-----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, P1W6XX/p8NqMjfBkA+KsU8Au+ijmOV6lDCCbB6co9eGqQ5+hEdpUczW7h4hVgWnz Rx3agB36oRigwVwDDCoqJA== 0000912057-97-011132.txt : 19970401 0000912057-97-011132.hdr.sgml : 19970401 ACCESSION NUMBER: 0000912057-97-011132 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: HCC INSURANCE HOLDINGS INC/DE/ CENTRAL INDEX KEY: 0000888919 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 760336636 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-13790 FILM NUMBER: 97569039 BUSINESS ADDRESS: STREET 1: 13403 NORTHWEST FRWY CITY: HOUSTON STATE: TX ZIP: 77040-6094 BUSINESS PHONE: 7136907300 10-K 1 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K /X/ Annual Report pursuant to Section 13 or 15(d)of the Securities Exchange Act of 1934 (Fee required). / / Transaction report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (No fee required). For the fiscal year ended _______December 31, 1996________________________ Commission file number _______0-20766_____________________________________ HCC Insurance Holdings, Inc. - -------------------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 76-0336636 - -------------------------------------------------------------------------------------------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 13403 Northwest Freeway, Houston, Texas 77040-6094 - -------------------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (713) 690-7300 - -------------------------------------------------------------------------------------------- (Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act: NONE Securities registered pursuant to Section 12 (g) of the Act: TITLE OF EACH CLASS COMMON STOCK, $1.00 PAR VALUE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __X__ No _____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. / / The aggregate market value on March 24, 1997, of the voting stock held by non-affiliates of the registrant was approximately $620.4 million. For purposes of the determination of the above stated amount, only directors and executive officers are presumed to be affiliates. The number of shares outstanding of each of the registrant's classes of common stock as of March 24, 1997:
CLASS SHARES OUTSTANDING - -------------------------------------------------------------------------- ------------------ Common Stock, $1.00 par value............................................. 36,167,935
Documents incorporated by reference: Information called for in Part III of this Form 10-K is incorporated by reference to the Registrant's definitive Proxy Statement to be filed within 120 days of the close of the Registrant's fiscal year in connection with the Registrant's annual meeting of shareholders. TABLE OF CONTENTS HCC INSURANCE HOLDINGS, INC.
PAGE ----- PART I. ITEM 1. Business......................................................................... 3 ITEM 2. Properties....................................................................... 20 ITEM 3 Legal Proceedings................................................................ 20 ITEM 4. Submission of Matters to a Vote of Security Holders.............................. 20 PART II. ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters........ 21 ITEM 6. Selected Financial Data.......................................................... 22 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....................................................................... 24 ITEM 8. Financial Statements and Supplementary Data...................................... 29 ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures...................................................................... 30 PART III. ITEM 10. Directors and Executive Officers of the Registrant............................... 30 ITEM 11. Executive Compensation........................................................... 30 ITEM 12. Security Ownership of Certain Beneficial Owners and Management................... 30 ITEM 13. Certain Relationships and Related Transactions................................... 30 PART IV. ITEM 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K................ 30 SIGNATURES.............................................................................................. 31
Forward-looking statements in this Form 10-K are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that all forward-looking statements involve risks and uncertainty, including without limitation, the risk of a significant natural disaster, the inability of the Company to reinsure certain risks, the adequacy of its loss reserves, expansion or contraction in its various lines of business, the impact of inflation, changing regulations in foreign countries, the effect of pending acquisitions, as well as general market conditions, competition, licensing and pricing. Please refer to the Company's Securities and Exchange Commission filings, copies of which are available from the Company without charge, for further information. 2 PART I ITEM 1. BUSINESS GENERAL HCC Insurance Holdings, Inc. ("HCCH" or the "Company") is a Delaware corporation with principal and executive offices located at 13403 Northwest Freeway, Houston, Texas 77040. HCCH and its consolidated subsidiaries are collectively referred to as the "Company". HCCH, through its subsidiaries, provides specialized property and casualty insurance to commercial customers, underwritten on both a direct and reinsurance basis, and, to a lesser extent, insurance agency services. The Company's principal insurance company subsidiaries are Houston Casualty Company ("HCC") and Trafalgar Insurance Company ("TIC") in Houston, Texas and IMG Insurance Company Ltd. ("IMG") in Amman, Jordan. The Company's principal agency subsidiaries are LDG Management Company, Incorporated ("LDG") in Wakefield, Massachusetts; HCC Underwriters, A Texas Corporation ("HCCU") in Houston, Texas; North American Special Risk Associates, Inc. ("NASRA") in Northbrook, Illinois and Middle East Insurance Brokers, Ltd. ("MEIB") in Amman, Jordan. The Company's underwriting activities are focused on providing aviation, marine, property, offshore energy and accident and health insurance on a worldwide basis and international reinsurance on these same lines of business. The Company also specializes in marketing and servicing complicated, high value, structured insurance and reinsurance programs placed on behalf of domestic and foreign clients which cover large, ocean marine fleets; complex, multinational, energy and industrial businesses; international aviation operations; large international property accounts; and a variety of accident and health related risks. The Company derives substantially the same amount of its business domestically and internationally. The Company operates primarily on a surplus lines or a non-admitted basis and is licensed in Texas and Oklahoma. Since its founding in 1974, the Company and its predecessor companies have been consistently profitable, generally reporting annual increases in gross written premium ("GWP"), net written premium ("NWP") and total revenue. During the period 1992 through 1996, the Company had an average combined ratio of 78.1% versus the less favorable 109.3% recorded by the U.S. property and casualty insurance industry overall (1992-1995). During the same period, the Company's GWP increased from $75.1 million to $230.8 million, an increase of 207% and net earnings increased from $5.3 million to $29.3 million, an increase of 454%. HCC and TIC are rated "A"(Excellent) by A.M. Best and HCC is rated "Aq" by S&P. An A.M. Best or S&P rating is intended to provide an independent opinion of an insurer's ability to meet its obligations to policyholders and should not be considered an investment recommendation. STRATEGY The Company's operating philosophy is to maximize underwriting profit while preserving the integrity of shareholders' equity. The Company concentrates its writings in selected, narrowly defined lines of business in which it believes there is a substantial opportunity to achieve underwriting profits. The Company primarily underwrites first party, physical damage coverages and lines of business which have relatively short lead times between the occurrence of an insured event and the reporting of claims to the Company. With respect to the underwriting management, marketing and related services, the Company seeks to offer quality underwriting, decision-making, support and reinsurance capacity and financial and other resources to take advantage of market opportunities for the development of new products. The property and casualty insurance underwriting business has historically been cyclical (though not seasonal). Within the overall cycle of the industry, particular lines of business experience their own cycles. 3 These cycles are characterized by periods of excess capital and significant competition in policy pricing, terms and conditions, followed by periods of capital shortages, typically resulting from adverse loss experience, which leads to decreased competition, higher premium rates and stricter underwriting standards. The position of a particular line of business in its respective underwriting cycle depends on prevailing premium rates, availability and cost of reinsurance, and other market conditions. The Company considers each of these factors in determining when to increase or decrease premium volume in each line. With this approach, the Company focuses on increasing net earnings rather than premium volume or market share. The Company purchases a substantial amount of reinsurance to limit its net loss from both individual and catastrophic risks. The degree to which the Company reinsures varies by, among other things, the particular risks inherent in the policies underwritten. The Company's business plan is to expand its underwriting activities and continue the growth of its insurance agency operations. However, the Company's business plan is shaped by its underlying operating philosophy, which is to maximize underwriting profit opportunities, while preserving the integrity of shareholders' equity and to seek to acquire complementary businesses with established management and reputation in the insurance agency field, whose business, the Company believes, can be enhanced through the synergism created by the Company's underwriting capabilities and other owned insurance businesses. As a result, the Company's primary interests are not in expanding market share or necessarily, GWP, but rather in increasing net earnings. To accomplish this objective, the Company: (i) has been and is prepared to emphasize or reduce underwritings in certain lines as premium rates, the availability and cost of reinsurance and other market conditions warrant; and (ii) will continue to attempt to limit its downside net loss exposure through the effective, prudent and conservative use of reinsurance. The Company believes its operational flexibility, experienced underwriting personnel, and access to and expertise in the reinsurance marketplace allow the Company to implement its strategy of emphasizing more profitable lines of business during periods of increased premium rates and de-emphasizing less profitable lines of business during periods of severe competition. In addition, through its acquisition and ownership of insurance agency businesses, the Company believes it has additional lines of business that can complement its underwriting activities. RECENT ACQUISITIONS Effective January 1, 1994, HCCU acquired a 25% interest in MEIB, a wholesale insurance and reinsurance broker based in Amman, Jordan. Concurrent with the purchase of IMG on October 1, 1994, HCCH acquired the remaining 75% of interest in MEIB and HCCU transferred its 25% interest in MEIB to HCCH, thereby making MEIB a wholly owned subsidiary of HCCH. To acquire 100% of MEIB, the Company issued 109,524 shares (pre split) of its Common Stock and paid a total of $3.9 million in cash. Effective October 1, 1994, HCCH acquired 100% of the stock of IMG, a property and casualty insurance company based in Amman, Jordan. IMG specializes in insuring large commercial risks. In exchange for IMG's stock, the Company issued 838,095 shares (pre split) of its Common Stock and paid $4.4 million in cash. These acquisitions were made in order to expand the Company's international business operations, principally in the Middle East, Asia and Africa. On May 24, 1996, the Company issued 6,250,000 shares of its common stock to acquire all of the outstanding shares of LDG. LDG acts on behalf of insurance and reinsurance companies and conducts its business in two areas: (i) insurance underwriting management and (ii) reinsurance underwriting management and intermediary services. LDG underwrites insurance and/or reinsurance in the following lines of business: medical stop-loss insurance for employer sponsored self-insured health plans, accident and health special risk, workers' compensation, alternative workers' compensation, and specialty aviation. LDG 4 generally concentrates on lines of business that have relatively short lead times between the occurrence of an insured event and the reporting of claims. On November 27, 1996, the Company issued 1,136,400 shares of its Common Stock and paid $1.7 million in cash to acquire all of the outstanding shares of North American Special Risk Associates, Inc. group of companies ("NASRA"). NASRA provides underwriting and claims management services to insurance and reinsurance companies primarily in occupational accident insurance for self-employed truckers. On January 24, 1997, the Company issued 266,667 shares of its Common Stock and paid $6.55 million in cash to acquire all of the occupational accident business of TRM International, Inc. These acquisitions were made in order to increase the agency (non-risk bearing) operations of the Company. PENDING ACQUISITIONS On January 6, 1997, the Company announced that it had agreed in principal to acquire all of the outstanding shares of Interworld Inc. group of companies ("Interworld") in exchange for 725,000 shares of the Company's Common Stock. Interworld, through its subsidiaries, acts as a managing general agency that specializes in underwriting general aviation risks throughout the United States, with special emphasis on private and corporate aircraft as well as small to medium size airports and commercial operators. On January 17, 1997, the Company and AVEMCO Corporation ("AVEMCO") jointly announced that they had signed a letter of intent to merge in a stock-for-stock transaction, each share of AVEMCO common stock to be exchanged for one share of HCCH's Common Stock. The Companies executed definitive agreements on February 28, 1997. AVEMCO provides specialized property and casualty insurance products and services, principally involving aviation. Non-aviation specialty lines include lenders single interest, short-term health and pleasure marine. Insurance products are distributed on a direct basis nationally and in Canada (except Quebec) and through agency and brokerage networks nationwide. AVEMCO's insurance services businesses offer management and related subrogation and salvage services, short-term health and travel insurance programs, administration and availability of short-term health programs primarily for foreign students resident in the United States, worldwide multilingual emergency assistance services for individuals who become ill or are injured while traveling abroad and computer software and related products and services for property and casualty insurance companies in the United States. The merger is subject to approval by each of the Company's shareholders and additional approval by certain regulatory agencies. The Companies have filed with the Securities and Exchange Commission a Join Proxy Statement/Prospectus relating to each of their respective Company's special shareholder's meeting. The Company anticipates that its Special Meeting of Shareholders will be held prior to May 31, 1997, and the merger will be consummated as soon thereafter as all other conditions to the merger are satisfied. There can be no assurance that the conditions to the proposed merger will be satisfied or that the shareholders will approve the transaction and the merger will consummated. These acquisitions are expected to expand and strengthen the Company's existing lines of business. INSURANCE COMPANY OPERATIONS The Company's property and casualty insurance business specializes in the direct, including facultative reinsurance, underwriting of aviation, marine, offshore energy, property and accident and health risks, as well as treaty reinsurance in the same lines of business. 5 LINES OF BUSINESS The following table sets forth the Company's GWP by line of business and the percent to total GWP for the periods indicated:
FOR THE YEARS ENDED DECEMBER 31, (DOLLARS IN THOUSANDS) --------------------------------------------------------------------- 1996 1995 1994 ----------------------- --------------------- --------------------- Direct Aviation...................................... $ 71,697 31% $ 63,615 27% $ 38,743 20% Marine........................................ 28,061 12 33,797 14 29,230 15 Offshore Energy............................... 8,496 4 14,893 6 20,123 11 Property...................................... 118,149 51 124,331 52 100,832 52 Accident and Health........................... 2,756 1 -- -- -- -- Reinsurance Excess of Loss................................ 734 .5 1,877 1 2,019 1 Proportional.................................. 862 .5 445 -- 1,931 1 ---------- --- ---------- --- ---------- --- Total gross written premium..................... $ 230,755 100% $ 238,958 100% $ 192,878 100% ---------- --- ---------- --- ---------- --- ---------- --- ---------- --- ---------- ---
The following table sets forth the Company's NWP by line of business and the percent to total NWP for the periods indicated:
FOR THE YEARS ENDED DECEMBER 31, (DOLLARS IN THOUSANDS) ------------------------------------------------------------------ 1996 1995 1994 ---------------------- -------------------- -------------------- Direct Aviation.......................................... $ 47,619 49% $ 38,788 39% $ 14,344 24% Marine............................................ 21,670 22 29,410 30 17,229 29 Offshore Energy................................... 3,472 4 5,115 5 8,194 14 Property.......................................... 21,534 22 24,186 24 17,242 29 Accident and Health............................... 2,671 3 -- -- -- -- Reinsurance Excess of Loss.................................... (1,047) (1) 833 1 759 1 Proportional...................................... 857 1 454 1 1,926 3 --------- --- --------- --- --------- --- Total net written premium........................... $ 96,776 100% $ 98,786 100% $ 59,694 100% --------- --- --------- --- --------- --- --------- --- --------- --- --------- ---
DIRECT AND FACULTATIVE REINSURANCE UNDERWRITING AVIATION--The Company insures predominantly foreign general aviation risks including fixed base, rotor wing and cargo operations and commuter airlines. The Company does not generally insure major domestic trunk airlines, satellites, corporate aircraft or United States passenger liabilities. The coverages underwritten include hull (including engines, avionics and other systems), liabilities, war, cargo and various ancillary coverages. The Company has been underwriting aviation risks since 1981. GWP has risen rapidly since 1992, increasing to $71.7 million in 1996 from $4.3 million in 1992. This growth has occurred due to a dramatic increase in rates as a result of extremely adverse worldwide underwriting results in prior years and the Company's ability to respond quickly to the opportunity to write new business in a rising market. In addition, the Company resumed writing domestic general aviation risks late in 1996. Rates have now reached very acceptable levels of profitability but the Company expects the increase in GWP and NWP to slow during 1997 as recent competition is beginning to effect this line of business. 6 Treaty reinsurance is maintained on an excess of loss basis to protect the Company against individual risk severity of loss and the relatively low level of catastrophe exposure that exists on this book of business. MARINE--The Company underwrites marine risks for ocean going vessels ("Blue Water"), inland and coastal trading vessels ("Brown Water") and fishing vessels. The coverages written include hull and machinery, liabilities (including protection and indemnity), marine cargo and various ancillary coverages. The Company has underwritten marine risks since 1984. Rates increased substantially between 1991 and 1993 and maintained an acceptable level of profitability. However, recent competition has caused downward pressure on the rates which has caused a reduction in GWP from $33.8 million in 1995 to $28.1 million in 1996. The Company believes rates will continue to soften during 1997. Treaty reinsurance is maintained on an excess of loss basis to protect the Company against individual risk severity of loss and the relatively low level of catastrophe exposure that exists on this book of business. OFFSHORE ENERGY--The Company has been underwriting offshore energy risks since 1988. Offshore energy risks include drilling rigs, production and gathering platforms, and pipelines. Coverages underwritten include physical damage, liabilities, business interruption and various ancillary coverages. Rates have declined significantly during the past few years to levels where profitability is unlikely. Underwriting has been on a very selective basis, striving for quality rather than quantity, which has resulted in a continued reduction in GWP from $20.1 million in 1994 to $8.5 million in 1996. The Company anticipates a further decline in GWP and NWP during 1997 and continues to evaluate the viability of this line of business. Treaty reinsurance is maintained on both a proportional and an excess of loss basis to protect the Company against individual risk severity of loss and the catastrophic exposure that exists, for example, from a hurricane in the Gulf of Mexico. PROPERTY--The Company specializes in writing catastrophe exposed risks in general and the property risks of large multinational corporations covering such commercial risks as hotels, office buildings, retail locations, factories, industrial plants, utilities, refineries, and natural gas and petrochemical plants. Coverage includes business interruption and physical damage, including flood and earthquake. The Company has written property business since 1986. GWP grew rapidly beginning in 1993 as the Company expanded its underwriting into international business, often in the same countries where it already wrote aviation and/or marine business. Dramatic rate increases occurred during the period 1993 to 1995 due to the severe lack of catastrophe capacity resulting from the effects of Hurricane Andrew and the Northridge Earthquake on the world's reinsurance markets. With support from its reinsurers, the Company moved quickly to take advantage of the changing market. During 1996, premium rates began to soften toward the end of the year. GWP grew from $14.9 million in 1992 to $124.3 million in 1995, with a slight decrease to $118.1 million in 1996. NWP also grew rapidly but substantial reinsurance costs will always keep the actual premium retained significantly smaller than GWP. In the absence of a major industry catastrophe loss, the Company expects both GWP and NWP to decline during 1997 as premium rates continue to soften. Treaty reinsurance is maintained on both a proportional and an excess of loss basis to ensure adequate protection, particularly against catastrophe exposures. The Company conservatively estimates its aggregate exposure in any individual catastrophe zone and maintains catastrophe reinsurance to cover its exposure to any one occurrence. ACCIDENT AND HEALTH--The Company began reinsuring accident and health risks during 1996 which are produced by the agencies acquired during the year. The risks underwritten include medical stop-loss insurance for employer sponsored self-insured health plans; reinsurance in the medical, accident and health special risk, workers' compensation and alternative workers' compensation areas; and occupational 7 accident insurance for self-employed truckers. The Company underwrites reinsurance in this area on both a proportional and excess of loss basis. The Company expects GWP and NWP to increase significantly during 1997. REINSURANCE UNDERWRITING The Company engages in reinsurance underwriting on a periodic basis when market rates and other conditions make it profitable to do so. The Company began writing treaty reinsurance in 1984, but has been dramatically reducing its book of business, particularly excess of loss business, due to the lack of adequate reinsurance protection available at any reasonable cost. EXCESS OF LOSS--The Company previously wrote excess of loss reinsurance, typically aviation, marine and non-marine catastrophe exposures. In 1992, due to a general market contraction of available reinsurance for excess of loss business, the Company was unable to purchase adequate protection at a reasonable cost and, therefore, elected not to continue writing this class other than selectively on a net basis. The run off of this line of business continues profitably. PROPORTIONAL--The Company underwrites proportional reinsurance on a selective basis. The exposures reinsured are typically the same type of risks that the Company underwrites on a direct basis. The Company provides this reinsurance to obtain a more diversified cross section of business which it might not otherwise have access to and for reciprocity with companies with whom it has an ongoing business relationship. FACULTATIVE--The Company underwrites facultative reinsurance in all of its lines of business. Typically, this is on international business in order to comply with local licensing requirements or as reinsurance of captives and usually can be considered direct business, as the Company maintains underwriting and claims control. However, all of this business is recorded under the caption of "Reinsurance Assumed". HOUSTON CASUALTY COMPANY HCC, the Company's principal insurance company subsidiary, operates worldwide in all of the lines of business in which the Company specializes. HCC's business is produced by independent agents and brokers, the group's agency subsidiaries, TIC, IMG and other insurance and reinsurance companies worldwide. HCC has a highly experienced staff of underwriters trained to deal with the high value, complicated exposures prevailing in the lines of business in which the Company specializes. As of December 31, 1996, HCC had statutory policyholders' surplus of $150.7 million. TRAFALGAR INSURANCE COMPANY HCC formed a wholly owned subsidiary, TIC, in 1993. TIC is an Oklahoma domiciled property and casualty insurance company which currently underwrites only domestic property risks and allows HCC to offer insurance on a surplus lines basis in certain jurisdictions where HCC is not permitted to do so. Applications for surplus lines approval are pending in many additional states and TIC will expand its operations as approvals are received. As of December 31, 1996, TIC had statutory policyholders' surplus of $27.6 million. 8 IMG INSURANCE COMPANY LTD. Organized in September, 1991, as a Jordanian Exempt Company ("JEC"), IMG conducts substantially all of its business outside of Jordan and is principally engaged in insuring and reinsuring large commercial risks in substantially the same lines of business as HCC. In connection with IMG's business, the Company has agreed to unconditionally guarantee certain of the insurance and reinsurance business of IMG. As of December 31, 1996, IMG had policyholders' surplus of $59.3 million. AGENCY OPERATIONS The Company's agency subsidiaries act on behalf of insurance and reinsurance companies, conducting business in the areas of insurance and reinsurance underwriting management and intermediary services. The agency subsidiaries do not assume any insurance or reinsurance risk themselves. LDG, the largest of these subsidiaries, manages and markets medical stop-loss and excess coverage insurance products principally to employer sponsored self-insured health plans. Other areas of LDG's business include medical, accident and health special risk, workers' compensation and alternative workers' compensation and specialty aviation reinsurance. NASRA acts as an insurance and reinsurance underwriting manager in the area of occupational accident insurance (similar to workers' compensation) to self-employed truckers. In addition, LDG and NASRA produce all of the Company's accident and health business. HCCU and MEIB specialize in marketing and servicing large, complicated insurance and reinsurance programs placed on behalf of multinational clients operating in the same lines of business that the Company underwrites. Such business is placed with domestic and international insurance companies, including HCC, TIC, and IMG, on a direct basis and through intermediaries. In addition, LDG, HCCU and MEIB act as reinsurance intermediaries on behalf of HCC, TIC, IMG and other insurance companies, placing both facultative and treaty reinsurance. The Company's revenue is composed of fee and commission income which increased to $38.5 million in 1996 from $17.0 million in 1992. Management expects continued growth in agency revenues in 1997, both from existing operations and pending acquisitions. REINSURANCE CEDED The Company principally utilizes reinsurance to reduce its net liability on individual risks, to protect against catastrophic losses and to achieve a desired ratio of NWP to policyholders' surplus. Various intermediaries, including LDG, HCCU and MEIB, facilitate the placement of this reinsurance coverage on behalf of the Company and are compensated, directly or indirectly, by the reinsurers. Reinsurance is ceded under treaties on both a proportional (where the reinsurer shares proportionately in premiums and losses) and an excess of loss basis (where only losses above a fixed point are reinsured). The Company also reinsures on a facultative (individual policy) basis on large individual risks. Management believes that the Company reinsures its risks to a greater extent than most of its competitors and most other insurance companies. This strategy greatly reduces the likelihood of a significant net loss from insurance company operations and protects the integrity of the Company's shareholders' equity. Under its current reinsurance protections, the Company has limited its net retained loss, across any single line of business, to a maximum of approximately $1.0 million for any one risk, but significantly less on most risks. The type, cost and limits of reinsurance purchased can vary from year to year based upon the Company's desired retention levels and the availability of adequate reinsurance at a reasonable price. The majority of the Company's reinsurance programs are renewed on a calendar year basis. For 1997, the Company has been successful in renewing its reinsurance protections at reduced costs to 1996 and was able to expand its underwriting capacity. This expanded capacity will assist the Company in taking advantage of underwriting opportunities as they present themselves. 9 The Company structures a specific reinsurance program for each line of business it underwrites. This reinsurance is placed to protect the Company from any foreseeable event; proportionally to cover frequency and for catastrophe coverage; excess of loss to cover severity on an individual risk; and catastrophe to cover losses involving multiple risks, such as those resulting from a hurricane or an earthquake. The Company does not expose itself to a net loss from an individual risk in excess of its reinsurance protection. The Company writes business in areas exposed to catastrophic losses and has significant exposures to this type of loss in California, certain Gulf Coast states and Mexico. The Company carefully assesses its overall exposures to a single catastrophic event and applies procedures, that it believes are more conservative than is typically used by the industry, to ascertain the Company's probable maximum loss ("PML") from any single event. The Company maintains reinsurance protection which it believes is sufficient to cover any foreseeable event. The Company receives an overriding (ceding) commission on the premium ceded to reinsurers which compensates the Company for the direct costs associated with the production of the premium, the servicing of the business during the term of the policies ceded, and the costs associated with the placement of the related reinsurance. In addition, certain of the Company's reinsurance treaties allow for a sharing with the Company by the reinsurers of the net profits generated under such treaties. The ceding of reinsurance does not discharge the Company from liability to its policyholders. The Company is required to pay losses even if the reinsurer fails to meet its obligations under the reinsurance contract. To minimize its exposure to reinsurance credit risk, the Company places its reinsurance with a diverse group of financially sound reinsurers. The Company's 1997 treaty reinsurance program was placed with more than 56 domestic and foreign reinsurers. As of December 31, 1996, the total amount recoverable from reinsurers was approximately $123.2 million, of which $21.7 million represents paid losses recoverable and $103.9 million represents outstanding losses recoverable less a $2.4 million reserve for uncollectible reinsurance. In addition, ceded unearned premium was $65.8 million. The Company held $67.9 million of irrevocable letters of credit and $9.1 million in cash to collateralize a portion of the total amount recoverable and had other payable balances due to its reinsurers of $89.6 million as potential offsets against reinsurance recoverables. The following table sets forth the reinsurers with a total recoverable balance greater than $10.0 million and the collateral and potential offsets held by the Company as of December 31, 1996 (dollars in thousands):
LETTERS OF REINSURANCE CREDIT, RECOVERABLES AND CASH DEPOSITS CEDED UNEARNED AND REINSURER LOCATION PREMIUM OTHER PAYABLES - ----------------------------------------------------- ---------------------- ---------------- ---------------- Underwriters at Lloyd's.............................. London, England $ 28,962 $ 18,446 GIO Insurance Limited................................ Sydney, Australia 25,204 26,106 Reinsurance Australia Corporation, Ltd. ............. Sydney, Australia 20,562 19,332 Underwriters Indemnity Company....................... Houston, TX 12,531 5,934 SCOR Reinsurance Company............................. New York, NY 11,105 2,428 AXA Reinsurance Company.............................. Wilmington, DE 10,402 2,759
Due to the Company's financial analysis of active and potential reinsurers and its conservative strategy of diversifying its reinsurers, the Company has never incurred a significant loss on recoverables from reinsurers. The Company has established a reserve of $2.4 million as of December 31, 1996, to reduce the effects of any recoverable problem. 10 OPERATING RATIOS PREMIUM TO SURPLUS RATIO The following table shows, for the periods indicated, the ratio of GWP and NWP to statutory policyholders' surplus for the Company's property and casualty insurance company subsidiaries:
FOR THE YEARS ENDED DECEMBER 31, (DOLLARS IN THOUSANDS) --------------------------------------------------------- 1996 1995 1994 1993 1992 ---------- ---------- ---------- ---------- --------- GWP.......................................... $ 230,755 $ 238,958 $ 192,878 $ 123,650 $ 75,119 NWP.......................................... 96,776 98,786 59,694 38,556 25,618 Policyholders' surplus....................... 212,194 177,317 134,464 102,803 39,146 GWP Ratio.................................... 108.7% 134.8% 143.4% 120.3% 191.9% GWP Industry Average(1)...................... * 194.0 221.8 224.4 238.0 NWP Ratio.................................... 45.6% 55.7% 44.4% 37.5% 65.4% NWP Industry average (1)..................... * 113.0 129.7 132.6 139.6
- ------------------------ * Industry average not yet available (1) Source: A.M. Best Company. While there is no statutory requirement regarding a permissible premium to surplus ratio, guidelines established by the National Association of Insurance Commissioners ("NAIC") provide that a property and casualty insurer's annual statutory GWP should not exceed 900% and NWP should not exceed 300% of its policyholders' surplus. In keeping with its philosophy of protecting its shareholders' equity and limiting its aggregate loss exposure, the Company maintains premium to surplus ratios significantly lower than such guidelines, and, as indicated above, below industry norms. COMBINED RATIO The underwriting experience of a property and casualty insurance company is indicated by its combined ratio. The Company's insurance subsidiaries' loss ratio, expense ratio and combined ratio, determined on the basis of statutory accounting principles ("SAP"), are shown in the following table:
1996 1995 1994 1993 1992 --------- --------- --------- --------- --------- Loss ratio............................................................... 56.4% 63.4% 64.6% 66.7% 66.2% Expense ratio............................................................ 15.6 11.5 10.2 14.4 21.7 --- --------- --------- --------- --------- Combined ratio........................................................... 72.0% 74.9% 74.8% 81.1% 87.9% --- --------- --------- --------- --------- --- --------- --------- --------- --------- Industry Average(1)...................................................... * 106.4% 108.4% 106.9% 115.7%
- ------------------------ * Industry average not yet available (1) Source: A.M. Best Company. RESERVES Applicable insurance laws and regulations, under which the Company operates, require that reserves be maintained for the payment of loss and loss adjustment expense ("LAE") with respect to both reported and incurred but not reported ("IBNR") claims under insurance and reinsurance policies issued by the Company. The Company establishes reserves through an evaluation of each individual claim rather than by any average reserving method. In the case of direct and facultative reinsurance business, loss reserves are determined by evaluating reported claims on the basis of the type of loss, jurisdiction of the occurrence, knowledge of the circumstances surrounding the claim, severity of injury or damage, potential for ultimate 11 exposure, experience with the insured and the line of business and policy provisions relating to the particular type of claim. The Company establishes loss reserves for excess of loss and proportional reinsurance claims based on information and reports received from ceding companies. Loss reserves for IBNR losses are determined in part on the basis of statistical information and in part on industry experience with respect to the probable number and nature of claims arising from occurrences which have not been reported. The Company does not discount any of its loss reserves. The period of time between the occurrence of an insured event and the final settlement of a claim may be many years, and during this period it often becomes necessary to adjust the claim estimates either upward or downward. Certain classes of marine and offshore energy insurance underwritten by the Company have historically had long lead times between the occurrence of an insured event, reporting of the claim to the Company, and final settlement. In such cases, the Company is forced to estimate reserves over long periods of time, with the possibility of several adjustments to reserves. Other classes of insurance, such as property, historically have shorter lead times between the occurrence of an insured event, reporting of the claim to the Company, and final settlement. The reserves with respect to such property classes are, therefore, less likely to be adjusted. The reserving process is intended to provide implicit recognition of the impact of inflation and other factors affecting loss payments by taking into account changes in historical payment patterns and perceived probable trends. However, there is no precise method for the subsequent evaluation of the adequacy of the consideration given to inflation, or to any other specific factor, some of which are interdependent. The Company underwrites, directly and through reinsurance, risks which are denominated in a number of foreign currencies, and therefore establishes and maintains loss reserves with respect to these policies in the respective currencies. These reserves are subject to exchange rate fluctuations, which may have an effect on the Company's earnings. The Company continues to limit its exposure to future currency fluctuations through the use of foreign currency forward contracts. The following loss development triangle shows changes in reserves in subsequent years from the prior loss estimates based on experience as of the end of each succeeding year on the basis of generally accepted accounting principles ("GAAP"). The estimate is increased or decreased as more information becomes known about the frequency and severity of losses for individual years. A redundancy means the original estimate was higher than the current estimate; a deficiency means that the current estimate is higher than the original estimate. 12 The first line of each loss development triangle presents, for each of the years indicated, the gross reserve liability including the reserve for IBNR losses. The first section of each table shows, by year, the cumulative amounts of loss and LAE paid as of the end of each succeeding year. The second section sets forth the re-estimates in later years of incurred losses, including payments, for the years indicated. The "cumulative redundancy (deficiency)" represents, as of December 31, 1996, the difference between the latest re-estimated reserves and the reserves as originally estimated. The following loss development triangle shows development in loss reserves on a gross basis:
FOR THE YEARS ENDED DECEMBER 31, (DOLLARS IN THOUSANDS) ---------------------------------------------------------- 1996 1995 1994 1993 1992 ---------- ---------- ---------- ---------- ---------- Balance Sheet Reserves:.............................. $ 185,822 $ 158,451 $ 129,755 $ 98,399 $ 81,997 Cumulative Paid as of: One year later..................................... 91,910 72,077 54,385 58,367 Two years later.................................... 109,912 90,994 89,519 Three years later.................................. 118,551 115,487 Four years later................................... 136,931 Re-estimated liability as of: End of year........................................ 185,822 158,451 129,755 98,399 81,997 One year later..................................... 204,262 148,168 121,428 116,007 Two years later.................................... 168,444 140,080 131,317 Three years later.................................. 160,180 148,748 Four years later................................... 169,450 Cumulative redundancy (deficiency)................... $ (45,811) $ (38,689) $ (61,781) $ (87,453)
[THE REMAINDER OF THIS PAGE LEFT INTENTIONALLY BLANK] 13 The following loss development triangle shows development in loss reserves on a net basis:
FOR THE YEARS ENDED DECEMBER 31, (DOLLARS IN THOUSANDS) ------------------------------------------------------------------------------ 1996 1995 1994 1993 1992 1991 1990 ---------- ---------- ---------- --------- --------- --------- --------- Gross reserves for loss and LAE.............. 185,822 158,451 129,755 98,399 81,997 83,889 64,287 Less reinsurance recoverables................ 103,888 92,125 85,214 66,468 60,232 69,325 49,600 ---------- ---------- ---------- --------- --------- --------- --------- Reserves for loss and LAE net of reinsurance................................ $ 81,934 $ 66,326 $ 44,541 $ 31,931 $ 21,765 $ 14,564 $ 14,687 Cumulative paid, net reinsurance as of One year later............................. 19,731 15,714 12,361 6,715 4,279 7,100 Two years later............................ 22,231 18,402 13,471 5,533 11,049 Three years later.......................... 20,900 15,238 10,112 11,396 Four years later........................... 15,923 10,812 15,050 Five years later........................... 11,018 15,453 Six years later............................ 15,317 Seven years later.......................... Eight years later.......................... Nine years later........................... Ten years later............................ Re-estimated liability, net of reinsurance as of End of year................................ 81,934 66,326 44,541 31,931 21,765 14,564 14,687 One year later............................. 62,523 42,923 32,648 21,513 14,951 17,514 Two years later............................ 43,316 32,544 22,061 14,590 17,707 Three years later.......................... 33,610 23,180 15,290 16,785 Four years later........................... 25,709 16,346 17,230 Five years later........................... 18,975 18,421 Six years later............................ 20,263 Seven years later.......................... Eight years later.......................... Nine years later........................... Ten years later............................ Cumulative redundancy (deficiency)........... $ 3,803 $ 1,225 $ (1,679) $ (3,944) $ (4,411) $ (5,576) 1989 1988 1987 1986 --------- --------- --------- --------- Gross reserves for loss and LAE.............. 48,948 30,680 32,066 22,357 Less reinsurance recoverables................ 36,586 22,253 25,106 17,118 --------- --------- --------- --------- Reserves for loss and LAE net of reinsurance................................ $ 12,362 $ 8,427 $ 6,960 $ 5,239 Cumulative paid, net reinsurance as of One year later............................. 5,515 725 2,544 2,316 Two years later............................ 8,182 2,334 2,490 3,845 Three years later.......................... 10,791 3,558 3,337 3,642 Four years later........................... 11,207 4,149 4,250 4,041 Five years later........................... 13,434 4,223 4,454 4,561 Six years later............................ 13,361 4,138 4,646 4,957 Seven years later.......................... 13,101 4,476 4,082 5,215 Eight years later.......................... 4,475 4,335 5,516 Nine years later........................... 4,379 5,670 Ten years later............................ 5,678 Re-estimated liability, net of reinsurance as of End of year................................ 12,362 8,427 6,960 5,239 One year later............................. 13,330 7,215 7,820 5,060 Two years later............................ 14,367 6,980 6,526 6,481 Three years later.......................... 14,621 6,339 5,815 5,472 Four years later........................... 14,426 6,406 5,871 5,825 Five years later........................... 13,975 6,278 5,842 5,578 Six years later............................ 13,994 5,893 5,752 5,520 Seven years later.......................... 14,991 5,830 5,272 5,457 Eight years later.......................... 6,408 5,290 6,009 Nine years later........................... 5,944 6,032 Ten years later............................ 6,181 Cumulative redundancy (deficiency)........... $ (2,629) $ 2,019 $ 1,016 $ (942)
14 The following table provides a reconciliation of the gross liability of loss and LAE on a GAAP basis at the beginning and end of 1996, 1995 and 1994:
FOR THE YEARS ENDED DECEMBER 31, (DOLLARS IN THOUSANDS) ---------------------------------- 1996 1995 1994 ---------- ---------- ---------- Reserves for loss and LAE at beginning of year............................... $ 158,451 $ 129,755 $ 98,399 Reserves acquired with purchase of subsidiary, net of eliminations........... -- -- 1,059 Provision for loss and LAE for claims occurring in the current year.......... 109,262 128,073 83,194 Increase in estimated loss and LAE for claims occurring in prior years (1)... 45,811 18,413 23,029 ---------- ---------- ---------- Incurred loss and LAE........................................................ 155,073 146,486 106,223 ---------- ---------- ---------- Loss and LAE payments for claims occurring during: Current year............................................................... 35,792 45,713 21,541 Prior years................................................................ 91,910 72,077 54,385 ---------- ---------- ---------- Loss and LAE payments........................................................ 127,702 117,790 75,926 ---------- ---------- ---------- Reserves for loss and LAE at end of the year................................. $ 185,822 $ 158,451 $ 129,755 ---------- ---------- ---------- ---------- ---------- ----------
- ------------------------ (1) Changes in loss and LAE reserves on a GAAP basis, for losses occurring in prior years, reflect the gross effect of the resolution of losses for other than the reserve value and the subsequent adjustments of loss reserves. The following table provides a reconciliation of the liability for loss and LAE, net of reinsurance ceded, on a GAAP basis at the beginning and end of 1996, 1995 and 1994:
FOR THE YEARS ENDED DECEMBER 31, (DOLLARS IN THOUSANDS) ------------------------------- 1996 1995 1994 --------- --------- --------- Reserves for loss and LAE at beginning of year................................... $ 66,326 $ 44,541 $ 31,931 Reserves acquired with purchase of subsidiary, net of eliminations............... -- -- 1,769 Provision for loss and LAE for claims occurring in the current year.............. 55,045 51,387 28,871 Increase in estimated loss and LAE for claims occurring in prior years (2)....... (3,803) (1,618) 717 --------- --------- --------- Incurred loss and LAE............................................................ 51,242 49,769 29,588 --------- --------- --------- Loss and LAE payments for claims occurring during: Current year................................................................... 15,903 12,268 6,386 Prior years.................................................................... 19,731 15,716 12,361 --------- --------- --------- Loss and LAE payments............................................................ 35,634 27,984 18,747 --------- --------- --------- Reserves for loss and LAE at end of the year..................................... $ 81,934 $ 66,326 $ 44,541 --------- --------- --------- --------- --------- ---------
- ------------------------ (2) Changes in loss and LAE reserves on a GAAP basis, for losses occurring in prior years, reflect the net effect of the resolution of losses for other than the reserve value and the subsequent adjustments of loss reserves. During 1996, the Company had gross loss and LAE deficiency of $45.8 million. The gross deficiency comes from two primary sources. The first source is the development of several large claims on individual policies which were substantially reinsured. These losses were either reported late or reserves were increased as subsequent information became available. However, because these policies were substantially reinsured, there is no material effect on a net basis. The second source is the run-off of the excess of loss 15 "spiral" business the Company ceased writing in 1991. This development is due to the delay in reporting of catastrophe losses by the London insurance market, coupled with the unprecedented number of catastrophes and subsequent insurance company insolvencies. As the Company did not have enough representative years' underwriting experience to base a more accurate estimate on, significant gross development has been experienced. However, this business is substantially reinsured, thereby not having a material effect on the Company's current operations or shareholders' equity. During 1996, the Company had net loss and LAE redundancy of $3.8 million relating to prior year losses compared to a redundancy of $1.6 million in 1995. The redundancies have been reflected in the statements of earnings for each year as they occur. The Company has no material exposure to environmental pollution losses, as the Company only began writing business in 1981 and policies issued by the Company normally contain pollution exclusion clauses which limit pollution coverage to "sudden and accidental" losses only, thus excluding intentional (dumping) and seepage claims. Therefore, the Company should not experience any material development in reserves from environmental pollution claims. INVESTMENTS Insurance company investments must comply with applicable laws and regulations which prescribe the kind, quality and concentration of investments. In general, these laws and regulations permit investments, within specified limits and subject to certain qualifications, in Federal, state and municipal obligations, corporate bonds, preferred and common equity securities, real estate mortgages and real estate. As of December 31, 1996, the Company had $320.3 million of investment assets, the majority of which were held by HCC. The Company's investment policy is determined by the Company's Board of Directors and is reviewed on a regular basis. Pursuant to its investment policy, the Company concentrates its investments in obligations of states, municipalities and political subdivisions, the interest income from which is predominantly exempt from Federal income tax. The interest rates on these securities are normally lower than rates on comparable taxable securities. The Company's portfolio of fixed income securities available for sale principally consists of intermediate term, tax-exempt securities. The Company generally intends to hold such securities to maturity. However, the Company regularly re-evaluates its position based upon market conditions, which may cause the Company to restructure its portfolio and realize gains or losses in order to maximize its total return on investments. Accordingly, all fixed income securities are classified as available for sale and are recorded at market value. The Company's financial statements reflect an unrealized ("mark-to-market") gain on fixed income securities available for sale as of December 31, 1996, of $2.1 million. Since the Company's intention is to hold these securities until maturity, it does not currently expect to realize any significant gain or loss on these investments. The Company has maintained a substantial level of cash and liquid short-term instruments in order to maintain the ability to fund large physical damage losses of the Company's insureds, should they occur. As of December 31, 1996, the Company had cash and short-term investments of approximately $56.3 million. The Company also maintains credit facilities which provide for $23 million in bank lines of credit for the issuance of letters of credit and short-term borrowings. From time to time the Company enters into foreign currency forward contracts as a hedge against foreign currency fluctuations, primarily British Pound Sterling. The Company's balances denominated in foreign currency fluctuate as transactions are recorded and settled. During 1996, the average Sterling liability, for subsidiaries whose functional currency was the United States dollar, was approximately L907,000 ($1.6 million at December 31, 1996, rate of exchange) which was hedged by an average open forward contract balance of approximately L460,000 ($785,000 at the December 31, 1996, rate of 16 exchange). There was one open foreign currency forward contract as of December 31, 1996, to purchase L500,000 ($856,000 at the December 31, 1996, rate of exchange) with a maturity of January, 1997. During January, 1997, the Company entered into a foreign currency forward contact totaling L500,000 ($856,000 at the December 31, 1996, rate of exchange). The Company expects to continue to limit its exposure to currency fluctuations through the use of foreign currency forward contracts. The Company utilizes these foreign currency forward contracts strictly as a hedge against existing exposure to foreign currency fluctuations and it does not do so as any form of speculative or trading investment. The following tables reflect the investments of the Company (dollars are expressed in thousands). The table set forth below reflects the average amount of investments, income earned, and the yield thereon for the years ended December 31, 1996, 1995, and 1994 respectively:
1996 1995 1994 ---------- ---------- ---------- Average investments................................................... $ 312,773 $ 258,584 $ 192,397 Net investment income................................................. 15,372 13,250 9,533 Average yield (1)..................................................... 4.9% 5.1% 5.0% Average tax equivalent yield (1)...................................... 6.7 6.7 6.7
- ------------------------ (1) Excluding realized and unrealized capital gains and losses. The table set forth below summarizes, by type, the investments of the Company as of December 31, 1996:
AMOUNT PERCENT OF TOTAL ---------- ----------------- Short-term investments................................................................ $ 53,100 16% U.S. Treasury securities.............................................................. 3,604 1 Obligations of states, municipalities and political subdivisions...................... 261,123 82 Marketable equity securities.......................................................... 2,433 1 ---------- --- Total investments................................................................... $ 320,260 100% ---------- --- ---------- ---
The table set forth below indicates the expected maturity distribution of the Company's fixed income securities as of December 31, 1996:
AMOUNT PERCENT OF TOTAL ---------- ----------------- One year or less...................................................................... $ 4,276 2% One year to five years................................................................ 67,383 25 Five years to ten years............................................................... 80,876 31 Ten years to fifteen years............................................................ 61,408 23 More than fifteen years............................................................... 50,784 19 ---------- --- Total fixed income securities....................................................... $ 264,727 100% ---------- --- ---------- ---
COMPETITION The insurance business is generally highly competitive. The Company faces competition from domestic and foreign insurers, some of whom are larger and have greater financial, marketing and management resources than the Company. The Company's profitability is affected by many other factors, including rate competition, severity and frequency of claims, interest rates, state regulations, court decisions, the judicial climate and general business conditions, all of which are outside the control of the Company. The Company's medical stop-loss business involves a diversified field of participants from small start-up 17 operations to large, well-established organizations. While the medical stop-loss business has been historically competitive, during the past several years there has been significant growth in the number of medical stop-loss insurance underwriters. The Company also faces intense and growing pressure from alternatives to employer sponsored self-insured health plans, such as fully-insured plans, HMOs and Point of Service plans, as well as from large well established direct insurers and competing underwriting managers providing similar medical stop-loss products to those offered by the Company to employer sponsored self-insured health plans. Competition in the reinsurance marketplace is primarily due to an increase in the number of reinsurers participating in the market as well as a tendency by reinsureds to retain a greater percentage of their own risk. The Company competes with other reinsurance underwriting managers and domestic and international reinsurance companies. The Company's results of operations may also be affected by the competition for reinsurance business between broker reinsurance markets and direct reinsurance writers. The Company also competes with many reinsurance intermediaries in the broker reinsurance market, some of which are affiliated with primary insurance brokers with substantial financial resources. In each of the above business areas, a significant number of the Company's competitors have financial resources, employees, facilities, market recognition, marketing, management, experience, and other resources substantially greater than those of the Company. REGULATION The operations of the Company are subject to state insurance laws and regulations which require the licensing of insurance agents, brokers, reinsurance intermediaries, reinsurance underwriting managers, and managing general agents which regulate certain aspects of their business. These laws and regulations are intended primarily for the protection of policyholders, rather than shareholders of the licensed entities, and may include requirements for certain provisions in contracts entered into between the Company and various insurers or reinsurers, certain record keeping and reporting requirements, advertising and business practice rules, and other matters. The Company's business depends on obtaining and maintaining licenses and approvals pursuant to which it operates, as well as compliance with pertinent regulations. In addition to the regulatory supervision of the insurance subsidiaries of the Company, the Company is subject to regulation under the Texas Insurance Holding Company System Regulatory Act, which contains certain reporting requirements including registration and the filing of annual reports. In such registration and annual reports, the Company is required to provide current information regarding its capital structure, general financial condition, ownership, management, and the identity of each member of its insurance holding company system. The Company is also required in such registration and annual reports to disclose certain agreements and transactions between the Company and its affiliates, which must satisfy certain standards set forth in the Texas Insurance Code. There can be no assurance given that the Company has all such required licenses, approvals of complying contracts or that such licenses, approvals or complying contracts can always be obtained or continued. In all jurisdictions, the applicable laws and regulations are subject to amendment or interpretation by regulatory authorities. Generally, such authorities are vested with relatively broad discretion to grant, renew and revoke licenses and approvals, and to implement regulations, and licenses may be denied or revoked for various reasons, including the violations of such regulations, conviction of crimes and the like. In some instances, the Company follows practices based on its interpretations, or those that it believes may be generally followed by the industry, which may be different from the requirements or interpretations of regulatory authorities. Accordingly, the possibility exists that the Company may be precluded or temporarily suspended from carrying on some or all of its activities or otherwise penalized in a given jurisdiction. Such preclusion or suspension could have a materially adverse effect on the business and results of operations of the Company. HCC is licensed as an admitted insurer in Texas, is an approved surplus lines insurer and an accredited reinsurer in Oklahoma and Maryland, is an approved surplus lines insurer in 32 states, and is otherwise permitted to write surplus lines insurance in nine more states, the District of Columbia, Guam and Puerto Rico. All surplus lines insurance is written through licensed surplus lines insurance brokers, who are required to ensure that no licensed admitted insurer will write a particular risk prior to placing that risk 18 with a surplus lines insurer. TIC is licensed as an admitted insurer in Oklahoma, is an approved surplus lines insurer and an accredited reinsurer in Texas, is a surplus line insurer in seven states and is otherwise permitted to write surplus lines insurance in nine more states and the District of Columbia. IMG is a JEC licensed as a property and casualty insurance company. Due to its status as a JEC, IMG cannot write Jordanian domiciled business directly, but can write reinsurance of Jordanian risks. Under the laws of its domiciliary state (Texas), HCC may only pay dividends out of its statutory earned surplus. The maximum amount of dividends that HCC may pay without prior regulatory approval in any twelve month period is the greater of its statutory net investment income for the prior year, or 10% of its statutory policyholders' surplus as of the prior year end, which at December 31, 1996, was $15.1 million. Under the laws of the State of Oklahoma, TIC may only pay dividends out of surplus funds. The maximum amount TIC may pay without prior regulatory approval is the greater of statutory net income excluding realized capital gains or 10% of statutory capital and surplus, which at December 31, 1996 was $2.8 million. As of December 31, 1996, HCC's total adjusted capital was 1,332% of the NAIC authorized control level risk-based capital and TIC's total adjusted capital was 17,928% of the NAIC authorized control level risk-based capital. PENDING LEGISLATION In recent years state legislatures have considered or enacted laws that alter and, in many cases, increase state authority to regulate insurance companies and insurance holding company systems. In addition, the NAIC and state insurance regulators, as part of the NAIC's state insurance department accreditation program, have re-examined existing laws and regulations, specifically focusing on insurance company investments, issues relating to the solvency of insurance companies, licensing and market conduct issues, interpretations of existing laws, the development of new laws, and the definition of extraordinary dividends. In addition, Congress and certain Federal agencies have conducted investigations of the current condition of the insurance industry in the United States to determine whether to impose Federal regulation of insurers and reinsurers. From time to time, Congress and certain states have considered various legislative proposals which would provide for governmental earthquake insurance coverage. Legislation has been introduced in Congress that could result in the Federal government's assuming some role in the regulation of the insurance industry. The Company does not know at this time the extent to which such Federal or state legislative or regulatory initiatives will be adopted, and no assurance can be given that they would not have a material adverse effect on the Company. EMPLOYEES As of December 31, 1996, the Company had 331 employees, which included seven executive, seventeen senior management and 45 other management personnel. The average experience in the insurance industry and tenure with the Company of the executive and senior management personnel was 21 and eight years, respectively. The Company is not a party to any collective bargaining agreement and has not experienced work stoppages or strikes as a result of labor disputes. The Company considers relations with its employees to be good. 19 ITEM 2. PROPERTIES HCC owns the building which houses the Company's principal and executive offices in Houston, Texas. The building contains approximately 54,000 square feet, substantially all of which are used by the Company. LDG's principal facility is leased office space in Wakefield, Massachusetts consisting of approximately 34,000 square feet. The lease terminates on October 31, 2001. Principal activities conducted at the Wakefield office include corporate management, finance and administration, marketing and actuarial services for all areas of LDG's business, and medical stop-loss insurance underwriting management, reinsurance underwriting management, claims, and reinsurance intermediary activities. LDG's Medical Stop-Loss Division maintains sales and administration offices in Atlanta, Georgia, Overland Park, Kansas, Portland, Maine, and Minneapolis, Minnesota. LDG maintains a reinsurance underwriting and sales office in New York, New York. LDG also maintains an office in London, England. NASRA's principal facility is newly leased office space in Northbrook, Illinois, consisting of approximately 18,000 square feet. The lease terminates on November 30, 2005. Principal activities conducted at the Northbrook office include corporate management, finance and administration, marketing, underwriting, customer service and claims activities. ITEM 3. LEGAL PROCEEDINGS The Company is a party to numerous lawsuits arising in the normal course of business. All pending lawsuits involve claims under policies underwritten or reinsured by the Company, which management believes have been adequately included in its established loss reserves. The Company believes the resolution of these lawsuits will not have a material adverse effect on its financial condition, results of operations or cash flows. ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the fourth quarter of 1996. [THE REMAINDER OF THIS PAGE LEFT INTENTIONALLY BLANK] 20 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION The Company's Common Stock began trading on the NASDAQ--National Market System ("NASDAQ") under the symbol HCCH on October 28, 1992, and traded on NASDAQ until June 19, 1995. On June 20, 1995, the Company's Common Stock began trading on the New York Stock Exchange ("NYSE") under the symbol HCC and currently trades on the NYSE. The high and low bid prices for quarterly periods during the period January 1, 1995 through June 19, 1995, as reported by NASDAQ and the high and low closing sales prices for the quarterly periods during the period June 20, 1995 through December 31, 1996, as reported by the NYSE were as follows:
1996 (1) ----------------- HIGH LOW ------ ------ First Quarter................................................................... $23 1/4 $14 1/2 Second Quarter.................................................................. 25 1/2 19 1/8 Third Quarter................................................................... 32 3/4 22 1/8 Fourth Quarter.................................................................. 29 1/4 23 1/8 1995 (1) ----------------- HIGH LOW ------ ------ First Quarter................................................................... $10 1/4 $7 7/8 Second Quarter.................................................................. 11 8 3/4 Third Quarter................................................................... 13 3/4 10 1/8 Fourth Quarter.................................................................. 15 1/4 12 1/4
- ------------------------ (1) The above prices have been retroactively adjusted to reflect the effects of the five-for-two stock split, payable as a 150% stock dividend to shareholders of record April 30, 1996. On March 24, 1997, the closing sales price of one share of HCCH's Common Stock as reported by the NYSE was $25.00. SHAREHOLDERS The Company has one class of authorized capital stock: 100,000,000 shares of Common Stock, par value $1.00 per share. As of March 24, 1997, there were 36,167,935 shares of issued and outstanding Common Stock held by 130 shareholders of record; however, the Company believes there are in excess of 5,000 beneficial owners. DIVIDENDS On April 19, 1996 the Company announced that the Board of Directors had declared a five-for-two stock split in the form of a 150% stock dividend, payable to shareholders of record April 30, 1996. In connection with this, the Company announced it would purchase, for cash, any fractional shares issued in connection with this split. On June 18, 1996, the Company announced its first cash dividend of $0.02 per share payable to shareholders of record July 1, 1996. The Company has paid a cash dividend of $0.02 per share in each succeeding quarter. On March 24, 1997, the Company declared a cash dividend of $0.03 per share and plans to continue to pay $0.03 per share dividend in future quarters. The Board of Directors may review the Company's dividend policy from time to time, and any determination with respect thereto will be made in light of regulatory and other conditions then existing, including the Company's earnings, financial condition, capital requirements, loan covenants, and other related factors. 21 ITEM 6. SELECTED FINANCIAL DATA The selected consolidated financial data set forth below has been derived from the Consolidated Financial Statements. All information contained herein should be read in conjunction with the Consolidated Financial Statements, the related notes thereto and Management's Discussion and Analysis included elsewhere in this document.
FOR THE YEARS ENDED DECEMBER 31, (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)(5) ----------------------------------------------------- 1996 1995 1994(4) 1993 1992 --------- --------- --------- --------- --------- STATEMENT OF EARNINGS DATA Revenue Net earned premium................................... $ 93,314 $ 80,011 $ 46,834 $ 32,663 $ 24,483 Fee and commission income............................ 38,462 32,887 28,456 24,073 16,998 Net investment income................................ 15,372 13,250 9,533 5,454 2,814 Net realized investment gain......................... 5,097 1,061 682 949 17 --------- --------- --------- --------- --------- Total revenue.................................... 152,245 127,209 85,505 63,139 44,312 Expense Loss and LAE......................................... 51,242 49,769 29,588 21,210 16,834 Operating expense Policy acquisition costs........................... 34,110 29,748 21,729 12,747 9,238 Compensation expense............................... 20,353 26,790 23,900 16,258 13,330 Other operating expense............................ 12,855 12,591 8,660 7,261 4,191 Ceding commissions................................. (30,268) (27,228) (20,210) (11,166) (6,276) --------- --------- --------- --------- --------- Net operating expense............................ 37,050 41,901 34,079 25,100 20,483 Compensatory stock grant and merger related expenses... 26,160 -- -- -- -- Interest expense....................................... 1,166 2,247 1,972 1,175 607 --------- --------- --------- --------- --------- Total expense.................................... 115,618 93,917 65,639 47,485 37,924 --------- --------- --------- --------- --------- Earnings before income tax provision................... 36,627 33,292 19,866 15,654 6,388 Income tax provision................................... 7,329 8,955 4,598 2,966 1,098 --------- --------- --------- --------- --------- Net earnings..................................... $ 29,298 $ 24,337 $ 15,268 $ 12,688 5,290 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Increase in redemption value of redeemable common stock (1).................................................. (1,124) --------- Net earnings applicable to nonredeemable common stock.......................................... 4,166 --------- --------- EARNINGS PER SHARE DATA Primary: Earnings per share applicable to nonredeemable common stock (2).......................................... $ 0.81 $ 0.75 $ 0.55 $ 0.53 $ 0.28 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Weighted average shares outstanding (2).............. 35,965 32,667 27,910 23,999 14,863 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Fully diluted: Earnings per share applicable to nonredeemable common stock (2).......................................... $ 0.81 $ 0.74 $ 0.55 $ 0.52 $ 0.27 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Weighted average shares outstanding (2).............. 35,986 32,804 27,998 24,199 15,260 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Cash dividends declared, per share..................... $ 0.06 --------- --------- PRO FORMA INFORMATION (6): Net earnings........................................... $ 43,655 --------- Earnings per share..................................... $ 1.21 --------- ---------
22
DECEMBER 31, (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)(5) ----------------------------------------------------- 1996 1995 1994(4) 1993 1992 --------- --------- --------- --------- --------- BALANCE SHEET DATA: Total investments.................................... $ 320,260 $ 305,287 $ 211,881 $ 172,913 $ 78,755 Reinsurance recoverables............................. 123,181 103,408 99,462 73,057 62,089 Premium, claims and other receivables................ 139,109 130,384 113,704 54,781 46,517 Ceded unearned premium............................... 65,845 73,282 60,671 26,177 9,830 Total assets......................................... 745,779 681,676 549,490 352,506 213,905 Loss and LAE payable................................. 185,822 158,451 129,755 98,399 81,997 Unearned premium..................................... 114,758 118,732 87,346 37,382 15,142 Total debt........................................... 16,500 16,661 44,908 28,944 3,673 Shareholders' equity................................. 240,690 195,459 114,374 93,451 43,168 Net tangible book value per share (2) (3)............ $ 6.41 $ 5.33 $ 3.50 $ 3.50 $ 2.01 Book value per share (2) (3)......................... $ 6.71 $ 5.65 $ 3.89 $ 3.50 $ 2.01
- -------------------------- (1) In a 1987 private placement, the Company sold shares of redeemable common stock, which incorporated a redemption obligation requiring the Company to repurchase such shares at a specified multiple of the then current book value. Prior to its October, 1992 initial public offering, the Company executed an agreement with the holders of the redeemable common stock whereby the redemption obligation would terminate upon the effective date of the initial public offering. During the period in which the redemption obligation was in force, the Company was required to reduce its earnings by an amount equal to the increase in the redemption value of the redeemable common stock and concurrently increase the book value of the redeemable common stock by a like amount. On October 28, 1992, the effective date of the Company's initial public offering, the redemption obligation terminated. (2) These amounts have been adjusted to reflect the effects of the three-for-two stock split payable as a 50% stock dividend to shareholders of record March 15, 1994, and the five-for-two stock split payable as a 150% stock dividend to shareholders of record April 30, 1996. (3) Book value per share is calculated by dividing shares outstanding into total shareholders' equity. Net tangible book value per share uses total shareholders' equity less goodwill as the numerator. (4) Effective October 1, 1994, the Company acquired 100% of the stock of IMG and MEIB. Both acquisitions were accounted for using the purchase method. Therefore, the results of operations from both companies are included in the consolidated statements of earnings beginning October 1, 1994 and assets and liabilities of IMG and MEIB have been included in the consolidated balance sheets beginning October 1, 1994. (5) On May 24, 1996, the Company acquired 100% of the outstanding common stock of LDG. This business combination has been accounted for as a pooling-of-interests and, accordingly, the consolidated financial data shown in this table has been restated to include the accounts and operations of LDG for all periods presented. On November 27, 1996, the Company acquired 100% of the outstanding shares of NASRA. This combination has been accounted for as a pooling-of-interests. However, the Company's consolidated financial statements have not been restated due to immateriality. (6) The pro forma amounts shown include the following adjustments relating to the merger of LDG and HCCH: a) to eliminate the non-recurring compensatory stock grant and expenses related to the merger, and b) to reflect appropriate Federal income tax expense on LDG's earnings for the period LDG was an S Corporation. 23 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS FORWARD-LOOKING STATEMENTS IN THIS FORM 10-K ARE MADE PURSUANT TO THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. INVESTORS ARE CAUTIONED THAT ALL FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTY, INCLUDING WITHOUT LIMITATION, THE RISK OF A SIGNIFICANT NATURAL DISASTER, THE INABILITY OF THE COMPANY TO REINSURE CERTAIN RISKS, THE ADEQUACY OF ITS LOSS RESERVES, EXPANSION OR CONTRACTION IN ITS VARIOUS LINES OF BUSINESS, THE IMPACT OF INFLATION, CHANGING REGULATIONS IN FOREIGN COUNTRIES, THE EFFECT OF PENDING ACQUISITIONS, AS WELL AS GENERAL MARKET CONDITIONS, COMPETITION, LICENSING AND PRICING. PLEASE REFER TO THE COMPANY'S SECURITIES AND EXCHANGE COMMISSION FILINGS, COPIES OF WHICH ARE AVAILABLE FROM THE COMPANY WITHOUT CHARGE, FOR FURTHER INFORMATION. GENERAL The Company's primary sources of revenue are earned premium and investment income derived from its insurance operations, and fee and commission income from its insurance agency operations. The Company's core underwriting activities involve providing aviation, marine, offshore energy, property, and accident and health insurance, which is underwritten on both a direct and a reinsurance basis. The Company concentrates on first party, physical damage coverages and lines of business which have relatively short lead times between the occurrence of an insured event and the reporting of claims to the Company. The Company also selectively underwrites a small amount of excess treaty reinsurance. The Company's agencies market and service medical stop-loss, occupational accident and excess coverage insurance products plus large complicated insurance and reinsurance programs on behalf of multinational clients. They also place reinsurance for the Company's insurance operations and other insurance companies. During recent years, the Company has substantially increased its capital and surplus through the issuance of equity securities, incurrence of debt, and earnings, thereby enabling it to increase its underwriting capacity. The Company has utilized this additional capital by increasing underwriting activity across many of its core lines of business, emphasizing lines of business and individual opportunities with the most favorable underwriting characteristics at a particular point in time. In each line of business, the Company also cedes premiums through the purchase of reinsurance in types and amounts appropriate to the line of business, market conditions and the Company's desired net risk retention profile. Accordingly, the Company has substantially increased both its GWP and NWP, although with different relative increases in each line of business. In addition, because the Company's operating expense and loss and LAE have not increased as quickly as its premium volume, the Company has been able to substantially expand its operating margins. 24 RESULTS OF OPERATIONS The following table sets forth certain premium revenue information for the periods indicated (dollars in thousands):
FOR THE YEARS ENDED DECEMBER 31, ---------------------------------- 1996 1995 1994 ---------- ---------- ---------- Direct.................................................................... $ 84,166 $ 111,466 $ 97,585 Reinsurance assumed....................................................... 146,589 127,492 95,293 ---------- ---------- ---------- Gross written premium............................................... 230,755 238,958 192,878 Reinsurance ceded......................................................... (133,979) (140,172) (133,184) ---------- ---------- ---------- Net written premium................................................. 96,776 98,786 59,694 Increase in unearned premium.............................................. (3,462) (18,775) (12,860) ---------- ---------- ---------- Net earned premium.................................................. $ 93,314 $ 80,011 $ 46,834 ---------- ---------- ---------- ---------- ---------- ----------
The following table sets forth the relationships of certain income statement items as a percent of total revenue for the periods indicated:
FOR THE YEARS ENDED DECEMBER 31, ------------------------------- 1996 1995 1994 --------- --------- --------- Net earned premium............................................................. 61.3% 62.9% 54.8% Fee and commission income...................................................... 25.3 25.9 33.3 All other income............................................................... 13.4 11.2 11.9 --------- --------- --------- Total revenue............................................................ 100.0 100.0 100.0 Loss and LAE................................................................... 33.7 39.1 34.6 Net operating expense.......................................................... 24.3 32.9 39.9 All other expense.............................................................. 17.9 1.8 2.3 --------- --------- --------- Earnings before taxes.................................................... 24.1 26.2 23.2 Income taxes................................................................... 4.9 7.1 5.3 --------- --------- --------- Net earnings............................................................. 19.2% 19.1% 17.9% --------- --------- --------- --------- --------- ---------
YEAR ENDED DECEMBER 31, 1996 VERSUS YEAR ENDED DECEMBER 31, 1995 Total revenue during 1996 increased 20% to $152.2 million from $127.2 million in 1995. 1996 GWP decreased to $230.8 million from $239.0 million in 1995, while 1996 NWP decreased from $98.8 million to $96.8 million. The decrease in written premium was a result of the planned exit from the offshore energy business as a result of increased competition that has driven rates below acceptable levels, as well as the softening in marine rates and, more recently, property rates. Net earned premium in 1996 increased from $80.0 million to $93.3 million, reflecting the large increase in written premium during 1995. Fee and commission (non-risk bearing) income in 1996 increased 17% to $38.5 million from $32.9 million in 1995, reflecting increased agency activities. Net investment income increased 16% to $15.4 million in 1996 from $13.3 million in 1995 reflecting a higher level of investment assets. Realized investment gains from sales of marketable equity securities were $5.3 million during 1996 compared to $1.1 million during 1995. Realized investment losses from dispositions of fixed income securities were $201,000 during 1996, compared to losses of $11,000 during 1995. During 1996, the Company liquidated most of its equity security portfolio and redeployed those investment assets into fixed income securities. Loss and LAE increased $1.5 million in 1996, to $51.2 million, reflecting the overall increase in business. During 1996, the Company had net loss and LAE redundancy of $3.8 million relating to prior 25 year losses compared to a redundancy of $1.6 million in 1995. However, during 1996, the Company had gross loss and LAE deficiency of $45.8 million. The gross deficiency comes from two primary sources. The first source is the development of several large claims on individual policies which were substantially reinsured. These losses were either reported late or reserves were increased as subsequent information became available. However, because these policies were substantially reinsured, there is no material effect on a net basis. The second source is the run-off of the excess of loss "spiral" business which the Company ceased writing in 1991. This development is due to the delay in reporting of catastrophe losses by the London market, coupled with the unprecedented number of catastrophes and subsequent insurance company insolvencies. As the Company did not have enough representative years' underwriting experience upon which to base a more accurate estimate, significant gross development has been experienced. However, this business is substantially reinsured, thereby not having a material effect on the Company's current operations or shareholders' equity. The Company continues to believe it has materially provided for all net incurred losses. Compensation expense decreased $6.4 million or 24% in 1996, to $20.4 million due primarily to changes in compensation to LDG's previous principal shareholders. Interest expense during 1996 decreased 48% to $1.2 million from $2.2 million during 1995 due to the reduced level of indebtedness as a portion of the proceeds of a June, 1995, public offering of Common Stock which was used to retire debt. Income tax expense decreased to $7.3 million in 1996, compared to $9.0 million in 1995. The decrease in income tax expense was a result of a deferred tax benefit of $9.6 million which was recorded in connection with the compensatory stock grant to certain LDG employees. Also, as an S corporation, LDG was exempt from Federal income taxes through May 21, 1996. Had LDG been subject to Federal income taxes for both years, additional income tax expense of $2.3 million and $722,000 would have been recorded during the years ended December 31, 1996 and 1995, respectively. Net earnings increased 20% to $29.3 million in 1996 from $24.3 million in 1995. Included in these amounts were merger related expenses of $2.1 million and a non-recurring compensation expense of $14.4 million (net of a $9.6 million tax benefit) recorded by LDG in connection with a compensatory stock grant from LDG's majority shareholder to certain key employees prior to the Company's May, 1996, acquisition of LDG. The compensation expense was a non-cash item however, $9.6 million of actual cash tax savings will be recognized. Earnings per share increased 8% to $0.81 in 1996 from $0.75 in 1995. Excluding the non-recurring compensation charge and the merger related expenses, net earnings in 1996 would have been $43.7 million, an increase of 56% over comparable 1995 amounts and earnings per share would have been $1.21, a 41% increase over comparable 1995 amounts. The non-recurring compensation expense also caused the net loss for the agency segment during 1996. The Company's insurance company subsidiaries' statutory combined ratio was 72.0% for 1996 compared to 74.9% in 1995. The Company's combined ratio remains significantly better than the industry average. YEAR ENDED DECEMBER 31, 1995 VERSUS YEAR ENDED DECEMBER 31, 1994 Total revenue during 1995 increased 49% to $127.2 million from $85.5 million in 1994. GWP increased 24% to $239.0 million from $192.9 million in 1994, while 1995 NWP increased 65% from $59.7 million to $98.8 million. Accordingly, net earned premium in 1995 increased 71% from $46.8 million to $80.0 million. These increases were due to substantial new business, rate increases on some renewals, particularly property and aviation, and increased retentions. Fee and commission (non-risk bearing) income in 1995 increased 16% to $32.9 million from $28.5 million in 1994, reflecting increased agency activities. Net investment income increased 39% to $13.3 million in 1995 from $9.5 million in 1994 reflecting a substantially higher level of investment assets due to increased operating cash flow and the deployment of the proceeds from a public offering of the Company's Common Stock. 26 Realized investment gains from sales of marketable equity securities were $1.1 million during 1995 compared to $775,000 during 1994. Realized investment losses from sales of fixed income securities were $11,000 during 1995, compared to losses of $89,000 during 1994. Loss and LAE increased $20.2 million in 1995, to $49.8 million, reflecting the overall increase in business written. During 1995, the Company had net loss and LAE redundancy of $1.6 million relating to prior year losses compared to a deficiency of $717,000 in 1994. However, during 1995, the Company had gross loss and LAE deficiency of $18.4 million. A substantial portion of this gross deficiency relates to the run-off of the excess of loss "spiral" business which the Company ceased writing in 1991. This development is due to the delay in reporting of catastrophe losses by the London market, coupled with the unprecedented number of catastrophes and subsequent insurance company insolvencies. As the Company did not have enough representative years' underwriting experience to base a more accurate estimate on, significant gross development has been experienced. However, this business is substantially reinsured, thereby not having a material effect on the Company's current operations or shareholders' equity. The Company continues to believe it has materially provided for all net incurred losses. Interest expense during 1995 increased 14% to $2.2 million from $2.0 million during 1994 due to the increased level of indebtedness during the first six months of 1995, which was incurred during late 1994 to fund the acquisitions of IMG and MEIB. Net earnings increased 59% to $24.3 million from $15.3 million in 1994. This increase was principally a result of more efficient and continued profitable underwriting plus higher investment income and fee and commission income. Earnings per share in 1995 increased 36% to $0.75 from $0.55 in 1994. This reflects the 59% increase in net earnings partially offset by the 17% increase in weighted average shares outstanding as a result of HCCH's 1994 acquisitions and 1995 public stock offering. HCCH's insurance company subsidiaries' statutory combined ratio was 74.9% for 1995 compared to 74.8% in 1994. HCCH's combined ratio remains significantly better than the industry average. LIQUIDITY AND CAPITAL RESOURCES HCCH completed an initial public offering of 1,437,500 shares (pre splits) of Common Stock during October, 1992 and secondary public offerings of 1,254,200 shares (pre splits) of Common Stock in September, 1993 and 2,012,500 shares (pre split) of Common Stock in June, 1995. The offerings dramatically improved the capital resources of the Company. The net proceeds of the offerings have been used to reduce the Company's indebtedness and to contribute capital to the insurance company subsidiaries. HCC now has more than $150 million in policyholders' surplus and IMG has more than $59 million. This additional capital enables both HCC and IMG to write significantly more premium income. The initial public offering also resulted in the termination of all redemption rights previously held by certain shareholders. The Company receives substantial cash from premiums and reinsurance recoverables, and, to a lesser extent, investment income, proceeds from sales and redemptions of investment assets and fee and commission income. The principal cash outflows are for the payment of claims, payment of premiums to reinsurers, purchase of investments, debt service, LAE, policy acquisition costs, operating expense, income and other taxes and dividends. During 1996, HCC renewed its existing credit facility which provides for a $12 million bank line of credit for the issuance of letters of credit and for short-term borrowings at the prime rate of interest. This line is collateralized by securities with a market value equal to 125% of the total sum of the letters of credit issued and cash advances outstanding. This facility matures on April 30, 1997. As of December 31, 1996, letters of credit in the amount of $4.6 million were issued on behalf of the HCC to collateralize certain reinsurance obligations, however no cash advances were outstanding under this line and, therefore, $7.4 million is available for short-term borrowings under this facility. 27 In January, 1997, the Company obtained an additional bank line of credit for $10.0 million. This credit facility provides for short-term borrowings and matures April 30, 1998. Interest is payable quarterly at either (i) variable at the banks prime rate; or (ii) fixed at the London Interbank Offering Rate ("LIBOR") plus 1 1/2%, at the option of the Company. The line of credit is collateralized by a pledge of all capital stock of HCC. This new line of credit improves the Company's short term liquidity. On September 14, 1993, HCCH borrowed $29.25 million from a bank. HCCH used the proceeds to retire previous indebtedness and make a $10.0 million capital contribution to HCC. The principal terms of the note, which matures on October 1, 1998 are (i) quarterly principal repayments of $1.5 million, increasing to $1.75 million; (ii) interest at the prime lending rate; (iii) collateralization by a pledge of all capital stock of HCC and substantially all of the common stock of IMG; and (iv) certain restrictive terms and conditions including restrictions on certain transactions in the Company's Common Stock or the capital stock of HCC and IMG and the maintenance of required financial ratios. During February, 1994, the note was amended by fixing the interest rate at 6.5% until February 7, 1997. Thereafter, the rate reverts to the prime lending rate or LIBOR plus 2.25%, at the Company's option. Additionally, the loan agreement prohibits the payment of dividends by the Company without the bank's approval. During 1995, the Company prepaid the first two installments of $1.5 million due in 1996. The bank deferred the second two installments due in 1996 until maturity. The Company paid the first 1997 quarterly payment of $1.5 million in January, 1997. The Company maintains a substantial level of cash and liquid short-term investments which are used to meet anticipated payment obligations. As of December 31, 1996, the Company had cash and short-term investments of approximately $56.3 million. The Company's consolidated investment portfolio of $320.3 million as of December 31, 1996, is available to provide additional liquidity and cash for operations. Property and casualty insurance companies domiciled in the State of Texas are limited in the payment of dividends to its shareholders in any 12 month period, without the prior written consent of the Commissioner of Insurance, to the greater of net investment income or 10% of statutory policyholders' surplus. HCC paid no dividends in 1996 to HCCH. During 1997, HCC's ordinary dividend capacity will be approximately $15.1 million. The Company believes that its operating cash flows, short-term investments and the bank lines of credit will provide sufficient sources of liquidity to meet its anticipated needs for the foreseeable future. At December 31, 1996, the Company had a net deferred tax asset of $11.5 million. Due to the Company's history of consistent earnings, strong operating cash flows, expectations for the future and the ability to hold investments to maturity, it is more likely than not that the Company will be able to realize the benefit of its deferred tax asset. As of December 31, 1996, HCC's total adjusted capital was $150.7 million, which is 1,332% of the NAIC authorized control level risk-based capital while TIC's total adjusted capital was $27.6 million, which is 17,928% of the NAIC authorized control level risk-based capital. Industry and regulatory guidelines suggest that a property and casualty insurer's annual statutory GWP should not exceed 900% of its statutory policyholders' surplus and NWP should not exceed 300% of its statutory policyholders' surplus. The Company maintains a premium to surplus ratio significantly lower than such guidelines, and for the year ended December 31, 1996, its annual statutory GWP was 108.8% of its statutory policyholders' surplus and NWP was 45.6% of its statutory policyholders' surplus. IMPACT OF INFLATION The Company's operations, like those of other property and casualty insurers, are susceptible to the effects of inflation, as premiums are established before the ultimate amounts of loss and LAE are known. Although management considers the potential effects of inflation when setting premiums, for competitive reasons, such premiums may not adequately compensate the Company for the effects of inflation. However, as the majority of the Company's business is comprised of lines which have short lead times 28 between the occurrence of an insured event, reporting of the claims to the Company and the final settlement of the claims, the effects of inflation are minimized. A significant portion of the Company's revenue is related to healthcare insurance and reinsurance products which are subject to the effects of the underlying inflation of medical costs. Such inflation in the costs of healthcare tends to generate increases in premiums for medical stop-loss coverage, resulting in greater revenue, but also higher claim payments. Inflation may have a negative impact on insurance and reinsurance operations by causing higher claim settlements than may originally have been estimated without an immediate increase in premiums to a level necessary to maintain profit margins being possible. No express provision for inflation is made, although trends are considered when setting underwriting terms and claim reserves for purposes of determining revenue from underwriting profit commission. Such reserves are subject to a continuing review process to assess their adequacy and are adjusted as deemed appropriate. In addition, the market value of the investments held by the Company varies depending on economic and market conditions and interest rates, which are highly sensitive to the policies of governmental and regulatory authorities. Any significant change in interest rates could therefore have a material adverse effect on the market value of the Company's investments. EXCHANGE RATE FLUCTUATIONS The Company underwrites risks which are denominated in a number of foreign currencies. It establishes and maintains loss reserves with respect to these policies in their respective currencies. These reserves are subject to exchange rate fluctuations which can have an effect on the Company's net earnings. The Company's principal area of exposure is with respect to fluctuation in the exchange rate between the British Pound Sterling and the United States Dollar. For the years ended December 31, 1996, 1995 and 1994, the gain (loss) from currency conversion was ($181,000), ($209,000) and $203,000, respectively. From time to time the Company enters into foreign currency forward contracts as a hedge against foreign currency fluctuations, primarily British Pound Sterling. The Company's balances denominated in foreign currency fluctuate as transactions are recorded and settled. During 1996, the average Sterling liability, for subsidiaries whose functional currency was the United States dollar, was approximately L907,000 ($1.6 million at the December 31, 1996, rate of exchange) which was hedged by an average open forward contract balance of approximately L460,000 ($785,000 at the December 31, 1996, rate of exchange). There was one open foreign currency forward contract as of December 31, 1996, to purchase L500,000 ($856,000 at the December 31, 1996, rate of exchange) with a maturity of January, 1997. During January, 1997, the Company entered into a foreign currency forward contract totaling L500,000 ($856,000 at the December 31, 1996, rate of exchange). The Company expects to continue to limit its exposure to currency fluctuations through the use of foreign currency forward contracts. The Company utilizes these foreign currency forward contracts strictly as a hedge against existing exposure to foreign currency fluctuations and it does not do so as any form of speculative or trading investment. EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS In February, 1997, the Financial Accounting Standards Board issued SFAS No.128 "Earnings Per Share". SFAS No.128 is effective for fiscal years ending after December 15, 1997. Early application is not permitted. SFAS No.128 modifies the denominator to be used in the earnings per share calculations, and requires additional disclosures of the calculations. However, the statement will have no effect on the Company's net earnings, shareholders' equity or cash flows. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements required in response to this section are submitted as part of Item 14 of this report. 29 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT For information regarding Directors and Executive Officers of the Registrant, reference is made to the Registrant's definitive proxy statement for its Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1996, and which is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION For information regarding Executive Compensation, reference is made to the Registrant's definitive proxy statement for its Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1996, and which is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT For information regarding Security Ownership of Certain Beneficial Owners and Management, reference is made to the Registrant's definitive proxy statement for its Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1996, and which is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS For information regarding Certain Relationships and Related Transactions, reference is made to the Registrant's definitive proxy statement for its Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1996, and which is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K FINANCIAL STATEMENTS AND SCHEDULES The financial statements and schedules listed in the accompanying index on page 32 are filed as part of this report. EXHIBITS The exhibits listed on the accompanying Index to Exhibits on page 33 are filed as part of this report. REPORTS ON FORM 8-K On December 11, 1996, the Registrant filed a report on Form 8-K reporting the consummation of the acquisition of all the outstanding shares of common stock of NASRA. 30 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. HCC INSURANCE HOLDINGS, INC. (Registrant) By: /s/ STEPHEN L. WAY ------------------------------------------ Stephen L. Way CHAIRMAN OF THE BOARD Dated: March 27, 1997 AND CHIEF EXECUTIVE OFFICER Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. NAME TITLE DATE - ------------------------------ --------------------------- ------------------- Chairman of the Board of /s/ STEPHEN L. WAY Directors and Chief - ------------------------------ Executive Officer March 27, 1997 (Stephen L. Way) (Principal Executive Officer) /s/ STEPHEN J. LOCKWOOD* - ------------------------------ Director, President March 27, 1997 (Stephen J. Lockwood) Executive Vice President, Secretary and Chief /s/ FRANK J. BRAMANTI Financial Officer - ------------------------------ (Principal Financial March 27, 1997 (Frank J. Bramanti) Officer and Principal Accounting Officer) /s/ JAMES M. BERRY* - ------------------------------ Director March 27, 1997 (James M. Berry) /s/ PATRICK B. COLLINS* - ------------------------------ Director March 27, 1997 (Patrick B. Collins) /s/ J. ROBERT DICKERSON* - ------------------------------ Director March 27, 1997 (J. Robert Dickerson) /s/ EDWIN H. FRANK, III* - ------------------------------ Director March 27, 1997 (Edwin H. Frank, III) /s/ JOHN L. KAVANAUGH* - ------------------------------ Director March 27, 1997 (John L. Kavanaugh) /s/ WALTER J. LACK* - ------------------------------ Director March 27, 1997 (Walter J. Lack) /s/ HUGH T. WILSON* - ------------------------------ Director March 27, 1997 (Hugh T. Wilson) *By: /s/ FRANK J. BRAMANTI ------------------------- Frank J. Bramanti, March 27, 1997 ATTORNEY-IN-FACT 31 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES Reports of Independent Accountants................................................... F-1 Consolidated Balance Sheets at December 31, 1996 and 1995............................ F-3 Consolidated Statements of Earnings for each of the years in the three-year period ended December 31, 1996............................................................ F-4 Consolidated Statements of Changes in Shareholders' Equity for each of the years in the three-year period ended December 31, 1996...................................... F-5 Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 1996............................................................ F-8 Notes to Consolidated Financial Statements........................................... F-9 SCHEDULES: Report of Independent Accountants......................................... S-1 Schedule 1 Summary of Investments other than Investments in Related Parties........ S-2 Schedule 2 Condensed Financial Information of Registrant........................... S-3 Schedule 3 Supplementary Insurance Information..................................... S-7 Schedule 4 Reinsurance............................................................. S-8
Schedules other than those listed above have been omitted because they are either not required, not applicable, or the required information is shown in the Consolidated Financial Statements and related notes thereto. 32 INDEX TO EXHIBITS (ITEMS DENOTED BY A LETTER ARE INCORPORATED BY REFERENCE TO OTHER DOCUMENTS PREVIOUSLY FILED WITH THE SECURITIES AND EXCHANGE COMMISSION AS SET FORTH AT THE END OF THIS INDEX. ITEMS NOT DENOTED BY A LETTER ARE BEING FILED HEREWITH.)
EXHIBIT NUMBER - ------------ (A)3.4 --Bylaws of HCC Insurance Holdings, Inc., as amended. (J)3.7 --Restated Certificate of Incorporation of HCC Holdings, Inc., filed with the Delaware Secretary of State on July 23, 1996. (A)4.1 --Specimen of Common Stock Certificate, $1.00 par value, of HCC Insurance Holdings, Inc. (A)10.17 --Cost Allocation Agreement dated September 1, 1991, by and among HCC Holdings, A Texas Corporation, Houston Casualty Company, Trafalgar Reinsurance Company Ltd., Houston Re Corporation and HCC Underwriters, A Texas Corporation (A)10.19 --Agreement for Allocation of Federal Income Tax dated November 29, 1991, by and among HCC Holdings, Inc., Houston Casualty Company, SBS Insurance Holdings, Trafalgar Reinsurance Company, Ltd., HCC Underwriters and Houston Re Corporation (A)10.22 --Investment Advisory Agreement dated January 10, 1992 between Houston Casualty Company and William Blair & Company relating to investment services to be provided by William Blair & Company (A)10.23 --HCC Insurance Holdings, Inc. 1992 Incentive Stock Option Plan (A)10.24 --Program License Agreement dated April 29, 1992, by and between EPG America, Inc., and HCC Holdings, Inc. pertaining to license for the computer services described therein (B)10.227 --Loan Agreement dated August 24, 1993 in the original principal amount of $29,250,000 executed by HCC Insurance Holdings, Inc., payable to First Interstate Bank of Texas, N.A. together with Promissory Note and Commercial Pledge Agreement relating thereto. (B)10.227.1 --Change in Loan Agreement dated February 7, 1994 between HCC Insurance Holdings, Inc. and First Interstate Bank of Texas, N.A. relating to the $29,250,000 loan. (B)10.228 --Promissory Note dated February 25, 1994 in the original principal amount of $12,000,000 executed by Houston Casualty Company, payable to First Interstate Bank of Texas, N.A. together with Commercial Pledge Agreement relating thereto. (C)10.302 --Aircraft Dry Lease Agreement effective January 4, 1995 between SLW Aviation, Inc. and HCC Insurance Holdings, Inc. (C)10.303 --Stock Purchase Agreement effective January 1, 1994 between River Investments Limited and HCC Underwriters, A Texas Corporation related to the acquisition of 25% of Middle East Insurance Brokers Ltd. (C)10.304 --Stock Purchase Agreement effective October 1, 1994 between various shareholders of Middle East Insurance Brokers Ltd. and HCC Insurance Holdings, Inc. related to the acquisition of 75% of Middle East Insurance Brokers Ltd. (C)10.305 --Stock Purchase Agreement effective October 1, 1994 between various shareholders of International Marine & General Insurance Company Ltd. and HCC Insurance Holdings, Inc. related to the acquisition of 100% of International Marine & General Insurance Company Ltd.
33
EXHIBIT NUMBER - ------------ (C)10.306 --Loan Agreement dated November 29, 1994 in the original principal amount of $20,000,000 executed by HCC Insurance Holdings, Inc., payable to First Interstate Bank of Texas, N.A. together with the Promissory Note. (D)10.320 --Promissory note dated April 30, 1995, in the original principal amount of $12,000,000 executed by Houston Casualty Company, payable to First Interstate Bank of Texas, N.A. (E)10.324 --HCC Insurance Holdings, Inc. 1994 Nonemployee Director Stock Option Plan. (F)10.325 --HCC Insurance Holdings, Inc. 1995 Flexible Stock Option Plan. (H)10.326 --Agreement and Plan of Reorganization dated February 22, 1996 between various shareholders of LDG Management Company Incorporated and affiliated companies and HCC Insurance Holdings, Inc. related to the acquisition of 100% of the common stock of LDG Management Company Incorporated and affiliated companies. (I)10.327 --Agreement and Plan of Reorganization dated February 28, 1997 between AVEMCO Corporation and HCC Insurance Holdings, Inc. related to the intent to merge in a stock for stock transaction. (J)10.328 --HCC Insurance Holdings, Inc. 1996 Nonemployee Director Stock Option Plan. (K)10.329 --HCC Insurance Holdings, Inc. 1995 Flexible Incentive Plan. 10.330 --Agreement and Plan of Reorganization dated November 27, 1996 between various shareholders of North American Special Risk Associates and affiliated companies and HCC Insurance Holdings, Inc. related to the acquisition of 100% of the common stock of North American Special Risk Associates, Inc. and affiliated companies. 10.331 --Agreement of Purchase and Sale dated January 23, 1997, between TRM International, Inc., Unicover Manager, Inc., North American Special Risk Associates, Inc. and HCC Insurance Holdings, Inc. 10.332 --Revolving Line of Credit Note dated October 7, 1996, in the original principal amount of $12,000,000 executed by Houston Casualty Company, payable to Wells Fargo Bank (Texas), National Association together with Credit Agreement and General Pledge Agreement and Amendment relating thereto. 10.333 --Revolving Line of Credit Note dated January 10, 1997, in the original principal amount of $10,000,000 executed by HCC Insurance Holdings, Inc., payable to Wells Fargo Bank (Texas), National Association together with Credit Agreement and General Pledge Agreement relating thereto. 11 --Statement Regarding Computation of Earnings Per Share 12 --Statement Regarding Computation of Ratios 21 --Subsidiaries of HCC Insurance Holdings, Inc. (G)24 --Powers of Attorney 27 --EDGAR Financial Data Schedule 28 --Information from reports furnished to the State Boards of Insurance
34 INDEX TO EXHIBITS (A) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Registration Statement (Registration No. 33-48737) filed October 27, 1992. (B) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Form 10K for the fiscal year ended December 31, 1993 filed March 30, 1994. (C) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Form 10K for the fiscal year ended December 31, 1994 filed March 30, 1995. (D) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Form 10Q for the fiscal quarter ended March 31, 1995 filed May 16, 1995. (E) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Registration Statement on Form S-8 (Registration No. 33-94472) filed July 11, 1995. (F) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Registration Statement on Form S-8 (Registration No. 33-94468) filed July 11, 1995. (G) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Form 10K for fiscal year ended December 31, 1995 filed March 28, 1996. (H) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Registration Statement (Registration No. 333-3652) filed April 15, 1996. (I) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc. Preliminary Registration Statement filed March 7, 1997. (J) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Registration Statement on Form S-8 (Registration No. 333-14479) filed October 18, 1996. (K) Incorporated by reference to the Exhibits to HCC Insurance Holdings, Inc.'s Registration Statement on Form S-8 (Registration No. 333-14471) filed October 18, 1996. 35 REPORT OF INDEPENDENT ACCOUNTANTS The Board of Directors and Shareholders HCC Insurance Holdings, Inc. We have audited the accompanying consolidated balance sheets of HCC Insurance Holdings, Inc. and Subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of earnings, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of HCC Insurance Holdings, Inc.'s management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the 1994 financial statements of LDG Management Company Incorporated and Affiliates, which statements reflect total revenues constituting 30 percent and net earnings constituting 12 percent of the related consolidated financial statement totals for the year ended December 31, 1994. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to data included for LDG Management Company Incorporated and Affiliates for 1994, is based solely on the report of the other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of the other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of HCC Insurance Holdings, Inc. and Subsidiaries as of December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. COOPERS & LYBRAND L.L.P. Houston, Texas March 27, 1997 F-1 REPORT OF INDEPENDENT ACCOUNTANTS The Board of Directors and Shareholders LDG Management Company Incorporated and Affiliates Wakefield, Massachusetts We have audited the combined statements of earnings, changes in shareholders' equity, and cash flow of LDG Management Company Incorporated (an S corporation) and Affiliates (S corporations) for the year ended December 31, 1994. These combined financial statements are the responsibility of the Companies' management. Our responsibility is to express an opinion on these combined financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the combined financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the combined 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 audit provides a reasonable basis for our opinion. In our opinion, the combined financial statements referred to above present fairly, in all material respects, the combined results of operations of LDG Management Company Incorporated and Affiliates and their cash flows for the year ended December 31, 1994, in conformity with generally accepted accounting principles. TONNESON & COMPANY C.P.A.'s P.C. Wakefield, Massachusetts April 6, 1995 F-2 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
DECEMBER 31, ------------------------------ 1996 1995 -------------- -------------- ASSETS Investments: Securities available for sale: Fixed income securities, at market (cost: 1996 $262,667,000; 1995 $231,807,000).............................................................. $ 264,727,000 $ 234,881,000 Marketable equity securities, at market (cost: 1996 $2,481,000 ; 1995 $10,097,000)............................................................... 2,433,000 13,812,000 Mortgage loans, at unpaid principal balance, net............................... -- 81,000 Short-term investments, at cost, which approximates market..................... 53,100,000 56,513,000 -------------- -------------- Total investments.......................................................... 320,260,000 305,287,000 Cash............................................................................. 3,212,000 3,574,000 Restricted cash and short-term investments....................................... 44,363,000 23,495,000 Reinsurance recoverables......................................................... 123,181,000 103,408,000 Premium, claims and other receivables............................................ 139,109,000 130,384,000 Ceded unearned premium........................................................... 65,845,000 73,282,000 Deferred policy acquisition costs................................................ 16,843,000 16,431,000 Property and equipment, net...................................................... 9,135,000 9,440,000 Deferred income tax.............................................................. 11,524,000 2,921,000 Other assets, net................................................................ 12,307,000 13,454,000 -------------- -------------- Total assets............................................................... $ 745,779,000 $ 681,676,000 -------------- -------------- -------------- -------------- LIABILITIES Loss and loss adjustment expense payable......................................... $ 185,822,000 $ 158,451,000 Reinsurance balances payable..................................................... 43,900,000 68,463,000 Unearned premium................................................................. 114,758,000 118,732,000 Deferred ceding commissions...................................................... 15,418,000 17,497,000 Premium and claims payable....................................................... 119,524,000 96,122,000 Notes payable.................................................................... 16,500,000 16,661,000 Accounts payable and accrued liabilities......................................... 9,167,000 10,291,000 -------------- -------------- Total liabilities.......................................................... 505,089,000 486,217,000 SHAREHOLDERS' EQUITY Common Stock, $1.00 par value; 100,000,000 shares authorized; (issued and outstanding: 1996 35,850,832 shares; 1995 13,838,802 shares)................... 35,851,000 13,839,000 Additional paid-in capital....................................................... 131,240,000 123,257,000 Retained earnings................................................................ 72,169,000 53,950,000 Unrealized investment gain, net.................................................. 1,303,000 4,417,000 Foreign currency translation adjustment.......................................... 127,000 (4,000) -------------- -------------- Total shareholders' equity................................................. 240,690,000 195,459,000 -------------- -------------- Total liabilities and shareholders' equity................................. $ 745,779,000 $ 681,676,000 -------------- -------------- -------------- --------------
See Notes to Consolidated Financial Statements. F-3 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------- 1996 1995 1994 ------------- ------------- ------------- REVENUE Net earned premium.................................................. $ 93,314,000 $ 80,011,000 $ 46,834,000 Fee and commission income........................................... 38,462,000 32,887,000 28,456,000 Net investment income............................................... 15,372,000 13,250,000 9,533,000 Net realized investment gain........................................ 5,097,000 1,061,000 682,000 ------------- ------------- ------------- Total revenue................................................. 152,245,000 127,209,000 85,505,000 EXPENSE Loss and loss adjustment expense.................................... 51,242,000 49,769,000 29,588,000 Operating expense: Policy acquisition costs.......................................... 34,110,000 29,748,000 21,729,000 Compensation expense.............................................. 20,353,000 26,790,000 23,900,000 Other operating expense........................................... 12,855,000 12,591,000 8,660,000 Ceding commissions................................................ (30,268,000) (27,228,000) (20,210,000) ------------- ------------- ------------- Net operating expense......................................... 37,050,000 41,901,000 34,079,000 Compensatory stock grant and merger related expenses................ 26,160,000 -- -- Interest expense.................................................... 1,166,000 2,247,000 1,972,000 ------------- ------------- ------------- Total expense................................................. 115,618,000 93,917,000 65,639,000 ------------- ------------- ------------- Earnings before income tax provision.......................... 36,627,000 33,292,000 19,866,000 Income tax provision................................................ 7,329,000 8,955,000 4,598,000 ------------- ------------- ------------- Net earnings.................................................. $ 29,298,000 $ 24,337,000 $ 15,268,000 ------------- ------------- ------------- ------------- ------------- ------------- EARNINGS PER SHARE DATA: Earnings per share.................................................. $ 0.81 $ 0.75 $ 0.55 ------------- ------------- ------------- ------------- ------------- ------------- Weighted average shares outstanding................................. 35,965,000 32,667,000 27,910,000 ------------- ------------- ------------- ------------- ------------- ------------- PRO FORMA INFORMATION (SEE NOTE 2): Net earnings........................................................ $ 43,655,000 ------------- ------------- Earnings per share.................................................. $ 1.21 ------------- -------------
See Notes to Consolidated Financial Statements. F-4 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
ADDITIONAL UNREALIZED COMMON PAID-IN RETAINED INVESTMENT STOCK CAPITAL EARNINGS GAIN (LOSS) ------------- -------------- ------------- ------------- BALANCE AS OF DECEMBER 31, 1993............................... $ 10,691,000 $ 61,721,000 $ 18,029,000 $ 3,035,000 128,588 shares of Common Stock issued for exercise of options, including tax benefit of $659,000............................ 128,000 1,216,000 -- -- 947,619 shares of Common Stock issued to acquire subsidiaries, net of 64,950 shares of Common Stock acquired as treasury stock........................................................ 948,000 11,983,000 -- -- Capital contributions to LDG prior to merger.................. -- 313,000 -- -- Net earnings.................................................. -- -- 15,268,000 -- Dividends to shareholders of LDG prior to merger.............. -- -- (1,855,000) -- Unrealized investment loss on fixed income securities, net of deferred tax benefit of $4,270,000........................... -- -- -- (8,017,000) Unrealized investment loss on marketable equity securities, net of deferred tax benefit of $148,000...................... -- -- -- (319,000) Sale of 64,950 shares of treasury stock....................... -- 1,247,000 -- -- Other......................................................... -- -- -- -- ------------- -------------- ------------- ------------- BALANCE AS OF DECEMBER 31, 1994........................... $ 11,767,000 $ 76,480,000 $ 31,442,000 $ (5,301,000) FOREIGN CURRENCY TOTAL TRANSLATION SHAREHOLDERS' ADJUSTMENT EQUITY ----------- -------------- BALANCE AS OF DECEMBER 31, 1993............................... $ (25,000) $ 93,451,000 128,588 shares of Common Stock issued for exercise of options, including tax benefit of $659,000............................ -- 1,344,000 947,619 shares of Common Stock issued to acquire subsidiaries, net of 64,950 shares of Common Stock acquired as treasury stock........................................................ -- 12,931,000 Capital contributions to LDG prior to merger.................. -- 313,000 Net earnings.................................................. -- 15,268,000 Dividends to shareholders of LDG prior to merger.............. -- (1,855,000) Unrealized investment loss on fixed income securities, net of deferred tax benefit of $4,270,000........................... -- (8,017,000) Unrealized investment loss on marketable equity securities, net of deferred tax benefit of $148,000...................... -- (319,000) Sale of 64,950 shares of treasury stock....................... -- 1,247,000 Other......................................................... 11,000 11,000 ----------- -------------- BALANCE AS OF DECEMBER 31, 1994........................... $ (14,000) $ 114,374,000
See Notes to Consolidated Financial Statements. F-5 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY--(CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
ADDITIONAL UNREALIZED COMMON PAID-IN RETAINED INVESTMENT STOCK CAPITAL EARNINGS GAIN (LOSS) ------------- -------------- ------------- ------------- BALANCE AS OF DECEMBER 31, 1994............................... $ 11,767,000 $ 76,480,000 $ 31,442,000 $ (5,301,000) 58,876 shares of Common Stock issued for exercise of options, including tax benefit of $252,000............................ 59,000 770,000 -- -- 2,012,500 shares of Common Stock issued in public offering, net of costs................................................. 2,013,000 45,957,000 -- -- Capital contribution to LDG prior to merger................... -- 50,000 -- -- Net earnings.................................................. -- -- 24,337,000 -- Dividends to shareholders of LDG prior to merger.............. -- -- (1,829,000) -- Unrealized investment gain on fixed income securities, net of deferred tax charge of $4,293,000............................ -- -- -- 7,973,000 Unrealized investment gain on marketable equity securities, net of deferred tax charge of $934,000....................... -- -- -- 1,745,000 Other......................................................... -- -- -- -- ------------- -------------- ------------- ------------- BALANCE AS OF DECEMBER 31, 1995........................... $ 13,839,000 $ 123,257,000 $ 53,950,000 $ 4,417,000 FOREIGN CURRENCY TOTAL TRANSLATION SHAREHOLDERS' ADJUSTMENT EQUITY ----------- -------------- BALANCE AS OF DECEMBER 31, 1994............................... $ (14,000) $ 114,374,000 58,876 shares of Common Stock issued for exercise of options, including tax benefit of $252,000............................ -- 829,000 2,012,500 shares of Common Stock issued in public offering, net of costs................................................. -- 47,970,000 Capital contribution to LDG prior to merger................... -- 50,000 Net earnings.................................................. -- 24,337,000 Dividends to shareholders of LDG prior to merger.............. -- (1,829,000) Unrealized investment gain on fixed income securities, net of deferred tax charge of $4,293,000............................ -- 7,973,000 Unrealized investment gain on marketable equity securities, net of deferred tax charge of $934,000....................... -- 1,745,000 Other......................................................... 10,000 10,000 ----------- -------------- BALANCE AS OF DECEMBER 31, 1995........................... $ (4,000) $ 195,459,000
See Notes to Consolidated Financial Statements. F-6 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY--(CONTINUED) FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
ADDITIONAL UNREALIZED COMMON PAID-IN RETAINED INVESTMENT STOCK CAPITAL EARNINGS GAIN (LOSS) ------------- -------------- ------------- ------------- BALANCE AS OF DECEMBER 31, 1995............................... $ 13,839,000 $ 123,257,000 $ 53,950,000 $ 4,417,000 20,758,172 shares of Common Stock issued for 150% stock dividend (see note 1)........................................ 20,758,000 (20,758,000) -- -- 117,458 shares of Common Stock issued for exercise of options, including tax benefit of $366,000............................ 118,000 725,000 -- -- Net earnings.................................................. -- -- 29,298,000 -- Cash dividends declared, $0.06 per share...................... -- -- (2,104,000) -- Compensatory grant of LDG stock prior to merger............... -- 23,682,000 -- -- Dividends to shareholders of LDG prior to merger.............. -- -- (3,683,000) -- Capitalize undistributed earnings of LDG upon conversion from S Corporation................................................ -- 3,840,000 (3,840,000) -- 1,136,400 shares of Common Stock issued for NASRA combination.................................................. 1,136,000 -- (1,452,000) -- Unrealized investment loss on fixed income securities, net of deferred tax benefit of $355,000............................. -- -- -- (659,000) Unrealized investment loss on marketable equity securities, net of deferred tax benefit of $1,307,000.................... -- -- -- (2,455,000) Other......................................................... -- 494,000 -- -- ------------- -------------- ------------- ------------- BALANCE AS OF DECEMBER 31, 1996........................... $ 35,851,000 $ 131,240,000 $ 72,169,000 $ 1,303,000 ------------- -------------- ------------- ------------- ------------- -------------- ------------- ------------- FOREIGN CURRENCY TOTAL TRANSLATION SHAREHOLDERS' ADJUSTMENT EQUITY ----------- -------------- BALANCE AS OF DECEMBER 31, 1995............................... $ (4,000) $ 195,459,000 20,758,172 shares of Common Stock issued for 150% stock dividend (see note 1)........................................ -- -- 117,458 shares of Common Stock issued for exercise of options, including tax benefit of $366,000............................ -- 843,000 Net earnings.................................................. -- 29,298,000 Cash dividends declared, $0.06 per share...................... -- (2,104,000) Compensatory grant of LDG stock prior to merger............... -- 23,682,000 Dividends to shareholders of LDG prior to merger.............. -- (3,683,000) Capitalize undistributed earnings of LDG upon conversion from S Corporation................................................ -- -- 1,136,400 shares of Common Stock issued for NASRA combination.................................................. -- (316,000) Unrealized investment loss on fixed income securities, net of deferred tax benefit of $355,000............................. -- (659,000) Unrealized investment loss on marketable equity securities, net of deferred tax benefit of $1,307,000.................... -- (2,455,000) Other......................................................... 131,000 625,000 ----------- -------------- BALANCE AS OF DECEMBER 31, 1996........................... $ 127,000 $ 240,690,000 ----------- -------------- ----------- --------------
See Notes to Consolidated Financial Statements. F-7 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, -------------------------------------------- 1996 1995 1994 ------------- -------------- ------------- Cash flows from operating activities: Net earnings..................................................... $ 29,298,000 $ 24,337,000 $ 15,268,000 Adjustments to reconcile net earnings to net cash provided by operating activities: Change in reinsurance recoverables............................. (19,773,000) (3,946,000) (25,233,000) Change in premium, claims and other receivables................ (8,725,000) (16,680,000) (56,061,000) Change in ceded unearned premium............................... 7,437,000 (12,611,000) (34,926,000) Change in deferred policy acquisition costs, net............... (2,491,000) (419,000) 1,115,000 Change in deferred income tax, net of tax effect of unrealized gain or loss................................................... (6,941,000) (1,545,000) (1,181,000) Change in loss and loss adjustment expense payable............. 27,371,000 28,696,000 28,746,000 Change in reinsurance balances payable......................... (24,563,000) 403,000 32,922,000 Change in unearned premium..................................... (3,974,000) 31,386,000 47,786,000 Change in premium and claims payable, net of restricted cash... 2,534,000 7,577,000 21,258,000 Change in accounts payable and accrued liabilities............. (1,841,000) 4,027,000 645,000 Net realized investment gain................................... (5,097,000) (1,061,000) (682,000) Noncash compensation expense................................... 24,176,000 -- -- Depreciation and amortization expense.......................... 2,318,000 1,700,000 1,284,000 Other, net..................................................... 3,126,000 767,000 328,000 ------------- -------------- ------------- Cash provided by operating activities........................ 22,855,000 62,631,000 31,269,000 Cash flows from investing activities: Sales of fixed income securities................................. 3,465,000 21,388,000 24,002,000 Maturity or call of fixed income securities...................... 8,285,000 8,162,000 25,000 Sales of equity securities....................................... 18,211,000 9,458,000 9,104,000 Net cash (paid) received in combinations......................... (1,753,000) -- 1,979,000 Cost of investments acquired..................................... (48,807,000) (107,639,000) (73,738,000) Purchases of property and equipment.............................. (1,724,000) (3,269,000) (1,438,000) Other, net....................................................... 81,000 1,229,000 826,000 ------------- -------------- ------------- Cash used by investing activities............................ (22,242,000) (70,671,000) (39,240,000) Cash flows from financing activities: Proceeds from notes payable...................................... 250,000 -- 20,110,000 Sale of Common Stock, net of costs............................... 843,000 48,799,000 1,344,000 Sales of treasury stock.......................................... -- -- 1,247,000 Capital contributions to LDG..................................... -- -- 313,000 Payments on notes payable........................................ (411,000) (28,247,000) (4,146,000) Dividends paid................................................... (5,070,000) (1,507,000) (1,855,000) ------------- -------------- ------------- Cash provided (used) by financing activities................. (4,388,000) 19,045,000 17,013,000 ------------- -------------- ------------- Net change in cash and short-term investments................ (3,775,000) 11,005,000 9,042,000 Cash and short-term investments at beginning of year......... 60,087,000 49,082,000 40,040,000 ------------- -------------- ------------- Cash and short-term investments at end of year............... $ 56,312,000 $ 60,087,000 $ 49,082,000 ------------- -------------- ------------- ------------- -------------- -------------
See Notes to Consolidated Financial Statements. F-8 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES HCC Insurance Holdings, Inc. and its subsidiaries (collectively, "the Company" or "HCCH"), include domestic and foreign property and casualty insurance companies and managing general agents, surplus lines insurance brokers and wholesale insurance and reinsurance brokers. HCCH, through its subsidiaries, provides specialized property and casualty insurance to commercial customers worldwide, underwritten on both a direct and reinsurance basis, in the areas of aviation, marine, property, offshore energy and accident and health. The principal insurance company subsidiaries are Houston Casualty Company ("HCC") and Trafalgar Insurance Company ("TIC") in Houston, Texas and IMG Insurance Company Ltd. ("IMG") in Amman, Jordan. The agency subsidiaries provide underwriting management and intermediary services for insurance and reinsurance companies, primarily in the accident and health area, but also in the same lines of business that the insurance subsidiaries operate. The principal agency subsidiaries are LDG Management Company Incorporated ("LDG") in Wakefield, Massachusetts, HCC Underwriters, A Texas Corporation ("HCCU") in Houston, Texas; North American Special Risk Associates, Inc. ("NASRA") in Northbrook, Illinois and Middle East Insurance Brokers, Ltd. ("MEIB") in Amman, Jordan. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. This affects amounts reported in the financial statements and the disclosure of contingent assets and liabilities. Actual results could differ from those estimates. A description of the significant accounting and reporting policies utilized by the Company in preparing the consolidated financial statements is as follows: PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The business combinations with LDG and NASRA have been recorded as poolings-of-interests. The Company's financial statements have been restated to include the accounts and operations of LDG for all periods presented. The financial statements have not been restated to include NASRA due to immateriality. (see note 2). INVESTMENTS Fixed income securities and marketable equity securities are classified as available for sale and are carried at quoted market value, if readily marketable, or at management's estimated fair value, if not readily marketable. The change in unrealized gain or loss with respect to these securities is recorded as a direct increase or decrease to shareholders' equity, net of related deferred income tax, if any. Fixed income securities available for sale are purchased with the original intent to hold to maturity, but which may be available for sale if market conditions warrant, or if the Company's investment policies dictate, in order to maximize the Company's investment yield. Mortgage loans on real estate are stated at the aggregate unpaid principal balance less unamortized fees. Short-term investments and restricted short-term investments are carried at cost which approximates market value. The realized gain or loss on investment transactions is determined on an average cost basis and included in earnings on the trade date. When impairment of the value of an investment is considered other than temporary, the decrease in value is reported in earnings as a realized investment loss and a new cost basis is established. F-9 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES (CONTINUED) PROPERTY AND EQUIPMENT Property and equipment are carried at cost, net of accumulated depreciation. Depreciation expense is provided using the straight-line method over the estimated useful lives of the related assets. Amortization of leasehold improvements is provided using the straight-line method over the term of the respective lease. Upon disposal of assets, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is included in earnings. Costs incurred in developing or purchasing management information systems are capitalized and included in property and equipment. These costs are amortized over their estimated useful lives from the dates the systems are placed in service. EARNED PREMIUM, DEFERRED POLICY ACQUISITION COSTS AND CEDING COMMISSIONS OF INSURANCE COMPANY SUBSIDIARIES Written premium, net of reinsurance, is generally included in earnings on a pro rata basis over the lives of the related policies. Policy acquisition costs related to unearned premium, which include commissions, taxes, fees and other direct costs of underwriting policies and ceding commissions allowed by reinsurers, which include expense allowances, are deferred and charged or credited to earnings on the same basis. Historical and current loss and loss adjustment expense experience are considered in determining the recoverability of deferred policy acquisition costs. FEE AND COMMISSION INCOME Fee and commission income is recognized on the revenue recognition date, which is the later of the effective date of the policy, the date when the premium can be reasonably estimated, or the date when substantially all required services relating to the insurance placement have been rendered to the client. Commission income relating to additional or return premiums or other policy adjustments is recognized when the events occur and the amounts become known or can be estimated. PREMIUM AND OTHER RECEIVABLES The Company has adopted the gross method for reporting receivables and payables on brokered transactions. Management considers all premium and other receivables to be collectable and, therefore, has not recorded an allowance for doubtful accounts. LOSS AND LOSS ADJUSTMENT EXPENSE OF INSURANCE COMPANY SUBSIDIARIES Loss and loss adjustment expense is based on undiscounted estimates of payments to be made for reported and incurred but not reported losses ("IBNR"), net of reinsurance and anticipated salvage and subrogation receipts. Estimates for reported losses are based on all available information, including reports received from ceding companies on assumed business. Estimates for IBNR are based both on the Company's and industry experience. While management believes that amounts included in the accompanying financial statements are adequate, such estimates may be more or less than the amounts ultimately F-10 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES (CONTINUED) paid when the claims are settled. The estimates are continually reviewed and any changes are reflected in current operations. REINSURANCE The Company records all reinsurance recoverables and ceded unearned premiums as assets and deferred ceding commissions as a liability. All such amounts are estimated and recorded in a manner consistent with the underlying reinsured contracts. Management has recorded a reserve for uncollectible reinsurance based on estimates of collectability. GOODWILL In connection with the Company's acquisitions of subsidiaries during 1994, the excess of cost over fair value of net assets acquired is being amortized using the straight-line method over forty years. Management of the acquired businesses have successfully operated in the Companies' insurance markets for a number of years and, with the additional capital provided by the Company, will be positioned to take advantage of increased underwriting opportunities. The Company has no reason to expect major changes in the business conditions in which the acquired companies operate which might affect the recoverability of the recorded intangibles. However, in the event business conditions change, the recoverability will be re-evaluated based upon revised projections of future undiscounted operating income and cash flows and, if impaired, the balances will be adjusted accordingly. Amortization charged to income for the years ended December 31, 1996, 1995 and 1994, was $289,000, $289,000 and $72,000, respectively. CASH AND CASH EQUIVALENTS For purposes of the consolidated statements of cash flows, the Company considers certificates of deposit, corporate demand notes receivable and commercial paper with original maturities of three months or less and money market funds as cash equivalents. These amounts are shown as short-term investments in the consolidated balance sheets. In conjunction with the management of reinsurance pools, the Company's agency subsidiaries withhold premium funds for the payment of claims which are shown as restricted cash and short-term investments on the consolidated balance sheets. The Company generally invests its excess cash with major banks and in investment grade commercial paper and repurchase agreements. These securities typically mature within 90 days and, therefore, bear minimal risk. The Company has not experienced any losses on these investments. FOREIGN CURRENCY TRANSLATION The functional currency of most foreign subsidiaries is the United States dollar. Assets and liabilities recorded in foreign currencies are translated into United States dollars at exchange rates in effect at the balance sheet date. Transactions in foreign currencies are translated at the rates of exchange in effect on the date the transaction occurs. The Company's foreign currency transactions are principally denominated in British Pound Sterling. From time to time the Company enters into foreign currency forward contracts as a hedge against foreign currency fluctuations. Gains or losses in the market value of foreign currency forward contracts are recognized in the statements of earnings concurrently with the gains and losses on F-11 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES (CONTINUED) the hedged balances. For the years ended December 31, 1996, 1995 and 1994, the gain (loss) from currency conversion was ($181,000), ($209,000) and $203,000, respectively. One subsidiary has a functional currency of the British Pound Sterling ("GBP"). Cumulative translation adjustment, representing the effect of translating this subsidiary's assets and liabilities into United States dollars is included in the foreign currency translation adjustment within shareholders' equity. INCOME TAX The domestic companies and the foreign insurance company subsidiaries (which have all elected to be taxed as domestic companies) file a single consolidated Federal income tax return and include the foreign subsidiaries' income to the extent required by law. Deferred income tax is accounted for using the liability method, which reflects the tax impact of temporary differences between the bases of assets and liabilities for financial reporting purposes and such bases as measured by tax laws and regulations. LDG was an S Corporation prior to its reorganization and merger with the Company. Therefore, Federal income tax expense was not provided for LDG's earnings until the S Corporation election was terminated. LDG is included in the Company's consolidated Federal income tax return beginning May 24, 1996. EARNINGS PER SHARE Earnings per share are based on the weighted average number of common and common equivalent shares outstanding during the year divided into net earnings. The shares issued in connection with the combination with LDG are included in outstanding shares for all periods presented. Outstanding common stock options, when dilutive, are considered to be common stock equivalents for the purpose of this calculation. The treasury stock method is used to calculate common stock equivalents due to options. The difference between primary and fully diluted earnings per share is not material. STOCK SPLITS In February, 1994, the Board of Directors declared a three-for-two stock split in the form of a 50% stock dividend on its shares of $1.00 par value Common Stock payable to shareholders of record March 15, 1994. This stock split was recorded retroactively as of December 31, 1993. In April, 1996, the Board of Directors declared a five-for-two stock split in the form of a 150% stock dividend on the Company's $1.00 par value Common Stock, payable to shareholders of record April 30, 1996. The par value of the Company's Common Stock remains unchanged. All per share, weighted average shares outstanding and option data presented in the consolidated financial statements and the notes thereto have been retroactively adjusted to reflect the effects of the splits. EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS In February, 1997, the Financial Accounting Standards Board issued SFAS No. 128 "Earnings Per Share". SFAS No. 128 is effective for fiscal years ending after December 15, 1997. Early application is not permitted. SFAS No. 128 modifies the denominator to be used in the earnings per share calculations, and requires additional disclosures of the calculations. However, the statement will have no effect on the Company's net earnings, shareholders' equity or cash flows. F-12 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (1) GENERAL INFORMATION AND SIGNIFICANT ACCOUNTING AND REPORTING POLICIES (CONTINUED) RECLASSIFICATIONS Certain amounts in the 1995 and 1994 consolidated financial statements have been reclassified to conform with the 1996 presentation. Such reclassifications had no effect on the Company's shareholders' equity, net earnings or cash flows. (2) ACQUISITIONS IMG AND MEIB Effective January 1, 1994, the Company acquired a 25% interest in MEIB. Concurrent with the purchase of IMG on October 1, 1994, the Company acquired the remaining 75% interest, thereby making MEIB a wholly-owned subsidiary of the Company. To acquire 100% interest of MEIB the Company issued 109,524 shares (pre split) of its Common Stock and paid a total of $3.9 million. During the first nine months of 1994, the Company accounted for its 25% interest using the equity method and beginning October 1, 1994, MEIB's results of operations have been included in the consolidated statements of earnings. Effective October 1, 1994, the Company acquired 100% of the stock of IMG. IMG specializes in insuring large commercial risks, with an emphasis on energy related business. In exchange for IMG's stock, the Company issued 838,095 shares (pre split) of its Common Stock and paid $4.4 million. IMG's results of operations have been included in the consolidated statements of earnings beginning October 1, 1994. Both acquisitions were accounted for using the purchase method. In each case the purchase price was allocated to assets acquired based on their estimated fair values. On a combined basis, the fair value of assets acquired was approximately $29.0 million and the fair value of liabilities assumed was approximately $18.3 million. This resulted in a combined total cost in excess of net assets acquired (goodwill) of approximately $11.6 million from both acquisitions. The resulting goodwill is being amortized on a straight-line basis over forty years. The following unaudited pro forma summary presents information for the year ended December 31, 1994, as if the acquisitions of IMG and MEIB had occurred at the beginning of the year after giving effect to certain adjustments including amortization of goodwill, increased interest expense from debt issued to fund the acquisitions and Federal income taxes. The pro forma summary is for information purposes only, does not necessarily reflect the actual results that would have occurred, nor is it necessarily indicative of future results of the combined Company.
UNAUDITED PRO FORMA INFORMATION 1994 - ------------------------------------------------------------------------------- ------------- Total revenue.................................................................. $ 89,110,000 Net earnings................................................................... 15,892,000 Earnings per share............................................................. 0.54
LDG On May 24, 1996, the Company issued 6,250,000 shares of its Common Stock to acquire all of the outstanding common stock of LDG. The former principal shareholder of LDG is a director of the Company. This business combination has been accounted for as a pooling-of-interests. The Company's F-13 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (2) ACQUISITIONS (CONTINUED) consolidated financial statements have been restated to include the accounts and operations of LDG for all periods presented. The consolidated financial statements include adjustments made to conform LDG's accounting policies for fee and commission income to that of HCCH. HCCH's policy is to recognize fee and commission income on the revenue recognition date (the later of the effective date of the policy, the date when premium can be reasonably estimated, or the date when substantially all required services relating to the placement have been rendered to the client), and subsequent policy adjustments and contingent profit commissions are recognized when events occur and amounts are known or can be reasonably estimated. LDG previously recognized fee and commission income on the later of the effective date or the reporting date, subsequent adjustments were recognized when they became due, and contingent profit commission was recognized when received. For the years ended December 31, 1995 and 1994, these adjustments decreased net income $119,000 and $844,000, respectively. Separate total revenue and net earnings (loss) amounts of the merged entities are presented for the periods prior to merger in the following table:
FOR THE FIVE FOR THE YEAR ENDED DECEMBER MONTHS 31, ENDED MAY 31, ----------------------------- 1996 1995 1994 ------------------ -------------- ------------- Total revenue: HCCH........................................................ $ 48,771,000 $ 99,197,000 $ 59,869,000 LDG......................................................... 12,893,000 28,012,000 25,636,000 ------------------ -------------- ------------- Total revenue........................................... $ 61,664,000 $ 127,209,000 $ 85,505,000 ------------------ -------------- ------------- ------------------ -------------- ------------- Net earnings (loss): HCCH........................................................ $ 12,144,000 $ 22,273,000 $ 13,409,000 LDG......................................................... (9,919,000) 2,064,000 1,859,000 ------------------ -------------- ------------- Net earnings.............................................. $ 2,225,000 $ 24,337,000 $ 15,268,000 ------------------ -------------- ------------- ------------------ -------------- -------------
Certain nonrecurring expenses were incurred during the first six months of 1996. Of the nonrecurring expenses, approximately $24.0 million was related to the compensatory grant of LDG stock to certain key employees by LDG's majority shareholder immediately prior to the combination. Other nonrecurring expenses, which totalled approximately $2.1 million, included legal, accounting and investment banking fees in connection with the merger. The following table presents pro forma net income and earnings per share amounts which reflect the elimination of nonrecurring compensation and merger related expenses in 1996, pro forma adjustments to all years to present Federal income taxes on LDG's earnings prior to its reorganization and merger with the Company and pro forma adjustments to reduce 1995 and 1994 F-14 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (2) ACQUISITIONS (CONTINUED) compensation expense based on employment arrangements in effect during 1996, for LDG's previous principal shareholders.
1996 1995 1994 -------------- ------------- ------------- Net earnings....................................................... $ 29,298,000 $ 24,337,000 $ 15,268,000 Nonrecurring expenses.............................................. 26,160,000 -- -- Compensation adjustment, net of state income tax................... -- 6,534,000 5,910,000 Pro forma Federal income tax....................................... (11,803,000) (2,923,000) (2,641,000) -------------- ------------- ------------- Pro forma net earnings......................................... $ 43,655,000 $ 27,948,000 $ 18,537,000 -------------- ------------- ------------- -------------- ------------- ------------- Pro forma earnings per share................................... $ 1.21 $ 0.86 $ 0.66 -------------- ------------- ------------- -------------- ------------- -------------
NASRA On November 27, 1996, the Company acquired all of the outstanding shares of NASRA by issuing 1,136,400 shares of its Common Stock and a payment of $1.7 million in cash to one dissenting shareholder. This combination has been accounted for as a pooling-of-interests. However, the Company's consolidated financial statements have not been restated due to immateriality. TRM On November 11, 1996, the Company announced that it had agreed to acquire all of the occupational accident business of the TRM International, Inc. group of companies ("TRM") in exchange for 266,667 shares of its Common Stock and $6.55 million in cash. The acquisition was finalized on January 24, 1997 and will be accounted for as a purchase. AMIG On January 6, 1997, the Company announced that it had agreed in principal to acquire all of the outstanding shares of Interworld Inc. Group ("Interworld") in exchange for 725,000 shares of its Common Stock. The transaction will be accounted for as a pooling-of-interests. AVEMCO On January 17, 1997, HCCH and AVEMCO Corporation ("AVEMCO") jointly announced that the Companies had signed a letter of intent to merge in a stock for stock transaction, each share of AVEMCO common stock to be exchanged for one share of HCCH's Common Stock. The Companies executed definitive agreements on February 28, 1997. This transaction will be accounted for as a pooling-of- interests. The merger is still subject to approval by the shareholders of both Companies and to certain regulatory approvals. As of March 1, 1997, there were 8.4 million shares of AVEMCO common stock outstanding. F-15 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (3) INVESTMENTS Substantially all of the Company's fixed income securities are investment grade; most are A rated or better. No high-yield corporate bonds are owned or contemplated. The amortized cost, gross unrealized gain or loss and estimated market value of securities available for sale are as follows:
GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED MARKET COST GAIN LOSS VALUE -------------- ------------ ------------- -------------- December 31, 1996: Marketable equity securities...................... $ 2,481,000 $ 256,000 $ (304,000) $ 2,433,000 US Treasury securities............................ 3,527,000 83,000 (6,000) 3,604,000 Obligations of states, municipalities and political subdivisions.......................... 259,140,000 3,078,000 (1,095,000) 261,123,000 -------------- ------------ ------------- -------------- Total securities available for sale............. $ 265,148,000 $ 3,417,000 $ (1,405,000) $ 267,160,000 -------------- ------------ ------------- -------------- -------------- ------------ ------------- -------------- December 31, 1995: Marketable equity securities...................... $ 10,097,000 $ 3,866,000 $ (151,000) $ 13,812,000 US Treasury securities............................ 3,914,000 44,000 (10,000) 3,948,000 Obligations of states, municipalities and political subdivisions.......................... 227,893,000 3,872,000 (832,000) 230,933,000 -------------- ------------ ------------- -------------- Total securities available for sale............. $ 241,904,000 $ 7,782,000 $ (993,000) $ 248,693,000 -------------- ------------ ------------- -------------- -------------- ------------ ------------- --------------
The amortized cost and estimated market value of fixed income securities available for sale at December 31, 1996, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
ESTIMATED AMORTIZED MARKET COST VALUE -------------- -------------- Due in 1 year or less............................................................ $ 4,229,000 $ 4,276,000 Due after 1 year through 5 years................................................. 66,362,000 67,383,000 Due after 5 years through 10 years............................................... 80,119,000 80,876,000 Due after 10 years through 15 years.............................................. 60,990,000 61,408,000 Due after 15 years............................................................... 50,967,000 50,784,000 -------------- -------------- Total fixed income securities available for sale............................. $ 262,667,000 $ 264,727,000 -------------- -------------- -------------- --------------
As of December 31, 1996, the Company's insurance company subsidiaries had deposited fixed income securities available for sale with an amortized cost of approximately $9.1 million (market: $9.1 million) to meet the deposit requirements of the insurance departments of certain states. F-16 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (3) INVESTMENTS (CONTINUED) The sources of net investment income for the years ended December 31, 1996, 1995 and 1994, are detailed below:
1996 1995 1994 ------------- ------------- ------------ Fixed income securities.............................................. $ 12,524,000 $ 10,172,000 $ 7,604,000 Short-term investments............................................... 2,817,000 2,952,000 1,633,000 Equity securities.................................................... 130,000 136,000 308,000 Other................................................................ 18,000 152,000 317,000 ------------- ------------- ------------ Total investment income.......................................... 15,489,000 13,412,000 9,862,000 Investment expense................................................... (117,000) (162,000) (329,000) ------------- ------------- ------------ Net investment income............................................ $ 15,372,000 $ 13,250,000 $ 9,533,000 ------------- ------------- ------------ ------------- ------------- ------------
There were no investments in fixed income securities available for sale that were non-income producing for the twelve months preceding December 31, 1996. F-17 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (3) INVESTMENTS (CONTINUED) Realized pre-tax gain (loss) on the sale of investments is as follows:
GAIN LOSS NET ------------ ------------- ------------ For the year ended December 31, 1996: Fixed income securities available for sale........................... $ 20,000 $ (221,000) $ (201,000) Equity securities available for sale................................. 5,635,000 (337,000) 5,298,000 ------------ ------------- ------------ Realized gain (loss)............................................... $ 5,655,000 $ (558,000) $ 5,097,000 ------------ ------------- ------------ ------------ ------------- ------------ For the year ended December 31, 1995: Fixed income securities available for sale........................... $ 513,000 $ (524,000) $ (11,000) Equity securities available for sale................................. 1,767,000 (697,000) 1,070,000 Other................................................................ 2,000 -- 2,000 ------------ ------------- ------------ Realized gain (loss)............................................... $ 2,282,000 $ (1,221,000) $ 1,061,000 ------------ ------------- ------------ ------------ ------------- ------------ For the year ended December 31, 1994: Fixed income securities available for sale........................... $ 152,000 $ (241,000) $ (89,000) Equity securities available for sale................................. 1,156,000 (381,000) 775,000 Other................................................................ -- (4,000) (4,000) ------------ ------------- ------------ Realized gain (loss)............................................... $ 1,308,000 $ (626,000) $ 682,000 ------------ ------------- ------------ ------------ ------------- ------------
(4) PROPERTY AND EQUIPMENT The following table summarizes property and equipment at December 31, 1996 and 1995:
ESTIMATED 1996 1995 USEFUL LIFE ------------- ------------- ------------- Building and improvements........................................... $ 6,150,000 $ 6,067,000 31.5 years Furniture, fixtures and equipment................................... 5,753,000 4,875,000 3 to 5 years Management information systems...................................... 5,356,000 4,847,000 3 to 7 years ------------- ------------- Total property and equipment.................................... 17,259,000 15,789,000 Less accumulated depreciation and amortization...................... (8,124,000) (6,349,000) ------------- ------------- Property and equipment, net..................................... $ 9,135,000 $ 9,440,000 ------------- -------------
(5) NOTES PAYABLE Notes payable at December 31, 1996 and 1995 are shown in the table below. The estimated fair value of the notes payable at December 31, 1996 and 1995, which is based on current rates offered to the company for debt with similar terms, approximates the carrying value.
1996 1995 ------------- ------------- First note......................................................................... $ 16,250,000 $ 16,250,000 Second note........................................................................ -- 411,000 Line of credit..................................................................... 250,000 -- ------------- ------------- Total notes payable............................................................ $ 16,500,000 $ 16,661,000 ------------- ------------- ------------- -------------
F-18 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (5) NOTES PAYABLE (CONTINUED) The first note is payable to a bank in quarterly installments of $1.5 million plus interest increasing to quarterly installments of $1.75 million plus interest as of October 1, 1997. Interest is payable quarterly at the prime rate (8 1/4% at December 31, 1996). During February, 1994, the first note was amended changing the interest rate to a fixed rate of 6 1/2% until February 7, 1997. The rate reverts back to the prime rate after such date or can be set at London Interbank Offering Rate ("LIBOR") plus 2 1/4% at the Company's discretion. The note is collateralized by all of the Common Stock of HCC. The loan agreement contains certain restrictive covenants, including restrictions on certain transactions in the Company's capital stock or the capital stock of HCC and the maintenance of required financial ratios. Additionally, the loan agreement prohibits the payment of dividends by the Company without the bank's approval. The bank has approved the Company's current dividend policy. During 1995, the Company prepaid the first two installments of $1.5 million due in 1996. The bank deferred the second two installments due in 1996 until maturity on October 1, 1998. The Company paid the first 1997 quarterly payment of $1.5 million in January, 1997. The second note was payable to a bank in monthly installments of $21,000 plus interest. This note was repaid in full during 1996. The outstanding advance at December 31, 1996, on a revolving line of credit, is owed to a bank and represents the maximum available on that line of credit. Interest is payable quarterly beginning March 20, 1997, at a variable rate which is the bank's prime rate plus one percent (9 1/4% at December 31, 1996). The principal is due in one payment upon maturity on December 20, 1998. The loan is collateralized by a certificate of deposit. At December 31, 1996, HCC maintained a revolving line of credit with a bank in the maximum amount of $12 million available through April 30, 1997. Advances under the line of credit are limited to amounts required to fund draws, if any, on letters of credit issued by the bank on behalf of HCC and short-term direct cash advances. The line of credit is collateralized by securities having an aggregate market value of up to $15 million, the actual amount of collateral at any one time being 125% of the aggregate amount outstanding. Interest on the line is payable at the bank's prime rate of interest (8 1/4% at December 31, 1996). At December 31, 1996, letters of credit totaling $4.6 million had been issued to insurance companies by the bank on behalf of HCC, with total securities collateralizing the line of $5.8 million. As of December 31, 1996, there were no cash advances outstanding under this line of credit, therefore, $7.4 million is available for short-term borrowings under this facility. Principal payments due on the note payable and the line of credit at December 31, 1996, are shown in the table below:
FOR THE YEARS ENDED DECEMBER 31, AMOUNT DUE - --------------------------------------------------------------------------------------------------- ------------- 1997..................................................................................... $ 6,250,000 1998..................................................................................... 10,250,000 ------------- Total principal payments due....................................................................... $ 16,500,000 ------------- -------------
(6) INCOME TAX Several of the Company's foreign subsidiaries are not subject to foreign income taxes and no foreign income tax expense was incurred for the three years ended December 31, 1996. United States Federal F-19 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (6) INCOME TAX (CONTINUED) income taxes are provided on all foreign earnings. As of December 31, 1996 and 1995, the Company had income taxes payable of $1.9 million and $702,000, respectively. For Federal income tax purposes, LDG has approximately $19.1 million of net operating loss carryforwards which will expire in the year 2010. The components of the income tax provision for the years ended December 31, 1996, 1995 and 1994, are as follows:
1996 1995 1994 ------------- ------------- ------------- Current............................................................. $ 14,655,000 $ 10,500,000 $ 5,782,000 Deferred: Change in net deferred tax at current enacted tax rate............ (7,326,000) (1,528,000) (1,201,000) Change in deferred tax valuation allowance........................ -- (17,000) 17,000 ------------- ------------- ------------- Total income tax provision...................................... $ 7,329,000 $ 8,955,000 $ 4,598,000 ------------- ------------- ------------- ------------- ------------- -------------
The composition of deferred tax assets and liabilities and the related tax effects as of December 31, 1996 and 1995, are as follows:
1996 1995 ------------- ------------ Tax net operating loss carryforward.................................................. $ 7,820,000 $ -- Excess of financial unearned premium over tax........................................ 3,930,000 3,714,000 Effect of loss reserve discounting and salvage and subrogation accrual for tax....... 3,199,000 2,746,000 Bad debt expense, deducted for financial over tax.................................... 845,000 838,000 Accrued expenses and other items deductible when paid for tax........................ 510,000 677,000 ------------- ------------ Total assets..................................................................... 16,304,000 7,975,000 Excess of financial over currently taxable earnings from foreign subsidiaries........ 421,000 -- Unrealized gain on increase in value of securities available for sale (shareholders' equity)............................................................................ 707,000 2,372,000 Deferred policy acquisition costs, net of ceding commissions, deductible for tax..... 3,027,000 2,240,000 Property and equipment depreciation and other items.................................. 625,000 442,000 ------------- ------------ Total liabilities................................................................ 4,780,000 5,054,000 ------------- ------------ Net deferred tax asset........................................................... $ 11,524,000 $ 2,921,000 ------------- ------------ ------------- ------------
Changes in the valuation allowance account applicable to the net deferred tax asset are as follows:
1996 1995 1994 --------- ---------- --------- Balance, beginning of year...................................................... $ -- $ 17,000 $ -- Increase charged (decrease credited) to income.................................. -- (17,000) 17,000 Valuation allowance acquired.................................................... 54,000 -- -- --------- ---------- --------- Balance, end of year........................................................ $ 54,000 $ 0 $ 17,000 --------- ---------- --------- --------- ---------- ---------
During 1994, the Company's statutory Federal income tax rate changed from 34% to 35%. This change resulted in a deferred tax benefit of approximately $70,000. The rate change also resulted in an F-20 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (6) INCOME TAX (CONTINUED) increase in the current income tax provision of approximately $135,000. The following table summarizes the differences between the Company's effective tax rate for financial statement purposes and the Federal statutory rate:
1996 1995 1994 ------------- ------------- ------------ Statutory tax rate............................................ 35.0% 35.0% 35.0% Federal tax at statutory rate................................. $ 12,819,000 $ 11,652,000 $ 6,953,000 Nontaxable municipal bond interest and dividends received deduction................................................... (3,670,000) (2,624,000) (2,176,000) State income taxes............................................ (234,000) 397,000 349,000 Tax exempt status of S Corporation............................ (1,617,000) (722,000) (651,000) Deferred taxes at date of S Corporation conversion............ (680,000) -- -- Other, net.................................................... 711,000 252,000 123,000 ------------- ------------- ------------ Income tax provision...................................... $ 7,329,000 $ 8,955,000 $ 4,598,000 ------------- ------------- ------------ ------------- ------------- ------------ Effective tax rate........................................ 20.0% 26.9% 23.1% ------------- ------------- ------------ ------------- ------------- ------------
(7) SEGMENT AND GEOGRAPHIC DATA The Company classifies its activities into two core business segments: 1) property and casualty insurance company operations and 2) insurance agency and brokerage operations. Corporate includes general corporate items and intersegment eliminations. The following table shows information by business segment and geographic location:
COMPANY AGENCY CORPORATE TOTAL -------------- ------------- ------------- -------------- For the year ended December 31, 1996: Revenue: Domestic........................................ $ 94,507,000 $ 36,418,000 $ 41,000 $ 130,966,000 Foreign......................................... 17,836,000 3,443,000 -- 21,279,000 Intersegment.................................... 600,000 763,000 (1,363,000) -- -------------- ------------- ------------- -------------- Total revenue................................. $ 112,943,000 $ 40,624,000 $ (1,322,000) $ 152,245,000 -------------- ------------- ------------- -------------- -------------- ------------- ------------- -------------- Net earnings: Domestic........................................ $ 28,340,000 $ (766,000) $ (2,853,000) $ 24,721,000 Foreign......................................... 5,254,000 (677,000) -- 4,577,000 -------------- ------------- ------------- -------------- Total net earnings............................ $ 33,594,000 $ (1,443,000) $ (2,853,000) $ 29,298,000 -------------- ------------- ------------- -------------- -------------- ------------- ------------- -------------- Depreciation and amortization..................... $ 1,509,000 $ 780,000 $ 29,000 $ 2,318,000 -------------- ------------- ------------- -------------- -------------- ------------- ------------- -------------- Capital expenditures.............................. $ 598,000 $ 1,126,000 $ -- $ 1,724,000 -------------- ------------- ------------- -------------- -------------- ------------- ------------- --------------
F-21 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (7) SEGMENT AND GEOGRAPHIC DATA (CONTINUED)
COMPANY AGENCY CORPORATE TOTAL -------------- ------------- ------------- -------------- For the year ended December 31, 1995: Revenue: Domestic........................................ $ 79,209,000 $ 30,766,000 $ 36,000 $ 110,011,000 Foreign......................................... 13,889,000 3,309,000 -- 17,198,000 Intersegment.................................... 474,000 383,000 (857,000) -- -------------- ------------- ------------- -------------- Total revenue................................. $ 93,572,000 $ 34,458,000 $ (821,000) $ 127,209,000 -------------- ------------- ------------- -------------- -------------- ------------- ------------- -------------- Net earnings: Domestic........................................ $ 17,192,000 $ 3,608,000 $ (1,824,000) $ 18,976,000 Foreign......................................... 4,508,000 853,000 -- 5,361,000 -------------- ------------- ------------- -------------- Total net earnings............................ $ 21,700,000 $ 4,461,000 $ (1,824,000) $ 24,337,000 -------------- ------------- ------------- -------------- -------------- ------------- ------------- -------------- Depreciation and amortization..................... $ 932,000 $ 758,000 $ 10,000 $ 1,700,000 -------------- ------------- ------------- -------------- -------------- ------------- ------------- -------------- Capital expenditures.............................. $ 2,399,000 $ 684,000 $ 186,000 $ 3,269,000 -------------- ------------- ------------- -------------- -------------- ------------- ------------- -------------- For the year ended December 31, 1994: Revenue: Domestic........................................ $ 54,060,000 $ 28,552,000 $ -- $ 82,612,000 Foreign......................................... 1,996,000 897,000 -- 2,893,000 Intersegment.................................... 674,000 376,000 (1,050,000) -- -------------- ------------- ------------- -------------- Total revenue................................. $ 56,730,000 $ 29,825,000 $ (1,050,000) $ 85,505,000 -------------- ------------- ------------- -------------- -------------- ------------- ------------- -------------- Net earnings: Domestic........................................ $ 12,475,000 $ 3,959,000 $ (1,377,000) $ 15,057,000 Foreign......................................... 725,000 (514,000) -- 211,000 -------------- ------------- ------------- -------------- Total net earnings............................ $ 13,200,000 $ 3,445,000 $ (1,377,000) $ 15,268,000 -------------- ------------- ------------- -------------- -------------- ------------- ------------- -------------- Depreciation and amortization..................... $ 632,000 $ 652,000 $ -- $ 1,284,000 -------------- ------------- ------------- -------------- -------------- ------------- ------------- -------------- Capital expenditures.............................. $ 1,033,000 $ 405,000 $ -- $ 1,438,000 -------------- ------------- ------------- -------------- -------------- ------------- ------------- --------------
Identifiable assets by business segment and geographic location are shown in the following table:
COMPANY AGENCY CORPORATE TOTAL -------------- -------------- ------------- -------------- December 31, 1996: Domestic....................................... $ 494,870,000 $ 119,628,000 $ 14,418,000 $ 628,916,000 Foreign........................................ 92,033,000 24,830,000 -- 116,863,000 -------------- -------------- ------------- -------------- Total identifiable assets.................... $ 586,903,000 $ 144,458,000 $ 14,418,000 $ 745,779,000 -------------- -------------- ------------- -------------- -------------- -------------- ------------- -------------- December 31, 1995: Domestic....................................... $ 466,366,000 $ 95,917,000 $ 11,917,000 $ 574,200,000 Foreign........................................ 89,078,000 18,398,000 -- 107,476,000 -------------- -------------- ------------- -------------- Total identifiable assets.................... $ 555,444,000 $ 114,315,000 $ 11,917,000 $ 681,676,000 -------------- -------------- ------------- -------------- -------------- -------------- ------------- --------------
F-22 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (7) SEGMENT AND GEOGRAPHIC DATA (CONTINUED) During 1996 and 1995, one broker in London, England, produced gross written premium to the Company of approximately $25.7 million and $31.2 million, respectively. This represents 11% and 13% of the Company's total gross written premium for those years. Approximately 55% of the gross written premium by the domestic insurance subsidiaries is for insureds located outside the United States. (8) REINSURANCE In the normal course of business the Company's insurance company subsidiaries cede a substantial portion of their premium to unrelated domestic and foreign reinsurers through quota share, surplus, excess of loss and facultative reinsurance agreements. Although the ceding of reinsurance does not discharge the primary insurer from liability to its policyholder, the subsidiaries participate in such agreements for the purpose of limiting their loss exposure and diversifying their business. Substantially all of the reinsurance assumed by the Company's insurance company subsidiaries was underwritten directly by the subsidiaries but issued by other unrelated companies in order to satisfy local licensing or other requirements, predominantly on foreign business or as reinsurance of captives. The following table represents the effect of such reinsurance transactions on net premium and loss and loss adjustment expense:
LOSS AND LOSS WRITTEN EARNED ADJUSTMENT PREMIUM PREMIUM EXPENSE --------------- --------------- --------------- For the year ended December 31, 1996: Direct business............................................ $ 84,166,000 $ 99,436,000 $ 57,768,000 Reinsurance assumed........................................ 146,589,000 135,294,000 97,305,000 Reinsurance ceded.......................................... (133,979,000) (141,416,000) (103,831,000) --------------- --------------- --------------- Net amounts.............................................. $ 96,776,000 $ 93,314,000 $ 51,242,000 --------------- --------------- --------------- --------------- --------------- --------------- For the year ended December 31, 1995: Direct business............................................ $ 111,466,000 $ 97,675,000 $ 81,425,000 Reinsurance assumed........................................ 127,492,000 110,344,000 65,061,000 Reinsurance ceded.......................................... (140,172,000) (128,008,000) (96,717,000) --------------- --------------- --------------- Net amounts.............................................. $ 98,786,000 $ 80,011,000 $ 49,769,000 --------------- --------------- --------------- --------------- --------------- --------------- For the year ended December 31, 1994: Direct business............................................ $ 97,585,000 $ 68,174,000 $ 45,386,000 Reinsurance assumed........................................ 95,293,000 76,895,000 60,837,000 Reinsurance ceded.......................................... (133,184,000) (98,235,000) (76,635,000) --------------- --------------- --------------- Net amounts.............................................. $ 59,694,000 $ 46,834,000 $ 29,588,000 --------------- --------------- --------------- --------------- --------------- ---------------
F-23 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (8) REINSURANCE (CONTINUED) The table below represents the composition of reinsurance recoverables in the accompanying consolidated balance sheets:
1996 1995 -------------- -------------- Reinsurance recoverable on paid losses....................... $ 21,708,000 $ 13,678,000 Reinsurance recoverable on outstanding losses................ 96,247,000 83,847,000 Reinsurance recoverable on IBNR.............................. 7,641,000 8,278,000 Reserve for uncollectible reinsurance........................ (2,415,000) (2,395,000) -------------- -------------- Total reinsurance recoverables........................... $ 123,181,000 $ 103,408,000 -------------- -------------- -------------- --------------
The insurance company subsidiaries require reinsurers not authorized by their respective states of domicile to collateralize their reinsurance obligations to the Company with letters of credit or cash deposits. At December 31, 1996, the Company held letters of credit and cash deposits in the amounts of $67.9 million and $9.1 million, respectively, to collateralize certain reinsurance balances. The Company has established a reserve of $2.4 million as of December 31, 1996, to reduce the effects of any recoverable problem. In order to minimize their exposure to reinsurance credit risk, the Company evaluates the financial condition of their reinsurers and place their reinsurance with a diverse group of financially sound companies. The following table shows reinsurance balances relating to the reinsurers with a total recoverable balance greater than $10.0 million and the collateral and potential offsets held by the Company as of each year end:
REINSURANCE RECOVERABLES AND LETTERS OF CREDIT, CEDED UNEARNED CASH DEPOSITS AND REINSURER LOCATION PREMIUM OTHER PAYABLES - ------------------------------------------------------ ------------------- ---------------- ------------------ December 31, 1996: Underwriters at Lloyd's............................. London, England $ 28,962,000 $ 18,446,000 GIO Insurance Limited............................... Sydney, Australia 25,204,000 26,106,000 Reinsurance Australia Corporation, Ltd.............. Sydney, Australia 20,562,000 19,332,000 Underwriters Indemnity Company...................... Houston, TX 12,531,000 5,934,000 SCOR Reinsurance Company............................ New York, NY 11,105,000 2,428,000 AXA Reinsurance Company............................. Wilmington, DE 10,402,000 2,759,000 December 31, 1995: GIO Insurance Limited............................... Sydney, Australia $ 30,160,000 $ 31,202,000 Underwriters at Lloyd's............................. London, England 24,518,000 25,916,000 Reinsurance Australia Corporation, Ltd.............. Sydney, Australia 16,620,000 14,198,000 AXA Reinsurance Company............................. Wilmington, DE 13,096,000 5,586,000
Approximately $1.9 million in recoverables is due from reinsurers that are either under regulatory supervision or insolvent. The Company holds letters of credit and cash deposits totaling $1.9 million to collateralize these balances plus other credits of $1.1 million available for potential offset. The Company is involved in a dispute with two reinsurers over coverage and other issues. The Company believes the reinsurers' positions are without merit and all amounts due from the reinsurers will be recovered. The total amount in dispute is approximately $3.4 million. F-24 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (9) COMMITMENTS AND CONTINGENCIES LITIGATION The Company is a party to numerous lawsuits arising in the normal course of business. All pending lawsuits involve claims under policies underwritten or reinsured by the Company, which management believes have been adequately included in its established loss reserves. The Company believes the resolution of these lawsuits will not have a material adverse effect on its financial condition, results of operations or cash flows. FOREIGN CURRENCY FORWARD CONTRACTS From time to time the Company enters into foreign currency forward contracts as a hedge against foreign currency fluctuations, primarily British Pound Sterling. The Company's balances denominated in foreign currency fluctuate as transactions are recorded and settled. During 1996, the average Sterling liability, for subsidiaries whose functional currency was the United States dollar, was approximately L907,000 ($1.6 million at the December 31, 1996, rate of exchange) which was hedged by an average open forward contract balance of approximately L460,000 ($785,000 at the December 31, 1996, rate of exchange). There was one open foreign currency forward contract as of December 31, 1996 to purchase L500,000 ($856,000 at the December 31, 1996, rate of exchange) with a maturity of January, 1997. As of December 31, 1996, the open foreign currency contract had a gain of $37,000. During January, 1997, the Company entered into a foreign currency forward contract for L500,000 ($856,000 at December 31, 1996, rate of exchange). The Company expects to continue to limit its exposure to currency fluctuations through the use of foreign currency forward contracts. The Company utilizes these foreign currency forward contracts strictly as a hedge against existing exposure to foreign currency fluctuations and it does not do so as any form of speculative or trading investment. LEASES The Company leases administrative office facilities under long-term noncancelable operating lease agreements expiring at various dates through October, 2001. The agreements generally require the payment of utilities, real estate taxes, insurance and repairs. The Company has recognized rent expense on a straight-line basis over the terms of these leases. In addition, the Company leases computer equipment and automobiles under operating leases expiring at various dates through the year 1999. Rent expense under these leases amounted to $1,495,000, $1,095,000 and $895,000 for the years ended December 31, 1996, 1995 and 1994, respectively. At December 31, 1996, future minimum annual rental payments required under the long-term noncancelable operating leases, excluding certain expenses payable by the Company, are as follows:
FOR THE YEARS ENDED DECEMBER 31, AMOUNT DUE - ---------------------------------------------------------------------------------------------------- ------------ 1997...................................................................................... $ 1,125,000 1998...................................................................................... 877,000 1999...................................................................................... 815,000 2000...................................................................................... 789,000 2001...................................................................................... 575,000 ------------ Total future minimum annual rental payments due..................................................... $ 4,181,000 ------------ ------------
F-25 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (10) RELATED PARTY TRANSACTIONS Certain of the Company's directors are officers, directors or owners of business entities with which the Company transacts business. Balances with these business entities and other related parties included in the accompanying consolidated balance sheets are as follows:
1996 1995 ------------ ------------ Marketable equity securities.......................................................... $ 773,000 $ -- Reinsurance recoverables.............................................................. 3,472,000 590,000 Ceded unearned premium................................................................ 9,059,000 4,786,000 Reinsurance balances payable.......................................................... 3,780,000 3,903,000 Premium payable....................................................................... 1,532,000 -- Loss and loss adjustment expense payable.............................................. 663,000 9,000 Accounts payable and accrued liabilities.............................................. -- 7,000
Transactions with these business entities and other related parties included in the accompanying consolidated statements of earnings are as follows:
1996 1995 1994 ------------- ------------ ------------ Gross earned premium.................................................. $ 871,000 $ -- $ -- Commission income..................................................... 1,249,000 -- -- Ceded earned premium.................................................. 12,050,000 1,194,000 1,017,000 Gross loss and loss adjustment expense................................ 661,000 106,000 157,000 Ceded loss and loss adjustment expense................................ 5,852,000 185,000 866,000 Other operating expense............................................... 1,011,000 758,000 104,000
During 1995, $63,000 was paid to a related party for construction management services related to improvements to the Company's offices in Houston, Texas. Also, during 1994, real estate acquired with the acquisition of IMG was sold to a related party for $788,000. There was no gain or loss recorded on this sale. (11) EMPLOYEE BENEFIT PLANS The Company has defined contribution retirement plans under Section 401(k) of the Internal Revenue Code which cover substantially all of the domestic employees who meet specified service requirements. The Company's contributions of these plans are based on varying percentages of the employees' contributions, up to varying maximum levels. The Company contributed $506,000, $693,000 and $646,000 to the plans for the years ended December 31, 1996, 1995 and 1994, respectively, which is included in compensation expense in the accompanying consolidated statements of earnings. (12) SHAREHOLDERS' EQUITY Under the Texas Insurance Code, HCC must maintain minimum statutory capital of $1,000,000 and minimum statutory surplus of $1,000,000, and can only pay dividends out of surplus funds. In addition, HCC is limited in the amount of dividends which it may pay in any twelve month period, without prior regulatory approval, to the greater of statutory net investment income for the prior calendar year or ten percent (10%)of statutory capital and surplus as of the prior calendar year end. During 1997, HCC's ordinary dividend capacity will be approximately $15.1 million. As of December 31, 1996, HCC's and TIC's total adjusted capital greatly exceeded the NAIC authorized control level risk-based capital. F-26 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (12) SHAREHOLDERS' EQUITY (CONTINUED) Under Jordanian Law, IMG and MEIB must transfer 10% of their earnings before income tax each year to a statutory reserve until the reserve balance equals the paid up capital balance. This reserve is not available for the payment of dividends. As of December 31, 1996, IMG and MEIB had combined capital plus statutory reserves totaling $17.0 million included as part their combined shareholders' equity totaling $61.1 million. (13) STOCK OPTIONS The Company has four option plans, the 1994 Nonemployee Director Stock Option Plan, the 1996 Nonemployee Director Stock Option Plan, the 1992 Incentive Stock Option Plan, and the 1995 Flexible Incentive Plan. All plans are administered by the Compensation Committee of the Board of Directors. Each option may be used to purchase one share of Common Stock of the Company. As of December 31, 1996, 4,004,669 shares of Common Stock were reserved for issuance of options, of which 1,748,276 shares were reserved for future issuances of options. Options generally vest over a one, three or five year period and expire ten years after grant date. All options have been granted at fixed exercise prices, generally at the market price of the Company's Common Stock on the grant date. Any excess of the market price on the grant date over the exercise price is recognized as compensation expense in the accompanying financial statements. During 1996, such compensation expense amounted to $494,000. If the fair value method of valuing compensation related to options would have been used, pro forma net earnings and pro forma earnings per share would have been $28.3 million, or $0.79 per share, for the year ended December 31, 1996. The pro forma compensation cost for the year ended December 31, 1995, is immaterial. The fair value of each option grant was estimated on the grant date using the Black-Scholes single option pricing model with the following assumptions: a) risk free interest rate of 5.6% for 1996 and 6.6% for 1995, b) expected volatility factor of .3, c) dividend yield of .3% for 1996 and 0% for 1995, and d) expected option life of six years. Stock option activity is shown below after adjustment for the effects of the three-for-two stock split payable as a 50% stock dividend to shareholders of record March 15, 1994, and for the effects of the five-for-two stock split payable as a 150% stock dividend to shareholders of record April 30, 1996. (See note 1).
1996 1995 1994 ---------------------------------- ------------------------------------ ---------- AVERAGE AVERAGE AVERAGE AVERAGE NUMBER OF EXERCISE FAIR NUMBER OF EXERCISE FAIR NUMBER OF SHARES PRICE VALUE SHARES PRICE VALUE SHARES ---------- ----------- --------- ---------- ----------- ----------- ---------- Outstanding, beginning of year....... 2,036,563 $ 9.29 1,166,187 $ 5.75 1,146,562 Granted at market value.............. 292,500 23.63 $ 9.87 1,078,751 12.29 $ 4.99 371,250 Granted above market value........... -- -- -- -- -- -- 59,000 Granted below market value........... 60,000 13.01 11.51 16,000 7.70 5.70 -- Cancelled............................ (12,250) 11.51 (77,184) 7.54 (89,155) Exercised............................ (120,420) 4.52 (147,191) 3.92 (321,470) ---------- ----------- ---------- ----------- ---------- Outstanding, end of year............. 2,256,393 $ 11.49 2,036,563 $ 9.29 1,166,187 ---------- ----------- ---------- ----------- ---------- ---------- ----------- ---------- ----------- ---------- Exercisable, end of year............. 722,142 $ 8.12 420,142 $ 4.49 387,021 ---------- ----------- ---------- ----------- ---------- ---------- ----------- ---------- ----------- ---------- AVERAGE EXERCISE PRICE ----------- Outstanding, beginning of year....... $ 3.77 Granted at market value.............. 7.87 Granted above market value........... 8.47 Granted below market value........... -- Cancelled............................ 3.93 Exercised............................ 2.14 ----- Outstanding, end of year............. $ 5.75 ----- ----- Exercisable, end of year............. $ 3.87 ----- -----
F-27 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (13) STOCK OPTIONS (CONTINUED) Options outstanding at December 31, 1996, are shown on the following schedule:
OPTIONS EXERCISABLE OPTIONS OUTSTANDING ---------------------------------------- ------------------------ AVERAGE REMAINING AVERAGE AVERAGE RANGE OF NUMBER OF CONTRACTUAL EXERCISE NUMBER OF EXERCISE EXERCISE PRICES SHARES LIFE PRICE SHARES PRICE - ----------------------------------------------------------- ---------- --------------- ----------- ----------- ----------- Under $4.00................................................ 239,842 3.33 years $ 3.73 225,782 $ 3.73 $4.00--$10.00.............................................. 619,050 6.33 7.19 200,927 6.90 $10.01--$15.00............................................. 1,105,001 8.78 12.37 295,433 12.31 $15.01--$21.00............................................. -- -- -- -- -- Over $21.00................................................ 292,500 8.98 23.63 -- -- ---------- --------------- ----------- ----------- ----------- Total Options.......................................... 2,256,393 7.55 years $ 11.49 722,142 $ 8.12 ---------- --------------- ----------- ----------- ----------- ---------- --------------- ----------- ----------- -----------
(14) STATUTORY TO GAAP RECONCILIATIONS Reconciliations of statutory policyholders' surplus as of December 31, 1996 and 1995, and net income for the years ended December 31, 1996, 1995 and 1994, of the Company's insurance company subsidiaries included in those companies' respective filings with regulatory authorities to the amounts shown in the F-28 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (14) STATUTORY TO GAAP RECONCILIATIONS (CONTINUED) accompanying consolidated financial statements on the basis of generally accepted accounting principles ("GAAP") are as follows:
1996 1995 -------------- -------------- Statutory policyholders' surplus................................................. $ 212,194,000 $ 177,317,000 Difference in carrying value of fixed income securities.......................... 1,652,000 2,467,000 Assets non-admitted for statutory reporting...................................... 2,174,000 2,973,000 Deferred policy acquisition costs and deferred ceding commissions capitalized for GAAP........................................................................... 820,000 (1,569,000) Deferred income taxes recorded for GAAP.......................................... 4,519,000 3,199,000 Statutory provisions for reinsurance, net of GAAP reserve for uncollectible reinsurance.................................................................... 1,587,000 4,224,000 Other............................................................................ (133,000) -- -------------- -------------- Shareholder's equity of insurance company subsidiaries on basis of GAAP...... 222,813,000 188,611,000 Equity attributable to non-insurance company parent and subsidiaries, net of elimination entries in consolidation........................................... 17,877,000 6,848,000 -------------- -------------- Total shareholders' equity per accompanying consolidated financial statements................................................................. $ 240,690,000 $ 195,459,000 -------------- -------------- -------------- --------------
1996 1995 1994 ------------- ------------- ------------- Statutory net income................................................ $ 34,640,000 $ 23,004,000 $ 15,711,000 Deferred income tax benefit (expense) not recorded for statutory purposes.......................................................... (250,000) 1,650,000 1,318,000 Change in deferred policy acquisition costs and deferred ceding commissions capitalized for GAAP.................................. 2,390,000 (165,000) (1,065,000) Provision for reinsurance not expensed for statutory purposes....... 100,000 (900,000) (600,000) Other, net.......................................................... (18,000) (10,000) (4,000) ------------- ------------- ------------- Net income of insurance company subsidiaries on basis of GAAP... 36,862,000 23,579,000 15,360,000 Net income (loss) attributable to non-insurance parent and subsidiaries...................................................... (7,564,000) 758,000 (92,000) ------------- ------------- ------------- Net earnings per accompanying consolidated financial statements.................................................... $ 29,298,000 $ 24,337,000 $ 15,268,000 ------------- ------------- ------------- ------------- ------------- -------------
(15) SUPPLEMENTAL CASH FLOW INFORMATION Supplemental cash flow information for the three years ended December 31, 1996, is summarized below:
1996 1995 1994 ------------ ------------ ------------ Interest paid........................................................... $ 1,109,000 $ 2,313,000 $ 1,876,000 Income tax paid......................................................... 13,740,000 9,803,000 5,139,000
F-29 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (15) SUPPLEMENTAL CASH FLOW INFORMATION (CONTINUED) The unrealized gain or loss on securities available for sale, deferred taxes related thereto, and the issuance of the Company's Common Stock for the purchase of subsidiaries are noncash transactions which have been included as direct increases or decreases in shareholders' equity. During the year ended December 31, 1995, non-cash contributions to LDG's additional paid-in capital of $50,000 was recorded by a reduction in certain payable balances. (16) LIABILITY FOR UNPAID LOSS AND LOSS ADJUSTMENT EXPENSE The following table provides a reconciliation of the liability of loss and loss adjustment expense, for the years ended December 31, 1996, 1995 and 1994:
1996 1995 1994 -------------- -------------- -------------- Reserves for loss and loss adjustment expense at beginning of the year...................................................... $ 158,451,000 $ 129,755,000 $ 98,399,000 Less reinsurance recoverables................................... 92,125,000 85,214,000 66,468,000 -------------- -------------- -------------- Net reserves at beginning of the year....................... 66,326,000 44,541,000 31,931,000 Net reserves acquired with purchase of subsidiary............... -- -- 1,769,000 Provision for loss and loss adjustment expense for claims occurring in the current year................................. 55,045,000 51,387,000 28,871,000 Increase (decrease) in estimated loss and loss adjustment expense for claims occurring in prior years................... (3,803,000) (1,618,000) 717,000 -------------- -------------- -------------- Incurred loss and loss adjustment expense, net of reinsurance............................................... 51,242,000 49,769,000 29,588,000 -------------- -------------- -------------- Loss and loss adjustment expense payments for claims occurring during: Current year.................................................... 15,903,000 12,268,000 6,386,000 Prior years..................................................... 19,731,000 15,716,000 12,361,000 -------------- -------------- -------------- Loss and loss adjustment expense payments, net of reinsurance............................................... 35,634,000 27,984,000 18,747,000 -------------- -------------- -------------- Net reserves at end of the year................................. 81,934,000 66,326,000 44,541,000 Plus reinsurance recoverables................................... 103,888,000 92,125,000 85,214,000 -------------- -------------- -------------- Reserves for loss and loss adjustment expense at end of the year................................................ $ 185,822,000 $ 158,451,000 $ 129,755,000 -------------- -------------- -------------- -------------- -------------- --------------
F-30 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (17) QUARTERLY FINANCIAL DATA (UNAUDITED)
FOURTH QUARTER THIRD QUARTER SECOND QUARTER FIRST QUARTER 1996 1996 1996 1996 -------------- ------------- -------------- ------------- Net earned premium................................ $ 27,212,000 $20,145,000 $ 22,459,000 $ 23,498,000 Fee and commission income......................... 8,428,000 9,981,000 10,536,000 9,517,000 Total revenue..................................... 41,424,000 35,569,000 37,768,000 37,484,000 Loss and loss adjustment expense.................. 14,367,000 10,508,000 12,128,000 14,239,000 Total expense..................................... 23,683,000 19,308,000 47,430,000 25,197,000 Earnings (loss) before income tax provision....... 17,741,000 16,261,000 (9,662,000) 12,287,000 Income tax provision (benefit).................... 5,177,000 4,931,000 (5,602,000) 2,823,000 -------------- ------------- -------------- ------------- Net earnings (loss)............................... $ 12,564,000 $11,330,000 $ (4,060,000) $ 9,464,000 -------------- ------------- -------------- ------------- -------------- ------------- -------------- ------------- Earnings per share data: Earnings per share................................ $ 0.35 $ 0.31 $ (0.11) $ 0.27 -------------- ------------- -------------- ------------- -------------- ------------- -------------- ------------- Weighted average shares outstanding............... 36,387,000 35,993,000 35,785,000 35,638,000 -------------- ------------- -------------- ------------- -------------- ------------- -------------- -------------
FOURTH QUARTER THIRD QUARTER SECOND QUARTER FIRST QUARTER 1995 1995 1995 1995 -------------- ------------- -------------- ------------- Net earned premium................................ $ 21,160,000 $20,254,000 $ 20,532,000 18,065,000 Fee and commission income......................... 9,437,000 7,860,000 8,182,000 7,408,000 Total revenue..................................... 35,000,000 31,535,000 32,186,000 28,488,000 Loss and loss adjustment expense.................. 12,749,000 12,517,000 13,227,000 11,276,000 Total expense..................................... 23,445,000 23,566,000 24,232,000 22,674,000 Earnings before income tax provision.............. 11,555,000 7,969,000 7,954,000 5,814,000 Income tax provision.............................. 3,208,000 2,333,000 1,987,000 1,427,000 -------------- ------------- -------------- ------------- Net earnings...................................... $ 8,347,000 $ 5,636,000 $ 5,967,000 $ 4,387,000 -------------- ------------- -------------- ------------- -------------- ------------- -------------- ------------- Earnings per share data: Earnings per share................................ $ 0.24 $ 0.16 $ 0.20 $ 0.15 -------------- ------------- -------------- ------------- -------------- ------------- -------------- ------------- Weighted average shares outstanding............... 35,156,000 34,999,000 30,506,000 29,906,000 -------------- ------------- -------------- ------------- -------------- ------------- -------------- -------------
All amounts have been restated to include the accounts and operations of LDG (see note 2). All share and per share data have been retroactively adjusted to reflect the effects of the five-for-two stock split and the shares issued in connection with the combination with LDG (see note 1). Nonrecurring expenses of $25.0 million were incurred in the second quarter of 1996. (see note 2). F-31 REPORT OF INDEPENDENT ACCOUNTANTS Our report on the consolidated financial statements of HCC Insurance Holdings, Inc. and Subsidiaries is included on page F-1 of this Form 10-K. Such report states that for the year ended December 31, 1994, our opinion, insofar as it relates to data included for LDG Management Company Incorporated and Affiliates for 1994, is based solely on the report of the other auditors. In connection with our audits and the report of other auditors of such financial statements, we have also audited the related financial statement schedules listed in the index on page 32 of this Form 10-K. Our opinion on the financial statement schedules, insofar as it relates to data included for LDG Management Company Incorporated and Affiliates for 1994, is based solely on the report of the other auditors. In our opinion, based on our audits and the report of other auditors, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein. COOPERS & LYBRAND L.L.P. Houston, Texas March 27, 1997 S-1 SCHEDULE 1 HCC INSURANCE HOLDINGS, INC. SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1996
COLUMN A COLUMN B COLUMN C COLUMN D - ---------------------------------------------------------------- -------------- -------------- -------------- AMOUNT AT WHICH SHOWN IN THE BALANCE TYPE OF INVESTMENT COST VALUE SHEET - ---------------------------------------------------------------- -------------- -------------- -------------- Fixed maturities available for sale: Bonds--United States government and government agencies and authorities................................................. $ 3,527,000 $ 3,604,000 $ 3,604,000 Bonds--states, municipalities and political subdivisions...... 126,256,000 127,552,000 127,552,000 Bonds--special revenue........................................ 132,884,000 133,571,000 133,571,000 -------------- -------------- -------------- Total fixed maturities available for sale................... 262,667,000 $ 264,727,000 264,727,000 -------------- -------------- -------------- -------------- Equity securities available for sale: Common stocks--banks, trusts & insurance companies............ 1,154,000 1,219,000 1,219,000 Common stocks--industrial..................................... 1,133,000 1,019,000 1,019,000 Nonredeemable preferred stocks................................ 194,000 195,000 195,000 -------------- -------------- -------------- Total equity securities available for sale.................. 2,481,000 $ 2,433,000 2,433,000 -------------- -------------- -------------- -------------- Short-term investments.......................................... 53,100,000 53,100,000 -------------- -------------- Total investments........................................... $ 318,248,000 $ 320,260,000 -------------- -------------- -------------- --------------
S-2 SCHEDULE 2 HCC INSURANCE HOLDINGS, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS
DECEMBER 31, ------------------------ 1996 1995 ----------- ----------- ASSETS Cash and short-term investments.................................. $ 4,192,000 $ 1,055,000 Investment in subsidiaries....................................... 253,680,000 208,006,000 Receivable from subsidiaries..................................... -- 630,000 Deferred Federal income tax...................................... 9,999,000 2,914,000 Other assets..................................................... 205,000 312,000 ----------- ----------- Total assets................................................. $268,076,000 $212,917,000 ----------- ----------- ----------- ----------- LIABILITIES AND SHAREHOLDERS' EQUITY Notes payable.................................................... $16,250,000 $16,250,000 Payable to subsidiaries.......................................... 8,636,000 -- Accounts payable and accrued liabilities......................... 2,500,000 1,208,000 ----------- ----------- Total liabilities............................................ 27,386,000 17,458,000 Total shareholders' equity................................... 240,690,000 195,459,000 ----------- ----------- Total liabilities and shareholders' equity................... $268,076,000 $212,917,000 ----------- ----------- ----------- -----------
See Note to Condensed Financial Information. S-3 SCHEDULE 2 HCC INSURANCE HOLDINGS, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF EARNINGS
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------- 1996 1995 1994 ------------- ------------- ------------- Equity in earnings of subsidiaries.................................. $ 32,621,000 $ 26,558,000 $ 16,881,000 Interest income..................................................... 41,000 36,000 -- Interest expense.................................................... 1,110,000 2,196,000 1,901,000 Merger related expenses............................................. 907,000 -- -- Other operating expense............................................. 1,832,000 784,000 341,000 ------------- ------------- ------------- Earnings before income tax benefit.............................. 28,813,000 23,614,000 14,639,000 ------------- ------------- ------------- Income tax benefit.................................................. 485,000 723,000 629,000 ------------- ------------- ------------- Net earnings.................................................... $ 29,298,000 $ 24,337,000 $ 15,268,000 ------------- ------------- ------------- ------------- ------------- -------------
See Note to Condensed Financial Information. S-4 SCHEDULE 2 HCC INSURANCE HOLDINGS, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, ---------------------------------------------- 1996 1995 1994 -------------- -------------- -------------- Cash flows from operating activities: Net earnings................................................... $ 29,298,000 $ 24,337,000 $ 15,268,000 Adjustment to reconcile net earnings to net cash provided (used) by operating activities: Undistributed net income of subsidiaries....................... (32,621,000) (26,558,000) (16,881,000) Change in deferred Federal income tax, net of tax effect of unrealized gain or loss........................................ (5,423,000) (1,546,000) (1,216,000) Amortization and other non-cash expenses....................... 29,000 10,000 116,000 Change in payable to subsidiaries and other.................... 8,971,000 230,000 210,000 -------------- -------------- -------------- Cash provided (used) by operating activities................. 254,000 (3,527,000) (2,503,000) Cash flows from investing activities: Cash contributions to subsidiaries............................. -- (24,072,000) (15,959,000) Purchase of subsidiaries....................................... (1,753,000) -- (8,375,000) Cash dividends from subsidiaries............................... 5,180,000 7,102,000 10,003,000 -------------- -------------- -------------- Cash provided (used) by investing activities................. 3,427,000 (16,970,000) (14,331,000) Cash flows from financing activities: Proceeds from note payable..................................... -- -- 20,000,000 Payments on notes payable...................................... -- (28,000,000) (4,000,000) Sale of Common Stock, net of costs............................. 843,000 48,799,000 1,344,000 Dividends paid................................................. (1,387,000) -- -- -------------- -------------- -------------- Cash provided (used) by financing activities................. (544,000) 20,799,000 17,344,000 -------------- -------------- -------------- Net increase in cash and short-term investments.............. 3,137,000 302,000 510,000 Cash and short-term investments at beginning of year......... 1,055,000 753,000 243,000 -------------- -------------- -------------- Cash and short-term investments at end of year............... $ 4,192,000 $ 1,055,000 $ 753,000 -------------- -------------- -------------- -------------- -------------- --------------
See Note to Condensed Financial Information. S-5 HCC INSURANCE HOLDINGS, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT NOTE TO CONDENSED FINANCIAL INFORMATION The accompanying condensed financial information should be read in conjunction with the consolidated financial statements and the related notes thereto of HCC Insurance Holdings, Inc. and Subsidiaries. Investments in subsidiaries are accounted for using the equity method. S-6 SCHEDULE 3 HCC INSURANCE HOLDINGS, INC. SUPPLEMENTARY INSURANCE INFORMATION (DOLLARS IN THOUSANDS)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN F COLUMN G COLUMN H ------------ --------------- ------------- ----------- ----------- --------------- ----------- (1) (1) (2) DECEMBER 31, ------------------------------------------- FOR THE YEARS ENDED DECEMBER 31, FUTURE POLICY ----------------------------------------- BENEFITS, BENEFITS, LOSSES, CLAIMS, DEFERRED POLICY CLAIMS LOSSES AND ACQUISITION AND LOSS UNEARNED PREMIUM NET INVESTMENT SETTLEMENT SEGMENTS COSTS EXPENSES PREMIUMS REVENUE INCOME EXPENSES ------------ --------------- ------------- ----------- ----------- --------------- ----------- 1996 Company...................... $ 1,425 $ 185,822 $ 114,758 $ 93,314 $ 13,932 $ 51,242 Agency....................... 1,399 Corporate.................... 41 ------- ------------- ----------- ----------- ------- ----------- Total........................ $ 1,425 $ 185,822 $ 114,758 $ 93,314 $ 15,372 $ 51,242 ------- ------------- ----------- ----------- ------- ----------- ------- ------------- ----------- ----------- ------- ----------- 1995 Company...................... $ (1,066) $ 158,451 $ 118,732 $ 80,011 $ 12,031 49,769 Agency....................... 1,183 Corporate.................... 36 ------- ------------- ----------- ----------- ------- ----------- Total........................ $ (1,066) $ 158,451 $ 118,732 $ 80,011 $ 13,250 $ 49,769 ------- ------------- ----------- ----------- ------- ----------- ------- ------------- ----------- ----------- ------- ----------- 1994 Company...................... $ (1,485) $ 129,755 $ 87,346 $ 46,834 $ 8,351 $ 29,588 Agency....................... 1,182 Corporate.................... ------- ------------- ----------- ----------- ------- ----------- Total........................ $ (1,485) $ 129,755 $ 87,346 $ 46,834 $ 9,533 $ 29,588 ------- ------------- ----------- ----------- ------- ----------- ------- ------------- ----------- ----------- ------- ----------- COLUMN I COLUMN J COLUMN K ------------- --------------- ----------- (2) AMORTIZATION OF DEFERRED POLICY ACQUISITION OTHER OPERATING PREMIUMS COSTS EXPENSES WRITTEN ------------- --------------- ----------- 1996 $ 3,842 $ 10,815 $ 96,776 20,561 1,832 ------ ------- ----------- $ 3,842 $ 33,208 $ 96,776 ------ ------- ----------- ------ ------- ----------- 1995 $ 2,520 $ 11,010 $ 98,786 27,586 785 ------ ------- ----------- $ 2,520 $ 39,381 $ 98,786 ------ ------- ----------- ------ ------- ----------- 1994 $ 1,519 $ 7,765 $ 59,694 24,454 341 ------ ------- ----------- $ 1,519 $ 32,560 $ 59,694 ------ ------- ----------- ------ ------- -----------
- ------------------------ (1) Columns C and D are shown ignoring the effects of reinsurance. (2) Net investment income was allocated to the company, and therefore the segment, on which the related investment asset was recorded. Other operating expenses were allocated to the company, and therefore the corresponding segment, which actually incurred those expenses. Note: Column E is omitted because the Company has no other policy claims and benefits payable. S-7 SCHEDULE 4 HCC INSURANCE HOLDINGS, INC. REINSURANCE
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F - ---------------------------------------------- ------------- -------------- -------------- -------------- -------------- (1) ASSUMED FROM PERCENT OF CEDED TO OTHER OTHER AMOUNT EARNED PREMIUM GROSS AMOUNT COMPANIES COMPANIES NET AMOUNT ASSUMED TO NET - ---------------------------------------------- ------------- -------------- -------------- -------------- -------------- For the year ended December 31, 1996: Property and liability insurance.............. $ 99,211,000 $ 141,331,000 $ 133,095,000 $ 90,975,000 146% Accident and health insurance................. 225,000 85,000 2,199,000 2,339,000 94% ------------- -------------- -------------- -------------- Total..................................... $ 99,436,000 $ 141,416,000 $ 135,294,000 $ 93,314,000 145% ------------- -------------- -------------- -------------- ------- ------------- -------------- -------------- -------------- ------- For the year ended December 31, 1995: Property and liability insurance.............. $ 97,675,000 $ 128,008,000 $ 110,344,000 $ 80,011,000 138% ------------- -------------- -------------- -------------- ------- ------------- -------------- -------------- -------------- ------- For the year ended December 31, 1994: Property and liability insurance.............. $ 68,174,000 $ 98,235,000 $ 76,895,000 $ 46,834,000 164% ------------- -------------- -------------- -------------- ------- ------------- -------------- -------------- -------------- -------
- ------------------------ (1) Substantially all of the reinsurance assumed by the Company's insurance company subsidiaries was underwritten directly by the subsidiaries but issued by other unrelated companies in order to satisfy local licensing or other requirements, predominantly on foreign business or as reinsurance of captives. S-8 EX-10.330 2 EXHIBIT 10.330 EXHIBIT 10.330 - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------ AGREEMENT AND PLAN OF REORGANIZATION dated as of November 27, 1996 by and among HCC INSURANCE HOLDINGS, INC., MERGER SUB, INC., and NORTH AMERICAN SPECIAL RISK ASSOCIATES, INC. NASRA TPA, INC. NASRA CONSULTING, INC. and GEORGE A. MELLON F. DONALD FLEMING J. NICHOLAS TEGENKAMP - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------ TABLE OF CONTENTS Page ARTICLE I THE MERGER....................................... 2 Section 1.1 The Merger.................................... 2 Section 1.2 Conversion of Shares.......................... 3 Section 1.3 Exchange of Certificates...................... 3 Section 1.4 Dissenting Shares............................. 4 Section 1.5 Escrow Agreement.............................. 4 Section 1.6 Satisfaction of Fleming's Dissenter's Rights.. 4 ARTICLE II THE SURVIVING CORPORATION........................ 5 Section 2.1 Articles of Incorporation..................... 5 Section 2.2 Bylaws........................................ 5 Section 2.3 Directors and Officers........................ 5 ARTICLE III REPRESENTATIONS AND WARRANTIES OF HOLDCO, AFFILIATED COMPANIES AND SHAREHOLDERS....................... 5 Section 3.1 Corporate Existence and Power................. 5 Section 3.2 Authorization................................. 6 Section 3.3 Governmental Authorization.................... 6 Section 3.4 Non-Contravention............................. 7 Section 3.5 Capitalization................................ 8 Section 3.6 Subsidiaries and Joint Ventures............... 9 Section 3.7 NASRA Financial Statements.................... 9 Section 3.8 TPA Financial Statements...................... 10 Section 3.9 Consulting Financial Statements............... 10 Section 3.10 Absence of Certain Changes.................... 10 Section 3.11 No Undisclosed Liabilities.................... 12 Section 3.12 Litigation.................................... 12 Section 3.13 Accounting Matters............................ 13 Section 3.14 Taxes......................................... 13 Section 3.15 Employee Benefit Plans, ERISA................. 14 Section 3.16 Material Agreements........................... 16 Section 3.17 Properties.................................... 16 Section 3.18 Environmental Matters......................... 17 Section 3.19 Labor Matters................................. 18 Section 3.20 Compliance with Laws.......................... 18 Section 3.21 Trademarks, Tradenames, Etc................... 18 Section 3.22 Sale of NASRA................................. 18 Section 3.23 Broker's Fees................................. 18 Section 3.24 Investment Representation..................... 18 i TABLE OF CONTENTS (Cont.) Section 3.25 Total Assets.................................. 19 Section 3.26 Resignation of Fleming........................ 19 ARTICLE IV REPRESENTATIONS AND WARRANTIES OF HCCH........... 19 Section 4.1 Corporate Existence and Power................. 19 Section 4.2 Corporate Authorization....................... 20 Section 4.3 Governmental Authorization.................... 20 Section 4.4 Non-Contravention............................. 20 Section 4.5 Capitalization of HCCH........................ 21 Section 4.6 Organization of Merger Sub.................... 22 Section 4.7 Subsidiaries.................................. 22 Section 4.8 SEC Filings................................... 22 Section 4.9 Financial Statements.......................... 23 Section 4.10 Absence of Certain Changes.................... 23 Section 4.11 No Undisclosed Liabilities.................... 24 Section 4.12 Litigation.................................... 24 Section 4.13 Taxes......................................... 24 Section 4.14 Employee Benefit Plans; ERISA................. 25 Section 4.15 Material Agreements........................... 26 Section 4.16 Properties.................................... 27 Section 4.17 Environmental Matters......................... 27 Section 4.18 Labor Matters................................. 28 Section 4.19 Compliance with Laws.......................... 28 Section 4.20 Trademarks, Tradenames, Etc................... 28 Section 4.21 Broker's Fees................................. 28 ARTICLE V COVENANTS OF HOLDCO, ETC......................... 28 Section 5.1 Conduct of Holdco and Affiliated Companies.... 28 Section 5.2 Shareholder Approval.......................... 30 Section 5.3 Access to Financial and Operational Information.................................. 30 Section 5.4 Other Offers.................................. 31 Section 5.5 Maintenance of Business....................... 31 Section 5.6 Compliance with Obligations................... 31 Section 5.7 Notices of Certain Events..................... 32 Section 5.8 Affiliates Agreement.......................... 32 Section 5.9 Necessary Consents............................ 32 Section 5.10 Regulatory Approval........................... 32 Section 5.11 Satisfaction of Conditions Precedent.......... 33 ii TABLE OF CONTENTS (Cont.) ARTICLE VI COVENANTS OF HCCH AND MERGER SUB................. 33 Section 6.1 Conduct of HCCH............................... 33 Section 6.2 Listing of HCCH Common Stock.................. 33 Section 6.3 Access to Financial and Operation Information. 33 Section 6.4 Maintenance of Business....................... 34 Section 6.5 Compliance with Obligations................... 34 Section 6.6 Notices of Certain Events..................... 34 Section 6.7 Obligations of Merger Sub..................... 35 Section 6.8 Notice to Affiliates.......................... 35 Section 6.9 Employee Matters.............................. 35 Section 6.10 Officers and Directors Insurance.............. 35 ARTICLE VII COVENANTS OF HCCH, HOLDCO AND AFFILIATED COMPANIES....................................... 35 Section 7.1 Advice of Changes............................. 35 Section 7.2 Regulatory Approvals.......................... 36 Section 7.3 Actions Contrary to Stated Intent............. 36 Section 7.4 Certain Filings............................... 36 Section 7.5 Communications................................ 36 Section 7.6 Satisfaction of Conditions Precedent.......... 36 Section 7.7 Tax Cooperation............................... 37 ARTICLE VIII CONDITIONS TO THE MERGER......................... 37 Section 8.1 Conditions to Obligations of HCCH and Merger Sub.................................. 37 Section 8.2 Conditions to Obligations of Holdco, Affiliated Companies and Shareholders........ 39 Section 8.3 Conditions to Obligations of Each Party....... 40 ARTICLE IX TERMINATION OF AGREEMENT......................... 40 Section 9.1 Termination................................... 40 Section 9.2 Effect of Termination......................... 41 ARTICLE X CLOSING MATTERS.................................. 41 Section 10.1 The Closing................................... 41 Section 10.2 Conversion of Certificates.................... 42 ARTICLE XI INDEMNIFICATION AND REMEDIES, CONTINUING COVENANTS....................................... 42 Section 11.1 Agreement to Indemnify........................ 42 iii TABLE OF CONTENTS (Cont.) Section 11.2 Indemnification with Respect to Jamaica Lawsuit and Taxes............................ 43 Section 11.3 HCCH Agreement to Indemnify................... 44 Section 11.4 Appointment of Representative................. 44 Section 11.5 Survival of Representations................... 45 Section 11.6 Procedure for Indemnification; Third Party Claims................................. 46 ARTICLE XII MISCELLANEOUS.................................... 46 Section 12.1 Further Assurances............................ 46 Section 12.2 Fees and Expenses............................. 47 Section 12.3 Notices....................................... 47 Section 12.4 Governing Law................................. 48 Section 12.5 Binding upon Successors and Assigns, Assignment................................... 48 Section 12.6 Severability.................................. 48 Section 12.7 Entire Agreement.............................. 48 Section 12.8 Amendment and Waivers......................... 48 Section 12.9 No Waiver..................................... 49 Section 12.10 Construction of Agreement..................... 49 Section 12.11 Counterparts.................................. 49 iv AGREEMENT AND PLAN OF REORGANIZATION THIS AGREEMENT AND PLAN OF REORGANIZATION (this "Agreement") is entered into as of the 27th day of November, 1996 by and among HCC Insurance Holdings, Inc., a Delaware corporation ("HCCH"), Merger Sub, Inc. an Illinois corporation and a wholly owned subsidiary of HCCH ("Merger Sub"), North American Special Risks Associates, Inc. ("Holdco" or "NASRA"), an Illinois corporation, NASRA TPA, Inc. ("TPA"), an Illinois corporation, NASRA Consulting, Inc. ("Consulting"), an Illinois corporation (TPA and Consulting being from time to time collectively referred to herein as the "Affiliated Companies"), George A. Mellon ("Mellon"), F. Donald Fleming ("Fleming"), and J. Nicholas Tegenkamp ("Tegenkamp") (Mellon, Fleming and Tegenkamp being collectively referred to as the "Original Shareholders" and the Original Shareholders and any person becoming a shareholder of Holdco subsequent to the date hereof and on or before the Effective Date who executes a counterpart signature page in the form attached hereto being collectively referred to herein as the "Shareholders"). As of the Effective Date, wherever used herein and in the NASRA Disclosure Schedule (as hereinafter defined), the term "Affiliated Companies" shall mean "Subsidiaries" (as hereinafter defined). RECITALS: A. The Boards of Directors of each of HCCH, Merger Sub and NASRA have determined (a) to engage in a transaction pursuant to which (i) prior to the Effective Date (as hereinafter defined), TPA shall become a wholly owned subsidiary of Holdco, by means of a contribution to the capital of Holdco by Mellon, of all of the shares of common stock of TPA held by Mellon in exchange for 5,382 shares of NASRA Common Stock, (ii) Consulting will merge into NASRA, with NASRA being the surviving company, and the Original Shareholders receiving 100 shares of NASRA Common Stock in consideration therefor, (iii) Merger Sub will merge with and into Holdco (the "Merger"), (iv) the capital stock of Merger Sub shall be converted into shares of common stock of Holdco (the "Holdco Common Stock"); and (v) each share of Holdco Common Stock outstanding immediately prior to the Effective Time shall be converted into shares of common stock, par value $1.00 per share, of HCCH (the "HCCH Common Stock") in the manner herein described, all upon the terms and subject to the conditions set forth herein or (b) if otherwise advised by counsel, to engage in a transaction involving any alternative structure whereby the Affiliated Companies will be able to carry out the intent of this Agreement as agreed upon in a writing signed by each party hereto. B. The Board of Directors of NASRA has determined that based on the relative values of their holdings of NASRA, including the detrimental effect of certain call options relating to the shares of NASRA Common Stock held by Fleming and Tegenkamp, the shares of NASRA held by the Original Shareholders result in the value of NASRA after consummation of the transactions described in Recital A above to be held as follows: Mellon - 93.6%; Fleming - 5.3% and Tegenkamp 1.1%, and the Original Shareholders have agreed to such relative values. C. The Boards of Directors of Holdco and the Affiliated Companies have approved, and the Board of Directors of Holdco has resolved, subject to the terms of this Agreement, to recommend that shareholders of Holdco approve the Merger, this Agreement and the Articles of Merger (as defined herein). D. The Board of Directors of HCCH has approved the Merger, this Agreement and the Articles of Merger. HCCH, as the sole shareholder of Merger Sub, has approved the Merger, this Agreement and the Articles of Merger. E. The parties intend for the transactions contemplated by this Agreement to qualify as a plan of reorganization in accordance with the provisions of Section 368(a) of the Internal Revenue Code of 1986, as amended (the "Code"), and to be accounted for as a "pooling-of-interests" for accounting purposes. F. Fleming has informed NASRA that he intends to dissent from agreeing to the transactions contemplated by this Agreement and the Merger and to receive the fair value for his shares of NASRA pursuant to the Illinois Business Corporation Act. NOW, THEREFORE, in consideration of the foregoing and the mutual representations, warranties, covenants and agreements set forth herein, the parties hereto do hereby agree as follows: ARTICLE I THE MERGER Section 1.1 The Merger. (a) Subject to the terms and conditions of this Agreement, Merger Sub will be merged into Holdco in accordance with the laws of the State of Illinois ("Illinois Law"), whereupon the separate existence of Merger Sub shall cease, and Holdco shall be the surviving corporation (the "Surviving Corporation"). (b) As soon as practicable after satisfaction or, to the extent permitted hereunder, waiver of all conditions to the Merger, Holdco and Merger Sub shall file articles of merger, in substantially the form attached hereto as Exhibit 1.1(b) (the "Articles of Merger"), in the Office of the Secretary of the State of Illinois, and make all such other filings or recordings required by Illinois Law in connection with the Merger. The Merger shall become effective at such time as the Articles of Merger are duly filed with the Office of the Secretary of the State of Illinois, in accordance with the relevant provisions of Illinois Law (the "Effective Time"). The date on which the Effective Time shall occur is referred to herein as the "Effective Date." (c) From and after the Effective Time, the Surviving Corporation shall possess all the rights, privileges, powers and franchises and be subject to all of the restrictions, disabilities and duties of Holdco and Merger Sub, all as provided under Illinois Law. 2 Section 1.2 Conversion of Shares. At the Effective Time, each share of common stock, par value $1.00 per share, of Merger Sub outstanding immediately prior to the Effective Time shall automatically and without any action on the part of the holder thereof, be converted into one share of common stock of the Surviving Corporation, and, except as set forth herein in connection with the payment of cash for Fleming's shares in NASRA, shares of Holdco Common Stock outstanding immediately prior to the Effective Time shall automatically and without any action on the part of the holder thereof cease to be outstanding and be converted into the right to receive shares of HCCH Common Stock as follows: (a) 7,404.2 shares of Holdco held by Mellon shall be converted into 1,123,200 shares of HCCH Common Stock; (b) 622.2 shares of Holdco held by Fleming shall be converted into 63,600 shares of HCCH Common Stock; and (c) 155.6 shares of Holdco held by Tegenkamp shall be converted into 13,200 shares of HCCH Common stock. No fractional shares shall be issued and each holder of Holdco Common Stock shall be entitled to the nearest whole share of HCCH Common Stock rounded upwards if such fractional share exceeds .5 and otherwise rounded downwards, provided, however, that HCCH shall under no circumstances be obligated hereunder to issue shares of HCCH Common Stock in excess of an aggregate of 1,200,000 shares of HCCH Common Stock. Section 1.3 Exchange of Certificates. (a) Prior to the Effective Date, HCCH shall appoint KeyCorp Shareholder Services, Inc. to act as exchange agent (the "Exchange Agent") in the Merger. (b) At the Effective Time, HCCH shall exchange the shares of HCCH Common Stock issuable pursuant to Section 1.2 in exchange for all outstanding shares of Holdco Common Stock (other than for shares of Holdco Common Stock held by any Shareholder who has elected to accept appraisal rights as contemplated by Section 1.4). (c) If prior to the Merger, HCCH recapitalizes either through a split-up of its outstanding shares into a greater number, or through a combination of its outstanding shares into a lesser number, or reorganizes, reclassifies or otherwise changes its outstanding shares into the same or a different number of shares of other classes (other than through a split-up or a combination of shares provided for in the previous clause), or declares a dividend on its outstanding shares payable in shares or securities convertible into shares (but not cash), the number of shares of HCCH Common Stock into which the shares of Holdco Common Stock are to be converted will be adjusted in proportion to such change. 3 Section 1.4 Dissenting Shares. (a) Notwithstanding any provision of this Agreement to the contrary, the shares of any holder of Holdco Common Stock who has demanded and perfected appraisal rights for such shares in accordance with Illinois Law and who, as of the Effective Time, has not effectively withdrawn or lost such appraisal rights ("Dissenting Shares") shall not be converted into or represent a right to receive HCCH Common Stock pursuant to Section 1.2, but the holder thereof shall only be entitled to such rights as are granted by Illinois Law. (b) Notwithstanding the provisions of subsection (a), if any holder of shares of Holdco Common Stock who demands appraisal of such shares under Illinois Law shall effectively withdraw such appraisal demand or fail to perfect or otherwise lose the right to appraisal, then, as of the later of the Effective Time and the occurrence of such event, such shareholder's shares of Holdco Common Stock shall automatically be converted into and represent only the right to receive HCCH Common Stock, without interest thereon, upon surrender of the certificate representing such shares. (c) Holdco shall give HCCH (i) prompt notice of any written demands for appraisal of any shares of Holdco Common Stock, withdrawals of such demands, and any other instruments served pursuant to Illinois Law and received by Holdco which relate to any such demand for appraisal and (ii) the opportunity to participate in all negotiations and proceedings which take place prior to the Effective Time with respect to demands for appraisal under Illinois Law. (d) If holders of Holdco Common Stock entitled to receive an excess of 100,000 shares of HCCH Common Stock demand appraisal rights as provided for herein and refuse to withdraw such demand prior to the Effective Date, HCCH, in its sole and absolute discretion, shall have the right to terminate this Agreement. Section 1.5 Escrow Agreement. Pursuant to an Escrow Agreement to be entered into on or before the Closing Date (as hereinafter defined) in substantially the form of Exhibit 1.5 (the "Escrow Agreement"), among HCCH, the Shareholders and KeyCorp Shareholders Services, Inc., as Escrow Agent, HCCH will withhold from the shares of HCCH Common Stock that would otherwise be delivered to the Shareholders, 10% of the total number of shares of HCCH Common Stock issued to the Shareholders in the Merger and 10% of the cash otherwise to be received by Fleming pursuant to this Agreement. On the Closing Date, HCCH will deposit, or cause to be deposited in escrow pursuant to the Escrow Agreement, certificates representing the shares and the cash thus withheld. The shares of HCCH Common Stock represented by the certificates and the cash deposited in escrow as provided above in this Section 1.5 (the "Escrow Shares") will be held as collateral for the indemnification obligations of the Shareholders under Sections 11.1 and 11.2 below and pursuant to the Escrow Agreement pending their release from escrow in accordance with the terms of the Escrow Agreement. Section 1.6 Satisfaction of Fleming's Dissenter's Rights. At the Effective Time, HCCH agrees that at the Closing it will pay to Fleming an amount equal to 63,600 multiplied 4 by the average of the high and low sales price of HCCH Common Stock on the New York Stock Exchange for the ten (10) trading days ending two trading days before the Effective Date, and that such amount is the fair value for Fleming's shares of NASRA and is in full satisfaction of Fleming's right to dissent from the consummation of the Merger in accordance with Illinois Law. ARTICLE II THE SURVIVING CORPORATION Section 2.1 Articles of Incorporation. At the Effective Time, the Articles of Incorporation of Merger Sub as in effect immediately prior to the Effective Time shall be the Articles of Incorporation of the Surviving Corporation. Section 2.2 Bylaws. At the Effective Time, the Bylaws of Merger Sub as in effect immediately prior to the Effective Time shall be the Bylaws of the Surviving Corporation. Section 2.3 Directors and Officers. From and after the Effective Time, until successors are duly elected or appointed and qualified in accordance with applicable law, the directors and officers of Merger Sub at the Effective Time shall become directors and the officers of the Surviving Corporation. In addition, HCCH shall take all necessary action to cause Mellon to be appointed Chairman of the Board, Chief Executive Officer and President of the Surviving Corporation, such appointment to become effective as of the Effective Time. ARTICLE III REPRESENTATIONS AND WARRANTIES OF HOLDCO, AFFILIATED COMPANIES AND SHAREHOLDERS Except as disclosed in a document referring specifically to this Agreement (the "NASRA Disclosure Schedule") which has been delivered to HCCH on or before the date hereof, each of Holdco, each Affiliated Company and each Shareholder (severally and not jointly) represents and warrants to HCCH as set forth below (it being agreed that the disclosure on the NASRA Disclosure Schedule of the existence of any document or fact or circumstance or situation relating to any representations, warranties, covenants or agreements in any section of this Agreement shall be automatically deemed to be disclosure of such document or fact or circumstance or situation for purposes of all other representations, warranties, covenants and agreements in this Agreement): Section 3.1 Corporate Existence and Power. Holdco and each of the Affiliated Companies is a corporation duly organized, validly existing and in good standing under the laws of the state of its incorporation, and have all corporate powers and all material governmental licenses, authorizations, consents and approvals (collectively, "Governmental Authorizations") 5 required to carry on its business as now conducted, except such Governmental Authorizations the failure of which to have obtained would not have a Material Adverse Effect, as hereinafter defined, on Holdco or such Affiliated Company. Holdco and each of the Affiliated Companies is duly qualified to do business as a foreign corporation and is in good standing in each jurisdiction where the character of the property owned or leased by it or the nature of its activities makes such qualification necessary, except where the failure to be so qualified would not have a Material Adverse Effect on Holdco or such Affiliated Company. For purposes of this Agreement, a "Material Adverse Effect," with respect to any person or entity (including without limitation Holdco, each Affiliated Company and HCCH), means a material adverse effect on the condition (financial or otherwise), business, properties, assets, liabilities (including contingent liabilities), results of operations or prospects of such person or entity and its affiliated companies and subsidiaries and/or parent corporation and/or corporations under the same stock ownership, taken as a whole; and "Material Adverse Change" means a change or a development involving a prospective change which would result in a Material Adverse Effect. Holdco has delivered to HCCH true and complete copies of Holdco's and each Affiliated Company's Articles of Incorporation or Articles of Incorporation, as the case may be, and Bylaws as currently in effect. Section 3.2 Authorization. (a) The execution, delivery and performance by Holdco and each of the Affiliated Companies of this Agreement and, in the case of Holdco, the Articles of Merger, and the consummation by Holdco and each of the Affiliated Companies of the transactions contemplated hereby and thereby including the execution of the Confidentiality Agreement (as hereinafter defined), are within Holdco and each Affiliated Company's corporate powers and have been duly authorized by all necessary corporate action, excluding approval by the Shareholders in connection with the consummation of the Merger. This Agreement, the Articles of Merger, and the Confidentiality Agreement constitute, or upon execution will constitute, valid and binding agreements of Holdco and each of the Affiliated Companies party thereto, enforceable against such agreeing party in accordance with their respective terms, except as such enforcement may be limited by bankruptcy, insolvency or other similar laws affecting the enforcement of creditors' rights generally or by general principles of equity. (b) Each of the Shareholders, severally, represents and warrants that he has full right, power and authority to enter into this Agreement, the Affiliates Agreement to be entered into by him, and each other agreement to be entered into by him in connection with the transactions contemplated hereby and that this Agreement, the Affiliates Agreement, and such other agreements contemplated hereby constitute, or upon execution will constitute, valid and binding agreements of such Shareholder, enforceable against him in accordance with their respective terms, except as such enforcement may be limited by bankruptcy, insolvency or other similar laws effecting the enforcement of creditors' rights generally or by general principles of equity. Section 3.3 Governmental Authorization. The execution, delivery and performance by Holdco, each of the Affiliated Companies and each Shareholder of this Agreement, the execution, delivery and performance by Holdco of the Articles of Merger and the Confidentiality 6 Agreement and the consummation of the Merger by Holdco require no action by or in respect of, or filing with, any governmental body, agency, official or authority other than: (a) the filing of Articles of Merger in accordance with Illinois Law; (b) compliance with any applicable requirements of the Hart-Scott-Rodino Antitrust improvements Act of 1976, as amended (the "HSR Act"); (c) compliance with any applicable requirements of the Securities Act and the rules and regulations promulgated thereunder; (d) compliance with any applicable foreign or state securities or "blue sky" laws; (e) compliance with any requirements of any federal, state, foreign or other insurance or reinsurance or intermediaries or managing general agent laws, including licensing or other related laws; (f) such other filings or registrations with, or authorizations, consents or approvals of, governmental bodies, agencies, officials or authorities, the failure of which to make or obtain (i) would not reasonably be expected to have a Material Adverse Effect on Holdco, the Affiliated Companies or the Surviving Corporation, or (ii) would not materially adversely affect the ability of Holdco, each Affiliated Company, HCCH or Merger Sub to consummate the transactions contemplated hereby and operate their businesses as heretofore operated. Section 3.4 Non-Contravention. The execution, delivery and performance by Holdco and each of the Affiliated Companies of this Agreement, the execution, delivery and performance by Holdco of the Articles of Merger and the consummation by Holdco and each of the Affiliated Companies of the transactions contemplated hereby and thereby do not and will not: (a) contravene or conflict with each such company's charter or bylaws; (b) assuming compliance with the matters referred to in Section 3.3 and assuming the requisite approval by the Shareholders of the Merger, contravene or conflict with or constitute a violation of any provision of any law, regulation, judgment, injunction, order or decree binding upon or applicable to Holdco or any of the Affiliated Companies; (c) conflict with or result in a breach or violation of, or constitute a default under, or result in a contractual right to cause the termination or cancellation of or loss of a material benefit under, or right to accelerate, any material agreement, contract or other instrument binding upon Holdco or any of the Affiliated Companies or any material license, franchise, permit or other similar authorization held by Holdco or any of the Affiliated Companies; or (d) result in the creation or imposition of any Lien (as hereinafter defined) on any material asset of Holdco or any of the Affiliated Companies, 7 except, with respect to clauses (b), (c) and (d) above, for contraventions, defaults, losses, Liens and other matters referred to in such clauses that in the aggregate would not be reasonably expected to have, individually or in the aggregate, a Material Adverse Effect on Holdco or any of the Affiliated Companies. For purposes of this Agreement, the term "Lien" means, with respect to any asset, any mortgage, lien, pledge, charge, security interest or encumbrance of any kind in respect of such asset. Section 3.5 Capitalization. (a) As of October 31, 1996, the authorized, issued and outstanding capital stock of each Affiliated Company was as follows: North American Special Risk Associates, Inc.: no par value, 100,000 shares Common Stock authorized; 2,700 shares issued and outstanding NASRA TPA, Inc.: no par value, 1,000,000 shares of Class A Common Stock and 1,000,000 shares of Class B Common Stock authorized; 1,000 shares of Class A issued and outstanding NASRA Consulting, Inc.: no par value, 1,000,000 shares Common Stock authorized; 450 shares issued and outstanding (b) After giving effect to the merger of Consulting with and into NASRA and the contribution of the TPA shares of common stock to NASRA by Mellon, there will be 8,400 shares of NASRA issued and outstanding. (c) All outstanding shares set forth in (a) and (b) above have been, or will be prior to the Effective Date, duly authorized and validly issued and are fully paid and nonassessable and free from any preemptive rights. Except as set forth in and as otherwise contemplated by this Agreement, for each of Holdco and each Affiliated Company there are outstanding (i) no shares of capital stock or other voting securities, (ii) no securities convertible into or exchangeable for shares of its capital stock or voting securities), (iii) no options or other rights to acquire, and no obligation to issue, any capital stock, voting securities or securities convertible into or exchangeable for its capital stock or other voting securities (the items in clauses (i), (ii) and (iii) being referred to collectively as the "NASRA Securities"), (iv) no obligations to repurchase, redeem or otherwise acquire any of its outstanding securities and (v) no contractual rights of any person or entity to include any such securities in any registration statement proposed to be filed under the Securities Act. 8 Section 3.6 Subsidiaries and Joint Ventures. (a) For purposes of this Section 3.6, (i) "Subsidiary" means, with respect to any entity, any corporation of which securities or other ownership interests having ordinary voting power to elect a majority of the board of directors or other persons performing similar functions are directly or indirectly owned by such entity, and (ii) "Joint Venture" means, with respect to any entity, any corporation or organization (other than such entity and any Subsidiary thereof) of which such entity or any Subsidiary thereof is, directly or indirectly, the beneficial owner of 25% or more of any class of equity securities or equivalent profit participation interest. For purposes of this Agreement, in no event shall "Subsidiary" or "Joint Venture" include Silver Eagle Agency, Inc., an Illinois corporation; or Mellon Patch, Inc., an Illinois corporation. (b) As of the date hereof, neither Holdco nor any of the Affiliated Companies has any Subsidiaries or Joint Ventures which are material to the business of Holdco or any of the Affiliated Companies. As of the Closing Date, as defined herein, the only Subsidiaries of Holdco shall be the Affiliated Companies and their respective jurisdictions of incorporation or organization and Holdco's ownership interest therein are identified in Exhibit 3.6(b). Other than Holdco's investments in its Subsidiaries as of the Effective Time, neither Holdco nor any of the Affiliated Companies own, directly or indirectly, any outstanding capital stock or equity interest in any corporation, partnership, Joint Venture or other entity. (c) All of the outstanding capital stock of, or other ownership interests in, each Subsidiary that is or may be owned by Holdco or any Affiliated Company on the Effective Date, and all of the outstanding stock of Holdco and each of the Affiliated Companies owned by the Shareholders directly or indirectly, is or will be owned by Holdco, or the Shareholders, as the case may be, directly or indirectly, free and clear of any material Lien and free of any other material limitation or restriction on its or their rights as owner thereof (including any restriction on the right to vote, sell or otherwise dispose of such capital stock or other ownership interests), other than those imposed by applicable law or this Agreement or the Affiliates Agreement (defined below). Each Shareholder represents and warrants only as to his or her individual ownership of Holdco Common Stock for purposes of this Section. Section 3.7 NASRA Financial Statements. NASRA has delivered to HCCH NASRA's unaudited balance sheet as of October 31, 1996 (the "Balance Sheet Date"), NASRA's unaudited income statements for the six month period ended September 30, 1996, NASRA's audited balance sheet as of March 31, 1996 and 1995, and NASRA's audited income statement for the fiscal years ended March 31, 1996, 1995, and 1994 (collectively, the "NASRA Financial Statements"). The NASRA Financial Statements present fairly in all material respects, substantially in conformity with generally accepted accounting principles consistently applied (except as indicated in the notes thereto), the financial position of NASRA as of the dates thereof and results of operations and cash flows for the periods therein indicated (subject to normal year-end adjustments in the case of any interim financial statements and the absence of certain footnotes in the case of unaudited financial statements). Holdco and the Affiliated Companies taken as a whole have no material debt, liability or obligation of any nature, whether accrued, absolute, contingent or 9 otherwise, and whether due or to become due, that is not reflected, reserved against or disclosed in the NASRA Financial Statements, except for (i) those reflected in the TPA Financial Statements (defined below), (ii) those reflected in the Consulting Financial Statements (defined below); (iii) those that are not required to be reported in accordance with the aforesaid accounting principles; (iv) normal or recurring liabilities incurred since October 31, 1996 in the ordinary course of business or (v) as disclosed in the NASRA Disclosure Schedule. Section 3.8 TPA Financial Statements. Holdco has delivered to HCCH TPA's unaudited balance sheet as of October 31, 1996 (the "Balance Sheet Date"), TPA's unaudited income statements for the nine month period ended September 30, 1996, TPA's audited balance sheet as of December 31, 1995 and 1994, and TPA's audited income statement for the fiscal years ended December 31, 1995, 1994, and 1993 (collectively, the "TPA Financial Statements"). The TPA Financial Statements present fairly in all material respects, substantially in conformity with generally accepted accounting principles consistently applied (except as indicated in the notes thereto), the financial position of TPA as of the dates thereof and results of operations and cash flows for the periods therein indicated (subject to normal year-end adjustments in the case of any interim financial statements and the absence of certain footnotes in the case of unaudited financial statements). Section 3.9 Consulting Financial Statements. Holdco has delivered to HCCH Consulting's unaudited balance sheet as of October 31, 1996 (the "Balance Sheet Date"), Consulting's unaudited income statements for the nine month period ended September 30, 1996, Consulting's unaudited balance sheet as of December 31, 1995 and 1994, and Consulting's unaudited income statement for the fiscal years ended December 31, 1995, 1994, and 1993 (collectively, the "Consulting Financial Statements"). The Consulting Financial Statements present fairly in all material respects, substantially in conformity with generally accepted accounting principles consistently applied (except as indicated in the notes thereto), the financial position of Consulting as of the dates thereof and results of operations and cash flows for the periods therein indicated (subject to normal year-end adjustments in the case of any interim financial statements and the absence of certain footnotes in the case of unaudited financial statements). Section 3.10 Absence of Certain Changes. Except as disclosed in the NASRA Disclosure Schedule, since March 31, 1996 with respect to NASRA and since December 31, 1995 with respect to TPA and Consulting, each Affiliated Company has in all material respects conducted its business in the ordinary course and there has not been: (a) any Material Adverse Change with respect thereto or any event, occurrence or development of a state of circumstances or facts known to Holdco or any of the Affiliated Companies, which as of the date hereof could reasonably be expected to have a Material Adverse Effect on Holdco or any of the Affiliated Companies; (b) any declaration, setting aside or payment or any dividend or other distribution in respect of any shares of capital stock of Holdco or any of the Affiliated Companies other than 10 the declaration, setting aside or payment of dividends in accordance with its existing dividend policy or practice, which policy or practice is not inconsistent with the Affiliated Companies' past policy or practice or with respect to NASRA or Consulting any declaration, setting aside or payment of distributions or dividends to "S" Corporation shareholders; (c) any repurchase, redemption or other acquisition by Holdco or any of the Affiliated Companies of any outstanding shares of capital stock or other securities of or other ownership interests in Holdco or any of the Affiliated Companies; (d) any amendment of any term of any outstanding securities of Holdco or any of the Affiliated Companies; (e) any damage, destruction or other property or casualty loss (whether or not covered by insurance) affecting the business, assets, liabilities, earnings or prospects of Holdco or any of the Affiliated Companies which, individually or in the aggregate, has had or would reasonably be expected to have a Material Adverse Effect on Holdco or any of the Affiliated Companies; (f) any increase in indebtedness for borrowed money or capitalized lease obligations of Holdco or any of the Affiliated Companies, except in the ordinary course of business; (g) any sale, assignment, transfer or other disposition of any tangible or intangible asset material to the business of Holdco or any of the Affiliated Companies, except in the ordinary course of business and for a fair and adequate consideration; (h) any amendment, termination or waiver by Holdco or any of the Affiliated Companies of any right of substantial value under any agreement, contract or other written commitment to which it is a party or by which it is bound; (i) any material reduction in the amounts of coverage provided by existing casualty and liability insurance policies with respect to the business or properties of Holdco or any of the Affiliated Companies; (j) any (i) grant of any severance or termination pay to any director, officer or employee of Holdco or any of the Affiliated Companies, (ii) entering into of any employment, deferred compensation or other similar agreement (or any amendment to any such existing agreement) with any director, officer or employee of Holdco or any of the Affiliated Companies, (iii) any increase in benefits payable under any existing severance or termination pay policies or employment agreements, or (iv) any increase in compensation, bonus or other benefits payable to directors, officers or employees of Holdco or any of the Affiliated Companies, in each case other than in the ordinary course of business consistent with past practice; (k) any new or amendment to or alteration of any existing bonus, incentive, compensation, severance, stock option, stock appreciation right, pension, matching gift, profit sharing, employee stock ownership, retirement, pension group insurance, death benefit, or other 11 fringe benefit plan, arrangement or trust agreement adopted or implemented by Holdco or any of the Affiliated Companies which would result in a material increase in cost; (l) any capital expenditures, capital additions or capital improvements incurred or undertaken by Holdco or any of the Affiliated Companies, except in the ordinary course of business; or (m) the entering into of any agreement by Holdco or any of the Affiliated Companies or any person on behalf of Holdco or any of the Affiliated Companies to take any of the foregoing actions. Section 3.11 No Undisclosed Liabilities. There are no liabilities of Holdco or any of the Affiliated Companies of any kind whatsoever that are, individually or in the aggregate, material to Holdco and the Affiliated Companies, taken as a whole, other than: (a) liabilities disclosed or provided for in the NASRA audited financial statements as of and for the fiscal year ended March 31, 1996 (including the notes thereto); (b) liabilities of NASRA incurred in the ordinary course of business consistent with past practice since March 31, 1996; (c) liabilities disclosed or provided for in the TPA audited financial statements as of and for the fiscal year ended December 31, 1995 (including the notes thereto): (d) liabilities of TPA incurred in the ordinary course of business consistent with past practice since December 31, 1995; (e) liabilities disclosed or provided for in the Consulting unaudited financial statements as of and for the fiscal year ended March 31, 1996 (including the notes thereto); (f) liabilities of Consulting incurred in the ordinary course of business consistent with past practice since March 31, 1996; and (g) liabilities under this Agreement or indicated in the NASRA Disclosure Schedule. Section 3.12 Litigation. Except as set forth in the NASRA Disclosure Schedule and other than actions, suits, proceedings, claims or investigation occurring in the ordinary course of business involving respective amounts in controversy of less than $10,000 each and $100,000 in the aggregate, there is no action, suit, proceeding, claim or investigation pending or, to the knowledge of Holdco, any of the Affiliated Companies or the Original Shareholders, overtly threatened, against Holdco or any of the Affiliated Companies or any of their assets or against or involving any of their officers, directors or employees in connection with the business or affairs of Holdco or any of the Affiliated Companies, including, without limitation, any such claims for indemnification arising under any agreement to which Holdco or any of the Affiliated Companies is a party. Neither Holdco nor any of the Affiliated 12 Companies is subject, or in default with respect, to any writ, order, judgment, injunction or decree which could, individually or in the aggregate, have a Material Adverse Effect on Holdco or any of the Affiliated Companies. Section 3.13 Accounting Matters. Except for all actions disclosed to and approved by HCCH, neither Holdco, any of the Affiliated Companies, nor any of the Shareholders knowingly has taken or agreed to take any action that (without giving effect to any action taken or agreed to be taken by HCCH or any of its affiliates) would prevent HCCH from accounting for the business combination to be effected by the Merger as a pooling-of-interests. Upon execution of this Agreement, each of Holdco, NASRA, TPA and Consulting will have received a letter from its independent public accountants to the effect that if the Merger were to be consummated on the date of this Agreement, each of Holdco, NASRA, TPA and Consulting qualifies as an entity that may be a party to a business combination for which the pooling-of-interests method of accounting would be available. Section 3.14 Taxes. (a) Each of Holdco and each of the Affiliated Companies (i) has filed when due (taking into account extensions) with the appropriate federal, state, local, foreign and other governmental agencies, all material tax returns, estimates and reports required to be filed by it, (ii) either paid when due and payable or established adequate reserves or otherwise, with respect to Holdco, NASRA, TPA and Consulting, accrued on the NASRA Financial Statements, TPA Financial Statements or Consulting Financial Statements all material federal, state, local or foreign taxes, levies, imposts, duties, licenses and registration fees and charges of any nature whatsoever, and unemployment and social security taxes and income tax withholding, including interest and penalties thereon ("Taxes") and there are no tax deficiencies claimed in writing by any Taxing authority and received by an Affiliated Company that, in the aggregate, would result in any tax liability in excess of the amount of the reserves or accruals and (iii) has or will establish in accordance with its normal accounting practices and procedures accruals and reserves that, in the aggregate, are adequate for the payment of all Taxes not yet due and payable and attributable to any period preceding the Effective Time. The NASRA Disclosure Schedule sets forth those tax returns of each of the Affiliated Companies (or any predecessor entities) for all periods that currently are the subject of audit by any federal, state, local or foreign taxing authority. (b) There are no material taxes, interest, penalties, assessments or deficiencies claimed in writing by any Taxing authority and received by any of the Affiliated Companies to be due in respect of any tax returns filed by any of the Affiliated Companies (or any predecessor corporations). Neither any of the Affiliated Companies nor any predecessor corporation, has executed or filed with the IRS or any other Taxing authority any agreement or other document extending, or having the effect of extending, the period of assessment or collection of any Taxes. 13 (c) No Affiliated Company is a party to or bound by (or will prior to the Effective Date become a party to or bound by) any Tax indemnity, Tax sharing or Tax allocation agreement or other similar arrangement. No Affiliated Company has been a member of an affiliated group or filed or been included in a combined, consolidated or unitary Tax return. (d) Consulting has maintained a valid subchapter S election pursuant to the Code, and there is no corporate income tax due from Consulting. Section 3.15 Employee Benefit Plans, ERISA. (a) Neither Holdco nor any of the Affiliated Companies is a party to any oral or written (i) employment, severance, collective bargaining or consulting agreement not terminable on 60 days' or less notice, (ii) agreement with any executive officer or other key employee of Holdco or any of the Affiliated Companies (A) the benefits of which are contingent, or the terms of which are materially altered, upon the occurrence of a transaction involving Holdco or any of the Affiliated Companies of the nature of any of the transactions contemplated by this Agreement, (B) providing any term of employment or compensation guarantee extending for a period longer than one year, or (C) providing severance benefits or other benefits after the termination of employment of such executive officer or key employee regardless of the reason for such termination of employment, (iii) agreement, plan or arrangement under which any person may receive payments subject to the tax imposed by Section 4999 of the Code, or (iv) agreement or plan, including, without limitation, any stock option plan, stock appreciation right plan, restricted stock plan or stock purchase plan, the benefits of which would be increased, or the vesting of benefits of which will be accelerated, by the occurrence of any of the transactions contemplated by this Agreement or the value of any of the benefits of which will be calculated on the basis of any of the transactions contemplated by this Agreement. (b) Neither Holdco, any Affiliated Company nor any corporation or other entity which under Section 4001(b) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), is under common control with Holdco or any Affiliated Company (a "NASRA ERISA Affiliate") maintains or within the past five years has maintained, contributed to, or been obligated to contribute to, any "Employee Pension Benefit Plan" ("Pension Plan") or any "Employee Welfare Benefit Plan" ("Welfare Plan") as such terms are defined in Sections 3(2) and 3(1) respectively of ERISA, which is subject to ERISA. Each Pension Plan and Welfare Plan disclosed in the NASRA Disclosure Schedule (which Plans have been heretofore delivered to HCCH) and maintained by NASRA has been maintained in all material respects in compliance with their terms and all provisions of ERISA and the Code (including rules and regulations thereunder) applicable thereto. (c) No Pension Plan or Welfare Plan is currently subject to an audit or other investigation by the Internal Revenue Service ("IRS"), the Department of Labor, the Pension Benefit Guaranty Corporation or any other governmental agency or office nor are any such Plans subject to any lawsuits or legal proceedings of any kind or to any material pending disputed claims by employees or beneficiaries covered under any such Plan or by any other parties. 14 (d) No "prohibited transaction," as defined in Section 406 of ERISA or Section 4975 of the Code, resulting in liability to Holdco, or any Affiliated Company, or any NASRA ERISA Affiliate has occurred with respect to any Pension Plan or Welfare Plan. Each of Holdco, each Affiliated Company or Original Shareholder has no knowledge of any breach of fiduciary responsibility under Part 4 of Title I of ERISA which has resulted in liability of Holdco, any Affiliated Company, and NASRA ERISA Affiliate, any trustee, administrator or fiduciary of any Pension Plan or Welfare Plan. (e) Neither Holdco, any Affiliated Company, nor any NASRA ERISA Affiliate, since January 1, 1986, has maintained or contributed to, or been obligated or required to contribute to, a "Multiemployer Plan," as such term is defined in Section 4001(a)(3) of ERISA. Neither Holdco, any Affiliated Company, nor any NASRA ERISA Affiliate has either withdrawn, partially or completely, or instituted steps to withdraw, partially or completely, from any Multiemployer Plan nor has any event occurred which would enable a Multiemployer Plan to give notice of and demand payment of any withdrawal liability with respect to Holdco, any Affiliated Company, or any NASRA ERISA Affiliate. (f) There is no contract, agreement, plan or arrangement covering any employee or former employee of Holdco or any NASRA ERISA Affiliate that, individually or collectively, could give rise to the payment of any amount that would not be deductible pursuant to the terms of Sections 162(a)(I) or 280G of the Code. (g) With respect to Holdco, each Affiliated Company and each NASRA ERISA Affiliate, the NASRA Disclosure Schedule correctly identifies each material agreement, policy, plan or other arrangement, whether written or oral, express or implied, fixed or contingent, to which Holdco or any Affiliated Company is a party or by which Holdco or any Affiliated Company or any property or asset of Holdco or any Affiliated Company is bound, which is or relates to a pension, option, bonus, deferred compensation, retirement, stock purchase, profitsharing, severance pay, health, welfare, incentive, vacation, sick leave, medical disability, hospitalization, life or other insurance or fringe benefit plan, policy or arrangement. (h) Neither Holdco, any Affiliated Company, nor any NASRA ERISA Affiliate maintains or has maintained or contributed to any Pension Plan that is or was subject to Section 302 of Title IV of ERISA or Section 412 of the Code. Holdco and each Affiliated Company has made available to HCCH, for each Pension Plan which is intended to be "qualified" within the meaning of Section 401(a) of the Code, a copy of the most recent determination letter issued by the IRS to the effect that each such Plan is so qualified and that each trust created thereunder is tax exempt under Section 501 of the Code, and Holdco and each Affiliated Company is unaware of any fact or circumstances that would jeopardize the qualified status of each such Pension Plan or the tax exempt status of each trust created thereunder. 15 Section 3.16 Material Agreements. (a) The NASRA Disclosure Schedule includes a complete and accurate list of all contracts, agreements, leases (other than NASRA Property Leases, as hereinafter defined), and instruments to which Holdco or any of the Affiliated Companies is a party or by which it or its properties or assets are bound which individually involve net payments or receipts in excess of $25,000 per annum, inclusive of contracts entered into with customers and suppliers in the ordinary course of business, or that pertain to employment or severance benefits for any officer, director or employee of Holdco or any of the Affiliated Companies, whether written or oral, but exclusive of contracts, agreements, leases and instruments terminable without penalty upon 60 days' or less prior written notice to the other party or parties thereto (the "Material NASRA Agreements"). (b) Neither Holdco nor any Affiliated Company nor, to the knowledge of Holdco or any Affiliated Company, any other party is in default under any Material NASRA Agreement and no event has occurred which (after notice or lapse of time or both) would become a breach or default under, or would permit modification, cancellation, acceleration or termination of any Material NASRA Agreement or result in the creation of any security interest upon, or any person obtaining any right to acquire, any properties, assets or rights of Holdco or any Affiliated Company, which, in any such case, has had or would reasonably be expected to have a Material Adverse Effect. (c) To the knowledge of Holdco and each Affiliated Company, each such Material NASRA Agreement is in full force and effect and is valid and legally binding and there are no material unresolved disputes involving or with respect to any Material NASRA Agreement. No party to a Material NASRA Agreement has advised Holdco or any Affiliated Company that it intends either to terminate a Material NASRA Agreement or to refuse to renew a Material NASRA Agreement upon the expiration of the term thereof. (d) Holdco and each Affiliated Company is not in violation of, or in default with respect to, any term of its Articles or Certificate of Incorporation, as the case may be, or Bylaws. Section 3.17 Properties. To the knowledge of Holdco and each of the Affiliated Companies, Holdco or such Affiliated Company owns no real estate, and all leases of real property to which Holdco or any of the Affiliated Companies is a party or by which it is bound ("NASRA Property Leases") are in full force and effect. To the knowledge of Holdco or any Affiliated Company, there exists no default under such NASRA Property Leases, nor any event which with notice or lapse of time or both would constitute a default thereunder, which default would have a Material Adverse Effect. All of the properties and assets which are owned by Holdco and each of the Affiliated Companies are owned by each of them, respectively, free and clear of any Lien, except for Liens which do not have a Material Adverse Effect. Holdco and each of the Affiliated Companies have good and indefeasible title with respect to such owned properties and assets subject to no Liens, other than those permitted under this Section 3.17, to 16 all of the properties and assets necessary for the conduct of their business other than to the extent that the failure to have such title would not have a Material Adverse Effect. Section 3.18 Environmental Matters. (a) For the purposes of this Agreement, the following terms have the following meanings: "Environmental Laws" shall mean any and all federal, state, local and foreign statutes, laws (including case law), regulations, ordinances, rules, judgments, orders, decrees, codes, plans, injunctions, permits, concessions, grants, franchises, licenses, agreements and governmental restrictions relating to human health, the environment or to emissions, discharges or releases of pollutants, contaminants, Hazardous Substances (as hereinafter defined) or wastes into the environment or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of pollutants, contaminants, Hazardous Substances or wastes or the clean-up or other remediation thereof. "Environmental Liabilities" shall mean all liabilities, whether vested or unvested, contingent or fixed, actual or potential, which (i) arise under or relate to Environmental Laws and (ii) relate to actions occurring or conditions existing on or prior to the Effective Time. "Hazardous Substances" shall mean any toxic, radioactive, caustic or otherwise hazardous substance, including petroleum, its derivatives, by-products and other hydrocarbons, or any substance having any constituent elements displaying any of the foregoing characteristics. "Regulated Activity" shall mean any generation, treatment, storage, recycling, transportation, disposal or release of any Hazardous Substances. (b) To the knowledge of Holdco or any of the Affiliated Companies, no notice, notification, demand, request for information, citation, summons, complaint or order has been received, no complaint has been filed, no penalty has been assessed and no investigation or review is pending, or to any such party's knowledge, has been threatened by any governmental entity or other party with respect to any (i) alleged violation of any Environmental Law, (ii) alleged failure to have any environmental permit, certificate, license, approval, registration or authorization required in connection with the conduct of its business or (iii) Regulated Activity. (c) Neither Holdco nor any of the Affiliated Companies has any material Environmental Liabilities and there has been no release of Hazardous Substances into the environment by Holdco or any of the Affiliated Companies or with respect to any of their respective properties which has had, or would reasonably be expected to have, a Material Adverse Effect. 17 Section 3.19 Labor Matters. Neither Holdco nor any of the Affiliated Companies is a party to any collective bargaining agreement or other labor union contract applicable to persons employed by Holdco or any such Affiliated Companies, nor do they know of any activities or proceedings of any labor union to organize any such employees. Section 3.20 Compliance with Laws. Except for violations which do not have and would not reasonably be expected to have, individually or in the aggregate, a Material Adverse Effect, neither Holdco nor any of the Affiliated Companies is in violation of, or has violated, any applicable provisions of any laws, statutes, ordinances or regulations or any term of any judgment, decree, injunction or order binding against it. Section 3.21 Trademarks, Tradenames, Etc. Holdco and the Affiliated Companies own or possess, or hold a valid right or license to use, all intellectual property, patents, trademarks, tradenames, servicemarks, copyrights and licenses, and all rights with respect to the foregoing, necessary for the conduct of their business as now conducted, without any known conflict with the rights of others. Section 3.22 Sale of NASRA. Except as contemplated by this Agreement, there are currently no discussions to which any of the Affiliated Companies is a party relating to (a) the sale of any material portion of their assets or (b) any merger, consolidation, liquidation, dissolution or similar transaction involving any of the Affiliated Companies whereby any of the Affiliated Companies will issue any securities or for which any of the Affiliated Companies is required to obtain the approval of its shareholders. Section 3.23 Broker's Fees. Neither Holdco, any Affiliated Company, any Original Shareholder nor anyone acting on the behalf or at the request thereof has any liability to any broker, finder, investment banker or agent, or has agreed to pay any brokerage fees, finder's fees or commissions, or to reimburse any expenses of any broker, finder, investment banker or agent in connection with the Merger. Section 3.24 Investment Representation. The shares of HCCH Common Stock to be acquired by the Shareholders pursuant to the Merger will be acquired solely for the account of such Shareholders, for investment purposes only and not with a view to the distribution thereof. The Shareholders are not participating, directly or indirectly, in any distribution or transfer of such HCCH Common Stock, nor are they participating, directly or indirectly, in underwriting any such distribution of HCCH Common Stock within the meaning of the Securities Act. Each Shareholder has such knowledge and experience in business matters that he is capable of evaluating the merits and risks of an investment in HCCH and the acquisition of the shares of HCCH Common Stock, and he is making an informed investment decision with respect thereto. The Shareholders have been informed by HCCH that the shares of HCCH Common Stock to be issued pursuant to this Agreement and the documents to be executed in connection herewith will not be registered under the Securities Act at the time of their issuance and may not be transferred, assigned or otherwise disposed of absent registration under the Securities Act or availability of an appropriate exemption therefrom. The Shareholders have further been informed 18 that HCCH will be under no obligation to register the shares of HCCH Common Stock under the Securities Act or to take any steps to assist the Shareholders to comply with any applicable exemption under the Securities Act with respect to the shares of HCCH Common Stock. Section 3.25 Total Assets. The total assets of Holdco and the Affiliated Companies plus the Designated Assets (as herein defined) of Mellon do not, in the aggregate, exceed $10 million. As used herein, "Designated Assets", means investment assets (excluding therefrom any assets of the Affiliated Companies), voting securities and other income-producing property. Section 3.26 Resignation of Fleming. Effective June 24, 1996, Fleming resigned as a director and officer of Holdco and each of the Affiliated Companies on which he was an officer and a member of the Board of Directors. ARTICLE IV REPRESENTATIONS AND WARRANTIES OF HCCH Except as disclosed in a document referring specifically to this Agreement or in a document, exhibit, or appendix filed with the Securities and Exchange Commission ("SEC") which has been filed on or before the date hereof, (collectively referred to herein as the "HCCH Disclosure Schedule") which has been delivered to Holdco and the Affiliated Companies on or before the date hereof, each of HCCH and Merger Sub represents and warrants to Holdco, the Affiliated Companies and the Shareholders as set forth below (it being agreed that the disclosure on the HCCH Disclosure Schedule of the existence of any document or fact or circumstance or situation relating to any representations, warranties, covenants or agreements in any section of this Agreement shall be automatically deemed to be disclosure of such document or fact or circumstance or situation for purposes of all other representations, warranties, covenants and agreements in this Agreement): Section 4.1 Corporate Existence and Power. HCCH and each of its Subsidiaries is a corporation duly incorporated, validly existing and in good standing under the laws of the state of its incorporation. Merger Sub is a corporation duly incorporated, validly existing and in good standing under the laws of the State of Illinois. Each of HCCH and each of its Subsidiaries has all corporate powers and all material Governmental Authorizations required to carry on its business as now conducted, except such Governmental Authorizations the failure of which to have obtained would not have a Material Adverse Effect on HCCH. HCCH and each of its Subsidiaries is duly qualified to do business as a foreign corporation and is in good standing in each jurisdiction where the character of the property owned or leased by it or the nature of its activities makes such qualification necessary, except where the failure to be so qualified would not have a Material Adverse Effect on HCCH. HCCH has delivered to NASRA true and complete copies of HCCH's Certificate of Incorporation and Bylaws and Merger Sub's Articles of Organization and Bylaws, each as currently in effect. 19 Section 4.2 Corporate Authorization. The execution, delivery and performance by HCCH and Merger Sub of this Agreement, the Articles of Merger and the Confidentiality Agreement and the consummation by HCCH and Merger Sub of the transactions contemplated hereby and thereby are within the corporate powers of HCCH and Merger Sub and have been duly authorized by all necessary corporate action. This Agreement, the Articles of Merger and the Confidentiality Agreement constitute, or upon execution will constitute, valid and binding agreements of HCCH and Merger Sub, respectively, enforceable in each case against each in accordance with their respective terms, except as such enforcement may be limited by bankruptcy, insolvency of other similar laws affecting the enforcement of creditors' rights generally or by general principles of equity. Section 4.3 Governmental Authorization. The execution, delivery and performance by HCCH and Merger Sub of this Agreement, the Articles of Merger and the Confidentiality Agreement and the consummation of the Merger by HCCH and Merger Sub, require no action by or in respect of, or filing with, any governmental body, agency, official or authority other than: (a) the filing of the Articles of Merger in accordance with Illinois Law; (b) compliance with any applicable requirements of the HSR Act; (c) compliance with any applicable requirements of the Exchange Act and the rules and regulations promulgated thereunder; (d) compliance with any applicable requirements of the Securities Act and the rules and regulations promulgated thereunder; (e) compliance with any applicable foreign or state securities or "blue sky" laws and the rules and regulations of the NYSE; (f) compliance with any applicable requirements of the Texas, Oklahoma or other insurance regulatory agency having authority over HCCH; and (g) such other filings or registrations with, or authorizations, consents or approvals of, governmental bodies, agencies, officials or authorities, the failure of which to make or obtain (i) would not reasonably be expected to have a Material Adverse Effect on HCCH or (ii) would not materially adversely affect the ability of Holdco, any Affiliated Company, HCCH or Merger Sub to consummate the transactions contemplated hereby and operate their businesses as heretofore operated. Section 4.4 Non-Contravention. The execution, delivery and performance by HCCH and Merger Sub of this Agreement and the Articles of Merger and the consummation by HCCH and Merger Sub of the transactions contemplated hereby and thereby do not and will not: 20 (a) contravene or conflict with the Articles or Certificate of Incorporation, as the case may be, or Bylaws of HCCH or Merger Sub; (b) assuming compliance with the matters referred to in Section 4.3, contravene or conflict with or constitute a violation of any provision of any law, regulation, judgment. injunction, order or decree binding upon or applicable to HCCH or Merger Sub or any Subsidiary of HCCH; (c) conflict with or result in a breach or violation of, or constitute a default under, or result in a contractual right to cause the termination or cancellation of or loss of a material benefit under, or right to accelerate, any material agreement, contract or other instrument binding upon HCCH or Merger Sub or any other Subsidiary of HCCH or any material license, franchise, permit or other similar authorization held by HCCH or Merger Sub or any other Subsidiary of HCCH; or (d) result in the creation or imposition of any Lien on any material asset of HCCH or Merger Sub or any other Subsidiary of HCCH, except, with respect to clauses (b), (c) and (d) above, for contraventions, defaults, losses, Liens and other matters referred to in such clauses that in the aggregate would not be reasonably expected to have, individually or in the aggregate, a Material Adverse Effect on HCCH. Section 4.5 Capitalization of HCCH (a) The authorized capital stock of HCCH consists of 100,000,000 shares of HCCH Common Stock. As of September 30, 1996, there were 34,679,307 shares of HCCH Common Stock issued and outstanding. All outstanding shares of HCCH Common Stock have been duly authorized and validly issued and are fully paid and nonassessable and free from any preemptive rights. Except as set forth in this Section and as otherwise contemplated by this Agreement and except as disclosed in public filings made by HCCH with the SEC prior to the Closing Date, and except for changes since September 30, 1996 resulting from the exercise of employee and director stock options, there are outstanding (i) no shares of capital stock or other voting securities of HCCH, (ii) no securities of HCCH convertible into or exchangeable for shares of capital stock or voting securities of HCCH and (iii) no options or other rights to acquire from HCCH, and no obligation of HCCH to issue, any capital stock, voting securities or securities convertible into or exchangeable for capital stock or other voting securities of HCCH (the items in clauses (i), (ii) and (iii) being referred to collectively as the "HCCH Securities"). There are no outstanding obligations of HCCH or any of its Subsidiaries to repurchase, redeem or otherwise acquire any HCCH Securities. (b) All shares of HCCH Common Stock issued in the Merger shall, upon issuance, be fully paid, validly issued and nonassessable. HCCH has reserved sufficient shares of HCCH Common Stock for issuance pursuant to the Merger. 21 Section 4.6 Organization of Merger Sub. The authorized capital stock of Merger Sub consists of 1,000 shares of common stock, par value $1.00 per share, all of which are issued and outstanding. All the issued and outstanding capital stock of Merger Sub is owned by HCCH. Merger Sub has not conducted any business prior to the date hereof and has no assets, liabilities or obligations of any nature other than those incident to its formation and pursuant to this Agreement. Section 4.7 Subsidiaries. (a) Each HCCH Subsidiary is a corporation duly incorporated, validly existing and in good standing under the laws of its jurisdiction of incorporation, has all corporate powers and all material Governmental Authorizations required to carry on its business as now conducted, except such Governmental Authorizations the failure of which to have obtained would not have a Material Adverse Effect on HCCH, and is duly qualified to do business as a foreign corporation and is in good standing in each jurisdiction where the character of the property owned or leased by HCCH, or the nature of its activities make such qualification necessary, except for those jurisdictions where failure to be so qualified would not, individually or in the aggregate, have a Material Adverse Effect on HCCH. All Subsidiaries and Joint Ventures material to the business of HCCH ("Material HCCH Subsidiaries") and their respective jurisdictions of incorporation or organization and HCCH's ownership interest therein are identified in the HCCH Disclosure Schedule. Other than its investments in its Subsidiaries and Joint Ventures, and shares of stock in publicly held companies aggregating less than 10% of such public company's outstanding stock, HCCH does not own, directly or indirectly, any outstanding capital stock or equity interest in any corporation, partnership, Joint Venture or other entity. (b) All of the outstanding capital stock of, or other ownership interests in, each Material HCCH Subsidiary that is owned by HCCH, is owned by HCCH, directly or indirectly, free and clear of any material Lien and free of any other material limitation or restriction on its rights as owner thereof (including any restriction on the right to vote, sell or otherwise dispose of such capital stock or other ownership interests), other than those imposed by applicable law. There are no existing options, calls or commitments of any character relating to the issued or unissued capital stock or other securities or equity interests (collectively, "HCCH Subsidiary Securities") of any HCCH Subsidiary. Section 4.8 SEC Filings. (a) HCCH has since October 28, 1992 filed all forms, proxy statements, schedules, reports and other documents required to be filed by it with the SEC pursuant to the Exchange Act. (b) HCCH has delivered, and will promptly deliver in the case of any of the following filed with the SEC on or after the date hereof and prior to the Effective Date, to Holdco: 22 (i) its annual reports on Form 10-K for its fiscal years ended December 31, 1995 and 1994; (ii) its quarterly report on Form 10-Q for its fiscal quarters ending March 31, June 30, and September 30, 1996; (iii) any current reports on Form 8-K since January 1, 1996 and its proxy or information statements relating to meetings of, or actions taken without a meeting by, the shareholders of HCCH held since January 1, 1996; and (iv) all of its other reports, statements, schedules and registration statements filed with the SEC since December 31, 1995. None of HCCH's Subsidiaries is required to file any forms, reports or other documents with the SEC. (c) As of its filing date, no such report or statement filed pursuant to the Exchange Act contained any untrue statement of a material fact or omitted to state any material fact necessary in order to make the statements made therein, in the light of the circumstances under which they were made, not misleading. (d) No registration statement filed pursuant to the Securities Act, if declared effective by the SEC, as of the date such statement or amendment became effective, contained any untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary to make the statements therein not misleading. Section 4.9 Financial Statements. The audited consolidated financial statements of HCCH included in its annual reports on Form 10-K and the unaudited financial statements of HCCH included in its quarterly reports on Form 10-Q referred to in Section 4.8 present fairly, in conformity with generally accepted accounting principles applied on a consistent basis (except as may be indicated in the notes thereto), the consolidated financial position of HCCH and its consolidated subsidiaries as of the dates thereof and their consolidated results of operations and cash flows for the periods then ended (subject to normal year-end adjustments in the case of any interim financial statements). For purposes of this Agreement, "HCCH Balance Sheet" means the consolidated balance sheet of HCCH as of September 30, 1996, and the notes thereto, contained in HCCH's quarterly report on Form 10-Q filed for its fiscal quarter then ended, and "HCCH Balance Sheet Date" means September 30, 1996. Section 4.10 Absence of Certain Changes. Except as disclosed in the HCCH Disclosure Schedule, since the HCCH Balance Sheet Date, HCCH and each of its Subsidiaries have in all material respects conducted their business in the ordinary course and there has not been: (a) any Material Adverse Change with respect to HCCH or any event, occurrence or development of a state of circumstances or facts known to HCCH, which as of the date hereof could reasonably be expected to have a Material Adverse Effect on HCCH; 23 (b) any amendment of any material term of any outstanding HCCH Securities; (c) any action by HCCH or, to HCCH's knowledge, any affiliate of HCCH which would preclude the ability of HCCH to account for the business combination to be effected by the Merger as a "pooling of interests" under generally accepted accounting principles; or (d) the entering into of any agreement by HCCH or any person on behalf of HCCH to take any of the foregoing actions. Section 4.11 No Undisclosed Liabilities. There are no liabilities of HCCH or any of its Subsidiaries of any kind whatsoever that are, individually or in the aggregate, material to HCCH and its Subsidiaries, taken as a whole, other than: (a) liabilities disclosed or provided for in the HCCH Balance Sheet (including the notes thereto); (b) liabilities incurred in the ordinary course of business consistent with past practice since the HCCH Balance Sheet Date; and (c) liabilities under this Agreement or as indicated in the HCCH Disclosure Schedule. Section 4.12 Litigation. Other than actions, suits, proceedings, claims or investigations occurring in the ordinary course of business or such actions, suits, proceedings, claims or investigations involving respective amounts in controversy of less than $100,000 each, there is no action, suit, proceeding, claim or investigation pending or, to the knowledge of HCCH, overtly threatened, against HCCH or any of its Subsidiaries or any of their assets or against or involving any of its officers, directors or employees in connection with the business or affairs of HCCH, including, without limitation, any such claims for indemnification arising under any agreement to which HCCH or any of its Subsidiaries is a party, which could, individually or in the aggregate, have a Material Adverse Effect on HCCH. HCCH is not subject to or in default with respect to any writ, order, judgment, injunction or decree which could, individually or in the aggregate, have a Material Adverse Effect on HCCH. Section 4.13 Taxes. (a) HCCH and each of its Subsidiaries (i) has filed when due (taking into account extensions) with the appropriate federal, state, local, foreign and other governmental agencies, all material tax returns, estimates and reports required to be filed by it, (ii) either paid when due and payable or established adequate reserves or otherwise accrued on the HCCH Balance Sheet all material Taxes, and there are no tax deficiencies claimed in writing by any Taxing authority and received by HCCH that, in the aggregate, would result in any tax liability in excess of the amount of the reserves or accruals, and (iii) has or will establish in accordance with its normal accounting practices and procedures accruals and reserves that, in the aggregate, are adequate for the payment of all Taxes not yet due and payable and attributable to any period preceding the 24 Effective Time. The HCCH Disclosure Schedule sets forth those tax returns of HCCH (or any predecessor entities) for all periods that currently are the subject of audit by any federal, state, local or foreign taxing authority. (b) There are no material taxes, interest, penalties, assessments or deficiencies claimed in writing by any taxing authority and received by HCCH or any of its Subsidiaries to be due in respect of any tax returns filed by HCCH (or any predecessor corporations) or any of its Subsidiaries. Neither HCCH nor any predecessor corporation, nor any of their respective Subsidiaries, has executed or filed with the IRS or any other Taxing authority any agreement or other document extending, or having the effect of extending, the period of assessment or collection of any Taxes. (c) HCCH is not a party to or bound by (or will prior to the Effective Date become a party to or bound by) any Tax indemnity, Tax sharing or Tax allocation agreement or other similar arrangement which includes a party other than HCCH and its Subsidiaries. Neither HCCH nor any of its Subsidiaries has been a member of an affiliated group other than one of which HCCH was the common parent, or filed or been included in a combined, consolidated or unitary Tax return other than one filed by HCCH (or a return for a group consisting solely of its Subsidiaries and predecessors). Section 4.14 Employee Benefit Plans; ERISA. (a) Neither HCCH nor any corporation or other entity which under Section 4001(b) of ERISA is under common control with HCCH (an "HCCH ERISA Affiliate") maintains or within the past five years has maintained, contributed to, or been obligated to contribute to, any Pension Plan or any Welfare Plan which is subject to ERISA. Each Pension Plan and Welfare Plan disclosed in the HCCH Disclosure Schedule (which Plans have been heretofore delivered to Holdco) and maintained by HCCH has been maintained in all material respects in compliance with their terms and all provisions of ERISA and the Code (including rules and regulations thereunder) applicable thereto. (b) Neither HCCH nor any HCCH ERISA Affiliate maintains or has maintained or contributed to any Pension Plan that is or was subject to Section 302 or Title IV of ERISA or Section 412 of the Code. HCCH has made available to Holdco and the Affiliated Companies, for each Pension Plan which is intended to be "qualified" within the meaning of Section 401(a) of the Code, a copy of the most recent determination letter issued by the IRS to the effect that each such Plan is so qualified and that each trust created thereunder is tax exempt under Section 501 of the Code, and HCCH is unaware of any fact or circumstances that would jeopardize the qualified status of each such Pension Plan or the tax exempt status of each trust created thereunder. (c) To the knowledge of HCCH, no Pension Plan or Welfare Plan is currently subject to an audit or other investigation by the IRS, the Department of Labor, the Pension Benefit Guaranty Corporation or any other governmental agency or office nor are any such Plans subject 25 to any lawsuits or legal proceedings of any kind or to any material pending disputed claims by employees or beneficiaries covered under any such Plan or by any other parties. (d) No "prohibited transaction," as defined in Section 406 of ERISA or Section 4975 of the Code, resulting in liability to HCCH or any HCCH ERISA Affiliate has occurred with respect to any Pension Plan or Welfare Plan. HCCH has no knowledge of any breach of fiduciary responsibility under Part 4 of Title I of ERISA which has resulted in liability of HCCH, any HCCH ERISA Affiliate, any trustee, administrator or fiduciary of any Pension Plan or Welfare Plan. (e) Neither HCCH nor any HCCH ERISA Affiliate, since January 1, 1986, has maintained or contributed to, or been obligated or required to contribute to, a "Multiemployer Plan," as such term is defined in Section 4001(a)(3) of ERISA. Neither HCCH nor any HCCH ERISA Affiliate has either withdrawn, partially or completely, or instituted steps to withdraw, partially or completely, from any Multiemployer Plan nor has any event occurred which would enable a Multiemployer Plan to give notice of and demand payment of any withdrawal liability with respect to HCCH or any HCCH ERISA Affiliate. (f) With respect to HCCH and each HCCH ERISA Affiliate, the HCCH Disclosure Schedule correctly identifies each material agreement, policy, plan or other arrangement, whether written or oral, express or implied, fixed or contingent, to which HCCH is a party or by which HCCH or any property or asset of HCCH is bound, which is or relates to a pension, option, bonus, deferred compensation, retirement, stock purchase, profit-sharing, severance pay, health, welfare, incentive, vacation, sick leave, medical disability, hospitalization, life or other insurance or fringe benefit plan, policy or arrangement. Section 4.15 Material Agreements. (a) The HCCH Disclosure Schedule includes a complete and accurate list of all contracts, agreements, leases (other than HCCH Property Leases, as hereinafter defined) and instruments to which HCCH or any of its Subsidiaries is a party or by which it or its properties or assets are bound which individually involve net payments or receipts in excess of $1,000,000 per annum, inclusive of contracts that pertain to employment or severance benefits for any officer, director or employee of HCCH, whether written or oral, but exclusive of contracts entered into with customers and suppliers in the ordinary course of business or contracts, agreements, leases and instruments terminable without penalty by HCCH upon 60 days or less prior written notice to the other party or parties thereto (the "Material HCCH Agreements"). (b) Neither HCCH, any HCCH Subsidiary, nor, to the knowledge of HCCH, any other party is in default under any Material HCCH Agreement and no event has occurred which (after notice or lapse of time or both) would become a breach or default under, or would permit modification, cancellation, acceleration or termination of any Material HCCH Agreement or result in the creation of any security interest upon, or any person obtaining any right to acquire, any 26 properties, assets or rights of HCCH which, in any such case, has had or would reasonably be expected to have a Material Adverse Effect on HCCH. (c) To the knowledge of HCCH, each such Material HCCH Agreement is in full force and effect and is valid and legally binding and there are no material unresolved disputes involving or with respect to any Material HCCH Agreement. No party to a Material HCCH Agreement has advised HCCH or any of its Subsidiaries that it intends either to terminate a Material HCCH Agreement or to refuse to renew a Material HCCH Agreement upon the expiration of the term thereof. (d) Each of HCCH, Merger Sub, and each HCCH Subsidiary is not in violation of, or in default with respect to, any term of its Certificate of Incorporation or Bylaws. Section 4.16 Properties. To the knowledge of HCCH, all leases of real property to which HCCH or any of its Subsidiaries is a party or by which it or any of its Subsidiaries is bound ("HCCH Property Leases") which are material to the business of HCCH and its Subsidiaries taken as a whole are in full force and effect. To the knowledge of HCCH, there exists no default under such HCCH Property Leases, nor any event which with notice or lapse of time or both would constitute a default thereunder by HCCH or any of its Subsidiaries, which default would have a Material Adverse Effect on HCCH. All of the properties and assets which are owned by HCCH and each of its Subsidiaries are owned by each of them, respectively, free and clear of any Lien, except for Liens which do not have a Material Adverse Effect on HCCH. HCCH and each of its Subsidiaries have good and indefeasible title with respect to such owned properties and assets subject to no Liens, other than those permitted under this Section 6, to all of the properties and assets necessary for the conduct of their business other than to the extent that the failure to have such title would not have a Material Adverse Effect on HCCH. Section 4.17 Environmental Mailers. (a) To the knowledge of HCCH, no notice, notification, demand, request for information, citation, summons, complaint or order has been received, no complaint has been filed, no penalty has been assessed and no investigation or review is pending, or to HCCH's knowledge, has been threatened by any governmental entity or other party with respect to any (i) alleged violation by HCCH or any of its Subsidiaries of any Environmental Law, (ii) alleged failure by HCCH or any such Subsidiary to have any environmental permit, certificate, license, approval, registration or authorization required in connection with the conduct of its business or (iii) Regulated Activity. (b) To the knowledge of HCCH, neither HCCH nor any of its Subsidiaries has any material Environmental Liabilities and there has been no release of Hazardous Substances into the environment by HCCH or any such Subsidiary or with respect to any of their respective properties which has had, or would be reasonably expected to have, a Material Adverse Effect on HCCH. 27 Section 4.18 Labor Matters. Neither HCCH nor any of its Subsidiaries is a party to any collective bargaining agreement or other labor union contract applicable to persons employed by HCCH or any such Subsidiary, nor do the executive officers of HCCH know of any activities or proceedings of any labor union to organize any such employees. Section 4.19 Compliance with Laws. Except for violations which do not have and would not reasonably be expected to have, individually or in the aggregate, a Material Adverse Effect on HCCH, neither HCCH nor any of its Subsidiaries is in violation of, or has violated, any applicable provisions of any laws, statutes, ordinances or regulations or any term of any judgment, decree, injunction or order binding against it. Section 4.20 Trademarks, Tradenames, Etc. HCCH owns or possesses, or holds a valid right or license to use, all intellectual property, patents, trademarks, tradenames, servicemarks, copyrights and licenses, and all rights with respect to the foregoing, necessary for the conduct of its business as now conducted, without any known conflict with the rights of others. Section 4.21 Broker's Fees. Neither HCCH nor Merger Sub, nor anyone acting on the behalf or at the request thereof has any liability to any broker, finder, investment banker or agent, or has agreed to pay any brokerage fees, finder's fees or commissions, or to reimburse any expenses of any broker, finder, investment banker or agent in connection with the Merger. ARTICLE V COVENANTS OF HOLDCO, ETC. From the date hereof until the occurrence of the earlier of (i) the Effective Time or (ii) termination of this Agreement pursuant to Section 9.1 hereof, (a) Holdco and each of the Affiliated Companies agrees, except as otherwise permitted with the written consent of HCCH, which consent shall not be unreasonably withheld, (b) with respect to Sections 5.1(i), 5.1(j) and 5.8, each Shareholder agrees and (c) with respect to Sections 5.4 and 5.10, Mellon agrees that: Section 5.1 Conduct of Holdco and Affiliated Companies. Holdco and each of the Affiliated Companies shall in all material respects conduct their business in the ordinary course. Without limiting the generality of the foregoing, from the date hereof until the Effective Time, except as contemplated by this Agreement: (a) Holdco and each of the Affiliated Companies will not adopt or propose any change in its Articles of Organization or Certificate of Incorporation or Bylaws; (b) Holdco and each of the Affiliated Companies will not enter into or amend any employment agreements (oral or written) or increase the compensation payable or to become payable by it to any of its officers, directors, or consultants over the amount payable as of December 31, 1995, or increase the compensation payable to any other employees (other than 28 (i) increases in the ordinary course of business which are not in the aggregate material to the Affiliated Companies, or (ii) pursuant to plans disclosed in NASRA Disclosure Schedule), or adopt or amend any employee benefit plan or arrangement (oral or written); (c) Holdco and each of the Affiliated Companies will not issue any NASRA Securities; (d) Holdco and each of the Affiliated Companies will keep in full force and effect any existing directors' and officers' liability insurance and will not modify or reduce the coverage thereunder; (e) Other than the payment of dividends in accordance with its existing dividend policy or practice, which policy or practice is consistent with past policy or practice, Holdco and each of the Affiliated Companies will not pay any dividend or make any other distribution to holders of its capital stock nor redeem or otherwise acquire any NASRA Securities; (f) Holdco and each of the Affiliated Companies will not, directly or indirectly, dispose of or acquire any material properties or assets except in the ordinary course of business; (g) Holdco and each of the Affiliated Companies will not incur any additional indebtedness for borrowed money except pursuant to existing arrangements which have been disclosed to HCCH prior to the date hereof; (h) Holdco and each of the Affiliated Companies will not amend or change the period of exercisability or accelerate the exercisability of any outstanding options or warrants to acquire shares of capital stock, or accelerate, amend or change the vesting period of any outstanding restricted stock; (i) Holdco, each Affiliated Company and each Shareholder will not knowingly take any action, other than those which have been disclosed to and approved by HCCH that would prevent the accounting for the business combination to be effected by the Merger as a pooling-of-interests; (j) Holdco, each of the Affiliated Companies and each of the Shareholders will not, directly or indirectly, agree or commit to do any of the foregoing; and (k) No Affiliated Company will (i) change accounting methods except as necessitated by changes which such Affiliated Company is required to make in order to prepare its federal, state and local tax returns; (ii) amend or terminate any contract, agreement or license to which it is a party (except pursuant to arrangements previously disclosed in writing to HCCH or disclosed in the NASRA Disclosure Schedule) except those amended or terminated in the ordinary course of business, consistent with past practices, or involving changes which are not materially adverse in amount or effect to Holdco and the Affiliated Companies taken as a whole; (iii) lend any amount to any person or entity, other than advances for travel and expenses which 29 are incurred in the ordinary course of business consistent with past practices, and which are not material in amount to Holdco and the Affiliated Companies, taken as a whole, which travel and expenses shall be documented by receipts for the claimed amounts; (iv) enter into any guarantee or suretyship for any obligation except for the endorsements of checks and other negotiable instruments in ordinary course of business, consistent with past practice; (v) waive or release any material right or claim except in the ordinary course of business, consistent with past practice; (vi) issue or sell any shares of its capital stock of any class or any other of its securities, or issue or create any warrants, obligations, subscriptions, options, convertible securities, stock appreciation rights or other commitments to issue shares of capital stock, or take any action other than this transaction to accelerate the vesting of any outstanding option or other security (except pursuant to existing arrangements disclosed in writing to HCCH before the date of this agreement); (vii) except for the Merger, merge, consolidate or reorganize with or acquire any entity; (viii) agree to any audit assessment by any tax authority or file any federal or state income or franchise tax return unless copies of such returns have been delivered to HCCH for its review prior to such agreement or filing; and (ix) terminate the employment of any key executive employee. Section 5.2 Shareholder Approval. At the earliest practicable date, Holdco and each Affiliated Company will duly call and hold a special shareholder meeting, or duly take action by the written consent of its shareholders, whereby this Agreement, the Merger and related matters will be submitted for the consideration and approval of its shareholders (the "Shareholder Vote") which approval will be recommended by the board of directors of Holdco and each Affiliated Company, as applicable, subject to Section 5.4. The Board of Directors of Holdco shall establish the record date for the meeting of Holdco shareholders at which the Merger will be approved before Mellon distributes or otherwise transfers any shares of Holdco or of any Affiliated Company to anyone other than an Original Shareholder. Each Shareholder Vote will be effected in compliance with applicable law. Section 5.3 Access to Financial and Operational Information. Holdco and each Affiliated Company will give HCCH, its counsel, financial advisors, auditors and other authorized representatives reasonable access during normal business hours to their offices, properties, books and records, will furnish to HCCH, its counsel, financial advisors, auditors and other authorized representatives such financial and operating data as such persons may reasonably request and will instruct its employees, counsel and financial advisors to cooperate with HCCH in its investigation of the business of Holdco and each Affiliated Company and in the planning for the combination of the businesses of Holdco and each Affiliated Company and HCCH following the consummation of the Merger; provided that no investigation pursuant to this Section shall affect any representation or warranty given hereunder. In addition, following the public announcement of this Agreement or the transactions contemplated hereby, Holdco and each Affiliated Company will cooperate in arranging joint meetings among representatives of Holdco and each Affiliated Company and HCCH and persons with whom they maintain business relationships. All requests for information made pursuant to this Section shall be directed to Mellon or such person as may be designated by him in writing. All information obtained pursuant to this Section 5.3 shall be 30 governed by the Confidentiality Agreement dated as of July 9, 1996 among HCCH and the Affiliated Companies (the "Confidentiality Agreement"). Section 5.4 Other Offers. (a) Holdco, each of the Affiliated Companies and Mellon will not, and will use their best efforts to cause their respective officers, directors, employees or other agents not to, directly or indirectly, (i) take any action to solicit, initiate or discuss any Acquisition Proposal (as hereinafter defined), or (ii) subject to the fiduciary duties of the Board of Directors under applicable law as advised by counsel, engage in negotiations with, or disclose any nonpublic information relating to, Holdco or any of the Affiliated Companies or afford access to the properties, books or records of Holdco or any of the Affiliated Companies to, any person or entity that may be considering making, or has made, an Acquisition Proposal. To the extent that Holdco or the Affiliated Companies or any of their respective officers, directors, employees or other agents, or Mellon are currently involved in any discussions with respect to any Acquisition Proposal or contemplated or proposed Acquisition Proposal, Holdco and the Affiliated Companies shall terminate, and shall use their best efforts to cause their respective officers, directors, employees or other agents to terminate, such discussions immediately. The term "Acquisition Proposal" as used herein means any offer or proposal for, or any indication of interest in, a merger or other business combination involving Holdco or the Affiliated Companies or the acquisition of any equity interest in, or a substantial portion of the assets of; Holdco or any of the Affiliated Companies other than the transactions contemplated by this Agreement. (b) Subject to their fiduciary duties, the Boards of Directors of Holdco and each of the Affiliated Companies, and each Original Shareholder shall not (i) withdraw or modify, or propose to withdraw or modify, in a manner adverse to HCCH, the approval or recommendation by such Board of Directors or Original Shareholder, of this Agreement, the Merger or the other documents or transactions contemplated hereby, (ii) approve or recommend, or propose to approve or recommend, any Acquisition Proposal (other than an Acquisition Proposal made by HCCH or an affiliate of HCCH) or (iii) approve or authorize the entering into any agreement with respect to any Acquisition Proposal. Section 5.5 Maintenance of Business. Holdco and each of the Affiliated Companies will use its reasonable best efforts to carry on its business, keep available the services of its officers and employees and preserve its relationships with those of its customers, agents, suppliers, licensors and others having business relationships with it that are material to its business in substantially the same manner as it has prior to the date hereof. If Holdco or any Affiliated Company becomes aware of a material deterioration or facts which are likely to result in a material deterioration in the relationship with any customers, supplier, licensor or others having business relationships with it, it will promptly in writing bring such information to the attention of the HCCH in writing. Section 5.6 Compliance with Obligations. Holdco and each of the Affiliated Companies shall each use its reasonable best efforts to comply in all material respects with (i) all 31 applicable federal, state, local and foreign laws, rules and regulations, (ii) all material agreements and obligations, including its respective charter and bylaws, by which it, its properties or its assets may be bound, and (iii) all decrees, orders, writs, injunctions, judgments, statutes, rules and regulations applicable to Holdco and each of the Affiliated Companies and their respective properties or assets. Section 5.7 Notices of Certain Events. Holdco and each of the Affiliated Companies shall, upon obtaining knowledge of any of the following, promptly notify HCCH of: (a) any notice or other communication from any person alleging that the consent of such person is or may be required in connection with the Merger, (b) any notice or other communication from any governmental or regulatory agency or authority in connection with the Merger, and (c) any actions, suits, claims, investigations or other judicial proceedings commenced or threatened against Holdco or any of the Affiliated Companies which, if pending on the date of this Agreement, would have been required to have been disclosed pursuant hereto or which relate to the consummation of the Merger. Section 5.8 Affiliates Agreement. To facilitate the treatment of the Merger for accounting purposes as a pooling-of-interests, Holdco, each Affiliated Company and each Original Shareholder shall use its or their best efforts to deliver to HCCH simultaneously with the execution of this Agreement, a written agreement from each of its "affiliates" (as that term is used in Rule 144 or 145 under the Securities Act) (the "Affiliates Agreement") in form and substance reasonably satisfactory to HCCH, and each Shareholder shall deliver to HCCH an executed Affiliates Agreement simultaneously with the execution hereof. Section 5.9 Necessary Consents. Holdco and each of the Affiliated Companies shall use reasonable best efforts to obtain such written consent and take such other actions as may be necessary or appropriate for Holdco and each of the Affiliated Companies to facilitate and allow the consummation of the transactions provided for herein and to facilitate and allow HCCH to carry on the acquired business after the Closing Date (as defined in Section 10.1 hereof). Section 5.10 Regulatory Approval. Holdco and each of the Affiliated Companies, and, where required pursuant to the HSR Act or the rules or regulations of any regulatory agency, Mellon, will execute and file, or join in the execution and filing, with any application or other document that may be necessary in order to obtain the authorization, approval or consent of any governmental body, federal, state, local or foreign which may be reasonably required, or which HCCH may reasonably request, in connection with the consummation of the transaction provided for in this Agreement. Holdco, each of the Affiliated Companies and Mellon, will use reasonable best efforts to obtain or assist HCCH in obtaining all such authorizations, approvals and consents. 32 Section 5.11 Satisfaction of Conditions Precedent. Holdco and each Affiliated Company shall use all reasonable efforts to cause the transactions provided for in this Agreement to be consummated, and, without limiting the generality of the foregoing to obtain all consents and authorizations of third parties and to make all filings with, and give all notices to, third parties that may be necessary or reasonably required on its part in order to effect the transactions provided for herein. ARTICLE VI COVENANTS OF HCCH AND MERGER SUB From the date hereof until the occurrence of the earlier of (i) the Effective Time or (ii) the termination of this Agreement pursuant to Section 9.1 hereof, HCCH and Merger Sub agree that, except as otherwise permitted with the written consent of NASRA, which consent shall not be unreasonably withheld: Section 6.1 Conduct of HCCH. HCCH and its Subsidiaries shall in all material respects conduct their business in the ordinary course provided, however, that nothing in this Agreement shall be construed to prohibit or otherwise restrain HCCH in any manner from acquiring other businesses or substantially all of the assets thereof. Without limiting the generality of the foregoing, from the date hereof until the Effective Time, except as contemplated hereby or previously disclosed by HCCH to NASRA in writing: (a) HCCH will not adopt or propose any change in its Certificate of Incorporation or Bylaws; (b) HCCH will not take any action that would result in a failure to maintain the trading of HCCH Common Stock on the NYSE; and (c) HCCH will not, and will not permit any of its Subsidiaries to, agree or commit to do any of the foregoing. Section 6.2 Listing of HCCH Common Stock. HCCH shall cause the shares of HCCH Common Stock to be issued in the Merger to be approved for listing on the NYSE on or before the Effective Time. Section 6.3 Access to Financial and Operation Information. HCCH will give NASRA, its counsel, financial advisors, auditors and other authorized representatives reasonable access during normal business hours to the offices, properties, books and records of HCCH and its Subsidiaries, will furnish to NASRA, its counsel, financial advisors, auditors and other authorized representatives such financial and operating data such as persons may reasonably request and will instruct HCCH's employees, counsel and financial advisors to cooperate with NASRA in its investigation of the business of HCCH and its Subsidiaries and in the planning for 33 the combination of the businesses of Holdco, the Affiliated Companies and HCCH following the consummation of the Merger and will furnish promptly to NASRA copies of all reports, schedules, registration statements, correspondence and other documents filed with or delivered to the SEC, provided that no investigation pursuant to this Section shall affect any representation or warranty given by HCCH to Holdco or the Affiliated Companies or the Shareholders hereunder. In addition, if requested by NASRA following the public announcement of this Agreement, HCCH will cooperate in arranging joint meetings among representatives of HCCH and NASRA and persons with whom HCCH maintains business relationships. All requests for a information made pursuant to this Section shall be directed to the Chief Financial Officer of HCCH or such person as may be designated by him in writing. All information obtained pursuant to this Section 6.3 shall be governed by the Confidentiality Agreement. Section 6.4 Maintenance of Business. HCCH will use its reasonable best efforts to carry on its business, keep available the services of its officers and employees and preserve its relationships with those of its customers, suppliers, licensors and others having business relationships with it that are material to its business in substantially the same manner as it has prior to the date hereof. If HCCH becomes aware of a material deterioration or facts which are likely to result in a material deterioration in the relationship with any material customer, supplier, licensor or others having business relationships with it, it will promptly bring such information to the attention of NASRA in writing. Section 6.5 Compliance with Obligations. HCCH and its Subsidiaries shall each use its reasonable best efforts to comply in all material respects with (i) all applicable federal, state, local and foreign laws, rules and regulations, (ii) all material agreements and obligations, including its respective charter and bylaws, by which it, its properties or its assets may be bound, and (iii) all decrees, orders, writs, injunctions, judgments, statutes, rules and regulations applicable to HCCH and its Subsidiaries and their respective properties or assets; except to the extent that the failure to comply with matters in clauses (i), (ii) and (iii) would not have a Material Adverse Effect on HCCH. Section 6.6 Notices of Certain Events. HCCH shall, upon obtaining knowledge of any of the following, promptly notify NASRA of: (a) any notice or other communication from any person alleging that the consent of such person is or may be required in connection with the Merger; (b) any notice or other communication from any governmental or regulatory agency or authority in connection with the Merger; and (c) any actions, suits, claims, investigations or other judicial proceedings commenced or threatened against HCCH or any of its Subsidiaries which, if pending on the date of this Agreement, would have been required to have been disclosed pursuant to Section 4.12 or which relate to the consummation of the Merger. 34 Section 6.7 Obligations of Merger Sub. HCCH will take all action necessary to cause Merger Sub to perform its obligations under this Agreement and to consummate the Merger on the terms and conditions set forth in this Agreement. Merger Sub will not issue any shares of its capital stock, any securities convertible into or exchangeable for its capital stock, or any option, warrant or other right to acquire its capital stock to any person or entity other than HCCH or a wholly owned Subsidiary of HCCH. Merger Sub shall not incur any indebtedness or liabilities of any kind except pursuant to this Agreement. Section 6.8 Notice to Affiliates. HCCH shall, at least 30 days prior to the Effective Date, cause to be delivered to each person HCCH believes to be an "affiliate," as that term is used in paragraphs (c) and (d) of Rule 145 under the Securities Act, of HCCH a notice informing such persons of restrictions on transfer resulting from the Merger being accounted for as a pooling-of-interests in accordance with generally accepted principles and all published rules, regulations and policies of the SEC. Section 6.9 Employee Matters. HCCH agrees that all employees of Holdco or any Affiliated Company that remain employed after the Effective Time shall, immediately following the Effective Time, be entitled to receive the same benefits to which other employees of HCCH are entitled to receive and shall be entitled to participate in HCCH's Employee Benefit Plan provided such employees have satisfied the plan's eligibility requirements. In addition, employees of Holdco or any Affiliated Company who shall remain employees of HCCH after the Effective Time (i) shall be credited (for purposes of both participation and investing) through their periods of service with Holdco or any Affiliated Company prior to the Effective Time, and (ii) shall be entitled to receive vacation leave accrued with Holdco or any Affiliated Company prior to the Effective Time. Section 6.10 Officers and Directors Insurance. Commencing upon the Effective Date, to the extent HCCH provides, in its sole discretion, liability insurance coverage to officers, directors and employees of HCCH, HCCH shall provide those persons who are officers, directors and employees of Holdco and each Affiliated Company and who become officers, directors or employees of HCCH with liability insurance coverage identical to that which it provides to other officers, directors and employees of HCCH. ARTICLE VII COVENANTS OF HCCH, HOLDCO AND AFFILIATED COMPANIES From the date hereof until the occurrence of the earlier of (i) the Effective Time or (ii) termination of this Agreement pursuant to Section 9.1 hereof, each of Holdco, the Affiliated Companies and HCCH agree that: Section 7.1 Advice of Changes. It will promptly advise the others in writing (i) of any event known to any of its executive officers or the Shareholders occurring subsequent to the date 35 of this Agreement that in its reasonable judgment renders any representation or warranty of such party contained in this Agreement, if made on or as of the date of such event or the Effective Date, untrue, inaccurate or misleading in any material respect and (ii) of any Material Adverse Change in the business condition of the party. Section 7.2 Regulatory Approvals. It shall execute and file, or join in the execution and filing of, any application or other document that may be necessary in order to obtain the authorization, approval or consent of any governmental body, federal, state, local or foreign, which may be requested in connection with the consummation of the Merger. Each party shall use its reasonable best efforts to obtain all such authorizations, approvals and consents. Section 7.3 Actions Contrary to Stated Intent. It shall not, from or after the date hereof and either before or after the Effective Time, take any action that would prevent the Merger from qualifying as a reorganization under Section 368(a) of the Code or prevent the business combination to be effected by the Merger from being accounted for as a pooling-of-interests under generally accepted accounting principles. Each of HCCH, Holdco and the Affiliated Companies shall use its reasonable best efforts to cause its affiliates not to take any action that would preclude the ability of HCCH to account for the business combination to be effected by the Merger as a pooling-of-interests. Section 7.4 Certain Filings. Holdco, each Affiliated Company and HCCH shall cooperate with one another: (a) in connection with the preparation of any filing required by the HSR Act; (b) in determining whether any action by or in respect of, or filing with, any governmental body, agency or official, or authority is required, or any actions, consents, approvals or waivers are required to be obtained from parties to any material contracts, in connection with the consummation of the transactions contemplated by this Agreement; and (c) in seeking any such actions, consents, approvals or waivers or making any such filings, furnishing information required in connection therewith and seeking timely to obtain any such actions, consents, approvals or waivers. Section 7.5 Communications. Neither Holdco, any Affiliated Company nor HCCH will furnish any communication outside of their respective companies, if the subject matter thereof relates to the transactions contemplated by this Agreement and is not in the ordinary course of business, without the prior approval of the other of them as to the content thereof, which approval shall not be unreasonably withheld; provided that the foregoing shall not be deemed to prohibit any disclosure required by any applicable law or rule of the NYSE. Section 7.6 Satisfaction of Conditions Precedent. HCCH, Holdco and each Affiliated Company will each use its reasonable best efforts to satisfy or cause to be satisfied all the 36 conditions precedent that are applicable to each of them, and to cause the transactions contemplated by this Agreement to be consummated, and, without limiting the generality of the foregoing, to obtain all material consents and authorizations of third parties and to make filings with, and give all notices to, third parties that may be necessary or reasonably required on its part in order to effect the transactions contemplated hereby. Section 7.7 Tax Cooperation. HCCH, Holdco and the Affiliated Companies shall cooperate in the preparation, execution and filing of all returns, questionnaires, applications or other documents regarding any transfer or gains, sales, use, transfer, value added, stock transfer and stamp taxes, any transfer, recording, registration and other fees, and any similar taxes or fees which become payable in connection with the transactions contemplated by this Agreement that are required or permitted to be filed on or before the Effective Time. ARTICLE VIII CONDITIONS TO THE MERGER Section 8.1 Conditions to Obligations of HCCH and Merger Sub. The obligations of HCCH and Merger Sub hereunder are subject to the fulfillment or satisfaction, on and as of the Effective Date, of each of the following conditions (any one or more of which may be waived by HCCH, but only in a writing signed by HCCH): (a) The representations and warranties of Holdco, each of the Affiliated Companies, and each Shareholder contained in Article III shall be true and accurate in all material respects on and as of the Effective Date with the same force and effect as if they had been made on the Effective Date (except to the extent a representation or warranty speaks specifically as of an earlier date and except for changes contemplated by this Agreement) and Holdco, each Affiliated Company and each Shareholder shall have provided HCCH with a certificate executed by the President and the Chief Financial Officer of the corporation or individually, as the case may be, dated as of the Effective Date, to such effect. (b) Holdco, each Affiliated Company, and each Shareholder shall have performed and complied in all material respects with all of the covenants contained herein on or before the Effective Date, and HCCH shall receive a certificate to such effect signed by the President and Chief Financial Officer of the corporation or individually, as the case may be. (c) Except as set forth in the NASRA Disclosure Schedule, there shall have been no Material Adverse Change in Holdco or any of the Affiliated Companies since June 30, 1996. (d) HCCH shall have received from (i) each person or entity who may be deemed pursuant to Section 5.8 to be an affiliate of Holdco or any Affiliated Company a duly executed Affiliates Agreement and (ii) each Shareholder the written agreement contemplated to be entered 37 into by such person pursuant to Section 5.8 and such agreements shall remain in full force and effect. (e) All written consents, assignments, waivers or authorizations, other than Governmental Authorizations, that are required as a result of the Merger for the continuation in full force and effect of any material contracts or leases of Holdco and each Affiliated Company shall have been obtained. (f) HCCH shall have received a written opinion from its counsel to the effect that the Merger will constitute a reorganization within the meaning of Section 368 of the Code. In preparing such opinion, counsel may rely on (and to the extent reasonably required, the parties and their shareholders shall make) reasonable representations related thereto. (g) HCCH shall have received the opinion of the general counsel to NASRA in form and substance satisfactory to HCCH. (h) All underwriting agreements of NASRA in force on the date hereof shall be in force on the Effective Date, except for such agreements which have been replaced with agreements of similar like and kind. (i) Mellon shall be alive and not, in any way, Disabled. For purposes of this Agreement, Mellon shall be deemed to be "Disabled" if he is unable to engage in any substantial portion of his regular duties for Holdco and each Affiliated Company by reason of any medically determinable physical or mental impairment which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months. (j) Holdco and each Affiliated Company shall have received the unqualified opinion of Jordan Patke & Associates, independent public accountants to Holdco and the Affiliated Companies on their audited financial statements for each of the most recent fiscal year end. (k) HCCH, Holdco and the Affiliated Companies shall have received a report addressed to each of them from Jordan Patke & Associates confirming that Holdco and the Affiliated Companies qualify as an entity that may be party to a business combination for which the pooling-of-interest method of accounting would be available and that the transactions contemplated hereby will qualify for pooling-of-interests treatment under generally accepted accounting principles. (l) Holdco and each Affiliated Company shall have delivered to HCCH its audited or unaudited, as the case may be balance sheet and its audited or unaudited, as the case may be income statement for each of the most recent fiscal year end. (m) Holdco, on an adjusted pro-forma combined basis with the Affiliated Companies and giving effect to this transaction, shall have earned no less than $1.63 million after taxes for the fiscal year ended March 31, 1996. 38 (n) HCCH shall have received a written report from Coopers & Lybrand L.L.P. in form reasonably satisfactory to HCCH (and generally in accordance with Statement of Auditing Standards No. 50), to the effect that the business combination to be effected by the Merger would be properly accounted for as a pooling-of-interests in accordance with generally accepted accounting principles and all published rules, regulations, and policies of the SEC. Section 8.2 Conditions to Obligations of Holdco, Affiliated Companies and Shareholders. Holdco's, each Affiliated Company's and each Shareholder's obligations hereunder are subject to the fulfillment or satisfaction, on and as of the Effective Date, of each of the following conditions (any one or more of which may be waived, but only in a writing signed by such party): (a) The representations and warranties of HCCH set forth herein shall be true and accurate in all material respects on and as of the Effective Date with the same force and effect as if they had been made on the Effective Date (except to the extent a representation or warranty speaks specifically as of an earlier date and except for changes contemplated by this Agreement) and HCCH shall have provided Holdco with a certificate executed by the President and the Chief Financial Officer of HCCH, dated as of the Effective Date, to such effect. For the purposes of determining the accuracy of the representations and warranties of HCCH, any change or effect in the business of HCCH that results in substantial part as a consequence of the public announcement or pendency of the intended acquisition of Holdco and the Affiliated Companies by HCCH shall not be deemed a Material Adverse Change or Material Adverse Effect or other breach of representation or warranty with respect to HCCH. (b) HCCH shall have performed and complied with all of its covenants contained herein in all material respects on or before the Effective Date, and Holdco shall receive a certificate to such effect signed by HCCH's President and Chief Financial Officer. (c) Except as set forth in the HCCH Disclosure Schedule, there shall have been no Material Adverse Change in HCCH since the HCCH Balance Sheet Date. (d) Holdco shall have received a written opinion in form and substance satisfactory to it from Winstead Sechrest & Minick P.C. to the effect that the Merger will be treated for federal income tax purposes as a tax-free reorganization within the meaning of Section 368 of the Code. In preparing such opinion, counsel may rely on (and to the extent reasonably required, Holdco, the Affiliated Companies and the Shareholders shall make) reasonable representations as to facts related thereto. (e) Holdco shall have received from Winstead Sechrest & Minick P.C., counsel to HCCH, an opinion in form and substance satisfactory to the Shareholders. (f) Mellon shall have been appointed Chairman of the Board, Chief Executive Officer and President of Holdco. 39 (g) The shares of HCCH Common Stock to be issued in the Merger shall have been approved for listing on the NYSE. Section 8.3 Conditions to Obligations of Each Party. The respective obligations of the parties hereunder are subject to the fulfillment, on and as of the Effective Date, of each of the following conditions (any one or more of which may be waived by such parties, but only in a writing signed by such parties): (a) Each of Holdco and each Affiliated Company's shareholders shall have duly a approved this Agreement, the Articles of Merger and the Merger, all in accordance with applicable laws and regulatory requirements. (b) No statute, rule, regulation, executive order, decree, injunction or restraining order shall have been enacted, promulgated or enforced (and not repealed, superseded or otherwise made inapplicable) by any court or governmental authority which prohibits the consummation of the Merger (each party agreeing to use its reasonable best efforts to have any such order, decree or injunction lifted). (c) There shall have been obtained any and all Governmental Authorizations, permits, approvals and consents of securities or "blue sky" commissions of any jurisdiction and of any other governmental body or agency, that may reasonably be deemed necessary so that the consummation of the Merger will be in compliance with applicable laws, the failure to comply with which would have a Material Adverse Effect on HCCH, Holdco, any Affiliated Company or the Surviving Corporation, or would be reasonably likely to subject any of HCCH, Merger Sub, Holdco, any Affiliated Company or any of their respective directors or officers to penalties or criminal liability. (d) The waiting period (and any extension thereof) applicable to the consummation of the Merger under the HSR Act, if applicable, shall have expired or been terminated. ARTICLE IX TERMINATION OF AGREEMENT Section 9.1 Termination. This Agreement may be terminated at any time prior to the Effective Time whether before or after the approval by the shareholders of Holdco and the Affiliated Companies: (a) By the mutual consent of the Boards of Directors of HCCH and Holdco. (b) By the Board of Directors of either HCCH or Holdco if there has been a material breach by the other of any representation or warranty contained in this Agreement, which in either case cannot be, or has not been, cured within 15 days after written notice of such breach 40 is given to the party committing such breach, provided that the right to effect such cure shall not extend beyond the date set forth in subparagraph (c) below. (c) By the Board of Directors of either HCCH or Holdco if (i) all conditions of Closing required by Article VIII hereof have not been met or waived by January 31, 1997, or (ii) the Merger has not occurred by such date; provided, however, that neither HCCH nor Holdco, shall be entitled to terminate this Agreement pursuant to this subparagraph (c) if such party is in willful and material violation of any of its representations, warranties or covenants in this Agreement. (d) If any governmental authority shall have issued an order, decree or ruling or taken any other action permanently enjoining, restraining or otherwise prohibiting the Merger and such order, decree, ruling or other action shall have become final and nonappealable. (e) By the Board of Directors of HCCH, if Mellon shall have become Disabled or shall have died. Section 9.2 Effect of Termination. Upon termination of this Agreement pursuant to this Article IX, this Agreement shall be void and of no effect and shall result in no obligation of or liability to any party or their respective directors, officers, employees, agents or shareholders, other than the obligations pursuant to the Confidentiality Agreement, unless such termination was the result of an intentional breach of any representation, warranty or covenant in this Agreement, in which case the party who breached the representation, warranty or covenant shall be liable to the other party for damages, and all costs and expenses incurred in connection with the preparation, negotiation, execution and performance of this Agreement. ARTICLE X CLOSING MATTERS Section 10.1 The Closing. Subject to termination of this Agreement as provided in Article IX above, the closing of the transactions provided for herein (the "Closing") will take place at the offices of Winstead Sechrest & Minick P.C., 910 Travis Street, Suite 1700, Houston, Texas 77002 at 10:00 a.m., Houston Time on November 27, 1996, or, if all conditions to Closing have not been satisfied or waived by such date, such other place, time and date as Holdco and HCCH may mutually select (the "Closing Date"). Prior to or concurrently with the Closing, the Agreement of Merger and such officers' certificates or other documents as may be required to effect the Merger will be filed in the office of the Secretary of the State of Illinois. Accordingly, the Merger will become effective at the Effective Time. 41 Section 10.2 Conversion of Certificates. (a) As of the Effective Time, all shares of Holdco or any Affiliated Company Common Stock that are outstanding immediately prior thereto will, by virtue of the Merger and without further action, cease to exist, and all such shares of Holdco will be converted into the right to receive from HCCH the number of shares of HCCH Common Stock determined as set forth in Section 1.3 hereof. (b) At and after the Effective Time, each certificate representing outstanding shares of Holdco Common Stock will represent the number of shares of HCCH Common Stock into which such shares of Holdco Common Stock will be deemed registered in the name of the holder of such certificate. At the Effective Time, the holder of shares of Holdco Common Stock will surrender the certificates for such shares (the "Holdco Certificates") to HCCH for cancellation. Promptly following the Effective Time and receipt of the Holdco Certificates, HCCH will cause its transfer agent to issue to such surrendering holder certificates for the number of shares of HCCH Common Stock to which such holder is entitled pursuant to the terms hereof. (c) All shares of HCCH Common Stock delivered upon the surrender of Holdco Certificates in accordance with the terms hereof will be delivered to the registered holder. After the Effective Time, there will be no further registration of transfers of the shares of Holdco Common Stock on the stock transfer books of Holdco. If, after the Effective Time, Holdco Certificates are presented for transfer or for any other reason, they will be canceled and exchanged and certificates therefor will be delivered as provided in this Section 10.2. (d) Until Holdco Certificates representing Holdco Common Stock outstanding prior to the Merger are surrendered pursuant to this Section 10.2, such certificates will be deemed, for all purposes, to evidence ownership of the number of whole shares of HCCH Common Stock into which the shares of Holdco Common Stock will have been converted pursuant to Section 1.3. ARTICLE XI INDEMNIFICATION AND REMEDIES, CONTINUING COVENANTS Section 11.1 Agreement to Indemnify. Subject to the limitations set forth in this Article XI and except as set forth in Section 11.2, each Shareholder, severally and Pro Rata (as hereinafter defined), will indemnify and hold harmless HCCH and its respective officers, directors, agents and employees, and each person, if any, who controls or may control HCCH within the meaning of the Securities Act (hereinafter in this Section 11.1 and in Section 11.2 below referred to individually as an "Indemnified Person" and collectively as "Indemnified Persons") from and against any and all claims, demands, actions, causes of action, losses, costs, damages, liabilities and expenses including, without limitation, reasonable legal fees, net of any recoveries under insurance policies recovered from third parties and tax savings known to 42 Indemnified Persons at the time of making of claims hereunder (hereafter in this Section 11.1 referred to as "HCCH Damages"), arising out of any misrepresentation or breach of or default under any of the representations, warranties, covenants or agreements given or made in this Agreement or any certificate or exhibit delivered by or on behalf of Holdco, any of the Affiliated Companies, or any of the Shareholders pursuant hereto. "Pro Rata" for purposes of Sections 11.1 and 11.2 with respect to each Shareholder shall mean the proportion that such Shareholder's holdings of Holdco Common Stock as of immediately prior to the Effective Time bears to the total shares of Holdco Common Stock held by all Shareholders as of immediately prior to the Effective Time. The indemnification provided for in this Section 11.1 will not apply unless and until the aggregate HCCH Damages for which one or more Indemnified Persons seeks indemnification exceeds $100,000 in the aggregate, in which event the indemnification provided for will include all HCCH Damages (a franchise deductible) up to the Maximum Shareholder Liability (as hereinafter defined). In seeking indemnification for HCCH Damages under this Section 11.1 following the Closing, the Indemnified Persons' remedy will be limited to receiving up to that number of shares of HCCH Common Stock determined by dividing (a) the amount of the HCCH Damages by (b) the closing sale price of HCCH's Common Stock on the New York Stock Exchange on the Effective Date (the "Closing Date Price"). Provided, however, that irrespective as to the number of claims asserted by Indemnified Persons hereunder and the amount of the HCCH Damages for which indemnification is sought, any such Shareholder, in the aggregate, shall under no circumstances be required to make indemnification payments hereunder beyond the Closing Date Price multiplied by the number of shares of HCCH Common Stock received by such Shareholder at the time of the Merger (the "Maximum Shareholder Liability"). Notwithstanding anything to the contrary set forth herein, in the event that at the time of the resolution of any such indemnification claim, such Shareholder does not hold the number of shares of HCCH Common Stock (including any shares otherwise acquired at any time before or after the Effective Time or at any time after any claim is made for indemnification) necessary to settle any indemnification claim, then such Shareholder shall pay in cash or other immediately available funds the cash equivalent of the remainder of his in-stock indemnification obligations under this Section 11.1 up to his Maximum Shareholder Liability. In lieu of HCCH Common Stock, any Shareholder shall have the option to pay in cash or other immediately available funds the cash equivalent of all or any part of his in-stock Maximum Shareholder Liability. Section 11.2 Indemnification with Respect to Jamaica Lawsuit and Taxes. In addition to the indemnification provided in Section 11.1 above, each Shareholder, severally and Pro Rata hereby specifically agrees individually to indemnify and hold harmless the Indemnified Persons from and against all HCCH Damages, whenever incurred, arising out of (a) that certain lawsuit styled Jamaica Citizens Bank Ltd. v. North American Special Risk Associates. Inc. and George A. Mellon, Case #96C-4203 in the United States District Court, Northern District of Illinois, Eastern Division (the "Jamaica Lawsuit") and (b) any Taxes arising out of or relating to the business of Holdco or the Affiliated Companies. In seeking indemnification for HCCH Damages under this Section following the Closing, the Indemnified Persons shall be entitled to exercise their remedies with respect to the Escrow Shares and any other assets deposited in escrow pursuant to the Escrow Agreement, but the indemnification provided for hereby shall not be limited to the Escrow Shares. 43 Section 11.3 HCCH Agreement to Indemnify. Subject to the limitations set forth in this Article XI, HCCH will indemnify and hold harmless NASRA, each Affiliated Company, and the NASRA Shareholders and their officers, shareholders, directors, administrators. successors and assigns (hereinafter in this Section 11.3 referred to individually as an "Indemnified Person" and collectively as "Indemnified Persons") from and against any and all claims, demands, actions, causes of action, losses, costs, damages, liabilities and expenses including, without limitation, reasonable legal fees, net of any recoveries under insurance policies, recoveries from third parties and tax savings known to Indemnified Persons at the time of making a claim hereunder (hereafter in this Section 11.3 referred to as "NASRA Damages") arising out of any misrepresentation or breach of or default under any of the representations, warranties, covenants and agreements given or made by HCCH or Merger Sub in this Agreement or any certificate or exhibit delivered by or on behalf of HCCH or Merger Sub pursuant hereto. In seeking indemnification for NASRA Damages under this Section 11.3 following the Closing, the Indemnified Person's remedy will be limited to receiving up to that number of shares of HCCH Common Stock determined by dividing (a) the amount of the NASRA Damages by (b) the Closing Date Price. Provided, however, that irrespective of the number of claims asserted by Indemnified Persons hereunder in the amount of the NASRA Damages for which indemnification is sought, HCCH, in the aggregate, shall under no circumstances be obligated to make an indemnification payment hereunder beyond that number of shares of HCCH Common Stock equal to the total number of shares of HCCH Common Stock provided to the NASRA Shareholders on the Effective Date (the "Maximum HCCH Liability"). The indemnification provided for in this Section 11.3 will not apply unless and until the aggregate NASRA Damages for which one or more Indemnified Person seeks indemnification exceeds $100,000 in the aggregate, in which event the indemnification provided for will include all NASRA Damages (a franchise deductible) up to the Maximum HCCH Liability. Section 11.4 Appointment of Representative. Subject to the successorship provisions of this Section 11.4, Mellon (the "Representative") is hereby irrevocably appointed as the attorney-in-fact and representative of the interests of the Shareholders for all purposes of this Agreement, and notice is hereby given thereof to HCCH and Merger Sub, and, without independent verification, HCCH and Merger Sub may rely upon Representative's undertakings in such capacity. The Representative shall have full and irrevocable authority on behalf of the Shareholders, and shall promptly and completely exercise such authority in a timely fashion to: (a) participate in, represent and bind the Shareholders in all respects with respect to any arbitration or legal proceeding relating to this Agreement, including, without limitation, the defense and settlement of any matter, and the calculation thereof for every purpose thereunder, consent to jurisdiction, enter into any settlement, and consent to entry of judgment, each with respect to any or all of the Shareholders; (b) receive, accept and give notices and other communications relating to this Agreement; 44 (c) take any action that the Representative deems necessary or desirable in order to fully effectuate the transactions contemplated by this Agreement; (d) execute and deliver any instrument or document that the Representative deems necessary or desirable in the exercise of his authority under this Section 11.4; and (e) waive the fulfillment of any condition or conditions to the Closing. Those Shareholders who, as of the Effective Date, hold a majority of the Holdco Common Stock may, at any time and by written action delivered to HCCH, remove the Representative or any successor thereto, but such removal shall be effective only upon the replacement of such Representative or successor by a new Representative designated, by written notice delivered to HCCH, by those Shareholders who, as of the date hereof hold a majority of Holdco Common Stock, provided, however, that any such notice shall be effective upon actual receipt by HCCH. Any such written notice shall be delivered to HCCH in accordance with the notice provisions set forth in Section 12.3 hereof. If any Representative shall have died, become incapacitated or unable to serve, those Shareholders who, as of the date hereof, hold a majority of Holdco Common Stock shall promptly designate by written notice delivered to HCCH, a replacement Representative. Any costs and expenses incurred by the Representative in connection with actions taken pursuant to or permitted by this Section 11.4 will be borne by the Shareholders and paid or reimbursed to the Representative Pro Rata. The foregoing authorization is granted and conferred in consideration for the various agreements and covenants of HCCH and Merger Sub contained herein. In consideration of the foregoing, and subject to the successorship provisions of this Section 11.4, this authorization granted to the Representative shall be irrevocable and shall not be terminated by any act of any of the Shareholders or by operation of law, whether by death or incompetence of any Shareholder or by the occurrence of any other event except the termination of this Agreement pursuant to Section 9.1 hereof. If after the execution hereof any such Shareholder shall die or become incompetent, the Representative is nevertheless authorized and directed to exercise the authority granted in this Section 11.4 as if such death or incompetence had not occurred and regardless of notice thereof. The Representative shall have no liability to any Shareholder for any act or omission or obligation hereunder, provided that such action or omission is taken by the Representative in good faith and without willful misconduct. Section 11.5 Survival of Representations. Unless any representation, warranty, covenant or agreement is required to terminate at an earlier time in order to maintain the appropriate pooling-of-interest accounting treatment, all representations, warranties, covenants and agreements concerned in this Agreement will remain operative and in full force and effect for a period of one year after the Closing (the last date of such applicable period of not more than one year being herein called the "Final Date"), regardless of any investigation made by or on behalf of the parties to this Agreement, upon which Final Date such representations, warranties, covenants and agreements shall expire and be of no further force and effect, except that the covenants set forth in the Confidentiality Agreement shall survive termination of this Agreement in accordance with 45 the terms of such Confidentiality Agreement. The indemnification referred to and set forth in Section 11.2 shall survive until a final resolution of such claim is effective. Any litigation or other action of any kind arising out of or attributable to a breach of any representation, warranty, covenant or agreement contained in this Agreement, except as set forth in Section 11.2, must be commenced prior to the Final Date. If not so commenced prior to the Final Date, any claims or indemnifications brought under this Article XI will thereafter conclusively deemed to be waived regardless of when such claim is or should have been discovered. Any such claim for indemnification brought under this Article XI, brought before the Final Date, should survive until a final resolution of such claim is effective. As set forth herein, no investigation by any party hereto into the business, operations and conditions of the other party shall diminish in any way the effect of any representation or warranty made by any such party in this Agreement or shall relieve any party of any of its obligations under this Agreement. Section 11.6 Procedure for Indemnification; Third Party Claims. (a) Promptly after receipt by an indemnified party under this Article XI of notice of a claim against it for indemnification brought under this Article XI (a "Claim"), the indemnified party will, if a claim is to be made against an indemnifying party, give prompt written notice to the indemnified party of the Plan, but the failure to promptly notify the indemnified party will not relieve the indemnified party of any liability that it may have to any indemnified party, except to the extent that the indemnifying party demonstrates that the defense of such action is prejudice by the indemnifying party's failure to give such prompt notice. Such notice shall contain a description in reasonable detail of facts upon which such Claim is based and, to the extent known, the amount thereof. (b) If any Claim referred to in this Article XI is made by a third party against an indemnified party and each gives written notice to the indemnifying party of the Claim, the indemnifying party will be entitled to participate in the defense of Claim and, to the extent that it wishes to assume the defense of the Claim and, after written notice from the indemnifying party to the indemnified party of its election to assume the defense of the Claim, the indemnifying party shall assume such defense and will not be liable to the indemnified party under this Article XI for any fees of other counsel or any other expenses with respect to the defense of the Claim in each case subsequently incurred by the indemnified party in connection with the defense of the Claim. ARTICLE XII MISCELLANEOUS Section 12.1 Further Assurances. Each party agrees to cooperate fully with the other parties and to execute such further instruments, documents and agreements and to give such further written assurances as may be reasonably requested by any other party to better 46 evidence and reflect the transactions described herein and contemplated hereby and to carry into effect the intents and purposes of this Agreement. Section 12.2 Fees and Expenses. Until otherwise agreed by the parties, each party shall bear its own fees and expenses, including counsel fees and fees of brokers and investment bankers contracted by such party, in connection with the transaction contemplated hereby. Section 12.3 Notices. Whenever any party hereto desires or is required to give any notice, demand, or request with respect to this Agreement, each such communication shall be in writing and shall be effective only if it is delivered by personal service or mailed, United States registered or certified mail, postage prepaid, or sent by prepaid overnight courier or confirmed telecopier, addressed as follows: HCCH and Merger Sub: HCC Insurance Holdings, Inc. 13403 Northwest Freeway Houston, Texas 77040-6094 Telecopy: (713) 462-2401 Attention: Stephen L. Way With copy to: Winstead Sechrest & Minick P.C. 910 Travis, Suite 1700 Houston, Texas 77002 Telecopy: (713) 951-3800 Attention: Arthur S. Berner, Esq. Holdco, each Affiliated Company and all Shareholders: North American Special Risk Associates, Inc. 3400 Dundee Road, Suite 300 Northbrook, Illinois 60062-5115 Telecopy: (847) 559-9558 Attention: George A. Mellon With copies to: Handler & Associates Ltd. 333 W. Wacker Dr., Suite 2020 Chicago, Illinois 60606-1226 Telecopy: (312) 641-6866 Attention: Thomas J. Handler 47 Such communications shall be effective when they are received by the addressee thereof Any party may change its address for such communications by giving notice thereof to other parties in conformity with this Section. In the event Mellon is no longer the Representative, such successor Representative's address shall be the address for the Shareholders. Section 12.4 Governing Law. The internal laws of the State of Texas (irrespective of its choice of law principles) will govern the validity of this Agreement, the construction of its terms, and the interpretation and enforcement of the rights and duties of the parties hereto. Any dispute arising hereunder shall lie exclusively in the state courts of the State of Texas. Section 12.5 Binding upon Successors and Assigns, Assignment. This Agreement and the provisions hereof shall be binding upon each of the parties, their permitted successors and assigns. This Agreement may not be assigned by any party without the prior consent of the others, provided however, that HCCH shall be permitted at any time prior to the Effective Time to cause the assignment of Merger Sub's rights and obligations under this Agreement to another wholly owned Subsidiary of HCCH (without in any way relieving HCCH of its obligations under this Agreement with respect to Merger Sub or the Merger). Section 12.6 Severability. If any provision of this Agreement, or the application thereof, shall for any reason or to any extent be invalid or unenforceable, the remainder of this Agreement and application of such provision to other persons or circumstances shall continue in full force and effect and in no way be affected, impaired or invalidated. Section 12.7 Entire Agreement. This Agreement, together with the Confidentiality Agreement, and the other agreements and instruments referenced herein constitute the entire understanding and agreement of the parties with respect to the subject matter hereof and supersede all prior and contemporaneous agreements or understandings, inducements or conditions, express or implied, written or oral, between parties with respect hereto. Section 12.8 Amendment and Waivers. Any amendment or waiver affecting the Shareholders shall be valid if consented to in writing by Shareholders holding a majority of the shares of Holdco Common Stock (i) if given or made prior to the Effective Time, such majority as determined as of the date of such amendment or waiver, and (ii) if given or made at or after the Effective Time, such majority as determined immediately prior to the Effective Time. Any term or provision of this Agreement may be amended, and the observance of any term of this Agreement may be waived (either generally or in a particular instance and either retroactively or prospectively) only by a writing signed by those persons as provided in this Section 12.8. The waiver by a party of any breach hereof or default in the performance hereof shall not be deemed to constitute a waiver of any other default or any succeeding breach or default, unless such waiver so expressly states. At any time before the Effective Time, this Agreement may be amended or supplemented by Holdco, the Affiliated Companies, the Shareholders or HCCH with respect to any of the terms contained in this Agreement. 48 Section 12.9 No Waiver. The failure of any party to enforce any of the provisions hereof shall not be construed to be a waiver of the right of such party thereafter to enforce such provisions. Section 12.10 Construction of Agreement. A reference to an Article, Section or an Exhibit shall mean an Article of, a Section in, or Exhibit to, this Agreement unless otherwise explicitly set forth. The titles and headings herein are for reference purposes only and shall not in any manner limit the construction of this Agreement which shall be considered as a whole. The words "include," "includes" and "including" when used herein shall be deemed in each case to be followed by the words "without limitation." Section 12.11 Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be an original as against any party whose signature appears thereon and all of which together shall constitute one and the same instrument. This Agreement shall become binding when one or more counterparts hereof, individually or taken together, shall bear the signatures of all the parties reflected hereon as signatories. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written. [Remainder of Page Intentionally Left Blank] 49 "HCC INSURANCE HOLDINGS, INC." By: /s/ FRANK J. BRAMANTI -------------------------- Name: Frank J. Bramanti Title: Executive Vice President "MERGER SUB, INC." By: /s/ FRANK J. BRAMANTI --------------------------- Name: Frank J. Bramanti Title: Vice President [Remainder of Page Intentionally Left Blank] Signature Page of Agreement and Plan of Reorganization "NORTH AMERICAN SPECIAL RISK ASSOCIATES. INC.," By: /s/ GEORGE A. MELLON ----------------------------- Name: George A. Mellon Title: President "NASRA TPA, INC." By: /s/ GEORGE A. MELLON ----------------------------- Name: George A. Mellon Title: President "NASRA CONSULTING, INC." By: /s/ GEORGE A. MELLON ------------------------------ Name: George A. Mellon Title: President "ORIGINAL SHAREHOLDERS" /s/ GEORGE A. MELLON -------------------------- George A. Mellon /s/ F. DONALD FLEMING -------------------------- F. Donald Fleming /s/ J. NICHOLAS TEGENKAMP -------------------------- J. Nicholas Tegenkamp Signature Page of Agreement and Plan of Reorganization EX-10.331 3 EXHIBIT 10.331 EXHIBIT 10.331 AGREEMENT OF PURCHASE AND SALE BY AND AMONG TRM INTERNATIONAL, INC. and UNICOVER MANAGERS, INC. AND NORTH AMERICAN SPECIAL RISK ASSOCIATES, INC. and HCC INSURANCE HOLDINGS, INC. -------------------------------------------- DATED JANUARY 23, 1997 -------------------------------------------- TABLE OF CONTENTS ARTICLE 1 PURCHASE AND SALE .......................................... 1 Section 1.1 Agreement to Sell ........................... 1 1.1.1 Non-Exclusive Asset Categories ....... 1 1.1.2 Transfer of Assets Free of Liens ..... 3 1.1.3 Excluded Assets ...................... 3 Section 1.2 Agreement to Purchase ....................... 3 Section 1.3 The Purchase Price .......................... 3 1.3.1 Purchase Price ....................... 3 1.3.2 Payment of Purchase Price ............ 3 Section 1.4 Assumption of Liabilities ................... 4 1.4.1 Assumed Liabilities ................. 4 1.4.2 Excluded Liabilities ................ 4 Section 1.5 Adjustments to Purchase Price ............... 4 Section 1.6 Allocation of Earned Commission ............. 5 ARTICLE 2 CLOSING, ITEMS TO BE DELIVERED, THIRD PARTY CONSENTS AND FURTHER ASSURANCES ................................................ 5 Section 2.1 Closing ..................................... 5 Section 2.2 Items to be Delivered at Closing ............ 5 2.2.1 Seller Documents ................... 5 2.2.2 Payment of Purchase Price .......... 6 2.2.3 Other Documents .................... 6 Section 2.3 Consent of Third Parties .................... 6 Section 2.4 Further Assurances .......................... 7 Section 2.5 Non-Assignable Contracts .................... 7 ARTICLE 3 REPRESENTATIONS AND WARRANTIES ................................ 7 Section 3.1 Representations and Warranties of Seller .... 7 3.1.1 Authorization ..................... 7 3.1.2 Corporate Status .................. 8 3.1.3 No Conflicts ...................... 9 3.1.4 Financial Statements .............. 9 3.1.5 Absence of Undisclosed Liabilities........................ 9 3.1.6 Taxes ............................. 9 3.1.7 Absence of Changes ................ 10 3.1.8 Litigation ........................ 12 3.1.9 Compliance with Laws; Governmental Approvals and Consents; Governmental Contracts ......................... 12 3.1.10 Operation of the Business ......... 12 3.1.11 Assets ............................ 12 3.1.12 Contracts ......................... 13 3.1.13 Territorial Restrictions .......... 14 3.1.14 Policyholders ..................... 14 3.1.15 Absence of Certain Business Practices ......................... 15 i TABLE OF CONTENTS (Continued) 3.1.16 Confidentiality .................... 15 3.1.17 Records ............................ 15 3.1.18 Brokers and Finders ................ 15 3.1.19 Receivables ........................ 15 3.1.20 Transactions with Affiliates ....... 16 3.1.21 Disclosure ......................... 16 Section 3.2 Securities Act of 1933 ...................... 16 3.2.1 Investment Representations and Warranties ......................... 16 3.2.2 Legends ............................ 17 Section 3.3 Representations and Warranties of Purchaser and HCCH. ................................... 18 3.3.1 Corporate Status and Authorization . 18 3.3.2 No Conflicts, Etc .................. 18 3.3.3 Capital Stock ...................... 19 3.3.4 SEC Filings ........................ 19 3.3.5 Financial Statements ............... 20 3.3.6 Absence of Certain Changes ......... 20 3.3.7 No Undisclosed Liabilities ......... 21 3.3.8 Broker's Fees ...................... 21 3.3.9 Territorial Restrictions ........... 21 3.3.10 Disclosure ......................... 21 ARTICLE 4 COVENANTS ..................................................... 22 Section 4.1. Covenants of Seller ......................... 22 4.1.1 Conduct of Truckers Business Prior to Closing .............................. 22 4.1.2 No Solicitation ...................... 23 4.1.3 Access and Information ............... 23 4.1.4 Public Announcements ................. 23 4.1.5 Further Actions ...................... 24 4.1.6 Further Assurances ................... 24 4.1.7 Disclosure Memorandum ................ 25 4.1.8 Enforcement of Rights and Non-Competition Agreement ............ 25 4.1.9 Transition Team ...................... 27 Section 4.2 Covenants of Purchaser ...................... 28 4.2.1 Public Announcements ................. 28 4.2.2 Further Actions ...................... 28 4.2.3 Further Assurances ................... 28 4.2.4 Rule 144 ............................. 29 4.2.5 Expenses of Transition Team .......... 29 4.2.6 Access and Information ............... 29 4.2.7 Material Adverse Changes ............. 30 4.2.8 Collection of Receivables for Seller . 30 ii TABLE OF CONTENTS (Continued) Section 5.1 Conditions to Obligations of Each Party ..... 30 5.1.1 No Injunction, Etc. .................. 30 Section 5.2 Conditions to Obligations of Purchaser and HCCH .................................... 30 5.2.1 Representations, Performance ......... 31 5.2.2 Consents ............................. 31 5.2.3 No Material Adverse Effect ........... 31 5.2.4 Collateral Agreements ................ 31 5.2.5 Corporate Proceedings ................ 32 5.2.6 Transfer Documents ................... 32 5.2.7 New Program Manager's Agreement ...... 32 5.2.8 Investment Letter .................... 32 Section 5.3 Conditions to Obligations of Seller ......... 32 5.3.1 Representations, Performance ......... 33 5.3.2 Corporate Proceedings ................ 33 5.3.3 Consents and Approvals ............... 33 5.3.4 Collateral Agreements ................ 33 5.3.5 No Material Adverse Effect ........... 33 ARTICLE 6 TERMINATION ................................................ 34 Section 6.1 Termination ................................. 34 Section 6.2 Effect of Termination ....................... 34 ARTICLE 7 INDEMNIFICATION ............................................ 35 Section 7.1 By Seller ................................... 35 Section 7.2 By Purchaser and HCCH ...................... 35 Section 7.3 Adjustments to Indemnification Payments ..... 36 Section 7.4 Indemnification Procedures .................. 36 Section 7.5 Limits on Indemnification ................... 37 ARTICLE 8 DEFINITIONS AND CONSTRUCTION Section 8.1 Definition of Certain Terms ................. 37 Section 8.2 Rules of Construction ....................... 43 ARTICLE 9 GENERAL PROVISIONS ......................................... 44 Section 9.1 Survival of Representations and Warranties .. 44 Section 9.2 Expenses .................................... 44 Section 9.3 Severability ................................ 45 Section 9.4 Notices ..................................... 45 Section 9.5 Headings .................................... 46 Section 9.6 Entire Agreement ............................ 46 Section 9.7 Counterparts ................................ 46 Section 9.8 Governing Law, Etc .......................... 46 iii TABLE OF CONTENTS (Continued) Section 9.9 Binding Effect..................................... 46 Section 9.10 Assignment......................................... 46 Section 9.11 No Third Party Beneficiaries....................... 46 Section 9.12 Amendment; Waivers, Etc. .......................... 47 Section 9.13 Form of Payments by Seller......................... 47 1 AGREEMENT OF PURCHASE AND SALE This AGREEMENT OF PURCHASE AND SALE (this "Agreement") dated as of January 23, 1997, and effective as of the Effective Date as defined herein, is being entered by and between TRM INTERNATIONAL, INC., a New Jersey corporation ("TRM"); and UNICOVER MANAGERS, INC., a New Jersey corporation ("Unicover") (TRM and Unicover sometimes referred to collectively herein as "Seller"), on the one hand; and NORTH AMERICAN SPECIAL RISK ASSOCIATES, an Illinois corporation ("Purchaser"); and HCC INSURANCE HOLDINGS, INC., a Delaware corporation ("HCCH"), on the other hand, with reference to the following RECITALS: RECITALS A. Seller is engaged in the business of the marketing and sale of occupational accident and related employers liability insurance Policies to owner/operators of long-haul trucking companies (the "Truckers Business" as defined herein). B. Purchaser is a wholly-owned Subsidiary of HCCH, and subject only to the limitations and exclusions contained in this Agreement, and upon the terms and conditions hereinafter set forth, Seller desires to sell and Purchaser desires to purchase the Truckers Business and certain of the assets of Seller used therein or related thereto. NOW, THEREFORE, in consideration of the recitals and of the respective covenants, representations, warranties and agreements herein contained, and intending to be legally bound hereby, the parties hereto hereby agree as follows: ARTICLE 1 PURCHASE AND SALE Section 1.1 Agreement to Sell. At the Closing hereunder (as defined in Section 2.1 hereof), and except as otherwise specifically provided in this Section 1.1, Seller agrees to grant, sell, convey, assign, transfer and deliver to Purchaser, upon and subject to the terms and conditions of this Agreement, all right, title and interest of Seller in and to the properties, assets and rights of Seller described in Section 1. 1. 1 (other than the Excluded Assets) relating to or used or held for use in connection with the Truckers Business as the same may exist on the Closing Date (collectively, the "Assets"). 1.1.1 Non-Exclusive Asset Categories. As used in this Agreement, the term "Assets" shall include, without limitation, all those items in the following categories that conform to the definition of the term "Assets" to the extent such items are used or held for use by Seller in connection with the Truckers Business: (a) transfer all amounts held in any Fiduciary Account, including, without limitation, (i) Billed Premium collected under the Policies prior to the Effective Date, net of any compensation due Seller and payments made to RNRS; and (ii) Billed Premium, including any compensation payable to Seller in connection with Billed Premium on and after the Effective Date, net of payments made to RNRS; (b) all of the interest of Seller in the American Association of Independent Contractors, Inc., an Indiana non-profit corporation ("AAIC"); (c) all accounts receivable and all notes, bonds and other evidences of indebtedness of and rights to receive payments from any Person held by the Seller relating to the Truckers Business for any periods on and after the Effective Date; (d) all of the binding authority and rights of the Seller related to the Truckers Business under all contracts, arrangements, licenses, leases and other agreements, including, without limitation, the Program Manager's Agreement, insurance policy Expirations as described in the Program Manager's Agreement, agreements with Producers, to the extent the same may be assignable by Seller, and any right to receive payment of any compensation on and after the Effective Date for Policies sold or services rendered under the Program Manager's Agreement on Billed Premium relating to any periods on and after the Effective Date and to assert claims and take other rightful actions in respect of breaches, defaults and other violations of such contracts, arrangements, licenses, leases and other agreements and otherwise; (e) all rights under a non-exclusive license to the use of Seller's proprietary software system related to the Truckers Business as set forth in the Software License Agreement, to the extent that the use of such software by Purchaser does not violate the terms of any license or other agreement with any other Person relating to such software system; (f) all books, records, manuals and other materials (in any form or medium) relating to the Truckers Business, including, without limitation, all records and materials maintained at the headquarters of Seller, advertising matter, correspondence, mailing lists, Expirations, lists of Policyholders, distribution lists, production data, sales and promotional materials and records, purchasing materials and records, personnel records, accounting records, Policy files and litigation files; (g) all rights to causes of action, lawsuits, judgments, claims and demands of any nature available to or being pursued by 2 the Seller with respect to Billed Premium due or collected in connection with the Truckers Business for any period on or after the Effective Date, whether arising by way of counterclaim or otherwise; and (h) all guarantees, warranties, indemnities and similar rights in favor of the Seller with respect to any Asset. 1.1.2 Transfer of Assets Free of Liens. Subject to the terms and conditions hereof, at the Closing, the Assets shall be transferred or otherwise conveyed to Purchaser free and clear of all Liens excepting only Assumed Liabilities, and Permitted Liens listed on Schedule 3.1.11. 1.1.3 Excluded Assets. Seller shall retain and not transfer, and Purchaser shall not purchase or acquire, any assets not identified in Section 1.1.1 (collectively, the "Excluded Assets"). Section 1.2 Agreement to Purchase. At the Closing, Purchaser shall purchase or otherwise obtain possession of the Assets from Seller, upon and subject to the terms and conditions of this Agreement and in reliance on the representations, warranties and covenants of Seller contained herein, in exchange for the Purchase Price (as defined in Section 1.3 hereof). In addition, Purchaser shall assume at the Closing and agree to pay, discharge or perform, as appropriate, certain liabilities and obligations of Seller only to the extent and as provided in Section 1.4 of this Agreement and Permitted Liens. Except as specifically provided in Section 1.4 hereof for Permitted Liens, Purchaser shall not assume or be responsible for any liabilities or obligations of the Truckers Business or of Seller. Section 1.3 The Purchase Price. 1.3.1 Purchase Price. The purchase price (the "Purchase Price") shall be an amount equal to: (a) 266,667 shares (collectively, the "HCCH Shares") of the Common Stock, par value $1.00 per share (the "HCCH Common Stock"), of HCCH; plus (b) $6,550,000 cash. On or before the Closing Date, and prior to Closing, HCCH shall transfer the Purchase Price to Purchaser as a contribution to the capital of Purchaser in compliance with Treasury Reg. Sec. 1.1502-13(f)(6)(ii). 1.3.2 Payment of Purchase Price. On the Closing Date Purchaser shall (i) deliver to Seller, on account of the Purchase Price, a certificate or certificates representing the HCCH Shares and registered in the names of Seller and/or the Principals in such proportions as Seller shall designate in writing to Purchaser, and 3 (ii) pay to Seller, on account of the Purchase Price, the amount of $6,550,000, in cash, by wire transfer of immediately available funds to such account or accounts or such Persons as Seller shall designate in writing to Purchaser. If, prior to Closing, HCCH recapitalizes either through a split-up of its outstanding shares into a greater number, or through a combination of its outstanding shares into a lesser number, or reorganizes, reclassifies, or otherwise changes its outstanding shares into the same or a different number of shares of other classes (other than through a split-up or a combination of shares provided for in the previous clause), or declares a dividend on its outstanding shares payable in shares or securities convertible into shares (but not cash), the number of shares of HCCH Common Stock that constitutes the HCCH Shares to be issued pursuant to the provisions of this Agreement will be adjusted in proportion to such change. Section 1.4 Assumption of Liabilities 1.4.1 Assumed Liabilities. At the Closing, and subject to the terms and conditions set forth herein, and effective as of the Effective Date, Purchaser shall and does hereby assume and agree to pay, honor and discharge when due any and all liabilities, obligations and commitments of Seller relating exclusively to the Truckers Business and/or the Assets, including, without limitation, compensation payable to Seller and any obligations of Seller to Producers under the Program Manager's Agreement, existing or arising out of Billed Premium collected under the Policies for any periods prior to the Effective Date (collectively, the "Assumed Liabilities") in accordance with the terms and provisions of the assumption agreement ("Assumption Agreement") in substantially the form of Exhibit A attached hereto and hereby made a part hereof. 1.4.2 Excluded Liabilities. Notwithstanding the foregoing or any other provision hereof or any schedule or exhibit hereto, and regardless of any disclosure to Purchaser, Purchaser shall not assume any liabilities, obligations or commitments of Seller relating to or arising out of any other business or operations of the Seller, or the ownership of any Excluded Assets by the Seller other than the Assumed Liabilities (the "Excluded Liabilities"). Section 1.5 Adjustments to Purchase Price. If, during the one-year period beginning on the Effective Date (the "Measurement Period"), (a) the Billed Premium for Policies issued in connection with the Truckers Business plus (b) the Billed Premium for New Business issued by any insurer in connection with the Truckers Business on and after the Effective Date, except that premium billed on an annual basis shall be allocated pro rata to the Measurement Period, (the amount of such calculation being the "Adjusted Gross Premium") is less than Sixteen Million Dollars ($16,000,000.00) (the "Minimum Premium"), Seller will refund to Purchaser an amount equal to the ratio of fifty percent (50.0%) of the difference between Eighteen Million One Hundred Twenty-Five Thousand Dollars ($18,125,000.00) (the "Target Premium") and the Adjusted Gross Premium, over the Target Premium, times Thirteen Million Seven Hundred Fifty Thousand Dollars ($13,750,000.00) payable in cash. 4 Section 1.6 Allocation of Earned Commission. Notwithstanding the Effective Date, the parties agree that all commission income earned with respect to Billed Premium in connection with the Truckers Business for the month of December 1996 (the "December Commission Income") shall be payable 50% to Seller and 50% to Purchaser. In addition, all commission earned with respect to Billed Premium in connection with the Truckers Business for the month of January 1997 (the "January Commission Income") shall be payable to Purchaser. The parties agree that, to the extent required by law, they will file tax returns consistent with the foregoing; provided, however, in the event that Seller is required for federal income tax purposes to report as ordinary income more than 50% of the December Commission Income and/or any portion of the January Commission Income, then the amount of December Commission Income and/or January Commission Income payable to Seller shall be increased, and the amount of December Commission Income and/or January Commission Income payable to Purchaser shall be decreased, by an amount equal to the difference between (a) the amount of the December Commission Income and/or January Commission Income required to be reported as income by Seller for federal income tax purposes in excess of the amount of the December Commission Income and/or January Commission Income actually paid to Seller (the "Excess Income Amount") multiplied by the highest combined federal, state and local income tax rates for individuals on ordinary income and (b) the Excess Income Amount multiplied by the highest combined federal, state and local income tax rates for individuals on long-term capital gains. ARTICLE 2 CLOSING, ITEMS TO BE DELIVERED, THIRD PARTY CONSENTS AND FURTHER ASSURANCES Section 2.1 Closing. The closing (the "Closing") of the sale and purchase of the Assets shall take place at 10:00 A.M., local time, on January 24, 1997, at the offices of Winstead Sechrest & Minick P.C., 910 Travis Street, Suite 1700, Houston, Texas 77002-5895, or at such other time or place or on such other date, in each case as may be mutually agreed upon in writing by Purchaser and Seller. The date of the Closing is sometimes herein referred to as the "Closing Date." Section 2.2 Items to be Delivered at Closing. At the Closing, and subject to the terms and conditions herein contained: 2.2.1 Seller Documents. Seller shall deliver to Purchaser the following: (i) such assignments, endorsements, and other good and sufficient instruments and documents of conveyance and transfer, in form reasonably satisfactory to Purchaser and its counsel, as shall be reasonably necessary and appropriate to transfer and assign to Purchaser all of Seller's right, title and interest in and to the Truckers Business and the Assets, including without limitation, all of Seller's rights under all agreements, contracts, commitments, leases, plans, bids, quotations, proposals, instruments and other 5 documents included in the Assets to which Seller is a party or by which it has rights on the Closing Date; (ii) the Software License Agreement executed by an officer of the Seller, in substantially the form of Exhibit B attached hereto and hereby made a part hereof; (iii) all of the corporate records, minute books, corporate seal, membership lists, and files of AAIC, and resignations of all of the officers, directors, attorney-in-fact, and agent for service of process of AAIC, and an assignment of all of Seller's interest, if any, in AAIC; (iv) Investment Letters, executed by a duly authorized officer of each Holder of the HCCH Shares, in substantially the form of Exhibit C attached hereto and hereby made a part hereof, and (v) the Noncompetition Agreements, executed by each of the Principals, in substantially the form of Exhibit D attached hereto and hereby made a part hereof; and simultaneously with such delivery, all such steps will be taken as may be required to put Purchaser in actual possession and operating control of the Truckers Business and the Assets. 2.2.2 Payment of Purchase Price. Purchaser shall deliver to Seller the HCCH Shares and cash representing the Purchase Price in accordance with Section 1.3.2 hereof and the Assumption Agreement, executed by an officer of Purchaser. 2.2.3 Other Documents. At or prior to the Closing, the parties hereto shall also deliver to each other the agreements, opinions, certificates and other documents and instruments referred to in Article 5 hereof. Section 2.3 Consent of Third Parties. The Closing and the consummation of the transactions contemplated by this Agreement are subject to the consent of RNRS to the assignment by Seller to Purchaser of its rights, duties and obligations under the Program Manager's Agreement, and the execution of a New Program Manager's Agreement on terms satisfactory to Purchaser by the Purchaser and RNRS, as set forth in correspondence between HCCH and RNRS dated October 21, 1996 through November 19, 1996, copies of which are attached hereto as Exhibit D and hereby made a part hereof In the event the approval or consent of RNRS to the assignment of Seller's rights, duties and obligations under the Program Manager's Agreement to Purchaser has not been obtained on or prior to the Closing Date, Seller shall continue to use all reasonable efforts to obtain such approval or consent after the Closing Date until such time as such approval or consent has been obtained, and Seller will cooperate with 6 Purchaser in any lawful and economically feasible arrangement to provide that Purchaser shall receive the interest of Seller in the benefits under the Program Manager's Agreement with respect to Billed Premium due and collected on and after the Effective Date, provided that Purchaser shall pay or satisfy the corresponding liabilities for the enjoyment of such benefit to the extent Purchaser would have been responsible therefor if such approval or consent had been obtained. Section 2.4 Further Assurances. Seller will, from time to time after the Closing, at Purchaser's request, execute, acknowledge and deliver to Purchaser such other instruments of conveyance and transfer and will take such other actions and execute and deliver such other documents, certifications and further assurances as Purchaser may reasonably require in order to vest in Purchaser, or to put Purchaser in possession of, the Truckers Business and/or any of the Assets, or to better enable Purchaser to complete, perform or discharge any of the Assumed Liabilities or obligations assumed by Purchaser at the Closing pursuant to Section 1.4 hereof. Each of the parties hereto will cooperate with the other and execute and deliver to the other parties hereto such other instruments and documents and take such other actions as may be reasonably requested from time to time by any other party hereto as necessary to carry out, evidence and confirm the intended purposes of this Agreement. Section 2.5 Non-Assignable Contracts. To the extent that any Contracts necessary for the transaction of the Truckers Business by Purchaser are non-assignable or not transferable to Purchaser, or non-assignable or non-transferable without the consent of a third party, or shall be subject to an option held by any other Person arising out of or maturing or originating by reason of a request by Seller to transfer or assign such Contract or by reason of the transactions contemplated in this Agreement, this Agreement shall not constitute a contract to assign or transfer such Contract if any attempt to transfer or assign such Contract would (i) constitute a breach of the provisions thereof; or (ii) create rights in any other Person not acceptable to Purchaser. If Seller shall have failed to procure the consent of any Person to such assignment or transfer or waiver of such option prior to the Closing Date, Seller shall use its commercially reasonable efforts to make the use and benefits of the Truckers Business and the Assets available to the Purchaser to the same extent, as nearly as may be possible, as if such impediment to assignment or transfer of any such Contract did not exist. ARTICLE 3 REPRESENTATIONS AND WARRANTIES Section 3.1 Representations and Warranties of Seller. Seller represents and warrants to Purchaser as of the date of this Agreement, except as set forth in the Disclosure Memorandum delivered to Purchaser as provided in Section 4.1.8 hereof, each of which exceptions shall specifically identify the relevant subsection hereof to which it relates and shall be deemed to be representations and warranties as if made hereunder, as follows: 3.1.1 Authorization. Seller has the corporate power and authority to execute and deliver this Agreement and each of the Collateral Agreements to which it is a party, to perform fully their respective obligations hereunder and 7 thereunder, and to consummate the transactions contemplated hereby and thereby. The execution and delivery by Seller of this Agreement, and the consummation of the transactions contemplated hereby, have been, and on the Closing Date the execution and delivery by Seller of each of the Collateral Agreements to which it is a party and the consummation of the transactions contemplated thereby will have been, duly authorized by all requisite corporate action of Seller. Seller has duly executed and delivered this Agreement to Purchaser and HCCH and on the Closing Date Seller will have duly executed and delivered to Purchaser and HCCH, each of the Collateral Agreements to which it or any of the Principals is a party. This Agreement is, and on the Closing Date each of the Collateral Agreements to which it is a party will be, legal, valid and binding obligations of Seller, enforceable against Seller in accordance with their respective terms. 3.1.2 Corporate Status (a) TRM and Unicover are each corporations duly organized, validly existing and in good standing under the laws of the jurisdiction of their respective incorporation, with full corporate power and authority to carry on their respective business (including, without limitation, the Truckers Business) and to own or lease and to operate their respective properties as and in the places where such business is conducted and such properties owned, leased or operated. TRM and Unicover have made elections to be treated as "S" corporations for federal income tax purposes. (b) TRM and Unicover are each duly qualified or licensed to do business in the jurisdictions set forth in Schedule 3.1.2(b), respectively, and are in good standing in each of the jurisdictions specified opposite their names in Schedule 3.1.2(b), which are the only jurisdictions in which the operation of the Truckers Business or the character of the properties owned, leased or operated by them in connection with the Truckers Business makes such qualification or licensing necessary. (c) TRM and Unicover have delivered to Purchaser complete and correct copies of each of their and AAIC's respective articles of incorporation and by-laws or other organizational documents, in each case, as amended and in effect on the date hereof. Neither TRM, Unicover nor AAIC are in violation in any material respect of any of the provisions of its respective articles of incorporation or by-laws or other organizational documents. (d) As of the date of this Agreement, there are no shares of common capital stock or membership interests of AAIC authorized or issued and outstanding. 8 3.1.3 No Conflicts. The execution, delivery and performance by Seller of this Agreement and each of the Collateral Agreements to which it may be a party, and the consummation of the transactions contemplated hereby and thereby, do not and will not conflict with or result in a violation of or a default under (with or without the giving of notice or the lapse of time or both) (i) any Applicable Law applicable to Seller or any Affiliate thereof or any of the properties or assets of Seller (including but not limited to the Assets), (ii) the articles of incorporation or by-laws or other organizational documents of Seller or AAIC or (iii) except as set forth in Schedule 3.1.3, any Contract or other contract, agreement or other instrument to which Seller or AAIC is a party or by which Seller, AAIC or any of their properties or assets, including but not limited to the Assets, may be bound or affected, except, in each case, the conflict, violation or breach of which could not reasonably be expected to have a Material Adverse Effect on the Truckers Business or the Assets. Except as specified in Schedule 3.1.3, no Governmental Approval or other Consent is required to be obtained or made by Seller in connection with the execution and delivery of this Agreement and the Collateral Agreements to which it is a party or the consummation of the transactions contemplated hereby or thereby, except any Consent to which the failure to obtain could not reasonably be expected to have a Material Adverse Effect on the Truckers Business or the Assets. 3.1.4 Financial Statements. Seller has delivered to Purchaser certain unaudited financial information and data prepared by Seller and setting forth Billed Premium and revenues received by Sellers for the Truckers Business (the "Financial Statements") as of August 31, 1996 (the "Financial Statement Date"). The Financial Statements present fairly in all material respects, the Billed Premium and gross premium revenues of Seller in connection with the Truckers Business for the periods indicated thereon. 3.1.5 Absence of Undisclosed Liabilities. Seller has no liabilities or obligations of any nature, whether known or unknown, absolute, accrued, contingent or otherwise and whether due or to become due, arising out of or relating to the Truckers Business, except (a) as set forth in Schedule 3.1.5, (b) as and to the extent disclosed or reserved against in the Financial Statements (including the notes thereto), (c) unknown contingent liabilities and (d) for liabilities and obligations that (i) were incurred after the Financial Statement Date in the ordinary course of business consistent with prior practice and (ii) individually and in the aggregate are not material to the Truckers Business and have not had or resulted in, and will not have or result in, a Material Adverse Effect on the Truckers Business or the Assets. 3.1.6 Taxes (a) Seller has (or by the Closing will have) duly and timely filed all Tax Returns relating to the Truckers Business with respect to Covered Taxes required to be filed on or before the 9 Closing Date ("Covered Returns"). Except for Covered Taxes set forth on Schedule 3.1.6(a), which are being contested in good faith and by appropriate proceedings, the following Covered Taxes have (or by the Closing Date will have) been duly and timely paid: (i) all Covered Taxes shown to be due on the Covered Returns, (ii) all deficiencies and assessments of Covered Taxes of which notice has (or by the Closing Date will have) been received by Seller that are or may become payable by Purchaser or chargeable as a lien upon the Truckers Business, and (iii) all other Covered Taxes due and payable on or before the Closing Date for which neither filing of Covered Returns nor notice of deficiency or assessment is required, of which Seller or any Shareholder is or reasonably should be (or by the Closing Date will be or reasonably should be) aware that are or may become payable by Purchaser or chargeable as a lien upon the Truckers Business. (b) Purchaser will not be required to deduct and withhold any amount pursuant to section 1445(a) of the Code upon the transfer of the Truckers Business to Purchaser. 3.1.7 Absence of Changes. Except as set forth on Schedule 3.1.7, since the Financial Statement Date, Seller has conducted the Truckers Business only in the ordinary course consistent with prior practice and has not, on behalf of, in connection with or relating to the Truckers Business or the Assets: (a) suffered any event which could reasonably be expected to have a Material Adverse Effect on the Truckers Business or the Assets; (b) incurred any known obligation or liability, absolute, accrued, contingent or otherwise, whether due or to become due, except current liabilities for trade or business obligations incurred in connection with the purchase of goods or services or otherwise in the ordinary course of business consistent with prior practice, none of which liabilities, in any case or in the aggregate, could reasonably be expected to have a Material Adverse Effect on the Truckers Business or the Assets; (c) mortgaged, pledged or subjected to any Lien, any property, business or assets, tangible or intangible, held in connection with the Truckers Business; (d) sold, transferred, leased to others or otherwise disposed of any of the Assets, or, except in the ordinary course of business and consistent with prior practice, cancelled or 10 compromised any debt or claim, or waived or released any right of substantial value relating to the Truckers Business or the Assets; (e) made, entered into or assumed, or suffered any amendment or termination of, any agreement, contract, commitment, lease or plan to which it is a party or by which it is bound and relating to the Truckers Business or the Assets, or received any notice of termination of any contract, lease or other agreement necessary for the operation of the Truckers Business or the Assets or suffered any damage, destruction or loss (whether or not covered by insurance) relating to the Truckers Business or Assets, except in any case or in the aggregate which could not reasonably be expected to have a Material Adverse Effect on the Truckers Business or the Assets; (f) made any material change in the rate of compensation, commission, bonus or other direct or indirect remuneration payable, or paid or agreed or orally promised to pay, conditionally or otherwise, any bonus, incentive, retention or other compensation, retirement, welfare, fringe or severance benefit or vacation pay, to or in respect of any Producer or agent of Seller relating to the Truckers Business, or made any other changes to its personnel practices, except in the ordinary course of business and consistent with past practice; (g) made any material change in its selling, marketing or advertising practices which could reasonably be expected to have a Material Adverse Effect upon the Truckers Business or the Assets; (h) instituted, settled or agreed to settle any litigation, action or proceeding before any court or governmental body relating to the Truckers Business or the Assets other than in the ordinary course of business consistent with past practices but not in any case involving amounts in excess of $10,000; (i) entered into any transaction, contract or commitment other than in the ordinary course of business consistent with prior practice, or paid or agreed to pay any brokerage, finder's fee, Taxes or other expenses in connection with, or incurred any severance pay obligations by reason of, this Agreement or the transactions contemplated hereby; or (j) taken any action or omitted to take any action that would result in the occurrence of any of the foregoing. 11 3.1.8 Litigation. Except as set forth on Schedule 3.1.8, there is no action, claim, demand, suit, proceeding, arbitration, grievance, citation, summons, subpoena, inquiry or investigation of any nature, civil, criminal, regulatory or otherwise, in law or in equity, pending or threatened against or relating to Seller in connection with the Assets or the Truckers Business or against or relating to the transactions contemplated by this Agreement, which constitutes or may constitute an Assumed Liability. 3.1.9 Compliance with Laws; Governmental Approvals and Consents; Governmental Contracts (a) Except as disclosed on Schedule 3.1.9(a), Seller has complied in all material respects with all, and is not in material violation of any, Applicable Laws applicable to the Truckers Business or the Assets, and Seller has not received any notice alleging any such conflict, violation, breach or default, except in either case where such failure to comply, conflict, violation, breach or default could not reasonably be expected to have a Material Adverse Effect on the Truckers Business or the Assets. (b) Schedule 3.1.9(b) sets forth all Governmental Approvals and other Consents issued to Seller in connection with the conduct of the Truckers Business or the ownership and use of the Assets, including, without limitation, all licenses, permits or similar authorizations for the marketing and sale of the Policies by Seller. (c) To the best of Seller's knowledge, there are no proposed laws, rules, regulations, ordinances, orders, judgments, decrees, governmental takings, condemnations or other proceedings which would be applicable to the Truckers Business or the Assets and which could reasonably be expected to have a Material Adverse Effect on the Truckers Business or the Assets, either before or after the Closing Date. 3.1.10 Operation of the Business. Except as set forth in Schedule 3.1.10, (a) Seller has not conducted the Truckers Business through any divisions or any direct or indirect Subsidiary or Affiliate of Seller other than AAIC and (b) no part of the Truckers Business is operated by Seller through any entity other than Seller or AAIC. 3.1.11 Assets. Except as disclosed in Schedule 3.1.11, Seller has good title to all the Assets, free and clear of any and all Liens other than Permitted Liens. The Assets comprise all assets required for the continued conduct of the Truckers Business by Purchaser as now being conducted by Seller. The Assets, taken as a whole, constitute all the properties and assets relating to or used or held for use 12 in connection with the Truckers Business during the past twelve months to the extent such assets are still in existence on the Closing Date, and except cash disposed of, accounts receivable collected, prepaid expenses realized, Contracts fully performed, properties or assets replaced by equivalent or superior properties or assets, in each case in the ordinary course of business consistent with prior practice, and the Excluded Assets. Except for the Excluded Assets, there are no assets or properties used in the operation of the Truckers Business and owned by any Person other than Seller that will not be leased or licensed to Purchaser under valid, current leases or license arrangements. The Assets are in all material respects adequate for the purposes for which such assets are currently used or are held for use, and are in reasonably good repair and operating condition (subject to normal wear and tear) and, to the knowledge of Seller, there are no facts or conditions affecting the Assets which could, individually or in the aggregate, interfere in any material respect with the use, occupancy or operation thereof as currently used, occupied or operated, or their adequacy for such use. 3.1.12 Contracts (a) Schedule 3.1.12(a) contains a complete and correct list of all agreements, contracts, commitments and other instruments and arrangements (whether written or oral) of the types described below which are related to or employed by Seller in connection with the Truckers Business to which Seller is a party or by which it is bound in connection with the Truckers Business or the Assets (the "Contracts"): (i) agreements, contracts, commitments, and other instruments and arrangements pursuant to which Seller serves as agent, manager, broker or third-party administrator in connection with the Truckers Business or any Prohibited Products; (ii) agreements, contracts, commitments, and other instruments and arrangements relating to the solicitation of new or additional business for or on behalf of Seller; (iii) employment, consulting, agency, collective bargaining or other similar contracts, agreements, and other instruments and arrangements relating to or for the benefit of current, future or former employees, officers, directors, shareholders, sales representatives, distributors, dealers, Producers, agents, independent contractors or consultants of Seller or any other Person and which require, in all cases, any payments of profits on Policies transferred to Purchaser as part of the Truckers Business; (iv) any other contracts, agreements or commitments that are material to the Truckers Business. 13 (b) Seller has delivered to Purchaser complete and correct copies of all written Contracts, together with all amendments thereto, and accurate descriptions of all material terms of all oral Contracts, which are set forth or required to be set forth in Schedule 3.1.12(a). (c) To the best of Seller's knowledge, all such Contracts are in full force and effect and enforceable against each party thereto. To the best of Seller's knowledge, there does not exist under any Contract any event of default or event or condition that, after notice or lapse of time or both, would constitute a material violation, material breach or event of default thereunder on the part of Seller or, to the best knowledge of Seller, any other party thereto except as set forth in Schedule 3.1.12(c) and except for such events or conditions that, individually and in the aggregate, (i) has not had or resulted in, and could not reasonably be expected to have or result in, a Material Adverse Effect on the Truckers Business or the Assets and (ii) has not and will not materially impair the ability of Seller to perform its respective obligations under this Agreement and under the Collateral Agreements to which it is a party. Except as set forth in Schedule 3.1.12(c), no Consent of any third party is required under any Contract as a result of or in connection with, and the enforceability of any Contract will not be affected in any manner by, the execution, delivery and performance of this Agreement or any of the Collateral Agreements or the consummation of the transactions contemplated hereby or thereby. (d) Seller has not granted any power of attorney relating to the Truckers Business, which is currently in effect. 3.1.13 Territorial Restrictions. Seller is not restricted by any written agreement or understanding with any other Person from carrying on the Truckers Business anywhere in the United States of America, and Purchaser shall not, solely as a result of its purchase of the Truckers Business from Seller pursuant hereto and the assumption of the Assumed Liabilities, become restricted in carrying on the Truckers Business anywhere in the United States of America by reason of any. restrictions imposed upon Seller under any such agreement or understanding. 3.1.14 Policyholders. Schedule 3.1.14 sets forth (a) the names and addresses of all owners, participants and/or holders of the Policies constituting the Truckers Business ("Policyholders") of Seller that purchased Policies through Seller or Producers of Seller which were in force and effect upon the Effective Date; (b) the amount of Billed Premium under such Policies during the one year period ending on the Effective Date of this Agreement; and (c) a list of the names and addresses of all Producers of such Policies. Seller has not received any notice or has any reason to believe that any Policyholder of Seller has lapsed or intends to permit its Policy to lapse or to non-renew any Policy. To the best knowledge of Seller, no Policyholder of Seller described in clause (a) of the first sentence of this section has otherwise threatened to take any action described in the preceding 14 sentence as a result of the consummation of the transactions contemplated by this Agreement and the Collateral Agreements. 3.1.15 Absence of Certain Business Practices. Seller has not, nor, to the best knowledge of Seller, has any officer, employee or agent of Seller, or, to the best knowledge of Seller, any other Person acting on behalf of Seller or any officer, employee or agent of Seller, directly or indirectly, within the past five year& given or agreed to give any gift, rebate, allowance or similar benefit to any Policyholder, Producer, governmental employee or other Person who is or may be in a position to help or hinder the Truckers Business (or assist Seller in connection with any actual or proposed transaction relating to the Truckers Business) (i) which subjected or might have subjected Seller to any damage or penalty in any civil, criminal or governmental litigation or proceeding, (ii) which if not given in the past, could reasonably be expected to have had a Material Adverse Effect on the Truckers Business or the Assets, (iii) which if not continued in the future, might have a Material Adverse Effect on the Truckers Business or the Assets or subject Purchaser or HCCH to suit or penalty in any private or governmental litigation or proceeding, (iv) for any of the purposes described in Section 162(c) of the Code or (v) for the purpose of establishing or maintaining any concealed hind or concealed bank account. 3.1.16 Confidentiality. Except as set forth on Schedule 3.1.16, Seller has taken all commercially reasonable steps necessary to preserve the confidential nature of all material confidential information (including, without limitation, any proprietary information) with respect to the Truckers Business. 3.1.17 Records. The books and records of Seller insofar as they relate to or affect the Truckers Business and the Assets are substantially complete and correct in all material respects. 3.1.18 Brokers and Finders. All negotiations relating to this Agreement, the Collateral Agreements, and the transactions contemplated hereby and thereby, have been carried on without the participation of any Person acting on behalf of Seller or its Affiliates in such manner as to give rise to any valid claim against Purchaser, or any of the Subsidiaries or Affiliates of Purchaser by any Person for any brokerage or finder's commission, fee or similar compensation, or for any bonus payable to any officer, director, employee, agent or sales representative of or consultant to Seller or its Affiliates upon consummation of the transactions contemplated hereby or thereby. 3.1.19 Receivables. All of Seller's receivables (including accounts receivable, loans receivable and advances) which have arisen in connection with the Truckers Business and which are reflected on the Financial Statements, and all such receivables which will have arisen since the Financial Statement Date, are valid and genuine and have arisen solely from bona fide transactions in the ordinary course of business consistent with past practices. To the best knowledge 15 of Seller, all such receivables are collectible, and none of such receivables is subject to valid defenses, set-offs or counterclaims except as reserved for in the Financial Statements. Schedule 3.1.19 hereto accurately lists as of December 31, 1996, all receivables arising out of or relating to the Truckers Business, the amount owing and the aging of such receivable, the name and last known address of the party from whom such receivable is owing, and any security in favor of Seller for the repayment of such receivable which such Seller purports to have. Seller has delivered to Purchaser complete and correct copies of all instruments, documents and agreements evidencing such receivables. 3.1.20 Transactions with Affiliates. No shareholder, director, officer or employee of Seller, or any member of his or her immediate family or any other of its, his or her Affiliates, owns or has a 5% or more ownership interest in any corporation or other entity that is or was during the last three years a party to, or in any property which is or Was during the last three years the subject of, any material contract, agreement or understanding, business arrangement or relationship with Seller or AAIC material to the Truckers Business. 3.1.21 Disclosure. No representation or warranty by Seller contained in this Agreement or any statement or certificate furnished or to be furnished by, or on behalf of Seller to Purchaser or its representatives in connection herewith or pursuant hereto contains or will contain any untrue statement of a material fact or omits or will omit to state any material fact required to make the statements contained herein or therein not misleading. Section 3.2 Securities Act of 1933 3.2.1 Investment Representations and Warranties. Seller represents and warrants, on behalf of itself and each of the Principals to whom it shall designate that any HCCH Shares should be distributed under this Agreement (collectively, "Holder(s)") to Purchaser and HCCH that: (a) Each Holder is an "accredited investor" as that term is defined in Rule 501 promulgated under the Securities Act. (b) The HCCH Shares to be received upon consummation of the transactions contemplated hereby will be acquired for investment for an indefinite period for each Holder's own account and not with a view to the sale or distribution of any part thereof, and that Holders have no present intention of selling or otherwise distributing the same. Holders do not have any contract, undertaking, agreement or arrangement with any Person to sell or transfer to such Person any of the HCCH Shares. (c) Each Holder understands that the HCCH Shares are not and may never be registered under the Securities Act on the ground 16 that the sale provided for in this Agreement and the issuance of securities is exempt from the registration provisions thereof, and that the reliance by Purchaser and HCCH on such exemption is predicated on Seller's representations set forth herein. (d) Seller agrees, and shall cause each of the Principals who are designated Holder to agree, that in no event will any Holder make a disposition of any of the HCCH Shares, unless the HCCH Shares shall have been registered under the Securities Act, unless and until (i) Holder shall have notified HCCH of the proposed disposition, and (ii) Holder shall have furnished HCCH with an opinion of counsel reasonably satisfactory to HCCH or a "no action" or interpretive letter from the Securities and Exchange Commission to the effect that such registration is not required under the circumstances of such sale or transfer. (e) Each Holder has such knowledge and experience in financial and business matters as to be capable of evaluating the merits and risks of Holder's investment, has the ability to bear the economic risks of Holder's investment and has been furnished with and has had access to such information as would be made available in the form of a registration statement together with such additional information as is necessary to verify the accuracy of the information supplied and to have all questions which have been asked by Holders answered by or on behalf of HCCH. (f) Each Holder understands that if a registration statement covering the HCCH Shares under the Securities Act is not in effect when such Holder desires to sell any of the HCCH Shares, Holder may be required to hold such HCCH Shares for an indeterminate period. Seller also acknowledges, and shall cause each Holder to acknowledge, that Holder understands that any sale of the HCCH Shares which might be made by Holder in reliance upon Rule 144 under the Securities Act may be made only in limited amounts in accordance with the terms and conditions of that Rule. Each Holder has consulted with Seller's or Holder's own counsel regarding the terms of Rule 144 and the restrictions on sales of the HCCH Shares imposed thereby, and is willing to accept the HCCH Shares pursuant to this Agreement subject to the limitations of Rule 144. 3.2.2 Legends. All certificates representing the HCCH Shares shall bear substantially the following legend: "THE SHARES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 17 1933, AS AMENDED, AND HAVE BEEN ACQUIRED BY THE HOLDER FOR INVESTMENT PURPOSES. SAID SHARES MAY NOT BE SOLD OR TRANSFERRED UNLESS (A) THEY HAVE BEEN REGISTERED UNDER SAID ACT, OR (B) THE TRANSFER AGENT (OR THE COMPANY IF THEN ACTING AS ITS TRANSFER AGENT) IS PRESENTED WITH EITHER A WRITTEN OPINION OF COUNSEL SATISFACTORY TO COUNSEL FOR THE COMPANY OR A 'NO-ACTION' OR INTERPRETIVE LETTER FROM THE SECURITIES AND EXCHANGE COMMISSION TO THE EFFECT THAT SUCH REGISTRATION IS NOT REQUIRED UNDER THE CIRCUMSTANCES OF SUCH SALE OR TRANSFER." Section 3.3 Representations and Warranties of Purchaser and HCCH. Purchaser and HCCH represent and warrant to Seller that: 3.3.1 Corporate Status and Authorization. Purchaser is a corporation duly organized, validly existing and in good standing under the laws of the State of Illinois, with full corporate power and authority to execute and deliver this Agreement and the Collateral Agreements to which it is a party, to perform its obligations hereunder and thereunder, and to consummate the transactions contemplated hereby and thereby. Purchaser is duly qualified and licensed and in good standing in each of the jurisdictions in which such qualification or licensing may be necessary for the transaction of the Truckers Business by Purchaser after the Closing Date. HCCH is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware, with full corporate power and authority to execute and deliver this Agreement and the Collateral Agreements to which it is a party, to perform its obligations hereunder and thereunder, and to consummate the transactions contemplated hereby and thereby. The execution and delivery by Purchaser and HCCH of this Agreement, and the consummation of the transactions contemplated hereby, have been, and on the Closing Date, the execution and delivery by the Purchaser and HCCH of each of the Collateral Agreements to which they are a party will have been, duly authorized by all requisite corporate action. Purchaser and HCCH have duly executed and delivered this Agreement and on the Closing Date will have duly executed and delivered the Collateral Agreements to which they are a party. This Agreement is, and on the Closing Date each of the Collateral Agreements to which they are a party will be, valid and legally binding obligations of Purchaser and HCCH, enforceable against Purchaser and HCCH in accordance with their respective terms. 3.3.2 No Conflicts, Etc. The execution, delivery and performance by Purchaser and HCCH of this Agreement and each of the Collateral Agreements to which they are a party, and the consummation of the transactions contemplated hereby and thereby, do not and will not conflict with or result in a violation of or under (with or without the giving of notice or the lapse of time, or both) (i) the respective articles of incorporation or by-laws or other organizational documents 18 of Purchaser or HCCH, (ii) any Applicable Law applicable to Purchaser or HCCH, or any of their respective Affiliates or any of their properties or assets or (iii) any contract, agreement or other instrument applicable to the Purchaser or HCCH, or any of their Affiliates or any of their properties or assets, except, in the case of clause (iii), for violations and defaults that, individually and in the aggregate, have not and will not materially impair the ability of the Purchaser or HCCH to perform its respective obligations under this Agreement or under any of the Collateral Agreements to which they are a party or to consummate the transactions contemplated hereby or thereby. Except as specified in Schedule 3.3.2, no Governmental Approval or other Consent is required to be obtained or made by Purchaser or HCCH in connection with the execution and delivery of this Agreement or the Collateral Agreements to which they are a party or the consummation of the transactions contemplated hereby and thereby. 3.3.3 Capital Stock. The authorized capital stock of HCCH consists of 100,000,000 shares of Common Stock, par value $1.00 per share, of which 35,815,457 shares were issued and outstanding as of November 30, 1996. All of the issued and outstanding shares of Common Stock have been duly authorized and validly issued and are fully paid and nonassessable. Except as set forth on Schedule 3.3.3 or as provided in this Agreement, (i) no subscription, warrant, option, convertible security or other right (contingent or otherwise) to purchase or acquire any shares of capital stock of HCCH is authorized or outstanding, (ii) there is not any commitment of HCCH to issue any subscription, warrant, option, convertible security or other such right or to issue or distribute to holders of any shares of its capital stock any evidences of indebtedness or assets of HCCH, and (iii) HCCH has no obligation (contingent or otherwise) to purchase, redeem or otherwise acquire any shares of its capital stock or any interest therein or to pay any dividend or make any other distribution in respect thereof. No person or entity is entitled to any preemptive or similar right with respect to the issuance of any capital stock of HCCH. 3.3.4 SEC Filings (a) HCCH has since October 28, 1992 filed all forms, proxy statements, schedules, reports and other documents required to be filed by it with the SEC pursuant to the Exchange Act. (b) HCCH has delivered, and will promptly deliver in the case of any of the following filed with the SEC on or after the date hereof and prior to the Effective Date, to Seller: (i) its annual reports on Form. 10-K for its fiscal years ended December 31, 1995 and 1994; (ii) its quarterly report on Form 10-Q for its fiscal quarters ending March 31, June 30, and September 30, 1996; 19 (iii) any current reports on Form 8-K since January 1, 1996 and its proxy or information statements relating to meetings of, or actions taken without a meeting by, the shareholders of HCCH held since January 1, 1996; and (iv) all of its other reports, statements, schedules and registration statements filed with the SEC since December 31, 1995. None of HCCH's Subsidiaries is required to file any forms, reports or other documents with the SEC. (c) As of its filing date, no such report or statement filed pursuant to the Exchange Act contained any untrue statement of a material fact or omitted to state any material fact necessary in order to make the statements made therein, in the light of the circumstances under which they were made, not misleading. (d) No registration statement filed pursuant to the Securities Act, if declared effective by the SEC, as of the date such statement or amendment became effective, contained any untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary to make the statements therein not misleading. 3.3.5 Financial Statements. The audited consolidated financial statements of HCCH included in its annual reports on Form 10-K and the unaudited financial statements of HCCH included in its quarterly reports on Form 10-Q referred to in Section 3.3.4 present fairly, in conformity with generally accepted accounting principles applied on a consistent basis (except as may be indicated in the notes thereto), the consolidated financial position of HCCH and its consolidated subsidiaries as of the dates thereof and their consolidated results of operations and cash flows for the periods then ended (subject to normal year-end adjustments in the case of any interim financial statements). For purposes of this Agreement, "HCCH Balance Sheet" means the consolidated balance sheet of HCCH as of September 30, 1996, and the notes thereto, contained in HCCH's quarterly report on Form 10-Q filed for its fiscal quarter then ended, and "HCCH Balance Sheet Date" means September 30, 1996. 3.3.6 Absence of Certain Changes. Since the HCCH Balance Sheet Date, HCCH and each of its Subsidiaries have in all material respects conducted their business in the ordinary course and, other than the acquisition of Purchaser by HCCH on November 27, 1996, there has not been: (a) any change with respect to HCCH or any event, occurrence or development of a state of circumstances or facts known to HCCH, which as of the date hereof could reasonably be expected to have a Material Adverse Effect on HCCH; 20 (b) any amendment of any material term of any outstanding securities of HCCH; (c) the entering into of any agreement by HCCH or any person on behalf of HCCH to take any of the foregoing actions. 3.3.7 No Undisclosed Liabilities. Except as set forth on Schedule 3.3.7, there are no liabilities of HCCH or any of its Subsidiaries of any kind whatsoever that are, individually or in the aggregate, material to HCCH and its Subsidiaries, taken as a whole, other than: (a) liabilities disclosed or provided for in the HCCH Balance Sheet (including the notes thereto); (b) liabilities incurred in the ordinary course of business consistent with past practice since the HCCH Balance Sheet Date (other than the acquisition of Purchaser by HCCH on November 27, 1996); and (c) liabilities under this Agreement. 3.3.8 Broker's Fees. Neither HCCH nor Purchaser, nor any Person acting on their behalf or at the request thereof has any liability to any broker, finder, investment banker or agent, or has agreed to pay any brokerage fees, finder's fees or commissions to any Person, or to reimburse any expenses of any broker, finder, investment banker or agent in connection with this Agreement. 3.3.9 Territorial Restrictions. Purchaser is not restricted by any written agreement or understanding with any other Person from carrying on the Truckers Business anywhere in the United States of America, and Purchaser shall not, solely as a result of its purchase of the Truckers Business from Seller pursuant hereto and the assumption of the Assumed Liabilities, become restricted in carrying on the Truckers Business anywhere in the United States of America by reason of any restrictions imposed upon Purchaser under any such agreement or understanding. 3.3.10 Disclosure. No representation or warranty by Purchaser or HCCH contained in this Agreement or any statement or certificate furnished or to be furnished by or on behalf of Purchaser or HCCH to Seller or its representatives in connection herewith or pursuant hereto contains or will contain any untrue statement of a material fact, or omits or will omit to state any material fact required to make the statements contained herein or therein not misleading. 21 ARTICLE 4 COVENANTS Section 4.1 Covenants of Seller 4.1.1 Conduct of Truckers Business Prior to Closing. From the date hereof to the Closing Date, except as expressly permitted or required by this Agreement or as otherwise consented to by Purchaser in writing, Seller will: (a) carry on the Truckers Business in, and only in, the ordinary course, in substantially the same manner as heretofore conducted, and use all reasonable efforts to preserve intact its present business organization, maintain its properties in commercially reasonable operating condition and repair, keep available the services of its present officers and significant employees, and preserve its relationship with agents, Producers, Policyholders and others having business dealings with it; (b) pay accounts payable and other obligations of Seller relating to the Truckers Business when they become due and payable in the ordinary course of business consistent with prior practice; (c) perform in all material respects all of its obligations under the Policies and all other Contracts, agreements and instruments relating to or affecting the Truckers Business or the Assets, and comply in all material respects with all Applicable Laws applicable to the Assets or the Truckers Business; (d) other than new Policies issued pursuant to the Program Manager's Agreement and amendments or endorsements to existing Policies in the ordinary course of business, not enter into or assume any material agreement, contract or instrument relating to the Truckers Business, or enter into or permit any material amendment, supplement, waiver or other modification in respect thereof, (e) not grant (or commit to grant) any increase in the compensation (including incentive or bonus compensation, commissions or service fees) of any agent or Producer engaged in the solicitation, sale or operation of the Truckers Business, or institute, adopt or amend (or commit to institute, adopt or amend) any compensation or benefit plan, policy, program or arrangement applicable to any such agent or Producer; and 22 (f) not take any action or omit to take any action, which action or omission would result in a breach of any of the representations and warranties set forth in Section 3.1.7. 4.1.2 No Solicitation. From the date of this Agreement to the Closing Date, neither the Seller, any of its respective Affiliates nor any Person acting on their behalf and under their control shall (i) solicit or encourage any inquiries or proposals for, or enter into any discussions with respect to, the purchase or sale of any properties and assets constituting the Assets or (ii) furnish or cause to be furnished any non- public information concerning the Truckers Business to any Person (other than Purchaser and its agents and representatives), other than in the ordinary course of business or pursuant to Applicable Law and after prior written notice to Purchaser. Seller shall not sell, transfer or otherwise dispose of, grant any option or proxy to any Person with respect to, create any Lien upon, or transfer any interest in, any Asset, other than in the ordinary course of business consistent with prior practice and in accordance with each and every term of this Agreement. 4.1.3 Access and Information (a) From the date of this Agreement to the Closing Date, Seller will (and will cause each of their respective Affiliates and their Affiliates' respective accountants, counsel, consultants, employees and agents) to give Purchaser and its accountants, counsel, consultants, employees and agents, full access during normal business hours to, and furnish them with all documents, records, work papers and information with respect to, all of such Person's properties, assets, books, contracts, commitments, reports and records relating to the Truckers Business and the Assets, as Purchaser shall from time to time reasonably request. In addition, Seller will permit Purchaser and Purchaser's accountants, counsel, consultants, employees and agents, reasonable access to such personnel of Seller during normal business hours as may be necessary or useful to Purchaser in its review of the properties, assets and business affairs of the Seller relating to the Truckers Business and the above-mentioned documents, records and information. Seller will endeavor to keep Purchaser generally informed as to the affairs of the Truckers Business. (b) Seller will retain all books and records relating to the Truckers Business in accordance with Seller's record retention policies as presently in effect. 4.1.4 Public Announcements. Except as required by Applicable Law, Seller shall not, and shall not permit any Affiliate to, make any public 23 announcement in respect of this Agreement or the transactions contemplated hereby without the prior written consent of Purchaser. 4.1.5 Further Actions (a) Seller agrees to use all reasonable good faith efforts to take all actions and to do all things reasonably necessary, proper or advisable to consummate the transactions contemplated hereby on the expected Closing Date. (b) Seller will, as promptly as practicable, file or supply, or cause to be filed or supplied, all applications, notifications and information required to be filed or supplied by it pursuant to Applicable Law in connection with this Agreement, the Collateral Agreements, the sale and transfer of the Truckers Business and the Assets pursuant to this Agreement and the consummation of the other transactions contemplated hereby and thereby. (c) Seller shall, as promptly as practicable, use all reasonable efforts to obtain, or cause to be obtained, all Consents (including, without limitation, all Governmental Approvals and any Consents required under any Contract) necessary to be obtained by Seller in order to consummate the sale and transfer of the Truckers Business and the Assets pursuant to the Agreement and the consummation of the other transactions contemplated hereby. (d) Seller shall, and shall cause each of its Affiliates to, coordinate and cooperate with Purchaser in exchanging such information and supplying such assistance as may be reasonably requested by Purchaser in connection with the filings and other actions contemplated by Section 4.2.2. (e) At all times prior to the Closing, Seller shall promptly notify Purchaser in writing of any fact, condition, event or occurrence that will or may result in the failure of any of the conditions contained in Sections 5.1 and 5.2 to be satisfied in any material respect, promptly upon becoming aware of the same. 4.1.6 Further Assurances. Following the Closing, Seller shall, and shall cause each of its Affiliates to, from time to time, execute and deliver such additional instruments, documents, conveyances or assurances and take such other actions as shall be necessary, or otherwise reasonably requested by Purchaser, to confirm and assure the rights and obligations provided for in this Agreement and in the Collateral Agreements to which it is a party and to render effective the consummation of the transactions contemplated thereby. 24 4.1.7 Disclosure Memorandum [Intentionally Omitted.] 4.1.8 Enforcement of Rights and Non-Competition Agreement (a) Cooperation in Enforcement of Rights. On and after the Closing Date, to the extent required to allow Purchaser to avail itself of any rights acquired or liabilities assumed hereunder and to exercise all legal, equitable and contractual rights acquired or liabilities assumed by Purchaser and HCCH hereunder, Seller shall, and shall cause its Affiliates to, at the request of Purchaser, cooperate with Purchaser in taking timely legal action and exercising all legal, equitable and contractual rights that may be available to Seller with respect thereto. (b) Support of Marketing Efforts of Purchaser. On and after the Closing Date, Purchaser shall have the exclusive right to market the Truckers Business through the Producers. Seller shall take any and all other commercially reasonable steps and actions that may be requested by Purchaser to effect the appointment of all Producers as agents of Purchaser, and to notify promptly such Producers of the assignment of their contracts to Purchaser with respect to the Truckers Business. (c) Non-Competition. Seller acknowledges and agrees that the Purchase Price paid by Purchaser to Seller for the Truckers Business and the Assets has been calculated and based upon, among other things, the present and future value of the Truckers Business. and the ability of Purchaser to conserve the Truckers Business following the Closing Date through the use of the Producers currently marketing and servicing the Policies under the Program Manager's Agreement in the continued marketing and servicing of the Policies, and that Purchaser's conservation efforts, and the future value of the Truckers Business, will be enhanced substantially by reason of the continued relationship among the Producers, Purchaser and RNRS. Seller recognizes and agrees that the nature of the Truckers Business is a national business throughout the continental United States of America, and that Purchaser will, after the Closing Date, continue to market the Truckers Business throughout the continental United States through a variety of channels, including by means of its own employees, brokers, representatives, agents, Producers, and otherwise. Seller also recognizes Purchaser's interest in protecting the Truckers Business and the establishment and maintenance of good relationships with the Producers and RNRS, and that such interest gives rise to Purchaser's desire to restrain Seller and the Principals, and their respective successors and assigns, from competing with 25 Purchaser in any Competitive Business for a reasonable period of time and within reasonable geographic limits after the Closing Date. Therefore, Seller agrees to enter into this covenant not to compete with Purchaser and shall cause each of the Principals to enter into the Noncompetition Agreements with Purchaser in consideration of the Purchaser's payment of the Purchase Price and the other agreements and covenants contained in this Agreement. ln consideration of the foregoing, Seller agrees that, during the ten (10) year period following the Effective Date, or for such shorter period during which Purchaser or its successors or assigns shall engage in the Truckers Business and except as may be specifically requested by Purchaser in writing or as otherwise required, permitted or contemplated under this Agreement, Seller will not, directly or indirectly, alone or with or through any other Person or entity, as a member of a partnership, limited liability company, or other business entity or as an investor in any security of any class (except for ownership of the HCCH Shares or as an investor in less than 5% of any outstanding equity securities of any corporation, partnership, limited liability company or other business entity), or as a consultant, advisor, agent, representative of any business entity, or through any officer, director, agent, employee, or Affiliate of the Seller, their successors or assigns, or by any contract, agreement, arrangement or understanding with any other Person or business entity, engage in a Competitive Business in any state, district or jurisdiction in the continental United States of America. Seller and Purchaser recognize and agree that Purchaser's enforcement of this covenant and the Noncompetition Agreements is necessary to prevent irreparable harm and damage to the Truckers Business acquired by Purchaser under this Agreement, and that the limitations as to time, geographical area and the scope of activity restrained hereby are reasonable and do not impose on Seller and the Principals any greater restraint than is necessary to protect the Truckers Business and Purchaser's relationships with the Producers and RNRS. If Seller or any of the Principals commits a breach, or threatens to commit a breach, of any of the provisions of this Section 4.1.8 or of the Noncompetition Agreements, Purchaser shall have the right and remedy, in addition to any other remedies available to it at law or in equity: (i) to have the provisions of this Section 4.1.8 specifically enforced by any court having equity jurisdiction, including, without limitation, immediate injunctive relief, it being acknowledged and agreed by Seller that any such breach or threatened breach will cause irreparable injury or harm to Purchaser and that 26 money damages will not provide an adequate remedy to Purchaser; and (ii) to require Seller and the Principals to account for and pay over to Purchaser all compensation, profits, monies, accruals, increments or other benefits (collectively, "Benefits") derived or received by Seller or the Principals as the result of any transactions constituting a breach of any of the provisions of this Section 4.1.8, and Seller hereby agrees to account for and pay over such Benefits to Purchaser; and (iii) to recover from Seller reasonable attorney's fees and expenses incurred by Purchaser in connection with any proceedings to enforce the provisions of this Section 4.1.8. (d) Each of the rights and remedies enumerated in this Section 4.1.8 shall be independent of the other, and shall be severally enforceable, and such rights and remedies shall be in addition to, and not in lieu of, any other rights and remedies available to Purchaser under law or in equity. In the event that Purchaser prevails in any action or proceeding in any court of competent jurisdiction that, results in a finding that this covenant or any of the Noncompetition Agreements have been breached or violated by Seller or any of the Principals, then the parties agree that, in addition to any other damages awarded to Purchaser for such violation or breach, the Seller shall pay to Purchaser an amount equal to two and one-half (2 1/2) times the total amount of damages, costs and attorney's fees awarded Purchaser by the court in any such court proceedings, not to exceed the Purchase Price as adjusted pursuant to Section 1.5. (e) If any provision of this Section 4.1.8 is held to be unenforceable because of the scope, duration or area of its applicability, the tribunal making such determination shall have the power to modify such scope, duration, or area, or all of them, and such provision or provisions shall then be applicable in such modified form. 4.1.9 Transition Team. Seller hereby designates Sue Carson and Bernadette Leiggi (the "Designated Employees") to assist in the orderly transfer of the Truckers Business from Seller to Purchaser ("Transition Services") during a period not less than six (6) months nor longer than one year from the Closing Date (the "Transition Period"). During the Transition Period, Seller shall provide and bear the cost of office space and related office furniture and equipment, 27 including, without limitation, computers, copy machines, facsimile machines, and other equipment customarily required in the operation of a managing general insurance agency, to support the Designated Employees in providing Transition Services to the Purchaser. Section 4.2 Covenants of Purchaser 4.2.1 Public Announcements. Prior to the Closing, except as required by Applicable Law, Purchaser and HCCH shall not, and shall not permit their Affiliates to, make any public announcement in respect of this Agreement or the transactions contemplated hereby without the prior written consent of Seller. 4.2.2 Further Actions (a) Purchaser and HCCH agree to use all commercially reasonable efforts in good faith to take all corporate and other actions and to do all things necessary, proper or advisable to consummate the transactions contemplated hereby by the expected Closing Date, including, without limitation, the issuance of the HCCH Shares to Purchaser by HCCH. (b) Purchaser and HCCH will, as promptly as practicable, file or supply, or cause to be filed or supplied, all applications, notifications and information required to be filed or supplied by Purchaser or HCCH pursuant to Applicable Law in connection with this Agreement, the Collateral Agreements to which they may be a party, the acquisition of the Assets pursuant to this Agreement, and the consummation of the other transactions contemplated hereby and thereby. (c) Purchaser and HCCH will coordinate and cooperate with Seller in exchanging such information and supplying such reasonable assistance as may be reasonably requested by Seller in connection with the filings and other actions contemplated by Section 4.1.6. (d) At all times prior to the Closing, Purchaser and HCCH shall promptly notify Seller in writing of any fact, condition, event or occurrence that will or may result in the failure of any of the conditions contained in Sections 5.1 and 5.3 to be satisfied, promptly upon becoming aware of the same. 4.2.3 Further Assurances. Following the Closing, Purchaser and HCCH shall, and shall cause its Subsidiaries and Affiliates to, from time to time, execute and deliver such additional instruments, documents, conveyances or assurances and take such other actions as shall be necessary, or otherwise reasonably 28 requested by Seller, to confirm and assure the rights and obligations provided for in this Agreement and in the Collateral Agreements and render effective the consummation of the transactions contemplated hereby and thereby. On or before the Closing Date, HCCH will make application to the New York Stock Exchange and will use reasonable commercial efforts to have the HCCH Shares listed thereon. 4.2.4 Rule 144. HCCH covenants and agrees that, for so long as it may be required to file reports under the Securities Act or the Exchange Act, as the case may be, it will undertake to file any reports that may be required to be filed by it under the Securities Act and the Exchange Act and that it will take such further action as Seller may reasonably request, from time to time, to the extent required to enable the Holders of the HCCH Shares to sell any of the HCCH Shares without registration under the Securities Act within the limitations or the exemptions provided by (a) Rule 144 under the Securities Act, as such rule may be amended from time to time, or (b) any similar or successor rule or regulation hereinafter adopted by the Securities and Exchange Commission. Upon the written request of Seller, HCCH will deliver to the Holders a written statement as to whether it has complied with such filing requirements. 4.2.5 Expenses of Transition Team. During the Transition Period, Purchaser agrees to reimburse Seller for fifty percent (50.0%) of the base salaries of the Designated Employees, and all telephone, facsimile, stationery and travel expenses incurred by the Designated Employees in connection with the rendering of Transition Services to Purchaser. Purchaser may, in its sole discretion and by providing notice in writing to Seller in the manner provided in this Agreement, terminate the Transition Period at any time after six (6) months thereof following the Closing Date; and shall not, on and after the date specified in such notice, be responsible for reimbursement of any salaries or other expenses of the Designated Employees other than salaries and expenses incurred prior to the date specified in the notice, and the Transition Period shall terminate upon such date. Upon such termination by Purchaser, Seller shall be relieved of any further obligation to provide Transition Services to Purchaser, but may, in its sole discretion, continue to provide such Transition Services and make available the services of the Designated Employees, at the sole expense of Seller. If Purchaser elects to terminate the Transition Period at any time prior to one year following the Closing Date, it will furnish Seller with monthly production reports of New Business for the remainder of the Measurement Period. 4.2.6 Access and Information. From the date of this Agreement and until the date of payment of any refund of any portion of the Purchase Price that may be required pursuant to the provisions of Section 1.5, Purchaser will (and will cause its Affiliates and their respective accountants, counsel, consultants, employees and agents) to give Seller and its accountants, counsel, consultants, employees and agents, full access during normal business hours to, and furnish them with all documents, records, work papers and information with respect to, 29 all of such Person's properties, assets, books, contracts, commitments, reports and records relating to the Truckers Business and the Assets, including, without limitation, the Billed Premium for New Business during the Measurement Period, as Seller shall from time to time reasonably request in connection with Purchaser's calculation of the Adjusted Gross Premium pursuant to the provisions of Section 1.5. In addition, Purchaser will permit Seller and Seller's accountants, counsel, consultants, employees and agents, reasonable access to such personnel of Purchaser during normal business hours as may be necessary or useful to Seller in its review of the calculation of the Adjusted Gross Premium by Purchaser. 4.2.7 Material Adverse Changes. From the date of this Agreement to the Closing Date, Purchaser and HCCH shall provide Seller with all information which Purchaser and HCCH are required to disclose to the public that may have a Material Adverse Effect upon the business or financial condition of HCCH or Purchaser, such disclosure to be made no later than the time such information is first disclosed by HCCH and/or Purchaser to the public. 4.2.8 Collection of Receivables for Seller. On and after the Closing Date, Purchaser shall use commercially reasonable efforts to collect all receivables, notes, bonds and other evidences of indebtedness of and rights to receive payments from any Person relating to the Truckers Business for any period prior to the Effective Date, and promptly account for and pay over to Seller any such amounts collected by Purchaser and due Seller. ARTICLE 5 CONDITIONS PRECEDENT Section 5.1 Conditions to Obligations of Each Party. The obligations of the parties to consummate the transactions contemplated hereby shall be subject to the fulfillment on or prior to the Closing Date of the following conditions: 5.1.1 No Injunction, Etc. Consummation of the transactions contemplated hereby shall not have been restrained, enjoined or otherwise prohibited by any applicable Law, including any order, injunction, decree or judgment of any court or other Governmental Authority. No court or other Governmental Authority shall have determined any Applicable Law to make illegal the consummation of the transactions contemplated hereby or by the Collateral Agreements, and no proceeding with respect to the application of any such Applicable Law to such effect shall be pending. Section 5.2 Conditions to Obligations of Purchaser and HCCH. The obligations of Purchaser and HCCH to consummate the transactions contemplated hereby shall be subject to the fulfillment (or waiver by Purchaser and HCCH) 30 on or prior to the Closing Date of the following additional conditions, which Seller agrees to use reasonable good faith efforts to cause to be fulfilled: 5.2.1 Representations, Performance. The representations and warranties of Seller contained in this Agreement and in the Collateral Agreements to which it is a party (i) shall be true and correct in all respects (in the case of any representation or warranty containing any materiality qualification) or in all material respects (in the case of any representation or warranty without any materiality qualification) at and as of the date hereof, and (ii) shall be repeated and shall be true and correct in all respects (in the case of any representation or warranty containing any materiality qualification) or in all material respects (in the case of any representation or warranty without any materiality qualification) on and as of the Closing Date with the same effect as though made on and as of the Closing Date. Seller shall have duly performed and complied in all material respects with all agreements and conditions required by this Agreement and each of the Collateral Agreements to which it is a party to be performed or complied with by it prior to or on the Closing Date. Seller shall have delivered or shall cause to be delivered to Purchaser a certificate, dated the Closing Date and signed by the duly authorized officers of Seller, to the foregoing effect. 5.2.2 Consents. Seller shall have obtained and shall have delivered or caused to be delivered to Purchaser copies of (i) all Governmental Approvals required to be obtained by Seller in connection with the execution and delivery of this Agreement and the Collateral Agreements to which Seller is a party and the consummation of the transactions contemplated hereby or thereby and (ii) subject to Section 2.5.5, all Consents (including, without limitation, all Consents required under any Contract material to the transfer of the Assets or the operation of the Truckers Business) necessary to be obtained in order to consummate the sale and transfer of the Assets pursuant to this Agreement and the consummation of the other transactions contemplated thereby and by the Collateral Agreements. 5.2.3 No Material Adverse Effect. Except as set forth in Schedule 3.1.8, no event, occurrence, fact, condition, change, development or effect shall have occurred, existed or come to exist that, individually or in the aggregate, has constituted or resulted in, or could reasonably be expected to constitute or result in, a Material Adverse Effect on the Truckers Business or the Assets. 5.2.4 Collateral Agreements. Purchaser shall have received each of the following agreements, in each case duly executed by the other parties thereto: (a) the Software License Agreement; (b) the Noncompetition Agreements. 31 5.2.5 Corporate Proceedings. All corporate and other proceedings of Seller in connection with this Agreement and the Collateral Agreements and the transactions contemplated hereby and thereby, and all documents and instruments incident hereto and thereto, shall be reasonably satisfactory in substance and form to Purchaser and HCCH and its counsel, and Purchaser and HCCH and its counsel shall have received all such documents and instruments, or copies thereof, certified if requested, as may be reasonably requested. 5.2.6 Transfer Documents. Seller shall have delivered or shall have caused to be delivered to Purchaser and HCCH at the Closing all documents, certificates and agreements necessary to transfer to Purchaser good and marketable title to the Truckers Business and the Assets, free and clear of any and all Liens thereon, other than Permitted Liens, including, without limitation: (a) an assignment and general conveyance, in form and substance reasonably satisfactory to Purchaser and HCCH, dated the Closing Date, with respect to the Assets (other than any Asset to be transferred pursuant to any of the instruments referred to in any other clause of this Section 5.2.6); and (b) assignments of all Contracts and any other agreements and instruments constituting a part of the Truckers Business and Assets to be transferred to Purchaser hereunder, dated the Closing Date, assigning to Purchaser all of Seller's right, title and interest therein and thereto with respect to Billed Premium for any period on and after the Effective Date, with any required Consent endorsed thereon; and (c) an assignment of Leases, dated as of the Closing Date, with respect to each Lease of Seller utilized in connection with the Truckers Business, including office equipment leases, in form and substance reasonably satisfactory to Purchaser, together with any necessary transfer declarations or other filings. 5.2.7 New Program Manager's Agreement. The Purchaser shall have entered into the New Program Manager's Agreement with RNRS substantially upon the terms set forth in Exhibit E. 5.2.8 Investment Letter. Each Holder shall have delivered an investment letter to HCCH in substantially the form attached hereto as Exhibit C. Section 5.3 Conditions to Obligations of Seller. The obligation of Seller to consummate the transactions contemplated hereby shall be subject to the fulfillment (or waiver by Seller), on or prior to the Closing Date, of the following additional conditions, which HCCH and Purchaser agree to use reasonable good faith efforts to cause to be fulfilled. 32 5.3.1 Representations, Performance. The representations and warranties of Purchaser and HCCH contained in this Agreement and the Collateral Agreements shall be true and correct in all respects (in the case of any representation or warranty containing any materiality qualification) or in all material respects (in the case of any representation or warranty without any materiality qualification) at and as of the date hereof and (ii) shall be repeated and shall be true and correct in all respects (in the case of any representation or warranty containing any materiality qualification) or in all material respects (in the case of any representation or warranty without any materiality qualification) on and as of the Closing Date with the same effect as though made at and as of such time. Purchaser and HCCH shall have duly performed and complied in all material respects with all agreements and conditions required by this Agreement and the Collateral Agreements to be performed or complied with by them prior to or on the Closing Date. Purchaser shall have delivered to Seller a certificate, dated the Closing Date and signed by a duly authorized officers of Purchaser and HCCH, to the foregoing effect. 5.3.2 Corporate Proceedings. All corporate proceedings of Purchaser and HCCH in connection with this Agreement, the Collateral Agreements and the transactions contemplated hereby and thereby, and all documents and instruments incident hereto and thereto, shall be reasonably satisfactory in substance and form to Seller, and its counsel, and Seller and its counsel shall have received all such documents and instruments, or copies thereof, certified if requested, as may be reasonably requested. 5.3.3 Consents and Approvals. Seller shall have obtained all Governmental Approvals necessary to consummate the transactions contemplated hereby. 5.3.4 Collateral Agreements. Purchaser and HCCH shall have entered into each of the Collateral Agreements to which it is a party, and Seller shall have received the Assumption Agreement, duly executed by an officer of Purchaser. 5.3.5 No Material Adverse Effect. Except as set forth on Schedule 3.3.7, no event, occurrence, fact, condition, change, development or effect shall have occurred, existed or come to exist that, individually or in the aggregate, has constituted or resulted in, or could reasonably be expected to constitute or result in, a Material Adverse Effect on Purchaser or HCCH. 33 ARTICLE 6 TERMINATION Section 6.1 Termination. This Agreement may be terminated at any time prior to the Closing Date: (a) by the written agreement of Purchaser and Seller; (b) by either Seller or Purchaser by written notice to the other party if the transactions contemplated hereby shall not have been consummated pursuant hereto by 5:00 p.m. Central Standard Time, on January 31, 1997, unless such date shall be extended by the mutual written consent of Seller and Purchaser; (c) by Purchaser by written notice to Seller if (i) the representations and warranties of Seller shall not have been true and correct in all respects (in the case of any representation or warranty containing any materiality qualification) or in all material respects (in the case of any representation or warranty without any materiality qualification) as of the date when made or (ii) if any of the conditions set forth in Section 5.1 or 5.2 shall not have been, or if it could not reasonably be expected that any of such conditions will be, fulfilled by 5:00 p.m. Central Standard Time, on January 31, 1997, unless such failure shall be due to the failure of Purchaser or HCCH to perform or comply with any of the covenants, agreements or conditions hereof to be performed or complied with by them prior to the Closing; or (d) by Seller by written notice to Purchaser if (i) the representations and warranties of Purchaser or HCCH shall not have been true and correct in all respects (in the case of any representation or warranty containing any materiality qualification) or in all material respects (in the case of any representation or warranty without any materiality qualification) as of the date when made or (ii) if any of the conditions set forth in Section 5.1 or 5.3 shall not have been, or if it could not reasonably be expected that any of such conditions will be, fulfilled by 5:00 p.m. Central Standard Time on January 31, 1997, unless such failure shall be due to the failure of Seller to perform or comply with any of the covenants, agreements or conditions hereof to be performed or complied with by them prior to the Closing. Section 6.2 Effect of Termination. In the event of the termination of this Agreement pursuant to the provisions of Section 6.1, this Agreement shall become void and have no effect, without any liability to any Person in respect hereof or of the transactions contemplated hereby on the part of any party hereto, or any of its directors, officers, employees, agents, consultants, representatives, advisers, stockholders or Affiliates, except as specified in Section 9.2 and except for any liability resulting from such party's breach of this Agreement. 34 ARTICLE 7 INDEMNIFICATION Section 7.1 By Seller. Seller shall defend, indemnify and hold harmless HCCH and Purchaser, their respective officers, directors, employees, agents, advisers, representatives in such capacities and Affiliates (collectively, the "Purchaser Indemnitees") from and against, and pay or reimburse Purchaser Indemnitees for, any and all claims, liabilities, obligations, losses, fines, costs, royalties, proceedings, deficiencies or damages (whether absolute, accrued, conditional or otherwise and whether or not resulting from third party claims), including expenses paid to third parties and reasonable outside attorneys' and accountants' fees incurred in the investigation or defense of any of the same or in asserting any of their respective rights hereunder (collectively, "Losses"), resulting from or arising out of: (i) any inaccuracy of any representation or warranty by Seller made or contained in this Agreement or in any Collateral Agreement to which it is a party or in connection herewith or therewith; (ii) any failure of Seller to perform in any material respect any covenant or agreement hereunder or under any Collateral Agreement to which it is a party or to fulfill any other obligation in respect hereof or of any Collateral Agreement to which it is a party; (iii) any Excluded Liabilities or Excluded Assets; and (iv) any and all Taxes of Seller and all Affiliates thereof not relating to or arising out of the Truckers Business. Notwithstanding anything in this Agreement to the contrary, the maximum aggregate amount recoverable by Purchaser Indemnitees for all claims for indemnification under this Agreement under this Section 7.1 shall, in the aggregate, not exceed the Purchase Price. Section 7.2 By Purchaser and HCCH. Purchaser and HCCH shall defend, indemnify and hold harmless Seller and its officers, directors, employees, agents, advisers, representatives and Affiliates (collectively, the "Seller Indemnitees") from and against any and all Losses resulting from or arising out of: (i) any inaccuracy in any representation or warranty by Purchaser or HCCH made or contained in this Agreement or in any Collateral Agreement to which it is a party or in connection herewith or therewith; or (ii) any failure of Purchaser or HCCH to perform in any material respect any covenant or agreement hereunder or under any Collateral 35 Agreement to which it is a party or fulfill any other obligation in respect hereof or thereof; (iii) the Assumed Liabilities; (iv) any Taxes relating to the Truckers Business for any period on and after the Effective Date; and (v) the operation of the Truckers Business by Purchaser or Purchaser's ownership, operation or use of the Assets following the Closing Date, except, in the case of clause (v), to the extent such Losses result from or arise out of the Excluded Liabilities or constitute Losses for which Seller is required to indemnify Purchaser Indemnitees under Section 7.1. Section 7.3 Adjustments to Indemnification Payments. Any payment made by Seller to Purchaser Indemnities, on the one hand, or by Purchaser to the Seller Indemnities, on the other hand, pursuant to this Article 7 in respect of any claim (i) shall be net of any insurance proceeds realized by and paid to the Indemnified Party in respect of such claim and (ii) shall be (A) reduced by an amount equal to any Tax benefits attributable to such claim and (B) increased by an amount equal to any Taxes attributable to the receipt of such payment, but only to the extent that such Tax benefits are actually realized, or such Taxes are actually paid, as the case may be, by Seller or by Purchaser or by any consolidated, combined or unitary group of which Purchaser or Seller is a member. The Indemnified Party shall use its reasonable efforts to make insurance claims relating to any claim for which it is seeking indemnification pursuant to this Article 7; provided that the Indemnified Party shall not be obligated to make such an insurance claim if the Indemnified Party in its reasonable judgment believes that the cost of pursuing such an insurance claim together with any corresponding increase in insurance premiums or other chargebacks to the Indemnified Party, as the case may be, would exceed the value of the claim for which the Indemnified Party is seeking indemnification. Section 7.4 Indemnification Procedures. In the case of any claim asserted by a third party against a party entitled to indemnification under this Agreement (the "Indemnified Party"), notice shall be given by the Indemnified Party to the party required to provide indemnification (the "Indemnifying Party") promptly after such Indemnified Party has actual knowledge of any claim as to which indemnity may be sought, and the Indemnified Party shall permit the 36 Indemnifying Party (at the expense of such Indemnifying Party) to assume the defense of any claim or any litigation resulting therefrom, provided that (i) the counsel for the Indemnifying Party who shall conduct the defense of such claim or litigation shall be reasonably satisfactory to the Indemnified Party, (ii) the Indemnified Party may participate in such defense at such Indemnified Party's expense, and (iii) the omission by any Indemnified Party to give notice as provided herein shall not relieve the Indemnifying Party of its indemnification obligation under this Agreement except to the extent that such omission results in a failure of actual notice to the Indemnifying Party and such indemnifying Party is materially damaged as a result of such failure to give notice. Except with the prior written consent of the Indemnified Party, no Indemnifying Party, in the defense of any such claim or litigation, shall consent to entry of any judgment or enter into any settlement that provides for injunctive or other nonmonetary relief affecting the Indemnified Party or that does not include as an unconditional term thereof the giving by each claimant or plaintiff to such Indemnified Party of a release from all liability with respect to such claim or litigation. In the event that the Indemnified Parry shall in good faith determine that the conduct of the defense of any claim subject to indemnification hereunder or any proposed settlement of any such claim by the Indemnifying Party might be expected to affect adversely the Indemnified Party's Tax liability or the ability of Purchaser to conduct its business, or that the Indemnified Party may have available to it one or more defenses or counterclaims that are inconsistent with one or more of those that may be available to the Indemnifying Party in respect of such claim or any litigation relating thereto, the Indemnified Party shall have the right at all times to take over and assume control over the defense, settlement, negotiations or litigation relating to any such claim at the sole cost of the Indemnifying Party, provided that if the Indemnified Party does so take over and assume control, the Indemnified Party shall not settle such claim or litigation without the written consent of the Indemnifying Parry, such consent not to be unreasonably withheld. In the event that the Indemnifying Party does not accept the defense of any matter as above provided, the Indemnified Parry shall have the full right to defend against any such claim or demand and shall be entitled to settle or agree to pay in full such claim or demand. In any event, the Indemnifying Party and the Indemnified Party shall cooperate in the defense of any claim or litigation subject to this Section 7 and the records of each shall be available to the other with respect to such defense. Section 7.5 Limits on Indemnification. Anything in this Agreement to the contrary notwithstanding, claims for indemnification of Losses hereunder shall not be made by any party unless the aggregate amount of such Losses exceeds Twenty-Five Thousand Dollars ($25,000.00) ("Threshold Amount"), and Seller shall have no obligation for any Losses in excess of the Purchase Price, as adjusted pursuant to Section 1.5. In the event the aggregate Losses for which any claim of indemnification is made exceed the Threshold Amount, the Indemnifying Party shall be liable for the full amount of such Losses, subject to the limitations set forth herein. ARTICLE 8 DEFINITIONS AND CONSTRUCTION Section 8.1 Definition of Certain Terms. Capitalized words and terms used in this Agreement, but not otherwise defined in this Article 8, shall have the meaning given them in the other Articles of this Agreement where such words or terms are first used and defined. Except as otherwise expressly provided or unless the context otherwise requires, the terms defined in this Section 8.1, whenever used in this Agreement (including in the Schedules), shall have the respective meanings assigned to them in this Section for all purposes of this Agreement, and include the plural as well as the singular. Adjusted Gross Premium: as defined in Section 1.5. 37 Affiliate: of a Person means a Person that directly or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with, the first Person. "Control" (including the terms "controlled by" and "under common control with") means the possession, directly or indirectly, of the power to direct or cause the direction of the management policies of a person, whether through the ownership of voting securities, by contract or credit arrangement, as trustee or executor, or otherwise. Agreement: this instrument as originally executed, including the Schedules hereto, or as it may be from time to time supplemented or amended by one or more supplements or amendments hereto entered pursuant to the applicable provisions hereof. Applicable Law: all applicable provisions of all (i) constitutions, treaties, statutes, laws (including the common law), rules, regulations, ordinances, codes or orders of any Governmental Authority, (ii) Governmental Approvals and (iii) orders, decisions, injunctions, judgments, awards and decrees of or agreements with any Governmental Authority. Assets: as defined in Section 1.1. Assumed Liabilities: as defined in Section 1.4.1 Assumption Agreement: as defined in Section 1.4.1, and in substantially the form of Exhibit A. Balance Sheet: the balance sheet contained in the Unaudited Financial Statements. Balance Sheet Date: as defined in Section 3.1.4. Billed Premium: premium billed in connection with the Policies or New Business. Closing: as defined in Section 2.1. Closing Date: as defined in Section 2.1. Code: the Internal Revenue Code of 1986, as amended. Collateral Agreements: the agreements and other documents and instruments described in Sections 5.2.4, 5.2.7, 5.2.8, & 5.3.4 the agreements in substantially the form set forth on the Exhibits attached to this Agreement. Competitive Business: Any business engaged as an agent or producer (other than as an agent for Purchaser), managing general agent or 38 underwriter for primary insurers in the offering, sale, solicitation, marketing, development, issuance or promotion of (a) occupational accident insurance issued to provide medical and indemnity benefits for work-related injuries to sole proprietor truckers, independent owner/operators of trucking companies, and independent operators or non-employee drivers of trucks owned by other Persons ("Sole Proprietor Truckers"); (b) related workers compensation insurance issued to Sole Proprietor Truckers who are not, as of the Effective Date, required by law to obtain workers compensation insurance and (c) liability policies or certificates of insurance, other than workers compensation insurance, issued primarily to indemnify insureds against claims by Sole Proprietor Truckers for benefits under a workers compensation statute or similar law. Purchaser acknowledges and agrees that Seller, either directly or indirectly through Affiliates or the Principals, or by contract, agreement or arrangement, is currently engaged in, and will continue to engage in after the Closing Date, the offering, sale, solicitation, marketing, development, issuance and promotion of (i) workers compensation insurance programs and products to Persons and entities other than to Sole Proprietor Truckers who are not required by law to obtain workers compensation insurance, (ii) reinsurance relating to the types of insurance described in clauses (a), (b) and (c) of this definition, (iii) administration of claims made under insurance policies for the types of insurance described in clauses (a), (b) and (c) of this definition and (iv) insurance programs and products other than those described in clauses (a), (b) and (c) of this definition; and, notwithstanding anything to the contrary contained herein or in any other agreement, Purchaser acknowledges and agrees that none of the activities described in clauses (i), (ii), (iii) and (iv) shall be considered to be a Competitive Business. Consent: any consent, approval, authorization, waiver, permit, grant, franchise, concession, agreement, license, exemption or order of, registration, certificate, declaration or filing with, or report or notice to, any Person, including but not limited to any Governmental Authority. Contract: as defined in Section 3.1.12(a). Covered Returns: as defined in Section 3.1.6(a). Covered Taxes: all Taxes relating to or assessed by reason of the Truckers Business or the Assets. Designated Employees: those employees of Seller designated in Section 4.1.9. Disclosure Memorandum: as defined in Section 4.1.8. Dollars or $: lawful money of the United States. Effective Date: 12:01 a.m. on December 1, 1996. 39 Exchange Act: the Securities Exchange Act of 1934, as amended. Excluded Assets: as defined in Section 1.1.3. Excluded Liabilities: as defined in Section 1.4.2. Expirations: all binding authority of Seller under the Program Manager's Agreement, including records and files of Seller for the solicitation and sale of Truckers Business written or bound through Seller under the Program Manager's Agreement. Fiduciary Account: any bank account or accounts maintained by Seller as trustee for RNRS for all premiums collected and received by Seller for Truckers Business written under the Program Manager's Agreement. Financial Statement Date: as defined in Section 3.1.4. Financial Statements: each of the financial statements required to be provided by Section 3.1.4. GAAP: generally accepted accounting principles as in effect in the United States. Government Approval: any Consent of, with or to any Governmental Authority. Governmental Authority: any nation or government, any state or other political subdivision thereof, any entity exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government, including, without limitation, any government authority, insurance regulatory authority, insurance director, commissioner or superintendent, or any agency, department, board, commission or instrumentality of the United States, any State of the United States or any political subdivision thereof, and any tribunal or arbitrator(s) of competent jurisdiction, and any self-regulatory organization. HCCH Balance Sheet: as defined in Section 3.3.5. HCCH Balance Sheet Date: as defined in Section 3.3.5. HCCH Common Stock: as defined in Section 1.3.1(a). HCCH Shares: as defined in Section 1.3.1(a). Holder: as defined in Section 3.2.1. Indemnified Party: as defined in Section 7.4. 40 Indemnifying Party: as defined in Section 7.4. IRS: the Internal Revenue Service. Leases: means all real property leases, subleases, licenses and occupancy agreements pursuant to which Seller is the lessee, sublessee, licensee or occupant other than real property leases, subleases, licenses and occupancy agreements included in Excluded Assets, and all equipment leases, licenses, licensing arrangements and other contracts providing in whole or in part for the use of, or limiting the use of, any copiers, office equipment, telephone systems, computers or data processing equipment or software relating to the Truckers Business. Lien: any mortgage, pledge, hypothecation, right of others, claim, security interest, encumbrance, lease, sublease, license, occupancy agreement, adverse claim or interest, easement, covenant, encroachment, burden, title defect, title retention agreement, voting trust agreement, interest, equity, option, lien, right of first refusal, charge or other restrictions or limitations of any nature whatsoever, including but not limited to such as may arise under any Contracts. Losses: as defined in Section 7.1. Material Adverse Effect: any event, occurrence, fact, condition, change or effect that is materially adverse to the business, operations, results of operations, condition (financial or otherwise), properties (including intangible properties), assets (including intangible assets) or liabilities of any Person. Minimum Premium: as defined in Section 1.5. New Business: Policies issued by RNRS or any other insurer written or renewed on or after the Effective Date for any Policyholder listed on Schedule 3.1.14 or by any Producer of Seller listed on Schedule 3.1.14. New Program Manager's Agreement: the program manager's agreement upon substantially the terms set forth on Exhibit E. Noncompetition Agreement: the agreements not to compete in substantially the form set forth on Exhibit D. Permitted Liens: (i) Liens reserved against in the Balance Sheet, to the extent so reserved, (ii) Liens for Taxes not yet due and payable or which are being contested in good faith and by appropriate proceedings if adequate reserves with respect thereto are maintained on Seller's books in accordance with GAAP, (iii) Liens listed on the Disclosure Memorandum, or (iv) Liens that, individually and in the aggregate, do not and would not materially detract from the value of any of the Assets or the Truckers Business or materially interfere with the use thereof as currently used or contemplated to be used or otherwise. 41 Person: any natural person, firm, partnership, association, corporation, company, trust, business trust, Governmental Authority or other entity. Policy; Policies: all individual and group policies of insurance (including endorsements), including master policies, certificates of insurance; renewal certificates, or riders, and which constitute part of the Truckers Business. Policyholder(s): as defined in Section 3.1.14. Principals: Robert J. Wojtowicz, John Pallat, Joseph Munson and Joseph Wojtowicz. Producer: any licensed insurance agent, broker, solicitor, representative, or sub-agent of any person recruited by, assigned to or under contract with Seller, and identified on Schedule 3.1.14. Program Manager's Agreement: the agreement, restated August 1, 1996 from the original dated November 17, 1992, by and among Seller and RNRS (on behalf of Reliance Insurance Company and Reliance National Indemnity Company), together with all Exhibits and Schedules thereto, and as the same may be amended, modified or supplemented by the parties thereto from time to time. Prohibited Products: insurance policies or products constituting or relating to a Competitive Business. Purchaser Indemnitees: as defined in Section 7.1. Purchase Price: as defined in Section 1.3.1. RNRS: Reliance National Risk Specialists, a division of Reliance Insurance Company. Securities Act: the Securities Act of 1933, as amended. Seller: as defined in the first paragraph of this Agreement. Software License Agreement: the agreement substantially in the form of Exhibit B. Subsidiary; Subsidiaries: each corporation or other Person in which a Person owns or controls, directly or indirectly, capital stock or other equity interests representing at least 50% of the outstanding voting stock or other equity interests. Supporting Documents: as defined in Section 4.1.8. 42 Tax: any federal, state, provincial, local, foreign or other income, alternative, minimum, accumulated earnings, personal holding company, franchise, capital stock, net worth, capital, profits, windfall profits, gross receipts, value added, sales, use, goods and services, excise, customs duties, transfer, conveyance, mortgage, registration, stamp, documentary, recording, premium, severance, environmental (including taxes under Section 59A of the Code), real property, personal property, ad valorem, intangibles, rent, occupancy, license, occupational, employment, unemployment insurance, social security, disability, workers' compensation, payroll, health care, withholding, estimated or other similar tax, duty or other governmental charge or assessment or deficiencies thereof (including all interest and penalties thereon and additions thereto whether disputed or not). Tax Return: any return, report, declaration, form, claim for refund or information return or statement relating to Taxes, including any schedule or attachment thereto, and including any amendment thereof. Transaction Expenses: as defined in Section 9.2. Transition Period: as defined in Section 4.1.9. Treasury Regulations: the regulations prescribed pursuant to the Code. Truckers Business: the classes of business, products, and Policies of insurance (including all endorsements), and lines and limits of insurance described on Exhibit A to the Program Manager's Agreement, as amended, modified or supplemented by the parties at any time prior to the Closing Date, and which would constitute a Competitive Business if engaged in by Seller or the Principals after the Closing Date. Section 8.2 Rules of Construction (a) "This Agreement" means this instrument as originally executed, including the Schedules hereto, or as it may be from time to time supplemented or amended by one or more supplements or amendments hereto entered pursuant to the applicable provisions hereof; (b) "includes" and "including" are not limiting, and, in each case, shall be construed as if followed by the words "without limitation," "but not limited to" or words of similar import; (c) "may not" is prohibitive, and not permissive; (d) "shall" is mandatory, and not permissive; 43 (e) "or" is not exclusive [i.e., if a party "may do (a), (b) or (c)," then the party may do all of any one of' or any combination of' (a), (b) or (c)] unless the context expressly provides otherwise; (f) all references in this instrument to designated "Articles," "Sections" and other subdivisions are to the designated Articles, Sections and other subdivisions of this instrument as originally executed; (g) the words "herein," "hereof," "hereto" and "hereunder" and other words of similar import refer to this Agreement as a whole and not to any particular Article, Section or other subdivision; (h) all terms used herein which are defined in the Securities Act, the Exchange Act or the rules and regulations promulgated thereunder have the meanings assigned to them therein unless otherwise defined herein; and (i) all accounting terms not otherwise defined herein have the meaning assigned to them in accordance with GAAP. ARTICLE 9 GENERAL PROVISIONS Section 9.1 Survival of Representations and Warranties. The representations and warranties contained in this Agreement shall survive the execution and delivery of this Agreement, any examination by or on behalf of the parties hereto and the completion of the transactions contemplated herein, but only to the extent specified below: (a) except as set forth in clauses (b) and (c) below, the representations and warranties contained in Section 3.1 and Section 3.2 shall survive for a period of two years following the Closing Date; (b) the representations and warranties contained in Sections 3.1.1, 3.1.2, 3.1.3, 3.3.1 and 3.3.2 shall survive without limitation; and (c) the representations and warranties of Seller contained in Section 3.1.6 shall survive as to any Tax covered by such representations and warranties for so long as any statute of limitations for such Tax remains open, in whole or in part, including without limitation by reason of waiver of such statute of limitations. Section 9.2 Expenses. Seller, on the one hand, and Purchaser and HCCH, on the other hand, shall bear their respective expenses, costs and fees (including attorneys', auditors' and financing commitment fees) in connection with the 44 transactions contemplated hereby, including the preparation, execution and delivery of this Agreement and compliance herewith (the "Transaction Expenses"), whether or not the transactions contemplated hereby shall be consummated. Section 9.3 Severability. If any provision of this Agreement, including any phrase, sentence, clause, Section or subsection is inoperative or unenforceable for any reason, such circumstances shall not have the effect of rendering the provision in question inoperative or unenforceable in any other case or circumstance, or of rendering any other provision or provisions herein contained invalid, inoperative, or unenforceable to any extent whatsoever. Section 9.4 Notices. All notices, requests, demands, waivers and other communications required or permitted to be given under this Agreement shall be in writing and shall be deemed to have been duly given if (a) delivered personally, (b) mailed by first-class, registered or certified mail, return receipt requested, postage prepaid, or (c) sent by next-day or overnight mail or delivery or (d) sent by telecopy or telegram, (i) if to Purchaser or HCCH, to: HCC Insurance Holdings, Inc. 13403 Northwest Freeway Houston, Texas 77040-6094 Attention: Stephen L. Way with a copy to: David D. Knoll, Esq. Winstead Sechrest & Minick P.C. 910 Travis, Suite 1700 Houston, Texas 77002-5895 (ii) if to Seller, to: TRM International, Inc. One Cragwood Road South Plainfield, N.J. 07080-1007 Attention: Robert J. Wojtowicz with a copy to: Eric I Cohen, Esquire Robinson Silverman Pearce Aronsohn & Berman LLP 1290 Avenue of the Americas New York, N.Y. 10104 or, in each case, at such other address as may be specified in writing to the other parties hereto. 45 All such notices, requests, demands, waivers and other communications shall be deemed to have been received (w) if by personal delivery on the day after such delivery, (x) if by certified or registered mail, on the seventh business day after the mailing thereof, (y) if by next-day or overnight mail or delivery, on the day delivered, (z) if by telecopy or telegram, on the next day following the day on which such telecopy or telegram was sent, provided that a copy is also sent by certified or registered mail. Section 9.5 Headings. The headings contained in this Agreement are for purposes of convenience only and shall not affect the meaning or interpretation of this Agreement. Section 9.6 Entire Agreement. This Agreement (including the Schedules hereto) and the Collateral Agreements to which all parties hereto are parties thereto (when executed and delivered) constitute the entire agreement and supersede all prior agreements and understandings, both written and oral, between the parties with respect to the subject matter hereof. Section 9.7 Counterparts. This Agreement may be executed in several counterparts, each of which shall be deemed an original and all of which shall together constitute one and the same instrument. Section 9.8 Governing Law, Etc. This Agreement shall be governed in all respects, including as to validity, interpretation and effect, by the internal laws of the State of Illinois, without giving effect to the conflict of laws rules thereof Purchaser and Seller hereby irrevocably submit to the jurisdiction of the courts of the State of Illinois and the Federal courts of the United States of America located in the State of Illinois, City of Chicago and County of Cook, solely in respect of the interpretation and enforcement of the provisions of this Agreement and of the documents referred to in this Agreement, and hereby waive, and agree not to assert, as a defense in any action, suit or proceeding for the interpretation or enforcement hereof or of any such document, that it is not subject thereto or that such action, suit or proceeding may not be brought or is not maintainable in said courts or that the venue thereof may not be appropriate or that this Agreement or any of such document may not be enforced in or by said courts, and the parties hereto irrevocably agree that all claims with respect to such action or proceeding shall be heard and determined in such an Illinois State or Federal court. Purchaser and Seller hereby consent to and grant any such court jurisdiction over the person of such parties and over the subject matter of any such dispute and agree that mailing of process or other papers in connection with any such action or proceeding in the manner provided in Section 9.4, or in such other manner as may be permitted by law, shall be valid and sufficient service thereof. Section 9.9 Binding Effect. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective heirs, successors and permitted assigns. Section 9.10 Assignment. This Agreement shall not be assignable or otherwise transferable by any party hereto without the prior written consent of the other parties hereto. Section 9.11 No Third Party Beneficiaries. Except as provided in Article 7 with respect to indemnification of Indemnified Parties hereunder, nothing 46 in this Agreement shall confer any rights upon any person or entity other than the parties hereto and their respective heirs, successors and permitted assigns. Section 9.12 Amendment; Waivers, Etc. No amendment, modification or discharge of this Agreement, and no waiver hereunder, shall be valid or binding unless set forth in writing and duly executed by the party against whom enforcement of the amendment, modification, discharge or waiver is sought. Any such waiver shall constitute a waiver only with respect to the specific matter described in such writing and shall in no way impair the rights of the party granting such waiver in any other respect or at any other time. Neither the waiver by any of the parties hereto of a breach of or a default under any of the provisions of this Agreement, nor the failure by any of the parties, on one or more occasions, to enforce any of the provisions of this Agreement or to exercise any right or privilege hereunder, shall be construed as a waiver of any other breach or default of a similar nature, or as a waiver of any of such provisions, rights or privileges hereunder. The rights and remedies herein provided are cumulative and are not exclusive of any rights or remedies that any party may otherwise have at law or in equity. The rights and remedies of any party based upon, arising out of or otherwise in respect of any inaccuracy or breach of any representation, warranty, covenant or agreement or failure to fulfill any condition shall in no way be limited by the fact that the act, omission, occurrence or other state of facts upon which any claim of any such inaccuracy or breach is based may also be the subject matter of any other representation, warranty, covenant or agreement as to which there is no inaccuracy or breach. The representations and warranties of Seller shall not be affected or deemed waived by reason of any investigation made by or on behalf of Purchaser (including but not limited to by any of their respective advisors, consultants or representatives) or by reason of the fact that Purchaser or any of such advisors, consultants or representatives knew or should have known that any such representation or warranty is or might be inaccurate. The representations and warranties of Purchaser shall not be affected or deemed waived by reason of any investigation made by or on behalf of Seller (including but not limited to by any of its advisors, consultants or representatives) or by reason of the fact that Seller any of such advisors, consultants or representatives knew or should have known that any such representation or warranty is or might be inaccurate. Section 9.13 Form of Payments by Seller. Any amounts payable by Seller to Purchaser under this Agreement shall be payable in cash, provided, however, if Seller is required to make any payments to Purchaser at any time before the expiration of any holding period for the HCCH Shares required under Securities Act Rule 144, Seller and the Holders may furnish to Purchaser a promissory note or notes bearing interest at the rate of nine percent (9.0%) per annum, secured by such number of the HCCH Shares, as shall be of a value equal to one hundred twenty-five percent (125.0%) of the principal amount of the note(s), payable upon the first date upon which the HCCH shares may be sold by Holders in compliance with Rule 144. 47 IN WITNESS WHEREOF, the parties have duly executed this Agreement as of the date first above written. TRM INTERNATIONAL, INC. By: /s/ Robert J. Wojtowicz --------------------------- Robert J. Wojtowicz President UNICOVER MANAGERS, INC. By: /s/ Illegible --------------------------- Executive Vice President --------------------------- [Title] NORTH AMERICAN SPECIAL RISK ASSOCIATES, INC. By: ------------------------- ------------------------- [Title] HCC INSURANCE HOLDINGS, INC. By: --------------------- Stephen L. Way, Chairman and Chief Executive Officer 48 IN WITNESS WHEREOF, the parties have duly executed this Agreement as of the date first above written. TRM INTERNATIONAL, INC. By: --------------------- Robert J. Wojtowicz President UNICOVER MANAGERS, INC. By: --------------------- --------------------- [Title] NORTH AMERICAN SPECIAL RISK ASSOCIATES, INC. By: /s/ FRANK J. BRAMANTI ----------------------- EVP & SEC ----------------------- [Title] HCC INSURANCE HOLDINGS, INC. By: /s/ FRANK J. BRAMANTI --------------------- Frank J. Bramanti EVP & CFO 48 INDEX OF DEFINED TERMS AAIC 2 Accredited investor 16 Adjusted Gross Premium 4 Affiliate 38 Agreement 1, 38 Applicable Law 38 Assets 1, 38 Assumed Liabilities 4, 38 Assumption Agreement 4, 38 Balance Sheet 38 Balance Sheet Date 38 Billed Premium 38 Closing 5, 38 Closing Date 5, 38 Code 38 Collateral Agreements 38 Consent 39 Contract 39 Contracts 13 Control 38 Covered Returns 10, 39 Covered Taxes 39 Designated Employees 27 Disclosure Memorandum 39 Dollars 39 Exchange Act 40 Excluded Assets 3, 40 Excluded Liabilities 4, 40 Fiduciary Account 40 Financial Statement Date 9 Financial Statements 9, 40 Financial Statement Date 40 GAAP 40 Government Approval 40 Governmental Authority 40 HCCH 1 HCCH Balance Sheet 20, 40 HCCH Balance Sheet Date 20, 40 HCCH Common Stock 3, 40 HCCH Shares 3, 40 Holder 40 Holder(s) 16 Indemnified Party 36, 40 Indemnifying Party 36, 41 49 IRS 41 Leases 41 Lien 41 Losses 35, 41 Material Adverse Effect 41 Measurement Period 4 Minimum Premium 4 New Business 41 New Program Manager's Agreement 41 Non-Competition Agreement 26, 41 Permitted Liens 41 Person 42 Policy; Policies 42 Policyholders 14 Producer 42 Program Manager's Agreement 42 Prohibited Products 42 Purchase Price 3, 42 Purchaser 1 Purchaser Indemnitees 35, 42 RNRS 42 Securities Act 42 Seller l, 42 Seller Indemnitees 35 Subsidiaries 42 Supporting Documents 42 Target Premium 4 Tax 43 Tax Return 43 Transaction Expenses 43, 45 Transition Period 27 Transition Services 27 Treasury Regulations 43 TRM 1 Truckers Business 1, 43 Unicover 1 50 EXHIBIT LIST Reference Exhibit Description 1.4.1 A Assumption Agreement 5.2.5(a) B Employment Agreements 5.2.5(b) C Software License Agreement 5.2.11 D Investment Letter 8.1 E New Program Manager's Agreement 8.1 F Program Manager's Agreement 51 EX-10.332 4 EXHIBIT 10.332 EXHIBIT 10.332 REVOLVING LINE OF CREDIT NOTE $12,000,000.00 Houston, Texas October 7, 1996 FOR VALUE RECEIVED, the undersigned HOUSTON CASUALTY COMPANY ("Borrower") promises to pay to the order of WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION ("Bank") at its office at 1000 Louisiana, Houston, Texas, or at such other place as the holder hereof may designate, in lawful money of the United States of America and in immediately available funds, the principal sum of Twelve Million Dollars ($12,000,000.00), or so much thereof as may be advanced and be outstanding, with interest thereon, to be computed on each advance from the date of its disbursement as set forth herein. INTEREST: (a) Interest. The outstanding principal balance of this Note shall bear interest (computed on the basis of a 360-day year, actual days elapsed, unless such calculation would result in a usurious rate, in which case interest shall be computed on the basis of 365/366-day year, as the case may be, actual days elapsed) at the lesser of (i) a rate per annum equal to the Prime Rate in effect from time to time, or (ii) the Maximum Rate. The "Prime Rate" is a base rate that Bank from time to time establishes and which serves as the basis upon which effective rates of interest are calculated for those loans making reference thereto. Each change in the rate of interest hereunder shall become effective on the date each Prime Rate change is announced within Bank. (b) Payment of Interest. Interest accrued on this Note shall be payable on the first (1st) day of each month, commencing December 1, 1996. BORROWING AND REPAYMENT: (a) Borrowing and Repayment. Borrower may from time to time during the term of this Note borrow, partially or wholly repay its outstanding borrowings, and reborrow, subject to all of the limitations, terms and conditions of this Note and of any document executed in connection with or governing this Note; provided however, that the total outstanding borrowings under this Note shall not at any time exceed the principal amount stated above. The unpaid principal balance of this obligation at any time shall be the total amounts advanced hereunder by the holder hereof less the amount of principal payments made hereon by or for any Borrower, which balance may be endorsed hereon from time to time by the holder. The outstanding principal balance of this Note shall be due and payable in full on April 30, 1997. (b) Advances. Advances hereunder, to the total amount of the principal sum stated above, may be made by the holder at the oral or written request of (i) or , any one acting alone, who are authorized to request advances and direct the disposition of any advances until written notice of the revocation of such authority is received by the holder at the office designated above, or (ii) any person, with respect to advances deposited to the credit of any account of any Borrower with the holder, which advances, when so deposited, shall be conclusively presumed to have been made to or for the benefit of each Borrower regardless of the fact that persons other than those authorized to request advances may have authority to draw against such account. The holder shall have no obligation to determine whether any person requesting an advance is or has been authorized by any Borrower. (c) Application of Payments. Each payment made on this Note shall be credited first, to any interest then due and second, to the outstanding principal balance hereof. EVENTS OF DEFAULT: This Note is made pursuant to and is subject to the terms and conditions of that certain Credit Agreement between Borrower and Bank dated as of October 7, 1996, as amended from time to time (the "Credit Agreement"). Any default in the payment or performance of any obligation under this Note, or any defined event of default under the Credit Agreement, shall constitute an "Event of Default" under this Note. MISCELLANEOUS: (a) Remedies. Upon the occurrence of any Event of Default, the holder of this Note, at the holder's option, may declare all sums of principal and accrued and unpaid interest outstanding hereunder to be immediately due and payable without presentment, demand, or any notices of any kind, including without limitation notice of nonperformance, notice of protest, protest, notice of dishonor, notice of intention to accelerate or notice of acceleration, all of which are expressly waived by each Borrower, and the obligation, if any, of the holder to extend any further credit hereunder shall immediately cease and terminate. Each Borrower shall pay to the holder immediately upon demand the full amount of all payments, advances, charges, costs and expenses, including reasonable attorney's fees (to include outside counsel fees and all allocated costs of the holder's in-house counsel to the extent permissible), expended or incurred by the holder in connection with the enforcement of the holder's rights and/or the collection of any amount which become due to the holder under this Note, and the prosecution or defense of any action in any way related to this Note, including without limitation, any action for declaratory relief, whether incurred at the trial or appellate level, in arbitration proceeding or otherwise, and including any of the foregoing incurred in connection with any bankruptcy proceeding (including without limitation, any adversary proceeding, contested matter or motion brought by Bank or any other person) relating to any Borrower or any other person or entity. (b) Obligations Joint and Several. Should more than one person or entity sign this Note as a Borrower, the obligations of each such Borrower shall be joint and several. (c) Governing Law. This Note shall be governed by and constructed in accordance with the laws of the State of Texas. (d) Savings Clause. It is the intention of the parties to comply strictly with applicable usury laws. Accordingly, notwithstanding any provision to the contrary in this Note, or in any contract, instrument or document evidencing or securing the payment hereof or otherwise relating hereto (each, a "Related Document"), in no event shall this Note or any Related Document require the payment or permit the payment, taking, reserving, receiving, collection or charging of any sums constituting interest under applicable laws that exceed the maximum amount permitted by such laws, as the same may be amended or modified from time to time (the "Maximum Rate"). If any such excess interest is called for, contracted for, charged, taken, reserved or received in connection with this Note or any Related Document, or in any communication by Bank or any other person to Borrower or any other person, or in the event that all or part of the principal or interest hereof or thereof shall be prepaid or accelerated, so that under any of such circumstances or under any other circumstances whatsoever the amount of interest contracted for, charged, taken, reserved or received on the amount of principal actually outstanding from time to time under this Note shall exceed the Maximum Rate, then in such event it is agreed that: (i) the provisions of this paragraph shall govern and control; (ii) neither Borrower nor any other person or entity now or hereafter liable for the payment of this Note or any Related Document shall be obligated to pay the amount of such interest to the extent it is in excess of the Maximum Rate; (iii) any such excess interest which is or has been received by Bank, notwithstanding this paragraph, shall be credited against the then unpaid principal balance hereof and thereof, or if this Note or any Related Document has been or would be paid in full by such credit, refunded to Borrower; and (iv) the provisions of this Note and each Related Document, and other communication to Borrower, shall immediately be deemed reformed and such excess interest reduced, without the necessity of executing any other document, to the Maximum Rate. The right to accelerate the maturity of this Note or any Related Document does note include the right to accelerate, collect or charge unearned interest, but only such interest that has otherwise accrued as of the date of acceleration. Without limiting the foregoing, all calculations of the rate of interest contracted for, charged taken, reserved or received in connection with this Note and any Related Document which are made for the purpose of determining whether such rate exceeds the Maximum Rate shall be made to the extent permitted by applicable laws by amortizing, prorating, allocating and spreading during the period of the full term of this Note or such Related Document, including all prior subsequent renewals and extensions hereof and thereof, all interest at any time contracted for, charged, taken, reserved or received by Bank. The terms of this paragraph shall be deemed to be incorporated into each Related Document. To the extent that Article 5069-1.04 of the Texas Revised Civil Statutes is relevant to Bank for the purpose of determining the Maximum Rate, Bank hereby elects to determine the applicable rate ceiling under such Article by the indicated (weekly) rate ceiling from time to time in effect, subject to Bank's right subsequently to change such method in accordance with applicable law, as the same may be amended or modified from time to time. (e) Right of Setoff; Deposit Accounts. Upon and after the occurrence of an Event of Default, (i) Borrower hereby authorizes Bank, at any time and from time to time, without notice, which is hereby expressly waived by Borrower, and whether or not Bank shall have declared this Note to be due and payable in accordance with the terms hereof, to set off against, and to appropriate and apply to the payment of, Borrower's obligations and liabilities under this Note (whether matured or unmatured, fixed or contingent, liquidated or unliquidated), any and all amounts owing by Bank to Borrower (whether payable in U.S. dollars or any other currency, whether matured or unmatured, and in the case of deposits, whether general or special (except trust and escrow accounts), time or demand and however evidenced), and (ii) pending any such action, to the extent necessary, to hold such amounts as collateral to secure such obligations and liabilities and to return as unpaid for insufficient funds any and all checks and other items drawn against any deposits so held as Bank, in its sole discretion, may elect. Borrower hereby grants to Bank a security interest in all deposits and accounts maintained with Bank and with any other financial institution to secure the payment of all obligations and liabilities of Borrower to Bank under this Note. (f) Business Purpose. Borrower represents and warrants that all loans evidenced by this Note are for a business, commercial, investment, agricultural or other similar purpose and not primarily for a personal, family or household use. (g) Certain Tri-Party Accounts. Borrower and Bank agree that Tex. Rev. Civ. Stat. Ann. Art. 5056, ch 15 (which regulates certain revolving credit loan accounts and revolving tri-party accounts) shall not apply to any revolving loan accounts created under this Note or maintained in connection herewith. NOTICE: THIS NOTE AND ALL OTHER DOCUMENTS RELATING TO THE INDEBTEDNESS EVIDENCED HEREBY CONSTITUTE A WRITTEN LOAN AGREEMENT WHICH REPRESENTS THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES RELATING TO THIS NOTE AND THE INDEBTEDNESS EVIDENCED HEREBY. IN WITNESS WHEREOF, the undersigned has executed this Note as of the date first written above. HOUSTON CASUALTY COMPANY By: Frank J. Bramanti Title: EVP & CFO CREDIT AGREEMENT THIS AGREEMENT is entered into as of October 7, 1996, by and between HOUSTON CASUALTY COMPANY, a Texas corporation ("Borrower"), and WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION ("Bank"). RECITAL Borrower has requested from Bank the credit accommodation described below, and Bank has agreed to provide said credit accommodation to Borrower on the terms and conditions contained herein. NOW, THEREFORE, for valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Bank and Borrower hereby agree as follows: ARTICLE I THE CREDIT SECTION 1.1. LINE OF CREDIT. (a) Line of Credit. Subject to the terms and conditions of this Agreement, Bank hereby agrees to make advances to Borrower from time to time up to and including April 30, 1997, not to exceed at any time the aggregate principal amount of Twelve Million Dollars ($12,000,000.00) ("Line of Credit"), the proceeds of which shall be used to finance working capital. Borrower's obligation to repay advances under the Line of Credit shall be evidenced by a promissory note substantially in the form of Exhibit A attached hereto ("Line of Credit Note"), all terms of which are incorporated herein by this reference. (b) Letter of Credit Subfeature. As a subfeature under the Line of Credit, Bank agrees from time to time during the term thereof to issue Standby Letters of Credit for the account of Borrower (each, a "Letter of Credit" and collectively, "Letters of Credit"); provided however, that the form and substance of each Letter of Credit shall be subject to approval by Bank, in its sole discretion; and provided further, that the aggregate undrawn amount of all outstanding Letters of Credit shall not at any time exceed Twelve Million Dollars ($12,000,000.00). The last day any such Letter of Credit may expire is April 30, 1998. The undrawn amount of all Letters of Credit shall be reserved under the Line of Credit and shall not be available for borrowings thereunder. Each Letter of Credit shall be subject to the additional terms and conditions of the Letter of Credit Agreement and related documents, if any, required by Bank in connection with the issuance thereof (each, a "Letter of Credit Agreement" and collectively, "Letter of Credit Agreements"). Each draft paid by Bank under a Letter of Credit shall be deemed an advance under the Line of Credit and shall be repaid by Borrower in accordance with the terms and conditions of this Agreement applicable to such advances; provided however, that if advances under the Line of Credit are not available, for any reason, at the time any draft is paid by Bank, then Borrower shall immediately pay to Bank the full amount of such draft, together with interest thereon from the date such amount is paid by Bank to the date such amount is fully repaid by Borrower, at the rate of interest applicable to advances under the Line of Credit. In such event Borrower agrees that Bank, in its sole discretion, may debit any demand deposit account maintained by Borrower with Bank for the amount of any such draft. (c) Borrowing and Repayment. Borrower may from time to time during the term of the Line of Credit borrow, partially or wholly repay its outstanding borrowings, and reborrow, subject to all of the limitations, terms and conditions contained herein or in the Line of Credit Note; provided however, that the total outstanding borrowings under the Line of Credit shall not at any time exceed the maximum principal amount available thereunder, as set forth above. SECTION 1.2. INTEREST/FEES. (a) Interest. The outstanding principal balance of the Line of Credit shall bear interest at the rate of interest set forth in the Line of Credit Note. (b) Computation and Payment. Interest shall be computed on the basis of a 360-day year, actual days elapsed, unless such calculation would result in a usurious rate, in which case interest shall be computed on the basis of a 365/366-day year, as the case may be, actual days elapsed. Interest shall be payable at the times and place set forth in the Line of Credit Note. (c) Letter of Credit Fees. Borrower shall pay to Bank (i) fees upon the issuance of each Letter of Credit equal to the greater of one percent (1.00%) of the face amount thereof, or $300.00, (ii) fees upon payment or negotiation by Bank of each draft under any Letter of Credit equal to $60.00, and (iii) fees upon the occurrence of any other activity with respect to any Letter of Credit (including without limitation, the transfer, amendment or cancellation of any Letter of Credit) equal to $40.00. -2- SECTION 1.3. COLLATERAL. As security for all indebtedness of Borrower to Bank subject hereto, Borrower hereby grants to Bank a security interest equal to one hundred twenty-five percent (125%) (based on the current market values of Borrower's outstanding Letters of Credit and advances under the Line of Credit) in Borrower's interest in and to the account maintained by Borrower with Wells Fargo Bank (Texas), National Association (Trust Department), as custodian (the "Custodian") under account number 9002183500 and styled Houston Casualty Company Custody Account(the "Account"), as same may have been or may be amended from time to time, and in and to all securities, certificates of deposit, monies, instruments, documents, general intangibles and other property held and to be held in the Account, or held or to be held by Custodian for the benefit of Debtor, together with all renewals, reinvestments and substitutions therefor, all monies, income, interest, profits, proceeds and benefits attributable or accruing to said property, including, but not limited to, all stock, voting, surrender, borrowing, redemption or similar rights, options, rights to subscribe, dividends, liquidated dividends, stock dividends, dividends paid in stock, new security or other properties or benefits to which the undersigned is or may hereafter become entitled to receive on account of said property, and all accruals or increases thereof. All of the foregoing shall be evidenced by and subject to the terms of such security agreements, financing statements, deeds of trust and other documents as Bank shall reasonably require, all in form and substance satisfactory to Bank. Borrower shall reimburse Bank immediately upon demand for all costs and expenses incurred by Bank in connection with any of the foregoing security, including without limitation, filing and recording fees and costs of appraisals, audits and title insurance. ARTICLE II REPRESENTATIONS AND WARRANTIES Borrower makes the following representations and warranties to Bank, which representations and warranties shall survive the execution of this Agreement and shall continue in full force and effect until the full and final payment, and satisfaction and discharge, of all obligations of Borrower to Bank subject to this Agreement. SECTION 2.1. LEGAL STATUS. Borrower is a corporation, duly organized and existing and in good standing under the laws of the State of Texas, and is qualified or licensed to do business (and is in good standing as a foreign corporation, if applicable) in all jurisdictions in which such qualification or licensing is required or in which the failure to so qualify or to be so licensed could have a material adverse effect on Borrower. -3- SECTION 2.2. AUTHORIZATION AND VALIDITY. This Agreement, the Line of Credit Note, and each other document, contract and instrument required hereby or at any time hereafter delivered to Bank in connection herewith (collectively, the "Loan Documents") have been duly authorized, and upon their execution and delivery in accordance with the provisions hereof will constitute legal, valid and binding agreements and obligations of Borrower or the party which executes the same, enforceable in accordance with their respective terms. SECTION 2.3. NO VIOLATION. The execution, delivery and performance by Borrower of each of the Loan Documents do not violate any provision of any law or regulation, or contravene any provision of the Articles of Incorporation or By-Laws of Borrower, or result in any breach of or default under any contract, obligation, indenture or other instrument to which Borrower is a party or by which Borrower may be bound. SECTION 2.4. LITIGATION. There are no pending, or to the best of Borrower's knowledge threatened, actions, claims, investigations, suits or proceedings by or before any governmental authority, arbitrator, court or administrative agency which could have a material adverse effect on the financial condition or operation of Borrower other than those disclosed by Borrower to Bank in writing prior to the date hereof. SECTION 2.5. CORRECTNESS OF FINANCIAL STATEMENT. The financial statement of Borrower dated December 31, 1995, a true copy of which has been delivered by Borrower to Bank prior to the date hereof, (a) is complete and correct and presents fairly the financial condition of Borrower, (b) discloses all liabilities of Borrower that are required to be reflected or reserved against under generally accepted accounting principles, whether liquidated or unliquidated, fixed or contingent, and (c) has been prepared in accordance with generally accepted accounting principles consistently applied. Since the date of such financial statement there has been no material adverse change in the financial condition of Borrower, nor has Borrower mortgaged, pledged, granted a security interest in or otherwise encumbered any of its assets or properties except in favor of Bank or as otherwise permitted by Bank in writing. SECTION 2.6. INCOME TAX RETURNS. Borrower has no knowledge of any pending assessments or adjustments of its income tax payable with respect to any year. SECTION 2.7. NO SUBORDINATION. There is no agreement, indenture, contract or instrument to which Borrower is a party or by which Borrower may be bound that requires the subordination in right of payment of any of -4- Borrower's obligations subject to this Agreement to any other obligation of Borrower. SECTION 2.8. PERMITS, FRANCHISES. Borrower possesses, and will hereafter possess, all permits, consents, approvals, franchises and licenses required and rights to all trademarks, trade names, patents, and fictitious names, if any, necessary to enable it to conduct the business in which it is now engaged in compliance with applicable law. SECTION 2.9. ERISA. Borrower is in compliance in all material respects with all applicable provisions of the Employee Retirement Income Security Act of 1974, as amended or recodified from time to time ("ERISA"); Borrower has not violated any provision of any defined employee pension benefit plan (as defined in ERISA) maintained or contributed to by Borrower (each, a "Plan"); no Reportable Event as defined in ERISA has occurred and is continuing with respect to any Plan initiated by Borrower; Borrower has met its minimum funding requirements under ERISA with respect to each Plan; and each Plan will be able to fulfill its benefit obligations as they come due in accordance with the Plan documents and under generally accepted accounting principles. SECTION 2.10. OTHER OBLIGATIONS. Borrower is not in default on any obligation for borrowed money, any purchase money obligation or any other material lease, commitment, contract, instrument or obligation. SECTION 2.11. ENVIRONMENTAL MATTERS. Except as disclosed by Borrower to Bank in writing prior to the date hereof, Borrower is in compliance in all material respects with all applicable federal or state environmental, hazardous waste, health and safety statutes, and any rules or regulations adopted pursuant thereto, which govern or affect any of Borrower's operations and/or properties, including without limitation, the Comprehensive Environmental Response, Compensation and Liability Act of 1980, the Superfund Amendments and Reauthorization Act of 1986, the Federal Resource Conservation and Recovery Act of 1976, and the Federal Toxic Substances Control Act, as any of the same may be amended, modified or supplemented from time to time. None of the operations of Borrower is the subject of any federal or state investigation evaluating whether any remedial action involving a material expenditure is needed to respond to a release of any toxic or hazardous waste or substance into the environment. Borrower has no material contingent liability in connection with any release of any toxic or hazardous waste or substance into the environment. -5- ARTICLE III CONDITIONS SECTION 3.1. CONDITIONS OF INITIAL EXTENSION OF CREDIT. The obligation of Bank to extend any credit contemplated by this Agreement is subject to the fulfillment to Bank's satisfaction of all of the following conditions: (a) Approval of Bank Counsel. All legal matters incidental to the extension of credit by Bank shall be satisfactory to Bank's counsel. (b) Documentation. Bank shall have received, in form and substance satisfactory to Bank, each of the following, duly executed: (i) This Agreement and the Line of Credit Note. (ii) Corporate Borrowing Resolution; (iii) Certificate of Incumbency; (iv) General Pledge Agreement (with Addendum); (v) Custodial Agreement; and (vi) Such other documents as Bank may require under any other Section of this Agreement. (c) Financial Condition. There shall have been no material adverse change, as determined by Bank, in the financial condition or business of Borrower [or any guarantor hereunder], nor any material decline, as determined by Bank, in the market value of any collateral required hereunder or a substantial or material portion of the assets of Borrower. (d) Insurance. Borrower shall have delivered to Bank evidence of insurance coverage on all Borrower's property, in form, substance, amounts, covering risks and issued by companies satisfactory to Bank, and where required by Bank, with loss payable endorsements in favor of Bank. SECTION 3.2. CONDITIONS OF EACH EXTENSION OF CREDIT. The obligation of Bank to make each extension of credit requested by Borrower hereunder shall be subject to the fulfillment to Bank's satisfaction of each of the following conditions: (a) Compliance. The representations and warranties contained herein and in each of the other Loan Documents shall be true on and as of the date of the signing of this Agreement and on the date of each extension of credit by Bank pursuant hereto, with the same effect as though such representations and warranties had been made on and as of each such date, and on each such date, no Event of Default as defined herein, and no condition, event or act which with the giving of notice or the passage of time or both would constitute such an Event of Default, shall have occurred and be continuing or shall exist. -6- (b) Documentation. Bank shall have received all additional documents which may be required in connection with such extension of credit. ARTICLE IV AFFIRMATIVE COVENANTS Borrower covenants that so long as Bank remains committed to extend credit to Borrower pursuant hereto, or any liabilities (whether direct or contingent, liquidated or unliquidated) of Borrower to Bank under any of the Loan Documents remain outstanding, and until payment in full of all obligations of Borrower subject hereto, Borrower shall, unless Bank otherwise consents in writing: SECTION 4.1. PUNCTUAL PAYMENTS. Punctually pay all principal, interest, fees or other liabilities due under any of the Loan Documents at the times and place and in the manner specified therein. SECTION 4.2. ACCOUNTING RECORDS. Maintain adequate books and records in accordance with generally accepted accounting principles consistently applied, and permit any representative of Bank, at any reasonable time, to inspect, audit and examine such books and records, to make copies of the same, and to inspect the properties of Borrower. SECTION 4.3. FINANCIAL STATEMENTS. Provide to Bank all of the following, in form and detail satisfactory to Bank: (a) not later than 120 days after and as of the end of each fiscal year, an audited financial statement of HCC Insurance Holdings, Inc., prepared by a certified public accountant acceptable to Bank, to include balance sheet, income statement, and statement of cash flows together with a copy of Form 10-K of HCC Insurance Holdings, Inc. for such year; (b) not later than 90 days after and as of the end of each quarter, a financial statement of HCC Insurance Holdings, Inc., prepared by a certified public accountant acceptable to Bank, to include a copy of Form 10-Q of HCC Insurance Holdings, Inc. for such year; (c) from time to time such other information as Bank may reasonably request. SECTION 4.4. COMPLIANCE. Preserve and maintain all licenses, permits, governmental approvals, rights, privileges and franchises necessary for the conduct of its business; and comply with the provisions of all documents -7- pursuant to which Borrower is organized and/or which govern Borrower's continued existence and with the requirements of all laws, rules, regulations and orders of any governmental authority applicable to Borrower and/or its business. SECTION 4.5. INSURANCE. Maintain and keep in force insurance of the types and in amounts customarily carried in lines of business similar to that of Borrower, including but not limited to fire, extended coverage, public liability, flood, property damage and workers' compensation, with all such insurance carried with companies and in amounts satisfactory to Bank, and deliver to Bank from time to time at Bank's request schedules setting forth all insurance then in effect. SECTION 4.6. FACILITIES. Keep all properties useful or necessary to Borrower's business in good repair and condition, and from time to time make necessary repairs, renewals and replacements thereto so that such properties shall be fully and efficiently preserved and maintained. SECTION 4.7. TAXES AND OTHER LIABILITIES. Pay and discharge when due any and all indebtedness, obligations, assessments and taxes, both real or personal, including without limitation Federal and state income taxes and state and local property taxes and assessments, except such (a) as Borrower may in good faith contest or as to which a bona fide dispute may arise, and (b) for which Borrower has made provision, to Bank's satisfaction, for eventual payment thereof in the event Borrower is obligated to make such payment. SECTION 4.8. NOTICE TO BANK. Promptly (but in no event more than five (5) days after the occurrence of each such event or matter) give written notice to Bank in reasonable detail of: (a) the occurrence of any Event of Default, or any condition, event or act which with the giving of notice or the passage of time or both would constitute an Event of Default; (b) any change in the name of Borrower; (c) the occurrence and nature of any Reportable Event or Prohibited Transaction, each as defined in ERISA, or any funding deficiency with respect to any Plan; or (d) any termination or cancellation of any insurance policy which Borrower is required to maintain, or any uninsured or partially uninsured loss through liability or property damage, or through fire, theft or any other cause affecting Borrower's property. -8- ARTICLE V NEGATIVE COVENANTS Borrower further covenants that so long as Bank remains committed to extend credit to Borrower pursuant hereto, or any liabilities (whether direct or contingent, liquidated or unliquidated) of Borrower to Bank under any of the Loan Documents remain outstanding, and until payment in full of all obligations of Borrower, subject hereto, Borrower will not without Bank's prior written consent: SECTION 5.1. USE OF FUNDS. Use any of the proceeds of any credit extended hereunder except for the purposes stated in Article I hereof. SECTION 5.2. OTHER INDEBTEDNESS. Create, incur, assume or permit to exist any indebtedness or liabilities resulting from borrowings, loans or advances, whether secured or unsecured, matured or unmatured, liquidated or unliquidated, joint or several, except (a) the liabilities of Borrower to Bank, and (b) any other liabilities of Borrower existing as of, and disclosed to Bank prior to, the date hereof. SECTION 5.5. MERGER, CONSOLIDATION, TRANSFER OF ASSETS. Merge into or consolidate with any other entity; make any substantial change in the nature of Borrower's business as conducted as of the date hereof; acquire all or substantially all of the assets of any other entity; nor sell, lease, transfer or otherwise dispose of all or a substantial or material portion of Borrower's assets except in the ordinary course of its business. SECTION 5.6. GUARANTIES. Guarantee or become liable in any way as surety, endorser (other than as endorser of negotiable instruments for deposit or collection in the ordinary course of business), accommodation endorser or otherwise for, nor pledge or hypothecate any assets of Borrower as security for, any liabilities or obligations of any other person or entity, except any of the foregoing in favor of Bank. SECTION 5.7. LOANS, ADVANCES, INVESTMENTS. Make any loans or advances to or investments in any person or entity, except any of the foregoing existing as of, and disclosed to Bank prior to, the date hereof. SECTION 5.8. DIVIDENDS, DISTRIBUTIONS. Declare or pay any dividend or distribution either in cash, stock or any other property on Borrower's stock now or hereafter outstanding, nor redeem, retire, repurchase or otherwise acquire any shares of any class of Borrower's stock now or hereafter outstanding, and Borrower shall provide to Bank, upon request, any -9- documentation required by Bank to substantiate the appropriateness of amounts paid or to be paid. SECTION 5.9. PLEDGE OF ASSETS. Mortgage, pledge, grant or permit to exist a security interest in, or lien upon, all or any portion of Borrower's assets now owned or hereafter acquired, except any of the foregoing in favor of Bank or which is existing as of, and disclosed to Bank in writing prior to, the date hereof. ARTICLE VI EVENTS OF DEFAULT SECTION 6.1. The occurrence of any of the following shall constitute an "Event of Default" under this Agreement: (a) Borrower shall fail to pay when due any principal, interest, fees or other amounts payable under any of the Loan Documents. (b) Any financial statement or certificate furnished to Bank in connection with, or any representation or warranty made by Borrower or any other party under this Agreement or any other Loan Document shall prove to be incorrect, false or misleading in any material respect when furnished or made. (c) Any default in the performance of or compliance with any obligation, agreement or other provision contained herein or in any other Loan Document (other than those referred to in subsections (a) and (b) above), and with respect to any such default which by its nature can be cured, such default shall continue for a period of twenty (20) days from its occurrence. (d) Any default in the payment or performance of any obligation, or any defined event of default, under the terms of any contract or instrument (other than any of the Loan Documents) pursuant to which Borrower has incurred any debt or other liability to any person or entity, including Bank. (e) The filing of a notice of judgment lien against Borrower; or the recording of any abstract of judgment against Borrower in any county in which Borrower has an interest in real property; or the service of a notice of levy and/or of a writ of attachment or execution, or other like process, against the assets of Borrower; or the entry of a judgment against Borrower. (f) Borrower shall become insolvent, or shall suffer or consent to or apply for the appointment of a receiver, trustee, custodian or liquidator of itself or any of its property, or shall generally fail to pay its debts as they become due, or shall make a general assignment for the benefit of creditors; Borrower shall file a voluntary petition in bankruptcy, or seeking -10- reorganization, in order to effect a plan or other arrangement with creditors or any other relief under the Bankruptcy Reform Act, Title 11 of the United States Code, as amended or recodified from time to time ("Bankruptcy Code"), or under any state or federal law granting relief to debtors, whether now or hereafter in effect; or any involuntary petition or proceeding pursuant to the Bankruptcy Code or any other applicable state or federal law relating to bankruptcy, reorganization or other relief for debtors is filed or commenced against Borrower, or Borrower shall file an answer admitting the jurisdiction of the court and the material allegations of any involuntary petition; or Borrower shall be adjudicated a bankrupt, or an order for relief shall be entered against Borrower by any court of competent jurisdiction under the Bankruptcy Code or any other applicable state or federal law relating to bankruptcy, reorganization or other relief for debtors. (g) There shall exist or occur any event or condition which Bank in good faith believes impairs, or is substantially likely to impair, the prospect of payment or performance by Borrower of its obligations under any of the Loan Documents. (h) The dissolution or liquidation of Borrower; or Borrower or any of its directors, stockholders or members, shall take action seeking to effect the dissolution or liquidation of Borrower. (i) Any change in ownership during the term of this Agreement of an aggregate of twenty-five percent (25%) or more of the common stock of Borrower. SECTION 6.2. REMEDIES. Upon the occurrence of any Event of Default: (a) all principal and accrued and unpaid interest outstanding under each of the Loan Documents, any term thereof to the contrary notwithstanding, shall at Bank's option and without notice become immediately due and payable without presentment, demand, or any notices of any kind, including without limitation notice of nonperformance, notice of protest, protest, notice of dishonor, notice of intention to accelerate or notice of acceleration, all of which are hereby expressly waived by each Borrower; (b) the obligation, if any, of Bank to extend any further credit under any of the Loan Documents shall immediately cease and terminate; and (c) Bank shall have all rights, powers and remedies available under each of the Loan Documents, or accorded by law, including without limitation the right to resort to any or all security for any credit accommodation from Bank subject hereto and to exercise any or all of the rights of a beneficiary or secured party pursuant to applicable law. All rights, powers and remedies of Bank may be exercised at any time by Bank and from time to time after the occurrence of an Event of Default, are -11- cumulative and not exclusive, and shall be in addition to any other rights, powers or remedies provided by law or equity. ARTICLE VII MISCELLANEOUS SECTION 7.1. NO WAIVER. No delay, failure or discontinuance of Bank in exercising any right, power or remedy under any of the Loan Documents shall affect or operate as a waiver of such right, power or remedy; nor shall any single or partial exercise of any such right, power or remedy preclude, waive or otherwise affect any other or further exercise thereof or the exercise of any other right, power or remedy. Any waiver, permit, consent or approval of any kind by Bank of any breach of or default under any of the Loan Documents must be in writing and shall be effective only to the extent set forth in such writing. SECTION 7.2. NOTICES. All notices, requests and demands which any party is required or may desire to give to any other party under any provision of this Agreement must be in writing and delivered to each party at the following address: BORROWER: HOUSTON CASUALTY COMPANY 13403 Northwest Freeway Suite 200 Houston, Texas 77040 BANK: WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION 1000 Louisiana, Third Floor Houston, Texas 77002 or to such other address as any party may designate by written notice to all other parties. Each such notice, request and demand shall be deemed given or made as follows: (a) if sent by hand delivery, upon delivery; (b) if sent by mail, upon the earlier of the date of receipt or three (3) days after deposit in the U.S. mail, first class and postage prepaid; and (c) if sent by telecopy, upon receipt. SECTION 7.3. COSTS, EXPENSES AND ATTORNEYS' FEES. Borrower shall pay to Bank immediately upon demand the full amount of all payments, advances, charges, costs and expenses, including reasonable attorneys' fees (to include outside counsel fees and all allocated costs of Bank's in-house counsel to the extent permissible), expended or incurred by Bank in connection with (a) the negotiation and preparation of this Agreement and the other Loan Documents, Bank's continued administration hereof and thereof, and the preparation of any amendments and waivers hereto and thereto, (b) the -12- enforcement of Bank's rights and/or the collection of any amounts which become due to Bank under any of the Loan Documents, and (c) the prosecution or defense of any action in any way related to any of the Loan Documents, including without limitation, any action for declaratory relief, whether incurred at the trial or appellate level, in an arbitration proceeding or otherwise, and including any of the foregoing incurred in connection with any bankruptcy proceeding (including without limitation, any adversary proceeding, contested matter or motion brought by Bank or any other person) relating to any Borrower or any other person or entity. SECTION 7.4. SUCCESSORS, ASSIGNMENT. This Agreement shall be binding upon and inure to the benefit of the heirs, executors, administrators, legal representatives, successors and assigns of the parties; provided however, that Borrower may not assign or transfer its interest hereunder without Bank's prior written consent. Bank reserves the right to sell, assign, transfer, negotiate or grant participations in all or any part of, or any interest in, Bank's rights and benefits under each of the Loan Documents. In connection therewith, Bank may disclose all documents and information which Bank now has or may hereafter acquire relating to any credit extended by Bank to Borrower, or its business, or any collateral required hereunder. SECTION 7.5. ENTIRE AGREEMENT; AMENDMENT. This Agreement and the other Loan Documents constitute the entire agreement between Borrower and Bank with respect to any extension of credit by Bank subject hereto and supersede all prior negotiations, communications, discussions and correspondence concerning the subject matter hereof. This Agreement may be amended or modified only by a written instrument executed by each party hereto. SECTION 7.6. NO THIRD PARTY BENEFICIARIES. This Agreement is made and entered into for the sole protection and benefit of the parties hereto and their respective permitted successors and assigns, and no other person or entity shall be a third party beneficiary of, or have any direct or indirect cause of action or claim in connection with, this Agreement or any other of the Loan Documents to which it is not a party. SECTION 7.7. TIME. Time is of the essence of each and every provision of this Agreement and each other of the Loan Documents. SECTION 7.8. SEVERABILITY OF PROVISIONS. If any provision of this Agreement shall be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity without invalidating the remainder of such provision or any remaining provisions of this Agreement. -13- SECTION 7.9. COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which when executed and delivered shall be deemed to be an original, and all of which when taken together shall constitute one and the same Agreement. SECTION 7.10. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the State of Texas. SECTION 7.11. SAVINGS CLAUSE. It is the intention of the parties to comply strictly with applicable usury laws. Accordingly, notwithstanding any provision to the contrary in the Loan Documents, in no event shall any Loan Documents require the payment or permit the payment, taking, reserving, receiving, collection or charging of any sums constituting interest under applicable laws that exceed the maximum amount permitted by such laws, as the same may be amended or modified from time to time (the "Maximum Rate"). If any such excess interest is called for, contracted for, charged, taken, reserved or received in connection with any Loan Documents, or in any communication by Lender or any other person to Borrower or any other person, or in the event that all or part of the principal or interest hereof or thereof shall be prepaid or accelerated, so that under any of such circumstances or under any other circumstance whatsoever the amount of interest contracted for, charged, taken, reserved or received on the amount of principal actually outstanding from time to time under the Loan Documents shall exceed the Maximum Rate, then in such event it is agreed that: (i) the provisions of this paragraph shall govern and control; (ii) neither Borrower nor any other person or entity now or hereafter liable for the payment of any Loan Documents shall be obligated to pay the amount of such interest to the extent it is in excess of the Maximum Rate; (iii) any such excess interest which is or has been received by Lender, notwithstanding this paragraph, shall be credited against the then unpaid principal balance hereof or thereof, or if any of the Loan Documents has been or would be paid in full by such credit, refunded to Borrower; and (iv) the provisions of each of the Loan Documents, and any other communication to Borrower, shall immediately be deemed reformed and such excess interest reduced, without the necessity of executing any other document, to the Maximum Rate. The right to accelerate the maturity of the Loan Documents does not include the right to accelerate, collect or charge unearned interest, but only such interest that has otherwise accrued as of the date of acceleration. Without limiting the foregoing, all calculations of the rate of interest contracted for, charged, taken, reserved or received in connection with any of the Loan Documents which are made for the purpose of determining whether such rate exceeds the Maximum Rate shall be made to the extent permitted by applicable laws by amortizing, prorating, allocating and spreading during the period of the full term of such Loan Documents, including all prior and subsequent renewals and extensions hereof or thereof, all interest at any time contracted for, charged, taken, reserved or received by Lender. The terms of this paragraph shall be deemed to be incorporated into each of the other Loan Documents. -14- To the extent that Article 5069-1.04 of the Texas Revised Civil Statutes is relevant to Lender for the purpose of determining the Maximum Rate, Bank hereby elects to determine the applicable rate ceiling under such Article by the indicated (weekly) rate ceiling from time to time in effect, subject to Lender's right subsequently to change such method in accordance with applicable law, as the same may be amended or modified from time to time. SECTION 7.12. RIGHT OF SETOFF; DEPOSIT ACCOUNTS. Upon and after the occurrence of an Event of Default, (a) Borrower hereby authorizes Bank, at any time and from time to time, without notice, which is hereby expressly waived by each Borrower, and whether or not Bank shall have declared any credit extended hereunder to be due and payable in accordance with the terms hereof, to set off against, and to appropriate and apply to the payment of, Borrower's obligations and liabilities under the Loan Documents (whether matured or unmatured, fixed or contingent, liquidated or unliquidated), any and all amounts owing by Bank to Borrower (whether payable in U.S. dollars or any other currency, whether matured or unmatured, and in the case of deposits, whether general or special (except trust and escrow accounts), time or demand and however evidenced), and (b) pending any such action, to the extent necessary, to hold such amounts as collateral to secure such obligations and liabilities and to return as unpaid for insufficient funds any and all checks and other items drawn against any deposits so held as Bank, in its sole discretion, may elect. Borrower hereby grants to Bank a security interest in all deposits and accounts maintained with Bank and with any other financial institution to secure the payment of all obligations and liabilities of Borrower to Bank under the Loan Documents. SECTION 7.13. BUSINESS PURPOSE. Borrower represents and warrants that any credit extended hereunder is for a business, commercial, investment, agricultural or other similar purpose and not primarily for a personal, family or household use. SECTION 7.14. ARBITRATION. (a) Arbitration. Upon the demand of any party, any Dispute shall be resolved by binding arbitration (except as set forth in (e) below) in accordance with the terms of this Agreement. A "Dispute" shall mean any action, dispute, claim or controversy of any kind, whether in contract or tort, statutory or common law, legal or equitable, now existing or hereafter arising under or in connection with, or in any way pertaining to, any of the -15- Loan Documents, or any past, present or future extensions of credit and other activities, transactions or obligations of any kind related directly or indirectly to any of the Loan Documents, including without limitation, any of the foregoing arising in connection with the exercise of any self-help, ancillary or other remedies pursuant to any of the Loan Documents. Any party may by summary proceedings bring an action in court to compel arbitration of a Dispute. Any party who fails or refuses to submit tb arbitration following a lawful demand by any other party shall bear all costs and expenses incurred by such other party in compelling arbitration of any Dispute. (b) Governing Rules. Arbitration proceedings shall be administered by the American Arbitration Association ("AAA") or such other administrator as the parties shall mutually agree upon in accordance with the AAA Commercial Arbitration Rules. All Disputes submitted to arbitration shall be resolved in accordance with the Federal Arbitration Act (Title 9 of the United States Code), notwithstanding any conflicting choice of law provision in any of the Loan Documents. The arbitration shall be conducted at a location in Texas selected by the AAA or other administrator. If there is any inconsistency between the terms hereof and any such rules, the terms and procedures set forth herein shall control. All statutes of limitation applicable to any Dispute shall apply to any arbitration proceeding. All discovery activities shall be expressly limited to matters directly relevant to the Dispute being arbitrated. Judgment upon any award rendered in an arbitration may be entered in any court having jurisdiction; provided however, that nothing contained herein shall be deemed to be a waiver by any party that is a bank of the protections afforded to it under 12 U.S.C. Section 91 or any similar applicable state law. (c) No Waiver; Provisional Remedies, Self-Help and Foreclosure. No provision hereof shall limit the right of any party to exercise self-help remedies such as setoff, foreclosure against or sale of any real or personal property collateral or security, or to obtain provisional or ancillary remedies, including without limitation injunctive relief, sequestration, attachment, garnishment or the appointment of a receiver, from a court of competent jurisdiction before, after or during the pendency of any arbitration or other proceeding. The exercise of any such remedy shall not waive the right of any party to compel arbitration hereunder. (d) Arbitrator Qualifications and Powers; Awards. Arbitrators must be active members of the Texas State Bar with expertise in the substantive laws applicable to the subject matter of the Dispute. Arbitrators are empowered to resolve Disputes by summary rulings in response to motions filed prior to the final arbitration hearing. Arbitrators (i) shall resolve all Disputes in accordance with the substantive law of the state of Texas, (ii) may grant any remedy or relief that a court of the state of Texas could order or grant -16- within the scope hereof and such ancillary relief as is necessary to make effective any award, and (iii) shall have the power to award recovery of all costs and fees, to impose sanctions and to take such other actions as they deem necessary to the same extent a judge could pursuant to the Federal Rules of Civil Procedure, the Texas Rules of Civil Procedure or other applicable law. Any Dispute in which the amount in controversy is $5,000,000 or less shall be decided by a single arbitrator who shall not render an award of greater than $5,000,000 (including damages, costs, fees and expenses). By submission to a single arbitrator, each party expressly waives any right or claim to recover more than $5,000,000. Any Dispute in which the amount in controversy exceeds $5,000,000 shall be decided by majority vote of a panel of three arbitrators; provided however, that all three arbitrators must actively participate in all hearings and deliberations. (e) Judicial Review. Notwithstanding anything herein to the contrary, in any arbitration in which the amount in controversy exceeds $25,000,000, the arbitrators shall be required to make specific, written findings of fact and conclusions of law. In such arbitrations (i) the arbitrators shall not have the power to make any award which is not supported by substantial evidence or which is based on legal error, (ii) an award shall not be binding upon the parties unless the findings of fact are supported by substantial evidence and the conclusions of law are not erroneous under the substantive law of the state of Texas, and (iii) the parties shall have in addition to the grounds referred to in the Federal Arbitration Act for vacating, modifying or correcting an award the right to judicial review of (A) whether the findings of fact rendered by the arbitrators are supported by substantial evidence, and (B) whether the conclusions of law are erroneous under the substantive law of the state of Texas. Judgment confirming an award in such a proceeding may be entered only if a court determines the award is supported by substantial evidence and not based on legal error under the substantive law of the state of Texas. (f) Miscellaneous. To the maximum extent practicable, the AAA, the arbitrators and the parties shall take all action required to conclude any arbitration proceeding within 180 days of the filing of the Dispute with the AAA. No arbitrator or other party to an arbitration proceeding may disclose the existence, content or results thereof, except for disclosures of information by a party required in the ordinary course of its business, by applicable law or regulation, or to the extent necessary to exercise any judicial review rights set forth herein. If more than one agreement for arbitration by or between the parties potentially applies to a Dispute, the arbitration provision most directly related to the Loan Documents or the subject matter of the Dispute shall control. This arbitration provision shall survive termination, amendment or expiration of any of the Loan Documents or any relationship between the parties. -17- NOTICE: THIS DOCUMENT AND ALL OTHER DOCUMENTS RELATING TO THE INDEBTEDNESS CONSTITUTE A WRITTEN LOAN AGREEMENT WHICH REPRESENTS THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES RELATING TO THE INDEBTEDNESS. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the day and year first written above. WELLS FARGO BANK (TEXAS), HOUSTON CASUALTY COMPANY NATIONAL ASSOCIATION By: /s/ FRANK J. BRAMANTI By: /s/ KEN TEUSINK Ken Tuesink Title: EVP & CFO Relationship Manager -18- GENERAL PLEDGE AGREEMENT TO: WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION 1. GRANT OF SECURITY INTEREST. For valuable consideration, the undersigned Houston Casualty Company, a Texas corporation, or any of them ("Debtor"), hereby assigns, transfers to and pledges with WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION, ("Bank"), and grants to Bank a security interest in, all money and property this day delivered to and deposited with Bank, together with all other money or property heretofore delivered or which shall hereafter be delivered to or come into the possession, custody or control of Bank in any manner or for any purpose whatsoever during the existence of this Agreement (collectively called "Collateral"), and whether held in a general or special account or deposit for safekeeping or otherwise, together with whatever is receivable or received when any of the Collateral or proceeds thereof are sold, collected, exchanged or otherwise disposed of, whether such disposition is voluntary or involuntary, including without limitation, (a) all rights to payment, including returned premiums, with respect to any insurance relating to any of the foregoing, (b) all rights to payment with respect to any cause of action affecting or relating to any of the foregoing, and (c) all stock rights, rights to subscribe, stock splits, liquidating dividends, cash dividends, dividends paid in stock, new securities or other property of any kind which Debtor is or may hereafter be entitled to receive on account of any securities pledged hereunder, including without limitation, stock received by Debtor due to stock splits or dividends paid in stock or sums paid upon or in respect of any securities pledged hereunder upon the liquidation or dissolution of the issuer thereof (hereinafter called "Proceeds"), and in the event that Debtor receives any such Proceeds, Debtor will hold the same in trust on behalf of and for the benefit of Bank and will immediately deliver all such Proceeds to Bank in the exact form received, with the endorsement of Debtor if necessary and/or appropriate undated stock powers duly executed in blank, to be held by Bank as part of the Collateral, subject to all terms hereof. 2. OBLIGATIONS SECURED. The obligations secured hereby are the payment and performance of: (a) all present and future Indebtedness of Debtor to Bank; (b) all obligations of Debtor and rights of Bank under this Agreement; and (c) all present and future obligations of Debtor to Bank of other kinds. The word "Indebtedness" is used herein in its most comprehensive sense and includes any and all advances, debts, obligations and liabilities of Debtor, or any of them, heretofore, now or hereafter made, incurred or created, whether voluntary or involuntary and however arising, whether due or not due, absolute or contingent, liquidated or unliquidated, determined or undetermined, and whether Debtor may be liable individually or jointly with others, or whether recovery upon such Indebtedness may be or hereafter becomes unenforceable. 3. TERMINATION. This Agreement will terminate upon the performance of all obligations of Debtor to Bank, including without limitation, the payment of all Indebtedness of Debtor to Bank, and the termination of all commitments of Bank to extend credit to Debtor, existing at the time Bank receives written notice from, Debtor of the termination of this Agreement. 4. OBLIGATIONS OF BANK. (a) Bank has no obligation to make any loans hereunder. Any money received by Bank in respect of the Collateral may be deposited, at Bank's option, into a non-interest bearing account over which Debtor shall have no control, and the same shall, for all purposes, be deemed Collateral hereunder. (b) Bank's obligation with respect to Collateral and Proceeds in its possession shall be strictly limited to the duty to exercise reasonable care in the custody and preservation of such Collateral and Proceeds, and such duty shall not include any obligation to ascertain or to initiate any action with respect to or to inform Debtor of maturity dates, conversion, call or exchange rights, or offers to purchase the Collateral or Proceeds, or any similar matters, notwithstanding Bank's knowledge of the same. Bank shall have no duty to take any steps necessary to preserve the rights of Debtor against prior parties, or to initiate any action to protect against the possibility of a decline in the market value of the Collateral or Proceeds. Bank shall not be obligated to take any action with respect to the Collateral or Proceeds requested by Debtor unless such request is made in writing and Bank determines, in its sole discretion, that the requested action would not unreasonably jeopardize the value of the Collateral and Proceeds as security for the Indebtedness. Bank may at any time deliver the Collateral and Proceeds, or any part thereof, to any Debtor, and the receipt thereof by any Debtor shall be a complete and full acquittance for the Collateral and Proceeds so delivered, and Bank shall thereafter be discharged from any liability or responsibility therefor. 5. REPRESENTATIONS AND WARRANTIES. Debtor represents and warrants to Bank that: (a) Debtor is the owner and has possession or control of the Collateral and Proceeds; (b) Debtor has the right to pledge the Collateral and Proceeds; (c) all Collateral and Proceeds are genuine, free from liens, adverse claims, setoffs, default, prepayment, defenses and conditions precedent of any kind or character, except the lien created hereby or as otherwise agreed to by Bank, or as heretofore disclosed by Debtor to Bank, in writing; (d) all statements contained herein and, where applicable, in the Collateral, are true and complete in all material respects; (e) no financing statement covering any of the Collateral or Proceeds, and naming any secured -2- party other than Bank, is on file in any public office; and (f) specifically with respect to Collateral and Proceeds consisting of investment securities, instruments, chattel paper, documents, contracts, insurance policies or any like property, (i) all persons appearing to be obligated thereon have authority and capacity to contract and are bound as they appear to be, and (ii) the same comply with applicable laws concerning form, content and manner of preparation and execution. 6. COVENANTS OF DEBTOR. (a) Debtor agrees in general: (i) to pay Indebtedness secured hereby when due; (ii) to indemnify Bank against all losses, claims, demands, liabilities and expenses of every kind caused by property subject hereto; (iii) to pay all costs and expenses, including reasonable attorneys' fees, incurred by Bank in the perfection and preservation of the Collateral or Bank's interest therein and/or the realization, enforcement and exercise of Bank's rights, powers and remedies hereunder; (iv) to permit Bank to exercise its powers; (v) to execute and deliver such documents as Bank deems necessary to create, perfect and continue the security interests contemplated hereby; and (vi) not to change its chief place of business or the places where Debtor keeps any of the Collateral or Debtor's records concerning the Collateral and Proceeds without first giving Bank written notice of the address to which Debtor is moving same. (b) Debtor agrees with regard to the Collateral and Proceeds, unless Bank agrees otherwise in writing: (i) not to permit any lien on the Collateral or Proceeds, except in favor of Bank; (ii) not to withdraw any funds from any deposit account pledged to Bank hereunder; (iii) not to sell, hypothecate or otherwise dispose of, nor permit the transfer by operation of law of, any of the Collateral or Proceeds or any interest therein; (iv) to keep, in accordance with generally accepted accounting principles, complete and accurate records regarding all Collateral and Proceeds, and to permit Bank to inspect the same and make copies thereof at any reasonable time; (v) if requested by Bank, to receive and use reasonable diligence to collect Proceeds, in trust and as the property of Bank, and to immediately endorse as appropriate and deliver such Proceeds to Bank daily in the exact form in which they are received together with a collection report in form satisfactory to Bank; (vi) not to commingle Collateral or Proceeds, or collections thereunder, with other property; (vii) in the event Bank elects to receive payments of Proceeds hereunder, to pay all expenses incurred by Bank in connection therewith, including expenses of accounting, correspondence, collection efforts, filing, recording, record keeping and expenses incidental thereto; (viii) to provide any service and do any other acts which may be necessary to keep all Collateral and Proceeds free and clear of all defenses, rights of offset and counterclaims; and (ix) if the Collateral or Proceeds consists of securities and so long as no Event of -3- Default exists, to vote said securities and to give consents, waivers and ratifications with respect thereto, provided that no vote shall be cast or consent, waiver or ratification given or action taken which would impair Bank's interests in the Collateral and Proceeds or be inconsistent with or violate any provisions of this Agreement. 7. POWERS OF BANK. Debtor appoints Bank its true attorney in fact to perform any of the following powers, which are coupled with an interest, are irrevocable until termination of this Agreement and may be exercised from time to time by Bank's officers and employees, or any of them, whether or not Debtor is in default: (a) to perform any obligation of Debtor hereunder in Debtor's name or otherwise; (b) to notify any person obligated on any security, instrument or other document subject to this Agreement of Bank's rights hereunder; (c) to collect by legal proceedings or otherwise all dividends, interest, principal or other sums now or hereafter payable upon or on account of the Collateral or Proceeds; (d) to enter into any extension, reorganization, deposit, merger or consolidation agreement, or any other agreement relating to or affecting the Collateral or Proceeds, and in connection therewith to deposit or surrender control of the Collateral and Proceeds, to accept other property in.exchange for the Collateral and Proceeds, and to do and perform such acts and things as Bank may deem proper, with any money or property received in exchange for the Collateral or Proceeds, at Bank's option, to be applied to the Indebtedness or held by Bank under this Agreement; (e) to make any compromise or settlement Bank deems desirable or proper in respect of the Collateral and Proceeds; (f) to insure, process and preserve the Collateral and Proceeds; (g) to exercise all rights, powers and remedies which Debtor would have, but for this Agreement, with respect to all Collateral and Proceeds subject hereto; and (h) to do all acts and things and execute all documents in the name of Debtor or otherwise, deemed by Bank as necessary, proper and convenient in connection with the preservation, perfection or enforcement of its rights hereunder. To effect the purposes of this Agreement or otherwise upon instructions of Debtor, or any of them, Bank may cause any Collateral and/or Proceeds to be transferred to Banks name or the name of Bank's nominee. If an Event of Default has occurred and is continuing, any or all Collateral and/or Proceeds consisting of securities may be registered, without notice, in the name of Bank or its nominee, and thereafter Bank or its nominee may exercise, without notice, all voting and corporate rights at any meeting of the shareholders of the issuer thereof, any and all rights of conversion, exchange or subscription, or any other rights, privileges or options pertaining to such Collateral and/or Proceeds, all as if it were the absolute owner thereof. The foregoing shall -4- include, without limitation, the right of Bank or its nominee to exchange, at its discretion, any and all Collateral and/or Proceeds upon the merger, consolidation, reorganization, recapitalization or other readjustment of the issuer thereof, or upon the exercise by the issuer thereof or Bank of any right, privilege or option pertaining to any shares of the Collateral and/or Proceeds, and in connection therewith, the right to deposit and deliver any and all of the Collateral and/or Proceeds with any committee, depository, transfer agent, registrar or other designated agency upon such terms and conditions as Bank may determine. All of the foregoing rights, privileges or options may be exercised without liability on the part of Bank or its nominee except to account for property actually received by Bank. Bank shall have no duty to exercise any of the foregoing, or any other rights, privileges or options with respect to the Collateral or Proceeds and shall not be responsible for any failure to do so or delay in so doing. 8. PAYMENT OF PREMIUMS, TAXES, CHARGES, LIENS AND ASSESSMENTS. Debtor agrees to pay, prior to delinquency, all insurance premiums, taxes, charges, liens and assessments against the Collateral and Proceeds, and upon the failure of Debtor to do so, Bank at its option may pay any of them and shall be the sole judge of the legality or validity thereof and the amount necessary to discharge the same. Any such payments made by Bank shall be obligations of Debtor to Bank, due and payable immediately upon demand, together with interest at a rate determined in accordance with the provisions of Section 15 hereof, and shall be secured by the Collateral and Proceeds, subject to all terms and conditions of this Agreement. 9. EVENTS OF DEFAULT. The occurrence of any of the following shall constitute an "Event of Default" under this Agreement: (a) any default in the payment or performance of any obligation, or any defined event of default, under (i) any contract or instrument evidencing any Indebtedness, or (ii) any other agreement between any Debtor and Bank, including without limitation any loan agreement, relating to or executed in connection with any Indebtedness; (b) any representation or warranty made by any Debtor herein shall prove to be incorrect, false or misleading in any material respect when made; (c) any Debtor shall fail to observe or perform any obligation or agreement contained herein; (d) any attachment or like levy on any property of any Debtor; and (e) Bank, in good faith, believes any or all of the Collateral and/or Proceeds to be in danger of misuse, dissipation, commingling, loss, theft, damage or destruction, or otherwise in jeopardy or unsatisfactory in character or value. 10. REMEDIES. Upon the occurrence of any Event of Default, Bank shall have the right to declare immediately due and payable all or any Indebtedness secured hereby and to terminate any commitments to make loans or otherwise -5- extend credit to Debtor. Bank shall have all other rights, powers, privileges and remedies granted to a secured party upon default under the Texas Uniform Commercial Code or otherwise provided by law, including without limitation, the right to contact all persons obligated to Debtor on any Collateral or Proceeds and to instruct such persons to deliver all Collateral and/or Proceeds directly to Bank. All rights, powers, privileges and remedies of Bank shall be cumulative. No delay, failure or discontinuance of Bank in exercising any right, power, privilege or remedy hereunder shall affect or operate as a waiver of such right, power, privilege or remedy; nor shall any single or partial exercise of any such right, power, privilege or remedy preclude, waive or otherwise affect any other or further exercise thereof or the exercise of any other right, power, privilege or remedy. Any waiver, permit, consent or approval of any kind by Bank of any default hereunder, or any such waiver of any provisions or conditions hereof, must be in writing and shall be effective only to the extent set forth in writing. It is agreed that public or private sales, for cash or on credit, to a wholesaler or retailer or investor, or user of property of the types subject to this Agreement, or public auction, are all commercially reasonable since differences in the sales prices generally realized in the different kinds of sales are ordinarily offset by the differences in the costs and credit risks of such sales. While an Event of Default exists: (a) Bank may, at any time and at Bank's sole option, liquidate any time deposits pledged hereunder, whether or not said time deposits have matured and notwithstanding the fact that such liquidation may give rise to penalties for early withdrawal of funds; (b) Debtor will not dispose of any of the Collateral or Proceeds except on terms approved by Bank; (c) Bank may appropriate the Collateral and apply all Proceeds toward repayment of the Indebtedness in such order of application as Bank may from time to time elect; and (d) at Bank's request, Debtor will assemble and deliver all Collateral and Proceeds, and books and records pertaining thereto, to Bank at a reasonably convenient place designated by Bank. For any Collateral or Proceeds consisting of securities, Bank shall have no obligation to delay a sale of any portion thereof for the period of time necessary to permit the issuer thereof to register such securities for public sale under any applicable state or Federal law, even if the issuer thereof would agree to do so. 11. DISPOSITION OF COLLATERAL AND PROCEEDS. Upon the transfer of all or any part of the Indebtedness, Bank may transfer all or any part of the Collateral or Proceeds and shall be fully discharged thereafter from all liability and responsibility with respect to any of the foregoing so transferred, and the transferee shall be vested with all rights and powers of Bank hereunder with respect to any of the foregoing so transferred; but with respect to any Collateral or Proceeds not so transferred, Bank shall retain -6- all rights, powers, privileges and remedies herein given. Any proceeds of any disposition of any of the Collateral or Proceeds, or any part thereof, may be applied by Bank to the payment of expenses incurred by Bank in connection with the foregoing, including reasonable attorneys' fees, and the balance of such proceeds may be applied by Bank toward the payment of the Indebtedness in such order of application as Bank may from time to time elect. 12. STATUTE OF LIMITATIONS. Until all Indebtedness shall have been paid in full and all commitments by Bank to extend credit to Debtor have been terminated, the power of sale and all other rights, powers, privileges and remedies granted to Bank hereunder shall continue to exist and may be exercised by Bank at any time and from time to time irrespective of the fact that the Indebtedness or any part thereof may have become barred by any statute of limitations, or that the personal liability of Debtor may have ceased, unless such liability shall have ceased due to the payment in full of all Indebtedness secured hereunder. 13. MISCELLANEOUS. (a) The obligations of Debtor hereunder are joint and several; (b) Debtor hereby waives any right (i) to require Bank to make any presentment or demand, or give any notices of any kind, including without limitation any notice of nonpayment or nonperformance, protest, notice of protest, notice of dishonor, notice of the intention to accelerate or notice of acceleration hereunder, (ii) to direct the application of payments or security for any Indebtedness of Debtor, or indebtedness of customers of Debtor, or (iii) to require proceedings against others or to require exhaustion of security; and (c) Debtor hereby consents to extensions, forbearances or alterations of the terms of Indebtedness, the release or substitution of security, and the release of any guarantors; provided however, that in each instance Bank believes in good faith that the action in question is commercially reasonable in that it does not unreasonably increase the risk of nonpayment of the Indebtedness to which the action applies. Until all Indebtedness shall have been paid in full, no Debtor shall have any right of subrogation or contribution, and each Debtor hereby waives any benefit of or right to participate in any of the Collateral or Proceeds or any other security now or hereafter held by Bank. Any requirement of reasonable notice to Debtor with respect to the sale or other disposition of Collateral shall be met if such notice is given pursuant to the requirements of Section 14 hereof at least 5 days before the date of any public sale or the date after which any private sale or other disposition will be made. 14. NOTICES. All notices, requests and demands required under this Agreement must be in writing, addressed to Bank at the address specified in any other loan documents entered into between Debtor and Bank and to Debtor -7- at the address of its chief executive office (or personal residence, if applicable) specified below or to such other address as any party may designate by written notice to each other party, and shall be deemed to have been given or made as follows: (a) if personally delivered, upon delivery; (b) if sent by mail, upon the earlier of the date of receipt or three (3) days after deposit in the U.S. mail, first class and postage prepaid; and (c) if sent by telecopy, upon receipt. 15. COSTS, EXPENSES AND ATTORNEYS' FEES. Debtor shall pay to Bank immediately upon demand the full amount of all payments, advances, charges, costs and expenses, including reasonable attorneys' fees (to include outside counsel fees and all allocated costs of Bank's in-house counsel to the extent permissible), incurred by Bank in exercising any right, power, privilege or remedy conferred by this Agreement or in the enforcement thereof, whether incurred at the trial or appellate level, in an arbitration proceeding or otherwise, and including any of the foregoing incurred in connection with any bankruptcy proceeding (including without limitation, any adversary proceeding, contested matter or motion brought by Bank or any other person) relating to Debtor or in any way affecting any of the Collateral or Bank's ability to exercise any of its rights or remedies with respect thereto. All of the foregoing shall be paid by Debtor from the date of demand to the date paid in full with interest at the maximum rate permitted by applicable law. 16. SUCCESSORS; ASSIGNS; AMENDMENT. This Agreement shall be binding upon and inure to the benefit of the heirs, executors, administrators, legal representatives, successors and assigns of the parties, and may be amended or modified only in writing signed by Bank and Debtor. 17. SEVERABILITY OF PROVISIONS. If any provision of this Agreement shall be held to be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or any remaining provisions of this Agreement. 18. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the state of Texas. Debtor warrants that its chief executive office (or personal residence, if applicable) is located at the following address: 13403 Northwest Freeway, Suite 200, Houston, Texas 77040. -8- IN WITNESS WHEREOF, this Agreement has been duly executed as of October 7, 1996. HOUSTON CASUALTY COMPANY BY: /s/ FRANK J. BRAMANTI Name: Frank J. Bramanti Title: EVP & CFO -9- ADDENDUM TO GENERAL PLEDGE AGREEMENT THIS ADDENDUM is attached to and made a part of that certain General Pledge Agreement ("Agreement") executed by HOUSTON CASUALTY COMPANY ("Debtor"), as of October 7, 1996, in favor of WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION ("Bank"). Debtor acknowledges and agrees as follows: 1. Collateral. Notwithstanding any reference in the Agreement to a transfer, pledge or delivery to Bank, or a deposit with Bank, of the Collateral and Proceeds defined in paragraph I of the Agreement, and notwithstanding any reference in the Agreement to the possession, custody or control by Bank of the Collateral or Proceeds, said Collateral includes without limitation: (a) all securities, bonds, documents, instruments, money, notes, repurchase agreements, general intangibles, financial assets, investment property, and all other property of whatever nature or description, whether tangible or intangible, whether certificated or uncertificated, now or hereafter held on account of or for Debtor in Debtor's Custody Account maintained with Custodian in the name of Debtor, under Account Number 9002183500 ("Account") ; (b) the Account itself and all replacements and substitutions therefor; and (c) Proceeds of all of the foregoing; provided however, that notwithstanding the generality of the foregoing, the term "Collateral" does not include any and Bank disclaims a security interest in all WF Securities or Collective Investment Funds (as hereinafter defined) now or hereafter in the Account. The parties hereto expressly agree that all property, including cash, certificates of deposit, and mutual funds held in the account are to be treated as "financial assets" under the Uniform Commercial Code of the State of Texas. 2. Security Interest. In accordance with and subject to the provisions of the Agreement, and to secure the obligations described therein, Debtor grants and transfers to Bank a security interest in all of the Collateral described in the Agreement and paragraph l of this Addendum. Grantor expressly agrees that all Collateral shall be security for the indebtedness secured hereby and by the Agreement, whether the Collateral is located at one or more offices, branches or affiliates of Bank or Custodian, and whether or not the office or branch where any secured indebtedness is created is aware of or relies upon the Collateral. 2 3. Account Activity. So long as no default exists with respect to the indebtedness secured hereby, Debtor may sell, exchange, transfer or otherwise dispose of assets in and withdraw assets from the Account, provided however that the Collateral Value of the Account, as hereinafter defined, shall at all times be equal to or greater than one hundred twenty five percent (125%) of the outstanding principal balance of the indebtedness secured hereby, but in no event shall the Collateral Value of the Account exceed Fifteen Million Dollars ($15,000,000.00). In the event that the Collateral Value of the Account should, for any reason and at any time, be less than the required amount, Debtor shall promptly either make a principal reduction on the indebtedness secured hereby, or pledge to Bank and deposit in the Account additional assets, of a nature satisfactory to Bank, in either case, sufficient such that the Collateral Value of the Account achieves the required amount. 4. Priority. The terms of this Addendum override and take precedence over any provision to the contrary in any other agreement or other documentation relative to the opening and maintenance of the Account. 3 5. Defined Terms. All terms defined in the Agreement and used herein shall have the same meaning when used in this Addendum. "Custodian" means Wells Fargo Bank (Texas), National Association (Trust Department), with whom the Account is registered and that has the custody and/or management of the securities and other financial assets comprising the Account. The Custodian may be a separate department, division, group or affiliate of Bank. "WF Securities" means stock, securities or obligations of Wells Fargo & Company or of any affiliate thereof (as the term affiliate is defined in Section 23A of the Federal Reserve Act (12 USC 371(c), as amended from time to time). 6. Negative Pledge. So long as Bank retains a security interest in the Collateral, Debtor shall not (a) further pledge, encumber, grant or permit to exist a security interest in or lien upon any assets now or hereafter in the Account, including without limitation, WF Securities or Collective Investment Funds, (b) cause any of the Collateral to be registered in the name of any party, other than Grantor, nor to grant to any other party any entitlement in any Collateral, (c) grant to any party, 4 other than Bank, the right to take any action with respect to the Collateral, including sale of such portions of the Collateral that are securities or other investment property, without any further action by Debtor or (d) the Account agreement between the Debtor and the Custodian, other than ordinary and reasonable charges in Custodian's charges for handling the Account, in any way which would affect Bank's interest in the Collateral without the prior written consent of Bank, or terminate the Account agreement without sixty (60) days' prior notice to Lender. 7. Instruction to Custodian. This Addendum constitutes an instruction and authorization by Debtor to the Custodian to abide by the terms hereof, and following written instructions from Bank, to take any action requested by Bank with respect to the Account with the necessity of no further action by Debtor. IN WITNESS WHEREOF, the Debtor has executed this Addendum as of the same date as the Agreement. HOUSTON CASUALTY COMPANY By: /s/ FRANK J. BRAMANTI Title: EVP & CFO 5 UCC-1 COLLATERAL DESCRIPTION All present and future right, title and interest in Debtor's Debtor's Custody Account maintained with Custodian in the name of Debtor, under Account Number 9002183500 (the "Account"); all property, whether tangible or intangible, now or hereafter maintained in or identified to the Account, including without limitation, all securities, bonds, documents, instruments, money, notes, repurchase agreements, general intangibles, financial assets, investment property, and other rights to payment, whether certificated or uncertificated, and any collateral therefor and/or guaranties thereof; all replacements and substitutions of the foregoing; and all proceeds of, and all additions to, the foregoing. 6 EX-10.333 5 EXHIBIT 10.333 EXHIBIT 10.333 REVOLVING LINE OF CREDIT NOTE $10,000,000.00 Houston, Texas January 10, 1997 FOR VALUE RECEIVED, the undersigned HCC INSURANCE HOLDINGS, INC., a Delaware corporation ("Borrower") promises to pay to the order of WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION ("Bank") at its office at 1000 Louisiana, Third Floor, Houston, Texas 77002, or at such other place as the holder hereof may designate, in lawful money of the United States of America and in immediately available funds, the principal sum of TEN MILLION AND NO/100 Dollars ($10,000,000.00), or so much thereof as may be advanced and be outstanding, with interest thereon, to be computed on each advance from the date of its disbursement as set forth herein. DEFINITIONS: As used herein, the following terms shall have meanings set forth after each, and any other term defined in this Note shall have the meanings set forth at the place defined: (a) "Business Day" means any day except Saturday, Sunday or any other day on which commercial banks in Texas are authorized or required by law to close. (b) "Fixed Rate Term" means a period commencing on a Business Day continuing for one (1), two (2) or three (3) months, as designated by Borrower, during which all or a portion of the outstanding principal balance of this Note bears interest determined in relation to LIBOR; provided however, that no Fixed Rate Term may be selected for a principal amount less than One Million and No/100 Dollars ($1,000,000.00); and provided further, that no Fixed Rate term shall extend beyond the scheduled maturity date hereof. If any Fixed Rate Term would end on a day which is not a Business Day, then such Fixed Rate Term shall be extended to the next succeeding Business Day. (c) "LIBOR" means the rate per annum (rounded upward, if necessary, to the nearest whole 1/8 of 1%) and determined pursuant to the following formula: LIBOR = BASE LIBOR -------------------------------------- 100% - LIBOR Reserve Percentage (i) "Base LIBOR" means the rate per annum for United States dollar deposits quoted by Bank as the Inter-Bank Market Offered Rate, with the understanding that such rate is quoted by Bank for the purpose of calculating effective rates of interest for loans making reference thereto, on the first day of a Fixed Rate Term for delivery of funds on said date for a period of time approximately equal to the number of days in such Fixed Rate Term and in an amount approximately equal to the principal amount to which such Fixed Rate Term applies. Borrower understands and agrees that Bank may base its quotation of the Inter-Bank Market Offered Rate upon such offers or other market indicators of the Inter-Bank Market as Bank in its discretion deems appropriate including, but no limited to, the rate offered for U.S. dollar deposits on the London Inter-Bank Market. (ii) "LIBOR Reserve Percentage" means the reserve percentage prescribed by the Board of Governors of the Federal Reserve System (or any successor) for "Eurocurrency Liabilities" (as defined in Regulation D of the Federal Reserve Board, as amended), adjusted by Bank for expected changes in such reserve percentage during the applicable Fixed Rate Term. (d) "Prime Rate" means at any time the rate of interest most recently announced within Bank at its principal office as its Prime Rate, with the understanding that the Prime Rate is one of Bank's base rates and serves as the basis upon which effective rates of interest are calculated for those loans making reference thereto, and is evidenced by the recording thereof after its announcement in such internal publication or publications as Bank may designate. INTEREST: (a) INTEREST. The outstanding principal balance of this Note shall bear interest (computed on the basis of a 360-day year, actual days elapsed, unless such calculation would result in a usurious rate, in which case interest shall be computed on the basis of 365/366-day year, as the case may be, actual days elapsed) at the lesser of (i) either (A) a fluctuating rate per annum equal to the Prime Rate in effect from time to time, or (B) a fixed rate per annum determined by Bank to be one and one-half percent (1.50%) above LIBOR in effect on the first day of the applicable Fixed Rate Term, or (ii) the Maximum Rate. When interest is determined in relation to the Prime Rate, each change in the rate of interest hereunder shall become effective on the date each Prime Rate change is announced within Bank. With respect to each LIBOR selection hereunder, Bank is hereby authorized to note the date, principal amount, interest rate and Fixed Rate Term applicable thereto and any payments made thereon on Bank's books and records (either manually or by electronic entry) and/or on any schedule attached to this Note, which notations shall be prima facie evidence of the accuracy of the information noted. (b) SELECTION OF INTEREST RATE OPTIONS. At any time any portion of this Note bears interest determined in relation to LIBOR, it may be continued by Borrower at the end the Fixed Rate Term applicable thereto so that all or a portion thereof bears interest determined in relation to the Prime Rate or to LIBOR for a new Fixed Rate Term designated by Borrower. At any time any portion of this Note bears interest determined in relation to the Prime Rate, Borrower may convert all or a portion thereof so that it bears interest determined in relation to LIBOR for a Fixed Rate Term designated by Borrower. At such time as Borrower requests an advance hereunder or wishes to select a LIBOR option for all or a portion of the outstanding principal balance hereof, and at the end of each Fixed Rate Term, Borrower shall give Bank notice specifying: (i) the interest rate option selected by Borrower; (ii) the principal amount subject thereto; and (iii) for each LIBOR selection, the length of the applicable Fixed Rate Term. Any such notice may be given by telephone so long as, with respect to each LIBOR selection, (A) Bank receives written confirmation from Borrower not later than three (3) Business Days after such telephone notice is given, and (B) such notice is given to Bank prior to 10:00 a.m., California time, three (3) Business Days before the first day of the Fixed Rate Term. For each LIBOR option requested hereunder, Bank will quote the applicable fixed rate to Borrower at approximately 10:00 a.m., California time, on the first day of the Fixed Rate Term. If Borrower does not immediately accept the rate quoted by Bank, any subsequent acceptance by Borrower shall be subject to a redetermination by Bank of the applicable fixed rate; provided however, that if Borrower fails to accept any such rate by 11:00 a.m., California time, on the Business Day such quotation is given, then the quoted rate shall expire and Bank shall have no obligation to permit a LIBOR option to be selected on such day. If no specific designation of interest is made at the time any advance is requested hereunder or at the end of any Fixed Rate Term, Borrower shall be deemed to have made a Prime Rate interest selection for such advance or the principal amount to which such Fixed Rate Term applied. (c) ADDITIONAL LIBOR PROVISIONS. (i) If Bank at any time shall determine that for any reason adequate and reasonable means do not exist for ascertaining LIBOR, then Bank shall promptly give notice thereof to Borrower. If such notice is given and until such notice has been withdrawn by Bank, then (A) no new LIBOR option may be selected by Borrower, and (B) any portion of the outstanding principal balance hereof which bears interest determined in relation to LIBOR, subsequent to the end of the Fixed Rate Term applicable thereto, shall bear interest determined in relation to the Prime Rate. (ii) If any law, treaty, rule, regulation or determination of a court or governmental authority or any change therein or in the interpretation or application thereof (each, a "Change in Law") shall make it unlawful for Bank (A) to make LIBOR options available hereunder, or (B) to maintain interest rates based on LIBOR, then in the former event, any obligation of Bank to make available such unlawful LIBOR options shall immediately be canceled, and in the latter event, any such unlawful LIBOR-based interest rates then outstanding shall be converted, at Bank's option, so that interest on the portion of the outstanding principal balance subject thereto is determined in relation to the Prime Rate; provided however, that if any such Change in Law shall permit any LIBOR-based interest rates to remain in effect until the expiration of the Fixed Rate Term applicable thereto, then such permitted LIBOR-based interest rates shall continue in effect until the expiration of such Fixed Rate Term. Upon the occurrence of any of the foregoing events, Borrower shall pay to Bank immediately upon demand such amounts as may be necessary to compensate Bank for any fines, fees, charges, penalties or other costs incurred or payable by Bank as a result thereof and which are attributable to any LIBOR options made available to Borrower hereunder, and any reasonable allocation made by Bank among its operations shall be conclusive and binding upon Borrower. (iii) If any Change in Law or compliance by Bank with any request or directive (whether or not having the force of law) from any central bank or other governmental authority shall: (A) subject Bank to any tax, duty or other charge with respect to any LIBOR options, or change the basis of taxation of payments to Bank of principal, interest, fees or any other amount payable hereunder (except for changes in the rate of tax on the overall net income of Bank); or (B) impose, modify or hold applicable any reserve, special deposit, compulsory loan or similar requirement against assets held by, deposits or other liabilities in or for the account of, advances or loans by, or any other acquisition of funds by any office of Bank; or (C) impose on Bank any other condition; and the result of any of the foregoing is to increase the cost to Bank of making, renewing or maintaining any LIBOR options hereunder and/or to reduce any amount receivable by Bank in connection therewith, then in any such case, Borrower shall pay to Bank immediately upon demand such amounts as may be necessary to compensate Bank for any additional costs incurred by Bank and/or reductions in amounts received by Bank which are attributable to such LIBOR options. In determining which costs incurred by Bank and/or reductions in amounts received by Bank are attributable to any LIBOR options made available to Borrower hereunder, any reasonable allocation made by Bank among its operations shall be conclusive and binding upon Borrower. (iv) Only one amount may be quoted a LIBOR rate, and that amount, except for permitted repayments, may not be changed between Fixed Rate Terms. (d) PAYMENT OF INTEREST. Interest accrued on any portion of this Note which bears interest determined in relation to the Prime Rate shall be payable on the last day of each calendar quarter, commencing March 31, 1997. Interest accrued on any portion of this Note which bears interest determined in relation to LIBOR shall be payable on the last day of each Fixed Rate Term. Borrower authorizes Bank to debit Borrower's accounts at Bank for all principal, interest, fees or other liabilities due to Bank under any of the Loan Documents as defined in the hereinafter described Credit Agreement. (e) DEFAULT INTEREST. From and after the maturity date of this Note, or such earlier date as all principal owing hereunder becomes due and payable by acceleration or otherwise, the outstanding principal balance of this Note shall bear interest until paid in full at an increased rate per annum (computed on the basis of a 360-day year, actual days elapsed, unless such calculation would result in a usurious rate, in which case interest shall be computed on the basis of a 365/366-day year, as the case may be, actual days elapsed) equal to four percent (4%) above the rate of interest from time to time applicable to this Note, but in no event at a rate greater than the Maximum Rate. BORROWING AND REPAYMENT: (a) BORROWING AND REPAYMENT. Borrower may from time to time during the term of this Note borrow, partially or wholly repay its outstanding borrowings, and reborrow, subject to all of the limitations, terms and conditions of this Note and of any document executed in connection with or governing this Note; provided however, that the total outstanding borrowings under this Note shall not at any time exceed the principal amount stated above. The unpaid principal balance of this obligation at any time shall be the total amounts advanced hereunder by the holder hereof less the amount of principal payments made hereon by or for any Borrower, which balance may be endorsed hereon from time to time by the holder. The outstanding principal balance of this Note together with all accrued but unpaid interest shall be due and payable in full on April 30, 1998. (b) ADVANCES. Advances hereunder, to the total amount of the principal sum stated above, may be made by the holder at the oral or written request of (i) Frank J. Bramanti or L. Edward Tuffly, any one acting alone, who are authorized to request advances and direct the disposition of any advances until written notice of the revocation of such authority is received by the holder at the office designated above, or (ii) any person, with respect to advances deposited to the credit of any account of any Borrower with the holder, which advances, when so deposited, shall be conclusively presumed to have been made to or for the benefit of each Borrower regardless of the fact that persons other than those authorized to request advances may have authority to draw against such account. The holder shall have no obligation to determine whether any person requesting an advance is or has been authorized by any Borrower. (c) APPLICATION OF PAYMENTS. Each payment made on this Note shall be credited first, to any interest then due and second, to the outstanding principal balance hereof. All payments credited to principal shall be applied first, to the outstanding principal balance of this Note which bears interest determined in relation to the Prime Rate, if any, and second, to the outstanding principal balance of this Note which bears interest determined in relation to LIBOR, with such payments applied to the oldest Fixed Rate Term first. PREPAYMENT: (a) PRIME RATE. Borrower may prepay principal on any portion of this Note which bears interest determined in relation to the Prime Rate at any time, in any amount and without penalty. (b) LIBOR. Borrower may prepay principal on any portion of this Note which bears interest determined in relation to LIBOR at any time and in the minimum amount of One Hundred Thousand and No/100 Dollars ($100,000.00); provided however, that if the outstanding principal balance of such portion of this Note is less than said amount, the minimum prepayment amount shall be the entire outstanding principal balance thereof. In consideration of Bank providing this prepayment option to Borrower, or if any such portion of this Note shall become due and payable at any time prior to the last day of the Fixed Rate Term applicable thereto, Borrower shall pay to Bank immediately upon demand a fee which is the sum of the discounted monthly differences for each month from the month of prepayment through the month in which such Fixed Rate Term matures, calculated as follows for each such month: (i) Determine the amount of interest which would have accrued each month on the amount prepaid at the interest rate applicable to such amount had it remained outstanding until the last day of the Fixed Rate Term applicable thereto. (ii) Subtract from the amount determined in (i) above the amount of interest which would have accrued for the same month on the amount prepaid for the remaining term of such Fixed Rate Term at LIBOR in effect on the date of prepayment for new loans made for such term and in a principal amount equal to the amount prepaid. (iii) If the result obtained in (ii) for any month is greater than zero, discount that difference by LIBOR used in (ii) above. Each Borrower acknowledges that prepayment of such amount may result in Bank incurring additional costs, expenses and/or liabilities, and that it is difficult to ascertain the full extent of such costs, expenses and/or liabilities. Each Borrower, therefore, agrees to pay the above-described prepayment fee and agrees that said amount represents a reasonable estimate of the prepayment costs, expenses and/or liabilities of Bank. EVENTS OF DEFAULT: This Note is made pursuant to and is subject to the terms and conditions of that certain Credit Agreement between Borrower and Bank dated as of January 10, 1997, as amended from time to time (the "Credit Agreement"). Any default in the payment or performance of any obligation under this Note, or any defined event of default under the Credit Agreement, shall constitute an "Event of Default" under this Note. MISCELLANEOUS: (a) REMEDIES. Upon the occurrence of any Event of Default, the holder of this Note, at the holder's option, may declare all sums of principal and accrued and unpaid interest outstanding hereunder to be immediately due and payable without presentment, demand, or any notices of any kind, including without limitation notice of nonperformance, notice of protest, protest, notice of dishonor, notice of intention to accelerate or notice of acceleration, all of which are expressly waived by each Borrower, and the obligation, if any, of the holder to extend any further credit hereunder shall immediately cease and terminate. Each Borrower shall pay to the holder immediately upon demand the full amount of all payments, advances, charges, costs and expenses, including reasonable attorney's fees (to include outside counsel fees and all allocated costs of the holder's in-house counsel to the extent permissible), expended or incurred by the holder in connection with the enforcement of the holder's rights and/or the collection of any amounts which become due to the holder under this Note, and the prosecution or defense of any action in any way related to this Note, including without limitation, any action for declaratory relief, whether incurred at the trial or appellate level, in an arbitration proceeding or otherwise, and including any of the foregoing incurred in connection with any bankruptcy proceeding (including without limitation, any adversary proceeding, contested matter or motion brought by Bank or any other person) relating to any Borrower or any other person or entity. (b) OBLIGATIONS JOINT AND SEVERAL. Should more than one person or entity sign this Note as a Borrower, the obligations of each such Borrower shall be joint and several. (c) GOVERNING LAW. This Note shall be governed by and constructed in accordance with the laws of the State of Texas. (d) SAVINGS CLAUSE. It is the intention of the parties to comply strictly with applicable usury laws. Accordingly, notwithstanding any provision to the contrary in this Note, or in any contract, instrument or document evidencing or securing the payment hereof or otherwise hereto (each, a "Related Document"), in no event shall this Note or any Related Document require the payment or permit the payment, taking, reserving, receiving, collection or charging of any sums constituting interest under applicable laws that exceed the maximum amount permitted by such laws, as the same may be amended or modified from time to time (the "Maximum Rate"). If any such excess interest is called for, contracted for, charged, taken, reserved or received in connection with this Note or any Related Document, or in any communication by Bank or any other person to Borrower or any other person, or in the event that all or part of the principal or interest hereof or thereof shall be prepaid or accelerated, so that under any of such circumstances or under any other circumstance whatsoever the amount of interest contracted for, charged, taken, reserved or received on the amount of principal actually outstanding from time to time under this Note shall exceed the Maximum Rate, then in such event it is agreed that: (i) the provisions of this paragraph shall govern and control; (ii) neither Borrower nor any other person or entity now or hereafter liable for the payment of this Note or any Related Document shall be obligated to pay the amount of such interest to the extent it is in excess of the Maximum Rate; (iii) any such excess interest which is or has been received by Bank, notwithstanding this paragraph, shall be credited against the then unpaid principal balance hereof or thereof, or if this Note or any Related Document has been or would be paid in full by such credit, refunded to Borrower; and (iv) the provisions of this Note and each Related Document, and any other communication to Borrower, shall immediately be deemed reformed and such excess interest reduced, without the necessity of executing any other document, to the Maximum Rate. The right to accelerate the maturity of this Note or any Related Document does not include the right to accelerate, collect or charge unearned interest, but only such interest that has otherwise accrued as of the date of acceleration. Without limiting the foregoing, all calculations of the rate of interest contracted for, charged, taken, reserved or received in connection with this Note and any Related Document which are made for the purpose of determining whether such rate exceeds the Maximum Rate shall be made to the extent permitted by applicable laws by amortizing, prorating, allocating and spreading during the period of the full term of this Note or such Related Document, including all prior and subsequent renewals and extensions hereof or thereof, all interest at any time contracted for, charged, taken, reserved or received by Bank. The terms of this paragraph shall be deemed to be incorporated into each Related Document. To the extent that Article 5069-1.04 of the Texas Revised Civil Statutes is relevant to Bank for the purpose of determining the Maximum Rate, Bank hereby elects to determine the applicable rate ceiling under such Article by the indicated (weekly) rate ceiling from time to time in effect, subject to Bank's right subsequently to change such method in accordance with applicable law, as the same may be amended or modified from time to time. (e) RIGHT OF SETOFF; DEPOSIT ACCOUNTS. Upon and after the occurrence of an Event of Default, (i) Borrower hereby authorizes Bank, at any time and from time to time, without notice, which is hereby expressly waived by Borrower, and whether or not Bank shall have declared this Note to be due and payable in accordance with the terms hereof, to set off against, and to appropriate and apply to the payment of, Borrower's obligations and liabilities under this Note (whether matured or unmatured, fixed or contingent, liquidated or unliquidated), any and all amounts owing by Bank to Borrower (whether payable in U.S. dollars or any other currency, whether matured or unmatured, and in the case of deposits, whether general or special (except trust and escrow accounts), time or demand and however evidenced), and (ii) pending any such action, to the extent necessary, to hold such amounts as collateral to secure such obligations and liabilities and to return as unpaid for insufficient funds any and all checks and other items drawn against any deposits so held as Bank, in its sole discretion, may elect. Borrower hereby grants to Bank a security interest in all deposits and accounts maintained with Bank and with any other financial institution to secure the payment of all obligations and liabilities of Borrower to Bank under this Note. (f) BUSINESS PURPOSE. Borrower represents and warrants that all loans evidenced by this Note are for a business, commercial, investment, agricultural or other similar purpose and not primarily for a personal, family or household use. (g) Certain Tri-Party Accounts. Borrower and Bank agree that Tex. Rev. Civ. Stat. Ann. Art. 5056, ch. 15 (which regulates certain revolving credit loan accounts and revolving triparty accounts) shall not apply to any revolving loan accounts created under this Note or maintained in connection herewith. NOTICE: THIS NOTE AND ALL OTHER DOCUMENTS RELATING TO THE INDEBTEDNESS EVIDENCED HEREBY CONSTITUTE A WRITTEN LOAN AGREEMENT WHICH REPRESENTS THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES RELATING TO THIS NOTE AND THE INDEBTEDNESS EVIDENCED HEREBY. IN WITNESS WHEREOF, the undersigned has executed this Note as of the date first written above. HCC INSURANCE HOLDINGS, INC., a Delaware corporation By: Name: Title: CREDIT AGREEMENT THIS AGREEMENT is entered into as of January 10, 1997, by and between HCC INSURANCE HOLDINGS, INC., a Delaware corporation ("Borrower"),and WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION ("Bank"). RECITAL Borrower has requested from Bank the credit accommodation described below, and Bank has agreed to provide said credit accommodation to Borrower on the terms and conditions contained herein. NOW, THEREFORE, for valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Bank and Borrower hereby agree as follows: ARTICLE I THE CREDIT SECTION 1.1. LINE OF CREDIT. (a) Line of Credit. Subject to the terms and conditions of this Agreement, Bank hereby agrees to make advances to Borrower from time to time up to and including April 30, 1998, not to exceed at any time the aggregate principal amount of TEN MILLION AND NO/100 Dollars ($10,000,000.00) ("Line of Credit"), the proceeds of which shall be used for working capital. Borrower's obligation to repay advances under the Line of Credit shall be evidenced by a promissory note substantially in the form of Exhibit "A" attached hereto ("Line of Credit Note"), all terms of which are incorporated herein by this reference. (b) Borrowing and Repayment. Borrower may from time to time during the term of the Line of Credit borrow, partially or wholly repay its outstanding borrowings, and reborrow, subject to all of the limitations, terms and conditions contained herein or in the Line of Credit Note; provided however, that the total outstanding borrowings under the Line of Credit shall not at any time exceed the maximum principal amount available thereunder, as set forth above. SECTION 1.2. INTEREST/FEES. (a) Interest. The outstanding principal balance of the Line of Credit Note shall bear interest at the rate of interest set forth in the Line of Credit Note. (b) Computation and Payment. Interest shall be computed on the basis of a 360-day year, actual days elapsed, unless such calculation would result in a usurious rate, in which case interest shall be computed on the basis of a 365/366-day year, as the case may be, actual days elapsed. Interest shall be payable at the times and place set forth in the Line of Credit Note. (c) Unused Commitment Fee. Borrower shall pay to Bank a fee equal to one-quarter percent (1/4%) per annum (computed on the basis of a 360-day year, actual days elapsed) on the average daily unused amount of the Line of Credit, which fee shall be calculated on a quarterly basis by Bank and shall be due and payable by Borrower in arrears and Bank shall be entitled to debit the accounts of Borrower at Bank for such fees. 1 SECTION 1.3. COLLATERAL. As security for all indebtedness of Borrower to Bank subject hereto, Borrower hereby grants to Bank security interests of first priority in 100% of the outstanding stock of Houston Casualty Company. All of the foregoing shall be evidenced by and subject to the terms of such security agreements, financing statements, deeds of trust and other documents as Bank shall reasonably require, all in form and substance satisfactory to Bank. Borrower shall reimburse Bank immediately upon demand for all costs and expenses incurred by Bank in connection with any of the foregoing security, including without limitation, filing and recording fees and costs of appraisals, audits and title insurance. SECTION 1.4. TERM LOAN. (a) Term Loan. Bank has made a loan to Borrower in the original principal amount of Twenty Million and No/100 Dollars ($20,000,000.00) ("Term Loan"), as evidenced by a promissory note dated November 29, 1994 ("Term Note"). (b) Repayment. Principal and interest on the Term Loan shall be repaid in accordance with the provisions of the Term Note. (c) Borrower expressly agrees that any default in the Term Note or in any documents executed in connection with or securing the Term Note or default in any other debt now or hereafter owed to Bank by Borrower or any of its subsidiaries or affiliates shall constitute a default under the Line of Credit Note, and that any default in the Line of Credit Note or any document executed in connection with or securing the Line of Credit Note or default in any other debt now or hereafter owed to Bank by Borrower or any of its subsidiaries or affiliates shall constitute a default in the Term Note. ARTICLE II REPRESENTATIONS AND WARRANTIES Borrower makes the following representations and warranties to Bank, which representations and warranties shall survive the execution of this Agreement and shall continue in fill force and effect until the fill and final payment, and satisfaction and discharge, of all obligations of Borrower to Bank subject to this Agreement. SECTION 2.1. LEGAL STATUS. Borrower is a corporation, duly organized and existing and in good standing under the laws of the State of Delaware, and is qualified or licensed to do business (and is in good standing as a foreign corporation, if applicable) in all jurisdictions in which such qualification or licensing is required or in which the failure to so qualify or to be so licensed could have a material adverse effect on Borrower. SECTION 2.2. AUTHORIZATION AND VALIDITY. This Agreement, the Line of Credit Note, and each other document, contract and instrument required hereby or at any time hereafter delivered to Bank in connection herewith (collectively, the "Loan Documents") have been duly authorized, and upon their execution and delivery in accordance with the provisions hereof will constitute legal, valid and binding agreements and obligations of Borrower or the party which executes the same, enforceable in accordance with their respective terms. SECTION 2.3. NO VIOLATION. The execution, delivery and performance by Borrower of each of the Loan Documents do not violate any provision of any law or regulation, or contravene any provision of the Articles of Incorporation or By-Laws of Borrower, or result in any breach of or default under any 2 contract, obligation, indenture or other instrument to which Borrower is a party or by which Borrower may be bound. SECTION 2.4. LITIGATION. There are no pending, or to the best of Borrower's knowledge threatened, actions, claims, investigations, suits or proceedings by or before any governmental authority, arbitrator, court or administrative agency which could have a material adverse effect on the financial condition or operation of Borrower other than those disclosed by Borrower to Bank in writing prior to the date hereof. SECTION 2.5. CORRECTNESS OF FINANCIAL STATEMENT. The financial statement of Borrower dated June 30, 1996, a true copy of which has been delivered by Borrower to Bank prior to the date hereof, (a) is complete and correct and presents fairly the financial condition of Borrower, (b)discloses all liabilities of Borrower that are required to be reflected or reserved against under generally accepted accounting principles, whether liquidated or unliquidated, fixed or contingent, and (c) has been prepared in accordance with generally accepted accounting principles consistently applied. Since the date of such financial statement there has been no material adverse change in the financial condition of Borrower, nor has Borrower mortgaged, pledged, granted a security interest in or otherwise encumbered any of its assets or properties except in favor of Bank or as otherwise permitted by Bank in writing. SECTION 2.6. INCOME TAX RETURNS. Borrower has no knowledge of any pending assessments or adjustments of its income tax payable with respect to any year. SECTION 2.7. NO SUBORDINATION. There is no agreement, indenture, contract or instrument to which Borrower is a party or by which Borrower may be bound that requires the subordination in right of payment of any of Borrower's obligations subject to this Agreement to any other obligation of Borrower. SECTION 2.8. PERMITS, FRANCHISES. Borrower possesses, and will hereafter possess, all permits, consents, approvals, franchises and licenses required and rights to all trademarks, trade names, patents, and fictitious names, if any, necessary to enable it to conduct the business in which it is now engaged in compliance with applicable law. SECTION 2.9. ERISA. Borrower is in compliance in all material respects with all applicable provisions of the Employee Retirement Income Security Act of 1974, as amended or recodified from time to time ("ERISA"); Borrower has not violated any provision of any defined employee pension benefit plan (as defined in ERISA) maintained or contributed to by Borrower (each, a "Plan"); no Reportable Event as defined in ERISA has occurred and is continuing with respect to any Plan initiated by Borrower; Borrower has met its minimum funding requirements under ERISA with respect to each Plan; and each Plan will be able to fulfill its benefit obligations as they come due in accordance with the Plan documents and under generally accepted accounting principles. SECTION 2.10. OTHER OBLIGATIONS. Borrower is not in default on any obligation for borrowed money, any purchase money obligation or any other material lease, commitment, contract, instrument or obligation. SECTION 2.11. ENVIRONMENTAL MATTERS. Except as disclosed by Borrower to Bank in writing prior to the date hereof, Borrower is in compliance in all material respects with all applicable federal or state environmental, hazardous waste, health and safety statutes, and any rules or regulations adopted pursuant thereto, which govern or affect any of Borrower's operations and/or properties, including without limitation, the Comprehensive Environmental Response, Compensation and Liability Act of 1980, the Superfund Amendments and Reauthorization Act of 1986, the Federal Resource Conservation and Recovery Act of 1976, and the Federal Toxic Substances Control Act, as any of the same may be amended, modified or supplemented from time to time. None of the operations of Borrower is the subject of any federal or state investigation evaluating whether any remedial action involving a material 3 expenditure is needed to respond to a release of any toxic or hazardous waste or substance into the environment. Borrower has no material contingent liability in connection with any release of any toxic or hazardous waste or substance into the environment. ARTICLE III CONDITIONS SECTION 3.1. CONDITIONS OF INITIAL EXTENSION OF CREDIT. The obligation of Bank to extend any credit contemplated by this Agreement is subject to the fulfillment to Bank's satisfaction of all of the following conditions: (a) Approval of Bank Counsel. All legal matters incidental to the extension of credit by Bank shall be satisfactory to Bank's counsel. (b) Documentation. Bank shall have received, in form and substance satisfactory to Bank, each of the following, duly executed: (i) This Agreement and the Line of Credit Note. (ii) General Pledge Agreement. (iii) Certified Copy of Resolutions (iv) Notice and Acknowledgment of No Oral Agreement (v) Attorney Representation Notice (vi) Borrower's Affidavit (vii) Borrower's Certificate (viii) Statement of Purpose for an Extension of Credit Secured by Margin Stock (ix) Such other documents as Bank may require under any other Section of this Agreement. (c) Financial Condition. There shall have been no material adverse change, as determined by Bank, in the financial condition or business of Borrower, nor any material decline, as determined by Bank, in the market value of any collateral required hereunder or a substantial or material portion of the assets of Borrower. (d) Insurance. Borrower shall carry insurance coverage on all Borrower's property, in form, substance, amounts, covering risks and issued by companies satisfactory to Bank, and where required by Bank and customary for the industry of Borrower, with loss payable endorsements in favor of Bank. SECTION 3.2. CONDITIONS OF EACH EXTENSION OF CREDIT. The obligation of Bank to make each extension of credit requested by Borrower hereunder shall be subject to the fulfillment to Bank's satisfaction of each of the following conditions: (a) Compliance. The representations and warranties contained herein and in each of the other Loan Documents shall be true on and as of the date of the signing of this Agreement and on the date of each extension of credit by Bank pursuant hereto, with the same effect as though such representations and warranties had been made on and as of each such date, and on each such date, no Event of Default as defined herein, and no condition, event or act which with the giving of notice or the passage of time or both would constitute such an Event of Default, shall have occurred and be continuing or shall exist. (b) Documentation. Bank shall have received all additional documents which may be required in connection with such extension of credit. 4 ARTICLE IV AFFIRMATIVE COVENANTS Borrower covenants that so long as Bank remains committed to extend credit to Borrower pursuant hereto, or any liabilities (whether direct or contingent, liquidated or unliquidated) of Borrower to Bank under any of the Loan Documents remain outstanding, and until payment in full of all obligations of Borrower subject hereto, Borrower shall, unless Bank otherwise consents in writing: SECTION 4.1. PUNCTUAL PAYMENTS. Punctually pay all principal, interest, fees or other liabilities due under.any of the Loan Documents at the times and place and in the manner specified therein, and immediately upon demand by Bank, the amount by which the outstanding principal balance of the Line of Credit Note at any time exceeds any limitation on borrowings applicable thereto. Borrower authorizes Bank to debit Borrower's accounts at Bank for all principal, interest, fees or other liabilities due to Bank under any of the Loan Documents. SECTION 4.2. ACCOUNTING RECORDS. Maintain adequate books and records in accordance with generally accepted accounting principles consistently applied, and permit any representative of Bank, at any reasonable time, to inspect, audit and examine such books and records, to make copies of the same, and to inspect the properties of Borrower. SECTION 4.3. FINANCIAL STATEMENTS. Provide to Bank all of the following, in form and detail satisfactory to Bank: (a) not later than one hundred twenty (120) days after and as of the end of each fiscal year, an audited financial statement of Borrower, prepared by a Certified Public Accountant acceptable to Bank, to include a copy of form 10-K of Borrower; (b) not later than ninety (90) days after and as of the end of each quarter, a financial statement of Borrower, prepared by Borrower, to include a copy of Form 10-Q of Borrower; (c) contemporaneously with each annual and quarterly financial statement of Borrower required hereby, a certificate of the president or chief financial officer of Borrower that said financial statements are accurate and that there exists no Event of Default nor any condition, act or event which with the giving of notice or the passage of time or both would constitute an Event of Default; (d) from time to time such other information as Bank may reasonably request. SECTION 4.4. COMPLIANCE. Preserve and maintain all licenses, permits, governmental approvals, rights, privileges and franchises necessary for the conduct of its business; and comply with the provisions of all documents pursuant to which Borrower is organized and/or which govern Borrower's continued existence and with the requirements of all laws, rules, regulations and orders of any governmental authority applicable to Borrower and/or its business. SECTION 4.5. INSURANCE. Maintain and keep in force insurance of the types and in amounts customarily carried in lines of business similar to that of Borrower, including but not limited to fire, extended coverage, public liability, flood, property damage and workers' compensation, with all such insurance carried with companies and in amounts satisfactory to Bank, and deliver to Bank from time to time at Bank's request schedules setting forth all insurance then in effect. SECTION 4.6. FACILITIES. Keep all properties useful or necessary to Borrower's business in good repair and condition, and from time to time make necessary repairs, renewals and replacements thereto so that such properties shall be fully and efficiently preserved and maintained. 5 SECTION 4.7. TAXES AND OTHER LIABILITIES. Pay and discharge when due any and all indebtedness, obligations, assessments and taxes, both real or personal, including without limitation Federal and state income taxes and state and local property taxes and assessments, except such (a) as Borrower may in good faith contest or as to which a bona fide dispute may arise, and (b) for which Borrower has made provision, to Bank's satisfaction, for eventual payment thereof in the event Borrower is obligated to make such payment. SECTION 4.8. LITIGATION. Promptly give notice in writing to Bank of any litigation pending or threatened against Borrower with a claim in excess of $100,000.00. SECTION 4.9. FINANCIAL CONDITION. Maintain Borrower's financial condition as follows using generally accepted accounting principles consistently applied and used consistently with prior practices (except to the extent modified by the definitions herein), with compliance determined commencing with Borrower's financial statements for the period ending December 31, 1996: (a) statutory Capital and Surplus of Borrower's insurance company subsidiaries not at anytime less than $200,000,000.00. Capital and Surplus shall equal common stock plus additional paid in capital plus retained earnings plus net unrealized investment gain (loss). (b) the statutory Combined Ratio of Borrower's insurance company subsidiaries for each fiscal quarter of Borrower not at anytime greater than 105% per consolidated financial statements of Borrower. Combined Ratio for a particular period of time, with respect to Borrower shall mean the sum of 1) the loss ratio percentage of Borrower, which shall be losses incurred plus loss expense incurred for such period divided by premiums earned by Borrower for such period, and 2) the expense ratio percentage of Borrower, which shall be other net operating expenses incurred for such period divided by net premiums earned by Borrower for such period, as such items would be reflected on a consolidated financial statement of Borrower for such period. SECTION 4.10. NOTICE TO BANK. Promptly (but in no event more than five (5) days after the occurrence of each such event or matter) give written notice to Bank in reasonable detail of: (a) the occurrence of any Event of Default, or any condition, event or act which with the giving of notice or the passage of time or both would constitute an Event of Default; (b) any change in the name or the organizational structure of Borrower; (c) the occurrence and nature of any Reportable Event or Prohibited Transaction, each as defined in ERISA, or any funding deficiency with respect to any Plan; or (d) any termination or cancellation of any insurance policy which Borrower is required to maintain, or any uninsured or partially uninsured loss through liability or property damage, or through fire, theft or any other cause affecting Borrower's property in excess of an aggregate of $100,000.00. SECTION 4.11. SUBSIDIARY REQUIREMENTS. Ensure that: (a) the total of all equity securities owned by Houston Casualty Company in non-affiliated entities shall at no time from and after the date hereof exceed 15% of total cash and invested assets of Houston Casualty Company per statutory financial statements for such time. (b) all investments in bonds by Houston Casualty Company will from and after the date hereof be of investment grade quality, except as set out herein. The non-investment grade debt securities of Houston Casualty Company shall not exceed five percent (5%) of the Total Invested Assets of Houston Casualty Company; non-investment grade debt securities are defined as debt securities that Moody's or Standard & Poor would classify with less than an A rating; Total Invested Assets of Houston Casualty Company are defined as cash and invested assets as indicated in the statutory financial statements of Houston Casualty Company prepared in accordance with requirements of the State Board of Insurance of Texas; 6 (c) the total of all equity securities owned by International Marine & General Insurance Company, Ltd., a Jordanian exempt company ("IMG") in non-affiliated entities shall at no time from and after the date hereof, exceed 15% of total cash and invested assets of IMG per the financial statements of IMG for such time prepared in accordance with generally accepted accounting principles. ARTICLE V NEGATIVE COVENANTS Borrower further covenants that so long as Bank remains committed to extend credit to Borrower pursuant hereto, or any liabilities (whether direct or contingent, liquidated or unliquidated) of Borrower to Bank under any of the Loan Documents remain outstanding, and until payment in full of all obligations of Borrower subject hereto, Borrower will not without Bank's prior written consent: SECTION 5.1. USE OF FUNDS. Use any of the proceeds of any credit extended hereunder except for the purposes stated in Article I hereof. SECTION 5.2. OTHER INDEBTEDNESS. Create, incur, assume or permit to exist with respect to Borrower, Houston Casualty Company or IMG, any indebtedness or liabilities resulting from borrowings, loans or advances, whether secured or unsecured, matured or unmatured, liquidated or unliquidated, joint or several, except (a) the liabilities of Borrower to Bank, (b) any other liabilities of Borrower existing as of, and disclosed to Bank prior to, the date hereof and accounts payable and other accrued liabilities in the normal course of Borrower's business, and (c) other indebtedness of Borrower and its subsidiaries to creditors other than Bank not exceeding $5,000,000.00 in the aggregate at any time. SECTION 5.3. MERGER, CONSOLIDATION, TRANSFER OF ASSETS. Unless Borrower is the surviving entity, merge into or consolidate with any other entity; make any substantial change in the nature of Borrower's business as conducted as of the date hereof; acquire all or substantially all of the assets of any other entity; nor sell, lease, transfer or otherwise dispose of all or a substantial or material portion of Borrower's assets except in the ordinary course of its business. SECTION 5.4. GUARANTIES. Guarantee or become liable in any way as surety, endorser (other than as endorser of negotiable instruments for deposit or collection in the ordinary course of business), accommodation endorser or otherwise for, nor pledge or hypothecate any assets of Borrower as security for, any liabilities or obligations of any other person or entity, except any of the foregoing in favor of Bank. SECTION 5.5. LOANS, ADVANCES, INVESTMENTS. Make any loans or advances to or investments in any person or entity, except any of the foregoing existing as of, and disclosed to Bank prior to, the date hereof. SECTION 5.6. DIVIDENDS, DISTRIBUTIONS. Declare or pay any dividend or distribution either in cash, stock or any other property on Borrower's stock now or hereafter outstanding, nor redeem, retire, repurchase or otherwise acquire any shares of any class of Borrower's stock now or hereafter outstanding. SECTION 5.7. PLEDGE OF ASSETS. Mortgage, pledge, grant or permit to exist a security interest in, or lien upon, all or any portion of Borrower's assets now owned or hereafter acquired, except any of the foregoing in favor of Bank or which is existing as of, and disclosed to Bank in writing prior to, the date hereof. 7 ARTICLE VI EVENTS OF DEFAULT SECTION 6.1. The occurrence of any of the following shall constitute an "Event of Default" under this Agreement: (a) Borrower shall fail to pay when due any principal, interest, fees or other amounts payable under any of the Loan Documents. (b) Any financial statement or certificate furnished to Bank in connection with, or any representation or warranty made by Borrower or any other party under this Agreement or any other Loan Document shall prove to be incorrect, false or misleading in any material respect when furnished or made. (c) Any default in the performance of or compliance with any obligation, agreement or other provision contained herein or in any other Loan Document (other than those referred to in subsections (a) and (b) above), and with respect to any such default which by its nature can be cured, such default shall continue for a period of twenty (20) days from its occurrence. (d) Any default in the payment or performance of any obligation, or any defined event of default, under the terms of any contract or instrument (other than any of the Loan Documents) pursuant to which Borrower has incurred any debt or other liability to any person or entity, including Bank. (e) The filing of a notice of judgment lien against Borrower; or the recording of any abstract of judgment against Borrower in any county in which Borrower has an interest in real property; or the service of a notice of levy and/or of a writ of attachment or execution, or other like process, against the assets of Borrower; or the entry of a judgment against Borrower. (f) Borrower shall become insolvent, or shall suffer or consent to or apply for the appointment of a receiver, trustee, custodian or liquidator of itself or any of its property, or shall generally fail to pay its debts as they become due, or shall make a general assignment for the benefit of creditors; Borrower shall file a voluntary petition in bankruptcy, or seeking reorganization, in order to effect a plan or other arrangement with creditors or any other relief under the Bankruptcy Reform Act, Title 11 of the United States Code, as amended or recodified from time to time ("Bankruptcy Code"), or under any state or federal law granting relief to debtors, whether now or hereafter in effect; or any involuntary petition or proceeding pursuant to the Bankruptcy Code or any other applicable state or federal law relating to bankruptcy, reorganization or other relief for debtors is filed or commenced against Borrower, or Borrower shall file an answer admitting the jurisdiction of the court and the material allegations of any involuntary petition; or Borrower shall be adjudicated a bankrupt, or an order for relief shall be entered against Borrower by any court of competent jurisdiction under the Bankruptcy Code or any other applicable state or federal law relating to bankruptcy, reorganization or other relief for debtors. (g) There shall exist or occur any event or condition which Bank in good faith believes impairs, or is substantially likely to impair, the prospect of payment or performance by Borrower of its obligations under any of the Loan Documents. (h) The dissolution or liquidation of Borrower; or Borrower, or any of its directors, stockholders or members, shall take action seeking to effect the dissolution or liquidation of Borrower. SECTION 6.2. REMEDIES. Upon the occurrence of any Event of Default: (a) all principal and accrued and unpaid interest outstanding under each of the Loan Documents, any term thereof to the contrary notwithstanding, shall at Bank's option and without notice become immediately due and payable without presentment, demand, or any notices of any kind, including without limitation notice of nonperformance, notice of protest, protest, notice of dishonor, notice of intention to accelerate or notice 8 of acceleration, all of which are hereby expressly waived by each Borrower; (b)the obligation, if any, of Bank to extend any further credit under any of the Loan Documents shall immediately cease and terminate; and (c) Bank shall have all rights, powers and remedies available under each of the Loan Documents, or accorded by law, including without limitation the right to resort to any or all security for any credit accommodation from Bank subject hereto and to exercise any or all of the rights of a beneficiary or secured party pursuant to applicable law. All rights, powers and remedies of Bank may be exercised at any time by Bank and from time to time after the occurrence of an Event of Default, are cumulative and not exclusive, and shall be in addition to any other rights, powers or remedies provided by law or equity. ARTICLE VII MISCELLANEOUS SECTION 7.1. NO WAIVER. No delay, failure or discontinuance of Bank in exercising any right, power or remedy under any of the Loan Documents shall affect or operate as a waiver of such right, power or remedy; nor shall any single or partial exercise of any such right, power or remedy preclude, waive or otherwise affect any other or further exercise thereof or the exercise of any other right, power or remedy. Any waiver, permit, consent or approval of any kind by Bank of any breach of or default under any of the Loan Documents must be in writing and shall be effective only to the extent set forth in such writing. SECTION 7.2. NOTICES. All notices, requests and demands which any party is required or may desire to give to any other party under any provision of this Agreement must be in writing delivered to each party at the following address: BORROWER: HCC INSURANCE HOLDINGS, INC. 13403 Northwest Freeway, Suite 200 Houston, Texas 77040 BANK: WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION 1000 Louisiana, 3rd Floor Houston, Texas 77002 Attn: Kenneth Teusink or to such other address as any party may designate by written notice to all other parties. Each such notice, request and demand shall be deemed given or made as follows: (a) if sent by hand delivery, upon delivery; (b) if sent by mail, upon the earlier of the date of receipt or three (3) days after deposit in the U.S. mail, first class and postage prepaid; and (c) if sent by telecopy, upon receipt. SECTION 7.3. COSTS, EXPENSES AND ATTORNEYS' FEES. Borrower shall pay to Bank immediately upon demand the full amount of all payments, advances, charges, costs and expenses, including reasonable attorneys' fees (to include outside counsel fees and all allocated costs of Bank's in-house counsel to the extent permissible), expended or incurred by Bank in connection with (a) the negotiation and preparation of this Agreement and the other Loan Documents, Bank's continued administration hereof and thereof, and the preparation of any amendments and waivers hereto and thereto, (b) the enforcement of Bank's rights and/or the collection of any amounts which become due to Bank under any of the Loan Documents, and (c) the prosecution or defense of any action in any way related to any of the Loan Documents, including without limitation, any action for declaratory relief, whether incurred at the trial or appellate level, in an arbitration proceeding or otherwise, and including any of the foregoing incurred in connection with any bankruptcy proceeding (including without limitation, any adversary proceeding, contested matter or motion brought by Bank or any other person) relating to any Borrower or any other person or entity. 9 SECTION 7.4. SUCCESSORS, ASSIGNMENT. This Agreement shall be binding upon and inure to the benefit of the heirs, executors, administrators, legal representatives, successors and assigns of the parties; provided however, that Borrower may not assign or transfer its interest hereunder without Bank's prior written consent. Bank reserves the right to sell, assign, transfer, negotiate or grant participations in all or any part of, or any interest in, Bank's rights and benefits under each of the Loan Documents. In connection therewith, Bank may disclose all documents and information which Bank now has or may hereafter acquire relating to any credit extended by Bank to Borrower, Borrower or its business, or any collateral required hereunder. SECTION 7.5. ENTIRE AGREEMENT; AMENDMENT. This Agreement and the other Loan Documents constitute the entire agreement between Borrower and Bank with respect to any extension of credit by Bank subject hereto and supersede all prior negotiations, communications, discussions and correspondence concerning the subject matter hereof. This Agreement may be amended or modified only by a written instrument executed by each party hereto. SECTION 7.6. NO THIRD PARTY BENEFICIARIES. This Agreement is made and entered into for the sole protection and benefit of the parties hereto and their respective permitted successors and assigns, and no other person or entity shall be a third party beneficiary of, or have any direct or indirect cause of action or claim in connection with, this Agreement or any other of the Loan Documents to which it is not a party. SECTION 7.7. TIME. Time is of the essence of each and every provision of this Agreement and each other of the Loan Documents. SECTION 7.8. SEVERABILITY OF PROVISIONS. If any provision of this Agreement shall be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity without invalidating the remainder of such provision or any remaining provisions of this Agreement. SECTION 7.9. COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which when executed and delivered shall be deemed to be an original, and all of which when taken together shall constitute one and the same Agreement. SECTION 7.10. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the State of Texas. SECTION 7.11. SAVINGS CLAUSE. It is the intention of the parties to comply strictly with applicable usury laws. Accordingly, notwithstanding any provision to the contrary in the Loan Documents, in no event shall any Loan Documents require the payment or permit the payment, taking, reserving, receiving, collection or charging of any sums constituting interest under applicable laws that exceed the maximum amount permitted by such laws, as the same may be amended or modified from time to time (the "Maximum Rate"). If any such excess interest is called for, contracted for, charged, taken, reserved or received in connection with any Loan Documents, or in any communication by Lender or any other person to Borrower or any other person, or in the event that all or part of the principal or interest hereof or thereof shall be prepaid or accelerated, so that under any of such circumstances or under any other circumstance whatsoever the amount of interest contracted for, charged, taken, reserved or received on the amount of principal actually outstanding from time to time under the Loan Documents shall exceed the Maximum Rate, then in such event it is agreed that: (i) the provisions of this paragraph shall govern and control; (ii) neither Borrower nor any other person or entity now or hereafter liable for the payment of any Loan Documents shall be obligated to pay the amount of such interest to the extent it is in excess of the Maximum Rate; (iii) any such excess interest which is or has been received by Lender, notwithstanding this paragraph, shall be credited against the then unpaid principal balance hereof or thereof, or if any of the Loan Documents has been or would be paid in full by such credit, refunded to Borrower; and (iv) the 10 provisions of each of the Loan Documents, and any other communication to Borrower, shall immediately be deemed reformed and such excess interest reduced, without the necessity of executing any other document, to the Maximum Rate. The right to accelerate the maturity of the Loan Documents does not include the right to accelerate, collect or charge unearned interest, but only such interest that has otherwise accrued as of the date of acceleration. Without limiting the foregoing, all calculations of the rate of interest contracted for, charged, taken, reserved or received in connection with any of the Loan Documents which are made for the purpose of determining whether such rate exceeds the Maximum Rate shall be made to the extent permitted by applicable laws by amortizing, prorating, allocating and spreading during the period of the full term of such Loan Documents, including all prior and subsequent renewals and extensions hereof or thereof, all interest at any time contracted for, charged, taken, reserved or received by Lender. The terms of this paragraph shall be deemed to be incorporated into each of the other Loan Documents. To the extent that Article 5069-1.04 of the Texas Revised Civil Statutes is relevant to Lender for the purpose of determining the Maximum Rate, Bank hereby elects to determine the applicable rate ceiilng under such Article by the indicated (weekly) rate ceiling from time to time in effect, subject to Lender's right subsequently to change such method in accordance with applicable law, as the same may be amended or modified from time to time. SECTION 7.12. RIGHT OF SETOFF; DEPOSIT ACCOUNTS. Upon and after the occurrence of an Event of Default, (a) Borrower hereby authorizes Bank, at any time and from time to time, without notice, which is hereby expressly waived by each Borrower, and whether or not Bank shall have declared any credit extended hereunder to be due and payable in accordance with the terms hereof, to set off against, and to appropriate and apply to the payment of, Borrower's obligations and liabilities under the Loan Documents (whether matured or unmatured, fixed or contingent, liquidated or unliquidated), any and all amounts owing by Bank to Borrower (whether payable in U.S. dollars or any other currency, whether matured or unmatured, and in the case of deposits, whether general or special (except trust and escrow accounts), time or demand and however evidenced), and (b) pending any such action, to the extent necessary, to hold such amounts as collateral to secure such obligations and liabilities and to return as unpaid for insufficient funds any and all checks and other items drawn against any deposits so held as Bank, in its sole discretion, may elect. Borrower hereby grants to Bank a security interest in all deposits and accounts maintained with Bank and with any other financial institution to secure the payment of all obligations and liabilities of Borrower to Bank under the Loan Documents. SECTION 7.13. BUSINESS PURPOSE. Borrower represents and warrants that any credit extended hereunder is for a business, commercial, investment, agricultural or other similar purpose and not primarily for a personal, family or household use. SECTION 7.14. ARBITRATION. (a) Arbitration. Upon the demand of any party, any Dispute shall be resolved by binding arbitration (except as set forth in (e) below) in accordance with the terms of this Agreement. A "Dispute" shall mean any action, dispute, claim or controversy of any kind, whether in contract or tort, statutory or common law, legal or equitable, now existing or hereafter arising under or in connection with, or in any way pertaining to, any of the Loan Documents, or any past, present or future extensions of credit and other activities, transactions or obligations of any kind related directly or indirectly to any of the Loan Documents, including without limitation, any of the foregoing arising in connection with the exercise of any self-help, ancillary or other remedies pursuant to any of the Loan Documents. Any party may by summary proceedings bring an action in court to compel arbitration of a Dispute. Any party who fails or refuses to submit to arbitration following a lawful demand by any other party shall bear all costs and expenses incurred by such other party in compelling arbitration of any Dispute. (b) Governing Rules. Arbitration proceedings shall be administered by the American Arbitration Association ("AAA") or such other administrator as the parties shall mutually agree upon in accordance 11 with the AAA Commercial Arbitration Rules. All Disputes submitted to arbitration shall be resolved in accordance with the Federal Arbitration Act (Title 9 of the United States Code), notwithstanding any conflicting choice of law provision in any of the Loan Documents. The arbitration shall be conducted at a location in Texas selected by the AAA or other administrator. If there is any inconsistency between the terms hereof and any such rules, the terms and procedures set forth herein shall control. All statutes of limitation applicable to any Dispute shall apply to any arbitration proceeding. All discovery activities shall be expressly limited to matters directly relevant to the Dispute being arbitrated. Judgment upon any award rendered in an arbitration may be entered in any court having jurisdiction; provided however, that nothing contained herein shall be deemed to be a waiver by any party that is a bank of the protections afforded to it under 12 U.S.C. Section 91 or any similar applicable state law. (c) No Waiver; Provisional Remedies, Self-Help and Foreclosure. No provision hereof shall limit the right of any party to exercise self-help remedies such as setoff, foreclosure against or sale of any real or personal property collateral or security, or to obtain provisional or ancillary remedies, including without limitation injunctive relief, sequestration, attachment, garnishment or the appointment of a receiver, from a court of competent jurisdiction before, after or during the pendency of any arbitration or other proceeding. The exercise of any such remedy shall not waive the right of any party to compel arbitration hereunder. (d) Arbitrator Qualifications and Powers: Awards. Arbitrators must be active members of the Texas State Bar with expertise in the substantive laws applicable to the subject matter of the Dispute. Arbitrators are empowered to resolve Disputes by summary rulings in response to motions filed prior to the final arbitration hearing. Arbitrators (i) shall resolve all Disputes in accordance with the substantive law of the state of Texas, (ii) may grant any remedy or relief that a court of the state of Texas could order or grant within the scope hereof and such ancillary relief as is necessary to make effective any award, and (iii) shall have the power to award recovery of all costs and fees, to impose sanctions and to take such other actions as they deem necessary to the same extent a judge could pursuant to the Federal Rules of Civil Procedure, the Texas Rules of Civil Procedure or other applicable law. Any Dispute in which the amount in controversy is $5,000,000 or less shall be decided by a single arbitrator who shall not render an award of greater than $5,000,000 (including damages, costs, fees and expenses). By submission to a single arbitrator, each party expressly waives any right or claim to recover more than $5,000,000. Any Dispute in which the amount in controversy exceeds $5,000,000 shall be decided by majority vote of a panel of three arbitrators; provided however, that all three arbitrators must actively participate in all hearings and deliberations. (e) Judicial Review. Notwithstanding anything herein to the contrary, in any arbitration in which the amount in controversy exceeds $25,000,000, the arbitrators shall be required to make specific, written findings of fact and conclusions of law. In such arbitrations (i) the arbitrators shall not have the power to make any award which is not supported by substantial evidence or which is based on legal error, (ii) an award shall not be binding upon the parties unless the findings of fact are supported by substantial evidence and the conclusions of law are not erroneous under the substantive law of the state of Texas, and (iii) the parties shall have in addition to the grounds referred to in the Federal Arbitration Act for vacating, modifying or correcting an award the right to judicial review of (A) whether the findings of fact rendered by the arbitrators are supported by substantial evidence, and (B) whether the conclusions of law are erroneous under the substantive law of the state of Texas. Judgment confirming an award in such a proceeding may be entered only if a court determines the award is supported by substantial evidence and not based on legal error under the substantive law of the state of Texas. (f) Miscellaneous. To the maximum extent practicable, the AAA, the arbitrators and the parties shall take all action required to conclude any arbitration proceeding within 180 days of the filing of the Dispute with the AAA. No arbitrator or other party to an arbitration proceeding may disclose the existence, content or results thereof, except for disclosures of information by a party required in the ordinary course of its business, by applicable law or regulation, or to the extent necessary to exercise any 12 judicial review rights set forth herein. If more than one agreement for arbitration by or between the parties potentially applies to a Dispute, the arbitration provision most directly related to the Loan Documents or the subject matter of the Dispute shall control. This arbitration provision shall survive termination, amendment or expiration of any of the Loan Documents or any relationship between the parties. NOTICE: THIS DOCUMENT AND ALL OTHER DOCUMENTS RELATING TO THE INDEBTEDNESS CONSTITUTE A WRITTEN LOAN AGREEMENT WHICH REPRESENTS THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES RELATING TO THE INDEBTEDNESS. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the day and year first written above. WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION By: /s/ KENNETH TEUSINK ------------------------------- Name: Kenneth Teusink ------------------------------- Title: Vice President ------------------------------- HCC INSURANCE HOLDINGS, INC., a Delaware corporation By: /s/ FRANK J. BRAMANTI ------------------------------- Name Frank J. Bramanti ------------------------------- Title: Exec VP & CFO ------------------------------- 13 GENERAL PLEDGE AGREEMENT TO: WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION 1. GRANT OF SECURITY INTEREST. For valuable consideration, the undersigned HCC INSURANCE HOLDINGS, INC., a Delaware corporation, or any of them ("Debtor"), hereby assigns, transfers to and pledges with WELLS FARGO BANK (TEXAS), NATIONAL ASSOCIATION ("Bank"), and grants to Bank a security interest in, all money and property this day or previously delivered to and deposited with Bank. including but not limited to, the property described on Exhibit "A" hereto, together with all other money or property heretofore delivered or which shall hereafter be delivered to or come into the possession, custody or control of Bank in any manner or for any purpose whatsoever during the existence of this Agreement (collectively called "Collateral"), and whether held in a general or special account or deposit for safekeeping or otherwise, together with whatever is receivable or received when any of the Collateral or proceeds thereof are sold, collected, exchanged or otherwise disposed of, whether such disposition is voluntary or involuntary,; including without limitation, (a) all rights to payment, including returned premiums, with respect to any insurance relating to any of the foregoing, (b) all rights to payment with respect to any cause of action affecting or relating to any of the foregoing, and (c) all stock rights, rights to subscribe, stock splits, liquidating dividends, cash dividends, dividends paid in stock, new securities or other property of any kind which Debtor is or may hereafter be entitled to receive on account of any securities pledged hereunder, including without limitation, stock received by Debtor due to stock splits or dividends paid in stock or sums paid upon or in respect of any securities pledged hereunder upon the liquidation or dissolution of the issuer thereof (hereinafter called "Proceeds"), and in the event that Debtor receives any such Proceeds, Debtor will hold the same in trust on behalf of and for the benefit of Bank and will immediately deliver all such Proceeds to Bank in the exact form received, with the endorsement of Debtor if necessary and/or appropriate undated stock powers duly executed in blank, to be held by Bank as part of the Collateral, subject to all terms hereof. 2. OBLIGATIONS SECURED. The obligations secured hereby are the payment and performance of: (a) all present and future Indebtedness of Debtor to Bank; (b)all obligations of Debtor and rights of Bank under this Agreement; and (c) all present and future obligations of Debtor to Bank of other kinds. The word "Indebtedness" is used herein in its most comprehensive sense and includes any and all advances, debts, obligations and liabilities of Debtor, or any of them, heretofore, now or hereafter made, incurred or created, whether voluntary or involuntary and however arising, whether due or not due, absolute or contingent, liquidated or unliquidated, determined or undetermined, and whether Debtor may be liable individually or jointly with others, or whether recovery upon such Indebtedness may be or hereafter becomes unenforceable. 3. TERMINATION. This Agreement will terminate upon the performance of all obligations of Debtor to Bank, including without limitation, the payment of all Indebtedness of Debtor to Bank, and the termination of all commitments of Bank to extend credit to Debtor, existing at the time Bank receives written notice from Debtor of the termination of this Agreement. 4. OBLIGATIONS OF BANK. (a) Bank has no obligation to make any loans hereunder. Any money received by Bank in respect of the Collateral may be deposited, at Bank's option, into a non-interest bearing account over which Debtor shall have no control, and the same shall, for all purposes, be deemed Collateral hereunder. (b) Bank's obligation with respect to Collateral and Proceeds in its possession shall be strictly limited to the duty to exercise reasonable care in the custody and preservation of such Collateral and Proceeds, and such duty shall not include any obligation to ascertain or to initiate any action with respect to or to inform Debtor of maturity dates, conversion, call or exchange rights, or offers to purchase the 1 Collateral or Proceeds, or any similar matters, notwithstanding Bank's knowledge of the same. Bank shall have no duty to take any steps necessary to preserve the rights of Debtor against prior parties, or to initiate any action to protect against the possibility of a decline in the market value of the Collateral or Proceeds. Bank shall not be obligated to take any action with respect to the Collateral or Proceeds requested by Debtor unless such request is made in writing and Bank determines, in its sole discretion, that the requested action would not unreasonably jeopardize the value of the Collateral and Proceeds as security for the Indebtedness. Bank may at any time deliver the Collateral and Proceeds, or any part thereof, to any Debtor, and the receipt thereof by any Debtor shall be a complete and full acquittance for the Collateral and Proceeds so delivered, and Bank shall thereafter be discharged from any liability or responsibility therefor. 5. REPRESENTATIONS AND WARRANTIES. Debtor represents and warrants to Bank that: (a) Debtor is the owner and has possession or control of the Collateral and Proceeds; (b) Debtor has the right to pledge the Collateral and Proceeds; (c) all Collateral and Proceeds are genuine, free from liens, adverse claims, setoffs, default, prepayment, defenses and conditions precedent of any kind or character, except the lien created hereby or as otherwise agreed to by Bank, or as heretofore disclosed by Debtor to Bank, in writing; (d) all statements contained herein and, where applicable, in the Collateral, are true and complete in all material respects; (e) no financing statement covering any of the Collateral or Proceeds, and naming any secured party other than Bank, is on file in any public office; and (f) specifically with respect to Collateral and Proceeds consisting of investment securities, instruments, chattel paper, documents, contracts, insurance policies or any like property, (i) all persons appearing to be obligated thereon have authority and capacity to contract and are bound as they appear to be, and (ii) the same comply with applicable laws concerning form, content and manner of preparation and execution. 6. COVENANTS OF DEBTOR. (a) Debtor agrees in general: (i) to pay Indebtedness secured hereby when due; (ii) to indemnify Bank against all losses, claims, demands, liabilities and expenses of every kind caused by. property subject hereto; (iii) to pay all costs and expenses, including reasonable attorneys' fees, incurred by Bank in the perfection and preservation of the Collateral or Bank's interest therein and/or the realization, enforcement and exercise of Bank's rights, powers and remedies hereunder; (iv) to permit Bank to exercise its powers; (v) to execute and deliver such documents as Bank deems necessary to create, perfect and continue the security interests contemplated hereby; and (vi) not to change its chief place of business or the places where Debtor keeps any of the Collateral or Debtor's records concerning the Collateral and Proceeds without first giving Bank written notice of the address to which Debtor is moving same. (b) Debtor agrees with regard to the Collateral and Proceeds, unless Bank agrees otherwise in writing: (i) not to permit any lien on the Collateral or Proceeds, except in favor of Bank; (ii) not to withdraw any finds from any deposit account pledged to Bank hereunder; (iii) not to sell, hypothecate or otherwise dispose of, nor permit the transfer by operation of law of, any of the Collateral or Proceeds or any interest therein; (iv) to keep, in accordance with generally accepted accounting principles, complete and accurate records regarding all Collateral and Proceeds, and to permit Bank to inspect the same and make copies thereof at any reasonable time; (v) if requested by Bank, to receive and use reasonable diligence to collect Proceeds, in trust and as the property of Bank, and to immediately endorse as appropriate and deliver such Proceeds to Bank daily in the exact form in which they are received together with a collection report in form satisfactory to Bank; (vi) not to commingle Collateral or Proceeds, or collections thereunder, with other property; (vii) in the event Bank elects to receive payments of Proceeds hereunder, to pay all expenses incurred by Bank in connection therewith, including expenses of accounting, correspondence, collection efforts, filing, recording, record keeping and expenses incidental thereto; (viii) to provide any service and do any other acts which may be necessary to keep all Collateral and Proceeds free and clear of all defenses, rights of offset and counterclaims; and (ix) if the Collateral or Proceeds consists of securities and so long as no Event of Default exists, to vote said securities and to give consents, 2 waivers and ratifications with respect thereto, provided that no vote shall be cast or consent, waiver or ratification given or action taken which would impair Bank's interests in the Collateral and Proceeds or be inconsistent with or violate any provisions of this Agreement. 7. POWERS OF BANK. Debtor appoints Bank its true attorney in fact to perform any of the following powers, which are coupled with an interest, are irrevocable until termination of this Agreement and may be exercised from time to time by Bank's officers and employees, or any of them, whether or not Debtor is in default: (a) to perform any obligation of Debtor hereunder in Debtor's name or otherwise; (b) to notify any person obligated on any security, instrument or other document subject to this Agreement of Bank's rights hereunder; (c) to collect by legal proceedings or otherwise all dividends, interest, principal or other sums now or hereafter payable upon or on account of the Collateral or Proceeds; (d) to enter into any extension, reorganization, deposit, merger or consolidation agreement, or any other agreement relating to or affecting the Collateral or Proceeds, and in connection therewith to deposit or surrender control of the Collateral and Proceeds, to accept other property in exchange for the Collateral and Proceeds, and to do and perform such acts and things as Bank may deem proper, with any money or property received in exchange for the Collateral or Proceeds, at Bank's option, to be applied to the Indebtedness or held by Bank under this Agreement; (e) to make any compromise or settlement Bank deems desirable or proper in respect of the Collateral and Proceeds; (f) to insure, process and preserve the Collateral and Proceeds; (g) to exercise all rights, powers and remedies which Debtor would have, but for this Agreement, with respect to all Collateral and Proceeds subject hereto; and (h) to do all acts and things and execute all documents in the name of Debtor or otherwise, deemed by Bank as necessary, proper and convenient in connection with the preservation, perfection or enforcement of its rights hereunder. To effect the purposes of this Agreement or otherwise upon instructions of Debtor, or any of them, Bank may cause any Collateral and/or Proceeds to be transferred to Bank's name or the name of Bank's nominee. If an Event of Default has occurred and is continuing, any or all Collateral and/or Proceeds consisting of securities may be registered, without notice, in the name of Bank or its nominee, and thereafter Bank or its nominee may exercise, without notice, all voting and corporate rights at any meeting of the shareholders of the issuer thereof, any and all rights of conversion, exchange or subscription, or any other rights, privileges or options pertaining to such Collateral and/or Proceeds, all as if it were the absolute owner thereof. The foregoing shall include, without limitation, the right of Bank or its nominee to exchange, at its discretion, any and all Collateral and/or Proceeds upon the merger, consolidation, reorganization, recapitalization or other readjustment of the issuer thereof, or upon the exercise by the issuer thereof or Bank of any right, privilege or option pertaining to any shares of the Collateral and/or Proceeds, and in connection therewith, the right to deposit and deliver any and all of the Collateral and/or Proceeds with any committee, depository, transfer agent, registrar or other designated agency upon such terms and conditions as Bank may determine. All of the foregoing rights, privileges or options may be exercised without liability on the part of Bank or its nominee except to account for property actually received by Bank. Bank shall have no duty to exercise any of the foregoing, or any other rights, privileges or options with respect to the Collateral or Proceeds and shall not be responsible for any failure to do so or delay in so doing. 8. PAYMENT OF PREMIUMS, TAXES, CHARGES, LIENS AND ASSESSMENTS. Debtor agrees to pay, prior to delinquency, all insurance premiums, taxes, charges, liens and assessments against the Collateral and Proceeds, and upon the failure of Debtor to do so, Bank at its option may pay any of them and shall be the sole judge of the legality or validity thereof and the amount necessary to discharge the same. Any such payments made by Bank shall be obligations of Debtor to Bank, due and payable immediately upon demand, together with interest at a rate determined in accordance with the provisions of Section 15 hereof, and shall be secured by the Collateral and Proceeds, subject to all terms and conditions of this Agreement. 9. EVENTS OF DEFAULT. The occurrence of any of the following shall constitute an "Event of Default" under this Agreement: (a) any default in the payment or performance of any obligation, or any defined event of default, under (i) any contract or instrument evidencing any Indebtedness, or (ii) any other agreement between any Debtor and Bank, including without limitation any loan agreement, 3 relating to or executed in connection with any Indebtedness; (b)any representation or warranty made by any Debtor herein shall prove to be incorrect, false or misleading in any material respect when made; (c) any Debtor shall fail to observe or perform any obligation or agreement contained herein; (d) any attachment or like levy on any property of any Debtor; and (e) Bank, in good faith, believes any or all of the Collateral and/or Proceeds to be in danger of misuse, dissipation, commingling, loss, theft, damage or destruction, or otherwise in jeopardy or unsatisfactory in character or value. 10. REMEDIES. Upon the occurrence of any Event of Default, Bank shall have the right to declare immediately due and payable all or any Indebtedness secured hereby and to terminate any commitments to make loans or otherwise extend credit to Debtor. Bank shall have all other rights, powers, privileges and remedies granted to a secured party upon default under the Texas Uniform Commercial Code or otherwise provided by law, including without limitation, the right to contact all persons obligated to Debtor on any Collateral or Proceeds and to instruct such persons to deliver all Collateral and/or Proceeds directly to Bank. All rights, powers, privileges and remedies of Bank shall be cumulative. No delay, failure or discontinuance of Bank in exercising any right, power, privilege or remedy hereunder shall affect or operate as a waiver of such right, power, privilege or remedy; nor shall any single or partial exercise of any such right, power, privilege or remedy preclude, waive or otherwise affect any other or further exercise thereof or the exercise of any other right, power, privilege or remedy. Any waiver, permit, consent or approval of any kind by Bank of any default hereunder, or any such waiver of any provisions or conditions hereof, must be in writing and shall be effective only to the extent set forth in writing. It is agreed that public or private sales, for cash or on credit, to a wholesaler or retailer or investor, or user of property of the types subject to this Agreement, or public auction, are all commercially reasonable since differences in the sales prices generally realized in the different kinds of sales are ordinarily offset by the differences in the costs and credit risks of such sales. While an Event of Default exists: (a) Bank may, at any time and at Bank's sole option, liquidate any time deposits pledged hereunder, whether or not said time deposits have matured and notwithstanding the fact that such liquidation may give rise to penalties for early withdrawal of funds; (b) Debtor will not dispose of any of the Collateral or Proceeds except on terms approved by Bank; (c) Bank may appropriate the Collateral and apply all Proceeds toward repayment of the Indebtedness in such order of application as Bank may from time to time elect; and (d) at Bank's request, Debtor will assemble and deliver all Collateral and Proceeds, and books and records pertaining thereto, to Bank at a reasonably convenient place designated by Bank. For any Collateral or Proceeds consisting of securities, Bank shall have no obligation to delay a sale of any portion thereof for the period of time necessary to permit the issuer thereof to register such securities for public sale under any applicable state or Federal law, even if the issuer thereof would agree to do so. 11. DISPOSITION OF COLLATERAL AND PROCEEDS. Upon the transfer of all or any part of the Indebtedness, Bank may transfer all or any part of the Collateral or Proceeds and shall be fully discharged thereafter from all liability and responsibility with respect to any of the foregoing so transferred, and the transferee shall be vested with all rights and powers of Bank hereunder with respect to any of the foregoing so transferred; but with respect to any Collateral or Proceeds not so transferred, Bank shall retain all rights, powers, privileges and remedies herein given. Any proceeds of any disposition of any of the Collateral or Proceeds, or any part thereof, may be applied by Bank to the payment of expenses incurred by Bank in connection with the foregoing, including reasonable attorneys' fees, and the balance of such proceeds may be applied by Bank toward the payment of the Indebtedness in such order of application as Bank may from time to time elect. 12. STATUTE OF LIMITATIONS. Until all Indebtedness shall have been paid in full and all commitments by Bank to extend credit to Debtor have been terminated, the power of sale and all other rights, powers, privileges and remedies granted to Bank hereunder shall continue to exist and may be exercised by Bank at any time and from time to time irrespective of the fact that the Indebtedness or any part thereof may have become barred by any statute of limitations, or that the personal liability of Debtor may have ceased, unless such liability shall have ceased due to the payment in full of all Indebtedness secured hereunder. 4 13. MISCELLANEOUS. (a) The obligations of Debtor hereunder are joint and several; (b) Debtor hereby waives any right (i) to require Bank to make any presentment or demand, or give any notices of any kind, including without limitation any notice of nonpayment or nonperformance, protest, notice of protest, notice of dishonor, notice of the intention to accelerate or notice of acceleration hereunder, (ii) to direct the application of payments or security for any Indebtedness of Debtor, or indebtedness of customers of Debtor, or (iii) to require proceedings against others or to require exhaustion of security; and (c) Debtor hereby consents to extensions, forbearances or alterations of the terms of Indebtedness, the release or substitution of security, and the release of any guarantors; provided however, that in each instance Bank believes in good faith that the action in question is commercially reasonable in that it does not unreasonably increase the risk of nonpayment of the Indebtedness to which the action applies. Until all Indebtedness shall have been paid in full, no Debtor shall have any right of subrogation or contribution, and each Debtor hereby waives any benefit of or right to participate in any of the Collateral or Proceeds or any other security now or hereafter held by Bank. Any requirement of reasonable notice to Debtor with respect to the sale or other disposition of Collateral shall be met if such notice is given pursuant to the requirements of Section 14 hereof at least 5 days before the date of any public sale or the date after which any private sale or other disposition will be made. 14. NOTICES. All notices, requests and demands required under this Agreement must be in writing, addressed to Bank at the address specified in any other loan documents entered into between Debtor and Bank and to Debtor at the address of its chief executive office (or personal residence, if applicable) specified below or to such other address as any party may designate by written notice to each other party, and shall be deemed to have been given or made as follows: (a) if personally delivered, upon delivery; (b) if sent by mail, upon the earlier of the date of receipt or three (3) days after deposit in the U.S. mail, first class and postage prepaid; and (c) if sent by telecopy, upon receipt. 15. COSTS, EXPENSES AND ATTORNEYS' FEES. Debtor shall pay to Bank immediately upon demand the full amount of all payments, advances, charges, costs and expenses, including reasonable attorneys' fees (to include outside counsel fees and all allocated costs of Bank's in-house counsel to the. extent permissible), incurred by Bank in exercising any right, power, privilege or remedy conferred by this Agreement or in the enforcement thereof, whether incurred at the trial or appellate level, in an arbitration proceeding or otherwise, and including any of the foregoing incurred in connection with any bankruptcy proceeding (including without limitation, any adversary proceeding, contested matter or motion brought by Bank or any other person) relating to Debtor or in any way affecting any of the Collateral or Bank's ability to exercise any of its rights or remedies with respect thereto. All of the foregoing shall be paid by Debtor from the date of demand to the date paid in full with interest at the maximum rate permitted by applicable law. 16. SUCCESSORS; ASSIGNS; AMENDMENT. This Agreement shall be binding upon and inure to the benefit of the heirs, executors, administrators, legal representatives, successors and assigns of the parties, and may be amended or modified only in writing signed by Bank and Debtor. 17. SEVERABILITY OF PROVISIONS. If any provision of this Agreement shall be held to be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or any remaining provisions of this Agreement. 18. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the state of Texas. Debtor warrants that its chief executive office (or personal residence, if applicable) is located at the following address: 13403 Northwest Freeway, Suite 200, Houston, Texas 77040. 5 IN WITNESS WHEREOF, this Agreement has been duly executed as of January 10, 1997. HCC INSURANCE HOLDINGS, INC., a Delaware corporation By: /s/ FRANK J. BRAMANTI ------------------------------- Name: Frank J. Bramanti ------------------------------- Title: Exec VP & CFO ------------------------------- 6 EXHIBIT "A" 1. One hundred percent (100%) of the Class A common stock of Houston Casualty Company, as evidenced by Certificate No. 73 in the amount of 4,411,765 shares in the name of HCC Insurance Holdings, Inc. 2. One hundred percent (100%) of the Class B common stock of Houston Casualty Company, as evidenced by Certificate No. 3 in the amount of 588,235 shares in the name of HCC Insurance Holdings, Inc. EX-11 6 EXHIBIT 11 Exhibit 11 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES COMPUTATION OF EARNINGS PER SHARE
For the years ended December 31, ------------------------------------------- 1996 1995 1994 ---- ---- ---- Net earnings $ 29,298,000 $ 24,337,000 $ 15,268,000 --------------- --------------- --------------- Primary: Weighted average common and common stock equivalents outstanding 35,965,000 32,667,000 27,910,000 --------------- --------------- --------------- Earnings per share $ 0.81 $ 0.75 $ 0.55 --------------- --------------- --------------- Reconciliation of number of shares outstanding: Common Stock outstanding at period end 35,851,000 13,839,000 11,767,000 Additional dilutive effect of outstanding options and warrants (as determined by the application of the treasury stock method) 1,196,000 181,000 200,000 Changes in Common Stock for issuance (1,082,000) (953,000) (803,000) Effect of five-for-two stock split (1) - 19,600,000 16,746,000 --------------- --------------- --------------- Weighted average common and common stock equivalents outstanding 35,965,000 32,667,000 27,910,000 --------------- --------------- --------------- Fully Diluted: Weighted average common and common stock equivalents outstanding 35,986,000 32,804,000 27,998,000 --------------- --------------- --------------- Earnings per share $ 0.81 $ 0.74 $ 0.55 --------------- --------------- --------------- Reconciliation of number of shares outstanding: Common Stock outstanding at period end 35,851,000 13,839,000 11,767,000 Additional dilutive effect of outstanding options and warrants (as determined by the application of the treasury stock method) 1,172,000 231,000 154,000 Changes in Common Stock for issuance (1,037,000) (948,000) (722,000) Effect of five-for-two stock split (1) - 19,682,000 16,799,000 --------------- --------------- --------------- Weighted average common and common stock equivalents outstanding 35,986,000 32,804,000 27,998,000 --------------- --------------- ---------------
(1) In April, 1996, the Board of Directors declared a five-for-two stock split in the form of a 150% stock dividend on the Company's $1.00 par value Common Stock, payable to shareholders of record April 30, 1996. The par value of the Company's Common Stock remains unchanged. Adjustments have been made to 1995 and 1994 amounts to present weighted average shares outstanding and earnings per share on a consistent basis. Note: Shares outstanding for all periods have been adjusted to include the 6,250,000 shares issued with respect to the acquisition of LDG. Prior periods have not been adjusted for 1,136,400 shares issued with the acquisition of NASRA due to immateriality. EX-12 7 EXHIBIT 12 Exhibit 12 HCC INSURANCE HOLDINGS, INC. AND SUBSIDIARIES STATEMENT OF RATIOS
For the years ended December 31, (dollars in thousands) ------------------------------------------------ 1996 1995 1994 1993 1992 -------- -------- -------- -------- -------- Gross premium to surplus ratio: Gross written premium 230,755 238,958 192,878 123,650 75,119 Policyholders' surplus 212,194 177,317 134,464 102,803 39,146 Premium to surplus ratio (1) 108.7% 134.8% 143.4% 120.3% 191.9%
(Gross premium to surplus ratio = gross written premium divided by policyholders' surplus) Net premium to surplus ratio:
Net written premium 96,776 98,786 59,694 38,556 25,618 Policyholders' surplus 212,194 177,317 134,464 102,803 39,146 Premium to surplus ratio (1) 45.6% 55.7% 44.4% 37.5% 65.4%
(Net premium to surplus ratio = net written premium divided by policyholders' surplus) Loss ratio:
Incurred loss and LAE 52,663 50,721 30,237 21,774 17,125 Net earned premium 93,314 80,011 46,834 32,663 25,875 Loss ratio (1) 56.4% 63.4% 64.6% 66.7% 66.2%
(Loss ratio = incurred loss and LAE divided by net earned premium) Expense ratio:
Underwriting expense 15,137 11,372 6,076 5,540 5,561 Net written premium 96,776 98,786 59,694 38,556 25,618 Expense ratio (1) 15.6% 11.5% 10.2% 14.4% 21.7%
(Expense ratio = underwriting expense divided by net written premium)
Combined ratio (1) 72.0% 74.9% 74.8% 81.1% 87.9%
(Combined ratio = loss ratio plus expense ratio) (1) Calculated for the Company's insurance company subsidiaries on the basis of statutory accounting principles. EX-21 8 EXHIBIT 21 Exhibit 21 HCC INSURANCE HOLDINGS, INC. SUBSIDIARIES
State or Country Name of Incorporation ---- ---------------- Houston Casualty Company...................................................................Texas HCC Underwriters, A Texas Corporation....................................................Texas Trafalgar Insurance Company...........................................................Oklahoma SBS Insurance Holdings, A Texas Corporation................................................Texas Houston Reinsurance Company, Ltd.......................................................Bermuda IMG Insurance Company Ltd.................................................................Jordan Middle East Insurance Brokers Ltd.........................................................Jordan LDG Management Company Incorporated................................................Massachusetts SRRF Management Incorporated..........................................................New York Medical Reinsurance Underwriters Incorporated....................................Massachusetts LDG Worldwide Limited.................................................................Delaware LDG Insurance Agency.............................................................Massachusetts North American Special Risk Associates, Inc.............................................Illinois NASRA TPA, Inc........................................................................Illinois
EX-27 9 EX 27
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION FROM THE CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF EARNINGS FOUND ON PAGES F-3 AND F-4 OF THE COMPANY'S FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 264,727,000 0 0 2,433,000 0 0 320,260,000 3,212,000 123,181,000 1,425,000 745,779,000 185,822,000 114,758,000 0 0 16,500,000 0 0 35,851,000 204,839,000 745,779,000 93,314,000 15,372,000 5,097,000 38,462,000 51,242,000 3,842,000 33,208,000 36,627,000 7,329,000 29,298,000 0 0 0 29,298,000 0.81 0.81 66,326,000 55,045,000 (3,803,000) 15,903,000 19,731,000 81,934,000 (3,803,000)
EX-28 10 EXHIBIT 28 Exhibit 28 HCC INSURANCE HOLDINGS, INC. SCHEDULE P OF INSURANCE COMPANY SUBSIDIARIES Schedule P of Houston Casualty Company included in its December 31, 1996 Annual Statement filed with the Texas Department of Insurance and Schedule P of Trafalgar Insurance Company included in its December 31, 1996 Annual Statement filed with the Oklahoma Department of Insurance have not been filed via EDGAR, but have been filed using Form SE. Schedule O for Houston Casualty Company and Trafalgar Insurance Company and Schedules O and P for IMG Insurance Company Ltd. and Houston Reinsurance Company Ltd., the Company's insurance company subsidiaries based in Jordan and Bermuda, respectively, are not included as they are not required to be filed with the respective regulatory authorities. -----END PRIVACY-ENHANCED MESSAGE-----