-----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, SqfAPhTo3qMk0UWnTkU+SFclVeewkj2lY9fSo6nKOBunqEbStis1WYcRSpuzmm6y dvKwOZCpbc2apYauGYldWA== 0000914039-97-000111.txt : 19970401 0000914039-97-000111.hdr.sgml : 19970401 ACCESSION NUMBER: 0000914039-97-000111 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: EXECUTIVE RISK INC /DE/ CENTRAL INDEX KEY: 0000914069 STANDARD INDUSTRIAL CLASSIFICATION: SURETY INSURANCE [6351] IRS NUMBER: 061388171 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-12800 FILM NUMBER: 97568992 BUSINESS ADDRESS: STREET 1: 82 HOPMEADOW ST CITY: SIMSBURY STATE: CT ZIP: 06070 BUSINESS PHONE: 8604082000 MAIL ADDRESS: STREET 1: 82 HOPMEADOW ST CITY: SIMSBURY STATE: CT ZIP: 06070-7683 10-K 1 FORM 10-K 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 ------------------------ FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 [FEE REQUIRED] FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NO. 1-12800 EXECUTIVE RISK INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 06-1388171 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.) INCORPORATION OR ORGANIZATION)
82 HOPMEADOW STREET, SIMSBURY, CT 06070-7683 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (860) 408-2000 ------------------------ SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: TITLE OF CLASS NAME OF EXCHANGE ON WHICH REGISTERED - -------------------------------------------------------------------------------------------- Common Stock, $.01 par value New York Stock Exchange
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 Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ___ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value on March 10, 1997 of the voting stock held by non-affiliates of the registrant was approximately $398,400,000. There were 9,329,457 shares of the registrant's Common Stock, $.01 par value outstanding, as of March 10, 1997. DOCUMENTS INCORPORATED BY REFERENCE (1) Portions of the 1996 Annual Report to Shareholders, as indicated herein (Part II). (2) Proxy Statement involving the election of directors and other matters which the registrant intends to file with the Commission within 120 days after December 31, 1996 (Part III). ================================================================================ 2 EXECUTIVE RISK INC. ------------------------ TABLE OF CONTENTS
PAGE ITEM NUMBER - ---- ------ PART I 1. Business....................................................................... 1 2. Properties..................................................................... 17 3. Legal Proceedings.............................................................. 17 4. Submission of Matters to a Vote of Security Holders............................ 17 PART II 5. Market for the Registrant's Common Stock and Related Stockholder Matters....... 17 6. Selected Financial Data........................................................ 18 7. Management's Discussion and Analysis of Financial Condition and Results of Operations........................................................ 18 8. Financial Statements and Supplementary Data.................................... 18 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures........................................................ 18 PART III 10. Directors and Executive Officers............................................... 19 11. Executive Compensation......................................................... 19 12. Security Ownership of Certain Beneficial Owners and Management................. 19 13. Certain Relationships and Related Transactions................................. 19 PART IV 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K................ 19 Signatures............................................................................ 20 Exhibit Index......................................................................... 21 Index to Financial Statements and Schedules........................................... 23
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. This Form 10-K, the Company's Annual Report to Stockholders, any Form 10-Q or any Form 8-K of the Company or any other written or oral statements made by or on behalf of the Company may include forward-looking statements which reflect the Company's current views with respect to future events and financial performance. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. These uncertainties and other factors (which are described in more detail elsewhere in this Form 10-K) include, but are not limited to, uncertainties relating to cyclical industry conditions, uncertainties relating to government and regulatory policies, the legal environment, the uncertainties of the reserving process, the competitive environment in which the Company operates, the uncertainties inherent in international operations, and interest rate fluctuations. The words "believe," "expect," "anticipate," "project" and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. 3 PART I ITEM 1. BUSINESS The Directors & Officers and Professional Liability Insurance Industry General. Executive Risk Inc. ("ERI" or the "Company") is a specialty insurance holding company incorporated under the laws of Delaware. Through its subsidiaries, ERI develops, markets and underwrites specialty line insurance products primarily throughout the United States. UAP Executive Partners ("UPEX"), which is a joint venture between the Company and Union des Assurances de Paris -- Incendie-Accidents ("UAP"), a subsidiary of AXA-UAP Group, a major European insurance group, markets directors and officers liability insurance ("D&O") internationally. The Company's core business lines are D&O and professional liability insurance, also known as errors and omissions insurance ("E&O"). Company subsidiaries also offer fidelity bonds and fiduciary liability insurance to corporations, employment practices liability insurance for corporations and their employees, technology maintenance and repair coverage for hospitals and clinics and healthcare stop-loss arrangements for medical professionals. Both D&O and E&O are designed to protect insureds against lawsuits and associated legal defense expenses. In connection with D&O coverage of for-profit corporations, such liabilities can arise from claims by customers, vendors, competitors and former employees, although the most severe liabilities have historically arisen from lawsuits by stockholders alleging director or officer failure to discharge duties to the corporation or violations of federal securities laws. In the case of not-for-profit organizations, the Company's coverage is often implicated in employment practices litigation. E&O is most often sold to professionals, such as attorneys, psychologists and insurance agents, among others, where the principal sources of potential claims are dissatisfied clients alleging breaches of professional standards or ethical violations. Fiduciary liability coverages are intended primarily to protect those who invest and administer benefit plan trusts, and fidelity insurance coverages (or crime coverage) insure against losses associated with employee theft and other types of dishonesty. Employment practices liability insurance, which is available to cover both the employing organization and its supervisors, insures against losses associated with employee claims such as sexual harassment, wrongful termination and discriminatory treatment. The Company's two non-liability related products are Systems Rx, a service contract and cost management product for owners of high-tech diagnostic equipment and related healthcare technology, and the recently introduced stop-loss policy for doctors enrolled in managed care organizations that use the so-called "capitation" method for capping treatment costs. The D&O Industry. Under various state laws, corporations are authorized to indemnify their directors and officers against legal claims arising in connection with their work on behalf of the corporation. In order to attract and retain qualified directors and officers, corporations purchase D&O, which typically covers the corporate entity, but only to the extent that it indemnifies officers and directors. D&O policies have traditionally also contained a provision that covers officers and directors directly, in order to insure against losses for which the corporation is legally or financially unable to indemnify. In recent years, many D&O insurers, including the Company, have begun to offer another form of coverage, so-called "entity coverage," which protects the corporation for limited classes of legal liability, even when directors and/or officers are not named as defendants in the claim. The demand for D&O insurance grew dramatically in response to increased activity in corporate mergers and acquisitions during the late 1970's and the 1980's and the attendant increase in shareholder lawsuits. By the mid-1980's, a number of carriers, having suffered large losses in this line of business, had reduced their D&O activities or had ceased offering D&O coverage altogether, resulting in a shortage of capacity or a "hard market" for D&O. The Company's subsidiary, Executive Re Inc. ("Executive Re"), was formed in late 1986, largely due to the decrease in D&O capacity. Today, ERI believes that a relatively small number of U.S. insurers, together with Underwriters at Lloyd's ("Lloyd's"), tend to dominate the D&O market for larger and medium-sized domestic corporations. Domestic demand for D&O has historically been affected by consolidation trends within certain industries. The Company's management believes that the D&O market will continue to be impacted by consolidating sectors, such as banking and financial services, as well as by statutory, regulatory and case law developments that affect executive liabilities. It is anticipated that opportunities for 1 4 growth in D&O demand may be found in the domestic not-for-profit sector, among non-bank financial institutions, corporations contemplating initial public offerings, small, privately-held commercial entities and in foreign markets, where shareholder rights movements are nascent. Historically, the single largest risk for which corporations purchased D&O insurance coverage has involved shareholder-based suits, either in the form of derivative actions under state corporation laws or in the form of class actions for securities fraud under Rule 10b-5 of the Securities and Exchange Commission ("SEC"), promulgated under the Securities Exchange Act of 1934. In December 1995, Congress passed the Private Securities Litigation Reform Act of 1995, which has a number of provisions purporting to affect the ability of private litigants to prosecute securities fraud suits. The Company's management believes that the effects of this legislation on the demand for D&O and upon the frequency and severity of D&O claims will not be known for several years. E&O Insurance. The E&O insurance industry tends to be more fragmented and regionalized than the D&O industry, since the risks underwritten vary significantly depending on the nature of the profession and the geographic area in which it is practiced. Success in E&O depends particularly on knowledgeable underwriting and on well-conceived distribution and claims handling systems. ERI's subsidiaries offer E&O coverage to a wide variety of professional classes, with major classes that include: large law firms (generally over 35 lawyers), psychologists, insurance agencies, real estate title and closing professionals, and mortgage brokers. The Company's underwriting for E&O business is divided between the Lawyers Professional Liability ("LPL") department and the Miscellaneous Professional Liability ("MPL") department, each of which has grown substantially during the past three years. All LPL policies are underwritten by Company-employed attorneys, all of whom have some large firm experience. Policies issued through the MPL Department are generally underwritten directly by Company-employed underwriters. However, a small but growing percentage of Company E&O coverage is being written through outside firms, known as program administrators, which have experience and expertise with respect to a specific class of risk and with which the Company has entered into written contractual agreements (see "Markets -- Errors and Omissions Insurance"). The Company History. The Company's subsidiary, Executive Re, was formed in 1986 by The Aetna Casualty and Surety Company ("Aetna") and certain other institutional investors to capitalize on the deficiency of insuring capacity which then existed in the D&O industry. It commenced operations in 1987. During its first five years, Executive Re established an underwriting and marketing infrastructure for the provision of D&O coverage through an insurance facility (the "Facility") with Aetna. Executive Risk Management Associates ("ERMA"), a Connecticut general partnership owned 30% by Executive Re and 70% by Aetna prior to January 1, 1994, was formed to market and underwrite D&O insurance policies. Executive Risk Indemnity Inc. ("ERII") was acquired to reinsure D&O policies for which Aetna was the direct insurer. In 1991, Executive Re took steps to expand domestically into E&O markets on a niche basis, and in 1993, began its overseas marketing efforts through UPEX, which is owned 50% by the Company and 50% by UAP. UPEX is a Paris-based underwriting agency that functions in much the same way ERMA has functioned within the Facility. The lead underwriter at UPEX is a former Company employee. In 1992, negotiations commenced for the acquisition of Aetna's ownership interest in ERMA. A reorganization transaction (the "1994 Transaction") was consummated on January 1, 1994. The Company had been formed in August 1993 in anticipation of the 1994 Transaction. As a result of the 1994 Transaction, ERI now owns a 70% direct ownership interest in ERMA, and has become the direct holding company of Executive Re (which owns the remaining 30% of ERMA) and the indirect holding company of the Executive Re subsidiaries, which include ERII, as well as ERII's surplus lines insurance subsidiary, Executive Risk Specialty Insurance Company ("ERSIC"). ERII and ERSIC are referred to herein as the "Insurance Subsidiaries." Further, the 1994 Transaction modified the Facility, permitting the Insurance Subsidiaries to underwrite D&O insurance directly. With the completion of the 1994 Transaction and ERI's initial public stock offering in March 1994, the Company became a publicly-owned insurance holding company. In May 2 5 1995, the Company incorporated Executive Risk N.V. ("ERNV"), a Dutch insurance company, to participate in professional liability opportunities. 1996 Aetna Transactions. In March 1996, the Company entered into a Stock Purchase Agreement (the "Stock Purchase Agreement") with Aetna and its then parent, Aetna Life and Casualty Company ("AL&C"). On March 26, 1996 (the "Repurchase Closing Date"), the Company purchased from Aetna 1,286,300 shares of ERI Common Stock and all 1,225,000 shares of ERI Class B Common Stock (together, the "Repurchased Common Stock"), at a price of $29.875 per share, or approximately $75 million in the aggregate. Prior to the Repurchase Closing Date, the Company's capital stock had consisted of 10,280,341 issued and outstanding shares of Common Stock and 1,225,000 issued and outstanding shares of Class B Common Stock. Prior to the Repurchase Closing Date, Aetna owned a total of 4,511,300 shares of ERI capital stock, consisting of (i) 3,286,300 shares of Common Stock, 32% of the issued and outstanding shares of Common Stock and (ii) all 1,225,000 shares of the Class B Common Stock. AL&C also owned and continues to own an option to purchase 100,000 shares of Company Common Stock at an exercise price of $12.00 per share (the "Aetna Option"). Counting the shares obtainable through exercise of the Aetna Option, AL&C had controlled 39.7% of the Common and Class B Common Stock outstanding prior to the Repurchase Closing Date. For approximately two and a half months following the Repurchase Closing Date, AL&C owned 2,000,000 shares of Common Stock, representing approximately 22% of the then issued and outstanding amount. In accordance with the Stock Purchase Agreement, the Company filed with the SEC a Form S-3 Registration Statement, under which it registered for public sale all 2,000,000 of Aetna's remaining shares. In connection with such offering, the Company also registered 300,000 newly issued shares. The underwritten public offering closed on June 7, 1996, on which date the 2,300,000 shares were sold at the price of $34.00 per share. Upon closure of such secondary offering, neither Aetna nor AL&C have any ownership interest in the Company, other than the Aetna Option. The Aetna Facility prior to 1997 Restructuring. Until early 1997, the Insurance Subsidiaries conducted D&O business primarily through the Facility, consisting of Aetna, ERII and ERSIC, each of which acted as an insurer or reinsurer, and ERMA, which acted as the product developer, marketer and managing underwriter. The Facility had operated under the terms of a number of related documents, including: (1) an Amended and Restated Agency and Insurance Services Agreement, dated as of January 1, 1994 among Aetna, the Company and ERMA (the "Pre-restructuring Agency Agreement"), (2) an Amended and Restated Quota Share Reinsurance Agreement, dated as of January 1, 1994, between Aetna and ERII respecting business issued by ERMA on Aetna policies (the "Pre-restructuring Aetna Quota Share Agreement"), (3) a Quota Share Reinsurance Agreement, dated as of January 1, 1994, between ERII and Aetna respecting certain business issued by ERMA on ERII policies (the "Pre-restructuring ERII Quota Share Agreement") and (4) a Quota Share Reinsurance Agreement, dated as of January 1, 1994, between ERSIC and Aetna respecting certain business issued by ERMA on ERSIC paper (the "Pre-restructuring ERSIC Quota Share Agreement"). Under the Pre-restructuring Agency Agreement, Aetna had authorized ERMA to underwrite and issue, on behalf of Aetna, policies of D&O insurance, financial institution trust department errors and omissions insurance ("Trust E&O"), and certain other insurance ("Other Lines"; collectively with D&O and Trust E&O, the "Aetna Lines"), all in accordance with prescribed underwriting guidelines and within defined liability limits. Under this agreement, ERMA had the exclusive right and authority to issue D&O insurance on behalf of Aetna in North America. This exclusive arrangement was binding on Aetna, its former parent, AL&C, and its subsidiaries; however, it was not binding on Aetna's current parent, Travelers/Aetna Property Casualty Corp. ("TAPCO"), or TAPCO's affiliates. The Pre-restructuring Agency Agreement was subject to termination upon two years' notice, provided that no such termination could be effective until December 31, 1999. Generally, where Aetna's policies were issued, Aetna ceded 50% of gross D&O liability to ERII on a quota share basis, with other specified percentages applicable to non-D&O policies. Where an Insurance Subsidiary's policy was issued, 12.5% of the gross D&O liability was ceded to Aetna on a quota share basis. For each reinsured policy, the reinsuring entity received premium from the reinsured entity and was obligated to pay a ceding commission to the reinsured entity. 3 6 The 1997 Facility Restructuring. On February 13, 1997, the Company announced a restructuring (the "Restructuring") of its relationship with Aetna. In connection with the Restructuring, the Pre-restructuring Agency Agreement, Pre-restructuring Aetna Quota Share Agreement, Pre-restructuring ERII Quota Share Agreement and Pre-restructuring ERSIC Quota Share Agreement have been terminated and replaced with the following agreements: (a) a Restructuring Agreement, dated February 13, 1997 (the "Restructuring Agreement") by and among the Company, and its subsidiaries, Executive Re, ERII, ERSIC and ERMA (collectively, the "Subsidiaries"), and Aetna and Aetna's direct subsidiary, Aetna Casualty & Surety Company of Canada; (b) an Agency and Insurance Services Agreement, dated as of January 1, 1997, between Aetna and ERMA (the "1997 Agency Agreement"); and (c) a Quota Share Reinsurance Agreement, dated as of January 1, 1997, between Aetna and ERII (the "1997 Reinsurance Agreement"). Pursuant to the 1997 Agency Agreement, ERMA retains the right and authority, on a non-exclusive basis, to (a) renew on Aetna paper all policies of Aetna Lines written or quoted prior to February 13, 1997, and (b) underwrite and issue new policies of Aetna D&O in the United States in accordance with existing underwriting guidelines and specified limitations on limits of liability. The 1997 Agency Agreement provides that annual gross premium volume written by ERMA with respect to Aetna Lines must not exceed an aggregate amount equal to the lesser of (a) 10% of the sum of the Company's total direct gross D&O premiums plus the total direct gross D&O premiums written by ERMA on Aetna policies under the 1997 Agency Agreement and (b) $25 million. The Company currently expects that it will underwrite and issue Aetna policies aggregating lower premium volumes than the maximums permitted under the 1997 Agency Agreement. Unless terminated sooner in accordance with its terms, the 1997 Agency Agreement will remain in effect through December 31, 1999 (subject to possible extension; see paragraph (e) below). Under the Pre-restructuring ERII and ERSIC Quota Share Agreements, Aetna had a 12.5% quota share participation in generally all direct D&O business written on ERII and ERSIC policies. Under the Restructuring Agreement, effective as of January 1, 1997, Aetna no longer participates in the Company's direct D&O business by way of reinsurance. During 1996, the Company's direct D&O business totaled approximately $225 million. Additionally, under the Pre-restructuring Aetna Quota Share Agreement, ERII had a 50% quota share participation in generally all Aetna D&O business issued by ERMA. ERII also had a quota share participation in Trust E&O and Other Lines business written by ERMA on behalf of Aetna. Pursuant to the Restructuring Agreement, as of January 1, 1997, ERII has a 100% quota share participation in all Aetna Lines business written by ERMA on behalf of Aetna. Under the 1997 Reinsurance Agreement, Aetna receives a ceding commission equal to actual producers' commissions plus 3.5% of gross written premiums, less return premiums, as an allowance for premium taxes and other costs and expenses incurred by Aetna in connection with the business covered under that agreement. In addition to modifying the agency and reinsurance relationships, the Restructuring Agreement provided for the following: (a) Mr. Joseph P. Kiernan, an officer of Aetna and TAPCO, has resigned from the Boards of Directors and Partnership Committee, as the case may be, of the Company, the Insurance Subsidiaries and ERMA, and Aetna no longer has any election or nomination rights with respect to the Boards of Directors or Partnership Committee of the Company and its Subsidiaries; (b) all restrictions on the Company's premium volume (other than as to the business written on Aetna policies as described above) and any remaining Aetna consent requirements for the Company's corporate governance have been terminated; (c) the Company has agreed to secure a portion of Aetna's reinsurance receivable from ERII under the Pre-restructuring Aetna Quota Share Agreement and the 1997 Reinsurance Agreement by means of providing Aetna with a standby letter of credit in an amount of not more than $25 million, subject to adjustment in the event of certain contingencies; (d) Aetna, on behalf of itself and its subsidiaries and certain affiliates, has agreed that for a period of two years it will not solicit the Company's (or any Subsidiary's) underwriters for employment; and 4 7 (e) the parties have mutually agreed to meet in 1999 to discuss the possibility of entering into another agency relationship with respect to D&O beyond December 31, 1999. Under the Restructuring, the Company and its Subsidiaries have relinquished the exclusive right to underwrite and issue D&O on Aetna policies. As a result, competition for D&O business through the end of 1999 may increase. Management is of the opinion that there are potential benefits to the Company by virtue of the Restructuring, principally those flowing from the cessation of Aetna's 12.5% quota share participation in ERII's and ERSIC's direct D&O business, as described above. The financial benefits that may result from the Restructuring depend upon a number of assumptions and marketplace considerations, which are impossible to quantify at this time. Markets Directors & Officers Insurance. ERI's strategy has been to position itself as a niche player, developing specialized expertise in specific industry groups. With respect to domestic D&O, the Company markets its products in three principal sectors: Commercial Entities, Financial Institutions and Not-for-Profit Organizations. Based on the 1996 survey of the D&O industry conducted by Watson Wyatt Worldwide, ERI's management believes that the Company is a leading underwriter of primary D&O in the United States. The following table shows the gross D&O premiums written for each of the three principal sectors for the periods indicated:
GROSS DOMESTIC D&O PREMIUMS WRITTEN YEAR ENDED DECEMBER 31, ----------------------------------- SECTOR 1996 1995 --------------------------------------------------- --------- --------- 1994 (IN THOUSANDS) --------- Commercial Entities.............................. $ 136,598 $ 88,318 $ 47,993 Financial Institutions........................... 54,433 45,169 36,922 Not-for-Profit Organizations..................... 52,888 26,826 20,547 --------- --------- --------- Total.................................... $ 243,919 $ 160,313 $ 105,462 ======== ======== ========
Within each of the D&O sectors, ERI has targeted and developed particular areas of expertise, a strategy that management believes has allowed ERMA and the Insurance Subsidiaries to develop and adapt their insurance products more knowledgeably and to underwrite submissions and process claims more professionally than competing companies. Management believes that such expertise, together with a strong reputation for prompt service and responsive claims handling, alleviates the pressure to compete on the basis of price during a "soft market," such as that which has prevailed within the industry in recent years. See "Competition." The Commercial Entities sector focuses principally on publicly owned, mid-sized companies, but also considers secondary layers of insurance (called "excess insurance") for larger public companies which carry primary D&O coverage from other insurers. In 1993, the Company also began to focus on coverages for small commercial entities (assets under $100 million), and a product specifically designed for the small, non-public commercial entity was introduced by the Company in late 1995. As with other sectors, ERI's commercial entity D&O strategy is to develop particularized knowledge of selected sub-sectors and then utilize its underwriting expertise in adapting coverage and assessing risks. Within the Financial Institutions D&O sector, the Company maintains specializations in several sub-sectors, such as community banks (including small depository institutions under $250 million in assets), large depository institutions, mortgage bankers, mutual fund companies and broker-dealers. The third sector, Not-for-Profit Organizations, underwrites for a variety of not-for-profit healthcare facilities (principally hospitals) and social service/charitable organizations (such as foundations, chambers of commerce, etc.). Errors & Omissions Insurance. ERMA underwrites and markets E&O insurance on ERII and ERSIC policy forms directly. Non-lawyer E&O underwriting has historically been performed within the MPL group, which was formed in 1992 and oversees the Company's basic line of E&O products. Through the MPL unit, the Company offers E&O products providing up to $5 million in coverage to a variety of smaller to medium- 5 8 sized, independent professional firms in a wide variety of service sectors, including financial services and real estate sectors. During 1996, the Company initiated an effort to focus on a line of financial institution E&O products, such as policies for mutual fund sponsors, financial advisory firms and related financial industry participants. Such products are offered via a new Financial Institutions E&O unit within the Underwriting Department. Following a research and development program, the Company formed the LPL underwriting group in 1993. Using only attorney-underwriters, this group underwrites E&O for mid-size and larger law firms (generally those with at least 35 lawyers) on a primary or excess coverage basis. The Company believes that its use of experienced lawyers in the marketing and underwriting process has proven to be attractive to firms within the target market. Effective January 1, 1996, a reinsurance program, involving a number of domestic and international reinsurance markets, is in place, and as a result, in 1996 the Company began to market lawyers E&O policies up to policy limits of $50 million each loss and $100 million in the aggregate. See "Reinsurance." Program administration involves contracting with third party producers who, with special expertise in a specific class of E&O risk, agree to underwrite Company policies within carefully defined parameters. The Company currently has four program administration arrangements in place, and management anticipates that this could evolve into a significant distribution methodology for the Company's E&O products. (See "Marketing.") International. In January 1993, the Company entered into a joint venture agreement with UAP to write D&O insurance for European companies. During 1996, UAP announced that it had agreed to merge with Axa; the merged entity, which is known as AXA-UAP Group, is the largest insurance organization in Europe. Under the UPEX joint venture agreement, the Company has agreed that it will not market D&O insurance outside North America, except that it may offer D&O through UPEX and in countries where UPEX elects not to do business. UPEX offers D&O policies issued by UAP, up to a maximum $25 million policy limit, subject to certain foreign currency adjustments, and the Company assumes a 50% participation in these policies. Commencing operations in November 1993, UPEX underwrote approximately $22 million in gross premiums in 1996. The management of AXA-UAP Group is largely comprised of AXA management officials, and the Company cannot at this time predict what, if any, effect the change in management will have with respect to the operation of the UPEX joint venture. The Company's Dutch subsidiary, ERNV, was founded in May 1995 to participate in professional liability opportunities. ERNV was formed initially to participate in a Netherlands-based D&O pool, which participation ended December 31, 1996. ERNV generated relatively small (less than $500,000) gross premiums in 1996. Marketing The Company's products are distributed principally through licensed independent property and casualty brokers, excess and surplus lines brokers and licensed wholesalers. The Company's products are distributed by several thousand brokers. During 1996, no single office of any broker or organization accounted for a material portion of the gross premiums written through ERMA, and the Company was not dependent on any one broker. With the exception of a four-person branch in the Chicago area, the Company services domestic brokers from its Simsbury, Connecticut headquarters. Improvements to the Company's product distribution system are regularly under review, and the Company has recently established regional subdivisions within the Underwriting Department, to better manage relations with producers and insureds across the country. Marketing is conducted in a variety of ways, but is generally targeted at the agent and broker audience. The Company produces a quarterly newsletter, containing articles of interest to the D&O and E&O industry, which is widely distributed. Advertisements, articles in trade publications, seminar participations and convention sponsorships are among the other methods used to market the Company's products. Particularly in the health care D&O line, arrangements with national hospital and health care associations have been useful in presenting the Company's products to target markets. An in-house marketing and communications staff produces (or oversees production of) all of the Company's public relations materials. The Company believes 6 9 that these efforts have resulted in widespread name recognition of the Company and its products within target markets. Beginning in 1995, the Company instituted relationships with insurance agencies with national or regional books of E&O program business. Under such a "program administration" relationship, a third party entity becomes the Company's agent to underwrite and issue E&O policies within guidelines specified by the Company. Program administrators are not authorized to handle or pay claims or bind reinsurance. The Company conducts due diligence procedures with respect to potential program administrators prior to entering into such contractual relationships, and it exercises on-going audit rights under the program administration agreements. As of year-end 1996, four program administration relationships were in effect, and others were being investigated. Underwriting General. The Company's general underwriting philosophy stresses two essential factors: expert consideration of complex insurance submissions, including those from harder-to-insure applicants, and profitability over premium growth. Accordingly, the Company prices premiums based primarily upon specific risk exposure, including loss experience, rather than primarily upon market factors. The table below sets forth statutory loss ratios and combined ratios for the periods indicated for the Insurance Subsidiaries and the property/casualty industry. The Insurance Subsidiaries' specialty products business is not directly comparable to the business of the property/casualty industry as a whole.
YEAR ENDED DECEMBER 31, STATUTORY ACCOUNTING -------------------------------------------- PRACTICES DATA 1996 1995 1994 1993 1992 -------------------------------------------- ---- ----- ----- ----- ----- Insurance Subsidiaries Loss Ratio................................ 67.6% 67.4% 67.6% 67.6% 71.5% Combined Ratio............................ 92.7 90.7 97.6 102.1 102.8 Industry(1) Loss Ratio................................ * 78.9 81.1 79.5 88.1 Combined Ratio(2)......................... * 105.0 107.2 105.7 114.6
- --------------- * Not available (1) Source: Best's Aggregates & Averages -- Property-Casualty. (2) Excludes policyholder dividends. The Company emphasizes industry specialization within its underwriting staff, which includes a number of professionals with operational experience from the industries being underwritten. ERMA's staff of underwriters works under the supervision of Stephen J. Sills, who has been with ERI since 1986 and is currently President, Chief Underwriting Officer and a director. In February 1997, the Company announced that John F. Kearney has been promoted to Senior Vice President and Chief Underwriting Officer of ERMA. In addition to consulting with members of the underwriting management team, underwriters may also consult with members of the Company's actuarial, claims and legal departments, as they analyze various aspects of a prospective insured's risk profile. Except with respect to the Company's higher volume, lower risk not-for-profit business (not including hospitals, where a Company-developed ratings system is utilized), submissions for D&O and E&O insurance are underwritten on a risk-by-risk basis. A large portion of the Company's policies have a one-year term, though the number of longer-term policies has been growing in recent years. Greater than one-year terms are offered in several situations, including "run-off " insurance coverage, which is most often purchased to protect the directors and officers of an acquired corporation during the three to six year period following a merger or acquisition. Most submissions for renewal of an expiring policy are re-underwritten and re-priced in accordance with the standard underwriting practices and procedures, which generally do not distinguish between new and renewal policies. The underwriting guidelines are set by the underwriting committees of the Insurance Subsidiaries. 7 10 Particularly in the underwriting of its insurance business, the Company relies heavily on advanced computer technology, including its proprietary Underwriter Work Station ("UWS") software. By utilizing down-loaded data from the U.S. Department of Commerce and other sources, the UWS can be used to perform sophisticated financial modeling tasks, providing the Company with what it believes to be a competitive advantage in information-intensive industry segments, such as banking and large commercial accounts. For not-for-profit D&O and E&O business lines, the UWS is focused primarily on maximizing efficiencies in submissions handling and response. Claims General. Claims arising under insurance policies underwritten by the Company are managed by the Company's Claims department. Because of the nature of the Company's policies and the persons covered by D&O insurance, claims tend to be reported soon after the occurrence of a loss or an event representing a potential loss. Claims personnel are assigned to handle claims based, in part, on industry specialization. To assist its staff in claims management, the Company has developed a comprehensive automated electronic claim file system (the "Claims Information System") for administering and investigating claims, and calculating and updating case reserves. When the Company receives notice of a loss or potential loss, a claims handler is assigned to the claim and a claim file is created in the Claims Information System. This system electronically attaches a copy of the policy file to the claim file and can also help determine whether there are obvious claim issues, such as a claim being made outside the policy period. The Claims Information System automatically composes certain routine correspondence to the insured. All outgoing correspondence, reports from monitoring counsel and other relevant data are entered in the Claims Information System claim file. In reviewing the claim, the Claims Information System, utilizing staff-entered severity code information relating to various claim characteristics, helps to ensure objectivity, and consequently consistency, of claims evaluation. The severity classification assigned to a particular claim assists in determining the frequency and manner in which the claim is administered. All significant claims are reviewed at least quarterly. Claims assigned a high severity code are monitored more frequently and typically assigned to outside legal counsel for review and monitoring. The Company's insurance policies have not generally contained a "duty to defend" provision requiring it to hire attorneys to defend its insureds, although duty to defend types of policies are becoming an increasingly important part of the Company's product mix. Even where there is no duty to defend, however, the Company does in certain instances become closely involved with defense counsel in evaluating claims and developing litigation management and settlement strategies. The Company believes that its experience in resolving claims and its proactive approach to claims management has contributed to the advantageous resolution of many cases. Based in part on the claims severity code and other factors developed by the claims handler (assisted by the Claims Information System), the Claims department recommends a case reserve for each claim. As more information is discovered with respect to a claim, the claims handler may recommend an increase or decrease in case reserves. The Company believes that the claims analysis permitted by the Claims Information System helps the Company to evaluate claims and make informed judgments with respect to case reserves promptly. See "Reserves." Reinsurance General. The Company has historically used reinsurance arrangements to limit the amount of risk retained under policies written or reinsured by the Insurance Subsidiaries. With respect to D&O risks, the Company purchased an excess-of-loss reinsurance treaty in 1995 and 1996 providing for 100% reinsurance protection (20% in 1994), subject to aggregate limits and other restrictions, on losses incurred in excess of $2.5 million up to a limit of $10 million. The treaty was renewed effective January 1, 1997 under substantially the same terms and conditions as applied in 1996. In 1995, ERII and ERSIC also entered into a D&O quota share reinsurance treaty, with various reinsurers, covering 90% of losses in excess of $10 million up to (i) $25 million through February 28, 1997 and (ii) $35 million from and after March 1, 1997, subject in both cases to certain limitations. In addition, for the Company's D&O coverages assumed from UAP since January 1, 1995, ERII 8 11 has entered into a quota share reinsurance treaty, with various reinsurers, which generally provides for 70% reinsurance protection on losses incurred, subject to certain restrictions. Effective January 1, 1996 and subject to certain limitations, the Company's Lawyers Professional Liability product is reinsured, through a number of domestic and international markets, in a combination quota share and excess of loss reinsurance program whereby the Company retains more of the risk insured on lower limit policies and cedes more of the risk insured on higher limit policies. This program limits the Company's exposure to slightly under $5 million on a policy with a maximum limit of $50 million. For the Company's other E&O coverages, ERII and ERSIC have entered into quota share reinsurance treaties with various reinsurers, which generally provide for between 75% and 90% reinsurance protection on losses incurred, subject to certain restrictions. Since the Company, in its role as ceding insurer, remains responsible for policy claims without regard to the extent the reinsurer does or does not pay such claims, reinsurers are carefully selected, taking into consideration the financial stability of a potential reinsurer and its service and claims paying history. While the Company endeavors to diversify its reinsurance relationships and to reinsure with financially sound reinsurers, there can be no assurance that the Company will not experience difficulties in the future in recovering under these arrangements should one or more of its reinsurers experience financial difficulties. The Company's reinsurance programs include material exposure to Lloyd's, which is a collection of underwriters (known as "Names") who group together annually to form syndicates. Lloyd's syndicates have experienced substantial underwriting losses and decreases in underwriting capacity in the past, and they underwent a restructuring of liabilities during 1996. The long-term success or failure of such restructuring could affect Lloyd's syndicates' ability to meet their reinsurance obligations. The Company, together with its reinsurance brokers, performs a periodic security analysis of its Lloyd's exposure, including quantitative and qualitative analyses, and management believes that the syndicates supporting the Company's reinsurance programs are financially stable. For the year ended December 31, 1996, the Company's total ceded premiums were approximately $121.7 million, of which approximately $33.2 million were ceded to Lloyd's syndicates. To date, the Company has experienced no reinsurance recoverable defaults. The availability and cost of reinsurance arrangements are subject to prevailing market conditions, which are beyond the Company's control. As a result of these or other factors, the Company may in the future choose to revise further its reinsurance practices to increase, decrease or eliminate entirely the amount of risk it cedes to reinsurers. Primarily due to expense considerations in light of past experience, the Company does not purchase "clash" reinsurance protection. Clash coverage protects the ceding insurer in situations where there are multiple losses -- either in a single line of business or multiple lines of business -- arising out of a single event. Reserves The Company is liable for losses and loss adjustment expenses ("LAE") under its insurance policies and reinsurance treaties. Both D&O and E&O policies are generally written on a "claims made" form. In general, a claims made policy provides for payment with respect to any claim made against the insured during the policy period with respect to a covered act. In many cases, several years may elapse between the reporting of the claim or covered act to the Company and the Company's payment on a related loss. The Company reflects its liability for the ultimate payment of incurred losses and LAE by establishing loss and LAE reserves, which are balance sheet liabilities representing estimates of future amounts needed to pay claims and related expenses with respect to insured events that have occurred. The Company maintains two classes of reserves. When a claim is reported, the Company establishes an initial case reserve for the estimated amount of the Company's ultimate losses and LAE. This estimate reflects a judgment, based on the Company's reserving practices and the experience of the Company's claims staff, regarding the nature and value of the reported claim. The Company may periodically adjust the amount of case reserves as additional information becomes known or partial payments are made. The Company also establishes incurred but not reported reserves ("IBNR reserves") on an aggregate basis to provide for future 9 12 developments on case reserves, as well as for claims reported to the insured or to the Company but not yet recorded by the Company. IBNR reserves are established based on the experience of the Company and the insurance industry generally with respect to the average frequency and severity of insured events. Reserves are estimates involving actuarial and statistical projections of the cost of the ultimate settlement and administration of claims, based on known facts and circumstances, predictions of future events, estimates of future trends in claims severity and other variable factors such as inflation and new concepts of liability. It may be necessary in the future to revise estimated potential loss exposure, and therefore the Company's loss reserves. During the claim settlement period, which may be years in duration, additional facts regarding claims and trends may become known. As the Company becomes aware of new information, it may refine and adjust its estimates of its ultimate liability. The revised estimates of ultimate liability may prove to be less than or greater than the actual settlement or award amount for which the claim is finally discharged. As a consequence, actual losses and LAE paid may deviate, perhaps substantially, from estimates reflected in the Company's reserves in its financial statements. The Company's Insurance Subsidiaries, like other insurance companies, are subject to the risk of severe or multiple losses, which could significantly exceed the maximum loss previously assumed. To the extent reserves prove to be inadequate after taking into account available reinsurance coverage, the Company augments its reserves, resulting in a current-year charge to earnings. In addition, loss reserves may prove to be inadequate in the event that a major part of the Company's reinsurance coverage were to become uncollectible. See "Reinsurance." Since 1988, the Company has retained the services of an independent actuarial consulting firm to provide opinions regarding reserves as required for state regulatory filings. The Company intends to retain such services in the future. Although the Company believes that its reserves are adequate, there can be no assurance that ultimate loss experience will not exceed the Company's reserves, which may result in a material adverse effect on the Company's financial condition and results of operations. The following table sets forth a reconciliation of beginning and ending reserves for unpaid losses and LAE, net of reserves for reinsured losses and LAE, for the years indicated.
YEAR ENDED DECEMBER 31, ---------------------------------- 1996 1995 1994 -------- -------- -------- (IN THOUSANDS) Reserves for losses and LAE at beginning of period, gross.................................................... $324,416 $254,758 $215,151 Reinsurance recoverable at beginning of period............. (33,531) (8,958) (6,053) -------- -------- -------- Reserves for losses and LAE at beginning of period, net.... 290,885 245,800 209,098 Provision for losses and LAE for current year claims....... 112,107 83,775 68,304 Decrease in estimated ultimate losses and LAE for prior year claims.............................................. (6,772) (5,245) (4,133) -------- -------- -------- Total incurred losses and LAE.............................. 105,335 78,530 64,171 Adjustment for foreign exchange loss on unpaid loss and LAE...................................................... (23) 58 27 Loss and LAE payments for claims attributable to: Current year............................................. 2,239 792 587 Prior years.............................................. 13,811 32,711 26,909 -------- -------- -------- Total payments............................................. 16,050 33,503 27,496 -------- -------- -------- Reserves for losses and LAE at end of period, net.......... 380,147 290,885 245,800 Reinsurance recoverable at end of period................... 76,916 33,531 8,958 -------- -------- -------- Reserves for losses and LAE at end of period, gross... $457,063 $324,416 $254,758 ======== ======== ========
As shown above, a result of the Company's normal reserving review, which includes a reevaluation of the adequacy of reserve levels for prior-years' claims, was that in 1996 the Company reduced its unpaid loss and LAE reserves for prior-years' claims by approximately $6.8 million. The Company does not consider reserve reductions to represent a trend, and there can be no assurance concerning future adjustments of reserves, 10 13 positive or negative, for prior-years' claims. The procedures used in determining appropriate reserves at December 31, 1996 were consistent with prior-years' reserving methodologies. Except for the last seven lines, the following "Development of Reserves" table presents the development of unpaid loss and LAE reserves, net of reinsurance, from 1987 through 1996. The last seven lines of the table present that type of development on a "gross-of-reinsurance" basis for the periods following the Company's adoption of Statement of Financial Standards No. 113, "Accounting and Reporting For Reinsurance of Short-Duration and Long-Duration Contracts," as of January 1, 1993. The top line of the table shows the reserves for unpaid losses and LAE, net of reinsurance recoverables on unpaid claims, at the end of each of the indicated years. That net reserve represents the amount of unpaid losses and LAE for claims arising in the current year and all prior years that were unpaid at the balance sheet date, including IBNR reserves. The upper portion of the table also shows the re-estimated amount of the previously recorded reserves based on experience as of the end of each succeeding year. The estimate changes as more information becomes known about the frequency and severity of claims for individual years. 11 14 DEVELOPMENT OF RESERVES (DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31, --------------------------------------------------------------------------------------------------------- 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 -------- -------- -------- --------- --------- --------- --------- --------- --------- --------- Reserves for losses and LAE, net............. $ 11,459 $ 43,273 $ 76,277 $ 111,987 $ 157,131 $ 188,438 $ 209,098 $ 245,800 $ 290,885 $ 380,147 Reserves re-estimated as of end of year: 1 year later....... 10,990 42,140 74,787 112,710 156,773 185,391 204,965 240,555 284,113 2 years later...... 10,345 38,653 70,708 112,333 153,726 181,258 199,720 233,783 3 years later...... 6,886 23,846 56,919 111,178 149,593 176,013 192,948 4 years later...... 2,801 10,057 55,764 110,597 144,348 169,241 5 years later...... 1,619 8,899 55,183 105,352 137,576 6 years later...... 1,635 8,916 49,938 100,368 7 years later...... 1,635 8,916 49,236 8 years later...... 1,635 8,916 9 years later...... 1,635 Cumulative redundancy (deficiency)......... 9,824 34,357 27,041 11,619 19,555 19,197 16,150 12,017 6,772 Cumulative paid as of: 1 year later....... $ 5 $ 50 $ 1,088 $ 9,491 $ 20,075 $ 25,838 $ 26,909 $ 32,711 $ 13,811 2 years later...... 33 449 4,815 26,321 44,814 47,270 56,823 42,851 3 years later...... 33 1,936 17,977 44,759 61,562 73,100 59,760 4 years later...... 1,283 2,072 26,483 56,572 78,916 75,751 5 years later...... 1,265 2,134 31,157 68,277 79,675 6 years later...... 1,265 4,421 38,435 68,671 7 years later...... 1,265 4,426 38,477 8 years later...... 1,265 4,441 9 years later...... 1,265 Net reserve -- December 31................... $ 209,098 $ 245,800 $ 290,885 $ 380,147 Reinsurance recoverables......... 6,053 8,958 33,531 76,916 -------- -------- -------- -------- Gross reserve -- December 31................... $ 215,151 $ 254,758 $ 324,416 $ 457,063 ======== ======== ======== ======== Net re-estimated reserve.............. 192,948 233,783 284,113 Re-estimated reinsurance recoverables......... 2,339 9,123 33,536 -------- -------- -------- Gross re-estimated reserve.............. $ 195,287 $ 242,906 $ 317,649 ======== ======== ======== Gross cumulative redundancy........... $ 19,864 $ 11,852 $ 6,767 ======== ======== ========
In the Company's early years of operation, the Company had little or no actual loss experience upon which to calculate reserves. As a result, its reserving methodologies were based largely on industry data. In recent years, the Company has developed reserves based upon its own loss experience. With this information available, the Company believes it is capable of estimating future losses, and consequently reserves, with a greater degree of accuracy than in the Company's early years of operations. There can be no assurance that the Company's reserves will be sufficient to cover ultimate losses. Investments The Company's investment philosophy is to seek optimum total return. This is done in a manner consistent with what management believes is a generally conservative investment approach, as evidenced by the portfolio's quality characteristics, liquidity and diversification. The Company has established investment guidelines and policies and oversees management of the investment portfolio through the Finance Committee of the Company's Board of Directors. Investment policies are approved by its Board of Directors or Finance Committee. All investments are reviewed periodically by the Finance Committee, and exceptional investment decisions are submitted for advance approval. In addition to the specifications in the investment policy statements, all investments of the Insurance Subsidiaries must meet the applicable state statutory requirements. 12 15 The Company's investment policies specify limitations as to type of investment and exposure to single issuers. Investments currently consist principally of U.S. Government securities, corporate and municipal obligations, mortgage-backed and asset-backed securities, partnership interests and common equities (including mutual fund shares). At December 31, 1996, the Company had no direct investments in mortgages or equity real estate, other than its headquarters building in Simsbury, Connecticut. Investments in securities backed by the full faith and credit of the U.S. Government and U.S. Government agencies may be made without limitation. Additionally, the Company's allocation to one of its external investment managers permits holdings of up to $6.9 million in non-investment grade debt securities. The following table summarizes the investment portfolio of the Company, by asset class, as of December 31, 1996.
DECEMBER 31, 1996 -------------------------------------- FAIR VALUE COST(1) PERCENT(2) ---------- -------- ---------- (DOLLARS IN THOUSANDS) U.S. Treasury or agency securities................. $ 24,734 $ 24,621 3.6% Municipal securities............................... 439,281 424,012 63.6 Corporate fixed income securities.................. 92,855 91,528 13.4 Mortgage and other asset backed securities......... 61,955 60,911 9.0 Foreign government securities...................... 1,567 1,517 0.2 -------- -------- ----- Total fixed maturities................... 620,392 602,589 89.8 -------- -------- ----- Equity securities.................................. 45,877 35,820 6.6 Short-term investments and cash.................... 24,706 24,706 3.6 -------- -------- ----- Total investments and cash............... $ 690,975 $663,115 100.0% ======== ======== =====
- --------------- (1) Amortized cost for fixed maturities and short-term investments. (2) Percent of total portfolio, based on fair value. Except with respect to a portion of the allocation to one of its investment managers, representing a small part of the total portfolio (see above), new investments in publicly-traded fixed income securities, both short-and long-term, are restricted to issues that maintain a quality rating equal or equivalent to Baa/BBB or better from Standard & Poor's ("S&P") or Moody's Investors Service, Inc. ("Moody's"). Should an investment in the portfolio be downgraded below this rating, the investment is not necessarily sold immediately but is closely monitored for further deterioration of credit quality and the need to write down the book value of the investment. Private placements or other investments with lower ratings or investments not rated by those agencies are permitted, if approved by the Finance Committee and reported to the Board of Directors. Cash and publicly-traded fixed income securities comprised 91.1% (based on fair value) of the total investment portfolio as of December 31, 1996. At December 31, 1996, over 99% of the Company's publicly-traded bond portfolio was rated investment grade. The following table sets forth the composition of the Company's publicly-traded fixed income securities, by quality rating, as of December 31, 1996.
RATINGS DECEMBER 31, (S&P/MOODY'S) 1996(1) ------------------------------------------------------------------------ ------------ AAA/Aaa............................................................... 57.7% AA/Aa................................................................. 20.7 A/A................................................................... 19.3 Other................................................................. 2.3 ----- Total......................................................... 100.0% =====
- --------------- (1) Based on fair value. 13 16 The National Association of Insurance Commissioners ("NAIC") has a fixed income securities rating system that assigns to investment securities certain ratings, called "NAIC designations," that are used by insurers when preparing their annual statutory financial statements. The NAIC assigns designations to publicly-traded and privately-placed securities. Designations assigned by the NAIC range from 1 to 6, with 1 representing securities of the highest quality. As of December 31, 1996, 97.1% (based on amortized cost) of the Insurance Subsidiaries' fixed income investment portfolio was invested in securities rated 1 by the NAIC. The investment portfolio is designed to provide sufficient liquidity to enable the Company to satisfy its obligations on a timely basis. Although the investment guidelines permit investments with a maturity range of up to 30 years, the Company generally invests in the five to fifteen year maturity range. The following table indicates the composition of the Company's fixed maturity investments, based on fair value, by time to maturity as of December 31, 1996.
TIME TO DECEMBER 31, MATURITY 1996 ------------------------------------------------------------------------ ------------ 0 -1 year............................................................... 6.5% 1 - 5 years............................................................. 30.7 5 - 10 years............................................................ 59.3 10+ years............................................................... 3.5 ----- Total......................................................... 100.0% =====
The investment policies of the Company permit hedging activities to mitigate losses associated with fluctuations in foreign currency. At this point, the Company has no material foreign currency exposure. The Company's initial investments of 6.0 million French francs in the UPEX joint venture and 3.0 million Dutch guilders in ERNV (see "International") are viewed as long-term capital commitments and, as such, are not hedged against fluctuations in the dollar value of the foreign currencies. The Company also maintains, in eleven different European currencies, $2.9 million (as translated to U.S. dollars) of loss reserves assumed from UAP, which are not hedged against fluctuations in the value of these currencies. The Company could determine at a future date to engage in hedging transactions with respect to any foreign currency risk associated with its international operations, including UPEX and ERNV. The Company's assets are invested, subject to the above mentioned statutory constraints and guidelines, to maximize after-tax investment returns. The Company attempts to optimize the blend of income from tax-exempt/taxable securities to achieve maximization of after-tax investment income. The following table illustrates the breakdown of the portfolio between taxable and tax-exempt securities as of December 31, 1996.
DECEMBER 31, 1996 --------------------------------- PERCENT FAIR VALUE ------- --------------------- (DOLLARS IN MILLIONS) Tax-exempt securities..................................... $ 439.3 63.6% Taxable securities........................................ 251.7 36.4 ------ ----- Total........................................... $ 691.0 100.0% ====== =====
The Company's investments are managed by Conning & Company, Black Rock Financial Management and Hyperion Capital Management. Conning & Company is a stockholder of the Company. In addition, the Company utilizes the investment management services of Vanguard Group. Regulation General. As insurance companies, ERII and ERSIC are subject to supervision and regulation in the states in which they transact business. Such supervision and regulation, which is designed primarily for the protection of policyholders and not shareholders, relates to most aspects of an insurance company's business and includes such matters as authorized lines of business; underwriting standards; financial condition standards; licensing of insurers; investment standards; premium levels; policy provisions; the filing of annual and other financial reports prepared on the basis of Statutory Accounting Practices; the filing and form of 14 17 actuarial reports; the establishment and maintenance of reserves for unearned premiums, losses and LAE; transactions with affiliates; dividends; changes in control; and a variety of other financial and nonfinancial matters. Additionally, ERMA is subject to supervision and regulation under state insurance agency laws in the states in which it does business as an insurance agent. Insurance regulatory authorities have broad administrative powers to regulate trade practices and in that connection to restrict or rescind licenses to transact business and to levy fines and monetary penalties against insurers and insurance agents found to be in violation of applicable laws and regulations. Licenses. The Company has obtained insurance company licenses for ERII in all states other than Colorado, where the application is pending, and Connecticut, where ERSIC is the licensed entity. ERSIC is licensed as an insurance company in Connecticut, its state of domicile, and is an eligible surplus lines insurer in all other states. In a small number of states, the Company's ability to write insurance is limited to its core liability lines, and the Company is seeking to expand its authority to include all property/casualty lines in such states. Future flexibility with respect to certain new products could be limited to the extent that the Company is unable to secure additional authorized lines of business in these remaining states. At December 31, 1996, ERMA was licensed as an insurance agent in 26 states and the District of Columbia, with ERMA officers licensed as agents or brokers in 49 states. At least 21 states license only individuals as insurance agents or brokers. Such restriction has not limited the Company's ability to write insurance; however, ERMA's ability to do business in the future could be limited to the extent that it is unable to secure necessary licenses. Regulation of Insurance Holding Companies. ERII and ERSIC are incorporated under the laws of Delaware and Connecticut, respectively. Delaware and Connecticut, like many other states, have laws governing insurance holding companies (such as ERI). Under Delaware and Connecticut law, ERII and ERSIC are each required to register annually and file certain reports with their respective domiciliary State Insurance Commissioners. Such reports must include current information concerning the capital structure, ownership, management, financial condition and general business operations of the filing Insurance Subsidiary and must also disclose certain agreements and transactions between such Insurance Subsidiary and its affiliates, which agreements must satisfy certain standards specified in the respective insurance laws. Under Delaware law, no person may acquire control of ERII or a corporation controlling ERII unless such person has filed a statement containing specified information with the Insurance Commissioner of the State of Delaware (the "Delaware Commissioner") and the Delaware Commissioner has approved such acquisition of control. Under Connecticut law, no person may acquire control of ERSIC or a corporation controlling ERSIC unless such person has filed a statement containing specified information with the Insurance Commissioner of the State of Connecticut (the "Connecticut Commissioner") and the Connecticut Commissioner has approved such acquisition of control. Under both Delaware and Connecticut law, any person acquiring, directly or indirectly, or holding proxies with respect to, 10% or more of the voting stock of any other person is presumed to have acquired "control" of such person. Accordingly, any purchase resulting in the purchaser owning 10% or more of the outstanding Common Stock of ERI would require prior approval of the Delaware and Connecticut Commissioners. Such prior approval requirement also would apply to an acquisition of proxies to vote 10% or more of the outstanding Common Stock of ERI and, therefore, in a proxy contest could delay or prevent a stockholder from acquiring such proxies. No assurance can be given as to whether or not the Company would seek to invoke these laws and regulations in the event of a contested solicitation of proxies. Under Delaware and Connecticut law, ERII and ERSIC, respectively, may not enter into certain transactions, including certain reinsurance agreements, management agreements and service contracts, with members of their insurance holding company system unless they have notified the applicable State Insurance Commissioner of their intention to enter into such a transaction and the applicable State Insurance Commissioner has not disapproved of such transaction within 30 days of such notice. Among other things, such transactions are subject to the requirements that their terms be fair and reasonable, that charges or fees for services performed must be reasonable and that the interests of policyholders not be adversely affected. 15 18 Dividend Restrictions. As an insurance holding company, the Company is dependent on dividends and other permitted payments from the Insurance Subsidiaries to pay its cash dividends to stockholders. The ability of ERII and ERSIC to pay dividends to the Company is subject to Delaware and Connecticut insurance laws, respectively. See Note 8 of the Notes to Consolidated Financial Statements in the Company's 1996 Annual Report to Stockholders. Regulatory Examinations. As part of its routine regulatory process, the Delaware Insurance Department conducts, typically once every three years, an examination of ERII. The report with respect to the most recent completed examination of ERII was issued in December 1995, and covered the period January 1990 through December 1993. The report contained no material adverse findings. ERSIC was incorporated in October 1991 and, as part of its routine regulatory process, the Connecticut Insurance Department conducts, typically once every five years, an examination of insurance companies domiciled in Connecticut. An examination of ERSIC by the Connecticut Insurance Department commenced in March 1995 and was completed in October 1995. Such examination covered the period from ERSIC's incorporation through December 31, 1993. There were no material adverse findings. Insurance regulatory authorities of other states in which the Insurance Subsidiaries hold insurance company licenses may examine the Company's selling practices within their jurisdictions, and such authorities are empowered to impose fines or other sanctions where such examinations reveal deficiencies. To date, only California has conducted a market conduct exam. That exam in 1996 resulted in no material adverse findings. The National Association of Insurance Commissioners. In addition to state-imposed insurance laws and regulations, the Insurance Subsidiaries are subject to accounting practices and reporting formats established by the NAIC. The NAIC also promulgates model insurance laws and regulations relating to insurance companies, which may or may not be adopted by state legislatures or departments of insurance. However, NAIC model laws and regulations have become increasingly important in recent years, due primarily to the NAIC's state regulatory accreditation program. Under this program, virtually all states have adopted certain required model laws and regulations and meet various staffing and other requirements and are "accredited" by the NAIC. Because the adoption of certain model laws and regulations is a prerequisite to accreditation, the NAIC's initiatives have taken on a greater level of practical importance in recent years. IRIS Ratios. The NAIC annually calculates 11 financial ratios to assist state insurance departments in monitoring the financial condition of insurance companies. Results are compared against a "usual range" of results for each ratio, established by the NAIC. For 1996, the Insurance Subsidiaries were outside the usual range for IRIS Ratio 2, "Change in Net Writings," which has been due to the above-average growth rate, due in part to conversions by insureds from Aetna D&O policies to ERII and ERSIC D&O policies. Additionally, ERSIC was outside the usual range for IRIS Ratio 8, "Agents' Balances to Surplus," at 52%, which resulted solely from the accounting for the intercompany pooling arrangement with ERII, and not from receivables actually due from third parties. On a group basis, the ratio of agents' balances to surplus is within the IRIS usual range. Management does not believe that the Insurance Subsidiaries' IRIS ratio results will adversely affect their ability to write new business. Capital and Surplus Requirements. The NAIC has developed risk-based capital ("RBC") formulas to be applied to all insurance companies, which formulas are used to calculate a minimum required statutory net worth, based on the underwriting, investment and other business risks inherent in an individual company's operations. Any insurance company which does not meet threshold RBC levels ultimately could become subject to increasing levels of regulatory scrutiny and regulatory action. Implementation of these requirements was required for the first time in regulatory filings covering fiscal 1994. The formulas for determining the amount of risk-based capital specify various weighting factors that are applied to financial balances or various levels of activity based on the perceived degree of risk. Regulatory compliance is determined by a ratio of the insurance company's regulatory total adjusted capital to its authorized control level risk-based capital, both as defined by the NAIC. At December 31, 1996, the total adjusted capital (as defined by the NAIC) of ERII and ERSIC was in excess of the risk-based capital regulatory action level. The application of the proceeds from the February 1997 offering of capital securities by a trust affiliated with the Company caused the total adjusted capital of ERII and ERSIC to exceed the risk-based capital company action level, which is a higher standard. See Note 16 of the Notes to Consolidated Financial Statements in the Company's 1996 Annual Report to Stockholders. 16 19 The Insurance Subsidiaries' total adjusted capital at December 31, 1994 and 1995 was in excess of the risk-based capital standards specified by the NAIC for 1994 and 1995. The insurance laws of Delaware and Connecticut limit the retained exposure on any one risk to 10% of capital and surplus. Competition The insurance industry is highly competitive. ERI competes with domestic and foreign insurers and reinsurers, some of which have greater financial, marketing and management resources than ERI, and it may compete with new market entrants in the future. The Company believes its major competitors are American International Group, Inc. and The Chubb Corporation, who the Company believes are dominant competitors in the industry. Other competitors include ACE Limited, Associated Electric & Gas Insurance Services Limited, CNA Financial Corp., EXEL Limited, Great American Insurance Company, Gulf Insurance Company, Lloyd's syndicates, PHICO Insurance Company, Reliance Group Holdings, Inc. and Zurich- American Insurance Company. Competition is based on many factors, including the perceived financial strength of the insurer, pricing and other terms and conditions, services provided, ratings assigned by independent rating organizations (including A.M. Best Company, Inc. and S&P), the speed of claims payment and the reputation and experience of the insurer. Ultimately, this competition could affect ERI's ability to attract business on terms having the potential to yield appropriate returns. Employees At December 31, 1996 the Company employed approximately 310 full-time employees. None of the employees is subject to collective bargaining agreements and the Company knows of no current efforts to implement such agreements. The Company believes it has a good relationship with its employees. ITEM 2. PROPERTIES ERI's executive offices occupy an approximately 120,000 square foot, two-story office building that the Company owns in Simsbury, Connecticut. The Company believes that the premises provide adequately for its near-term space requirements in Connecticut. In addition, the Company occupies office space in the Chicago area (1,300 square feet) for its remote office operations. The operations of the Company are supported by local area networks of personal computers. The local networks in Simsbury and the Chicago area are interconnected by way of wide area telecommunications and provide services such as electronic mail, desktop faxing, real-time data communications, and batch file transfers. ITEM 3. LEGAL PROCEEDINGS The Company is subject to routine legal proceedings in connection with its insurance business. The Company does not believe that these legal proceedings will have a material adverse effect on the Company. ITEM 4. SUBMISSION TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the fourth quarter of 1996. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS Market Information The Common Stock, $.01 par value, of Executive Risk Inc. was listed for trading on the New York Stock Exchange ("NYSE") on March 15, 1994 under the symbol "ER". For the periods presented below, the high and low sales prices of the Registrant's Common Stock on the NYSE were as follows:
THREE MONTHS ENDED ------------------------------------------------------------ MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 ------------ -------- ------------- ------------ 1996 ----- High sales price................... $ 33.000 $ 38.250 $38.500 $ 42.000 Low sales price.................... $ 26.250 $ 29.250 $33.375 $ 34.125
17 20
THREE MONTHS ENDED ------------------------------------------------------------ MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 ------------ -------- ------------- ------------ 1995 ----- High sales price................... $ 17.125 $ 19.000 $23.875 $ 29.000 Low sales price.................... $ 13.625 $ 16.625 $18.375 $ 22.000
THREE MONTHS ENDED PERIOD ENDED ------------------------------------------- MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 ------------ -------- ------------- ------------ 1994 ----- High sales price................... $ 12.500 $ 14.875 $15.875 $ 14.250 Low sales price.................... $ 10.875 $ 10.875 $12.750 $ 12.250
Stockholders There were 94 holders of record of shares of the Company's Common Stock as of February 26, 1997. Approximately 90% of the Registrant's outstanding shares of Common Stock were held of record by Cede & Co., for an unknown number of beneficial owners. Dividends The Company paid cash dividends of $.02 per share in each quarter of 1996, 1995 and in June, September and December 1994. There is presently no intention to either increase or decrease the cash dividend on the Company's Common Stock in the foreseeable future. Future dividends will be dependent upon, among other things, the Company's earnings, financial condition, capital requirements and general business conditions. ITEM 6. SELECTED FINANCIAL DATA Financial Highlights on the inside front cover of the Company's 1996 Annual Report to Shareholders is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 24 through 30 of the 1996 Annual Report to Stockholders is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following consolidated financial statements of Executive Risk Inc. and its subsidiaries, included on pages 35 through 52 of the Company's 1996 Annual Report to Stockholders, are incorporated herein by reference: -- Consolidated Balance Sheets at December 31, 1996 and 1995. -- Consolidated Statements of Income for the years ended December 31, 1996, 1995 and 1994. -- Consolidated Statements of Stockholders' Equity for the years ended December 31, 1996, 1995 and 1994. -- Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994. -- Notes to Consolidated Financial Statements. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 18 21 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS Information concerning the Company's directors and executive officers is incorporated herein by reference to the caption "Item 1. Election of Directors" in the definitive Proxy Statement involving the election of directors and other matters (the "Proxy Statement") which the Company intends to file with the Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934 not later than 120 days after December 31, 1996. ITEM 11. EXECUTIVE COMPENSATION Incorporated herein by reference to the caption "Executive Compensation" in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Incorporated by reference to the caption "Beneficial Ownership of Stock" in the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated by reference to the captions "Certain Relationships and Related Transactions" and "Compensation Committee Interlocks and Insider Participation" in the Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K Financial Statements and Schedules The Financial Statements and schedules listed in the accompanying Index to Financial Statements and Schedules are filed as part of this Report. Exhibits The exhibits listed on the accompanying Index to Exhibits are filed as part of this report. Reports on Form 8-K The Company filed no Current Reports on Form 8-K during the quarter ended December 31, 1996. On February 18, 1997, the Company filed a Current Report on Form 8-K relating to the restructuring of its underwriting and reinsurance relationships with Aetna. 19 22 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. EXECUTIVE RISK INC. (REGISTRANT) By: /s/ LEROY A. VANDER PUTTEN ------------------------------------ LEROY A. VANDER PUTTEN CHAIRMAN AND CHIEF EXECUTIVE OFFICER Dated: March 25, 1997 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:
SIGNATURE TITLE DATE - --------------------------------------------- ----------------------------- --------------- /s/ LeRoy A. Vander Putten Chairman of the Board and March 25, 1997 - --------------------------------------------- Chief Executive Officer LEROY A. VANDER PUTTEN /s/ Robert H. Kullas Director, Vice Chairman and March 25, 1997 - --------------------------------------------- Chief Operating Officer ROBERT H. KULLAS /s/ Stephen J. Sills Director and President March 25, 1997 - --------------------------------------------- STEPHEN J. SILLS /s/ Gary G. Benanav Director March 25, 1997 - --------------------------------------------- GARY G. BENANAV /s/ Barbara G. Cohen Director March 25, 1997 - --------------------------------------------- BARBARA G. COHEN /s/ John G. Crosby Director March 25, 1997 - --------------------------------------------- JOHN G. CROSBY /s/ Patrick A. Gerschel Director March 25, 1997 - --------------------------------------------- PATRICK A. GERSCHEL /s/ Peter Goldberg Director March 25, 1997 - --------------------------------------------- PETER GOLDBERG /s/ Michael D. Rice Director March 25, 1997 - --------------------------------------------- MICHAEL D. RICE /s/ Joseph D. Sargent Director March 25, 1997 - --------------------------------------------- JOSEPH D. SARGENT /s/ Robert V. Deutsch Executive Vice President, March 25, 1997 - --------------------------------------------- Chief Financial Officer, ROBERT V. DEUTSCH Chief Actuary and Chief Accounting Officer
20 23 INDEX TO EXHIBITS
EXHIBIT NO. - ----------- (3) -- Articles of incorporation and bylaws: 3.1 Amended and Restated Certificate of Incorporation of Executive Risk Inc., incorporated herein by reference to Exhibit 3.2 to the Registration Statement on Form S-1 (No. 33-70820) of the Company (herein the "Registration Statement"). 3.2 Restated Bylaws of Executive Risk Inc., incorporated herein by reference to Exhibit 3 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994. (10) -- Material contracts 10.1 Stock Purchase Option between Executive Risk Inc. and The Aetna Casualty and Surety Company, incorporated herein by reference to Exhibit 10.3 to the Registration Statement. 10.2 Joint Venture Agreement, dated January 21, 1993, between Executive Re Inc. and Union des Assurance de Paris'IARD, incorporated herein by reference to Exhibit 10.17 to the Registration Statement. 10.3 Rights Agreement between Executive Risk Inc. and Mellon Bank, N.A., as Rights Agent, incorporated herein by reference to Exhibit 10.19 to the Registration Statement. 10.4 Employment Agreement, dated as of March 15, 1995, by and between Executive Risk Inc. and Robert H. Kullas, incorporated herein by reference to Exhibit 10.13 to Annual Report on Form 10-K for the fiscal year ended December 31, 1994 (the "1994 10-K"). 10.5 Employment Agreement, dated as of March 15, 1995, by and between Executive Risk Inc. and Stephen J. Sills, incorporated herein by reference to Exhibit 10.14 of the 1994 10-K. 10.6 Employment Agreement, dated as of March 15, 1995, by and between Executive Risk Inc. and Robert V. Deutsch, incorporated herein by reference to Exhibit 10.15 to the 1994 10-K. 10.7 Executive Risk Inc. Nonqualified Stock Option Plan, as amended and restated, filed herewith. 10.8 Executive Risk Inc. Employee Incentive Nonqualified Stock Option Plan, as amended and restated, filed herewith. 10.9 Executive Risk Inc. IPO Stock Compensation Plan, as amended and restated, filed herewith. 10.10 Executive Risk Inc. Incentive Compensation Plan, incorporated herein by reference to Exhibit 10.19 to the 1994 10-K. 10.11 Executive Risk Inc. Retirement Plan, incorporated herein by reference to Exhibit 10.27 to the Registration Statement. 10.12 Executive Risk Inc. Nonemployee Directors Stock Option Plan, as amended and restated, filed herewith. 10.13 Employment Agreement, dated as of March 31, 1995, by and between the Company and LeRoy A. Vander Putten, incorporated herein by reference to Exhibit 10.2 to Quarterly Report on Form 10-Q for the period ended March 31, 1995. 10.14 Supplemental Pension Agreement by and among the Company, Aetna Life and Casualty Company and LeRoy A. Vander Putten, dated as of March 31, 1995, incorporated herein by reference to Exhibit 10.3 to Quarterly Report on Form 10-Q for the period ended March 31, 1995.
21 24
EXHIBIT NO. - ----------- 10.15 Executive Risk Inc. Stock Incentive Plan, incorporated herein by reference to Exhibit 10.25 to Annual Report on Form 10-K for the year ended December 31, 1996 (the "1996 10-K"). 10.16 Executive Risk Inc. Performance Share Plan, incorporated herein by reference to Exhibit 10.26 to the 1996 10-K. 10.17 Stock Purchase Agreement, dated as March 22, 1996 by and among the Executive Risk Inc., The Aetna Casualty and Surety Company and Aetna Life and Casualty Company, incorporated by reference to Exhibit 2 to Current Report on Form 8-K dated March 25, 1996 (the "March 1996 8-K"). 10.18 Term Loan Agreement, dated as of March 26, 1996, among Executive Risk Inc., the Banks signatory thereto and The Chase Manhattan Bank (National Association), as Agent, incorporated by reference to Exhibit 3(a) to the March 1996 8-K. 10.19 Stock Pledge Agreement, dated as of March 26, 1996, between Executive Risk Inc. and The Chase Manhattan Bank (National Association), as Agent, incorporated by reference to Exhibit 3(b) to the March 1996 8-K. 10.20 Restructuring Agreement, dated as of February 13, 1997, by and among Executive Risk Inc., Executive Re Inc., Executive Risk Indemnity Inc., Executive Risk Specialty Insurance Company, Executive Risk Management Associates, The Aetna Casualty and Surety Company and Aetna Casualty and Surety of Canada, incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K dated February 18, 1997 (the "February 1997 8-K"). 10.21 Agency and Insurance Services Agreement, dated as of January 1, 1997, by and between The Aetna Casualty and Surety Company and Executive Risk Management Associates, incorporated by reference to Exhibit 10.2 to the February 1997 8-K. 10.22 Quota Share Reinsurance Agreement, dated as of January 1, 1997, by and between The Aetna Casualty and Surety Company and Executive Risk Indemnity Inc., incorporated by reference to Exhibit 10.3 to the February 1997 8-K. (11) Statement regarding computation of per share earnings (13) Executive Risk Inc. 1996 Annual Report to Stockholders; except for those portions thereof which are expressly incorporated by reference in the Annual Report on Form 10-K for the year ended December 31, 1996, the Report to Stockholders is furnished for the information of the Securities and Exchange Commission only and is not to be deemed "filed" as part of this Annual Report on Form 10-K. (21) Subsidiaries of Executive Risk Inc. (23) Consents of experts and counsel 23.1 Consent of Ernst & Young LLP
22 25 INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
PAGES ----- Financial Statements of Executive Risk Inc. Report of Independent Auditors on Financial Statements............................ * Consolidated Balance Sheets at December 31, 1996 and 1995......................... * Consolidated Statements of Income for the years ended December 31, 1996, 1995 and * 1994............................................................................ Consolidated Statements of Stockholders' Equity for the years ended December 31, * 1996, 1995 and 1994............................................................. Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 * and 1994........................................................................ Notes to Financial Statements..................................................... * Schedule(s) II Condensed Financial Information of Registrant -- Balance Sheets................................................................. S-1 -- Statements of Income........................................................... S-2 -- Statements of Cash Flows....................................................... S-3
Schedules not listed above have been omitted because they are not applicable or are not required, or the information required to be set forth therein is included in the Consolidated Financial Statements or Notes thereto. - --------------- * Incorporated by reference to the Executive Risk Inc. 1996 Annual Report to Stockholders; see Exhibit 13 to this Annual Report on Form 10-K. 23 26 EXECUTIVE RISK INC. (PARENT COMPANY ONLY) SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS
DECEMBER 31, --------------------- 1996 1995 -------- -------- (In thousands) ASSETS Fixed maturities available for sale.................................. $ -- $ 16,717 Cash and short-term investments...................................... 109 401 -------- -------- TOTAL CASH AND INVESTED ASSETS.................................. 109 17,118 Accrued investment income............................................ 263 Intercompany receivable.............................................. 815 -- Investment in subsidiaries and equity investees...................... 206,366 187,539 Deferred income taxes................................................ 3,275 1,888 Other assets......................................................... 6,413 4,398 -------- -------- TOTAL ASSETS.................................................... $216,978 $211,206 ======== ======== LIABILITIES Note payable to bank................................................. 70,000 25,000 Intercompany payable................................................. -- 4,211 Accrued expenses and other liabilities............................... 2,203 4,270 -------- -------- TOTAL LIABILITIES............................................... 72,203 33,481 STOCKHOLDERS' EQUITY Common Stock......................................................... 104 116 Additional paid-in capital........................................... 93,651 87,228 Unrealized gain on investments, net of tax........................... 18,382 19,156 Currency translation adjustments..................................... (186) 29 Retained earnings.................................................... 65,384 74,315 Cost of shares in treasury........................................... (32,560) (3,119) -------- -------- TOTAL STOCKHOLDERS' EQUITY...................................... 144,775 177,725 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY...................... $216,978 $211,206 ======== ========
S-1 27 EXECUTIVE RISK INC. (PARENT COMPANY ONLY) SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31, ------------------------------- 1996 1995 1994 ------- ------- ------- (In thousands) REVENUES Net investment income....................................... $ 624 $ 779 $ 89 Net realized capital gains.................................. 503 -- -- ------- ------- ------- TOTAL REVENUES........................................... 1,127 779 89 EXPENSES General and administrative expenses......................... 3,460 2,321 2,097 Long-term incentive compensation............................ 187 1,458 1,009 Interest expense............................................ 4,335 1,893 1,440 ------- ------- ------- TOTAL EXPENSES........................................... 7,982 5,672 4,546 ------- ------- ------- INCOME (LOSS) BEFORE TAXES AND EARNINGS OF SUBSIDIARIES........................................... (6,855) (4,893) (4,457) Federal income tax benefit.................................. (2,543) (2,100) (1,473) ------- ------- ------- INCOME (LOSS) BEFORE EARNINGS OF SUBSIDIARIES........................................... (4,312) (2,793) (2,984) Equity in earnings of subsidiaries.......................... 32,417 28,079 22,224 ------- ------- ------- NET INCOME............................................... $28,105 $25,286 $19,240 ======= ======= =======
S-2 28 EXECUTIVE RISK INC. (PARENT COMPANY ONLY) SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, ---------------------------------- 1996 1995 1994 -------- -------- -------- (In thousands) OPERATING ACTIVITIES Net income............................................... $ 28,105 $ 25,286 $ 19,240 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of bond premium.......................... 16 36 4 Equity in earnings of Subsidiaries.................... (32,417) (28,079) (22,224) Net realized gains on investments..................... (503) Deferred income taxes................................. (1,073) (622) (1,579) Other................................................. (635) (1,450) 1,341 Change in: Accrued investment income........................... 263 (146) (117) Intercompany receivable/payable..................... 6,737 3,099 597 Accrued expenses and other liabilities.............. 587 1,476 2,168 -------- -------- -------- Net Cash Provided by (Used in) Operating Activities..................................... 1,080 (400) (570) INVESTING ACTIVITIES Purchase of investment securities........................ (1,379) (10,481) (5,354) Proceeds from sales of fixed maturities held for sale 17,661 Contribution of capital to ERII.......................... (10,870) (12,000) Distributions from subsidiaries.......................... 15,104 14,387 5,864 -------- -------- -------- Net Cash Provided by (Used in) Investing Activities..................................... 20,516 3,906 (11,490) FINANCING ACTIVITIES Proceeds from exercise of options........................ 423 241 Cost of repurchase of Common Stock....................... (75,025) (3,119) Placement fees and other................................. (192) Repayment of note payable to bank........................ (25,000) Note payable to bank..................................... 70,000 Loan arrangement fees.................................... (980) Proceeds from over-allotment option exercise............. 9,675 Dividends paid on Common Stock........................... (789) (919) (690) Proceeds from issuance of Common Stock................... 11,160 Proceeds from conversion of warrants..................... 4,200 Offering Costs........................................... (912) Dividends paid on Preferred Stock........................ (1,031) -------- -------- -------- Net Cash (Used in) Provided by Financing Activities..................................... (21,888) (3,797) 12,727 -------- -------- -------- Net (Decrease) Increase in Cash and Short-Term Investments.................................... (292) (291) 667 Cash and short-term investments at beginning of period..... 401 692 25 -------- -------- -------- Cash and Short-Term Investments at End of Period......................................... $ 109 $ 401 $ 692 ======== ======== ======== Supplemental Cash Flow Disclosures: Income taxes received (paid)............................. $ 763 $ (70) $ 350 Interest paid on debt.................................... (4,131) (1,888) (1,451)
S-3 EX-10.7 2 EXHIBIT 10.7 1 Exhibit 10.7 As Amended Through February 18, 1997 EXECUTIVE RISK INC. NONQUALIFIED STOCK OPTION PLAN 1. PURPOSE OF THE PLAN. The purpose of the Executive Risk Inc. Nonqualified Stock Option Plan (the "Plan") is to further the long-term growth in earnings of Executive Risk Inc. (the "Company") by offering special incentives in the form of a nonqualified stock option plan for the benefit of those officers or employees of the Company and of any of its Subsidiaries who will be largely responsible for such growth. It is the express purpose of this Plan to provide such officers and employees with the opportunity to acquire or increase their equity ownership in the Company through the purchase of shares of the Company's Common Stock under a plan which is not designed to meet the requirements of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"). 2. DEFINITIONS. The singular shall include the plural and vice versa, and the use of one gender shall be deemed to include the other whenever appropriate. a. Beneficiary - Any person who may, under a Participant's will or under the laws of descent and distribution, including the Participant's personal 2 representative, succeed to the Participant's right to exercise any Option by reason of the Participant's death. b. Committee - The Committee appointed by the Board of Directors of the Company pursuant to Section 3 hereof. c. Option - A Participant's right to purchase one or more shares of Stock, as granted and determined in accordance with the provisions of this Plan. d. Option Price - The amount to be paid for the purchase of shares of Stock on exercise of an Option as determined by the Committee in accordance with the provisions of this Plan. e. Employee - Any person, including any officer, employed by the Company or any Subsidiary of the Company. f. Employment - The time period during which any individual is an Employee. g. Participant - An Employee who becomes eligible to participate in this Plan under Paragraph 4 hereof. h. Permanent and Total Disability - The inability of a Participant to engage in his normal employment activity by reason of any medically determined physical or mental impairment that can be expected to result in death or that can be expected to last for a continuous period of not less than 12 months. i. Stock - The Company's $.01 par value common stock. 2 3 j. Subsidiary - Any corporation of which 50 percent or more of the combined voting power of all classes of stock is owned by the Company or a Subsidiary of the Company. 3. ADMINISTRATION OF THE PLAN. a. The Plan shall be administered by a Committee comprised of no fewer than two persons which is a committee of the Board of Directors of the Company or a subcommittee thereof. Each Committee member shall be ineligible, and shall have been ineligible for the one-year period prior to appointment thereto, for selection as a person to whom stock options or other equity securities of the Company may be granted or awarded pursuant to the Plan or, solely to the extent necessary to be deemed a "disinterested person" within the meaning of Rule 16b-3 under the Securities Exchange Act of 1934 (the "Exchange Act"), pursuant to any similar plan of the Company or any affiliate of the Company. In addition, each Committee member shall satisfy the requirements of an "outside director" within the meaning of Section 162(m) of the Code. b. Subject to the provisions of the Plan, the Committee shall have exclusive power to select the Employees to be granted Options pursuant to the Plan, to determine the number of shares of Stock to be covered by any Option, to determine the Option Price for any Stock, and to determine the conditions subject to which Options may be granted or exercised. Notwithstanding the foregoing, the maximum 3 4 number of aggregate shares of Common Stock that may be subject to Options granted to any Participant under the Plan shall be 750,000 shares, subject to adjustment as provided in Section 12c hereof. c. Decisions and determinations by the Committee shall be final and binding upon all parties, including stockholders, Participants, Beneficiaries, and other Employees. The Committee shall have the authority to interpret the Plan, to establish and revise rules and regulations relating to the Plan, and to make any other determinations that it believes necessary or advisable for the administration of the Plan. d. It is the intent of the Company that the Plan comply in all respects with Section 162(m) of the Code with respect to persons who are or may become "covered employees" within the meaning of Section 162(m) of the Code, that any ambiguities or inconsistencies in constructions of the Plan be interpreted to give effect to such intention and that if any provision of the Plan is found not to be in compliance with Section 162(m) of the Code, such provisions shall be deemed null and void to the extent required to permit the Plan to comply with Section 162(m) of the Code. The Committee may adopt rules and regulations under the Plan in furtherance of the intent of the foregoing. 4. PARTICIPATION. Participants in the Plan shall be selected by the Committee from among the Employees. 4 5 5. EFFECTIVE DATE AND TERMINATION OF PLAN. a. The Plan shall become effective upon its adoption by the Board of Directors of the Company. b. The Plan shall terminate ten years after the date on which it is adopted by the Board of Directors of the Company, but the Board of Directors may terminate the Plan at any time prior thereto. Termination of the Plan under this Section 5b shall not alter or impair any of the rights or obligations under any option previously granted under the Plan without the consent of the holder of the option. 6. LIMITATIONS ON NUMBER OF SHARES SUBJECT TO OPTIONS. The number of shares of Stock that may be issued pursuant to Options granted under this Plan shall not exceed 3,000,000 shares. If any Options granted under this Plan expire or terminate for any reason without having been exercised in full, the unpurchased shares subject to such expired or terminated Options may again be optioned under this Plan, subject to its terms. 7. DURATION OF OPTIONS. Options granted to Participants shall be exercisable within 121 months after the date of grant or within such shorter period as may be determined by the Committee. 8. OPTION PRICE. The Option Price for each share of Stock subject to any Option granted to Participants shall be determined by the Committee in its sole discretion. 5 6 9. TERMS OF EXERCISE. a. Medium of Payment. The Option Price for shares purchased through the exercise of an Option shall be payable either in cash or in shares of Stock, as determined by the Committee. b. Transferability of Options. All Options shall be nontransferable except (i) upon the Participant's death, by the Participant's will or the laws of descent and distribution or (ii) on a case-by-case basis as may be approved by the Committee in its discretion, in accordance with the terms provided below. Each Option Agreement shall provide that the Participant may, during his lifetime and subject to the prior approval of the Committee at the time of proposed transfer, transfer all or part of the Option to a Permitted Transferee (as defined below), provided that such transfer is made by the Participant for estate or tax planning purposes or for donative purposes and no consideration (other than nominal consideration) is received by the Participant therefor. The transfer of an Option shall be subject to such other terms and conditions as the Committee may in its discretion impose from time to time, including a condition that the portion of the Option to be transferred be vested and exercisable by the Participant at the time of transfer. Subsequent transfers of an Option transferred under this paragraph 9.b. shall be prohibited other than by will or the laws of descent and distribution upon the death of the transferee. 6 7 For purposes hereof, a "Permitted Transferee" shall be any member of the Participant's immediate family or a charitable institution (each as defined below), or a trust for the exclusive benefit of such immediate family members or charitable institution, or to a partnership, corporation or limited liability company the equity interests of which are owned exclusively by the Participant and/or one or more members of his immediate family. For purposes of the preceding definition, (i) the "immediate family" of the Participant shall mean and include the Participant's spouse, any descendant of the Participant or his spouse (including descendants by adoption), and any descendant of either parent of the Participant (including descendants by adoption), and (ii) a "charitable institution" shall mean and include any organization described in each of sections 170(b)(1)(A), 170(c), 2055(a) and 2522(a) of the Code, as well as any charitable remainder trust created under section 664 of the Code, the income beneficiary of which is a member of the Participant's immediate family or a trust or other entity described above in this paragraph (b). c. Transferability of Stock. All Options shall be granted on the condition that the Participant shall not resell any Stock purchased by the exercise of an Option except in compliance with all applicable state and federal securities laws and regulations. Unless there is a registration statement in effect with respect to the resale of Stock subject to an Option held by the Participant, each 7 8 Participant shall, prior to the exercise of any Option, deliver to the Company a written representation in form satisfactory to the Committee that it is his intention to acquire the shares for investment and not for resale, and each Participant shall, prior to any transfer of Stock purchased through the exercise of an Option, advise the Company of the proposed transfer and demonstrate, to the satisfaction of the Committee, that such transfer is in compliance with such laws and regulations. d. Waiting period. An Option granted under the Plan shall be exercisable in installments as follows: to the extent of 20 percent of the number of shares originally covered thereby on the later of the date the Plan becomes effective or the date on which the Participant holding such Option becomes an Employee, and, to the extent of an additional 20 percent of the number of such shares, on each of the first, second, third and fourth anniversaries of the date on which such Participant becomes an Employee and such installments shall be cumulative. Notwithstanding the foregoing, the Committee, in its sole discretion, may prescribe a different installment exercise provision in an Option Agreement for an Option granted to a Participant under the Plan. e. Other Terms. The Committee shall have the power to determine such additional terms for the exercise of Options not inconsistent with the terms of this Plan as it deems appropriate. 8 9 10. TERMINATION OF EMPLOYMENT. a. For Reasons Other Than Death, Disability or Retirement. If any Participant's Employment should terminate for any reason other than his death, his Permanent and Total Disability or his Retirement (as defined below) at a time when one or more of the Participant's Options remains outstanding, then each such Option shall terminate on the earlier to occur of (i) the date of expiration of the Option provided in the Option Agreement or (ii) the date that is three months after the date of such termination of Employment. b. Participant's Death, Disability or Retirement. If a Participant's Employment is terminated by reason of his death, Permanent and Total Disability or his Retirement (as defined below) at a time when one or more of his Options remains outstanding, then each such Option shall terminate on the earlier to occur of (i) the date of expiration of the Option provided in the Option Agreement or (ii) three years after the date of his death, Permanent and Total Disability or Retirement. In the event of the Participant's death, the Option shall be exercisable by the Participant's Beneficiary. For purposes hereof, "Retirement" means termination of employment with the Company (x) at age 65 or greater or (y) at age 50 or greater so long as the Participant's age plus his full years of employment (measured based on 12 full calendar months of 9 10 service) by the Company or any Subsidiary equals or exceeds 60. c. Notwithstanding the foregoing provisions of this Section 10, but subject to the provisions of Section 7, the Committee, in its sole discretion, may provide in an Option Agreement for any shorter or longer exercise period upon termination of employment for any reason, and may extend the date upon which any Option may expire in the event of a Participant's termination of employment for any reason. 11. OPTION AGREEMENT. Upon the grant of any Option hereunder, the Participant shall be required to sign an Option Agreement, in such form as shall be prescribed by the Committee, reflecting the terms and conditions of the Option. Each such Option Agreement shall refer to this Plan and shall give notice to the Participant that all Options are subject to the terms and conditions of this Plan. 12. MISCELLANEOUS PROVISIONS. a. This Plan shall be governed by, and construed in accordance with Delaware law. b. No Employee or other person shall have any claim or right to become a Participant of this Plan. Neither this Plan nor any action taken hereunder shall be construed as giving to any Employee any right to remain employed. 10 11 c. In the event that there is any change in the Stock through merger, consolidation, reorganization, recapitalization or otherwise, or if there shall be any dividend on the Stock payable in such stock or if there shall be a stock split, combination of shares or other changes in the Company's capital structure, the number of shares available for option under this Plan shall be proportionately adjusted by the Committee to reflect any such change and the shares subject to Options previously granted and the price per share in each Option shall be proportionately adjusted by the Committee as it deems equitable, in its absolute discretion, to prevent dilution or enlargement of the Participant's rights under the Option. The issuance of stock for consideration and the issuance of stock rights shall not be considered a change in the Company's capital structure. No adjustment provided for in this paragraph shall require the issuance of any fractional share. d. The Company shall at all times during the term of this Plan reserve and keep available an amount of Stock sufficient to satisfy the requirements of this Plan, and shall pay all fees and expenses necessarily incurred by the Company in connection with the exercise of Options granted hereunder. In addition, to the extent that the Stock is registered pursuant to any Federal or State securities statutes and/or listed on any national, regional or local stock exchange, the Company shall cause any and all 11 12 Stock issued or to be issued under this Plan to be so registered and/or listed, at the sole expense of the Company. e. The Board of Directors of the Company may at any time terminate or amend this Plan in any respect; provided that the approval of the Company's stockholders will be required for any amendment that (i) changes the class of persons eligible for the grant of an Option under the Plan, (ii) increases (other than as described in Section 12c hereof) either the maximum number of shares of Common Stock subject to Options granted under the Plan (as described in Section 6 hereof) or the maximum number of shares of Common Stock that may be subject to Options granted to any Participant (as described in Section 3.b hereof), (iii) materially increases the benefits accruing to Participants under the Plan, within the meaning of Rule 16b-3 under the Exchange Act, or (iv) otherwise requires stockholder approval to comply with the provisions of Rule 16b-3 under the Exchange Act or Section 162(m) of the Code. Any such approval shall be by the affirmative votes of the stockholders of the Company present, or represented, and entitled to vote at a meeting duly held in accordance with applicable state law and the Certificate of Incorporation and By-Laws of the Company. Notwithstanding the foregoing, no amendment or modification of the Plan shall in any manner affect any Option theretofore granted without the consent of the Optionee or his Beneficiary. 12 EX-10.8 3 EXHIBIT 10.8 1 Exhibit 10.8 As Amended Through February 18, 1997 EXECUTIVE RISK INC. EMPLOYEE INCENTIVE NONQUALIFIED STOCK OPTION PLAN 1. PURPOSE OF THE PLAN. The purpose of the Executive Risk Inc. Employee Incentive Nonqualified Stock Option Plan (the "Plan") is to further the long-term growth in earnings of Executive Risk Inc. (the "Company") by offering special incentives in the form of a nonqualified stock option plan for the benefit of all employees of the Company and of any of its Subsidiaries who are considered non-officers, and whose efforts have assisted the Company in meeting its mission, either directly or indirectly. It is the express purpose of this Plan to provide such employees with the opportunity to acquire equity ownership in the Company through the issuance of Options to purchase shares of the Company's Common Stock under a plan which is not designed to meet the requirements of Section 422 of the Internal Revenue Code of 1986. 2. DEFINITIONS. The singular shall include the plural and vice-versa, and the use of one gender shall be deemed to include the other whenever appropriate. a. Beneficiary - Any person who may, under a Participant's will or under the laws of descent and distribution, including the Participant's personal representative, succeed to the Participant's right to exercise any Option by reason of the Participant's death. b. Committee - The Committee on Directors and Compensation of the Board of Directors of the Company, or such other Committee as the Board of Directors may designate to administer the Plan from time to time. 2 c. Employee - Any person, not including any officer, employed full-time by the Company or any Subsidiary of the Company. d. Employment - The time period during which any individual is an Employee. Employment shall be determined in accordance with Section 1.421-7(h)(2) of the U.S. Treasury Regulations, a copy of which is annexed hereto. e. Option - A Participant's right to purchase one or more shares of Stock, as granted and determined in accordance with the provisions of this Plan. f. Option Price - The amount to be paid for the purchase of shares of Stock on exercise of an Option as determined by the Board of Directors of the Company. g. Participant - An Employee who becomes eligible to participate in the Plan under Paragraph 4 hereof. h. Permanent and Total Disability - The inability of a Participant to engage in his or her normal employment activity by reason of any medically determined physical or mental impairment that can be expected to result in death or that can be expected to last for a continuous period of not less than 12 months. i. Stock - The Company's $.01 par value common stock. j. Subsidiary - Any corporation of which 50 percent or more of the combined voting power of all classes of stock is owned by the Company or a Subsidiary of the Company. 3. ADMINISTRATION OF THE PLAN. a. The Plan shall be administered by the Committee. No member of the Committee may participate in the Plan. b. Subject to the provisions of the Plan, the Committee shall have exclusive power to select the Employees to be granted Options pursuant to the Plan, to determine the number of shares of Stock to be covered by any Option, and to 2 3 determine the conditions subject to which Options may be granted or exercised. c. Decisions and determinations by the Committee shall be final and binding upon all parties, including stockholders, Participants, Beneficiaries, and other Employees. The Committee shall have authority to interpret the Plan, to establish and revise rules and regulations relating to the Plan, and to make any other determinations that it believes necessary or advisable for the administration of the Plan. 4. PARTICIPATION. Participants in the Plan shall be selected by the Committee based upon length of employment and at the sole discretion of the Committee. a. Length of Employment - An Employee shall be eligible to participate in the Plan after completion of two full years (24 months) of full-time Employment. 5. EFFECTIVE DATE AND TERMINATION OF PLAN. a. The Plan shall become effective upon its adoption by the Board of Directors of the Company. b. The Plan shall terminate ten years after the date on which it is effective, but the Board may terminate the Plan at any time prior thereto. Termination of the Plan under this Section 5b shall not alter or impair any of the rights or obligations under any Option previously granted under the Plan without the consent of the holder of the Option. 6. LIMITATIONS ON NUMBER OF SHARES SUBJECT TO OPTIONS. a. Total - The number of shares of Stock that may be issued pursuant to Options granted under this Plan shall not exceed 10,000 shares. If any Options granted under this Plan expire or terminate for any reason without having been exercised in full, the unpurchased shares subject to such 3 4 expired or terminated Options may again be optioned under this Plan, subject to its terms. b. Participants - The number of shares of Stock for which Options may be granted to any eligible Participant shall be based on the following schedule upon completion of two years of employment:
ANNUAL BASE SALARY NUMBER OF SHARES TO BE GRANTED ------------------ ------------------------------ $15,000 - $24,999 300 $25,000 - $34,999 500 $35,000 - $49,000 600 $50,000 + 800
Notwithstanding the foregoing, the Committee, in its sole discretion, may grant an Option for a number of shares of Stock without regard to the foregoing schedule. 7. DURATION OF OPTIONS. Options granted to Participants shall be exercisable within (121) months after the date of grant, or within such shorter period as may be determined by the Board. 8. OPTION PRICE. The Option Price for each share of Stock subject to any Option granted to Participants shall be not less than the fair market value of such share (as determined by the Board of Directors of the Company) as of the date on which the Option is granted. 9. TERMS OF EXERCISE. a. Medium of Payment - The Option Price for shares purchased through the exercise of an Option shall be payable in cash. b. Transferability of Options - All Options shall be nontransferable except (i) upon the Participant's death, by the Participant's will or the laws of descent and distribution or (ii) on a case-by-case basis as may be approved by the 4 5 Committee in its discretion, in accordance with the terms provided below. Each Option Agreement shall provide that the Participant may, during his lifetime and subject to the prior approval of the Committee at the time of proposed transfer, transfer all or part of the Option to a Permitted Transferee (as defined below), provided that such transfer is made by the Participant for estate or tax planning purposes or for donative purposes and no consideration (other than nominal consideration) is received by the Participant therefor. The transfer of an Option shall be subject to such other terms and conditions as the Committee may in its discretion impose from time to time, including a condition that the portion of the Option to be transferred be vested and exercisable by the Participant at the time of transfer. Subsequent transfers of an Option transferred under this paragraph 9.b. shall be prohibited other than by will or the laws of descent and distribution upon the death of the transferee. For purposes hereof, a "Permitted Transferee" shall be any member of the Participant's immediate family or a charitable institution (each as defined below), or a trust for the exclusive benefit of such immediate family members or charitable institution, or to a partnership, corporation or limited liability company the equity interests of which are owned exclusively by the Participant and/or one or more members of his immediate family. For purposes of the preceding definition, (i) the "immediate family" of the Participant shall mean and include the Participant's spouse, any descendant of the Participant or his spouse (including descendants by adoption), and any descendant of either parent of the Participant (including descendants by adoption), and (ii) a "charitable institution" shall mean and include any organization described in each of sections 170(b)(1)(A), 170(c), 2055(a) and 2522(a) of the Code, as well as any charitable remainder trust created under section 664 of the Code, the income beneficiary of which is a member of the 5 6 Participant's immediate family or a trust or other entity described above in this paragraph (b). c. Transferability of Stock - All Options shall be granted on the condition that the Participant shall not resell any Stock purchased by the exercise of an Option except (i) in compliance with all applicable state and federal securities law and regulations and (ii) upon the Company's successful completion of an initial public offering of the Stock ("IPO"), upon which time a one-time opportunity to sell Stock back to the Company will be allowed at a price equal to the average per share price (net of any fees or commissions payable to underwriters in connection with the IPO) at which shares of the Stock were sold by the Company in the IPO. Unless there is a registration statement in effect with respect to the resale of Stock subject to an Option held by the Participant, each Participant shall, prior to the exercise of any Option, deliver to the Company a written representation in form satisfactory to the Committee that it is his or her intention to acquire the share for investment and not for resale. Each Participant shall, prior to any transfer of Stock purchased through the exercise of an Option, advise the Company of the proposed transfer and demonstrate, to the satisfaction of the Committee, that such transfer is in compliance with such laws and regulations. d. Other Terms - The Committee shall have the power to determine such additional terms for the exercise of Options not inconsistent with the terms of this Plan as it deems appropriate. 10. TERMINATION OF EMPLOYMENT. a. For Reasons Other Than Death, Disability or Retirement. If any Participant's Employment should terminate for any reason other than his death, his Permanent and Total Disability or his Retirement (as defined below) at a time when one or more of the Participant's Options remains outstanding, then each such Option shall terminate on the earlier to occur 6 7 of (i) the date of expiration of the Option provided in the Option Agreement or (ii) the date that is three months after the date of such termination of Employment. b. Participant's Death, Disability or Retirement. If a Participant's Employment is terminated by reason of his death, Permanent and Total Disability or his Retirement (as defined below) at a time when one or more of his Options remains outstanding, then each such Option shall terminate on the earlier to occur of (i) the date of expiration of the Option provided in the Option Agreement or (ii) three years after the date of his death, Permanent and Total Disability or Retirement. In the event of the Participant's death, the Option shall be exercisable by the Participant's Beneficiary. For purposes hereof, "Retirement" means termination of employment with the Company (x) at age 65 or greater or (y) at age 50 or greater so long as the Participant's age plus his full years of employment (measured based on 12 full calendar months of service) by the Company or any Subsidiary equals or exceeds 60. c. Notwithstanding the foregoing provisions of this Section 10, but subject to the provisions of Section 7, the Committee, in its sole discretion, may provide in an Option Agreement for any shorter or longer exercise period upon termination of employment for any reason, and may extend the date upon which any Option may expire in the event of a Participant's termination of employment for any reason. 11. OPTION AGREEMENT. Upon the grant of any Option hereunder, the Participant shall be required to sign an Option Agreement, in such form as shall be prescribed by the Committee, reflecting the terms and conditions of the Option. Each such Option Agreement shall refer to this Plan and shall give notice to the Participant that all Options are subject to the terms and conditions of this Plan. 7 8 12. MISCELLANEOUS PROVISIONS. a. This Plan shall be governed by, and construed in accordance with, Delaware law. b. No Employee or other person shall have any claim or right to become a Participant of this Plan. Neither this Plan nor any action taken hereunder shall be construed as giving to any Employee any right to remain employed. c. In the event that there is any change in the Stock through merger, consolidation, reorganization, recapitalization or otherwise, or if there shall be any dividend on the Stock payable in such Stock or if there shall be a stock split, combination of shares or other changes in the Company's capital structure, the number of shares available for options under this Plan shall be proportionately adjusted by the Committee (as approved by the Board of Directors of the Company or a Committee thereof) to reflect any such change and the shares subject to Options previously granted and the price per share in each Option shall also be proportionately adjusted by the Committee (as approved by the Board of Directors of the Company of a Committee thereof, as it deems equitable, in its absolute discretion) to prevent dilution or enlargement of the Participant's rights under the Option. The issuance of Stock for consideration and the issuance of stock rights shall not be considered a change in the Company's capital structure. No adjustment provided for in this paragraph shall require the issuance of any fractional shares. d. The Company shall at all times during the term of this Plan reserve and keep available an amount of Stock sufficient to satisfy the requirements of this Plan, and shall pay all fees and expenses necessarily incurred by the Company in connection with the exercise of Options granted hereunder. In addition, to the extent that the Stock is registered pursuant to any Federal or State securities statutes and/or listed on any national, regional or local stock exchange, the Company shall use its best efforts that any and all Stock 8 9 issued or to be issued under this Plan and/or listed, be at the sole expense of the Company. e. The Board may at any time terminate or amend this Plan in any respect; provided that any amendment of this Plan would increase the total number of shares of Company Stock which may be issued and sold under the Plan (except for the application of Section 12c of the Plan) shall be effective only if approved by the stockholders of the Company. 9 EX-10.9 4 EXHIBIT 10.9 1 Exhibit 10.9 EXECUTIVE RISK INC. IPO STOCK COMPENSATION PLAN 1. PURPOSE OF THE PLAN. The purpose of this Executive Risk Inc. IPO Stock Compensation Plan (the "Plan") is to reward successful management of Executive Risk Inc. (the "Company") and its Subsidiaries and to attract and retain, and encourage superior performance by, the key employees upon which the continued growth and profitability of the Company depend by offering special incentives in the form of cash awards and options to purchase common stock upon the closing of an initial public offering ("IPO") or Change in Control (as defined below), for the benefit of those officers and key employees of the Company and its Subsidiaries who will be largely responsible for such growth. 2. DEFINITIONS. (a) Award - Any award granted to a Participant pursuant to Section 6 of the Plan. (b) Beneficiary - Any person who may, under a Participant's will or under the laws of descent and distribution, including the Participant's personal representative, succeed to the Participant's right to receive any Award or exercise any Option by reason of the Participant's death. For purposes of Section 12 of the Plan, a Participant's Beneficiary shall be the Beneficiary named by the Participant on a form provided by the Company 2 for this purpose or for purposes of the Company's life insurance program, as determined by the Board. (c) Board - The Company's Board of Directors. (d) Employee - Any person, including any officer, employed by the Company of any Subsidiary of the Company (and not including any member of the Board who is not also an Employee of the Company or any Subsidiary). (e) Employment - The time period during which any individual is an Employee. (f) Option - A Participant's right to purchase one or more shares of Stock, as granted and determined in accordance with the provisions of the Plan. (g) Participant - An Employee who participates in the Plan under Section 4 hereof. (h) Permanent and Total Disability - The inability of a Participant to engage in his normal employment activity by reason of any medically determined physical or mental impairment that can be expected to result in death or that can be expected to last for a continuous period of not less than 12 months. (i) Share Units - The notional shares, assigned by the Board to each Participant, which shall provide the basis on which Awards are made in accordance with Section 6. (j) Share Value - The value attributed to each share of Stock for purposes of determining the amount of any Award (including the exercise price of an Option), as provided in Section 8. 2 3 (k) Stock - The Company's $0.01 par value common stock. (l) Subsidiary - Any corporation of which 50 percent or more of the combined voting power of all classes of stock is owned by the Company or a Subsidiary. (m) Triggering Event - The occurrence of an IPO or Change in Control, as defined in Section 7. 3. ADMINISTRATION OF THE PLAN. (a) The Plan shall be administered by the Board. Membership on the Board shall in no way affect the eligibility of a member for participation in the Plan; provided, however, that no such member of the Board shall participate in any decision affecting solely his interest or participation in the Plan. (b) Decisions and determinations by the Board shall be final and binding upon all parties, including stockholders, Participants, Beneficiaries and other Employees. The Board shall have the authority to interpret the Plan, to establish and revise rules and regulations relating to the Plan and to make any other determinations that it believes necessary or advisable for the administration of the Plan; provided, however that the Board shall not have the authority to make any determination that changes the identity of Participants in the Plan or that changes the timing, pricing or amount of any Award made under the Plan. 3 4 (c) The Board shall have the authority to delegate to a committee any of its powers or authority under the Plan. 4. PARTICIPATION. The number of Share Units granted to each Participant shall be equal to the number of Share Units originally allocated to the Participant under the Executive Re Inc. IPO Stock Compensation Plan, adjusted to reflect the 1 to 10 exchange ratio upon which shares of common stock of Executive Re Inc. are exchanged for shares of Stock pursuant to the transaction in which Executive Re Inc. becomes a Subsidiary. No additional Share Units shall be granted under the Plan. 5. EFFECTIVE DATE. The Plan shall become effective upon its adoption by the Board and approval by the Company's stockholders. 6. AWARDS. Awards under the Plan shall consist of a Cash Payment component and, in the event of an IPO, a Stock Option grant component. Any Participant who has been allocated Share Units under the Plan and who is still an Employee on the date of a Triggering Event (which occurs prior to January 1, 1996) shall be entitled to receive an Award, subject to the provisions of Section 12 below, as follows: (a) If the Triggering event is an IPO, the Participant's Award shall consist of: 4 5 (i) a Cash Payment, in an amount equal to the product of 1/3 (one-third) of the number of Share Units he has been allocated times the Share Value (in effect at the time of the Triggering Event pursuant to Section 8 hereof), payment of which shall be made in a lump-sum cash payment within 30 days of the Triggering Event; and (ii) two Options, one of which shall be granted on the first anniversary date of the Triggering Event and the second of which shall be granted on the second anniversary date of the Triggering Event. Each Option shall permit the Participant (or his Beneficiary in the event of his death after the Triggering Event) to purchase a number of shares of Stock equal to 10/7 (one and three-sevenths) times 1/3 (one-third) of the number of Share Units he has been allocated, for a per share purchase price equal to 3/10 (three-tenths) times the applicable Share Value under subsection 8(c)(ii) below. (b) If the Triggering Event is a Change in Control, a Participant's Award shall consist of a Cash Payment, in an amount equal to the product of the number of Share Units he has been allocated times the Share Value, payment of which shall be made in a lump-sum cash payment within 30 days of the Triggering Event. Notwithstanding anything elsewhere in the Plan to the contrary, if the Employment of a Participant who has been allocated Share Units under the Plan is terminated for any reason (including death or Permanent and Total 5 6 Disability) prior to the occurrence of a Triggering Event, he shall not be entitled to receive any Award. 7. TRIGGERING EVENTS. A Triggering Event shall be deemed to have occurred upon either: (a) the closing of an initial public offering of the Stock, if any; or (b) a Change in Control of the Company. For purposes of this Section, a Change in Control shall be deemed to have occurred if and when: (i) there shall be consummated any consolidation or merger of the Company in which the Company is not the continuing or surviving corporation or pursuant to which shares of the Company's common stock would be converted in whole or in part into cash, securities or other property as a result of a tender, leveraged buyout or exchange offer, open market purchases, privately negotiated purchases or otherwise. However, the occurrence described in this paragraph (i) shall only constitute a Change in Control if any "person" (as such term is used in Sections 13(d)(3) and 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) shall be or become, immediately after the merger, the beneficial 6 7 owner (within the meaning of Rule 13d-3 under the Exchange Act) of securities of the surviving corporation representing more than 50% of the combined voting power of the surviving corporation's then-outstanding securities (on a fully diluted basis) ordinarily (and apart from rights accruing in special circumstances) having the right to vote in the election of directors (the "Acquiring Party"); or (ii) there shall be consummated any sale, lease, exchange or transfer (in one transaction or a series of related transactions) of all or substantially all the assets or business of the Company or ERIC Reinsurance Company; or (iii) any "person" (as such term is used in Sections 13(d)(3) and 14(d)(2) of the Exchange Act), other than (A) the Company or a Subsidiary thereof or (B) any employee benefit plan sponsored by the Company or a Subsidiary thereof or (C) any person who is on the date hereof a holder or an affiliate (as defined in Rule 12b-2 under the Exchange Act) of a holder of any equity securities of the Company, shall become the beneficial owner (within the meaning of Rule 13d-3 under the Exchange Act) of securities of the 7 8 Company representing more than 25% of the combined voting power of the Company's then-outstanding securities (on a fully diluted basis) ordinarily (and apart from rights accruing in special circumstances) having the right to vote in the election of directors, as a result of a tender, leveraged buyout or exchange offer, open market purchases, privately negotiated purchases or otherwise; provided, however, that, if any person who is on the date hereof a holder or an affiliate of a holder of any equity securities of the Company becomes the Acquiring Party under subparagraph (i), or the acquiror of all or substantially all of the assets or business of the Company under subparagraph (ii), or in the event of an occurrence described in subparagraph (iii) of this paragraph (b), a Change in Control shall be deemed to have occurred only if the Company had achieved a Return on Equity of 7% or more for the four calendar quarters immediately preceding the Change in Control. For purposes of this Section, the term "Return on Equity" shall mean the Company's GAAP Income as reported in the consolidated financial statements of the Company and its Subsidiaries divided by the GAAP shareholders' equity as reported in such statements. 8. SHARE VALUE. For purposes of determining the amount of a Cash Payment under subsections 6(a)(i) or 6(b) above and the 8 9 exercise price for an Option under subsection 6(a)(ii) above, the Share Value for each share of Stock shall be: (a) in the event of a Change in Control which involves the sale of Stock for a single cash purchase price, the gross per share price of such sale; (b) in the event of a Change in Control which does not involve the sale of Stock for a single cash purchase price, a price equal to the per share value of each share as determined on an equitable basis by the Board at the time of such Change in Control or as soon as practicable thereafter; or (c) in the event of an IPO, (i) for purposes of determining the amount of the Cash Payment, the average per share price (net of any fees or commissions payable to underwriters in connection with the IPO) at which shares of the Stock were sold by the Company and (ii) for purposes of determining the exercise price for an Option granted under subsection 6(a)(ii) above, the average closing price of a share of Stock for the 30-day period immediately preceding the date on which the Option is granted. 9. EXERCISE OF OPTIONS. (a) Method of Exercise. An Option shall be exercised, in whole or in part, by written notice directed to the Chief Executive Officer of the Company, at the Company's principal place of business, which notice shall specify the Option which is being exercised, and the number of shares being purchased. The notice shall be accompanied 9 10 by payment of the Option Price for the number of shares specified in the notice by the Participant or by his Beneficiary. (b) Medium of Payment. The Option Price for shares purchased through the exercise of an Option shall be payable either in cash or in shares of Stock, as determined by the Board. (c) Duration of Options. Subject to the provisions of Section 12 below, any Option granted under the Plan shall be exercisable at any time within 120 months of the date on which the Option is granted. (d) Transferability of Options. All Options shall be nontransferable except, upon the Participant's death following a Triggering Event, by the Participant's will or by the laws of descent and distribution. During the Participant's lifetime, Options shall be exercisable only by the Participant. (e) Other Terms. The Board of Directors shall have the power to determine such additional terms for the exercise of Options not inconsistent with the terms of the Plan as it deems appropriate. (f) Delivery of Stock Certificate Upon Exercise. Upon each exercise of an Option, the Company shall mail or deliver to the Optionee, as promptly as practicable, a stock certificate or certificates representing the shares of Stock then purchased, and will pay all stamp taxes payable in connection therewith. Notwithstanding the foregoing, the 10 11 Company shall not be obligated to deliver any such certificate or certificates upon exercise of an Option until the Company shall have received such assurances from its counsel as the Company may reasonably request that the exercise of an Option and the issuance of Option shares pursuant to such exercise will not violate the Securities Act of 1933, as amended (as then in effect or any similar statute then in effect), or the securities laws or any state applicable to such exercise, issuance or transfer. Such assurances may include (but need not be limited to) opinions of counsel to the Company, covenants by the holder or transferee to observe such Act and laws and the placement of a legend on such certificate or certificates restricting subsequent transfers or sales except in compliance with such Act and laws. Further, the Company (or a parent company or a Subsidiary) may make such provisions as it may deem appropriate for the withholding of any taxes or payment of any taxes which it determines it may be required to withhold or pay in connection with any Option or the payment of Stock pursuant to exercise of an Option. The obligation of the Company to issue and deliver shares pursuant to the exercise of an Option is conditioned upon the satisfaction of the provisions set forth in the preceding sentence. 11 12 10. LIMITATIONS ON NUMBER OF SHARES SUBJECT TO OPTIONS. The number of shares of Stock that may be purchased pursuant to Options granted under the Plan shall not exceed 161,905 shares. 11. REGISTRATION. The parties understand that the Stock is not registered pursuant to any Federal or State securities statutes, nor is it currently listed on any national, regional or local stock exchange. To the extent that the Stock is so registered or listed subsequent to the effective date of the Plan, all shares of Stock issued pursuant to the Plan shall be so registered and listed, regardless of whether such Stock is issued prior to or subsequent to the date of such registration or listing. 12. TERMINATION OF EMPLOYMENT. (a) Prior to Full Distribution of an Award. If a Participant's Employment is terminated upon or following a Triggering Event which is a Change in Control (or following a Triggering Event which is an IPO and which is followed by a Change in Control), then he shall receive his Award regardless of whether or not he continues Employment following the Change in Control. But if a Participant is entitled to an Award following a Triggering Event which is an IPO (which is not followed by a Change in Control), then payment of the Cash Payment shall be conditioned upon his continued Employment through the date of payment, and the granting of any Option shall be conditioned upon his 12 13 continued Employment through the date of grant; provided, however, that, if the termination of Employment is because of the Participant's Permanent and Total Disability, he shall receive his entire Award (on the dates set forth in Section 6) regardless of whether or not he is still employed by the Company or a Subsidiary; and further, provided, that, if the termination of Employment is because of a Participant's death prior to the full distribution of an Award, any Award due to the Participant shall be distributed (on the dates set forth in Section 6) to his Beneficiary. If there is no such surviving Beneficiary, Awards due with respect to the Participant shall be distributed to the Participant's estate. Notwithstanding anything else in the Plan to the contrary, any Option granted following a Participant's termination of Employment (which was prior to a date of grant) pursuant to this paragraph (a) shall not be exercisable for more than one year after the date of grant. (b) Following Distribution of an Award. (i) For Reasons Other Than Death. If any Participant's Employment should terminate for any reason other than his death, at a time when one or more of his Options remains outstanding, then each such Option shall terminate on the earlier to occur of the date provided in the Option or the date that is (A) two months after the date of such termination of Employment, if such 13 14 termination of Employment is for any reason other than the Participant's Permanent and Total Disability or (B) one year after the date of such termination of Employment, if such termination of Employment is on account of the Participant's Permanent and Total Disability. (ii) Participant's Death. If a Participant's Employment is terminated by reason of his death at a time when one or more of his Options remains outstanding, then each such Option shall be exercisable by the Participant's Beneficiary and shall terminate on the earlier of the date provided in the Option or one year after the date of his death. (iii) Notwithstanding the foregoing provisions of this Section 12(b), but subject to the provisions of Section 9(c), the Board, in its sole discretion, may extend the date upon which any Option may expire in the event of a Participant's termination of employment for any reason. 13. OPTION AGREEMENT. Upon the grant of an Option hereunder, the Participant shall be required to sign an Agreement, in such form as shall be prescribed by the Board, reflecting the terms and conditions of 14 15 the Option. Each such Option agreement shall refer to the Plan and shall give notice to the Participant that all the Options are subject to the terms and conditions of the Plan. 14. MISCELLANEOUS PROVISIONS. (a) The Plan shall be governed by, and construed in accordance with, Delaware law. (b) No Employee or other person shall have any claim or right to become a Participant in the Plan. Neither the Plan nor any action taken hereunder shall be construed as giving to any Employee any right to remain employed. (c) No Award under the Plan shall be assignable or transferable by the recipient thereof, except by will or by the laws of descent and distribution. (d) Payment of Cash Payments under the Plan are to be made in cash and shall be net of an amount sufficient to satisfy any Federal, state and/or local withholding or other employment tax requirements. (e) Any Cash Payment under Section 6 shall be rounded to the nearest whole dollar. The per share exercise price for any Option under subsection 6(b) shall be rounded to the nearest whole cent. The number of shares issuable under any Option under subsection 6(b) shall be rounded to the nearest whole share. (f) In the event that there is any change in the Stock of the Company through merger, consolidation, reorganization, recapitalization or otherwise, or if there shall be any dividend on the Stock payable in such Stock or if there shall be a stock split, combination of shares or other changes in the Company's 15 16 capital structure, the number of Share Units or Option shares allocated or available (or the types of shares which constitute Stock) under the Plan shall be proportionately adjusted by the Board to reflect any such change as it deems equitable, in its absolute discretion, to prevent dilution or enlargement of the Participant's rights under an Award. The issuance of Stock for consideration and the issuance of stock rights shall not be considered a change in the Company's capital structure. No adjustment provided for in this paragraph shall require the issuance of any fractional Share Units. (g) The Board shall have the right to terminate the Plan and to amend or suspend the Plan at any time; provided, however, that no such termination, amendment or suspension shall, without the consent of the respective Participants, operate to annul any Award that has been approved by the Board under the Plan; provided, further that the approval of the Company's stockholders will be required for any amendment that (i) changes the class of persons eligible for the grant of an Award, (ii) increases the maximum number of shares of Stock subject to Options under the Plan or (iii) materially increases the benefits accruing to Participants under the Plan, within the meaning of Rule 16b-3 under the Securities Exchange Act of 1934. (h) the singular shall include the plural and vice versa, and the use of one gender shall be deemed to include the other whenever appropriate. 16 17 EXECUTIVE RISK INC. NONEMPLOYEE DIRECTORS STOCK OPTION PLAN AS AMENDED THROUGH FEBRUARY 18, 1997 EX-10.12 5 EXHIBIT 10.12 1 Exhibit 10.12 EXECUTIVE RISK INC. NONEMPLOYEE DIRECTORS STOCK OPTION PLAN ARTICLE I PURPOSE 1.1 The Executive Risk Inc. Nonemployee Directors Stock Option Plan is intended to advance the interests of Executive Risk Inc. and its stockholders by attracting, retaining and motivating the performance of nonemployee directors of Executive Risk Inc., and to encourage and enable such directors to acquire and retain a proprietary interest in Executive Risk Inc. by ownership of its stock. ARTICLE II DEFINITIONS 2.1 "Board" means the Board of Directors of the Company. 2.2 "Code" means the Internal Revenue Code of 1986, as amended. 2.3 "Committee" means the Committee on Directors and Compensation of the Board. 2.4 "Common Stock" means the Company's Common Stock, par value $.01 per share. 2.5 "Company" means Executive Risk Inc. 2.6 "Date of Grant" means the date on which an Option is granted. 2.7 " Fair Market Value" means the closing price of the Common Stock on the New York Stock Exchange (or any other stock exchange on which the Common Stock is listed) on the date as of which Fair Market Value is to be determined or, in the absence of any reported sales of Common Stock on such date, on the first preceding date on which any such sale shall have been reported. If the Common Stock is not listed on any stock exchange on the date as of which Fair Market Value is to be determined, the Board shall determine in good faith the fair market value in whatever manner it considers appropriate. 2 2.8 "Fee Option" means a stock option granted in lieu of certain directors fees under Article V of the Plan. 2.9 "Fees" means the compensation earned by a Nonemployee Director for services rendered by him as a Nonemployee Director as an annual retainer fee or as fees for participating in meetings of the Board or of any standing or special committee of the Board. 2.10 "Outside Consultant" means a nationally recognized public accounting or consulting firm or similar entity that is independent of the Company and its affiliates which is appointed by the Board to perform certain calculations and make other determinations in accordance with the terms of the Plan. 2.11 "Nonemployee Director" means any current or former member of the Board who is not an officer or employee of the Company. 2.12 "Option" means a Fee Option or a Performance Option granted under the Plan. 2.13 "Option Price" means the price at which each share of Common Stock subject to an Option may be purchased. 2.14 "Optionee" means a person to whom an Option has been granted, which Option has not expired under the Plan. 2.15 "Performance Option" means a stock option granted under Article VI of the Plan based on the financial performance of the Company. 2.16 "Permanent and Total Disability" means the inability of an Optionee to perform his duties as a member of the Board 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. 2.17 "Plan" means this Executive Risk Inc. Nonemployee Directors Stock Option Plan. 2.18 "Return on Equity" means, with respect to any company for which Return on Equity is calculated, the income of the company (calculated in accordance with generally accepted accounting principles) for a fiscal year of such company, divided by the average equity of such company's shareholders for such fiscal year (as reported in such company's audited financial statements). 2 3 2.19 "Stock Option Agreement" means an agreement between the Company and an Optionee under which the Optionee may purchase Common Stock under the Plan. ARTICLE III ADMINISTRATION Subject to the express provisions of the Plan, the Committee shall have discretionary authority to interpret the Plan, to prescribe, amend and rescind rules and regulations relating to it, to determine the details and provisions of each Stock Option Agreement, and to make all determinations necessary or advisable in the administration of the Plan. All such actions and determinations by the Committee shall be conclusively binding for all purposes and upon all persons. Notwithstanding the foregoing or anything elsewhere in the Plan, the Committee shall have no discretionary authority with respect to the determination of the number of shares of Common Stock, the Option Price or the Date of Grant of any Option granted under the Plan. The Committee shall not be liable for any action or determination made in good faith with respect to the Plan, any Option or any Stock Option Agreement entered into hereunder. ARTICLE IV SHARES OF STOCK SUBJECT TO PLAN 4.1 Number of Shares. Subject to adjustment pursuant to the provisions of this Article IV, the maximum number of shares of Common Stock which may be issued and sold hereunder shall be 500,000 shares. Shares of Common Stock issued and sold under the Plan may be either authorized but unissued shares or shares held in the Company's treasury. Shares of Common Stock covered by an Option that shall have been exercised shall not again be available for an Option grant. If an Option shall terminate for any reason without being wholly exercised, the number of shares to which such Option termination relates shall again be available for grant hereunder. 4.2 Antidilution. In the event of a reorganization, recapitalization, stock split, stock dividend, combination of shares, merger or consolidation, or the sale, conveyance, lease or other transfer by the Company of all or substantially all of its property, or any other change in the corporate structure or shares of the Company, pursuant to any of which events the then outstanding shares of Common Stock are split up or combined, or are changed into, become exchangeable at the holder's election for, or entitle the 3 4 holder thereof to, other shares of stock, or in the case of any other transaction described in Section 424(a) of the Code, the Board may proportionately change the number and kind of shares (including by substitution of shares of another corporation) subject to the Options and/or the Option Price of such shares in the manner that it shall deem to be equitable and appropriate. ARTICLE V FEE OPTIONS 5.1 Grant of Fee Option. Subject to Section 8.4 hereof, as of each Date of Grant (determined under Section 5.2), each Nonemployee Director shall receive a grant of a Fee Option at an Option Price (determined under Section 5.3) to purchase a number of shares of Common Stock (determined under Section 5.4) in lieu of a portion of his Fees (determined under Section 5.5) which he earned during the calendar quarter ending immediately prior to such Date of Grant. 5.2 Fee Option Date of Grant. The Date of Grant of a Fee Option shall be the first business day of the calendar quarter immediately following the calendar quarter during which Fees are earned for a Nonemployee Director. 5.3 Fee Option Price. The Option Price of each share of Common Stock subject to a Fee Option shall be 30% of Fair Market Value on the applicable Date of Grant. 5.4 Number of Fee Option Shares. The number of shares of Common Stock subject to any Fee Option shall equal "A" divided by "B", rounded to the nearest whole share, where: "A" equals the dollar amount of the Nonemployee Director's Fees which were earned during the calendar quarter ending immediately prior to the Date of Grant, times the Conversion Percentage applicable to such Nonemployee Director (determined in accordance with Section 5.5 below); and "B" equals the excess of Fair Market Value of the Common Stock on the applicable Date of Grant over the Option Price with respect to a Fee Option (determined under Section 5.3). 5.5 Conversion Percentage. The Conversion Percentage applicable to a Nonemployee Director is the percentage of Fees earned by such Nonemployee Director, in lieu of which he shall receive Fee Options, determined in accordance with the following table based on such Nonemployee 4 5 Director's age at the beginning of the calendar year during which such Fees are earned.
Age at Beginning of Calendar Year Conversion Percentage --------------------------------- --------------------- under age 50 75 % age 50 but under age 60 50 % over age 60 25 %
ARTICLE VI PERFORMANCE OPTIONS 6.1 Grant of Performance Option. As of each Date of Grant (determined under Section 6.2), each Nonemployee Director who was a member of the Board during the last fiscal year of the Company ending prior to the Date of Grant shall receive a grant of a Performance Option at an Option Price (determined under Section 6.3) to purchase a number of shares of Common Stock (determined under Section 6.4). 6.2 Performance Option Date of Grant. The Date of Grant of each Performance Option for each year shall be the earlier of the date on which the annual meeting of the stockholders of the Company is held for such year or May 15 of such year. 6.3 Performance Option Price. The price of each share of Common Stock subject to a Performance Option shall be Fair Market Value on the Date of Grant. 6.4 Number of Performance Option Shares. The number of shares of Common Stock subject to any Performance Option shall equal (i) the Dollar Amount determined in accordance with the following table on the basis of the average Return on Equity of the Company for the three most recently ended fiscal years prior to the applicable Date of Grant, as compared with the average of the Returns on Equity for each of the respective members of the "Peer Group" (defined in Section 6.5 below) for the three most recently ended fiscal years of each such company, divided by (ii) the "Performance Option Value" (defined below) on the last business day before the applicable Date of Grant, rounded to the nearest whole share. 5 6
Company Percentile Within Peer Group Based on Return on Equity Dollar Amount ------------------------------------ ------------- 75th percentile or above $ 18,000 50th through 74th percentile $ 12,000 25th through 49th percentile $ 6,000 below 25th percentile $ 0
For purposes of this Section 6.4, "Performance Option Value" means the present value on the Date of Grant of a Performance Option to purchase a share of Common Stock, determined by an Outside Consultant in accordance with the generally accepted principles of the "Black-Scholes" option pricing model adopted for use in valuing employee stock options. Notwithstanding the foregoing, in the case of a Nonemployee Director who was not a member of the Board for the entire fiscal year preceding such Date of Grant, the number of shares of Common Stock subject to his or her Performance Option for such period shall be the product of (i) the number of such shares that would otherwise have been granted to such Nonemployee Director had he or she been a member of the Board for such entire period and (ii) a ratio, the numerator of which is the number of full months of his or her membership on the Board during such fiscal year and the denominator of which is twelve. 6.5 Peer Group. The Peer Group shall consist of a group of publicly traded reinsurance companies selected by the Outside Consultant (which selection shall be made prior to the granting of Performance Options under the Plan) as an appropriate comparison group for evaluating the Return on Equity of the Company, taking into account the following factors: stockholders equity, net income and net written premiums. In the event that any company in the Peer Group at any time ceases to be a publicly traded reinsurance company or otherwise fails to meet the Peer Group standard referred to above, such company shall be promptly deleted from the Peer Group. The Outside Consultant, in its discretion, may also delete any other company from the Peer Group, either permanently or with respect to a limited number of the Company's fiscal years, if, because of any change in the nature of such company's business or its structure or the occurrence of any merger, consolidation, reorganization, recapitalization, tender or exchange offer or other corporate transaction affecting such company, the Outside Consultant believes such company no longer is a suitable referent for evaluating the Return on Equity of the Company. In the event of any such deletion, the Outside Consultant may, in its discretion, replace any such deleted company with one or more additional publicly traded reinsurance companies that meet the foregoing Peer Group standard and that the Outside Consultant deems to be appropriate referents for such evaluation, but any 6 7 such replacement company shall only be included in the Peer Group with respect to fiscal years of the Company beginning after the date that such replacement company is so designated. ARTICLE VII VESTING AND TERMS OF OPTIONS 7.1 Vesting; Term of Option. Each Fee Option and Performance Option shall vest and become exercisable immediately on the Date of Grant of such Option. Notwithstanding the foregoing or anything elsewhere in the Plan to the contrary, an unexercised Option shall expire ten years from the Date of Grant. 7.2 Stock Option Agreement. The Company and the Optionee shall execute a Stock Option Agreement which shall set forth such terms and conditions of the Option as may be determined by the Committee to be consistent with the Plan, and which may include additional provisions and restrictions that are not inconsistent with the Plan. 7.3 Option Exercise. A vested Option may be exercised in whole or in part at any time, with respect to whole shares only, within the period permitted for the exercise thereof, and shall be exercised by written notice of intent to exercise the Option with respect to a specified number of shares delivered to the Company at its principal office, and payment in full to the Company at said office of the amount of the Option Price for the number of shares of the Common Stock with respect to which the Option is then being exercised. Payment of the Option Price shall be made in cash. 7.4 Transferability of Options. All Options shall be nontransferable except (i) upon the Optionee's death, by the Optionee's will or the laws of descent and distribution or (ii) on a case-by-case basis as may be approved by the Committee in its discretion, in accordance with the terms provided below. Each Stock Option Agreement shall provide that the Optionee may, during his lifetime and subject to the prior approval of the Committee at the time of proposed transfer, transfer all or part of the Option to a Permitted Transferee (as defined below), provided that such transfer is made by the Optionee for estate or tax planning purposes or for donative purposes and no consideration (other than nominal consideration) is received by the Optionee therefor. The transfer of an Option shall be subject to such other terms and conditions as the Committee may in its discretion impose from time to time, including a condition that the portion of the Option to be transferred be vested and exercisable by the Optionee at the time of transfer. Subsequent transfers of an Option transferred under this section 7.4. shall be prohibited 7 8 other than by will or the laws of descent and distribution upon the death of the transferee. For purposes hereof, a "Permitted Transferee" shall be any member of the Optionee's immediate family or a charitable institution (each as defined below), or a trust for the exclusive benefit of such immediate family members or charitable institution, or to a partnership, corporation or limited liability company the equity interests of which are owned exclusively by the Optionee and/or one or more members of his immediate family. For purposes of the preceding definition, (i) the "immediate family" of the Optionee shall mean and include the Optionee's spouse, any descendant of the Optionee or his spouse (including descendants by adoption), and any descendant of either parent of the Optionee (including descendants by adoption), and (ii) a "charitable institution" shall mean and include any organization described in each of sections 170(b)(1)(A), 170(c), 2055(a) and 2522(a) of the Code, as well as any charitable remainder trust created under section 664 of the Code, the income beneficiary of which is a member of the Optionee's immediate family or a trust or other entity described above in this Section 7.4. ARTICLE VIII TERMINATION OF SERVICE 8.1 Death. If an Optionee shall die at any time after the Date of Grant and while he is a member of the Board, the executor or administrator of the estate of the decedent, or the person or persons to whom an Option shall have been validly transferred in accordance with Section 7.4 hereof pursuant to will or the laws of descent and distribution, shall have the right, during the period ending three years after the date of the Optionee's death (subject to Section 7.1 hereof concerning the maximum term of an Option), to exercise the Optionee's Option to the extent that it shall not have been previously exercised. 8.2 Disability. If an Optionee's service as a member of the Board shall be terminated as a result of his Permanent and Total Disability at any time after the Date of Grant of an Option, the Optionee (or in the case of an Optionee who is legally incapacitated, his guardian or legal representative) shall have the right, during a period ending three years after the date of his termination as a member of the Board (subject to Section 7.1 hereof concerning the maximum term of an Option), to exercise such Option to the extent that it shall not have been previously exercised. 8.3 Other Termination of Service. If an Optionee's service as a member of the Board shall be terminated for any reason other than death, Permanent and Total Disability or 8 9 removal for cause, the Optionee shall have the right, during the period ending three years after such termination (subject to Section 7.1 hereof concerning the maximum term of an Option), to exercise such Option to the extent that it shall not have been previously exercised. 8.4 Termination of Plan Participation. Notwithstanding anything elsewhere in the Plan to the contrary, a Nonemployee Director's eligibility for grants of Fee Options under the Plan shall cease as of the date on which his services as a member of the Board terminate. The Fee for any Nonemployee Director whose Board membership terminates at any time after such Fee is earned by such Nonemployee Director, but before the Date of Grant relating to such Fee Option, shall be paid in cash. 8.5 Removal for Cause. If an Optionee shall be removed from the Board for cause, the Optionee's right to exercise any unexercised portion of his Option shall immediately terminate and all rights thereunder shall cease. An Optionee shall be considered to have been removed for "cause" for purposes of this Section 8.5 when he shall have been removed from the Board by the stockholders of the Company for cause in accordance with applicable state law and the Certificate of Incorporation and By-Laws of the Company. ARTICLE IX STOCK CERTIFICATES 9.1 Issuance of Certificates. Subject to Section 9.2 hereof, the Company shall issue a stock certificate in the name of the Optionee (or other person exercising the Option in accordance with the provisions of the Plan) for the shares of Common Stock purchased by exercise of an Option as soon as practicable after due exercise and payment of the aggregate Option Price for such shares. 9.2 Conditions. The Company shall not be required to issue or deliver any certificate for shares of Common Stock purchased upon the exercise of any Option granted hereunder or any portion thereof prior to fulfillment of all of the following conditions: (a) The completion of any registration or other qualification of such shares, under any federal or state law or under the rulings or regulations of the Securities and Exchange Commission or any other governmental regulatory body, that the Board shall in its sole discretion deem necessary or advisable; 9 10 (b) The obtaining of any approval or other clearance from any federal or state governmental agency that the Board shall in its sole discretion determine to be necessary or advisable; (c) The lapse of such reasonable period of time following the exercise of the Option as the Board from time to time may establish for reasons of administrative convenience; (d) Satisfaction by the Optionee of any applicable withholding taxes or other withholding liabilities; and (e) If required by the Board, in its sole discretion, the receipt by the Company from an Optionee of (i) a representation in writing that the shares of Common Stock received upon exercise of an Option are being acquired for investment and not with a view to distribution and (ii) such other representations and warranties as are deemed necessary by counsel to the Company. 9.3 Legends. The Company reserves the right to legend any certificate for shares of Common Stock, conditioning sales of such shares upon compliance with applicable federal and state securities laws and regulations. ARTICLE X TERMINATION AND AMENDMENT 10.1 Termination. The Plan shall terminate on March 22, 2004. The Board may, in its sole discretion and at any earlier date, terminate the Plan. Notwithstanding the foregoing, no termination of the Plan shall in any manner affect any Option theretofore granted without the consent of the Optionee or the permitted transferee of the Option. 10.2 Amendment. The Board may at any time and from time to time and in any respect, amend or modify the Plan; provided, however, that (i) the Board may not act more than once every six months to amend the provisions of the Plan relating to the determination of the number of shares of Common Stock, the Option Price or the Date of Grant of any Option under the Plan; and (ii) the approval of the Company's stockholders will be required for any amendment that (a) changes the class of persons eligible for the grant of Options; or (b) increases (other than as described in Section 4.2) the maximum number of shares of Common Stock subject to Options granted under the Plan, as specified in Section 4.1 hereof. Any such approval shall be by the affirmative votes of the stockholders of the Company present, or represented, and entitled to vote at a meeting duly held in accordance with applicable state law and the Certificate of Incorporation and 10 11 By-Laws of the Company. The Committee may at any time and from time to time amend or modify the Plan to the extent that any such amendment or modification is not of a nature described in the proviso contained in the first sentence hereof. Notwithstanding the foregoing, no amendment or modification of the Plan shall in any manner affect any Option theretofore granted without the consent of the Optionee or the permitted transferee of the Option. ARTICLE XI MISCELLANEOUS 11.1 Service on Board. Nothing in the Plan, in the grant of any Option or in any Stock Option Agreement shall confer upon any Nonemployee Director the right to continue service as a member of the Board. 11.2 Rights as Shareholder. An Optionee or the permitted transferee of an Option shall have no rights as a shareholder with respect to any shares subject to such Option prior to the purchase of such shares by exercise of such Option as provided herein. Nothing contained herein or in the Stock Option Agreement relating to any Option shall create an obligation on the part of the Company to repurchase any shares of Common Stock purchased hereunder. 11.3 Plan Binding on Successors. The Plan shall be binding upon the Company, its successors and assigns, and the Optionee, his executor, administrator and permitted transferees. 11.4 Construction and Interpretation. Whenever used herein, nouns in the singular shall include the plural, and the masculine pronoun shall include the feminine gender. Headings of Articles and Sections hereof are inserted for convenience and reference and constitute no part of the Plan. 11.5 Severability. If any provision of the Plan or any Stock Option Agreement shall be determined to be illegal or unenforceable by any court of law in any jurisdiction, the remaining provisions hereof and thereof shall be severable and enforceable in accordance with their terms, and all provisions shall remain enforceable in any other jurisdiction. 11.6 Governing Law. The validity and construction of this Plan and of the Stock Option Agreements shall be governed by the laws of the State of Delaware. 11 12 The Executive Risk Inc. Nonemployee Directors Stock Option Plan was duly adopted and approved by the Board of Directors of Executive Risk Inc. on the 30th day of December, 1993, and the two amendments and restatements thereof were duly adopted and approved by the Board of Directors of Executive Risk Inc. on the 1st day of August, 1995 and as of the 15th day of August 1996, respectively. -------------------------------------------------- Secretary of Executive Risk Inc. 12 EX-11 6 EXHIBIT 11 1 Exhibit 11 EXECUTIVE RISK INC. COMPUTATION OF EARNINGS PER SHARE (Unaudited)
Year Ended December 31, (In thousands, except per share data) 1996 1995 1994 PRIMARY Average shares outstanding 9,815 11,491 5,076 Warrants and options 694 465 163 Preferred stock conversion 4,869 ------- ------- -------- Total shares outstanding 10,509 11,956 10,108 Net income $28,105 $25,286 $ 19,240 Preferred dividends (1,031) ------- ------- -------- Earnings attributable to common stockholders $28,105 $25,286 $ 18,209 ------- ------- -------- Per share amount $ 2.67 $ 2.11 $ 1.80 ======= ======= ======== FULLY DILUTED Average shares outstanding 9,815 11,491 11,188 Warrants and options 727 487 177 ------- ------- -------- Total shares outstanding 10,542 11,978 11,365 Net income $28,105 $25,286 $ 19,240 ------- ------- -------- Earnings attributable to common stockholders $28,105 $25,286 $ 19,240 ------- ------- -------- Per share amount $ 2.67 $ 2.11 $ 1.69 ======= ======= ========
4 EX-13 7 EXHIBIT 13 1 Exhibit 13 Portions of Executive Risk Inc. 1996 Annual Report to Stockholders MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Consolidated Financial Statements of the Company and related notes thereto. GENERAL Management's discussion and analysis of financial condition and results of operations compares certain financial results for the year ended December 31, 1996 with the corresponding periods for 1995 and 1994. The results of Executive Risk Inc. (the "Company" or "ERI") include the consolidated results of Executive Risk Management Associates ("ERMA"), Executive Re Inc. ("Executive Re") and Executive Re's insurance subsidiaries, Executive Risk Indemnity Inc. ("ERII") and Executive Risk Specialty Insurance Company ("ERSIC"). The Company's results also include its 50% interest in UAP Executive Partners ("UPEX"), a French insurance underwriting agency which is a joint venture between the Company and Union des Assurances de Paris - Incendie-Accidents. This investment is reported using the equity method of accounting. In addition, the Company's 1996 and 1995 results include Executive Risk N.V. ("ERNV"), a Dutch insurance company incorporated in May 1995 in the Netherlands under the ownership of Executive Re. On March 22, 1996, ERI entered into a Stock Purchase Agreement (the "Agreement") with Aetna Life and Casualty Company ("AL&C") and AL&C's wholly-owned subsidiary, The Aetna Casualty and Surety Company ("Aetna"). Prior to the closing of the Agreement, Aetna owned 4,511,300 shares of the Company's capital stock, consisting of (i) 3,286,300 shares of Common Stock and (ii) all 1,225,000 shares of the Class B Common Stock. Through this investment and an option to purchase 100,000 shares of Common Stock at an exercise price of $12 per share, Aetna controlled approximately 40% of the Company's capital stock. Pursuant to the Agreement, on March 26, 1996, the Company purchased 1,286,300 shares of Common Stock and 1,225,000 shares of Class B Common Stock from Aetna at a per share price of $29.875, or approximately $75 million in the aggregate. In connection with the Agreement, the Company secured a $70 million senior credit facility (the "Senior Credit Facility") arranged through The Chase Manhattan Bank ("Chase"). See "Liquidity and Capital Resources." Upon the closing of the Agreement, 2,000,000 shares of Common Stock, representing approximately 22% of the Company's issued and outstanding Common Stock, remained under Aetna ownership. Subsequently, in connection with the acquisition of Aetna by The Travelers Insurance Group Inc., Aetna transferred ownership of the remaining Common Stock to AL&C. The Agreement also contained provisions requiring the Company to file a registration statement with respect to the remaining 2,000,000 shares of Common Stock under AL&C ownership and AL&C was obligated to sell all of these shares in an underwritten secondary offering. The secondary offering was completed on June 7, 1996. In conjunction with the secondary offering, the Company granted to the underwriters an option to purchase an additional 300,000 shares of Common Stock, at $34.00 per share less underwriting discounts and commissions of $1.75 per share, to cover over-allotments. This over-allotment option was exercised in full, and the Company received $9.7 million in proceeds which were used for general corporate purposes. The 300,000 shares of Common Stock for the over-allotment option were issued from shares held in treasury. On May 10, 1996, the Board of Directors approved a resolution to retire the 1,225,000 shares of Class B Common Stock in treasury acquired in the Aetna stock repurchase as described above. On February 5, 1997, in connection with a capital securities offering by a trust established by the Company, the Company repaid the $70 million outstanding under the term loan portion of the Senior Credit Facility. See "Liquidity and Capital Resources." The Company's financial position and results of operations are subject to fluctuations due to a variety of factors. Abnormally high severity or frequency of claims in any period could have a material adverse effect on the Company. Also, reevaluations of the Company's loss reserves could result in an increase or decrease in reserves and a corresponding adjustment to earnings. Additionally, the insurance industry is highly competitive. The Company competes with domestic and foreign insurers and reinsurers, some of which have greater financial, marketing and management resources than the Company, and it may compete with new market entrants in the future. Competition is based on many factors, including the perceived market strength of the insurer, pricing and other terms and 5 2 conditions, services provided, the speed of claims payment, the reputation and experience of the insurer, and ratings assigned by independent rating organizations (including A.M. Best Company, Inc. ("A.M. Best") and Standard & Poor's ("S&P")). ERII and ERSIC's current pooled rating from A.M. Best is "A". ERII and ERSIC's current pooled claims-paying ability rating from S&P is "A+". These ratings are based upon factors of concern to policyholders, including financial condition and solvency, and are not directed to the protection of investors. RESULTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1996 AND 1995 Gross premiums written increased by $121.5 million, or 58%, to $332.1 million in 1996 from $210.6 million in 1995. The increase was partially due to growth in sales in all of the Company's key lines of business, including domestic and international directors and officers ("D&O") liability insurance, and lawyers professional liability and miscellaneous professional liability errors and omissions ("E&O") insurance. Also contributing to the rise in gross premiums written was the Company's issuance of ERII and ERSIC D&O policies, rather than Aetna policies, to both new and renewing insureds. Converting an insured to ERII or ERSIC from Aetna resulted in the Company receiving 100% of the gross premiums written (and ceding 12.5% to Aetna) as compared to receiving 50% when reinsuring Aetna's risks. In 1996, $226.3 million of gross D&O premiums written were issued on ERII and ERSIC policies as compared to $99.0 million in 1995. As a portion of the increase in gross premiums written was attributable to conversions from Aetna to ERII and ERSIC, it is unlikely that the rate of growth achieved in 1996 can be sustained in 1997. Pursuant to a restructuring of the Company's relationship with Aetna entered into on February 13, 1997 (the "Restructuring"), effective January 1, 1997, the Company assumes 100% of the D&O written by ERMA on Aetna policies as compared to the 50% assumed prior to January 1, 1997. See Note 16 of Notes to Consolidated Financial Statements of the Company. As the underwriting and issuance of Aetna policies represents a shrinking percentage of the Company's gross premiums written, the Company does not believe that this change will have a material effect on 1997 gross premiums written. Ceded premiums increased $56.2 million, or 86%, to $121.7 million in 1996 from $65.5 million in 1995. The rise in ceded premiums was due principally to an increase in direct premium volume, a portion of which is ceded to reinsurers under the Company's various D&O and E&O treaties. Pursuant to the Restructuring, also effective January 1, 1997, Aetna is no longer a 12.5% quota share reinsurer of the Company's direct D&O business. Due to this change, in 1997 the Company will pay less in ceded premiums, and generally retain slightly more risk, than if it had continued the reinsurance arrangement with Aetna as in 1996. As a result of the foregoing, net premiums written increased $65.3 million, or 45%, to $210.4 million in 1996 from $145.1 million in 1995. Over the same periods, net premiums earned increased to $155.8 million from $116.4 million. Net investment income increased by $5.9 million, or 22%, to $32.6 million in 1996 from $26.7 million in 1995. This increase resulted principally from growth in the Company's investment portfolio, measured on an amortized cost basis, from $520.9 million at December 31, 1995 to $663.1 million at December 31, 1996, as well as a slight increase in nominal investment yields. The Company's equity investment balances were $45.9 million and $26.1 million at December 31, 1996 and 1995, respectively, and the cash and short-term investment balances were $24.7 million and $20.2 million, respectively, for the same periods. The Company manages its portfolio on a total return basis, and, as such, its investments in equity securities are made for their perceived superior return potential over the long term. Growth in invested assets resulted primarily from strong cash flows from insurance operations. The nominal portfolio yield of the fixed maturity portfolio at December 31, 1996 was 6.18%, as compared to 6.09% at December 31, 1995. The tax-equivalent yields on the fixed maturity portfolio were 8.00% and 8.25% for these periods, respectively. See "Liquidity and Capital Resources." The Company's net realized capital gains were $1.0 million in 1996, as compared to $1.6 million in 1995. In 1996, capital gains were realized from the sale of fixed maturities to provide available cash for the repurchase of Common Stock and Class B Common Stock from Aetna. In addition, capital gains were realized from equity mutual fund distributions and certain equity limited partnership investments. Partially offsetting the gains were net realized capital losses from fixed maturities sold at a loss and replaced with higher yielding securities. Loss and loss adjustment expenses ("LAE") increased $26.8 million, or 34%, to $105.3 million in 1996 from $78.5 million in 1995 due to higher premiums earned. The Company's loss ratio increased slightly to 67.6% in 1996 from 67.4% in 1995. In connection with the Company's normal reserving review, which includes a reevaluation of the adequacy of reserve levels for prior years' claims, the Company reduced its unpaid loss and LAE reserves in 1996 6 3 for prior report years by approximately $6.8 million. In 1995, the Company reduced its unpaid loss and LAE reserves for prior report years by approximately $5.2 million. These reductions produced corresponding increases in the Company's net income of approximately $4.4 million, or $0.42 per share, in 1996 and $3.4 million, or $0.28 per share, in 1995. There is no assurance that reserve adequacy reevaluations will produce similar reserve reductions and net income increases in the future. Policy acquisition costs increased $5.9 million, or 27%, to $27.8 million in 1996 from $21.9 million in 1995. The Company's ratio of policy acquisition costs to net premiums earned declined to 17.8% in 1996 from 18.8% in 1995. The decrease in the acquisition cost ratio was primarily due to savings achieved by paying less in override commissions to Aetna as a result of successfully converting insureds from Aetna policies to ERII and ERSIC policies. Under the Amended and Restated Agency and Insurance Services Agreement among Aetna, the Company and ERMA, ERMA paid Aetna an override commission equal to 3% of gross written premiums with respect to Aetna D&O policies issued by ERMA through June 30, 1996. Pursuant to this agreement, effective with respect to business written on or after July 1, 1996, ERMA was no longer required to pay an override commission to Aetna. General and administrative ("G&A") expenses increased $6.4 million, or 59%, to $17.1 million for the year ended December 31, 1996, as compared to $10.7 million for the year ended December 31, 1995. The increase in G&A costs was due largely to increased compensation, benefit and related overhead costs associated with new employees hired to support the growth in premium volume. The ratio of G&A costs to net premiums earned increased to 11.0% in 1996 from 9.3% in 1995. As a result of the changes in the aforementioned ratios, the Company's GAAP combined ratio increased to 96.4% in 1996 from 95.5% in 1995. A combined ratio below 100% indicates profitable underwriting prior to the consideration of investment income, capital gains and interest expense. A company with a combined ratio exceeding 100% can still be profitable due to such factors as investment income and realized capital gains. Long-term incentive compensation in 1996 and 1995 of $0.2 million and $1.5 million, respectively, consisted of non-cash charges to earnings for the value of the stock option element of the IPO Stock Compensation Plan (the "IPO Plan"). See Note 8 of Notes to Consolidated Financial Statements of the Company for a further discussion of the IPO Plan. Interest expense was incurred principally on the outstanding balances under the Company's bank credit agreement. Higher outstanding debt balances in 1996 resulted in an increase in interest expense to $4.5 million in 1996 as compared to $2.0 million in 1995. The outstanding balances were $25 million for 1995, $25 million from January 1, 1996 through March 26, 1996 and $70 million from March 26, 1996 to December 31, 1996. See "Liquidity and Capital Resources" and Note 6 of Notes to Consolidated Financial Statements of the Company. Income tax expense increased $1.7 million, or 37%, to $6.6 million for the year ended December 31, 1996, as compared to $4.9 million for the year ended December 31, 1995. The Company's effective tax rate increased to 19.1% in 1996 from 16.1% in 1995. The increase in the effective tax rate was due in part to growth in pre-tax income outpacing the increase in tax-exempt investment income and an increase in the Company's state tax liability. See Note 11 of Notes to Consolidated Financial Statements of the Company. As a result of the factors described above, net income increased $2.8 million, or 11%, to $28.1 million, or $2.67 per fully diluted share, in 1996 from $25.3 million, or $2.11 per fully diluted share, in 1995. The Company's operating earnings, calculated as net income before realized capital gains or losses, net of tax, increased $3.1 million, or 13%, to $27.4 million, or $2.60 per fully diluted share, in 1996 from $24.3 million, or $2.02 per fully diluted share, in 1995. YEARS ENDED DECEMBER 31, 1995 AND 1994 Gross premiums written increased by $80.4 million, or 62%, to $210.6 million in 1995 from $130.2 million in 1994. The increase was partially due to growth in sales in all of the Company's key lines of business. Also contributing to the rise in gross premiums written was the Company's issuance of ERII and ERSIC D&O policies, rather than Aetna policies, to both new and renewing insureds. In 1995, $99.0 million of gross D&O premiums written were issued on ERII and ERSIC policies as compared to $7.2 million in 1994. Ceded premiums increased $43.6 million, or 199%, to $65.5 million in 1995 from $21.9 million in 1994. The rise in ceded premiums was partly attributable to increased coverage purchased in 1995 under the Company's D&O reinsurance arrangement to 100% of losses incurred in excess of $2.5 million up to a limit of $10 million, subject to 7 4 aggregate limits and other restrictions. In 1994, the D&O reinsurance coverage purchased provided for 20% reinsurance protection on losses incurred in excess of $2.5 million up to a limit of $10 million, subject to aggregate limits and other restrictions. Also contributing to the rise in ceded premiums was the increase in quota share reinsurance under the Company's various other D&O and E&O treaties, resulting from an increase in direct premium volume. As a result of the foregoing, net premiums written increased $36.8 million, or 34%, to $145.1 million in 1995 from $108.3 million in 1994. Over the same periods, net premiums earned increased to $116.4 million from $95.0 million. Net investment income increased by $4.2 million, or 19%, to $26.7 million in 1995 from $22.5 million in 1994. This increase resulted principally from growth in the Company's investment portfolio, measured on an amortized cost basis, from $436.5 million at December 31, 1994 to $520.9 million at December 31, 1995, partially offset by a slight decline in investment yields. The Company's equity investment balances were $26.1 million and $24.3 million at December 31, 1995 and 1994, respectively, and the cash and short-term investment balances were $20.2 million and $24.6 million, respectively, for the same periods. The nominal portfolio yield of the fixed maturity portfolio at December 31, 1995 was 6.09%, as compared to 6.13% at December 31, 1994. The tax-equivalent yields on the fixed maturity portfolio were 8.25% and 8.56% for these periods, respectively. See "Liquidity and Capital Resources." The Company's net realized capital gains were $1.6 million in 1995, as compared to net realized capital losses of $0.5 million in 1994. During the second quarter of 1995, the Company realized a $2.8 million gain resulting from the acquisition by USF&G Corporation ("USF&G") of Discover Re Managers, Inc. ("Discover Re"), of which the Company was a stockholder. In connection with this transaction, a stock-for-stock swap of Discover Re stock for USF&G stock occurred as well as the receipt and simultaneous exercise by the Company of a warrant to purchase USF&G stock. In December 1995, the Company sold its entire position in USF&G stock. Partially offsetting the gain were net realized capital losses from fixed maturities sold in order to increase the portfolio's tax-equivalent yield. Loss and LAE increased $14.3 million, or 22%, to $78.5 million in 1995 from $64.2 million in 1994 due to higher premiums earned. The Company's loss ratio declined slightly to 67.4% in 1995 from 67.6% in 1994. In connection with the Company's normal reserving review, which includes a reevaluation of the adequacy of reserve levels for prior years' claims, the Company reduced its unpaid loss and LAE reserves in 1995 for prior report years by approximately $5.2 million. In 1994, the Company reduced its unpaid loss and LAE reserves for prior report years by approximately $4.1 million. These reductions produced corresponding increases in the Company's net income of approximately $3.4 million, or $0.28 per share, in 1995 and $2.7 million, or $0.24 per share, in 1994. Policy acquisition costs increased $3.2 million, or 17%, to $21.9 million in 1995 from $18.7 million in 1994. The Company's ratio of policy acquisition costs to net premiums earned declined to 18.8% in 1995 from 19.7% in 1994. The decrease in the acquisition cost ratio was primarily due to savings achieved by paying less in override commissions to Aetna as a result of successfully converting D&O insureds from Aetna to ERII and ERSIC policies. G&A expenses increased $1.8 million, or 21%, to $10.7 million for the year ended December 31, 1995, as compared to $8.9 million for the year ended December 31, 1994. The increase in G&A costs was due largely to increased compensation, benefit and related overhead costs associated with the growth in premium volume. The ratio of G&A costs to net premiums earned remained relatively stable at 9.3% in 1995 versus 9.4% in 1994. As a result of the declines in the aforementioned ratios, the Company's GAAP combined ratio decreased to 95.5% in 1995 from 96.7% in 1994. Long-term incentive compensation in 1995 and 1994 of $1.5 million and $1.0 million, respectively, consisted of non-cash charges to earnings for the value of the stock option element of the IPO Plan. Interest expense increased by $0.5 million, or 33%, to $2.0 million in 1995 as compared to $1.5 million in 1994, due primarily to higher interest rates and a higher average outstanding balance on the debt during 1995. Income tax expense increased $1.4 million, or 37%, to $4.9 million for the year ended December 31, 1995, as compared to $3.5 million for the year ended December 31, 1994. The Company's effective tax rate increased slightly to 16.1% in 1995 from 15.5% in 1994. The increase in the effective tax rate was due principally to growth in pre-tax income outpacing the increase in tax-exempt investment income. 8 5 As a result of the factors described above, net income increased $6.1 million, or 31%, to $25.3 million, or $2.11 per fully diluted share, in 1995 from $19.2 million, or $1.69 per fully diluted share, in 1994. The Company's operating earnings increased $4.8 million, or 24%, to $24.3 million, or $2.02 per fully diluted share, in 1995 from $19.5 million, or $1.72 per fully diluted share, in 1994. LIQUIDITY AND CAPITAL RESOURCES ERI is a holding company, the principal asset of which is equity in its subsidiaries. ERI's cash flows depend primarily on dividends and other payments from its subsidiaries. ERI's sources of funds consist primarily of premiums received by the insurance subsidiaries, revenues received by ERMA under insurance agency arrangements, investment income, and proceeds from the sales and redemptions of investments. Funds are utilized principally to pay claims and operating expenses, to purchase investments, and to pay interest and principal under the terms of the Company's indebtedness for borrowed money. Cash flows from operating activities were $169.5 million, $86.0 million and $78.7 million for 1996, 1995 and 1994, respectively. The increase in operating cash flows in 1996 resulted principally from the increase in net premiums received and the settlement of fewer losses than anticipated in 1996. The losses that were not settled in 1996 could be settled in 1997. Such rising loss payments are expected of a maturing professional liability underwriter. The primary components of the cash flow increase in 1995 over 1994 were increased net premiums received coupled with lower than anticipated loss payments. The Company believes that it has sufficient liquidity to meet its anticipated insurance obligations as well as its operating and capital expenditure needs. Consistent with the Company's emphasis on total return, the Company's investment strategy emphasizes quality, liquidity and diversification. With respect to liquidity, the Company considers liability durations, specifically loss reserves, when determining investment maturities. In addition, maturities have been staggered to produce a pre-planned pattern of cash flows for purposes of loss payments and reinvestment opportunities. Average investment duration of the fixed maturity portfolio at December 31, 1996, 1995 and 1994 was approximately 4.6, 4.6 and 4.1 years, respectively, as compared to an expected loss reserve duration of 5.0 to 5.5 years. The Company's short-term investment pool was $24.7 million (3.6% of the total investment portfolio) at December 31, 1996 and $20.2 million (3.7%) at December 31, 1995. Cash and publicly traded fixed income securities constituted 91% of the Company's total investment portfolio at December 31, 1996. The Company's entire investment portfolio is classified as available for sale under the provisions of Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities," and is reported at fair value, with the resulting unrealized gains or losses included as a separate component of stockholders' equity until realized. Due to the overall rise in interest rates, the market value of the portfolio at December 31, 1996 was 103% of amortized cost versus 105% of amortized cost at December 31, 1995. At December 31, 1996 and 1995, stockholders' equity was increased by $11.7 million and $15.4 million, respectively, to record the Company's fixed maturity investment portfolio at fair value. At December 31, 1996 and 1995, the Company owned no derivative instruments, except for certain mortgage and other asset backed securities and an interest rate protection agreement, discussed below, which was used to effectively convert a portion of its floating rate debt to a fixed rate basis, thus reducing the impact of interest rate changes on future income. Prior to the closing of the Agreement with AL&C, the Company maintained a credit agreement with Chase, Morgan Guaranty Trust Company of New York and The Fleet National Bank of Connecticut to borrow up to $50 million, of which $25 million was outstanding through March 26, 1996 (the "Closing Date"). In connection with the Agreement, the Company borrowed $70 million on the Closing Date under the terms of the Senior Credit Facility arranged through Chase. The proceeds of the loan were utilized as follows: $38 million to partially finance the repurchase of Common Stock and Class B Common Stock from Aetna, $25 million to refinance the Company's previously existing debt, and $7 million for general corporate purposes. In addition, the Company obtained through Chase a $25 million revolving credit facility. The Company has no plans to draw funds under the revolving credit facility. On February 5, 1997, in connection with a capital securities offering by a trust established by the Company as discussed below, the Company repaid the $70 million outstanding under the term loan portion of the Senior Credit Facility. Interest accrued on the principal balances outstanding under the term loan at a rate per annum equal to (a) the higher of (i) the federal funds rate plus a stipulated percentage and (ii) Chase's prime rate or (b) for London Interbank Offered Rate ("LIBOR") based loans, LIBOR plus a stipulated percentage over LIBOR based on the Company's debt-to-capital ratio and its then effective S&P claims-paying ability rating. 9 6 On May 31, 1996, as required under the term loan agreement in connection with the Senior Credit Facility, the Company entered into an interest rate protection agreement providing interest rate protection for an aggregate notional amount equal to 50% of the principal outstanding under the term loan. This interest rate protection agreement effectively converted a portion of the Company's floating rate debt to a fixed rate basis. Including the interest rate protection agreement, the all-in borrowing rate for the Company at December 31, 1996 was 7.09%. The fair value of the interest rate protection agreement was not recognized in the financial statements. On February 5, 1997, the Company formed Executive Risk Capital Trust (the "Trust"), a Delaware statutory business trust, the common securities of which are owned by the Company. The Trust sold 125,000 8.675% Series A Capital Securities ($1,000 per Capital Security) (the "Capital Securities") to certain institutional accredited investors pursuant to SEC Rule 144A and Regulation S. The Trust used the $125 million of proceeds received from the sale of the Capital Securities to purchase Junior Subordinated Debentures (the "Debentures") from the Company. The Company utilized the $123.5 million of net proceeds as follows: $70 million to repay the amount outstanding under the term loan portion of the Senior Credit Facility, $45 million to make a surplus contribution to ERII and $8.5 million for general corporate purposes. The interest rate protection agreement on the Senior Credit Facility was terminated in February 1997, concurrent with the repayment of the amounts outstanding under that facility. Holders of the Capital Securities will be entitled to receive cumulative cash distributions, accumulating from the date of original issuance and payable semi-annually in arrears on February 1 and August 1 of each year at an annual rate of 8.675%. Interest on the Debentures, and hence distributions on the Capital Securities, may be deferred to the extent set forth in the applicable instrument. The Capital Securities are subject to mandatory redemption on February 1, 2027, at a redemption price equal to the principal amount of, plus accrued but unpaid distributions on, the Debentures. The Capital Securities are also prepayable in certain other specified circumstances at a prepayment price which includes a make-whole premium and in certain other cases without a make-whole premium. Payments of distributions and other amounts due on the Capital Securities have been guaranteed by the Company to the extent set forth in the applicable guarantee instrument. In each of March, June, September and December of 1996, the Company paid dividends to common stockholders of record of $0.02 per share. Such common stock dividends totaled $0.8 million. ERII and ERSIC are subject to state regulatory restrictions which limit the amount of dividends payable by these companies. Subject to certain net income carryforward provisions, ERII must obtain approval of the Insurance Commissioner of the State of Delaware in order to pay, in any 12-month period, dividends which exceed the greater of 10% of surplus as regards policyholders as of the preceding December 31 and statutory net income less realized capital gains for the preceding calendar year. Dividends may be paid by ERII only out of earned surplus. ERSIC must obtain approval of the Insurance Commissioner of the State of Connecticut in order to pay, in any 12-month period, dividends which exceed the greater of 10% of surplus with respect to policyholders as of the preceding December 31 and statutory net income for the preceding calendar year. In addition, ERSIC may not pay any dividend or distribution in excess of the amount of its earned surplus, as reflected in its most recent statutory annual statement on file with the Connecticut Insurance Commissioner, without such Commissioner's approval. Both ERII and ERSIC are required to provide notice to the Insurance Commissioners of the States of Delaware and Connecticut, respectively, of all dividends to shareholders. Additionally, both Delaware and Connecticut law require that the statutory surplus of ERII or ERSIC, as applicable, following any dividend or distribution be reasonable in relation to its outstanding liabilities and adequate for its financial needs. OTHER Delaware and Connecticut, the respective states of domicile of ERII and ERSIC, impose minimum risk-based capital requirements on all insurance companies that were developed by the National Association of Insurance Commissioners ("NAIC"). The formulas for determining the amount of risk-based capital specify various weighting factors that are applied to financial balances or various levels of activity based on the perceived degree of risk. Regulatory compliance is determined by a ratio of the insurance company's regulatory total adjusted capital to its authorized control level risk-based capital, both as defined by the NAIC. At December 31, 1996, the total adjusted capital (as defined by the NAIC) of ERII and ERSIC was in excess of the risk-based capital regulatory action level. The application of the proceeds from the February 1997 Capital Securities offering caused the total adjusted capital of ERII and ERSIC to exceed the risk-based capital company action level, which is a higher standard. 10 7 Report of Independent Auditors To the Stockholders and Board of Directors Executive Risk Inc. We have audited the accompanying consolidated balance sheets of Executive Risk Inc. and its subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Executive Risk Inc. and its subsidiaries at 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. /s/ Ernst & Young LLP Stamford, Connecticut February 7, 1997 11 8 EXECUTIVE RISK INC. CONSOLIDATED BALANCE SHEETS
December 31, (In thousands, except share data) 1996 1995 ASSETS Fixed maturities available for sale, at fair value (amortized cost: 1996 - $602,589 and 1995 - $480,135) $ 620,392 $ 503,485 Equity securities available for sale, at fair value (cost: 1996 - $35,820 and 1995 - $20,474) 45,877 26,123 Cash and short-term investments, at cost which approximates market 24,706 20,244 Total Cash And Invested Assets 690,975 549,852 Premiums receivable 26,757 28,735 Reinsurance recoverables 77,724 33,781 Accrued investment income 10,126 9,409 Investment in UPEX 1,087 990 Deferred acquisition costs 22,696 16,244 Prepaid reinsurance premiums 66,088 32,303 Deferred income taxes 26,269 18,337 Other assets 19,525 16,269 Total Assets $ 941,247 $ 705,920 LIABILITIES Loss and loss adjustment expenses $ 457,063 $ 324,416 Unearned premiums 205,348 116,971 Note payable to bank 70,000 25,000 Ceded balances payable 26,402 18,083 Accrued expenses and other liabilities 37,659 43,725 Total Liabilities 796,472 528,195 STOCKHOLDERS' EQUITY Common Stock, $.01 par value; authorized - 52,500,000 shares; issued - 1996 - 10,439,628 shares and 1995 - 11,626,766 shares; outstanding - 1996 - 9,325,207 and 1995 - 11,497,816 104 116 Additional paid-in capital 93,651 87,228 Unrealized gains on investments, net of tax 18,382 19,156 Currency translation adjustments (186) 29 Retained earnings 65,384 74,315 Cost of shares in treasury, at cost: 1996 - 1,114,421 shares and 1995 - 128,950 shares (32,560) (3,119) Total Stockholders' Equity 144,775 177,725 Total Liabilities and Stockholders' Equity $ 941,247 $ 705,920
The accompanying notes are an integral part of the consolidated financial statements. 12 9 EXECUTIVE RISK INC. CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31, (In thousands, except per 1996 1995 1994 share data) REVENUES Gross premiums written $ 332,085 $ 210,640 $ 130,199 Premiums ceded (121,709) (65,519) (21,914) Net premiums written 210,376 145,121 108,285 Change in unearned premiums (54,592) (28,687) (13,324) Net Premiums Earned 155,784 116,434 94,961 Net investment income 32,646 26,706 22,497 Net realized capital gains (losses) 1,047 1,588 (455) Other income 166 83 82 Total Revenues 189,643 144,811 117,085 EXPENSES Loss and loss adjustment expenses 105,335 78,530 64,171 Policy acquisition costs 27,803 21,931 18,723 General and administrative expenses 17,068 10,730 8,890 Long-term incentive compensation 187 1,458 1,009 Interest expense 4,511 2,022 1,519 Total Expenses 154,904 114,671 94,312 Income Before Income Taxes 34,739 30,140 22,773 Income tax expense (benefit) Current 14,201 9,890 8,755 Deferred (7,567) (5,036) (5,222) 6,634 4,854 3,533 NET INCOME $ 28,105 $ 25,286 $ 19,240 Earnings per common and common equivalent share $ 2.67 $ 2.11 $ 1.80 Earnings per common share - assuming full dilution $ 2.67 $ 2.11 $ 1.69
The Company engages in transactions with related parties. See Notes 5 and 9. The accompanying notes are an integral part of the consolidated financial statements. 13 10 EXECUTIVE RISK INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
December 31, (In thousands) 1996 1995 1994 PREFERRED STOCK: Balance, beginning of year $ 0 $ 0 $ 6 Preferred stock conversion -- -- (6) Balance, end of year 0 0 0 COMMON STOCK: Balance, beginning of year 116 115 26 Options exercised -- 1 -- Preferred stock conversion -- -- 61 Common shares issued pursuant to the Transaction: Common Stock -- -- 12 Class B Common Stock -- -- 12 Common shares issued/warrants exercised pursuant to IPO, net of related expenses 10 Treasury shares retired (12) -- (2) Cashless exercise of warrants -- -- (4) Balance, end of year 104 116 115 ADDITIONAL PAID-IN CAPITAL: Balance, beginning of year 87,228 84,725 72,369 Options exercised 730 2,418 -- Directors' options fees granted 66 85 163 Secondary offering over-allotment option exercised 713 -- -- Secondary offering related expenses (192) -- -- Employee stock-based compensation plans 5,444 -- -- Common shares issued pursuant to the Transaction -- -- 706 Common shares issued/warrants exercised pursuant to IPO, net of related expenses -- -- 13,825 Class B Common Stock shares in treasury retired (338) -- (2,338) Balance, end of year 93,651 87,228 84,725 UNREALIZED GAINS (LOSSES): on Investments: Balance, beginning of year 19,156 (3,958) 12,399 Unrealized gains (losses) on investments (774) 23,114 (16,357) Balance, end of year 18,382 19,156 (3,958) CURRENCY TRANSLATION ADJUSTMENTS: Balance, beginning of year 29 24 (52) Currency translation adjustments (215) 5 76 Balance, end of year (186) 29 24 RETAINED EARNINGS: Balance, beginning of year 74,315 49,948 32,429 Net Income 28,105 25,286 19,240 Preferred Stock dividends -- -- (1,031) Common Stock dividends (789) (919) (690)
14 11 Treasury shares retired (36,247) -- -- Balance, end of year 65,384 74,315 49,948 COMMON STOCK IN TREASURY: Balance, beginning of year (3,119) 0 (2,340) Common Stock repurchase (38,428) -- -- Class B Common Stock repurchase (36,597) -- -- Secondary offering over-allotment option exercised 8,962 -- -- Treasury shares reissued 25 -- -- Treasury shares repurchased -- (3,119) -- Treasury shares retired 36,597 -- 2,340 Balance, end of year (32,560) (3,119) 0 TOTAL STOCKHOLDERS' EQUITY $ 144,775 $ 177,725 $ 130,854
The accompanying notes are an integral part of the consolidated financial statements. 15 12 EXECUTIVE RISK INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, (In thousands) 1996 1995 1994 OPERATING ACTIVITIES Net income $ 28,105 $ 25,286 $ 19,240 Adjustments to reconcile net income to net cash provided by operating activities: Amortization and depreciation 1,729 935 435 Share of income of UPEX (166) (83) (82) Deferred income taxes (7,567) (5,036) (5,222) Amortization of bond premium 1,019 1,541 2,027 Net realized (gains) losses on investments (1,047) (1,588) 455 Other (1,672) (2,477) (598) Change in: Premiums receivable, net of ceded balances payable 10,297 (289) (2,198) Accrued investment income (717) (1,544) (891) Deferred acquisition costs (6,452) (5,384) (1,020) Loss and loss adjustment expenses, net of reinsurance recoverables 88,704 44,841 36,696 Unearned premiums, net of prepaid reinsurance premiums 54,592 28,687 13,324 Accrued expenses and other liabilities 2,649 1,099 16,557 Net Cash Provided by Operating Activities 169,474 85,988 78,723 INVESTING ACTIVITIES Proceeds from sales of fixed maturities available for sale 179,510 76,721 74,527 Proceeds from sales of equity securities available for sale -- 12,880 2,732 Proceeds from maturities of investment securities 34,586 32,113 21,918 Purchase of investment securities (354,339) (204,159) (167,239) Net capital expenditures (2,881) (4,069) (7,411) Net assets acquired in acquisition of ERMA -- -- 1,716 Net Cash Used in Investing Activities (143,124) (86,514) (73,757) FINANCING ACTIVITIES Proceeds from exercise of options 423 241 -- Cost of repurchase of Common Stock (75,025) (3,119) -- Placement fees and other (192) Repayment of note payable to bank (25,000) -- (25,000) Note payable to bank 70,000 -- 25,000 Loan arrangement fees (980) -- -- Proceeds from over-allotment option exercise 9,675 -- -- Dividends paid on Common Stock (789) (919) (690) Dividends paid on Preferred Stock (1,031) Proceeds from issuance of Common Stock -- -- 11,160 Proceeds from conversion of warrants -- -- 4,200 Offering costs -- -- (912) Net Cash (Used in) Provided by Financing Activities (21,888) (3,797) 12,727 Net Increase (Decrease) in Cash and Short-Term Investments 4,462 (4,323) 17,693 Cash and short-term investments at beginning of period 20,244 24,567 6,874
16 13 Cash and Short-Term Investments at End of Period $ 24,706 $ 20,244 $ 24,567
The accompanying notes are an integral part of the consolidated financial statements. 17 14 FOOTNOTES NOTE 1 - ORGANIZATION AND PRINCIPLES OF CONSOLIDATION Executive Risk Inc. (the "Company" or "ERI") was formed under the laws of the State of Delaware. As of December 31, 1996, the Company owns all of the outstanding stock of Executive Re Inc. ("Executive Re"), and Executive Re owns all of the outstanding stock of Executive Risk Indemnity Inc. ("ERII") and Executive Risk N.V. ("ERNV"). ERII owns all of the outstanding stock of Executive Risk Specialty Insurance Company ("ERSIC"). In addition, the Company and Executive Re own 100% of Executive Risk Management Associates ("ERMA"), a Connecticut general partnership. ERII, a Delaware corporation, commenced insurance operations under the ownership of Executive Re in 1986. ERSIC, a Connecticut corporation, commenced insurance operations in 1992. ERNV, a Dutch insurance company, was incorporated in May 1995 in the Netherlands to participate in professional liability insurance opportunities. The Company develops, markets and underwrites specialty line insurance products. The Company's primary business is directors and officers liability insurance ("D&O"). The Company markets its D&O products in three principal sectors: Commercial Entities, Financial Institutions and Not-for-Profit Institutions. The Company also offers professional liability insurance, known as errors and omissions insurance ("E&O"), to a variety of professions, principal among which are large law firms, insurance agents, psychologists, mortgage brokers and real estate and title professionals. Through ERII and ERSIC, the Company writes, on a direct basis, D&O and E&O throughout the United States, and reinsures D&O and certain ancillary lines of insurance written by The Aetna Casualty and Surety Company ("Aetna") (Note 5), a stockholder of the Company until March 1996 (Note 3). The Company's products are distributed through licensed independent property and casualty brokers, excess and surplus lines brokers and licensed wholesalers. The following summarizes gross premiums written by the Company's key lines of business:
Year Ended December 31, (In thousands) 1996 1995 1994 D&O $254,965 $170,247 $107,082 E&O 77,120 40,393 23,117 Total $332,085 $210,640 $130,199
The 1996 and 1995 consolidated financial statements include the Company, Executive Re, ERII, ERSIC, ERMA and ERNV. All references made herein to the Company include ERI and all of its subsidiaries unless otherwise noted. The 1994 consolidated financial statements include the Company, Executive Re, ERII, ERSIC and ERMA. All significant intercompany amounts are eliminated in consolidation. Certain prior year amounts have been reclassified to conform with the 1996 presentation. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation: The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles ("GAAP"), some of which require the use of management's estimates. Actual results could differ from those estimates. Accounting Standards: In December 1996, the Company implemented the supplemental pro forma provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). SFAS 123, if adopted, requires companies to recognize compensation expense for grants of stock, stock options and other equity instruments to employees and 18 15 directors based on their respective fair values at the date of grant. However, the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") may still be utilized with supplemental pro forma disclosures of net income and earnings per share being made in the footnotes as if the provisions of SFAS 123 had been applied. SFAS 123 is effective for fiscal years beginning after December 15, 1995. The Company continues to apply the requirements of APB 25 in the accompanying financial statements with supplemental pro forma disclosures provided in the notes to the consolidated financial statements (Note 8). Investments: In accordance with the provisions of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the Company has classified its entire portfolio of fixed maturities and equity securities as available for sale and reports such investments at fair value. Fair values are determined by quoted market prices when available or, in the case of private placements, are estimated by discounting expected future cash flows using a market rate on fixed maturities with similar terms and credit worthiness. The Company's classification of its portfolio as available for sale provides the Company with the flexibility to adjust its portfolio as needed in response to changes in operating, tax and regulatory conditions. Short-term investments are carried at cost which approximates market. The amortized cost of fixed maturities is adjusted for amortization of premiums and accretion of discounts to maturity which are included in investment income. Unrealized gains and losses resulting from changes in fair values of fixed maturities and equity securities are reflected in stockholders' equity, net of applicable deferred income taxes. Realized capital gains and losses are reported in revenues and are determined based on the specific identification of the investments sold. Investment in UPEX: The Company's 50% interest in UAP Executive Partners ("UPEX"), a French underwriting agency which is a joint venture between the Company and Union des Assurances de Paris - Incendie-Accidents ("UAP"), is reported using the equity method of accounting. Financial results are reported to the Company in French francs. The Company's share of income and losses has been calculated using the average exchange rate in effect during the period. Resulting translation gains and losses are reported as a separate component of stockholders' equity. Consolidation of ERMA Results: As the majority of ERMA's activities relate to the marketing and underwriting of insurance policies, a substantial portion of the revenues ERMA received from Aetna for underwriting and management services during the years 1994 through 1996 offset the Company's policy acquisition costs. The remaining portion of the revenues received from Aetna related to the general and administrative ("G&A") costs of running the business, and were therefore offset against the Company's G&A expenses (Note 16). Premium Income and Unearned Premiums: Gross premiums written are recognized as premiums earned principally on a pro rata basis over the in-force period of the policies. Ceded reinsurance premiums are charged against premiums earned on the same basis. Unearned premiums and prepaid reinsurance premiums represent the portions of premiums written and ceded applicable to the unexpired terms of the related policies. Deferred Acquisition Costs: Deferred acquisition costs, including commissions net of allowances on ceded reinsurance, and the portion of ERMA's revenues relating to the acquisition of premiums, are deferred and amortized on a pro rata basis over the period that the related premiums are earned. Loss and Loss Adjustment Expense Reserves: As 19 16 substantially all of the Company's business is written on a claims-made form of coverage, the reserves for loss and loss adjustment expenses represent the estimated liability on outstanding claims, based on an evaluation of reported claims. Although considerable variability is inherent in such estimates, management believes that the recorded reserves for loss and loss adjustment expenses are adequate in the aggregate to cover the ultimate resolution of reported claims. These estimates are continually reviewed and any required adjustments are reflected in current operations. Reinsurance Recoverables: In the normal course of business, the Company seeks to manage its exposure to potential losses arising from risks it assumes or writes by reinsuring certain levels of risk with various reinsurers (Note 5). Amounts recoverable from reinsurers are estimated in a manner consistent with the loss and loss adjustment expense reserves associated with the outstanding claims. Income Taxes: The provision for federal and state income taxes excludes the effect of permanent differences between income before taxes and taxable income. Deferred income taxes are provided for the tax effects of temporary differences between amounts reported for financial reporting and for income tax purposes. Statements of Cash Flows: In the accompanying statements of cash flows, the Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Cash and cash equivalents are classified as cash and short-term investments in the accompanying balance sheets. Earnings Per Share: Earnings per common and common equivalent share are based on the weighted average common and common equivalent shares outstanding during the period. Common equivalents consist of options and warrants to purchase common stock, and their impact on earnings per share is measured by application of the "treasury stock" method. Earnings per common and common equivalent share represent earnings attributable to common stockholders (net income less preferred stock dividends) divided by common and common equivalent shares. Fully diluted earnings per share include the effect of all dilutive securities, which include common equivalent shares, by application of the "if-converted" method. The number of shares used for computing primary and fully diluted earnings per share were as follows:
(In thousands) 1996 1995 1994 Primary 10,509 11,956 10,108 Fully diluted 10,542 11,978 11,365
NOTE 3 - TRANSACTION, STOCK REPURCHASE AND OFFERINGS On November 5, 1993, Executive Re, Aetna and ERI entered into an Exchange Agreement (the "Exchange Agreement") providing for Aetna to assign its 70% interest in ERMA to ERI in exchange for (a) 1,225,000 shares of Common Stock, (b) 1,225,000 shares of Class B Common Stock and (c) an option (the "Aetna Stock Option"), which is an option to purchase 100,000 shares of Common Stock at $12 per share, the price at which shares were offered to the public in an underwritten initial public offering (the "Offering"). The Exchange Agreement provided for a restructuring (the "1994 Restructuring") in which Executive Re merged with a subsidiary of ERI, with the former stockholders of Executive Re (including Aetna) receiving 10 shares of Common Stock and 1 share of Class A Preferred Stock of ERI in exchange for each share of common stock and preferred stock, respectively, of Executive 20 17 Re. As a result of the 1994 Restructuring, Executive Re became a subsidiary of ERI. The Exchange and the 1994 Restructuring, referred to herein collectively as the "Transaction," occurred on January 1, 1994. The Transaction was accounted for at ERMA's historical basis. In March 1994, ERI sold three million shares of its Common Stock in the Offering at a price of $12 per share. The Company received net proceeds of approximately $9.7 million from the sale of shares by the Company, after deducting underwriting commissions and expenses of approximately $2.3 million, and $4.2 million from the exercise of warrants in connection with the Offering. The Company contributed $12.0 million of these proceeds to ERII to support future growth and increase underwriting capacity. On March 22, 1996, the Company entered into a Stock Purchase Agreement (the "Agreement") with Aetna Life and Casualty Company ("AL&C") and AL&C's wholly-owned subsidiary, Aetna. Prior to the closing of the Agreement, Aetna owned 4,511,300 shares of the Company's capital stock, consisting of (i) 3,286,300 shares of Common Stock and (ii) all 1,225,000 shares of the Class B Common Stock. Through this investment and the Aetna Stock Option, Aetna controlled approximately 40% of the Company's capital stock. Pursuant to the Agreement, on March 26, 1996, the Company purchased 1,286,300 shares of Common Stock and 1,225,000 shares of Class B Common Stock from Aetna at a per share price of $29.875, or approximately $75 million in the aggregate. In connection with the Agreement, the Company secured a $70 million senior credit facility (the "Senior Credit Facility") arranged through The Chase Manhattan Bank ("Chase") (Note 6). Upon the closing of the Agreement, 2,000,000 shares of Common Stock, representing approximately 22% of the Company's issued and outstanding Common Stock, remained under Aetna ownership. Subsequently, in connection with the acquisition of Aetna by The Travelers Insurance Group Inc., Aetna transferred ownership of the remaining Common Stock to AL&C. The Agreement also contained provisions requiring the Company to file a registration statement with respect to the remaining 2,000,000 shares of Common Stock under AL&C ownership and AL&C was obligated to sell all of these shares in an underwritten secondary offering (the "Secondary Offering"). The Secondary Offering was completed on June 7, 1996. In conjunction with the Secondary Offering, the Company granted to the underwriters an option to purchase an additional 300,000 shares of Common Stock, at $34.00 per share less underwriting discounts and commissions of $1.75 per share, to cover over-allotments. This over-allotment option was exercised in full, and the Company received $9.7 million in proceeds. The proceeds were used for general corporate purposes. NOTE 4 - PRO FORMA FINANCIAL DATA The following table presents consolidated pro forma income statement data for the years ended December 31, 1996 and 1995, as adjusted to give pro forma effect to the stock repurchase of 2,511,300 shares of the Company's capital stock at $29.875 per share and the exercise of the 300,000 share over-allotment option in the Secondary Offering, at $32.25 per share, as if they had occurred on January 1, 1996 and 1995, respectively.
Year Ended December 31, (In thousands, except per share data) 1996 1995 Total revenues $189,483 $143,639 Net income 27,482 22,187 Weighted average shares outstanding - assuming full dilution 9,936 9,767
21 18 Earnings per common share - assuming full dilution $ 2.77 $ 2.27
NOTE 5 - UNDERWRITING AND REINSURANCE ERMA and Aetna entered into an insurance services agreement under which ERMA was appointed Aetna's underwriting manager. Under this agreement, ERMA received a commission, net of reimbursement to Aetna for its payment of substantially all general and administrative costs incurred by ERMA, of 3% of gross premiums written reported by ERMA to Aetna. This agreement was amended and restated effective January 1, 1994, pursuant to the Transaction. This agreement was again amended effective January 1, 1995, changing commission rates charged by ERMA to Aetna. Under this amended and restated insurance services agreement among the Company, ERMA and Aetna, ERMA was appointed as Aetna's underwriting manager and received a commission in 1996 and 1995 of 24% (23% in 1994) of the portion of premiums written reported by ERMA to Aetna. The Company paid a commission to ERMA equal to ERMA's costs of producing business for the Company. Additionally, ERMA paid an override to Aetna of 3% of gross premiums written with respect to Aetna D&O policies issued through ERMA. As the Company met certain financial tests, the 3% override was discontinued on July 1, 1996. The business underwritten by ERMA on behalf of Aetna generally was reinsured 50% by ERII through December 31, 1996. ERII paid a ceding commission of 3% of premiums reinsured for premium taxes plus ERII's share of certain costs of ERMA related to this business. ERII entered into several quota share reinsurance treaties with Aetna. Under the largest reinsurance treaty, ERII assumed 50% of the risk associated with the first $20 million of coverage provided by each D&O policy issued by Aetna. Under the other reinsurance treaties, ERII assumed a portion of the risk associated with up to $10 million of coverage provided by various D&O and ancillary line coverages issued by Aetna. During 1996, 1995 and 1994, gross premiums written assumed by ERII under the various agreements with Aetna were approximately $13.8 million, $60.5 million and $97.7 million, respectively. On February 13, 1997, the Company and Aetna entered into a series of agreements whereby the Company released Aetna from its contractual obligation to issue D&O exclusively through ERMA until December 31, 1999. As part of these agreements, effective January 1, 1997, the Company assumes 100% of the D&O written by ERMA on Aetna policies issued through ERMA (Note 16). UPEX underwrites, on behalf of UAP, policies providing D&O coverage up to a maximum policy limit of $25 million, subject to certain foreign currency adjustments, of which the Company generally assumed a 50% participation in 1996 and 1995 and a 15% participation in 1994. The Company, through ERII and ERSIC, cedes reinsurance to manage its exposure to potential losses arising from risks it assumes or writes. The largest reinsurance programs include the following: ERII and ERSIC entered into quota share reinsurance treaties with Aetna, similar to those discussed above, pursuant to which Aetna generally assumed 12.5% in 1996 and 1995 and 50% in 1994 of the risk associated with D&O policies issued by ERII and ERSIC. Gross premiums written ceded by ERII and ERSIC under the various agreements with Aetna were approximately $28.2 million, $13.4 million and $3.9 million in 1996, 1995 and 1994, respectively. In connection with the Company releasing Aetna from its contractual obligation to issue D&O exclusively through ERMA, effective January 1, 1997, Aetna is no longer a 12.5% quota share reinsurer of D&O policies issued by ERII and ERSIC (Note 16). ERII and ERSIC have entered into an excess of loss reinsurance arrangement 22 19 principally with Underwriters at Lloyd's ("Lloyd's"). The Company's D&O reinsurance provides for 100% reinsurance protection (20% in 1994) on losses incurred in excess of $2.5 million up to a limit of $10 million, subject to aggregate limits and other restrictions. For 1996 and 1995, ERII and ERSIC also have entered into a D&O quota share reinsurance treaty, with various reinsurers, generally covering 90% of losses in excess of $10 million up to a limit of $25 million, subject to certain limitations. For the Company's D&O coverages assumed from UAP in 1996 and 1995, ERII has entered into a quota share reinsurance treaty, with various reinsurers, which generally provides for 70% reinsurance protection on losses incurred, subject to certain restrictions. Effective January 1, 1996 and subject to certain limitations, the Company's Lawyers Professional Liability product is reinsured, through a number of domestic and international markets, in a combination quota share and excess of loss reinsurance program whereby the Company retains more of the risk insured on lower limit policies and cedes more of the risk insured on higher limit policies. This program limits the Company's exposure to slightly under $5 million on a policy with a maximum limit of $50 million. For the Company's other E&O and ancillary D&O coverages, ERII and ERSIC have entered into quota share reinsurance treaties, with various reinsurers, which generally provide for between 75% and 90% reinsurance protection on losses incurred, subject to certain restrictions. Entering into reinsurance arrangements does not discharge the Company's obligation to pay policy claims on the reinsured business. The ceding insurer remains responsible for policy claims without regard to the extent the reinsurer pays such claims. The components of the Company's premiums written and earned were as follows:
Year Ended December 31, (In thousands) 1996 1995 1994 Premiums Written Direct $ 305,265 $ 134,312 $ 25,735 Assumed 26,820 76,328 104,464 Ceded (121,709) (65,519) (21,914) Net Premiums Written $ 210,376 $ 145,121 $ 108,285 Premiums Earned Direct $ 195,201 $ 71,071 $ 12,529 Assumed 48,463 91,604 93,486 Ceded (87,880) (46,241) (11,054) Net Premiums Earned $ 155,784 $ 116,434 $ 94,961
Ceded loss and loss adjustment expenses amounted to $48.3 million, $25.1 million and $2.9 million in 1996, 1995 and 1994, respectively. A portion of the Company's ceded reinsurance is placed with Lloyd's syndicates. To date, the Company has not experienced any reinsurance recoverable defaults. Further, Lloyd's syndicates have established trust funds securing their obligations to U.S. cedants. NOTE 6 - CREDIT AGREEMENT On November 9, 1994, the Company entered into a credit facility agreement with Chase, Morgan Guaranty Trust Company of New York and The Fleet National Bank of Connecticut (formerly Shawmut Bank Connecticut, N.A.) (the "Banks"). Proceeds of the loan were used to repay $20 million outstanding under a previously existing facility, and the balance was used for general corporate purposes. At December 31, 1994, the interest rate on the loan was 6.83%. 23 20 During December 1995, the Company renegotiated certain terms of the above agreement, and a new agreement was signed on December 20, 1995 (the "Closing Date"). The facility was structured in two parts as follows: The term loan of $25 million remained fully drawn on the Closing Date. An additional $25 million of borrowings was available to the Company under a revolving credit facility. This facility terminated 364 days from the Closing Date but was renewable, subject to the approval of the Banks, at the Company's option, for four additional 364-day periods. A fee was assessed on the unborrowed portion of the revolving credit facility. During the second quarter of 1995, the Company entered into an interest rate swap agreement to modify the interest characteristics of the $25 million outstanding debt from a floating to a semi-fixed interest rate basis. Under the terms of the swap transaction, the borrowing rate for the Company was 6.92% at December 31, 1995. The fair value of the swap agreement was not recognized in the financial statements. The swap was effective from May 15, 1995 through March 26, 1996. On March 26, 1996, in connection with the repurchase of Common Stock from Aetna, the Company borrowed $70 million under the terms of the Senior Credit Facility arranged through Chase. The proceeds of the loan were utilized as follows: $38 million to partially finance the repurchase of Common Stock and Class B Common Stock from Aetna (Note 3), $25 million to refinance the Company's previously existing debt, and $7 million for general corporate purposes. In addition, the Company has obtained through Chase a $25 million revolving credit facility. The Company has no current plans to draw funds under the revolving credit facility. On May 31, 1996, as required under the term loan agreement in connection with the Senior Credit Facility, the Company entered into an interest rate protection agreement providing interest rate protection for an aggregate notional amount equal to 50% of the principal outstanding under the term loan. This interest rate protection agreement effectively converted a portion of the Company's floating rate debt to a fixed rate basis. Including the interest rate protection agreement, the all-in borrowing rate for the Company was 7.09% at December 31, 1996. The fair value of the interest rate protection agreement was not recognized in the financial statements. In connection with the Senior Credit Facility, the Company pledged the stock of its direct subsidiary, Executive Re, and Executive Re pledged the stock of its direct subsidiary, ERII. The terms of the credit agreements required, among other things, that the Company maintain certain defined minimum consolidated net worth and combined statutory surplus levels, and certain debt leverage, premiums-to-surplus and fixed charge ratios, and placed restrictions on the payment of dividends, the incurrence of additional debt, the sale of assets, the making of acquisitions and the incurrence of liens. Interest paid on debt totaled $3.9 million, $1.8 million and $1.3 million in 1996, 1995 and 1994, respectively. The carrying value of the loan approximates its fair value. On February 5, 1997, in connection with a capital securities offering by a trust established by the Company, the Company repaid the $70 million outstanding under the term loan portion of the Senior Credit Facility and terminated the associated interest rate protection agreement on the term loan (Note 16). NOTE 7 - INVESTMENT INFORMATION Fixed Maturities: The amortized cost and fair value of investments in fixed maturities as of December 31, 1996 and 1995 were as follows: 24 21
Gross Gross Amortized Unrealized Unrealized Fair (In thousands) Cost Gains Losses Value 1996 United States Government or agency securities $ 24,621 $ 178 ($ 65) $ 24,734 Obligations of states and political subdivisions 424,012 15,403 (134) 439,281 Corporate securities 91,528 1,463 (136) 92,855 Mortgage and other asset backed securities 60,911 1,168 (124) 61,955 Foreign governments 1,517 50 -- 1,567 $ 602,589 $ 18,262 ($ 459) $ 620,392 1995 United States Government or agency securities $ 20,955 $ 477 ($ 1) $ 21,431 Obligations of states and political subdivisions 390,161 19,463 (4) 409,620 Corporate securities 50,360 2,276 -- 52,636 Mortgage and other asset backed securities 17,015 1,083 -- 18,098 Foreign governments 1,644 56 -- 1,700 $ 480,135 $ 23,355 ($ 5) $ 503,485
Realized capital gains and losses on sales of fixed maturities were as follows:
Year Ended December 31, (In thousands) 1996 1995 1994 Gross realized capital gains $ 1,913 $ 175 $ 544 Gross realized capital losses (2,071) (1,649) (1,092)
The amortized cost and fair value of investments in fixed maturities at December 31, 1996 are shown below by effective maturity dates except that for mortgage and other asset backed securities, maturities are calculated using expected maturity dates, which are based on historic cash flow patterns. Effective maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Amortized Fair (In thousands) Cost Value Due in one year or less $ 39,828 $ 40,326 Due after one year through five years 186,136 190,586 Due after five years through ten years 355,725 368,075 Due after ten years 20,900 21,405 $602,589 $620,392
Changes in unrealized gains and losses were as follows:
Year Ended December 31, (In thousands) 1996 1995 1994 Fixed maturities ($ 5,547) $ 27,369 ($22,790) Equity securities 4,408 6,320 (685)
Investment Income: The components of net investment income were as follows:
Year Ended December 31, (In thousands) 1996 1995 1994 Fixed maturities Taxable $ 8,672 $ 5,052 $ 4,916 Tax-exempt 22,400 20,242 16,701 Dividends 637 868 409 Short-term investments 1,714 1,132 1,019
25 22 33,423 27,294 23,045 Investment expenses 777 588 548 Net investment income $32,646 $26,706 $22,497
NOTE 8 - STOCKHOLDERS' EQUITY Preferred Stock: The Company has 4,000,000 preferred shares authorized at December 31, 1996 and 1995, with no shares issued or outstanding. Treasury Shares: On November 3, 1995, the Board of Directors approved a one-year stock repurchase program to repurchase shares of the Company's Common Stock up to a maximum of $6.0 million (200,000 shares), at prevailing prices in open market or negotiated transactions. Under this program, in 1995 the Company purchased 128,950 shares at an average price of $24.185 per share. These repurchased shares are held in treasury at December 31, 1996, generally for use in connection with employee stock option exercises and other employee benefit plans. Pursuant to the Aetna stock repurchase (Note 3), all 1,225,000 shares of Class B Common Stock and 1,286,300 shares of Common Stock were repurchased at a per share price of $29.875 and held in treasury during the first quarter of 1996. In connection with the Secondary Offering, the 300,000 shares of Common Stock for the over-allotment option (at a net per share price of $32.25) were issued from shares held in treasury. On May 10, 1996, the Board of Directors approved a resolution to retire all 1,225,000 shares of Class B Common Stock held in treasury. Common Stock Purchase Warrants: There were 1,000,000 Common Stock Purchase Warrants outstanding prior to the 30,000 warrants previously owned by ERMA being retired in connection with the Transaction discussed in Note 3. In connection with the Offering, all of the remaining Warrants were exercised. The exercise price in respect of Warrants to purchase 550,000 shares of Common Stock was paid by the delivery to the Company of 458,336 shares of Common Stock, valued for its purpose at a per share price equal to the per share price to the public of Common Stock sold in the Offering (i.e., $12). The remaining Warrants were exercised by the payment to the Company of cash, resulting in proceeds to the Company of $4.2 million during 1994. There were no warrants outstanding at December 31, 1996 and 1995. Stock Option Plans: The Company applies APB 25 and related interpretations in accounting for its stock-based compensation plans. Under APB 25, compensation expense for stock option and award plans is recognized as the difference between the fair value of the stock at the date of grant less the amount, if any, the employee or director is required to pay. The Company has a Nonqualified Stock Option Plan and an Employee Incentive Nonqualified Stock Option Plan whereby key employees may be granted options to purchase shares of the Company's Common Stock at a price not less than the fair market value of such shares (as determined by the Committee on Directors and Compensation of the Company's Board of Directors) at the date on which the options are granted. In November 1990, the Company adopted the IPO Stock Compensation Plan (the "IPO Plan") under which Share Units were granted to certain key employees. On the date of the closing of the Offering, the Share Units were converted into the right to receive 161,905 stock options to purchase Common Stock at an exercise price equal to 30% of the average closing price of the Common Stock for the 30-day period immediately preceding that date. Options representing one-half of the total award were granted on March 22, 1995 to those specified employees employed by the Company on that date. The other half were granted on March 22, 1996 to those specified employees still employed by the Company on that date. Information with respect to the employee stock options was as follows: 26 23
1996 1995 Weighted Weighted Average Average Number of Exercise Number of Exercise Shares Price Shares Price Outstanding at beginning of year 1,292,304 $12.77 1,329,350 $13.33 Granted 219,202 20.54 101,104 7.42 Exercised (31,137) 12.53 (131,312) 14.29 Forfeited (15,075) 17.95 (6,838) 13.44 Outstanding at end of year 1,465,294 $13.89 1,292,304 12.77 Options exercisable at end of year 1,066,418 $12.26 768,042 12.20 Shares reserved under option plans 2,847,551 -- 2,878,688 -- Weighted average fair value of options granted during the year $18.92 -- $12.52 --
In connection with the majority of options exercised in 1995, promissory notes were issued in favor of the Company. In 1994, the Company had 3,010,000 shares reserved under the employee stock option plans, with 583,050 shares exercisable at December 31, 1994. 1,340,550 options were outstanding at January 1, 1994 and 11,200 options were forfeited during the year. 1,329,350 options were outstanding at December 31, 1994, at a weighted average exercise price of $13.33. The following table summarizes information about the Company's employee stock options outstanding at December 31, 1996.
Options Outstanding Options Exercisable Average Remaining Range of Number of Average Contractual Number of Average Exercise Prices Options Price Life (Years) Options Price $ 4.88 - $10.00 229,044 $ 7.80 6.3 229,044 $ 7.80 $12.00 - $20.00 1,102,500 13.52 5.8 837,374 13.49 $26.00 - $34.00 133,750 27.36 9.3 -- -- $ 4.88 - $34.00 1,465,294 $13.89 6.2 1,066,418 $12.26
The Company has adopted a Nonemployee Directors Option Plan (the "Directors Plan") to provide its nonemployee directors with stock-based incentive compensation. The Directors Plan is intended to relate director compensation to the financial performance of the Company and the market value of the Common Stock. Information with respect to the Directors Plan options was as follows:
1996 1995 Weighted Weighted Average Average Number of Exercise Number of Exercise Shares Price Shares Price Outstanding at beginning of year 83,026 $ 10.89 59,798 $ 9.48 Granted 11,242 24.25 24,148 14.43 Exercised (6,725) 4.89 (920) 12.00 Forfeited (5,258) 15.22 -- -- Outstanding at end of year 82,285 $ 12.93 83,026 $ 10.89 Options exercisable at end of year 72,176 $ 11.12 58,878 $ 9.44 Shares reserved under option plans 492,355 -- 499,080 -- Weighted average fair value of options granted during the year $ 18.92 -- $ 10.02 --
27 24 In 1994, the Company had 500,000 shares reserved under the Directors Plan, with 42,020 shares exercisable at December 31, 1994. 59,798 options were granted and outstanding at December 31, 1994, at a weighted average exercise price of $9.48. The following table summarizes information about the Directors Plan stock options outstanding at December 31, 1996.
Options Outstanding Options Exercisable Average Remaining Range of Number of Average Contractual Number of Average Exercise Prices Options Price Life (Years) Options Price $ 3.32 - $11.51 20,058 $ 4.78 7.8 17,726 $ 4.16 $12.00 40,100 12.00 7.3 40,100 12.00 $17.25 - $30.75 22,127 21.99 8.7 14,350 17.25 $ 3.32 - $30.75 82,285 $ 12.93 7.8 72,176 $ 11.12
In connection with the aforementioned employee and director stock option plans, the Company accrued compensation expense, under APB 25, for the years ended December 31, 1996, 1995 and 1994, of approximately $0.7 million, $1.5 million and $1.2 million, respectively. Stock Incentive and Performance Share Plans: In November 1995, the Board of Directors approved two long-term stock-based incentive compensation plans, the Stock Incentive Plan (the "SIP") and the Performance Share Plan (the "PSP"), together referred to herein as the "1995 Plans." The SIP became effective as of January 1, 1996 and the PSP as of January 1, 1995. The Company has reserved 250,000 shares of Common Stock for issuance under the SIP and 1,000,000 shares of Common Stock for issuance under the PSP, subject to the restrictions set forth in each of the respective Plans, and to the approval of the Committee on Directors and Compensation of the Board of Directors. Under the SIP, employees are eligible to be granted stock "units," bearing a relationship to their respective cash bonuses under the Company's Incentive Compensation Plan, which convert into shares of Common Stock upon completion of the applicable vesting period (generally three years). Virtually all employees are eligible to receive awards under the SIP with respect to any fiscal year, other than those employees receiving awards under the PSP with respect to that year. Under the PSP, certain key employees designated by the Committee on Directors and Compensation are eligible to receive awards of "performance share units" which convert into Common Stock and/or cash, as determined by the Committee on Directors and Compensation, upon completion of the performance period to which such awards relate. The amount of Common Stock and/or cash, if any, to be received by participants in the PSP is dependent upon, among other things, the financial performance of the Company during the relevant performance period. The first performance period under the PSP is the three year period beginning on January 1, 1995 and ending on December 31, 1997. 8,525 share units were granted in 1996 under the SIP, of which 500 share units were subsequently forfeited. 83,050 performance share units were granted under the PSP in 1996, of which 2,850 performance share units were subsequently forfeited. The weighted average fair value of the share units and performance share units granted during 1996 was $30.48 per share unit. The Company accrued compensation expense, under APB 25, for the years ended December 31, 1996 and 1995 of approximately $1.8 million and $0.6 million, respectively, in connection with the SIP and PSP. Supplemental and Pro Forma Disclosures: The following pro forma information regarding net income and earnings per share, required by SFAS 123, have been determined as if the Company had accounted for its stock-based compensation plans under the fair value methods described in that statement. The fair value of options and other awards granted under the Company's stock-based compensation plans were estimated at the date of 28 25 grant using a Black-Scholes option pricing model. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option pricing models require the input of highly subjective assumptions including the expected dividend yield, the expected life of the options, the expected price volatility and the risk-free interest rate. The weighted average dividend yield for stock option grants during 1996 and 1995 was .26% and .47%, respectively. The weighted average expected life for 1996 and 1995 was 8.8 years and 9.3 years, respectively. The weighted average volatility for 1996 and 1995 was .27% and .28%, respectively. The weighted average risk-free interest rate for 1996 and 1995 was 6.36% and 7.10%, respectively. For purposes of pro forma disclosures, the estimated fair value of the options and stock awards is amortized to expense over the options' and awards' vesting period and does not include grants prior to January 1, 1995. As such, the pro forma net income and earnings per share are not indicative of future years. The Company's pro forma information was as follows: (In thousands, except per share data)
1996 1995 Net income As reported $ 28,105 $ 25,286 Pro forma 27,040 25,665 Primary earnings per share As reported $ 2.67 $ 2.11 Pro forma 2.60 2.20 Fully diluted earnings per share As reported $ 2.67 $ 2.11 Pro forma 2.58 2.17
Rights Plan: The Company has adopted a Shareholder Rights Plan (the "Rights Plan"). When exercisable, each Right entitles the registered holder to purchase from ERI one share of Common Stock at a price of $60.32 per share, subject to adjustment. The Rights Plan has certain anti-takeover effects. The Rights will cause substantial dilution to a person or group that attempts to acquire the Company on terms not approved by the Board of Directors. Retained Earnings: ERII and ERSIC are subject to state regulatory restrictions which limit the maximum amount of dividends payable. Subject to certain net income carryforward provisions as described below, ERII must obtain approval of the Insurance Commissioner of the State of Delaware in order to pay, in any 12-month period, "extraordinary" dividends which are defined as those in excess of the greater of 10% of surplus as regards policyholders as of the prior year-end and statutory net income less realized capital gains for such prior year. Dividends may be paid by ERII only out of earned surplus. In addition, ERII must provide notice to the Insurance Commissioner of the State of Delaware of all dividends and other distributions to shareholders within five business days after declaration and at least ten days prior to payment. Further, ERII may not pay an "extraordinary" dividend until thirty days after the Delaware Commissioner has received notice of such dividend and has either (i) not disapproved such dividend within such 30-day period or (ii) approved such dividend within such 30-day period. ERSIC must obtain approval of the Insurance Commissioner of the State of Connecticut in order to pay, in any 12-month period, "extraordinary" dividends which are defined as those in excess of the greater of 10% of surplus as regards policyholders as of the prior year-end and statutory net income for such prior year. The Connecticut law further provides that (i) ERSIC must report to the Connecticut Commissioner, for informational purposes, all dividends and other distributions within fifteen business days after the declaration thereof and (ii) ERSIC may not pay any dividend or 29 26 distribution in excess of its earned surplus, as reflected in its most recent statutory annual statement on file with the Connecticut Commissioner, without such Commissioner's approval. Under applicable insurance law, the retained exposure of ERII or ERSIC on any one risk cannot exceed 10% of its statutory capital and surplus. NOTE 9 - RELATED PARTIES The investments of the Company have been managed by Conning & Company), a stockholder of the Company. The related agreement associated with this service stipulates annual fees based on the aggregate invested assets of the Company. The management contract with Conning & Company expires in June 1997. The aggregate payments by the Company under this agreement were approximately $0.6 million in 1996 and $0.5 million in each of 1995 and 1994. Note 10 - Retirement Plans The Company maintains a defined contribution retirement plan (the "Plan") covering substantially all employees. Under the Plan, the Company contributes 4% of total compensation up to the social security wage base. Thereafter, the Company contributes 8% of the total compensation that exceeds this wage base. In addition, employees may contribute up to 10% of total compensation to the Plan. This employee contribution is matched by the Company according to several factors, including the Company's average return on equity for the three preceding years and whether the employee is an officer of the Company and/or its subsidiaries. The Company also maintains the Benefit Equalization Plan (the "BEP"), a supplemental, nonqualified defined contribution plan. The BEP covers certain officers of the Company for the portion of retirement contributions, as determined by the provisions of the Plan, which exceed IRS limitations on contributions and eligible compensation. Amounts contributed by the Company to these retirement plans were $1.7 million, $1.3 million and $1.1 million in 1996, 1995 and 1994, respectively. These amounts include contributions in respect of service in prior years with the Company. The Company has entered into a Supplemental Pension Agreement (the "SPA") with its Chief Executive Officer ("CEO") and AL&C which replaced the 1988 retirement arrangement among the parties, under which the Company had previously accrued an unfunded, non-tax qualified defined benefit. Under the SPA and the CEO's Employment Agreement, (i) the CEO participates in the Plan and the BEP, to the same extent as other Company employees and (ii) the Company has an obligation to make premium payments on a life insurance policy in the initial amount of $1 million owned by an irrevocable trust established by the CEO, a so-called "split-dollar" arrangement. On January 21, 1997, the Company announced that its CEO (and Chairman) will retire as an officer and director on May 30, 1997. The current Vice Chairman and Chief Operating Officer has been elected by the Board of Directors to become Chairman effective May 30, 1997. The current President and Chief Underwriting Officer of the Company will succeed the CEO, retaining his title as President. The Company's obligation to make additional contributions to the Plan and the BEP on behalf of the retiring CEO will end with his retirement. The Company's obligation to make premium payments on the life insurance policy as described above will continue. Note 11 - Income Taxes Income tax expense (benefit) is comprised of the following: 30 27
Year Ended December 31, (In thousands) 1996 1995 1994 Paid or payable on currently taxable income: Federal $ 13,240 $ 9,875 $ 8,435 State 961 15 320 Net decrease due to deferred income taxes (7,567) (5,036) (5,222) Income tax expense $ 6,634 $ 4,854 $ 3,533
The provision for income taxes varies from the amount which would be computed using the federal statutory income tax rate as follows:
Year Ended December 31, (In thousands) 1996 1995 1994 Pre-tax income $ 34,739 $ 30,140 $ 22,773 Application of the federal statutory tax rate - 35% $ 12,159 $ 10,549 $ 7,970 Tax effect of: Tax-exempt interest (6,676) (6,059) (4,973) State income taxes 625 10 208 Dividends received and other 526 354 328 Total income tax provision $ 6,634 $ 4,854 $ 3,533
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial statement reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities are summarized as follows:
December 31, (In thousands) 1996 1995 1994 Deferred tax assets: Loss reserve discounting $ 30,871 $ 24,178 $ 21,134 Unearned premiums 9,462 5,750 3,807 Unrealized losses on investments -- -- 1,595 Other 4,518 4,544 2,166 Total deferred tax assets 44,851 34,472 28,702 Valuation allowance -- -- (854) Deferred tax liabilities: Deferred acquisition costs 7,707 5,510 3,692 Unrealized gains on investments 9,475 9,842 -- Other 1,400 783 273 Total deferred tax liabilities 18,582 16,135 3,965 Net deferred tax assets $ 26,269 $ 18,337 $ 23,883
Income taxes paid were $12.4 million, $10.6 million and $7.3 million in 1996, 1995 and 1994, respectively. NOTE 12 - UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES The following table sets forth the activity in unpaid loss and loss adjustment expenses ("LAE"), net of reserves for reinsured loss and LAE, for the years indicated. 31 28
Year Ended December 31, (In thousands) 1996 1995 1994 Reserves for losses and LAE at beginning of period, gross $ 324,416 $ 254,758 $ 215,151 Reinsurance recoverable at beginning of period (33,531) (8,958) (6,053) Reserves for losses and LAE at beginning of period, net 290,885 245,800 209,098 Provision for losses and LAE for current year claims 112,107 83,775 68,304 Decrease in estimated ultimate losses and LAE for prior year claims (6,772) (5,245) (4,133) Total incurred losses and LAE 105,335 78,530 64,171 Adjustment for foreign exchange loss on unpaid loss and LAE (23) 58 27 Loss and LAE payments for claims attributable to: Current year 2,239 792 587 Prior years 13,811 32,711 26,909 Total payments 16,050 33,503 27,496 Reserves for losses and LAE at end of period, net 380,147 290,885 245,800 Reinsurance recoverable at end of period 76,916 33,531 8,958 Reserves for losses and LAE at end of period, gross $ 457,063 $ 324,416 $ 254,758
NOTE 13 - PRESCRIBED OR PERMITTED STATUTORY PRACTICES ERII and ERSIC, which are domiciled in Delaware and Connecticut, respectively, prepare their statutory financial statements in accordance with accounting principles and practices prescribed or permitted by their respective state insurance departments. Prescribed statutory accounting practices include state laws, regulations and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners ("NAIC"). Permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices differ from state to state, may differ from company to company within a state and may change in the future. Furthermore, the NAIC has a project to codify statutory accounting practices, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. Accordingly, that project will likely change the definitions of what comprises prescribed versus permitted statutory accounting practices and may result in changes to the accounting policies that insurance companies use to prepare their statutory financial statements. ERII and ERSIC follow prescribed accounting practices in preparing their statutory financial statements, in all material respects. NOTE 14 - RECONCILIATION - GENERALLY ACCEPTED ACCOUNTING PRINCIPLES BASIS TO STATUTORY BASIS The following table reconciles consolidated net income and stockholders' equity as reported herein on the basis of GAAP with ERII's consolidated statutory basis income and consolidated statutory basis capital and surplus. ERII's consolidated results include those of its wholly owned subsidiary, ERSIC. 32 29
Year Ended December 31, (In thousands) 1996 1995 1994 Consolidated GAAP income $ 28,105 $ 25,286 $ 19,240 Eliminate parent company loss 5,037 2,183 867 ERII consolidated GAAP income 33,142 27,469 20,107 Add (subtract) GAAP adjustments: Deferred acquisition costs (11,754) (3,221) (4,275) Deferred income tax benefits (6,213) (4,348) (3,182) Other 13 24 17 ERII consolidated statutory income $ 15,188 $ 19,924 $ 12,667 Consolidated GAAP stockholders' equity $ 144,775 $ 177,725 $ 130,854 Eliminate parent company deficit 64,843 663 9,973 ERII consolidated GAAP stockholders' equity 209,618 178,388 140,827 Add (subtract) GAAP adjustments: Deferred acquisition costs (29,090) (17,336) (14,115) Deferred income tax benefits (22,207) (16,109) (21,843) Adjust invested assets to statutory value (17,753) (21,824) 3,883 Other (2,163) (1,654) (1,351) ERII consolidated statutory capital and surplus $ 138,405 $ 121,465 $ 107,401
NOTE 15 - CONSOLIDATED QUARTERLY DATA (UNAUDITED)
First Second Third Fourth (In thousands, except per share data) Quarter Quarter Quarter Quarter Year 1996 Net premiums earned $ 33,913 $ 36,425 $ 41,066 $ 44,380 $155,784 Net investment income 7,375 7,450 8,389 9,432 32,646 Income before income taxes 8,763 6,722 8,103 11,151 34,739 Federal and state income tax expense 1,538 1,162 1,359 2,575 6,634 Net Income 7,225 5,560 6,744 8,576 28,105 Earnings per common share - assuming full dilution(1) 0.60 0.56 0.67 0.85 2.67 Common Stock price range (2) - High 33 38 1/4 38 1/2 42 42 - Low 26 1/4 29 1/4 33 3/8 34 1/8 26 1/4 1995 Net premiums earned $ 25,287 $ 28,012 $ 30,549 $ 32,586 $116,434 Net investment income 6,284 6,406 6,761 7,255 26,706 Income before income taxes 6,041 8,774 7,490 7,835 30,140 Federal and state income tax expense 743 1,705 1,298 1,108 4,854 Net Income 5,298 7,069 6,192 6,727 25,286 Earnings per common share - assuming full dilution 0.45 0.59 0.51 0.56 2.11 Common Stock price range (2) - High 17 1/8 19 23 7/8 29 29 - Low 13 5/8 16 5/8 18 1/2 22 13 5/8
(1) The sum of the 1996 quarters' earnings per share does not equal the full year's per share amount. (2) The stock price range is based on closing prices reported by Bloomberg L.P. The Company paid quarterly dividends of $0.02 per share in 1996 and 1995. The Company currently intends to continue paying regular cash dividends on a quarterly basis. See Notes 6 and 8 for information on potential restrictions on the payment of future dividends. As of February 26, 1997, the approximate number of common shareholders of 33 30 record was 94. NOTE 16 - SUBSEQUENT EVENT On February 5, 1997, the Company formed Executive Risk Capital Trust (the "Trust"), a Delaware statutory business trust, the common securities of which are owned by the Company. The Trust sold 125,000 8.675% Series A Capital Securities ($1,000 per Capital Security) (the "Capital Securities") to certain institutional accredited investors pursuant to SEC Rule 144A and Regulation S. The Trust used the $125 million of proceeds received from the sale of the Capital Securities to purchase Junior Subordinated Debentures (the "Debentures") from the Company. The Company utilized the $123.5 million of net proceeds as follows: $70 million to repay the amount outstanding under the term loan portion of the Senior Credit Facility, $45 million to make a surplus contribution to ERII and $8.5 million for general corporate purposes. Holders of the Capital Securities will be entitled to receive cumulative cash distributions, accumulating from the date of original issuance and payable semi-annually in arrears on February 1 and August 1 of each year at an annual rate of 8.675%. Interest on the Debentures, and hence distributions on the Capital Securities, may be deferred to the extent set forth in the applicable instrument. The Capital Securities are subject to mandatory redemption on February 1, 2027, at a redemption price equal to the principal amount of, plus accrued but unpaid distributions on, the Debentures. The Capital Securities are also prepayable in certain other specified circumstances at a prepayment price which includes a make-whole premium and in certain other cases without a make-whole premium. Payments of distributions and other amounts due on the Capital Securities have been guaranteed by the Company to the extent set forth in the applicable guarantee instrument. On February 13, 1997, the Company and Aetna entered into a series of agreements whereby the Company released Aetna from its contractual obligation to issue D&O exclusively through ERMA until December 31, 1999, and Aetna may therefore begin to compete with the Company on D&O sooner than it otherwise could have. In exchange, Aetna has agreed that, effective January 1, 1997, Aetna is no longer a 12.5% quota share reinsurer of the Company's direct D&O business. Additionally, effective January 1, 1997, the Company assumes 100% of the D&O written by ERMA on Aetna policies as compared to 50% in 1996 and prior years. Due to these changes, in 1997 the Company will pay less in ceded premiums, and generally retain slightly more risk, than if it had continued the prior reinsurance arrangements with Aetna. 34 EX-23 8 EXHIBIT 23 1 Exhibit 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report (Form 10-K) of Executive Risk Inc. of our report dated February 7, 1997, included in the 1996 Annual Report to Stockholders of Executive Risk Inc. Our audits also included the financial statement schedule of Executive Risk Inc. listed in Item 14. This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP Stamford, Connecticut February 7, 1997 35 EX-27 9 EX-27
7 This schedule contains summary financial information extracted from the Company's 1996 10-K and is qualified in its entirety by reference to such financial statements. 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 620,392 0 0 45,877 0 0 666,269 24,706 808 22,696 941,247 457,063 205,348 0 0 70,000 0 0 104 144,671 941,247 155,784 32,646 1,047 166 105,335 27,803 21,766 34,739 6,634 28,105 0 0 0 28,105 2.67 2.67 324,416 112,107 (6,772) (2,239) (13,811) 457,063 0
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