sections of this prospectus need to be considered in connection with the Risk Factors discussed earlier in this prospectus. - ------------------------------------------------------------------------------- Our operating results are primarily the results of our workers' compensation insurance subsidiaries and consist of underwriting profit/loss, net investment income, net realized gains/losses, other income/expense, interest expense on the old junior subordinated debentures, and income taxes. Results of Operations for the Nine Months Ended September 30, 2000 Compared to the Nine Months Ended September 30, 1999 Our income before taxes decreased by $25.9 million for the nine months ended 2000 compared to 1999. The major components of the change were: o $32.7 million increase in net earned premiums; o $0.9 million decrease in investment income; o $49.2 million increase in loss and loss adjustment expenses; o $2.9 million increase in policy acquisition costs; and o $2.4 million increase in general, administrative and other expenses. Revenues: Our revenue is comprised of net earned premiums, net investment income and net realized gains/losses. Total revenue increased by 45% for the nine months ended September 30, 2000 compared to 1999. The increase was largely due to a larger amount of written premiums. The components increasing written premiums included a 17% composite increase in premium rates for all states and a 25% increase in production growth. Net earned premiums are the end result of direct written premiums, plus the change in unearned premiums, less premiums ceded to reinsurers. Our direct written premiums increased by 44% due primarily to growth in California and Nevada. Partially offsetting the growth in direct written premiums was an increase in premiums ceded to reinsurers, which increased by 30%. The growth in ceded reinsurance premiums was lower than the growth in direct written premiums primarily due to the expiration of our low level reinsurance agreement on June 30, 2000 and new lower cost reinsurance agreements, all of which reduced the percentage of premiums being ceded. As compared to the low level reinsurance agreement that expired on June 30, 2000, the new lower cost reinsurance agreements will result in higher net earned premium revenues, as we will be retaining more of the premium dollars, but also lead to our keeping more of the incurred losses. This may result in a higher loss and LAE ratio if the percentage increase in the additional incurred losses should be greater than the percentage increase in the additional premiums we retained. The effect on the balance sheet will result in a lower amount of reinsurance recoverables. However, due to the length of time that it typically takes to fully pay a claim, we should see an increase in cash flow and amounts available to be invested. The following table shows a comparison of direct written premiums, by state, for the nine months ended September 30, 2000 and 1999:
Nine Months Ended September 30, 2000 % of total 1999 % of total (dollars in millions) California $117.6 76.9% $ 86.5 81.4% Colorado 12.4 8.1 9.1 8.6 Nevada 11.3 7.4 0.8 0.7 Texas 5.6 3.6 5.5 5.2 Other States 6.1 4.0 4.4 4.1 --------- ------- --------- ------ Total $153.0 100.0% $106.3 100.0% ====== ===== ====== =====
- ------------------------------------------------------------------------------- As shown in the preceding table, our largest premium state, California, had the largest increase in written premiums. For the nine months ended September 30, 2000, we have obtained an average premium rate increase on renewing policies of approximately 25%. The market-pricing environment in California has become more favorable since 1999 in reaction to industry-wide losses in the workers' compensation line, increased reinsurance costs and competitors retreating from the market. In Nevada, we began writing premiums on July 1, 1999, which was the first date private carriers were allowed to issue workers' compensation policies in the state. Premiums in force are an indicator of future written premium trends. Inforce premiums are the total estimated annual premiums of all policies in force at a point in time. Total inforce premiums increased by 36% to $189,557,000 at September 30, 2000. Total inforce premiums have dropped slightly (.05%) from its highest point in the last twelve months which was in August 2000. This indicates a potential slowing trend in premiums written, especially in California, due largely to business lost because of the higher premium rate increases we have been trying to obtain. The number of inforce policies at September 30, 2000 has also dropped by 1.3% from its highest point in the last twelve months, which was also August 2000. Effective July 1, 1998, we entered into what we refer to as a "low level" reinsurance agreement. See Losses and Loss Adjustment Expenses below for further details on this agreement. The favorable terms of the low level reinsurance agreement provided us with an improved loss ratio as we reinsured a significant amount of losses to the reinsurer. However, the ceded premiums we paid the reinsurer reduced the cash available for investment and temporarily created negative cash flow for us. The $900,000 or 7% reduction in net investment income for the nine months ended September 30, 2000, compared to the prior period, is due to a reduction in investments primarily because of higher ceded premiums paid to reinsurers in 2000. We had net realized losses of $460,000 for the nine months ended September 30, 2000 compared to net realized losses of $174,000 for the prior period. We have tried to manage our investment portfolio to minimize unplanned sales of our available-for-sale investments. Losses and Loss Adjustment Expenses: The $49.2 million increase in losses and loss adjustment expenses, which we refer to as LAE, is attributable to the following reasons: o Approximately $19.5 million of the increase is related to our premium growth. o We recorded $20.2 million of net adverse loss development for prior accident years. The net adverse development recorded in 2000 for the prior accident years, primarily 1996 to 1999, was largely attributable to higher costs per claim, or claim severity, in California. Higher claim severity has had a negative impact on the entire California workers' compensation industry. See our discussion above in "Business - Losses and Loss Adjustment Expenses." o We are establishing a higher loss and LAE ratio for the 2000 accident year, which has resulted in an increase of approximately $8.3 million. In light of the net adverse loss development we recorded in the fourth quarter of 1999 of $9.9 million and the lower premium rates on policies written in o 1999, we believed it prudent to establish the 2000 accident year reserves at a higher rate. o The remaining difference is due to the expiration of the low level reinsurance policy on June 30, 2000. We have a higher risk exposure on policies effective after that date, which results in a higher amount of net incurred loss and LAE. Under our low level reinsurance agreement, we reinsure 30% of the first $10,000 of each claim, 75% of the next $40,000 and 100% of the next $450,000. The maximum net loss retained on any one claim ceded under this agreement is $17,000. This agreement covered all policies in force at July 1, 1998 and continued until June 30, 2000 when we executed an option to extend coverage to all policies in force as of June 30, 2000. For policies effective from July 1, 2000, we obtained excess of loss reinsurance for 100% of the losses above $250,000 and less than $500,000. We already had an existing excess of loss reinsurance agreement that covered 100% of the losses above $500,000. As a percentage of net earned premiums, the loss and LAE ratio for the nine months ended September 30, 2000 was 92.4% compared to 59.8% for 1999. The 2000 loss ratio was significantly impacted by the $20.2 million net adverse development, which represents 22.2% of net earned premiums. In addition, the expiration of the low level reinsurance agreement is resulting in a higher loss and LAE ratio on policies effective after June 30, 2000 as we are keeping more of the losses. Underwriting Expenses: Underwriting expenses consist of policy acquisition costs and other underwriting costs. Policy acquisition costs are those expenses that are directly related to, and vary with, written premiums. Examples of policy acquisition costs are commissions and allowances paid to agents and brokers, premium taxes, boards and bureau fees and certain operating expenses primarily related to our underwriting and marketing departments. The increase in policy acquisition costs of $2.9 million for the nine months ended September 30, 2000 compared to 1999 is primarily attributable to the increase in net earned premiums. Other underwriting expenses increased by $0.7 million for the nine months ended September 30, 2000 compared to 1999 due to higher personnel costs to service the increase in premium growth. As a percentage of net earned premiums, the underwriting expense ratio was 28.6% in 2000 compared to 35.6% in 1999. The improvement in the expense ratio was due in part to higher net earned premiums, which provides a larger base to spread our fixed costs, smaller growth in personnel expenses and lower agents' commissions and allowances. General, Administrative and Other Expenses: Included in this income statement line item are other underwriting expenses of $15.7 million for the nine months ended September 30, 2000 compared to $15.0 million for the prior year period. Also included are policyholders' dividends of $1.7 million for the nine months ended September 30, 2000 compared to nil in 1999. The majority of the dividends are for Nevada participating policies and represent 1.8% of net earned premiums. In addition, in 2000, we wrote-off capitalized costs of $3.0 million on an information system software project that was cancelled because the vendor was unable to fulfill its contractual obligations. Combined Ratio: The combined ratio is a measurement of underwriting profit or loss and is the sum of the loss and LAE ratio, underwriting expense ratio and policyholders' dividend ratio. A combined ratio of less than 100% indicates an underwriting profit. Our combined ratio was 121.0% for the nine months ended September 30, 2000 compared to 95.4% for the same period in 1999. The increase was primarily due to a higher loss and LAE ratio of 32.6 percentage points, offset slightly by a decrease in the underwriting expense ratio of 8.8 percentage points and a new policyholders' dividends ratio of 1.8 percentage points. The increase in the loss and LAE ratio was due to: o net adverse loss development of $20.2 million, which represents 22.2% of net earned premiums, on prior accident years recorded in 2000 compared to no loss development for the nine months ended 1999; and o higher loss and LAE ratio on the 2000 accident year, which represents 9.1% of net earned premiums. The higher loss and LAE ratio is due in part to the net adverse loss development we recorded in the fourth quarter of 1999 of $9.9 million and to the lower premium rates on policies written in 1999. Income Taxes: For the nine months ended September 30, 2000, we recorded a tax benefit of $4.9 million compared to a tax provision of $4.8 million in the prior year period. The effective tax rate was 35% for the 2000 period compared to 41% for the 1999 period. The decrease in the effective tax rate was due to deferred income tax valuation allowances recorded in 1999. Results of Operations for the Year ended December 31, 1999 Compared to the Year Ended December 31, 1998 Our income before taxes decreased by $10.8 million for the year ended December 31, 1999 compared to 1998. The major components of the change were: o $51.3 million decrease in net earned premiums; o $2.5 million decrease in investment income; o $2.4 million decrease in net realized gains; o $32.9 million decrease in loss and loss adjustment expenses; and o $12.9 million decrease in policy acquisition costs. Revenues: Our revenue is comprised of net earned premiums, net investment income and net realized gains/losses. Total revenue decreased by 36% for the year ended December 31, 1999 compared to 1998 and was due to a significant reduction in net earned premiums. In addition, negative cash flows from operations resulted in lower net investment income. Net earned premiums are the end result of direct written premiums, plus the change in unearned premiums, less premiums ceded to reinsurers. Our direct written premiums decreased by $5.1 million or 3% due primarily to lower prices for workers' compensation insurance in California. The increase in ceded reinsurance premiums of $44.0 million was primarily due to the low level reinsurance agreement, which is discussed below. The following table shows a comparison of direct written premiums, by state, for the year ended December 31, 1999 and 1998:
Year Ended December 31, 1999 % of total 1998 % of total (dollars in millions) California $120.5 80.9% $129.3 84.0% Colorado 12.3 8.3 12.0 7.8 Texas 7.2 4.8 8.1 5.3 Nevada 2.6 1.8 0.0 0.0 Other States 6.2 4.2 4.5 2.9 -------- ------- ------- ------- Total $148.8 100.0% $153.9 100.0% ====== ====== ====== =====
Our largest premium state, California, also had the largest decrease in written premiums due in large part to increasing price competition. The market-pricing environment in California became less favorable at the end of 1998 due to some competitors using reinsurance as a way of reducing premium rates to gain market share. We began writing workers' compensation insurance in Nevada on July 1, 1999, the first date private insurance carriers were allowed to issue workers' compensation policies in the state. - ------------------------------------------------------------------------------ Premiums in force are an indicator of future written premium trends. Inforce premiums are the total estimated annual premiums of all policies in force at a point in time. Although direct premium writings decreased for the year ended December 31, 1999 compared to 1998, total inforce premiums at December 31, 1999 increased by 17% to $155.0 million. This indicates an upward trend in premium growth, especially in California, in the latter part of 1999. The number of inforce policies at December 31, 1999 also increased by 23% to 15,485. Effective July 1, 1998, we entered into what we refer to as a "low level" reinsurance agreement. See Losses and Loss Adjustment Expenses below for further details on this agreement. The favorable terms of the low level reinsurance agreement provided us with an improved loss ratio as we reinsured a significant amount of losses to the reinsurer. However, the ceded premiums we paid the reinsurer reduced the cash available for investment and temporarily created negative cash flow for us. The negative cash flow created by the low level reinsurance agreement was the primary reason for the lower net investment income of $2.5 million. We had net realized losses of $381,000 for the year ended December 31, 1999 compared to net realized gains of $2.0 million in 1998. We try to manage our investment portfolio to minimize unplanned sales of our available-for-sale investments. In 1998, we sold some of our investments in debt securities and realized some gains. Losses and Loss Adjustment Expenses: The $32.9 million decrease in the losses and LAE is attributable to the following reasons: o Due to the low level reinsurance agreement, our reinsurer is at risk for more of our losses and LAE on policies in force at July 1, 1998. This agreement reduced the dollar amount of losses and LAE for the year ended December 31, 1999 by approximately $70 million. o We recorded $9.9 million of net adverse loss development for prior accident years in the fourth quarter of 1999 compared to net favorable loss development of $9.6 million in 1998. The net adverse development recorded in 1999 was primarily attributable to higher costs per claim, or claim severity, in California on accident years 1996 to 1998. The entire California workers' compensation industry has been adversely affected by higher claim severity. See our discussion above in "Business - Losses and Loss Adjustment Expenses." The number of reported claims per $1 million of earned premium, or claims frequency, did not significantly change when compared to our historical patterns. The net favorable loss development recorded in 1998 was due to lower than expected loss and LAE payments, primarily on accident years 1992 to 1995. Due to adverse reserve trends that we experienced in calendar years 1991 and 1992, we established reserves on accident years 1992 through 1995 at higher levels so as to avoid future adverse development. Actual loss payments have come in at levels below our projections and this favorable development was taken into income only after we and our outside actuary were satisfied that the development was substantially complete. o The amount of direct losses and LAE reserves (i.e., before deducting reinsurance recoveries) recorded in 1999 were higher by approximately $22 million due to the trend in higher claim severity. This was partially offset by an increase in excess reinsurance recoverable of $4.5 million. In 1998, we recorded favorable loss development and this trend was factored into the loss ratio to record the 1999 accident year reserves. Under our low level reinsurance agreement, we reinsure 30% of the first $10,000 of each claim, 75% of the next $40,000 and 100% of the next $450,000. The maximum net loss retained on any one claim ceded under this agreement is $17,000. This agreement covered all policies in force at July 1, 1998. We also had excess of loss reinsurance agreements that covered 100% of the losses above $500,000 to $100 million. As a percentage of net earned premiums, the loss and LAE ratio for year ended December 31, 1999 was 74.1% compared to 70.3% for 1998. The increase is due to the following: o The $9.9 million of net adverse loss development for prior accident years recorded in the fourth quarter of 1999 compared to favorable loss development of $9.6 million in 1998 accounts for an increase in the loss and LAE ratio of approximately 19 percentage points. o The additional amounts of ceded losses and LAE due to the low level reinsurance agreement have reduced the net loss and LAE ratio by approximately 11 percentage points. o The remainder of the difference is due to the lower direct reserves that were established on the 1999 accident year. Underwriting Expenses: Underwriting expenses consist of policy acquisition costs and other underwriting costs. Policy acquisition costs are those expenses that are directly related to, and vary with, written premiums. Examples of policy acquisition costs are commissions and allowances paid to agents and brokers, premium taxes, boards and bureau fees and certain operating expenses primarily related to underwriting and marketing departments. Policy acquisition costs decreased by $12.9 million or 67% for the year ended December 31, 1999 compared to 1998. The decrease was all due to a ceding commission of $14.7 million received on the low level reinsurance agreement as a partial reimbursement of our expenses. Partially offsetting the ceding commissions were higher commissions paid to agents and brokers in order to remain competitive in the market place. Other underwriting expenses increased by $.6 million in 1999 compared to 1998 due to higher personnel costs to service the increase in premium growth. As a percentage of net earned premiums, the underwriting expense ratio was 31.5% in 1999 compared to 28.4% in 1998. The improvement in the expense ratio was largely due to the ceding commissions. General, Administrative and Other Expenses: The increase in this income statement line item was primarily due to other underwriting expenses of $19.6 million for the year ended December 31, 1999 compared to $19.0 million for 1998. Combined Ratio: The combined ratio is a measurement of underwriting profit or loss and is the sum of the loss and LAE ratio, underwriting expense ratio and policyholders' dividend ratio. A combined ratio of less than 100% indicates an underwriting profit. Our combined ratio was 105.5% for the year ended December 31, 1999 compared to 98.7% for 1998. The increase was due to a higher loss and LAE ratio of 3.8 percentage points and a higher underwriting expense ratio of 3.1 percentage points. The increase in the 1999 year loss and LAE ratio was primarily due to net adverse loss development of $9.9 million, which represents 11.9% of 1999 net earned premiums, whereas the 1998 year had favorable loss development of $9.6 million, which represented 7.1% of 1998 net earned premiums. The change in loss development was partially offset by additional amounts of ceded losses and LAE under the low level reinsurance agreement. The increase in the underwriting expense ratio was primarily due to the lower net earned premium base in 1999. Income Taxes: For the year ended December 31, 1999, we recorded a tax provision of $3.6 million compared to a tax provision of $4.2 million in 1998. The effective tax rate was 50% for 1999 compared to 23% for 1998. The increase in the effective tax rate for 1999 was due to the fact that all of the California Indemnity net operating losses, or NOLs, which had been fully reserved were utilized during 1998 and the accompanying valuation allowances were reversed. As a result of these valuation allowance reversals the tax expense and effective tax rate were reduced in 1998. On a separate return basis, CII Financial has historically recorded NOLs, including the three years ended December 31, 1999 for which valuation allowances have been recorded due to CII Financial's inability to generate significant earnings on its own. Results of Operations for the Year Ended December 31, 1998 Compared to the Year Ended December 31, 1997 Our income before taxes increased by $7.1 million for the year ended December 31, 1998 compared to 1997. The major components of the change were: o $5.1 million increase in net earned premiums; o $1.5 million increase in investment income; o $1.4 million increase in net realized gains; and o $1.0 million increase in loss and loss adjustment expenses. Revenues: Our revenue is comprised of net earned premiums, net investment income and net realized gains/losses. Total revenue increased by $7.9 million or 5% for the year ended December 31, 1998 compared to 1997. The increase was largely due to higher net earned premiums of $5.1 million. Net earned premiums are the end result of direct written premiums, plus the change in unearned premiums, less premiums ceded to reinsurers. Our direct written premiums increased by $18.3 million or14% due primarily to increased premium growth in California. Ceded reinsurance premiums also increased by $14.8 million and were primarily due to the low level reinsurance agreement, which is discussed below. The following table shows a comparison of direct written premiums, by state, for the year ended December 31, 1998 and 1997:
Year Ended December 31, 1998 % of total 1997 % of total (dollars in millions) California $129.3 84.0% $113.1 83.4% Colorado 12.0 7.8 12.8 9.4 Texas 8.1 5.3 6.3 4.6 Other States 4.5 2.9 3.4 2.6 Total $153.9 100.0% $135.6 100.0%
============================================================================== Our largest premium state, California, had the largest increase in written premiums due in large part to premium growth from writing more policies that occurred in the first half of 1998. The market-pricing environment in California became less favorable at the end of 1998 due to some competitors using reinsurance as a way of reducing premium rates to gain market share. Premiums in force are an indicator of future written premium trends. Inforce premiums are the total estimated annual premiums of all policies in force at a point in time. Although total inforce premiums at December 31, 1998 increased by 3% to $132.8 million from December 31, 1997, there was a downward trend in the last half of 1998. Total inforce premiums increased in the first half of 1998 from $128.8 million at January 1, 1998 to a high of $142.8 million in July 1998 and declined in the last half of 1998 due to escalating price competition in California. Effective July 1, 1998, we entered into what we refer to as a "low level" reinsurance agreement. See Losses and Loss Adjustment Expenses below for further details on this agreement. The favorable terms of the low level reinsurance agreement provided us with an improved loss ratio as we reinsured a significant amount of losses to the reinsurer. However, the ceded premiums we paid the reinsurer reduced the cash available for investment and temporarily created negative cash flow for us. Our first payment to the reinsurer was not made until the end of December 1998. Thus, the timing of this payment did not reduce our net investment income in 1998 the increase in our investment income was related to the increase in our investment portfolio throughout most of 1998. In 1998, we had net realized gains of $2.0 million for the year ended December 31, 1998 compared to net realized gains of $.6 million in 1997. We try to manage our investment portfolio to minimize unplanned sales of our available-for-sale investments. In 1998 and 1997, we sold some of our investments in debt securities and realized some gains. Losses and Loss Adjustment Expenses: The $1.0 million net increase in the losses and LAE was primarily attributable to premium growth, which increased losses and LAE by $16.2 million. This increase was substantially reduced by the effects of the low level reinsurance agreement which reduced the dollar amount of losses and LAE in 1998 by approximately $21.0 million. Changes in excess reinsurance resulted in an increase in losses and LAE of $5.9 million. Under our low level reinsurance agreement, we reinsure 30% of the first $10,000 of each claim, 75% of the next $40,000 and 100% of the next $450,000. The maximum net loss retained on any one claim ceded under this agreement is $17,000. This agreement covered all policies in force at July 1, 1998. We also had excess of loss reinsurance agreements that covered 100% of the losses above $500,000 to $100 million. As a percentage of net earned premiums, the loss and LAE ratio for year ended December 31, 1998 was 70.3% compared to 72.2% for 1997. The reduction was primarily due to the effects of the low level reinsurance agreement. In addition, we also had net favorable loss development on prior accident years of $9.6 million compared to net favorable loss development of $9.0 million in 1997. The net favorable loss developments were primarily attributable to lower than expected loss and LAE payments. Underwriting Expenses: Underwriting expenses consist of policy acquisition costs and other underwriting costs. Policy acquisition costs are those expenses that are directly related to, and vary with, written premiums. Examples of policy acquisition costs are commissions and allowances paid to agents and brokers, premium taxes, boards and bureau fees and certain operating expenses primarily related to underwriting and marketing departments. Policy acquisition costs decreased by $.6 million. The increase in policy acquisition costs that would normally accompany an increase in related premium revenues was substantially offset by a ceding commission of approximately $3.9 million. We received a ceding commission on the low level reinsurance agreement as a partial reimbursement of our expenses. Other underwriting expenses increased by $0.5 million or 3% for the year ended December 31, 1998 compared to 1997. As a percentage of net earned premiums, the underwriting expense ratio was 28.4% in 1998 compared to 29.7% in 1997. The decrease in the expense ratio was largely due to the ceding commission received on the low level reinsurance agreement. General, Administrative and Other Expenses: The increase in this income statement line item was primarily due to other underwriting expenses of $19.0 million for the year ended December 31, 1998 compared to $18.5 million for 1997. Combined Ratio: The combined ratio is a measurement of underwriting profit or loss and is the sum of the loss and LAE ratio, underwriting expense ratio and policyholders' dividend ratio. A combined ratio of less than 100% indicates an underwriting profit. Our combined ratio was 98.7% for the year ended December 31, 1998 compared to 101.9% for 1997. The decrease was primarily due to a lower loss and LAE ratio of 2.0 percentage points and a lower underwriting expense ratio of 1.2 percentage points. The decrease in the 1998 year loss and LAE ratio was primarily due to the low level reinsurance agreement and net favorable loss development of $9.6 million, which represents 7.1% of 1998 net earned premiums. The 1997 year had net favorable loss development of $9.0 million, which represented 7.0% of 1997 net earned premiums. The decrease in the underwriting expense ratio was primarily due to the ceding commission received on the low level reinsurance agreement of $3.9 million. Income Taxes: For the year ended December 31, 1998, we recorded a tax provision of $4.2 million compared to a tax provision of $0.3 million in 1997. The effective tax rate was 23% for 1998 compared to 2% for 1997. Both the 1998 and 1997 effective tax rates were less than the statutory rate primarily due to reductions in the deferred income tax valuation allowance from the use of net operating loss carryforwards of California Indemnity. Liquidity and Capital Resources Our insurance subsidiaries require liquidity to pay policy claims and benefits, for operating expenses, income taxes and to purchase fixed assets to maintain and enhance their operations. The source of our insurance subsidiaries' funds come from the premiums we collect, the investment income we earn and receipts from our reinsurers. The liquidity needs of our non-insurance operations, which are essentially the holding company, CII Financial, are substantially all related to the servicing of interest payments on the old junior subordinated debentures and, eventually, the payment of these debentures at maturity. Our insurance subsidiaries are required to maintain sufficient liquid assets to pay claims and other policy obligations. Workers' compensation insurance is referred to as "long-tail" business because of the length of time that typically occurs between when the premium is collected and when a claim is fully paid and settled due to life-time benefits that could be provided to a claimant. The excess of premiums collected over claims and expenses paid are invested until needed. State regulations dictate the kinds of investments we can have and we try to match the maturity of our investments with expected future cash needs. Our only significant short-term non-insurance liquidity need is the repayment of the $47 million in old junior subordinated debentures, which are due on September 15, 2001, and is discussed further below. If our proposed exchange offer for the old junior subordinated debentures is successful and we issue new senior subordinated debentures with a maturity date of September 15, 2006, then our long-term non-insurance liquidity needs will be to service this new debt. We expect to service this new debt from future cash flows, primarily from dividends that will be paid by our insurance subsidiaries from their future earnings. We had negative cash flows from operating activities of $2.3 million for the nine months ended September 30, 2000 and $29.5 million for the year ended December 31, 1999. Our negative cash flow for the 2000 period was largely due to a net loss of $8.5 million and an increase in reinsurance recoverable on paid and unpaid losses of $79.7 million, which were partially offset by an increase in loss and LAE reserves of $97.5 million. Our negative cash flow for the 1999 year was primarily due to a net increase in reinsurance recoverable on paid and unpaid losses of $73.4 million offset by an increase in loss and LAE reserves of $32.1 million, an increase in deferred income taxes of $5.9 million and net income of $3.6 million. The increases in reinsurance recoverable were primarily due to the low level reinsurance agreement. The increases in the loss and LAE reserves were due to premium growth as well as adjustments related to net adverse development on prior accident years recorded in 2000 of $20.2 million and $9.9 million in 1999. Our net cash provided by investing activities was $9.9 million for the nine month 2000 period and $24.8 million for the year ended 1999. Capital expenditures in 2000 were $0.8 million and $4.2 million in the year ended 1999. Our insurance subsidiaries anticipate their capital expenditures to approximate $2 to $4 million per year over the next several years. Due to the negative cash flows from operations, we had to sell some of our investments. Our net cash flows from financing activities were a negative $5.1 million for the nine month 2000 period and negative $0.6 million for the year 1999. The negative cash flows from financing activities for both periods were a result of our repurchase of old junior subordinated debentures in the open market. In September 1991, CII Financial, the holding company, issued the old junior subordinated debentures. The old junior subordinated debentures bear interest at 7 1/2% per annum, which is due semi-annually on March 15 and September 15. Each $1,000 in principal is convertible into 25.382 shares of common stock of our ultimate parent company, Sierra Health Services, at a conversion price of $39.398 per share. The old junior subordinated debentures have no financial ratio covenants. The primary covenants include the timely payment of principal, premium, interest and taxes. Other covenants include our agreement to maintain our existence, business properties and an office where the old junior subordinated debentures can be surrendered for payment, transfer or conversion. There are also covenants regarding our offering to purchase the old junior subordinated debentures upon specified non-approved mergers and changes in control. Since Sierra's acquisition of us was approved by our board of directors and our shareholders, we were not required to offer to purchase the old junior subordinated debentures. The new senior subordinated debentures will have covenants similar to the old junior subordinated debentures. Unamortized issuance costs of $362,000 are included in other assets on the balance sheet and are being amortized over the life of the old junior subordinated debentures. The old junior subordinated debentures are junior subordinated obligations of CII Financial only and are not guaranteed by Sierra. Sierra has a bank credit facility with outstanding borrowings of $185 million at September 30, 2000. Sierra was in breach of its financial covenants (leverage ratio, consolidated net worth and fixed charges coverage ratio) at June 30, 2000. In consideration of the banks granting a waiver of compliance, in August 2000, CII Financial became a guarantor of the Sierra credit facility debt. The guaranty of the bank debt ranks senior to the old junior subordinated debentures. The waivers expired on October 31, 2000 and Sierra received a notice of default from the banks on November 8, 2000. The credit facility was amended and restated on December 15, 2000. The new credit agreement currently provides Sierra with a revolving credit facility of $135 million. The available amounts, which Sierra can borrow under the credit facility, will be reduced by amounts ranging from $2.0 million to $10.0 million every six months starting in June 2001. This may necessitate a loan paydown of the amount of outstanding loans in excess of the reduced commitments, if any. In addition, under certain circumstances, Sierra would be required to make prepayments of the loans, and the amount available to Sierra under the revolving credit facility would be reduced. For example, 80% of any excess cash flow that Sierra has in each year must be applied to a repayment of the credit facility. In addition, if Sierra or a subsidiary of Sierra (other than a regulated subsidiary and other specified subsidiaries) engages in an asset sale or a sale-leaseback transaction (with the exception of specified assets in the new credit agreement), 80% of the net cash proceeds must be applied to a repayment of the loans and a reduction of the amount available under the revolving credit facility. In addition, 100% of the net cash proceeds of a debt issuance (excluding issuances by CII Financial) must be applied to a repayment of the loans and a reduction in the amount available under the revolving credit facility. Subject to normal qualifications and exceptions, Sierra has covenants that, among other things, will restrict the ability of Sierra and its subsidiaries, including CII Financial, to dispose of assets, incur indebtedness, pay dividends, make investments, loans or advances, make acquisitions, engage in mergers or consolidations, or make capital expenditures and which otherwise restrict certain corporate activities. In addition, Sierra is required to comply with specified financial ratios, as defined in the new credit agreement, including minimum interest coverage ratios and leverage ratios. Since December 15, 2000, Sierra has been in compliance with the financial covenants of the new credit agreement. CII Financial is a holding company and its only significant assets are its investment in California Indemnity Insurance Company. Of the cash and cash equivalents held at September 30, 2000, approximately $231 million were designated for use only by the regulated insurance companies. CII Financial has limited sources of cash and is dependent upon dividends paid by California Indemnity. The payment of stockholders' dividends by California Indemnity is regulated by the California Insurance Code and, at a minimum, requires a 10 work day prior notice to the California Department of Insurance. If a payment of a dividend or distribution whose fair market value, together with that of other dividends or distributions made within the preceding 12 months, exceeds the greater of ten percent of the insurer's surplus or its net income for the preceding year end, then the insurance commissioner has up to 30 days to disapprove it. The California Insurance Department will not allow a payment of a dividend or distribution if it will cause an insurer's policyholders' surplus to be unreasonable in relation to the insurer's liabilities and the adequacy of the insurer's financial needs. In making this determination, the Department of Insurance considers a variety of factors including, but not limited to, the size of the insurer, the amount, type and geographic concentration of insurance it writes, the quality of its assets and reinsurance programs, and operating trends. In addition, California law provides that an insurer may not pay a dividend without the prior approval of the state insurance commissioner to the extent the cumulative amount of dividends or distributions paid or proposed to be paid in any year exceeds the amount shown as unassigned funds (reduced by any unrealized gains included in such amount) on the insurer's statutory statement as of the previous December 31. As of September 30, 2000, California Indemnity Insurance Company, which is our only direct insurance subsidiary, did not have any unassigned funds from which it could pay a dividend without prior approval. California Indemnity Insurance Company declared and paid no dividends to CII Financial in 1998 but paid $6.0 million of dividends to it in 1999 and $6.7 million in 2000. Sierra advanced $365,000 to us in order to enable us to make our September 15, 2001 interest payment on the old junior subordinated debentures. Sierra's amended and restated bank credit facility will limit Sierra's ability to make any future advances to us. Since we do not believe that we will have sufficient sources of cash to pay the maturing old junior subordinated debentures, we are proposing to exchange the old junior subordinated debentures for a combination of cash and/or new senior subordinated debentures. The sources for the cash portion of the proposed exchange offer are dependent upon our receiving approval from the California Department of Insurance to allow California Indemnity Insurance Company to pay a dividend to CII Financial and upon loans from Sierra and/or other affiliates. However, these types of loans are limited by Sierra's credit facility. In addition, in order to issue the new senior subordinated debentures in the proposed exchange offer, we will need the consent of a two-thirds majority in principal amount of the lenders under Sierra's credit facility. If the proposed exchange offer is unsuccessful and we were to default on the payment of the old junior subordinated debentures when they mature, then there will be a cross default on Sierra's credit facility debt and the banks may demand that CII Financial perform on its payment guaranty. If we then had to sell our insurance subsidiaries, our net cash proceeds would probably be substantially less than if the sale were to occur when we were not in a default situation. Under such circumstances, the California Department of Insurance could, among other things, exercise its oversight powers to preserve the assets of the insurance companies for the benefit of the policyholders and claimants and could prevent or significantly delay a possible sale of our insurance subsidiaries. Since our acquisition by Sierra in October 1995, we have paid dividends to Sierra totaling $2.6 million. Since the acquisition, Sierra has contributed $3.7 million to us by purchasing in the open market old junior subordinated debentures and contributing them to us for retirement. Inflation Inflation can be expected to affect our operating performance and financial condition in several aspects. Inflation can reduce the market value of our investment portfolio; however, we try to manage our investment portfolio to minimize unplanned sales. Inflation can adversely affect the portion of loss and LAE reserves that relate to hospital and medical expenses, although some medical expenses are established by statute. Loss reserves related to indemnity benefits for lost wages are not directly affected by inflation as these amounts are established by statute. We do not believe that inflation has had a material effect on our results of operations. Recent Accounting Pronouncements In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 clarifies existing accounting principles related to revenue recognition in financial statements. We are required to comply with the provisions of SAB 101 in the quarter ending December 31, 2000. Based upon the current nature of our operations, we do not believe that SAB 101 will have any impact on our results of operations. In June 1998, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), as amended, which is effective for fiscal years beginning after June 15, 2000. SFAS 133 establishes additional accounting and reporting standards for derivative instruments and hedging activities. SFAS 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position. This statement also defines and allows companies to apply hedge accounting to its designated derivatives under certain instances. It also requires that all derivatives be marked to market on an ongoing basis. This applies whether the derivatives are stand-alone instruments, such as warrants or interest rate swaps, or embedded derivatives, such as call options contained in convertible debt investments. Along with derivatives, in the case of qualifying hedges, the underlying hedge items are also to be marked to market. These market value adjustments are to be included either in the income statement or other comprehensive income, depending on the nature of the hedged transaction. The fair value of financial instruments is generally determined by reference to market values resulting from trading on a national securities exchange or in an over the counter market. In cases where derivatives relate to financial instruments of non-public companies, or where quoted market prices are otherwise not available, such as for derivative financial instruments, fair value is based on estimates using present value or other valuation techniques. Based on our understanding of SFAS 133, we do not believe that we have any derivative instruments and do not have any hedging activities. The majority of our investments are held by our insurance subsidiaries, which are regulated as to the types of investments they may hold. Quantitative and Qualitative Disclosures About Market Risk At December 31, 1999, we had $217.1 million in cash, cash equivalents and invested assets of which $215.5 million is designated for use only by our regulated insurance subsidiaries. Our invested assets consist of debt securities of $190.3 million, of which $165.3 million were classified as available-for-sale and $25.0 million was classified as held-to-maturity. These investments are substantially investment grade securities. Our investment policies emphasize return of principal and liquidity and are focused on fixed returns that limit volatility and risk of principal. Our primary market risk associated with our investment portfolio is interest rate risk. Assuming interest rates were to increase by a factor of 1.1, the net hypothetical loss in fair value of shareholder's equity related to financial instruments would approximately be $6.1 million after tax. This would represent approximately 9% of shareholder's equity. We believe that if interest rates were to increase by this amount, it would not have a material impact on our future earnings or cash flows as it is unlikely that we would need or choose to substantially liquidate our investment portfolio. At September 30, 2000, we had $214.2 million in cash, cash equivalents and invested assets of which $213.4 million is designated for use only by our regulated insurance subsidiaries. Our invested assets consisted of debt securities of $186.8 million, of which $164.7 million were classified as available-for-sale and $22.1 million were classified as held-to-maturity. The composition of our investments and our investment policies have not materially changed when compared to December 31, 1999. We believe that if interest rates were to increase as described above, it would not have a material impact on our future earnings or cash flows as it is unlikely that we would need or choose to substantially liquidate our investment portfolio. The effect of interest rate risk on potential near-term net income, cash flow and fair value was determined based on commonly used sensitivity analyses. The models project the impact of interest rate changes on a wide range of factors, including duration and prepayment. Fair value was estimated based on the net present value of cash flows or duration estimates, assuming an immediate 10% increase in interest rates. MANAGEMENT Directors and Executive Officers The following table sets forth information concerning our directors and executive officers. - ------------------------------------------------------------------------------
Name Position Age - ----------------------------------------------------------------------------- Paul H. Palmer Director 39 Frank E. Collins Director 46 Kathleen M. Marlon President, Chief Executive Officer, Chairman and Director 42 John F. Okita Chief Financial Officer 52 Robert G. Riordan Vice President, Region II 48 Robert L. Selli Vice President, Region I 59 David M. Sonenstein General Counsel and Secretary 53 - -------------------------------------------------------------------------------
Paul H. Palmer, Director. Mr. Palmer is the vice president of finance, chief financial officer and treasurer of Sierra. He was promoted to these offices in 1998. Prior to this, he was assistant vice president of Sierra from May 1996, corporate controller from November 1994 and director of finance when he joined Sierra in 1993. Prior to joining Sierra, Mr. Palmer was an audit manager at Deloitte & Touche LLP (formerly Touche Ross) in Las Vegas and California from 1988 to 1993. Mr. Palmer is a certified public accountant with an MBA and masters in accounting from Brigham Young University. He is a member of the American Institute of Certified Public Accountants, the Nevada State Society of Certified Public Accountants and the California State Society of Certified Public Accountants. Frank E. Collins, Director. Mr. Collins joined Sierra in 1986 as general counsel and secretary. In 1997 he was appointed executive vice president. From 1981 to 1986, Mr. Collins was employed by Blue Cross and Blue Shield of Kansas City, originally as staff legal counsel and in early 1986 as associate general counsel. Mr. Collins also served as counsel for the Missouri Division of Insurance from 1979 to 1981, where he was responsible for providing legal advice on insurance- and HMO-related regulatory issues. Mr. Collins received his Juris Doctorate in 1979 from the University of Missouri at Kansas City school of law and is a member of the Missouri Bar Association. Kathleen M. Marlon, President, Chief Executive Officer, Chairman and Director. Ms. Marlon joined Sierra in March 1986. In 1990, she became president and chief operating officer of Sierra Healthcare Options, Inc., a start-up subsidiary of Sierra. In February 1996, Ms. Marlon became our president and chief executive officer. In December 2000, Ms. Marlon became our chairman. Prior to joining Sierra, Ms. Marlon held technical and management positions for six years with Delphi Systems and Quality Systems. Ms. Marlon received her Bachelor of Science in Accounting from the University of Southern California in 1980. Ms. Marlon has successfully completed the CPA exam and Property & Casualty and Health licensing exams and holds a F.L.M.I. designation. Ms. Marlon is married to Anthony M. Marlon's nephew. Anthony M. Marlon is the chairman and chief executive officer of Sierra. John F. Okita, Chief Financial Officer. Mr. Okita has served in this capacity since he started his employment with us in April 1992 until September 1999 and from June 2000 to present. In September 1999, Mr. Okita left us to become the corporate controller of Sierra, a position he still holds. In June 2000 he returned to us as our chief financial officer. Mr. Okita is a certified public accountant and a licensed attorney and has over twenty years of property-casualty insurance industry experience. Prior to joining us, Mr. Okita was in private tax and financial consulting practice. Mr. Okita served in several financial executive capacities at Fremont Insurance Group between 1980 and 1990. Prior to that, Mr. Okita was employed by Coopers & Lybrand from 1975 and audited both property-casualty and life insurance companies. Mr. Okita received his Bachelor of Science in Business Administration from California State University at Los Angeles and his Juris Doctorate from Loyola Law School. Robert G. Riordan, Senior Vice President, Field Operations. Mr. Riordan was promoted to this position in May 1997 after having served as director of field operations since November 1993. He was vice president of Northern California operations for USA Casualty Company from November 1991 until joining Sierra in 1993. Prior to USA Casualty, Mr. Riordan had held various underwriting, marketing and financial reporting positions with Fireman's Fund Insurance Companies since 1976. Mr. Riordan attended Steubenville College where he received a Bachelor of Science degree in Business Administration. Robert L. Selli, Vice President, Underwriting. Mr. Selli was promoted in November 1997 after serving as director of underwriting since December 1996. Mr. Selli has served as Northern California Underwriting Manager and key member of our California Open Rating Task Force since he joined us in January 1994. Prior to that time, Mr. Selli held various underwriting management and marketing positions with Fireman's Fund Insurance Company and Zurich American since entering the industry in 1967. Mr. Selli attended San Francisco State University where he received a Bachelor of Arts degree in economics. David M. Sonenstein, General Counsel and Secretary. Mr. Sonenstein has served as general counsel since joining us in August 1997 and as secretary since early 1999. Mr. Sonenstein served as vice president and associate general counsel of Fireman's Fund Insurance Company, from 1991 to 1997. He started his employment with Fireman's Fund as Associate Counsel in 1979. Mr. Sonenstein was in private practice from 1972 to 1979. Mr. Sonenstein graduated from Claremont Men's College with a Bachelor of Arts degree and received his Juris Doctorate in 1972 from Hastings College of Law. Executive Compensation The following table sets forth information with respect to the compensation paid by us for the year ended December 31, 1999 to our chief executive officer and to each of our four next most highly compensated executive officers: SUMMARY COMPENSATION TABLE
Name of Individual Or Number Of Persons In Capacities in Cash Compensation All Other ----------- ------------ Group Which Served Bonus Compensation Kathleen M. Marlon President, Chief $214,291 $78,733 $25,457 (1) Executive Officer Richard E. Dobson Chief Legal Officer 225,715 47,800 13,115 John F. Okita Chief Financial 126,912 66,698 21,487 Officer Robert G. Riordan Senior Vice 139,445 30,047 10,907 President, Field Operations David M. Sonenstein General Counsel 124,214 27,583 13,342
- -------------- (1) Includes $15,451 of compensation resulting from split-dollar insurance policies purchased in 1997, calculated based on regulations of the SEC. The regulations require compensation to be calculated on the assumption that most of the premiums paid by us represent a long-term, no-interest loan to the executive. This assumption results in high compensation expense being shown in early years of the expected life of each policy and lower expense in later years, while in fact the cash surrender value of such a policy to the executive is very low in the early years and higher only in the late years. Compensation of Directors The directors are our employees or employees of Sierra and receive no additional compensation for their service on our board. Employment Agreements Our subsidiary, California Indemnity Insurance Company, has entered into a three-year employment agreement with Kathleen M. Marlon, its chief executive officer. Under the agreement, Ms. Marlon may voluntarily terminate employment upon 60 days' notice. California Indemnity may terminate her employment, with or without cause, in accordance with California Indemnity's usual policies and procedures. The employment agreement provides that, in the event of a termination by California Indemnity without cause, a severance payment will be paid in the amount of 12 months' salary to Ms. Marlon. The agreement also provides that, a disability must continue for at least six months before California Indemnity may terminate her employment. In the event of a change in control not approved by the board of directors of California Indemnity, or if a change in control is approved by the board but within two years thereafter Ms. Marlon is terminated without cause, demoted, provided reduced compensation or required to relocate, Ms. Marlon will be entitled to receive a payment equal to a multiple of two times her salary and target annual incentive. In addition, if "golden parachute" excise taxes apply to compensation paid by California Indemnity, California Indemnity will provide a gross-up payment sufficient to cause the after-tax value of the compensation and the gross-up payment to Ms. Marlon to be the same as if no such excise had applied. The employment agreement contemplates annual adjustments in compensation based on job duties, performance goals and objectives and other reasonable standards deemed appropriate by California Indemnity. The agreement restricts Ms. Marlon's use and disclosure of confidential information, interference with California Indemnity's business relationships, and competition with California Indemnity, including a prohibition, for a one-year period following any termination of employment, on her working for a competitor which operates in California, Nevada, or Texas. Stock Options Our executive officers participate in Sierra's stock option plan. The following table contains information concerning the grants by Sierra of stock options to acquire Sierra common stock to the named executives during fiscal year 1999:
OPTION/SAR GRANTS IN FISCAL YEAR 1999 Individual Grants (1) Number of % of Total -------------- Potential Realizable Securities Options/SARs Value at Assumed Underlying Granted to Exercise or Annual Rates of Stock Options/SARs Employees in Base Price Expiration Price Appreciation for Granted (#) 1999 ($/Share) Date Option Terms 5% ($) 10% ($) Kathleen M. Marlon 75,000 (2)(3) 47% 8.00 10/12/05 $204,057 $462,937 Richard E. Dobson -0- N/A N/A N/A N/A N/A John F. Okita 10,000 (2)(3) 6% 8.00 10/12/05 27,208 61,725 Robert G. Riordan 7,500 (3)(4) 5% 6.6875 12/30/05 31,543 79,936 David M. Sonenstein 7,500 (3)(4) 5% 6.6875 12/30/05 31,543 79,936
- ------------- - ------------------------------------------------------------------------------ (1) All options were granted at an exercise price equal to the fair market value of Sierra common stock on the option grant date. The exercise price may be paid by the optionee in cash or by check, except that Sierra's stock plan committee may, in its discretion, allow such payment to be by surrender of unrestricted shares of Sierra common stock (at their fair market value on the date of exercise), or by a combination of cash, check and unrestricted shares. (2) These options were granted on October 13, 1999 and vest and are exercisable at the rate of 20% per year starting with the first anniversary date of the grant and will expire not later than six years after grant. (3) All awards were non-qualified stock options granted pursuant to Sierra's 1995 long-term incentive plan. No stock appreciation rights were granted with the above awards. Upon a change of control of Sierra, as defined in the 1995 Plan, the vesting of the options will be automatically accelerated, provided, however, that Sierra's stock plan committee may exclude a change of control transaction from the foregoing provisions and permit the option to continue to vest in accordance with its original terms. In addition, the options shown above will terminate and may no longer be exercised if the respective optionee ceases to be an employee or director of Sierra or one of its affiliates, except certain post-termination exercise periods are permitted in the case of death, disability, or other involuntary termination except for a termination for "cause." The options together with certain gains realized upon exercise of the options during a specified period will be subject to forfeiture if the optionee engages in certain acts in competition with Sierra or one of its affiliates, misuses proprietary information of Sierra or one of its affiliates, or fails to assist Sierra or one of its affiliates in litigation. Cashless withholding to satisfy tax obligations may be permitted by Sierra's stock plan committee. (4) These options were granted on December 31, 1999 and vest and are exercisable at the rate of 20% per year starting with the first anniversary date of the grant and will expire not later than six years after grant. Option Exercises and Holdings The following table provides information with respect to the named executives concerning the exercise of Sierra stock options during the fiscal year ended December 31, 1999 and unexercised Sierra stock options held as of December 31, 1999:
Aggregated Option/SAR Exercises in Fiscal 1999 and Year-End Option Values ------------------ Number of Securities Value of Underlying Unexercised Unexercised In-the-Money Options/SARs at Options/SARs at Shares FY-End (#) FY-End ($) Acquired on Value Exercisable/ Exercisable/ Exercise (#) Realized ($) Unexercisable Unexercisable (1) Kathleen M. Marlon -0- -0- 46,963 / 105,537 -0- / -0- Richard E. Dobson (2) -0- -0- 36,825 / 5,675 -0- / -0- John F. Okita -0- -0- 43,215 / 15,625 -0- / -0- Robert G. Riordan -0- -0- 11,671 / 21,234 -0- / -0- David M. Sonenstein -0- -0- 1,700 / 10,550 -0- / -0-
- -------------- (1) Based on the closing price of Sierra common stock on December 31, 1999, which was $6.6875, minus the exercise price of the option. (2) Mr. Dobson's right to acquire stock pursuant to his options terminated on August 28, 2000. CII Financial's Supplemental Executive Retirement Plans Certain of our executive officers were participants in the CII Financial, Inc. Supplemental Executive Retirement Plan, or the SERP Plan, and the CII Financial, Inc. Supplemental Senior Executive Retirement Plan, or the Senior SERP Plan. These plans were effective as of January 1, 1990 and the SERP Plan was amended and restated April 24, 1993. When we were acquired by Sierra in October 1995, both plans were frozen as to any new contributions, participants, and accrued benefits. The Senior SERP Plan had only one participant, Mr. Joseph G. Havlick, who at that time was our chief executive officer. Of the eight participants in the SERP Plan, only Mr. Okita remains an officer of CII Financial. Our Board of Directors appoints a committee to administer both plans. Participation in both plans was limited to the executives, officers and employees selected by our chief executive officer and approved by our board of directors. The criteria used to determine participation in either plan was the participant's position, past contributions and anticipated contributions to our future success. The committee determined the benefit amount that would be paid at the participant's normal retirement age. The initial benefit amount was discretionary and was adjusted based on the participant's employment service years from the date of participation. Participants were given credit for employment prior to the plans' effective date of January 1, 1990. Under the SERP Plan, the benefit amount was also adjusted based on whether a participant retired at, prior to, or after, normal retirement age. Benefit amounts under both plans are paid in equal monthly installments over a 10-year period. Both plans also provide for a benefit payable over a 10-year period if a participant dies while still employed by us. Mr. Okita's annual benefits under the SERP Plan are $300. Sierra's Supplemental Executive Retirement Plan Ms. Kathleen Marlon participates in Sierra's Supplemental Executive Retirement Plan II (the "Supplemental Plan II"), which provides retirement benefits for selected executive officers. Under the Supplemental Plan II, each executive selected for participation generally will be entitled to receive annual payments, following retirement, disability, and certain other terminations of employment, for a 15-year period, equal to 2.5% of their "final average compensation" (as defined) for each year of service credited to the executive up to 20 years, reduced by an amount equal to the annualized payout over a 15-year period that would be payable to the executive as a result of Company contributions under the 401(k) Plan and the Deferred Compensation Plan (but not reduced for social security payments or other offsets). An executive's right to benefits under the Supplemental Plan II vests when five years of service have been credited or earlier upon the executive's death or disability or upon occurrence of a change in control (defined in the same way as under other compensatory plans). Upon the death of the executive, benefits will be payable for the 15-year period to the executive's beneficiary. Benefits will begin after retirement at or after age 65, a termination at or after age 55 and ten years of credited service, or a termination due to disability, and benefits will begin, in the case of other terminations (except a termination for "cause," as defined) prior to a change in control, at the later of termination or the date the executive would have completed ten years of service but for the termination. The following table shows the approximate amounts of annual retirement income that would be payable under the Supplemental Plan II to executives covered by it based on various assumptions as to final average compensation and years of service, assuming benefits are paid out over 15 years:
Estimated Annual Benefits Based on Credited Years of Service Final Average Compensation --------------- ------------ 5 Years 10 Years 15 Years 20 Years 30 Years ------- -------- -------- -------- -------- $200,000 $23,366 $46,732 $70,099 $92,465 $93,465 400,000 45,225 90,450 135,675 180,900 180,900 600,000 67,837 135,675 203,512 271,350 271,350
- ------------------------------------------------------------------------------- Final average compensation generally means the average of the three highest years of compensation out of the last five years, with compensation being generally the amounts reported as salary and bonus in the Summary Compensation Table. Ms. Marlon has 14 years of credited service under the Supplemental Plan II. An additional year of service will be credited in the event of a termination within six years after a change in control, and the year of service for the year of the change in control will be deemed completed at the time of the change in control. An executive's or beneficiary's benefits are payable in a lump sum in certain circumstances, including following a change in control. No other executives of CII Financial participate in Sierra's Supplemental Executive Retirement Plan II. CERTAIN TRANSACTIONS We intend to finance all or a portion of the cash consideration in the exchange offer, together with interest and expenses, with a loan from one of our affiliates. We will not be able to determine the amount of cash needed until the expiration of the exchange offer. Our affiliates have no obligation to advance these funds to us. However, in the event the loan is made, the indebtedness will be represented by a demand promissory note issued to the affiliate bearing interest at a rate equal to the then current interest rate on Sierra's credit facility. This affiliate note will rank senior to both the old junior subordinated debentures and the new senior subordinated debentures. In August 2000, we, and some other subsidiaries of Sierra, became a guarantor of Sierra's obligations under its senior secured credit facility. For more information concerning this guaranty, see "Description of Other Indebtedness." In order to make the September 15, 2000 interest payment on the old junior subordinated debentures, Sierra advanced $365,000 to us. Effective January 1, 1999, Sierra entered into separate but similar investment services agreements with California Indemnity Insurance Company, Commercial Casualty Insurance Company, Sierra Insurance Company of Texas and CII Insurance Company. Under these agreements Sierra manages the investments of the insurers. The management is, however, subject to the insurers' investment guidelines and the ultimate control of each insurer's board of directors. The management fee is a percentage of the total amount under management. The annual investment fees paid by the insurance companies in 1999 were approximately $335,000 and in 2000 were approximately $400,000. Effective January 1, 1999, Sierra and California Indemnity Insurance Company agreed that Sierra would furnish it services, including accounting, human resources, systems and other administrative services. The fee for the services is based on the lower of actual cost or fair market value. The services are subject to the ultimate control of California Indemnity Insurance Company's board of directors. The annual fees for these services were approximately $1,003,000 in 1999 and $1,200,000 in 2000. On March 31, 2000, California Indemnity Insurance Company loaned $7.4 million to Sierra, its ultimate parent. The loan was secured by a first trust deed mortgage on property at 4475 South Eastern Avenue in Las Vegas, Nevada. The loan is due April 1, 2005 with a right to accelerate on the part of the lender on or after April 1, 2001. The interest rate for the loan is 8% per annum and the loan to value was approximately 60%. Sierra Health Services has paid $441,000 as of November 30, 2000 in interest from the date of the loan. A sale of the 4475 South Eastern property to a non-affiliated real estate partnership closed December 28, 2000. Under the terms of the purchase and sale agreement, the purchaser assumed the first trust deed mortgage with amended terms. The interest rate was increased and the acceleration clause was eliminated by payment of additional fees, and the loan's maturity was set at December 31, 2001 with the ability of the borrower to extend for two periods of six months, subject to notice before the extension and payment to California Indemnity Insurance Company of additional fees. Sierra, California Indemnity Insurance Company and Commercial Casualty Insurance Company are partners in a limited partnership called 2716 North Tenaya Way Limited Partnership. This partnership owns the building located at that address in Las Vegas, Nevada. The two insurers are limited partners in the partnership whereas Sierra Health Services is the general partner. The two limited partners own approximately 13.5% of the partnership each. They also lease a portion of the building from the partnership. The lease payments during 1999 for both companies were $1,168,000 and for this year to date were $1,160,000 as of November 30, 2000. A sale of the partnership's building to a third party closed on December 28, 2000. At closing, the net proceeds to the two limited partners were approximately $8 million in total and the original lease was canceled effective December 28, 2000. Sierra entered into a 15 year master lease with the new owner of the property. Sierra and California Indemnity Insurance Company have entered into a new one-year sublease, for the space occupied by California Indemnity Insurance Company, effective January 1, 2001. The total amount of rent under the sublease will be approximately equivalent to that under the former lease with the partnership and will be determined based upon the new lease costs of Sierra under the master lease. The sublease is subject to the provisions of the master lease. It will automatically renew from year to year unless California Indemnity Insurance Company gives notice to cease renewing on or before December 1 in any year. The renewal can not extend beyond the length of the master lease. Effective January 1, 1996, federal income taxes are calculated pursuant to a tax allocation agreement between Sierra and CII Financial. Income taxes are allocated on a separate return basis for each company and tax benefits are recorded only to the extent that an entity could recoup taxes paid in prior years. All of our directors are also executive officers of Sierra. PRINCIPAL STOCKHOLDERS Sierra owns 100% of our issued and outstanding capital stock. DESCRIPTION OF OTHER INDEBTEDNESS Sierra's credit facility is governed by an Amended and Restated Credit Agreement entered into by Sierra on December 15, 2000 with a syndicate of banks for which Bank of America, N.A., is the Administrative Agent and Issuing Bank. Other lenders include First Union National Bank, Deutsche Bank, AG, Credit Lyonnais, Bank One, N.A., Wells Fargo Bank, N.A., and Union Bank of California, N.A. Bank of America, N.A. is an affiliate of Banc of America Securities LLC, the dealer manager for the exchange offer. The new credit agreement amended Sierra's preceding credit agreement, which Sierra entered into in 1998. Sierra was not in compliance with the terms of the financial covenants in the preceding credit agreement and received a notice of default from its lenders on November 8, 2000 with respect to this non-compliance. Since December 15, 2000, Sierra has been in compliance with the covenants under the Amended and Restated Credit Agreement. We have irrevocably and unconditionally guaranteed all obligations under this credit facility. Revolving Loans The new credit agreement currently provides Sierra with a revolving credit facility of $135 million. The proceeds from revolving loans under the revolving credit facility may be used for general working capital and general corporate purposes. As of December 31, 2000, the facility was fully drawn with an outstanding balance of $135 million. The available amounts which Sierra can borrow under the credit facility will be reduced by specified amounts, on certain dates. If the total amount of outstanding loans exceeds the availability under the credit facility, as reduced, Sierra will be required to immediately prepay 100% of the excess amount. Under certain additional circumstances, Sierra would be required to make prepayments of the loans, and the amount available to Sierra under the revolving credit facility would be reduced. For example, 80% of any excess cash flow that Sierra has in each year must be applied to a repayment of the loans and a reduction of the amount available under the revolving credit facility. In addition, if Sierra or a subsidiary of Sierra (other than an HMO subsidiary and certain other subsidiaries) engages in an asset sale or a sale-leaseback transaction (with the exception of certain assets specified in the new credit agreement), 80% of the cash proceeds (net of certain expenses) must be applied to a repayment of the loans and a reduction of the amount available under the revolving credit facility. Similarly, 80% of the cash proceeds (net of certain expenses) of certain equity issuances by us or any of our subsidiaries and 100% of the cash proceeds (net of certain expenses) of a debt issuance by Sierra (excluding us) must be applied to a repayment of the loans and a reduction in the amount available under the revolving credit facility. The credit facility terminates on September 30, 2003. On that date, Sierra will be required to repay the aggregate principal amount of the revolving loans outstanding. Interest Under the credit facility, revolving loans bear interest at the applicable margin plus the greater of: o 0.5% per annum above the latest federal funds rate; or o the per annum prime lending rate of Bank of America, N.A. The applicable margin is initially 1.75%. However, the applicable margin may be increased or decreased in certain circumstances. Fees In connection with the credit facility, Sierra will pay certain customary fees, including agents' fees, commitment fees, and amendment fees. Covenants Subject to normal qualifications and exceptions, Sierra has certain covenants that, among other things, will restrict the ability of Sierra and its subsidiaries, including CII Financial, to dispose of assets, incur indebtedness, pay dividends, make investments, loans or advances, make acquisitions, engage in mergers or consolidations, or make capital expenditures and which otherwise restrict certain corporate activities. In addition, under the senior credit facility Sierra will be required to comply with specified financial ratios, as defined in the credit agreement, including minimum interest coverage ratios and leverage ratios. Events of Default The credit facility may be terminated before September 30, 2003 upon the occurrence of any event of default. Upon the occurrence of an event of default, with certain limitations, Sierra's obligations under the new credit agreement which are at that time outstanding may become accelerated. Events of default under the credit facility consist of customary specified events. A default in payment on our debentures would constitute an event of default. A bankruptcy proceeding or other similar event involving us would also constitute an event of default. Security The payment and performance of Sierra's obligations under the credit facility are secured by: o liens on substantially all of Sierra's assets and the assets of Sierra's subsidiaries, other than CII Financial and Sierra's other regulated subsidiaries; o a guaranty of Sierra's obligations thereunder by each of Sierra's subsidiaries, including CII Financial, but excluding our insurance subsidiaries and Sierra's other regulated subsidiaries; and o other collateral arrangements, subject to pledge agreements, the security agreements, deeds of trust, and similar arrangements between Sierra, Sierra's subsidiaries, and the lending banks. UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS We have set out below our unaudited pro forma consolidated financial statements. Due to the possibility of different outcomes to the exchange offer based upon the elections made by tendering holders, we are demonstrating three different presentations of pro forma financial information as illustrations of the range of potential results. Presentation one assumes the exchange of $47,059,000 in principal amount of old junior subordinated debentures for $10,237,500 in cash and $27,559,000 in principal amount of new 9% senior subordinated debentures. Presentation two assumes the exchange of $47,059,000 in principal amount of old junior subordinated debentures for $5,250,000 in cash and $37,059,000 in principal amount of new 9% senior subordinated debentures. Presentation three assumes the exchange of $47,059,000 in principal amount of old junior subordinated debentures for $47,059,000 in principal amount of new 9% senior subordinated debentures. Each of the unaudited pro forma consolidated balance sheets as of September 30, 2000 have been prepared on the basis that the exchange offer as described above had occurred on September 30, 2000. Each of the unaudited pro forma consolidated statements of operations for the nine months ended September 30, 2000 and the year ended December 31, 1999 have been prepared as if the exchange offer had occurred on January 1, 1999. You should read this information with the accompanying notes and our consolidated financial statements, which are included in this prospectus. The accompanying pro forma consolidated financial statements do not purport to represent what our results of operations would have been had such transactions and events occurred on the dates specified, or to project our results of operations for any future period or date. The pro forma adjustments are based on available information and certain adjustments that our management believes are reasonable. In the opinion of our management, all adjustments have been made that are necessary to present fairly the unaudited pro forma consolidated data. PRESENTATION ONE NOTES TO UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET SEPTEMBER 30, 2000 Presentation one assumes the exchange of $47,059,000 in principal amount of old junior subordinated debentures for $10,237,500 in cash and $27,559,000 in principal amount of new 9% senior subordinated debentures. The accompanying unaudited pro forma consolidated balance sheet reflects the following adjustments: (a) Payment of the outstanding accrued interest on the old junior subordinated debentures as of September 30, 2000 of $145,000. (b) Payment of $1,600,000 in debt issuance costs to be recognized as expense in the period incurred. This amount is reflected in equity net of tax expense and as a deferred tax asset. (c) A $5,000,000 loan from Sierra to the CII Financial evidenced by the affiliate note. (d) An exchange of $27,559,000 aggregate principal amount of the old junior subordinated debentures for new senior subordinated debentures in the aggregate principal amount of $27,559,000 and a deferred gain of $9,262,500 to be amortized over the term of the new senior subordinated debentures. (e) $19,500,000 aggregate principal amount of old junior subordinated debentures retired in exchange for a $10,237,500 cash payment. CII FINANCIAL, INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET SEPTEMBER 30, 2000 (In thousands, except for share data)
Historical Adjustments Pro forma ASSETS Invested assets: Debt securities, available for sale, at fair value $164,660 $164,660 Debt securities, held-to-maturity, at amortized cost 22,154 22,154 Preferred stock, at fair value 1,732 1,732 Mortgage loans on non-affiliated real estate 6,281 6,281 ------ ----- - --------------------------------------------------------- Total invested assets 194,827 194,827 Cash and cash equivalents 19,408 $(6,983) (a),(b),(c),(e) 12,425 Reinsurance recoverable 211,594 211,594 Premiums receivable (net of allowance of $1,134) 13,402 13,402 Investment income receivable 2,406 2,406 Deferred policy acquisition costs 2,732 2,732 Mortgage loans on affiliated real estate 10,261 10,261 Real estate limited partnership 7,108 7,108 Federal income taxes receivable 9,478 9,478 Deferred income taxes 15,984 560 (b) 16,544 Property and equipment, net 5,097 5,097 Other assets 555 555 - --------------------------------------------------------- ------------- ---------------- ------------ TOTAL ASSETS $492,852 $(6,423) $486,429 LIABILITIES Reserve for losses and loss adjustment expenses $341,902 $341,902 Unearned premiums 16,206 16,206 Ceded reinsurance premiums payable 7,424 7,424 Old junior subordinated debentures 47,059 $(47,059) (d),(e) 0 New senior subordinated debentures 36,821 (d) 36,821 Accounts payable and other accrued expenses 15,969 (145) (a) 15,824 Affiliate note 5,000 (c) 5,000 Payable to affiliates 2,487 2,487 Deferred tax liability 3,291 3,291 - --------------------------------------------------------- ------------- ---------------- ------------ TOTAL LIABILITIES 434,338 (5,383) 428,955 COMMITMENTS AND CONTINGENCIES STOCKHOLDER'S EQUITY Common Stock, no par value, 1,000 shares Authorized; shares issued and outstanding - 100 3,604 3,604 Additional paid - in capital 64,450 64,450 Accumulated other comprehensive loss: Unrealized holding loss on available-for sale-investments (8,651) (8,651) Accumulated deficit (889) (1,040) (b) (1,929) - --------------------------------------------------------- ------------- ---------------- ------------ TOTAL STOCKHOLDER'S EQUITY 58,514 (1,040) 57,474 TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $492,852 $(6,423) $486,429
============================================================================== See the accompanying notes on page 70 PRESENTATION ONE NOTES TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 2000 AND YEAR ENDED DECEMBER 31, 1999 Presentation one assumes the exchange of $47,059,000 in principal amount of old junior subordinated debentures for $10,237,500 in cash and $27,559,000 in principal amount of new 9% senior subordinated debentures. The accompanying unaudited pro forma consolidated statement of operations reflects the following adjustments: (f) Decrease in investment income as a result of less cash available during the period for investments. Amount is calculated based on net cash used for the transaction and the average investment yield during the period of approximately 6.5%. (g) Recognition of the $1,600,000 in debt issuance costs as incurred. (h) Adjustment of interest expense based on a reduction in the outstanding principal balance and an increase in the interest rate of the outstanding debentures as a result of the exchange. Historical figures are based on a weighted average of $48,302,000 and $50,875,000 in outstanding junior subordinated debentures during the periods ending September 30, 2000 and December 31, 1999, respectively, at a 7.5% interest rate. Pro forma figures are based on $27,559,000 in outstanding senior subordinated debentures at a 9% interest rate. (i) Interest expense on the $5,000,000 affiliate note based on a 9% rate of interest. (j) Reduction of interest expense for the amortization of the deferred gain on the restructuring of the old junior subordinated debentures. The deferred gain of $9,262,500 will be amortized over the life of the new senior subordinated debentures using the effective interest rate method. (k) A reduction of income taxes as a result of the pro forma adjustments at an assumed effective tax rate of 35%. PRESENTATION ONE CII FINANCIAL, INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 2000 (In thousands)
Historical Adjustments Pro forma REVENUES Direct written premiums $153,034 $153,034 Changes in direct unearned premiums (2,906) (2,906) Direct earned premiums 150,128 150,128 Less: premiums ceded 59,177 59,177 Net earned premiums 90,951 90,951 Net investment income 11,217 $(340) (f) 10,877 Net realized investment losses (460) (460) Total revenues 101,708 (340) 101,368 COSTS AND EXPENSES Losses and loss adjustment expenses 207,323 207,323 Reinsurance recoveries (123,303) (123,303) Net loss and loss adjustment expenses 84,020 84,020 Policy acquisition costs 8,606 8,606 General and administrative and other 17,372 17,372 Asset impairment 3,000 3,000 Interest expense 2,717 (1,335) (h), (i),(j) 1,382 Total costs and expenses 115,715 (1,335) 114,380 LOSS BEFORE FEDERAL INCOME TAX BENEFIT (14,007) 995 (13,012) Federal income tax benefit (4,902) 348 (k) (4,554) (LOSS) INCOME FROM CONTINUING OPERATIONS $(9,105) $647 $(8,458)
=============================================================================== See the accompanying notes on page 72 PRESENTATION ONE CII FINANCIAL, INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS YEAR ENDED DECEMBER 31, 1999 (In thousands)
Historical Adjustments Pro forma REVENUES Direct written premiums $148,824 $148,824 Changes in direct unearned premiums (2,142) (2,142) Direct earned premiums 146,682 146,682 Less: premiums ceded 63,727 63,727 Net earned premiums 82,955 82,955 Net investment income 15,776 $(454) (f) 15,322 Net realized investment losses (381) (381) Total revenues 98,350 (454) 97,896 COSTS AND EXPENSES Losses and loss adjustment expenses 157,424 157,424 Reinsurance recoveries (95,963) (95,963) Net loss and loss adjustment expenses 61,461 61,461 Policy acquisition costs 6,339 6,339 General and administrative and other 19,749 1,600 (g) 21,349 Interest expense 3,706 (1,866) (h), (i), (j) 1,840 Total costs and expenses 91,255 (266) 90,989 LOSS BEFORE FEDERAL INCOME TAX BENEFIT 7,095 (188) 6,907 Federal income tax benefit 3,602 (66) (k) 3,536 INCOME (LOSS) FROM CONTINUING OPERATIONS $3,493 $(122) $3,371
============================================================================== See the accompanying notes on page 72 PRESENTATION TWO NOTES TO UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET SEPTEMBER 30, 2000 Presentation two assumes the exchange of $47,059,000 in principal amount of old junior subordinated debentures for $5,250,000 in cash and $37,059,000 in principal amount of new 9% senior subordinated debentures. The accompanying unaudited pro forma consolidated balance sheet reflects the following adjustments: (l) Payment of the outstanding accrued interest on the old junior subordinated debentures as of September 30, 2000 of $145,000. (m) Payment of $1,600,000 in debt issuance costs to be recognized as expense in the period incurred. This amount is reflected in equity net of tax expense and as a deferred tax asset. (n) An exchange of $37,059,000 aggregate principal amount of the old junior subordinated debentures for new senior subordinated debentures in the aggregate principal amount of $37,059,000 and a deferred gain of $4,750,000 to be amortized over the term of the new senior subordinated debentures. (o) $10,000,000 aggregate principal amount of old junior subordinated debentures retired in exchange for a $5,250,000 cash payment. PRESENTATION TWO CII FINANCIAL, INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET SEPTEMBER 30, 2000 (In thousands, except for share data)
Historical Adjustments Pro forma ASSETS Invested assets: Debt securities, available for sale, at fair value $164,660 $164,660 Debt securities, held-to-maturity, at amortized cost 22,154 22,154 Preferred stock, at fair value 1,732 1,732 Mortgage loans on non-affiliated real estate 6,281 6,281 -------------- ------------- Total invested assets 194,827 194,827 -------------- ------------- Cash and cash equivalents 19,408 $(6,995) (l),(m),(o) 12,413 Reinsurance recoverable 211,594 211,594 Premiums receivable (net of allowance of $1,134) 13,402 13,402 Investment income receivable 2,406 2,406 Deferred policy acquisition costs 2,732 2,732 Mortgage loans on affiliated real estate 10,261 10,261 Real estate limited partnership 7,108 7,108 Federal income taxes receivable 9,478 9,478 Deferred income taxes 15,984 560 (m) 16,544 Property and equipment, net 5,097 5,097 Other assets 555 555 TOTAL ASSETS ------------- ---------------- ------------ $492,852 $(6,435) $486,417 LIABILITIES Reserve for losses and loss adjustment expenses $341,902 $341,902 Unearned premiums 16,206 16,206 Ceded reinsurance premiums payable 7,424 7,424 Old junior subordinated debentures 47,059 $(47,059) (n),(o) 0 New senior subordinated debentures 41,809 (n) 41,809 Accounts payable and other accrued expenses 15,969 (145) (l) 15,824 Payable to affiliates 2,487 2,487 Deferred tax liability 3,291 3,291 TOTAL LIABILITIES ------------- ---------------- ------------ 434,338 (5,395) 428,943 COMMITMENTS AND CONTINGENCIES STOCKHOLDER'S EQUITY Common Stock, no par value, 1,000 shares authorized; shares issued and outstanding - 100 3,604 3,604 Additional paid - in capital 64,450 64,450 Accumulated other comprehensive loss: Unrealized holding loss on available-for (8,651) (8,651) sale-investments Accumulated deficit (889) (1,040) (m) (1,929) TOTAL STOCKHOLDER'S EQUITY ------------- ---------------- ------------ 58,514 (1,040) 57,474 TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $492,852 $(6,435) $486,417
============================================================================= See the accompanying notes on page 75 PRESENTATION TWO NOTES TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 2000 AND YEAR ENDED DECEMBER 31, 1999 Presentation two assumes the exchange of $47,059,000 in principal amount of old junior subordinated debentures for $5,250,000 in cash and $37,059,000 in principal amount of new 9% senior subordinated debentures. The accompanying unaudited pro forma consolidated statement of operations reflects the following adjustments: (p) Decrease in investment income as a result of less cash available during the period for investments. Amount is calculated based on net cash used for the transaction and the average investment yield during the period of approximately 6.5%. (q) Recognition of the $1,600,000 in debt issuance costs as incurred. (r) Adjustment of interest expense based on a reduction in the outstanding principal balance and an increase in the interest rate of the outstanding debentures as a result of the exchange. Historical figures are based on a weighted average of $48,302,000 and $50,875,000 in outstanding junior subordinated debentures during the periods ending September 30, 2000 and December 31, 1999, respectively, at a 7.5% interest rate. Pro forma figures are based on $37,059,000 in outstanding senior subordinated debentures at a 9% interest rate. (s) Reduction of interest expense for the amortization of the deferred gain on the restructuring of the old junior subordinated debentures. The deferred gain of $5,750,000 will be amortized over the life of the new senior subordinated debentures using the effective interest rate method. (t) A reduction of income taxes as a result of the pro forma adjustments at an assumed effective tax rate of 35%. PRESENTATION TWO CII FINANCIAL, INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 2000 (In thousands)
Historical Adjustments Pro forma REVENUES Direct written premiums $153,034 $153,034 Changes in direct unearned premiums (2,906) (2,906) Direct earned premiums 150,128 150,128 Less: premiums ceded 59,177 59,177 Net earned premiums 90,951 90,951 Net investment income 11,217 $(341) (p) 10,876 Net realized investment losses (460) (460) ------------------- Total revenues 101,708 (341) 101,367 ------------------- COSTS AND EXPENSES Losses and loss adjustment expenses 207,323 207,323 Reinsurance recoveries (123,303) (123,303) Net loss and loss adjustment expenses 84,020 84,020 Policy acquisition costs 8,606 8,606 General and administrative and other 17,372 17,372 Asset impairment 3,000 3,000 Interest expense 2,717 (601) (r),(s) 2,116 Total costs and expenses 115,715 (601) 115,114 LOSS BEFORE FEDERAL INCOME TAX BENEFIT (14,007) 260 (13,747) Federal income tax benefit (4,902) 91 (t) (4,811) (LOSS) INCOME FROM CONTINUING OPERATIONS $(9,105) $169 $(8,936)
============================================================================== See the accompanying notes on page 77 PRESENTATION TWO CII FINANCIAL, INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS YEAR ENDED DECEMBER 31, 1999 (In thousands)
Historical Adjustments Pro forma REVENUES Direct written premiums $148,824 $148,824 Changes in direct unearned premiums (2,142) (2,142) Direct earned premiums 146,682 146,682 Less: premiums ceded 63,727 63,727 Net earned premiums 82,955 82,955 Net investment income 15,776 $(454) (p) 15,322 Net realized investment losses (381) (381) ------------------- Total revenues 98,350 (459) 97,896 ------------------- COSTS AND EXPENSES Losses and loss adjustment expenses 157,424 157,424 Reinsurance recoveries (95,963) (95,963) Net loss and loss adjustment expenses 61,461 61,461 Policy acquisition costs 6,339 6,339 General and administrative and other 19,749 1,600 (q) 21,349 Interest expense 3,706 (934) (r),(s) 2,772 Total costs and expenses 91,255 666 91,921 LOSS BEFORE FEDERAL INCOME TAX BENEFIT 7,095 (1,120) 5,975 Federal income tax benefit 3,602 (392) (t) 3,210 INCOME (LOSS) FROM CONTINUING OPERATIONS $3,493 $(728) $2,765
============================================================================== See the accompanying notes on page 77 PRESENTATION THREE NOTES TO UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET SEPTEMBER 30, 2000 Presentation three assumes the exchange of $47,059,000 in principal amount of old junior subordinated debentures for $47,059,000 in principal amount of new 9% senior subordinated debentures. The accompanying unaudited pro forma consolidated balance sheet reflects the following adjustments: (u) Payment of the outstanding accrued interest on the old junior subordinated debentures as of September 30, 2000 of $145,000. (v) Payment of $1,600,000 in debt issuance costs to be recognized as expense in the period incurred. This amount is refleced as an after tax expense and a deferred tax asset. (w) An exchange of $47,059,000 aggregate principal amount of the old junior subordinated debentures for new senior subordinated debentures in the aggregate principal amount of $47,059,000. PRESENTATION THREE CII FINANCIAL, INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET SEPTEMBER 30, 2000 (In thousands, except for share data)
Historical Adjustments Pro forma ASSETS Invested assets: Debt securities, available for sale, at fair value $164,660 $164,660 Debt securities, held-to-maturity, at amortized cost 22,154 22,154 Preferred stock, at fair value 1,732 1,732 Mortgage loans on non-affiliated real estate 6,281 6,281 -------------- ------------- Total invested assets 194,827 194,827 -------------- ------------- Cash and cash equivalent 19,408 $(1,745) (u),(v) 17,663 Reinsurance recoverable 211,594 211,594 Premiums receivable (net of allowance of $1,134) 13,402 13,402 Investment income receivable 2,406 2,406 Deferred policy acquisition costs 2,732 2,732 Mortgage loans on affiliated real estate 10,261 10,261 Real estate limited partnership 7,108 7,108 Federal income taxes receivable 9,478 9,478 Deferred income taxes 15,984 560 (v) 16,544 Property and equipment, net 5,097 5,097 Other assets 555 555 TOTAL ASSETS ------------- ---------------- ------------ $492,852 $(1,185) $491,667 LIABILITIES Reserve for losses and loss adjustment expenses $341,902 $341,902 Unearned premiums 16,206 16,206 Ceded reinsurance premiums payable 7,424 7,424 Old junior subordinated debentures 47,059 $(47,059) (w) 0 New senior subordinated debentures 47,059 (w) 47,059 Accounts payable and other accrued expenses 15,969 (145) (u) 15,824 Payable to affiliates 2,487 2,487 Deferred tax liability 3,291 3,291 TOTAL LIABILITIES ------------- ---------------- ------------ 434,338 (145) 434,193 COMMITMENTS AND CONTINGENCIES STOCKHOLDER'S EQUITY Common Stock, no par value, 1,000 shares Authorized; shares issued and outstanding - 100 3,604 3,604 Additional paid - in capital 64,450 64,450 Accumulated other comprehensive loss: Unrealized holding loss on available-for (8,651) (8,651) sale-investments Accumulated deficit (889) (1,040) (v) (1,929) TOTAL STOCKHOLDER'S EQUITY ------------- ---------------- ------------ 58,514 (1,040) 57,474 TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $492,852 $(1,185) $491,667 See the accompanying notes on page 80 ===================================================================================================================
PRESENTATION THREE NOTES TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 2000 AND YEAR ENDED DECEMBER 31, 1999 Presentation three assumes the exchange of $47,059,000 in principal amount of old junior subordinated debentures for $47,059,000 in principal amount of new 9% senior subordinated debentures. The accompanying unaudited pro forma consolidated statement of operations reflects the following adjustments: (x) Decrease in investment income as a result of less cash available during the period for investments. Amount is calculated based on net cash used for the transaction and the average investment yield during the period of approximately 6.5%. (y)Recognition of the $1,600,000 in debt issuance costs as incurred. (z)Adjustment of interest expense based on a reduction in the outstanding principal balance and an increase in the interest rate of the outstanding debentures as a result of the exchange. Historical figures are based on a weighted average of $48,302,000 and $50,875,000 in outstanding junior subordinated debentures during the periods ending September 30, 2000 and December 31, 1999, respectively, at a 7.5% interest rate. Pro forma figures are based on $47,059,000 in outstanding senior subordinated debentures at a 9% interest rate. (A) A reduction of income taxes as a result of the pro forma adjustments at an assumed effective tax rate of 35%. PRESENTATION THREE CII FINANCIAL, INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 2000 (In thousands)
Historical Adjustments Pro forma REVENUES Direct written premiums $153,034 $153,034 Changes in direct unearned premiums (2,906) (2,906) Direct earned premiums 150,128 150,128 Less: premiums ceded 59,177 59,177 Net earned premiums 90,951 90,951 Net investment income 11,217 $(85) (x) 11,132 Net realized investment losses (460) (460) ------------------- Total revenues 101,708 (85) 101,623 ------------------- COSTS AND EXPENSES Losses and loss adjustment expenses 207,323 207,323 Reinsurance recoveries (123,303) (123,303) Net loss and loss adjustment expenses 84,020 84,020 Policy acquisition costs 8,606 8,606 General and administrative and other 17,372 17,372 Asset impairment 3,000 3,000 Interest expense 2,717 459 (z) 3,176 Total costs and expenses 115,715 459 116,174 LOSS BEFORE FEDERAL INCOME TAX BENEFIT (14,007) (544) (14,551) Federal income tax benefit (4,902) (191) (z) (5,093) (LOSS) INCOME FROM CONTINUING OPERATIONS $(9,105) $(353) $(9,458)
============================================================================== See the accompanying notes on page 82 PRESENTATION THREE CII FINANCIAL, INC. AND SUBSIDIARIES UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS YEAR ENDED DECEMBER 31, 1999 (In thousands)
Historical Adjustments Pro forma REVENUES Direct written premiums $148,824 $148,824 Changes in direct unearned premiums (2,142) (2,142) Direct earned premiums 146,682 146,682 Less: premiums ceded 63,727 63,727 Net earned premiums 82,955 82,955 Net investment income 15,776 $(113) (x) 15,663 Net realized investment losses (381) (381) ------------------- Total revenues 98,350 (113) 98,237 ------------------- COSTS AND EXPENSES Losses and loss adjustment expenses 157,424 157,424 Reinsurance recoveries (95,963) (95,963) Net loss and loss adjustment expenses 61,461 61,461 Policy acquisition costs 6,339 6,339 General and administrative and other 19,749 1,600 (y) 21,349 Interest expense 3,706 420 (z) 4,126 Total costs and expenses 91,255 2,020 93,275 LOSS BEFORE FEDERAL INCOME TAX BENEFIT 7,095 (2,133) 4,962 Federal income tax benefit 3,602 (747) (A) 2,855 INCOME (LOSS) FROM CONTINUING OPERATIONS $3,493 $(1,386) $2,107
============================================================================ See the accompanying notes on page 82 DESCRIPTION OF DEBENTURES Principal Differences Between Old Junior Subordinated Debentures and New Senior Subordinated Debentures The terms of the new senior subordinated debentures and the related indenture are identical in all material respects to the terms of the old junior subordinated debentures and the related indenture, except for: o The new senior subordinated debentures will rank senior in right of payment to any old junior subordinated debentures which are not tendered. o You will receive a higher rate of interest on the new senior subordinated debentures, which will pay 9% per annum, than on the old junior subordinated debentures, which pay 7 1/2% per annum. o The scheduled maturity date of the new senior subordinated debentures is September 15, 2006, which is five years later than September 15, 2001, the scheduled maturity date of the old junior subordinated debentures. o The new senior subordinated debentures will not be convertible into Sierra common stock. The old junior subordinated debentures are convertible into Sierra common stock at $39.398 per share. New Senior Subordinated Debentures We will issue the new senior subordinated debentures under an indenture between us and Wells Fargo Bank Minnesota, N.A., as trustee. A copy of the indenture substantially in the form in which it is to be executed is filed as an exhibit to the registration statement of which this prospectus is a part. The following description is a summary of the material provisions of the indenture relating to the new senior subordinated debentures and does not describe the indenture in its entirety. This summary is subject to and qualified by reference to all of the provisions in the indenture, including definitions of certain terms used in the indenture. We urge you to read the indenture because it, and not the summary description below, defines your rights. Copies of the indenture will be available for inspection at the Corporate Trust Offices of the trustee in Minneapolis, Minnesota. General. The new senior subordinated debentures will be limited to $47,059,000 aggregate principal amount. The new senior subordinated debentures will be subordinated obligations of CII Financial and will not be guaranteed by Sierra. The new senior subordinated debentures will be subordinate to all our senior indebtedness, including our guaranty of Sierra's credit facility and the affiliate note. However, the new senior subordinated debentures will rank senior to the old junior subordinated debentures. We are required to repay the principal amount of the new senior subordinated debentures in full on September 15, 2006. The new senior subordinated debentures will bear interest from the date of issuance, at the rate per annum of 9%. We will pay interest on the new senior subordinated debentures on March 15 and September 15 of each year, commencing on March 15, 2001, to the person in whose name the new debenture (or any predecessor debenture) is registered, subject to certain exceptions, at the close of business on March 1 or September 1, as the case may be, before each interest payment date. Principal and interest on the new senior subordinated debentures will be payable and transfers will be registrable, at an office of the trustee or our office or agency maintained for such purpose in Minneapolis, Minnesota, provided that, at our option, payment of interest may be made by check mailed to the address of the person entitled thereto as it appears in the debenture register. Subordination of Debentures. The payment of principal, any premium and interest on the new senior subordinated debentures, including amounts payable on any redemption or repurchase, will be subordinated to the prior payment in full of all our senior debt. The new senior subordinated debentures will rank senior to the old junior subordinated debentures. Senior debt is defined in the indenture as the principal of, and interest on all our debt, whether outstanding on the date of the indenture or thereafter created, incurred, guaranteed or assumed, other than o the new senior subordinated debentures; o the old junior subordinated debentures; and o any debt which provides, or in respect of which any instrument creating or evidencing such debt or pursuant to which the same is outstanding provides, that such debt is not superior in right of payment to the new senior subordinated debentures. Debt is defined in the indenture to mean: o all debt which is (a) for money borrowed, (b) evidenced by a note, bond or similar instrument given in connection with the acquisition of any businesses, properties or assets of any kind, but excluding any other trade accounts payable or accrued liabilities arising in the ordinary course of business or (c) purchase money indebtedness with respect to the purchase of any real or personal property or any interest therein; o obligations under certain leases; o amendments, renewals, extensions, modifications and refundings of any debt or obligations referred to above; and o any debt or obligations referred to above in respect of which we are liable, contingently or otherwise, to pay or advance money or property as a guarantor, endorser or otherwise. In August 2000, we became a guarantor of Sierra's revolving credit facility, which at December 31, 2000 was fully drawn and had an outstanding balance of $135 million. The new senior subordinated debentures are subordinated to this guaranty of the credit facility debt. Our senior debt will also include the affiliate note. The terms of our debentures do not limit our ability to incur additional senior debt. As of December 31, 2000, other than debt incurred in the ordinary course of business, we had $182,059,000 of indebtedness, consisting of the old junior subordinated debentures and the credit facility guaranty. Upon any payment or distribution of assets to creditors as a result of a liquidation, dissolution, winding up, reorganization for the benefit of creditors, marshalling of assets or any bankruptcy, insolvency or similar proceedings involving us, the holders of all senior debt will first be entitled to receive payment in full before you will be entitled to receive any payment on the new senior subordinated debentures. No such payment in respect of the new senior subordinated debentures may be made if there shall have occurred and be continuing a default in any payment with respect to any senior debt, or an event of default in respect to any senior debt resulting in acceleration of the maturity thereof, or if any judicial proceeding shall be pending with respect to any such default. If the new senior subordinated debentures are declared due and payable before their stated maturity, no payment may be made in respect of the new senior subordinated debentures unless and until all senior debt shall have been paid in full. By reason of such subordination, in the event of insolvency, our creditors who are holders of senior debt may recover more ratably than you will. The new senior subordinated debentures will be senior to the old junior subordinated debentures. The indenture will permit the trustee to become our creditor and to enforce its rights as a creditor, including rights as a holder of senior debt. Redemption. The new senior subordinated debentures will be redeemable upon not less than 25 nor more than 60 days' notice by mail at any time, in whole or in part, at our election, on or prior to September 15, 2001 at a redemption price equal to 100.75% of the principal amount together with accrued interest to the redemption date, or after September 15, 2001 at a redemption price equal to 100% of the principal amount together with accrued interest to the redemption date, subject to the right of holders of record on regular record dates to receive interest due on an interest payment date. Repurchase at Option of Holders Upon Change in Control. If a change in control as defined below occurs, you will have the right, at your option, to require us to repurchase for cash all of your new senior subordinated debentures not previously called for redemption, or any portion of the principal amount thereof, that is equal to $1,000 or an integral multiple of $1,000. The price we are required to pay is 100% of the principal amount of the new senior subordinated debentures to be repurchased, together with accrued interest to the repurchase date. Such right may not be waived by our board of directors. Within 30 days after the occurrence of a change in control, we are obligated to mail to you notice of such change in control and of the repurchase right arising as a result thereof. We must also deliver a copy of this notice to the trustee and cause a copy of such notice to be published in a newspaper of general circulation in Los Angeles, California and in the Borough of Manhattan, The City of New York. To exercise the repurchase right, you must deliver to the trustee the new senior subordinated debentures with respect to which the repurchase right is being exercised, duly endorsed for transfer to us. We are required to repurchase the new senior subordinated debentures on the date that is 45 days after the date of our notice, which we refer to as the repurchase date. A change in control will be deemed to have occurred at the time after the new senior subordinated debentures are issued that any person, including any syndicate or group deemed to be a "Person" under Section 13(d)(3) of the Exchange Act, is or becomes the beneficial owner, directly or indirectly, through a purchase, merger or other acquisition transaction or series of transactions, of shares of our capital stock entitling such person to exercise 50% or more of the total voting power of all shares of our capital stock that are entitled to vote in elections of directors. For purposes of these provisions, whether a person is a "beneficial owner" will be determined in accordance with Rule l3d-3 promulgated by the SEC under the Exchange Act as in effect on the date of execution of the indenture. Merger and Consolidation. The indenture will provide that we may consolidate with or merge into any other corporation, or convey, transfer or lease its properties and assets substantially as an entirety to any person, provided that in any such case: o the successor corporation assumes by a supplemental indenture our obligations under the indenture; o immediately after giving effect to such transaction, no default will have occurred and be continuing; and o we deliver to the trustee an officer's certificate and an opinion of counsel stating that the terms of the indenture with respect to such event have been complied with. Upon compliance with these provisions by a successor corporation, we, except in the case of a lease, would be relieved of our obligations under the indenture and the new senior subordinated debentures. Modification of the Indenture. Modifications and amendments of the indenture may be made by us and the trustee with the consent of the holders of a majority in principal amount of the outstanding debentures. However, none of the following modifications or amendments may be made without your consent: o change the stated maturity date of the principal of, or any installment of interest on, the new senior subordinated debentures; o reduce the principal amount of, any interest on, or premium payable on redemption of, any new debenture; o change the place or currency of payment on the new senior subordinated debentures; o impair your right to institute suit for the enforcement of any payment on the new senior subordinated debentures when due; o modify the provisions of the indenture with respect to the subordination of the new senior subordinated debentures in a manner adverse to you; or o reduce the percentage in principal amount of new senior subordinated debentures the consent of whose holders is required for modification or amendment of the indenture or for waiver of compliance with certain provisions of the indenture or for waiver of certain defaults. Events of Default, Notice and Waiver. The following are events of default under the indenture: o we fail to make a payment of interest on the new senior subordinated debentures when due, and this failure continues for 30 days; o we fail to make the payment of principal on the new senior subordinated debentures, when due; o we fail in the performance of any other covenant and this failure continues for 60 days after written notice, as provided in the indenture; o we default in respect of our indebtedness for money borrowed which results in acceleration of the maturity of $1,000,000 or more of indebtedness, if such acceleration is not rescinded or indebtedness discharged within 10 days after written notice to us, as provided in the indenture; and o certain events in bankruptcy, insolvency or reorganization involving us. If any event of default shall happen and be continuing, the trustee or the holders of 25% in principal amount of the outstanding new senior subordinated debentures may declare the debentures due and payable. However, after a declaration of acceleration has been made with respect to the new senior subordinated debentures, but before a judgment or decree based on acceleration has been obtained, the holders of a majority in principal amount of the outstanding debentures may, under certain circumstances, rescind and annul such acceleration. An event of default under the new senior subordinated debentures may result in a cross default under Sierra's credit facility. In the event of a default under Sierra's credit facility, Sierra's lenders may, at their option, require us to perform on our guaranty of the credit facility. Our obligations under the credit facility guaranty will rank senior to our obligations under the new senior subordinated debentures. The indenture will provide that the trustee will be under no obligation, subject to the duty of the trustee during default to act with the required standard of care, to exercise any of its rights or powers under the indenture at the request or direction of any of the holders, unless such holders shall have offered to the trustee reasonable security or indemnity against the costs, expenses and liabilities which might be incurred by it in compliance with such request or direction. Subject to certain conditions, the holders of a majority in principal amount of the outstanding debentures will have the right to direct the time, method and place of conducting any proceeding for any remedy available to the trustee or exercising any trust or power conferred on the trustee. The holders of a majority in principal amount of the outstanding debentures may on behalf of the holders of all new senior subordinated debentures waive compliance by us with certain restrictive provisions of the indenture. The holders of a majority in principal amount of the outstanding debentures may on behalf of the holders of new senior subordinated debentures waive certain past defaults except a default in payment of the principal of, or premium, if any, or interest on any new debenture or in respect of a provision which under the indenture cannot be modified or amended without the consent of the holder of each outstanding debenture affected thereby. We will be required to furnish the trustee annually a statement as to any default by it in the performance of certain covenants in the indenture. Concerning the Trustee. The trustee may act as a depository for funds of, make loans, which may constitute senior debt, to and perform other commercial banking services for us in the ordinary course of business. Neither the trustee nor any of its affiliates currently performs any commercial banking services for us. Old Junior Subordinated Debentures The old junior subordinated debentures were issued under an indenture dated September 15, 1991. The indenture is a contract between us and Chase Manhattan Bank and Trust Company, National Association (as successor to Manufacturers Hanover Trust Company) as trustee. The following description is a summary of the material provisions of the indenture relating to the old junior subordinated debentures and does not describe the indenture in its entirety. This summary is subject to and qualified by reference to all of the provisions in the indenture, including definitions of certain terms used in the indenture. We urge you to read the indenture because it, and not the summary description below, defines your rights. Copies of the indenture will be available for inspection at the Corporate Trust Offices of the trustee in San Francisco, California. General. The old junior subordinated debentures are subordinated obligations of CII Financial and are not guaranteed by Sierra. The old junior subordinated debentures are subordinate to all our senior indebtedness, including the new senior subordinated debentures, our guaranty of Sierra's credit facility and the affiliate note. We are required to repay the principal amount of the old junior subordinated debentures in full to you on September 15, 2001. The old junior subordinated debentures bear interest, at the rate per annum of 7 1/2%. We pay interest on the old junior subordinated debentures on March 15 and September 15 of each year, to the person in whose name the old junior subordinated debenture (or any predecessor debenture) is registered, subject to certain exceptions, at the close of business on March 1 or September 1, as the case may be, before each interest payment date. Principal of, and premium, if any, and interest on the old junior subordinated debentures are payable and the old junior subordinated debentures are convertible and exchangeable and transfers are registrable, at an office of the trustee or our office or agency maintained for such purpose in San Francisco, California, provided that, at our option, payment of interest may be made by check mailed to the address of the person entitled thereto as it appears in the debenture register. Conversion Rights. You may, at your option, convert any portion of the principal amount of any old junior subordinated debenture that is an integral multiple of $1,000 into shares of Sierra common stock at any time prior to redemption, repurchase or maturity of the old junior subordinated debentures, at the conversion price of $39.398 per share. Your right to convert any old junior subordinated debentures called for redemption or to be repurchased will terminate at the close of business on the redemption date or the repurchase date, as the case may be, and will be lost if not exercised prior to that time. The conversion price is subject to adjustment in certain events, including: o dividends, and other distributions, payable in Sierra common stock on shares of Sierra capital stock; o the issuance to all stockholders of Sierra common stock of certain rights, options or warrants entitling them to subscribe for or purchase Sierra common stock at less than the then current market price per share; o subdivisions and combinations of Sierra common stock; o the distribution to all holders of Sierra common stock of evidences of debt securities of Sierra or of CII Financial, shares of any class of capital stock, cash or assets, including securities, but excluding any rights, options or warrants referred to above, excluding any dividend or distribution paid exclusively in cash, and excluding any dividend or distribution in Sierra common stock; o distributions to all holders of Sierra common stock of cash, excluding any cash that is distributed as part of a distribution referred to above, in an aggregate amount that together with the aggregate amount of certain other distributions, exceeds 10% of our market capitalization, being the product of the current market price per share of the Sierra common stock on the date fixed for shareholders entitled to receive such distribution and the number of shares of Sierra common stock outstanding on such date; and o tender offers made by us or any of our subsidiaries for all or any portion of Sierra common stock involving an aggregate consideration having a fair market value on the last time, which we refer to as the expiration time, tenders may be made pursuant to such tender offer that, together with the aggregate amount of certain other distributions, exceeds 5% of Sierra market capitalization on the expiration time, being the product of the current market price per share of the Sierra common stock on the expiration time and the number of shares of Sierra common stock outstanding, including any tendered shares, on the expiration time. In addition to the foregoing adjustments, we are permitted to make such reductions in the conversion price as we consider to be advisable in order that any event treated for United States federal income tax purposes as a dividend of stock or stock rights will not be taxable to the recipients. We will not be required to make adjustments in the conversion price of less than 1% of such price, but any adjustment that would otherwise be required to be made will be taken into account in the computation of any subsequent adjustment. In the case of certain consolidations or mergers to which we are a party or the transfer of substantially all of our assets, each old junior subordinated debenture then outstanding would, without your consent, become convertible only into the kind and amount of securities, cash and other property receivable upon such consolidation, merger or transfer by a holder of the number of shares of Sierra common stock into which such old junior subordinated debenture was convertible immediately prior to such consolidation, merger or transfer, assuming such holder of Sierra common stock failed to exercise any rights of election and received per share the kind and amount received per share by a plurality of the non-electing shares. Other than as set forth above, the conversion price is not subject to adjustment in the event of the sale of Sierra common stock at less than market value. If any such sale negatively affects the market price for Sierra common stock, the value of the old junior subordinated debentures may also be adversely affected. Fractional shares of Sierra common stock will not be issued upon conversion, and, in lieu thereof, we will pay cash to you based upon the market price of the Sierra common stock. At the close of business on a record date you will be entitled to receive the interest payable on the old junior subordinated debentures on the corresponding interest payment date notwithstanding the subsequent conversion thereof or our default in payment of the interest due on such interest payment date, subject to certain provisions applicable to defaulted interest. No payment or adjustment will be made upon conversion for interest accrued on the old junior subordinated debentures or for dividends on Sierra common stock issued on conversion. Therefore, old junior subordinated debentures surrendered for conversion during the period from the close of business on any record date to the opening of business on the corresponding interest payment date, except old junior subordinated debentures called for redemption, or to be repurchased, on such interest payment date or on a redemption date or a repurchase date within such period, must be accompanied by payment of an amount equal to the interest payable on the interest payment date. The holder of old junior subordinated debentures on a record date who converts old junior subordinated debentures on an interest payment date will receive the interest and need not include a payment for any such interest upon surrender of old junior subordinated debentures for conversion. Subordination of Debentures. The payment of principal, any premium and interest on the old junior subordinated debentures, including amounts payable on any redemption or repurchase, will be subordinated to the prior payment in full of all our senior debt. Senior debt is defined in the indenture as the principal of, and premium, if any, and interest on all our debt, whether outstanding on the date of the indenture or thereafter created, incurred, guaranteed or assumed, other than: o the old junior subordinated debentures; and o any debt which provides, or in respect of which any instrument creating or evidencing such debt or pursuant to which the same is outstanding provides, that such debt is not superior in right of payment to the new debentures. Debt is defined in the indenture to mean: o all debt which is (a) for money borrowed, (b) evidenced by a note, bond or similar instrument given in connection with the acquisition of any businesses, properties or assets of any kind, but excluding any other trade accounts payable or accrued liabilities arising in the ordinary course of business or (c) purchase money indebtedness with respect to the purchase of any real or personal property or any interest therein; o obligations under certain leases; o amendments, renewals, extensions, modifications and refundings of any debt or obligations referred to above; and o any debt or obligations referred to above in respect of which we are liable, contingently or otherwise, to pay or advance money or property as a guarantor, endorser or otherwise. In August 2000, we became a guarantor of Sierra's revolving credit facility, which at December 31, 2000 was fully drawn and had an outstanding balance of $135 million. The old junior subordinated debentures are subordinated to this guaranty of the credit facility debt. Our senior debt will also include the new senior subordinated debentures to be issued in the exchange offer and the affiliate note. The terms of our debentures do not limit our ability to incur additional senior debt. Upon any payment or distribution of assets to creditors as a result of a liquidation, dissolution, winding up, reorganization for the benefit of creditors, marshalling of assets or any bankruptcy, insolvency or similar proceedings involving us, the holders of all senior debt will first be entitled to receive payment in full before you will be entitled to receive any payment on the old junior subordinated debentures. No such payment in respect of the old junior subordinated debentures may be made if there shall have occurred and be continuing a default in any payment with respect to any senior debt, or an event of default in respect to any senior debt resulting in acceleration of the maturity thereof, or if any judicial proceeding shall be pending with respect to any such default. If the old junior subordinated debentures are declared due and payable before their stated maturity, no payment may be made in respect of the old junior subordinated debentures unless and until all senior debt shall have been paid in full. For purposes of the subordination provisions, the payment, issuance or delivery of cash, property or securities, other than our stock and certain subordinated securities, upon conversion of an old junior subordinated debenture, will be deemed to constitute payment on account of the principal of such old junior subordinated debentures. By reason of such subordination, in the event of insolvency, our creditors who are holders of senior debt may recover more ratably than you will. The old junior subordinated debentures are subordinate to the new senior subordinated debentures. The indenture permits the trustee to become our creditor and to enforce its rights as a creditor, including rights as a holder of senior debt. Redemption. The old junior subordinated debentures are currently redeemable upon not less than 25 nor more than 60 days' notice by mail at any time, in whole or in part, at our election, are currently at a redemption price equal to 100.75% of the principal amount together with accrued interest to the redemption date, subject to the right of holders of record on regular record dates to receive interest due on an interest payment date. Repurchase at Option of Holders Upon Change in Control. If a change in control as defined below occurs, you will have the right, at your option, to require us to repurchase all of your old junior subordinated debentures not previously called for redemption, or any portion of the principal amount thereof, that is equal to $1,000 or an integral multiple of $1,000. The price we are required to pay is 100% of the principal amount of the old junior subordinated debentures to be repurchased, together with accrued interest to the repurchase date. Such right may not be waived by our board of directors or by the board of directors of Sierra. At our option, instead of paying the repurchase price in cash, we may pay the repurchase price in Sierra common stock valued at 95% of the average of the closing prices of Sierra common stock for the five trading days ending on the third trading day preceding the repurchase date. We may only pay the repurchase price in Sierra common stock if such Sierra common stock is listed on a national securities exchange or quoted on the NASDAQ National Market System at the time of payment. Sierra has no obligation to issue shares in this event. Within 30 days after the occurrence of a change in control, we are obligated to mail to you notice of such change in control and of the repurchase right arising as a result thereof. We must also deliver a copy of this notice to the trustee and cause a copy of such notice to be published in a newspaper of general circulation in Los Angeles, California and in the Borough of Manhattan, The City of New York. To exercise the repurchase right, you must deliver to the trustee the old junior subordinated debentures with respect to which the repurchase right is being exercised, duly endorsed for transfer to us. We are required to repurchase the old junior subordinated debentures on the date that is 45 days after the date of our notice, which we refer to as the repurchase date. At least two trading days prior to the repurchase date, we must publish a notice in the manner described above specifying whether we will pay the repurchase price in cash or in Sierra common stock. A change in control will be deemed to have occurred at the time after the old junior subordinated debentures are issued that any person, including any syndicate or group deemed to be a "Person" under Section 13(d)(3) of the Exchange Act, is or becomes the beneficial owner, directly or indirectly, through a purchase, merger or other acquisition transaction or series of transactions, of shares of our capital stock entitling such person to exercise 50% or more of the total voting power of all shares of our capital stock that are entitled to vote in elections of directors. For purposes of these provisions, whether a person is a "beneficial owner" will be determined in accordance with Rule l3d-3 promulgated by the SEC under the Exchange Act as in effect on the date of execution of the indenture. However, a change in control will not be deemed to have occurred if either (a) the closing price per share of Sierra common stock for any five trading days within a period of 10 consecutive trading days ending immediately before the change in control shall equal or exceed 105% of the conversion price in effect on each of those trading days, or (b) all of the consideration (excluding cash payments for fractional shares) in the transaction or transactions constituting the change in control consists of shares of common stock traded on a national securities exchange or quoted on the NASDAQ National Market System and as a result of such transaction or transactions the old junior subordinated debentures become convertible solely into such common stock. Rule 13e-4 under the Exchange Act requires the dissemination of certain information to security holders in the event of an issuer tender offer and may apply in the event that the repurchase option becomes available to you. We will comply with this rule to the extent it applies at that time. Merger and Consolidation. The indenture provides that we may consolidate with or merge into any other corporation, or convey, transfer or lease its properties and assets substantially as an entirety to any person, provided that in any such case: o the successor corporation assumes by a supplemental indenture our and Sierra's obligations under the indenture, o immediately after giving effect to such transaction, no default will have occurred and be continuing, and o we deliver to the trustee an officer's certificate and an opinion of counsel stating that the terms of the indenture with respect to such event have been complied with. Upon compliance with these provisions by a successor corporation, we, except in the case of a lease, would be relieved of our obligations under the indenture and the old junior subordinated debentures. Modification of the Indenture. Modifications and amendments of the indenture may be made by us and the trustee with the consent of the holders of a majority in principal amount of the outstanding debentures. However, none of the following modifications or amendments may be made without your consent: o change the stated maturity date of the principal of, or any installment of interest on, the old junior subordinated debentures; o reduce the principal amount of, any interest on, or premium payable on redemption of, any old junior subordinated debenture; o change the place or currency of payment on the old junior subordinated debentures; o impair your right to institute suit for the enforcement of any payment on the old junior subordinated debentures when due; o adversely affect your right to convert the old junior subordinated debentures into Sierra common stock; o modify the provisions of the indenture with respect to the subordination of the old junior subordinated debentures in a manner adverse to you; or o reduce the percentage in principal amount of old junior subordinated debentures the consent of whose holders is required for modification or amendment of the indenture or for waiver of compliance with certain provisions of the indenture or for waiver of certain defaults. Events of Default, Notice and Waiver. The following are events of default under the indenture: o we fail to make a payment of interest on the old junior subordinated debentures due, and this failure continues for 30 days; o we fail to make the payment of principal or premium, if any, on the old junior subordinated debentures, when due; o we fail in the performance of any other covenant and this failure continues for 60 days after written notice, as provided in the indenture; o we default in respect of our indebtedness for money borrowed which results in acceleration of the maturity of $1,000,000 or more of indebtedness, if such acceleration is not rescinded or indebtedness discharged within 10 days after written notice to us, as provided in the indenture; and o certain events in bankruptcy, insolvency or reorganization involving us. If any event of default shall happen and be continuing, the trustee or the holders of 25% in principal amount of the outstanding debentures may declare the old junior subordinated debentures due and payable. However, after a declaration of acceleration has been made with respect to the old junior subordinated debentures, but before a judgment or decree based on acceleration has been obtained, the holders of a majority in principal amount of the outstanding debentures may, under certain circumstances, rescind and annul such acceleration. The indenture will provide that the trustee will be under no obligation, subject to the duty of the trustee during default to act with the required standard of care, to exercise any of its rights or powers under the indenture at the request or direction of any of the holders, unless such holders shall have offered to the trustee reasonable security or indemnity against the costs, expenses and liabilities which might be incurred by it in compliance with such request or direction. Subject to certain conditions, the holders of a majority in principal amount of the outstanding debentures will have the right to direct the time, method and place of conducting any proceeding for any remedy available to the trustee or exercising any trust or power conferred on the trustee. The holders of a majority in principal amount of the outstanding debentures may on behalf of the holders of all old junior subordinated debentures waive compliance by us with certain restrictive provisions of the indenture. The holders of a majority in principal amount of the outstanding debentures may on behalf of the holders of old junior subordinated debentures waive certain past defaults except a default in payment of the principal of, or premium, if any, or interest on any old junior subordinated debenture or in respect of a provision which under the indenture cannot be modified or amended without the consent of the holder of each outstanding debenture affected thereby. We will be required to furnish the trustee annually a statement as to any default by it in the performance of certain covenants in the indenture. Concerning the Trustee. The trustee may act as a depository for funds of, make loans, which may constitute senior debt, to and perform other commercial banking services for us or for us in the ordinary course of business. The trustee is one of the lenders under Sierra's credit facility. BOOK-ENTRY SYSTEM -- THE DEPOSITORY TRUST COMPANY The new senior subordinated debentures will be evidenced by a global security initially deposited with The Depository Trust Company, or DTC, and registered in the name of Cede & Co., as DTC's nominee. Except as set forth below, the global security may be transferred only to another nominee of DTC or to a successor of DTC or its nominee. Holders of the new senior subordinated debentures may hold their interests in the global security directly through DTC or indirectly through organizations which are participants in DTC, called "participants". Transfers between participants will be affected in the ordinary way in accordance with DTC rules and will be settled in clearinghouse funds. The laws of some states require that some persons take physical delivery of securities in definitive form. As a result, holders may be unable to transfer beneficial interests in the global security to those persons. Holders that are not participants may beneficially own interests in the global security held by DTC only through participants or indirect participants, including banks, brokers, dealers, trust companies and other parties that clear through or maintain a custodial relationship with a participant. So long as Cede & Co., as the nominee of DTC, is the registered owner of the global security, Cede & Co. will be considered the sole holder of the global security for all purposes. Except as provided below, owners of beneficial interests in the global security will not: o be entitled to have certificates registered in their names; o be entitled to receive physical delivery of certificates in definitive form; and o be considered registered holders. We will make payments of interest on and principal of and the redemption or repurchase price of the global security to Cede & Co., the nominee for DTC, as the registered holder of the global security. We will make these payments by wire transfer of immediately available funds. Neither we, the trustee nor any paying agent will have any responsibility or liability for: o records or payments on beneficial ownership interests in the global security; or o maintaining, supervising or reviewing any records relating to those beneficial ownership interests. We have been informed that DTC's practice is to credit participants' accounts on the payment date. These payments will be made in amounts proportionate to participants' beneficial interests in the new senior subordinated debentures. Payments by participants to owners of beneficial interests in the new senior subordinated debentures represented by the global security held through participants will be the responsibility of those participants. We will send any redemption notices to Cede & Co. We understand that if less than all of the new senior subordinated debentures are being redeemed, DTC's practice is to determine by lot the amount of the holdings of each participant to be redeemed. We also understand that neither DTC nor Cede & Co. will consent or vote with respect to the new senior subordinated debentures. We have been advised that under its usual procedures, DTC will mail an "omnibus proxy" to us as soon as possible after the record date. The omnibus proxy assigns Cede & Co.'s consenting or voting rights to those participants to whose accounts the exchange notes are credited on the record date identified in a listing attached to the omnibus proxy. A person having a beneficial interest in new senior subordinated debentures represented by the global security may be unable to pledge that interest to persons or entities that do not participate in the DTC system, or to take other actions in respect of that interest, because that interest is not represented by a physical certificate. DTC has advised us that it is: o a limited purpose trust company organized under the laws of the State of New York; o a member of the Federal Reserve System; o a "clearing corporation" within the meaning of the Uniform Commercial Code, and o a "clearing agency" registered pursuant to the provisions of Section 17A of the Exchange Act. DTC was created to hold securities for its participants and to facilitate the clearance and settlement of securities transactions between participants through electronic book-entry changes to accounts of its participants. Some of the participants, together with other entities, own DTC. Indirect access to the DTC system is available to others such as banks, brokers, dealers and trust companies that clear through, or maintain a custodial relationship with a participant, either directly or indirectly. DTC is under no obligation to perform or continue to perform the above procedures. DTC may discontinue these at any time. If DTC is at any time unwilling or unable to continue as depository and a successor depository is not appointed by us within 90 days, we will cause new senior subordinated debentures to be issued in definitive form in exchange for the global security. MATERIAL UNITED STATES FEDERAL INCOME TAX CONSEQUENCES The following discussion summarizes the material United States federal income tax consequences to us and to United States holders of the exchange offer and of the acquisition, ownership and disposition of the new senior subordinated debentures. A United States holder is (1) an individual citizen or resident of the United States or (2) a corporation created or organized in or under the laws of the United States or any political subdivision thereof. This discussion does not purport to describe all of the tax considerations that may be relevant to a holder of old junior subordinated debentures. The following summary deals only with old junior subordinated debentures that are, and new senior subordinated debentures that will be, held as capital assets by United States holders, and does not deal with persons that are subject to special tax rules, such as: o dealers or traders in securities or currencies; o financial institutions or other United States holders that treat income in respect of the old junior subordinated debentures or new senior subordinated debentures as financial services income; o insurance companies; o tax-exempt entities; o persons holding old junior subordinated debentures or new senior subordinated debentures as a part of a straddles, conversion transaction or other arrangement involving more than one position; o persons that have a principal place of business or "tax home" outside the United States; or o persons whose "functional currency" is not the U.S. dollar. The discussion below is based upon the provisions of the United States Internal Revenue Code of 1986, as amended, and regulations, rulings and judicial decisions thereunder as of the date of this prospectus; any of these authorities may be repealed, revoked or modified, perhaps with retroactive effect, so as to result in United States federal income tax consequences different from those discussed below. The statements of law and legal conclusions set out below regarding material tax consequences to us and United States holders of the exchange offer are the opinion of Morgan, Lewis & Bockius LLP, our special United States tax counsel. However, opinions of tax counsel are not binding on United States tax authorities or courts. Because United States tax consequences may differ from one holder to the next, the discussion set out below does not purport to describe all of the tax considerations that may be relevant to you and your particular situation. Accordingly, you are advised to consult your own tax advisor as to the United States federal, state, local and other tax consequences of the exchange offer and of the acquisition, ownership and disposition of new senior subordinated debentures. The statements of United States tax law set out below are based on the laws and interpretations in force as of the date of this prospectus, and are subject to any changes occurring after that date. Tax Consequences to Us A corporation will recognize cancellation of indebtedness income upon the satisfaction of its indebtedness for an amount that is less than the amount of the indebtedness. If the exchange offer is consummated, then we will realize ordinary income from (1) the payment of cash in satisfaction of the old junior subordinated debentures to the extent that the adjusted issue price, which is the stated principal amount, of the old junior subordinated debentures extinguished exceeds the amount of cash paid and (2) the exchange of new senior subordinated debentures for old junior subordinated debentures to the extent that the adjusted issue price of the old junior subordinated debentures exceeds the issue price of the new senior subordinated debentures exchanged therefor. As discussed more fully below, the issue price of a new senior subordinated debenture probably will equal the stated principal amount of the new senior subordinated debenture, in which case no cancellation of indebtedness income will arise from the exchange of new senior subordinated debenture for the old junior subordinated debenture. No assurance can be given in this respect, however, and it is possible that the issue price will equal the fair market value of the new senior subordinated debenture or of the old junior subordinated debenture exchanged therefor, in which case we would probably recognize cancellation of indebtedness income with respect to the exchange of new senior subordinated debentures for old junior subordinated debentures (See paragraph 3. under --Tax Consequences to United States Holders of the Exchange Offer--Exchange of New Senior Subordinated Debentures for Old Junior Subordinated Debentures--The Exchange). Tax Consequences to United States Holders of the Exchange Offer Your tax consequences will depend on the option that you select. The discussion under each of the headings below describes the tax consequences applicable to each option under the exchange offer: receiving cash in satisfaction of your old junior subordinated debentures, exchanging your old junior subordinated debentures for new senior subordinated debentures or continuing to hold your old junior subordinated debentures. Receipt of Cash for Old Junior Subordinated Debentures A United States holder that receives cash under the exchange offer will recognize gain or loss in an amount equal to the difference between (1) the amount of cash received and (2) the adjusted tax basis of the old junior subordinated debentures in the hands of the United States holder. Except as discussed below, the gain or loss recognized by a United States holder will be treated as capital gain or loss and will be long-term capital gain or loss if the old junior subordinated debentures have been held for more than one year. Gain recognized by a United States holder will be treated as ordinary income, to the extent of any market discount on the old junior subordinated debentures that has accrued during the period that the United States holder held the old junior subordinated debentures and that has not previously been included in income by the United States holder. A United States holder also will recognize ordinary income in an amount equal to the cash payments received as payment of the interest that has accrued on the old junior subordinated debentures. Exchange of New Senior Subordinated Debentures for Old Junior Subordinated Debentures The Exchange The exchange of new senior subordinated debentures for old junior subordinated debentures pursuant to the exchange offer may be treated as a taxable exchange or as a reorganization and recapitalization, within the meaning of Section 368(a)(1)(E) of the Internal Revenue Code. An exchange of new senior subordinated debentures for old junior subordinated debentures will be treated as a recapitalization only if both the old junior subordinated debentures and the new senior subordinated debentures are treated as "securities" for purposes of the reorganization provisions of the Internal Revenue Code. The term "securities" is not defined in the Internal Revenue Code or in the regulations promulgated thereunder. Under applicable administrative pronouncements and judicial decisions, as a general proposition, the original term of a debt instrument is the most important factor in determining whether the debt instrument is a security: debt instruments with an original term of at least ten years usually being considered securities and debt instruments with a term of five years or less usually not being considered securities. However, (1) the term of a debt instrument is not necessarily determinative, and other factors such as the degree of participation and continuing interest associated with the debt instrument may be relevant, (2) even under this simplified original-term test, the status of debt instruments with an original term of between five and ten years, such as the new senior subordinated debentures, is not clear, and (3) in any event, the applicable judicial decisions are not entirely consistent. Accordingly, there can be no assurance that the Internal Revenue Service (IRS) or a court will agree that the new senior subordinated debentures properly are treated as securities. If the new senior subordinated debentures that a United States Holder receives are not treated as securities then the exchange will be treated as a taxable transaction, rather than as a recapitalization. You are encouraged to consult your own tax advisor as to whether an exchange of new senior subordinated debentures for old junior subordinated debentures will be treated as a recapitalization. The exchange should have the following United States federal income tax consequences: 1. An exchanging United States holder of old junior subordinated debentures should realize gain or loss in an amount equal to the difference between (1) the issue price of the new senior subordinated debentures received and (2) the adjusted tax basis of the old junior subordinated debentures in the hands of the United States holder. The amount of gain or loss realized, as opposed to the amount of gain or loss recognized, does not depend on whether the exchange is treated as a taxable exchange or as a recapitalization. A United States holder also will recognize ordinary income in an amount equal to the cash payments received in satisfaction of interest that has accrued on the old junior subordinated debentures. 2. The issue price of the new senior subordinated debentures will depend upon whether the new senior subordinated debentures or the old junior subordinated debentures are "traded on an established market" at any time within the 60-day period ending 30 days after the issue date of the new senior subordinated debentures. For this purpose, a debt instrument is considered to be traded on an established market, if (1) the debt instrument is listed on a national securities exchange, an interdealer quotation system sponsored by a national securities association or a designated foreign exchange or board of trade, (2) the debt instrument is traded either on a board of trade designated as a contract market by the Commodities Futures Trading Commission or on an interbank market, (3) the debt instrument appears on a "quotation medium,"which is a system of general circulation that provides a reasonable basis to determine fair market value by disseminating either recent price quotations of one or more identified brokers, dealers or traders or actual prices of recent sales transactions, or (4) price quotations for the debt instrument otherwise are readily available from dealers, brokers or traders. We do not believe that the old junior subordinated debentures have been traded on an established securities market. Because we will not list the new senior subordinated debentures on the New York Stock Exchange until after 30 days following the issue date of the new senior subordinated debentures, the new senior subordinated debentures should not be treated as traded on an established securities market within 30 days after their issue date, except in the unlikely event that a significant amount of trading takes place off the Exchange within this 30-day period. 3. If neither the new senior subordinated debentures nor the old junior subordinated debentures are traded on an established market, then the issue price of the new senior subordinated debentures will be equal to their stated principal amount ($1000 per new senior subordinated debenture). If the new senior subordinated debentures are traded on an established market, then the issue price of the new senior subordinated debentures will be their fair market value on the issue date. If the old junior subordinated debentures are, and the new senior subordinated debentures are not, traded on an established market, then the issue price of the new senior subordinated debentures will be the fair market value on the issue date of the old junior subordinated debentures surrendered in exchange therefor. 4. If the exchange made by an exchanging United States holder is treated as a recapitalization, then gain or loss, if any, realized by the United States holder will not be recognized. 5. If the exchange made by an exchanging United States holder is treated as a taxable exchange, then gain, if any, realized by the United States holder will be recognized. Loss, if any, realized by the exchanging United States holder will be recognized only to the extent permitted under the wash sale rules of Section 1091 of the Internal Revenue Code. You are advised to consult your own tax advisor as to the potential application of the wash sale rules. 6. Except as discussed below, gain or loss recognized by an exchanging United States holder of old junior subordinated debentures will be treated as capital gain or loss. Gain recognized by an exchanging United States holder will be treated as ordinary income, to the extent of any market discount on the old junior subordinated debentures that has accrued during the period that the exchanging United States holder held the old junior subordinated debentures and that has not previously been included in income by the United States holder. An old junior subordinated debenture generally will be considered to have been acquired with market discount if the issue price of the old junior subordinated debenture at the time of acquisition exceeded the initial tax basis of the old junior subordinated debenture in the hands of the United States holder by more than a specified de minimis amount. Market discount accrues on ratable basis, unless the United States holder elects to accrue the market discount using a constant-yield method. If the exchange made by an exchanging United States holder is treated as a recapitalization, then any accrued market discount on the old junior subordinated debentures that is not recognized on the exchange will be transferred to the new senior subordinated debentures received. 7. If the exchange made by an exchanging United States holder is treated as a recapitalization, then the tax basis of the new senior subordinated debentures received in the hands of the United States holder will be equal to the adjusted tax basis of the old junior subordinated debentures transferred in the exchange. The holding period of the new senior subordinated debentures will include the holding period of the old junior subordinated debentures surrendered in the exchange. 8. If the exchange made by an exchanging United States holder is treated as a taxable exchange, then the tax basis of the new senior subordinated debentures received in the hands of the United States holder will be equal to their issue price. The holding period of the new senior subordinated debentures will not include the holding period of the old junior subordinated debentures surrendered in the exchange. Tax Treatment of the New Senior Subordinated Debentures Stated Interest Interest on a new senior subordinated debenture, other than interest that is not "qualified stated interest," will be taxable to a United States holder as ordinary interest income at the time that the interest is received or is accrued, in accordance with the United States holder's method of accounting for federal income tax purposes. In general, qualified stated interest is stated interest that is unconditionally payable at least annually at a single fixed rate during the entire term of a debt obligation. Original Issue Discount General. Whether the new senior subordinated debentures are issued with original issue discount (OID) will depend upon whether the issue price of the new senior subordinated debentures is calculated with respect to their issue price or their fair market value. If, as discussed above, the issue price of the new senior subordinated debentures is equal to their principal amount, then the new senior subordinated debentures would not be treated as issued with OID and the rest of the discussion under this heading "--Original Issue Discount" would not be applicable to the new senior subordinated debentures. If, on the other hand, the issue price of the new senior subordinated debentures is based on the fair market value of the new senior subordinated debentures or the old junior subordinated debentures, then the new senior subordinated debentures probably would be treated as issued with OID. The amount of OID on a new senior subordinated debenture will be equal to the excess of (1) the stated redemption price at maturity of the new senior subordinated debenture over (2) the issue price of the new senior subordinated debenture, determined in the manner described above. The stated redemption price at maturity of a new senior subordinated debenture is the sum of all payments on the new senior subordinated debenture other than payments of qualified stated interest. Subject to the discussion below under "-Acquisition Premium," a United States holder of a new senior subordinated debenture issued with OID must include OID in income, as ordinary interest income, as it accrues, on a constant-yield basis, before the receipt of cash attributable to this income, and will be required to include in income increasingly greater amounts of OID over the life of the new senior subordinated debenture. The amount of OID includible in income by a United States holder is the sum of the daily portions of OID with respect to the new senior subordinated debenture for each day during the taxable year or portion of the taxable year on which the United States holder holds the new senior subordinated debenture, known as accrued OID. The daily portion is determined by allocating to each day in any "accrual period" a pro rata portion of the OID allocable to that accrual period. Accrual periods with respect to a new senior subordinated debenture may be of any length selected by the United States holder and may vary in length over the term of the new senior subordinated debenture, so long as (1) no accrual period is longer than one year and (2) each scheduled payment of interest or principal on the new senior subordinated debenture occurs on either the final or first day of an accrual period. The amount of OID allocable to an accrual period is equal to the excess of (1) the product of the adjusted issue price of the new senior subordinated debenture at the beginning of the accrual period and the yield to maturity of the new senior subordinated debenture, determined on the basis of compounding at the close of each accrual period and properly adjusted for the length of the accrual period, over (2) the sum of the payments of qualified stated interest on the new senior subordinated debenture that are allocable to the accrual period. The "adjusted issue price" of a new senior subordinated debenture at the beginning of any accrual period is the issue price of the new senior subordinated debenture, increased by the amount of accrued OID for all prior accrual periods and decreased by the amount of any payments previously made on the new senior subordinated debenture other than payments of qualified stated interest. The amount of OID allocable to an initial short accrual period may be computed using any reasonable method, if all other accrual periods other than a final short accrual period are of equal length. The amount of OID allocable to the final accrual period is the difference between the amount payable at the maturity of the new senior subordinated debenture and the new senior subordinated debenture's adjusted issue price as of the beginning of the final accrual period. In general, the effect of the OID provisions described above is that United States holders will realize interest income on the new senior subordinated debentures on a constant-yield basis over the term of the new senior subordinated debentures; United States holders generally will not realize additional income on the receipt of payments, other than payments of qualified stated interest, on the new senior subordinated debentures, even if those payments are denominated as interest. Acquisition Premium. A United States holder that acquires a new senior subordinated debenture for an amount less than or equal to the sum of all amounts payable on the new senior subordinated debenture after the acquisition date, other than payments of qualified stated interest, but in excess of its adjusted issue price (this excess being "acquisition premium") and that does not make the election described below under "Election To Treat All Interest As Original Issue Discount," is permitted to reduce the daily portions of OID includible in its income. The amount of this reduction is calculated by multiplying the daily portion of OID by a fraction, the numerator of which is the excess of the United States holder's adjusted tax basis in the new senior subordinated debenture immediately after its acquisition over the adjusted issue price of the new senior subordinated debenture, and the denominator of which is the excess of the sum of all amounts payable on the new senior subordinated debenture after the acquisition date, other than payments of qualified stated interest, over the adjusted issue price of the new senior subordinated debenture. The ability to reduce OID inclusions to reflect acquisition premium in the manner described above is specifically available to a United States holder (1) that acquires new senior subordinated debentures with OID pursuant to the exchange offer in a transaction treated as a recapitalization and (2) that realizes a loss on the exchange that it is not permitted to recognize under the recapitalization rules, with the consequence that its initial tax basis in the new senior subordinated debentures exceeds the adjusted issue price of those debentures. Election To Treat All Interest as Original Issue Discount. A United States holder may elect to include in gross income all interest that accrues on a new senior subordinated debenture using the constant-yield method described above under the heading "Original Issue Discount -General," with the modifications described below. For purposes of this election, interest includes stated interest, OID, market discount and de minimis market discount, as adjusted by any acquisition premium. In applying the constant-yield method to a new senior subordinated debenture with respect to which this election has been made, the issue price of the new senior subordinated debenture will equal the electing United States holder's adjusted basis in the new senior subordinated debenture immediately after its acquisition, the issue date of the new senior subordinated debenture will be the date of its acquisition by the electing United States holder and no payments on the new senior subordinated debenture will be treated as payments of qualified stated interest. This election generally will apply only to the new senior subordinated debenture with respect to which it is made and may not be revoked without the consent of the IRS. If the election to apply the constant-yield method to all interest on a new senior subordinated debenture is made with respect to a market discount debenture, then the electing United States holder will be treated as having made the election discussed below under "Market Discount" to include market discount in income currently over the life of all debt instruments held or thereafter acquired by the United States holder. Market Discount A new senior subordinated debenture will be considered to be a market discount debenture if the adjusted issue price of the new senior subordinated debenture at the time of acquisition exceeds the initial tax basis of the new senior subordinated debenture in the hands of the United States holder by more than a specified de minimis amount. If this excess is not sufficient to cause the new senior subordinated debenture to be a market discount debenture, this excess constitutes "de minimis market discount." In addition, as discussed above under "Exchange of New Senior Subordinated Debentures for Old Junior Subordinated Debentures-The Exchange," if a United States holder acquires new senior subordinated debentures pursuant to the exchange offer in an exchange treated as a recapitalization, then accrued market discount on an old junior subordinated debenture that is not taken into account in connection with the exchange will carry over to the new senior subordinated debenture received in exchange. Any gain recognized on the receipt of payments on or disposition of a market discount debenture will be treated as ordinary income to the extent that this gain does not exceed the accrued market discount on the new senior subordinated debenture. Alternatively, a United States holder of a market discount debenture may elect to include market discount in income currently over the life of the new senior subordinated debenture. This election shall apply to all debt instruments with market discount acquired by the electing United States holder on or after the first day of the first taxable year to which the election applies. This election may not be revoked without the consent of the IRS. A United States holder that makes the election described under "Original Issue Discount-Election To Treat All Interest as Original Issue Discount" will be deemed to have elected to include market discount in income currently. Market discount on a market discount debenture will accrue on a ratable basis unless the United States holder elects to accrue this market discount using a constant-yield method. This election shall apply only to the new senior subordinated debenture with respect to which it is made and may not be revoked without the consent of the IRS. A United States holder of a market discount debenture that does not elect, and is not deemed to have elected, to include market discount in income currently generally will be required to defer deductions for net direct interest expense with respect to the new senior subordinated debenture (defined for each taxable year as the excess of interest expense allocable to the new senior subordinated debenture over interest, including OID, includible in income in respect of the new senior subordinated debenture) in an amount not exceeding the accrued market discount on the new senior subordinated debenture until the maturity or disposition of the new senior subordinated debenture. Purchase, Sale and Retirement of New Senior Subordinated Debentures A United States holder's initial tax basis in a new senior subordinated debenture, determined in the manner described above under "Exchange of New Senior Subordinated Debentures for Old Junior Subordinated Debentures-The Exchange," will be increased by the amount of any OID or market discount included in the United States holder's income with respect to the new senior subordinated debenture and reduced by the amount of any payments on the new senior subordinated debenture other than payments of qualified stated interest. A United States holder generally will recognize gain or loss on the sale or retirement of a new senior subordinated debenture in an amount equal to the difference between the amount realized on the sale or retirement, other than amounts attributable to accrued but unpaid interest, which will be taxable as ordinary income, and the tax basis of the new senior subordinated debenture. Except to the extent described above under "-Market Discount," gain or loss recognized on the sale or retirement of a new senior subordinated debenture will be capital gain or loss and will be long-term capital gain or loss if the new senior subordinated debenture has been held for more than one year. Nonparticipation in the Exchange Offer A United States holder that does not participate in the exchange offer and instead retains its old junior subordinated debentures will not recognize any gain or loss as a result of the consummation of the exchange offer. LEGAL MATTERS The validity of our new senior subordinated debentures offered by this prospectus will be passed upon for us by Morgan, Lewis & Bockius LLP, New York, New York. EXPERTS The financial statements and related financial statement schedule of CII Financial, Inc. and subsidiaries as of December 31, 1999 and 1998, and for each of the three years in the period ended December 31, 1999, included in this prospectus have been audited by Deloitte & Touche LLP, independent auditors, as stated in their report appearing herein, and have been so included in reliance upon the reports of such firm given upon their authority as experts in accounting and auditing. ANNEX I GLOSSARY OF SELECTED INSURANCE TERMS The following terms when used in this Prospectus have the following meanings: Assume.............................. To receive from a ceding company, all or a portion of a risk in consideration of a premium. Cede................................. To transfer to a reinsurer, all or a portion of a risk in consideration of a premium. Combined ratio..................... The sum of the loss ratio, the underwriting expense ratio and the policyholders' dividend ratio, expressed as a percentage. A combined ratio less than 100% indicates an underwriting profit. Direct written premiums......... Premiums written by an insurer before the assumption and cession of reinsurance. Loss ratio........................... The ratio arrived at by dividing the amount of losses and loss adjustment expenses by net earned premiums. Losses ........................... For workers' compensation insurance, payments and reserves needed to provide indemnity, medical and rehabilitation costs to injured workers. Loss adjustment expenses...... The expenses of settling claims, including legal, other fees and general expenses. Net earned premiums............ The portion of premiums applicable to the expired period of policies after the assumption and cession of reinsurance. Net written premiums............ Premiums retained by an insurer after the assumption and cession of reinsurance. Participating policy............... An insurance policy where the policyholders may receive a "dividend" which is a partial return of premium, after the policy period if, among other factors, the insured has had a favorable claims history during the period; that is, the policyholder "participates" in the savings resulting from a favorable claims history, among other factors. Policy acquisition costs......... Agents' and brokers' commissions, premium taxes, boards and bureau fees, marketing, underwriting and other direct expenses associated with acquiring and retaining business. Policyholders' dividend ratio... The ratio arrived at by dividing the amount of policyholders' dividends incurred by net earned premiums. Policyholders' surplus............ The sum remaining after all liabilities are subtracted from all assets, applying statutory accounting principles. This sum is regarded as financial protection to policyholders in the event an insurance company suffers unexpected or catastrophic losses. Quota share reinsurance......... A form of reinsurance in which the reinsurer assumes an agreed percentage of certain risks insured by the ceding insurer up to a specified amount, and shares premiums and losses proportionately. Reinsurance........................ An agreement whereby an original insurer remits a portion of the premium to a reinsurer as payment for the reinsurers assumption of a portion of the risk. Reinsurance can be effected by "treaties," where a reinsurance treaty automatically covers all risks of a defined category, amount and type, or by "facultative reinsurance." Facultative reinsurance is negotiated between an original insurer and the reinsurer on an individual, contract-by-contract basis. Reserves or loss reserves......... A balance sheet liability for unpaid losses representing estimates of amounts needed to pay reported and unreported claims and related loss adjustment expenses. Statutory accounting............... Recording transactions and preparing financial statements in accordance with the rules and procedures adopted by regulatory authorities, generally reflecting a liquidating, rather than a going concern, concept of accounting. Treaty.............................. See Reinsurance. Unassigned funds..................... The cumulative amount of retained net profits from insurance operations, or earned surplus including investment income, as determined under statutory accounting principles. Underwriting..................... The process whereby an insurer reviews applications submitted for insurance coverage and determines whether it will accept all or part, and at what premium, of the coverage being requested. Underwriting expenses............ The aggregate of policy acquisition costs and the portion of administrative, general and other expenses attributable to insurance operations. Underwriting expense ratio...... For generally accepted accounting principles ("GAAP"), the ratio arrived at by dividing the amount of GAAP underwriting expenses by net earned premiums. For statutory accounting basis, the ratio arrived at by dividing the amount of statutory underwriting expenses by net written premiums. Underwriting profit (loss)...... The amount of net income (loss) from insurance operations, exclusive of net investment or other income. F-3 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS CII Financial, Inc. and Subsidiaries Page Management Report on Consolidated Financial Statements F-2 Report of Independent Auditors F-3 Consolidated Financial Statements for the Nine Months Ended September 30, 2000 and 1999(unaudited), and the Years Ended December 31, 1999, 1998 and 1997: Consolidated Balance Sheets F-4 Consolidated Statements of Operations F-5 Consolidated Statements of Stockholder's Equity F-6 Consolidated Statements of Cash Flows F-7 Notes to Consolidated Financial Statements F-8 Supplemental Financial Statement Schedule F-24 MANAGEMENT REPORT ON CONSOLIDATED FINANCIAL STATEMENTS The management of CII Financial, Inc. is responsible for the integrity and objectivity of the accompanying consolidated financial statements. The statements have been prepared in conformity with accounting principles generally accepted in the United States of America applied on a consistent basis and are not misstated due to fraud or material error. The statements include some amounts that are based upon the Company's best estimates and judgment. The accounting systems and controls of the Company are designed to provide reasonable assurance that transactions are executed in accordance with management's authorization, that the financial records are reliable for preparing financial statements and maintaining accountability for assets, and that assets are safeguarded against losses from unauthorized use or disposition. Management believes that for the year ended December 31, 1999, such systems and controls were adequate to meet the objectives discussed herein. The accompanying consolidated financial statements have been audited by independent certified public accountants, whose audits thereof were made in accordance with auditing standards generally accepted in the United States of America and included a review of internal accounting controls to the extent necessary to design audit procedures aimed at gathering sufficient evidence to provide a reasonable basis for their opinion on the fairness of presentation of the consolidated financial statements taken as a whole. Kathy Marlon, Chairman and Chief Executive Officer John F. Okita Chief Financial Officer Report of Independent Auditors To the Board of Directors and Stockholder CII Financial, Inc. Las Vegas, Nevada We have audited the accompanying consolidated balance sheets of CII Financial, Inc. and Subsidiaries as of December 31, 1999 and 1998 and the related consolidated statements of operations, stockholder's equity, and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of CII Financial, Inc. and Subsidiaries at December 31, 1999 and 1998 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1999 in conformity with accounting principles generally accepted in the United States of America. Our audits were conducted for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The supplemental schedule listed in the index to the consolidated financial statements is presented for the purpose of additional analysis and is not a required part of the basic consolidated financial statements. This schedule is the responsibility of the management of CII Financial, Inc. Such schedule has been subjected to the auditing procedures applied in our audits of the basic consolidated financial statements and, in our opinion, is fairly stated in all material respects when considered in relation to the basic consolidated financial statements taken as a whole. /s/ DELOITTE & TOUCHE, LLP Las Vegas, Nevada December 21, 2000 (except for Note 12, as to which the date is December 28, 2000) CII FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands except for share data)
September 30, December 31, 2000 1999 1998 ---- ---- ---- (Unaudited) ASSETS Invested assets: Debt securities, available-for-sale, at fair value $164,660 $165,296 $185,644 Debt securities, held-to-maturity, at amortized cost 22,154 25,023 53,967 Preferred stock, at fair value 1,732 3,486 882 ---------- ---------- ---------- Mortgage loans on non-affiliated real estate 6,281 6,416 11,635 ----------- ----------- --------- Total invested assets 194,827 200,221 252,128 --------- --------- -------- Cash and cash equivalents 19,408 16,833 22,114 Reinsurance recoverable 211,594 131,862 58,424 Premiums receivable (net of allowances of $1,134 (unaudited), $1,134 and 1,278) 13,402 9,391 10,612 Investment income receivable 2,406 2,786 2,782 Deferred policy acquisition costs 2,732 2,378 1,804 Mortgage loans on affiliated real estate 10,261 2,959 3,082 Real estate limited partnership 7,108 6,559 6,185 Federal income taxes receivable 9,478 4,896 492 Deferred income taxes 15,984 17,344 15,929 Property and equipment, net 5,097 8,354 5,253 Other assets 555 755 1,075 ------------ ------------ ----------- TOTAL ASSETS $492,852 $404,338 $379,880 ======== ======== ======== LIABILITIES Reserve for loss and loss adjustment expenses $341,902 $244,394 $212,264 Unearned premiums 16,206 13,300 11,158 Ceded reinsurance premiums payable 7,424 9,321 8,739 Convertible subordinated debentures 47,059 50,498 51,251 Accounts payable and other accrued expenses 15,969 15,265 18,788 Payable to affiliates 2,487 2,768 2,105 Deferred tax liability 3,291 2,739 1,628 ---------- ---------- ---------- TOTAL LIABILITIES 434,338 338,285 305,933 -------- -------- -------- COMMITMENTS AND CONTINGENCIES STOCKHOLDER'S EQUITY Common stock, no par value, 1,000 shares authorized; shares issued and outstanding - 100 3,604 3,604 3,604 Additional paid-in capital 64,450 64,450 64,450 Accumulated other comprehensive loss: Unrealized holding loss on available-for-sale investments (8,651) (12,200) (702) (Accumulated deficit) retained earnings (889) 10,199 6,595 ----------- ---------- ---------- TOTAL STOCKHOLDER'S EQUITY 58,514 66,053 73,947 ---------- ---------- --------- TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $492,852 $404,338 $379,880 ======== ======== ========
See the accompanying notes to consolidated financial statements. CII FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands)
Nine Months Ended Year Ended December 31, September 30, 2000 1999 1999 1998 1997 ---- ---- ---- ---- ---- (Unaudited) (Unaudited) REVENUES Direct written premiums, gross $153,034 $106,291 $148,824 $153,914 $135,580 Changes in direct unearned premiums (2,906) (2,579) (2,142) 127 (1,400) ---------- ---------- ---------- ----------- ---------- Direct earned premiums, gross 150,128 103,712 146,682 154,041 134,180 Less: premiums ceded 59,177 45,458 63,727 19,767 4,983 --------- --------- --------- --------- ---------- Net earned premiums 90,951 58,254 82,955 134,274 129,197 Net investment income 11,217 12,075 15,776 18,241 16,781 Net realized investment (losses) gains (460) (174) (381) 1,988 580 ---------- ---------- ---------- ---------- ----------- Total revenues 101,708 70,155 98,350 154,503 146,558 ------- -------- -------- -------- -------- COSTS AND EXPENSES Loss and loss adjustment expenses 207,323 94,815 157,424 115,759 99,553 Reinsurance recoveries (123,303) (60,002) (95,963) (21,412) (6,221) -------- -------- --------- --------- ---------- Net loss and loss adjustment expenses 84,020 34,813 61,461 94,347 93,332 Policy acquisition costs 8,606 5,737 6,339 19,216 19,860 General and administrative and other 17,372 15,000 19,749 18,761 18,462 Asset impairment 3,000 Interest expense 2,717 2,751 3,706 4,301 4,091 --------- --------- ---------- ---------- ---------- Total costs and expenses 115,715 58,301 91,255 136,625 135,745 -------- -------- --------- -------- -------- (LOSS) INCOME BEFORE FEDERAL INCOME TAX (BENEFIT) EXPENSE AND EXTRAORDINARY GAIN (14,007) 11,854 7,095 17,878 10,813 Federal income tax (benefit) expense (4,902) 4,815 3,602 4,166 272 --------- --------- --------- ---------- ----------- (LOSS) INCOME BEFORE EXTRAORDINARY GAIN (9,105) 7,039 3,493 13,712 10,541 --------- -------- --------- --------- --------- ------------- ---------- ------------ ------------- Extraordinary gain from debt extinguishments (net of income taxes of $353 and $0 (unaudited), $59, $25, and $1) 654 _______ 111 48 2 ---------- ---------- ------------ ------------- NET (LOSS) INCOME $ (8,451) $ 7,039 $ 3,604 $ 13,760 $ 10,543 ======== ======= ======== ======== ========
See the accompanying notes to consolidated financial statements. CII FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY (In thousands) ------------ --------- -----------
Common Stock Additional Accumulated Comprehensive (Accumulated Total Paid-in Other Income (Loss) Deficit) Stockholder's Number of Capital Comprehensive Retained Equity Shares Amount Income (Loss) Earnings ------------ --------- ----------- -------------- --------------- ------------- -------------- BALANCE, JANUARY 1, 1997 100 $3,604 $58,630 $ 303 $ (17,708) $44,829 Comprehensive income: Net income $10,543 10,543 10,543 Unrealized gain on available-for-sale investments, net of tax 949 949 949 Reclassification adjustment for gains included in net income (580) (580) (580) ---------- Comprehensive income $10,912 ======= Stock option activity 1,737 1,737 ------------ ------------------- ------------ ------------ -------- BALANCE, DECEMBER 31, 1997 100 3,604 60,367 672 (7,165) 57,478 Comprehensive income: Net income 13,760 13,760 13,760 Unrealized gain on available-for-sale investments, net of tax 614 614 614 Reclassification adjustment for gains included in net income (1,988) (1,988) (1,988) --------- Comprehensive income $12,386 ======= Capital contribution from parent 3,665 3,665 Stock option activity 418 418 ------------ -------------------- ------------ ------------ --------- BALANCE, DECEMBER 31, 1998 100 3,604 64,450 (702) 6,595 73,947 Comprehensive income: Net income 3,604 3,604 3,604 Unrealized loss on available-for-sale investments, net of tax (11,879) (11,879) (11,879) Reclassification adjustment for losses included in net income 381 381 381 --------- Comprehensive income $ (7,894) ------------ ---------------------------------- ========= ------------ BALANCE, DECEMBER 31, 1999 100 3,604 64,450 (12,200) 10,199 66,053 Comprehensive income: Net loss (unaudited) (8,451) (8,451) (8,451) Unrealized gain on available-for-sale investments, net of tax (unaudited) 3,089 3,089 3,089 Reclassification adjustment for losses included in net income (unaudited) 460 460 460 --------- Comprehensive income (unaudited) $ (4,902) ========= Dividend paid to parent (unaudited) (2,637) (2,637) BALANCE, SEPTEMBER 30, 2000 (unaudited) 100 $3,604 $64,450 $ (8,651) $ (889) $58,514 === ====== ======= ======== ======= =======
See the accompanying notes to consolidated financial statements. CII FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Nine Months Ended Year Ended December 31, September 30, 2000 1999 1999 1998 1997 ---- ---- ---- ---- ---- (Unaudited) (Unaudited) CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income $(8,451) $7,039 $3,604 $13,760 $10,543 Adjustments to reconcile net (loss) income to net cash provided by operating activities: Extraordinary gain (1,007) (170) (73) (3) Depreciation and amortization 1,197 950 1,220 1,550 928 Provision for asset impairment 3,000 Provision for losses on premiums (144) (144) Change in assets and liabilities: Premiums receivable (4,011) 1,303 1,365 1,078 504 Investment income receivable 380 238 (3) 1,768 (820) Deferred policy acquisition costs (354) (773) (574) (3) 31 Payable to affiliates (281) 3,555 662 10,213 834 Reinsurance recoverable (79,732) (39,471) (73,438) (37,011) (5,634) Federal income taxes receivable (4,582) 2,650 (4,404) (697) (3,022) Deferred income taxes 5,887 (1,637) (2,044) Reserve for loss and loss adjustment expense 97,508 879 32,130 9,565 14,923 Unearned premiums 2,906 2,579 2,142 (127) 1,400 Accounts payable and other accrued expenses 704 (2,130) (3,523) 4,889 589 Ceded reinsurance premiums payable (1,897) (3,241) 582 7,843 (42) Other assets (7,633) 4,366 5,142 (13,988) (807) --------- --------- --------- -------- ---------- Net cash (used in) provided by operating activities (2,253) (22,200) (29,522) (2,870) 17,380 --------- -------- -------- --------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (820) (4,011) (4,176) (4,395) (10,419) Purchase of available-for-sale investments (111,727) (159,576) (291,863) (682,334) (512,653) Proceeds from sales/maturities of available-for-sale investments 119,577 148,251 291,919 687,415 478,203 Purchase of held-to-maturity investments (1,499) (7,086) (7,133) (38,056) (7,776) Proceeds from maturities of held-to-maturity investments 4,366 30,980 36,077 18,087 4,872 ----- ------- ------- ------- ------ Net cash provided by (used in) investing activities 9,897 8,558 24,824 (19,283) (47,773) ------ ----- ------ ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Repurchase of convertible subordinated debentures (2,432) (55) (583) (3,143) (27) Dividend to Sierra (2,637) Capital contribution 3,665 Stock option activity ------------ 418 1,737 -------------- -- ----------------------- --------- Net cash (used in) provided by financing activities (5,069) (55) (583) 940 1,710 ---------- ------------ ----------- ---------- --------- NET CHANGE IN CASH AND CASH EQUIVALENTS 2,575 (13,697) (5,281) (21,213) (28,683) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 16,833 22,114 22,114 43,327 72,010 -------- -------- -------- -------- -------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $19,408 $ 8,417 $16,833 $22,114 $43,327 ======= ======== ======= ======= ======= SUPPLEMENTAL DISCLOSURES OF CASH FLOW DATA Cash paid during the year for interest (net of amount $3,713 $3,712 $3,724 $4,380 $4,088 capitalized) Cash paid during the year for income taxes 7 1,834 1,834 7,220 4,303
See the accompanying notes to consolidated financial statements. 1. Business CII Financial, Inc. ("CII Financial") was incorporated in the State of California on September 15, 1988. On October 31, 1995 Sierra Health Services, Inc. ("Sierra") acquired CII Financial for approximately $76.3 million of common stock in a transaction accounted for as a pooling of interests. CII Financial is a holding company primarily engaging in writing workers' compensation insurance through its wholly-owned subsidiaries, California Indemnity Insurance Company ("California Indemnity"), Commercial Casualty Insurance Company ("Commercial Casualty"), CII Insurance Company ("CII Insurance") and Sierra Insurance Company of Texas ("Sierra Texas"). As used herein, the term "the Company" means CII Financial, Inc. and its subsidiaries, and the term "CII Financial" means CII Financial, Inc., exclusive of such subsidiaries. 2. Summary of Significant Accounting Policies Principles of Consolidation. All significant intercompany transactions and balances have been eliminated. The consolidated financial statements of CII Financial include the accounts of all of its wholly-owned subsidiaries, California Indemnity, Commercial Casualty, Sierra Texas, CII Insurance, Sierra Insurance Agency, CII Leasing, Inc., Financial Assurance Company, Ltd. and CII Premium Finance Company. CII Leasing, Inc. and CII Premium Finance Company are both inactive subsidiaries. Unaudited Financial Statements. The accompanying unaudited balance sheet, as of September 30, 2000 and the consolidated statements of operations, stockholder's equity and cash flows for the nine month periods ended September 30, 2000 and 1999, have been prepared in conformity with accounting principles generally accepted in the United States of America but do not contain all of the information and disclosures that would be required in a complete set of audited financial statements. They should, therefore, be read in conjunction with the audited consolidated financial statements and related notes thereto for the years ended December 31, 1999, 1998 and 1997. In the opinion of management, the accompanying unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial results for the interim periods presented. Premium Revenues. Revenue from workers' compensation premiums are calculated by formula such that the premium written is earned pro rata over the term of the policy. Premiums written in excess of premiums earned are recorded as unearned premium revenue. The premium for workers' compensation insurance is calculated as a factor of an insured's payroll dollars during the period of coverage. At the inception of the policy, annual payroll dollars are estimated and the policy is issued with estimated annual premiums which are billed based on this estimate. Actual premiums for past interim coverage periods are periodically determined through payroll reporting and interim premium audits. The final actual premium is not determined until a final premium audit is performed, which occurs after the policy has expired. Direct premiums earned but not billed at the end of each accounting period are estimated and accrued, based on historical premium audit trends. Differences between such estimates and final billings are included in current operations. Accrued earned but unbilled premiums are included with premiums receivable. The number and dollar amount of issued workers' compensation insurance policies that are subject to retrospective adjustments based on incurred or paid claims or experienced rated premiums are not significant. Premium revenue is shown net of premiums ceded to reinsurers. General and Administrative Expenses. Policyholder's dividends and management fees are included in general and administrative expenses. Deferred Policy Acquisition Costs. Policy acquisition costs consist of commissions, premium taxes and other underwriting costs, which are directly related to the production and retention of new and renewal business and are deferred and amortized as the related premiums are earned. Should it be determined that future policy revenues and earnings on invested funds relating to existing insurance contracts will not be adequate to cover related costs and expenses, deferred costs are expensed. Cash and Cash Equivalents. The Company considers cash and cash equivalents as all highly liquid instruments with an original maturity of three months or less at the time of purchase. The carrying amount of cash and cash equivalents approximates fair value because of the short maturity of these instruments. Investments. Available-for-sale debt securities and preferred stocks are stated at fair value with unrealized gains and losses recorded as a separate component of other comprehensive income (loss), net of deferred income taxes. Held-to-maturity debt securities are carried at amortized cost. The insurance subsidiaries are required by state regulatory agencies to maintain certain deposits and must also meet certain net worth and reserve requirements. The Company, and its subsidiaries, are in compliance with the applicable minimum regulatory and capital requirements. Investment income is recognized when earned. Gains and losses on disposition are based on net proceeds and the adjusted carrying amount of the securities sold, using the specific identification method. The Company has an investment in a real estate limited partnership that is accounted for under the equity method. Under the equity method, original investments are recorded at cost and adjusted by the Company's share of earnings, losses and distributions. Property and Equipment. Property and equipment, consisting of buildings and leasehold improvements, furniture and fixtures, data processing equipment and vehicles, is stated at cost less accumulated depreciation. Depreciation is computed on a straight-line basis over periods ranging from 5 to 10 years with leasehold improvements depreciated over the term of the lease. Reinsurance. In the normal course of business, insurance companies seek to reduce the effects of events that may cause unfavorable underwriting results by reinsuring certain levels of risk in various levels of exposure with reinsurers. Amounts recoverable from the reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Reinsurance receivables, including amounts related to paid and unpaid losses, are reported as assets rather than a reduction of the related liabilities. Reserve for Loss and Loss Adjustment Expenses. The reserve for workers' compensation loss and loss adjustment expense ("loss and LAE") consists of estimated costs of each unpaid claim reported to the Company prior to the close of the accounting period as well as those incurred but not yet reported. The methods for establishing and reviewing such liabilities are continually reviewed and adjustments are reflected in current operations. The Company does not discount its loss and LAE reserves. Income Taxes. The Company accounts for income taxes using the liability method. Deferred income tax assets and liabilities result from temporary differences between the tax basis of assets and liabilities and the reported amounts in the consolidated financial statements that will result in taxable or deductible amounts in future years. The Company's temporary differences arise principally from certain net operating losses, accrued expenses, reserves for loss and LAE and depreciation. Federal income taxes are calculated pursuant to a tax allocation agreement between Sierra and the Company. Income taxes are allocated on a separate return basis for each company and tax benefits are recorded only to the extent that an entity could recoup taxes paid in prior years. Concentration of Credit Risk. The Company's financial instruments that are exposed to credit risk consist primarily of investments and accounts receivable. The Company maintains cash and cash equivalents and investments with various financial institutions. These financial institutions are located in many different regions, and Company policy is designed to limit exposure with any one institution. Credit risk with respect to accounts receivable is generally diversified due to the large number of entities comprising the Company's customer base and their dispersion across many different industries. These customers are primarily located in the states in which the Company operates principally California, Colorado, Nevada and Texas. However, the Company is licensed and does business in several other states. The Company also has receivables from certain reinsurers. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. All reinsurers that the Company has reinsurance contracts with are rated A- or better by the A.M. Best Company. Recently Issued Accounting Standards. In June 1998, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), as amended, which is effective for fiscal years beginning after June 15, 2000. SFAS 133 establishes additional accounting and reporting standards for derivative instruments and hedging activities. SFAS 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position. This statement also defines and allows companies to apply hedge accounting to its designated derivatives under certain instances. It also requires that all derivatives be marked to market on an ongoing basis. This applies whether the derivatives are stand-alone instruments, such as warrants or interest rate swaps, or embedded derivatives, such as call options contained in convertible debt investments. Along with the derivatives, in the case of qualifying hedges, the underlying hedged items are also to be marked to market. These market value adjustments are to be included either in the income statement or other comprehensive income, depending on the nature of the hedged transaction. The fair value of financial instruments is generally determined by reference to market values resulting from trading on a national securities exchange or in an over the counter market. In cases where derivatives relate to financial instruments of non-public companies, or where quoted market prices are otherwise not available, such as for derivative financial instruments, fair value is based on estimates using present value or other valuation techniques. Based on management's understanding of SFAS 133, the Company does not believe that it has any derivative instruments and does not have any hedging activities. The majority of the Company's investments are held by insurance companies, which are regulated as to the types of investments they may hold. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 clarifies existing accounting principles related to revenue recognition in financial statements. The Company is required to comply with the provisions of SAB 101 in its quarter ending December 31, 2000. Based upon the current nature of the Company's operations, management does not believe that SAB 101 will have any impact on the Company's results of operations. Business Segment. As of December 31, 1999 the Company operated in a single business segment, workers' compensation insurance. Use of Estimates in the Preparation of Financial Statements. The preparation of the Company's financial statements requires management to make estimates and assumptions that affect the amounts of reported assets and liabilities, particularly loss and LAE reserves and incurred loss and LAE reported in the financial statements. Loss and LAE reserves have a significant degree of uncertainty when related to their subsequent payments. Although reserves are established on the basis of a reasonable estimate, it is not only possible but probable that reserves will differ from their related subsequent developments. Underlying causes for this uncertainty include, but are not limited to, uncertainty in development patterns and unanticipated inflationary trends affecting the services provided by the insurance contract. This uncertainty can result in both adverse as well as favorable development of actual subsequent activity when compared to the reserve established. Any subsequent change in loss and LAE reserves established in a prior year would be reflected in the current year's operating results. 3. Property and Equipment Property and equipment at December 31, consists of the following (in thousands):
1999 1998 -------- -- ---- Buildings and leasehold improvements $1,124 $ 974 Furniture, fixtures and equipment 3,003 2,936 Data processing equipment and software 3,560 3,154 Construction in progress 5,178 1,625 Less: accumulated depreciation (4,511) (3,436) ------ ------ Net property and equipment $8,354 $5,253 ======= ======
Depreciation expense in 1999, 1998 and 1997 was $1,075,000, $1,345,000 and $722,000, respectively. During the second quarter of 2000 the Company wrote-off capitalized costs of $3.0 million related to the application development of an information system software project that was canceled because the vendor was unable to fulfill its contractual obligations. The amounts written off include software and consulting costs of $1,687,000 and capitalized internal personnel costs of $1,314,000. 4. Investments The following table summarizes the Company's debt securities and preferred stock investments as of December 31, 1999 (in thousands): -----------
Gross Gross ----------- Unrealized Unrealized Fair Value Amortized Gains Losses Cost Available-for-Sale: U.S. Government and its Agencies.......................................... $101,102 $122 $13,041 $ 88,183 Municipal Obligations......................................... 31,818 20 1,236 30,602 Corporate Bonds............................................... 32,907 45 1,730 31,222 Other......................................................... 17,908 2,619 15,289 Total Debt Securities......................................... 183,735 187 18,626 165,296 Preferred Stock............................................... 3,817 331 3,486 Total Available-for-Sale................................... $187,552 $187 $18,957 $168,782 Held-to-Maturity U.S. Government ======================================================================== and its Agencies.......................................... $9,782 $341 $ 708 $ 9,415 Municipal Obligations......................................... 5,558 64 55 5,567 Corporate Bonds............................................... 5,738 115 5,853 Other......................................................... 3,945 751 3,194 Total Held-to-Maturity...................................... $25,023 $520 $1,514 $ 24,029
The following table summarizes the Company's debt securities and preferred stock investments as of December 31, 1998 (in thousands): -----------
Gross Gross ----------- Unrealized Unrealized Fair Value Amortized Gains Losses Cost Available-for-Sale: U.S. Government $ and its Agencies.......................................... $78,071 $717 $1,189 77,599 Municipal Obligations......................................... 23,585 145 227 23,503 Corporate Bonds............................................... 76,479 596 823 76,252 Other......................................................... 8,542 19 271 8,290 Total Debt Securities......................................... 186,677 1,477 2,510 185,644 Preferred Stock............................................... 931 9 58 882 Total Available-for-Sale.................................... $187,608 $1,486 $2,568 $186,526 Held-to-Maturity U.S. Government ======================================================================== and its Agencies.......................................... $15,492 $ 47 $ 483 $ 15,056 Municipal Obligations......................................... 6,300 319 6,619 Corporate Bonds............................................... 11,909 557 12,466 Other......................................................... 20,266 937 19,329 Total Held-to-Maturity...................................... $53,967 $ 923 $1,420 $ 53,470
=============================================================================== The contractual maturities of available-for-sale debt securities at December 31, 1999 are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations.
(in thousands) Amortized Estimated Cost Fair Value Due in one year or less....................................... $ 8,492 $ 8,485 Due after one year through five years......................... 38,414 37,688 Due after five years through ten years........................ 13,909 13,298 Due after ten years through fifteen years..................... 13,844 12,664 Due after fifteen years....................................... 109,076 93,161 --------- --------- Total.................................................... $183,735 $165,296 ======== ========
- ------------------------------------------------------------------------------- The contractual maturities of held-to-maturity debt securities at December 31, 1999 are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations:
(in thousands) Amortized Estimated Cost Fair Value Due in one year or less....................................... $ 2,580 $ 2,611 Due after one year through five years......................... 9,565 9,585 Due after five years through ten years........................ 776 775 Due after ten years through fifteen years..................... 4,795 4,565 Due after fifteen years....................................... 7,307 6,493 --------- ----------- Total.................................................... $25,023 $ 24,029 ======= ========
- ------------------------------------------------------------------------------- Gross realized gains on investments for the nine months ended September 30, 2000 and the years ended December 31, 1999, 1998 and 1997 were $220,000 (unaudited), $261,000, $4,120,000 and $2,517,000, respectively. Gross realized losses on investments for the nine months ended September 30, 2000 and the years ended December 31, 1999, 1998 and 1997 were $680,000 (unaudited), $642,000, $2,132,000 and $1,937,000, respectively. Investment income, by major category of investments, is summarized as follows (in thousands):
Nine months ended September 30, Year Ended December 31, 2000 1999 1999 1998 1997 -------- -- ----- -- ----- -------- ------ (Unaudited) (Unaudited) Interest from debt securities $10,352 $10,962 $14,387 $17,175 $16,206 Dividend income from preferred stock 280 328 411 511 358 Mortgage interest 592 928 1,130 734 397 Other 42 ______ ----------- -------- -------------- Total investment income 11,266 12,218 15,928 18,420 16,961 Investment expenses 49 143 152 179 180 ----------- --------- ---------- ---------- ---------- Net investment income $11,217 $12,075 $15,776 $18,241 $16,781 ======= ======= ======= ======= =======
Of the total debt securities and cash equivalents, $152,356,000, $171,639,000 and $179,878,000, at fair value, were on deposit with regulatory authorities in compliance with certain legal requirements related to the insurance operations at September 30, 2000, December 31, 1999 and 1998, respectively. The Company holds certain mortgage notes on residential and commercial real estate. In connection with CII Financial's relocation of its principal executive offices to Pleasanton, California in July 1992, to retain key officers and other employees, the Company extended mortgage loans for the purchase of such employees' principal residences. The interest rate was reduced to a fixed rate of 3% per annum; the maturity date was fixed to March 2009; and each loan can be assumed, one time, by a qualified purchaser of the employee's residence. The interest rate, upon assumption, increases to 3.5% per annum. As of December 31, 1999 and 1998, the outstanding balances on employee relocation loans were $4,764,000 and $4,949,000, respectively. The Company also holds commercial mortgage loans, the majority of which are with Sierra affiliates. These loans are also first trust deeds and earn between 7% and 11 1/2% per annum. The Company has one mortgage loan with a non-affiliated third party which is currently in default; the principle balance outstanding was $1,633,000 at September 30, 2000. The property has been appraised at a value that exceeds book value. Interest income has not been accrued since the default date. The Company is currently litigating the priority of its lien on the property. The Company has made demand under its title insurance policy and will foreclose pending the outcome of the litigation on its claim. 5. Reinsurance The Company has reinsurance agreements or treaties in effect with unrelated entities. In 1999 and 1998, workers' compensation claims between $500,000 and $100,000,000 per occurrence are 100% reinsured. In 1997, workers' compensation claims between $350,000 and $60,000,000 per occurrence were 100% reinsured. In addition, effective July 1, 1998, workers' compensation claims below $500,000 per occurrence were reinsured under quota share and excess of loss reinsurance agreements (referred to as "low level reinsurance") with an A+ rated carrier. Under this agreement, the Company reinsures 30% of the first $10,000 of each loss, 75% of the next $40,000 and 100% of the next $450,000. The Company receives a 9.25% ceding commission from the reinsurer as a partial reimbursement of its operating expenses. The low level reinsurance agreement expired on June 30, 2000; however the Company opted to continue ceding premiums and losses under the low level agreement on a run off basis for all policies in force on June 30, 2000. Effective January 1, 2000 we entered into a reinsurance contract that provides statutory (unlimited) coverage for workers' compensation claims in excess of $500,000 per occurrence. The contract is in effect for claims occurring on or after January 1, 2000 through December 31, 2000. On July 1, 2000, the Company entered into a reinsurance agreement that covers losses on claims in excess of $250,000 to $500,000 for policies issued after June 30, 2000. The low level reinsurance agreement was consummated early in the fourth quarter of 1998 but coverage was made retroactive to July 1, 1998. Therefore, this agreement contained both retroactive (covering claims occurring in the third calendar quarter of 1998) and prospective reinsurance coverage (covering claims occurring after September 30, 1998) and, in accordance with Statement of Financial Accounting Standards No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts" ("SFAS 113"), the Company has bifurcated the low level reinsurance agreement to account for the different accounting treatments. The amount by which the estimated ceded liabilities exceed the amount paid for the retroactive coverage is reported as a deferred gain and amortized to income as a reduction of incurred losses over the estimated remaining settlement period using the interest method. Any subsequent changes in estimated or actual cash flows related to the retroactive coverage are accounted for by adjusting the previously recorded deferred gain to the balance that would have existed had the revised estimate been available at the inception of the reinsurance transactions, with a corresponding charge or credit to income. During 1999, the Company recorded an adjustment to increase its deferred gain related to retroactive reinsurance coverage by $4,615,000. For the years ended December 31, 1999 and 1998, the Company amortized deferred gains of $3,850,000 and $1,038,000, respectively. In accordance with SFAS 113, losses ceded under prospective reinsurance reduce direct incurred losses and amounts recoverable are reported as an asset. At December 31, 1999 and 1998, the amount of reinsurance recoverable under prospective reinsurance contracts for unpaid loss and LAE was $110,089,000 and $37,797,000, respectively. At December 31, 1999 and 1998, the amount of reinsurance recoverable under the retroactive reinsurance contract was $14,842,000 and $18,710,000, respectively. The amount of reinsurance receivable for paid loss and LAE was $6,931,000 and $1,917,000 at December 31, 1999 and 1998, respectively. Such amortization is included in loss and loss adjustment expense on the accompanying consolidated statements of operations. Reinsurance contracts do not relieve the Company from its obligations to enrollees or policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. Substantially all of the reinsurance recoverables are due from reinsurers rated A+ by the A.M. Best Company and all amounts are considered to be collectible. The following table provides workers' compensation prospective reinsurance information for the periods ended (in thousands):
Change in Recoveries Recoverable on Paid or Unpaid Premiums Loss / LAE Loss / LAE Ceded Nine Months Ended September 30, 2000 (Unaudited): Low level reinsurance carrier $36,180 $79,170 $56,732 Excess of loss reinsurance carriers 1,678 6,275 2,445 --------- --------- --------- Total $37,858 $85,445 $59,177 ======= ======= ======= Nine Months Ended September 30, 1999 (Unaudited): Low level reinsurance carrier $14,088 $40,191 $43,264 Excess of loss reinsurance carriers 2,578 3,145 2,194 --------- --------- --------- Total $16,666 $43,336 $45,458 ======= ======= ======= Year Ended December 31, 1999: Low level reinsurance carrier $21,941 $69,104 $60,702 Excess of loss reinsurance carriers 1,730 3,188 3,025 --------- --------- --------- Total $23,671 $72,292 $63,727 ======= ======= ======= Year Ended December 31, 1998: Low level reinsurance carrier $ 1,379 $19,664 $16,095 Excess of loss reinsurance carriers 3,292 (2,923) 3,672 -------- -------- --------- Total $ 4,671 $16,741 $19,767 ======= ======= ======= Year Ended December 31, 1997: Excess of loss reinsurance carriers $ 841 $ 5,380 $ 4,983 ======== ======== ========
6. Loss and Loss Adjustment Expenses The following table provides a reconciliation of the beginning and ending reserve balances for unpaid loss and LAE. The loss estimates are subject to change in subsequent accounting periods and any change to the current reserve estimates would be accounted for in future results of operations. While management of the Company believes that current estimates are reasonable, significant adverse or favorable loss development could occur in the future.
Nine Months Ended (In thousands) September 30, Year Ended December 31, 2000 1999 1999 1998 ---- -------- ---- ------- ------------ ---- ------- (Unaudited) (Unaudited) 1997 Net beginning loss and LAE reserve $134,305 $174,467 $174,467 $181,643 $172,100 -------- -------- -------- -------- -------- Net provision for insured events incurred in: Current year 63,843 36,061 51,541 103,990 102,302 Prior years 20,177 (1,248) 9,920 (9,643) (8,970) --------- --------- ---------- ----------- --------- Total net provision 84,020 34,813 61,461 94,347 93,332 --------- --------- --------- ---------- --------- Net payments for loss and LAE Attributable to insured events incurred in: Current year 15,763 12,836 21,207 29,591 26,812 Prior years 49,893 64,668 80,416 71,932 56,977 --------- -------- --------- --------- --------- Total net payments 65,656 77,504 101,623 101,523 83,789 --------- -------- -------- -------- --------- Net ending loss and LAE reserve 152,669 131,776 134,305 174,467 181,643 Reinsurance recoverable 189,233 81,367 110,089 37,797 21,056 --------- --------- -------- --------- ---------- Gross ending loss and LAE reserve $341,902 $213,143 $244,394 $212,264 $202,699 ======== ======== ======== ======== ========
During the nine months ended September 30, 2000, the Company experienced net adverse development related to accident years 1999 and prior. Estimated loss and LAE incurred in accident years 1996 to 1998 have developed significantly in response to the continuation of increasing claim severity patterns on the Company's California book of business. Many workers' compensation insurance carriers in California are also experiencing high claim severity. For claims occurring on and after July 1, 1998, the Company has reinsured a percentage of the higher claim severity to its reinsurer under the Company's low level reinsurance agreement. The low level reinsurance agreement expired on June 30, 2000; however the Company opted to continue ceding premiums and losses under the low level agreement on a run off basis for all policies in force on June 30, 2000. Effective January 1, 2000 we entered into a reinsurance contract that provides statutory (unlimited) coverage for workers' compensation claims in excess of $500,000 per occurrence. The contract is in effect for claims occurring on or after January 1, 2000 through December 31, 2000. On July 1, 2000, the Company entered into a reinsurance agreement that covers losses on claims in excess of $250,000 to $500,000 for policies issued after June 30, 2000. 7. Long Term Debt 7 1/2% Convertible Subordinated Debentures. The Company's long-term debt at September 30, 2000 and December 31, 1999 and 1998 consists of convertible subordinated debentures with an outstanding balance of $47,059,000, $50,498,000 and $51,251,000 respectively. In September 1991, the Company issued convertible subordinated debentures (the "Debentures") due September 15, 2001. The Debentures bear interest at 7 1/2% which is due semi-annually on March 15 and September 15. Each $1,000 in principal is convertible into 25.382 shares of Sierra common stock at a conversion price of $39.398 per share. Unamortized issuance costs of $111,000, $362,000 and $509,000 at September 30, 2000 and December 31, 1999 and 1998, are included in other assets on the consolidated balance sheets and are being amortized over the life of the Debentures. Accrued interest on the Debentures as of September 30, 2000 and December 31, 1999 and 1998 was $111,000, $1,099,000 and $1,117,000, respectively. The Debentures are redeemable in whole or in part, at a redemption price of 100.75% plus accrued interest. The Debentures are subordinated obligations of CII Financial only and were not assumed or guaranteed by Sierra. During the nine months ended September 30, 2000 and the years ended December 31, 1999, 1998 and 1997, the Company and/or Sierra repurchased $3,457,000, $753,000, $3,216,000 and $30,000 respectively, of the debentures on the open market resulting in extraordinary gains of $1,007,000, $170,000, $73,000 and $3,000 and a corresponding tax provision of $353,000, $59,000, $25,000 and $1,000 in 2000, 1999, 1998 and 1997 respectively. Sale and purchase activity for the Debentures, to parties other than the Company or Sierra, is believed to be minimal and there is no known market quotation system for the Debentures. The fair value of the Debentures at September 30, 2000 and December 31, 1999 was $23,530,000 and $35,601,000, respectively, which was determined based on purchases made by the Company during September 2000 and the estimated market price on December 31, 1999. The September 30, 2000 price is based on $18,000 stated value debentures purchased for $9,000 and may not be indicative of the actual market value. The Debentures are scheduled to mature on September 15, 2001. CII Financial has limited sources of cash and borrowed approximately $365,000 from Sierra to make the September 15, 2000 interest payment. CII Financial is dependent upon dividends from its subsidiary, California Indemnity Insurance Company, to meet its debt payment obligations. Currently, California Indemnity cannot pay any dividends without prior approval by the California Department of Insurance as it has no earned surplus and it may not have sufficient earned surplus from which to pay a dividend to CII Financial when the Debentures mature in 2001. Sierra has no obligation to lend any or enough funds to CII Financial to pay the Debentures when they mature. Accordingly, CII Financial does not expect to have readily available funds to pay the Debentures when they mature. The Company is exploring strategies regarding refinancing of the 7 1/2% subordinated convertible debentures including refinancing, extending the maturity date or exchanging the Debentures. There can be no assurances that CII Financial or Sierra will have the cash resources required to meet the obligations under the Debentures or that the Company will be able to successfully implement a strategy for refinancing of the Debentures. In December 2000, CII Financial commenced a proposed exchange offer to the holders of the 7 1/2% debentures to restructure the debt, extend the maturity date and reduce the overall debt of the Company. The offering proposed to exchange an amount of cash plus new subordinated debentures with a later maturity date. 8. Commitments and Contingencies Leases. The Company is the lessee under several operating leases most of which relate to office facilities and equipment. The rentals on these leases are charged to expense over the lease term and, where applicable, provide for rent escalations based on certain costs and price index factors. The following is a schedule, by year, of the future minimum lease payments under existing operating leases (in thousands): Year Ending December 31, 2000............................................. $ 2,756 2001............................................. 2,617 2002............................................. 2,457 2003............................................. 1,661 2004............................................. 1,297 Thereafter....................................... 5,342 ---------- Total....................................... $ 16,130 ======== Rent expense totaled $2,602,000, $1,314,000 and $1,313,000 in 1999, 1998 and 1997, respectively. Guaranty of Sierra's Credit Facility Debt. At June 30, 2000, Sierra was not in compliance with certain financial covenants relating to its line of credit. The lenders provided Sierra with waivers effective June 30, 2000 and expiring October 31, 2000. In consideration for the banks granting one of the waivers, in August 2000, CII Financial became a guarantor of the Sierra credit facility debt. Should CII Financial be asked by the banks to perform on its guaranty, the Debentures would be subordinated to Sierra's credit facility debt. The waivers expired on October 31, 2000 and Sierra received a Notice of Default from the banks on November 8, 2000. No demand was made by the banks to perform on the guaranty and Sierra was able to amend its credit facility agreement on December 15, 2000. The new Sierra credit facility agreement expires on September 30, 2003. In the amended agreement, CII Financial continues to provide a guaranty of the debt in the event of a default by Sierra. Litigation and Legal Matters. The Company is subject to various claims and other litigation in the ordinary course of business. Such litigation includes claims for workers' compensation and claims by providers for payment for medical services rendered to injured workers. In the opinion of the Company's management, the ultimate resolution of pending legal proceedings should not have a material adverse effect on the Company's financial condition. 9. Federal Income Taxes A summary of the provision for income taxes for the years ended December 31, 1999, 1998 and 1997 is as follows (in thousands):
Year Ended December 31, 1999 1998 1997 -------- -------- ------ (Benefit) provision for income taxes: Current tax on operating income ($2,286) $6,829 $3,045 Deferred tax on operating income 5,888 (2,663) (2,773) ------- ------ ----- Total tax on operating income 3,602 4,166 272 Current tax on extraordinary gain 59 25 1 ---------- --------- ---------- Total $3,661 $4,191 $ 273 ======= ====== ======
The following reconciles the difference between the 1999, 1998 and 1997 reported and statutory provision for income taxes:
1999 1998 1997 -- ------ -- ------ -- ---- Statutory rate 35% 35% 35% Tax preferred investments (6%) (2%) (4%) Change in valuation allowance 16% (11%) (34%) Other 5% 1% 5% ------- ------ ----- Provision for income taxes 50% 23% 2% ====== ===== =====
In 1991 and 1992, California Indemnity had taxable net operating losses ("NOLs") that were available, under the tax sharing agreement, to be carried forward to offset future taxable income. The deferred income tax asset related to these NOLs was fully reserved with a valuation allowance. In 1997 and 1998, California Indemnity had taxable operating income, which was partially offset by the NOLs, due to the separate return limitation year rules. The valuation allowances were reversed as the NOL was used and the NOLs were fully utilized in 1998. On a separate return basis, CII Financial has historically had taxable NOLs, including the three years ended December 31, 1999. Under the tax sharing agreement, valuation allowances have been established for the deferred income tax asset related to CII Financial's NOLs as they can only utilize the NOLs to the extent that they have income on a separate return basis. Under the tax sharing agreement, NOTES TO CONSOLIDATED FINANCIAL STATEMENTS the amount and expiration dates of CII Financial's NOLs as of December 31, 1999 are as follows: Generated Amount Expires --------- ------ ------- 1993 $ 1,935,000 2008 1994 7,185,000 2009 1995 6,533,000 2009 1995 793,000 2010 1996 3,339,000 2011 1997 4,122,000 2012 1998 3,685,000 2018 1999 3,250,000 2019 ------------------ $30,842,000 ================== F-26 The tax effects of significant items comprising the Company's net deferred tax assets are as follows (in thousands):
1999 1998 -- ------ -- ---- Deferred tax assets: Loss and LAE reserves $ 1,956 $ 6,401 Accruals not currently deductible 1,128 1,374 Compensation accruals 616 754 Bad debt allowances 397 447 Loss carryforwards and credits 13,514 12,657 Unearned premiums 935 781 Deferred reinsurance gains 2,456 2,188 Unrealized investment losses 6,569 378 --------- --------- Total 27,571 24,980 Deferred tax liabilities: Deferred policy acquisition costs 832 631 Depreciation and amortization 1,255 454 Other 652 543 ---------- ---------- Total 2,739 1,628 Net deferred tax asset before valuation allowance 24,832 23,352 Valuation allowance (10,227) (9,052) ------- --------- Net deferred tax asset $14,605 $14,300 ======= =======
In lieu of state franchise and corporate income taxes, California Indemnity, Commercial Casualty, CII Insurance and Sierra Texas pay premium taxes based upon direct written premiums to the states in which they write business. Premium tax expense of $4,078,000, $4,228,000 and $3,730,000 is included in policy acquisition costs in the consolidated statements of operations for the years ended December 31, 1999, 1998 and 1997, respectively. Current tax receivable balances are $6,919,000, $4,896,000 and $492,000 as of September 30, 2000 and December 31, 1999 and 1998, respectively. These amounts are due from Sierra as the administrative agent under the tax sharing agreement. 10. Dividend Restrictions - Insurance Subsidiaries Under California insurance company statutes and regulations, California Indemnity, Commercial Casualty and CII Insurance are restricted as to the amount of dividends they may pay on their common stock to their respective parent companies. Sierra Texas is regulated by Texas insurance statutes and regulations that are similar to California in terms of paying dividends. No dividends may be paid without at least ten business days prior notice to the Insurance Commissioner. Unless specially approved by the Insurance Commissioner prior to payment, dividends may be paid only out of accumulated earned surplus, excluding any earned surplus attributable to unrealized appreciation in assets or an exchange of assets. If a dividend or other distribution is contemplated which, along with all other dividends or distributions made within the preceding twelve months, exceeds the greater of 10% of the insurance company's policyholders' surplus as of the end of the prior calendar year or net income for such calendar year, at least 30 days prior notice to the Commissioner must be given, and no payment of the dividend or distribution may be made unless and until (i) the Commissioner has approved it or (ii) the 30 days have elapsed and the Commissioner has not disapproved the proposed payment. Net income and stockholder's equity of domestic insurance subsidiaries, as filed with regulatory authorities on the basis of statutory accounting practices, are summarized as follows (in thousands):
Nine Months Year Ended December 31, Ended September 30, 2000 1999 1998 1997 --------- --------- --------- ------- (Unaudited) Statutory net (loss) income for the period ended $ (7,185) $ 12,283 $ 20,877 $11,277 Statutory stockholder's equity at the period ended 106,078 118,278 116,580 96,061
Based on its financial position as of December 31, 1999, California Indemnity can pay $6,840,000 in shareholder dividends to CII Financial during 2000 without the prior approval of the California Insurance Commissioner. Commercial Casualty, CII Insurance and Sierra Texas can pay $1,686,000, $376,000 and $216,000, respectively to California Indemnity without prior approval of the applicable state insurance commissioner. CII Financial, Inc. paid dividends of $2,637,000, in March 2000, to Sierra. California Indemnity paid dividends to CII Financial of $6,800,000 and $6,000,000, during 2000 and 1999, respectively. During 1999, Commercial Casualty paid $1,700,000 in dividends to California Indemnity. Due notice was filed with the California Department of Insurance, and the payment was made after the expiration of the required waiting period in accordance with California Insurance regulations. The National Association of Insurance Commissioners adopted risk-based capital guidelines for property-casualty insurance companies whereby required statutory surplus would be based, in part, on a formula based risk assessment of the individual investments held in the insurance company's portfolio. The Company's risk-based capital results for the years ended December 31, 1999, 1998 and 1997 exceeded the minimum surplus required under the regulations. In March 1998, the NAIC adopted the Codification of Statutory Accounting Principals (the "Codification"). The Codification, which is intended to standardize regulatory accounting and reporting for the insurance industry, becomes effective January 1, 2001. However, statutory accounting principles will continue to be established by individual state laws and permitted practices. The state of California has indicated that it intends to require adoption of the Codification for the preparation of statutory financial statements. The Company has not finalized the quantification of the effects of the Codification on its statutory financial statements. 11. Employee Compensation and Benefit Plans Defined Contribution Plan. All employees who meet minimum requirements can participate in Sierra's defined contribution pension and 401(k) plan (the "Plan"). The Plan covers all employees who meet certain age and length of service requirements. For the years ended December 31, 1998 and 1997 and for the six months ended June 30, 1999, the Company contributed a maximum of 2% of eligible employees' compensation and matched 50% of a participant's elective deferral up to a maximum of either 10% of an employee's compensation or the maximum allowable under current IRS statute. Effective July 1, 1999, the Plan was modified such that the Company matches 50%-100% of an employee's elective deferral and the maximum Company match is 6% of a participant's annual compensation, subject to Internal Revenue Service limits. The Plan does not require additional Company contributions. For the years ended December 31, 1999, 1998 and 1997, the Company expensed $601,000, $625,000 and $630,000, respectively, to this plan. Executive Retirement Plans. The Company offered key employees and officers a Supplemental Executive Retirement Plan and Supplemental Senior Executive Retirement Plan. Eligibility for participation in both plans was limited to officers and key employees selected and approved by the Board of Directors. These plans were terminated effective October 31, 1995, and there have been no further contributions. Pursuant to contractual obligations under the plans, the Company paid $250,000 to a former plan participant in each of the years ended December 31, 1999, 1998 and 1997. Employment Contracts. The Company currently has an employment contract with its Chief Executive Officer expiring December 2001. Minimum aggregate cash compensation obligations under this contract are $214,000 for both 2000 and 2001. Employee Stock Purchase Plan. The Company offers employee stock purchase plans through Sierra (the "Purchase Plan") whereby employees may purchase newly issued shares of stock through payroll deductions at 85% of the fair market value of such shares on specified dates as defined in the Purchase Plan. Stock Option Plans. The Company offers several plans, through Sierra, that provide common stock-based awards to employees and to non-employee directors. The plans provide for the granting of options, stock, and other stock-based awards. Awards are granted by a committee appointed by the Sierra Board of Directors and no specific amount has been reserved for the Company's employees. Options become exercisable at such times and in such installments as set by the committee. The exercise price of each option equals the market price of Sierra stock on the date of grant. Stock options generally vest at a rate of 20% - 25% per year. Options generally expire one year after the end of the vesting period. The tax benefit related to the exercise of options by Company employees is passed on to the Company by Sierra. This totaled $0, $418,000 and $1,737,000 for 1999, 1998 and 1997 respectively. The following table reflects the activity of the stock option plans:
Number of Option Weighted Shares Price Average Price Outstanding January 1, 1997 838,000 $ 6.31 - $23.33 $12.78 Granted.................................. 59,000 17.58 - 24.50 22.87 Exercised................................ (481,000) 6.31 - 21.17 11.86 Canceled................................. (3,000) 6.31 - 16.67 12.89 ---------- Outstanding December 31, 1997 .............. 413,000 6.31 - 24.50 15.31 Granted.................................. 32,000 16.94 - 22.38 21.53 Exercised................................ (110,000) 6.31 - 19.08 13.21 Canceled................................. (12,000) 9.91 - 24.50 17.85 ------------- Outstanding December 31, 1998............... 323,000 6.31 - 24.50 16.56 Granted.................................. 152,000 6.69 - 21.00 8.87 Exercised................................ (1,000) 6.31 - 11.71 7.81 Canceled................................. (19,000) 11.71 - 24.50 13.87 --------- Outstanding December 31, 1999............... 455,000 6.31 - 24.50 14.12 ======== Exercisable at December 31, 1999 ........... 203,000 $ 6.31 - $24.50 $16.23
======= The following table summarizes information about stock options outstanding at December 31, 1999:
Weighted Average Weighted Average Range of Exercise Contractual Life Options Exercise Price Prices Remaining in Days Outstanding Exercisable Outstanding Exercisable - ----------------------- ----------------- ---------------------------- ---------------------------- $ 6.31 - $ 8.00 1,981 152,000 16,000 $ 7.24 $ 4.82 9.91 - 12.08 4,445 88,000 53,000 10.65 10.52 16.67 - 21.17 1,039 137,000 102,000 17.19 17.11 22.38 - 24.50 1,513 78,000 32,000 21.34 18.29
Accounting for Stock-Based Compensation. The Company uses the intrinsic value method in accounting for its stock-based compensation plans. Accordingly, no compensation cost has been recognized for its employee stock option plans nor the Purchase Plans. Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans, the Company's net income for the years ended December 31 would have been reduced to the pro forma amounts indicated below:
For the Years Ended ----------------------------------------------------- 1999 1998 1997 ---- ---- ---- Net Income As reported $3,604,000 $13,760,000 $10,543,000 Pro forma 3,188,000 13,479,000 10,291,000
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 1999, 1998 and 1997, respectively: dividend yield of 0% for all years; expected volatility of 43%, 37% and 35%; risk-free interest rates of 5.86%, 4.43% and 5.91%; and expected lives of four to five years. The weighted average fair value of options granted in 1999, 1998 and 1997 was $3.82, $9.34 and $12.43, respectively. The fair value of the look-back option implicit in each offering of the Purchase Plans is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 1999, 1998 and 1997, respectively: dividend yield of 0% for all years; expected volatility of 45%, 32% and 35%; risk-free interest rates of 4.66%, 5.30%, and 5.32%; and expected lives of six months for all years. During 1999, the Company extended by three years the expiration date for 6,000 options covering shares that would have expired in 1999 and 2000. The exercise price per share for these options ranges from $12.08 to $19.08. No expense was recognized in the consolidated statement of operations related to these options. Expense of $31,000 is included in the Pro forma information presented. Due to the fact that the Company's stock option programs vest over many years and additional awards are made each year, the above pro forma numbers are not indicative of the financial impact had the disclosure provisions of FAS 123 been applicable to all years of previous option grants. The above numbers do not include the effect of options granted prior to 1995. F-25 12. Other Related Party Transactions The Company entered into a management services agreement with Sierra effective January 1, 1999. The agreement provides investment, accounting, human resources, systems and other administrative services. The fee for the services is based on actual direct and allocable costs related to the services rendered and does not include any management overhead allocations. Allocable costs, consisting primarily of rent and related property expenses, equipment and other non-labor costs, were pro ratably determined using methods that management believes are reasonable and appropriate. The methods of allocations were primarily determined based on the number of employees and occupied square footage. Management fee expense for 1999 totaled $1,338,000. The Company did not have a management agreement with Sierra prior to January 1, 1999. The Company purchases employee health insurance from its affiliates, Health Plan of Nevada, Inc., Sierra Health and Life Insurance Company, Inc. and Texas Health Choice, L.C. The Company paid $642,000, $528,000 and $498,000 to the aforementioned affiliates for years ended 1999, 1998 and 1997, respectively. The premiums paid to its affiliates were determined on an arms-length basis. At January 1, 1998, California Indemnity had an investment in real estate owned and occupied of $11,959,000. During the year, California Indemnity obtained a mortgage loan on this property in the amount of $5,000,000. In the fourth quarter of 1998, the property, net of the mortgage loan, with a book value of $8,442,000, which approximated fair value, was contributed to a real estate limited partnership of which Sierra is the general partner. California Indemnity agreed to adjust its partnership interest to approximate its occupancy. The adjustment, which was based on the then equity value of the partnership, resulted in Sierra purchasing a portion of California Indemnity's interests for $2,262,000. Simultaneously with the execution of the partnership agreement, California Indemnity contributed one-half of its adjusted interest into the limited partnership, valued at $3,092,000, to its wholly-owned subsidiary, Commercial Casualty. There were no gains or losses recorded on these transactions as book value approximated fair value at the time of the transaction. Together, California Indemnity and Commercial Casualty own limited partner interests totaling approximately 27% of the limited partnership. These transactions were done to enable both companies to qualify for certain premium tax credits in the state of Nevada and were approved by the California Department of Insurance. As part of the transaction to form and fund the limited partnership, California Indemnity was released from any obligation directly under the mortgage loan. Concurrent with the sale of the real estate, California Indemnity entered into a rental agreement with the related partnership under which California Indemnity leases a portion of the transferred real estate. Rental expense under this agreement was approximately $1,168,000 and $270,000 in 1999 and 1998, respectively. In December 2000, in conjunction with a sale-leaseback transaction of Sierra's Las Vegas real estate portfolio, the limited partnership sold the real estate to an unrelated third party and the rental agreement was canceled. Sierra entered into a 15-year master lease with the third party purchaser on this real estate. Effective January 1, 2001, Sierra and California Indemnity have entered into a one-year sublease for the space occupied by California Indemnity. The sublease is subject to the provisions of Sierra's master lease and automatically renews from year to year unless California Indemnity gives notice prior to December 1st of each year. In September 1998, California Indemnity refinanced a 15-year mortgage note of an affiliated real estate partnership. Sierra is the majority owner of the partnership. The note is secured by a first deed of trust and pays interest at 7% per annum. The loan to value ratio was approximately 68%. In December 2000, in conjunction with a sale-leaseback of Sierra's Las Vegas real estate portfolio, the mortgage note receivable was paid in full. In March 2000, California Indemnity financed a $7,400,000 five-year mortgage note to Sierra. The note is secured by a first deed of trust and earns quarterly interest payments at 8.75% per annum beginning April 1, 2000 until April 1, 2005, when the unpaid principal balance is due and payable in full. The note is callable in April 2001. In December 2000, in conjunction with a sale-leaseback of Sierra's Las Vegas real estate portfolio, the mortgage note was assumed by the buyer, the interest rate was increased and the maturity date was set at December 31, 2001. The buyer can extend the maturity date for two periods of six months with proper notice to California Indemnity and payment of additional fees. In order to make the September 15, 2000 interest payment on the junior subordinated debentures, Sierra advanced $365,000 to CII Financial, Inc. 13. Quarterly Results of Operations (Unaudited) The following table sets forth the unaudited data regarding operations for each quarter of the nine months ended September 30, 2000, and the years ended December 31, 1999 and 1998. In the opinion of management, such unaudited data includes all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the information presented. The Company's operating results for any quarter are not necessarily indicative of the operating results for any future period. Nine months ended September 30, 2000 (in thousands):
3rd Quarter 2nd Quarter 1st Quarter Net earned premiums $38,263 $27,344 $25,344 Net investment income 3,817 3,571 3,369 --------- ---------- --------- Total revenues 42,080 30,915 28,713 Costs and expenses 40,832 48,957 25,926 -------- ---------- -------- Income (loss) before income tax and extraordinary gain 1,248 (18,042) 2,787 Federal income tax provision (benefit) 437 (6,492) 1,153 ---------- ---------- --------- Income (loss) before extraordinary gain 811 (11,550) 1,634 Extraordinary gain, net of tax 93 485 76 ----------- ------------ ---------- Net income (loss) $ 904 $(11,065) $ 1,710 ========= ======== =======
Year ended December 31, 1999 (in thousands):
4th Quarter 3rd Quarter 2nd Quarter 1st Quarter Net earned premiums $24,705 $21,860 $18,470 $17,920 Net investment income 3,490 3,788 3,944 4,173 --------- --------- -------- -------- Total revenues 28,195 25,648 22,414 22,093 Costs and expenses 32,952 21,451 18,641 18,211 ------- -------- ------- ------- (Loss) income before income tax and extraordinary gain (4,757) 4,197 3,773 3,882 Federal income tax (benefit) provision (1,212) 1,679 1,535 1,600 -------- -------- -------- -------- (Loss) income before extraordinary gain (3,545) 2,518 2,238 2,282 Extraordinary gain, net of tax 109 1 1 ---------- --------- ----------- ----------- Net (loss) income $ (3,436) $ 2,518 $ 2,239 $ 2,283 ======== ======= ======= =======
Year ended December 31, 1998 (in thousands):
4th Quarter 3rd Quarter 2nd Quarter 1st Quarter Net earned premiums $24,308 $40,162 $36,978 $32,826 Net investment income 4,511 5,445 5,540 4,733 -------- -------- -------- -------- Total revenues 28,819 45,607 42,518 37,559 Costs and expenses 22,946 40,901 37,896 34,882 ------- ------- ------- ------- Income before income tax and extraordinary gain 5,873 4,706 4,622 2,677 Federal income tax Provision (benefit) 4,192 (25) (1) ______ ------- ---------- ----------- Income before extraordinary gain 1,681 4,731 4,623 2,677 Extraordinary gain, net of tax ______ 45 3 ______ ---------- ----------- Net income $ 1,681 $ 4,776 $ 4,626 $ 2,677 ======= ======= ======= =======
F-28 CII FINANCIAL, INC. AND SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEETS - Parent Company Only (In thousands)
September 30, December 31, 2000 1999 1998 ---- ---- ---- ASSETS (Unaudited) Cash and cash equivalents $ 83 $ 857 $ 481 Equity in net assets of subsidiaries 104,512 115,002 125,945 Property and equipment, net 1,216 1,621 2,209 Net due from affiliates 936 Other assets 314 568 1,051 ------------ ------------ ----------- TOTAL ASSETS $107,061 $118,048 $129,686 ======== ======== ======== LIABILITIES AND STOCKHOLDER'S EQUITY Convertible subordinated debentures $ 47,059 $ 50,498 $ 51,251 Net payable to affiliates 251 3,217 Accrued interest payable 111 1,099 1,117 Accounts payable and accrued expenses 1,377 147 154 ----------- ----------- ------------ TOTAL LIABILITIES 48,547 51,995 55,739 ---------- --------- ---------- STOCKHOLDER'S EQUITY Common stock, no par value, 1,000 shares authorized; shares issued and outstanding - 100 3,604 3,604 3,604 Additional paid-in capital 64,450 64,450 64,450 Accumulated other comprehensive loss: Unrealized holding loss on available-for-sale investments of subsidiaries (8,651) (12,200) (702) (Accumulated deficit) retained earnings (889) 10,199 6,595 ----------- ---------- ----------- TOTAL STOCKHOLDER'S EQUITY 58,514 66,053 73,947 ---------- ---------- ---------- TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $107,061 $118,048 $129,686 ======== ======== ========
CII FINANCIAL, INC. AND SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued) CONDENSED STATEMENT OF OPERATIONS - Parent Company Only (In thousands)
Nine Months Ended September Year Ended December 31, 30, 2000 1999 1999 1998 1997 ---- ---- ---- ---- ---- (Unaudited) (Unaudited) REVENUES Net investment income $ 38 $ 1 $ 25 $ 118 Realized gains on investments 294 Other 707 $ 840 1,084 1,323 435 -------- -------- -------- -------- -------- Total revenues 745 840 1,085 1,348 847 --------- --------- -------- -------- -------- EXPENSES Interest expense 2,725 2,882 3,707 3,997 4,088 General and administrative 523 620 765 897 568 -------- -------- --------- --------- -------- Total expenses 3,248 3,502 4,472 4,894 4,656 ------- ------- -------- -------- ------- Equity in undistributed (loss) earnings of subsidiaries (7,239) 9,701 7,141 17,309 14,062 ------ ------- ----- ------ ------ (LOSS) INCOME BEFORE FEDERAL INCOME TAX (BENEFIT) EXPENSE AND EXTRAORDINARY GAIN (9,742) 7,039 3,754 13,763 10,253 Federal income tax (benefit) expense (637) 261 51 (288) -------- ------------ --------- ---------- --------- (LOSS) INCOME BEFORE EXTRAORDINARY GAIN (9,105) 7,039 3,493 13,712 10,541 -------- ------- -------- ------- -------- Extraordinary gain from debt extinguishments (net of income taxes of $353, $0, $59, $25 and $1) 654 111 48 2 ---------- ------------ --------- ---------- ------------ NET (LOSS) INCOME $(8,451) $7,039 $3,604 $13,760 $10,543 ======= ====== ====== ======= =======
CII FINANCIAL, INC. AND SUBSIDIARIES SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued) CONDENSED STATEMENT OF CASH FLOWS - Parent Company Only (In thousands)
Nine Months Ended September 30, Year Ended December 31, 2000 1999 1999 1998 1997 ---- ---- ---- ---- ---- (Unaudited) (Unaudited) CASH FLOW OPERATING ACTIVITIES: Net (loss) income $ (8,451) $ 7,039 $ 3,604 $ 13,760 $10,543 Adjustments to reconcile net (loss) income to net cash used in operating activities: Equity in undistributed earnings of subsidiaries 7,239 (9,701) (7,141) (17,309) (14,062) Extraordinary gain (1,007) (170) (73) (3) Depreciation and amortization 524 520 721 883 464 Change in assets and liabilities: Net payable to parent and subsidiaries (1,187) 69 (2,370) 1,126 53 Other assets 134 311 338 (466) 2,040 Accounts payable and accrued expenses 1,231 (428) (7) 374 (2,113) Interest payable -------- (988) (961) (18) (78) 3 ---------- --------- --- ---------- ----------- Net cash used in operating activities (2,505) (3,151) (5,043) (1,783) (3,075) --------- -------- --------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures 77 2 (553) 210 -------- --------- --------- -------- ------ ------- -------- --------- --------- Proceeds from sales/maturities of available-for-sale -------- --------- -------- investments 2,698 ------ ------- -------- --------- --------- Net cash provided by (used in) investing activities ---- -------------------- 77 2 (553) 2,908 ---------- ------------- - --------- CASH FLOW FROM FINANCING ACTIVITIES: Repurchase of convertible subordinated debentures (2,432) (55) (583) (3,143) (27) Capital contribution 3,665 Dividend to Sierra (2,637) Dividend from subsidiaries 6,800 3,000 6,000 ------ ------ ---------- --------- Stock option activity --------- _______ 418 1,737 ------ ------ ---------- --------- Net cash provided by financing activities ------ 1,731 2,945 5,417 940 1,710 ---------- ---------- ----- ---------- ---------- NET CHANGE IN CASH AND CASH --------- EQUIVALENTS (774) (129) 376 (1,396) 1,543 ---------- ---------- --- ------- --------- ---------- ---------- ---------- --- -------- ---------- CASH AND CASH EQUIVALENTS AT --------- BEGINNING OF PERIOD 857 481 481 1,877 334 ---------- ---------- --- -------- ---------- CASH AND CASH EQUIVALENTS AT END OF $ ======== PERIOD $ 83 $ 352 857 $ 481 $1,877 ========== =========== === ========= ======
No person has been authorized to give any information or to make any representations other than those contained in the exchange offer and, if given or made, such information or representations must not be relied upon as having been authorized. This statement and any related documents do not constitute an offer to buy or the solicitation of an offer to sell debentures or common stock in any circumstances in which such offer or solicitation is unlawful. In those jurisdictions where the securities, blue sky or other laws require the offer to be made by a licensed broker or dealer, the offer shall be deemed to be made on behalf of CII Financial by the dealer manager or one or more registered brokers or dealers licensed under the laws of such jurisdiction. In order to tender, a holder must send or deliver a properly completed and signed Letter of Transmittal, certificates for old junior subordinated debentures and any other required documents to the Exchange Agent at its address set forth below or tender pursuant to DTC's Automated Tender Offer Program. The Exchange Agent for the Exchange Offer is: WELLS FARGO CORPORATE TRUST By Registered & Certified Mail: WELLS FARGO BANK MINNESOTA, N.A. Corporate Trust Operations MAC N9303-121 PO Box 1517 Minneapolis, MN 55480 By Regular Mail or Overnight Courier: WELLS FARGO BANK MINNESOTA, N.A. Corporate Trust Operations MAC N9303-121 Sixth & Marquette Avenue Minneapolis, MN 55479 In Person by Hand Only: WELLS FARGO BANK MINNESOTA, N.A. 12th Floor - Northstar East Building Corporate Trust Services 608 Second Avenue South Minneapolis, MN 55479 By Facsimile (for Eligible Institutions only): (612) 667-4927 For Information or Confirmation by Telephone: (800) 344-5128 Any questions or requests for assistance or for additional copies of this Prospectus, the Letter of Transmittal or related documents may be directed to the Information Agent at its telephone number set forth below. A holder may also contact the Dealer Manager at its telephone number set forth below or such holder's broker, dealer, commercial bank, trust company or other nominee for assistance concerning the Exchange Offer. The Information Agent for the Exchange Offer is: D.F. King & Co., Inc. 77 Water Street New York, New York 10005 Bankers and Brokers Call Collect: (212) 269-5550 All Others Call Toll-Free: (800) 735-3591 The exclusive Dealer Manager for the Exchange Offer is: Banc of America Securities LLC 100 North Tryon Street, 7th Floor Charlotte, North Carolina 28255 Attention: High Yield Special Products (704) 388-4813 (Collect) (888) 292-0070 (Toll Free) PART II INFORMATION NOT REQUIRED IN PROSPECTUS Item 20. Indemnification of Directors and Officers. Section 317 of the California Corporations Code authorizes a corporation to indemnify any director or officer who was or is a party or is threatened to be made a party to any proceeding (other than an action by or in the right of the corporation to obtain a judgment in its favor) because the person is or was a director or officer of the corporation, against expenses, judgments, fines, settlements and other amounts actually and reasonably incurred in connection with the proceeding. This indemnification is allowed only if the person acted in good faith and in a manner the person reasonably believed to be in the best interests of the corporation. In the case of a criminal proceeding, the person must have had no reasonable cause to believe his or her conduct was unlawful. A corporation may advance expenses incurred in defending any proceeding prior to the final disposition of the proceeding if the corporation receives an undertaking by or on behalf of the director or officer to repay that amount if it is ultimately determined that the person is not entitled to be indemnified. A corporation may also indemnify a director or officer against expenses actually and reasonably incurred by that person in connection with the defense or settlement of the action by or in the right of the corporation to obtain a judgment in its favor. This indemnification is allowed only if the person acted in good faith and in a manner the person believed to be in the best interests of the corporation and its shareholders. The decision of whether indemnification will be provided in a particular case will be made by (i) a majority vote of a quorum consisting of directors who are not parties to the proceeding, (ii) if a quorum is not obtainable, by independent legal counsel in a written opinion, (iii) approval of a majority of the shareholders, excluding the shares of the person to be indemnified; or (iv) the court in which the proceeding is or was pending. Indemnification is not allowed if it would be inconsistent with (i) a resolution of the shareholders, (ii) the company's articles of incorporation or by-laws, (iii) an agreement in effect at the time of the cause of action, or (iv) any condition expressly imposed by a court in approving a settlement. In addition, a California corporation may obtain and maintain insurance on behalf of any director or officer of the corporation for any liability asserted against him or her, whether or not the corporation has the power to indemnify him or her against liability under the California Corporations Code. Article 7 of CII Financial, Inc.'s (the "Company") by-laws provide for the indemnification under certain conditions of directors, officers, employees any agents acting in their official capacities. The Company has not entered into separate indemnification agreements with any of its officers or directors. The Company has purchased directors' and officers' liability insurance insuring the Company's officers and directors against certain liabilities and expenses incurred by such persons in such capacities. Item 21. Exhibits and Financial Statement Schedules. (a) Exhibits Exhibit Number Description 1 --Form of Dealer Management Agreement 3.1 --Articles of Incorporation of the Company 3.2 --Bylaws of the Company 4.1 --Form of Indenture, of old junior subordinated debentures due 2001 from the Company to Manufacturers Hanover Trust Company as Trustee dated September 15, 1991, incorporated by reference to Exhibit 4.2 of Post-Effective Amendment No. 1 on Form S-3 to Registration Statement on Form S-4 dated October 6, 1995 (Reg. No. 33-60591) 4.2 --First Supplemental Indenture between the Company, Sierra Health Services, Inc. ("Sierra") and Chemical Bank as Trustee, dated as of October 31, 1995, to Indenture dated September 15, 1991, incorporated by reference to Exhibit 4.3 of Post-Effective Amendment No. 2 on Form S-3 to Registration Statement on Form S-4 dated October 31, 1995 (Reg. No. 33-60591) 4.3 --Form of Indenture, of 9% senior subordinated debentures due September 15, 2006 from the Company to Wells Fargo Bank Minnesota, N.A., as Trustee** 4.4 --Specimen 9% senior subordinated debenture due September 15, 2006 of the Company (included in Exhibit 4.3 hereto)** 5 --Form of Opinion of Morgan, Lewis & Bockius LLP as to the legality of the 9% senior subordinated debentures due September 15, 2006 of the Company being registered** 8 --Form of Opinion of Morgan, Lewis & Bockius LLP, special United States tax counsel to the Company** 10.1 --Credit Agreement dated as of October 30, 1998, among Sierra as borrower, Bank of America National Trust and Savings Association as Administrative Agent and Issuing Bank, First Union National Bank as Syndication Agent, and the other financial institutions party thereto, dated as of October 30, 1998, incorporated by reference to Exhibit 10.4 to Sierra's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1998 10.2 --First Amendment to Credit Agreement among Sierra, as borrower, Bank of America National Trust and Savings Association as Administrative Agent and Issuing Bank and the other financial institutions party thereto, dated as of November 23, 1998, incorporated by reference to Exhibit 10.5 to Sierra's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1998 10.3 --Second Amendment to Credit Agreement among Sierra as borrower, Bank of America National Trust and Savings Association as Administrative Agent and the other financial institutions party thereto, dated as of January 15, 1999, incorporated by reference to Exhibit 10.6 to Sierra's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1998 10.4 --Third Amendment to Credit Agreement among Sierra as borrower, Bank of America National Trust and Savings Association as Administrative Agent and the other financial institutions party thereto, dated as of September 30, 1999, incorporated by reference to Exhibit 10.7 to Sierra's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1999 10.5 --Amended and Restated Credit Agreement among Sierra as borrower, Bank of America, N.A. as Administrative Agent and Issuing Bank, First Union National Bank, as Syndication Agent and the other financial institutions party thereto, dated as of December 15, 2000, incorporated by reference to Sierra's Current Report on Form 8-K dated December 15, 2000 10.6 --Intercompany Services Agreement dated January 1, 1999, by and between Sierra and California Indemnity Insurance Company 10.7 --Tax Allocation Agreement dated May 30, 1997, among Sierra, Health Plan of Nevada, the Company, Sierra Health and Life Insurance Company, California Indemnity Insurance Company, Commercial Casualty Insurance Company and CII Insurance Company 10.8 --HCO Contract with Claims Administrator and Supplement dated January 19, 2001 among California Indemnity Insurance Company, and each of its insurer subsidiaries, and Sierra Health and Life Insurance Company. 10.9 --Agreement and Plan of Merger dated as of June 12, 1995 among Sierra, Health Acquisition Corp., and the Company, incorporated by reference to the Report on Form 8-K dated June 13, 1995, as amended 10.10 --Guaranty, dated as of August 23, 2000, among the Company, among others, as guarantors, in favor of Bank of America National Trust and Savings Association as Administrative Agent and the other financial institutions party thereto, incorporated by reference to Sierra's Quarterly Report on Form 10-Q filed for the quarter ended September 30, 2000 10.11 --First and Second Underlying Excess Loss Reinsurance Agreement dated July 1, 1998, by and between Traveler's Indemnity Insurance Company of Illinois, California Indemnity Insurance Company, Commercial Casualty Insurance Company, CII Insurance Company and Sierra Insurance Company of Texas 10.12 --Casualty Quota Share Reinsurance Agreement dated July 1, 1998, by and between Traveler's Indemnity Insurance Company of Illinois, California Indemnity Insurance Company, Commercial Casualty Insurance Company, CII Insurance Company and Sierra Insurance Company of Texas 10.13 --Statutory Workers' Compensation Excess of Loss Reinsurance Agreement dated January 1, 2000, by and between National Union Fire Insurance Company of Pittsburgh, Pennsylvania, California Indemnity Insurance Company, Commercial Casualty Insurance Company, CII Insurance Company and Sierra Insurance Company of Texas 10.14 --Workers' Compensation Excess of Loss Reinsurance Agreement dated July 1, 2000, by and between National Union Fire Insurance Company of Pittsburgh, Pennsylvania, California Indemnity Insurance Company, Commercial Casualty Insurance Company, CII Insurance Company and Sierra Insurance Company of Texas 10.15 --Limited Partnership Agreement of the 2716 N. Tenaya Way Limited Partnership dated December 3, 1998, among California Indemnity Insurance Company, Commercial Casualty Insurance Company and Sierra 10.16 --Sublease of 2716 North Tenaya Way, Las Vegas, Nevada, dated January 25, 2001, among Sierra and California Indemnity Insurance Company 10.17 --Intercompany Pooling Agreement dated January 1, 1999, among California Indemnity Insurance Company, Commercial Casualty Insurance Company, CII Insurance Company and Sierra Insurance Company of Texas 10.18 --Investment Services Agreement dated January 1, 1999, between Sierra and California Indemnity Insurance Company 10.19 --Investment Services Agreement dated January 1, 1999, between Sierra and Commercial Casualty Insurance Company 10.20 --Investment Services Agreement dated January 1, 1999, between Sierra and CII Insurance Company 10.21 --Investment Services Agreement dated January 1, 1999, between Sierra and Sierra Insurance Company of Texas 12 --Ratio of Earnings to Fixed Charges of the Company 21 --Subsidiaries of the Company 23.1 --Consent of Deloitte & Touche LLP 23.2 --Consent of Morgan, Lewis & Bockius LLP (included in the opinions filed as Exhibit 5 and Exhibit 8)** 24 --Powers of Attorney for the Company (included on signature page hereof)* 25 --Statement of Eligibility of Trustee on Form T-1 27 --Financial Data Schedule* 99.1 --Form of Letter of Transmittal* 99.2 --Form of Notice of Guaranteed Delivery* 99.3 --Form of Notice of Brokers, Dealers, Commercial Banks, Trust Companies and other Nominees* 99.4 --Form of Notice to Clients* - ------------------- 99.5 --Form of Company Letter to Debenture holders* - ------------------- * Previously filed. **To be filed by amendment. Item 22. Undertakings. The undersigned registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: (i) To include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; (ii)To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than 20 percent change in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement. (iii) To include any material with respect to the plan of distribution and not previously disclosed in the registration statement or any material change to such information in the registration statement; (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. (4) Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. SIGNATURES Pursuant to the requirements of the Securities Act, the Registrant has duly caused this Amendment No. 1 to Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Las Vegas, State of Nevada, on the 5th day of February 2001. CII FINANCIAL, INC. By /s/ Kathleen M. Marlon --------------------------------------------- Kathleen M. Marlon President, Chief Executive Officer and Chairman Pursuant to the requirements of the Securities Act of 1933, this Amendment No. 1 to Registration Statement has been signed by the following persons in the capacities and on the dates indicated. Signature Title Date /s/ Kathleen M. Marlon President, Chief Executive Officer, February 5, 2001 - ---------------------- Chairman and Director Kathleen M. Marlon (Principal Executive Officer) /s/ John F. Okita Chief Financial Officer February 5, 2001 - --------------------- (Principal Financial John F. Okita and Accounting Officer) /s/ Paul H. Palmer Director February 5, 2001 - --------------------- Paul H. Palmer /s/ Frank E. Collins Director February 5, 2001 - --------------------- Frank E. Collins Exhibit Index Exhibit Number Description 1 --Form of Dealer Management Agreement 3.1 --Articles of Incorporation of the Company 3.2 --Bylaws of the Company 4.1 --Form of Indenture, of old junior subordinated debentures due 2001 from the Company to Manufacturers Hanover Trust Company as Trustee dated September 15, 1991, incorporated by reference to Exhibit 4.2 of Post-Effective Amendment No. 1 on Form S-3 to Registration Statement on Form S-4 dated October 6, 1995 (Reg. No. 33-60591) 4.2 --First Supplemental Indenture between the Company, Sierra Health Services, Inc. ("Sierra") and Chemical Bank as Trustee, dated as of October 31, 1995, to Indenture dated September 15, 1991, incorporated by reference to Exhibit 4.3 of Post-Effective Amendment No. 2 on Form S-3 to Registration Statement on Form S-4 dated October 31, 1995 (Reg. No. 33-60591) 4.3 --Form of Indenture, of 9% senior subordinated debentures due September 15, 2006 from the Company to Wells Fargo Bank Minnesota, N.A., as Trustee** 4.4 --Specimen 9% senior subordinated debenture due September 15, 2006 of the Company (included in Exhibit 4.3 hereto)** 5 --Form of Opinion of Morgan, Lewis & Bockius LLP as to the legality of the 9% senior subordinated debentures due September 15, 2006 of the Company being registered** 8 --Form of Opinion of Morgan, Lewis & Bockius LLP, special United States tax counsel to the Company** 10.1 --Credit Agreement dated as of October 30, 1998, among Sierra as borrower, Bank of America National Trust and Savings Association as Administrative Agent and Issuing Bank, First Union National Bank as Syndication Agent, and the other financial institutions party thereto, dated as of October 30, 1998, incorporated by reference to Exhibit 10.4 to Sierra's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1998 10.2 --First Amendment to Credit Agreement among Sierra, as borrower, Bank of America National Trust and Savings Association as Administrative Agent and Issuing Bank and the other financial institutions party thereto, dated as of November 23, 1998, incorporated by reference to Exhibit 10.5 to Sierra's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1998 10.3 --Second Amendment to Credit Agreement among Sierra as borrower, Bank of America National Trust and Savings Association as Administrative Agent and the other financial institutions party thereto, dated as of January 15, 1999, incorporated by reference to Exhibit 10.6 to Sierra's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1998 10.4 --Third Amendment to Credit Agreement among Sierra as borrower, Bank of America National Trust and Savings Association as Administrative Agent and the other financial institutions party thereto, dated as of September 30, 1999, incorporated by reference to Exhibit 10.7 to Sierra's Annual Report on Form 10-K filed for the fiscal year ended December 31, 1999 10.5 --Amended and Restated Credit Agreement among Sierra as borrower, Bank of America, N.A. as Administrative Agent and Issuing Bank, First Union National Bank, as Syndication Agent and the other financial institutions party thereto, dated as of December 15, 2000, incorporated by reference to Sierra's Current Report on Form 8-K dated December 15, 2000 10.6 --Intercompany Services Agreement dated January 1, 1999, by and between Sierra and California Indemnity Insurance Company 10.7 --Tax Allocation Agreement dated May 30, 1997, among Sierra, Health Plan of Nevada, the Company, Sierra Health and Life Insurance Company, California Indemnity Insurance Company, Commercial Casualty Insurance Company and CII Insurance Company 10.8 --HCO Contract with Claims Administrator and Supplement dated January 19, 2001 among California Indemnity Insurance Company, and each of its insurer subsidiaries, and Sierra Health and Life Insurance Company. 10.9 --Agreement and Plan of Merger dated as of June 12, 1995 among Sierra, Health Acquisition Corp., and the Company, incorporated by reference to the Report on Form 8-K dated June 13, 1995, as amended 10.10 --Guaranty, dated as of August 23, 2000, among the Company, among others, as guarantors, in favor of Bank of America National Trust and Savings Association as Administrative Agent and the other financial institutions party thereto, incorporated by reference to Sierra's Quarterly Report on Form 10-Q filed for the quarter ended September 30, 2000 10.11 --First and Second Underlying Excess Loss Reinsurance Agreement dated July 1, 1998, by and between Traveler's Indemnity Insurance Company of Illinois, California Indemnity Insurance Company, Commercial Casualty Insurance Company, CII Insurance Company and Sierra Insurance Company of Texas 10.12 --Casualty Quota Share Reinsurance Agreement dated July 1, 1998, by and between Traveler's Indemnity Insurance Company of Illinois, California Indemnity Insurance Company, Commercial Casualty Insurance Company, CII Insurance Company and Sierra Insurance Company of Texas 10.13 --Statutory Workers' Compensation Excess of Loss Reinsurance Agreement dated January 1, 2000, by and between National Union Fire Insurance Company of Pittsburgh, Pennsylvania, California Indemnity Insurance Company, Commercial Casualty Insurance Company, CII Insurance Company and Sierra Insurance Company of Texas 10.14 --Workers' Compensation Excess of Loss Reinsurance Agreement dated July 1, 2000, by and between National Union Fire Insurance Company of Pittsburgh, Pennsylvania, California Indemnity Insurance Company, Commercial Casualty Insurance Company, CII Insurance Company and Sierra Insurance Company of Texas 10.15 --Limited Partnership Agreement of the 2716 N. Tenaya Way Limited Partnership dated December 3, 1998, among California Indemnity Insurance Company, Commercial Casualty Insurance Company and Sierra 10.16 --Sublease of 2716 North Tenaya Way, Las Vegas, Nevada, dated January 25, 2001, among Sierra and California Indemnity Insurance Company 10.17 --Intercompany Pooling Agreement dated January 1, 1999, among California Indemnity Insurance Company, Commercial Casualty Insurance Company, CII Insurance Company and Sierra Insurance Company of Texas 10.18 --Investment Services Agreement dated January 1, 1999, between Sierra and California Indemnity Insurance Company 10.19 --Investment Services Agreement dated January 1, 1999, between Sierra and Commercial Casualty Insurance Company 10.20 --Investment Services Agreement dated January 1, 1999, between Sierra and CII Insurance Company 10.21 --Investment Services Agreement dated January 1, 1999, between Sierra and Sierra Insurance Company of Texas 12 --Ratio of Earnings to Fixed Charges of the Company 21 --Subsidiaries of the Company 23.1 --Consent of Deloitte & Touche LLP 23.2 --Consent of Morgan, Lewis & Bockius LLP (included in the opinions filed as Exhibit 5 and Exhibit 8)** 24 --Powers of Attorney for the Company (included on signature page hereof)* 25 --Statement of Eligibility of Trustee on Form T-1 27 --Financial Data Schedule* 99.1 --Form of Letter of Transmittal* 99.2 --Form of Notice of Guaranteed Delivery* 99.3 --Form of Notice of Brokers, Dealers, Commercial Banks, Trust Companies and other Nominees* 99.4 --Form of Notice to Clients* - ------------------- 99.5 --Form of Company Letter to Debenture holders* - ------------------- * Previously filed. **To be filed by amendment. EX-1 2 0002.txt Exhibit 1 BANC OF AMERICA SECURITIES LLC BANK OF AMERICA CORPORATE CENTER 100 NORTH TRYON STREET, SEVENTH FLOOR CHARLOTTE, NC 28255 January 31, 2001 CII Financial, Inc. 2716 North Tenaya Way Las Vegas, Nevada 89128 Attn: Kathleen M. Marlon President and Chief Executive Officer Ladies and Gentlemen: This amended and restated letter agreement (the "Agreement"), is made and entered into by and between CII Financial, Inc., a California corporation (the "Company"), and Banc of America Securities LLC ("BAS" or the "Dealer Manager") in order to amend and restate that certain letter agreement, dated December 22, 2000 (the "Original Agreement"), pursuant to which the Company has retained BAS to act as the exclusive dealer manager on the terms and subject to the conditions set forth therein, in connection with the Company's proposed exchange offer for its 7 1/2% convertible subordinated debentures due 2001 (the "Old Debentures"). In consideration of the mutual covenants and agreements of the parties set forth herein and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Original Agreement is hereby amended and restated in its entirety and shall continue in full force and effect as set forth herein. The Company proposes to offer to exchange (collectively referred to as the "Offer"): (i) $1,000 in principal amount of its new 9% senior subordinated debentures due September 15, 2006 (the "New Debentures") for every $1,000 in principle amount of the Old Debentures that are tendered or (ii) $525 in cash for every $1,000 in principal amount of the Old Debentures that are tendered, subject to a maximum of $19,500,000 aggregate principal amount of Old Debentures to be exchanged for cash. The Offer shall be made upon the terms and subject to the conditions set forth in the Registration Statement on Form S-4 (the "Registration Statement") and the Prospectus and Exchange Offer (the "Prospectus") contained therein (including all information incorporated by reference therein and exhibits, appendices and attachments thereto, as amended, modified or supplemented from time to time, the "Exchange Offer"). The holders of the Old Debentures are hereinafter referred to as the "Holders." Capitalized terms used and not defined in this letter agreement shall have the meanings assigned to them in the Exchange Offer. 1. Engagement. ---------- Subject to the terms and conditions set forth herein: (a) The Company hereby retains the Dealer Manager, and the Dealer Manager agrees to act, as the exclusive dealer manager to the Company in connection with the Offer until the date on which the Offer expires or is earlier terminated in accordance with its terms. BAS will advise the Company with respect to the terms and timing of the Offer and assist the Company in preparing any documents (including the Exchange Offer) to be delivered by the Company to the Holders or used in connection with the Offer (collectively, the "Documents"). The Company authorizes BAS, in accordance with its customary practices and consistent with industry practice and all applicable laws, to communicate generally regarding the Offer with the Holders and their authorized agents in connection with the Offer. (b) The Company acknowledges that BAS has been retained solely to provide the services set forth in this Agreement. In rendering such services, BAS shall act as an independent contractor, and any duties of BAS arising out of its engagement hereunder shall be owed solely to the Company. The Company also acknowledges that (i) the Documents have been or will be prepared and approved by and are the sole responsibility of the Company, (ii) BAS shall not be deemed to act as an agent of the Company or any of its affiliates (except that in any jurisdiction in which the Offer is required to be made by a registered licensed broker or dealer, it shall be deemed made by the Dealer Manager on behalf of the Company) and neither the Company nor any of its affiliates shall be deemed to act as the agent of BAS and (iii) no securities broker, dealer, bank or trust company shall be deemed to act as the agent of BAS or as the agent of the Company or any of its affiliates, and BAS shall not be deemed to act as the agent of any securities broker, dealer, bank or trust company. BAS shall not have any liability in tort, contract or otherwise to the Company or to any of its affiliates for any act or omission on the part of any securities broker or dealer or any bank or trust company or any other person except to the extent that such liability arises out of the gross negligence, bad faith or the willful misconduct of BAS. (c) The Company acknowledges that the Dealer Manager is a securities firm that is engaged in securities trading and brokerage activities as well as in providing investment banking and financial advisory services. In the ordinary course of trading and brokerage activities, the Dealer Manager and its affiliates may at any time hold long or short positions, and may trade or otherwise effect transactions, for their own account or the accounts of customers, in debt or equity securities of the Company and its affiliates or other entities that may be involved in the transactions contemplated hereby. (d) BAS agrees, in accordance with its customary practice and consistent with industry practice and in accordance with applicable law and the Offer, to perform those services in connection with the Offer as are customarily performed by investment banks in connection with similar transactions of a like nature, including, but not limited to, using all reasonable efforts to solicit tenders of Old Debentures pursuant to the Offer and communicating generally regarding the Offer with brokers, dealers, commercial banks and trust companies and other Holders. (e) The Company shall arrange for D.F. King & Co., Inc. to act as information agent (the "Information Agent") in connection with the Offer and, as such, to advise the Dealer Manager promptly as to such matters relating to the Offer as the Dealer Manager may reasonably request. The Company shall arrange with Wells Fargo Corporate Trust to act as the exchange agent (the "Exchange Agent") in connection with the Offer, and as such to advise the Dealer Manager promptly as to such matters relating to the Offer as the Dealer Manager may reasonably request. In addition, the Company hereby authorizes the Dealer Manager to communicate with the Information Agent, the Exchange Agent, The Depository Trust Company and others as appropriate with respect to matters relating to the Offer. (f) The Company shall furnish the Dealer Manager, or take efforts to cause the Trustee or registrars for the Old Debentures to furnish the Dealer Manager, as soon as practicable, with cards or lists or copies thereof showing the names of persons who were the Holders of record of Old Debentures as of the date or dates specified by the Dealer Manager and, to the extent reasonably available to the Company, the beneficial Holders of the Old Debentures as of such date or dates, together with their addresses and the principal amount of Old Debentures held by them. Additionally, the Company shall update such information from time to time during the term of this Agreement as reasonably requested by the Dealer Manager and to the extent such information is reasonably available to the Company within the time constraints specified. (g) The Company agrees to advise the Dealer Manager promptly of the occurrence of any event, of which it becomes aware, which could cause or require the Company to withdraw, rescind or modify the Documents. In addition, if any event occurs as a result of which it shall be necessary to amend or supplement any Documents in order to make the statements therein, in light of the circumstances under which they were made, not misleading in any material respect, the Company shall, promptly upon becoming aware of any such event, advise the Dealer Manager of such event and, as promptly as practicable under the circumstances, prepare and furnish copies of such amendments or supplements of any such Documents to the Dealer Manager, so that the statements in such Documents, as so amended or supplemented, will not, in light of the circumstances under which they were made, be misleading in any material respect. (h) Except as otherwise required by law or regulation, the Company will not use or publish any material in connection with the Offer, or refer to the Dealer Manager in any such material, without the prior approval of the Dealer Manager (which shall not be unreasonably withheld). The Company, upon receiving such approval, will promptly furnish the Dealer Manager with as many copies of such approved materials as the Dealer Manager may reasonably request. (i) The Company will promptly inform the Dealer Manager of any litigation or administrative or similar proceeding of which it becomes aware which is initiated or threatened with respect to the Offer. (j) Upon completion of the Offer, the Company agrees to pay promptly, in accordance with the terms of the Documents, the applicable consideration for the Old Debentures to the Holders entitled thereto. 2. Fees and Expenses. (a) In consideration of services provided hereunder as the Dealer Manager, the Company shall pay the Dealer Manager the cash fees as set forth in that certain engagement letter from BAS with you dated as of November 16, 2000 (the "Engagement Letter"), and the provisions of the Engagement Letter regarding fees to be paid by the Company for the services of BAS are incorporated by reference herein as if restated herein in full. (b) Whether or not any Old Debentures are tendered pursuant to the Offer or in the event that this Agreement is terminated by either the Company or the Dealer Manager in accordance with the provisions contained herein, the Company shall (x) pay all expenses of (i) the preparation, printing, mailing and publishing of the Documents, (ii) any and all amounts payable to securities brokers and dealers (including the Dealer Manager), commercial banks, trust companies and nominees as reimbursement of their customary mailing and handling expenses incurred in forwarding the Documents to their customers, and of any forwarding agent, and all other expenses of the Company, (iii) all reasonable fees and expenses of the Information Agent and the Exchange Agent, (iv) all advertising charges, (v) all other expenses in connection with the Offer, and (y) reimburse the Dealer Manager for all reasonable expenses incurred by the Dealer Manager in connection with its services as Dealer Manager under this Agreement, including its reasonable out of pocket expenses and the reasonable fees and expenses of Moore & Van Allen PLLC, counsel to the Dealer Manager, provided that such fees and expenses of such counsel shall not exceed a total amount of $100,000. 3. Termination. ----------- Subject to Section 8 hereof, this Agreement may be terminated by the Company on the date the Company terminates (by notice in writing to the Dealer Manager) or withdraws the Offer. 4. Representations and Warranties by the Company. --------------------------------------------- The Company represents and warrants to the Dealer Manager (i) as of the date of the Original Agreement, (ii) subject to the proviso contained in clause (A) of the first paragraph of Annex A hereto regarding indemnification, on each date that any Documents are published, sent, given or otherwise distributed, and (iii) on the date of exchange of New Debentures and/or cash for the Old Debentures by the Company pursuant to the Offer and upon the consummation of the Offer that: (a) Each of the Company and its subsidiaries (including when referred to herein any direct and indirect subsidiaries) has been duly formed and is validly existing (in the case of the Company, as a corporation) and in good standing under the laws of the jurisdiction of its formation. (b) The Company (i) has all necessary corporate power and authority to execute and deliver this Agreement, and to perform all its obligations hereunder to issue the New Debentures and to pay the cash consideration in exchange for the Old Debentures to consummate the Offer in accordance with its terms, and (ii) shall use all reasonable efforts to take on a timely basis all actions necessary or required in relation to the Offer. (c) The Company has taken all necessary corporate action to authorize the making and consummation of the Offer and the execution, delivery and performance by the Company of this Agreement; and this Agreement has been duly executed and delivered by the Company and assuming due authorization, execution and delivery by the Dealer Manager, constitutes a valid and legally binding agreement of the Company. (d) The New Debentures have been duly authorized by the Company for issuance and exchange pursuant to the Offer and, when duly executed, authenticated, issued and delivered in the manner provided for in the New Indenture (as defined below) against payment of the consideration therefor as contemplated by the Offer, will constitute valid, legal and binding obligations of the Company, enforceable against the Company in accordance with their terms, subject, as to enforcement of remedies, to bankruptcy, insolvency, reorganization, moratorium or similar laws affecting creditors' rights generally, general equitable principles and the discretion of courts in granting equitable remedies. The New Debentures will be substantially in the form contemplated by, and entitled to the benefits of, the New Indenture. (e) The New Indenture shall have been duly authorized, executed and delivered by the Company and, upon such authorization, execution and delivery, will constitute a valid, legal and binding agreement of the Company, enforceable against the Company in accordance with its terms, subject, as to enforcement of remedies, to bankruptcy, insolvency, reorganization, moratorium or similar laws affecting creditors' rights generally, general equitable principles and the discretion of courts in granting equitable remedies. (f) The New Debentures will conform in all material respects to the descriptions thereof contained in the Prospectus and, when issued, will be in substantially the form required by the New Indenture, as filed as an exhibit to the Registration Statement. (g) The Offer meets the requirements for use of Form S-4 under the Securities Act of 1933, as amended (the "Securities Act"). Upon issuance of the New Debentures and upon consummation of the transactions contemplated by the Offer, the indenture pursuant to which the New Debentures are issued (the "New Indenture") shall have been duly qualified under the Trust Indenture Act of 1939, as amended (the "Trust Indenture Act"). (h) The Company will use all reasonable efforts to qualify the New Debentures for offering and sale under the applicable securities laws of such states and other jurisdictions (domestic and foreign) as contemplated by the Offer and shall maintain such qualifications in effect for so long as required for the distribution of the New Debentures; provided, however, that the Company shall not be obligated to file any general consent to service of process or to qualify as a foreign corporation or as a broker or dealer in securities in any jurisdiction in which it is not so qualified or to subject itself to taxation in respect of doing business in any jurisdiction in which it is not otherwise so subject. (i) The Offer and the Documents (including the documents incorporated or deemed to be incorporated by reference into the Documents) comply and (as amended or supplemented, if amended or supplemented) will comply in all material respects with all applicable requirements of the federal securities laws and the Trust Indenture Act and with all applicable foreign, local or state securities laws, and, in each case, the rules and regulations thereunder; and the Documents (including the documents incorporated or deemed to be incorporated by reference into the Documents) do not and (as amended or supplemented, if amended or supplemented) will not contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. (j) The financial statements, together with related schedules, included in each of the Documents present fairly the consolidated financial position, results of operations, stockholder's equity and cash flows of the Company and its subsidiaries on the basis stated therein at the respective dates or for the respective periods to which they relate; and such statements and related schedules have been prepared in accordance with generally accepted accounting principles consistently applied throughout the periods involved, except as disclosed therein. (k) The Offer pursuant to the terms of the Documents, including the receipt of certain third party consents, and the execution, delivery and performance by the Company of this Agreement and the transactions contemplated hereby and thereby (x) do not and will not conflict with, or result in a breach or violation of, or constitute a default under, any of the provisions of the New Indenture or of the charter or bylaws (or similar organizational documents) of the Company or any other note, indenture (including without limitation the indenture governing the Old Debentures), loan agreement, mortgage or other agreement, instrument or undertaking to which the Company or any of its subsidiaries or affiliates is a party or by which any of them is bound or to which any of their properties or assets is subject, and (y) will not result in any violation of any law, rule or regulation or any order of any court or of any other governmental agency or instrumentality having jurisdiction over the Company or any of its subsidiaries or affiliates or any of its or their respective properties or assets. (l) No consent, approval, authorization or order of, or registration, qualification or filing with, any court or regulatory authority or other governmental agency or instrumentality is or will be required in connection with the making or consummation of the Offer or the execution, delivery or performance by the Company of this Agreement and the transactions contemplated hereby, except as such may be described in the Exchange Offer or such as would not have a material adverse effect on the operations, assets, condition (financial or otherwise) or prospects of the Company or any of its subsidiaries or affiliates, or on the ability of the parties to consummate the Offer as contemplated thereby (a "Material Adverse Effect"). (m) the Company shall advise the Dealer Manager promptly of (i) the occurrence of any event of which the Company becomes aware which could cause the Company to withdraw, rescind or terminate the Offer or would permit the Company to exercise any right not to purchase or exchange Old Debentures tendered under the Offer, (ii) the occurrence of any event of which the Company becomes aware, or the discovery by the Company of any fact, the occurrence or existence of which it believes would make it necessary or advisable to make any change in the Documents being used or would cause any representation or warranty contained in this Agreement to be untrue or inaccurate in any material respect, (iii) any proposal or requirement to make, amend or supplement any Document or any filing in connection with the Offer pursuant to the Securities Act, the Exchange Act, the Trust Indenture Act or any applicable law, rule or regulation, (iv) its awareness of the issuance by any regulatory authority of any comment or order or the taking of any other action concerning the Offer (and, if in writing, will furnish the Dealer Manager with a copy thereof), (v) its awareness of any material developments in connection with the Offer or the financing thereof including, without limitation, the commencement of any lawsuit relating to the Offer and (vi) any other information known to the Company relating to the Offer, the Documents or this Agreement which the Dealer Manager may from time to time reasonably request. (n) There is no action, suit or proceeding before or by any court or governmental agency or body now pending or, to the knowledge of the Company, threatened against the Company or any of its subsidiaries which would adversely affect in any material respect the Offer pursuant to the terms of the Documents or the effectiveness of this Agreement. The representations and warranties set forth in this Section 4 shall remain operative and in full force and effect regardless of (i) any investigation made by or on behalf of any Indemnified Person (as defined in Annex A attached hereto) or (ii) any termination of this Agreement. 5. Conditions and Obligations. -------------------------- The obligations of the Dealer Manager to act as a Dealer Manager hereunder shall at all times be subject, in its discretion, to the conditions that: (a) All representations and warranties of the Company contained herein or in any certificate or writing delivered hereunder at all times during the Offer shall be true and correct in all material respects. (b) The Company at all times during the Offer shall have performed, in all material respects, all of its obligations hereunder required as of such time to have been performed by it. (c) Counsel for the Company shall have delivered to the Dealer Manager an opinion, on the date of closing of the Offer, reasonably acceptable to the Dealer Manager, dated such date and covering substantially the following matters: (i) The Company has been duly incorporated and is validly existing as a corporation in good standing under the laws of California. (ii) (a) The Company has duly taken all necessary corporate action to authorize the making and consummation of the Offer pursuant to the terms of the Documents and the execution, delivery and performance by the Company of this Agreement, and (b) this Agreement has been duly executed and delivered by the Company. (iii) The New Debentures have been duly authorized by the Company and, when executed, authenticated, and issued in accordance with the provisions of the New Indenture and delivered and exchanged as contemplated by the Offer, will constitute legal, valid and binding obligations of the Company, enforceable against the Company in accordance with their terms, subject, as to enforcement of remedies, to bankruptcy, insolvency, reorganization, moratorium or similar laws affecting creditors' rights generally, general equitable principles and the discretion of the courts in granting equitable remedies; and the New Debentures will be entitled to the benefits of the New Indenture. The New Debentures will in all material respects be in the form contemplated by the New Indenture. (iv) The New Indenture has been duly authorized, executed and delivered by the Company and, assuming that the Trustee has satisfied all legal requirements that are applicable to it to the extent necessary to make the New Indenture enforceable against it, the New Indenture constitutes a legal, valid and binding instrument of the Company, enforceable against the Company in accordance with its terms, subject, as to enforcement of remedies, to bankruptcy, insolvency, reorganization, moratorium or similar laws affecting creditors' rights generally, general equitable principles and the discretion of the courts in granting equitable remedies; and the New Indenture has been duly qualified under the Trust Indenture Act. (v) The New Debentures and the New Indenture conform in all material aspects to the description thereof in the Prospectus. (vi) The statements in the Prospectus under the caption "Description of Debentures", "United States Federal Income Tax Consequences", and in the Registration Statement under Item 15, insofar as such statements constitute matters law, summaries of legal matters, the Company's Articles of Incorporation and Bylaws or legal proceedings, or legal conclusions, has been reviewed by us and is correct in all material respects. (vii) The Registration Statement has become effective under the Securities Act and the Prospectus has been filed pursuant to Rule 424(b) under the Securities Act in the manner and within the time period required by Rule 424. To our knowledge, no stop order suspending the effectiveness of the Registration Statement or any part thereof has been issued and no proceedings for that purpose have been instituted or are pending under the Securities Act. (viii) The Registration Statement, as of its effective date, and the Prospectus, as of its date and upon consummation of the transactions contemplated by the Offer, complied as to form in all material respects with the requirements of the Securities Act and the rules and regulations thereunder (in each case other than the financial statements and supporting schedules, and the Form T-1 included or incorporated by reference therein, as to which such counsel need express no opinion). (ix) Assuming the due authorization, execution and delivery of this Agreement by the Dealer Manager, this Agreement constitutes the valid and legally binding obligation of the Company, enforceable against the Company in accordance with its terms, except to the extent that such enforceability may be limited by applicable bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium and similar laws affecting creditors' rights generally and by general equitable principles (whether considered in a proceeding in equity or at law), and except that rights to indemnification or contribution contained in this Agreement may be limited by federal or state securities laws or public policy relating thereto. (x) The making and consummation of the Offer pursuant to the terms of the Documents and the execution, delivery and performance by the Company of this Agreement, the New Indenture, the Documents and the transactions related hereto and thereto (A) do not and will not conflict with, or result in a breach or violation of, or constitute a default under, the charter or bylaws (or similar organizational documents) of the Company or of any material note, indenture (including without limitation the indenture governing the Old Debentures), loan agreement, mortgage or other agreement, instrument or undertaking of which counsel has knowledge of which the Company, any of its subsidiaries or affiliates is a party or by which any of them is bound or any of their respective subsidiaries or affiliates is a party or by which any of them is bound or to which any of their respective properties or assets is subject will not result in a violation of any corporate or foreign or federal law, rule or regulation applicable to, or any order known to such counsel of any court or of any other governmental agency or instrumentality having jurisdiction over the Company or any of its subsidiaries or affiliates or any of their respective properties or assets and will comply in all material respects with the requirements of all applicable federal securities laws, rules and regulations. (xi) Except for filings under state securities laws and consent of insurance regulators, no consent, approval, authorization, order of, or registration, qualification or filing with, any court or regulatory authority or governmental agency or instrumentality is or will be required in connection with the making and consummation of the Offer pursuant to the terms of the Documents or the execution, delivery and performance by the Company of this Agreement and the transactions contemplated hereby. In giving the opinions required by this Section 5, such counsel shall additionally state that such counsel has participated in conferences and discussions with the Company, the Dealer Manager, the Dealer Manager's counsel and others in the course of the preparation by the Company of the Offer, at which conferences the contents of the Exchange Offer and other related documents were discussed, and, although such counsel has not independently verified and is not passing upon and assumes no responsibility for the accuracy, completeness or fairness of the information included in the Registration Statement and in the Prospectus (except for the opinion rendered in item 5(c)(vi) above), no facts have come to such counsel's attention which lead such counsel to believe that the Registration Statement or the Prospectus 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 contained therein, in light of the circumstances under which they were made, not misleading (it being understood that such counsel shall express no view with respect to the financial statements and the related schedules thereto, contained or incorporated by reference in the Registration Statement and the Prospectus). All or portions of such opinion may be rendered by one or more internal or special counsel to the Company reasonably acceptable to the Dealer Manager and its counsel. 6. Indemnification. --------------- In consideration of the engagement hereunder, the Company shall indemnify and hold BAS harmless, and BAS shall indemnify and hold the Company harmless, in each case to the extent set forth in Annex A hereto, which provisions are incorporated by reference herein and constitute a part hereof. 7. Confidentiality. --------------- BAS shall use all information provided to it by or on behalf of the Company hereunder solely for the purpose of providing the services which are the subject of this Agreement and the transactions contemplated hereby and shall treat confidentially all such information, provided that nothing herein shall prevent BAS from disclosing any such information (i) pursuant to the order of any court or administrative or similar proceeding, (ii) upon the request or demand of any regulatory authority having jurisdiction over BAS or any of its affiliates, (iii) to the extent that such information is or becomes publicly available other than by reason of disclosure by BAS in contravention of this Agreement or (iv) to its employees, legal counsel, independent auditors and other experts or agents who need to know such information and are informed of the confidential nature of such information. With respect to clause (i) or (ii) above, prior to making any such disclosure, BAS shall notify the Company of such order or request and use commercially reasonable efforts to cooperate with the Company, at the Company's expense, in seeking a protective order or taking such action as the Company may reasonably request, consistent with applicable law. Notwithstanding the foregoing provisions of this Section 7, BAS may share any information or matters relating to the Company, the Offer and the transactions contemplated hereby with its affiliates, and such affiliates may likewise share information relating to the Company with BAS. BAS shall be responsible for compliance by its affiliates with this Section 7. 8. Survival. -------- The agreements contained in Sections 1(b), 2, 6 and 7 and the representations and warranties of the Company set forth in Section 4 hereof shall survive any termination or cancellation of this Agreement, any completion of the engagement provided by this Agreement and any investigation made by or on behalf of the Company, BAS or any Indemnified Person (as defined in Annex A) and shall survive the termination or consummation of the Offer. 9. Governing Law. ------------- This Agreement shall be governed by and construed in accordance with the laws of the State of New York applicable to contracts made and to be performed entirely within that State. THE COMPANY AND BAS IRREVOCABLY AGREE TO WAIVE TRIAL BY JURY IN ANY ACTION, PROCEEDING, CLAIM OR COUNTERCLAIM BROUGHT BY OR ON BEHALF OF ANY PARTY RELATED TO OR ARISING OUT OF THIS AGREEMENT OR THE TRANSACTIONS CONTEMPLATED HEREBY. 10. Notices. ------- Except as otherwise expressly provided in this Agreement, whenever notice is required by the provisions of this Agreement to be given to (i) the Company, such notice shall be in writing addressed to CII Financial, Inc., 2716 North Tenaya Way, Las Vegas, Nevada, Attention: Kathleen M. Marlon, facsimile number: (702) 242-4819, with a copy to Morgan, Lewis & Bockius LLP, 101 Park Avenue, New York, New York 10178, facsimile number: (212) 309-6273, and (ii) BAS, such notice shall be in writing addressed to Banc of America Securities LLC, Bank of America Corporate Center, 100 North Tryon Street, Seventh Floor, Charlotte, North Carolina 28255, Attention: Andrew C. Karp, facsimile number: (704) 388-0830. 11. Miscellaneous. ------------- This Agreement contains the entire agreement between the parties relating to the subject matter hereof and supersedes all oral statements and prior writings with respect thereto. This Agreement may not be amended or modified except by a writing executed by each of the parties hereto. Section headings herein are for convenience only and are not part of this Agreement. This Agreement is solely for the benefit of the Company and BAS, and no other person (except for Indemnified Persons, to the extent set forth in Annex A hereto) shall acquire or have any rights under or by virtue of this Agreement. If any term, provision, covenant or restriction contained in this Agreement is held by a court of competent jurisdiction to be invalid, void or unenforceable or against public policy, the remainder of the terms, provisions, covenants and restrictions contained herein shall remain in full force and effect and shall in no way be affected, impaired or invalidated. The Company and BAS shall endeavor in good faith negotiations to replace the invalid, void or unenforceable provisions with valid provisions, the economic effect of which comes as close as possible to that of the invalid, void or unenforceable provisions. Neither the failure nor any delay by any party in exercising any right, power or privilege under this Agreement will operate as a waiver of such right, power or privilege, and no single or partial exercise of any such right, power or privilege will preclude any other or further exercise of such right, power or privilege or the exercise of any other right, power or privilege. This Agreement may be executed in counterparts, each of which will be deemed an original, but all of which, taken together, will constitute one and the same instrument. If the foregoing correctly sets forth your understanding, please indicate your acceptance of the terms hereof by signing in the appropriate space below and returning to BAS the enclosed duplicate originals hereof, whereupon this letter shall become a binding agreement between us. Very truly yours, BANC OF AMERICA SECURITIES LLC 100 North Tryon Street Seventh Floor Charlotte, NC 28255 By: -------------------------------------------------- Name: Andrew C. Karp Title: Managing Director Accepted and agreed to as of the date first written above: CII FINANCIAL, INC. By: -------------------------------------------------- Name: Kathleen M. Marlon Title: President and Chief Executive Officer ANNEX A to that Certain Amended and Restated Dealer Manager Letter Agreement (the "Agreement") dated as of January 31, 2001 between Banc of America Securities LLC and CII Financial, Inc. The Company shall indemnify and hold harmless the Dealer Manager and the Dealer Manager's affiliates and officers, directors, employees, legal counsel, independent auditors, agents and controlling persons (each a "Dealer Manager Indemnified Person") from and against any and all losses, claims, damages, liabilities and reasonable expenses, joint or several, to which any such Dealer Manager Indemnified Person may become subject arising out of or based upon (A) any untrue or alleged untrue statement of a material fact contained in the Documents or any of the documents incorporated by reference therein or in any amendment or supplement to any of the foregoing, or the omission or alleged omission to state therein a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading; provided, however, that the foregoing indemnity with respect to any such untrue statement or omission shall not inure to the benefit of such Dealer Manager Indemnified Person if, and to the extent that the Company is materially prejudiced thereby, the Company shall sustain the burden of proving, and a determination shall have been made by a court of competent jurisdiction by final and nonappealable judgment, that (i) the untrue statement or omission contained in the Documents was corrected in a subsequent amendment thereto; (ii) the person asserting any such claim was not sent or given a copy of the amended Document (excluding any documents incorporated by reference) which corrected the untrue statement or omission at or prior to the purchase or exchange of such Old Debentures if required by applicable law; and (iii) the Company had previously satisfied its obligation to provide a sufficient number of copies of the Documents; (B) any withdrawal, termination, rescission or modification of, or failure to purchase or exchange Old Debentures properly tendered pursuant to, the Offer; (C) any breach by the Company of any representation or warranty or failure to comply with any of the agreements set forth in the Agreement to which this Annex A is attached; or (D) the transactions contemplated by the Agreement to which this Annex A is attached or the performance by the Dealer Manager thereunder, or any claim, litigation, investigation or proceedings relating to the foregoing (collectively, "Dealer Manager Proceedings"), regardless of whether any of such Dealer Manager Indemnified Persons is a party thereto, and to reimburse such Dealer Manager Indemnified Persons for any reasonable legal or other reasonable out-of-pocket expenses as they are incurred in connection with investigating or defending any of the foregoing, provided that such indemnification will not, as to any Dealer Manager Indemnified Person, apply to losses, claims, damages, liabilities or expenses to the extent that they are (i) in the case of clause (A) above, caused by an untrue statement or omission or alleged untrue statement or omission that is made in reliance upon and in conformity with information relating to the Dealer Manager furnished in writing to the Company by the Dealer Manager expressly for inclusion in the Documents as specified herein, or (ii) in the case of clause (D) above, finally judicially determined to have resulted from the gross negligence or willful misconduct of such Dealer Manager Indemnified Person. The Company shall not be liable for any settlement of any lawsuit, claim or proceeding effected without its written consent (which consent shall not be unreasonably withheld or delayed), but if settled with such consent, the Company and its subsidiaries jointly and severally agree, subject to the provisions of this Annex A, to indemnify the Dealer Manager Indemnified Person from and against any loss, damage, liability or expense by reason of such settlement. The Dealer Manager shall indemnify and hold harmless the Company and its affiliates and officers, directors, employees, legal counsel, independent auditors, agents and controlling persons (each a "Company Indemnified Person") from and against any and all losses, claims, damages, liabilities and reasonable expenses, joint or several, to which any such Company Indemnified Person may become subject arising out of or based upon the transactions contemplated by the Agreement to which this Annex A is attached or the performance by the Company thereunder, or any claim, litigation, investigation or proceedings relating to the foregoing ("Company Proceedings") regardless of whether any of such Company Indemnified Persons is a party thereto, and to reimburse such Company Indemnified Persons for any reasonable legal or other reasonable out of pocket expenses as they are incurred in connection with investigating or defending any of the foregoing, but only to the extent such losses, claims, damages, liabilities or expenses that are finally judicially determined to have resulted from (x) the gross negligence or willful misconduct of any Dealer Manager Indemnified Person, or (y) any material misstatement or omission that is made in reliance upon and in conformity with information relating to the Dealer Manager furnished in writing to the Company by the Dealer Manager expressly for inclusion in the Documents. The Company acknowledges that such information in (y) above refers to the penultimate line on the cover page and the last line on the back cover page of the Prospectus (and elsewhere in the Documents) specifying the identity, address and phone number of BAS. The terms "Dealer Manager Indemnified Person" and "Company Indemnified Person" are herein collectively referred to as an "Indemnified Person" and the terms "Dealer Manager Proceedings" and "Company Proceedings" are herein collectively referred to as "Proceedings". The Dealer Manager shall not be liable for any settlement of any lawsuit, claim or proceeding effected without its written consent (which consent shall not be unreasonably withheld or delayed), but if settled with such consent, the Dealer Manager agrees, subject to the provisions of this Annex A, to indemnify the Company Indemnified Person from and against any loss, damage or liability by reason of such settlement. Promptly after receipt by an Indemnified Person of notice of the commencement of any Proceedings, such Indemnified Person will, if a claim in respect thereof is to be made against the Company or the Dealer Manager, as the case may be, as indemnifying party (the "Indemnifying Party") for indemnification hereunder, notify such Indemnifying Party in writing of the commencement thereof; provided that (i) the failure so to notify the Indemnifying Party will not relieve any Indemnifying Party from any liability which it may have hereunder except to the extent such failure to give notice results in the loss or compromise of any material rights or defenses of the Indemnifying Party, and (ii) the failure so to notify such Indemnifying Party will not relieve any Indemnifying Party from any liability which it may have to such Indemnified Person otherwise than on account of the Agreement or this Annex A. In case any such Proceedings are brought against any Indemnified Person and it notifies the applicable Indemnifying Party of the commencement thereof, such Indemnifying Party will be entitled to participate therein, and, to the extent that it may elect by written notice delivered to such Indemnified Person, to assume the defense thereof, with counsel reasonably satisfactory to such Indemnified Person, provided that if the defendants in any such Proceeding include both such Indemnified Person and the Indemnifying Party and counsel to such Indemnified Person shall have reasonably concluded that there may be legal defenses available to it which are different from or additional to those available to the Indemnifying Party or its affiliates, such Indemnified Person shall have the right to select separate counsel to assert such legal defenses and to otherwise participate in the defense of such Proceedings on behalf of such Indemnified Person, it being understood, however, that counsel for all Indemnified Persons shall be designated in writing by BAS so long as it is one of the Indemnified Persons or by mutual agreement if it is not such a person. Upon receipt of notice from the Indemnifying Party to such Indemnified Person of its election so to assume the defense of such Proceedings within 30 days after receipt of such notice and approval by such Indemnified Person of counsel, the Indemnifying Party shall not be liable to such Indemnified Person for legal expenses of other counsel subsequently incurred by such Indemnified Person in connection with the defense thereof (other than reasonable costs of investigation and in addition to any local counsel) unless (i) such Indemnified Person shall have employed separate counsel in connection with the assertion of legal defenses in accordance with the proviso to the next preceding sentence (it being understood, however, that the Indemnifying Party shall not be liable for the expenses of more than one separate counsel, approved by the Indemnified Party, representing the Indemnified Persons who are parties to such Proceedings), (ii) the Indemnifying Party shall not have employed separate counsel reasonably satisfactory to such Indemnified Person to represent such Indemnified Person within a reasonable time after notice of commencement of the Proceedings, or (iii) the Indemnifying Party fails to assume such defense within the 30 days specified above, or (iv) the Indemnifying Party shall have authorized in writing the employment of counsel for such Indemnified Person. The Indemnifying Party shall not effect, without the prior written consent of the Indemnified Person, any settlement of any pending or threatened Proceedings unless such settlement includes an unconditional release from the party bringing such Proceedings of such Indemnified Person and does not include a statement as to or an admission of fault, culpability or a failure to act by or on behalf of any Indemnified Person. If at any time an Indemnified Party shall have requested an Indemnifying Party to reimburse the Indemnified Party for reasonable fees and expenses of counsel, such Indemnifying Party agrees that it shall be liable for any settlement of the nature contemplated by the preceding paragraphs effected without its written consent if (i) such settlement is entered into more than 45 days after receipt by such Indemnifying Party of the aforesaid request, (ii) such Indemnifying Party shall have received notice of the terms of such settlement at least 30 days prior to such settlement being entered into and (iii) such Indemnifying Party shall not have reimbursed such Indemnified Party in accordance with such request prior to the date of such settlement. Notwithstanding the immediately preceding sentence, if at any time an Indemnified Party shall have requested an Indemnifying Party to reimburse the Indemnified Party for fees and expenses of counsel, an Indemnifying Party shall not be liable for any settlement of the nature contemplated by the preceding paragraphs effected without its consent if such Indemnifying Party (a) reimburses such Indemnified Party in accordance with such request to the extent it considers such request to be reasonable and (b) provides written notice to the Indemnified Party substantiating the unpaid balance as unreasonable, in each case prior to the date of such settlement. If for any reason the foregoing indemnification is unavailable to any Indemnified Person or insufficient to hold it harmless, then the applicable Indemnifying Party shall contribute to the amount paid or payable by such Indemnified Person as a result of such loss, claim, damage, liability or expense in such proportion as is appropriate to reflect not only the relative benefits received by the Indemnifying Party on the one hand and such Indemnified Person on the other hand, but also the relative fault of the Indemnifying Party on the one hand, and such Indemnified Person, on the other hand, as well as any relevant equitable considerations. It is hereby agreed that the relevant benefits to the Company (including its affiliates, officers, directors, employees, legal counsel, independent auditors, agents and controlling persons) on the one hand and the Dealer Manager (including its affiliates, officers, directors, employees, agents and controlling persons) on the other hand shall be deemed to be in the same proportion as (i) the aggregate original principal amount of the Old Debentures outstanding bears to (ii) the fee paid or proposed to be paid to the Dealer Manager pursuant to Section 2 of the Agreement to which this Annex A is attached. The relative fault of the Indemnifying Party on the one hand and the Indemnified Person on the other hand relating to an untrue or alleged untrue statement of material fact or the omission or alleged omission to state a material fact shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by, or relating to, the Indemnifying Party and its affiliates or the Indemnified Person and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The indemnity, reimbursement and contribution obligations of an Indemnifying Party under this Annex A shall be in addition to any liability which such Indemnifying Party may otherwise have to an Indemnified Party and shall be binding upon and inure to the benefit of any successors, assigns, heirs and personal representatives of such Indemnifying Party and any such Indemnified Person. Notwithstanding the foregoing, in no event shall the Dealer Manager be liable under the foregoing indemnity, reimbursement and contribution provisions in an amount in excess of the fees actually received by the Dealer Manager pursuant to the Agreement to which this Annex A is attached. Capitalized terms used but not defined in this Annex A have the meanings assigned to such terms in the Agreement to which this Annex A is attached. EX-3 3 0003.txt Exhibit 3.1 A467587 ENDORSED FILED In the office of the Secretary of State Of the State of California OCT 31 1995 BILL JONES; Secretary of State AGREEMENT OF MERGER AMONG SIERRA HEALTH SERVICES, INC. HEALTH ACQUISITION CORP. AND CII FINANCIAL, INC. THIS AGREEMENT OF MERGER, is entered into to be effective on the Effective Date set forth below by and among Sierra Health Services, Inc., a Nevada corporation ("Sierra"), Health Acquisition Corp., a California corporation and a wholly-owned subsidiary of Sierra ("Sierra Sub"), and CII Financial, Inc., a California corporation ("CII"). W I T N E S S E T H WHEREAS, the parties to this Agreement have determined that it is in the best interests of each of them to merge Sierra Sub with and into CII. NOW, THEREFORE, in consideration of the premises and the mutual covenants set forth below, and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties to this Agreement hereby agree as follows: A G R E E M E N T 1. Merger. Upon the Effective Date, as defined below, Sierra Sub shall be merged with and into CII (the "Merger") in accordance with the provisions of the California General Corporation Law (California Corporations Code Section 1100 et seq. (the "Law")). For purposes of the Law and this Agreement, CII shall be the surviving corporation, and Sierra Sub shall be the disappearing corporation. 2. Name. The name of the surviving corporation shall be "CII Financial, Inc." 3. Effective Date. The Merger shall become effective at 11:59 p.m. Pacific Standard Time on October 31, 1995 (the "Effective Date"). 4. Compliance with Law. The parties shall take such steps as may be necessary under the Law or otherwise to give effect to this Agreement, including the filing of a copy of this Agreement in the offices of the Secretary of State of the State of California, together with the certificates required by Section 1103 of the Law. 5. Articles of Incorporation. On the Effective Date, Article IV of the Articles of Incorporation of the surviving corporation shall be amended to read in its entirety as provided in Exhibit A attached hereto and incorporated herein. 6. Effect on Outstanding Shares of Disappearing and Surviving Corporation. On the Effective Date, by virtue of the Merger and without any action on the part of the holder of any shares of common stock, stated value $.50 per share, of CII (the "CII Common Stock") or capital stock of Sierra Sub, except for shares of CII Common Stock as to which dissenters' rights are perfected under the General Corporation Law of California: (a) Each issued and outstanding share of the capital stock of Sierra Sub shall be converted into and become one fully paid and nonassessable share of common stock, stated value $.50 per share, of the surviving corporation. (b) All shares of CII Common Stock that are owned by Sierra, Sierra Sub or any other wholly-owned subsidiary of Sierra shall be canceled and retired and shall cease to exist and no stock of Sierra or other consideration shall be delivered in exchange therefor. (c) (i) Subject to Section 6(d), each issued and outstanding share of CII Common Stock (other than shares to be cancelled in accordance with Section 6(b) shall be converted into the right to receive .370 of a fully paid and nonassessable share of common stock, par value $.005 per share, of Sierra (the "Sierra Common Stock"), including the corresponding percentage of a right (the "Right") to purchase shares of Series A Junior Participating Preferred Stock of Sierra pursuant to the Rights Agreement (the "Rights Agreement") dated as of June 14, 1994 between Sierra and Continental Stock Transfer & Trust Company, as Rights Agent. Prior to the "distribution date" (as defined in the Rights Agreement), all references in this Agreement to Sierra Common Stock to be received pursuant to the Merger shall be deemed to include the Rights. All such shares of CII Common stock shall no longer be outstanding and shall automatically be cancelled and retired and shall cease to exist, and each holder of a certificate representing any such shares shall cease to have any rights with respect thereto, except the right to receive the shares of Sierra Common Stock to be issued in consideration therefor upon the surrender of such certificate, without interest. (ii) With respect to CII's 7 1/2% Convertible Subordinated Debentures Due 2001 (the "CII Debentures") issued pursuant to the Indenture (the "Indenture") dated as of September 15, 1991 between CII and Manufacturers Hanover Trust Company, as Trustee (the "Trustee"), and pursuant to an indenture supplemental thereto to be executed by and among CII, Sierra and the Trustee, the CII Debentures will no longer be convertible into CII Common Stock and will become convertible into Sierra Common Stock. The price at which such shares of Sierra Common Stock shall be delivered upon conversion of the CII Debentures shall be the quotient of the "conversion price" (as defined in the Indenture) in effect immediately prior to the Effective Date divided by .370, subject to further adjustment as provided in the Indenture. (iii) With respect to CII's stock option plans (the "CII Plans"), each outstanding option to purchase shares of CII Common Stock issued pursuant to the CII Plans will be assumed by Sierra and will constitute an option to acquire the same number of shares of Sierra Common Stock into which such shares would have been converted pursuant to the Merger had such options been exercised immediately prior to the Effective Date. (d) No fractions of a share of Sierra Common Stock shall be issued in the Merger, but in lieu thereof each holder of shares of CII Common Stock otherwise entitled to a fraction of a share of Sierra Common Stock shall, upon surrender of his or her certificate or certificates, be entitled to receive an amount of cash (without interest) determined by multiplying the closing price for Sierra Common Stock as reported on the New York Stock Exchange Composite Transactions on the business day two days prior to the Effective date by the fractional share interest to which such holder would otherwise be entitled. 7. Effect of Merger. The effect of the Merger shall be as prescribed by the Law. Pursuant to Section 1107 of the Law, without any further act of the parties: (a) On the Effective Date, the separate existence of Sierra Sub shall cease, and the surviving corporation shall succeed, without other transfer, to all the rights and properties of Sierra Sub and shall be subject to all the debts and liabilities of Sierra Sub in the same manner as if the surviving corporation had itself incurred them. (b) After the Effective Date, all rights of creditors and all liens upon the property of Sierra Sub shall be preserved unimpaired, provided of Sierra Sub shall be preserved unimpaired, provided that such liens of Sierra Sub shall be limited to the property affected thereby immediately prior to the Effective Date. (c) After the Effective Date, any action or proceeding pending by or against Sierra Sub may be prosecuted to judgment, which shall bind the surviving corporation, or the surviving corporation may be proceeded against or substituted in place of Sierra Sub. 8. Miscellaneous. 8.1 Governing Law. This Agreement, the transactions contemplated hereby and the rights of the parties hereunder and under statutory and common law with respect to the transactions contemplated hereby shall be governed and construed in accordance with the laws of the State of California. 8.2 Headings. The headings and subheadings used in this Agreement are for convenience of reference only and shall not be considered in construing this Agreement. 8.3 Counterpart Execution. This Agreement may be executed in two or more counterparts all of which shall be considered one and the same agreement and shall become effective when two or more counterparts have been signed by each of the parties and delivered to the other parties, it being understood that all parties need not sign the same counterpart. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of October 20, 1995. SIERRA HEALTH SERVICES, INC. By:__________/s/_________________ Erin E. MacDonald President ______/s/__________________ Frank E. Collins Secretary HEALTH ACQUISITION CORP. By:____________/s/________________ Erin E. MacDonald President ______/s/___________________ Frank E. Collins Secretary CII FINANCIAL, INC. By:_____________________________ Joseph G. Havlick Chairman of the Board, Chief Executive Officer and President - ------------------------ Richard E. Dobson Secretary IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of October 20, 1995. SIERRA HEALTH SERVICES, INC. By:__________/s/_________________ Erin E. MacDonald President ______/s/__________________ Frank E. Collins Secretary HEALTH ACQUISITION CORP. By:____________/s/________________ Erin E. MacDonald President ______/s/___________________ Frank E. Collins Secretary CII FINANCIAL, INC. By:__________/s/___________________ Joseph G. Havlick Chairman of the Board, Chief Executive Officer and President ____/s/____________________ Richard E. Dobson Secretary EXHIBIT A IV "The corporation is authorized to issue only one class of shares of stock which shall be designated as "Common Stock" and the total number of shares which this corporation is authorized to issue is one thousand (1,000)." CERTIFICATE OF APPROVAL OF AGREEMENT OF MERGER OF CII FINANCIAL, INC. Joseph G. Havlick and Richard E. Dobson do hereby certify that: 1. They are the President and Secretary, respectively, of CII Financial, Inc., A California corporation (the "Corporation"). 2. The principal Terms of the agreement of merger in the form attached hereto were duly approved by the Board of Directors of the Corporation. 3. There is only one class of shares of the Corporation and the total number of outstanding shares entitled to vote on the agreement of merger is 7,187,721 shares. 4. The principal terms of the agreement of merger in the form attached hereto were duly approved by the Corporation by the vote of a number of shares that equaled or exceeded the vote required. 5. The percentage vote required is ore than 50% of the outstanding shares. We further declare under penalty of perjury under the laws of the State of California that the matters set forth in this Certificate are true and correct of our own knowledge. DATE: October 31, 1995 __________/s/________________________ Joseph G. Havlick, President __________/s/________________________ Richard E. Dobson, Secretary CERTIFICATE OF APPROVAL OF AGREEMENT OF MERGER OF HEALTH ACQUISITION CORP. Erin E. MacDonald and Frank E. Collins do hereby certify that: 1. They are the president and the secretary, respectively, of Health Acquisition Corp., a California corporation (the "Corporation"). 2. The principal Terms of the agreement of merger in the form attached hereto were duly approved by the board of directors of the corporation. 3. There is only one class of shares of the Corporation and the total number of outstanding shares entitled to vote on the agreement of merger is 100. 4. The principal terms of the agreement of merger in the form attached hereto were duly approved by the Corporation by the vote of a number of shares which equaled or exceeded the vote required. 5. The percentage vote required is ore than 50% of the outstanding shares. 6. The vote required of the shareholders of Sierra Health Services, Inc., the parent of the Corporation, was obtained. We further declare under penalty of perjury under the laws of the State of California that the matters set forth in this certificate are true and correct of our own knowledge. Date: October 31, 1995. -- __________/s/__________________ Erin E. MacDonald, President __________/s/__________________ Frank E. Collins, Secretary 1622843 ENDORSED FILED In the office of the Secretary of State Of the State of California SEP 15 1998 MARCH FONG EU; Secretary of State ARTICLES OF INCORPORATION OF CII FINANCIAL, INC. I The name of this corporation is CII FINANCIAL, INC. II The purpose of this corporation is to engage in any lawful act or activity for which a corporation may be organized under the General Corporation Law of California other than the banking business, the trust company business or the practice of a profession permitted to be incorporated. III The name and address in the State of California of this corporation's initial agent for service of process is: Joseph G. Havlick, 4001 West Alameda Avenue, Suite 301, Burbank, California 91505. IV The corporation is authorized to issue only one class of shares of stock which shall be designated as "Common Stock"; and the total number of shares which this corporation is authorized to issue is one hundred million (100,000,000). V Section 1. The liability of the directors of the corporation for monetary damages shall be eliminated to the fullest extent permissible under California law. Section 2. The corporation is authorized to provide indemnification of agents (as defined in Section 317 of the California Corporations Code) through bylaw provisions, agreements with the agents, vote of shareholders or disinterested directors, or otherwise, in excess of the indemnification otherwise permitted by limits set forth in Section 204 of the California Corporations Code with respect to actions for breach of duty to the corporation or its shareholders. The corporation is further authorized to provide insurance for agents as set forth in Section 317 of the California Corporations Code, provided that, in cases where the corporation owns all or a portion of the shares of the company issuing the insurance policy, the company and/or the policy must meet one of the two sets of conditions set forth in Section 317, as amended. CIIF ARTICLES PAGE 2 Section 3. Any repeal or modification of the foregoing provisions of this Article V by the shareholders of this corporation shall not adversely affect any right or protection of an agent of this corporation existing at the time of such repeal or modification. DATED: September 13, 1988. ___________/s/____________________ Trude A. Tsujimoto Incorporator I hereby declare that I am the person who executed the foregoing Articles of Incorporation, which execution is my act and deed. _________/s/______________________ Trude A. Tsujimoto EX-3 4 0004.txt Exhibit 3.2 AMENDED AND RESTATED BYLAWS OF CII FINANCIAL, INC. (A CALIFORNIA CORPORATION) ARTICLE I. OFFICES Section 1.01 Principal Executive Office. The principal executive office of the corporation is hereby fixed in Pleasanton, County of Alameda, California. The Board of Directors is hereby granted full power and authority to change said principal office from one location to another. Section 1.02 Other Offices. The corporation may also have an office or offices at such other place or places, either within or without the State of California, as the Board may from time to time determine or as the business of the corporation may require. ARTICLE II. STOCKHOLDERS Section 2.01 Annual Meetings. The Annual Meeting of stockholders of the corporation, for the purpose of electing directors and for the transaction of such other proper business as may come before such meeting, may be held on such day and at such time as the Board shall determine by resolution; provided, however that should said day fall upon a Saturday, Sunday or legal holiday observed by the corporation at its principal executive office, then any such Annual Meeting of stockholders shall be held at the same time and place on the next day thereafter ensuing which is a full business day. If the Board fails to designate the date and time of an Annual Meeting, said Annual Meeting shall be held on the first Tuesday of June of each Year. Section 2.02 Special Meetings. Special Meetings of stockholders may be called at any time for any purpose or purposes permitted under California law by the Board, by the Chairman of the Board, by the President or by stockholders entitled to cast not less than ten percent (10%) of the votes at such meeting. Section 2.03 Place of Meetings. All meetings of stockholders shall be held either at the principal executive office of the corporation or at any other location within or without the State of California, as shall be determined from time to time by the Board of Directors or as specified in the respective notices or waivers of notice thereof. Section 2.04 Notice of meetings. (a) Written notice of each Annual or Special Meeting of stockholders shall be given not less than ten (10) nor more than sixty (60) days before the date of the meeting to each stockholder entitled to a vote thereat. Such notice shall state the place, date, and hour of the meeting, and (i) in the case of a Special Meeting, the general nature of the business to be transacted; or (ii) in the case of the Annual Meeting, those matters which the Board, at the time of the mailing of the notice, intends to present for action by the stockholders, but any proper matter may be presented at the meeting for such action. The notice of any meeting at which directors are to be elected shall include the names of the nominees intended at the time of the notice, to be presented by management for election. (b) Notice of a meeting of stockholders shall be given either personally or by mail addressed, postage prepaid, to the stockholder at the address of such stockholder appearing on the books of the corporation, or if no such address appears or is given constructive notice may be given to him as provided by the California General Corporation Law. Notice of any meeting of stockholders shall not be required to be given to any stockholder who shall have waived such notice; and such notice shall be deemed waived by any stockholder who shall attend such meeting in person or by proxy, except a stockholder who shall attend such meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business on the grounds that the meeting has not been lawfully called or convened. An affidavit by the Secretary of the corporation of mailing of any notice shall be Prima facie evidence of the giving of the notice. Section 2.05 Quorum and Vote Required. (a) At any meeting of stockholders the holders of record of a majority of the shares issued and outstanding and entitled to a vote thereat, represented in person or by proxy, shall constitute a quorum for the transaction of business. The affirmative vote of the holders of the majority of the shares of such stock so constituting a quorum shall be considered to be the act of the stockholders, unless the vote of a greater number or voting by classes is required by the General Corporation Law or the Articles of Incorporation. (b) The stockholders present at a duly called or held meeting at which a quorum is present may continue to do business until adjournment, notwithstanding withdrawal of enough stockholders to leave less than a quorum (as hereinabove defined), if any action taken (other than adjournment) is approved by at least a majority of the number of shares required, as noted above, to constitute a quorum. Section 2.06 Adjourned Meeting and Notice Thereof. (a) Any meeting of stockholders, whether or not a quorum is present, may be adjourned from time to time. In the absence of a quorum no other business may be transacted at such adjourned meeting. (b) It shall not be necessary to give any notice of the time and place of an adjourned meeting or of the business to be transacted thereat, other than by announcement at the meeting at which such adjournment is taken; provided, however, that when a meeting of stockholders is adjourned for more than forty-five (45) days or, if after adjournment a new record date is fixed for the adjourned meeting, notice of the adjourned meeting shall be given as in the case of an original meeting. Section 2.07 Voting. The stockholders entitled to notice of any meeting or to vote at any such meeting shall be only persons in whose name shares stand on the stock records of the corporation on the record date determined in accordance with Section 2.08 of this Article. Persons holding stock of the corporation in a fiduciary capacity shall be entitled to vote such stock. Persons whose stock is pledged shall be entitled to vote the pledged stock, unless in the transfer by the pledge on the books of the corporation he shall have expressly empowered the pledge to vote thereon, in which case only the pledge, or his proxy, may represent such stock and vote thereon. Stock having voting power standing of record in the names of two or more persons, whether fiduciaries, members of a partnership, joint tenants, tenants in common, tenants by the entirety or otherwise, or with respect to which two or more persons have the same fiduciary relationship, shall be voted by any one of the registered holders, either in person or by proxy. Section 2.08 Record Date. (a) The Board may fix in advance a record date for the determination of stockholders entitled to notice of any meeting or to vote or entitled to receive payment of any rights, or entitled to rights, or entitled to exercise any rights in respect to any other lawful action. The record date so fixed shall be not more than sixty (60) nor less than ten (10) days prior to the date of the meeting nor more than sixty (60) days prior to any of the other aforementioned actions. When a record date is so fixed, only stockholders of record on that date are entitled to notice of and to vote at the meeting or to receive the dividend, distribution, or allotment of rights, or to exercise of the rights, as the case may be, not withstanding any transfer of shares on the books of the corporation after the record date. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting unless the Board fixes a new record date for the adjourned meeting. The Board shall fix a new record date if the meeting is adjourned for more than forty-five (45) days from the date set for the original meeting. (b) If no record date is fixed by the Board, the record date for determining stockholders entitled to notice of or to vote at a meeting of stockholders shall be the close of business on the business day next preceding the day on which notice is given or, if notice is waived, at the close of business on the business day next preceding the day on which the meeting is held. If no record date is fixed by the Board, the record date for determining stockholders for any other purpose shall be at the close of business on the day on which the Board adopts the resolution relating thereto, or the sixtieth (60th) day prior to the date of such other action, whichever is later. Section 2.09 Consent of Absentees. The transactions of any meeting of stockholders, however called and noticed, and wherever held, are as valid as though had at a meeting duly held after regular call and notice, if a quorum is present either in person or by proxy, and if, either before or after the meeting, each of the persons entitled to vote, not present in person or by proxy, signs a written waiver of notice or a consent to the holding of the meeting or an approval of the minutes thereof. All such waivers, consents, or approvals shall be filed with the corporate records or be made a part of the minutes of such meeting. Section 2.10 Action Without Meeting. Any action which, under any provision of law, may be taken at any Annual or Special Meeting of stockholders, may be taken without a meeting and without prior notice thereof if a consent in writing, setting forth the actions so taken, shall be signed by the holders of record of the issued and outstanding shares having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted; provided, however, that directors may not be elected by written consent except by the unanimous written consent of all shares entitled to vote for the Selection of directors. Unless a record date for voting purposes be fixed as provided in Section 2.08 of this Article, the record date for determining stockholders entitled to give consent pursuant to this Section 2.10, when no prior action by the Board has been taken, shall be the day on which the first written consent is given. Section 2.11 Proxies. Every person entitled to vote shares has the right to do so either in person or by one or more persons authorized by a written proxy executed by such stockholder and filed with the Secretary of the corporation not less than forty-eight (48) hours prior to the meeting; provided, however, that no proxy may be voted or acted upon after eleven (11) months from its date unless the proxy shall provide for a longer period. A proxy may be revoked by a writing delivered to the Secretary of the corporation stating that the proxy is revoked, or by a subsequent proxy executed or, as to any meeting, by attendance at such meeting and voting in person by the person executing the proxy. Section 2.12 Conduct of Meetings. The Chairman of the Board or in his absence the President of the corporation, or in his absence the vice-president designated by him, shall preside as Chairman at all meetings of stockholders. The Chairman shall conduct each such meeting in a businesslike and fair manner, but shall not be obligated to follow any technical, formal or parliamentary rules or principles of procedure. The Chairman's ruling on procedural matters shall be conclusive and binding on all stockholders, unless at the time of a ruling a request for a vote is made by a stockholder entitled to vote and who is represented in person or by proxy at the meeting, in which case the decision of a majority of such shares shall be conclusive and binding on all stockholders. Without limiting the generality of the foregoing, the Chairman shall have all of the powers usually vested in the Chairman of a meeting of stockholders. Section 2.13 Inspectors of Election. In advance of any meeting of stockholders, the Board may appoint inspectors of election to act at the meeting and any adjournment thereof. If inspectors are not appointed, or if any persons so appointed fail to appear or refuse to act, the chairman of such meeting may appoint inspectors at the meeting. The number of inspectors shall be either one (1) or three (3). Each inspector so appointed shall first subscribe an oath to faithfully execute the duties of an inspector at such meeting with strict impartiality and according to the best of his ability. Such inspectors (I) shall decide upon the qualification of those entitled to vote; (ii) shall report the number of shares represented at the meeting and entitled to vote on the question presented; (iii) shall conduct the balloting and accept the votes; and (iv) when the voting is completed, shall ascertain and report the number of shares voted respectively for and against each question presented. Reports of the inspectors shall be in writing and subscribed and delivered by them to the Secretary of the corporation. The inspectors need not be stockholders of the corporation, and any officer of the corporation may be an inspector on any question other than a vote for or against a proposal in which he shall have a material interest of any nature. ARTICLE III. DIRECTORS Section 3.01 Powers. Subject to any limitation of the Articles of Incorporation, of these Bylaws, and of actions required by law to be approved by the stockholders, the business and affairs of the corporation shall be managed and all corporate powers shall be vested in, and exercised by or under the direction of the Board of Directors. The Board may, as permitted by law, delegate the management of the day-to-day operation of the business of the corporation to a management company or other persons or officers of the corporation, provided that the business and affairs of the corporation shall be managed and all corporate powers shall be exercised under the ultimate direction of the Board. Section 3.02 Number of Directors. The authorized number of directors of the corporation shall be not less than three (3) directors nor more than a maximum of five (5) directors, provided that at least two (2) directors shall constitute a quorum at any meeting of the directors. The exact number of directors shall be set within these limits from time to time (a) by approval of the Board of Directors, or (b) by the affirmative vote of a majority of the shares represented and voting at a duly held meeting at which a quorum is present (which shares voting affirmatively also constitute at least a majority of the required quorum) or by the written consent of shareholders pursuant to Section 2.10 hereinabove. Each of the directors shall be at least eighteen (18) years of age. A majority of the directors shall be citizens and residents of the United States. Section 3.03 Election and Term of Office. (a) Directors will be elected in the manner provided herein at each Annual Meeting of stockholders, but if such Annual Meeting of stockholders is not held or the Directors are not elected thereat, the Directors may be elected at any Special Meeting of stockholders held for that purpose. Each Director, including a Director elected to fill a vacancy, shall hold office until the next Annual Meeting of stockholders and until a successor has been duly elected and qualified. (b) At each election the persons receiving the greatest number of votes, up to the number of Directors then to be elected, shall be the persons then elected. The election of Directors shall be subject to any provisions contained in the Articles of Incorporation relating thereto, and to any provisions of law for cumulative voting. Nominations of persons to serve as Directors shall be submitted to the Secretary of the corporation at the meeting of stockholders at which Directors will be elected. Section 3.04 Resignation. Any Director may resign at any time by giving written notice to the Board or to the Chairman of the Board, the President or the Secretary of the corporation. Any such resignation shall take effect at the times specified therein, or, if the time be not specified, it shall take effect immediately upon its receipt; and, unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it effective. If resignation is to be effective at a future time, a successor may be elected to take office when the resignation becomes effective. Section 3.05 Vacancies. (a) A vacancy or vacancies in the Board shall be deemed to exist in case of the death, resignation or removal of any Director, or if the authorized number of Directors is increased, or if the stockholders fail at any Annual or Special Meeting of stockholders at which any Directors are elected to elect the full authorized number of Directors to be voted for at said meeting. (b) The Board may declare vacant the office of a Director who has been declared of unsound mind by an order of court or who has been convicted of a felony. Except to the extent it would be contrary to the Articles of Incorporation or law, any Director may be removed at any time, with or without cause, by the affirmative vote of stockholders having a majority of the voting power of the corporation given at a Special Meeting of stock-holders called for that purpose; provided, however, that no Director may be removed (unless the entire Board of Directors is removed) when the votes cast against removal, or not consenting in writing to such removal, would be sufficient to elect such Director if voted cumulatively at an election at which the total number of votes were cast (or if such action is taken by written consent, all shares entitled to vote were voted) and the entire number of Directors authorized at the time of the Director's most recent election were then being elected. (c) No reduction of the authorized number of Directors shall have the effect of removing any Director prior to the expiration of the Director's term of office. (d) Except as otherwise provided in the Articles of Incorporation, any vacancy on the Board, whether because of death, resignation, disqualification, an increase in the number of directors, or any other cause, may be filled by the vote of the majority of the remaining Directors, although less than a quorum; provided, however, that a vacancy occurring by reason of removal of a Director may be filled only by the stockholders. The stockholders may elect a Director at any time to fill a vacancy not filled by the Directors, and any such election by written consent shall require the consent of a majority of the stockholders entitled to vote; provided, however, that no Director shall be elected by written consent to fill a vacancy created by removal of any Director, except, by the unanimous written consent of all stockholders entitled to vote for the election of Directors. Each Director chosen to fill a vacancy shall hold office until his successor shall have been elected and qualified or until he shall resign or shall have been removed. Section 3.06 Place of Meetings. All meetings of the Board shall be held either at the principal executive office of the corporation or at any other location within or without the State of California as shall be determined, from time to time, by the Board of Directors, or as specified in the respective notices or waivers of notice thereof. Section 3.07 First Meeting. Immediately following each Annual Meeting of stockholders the Board shall meet for the purpose of organization, selection of a Chairman of the Board, election of Officers, and the transaction of any other proper business. Except as provided by law, notice of such first Meeting is hereby dispensed with. Section 3.08 Regular Meetings. The Board shall hold Regular Meetings at least once per calendar quarter. Except as provided by law, notice of Regular meetings is hereby dispensed with. Section 3.09 Special Meetings. (a) Special Meetings of the Board may be called at any time by the Chairman of the Board, the President, or the Secretary or by any two directors. (b) Special Meetings of the Board shall be held upon at least four (4) days' written notice or forty-eight (48) hours notice given personally or by telephone, telegraph, telex or other similar means of communication. Any such notice shall be addressed or delivered to each Director at such Director's address as it is shown upon the records of the corporation or as may have been given to the corporation by the Director for purposes of notice. Section 3.10 Quorum. The presence of a majority of the directors present at any meeting of the Board, but which majority shall in no event be less than two (2) directors, shall be required to constitute a quorum of the Board for the transaction of business at any meeting of the Board, except to adjourn as hereinafter provided. Every act or decision done or made by a majority of the Directors present at a meeting duly held at which a quorum is present shall be regarded as the act of the Board, unless a greater number be required by law, by these Bylaws, or by the Articles of Incorporation. A meeting at which a quorum is initially present may continue to transact business notwithstanding the withdrawal of Directors, if any action taken is approved by at least a majority of the number of Directors required, as noted above, to constitute a quorum for such meeting. The Directors shall act only as a Board, and the individual Directors shall have no power as such, unless such power be expressly conferred upon a Director by a duly adopted resolution of the Board. Section 3.11 Participation in Meetings by Conference Telephone. Members of the Board may participate in a meeting through use of conference telephone or similar communications equipment, so long as all members participating in such meeting can hear and freely communicate with one another. Section 3.12 Waiver of Notice. The transactions of any meeting of the Board, however called and noticed or wherever held, shall be as valid as though had at a meeting duly held after regular call and notice if a quorum be present and if, either before or after the meeting, each of the Directors not present signs a written waiver of notice, a consent to holding such meeting or an approval of the minutes thereof. All such waivers, consents or approvals shall be filed with the corporate records or be made a part of the minutes of the meeting. Section 3.13 Adjournment. A majority of the Directors present, whether or not a quorum is present, may adjourn any meeting of Directors to another time and place. If the meeting is adjourned for more than twenty-four (24) hours, notice of any adjournment to another time or place shall be given prior to the time of the adjourned meeting to the Directors who were not present at the time of adjournment. Section 3.14 Fees and Compensation. No stated salary shall be paid to Directors, as such, for their services, but by resolution of the Board a fixed sum and expenses of attendance, if any, may be allowed for attendance at each Regular or Special Meeting of the Board or an annual Director's fee, or both, may be paid; provided that nothing herein contained shall be construed to preclude any Director from serving the corporation in any other capacity and receiving compensation therefore. Members of Board committees may be allowed like compensation for attending committee meetings. Section 3.15 Action Without Meeting. Any action required or permitted to be taken by the Board may be taken without a meeting if all members of the Board shall individually or collectively consent in writing to such action. Such consent or consents shall have the same effect as a unanimous vote of the Board and shall be filed with the minutes of the proceedings of the Board. Any action without a meeting of the Board shall be limited to those situations where time is of the essence and not in lieu of a regularly scheduled meeting. Section 3.16 Committees. The Board may, by resolution passed by a majority of the authorized number of Directors, designate one or more committees, each committee to consist of at least three (3) of the directors of the corporation. Among these committees may be an Executive Committee which shall have and may exercise all the powers and authority of the Board in the management of the affairs of the corporation between Regular or Special meetings of the Board. Section 3.17 Officers of the Board. The Board shall have a Chairman of the Board and may, at the discretion of the Board, have one or more Vice Chairmen. The Chairman of the Board and the Vice Chairmen shall be appointed from time to time by the Board, and shall have such powers and duties as shall be designated by the Board or as provided herein in these Bylaws. ARTICLE IV.OFFICERS Section 4.01 Officers. The principal corporate and executive officers of the corporation shall be a president, a vice president, a secretary and a chief financial officer. The corporation may also have, at the discretion of the board of directors, a chairman of the board and such other officers, with such titles and duties as may be determined by the board of directors. One person may hold two or more offices, except that the offices of president and secretary shall not be held by the same person. Section 4.02 Election and Term of Office. The officers of the corporation, except those appointed by delegated authority pursuant to Section 4.03 of this Article, shall be elected annually the board of directors, and each such officer shall hold office after the expiration of his term until a successor is chosen or until his resignation or removal before the expiration of his term. A failure to elect officers shall not require the corporation to be dissolved. Section 4.03 Subordinate Officers, Committees and Agents. The board of directors may from time to time elect such other officers and appoint such committees, employees, or other agents as the business of the corporation may require, including one or more assistant secretaries, and one or more assistant treasurers, each of whom shall hold office for such period, have such authority, and perform such duties as are provided in these bylaws, or as the board of directors may from time to time determine. The board of directors may delegate to any officer or committee the power to appoint subordinate officers and to retain or appoint employees or other agents, or committees thereof, and to prescribe the authority and duties of such subordinate officers, committees, employees or other agents. Section 4.04 Removal and Resignation. Any officer may be removed, either with or without cause, by a majority of the directors at the time in office, at any regular or special meeting of the board of directors, or, except in case of an officer chosen by the board of directors, by any officer upon whom such power of removal may be conferred by the board of directors, subject, in each case, to the rights, if any, of any such officer under any contract of employment with the corporation. Any officer may resign at any time by giving written notice to the corporation, without prejudice, however, to the rights, if any, of the corporation under any contract to which such officer is a party. Any such resignation shall take effect at the date of the receipt of such notice or at any later time specified therein; and unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it effective. Section 4.05 Vacancies. A vacancy in any office shall be filled in the manner prescribed in these bylaws for regular appointments to such office. Section 4.06 Duties and Compensation. Officers of the corporation shall have such powers and duties, and shall receive such compensation therefor, as may be specified from time to time by the board of directors. In the absence of any contrary determination by the board of directors, the president shall be the general manager and chief executive officer of the corporation and shall, subject to the power and authority of the board of directors, have general supervision, direction, and control of the officers, employees, business, and affairs of the corporation. The president shall sign, execute and acknowledge, or authorize another officer or agent to sign, execute and acknowledge in the name of the corporation, deeds, mortgages, bonds, contracts or other instruments, except in cases where the signing and execution thereof shall be expressly delegated by the board of directors, or by these bylaws, to some other officer or agent of the corporation. ARTICLE V. CONTRACTS, CHECKS, DRAFTS, BANK ACCOUNTS, ETC. Section 5.01 Execution of Contracts. Except as these Bylaws may otherwise provide, the Board may, by duly adopted resolution, authorize any officer or agent of the corporation to enter into any contract or execute any instrument in the name and on behalf of the corporation and such authority may be general or confined to specific instances; and unless so authorized by the Board or by these Bylaws, no officer, agent or employee shall have any power or authority to bind the corporation by any contract or engagement or to pledge its credit or to render it liable for any purpose or in any amount. Section 5.02 Checks, Drafts, Etc. All checks, drafts or other orders for payment of money, notes or other evidence of indebtedness, issued in the name of or payable to the corporation, shall be signed or endorsed by such person or persons and in such manner as, from time to time, shall be determined by resolution of the Board. Each such person shall give such bond, if any, as the Board may require. Section 5.03 Deposit. All funds of the corporation not otherwise employed shall be deposited from time to time to the credit of the corporation in such banks, trust companies or other depositories as the Board may select, or as may be selected by any Board committee, Officer, assistant, agent or attorney of the corporation to whom such power shall have been delegated by the Board. For the purpose of deposit and for the purpose of collection for the account of the corporation, the President, Secretary, any Vice-President or the Treasurer (or any other Officer, assistant, agent or attorney of the corporation who shall from time to time be determined by the Board) may endorse, assign and deliver checks, drafts and other orders for the payment of money which are payable to the order of the corporation. Section 5.04 General and Special Bank Accounts. The Board may from time to time authorize the opening and keeping of general and special bank accounts with such banks, trust companies or other depositories as the Board may select or as may be selected by any Board committee, Officer, assistant, agent or attorney of the corporation to whom such power shall have been delegated by the Board. The Board may make such special rules and regulations with respect to such bank accounts, not inconsistent with the provisions of these Bylaws, as it may deem expedient. ARTICLE VI. SHARES AND THEIR TRANSFER Section 6.01 Certificates for Stock. Every owner of stock of the corporation shall be entitled to have a certificate or certificates, to be in such form as the Board shall prescribe, certifying the number and class of shares of the stock of the corporation owned by him. The certificates representing shares of such stock shall be numbered in the order in which they shall be issued, and shall be signed in the name of the corporation by the Chairman of the Board, or the President, and by the Secretary or Assistant Secretary, or the transfer agent or registrar of the corporation. Any of the signatures on the certificates may be a facsimile, provided that at least the signature of the corporation's transfer agent or registrar is an original signature. In case any Officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon any such certificate shall thereafter have ceased to be such Officer, transfer agent or registrar before such certificate is issued, such certificate may nevertheless be issued by the corporation with the same effect as though the person who signed such certificate, or whose facsimile signature shall have been placed thereupon, were such Officer, transfer agent or registrar at the date of issue. A record shall be kept of the respective names of the persons, firms or corporations owning the stock represented by such certificates, respectively, and the respective issuance dates thereof, and in case of cancellation, the respective dates of cancellation. Every certificate surrendered to the corporation for exchange or transfer shall be canceled, and no new certificate or certificates shall be issued in exchange for any existing certificate until such existing certificate shall have been so canceled, except in cases provided for in Section 6.04. 6.02 Transfer of Stock. Transfers of shares of stock of the corporation shall be made only on the books of the corporation by the registered holder thereof, or by his attorney thereunto authorized by power of attorney duly executed and filed with the Secretary of the corporation or with a transfer agent appointed as provided in Section 6.03, and upon surrender of the certificate or certificates for such shares properly endorsed and the payment of all required taxes thereon. The person in whose name shares of stock stand on the books of the corporation shall be deemed the owner thereof for all purposes as regards the corporation. Whenever any transfer of shares shall be made for collateral security, and not absolutely, such fact shall be stated expressly in the entry of transfer if, when the certificate or certificates shall be presented to the corporation for transfer, both the transferor and the transferee request the corporation to do so. Section 6.03 Regulations. The Board may make such rules and regulations as it may deem expedient, not inconsistent with these Bylaws, concerning the issue, transfer and registration of certificates for shares of the stock of the corporation. It may appoint, or authorize any Officer or Officers to appoint one or more transfer agents and one or more registrars, and may require all certificates for stock to bear the signature or signatures or facsimiles thereof of any of them. Section 6.04 Lost, Stolen, Destroyed, and Mutilated Certificates. In any case of loss, theft, destruction, or mutilation of any certificate of stock, another certificate may be issued in its place upon proof of such loss, theft, destruction, or mutilation, and upon the giving of a bond of indemnity to the corporation in such form and in such sum as the Board may direct; provided, however, that a new certificate may be issued without requiring any bond when, in the judgment of the Board, it is proper to do so. ARTICLE VII INDEMNIFCATION Section 7.01 Right to Indemnification. Each person who was or is a party or is threatened to be made a party to or is involved (as a party, witness, or otherwise), in any threatened, pending, or completed action, suit or proceeding, whether civil, criminal, administrative, or investigative (hereafter a "Proceeding"), by reason of the fact that he, or a person of whom he is the legal representative, is or was a director, officer, employee, or agent of the corporation or is or was serving at the request of the corporation as a director, officer, employee, or agent of another foreign or domestic corporation, partnership joint venture, trust, or other enterprise, or was a director, officer, employee, or agent of a foreign or domestic corporation that was a predecessor corporation of the corporation or of another enterprise at the request of such predecessor corporation including service with respect to employee benefit plans, whether the basis of the Proceeding is alleged action in an official capacity as a director, officer, employee, or agent or in any other capacity while serving as a director, officer, employee, or agent (hereafter an "Agent"), shall be indemnified and held harmless by the corporation to the fullest extent authorized by statutory and decisional law, as the same exists or may hereafter be interpreted or amended (but, in the case of any such amendment or interpretation, only to the extent that such amendment or interpretation permits the corporation to provide broad indemnification rights than were permitted prior thereto) against all expenses, liability, and loss (including attorneys' fees, judgments, fines, ERISA excise taxes and penalties paid or to be paid in settlement, any interest, assessments, or other charges imposed thereon, and any federal, state, local, or foreign taxes imposed on any Agent as a result of the actual or deemed receipt of any payments under this Article) incurred or suffered by such person in connection with investigating, defending, being a witness in, or participating in (including on appeal), or preparing for any of the foregoing in, any Proceeding (hereafter "Expenses"). The right to indemnification conferred in this Article shall be a contract right. It is the corporation's intention that these bylaws provide indemnification in excess of that expressly permitted by Section 317 of the California General Corporation Law, as authorized by the corporation's Articles of Incorporation. Section 7.02 Authority to Advance Expenses. The right to indemnification provided in Section 7.01 of these Bylaws shall include the right to be paid, in advance of a Proceeding's final disposition, Expenses incurred in defending that Proceeding; Provided, however, that if required by the California General Corporation Law, as amended, the payment of Expenses in advance of the final disposition of the Proceeding shall be made only upon delivery to the corporation of an undertaking by or on behalf of the Agent to repay such amount if it shall ultimately be determined that he is not entitled to be indemnified by the corporation as authorized under this Article or otherwise. The Agent's obligation to reimburse the corporation for the Expense advances shall be unsecured and no interest shall be charged thereon. Section 7.03 Right of Agent to Bring Suit. If a claim under Section 7.01 or 7.02 of these Bylaws is not paid in full by the corporation within thirty (30) days after a written claim has been received by the corporation, the Agent may at any time thereafter bring suit against the corporation to recover the unpaid amount of the claim and, if successful in whole or in part, the Agent shall also be entitled to be paid the expense (including attorneys' fees) of prosecuting such claim. It shall be a defense to any such action (other than an action brought to enforce a claim for expenses incurred in defending a Proceeding in advance of its final disposition where the required undertaking has been tendered to the corporation) that the Agent has not met the standards of conduct that make it permissible under the California General Corporation Law for the corporation to indemnify the Agent for the amount claimed. The burden of proving such a defense shall be on the corporation. Neither the failure of the corporation (including its Board of Directors, independent legal counsel, or its stockholders) to have made a determination prior to the commencement of such action that indemnification of the Agent is proper under the circumstances because he has met the applicable standard of conduct set forth in the California General Corporation Law, nor an actual determination by the corporation (including its Board of Directors, independent legal counsel, or its stockholders) that the Agent had not met such applicable standard of conduct, shall be a defense to the action or create a presumption that claimant has not met the applicable standard of conduct. Section 7.04 Provisions Nonexclusive. The rights conferred on any person by this Article shall not be exclusive of any other rights that such person may have or hereafter acquire under any statute, provision of the Articles of Incorporation, agreement, vote of stockholders or disinterested directors, or otherwise, both as to action in an official capacity and as to action in another capacity while holding such office. To the extent that any provision of the Articles, agreement, or vote of the stockholders or disinterested directors is inconsistent with these bylaws, the provision, agreement, or vote shall take precedence. Section 7.05 Authority to Insure. The corporation may purchase and maintain insurance to protect itself and any Agent against any Expense asserted against or incurred by such person, whether or not the corporation would have the power to indemnify the Agent against such Expense under applicable law or the provisions of this Article, provided that, in cases where the corporation owns all or a portion of the shares of the company issuing the insurance policy, the company and/or the policy must meet one of the two sets of conditions set forth in Section 317 of the California General Corporation Law, as amended. Section 7.06 Survival of Rights. The rights provided by this Article shall continue as to a person who has ceased to be an Agent and shall inure to the benefit of the heirs, executors, and administrators of such person. Section 7.07 Settlement of Claims. The corporation shall not be liable to indemnify any Agent under this Article (a) for any amounts paid in settlement of any action or claim effected without the corporation's written consent, which consent shall not be unreasonably withheld; or (b) for any judicial award, if the corporation was not given a reasonable and timely opportunity, at its expense, to participate in the defense of such action. Section 7.08 Effect of Amendment. Any amendment, repeal, or modification of this Article shall not adversely affect any right or protection of any Agent existing at the time of such amendment, repeal, or modification. Section 7.09 Subrogation. In the event of payment under this Article, the corporation shall be subrogated to the extent of such payment to all of the rights of recovery of the Agent, who shall execute all papers required and shall do everything that may be necessary to secure such rights, including the execution of such documents necessary to enable the corporation effectively to bring suit to enforce such rights. Section 7.10 No Duplication of Payments. The corporation shall not be liable under this Article to make any payment in connection with any claim made against the Agent to the extent the Agent has otherwise actually received payment (under any insurance policy, agreement, vote, or otherwise) of the amounts otherwise indemnifiable hereunder. ARTICLE VIII. MISCELLANEOUS Section 8.01 Seal. The Board shall provide a corporate seal, which shall be in the form of a circle and shall bear the name of the corporation and words and figures showing that the corporation was incorporated in the State of California and the year of incorporation. Section 8.02 Waiver of Notices. Whenever notice is required to be given by these Bylaws or the Articles of Incorporation or by law, the person entitled to said notice may waive such notice in writing, either before or after the time stated therein, and such waiver shall be deemed equivalent to notice. Section 8.03 Fiscal Year. The fiscal year of the corporation shall begin on the first day of January in each year. Section 8.04 Dividends. The Board may from time to time declare, and the corporation may pay, dividends on its outstanding stock in the manner and on the terms and conditions provided by law, subject to any contractual restrictions to which the corporation is then subject. Section 8.05 Representation of Shares of Other Corporations. The President or any Officer or Officers authorized by the Board or by the President are each authorized to vote, represent, and exercise on behalf of the corporation all rights incident to any and all shares of any other corporation or corporations standing in the name of this corporation. The authority granted herein may be exercised either by any such Officer in person or by any other person authorized to do so by proxy or power of attorney duly executed by said Officer. Section 8.06 Inspection of Bylaws. The corporation shall keep at its principal executive office the original or a copy of its Bylaws as amended to date which shall be open to inspection by stockholders at all reasonable times during office hours. If the principal executive office of the corporation is outside the State of California and the corporation has no principal business office in such state, it shall upon the written notice of any stockholder furnish to such stockholder a copy of these Bylaws as amended to date. The original or a copy of the Bylaws certified to be a true copy by the Secretary or an Assistant Secretary of the Corporation shall be prima facie evidence of the adoption of such Bylaws and of the matters stated therein. Section 8.07 Amendment of Bylaws. (a) Except as otherwise provided by law or Section 3.02 of these bylaws, these bylaws may be amended or repealed by the Board of Directors or by the affirmative vote of a majority of the outstanding shares entitled to vote, including, if applicable, the affirmative vote, including, if applicable, the affirmative vote of a majority of the outstanding shares of each class or series entitled by law or the Articles of Incorporation to vote as a class or series on the amendment or repeal or adoption of any bylaw or bylaws; provided, however, after issuance of shares, a bylaw specifying or changing a fixed number of directors or the maximum or minimum number or changing from a fixed to a variable board or vice versa may only be adopted by approval of the outstanding shares as provided herein. (b) Subject to the right of the outstanding shares to adopt, amend, or repeal Bylaws and to any restrictions imposed by the Articles of Incorporation on the power of the Board to adopt, amend, or repeal Bylaws, these Bylaws may, from time to time and at any time, be amended or repealed, and new or additional Bylaws adopted, by approval of the Board, provided, however, that such Bylaws may not contain any provision in conflict with law or with the Articles of Incorporation. After shares are issued, any Bylaw changing the number of Directors or changing from a variable to a fixed Board may be adopted only by approval of the outstanding shares. Section 8.08 Construction of Bylaws. Unless otherwise stated in these Bylaws or unless the context requires, the definitions contained in the General Corporation Law shall govern the construction of these Bylaws. Without limiting the generality of the foregoing, the masculine gender includes the feminine and neuter, the singular number includes the plural and the plural number includes the singular, and the word "person" includes a corporation or other entity as well as a natural person. EX-10 5 0005.txt Exhibit 10.6 INTERCOMPANY SERVICE AGREEMENT This Agreement effective January 1, 1999, by and between California Indemnity Insurance Company (hereinafter referred to as "CIIC"), a California Insurer, and Sierra Health Services, Inc., a Nevada corporation (hereinafter referred to as "SHS"). RECITALS WHEREAS, CIIC desires to utilize certain management services which can be provided by SHS; and WHEREAS, such an arrangement will achieve certain operating economies and improve services to the benefit of CIIC. NOW THEREFORE, it is AGREED as follows: 1. PERFORMANCE OF SERVICES AND FACILITIES SHS agrees to provide and CIIC agrees to accept, certain executive, administrative, and other services that are customary and usual of an insurance company to enable CIIC to operate its business. Such services shall include, but are not limited to, the following. (Deletions or additions to the specific functions and services may be made by mutual agreement of the parties in writing): (a) Data Processing Services, including provision for necessary programming for present and new systems application. This will include use of data processing programs and hardware, all supplies, input, processing and output requirements, maintenance of access equipment and software, network support as may be required by CIIC. In addition, this includes reports operations and financial reports. (b) Tax Accounting services, including the preparation of and timely filing of tax returns with various applicable taxing authorities, all under the ultimate supervision of the Board of Directors and responsible officers of CIIC. (c) General Administrative and Facilities Services, including but not limited to mailroom, purchasing, phone receptionist, warehouse, storage and office lease management. (d) Actuarial, all under the ultimate supervision of the Board of Directors and responsible officers of CIIC. (e) Human resource and payroll services, including processing of payroll and keeping of appropriate records, advertising and recruiting costs for new or open positions, administration of health insurance, retirement and other benefits. 2. RESPONSIBILITIES SHS shall be responsible for the fitness of personnel for a particular position and shall use its best efforts to ensure that any person employed by it to provide services to CIIC shall have necessary and appropriate credentials, expertise, and personal qualities relative thereto. All services provided by SHS under this Agreement shall be subject to the direction and control and ultimate veto of the authorized officers of CIIC. All accounts, documents, files, vouchers, data, letters and all other papers and records created and maintained by SHS pursuant to this Service Agreement are the property of CIIC and shall be open at all times to inspection by CIIC or its designees upon reasonable notice and , upon termination of this Service agreement, shall be returned to CIIC if it so requests. However, SHS shall be permitted to make copies of such records at its expense. 3. COMPENSATION SHS shall, at its option, send invoices as often as monthly, but no less than annually, for all services provided hereunder and CIIC agrees to pay SHS within 10 calendar days after receipt unless it objects to such charges as provided below. The fees to be charged for all services hereunder shall be those actually incurred by SHS, or at the option of CIIC at its reasonable estimate of the cost directly to it if it staffed or performed such function directly (including all applicable benefit, overhead and related business costs), whichever is less, all pursuant to allocation reasonably applied to such services. The manner and method allocation shall be settled between SHS and CIIC on or before the end of the first quarter of any calendar year in which services are rendered under this Agreement and shall be specified in writing. Unless otherwise agreed allocation of staff services will be based upon actual time SHS personnel allocated to performing the services required but may be estimated for any particular services whose annual allocation would be less than $50,000. From time to time as is reasonable, SHS and CIIC will survey the actual costs of SHS in supplying the services hereunder and the method of allocation. In surveying the method of allocation the parties shall be guided by guidelines, if any published by the National Association of Insurance Commissioners . CIIC also shall pay directly to SHS the amount of reasonable out of pocket expenses including reimbursement for travel and entertainment expense, etc., relating to CIIC. SHS's determination of charges hereunder shall be presented to CIIC and if CIIC objects to any such determination, it shall so advise within thirty (30) days of receipt of notice of said determination. Unless the parties can reconcile any such objection, they shall agree to the selection of a firm of independent certified public accountants which shall determine the charges properly allocable to CIIC, and shall, within a reasonable time, submit such determination, together with the basis therefore, in writing to both parties whereon such determination shall be binding. The expenses of such a determination by a firm of independent certified public accountants shall be borne equally by both parties. Each party shall be responsible for maintaining full and accurate accounting records of all services rendered and facilities used pursuant to this Agreement and such additional information as may reasonably be requested for purposes of the parties' bookkeeping and accounting operations. 4. TERM This Agreement or any part thereof shall remain in effect until terminated in whole or in part by either party upon giving one hundred eighty days (180) written notice to the other party. 5. REPRESENTATION Each of the parties represents to the other that it has proper authority to enter into, and be bound by and carry out the terms of this Agreement, that it is legally organized and in good standing under the laws of the various jurisdiction in which it does business, that it is not party to any agreement, oral or written, which is in violation of or in conflict with the terms hereof, and that it has no knowledge of any law or regulation which will make this agreement void or unenforceable. 6. SEVERABILITY In the event that any part of this Agreement is held to be invalid or unenforceable, then the remainder of this Agreement shall remain in full force and effect. 7. ASSIGNMENT Any rights pursuant hereto shall not be assignable by any party hereto, except by operation of law. Nothing in this Agreement, expressed or implied, is intended to confer on any person other than the parties hereto, or their respective legal successors, any rights, remedies, obligations or liabilities, or to relieve any person other than the parties hereto or their respective legal successors, from any obligations or liabilities that would otherwise be applicable. 8. GOVERNING LAW This Agreement is made pursuant to and shall be governed by, interpreted under, and the rights of the parties determined in accordance with, the laws of the state of California. 9. ARBITRATION Any disputes hereunder shall be settled by binding arbitration in accordance with the general arbitration rules of the American Arbitration Association. Such arbitration shall take place in Las Vegas, Nevada. The decision of the arbitrators shall be final and no party shall have any right of appeal with respect thereto. 10. NOTICES All notices, statements or requests to be given hereunder shall be in writing and shall be deemed to have been duly given when delivered by hand to an officer of the other party, or when deposited with the U.S. Postal Service, as certified or registered mail, postage prepaid as follows: California Indemnity Insurance Company 2716 North Tenaya Way Las Vegas, Nevada 89128 Attention: Chief Financial Officer Sierra Health Services, Inc. 2724 North Tenaya Way Las Vegas, Nevada 89128 Attention: Chief Financial Officer the or to such person or place as each party may from time to time designate by written notice sent as aforesaid. IN WITNESS WHEREOF, the parties hereto intending to be legally bound hereby have executed this Agreement on the date first above written. SIERRA HEALTH SERVICES, INC. BY: s/Paul H. Palmer Paul H. Palmer Vice President, Chief Financial Officer and Treasurer CALIFORNIA INDEMNITY INSURANCE COMPANY BY: s/John F. Okita John F. Okita Chief Financial Officer and Treasurer EX-10 6 0006.txt Exhibit 10.7 TAX ALLOCATION AGREEMENT TAX ALLOCATION AGREEMENT, made as of the 30th day of May, 1997 by and between Sierra Health Services, Inc. a Nevada corporation ("Parent"), and its subsidiaries as listed on page 5 of this agreement (hereinafter "Subsidiary"). WHEREAS, Parent and Subsidiary desire to provide, from and after January 1, 1996, (the "Effective Date"), for the payment to Parent of amounts with respect to income taxes; NOW THEREFOR, in consideration of the foregoing, and of the mutual covenants and promises herein contained, Parent and Subsidiary agree as follows: 1. Agreement to Join in Consolidated Returns 1.1 Subsidiary agrees to join with Parent and any affiliate of Parent in any consolidated federal income tax return filed by any affiliated group ("Consolidated Return") for any taxable year in which Parent is included. 1.2 Subsidiary hereby irrevocably designates Parent as its agent for the purpose of taking any and all action necessary or incidental to the filing of Consolidated Returns. Subsidiary agrees to furnish Parent with any and all information requested by Parent in order to carry out the provisions of this Agreement; to cooperate with Parent in filing any return or consent contemplated by this Agreement; to take such action as Parent may request, including, but not limited to, the filing of all elections and the filing of requests for the extension of time within which to file tax returns; and to cooperate in connection with any refund claim. 1.3 In each taxable year ending after the Effective Date, Subsidiary shall make payment to Parent of the federal income tax liability of the Subsidiary for such taxable year, determined in accordance with Section 2, and (as between Parent and subsidiary) Parent shall have the sole responsibility for making any required payments to the Internal Revenue service (the "Service") or any tax allocation payments to a common parent that is not Parent in satisfaction of the consolidated federal income tax liability of the consolidated Group for such year. For each quarter of each fiscal year ending after the Effective Date, Subsidiary shall make payment to Parent of a portion of the amount required to be paid pursuant to Section 2 equal to the amount of the installment payment of estimated income tax that subsidiary would be required to make to the Service for such quarter under Section 6655 of the Internal Revenue Code of 1986, as amended (the "Code"), as though Subsidiary were filing and had previously filed a separate return, no later than five business days prior to the date upon which Subsidiary would be required to make such payment to the Service; provided that, if the affiliated group qualified as a large corporation under Section 6655(g)(2) of the code, then Subsidiary shall be deemed to be a large corporation for purposes of this Agreement. Promptly following the close of each fiscal year ending after the Effective date and no later than the tenth day of the third month following the end of the fiscal year and again within thirty (30) days of the filing of the consolidated return with the Service, Subsidiary shall pay or cause to be paid to Parent the excess, if any, of the amount payable with respect to such taxable year, determined in accordance with Section 2, over the aggregate of all amounts previously paid pursuant to this Section 1.3 by Subsidiary to Parent with respect to such taxable year, subject to adjustment upon filing a final return if the consolidated return is filed on extension. If Parent fails to file a Consolidated Return that includes the Consolidated Group for any taxable year for which Subsidiary has made or caused to be made a payment or payments pursuant to this Section 1.3, Parent shall promptly refund such payment or payments. 1.4 The amount of any overpayment made pursuant to Section 1.3 shall be credited against or added to as the case may be, the amount otherwise required to be paid for the fiscal quarter within which the amount of such overpayment first becomes reasonably ascertainable and available to Parent as a refund or allowable credit against Parent's tax payment requirements; provided, however, that upon written request (including supporting schedules) of Subsidiary, made after the close of any taxable year but within the period described in Section 6425(a)(1) of the code, Parent shall repay to Subsidiary, within the period described in Section 6425(b)(1) of the Code, the amount of any net remaining overpayment of consolidated tax liability of the Consolidated Group for such year. 1.5 Subsidiary agrees to pay Parent for all claims of liability for federal income tax, interest thereon, and penalties with respect thereto asserted by the Service (relating to subsidiary's taxable income and deductions), arising from any taxable period for which Parent filed Consolidated Return that included the Subsidiary. 1.6 Subsidiary shall cooperate fully with Parent in any audit or any proceeding relating to any Consolidated Return and shall pay an appropriate share of the expenses of any such audit or other proceeding. Parent shall have sole control over the discretion as to the undertaking, conduct settlement or other disposition of any tax controversy out of any Consolidated Return filed by Parent. 2. Computation of Tax Liability of the Consolidated Group 2.1 For the first taxable year ending after the Effective Date, and for each subsequent taxable year of the Consolidated Group for which this Agreement remains in effect, Subsidiary shall pay to Parent (in the manner provided in Section 1.3 hereof) an amount equal to the federal income tax liability that would have been payable by Subsidiary for such year (or portion thereof), determined as if Subsidiary had filed a separate federal income tax return for such year (or portion thereof) and for all previous years, computed in accordance with the actual elections, conventions and other determinations with respect to Subsidiary reflected in the Consolidated Return. Payments required to be made in any taxable year pursuant to this Section 2.1 shall be made without regard to the actual consolidated federal income tax liability, if any, of the Consolidated Group. 2.2 If Subsidiary would be entitled to a refund of federal income taxes previously paid to Parent pursuant to this Agreement computed in the manner described in Section 2.1 hereof, as a result of any losses, deductions or credits claimed by Subsidiary for any taxable year (or portion thereof) for which this Agreement may be in effect, whether or not Subsidiary is included in a Consolidated Return for such year (or portion thereof)(any such entitlement to a refund being referred to herein as a "Separate Return Tax Benefit"), whether by reason of a carryback of a net operating loss, or a net capital loss or tax credit, or otherwise, then, upon written request (including supporting schedules) of subsidiary, made within the period described in Section 6411(a) of the Code, Parent shall pay, subject to Section 3, the amount of such Separate Return Tax Benefit to Subsidiary, within the period described in Section 6411(b) of the Code. 3. Establishment of Separate Escrow Agreement The Parent shall establish a separate escrow account (the "Escrow Account") into which shall be deposited, with respect to each taxable year, the amount, if any, by which Subsidiary's payments to Parent of such year exceeds the actual income tax payment made by the Consolidated Group for such year, provided, however, that if as a result of any adjustment after such year the actual tax payment by the Consolidated Group for such year is changed, the amount of the change shall be added to or released from the Escrow Account to reflect the adjusted Consolidated Group tax liability for such year, determined in accordance with the provisions of Section 1.3. The Escrow Account shall be funded either in cash or assets then eligible for investment by insurers under the Nevada insurance laws and any combination of the two. Assets in the Escrow Account shall be released to Parent at such time and from time to time as the permissible period for loss carrybacks by Subsidiary have elapsed and Subsidiary does not have a claim to recoup all or part of the taxes paid by it. In addition, in the event that Subsidiary would be entitled, as a taxpayer filing a separate return, to a carryback loss, entitling it to recoup income taxes previously paid, or if it is otherwise entitled to a refund of taxes, then payment to Subsidiary of this amount shall be made (1) out of any refund made to the Consolidated Group by the taxing authority and, if this is insufficient, (2) directly by the Parent, at the option of Parent, out of the Escrow Account. To the extent that any such payment to the Subsidiary comes from a refund by the taxing authority or directly from a Parent, assets in the Escrow Account I the amount equal to such payment shall be released to the Parent, provided that such releases shall not include amounts which would be available for loss carrybacks until Subsidiary is entitled to claim such amounts on a carryback basis or until the applicable permissible period for loss carrybacks for Subsidiary have elapsed. 4. Adjustments. Any adjustment of income, deduction, or credit that result after the taxable year in question by reason of any carryback, amended return, claim for refund, or audit shall be given effect by re-determining amounts payable and reimbursable hereunder for such taxable year and all subsequent taxable years for which this Agreement is in effect as if such adjustment had been part of the original determination hereunder, with interest payable in the amounts provided in Section 6621 of the Code. 5. State Taxes 5.1 Subsidiary agrees at the request of Parent to join with Parent and any affiliate of Parent in any consolidated, combined or unitary state or local income or franchise tax return filed by any affiliated group ("Combined Return") for any taxable year in which Parent or affiliate or Parent is included. 5.2 If, at the time from and after the Effective Date, the liability for any state or local income or franchise taxes of (I) Subsidiary and (ii) Parent or any other direct or indirect subsidiary of Parent is determined on a consolidated, combined or unitary basis, this Agreement shall be applied in like manner to all matters relating to such taxes, after taking into consideration to what extent Subsidiary has been included in any Combined Return that relates to such taxes. 6. Arbitration All disputes of every nature related to this Agreement, which the parties have been unable to resolve by themselves, shall be submitted to arbitration upon written request of either party. The arbitration shall be by a single arbitrator, if the parties can agree upon the arbitrator, but, if the parties cannot agree upon a single arbitrator within ten (10) business days after the request for arbitration has been made, then the requesting party shall within ten (10) calendar days thereafter designate an arbitrator and give notice thereof to the other party who shall, in turn, designate an arbitrator within ten (10) calendar days, and shall so notify the requesting party. The two arbitrators, in turn, shall designate a third arbitrator, and the arbitration panel shall determine the procedures to be followed in the proceedings. If one of the parties is an insurance subsidiary, then at least one of the arbitrators shall be an active or retired disinterested officer of an insurance company not affiliated with any of the parties hereto. A decision by the single arbitrator or by a majority of the three arbitrators shall be final and binding upon the parties. The arbitration shall be conducted in Nevada, unless the parties agree upon another location. A Superior Court of Nevada shall have jurisdiction over the parties to enforce the arbitration decision and, upon application of either party, shall be empowered to issue appropriate orders in aid of discovery and/or to compel testimony. 7. Effective Date and Termination This Agreement shall be effective retroactive to the beginning of the taxable years of Parent and Subsidiary commencing on the Effective Date and for all taxable years in which parent files a Consolidated Return that includes the Subsidiary unless terminated by mutual agreement of the parties. 8. Captions All Section captions contained in this Agreement are for convenience only and shall not be deemed a part of this Agreement 9. Counterparts This Agreement may be executed in counterparts, each of which shall constitute an original and all of which, when taken together, shall constitute one agreement. 10. Amendment; Waiver This Agreement may be amended, modified, superseded, canceled or extended, and the provisions hereof may be waived, only by a written instrument signed by the parties or, in the case of a waiver, by the party waiving compliance. 11. Governing Law. This Agreement shall be governed by the laws of the State of Nevada, without regard to the conflict of laws rules thereof. 12. Successors and Assigns This Agreement shall be binding upon, and shall inure to the benefit of, the parties thereto and their respective successors and assigns. IN WITNESS WHEREOF, Parent and Subsidiary have executed this Agreement as of the day and year first above written. HEALTH PLAN OF NEVADA, INC. CALIFORNIA INDEMNITY INSURANCE COMPANY By: Jonathon Bunker By: Kathleen M. Marlon --------------------------------- ------------------------ Title: President Title: CEO ------------------------------ ------ CII FINANCIAL, INC. CII INSURANCE COMPANY By: Kathleen M. Marlon By: Kathleen M. Marlon --------------------------------- ------------------------ Title: CEO Title: CEO ------------------------------ ------ SIERRA HEALTH & LIFE INS. CO., COMMERCIAL CASUALTY INC. INSURANCE COMPANY By: Jonathon Bunker By: Kathleen M. Marlon --------------------------------- ------------------------ Title: President Title: CEO ------------------------------ ------ SIERRA HEALTH SERVICES, INC. By: Erin MacDonald Title: President EX-10 7 0007.txt Exhibit 10.8 SIERRA HEALTH AND LIFE INSURANCE COMPANY HCO CONTRACT WITH CLAIMS ADMINISTRATOR This Agreement made by and between California Indemnity Insurance Company, and each of its insurer subsidiaries, (the "Claims Administrator") Sierra Health and Life Insurance Company (hereinafter referred to as the "HCO"). WHEREAS, the Claims Administrator provides a plan of Workers' Compensation benefits to its insured employer clients or qualified self insured employer or self insured group clients in the State of California; and WHEREAS, the Claims Administrator desires to incorporate Health Care Organizations into some or all of these plans, subject to the laws of the State of California; and WHEREAS, the Claims Administrator is willing to make appropriate arrangements with its insured employer, qualified self insured employer, and/or self insured group clients; NOW, THEREFORE, in consideration of the mutual promises contained in this Agreement, the Claims Administrator and the HCO hereby agree as follows: A. Definitions For the purposes of this Agreement: |X| "Health Care Organization" or "HCO" means an organization certified under Section 4600.5 of the Labor Code and Article 4, Sections 9770 through 9779.2 of the Administrative Rules of the Division of Workers' Compensation, Department of Industrial Relations, State of California, and providing the services defined in Exhibit A of this Agreement. |X| "HCO Enrollee" means a person who is eligible to receive services from an HCO, as defined in Section 4600.5 et seq of the California Labor Code. |X| "Claims Administrator" means a self-administered insurer providing security for the payment of compensation required by Divisions 4 and 4.5 of the California Labor Code, a self-administered, self-insured employer, or a third party claims administrator for a self-insured employer, self insured group, insurer, legally uninsured employer, or joint powers authority. |X| "Employer" means an employer as defined in Section 3300 of the California Labor Code. |X| "Emergency" is defined as those health care services provided to evaluate and treat medical conditions of recent onset and severity that would lead a prudent layperson to believe that urgent and/or unscheduled medical care is required. |X| Injuries covered by the HCO are those that occur during the policy year. Medical management will be provided both during the control period and after the control period ends, if the customer wishes to have the HCO continue. For injuries that occur in one policy year, but continue into another policy year, the HCO will provide medical management during the control period, regardless of policy year. |X| "Medical Case Management" means Medical Disability Management and Utilization Management. "Medical Disability Management" means the determination of medical necessity, appropriateness of care, length of stay, intensity of service related to treatment of HCO Enrollees by Network Providers. "Utilization Management" means the management, assessment, improvement or review of patient care and decision making through case by case assessment of the medical reasonableness or medical necessity of the frequency, duration, level and appropriateness of medical care and services, based upon professionally recognized standards of care, which may include prospective, concurrent or retrospective review of a request for authorization of medical treatment. B. Obligations of the HCO 1. The HCO shall provide medical and managed care services in accordance with the terms of this Agreement and applicable laws and regulations. 2. The HCO's services under this Agreement shall include the services described in Exhibit A (Services of the HCO) and Exhibit C (Coordination with Claims Administration, Return to Work, and Health and Safety Functions), which are attached hereto and incorporated by reference herein. The HCO will provide the Claims Administrator's clients with the option of the Spectrum HCO or the Select HCO. Exhibits A and C outline the differences between Spectrum and Select. Said services shall be performed in accordance with the terms and conditions set forth in Exhibit B (Confidentiality Policy) and Exhibit D (List of Charges), which are attached hereto and incorporated by reference herein. Provided, however, if an HCO enrollee obtains initial treatment from a provider not part of the HCO Network prior to notifying an employer or the Claims Administrator, payment for such treatment will be approved by the HCO. However, any further treatment will not be approved by the HCO for payment. The HCO Enrollee will be notified by the HCO and the HCO will require the Enrollee to select treatment from a Provider in the HCO Network. 3. The HCO will provide the Claims Administrator with all claims information, reimbursement reports, evaluations, return to work reports, and other data necessary to pay claims in a timely and accurate manner and to perform other tasks of coordination with the HCO normally associated with managing and settling workers' compensation. 4. The HCO will provide enrollment and membership material required under the Administrative Rules of the Division of Worker's Compensation section of Article 4. These materials will be provided to employees of employers that contract with the Claims Administrator for an HCO plan of workers' Compensation. 5. The HCO will provide to the Claims Administrator with the length of medical control and current enrollment information for each enrollee 15 days after the conclusion of the enrollment period. 6. The HCO will provide to the Claims Administrator all reports required under Article 4, including those reports specifically named for purposes of detecting targeted workplace hazards, and other reports as may be agreed to elsewhere in this Agreement. 7. The HCO will provide on the Claims Administrator's behalf, enrollment, treatment, outcomes, and other related information to the Division of Workers' Compensation as required under Article 4. 8. The HCO will adhere insofar as is consistent with the reporting requirements for HCOs, with the policy of confidentiality of information as set forth in Exhibit B. 9. Audit: a. Subject to the following provisions of this subsection (a), the Claims Administrator or its agent may audit the HCO's compliance with its obligations under this Agreement and the HCO shall supply the Claims Administrator or its agent with access to information acquired or maintained by the HCO in performing services under this Agreement. The HCO shall be required to supply only such information which is in its possession and which is reasonably necessary for the Claims Administrator to perform activities related to its workers' compensation plan, provided that such disclosure is not prohibited by any third party contracts to which the HCO is a signatory or any requirements of law. The Claims Administrator or its agent shall give the HCO prior written notice of its intent to perform such an audit and its need for such information and shall represent to the HCO that the information which is disclosed therein is reasonably necessary for the workers' compensation program. All audits and information disclosures shall occur at a reasonable time and place and at the Claims Administrator's expense. The Claims Administrator may designate a representative to conduct or participate in the audit, or to receive access to such information, provided that the Claims Administrator and the representative enter into a written agreement with the HCO under which the representative agrees to use any disclosed information solely for the workers' compensation program, to keep such information confidential, and to indemnify the HCO for any losses related to the disclosure. b. Any reports, information, or documentation provided, made available, or learned by either of the parties to this Agreement which contain personally identifiable or medical information about any Enrollee or health care provider or which contain information which has been designated as proprietary or confidential by either party shall be held in the strictest confidence and in accordance with the requirements of all applicable laws. 10. The HCO maintains Professional Liability insurance coverage which will cover the HCO for claims arising out of an alleged act, error, or omission in the performance of the HCO's professional services and operations. A certificate of insurance is available upon request. 11. The HCO agrees to defend, indemnify, and hold harmless the Claims Administrator against any and all suits, claims, damages, losses, and expenses, including attorney's fees arising out of the HCO's decisions regarding reimbursements to providers, medical necessity of procedures or its disclosure of confidential, personally identifiable and/or medical record information. Notwithstanding the foregoing, the HCO shall not be responsible for any suits, claims, damages, losses, or expenses, including attorney's fees, arising from a judgment based on a final decision by a court of competent jurisdiction where liability is based on the Claims Administrator's negligence or willful misconduct. C. Claims Administrator's Obligations 1. The Claims Administrator agrees that the decisions made by the HCO within the scope of its normal duties and applicable regulations are binding and that the Claims Administrator will observe the HCO's instructions for payment for medical services, referral of injured employees to appropriate medical providers, and determinations of medical necessity as final. The Claims Administrator agrees to abide by the requirements (outlined in Exhibit I, Employer's Workers' Compensation Health Care Organization Enrollment Kit) of the appropriate HCO, Select or Spectrum, in relation to provider election and assignment. 2. The Claims Administrator agrees to coordinate Return to Work (Described in Exhibit A) and Health and Safety programs (described in Exhibit C), and to instruct the Employer(s) accordingly. This must include a requirement that the Health and Safety vendor offered by the employer must allow monitoring by the HCO. 3. The Claims Administrator agrees to provide the HCO with a listing of all employees (described in Exhibit F) or one copy of all employees' enrollment forms, who have selected the HCO and to update this list no less than monthly as new employees make their HCO selection and employees are terminated. 4. The Claims Administrator agrees to work with the participating employer(s) to distribute and display, following mutually agreed procedures, informational materials provided by the HCO for Enrollees (all current employees and any new employees hired after the initial enrollment period.) All participating employer(s) will make reasonable provisions for the HCO to conduct management and/or employee enrollment meetings as may be needed to install the HCO correctly. If employee enrollment meetings are not held, then the employer will disseminate HCO informational materials via interoffice mail or US Mail prior to the enrollment start date. 5. The Claims Administrator agrees to pay the HCO in accordance with the terms of Exhibit D for the HCO service provided under this Agreement. The HCO will produce a monthly invoice, as described in Exhibit D, and will submit the invoice to the Claims Administrator for payment. Payment is due within thirty (30) calendar days from the stated due date. 6. The Claims Administrator agrees that the HCO will provide its services only for those employer(s) and their employees who have enrolled (enrollees) in the HCO. The Claims Administrator further agrees that it shall be responsible for paying the HCO for all services rendered by the HCO pursuant to the terms of this Agreement on behalf of employer(s). The Claims Administrator also agrees that it will have sole discretion in determining which claims are to be controverted, investigated, and accepted or denied as compensable under workers' compensation. Claims Administrator agrees to use the modified DWC 500-D form for notice of delay in determining liability for worker's compensation benefits. The payor agrees that if an employer directs a worker to an HCO provider, the employer/insurer is liable for medical care rendered until a denial of compensability or denial of authorization for any medical care is stated. Thus, in cases of delay, the HCO will not condition treatment of an HCO patient on the employer agreement to pay for it, unless the employer/insurer has provided a written statement that no medical care will be authorized pending determination of compensability. In the latter case the employee must be notified of his or her right to self-procure treatment. The Claims Administrator is the final judge of compensability and the role of the HCO and the Primary Treating Physician has been discussed in other sections. It is usual and customary for the first evaluation and treatment session to be paid by the workers' compensation insurance in non-compensable cases. All other non-compensable encounters are usually charged to the patient/Employee Benefits Insurer by the provider of service. This may be customized per agreement with the employer or other parties. The claim payor agrees to notify the HCO, as soon as is practical, as to any delay in decision or denial (for non-medical reasons) and to provide the HCO with verification that the employee has been made aware of their right to self procure treatment. This information shall be forwarded to the HCO in a mutually agreeable electronic format. 7. The Claims Administrator represents and warrants that none of the activities of the HCO under this Agreement constitute violation of any agreement of confidentiality between the Claims Administrator and any individuals or other parties. 8. The Claims Administrator agrees to defend, indemnify, and hold harmless the HCO against any and all suits, claims, damages, losses, and expenses, including attorney's fees arising out of the Claims Administrator's decisions regarding reimbursements, the management of Return to Work issues and ADA (Americans with Disabilities Act) exposures or its disclosure of confidential, personally identifiable and/or medical record information. Notwithstanding the foregoing, the Claims Administrator shall not be responsible for any suits, claims, damages, losses, or expenses, including attorney's fees, arising from a judgment based on a final decision by a court of competent jurisdiction where liability is based on the HCO's negligence or willful misconduct. 9. The Claims Administrator shall make available to HCO specific claim information (including but not limited to that specified in Exhibit A, Section C, Exhibit F and Exhibit H), which is a required reporting task by the Division of Workers' Compensation. This data will be reported to the HCO for each month no later than the 15th calendar day of the succeeding month. The HCOs will do a quality control review of the data and notify the Claims Administrator of any missing, incomplete or incorrect data. The Claims Administrator will correct and return the file(s) pertaining to any month no later than the last day of the succeeding month. If the original data or the corrected data is not provided by the above specified dates, then the Claims Administrator will be responsible for any fines or late fees imposed by the State due to the late or improper delivery of the required data. The HCO and the Claims Administrator will coordinate access to the Claims Admnistrator's data processing system to make the information required under this section available to the HCO, all in accordance with applicable law. D. Terms of Agreement 1. This Agreement will commence on December 18, 2000 and will be extended annually unless terminated earlier by the Claims Administrator or the HCO as outlined in Paragraph 2 of this Section, or written notice of termination is given by either party by giving the other party at least thirty (30) days written notice prior to the effective date of termination. 2. This Agreement may be terminated as follows: a. The HCO may terminate the Agreement for any Event of Default immediately upon written notice to the Claims Administrator. b. The Claims Administrator may terminate this Agreement as set forth on Section E, paragraph 6, Events of Default. 3. Notwithstanding the Termination or Expiration of this Agreement the Claims Administrator will remain fully liable to the HCO for all charges and fees due in accordance with the terms and provisions of this Agreement with respect to services performed before such termination. 4. Statutory Span of Control: The services of the HCO described in Exhibit A will apply to each workers' compensation claim accepted by the Claims Administrator for the duration of the statutory span of control permitted under the Labor Code 4600.3 and under subsequent regulations adopted by the Department of Workers' Compensation pursuant to this section. This provision applies to all claims under management by the HCO at the cancellation of this Agreement or unless such cancellation is enforced under the Default or impossibility of Performance provisions of this Agreement. E. General Provisions 1. Notices. Any notice required hereunder shall be in writing and shall be deemed delivered when mailed, postage prepaid, by registered or certified mail, return receipt requested, to the following addresses: Addresses for the HCO: Address for the Claims Administrator - ------------------------------------------------------- ----------------------- Sierra Health and Life Insurance Company California Indemnity Insurance Company Attn: President Attn: President 2720 North Tenaya Way 2716 North Tenaya Way Las Vegas, Nevada 89128 Las Vegas, Nevada 89128 - ------------------------------------------------------- ----------------------- 2. Impossibility of Performance. Neither party shall be deemed to be in violation of this Agreement if they are prevented from performing any of their obligations hereunder for any reason beyond their control, including, without limitation, acts of God or statutes, regulations, rules or actions of any federal, state, or local government, or any agency thereof. Further, the HCO shall not be in violation of this Agreement if it is precluded from fulfilling its obligations hereunder as a result of the failure of any employer(s), the Claims Administrator, or any Enrollee(s) or other service vendor to the plan of workers' compensation to cooperate fully with the HCO's reasonable requests for information or if incorrect or incomplete information is provided to the HCO by any employer(s), an Enrollee, the Claims Administrator or any other person or entity. 3. Governing Law. This Agreement shall be governed by the laws of the State of California and all of the terms and provisions hereof, and the rights and obligations of the parties hereto shall be construed and enforced in accordance with the laws thereof. 4. Invalid Provisions. In the event that one or more provisions contained herein shall be invalid or held unlawful under any applicable state or federal law, this instrument shall be construed as if such invalid provisions had not been inserted, and the balance of this Agreement shall remain in full force and effect. In the event that any portion of the underlying statutes or regulations which govern the formation of and operation of Health Care Organizations in California shall be found invalid by final order by a court with competent jurisdiction, if such determination does not fatally impair the provision of the services described in Exhibit A or elsewhere in this Agreement, this Agreement shall be construed as if the invalid statute or regulation had not been included and the balance of the Agreement shall remain in full force and effect. 5. Limitation of Liability. The HCO makes no representation that any employer's plan of workers' compensation is authorized to insure or self-insure its workers' compensation obligations. It is the responsibility of the employer(s), the Claims Administrator, and the insurance carrier, if one is present, to obtain all necessary authorizations from government authorities. The Claims Administrator agrees that it is responsible to fund claim payments or to determine that such funding ability exists. The HCO is not an insurance company and this Agreement is not a contract of insurance. In the event that the HCO should fail to materially perform its duties hereunder and if such failure is not corrected within thirty (30) days after written notice by the Claims Administrator to the HCO of such failure, then the Claims Administrator may terminate this Agreement immediately upon written notice to the HCO. The foregoing is in lieu of all other warranties, expressed or implied (including warranties of merchantability and fitness for a particular purpose) and all liability for special, indirect, or consequential damages, including lost profits, even if the HCO has been advised of the possibility of such damages. 6. Events of Default. Each of the following events will constitute an Event of Default. a. The failure of the Claims Administrator to make any payment of charges or fees within five (5) days after the due date or the date of receipt of the invoice, whichever is later; or b. The failure of the Claims Administrator to perform or satisfy the requirements of any condition, obligation or provision under this Agreement and such failure is not corrected by the Claims Administrator with thirty (30) days after written notice by the HCO to the Claims Administrator of such failure; or c. The failure of the Claims Administrator to correct repetitive performance deficiencies; or d. The Claims Administrator becomes insolvent or is unable to pay its debts as they become due or the Claims Administrator is declared bankrupt or insolvent, or if a debtor relief proceeding has been brought by or against it; or e. The Claims Administrator loses its authority to act as a TPA for qualified self-insurers or is placed under receivership or other legal action by the State of California. 7. Sole Benefit. This Agreement is for the sole benefit of the parties and in no event shall this Agreement be construed to be for the benefit of any third party, and the HCO will not be liable for any loss, liability, damages, or expense to any person not a party to this Agreement. 8. Assignment. No assignment by either party of this Agreement will be valid without the written consent of the other party, which consent will be reasonably given. Notwithstanding the foregoing, the HCO may at any time assign its rights and delegate its duties hereunder to any of its affiliated companies, to the extent that such assignment is permitted under the laws and regulations governing the operation of Health Care Organizations. 9. Failure of Enforcement. The HCO's failure to enforce at any time any of the provisions of this Agreement, or to exercise any option which is herein provided, or to require at any time performance by the employer(s) or the Claims Administrator of any of the provisions hereof, will in no way be construed to be a waiver of such provisions, or in any way affect the validity of this Agreement or any part thereof, the HCO's right to thereafter enforce each and every provision of this Agreement, or to exercise any right or remedy available to the HCO under applicable law. 10. Legal Agreement. If any provision of this Agreement is found to be unenforceable by a final order of a court of competent jurisdiction, the provision so affected will be limited only to the extent necessary to permit compliance with the minimum legal requirement, and all such other provisions of this Agreement will continue in full force and effect. 11. Amendments. This Agreement may be amended by the parties at any time so long as each amendment is in writing and signed by an authorized officer of both parties. 12. Entire Contract. This Agreement and the Exhibits attached constitute the entire contract between the parties and shall not be amended except by a written instrument signed by both parties. This agreement supersedes all other agreements, whether written or oral, between the parties. IN WITNESS WHEREOF, the parties have executed this Agreement in duplicate by their respective officers only authorized to do so as of the day and year noted below. Sierra Health and Life Insurance Company By_______________________________ Dated: January 19, 2001 Jonathon W. Bunker Title: President California Indemnity Insurance Company (and its wholly-owned subsidiaries) By s/Kathleen M. Marlon Dated: January 19, 2001 -------------------- Title: President and Chief Executive Officer EX-10 8 0008.txt Exhibit 10.11 FIRST AND SECOND UNDERLYING EXCESS OF LOSS REINSURANCE AGREEMENT This Agreement is made and entered into by and between CALIFORNIA INDEMNITY INSURANCE COMPANY, Pleasanton, California, COMMERCIAL CASUALTY INSURANCE COMPANY, Pleasanton, California, CII INSURANCE COMPANY, Pleasanton, California, SIERRA INSURANCE COMPANY OF TEXAS, Dallas, Texas, (hereinafter together called the "Company") and the Reinsurer specifically identified on the signature page of this Agreement (hereinafter called the "Reinsurer"). ARTICLE 1 BUSINESS REINSURED This Agreement is to indemnify the Company in respect of the net excess liability as a result of any loss or losses which may occur during the term of this Agreement under any Policies covering statutory Workers' Compensation, including Employers' Liability and Longshore and Harbor Workers' Compensation Act business (USL&HW not to exceed 20% of the Company's total Gross Net Earned Premium Income, or so deemed), in force, written or renewed by the Company during the term of this Agreement, subject to the terms and conditions contained herein. ARTICLE 2 COVER The Reinsurer will be liable in respect of each and every Loss Occurrence, irrespective of the number of Policies involved, for A. 75% of the Ultimate Net Loss over and above an initial Ultimate Net Loss of $10,000 each and every Loss Occurrence, subject to a limit of liability to the Reinsurer of $30,000 (being 75% of $40,000) of Ultimate Net Loss each and every Loss Occurrence. The Company will retain 25% of all losses recoverable hereunder net and unreinsured except to the extent reinsured among or between the individual named Companies. B. 100% of the Ultimate Net Loss over and above an initial Ultimate Net Loss of $50,000 each and every Loss Occurrence, subject to a limit of liability to the Reinsurer of $450,000 of Ultimate Net Loss each and every Loss Occurrence. Recoveries from Section A. will not be deducted when establishing Ultimate Net Loss for purposes of Section B. ARTICLE 3 TERM This Agreement shall become effective at 12:01 a.m., Las Vegas, Nevada local time, July 1, 1998, and shall remain in full force and effect for twenty-four months, expiring 12:01 a.m., Las Vegas, Nevada local time, July 1, 2000. Upon expiration of this Agreement, the entire liability of the Reinsurer for losses occurring subsequent to expiration shall cease concurrently with the expiration. However, the Company will have the option of requiring the Reinsurer to continue to cover all Policies which are in force at the date of the expiration of this Agreement until the natural expiration or anniversary of such Policies, whichever occurs first, but in no event longer than 12 months, plus odd time, not to exceed 18 months in all from the date of the expiration of this Agreement. The premium applicable to the run-off period shall be the Gross Net Earned Premium Income earned during the run-off period for Policies in force as of the expiration date of this Agreement, payable in accordance with the ACCOUNTS AND REMITTANCES ARTICLE of this Agreement. ARTICLE 4 TERRITORY This Agreement applies to losses arising out of Policies written in the United States of America, its territories and possessions, wherever occurring. ARTICLE 5 EXCLUSIONS This Agreement does not cover: A. Aggregate Excess Workers' Compensation Policies. B. Assumed reinsurance unless assumed from a fronting company in the state of Nevada if the Company assumes 100% of the fronting company's liability and manages the underwriting and claims of the business assumed from such fronting company. C. Loss Portfolio Transfers. D. Financial Guarantee and Insolvency business when written as such. E. Liability of the Company arising by contract, operation of law or otherwise from its participation or membership, whether voluntary or involuntary, in any insolvency fund. "Insolvency fund" includes any guarantee fund, insolvency fund, plan, pool, association, fund or other arrangement, howsoever denominated, established or governed, which provides for any assessment of or payment or assumption by the Company of part or all of any claim, debt, charge, fee or other obligation of an insurer or its successors or assigns which has been declared by any competent authority to be insolvent or which is otherwise deemed unable to meet any claim, debt, charge, fee or other obligation in whole or in part. F. Loss due to war, whether or not declared, invasion, civil war, insurrection, rebellion, revolution, or to confiscation by duly constituted government or civil authorities. G. Nuclear Incidents as per the Nuclear Incident Exclusion Clauses - Liability - Reinsurance - U.S.A. and Canada attached to and forming part of this Agreement. H. Second Injury Funds and Policies issued by the Company as an Assigned Risk Servicing Carrier or Residual Market Assessments, except direct assignments assumed by the Company in place of Residual Market Assessments are not excluded. I. Risks classified under NCCI codes 1164 and 1165. J. Policies with deductibles or self-insured retentions exceeding $10,000. K. Policies where all or a portion of coverage is provided by a captive including ceded reinsurance to a captive and/or assumed reinsurance from a captive whether or not such captive is owned or partially owned by the Company. ARTICLE 6 ACCOUNTS AND REMITTANCES A. Within 45 days following the end of each month while this Agreement is in force or obligations under it are due from any party hereto, the Company will render separate net accounts by Accident Year to the Reinsurer. The accounts will contain the following: 1. Reinsurance premium, calculated as follows: a. For Section A. of the COVER ARTICLE, 13.00% multiplied by 75% (or 9.75%) of the Company's Gross Net Earned Premium Income. b. For Section B. of the COVER ARTICLE, 9.00% multiplied by 100% of the Company's Gross Net Earned Premium Income. 2. Ultimate Net Loss paid during the month on losses occurring during the term of the Agreement; plus 3. Subrogation or other recoveries during the month on losses occurring during the term of the Agreement. The accounts shall also reflect the net balance due and the debtor party from whom it is due. Within 60 days following the end of the month the debtor party will remit to the creditor party any balance due. These accounts will also bear a notation advising of the following information: 1. A list of ground-up losses occurring during the term of the Agreement which exceed $5,000 on an incurred loss basis. The list will include the following: a. Name of Insured b. Name of Claimant c. Date of Loss d. Company claim number e. Injury code f. Paid, outstanding and incurred amounts (medical, indemnity and expense) g. Policy deductible amount (if any) 2. Outstanding loss and loss expense reserve at the end of the month. 3. A listing of ground up Occupational Disease, Cumulative Trauma, Extra Contractual Obligations, Loss In Excess Of Original Policy Limits and Employers' Liability losses occurring during the term of this Agreement. Also, a listing of statutory penalty amounts, (if any), assessed with respect to losses occurring during the term of this Agreement with reasons such amounts have been assessed and actions taken to avoid such penalties in the future per the requirements of the DELAY, OMISSION OR ERROR ARTICLE of this Agreement. 4. Premium and payroll associated with all NCCI Class Codes containing "D" and "E" modifiers, or such similar modifiers in California, written by the Company. 5. A listing of premiums returned under dividend rating plans. B. Anything to the contrary in this Article notwithstanding, the first account (the "First Account") under this section and remittance based upon it, will be rendered December 15, 1998, or the first business day after the Reinsurance Placement Summary is fully executed by the Company and the Reinsurer, whichever is later, and will cover all activity from July 1, 1998 through October 31, 1998. The premium and loss information on such account will be estimated by the Company and any increase or decrease in the amount of such account will be rectified in the next account due from the Company January 15, 1999. However, the provisions of the LATE PAYMENTS ARTICLE shall not apply to the First Account. C. Within 45 days following the end of each calendar year, the Company shall furnish to the Reinsurer for such year any other information which the Reinsurer may require for its Annual Convention Statement which may be reasonably available to the Company. The Company shall also cooperate with the Reinsurer in preparing lists of outstanding claims and in providing reasonable staff time to assist the Reinsurer with the preparation of actuarial values of outstanding claims to meet the sunset and/or commutation requirements of the Reinsurer's retrocessionaires. ARTICLE 7 DEFINITIONS A. The term "Ultimate Net Loss" as used in this Agreement shall mean the actual loss paid by the Company or for which the Company becomes liable to pay, such loss to include 100% of any Extra Contractual Obligation amount as defined in the EXTRA CONTRACTUAL OBLIGATIONS ARTICLE, 100% of any Loss In Excess Of Original Policy Limits amount as defined in the LOSS IN EXCESS OF ORIGINAL POLICY LIMITS ARTICLE, Loss Adjustment Expense, and statutory penalties. Salvages and all recoveries, net of actual expenses incurred related to obtaining them, including recoveries under all reinsurances which inure to the benefit of this Agreement (whether such reinsurance is recovered or not), shall be first deducted from such loss to arrive at the amount of liability attaching hereunder. Nothing in this clause shall be construed to mean that losses are not recoverable hereunder until the Company's Ultimate Net Loss has been ascertained. All salvages, recoveries or payments recovered or received subsequent to loss settlement hereunder shall be applied as if recovered or received prior to the aforesaid settlement, and all necessary adjustments shall be made by the parties hereto. All salvage, recoveries or payments received shall always be used to reimburse excess reinsurers in the reverse order of their priority according to their participation in the loss. For purposes of this definition, the phrase "becomes liable to pay" shall mean the existence of a judgment which the Company does not intend to appeal, or a release has been obtained by the Company, or the Company has accepted a proof of loss. Any loss settlement made by the Company, provided it is within the terms and conditions of this Agreement, whether under strict Policy conditions or by way of compromise, shall be unconditionally binding upon the Reinsurer, however, ex gratia payments made by the Company are excluded hereunder. B. The term "Loss Occurrence" as used in this Agreement shall mean any one disaster or casualty or accident or loss or series of disasters or casualties or accidents or losses arising out of or caused by one event, except that: As respects an occupational disease or cumulative trauma suffered by an employee for which the employer is liable, such occupational disease or cumulative trauma shall be deemed a separate Loss Occurrence for each employee. A loss as respects each employee affected by an occupational disease or cumulative trauma shall be deemed to have been sustained by the Company at the date when compensable disability of the employee commences under applicable law and not at any other date. The terms "occupational disease" or "cumulative trauma" shall be as defined by applicable statutes or regulations. C. The term "Gross Net Earned Premium Income (GNEPI)" as used in this Agreement shall mean gross earned premium income on business subject to this Agreement after (i) the application of experience modifications, schedule or other rating plans, premium discounts, expense constants, loss constants and the application of discounts granted for deductible or self-insured retention plans and (ii) adjustment by retrospective rating plan calculations and dividend rating plan payments (such dividend rating plan payments not to reduce GNEPI more than 2.5%). Retrospective rating plan adjustments and dividend rating plan payments shall be pro rated based on the earned premium of each individual Policy during the term of this Agreement. D. The term "Policy(ies)" as used in this Agreement shall mean any binder, policy, or contract of insurance or reinsurance issued, accepted or held covered provisionally or otherwise, by the Company for business covered hereunder. E. The term "Loss Adjustment Expense" as used in this Agreement shall mean all expenses paid or to be paid in connection with the defense, litigation or medical cost containment of claims under Policies reinsured hereunder as per the 1998 NAIC definition of allocated loss adjustment expense (including claim-specific declaratory judgment expenses and excluding unallocated loss adjustment expenses as per 1998 NAIC definition). The phrase "claim-specific declaratory judgment expenses" as used in this Agreement means all expenses incurred in connection with declaratory judgment actions brought to determine defense and/or indemnification obligations that are allocable to specific policies and claims subject to this Agreement. Declaratory judgment expense will be deemed to have been incurred on the date of the original loss (if any) giving rise to the declaratory judgment action. F. The term "Accident Year" as used in this Agreement shall mean the premium earned and losses occurring in the 12 consecutive months commencing with each January 1st, except that the first Accident Year shall be the period from inception to December 31, 1998. ARTICLE 8 NET RETAINED LIABILITY The term "Net Retained Liability" as used in this Agreement shall mean the liability of the Company which the Company retains net for its own account. The Company may carry 30% underlying quota share reinsurance, recoveries under which shall be disregarded when determining the Net Retained Liability hereunder. Reinsurance among or between the individual named Companies shall be disregarded when determining the Net Retained Liability of the Company. The amount of the Reinsurer's liability hereunder in respect of any loss or losses shall not be increased by reason of the inability of the Company to collect from any other reinsurers, whether specific or general, any amounts which may have become due from them, whether such inability arises from the insolvency of such other reinsurers or otherwise. ARTICLE 9 LATE PAYMENTS A. Payments Due the Company In the event any loss or other payment due the Company is not received by the Company by the payment due date (or in the event a payment due date is not specified herein, the payment due date for the purposes of this Article shall be thirty (30) days from the date the Company has mailed to the Reinsurer a definitive statement of loss), then within thirty (30) days of the Company's demand, the Reinsurer shall reimburse the Company for any and all costs and expenses (except those costs and expenses the Company and the Reinsurer are required to share equally pursuant to the ARBITRATION ARTICLE herein), including reasonable attorneys fees incurred by the Company in connection with the collection or enforcement of any of the Reinsurer's payment obligations to the Company. In addition, with respect to any of the Reinsurer's payment obligations that remain outstanding beyond the due date, the Reinsurer agrees that the Company may charge the Reinsurer interest on those obligations. If the Company chooses to exercise this option, interest shall accrue annually at a rate of two (2) times the prime rate of interest in effect at Citibank, 399 Park Avenue, New York, New York, but not to exceed the highest rate allowed by law, from the date of the Company's demand for payment until the date payment is received by the Company. B. Payments Due the Reinsurer In the event any premium or other payment due the Reinsurer is not received by the Reinsurer or the Intermediary named herein within thirty (30) days following the date on which payment is due, then within thirty (30) days of the Reinsurer's demand the Company shall reimburse the Reinsurer for any and all costs and expenses (except those costs and expenses the Company and the Reinsurer are required to share equally pursuant to the ARBITRATION ARTICLE herein), including reasonable attorneys fees incurred by the Reinsurer in connection with the collection or enforcement of the Company's payment obligation to the Reinsurer. In addition, with respect to any of the Company's payment obligations that remain outstanding beyond the due date, the Company agrees that the Reinsurer may charge the Company interest on those obligations. If the Reinsurer chooses to exercise this option, interest shall accrue annually at a rate of two (2) times the prime rate of interest in effect at Citibank, 399 Park Avenue, New York, New York, but not to exceed the highest rate allowed by law, from the date of the Reinsurer's demand for payment until the date payment is received by the Reinsurer or the Intermediary. C. Waiver Any interest, costs and expenses, including reasonable attorneys fees due under this Article of less than $1,000 shall be waived by the party to which it is owed. Any interest, costs and expenses, including reasonable attorneys fees due under this Article of $1,000 or greater may be waived by the party to which it is owed. Any waiver of such amounts, however, shall not affect the waiving party's rights under this Article with respect to any other failure by the other party to make payments when due under this Article. ARTICLE 10 CURRENCY The currency to be used for all purposes of this Agreement shall be United States of America currency. ARTICLE 11 REINSURANCE LOSS FUNDING (This Article shall apply individually to each participating Reinsurer.) As regards Policies issued by the Company coming with the scope of this Agreement, the Company and the Reinsurer agree to the following: A. If the Reinsurer is or becomes unauthorized in any state of the United States of America or the District of Columbia and such authorization is required by insurance regulatory authorities in order for the Company to take full credit for the reinsurance provided by this Agreement, the Reinsurer hereby agrees to fund known outstanding Losses including Loss Adjustment Expense relating thereto, Losses and Loss Adjustment Expense paid by the Company but not recovered from the Reinsurer, and any reserve for incurred but not reported Losses, as shown in the statement prepared by the Company (hereinafter referred to as "Reinsurer's Obligations") by funds withheld, Letter of Credit and/or cash advances and/or Escrow Accounts for the benefit of the Company. The Reinsurer shall have the option of determining the method of funding referred to above provided it is acceptable to the insurance regulatory authorities having jurisdiction over the Company's reserves. The Reinsurer hereby agrees that if the method of funding is by cash advance the Reinsurer will deposit said cash advance in an interest bearing account of a bank acceptable to the Company and the insurance regulatory authorities, for the benefit of the Company. The Company agrees that any interest thereon not in excess of the U.S. prime rate shall accrue to the benefit of the Reinsurer provided the balance in said cash account is at all times at least equal to the Reinsurer's Obligations. As security for payment and performance of the Reinsurer's Obligations to the Company, the Reinsurer hereby unconditionally delivers, pledges, transfers and assigns to and grants to the Company an irrevocable and continuing security interest in this cash and in any and all renewals, replacements, substitutions and extensions thereof and in all proceeds thereof. The Reinsurer hereby appoints the Company as the Reinsurer's attorney in fact to perform (as the Company deems appropriate but without any requirement to do so) any and all acts the Company deems prudent to protect and preserve the Company's rights and security interests provided hereunder. The Reinsurer also represents that: 1. The cash is genuine, and in all respects what it is purported to be; and 2. The Reinsurer is the sole owner of the cash, free and clear of all security interests, liens, restrictions and other encumbrances of any kind except the security interests granted to the Company hereunder; and 3. The Reinsurer is authorized in all respects to pledge the cash to the Company. When funding is by a Letter of Credit, the Reinsurer agrees to apply for and secure timely delivery to the Company of a clean, irrevocable and unconditional Letter of Credit issued by a bank and containing provisions acceptable to the insurance regulatory authorities having jurisdiction over the Company's reserves and acceptable to the Company in an amount equal to the Reinsurer's proportion of said reserves. Such Letter of Credit shall be issued for a period of not less than one year, and shall be automatically extended for one year from its date of expiration or any future expiration date unless thirty (30) days prior to any expiration date an issuing bank shall notify the Company by certified or registered mail that the issuing bank elects not to consider the Letter of Credit extended for any additional period. B. If a Letter of Credit is the method of funding, it shall contain an issue date and date of expiration and shall stipulate that the beneficiary need only draw a sight draft under the Letter of Credit and present it to obtain funds and that no other documents need be presented. The Letter of Credit shall also indicate that it is not subject to any condition or qualifications outside of the Letter of Credit. In addition, the Letter of Credit itself shall not contain reference to any other agreements, document or entities. The Letters of Credit and/or cash advance and/or Escrow Accounts for the benefit of the Company provided by the Reinsurer pursuant to Section I. of this Article may be drawn upon at any time, notwithstanding any other provision of this Agreement, and be utilized by the Company or any successor, by operation or law, of the Company including, without limitation, any liquidator, rehabilitator, receiver or conservator of the Company for the following purposes, unless otherwise provided for in a separate Trust Agreement: 1. To reimburse the Company for the Reinsurer's Obligations, which have not been otherwise paid; 2. To make refund of any sum which is in excess of the actual amount required to pay the Reinsurer's Obligations under this Agreement; 3. In the event of expiration of the Letter of Credit as provided for above, to establish a deposit of the Reinsurer's Obligations under this Agreement. Such cash deposit shall be held in an interest bearing account separate from the Company's other assets, and interest thereon not in excess of the U.S. prime rate shall accrue to the benefit of the Reinsurer provided the balance in said cash account is at all times at least equal to the Reinsurer's Obligations; 4. To pay the Reinsurer's share of any other amounts the Company claims are due under this Agreement. C. In the event the amount drawn by the Company on any Letter of Credit and/or cash advance and/or Escrow Accounts for the benefit of the Company is in excess of the actual amount required for A. or C., or in the case of D., the actual amount determined to be due, the Company shall promptly return to the Reinsurer the excess amount so drawn provided the Reinsurer's Obligations under this Agreement are deemed to be final by the Company. All of the foregoing shall be applied without diminution because of insolvency on the part of the Company or the Reinsurer. D. The issuing bank shall have no responsibility whatsoever in connection with the propriety of withdrawals made by the Company or the disposition of funds withdrawn, except to ensure that withdrawals are made only upon the order of properly authorized representatives of the Company. E. At annual intervals, or more frequently as agreed, but never more frequently than quarterly, the Company shall prepare a specific statement of the Reinsurer's Obligations, for the sole purpose of amending the Letter of Credit and/or cash advances and/or Escrow Accounts for the benefit of the Company, in the following manner: 1. If the statement shows that the Reinsurer's Obligations exceed the balance of Letter of Credit and/or cash advance and/or Escrow Account for the benefit of the Company, as of the statement date, the Reinsurer shall, within thirty (30) days after receipt of notice of such excess, secure delivery to the Company an amendment to the Letter of Credit and/or cash advance and/or Escrow Account, increasing the amount of funding by the amount of such difference. 2. If, however, the statement shows that the Reinsurer's Obligations are less than the balance of Letter of Credit and/or cash advance and/or Escrow Account for the benefit of the Company, as of the statement date, the Company shall, within thirty (30) days after receipt of written request from the Reinsurer, release such excess funding by agreeing to secure an amendment to the Letter of Credit and/or cash advance and/or Escrow Account for the benefit of the Company, reducing the amount of funding available by the amount of such excess funding. ARTICLE 12 TAXES The Company will be liable for taxes (except Federal Excise Tax) on premiums reported to the Reinsurer hereunder. Federal Excise Tax applies only to those Reinsurers, excepting Underwriters at Lloyd's, London and other Reinsurers exempt from the Federal Excise Tax, who are domiciled outside the United States of America. The Reinsurer has agreed to allow for the purpose of paying the Federal Excise Tax 1% of the premium payable hereon to the extent such premium is subject to Federal Excise Tax. In the event of any return of premium becoming due hereunder the Reinsurer will deduct 1% from the amount of the return and the Company or its agent should take steps to recover the Tax from the U.S. Government. ARTICLE 13 ORIGINAL CONDITIONS All amounts ceded hereunder shall be subject to the same gross rates and to the same clauses, conditions, and modifications of the Policies, subject to the limits, terms and conditions of this Agreement. ARTICLE 14 EXTRA CONTRACTUAL OBLIGATIONS In no event shall the Reinsurer participate in Extra Contractual Obligations which are awarded against the Company unless the Reinsurer shall have been made aware of and shall have the opportunity to counsel, associate or otherwise become involved with the actions taken, or not taken, by the Company which led to the awarding of extra contractual damages. The Company shall notify the Reinsurer of the circumstances of any potential or impending extra contractual damage claim as soon as practicable by sending a letter certified or registered mail or by other carrier service providing receipt of delivery to the Reinsurance Counsel of the Reinsurer's Home Office Commercial Lines Law Department. The Reinsurer will then notify the Company by letter of its wish to counsel, associate or otherwise become involved with such claim within thirty (30) days of receipt of the above mentioned letter of notification or sooner if circumstances require, but in no event sooner than ten (10) days of receipt of the notification letter. Failure on the part of the Reinsurer to advise the Company of its response in the manner herein described shall constitute automatic agreement with the Company's mode of handling the claim. Payment of such awarded damages will be subject to the limit of liability shown in the COVER ARTICLE of this Agreement. For purposes of this provision, the following definition shall apply: The term "Extra Contractual Obligations" is defined as those liabilities not covered under any other provision of this Agreement and which arise from the handling of any claim on business covered hereunder, such liabilities arising because of, but not limited to, the following: failure by the Company to settle within the policy limit, or by reason of alleged or actual negligence, fraud, or bad faith in rejecting an offer of settlement or in the preparation of the defense or in the trial of any action against its insured or reinsured or in the preparation of prosecution of an appeal consequent upon such action. The date on which any Extra Contractual Obligation is incurred by the Company shall be deemed, in all circumstances, to be the date of the original Loss Occurrence. However, Extra Contractual Obligations shall not apply where the loss has been incurred due to fraud by a member of the Board of Directors or a corporate officer of the Company acting individually or collectively or in collusion with any individual or corporation or any other organization or party involved in the presentation, defense or settlement of any claim covered hereunder. ARTICLE 15 LOSS IN EXCESS OF ORIGINAL POLICY LIMITS The Reinsurer shall indemnify the Company, within the limits hereof, in respect of Loss In Excess Of Original Policy Limits having been incurred because of the Company's failure to settle within the Policy limit or by reason of alleged or actual negligence, fraud, or bad faith in rejecting an offer of settlement or in the preparation of the defense or in the trial of any action against its insured or reinsured, or in the preparation or prosecution of an appeal consequent upon such action. However, this Article shall not apply where the Loss In Excess Of Original Policy Limits has been incurred due to fraud by a member of the Board of Directors or by a corporate officer of the Company acting individually or collectively or in collusion with any individual or corporation or any other organization or party involved in the presentation, defense or settlement of any claim covered hereunder. The term "Loss In Excess Of Original Policy Limits" shall mean any amounts for which the Company would have been contractually liable to pay under Employers' Liability had it not been for the limit of the Policy. ARTICLE 16 DELAY, OMISSION OR ERROR Inadvertent delays, errors or omissions made in connection with this Agreement or any transaction hereunder shall not relieve either party from any liability which would have attached had such delay, error or omission not occurred, provided always that such error or omission is rectified as soon as possible after discovery. ARTICLE 17 INSPECTION The Company shall place at the disposal of the Reinsurer at all reasonable times, and the Reinsurer shall have the right to inspect, through its authorized representatives, all books, records and papers of the Company in connection with any reinsurance hereunder, or claims in connection herewith. However, no payment of any account on which the Reinsurer is the debtor party shall be withheld or delayed pending the Reinsurer's exercise of its rights under this Article or any other right to audit the Company's books and records. ARTICLE 18 ARBITRATION A. As a condition precedent to any right of action hereunder, any dispute between the Company and the Reinsurer arising out of, or relating to the formation, interpretation, performance or breach of this Agreement, whether such dispute arises before or after termination of this Agreement, shall be submitted to arbitration. Arbitration shall be initiated by the delivery of a written notice of demand for arbitration sent certified or registered mail or by other carrier services providing receipt of delivery by one party to the other. B. One arbitrator shall be chosen by each party and the two arbitrators shall, before instituting the hearing, choose an impartial third arbitrator who shall preside at the hearing. If either party fails to appoint its arbitrator within thirty (30) days after being requested to do so by the other party, the latter may appoint the second arbitrator. C. If the two arbitrators are unable to agree upon the third arbitrator within thirty (30) days of their appointment, the third arbitrator shall be selected from a list of six individuals (three named by each arbitrator) by a judge of the federal district court having jurisdiction over the geographical area in which the arbitration is to take place, or if the federal court declines to act, the state court having general jurisdiction in such area. If the state court also declines to act, each arbitrator shall then decline two of the nominations presented by the other arbitrator. The third arbitrator shall then be chosen from the remaining two nominations by drawing lots. D. All arbitrators shall be disinterested active or former officials of insurance or reinsurance companies, not under the control and without past employment or directorial relationships to either party to this Agreement. Within ten (10) days of his or her notification that he or she has been selected as an arbitrator, such arbitrator shall make full written disclosure of all business, social, or familial relationships with either party or their employees. E. Within thirty (30) days after notice of appointment of all arbitrators, the panel shall meet, and unless the panel establishes an alternative schedule, the parties shall abide by the following deadlines: (a) ninety (90) days for the filing of the claimant's and respondent's brief and the claimant's reply, (b) sixty (60) days for the period of discovery and (c) ninety (90) days from the conclusion of the hearing for the panel to render its decision. F. The panel shall be relieved of all judicial formality and shall not be bound by the strict rules of procedure and evidence. Arbitration shall take place in Las Vegas, Nevada. The decision of any two arbitrators when rendered in writing shall be final and binding. The panel is empowered to grant interim relief as it may deem appropriate. G. The panel shall interpret this Agreement as an honorable engagement rather than as merely a legal obligation and shall make its decision considering the custom and practice of the applicable insurance and reinsurance business as promptly as possible following the termination of the hearings. Judgment upon the award may be entered in any court having jurisdiction thereof. H. Each party shall bear the expense of its own arbitrator and shall jointly and equally bear with the other party the cost of the third arbitrator and the remaining costs of the arbitration, except as respects those costs and expenses outlined in the LATE PAYMENTS ARTICLE of this Agreement. ARTICLE 19 SERVICE OF SUIT (This Article is applicable only to an unauthorized Reinsurer in the State of New York or to a Reinsurer who is domiciled outside the United States of America. This Article is not intended to conflict with or override the parties' obligation to arbitrate their disputes in accordance with the ARBITRATION ARTICLE of this Agreement.) In the event of the failure of the Reinsurer hereon to pay any amount claimed to be due hereunder, the Reinsurer, at the request of the Company, will submit to the jurisdiction of a court of competent jurisdiction within the United States of America, and will comply with all requirements necessary to give such court jurisdiction, and all matters hereunder shall be determined in accordance with the law and practice of such court. Nothing in this clause constitutes or should be understood to constitute a waiver of the Reinsurer's rights to commence an action in any Court of competent jurisdiction in the United States, to remove an action to a United States District Court, or to seek a transfer of a case to another Court as permitted by the laws of the United States or of any State in the United States. It is further agreed that service of process in such suit may be made upon Messrs. Mendes and Mount, 750 Seventh Avenue, New York, New York 10019-6829, and that in any suit instituted, the Reinsurer will abide by the final decision of the Court or of any Appellate Court in the event of an appeal. The above-named are authorized and directed to accept service of process on behalf of Reinsurer in any such suit and/or upon the request of the Company to give a written undertaking to the Company that they will enter a general appearance upon the Reinsurer's behalf in the event such a suit shall be instituted. Further, pursuant to any statute of any state, territory or district of the United States which makes provision therefor, the Reinsurer hereon hereby designates the Superintendent, Commissioner or Director of Insurance or other officer specified for that purpose in the statute, or his successor or successors in office, as their true and lawful attorney upon whom may be served any lawful process in any action, suit or proceeding instituted by or on behalf of the Company or any beneficiary hereunder arising out of this Agreement, and hereby designates the above-named as the firm to whom the said officer is authorized to mail such process or true copy thereof. ARTICLE 20 INSOLVENCY In the event of the insolvency of the Company, this reinsurance shall be payable directly to the Company, or to its liquidator, receiver, conservator or statutory successor on the basis of the liability of the Company without diminution because of the insolvency of the Company or because the liquidator, receiver, conservator or statutory successor of the Company has failed to pay all or a portion of any claim. It is agreed, however, that the liquidator, receiver, conservator or statutory successor of the Company shall give written notice to the Reinsurer of the pendency of a claim against the Company indicating the Policy reinsured, which claim would involve a possible liability on the part of the Reinsurer within a reasonable time after such claim is filed in the conservation or liquidation proceeding or in the receivership, and that during the pendency of such claim, the Reinsurer may investigate such claim and interpose, at its own expense, in the proceeding where such claim is to be adjudicated any defense or defenses that they may deem available to the Company or its liquidator, receiver, conservator or statutory successor. The expense thus incurred by the Reinsurer shall be chargeable, subject to the approval of the court, against the Company as part of the expense of conservation or liquidation to the extent of a pro rata share of the benefit which may accrue to the Company solely as a result of the defense undertaken by the Reinsurer. Where two or more Reinsurers are involved in the same claim and a majority in interest elect to interpose defense to such claim, the expense shall be apportioned in accordance with the terms of the reinsurance Agreement as though such expense had been incurred by the Company. As to all reinsurance made, ceded, renewed or otherwise becoming effective under this Agreement, the reinsurance shall be payable as set forth above by the Reinsurer to the Company or to its liquidator, receiver, conservator or statutory successor, except as provided by Sections 4118 (a)(1)(A) and 1114(c) of the New York Insurance Law or except (1) where the Agreement specifically provides another payee in the event of the insolvency of the Company, and (2) where the Reinsurer, with the consent of the direct insured or insureds, has assumed such Policy obligations of the Company as direct obligations of the Reinsurer to the payees under such Policies and in substitution for the obligations of the Company to such payees. Then, and in that event only, the Company, with the prior approval of the certificate of assumption on New York Risks by the Superintendent of Insurance of the State of New York, is entirely released from its obligation and the Reinsurer pays any Loss directly to payees under such Policy. ARTICLE 21 SEVERABILITY In the event any provision of this Agreement shall be declared illegal, invalid or unenforceable by any regulatory body or court having jurisdiction over this Agreement, such provision shall be considered void in such jurisdiction but this shall not affect the validity or enforceability of any other provision of this Agreement or the enforceability of such provision in any other jurisdiction. ARTICLE 22 OFFSET The Company and the Reinsurer, each at its option, may offset any balance or balances, whether on account of premiums, claims and losses, loss expenses or salvages due from the Company or the Reinsurer, as the case may be, under this Agreement and the Casualty Quota Share Reinsurance Agreement. However, in the event of insolvency of any party hereto, offsets shall only be allowed in accordance with applicable law. ARTICLE 23 CONFIDENTIALITY All information provided by the Company to the Reinsurer shall be kept confidential as against third parties, unless the disclosure is required pursuant to process of law or unless the disclosure is to the Reinsurer's retrocessionaires, financial auditors or governing regulatory bodies. The Company shall not publish or advertise the name of the Reinsurer, other than to regulators and rating agencies. ARTICLE 24 RIGHTS In no event shall anyone other than the Company, or in the event of the Company's insolvency, its receiver, liquidator or statutory successor, have any rights under this Agreement, and said Agreement shall not be assignable by the Company or the Reinsurer without the prior written consent of the other party. ARTICLE 25 ENTIRE AGREEMENT This Agreement embodies the entire contract between the parties as to the subject matter hereof. No waiver, modification, variation, change or amendment to this Agreement will be binding on either party unless reduced to writing and signed by a duly authorized officer of each party. ARTICLE 26 INTERMEDIARY Sedgwick Re, Inc. is hereby recognized as the Intermediary negotiating this Agreement for all business hereunder. All communications including notices, premiums, return premiums, commissions, taxes, losses, loss adjustment expenses, salvages and loss settlements relating thereto shall be transmitted to the Reinsurer or the Company through Sedgwick Re, Inc., 1501 Fourth Avenue, Suite 1400, Seattle, Washington 98101. Payments by the Company to the Intermediary shall be deemed to constitute payment to the Reinsurer. Payments by the Reinsurer to the Intermediary shall be deemed only to constitute payment to the Company to the extent that such payments are actually received by the Company. ARTICLE 27 PARTICIPATION: FIRST AND SECOND UNDERLYING EXCESS OF LOSS REINSURANCE AGREEMENT EFFECTIVE: July 1, 1998 This Agreement obligates the Reinsurer for _______% of the interests and liabilities set forth under this Agreement. The participation of the Reinsurer in the interests and liabilities of this Agreement shall be separate and apart from the participations of other reinsurers and shall not be joint with those of other reinsurers, and the Reinsurer shall in no event participate in the interests and liabilities of other reinsurers. IN WITNESS WHEREOF, the parties hereto, by their authorized representatives, have executed this Agreement as of the following dates: PARTICIPATING REINSURERS - ----------------------------------------------------------------------------- The Travelers Indemnity Company of Illinois 100.00% Upon completion of Reinsurers' signing, fully executed signature pages will be forwarded to you for the completion of your file. and in Las Vegas, Nevada, this day of , 1999. CALIFORNIA INDEMNITY INSURANCE COMPANY COMMERCIAL CASUALTY INSURANCE COMPANY CII INSURANCE COMPANY SIERRA INSURANCE COMPANY OF TEXAS By_________________________________________ (signature) ------------------------------------------- (name) ------------------------------------------- (title) FIRST AND SECOND UNDERLYING EXCESS OF LOSS REINSURANCE AGREEMENT issued to CALIFORNIA INDEMNITY INSURANCE COMPANY COMMERCIAL CASUALTY INSURANCE COMPANY CII INSURANCE COMPANY SIERRA INSURANCE COMPANY OF TEXAS NUCLEAR INCIDENT EXCLUSION CLAUSE - LIABILITY - REINSURANCE - U.S.A. (Wherever the word "Reassured" appears in this clause, it shall be deemed to read "Reassured", "Reinsured", "Retrocedent", or whatever other word is employed throughout the text of the reinsurance agreement to which this clause is attached to designate the company or companies reinsured.) (1) This reinsurance does not cover any loss or liability accruing to the Reassured as a member of, or subscriber to, any association of insurers or reinsurers formed for the purpose of covering nuclear energy risks or as a direct or indirect reinsurer of any such member, subscriber or association. (2) Without in any way restricting the operation of paragraph (1) of this Clause it is understood and agreed that for all purposes of this reinsurance all the original policies of the Reassured (new, renewal and replacement) of the classes specified in Clause 11 of this paragraph (2) from the time specified in Clause III in this paragraph (2) shall be deemed to include the following provision (specified as the Limited Exclusion Provision): Limited Exclusion Provision.* I. It is agreed that the Policy does not apply under any liability coverage, To { injury, sickness, disease, death or destruction { bodily injury or property damage with respect to which an insured under the Policy is also an insured under a nuclear energy liability Policy issued by Nuclear Energy Liability Insurance Association, Mutual Atomic Energy Liability Underwriters or Nuclear Insurance Association of Canada, or would be an insured under any such Policy but for its termination upon exhaustion of its limit of liability. II. Family Automobile Policies (liability only), Special Automobile Policies (private passenger automobiles, liability only), Farmers Comprehensive Personal Liability Policies (liability only), Comprehensive Personal Liability Policies (liability only) or policies of a similar nature; and the liability portion of combination forms related to the four classes of policies stated above, such as the Comprehensive Dwelling Policy and the applicable types of Homeowners Policies. III. The inception dates and thereafter of all original policies as described in 11 above, whether new, renewal or replacement, being policies which either (a) become effective on or after lst May, 1960, or (b) become effective before that date and contain the Limited Exclusion Provision set out above; provided this paragraph (2) shall not be applicable to Family Automobile Policies, Special Automobile Policies, or policies or combination policies of a similar nature, issued by the Reassured on New York risks, until 90 days following approval of the Limited Exclusion Provision by the Governmental Authority having jurisdiction thereof. (3) Except for those classes of policies specified in Clause 11 of paragraph (2) and without in any way restricting the operation of paragraph (1) of this Clause, it is understood and agreed that for all purposes of this reinsurance the original liability policies of the Reassured (new, renewal and replacement) affording the following coverages: Owners, Landlords and Tenants Liability, Contractual Liability, Elevator Liability, Owners or Contractors (including railroad) Protective Liability, Manufacturers and Contractors Liability, Product Liability, Professional and Malpractice Liability, Storekeepers Liability, Garage Liability, Automobile Liability (including Massachusetts Motor Vehicle or Garage Liability) shall be deemed to include, with respect to such coverages, from the time specified in Clause V of this paragraph (3), the following provision (specified as the Broad Exclusion Provision): Broad Exclusion Provision.* It is agreed that the Policy does not apply: I. Under any Liability Coverage, to { injury, sickness, disease, death or destruction { bodily injury or property damage (a) with respect to which an insured under the Policy is also an insured under a nuclear energy liability Policy issued by Nuclear Energy Liability Insurance Association, Mutual Atomic Energy Liability Underwriters or Nuclear Insurance Association of Canada, or would be an insured under any such Policy but for its termination upon exhaustion of its limit of liability; or (b) resulting from the hazardous properties of nuclear material and with respect to which (1) any person or organization is required to maintain financial protection pursuant to the Atomic Energy Act of 1954, or any law amendatory thereof, or (2) the insured is, or had this Policy not been issued would be, entitled to indemnity from the United States of America, or any agency thereof, under any agreement entered into by the United States of America, or any agency thereof, with any person or organization. II. Under any Medical Payments Coverage, or under any Supplementary Payments Provision relating to {immediate medical or surgical relief {first aid to expenses incurred with respect to {bodily injury, sickness, disease or death {bodily injury resulting from the hazardous properties of nuclear material and arising out of the operation of a nuclear facility by any person or organization. III. Under any Liability Coverage, to {injury, sickness disease, death or destruction {bodily injury or property damage resulting from the hazardous properties of nuclear material, if (a) the nuclear material (1) is at any nuclear facility owned by, or operated by or on behalf of, an insured or (2) has been discharged or dispersed therefrom; (b) the nuclear material is contained in spent fuel or waste at any time possessed, handled, used, processed, stored, transported or disposed of by or on behalf of an insured; or (c) the {injury, sickness, disease, death or destruction {bodily injury or property damage arises out of the furnishing by an insured of services, materials, parts or equipment in connection with the planning, construction, maintenance, operation or use of any nuclear facility, but if such facility is located within the United States of America, its territories or possessions or Canada, this exclusion (c) applies only to {injury to or destruction of property at such nuclear facility. {property damage to such nuclear facility and any property thereat. IV. As used in this endorsement: "hazardous properties" include radioactive, toxic or explosive properties; "nuclear material" means source material, special nuclear material or byproduct material; "source material", "special nuclear material", and "byproduct material" have the meanings given them in the Atomic Energy Act of 1954 or in any law amendatory thereof; "spent fuel" means any fuel element or fuel component, solid or liquid, which has been used or exposed to radiation in a nuclear reactor; "waste" means any waste material (1) containing byproduct material other than tailings or wastes produced by the extraction or concentration of uranium or thorium from any ore processed primarily for its source material content, and (2) resulting from the operation by any person or organization of any nuclear facility included under the first two paragraphs of the definition of nuclear facility; "nuclear facility" means (a) any nuclear reactor, (b) any equipment or device designed or used for (1) separating the isotopes of uranium or plutonium, (2) processing or utilizing spent fuel, or (3) handling, processing or packaging waste, (c) any equipment or device used for the processing, fabricating or alloying of special nuclear material if at any time the total amount of such material in the custody of the insured at the premises where such equipment or device is located consists of or contains more than 25 grams of plutonium or uranium 233 or any combination thereof, or more than 250 grams of uranium 235, (d) any structure, basin, excavation, premises or place prepared or used for the storage or disposal of waste, and includes the site on which any of the foregoing is located, all operations conducted on such site and all premises used for such operations: "nuclear reactor" means any apparatus designed or used to sustain nuclear fission in a self-supporting chain reaction or to contain a critical mass of fissionable material; With respect to injury to or destruction of property, the word "injury" or "destruction" of property includes all forms of radioactive contamination of property. V. The inception dates and thereafter of all original policies affording coverages specified in this paragraph (3), whether new, renewal or replacement, being policies which become effective on or after lst May, 1960, provided this paragraph (3) shall not be applicable to (i) Garage and Automobile Policies issued by the Reassured on New York risks, or (ii) statutory liability insurance required under Chapter 90, General Laws of Massachusetts, Until 90 days following approval of the Broad Exclusion Provision by the Governmental Authority having jurisdiction thereof. (4) Without in any way restricting the operation of paragraph (1) of this Clause, it is understood and agreed that paragraphs (2) and (3) above are not applicable to original liability policies of the Reassured in Canada and that with respect to such policies this Clause shall be deemed to include the Nuclear Energy Liability Exclusion Provisions adopted by the Canadian Underwriters' Association or the Independent Insurance Conference of Canada. * NOTE. The words printed in italics in the Limited Exclusion Provision and in the Broad Exclusion Provision shall apply only in relation to original liability policies which include a Limited Exclusion Provision or a Broad Exclusion Provision containing those words. NUCLEAR INCIDENT EXCLUSION CLAUSE - LIABILITY - REINSURANCE - CANADA 1 . This Agreement does not cover any loss or liability accruing to the Retrocedent as a member of, or subscriber to, any association of insurers or reinsurers formed for the purpose of covering nuclear energy risks or as a direct or indirect reinsurer of any such member, subscriber or association. 2. Without in any way restricting the operation of paragraph 1 of this clause it is agreed that for all purposes of this Agreement all the original liability contracts of the Retrocedent, whether new, renewal or replacement, of the following classes, namely, Personal Liability. Farmers Liability. Storekeepers Liability. which become effective on or after 31st December 1984, shall be deemed to include, from their inception dates and thereafter, the following provision: Limited Exclusion Provision. This Policy does not apply to bodily injury or property damage with respect to which the Insured is also insured under a contract of nuclear energy liability insurance (whether the Insured is unnamed in such contract and whether or not it is legally enforceable by the Insured) issued by the Nuclear Insurance Association of Canada or any other group or pool of insurers or would be an Insured under any such Policy but for its termination upon exhaustion of its limits of liability. With respect to property, loss of use of such property shall be deemed to be property damage. 3. Without in any way restricting the operation of paragraph 1 of this clause it is agreed that for all purposes of this Agreement all the original liability contracts of the Retrocedent, whether new, renewal or replacement, of any class whatsoever (other than Personal Liability, Farmers Liability, Storekeepers Liability or Automobile Liability contracts), which become effective on or after 31st December 1984, shall be deemed to include, from their inception dates and thereafter, the following provision of: Broad Exclusion Provision. It is agreed that this Policy does not apply: (a) to liability imposed by or arising under the Nuclear Liability Act; nor (b) to bodily injury or property damage with respect to which an Insured under this Policy is also insured under a contract of nuclear energy liability insurance (whether the Insured is unnamed in such contract and whether or not it is legally enforceable by the Insured) issued by the Nuclear Insurance Association of Canada or any other insurer or group or pool of insurers or would be an Insured under any such Policy but for its termination upon exhaustion of its limit of liability; nor (c) to bodily injury or property damage resulting directly or indirectly from the nuclear energy hazard arising from: (i) the ownership, maintenance, operation or use of a nuclear facility by or on behalf of an Insured; (ii) the furnishing by an Insured of services, materials, parts or equipment in connection with the planning, construction, maintenance, operation or use of any nuclear facility; and (iii)the possession, consumption, use, handling, disposal or transportation of fissionable substances, or of other radioactive material (except radioactive isotopes, away from a nuclear facility, which have reached the final stage of fabrication so as to be useable for any scientific, medical, agricultural, commercial or industrial purpose) used, distributed, handled or sold by an Insured. As used in this Policy: 1. The term "nuclear energy hazard" means the radioactive, toxic, explosive, or other hazardous properties of radioactive material; 2. The term "radioactive material" means uranium, thorium, plutonium, neptunium, their respective derivatives and compounds, radioactive isotopes of other elements and any other substances that the Atomic Energy Control Board may, by regulation, designate as being prescribed substances capable of releasing atomic energy, or as being requisite for the production, use or application of atomic energy; 3. The term "nuclear facility" means: (a) any apparatus designed or used to sustain nuclear fission in a self-supporting chain reaction or to contain a critical mass of plutonium, thorium and uranium or any one or more of them; (b) any equipment or device designed or used for (i) separating the isotopes of plutonium, thorium and uranium or any one or more of them, (ii) processing or utilizing spent fuel, or (iii) handling, processing or packaging waste; (c) any equipment or device used for the processing, fabricating or alloying of plutonium, thorium or uranium enriched in the isotope uranium 233 or in the isotope uranium 235, or any one or more of them if at any time the total amount of such material in the custody of the Insured at the premises where such equipment or device is located consists of or contains more than 25 grams of plutonium or uranium 233 or any combination thereof, or more than 250 grams of uranium 235; (d) any structure, basin, excavation, premises or place prepared or used for the storage or disposal of waste radioactive material; and includes the site on which any of the foregoing is located, together with all operations conducted thereon and all premises used for such operations. 4. The term "fissionable substance" means any prescribed substance that is, or from which can be obtained, a substance capable of releasing atomic energy by nuclear fission. 5. With respect to property, loss of use of such property shall be deemed to be property damage. ARTICLE 29 PARTICIPATION: CASUALTY QUOTA SHARE REINSURANCE AGREEMENT EFFECTIVE: July 1, 1998 This Agreement obligates the Reinsurer for 100.00% of the interests and liabilities set forth under this Agreement. The participation of the Reinsurer in the interests and liabilities of this Agreement shall be separate and apart from the participations of other reinsurers and shall not be joint with those of other reinsurers, and the Reinsurer shall in no event participate in the interests and liabilities of other reinsurers. IN WITNESS WHEREOF, the parties hereto, by their authorized representatives, have executed this Agreement as of the following dates: In Hartford, Connecticut, this 31st day of March, 1999. THE TRAVELERS INDEMNITY COMPANY OF ILLINOIS Naperville, Illinois By Jonathan B. Hale Jonathan B. Hale Jonathan B. Hale And in Las Vegas, Nevada, this 22nd day of March, 1999. CALIFORNIA INDEMNITY INSURANCE COMPANY COMMERCIAL CASUALTY INSURANCE COMPANY CII INSURANCE COMPANY SIERRA INSURANCE COMPANY OF TEXAS By: Kathleen M. Marlon Kathleen M. Marlon CEO and PRESIDENT EX-10 9 0009.txt Exhibit 10.12 CASUALTY QUOTA SHARE REINSURANCE AGREEMENT This Agreement is made and entered into by and between CALIFORNIA INDEMNITY INSURANCE COMPANY, Pleasanton, California, COMMERCIAL CASUALTY INSURANCE COMPANY, Pleasanton, California, CII INSURANCE COMPANY, Pleasanton, California, SIERRA INSURANCE COMPANY OF TEXAS, Dallas, Texas, (hereinafter together called the "Company") and the Reinsurer specifically identified on the signature page of this Agreement (hereinafter called the "Reinsurer"). ARTICLE 1 BUSINESS REINSURED This Agreement is to share with the Reinsurer the interests and liabilities of the Company's net retained liability as a result of any loss or losses occurring with a date of loss during the term of this Agreement under all Policies of statutory Workers' Compensation, including Employers' Liability and Longshore and Harbor Workers' Compensation Act business (USL&HW not to exceed 20% of the Company's total Gross Net Earned Premium Income, or so deemed), in force, written or renewed by the Company during the term of this Agreement, subject to the terms and conditions contained herein. ARTICLE 2 COVER The Company will cede, and the Reinsurer will accept as reinsurance, a 30% share of up to $10,000 Ultimate Net Loss each and every Loss Occurrence, irrespective of the number of Policies involved, under all business reinsured hereunder. As respects Policies containing a deductible and/or self-insured retention, it is understood and agreed that the reinsurance shall apply from the ground up but will be limited to the difference between $10,000 each and every Loss Occurrence and the deductible and/or self-insured retention amount, regardless of whether or not any deductible was actually collected by the Company. The Company's 70% retention shall remain net and unreinsured, except to the extent reinsured among or between the individual named Companies. ARTICLE 3 TERM This Agreement shall become effective at 12:01 a.m., Las Vegas, Nevada local time, July 1, 1998, and shall remain in full force and effect for twenty-four months, expiring 12:01 a.m., Las Vegas, Nevada local time, July 1, 2000. Upon expiration of this Agreement, the entire liability of the Reinsurer for losses occurring subsequent to expiration shall cease concurrently with the expiration. However, the Company will have the option of requiring the Reinsurer to continue to cover all Policies which are in force at the date of the expiration of this Agreement until the natural expiration or anniversary of such Policies, whichever occurs first, but in no event longer than 12 months, plus odd time, not to exceed 18 months in all from the date of the expiration of this Agreement. The premium applicable to the run-off period shall be the Gross Net Earned Premium Income earned during the run-off period for Policies in force as of the expiration date of this Agreement, payable in accordance with Article 6, ACCOUNTS AND REMITTANCES of this Agreement. ARTICLE 4 TERRITORY This Agreement applies to losses arising out of Policies written in the United States of America, its territories and possessions, wherever occurring. ARTICLE 5 EXCLUSIONS This Agreement does not cover: A. Aggregate Excess Workers' Compensation Policies. B. Assumed reinsurance unless assumed from a fronting company in the state of Nevada if the Company assumes 100% of the fronting company's liability and manages the underwriting and claims of the business assumed from such fronting company. C. Loss Portfolio Transfers. D. Financial Guarantee and Insolvency business when written as such. E. Liability of the Company arising by contract, operation of law or otherwise from its participation or membership, whether voluntary or involuntary, in any insolvency fund. "Insolvency fund" includes any guarantee fund, insolvency fund, plan, pool, association, fund or other arrangement, howsoever denominated, established or governed, which provides for any assessment of or payment or assumption by the Company of part or all of any claim, debt, charge, fee or other obligation of an insurer or its successors or assigns which has been declared by any competent authority to be insolvent or which is otherwise deemed unable to meet any claim, debt, charge, fee or other obligation in whole or in part. F. Loss due to war, whether or not declared, invasion, civil war, insurrection, rebellion, revolution, or to confiscation by duly constituted government or civil authorities. G. Nuclear Incidents as per the Nuclear Incident Exclusion Clauses - Liability - Reinsurance - U.S.A. and Canada attached to and forming part of this Agreement. H. Second Injury Funds and Policies issued by the Company as an Assigned Risk Servicing Carrier or Residual Market Assessments, except direct assignments assumed by the Company in place of Residual Market Assessments are not excluded. I. Risks classified under NCCI codes 1164 and 1165. J. Policies with deductibles or self-insured retentions exceeding $10,000. K. Policies where all or a portion of coverage is provided by a captive including ceded reinsurance to a captive and/or assumed reinsurance from a captive whether or not such captive is owned or partially owned by the Company. ARTICLE 6 ACCOUNTS AND REMITTANCES A. Within 45 days following the end of each month while this Agreement is in force or obligations under it are due from any party hereto, the Company will render separate net accounts by Accident Year to the Reinsurer. The accounts will contain the following: 1. 30% of Gross Net Earned Premium Income for the month; less 2. The ceding commission as provided for in this Agreement; less 3. Ultimate Net Loss paid during the month on losses occurring during the term of the Agreement; plus 4. Subrogation or other recoveries during the month on losses occurring during the term of the Agreement. The accounts shall also reflect the net balance due and the debtor party from whom it is due. Within 60 days following the end of the month the debtor party will remit to the creditor party any balance due. These accounts will also bear a notation advising of the following information: 1. A list of ground-up losses occurring during the term of the Agreement which exceed $5,000 on an incurred loss basis. The list will include the following: a. Name of Insured b. Name of Claimant c. Date of Loss d. Company claim number e. Injury code f. Paid, outstanding and incurred amounts (medical, indemnity and expense) g. Policy deductible amount (if any) 2. Outstanding loss and loss expense reserve at the end of the month. 3. A listing of ground up Occupational Disease, Cumulative Trauma, Extra Contractual Obligations, Loss In Excess Of Original Policy Limits and Employers' Liability losses occurring during the term of this Agreement. Also, a listing of statutory penalty amounts, (if any), assessed with respect to losses occurring during the term of this Agreement with reasons such amounts have been assessed and actions taken to avoid such penalties in the future per the requirements of the DELAY, OMISSION OR ERROR ARTICLE of this Agreement. 4. Premium and payroll associated with all NCCI Class Codes containing "D" and "E" modifiers, or such similar modifiers in California, written by the Company. 5. A listing of premiums returned under dividend rating plans. B. Anything to the contrary in this Article notwithstanding, the first account (the "First Account") under this section and remittance based upon it, will be rendered December 15, 1998, or the first business day after the Reinsurance Placement Summary is fully executed by the Company and the Reinsurer, whichever is later, and will cover all activity from July 1, 1998 through October 31, 1998. The premium and loss information on such account will be estimated by the Company and any increase or decrease in the amount of such account will be rectified in the next account due from the Company January 15, 1999. However, the provisions of the LATE PAYMENTS ARTICLE shall not apply to the First Account. C. Within 45 days following the end of each calendar year, the Company shall furnish to the Reinsurer for such year any other information which the Reinsurer may require for its Annual Convention Statement which may be reasonably available to the Company. The Company shall also cooperate with the Reinsurer in preparing lists of outstanding claims and in providing reasonable staff time to assist the Reinsurer with the preparation of actuarial values of outstanding claims to meet the sunset and/or commutation requirements of the Reinsurer's retrocessionaires. ARTICLE 7 CEDING COMMISSION The Reinsurer will allow the Company a ceding commission of 44.00% of the Gross Net Earned Premium Income ceded hereunder. ARTICLE 8 DEFINITIONS A. The term "Ultimate Net Loss" as used in this Agreement shall mean the actual loss paid by the Company or for which the Company becomes liable to pay, such loss to include 100% of any Extra Contractual Obligation amount as defined in the EXTRA CONTRACTUAL OBLIGATIONS ARTICLE, 100% of any Loss In Excess Of Original Policy Limits amount as defined in the LOSS IN EXCESS OF ORIGINAL POLICY LIMITS ARTICLE, Loss Adjustment Expense, and statutory penalties. Salvages and all recoveries, net of actual expenses incurred related to obtaining them, including recoveries under all reinsurances which inure to the benefit of this Agreement (whether such reinsurance is recovered or not), shall be first deducted from such loss to arrive at the amount of liability attaching hereunder. Nothing in this clause shall be construed to mean that losses are not recoverable hereunder until the Company's Ultimate Net Loss has been ascertained. All salvages, recoveries or payments recovered or received subsequent to loss settlement hereunder shall be applied as if recovered or received prior to the aforesaid settlement, and all necessary adjustments shall be made by the parties hereto. All salvage, recoveries or payments received shall always be used to reimburse excess reinsurers in the reverse order of their priority according to their participation in the loss. For purposes of this definition, the phrase "becomes liable to pay" shall mean the existence of a judgment which the Company does not intend to appeal, or a release has been obtained by the Company, or the Company has accepted a proof of loss. Any loss settlement made by the Company, provided it is within the terms and conditions of this Agreement, whether under strict Policy conditions or by way of compromise, shall be unconditionally binding upon the Reinsurer, however, ex gratia payments made by the Company are excluded hereunder. B. The term "Loss Occurrence" as used in this Agreement shall mean any one disaster or casualty or accident or loss or series of disasters or casualties or accidents or losses arising out of or caused by one event, except that: As respects an occupational disease or cumulative trauma suffered by an employee for which the employer is liable, such occupational disease or cumulative trauma shall be deemed a separate Loss Occurrence for each employee. A loss as respects each employee affected by an occupational disease or cumulative trauma shall be deemed to have been sustained by the Company at the date when compensable disability of the employee commences under applicable law and not at any other date. The terms "occupational disease" or "cumulative trauma" shall be as defined by applicable statutes or regulations. C. The term "Gross Net Earned Premium Income (GNEPI)" as used in this Agreement shall mean gross earned premium income on business subject to this Agreement after (i) the application of experience modifications, schedule or other rating plans, premium discounts, expense constants, loss constants and the application of discounts granted for deductible or self-insured retention plans and (ii) adjustment by retrospective rating plan calculations and dividend rating plan payments (such dividend rating plan payments not to reduce GNEPI more than 2.5%) and (iii) reduction by 24.406% paid for excess of loss reinsurance. Retrospective rating plan adjustments and dividend rating plan payments shall be pro rated based on the earned premium of each individual Policy during the term of this Agreement. D. The term "Policy(ies)" as used in this Agreement shall mean any binder, policy, or contract of insurance or reinsurance issued, accepted or held covered provisionally or otherwise, by the Company for business covered hereunder. E. The term "Accident Year" as used in this Agreement shall mean the premium earned and losses occurring in the 12 consecutive months commencing with each January 1st, except that the first Accident Year shall be the period from inception to December 31, 1998. ARTICLE 9 ORIGINAL CONDITIONS All amounts ceded hereunder shall be subject to the same gross rates and to the same clauses, conditions, and modifications of the Policies, subject to the limits, terms and conditions of this Agreement. ARTICLE 10 LATE PAYMENTS A. Payments Due the Company In the event any loss or other payment due the Company is not received by the Company by the payment due date (or in the event a payment due date is not specified herein, the payment due date for the purposes of this Article shall be thirty (30) days from the date the Company has mailed to the Reinsurer a definitive statement of loss), then within thirty (30) days of the Company's demand, the Reinsurer shall reimburse the Company for any and all costs and expenses (except those costs and expenses the Company and the Reinsurer are required to share equally pursuant to the ARBITRATION ARTICLE herein), including reasonable attorneys fees incurred by the Company in connection with the collection or enforcement of any of the Reinsurer's payment obligations to the Company. In addition, with respect to any of the Reinsurer's payment obligations that remain outstanding beyond the due date, the Reinsurer agrees that the Company may charge the Reinsurer interest on those obligations. If the Company chooses to exercise this option, interest shall accrue annually at a rate of two (2) times the prime rate of interest in effect at Citibank, 399 Park Avenue, New York, New York, but not to exceed the highest rate allowed by law, from the date of the Company's demand for payment until the date payment is received by the Company. B. Payments Due the Reinsurer In the event any premium or other payment due the Reinsurer is not received by the Reinsurer or the Intermediary named herein within thirty (30) days following the date on which payment is due, then within thirty (30) days of the Reinsurer's demand the Company shall reimburse the Reinsurer for any and all costs and expenses (except those costs and expenses the Company and the Reinsurer are required to share equally pursuant to the ARBITRATION ARTICLE herein), including reasonable attorneys fees incurred by the Reinsurer in connection with the collection or enforcement of the Company's payment obligation to the Reinsurer. In addition, with respect to any of the Company's payment obligations that remain outstanding beyond the due date, the Company agrees that the Reinsurer may charge the Company interest on those obligations. If the Reinsurer chooses to exercise this option, interest shall accrue annually at a rate of two (2) times the prime rate of interest in effect at Citibank, 399 Park Avenue, New York, New York, but not to exceed the highest rate allowed by law, from the date of the Reinsurer's demand for payment until the date payment is received by the Reinsurer or the Intermediary. C. Waiver Any interest, costs and expenses, including reasonable attorneys fees due under this Article of less than $1,000 shall be waived by the party to which it is owed. Any interest, costs and expenses, including reasonable attorneys fees due under this Article of $1,000 or greater may be waived by the party to which it is owed. Any waiver of such amounts, however, shall not affect the waiving party's rights under this Article with respect to any other failure by the other party to make payments when due under this Article. ARTICLE 11 NET RETAINED LIABILITY This Agreement applies only to that portion of any insurances or reinsurances covered by this Agreement which the Company retains net for its own account, and in calculating the amount of any loss hereunder, only loss or losses in respect of that portion of any insurances or reinsurances which the Company retains net for its own account shall be included, it being understood and agreed that the amount of the Reinsurer's liability hereunder in respect of any loss or losses shall not be increased by reason of the inability of the Company to collect from any other reinsurers, whether specific or general, any amounts which may have become due from them, whether such inability arises from the insolvency of such other reinsurers or otherwise. Reinsurance among or between the individual named Companies shall be disregarded when determining the Net Retained Liability of the Company. ARTICLE 12 CURRENCY The currency to be used for all purposes of this Agreement shall be United States of America currency. ARTICLE 13 REINSURANCE LOSS FUNDING (This Article shall apply individually to each participating Reinsurer.) As regards Policies issued by the Company coming with the scope of this Agreement, the Company and the Reinsurer agree to the following: A. If the Reinsurer is or becomes unauthorized in any state of the United States of America or the District of Columbia and such authorization is required by insurance regulatory authorities in order for the Company to take full credit for the reinsurance provided by this Agreement, the Reinsurer hereby agrees to fund known outstanding Losses including Loss Adjustment Expense relating thereto, Losses and Loss Adjustment Expense paid by the Company but not recovered from the Reinsurer, and any reserve for incurred but not reported Losses, as shown in the statement prepared by the Company (hereinafter referred to as "Reinsurer's Obligations") by funds withheld, Letter of Credit and/or cash advances and/or Escrow Accounts for the benefit of the Company. The Reinsurer shall have the option of determining the method of funding referred to above provided it is acceptable to the insurance regulatory authorities having jurisdiction over the Company's reserves. The Reinsurer hereby agrees that if the method of funding is by cash advance the Reinsurer will deposit said cash advance in an interest bearing account of a bank acceptable to the Company and the insurance regulatory authorities, for the benefit of the Company. The Company agrees that any interest thereon not in excess of the U.S. prime rate shall accrue to the benefit of the Reinsurer provided the balance in said cash account is at all times at least equal to the Reinsurer's Obligations. As security for payment and performance of the Reinsurer's Obligations to the Company, the Reinsurer hereby unconditionally delivers, pledges, transfers and assigns to and grants to the Company an irrevocable and continuing security interest in this cash and in any and all renewals, replacements, substitutions and extensions thereof and in all proceeds thereof. The Reinsurer hereby appoints the Company as the Reinsurer's attorney in fact to perform (as the Company deems appropriate but without any requirement to do so) any and all acts the Company deems prudent to protect and preserve the Company's rights and security interests provided hereunder. The Reinsurer also represents that: 1. The cash is genuine, and in all respects what it is purported to be; and 2. The Reinsurer is the sole owner of the cash, free and clear of all security interests, liens, restrictions and other encumbrances of any kind except the security interests granted to the Company hereunder; and 3. The Reinsurer is authorized in all respects to pledge the cash to the Company. When funding is by a Letter of Credit, the Reinsurer agrees to apply for and secure timely delivery to the Company of a clean, irrevocable and unconditional Letter of Credit issued by a bank and containing provisions acceptable to the insurance regulatory authorities having jurisdiction over the Company's reserves and acceptable to the Company in an amount equal to the Reinsurer's proportion of said reserves. Such Letter of Credit shall be issued for a period of not less than one year, and shall be automatically extended for one year from its date of expiration or any future expiration date unless thirty (30) days prior to any expiration date an issuing bank shall notify the Company by certified or registered mail that the issuing bank elects not to consider the Letter of Credit extended for any additional period. B. If a Letter of Credit is the method of funding, it shall contain an issue date and date of expiration and shall stipulate that the beneficiary need only draw a sight draft under the Letter of Credit and present it to obtain funds and that no other documents need be presented. The Letter of Credit shall also indicate that it is not subject to any condition or qualifications outside of the Letter of Credit. In addition, the Letter of Credit itself shall not contain reference to any other agreements, document or entities. The Letters of Credit and/or cash advance and/or Escrow Accounts for the benefit of the Company provided by the Reinsurer pursuant to Section I. of this Article may be drawn upon at any time, notwithstanding any other provision of this Agreement, and be utilized by the Company or any successor, by operation or law, of the Company including, without limitation, any liquidator, rehabilitator, receiver or conservator of the Company for the following purposes, unless otherwise provided for in a separate Trust Agreement: 1. To reimburse the Company for the Reinsurer's Obligations, which have not been otherwise paid; 2. To make refund of any sum which is in excess of the actual amount required to pay the Reinsurer's Obligations under this Agreement; 3. In the event of expiration of the Letter of Credit as provided for above, to establish a deposit of the Reinsurer's Obligations under this Agreement. Such cash deposit shall be held in an interest bearing account separate from the Company's other assets, and interest thereon not in excess of the U.S. prime rate shall accrue to the benefit of the Reinsurer provided the balance in said cash account is at all times at least equal to the Reinsurer's Obligations; 4. To pay the Reinsurer's share of any other amounts the Company claims are due under this Agreement. C. In the event the amount drawn by the Company on any Letter of Credit and/or cash advance and/or Escrow Accounts for the benefit of the Company is in excess of the actual amount required for A. or C., or in the case of D., the actual amount determined to be due, the Company shall promptly return to the Reinsurer the excess amount so drawn provided the Reinsurer's Obligations under this Agreement are deemed to be final by the Company. All of the foregoing shall be applied without diminution because of insolvency on the part of the Company or the Reinsurer. D. The issuing bank shall have no responsibility whatsoever in connection with the propriety of withdrawals made by the Company or the disposition of funds withdrawn, except to ensure that withdrawals are made only upon the order of properly authorized representatives of the Company. E. At annual intervals, or more frequently as agreed, but never more frequently than quarterly, the Company shall prepare a specific statement of the Reinsurer's Obligations, for the sole purpose of amending the Letter of Credit and/or cash advances and/or Escrow Accounts for the benefit of the Company, in the following manner: 1. If the statement shows that the Reinsurer's Obligations exceed the balance of Letter of Credit and/or cash advance and/or Escrow Account for the benefit of the Company, as of the statement date, the Reinsurer shall, within thirty (30) days after receipt of notice of such excess, secure delivery to the Company an amendment to the Letter of Credit and/or cash advance and/or Escrow Account, increasing the amount of funding by the amount of such difference. 2. If, however, the statement shows that the Reinsurer's Obligations are less than the balance of Letter of Credit and/or cash advance and/or Escrow Account for the benefit of the Company, as of the statement date, the Company shall, within thirty (30) days after receipt of written request from the Reinsurer, release such excess funding by agreeing to secure an amendment to the Letter of Credit and/or cash advance and/or Escrow Account for the benefit of the Company, reducing the amount of funding available by the amount of such excess funding. ARTICLE 14 TAXES The Company will be liable for taxes (except Federal Excise Tax) on premiums reported to the Reinsurer hereunder. Federal Excise Tax applies only to those Reinsurers, excepting Underwriters at Lloyd's, London and other Reinsurers exempt from the Federal Excise Tax, who are domiciled outside the United States of America. The Reinsurer has agreed to allow for the purpose of paying the Federal Excise Tax 1% of the premium payable hereon to the extent such premium is subject to Federal Excise Tax. In the event of any return of premium becoming due hereunder the Reinsurer will deduct 1% from the amount of the return and the Company or its agent should take steps to recover the Tax from the U.S. Government. ARTICLE 15 LOSS ADJUSTMENT EXPENSE "Loss Adjustment Expense" means all expenses paid or to be paid in connection with the defense, litigation or medical cost containment of claims under Policies reinsured hereunder as per the 1998 NAIC definition of allocated loss adjustment expense (including claim-specific declaratory judgment expenses and excluding unallocated loss adjustment expenses as per 1998 NAIC definition). The phrase "claim-specific declaratory judgment expenses" as used in this Agreement means all expenses incurred in connection with declaratory judgment actions brought to determine defense and/or indemnification obligations that are allocable to specific policies and claims subject to this Agreement. Declaratory judgment expense will be deemed to have been incurred on the date of the original loss (if any) giving rise to the declaratory judgment action. ARTICLE 16 EXTRA CONTRACTUAL OBLIGATIONS In no event shall the Reinsurer participate in Extra Contractual Obligations which are awarded against the Company unless the Reinsurer shall have been made aware of and shall have the opportunity to counsel, associate or otherwise become involved with the actions taken, or not taken, by the Company which led to the awarding of extra contractual damages. The Company shall notify the Reinsurer of the circumstances of any potential or impending extra contractual damage claim as soon as practicable by sending a letter certified or registered mail or by other carrier service providing receipt of delivery to the Reinsurance Counsel of the Reinsurer's Home Office Commercial Lines Law Department. The Reinsurer will then notify the Company by letter of its wish to counsel, associate or otherwise become involved with such claim within thirty (30) days of receipt of the above mentioned letter of notification or sooner if circumstances require, but in no event sooner than ten (10) days of receipt of the notification letter. Failure on the part of the Reinsurer to advise the Company of its response in the manner herein described shall constitute automatic agreement with the Company's mode of handling the claim. Payment of such awarded damages will be subject to the limit of liability shown in the COVER ARTICLE of this Agreement. For purposes of this provision, the following definition shall apply: The term "Extra Contractual Obligations" is defined as those liabilities not covered under any other provision of this Agreement and which arise from the handling of any claim on business covered hereunder, such liabilities arising because of, but not limited to, the following: failure by the Company to settle within the policy limit, or by reason of alleged or actual negligence, fraud, or bad faith in rejecting an offer of settlement or in the preparation of the defense or in the trial of any action against its insured or reinsured or in the preparation of prosecution of an appeal consequent upon such action. The date on which any Extra Contractual Obligation is incurred by the Company shall be deemed, in all circumstances, to be the date of the original Loss Occurrence. However, Extra Contractual Obligations shall not apply where the loss has been incurred due to fraud by a member of the Board of Directors or a corporate officer of the Company acting individually or collectively or in collusion with any individual or corporation or any other organization or party involved in the presentation, defense or settlement of any claim covered hereunder. ARTICLE 17 LOSS IN EXCESS OF ORIGINAL POLICY LIMITS The Reinsurer shall indemnify the Company, within the limits hereof, in respect of Loss In Excess Of Original Policy Limits having been incurred because of the Company's failure to settle within the Policy limit or by reason of alleged or actual negligence, fraud, or bad faith in rejecting an offer of settlement or in the preparation of the defense or in the trial of any action against its insured or reinsured, or in the preparation or prosecution of an appeal consequent upon such action. However, this Article shall not apply where the Loss In Excess of Original Policy Limits has been incurred due to fraud by a member of the Board of Directors or by a corporate officer of the Company acting individually or collectively or in collusion with any individual or corporation or any other organization or party involved in the presentation, defense or settlement of any claim covered hereunder. The term "Loss In Excess of Original Policy Limits" shall mean any amounts for which the Company would have been contractually liable to pay under Employers' Liability had it not been for the limit of the Policy. ARTICLE 18 DELAY, OMISSION OR ERROR Inadvertent delays, errors or omissions made in connection with this Agreement or any transaction hereunder shall not relieve either party from any liability which would have attached had such delay, error or omission not occurred, provided always that such error or omission is rectified as soon as possible after discovery. ARTICLE 19 INSPECTION The Company shall place at the disposal of the Reinsurer at all reasonable times, and the Reinsurer shall have the right to inspect, through its authorized representatives, all books, records and papers of the Company in connection with any reinsurance hereunder, or claims in connection herewith. However, no payment of any account on which the Reinsurer is the debtor party shall be withheld or delayed pending the Reinsurer's exercise of its rights under this Article or any other right to audit the Company's books and records. ARTICLE 20 ARBITRATION A. As a condition precedent to any right of action hereunder, any dispute between the Company and the Reinsurer arising out of, or relating to the formation, interpretation, performance or breach of this Agreement, whether such dispute arises before or after termination of this Agreement, shall be submitted to arbitration. Arbitration shall be initiated by the delivery of a written notice of demand for arbitration sent certified or registered mail or by other carrier services providing receipt of delivery by one party to the other. B. One arbitrator shall be chosen by each party and the two arbitrators shall, before instituting the hearing, choose an impartial third arbitrator who shall preside at the hearing. If either party fails to appoint its arbitrator within thirty (30) days after being requested to do so by the other party, the latter may appoint the second arbitrator. C. If the two arbitrators are unable to agree upon the third arbitrator within thirty (30) days of their appointment, the third arbitrator shall be selected from a list of six individuals (three named by each arbitrator) by a judge of the federal district court having jurisdiction over the geographical area in which the arbitration is to take place, or if the federal court declines to act, the state court having general jurisdiction in such area. If the state court also declines to act, each arbitrator shall then decline two of the nominations presented by the other arbitrator. The third arbitrator shall then be chosen from the remaining two nominations by drawing lots. D. All arbitrators shall be disinterested active or former officials of insurance or reinsurance companies, not under the control and without past employment or directorial relationships to either party to this Agreement. Within ten (10) days of his or her notification that he or she has been selected as an arbitrator, such arbitrator shall make full written disclosure of all business, social, or familial relationships with either party or their employees. E. Within thirty (30) days after notice of appointment of all arbitrators, the panel shall meet, and unless the panel establishes an alternative schedule, the parties shall abide by the following deadlines: (a) ninety (90) days for the filing of the claimant's and respondent's brief and the claimant's reply, (b) sixty (60) days for the period of discovery and (c) ninety (90) days from the conclusion of the hearing for the panel to render its decision. F. The panel shall be relieved of all judicial formality and shall not be bound by the strict rules of procedure and evidence. Arbitration shall take place in Las Vegas, Nevada. The decision of any two arbitrators when rendered in writing shall be final and binding. The panel is empowered to grant interim relief as it may deem appropriate. G. The panel shall interpret this Agreement as an honorable engagement rather than as merely a legal obligation and shall make its decision considering the custom and practice of the applicable insurance and reinsurance business as promptly as possible following the termination of the hearings. Judgment upon the award may be entered in any court having jurisdiction thereof. H. Each party shall bear the expense of its own arbitrator and shall jointly and equally bear with the other party the cost of the third arbitrator and the remaining costs of the arbitration, except as respects those costs and expenses outlined in the LATE PAYMENTS ARTICLE of this Agreement. ARTICLE 21 SERVICE OF SUIT (This Article is applicable only to an unauthorized Reinsurer in the State of New York or to a Reinsurer who is domiciled outside the United States of America. This Article is not intended to conflict with or override the parties' obligation to arbitrate their disputes in accordance with the ARBITRATION ARTICLE of this Agreement). In the event of the failure of the Reinsurer hereon to pay any amount claimed to be due hereunder, the Reinsurer, at the request of the Company, will submit to the jurisdiction of a court of competent jurisdiction within the United States of America, and will comply with all requirements necessary to give such court jurisdiction, and all matters hereunder shall be determined in accordance with the law and practice of such court. Nothing in this clause constitutes or should be understood to constitute a waiver of the Reinsurer's rights to commence an action in any Court of competent jurisdiction in the United States, to remove an action to a United States District Court, or to seek a transfer of a case to another Court as permitted by the laws of the United States or of any State in the United States. It is further agreed that service of process in such suit may be made upon Messrs. Mendes and Mount, 750 Seventh Avenue, New York, New York 10019-6829, and that in any suit instituted, the Reinsurer will abide by the final decision of the Court or of any Appellate Court in the event of an appeal. The above-named are authorized and directed to accept service of process on behalf of Reinsurer in any such suit and/or upon the request of the Company to give a written undertaking to the Company that they will enter a general appearance upon the Reinsurer's behalf in the event such a suit shall be instituted. Further, pursuant to any statute of any state, territory or district of the United States which makes provision therefor, the Reinsurer hereon hereby designates the Superintendent, Commissioner or Director of Insurance or other officer specified for that purpose in the statute, or his successor or successors in office, as their true and lawful attorney upon whom may be served any lawful process in any action, suit or proceeding instituted by or on behalf of the Company or any beneficiary hereunder arising out of this Agreement, and hereby designates the above-named as the firm to whom the said officer is authorized to mail such process or true copy thereof. ARTICLE 22 INSOLVENCY In the event of the insolvency of the Company, this reinsurance shall be payable directly to the Company, or to its liquidator, receiver, conservator or statutory successor on the basis of the liability of the Company without diminution because of the insolvency of the Company or because the liquidator, receiver, conservator or statutory successor of the Company has failed to pay all or a portion of any claim. It is agreed, however, that the liquidator, receiver, conservator or statutory successor of the Company shall give written notice to the Reinsurer of the pendency of a claim against the Company indicating the Policy reinsured, which claim would involve a possible liability on the part of the Reinsurer within a reasonable time after such claim is filed in the conservation or liquidation proceeding or in the receivership, and that during the pendency of such claim, the Reinsurer may investigate such claim and interpose, at its own expense, in the proceeding where such claim is to be adjudicated any defense or defenses that they may deem available to the Company or its liquidator, receiver, conservator or statutory successor. The expense thus incurred by the Reinsurer shall be chargeable, subject to the approval of the court, against the Company as part of the expense of conservation or liquidation to the extent of a pro rata share of the benefit which may accrue to the Company solely as a result of the defense undertaken by the Reinsurer. Where two or more Reinsurers are involved in the same claim and a majority in interest elect to interpose defense to such claim, the expense shall be apportioned in accordance with the terms of the reinsurance Agreement as though such expense had been incurred by the Company. As to all reinsurance made, ceded, renewed or otherwise becoming effective under this Agreement, the reinsurance shall be payable as set forth above by the Reinsurer to the Company or to its liquidator, receiver, conservator or statutory successor, except as provided by Sections 4118 (a)(1)(A) and 1114(c) of the New York Insurance Law or except (1) where the Agreement specifically provides another payee in the event of the insolvency of the Company, and (2) where the Reinsurer, with the consent of the direct insured or insureds, has assumed such Policy obligations of the Company as direct obligations of the Reinsurer to the payees under such Policies and in substitution for the obligations of the Company to such payees. Then, and in that event only, the Company, with the prior approval of the certificate of assumption on New York Risks by the Superintendent of Insurance of the State of New York, is entirely released from its obligation and the Reinsurer pays any Loss directly to payees under such Policy. ARTICLE 23 SEVERABILITY In the event any provision of this Agreement shall be declared illegal, invalid or unenforceable by any regulatory body or court having jurisdiction over this Agreement, such provision shall be considered void in such jurisdiction but this shall not affect the validity or enforceability of any other provision of this Agreement or the enforceability of such provision in any other jurisdiction. ARTICLE 24 OFFSET The Company and the Reinsurer, each at its option, may offset any balance or balances, whether on account of premiums, claims and losses, loss expenses or salvages due from the Company or the Reinsurer, as the case may be, under this Agreement and the First and Second Underlying Excess of Loss Reinsurance Agreement. However, in the event of insolvency of any party hereto, offsets shall only be allowed in accordance with applicable law. ARTICLE 25 CONFIDENTIALITY All information provided by the Company to the Reinsurer shall be kept confidential as against third parties, unless the disclosure is required pursuant to process of law or unless the disclosure is to the Reinsurer's retrocessionaires, financial auditors or governing regulatory bodies. The Company shall not publish or advertise the name of the Reinsurer, other than to regulators and rating agencies. ARTICLE 26 RIGHTS In no event shall anyone other than the Company, or in the event of the Company's insolvency, its receiver, liquidator or statutory successor, have any rights under this Agreement, and said Agreement shall not be assignable by the Company or the Reinsurer without the prior written consent of the other party. ARTICLE 27 ENTIRE AGREEMENT This Agreement embodies the entire contract between the parties as to the subject matter hereof. No waiver, modification, variation, change or amendment to this Agreement will be binding on either party unless reduced to writing and signed by a duly authorized officer of each party. ARTICLE 28 INTERMEDIARY Sedgwick Re, Inc. is hereby recognized as the Intermediary negotiating this Agreement for all business hereunder. All communications including notices, premiums, return premiums, commissions, taxes, losses, loss adjustment expenses, salvages and loss settlements relating thereto shall be transmitted to the Reinsurer or the Company through Sedgwick Re, Inc., 1501 Fourth Avenue, Suite 1400, Seattle, Washington 98101. Payments by the Company to the Intermediary shall be deemed to constitute payment to the Reinsurer. Payments by the Reinsurer to the Intermediary shall be deemed only to constitute payment to the Company to the extent that such payments are actually received by the Company. ARTICLE 29 PARTICIPATION: CASUALTY QUOTA SHARE REINSURANCE AGREEMENT EFFECTIVE: July 1, 1998 This Agreement obligates the Reinsurer for 100% of the interests and liabilities set forth under this Agreement. The participation of the Reinsurer in the interests and liabilities of this Agreement shall be separate and apart from the participations of other reinsurers and shall not be joint with those of other reinsurers, and the Reinsurer shall in no event participate in the interests and liabilities of other reinsurers. IN WITNESS WHEREOF, the parties hereto, by their authorized representatives, have executed this Agreement as of the following dates: PARTICIPATING REINSURERS - --------------------------------------------------------------------------- The Travelers Indemnity Company of Illinois 100.00% In Hartford, Connecticut this 31st day of March , 1999 THE TRAVELERS INDEMNITY COMPANY OF ILLINOIS Naperville, Illinois By s/Jonathan B. Hale Jonathan B. Hale Second Vice President and in Las Vegas, Nevada, this 22nd day of March, 1999. CALIFORNIA INDEMNITY INSURANCE COMPANY COMMERCIAL CASUALTY INSURANCE COMPANY CII INSURANCE COMPANY SIERRA INSURANCE COMPANY OF TEXAS By s/Kathleen Marlon ----------------- (signature) Kathleen M. Marlon ------------------------------- (name) CEO and President ------------------------------ (title) CASUALTY QUOTA SHARE REINSURANCE AGREEMENT issued to CALIFORNIA INDEMNITY INSURANCE COMPANY COMMERCIAL CASUALTY INSURANCE COMPANY CII INSURANCE COMPANY SIERRA INSURANCE COMPANY OF TEXAS NUCLEAR INCIDENT EXCLUSION CLAUSE - LIABILITY - REINSURANCE - U.S.A. (Wherever the word "Reassured" appears in this clause, it shall be deemed to read "Reassured", "Reinsured", "Retrocedent", or whatever other word is employed throughout the text of the reinsurance agreement to which this clause is attached to designate the company or companies reinsured.) (1) This reinsurance does not cover any loss or liability accruing to the Reassured as a member of, or subscriber to, any association of insurers or reinsurers formed for the purpose of covering nuclear energy risks or as a direct or indirect reinsurer of any such member, subscriber or association. (2) Without in any way restricting the operation of paragraph (1) of this Clause it is understood and agreed that for all purposes of this reinsurance all the original policies of the Reassured (new, renewal and replacement) of the classes specified in Clause 11 of this paragraph (2) from the time specified in Clause III in this paragraph (2) shall be deemed to include the following provision (specified as the Limited Exclusion Provision): Limited Exclusion Provision.* I. It is agreed that the Policy does not apply under any liability coverage, To { injury, sickness, disease, death or destruction { bodily injury or property damage with respect to which an insured under the Policy is also an insured under a nuclear energy liability Policy issued by Nuclear Energy Liability Insurance Association, Mutual Atomic Energy Liability Underwriters or Nuclear Insurance Association of Canada, or would be an insured under any such Policy but for its termination upon exhaustion of its limit of liability. II. Family Automobile Policies (liability only), Special Automobile Policies (private passenger automobiles, liability only), Farmers Comprehensive Personal Liability Policies (liability only), Comprehensive Personal Liability Policies (liability only) or policies of a similar nature; and the liability portion of combination forms related to the four classes of policies stated above, such as the Comprehensive Dwelling Policy and the applicable types of Homeowners Policies. III. The inception dates and thereafter of all original policies as described in 11 above, whether new, renewal or replacement, being policies which either (a) become effective on or after lst May, 1960, or (b) become effective before that date and contain the Limited Exclusion Provision set out above; provided this paragraph (2) shall not be applicable to Family Automobile Policies, Special Automobile Policies, or policies or combination policies of a similar nature, issued by the Reassured on New York risks, until 90 days following approval of the Limited Exclusion Provision by the Governmental Authority having jurisdiction thereof. (3) Except for those classes of policies specified in Clause 11 of paragraph (2) and without in any way restricting the operation of paragraph (1) of this Clause, it is understood and agreed that for all purposes of this reinsurance the original liability policies of the Reassured (new, renewal and replacement) affording the following coverages: Owners, Landlords and Tenants Liability, Contractual Liability, Elevator Liability, Owners or Contractors (including railroad) Protective Liability, Manufacturers and Contractors Liability, Product Liability, Professional and Malpractice Liability, Storekeepers Liability, Garage Liability, Automobile Liability (including Massachusetts Motor Vehicle or Garage Liability) shall be deemed to include, with respect to such coverages, from the time specified in Clause V of this paragraph (3), the following provision (specified as the Broad Exclusion Provision): Broad Exclusion Provision.* It is agreed that the Policy does not apply: I. Under any Liability Coverage, to { injury, sickness, disease, death or destruction { bodily injury or property damage (a) with respect to which an insured under the Policy is also an insured under a nuclear energy liability Policy issued by Nuclear Energy Liability Insurance Association, Mutual Atomic Energy Liability Underwriters or Nuclear Insurance Association of Canada, or would be an insured under any such Policy but for its termination upon exhaustion of its limit of liability; or (b) resulting from the hazardous properties of nuclear material and with respect to which (1) any person or organization is required to maintain financial protection pursuant to the Atomic Energy Act of 1954, or any law amendatory thereof, or (2) the insured is, or had this Policy not been issued would be, entitled to indemnity from the United States of America, or any agency thereof, under any agreement entered into by the United States of America, or any agency thereof, with any person or organization. II. Under any Medical Payments Coverage, or under any Supplementary Payments Provision relating to {immediate medical or surgical relief {first aid to expenses incurred with respect to {bodily injury, sickness, disease or death {bodily injury resulting from the hazardous properties of nuclear material and arising out of the operation of a nuclear facility by any person or organization. III. Under any Liability Coverage, to {injury, sickness disease, death or destruction {bodily injury or property damage resulting from the hazardous properties of nuclear material, if (a) the nuclear material (1) is at any nuclear facility owned by, or operated by or on behalf of, an insured or (2) has been discharged or dispersed therefrom; (b) the nuclear material is contained in spent fuel or waste at any time possessed, handled, used, processed, stored, transported or disposed of by or on behalf of an insured; or (c) the {injury, sickness, disease, death or destruction {bodily injury or property damage arises out of the furnishing by an insured of services, materials, parts or equipment in connection with the planning, construction, maintenance, operation or use of any nuclear facility, but if such facility is located within the United States of America, its territories or possessions or Canada, this exclusion (c) applies only to {injury to or destruction of property at such nuclear facility. {property damage to such nuclear facility and any property thereat. IV. As used in this endorsement: "hazardous properties" include radioactive, toxic or explosive properties; "nuclear material" means source material, special nuclear material or byproduct material; "source material", "special nuclear material", and "byproduct material" have the meanings given them in the Atomic Energy Act of 1954 or in any law amendatory thereof; "spent fuel" means any fuel element or fuel component, solid or liquid, which has been used or exposed to radiation in a nuclear reactor; "waste" means any waste material (1) containing byproduct material other than tailings or wastes produced by the extraction or concentration of uranium or thorium from any ore processed primarily for its source material content, and (2) resulting from the operation by any person or organization of any nuclear facility included under the first two paragraphs of the definition of nuclear facility; "nuclear facility" means (a) any nuclear reactor, (b) any equipment or device designed or used for (1) separating the isotopes of uranium or plutonium, (2) processing or utilizing spent fuel, or (3) handling, processing or packaging waste, (c) any equipment or device used for the processing, fabricating or alloying of special nuclear material if at any time the total amount of such material in the custody of the insured at the premises where such equipment or device is located consists of or contains more than 25 grams of plutonium or uranium 233 or any combination thereof, or more than 250 grams of uranium 235, (d) any structure, basin, excavation, premises or place prepared or used for the storage or disposal of waste, and includes the site on which any of the foregoing is located, all operations conducted on such site and all premises used for such operations: "nuclear reactor" means any apparatus designed or used to sustain nuclear fission in a self-supporting chain reaction or to contain a critical mass of fissionable material; With respect to injury to or destruction of property, the word "injury" or "destruction" of property includes all forms of radioactive contamination of property. V. The inception dates and thereafter of all original policies affording coverages specified in this paragraph (3), whether new, renewal or replacement, being policies which become effective on or after lst May, 1960, provided this paragraph (3) shall not be applicable to (i) Garage and Automobile Policies issued by the Reassured on New York risks, or (ii) statutory liability insurance required under Chapter 90, General Laws of Massachusetts, Until 90 days following approval of the Broad Exclusion Provision by the Governmental Authority having jurisdiction thereof. (4) Without in any way restricting the operation of paragraph (1) of this Clause, it is understood and agreed that paragraphs (2) and (3) above are not applicable to original liability policies of the Reassured in Canada and that with respect to such policies this Clause shall be deemed to include the Nuclear Energy Liability Exclusion Provisions adopted by the Canadian Underwriters' Association or the Independent Insurance Conference of Canada. * NOTE. The words printed in italics in the Limited Exclusion Provision and in the Broad Exclusion Provision shall apply only in relation to original liability policies which include a Limited Exclusion Provision or a Broad Exclusion Provision containing those words. NUCLEAR INCIDENT EXCLUSION CLAUSE - LIABILITY - REINSURANCE - CANADA 1 . This Agreement does not cover any loss or liability accruing to the Retrocedent as a member of, or subscriber to, any association of insurers or reinsurers formed for the purpose of covering nuclear energy risks or as a direct or indirect reinsurer of any such member, subscriber or association. 2. Without in any way restricting the operation of paragraph 1 of this clause it is agreed that for all purposes of this Agreement all the original liability contracts of the Retrocedent, whether new, renewal or replacement, of the following classes, namely, Personal Liability. Farmers Liability. Storekeepers Liability. which become effective on or after 31st December 1984, shall be deemed to include, from their inception dates and thereafter, the following provision: Limited Exclusion Provision. This Policy does not apply to bodily injury or property damage with respect to which the Insured is also insured under a contract of nuclear energy liability insurance (whether the Insured is unnamed in such contract and whether or not it is legally enforceable by the Insured) issued by the Nuclear Insurance Association of Canada or any other group or pool of insurers or would be an Insured under any such Policy but for its termination upon exhaustion of its limits of liability. With respect to property, loss of use of such property shall be deemed to be property damage. 3. Without in any way restricting the operation of paragraph 1 of this clause it is agreed that for all purposes of this Agreement all the original liability contracts of the Retrocedent, whether new, renewal or replacement, of any class whatsoever (other than Personal Liability, Farmers Liability, Storekeepers Liability or Automobile Liability contracts), which become effective on or after 31st December 1984, shall be deemed to include, from their inception dates and thereafter, the following provision of: Broad Exclusion Provision. It is agreed that this Policy does not apply: (a) to liability imposed by or arising under the Nuclear Liability Act; nor (b) to bodily injury or property damage with respect to which an Insured under this Policy is also insured under a contract of nuclear energy liability insurance (whether the Insured is unnamed in such contract and whether or not it is legally enforceable by the Insured) issued by the Nuclear Insurance Association of Canada or any other insurer or group or pool of insurers or would be an Insured under any such Policy but for its termination upon exhaustion of its limit of liability; nor (c) to bodily injury or property damage resulting directly or indirectly from the nuclear energy hazard arising from: (i) the ownership, maintenance, operation or use of a nuclear facility by or on behalf of an Insured; (ii) the furnishing by an Insured of services, materials, parts or equipment in connection with the planning, construction, maintenance, operation or use of any nuclear facility; and (iii)the possession, consumption, use, handling, disposal or transportation of fissionable substances, or of other radioactive material (except radioactive isotopes, away from a nuclear facility, which have reached the final stage of fabrication so as to be useable for any scientific, medical, agricultural, commercial or industrial purpose) used, distributed, handled or sold by an Insured. As used in this Policy: 1. The term "nuclear energy hazard" means the radioactive, toxic, explosive, or other hazardous properties of radioactive material; 2. The term "radioactive material" means uranium, thorium, plutonium, neptunium, their respective derivatives and compounds, radioactive isotopes of other elements and any other substances that the Atomic Energy Control Board may, by regulation, designate as being prescribed substances capable of releasing atomic energy, or as being requisite for the production, use or application of atomic energy; 3. The term "nuclear facility" means: (a) any apparatus designed or used to sustain nuclear fission in a self-supporting chain reaction or to contain a critical mass of plutonium, thorium and uranium or any one or more of them; (b) any equipment or device designed or used for (i) separating the isotopes of plutonium, thorium and uranium or any one or more of them, (ii) processing or utilizing spent fuel, or (iii) handling, processing or packaging waste; (c) any equipment or device used for the processing, fabricating or alloying of plutonium, thorium or uranium enriched in the isotope uranium 233 or in the isotope uranium 235, or any one or more of them if at any time the total amount of such material in the custody of the Insured at the premises where such equipment or device is located consists of or contains more than 25 grams of plutonium or uranium 233 or any combination thereof, or more than 250 grams of uranium 235; (d) any structure, basin, excavation, premises or place prepared or used for the storage or disposal of waste radioactive material; and includes the site on which any of the foregoing is located, together with all operations conducted thereon and all premises used for such operations. 4. The term "fissionable substance" means any prescribed substance that is, or from which can be obtained, a substance capable of releasing atomic energy by nuclear fission. 5. With respect to property, loss of use of such property shall be deemed to be property damage. ARTICLE 29 PARTICIPATION: CASUALTY QUOTA SHARE REINSURANCE AGREEMENT EFFECTIVE: July 1, 1998 This Agreement obligates the Reinsurer for 100.00% of the interests and liabilities set forth under this Agreement. The participation of the Reinsurer in the interests and liabilities of this Agreement shall be separate and apart from the participations of other reinsurers and shall not be joint with those of other reinsurers, and the Reinsurer shall in no event participate in the interests and liabilities of other reinsurers. IN WITNESS WHEREOF, the parties hereto, by their authorized representatives, have executed this Agreement as of the following dates: In Hartford, Connecticut, this 31st day of March, 1999. THE TRAVELERS INDEMNITY COMPANY OF ILLINOIS Naperville, Illinois By Jonathan B. Hale Jonathan B. Hale Jonathan B. Hale And in Las Vegas, Nevada, this 22nd day of March, 1999. CALIFORNIA INDEMNITY INSURANCE COMPANY COMMERCIAL CASUALTY INSURANCE COMPANY CII INSURANCE COMPANY SIERRA INSURANCE COMPANY OF TEXAS By: Kathleen M. Marlon Kathleen M. Marlon CEO and PRESIDENT EX-10 10 0010.txt Exhibit 10.13 STATUTORY WORKERS' COMPENSATION EXCESS OF LOSS REINSURANCE AGREEMENT This Agreement is made and entered into by and between CALIFORNIA INDEMNITY INSURANCE COMPANY, Pleasanton, California, COMMERCIAL CASUALTY INSURANCE COMPANY, Pleasanton, California, CII INSURANCE COMPANY, Pleasanton, California, SIERRA INSURANCE COMPANY OF TEXAS, Dallas, Texas, and all of their existing and future subsidiary companies (hereinafter together called the "Company") and the Reinsurer specifically identified on the signature page of this Agreement (hereinafter called the "Reinsurer"). ARTICLE 1 BUSINESS REINSURED This Agreement is to indemnify the Company in respect of the net excess liability as a result of any loss or losses which may occur during the term of the Agreement under any Policies classified by the Company as statutory Workers' Compensation, including Employers' Liability and United States Longshore and Harbor Workers' Compensation Act, in force, written or renewed by the Company, subject to the terms and conditions herein contained. ARTICLE 2 COVER A. With respect to those Policies providing statutory Workers' Compensation benefits covered hereunder, the Reinsurer will be liable in respect of each and every Loss Occurrence, irrespective of the number and kinds of Policies involved, for the Ultimate Net Loss over and above an initial Ultimate Net Loss of $500,000 each and every Loss Occurrence. B. With respect to Employer's Liability, the Reinsurer will be liable in respect of each and every Loss Occurrence, irrespective of the number and kinds of Policies involved, for the Ultimate Net Loss over and above an initial Ultimate Net Loss of $500,000 each and every Loss Occurrence, subject to a limit of liability to the Reinsurer of $4,500,000 each and every Loss Occurrence. C. As respects Loss Occurrences involving both Paragraphs A. and B., the Company shall retain the first $500,000 of Ultimate Net Loss each and every Loss Occurrence. The Reinsurer shall then be liable for the amount by which such Ultimate Net Loss exceeds $500,000 each and every Loss Occurrence. Recoveries under Paragraphs A. and B. of this Article and loss in excess of coverage afforded by Paragraphs A. and B. will be deducted in determining Ultimate Net Loss for purposes of this paragraph. The maximum contribution to the Ultimate Net Loss arising from Employers' Liability shall be $5,000,000. However, as respects occupational disease or cumulative trauma losses, injuries to each employee shall be deemed to be a separate Loss Occurrence. ARTICLE 3 TERM This Agreement shall become effective at 12:01 a.m., Las Vegas, Nevada local time, January 1, 2000, and shall remain in full force and effect for 36 months, expiring 12:01 a.m., Las Vegas, Nevada local time, January 1, 2003. However, should the Company's annual Gross Net Earned Premium Income estimate for the period January 1, 2001 through January 1, 2002 be greater than 145% of the Gross Net Earned Premium Income estimate for the period January 1, 2000 through January 1, 2001, the Reinsurer shall have the option to terminate this Agreement at December 31, 2000. Should the Company's Gross Net Earned Premium Income estimate for the January 1, 2002 through January 1, 2003 annual period be greater than 145% of the Gross Net Earned Premium Income estimate for the annual period January 1, 2001 through January 1, 2002, the Reinsurer shall have the option to terminate this Agreement at December 31, 2001. For the purposes of this Article, the Company will provide the Reinsurer with the applicable Gross Net Earned Premium Income estimates not less than 30 days prior to January 1, 2001 and January 1, 2002. The Reinsurer may only exercise its option to terminate under this paragraph, if and only if, it gives notice of such termination in writing to the Company within 15 days after the Company has provided the Reinsurer with the Gross Net Earned Premium estimate for the applicable annual period. The estimates may be transmitted to the Reinsurer at the following address and/or telecopy number: National Union, 175 Water Street, 21st Floor, New York, New York 10038, Attention: Excess Casualty Group/Excess Workers' Compensation Division, (212)458-5871. The notice may be transmitted to the Company at the address and telecopy number provided in the ARBITRATION ARTICLE. Such notices and estimates shall be deemed to be received by the Company and/or Reinsurer upon transmission of the telecopy, or as regards mail transmissions, five business days after the postmark date. The Reinsurer and the Company agree that the Gross Net Earned Premium estimate for the year January 1, 2000 through January 1, 2001 shall be $191,000,000. In the event the Company does not provide the Reinsurer with the applicable Gross Net Earned Premium estimate 30 days prior to January 1, 2001 or January 1, 2002 the Reinsurer has the option to immediately provide notice of termination to be effective January 1, 2001 or January 1, 2002, respectively. Upon expiration or termination of this Agreement, the entire liability of the Reinsurer for losses occurring subsequent to expiration or termination shall cease concurrently with the date of expiration or termination. However, the Company will have the option of requiring the Reinsurer to continue to cover all Policies which are in force at the date of expiration or termination of this Agreement until the natural expiration or anniversary of such Policies, whichever occurs first, but in no event longer than 12 months plus odd time, not to exceed 18 months in all from the date of expiration or termination of this Agreement. The premium applicable to the run-off period shall be at the rate set forth in this Agreement multiplied by the Gross Net Earned Premium Income earned during each calendar quarter of the run-off period for Policies in force as of the expiration date of this Agreement. Such premium shall be payable no later than 30 days after the end of each calendar quarter during the run-off period. Should this Agreement terminate or should an anniversary date occur while a loss covered hereunder is in progress, the Reinsurer shall be responsible for the loss in progress in the same manner and to the same extent it would have been responsible had the Agreement terminated or anniversary date occurred the day following the conclusion of the loss in progress. ARTICLE 4 TERRITORY This Agreement applies to losses arising out of Policies written in the United States of America, its territories and possessions, wherever occurring. ARTICLE 5 warranties A. It is warranted for purposes of this Agreement that the maximum Policy limit as respects Employers' Liability is $2,500,000, or so deemed, except where statutory limits are higher, or where statutes, regulatory action/requirement or court case/case law provide for unlimited coverage. B. It is warranted for purposes of this Agreement that business classified under the United States Longshore and Harbor Workers' Compensation Act, other than incidental, or "if any" coverage, shall be covered hereunder only when the payroll applicable to the USL&H exposure does not exceed 10% of the overall payroll for an insured's Policy. ARTICLE 6 EXCLUSIONS This Agreement does not cover: 1. Assumed reinsurance, unless assumed (a) from intercompany pooling arrangements or (b) from a fronting company if the Company manages the underwriting and claims of such fronting company or (c) from a company which has originally assumed business otherwise subject to the Agreement from the Company with a cut-through clause and which business the Company is reassuming. 2. Nuclear risks as defined in the "Nuclear Incident Exclusion Clause - Liability - Reinsurance" attached to and forming part of this Agreement. 3. Financial Guarantee and Insolvency business when written as such. 4. Any liability derived from any Pool, association or similar facility, directly as a member or indirectly by way of assessment, reinsurance or similar mechanisms. 5. Liability of the Company arising by contract, operation of law, or otherwise, from its participation or membership, whether voluntary or involuntary, in any insolvency fund. "Insolvency Fund" includes any guarantee fund, insolvency fund, plan, pool, association, fund or other arrangement, howsoever denominated, established or governed, which provides for any assessment of or payment or assumption by the Fund of part or all of any claim, debt, charge, fee, or other obligation of any insurer, or its successors or assigns, which has been declared by any competent authority to be insolvent, or which is otherwise deemed unable to meet any claim, debt, charge, fee or other obligation in whole or in part. 6. All claims arising from employment relating to the following industries: a. Operations where the governing classifications are Railroad class codes. b. Underground mining. c. Oil and Gas drilling, refining, production or manufacturing. d. Tunneling Operations involving tunnels over 100 feet in length (auguring shall not be considered tunneling). e. The manufacturing, storage or transportation of fireworks, ammunition, nitroglycerin or other explosive substances or devices. f. Professional sports teams. g. Asbestos Abatement when written as such. 7. The following classes of employment except where the exposures are incidental to an original insured's overall Workers' Compensation exposure as measured by payroll. Incidental is defined for the purposes of this Agreement as less than 10% of the insured's overall Workers' Compensation payroll (excluding clerical): a. Construction and maintenance of coffer dams. b. Tower, steeple and chimney shaft work, but this exclusion does not include church work. 8. Policies attaching excess of a self-insured retention or a deductible of $50,000 or more. 9. Aggregate Policies. 10. Business underwritten on behalf of the Company by Managing General Underwriters or Managing General Agencies (MGU's or MGA's). ARTICLE 7 PREMIUM A. As respects the first Agreement Year, the Company will pay the Reinsurer a deposit premium of $2,865,000, to be paid quarterly in advance in the amount of $429,750 (15%) on January 1, 2000, $573,000 (20%) on April 1, 2000, $859,500 (30%) on July 1, 2000, and $1,002,750 (35%) on October 1, 2000. Within 60 days following the end of the first Agreement Year, the Company will calculate a premium at a rate of 1.50% multiplied by the Company's Gross Net Earned Premium Income. Should the premium so calculated exceed the deposit premium paid in accordance with the above paragraph, the Company will immediately pay the Reinsurer the difference. Should the premium so calculated be less than the deposit premium, the Reinsurer will pay the Company the difference within 30 days after receipt and verification of the Company's report, subject to a minimum premium of $2,292,000. B. As respects the second Agreement Year, the Company will pay the Reinsurer a deposit premium equal to the amount determined by multiplying the estimated Gross Net Earned Premium Income for the second Agreement Year by a rate of 1.50%, to be paid quarterly in advance based upon the following percentage schedule, 15% on January 1, 2001, 20% on April 1, 2001, 30% on July 1, 2001, and 35% on October 1, 2001. Within 60 days following the end of the second Agreement Year, the Company will calculate a premium at a rate of 1.50% multiplied by the Company's Gross Net Earned Premium Income. Should the premium so calculated exceed the deposit premium paid in accordance with the above paragraph, the Company will immediately pay the Reinsurer the difference. Should the premium so calculated be less than the deposit premium, the Reinsurer will pay the Company the difference within 30 days of receipt and verification of the Company's report, subject to a minimum premium equal to 80% of the deposit premium for the second Agreement Year. C. As respects the third Agreement Year, the Company will pay the Reinsurer a deposit premium equal to the amount determined by multiplying the estimated Gross Net Earned Premium Income for the third Agreement Year by a rate of 1.50%, to be paid quarterly in advance based upon the following percentage schedule, 15% on January 1, 2002, 20% on April 1, 2002, 30% on July 1, 2002, and 35% on October 1, 2002. Within 60 days following the end of the third Agreement Year, the Company will calculate a premium at a rate of 1.50% multiplied by the Company's Gross Net Earned Premium Income. Should the premium so calculated exceed the deposit premium paid in accordance with the above paragraph, the Company will immediately pay the Reinsurer the difference. Should the premium so calculated be less than the deposit premium, the Reinsurer will pay the Company the difference within 30 days of receipt and verification of the Company's report, subject to a minimum premium equal to 80% of the deposit premium for the third Agreement Year. ARTICLE 8 REPORTS Within 60 days following the end of each Agreement Year, the Company will furnish the Reinsurer with: A. Gross Net Earned Premium Income of the Company for the Agreement Year. B. Any other information which the Reinsurer may require to prepare its Annual Statement which is reasonably available to the Company. ARTICLE 9 DEFINITIONS A. The term "Policy" as used in this Agreement shall mean any binder, policy, or contract of insurance or reinsurance issued, accepted or held covered provisionally or otherwise, by or on behalf of the Company. B. The term "Ultimate Net Loss" as used in this Agreement shall mean the actual loss paid by the Company, or for which the Company becomes liable to pay; such loss to include expenses of investigation, litigation and interest (including interest accrued prior to judgment where such interest is added to the judgment and interest accrued subsequent to judgment), statutory penalties, 100% claim-specific declaratory judgment expenses, 90% of any Extra Contractual Obligation amount as defined in the EXTRA CONTRACTUAL OBLIGATIONS ARTICLE, 90% of any Excess Of Policy Limits amount as defined in the EXCESS OF POLICY LIMITS ARTICLE, and all other Defense and Cost Containment Expenses of the Company incurred in connection with the loss, including subrogation, salvage, and recovery expenses. As respects Policies containing a deductible or self-insured retention of less than $50,000, and where standard premium is included within the Company's Gross Net Earned Premium Income, it is understood and agreed that the Company's Ultimate Net Loss will include the amount of the deductible or self-insured retention. All salvages, recoveries or payments recovered or received subsequent to loss settlement hereunder shall be applied as if recovered or received prior to the aforesaid settlement, and all necessary adjustments shall be made by the parties hereto. For purposes of this definition, the phrase "becomes liable to pay" shall mean the existence of a judgment which the Company does not intend to appeal, or a release has been obtained by the Company, or the Company has accepted a proof of loss. The phrase "claim-specific declaratory judgment expenses," as used in this Agreement will mean all expenses incurred by the Company in connection with declaratory judgment actions brought to determine the Company's defense and/or indemnification obligations that are allocable to specific Policies and claims subject to this Agreement. Declaratory judgment expenses will be deemed to have been incurred by the Company on the date of the original loss (if any) giving rise to the declaratory judgment action. "Annual Statement Instructions" as used in this Agreement shall mean the Annual Statement Instructions for Property Casualty Insurance Companies in effect for the Year 1999 published by the National Association of Insurance Commissioner and related guidance given by that organization. "Defense and Cost Containment Expenses" as used in this Agreement shall have the meaning given to such terms by the Annual Statement Instructions. Nothing in this clause shall be construed to mean that losses are not recoverable hereunder until the Company's Ultimate Net Loss has been ascertained. C. The term "Loss Occurrence" as used in this Agreement shall mean any one disaster or casualty or accident or loss or series of disasters or casualties or accidents or losses arising out of or caused by one event except that: As respects an occupational disease or cumulative trauma suffered by an employee for which the employer is liable, such occupational disease or cumulative trauma shall be deemed a separate Loss Occurrence within the meaning hereof for each employee affected. A loss as respects each employee affected by an occupational disease or cumulative trauma shall be deemed to have been sustained by the Company at the date when compensable disability of the employee commenced, or if there is no such disability, when the medical treatment commenced, but in no event later than the last day of employment during the term of the policy or policies of the Company. The term "occupational disease" is defined as an abnormal condition that fulfills all of the following conditions: 1. It is not traceable to a definite compensable accident occurring during the employee's present or past employment, 2. It has been caused by continued and prolonged exposure to a disease producing agent or agents present in employee's occupational environment, 3. It has resulted in disability or death. The term "cumulative trauma" is defined as an injury that fulfills all of the following conditions: 1. It is not traceable to a definite compensable accident occurring during the employee's present or past employment, 2. It has occurred from, and has been aggravated by, a repetitive employment related practice, 3. It has resulted in disability or death. D. The term Managing General Underwriter as used in this Agreement shall mean any person, firm, association, or corporation (not a part of the Company reinsured hereunder) that either separately or together with affiliates, directly underwrites business on behalf of the Company. The term underwrite as used in this definition shall mean the final power and authority to accept or reject risk on behalf of the Company without any veto or other right of rejection in the Company. Underwrite does not mean only the power to bind. E. The term Managing General Agent as used in this Agreement shall mean any person, firm, association, or corporation (not a part of the Company reinsured hereunder) that either separately or together with affiliates, directly produces and underwrites business on behalf of the Company and which adjusts and pays claims on behalf of the Company. The term underwrite as used in this definition shall mean the final power and authority to accept or reject risk on behalf of the Company without any veto or other right of rejection in the Company. Underwrite does not mean only the power to bind. F. The term "Gross Net Earned Premium Income (GNEPI)" as used in this Agreement shall mean gross earned premium income on business subject to this Agreement after (i) the application of experience modifications, schedule or other rating plans, premium discounts, expense constants, loss constants and the application of discounts granted for deductible or self-insured retention plans less than $10,000 and (ii) adjustment by retrospective rating plan calculations and dividend rating plan payments. Retrospective rating plan adjustments and dividend rating plan payments shall be pro rated based on the earned premium of each individual Policy during the term of this Agreement. The Gross Net Earned Premium Income will also include the undiscounted premium associated with the large deductible and self-insured retention Policies, i.e. those deductibles or self-insured retentions greater than or equal to $10,000, but less than $50,000. G. The term "Agreement Year" as used in this Agreement shall mean the 12 consecutive months commencing with each January 1. ARTICLE 10 Net Retained Lines This Agreement applies only to that portion of any insurances or reinsurances covered by this Agreement which the Company retains net for its own account. In calculating the amount of any loss hereunder and also in computing the amount in excess of which this Agreement attaches, only loss or losses in respect of that portion of any insurances or reinsurances which the Company retains net for its own account shall be included. The Reinsurer's liability hereunder in respect of any loss or losses shall not be increased by reason of the inability of the Company to collect from any other reinsurers, whether specific or general, any amounts which may have become due from them whether such inability arises from the insolvency of such other reinsurers or otherwise. However, the Company may carry underlying quota share or excess of loss reinsurance and recoveries made thereon shall be disregarded for all purposes of this Agreement and shall inure to the sole benefit of the Company and shall not be used in calculating what portion the Company retains net for its own account. ARTICLE 11 late payments The provisions of this Article shall not be implemented unless specifically invoked in writing by the Reinsurer or the Company. The interest amounts provided for in this Article will apply to the Reinsurer or to the Company in the following circumstances: A. Payment of any premium shall be due to the Reinsurer within 30 calendar days of the date specified in this Agreement. The calculation of the premium adjustment will be provided by the Company to the Reinsurer within 60 calendar days of the expiry of this Agreement with payment due by the debtor party within 30 days thereafter. B. Loss payment owed by the Reinsurer to the Company shall have a due date to the Company of 30 calendar days following the date that satisfactory billing/proof of loss is received by the Reinsurer. C. Failure by the Reinsurer or Company to comply with their respective payment obligations within the time periods as above provided will result in a simple interest penalty calculated as follows: 1. The number of full calendar days which have passed since the due date of the payment; multiplied by 2. Either 1/365ths of 9%, or 1/365ths of 150% of the one-year United States Treasury Bill Rate as quoted in The Wall Street Journal on the first business day of the month in which the due date of the payment falls, whichever is higher; multiplied by 3. The amount past due. The accumulation of the number of days that any payment is past due will stop on the date that the Intermediary receives payment. The Intermediary will forward payment to the owed party within seven calendar days of its receipt of such past due amounts. Any interest which occurs pursuant to this Article shall be calculated by the party to which it is owed. Any interest due shall be immediately payable by the other party. D. The validity of any claim or payment may be contested under the provisions of this Agreement. If the debtor party prevails in an arbitration or any other proceeding, there shall be no interest penalty due. Otherwise, any interest penalty due will be determined in the arbitration or other proceeding. E. If a Reinsurer advances payment of any claim it is contesting, and prevails, the Company shall return such payment or part thereof as is determined by the arbitration plus pay interest on same, calculated as per the provisions of this Article. F. Any interest which occurs pursuant to this Article may be waived by the party to which it is owed. Further, any interest which is calculated pursuant to this Article that is $100 or less shall be waived. Waiver of such interest, however, shall not affect the waiving party's right to similar interest for any other failure by the other party to make payment when due under this Agreement. G. Nothing in this Article shall diminish any legal remedy which either party may have against the other. ARTICLE 12 Commutation This Article will only take effect should the parties hereto mutually agree to commute one or any number of losses under this Agreement. There will be no obligation on the part of either party to so commute. At any time after seven years following the date of such loss and upon mutual agreement of the Company and the Reinsurer, said loss (including loss expenses) may be commuted. If the value of said loss, including amounts falling to the share of the Reinsurers, cannot be agreed upon by the parties to this Agreement, said value may be determined by: A. An annuity calculation based on the following criteria: 1. In respect of all "index-linked" benefits, annuity values shall be calculated based upon applicable statutes. 2. In respect of all unindexed benefits annuity values shall be calculated based upon an annual discount equal to the five-year Treasury Note rate averaged over the five-year period immediately preceding the calculation. 3. All future medical costs shall be based upon the Company's evaluation of long-term medical, care and rehabilitation requirements, using an annual discount equal to the five-year Treasury Note rate and an annual escalation equal to the Medical CPI rate averaged over the five-year period immediately preceding the calculation. 4. Where applicable, impaired life expectancy, survivors life expectancy and remarriage probability will be reflected in the calculation by employing tables required by state statutes. B. The Company may determine the present value by purchasing (or obtaining a quotation for) an annuity from any carrier who is "A" or better rated by A. M. Best Company. The Reinsurers' proportion of the amount determined will be considered their total liability for such loss and the lump sum payment thereof will constitute a complete release of the Reinsurers from their liability for such loss. This Commutation Clause shall survive the expiration or termination of this Agreement. ARTICLE 13 Currency The currency to be used for all purposes of this Agreement shall be United States of America currency. ARTICLE 14 Loss Funding A. This clause is only applicable to those Reinsurers who cannot qualify for credit by the State having jurisdiction over the Company's loss reserves. As regards policies or bonds issued by the Company coming within the scope of this Agreement, the Company agrees that when it shall file with the insurance department or set up on its books reserves for losses covered hereunder which it shall be required to set up by law it will forward to the Reinsurer a statement showing the proportion of such loss reserves which is applicable to them. The Reinsurer hereby agrees that it will apply for and secure delivery to the Company a clean irrevocable and unconditional Letter of Credit issued by a bank chosen by the Reinsurer and acceptable to the appropriate insurance authorities, in an amount equal to the Reinsurer's proportion of the loss reserves in respect of known outstanding losses that have been reported to the Reinsurer, loss expenses relating thereto and Incurred But Not Reported loss and loss expense as shown in the statement prepared by the Company. The Letter of Credit shall be "Evergreen" and shall be issued for a period of not less than one year, and shall be automatically extended to one year from its date of expiration or any future expiration date unless thirty (30) days prior to any expiration date, the bank shall notify the Company by certified or registered mail that it elects not to consider the Letter of Credit extended for any additional period. The bank chosen for the issuance of the Letter of Credit shall have no responsibility whatsoever in connection with the propriety of withdrawals made by the Company or the disposition of funds withdrawn, except to ensure that withdrawals are made only upon the order of properly authorized representatives of the Company. At annual Intervals, or more frequently as agreed but never more frequently than semiannually, the Company shall prepare a specific statement, for the sole purpose of amending the Letter of Credit, of the Reinsurer's share of known and reported outstanding losses and Allocated Loss Expenses relating thereto. If the statement shows that the Reinsurer's share of such losses and Allocated Loss Expenses, and Incurred But Not Reported loss and loss expense, exceeds the balance of credit as of the statement date, the Reinsurer shall, within thirty (30) days after receipt of notice of such excess, secure delivery to the Company of an amendment of the Letter of Credit increasing the amount of credit by the amount of such difference. If, however, the statement shows that the Reinsurer's share of known and reported outstanding losses plus Allocated Loss Expenses, and Incurred But Not Reported loss and loss expense, relating thereto is less than the balance of credit as of the statement date, the Company shall, within thirty (30) days after receipt of written request form the Reinsurer, release such excess credit by agreeing to secure an amendment to the Letter of Credit. B. In addition to the requirements set forth above, if the Reinsurer ceases to be admitted for workers compensation insurance in any state at any time in which there are obligations ceded by the Company under this Agreement and such event requires the Company to increase any deposit that it must make in such state or to such state authorities accordance with the laws of such state, on account of its direct workers' compensation premium written in the state, Reinsurer shall forthwith remit to Company the amount of such increase, which funds Company will hold as funds withheld under this Agreement. In lieu of such remittance but only to the extent permitted by and in accordance with the law of such state, Reinsurer, may underwrite as surety (if admitted to write surety insurance in such state) or procure from an admitted surety a surety bond naming the Company, as principal, and such authorities as beneficiary in the form such authorities may require. If the Reinsurer remits funds under this portion of this Article such funds will be credited to its obligation to post letters of credit, if it is otherwise so required. ARTICLE 15 Taxes The Company will be liable for taxes (except Federal Excise Tax) on premiums reported to the Reinsurer hereunder. Federal Excise Tax applies only to those Reinsurers, excepting Underwriters at Lloyd's, London and other Reinsurers exempt from the Federal Excise Tax, who are domiciled outside the United States of America. The Reinsurer has agreed to allow for the purpose of paying the Federal Excise Tax 1% of the premium payable hereon to the extent such premium is subject to Federal Excise Tax. In the event of any return of premium becoming due hereunder, the Reinsurer will deduct 1% from the amount of the return, and the Company or its agent should take steps to recover the Tax from the U.S. Government. ARTICLE 16 Notice of Loss and Loss Settlements The Company will advise the Reinsurer promptly of all claims which in the opinion of the Company may involve the Reinsurer, and of all subsequent developments on these claims which may materially affect the position of the Reinsurer, such advices to include any claim where the reserve is 50% or more of the Company's retention; and, irrespective of the reserve or of any question on liability or coverage, any claim involving: A. Fatalities. B. Spinal cord injury - paraplegia, quadriplegia. C. Amputation - requiring prostheses. D. Brain injuries resulting in impairment of physical functions. E. Second or Third Degree burns involving 40% or more of the body. F. Injuries resulting in partial or total paralysis of upper or lower extremities. G. Loss of sight in one or both eyes. The Reinsurer agrees to abide by the loss settlements of the Company, it being understood, however, that when so requested the Company will afford the Reinsurer an opportunity to be associated with the Company, at the expense of the Reinsurer, in the defense of any claim or suit or proceeding involving this reinsurance and the Company will cooperate in every respect in the defense of such claim, suit or proceeding. The Reinsurer will pay its share of loss settlements immediately upon receipt of proof of loss from the Company. ARTICLE 17 Extra Contractual Obligations This Agreement shall protect the Company, subject to the Reinsurer's limit of liability appearing in the COVER ARTICLE of this Agreement, where the loss includes any Extra Contractual Obligations as provided for in the definition of Ultimate Net Loss. "Extra Contractual Obligations" are defined as those liabilities not covered under any other provision of this Agreement and which arise from handling of any claim on business covered hereunder, such liabilities arising because of, but not limited to, the following: failure by the Company to settle within the Policy limit, or by reason of alleged or actual negligence, fraud or bad faith in rejecting an offer of settlement or in the preparation of the defense or in the trial of any action against its insured or in the preparation or prosecution of an appeal consequent upon such action. The date on which any Extra Contractual Obligation is incurred by the Company shall be deemed, in all circumstances, to be the date of the original Loss Occurrence. However, this Article shall not apply where the loss has been incurred due to the fraud of a member of the Board of Directors or a corporate officer of the Company acting individually or collectively or in collusion with any individual or corporation or any other organization or party involved in the presentation, defense or settlement of any claim covered hereunder. ARTICLE 18 Excess of Policy Limits In the event the Ultimate Net Loss includes an amount in excess of the Company's Policy limit, such amount, as provided for in the definition of Ultimate Net Loss, in excess of the Company's Policy limit shall be added to the amount of the Company's Policy limit, and the sum thereof shall be covered hereunder, subject to the Reinsurer's limit of liability appearing in the COVER ARTICLE of this Agreement. However, this Article shall not apply where the loss has been incurred due to the fraud of a member of the Board of Directors or a corporate officer of the Company acting individually or collectively or in collusion with any individual or corporation or any other organization or party involved in the presentation, defense or settlement of any claim covered hereunder. For the purpose of this Article, the word "loss" shall mean any amounts for which the Company would have been contractually liable to pay had it not been for the limit of the original Policy. ARTICLE 19 Delay, Omission or Error Any inadvertent delay, omission or error shall not be held to relieve either party hereto from any liability which would attach to it hereunder if such delay, omission or error had not been made, providing such delay, omission or error is rectified upon discovery. ARTICLE 20 Inspection The Company shall place at the disposal of the Reinsurer at all reasonable times, and the Reinsurer shall have the right to inspect, through its authorized representatives, all books, records and papers of the Company in connection with any reinsurance hereunder, or claims in connection herewith. However, no claim payment due from the Reinsurer shall be withheld or delayed pending the Reinsurer's exercise of its rights under this Article or any other right to audit the Company's books and records. ARTICLE 21 Arbitration Any dispute arising out of or related in any way to this Agreement, wherever occurring, including it's formation and validity shall be submitted to arbitration by a panel of three arbitrators sitting in Las Vegas, Nevada or such other place as the parties may mutually agree in writing. The Arbitration shall be conducted under the Procedures for the Resolution of U. S. Insurance and Reinsurance Disputes as attached (the "Procedures"). The parties hereby select the following related to the procedures. (1) Alternative Section 6.2 is selected (2) the list maintained under Section 6.7(a) for the selection of the umpire will be that of the American Arbitration Association or if that organization does not maintain a list then by ARISA (U.S.). Should either of these organizations not maintain a list as required under Section 6.7(a) within 30 calendar days after the appointment of the second arbitrator, either party may initiate proceedings in the United States District Court for Nevada (Las Vegas Division) to obtain appointment of the umpire, of if the Federal Court declines to act, the State Court having jurisdiction over Las Vegas, Nevada. The parties may each submit a brief summary of the issues in dispute to the Court with the names of up to three candidates, together with resumes of their experience and qualification, from which the umpire shall be selected and who shall meet the requirements of this Agreement. In addition to the Procedures: (1) the parties agree that in so far as the Panel looks to the substantive law, it shall consider the law of the State of California exclusive of that state's rules with respect to conflicts of law. (2) within thirty (30) days after notice of appointment of all arbitrators, the Panel shall meet, and unless the Panel establishes, the parties and the Panel shall abide by the following deadlines: (a) ninety (90) days for the filing of the claimant's and respondent's brief and the claimant's reply, (b) sixty (60) days for the period of discovery. Addresses for Notice under Section 3 of the Procedures is: For: California Indemnity Insurance Company Commercial Casualty Insurance Company Sierra Insurance Company of Texas CII Insurance Company 2716 North Tenaya Way Las Vegas, Nevada 89128 Attention: General Counsel Telecopy: (702)869-2415 For: National Union Insurance Company 175 Water Street, 11th Floor New York, New York 10038 Attention: Mr. John Cavoores, President Telecopy: (212)458-1775 Matters related to the Arbitration and arbitrability and enforcement of this Agreement shall be subject to the Federal Arbitration Act (9 U. S. C. Section 1 and following). This Article shall survive the expiration or termination of this Agreement. ARTICLE 22 Service of Suit If the Reinsurer fails to pay any amount claimed to be due hereunder, the Reinsurer, at the request of the Company, will submit to the jurisdiction of a Court of competent jurisdiction within the United States of America and will comply with all requirements necessary to give such court jurisdiction. Service of process in such suit may be made upon the Commissioner of Insurance State of California. In any suit instituted against the Reinsurer under this Agreement, the Reinsurer will abide by the final decision of such court or of any Appellate Court in the event of an appeal. The person named above is authorized and directed to accept service of process on behalf of the Reinsurer in any such suit and, upon request of the Company, to give a written undertaking to the Company that a general appearance will be entered on behalf of the Reinsurer in the event such a suit shall be instituted. Further, pursuant to any statute of any state, territory or district of the United States of America which makes provision therefor, the Reinsurer hereby designates the Superintendent, Commissioner or Director of Insurance or other officer specified for that purpose in the statute, or his successor or successors in office, as its true and lawful attorney upon whom may be served any lawful process in any action, suit or proceeding instituted by or on behalf of the Company or any beneficiary arising out of this Agreement, and hereby designates the person named above as the party to whom the said officer is authorized to mail such process or a true copy thereof. This Article is not intended nor shall it imply nor have the effect that a dispute arising out of or related to this agreement, whenever occurring, shall not be submitted to arbitration pursuant to the ARBITRATION ARTICLE. It is intended to aid in the enforcement of the ARBITRATION ARTICLE and any award arising under it. ARTICLE 23 Insolvency A. In the event of the insolvency and the appointment of a conservator, liquidator or statutory successor of the Company, the portion of any risk or obligation assumed by the Reinsurer shall be payable to the conservator, liquidator or statutory successor on the basis of claims allowed against the insolvent Company by any court of competent jurisdiction or by any conservator, liquidator or statutory successor of the Company having authority to allow such claims, without diminution because of that insolvency or because the conservator, liquidator or statutory successor has failed to pay all or a portion of any claims. Payments by the Reinsurer as set forth in this paragraph shall be made directly to the Company or to its conservator, liquidator or statutory successor, except where this Contract specifically provides another payee of such reinsurance in the event of the insolvency of the Company. The conservator, liquidator or statutory successor of the Company shall give written notice of the pendency of a claim against the Company indicating the policy or bond reinsured, within a reasonable time after such claim is filed, and the Reinsurer may interpose, at its own expense, in the proceeding where such claim is to be adjudicated, any defense or own expense, in the proceeding where such claim is to be adjudicated, any defense or defenses which it may deem available to the Company or its conservator, liquidator or statutory successor. The expense thus incurred by the Reinsurer shall be payable, subject to the court approval, out of the estate of the insolvent Company as part of the expense of conservation or liquidation to the extent of a proportionate share of the benefit which may accrue to the Company in conservation or liquidation solely as a result of the defense undertaken by the Reinsurer. B. Where two or more reinsurers are involved in the same claim and a majority in interest elect to interpose defense to such claim, the expense shall be apportioned in accordance with the terms of this Contract as though such expense had been incurred by the Company. C. In the event of the insolvency of any company or companies included in the designation of "Company," this clause will apply only to the insolvent company or companies. ARTICLE 24 offset Each party hereto shall have, and may exercise at any time and from time to time, the right to offset any balance or balances, whether on account of premiums or on account of losses or otherwise, due from such party to the other under this Agreement provided, however, that in the event of the insolvency of a party hereto, offsets shall only be allowed in accordance with applicable statutes and regulations. ARTICLE 25 confidentiality Any materials provided in the course of inspections or information tendered pursuant to the Agreement shall be kept confidential by the Reinsurer as against third parties and its affiliates, unless the disclosure is required pursuant to process of law or unless the disclosure is to Reinsurer's retrocessionaires, financial auditors or governing regulatory bodies. Disclosing or using this information for any purpose beyond the scope of this Agreement, or beyond the exceptions set forth above, is expressly forbidden without the prior consent of the Company. ARTICLE 26 severability If any provision of this Agreement shall be rendered illegal or unenforceable by the laws, regulations or public policy of any state, such provision shall be considered void in such state, but this shall not affect the validity or enforceability of any other provisions of this Agreement or the enforceability of such provision in any other jurisdiction. ARTICLE 27 entire agreement This Agreement constitutes the entire Agreement between the parties with respect to the business being reinsured hereunder and the obligations of the parties are determined solely by the terms of the Agreement. Any changes or modification to the Agreement shall be made by written amendment to the Agreement and signed by both parties. ARTICLE 28 Intermediary Guy Carpenter & Company, Inc. is hereby recognized as the Intermediary negotiating this Agreement for all business hereunder. All communications, including notices, premiums, return premiums, commissions, taxes, losses, loss adjustment expenses, salvages and loss settlements relating thereto (except those related to the TERM and ARBITRATION ARTICLES) shall be transmitted to the Reinsurer or the Company through Guy Carpenter & Company, Inc., 1501 Fourth Avenue, Suite 1400, Seattle, Washington 98101. Payments by the Company to the Intermediary shall be deemed to constitute payment to the Reinsurer. Payments by the Reinsurer to the Intermediary shall be deemed only to constitute payment to the Company to the extent that such payments are actually received by the Company. ARTICLE 29 PARTICIPATION: STATUTORY WORKERS' COMPENSATION EXCESS OF LOSS - ------------- REINSURANCE AGREEMENT EFFECTIVE: January 1, 2000 This Agreement obligates the Reinsurer for 100.00% of the interests and liabilities set forth under this Agreement. The participation of the Reinsurer in the interests and liabilities of this Agreement shall be separate and apart from the participations of other reinsurers and shall not be joint with those of other reinsurers, and the Reinsurer shall in no event participate in the interests and liabilities of other reinsurers. IN WITNESS WHEREOF, the parties hereto, by their authorized representatives, have executed this Agreement as of the following dates: In New York, New York, this 25th day of Septebmer, 2000. NATIONAL UNION FIRE INSURANCE COMPANY OF PITTSBURGH, PENNSYLVANIA Pittsburgh, Pennsylvania By s/James P. Tamborrino (signature) James P. Tamborrino ------------------- (name) Assistant Vice President (title) Ref. No.: 703-4036 and in Las Vegas, Nevada, this 21st day of September, 2000. CALIFORNIA INDEMNITY INSURANCE COMPANY COMMERCIAL CASUALTY INSURANCE COMPANY CII INSURANCE COMPANY SIERRA INSURANCE COMPANY OF TEXAS and all of their existing and future subsidiary companies By s/ Kathleen M. Marlon ------------------------------------ (signature) Kathleen M. Marlon ------------------------------------ (name) President -------------------------------- (title) STATUTORY WORKERS' COMPENSATION EXCESS OF LOSS REINSURANCE AGREEMENT issued to CALIFORNIA INDEMNITY INSURANCE COMPANY COMMERCIAL CASUALTY INSURANCE COMPANY CII INSURANCE COMPANY SIERRA INSURANCE COMPANY OF TEXAS NUCLEAR INCIDENT EXCLUSION CLAUSE - LIABILITY - REINSURANCE - U.S.A. (Wherever the word "Reassured" appears in this clause, it shall be deemed to read "Reassured," "Reinsured," "Company," or whatever other word is employed throughout the text of the reinsurance agreement to which this clause is attached to designate the company or companies reinsured.) (1) This reinsurance does not cover any loss or liability accruing to the Reassured as a member of, or subscriber to, any association of insurers or reinsurers formed for the purpose of covering nuclear energy risks or as a direct or indirect reinsurer of any such member, subscriber or association. (2) Without in any way restricting the operation of paragraph (1) of this Clause it is understood and agreed that for all purposes of this reinsurance all the original policies of the Reassured (new, renewal and replacement) of the classes specified in Clause II of this paragraph (2) from the time specified in Clause III in this paragraph (2) shall be deemed to include the following provision (specified as the Limited Exclusion Provision): Limited Exclusion Provision.* I. It is agreed that the policy does not apply under any liability coverage, to injury, sickness, disease, death or destruction bodily injury or property damage with respect to which an insured under the policy is also an insured under a nuclear energy liability policy issued by Nuclear Energy Liability Insurance Association, Mutual Atomic Energy Liability Underwriters or Nuclear Insurance Association of Canada, or would be an insured under any such policy but for its termination upon exhaustion of its limit of liability. II. Family Automobile Policies (liability only), Special Automobile Policies (private passenger automobiles, liability only), Farmers Comprehensive Personal Liability Policies (liability only), Comprehensive Personal Liability Policies (liability only) or policies of a similar nature; and the liability portion of combination forms related to the four classes of policies stated above, such as the Comprehensive Dwelling Policy and the applicable types of Homeowners Policies. III. The inception dates and thereafter of all original policies as described in II above, whether new, renewal or replacement, being policies which either (a) become effective on or after 1st May, 1960, or (b) become effective before that date and contain the Limited Exclusion Provision set out above; provided this paragraph (2) shall not be applicable to Family Automobile Policies, Special Automobile Policies, or policies or combination policies of a similar nature, issued by the Reassured on New York risks, until 90 days following approval of the Limited Exclusion Provision by the Governmental Authority having jurisdiction thereof. (3) Except for those classes of policies specified in Clause II of paragraph (2) and without in any way restricting the operation of paragraph (1) of this Clause, it is understood and agreed that for all purposes of this reinsurance the original liability policies of the Reassured (new, renewal and replacement) affording the following coverages: Owners, Landlords and Tenants Liability, Contractual Liability, Elevator Liability, Owners or Contractors (including railroad) Protective Liability, Manufacturers and Contractors Liability, Product Liability, Professional and Malpractice Liability, Storekeepers Liability, Garage Liability, Automobile Liability (including Massachusetts Motor Vehicle or Garage Liability) shall be deemed to include, with respect to such coverages, from the time specified in Clause V of this paragraph (3), the following provision (specified as the Broad Exclusion Provision): Broad Exclusion Provision.* It is agreed that the policy does not apply: I. Under any Liability Coverage, to injury, sickness, disease, death or destruction bodily injury or property damage (a) with respect to which an insured under the policy is also an insured under a nuclear energy liability policy issued by Nuclear Energy Liability Insurance Association, Mutual Atomic Energy Liability Underwriters or Nuclear Insurance Association of Canada, or would be an insured under any such policy but for its termination upon exhaustion of its limit of liability; or (b) resulting from the hazardous properties of nuclear material and with respect to which (1) any person or organization is required to maintain financial protection pursuant to the Atomic Energy Act of 1954, or any law amendatory thereof, or (2) the insured is, or had this policy not been issued would be, entitled to indemnity from the United States of America, or any agency thereof, under any agreement entered into by the United States of America, or any agency thereof, with any person or organization. II. Under any Medical Payments Coverage, or under any Supplementary Payments Provision relating to Immediate medical or surgical relief first aid, to expenses incurred with respect to Bodily injury, sickness, disease or death bodily injury resulting from the hazardous properties of nuclear material and arising out of the operation of a nuclear facility by any person or organization. III. Under any Liability Coverage, to injury, sickness, disease, death or destruction bodily injury or property damage resulting from the hazardous properties of nuclear material, if (a) the nuclear material (1) is at any nuclear facility owned by, or operated by or on behalf of, an insured or (2) has been discharged or dispersed therefrom; (b) the nuclear material is contained in spent fuel or waste at any time possessed, handled, used, processed, stored, transported or disposed of by or on behalf of an insured; or (c) the injury, sickness, disease, death or destruction bodily injury or property damage arises out of the furnishing by an insured of services, materials, parts or equipment in connection with the planning, construction, maintenance, operation or use of any nuclear facility, but if such facility is located within the United States of America, its territories or possessions or Canada, this exclusion (c) applies only to injury to or destruction of property at such nuclear facility. property damage to such nuclear facility and any property thereat. IV. As used in this endorsement: "hazardous properties" include radioactive, toxic or explosive properties; "nuclear material" means source material, special nuclear material or byproduct material; "source material," "special nuclear material," and "byproduct material" have the meanings given them in the Atomic Energy Act of 1954 or in any law amendatory thereof; "spent fuel" means any fuel element or fuel component, solid or liquid, which has been used or exposed to radiation in a nuclear reactor; "waste" means any waste material (1) containing byproduct material other than tailings or wastes produced by the extraction or concentration of uranium or thorium from any ore processed primarily for its source material content, and (2) resulting from the operation by any person or organization of any nuclear facility included under the first two paragraphs of the definition of nuclear facility; "nuclear facility" means (a) any nuclear reactor, (b) any equipment or device designed or used for (1) separating the isotopes of uranium or plutonium, (2) processing or utilizing spent fuel, or (3) handling, processing or packaging waste, (c) any equipment or device used for the processing, fabricating or alloying of special nuclear material if at any time the total amount of such material in the custody of the insured at the premises where such equipment or device is located consists of or contains more than 25 grams of plutonium or uranium 233 or any combination thereof, or more than 250 grams of uranium 235, (d) any structure, basin, excavation, premises or place prepared or used for the storage or disposal of waste, and includes the site on which any of the foregoing is located, all operations conducted on such site and all premises used for such operations; "nuclear reactor" means any apparatus designed or used to sustain nuclear fission in a self-supporting chain reaction or to contain a critical mass of fissionable material; With respect to injury to or destruction of property, the word "injury" or destruction "property damage" includes all forms of radioactive contamination of property. includes all forms of radioactive contamination of property. V. The inception dates and thereafter of all original policies affording coverages specified in this paragraph (3), whether new, renewal or replacement, being policies which become effective on or after 1st May, 1960, provided this paragraph (3) shall not be applicable to (i) Garage and Automobile Policies issued by the Reassured on New York risks, or (ii) statutory liability insurance required under Chapter 90, General Laws of Massachusetts, until 90 days following approval of the Broad Exclusion Provision by the Governmental Authority having jurisdiction thereof. (4) Without in any way restricting the operation of paragraph (1) of this Clause, it is understood and agreed that paragraphs (2) and (3) above are not applicable to original liability policies of the Reassured in Canada and that with respect to such policies this Clause shall be deemed to include the Nuclear Energy Liability Exclusion Provisions adopted by the Canadian Underwriters' Association or the Independent Insurance Conference of Canada. - ------------------------------------------------------------------------------ * NOTE. The words printed in italics in the Limited Exclusion Provision and in the Broad Exclusion Provision shall apply only in relation to original liability policies which include a Limited Exclusion Provision or a Broad Exclusion Provision containing those words. - ----------------------------------------------------------------------------- Procedures for the Resolution of U.S. Insurance and Reinsurance DisputesDISCLAIMER The Reinsurance Dispute resolution Task force recommends that interested parties consult their own legal counsel concerning these Procedures, their use or interpretation. These procedures do not necessarily express the views of individual members of the Reinsurance Dispute Resolution Task Force or the firms or entities for which they work or which they represent. TABLE OF CONTENTS FOREWORD.................................................i INTRODUCTION.............................................iii PROCEDURES FOR THE RESOLUTION OF U.S. INSURANCE AND REINSURANCE DISPUTES INTRODUCTION.............................................1 DEFINITIONS..............................................2 NOTICE AND TIME PERIODS..................................3 COMMENCEMENT OF ARBITRATION..............................4 RESPONSE BY RESPONDENT...................................5 APPOINTMENT AND COMPOSITION OF THE PANEL.................6 CONFIDENTIALITY..........................................7 INTERIM RELIEF...........................................8 LOCATION OF PROCEEDINGS..................................9 PREHEATING PROCEDURE.....................................10 DISCOVERY................................................11 MEDIATION OR SETTLEMENT..................................12 SUMMARY DISPOSITION AND EX PARTE HEARING.................13 ARBITRATION HEARING......................................14 AWARD....................................................15 ALTERNATIVE STREAMLINED PROCEDURES.......................16 SEVERABILITY.............................................17 FOREWORD The insurance and reinsurance industries have long recognized the value of alternative dispute resolution mechanism, demonstrated by the fact that arbitration clauses can be found in reinsurance contracts dating as far back as the early 1800's. 'The purpose of these Procedures is to formalize what has been, until now, an ad hoc, albeit highly developed, process used by the industry for decades. While various alternative dispute resolution service provide have developed generic arbitration procedures, and the members of the Task Force appreciate those efforts, the Task Force believes that specific industry procedures are beneficial, and needed, in order to combine the experience reflected in the generic procedures with the custom and practice developed in the insurance and reliance industries. It is the hope of the Task Force in member that the Procedures for the Resolution of U.S. Insurance and Reinsurance Dispute will provide a helpful framework for the conduct of future industry arbitrations and a sense of greater certainty at the time of entering into contracts about how disputes will be handled in the unfortunate event that they arise. INTRODUCTION The Reinsurance Dispute Resolution Task Force (Task Force) was established in the fall of 1997. Its mission was to: Improve the reinsurance dispute resolution process by identifying common problems and recommending industry-wide, flexible, business like solutions. The Task Force undertook a variety of tasks, one of which was to draft a set of procedures that could be utilized by the insurance and reinsurance industries for the resolution of their contractual disputes. This set of procedures is refined to as the Procedures for the Resolution of U.S. Insurance and Reinsurance Disputes (Procedures). In undertaking this effort, the Task Force attempted to balance several goals. One was to set forth, in writing the actual practice that exists insurance and reinsurance arbitrations today. The Second was to enhance and clarify minor procedural issues that sometimes result in unnecessary skirmishes between Parties. And the third, was to tackle some of the major issues that cause a lack of confidence and inefficiencies in the current system, and recommend alternative procedures that might result in greater fairness and a higher level of certainty to the Parties. An example of this third goal is the umpire Selection process created in article 6 of the Procedures. The often-used process of selecting an umpire by lot (in the absence of agreement) is a random, arbitrary one which is prone to potential manipulation. The umpire selection process reflected in article 6 is intended to encourage parties to reach agreement on au umpire and remove or reduce the potential for manipulation, arbitrariness or chance in the event that agreement can-not be reached. It is intended to motivate the parties to select competent, well qualified individuals. In the process of drafting the procedures, the Task Force considered and, in some cases, debated, at length, many topics. The resolution of some of those issues are reflected in these Procedures. However, other issues, though they were fully considered, are ones on which the Task Force took no position and are not addressed in these Procedures. Examples include the precedential or collateral effect of arbitration awards and the designation of a choice of law provision. Although the Task Force addressed the issue of consolidation involving multiple reinsurers, the same contract and the same loss, the Task Force declined to address other circumstances where consolidation might arise. The decision of the Task Force to limit its consideration of consolidation to the circumstances described in the optional provision in the sample arbitration clause should not be construed as an indication of whether Task Force members believed consolidation was appropriate in other circumstances- The Task Force, as a whole, believes that the Procedures are an important step forward in preventing unnecessary friction in the arbitration process and providing parties with more certainty regarding what to expect from the process. It is hoped that contracting parties will consider incorporating these Procedures in their future contracts or, through a separate agreement applying them to their existing relationships. Parties should fee1 free to incorporate them, as written, or with modifications appropriate to their unique situations. PROCEDURES FOR THE RESOLUTION OF U.S. INSURANCE AND REINSURANCE: DISPUTES September 1999 1. INTRODUCTION 1.1 These procedures shall be known as the Procedures for the Resolution of U.S. Insurance and Reinsurance Disputes ("Procedures"). When an agreement, submission or reference provides for or otherwise refer to arbitration trader the Procedures for the Resolution of U.S. Insurance and Reinsurance Disputes, the Parties agree that the arbitration shall be conducted in accordance with these Procedures. 1.2 The Parties may agree on any procedures not specified herein or may alter these Procedure by written agreement. Any such Party-agreed procedures shall be enforceable as if contained in these Procedures. These Procedures shall control any matters not changed by the Party-agreed procedures. 1.3 Certain provisions are accompanied by explanatory notes. If any note conflicts in any way with the Procedures, the Procedures prevail. 1.4 Any dispute concerning the interpretation of these Procedures shall be determined by the Panel. 1.5 The Panel shall have all powers and authority not inconsistent with these Procedures and the Agreement of the Parties. 2. DEFINITIONS 2.1 Arbitration Agreement - an agreement to submit present or future disputes to arbitration, whether contained in a reinsurance contract or other written agreement. 2.2 Arbitration Award or award - includes the final award described inP. 15.2 and any interim award. 2.3 Disinterested - as used in P. 16.1 and P. 16.4 means that no member of the Panel shall be under the control of either party, nor shall any member of the panel have a financial interest in the outcome of the arbitration. 2.4 Notice Of Arbitration - the notice sent by the petitioner in accordance withP. 4.1. 2.5 Panel - the body charged with determining the dispute as defined byP. 6.1. 2.6 Party or Parties - the Petitioner and the Respondent and any other individuals or entities voluntarily, by compulsion or contractually joined in the proceedings. 2.7 Petitioner - the Party who commences arbitration. 2.8 Procedures - as defined by Article 1. 2.9 Respondent -a Party against whom arbitration is commenced. 2.10 Response - the Response to the Notice of Arbitration sent by the Respondent in accordance withP. 5.1. 3. NOTICE AND TIME PERIODS Notices 3.1 Notices under these Procedures are deemed to be given if delivered, in accordance with P. 3.2, to a Party's principal place of business or other address designated by the Party or if delivered to another entity designated by the Party in there reinsurance contract or other written agreement. 3.2 Notices required to be given under these Procedures are deemed to be given: (a) if sent by fax, on the date transmitted; (b) if sent by mail upon delivery; (c) if sent by certified registered mail or another service which produces a receipt, as indicated on the receipt. Note 3.2 - --Notices of Arbitration, Responses to Notices of Arbitration and Appointment of Arbitrator should, where possible, be given in a manner that produces proof of receipt (registered or certified mail or courier). After the arbitration has been commenced, notices and correspondence should, where possible, be given by instantaneous (fax or e-mail) or other expedited manner of communication. Time Periods 3.3 When calculating any time period under these Procedures, the period shall start to run from the day immediately after that upon which notice is given. Time will then run continuously (including non-business days) - If a time period expires at the end of a non-business day in the country of the recipient the time period will be deemed extended until the end of the first following business day. 4. COMMENCEMENT OF ARBITRATION PROCEEDINGS 4.1 An arbitration should be initiated by a demand, in writing, that identifies the (1) Petitioner and the name of the contact person to whom all communications are to be addressed (including telephone, fax and e-mail information); (2) Respondent, as identified in the reinsurance contract, against whom arbitration is sought; (3) contract at issue; and (4) nature of the claims and/or issues. 4.2 The arbitration is commenced under these Procecures on the date the Respondent, or its designated representative, receives the Notice of Arbitration. 4.3 The Petitioner shall identify its Party-appointed arbitrator in accordance withP. 6.3. 5. RESPONSE BY RESPONDENT 5.1 Parties who receive a demand for arbitration shall respond to the demand, in writing, within 30 days, and such Response should contain the (1) identification of the entities on whose behalf the Response is sent and the name of the contact person to whom all communications are to be addressed (including telephone, fax and e-mail information); (2) designation of the Respondent's Party-appointed arbitrator, in accordance with P. 6.3; and (3) identification of any claims of the Respondent. 6. APPOINTMENT AND COMPOSITION OF TIIE PANEL 6.1 The Panel shall consist of three Disinterested arbitrators, one to be appointed by the Petitioner, one to be appointed by the Respondent and the third to be appointed by the two Party-appointed arbitrators. The third arbitrator shall serve as the umpire, who shall be neutral. 6.2 The arbitrators and umpire shall be persons who are current or former officers or executives of an insurer or reinsurer. Alternative 6.2: The arbitrators and umpire shall be persons who are current or former officers or executives of an insurer or reinsurer or other professionals with no less than ten years of experience in or serving the insurance or reinsurance industry.1 6.3 Within thirty (30) days following the commencement of arbitration proceedings, each Party shall provide the other Party with the identification of its Party-appointed arbitrator, his or her address (including telephone, fax and e-mail information), and provide a copy of the arbitrator's cirriculum vitae. 6.4 In the event that either Party fails to appoint an arbitrator within 30 days of commencement of the arbitration, the non-defaulting Party will appoint an arbitrator to at as the Party-appointed arbitrator for the defaulting Party. 6.5 The umpire shall be appointed by the two Party-appointed arbitrators as soon as practical (but no later than 30 days) after the appointment of the second arbitrator. 6.6 The Party-appointed arbitrators mav consult, in confidence, with the Party who appointed them concerning the appointment of the umpire. 6.7 (a) Where the two Party-appointed arbitrators have failed to reach agreement on an umpire within the time specified in P. 6.5 each Party shall exchange, within the time specified in P. 6.5, each Party shall exchange, within 7 days thereafter, eight names of individuals chosen from the list maintained by _______________for the purpose of umpire selection.2 (b) Within 7 days of the exchange of names as set forth inP. 6.2(a), the Party arbitrators shall send a joint request to the umpire candidates to complete an umpire questionnaire. Candidates will be requested to return such questionnaire to each Party arbitrator so that it is received within 20 days from the date the questionnaire is sent. If any individual fails to return a questionnaire within the required time period or refuses to serve, the process set forth in this article shall continue with the remaining names. In the event that one Party's candidate pool of 8 individuals is reduced due to the failure to return questionnaires or refusals to serve, the other Party shall, within 7 days, reduce its candidate pool to the same number of individuals. If, however, one Party's candidate pool falls below 3 individuals, that party shall, within the same 7 days, name additional individuals to replenish its candidate pool to 3 individuals from the list designated in subparagraph(a). Each additional candidate shall be asked by the Parties to complete an umpire questionnaire and return such questionnaire to each Party within 20 days from the date the questionnaire is sent during the same 7 day period that candidate pool is being replenished to 3 individuals, the other Party shall reduce its candidate pool to 3 individuals. Both Parties shall proceed in accordance with subparagraph (d) with 3 individuals each. Note to 6.7(b) - After the return of the questionnaire, if there are common individuals on the Parties' lists, the Parties are encouraged to reach agreement among those individuals without having to proceed to the ranking process. (c) Within 7 days after the process in subparagraph (b) is completed, each Party shall select three names from the other Party's list and notify the other Party of such selection. (d) Within 7 days after receiving the other Parties' selections as set forth in subparagraph (c), each Party shall rank each of the 6 selected umpire names in order of preference, with the number "1" being the most preferred and notify the other Party of such ranking. The individual with the lowest total numerical ranking shall act as umpire. If the ranking results in a tie, the Parties shall draw lots from among the individuals tied for the lowest total numerical rank. The individual chosen by lot shall act as umpire. (d) If either Party fails to meet the time periods required in this P. 6.7, the non-defaulting Party will appoint the umpire from its original candidate pool identified in subparagraph (a). Note to 6.7 - Unilateral contact between a Party-appointed arbitrator and an individual considered for appointment as a default umpire under this paragraph should not be permitted. It is intended that the individuals named not be advised of which Party initiated their selection. 6.8 If after appointment any Party-appointed arbitrator is unable or unwilling to serve, the party who originally appointed the arbitrator shall appoint a replacement within 14 days of the party's receipt of notification of the arbitrator's unavailability. If the Party fails to do so, the non-defaulting Party will appoint replacement within 14 days. 6.9 If after appointment an -umpire is unable or unwilling to serve, a replacement umpire shall be chosen by the two Party-appointed arbitrators as soon as practical (but no later than 14 days) after notification of the umpire's inability or unwillingness to serve. Where the two Party-appointed arbitrators are unable to reach agreement, the Parties shall appoint a replacement umpire in accordance with the procedure set forth in P. 16.7. 6.10 Unless otherwise awarded by the Panel pursuant to each Party shall bear the costs of its Party-appointed arbitrator and shall share equally the cost of the umpire. 7. CONFIDENTIALITY 7.1 All meetings and hearings of the Panel are private and confidential to the Parties. Only the Panel, the Parties, the duly authorized representatives of the Parties and others participating in the proceedings may be admitted to meetings and hearings. 7.2 The Panel and the Parties shall use their best efforts to maintain the confidential nature of the arbitration proceedings and the Award, including the hearing and any written explanation of the Award, except (a) as necessary in connection with a judicial proceeding, relating to the arbitration or the Award; (b) as other wise required by law, regulation independent accounting audit or judicial decision; (c) to support reinsurance or retrocessioal recoveries; or (d) as otherwise agreed by the Parties. The Parties shall use their best efforts to maintain this confidentiality when pursuing any of the exceptions set forth in this paragraph, including the filing of pleadings under seal when permitted. 8. INTERIM RELIEF 8.1 A Panel may issue orders for interim relief, including pre- award security. 9. LOCATION OF PROCEEDINGS 9.1 The location of all proceedings shall be at a place specified in the Arbitration Agreement or as otherwise agreed to by the Parties. In the absence of agreement, the location shall be in a convenient location as determined by the Panel. 10. PRE-HEAR.CVGPROCEDURE Organizational Meeting 10.1 The Panel shall conduct an organizational meeting with the Parties and any authorized representatives for the purposes of clarifying the focus of the arbitration hearing resolving any outstanding issues relating to the send of the hearing and establishing a schedule for the conduct of the proceedings in general. The organizational meeting may be conducted by telephone if agreed to by the Parties or, in the absence o agreement, if determined appropriate by the Panel. 10.2 At the organizational meeting, all member of the Panel shall reveal on the record their past; present and any known future business and personal relationships with the Parties, the Parties' counsel with other Panel members, and with potential in witnesses if identified ' documents provided the Panel members. Once disclosures have been made by all Panel members, Parties may be asked by the Panel to accept the Panel as duly constituted. 10.3 At the organizational meeting, each Party-appointed arbitrator shall disclose whether communications with the appointing Party or its counsel have-taken place. In complying with this disclosure requirement, it is sufficient that the Party-appointed arbitrator disclose the fact that such communication has occurred without disclosing the content of the communication except that Party-appointed arbitrators shall identify any documents that they have examined relating to the proceedings. Such documents shall be furnished to the remainder of the Panel and the other Party. 10.4 The Panel may require that each Party submit concise written statements of position, including summaries of the facts and evidence a Party intends to present, discussion of the applicable law and the basis for the requested award or denial of relief sought. The statements, which may be in letter form, shall be provided to the other Party and the Panel at least 7days prior to the organizational meeting. 10.5 A formal record or transcript of the organizational meeting shall be kept, unless waived by the Parties. The cost of the record or transcript shall be shared equally by the Parties. The Panel shall place on the record the disclosures required by P. 10-2. 10.6 The Panel may allow the Parties to present a brief overview of the matters set-forth in P. 10.4, whether or not written Submissions were requested or received by the Panel. 10.7 The Panel shall address the following: (a) Establish a date for the cut-off of all ex parte communications between the Parties and their Party-appointed arbitrators; (b) Outstanding issues, if any, concerning fees or payment schedules of the arbitrators and/or the umpire; (c) "Hold Harmless" or indemnification agreement from the Parties flowing to the Panel; (d) Confidentiality agreements to ensure the confidentiality provided in article 7; (e) The extent to which depositions and other discovery will be allowed and the date by which they must be completed; (f) The briefing schedule, including the dates briefs are due, whether briefs are to be sequential or simultaneous and whether the briefs have a specified page limit; (g) The date by which fact and expert witnesses must be disclosed, documents exchanged and briefs submitted; (h) whether the Parties prefer a written rationale for the Panel's decision; and (i) Requests, if any, for interim relief as set forth in P. 8.1. 11. DISCOVERY 11.1 The Parties shall cooperate in good faith in the voluntary, prompt and informal exchange of all not-privileged documents and other information relevant to the dispute. 11.2 In addition to the voluntary exchange contemplated by P. 11.1, the Panel shall have the power to order, subject to applicable privileges, the disclosure of such documents or class of documents relevant to the dispute as it considers necessary for the proper resolution of the dispute and to determine the date by which the documents must be disclosed. 11.3 The Panel shall have the power to authorize the Parties to conduct such depositions as are reasonably necessary. 11.4 The Panel may require each Party to provide a list of witnesses whom they intend to call at the hearing. 11.5 The Panel may Emit document production, expert testimony and witnesses of fact on grounds of number, duplication or relevance. 12. MEDIATION OR SETTLEMENT 12.1 The Parties may agree, at any stage of the arbitration. proceedings, to submit to mediation. 12.2 If the Panel determines that settlement may be appropriate under the circumstances, the Panel may request that the Parties consider settlement through mediation or otherwise, provided such efforts do not delay the arbitration proceedings. 13. SUMMARY DISPOSITION AND EX PARTE HEARING 13.1 The Panel may lieu and determine a motion for summary disposition of a particular claim or issue, either by agreement of all Parties or at the request of one Party, provided the other interested Party has reasonable notice and opportunity to respond to such request. Note to 13.1: By authorizing the Panel to grant summary disposition, the Parties using these Procedures do not intend to waive their rights under the Federal Arbitration Act to contest the appropriateness of such an action where such rights have been reserved. 13-2 If a Party has failed to participate in the pre-hearing proceedings and the Panel reasonably believes that the Party will not participate in the hearing, the Panel may proceed with the hearing on an ex parts basis or may dispose of some or all issues pursuant to P. 13. 1. The non-participating Party shall be provided with notice thirty (30) days prior to the hearing or disposition pursuant to P. 13.1. 14. ARBITRATION HEARING 14.1 Unless the Parties otherwise agree, there should be as stenographic record kept of the proceedings. 14.2 The Panel may decide whether and to what extent there should be oral or written evidence or submissions. 14.3 The Panel shall interpret the underlying agreement, which is the subject of the arbitration, as an honorable engagement and shall not be obligated to follow the strict rules of law or evidence. In making their Award, the Panel shall apply the custom and practice of the insurance and reinsurance industry, with a view to effecting the general purpose of the underlying agreement which is the subject of the arbitration. . 14.4 Subject to the control of the Panel, the Parties may question any witnesses who appear at the hearing. Panel members may also question such witnesses. 14.5 A Party may request that the other Party produce at the hearing a witnesses in their employer under their control without need of a subpoena. The Panel may issue subpoenas for the attendance of witnesses or the production of documents. A Party or the subpoenaed person may file an objection with the Panel who shall promptly rule on the objection weighing both the burden on the producing Party and the need of the proponent for the witness or other evidence. 14.6 The Panel shall require that witnesses testify under oath, unless waived by all parties. The Panel shall have the discretion to permit testimony by telephone, affidavit or recorded by transcript, videotape, or other means, and may rely upon such evidence as it deems appropriate. Where there has been no opportunity for cross-examination by the other Party, such evidence may be permitted by the Panel only for good cause shown. The Panel may limit testimony to exclude evidence that would be immaterial or unduly repetitive, provided that all Parties are afforded the opportunity to present material and relevant evidence. 14.7 When the Panel determines that all relevant and material evidence and arguments have been presented, the Panel shall declare the evidentiary portion of the hearing closed. 14.8 At the conclusion of the evidentiary portion of the hearing, the Parties shall submit a proposed form of order to the Panel and to the other Party that precisely identifies the nature of the relief that the Parties seek from the Panel. 14.9 The Panel shall close the hearing following closing arguments and/or post hearing briefs, if any. 15. AWARD 15.1 Absent good cause for an extension as determined by the Panel, the Panel shall render the Award within thirty (30) days after the date of the closing of the hearing or, if an arbitration hearing has been waived or otherwise dispensed with, within thirty (30) days after the date that the Panel received all materials submitted by the Parties for disposition. 15.2 The decision and award of a majority of the Panel shall be final and binding on the Parties. 15.3 The Panel is authorized to award any remedy permitted by the Arbitration Agreement or subsequent written agreement of the Parties In the absence of explicit written agreement to the contrary, the panel is also authorized to award any remedy or sanctions allowed by applicable law, including, but not limited to: monetary damages; equitable relief, pre-or post-award interest costs of arbitration; attorneys fee; and other final or interim relief. 15.4 The Award shall consist of a written statement signed by a majority of the Panel setting forth the disposition of the claims and the relief, if any, awarded. If both parties request a written rationale for the Panel's Award, the Panel shall provide one. If either Party objects to a written rationale, the Panel shall not issue one. 15.5 The prohibition on ex-parte communications shall remain in effect until the earlier of the Parties waiving their right to challenge the Award, the expiration of the time period during which a challenge could be filed without any such challenge being filed, or the conclusion of any challenge to the Award. 15.5 The prohibition on ex-parte communications shall remain in effect until the earlier of the Parties waiving their right to challenge the Award, the expiration of the time period during which a challenge could be filed without any such challenge being filed, or the conclusion of any challenge to the Award. 16.1 ALTERNATIVE STREAMLINED PROCEDURES 16.1 The purpose of the streamlined Procedures in this article is to provide a fair, fast and efficient alternative process for resolving disputes in which the Parties agree that streamlined Procedures are appropriate. Parties are encouraged to discuss the use of these Procedures prior to communicating a demand for arbitration. By agreement, the Parties may want to expand these Procedures to accommodate the unique needs of their particular dispute. Note to 16.1 - It is contemplated that the needs of a particular arbitration may require a one-day hearing, the voluntary exchange of documents agreed to by the Parties, or the testimony of witnesses. This article is designed to be the basic streamlined process which can form the structure for the Parties to add to as they deem appropriate to the particular dispute. The Parties are encouraged to discuss these added features and reach agreement prior to invoking the use of this article. 16.2 A request for arbitration utilizing these streamlined Procedures may be made by the Petitioner in its written demand for arbitration pursuant to P. 4.1. When a request for streamlined arbitration is made by the Petitioner, the Respondent must agree, in writing, no later than 7 days from the date of receiving such request. Failure of the Respondent to reply within 7 days shall be deemed to be a rejection of the request, and the arbitration will proceed in accordance with the provisions of articles 1 through 15 of these Procedures. 16.3 Upon receipt of a demand for arbitration, the Respondent may request the use of streamlined Procedures, in writing, no later than 7 days after receipt of the arbitration demand from the Petitioner. The Petitioner must agree, in writing, no later than 7 days from the date that the Petitioner receives such request. failure of the Petitioner to respond within 7 days shall be deemed a rejection of the request, and the arbitration will proceed in accordance with the provisions of articles 1 through 15 of these Procedures. 16.4 The Panel shall consist of one Disinterested, neutral arbitrator, selected by agreement of the Parties. If the Parties cannot agree on an appointment within 30 days of the agreement to proceed by these streamlined Procedures, the Parties shall default to the use of articles I through 1 5 of these Procedures A in lieu of proceeding pursuant to this article. 16.5 Ex-parte communication with the neutral arbitrator is prohibited. 16.6 Within 21 days from the date the neutral arbitrator is agreed upon, the Parties and the neutral arbitrator will conduct an or, organizational meeting by telephone conference call to familiarize the neutral arbitrator with the issues in dispute and to agree on a schedule for submission of briefs. 16.7 There shall be no discovery, unless the Parties agree otherwise. 16.8 The dispute shall be submitted to the neutral arbitrator on briefs and documentary evidence only, unless the Parties agree otherwise. 16.9 The neutral arbitrator shall render its decision in accordance with the provisions of article 15 of these Procedures. 17. SEVERABILITY 17.1 If any provision of these Procedures, or amendments thereto, is held invalid, such invalidity shall not affect other provisions or applications of these Procedures which can be given effect without the invalid application or provision, and to this end each provision of these Procedures, and any amendments thereto, is severable. Members of the Reinsurance Dispute Resolution Task Force Linda Martin Barber Navigant Consulting, Inc. Paul A. Bellone Commercial Risk Re-Insurance Company Peter T. Beresford CNA Derrick W. K. Brown KWELM Management Services, Ltd. Earl Davis San Francisco Re/Fireman's Fund Richard DeCoux PMA Reinsurance Corporation Dale Diamond AXA Reinsurance Company Caleb L Fowler Former President of CIGNA Property/Casualty Mark S. Gurevitz The Hartford Debra J. Hall Reinsurance Association of America Robert M. Hall RMH Consulting Members of the Reinsurance Dispute Resolution Task force (cont-d) Ronald A. Jacks Syhia Kamisky Michael Kelly Equitas Eric Kobrick American International Group, Inc. Kathleen Krimmel ACE USA Pierre G. Laurin Zurich-U.S. Michael Lovendusky American Insurance Association Andrew Maneval Honzon Management Group, LLC Christian M. Milton American lnternational Group, Inc. Thomas S. Orr General Reinsurance Corporation Pamela K. Parkos Brokers & Reinsurance Markets Association James J. Powers Members of the Reinsurance Dispute Resolution Task Force (cont'd) Kevin J. Shea Signet Star Reinsurance Company Gregory A. Speed American Re-Insurance Company James Sporleder Allstate Insurance Company Members of the Reinsurance Dispute Resolution Task Force (cont'd) Kevin J. Shea Signet Star Reinsurance Company Gregory A. Speed American Re-Insurance Company James Sporleder Allstate Insurance Company EX-10 11 0011.txt Exhibit 10.14 WORKERS' COMPENSATION EXCESS OF LOSS REINSURANCE AGREEMENT This Agreement is made and entered into by and between CALIFORNIA INDEMNITY INSURANCE COMPANY, Pleasanton, California, COMMERCIAL CASUALTY INSURANCE COMPANY, Pleasanton, California, CII INSURANCE COMPANY, Pleasanton, California, SIERRA INSURANCE COMPANY OF TEXAS, Dallas, Texas, and all of their existing and future subsidiary companies (hereinafter together called the "Company") and the Reinsurer specifically identified on the signature page of this Agreement (hereinafter called the "Reinsurer"). ARTICLE 1 BUSINESS REINSURED This Agreement is to indemnify the Company in respect of the net excess liability as a result of any loss or losses which may occur during the term of the Agreement under any Policies classified by the Company as statutory Workers' Compensation, including Employers' Liability and United States Longshore and Harbor Workers' Compensation Act, written or renewed by the Company, subject to the terms and conditions herein contained. ARTICLE 2 COVER The Reinsurer will be liable in respect of each and every Loss Occurrence, irrespective of the number and kinds of Policies involved, for the Ultimate Net Loss over and above an initial Ultimate Net Loss of $250,000 each and every Loss Occurrence, subject to a limit of liability to the Reinsurer of $250,000 each and every Loss Occurrence. ARTICLE 3 commencement and TERMination This Agreement shall become effective at 12:01 a.m., Local Standard Time, July 1, 2000, and shall remain in full force and effect until terminated as provided in the following paragraph. Either the Company or the Reinsurer shall have the right to terminate this Agreement as of 12:01 a.m., Local Standard Time, any July 1, by giving 90 days' prior notice in writing via either Certified or Registered Mail, return receipt requested. Upon termination of this Agreement, the entire liability of the Reinsurer for losses occurring subsequent to termination of this Agreement shall cease concurrently with the termination date of this Agreement. However, the Company will have the option of requiring the Reinsurer to continue to cover all Policies which are in force at the date of termination of this Agreement until the natural expiration or anniversary of such Policies, whichever occurs first, but in no event longer than 12 months plus odd time, not to exceed 18 months in all from the date of termination of this Agreement. The premium applicable to the run-off period, if any, shall be mutually agreed by the parties at the time of termination. Should this Agreement terminate or should an anniversary date occur while a loss covered hereunder is in progress, the Reinsurer shall be responsible for the loss in progress in the same manner and to the same extent it would have been responsible had the Agreement terminated or anniversary occurred the day following the conclusion of the loss in progress. Should a Loss Occurrence involve more than one insured or policy and more than one reinsurance Agreement period, the Reinsurer's limit and the Company's retention as respects the claim or claims covered under this Agreement shall be the percentage of the limit and retention of this Agreement that the amount of the covered claim or claims bears to the total of all claims in the Loss Occurrence. ARTICLE 4 TERRITORY This Agreement applies to losses arising out of Policies written in the United States of America, its territories and possessions, wherever occurring. ARTICLE 5 EXCLUSIONS This Agreement does not cover: 1. Assumed reinsurance, unless assumed (a) from intercompany pooling arrangements or (b) from a fronting company if the Company manages the underwriting and claims of such fronting company. 2. Nuclear risks as defined in the "Nuclear Incident Exclusion Clause - Liability - Reinsurance" attached to and forming part of this Agreement. 3. Financial Guarantee and Insolvency business when written as such. 4. Any liability derived from any Pool, association or similar facility, directly as a member or indirectly by way of assessment, reinsurance or similar mechanisms. 5. Liability of the Company arising by contract, operation of law, or otherwise, from its participation or membership, whether voluntary or involuntary, in any insolvency fund. "Insolvency Fund" includes any guarantee fund, insolvency fund, plan, pool, association, fund or other arrangement, howsoever denominated, established or governed, which provides for any assessment of or payment or assumption by the Fund of part or all of any claim, debt, charge, fee, or other obligation of any insurer, or its successors or assigns, which has been declared by any competent authority to be insolvent, or which is otherwise deemed unable to meet any claim, debt, charge, fee or other obligation in whole or in part. 6. All claims arising from employment relating to the following industries: a. Operations where the governing classifications are Railroad class codes. b. Underground mining. c. Oil and Gas drilling, refining, production or manufacturing. d. Tunneling Operations involving tunnels over 100 feet in length (auguring shall not be considered tunneling). e. The manufacturing, storage or transportation of fireworks, ammunition, nitroglycerin or other explosive substances or devices. f. Professional sports teams. g. Asbestos Abatement when written as such. 7. The following classes of employment except where the exposures are incidental to an original insured's overall Workers' Compensation exposure as measured by payroll. Incidental is defined for the purposes of this Agreement as less than 10% of the insured's overall Workers' Compensation payroll (excluding clerical): a. Construction and maintenance of coffer dams. b. Tower, steeple and chimney shaft work, but this exclusion does not include church work. 8. Policies attaching excess of a self-insured retention or a deductible of $50,000 or more. 9. Aggregate Policies. 10. Business underwritten on behalf of the Company by Managing General Underwriters or Managing General Agencies (MGU's or MGA's). ARTICLE 6 PREMIUM A. The Company will pay the Reinsurer a deposit premium of $2,100,000 for each Agreement Year that this Agreement remains in force, to be paid in the amount of $315,000 (15%) on July 1, 2000, $420,000 (20%) on October 1, 2000, $630,000 (30%) on January 1, 2001, and $735,000 (35%) on April 1, 2001. B. Within 60 days following the end of each Agreement Year, the Company will calculate a premium at a rate of 1.87% multiplied by the Company's Gross Net Earned Premium Income. Should the premium so calculated exceed the deposit premium paid in accordance with Paragraph A. above, the Company will immediately pay the Reinsurer the difference. Should the premium so calculated be less than the deposit premium, the Reinsurer will immediately pay the Company the difference subject to a minimum premium of $1,400,000 each Agreement Year. Any additional premium due the Reinsurer shall be remitted with the Company's report and any return premium due the Company shall be remitted by the Reinsurer within 30 days after receipt and verification of the Company's report. C. Within 60 days after the end of each Agreement Year, a report of the Company's Gross Net Earned Premium Income shall be provided to the Reinsurer in a spreadsheet file listing each Policy incepting during the Agreement Year along with the respective Policy term, written premium and calculation of the earned premium during the Agreement Year for each Policy, regardless of when the respective Policy was booked by the Company. ARTICLE 7 REPORTS Within 60 days following the end of each Agreement Year, the Company will furnish the Reinsurer with: A. Gross Net Earned Premium Income of the Company for the Agreement Year. B. Any other information which the Reinsurer may require to prepare its Annual Statement which is reasonably available to the Company. ARTICLE 8 DEFINITIONS A. The term "Policy" as used in this Agreement shall mean any binder, policy, or contract of insurance or reinsurance issued, accepted or held covered provisionally or otherwise, by or on behalf of the Company. B. The term "Ultimate Net Loss" as used in this Agreement shall mean the actual loss paid by the Company, or for which the Company becomes liable to pay; such loss to include expenses of investigation, litigation and interest (including interest accrued prior to judgment where such interest is added to the judgment and interest accrued subsequent to judgment), statutory penalties, claim-specific declaratory judgment expenses, 90% of any Extra Contractual Obligation amount as defined in the EXTRA CONTRACTUAL OBLIGATIONS ARTICLE, 90% of any Excess Of Policy Limits amount as defined in the EXCESS OF POLICY LIMITS ARTICLE, and all other Defense and Cost Containment Expenses of the Company incurred in connection with the loss, including subrogation, salvage, and recovery expenses. As respects Policies containing a deductible or self-insured retention of less than $50,000, and where standard premium is included within the Company's Gross Net Earned Premium Income, it is understood and agreed that the Company's Ultimate Net Loss will include the amount of the deductible or self-insured retention. All salvages, recoveries or payments recovered or received subsequent to loss settlement hereunder shall be applied as if recovered or received prior to the aforesaid settlement, and all necessary adjustments shall be made by the parties hereto. For purposes of this definition, the phrase "becomes liable to pay" shall mean the existence of a judgment which the Company does not intend to appeal, or a release has been obtained by the Company, or the Company has accepted a proof of loss. The phrase "claim-specific declaratory judgment expenses," as used in this Agreement will mean all expenses incurred by the Company in connection with declaratory judgment actions brought to determine the Company's defense and/or indemnification obligations that are allocable to specific Policies and claims subject to this Agreement. Declaratory judgment expenses will be deemed to have been incurred by the Company on the date of the original loss (if any) giving rise to the declaratory judgment action. "Defense and Cost Containment Expenses" as used in this Agreement shall have the meaning given to such terms by the Annual Statement Instructions. "Annual Statement Instructions" as used in this Agreement shall mean the Annual Statement Instructions for Property Casualty Insurance Companies in effect for the Year 1999 published by the National Association of Insurance Commissioners and related guidance given by that organization. Nothing in this clause shall be construed to mean that losses are not recoverable hereunder until the Company's Ultimate Net Loss has been ascertained. C. The term "Loss Occurrence" as used in this Agreement shall mean any one disaster or casualty or accident or loss or series of disasters or casualties or accidents or losses arising out of or caused by one event except that: As respects an occupational disease or cumulative trauma suffered by an employee for which the employer is liable, such occupational disease or cumulative trauma shall be deemed a separate Loss Occurrence within the meaning hereof for each employee affected. A loss as respects each employee affected by an occupational disease or cumulative trauma shall be deemed to have been sustained by the Company at the date when compensable disability of the employee commenced, or if there is no such disability, when the medical treatment commenced, but in no event later than the last day of employment during the term of the policy or policies of the Company. The term "occupational disease" is defined as an abnormal condition that fulfills all of the following conditions: 1. It is not traceable to a definite compensable accident occurring during the employee's present or past employment, 2. It has been caused by continued and prolonged exposure to a disease producing agent or agents present in employee's occupational environment, 3. It has resulted in disability or death. The term "cumulative trauma" is defined as an injury that fulfills all of the following conditions: 1. It is not traceable to a definite compensable accident occurring during the employee's present or past employment, 2. It has occurred from, and has been aggravated by, a repetitive employment related practice, 3. It has resulted in disability or death. D. The term Managing General Underwriter as used in this Agreement shall mean any person, firm, association, or corporation (not a part of the Company reinsured hereunder) that either separately or together with affiliates, directly underwrites business on behalf of the Company. The term underwrite as used in this definition shall mean the final power and authority to accept or reject risk on behalf of the Company without any veto or other right of rejection in the Company. Underwrite does not mean only the power to bind. E. The term Managing General Agent as used in this Agreement shall mean any person, firm, association, or corporation (not a part of the Company reinsured hereunder) that either separately or together with affiliates, directly produces and underwrites business on behalf of the Company and which adjusts and pays claims on behalf of the Company. The term underwrite as used in this definition shall mean the final power and authority to accept or reject risk on behalf of the Company without any veto or other right of rejection in the Company. Underwrite does not mean only the power to bind. F. The term "Gross Net Earned Premium Income (GNEPI)" as used in this Agreement shall mean gross earned premium income on business subject to this Agreement after (i) the application of experience modifications, schedule or other rating plans, premium discounts, expense constants, loss constants and the application of discounts granted for deductible or self-insured retention plans less than $10,000 and (ii) adjustment by retrospective rating plan calculations and dividend rating plan payments. Retrospective rating plan adjustments and dividend rating plan payments shall be pro rated based on the earned premium of each individual Policy during the term of this Agreement. The Gross Net Earned Premium Income will also include the undiscounted premium associated with the large deductible and self-insured retention Policies, i.e. those deductibles or self-insured retentions greater than or equal to $10,000, but less than $50,000. G. The term "Agreement Year" as used in this Agreement shall mean the 12 consecutive months commencing with each July 1. ARTICLE 9 Net Retained Lines This Agreement applies only to that portion of any insurances or reinsurances covered by this Agreement which the Company retains net for its own account. In calculating the amount of any loss hereunder and also in computing the amount in excess of which this Agreement attaches, only loss or losses in respect of that portion of any insurances or reinsurances which the Company retains net for its own account shall be included. The Reinsurer's liability hereunder in respect of any loss or losses shall not be increased by reason of the inability of the Company to collect from any other reinsurers, whether specific or general, any amounts which may have become due from them whether such inability arises from the insolvency of such other reinsurers or otherwise. However, the Company may carry underlying quota share or excess of loss reinsurance and recoveries made thereon shall be disregarded for all purposes of this Agreement and shall inure to the sole benefit of the Company and shall not be used in calculating what portion the Company retains net for its own account. ARTICLE 10 Currency The currency to be used for all purposes of this Agreement shall be United States of America currency. ARTICLE 11 Loss Funding A. This clause is only applicable to those Reinsurers who cannot qualify for credit by the State having jurisdiction over the Company's loss reserves or has such credit disallowed by the Director or Commissioner of Insurance of such State. As regards policies or bonds issued by the Company coming within the scope of this Agreement, the Company agrees that when it shall file with the insurance department or set up on its books reserves for losses covered hereunder which it shall be required to set up by law it will forward to the Reinsurer a statement showing the proportion of such loss reserves which is applicable to them. The Reinsurer hereby agrees that it will apply for and secure delivery to the Company a clean irrevocable and unconditional Letter of Credit issued by a bank chosen by the Reinsurer and acceptable to the appropriate insurance authorities, in an amount equal to the Reinsurer's proportion of the loss reserves in respect of known outstanding losses that have been reported to the Reinsurer, loss expenses relating thereto and Incurred But Not Reported loss and loss expense as shown in the statement prepared by the Company. The Letter of Credit shall be "Evergreen" and shall be issued for a period of not less than one year, and shall be automatically extended to one year from its date of expiration or any future expiration date unless thirty (30) days prior to any expiration date, the bank shall notify the Company by certified or registered mail that it elects not to consider the Letter of Credit extended for any additional period. The bank chosen for the issuance of the Letter of Credit shall have no responsibility whatsoever in connection with the propriety of withdrawals made by the Company or the disposition of funds withdrawn, except to ensure that withdrawals are made only upon the order of properly authorized representatives of the Company. At annual Intervals, or more frequently as agreed but never more frequently than semiannually, the Company shall prepare a specific statement, for the sole purpose of amending the Letter of Credit, of the Reinsurer's share of known and reported outstanding losses and Allocated Loss Expenses relating thereto. If the statement shows that the Reinsurer's share of such losses and Allocated Loss Expenses, and Incurred But Not Reported loss and loss expense, exceeds the balance of credit as of the statement date, the Reinsurer shall, within thirty (30) days after receipt of notice of such excess, secure delivery to the Company of an amendment of the Letter of Credit increasing the amount of credit by the amount of such difference. If, however, the statement shows that the Reinsurer's share of known and reported outstanding losses plus Allocated Loss Expenses, and Incurred But Not Reported loss and loss expense, relating thereto is less than the balance of credit as of the statement date, the Company shall, within thirty (30) days after receipt of written request form the Reinsurer, release such excess credit by agreeing to secure an amendment to the Letter of Credit. B. In addition to the requirements set forth above, if the Reinsurer ceases to be admitted for workers compensation insurance in any state at any time in which there are obligations ceded by the Company under this Agreement or the Director or Commissioner of Insurance of any state denies credit for reinsurance liabilities ceded under this Agreement, and such event requires the Company to increase any deposit that it must make in such state or to such state authorities accordance with the laws of such state, on account of its direct workers' compensation premium written in the state, Reinsurer shall forthwith remit to Company the amount of such increase, which funds Company will hold as funds withheld under this Agreement. In lieu of such remittance but only to the extent permitted by and in accordance with the law of such state, Reinsurer, may underwrite as surety (if admitted to write surety insurance in such state) or procure from an admitted surety a surety bond naming the Company, as principal, and such authorities as beneficiary in the form such authorities may require. If the Reinsurer remits funds under this portion of this Article such funds will be credited to its obligation to post letters of credit, if it is otherwise so required. ARTICLE 12 Taxes The Company will be liable for taxes (except Federal Excise Tax) on premiums reported to the Reinsurer hereunder. Federal Excise Tax applies only to those Reinsurers, excepting Underwriters at Lloyd's, London and other Reinsurers exempt from the Federal Excise Tax, who are domiciled outside the United States of America. The Reinsurer has agreed to allow for the purpose of paying the Federal Excise Tax 1% of the premium payable hereon to the extent such premium is subject to Federal Excise Tax. In the event of any return of premium becoming due hereunder, the Reinsurer will deduct 1% from the amount of the return, and the Company or its agent should take steps to recover the Tax from the U.S. Government. ARTICLE 13 Notice of Loss and Loss Settlements The Company will promptly advise the Reinsurer, via a quarterly bordereau, of all claims which in the opinion of the Company may involve the Reinsurer, and of all subsequent developments on these claims which may materially affect the position of the Reinsurer. The quarterly bordereau shall include any claim where the incurred is 50% or more of the Company's retention; and, irrespective of the incurred or of any question on liability or coverage, any claim involving: A. Fatalities. B. Spinal cord injury - paraplegia, quadriplegia. C. Amputation - requiring prostheses. D. Brain injuries resulting in impairment of physical functions. E. Second or Third Degree burns involving 40% or more of the body. F. Injuries resulting in partial or total paralysis of upper or lower extremities. G. Loss of sight in one or both eyes. In addition, the Company will provide an individual notice of loss to the Reinsurer when the incurred value of any claim exceeds the retention under this Agreement. Any loss settlement made by the Company, provided it is within the terms and conditions of this Agreement, whether under strict Policy conditions or by way of compromise, shall be unconditionally binding upon the Reinsurer, however, ex-gratia payments made by the Company are excluded hereunder. When so requested the Company will afford the Reinsurer an opportunity to be associated with the Company, at the expense of the Reinsurer, in the defense of any claim or suit or proceeding involving this reinsurance and the Company will cooperate in every respect in the defense of such claim, suit or proceeding. The Reinsurer will pay its share of loss settlements no later than 14 calendar days after receipt of proof of loss from the Company. ARTICLE 14 Extra Contractual Obligations This Agreement shall protect the Company, subject to the Reinsurer's limit of liability appearing in the COVER ARTICLE of this Agreement, where the loss includes any Extra Contractual Obligations as provided for in the definition of Ultimate Net Loss. "Extra Contractual Obligations" are defined as those liabilities not covered under any other provision of this Agreement and which arise from handling of any claim on business covered hereunder, such liabilities arising because of, but not limited to, the following: failure by the Company to settle within the Policy limit, or by reason of alleged or actual negligence, fraud or bad faith in rejecting an offer of settlement or in the preparation of the defense or in the trial of any action against its insured or in the preparation or prosecution of an appeal consequent upon such action. The date on which any Extra Contractual Obligation is incurred by the Company shall be deemed, in all circumstances, to be the date of the original Loss Occurrence. However, this Article shall not apply where the loss has been incurred due to the fraud of a member of the Board of Directors or a corporate officer of the Company acting individually or collectively or in collusion with any individual or corporation or any other organization or party involved in the presentation, defense or settlement of any claim covered hereunder. ARTICLE 15 Excess of Policy Limits In the event the Ultimate Net Loss includes an amount in excess of the Company's Policy limit, such amount, as provided for in the definition of Ultimate Net Loss, in excess of the Company's Policy limit shall be added to the amount of the Company's Policy limit, and the sum thereof shall be covered hereunder, subject to the Reinsurer's limit of liability appearing in the COVER ARTICLE of this Agreement. However, this Article shall not apply where the loss has been incurred due to the fraud of a member of the Board of Directors or a corporate officer of the Company acting individually or collectively or in collusion with any individual or corporation or any other organization or party involved in the presentation, defense or settlement of any claim covered hereunder. For the purpose of this Article, the word "loss" shall mean any amounts for which the Company would have been contractually liable to pay had it not been for the limit of the original Policy. ARTICLE 16 Delay, Omission or Error Any inadvertent delay, omission or error shall not be held to relieve either party hereto from any liability which would attach to it hereunder if such delay, omission or error had not been made, providing such delay, omission or error is rectified upon discovery. ARTICLE 17 Inspection The Company shall place at the disposal of the Reinsurer at all reasonable times, and the Reinsurer shall have the right to inspect, through its authorized representatives, all books, records and papers of the Company in connection with any reinsurance hereunder, or claims in connection herewith. However, no claim payment due from the Reinsurer shall be withheld or delayed pending the Reinsurer's exercise of its rights under this Article or any other right to audit the Company's books and records. ARTICLE 18 Arbitration Any dispute arising out of or related in any way to this Agreement, wherever occurring, including it's formation and validity shall be submitted to arbitration by a panel of three arbitrators sitting in Las Vegas, Nevada or such other place as the parties may mutually agree in writing. The Arbitration shall be conducted under the Procedures for the Resolution of U. S. Insurance and Reinsurance Disputes as attached (the "Procedures"). The parties hereby select the following related to the procedures. (1) Alternative Section 6.2 is selected (2) the list maintained under Section 6.7(a) for the selection of the umpire will be that of the American Arbitration Association or if that organization does not maintain a list then by ARISA (U.S.). Should either of these organizations not maintain a list as required under Section 6.7(a) within 30 calendar days after the appointment of the second arbitrator, either party may initiate proceedings in the United States District Court for Nevada (Las Vegas Division) to obtain appointment of the umpire, of if the Federal Court declines to act, the State Court having jurisdiction over Las Vegas, Nevada. The parties may each submit a brief summary of the issues in dispute to the Court with the names of up to three candidates, together with resumes of their experience and qualification, from which the umpire shall be selected and who shall meet the requirements of this Agreement. In addition to the Procedures: (1) the parties agree that in so far as the Panel looks to the substantive law, it shall consider the law of the State of California exclusive of that state's rules with respect to conflicts of law. (2) within thirty (30) days after notice of appointment of all arbitrators, the Panel shall meet, and unless the Panel establishes, the parties and the Panel shall abide by the following deadlines: (a) ninety (90) days for the filing of the claimant's and respondent's brief and the claimant's reply, (b) sixty (60) days for the period of discovery. Addresses for Notice under Section 3 of the Procedures is: For: California Indemnity Insurance Company Commercial Casualty Insurance Company Sierra Insurance Company of Texas CII Insurance Company 2716 North Tenaya Way Las Vegas, Nevada 89128 Attention: General Counsel Telecopy: (702)869-2415 For: National Union Insurance Company 175 Water Street, 11th Floor New York, New York 10038 Attention: Mr. John Cavoores, President Telecopy: (212)458-1775 Matters related to the Arbitration and arbitrability and enforcement of this Agreement shall be subject to the Federal Arbitration Act (9 U. S. C. Section 1 and following). This Article shall survive the expiration or termination of this Agreement. ARTICLE 19 Service of Suit If the Reinsurer fails to pay any amount claimed to be due hereunder, the Reinsurer, at the request of the Company, will submit to the jurisdiction of a Court of competent jurisdiction within the United States of America and will comply with all requirements necessary to give such court jurisdiction. Service of process in such suit may be made upon the Commissioner of Insurance State of California. In any suit instituted against the Reinsurer under this Agreement, the Reinsurer will abide by the final decision of such court or of any Appellate Court in the event of an appeal. The person named above is authorized and directed to accept service of process on behalf of the Reinsurer in any such suit and, upon request of the Company, to give a written undertaking to the Company that a general appearance will be entered on behalf of the Reinsurer in the event such a suit shall be instituted. Further, pursuant to any statute of any state, territory or district of the United States of America which makes provision therefor, the Reinsurer hereby designates the Superintendent, Commissioner or Director of Insurance or other officer specified for that purpose in the statute, or his successor or successors in office, as its true and lawful attorney upon whom may be served any lawful process in any action, suit or proceeding instituted by or on behalf of the Company or any beneficiary arising out of this Agreement, and hereby designates the person named above as the party to whom the said officer is authorized to mail such process or a true copy thereof. This Article is not intended nor shall it imply nor have the effect that a dispute arising out of or related to this agreement, whenever occurring, shall not be submitted to arbitration pursuant to the ARBITRATION ARTICLE. It is intended to aid in the enforcement of the ARBITRATION ARTICLE and any award arising under it. ARTICLe 20 Insolvency A. In the event of the insolvency and the appointment of a conservator, liquidator or statutory successor of the Company, the portion of any risk or obligation assumed by the Reinsurer shall be payable to the conservator, liquidator or statutory successor on the basis of claims allowed against the insolvent Company by any court of competent jurisdiction or by any conservator, liquidator or statutory successor of the Company having authority to allow such claims, without diminution because of that insolvency or because the conservator, liquidator or statutory successor has failed to pay all or a portion of any claims. Payments by the Reinsurer as set forth in this paragraph shall be made directly to the Company or to its conservator, liquidator or statutory successor, except where this Contract specifically provides another payee of such reinsurance in the event of the insolvency of the Company. The conservator, liquidator or statutory successor of the Company shall give written notice of the pendency of a claim against the Company indicating the policy or bond reinsured, within a reasonable time after such claim is filed, and the Reinsurer may interpose, at its own expense, in the proceeding where such claim is to be adjudicated, any defense or own expense, in the proceeding where such claim is to be adjudicated, any defense or defenses which it may deem available to the Company or its conservator, liquidator or statutory successor. The expense thus incurred by the Reinsurer shall be payable, subject to the court approval, out of the estate of the insolvent Company as part of the expense of conservation or liquidation to the extent of a proportionate share of the benefit which may accrue to the Company in conservation or liquidation solely as a result of the defense undertaken by the Reinsurer. B. Where two or more reinsurers are involved in the same claim and a majority in interest elect to interpose defense to such claim, the expense shall be apportioned in accordance with the terms of this Contract as though such expense had been incurred by the Company. C. In the event of the insolvency of any company or companies included in the designation of "Company," this clause will apply only to the insolvent company or companies. ARTICLE 21 offset Each party hereto shall have, and may exercise at any time and from time to time, the right to offset any balance or balances, whether on account of premiums or on account of losses or otherwise, due from such party to the other under this Agreement provided, however, that in the event of the insolvency of a party hereto, offsets shall only be allowed in accordance with applicable statutes and regulations. ARTICLE 22 confidentiality Any materials provided in the course of inspections or information tendered pursuant to the Agreement shall be kept confidential by the Reinsurer as against third parties and its affiliates, unless the disclosure is required pursuant to process of law or unless the disclosure is to Reinsurer's retrocessionaires, financial auditors or governing regulatory bodies. Disclosing or using this information for any purpose beyond the scope of this Agreement, or beyond the exceptions set forth above, is expressly forbidden without the prior consent of the Company. ARTICLE 23 severability If any provision of this Agreement shall be rendered illegal or unenforceable by the laws, regulations or public policy of any state, such provision shall be considered void in such state, but this shall not affect the validity or enforceability of any other provisions of this Agreement or the enforceability of such provision in any other jurisdiction. ARTICLE 24 entire agreement This Agreement constitutes the entire Agreement between the parties with respect to the business being reinsured hereunder and the obligations of the parties are determined solely by the terms of the Agreement. Any changes or modification to the Agreement shall be made by written amendment to the Agreement and signed by both parties. ARTICLE 25 Intermediary Guy Carpenter & Company, Inc. is hereby recognized as the Intermediary negotiating this Agreement for all business hereunder. All communications, including notices, premiums, return premiums, commissions, taxes, losses, loss adjustment expenses, salvages and loss settlements relating thereto (except those related to the ARBITRATION ARTICLE) shall be transmitted to the Reinsurer or the Company through Guy Carpenter & Company, Inc., 1501 Fourth Avenue, Suite 1400, Seattle, Washington 98101. Payments by the Company to the Intermediary shall be deemed to constitute payment to the Reinsurer. Payments by the Reinsurer to the Intermediary shall be deemed only to constitute payment to the Company to the extent that such payments are actually received by the Company. ARTICLE 26 PARTICIPATION: WORKERS' COMPENSATION EXCESS OF LOSS - ------------- REINSURANCE AGREEMENT EFFECTIVE: July 1, 2000 This Agreement obligates the Reinsurer for 100.00% of the interests and liabilities set forth under this Agreement. The participation of the Reinsurer in the interests and liabilities of this Agreement shall be separate and apart from the participations of other reinsurers and shall not be joint with those of other reinsurers, and the Reinsurer shall in no event participate in the interests and liabilities of other reinsurers. IN WITNESS WHEREOF, the parties hereto, by their authorized representatives, have executed this Agreement as of the following dates: In New York, New York, this 11th day of January , 2001. NATIONAL UNION FIRE INSURANCE COMPANY OF PITTSBURGH, PENNSYLVANIA Pittsburgh, Pennsylvania By s/James P. Tamborrino (signature) James P. Tamborrino (name) Assistant Vice President (title) and in Las Vegas, Nevada, this 4th day of January , 2001. CALIFORNIA INDEMNITY INSURANCE COMPANY COMMERCIAL CASUALTY INSURANCE COMPANY CII INSURANCE COMPANY SIERRA INSURANCE COMPANY OF TEXAS and all of their existing and future subsidiary companies By s/Kathleen M. Marlon -------------------- (signature) Kathleen M. Marlon ------------------ (name) CEO and President ----------------- (title) WORKERS' COMPENSATION EXCESS OF LOSS REINSURANCE AGREEMENT issued to CALIFORNIA INDEMNITY INSURANCE COMPANY COMMERCIAL CASUALTY INSURANCE COMPANY CII INSURANCE COMPANY SIERRA INSURANCE COMPANY OF TEXAS NUCLEAR INCIDENT EXCLUSION CLAUSE - LIABILITY - REINSURANCE - U.S.A. (Wherever the word "Reassured" appears in this clause, it shall be deemed to read "Reassured," "Reinsured," "Company," or whatever other word is employed throughout the text of the reinsurance agreement to which this clause is attached to designate the company or companies reinsured.) (1) This reinsurance does not cover any loss or liability accruing to the Reassured as a member of, or subscriber to, any association of insurers or reinsurers formed for the purpose of covering nuclear energy risks or as a direct or indirect reinsurer of any such member, subscriber or association. (2) Without in any way restricting the operation of paragraph (1) of this Clause it is understood and agreed that for all purposes of this reinsurance all the original policies of the Reassured (new, renewal and replacement) of the classes specified in Clause II of this paragraph (2) from the time specified in Clause III in this paragraph (2) shall be deemed to include the following provision (specified as the Limited Exclusion Provision): Limited Exclusion Provision.* I. It is agreed that the policy does not apply under any liability coverage, to {injury, sickness, disease, death or with respect to which an destruction insured under the policy is bodily injury or property damage also an insured under a nuclear energy liability policy issued by Nuclear Energy Liability Insurance Association, Mutual Atomic Energy Liability Underwriters or Nuclear Insurance Association of Canada, or would be an insured under any such policy but for its termination upon exhaustion of its limit of liability. II. Family Automobile Policies (liability only), Special Automobile Policies (private passenger automobiles, liability only), Farmers Comprehensive Personal Liability Policies (liability only), Comprehensive Personal Liability Policies (liability only) or policies of a similar nature; and the liability portion of combination forms related to the four classes of policies stated above, such as the Comprehensive Dwelling Policy and the applicable types of Homeowners Policies. III. The inception dates and thereafter of all original policies as described in II above, whether new, renewal or replacement, being policies which either (a) become effective on or after 1st May, 1960, or (b) become effective before that date and contain the Limited Exclusion Provision set out above; provided this paragraph (2) shall not be applicable to Family Automobile Policies, Special Automobile Policies, or policies or combination policies of a similar nature, issued by the Reassured on New York risks, until 90 days following approval of the Limited Exclusion Provision by the Governmental Authority having jurisdiction thereof. (3) Except for those classes of policies specified in Clause II of paragraph (2) and without in any way restricting the operation of paragraph (1) of this Clause, it is understood and agreed that for all purposes of this reinsurance the original liability policies of the Reassured (new, renewal and replacement) affording the following coverages: Owners, Landlords and Tenants Liability, Contractual Liability, Elevator Liability, Owners or Contractors (including railroad) Protective Liability, Manufacturers and Contractors Liability, Product Liability, Professional and Malpractice Liability, Storekeepers Liability, Garage Liability, Automobile Liability (including Massachusetts Motor Vehicle or Garage Liability) shall be deemed to include, with respect to such coverages, from the time specified in Clause V of this paragraph (3), the following provision (specified as the Broad Exclusion Provision): Broad Exclusion Provision.* It is agreed that the policy does not apply: I. Under any Liability Coverage, to {injury, sickness, disease, death or destruction bodily injury or property damage (a) with respect to which an insured under the policy is also an insured under a nuclear energy liability policy issued by Nuclear Energy Liability Insurance Association, Mutual Atomic Energy Liability Underwriters or Nuclear Insurance Association of Canada, or would be an insured under any such policy but for its termination upon exhaustion of its limit of liability; or (b) resulting from the hazardous properties of nuclear material and with respect to which (1) any person or organization is required to maintain financial protection pursuant to the Atomic Energy Act of 1954, or any law amendatory thereof, or (2) the insured is, or had this policy not been issued would be, entitled to indemnity from the United States of America, or any agency thereof, under any agreement entered into by the United States of America, or any agency thereof, with any person or organization. II. Under any Medical Payments Coverage, or under any Supplementary Payments Provision relating to {Immediate medical or surgical relief to expenses incurred with first aid, respect to {Bodily injury, sickness, disease or resulting from the death hazardous properties of bodily injury nuclear material and arising out of the operation of a nuclear facility by any person or organization. III. Under any Liability Coverage, to {injury, sickness, disease, death or destruction bodily injury or property damage resulting from the hazardous properties of nuclear material, if (a) the nuclear material (1) is at any nuclear facility owned by, or operated by or on behalf of, an insured or (2) has been discharged or dispersed therefrom; (b) the nuclear material is contained in spent fuel or waste at any time possessed, handled, used, processed, stored, transported or disposed of by or on behalf of an insured; or (c) the {injury, sickness, disease, death or destruction arises out of the bodily injury or property damage furnishing by an insured of services, materials, parts or equipment in connection with the planning, construction, maintenance, operation or use of any nuclear facility, but if such facility is located within the United States of America, its territories or possessions or Canada, this exclusion (c) applies only to {injury to or destruction of property at such nuclear facility. property damage to such nuclear facility and any property thereat. IV. As used in this endorsement: "hazardous properties" include radioactive, toxic or explosive properties; "nuclear material" means source material, special nuclear material or byproduct material; "source material," "special nuclear material," and "byproduct material" have the meanings given them in the Atomic Energy Act of 1954 or in any law amendatory thereof; "spent fuel" means any fuel element or fuel component, solid or liquid, which has been used or exposed to radiation in a nuclear reactor; "waste" means any waste material (1) containing byproduct material other than tailings or wastes produced by the extraction or concentration of uranium or thorium from any ore processed primarily for its source material content, and (2) resulting from the operation by any person or organization of any nuclear facility included under the first two paragraphs of the definition of nuclear facility; "nuclear facility" means (a) any nuclear reactor, (b) any equipment or device designed or used for (1) separating the isotopes of uranium or plutonium, (2) processing or utilizing spent fuel, or (3) handling, processing or packaging waste, (c) any equipment or device used for the processing, fabricating or alloying of special nuclear material if at any time the total amount of such material in the custody of the insured at the premises where such equipment or device is located consists of or contains more than 25 grams of plutonium or uranium 233 or any combination thereof, or more than 250 grams of uranium 235, (d) any structure, basin, excavation, premises or place prepared or used for the storage or disposal of waste, and includes the site on which any of the foregoing is located, all operations conducted on such site and all premises used for such operations; "nuclear reactor" means any apparatus designed or used to sustain nuclear fission in a self-supporting chain reaction or to contain a critical mass of fissionable material; With respect to injury to or destruction of property, the word "injury" or destruction "property damage" includes all forms of radioactive contamination of property. includes all forms of radioactive contamination of property. V. The inception dates and thereafter of all original policies affording coverages specified in this paragraph (3), whether new, renewal or replacement, being policies which become effective on or after 1st May, 1960, provided this paragraph (3) shall not be applicable to (i) Garage and Automobile Policies issued by the Reassured on New York risks, or (ii) statutory liability insurance required under Chapter 90, General Laws of Massachusetts, until 90 days following approval of the Broad Exclusion Provision by the Governmental Authority having jurisdiction thereof. (4) Without in any way restricting the operation of paragraph (1) of this Clause, it is understood and agreed that paragraphs (2) and (3) above are not applicable to original liability policies of the Reassured in Canada and that with respect to such policies this Clause shall be deemed to include the Nuclear Energy Liability Exclusion Provisions adopted by the Canadian Underwriters' Association or the Independent Insurance Conference of Canada. - ------------------------------------------------------------------------------ * NOTE. The words printed in italics in the Limited Exclusion Provision and in the Broad Exclusion Provision shall apply only in relation to original liability policies which include a Limited Exclusion Provision or a Broad Exclusion Provision containing those words. - ----------------------------------------------------------------------------- Procedures for the Resolution of U.S. Insurance and Reinsurance DisputesDISCLAIMER The Reinsurance Dispute resolution Task force recommends that interested parties consult their own legal counsel concerning these Procedures, their use or interpretation. These procedures do not necessarily express the views of individual members of the Reinsurance Dispute Resolution Task Force or the firms or entities for which they work or which they represent. TABLE OF CONTENTS FOREWORD.................................................i INTRODUCTION.............................................iii PROCEDURES FOR THE RESOLUTION OF U.S. INSURANCE AND REINSURANCE DISPUTES INTRODUCTION.............................................1 DEFINITIONS..............................................2 NOTICE AND TIME PERIODS..................................3 COMMENCEMENT OF ARBITRATION..............................4 RESPONSE BY RESPONDENT...................................5 APPOINTMENT AND COMPOSITION OF THE PANEL.................6 CONFIDENTIALITY..........................................7 INTERIM RELIEF...........................................8 LOCATION OF PROCEEDINGS..................................9 PREHEATING PROCEDURE.....................................10 DISCOVERY................................................11 MEDIATION OR SETTLEMENT..................................12 SUMMARY DISPOSITION AND EX PARTE HEARING.................13 ARBITRATION HEARING......................................14 AWARD....................................................15 ALTERNATIVE STREAMLINED PROCEDURES.......................16 SEVERABILITY.............................................17 FOREWORD The insurance and reinsurance industries have long recognized the value of alternative dispute resolution mechanism, demonstrated by the fact that arbitration clauses can be found in reinsurance contracts dating as far back as the early 1800's. 'The purpose of these Procedures is to formalize what has been, until now, an ad hoc, albeit highly developed, process used by the industry for decades. While various alternative dispute resolution service provide have developed generic arbitration procedures, and the members of the Task Force appreciate those efforts, the Task Force believes that specific industry procedures are beneficial, and needed, in order to combine the experience reflected in the generic procedures with the custom and practice developed in the insurance and reliance industries. It is the hope of the Task Force in member that the Procedures for the Resolution of U.S. Insurance and Reinsurance Dispute will provide a helpful framework for the conduct of future industry arbitrations and a sense of greater certainty at the time of entering into contracts about how disputes will be handled in the unfortunate event that they arise. INTRODUCTION The Reinsurance Dispute Resolution Task Force (Task Force) was established in the fall of 1997. Its mission was to: Improve the reinsurance dispute resolution process by identifying common problems and recommending industry-wide, flexible, business like solutions. The Task Force undertook a variety of tasks, one of which was to draft a set of procedures that could be utilized by the insurance and reinsurance industries for the resolution of their contractual disputes. This set of procedures is refined to as the Procedures for the Resolution of U.S. Insurance and Reinsurance Disputes (Procedures). In undertaking this effort, the Task Force attempted to balance several goals. One was to set forth, in writing the actual practice that exists insurance and reinsurance arbitrations today. The Second was to enhance and clarify minor procedural issues that sometimes result in unnecessary skirmishes between Parties. And the third, was to tackle some of the major issues that cause a lack of confidence and inefficiencies in the current system, and recommend alternative procedures that might result in greater fairness and a higher level of certainty to the Parties. An example of this third goal is the umpire Selection process created in article 6 of the Procedures. The often-used process of selecting an umpire by lot (in the absence of agreement) is a random, arbitrary one which is prone to potential manipulation. The umpire selection process reflected in article 6 is intended to encourage parties to reach agreement on au umpire and remove or reduce the potential for manipulation, arbitrariness or chance in the event that agreement can-not be reached. It is intended to motivate the parties to select competent, well qualified individuals. In the process of drafting the procedures, the Task Force considered and, in some cases, debated, at length, many topics. The resolution of some of those issues are reflected in these Procedures. However, other issues, though they were fully considered, are ones on which the Task Force took no position and are not addressed in these Procedures. Examples include the precedential or collateral effect of arbitration awards and the designation of a choice of law provision. Although the Task Force addressed the issue of consolidation involving multiple reinsurers, the same contract and the same loss, the Task Force declined to address other circumstances where consolidation might arise. The decision of the Task Force to limit its consideration of consolidation to the circumstances described in the optional provision in the sample arbitration clause should not be construed as an indication of whether Task Force members believed consolidation was appropriate in other circumstances- The Task Force, as a whole, believes that the Procedures are an important step forward in preventing unnecessary friction in the arbitration process and providing parties with more certainty regarding what to expect from the process. It is hoped that contracting parties will consider incorporating these Procedures in their future contracts or, through a separate agreement applying them to their existing relationships. Parties should fee1 free to incorporate them, as written, or with modifications appropriate to their unique situations. PROCEDURES FOR THE RESOLUTION OF U.S. INSURANCE AND REINSURANCE: DISPUTES September 1999 1. INTRODUCTION 1.1 These procedures shall be known as the Procedures for the Resolution of U.S. Insurance and Reinsurance Disputes ("Procedures"). When an agreement, submission or reference provides for or otherwise refer to arbitration trader the Procedures for the Resolution of U.S. Insurance and Reinsurance Disputes, the Parties agree that the arbitration shall be conducted in accordance with these Procedures. 1.2 The Parties may agree on any procedures not specified herein or may alter these Procedure by written agreement. Any such Party-agreed procedures shall be enforceable as if contained in these Procedures. These Procedures shall control any matters not changed by the Party-agreed procedures. 1.3 Certain provisions are accompanied by explanatory notes. If any note conflicts in any way with the Procedures, the Procedures prevail. 1.4 Any dispute concerning the interpretation of these Procedures shall be determined by the Panel. 1.5 The Panel shall have all powers and authority not inconsistent with these Procedures and the Agreement of the Parties. 2. DEFINITIONS 2.1 Arbitration Agreement - an agreement to submit present or future disputes to arbitration, whether contained in a reinsurance contract or other written agreement. 2.2 Arbitration Award or award - includes the final award described inP. 15.2 and any interim award. 2.3 Disinterested - as used in P. 16.1 and P. 16.4 means that no member of the Panel shall be under the control of either party, nor shall any member of the panel have a financial interest in the outcome of the arbitration. 2.4 Notice Of Arbitration - the notice sent by the petitioner in accordance withP. 4.1. 2.5 Panel - the body charged with determining the dispute as defined byP. 6.1. 2.6 Party or Parties - the Petitioner and the Respondent and any other individuals or entities voluntarily, by compulsion or contractually joined in the proceedings. 2.7 Petitioner - the Party who commences arbitration. 2.8 Procedures - as defined by Article 1. 2.9 Respondent -a Party against whom arbitration is commenced. 2.10 Response - the Response to the Notice of Arbitration sent by the Respondent in accordance withP. 5.1. 3. NOTICE AND TIME PERIODS Notices 3.1 Notices under these Procedures are deemed to be given if delivered, in accordance with P. 3.2, to a Party's principal place of business or other address designated by the Party or if delivered to another entity designated by the Party in there reinsurance contract or other written agreement. 3.2 Notices required to be given under these Procedures are deemed to be given: (a) if sent by fax, on the date transmitted; (b) if sent by mail upon delivery; (c) if sent by certified registered mail or another service which produces a receipt, as indicated on the receipt. Note 3.2 - --Notices of Arbitration, Responses to Notices of Arbitration and Appointment of Arbitrator should, where possible, be given in a manner that produces proof of receipt (registered or certified mail or courier). After the arbitration has been commenced, notices and correspondence should, where possible, be given by instantaneous (fax or e-mail) or other expedited manner of communication. Time Periods 3.3 When calculating any time period under these Procedures, the period shall start to run from the day immediately after that upon which notice is given. Time will then run continuously (including non-business days) - If a time period expires at the end of a non-business day in the country of the recipient the time period will be deemed extended until the end of the first following business day. 4. COMMENCEMENT OF ARBITRATION PROCEEDINGS 4.1 An arbitration should be initiated by a demand, in writing, that identifies the (1) Petitioner and the name of the contact person to whom all communications are to be addressed (including telephone, fax and e-mail information); (2) Respondent, as identified in the reinsurance contract, against whom arbitration is sought; (3) contract at issue; and (4) nature of the claims and/or issues. 4.2 The arbitration is commenced under these Procecures on the date the Respondent, or its designated representative, receives the Notice of Arbitration. 4.3 The Petitioner shall identify its Party-appointed arbitrator in accordance withP. 6.3. 5. RESPONSE BY RESPONDENT 5.1 Parties who receive a demand for arbitration shall respond to the demand, in writing, within 30 days, and such Response should contain the (1) identification of the entities on whose behalf the Response is sent and the name of the contact person to whom all communications are to be addressed (including telephone, fax and e-mail information); (2) designation of the Respondent's Party-appointed arbitrator, in accordance with P. 6.3; and (3) identification of any claims of the Respondent. 6. APPOINTMENT AND COMPOSITION OF TIIE PANEL 6.1 The Panel shall consist of three Disinterested arbitrators, one to be appointed by the Petitioner, one to be appointed by the Respondent and the third to be appointed by the two Party-appointed arbitrators. The third arbitrator shall serve as the umpire, who shall be neutral. 6.2 The arbitrators and umpire shall be persons who are current or former officers or executives of an insurer or reinsurer. Alternative 6.2: The arbitrators and umpire shall be persons who are current or former officers or executives of an insurer or reinsurer or other professionals with no less than ten years of experience in or serving the insurance or reinsurance industry.1 6.3 Within thirty (30) days following the commencement of arbitration proceedings, each Party shall provide the other Party with the identification of its Party-appointed arbitrator, his or her address (including telephone, fax and e-mail information), and provide a copy of the arbitrator's cirriculum vitae. 6.4 In the event that either Party fails to appoint an arbitrator within 30 days of commencement of the arbitration, the non-defaulting Party will appoint an arbitrator to at as the Party-appointed arbitrator for the defaulting Party. 6.5 The umpire shall be appointed by the two Party-appointed arbitrators as soon as practical (but no later than 30 days) after the appointment of the second arbitrator. 6.6 The Party-appointed arbitrators mav consult, in confidence, with the Party who appointed them concerning the appointment of the umpire. 6.7 (a) Where the two Party-appointed arbitrators have failed to reach agreement on an umpire within the time specified in P. 6.5 each Party shall exchange, within the time specified in P. 6.5, each Party shall exchange, within 7 days thereafter, eight names of individuals chosen from the list maintained by _______________for the purpose of umpire selection.2 (b) Within 7 days of the exchange of names as set forth inP. 6.2(a), the Party arbitrators shall send a joint request to the umpire candidates to complete an umpire questionnaire. Candidates will be requested to return such questionnaire to each Party arbitrator so that it is received within 20 days from the date the questionnaire is sent. If any individual fails to return a questionnaire within the required time period or refuses to serve, the process set forth in this article shall continue with the remaining names. In the event that one Party's candidate pool of 8 individuals is reduced due to the failure to return questionnaires or refusals to serve, the other Party shall, within 7 days, reduce its candidate pool to the same number of individuals. If, however, one Party's candidate pool falls below 3 individuals, that party shall, within the same 7 days, name additional individuals to replenish its candidate pool to 3 individuals from the list designated in subparagraph(a). Each additional candidate shall be asked by the Parties to complete an umpire questionnaire and return such questionnaire to each Party within 20 days from the date the questionnaire is sent during the same 7 day period that candidate pool is being replenished to 3 individuals, the other Party shall reduce its candidate pool to 3 individuals. Both Parties shall proceed in accordance with subparagraph (d) with 3 individuals each. Note to 6.7(b) - After the return of the questionnaire, if there are common individuals on the Parties' lists, the Parties are encouraged to reach agreement among those individuals without having to proceed to the ranking process. (c) Within 7 days after the process in subparagraph (b) is completed, each Party shall select three names from the other Party's list and notify the other Party of such selection. (d) Within 7 days after receiving the other Parties' selections as set forth in subparagraph (c), each Party shall rank each of the 6 selected umpire names in order of preference, with the number "1" being the most preferred and notify the other Party of such ranking. The individual with the lowest total numerical ranking shall act as umpire. If the ranking results in a tie, the Parties shall draw lots from among the individuals tied for the lowest total numerical rank. The individual chosen by lot shall act as umpire. (d) If either Party fails to meet the time periods required in this P. 6.7, the non-defaulting Party will appoint the umpire from its original candidate pool identified in subparagraph (a). Note to 6.7 - Unilateral contact between a Party-appointed arbitrator and an individual considered for appointment as a default umpire under this paragraph should not be permitted. It is intended that the individuals named not be advised of which Party initiated their selection. 6.8 If after appointment any Party-appointed arbitrator is unable or unwilling to serve, the party who originally appointed the arbitrator shall appoint a replacement within 14 days of the party's receipt of notification of the arbitrator's unavailability. If the Party fails to do so, the non-defaulting Party will appoint replacement within 14 days. 6.9 If after appointment an -umpire is unable or unwilling to serve, a replacement umpire shall be chosen by the two Party-appointed arbitrators as soon as practical (but no later than 14 days) after notification of the umpire's inability or unwillingness to serve. Where the two Party-appointed arbitrators are unable to reach agreement, the Parties shall appoint a replacement umpire in accordance with the procedure set forth in P. 16.7. 6.10 Unless otherwise awarded by the Panel pursuant to each Party shall bear the costs of its Party-appointed arbitrator and shall share equally the cost of the umpire. 7. CONFIDENTIALITY 7.1 All meetings and hearings of the Panel are private and confidential to the Parties. Only the Panel, the Parties, the duly authorized representatives of the Parties and others participating in the proceedings may be admitted to meetings and hearings. 7.2 The Panel and the Parties shall use their best efforts to maintain the confidential nature of the arbitration proceedings and the Award, including the hearing and any written explanation of the Award, except (a) as necessary in connection with a judicial proceeding, relating to the arbitration or the Award; (b) as other wise required by law, regulation independent accounting audit or judicial decision; (c) to support reinsurance or retrocessioal recoveries; or (d) as otherwise agreed by the Parties. The Parties shall use their best efforts to maintain this confidentiality when pursuing any of the exceptions set forth in this paragraph, including the filing of pleadings under seal when permitted. 8. INTERIM RELIEF 8.1 A Panel may issue orders for interim relief, including pre- award security. 9. LOCATION OF PROCEEDINGS 9.1 The location of all proceedings shall be at a place specified in the Arbitration Agreement or as otherwise agreed to by the Parties. In the absence of agreement, the location shall be in a convenient location as determined by the Panel. 10. PRE-HEAR.CVGPROCEDURE Organizational Meeting 10.1 The Panel shall conduct an organizational meeting with the Parties and any authorized representatives for the purposes of clarifying the focus of the arbitration hearing resolving any outstanding issues relating to the send of the hearing and establishing a schedule for the conduct of the proceedings in general. The organizational meeting may be conducted by telephone if agreed to by the Parties or, in the absence o agreement, if determined appropriate by the Panel. 10.2 At the organizational meeting, all member of the Panel shall reveal on the record their past; present and any known future business and personal relationships with the Parties, the Parties' counsel with other Panel members, and with potential in witnesses if identified ' documents provided the Panel members. Once disclosures have been made by all Panel members, Parties may be asked by the Panel to accept the Panel as duly constituted. 10.3 At the organizational meeting, each Party-appointed arbitrator shall disclose whether communications with the appointing Party or its counsel have-taken place. In complying with this disclosure requirement, it is sufficient that the Party-appointed arbitrator disclose the fact that such communication has occurred without disclosing the content of the communication except that Party-appointed arbitrators shall identify any documents that they have examined relating to the proceedings. Such documents shall be furnished to the remainder of the Panel and the other Party. 10.4 The Panel may require that each Party submit concise written statements of position, including summaries of the facts and evidence a Party intends to present, discussion of the applicable law and the basis for the requested award or denial of relief sought. The statements, which may be in letter form, shall be provided to the other Party and the Panel at least 7days prior to the organizational meeting. 10.5 A formal record or transcript of the organizational meeting shall be kept, unless waived by the Parties. The cost of the record or transcript shall be shared equally by the Parties. The Panel shall place on the record the disclosures required by P. 10-2. 10.6 The Panel may allow the Parties to present a brief overview of the matters set-forth in P. 10.4, whether or not written Submissions were requested or received by the Panel. 10.7 The Panel shall address the following: (a) Establish a date for the cut-off of all ex parte communications between the Parties and their Party-appointed arbitrators; (b) Outstanding issues, if any, concerning fees or payment schedules of the arbitrators and/or the umpire; (c) "Hold Harmless" or indemnification agreement from the Parties flowing to the Panel; (d) Confidentiality agreements to ensure the confidentiality provided in article 7; (e) The extent to which depositions and other discovery will be allowed and the date by which they must be completed; (f) The briefing schedule, including the dates briefs are due, whether briefs are to be sequential or simultaneous and whether the briefs have a specified page limit; (g) The date by which fact and expert witnesses must be disclosed, documents exchanged and briefs submitted; (h) whether the Parties prefer a written rationale for the Panel's decision; and (i) Requests, if any, for interim relief as set forth in P. 8.1. 11. DISCOVERY 11.1 The Parties shall cooperate in good faith in the voluntary, prompt and informal exchange of all not-privileged documents and other information relevant to the dispute. 11.2 In addition to the voluntary exchange contemplated by P. 11.1, the Panel shall have the power to order, subject to applicable privileges, the disclosure of such documents or class of documents relevant to the dispute as it considers necessary for the proper resolution of the dispute and to determine the date by which the documents must be disclosed. 11.3 The Panel shall have the power to authorize the Parties to conduct such depositions as are reasonably necessary. 11.4 The Panel may require each Party to provide a list of witnesses whom they intend to call at the hearing. 11.5 The Panel may Emit document production, expert testimony and witnesses of fact on grounds of number, duplication or relevance. 12. MEDIATION OR SETTLEMENT 12.1 The Parties may agree, at any stage of the arbitration. proceedings, to submit to mediation. 12.2 If the Panel determines that settlement may be appropriate under the circumstances, the Panel may request that the Parties consider settlement through mediation or otherwise, provided such efforts do not delay the arbitration proceedings. 13. SUMMARY DISPOSITION AND EX PARTE HEARING 13.1 The Panel may lieu and determine a motion for summary disposition of a particular claim or issue, either by agreement of all Parties or at the request of one Party, provided the other interested Party has reasonable notice and opportunity to respond to such request. Note to 13.1: By authorizing the Panel to grant summary disposition, the Parties using these Procedures do not intend to waive their rights under the Federal Arbitration Act to contest the appropriateness of such an action where such rights have been reserved. 13-2 If a Party has failed to participate in the pre-hearing proceedings and the Panel reasonably believes that the Party will not participate in the hearing, the Panel may proceed with the hearing on an ex parts basis or may dispose of some or all issues pursuant to P. 13. 1. The non-participating Party shall be provided with notice thirty (30) days prior to the hearing or disposition pursuant to P. 13.1. 14. ARBITRATION HEARING 14.1 Unless the Parties otherwise agree, there should be as stenographic record kept of the proceedings. 14.2 The Panel may decide whether and to what extent there should be oral or written evidence or submissions. 14.3 The Panel shall interpret the underlying agreement, which is the subject of the arbitration, as an honorable engagement and shall not be obligated to follow the strict rules of law or evidence. In making their Award, the Panel shall apply the custom and practice of the insurance and reinsurance industry, with a view to effecting the general purpose of the underlying agreement which is the subject of the arbitration. . 14.4 Subject to the control of the Panel, the Parties may question any witnesses who appear at the hearing. Panel members may also question such witnesses. 14.5 A Party may request that the other Party produce at the hearing a witnesses in their employer under their control without need of a subpoena. The Panel may issue subpoenas for the attendance of witnesses or the production of documents. A Party or the subpoenaed person may file an objection with the Panel who shall promptly rule on the objection weighing both the burden on the producing Party and the need of the proponent for the witness or other evidence. 14.6 The Panel shall require that witnesses testify under oath, unless waived by all parties. The Panel shall have the discretion to permit testimony by telephone, affidavit or recorded by transcript, videotape, or other means, and may rely upon such evidence as it deems appropriate. Where there has been no opportunity for cross-examination by the other Party, such evidence may be permitted by the Panel only for good cause shown. The Panel may limit testimony to exclude evidence that would be immaterial or unduly repetitive, provided that all Parties are afforded the opportunity to present material and relevant evidence. 14.7 When the Panel determines that all relevant and material evidence and arguments have been presented, the Panel shall declare the evidentiary portion of the hearing closed. 14.8 At the conclusion of the evidentiary portion of the hearing, the Parties shall submit a proposed form of order to the Panel and to the other Party that precisely identifies the nature of the relief that the Parties seek from the Panel. 14.9 The Panel shall close the hearing following closing arguments and/or post hearing briefs, if any. 15. AWARD 15.1 Absent good cause for an extension as determined by the Panel, the Panel shall render the Award within thirty (30) days after the date of the closing of the hearing or, if an arbitration hearing has been waived or otherwise dispensed with, within thirty (30) days after the date that the Panel received all materials submitted by the Parties for disposition. 15.2 The decision and award of a majority of the Panel shall be final and binding on the Parties. 15.3 The Panel is authorized to award any remedy permitted by the Arbitration Agreement or subsequent written agreement of the Parties In the absence of explicit written agreement to the contrary, the panel is also authorized to award any remedy or sanctions allowed by applicable law, including, but not limited to: monetary damages; equitable relief, pre-or post-award interest costs of arbitration; attorneys fee; and other final or interim relief. 15.4 The Award shall consist of a written statement signed by a majority of the Panel setting forth the disposition of the claims and the relief, if any, awarded. If both parties request a written rationale for the Panel's Award, the Panel shall provide one. If either Party objects to a written rationale, the Panel shall not issue one. 15.5 The prohibition on ex-parte communications shall remain in effect until the earlier of the Parties waiving their right to challenge the Award, the expiration of the time period during which a challenge could be filed without any such challenge being filed, or the conclusion of any challenge to the Award. 15.5 The prohibition on ex-parte communications shall remain in effect until the earlier of the Parties waiving their right to challenge the Award, the expiration of the time period during which a challenge could be filed without any such challenge being filed, or the conclusion of any challenge to the Award. 16.1 ALTERNATIVE STREAMLINED PROCEDURES 16.1 The purpose of the streamlined Procedures in this article is to provide a fair, fast and efficient alternative process for resolving disputes in which the Parties agree that streamlined Procedures are appropriate. Parties are encouraged to discuss the use of these Procedures prior to communicating a demand for arbitration. By agreement, the Parties may want to expand these Procedures to accommodate the unique needs of their particular dispute. Note to 16.1 - It is contemplated that the needs of a particular arbitration may require a one-day hearing, the voluntary exchange of documents agreed to by the Parties, or the testimony of witnesses. This article is designed to be the basic streamlined process which can form the structure for the Parties to add to as they deem appropriate to the particular dispute. The Parties are encouraged to discuss these added features and reach agreement prior to invoking the use of this article. 16.2 A request for arbitration utilizing these streamlined Procedures may be made by the Petitioner in its written demand for arbitration pursuant to P. 4.1. When a request for streamlined arbitration is made by the Petitioner, the Respondent must agree, in writing, no later than 7 days from the date of receiving such request. Failure of the Respondent to reply within 7 days shall be deemed to be a rejection of the request, and the arbitration will proceed in accordance with the provisions of articles 1 through 15 of these Procedures. 16.3 Upon receipt of a demand for arbitration, the Respondent may request the use of streamlined Procedures, in writing, no later than 7 days after receipt of the arbitration demand from the Petitioner. The Petitioner must agree, in writing, no later than 7 days from the date that the Petitioner receives such request. failure of the Petitioner to respond within 7 days shall be deemed a rejection of the request, and the arbitration will proceed in accordance with the provisions of articles 1 through 15 of these Procedures. 16.4 The Panel shall consist of one Disinterested, neutral arbitrator, selected by agreement of the Parties. If the Parties cannot agree on an appointment within 30 days of the agreement to proceed by these streamlined Procedures, the Parties shall default to the use of articles I through 1 5 of these Procedures A in lieu of proceeding pursuant to this article. 16.5 Ex-parte communication with the neutral arbitrator is prohibited. 16.6 Within 21 days from the date the neutral arbitrator is agreed upon, the Parties and the neutral arbitrator will conduct an or, organizational meeting by telephone conference call to familiarize the neutral arbitrator with the issues in dispute and to agree on a schedule for submission of briefs. 16.7 There shall be no discovery, unless the Parties agree otherwise. 16.8 The dispute shall be submitted to the neutral arbitrator on briefs and documentary evidence only, unless the Parties agree otherwise. 16.9 The neutral arbitrator shall render its decision in accordance with the provisions of article 15 of these Procedures. 17. SEVERABILITY 17.1 If any provision of these Procedures, or amendments thereto, is held invalid, such invalidity shall not affect other provisions or applications of these Procedures which can be given effect without the invalid application or provision, and to this end each provision of these Procedures, and any amendments thereto, is severable. Members of the Reinsurance Dispute Resolution Task Force Linda Martin Barber Navigant Consulting, Inc. Paul A. Bellone Commercial Risk Re-Insurance Company Peter T. Beresford CNA Derrick W. K. Brown KWELM Management Services, Ltd. Earl Davis San Francisco Re/Fireman's Fund Richard DeCoux PMA Reinsurance Corporation Dale Diamond AXA Reinsurance Company Caleb L Fowler Former President of CIGNA Property/Casualty Mark S. Gurevitz The Hartford Debra J. Hall Reinsurance Association of America Robert M. Hall RMH Consulting Members of the Reinsurance Dispute Resolution Task force (cont-d) Ronald A. Jacks Syhia Kamisky Michael Kelly Equitas Eric Kobrick American International Group, Inc. Kathleen Krimmel ACE USA Pierre G. Laurin Zurich-U.S. Michael Lovendusky American Insurance Association Andrew Maneval Honzon Management Group, LLC Christian M. Milton American lnternational Group, Inc. Thomas S. Orr General Reinsurance Corporation Pamela K. Parkos Brokers & Reinsurance Markets Association James J. Powers Members of the Reinsurance Dispute Resolution Task Force (cont'd) Kevin J. Shea Signet Star Reinsurance Company Gregory A. Speed American Re-Insurance Company James Sporleder Allstate Insurance Company Members of the Reinsurance Dispute Resolution Task Force (cont'd) Kevin J. Shea Signet Star Reinsurance Company Gregory A. Speed American Re-Insurance Company James Sporleder Allstate Insurance Company EX-10 12 0012.txt Exhibit 10.15 AMENDED AND RESTATED LIMITED PARTNERSHIP AGREEMENT OF 2716 NORTH TENAYA WAY LIMITED PARTNERSHIP THIS AMENDED AND RESTATED AGREEMENT OF LIMITED PARTNERSHIP ("Agreement") is made and entered into this 29th day of December, 1998, by and between Sierra Health Services, Inc., a Nevada corporation (the "General Partner"), California Indemnity Insurance Company, a California corporation, ("CIIC") and Commercial Casualty Insurance Company, a California corporation ("CCIC," and together with CIIC and all other persons who shall execute a copy of this Agreement and such other documents as required by the General Partner in such capacity, collectively, the "Limited Partners"). The General Partner and Limited Partners are hereinafter collectively referred to as the "Partners." ARTICLE I ORGANIZATIONAL MATTERS 1.1 Formation. The General Partners and CHC (the "Initial Partners") formed this limited partnership (the "Partnership") pursuant to the provisions of Nevada's Uniform Limited Partnership Act (the "Act"), Nevada Revised Statutes ("NRS") Chapter 88, on December 7, 1998. Pursuant to NRS Section 88.420(2)(a), CCIC is being admitted as an additional limited partner of the Partnership, which admission shall be effective upon the Initial Partners executing this Agreement where indicated below, such signatures to be conclusive evidence of their written consent to such admission. 1.2 Name. The business of the Partnership shall be carried on in the name of "2716 North Tenaya Way Limited Partnership." 1.3. Partnership Office. The Partnership shall maintain an office at 2716 North Tenaya Way, Las Vegas, Nevada 89114-5645, at which must be kept the following records required by NRS 88.335 to be so maintained (or at which must be kept such different records as may subsequently be required to be so maintained by subsequent change to the Act): (a) A current list of the full name and last known business address of each Partner, separately identifying the General Partner and the Limited Partners in alphabetical order; (b) A copy of the Certificate of Limited Partnership and all certificates of amendment thereto, together with executed copies of any powers of attorney pursuant to which any certificate has been executed; (c) Copies of the Partnership's federal, state, and local income tax returns and reports, if any, for the three most recent years; (d) Copies of any then effective written partnership agreements and of any financial statements of the Partnership for the three most recent years; and (e) Unless it continues to be contained in this Agreement or an amendment there to, a writing setting out: (i) The amount of cash and a description and statement of the agreed value of the other property or services contributed by each Partner and which each Partner has agreed to contribute; (ii) The times at which or events on the happening of which any additional contributions agreed to be made by each Partner are to be made; (iii) Any right of a Partner to receive, or of a General Partner to make, distributions to a Partner which include a return of all or any part of the Partner's contribution; and (iv) Any events upon the happening of which the Partnership is to be dissolved and its affairs wound up. Records kept pursuant to this Section shall be subject to inspection and copying at the reasonable request, and at the expense, of any Partner during ordinary business hours. 1.4 Agent for Service of Process. The name and address of the agent for service of process required to be maintained by NRS 88.330 shall be the same as set forth in the Certificate of Limited Partnership. The General Partner shall require said agent, within thirty (30) days after acceptance of an initial appointment, to file a certificate thereof in the Office of the Secretary of State of Nevada. 1.5 Partnership Offices. The Partnership may maintain an office or offices at such place or places, either within or without the State of Nevada, as may be determined, from time to time, by the General Partner. 1.6 Duration. The term of the Partnership shall commence on the execution and flag of a Certificate of Limited Partnership pursuant to NRS 88.350. The Partnership shall not be dissolved nor cease to do business prior to the expiration of that certain Lease dated December 28, 1998, by and between the Partnership, as lessor, and the Limited Partners, as lessee (the "Lease"), without the unanimous consent of the Partners. The latest date upon which the Partnership is to dissolve shall be the earlier of the date upon which the Lease expires or the 31st day of December, 2018, unless the Partners unanimously consent to the continuation of the Partnership. The Partnership shall terminate sooner if otherwise required (i) under this Agreement, (ii) by operation of law or (iii) by agreement of the Partners. 1.7 Certificate of Limited Partners. The Initial Partners filed a Certificate of Limited Partnership with the Nevada Secretary of State pursuant to the terms of NRS 88.350 on December 7, 1998. Upon the execution of this Agreement, the Partners shall perform all other acts and deeds necessary or required by the Act or any other law to perfect and maintain the Partnership as a limited partnership under the laws of the State of Nevada. 1.8 Delivery of Certificates to Limited Partners. The Partnership shall maintain at the Partnership's office specified in Section 1.3 herein above a copy of the Certificate of Limited Partnership and each certificate of amendment or cancellation, in lieu of delivering or mailing a copy of same to each Limited Partner under NRS 88.390. 1.9 Annual List. On or before the last day of the month in which the anniversary date of the filing of the Partnership's Certificate of Limited Partnership occurs in each year, the General Partner shall cause to be filed with the Nevada Secretary of State a list of the Partnership's General Partners and a designation of its agent in Nevada for service of process, certified by the General Partner of the Partnership. The list must, after the name of each General Partner listed thereon, set forth each General Partner's post office box or street address. ARTICLE II AUTHORITY OF PARTNERSHIP 2.1 Purpose. The purposes of the Partnership are to own, maintain, operate and lease certain real property and improvements thereon consisting of an office building (the "Office Building") and associated improvements located at 2716 North Tenaya Way, Las Vegas, Nevada, and more particularly described in Exhibit "A" attached hereto and incorporated by this reference (the "Property"). 2.2 Powers. In order to carry out its purposes, and not in limitation thereof, the Partnership is authorized and empowered to perform any and all acts and deeds necessary, appropriate, proper, advisable, incidental to, or convenient for the furtherance and accomplishment of the purposes of the Partnership, and for the protection and benefit of the Partnership, including, but not limited to, the following: (a) Borrow money and issue evidence of indebtedness, on behalf of the Partnership or any entity in which the Partnership has an interest, in furtherance of the Partnership business and secure any such indebtedness by mortgage, pledge, or other lien of the Partnership property with the consent of the Partners in writing thereto, provided that no Limited Partner shall have any personal liability on any such indebtedness without the express written consent of such Partner; (b) Conduct any kind of activity, and enter into and perform contracts of any kind necessary to, or in connection with, or incidental to the accomplishment of the purposes of the Partnership; (c) Maintain, operate and lease the Property; and (d) Subject to the limitations expressly set forth elsewhere in this Agreement, negotiate for and conclude agreements for the sale, exchange, or other disposition of all or substantially all of the property of the Partnership, or for the refinancing of any loan on the property of the Partnership. 2.3 Limited Partners' Use of the Office Building. Notwithstanding anything to the contrary in Sections 1.3 and 1.5, at all times during the duration of the Partnership, the Limited Partners shall use and occupy the Office Building as their respective "regional home office" or "home office," as applicable, as those terms are used and defined in NRS Chapter 680B. ARTICLE III PARTNERS AND THEIR CONTRIBUTIONS 3.1 Partners. The Partners, their principal place of business and the amounts of their contributions to the capital of the Partnership are set forth in Exhibit "B", attached hereto and incorporated by this reference. The contribution of a Partner may be in cash, property, or services rendered, or a promissory note or other binding obligation to contribute cash or property or to perform services. 3.2 Percentage Interests. As used in this Agreement, "Percentage Interest" means, with respect to a particular Partner, the proportionate share of the Interests in the Partnership held by such Partner as set forth in Schedule 1. For purposes hereof, "Interest" means the entire ownership interest of a Partner in the Partnership at any time, including the right of such Partner to any and all benefits to which a Partner may be entitled as provided under NRS and this Agreement. 3.3 Adjustment of Percentage Interest. The combined Percentage Interests of the Limited Partners (which shall be evenly divided among all the Limited Partners) shall at all times be equal to the proportion of the floor area of the Building leased by the Limited Partners pursuant to the Lease (the "Occupancy Percentage") in relation to the total floor area of the Office Building and all other buildings, if any, on the Property. If at any time the Lease is amended such that the occupancy Percentage is higher or lower than the Occupancy Percentage as previously set for the Lease, the combined Percentage Interests of the Partners (including the General Partner) shall be automatically adjusted such that the combined Percentage Interests of the Limited Partners are equal to the Occupancy Percentage. Regardless of whether the Lease is amended, the combined Percentage Interests of the Limited Partners shall always equal (and the Percentage Interests of the Partners shall be adjusted accordingly) to the proportion of the floor area of the Office Building used as the respective home office or regional home office by the Limited Partners in relation to the total floor area of the Office Building and all other buildings, if any, on the Property, it being the express intention of the Partners that the Limited Partners will remain eligible for the tax credit provided under NRS 680B.050 and 680.055. The adjustments to Percentage Interests required under this Section 3.3 shall be effective automatically and do not require an amendment to this Agreement or Schedule I. Once each quarter, or at such other times as may be required by the Executive Director of the Nevada Department of Taxation, the Partners shall execute a certificate setting forth their respective Interests, Percentage Interests and Occupancy Percentage of the Partners, said certificate to be kept at the Partnership office in accordance with Section 1.3(a). 3.4 Return of Capital Contributions. Except as required to make the proper adjustments to their respective Percentage Interests required in Section 3.3, no Partner shall be entitled to a turn of its contribution except to the extent permitted by the unanimous consent of the Partners. 3.5 Additional Capital Contributions. Except as required to make the proper adjustments to their respective Percentage Interests required in Section 3.3, no Partner may make additional contributions to the Partnership except to the extent permitted by the unanimous consent of the Partners. 3.6 Capital Accounts. A separate capital account shall be established by the Partnership for each Partner. The capital account of each Partner shall be increased (credited) by (i) the total capital contributed by the Partner, (ii) all profits and gains allocated to the Partner and (iii) any increase in the Partner's Percentage Interest caused by an adjustment made pursuant to Section 3.3.The capital account of each Partner shall be decreased (debited) by (i) any losses allocated to the Partner and (ii) any decrease in the Partner's Percentage Interest caused by an adjustment made pursuant to Section 3.3. ARTICLE IV PROFITS AND LOSSES; CASH DISTRIBUTIONS; TAX CREDITS 4.1 Fiscal Year. The fiscal year of the Partnership shall be the calendar year. 4.2 Profits, Losses, and Tax Credits. (a) Profits and Losses. Profits and losses of the Partnership, if any, shall be allocated to the Partners according to their respective Percentage Interests. (b) Tax Credits. Tax credits, defined as any right to offset expenditures of the Partnership directly against the federal income tax of the Partners, shall be allocated for each fiscal year in the same manner as profits and losses are allocated in the foregoing subsection (a). 4.3 Determination of Profits and Losses. Profits and losses for all purposes hereunder shall be determined in accordance with the accounting method followed by the Partnership for federal income tax purposes, except that any optional basis adjustments made pursuant to Section 734 or Section 743 of the Internal Revenue Code of 1986, as amended, including those provisions affected by The Tax Reform Act of 1986, or any corresponding provisions of any succeeding law (all of which, except for the Section reference, are hereinafter referred to as the "Code"), and any regulations promulgated thereunder, shall not be taken into account. Every item of income, gain, loss, deduction, credit, or tax preference entering into the computation of such profit or loss, or applicable to the period during which such profit or loss was realized, shall be considered allocated to each Partner in the same proportion as profits and losses are allocated to such Partner under Section 4.2. 4.4 Allocation of Gains and Losses. Gains and losses realized by the Partnership upon the sale, exchange, or other disposition of the Property shall be allocated in the same manner as the profits and losses heretofore set forth in Section 4.2. 4.5 Distribution of Proceeds from Sale, Refinancing. or Liquidation of the Partnership Property. In the event the Partnership sells or refinances the Property, or the Partnership's assets are liquidated, the net proceeds from any such sale, refinancing, or liquidation pursuant to Article 8 will be distributed and applied by the Partnership in the following order of priority: (a) To the payment of debts and liabilities of the Partnership (including all expenses of the Partnership incident to any such sale or refinancing), excluding debts and liabilities of the Partnership to Partners or any affiliates; (b) To the setting up of any reserves which the Partners deem reasonably necessary for contingent, unmatured, or unforeseen liabilities or obligations of the Partnership; (c) To the repayment of the balances due on cash loans made by any Partner; (d) To Partners in the amount of their initial capital contributions; and (e) Thereafter, to the Partners in accordance with their percentage interests in profits and losses, respectively. ARTICLE V MANAGEMENT, POWERS, DUTIES, AND RESTRICTIONS 5.1 General Partner. Sierra Health Services, Inc., a Nevada corporation, shall serve as the General Partner. 5.2 Authority of General Partner. Except to the extent otherwise set forth herein, the General Partner shall have full, complete, and exclusive discretion to manage and control the business of the Partnership for the purposes herein stated, shall make all decisions affecting the business of the Partnership to the best of its ability, and shall use its best efforts to carry out the purposes of the Partnership. In so doing, the General Partner shall take all actions necessary or appropriate to protect the interests of the Partners as a group and the Partnership. The General Partner, on behalf of the Partnership and in furtherance of the business of the Partnership, shall have the authority to perform all acts which the Partnership is authorized to perform, including, but not limited to, the following: (a) Compromise, submit to arbitration, sue on, or defend all claims in favor of or against the Partnership; (b) Make and revoke any election permitted the Partnership by any taxing authority; (c) Perform any and all acts it deems necessary or appropriate for the protection and preservation of the assets of the Partnership; and (d) Obtain and keep in force property, casualty, and public liability insurance, in such amounts and upon such terms and with such earners as will adequately protect the Partnership and the Property. 5.3 Limitations on Authority of General Partner. The General Partner shall have no authority to do any of the following without the prior written consent of the Limited Partners: (a) Borrow money or execute notes, deeds of trust or any other documents encumbering all or any portion of the Property; (b) Do any act in contravention of the Partnership Agreement; (c) Do any act that would make it impossible to carry on the ordinary business of the Partnership; (d) Confess a judgment against the Partnership; (e) Possess Partnership property for other than Partnership purposes; (f) Admit a person as a General Partner; or (g) Sell, contract to transfer, assign, hypothecate or in any way alienate all or any part of its Interest as General Partner other than as specifically permitted under any applicable portion of this Partnership Agreement. ARTICLE VI WITHDRAWAL OR REMOVAL OF GENERAL PARTNER 6.1 Voluntary Withdrawal. The General Partner may not unilaterally withdraw from the Partnership as General Partner at any time. Any such withdrawal shall constitute a breach of this Partnership Agreement. 6.2 Removal of General Partner . In addition to all other provisions under this Partnership Agreement or applicable law for removal of a General Partner, the General Partner may be removed upon the commission of fraud or gross negligence in conducting the business affairs of the Partnership. ARTICLE VII BOOKS AND RECORDS, ACCOUNTING, TAX ELECTIONS, ETC. 7.1 Books and Records. The Partnership shall maintain full and accurate books of account in accordance with sound federal income tax principles and generally accepted accounting principles. These and all other records of the Partner including information relating to the status of the Partnership, its business, and a list of the names and addresses of all Partners, shall be kept at the principal office and place of business of the Partnership and shall be available for examination there by any Partner or such Partner's duty authorized representative at any and all reasonable times. 7.2 Banking. The General Partner shall have a fiduciary responsibility for the safekeeping and use of all funds and assets of the Partnership, whether or not in the immediate possession or control of the Partners. The funds of the Partnership shall not be commingled with the funds of any other person or entity, and the Partners shall not employ such funds in any manner except for the benefit of the Partnership. All funds of the Partnership, not otherwise invested, shall be deposited in one or more accounts maintained in such banking institutions as the General Partner shall, from time to time, determine, and withdrawals therefrom shall be made only in there regular course of the Partnership's business day on such signature or signatures as the General Partner may, from time to time, determine. 7.3 Accountants. The accountants for the Partnership shall be such firm of public accountants as shall be elected by the General Partner, the cost of which shall be borne by the Partnership. Said accountants shall prepare for execution by the Partners all tax returns of the Partnership and, when required, shall audit the books of the Partnership and certify, in accordance with generally accepted accounting principles, a balance sheet, a profit and loss statement, and a cash flow statement, the cost of which shall be borne by the Partnership. 7.4 Resorts to Partners. The Partners agree that the Partners will provide all of the information necessary for the preparation of Internal Revenue Service Form 1065 to the Partnership's accountants within one (1) calendar month after the close of each fiscal year. 7.5 Optional Basis Adjustment. In the event of the transfer of all or any part of an Interest of a Partner, or death of any individual Partner, or upon a distribution of property to a Partner, the Partnership may elect to adjust the federal income tax basis of Partnership property in accordance with Section 754 of the Code in the manner provided in Section 734 or Section 743 thereof and regulations promulgated thereunder. However, notwithstanding an election pursuant to said Section 754 with respect to the Interest of any Partner, the determination of profits, losses, and the capital account balances, shall for all purposes of this Agreement, be made without taking into account any adjustments resulting from such election, and such adjustment shall only be taken into account on the income tax returns of the Partners affected thereby. 7.6 Tax Returns: "Tax Matters Partner". Treatment of Partnership Items: Request for Adjustment (a) For Federal income tax purposes, the General Partner is selected by the Partners to represent the Partnership and is designated the "Tax Matters Partner". (b) The Tax Matters Partner shall prepare and file timely all federal, state and local income and other tax returns and reports, including, but not limited to, a form furnished by or acceptable to the executive director of the Nevada department of taxation pursuant to NRS 680B.050(3), as may be required as a result of the business of the Partnership. Not less than thirty days prior to the date (as extended) on which the Partnership is to file its federal income tax return or any state income tax return, the return proposed to be filed by the Tax Matters Partner shall be furnished to the Partners for review and comment. In addition, not less than ten (10) days after the date on which the Partnership actually files its federal income tax return or any state income tax return, a copy of the return so filed by the Tax Matters Partner shall be furnished to the Partners. The Tax Matters Partner shall promptly notify the Partners if any tax return or report of the Partnership is audited or if any adjustments are proposed by any governmental body. (c) As between the Partners, the Tax Matters Partner is hereby appointed the "tax matters partner" (as such term is defined in Section 6231(a)(7) of the Internal Revenue Code) and is authorized to file all statements and forms on behalf of the Partnership which may be required by regulations issued or to be issued by the Internal Revenue Service to indicate such designation. If the Tax Matters Partner is ratified by the Internal Revenue Service of its intent to audit a federal income tax return of the Partnership, the Tax Matters Partner shall promptly notify the Partners and shall keep the Partners informed of the progress of the examination. In the event of an audit of the Partnership's income tax returns by the Internal Revenue Service, the Tax Matters Partner may, at the expense of the Partnership, retain account and other professionals to participate in the audit. The Tax Matters Partner shall promptly communicate the results of any formal partnership administrative adjustment to the Partners and shall promptly advise the Partners of proposed settlement options when presented by the Internal Revenue Service. (d) The Partners agree to notify the Tax Matters Partner of any proposed inconsistent treatment of any item of Partnership income, gain, loss, deduction or credit between the treatment of such item reflected on the Partner's share of income, credits, deductions, etc., and the treatment proposed to be made by the Partner on the Partner's federal income tax return. The treatment of any such item shall be subject to the approval of the General Partner. (e) Except as provided below, each Partner agrees not to file an "administrative adjustment request" (as such term is utilized in Section 6227 of the Internal Revenue Code) with respect to a "Partnership item" (as such term is defined in Section 6231(a)(3) of the Internal Revenue Code) of the Partnership. If the Partners propose that the Tax Matters Partner should file on behalf of the Partnership an administrative adjustment request, the Partners shall first notify the Tax Matters Partner of such proposal. If the Tax Matters Partner agrees with the proposal, he shall file the request. If the Tax Matters Partner proposes to file an administrative adjustment request or file an amended federal income tax return with regard to prior years of the Partnership, then the Partners shall be entitled to ten (10) days notice to review the proposed administrative adjustment request or amended federal income tax return, as the case may be. The Tax Matters Partner shall not file an administrative adjustment request or amended federal income tax return with regard to a prior year of the Partnership without the written consent of all of the Partners. ARTTCLE VII DISSOLUTION AND LIQUIDATION OF THE PARTNERSHIP 8.1 Dissolution of the Partnership. The Partnership shall be dissolved upon: (a) The sale or other disposition of the Property and the collection of all the proceeds therefrom; or (b) Any other event causing the dissolution of the Partnership under this Agreement, the Act or any other applicable law. 8.2 Winding-Up and Dissolution. Upon the dissolution of the Partnership pursuant to the preceding Section 8.1, the Partnership business shall be wound up and its assets distributed as provided in Article IV. For the purposes of this Section 8.2, to the extent that depreciation or amortization deduction taken into account by the General Partner shall cause a deficit in the General Partner's capital account, such deficit, to the extent the amount of any depreciation or amortization so taken, shall not be deemed to be the personal liability of the General Partner. Upon complete dissolution and distribution of the Partnership's assets, the Partners shall cease to be Partners of the Partnership. Upon the dissolution of the Partnership, the accountants for the Partnership shall promptly prepare and furnish to each Partner a statement setting forth the assets and liabilities of the Partnership upon its dissolution. Promptly following the distribution of the Partnership's property and assets, the Partnership's accountant shall prepare for each Partner a statement showing the manner in which the Partnership assets were distributed. 8.3 Election to Reform. Notwithstanding anything to the contrary herein contained, upon the dissolution of the Partnership pursuant to Section 8.1, the Partners may form a successor Partnership (whether limited or general) or a joint venture or any other entity to continue the business of the Partnership. ARTICLE IX GENERAL PROVISIONS 9.1 Amendments. Amendments to this Agreement may be proposed by a Partner, who Shall give notice to the other Partners of (1) the text of such amendment; (2) the statement of the purpose of such amendment; and (3) if required by the other Partners, an opinion of counsel that such amendment is permitted under the Act and will not adversely affect the Partnership's classification as a partnership for federal income tax purposes under Section 7701 of the Code and regulations promulgated thereunder. Any amendments proposed pursuant to this Section 9.1 shall be considered effective only after the same have been reduced to a written instrument signed by all of the Partners. 9.2 Notices. Wherever provision is made in this Agreement for the giving, service, or delivery of any notice, statement, or other instrument, such notice shall be deemed to have been duly given, served, and delivered if mailed by United States registered or certified mail (return receipt requested), addressed to the party entitled to receive the same in accordance with the addresses set forth in Exhibit "B". Except where otherwise specified in this Agreement, any notice, statement, or other instrument shall be deemed to have been given, served, and delivered on the date on which such notice was mailed as herein provided. 9.3 Arbitration. Any controversy or claim arising out of or relating to this Agreement, or breach thereof, shall be settled by arbitration in the State of Nevada in accordance with the Rules of the American Arbitration Association, and judgment upon the award may be entered in any court having jurisdiction thereof pursuant to the provisions of NRS Chapter 38. 9.4 Benefit. The terms, conditions, covenants, and agreements herein contained shall inure to the benefit of and be binding upon the parties hereto and their respective executors, administrators, successors, assigns, receivers and trustees. 9.5 Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed to be an original copy, all of which together shall constitute one Agreement, binding on all parties hereto, notwithstanding that all the parties shall not have signed the same counterparts. 9.6 Entire Agreement. This Agreement, the Lease and any information incorporated herein by reference, set forth all (and is intended by all parties to be an integration of all of there presentations, promises, agreements, and understandings among the parties hereto with respect to the Partnership, the Partnership's business, and the property of the Partnership. There are no representations, promises, agreements, or understandings, oral or written, express or in applied, among the parties other than as set forth or incorporated herein. 9.7 Construction. The captions and section and article numbers appearing in this Agreement are inserted only as a matter of convenience and in no way define, limit, construe, or describe the scope or intent of such sections or articles of this Agreement, nor in any way affect the terms and conditions hereof. The necessary grammatical changes required to make the provisions of this Agreement apply in a plural sense, where required, or to a particular gender shall, in all instances, be assumed as though in each case fully expressed. 9.8 Partial Invalidity. If any term, covenant, or condition of this Agreement or the application thereof to any person or circumstance shall, to any extent, be invalid or unenforceable, the remainder of this Agreement or the application of such term, covenant, or condition to persons or circumstances other than those as to which it is held invalid or unenforceable, shall not be affected thereby and each term, covenant, or condition of this Agreement shall be valid and enforced to the fullest extent permitted by law. 9.9 Applicable Law. The laws of the State of Nevada shall govern the validity, performance, and enforcement of this Agreement. 9. 10 Acknowledgment by Limited Partner. Each of the Limited Partners represents, warrants and acknowledges that: (a) such Limited Partner understands that the interest being acquired here under is not readily transferable and that no market is made or exists for the sale of its Interest; (b) such Limited Partner is experienced in evaluating investments of the nature contemplated by this Agreement, and that it has sufficient knowledge, information and experience in financial and business matters to be able to evaluate the merits and risks of this investment; and (c) such Limited Partner understands that: THE LIMITED PARTNERSHIP INTERESTS HEREIN HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR THE APPLICABLE STATE SECURITIES ACT BY REASON OF EXEMPTION. THESE INTERESTS HAVE BEEN ACQUIRED FOR INVESTMENT ONLY AND MAY NOT BE SOLD OR TRANSFERRED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION OR AN OPINION OF COUNSEL ACCEPTABLE TO THE GENERAL PARTNER THAT SUCH REGISTRATION IS NOT REQUIRED THE SALE OR TRANSFER OF SUCH INTEREST IS ALSO RESTRICTED BY THIS LIMITED PARTNERSHIP AGREEMENT, BY ANY SUBSCRIPTION AGREEMENT SIGNED BY SAID LIMITED PARTNER AND BY ALL OTHER RELATED PARTNERSHIP DOCUMENTS. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above-written. General Partner Sierra Health Services, Inc. By:________________________ ------------ Its: ________________________ Limited Partners California Indemnity Insurance Company By:________________________ ------------------------ Its_________________________ Commercial Casualty Insurance Company By:________________________ ------------------------ Its: ________________________ EXHIBIT "A" LEGAL DESCRIPTION OF THE PROPERTY A parcel of land being a portion of the Southeast Quarter (SE 1/4) of Section 15, Township 20 South, Range 60 East, M.D.M., City of Las Vegas, Clark County, Nevada. Also being a portion of Lot 4 in Block 1 of the re-subdivision of a portion of the Las Vegas Technology Center, a Commercial Subdivision recorded in Plats Book 47, Page 35, Clark County, Nevada, Official Records. This legal description and map also supersedes the Record of Surveys File 68, Page 77, described as follows: COMMENCING at the intersection of the centerline of Peak Drive and the centerline of Tenaya Way; Thence South 00(Degree)02'37" West along the centerline of Tenaya Way 40.07 feet; thence departing said centerline of Tenaya Way South 89(Degree)57'23" East 40.00 feet to a point on the East right of way of Tenaya Way; Thence along said East right of way South 00(Degree)02'37" West 295.66 feet to a point of tangency; Thence curving right along the arc of a curve having a radius of 1207.37 feet an arc length of 73.79 feet concave to the West, through a central angle of 03(Degree)30'06" to a point where the radius point bears North 86(Degree)27'20" West; Thence departing the East right of way of Tenaya Way South 86(Degree)00'00" East 265.43 feet; Thence South 76(Degree)59'07" East 76.58 feet; Thence South 86(Degree)00'00" East 453.68 feet; Thence South 04(Degree)00'00" West 35.00 feet to the POINT OF BEGINNING; Thence continuing South 04(Degree)00'00"West 35.00 feet; Thence North 86(Degree)00'00" West 360.91 feet; Thence South 00(Degree)00'00" West 346.49 feet; Thence North 86(Degree)00'00" West 64.23 feet; Thence South 22(Degree)06'13" West 62.59 feet to a point on the Northerly right of way of Box Canyon Drive, same point being a point on a curve where the radius point bears South 22(Degree)07'47" West; Thence along said curve concave to the Southwest, curving right an arc length of 366.57 feet through a central angle of 43(Degree)37'14" to a point of tangency; Thence South 24(Degree)14'59" East 63.83 feet; Thence departing said Northerly right of way of Box Canyon Drive North 65(Degree)43'29" East 629.72 feet to a point on the West right of way of Oran K. Gragson Highway United States 95; same point being on a non tangent curve where the radius point bears South 80(Degree)27'02" West concave to the Southwest; Thence curving left along said curve having a radius of 9900.00 feet an arc distance of 443.40 feet through a central angle of 02(Degree)33'58" to a point where the radius point bears South 77(Degree)53'03" West; Thence departing said West right of way of Oran K. Gragson Highway United States 95 North 86(Degree)00'00" West 301.03 feet to the POINT OF BEGINNING. EXIHBIT "B" LIST OF PARTNERS AND CONTRIBUTIONS General Partner Name/Address Contribution Sierra Health Services, Inc. $66.67, all of its undivided two-thirds 2716 No. Tenaya Way (2/3) interest in the property described on Las Vegas, Nevada 89128 Exhibit "A," and unamortized loan fees Attn: Executive Vice President relating to the same through December, 1998. Administrative Services Limited Partners Name/Address Contribution - ------------ ------------ California Indemnity Insurance Company $33.33 and all of its undivided 2716 No. Tenaya Way one-third (1/3) interest in the Las Vegas, Nevada 89128 property described on Exhibit "A." Attn: President Commercial Casualty Insurance Company 2716 No. Tenaya Way Las Vegas, Nevada 89128 Attn: President SCHEDULE PARTNERSHIP INTERESTS General Partner Sierra Health Services, Inc. 75.644% Limited Partners California Indemnity Insurance Company 12.178% Commercial Casualty Insurance Company 12.178% EX-10 13 0013.txt Exhibit 10.16 Sublease Section I This Sublease is by and between SIERRA HEALTH SERVICES, INC. (herein "Sublessor") and CALIFORNIA INDEMNITY INSURANCE COMPANY, a subsidiary of Sublessor (herein "Sublessee"). Sublessor is the Tenant under that Lease Agreement set out as Attachment 1 to this Sublease (herein the "Master Lease"). Section II Sublessor hereby Subleases to Sublessee the office space consisting of a portion of the 5th and 6th floors, as highlighted on Exhibit A attached and made a part of this Sublease, of the building known as 2716 North Tenaya Way (herein the "Building") and at the same address in the City of Las Vegas, State of Nevada, referred to below as the Premises. This Sublease is subject to the provisions of the Master Lease and in case of any conflict with the applicable terms of the Master Lease, the terms of the Master Lease shall prevail. The Term of this Sublease may not extend beyond the Term of the Master Lease. This Sublease shall not affect or reduce any obligation of the Sublessor as Tenant under the Master Lease or any rights of the Landlord under the Master Lease. Sublessor may not mortgage or pledge any right under this Sublease except as expressly permitted under the Master Lease. Sublessor shall deliver a conformed copy hereof to the Landlord and Lender as defined under the Master Lease within 10 days after its execution. Section III Term The Premises are Subleased for a term to commence January 1, 2001, and to end at 11:59 p.m. Las Vegas local time on December 31, 2001, or on such earlier date as this Sublease may terminate as provided below, except that, if any such date falls on a Sunday or a holiday, then this Sublease shall end at 11:59 p.m. Las Vegas, Nevada, local time on the business day next preceding the mentioned date. Unless Subleases shall notify Sublessor in writing otherwise on or before December 1st of the original or extended term of the Sublease, this Sublease including all its terms, provisions and covenants will be automatically extended for an additional period of 1 year, provided, this Sublease may not be extended longer than the Term permitted under the Master Lease. Section IV Rent The total rent is the sum of Two Dollars and Thirty-Nine Cents ($2.39) per rentable square foot per month, which sum is payable, in advance, on the first day of each calendar month during the initial term and if the Sublease is extended pursuant to the provisions of Section III, the rent for the extended term shall be as set forth in Section XXX. Section V Use and Occupancy Sublessee shall use and occupy the Premises as a business office to conduct its affairs as an insurer and for general office purposes and for no other purpose. Sublessor represents that the Subleased property may lawfully be used for such purpose. Section VI Place for Payment of Rent Sublessee shall pay rent, and any additional rent as provided below, to Sublessor at Sublessor's stated address, or at such other place as Sublessor may designate in writing, without demand and without counterclaim, deduction, or setoff. Section VII Care and Repair of Premises (a) Sublessee shall commit no act of waste and shall take good care of the Premises and the fixtures and appurtenances therein, and shall, in the use and occupancy of the Premises, conform to all laws, orders and regulations of the federal, state, and municipal governments or any of their departments. Sublessor shall make all necessary repairs to the Premises, except where the repair has been made necessary by misuse or neglect by Sublessee or Sublessee's agents, servants, visitors or licensees. All improvements made by Sublessee to the Premises which are so attached to the Premises that they cannot be removed without material injury to the Premises, shall become the property of Sublessor on installation. (b) Not later than the last day of the term, Sublessee shall, at Sublessee's expense, remove all of Sublessee's personal property and those improvements made by Sublessee that have not become the property of Sublessor, including trade fixtures, cabinet work, movable paneling, partitions and the like; repair all injury done by or in connection with the installation or removal the property and improvements; and surrender the Premises in as good condition as they were at the beginning of the term, reasonable wear, and damage by fire, the elements, casualty, or other cause not due to the misuse or neglect by Sublessee or Sublessee's agents, servants, visitors or licensees, excepted. All property of Sublessee remaining on the Premises after the last day of the term of this Sublease shall be conclusively deemed abandoned and may be removed by Sublessor, and Sublessee shall reimburse Sublessor for the costs of such removal. Sublessor may have any such property stored at Sublessee's risk and expense. Section VIII Alternations, Additions or Improvements Sublessee shall not, without first obtaining the written consent of Sublessor, make any alterations, additions or improvements in, to or about the Premises. Section IX Prohibition Against Activities Increasing Fire Insurance Rates Sublessee shall not do or suffer anything to be done on the Premises that will cause an increase in the rate of fire insurance on the building. Section X Accumulation of Waste or Refuse Matter Sublessee shall not permit the accumulation of waste or refuse matter on the Subleased Premises or anywhere in or near the building. Section XI Abandonment Sublessee shall not, without first obtaining the written consent of Sublessor, abandon the Premises, or allow the Premises to become vacant or deserted. Section XII Assignment or Sublease Sublessee shall not, without first obtaining the written consent of Sublessor, assign, mortgage, pledge or encumber this Sublease, in whole or in part, or sublet the Premises or any part of such Premises or any part thereof. This covenant shall be binding on the legal representatives of Sublessee, and on every person to whom Sublessee's interest under this Sublease passes by operation of law, but shall not apply to an assignment or subletting to the parent or subsidiary of a corporate Sublessee or to a transfer to the Subleasehold interest occasioned by a consolidation or merger involving such Sublessee. Section XIII Compliance with Rules and Regulations Sublessee shall observe and comply with the rules and regulations set forth below, which are made part of this agreement, and with such further reasonable rules and regulations as Sublessor may prescribe, on written notice to Sublessee, for the safety, care, and cleanliness of the building and the comfort, quiet, and convenience of other occupants of the building. Section XIV Elevator Service Sublessor shall furnish passenger elevator service on business days, and on other days subject to the security of the Premises. Section XV Services and Utilities Provided that Sublessee is not in default hereunder, Sublessor agrees to furnish to the premises during reasonable hours of generally recognized business days, to be determined by Sublessor at its reasonable discretion, and subject to the rules and regulations of the Building of which the Premises are a part, electricity for normal lighting and fractional horsepower office machines, heat and air conditioning , landscape maintenance, required for the comfortable use and occupation of the Premises, and janitorial service. Sublessor shall also maintain and keep lighted common stairs, common entries and toilet rooms in the Building of which the Premises are a part. Sublessor shall not be liable for, and Sublessee shall not be entitled to, any reduction of rental by reason of Sublessor's failure to furnish any of the foregoing when such failure is caused by accident, breakage, repairs, strikes, lockouts or other labor disturbances or labor disputes of any character, or by any other cause similar or dissimilar, beyond the reasonable control of Sublessor. The costs of any such meters and of installation maintenance and repair thereof shall be paid for by the Sublessee and Sublessee agrees to pay to Sublessor promptly upon demand therefor by Sublessor for all such water and electric current consumed as shown by said meters, at the rates charged for such services by the local public utility furnishing the same, plus any additional expense incurred in keeping account of the water and electric current so consumed. If a separate meter is not installed, such excess cost for such water and electric current will be established by an estimate made by a utility company or electrical engineer. Section XVI Insurance (a) Sublessor shall maintain property coverage insurance on the Building Shell and appurtenant structures in such amounts as Sublessor and any Mortgagees may deem necessary or appropriate. Such insurance shall be maintained at the expense of Sublessor (as a part of Operating Expenses), and payments for losses thereunder shall be made solely to Sublessor or the Mortgagees as their respective interests shall appear. Sublessee shall obtain and keep in force at all times during the Sublease Term, a policy or policies of insurance covering loss or damage to all of the improvements, betterments, income and business contents located within the Premises other than the in the amount of the full replacement value thereof as ascertained by the Sublessee's insurance carrier, as the same may exist from time to time, against all perils normally covered in an "all risk" policy (including the perils of flood and surface waters), as such term is used in the insurance industry; provided however, that Sublessee shall have no obligation to insure against earthquake. (b) Sublessee shall, at Sublessee's expense maintain a policy of Commercial General Liability Insurance insuring Sublessor and Sublessee against liability arising out of the ownership, use, occupancy or maintenance of the Premises. The initial amount of such insurance shall be at least One Million Dollars ($1,000,000), and shall be subject to periodic increase upon reasonable demand by Sublessor based upon inflation, increased liability awards, recommendation of professional insurance advisors, and other relevant factors. However, the limits of such insurance shall not limited Sublessee's liability or relieve Sublessee of any obligation hereunder. Sublessor shall be named as an additional insured on said policies and the policies shall contain the following provision: "Such insurance as afforded by this policy for the benefit of Sublessor shall be primary as respects any claims, losses or liabilities arising out the use of Premises by the Sublessee or by Sublessee's operation and any insurance carried by Sublessor shall be excess and non-contributing." The policy shall insure Sublessee's performance of the indemnity provisions of this Sublease. (c) Insurance required to be maintained by Sublessee hereunder shall be in companies holding a "General Policyholders' Rating" of A or better and a "financial rating" of 10 or better, as set forth in the most current issue of "Best's Insurance Guide." Sublessee shall promptly deliver to Sublessor, within thirty (30) days of the Commencement Date, original certificates evidencing the existence and amounts of such insurance. No such policy shall be cancelable or subject to reduction of coverage excepts after sixty (60) days prior written notice to Sublessor. Sublessee shall, within thirty (30) days prior to the expiration, cancellation or reduction of such policies, furnish Sublessor with renewals or "binders" thereof. Sublessee shall not do or permit to be done anything which shall invalidate the insurance policies required under this Sublease. (d) Sublessee and Sublessor shall obtain from the issuer of the insurance policy referred to in subsection (a) a waiver of subrogation provision in said policies and Sublessee and Sublessor hereby re Sublease and relieve, and waives any and all rights of recovery against Sublessor or Sublessee, or against the employees, officers, agents and representatives of Sublessor or Sublessee, for loss or damage arising out of or incident to the perils insured against under this subsection (a) which perils occur in, on or about the Premises or the Building, whether due to the negligence of Sublessor or Sublessee or their agents, employees, contractors or invitees. The extent of any waiver of subrogation by Sublessee or Sublessor in this subsection (d) is limited to the extent o insurance carried by Sublessor and Sublessee pursuant to subsection (a) of this Sublease. (e) Sublessor presently purchases insurance in which the Sublessor and the Sublessee, as a wholly owned subsidiary of Sublessor, is also a named insured. Unless Sublessee shall receive notice from Sublessor to obtain independent insurance, the insurance the Sublessor so purchases shall be deemed sufficient to satisfy the requirements under this Sublease and Subsection (a) through (d) of this Section shall not apply. Section XVII Property Taxes Sublessee shall pay or cause to be paid, before delinquency, any and all taxes levied or assessed and which become payable during the term hereof upon all Sublessee's Subleasehold improvements, equipment, furniture, fixtures and personal property located in the Premises, except that which has been paid for by Sublessor, and is the standard of the Building. In the event any or all of the Sublessee's Subleasehold improvements, equipment, furniture, fixtures and personal property shall be assessed and taxed with the Building, Sublessee shall pay to Sublessor its share of such taxes within ten (10) days after delivery to Sublessee by Sublessor of a statement in writing setting forth the amount of such taxes applicable to Sublessee's property. Section XVIII Quiet Enjoyment Sublessor covenants that if, and so long as, Sublessee pays the rent, and any additional rent as provided, and performs the covenants of this Sublease, Sublessee shall peaceably and quietly have, hold, and enjoy the Premises for the term mentioned, subject to the provisions of this Sublease. XIX Effect of Other Representations No representations or promises shall be binding on the parties to this agreement except those representations and promises contained or in some future writing signed by the party making such representations or promises. Section XX Casualty to the Premises If the Premises or any part thereof suffers a Casualty (as defined in the Master Lease), Sublessee shall give prompt written notice thereof to the Sublessor and such notice shall contain the information required under Section 3.2 of the Master Lease. Such notice shall not be required is there is a Casualty to the Building as a whole and not just to the Premises. If the Casualty is a (i) Major Casualty (as defined in the Master Lease) or (ii) is a Casualty relating only to the Premises and the Restoration Cost (as defined in the Master Lease) related to the Premises exceeds 50% of the Stipulated Loss Value as defined in the Master Lease multiplied by a fraction of the total rental square feet leased pursuant to the Master Lease to the total rental square feet subleased under this Sublease, then Sublessee may give notice of its intention to terminate this Sublease on the Lease Termination Date as defined in the Master Lease which shall include, as appropriate the certificate and documentation required under Section 3.2(c) of the Master Lease as it related to this Sublease. Section XXI Restoration If the Sublessor is required under Section 3.5 of the Master Lease to restore the Master Lease Premises (as therein defined), and Sublessee has not given notice to terminate this Sublease, as permitted hereunder, Sublessee shall cooperate with Sublessor in such restoration and shall pay to Sublessor a portion of any costs that Sublessor must bear out of its own funds (as set forth in Section 3.5 (c) of the Master Lease allocated on the basis of the rentable square feet subleased under this Sublease to the total rentable square feet leased under the Master Lease. Section XXII Eminent Domain If there is a Condemnation (as defined in the Master Lease) of Premises or any part of the Premises or any estate in the Premises, or any other part of the building materially affecting Sublessee's use of the Premises, Sublessee shall give Sublessor a notice of such Condemnation. If the Condemnation is Total Condemnation (as defined in the Master Lease), this Sublease shall terminate on the Lease Termination Date (as defined in the Master Lease) after receipt of the notice by the Sublessor. If the Condemnation is a Major Condemnation (as defined in the Master Lease), Sublessee shall not later than thirty days after such Major Condemnation, give notice of its intention to terminate this Sublease on the first Payment Date which occurs not less than 120 nor more than 150 days after delivery of such notice. Sublessee shall not be entitled to any part of the award for any Condemnation or any payment in lieu of such payment, but Sublessee may file a claim for any taking of fixtures and improvements owned by Sublessee, and for moving expenses. Section XXIII Sublessor's Remedies on Default If Sublessee defaults in the payment of rent, or any additional rent, or defaults in the performance of any of the other covenants or conditions of this agreement, Sublessor may give Sublessee notice of such default and if Sublessee does not cure any rent, or additional rent, default within 15 days, or other default within 30 days, after the giving of such notice (or if such other default is of such nature that it cannot be completely cured within such period, if Sublessee does not commence such curing within such 30 days and thereafter proceed with reasonable diligence and in good faith to cure such default), then Sublessor may terminate this Sublease on not less than 15 days' notice to Sublessee. On the date specified in the notice the term of this Sublease shall terminate and Sublessee shall then quit and surrender the Premises to Sublessor. If this Sublease shall have been so terminated by Sublessor, Sublessor may at any time thereafter resume possession of the Premises by any lawful means and remove Sublessee or other occupants and their effects. Section XXIV Deficiency In any case where Sublessor has recovered possession of the Premises by reason of Sublessee's default, Sublessor may, at Sublessor's option, occupy the Premises or cause the Premises to be redecorated, altered, divided, consolidated with other adjoining Premises, or otherwise changed or prepared for reletting, and may relet the Premises or any part of the Premises as agent of Sublessee or otherwise, for a term or terms to expire prior to, at the same time as, or subsequent to, the original expiration date of this Sublease, at Sublessor's option , and receive the rent therefore. Rent so received shall be applied first to the payment of such expenses as Sublessor may have incurred in connection with the recovery of possession, redecorating, altering, dividing, consolidating with other adjoining Premises, or otherwise changing or preparing for reletting, and the reletting, including brokerage and reasonable attorney fees, and then to the payment of damages in amounts equal to the rent under this agreement and to the costs and expenses of performance of the other covenants of Sublessee as provided. Sublessee agrees, in any such case, whether or not Sublessor has relet, to pay to Sublessor damages equal to the rent and other sums agreed to be paid by Sublessee, less the net proceeds of the reletting, if any, and the damages shall be payable by Sublessee on the several rent days above specified. In reletting the Premises, Sublessor may grant rent concessions, and Sublessee shall not be credited with such concession. No such reletting shall constitute a surrender and acceptance or be deemed evidence of a surrender and acceptance. If Sublessor elects, pursuant to this agreement, actually to occupy and use the Premises or any part of the Premises during any part of the balance of the term as originally fixed or since extended, there shall be allowed against Sublessee's obligation for rent or damages as defined, during the period of Sublessor's occupancy, the reasonable value of such occupancy, not to exceed in any event the rent reserved and such occupancy shall not be construed as a relief of Sublessee's liability under this agreement. Sublessee waives all right of redemption to which Sublessee or any person claiming under Sublessee might be entitled by any law no or hereafter in force. Sublessor's remedies under this agreement are in addition to any remedy allowed by law. Section XXV Effect of Failure To Insist on Strict Compliance with Conditions The failure of either party to insist on strict performance of any covenant or condition of this agreement, or to exercise any option contained, shall not be construed as a waiver of such covenant, condition, or option in any other instance. This Sublease cannot be changed or terminated orally. Section XXVI Collection of Rent from any Occupant If the Premises are sublet or occupied by anyone other than Sublessee and Sublessee is in default under this agreement, or if this Sublease is assigned by Sublessee, Sublessor may collect rent from the assignee, subtenant, or occupant, and apply the net amount collected to the rent reserved. No such collection shall be deemed a waiver of the covenant against assignment and subletting, or the acceptance of such assignee, subtenant, or occupant as Sublessee, or a re Sublease of Sublessee from further performance of the covenants contained. Section XXVII Subordination of Sublease Sublessee accepts this Sublease subject and subordinate to any mortgage, deed of trust or other lien presently existing or hereafter arising upon the Premises, upon the Building as a whole, and to any renewals, refinancing and extensions thereof, but Sublessee agrees that any such mortgagee shall have the right at any time to subordinate such mortgage, deed of trust or other lien to this Sublease on such terms and subject to such conditions as such mortgagee may deem appropriate in its discretion. Sublessor is hereby irrevocably vested with full power and authority to subordinate this Sublease to any mortgage, deed of trust or other lien now existing or hereinafter placed upon the Premises or the Building as a whole, and Sublessee agrees upon demand to execute such further instruments subordinating this Sublease or attorning to the holder of any such liens as Sublessor may request. In the event that Sublessee should fail to execute any such instrument promptly as requested, Sublessee hereby irrevocably constitutes Sublessor as its attorney-in-fact to execute such instrument in Sublessee's name, place and stead, it being agreed that such power is one coupled with an interest. Section XXVIII Sublessee's Estoppel Certificate Sublessee shall from time to time, on not less than 30 days' prior written request by Sublessor, execute, acknowledge, and deliver to Sublessor a written estoppel certificate certifying that the Sublease is unmodified and in full force and effect, or that the Sublease is in full force and effect as modified and listing the instruments of modification; the dates to which the rents and other charges have been paid; and, whether or not to the best of Sublessee's knowledge Sublessor is in default under this Sublease and, if so, specifying the nature of the default. Section XXIX Sublessor's Right to Cure Sublessee's Breach If Sublessee breaches any covenant or condition of this Sublease, Sublessor may, on reasonable notice to Sublessee (except that no notice need be given in case of emergency), cure such breach at the expense of Sublessee and the reasonable amount of all expenses, including attorney fees, incurred by Sublessor in so doing (whether paid by Sublessor or not) shall be deemed additional rent payable on demand. Section XXX Rental Adjustment (a) The annual rental in the year beginning January 1, 2002, if this Sublease shall be extended in accordance with its terms and in each of the years of this Sublease if further extended thereafter shall be increased or decreased by the amount Sublessor's actual per square foot (I) Rent as adjusted for such year in the Master Lease and (II) costs of operating and maintaining the Building have increased or decreased in the immediately preceding Sublease year over the preceding Sublease year. (b) Within sixty days after the last day of each Sublease year, commencing with the last day of the first Sublease year, Sublessor will furnish to Sublessee a written statement of the total cost of operating and maintaining the building for each of the prior Sublease year. Such total costs for each such preceding year shall be divided by the total rentable area in the building, and the resulting quotient shall be the square foot cost of operating and maintaining the building for the year. (c) The words "actual per square foot cost of maintaining and operating the building" as used in this section, shall mean the total of all amounts actually expended in a Sublease year by Sublessor in operating and maintaining the building (including, but not by way of limitation, the amounts expended for electricity, heat, taxes, and insurance premiums, excluding depreciation) divided by the total number of square feet of rental space in the office building. (d) Until receipt of such statements pertaining to cost in any Sublease year, commencing with the second Sublease year, Sublessee shall continue to pay the monthly installment of rental paid by Sublessee during the prior Sublease year. Commencing with the first day of the calendar month immediately following receipt of such statement, Sublessee shall pay monthly rental installments based upon the newly determined annual rent. Within fifteen days after receipt of the statement, Sublessee shall pay to Sublessor any additional rental due for the previous month or months of the then current Sublease year resulting from the increase in the annual rental rates. Any credit due to Sublessee as a result of the decrease of the annual rental shall be credited by Sublessor upon Sublessee's monthly rental installment due on the first day of the month immediately following the delivery of such certified statement by Sublessor to Sublessee. Section XXXI Notices Any notice by either party to the other shall be in writing and shall be deemed to have been duly given only if delivered personally or sent by registered or certified mail in an addressed postpaid envelope; if to Sublessee, at the Building; if to Sublessor the Building; or, to either, at such other address as Sublessee or Sublessor, respectively, may designate in writing. Notice shall be deemed to have been duly given, if delivered personally, on delivery, and if mailed, on the 3rd day after the mailing of such notice. Section XXXII Sublessor's Right to Inspection Repair, and Maintenance Sublessor may enter the Premises at any reasonable time, on adequate notice to Sublessee (except that no notice need be given in case of emergency) for the purpose of inspection or the making of such repairs, replacements, or additions in, to on and about the Premises or the building, as Sublessor deems necessary or desirable. Sublessee shall have no claim or cause of action against Sublessor by reason of such entry except as provided in Section XXXIII of the agreement. Section XXXIII Interruption of Services or Use Interruption or curtailment of any service maintained in the building, if caused by strikes, mechanical difficulties, or any causes beyond Sublessor's control whether similar or dissimilar to those enumerated, shall not entitle Sublessee to any claim against Sublessor or to any abatement in rent, and shall not constitute constructive or partial eviction, unless Sublessor fails to take such measures as may be reasonable in the circumstances to restore the service without undue delay. If the Premises are rendered untenantable in whole or in part, for a period of 15 business days, by the making of repairs, replacements, or additions, other than those made with Sublessee's consent or caused by misuse or neglect by Sublessee or Sublessee's agents, servants, visitors, or licensees, there shall be a proportionate abatement of rent during the period of such untenantability. Section XXXIV Conditions of Sublessor's Liability Sublessee shall not be entitled to claim a constructive eviction from the Premises unless Sublessee shall have first notified Sublessor in writing of the condition or conditions giving rise to such eviction, and, if the complaints be justified, unless Sublessor shall have failed within a reasonable time after receipt of such notice to remedy such conditions. Section XXXV Binding Effect on Successors and Assigns The provisions of this Sublease shall apply to, bind, and insure to the benefit of Sublessor and Sublessee, and their respective heirs, successors, legal representatives, and assigns. It shall be deemed without further agreement that the purchaser or the mortgagee in possession has assumed and agreed to carry out any and all covenants and obligations of Sublessor under this agreement. Section XXXVI Section Headings The Section headings in this Sublease are intended for convenience only and shall not be taken into consideration in any construction or interpretation of this Sublease or any of its provisions. This Sublease is entered into to be effective January 1, 2001 SUBLESSOR Sierra Heath Services, Inc. By_______________s/____________ Dated: January 25, 2001 Name: William R. Godfrey Title: Executive Vice President Administrative Services SUBLESSEE California Indemnity Insurance Company By___________s/________________ Dated: January 25, 2001 Name: Kathleen M. Marlon Title: Chairman, President and Chief Executive Officer EX-10 14 0014.txt Exhibit 10.17 AMENDED AND RESTATED INTERCOMPANY POOLING AGREEMENT This Agreement is entered into by and between California Indemnity Insurance Company ["CIIC"], Commercial Casualty Insurance Company ["CCIC"], CII Insurance Company ["CII Insurance"] and Sierra Insurance Company of Texas ["SIC Texas"], collectively referred to as the "Parties". WHEREAS, the Parties to this agreement are insurers duly authorized to transact workers' compensation insurance in various states; and WHEREAS, CCIC is a wholly-owned subsidiary of CIIC; and WHEREAS SIC Texas is a wholly owned subsidiary of CIIC; and WHEREAS CII Insurance is a wholly owned subsidiary of CIIC; and WHEREAS, in order that the Parties may obtain increased efficiency in operations and other advantages, it is desirable to effect this Intercompany Pooling Agreement ["Agreement"]. NOW THEREFORE, in consideration of the promises and the terms and conditions hereinafter set forth, the Parties agree as follows: 1. As used in this Agreement: [a] The term "insurance to which this Agreement applies" shall mean all workers' compensation insurance policies, certificates, contracts and reinsurance [other than reinsurance under this Agreement] issued, written or assumed by the Parties that are in force on or after January 1, 1999. Any premium transactions on policies not in force as of January 1, 1999 are also included in this Agreement so long as the transaction results in the recognition of additional or return earned premiums on or after January 1, 1999. [b] The term "net earned premiums" shall mean earned premiums on insurance to which this Agreement applies, net of ceded reinsurance other than this Agreement. [c] The term "losses" shall mean losses incurred on insurance to which this Agreement applies, net of subrogation and reinsurance recoveries. [d] The term "loss adjustment expenses" or "LAE" shall mean allocated or unallocated loss adjustment expenses incurred on insurance to which this Agreement applies, net of subrogation and reinsurance recoveries. [e] The term "underwriting expenses" shall mean other underwriting expenses as calculated for the Underwriting and Investment Exhibit, Part 4, column 2 of the statutory annual statement. [f] The term "pooled business" shall mean all net premiums [written and earned], losses, LAE and underwriting expenses incurred under all insurance policies written by CIIC, CCIC, CII Insurance and SIC Texas to which this Agreement applies. [g] The Agreement excludes any and all investment income and investment related expenses and any miscellaneous non-underwriting income or expenses. [h] The term "applicable percentage[s]" is the participating percentage[s] allocable to CIIC, CCIC, CII Insurance and SIC Texas of the pooled business. The sum of the participating percentages shall equal 100%. The applicable percentage for each of the Parties is set forth in Exhibit A to this Agreement. 2. CCIC hereby cedes and transfers to CIIC, and CIIC hereby reinsures and assumes from CCIC, all premiums, losses, LAE and expenses, including those associated with occupying space in CIIC's owned or leased real estate, incurred under all insurance policies written by CCIC to which this Agreement applies. SIC Texas hereby cedes and transfers to CIIC, and CIIC hereby reinsures and assumes from SIC Texas, all premiums, losses, LAE and expenses including those associated with occupying space in CIIC's owned or leased real estate incurred under all insurance policies written by notice shall be given and such premium or losses not be paid CII Insurance hereby cedes and transfers to CIIC, and CIIC hereby reinsures and assumes from CII Insurance, all premiums, losses, LAE and expenses, including those associated with occupying space in CIIC's owned or leased real estate, incurred under all insurance policies written by CII Insurance to which this Agreement applies. Unless otherwise mutually agreed, cancellation of this Agreement will be on a run-off basis until all liabilities of the pooled business have been settled or expired. 3. CIIC hereby retrocedes and transfers to CCIC, and CCIC hereby reinsures and assumes from CIIC, the applicable percentage allocable to CCIC of the pooled business. CIIC hereby retrocedes and transfers to SIC Texas, and SIC Texas hereby reinsures and assumes from CIIC, the applicable percentage allocable to SIC Texas of the pooled business. CIIC hereby retrocedes and transfers to CII Insurance, and CII Insurance hereby reinsures and assumes from CIIC, the applicable percentage allocable to CII Insurance of the pooled business 4. From and after the effective date of this Agreement, CIIC, CCIC, CII Insurance and SIC Texas will each continue to collect any and all premiums due on insurance policies written by them. Uncollectible premiums and/or agents' balances remain the sole responsibility of the company which wrote the policy and are not included. 5. CIIC, CCIC, CII Insurance and SIC Texas shall bear the losses, LAE and expenses of the pooled business according to their applicable percentages of such business. All such losses, LAE and expenses shall be paid by CIIC, CCIC, CII Insurance and SIC Texas, respectively, according to their applicable percentages of the pooled business. 6. The obligations of the Parties in Paragraphs 4 and 5 shall be offsetting and only net amounts of cash shall be paid, assigned or transferred to settle balances due under this Agreement. 7. An accounting of all payment obligations described in the preceding paragraphs shall be rendered by CIIC or its designated agent on a quarterly basis. Each such accounting shall be due within forty-five [45] days after the end of the quarter covered thereby. The resulting obligations shall be settled in cash, by assignment or transfer as promptly thereafter as possible but in no event later than ninety [90] days after the end of said quarter. Only net amounts due as reflected in the accounting need be remitted. 8. [a] If the reinsurance provided under this Agreement is disallowed to any party for financial statement purposes by the insurance regulatory authority of any state due to the laws or regulations of such state pertaining to reinsurance effected with unauthorized companies, letters of credit or some other form of security collateral will be provided by the assuming party to secure all reinsurance credits ceded to the assuming party. The cost to provide security collateral will be shared by the Parties according to their applicable percentages of the pooled business. [b] If letters of credit are provided, such letters of credit may be drawn upon at any time, notwithstanding any provisions of this Agreement, and shall be utilized by the party who is the ceding insurer under this Agreement or its successors in interest for the following purposes: [i] to reimburse the ceding insurer for the assuming party's share of the premiums returned to the owners of policies reinsured under this Agreement on account of cancellation of such policies; [ii] to reimburse the ceding insurer for the assuming party's share of losses paid by the ceding insurer under the terms and provisions of the polices reinsured under this Agreement; [iii] in the event of notice of nonrenewal of the letter of credit, to fund an account with the ceding insurer in an amount at least equal to the deduction, for the reinsurance ceded, from the ceding insurer's liabilities for policies ceded under this Agreement [such amount shall include but not be limited to, amount for policy reserves, claims and losses incurred, and unearned premium reserves]; and [iv] to pay any other amounts due to the ceding insurer under this Agreement. All amounts payable under the letters of credit shall be without diminution because of the insolvency on the part of the ceding insurer. [c] If funds are withheld pursuant to this Agreement, by a party who is a ceding insurer under this Agreement, such funds shall be held by or on behalf of the ceding insurer in the United States and shall be segregated from other operating accounts and securities invested by the ceding insurer and shall clearly acknowledge ownership by the ceding insurer. The ceding insurer will maintain a subledger detailing all transactions pertinent to each assets so held under this Agreement. 9. Notwithstanding any other provisions of this Agreement, policyholders' dividends declared and paid by any party hereto by reason of participating provisions in policies may reflect the direct experience of that party with respect to such insurance and any other factors deemed relevant by its governing board, subject, however, to the applicable provisions of the California Insurance Code or Texas Insurance Code [as applicable to SIC Texas] or any other applicable legal requirements. The aggregate expense of all such dividends declared and paid shall be allocated among the Parties according to their applicable percentages of the pooled business. 10. CIIC is authorized to arrange for general reinsurance applicable to the pooled business. The expense of such reinsurance shall be allocated among the Parties according to their applicable percentages of the pooled business. 11. INITIAL PORTFOLIO TRANSFER - To facilitate the initial accounting of this Agreement, CCIC, CII Insurance and SIC Texas hereby cede and transfer to CIIC, and CIIC hereby reinsures and assumes from CCIC, CII Insurance and SIC Texas, their net outstanding losses, LAE and unearned premium reserves and other liabilities related to underwriting expense [collectively referred to as "reserves"] as of January 1, 1999. CIIC hereby retrocedes and transfers to CCIC, CII Insurance and SIC Texas, and CCIC, CII Insurance and SIC Texas hereby reinsure and assume the applicable percentage allocable to CCIC, CII Insurance and SIC Texas of the January 1, 1999 pooled total of the reserves. If the retrocession of the reserves results in CCIC, CII Insurance or SIC Texas assuming more than what was ceded, then CIIC shall pay a reinsurance premium to CCIC, CII Insurance or SIC Texas equal to the difference between the amount ceded and amount assumed. If the retrocession of the reserves results in CCIC, CII Insurance or SIC Texas assuming less than what was ceded, then CCIC, CII Insurance or SIC Texas shall pay a reinsurance premium to CIIC equal to the difference between the amount ceded and amount assumed. The resulting premium is not to be included in the pooled business of this Agreement. 12. This Agreement supersedes the Amended and Restated Intercompany Pooling Agreement between CIIC, SIC of Texas and CCIC effective January 1, 1998. 13. Any and all books, records and documents relating to the subject matter of this Agreement shall at all reasonable times be available for inspection by the other party hereto, and it is mutually agreed that errors and omissions inadvertently made shall not invalidate the liability of any party to this Agreement. 14. In the event of insolvency and the appointment of a conservator, liquidator or statutory successor of any ceding company, the portion of any risk or obligation assumed by the assuming party shall be payable to the conservator, liquidator, or statutory successor on the basis of claims allowed against the insolvent company by any court of competent jurisdiction or by any conservator, liquidator or statutory successor of the company having authority to allow such claims, without diminution because of that insolvency , or because the conservator, liquidator, or statutory successor has failed to pay all or a portion of any claims. Payments by a party which is an assuming party under this Agreement shall be made directly to a party that is a ceding insurer under this Agreement or to its conservator, liquidator, or statutory successor, except where the contract of insurance or reinsurance specifically provides another payee of such reinsurance in the event of the insolvency of such ceding insurer. 15. The conservator, liquidator or statutory successor of any ceding party hereto shall give written notice of the pendency of a claim against the ceding party, indicating the policy reinsured, which claim would involve a possible liability on the part of the assuming party to this Agreement. Such notice shall be given within a reasonable time after such claim is filed in the conservation or liquidation proceeding or in receivership. During pendency of such claim, the assuming party may investigate such claim and interpose, at its own expense, in the proceeding where the claim is to be adjudicated, any defense or defenses deemed available to the ceding company or its conservator, liquidator or statutory successor. The expense thus incurred by the assuming party shall be chargeable, subject to the approval of the court, against the ceding party as part of the expense of the conservation or liquidation to the extent of a proportionate share of the benefit which may accrue to the ceding party in conservation or liquidation, solely as a result of the defense undertaken by the assuming party. 16. ARBITRATION - Any unresolved difference of opinion between the parties shall be submitted to arbitration by three arbitrators. One arbitrator shall be chosen by CIIC and one shall be chosen by CCIC, CII Insurance or SIC Texas as the case may require. The third arbitrator shall be chosen jointly by the other two arbitrators within ten [10] days after they have been appointed. If the two arbitrators cannot agree upon the third arbitrator, each arbitrator shall nominate three persons of whom the other shall reject two. The third arbitrator shall then be chosen by drawing lots. If either party fails to choose an arbitrator within thirty [30] days after receiving the written request of the other party to do so, the latter shall choose both arbitrators, who shall then choose the third arbitrator. The arbitrators shall be impartial and shall be present or former officials of property or casualty insurance or reinsurance companies. The party requesting arbitration [the "Petitioner"] shall submit its brief to the arbitrators within thirty [30] days after notice of the selection of the third arbitrator. Upon receipt of Petitioner's brief, the other party [the "Respondent"] shall have thirty [30] days to file a reply brief. Upon receipt of Respondent's reply brief, Petitioner shall have twenty [20] days to file a rebuttal brief. Upon receipt of Petitioner's rebuttal brief, Respondent shall have twenty [20] days to file its rebuttal brief. The arbitrators may extend the time for filing of briefs at the request of either party but not for more than sixty [60] days. The arbitrators are relieved from judicial formalities and, in addition to considering the rules of law and customs and practices of the insurance and reinsurance business, shall make their award with a view to effecting the intent of this Agreement. The decision of the majority shall be final and binding upon the Parties. The costs of arbitration, including fees of the arbitrators, shall be shared equally unless the arbitrators decide otherwise. The arbitration shall be held at the times and places agreed upon by the arbitrators. 17. This Agreement is a continuing one as to duration but may be canceled by mutual consent or for failure to pay premium or losses due under it if 30 days prior written notice shall be given and such premium or losses not be paid. Unless otherwise mutually agreed, cancellation of this Agreement will be on a run-off basis until all liabilities of the pooled business have been settled or expired. 18. This Agreement is made in Pleasanton, California, effective January 1, 1999, and shall be subject to and interpreted in accordance with the laws of California. 19. This Agreement constitutes the entire agreement among the parties to it with respect to the business being reinsured hereunder. There are no understandings among the parties other than as expressed in this Agreement. 20. Any change or modification to this Agreement may only be made by amendment to this Agreement which is signed by the parties. IN WITNESS THEREOF, the Parties hereto have caused this Agreement to be executed by its respective duly authorized officers. CALIFORNIA INDEMNITY INSURANCE COMPANY By: s/Kathleen M. Marlon Kathleen M. Marlon Chief Executive Officer COMMERCIAL CASUALTY INSURANCE COMPANY By: s/Kathleen M. Marlon Kathleen M. Marlon Chief Executive Officer SIERRA INSURANCE COMPANY OF TEXAS By: s/Kathleen M. Marlon Kathleen M. Marlon Chief Executive Officer CII INSURANCE COMPANY By: s/Kathleen M. Marlon Kathleen M. Marlon Chief Executive Officer INTERCOMPANY POOLING AGREEMENT EXHIBIT A APPLICABLE PERCENTAGES Effective January 1, 1999, the applicable percentages for each participant to the Amended and Restated Intercompany Pooling Agreement are as follows: California Indemnity Insurance Company 90% Sierra Insurance Company of Texas 1% Commercial Casualty Insurance Company 7% CII Insurance Company 2% ------- Total 100% === EX-10 15 0015.txt Exhibit 10.18 INVESTMENT SERVICES AGREEMENT THIS AGREEMENT is between CALIFORNIA INDEMNITY INSURANCE COMPANY (hereafter "Company"), and SIERRA HEALTH SERVICES, Inc., a Nevada corporation (hereafter "Investment Manager") and is effective as of January 1, 1999. Whereas, Company is an insurance company with substantial investments; and Whereas, it would be beneficial for Company to obtain investment services set forth herein subject to the review and ultimate control of its Board of Directors and its appropriate officers; and Whereas, Investment Manager can supply investment services to Company as described in this Agreement. Now, therefore, the parties agree as follows: 1. INVESTMENT SERVICES (a) Investment Manager shall furnish to Company investment services for the Investment Assets (as hereinafter defined) of Company, such services to include the following: 1. to counsel and advise Company and its Board of Directors in connection with the formulation of investment programs designed to accomplish its investment objectives; and 2. to manage the Investment Assets in accordance with the laws applicable to Company and with the investment policies, objectives, directions and guidelines established by the Board of Directors and officers of Company; and 3. subject to other provisions of this Agreement including but not limited to Section 1(c) of this Agreement, to have full discretion and authority, without prior consultation or prior approval, to buy, sell and otherwise trade in stocks, bonds and other securities and take such other actions which Investment Manager shall deem requisite, appropriate or advisable. However, Investment Manager shall not act as custodian of the Investment Assets. (b) Investment Manager agrees that it will maintain adequate records relating to the furnishing of investment services under this Agreement, including those with respect to the acquisition and disposition of securities for Company. (c) Investment Manager agrees that the investment services it furnishes will be in accordance with (1) Company's general investment policies, objectives and guidelines established from time to time by its Board of Directors and (2) any written instructions given by the Chief Executive Officer or Chief Financial Officer of Company or persons designated by either of them in writing as such written instructions shall be sent from time to time in writing by Company to Investment Manager. (d) Investment Assets shall mean all bonds, stocks (exclusive of those of affiliates and subsidiaries), short-term investments and other invested assets (i) reportable as held by Company on Schedules B, BA, C and D in the Investment Reporting System of Company and (ii) any other assets of the Company as Investment Manager and Company may from time to time agree. 2. PURCHASE AND SALE OF SECURITIES (a) Investment Manager shall place all orders for the purchase and sale of portfolio securities for Company's account with brokers or dealers selected by Investment Manager, which may include a person affiliated with Investment Manager, as the term affiliated person is defined in the Investment Company Act of 1940 (hereafter "Affiliate"). Investment Manager shall seek to execute portfolio transactions on terms which are advantageous to Company. In selecting brokers or dealers to execute transactions, Investment Manager shall use its best efforts to obtain the best price and execution for Company; provided however, with respect to an Affiliate, Investment Manager shall comply with the additional requirements set forth in paragraph 2 (b) below. In evaluating the terms available for executing particular transactions for Company and in selecting brokers and dealers to execute such transactions, Investment Manager may consider, in addition to commission cost, the financial stability and reputation and execution capability of brokers and dealers and the brokerage and research services (as those terms are defined in Section 28(e) of the Securities Exchange Act of 1934, as amended) provided by brokers and dealers for the account of Company. Subject to paragraph 2(b) below, Investment Manager is authorized to pay a broker or dealer who provides such brokerage and research services a commission for executing a Company portfolio transaction which is in excess of the amount of commission another broker or dealer would have charged for effecting that transaction if Investment Manager determines that such commission is reasonable in relation to the value of the brokerage and research services provided by such broker or dealer. This determination may be made in terms of either a particular transaction or the overall responsibilities which Investment Manager has with respect to all of the accounts over which it exercises investment discretion. (b) Should an Affiliate engage in "agency cross transactions" (as defined in Section 275.206(3)-2 of the Investment Advisers Act of 1940) in which the Affiliate acts as broker for both sides of a transaction and may receive commissions from, and have a potentially conflicting division of loyalties and responsibilities regarding, both parties, or act as principal for its own account coming within the provisions of Section 206 of the Investment Advisers Act of 1940, Company for itself and its subsidiaries and affiliates which are furnished services under this Agreement consent to: (1) such agency cross transactions with such Affiliate, and (2) transactions in which such Affiliate is acting as principal for its own account, so long as more favorable terms are not practically available from another broker or seller as the case may be or so long as the specific transaction is consented to by Company. Company may revoke this consent at any time by giving notice to Investment Manager. In transactions other than agency cross transactions and principal transactions specified above, Investment Manager may select an Affiliate as a broker or dealer to place or execute orders for the purchase or sale of securities pursuant to Investment Manager's authority under this Agreement, so long as the commission rate charged by the Affiliate for such sale or purchase conforms to the requirements of paragraph 2(a) above and is equal to or lower than that charged any of its other customers for like sales or purchases. (c) Provided the investment objectives of this Agreement are adhered to, Company agrees that Investment Manager may aggregate sales and purchase orders of Investment Assets with similar orders being made simultaneously for other accounts managed by Investment Manager, if in Investment Manager's reasonable judgment such aggregation shall result in an overall economic benefit to the Investment Assets taking into consideration the advantageous selling or purchase price, brokerage commission and other expenses. Company acknowledges that the determination of such economic benefit to Company by Investment Manager represents Investment Manager's evaluation that Company is benefited by relatively better purchase or sales prices, lower commission expenses and beneficial timing of transactions or a combination of these and other factors. 3. INVESTMENT FEES; EXPENSES (a) Company shall pay to Investment Manager a fee equal to the Investment Manager's allocated costs in rendering the services in this Agreement. Allocation shall be made at the end of each calendar quarter and shall be derived from the Investment Manager's costs for such quarter allocated on the basis of the Fair Market Value of the Investment Assets for which services are rendered under this Agreement to the Fair Market Value of all Investment Assets the Investment Manager managed or for which services similar to the services under this Agreement were rendered during such Quarter. The fee shall be payable in arrears 30 days after the end of each calendar quarter in which the Investment Services Agreement is in force. (b) Fair Market Value on any date shall mean the fair market value of the Investment Assets as reported in the Company or Investment Manager Investment Reporting System for such date in accordance with the procedures and rules for such Reporting System as audited by the auditors of Company. Quarterly Ending Fair Market Value shall be the Fair Market Value on the last day of any calendar quarter. (c) If services rendered hereunder shall commence on a day other than the first day of a calendar quarter or terminate other than on the last day of a calendar quarter, the above fee shall be fairly and equitably prorated. (d) Investment Manager shall furnish at its own expense all facilities and administrative, accounting, clerical, statistical, correspondence and other services necessary to supply the investment services required under this Agreement. However, Company shall be responsible for the expenses of: (1) brokerage commissions, issue and transfer taxes and other costs in connection with securities transactions to which Company is a party, including any portion of such commissions attributable to research and brokerage services; (2) taxes payable by Company to federal, state and other governmental agencies, (3) primary record keeping and (4) custodial fees and expenses. 4. ULTIMATE CONTROL All services furnished under this Agreement shall always be subject to the direction and control of the Board of Directors and the authorized Officers of Company. The Board shall act in accordance with Section 1200 of the California Insurance Code to approve or ratify all the investments made in accordance with this Agreement and; if the Board acts not to approve any investment made under this Agreement the investment shall be disposed of in as prompt a manner as reasonable. Notwithstanding any other provision of this Agreement, it is understood and agreed that Company reserves the right to direct any action to be taken hereunder on its behalf by Investment Manager. 5. NON-EXCLUSIVITY OF SERVICES The services of Investment Manager to be provided to Company hereunder are not to be deemed exclusive and Investment Manager shall be free to provide similar services for its own account and the accounts of other persons provided that such services do not materially interfere with its services hereunder. 6. LIABILITY; INDEMNIFICATION Investment Manager shall be liable to Company for any liability, damages or expenses of Company arising out of the negligence, gross negligence or willful misfeasance of Investment Manager or any of its directors, officers, employees or Affiliates in providing services under this Agreement. 7. TERMINATION This Agreement may be terminated by either Company or Investment Manager upon notice to the other party sent at least thirty days prior to the date set for termination in such notice; provided further, that in the event of a material breach of this Agreement by the other party, this Agreement may be terminated by Company or Investment Manager upon notice in writing sent at least 10 days prior to the date set for termination in such notice. Company shall pay any investment fees due hereunder, prorated to the date of termination, within ten days following the date of termination. 8. NOTICES Notices or other writings given or sent under or pursuant to this Agreement shall be in writing and be deemed to have been given or sent if delivered to the party at its address listed below in person or by telex or telecopy or within 2 days of mailing if mailed postage prepaid to such address. The addresses of the parties are: California Indemnity Insurance Company 2716 North Tenaya Way Las Vegas, Nevada 89128 Attention: Chief Financial Officer Telecopy :702 869 2379 Sierra Health Services, Inc. 2720 North Tenaya Way Las Vegas, Nevada 89128 Attention: Chief Financial Officer Telecopy :702 242 7534 Each party may change its address by giving notice as herein required. 9. SOLE INSTRUMENT This instrument constitutes the sole and only agreement of the parties to it relating to its object and correctly sets forth the rights, duties, and obligations of each party to the other as of its date. Any prior agreements, promises, negotiations or representations not expressly set forth in this Agreement are of no force or effect. 10. WAIVER OR MODIFICATION No waiver or modification of this Agreement shall be effective unless reduced to a written document signed by the party to be charged. 11. LAW OF CALIFORNIA This Agreement shall be governed by and construed in accordance with the laws of the State of California . 12. ASSIGNMENT AND DELEGATION No party to this Agreement shall have the right to sell, transfer, delegate, or assign this Agreement, its rights or duties to any person, firm, or corporation at any time during its term and any proposed assignee shall acquire no rights nor be able to assume any obligations unless the written consent of the other party to this Agreement is given before such assignment or delegation takes place. Nevertheless, Investment Manager may appoint other investment advisers as sub advisers for the Investment Assets. 13. REPORTS AND RECORDS Investment Manager shall provide to Company such oral or written reports as to its services provided under this Agreement as Company shall reasonably require but shall report investments at least quarterly. All records maintained pursuant to this Agreement shall be deemed the property of Company and shall be subject to examination by Company and by persons authorized by it, or by governmental authorities, at all times upon reasonable notice. Except as expressly authorized in this Agreement or directed by the other party in writing, Investment Manager and Company shall keep confidential the records and other information obtained by reason of this Agreement (including, with respect to Company, the investment information and recommendations provided to it by Investment Manager). Upon termination of this Agreement, Investment Manager shall promptly upon demand return to Company all such records, except that Investment Manager may retain one copy in the files of its legal counsel. 14. All references in this Agreement to "days" shall mean calendar not business days. IN WITNESS WHEREOF the parties hereto execute this Agreement and make it effective on the date set forth above. CALIFORNIA INDEMNITY INSURANCE COMPANY By s/John Okita J. Okita Chief Financial Officer SIERRA HEALTH SERVICES, INC. By s/Paul Palmer P. Palmer Chief Financial Officer EX-10 16 0016.txt Exhibit 10.19 INVESTMENT SERVICES AGREEMENT THIS AGREEMENT is between COMMERCIAL CASUALTY INSURANCE COMPANY (hereafter "Company"), and SIERRA HEALTH SERVICES, Inc., a Nevada corporation (hereafter "Investment Manager") and is effective as of January 1, 1999. Whereas, Company is an insurance company with substantial investments; and Whereas, it would be beneficial for Company to obtain investment services set forth herein subject to the review and ultimate control of its Board of Directors and its appropriate officers; and Whereas, Investment Manager can supply investment services to Company as described in this Agreement. Now, therefore, the parties agree as follows: 1. INVESTMENT SERVICES (a) Investment Manager shall furnish to Company investment services for the Investment Assets (as hereinafter defined) of Company, such services to include the following: 1. to counsel and advise Company and its Board of Directors in connection with the formulation of investment programs designed to accomplish its investment objectives; and 2. to manage the Investment Assets in accordance with the laws applicable to Company and with the investment policies, objectives, directions and guidelines established by the Board of Directors and officers of Company; and 3. subject to other provisions of this Agreement including but not limited to Section 1(c) of this Agreement, to have full discretion and authority, without prior consultation or prior approval, to buy, sell and otherwise trade in stocks, bonds and other securities and take such other actions which Investment Manager shall deem requisite, appropriate or advisable. However, Investment Manager shall not act as custodian of the Investment Assets. (b) Investment Manager agrees that it will maintain adequate records relating to the furnishing of investment services under this Agreement, including those with respect to the acquisition and disposition of securities for Company. (c) Investment Manager agrees that the investment services it furnishes will be in accordance with (1) Company's general investment policies, objectives and guidelines established from time to time by its Board of Directors and (2) any written instructions given by the Chief Executive Officer or Chief Financial Officer of Company or persons designated by either of them in writing as such written instructions shall be sent from time to time in writing by Company to Investment Manager. (d) Investment Assets shall mean all bonds, stocks (exclusive of those of affiliates and subsidiaries), short-term investments and other invested assets (i) reportable as held by Company on Schedules B, BA, C and D in the Investment Reporting System of Company and (ii) any other assets of the Company as Investment Manager and Company may from time to time agree. 2. PURCHASE AND SALE OF SECURITIES (a) Investment Manager shall place all orders for the purchase and sale of portfolio securities for Company's account with brokers or dealers selected by Investment Manager, which may include a person affiliated with Investment Manager, as the term affiliated person is defined in the Investment Company Act of 1940 (hereafter "Affiliate"). Investment Manager shall seek to execute portfolio transactions on terms which are advantageous to Company. In selecting brokers or dealers to execute transactions, Investment Manager shall use its best efforts to obtain the best price and execution for Company; provided however, with respect to an Affiliate, Investment Manager shall comply with the additional requirements set forth in paragraph 2 (b) below. In evaluating the terms available for executing particular transactions for Company and in selecting brokers and dealers to execute such transactions, Investment Manager may consider, in addition to commission cost, the financial stability and reputation and execution capability of brokers and dealers and the brokerage and research services (as those terms are defined in Section 28(e) of the Securities Exchange Act of 1934, as amended) provided by brokers and dealers for the account of Company. Subject to paragraph 2(b) below, Investment Manager is authorized to pay a broker or dealer who provides such brokerage and research services a commission for executing a Company portfolio transaction which is in excess of the amount of commission another broker or dealer would have charged for effecting that transaction if Investment Manager determines that such commission is reasonable in relation to the value of the brokerage and research services provided by such broker or dealer. This determination may be made in terms of either a particular transaction or the overall responsibilities which Investment Manager has with respect to all of the accounts over which it exercises investment discretion. (b) Should an Affiliate engage in "agency cross transactions" (as defined in Section 275.206(3)-2 of the Investment Advisers Act of 1940) in which the Affiliate acts as broker for both sides of a transaction and may receive commissions from, and have a potentially conflicting division of loyalties and responsibilities regarding, both parties, or act as principal for its own account coming within the provisions of Section 206 of the Investment Advisers Act of 1940, Company for itself and its subsidiaries and affiliates which are furnished services under this Agreement consent to: (1) such agency cross transactions with such Affiliate, and (2) transactions in which such Affiliate is acting as principal for its own account, so long as more favorable terms are not practically available from another broker or seller as the case may be or so long as the specific transaction is consented to by Company. Company may revoke this consent at any time by giving notice to Investment Manager. In transactions other than agency cross transactions and principal transactions specified above, Investment Manager may select an Affiliate as a broker or dealer to place or execute orders for the purchase or sale of securities pursuant to Investment Manager's authority under this Agreement, so long as the commission rate charged by the Affiliate for such sale or purchase conforms to the requirements of paragraph 2(a) above and is equal to or lower than that charged any of its other customers for like sales or purchases. (c) Provided the investment objectives of this Agreement are adhered to, Company agrees that Investment Manager may aggregate sales and purchase orders of Investment Assets with similar orders being made simultaneously for other accounts managed by Investment Manager, if in Investment Manager's reasonable judgment such aggregation shall result in an overall economic benefit to the Investment Assets taking into consideration the advantageous selling or purchase price, brokerage commission and other expenses. Company acknowledges that the determination of such economic benefit to Company by Investment Manager represents Investment Manager's evaluation that Company is benefited by relatively better purchase or sales prices, lower commission expenses and beneficial timing of transactions or a combination of these and other factors. 3. INVESTMENT FEES; EXPENSES (a) Company shall pay to Investment Manager a fee equal to the Investment Manager's allocated costs in rendering the services in this Agreement. Allocation shall be made at the end of each calendar quarter and shall be derived from the Investment Manager's costs for such quarter allocated on the basis of the Fair Market Value of the Investment Assets for which services are rendered under this Agreement to the Fair Market Value of all Investment Assets the Investment Manager managed or for which services similar to the services under this Agreement were rendered during such Quarter. The fee shall be payable in arrears 30 days after the end of each calendar quarter in which the Investment Services Agreement is in force. (b) Fair Market Value on any date shall mean the fair market value of the Investment Assets as reported in the Company or Investment Manager Investment Reporting System for such date in accordance with the procedures and rules for such Reporting System as audited by the auditors of Company. Quarterly Ending Fair Market Value shall be the Fair Market Value on the last day of any calendar quarter. (c) If services rendered hereunder shall commence on a day other than the first day of a calendar quarter or terminate other than on the last day of a calendar quarter, the above fee shall be fairly and equitably prorated. (d) Investment Manager shall furnish at its own expense all facilities and administrative, accounting, clerical, statistical, correspondence and other services necessary to supply the investment services required under this Agreement. However, Company shall be responsible for the expenses of: (1) brokerage commissions, issue and transfer taxes and other costs in connection with securities transactions to which Company is a party, including any portion of such commissions attributable to research and brokerage services; (2) taxes payable by Company to federal, state and other governmental agencies, (3) primary record keeping and (4) custodial fees and expenses. 4. ULTIMATE CONTROL ---------------- All services furnished under this Agreement shall always be subject to the direction and control of the Board of Directors and the authorized Officers of Company. The Board shall act in accordance with Section 1200 of the California Insurance Code to approve or ratify all the investments made in accordance with this Agreement and; if the Board acts not to approve any investment made under this Agreement the investment shall be disposed of in as prompt a manner as reasonable. Notwithstanding any other provision of this Agreement, it is understood and agreed that Company reserves the right to direct any action to be taken hereunder on its behalf by Investment Manager. 5. NON-EXCLUSIVITY OF SERVICES The services of Investment Manager to be provided to Company hereunder are not to be deemed exclusive and Investment Manager shall be free to provide similar services for its own account and the accounts of other persons provided that such services do not materially interfere with its services hereunder. 6. LIABILITY; INDEMNIFICATION Investment Manager shall be liable to Company for any liability, damages or expenses of Company arising out of the negligence, gross negligence or willful misfeasance of Investment Manager or any of its directors, officers, employees or Affiliates in providing services under this Agreement. 7. TERMINATION This Agreement may be terminated by either Company or Investment Manager upon notice to the other party sent at least thirty days prior to the date set for termination in such notice; provided further, that in the event of a material breach of this Agreement by the other party, this Agreement may be terminated by Company or Investment Manager upon notice in writing sent at least 10 days prior to the date set for termination in such notice. Company shall pay any investment fees due hereunder, prorated to the date of termination, within ten days following the date of termination. 8. NOTICES Notices or other writings given or sent under or pursuant to this Agreement shall be in writing and be deemed to have been given or sent if delivered to the party at its address listed below in person or by telex or telecopy or within 2 days of mailing if mailed postage prepaid to such address. The addresses of the parties are: Commercial Casualty Insurance Company 2716 North Tenaya Way Las Vegas, Nevada 89128 Attention: Chief Financial Officer Telecopy :702 869 2379 Sierra Health Services, Inc. 2720 North Tenaya Way Las Vegas, Nevada 89128 Attention: Chief Financial Officer Telecopy :702 242 7534 Each party may change its address by giving notice as herein required. 9. SOLE INSTRUMENT --------------- This instrument constitutes the sole and only agreement of the parties to it relating to its object and correctly sets forth the rights, duties, and obligations of each party to the other as of its date. Any prior agreements, promises, negotiations or representations not expressly set forth in this Agreement are of no force or effect. 10. WAIVER OR MODIFICATION No waiver or modification of this Agreement shall be effective unless reduced to a written document signed by the party to be charged. 11. LAW OF CALIFORNIA This Agreement shall be governed by and construed in accordance with the laws of the State of California . 12. ASSIGNMENT AND DELEGATION No party to this Agreement shall have the right to sell, transfer, delegate, or assign this Agreement, its rights or duties to any person, firm, or corporation at any time during its term and any proposed assignee shall acquire no rights nor be able to assume any obligations unless the written consent of the other party to this Agreement is given before such assignment or delegation takes place. Nevertheless, Investment Manager may appoint other investment advisers as sub advisers for the Investment Assets. 13. REPORTS AND RECORDS Investment Manager shall provide to Company such oral or written reports as to its services provided under this Agreement as Company shall reasonably require but shall report investments at least quarterly. All records maintained pursuant to this Agreement shall be deemed the property of Company and shall be subject to examination by Company and by persons authorized by it, or by governmental authorities, at all times upon reasonable notice. Except as expressly authorized in this Agreement or directed by the other party in writing, Investment Manager and Company shall keep confidential the records and other information obtained by reason of this Agreement (including, with respect to Company, the investment information and recommendations provided to it by Investment Manager). Upon termination of this Agreement, Investment Manager shall promptly upon demand return to Company all such records, except that Investment Manager may retain one copy in the files of its legal counsel. 14. All references in this Agreement to "days" shall mean calendar not business days. IN WITNESS WHEREOF the parties hereto execute this Agreement and make it effective on the date set forth above. COMMERCIAL CASUALTY INSURANCE COMPANY by s/John Okita J. Okita Chief Financial Officer SIERRA HEALTH SERVICES, INC. by s/Paul Palmer P. Palmer Chief Financial Officer EX-10 17 0017.txt Exhibit 10.20 INVESTMENT SERVICES AGREEMENT THIS AGREEMENT is between CII INSURANCE COMPANY (hereafter "Company"), and SIERRA HEALTH SERVICES, Inc., a Nevada corporation (hereafter "Investment Manager") and is effective as of January 1, 1999. Whereas, Company is an insurance company with substantial investments; and Whereas, it would be beneficial for Company to obtain investment services set forth herein subject to the review and ultimate control of its Board of Directors and its appropriate officers; and Whereas, Investment Manager can supply investment services to Company as described in this Agreement. Now, therefore, the parties agree as follows: 1. INVESTMENT SERVICES (a) Investment Manager shall furnish to Company investment services for the Investment Assets (as hereinafter defined) of Company, such services to include the following: 1. to counsel and advise Company and its Board of Directors in connection with the formulation of investment programs designed to accomplish its investment objectives; and 2. to manage the Investment Assets in accordance with the laws applicable to Company and with the investment policies, objectives, directions and guidelines established by the Board of Directors and officers of Company; and 3. subject to other provisions of this Agreement including but not limited to Section 1(c) of this Agreement, to have full discretion and authority, without prior consultation or prior approval, to buy, sell and otherwise trade in stocks, bonds and other securities and take such other actions which Investment Manager shall deem requisite, appropriate or advisable. However, Investment Manager shall not act as custodian of the Investment Assets. (b) Investment Manager agrees that it will maintain adequate records relating to the furnishing of investment services under this Agreement, including those with respect to the acquisition and disposition of securities for Company. (c) Investment Manager agrees that the investment services it furnishes will be in accordance with (1) Company's general investment policies, objectives and guidelines established from time to time by its Board of Directors and (2) any written instructions given by the Chief Executive Officer or Chief Financial Officer of Company or persons designated by either of them in writing as such written instructions shall be sent from time to time in writing by Company to Investment Manager. (d) Investment Assets shall mean all bonds, stocks (exclusive of those of affiliates and subsidiaries), short-term investments and other invested assets (i) reportable as held by Company on Schedules B, BA, C and D in the Investment Reporting System of Company and (ii) any other assets of the Company as Investment Manager and Company may from time to time agree. 2. PURCHASE AND SALE OF SECURITIES (a) Investment Manager shall place all orders for the purchase and sale of portfolio securities for Company's account with brokers or dealers selected by Investment Manager, which may include a person affiliated with Investment Manager, as the term affiliated person is defined in the Investment Company Act of 1940 (hereafter "Affiliate"). Investment Manager shall seek to execute portfolio transactions on terms which are advantageous to Company. In selecting brokers or dealers to execute transactions, Investment Manager shall use its best efforts to obtain the best price and execution for Company; provided however, with respect to an Affiliate, Investment Manager shall comply with the additional requirements set forth in paragraph 2 (b) below. In evaluating the terms available for executing particular transactions for Company and in selecting brokers and dealers to execute such transactions, Investment Manager may consider, in addition to commission cost, the financial stability and reputation and execution capability of brokers and dealers and the brokerage and research services (as those terms are defined in Section 28(e) of the Securities Exchange Act of 1934, as amended) provided by brokers and dealers for the account of Company. Subject to paragraph 2(b) below, Investment Manager is authorized to pay a broker or dealer who provides such brokerage and research services a commission for executing a Company portfolio transaction which is in excess of the amount of commission another broker or dealer would have charged for effecting that transaction if Investment Manager determines that such commission is reasonable in relation to the value of the brokerage and research services provided by such broker or dealer. This determination may be made in terms of either a particular transaction or the overall responsibilities which Investment Manager has with respect to all of the accounts over which it exercises investment discretion. (b) Should an Affiliate engage in "agency cross transactions" (as defined in Section 275.206(3)-2 of the Investment Advisers Act of 1940) in which the Affiliate acts as broker for both sides of a transaction and may receive commissions from, and have a potentially conflicting division of loyalties and responsibilities regarding, both parties, or act as principal for its own account coming within the provisions of Section 206 of the Investment Advisers Act of 1940, Company for itself and its subsidiaries and affiliates which are furnished services under this Agreement consent to: (1) such agency cross transactions with such Affiliate, and (2) transactions in which such Affiliate is acting as principal for its own account, so long as more favorable terms are not practically available from another broker or seller as the case may be or so long as the specific transaction is consented to by Company. Company may revoke this consent at any time by giving notice to Investment Manager. In transactions other than agency cross transactions and principal transactions specified above, Investment Manager may select an Affiliate as a broker or dealer to place or execute orders for the purchase or sale of securities pursuant to Investment Manager's authority under this Agreement, so long as the commission rate charged by the Affiliate for such sale or purchase conforms to the requirements of paragraph 2(a) above and is equal to or lower than that charged any of its other customers for like sales or purchases. (c) Provided the investment objectives of this Agreement are adhered to, Company agrees that Investment Manager may aggregate sales and purchase orders of Investment Assets with similar orders being made simultaneously for other accounts managed by Investment Manager, if in Investment Manager's reasonable judgment such aggregation shall result in an overall economic benefit to the Investment Assets taking into consideration the advantageous selling or purchase price, brokerage commission and other expenses. Company acknowledges that the determination of such economic benefit to Company by Investment Manager represents Investment Manager's evaluation that Company is benefited by relatively better purchase or sales prices, lower commission expenses and beneficial timing of transactions or a combination of these and other factors. 3. INVESTMENT FEES; EXPENSES (a) Company shall pay to Investment Manager a fee equal to the Investment Manager's allocated costs in rendering the services in this Agreement. Allocation shall be made at the end of each calendar quarter and shall be derived from the Investment Manager's costs for such quarter allocated on the basis of the Fair Market Value of the Investment Assets for which services are rendered under this Agreement to the Fair Market Value of all Investment Assets the Investment Manager managed or for which services similar to the services under this Agreement were rendered during such Quarter. The fee shall be payable in arrears 30 days after the end of each calendar quarter in which the Investment Services Agreement is in force. (b) Fair Market Value on any date shall mean the fair market value of the Investment Assets as reported in the Company or Investment Manager Investment Reporting System for such date in accordance with the procedures and rules for such Reporting System as audited by the auditors of Company. Quarterly Ending Fair Market Value shall be the Fair Market Value on the last day of any calendar quarter. (c) If services rendered hereunder shall commence on a day other than the first day of a calendar quarter or terminate other than on the last day of a calendar quarter, the above fee shall be fairly and equitably prorated. (d) Investment Manager shall furnish at its own expense all facilities and administrative, accounting, clerical, statistical, correspondence and other services necessary to supply the investment services required under this Agreement. However, Company shall be responsible for the expenses of: (1) brokerage commissions, issue and transfer taxes and other costs in connection with securities transactions to which Company is a party, including any portion of such commissions attributable to research and brokerage services; (2) taxes payable by Company to federal, state and other governmental agencies, (3) primary record keeping and (4) custodial fees and expenses. 4. ULTIMATE CONTROL ---------------- All services furnished under this Agreement shall always be subject to the direction and control of the Board of Directors and the authorized Officers of Company. The Board shall act in accordance with Section 1200 of the California Insurance Code to approve or ratify all the investments made in accordance with this Agreement and; if the Board acts not to approve any investment made under this Agreement the investment shall be disposed of in as prompt a manner as reasonable. Notwithstanding any other provision of this Agreement, it is understood and agreed that Company reserves the right to direct any action to be taken hereunder on its behalf by Investment Manager. 5. NON-EXCLUSIVITY OF SERVICES The services of Investment Manager to be provided to Company hereunder are not to be deemed exclusive and Investment Manager shall be free to provide similar services for its own account and the accounts of other persons provided that such services do not materially interfere with its services hereunder. 6. LIABILITY; INDEMNIFICATION Investment Manager shall be liable to Company for any liability, damages or expenses of Company arising out of the negligence, gross negligence or willful misfeasance of Investment Manager or any of its directors, officers, employees or Affiliates in providing services under this Agreement. 7. TERMINATION This Agreement may be terminated by either Company or Investment Manager upon notice to the other party sent at least thirty days prior to the date set for termination in such notice; provided further, that in the event of a material breach of this Agreement by the other party, this Agreement may be terminated by Company or Investment Manager upon notice in writing sent at least 10 days prior to the date set for termination in such notice. Company shall pay any investment fees due hereunder, prorated to the date of termination, within ten days following the date of termination. 8. NOTICES Notices or other writings given or sent under or pursuant to this Agreement shall be in writing and be deemed to have been given or sent if delivered to the party at its address listed below in person or by telex or telecopy or within 2 days of mailing if mailed postage prepaid to such address. The addresses of the parties are: CII Insurance Company 2716 North Tenaya Way Las Vegas, Nevada 89128 Attention: Chief Financial Officer Telecopy :702 869 2379 Sierra Health Services, Inc. 2720 North Tenaya Way Las Vegas, Nevada 89128 Attention: Chief Financial Officer Telecopy :702 242 7534 Each party may change its address by giving notice as herein required. 9. SOLE INSTRUMENT --------------- This instrument constitutes the sole and only agreement of the parties to it relating to its object and correctly sets forth the rights, duties, and obligations of each party to the other as of its date. Any prior agreements, promises, negotiations or representations not expressly set forth in this Agreement are of no force or effect. 10. WAIVER OR MODIFICATION No waiver or modification of this Agreement shall be effective unless reduced to a written document signed by the party to be charged. 11. LAW OF CALIFORNIA ----------------- This Agreement shall be governed by and construed in accordance with the laws of the State of California . 12. ASSIGNMENT AND DELEGATION No party to this Agreement shall have the right to sell, transfer, delegate, or assign this Agreement, its rights or duties to any person, firm, or corporation at any time during its term and any proposed assignee shall acquire no rights nor be able to assume any obligations unless the written consent of the other party to this Agreement is given before such assignment or delegation takes place. Nevertheless, Investment Manager may appoint other investment advisers as sub advisers for the Investment Assets. 13. REPORTS AND RECORDS Investment Manager shall provide to Company such oral or written reports as to its services provided under this Agreement as Company shall reasonably require but shall report investments at least quarterly. All records maintained pursuant to this Agreement shall be deemed the property of Company and shall be subject to examination by Company and by persons authorized by it, or by governmental authorities, at all times upon reasonable notice. Except as expressly authorized in this Agreement or directed by the other party in writing, Investment Manager and Company shall keep confidential the records and other information obtained by reason of this Agreement (including, with respect to Company, the investment information and recommendations provided to it by Investment Manager). Upon termination of this Agreement, Investment Manager shall promptly upon demand return to Company all such records, except that Investment Manager may retain one copy in the files of its legal counsel. 14. All references in this Agreement to "days" shall mean calendar not business days. IN WITNESS WHEREOF the parties hereto execute this Agreement and make it effective on the date set forth above. CII INSURANCE COMPANY by_______s/___________________________ J. Okita Chief Financial Officer SIERRA HEALTH SERVICES, INC. by________s/__________________________ P. Palmer Chief Financial Officer EX-10 18 0018.txt Exhibit 10.21 INVESTMENT SERVICES AGREEMENT THIS AGREEMENT is between SIERRA INSURANCE COMPANY OF TEXAS (hereafter "Company"), and SIERRA HEALTH SERVICES, Inc., a Nevada corporation (hereafter "Investment Manager") and is effective as of January 1, 1999. Whereas, Company is an insurance company with substantial investments; and Whereas, it would be beneficial for Company to obtain investment services set forth herein subject to the review and ultimate control of its Board of Directors and its appropriate officers; and Whereas, Investment Manager can supply investment services to Company as described in this Agreement. Now, therefore, the parties agree as follows: 1. INVESTMENT SERVICES (a) Investment Manager shall furnish to Company investment services for the Investment Assets (as hereinafter defined) of Company, such services to include the following: 1. to counsel and advise Company and its Board of Directors in connection with the formulation of investment programs designed to accomplish its investment objectives; and 2. to manage the Investment Assets in accordance with the laws applicable to Company and with the investment policies, objectives, directions and guidelines established by the Board of Directors and officers of Company; and 3. subject to other provisions of this Agreement including but not limited to Section 1(c) of this Agreement, to have full discretion and authority, without prior consultation or prior approval, to buy, sell and otherwise trade in stocks, bonds and other securities and take such other actions which Investment Manager shall deem requisite, appropriate or advisable. However, Investment Manager shall not act as custodian of the Investment Assets. (b) Investment Manager agrees that it will maintain adequate records relating to the furnishing of investment services under this Agreement, including those with respect to the acquisition and disposition of securities for Company. (c) Investment Manager agrees that the investment services it furnishes will be in accordance with (1) Company's general investment policies, objectives and guidelines established from time to time by its Board of Directors and (2) any written instructions given by the Chief Executive Officer or Chief Financial Officer of Company or persons designated by either of them in writing as such written instructions shall be sent from time to time in writing by Company to Investment Manager. (d) Investment Assets shall mean all bonds, stocks (exclusive of those of affiliates and subsidiaries), short-term investments and other invested assets (i) reportable as held by Company on Schedules B, BA, C and D in the Investment Reporting System of Company and (ii) any other assets of the Company as Investment Manager and Company may from time to time agree. 2. PURCHASE AND SALE OF SECURITIES (a) Investment Manager shall place all orders for the purchase and sale of portfolio securities for Company's account with brokers or dealers selected by Investment Manager, which may include a person affiliated with Investment Manager, as the term affiliated person is defined in the Investment Company Act of 1940 (hereafter "Affiliate"). Investment Manager shall seek to execute portfolio transactions on terms which are advantageous to Company. In selecting brokers or dealers to execute transactions, Investment Manager shall use its best efforts to obtain the best price and execution for Company; provided however, with respect to an Affiliate, Investment Manager shall comply with the additional requirements set forth in paragraph 2 (b) below. In evaluating the terms available for executing particular transactions for Company and in selecting brokers and dealers to execute such transactions, Investment Manager may consider, in addition to commission cost, the financial stability and reputation and execution capability of brokers and dealers and the brokerage and research services (as those terms are defined in Section 28(e) of the Securities Exchange Act of 1934, as amended) provided by brokers and dealers for the account of Company. Subject to paragraph 2(b) below, Investment Manager is authorized to pay a broker or dealer who provides such brokerage and research services a commission for executing a Company portfolio transaction which is in excess of the amount of commission another broker or dealer would have charged for effecting that transaction if Investment Manager determines that such commission is reasonable in relation to the value of the brokerage and research services provided by such broker or dealer. This determination may be made in terms of either a particular transaction or the overall responsibilities which Investment Manager has with respect to all of the accounts over which it exercises investment discretion. (b) Should an Affiliate engage in "agency cross transactions" (as defined in Section 275.206(3)-2 of the Investment Advisers Act of 1940) in which the Affiliate acts as broker for both sides of a transaction and may receive commissions from, and have a potentially conflicting division of loyalties and responsibilities regarding, both parties, or act as principal for its own account coming within the provisions of Section 206 of the Investment Advisers Act of 1940, Company for itself and its subsidiaries and affiliates which are furnished services under this Agreement consent to: (1) such agency cross transactions with such Affiliate, and (2) transactions in which such Affiliate is acting as principal for its own account, so long as more favorable terms are not practically available from another broker or seller as the case may be or so long as the specific transaction is consented to by Company. Company may revoke this consent at any time by giving notice to Investment Manager. In transactions other than agency cross transactions and principal transactions specified above, Investment Manager may select an Affiliate as a broker or dealer to place or execute orders for the purchase or sale of securities pursuant to Investment Manager's authority under this Agreement, so long as the commission rate charged by the Affiliate for such sale or purchase conforms to the requirements of paragraph 2(a) above and is equal to or lower than that charged any of its other customers for like sales or purchases. (c) Provided the investment objectives of this Agreement are adhered to, Company agrees that Investment Manager may aggregate sales and purchase orders of Investment Assets with similar orders being made simultaneously for other accounts managed by Investment Manager, if in Investment Manager's reasonable judgment such aggregation shall result in an overall economic benefit to the Investment Assets taking into consideration the advantageous selling or purchase price, brokerage commission and other expenses. Company acknowledges that the determination of such economic benefit to Company by Investment Manager represents Investment Manager's evaluation that Company is benefited by relatively better purchase or sales prices, lower commission expenses and beneficial timing of transactions or a combination of these and other factors. 3. INVESTMENT FEES; EXPENSES (a) Company shall pay to Investment Manager a fee equal to the Investment Manager's allocated costs in rendering the services in this Agreement. Allocation shall be made at the end of each calendar quarter and shall be derived from the Investment Manager's costs for such quarter allocated on the basis of the Fair Market Value of the Investment Assets for which services are rendered under this Agreement to the Fair Market Value of all Investment Assets the Investment Manager managed or for which services similar to the services under this Agreement were rendered during such Quarter. The fee shall be payable in arrears 30 days after the end of each calendar quarter in which the Investment Services Agreement is in force. (b) Fair Market Value on any date shall mean the fair market value of the Investment Assets as reported in the Company or Investment Manager Investment Reporting System for such date in accordance with the procedures and rules for such Reporting System as audited by the auditors of Company. Quarterly Ending Fair Market Value shall be the Fair Market Value on the last day of any calendar quarter. (c) If services rendered hereunder shall commence on a day other than the first day of a calendar quarter or terminate other than on the last day of a calendar quarter, the above fee shall be fairly and equitably prorated. (d) Investment Manager shall furnish at its own expense all facilities and administrative, accounting, clerical, statistical, correspondence and other services necessary to supply the investment services required under this Agreement. However, Company shall be responsible for the expenses of: (1) brokerage commissions, issue and transfer taxes and other costs in connection with securities transactions to which Company is a party, including any portion of such commissions attributable to research and brokerage services; (2) taxes payable by Company to federal, state and other governmental agencies, (3) primary record keeping and (4) custodial fees and expenses. 4. ULTIMATE CONTROL All services furnished under this Agreement shall always be subject to the direction and control of the Board of Directors and the authorized Officers of Company. The Board shall act to approve the investments made in accordance with this Agreement; if the Board acts not to approve any investment made under this Agreement the investment shall be disposed of in as prompt a manner as reasonable. Notwithstanding any other provision of this Agreement, it is understood and agreed that Company reserves the right to direct any action to be taken hereunder on its behalf by Investment Manager. 5. NON-EXCLUSIVITY OF SERVICES The services of Investment Manager to be provided to Company hereunder are not to be deemed exclusive and Investment Manager shall be free to provide similar services for its own account and the accounts of other persons provided that such services do not materially interfere with its services hereunder. 6. LIABILITY; INDEMNIFICATION Investment Manager shall be liable to Company for any liability, damages or expenses of Company arising out of the negligence, gross negligence or willful misfeasance of Investment Manager or any of its directors, officers, employees or Affiliates in providing services under this Agreement. 7. TERMINATION This Agreement may be terminated by either Company or Investment Manager upon notice to the other party sent at least thirty days prior to the date set for termination in such notice; provided further, that in the event of a material breach of this Agreement by the other party, this Agreement may be terminated by Company or Investment Manager upon notice in writing sent at least 10 days prior to the date set for termination in such notice. Company shall pay any investment fees due hereunder, prorated to the date of termination, within ten days following the date of termination. 8. NOTICES Notices or other writings given or sent under or pursuant to this Agreement shall be in writing and be deemed to have been given or sent if delivered to the party at its address listed below in person or by telex or telecopy or within 2 days of mailing if mailed postage prepaid to such address. The addresses of the parties are: Sierra Insurance Company of Texas 2716 North Tenaya Way Las Vegas, Nevada 89128 Attention: Chief Financial Officer Telecopy :702 869 2379 Sierra Health Services, Inc. 2720 North Tenaya Way Las Vegas, Nevada 89128 Attention: Chief Financial Officer Telecopy :702 242 7534 Each party may change its address by giving notice as herein required. 9. SOLE INSTRUMENT This instrument constitutes the sole and only agreement of the parties to it relating to its object and correctly sets forth the rights, duties, and obligations of each party to the other as of its date. Any prior agreements, promises, negotiations or representations not expressly set forth in this Agreement are of no force or effect. 10. WAIVER OR MODIFICATION No waiver or modification of this Agreement shall be effective unless reduced to a written document signed by the party to be charged. 11. LAW OF TEXAS This Agreement shall be governed by and construed in accordance with the laws of the State of Texas. 12. ASSIGNMENT AND DELEGATION No party to this Agreement shall have the right to sell, transfer, delegate, or assign this Agreement, its rights or duties to any person, firm, or corporation at any time during its term and any proposed assignee shall acquire no rights nor be able to assume any obligations unless the written consent of the other party to this Agreement is given before such assignment or delegation takes place. Nevertheless, Investment Manager may appoint other investment advisers as sub advisers for the Investment Assets. 13. REPORTS AND RECORDS Investment Manager shall provide to Company such oral or written reports as to its services provided under this Agreement as Company shall reasonably require. All records maintained pursuant to this Agreement shall be deemed the property of Company and shall be subject to examination by Company and by persons authorized by it, or by governmental authorities, at all times upon reasonable notice. Except as expressly authorized in this Agreement or directed by the other party in writing, Investment Manager and Company shall keep confidential the records and other information obtained by reason of this Agreement (including, with respect to Company, the investment information and recommendations provided to it by Investment Manager). Upon termination of this Agreement, Investment Manager shall promptly upon demand return to Company all such records, except that Investment Manager may retain one copy in the files of its legal counsel. 14. All references in this Agreement to "days" shall mean calendar not business days. IN WITNESS WHEREOF the parties hereto execute this Agreement and make it effective on the date set forth above. SIERRA INSURANCE COMPANY OF TEXAS by__________________________________ J. Okita Chief Financial Officer SIERRA HEALTH SERVICES, INC. by__________________________________ P. Palmer Chief Financial Officer EX-12 19 0019.txt EXHIBIT 12 RATIO OF EARNINGS TO FIXED CHARGES
Nine Months Ended For the year Ended December 31, September 30, ----------------- --------------------------------------------------- 2000 1999 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- ---- ---- (dollars in thousands) (dollars in thousands) Pre-tax (loss) income before $(14,007) $11,854 $7,095 $17,878 $10,813 $10,630 $9,083 discontinued operations and extraordinary gains Fixed Charges: Interest expense 2,717 2,751 3,706 4,301 4,091 4,123 4,868 Capitalized interest 0 130 130 0 0 0 0 Interest relating to rental 704 632 867 438 438 542 491 ------ ------ ------ ------ ------ ------ ------ expense (1) Total fixed charges 3,421 3,513 4,703 4,739 4,524 4,665 5,359 Earnings available for fixed $(10,586) $15,367 $11,798 $22,617 $15,342 $15,295 $14,442 charges Ratio of earnings to fixed charges (3.09x) 4.37x 2.51x 4.77x 3.39x 3.28x 2.69x - ------------------------------------ ------------ ---------- ---------- ----------- ---------- ------------ ----------
- ------------------------- (1) The representative interest portion of rental expense was deemed to be one-third of all rental expense. Earnings were not sufficient to cover fixed charges during the first nine months of 2000 by $14,007,000; all other periods had sufficient income to cover charges. PRO FORMA RATIO OF EARNINGS TO FIXED CHARGES
Nine Nine Nine Months Months Year Months Year Ended Year Ended Ended Ended Ended Ended September December September December September December 30, 2000 31, 1999 30, 2000 31, 1999 30, 2000 31, 1999 --------- --------- --------- -------- --------- --------- Presentation One (1) Presentation Two (2) Presentation Three (3) (dollars in thousands) (dollars in thousands) (dollars in thousands) Pre-tax (loss) income before $(13,012) $6,907 $(13,747) $5,975 $(14,551) $4,962 discontinued operations and extraordinary gains Fixed Charges: Interest expense 1,382 1,840 2,116 2,772 3,176 4,126 Capitalized interest 0 130 0 130 0 130 Interest relating to rental 704 867 704 867 704 867 ------ ------ ------ ------ ------ ------ expense (4) Total fixed charges 2,086 2,837 2,820 3,769 3,880 5,123 Earnings available for fixed $(10,926) $9,744 $(10,927) $9,744 $(10,671) $10,085 charges Ratio of earnings to fixed (5.24x) 3.44x (3.87x) 2.59x (2.75x) 1.97x charges - ----------------------------------- ------------ ------------ ------------ ---------- ------------ -----------
- ------------------------- (1) Presentation One assumes the exchange of $47,059,000 in principal amount of old junior subordinated debentures for $10,237,500 in cash and $27,559,000 in principal amount of new 9% senior subordinated debentures. (2) Presentation Two assumes the exchange of $47,059,000 in principal amount of old junior subordinated debentures for $5,250,000 in cash and $37,059,000 in principal amount of new 9% senior subordinated debentures. (3) Presentation Three assumes the exchange of $47,059,000 in principal amount of old junior subordinated debentures for $47,059,000 in principal amount of new 9% senior subordinated debentures. (4) The representative interest portion of rental expense was deemed to be one-third of all rental expense. Pro forma earnings were not sufficient to cover fixed charges during the first nine months of 2000 by $13,012,000 for presentation one, $13,747,000 for presentation two and $14,551,000 for presentation three; all other periods had sufficient income to cover charges. EX-21 20 0020.txt Exhibit 21 Subsidiaries of the Company Name of Company Incorporated Under the Laws of CII Insurance Agency, Inc. California California Indemnity Insurance Company California Commercial Casualty Insurance Company California CII Insurance Company California Sierra Insurance Company of Texas Texas Sierra Financial Agency, Inc. Nevada EX-23 21 0021.txt Exhibit 23.1 INDEPENDENT AUDITORS' CONSENT To the Board of Directors and Stockholder of CII Financial, Inc. Las Vegas, Nevada We consent to the use in this Amendment No. 1 to Registration Statement No.333-52726 of CII Financial, Inc. on Form S-4 of our report dated December 21, 2000 (except for Note 12 as to which the date is December 28, 2000), appearing in the Prospectus, which is a part of this Registration Statement, and to the references to us under the headings "Summary Historical Financial and Other Data of CII Financial", "Selected Financial and Other Data" and "Experts" in such Prospectus. /s/DELOITTE & TOUCHE LLP Las Vegas, Nevada February 2, 2001 EX-25 22 0022.txt Exhibit 25 =============================================================================== =============================================================================== SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------------------- FORM T-1 STATEMENT OF ELIGIBILITY UNDER THE TRUST INDENTURE ACT OF 1939 OF A CORPORATION DESIGNATED TO ACT AS TRUSTEE ----------------------------- CHECK IF AN APPLICATION TO DETERMINE ELIGIBILITY OF A TRUSTEE - ----- PURSUANT TO SECTION 305(b) (2) WELLS FARGO BANK MINNESOTA, NATIONAL ASSOCIATION (Exact name of trustee as specified in its charter) A U.S. National Banking Association 41-1592157 (Jurisdiction of incorporation or (I.R.S. Employer organization if not a U.S. national Identification No.) bank) Sixth Street and Marquette Avenue Minneapolis, Minnesota 55479 (Address of principal executive offices) (Zip code) Stanley S. Stroup, General Counsel WELLS FARGO BANK MINNESOTA, NATIONAL ASSOCIATION Sixth Street and Marquette Avenue Minneapolis, Minnesota 55479 (612) 667-1234 (Agent for Service) ----------------------------- CII FINANCIAL, INC. (Exact name of obligor as specified in its charter) California 95-4188244 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2716 North Tenaya Way Las Vegas, Nevada 89128 (Address of principal executive offices) (Zip code) ----------------------------- 9% Senior Subordinated Debentures due 2006 (Title of the indenture securities) ============================================================================= Item 1. General Information. Furnish the following information as to the trustee: -------------------- (a) Name and address of each examining or supervising authority to which it is subject. Comptroller of the Currency Treasury Department Washington, D.C. Federal Deposit Insurance Corporation Washington, D.C. The Board of Governors of the Federal Reserve System Washington, D.C. (b) Whether it is authorized to exercise corporate trust powers. The trustee is authorized to exercise corporate trust powers. Item 2. Affiliations with Obligor. If the obligor is an affiliate of the trustee, describe each such affiliation. -------------------------- None with respect to the trustee. No responses are included for Items 3-14 of this Form T-1 because the obligor is not in default as provided under Item 13. Item 15. Foreign Trustee. Not applicable. ---------------- Item 16. List of Exhibits. List below all exhibits filed as a part of this Statement of Eligibility. ----------------- Wells Fargo Bank incorporates by reference into this Form T-1 the exhibits attached hereto. Exhibit 1. a. A copy of the Articles of Association of the trustee now in effect.*** Exhibit 2. a. A copy of the certificate of authority of the trustee to commence business issued June 28, 1872, by the Comptroller of the Currency to The Northwestern National Bank of Minneapolis.* b. A copy of the certificate of the Comptroller of the Currency dated January 2, 1934, approving the consolidation of The Northwestern National Bank of Minneapolis and The Minnesota Loan and Trust Company of Minneapolis, with the surviving entity being titled Northwestern National Bank and Trust Company of Minneapolis.* c. A copy of the certificate of the Acting Comptroller of the Currency dated January 12, 1943, as to change of corporate title of Northwestern National Bank and Trust Company of Minneapolis to Northwestern National Bank of Minneapolis.* d. A copy of the letter dated May 12, 1983 from the Regional Counsel, Comptroller of the Currency, acknowledging receipt of notice of name change effective May 1, 1983 from Northwestern National Bank of Minneapolis to Norwest Bank Minneapolis, National Association.* e. A copy of the letter dated January 4, 1988 from the Administrator of National Banks for the Comptroller of the Currency certifying approval of consolidation and merger effective January 1, 1988 of Norwest Bank Minneapolis, National Association with various other banks under the title of "Norwest Bank Minnesota, National Association."* f. A copy of the letter dated July 10, 2000 from the Administrator of National Banks for the Comptroller of the Currency certifying approval of consolidation effective July 8, 2000 of Norwest Bank Minnesota, National Association with various other banks under the title of "Wells Fargo Bank Minnesota, National Association."**** Exhibit 3. A copy of the authorization of the trustee to exercise corporate trust powers issued January 2, 1934, by the Federal Reserve Board.* Exhibit 4. Copy of By-laws of the trustee as now in effect.*** Exhibit 5. Not applicable. Exhibit 6. The consent of the trustee required by Section 321(b) of the Act. Exhibit 7. A copy of the latest report of condition of the trustee published pursuant to law or the requirements of its supervising or examining authority. Filed in paper format pursuant to form SE. Exhibit 8. Not applicable. Exhibit 9. Not applicable. * Incorporated by reference to exhibit number 25 filed with registration statement number 33-66026. *** Incorporated by reference to exhibit T3G filed with registration statement number 022-22473 **** Incorporated by reference to exhibit number 25.1 filed with registration statement number 001-15891 SIGNATURE Pursuant to the requirements of the Trust Indenture Act of 1939, as amended, the trustee, Wells Fargo Bank Minnesota, National Association, a national banking association organized and existing under the laws of the United States of America, has duly caused this statement of eligibility to be signed on its behalf by the undersigned, thereunto duly authorized, all in the City of Minneapolis and State of Minnesota on the 24th day of January 2001. WELLS FARGO BANK MINNESOTA, NATIONAL ASSOCIATION ---------------------- Timothy P. Mowdy Corporate Trust Officer EXHIBIT 6 January 24, 2001 Securities and Exchange Commission Washington, D.C. 20549 Gentlemen: In accordance with Section 321(b) of the Trust Indenture Act of 1939, as amended, the undersigned hereby consents that reports of examination of the undersigned made by Federal, State, Territorial, or District authorities authorized to make such examination may be furnished by such authorities to the Securities and Exchange Commission upon its request therefor. Very truly yours, WELLS FARGO BANK MINNESOTA, NATIONAL ASSOCIATION -------------------------- Timothy P. Mowdy Corporate Trust Officer -----END PRIVACY-ENHANCED MESSAGE-----